Operations Excellence




Effective inventory management has historically been treated as one of the necessities of successful operations management. The objective of this presentation is to demonstrate that a strategy that concentrates on minimizing inventory requirements, and there­fore inventory costs, will yield continuously improving benefits in the management of all manufacturing resources and can actually serve as the focal point of a company's world-class journey.

The basis of this approach lies in the fact that all manufacturing operations involve adding value to inventory in the form of labor, technology, research, packaging, distribution, etc. Profit, of course, results from adding more value than cost. Movement, handling, and stagnation of inventory always incur cost but only contribute to the profit margin when the material changes form or when the result of the movement somehow is value added. AH costs (including overhead) as well as value can be tied to inventory movement—inventory must move before value can be added to it. When this movement results in added value, it can be tracked easily via computer transactions because of the change in part number and increase in unit cost that accompany the transactions. Movement that does not record a value-added change only incurs cost, and could also be tracked. Efforts to minimize inventory costs will necessarily be concentrated on maximizing the effi­ciency with which value is added to that inventory by minimizing the non-value-added transactions. To categorize illustrations of how this theory might work if put into practice, I have chosen the aggregate versus discrete approach to inventory management.

Aggregate Considerations

The foundation for the aggregate approach to this topic can best be demonstrated using the order cost/carrying cost curve diagram, which illustrates that the point where total cost is lowest corre­sponds to the point where the two opposing cost curves intersect. A familiar feature of this diagram is that the total cost curve is very flat on either side of its lowest point, which means that if your lot size calculation yields results that are even close to this point, you realize 85% to 90% of the benefit that is to be gained from any lot-sizing program. In a competitive environment, no matter how accurately order quantities and the resultant inventory levels are calculated and managed, only a limited advantage can be gained over the competition through these traditional methods. In this scenario, competitive cost reduction opportunities are severely limited, yet inventory is one of our most expensive resources. In order to gain further advantage, a company must look to significantly reducing the need for inventory by asking repeatedly why we have it. Although a labor-intensive operation may not benefit as greatly from this approach, a company with a high percentage of material costs could benefit greatly if its strategic direction is proportionately focused on improved, per­haps even revolutionary, inventory management techniques.

One of the major reasons for carrying inventory, whether in finished goods or in raw materials, is to buffer between forecasted demand and actual demand. More accurate forecasting reduces the need for inventory on many levels. Safety stock, whether it takes the form of raw materials, finished goods, or lead time, or is buried in the forecast itself, becomes less necessary as forecast­ing gets more accurate. Improved forecasting especially reduces

the need for expensive and highly inflexible finished goods and distribution inventories. A company looking for ways to reduce the need for inventory will quickly discover that concentration on this area will yield excellent results.

A concentrated search for unnecessary inventory in almost any company will lead to a study of work-in-process. Work-in-process inventory collects at every point where there is an interruption or the possibility of an interruption in the production flow. The entire field of production activity control is dedicated to tracking inven­tory through processes complicated by lot sizing, queues, discrete and inconsistent operations, and the resultant long cycle times. The study of ways to reduce this wasteful aggregation of inventory will lead to one conclusion. Eliminate the need! Improved plan­ning, beginning at the forecasting level, reduces interruptions to the process. To reduce lot sizes, a company must significantly reduce setups. Flexible manufacturing systems might be devel­oped to allow different products to flow through the same routing. Dedicated production lines, where appropriate, make it much easier for production to approximate a pipeline, which allows inventory to flow through the value-added process, yielding highly predictable results and reduced cycle times. Standardized containers and lot sizes foster even greater predictability and repetition, and can lead to the development of a Kanban system.

Another place where inventory costs hide is in an "overhead" or "sunk" cost that accompanies each individual SKU. Order costs, safety stock, lot size inventory, wasted storage space, data control and planning costs, and design costs all accompany each item that is required for production. These costs will largely be minimized by taking advantage of every reasonable opportunity for compo­nent standardization, which is in itself a major part of every design for manufacturability program. Such a focus also yields results in customer service and after-market programs, increasing the flex­ibility and therefore reducing the costs of service parts inventories as well as the diagnostics and repair costs themselves.

A company concentrating on maximizing its inventory investment must at some point ask itself, "In what form is our inventory most valuable to us?" Such an analysis generally follows the master scheduling principle of concentrating the forecasting at the point where there are the fewest SKUs. However, other factors must be taken into consideration, such as:

1. What percentage of the finished value is in raw materials versus value-added in the form of labor and technology?

2. What are the lead time demands on customer delivery?

3. What are the risks of obsolescence or other forms of

attrition to finished or semifinished goods? These factors must all be weighed to help a company determine whether its inventory should be stocked as raw materials, semi­finished goods, or finished goods, and in what proportions.

The effort toward world-class inventory management cannot be confined just to inventory within the plant walls. Costs begin to accumulate as soon as a purchase order is initiated; the cash register ching-chings merrily even during that introductory ven­dor visit. Our strategy for strategic inventory management will eventually extend to suppliers' processes also. Opportunities abound to reduce costs by influencing the same improvements at 

suppliers' plants that have proven so successful at our own. The result—process improvement, quality at the source, optimized deliv­ery schedules and performance, and ultimately reduced costs.

This idea of influencing inventory management beyond the plant walls can affect the other end of the supply chain dramatically. Unless we deliver product directly into the hands of the end user, there is inventory somewhere between the manufacturing plant and them. It may be held in a company-owned distribution system, or in customer-owned warehouses. It may be at the impulse display in retail operations or in a manufacturing stockroom. Regardless, inventory in the distribution pipeline continues to play its role, continues to accrue cost, and by physically moving closer to the end user, continues to accumulate value. Opportunities to balance the cost-benefit equilibrium are often overlooked even by major corporations, and such an oversight can be very costly.

The elimination of waste in adding value to inventory will eventually focus on that elusive feature called quality—quality in the product, quality in the systems, quality in execution, quality in the results. Until a process is performed perfectly, whether it is handling, movement, value-added processing, R&D, Sales and Marketing, or Field and Customer Service, it can be improved. And in any case where the process involves adding costs or value to company-owned resources, that improvement can be measured by tracking added costs against added value in whatever unit that resource itself is measured in. Again, since virtually all company operations are in some way dedicated to changing physical inventory into a sellable form, efforts to improve this process will eventually result in improved quality through the entire operation.

To be Continued


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