Managing Capacity and Inventory
In two previous posts by Pete King (Optimizing Safety Stock and Optimizing Cycle Stock), we discussed the fundamentals of inventory management and setting cycle and safety stock targets for individual materials. In this post, we will talk about using the targets to achieve working capital, customer service, and production efficiency goals.
The stock of any single material will never be constant: it will change with phases in a product’s production cycle and fluctuations in its demand or line efficiency. Carrying safety stock is pointless if it is never used. Consequently, the inventory of any single material can vary between zero and a high number.
FIGURE 1: Cycle and safety stock of a single material with a fourteen-day production cycle.
It’s not bad management if some products are below safety stock or above their targets. However, the aggregate stock of all products at a site should be relatively constant and managed to an upper and lower limit, and it is a problem if too many materials are high or low at once.
If too many products are high at once, working capital is not being used efficiently, there may be insufficient storage space, handling and damage costs will increase, and the risk of obsolescence or shelf-life expiration increases. The upper limit of total site inventory is the point at which production should be curtailed or additional demand should be accepted or created. Inventories higher than this limit tie up capital without incurring additional benefits.
If too many products are low at once, it will over tax the production lines. The lower limit of aggregate inventory is the point at which the site can no longer produce economically because there is not enough time to complete the efficient production sequence or to finish one thing before something else is needed.
Most product groups have an ideal sequence of production, and efficiency will be lost if they are produced out of sequence. Allergens and colors are two examples. A sequence that adds allergens will minimize cleaning, since the process must be thoroughly cleaned as soon as an allergen is subtracted. Colors may be able to flow from light to dark, or in a color wheel sequence, with little or no cleaning between them.
Low inventories disrupt the efficient sequence, since there isn’t time to produce a reasonable size batch of each product in the sequence before something else becomes a priority. When inventories fall below the lower limit, production scheduling becomes like a game of “whack a mole”. At Procter & Gamble we used to call it the death spiral. Inventories are too low to produce on an efficient production cycle and disruption increases, the shorter cycles and disruptions cause less efficient production which leads to even lower inventories, which lead to even shorter cycles, even less efficiency, and even more disruption.
The aggregate inventory limits should include allowances for the time required to move or stage stock before it can be used or shipped, stock in quality inspection, off quality, and other non-performing inventories.
FIGURE 2: Aggregate Inventory Components
Setting Inventory Limits:
Inventory limits should be set for a related group of products that use the same pool of capacity or production lines and resources. This doesn’t mean that every product in the group must be interchangeable on every line. Let’s consider a food plant making multiple kinds of products, we might set inventory limits for canned foods and frozen foods, but it wouldn’t make sense to group the inventory limits for frozen foods and canned foods together. And it might make sense to sub-group by can size or serving size if the production lines were different and there was no ability to move products between the major size groups.
The Lower Limit:
The lower limit of inventory for efficient production is readily calculable. It’s the sum for all products in the group of safety inventories, average cycle stock, quality inspection inventories, staging or transportation inventories, and held, dead, or other non-performing stock. Our earlier posts (Optimizing Safety Stock and Optimizing Cycle Stock) and white paper explained how to calculate them.
The allowances for other stocks can be calculated in several ways. One is simply to look at how much stock is currently tied up in each category, or to develop an average for each over time. Another is to take a more data-based view, by asking questions like: how long should it take for an item to clear quality inspection? How long should it take for a material to be ready for use from the time it is received? How long should it take us to move finished product through the plant to the shipping dock? How long should it take us to work off or disposition held product and what is the rate of products put on hold? The answers to these questions can be converted from time to quantity by estimating an hourly, daily, or weekly volume.
The Upper Limit:
The upper limit is harder to calculate and more subject to judgement, it is the point at which production should be curtailed or additional demand should be accepted or created. Protecting customer service and reducing changeover costs are subject to the law of diminishing returns.
FIGURE 3: Diminishing returns of increasing safety stock on service levels
FIGURE 4: Diminishing returns of increasing cycle stock on production efficiency
Inventories higher than the upper limit tie up capital without incurring additional benefits. The costs of handling, damage, obsolesce, and expiration increase out of proportion with any offsetting benefit of protecting service or minimizing changeovers.
Often physical space, working capital limits, or shelf life limits can put a hard ceiling on the maximum. In the absence of constraints, the question becomes one of looking at the range of variability in the site’s total demand over time. The distance between the upper and lower limits should allow for inventory to bounce between the two limits given natural variability. Beyond the upper limit or below the lower limit, it should be unlikely that inventory will return to the range without corrective action.
It may be helpful to think of the difference between the upper and lower limits of inventory as business protection inventory. The inventory that keeps you in the efficient production zone, without being wasteful of working capital.
FIGURE 5: Example of Total Site Demand for a 3 Month Period.
Figure 5 shows how much higher or lower a site’s total demand might be over a three-month period for a non-seasonal business, pre-COVID. It ranged from 15 percent lower than average to 25 percent higher than average. To protect the business, the site would need some combination of the ability to ramp up 25% or to have one month’s average demand available as business protection inventory.
Statistically, it’s possible to calculate the combined variability of all products at the site; however, there is often a correlation between products and external causes like events, weather, or competitive action that cause many products to move together, rendering the statistics invalid. Therefore, judgement, hard limits, or the review of demand history may be the best method.
Regardless of the difficulty in setting the limits, choosing almost any informed set of targets, and managing against them will improve results.
Managing to the Inventory Limits:
Next, let’s consider the actions to take when approaching or outside the limits.
Below the lower limit, production efficiency will decrease, and disruption will increase. In the extreme, it will result in the death spiral discussed in the opening paragraphs, where disruption leads to lower efficiency, which leads to more disruption and even lower efficiencies. It’s important to stop the cycle before it starts. When inventories are trending dangerously low, production should be added, or demand should be managed.
If a site ever finds itself in the death spiral, the only way out is to manage demand or increase capacity. Recently, Covid and supply chain disruptions put many sites into this area. A typical response was to prioritize customers and reduce the product assortment to allow more efficient production.
The upper limit is easier to manage, but often more painful internally. It’s easier because one solution is just to stop producing. It’s painful because no one likes to shut down lines and employees can become demoralized. Often it conflicts with how results are measured, and how people are rewarded. This can be mitigated by planning in advance for what to do with downtime and using balanced measures for results and reward systems.
An alternative to curtailing production is to accept additional demand or generate demand, often through promotion and pricing; however, these actions typically have a longer lead-time than production curtailment, and must be put in motion before the inventory limits are reached.
An Inventory Management Example:
A large integrated paper company had a wood pulp and a diaper division. One grade of internally produced wood pulp was used in the manufacture of the diaper absorbent core. On average, the output of the pulp plant equaled the requirements of the diaper division; however, there was variation in the rate of pulp production and in the demand for diapers.
Company management believed there was a cost advantage to using all the diaper pulp production internally, and was reluctant to sell pulp on the outside market when diaper demand was low or when the pulp division was running at high efficiency. When the pulp division had production upsets, or when diaper demand was high, there was a reluctance to purchase pulp from the outside market until the last minute, resulting in crisis purchasing of pulp to avoid shutdowns of diaper lines. History showed a cyclical stockpiling of large quantities of pulp in high cost outside warehousing, followed by periods of low inventory with expedited purchases of premium cost pulp from the outside market.
A simulation was created to show that if buying and selling were done mechanically, at certain inventory levels, the total amount of buying and selling was relatively small, inventory stayed within limits, and the overall result was more profitable.
A meeting was called with the top management of the diaper and pulp divisions. the meeting kicked off by explaining that even though demand and supply were equal on average, historically there were periods where the volume mismatch was significant, both high and low.
The simulation was used to educate management that there were times when it was more profitable to sell pulp than to store it, and other times where a minimum stock should be maintained by purchasing pulp from the outside market in an orderly fashion. The rules were followed in subsequent years and inventory remained in limits. The diaper lines ran better because they were supplied with fresher pulp from consistent sources.
To learn more, and discover how to put this into action at your plant, visit our Inventory Management webpage or schedule a call here:
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Peter L. King, CSCP, is a Principal Consultant at Phenix Planning and Scheduling specializing in the application of lean concepts to process manufacturing and global supply chains. Prior to this, he spent 40 years with DuPont in a variety of manufacturing automation, project management and lean continuous improvement programs. King also is the author of several books on lean, including Lean for the Process Industries – Dealing with Complexity.
Mac Jacob, Head of Product, CPIM, SCOR-P, was a key contributor to building Procter & Gamble’s supply chain, ranked as one of the four best in the world by the Gartner Group. He started in project management, production planning, warehousing, and shipping in a small manufacturing plant, and then became the planning manager for Luvs Diapers for North America. He realized that it was the supply chain systems that were holding back the business and led a project that eventually became P&G’s global SAP/MRP II implementation. At one time or another, he was the business leader, developed the work processes, and wrote the original training materials for most of P&G’s supply chain planning systems.
About Phenix Software
Changeovers and incorrect inventory levels waste significant time and money and affect customer service. Phenix planning and scheduling software uses Aligned Product Wheels to minimize waste and align production with the business’s customer service, cost and working capital goals.