How to Find Hidden Cash Reserves

Manufacturers today must be fast and nimble enough to react quickly to changes in customer demand and do it with little inventory. Gone are the days when manufacturers could stockpile large quantities of raw materials, load up the shop floor with work-in-process and pack warehouses with finished goods. The old ways caused erratic and long lead times, high costs, and required too much inventory.

In a recent survey undertaken by consulting firm R. Michael Donovan & Co. Inc. (Natick, Mass.), 82% of senior executives who responded said that inventory reduction was a major concern for them. "Inventories can absorb massive amounts of cash," explained Mike Donovan," president of the firm. "The fact is most manufacturers carry too much inventory. The vast amounts of money tied up in inventory could be better spent elsewhere, such as new product development, acquisitions, modernization, reengineering, expansion and debt reduction. In many cases, inventory is so bloated that a high percentage of it will become obsolete before it's sold. Worse, too much inventory is merely a symptom of more serious and costly business process and system problems that afflict many companies."

Some of these problems include poor forecasting, inadequate production scheduling, low quality, bottlenecks, long cycle times, high costs and wrong performance metrics. "For instance, poor sales forecasts are often used to schedule production, sometimes for months in advance," Donovan said. "When actual customer demand is not what was forecast, inventory quickly accumulates in expensive piles and customer service goes down. Then the cycle just keeps repeating itself, further compounding the cash flow and service problems that already exist."

Most experts agree that top-heavy inventories are a giant cash vacuum and need to be turned off to free up cash for investment in revenue growth activities. So how can this be accomplished? According to Donovan, one of the major impediments to inventory reduction is the mistaken notion that improved inventory management is all that is required to get the job done. The real culprits are the inefficient business processes that cause excessive inventories to exist in the first place. He offers eight suggestions on how to reduce inventory and tap the hidden cash reserve:

Don't Blame Inventory Control. Certainly some aspects of inventory investment are the result of inventory control, but often their behavior is caused by management's certain negative reaction to material shortages versus periodic and less severe response to excesses. For the most part, inventory excesses can only be eliminated when the cross-functional business processes that cause the need for inventory buffers (excess) are fixed. It's futile to think inventories can be isolated and subsequently managed. Inventories are invariably the result of how well many cross-functional business processes really work.
Reengineer. Major reductions in all forms of inventory usually require reengineering the order-to-delivery cycle to find ways to do it faster, better, cheaper. When you fix the business processes that caused the excess inventory buffers to exist in the first place, you will also shorten cycle time, decrease costs, increase quality and improve customer service.
Improve Supply Chain Management. By streamlining the entire supply chain, a company can reduce inventory, improve time to market, compress cycle times, free up more cash, and improve profitability. World class manufacturers are beginning to use every resource at their disposal to speed up the order-to-delivery cycle, and one result is the reduction of all forms of inventory. Manufacturers are establishing computer-to-computer links (EDI) with suppliers and customers to provide them with a window on their operations. In addition, many manufacturers are actively consolidating their supply bases by following a single vendor partnership approach to a much closer relationship with suppliers. By becoming an integral, larger part of the customer's and supplier's businesses, both parties gain greater leverage.
Improve Production Scheduling. Poor production scheduling invariably results in manufacturing flow imbalances, causing bottlenecks and reduced throughput. This will inevitably result in erratic output, more inventory and longer cycle times. The old illogical scheduling logic used by most MRP II systems today needs to be replaced with an approach that works, Donovan observed.
Use Effective Performance Metrics. Many manufacturers actually reward behavior that tends to bloat inventory levels everywhere. For instance, if production performance is based on efficiency, utilization and standard hours produced, you can be assured that parts will get produced and put into inventory even when there are no orders requiring the parts.
Utilize "Pull" Inventory Based on Demand. Many manufacturers base raw material and/or finished goods inventory stocking levels on inaccurate, long-term sales projections. The high cost of these "bad numbers" if they aimlessly drive operations - as they often do - is the depression of overall business performance. One result is that companies that use a total "push" inventory system will end up with high inventories. An excellent method for achieving greater effectiveness with working capital and freeing up valuable cash is to acquire materials and put them through production so fast that inventory doesn't have time to become a liability. This requires a well-engineered order-to-delivery process that can have enormous benefits beyond just inventory reduction.
Reduce Cycle Times. Cycle time reduction almost always means reduced costs, reduced inventory levels, improved production predictability, increased customer service, and better quality. To reduce cycle time, manufacturers need to streamline every aspect of their operations, especially the order-to-delivery process. If this is done right, you will by necessity "fix" many support functions as well.
Develop Flexible Manufacturing. When a manufacturer is rigidly set up to produce long production runs, there is a tendency to maintain higher-than-necessary production levels, even in the face of reduced demand. The inflexible manufacturer maintains high production to absorb overhead in inventory, making meaningless numbers look good. This practice inevitably results in cash being frozen in inventory.

To minimize inventory excesses and improve customer responsiveness, more and more manufacturers are building flexibility into their operations - flexibility in how they operate to quickly respond to changing customer demand. The value that a manufacturer offers its customers is more important than having just the lowest overall price. Value includes short lead times, quality materials, on-time delivery, good customer service, and a fair price.

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