The main mission of lean manufacturing is to eliminate waste and create a more efficient factory. Any factory with excessive inventory cannot be categorised as lean or run efficiently as excessive inventory is one of the top forms of waste, weighing down all operations, not just the warehouse.
Despite this, many factories, especially in China, do not see the harm that excessive inventory can cause. They often believe that a significant ‘safety stock’ is necessary and will often buy large volumes at a discount. While this might seem like a good idea on paper, in practice, it really isn’t - it is really an example of being penny wise and pound foolish.
In this article, we’re going to take a look at the 3 primary ways excessive inventory is harmful to your factory.
Note: For this blog excessive inventory is either raw materials or finished products. Work-in-progress (WIP) is not included. That is a whole other subject.
3 Primary Ways Excessive Inventory Is Harmful to Factories
1. Space Usage
Most factories we visit have trouble with capacity and productivity, yet they have mountains (sometimes literally) of excessive inventory that takes up space that could be used to solve their capacity and productivity problems. The owners of these factories lament that they do not have enough space and are looking for a new location with more room. When we tell them that they have plenty of space if they reduce their existing inventory, they don't believe it can be done, yet it can be done. They are under the impression that inventory creates value while it doesn’t, so any space that can be converted from inventory storage to productive space will produce value. Tying up space in inventory means lower production, lower sales, and lower revenues.
Note: value in this context is any activity that improves the product so it can be completed and sold.
2. Cash Flow
Many companies seem to think of inventory as “free” since it is already purchased. Nothing could be further from the truth. Inventory is not free and is a considerable drain on company cash flow. Poor cash flow is often the primary reason companies go bankrupt.
Inventory is just money sitting around until it is used to complete a product. The general rule is that inventory costs 25% of its total value, for example, $40,000 worth of inventory will cost the company $10,000, most companies would be happy to only have that much inventory. One of our previous clients had $500,000 worth of inventory meaning that it costs the company $125,000 to have it sit in the factory.
Think of it this way: if you spend $50,000 on raw materials you can produce $250,000 worth of finished goods. However, if those goods are not manufactured 6 months after you have bought the raw materials, it means you have $50,000 on the books for 6 months before those materials can be used to generate revenue. Moving that inventory in a week gives you more cash.
3. Expired Materials and Product
Most raw materials eventually become either unusable or outdated. This means that they cannot be sold or used to make new products. A bamboo manufacturer we worked with had bamboo that was over a year old in its warehouse. At that time, much of the bamboo was warped and damaged and could not be made into finished goods. The manufacturer had brought it in bulk to save money but ended up losing money, it is like buying food on sale and letting it spoil. Yes, you saved money, but you did not receive any benefit from the purchase, and it's easier than you think to allow old inventory to accumulate. Over the past month, I was at 2 client sites and saw raw materials from 2018 and even 2013! These items may be long forgotten but it was an easily avoidable waste of money and space.
These are the primary ways that excessive inventory can be harmful to your factory. While it is easy to fall into these mistakes, it is harder to get out of them. Only through concerted effort and lean thinking can you bring your inventory down and reap the benefits of better cash flow and space usage. We recommend checking out our blog about inventory cost reduction methods for China to get started with the process.
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