Business Management

Inventory reduction can be one of the most powerful and value-adding activities that a company can undertake. This is because inventory reduction generates cash, just as sales or cost reduction activities generate cash. This cash is just as real and just as valuable to the company as cash that is generated through sales or cost reduction.
When the inventory being held is indirect inventory (that is, it is not being held for manufacture and, therefore, automatically moving through the supply chain), then the benefit is even greater. With MRO inventory, it is possible that some inventory will never be used and will only ever be a cash drain on the company.
So why do so many companies allow their indirect inventory to be a ‘fat and lazy’ investment? Why do they not apply a simple process that safely minimizes their investment? There may be several reasons.
First, there may be limited knowledge of the alternatives. Many companies think that optimization using software is the only solution. However, companies that do apply optimization software may be achieving less than 1/7th of their inventory reduction potential. There may also be a lack of resources to conduct an inventory reduction program. However, in the author’s experience, once the potential to generate cash with zero capital investment is understood, then the resources can always be found.
More likely companies are prevented from taking action because of the beliefs and assumptions that they make about inventory reduction. These beliefs and assumptions are truisms that can (and do) destroy a company’s wealth by allowing an over-investment in inventory.
Five common truisms have been identified. These are called the 5 Myths of Inventory Reduction. To successfully effect an inventory reduction program, a company must recognize these myths and then deal with them every time they are raised as being the reason for inaction or lack of progress. Like all good truisms, they are each based on an element of truth, but they are not universally true. And like all management myths, they work to prevent effective action.
The impact of these myths is that they limit the ability to fully realize the potential opportunity of inventory reduction. Therefore, they limit the cash that may be realized through delivering a successful program. Recognizing these myths and applying appropriate management solutions to overcome them will help you to deliver sustainable inventory reduction. The Five Myths of Inventory Reduction are:
Economic quantities save money.
Risk must be re-evaluated to reduce inventory.
Consignment stocks must cost more.
Software will solve the problem.
Putting items into inventory shares the cost.Myth #1: Economic Quantities Save Money.
In inventory management, items often get ordered in an economic quantity so that the cost per item is at a minimum. This way of ordering is seen to be economic because the subsequent issue cost of the item is at a minimum and the business, operational, or project budget subsequently records a lower cost. The term economic order quantity is often used. Ordering in this way is not economic, however, in situations where the items are not used, where they are written down as slow moving, or where the holding cost ultimately exceeds the procurement saving. Determining the true economic position of holding spares requires a consideration of the total company cash cost, not just the departmental or project charge.
Myth #2: Risk Must Be Re-Evaluated To Reduce Inventory.
Reducing holding quantities in inventory is often seen as requiring a corresponding increase in risk. The risk might be the risk of a lost sale or, in manufacturing, the risk of extended downtime. How often have you heard someone say ‘We need our inventory or we won’t make sales’ or ‘We need our inventory or our downtime will go through the roof’? Some companies believe that inventory can only be reduced when their maintenance systems are sufficiently sophisticated that they can predict demand or they have eliminated unplanned failure. (Many vendors also work hard to perpetuate this myth.) Both of these positions implicitly assume that the existing holdings are as lean as they can be in the current operational dynamic. While it is possible that this is true, experience shows that it is unlikely.
Myth #3: Consignment Stock Must Cost More.
Arranging to only pay for items at the time they are issued for use is referred to as consignment stocking. With consignment stocking, the supplier owns the items, even on your premises, until your team issues or uses them. As the supplier must now finance the stock and accept the inventory risk, it is often believed that additional costs will be passed on to the purchaser. This is not, however, always the case. Gaining control of stocking gives the supplier many more options to be proactive in the management of the supply chain. They can schedule manufacturing and deliveries to suit their timetable rather than be reactive to your purchase orders, they can draw on a wider network to manage safety stocks, and they can even draw against your holding to supply other customers. The flexibility of consignment stocking can provide the supplier the opportunity to reduce supply costs through improved manufacturing and supply chain efficiencies.
Myth #4: Software Will Solve The Problem.
Almost everybody realizes that software alone does not provide a solution. Yet, many companies, when faced with an inventory reduction program, see the need for a new software solution as being a key prerequisite. Sometimes this software is inventory management software and sometimes it is the use of a new tool such as optimization software. Data availability and visibility are key requirements of inventory reduction, but software is only a tool. Like all tools, it needs to be used properly and in the proper context. Ongoing inventory reduction is achieved by a combination of culture, knowledge, and data availability. There are any number of examples where the same software exists in different parts of the same company and yet vastly different results are achieved.
Myth #5: Putting Items into Inventory Saves Money.
Adding an item to inventory is sometimes seen as way of spreading the cost of the item so that the original purchaser can get a lower charge to their budget. Managing budgets in this way is particularly relevant with project and engineering items that have a minimum order quantity. Myth #5 is similar to Myth#1: Economic Quantities Save Money, except that the focus here is not on purchasing efficiencies, but rather on operational or project budgets. Ordering items where the delivery is in excess of needs and having the excess put into inventory reduces the direct cost to the immediate budget. Managing the purchase in this way has the impact of appearing to save money, but it does not change the actual cash cost to the company.
Summary
Achieving sustainable inventory reduction relies upon the implementation of new management practices, measures, and reporting to drive new behavior. As in most areas of management, however, there are truisms that often prevent action, or worse, give the appearance of action but no sustainable benefit. These are called the 5 Myths of Inventory Reduction. These myths have the dual impact of adding to the inventory investment and preventing action to achieve sustainable reduction. Overcoming these myths requires a universal recognition of the cash impact of inventory and an understanding of the behavioral issues that impact management decisions. Only after these myths are recognized and overcome can sustainable inventory reduction be achieved.