April 1998 • Volume 8 • Number 4
Establishing a New Metric:
Inventory Levels in Miles Per Hour
By comparing inventory forecasting to planning for a road trip, we discover that not only are accurate, long-range results achievable, but that we can make adjustments along the way and ensure an enjoyable trip.
By Stephen T. Desirey, CPIM
Companies have long been searching for that perfect metric to measure the correct level for inventories. So what is this metric? A typical answer to the question might be: It depends. But the correct answer is: miles per hour. Of course, this can be easily converted to kilometers per hour to measure total inventory levels around the world.
Now that we have arrived at a basis for the metric, the correct level of inventory we want to achieve is: zero. The process to achieve this level is to eliminate 50 percent of your warehouse space in the next six months. Although this may seem impossible, the business will be able to find a way to do it. This rather simple solution is based on asking your customer to give you adequate lead time so that you can supply their order. If your customer is unable to provide you with this luxury, then you should calculate your speed of inventory for each corresponding time bucket.
To begin understanding how best to do this, we should think of inventory planning in the same manner as one would in planning the time required for driving from New York to Los Angeles.
Historical Perspective
The direction of focus on year-end inventory levels typically occurs in mid-October each year. I originally thought a correlation could be found here because this is the time of year when the first leaves begin to fall — the cascading foliage serving as a trigger for managers across the northern hemisphere to decree that it is time to lower the inventories for the year-end Wall Street competition. Unfortunately, this is too late. By the time the word is communicated to the total business, the silos and bins are full of raw material, the factory floor is full of work in process, and customers are trying to reduce their inventories. No one is ready to accept the extra inventory.
History also shows that some customers have moved their fiscal inventory year end to July, thereby allowing them to participate in the year-end sales promotion to lower inventories at reduced prices.
Are there any other ways? Yes. Perhaps if we examine the inventory earlier, then we might find a larger-than-necessary category of wider specification product. Perhaps some of this should be recycled? Sounds good in principle, but what happens to the manufacturing cost for doing such a devilish deed this late in the year? Manufacturing cost incurs an abnormal charge, and the cost of goods will increase. This is a fatal effort by the business leader, because the profit projections were not prepared for this. Such a response does not stand a chance for success. So if we stop all incoming deliveries of raw materials and rapidly reduce prices in order to lower inventories, what do you think happens in January to the customer delivery performance? And how does this action impact loyal suppliers? This is obviously not the solution.
I have learned that inventory levels set in miles per hour does work. If I go back to the response: "it depends," I will find that this also is the answer to the question "how fast should I drive on the highway?" Let's explore the similarity of both situations.
On the highway we typically travel at a rate of speed that is a function of the speed limit for the road, the conditions of the road, the conditions of the vehicle and the time that is available to reach our destination according to the required arrival time. But we are doing something a little different here in our planning. We are not afraid to look into the future, and we set realistic times for our journey. We will plan and determine such things as lower speeds for the mountainous areas of our trip, time for breaks and meals, time for overnight rests, and higher speed times for the open flat areas that offer maximum visibility. If this plan is broken down in segments, we would discover that the speed we will travel is a direct function of the conditions noted above. At this point we make a big discovery: We are looking forward in our planning and not just looking out the rear window to see where we have been in order to plan our total trip.
Let's make a clear comparison between the speed of our vehicle and the inventory levels required to run our business for each time bucket. We have a couple of points to compare:
Furthermore, as we continue to look at the variables on inventory, we will discover multiple descriptors for inventories and that all inventory items are not of equal value.
Product Inventory Descriptors
It is only by differentiating product in this way that meaningful decisions can be made. Remember, this lower-value inventory will consume the same dollar value as the active inventory. This fact should serve to force businesses to confront the issue of slow-moving or obsolete stocks. It should also prevent them from making poor decisions based on the appearance of high levels of inventory when the active inventory is actually very low.
Using the differentiation of product discussed above will allow us to use inventory similarly to the way we use brakes, turn indicators and, of course, the accelerator pedal. Herein we discover that one speed will not work for the whole journey.
A fitting conclusion for this portion of the trip, based on a Pareto analysis for the make-up of the inventory and a heavily borrowed line from the motion picture "Field of Dreams," could be: If you provide a category and storage space for inventory, it will come. Authorizing additional warehouse storage space is an admission of failure. The goal has to be zero inventory — a speed of 0 mph. The next best outcome is to have no finished product inventory, nor any necessary inventory in the form of raw materials. However, market demands may not permit this when customer lead times are shorter than the supply time. In this case, the effort must focus on flexibility and velocity of the product. A general rule to invoke here is the dust test. If the product is gathering dust, then it should be evicted. We must either begin removing these slow-moving occupants from our inventory or begin charging them rent. Otherwise, inventories will continue to lose value.
When you have the opportunity, go to the storage area and see these freeloaders for yourself. Typically you will not be able to see them in the traditional accounting systems, as they are well hidden.
Where is the speedometer?
At DuPont, sales and operations planning has become the first module of business resource planning that is providing real value in connecting the whole value chain. It is frequently described as the process that initially gathers the "low-hanging fruit." Nevertheless, benefits can be gained just through the formal communication of connecting the demand chain to the supply chain. This process helps reconcile how fast (volume of inventory) our speed must be in order to balance the supply capabilities with the demand chain. For some time periods the speed will be greater (larger volumes) as we maintain that optimum inventory level based on a moving three-month demand horizon plan and the corresponding lead time of the product. This is a decision-making process that helps assure that the business has visibility to the obstacles down the road that could prevent financial success.
Sales and operations planning (not just a monthly meeting) reconciles how the demand and supply operations are meeting the business strategy. The meeting to discuss these issues should be the two most valuable hours business leadership will spend each month in order to plan how their business will meet customer demand needs over the next 18 months. Forward visibility is provided here to prevent or minimize future problems through proactive planning versus typical reactive/crisis planning. This means making and documenting choices/decisions today that will impact the future. This is not a production scheduling meeting, but rather a business future history to test if the current actions are in line to meet the financial goals and commitment of the business. The full scope of the process is inclusive of the market segment, market segment aggregates, and regional and global businesses. In this process you are not permitted to drive looking out of the rear window. Eighty percent of the discussion must focus on the future.
Once this process is complete, the weeks/months when it will be necessary to drive the raw and finished inventories faster will be indicated — not just the aggregate of these inventories, but specific items that need to be increased or decreased. Aggregate inventory management is a shortcut to high inventories. Inventory does not just happen, it is a result of the variances of demand and supply. Take control.
Demand Plan Review
You will be planning what you are selling, not selling what you are making.
Supply Plan Review
Metrics
Attendees
Summary
Inventory can be measured in miles per hour only if all of the journey conditions of customer service levels, demand plan, supply plan, financial objectives and overall business strategy are linked into the managing processes for the company's particular vehicular operating system. Business management processes must have the rigor and hands-on-the-wheel leadership involvement required to make the changes necessary to drive business success. If we elect not to make this choice, then the destination of our journey will be the scrap metal pile for businesses that were inept to change.
Attention to inventory levels seems to increase in the fourth quarter of our game. Wall Street and the federal government will measure it, and fortunes are made and lost in the blink of an eye. Business leaders have scored big or lost their jobs as a result of this year-end number. In the past, this number was only watched at year end, with little attention being paid to it during the fiscal year. Why?
Product inventories should be discussed against the business plan. It will be important to maintain appropriate differentiation in the category in which the product is listed, as this impacts the availability and proper inventory management of this liability. Categories include:
Before locating the speedometer, it will be necessary to install a managing process to provide the necessary structure to connect the business strategy to the operational aspects of inventory management. The sales and operations planning process fits that need perfectly.
The key product of the sales and operations planning meeting is to reconcile any differences that may exist between the operations and the business strategy. For that reason, reviewing the demand plans for the next 18 months becomes very important. This review of demand should start with an explanation of any variance that exists between actual demand and the sales and operations plan over the previous three months. It should then take the plan over the next three to four months as one grouping, and the next five to 10 months as a second grouping. This process is demand management — not just taking orders. No longer can we count on just a hope and a prayer to manage demand. This review should share the proposed demand plan with the group and discuss:
Given that this is a demand-driven process, supply is planned to meet the demand plan. Supply is inclusive of locally produced, inter-regional, intra-regional and purchased supply. The supply manager will be maintaining a readiness to manage capacity, uptime and quality performance in a way that meets the demand plan on time and within the financial inventory (raw and semi-finished materials included) constraints of the business plan. There will be pressure on the supply manager to overproduce during times of high yields and above-goal specifications. However, producing above the plan will result in excess inventory. Unless you are making cheddar cheese or Tennessee sipping whisky, your product will not become better with age. At times it may be appropriate for the supply plan to present a similar spreadsheet with the focus on capacity. This approach will compare the mix of planned items in a metric of sales volume to capacity ratio for a given time bucket.
Business resource planning has several key metrics that should be reviewed in the sales and operations planning meeting. This includes diagnostic measurements on how well the business is meeting customer needs. These measurements project how well demand and supply are balanced so that the financial resources of the business can be met. Among these are:
did the product/services arrive on time?
are the sales predictions improving at a rate that permits the supply plan to operate in a more stable manner?
did the plant produce what it was supposed to produce in the time and quantity of the plan?
did the plant operate as planned or did it require frequent unplanned changes?
are the suppliers delivering the raw materials in the time frame that has been requested?
are we driving at the right speed for the demand required each month relative to our ability to supply?
The meeting must have the following persons in attendance (or substitutes with designated authority):
accountable for profit and health of the business
accountable for customer demand (including being accountable for customer selection priorities in times of product shortfall)
a resource to the demand manager for planning/forecasting demand
accountable for all production assets and supply of products
a resource to the supply manager for the capabilities of production and supply
accountable for development of new products
accountable for summarizing the financial commitments
minutes of the meeting should be written by someone not directly involved in the actual sales and operations planning meeting
As each meeting concludes, each participant should have a clear understanding of the opportunities and limitations of the business at this moment and for the next 18 months. In many cases, teams will have converted the demand and supply plans into a pro-forma profit statement, and will know the relative sensitivity for the current year's financial commitment. This brings in another advantage for the 18-month planning horizon — the basis for the next year's profit objective with the best data available to the business team at this time. At the end of the meeting there should be agreement by the members as to which of the following scenarios exist:
Stephen T. Desirey, CPIM, is a chemical engineer at the DuPont Company and manager of the company's Continuous Business Improvement Center.
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