The old saying goes, "an ounce of prevention is worth a pound of cure." In the last year, U.S. companies have been trying to find a cure for their inventory ills. The costs have been staggering, especially for high-tech companies.
Not only have they expended millions of man-hours trying to dispose of stagnant inventory, but they have also had to take inventory write-offs worth billions of dollars. Like so many ailments, the path to prevention starts with an understanding of what causes inventory exposure, and ultimately an inventory build-up. Four major areas represent the bulk of the problem.
- Forecast and sales processes. The most obvious problem is a forecast that is too high. If a company forecasts and plans to build 100 units of a product, but only sells 70 units, it is likely there will be some residual inventory. A forecast that is too low can also be a problem if demand is added later, creating unmatched sets. Forecast inaccuracies can't be eliminated completely. But training, improved tools, focused personnel, and appropriate metrics can all help narrow the volatility and errors.
A company can also expose itself to inventory risks based on the difference between lead times quoted to customers and the total product lead time, which includes the lead time to acquire all of the parts and build the product. If a company quotes a lead time of four weeks for its product yet has a total product lead time of 16 weeks, then the company has 12 weeks' worth of exposure. In other words, the company has to begin to make an investment in the product 12 weeks before it will get an order from the customer.
Even if the company does not have the inventory sitting on the shelf, it usually has liability in the form of a forecast or purchase orders. Given competitive pressures, it is sometimes forced to accept this exposure. The key is to manage the portfolio of products in a way that overall liability can be minimized.
Depending on competition, ease of market entry, and loyalty of the customer base, a company may be able to push the quoted lead times much closer to the total lead times for specific products. On the other hand, understanding this exposure may motivate the company to look at the supply chain for key products and develop creative ways to shorten the total lead time and reduce the exposure.
- Unmatched sets of inventory. No product ships until all the parts to complete its build are available. Inventory stranded due to missing or delayed materials can be significant and is a bigger problem than most supply chain professionals realize. It is not unusual to be able to trace 25% of a company's inventory to this problem. Some of the issues that cause the missing last part are well understood: late deliveries by suppliers, quality problems that make some inventory unusable, and stock-room control issues that cause surprise shortages.
One area less understood is the mismatched sets that are caused by unexpected demand. When new demand is loaded inside the time it takes to secure supply for each part, there is a good chance that one or more parts will be missing at the planned production start date. Most companies have not sufficiently studied, and do not understand fully, the total lead time for their products.
As a result, demand is loaded at the date it is needed and the planners and buyers do their best to meet the date. The problem occurs when these groups are set up to fail on a regular basis because the organization lacks knowledge on what is reasonable.
Companies have two basic choices to deal with this problem.
They can spend the time understanding their supply chain for key products and set policies for adding new demand that live within the existing constraints. Alternately, they can work with suppliers and their manufacturing operations to address constraints and enhance the flexibility of the supply chain to meet the requirements for changing demand. In either case, the important point is to make the reality of the supply chain's flexibility equal to or greater than what the company requires in the way of flexibility.
- Order policies and system parameters. An MRP system will drive inventory based on the parameters it is given and will attempt to minimize inventory. Items like lead time, yield, minimums, shrinkage factor, days of supply or order policy, safety stock, and buffer times create a framework for inventory. Even if everything else is working perfectly, these parameters will drive a fundamental level of inventory.
The problem in this area occurs because many companies don't manage their parameters very well. Order policies are established based on the archaic practice of tying them to a parts A-B-C classification. Component lead times are addressed sporadically and normally when there is a crisis, which is too late.
Manufacturing lead times are set at the maximum that the manufacturing operation can negotiate, causing the maximum amount of WIP and idle components. Parameters such as yields, buffer times, and shrinkage are typically addressed once and then remain untouched for long periods. Companies need to esta
blish an ongoing process to review, measure, and update these parameters so that they can appropriately manage this fundamental level of inventory.
- Product changes. Companies are continuously updating their products to improve performance and lower cost. The process, which usually involves a number of people in various functional areas, can be complex and prone to errors. Inventory can build up in two ways: inventory made obsolete due to the change, and inventory stranded due to a delay in implementation.
The key to minimizing inventory is to have a good process for communicating potential changes, to have a robust set of tools to analyze the trade-offs that are critical for setting the effective date, and to have a solid process for monitoring critical events that may impact the effective date once it is set. Fortunately, these problems are well studied and a number of solutions are available in the market that can help a company improve its performance in this area.
The issues that drive inventory are varied and sometimes complex. Companies have been fighting the symptoms (i.e., high inventory levels) without necessarily fixing the problems. It is only by understanding the root cause of inventory that companies can hope to produce a lasting reduction in its level. By focusing on these four areas, companies will take a positive step toward that goal.
John Holton is the co-founder and chief executive of Symphony Consulting Inc., Sunnyvale, Calif.