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 Is Your Inventory Spinning or Turning?

by Dave Garwood

In today's cyberspace business world, the term "inventory turns" is obsolete. Turns implies the inventory rolls over once in awhile, dust flies and crickets come hopping out! The new term in this internet era is "inventory spins" and the new standard for excellence is double-digit sales to inventory ratios.

Sound like a pipe dream? Maybe. But I don't think so. Inventory is the net result of demand plans, planning parameters and supply plans flowing into the inventory management process and shipments going out the bottom.

Inventory is Result Graphic

Inventory management is a business process. Apply the same principles to this process that we used to get to zero defects and double digit spins will follow. The path to high quality results is not a secret or magic and it works every time -- set expectations, measure results, find root causes when expectations are not met, Pareto them and then take corrective action. Apply these steps to the inventory management process and the "quality" improves every time. If your inventory is not spinning, consider these most frequent root causes:

Major Root Causes of Excess Inventory
Excess inventory can pile up for many reasons. Based on my experience, these are the major drivers in the most significant contribution sequence to excess inventory:

Excess Inventory Graphic

I will briefly elaborate on each and suggest a corrective action.

Root Cause #1: Plans Not Integrated
We often have financial plans, sales plans, manufacturing plans, new product launch plans and supply plans (called master schedules) loaded in our new multi-million dollar ERP software. All of these were developed by hardworking, well-intentioned people with different goals. The problem is, the plans are not the same. They are not integrated. We are likely bringing in too much of the wrong material and not enough of the right material -- and we don't even know it until the excess inventory accumulates on the balance sheet.

Fortunately, the corrective action is not technically difficult nor expensive to implement. Skeptical? Email us and we will send you testimonials to confirm this claim. The solution does require significant behavioral changes and strong leadership from the executive management ranks. The proven tool is an effective Sales and Operations Planning (SOP) process. (Send for our SOP Starter Kit in our bookstore and get the detailed steps. The kit also includes a simple audit to self determine the effectiveness of your current process to integrate the plans ranks with others. If the SOP Kit doesn't help, send it back for a full refund).

Root Cause #2: Overloaded Master Schedule
Hope springs eternal. We frequently use several logical thoughts to rationalize overloading the Master Schedules. First, since we never seem to meet 100% of the schedule, we schedule more to allow for some failure. If we historically make 80% of the schedule, overschedule by 20% to make sure we meet the plan. Another rationalization -- we don't know our capacity, so let's over schedule to find out! The old "keep the carrot out in front of the horse" approach. Overloading insures we bring in more material than needed unless informal systems (read: expeditors) override the schedule in time to bring sanity into our actions and slow down the inventory input!

The solution is to link the detailed master schedules to the SOP Supply plans and validate the supply plans with historical demonstrated capacity.

Root Cause #3: Poor Demand Planning
Forecasts will never be accurate. But they should be reasonable. The supply plans that drive inventory input to the balance sheet are almost always based on anticipated demand, i.e. forecast. The best forecast of demand is a customer order. Second best is an inquiry from a specific customer who is close to making a decision. Because of lead times, we often have to make a "buy" or "not buy" decision and don't have either a firm order or a hot prospect. The only choice is to make an educated guess! The quality of the demand plans becomes a critical input to the inventory management process and a significant factor in the result.

Here are a just a few of the key questions that must be continuously answered -- Is the new customer order part of or in addition to the forecast? If the demand has not been totally consumed by customer orders for the next 4 weeks, should the demand plan be reduced? Does the total demand plan pass the sanity checks? Who is accountable for the "quality" of the demand plan?

The solution is to treat demand planning as a process and apply the quality management principles to the process. Set Zero Defect expectations. Make demand planning part of your Six Sigma initiative. Measure demand quality, assign accountability for demand quality and tie performance to compensation. Stand back and watch how much the "quality" improves. Isn't this the same proven approach we used to reduce warranty expense and plant rework/scrap costs?

Root Cause #4: Large lot Sizes
How many times have you heard this comment, "If you are going to make 1000, might as well go ahead and make 3000 ... the other 2000 are practically free!" "Bigger is better" is one of the most embedded paradigms in industry! While larger lot sizes may be justified in a few cases, they always result in more inventory than gets used. When the demand drops, the 4-week supply quickly becomes a 6-month supply. The risk of excess inventory goes up exponentially as lot sizes increase.

The solution is to declare war on all excuses for making or buying any more today than you think you will use in the same day. Measure the current average lot sizes and plot the progress of reducing them without cost increases. It can be done! Tie compensation to results.

Root Cause #5: Excessive Time Fences
The time fence is the longest cumulative lead time for all items required to make the product. The time fence is a function of supply lead times -- both manufacturing and supplier lead times. For example, if the lead time for a purchased metal casting is 10 weeks and an additional 3 weeks is required to machine it before shipment, the time fence is 13 (10 + 3 =13 ) weeks. If a shipping box is also required and it's lead time is 12 weeks, the time fence is still 13 weeks. The inventory commitment begins to increase as the supply schedule crosses the time fence. As the schedule approaches today, we may elect to not finish producing the final product, but most of the inventory is already on the balance sheet. Since customer delivery lead times are almost always a lot shorter than the time fence, some of the inventory commitment decisions, i.e. start working on the items, is based on uncertain demand plans. The longer the time fences, the higher the risk. The result is more excess inventory.

The solution is to declare war on long lead times to minimize the risk impact. Reduce time fences at least 50%. Establish a starting point and measure progress. In most companies, supplier lead times account for 80% of the time fence. Make lead times an equal consideration to purchase price when selecting suppliers. Tie supplier manager's compensation to time fence reduction.

Root Cause #6: Too Many Products and Options
A client recently discovered that they had over 5000 accessories, all with assigned part numbers, that they sold and shipped with the product. These were items such as cables, holsters, connectors, adapters, etc. Most of these accessories didn't cost much, but the supply lead times were not always short either. Of course, the customer (and the sales group) expected short delivery for these "incidental" items. When product deliveries were held up because the accessories weren't available, the customer and salesperson went non-linear!

The sales department suggested they carry a bunch of all of them in inventory. The CFO choked and vetoed the idea. The CFO suggested that they keep zero inventory of all 5000 -- just let the customer wait and make or buy them after the customer ordered. The Sales department screamed and threatened mutiny. The answer was to weed the list down to the few needed items that would meet the needs of most of the marketplace, a process called "Rationalizing" the product offering.

A set of criteria was established for items that would be forecasted and offered for short delivery based on annual demand, frequency of demand and profit margin. The list of accessories for quick delivery was reduced to about 200 items and communicated to the sales force and customers in a catalog. The other 4800 items were either not offered for sale at all or offered with only enough lead time to make or buy after the customer ordered. The sales group was responsible for maintaining a forecast with some IT systems help. A Planner was assigned to manage a reasonable inventory based on the forecast for the selected 200 accessories.

This same problem frequently occurs with finished products, product options and spare parts. After planners have been repeatedly chastised for not being able to deliver, they load the shelves with every flavor and color. The result is excess inventory.

The solution to this excessive product and option problem is to start by documenting a set of rationalization rules. This is a set of criteria for determining what will and will not be preplanned (i.e. forecasted) and made available for short delivery lead times. It doesn't take long to draft a recommendation. It does take courage, conviction and leadership to enforce the rules daily.

Where to Start?
There are likely more potential root causes of excess inventory. I find these 6 to be the most frequent and the biggest culprits. Determine which ones are most significant in your business. Focus on overcoming them and watch your inventory spin!

If you would like a complimentary copy of our Inventory Spin Audit, email us and we will email you back a copy the same day.

All Contents Copyright � 2002 R. D. Garwood, Inc. All Rights Reserved.