I once went to a warehouse in the Northeast to help a business struggling with late deliveries. Their product only took a few days to manufacture, but their lead time was almost 40 weeks and climbing. As I toured the facility I could see why. Boxes of finished goods were everywhere. All the shelves were full and pallets of boxes were clogging the aisles. Then I found out they had a second warehouse!
The inventory wasn’t the problem. It was the symptom. The real issue was a poorly executed Sales and Operations Planning process (S&OP). When sales, operations, purchasing, and finance aren’t working from the same plan, customers wait longer, employees become frustrated, and profitability suffers. Let’s talk about some of the root causes.
The Disconnect
Excess inventory is like the backpack nobody wants to carry. Not only is it heavy, but it’s often filled with too much of the wrong things and too few of the right ones. With the organization in my intro, I suspected the excess inventory was a major contributor to their lead-time issue. I knew from experience that when WIP climbs throughput tends to drop. Leaning out WIP would be key to improving delivery times. To determine the root cause, I followed the process from beginning to end, asking enough “5 Whys” to make everyone uncomfortable.
When an order came in and inventory was either too low to fill or completely out of stock, instead of converting a planned order from MRP, the planning team analyzed historical order volumes and released a job to produce a full quarter’s worth of inventory of those part numbers. To complicate matters, when operations was manufacturing the products, they would run larger quantities than requested on the work order to amortize setup costs. Not only that, once set up, they looked at inventory on additional parts made from that die, not the ones on the work order mind you, and ran any SKUs that also happened to be out of stock.
No wonder lead times were long. They were using their equipment to build supply for the orders of the future instead of for the orders of the present.
The Signal that Got Lost
When I was a new Controller, one of the first analyses I did was to start understanding our inventory position to see what we might be overbuying. Something immediately jumped out. We had over $1M of bearing inventory on hand. These weren’t commodity bearings either, they were long-lead aerospace bearings specified on a customer’s drawing. When I looked at the inventory transaction history, receipts had been rolling in on a blanket PO for months but there were hardly any material issues to the floor. When I learned from sales that the customer had greatly reduced their demand for these parts I was upset. What was I supposed to do with all these non-sellable bearings and what impact would it have on our P&L? What was my hot-headed GM going to say when I brought it up given we were already having a tough time hitting our quarterly EBITDA targets? The real question was how could such a costly disconnect have happened in the first place and why didn’t the signal get to purchasing to revise their purchase order?
In my case, an Ops manager who couldn’t ship product one month because of a bearing shortage jumped all over a purchasing manager who overreacted and overbought to prevent getting yelled at again. You may be seeing a version of this play out at your organizations. This is called the bullwhip effect, where relatively small changes in demand create increasingly larger distortions as they move through the supply chain. An article from MIT shares the four drivers of this behavior:
- Demand forecast updating – when an organization plans procurement activity around other inputs than true consumer demand
- Order batching – placing large orders to save on ordering costs like tiered pricing or freight costs
- Price fluctuations – when sales drives demand through promotions and therefore distorts true consumption patterns
- Rationing and shortage gaming – the toilet paper and facemask issue from the pandemic days where customers overbuy from panic and then cancel once supply stabilizes
Trail Markers: Reducing the Bullwhip Effect
Here are some practical steps you can take to get you going down the right trail and to avoid bullwhip effect:
- Share true end customer demand data across your organization so purchasing can see the raw demand signals
- Give purchasing visibility to the actual production schedule, not just the unfiltered list of open SO demand and their due dates
- Work with vendors to create smaller order increments to reduce demand fluctuations into their systems
- Allocate your supply based on past buying behavior, not present orders. We’ll talk more about moderating demand signals in my next blog post.
- Move away from gut-feel safety stock numbers. Buffer quantities should be a calculation, not driven by the fear of running out
- Pareto out your open POs by unreceived value and validate the demand and supply are properly linked. Focus on long-lead and specialty items that will be difficult to return.
- Use metrics for purchasing other than just a stockout rate. Things like E&O and inventory turns. It is important to incentivize good business practices rather than the success of supporting bad ones.
Once your demand and supply plans are synchronized you can get away from reactive behaviors and focus on getting the production schedule smooth and accurate.
Somebody Has to Carry It
Remember that second warehouse? It was filled just as full as the first one. Here is what that meant for the people on the floor. Every pallet needed a space to live, someone to keep track of it, someone to move it, and someone to count it (which is why they didn’t do regular physicals). When combined with ship complete requirements, the dock crew was condemned to a daily game of Tetris with product that couldn’t be converted into a sale until all the SKUs were in place.
When I asked the owner about the inventory carrying costs and tie-up of working capital his response was “the investors don’t care about inventory.” That may be true, but your customers surely care about your growing lead time and the rising unit costs of your product. Every pallet sitting in a warehouse represents cash that can no longer be invested in people, equipment, new products, or growth. It is only a matter of time before the right group of investors gets together, sees the opportunity and low barrier to entry, and then undercuts the business you’ve worked for decades to build. That heavy backpack is going to slow you down and eventually you’ll start to see other hikers pass you by.
The hardest part to get across, even to good leaders, is that this isn’t a work ethic problem. Nobody on the floor decided to overbuy bearings or build ahead of demand. They just live with the result. You cannot 5S your way out of the inventory glut caused by the breakdown in communication and synchronization between operations and planning/procurement.
So where does this actually get fixed? Upstream, through a disciplined Sales and Operations Planning (S&OP) process. Sales, purchasing, manufacturing, and finance must all be looking at the same demand signal and agreeing on the same plan before anyone commits capital to it. Like any successful hike, the goal isn’t to carry more gear than everyone else. It’s to carry exactly what you need and no more.
In my next post, I’ll walk through what that process actually looks like in practice. I’ll also have a free field guide ready on my Resources page to help you get started.
If your warehouse feels more like a storage facility than a production facility, give Trail Guide a call.
