I get asked quite a bit about Lean inventory management. The notion is sublimely simple, however the application may often be a bit more involved. Lean principles tell us that all forms of inventory should be minimized (raw materials, work-in-process, and finished goods) in order to shorten our lead times and to diminish our capital risk. Some people want to take this idea too far and suggest that we should eliminate inventory altogether, but that isn’t the goal at all. Up-stream lead times simply won’t permit this in most circumstances. Ideally, you should determine and maintain an optimum inventory level for your particular situation and customer needs. This should take into account customer expectations, demand, and processing constraints.
Managing physical inventory doesn’t have to be complicated, but it does take some up front effort. The notion of ABC classification for physical inventory is profoundly helpful to begin sorting out this problem. The ABC approach helps us manage inventory by associating simple visual cues to our merchandise.
Products judged as having “A” characteristics include products that are fast movers, high margin, and/or flagship products. These are the items that deliver unquestionably high value to your organization. According to the Pareto principle, these “A” products will likely represent about 20% of the portfolio but make up about 80% of your revenue stream.
Products gaged to be in the “B” category will be products that move periodically or steadily, but in smaller quantities, and/or products with modest margin that are deemed as “necessary” for the sale. These are the type of things you’d find on the Value Menu at the local fast food restaurant.
Products judged to have “C” properties are typically very slow movers that may include outdated, obsolete, or discounted products, or perhaps special items being evaluated for future launches. If these items are expected to remain available in the system, we must insure that they do not get in the way both physically or economically. In other words, they should be physically remote to normal operations and they should not compete against higher margin products.
The ABC approach helps to guide us in how we physically arrange the items because A items should always be convenient and in close proximity to the customer, B items a bit farther away, and C items in the least prime locations of all. This affords us the opportunity ease the release of products the customer actually wants without interference by products the customer doesn’t.
I personally advocate for color coding when possible, to make these products unambiguously apparent. Use green stickers or other indicators for the A materials, yellow for the B materials, and red for the C items. This way proper positioning can be determined at a glance.
Additionally, ABC is useful to help us prioritize the activities that go into product line management. Products and families of the A variety should receive preferential attention as their value to the company and customer is greater. You only have so many hours in a week and so many dollars available to spend. Prioritize the use of both.
An often neglected aspect of inventory management that is related to classification is rationalization. Rationalization is the critical process by which we optimize the portfolio itself and not just the organization of it. Most companies don’t realize that they are carrying items whose value is net negative because they ultimately cost more than they can generate. More than 20% of products in most companies are net neutral or net negative anchors and need to be trimmed or reformed to become positive performers. Often, these anchors are legacy products that have outlived their life-cycles and are in need to retirement or replacement.
This phenomenon can be illustrated easily if true costing data is being collected respective to every product. The results are startling and often referred to as the whale curve; an example presented below from Wilson Perumal and Company. The realization of this massive waste wherein products have negative profits should prompt management to carefully examine the overall portfolio. Difficult decisions need to be made in order to reform these anchor products (through concerted improvement or replacement), to retire them, or perhaps to divest of entire product lines.
Another useful tip is to apply Pareto thinking to your overall portfolio. Normally, 20% of your products will generate about 80% of the revenue. If you find that this not the case, you may want to closely examine the portfolio. Often I’ve seen 80% of the revenue being generated by less than 5% of the products. This is a dangerous position to be in.
Assuming that the portfolio is performing adequately and not in immediate need of rationalization attention, you will find the ABC classification is a useful technique that quickly organizes your entire product landscape. Reduce effort applied, distance travelled, and dollars spent in your organization by applying ABC principles to your inventory management approach. Delivering value to your customers quickly and reliably will always work in your favor.
Lean in and Lean on.