The Impact of Inventory Turns on Speed, Quality, and Costs

By creating low inventory environments, pharma can establish the “Leanness” that it sorely lacks.

By Robert E. Spector, Principal, Tunnell Consulting

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Lean Management represents one of the most favored business improvement programs today.    Pioneered by Toyota in the 1950s, Lean aims to eliminate waste in every area of the business, including customer relations, product design, supplier networks, and factory management. Its objectives include using less human effort, less inventory, less space, and less time to produce high-quality products as efficiently and economically as possible while being highly responsive to customer demand [1].

Although there is no universally accepted measure of a company’s “Leanness”, inventory turns are a reliable indicator. The trend of inventory turns over time indicates how well a company is progressing in terms of becoming more Lean and improving its processes. 

How does the pharmaceutical industry rank on this measure compared to other industries?  Unfortunately, at the very bottom. But by adopting Lean principles, Pharma companies can increase inventory turns and not only achieve significant financial benefits but also enhance competitiveness in the all-important areas of speed, quality and costs. 

Inventory Turns as a Measure of Leanness

Inventory turnover—defined as the cost of sales (also known as cost of goods sold) divided by the average inventory level over some time period—is a convenient proxy measure of Leanness.

Recall that the goal of Lean is to achieve improvements in the competitive edge elements of speed, quality and cost. Lower levels of inventory directly correlate to improvement in these competitive edge factors, as we will show. That’s why Japanese manufacturers focus intently on reducing inventory, sometimes characterizing inventory as “evil.” Similarly, noted Lean experts such as Richard Schonberger view inventory as a catch basin for a multitude of business ills.

Inventory turns also straightforwardly correlate with the bottom-line measure of business success: cash flows. Reduced inventories mean more cash in the bank, freeing up cash that can be used for other purposes. However, reduced inventories are beneficial only if the reduction derives from process improvement—the core of Lean. If a company cuts inventories without improving processes, then stock-outs and lost customers will far outweigh any benefits of increased cash flows.

In addition, inventory is a standard financial metric and is readily comparable company-to-company, as well as over time within a business. It is also highly visible. Walk around a facility characterized by high levels of inventory and you can conclude that the facility is fat, not Lean. 

The Impact on Speed

The impact of inventory on speed, quality, and costs becomes clear when a high inventory manufacturing environment is contrasted with a low inventory environment.

Figure 1

Although there is no absolute measure, comparisons with competitors can help determine whether a company is a high inventory or low inventory operation. 

Suppose, for example, a company has an order for 1,000 units which are manufactured in a three-step production process that is run over two shifts, 16 hours a day, five days a week for a total of 80 working hours per week. In a traditional high inventory manufacturing environment (Figure 1), the material might be released from stores, processed and moved through the plant in a single batch of 1,000 units. That is, each operation completes work on the entire batch before any material is moved to the next operation. Each step processes and transforms the input materials incrementally. 

In this high inventory example, almost six weeks are required to complete the order. Compare that to the results from a low inventory manufacturing example (Figure 2) in which Lean principles such as setup reduction, flow layouts and pull production have been applied in order to reduce the batch size all the way through production. There is no longer any waiting until each operation is completed for the entire order before moving it to the next operation. Material is moved between operations in batch sizes of 100 units, allowing several operations to work on the same production order simultaneously. 

In any production process the slowest operation acts as the constraint to the system and sets the throughput rate for the entire process. In this example, that constraint is the second operation, with a throughput rate of 12 minutes per unit.

Figure 2

Releasing material at a rate faster than the slowest operation will only cause build-up of inventory in the system. So an additional change must be made: release material into the system only to keep the constraint busy versus that of the high inventory environment in which the entire order is released to the first operation.

As a result of these changes, the work-in-process inventory level is much lower and the order is completed in half the time. This phenomenon is also demonstrated by Little’s Law, which shows that lead times are directly proportional to the amount of work-in-progress, i.e., inventory.   Production lead times and work-in-progress inventory are mirror images of each other: reducing work-in-progress inventory proportionally reduces lead times. Therefore, if a product can be produced in less time, then capacity has, effectively, been increased—that is, the number of units processed per unit time increases. For both generic and brand drug manufacturers, the ability to ramp up quickly to meet surges in market demand confers a significant competitive advantage. 

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