How Do You Decrease Your Inventory Investment?

By Wally Wilson, CMRP, CPIM, Life Cycle Engineering
As appeared in Noria's e-newsletter, Reliable Plant Mail

Inventory requires an investment of valuable cash. Regardless of whether the investment is in raw material, work-in-process (WIP), or finished goods, the dollars invested will not be available until the inventories are converted into a value-added finished product for customer orders. The faster a business can convert a customer order to a cash payment for goods sold, the better their cash flow and long-term profitability of the business. Implementing tools and technologies to manage inventory levels in each of these stages is difficult and the risk of reducing inventory levels too much can put you in a position to experience stock outs and lost business when unexpected customer orders are received or your supplier experiences unexpected interruptions.

Lean manufacturing or Just-In-Time (JIT) inventory management have been identified as the preferred methodology to reduce inventory levels. Basing inventory needs on customer demand creates a pull system that generates actual inventory requirements as customer orders for goods are received. The use of a Kanban tagging system as a means of communication to trigger an action to restock a workstation or move inventory can be an efficient tool to reduce and control WIP inventory on the production floor. Most businesses have a push system that generates excessive levels of inventories and safety stock that take up valuable warehouse space and generate holding costs to store and wait for customer orders for the finished product.

A lean manufacturing pull system has several benefits and makes production systems more efficient, cost effective, and responsive to customer demands. A reduction in inventory dollars invested is realized through increased inventory turns and a finished goods inventory that is more responsive to customer needs. This would generate more cash to invest in other areas of the business, such as new equipment, new product lines, and higher profits for the business and shareholders. It is easy to become too aggressive in reducing inventory levels before establishing trusted supplier partnerships. Because of the interdependence with suppliers, lines of communication are critical to ensure risks are identified and mitigated before they have negative effects on your business.

Dell Computers has been working on developing their pull system for several years. The company has reduced their on-hand inventory of computer components used to build new computers from an 11 week on hand inventory to a current inventory requirement of less than a week. To accomplish this level of efficiency, Dell doesn’t build the computer until they have a customer order in hand and the order has been confirmed with the customer. Once the customer has verified the computer components, the unit is built to the customer’s specification.

Pull systems are also used by fast food businesses like McDonald’s, Burger King, and many other food service providers. Under the previous McDonald’s system, hamburger patties were cooked and the sandwiches were kept warm under a heat lamp until a customer ordered their food. If orders were not received for the premade sandwiches within about 30 minutes the food had to be thrown out. When McDonald’s adopted a pull system for their food service, the heat lamps were removed and food is prepared as customers place their orders. As would be expected, inventory investment and product waste were reduced dramatically across the McDonald’s organization.

Reducing waste in the form of excess inventory allows a business to invest much less cash in their inventory and positions them to be more responsive to their customers’ needs. Eliminating all forms of waste in the lean manufacturing environment is a critical factor to move from a push to a pull system. Some areas of operational inefficiencies are obvious and implementing solutions to eliminate these shortcomings are quick fixes with little risk to the overall business function. As a continuous improvement program moves toward best practice application, more and more issues are exposed that need to be addressed with a long-term strategy before trying to move to the next level. Just-In-Time inventory systems provide for an attractive cost-cutting production system as long as risks are communicated, weighed, and mitigated on a daily basis.

© Life Cycle Engineering, Inc.

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