Dr. Watson Says: |
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What Do You Say?
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Several years ago, one of my students who worked for a Fortune 100 company told the following story:
"The CEO mandated that the company reduce inventory by 75%. This was easy, the company reduced inventory by 75%. Problem solved, right? Well, production the next month slipped by 50%. Then, because they couldn’t ship orders, sales slipped by 75%. They raised the inventory levels back up and everyone pretended the program never existed."
What went wrong? Inventory was playing a key role in buffering variability and the CEO didn’t realize it. When something went wrong in the supply chain, customers had to wait.
If the CEO had realized that there are three ways to buffer variability in your supply chain, he might not have tried to just reduce inventory. As a reminder, you can buffer variability as follows:
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With inventory—when something goes wrong, you have a pile of extra inventory cover your needs
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With capacity—when something goes wrong, you run overtime or pay for expediting to cover your needs
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With time—when something goes wrong, you simply make your customer wait.
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Previous Columns by
Dr. Watson |
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A common supply chain buffer is inventory. This is one of the main reasons you have a distribution center that stocks inventory.
One problem that companies run into is that their inventory buffer is too small—like the mandated 50% smaller pile the CEO above recommended. When this happens, you will unintentionally revert to the other two buffers—you will expedite shipments or make your customers wait longer (and not book the sales).
One way to think about a good buffer is that it should be large enough so that customers who are served by this buffer don’t see any problems. You may have terrible suppliers, unreliable plants, and unpredictable customers. But, if you easily satisfy demand from inventory, your customers are none the wiser and think you are running a good supply chain.
You also don’t want to have too much inventory. If you do, you are tying up too much cash—cash you could use for new investments—and have too much in extra carrying costs.
To properly set your inventory levels, you should account for the major components that drive inventory levels such as expected demand and variability; supplier lead time and lead time variability, supplier service levels, your desired service level, and your batch sizes. With these inputs, there is commercial software that will calculate the proper inventory levels for you—that is the easy part.
One hard part is maintaining a good inventory buffer with the right level of inventory. For this, I’ve seen that is important for customers to put a strong process in place to reset the inventory levels every month or quarter.
The other hard part is that at some point, someone will complain that you have too much inventory. If you are setting your inventory levels correctly, the inventory isn’t the problem. The problem is that you have to too much variability in the supply chain. To reduce the inventory, go after the variability first and then reduce inventory later.
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