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When is Inventory Too “Lean”? Finding the Right Balance

By Jeff Bodenstab3 Nov 2015

I learned about “lean manufacturing” (or simply “lean”) back in the 1990s when I met James Womack and read his book “The Machine that Changed the World”. Based on MIT’s five-year, fourteen-country study – one of the largest and most thorough ever undertaken — the book describes the entire managerial system of lean production. It described not only a fundamentally different system of business, but a very different way of thinking about how humans work together to create value.

Since then, lean practitioners have gone on to make great strides and contributions, not only in the automotive industry but in many other types of businesses and organizations. In the last twenty plus years “lean thinking” has fundamentally changed the way many companies, and sometimes whole industries, operate.

But we have also seen companies misinterpret the lean message when it comes to inventory. It’s good to trim bloated inventory and free up working capital. But with today’s volatile demand (especially in omni-channel environments), a delivery model that doesn’t have an inventory buffer can turn out to be “just not in time.”

It’s pretty clear what we don’t want: bulging warehouses that obscure true demand and inhibit the ability to match production and fulfillment. And we especially don’t want an environment where a shift in demand or a contraction in the business cycle leads to eating huge inventory losses.

But inventory optimization can actually contribute to a lean environment. That’s because lean operations often work best in a relatively stable environment with less demand fluctuation. So well-placed downstream inventory buffers, located between end-customer demand and production, can help create a better environment for lean operations.

The key is to identify buffer stocks that prevent lost sales, customer dissatisfaction and foregone revenue. That is to right-size your inventory—eliminate the least effective stock, but ensure profit-generating and strategic products are properly served. Capital is thus reallocated to the most financially productive areas. Inventories that are not aligned with profits and customer service are drawn down.

A.T. Kearney tackles the subject in a recent paper, Making Sure Lean Stocks Are Properly Nourished. “Accepting the idea of right-sized inventory rather than zero inventory changes the whole perspective: it is just as bad to be under-stocked as over-stocked,” the report says. “The one sure thing about sales forecasts is that they will be wrong, so unless your customers are willing to wait longer than your total supply lead time, you will need to buffer stock somewhere.”

To be sure, inventory has costs—working capital, stock management, space, insurance, shrinkage, expiration, obsolescence, damage and markdowns. But inventory availability also drives sales and reputation. Stock on-hand is crucial to achieving high service levels and managing unforeseen events.

Upstream inventory (located between production and suppliers) is also important to supply resilience. The A.T. Kearney report points out that, “Today’s long, complex supply chains are more vulnerable to disruption than in the past. The ability to withstand not just day-to-day fluctuations but even a prolonged breakdown is essential to business continuity.”

Predicting demand more effectively reduces inventory requirements and inventory challenges. A better grasp of demand characteristics generates more reliable sales forecasts and more predictable supply chain requirements. So a right-sized inventory strategy couples enhanced demand planning and demand sensing with awareness of production, storage, transport, lead time and working capital constraints.

A.T. Kearney calls for “a new view on lean inventory, one that is sustainable and healthy. Not size zero, but rather size right.” Drawing an analogy from skinny fashion models who sacrifice muscle in the pursuit of a clothes-hanger physique, they liken good inventory to muscle — muscle that allows businesses to execute.

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