The Beauty and Horror of your Inventory

Ryan Anderson
February 18, 2015
I’ve met more than a few businesspeople that seem to love their inventory. While in a few very specialized businesses inventory can be a real boon, in most it’s an insidious drag on the whole business. Several of my colleagues have cited the value of avoiding a stock out at all costs. In those few businesses with an exceedingly high cost of stock out, they may be justified in carrying some inventory. Otherwise, inventory is the devil.

There are Three Main Types of Inventory:

Work In Progress (WIP) – Anything you’ve started working on Raw Goods – The raw material you make your product from. Finished Goods – That beautiful finished product that you eventually sell to a customer  

Work in Progress

Generally, one of the worst pieces of inventory a business can carry is work in progress inventory. Work in progress has not only consumed raw goods, but used up labor time, is clogging up the production floor, and it’s begging to get lost, stolen, or damaged. I know I’ve found a client that needs my help when I walk into their plant and see Work In Progress (WIP) all over the place. WIP reduces your on time delivery and directly drives up you material handling costs (Somebody has to go find that piece of WIP you were working on last week once you’re ready to finish it). And lest all of you office jockeys think you can laugh this off: Business processes have WIP too. Loan applications, PCRs, bills, and almost any form sitting on your desk can all be looked at as a form of inventory (granted they don’t require significant capital investment, but they use up VERY expensive labor hours). Remember the last time the accountant told you he’d address your new red hot issue once he’d finished entering the bills for the week? Yep, those bills were work in progress preventing the accountant from responding to customer (your) demand. Most of the traditional lean techniques applied on the shop floor can be modified to help improve flow in an office environment.  

Finished Goods

Finished goods is often cited as ‘good’ or ‘liquid’ inventory. I beg to differ. That’s money sitting in a warehouse that you are paying interest on. Many businessmen confuse the cost of a stock out (the proverbial shelf goes empty) to a missed sale (customer asked for it, but couldn’t get it). Stock outs don’t have a cost unless a customer came in to buy whatever it was you were stocked out of. Not that I encourage stocking out, but for items that turn a low volume, stock outs probably ought to happen somewhat regularly. This pushes you towards what’s known as a build to order system, which is usually very efficient.  

Raw goods inventory

Raw goods inventory is still inventory. In some industries, the savings achieved when you buy in bulk offset the cost of the capital invested. But, I encourage all of my clients to examine that assumption very closely. If you’re buying in bulk, then there is a high probability that you are buying a commoditized product. In such cases, see my thoughts below about vendor managed inventory. Vendor sales people often temp us with volume discounts and encourage bulk purchasing because it isn’t their capital that gets invested. There are many ways you will hear about to kill your inventory. Personally I always smile when a client assumes that they need to by a bunch of computers and barcode scanners to control their inventory. While technology is the best solution in some cases (usually involving a large number of Stock Keeping Units (SKUs), or multiple storage locations), in many cases the thousands of dollars required to implement a complex computerized system isn’t needed. When Kiichiro Toyoda started implementing lean, he didn’t go to computers. He used things like color coded index cards. Personally, I’m a big fan of the low tech methods early in the lean process. In the early going, things are changing so rapidly that it can get expensive if you keep trying to modify the computer system. That said, if you’re Amazon, or running a dozen warehouses with thousands (if not millions) of SKUs, you need computers and barcode readers. If your raw goods inventory is a highly commoditized product, and on any given week three potential vendors are calling trying to sell you some. The good news is that your vendors want to build a closer relationship with you, and they’ll probably be willing to consider any measures required to strengthen their incumbency. So, given that you’re in a position of strength, use it. Ask your vendors to come in and take a look at the facility, see if they have suggestions about how you could better manage your raw goods. Keep in mind, they see at least dozens of other plants using their product. You’d be surprised what they might be able to suggest or do for you. A few vendors will probably mention vendor managed inventory. This would be where they take responsibility to keep your shelves full, and you simply pay for inventory as it comes in the back door. Vendor managed inventory can be a great solution for some businesses, if the vendor is good at it. The real game changer however, is vendor consigned inventory. To take raw goods on consignment, you’ll usually have to submit to vendor managed inventory. But the advantage here is that despite what is sitting on the shelf, you pay for the raw goods as you use them. That bundle of steel might have sat on your floor for a month, but you don’t pay for it (i.e. invest capital) until you load it into a machine and do something with it. If your vendors won’t consign inventory to you, maybe it’s time to take a few of those phone calls and see if one of the other vendors who always want to buy you lunch can make consignment happen. That said if your input inventory is something with a limited supply base (think aircraft parts and high voltage circuit breakers), you can largely ignore this paragraph. Your vendors probably won’t play ball, but it can’t hurt to ask either. The most efficient way I’ve found to attack Work In Progress Inventory is through a long and dedicated lean implementation journey. If nobody at your company knows what that means, scores of consultants like myself will be happy to help educate you, and help start you down the road to lean. Lean implementation addresses many issues in both the manufacturing and office environments, with inventory being only one. But, properly implemented, lean can make a huge difference in a business. While inventory is a temping security blanket, many clients simply don’t see all of the time and money they have invested on their own floor. Instead of addressing organizational inefficiency, they simply throw inventory at a problem. They try it the first time, and it works, then they keep doing it. The next thing they know, they’re calling me complaining about overtime costs and insufficient credit lines. Don’t let the devil take you, keep your inventory as LOW as possible.

About the Author

Ryan Anderson

Ryan Anderson is a consultant based out of Greensboro, NC. Ryan has worked for companies in the Fortune 200 to mom and pop businesses. In prior positions he's worked in oil and gas, aerospace, electrical distribution manufacturing, and SCUBA shops. His expertise includes operations management and strategic planning.

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