After decades of ERP enterprise architecture experience, many organizations still do not have the proper best practices (or practices at all), gates, controls, and metrics in place to answer this question with any credibility. Many of the most seasoned ERP users have retired. Many of the newer master schedulers, planners, and buyers have not yet developed the basic end-to-end ERP and manufacturing systems fundamentals. Many organizations are too busy and cost conscious to provide the necessary education and talent development. Many react to complex, deep rooted issues with quick, symptomatic band aid fixes, so nothing improves in a permanent and sustainable manner. And as a result, many choose to use their expensive ERP infrastructures as a pure financial accounting and reporting system. They underutilize the true power of ERP to leverage operations and achieve breakthroughs in revenues, profits, and asset performance.
The Common Dilemma
Another real world observation: ERP Déjà vu. Many of the answers and root causes to the above question are the same answers as 5, 10, or 25 years ago. Too many organizations do not make the time or effort to evaluate what is going on down in the details of the ERP enterprise architecture – Specifically in:
- Sales and operations planning or S&OP,
- Production and material planning,
- Global sourcing and procurement,
- Bill of Material (BOMs) maintenance and accuracy,
- Engineering documentation and ECN rev controls,
- Quality standards and specifications,
- Workmanship standards, instructions, visual aids,
- Order policies and planning assumptions,
- Financial and cost accounting standards,
- Scrap and rework accounting,
- Cycle counting and inventory accuracy,
- Item master data integrity,
- Unique demand stream characteristics and SKU turns,
- Open PO spend commitments vs. operating and financial plans,
- Build and ship status,
- Supplier management and performance,
- And hundreds of other drivers of poor performance.
Failure to continuously address these issues makes it impossible to sustain or improve ERP operations and inventory performance. The sad reality is that progress goes backwards in a negative direction with negative consequences. The true answers usually reveal themselves when it’s too late – as excess inventory, massive shortages, capacity overload, quality problems, a clogged operation with poor delivery performance, overtime and premium freight as the norm, low efficiencies, and surprise write-offs and restructuring costs.
Asset, Liability, or Equity Drain?
Inventory is an asset when the right series of supply chain best practices exist from forecasting, S&OP, operations planning and execution, and supplier management. New
product development, engineering, and quality are also critical elements of success. The right inventory is always positioned in the right places at the right quantities and at the right times. Perfection, but not reality. Everyone knows that forecasts are inaccurate, and what an organization plans to build to support revenues in the beginning of the month is different from what is actually sold to make the numbers at the end of the month.
The first step at reducing supply chain complexity and variation is to move away from the one size fits all management practices. One size does not fit all; every organization has multiple demand/supply chains with different customer requirements and operating characteristics. This may not be so obvious but it is a fact. The key to success is applying the right, best-fit supply chain best practices to these different value streams.
Despite ERP’s 50+ year history, many organizations still ship 80% of their revenues in the last week of the month which creates a timing difference in the planning system. This is all called variation, and variation is inevitable in the real world. The key to success lies in reducing variation through improvement, and building broader capabilities to respond to inherent and non-assignable variation in supply chains. Both require the right structured means and deliberate actions. Although technology has evolved significantly, the same basic ERP fundamentals remain a key to continued success.
There are situations where organizations need to put a deliberate buffer in place. For example, ordering raw materials with long lead times and exceed near-in demand, and building finished goods ahead is a good temporary strategy when consolidating facilities or introducing new products with a high upside potential. This is not evil; this is smart and temporary is the key word. Managing inventory to the correct, ever changing target service levels while achieving 100% customer satisfaction is what makes inventory an asset.
Inventory is a liability when the end-to-end supply chain is corrupted by many wasteful short term survival activities. One of the largest symptoms is an organization that does not understand their enterprise architecture, and a leadership team that is unwilling to invest in the effort to turn things around;
- The norm becomes the reliance on the morning hot list meetings, expediting, excuses and finger pointing, conflicting management directives, and other heroic efforts – all based more on symptomatic perceptions and opinions rather than repeatable process and facts.
- To justify the chaos, some executives might say things like “Too much inventory isn’t so bad, the interest rates are low.”
- When things get bad enough, out comes the across-the-board financial directives to slash inventory and at the same time, audaciously push orders through the system – which exacerbates these problems.
- The result is a constant struggle with angry customers, missed revenues, the existence of both massive shortages and large excess inventory, conflicting information and multiple versions of the facts, serious quality, warranty, and returns issues.
Let’s face it. Too much inventory or the wrong inventory is an operating liability. It gets analyzed, moved, counted, lost, damaged, recounted, mislabeled, comingled, expired, ECN’ed away, cleaned up, picked incorrectly, repackaged, and then used too slowly or not at all. Inventory can quickly become a serious operating and financial liability.
Inventory as an equity drain is the consequential red zone of inventory management. It is the ultimate, non-reversible outcome of operating in an inventory in a liability mode as the standard protocol. The longer organizations operate in this mode, the more inventory sins are committed and swept under the rug, and the larger the problems grow. The complexity of ever eliminating root causes increases because they multiply in complexity and become hidden under the radar of daily work;
- Management knows that these problems exist and they postpone dealing with it for as long as possible because fixing these problems has a much lower priority than short term performance.
- Additionally, fixing these problems is complex, requires time and resources, and results in a negative hit to financial performance.
- Eventually management solves the problem by allocating financial reserves to cover the cost of write-offs and conveniently explains things away to stakeholders by restructuring charges.
Processing equity drains (writing off inventory) has become an institutionalized financial practice. Does this eliminate the root causes of write-offs? Are more restructuring charges inevitable in the near future? The answers to these questions are obvious as long as organizations choose to operate in an inventory as a liability mode. Inventory as a liability can be predicted and prevented up front with the right proactive leadership and an effective ERP analytics. Realistically, 100% of obsolete inventory cannot be eliminated but a large layer can and this is pure bottom line profit. It is always interesting what the right, drill-down analytics reveals about root causes and repeating operating patterns that create obsolete inventory in the first place. Analytics can peg causals to a poor product development process, failure to understand specific customer requirements, overstated forecasting and S&OP, incorrect planning parameters, specific disconnects between the operating plan and spend plan, PPV and volume discount deals, a specific engineer, buyer, or supplier practice, and many other surprises that can be turned into actionable improvements.
The Only Right Answer to Your Story: “ASSET”
There is only one logical operating choice for organizations and this is managing inventory and the supply chain as an asset. Not a financial asset, but a competitive business asset. Managing inventory as a strategic asset is a leadership choice. In this mode, not all inventory is evil; it is strategically planned, positioned, measured, and adjusted to optimize the customer experience and financial performance.
Organizations with excellent inventory performance have a few common operating best practices:
- Recognize multiple demand/supply chains. Segment and manage the product portfolio into various demand streams based on critical operating parameters (e.g., premier customers, make-to-stock, configure-to-order, custom, revenues, ship volumes and topology, and other fact-based attributes). Their process is not a one size fits all approach and they recognize the different dynamics in different demand and supply streams.
- Invest in ERP generic business education, software features and functionality. Too many people who are responsible for millions of dollars in assets do not understand the basics of ERP and the consequences of end-running the formal process and practices. Others are missing the fundamental practices and using ERP primarily as an accounting and financial reporting system.
- Understand with data and facts, the specific demand/supply variation points and root causes in the end-to end supply chain, and buffer these performance detractors with temporary, selective and scientifically determined hedge buffers (Note: Temporary is the key word. Organizations need to supplement their hedge strategies with an aggressive improvement initiative to eliminate root causes and manage down/remove the hedges).
- Adapt Lean and other strategic improvement principles to the professional, knowledge-based world of enterprise transactional processes. A few manual production boards, 5S labeling and signage, or other canned Lean production tools just doesn’t cut it in this highly complex technology environment. The problems and root causes are hidden, and require a more creative forensics problem solving approach to achieve bottom-line success.
- Install the proper business analytics and real time performance dashboards to monitor system-wide performance and make the right corrective actions in the right places. Additionally, implement basic Lean practices such as process shut downs and escalations to fix problems on the spot.
- Implement a robust go-to-market process that leverages common design standards, materials, capable processes, and suppliers. Any variations due to design, quality, reliability, and velocity increases supply chain inventories and lead times by default.
- Rationalize the product portfolio and the associated materials and suppliers to reduce supply chain complexity, and strive to identify synergies and consolidation opportunities via product management, design, process engineering and improvement, and the supply base.
- Evaluate the options of offshoring vs. re-shoring based on a fully loaded, total landed cost of ownership basis. These decisions impact the length and flexibility of supply chains and the speed of responding to changing market and/or operating conditions.
- Continue to eliminate detractors, drive down cycle times, and improve the flexibility and capability of responding to inherent uncertainties in demand and supply.
This is an abbreviated list, the details of their best practices are much more complicated but definitely worth the ROI. Inventory as an asset requires a deep understanding of the enterprise architecture and the right disciplines and best practices to optimize pipeline throughput and performance. These organizations are on a very visible mission of relentless, never ending continuous supply chain improvement.
What’s the Story with Your Inventory? The right answer is a moving target with a rising bar. The right real time metrics and predictive/preventive analytics must be in place to answer this question at any time with any credibility. Any particular right answer in time is just a data point, the very beginning of a total supply chain transformation initiative – an initiative that is a continuous improvement journey, not a destination. Every day is a new day with new opportunities for improvement. Success requires a deep understanding of both business process improvement and the ERP enterprise architectures. But recognize that technology by itself is not the answer. Before you go deeper into the cloud, big data, or pervasive interoperability, think about the people and essential process basics. It takes a great supply chain team who can understand and uniformly interpret ERP information, make the right evidence-based decisions, and take the right deliberate actions to continuously improve and run the business successfully. One message is clear and fifty years old: Don’t forget the basic disciplines and best practices, and the people side of ERP on the way to supply chain excellence.
About the Author
Terence T. Burton is President and Chief Executive Officer of The Center for Excellence in Operations, Inc. (CEO), a management consulting firm that works with mid-market and private equity organizations on Operations, Supply Chain, Go-To-Market, and other major strategic and operational improvement initiatives. CEO is located in Bedford, New Hampshire with offices in Munich, Germany.
Terry is the author of a new book by McGraw-Hill, Global KATA: Success Through the Lean Business System Reference Model™.
For additional information visit www.ceobreakthrough.com or contact the author directly at email@example.com