Little’s Law states that, in any process, the average inventory is equal to the average flow rate times the average flow time. Now, unlike most other things are the equations in mathematics that I know that
were proven by some ancient Greeks, Little’s Law is actually a fairly recent mathematical discovery.
We’ll see how to apply Little’s Law, and that it’s quite a powerful tool for you as you’re going to analyze processes with respect to inventory, flow rate, and flow time.
What are the implications of Little’s Law?
First of all, Little’s Law tells us that from the three fundamental performance measures, inventory, flow rate, and flow time, two of them you might be able to mess around with. But then, the third one is written in law by nature.
Now, typically in a process, flow rate and inventory are relatively easy to observe. Flow time in contrast, is not.
On average in the process, inventory equals flow rate times flow time. Little’s Law is not an empirical law. To prove Little’s Law, we have to turn to stochastic optimization, and do some heavy lifting math. The strength and the weakness of Little’s Law is that it deals with averages.
Inventory Turns = COGS / Inventory
Cost Advantage
Inventory Costs
Once we have defined inventory turns, we can also compute a cost advantage, that a company has if it’s turning its inventory faster than its competitors.
So simply by turning the inventory faster we are gaining a dramatic competitive advantage. Holding inventory is expensive. Unless you’re holding French red wine in inventory, that might gain in value as it gets older, most of the things lose value. At the same time, you have to finance the inventory, which takes working capital. For this reason, inventory turns is a powerful metric to capture how well you’re using your working capital. The margin advantage that you might get from faster transit looks initially small. However, if you compare it to the net margin of a business. In most businesses, fast returns has a very significant impact on the bottom.
**These are my notes from my Operations Management Course by Prof. Christian Terwiesch, Wharton University of Pennsylvania
