In Chapter 24 of their book the authors tell us that in order to better understand how to determine the buffer levels of strategic positions/parts we must first answer a question: Is inventory an asset or a liability? The authors explain that according to the balance sheet, it is an asset. They go on to explain that in the 1980's and 1990's we saw many large companies playing an interesting paper game with inventory. Despite having no demand, many companies continued to build inventory realizing the accounting value-add from that inventory, and declared profits against it. In the process, the company was drained of cash and went deeply into debt, but according to generally accepted accounting principles (GAAP), they were profitable. The authors further explain that today, with the proliferation of methodologies such as Lean and the Theory of Constraints (TOC), in addition to the global economic meltdown starting in 2008, fewer companies could afford to play these games. Wall Street also has become aware of this ruse and the penalties of too much inventory.
The authors explain that with regard to inventory and planning, we should assume the word asset means that inventory is available in a quantity sufficient to capture a valid market opportunity and nothing more. Continuing, they explain that extrapolating this definition further, it can be concluded that there is liability when a company has more inventory than is necessary to meet market requirements (overages) and when it does not have enough (shortages).
In order to illustrate the concepts of asset and liabilities as related to inventory levels, the authors present the following simple graphic. In this graphic the Y axis determines whether the inventory position is an asset or liability. Asset and liability are delineated by the X axis, which depicts quantity. Above the X axis, the inventory position is an asset; below it is a liability. Where the axes intersect, the quantity is zero. Clearly, when companies do not have enough inventory, there will be stock-outs, back-orders and missed sales. Conversely, as inventory quantities grow beyond the market's desire, the organization wastes cash, capacity and space. This graphic clearly depicts two points that represent the limits that a company must manage to stay within with regard to both individual part/SKU buffer levels and its aggregate inventory position.
OK, back to my series on DDMRP. In my last posting I laid out the five primary components, along with a brief description of each, of Demand-Driven MRP as follows:
- Strategic Inventory Positioning
- Buffer Profiles and Level Determination
- Dynamic Buffers
- Demand-Driven Planning
- Highly Visible and Collaborative Execution
In their book, the authors depict the five primary components, in linked order, like the following visual display. This graphic quite vividly displays a structured order for implementing Demand Driven Material Requirements Planning (DDMRP).
In my next posting we will discuss the five components of DDMRP. Again, I want to remind everyone that these same authors have put together a conference set for March 2015 in Houston, Tx and I encourage everyone to attend to learn first-hand from these experts. And the good news is, they have set up a special promo code for my readers that further discounts the early bird registration, but you must take advantage of it before December 31st. The promo code is BOBSBLOG so if you plan to attend, make sure you sign up by December 31st to get your extra discount. Here is a link to the conference registration: