Everyone knows that inventory costs money. Inventory is subject to obsolescence. It ties up cash, takes up space, hides defects, deteriorates with time, gets damaged, must be counted, and moved, etc.
But that doesn’t explain how inventory reduction can be used to drive improvement.
The Japanese have an expression. “Inventory is a narcotic” It makes you feel good, while it hides your problems..
How does inventory “hide” problems?
While it may not be intuitively obvious, using inventory to hide problems is commonplace. Manufacturers, wholesalers, distributors, and retailers all regularly use inventory to cover for a poor performing supply chain as well as for inefficient, or ineffective internal operations.
This phenomenon is best explained by way of example:
Let’s say that I have a retail establishment, and one of my suppliers is unreliable (has a history of poor on-time delivery performance). I will very likely carry additional safety stock (inventory) to avoid a possible stock-out, just in case he delivers late.
If I have a manufacturing concern, and one of my pieces of equipment has a long changeover time, the odds are, I will produce in large batches to minimize the number of changeovers required. Large batches result in carrying inventory (If I produce a month’s worth of product at a time, it will take a month to use it all up).
Suppose I run a distribution center and one of my key suppliers is overseas. I may choose to buy this item in large quantities in order to reduce the per-unit shipping cost.
There are many more examples, but let’s dig into these few a little deeper.
In the retail example, we carried additional stock, inventory, to “hide” a supplier reliability issue.
Our manufacturer carried additional inventory to “hide” a changeover (set-up) cost problem.
The distributor was forced to carry extra inventory to “hide” a shipping/transportation problem.
The insidious effect is that once the inventory is put in place, the underlying problem is no longer urgent. Extra inventory allows us to “live with” the problem, never fixing the real underlying issue.
Time-management studies clearly indicate that the typical manager spends most of his / her time addressing “urgent” issues, while truly important items get postponed, i.e. “Urgent” generally gets priority over “Important”.
Is it important to have reliable suppliers? Is cost control important? Is it important to be quick? Agile? Responsive? Of course it is. But as long as we have a comfortable level of inventory, it isn’t urgent.
What’s the point?
Urgent Items get priority, and, Inventory reduction makes IMPORTANT issues URGENT.
The classical way to illustrate this relationship is known as the rocks and the water. (below).
In this analogy, we’re in our corporate boat, sailing merrily across a pond. Underneath the water lies a myriad of rocks: big rocks, little rocks, some near the surface, some way down near the bottom.
The water represents the inventory we carry inside our company. The rocks represent the problems we face, every day, in running our operation.
As we reduce the water (inventory), rocks (problems) begin to surface. Each problem requires a decision: Can we remove the rock, or should we put some inventory back into the system?
Removing the rocks reduces costs, simplifies operations, improves flow, etc.
And note that the inventory reduction process prioritizes our improvement efforts. Any exposed rock gets a high priority for improvement efforts.
There is another powerful benefit that comes from the inventory reduction process. It forces the enterprise to “optimize” the total value stream, and not, necessarily, each individual process.
In addition to forcing continuous improvement, inventory reduction generates tax-free cash. This will generally provide some or all of the funding required to resolve the more difficult problems.
The process requires a sizable dose of “common sense”. Needless to say, if you’re risking “drilling a hole below the water line”, you’d want to fix the problems first, then reduce the inventory. And, in some cases, the solution to the “rock” is too costly, or will require an extensive period of time to implement.
In these cases, management may make a business decision to hold inventory, and live with the problem, for the time being. In most cases, however, minimal analysis is required. Drop the inventory and see what, if any, issues arise. Then fix them.
The good news is that in most companies, the initial inventory level is considerably above the serious rocks. Significant amounts of cash can generally be attained relatively painlessly as inventory is dropped 10-30%. It is after this “euphoria stage” that the real process improvements, driven by further inventory reductions, will begin to take place.
What are some typical improvement initiatives that inventory is likely to highlight?
Supplier lead times, quality, and reliability (on-time delivery) are almost always exposed as significant opportunities. This provides an obvious advantage for domestic / local suppliers, and an additional competitive edge for non-unionized companies due to the reduced likelihood of a potential supply disruption caused by a work stoppage.
The need to balance short-term production with demand is another rock that is likely to be exposed. For a manufacturer, that may lead to a need to cross train employees so that any fabricated part or subassembly can be produced as / when needed. As inventory is squeezed further, it will no longer be sufficient to operate only the bottleneck pieces of equipment on multiple shifts. There will be a need to spread the entire workforce more evenly across the available shifts.
For a wholesaler or retailer, it will require more frequent deliveries of replenishment stock, scheduled to match the seller’s hours/days of operation. It may require receiving and stocking on the night shift, so that all available inventory is clearly visible during business hours.
Note that as the frequency of deliveries goes up, the number of inventory transactions also go up. This will lead to a need to reduce / eliminate the “per transaction” costs. This can be accomplished through the use of such lean tools and techniques as vendor managed inventory. Here, the customer no longer orders parts. The supplier provides them based upon some predetermined criteria such as agreement to keep the customer’s on-hand supply of a part between a minimum and a maximum quantity, or a simple “replace what was sold” approach. Frequent deliveries also can create additional material handling issues if things continue to be done the “old way”. A classical solution is point-of-use stocking. Here material is no longer received into a stockroom. The parts are delivered directly to their point of use, i.e. the correct assembly station, or the appropriate shelf of the supermarket.
Increasing the number of deliveries also increases the quantity of receiving and payables transactions. This rock will drive the customer to consider innovations such as “pay on sale”. In this environment, the bicycle manufacturer pays his tire supplier for the appropriate two tires, based not on his tire receipts, but on his shipments of bicycles; I shipped 10 bicycles, therefore I must have used 20 tires. In the retail or wholesale environment, replenishment orders and/or accounts payable are often accomplished through the data accumulated from the point of sale terminals. The bar code correctly identifies the item sold, notifies the supplier to ship a replacement, and informs accounts payable to pay the supplier for the item.
The need, mentioned above, to cross train employees leads to a need to simplify and standardize work. Workplace layout improvement, standardization, and visual factory techniques are employed.
Note that each inventory-induced change had the impact of reducing non-value adding activities (waste) and thereby driving down total cost.