Have you overfocused?

by R.T. "Chris" Christensen

Time after time, I see companies focus on one aspect of the business and narrow the scope of activity to such a low level that they spend dollars to save nickels.

The focus level is so minute and so sharp that the overall objective gets lost and no one pays attention to the overall cost of the project.

The old joke on this is the alligator and the swamp. The guy concentrates so hard on the alligators that he loses sight of the task at hand — draining the swamp. By not removing the breeding ground that caused the problem, he continually gets a new crop of gators to deal with. He works hard and spends a lot of money, but the problem never goes away.

He overfocused. Does your organization overfocus? Start by looking at the goals and objectives outlined by management. What you find here is not the tools and techniques to attain corporate objectives, but the savings the corporation wants to achieve in the next fiscal year. This is good, to a point. But in attaining some of these goals, you must be careful and not overfocus.

You’ll get the idea by looking at one example I ran into.

Several months ago, I worked with a company whose corporate goal was an inventory turn rate of 26 turns per year. It wanted 26 turns for everything that was on hand. The company figured the savings would be enormous because it would only have two weeks of inventory on the shelf and would minimize the amount of money it invested in inventory.

The company was at about three turns per year, which, if you do the math, gave it the opportunity to reduce investment in inventory by a factor of nine. That doesn’t even include the savings in carrying cost and space utilization.

It was a lofty goal, but the project fell short. While the company got the sought-after 26 turns per year, it didn’t see a major, positive shift in the corporation’s cash position.

Why? The savings attained by reducing inventory were lost in the amount of money it cost to operate the company at that inventory level.

An example of one item carried in the inventory illustrates the point. The maintenance store stocked a plastic bag used to protect equipment when maintenance workers did periodic cleanup in the factory. The company used $180 worth of plastic bags per year. It worked hard and did reach 26 turns per year for this item. It also had three stockouts because it ran out of bags. It also lost production because workers couldn’t perform the necessary cleanup when needed and, therefore, had to shut equipment down until bags came in. The quick solution to the stockout was air freight.

Let’s analyze this problem and look at the cost structure for attaining 26 inventory turns per year.

Average annual purchase                                   $180
Average maximum inventory                               $6.92
Average on-hand inventory (half-full bin)                $3.46

Cost of maintaining inventory               
Purchase orders per year                                    26
Cost to purchase @ $200/PO                              $5,200
Carrying cost                                                      not measured
Air freight for 3 stockouts                                     $500
Lost production                                                   expensive
Total annual cost to maintain $3.46 of inventory     $5,700+

Now, let’s look at the cost structure for attaining one turn per year.

Average annual purchase                                      $180
Average maximum inventory                                  $180
Average on-hand inventory                                     $90

Cost of maintaining inventory               
Purchase orders per year                                     1
Cost to purchase @ $200/PO                               $200
Carrying cost                                                       not measured
Air freight for 3 stockouts (one every 12 years)        $20
Lost production                                                     virtually none
Total annual cost to maintain $90 of inventory          $220

This company brought on-hand inventory from $90 to $3.46, a reduction of $86.54. But, it spent an additional $5,480 in acquisition costs to get that savings. It overfocused by stressing the amount of money invested in inventory. No one looked at acquisition costs.

Look at your operation. Have you overfocused?

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.

This article appeared in the October/November 2001 issue of MRO Today magazine. Copyright 2001.

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