"Inventory Exposure: the Problem that Operations and Materials Groups Can't Solve Alone"
In countless companies around the country, the responsibility for inventory management falls within the purview of the Materials and/or the Operations group. The problem is that these organizations are positioned to fail because they cannot fully control the framework that causes inventory exposure.
The good news is that there is a solution and it starts with a broader, more cross-functional perspective on the problem. Let us explain by starting with the framework for inventory exposure. Each product has a set of materials that goes into it. To transform the material into a product, there is a set of value-added steps that the product must go through. All of the material and each of the value- added steps have an associated cost and lead-time. Plot the escalating investment in a product over time and you have what we call the "Product Time- Investment Curve." This curve shows the degree and timing of the financial exposure a company incurs in the supply chain prior to shipping the product to a customer. A typical curve will show that a company takes on significant financial exposure weeks or months ahead of time.
In a perfect world, where demand is known, lead-time and the associated inventory exposure present no risk because you can plan inventory for when you know it will be needed. In the real world, where demand is uncertain, you cannot be confident that the inventory you have planned will be consumed when you think. The more exposure you have, the greater your probability of having excess inventory liability. The only way to reduce your exposure is to close what we call the Inventory Worry Gap (i.e. the difference between when a company is significantly committed to inventory and the time when the company has coverage in the form of a customer order).
There are two basic ways to achieve this: you can compress the lead-time profile for your products or you can increase the lead-time you quote to customers. Managed properly, you can decrease your inventory exposure, increase your inventory turns, improve your ability to respond to critical customer requirements, and in general, make management and shareholders happier. Although the topic is too big to address completely in a newsletter, here is the basic approach.
Compressing a product's lead-time profile takes time, energy, and a creative use of a bag of tools including postponement, strategic buffers, and methods to reduce transformation time. It may not be realistic to make this investment on all products. Choose your battles carefully and start with changes that have the greatest impact. A one-week reduction in the transformation time leads to a reduction in WIP. It also cuts a week from how far in advance you need to place orders for each component, thereby reducing your inventory exposure even more.
The other option is to adjust the product lead-times you quote to customers. Most companies set lead- times without a real dialogue about the trade-offs concerning inventory exposure and the impact on financial performance. Clearly, there are some products where you must have stock available or risk losing the customer. In most companies, there are also products that are older or less important or where the competitive environment is less threatening. In those cases, it makes sense to increase the lead-time and let the customer off-load your company from some uncovered risk.
Regardless of which approach you take, the key is to close the gap between the exposure dictated by the lead-times involved in a product, and the amount of coverage you have in the form of customer orders. The bigger the gap, the more inventory exposure you have. Close the gap and you reduce your inventory liability.
If you would
like to learn more, or if you think Symphony could help in your efforts to
reduce inventory liability, please contact us. Symphony also teaches a two
day workshop titled "Reducing Inventory Liability and Enhancing Supply
Flexibility." In this workshop, we share information and methodologies
that help companies achieve breakthrough performance in these areas.