Inventory and natural disasters

by James McIntosh, Performance Improvement Manager - QMI Solutions

In Queensland, Australia, we experienced widespread and severe flooding in January. Thanks to good town planning, houses are often on high ground and businesses in nice, flat, low lying flood plains, so many businesses were affected.

We've noticed that the companies with less inventory and good 5S recovered from the immediate impact of the floods much more quickly, as there was less junk to clean up. In fact, some un-lean companies were so overwhelmed that they weren't able to face the prospect of cleaning up, and just walked away.

Also, the companies with lower inventory and generally good Lean practices have returned to production quicker and more effectively, because they have been able to work on both "business as usual" and "manage by exception" much more quickly.  Through our network, I have heard of companies which had large amounts of inventory and have spent a lot of time trying to figure out what they could make with it, given the parts which were damaged and needed to be replaced.

Of course, this is a case where global supply was still available. Japan's crisis is different, as it affects global automotive supply chains. In that case, people are making the point that large amounts of inventory might buffer against these occurrences - and there is a real impact when people shy away from reducing inventory levels because of this belief. Complex assemblies such as automobiles rely on a vast variety of components, sourced from around the world due to price pressures. Also, each single item is required - you can't make the car without the badge, just as you can't make it without the wheels.

To maintain a meaningful buffer, you must buffer every single component. The storage and capital investment required would be so vast - imagine trying to buffer against a 6 month interruption at a small to medium sized plant by storing 200,000 cars or so.... at $15,000 per car that's 3 billion dollars tied up in inventory. Even if the buffering worked, a plant producing 400,000 vehicles a year carries a burden of $750 per car, if the cost of money is 10% and any other costs of storing, insuring, handling, obsolescence and shrinkage are ignored. This makes the plant unable to compete due to the cost and is the very reason why Lean companies outcompete others.

Globalisation means exposure to risks, globally - an earthquake in Japan that knocks out your transmission plant impacts you, as well as the event in Germany that knocks out your ABS module plant, and the event in Malaysia that halts your injection moulded parts.....so the frequency of major events which might affect you is increased. This leads people to think about local sourcing, to reduce the exposure frequency - however you have reduced your pool of possible suppliers so it is likely that won't be able to access world's best producers. Again, if the cost/quality/service penalty on your $15,000 of components is 5%, that's a burden of $750 per car, with the result that you're unable to compete.

So maybe the answer is diversification of your suppliers - gearboxes both from Mexico and Japan, or diverse model production at a given plant. These options also have a cost.

The reality if of course that you choose a strategy, each of which comes with benefits and drawbacks. I feel that the current costs of transport are so low, economies of scale so large, benefits of sourcing world's best so great, and major interruptions like the current one so infrequent (and shared by our competitors) that the only sensible strategy for the automotive industry and many others is world's best sourcing, with low levels of inventory. However, I can not back this up with data, and the answer is different across industries, markets and products.

High inventory levels are used where the capital investment in operating equipment is very large, such as aircraft and minerals processing plants.

Local sourcing is used in specialist flexible areas such as service and custom fabrication.  Diversification is used in risk sensitive areas such as defence.

My fear is that manufacturing and assembly, which should use world's best sourcing with low inventory, will change strategies due to the current Japanese crisis and suffer because of it.  What do you think?

Through his role as Performance Improvement Manager at QMI Solutions, James McIntosh extensive experience in Lean process improvement, including supply chain and inventory optimisation across mining, automotive, transport industries.