Well, to me inventory turns should be a focus for every company because it a key to creating flow. This is true in both manufacturing and non-manufacturing companies. A non-manufacturing company might say, “hey wait a minute I don’t really have inventory in the traditional sense so this can’t apply to me.” Sure they may not have warehouses full of various parts like a manufacturing company does but they still have what I would call “inventory” but it just takes on a different form. For example, a hospital’s inventory consists of a bunch of human bodies that you are trying to move through various processes as quickly and efficiently as possible. A bank or insurance company always has an “inventory of say loan applications or requests for insurance that are waiting to be underwritten. The faster you turn this inventory the shorter your lead times and the better your customer service.
For manufacturing companies I see inventory turns as one of the most important measures you can have. In fact, if you wanted to simplify things and run your manufacturing company using only two measurements then the two that I would pick would be 100% on time customer service and inventory turns. These two measurements will drive everything else. If they both are increasing then everything else will inevitably be improving as well. Productivity, quality, sales growth, lead times, earnings, return on capital and most importantly enterprise value will improve. In fact, you cannot increase both customer service and inventory turns and not see improvements in all these metrics as a result.
But why inventory turns? Isn’t that just some minor “manufacturing thing?” And how can I have good customer service without carrying enough inventory to meet customer demands? I think we have all been taught that having extra inventory “just -in-case” something goes wrong is essential for any business. The traditional management approach is to produce things in big batches. Our finance gurus tell us that is how to have the lowest cost. “Sell one- make 10,000” is one way to think about this. Add to that the fact that Sales and Marketing don’t really trust Operations (i.e. the manufacturing department) and are always arguing for more inventory to be safe. As a result, you will find the idea that the best way to increase customer service is to increase inventory turns (i.e. reduce inventory) to be a very hard sell in most traditionally run companies.
So why even think about this and why does it work? Let’s remember that lean practice keeps the main focus always on removing waste from your own operations in order to deliver move value to your customers. In his list of 7 types of waste, Taiichi Ohno cites Overproduction (i.e. the building of excess inventory) as the number one waste. So if we want to deliver more value to our customers such that we can grow and gain market share then we should certainly focus on reducing inventory. This will free up a lot of cash that is currently being wasted (I call it “sleeping money”) that can be reinvested in new products, new equipment, or acquisitions that will help expand our market share. And of course as you reduce inventory you also free up a lot of floor space (where the “sleeping money” used to be) that can be used to accommodate this increased growth. Your costs will come down, as carrying this excess inventory is expensive both from a capital invested point of view and from all the hidden operational costs involved. I say hidden because most accounting systems can’t capture the cost of moving, storing, moving again, damaging and eventually writing off a portion of this excess inventory.
Now that seems pretty straightforward and should make sense to most people. But like everything else in lean, the fact that it is the polar opposite of everything the traditional management team has been taught, means it will face resistance. In this case fear might even be a better word. “Heck, we’re struggling now with the inventory levels we currently have, how will we survive with even less inventory? You must be nuts.”
So, how you go about this is extremely important. In the past many companies have followed the path of “lower the water (i.e. the inventory) to find the rocks, then fix the rocks and lower it some more.” This usually leads to disaster in a very short time which leads to, you guessed it…management reverting back to building even more inventory.
To avoid this you need to understand why most companies build in big batches in the first place. It is normally because they take their setup times for granted, as in…wait for it…“Nothing we can do about that.” The lean manager, however, knows this is not true. Setup times can be drastically reduced without much capital spending. Our experience at Wiremold, for example, on many different types of equipment showed that we could cut set up times by about 90% during a one week kaizen. You can’t spend much money in a week. Even with that we kept going back again and again to reduce setup even further. Some examples; injection molding machines from 2.5 hours to 2 minutes, a 150 ton, coil fed punch press from 3 hours 10 minutes to 1 minute, a rolling mill from 14 hours to 6 minutes etc. etc. etc. Machines that we used to change 3 times per week were changing 20-30 times per day. As a result our batch sizes got smaller and smaller. Inventory turns increased dramatically and along with it our customer service was vastly improved. Our lead times went from 4-6 weeks to 1-2 days. We were growing and gaining market share. We freed up over half our floor space and used the cash from the inventory reduction to purchase 21 companies over the course of about 9 years.
But the lean leader understands that getting better inventory turns is not just about setup reduction. Changing from a functional organizational structure which by necessity batches everything to a value stream structure with a cellular layout where product can flow at the pull of the customer is another necessary step. Doing this will further reduce floor space, improve quality and productivity, shorten lead times and give a big boost to inventory turns. In addition, it allows the entire workforce to see the product built complete from raw material to in the box whereas in the functional structure most people only saw component parts and not the finished product. The same is true for say a bank where a loan application may have to travel through seven different departments all located on different floors or a hospital where you have to go through 9-12 separate fiefdoms to get treated for even minor injuries.
Increasing inventory turns is also a key to creating the learning environment which is so key to becoming a lean enterprise. Every time you remove more inventory learning occurs as the team has to figure out how to serve the customer without the crutch of excess inventory that was present in the prior functional batch state. The excess inventory was just there to hide the waste that existed. As the inventory comes out this waste must be eliminated and everyone is responsible for making this happen so lots of learning occurs every day.
So, ok, increasing inventory turns can drive a lot of growth and profitability. We increased operating income by 13.4x and enterprise value by just under 2,500% over these same 9+ years, but what should be the measure or target? When we started our inventory turns were 3.4x. We set an initial target of 20x. “Say what, 20x, why not 5x or something realistic?” Well, and I think this is very important, we set 20x because we wanted to change the conversation. We needed people to start thinking outside the box. Maybe you could get to 5x from 3.4 buy just working a little smarter but mostly staying the same. Getting to 20x on the other hand requires a total change in mindset. Once you get there however everything will have changed. Your customer service will be better and your lead-times will be way shorter than your competitors, weeks to days. Your costs will also be much lower and your quality much higher. But don’t stop there. Once you get to 20x then set a new target of 30x. This will be much harder but you need to keep driving out the waste. Even at 20x the company who is still at 3-4x inventory turns can’t compete. The changes that had to be made to get to 20x put that company in a totally different category than the company that stayed in the 3-4x state.
For acquisitions this focus on increasing inventory turns was a home run. Not only did we free up the cash to do the acquisitions in the first place but most of them were only turning inventory about 3x. Boy this was yummy. We knew we would be able to get those turns up to 6x by the end of the first year and to about 10x by the end of the third year. Combined with the rest of our lean implementation we were able, for the most part, to get all of our purchase price back in cash by the end of the 3rd year and then these companies were contributing cash towards the next new product or the next acquisition. The gift that keeps on giving, so to speak.
We of course had our suppliers in lock step with daily deliveries so that we always had raw material to respond to customer demand. As an example our biggest raw material was steel. We went from carrying 4 months worth to about 2 days worth and never ran out. We got 6-8 truckloads of steel per day but a good pull system can make this work very smoothly. So contrary to the traditional approach increasing inventory turns is the best way to increase your customer service and overall financial results. Put your focus on tracking the two measures I outlined above,100% customer service and increasing inventory turns. I’m sure you will get great results as well.
