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Inventory is the necessary evil of manufacturing. While generally speaking, having less inventory is better than more inventory, the true overarching goal is to have the right inventory, in the right place and in the right quantity, to enable the steady flow of production activity and customer order fulfillment.
Manufacturing inventory generally comes in three flavours: raw material, work-in-process and finished goods.
Raw material is just that – raw. This is the stuff that is purchased from suppliers and generally is either in-transit, or in storage at the manufacturer. The big issues with raw materials are determining how much to buy, and when to buy it. The best scenario is when your customer gives you four weeks to fill an order and you can buy materials and make the product in less than that time. In this case, you simply buy exactly the required amount of raw materials. The other extreme is when you have to purchase materials and make product based on a forecast. If it takes 12 weeks to purchase raw materials and four weeks to make your product, this means that you have to forecast at least 16 weeks out as to expected sales and associated raw material needs.
Forecasting is something that most manufacturers find to be a challenge; after all, predicting the future can be tricky. However, the process of forecasting can be improved, mainly be recognizing that it is a business process. Effectively incorporating historical sales data, together with future demand intelligence and current sales activity, can lead to better forecasts.
As well, improving the communication between the sales team and the production team through something called Sales and Operations Planning (S&OP) is another tactic that improves forecasting and raw material purchasing. For example, it’s not uncommon for sales to change the forecast or promise customer delivery of product without consulting with production to see if what they have promised can actually be delivered. If it takes 12 weeks to buy raw material, then changing the forecast for eight weeks out doesn’t really make sense!
So, with raw materials, we want to minimize the amount (investment) while ensuring that there is enough to satisfy customer demand. This is done through better planning/forecasting and reducing lead times. If purchase lead times can be reduced from 12 weeks to six weeks, and if manufacturing lead times can be reduced from four weeks to two weeks, this reduces the amount of forecasting (from 16 weeks out to only eight weeks) you have to do.
Another thing to consider when looking at raw material is the comparison of inventory to consumption. If a manufacturer consumes $12 million a year of raw material, and they have $3 million of raw material inventory, this suggests that they have three months worth of inventory and that they turn their inventory four times a year. At the same time, if the bulk of their raw materials can be purchased within, say, three to four weeks, this begs the question, “why do they have three months of inventory on-hand?”.
WIP is material that is in some state of being transformed from raw to finished. WIP may be in this state for just minutes or days or weeks.
Ideally, material is in this state for as little time as possible. If it takes four hours of actual work time to convert raw material to finished goods, yet the WIP phase lasts for days or weeks, then this suggests that there is lots of waste/delay in the production system. This is where Lean Manufacturing comes into play to help eliminate the “cause for the pause”.
Some common WIP issues include tracking WIP and assigning a value to WIP. The longer WIP is WIP, the more complex it is to keep track of it. As for WIP costing, this requires accurate bills of materials and routings, to keep track of the material consumed and the labour and machine time invested.
This is what is sold to the customer. Having just enough to enable order fulfillment is the objective, without having too much that is simply money on the shelf, and is at risk of becoming obsolete or expiring (i.e. food items). There’s also the issue of physical warehouse space to store these materials. And, in some cases, storing finished goods in multiple locations to enable quick customer delivery.
Again, if the manufacturer has the equivalent of four months worth of finished goods, it begs the question of “why?” As well, if the percent of customer orders that can be filled from finished goods is less than 100 percent, yet there are lots of finished goods, the issue begins to look like one of having too much of the wrong inventory. Typical root causes include poor forecasting and a disconnect between sales activity and production activity. Like when dealing with raw materials, the forecasting process can be improved and a S&OP can help to keep Sales and Production on the same page.
Another variation of finished goods inventory is semi-finished goods. This is stuff that is kept in some bulk form then is finished to fill specific customer demand. This last step might be packaging, where orders for the 100 gram package of, say, salami come in and are filled by taking one kg salamis and slicing off 100 grams and packing. As it’s easier to forecast the overall demand for salami versus the demand for 100 gram, 250 gram, 500 gram and other package variations, it can be a smart strategy to hold semi-finished product to provide greater flexibility.
As discussed above, managing inventory and ensuring that you have the right inventory at the right place and time can be a significant challenge. Inventory is the result of manufacturing planning (forecasting, etc.) and execution (purchasing, production, etc.) Therefore, improvements to inventory necessarily require improvements to manufacturing planning and execution.
The task is to determine the root causes of inventory issues and then to make the right corrections, be it process, systems or people.
At times, manufacturers will know that they have inventory issues and they will already be searching for solutions. Getting to the real root cause is critical;it is often not done well and that can mean the coming up with the wrong, or temporary, solution. (e.g. looking for a new ERP system to help manage inventory when the root cause might be poor forecasting). At other times, manufacturers will just assume that they need all the inventory they have to run their business. They haven’t questioned why they have four months of raw material when the average lead time is three weeks, and so on.
A good question for manufacturers to periodically ask is: “Why have any inventory at all?” Of course, some inventory is required, but it should be by design and not “just because.”
Another good question is:, “How big of a deal would it be to be able to run my business with 25 percent less inventory?” This usually prompts an increased focus on inventory reduction opportunities.
I once heard an invest analyst say that “inventory management is an indicator of management competency.” It’s easy to have too much inventory and not enough of the right inventory. In contrast, it takes some skill and sophistication to do a good job of inventory management.
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