An Inventory Quote and Story: Educational Lessons on Root Causes and Controlling Inventory
You may be trying to control the wrong thing, and that may be sinking your ship. That’s why you must look for the rocks and remove them rather than smashing into or avoiding them.
Steve Johanson, who founded Starboard and is now an SVP with Logility, inspired this post with a comment he left on LinkedIn. He frequently uses this mantra: “The lower you set your safety stock targets, the higher your actual inventory becomes.”
I interpreted this to mean you can set your safety stock targets as low as you want. However, if you have diligent inventory managers, they’ll ignore those targets and order even more.
This reminded me of a story I heard in grad school in the ‘90s and still use.
It was told by a Kellogg MBA student who worked for a well-respected Fortune 100 manufacturing company. One weekend, the CEO read about the benefits of just-in-time (JIT) and low inventory. (JIT was quite a hot topic then as companies were trying to figure out Toyota’s magic formula).
The CEO decided to reduce inventory by 90%. This was easy. The company stopped ordering (or making components) and drained the existing inventory. (Granted, in the telling, the story might have been exaggerated. But these types of stories were common back then.) So, as the story goes…
Pretty quickly, manufacturing output dropped by 90%; they didn’t have all the components to make the final product. But this was viewed as just part of the process. A popular Toyota lesson was that inventory was like a river. When you lower the volume of water in the river, you can see the rocks. The rocks were the problems in your process. So, you reduce the inventory to see the problems you need to fix.
However, in their excellent Factory Physics textbook, Hopp and Spearman say you can smash your boat on these rocks.
Since manufacturing dropped by 90%, shipments of final products fell by 90%.
Therefore, since shipments dropped, the revenue at the end of the month decreased by 90%. This caused them to drop the program. All the inventory (and more) came back to get sales back up. After that, no one ever mentioned the program again.
This story and Johanson’s quote have two lessons about inventory.
First, to reduce inventory and keep your business going, you need to fix the root causes. The root causes can be a high forecast error, lead times, lead time variability, batch sizes, and many other factors.
As Hopp and Spearman would say: Use science to find the root causes (the rocks), fix the root causes (remove the rocks), and then lower your inventory (so you don’t smash your boat on the rocks).
The second, more subtle lesson is that you can’t directly control inventory. This isn’t always intuitive to new students, executives, or people who haven’t thought about inventory. Inventory is physical and obvious – you can see, touch, and move it. It would seem like you would control it directly.
Instead, you control inventory with your orders or your production. And this is not an exact science. If the product doesn’t arrive on time or demand is high, you’ll be short on inventory. So, you have to build in a buffer as part of the ordering process. At a high level, you order more than you’ll need (on average), and those items will arrive sooner than you need them (on average).
The order timing and size are where the formulas come in. If you have a good formula, it gives you a reasonable estimate of how much you should order to protect against uncertainty.
Everything in this post is probably obvious to most readers. However, I posted this because we all have to teach new people and explain these concepts to executives.
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