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.
Product
Quality
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.
Product
Engineering
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.
Higher
Margins
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.
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