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Lowering inventories is one of the quickest ways to decrease working capital needs. Performance measurements, such as the old standby ROA (return on assets) and the newer EVA (economic value added), as well as other measures that gauge how efficiently capital is used, have become more common organizational drivers.
In fact, many an executive’s bonus depends, at least in part, on how efficiently capital is used.
Couple the drive for efficient capital use with the need to respond more quickly to changes in customer demand, with shorter and shorter order-to-delivery cycle times, and you have a problem that is challenging many manufacturers. In the past, manufacturers would stockpile large quantities of raw materials, load up the shop floor with work in process and pack warehouses with finished goods.
Not only do those old ways increase working capital needs, they contribute in a big way to erratic and longer lead times and increasing overall costs.
The pressures to reduce inventories, and therefore working capital requirements, are increasing even in times of relatively low interest rates. Management’s quandary is that there are many opportunities to use sources of capital — not just more efficiently, but in ways that yield high rates of return elsewhere. For example, reducing inventories could provide the capital to finance new product development, expanded marketing and sales, modernization, business process redesign, expansion, acquisitions and debt reduction.
Constant analysis, manipulation
Even though inventories are under constant analysis and manipulation, permanent inventory reduction opportunities go largely unused. Well-intended efforts to reduce inventory often get only temporary results. Yet, it is relatively easy for most companies to reduce inventories permanently by at least 20 percent in six months and, in some cases, as little as three months, without major process changes or lots of expensive software.
One major benefit of this approach is that cash is made available to further improve your supply chain management and put you in a positive cash flow position when you start.
In some cases, inventory is so bloated that much of it becomes obsolete before it is sold. Too much inventory is a certain indicator that serious and costly business process problems exist. Some of these problems are ineffective sales and operations planning, poor forecasting, inadequate product specifications, over planning, ineffective production scheduling, low quality, bottlenecks, long cycle times, product and process problems, high costs, poor vendors and wrong performance metrics.
Assess order-to-delivery process
One way you can get a good handle on the inventory, service and cycle time dilemma is to assess your order-to-delivery process. Many companies limp along with well-intentioned, but ineffective, approaches to their order-to-delivery process. As a result, management is often frustrated by the seeming inability to solve the inventory, lead time and service dilemma once and for all. Why do companies repeatedly fail to achieve consistently high levels of customer service and permanent inventory and cycle time reductions?
The 25 self-assessment questions that follow will help you assess your situation. Of course, 25 questions do not probe every area you should assess, but the intent here is to provide your organization with a perspective of what you need to do to launch an improvement effort. One way to use these questions is to have your entire management team answer each question, meet and discuss each question that received one or more “No” answers, and outline your corrective action needs. As you proceed through the diagnostic questions, make appropriate notes about particular areas of concern. The notes could be very helpful during subsequent discussions and corrective action planning.
1) Every product has a well-defined manufacturing and inventory deployment strategy. ____Yes ____ No
2) We have clearly defined organizational accountability for the performance of each inventory segment. ____Yes ____ No
3) Our inventory record information is real time and 99 percent-plus accurate. ____Yes ____ No
4) Our bills of material are 100 percent accurate. ____Yes ____ No
5) We create little to no inventory obsolescence as a result of engineering changes. ____Yes ____ No
6) Our forecasting process has the demand variability integrated with a service-oriented inventory deployment strategy. ____Yes ____ No
7) We have a comprehensive and effective sales and operations planning process that is management’s handle on sales, production, lead time and inventory plans. ____Yes ____ No
8) We start the assembly process without any material shortages. ____Yes ____ No
9) We use distribution requirements planning (DRP) to plan inventory for distribution centers. ____Yes ____ No
10) We have a comprehensive, dynamic inventory performance monitoring system that pinpoints inventory investment problems before they occur. ____Yes ____ No
11) The impact on inventory from cycle-time reduction has been properly analyzed and quantified. ____Yes ____ No
12) We have mapped all supply chain processes and clearly identified value-added and non-value-added activities, bottlenecks, queues, cycle times, etc. ____Yes ____ No
13) We have specifically defined the barriers that prevent us from achieving increases in service and reductions in inventory, and are actively removing the barriers. ____Yes ____ No
14) We have organized and trained multifunctional teams that are working aggressively on improving information and material flow to achieve a high-velocity supply chain. ____Yes ____ No
15) We have decreased our manufacturing and vendor lead times by at least 50 percent over the past three years. ____Yes ____ No
16) Our lot sizes and setup times have been reduced by at least 50 percent over the past three years. ____Yes ____ No
17) We have reduced queues and work-in-process inventories by 50 percent or more over the past three years. ____Yes ____ No
18) Our processes perform to a level where no inventory buffers are required to protect against quality problems. ____Yes ____ No
19) We have agreements with key vendors for short cycle deliveries and mutually agreed-upon goals for continuous improvement. ____Yes ____ No
20) Our approach to supply base management has each critical vendor’s processes certified to a no-inspection-required status. ____Yes ____ No
21) We use an e-supply chain approach for communications and transactions with our suppliers. ____Yes ____ No
22) We know our precise lead time for customer deliveries or to replenish inventories. ____Yes ____ No
23) We have an active, ongoing program for vendor-delivered, point-of-use inventories. ____Yes ____ No
24) Our production supervisors spend little to no time expediting materials or firefighting due to parts or material shortages. ____Yes ____ No
25) Our primary performance measurements and reward system are heavily weighted toward short cycle times and quick response with minimal inventories. ____Yes ____ No
How is your score?
If you answered “No” to many of the first 10 questions, answering with a meaningful “Yes” to any of the remaining 15 is very difficult. Worse, answering “No” to any of the first 10 questions, except DRP if it’s not required, means your business is at risk.
If you were able to answer “Yes” to all (or nearly all) of the questions, your company is more advanced than most. In fact, all “Yes” answers would likely mean that your company is in a very elite class of top-performing manufacturing companies. On the other hand, many “No” answers are solid indicators that your entire supply chain is costing you money and very likely is now (or will be) putting you at a competitive disadvantage. Many executives agree that top-heavy inventories are a giant cash vacuum that needs to be turned off in order to free up cash for investment in revenue and profit growth activities.
How can this be accomplished? First, most manufacturers have enough cash tied up in inventory to easily pay for a new supply chain management system. Better yet, you can more than likely get that cash out of inventory beforehand. The notion that significant inventory reductions are only possible by radically changing business processes is misleading. The fact is, minor process changes and better use of processes and systems already in place will let many companies achieve a 20 percent-plus inventory reduction really fast. This is possible with the proper combination of analytical techniques, enhanced planning mechanisms, essential-to-know information feedback and effective decision support.
Once inventories have been lowered, the cash made available for investment in the big job of radically redesigning the supply chain can begin. By streamlining the entire supply chain, a company can free up more cash by reducing inventory even further, improving service, compressing cycle times, decreasing costs and improving profitability.
World-class manufacturers have allocated the necessary resources to speed up the order-to-delivery cycle and improve the entire supply chain, and the result is clearly visible in service performance and reduction of all forms of inventory.
Customers and suppliers are linking by e-supply chains to improve communications, shorten cycle times and lower costs.
Providing top-notch customer service and enhancing profits are critical objectives to the success of any manufacturer.
To minimize inventory excesses and improve customer responsiveness, more and more manufacturers are building flexibility into their operations — flexibility in how they operate in order to respond quickly to changing customer demand.
Today, the value that a manufacturer offers its customers is more important than having just the lowest overall price.
About the author:
R. Michael Donovan is the president of R. Michael Donovan & Co. Inc., an international management consulting firm. Contact him at 508-788-1100 or firstname.lastname@example.org. The firm’s Web address is www.rmdonovan.com.