In Defense of Inventory

The longer I work in supply chain management, the more I feel that inventory, and the role of inventory in delivering supply chain excellence, is not well understood. For the uneducated it is seen as a line on the balance sheet to be reduced. Many see it as a pocketbook--a place to fund corporate initiatives--but it is not.

Last week I worked with a company on this struggle. The financial team saw inventory as an opportunity. They believed that they could just cut it and drive a large improvement in working capital. To prove the fact, they hired a leading strategic consulting group to support their argument. This was despite the fact that they were overperforming on inventory to their peer group and underperforming on margin and growth. As they talked I smiled externally, and sighed in my gut. Inventory is frequently a whipping boy. The supply chain is a complex system with nonlinear relationships between cost, inventory and customer service. It is for this reason I write this blog post to defend inventory.

Inventory is the most important buffer in the supply chain for supply and demand volatility. Today this is more critical because the other supply chain buffers are less effective (excess capacity and time). Both have been tightly squeezed. Why? The time cycles are shorter and manufacturing asset utilization is higher.

If volatility increases, the amount of inventory will also need to increase. Likewise, if the number of items increases, the amount of inventory increases exponentially. I struggle when I work with teams when these relationships are not well understood.

Figure 1. Performance Versus Importance to Achieve Inventory Goals

There are many misconceptions. Let me start with the three I see the most:

• Inventory Is Waste. In Lean manufacturing there is a focus on the elimination of MUDA (the term used for waste). The definition of a buffer strategy for inventory should not be confused as waste. Inventory is the most important buffer in the supply chain. Slow and obsolete inventory (SLOB) is waste. Likewise, there is a belief that companies Do Not Need Inventory. WOAH! I laugh and disagree. Inventory is required to buffer supply and demand uncertainty. The greater the volatility, the greater the need for an inventory buffer strategy.
• Forecast Accuracy Improvements Have a Large Impact on Inventory Levels. I used to believe that forecast accuracy had a large impact on inventory, but I no longer believe that improved forecast accuracy improves inventory levels. I think the impact is minimal. Why? The forecast accuracy number is tightly coupled to safety stock calculations. My argument is that historically, the focus has been on safety stock when the greater opportunity is in managing the other forms and function of inventory. The second issue is that most organizations I work with have improved forecasting, but have not improved the use of demand data into manufacturing or distribution strategies. A forecast in isolation does not improve inventory. Likewise, safety stock is a small percentage of inventory (20-30%). The greater opportunity is in the definition of inventory strategies to improve the form and function of inventory. A case is not a case.
• A Case Is a Case. Not all inventory is created equally. In thinking about demand flows, and the right inventory targets, companies need to evaluate the form which inventory is held in, and the function of inventory in the supply chain. While most companies are focused intensely on safety stock, the opportunity today is usually cycle stock. (The ability to improve the cycling of products through a manufacturing location.) The definition of form and function of inventory is outlined in Table 1.

Table 1. Definition of Form and Function of Inventory

So when the next corporate strategy group comes and asks for a cut in inventory, show them your charts on the form and function of inventory. (Chart your own segments and focus on form and function of inventory. Understand your internal drivers.) Discuss the role of inventory as the buffer between uncertainty and customer service. Note in Figure 2 that Economic Uncertainty and Demand Volatility are both large and overlapping circles in the research.

Figure 2. Supply Chain Risk Drivers

While I agree that usually the organizations with the best customer service will also have the least inventory, this happens over time based on well-executed supply chain strategies. Willy-nilly cuts and arbitrary decisions are just not the answer. It is for this reason that I pen this post in defense of inventory. I just hate to see companies making the same mistakes over and over.

Your thoughts? I would love to hear your stories. Please share your thoughts on inventory.