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Why Inventory isn’t always ‘Muda’ (waste)


Posted on: 15-03-2018 16:27:44163

Sometimes I can’t help raising my eyebrows when I hear financial managers and consultants complain about stocks. The financial managers typically see stock as ‘capital employed’, which they for good reasons like to see as low as possible. Capital employed is investment, and the higher the investment with a given return, the lower the return on investment. You will probably often hear the statement “Your stock is too high” from that corner.  They can be right, and they can be wrong and, given the proper arguments and logic, most financial people are open for discussion. My eyebrows tend to rise higher when talking to too dogmatic Lean experts and consultants. And, for the record, I do know many non-dogmatic, common sense thinking Lean experts.

Muda

In the Lean philosophy ‘stock’ is one of the eight types of “Muda”, a Japanese word for “waste”. A too dogmatic interpretation of ‘stock = waste’ implies that all inventory is evil, making inventory despicable, something you should not have. Then they propagate that all goods must be ordered demand driven (Pull), not forecast driven (push). Allow me to bring in some logistics thinking and common sense to this discussion. It may help you in your discussions with financial people and it is ammo against too dogmatic ‘Inventory is waste’ thinkers.

First, yes! One can have too much inventory, and too much inventory is waste. Storing stuff takes warehouse space and labor capacity, the stock can become obsolete, you must invest money in it, and so forth. Avoid holding too much stock.

How to recognize ‘too much’ stock

The question is “How can you recognize ‘too much’”?  By applying complicated Demand-Stock-Supply matching algorithms (as embedded in Every Angle by the way). But also by answering the question ‘Is it economically sensible to keep this amount of stock?”

From a cash viewpoint ‘economically sensible’ means “By holding this inventory I will receive more cash than when I don’t, and I will spend less then that surplus.” First simple rule, take all the cash effects into account, asking yourself ‘What are the cash expenses and cash receipts that I won’t have, when I would not keep the stock?’

Second rule, try to figure out why you are holding the stock? Let me comment on four reasons in this blog:

  1. You are storing lead-time reduction: your customers demand shorter lead times than the lead time you need to supply the goods (via purchase and/or production), so if you don’t keep stock of those products, you will not sell. The stock on hand allows you to deliver the goods within the requested lead-time
  2. You are storing production capacity:g. The summer demand for ice cream of an ice cream manufacturer may be higher than his production capacity. That capacity is available in the winter period. Putting capacity on stock is economically sensible when the stock carrying expenses (energy and space) are lower than the added value of the stored ice-cream (sales price minus cost of goods).
  3. You are buffering to neutralize uncertainty. Uncertainty is everywhere in business. Your suppliers can have fluctuating quality or lead-times, your production can suffer from the same issues, your forecast accuracy can be bad, and your customers can be quite frantic changing lead-times, specifications or cancelling orders. This type of variation (called Mura in Lean) is killing proper supply chain management. Reducing variation (one of the major principles of JIT and Lean too) is always smart. But sometimes it is impossible or too costly to eliminate the uncertainty (ice cream makers still cannot influence the weather). In these cases, a properly defined safety stock will neutralize uncertainty.
  4. You are storing ‘expense savings’. A pharmacy can be delivered two to three times per day by pharma wholesalers. Sounds like ‘no need to carry stock’. But what to decide when a big pharma company offers to provide a bigger batch at thirty percent of the wholesalers price, with no obsolescence risk (e.g. aspirins) and when the pharmacist ha enough room to store the stuff? Then, it would be economically insensible to say no. Buying the bigger batch puts the 30% saving on stock (remember, no obsolescence risk).

Having too much stock is not economically sensible, but so is having too little stock, by going too far and too dogmatic in the reducing waste business (called Muri in Lean). When properly controlled, the first three types of stock avoid having too little stock.

Root cause

It is also interesting to focus on the root causes of being stuck with stock. ‘Because of stupid decisions!’, is often claimed. My observation is that this is not that often the case. More likely causes are erroneous master data and operational data. Master data parameters as minimum order quantity, order point and safety stock must be maintained and kept in balance with reality for hundreds to thousands of products. Parameters heavily used in the demand-supply chain algorithms (e.g. MRP). When these master data parameters are dubious, so will be the algorithms output. The same goes for operational data, such as purchase orders, production orders and sales orders and erroneous stock levels. We often find old open orders still reserving inventory in SAP, for example. You should realize that these calculations are automatically executed by the MRP system, on thousands of materials, sales orders, production orders and purchase orders. A couple of human eyes cannot simply oversee this complexity. Figuring all of this out requires complicated and solid algorithm logic, specifically tuned to your ERP system.

Every Angle delivers this knowledge and algorithms out-of-the-box for an SAP ERP driven company. And I am also convinced that you will take more sensible inventory decisions answering the questions presented above. Know more, act faster!

Jacques Adriaansen 
Business Improvement Thought Leader


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