DRIVERS OF INVENTORY
Why should there be inventory in the process when we all want to be lean and live without inventory?
Inventory can be used to shield us from the variability of demand. Inventory can also be used to shield us from the internal variability be it in the form of set up times or the variability in processing times. For this reason, inventory is really a very powerful symptom that guides you in improving your processing. Wherever you see inventory, you will have the supply and demand mismatches and those tend to be the biggest opportunities for process improvement.
Why do firms hold inventory? – VARIABILITY is a big driver why firms hold inventory.
Buffer or suffer? Buffer or suffer means, that in a system that is not able to buffer the variability, we will suffer a loss of flow rate.
MAKE TO ORDER vs. MAKE TO STOCK
The McDonald’s approach – make to stock or make to inventory. The main advantage of make to stock, is that it allows to scale economies in production. The second advantage of it, is, it also allows for short flow time for the customer order. If following the make to stock model, the firm holds inventory even if it has not yet seen the demand. This allows the operations to look faster about to, to the customer. Remember, the customer doesn’t want to wait. The operation looks fast to the customer, even though internally, it might actually be very slow.
We notice this by comparing the two biggest restaurant chains in the world, Subway and McDonald’s. At Subway, as we’ve already discussed, customers wait for their sandwiches to be made because the sandwiches are made to the customer order. The customer orders a sandwich and then stands there in line, potentially waiting with other customers, until their specific sandwich uniquely made for them is completed.
Mcdonald’s follows a different strategy. At McDonald’s, the restaurant makes a whole batch of sandwiches. They don’t make just one cheeseburger, they just do twenty in a row. Then, the sandwiches will wait for the customer orders. So, instead of the customer waiting for the sandwich, at McDonald’s, you have the sandwich waiting for the customers. The benefit of that is when the customer order finally comes in, you don’t have to make the sandwich, you can fulfill it immediately. So, instead of having the customer wait for the sandwiches, the sandwich waits for the customer. You have a longer flow time for the hamburger, but a short flow time for the customer order.
In the Subway setting, the benefits of make to order are that you can make the sandwiches fresh. The flow time for the sandwich are short, which comes at the expense of the waiting time for the customer. It also allows for more customization. It would be impractical to hold all potential versions of a Subway sandwich in inventory. By making the sandwiches to order, you can allow the customer to choose whether they want extra mayonnaise or no onions on their sandwich. The final benefit of make to order is that you’re producing in exactly the quantity of demand. This is called CUSTOMER CHOICE. Make to order allows you, as we discussed, to dramatically increase the level of customization in the production.
Do inventory cost us money to store as we’ve seen in the calculations with inventory turns?
5 Reasons for Inventory is also 5 Reasons for Longer Flow Time
Inventory helps us with the flow rate by decoupling the supply and demand. This is one of the reasons why companies like to have inventory.
1. Pipeline inventory is a direct result of Little’s Law: I=RT. You will need some minimum inventory because of the flow time > zero. Minimum inventory any operation needs to exist.
2. Seasonal inventory. Driven by seasonal variation in demand and constant capacity. Driven by variations in the supply rate to match a seasonal demand.
3. Cycle inventory. Economies of scale in production. Driven by variations in the supply rate to match a seasonal demand.
4. Safety inventory. Buffer against demand. Driven by the variability in the spirit of buffer or suffer.
5. Decoupling inventory / buffers. Buffers between several internal steps in the operation.
Driven by the variability in the spirit of buffer or suffer.
**These are my notes from my Operations Management Course by Prof. Christian Terwiesch, Wharton University of Pennsylvania
