In Distribution centric organizations, the level of Inventory is perceived to be a critical measure to understand the health of the system (inventory with respect to sale). The traditional measure is Inventory turns i.e. Annual (or monthly) Sales / Inventory on hand (on a particular day).
In companies that implement the TOC replenishment solution, the items under replenishment at the stocking locations are maintained with buffer norms. The norm level is distributed equally in three zones- Red, Yellow and Green, with Red being the bottom 1/3rd. On depletion (consumption) of the stocks from the buffer, the items are replenished in quantities equal to the depletion (consumption). The norms are increased only if there are continuous penetrations in the red zone, while they are decreased only when the stock levels remain in green for a long period. The increases are in steps of one third of current buffer norm. This mechanism of changing norms levels is called Dynamic Buffer Management.
Companies report the terminal inventory at the end of a period- a month, quarter or year. This measure is also used to evaluate and appraise managers. The higher the terminal inventory turns reported, more effective the management is perceived to be. Let us examine how managers can report good numbers:
- Finished goods: The sales team manages the environment of the organization such that a large chunk of sales happen close to the month/quarter/year end. In some cases this is as high as 40% of the total sales is achieved in the period end peak. This flushing out of the finished goods stock reflects a very healthy (low inventory and high turns) performance.
- Raw Materials: Entry of raw material (RM) in the plant is be controlled by issuing instructions to suppliers to keep material ready and deliver on the first day of the next month. This ensures that the period end inventory of RM is low. The same material arriving 2-3 days later gives an illusion of the plant being operated on low inventory turns.
- WIP: The plants produce to cater to the requirement of high sales in point one above and are also act accordingly to point 2, thus ensuring that the WIP in plant is quite minimal when the stock is taken for reporting purposes.
It, is quite evident what the combined effect of points 1, 2 and 3 above is, however, more importantly such a practice has no effect on cash flow which is one of the aims of having higher inventory turns.
What are the negative ramifications of actions which are seemingly so good from the reports?
In a distribution environment, a key enabler of sales is availability. When inventories are depressed at the period end, availability of the high runners suffers for any incremental sales increase that may exist. As inventory is easily measured and reviewed than lost sales, reviewing and pushing for higher inventory turns gets prominence over lost sales.