Inventory Management Review

A Message for the IMR Community

First of all, thank you to all for reading.  I want everyone who has requested the spreadsheets to know that I will send them out as soon as I get a chance.  In exchange for sending them out, I would appreciate everyone who is using it for a project to write a short article detailing how it was useful to you.  I will read all the articles and will post the one I feel is most beneficial to the IMR community.  I won't hound you for the article, but I feel like this will be a positive learning experience for all of us.

Second, I want to reply to Felipe and Ryan for their comments on my article on Wal Mart's Suppliers.  Excellent comments by these two gentlemen.  They have remind me that I need to devote an article to the bullwhip effect.  I will be short on time for the next week or so, but I plan to write the article soon.  For now, I will say that the bullwhip effect typically is more of an issue further down the supply chain then that close to the consumer, however, you are correct, suppliers have a harder time with service level then Wal-Mart does.  Thank you Ryan and Felipe, and thank you to everyone for reading.

Reader Response

Recently, IMR reader Gwen left a comment on the site that made me think of a few thoughts worth writing about.  Her comment was in response to my article on the risk of keeping a small number of suppliers.  She said that while it's risky to keep only one supplier, it's also believed to be risky to "keep only one business."

Without a doubt, Gwen, there are risks associated with keeping all of your eggs in one basket.  What's worse is having two different sets of eggs, each an integral part of your business, both kept in only two baskets.

Hard to follow metaphors aside, what I'm trying to say is that as risky as it is to keeping only one supplier, because if the supplier fails you, you may fail, and as risky as it is to keeping only one business, because if that business fails, you may fail, the risk associated with keeping only one business with only supplier is a far greater risk than either risk on its own.

This is just simple statistics that if there is a 50% chance your one business will fail and if there is a 50% your one supplier will fail you, you do not have a 50% of success, but rather a 25% percent chance of success.

However, some risks are a necessary part of business.  Maybe, the only way to succeed is to rely on one supplier.  That could be the only way to achieve a much-needed JIT system because of the work associated with getting such a system running properly, and without the lower holding costs of a JIT system, competition will crush you.

But, as we mentioned, this is very risky.  And, if only having one core business is risky, then what does this tell us about firms like Wal-Mart that utilize a broad product line compared to firms like Toyota with a much smaller product line, or how about a mom and pop shop trying to cut down on their number of suppliers in order to lower inventory in a poor attempt to compete with Wal-Mart on price?  Perhaps an inherent disadvantage is occuring here.

But, to respond to Gwen's comment, I agree, there is risk with keeping only one business.  On the flip side, there is also a chance for an explosion of profits.  Fortunately, I'm the son of a mutual fund industry veteran so I know enough about hedging my bets to keep from putting all of my eggs into one basket.

But, there is a time and place for investing in one business.  More appropriate to this site, there is a time and place for investing in a sole supplier.  Risky, perhaps, but more importantly, there is a potential for a competitive advantage.

If there are better ways to achieve better drops in inventory then by relying on a sole supplier, then obviously go for it.  But, if it comes down to taking on more risk for a potential large competitive advantage, then you need to ask yourself, is the risk worth the added value?

Wal-Mart Increases its Supplier's Inventory Levels

With all the Just-In-Time talk and knowledge regarding better management and understanding of inventory, you'd think that average levels would be decreasing.  Well, I still think that at a well-managed company, they should be, but Susan K. Lacefield, accociate editor of Logistics Management, wrote a pretty interesting article that found otherwise.

In a poll of her magazine's internet readers, she found that over 60% of companies expect to see inventory levels rising over the next year.  The specifics regarding why are some pretty interesting reasons.

Most notably, Wal-Mart's JIT efforts are leaving their suppliers with more inventory.  If you think about this, it makes a lot of sense.  Wal-Mart does not want to hold inventory.  At the same time, they do not want backorders.  The only way to do this is to be able to replenish their stock at a moment's notice.  So what does this do to their suppliers?  According to Logistics Management, it shoots supplier's inventories straight up.

The demands that Wal-Mart places on its suppliers are incredible because of the power Wal-Mart places on its suppliers.  Personally, I'm waiting for the day when Wal-Mart's suppliers form a massive supplier's union (sounds like collusion to me), but until then, good for Wal-Mart for leveraging what it can out of its suppliers.  Also in the mean time, suppliers are forced to hold incredible safety stocks to make sure they can satisfy Wal- Mart's demands.

Basically, the suppliers don't have a choice in the matter.  Wal-Mart's business, even with the demands on service, is too good to pass up.  But, Wal-Mart is not about to have a stockout due to some supplier's inability to provide a 99% service level.  Wal-Mart, like many huge companies, will not wait.  Many companies are:

requiring shorter lead times even as more companies implement 'zero tolerance' policies for late shipments.

Zero tolerance is a hell of a statement from a company that knows service level.  To provide even a 97% service level compared to a 95% service can result in a huge increase in inventory.  Zero-tolerance is wild.  In fact it is actually impossible.  No matter what a company holds in inventory, there is always the possibility that Wal-Mart could order one more than that.  Couple this with a shorter lead time to Wal-Mart and inventories are stagerring.

Not only does Wal-Mart demand what they want when they want it, but also, as one Logtistics Management survey respondant said regarding why he has to hold more inventory:

Wal-Mart is ordering fewer cases more frequently

For a company, this means that they can either produce smaller batches, or hold onto more inventory.  Because if a company cannot produce less and faster, than they have to produce a large amount and then, instead of producing a large amount and getting rid of it all at once, they have to get rid of it slowly over time, which increases average inventory.

While Wal-Mart may be getting the good end of the deal, one thing is for sure, there's a reason suppiers put up with these demands, and it's not because the business with Wal-Mart is bad.

If you would like more informatin regarding this article, Shippers are seeing inventory rising,  it can found in the October 2005 Logistics Management Vol. 44, No. 10 issue.  Additionally, feel free to leave comments with a question and your email address.

Postponement Calculations Part II: After Postponement

This post is the final part of the two part series on the effects of implementing postponement.  If you have not read part 1, I highly suggest doing so.

Using Postponement

Altering the production process, the firm that manufactures the DD1 and DD2 has created a new process that allows for the production of the DD0.  The DD0 is a product that is not sold on its own but can be turned into either the DD1 or the DD2.  The DD0 has a production time of 19 days and takes 1 day to turn into a DD1 or a DD2.

This allows for the postponement of the DD product line.  Now, there is need for three different types of inventories.  Finished goods inventory is held for the DD1 and the DD2, but now with shorter lead times, and WIP inventory is held in the form of DD0.

In order to achieve the same service level, what are the optimal value for each product?

DD1 and DD2 still have the same standard deviation, but now have a day lead time instead of a 20 day lead time.  This is because it only takes one day to turn a DD0 in either good.  Using the new lead time, the equation looks like this:

DD1 Safety Stock= 2.05*180*SQRT(1)=369 Units

DD2 Safety Stock= 2.05*200*SQRT(1)=410 Units

DD0 inventory has a 19 day lead time.  The z-value is still 2.05.  The standard deviation is the only tricky part to find.  Pooled standard deviation is not the sum of the individual standard deviations.  Instead, it is the square root of the sum of the individual values squared.  So, for this particular problem that means it is:

SQRT(180^2+200^2) = 269

Now that we have all the values we need, the final step is to plug them into the formula:

DD0 Safety Stock= 2.05*269*SQRT(19) = 2,408

The sum of all 3 inventories is 3,189, which is 300 less units than the old system and an 8% reduction in inventory.  Additionally, the majority of that inventory is WIP which means that it does not hold the entire value that the FG do and therefore holds reasonable expectations that holding costs are lower.

This example is not only reasonable, but as I've discussed in previous articles, a technique that has saved many firms, such as the adhesive firm and firms in the paint industry, huge investments in their inventory.

For more information regarding postponement, please leave a comment with your email address.