Zero Inventory

8/7/2019 Zero Inventory

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INVENTORY PHILOSOPHY

The basic principle of JIT is the continuous reduction of all inventories while satisfyingchanging market demand with short lead times and flexible production. Service level orthe ability to satisfy demand comes from fast production and delivery, rather than through

pre-produced inventory from the warehouse as in the case of traditional management.High sales and good service are achieved by JIT without the high cost of inventory,foremost of which are financing cost, space, and risk of obsolescence. In a volatile andcompetitive market, inventory is deemed as risk and waste, rather than as safety bufferand asset.

JITs view of inventory can be summarized as follows:

Inventory can reduce profits.

Inventory is not a safety buffer.

Inventory is not an asset but waste.

Inventory cannot be optimized.

Inventory can adversely affect quality.

Inventory Can Reduce Profits

Inventory is not an innocent entry in the balance sheet. Indirectly, it can affect the incomestatement and reduce profits. Companies usually see their hard-earned operating profits

drastically diminished, if not eliminated, by non-operating interest expenses mostly dueto funds tied up in unseen idle inventory. Inventory, though not an income statementitem, also pushes up operating costs in a silent but no small way rent, leases, energy,and insurance. Expensive manpower to maintain and handle inventories are safely hiddenand embedded in direct and indirect labor costs. Defects and spoilage due to excessiveinventory (explained below), can bloat material consumption and costs unnoticed. Mostcash flow problems resulting in expensive borrowing and frantic juggling of funds comefrom failure to liquidate inventories. Inventory is not free.

Inventory Is Not a Safety Buffer

Conventional wisdom dictates that inventory should be carried as buffer or safety stock toabsorb sudden or abnormal rise in customer demand. But in case of sudden drop indemand, which is the more common occurrence in this highly competitive environment,inventory becomes a drag. Most inventory control systems are designed to cope withquantitative but not qualitative changes in demand. If you have adequate stocks of thewrong products, then your safety stock is unsafe. A more formidable challenge at presentis adapting to changes in variety or product mix that the market wants, rather than


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changes in volume a task that conventional inventory management cannot effectivelydo.

A specific level of finished goods inventory is often maintain to provide a targetedcustomer service level satisfying the customer, say, from 95% to 99% of the time.

Increasing inventory may be the simplest way to increase service level, but it is also themost expensive; moreover, it is inflexible and cannot quickly adapt to high productvariety situation. Reducing lead time or processing time is more effective and lessexpensive. The logic of the brisk fast food business is lead time management withminimum inventory and minimum space. This JIT principle was successfully applied byToyota to car manufacturing. Short lead time, rather than huge inventories, is ideal forhigh variety, perishable, fashionable, and high obsolescence products that describe mostof the consumers products of today and tomorrow.

In case of raw materials and supplies, these are often stockpiled to maintain a buffer orhedge against future price increases. True, prices go up, but they also go down; and in

case prices continuously go up, no amount of inventory build-up will give you long termprotection and advantages if you are in operation indefinitely. The main business of anybusiness is business, not speculative activity, gambling included, there are always morelosers than winners. Any short-term gain from hoarding is windfall due to luck and notmanagement.

Inventory Is Not an Asset but Waste

What makes most managers treat inventory indifferently or favorably is its accountingtreatment as a current asset. More often than not, inventories are neither current norassets; and to further complicate things and multiply the illusion, many companies use the

current ratio (current assets/current liabilities) to gauge their liquidity position. Currentliabilities are usually more current than current assets. It is often much harder to liquidatecurrent assets inventory and its sister, accounts receivable than it is to postponepayment of current liabilities. One company tried to borrow a $50,000 working capitalloan from a bank which refused to give it after examining its balance sheet anddiscovering that it had $1,000,000 in inventories. The company hesitated to explain thatthe bulk was made up of old stock, slow-moving and never-moving obsolete items whichwere carried over in the books for years.

The primary accounting basis for classifying an item an asset is cost, because cost isobjective and documented, rather than market value which is subjective and unrealized.But cost does not necessarily confer value to an asset. The fact that the company incurredcost in purchasing or producing an asset does not mean it can be sold. Fixed assets likeland retain and increase in value over time, but inventories are subject to high degree ofobsolescence and spoilage and therefore their costs seldom reflect their true market value.In case of drop (but not increase) in market value, accounting practice allows thedevaluation of inventories. But this painful task is rarely done since it would drasticallyreduce the companys asset base and serve to expose the negligence and incompetence ofthe current management.


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Inventory Cannot Be Optimized

Most literature on production and inventory management subscribes to the traditionalview that the level of inventory can be optimized by ordering an economic order quantity(EOQ). The EOQ formula states that the optimum order or production quantity is the

amount at which the carrying costs (insurance, interest, etc.) equals the ordering or setupcosts (paperwork, machine-set-up time, etc.). The principle says that any amount belowor above this EOQ will tend to increase total costs. The theory is correct, simple,beautiful, but seldom applied in practice.

Why is the EOQ approach a failure? One reason is its utter simplicity it is limited tounrealistic single-product, steady demand and static costs assumptions. The EOQprinciple also requires lots of accurate information as inputs, carrying costs, setup cost,unit costs, and demand for each product. Most companies do not possess, update, normonitor this information consistently or accurately.

JITs zero inventory has none of the EOQs drawbacks. It is easy and simple toformulate, understand, instruct, follow, and execute. Under zero inventory,

minimum is optimum. The object is to minimize all inventory and order quantities

until these reach zero levels. It is not deriving some vague magic number from other

vague numbers. Zero inventory can be applied in the most static or dynamic

situation even with the most imperfect or incomplete information. The zero targets

stay even when products, costs, or demand pattern change, and whether or not you

know all about your costs and products.

Excess Inventory Can Adversely Affect Quality

Excess Inventory- A Roadblock to World-Class Manufacturing

The most unrecognized adverse effect of inventory is its encouragement of bad qualityand sloppy workmanship. The mere sight of abundant supply and stocks make mostworkers very careless in handling parts and products because it makes them think thatthere is a second or another chance to undo, rework, hide, or cover up first-time mistakes.Inventories, looked upon as buffer or back-up, make it very difficult for employees to doit right the first time.

Results of excess inventory

Increased labor cost Increased fuel cost Cost of interest on working capital Increased space cost Increased maintenance cost Material scrap and rework Material aging Risk of material obsolescence


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More transactions = wasted time

Measures against excess inventory

Production only of the number of items required by the subsequent process

Layout: from functional to cellular Seamless flow between work centers Disposal of obsolete materials

Very important: excess inventory hides problems, because it generates an alternative toinvestigating the root cause of the problem.

In JIT companies, the output of one station immediately becomes the input of the next,and not thrown into a heap of buffer of work-in-process. With little stocks (ideally one

piece), between them, JIT work stations are effectively coupled; defects are easily spottedand solved since the receiving station rejects them right away and returns them to issuingstation that just produced them. This instantaneous feedback on quality is not possibleunder the conventional JIC (Just-in-case) systems in which molehills of buffer separate ordecouple work stations that tend to mind their own business until disaster suddenlystrikes and the problem goes beyond control. Since the entire JIT production line wouldstop if any work station stops, the workers and managers make sure no problem occursanywhere in the line.

EXCUSES FOR HIGH INVENTORY

There is an inventory of excuses which a typical manager uses to maintain the status quoof high inventory. Using the output-process-input framework, we can classify these intothe following elements.

1. Output instability

Unreliable demand

Unsteady demand

Poor forecasting

Lack of market information

2. Process instability

Long production lead time

Long setup times


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Frequent machine breakdown

High defect rate

Labor unrest

High absenteeism/employee turnover

Equipment capacity imbalance

3. Input instability

Unreliable suppliers

Long lead time

Unstable prices

We could add a fourth, very fashionable group of excuses:

4. Environment instability

Bad roads

Bad traffic

Bad government

A typical manager who makes use of these excuses admits his own helplessness andincompetence in dealing directly with these problems, without actually solving oreliminating their roots. What is management for if its solution to practically all problemsis to build up inventory? To incompetent managers, inventory is the easiest way to paperover problems, especially if the company has adequate financial resources at its disposal.High inventory is often a symptom of mismanagement or no management at all.

HOW JIT COPES WITH INSTABILITIES

The approach of a JIT manufacturer is totally different. To cope with output instability, it

involves the customer in its planning and designing activities, and sets up flexibleproduction processes that can cope with changes in market demand and variety. Ittherefore relies much less on forecasts and their accuracy; it assumes all forecasts are andwill be wrong anyway.

To deal with process instabilities without resorting to inventories, the JIT manufacturercontinuously reduces all lead times and setup times through Kaizen or continuousimprovement. Machines and equipment are made reliable through Total Productive


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Maintenance (TPM). Employees and workers are formed into self-managing teamsempowered to solve their own problems. Employees are trained with multiple skills sothat capacity and productivity are not adversely affected by absenteeism and turnover.

A JIT manufacturer trains its suppliers to reduce instabilities in input quality and

delivery. Establishing partnerships with suppliers, local and foreign, often leads to betterquality and more reliable delivery of raw materials and supplies. To make them moremanageable, the number of suppliers is also reduced. Toyota has about 200 supplierswhile Ford has about 8,000, or 40 times more.8 Moreover, JIT manufacturers do notresort to speculation and hoarding when prices of raw materials fluctuate; these solutionsusually create more problems.

What about environmental constraints or things beyond ones control? The point is notto use them as excuses to defer action on the output-process-input instabilities. JITmanufacturers have demonstrated that substantial reduction in inventory can be achievedthrough improvement in internal system efficiency even within the harshest

environmental conditions.

PITFALLS IN APPLYING JIT

Failures in implementing JIT outside Japan, especially in other Asian countries, comefrom managements lack of understanding of the JIT philosophy. They think it is just aninventory reduction exercise, and not a competitive strategy to improve quality, responsetime, productivity, and cost at the same time. A fat person trying to be slim does notsucceed by having his fat surgically removed, or by eating less and taking medicine. Onlya change in lifestyle will be effective. JIT is similar in that it requires a total and drasticsystem change including organizational structures, management styles, and company

policies, especially in manufacturing. JIT does not begin with reducing inventory, anddoes not end with it. JIT begins with serving the customers - the market fast anytimewith the quality and quantity of goods they want no more no less. This principle ofcustomer service applies to all departments in the company. Every department is treatedas the internal customer of the preceding department which must produce and serve onlythe quality and quantity its internal customer requires. The expectation is that if everydepartment serves its internal customers well and fast, then the company can serve thepaying or external customer similarly.

Another common misunderstanding of JIT is that it starts with suppliers and the reductionof raw material inventory. Many companies find it tempting and easy to start JIT byrequiring their suppliers to deliver just-in-time, i.e. more frequent deliveries with smallerlots sizes. More often than not, suppliers cannot cope with the sudden change inrequirements because they themselves are not familiar with JIT principles. If onesproduction system is not streamlined, then this approach simply results in transferringones inventory to the suppliers warehouse. Because both buyer and suppliers are notready for JIT, implementation fails, and then JIT is blamed and criticized for not beingpractical. The truth is that JIT principles are valid, but the implementers are ignorant andunprepared.


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The proper way to start is to reduce finished goods inventory levels inventory with thehighest value and closest to the customer by producing or assembling only what isordered by the customer as close as possible. After succeeding at this level, then JIT isapplied to work-in-process (WIP) inventory, the inventory with the next highest value-added, by applying the concept of internal customers and internal suppliers. The last

stage is reduction of raw materials. This stage starts not by mandating suppliers to deliverjust-in-time but by training them first on JIT and improving their internal productionsystem. This is done through partnering with suppliers and subcontractors. Ideally, JITshould be applied on a pilot line which then becomes a model for JIT implementation inall other lines.

JIT CREATES A CRISIS MANAGEMENT

In spite of Japans unquestionable economic strength, the Japanese people seem to throbwith vitality as if they were still reconstructing a country just devastated by war, as ifthey were no tomorrow. JIT could partly explain this crisis mentality amidst theprosperity of the 1990s.

JIT has formalized crisis management into a total management philosophy whichencompasses marketing, finance, human resource development and business policy complete with maxims, pamphlets and mentors. JIT, though pioneered by Toyota,distinctly reflects the Japanese national character.

Though on the surface, it seems that JIT is all about inventory reduction; it also simulatesa crisis so that managers and workers are always on their toes, ready to do their best, withor without any real crisis. Managers are trained to imagine the worst possible scenarios;plummeting sales, raw material supply cuts, walkouts and strikes, fires and accidents. Themessage is clear: Do your best today to avoid disaster tomorrow.

Production workers, however, are slow to appreciate any of the macro-level crisiswhich threaten Japan businesses today, such as cutthroat competition, import barriers,appreciation of the yen and imminent obsolescence of most of the present technology.The managers, therefore, induce an artificial crisis at the shop floor level which can befelt by all the employees. This crisis may or may not be related to any real threat.

The tension generated by the stimulated crisis, however, is a positive tension and seldomresults in any counterproductive fear or undue anxiety among workers. They becomeaccustomed to using their survival instinct on a daily basis, and this makes every workingday a challenge, a victory to achieve rather than merely a boring expanse of time. Toyota,the richest Japanese manufacturing company in terms of sales, profit and cash, may beone of the least vulnerable companies to the threats in the economic environment. Yet,


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Toyota continues to rely on crisis simulation in its management, and has substantiallyreduced working capital requirements and amassed tremendous cash reserves as a result.

By deliberately reducing all inventories, the lifeblood of any manufacturing concern, to aminimum, JIT induces a crisis at the shop floor level. Stockpiles of everything from raw

materials to finished goods are reduce including nuts and bolts, paper clips, pistons,crates and even finished Corollas.

In theory, inventory should be reduced down to the one-piece level. Each work stationwould process only one piece at a time and would thus only need one piece from thepreceding station. The result is a synchronized one-piece flow of goods from the rawmaterials receiving station to the finished goods packing department. The kanban orsmall signboard, which acts like an internal purchase order, is sent by one station, theinternal customer, to the preceding one, the internal supplier, to cl another piece.

In reality, however, Toyota does not reduce inventory so much as it designs systems from

the very start to operate on very low levels of inventory. It does not mean that Toyotacannot afford to stockpile inventory, but that it prefers to invest In the workers ability,flexibility and a sense of responsibility.

Though most workers still do not work for one piece at a time, working with very lowinventory levels exerts tremendous pressure on them and drastically changes theirworking methods, habits and attitudes. This works in the same way that being lost in astrange town with little cash makes you very resourceful with your money. The lesson isclear: a vital resource pared down to a certain minimum, whether deliberate, accidental ornatural, induced one to use that resource very wisely. The important point is not so muchwhat happens to the resource, but what happens to the attitudes, outlook and level of

alertness of the user.

In the JIT system, the vital resource is inventory and the user, though not the owner, isthe worker. JIT stimulates the desired crisis mentality in the worker because failure toproduce a piece for any reason stops subsequent operations. Without any buffer stock,this stoppage will be instantaneous and will affect the entire production line.

In practice, however, the factory does not close down simply because a worker breaks apiston or a machine overheats. All workers are trained to come to the rescue of a workstation in trouble and to return the situation to normal as quickly as possible.

Each worker must press a signal button to alert others to any abnormal situation whichmight lead to work stoppage. This button ensures that everyone in the factory gets themessage, activating giant light panels hanging from the ceiling as well as noisy buzzers.There are distinct lights and signals for different problems: red lights for a machinebreakdown or a defective part from the previous station, yellow light for a time-outrequired setting up a machine or machine tool, and a white light for no part received fromthe previous station.


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As each worker wants to avoid catching the attention of the whole workforce or annoyingothers by a production stop, he or she learns to develop a sense of responsibility for workusually only found in skilled craftsmen and high caliber managers. The beauty of the JITsystem is in that it makes the worker realize, in practice as well as in theory, that he orshe is a critical link in production.

The substantial savings and cost reduction due to low inventory requirements are justbonus side-effects of the kanban system. The ultimate goal is still profits, but theJapanese companies hope to reach their profit targets by perfecting their workers.

The workers also ensure that defects are reduced to an absolute minimum, because theabsence of buffer stocks prevents them from hiding any defects. In spite of the pressure tofinish one piece just in time to feed the next station, the workers are not tempted to passon a defective product just to follow the cadence because they know that this will causemore chaos down the line and solicit immediate reprimands from the receiving station. Azero defect rate is not merely a target set by the managers, but is a condition implied and

even required by the logic of the JIT.

The workers develop the ability to control the equipment as well as their own work. Theydo not go home until their machinery is repaired, so that they will not cause anyinconvenience to coworkers the next day. Again the inherent logic of JIT naturally makesthe workers experts in preventive maintenance a feat which no amount of seminars orprodding from the factory head can accomplish. One Japanese worker even painted on hismachine: I will guard this machine with my life.

The workers also learn to reduce setup and changeover times which can cause machinedowntime and line stoppage. By minimizing changeover times, Toyota realized that

multiple product brands and models could be processed on the same day withoutsignificant delays.

Toyota has eliminated the need for warehouse space and incoming inspection. Suppliersregularly unload raw materials or parts in small lots direct to the production line, whiletrucks pick up finished cars direct from the packing station for delivery to dealers.

One of the basic principles of JIT is to make problems visible so that they may attractattention and prompt early and speedy solution. Lowering inventory levels exposesproblems in the factory: defective parts, inefficient workers, unreliable machines, poorworking methods, excess equipment capacity, and dead or obsolete stocks.

The JIT system applies a Japanese adage to the business world: In times of peace andprosperity, think always of the threats and hardships of war. The Japanese have simplyadapted their formula for survival into a formula for success.

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