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Don’t Swing Between Just-in-Time and Just-in-Case. (There’s a Better Framework.)
I understand that shortages can drag down revenue, but excess inventory can drag down your bottom line even more. Here’s why.
Whenever a natural disaster causes product shortages, you’ll hear people say that supply chains need to move from just-in-time to just-in-case.
The implication is that the supply chain was too lean and didn’t have enough inventory to meet the unexpectedly rapid increase in demand.
Coming out of the pandemic and other recent events that have disrupted supply chain flows, some companies took this advice and have started building up their just-in-case inventory. But as those triggering events are resolved and urgent demand decreases, I’ve heard that just-in-case inventory is often viewed as excess and obsolete inventory.
In other words, just-in-case inventory can quickly become a drag on financial performance.
Unfortunately, the terms just-in-time and just-in-case are catchy but don’t give us real guidance. Here are two misconceptions that lead us astray.
First, “just-in-time” is now used to just mean keeping a bare minimum amount of inventory. But the idea came out of Toyota’s overall lean manufacturing strategy. In the overall lean manufacturing approach, Toyota’s leaders did hundreds of things that allowed them to run efficiently with low inventories. But if firms just implement low inventories without understanding all the other aspects of the system, it will cause problems.
Second, when some suggest the need for “just-in-case” inventory, it often comes with the hidden assumption that it would have been easy to predict what was needed.
There is a great line toward the end of Goldratt’s The Goal where they are talking about how to win a big deal. The sales leader says “...if we had only had the foresight to build a finished goods inventory of Model 12’s while we had those slow sales months…”
By this point in the book, the lead character is smiling to himself knowing that they have warehouses full of products that they’ll never sell. They never would have guessed to make this product.
Hopp and Spearman’s great textbook Factory Physics suggests a better way to think about this problem in one of its laws: “Variability in any production/operations system will be buffered by some combination of inventory, capacity, or time.”
In other words, you’ll buffer against variability by having inventory, having capacity (to quickly recover when there is a problem), or with time (by making your customers wait for you to recover).
For example, if you don’t buffer against variability by having inventory or extra capacity, it will default to time. (You just won’t be able to meet demand). You don’t get a free pass.
Also, the more variability you have, the larger your buffers need to be.
I think it is important to think about your buffer strategies for normal times vs. natural disaster times.
In normal times, you experience variability because demand forecasts aren’t perfect, machines break down, shipments are late, and so on. In normal times, inventory is a fine buffer. You might keep a few weeks or a few months of supply, but it doesn’t create an unusual drag on your supply chain.
In this case, you don’t reduce inventory by carelessly implementing a just-in-time system. Instead, the observation above suggests that you work to reduce all the sources of variability, and inventory can naturally settle at a lower point without impacting your business. And, by the way, this is what Toyota did over many years.
In natural disaster times, the variability is extremely high. That is, demand for certain products may go up by 10X, or all the ports, factories, suppliers, and/or regions shut down.
It is in these times when I hear the most about just-in-case inventory. But the variability is so high that the amount of inventory that would have been needed could easily turn into a financial problem that threatens the existence of the company if the event doesn’t happen.
That is, if a company builds inventory for these situations, there is a good chance that the inventory will be for the wrong product, go obsolete, be damaged, spoil, or bankrupt the company before it is ever used. For example, Clorox Wipes saw a sudden increase in demand of 500% in 2020. Yet, in 2010, company leaders had started to fill warehouses just in case demand increased by 5X, as that would have been too big of a drag on the company.
Instead, the Factory Physics law offers another way to look at the situation. Since these variability events will happen, we still need to choose the buffer.
Toyota offers a good example. In 2016, the WSJ wrote an article after an earthquake shut down suppliers, causing a production halt. Japan has been hit by a lot of earthquakes. You might think that Toyota would naturally adopt a just-in-case approach.
Nope.
Instead, Toyota was good to have a small buffer of time – company leaders were willing to halt production. And their big investment was in extra capacity. They said: “...we have been focused on how to understand and identify issues in case of a problem, and how quickly we could recover.”
Being able to quickly recover means having alternative sources of supply, having ways to shift production, and making an investment to understand critical suppliers deep in the supply chain. None of this is free, but they thought this was a better investment than excess inventory.
Every case will be different and requires hard work to create a strategy. There are arguments to be made for stockpiling some critical raw materials. But the point is that you shouldn’t shift to just-in-case inventory without thinking through all the ways to build in extra capacity to react to natural disasters.
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Want to hear more experts' take on how to right-size inventory? Check out these conversations:
- Ask the Experts: Supply Chain Disruptions are Making It Hard to Manage Inventory. But are There Certain Tools or Tactics That Could Make It Easier?
- KAIZEN and the Art of Inventory Improvement
- If You Dread Having “Dead Inventory,” Consider This
- The (New) Best Way to Optimize Inventory Performance in the New Normal
- Retail’s Big Dilemma: Excess Inventory
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