By Steven A. Melnyk & R.T. "Chris" Christensen

You get a memo from up high informing you that because of increasing inventory costs, it has been decided that inventory should be cut by 30 percent. How did this number come about? You are not sure. It seems to be either a NRN (nice round number) or a magic number. You are also informed that if you don't cut the inventory, your successor will. You look at your inventory profile. You find yourself with fast moving inventory and slow moving inventory. Which do you cut?

Most of you will have picked the slow movers and been wrong. Remember that these are slow movers. By definition, it is going to take a long time before we see any reduction in inventory sufficient to meet the 30 percent reduction goal set by management. Instead, you focus on the fast movers. You cut them by more than 30 percent (to compensate for the slow movers). However, you have not attacked the reason for the inventory in the first place. You have imposed an arbitrary approach. The result is that before long, people who needed the inventory begin to notice that there is less of it available.

In many cases, the person who notices is the marketing manager. That person probably noticed it because customers were complaining about the lack of inventory. So he/she comes to you and asks what is happening to inventory. You reply that it has been reduced (your answers have a reputation of being to the point). The marketing manager wants to know why. You say that you were instructed to do so by upper management. This answer does not satisfy the marketing manager who proceeds to tell you where you will go when you die, describes the nature of your ancestry, and then leaves. The marketing manager then goes to his/her boss and tells all about the problems he/she is having.

Ultimately, as complaints from the customers increase, upper management sees the folly of their ways and increases inventory. In many cases, the new levels are higher than those that previously existed. The lesson in this story is a simple one: You can never mandate an effective long-term reduction in inventory unless you identify and attack the reasons for inventory.

However, identifying the functions provided by inventory is not enough. You must also examine the form and position of the inventory. The form describes where in the process the inventory is located. The position of the inventory describes the location of the inventory in the supply chain.


Forms of inventory
In general, inventory can take one of five forms. It can take the form of raw materials. This refers to inputs acquired from suppliers, or more simply: what is brought into the firm. These items could be raw inputs such as iron ore or processed components such as microcomputer chips. This inventory is the most flexible in that it can be transformed into any end item that we want. However, to make this transformation requires, relatively, the most lead time.

The second form of inventory is that of work in process. These are items that are being worked within the process. They are nearer the ultimate form desired by the inventory as compared to raw materials. Yet, they are still not ready to be shipped out.

The third form is that of finished or shippable goods. These are the items that we provide our customer. They are our end items. Once made, these items require the least amount of lead time (relative to raw materials). Yet, they offer us an interesting trade-off in that they are also the least flexible because they have been configured into their final form (it is difficult to change a red car to a blue car). Of the first forms of inventory, they tend to be most expensive (because of the additional materials, labor and other associated costs incurred during the transformation process).

These first three forms are the ones with which most of us are familiar. However, there are two additional forms that inventory can take. The first is maintenance, repair and operating inventory. This is more commonly referred to as MRO. This inventory refers to the stock of items that we need for the operation and maintenance of the transformation process. In MRO, we tend to find items such as rags, oil, staples, nipples for glue guns, and gloves. In many firms, this is a major investment.

The final form that inventory can take is that of money. With this form, we recognize that management need not invest in inventories of parts. They can decide that it is in their best interest to keep the resources in cash.

With these five forms, we can examine the form distribution of our inventory (i.e., what percentage is work in process, raw material, finished goods, MRO and cash). However, these forms are not enough. We need to look at where in the supply chain the inventory can be located.


Position of the inventory in the supply chain
In general, within the supply chain, we can position our inventory at one of four locations. The first location is at our suppliers or with our purchasing system. The second location is within our plants at the manufacturing system. The third position is in the logistics system. This position includes inventory that is in transit (i.e., on trucks or in rail cars). It also includes inventory that is located at our various warehouses. Finally, the inventory could be located in the marketing system next to our customers.


Putting things together
What we now have is three sets of dimensions. These dimensions consist of function (six different types), form (five different types), and position (four different positions). This gives us 120 possible combinations. With these various combinations, we can now begin to examine our inventory and to assign the inventory to one of the 120 different combinations. We can now begin to see the distribution of inventory. With this information, and Pareto analysis, we can target those combinations that represent the largest investments of inventory. By the way, if you find yourself with inventory that cannot be assigned to any one of these 120 different combinations, then you have inventory that is "out-of-control." That is, it is present. Yet, we do not know why we have it or what function or position or form it is taking.

Next month, we will look at how to extend this analysis by using a modified version of ABC analysis.


Lessons learned
In this month's column, we have learned that:

•It is dangerous to manage inventory through management mandates.

•Inventory can take one of five forms: raw materials, work in process, finished goods, MRO and cash.

•Inventory can be located at one of four places in the supply chain: with our suppliers or in purchasing; within the manufacturing system; within the logistics systems; or in marketing near to the customer.

•With these six functions, five forms, and four locations, we can develop a tool (a matrix) for determining where the inventory is. The resulting matrix can be used to direct attention and to identify those combinations that are high and offer management opportunities for systematic inventory reductions.

Copyright © 2020 by APICS — The Educational Society for Resource Management. All rights reserved.

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