| INTRODUCTION | | | | that the way to reduce the set-up portion of |
| | | | overall run time is to increase lot sizes.- Labor |
| INVENTORY is the largest single asset on the | | | | Content - Reduction of direct labor has been one |
| balance sheet of many manufacturers and | | | | of the few bright spots in American productivity |
| distributors. It is usually the most expensive asset | | | | improvements over the years. The area to look |
| to own and maintain as well, with estimates of | | | | at is labor variances, due to down time, quality |
| carrying costs typically running 25-30 cents or | | | | problems, material shortages, etc., and in indirect |
| more on the dollar annually. Therefore, any useful | | | | labor. In short, reduce the overhead due to other |
| suggestions to optimize INVENTORY investment | | | | factors increasing labor.The preceding sections |
| and associated expenses would be most | | | | should give you a better idea of the significance |
| valuable.The paper addresses how to manage | | | | of INVENTORY, and what affects it. If you have |
| INVENTORY investment to optimum levels, which | | | | been reading carefully, you have already seen |
| means a reduction or major redistribution of it in | | | | opportunities for reduction, since knowing the |
| most companies. Optimal INVENTORY levels | | | | question is frequently half of the answer. The |
| come down as management makes the operation | | | | next section will amplify and clarify some of |
| more efficient by improving processes, reducing | | | | these... |
| lead-time, managing supply and demand | | | | |
| better.One can't "attack" INVENTORY effectively, | | | | HOW TO REDUCE INVENTORY |
| but only its underlying causes, which will be | | | | |
| discussed. Most INVENTORY "problems" are | | | | Advice To The Boss |
| merely a reflection of management, design, | | | | |
| process or operational problems. Current literature | | | | Let's now discuss some specifics for helping to |
| on Just-in-Time and World-Class Manufacturing | | | | tame the beast. To begin with, let's first set up a |
| addresses how inventory reduction is a | | | | program to do this with little initial out-of-pocket |
| by-product of doing things right the first time. | | | | costs, a fast payback and subsequent return on |
| | | | investment!Your controller will love this.It sounds |
| WHAT IS THE SIGNIFICANCE OF INVENTORY? | | | | almost ridiculously simple, but there is a sequence |
| | | | that one ought to address inventory reduction |
| Why is INVENTORY "bad"? | | | | activities in:- Don't bring it in. An ounce of |
| | | | prevention is worth a pound of cure. Don't order |
| INVENTORY is a major capital investment | | | | what you don't need. For existing commitments, |
| affecting cash flow and profitability. Inventory | | | | cancel or reschedule where practical. |
| comprising one-third to one-half of companies' | | | | - If you already have it, ship it. Work on |
| total assets isn't unusual. There are significant | | | | eliminating constraints to getting product shipped. |
| expenses associated with possessing it. | | | | Sell excess inventory at full price/cost, if possible. |
| INVENTORY reductions can do more to improve | | | | - Try to rework or substitute. Attempt to |
| ROA (Return On Assets) in most companies than | | | | rework, retest inventory, try to substitute it in |
| most other factors. For instance, a 50% reduction | | | | place of parts that have been specified. |
| inINVENTORY will typically account for a 10-25% | | | | - Salvage it for cash at a reduced rate |
| improvement in ROA! Certain industries, such as | | | | - Dump it. If all else fails and it's really not |
| aerospace and defense, widely believe that | | | | needed, throw it away, because the tax write-off |
| INVENTORY is a non-issue, because they receive | | | | and lower holding costs alone will make it |
| "progress payments" from customers or because | | | | worthwhile.Try the specific recommendations |
| they "write-off" job-end variances and leftover | | | | contained in the sections following... |
| "residual" inventories. The facts are that these | | | | |
| companies need to watch inventories even more | | | | Short-Term Activities |
| closely but first they need to be made aware | | | | |
| that there are INVENTORIES to watch.Excess | | | | Since it is an "established" fact that most |
| inventories subject the manufacturer to additional | | | | managers think "only of short term profits," let's |
| liabilities for things such as obsolescence, rework, | | | | cover the stuff we can do right away first. The |
| storage charges, etc. Most of these ultimately end | | | | author doesn't believe that most top managers |
| up "written off" and are applied to "overhead", but | | | | really believe this but knows that in order to keep |
| this eventually raises the overhead rate, which | | | | a business going and to keep your job, you do |
| increases costs of doing business, which raises | | | | have to show short-term results.Assign |
| prices, which makes companies less | | | | responsibility/accountability for inventory reduction |
| competitive.Carrying Costs | | | | |
| | | | Not just to the materials people, but production, |
| Let's look at what goes into INVENTORY "cost | | | | sales and engineering also. This should probably be |
| of ownership", frequently called the "carrying cost" | | | | a team, with ONE person clearly in charge, who |
| and expressed in terms of percent cost of | | | | should a vice president, rather than a summer |
| INVENTORY valuation per year of ownership. For | | | | intern.Get Control of The Checkbook |
| example, a 25% carrying cost would indicate that | | | | |
| it costs about $.25 to own each $1.00 of | | | | This is one of the first things that "turnaround |
| INVENTORY each year. These costs consist of:- | | | | artists" always do to rescue a foundering |
| Cost of money - The cost of capital to the | | | | company. Insist on getting justification for all new |
| company or, in some cases the "opportunity cost" | | | | INVENTORY expenditures - especially "A" items |
| or return that could be earned on the money by | | | | (most expensive ones). Sign all major approvals |
| applying it productively elsewhere. The cost of | | | | and checks yourself. This has an amazing and |
| money has ranged anywhere from 6% to 18% in | | | | rapid effect on INVENTORY and has been |
| the last 25 years. Obviously, cost of money has a | | | | practiced first-hand by the author and |
| very significant impact on investment strategy.- | | | | customers.Use this process to force those |
| Obsolescence - The risk of INVENTORY never | | | | responsible to justify what they are doing and |
| being used, or needing rework to make it usable, | | | | why and to think through these policies and their |
| needs to be factored into the cost of owning | | | | enforcement in a new light - that of investment |
| INVENTORY. In theory (and practice), the larger | | | | management. While you are doing this, use it to |
| the INVENTORY is, and the longer it is held, the | | | | study the dynamics of INVENTORY planning |
| more likely engineering changes, customer | | | | systems and to decide what INVENTORY |
| preferences and technological changes will render | | | | investments should be and what problems really |
| that INVENTORY unusable.- Shrinkage - A portion | | | | are. You should develop a matrix of inventory |
| of INVENTORY becomes unavailable to the | | | | days coverage targets by commodity by product |
| owner due to loss, damage, theft or spoilage. The | | | | line by planner. Then cost it out and track actual |
| longer INVENTORY is there and the more there | | | | performance. Be sure to track commitments and |
| is, the more likely this is to happen. Steps to | | | | planned amounts.Conduct basic indoctrination of |
| prevent it only raise carrying costs in other areas, | | | | people affecting INVENTORY most |
| such as security, air conditioning, better control | | | | dramatically--planners, buyers, production |
| systems, recruiting policies, etc.- Quality Factors - | | | | management, sales, customer service- establish |
| Allowances for yield, attrition, scrap and rework. | | | | some temporary "edicts" and enforce them until |
| This is really more of a function of the process | | | | more formal policies/procedures can be |
| than the amount of INVENTORY invested and is | | | | established/changed later on. Make sure you know |
| more related to throughput, but is usually | | | | what you are doing before you establish these. |
| expressed as part of the aggregate INVENTORY | | | | Beware of mindless "across the board reduction" |
| carrying cost.- Technological or Price Obsolescence | | | | edicts that could result in hurting service and |
| - Prices don't always go up. In fact, in industries | | | | profits.Have your people perform a quick |
| such as electronics, prices often plummet due to | | | | "thumbnail" INVENTORY analysis |
| constantly improving designs, product and process | | | | |
| technology improvements. Therefore, it is | | | | Start with items currently on order, in process, |
| desirable to minimize inventories in high-risk areas.- | | | | or being planned. As Al Agosti of IQR says, "first |
| Taxes - There are two dimensions to this: 1) In | | | | stop the bleeding. Then take away the knife." It |
| some areas, a tax is levied on inventories, so the | | | | always amazes me that companies will spend a |
| more INVENTORY, the more tax is paid. 2) | | | | fortune to analyze INVENTORY, which is already |
| INVENTORY is regarded as an asset by most | | | | there, but ignore huge impending expenditures, |
| accounting and tax rules. Therefore, building large | | | | which they can do something about before |
| inventories shows "profits" and profits are usually | | | | disaster strikes. To do this, perform a quick |
| taxed, usually by multiple government entities.- | | | | "ABC" analysis, identifying only the expensive ("A") |
| Insurance - The cost of carrying insurance on | | | | items initially. In most companies, these are only |
| INVENTORY needs to be considered, as well as | | | | 5-15% of the total items and can be leveraged to |
| insuring the space, equipment, people and other | | | | provide quick benefits in terms of investment |
| resources needed to control it.- Space - Costly | | | | management. After this has been done, get |
| storage space sometimes occupies 25-30% of | | | | together with the management team, do a quick |
| the total facility, when one considers raw material | | | | brainstorm and put together a Pareto chart, |
| warehouses, stockrooms, work-in-process | | | | showing problems in descending order of |
| storage, receiving, shipping, outside warehouses, | | | | importance.Start with a calculation of what is |
| MRB and residual storage areas. INVENTORY | | | | actually needed: |
| reduction campaigns frequently help companies | | | | - Go through all the arguments of why people |
| avoid the need to move to large facilities, or | | | | need more, sooner and then get people to agree |
| permit them to shut down or cut back existing | | | | on how they can avoid doing that. |
| facilities.- Manpower - All of this INVENTORY | | | | - Cut new INVENTORY scheduled to come in |
| needs people to order, receive inspect, record, | | | | whenever possible. |
| move, count, store, retrieve, post it to the ledger, | | | | - Determine right away what can be cancelled, |
| etc. People are the largest or second largest | | | | rescheduled, returned to vendor for credit or sold |
| expense (behind material) for most | | | | for salvage. Balance the costs of doing this |
| manufacturers.- Record Keeping Systems - | | | | against the relative benefits. |
| Software, procedures, equipment and paper must | | | | - Work on getting product shipped and billed to |
| be used to stay on top of INVENTORY.- Material | | | | get INVENTORY relief. |
| Handling/Storage Equipment - Conveyors, fork | | | | - Try to match INVENTORY input closer to ship |
| lifts, bar code readers, scales, AS/RS, trucks, | | | | date (reduce lead times and carrying time) |
| carts, bins, racks, shelves must all be purchased, | | | | - Determine if excess/obsolete finished goods |
| leased, maintained and cared for.- Physical | | | | can be put on promotion or "fire sale." Do so if |
| Inventories, Reconciliations - Must be conducted to | | | | appropriate. |
| ensure that inventories are properly accounted | | | | - Lean on customers who have cancelled |
| for and maintained.- Transportation - Must be | | | | rescheduled orders to your detriment. Try to get |
| provided to move INVENTORY in and out of the | | | | them to pay for part of these costs, accept the |
| facility, to vendors, within the facility to different | | | | INVENTORY, or use these incidents as levers to |
| workstations and storage areas.- Energy - Heat, | | | | improve future terms. |
| light, humidity control, air conditioning, refrigeration | | | | - Look for obvious bottlenecks in the planning |
| and fuel must be consumed to make all this | | | | and processing of orders such as: |
| happen. | | | | - Amount of lead-time and queue permitted. |
| | | | - Lot size and cycle times. |
| WHAT AFFECTS INVENTORY? | | | | - Scheduling assumptions |
| | | | - Major bottlenecks caused by improper manning, |
| One must "know thine enemy" to successfully | | | | defective or poorly maintained equipment, etc. |
| deal with it. Now that we've discussed the | | | | - Build-ahead and buffer policiesSet goals for |
| significance of INVENTORY, let's determine why it | | | | inventory down to the level of managers and |
| exists and what makes it go up or | | | | planners |
| down.INVENTORY is not always evil. It usually | | | | |
| exists for a reason, however a reason is not | | | | Do this "rough cut," for "A" items first-- more |
| always true justification. INVENTORY is frequently | | | | detailed analysis comes later. Set targets by |
| kept as a buffer and masks other problems.Major | | | | planner, buyer, product line or any other |
| Reasons for Inventory | | | | meaningful political or production entity that will |
| | | | foster accountability, which you will want to later |
| - Net Demand - Demand derived directly from | | | | measure results against and enforce.Go for the |
| customer requirements or internal demand.- | | | | "easy wins" with the best payback first. Don't fall |
| Pipeline - INVENTORY needed to sustain the | | | | into "paralysis by analysis." You can do more in |
| process over its cumulative lead-time through all | | | | the first few months than you think.Establish |
| operations and holding points. Also included in the | | | | formal problem solving methodology |
| pipeline are paperwork operations, such as billing, | | | | |
| which could increase inventory if not done timely | | | | Use task teams, quality circles, natural work |
| enough.- Quality - Yield, attrition, scrap, rework | | | | groups, tiger teams or whatever they're calling |
| allowances impacting amount of inventory and | | | | them this month and have these groups identify |
| time inventory is in process.- Lot Size - Lot size | | | | major problems, opportunities and then address |
| considerations include vendor minimum order | | | | the solutions.Perform "stock location audit" |
| quantities, raw material and manufacturing lot | | | | |
| sizes due to setup and other nonrecurring, | | | | Simply go out to the shop and write down only |
| lot-related cost considerations and run time impact | | | | the identity (part number) and location of all |
| considerations.- Supply Buffer - Extra INVENTORY | | | | storeroom and/or work-in-process and other |
| carried as a hedge against unreliability of vendor | | | | inventories, then compare to your records. Don't |
| or factory schedules, inaccurate records, | | | | even bother to count it (that's what takes the |
| unpredictable quality or other fluctuations tending | | | | longest).Take your "hits" for inventory early |
| to reduce reliability of providing materials on | | | | |
| demand.- Demand Buffer - Extra INVENTORY | | | | As soon as you have some idea of the |
| planned due to uncertainty of the true | | | | magnitude of excess/obsolete inventory, work on |
| requirement need date or quantity, which may | | | | getting financial and general management to "write |
| vary due to poor forecasts, transportation | | | | it off", in order to get the tax benefits, where |
| problems, or various contingencies.- Hedge - | | | | favorable.That depletes my INVENTORY of quick |
| Inventory acquired for speculative purposes with | | | | fixes. Now it gets a little harder...Inventory |
| the exception that prices will rise later, justifying | | | | Analysis/Target Setting |
| the earlier investment risk.Other Factors Affecting | | | | |
| INVENTORY | | | | Joe Barcy of Inventory Performance Systems |
| | | | calls it the "Divide and Conquer" approach. What |
| The reasons given above are those that apply | | | | he meant is that a company has to bring |
| for a given set of circumstances or basic | | | | decisions and measurements down to the level of |
| assumptions about design, processes, etc. The | | | | accountability and below (to the person/part |
| factors below are more basic and can have a | | | | number/cost element level) and also aggregate |
| more profound long-term effect on INVENTORY:- | | | | this information up to meaningful levels for |
| Product Design - A product design that minimizes | | | | analysis by various levels of management.First, |
| the number of parts, picks easily obtainable | | | | group INVENTORY items at the part number level |
| materials and components, lends itself to | | | | into categories by responsible planner and/or |
| manufacturing with the simplest possible facilities | | | | buyer and commodity. Do this in descending dollar |
| and equipment will minimize INVENTORY costs | | | | sequence, preferably by projected usage |
| over the long pull.- Materials Supply - Specifying | | | | (historical usage, if that's all you can find, but it has |
| quality materials, well suited to the process and | | | | its disadvantages). If you don't have the ability to |
| application, with easy availability, low prices, | | | | do this by computer, do it by hand for the A |
| reliability of supply and short response time are all | | | | items first - look up production plans, sales |
| big advantages that can facilitate INVENTORY | | | | forecasts and buy cards, then extend quantities |
| reduction. Having the best sources for key | | | | by approximate costs. Use purchase history, |
| materials or changing existing arrangements can | | | | quotes, accounting department support, or |
| do a lot to help minimize inventories.- Processes - | | | | whatever you can get. Getting it done fast and |
| Good, reliable processes will help reduce | | | | approximately is much more important than |
| INVENTORY, because they will help reduce scrap, | | | | carrying it out to four decimal places. Remember: |
| rework and attrition, and also provide a more | | | | money is being wasted while you delay!Analyze |
| reliable flow of supply, which will help reduce | | | | INVENTORY on the following suggested |
| buffer stocks, safety stocks, safety lead time | | | | parameters: |
| INVENTORY and eliminate much accumulation of | | | | |
| INVENTORY on the production floor.- Facilities | | | | 1. ABCD classification (by annual usage value) |
| Layout/Design - INVENTORY may be increased | | | | 2. Turnover/investment performance |
| significantly if this is not done properly. Widely | | | | 3. Highest dollars committed |
| scattered plants, multi-story buildings with | | | | 4. Highest dollars in INVENTORY |
| inadequate material flow capabilities and processes | | | | 5. Most longest period coverage planned/available |
| distributed over many different departments, all | | | | 6. Items with coverage/commitments greater |
| increase the amount of part travel, possibility of | | | | than policyOnce you have all this data, set |
| loss, delays and need for manpower and extra | | | | targets, measure and control performance.Data |
| equipment to support the process.- Service | | | | Accuracy Program |
| Objectives - The required response time and | | | | |
| reliability of service to customers has a big impact | | | | Set up a formal, ongoing program to clean up |
| on INVENTORY costs. For instance, if industry | | | | and maintain accurate records for inventory, |
| standards allow making to customer specifications | | | | bill-of-material, routings and planning data. See my |
| from scratch, there may be less need to maintain | | | | article: Inventory Accuracy in 60- Days!Policies |
| finished goods inventories. If customers or | | | | Procedures |
| distributors carry stock, that reduces pressure | | | | |
| upon the supplier to maintain inventories and | | | | Write/update policies and procedures to guide |
| reduce them quickly.- Planning/Control Systems - | | | | your operation. Conduct an ongoing education and |
| Systems employed to manage supply and | | | | training program to ensure that people know |
| demand and control the production process have | | | | what to do and how to do it.How to Optimize |
| a large effect on INVENTORY.The systems we | | | | inventory Levels |
| refer to are: | | | | |
| | | | If you're expecting a neat formula here to plug in |
| - Front End | | | | your numbers, you're sadly mistaken. It doesn't |
| - Forecasting | | | | exist and if someone tells you it does, it probably |
| - Production Planning | | | | doesn't work. Here are a few ideas that have |
| - Master Production Scheduling | | | | worked for me:- Estimate target days coverage |
| - Capacity Requirements Planning | | | | using the team's best judgment for each |
| | | | commodity/product line. Obviously there will be |
| - Engineering | | | | some exception items. |
| - Bill-of-materials | | | | - The "one less" approach: Try reducing |
| - Change Control | | | | inventories in doubtful areas a little bit at a time. |
| - Routing/Process | | | | Pull back when you get in trouble or when you |
| | | | spot a constraint. Continue after you have |
| - Material Planning | | | | relieved the constraint(s) some. |
| - Time Phasing Tools | | | | - The lead time/cost build up chart: Construct a |
| - Requirements Calculations/netting | | | | graph per product showing the time phased cost |
| | | | buildup in cost of goods sold amount. Have the |
| - Shop Floor Control | | | | team meet to see where lead times, lot sizes, |
| | | | attrition factors and buffers can be reduced. |
| - Data Integrity | | | | - Modeling tools, Advanced Planning Systems |
| - Bill-of-material | | | | (APS), have some potential for optimizing certain |
| - MPS | | | | situations, but they have been a bit oversold and |
| - INVENTORY, PO, RM, WIP, QA, FG | | | | are not easy to set up and maintain.Key Points |
| - ProcessCost | | | | |
| | | | To summarize some important points for your |
| - Material Costs - Material cost increases | | | | future reference:- Inventory reduction is one of |
| (obviously) raise INVENTORY. Lowest unit cost | | | | the cheapest ways to improve profits |
| does not necessarily mean lowest cost of doing | | | | - Get control of the "checkbook"! |
| business, or even lowest cost of material, for that | | | | - Use Pareto's 80-20% principle to leverage your |
| matter. These can be deceptive, because as | | | | time and investment - choose your battles - |
| material costs go up, turns do not decrease, | | | | biggest bang for the buck. |
| because they are being measured on a new and | | | | - Once of prevention = pound of cure |
| higher base.- Overhead - Burden rates of 300%, | | | | - Set targets - "divide and conquer"! |
| 500% or more are not uncommon. Having a high | | | | - Force accountability- Set up a responsible team- |
| overhead rate is not "bad", only total costs that | | | | hold it accountable. Include in performance |
| are too high are "bad". Your overhead rate is a | | | | appraisals, incentives |
| reflection of cost distribution and accounting | | | | - Question assumptions - eliminate waste |
| techniques as well. However, if overhead is going | | | | - Doing business right will automatically reduce |
| up without attendant drops in other areas and if | | | | excess inventory in most cases, but still needs |
| other industry competitors are doing better, then | | | | monitoring and control.This article is also available |
| it's "bad."- Setup and Other Nonrecurring Costs - | | | | on our website: PROACTION - Generating Best |
| In most companies, these are either part of | | | | Practices. It is an excerpt of a paper originally |
| direct labor or buried in overhead. I broke them | | | | written by George Miller, Founder of PROACTION. |
| out separately here because of their differing | | | | It has been modified and updated by Paul Deis, |
| characteristics. Many manufacturing people feel | | | | PROACTION CEO. |