Manufacturing Strategy for Window Fabricators 15 - The hidden costs of inventory

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Inventory is an unseen cost. It appears to be totally necessary but is it really? Inventory could be silently eating into your profits while affecting your production efficiency.


A review of the basics by Robin Kent of Tangram Technology.

  Download Adobe Acrobat file of complete series to date

Why worry about inventories?

The cost of inventory should be an area of constant concern to any business. Too much inventory not only eats up the working capital of a company and creates cash flow problems but it also needs additional space and people to manage it. Inventory is not passive or free, it actually costs money to have goods in the company and costs can be reduced by reducing the inventory levels. The opposite problem of too little inventory can cause production delays and poor customer service. Getting the balance right is essential and one knee-jerk but ultimately doomed response is to require Just-In-Time (JIT) deliveries from the major suppliers. A better response is to implement ‘The return of the JEDI’ where JEDI is ‘Just Enough Desirable Inventory’.

The cost of inventory

The real cost of inventory is estimated to be 30% of the total inventory held and if you hold an inventory of £100,000 then the cost per year is around £30,000. Little wonder that many companies now see inventory reduction as a method of freeing up cash and reducing labour costs. JIT or JEDI production methods can reduce inventory but there are other practical things you can do to start an inventory reduction programme.

Stock takes

Greatly reduced inventory means quick, easy and accurate stock takes - in fact, if things are done properly, the inventory is so low and so stable that stock takes are simply not necessary. Simply add a notional figure for stock held back into the accounts. Think of all the effort and cost saved in the process of counting, reconciling and getting it wrong anyway.

Improve the inventory accuracy

If you don't know how much you have or where it is, then it doesn’t exist. A high inventory accuracy (a minimum of 95%) is an essential to starting any inventory reduction process. Inventory accuracy requires well-designed cycle counting systems. These can very rapidly pay for themselves by not only counting things but also identifying and solving inventory system problems. Don’t just collect the numbers, analyse them and work to improve them. At the end of the inventory reduction process the stock take process may well be redundant but at the start it is an essential tool.

Reduce the lead time

Long lead times automatically mean more inventories as Work-in-Progress (WIP) in the system. A former client had a 16-week lead time (for windows!) and had 16 weeks worth of production on the factory floor at any one time – their main concern was to keep the saws going! The space used was enormous; orders regularly got ‘lost’ in the factory and close to £750,000 of cash was tied up as WIP. They didn’t listen, they ran out of cash and they are no longer with us. Don't start to produce an order unless you intend to do something with it. Don’t make anything for anybody, make them come and get it. Reduce your production lead times to a maximum of 2 days (it only takes about an hour to make a window so 2 days in the production system is actually excessive) and issue production orders only when needed on the shop floor.

Increase the speed of operation

Inventory levels often have little to do with the level of customer service that you claim or want to provide. They are more dependent on the time taken to replace the materials used and the supplier reliability. If it takes 4 weeks to replace an item, you need to reorder when are down to 4 weeks stock at minimum (JEDI) or you risk running out of materials. Purchase from reliable suppliers with short lead times and inventories can drop dramatically. Make lead times and their reliability a key factor in the purchasing process. Short lead times from reliable suppliers can save more money than reduced ‘headline’ prices from unreliable suppliers.

Eliminate process misalignment

Watch out for the ‘economies of scale’ argument. Buy in the same units that you sell in. If you sell tens of products per week then buy tens of the raw materials per week. Buying thousands of the raw materials to get ‘economies of scale’ is a recipe for disaster. It creates large quantities of inventory, slow stock movement, possible product obsolescence, possible product damage and it locks cash up as inventory. Large stocks also reduce your responsiveness to customer demand - you cannot introduce new products until the entire inventory is used up. Buy what you need to match the customer consumption rate.

Specialise and throw it out

Have you ever heard: ‘If we don't carry that item then the customer won't buy from us’, but where else can they go if no one else stocks it? What about ‘We keep the mis-measures and quality rejects, someone will buy them some day’ or ‘We paid too much for it to throw it away’ or ‘It is written off so it doesn’t owe us anything’. The simple fact is that the products will all still be sitting there: taking up space, clogging the system and confusing people: get rid of them. Sell them now to generate some real cash (however small) for the business.

Get rid of the stores area (and the store man)

Stores areas are great hiding places for inventory and other redundant parts and you actually pay the store man to hide it for you! Make the operators and supervisors who use the parts responsible for ordering the parts and storing them in the production area (which is where the materials should be anyway). When they know that if they run out of parts then they stop work and don’t get paid, they will order the right levels at the right times.

Devolve the responsibility to the people who suffer if the component isn’t there. They will really care about it.

Putting the products by the operators also means that there is no time spent going to the stores (a great day out), filling out the forms and having a chat on the way.

Replenish based on market demand

Forecasts are educated guesses and their accuracy gets worse as they extend into the future. Use the market demand (and your high inventory accuracy) to replace the inventory as customers are actually buying products. Forecasts are always wrong and will either cost you money as excess inventory or customer service through lack of product.

Reprise

High inventory levels are not a necessity; they are a failure of management to actually manage and are a real cash drain on your business. An inventory reduction programme will pay for itself by releasing real cash into your business, releasing space for production and at the same time improving your responsiveness.

An inventory reduction programme will pay for itself many times over so what are you waiting for? There is no excuse not to start to reduce inventory today.

The hidden costs of inventory:

Purchased goods:

  • Purchasing costs.

  • Freight costs.

  • Inwards goods and inspection costs.

  • Warehouse labour for storing, moving etc.

Manufactured goods:

  • Manufacturing time/labour.

  • Manufacturing materials.

  • Time/labour for manufacturing order preparation.

  • Inspection costs.

Additional general costs:

  • Higher insurance.

  • Increased space needed.

  • Increased materials handling needed.

  • Lower return on investment.

  • Increased physical stocktaking (and increased risk of errors).

  • Increased record keeping and accounting.

  • Increased probability of loss, damage and deterioration.

  • Increased probability of obsolescence.

Economic ordering

It is possible to balance the cost of placing an order against the cost of holding the inventory by using the formula:

Economic order quantity: Annual usage (£) x Cost of order
Cost of holding material.

Note: As purchasing reduces the ‘cost of order’ down to zero through blanket orders and call-offs then the economic order quantity also approaches zero and it is feasible to ‘sell daily - make daily - buy daily’.

'Manufacturing Strategy' Series.

The 'Manufacturing Strategy' series is designed to give window fabricators a set of ideas for managing production. The series is being published in Fenestra on a monthly basis and published here after the Fenestra publication. The series is:

Part 1: The Essential Part 
Part 2: The Systems
 
Part 3: Just-in-Time

Part 4: Optimised Production Technology

Part 5: Work Cells

Part 6: Machines
Part 7: Machines (2)

Part 8: Scheduling

Part 9: Waste (Methods)

Part 10: Waste (Materials)

Part 11: Supply Chain

Part 12: Measurement
Part 13: Things to do NOW!
Part 14: The Cost of Quality

Part 15: The Hidden costs of inventory

Part 16: Environmental management

Part 17: Continuous Improvement

Last edited: 17/02/15

© Tangram Technology Ltd. 2005

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