Does Higher Inventory = Lower Customer Service?

by Dave Garwood

Every sales person's worst nightmare is the dreaded inventory reduction program. Intuitive reasoning can lead them to believe that lower inventory will result in bare shelves and unhappy customers. It just seems logical! Most inventory text books validate the less inventory fear. The books are loaded with formulas and full of charts showing graphs of how much more inventory is needed to get higher fill rates and thus, happier customers. Unfortunately, experience proves the opposite. As inventories rise, customer service usually dives! Conversely, as inventories shrink, customer service improves.

What's Wrong with the Theory?
So where does the "gut feeling" and inventory theory break down? First, intuitive thinking assumes that the inventory on the shelf somehow magically matches what the customers want. Since the customer wants delivery in a few days and it takes a few weeks to buy material and produce the product, most of the products on the shelves were put there after looking into a crystal ball -- anticipating what specific flavor the customer might order. Need I say more? What if the forecast is high on the Red ones and low in the Blue ones? We end up with excess Red inventory and run out of the Blue ones ... high inventory and low fill rates. A bunch of the wrong items and not enough of the right ones end up on the shelf. Adding to the inventory of the wrong ones won't help.

Second, the calculations in most inventory theory books focus on determining how much buffer (also called safety stock or kanban size ) is required to absorb demand variations around a planned "average" demand while waiting on the next delivery to the warehouse or stockroom. This assumed the "average" demand was close to the right number. Big assumption! In fact, most companies do a poor job of planning demand and the actual demand over a period of time can often be 25-50% above or below the "average." Safety stock won't likely buffer this variation. And if we bought and produced to the higher demand, we are stuck with excess inventory when the actual demand falls short.

Certainly, demand variations are one consideration for determining the inventory needed. However, the inventory we actually end up with in the warehouse is caused by many more factors. These other factors are usually the major inventory drivers. Inventory in the warehouse is a by product of the how well the processes that manage these drivers are managed.

A Simple Look at the Inventory
The inventory we see in the warehouse and on the balance sheet , i.e. level in the tank, is simply the difference between how much went in and how much came out of the tank!

The three primary inventory drivers are:
1. the demand plans
2. the planning parameters, such as lot sizes, lead times and manufacturing process
3. the supply plans

These three drivers determine the inventory flow into the pipeline and fill the tank. Shipments drain the tank. We really can't manage the level in the tank -- and thus inventory. We can manage the processes that manage demand, manage supply and establish the planning parameters. These are the real handles on managing the inventory. When these processes are poorly managed, high inventories of the wrong stuff and bare shelves of the right stuff is the result.

Managing Demand Plans
The acceptable customer delivery lead time is established by competition. The time it takes to make the product is a function of planned lead times -- usually mostly supplier lead times. The customer delivery lead time and planned lead times (often called time fences) are independent variables. The customer delivery lead time is almost always less than the time it takes to buy material and make the product.

When this happens, forecasting is absolutely required. We can debate who does it and how. We can and should debate what level of detail to forecast. We can and should debate how many products or options we should offer for quick delivery. But the debate of whether to forecast or not is over. Managing the total volume in the forecast is part of the SOP process. Managing the product mix is part of the Master Scheduling process. (See our Hot Info archives for more information on both). Mismanaging either of these processes results in too much inventory of the wrong products, components and raw material of some things and not enough of others. Lack of confidence in the demand plans sends the organization into chaos .... everyone independently develops their own demand plans. The solution is to raise the effectiveness of the SOP and Master Scheduling process. (See our Bookstore for details on our SOP Starter Kit).

Managing Supply Plans
The Supply Plans determine the amount of material put into the supply chain and eventually on the warehouse racks. The Supply Plan should reflect what we would like to do, i.e. satisfy the demand plans, and also what we can do, i.e. respect realistic supply chain constraints. When the Demand Plans are optimistic, the Supply Plan will drive excess inventory into the supply chain. However, not all of the Supply Plan problems are rooted in the quality of the Demand Plans. An equally frequent problem is Supply Plans that are "front end" loaded or cause a Required Capacity that exceeds the Demonstrated Capacity. These problems become worse when the product requires several items to come together for assembly or finishing. The worst condition is to have all but one component. The shelves are loaded with all the inventory needed to make the shipments -- almost! Inventory piles up waiting for the few missing items. The solution is to have an effective closed-loop planning process. This means not only resolving the conflict between the Required and Demonstrated capacity, but conflicts between due and need dates. (See our Hot Info archives for more information about managing capacity and closed-loop planning).

Planning Parameters
Consider this situation: the need is for 3 units this week. But the supplier (or work cell in our plant) requires a minimum of 30 to be made to keep the cost reasonable. This is the lot size. When we get the 30 and use 3, the rest sit in inventory, waiting. When the 30 lot size grows to become 300, we have a bunch sitting and waiting -- not helping at all with fill rates. The result? Higher inventory and no increase in customer service. The solution? Drive the lot sizes down until they can economically be produced without any minimum. Certainly not an easy, quick job, but it can and has been done. A reasonable target -- reduce the average lot size in half within 6-12 months.

Long supplier and internal manufacturing lead times cause several problems. The longer lead time means we have to make supplier commitments based on a forecast further in the future. This forecast is certain to be less accurate. Longer manufacturing lead times require the raw material and purchased components to arrive earlier. Both add to inventory and give zero contribution to improving customer service.

Do we need to make or buy more? Depends. Once we know how many we need, we need to know how many we already have in inventory before deciding. When the inventory records are poor, many of these decisions are wrong. We make more when should have and don't make any when we should have. Get the picture? Same old story -- inventory up and service down. The solution -- fix the inventory recordkeeping process. (See our Hot Info archives for more information about how to keep high-quality inventory records).

Some manufacturing processes require material to move in batches and wait between operations. The Work-in-Process (WIP) piles up. Lead times stretch out. Inventories rise. Service is not improved! The solution is to "lean" the process. Establish flow lines or cells to keep the material flowing.

The Final Word
The overall message is simple. The companies who Spin (as opposed to Turn ) their inventory don't manage the inventory. They focus on the processes and planning parameters. Lower inventory and higher customer service is the result. Try it!