Today's post is about Inventory Turns. Most businesses understand the cost of slow turns. The capitalization requirements associated with slow moving inventory can eat a company alive. Since the cost of money is so well understood, many companies focus on inventory reductions to improve their bottom lines.
What is often unclear is the opportunity cost of having too little inventory. What happens when "Just-In-Time" (JIT) is actually LATE? In fact, this happens fairly often.
But Why?... Just-In-Time was developed as an outgrowth of the application of Lean Principles to Automotive manufacturing primary at Toyota. And the theory is sound. But there is often a distinct difference between JIT in Automotive and the rest of the industrialized world. Its a difference of scale.
JIT in an automotive plant or at a cell phone manufacturing facility is different than a factory that turns out product by the hundreds or even thousands. If you build garbage trucks, rock drills or CNC machines, you just don't rate. Now I will be the first to admit that its not a situation that ALWAYS exists, but it is much more the rule than the exception and you need to build this understanding into your business model. Here's why.
If you build garbage trucks, you'll purchase a few hundred truck/chassis combinations from your supplier. The engines in those vehicles are being supplied by the tens of thousands to the primary vehicle manufacturers and so are the electronics, and the hydraulics and all the other sub-assemblies that you'll need to complete the manufacturing process. Keep in mind that your sub assemblies are made up of your suppliers' sub-assemblies and so the opportunity for a missed critical path item grows geometrically with each complex part added. and failures in supply chain cascade.
Here comes the obvious problem statement... and the under-utilized solution. You cant sell product from an empty shelf... But you can build a model for the value of that lost sale.... And you MUST do so.
In manufacturing environments of limited volume, you have to track the sales you've lost. Most companies only track the wins (Revenue). But unless you know what you've lost and why you lost it, you cant value stream a solution.
At one recent establishment (who shall remain nameless), our lead times exceeded 90 days. It wasn't all that uncommon to go beyond 120 days. And we had no clout to demand better turn-around from our major suppliers. But we also didn't know the opportunity cost. To resolve the issue I implemented a lost sale log. At the end of one year, we knew we'd lost nearly $80 Million in orders from customers who couldn't wait. Even a company with the thinnest margins can reasonably claim they'd earn a 20% margin on those dollars so we'd given up $16 Mil in income. (OUCH)
Now I had a compelling story. The lost income was more than the cost of capital by a factor of 16. Whats more, we were then able to increase our inventory levels by just over $1 Mil in order to position ourselves for that growth. For the first time in decades, the company was quantifying the opportunity costs associated with increasing inventory turns. And it was not a desirable tradeoff.
As a Marketing Manager or a Sales leader, you have to speak to finance in terms they relate to. The same applies to other departments as well. If your audience is Engineering, understand the cost of quality in actual dollars NOT hurt feelings. Take the argument out of the emotional realm and translate theoretical costs into real dollars. We finally did it, and it translated into 20% growth and significant contributions at the top AND the bottom line. Good Luck
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