Excess inventory is experienced by nearly every manufacturer – and it’s a big problem. Inventory is one of the 7 Lean Mudas (Japanese term for ‘waste’). It leads to an inefficient supply chain that is riddled with waste, which in turn reduces profit, customer satisfaction, and everything else lean manufacturers work to improve.
COST OF EXCESS INVENTORY
According to Chris McLaughlin at LeanCor, a lean consulting company, Inventory Carrying Cost (ICC) is estimated to be an astonishing 18-25%. Now think about all of your inventory. If you have $1,000,000 of inventory sitting in your warehouse or manufacturing facility, you could be paying a whopping $250,000 per year! In this scenario, just reducing your inventory by 10% could save $100,000/year. If you are a large manufacturer, your facilities and suppliers might have millions of dollars in inventory savings available. Clearly, optimizing inventory levels should be a high priority to any manufacturer and supply chain. Keep in mind that it is not always in your supply chain’s best interest to reduce inventory. It is important to perform a cost-benefit analysis of the potential savings you will gain from reducing inventory vs. costs that might be incurred from reducing inventory.
We now know the potential costs associated with having an inefficient supply chain with excess inventory, but what causes this problem? There are a number of root causes that could be the culprit. Every supply chain is different, and it’s up to your organization to determine the root causes that exist. Some example causes of excess inventory are the following:
- • Long lead-time & high lead-time variation
- • Poor safety stock calculations
- • High demand variation
- • Lack of collaboration between you and your suppliers
- • Large number of obsolete parts
- • Poor forecasting techniques
Oftentimes, excess inventory is a combination of all of the above, plus more!
The process of determining the root cause of your excessive inventory is extremely important because without a root cause, you can’t create a plan and you have no direction (or in other words, you’re a chicken running around with its head cut off.) At this point of the process, a Plan For Every Part (PFEP) incorporating supplier collaboration becomes extremely helpful. Crucial information regarding lead-time, demand, demand variability, order quantities/cycles, and space-planning metrics will help your organization to determine the problems in your supply chain leading to excess inventory. If unsure how to approach the problem, the Lean Six Sigma methodology of DMAIC (Define, Measure, Analyze, Improve, Control) should be considered.
In an ideal world, you and your suppliers would have instant and accurate information flow. This premise applies to in-house suppliers (for example one line to another line), as well.
THE INVENTORY QUALITY RATIO
The Inventory Quality Ratio (IQR) is a technique to measure inventory performance that can be used to identify opportunities for inventory optimization. IQR is a simple calculation – it measures the active inventory divided by the total inventory. By doing this, you discover how much of your inventory is just “sitting” there. IQR is used by many companies around the world to reduce inventories by millions of dollars.
A quick explanation is given by David with LeanPlanet.org (plus a bit of paraphrasing):
First, divide your inventory into four quality categories:
1. Active – Items with future requirements and current usage
2. Slow Moving – Items with future requirements but no usage for 6 months
3. Excess – Items with no demand and no usage for 6 months
4. Obsolete – Items with no demand and no usage for 12 months
Second, determine the dollar amount for each category. Now, divide the cost of Active parts by the summation of the cost of all of your inventory parts to get your Inventory Quality Ratio – in other words, this is just the percent Active parts. The average is around 40-45% starting out.
Now you can drill into each item and work to discover the problems that exist and make changes.
Having easy access to standardized and accurate data is an important first step in nearly every supply chain problem. Seamless collaboration between you and your suppliers is a must when wanting to reduce inventory.
loopPFEP, Loop Supply Systems’ web-based PFEP software, is all of this and more.
With loopPFEP, it is easy to discover the root causes associated with your excess inventory by viewing KPIs (Key Performance Indicators). You can then use these KPIs to track your progress in fixing the issues at hand. An example of using KPIs for inventory reduction is the following:
Imagine your company’s largest manufacturing facility is experiencing issues with excess inventory. It’s costing you thousands, if not millions of dollars a year in waste and lost production.
Your lead Manufacturing Engineer has a hunch that it’s from excessive lead times at some of your larger suppliers. Using information that has been gathered and entered into your highly accessible PFEP application, you quickly create a report that compares the average lead-time of your suppliers to the industry average.
Just as your Manufacturing Engineer thought, there is a huge problem with many of your suppliers’ lead-time. You can now work on improvements using other tools provided by loopPFEP. Now, utilizing your newly created KPI, you can monitor your work and gain insight into whether or not you are making the necessary improvements.
In the above example, loopPFEP is the ideal candidate software solution because of the ease at which each member of the supply chain can work with the same set of data. Spreadsheets aren’t going to help you when 10 people need to work on the same set of data – five of which work at separate suppliers’ facilities. You need a standardized and centralized set of data, and that’s what a web-based PFEP that shares data with all members of the supply chain will do.
Since all of the data is already in your web-based PFEP application, you can even view your Inventory Quality Ratio and begin to make changes to your inventory. loopPFEP interfaces with your ERP & MRP systems to determine future demand, allowing for the IQR calculation to be made and displayed to whoever is allowed access to the data.
One of the hardest parts of maintaining inventory is simply knowing your inventory. Inventory counts are labor intensive and costly. Wouldn’t it be great if you could just monitor your inventory online? Well, that’s exactly what Loop Supply Systems’ loopTrack can do. By having access to future demand of parts in loopPFEP, we can setup an auto-notification system to notify you when you’re ordering a part that falls into one of the IQR categories other than Active. This allows you to keep your inventory at an optimized level — with less manual work.
About loopPFEP & loopTrack
loopPFEP is a web-based PFEP application that promotes supplier collaboration and creates the ability to share part and logistics data throughout your entire supply chain. Analyze, optimize, and implement improvements in your supply chain to receive cost savings to your bottom-line. View part capacity information from your suppliers months in advance!
loopTrack is a web-based packaging management solution designed for real-time packaging and inventory visibility throughout your entire supply chain. Incorporated with the latest RFID technology, loopTrack can hear the movement of packaging — eliminating the manual effort needed for locating and scanning barcode tags.
Check out “Returnable Container Tracking with RFID“, our most recent blog post!
ADDITIONAL INVENTORY REDUCTION RESOURCES
Keep in mind that continuous improvement is a key feature of a lean manufacturing environment. To permanently maintain inventory at satisfactory levels, continuous improvement efforts must remain a top priority.
Here are some additional resources that might help you on your Inventory Reduction Journey:
• Reducing Excess and Obsolete Inventory with Lean Six Sigma
• 25 Ways to Lower Inventory Costs
If you’d like to learn more about inventory reduction or how to further improve your supply chain, feel free to contact us at 205-444-1185 or visit our website at www.loopsupplysystems.com.