You try to protect the monetary value in your car in the event something happens and you’re faced with a large financial loss.

But if you drive an old car like mine — 262,000 miles and counting — you don’t need much insurance because the potential loss is small monetarily.  Even though I’d really miss that car, it’s just not worth spending much money to insure.

The question then becomes this: How much are you willing to pay to protect your assets from a potential loss due to unforeseen circumstances?  New car, high premium?  Old car, no insurance?  And if you think about it, isn’t inventory the same as insurance?

Analyze inventory by the two kinds of loss
The main reason we carry inventory is to protect our company from a loss of production or a loss of time that could’ve generated value for the enterprise.  This is the first type of cost, the loss of capacity to generate value.

The second type of loss is the one we all think of first — the cost of repairing the equipment.

We generally don’t think of the cost of the lost production we incur when the equipment is down for repair.  That’s because this downtime cost is only valid if there are orders waiting completion on this equipment and/or the machine is not loaded heavily and there is time to get the repairs done and still meet manufacturing deadlines.

But this is exactly the area we need to evaluate extensively in order to manage lost revenue.  Today, we run our equipment at increasingly higher output levels, which means we have less time to fix things when they break.

This is the area we need to address — inventory as insurance.

A new understanding brings about new questions
Now that we understand loss and the types of losses we’re trying to minimize, we can truly utilize this insurance concept.  Insurance protects us from only one type of loss — loss due to machine downtime and missed production opportunities.  Inventory can’t reduce cost when a part is required.  You must pay for the part and be done with it.

But for lost production time, having the part in inventory can be the shortest way to get the machine back up and running and minimize the other cost — the cost of lost production.  That’s what inventory is all about — minimizing lost saleable production time.  Inventory minimizes your risk to loss just as insurance minimizes your risk of a loss should an unpredictable event occur.

Now with inventory thought of as insurance, ask the following questions to your managers the next time they ask you to reduce inventory:

Question 1: “How much of an insurance premium are you willing to spend in the form of inventory to protect you from a loss in revenue?”

Question 2: “How much risk are you willing to expose the company to in the event of an equipment failure?”  

This is your justification for carrying inventory.  You may be surprised at the answers you get when you ask your managers to define inventory this way.