THE WASTE OF INVENTORY LOGISTICS AND INVENTORY MANAGEMENT Logistics is all about managing inventory, whether the inventory is in motion, or sitting, whether itis in a raw state, in process, or completed (Finished goods). And true to the cliché noted in Chapter 2, which suggests that you cannot make something out of nothing, you must have inventory to sell anything. The prom. ise to serve a customer cannot be extended assuredly unless the product is on hhand or can be made available in a timely manner. The challenge comes when customers demand the product NOW and you have to speculate about what they ‘will want, in what quantities, and where to position it. The imperative, therefore, becomes having inventory available when and where customers want it. Logistics professionals often recite the “Bill of “Rights” when describing what itis that they do: delivering the right product to the right place at the right time in the right quantity and condition, and at the right cost. Having the right inventory on hand and near customers is the simplest way to ensure that they walk away happy. But like anything that is good for you and necessary for survival, it is possible to have too much of a good thing. We all need proper nutrition to survive, yet we also know what too many calories can do to the waistline. Unfortunately, as alluded to in Chapter 1, the strange truth of the ‘matter is that many of us are addicted to inventory. How many plant managers do you know who stash an extra box of parts in their office like a forbidden pack of cigarettes to cover them when a craving becomes too strong? It is an obsession that afflicts more people and companies than you might imagine. 920 _Lean Six Sigma Logistics THE TEMPTATION OF INVENTORY Inventory reduction is the driving force behind many a “Lean” initiative. It is one of the forms of “muda,” or waste, originally identified by Taiichi Ohno in his list of seven. Inventory is also perhaps the most visible form of waste.* The fact that we have warehouses and distribution centers is a testament to the fact, that we have inventory and, usually, lots of it. Inventory often represents some~ where between 5 and 30 percent of a manufacturer's total assets and may represent half of a retailer's total assets. These estimates are based on end-of- quarter or fiscal year-end observations, when inventories are at their most depleted state for the sake of periodic financial reporting. They may lurk considerably higher over the course of the period. And, like any asset, inventory has to be managed. It has to be acquired, received, housed, paid for, and insured — adding cost on top of the original purchase price for the goods or materials, ‘So why does it happen so often that we have more inventory than we really need? We hold inventory because in the absence of instantaneous manufactur- ing and delivery, we have to position inventory in the distribution channel in advance of demand to meet today’s “I want it now!” society. Lofty expectations for in-stock availability drive the placement of these inventories not only in retail consumer channels but also in industrial (business-to-business) environ- ‘ments. Until we can achieve instantaneous mass-customized manufacturing and Star Trek-like beaming capabilities, the fact is that we must anticipate what customers want, the quantities they want, and where they want them when the expectation of perfect in-stock availability is in place. With this in mind, we make our best guess at demand (1e., forecast) and acquire supplies in advance to support the expected demand. ‘The one thing that is absolute about a forecast is that it will be precisely ‘wrong. The two important questions are “How wrong will we be?” and “In which direction will we be off — under or over forecast?” Some forces within a company make common practice of keeping the forecast (and ensuing expec- tations) low in order to beat the forecast, indicating perseverance and goal accomplishment. Others push the forecast higher to justify added capacity or to signal future sales to current and prospective investors. This inventory must * Talichi Ohno developed a list consisting of seven basic forms of muda: (1) defects in production, (2) overproduction, (3) inventories, (4) unnecessary processing, (5) unneces- sary movement of people, (6) unnecessary transport of goods, and (7) waiting by employ- fees. Womack and Jones added to this list with the muda of goods and services tht fil to meet the needs of customers. (Sources: Ohno, Taichi, The Toyora Production System Beyond Large-Scale Production, Productivity Press, Portland, OR, 1988 and Womack, James P. and Jones, David T., Lean Thinking, Simon & Schuster, New York, 1996.)The Waste of Inventory 21 often be sold off at discount, disposed of, or maintained until inventories even- tually become depleted. Many companies realize that working within a shorter planning horizon holds several important benefits. First, it allows a company to rely less on the long-range forecast, which we all know will inevitably be wrong. By relying less on the forecast and more on actual demand, we can reduce the risk of miscalculating the future and, in turn, hold less inventory. The shorter planning, horizon also supports more frequent replenishment and smaller lot sizes, which should translate into fresher products available for customers and less risk of obsolescence. ‘When demand is highly seasonal, we often must engage in long-range plan- ning, buying materials and producing products well in advance of the peak season, given an economic inability to make everything necessary to satisfy the seasonal spike in the immediate term. Still others concern themselves little with the fact that continuous, large-batch production leads to excess inventory. In many process industries like petroleum refining and paper milling, shutting down the machines is the equivalent of shutting down the ocean; you just cannot do it. Achieving the lowest per-unit production cost is still the single highest priority in many industries today. This mind-set also leads many companies and entire industries to seek offshore manufacturing activity to reduce production costs, ‘That speaks to the normal scope of business activity, but what about when something strange happens in supply or demand? Imagine an unplanned plant shutdown at a key supplier. Imagine all of the ports along the western coast of the United States being closed for an indefinite time period. Imagine the de- livery truck that gets slowed by inclement weather or stuck in traffic or the driver who simply gets lost. Unfortunately, it does not take a wild imagination to conjure up these images; they can happen at any time to any company. And what about something positive like the new product that really soars into the marketplace, exceeding anyone's “realistic” sales expectations? Or what about the sales promotion that really had traction?” Demand, too, can surprise us. And so we hold extra inventory to cover us in these situations when an unexpected hiccup occurs in a supply chain process or demand exceeds the forecast. What is interesting is that we NEVER expect to use the safety stock; if we did, it would be factored in the planned cycle stock. ‘These occurrences represent the many different ways in which variance ‘manifests. Itis the goal of Six Sigma to control the variation, to improve supply chain processes so that the job gets done better on a consistent basis. Six Sigma also captures the experience and expectations of the customer, reducing the likelihood of developing products and services that are inconsistent with market ‘wants and needs, but also alleviating the risk of being caught off guard when22 _Lean Six Sigma Logistics ‘a product tanks or skyrockets. Those companies that engage in offshore manu- facturing experience the brunt of these swings even more when they send their operations away from the home market, often moving operations away from not only the customer but also away from the predominant supply base. While production costs most definitely can be reduced through this action, most companies have learned that offshore manufacturing leads to an entirely differ- cent set of problems in the supply chain: variances. Variances in inbound and outbound logistics and variances in production control areas such as quality, quantity, and time make many question whether it was worth the leap. All these variances instill greater need for inventory. Extra inventory is sometimes acquired for reasons other than protection from supply chain disruptions and demand spikes. Companies in many industries take on inventory for speculative purposes given the possibility that supplies might come into shortage or that price increases are on the horizon. Scrap recyclers, for instance, make a necessary habit of acquiring high-quality scrap materials, whenever they become available. Dealers of limited-edition automobiles and other collectibles engage in similar opportunistic buying. Meanwhile, commod- ity dealers like those in the oil and gas industry, precious metals, and grain marketing keep close eyes on the futures market, with the prospect of arbitrage (buy low now, sell high later) driving their purchasing behavior. THE COSTS OF HOLDING INVENTORY Regardless of the reason, what companies have to realize is that there are very real costs associated with holding all inventory. The costs go well beyond the outlay of the inventory “investment.” We will review the elements of inventory carrying cost that should be applied to the value of average inventory to de- termine the annual dollar cost of holding inventory (see Figure 3.1) Inventory carrying costs serve up an interesting concept, representing both accounting costs and economic costs. An “accounting cost” is one that plicit and calls for a cash outlay and registers on the books of the company. An “economic cost” is implicit; it does not necessarily involve an outlay, but rather an opportunity cost. Most companies recognize that there is some cost associated with holding inventory and apply a round figure to the problem of determining carrying cost, but there is rarely any idea of where that figure originated. Too often, a company’s inventory carrying cost percentage is deter- mined every great while and rarely understood, and even less commonly chal- lenged. This lack of understanding and reluctance to challenge the car percentage often results in gross miscalculation in determining annual