I have repeatedly come across factories that keep a lot of on-hand safety stock, and found that material shortage is among the top reasons of unexpected production downtime. The same goes for retail operations that have kept safety stock levels arbitrarily high. More often than not, shortage is not reduced by increasing stock levels.
At first glance, this may seem counter-intuitive. After all, textbook stock management models always indicate that safety stock level and the probability of shortage have an inverse relationship, with each directly impacting service levels. If you reduce stock, the chance of shortage increases, which leads directly to a lost sales opportunity. On the other hand, if you increase stock, then you tie up more working capital and risk increased product obsolescence. In the end, the expectation is that serving customers is a financial tradeoff between either risking a shortage or maintaining too high a stock level.
In practice, this is not necessarily true. In fact, I would argue that in order to reduce the likelihood of having a shortage, you need to first reduce your stock level.
Why Shortage vs. Stock is Not Really a Tradeoff
The reason is that having excess inventory has many side effects not accounted for by the “textbook” model. Most notably are the following:
- Inefficient use of procurement budget
Procurement typically has a fixed budget. High inventory levels, therefore, reduce the flexibility of allocating budget to purchase what is really needed, especially later in the year. This is very common in retail as well as with large manufacturers’ raw material procurement and sales operations. - Loose inventory management practice
Excess stock level tends to create an inappropriate vigilance by managers. When less attention is focused on keeping stock levels low, larger variability of turnover among SKUs can occur, contributing to inaccuracies and incorrect replenishment orders. - Lack of continuous improvement incentives
Drawing from classical Lean wisdom, when stock levels are excessively high, operational or procedural problems are hidden. There is no pressure to improve supply chain responsiveness by reducing manufacturing lead time or improving overall material flow synchronization. Eventually, demand and the competition will catch up with the limitation of the supply chain responsiveness, creating big problems not easily or quickly solved. For example, studies have shown that US automobile manufacturers tend to keep higher dealer stock than their Japanese counterparts. This has been one of the major differences in competitiveness between US and Japan automotive companies.
Classical inventory models assume that inventory decouples supply and demand functions. In practice, the supply chain is complex, so you cannot simply decouple demand and supply with safety stocks. The key success factor to reducing the likelihood of shortage is hence to actively manage this complex relationship by better synchronizing manufacturing with customer demand.
Take the example of a manufacturing plant that I recently visited. They produce products distributed across US through a franchise network. Five years ago their plant inventory was at 90 days and they only meet 70% of customer orders. Today, their plant and downstream distribution center total less than 80 days of inventory while meeting over 96% of orders. A driving factor of this change is that the manufacturing plant is now accountable for not only the plant inventory, but also a downstream DC and eventually another warehouse’s inventory. In this case, the overall stock reduction has put manufacturing operations under pressure to reduce lead time and improve flexibility. These improvements could not have been achieved if manufacturing and supply chain operations were managed separately as silos.
By the same token, manufacturers are now using the latest information technology to synchronize better with their suppliers. An industrial equipment manufacturing plant I visited has implemented an IT platform that allows them to see, in real-time, the progress of WIP across its suppliers’ production lines. This visibility has let them better control material synchronization between key parts suppliers and in-house final assembly operations, resulting in a reduction of inventory and shortages.
Are you challenged with why your stock levels remain high yet you still can not reduce shortages? Do you see your manufacturing operations driving supply chain stock management? What is keeping your manufacturing operations from better synchronizing with market demand as well as supplier operations?
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