In my last posting I talked about how excessive inventory can negatively impact lead times and on-time deliveries. For those of you who have read The Race by Bob Fox and Eli Goldratt, you already know that high levels of inventory can be devastating to companies and negatively impact what Fox and Goldratt referred to as the six competitive edge factors. In this posting I want to share what Fox and Goldratt presented in their book, The Race, and how high levels of inventory negatively impact these six competitive edge issues.
Fox and Goldratt tell us that we can gain competitive edge by having better products, lower prices and faster response. They also explain that oddly enough, each of these three categories can be separated into two distinct branches as follows:
- Product - Quality & Engineering
- Price - Higher Margins & Lower Investment Per Unit
- Responsiveness - Due-Date Performance & Shorter Quoted Lead Time
Let’s look at each of these in a bit more detail and see how each one is negatively impacted by high levels of inventory like I presented in my last posting for nonsynchronized manufacturing environments. Using the same logic I presented in my last posting, Fox and Goldratt compare a nonsynchronized and synchronized environment where there is an order for 1,000 pieces. In the unsynchronized environment the time to complete the order is roughly 4 months whereas in a synchronized environment this same order takes only about 2 months. Remember from my last posting that in the unsynchronized setting all 1,000 pieces are completed before they are passed on to the next process while in a synchronized environment a smaller subset of the 1,000 pieces (i.e. 200 pieces in their example) are completed and passed on immediately to the next process step. In Bob and Eli’s example there were five distinct process steps each with varying cycle times. So with this scenario in mind, let’s now take a look at how a high inventory environment impacts each of the six competitive edge factors.
Suppose in manufacturing the 1,000 piece order that the product is damaged at the first operation. The defect will eventually be caught, but where? In many companies the “where” is after inspection after the last operation has been completed. Think about it…..the damage occurred nearly two months ago!! So all the pieces produced up to that point have to be either reworked or scrapped. What’s more, we now have to expedite this order to meet customer due dates. In a synchronized environment, because we have much less damaged inventory, we will detect the damage sooner and have a much better chance of determining the root cause because we’re still running parts at the first operation. Fewer replacement parts will be required and we probably will not have to resort to expensive overtime, expedited shipments, etc.
Fox and Goldratt tell us that the purpose of product engineering changes are to improve our products, to make them superior to our competition, so how does high inventory impact this competitive edge factor? Assume that an engineering change order affecting the first operation is released one month after an order has been started. In a high inventory environment, this operation has already been completed. So if you’re the manager, what choices do you have? You could scrap or rework (if that’s possible) the pieces or you could delay implementing the change. If you delay the implementation, then you’re looking at a delay of more than 3 months at best before the change hits the market place. In a low inventory environment, a portion of the order has not yet been processed through the first operation. In fact, the new product with the change can be ready in as little as two weeks.
Fox and Goldratt tell us that price is a well understood and sought after competitive advantage and that companies with high margins have flexibility to selectively lower prices. Or it can use its high margins to gain a competitive edge in other ways such as increasing its sales force, advertising or product engineering. Many companies suffer from what is called the end-of-the-month syndrome or the hockey stick effect. Whenever we find ourselves in a time crunch to meet a delivery due date we invariably turn to things like overtime, premium freight and other expensive unplanned actions which may or may not result in the order getting shipped on time. When this happens we incur additional operating expense and our margins shrink accordingly all because of excessive inventory in the system. In a low inventory environment we rarely have to resort to these actions that negatively impact our profit margins because our flow is synchronized and out lead times are where they should be.
Lower Investment Per Unit
Fox and Goldratt tell us that coping with the end-of-the-month syndrome is a major, on-going problem for many companies. Every month we encounter a surge of product at the final operation that must be processed in the last week of the month if we are to meet customer due dates. We typically resort to high overtime, premium freight, etc. but sometimes we request and ultimately purchase expensive equipment to avoid this happening in the future. And because we have excessive amounts of inventory, in some cases we believe we need to purchase more storage space. The fact is, there is usually enough capacity already in place, but because we’re working in a nonsynchronized, high inventory environment, we make the fatal mistake of purchasing more capacity or even more space. The perceived need for more capacity increases the investment required per unit of product. In a low inventory environment the investment in equipment, facilities and inventory is much less and our return on investment is much higher.
Due Date Performance
Fox and Goldratt tell us that in order to understand the impact of WIP on due dates we must first examine something that looks at first glance as totally unrelated – the validity of our product forecast. The key point is that forecasts are only accurate within a certain window of time and then drastically deteriorates within a very short period of time. If we operate in a high inventory environment, it means that we have much longer lead times than the valid forecast horizon. As a result, the high inventory company’s production plans are based upon pure guesses and not on a reliable forecast. When we operate in a low inventory environment, our forecast automatically becomes a more reliable forecast and our on-time deliveries will be much improved because our production plans are being driven by more reliable information. This improvement in stability also has a positive impact on our supplier performance.
Shorter Quoted Lead Times
In industry after industry companies that have reduced their quoted lead times are winning significant amounts of market share. For many people it seems as if shorter quoted lead times should require more inventory, especially in WIP and finished goods. The fact is, production lead times and work-in-process inventory are really the same thing. One is the mirror image of the other. If we reduce WIP then production lead times are reduced proportionally. Fox and Goldratt tell us that what is not well recognized is that finished goods inventory should be proportionate to WIP inventory. What’s that mean?
Consider if a plant has one week of WIP inventory, then on average its production lead time will also be one week. Suppose this plant is serving a very demanding market, a market that requires immediate deliveries. Since the plant could supply everything within one week, they should have about 1 to 1 ½ weeks of finished goods inventory in order to meet customer demand. If another plant has 3 months-worth of WIP inventory in this same market, it will be forced to hold nearly 5 months of finished goods. Management must adjust their finished goods inventory in accordance with any new level of WIP to achieve these benefits.
Fox and Goldratt’s analysis of these competitive edge elements illustrates how closely inventory is linked to sales (throughput). Inventory should now be associated in our minds with future sales, with our ability to survive and thrive in tomorrow’s markets. The key point is that the less inventory that we hold today, the more secure our future will be. If you haven’t ever read The Race, I encourage you to get a copy and learn from two great men….Bob Fox and the late Eli Goldratt.