“Anticipate the difficult by managing the easy.”
The Bake Sale Debacle:
Imagine with me: you’re taking part in a bake sale for your son’s hockey team. Customers have 2 weeks to fill out an order form for various treats; you’re in charge of baking the Rice Krispie squares.
You make a good guess that each of the team’s 20 players will sell 3 orders of a quarter pan each, so you buy enough materials for 15 pans of squares. You get a great deal at Costco buying that many boxes of cereal and marshmallow bags at once.
Here’s your budget:
15 pans @ $20/pan
15 jumbo Rice Krispies @ $5 each = $75
15 jumbo marshmallow bags @ $3 each = $45
Gas to/from Costco = $10
The orders trickle in. A square here, a square there. But the big orders never come in for you. Instead, they overwhelm the Nanaimo square mom down the block. She’s swamped, all the while after selling a measly 7 pans your kitchen is still crammed with materials and you’re $25 in the hole for materials.
So what happened?
Expect the Unexpected:
You made an educated projection of how much you’d sell, and you bought your products at a reduced rate based on that projection. You even saved fuel and time by making fewer trips. You should have come out ahead.
But the unexpected happened: the nanaimo bar competition. As you munch on Rice Krispies for the next year, you tell yourself, “I couldn’t have known.” But, there is always the unknown. Therefore we need to plan for the unknown.
You actually had another option. You could have bought enough ingredients to get started, then waited for more orders to buy more.
Just-in-Time Inventory Management was developed in Japan in the 60s and 70s and perfected by Toyota. The philosophy is simple: only have enough raw materials to fulfill the orders you’ve taken.
The secret is in developing a reliable supply line to bring in just enough materials on fairly short notice. Just-in-time for your bake sale would have looked like this:
- You buy enough raw materials to get started with a couple pans.
- You make more frequent trips to the store. You buy smaller boxes of Rice Krispies. Thus, you pay slightly more in transportation and materials.
- You save by staying close to the rocks, and not carrying any more inventory than you need.
Here’s what a Just-in-Time process for your bake sale would have looked like:
8 pans @ $20/pan = $160
12 midsize Rice Krispies @ $3.75 each = $45
12 midsize Marshmallow Bags @ $2.25 each = $27
Gas to/from Costco = $30
Your costs were higher. But you turned a $25 loss into a $58 profit. You expected the unexpected and built flexibility into your model instead of optimism.
The deadly waste of Over-Inventory is dangerous because it’s so often overlooked. When we bring in more inventory than we need, it doesn’t just sit in the corner.
It wastes money every day it sits there:
- Every dollar we tie up in inventory is a dollar less in cash flow; a dollar less we can use to run our business.
- As inventory sits, it ages. It gets old, goes bad, becomes obsolete. We often eventually need to discount, throw away, or write it off
- Every time you have to move it, money is wasted.
All in, the cost of carrying inventory for a long period is 25-30% of its value. For most businesses, that eats your profit margin even if you can sell it at full price.
Toyota is the king of Just-In-Time Inventory Control, waiting until it receives orders before ordering parts. But when you’re close to the rocks, there’s no room for error: in 1997 a fire at a Toyota parts manufacturer shut Toyota assembly lines down for weeks because they ran out of the part after just one day.
Examples like that are illustrative of risk, but incredibly rare. For lean businesses adept at Just-in-Time, the waste saved is well worth the odd hiccup.
Whether you’re a large manufacturer or a tiny kitchen cook, the first step is making your supply chain as reliable as possible. Step 2 is Just-in-Time.