Lean's impact on inventory

by R.T. "Chris" Christensen

If you track inventory levels in American industry, you noticed a continuous downturn over a span of 18 months in the amount of inventory carried by manufacturing operations. This means a continual decline in the amount of materials and finished goods in manufacturing’s inventory coffers. March broke that streak.

March saw an increase in the amount of goods carried by U.S. industrial companies. Pessimists say that sales are falling still further and inventories increased because industry didn’t even sell what it made. In truth, I believe it’s a sign that things are getting better.

I think the manufacturing industry is in a business climate where corporations have stopped wholesaling inventories to get them off their books and are now looking at the reality of doing business. To do business, we must have some products sitting in inventory as finished goods, as well as enough raw materials to enable industry to meet customer demands. This is where the concepts of lean manufacturing come into play.

Some people believe that the basic theory of lean manufacturing is to do more with less and “lean out” the organization.  That supports the theory that reducing the amount we have in inventory reduces our costs.  But in the proceeding 18 months of reducing inventory, industry experienced a decrease in sales and corporate profits as the world economy declined. The reduction of inventory alone did little to nothing to reduce declining profits. By concentrating efforts on simply reducing the amount of product in inventory, industry overfocused. Companies concentrated on one facet of the business environment.  They took the philosophy of lean as a cost-cutting tool and, by overfocusing, missed the overall goal of maximizing profits.  Short-term savings can lead to long-term disaster.

If you really look at the concept of lean manufacturing, you see the need for a balanced business approach. You need inventory in your operations to meet customers’ short-term demands. Why? To answer that, look at the business’ overall cost structure. Reducing only inventory places you in a position of having to produce to meet customer demand. That forces you to work in smaller batch sizes to meet individual customer orders. And while smaller lot sizes keep inventories low, in reality this increases your cost because you increase your non-valued-added batch costs in order processing, scheduling and setup times.

In turn, the bottom-line effect lowered your plant’s output capacity and increased the per-piece cost to manufacture goods and services. You actually raised the cost to produce and increased the lead time to deliver to your customers.  You overfocused and failed to see the overall picture.

Lean principles mean you must reduce the OVERALL cost. You must address the total cost of delivering goods and services to clients.

As you begin to see increases in inventories, you get the feeling that the economy is, in fact, beginning to turn around.  People apply lean thinking to the process and look at the total cost of delivering goods. That increases the amount carried in inventory and focuses on the total cost picture.

American industry is not out of the woods on this business downturn yet. However, industry is embracing lean manufacturing, and, as a result, is starting to see a rise in the amount of inventory companies carry. That paints a healthy picture of the economy.  It also points to a balanced approach to meeting customer demand, through producing to order and shipping from inventory.

R.T. "Chris" Christensen is the director of the University of Wisconsin School of Business' operations management program. If you have an inventory management question, contact Coach Christensen by phone at 608-441-7326 or e-mail cchristensen@execed.bus.wisc.edu. 

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