Inventory

The first bullet point is a strategy applied by short-term organizational leaders within companies that use absorption accounting practices. An increase in inventory at the end of a financial period can improve the gross margin on paper, by spreading the fixed costs over more pieces.

The Cost of Goods Sold (COGS) is driven lower for the period and then taking the Sales - COGS = inflated profit.

The downside is that this will catch up to them and the opposite should occur in the long run (assuming you can build inventory to a higher level infinitely). Moreover, it is hinders cash flow by tying it up in goods available for sale - not yet sold.

There are plenty of cases that have found bonus programs structured around PROFIT, without consideration to the suboptimization of cash flow or inventory on hand and this measurement behavior will lead executives to build inventory. They collect their bonus and exit the company, an ethics issue being driven by a poor measurement system.

Six Sigma role in Inventory Control

1) Buffer, cover the variation that will likely always exist but always strive to minimize it further

2) Satisfy customer demand

Reducing variation enables inventory reduction and not the other way around. Six Sigma is centered on VARIATION reduction.

Not all inventory is bad since every process has some amount of variation (hopefully common cause only). The goal of Six Sigma is to reduce variation and in this case reducing the variation in any or all of the inputs listed above in the bullet points. This will improve stability, repeatability, control, and allow for permanent inventory reduction.

As long as there is uncontrolled variation, an organization must carry inventory to cover the "just-in-cases" or risk jeopardizing a customer, shutting the down, or negatively impacting their scorecard.

Production Systems

2) Pull Systems carry the second most amounts of inventory. These are replenishment systems based on Kanban (or certain level of stock). The benefit is level loading in the production environment and replace only what is pulled in level amounts each time. There will always be inventory at the end when a product goes obsolete (unless communication is advanced to detect this and prevent this on the final release). This system requires a degree of stability in the pull (shipment history), the forecast is irrelevant.

3) MRP/Forecast/Push Systems carry the most inventory and are the most common system still found in most organizations. Trying to rely on human developed models and forecast is risk.

Replacing what was pulled based on a history does not lie, but building to a forecast, especially with long lead time products or within a dynamic market, is high risk and exposes a lot of variation. Therefore, excess inventory is carried all the time resulting in a constant, higher level of cash tied up than a BTO or Pull System and a higher level of excess inventory when a product becomes obsolete.

Common Organizational Message

Organizations frequently target inventory reduction to free up cash. Metrics they drive include a lower DIOH (Days Inventory On Hand) or increased Inventory Turns. This is a great idea and good thing to target to improve cash flow but the focus should be on fixing the key inputs that are causing the need to carry the inventory.

The metrics should be on-time delivery of suppliers, indirect material stability, Kanban card audits, or on other important leading indicators that cover most valuable organizational value streams.

Inventory is not a lever that is turned on and off or down or up without a plan and system to explain it. Lead time must be reduced (the mean) and the variation within the value stream must be first controlled, then reduce the common cause. This will automatically lead to better cash flow.

Better cash flow allows an organization to lower their leverage, invest in other opportunities, meet shareholder expectation that promotes more investement, improve credit ratings and borrowing capability, and many more. Most of the same reasons we watch our inventory at home.

ANALOGY:
Why don't we buy 10 gallons of milk at one time? We know that we will eventually consume all 10 gallons so why not buy it all at once.

It will save me trips to the store and I handle it all at once (large batch - one set up mentality) and forget about for a long time.

These below are the same responses for a business.

1) It won't leave cash for other groceries or to pay the mortgage, keep the lights on, pay for health care, etc.

2) It will spoil before use. There are products have a shelf life such as some steel products, they may rust over time.

3) It costs to store it all. Is it worth buying two more refrigerators and dedicating square footage of your home to storing milk? Just like a business, that space could be leased out, not purchased at all, or used for machinery.

Inventory Reduction Strategies

That is, try to hold the at the second to last process and some more at the next process upstream. In other words, the pieces are in WIP and the costs to put them into FG early have not been applied. This also allows handling and storage space for only the amounts that are actually needed.

SECOND

Wilfred Pareto's principle of 80/20. Focus on the 20% of the items that make up 80% of the total inventory dollars. A small lead time improvement in those value streams will have the most significant cash flow improvement.

THIRD

A common theme pushed is to reduce set-up time. While this is always ideal, it may not provide the biggest bang for the buck. A Six Sigma team should strive to remove the largest amount of time to reduce the mean lead time of a value stream AND the input creating the most variation within the value stream (whether it is in one process or multiple, systems, transactional, or elsewhere).

FOURTH

Put the tightest control with the highest amount of poka-yokes around the high dollar products. After that, put medium controls and resources towards the mid-level valued products. As time goes on more attention can be focused on the non-vital few working your way down the Pareto Diagram.

Inventory is a lagging metric. It is a result of inputs and is not a variable switch that can be controlled itself without serious risks customer.

Often executives like to mandate inventory reduction and will require a lower DIOH or increased turns. This is a great idea and good thing to target to improve cash flow but the focus should be on fixing the key inputs that are causing the need to carry the inventory.

The metrics should be on-time delivery of suppliers, indirect material stability, Kanban card audits, or on other important leading indicators that cover most valuable organizational value streams.

Inventory is not a lever that is turned on and off or down or up without a plan and system to explain it. Lead time must be reduced (the mean) and the variation within the value stream must be first controlled, then reduce the common cause. This will automatically lead to better cash flow.

Better cash flow allows an organization to lower their leverage, invest in other opportunities, meet shareholder expectations promoting further investment, improve credit ratings and borrowing capability, and many more. Most of the same reasons we watch our inventory at home.

ANALOGY:
Why don't we buy 30 gallons of milk at one time? We know that we will eventually consume all 30 gallons so why not buy it all at once.

It will save me trips to the store and I handle it all at once (large batch - one set up mentality) and forget about for a long time.

These below are the same responses for a business.

1) It won't leave cash for other groceries or to pay the mortgage, keep the lights on, pay for health care, etc.

2) It will spoil before use. There are products have a shelf life such as some steel products, they may rust over time.

3) It costs to store it all. Is it worth buying two more refrigerators and dedicating square footage of your home to storing milk? Just like a business, that space could be leased out, not purchased at all, or used for machinery.

FIFTH

If your struggling with suppliers and it appears to be low chance of improvement, then bite the bullet here with adding more inventory of raw material and indirect materials. Do so carefully and with moderation, don't forget to seek approval from finance and Six Sigma organization. But the value stream MUST have stable inputs into the processes (others include stable manpower, machine uptime). Raw materials, subassemblies systems, must be available and reliable to start any deep dive into the value stream.

It is recommended that all these materials and indirect materials be put on a KANBAN system to avoid running out BUT if there is so much instability in their delivery or availability then that will not be effective either.