One thing is for sure, keeping up with the ever changing demands of customers is no easy task. When confronted with the enormous challenges of pleasing customer demand for faster lead times, configured products, and lower prices, a common strategy for many producers is to just throw money at the problem in hopes of keeping customers happy. For most, this “investment” takes the form of increased inventory levels with a corresponding increase in working capital demand. This defensive money strategy has been a reliable fall-back solution for meeting on-time delivery of customer demand for many years.Although exhausted managers know this strategy may not be the least-cost solution, they hope to buy enough time until a better strategy comes along. Fortunately, for manufacturers, the Lean operating system includes a manufacturing strategy that allows production of even highly configured products every day greatly reducing the need to maintain large work-in-process and finished goods inventories as a buffer to provide the flexibility customers demand.

Although pouring money into inventories in hopes of providing a buffer between manufacturing capability and customer demands for rapid response, the resulting increase in inventory investment has cost implications on the balance sheet: increased working capital requirements. Increased inventories also negatively impacts customer lead time as new customer demand must work its way through work in process queues at each manufacturing process actually lengthening response time to customers.

Many variations of inventory strategies have evolved to accommodate the time gap between customer lead time and actual manufacturing response time. Building to a partial level of completion using the common levels of a BOM and finishing assembly with additional configurable materials based on the receipt of actual customer demand is a common strategy. Purchase of the component inventories needed in the stockroom is still based on a forecasted projection of the final configuration a customer might order. As with any forecast, should customers fail to purchase the planned configuration, excess, slow-moving parts or obsolete raw material inventories are a likely result.

1) Build a WIP inventory of assemblies or subassemblies forecasted in advance of demand. This inventory can be completed earlier than receipt of an actual customer order. These items can then be finished in a shorter lead time by using a final assembly schedule. When customer demand is received, pre-built subassemblies are attached to a partially completed unit to finish the build configuration to meet the customer’s demand. If product mix and volume are unpredictable, greater raw material levels in proportion to lead time shortfall are necessary to maintain lead time expectations. The cost of additional raw materials and selected WIP is less than building and maintaining finished units and storing them in a FGI.

Because no customer is likely to wait for supplier lead time plus manufacturing’s lead time to receive demand, supplier delivery lead time can dictate the quantities of purchased materials necessary to be kept on hand in a store’s inventory. Regardless of the customer satisfaction solution chosen, every manufacturer must determine the appropriate amount of inventory to be maintained to provide the customer differential of response time and delivery.

With current planning systems, inventory levels are determined by forecasting the customer demand to be produced in advance of the receipt of an actual sales order.

2) Ship products that have been produced in advance from a FGI. Shipping from FGI is a common solution that works well if products are generic and order patterns are predictable. If the products customers are buying are custom configured or designed to order, predicting the right mix and volume of FGI’s can be a risky proposition. For the most expensive categories of inventory an inaccurate forecast can be an expensive guess. For custom-configured or designed-to-order products, producing the most historically popular models is best. However, even with this strategy, manufacturers run the increased peril of product obsolescence. Regardless of the chosen technique, inventory investment is required. The question is how much is the right amount?

Customer response policies are based on the amount of time required to produce products. Longer lead times through manufacturing cause inventory levels to become unusually large and require proportionately greater inventory investments! Of course, the sum of all these inventories has a direct impact on working capital requirements. Inventories not only require space on the shop floor, in warehouses, and at distribution centers, the space required is not free. It adds overhead to the cost of doing business. Inventory always has financial implications!

In addition to inventory investment strategies for responding to customer demand in less time than required to produce new product from the gateway process to shipping. A throwing-money-at-a-problem strategy causes funds to be invested in additional purchased inventory:

  • If suppliers expect to be paid in 30 days (N30), paid-for purchased materials reside in a stockroom for 30 days before work begins in manufacturing.
  • If manufacturing conversion time is 4 weeks, money is committed to WIP for the 4 weeks required to manufacture the product.
  • If FGI levels are 3 to 4 weeks, cash is committed for an additional 3 to 4 weeks.
  • If invoices are not always paid immediately after products have been shipped to satisfy a customer’s demand, cash is committed even longer.

Using this typical inventory investment as an example, money will be committed to the inventory strategy for at least 12 to 13 weeks, resulting in an inventory turn of four. An inventory turn rate of four translates into a working capital requirement of 25 cents of every dollar shipped in revenue to support this level of committed, purchased inventories.

What is an acceptable level of working capital for your company?