Do We Need Inventory?

POSTED: Apr. 26, 2017

Program ParticipantIt seems to be part of human nature to save things; just in case. We want something in reserve that we can fall back on. We like the security. Inventory can serve such a purpose in our workplaces. When we see work in process, we might feel encouraged that there is work to do. We might also feel a bit intimidated or overwhelmed.

Lean Thinking identifies inventory as one of the eight forms of waste. From a purist’s viewpoint, it is unnecessary and undesirable. Ideally, we want to make only what the customer wants, when he or she wants it, without defects, in a safe work environment. Let’s face it, however, most of our workplaces aren’t ideal yet. In our journey to the “Ideal State,” inventory may be necessary as we make improvements. But how much inventory should we have? Where and in what form should we have it?

Traditional manufacturing methods might identify an economic order quantity, or economic lot size, which would spread out the cost of set-up over a larger volume of parts. But what happens to those parts that the customer didn’t order now? They are placed into storage to be used to satisfy future orders, if those future orders ever come. If future orders don’t arrive, we end up with obsolete inventory to scrap. Scrapping product is painful and visible, but the time lost in the set-up and manufacture of this lot is gone forever. It could have been used to fulfill real, current customer orders instead! Perhaps some of us would be willing to gamble or risk the cash tied up in this inventory, but there is an alternative.

First, we need to decide the overall finished goods strategy. A “make to inventory” (MTI) approach would establish a “supermarket.” Predetermined quantities of parts would be stocked, and orders would be filled from this inventory which would subsequently be replenished. The advantages for the customer, if we have adequately sized the stock, are a shortened lead time and high service level (on time delivery). The inventory can also serve as a time buffer for the provider to more evenly spread production in a way that optimizes operations and smooths out variability in demand. In Lean vernacular, this is called Heijunka or level loading. The disadvantages for the provider is cash tied up in the inventory and a reduced connection or understanding of true, real-time demand.

Alternatively, we could select a “make to order” (MTO) approach and avoid the creation of “supermarket” inventory. Customer orders would be scheduled and produced upon receipt. The producer would have less cash tied up in inventory, but the customer would have a longer lead time from order placement to receipt of goods or services. The producer would have a direct connection to the demand, but this would make production more susceptible to demand variability. This variability could be smoothed by strategically establishing inventory of high volume, stable demand parts. This material could then serve as a time buffer when demand is high. The regular demand orders could be satisfied from inventory and the available production time could be focused on satisfying the short-term demand on the irregular orders. The strategic finished goods inventory of high volume, stable demand parts is another example of the Heijunka, or level loading, concept. We should avoid creating inventory of low volume, high variability demand parts as this would result in stranded or excess inventory, which will not be sold. The quantities produced on such parts should only be what are required to satisfy real customer orders, without concern for the “economic lot size.” This might raise alarm with traditional manufacturing thinking, because the set-up costs are not adequately absorbed. Lean Thinking, however, recognizes set-up as a waste to be reduced or eliminated. The “pain” caused by the unabsorbed set-up costs should drive continuous improvement activities to reduce set-up time. 

“Make to inventory” and “make to order” approaches, as described above, require some amount of inventory to operate properly. But, what is the right amount? How much is really needed? The answer is, it depends on your goals. Customers place orders for a quantity and a delivery date. Providers receive orders from multiple customers and strive to satisfy this consolidated demand as requested. The providers are constrained, however, by the capacity and lead time of their value streams. For a given value stream, demand level and demand variability, the service level (on time delivery), lead time and minimum inventory are interdependent. 

It makes sense to determine the service level and lead time based on the requirements of the market. If a provider isn’t satisfying the needs of the customers, the customers will find other providers that will. The minimum inventory needed to fulfill these needs is dependent on these two factors (service level and lead time). If the resultant inventory level consumes more cash than is desired financially, actions to reduce inventory could include: 

1)    Reduce service level or increase lead time
2)    Reduce demand or demand variability by working with customers
3)    Improve the value stream to be more responsive.

The Lean Thinking approach advocates improving the value stream by reducing the lead time and increasing the ability to handle demand variability. This is accomplished by reducing the batch or lot sizes to establish a shorter interval. The interval is the frequency that different parts are produced, or services are provided, within a repeating schedule. Reducing the interval means smaller batch sizes and this exposes the waste of set-up time and costs. Set-up reduction is necessary to shorten the interval. A shorter interval means lower inventory for a given service level, lead time and demand/demand variability. 

Inventory is a waste and it should be reduced or eliminated if possible. Arbitrarily doing so, however, can lead to instability and dissatisfied customers. Your Current State requires a minimum or “right-sized” inventory to meet the service level, lead time and demand/demand variability. The foundation of Lean and the House of Toyota is stability. Strategic determination of inventory, based on the appropriate finished goods strategy (MTI or MTO), establishes service and lead time stability for customers. From this stable platform, continuous improvement can focus on reducing the interval by reducing batch sizes and set-up time. 

It’s a never-ending journey to perfection. Enjoy the ride!