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Inventory Is Ignorance

Costikyan Jarvis, of Jarvis Cutting Tools, recently wrote to me about a manufacturing executive program he recently attended at Harvard, in which the instructor told the class that, "Inventory is ignorance."

As if to prove the point, I was sent another story from a lean coach at one of the better MEP's.  I'll keep it anonymous at this point - after all, the MEP lean guy was there because the company wants to become lean and there is no cause to embarrass them.  If the would-be lean company still thinks this way a year from now, I'll name names and we'll see if I can't shame them into becoming leaner. At any rate, here's the story:

"Last week I was working on a set-up reduction kaizen project. We were applying the usual SMED methodology and carefully analyzing the elements of the set-up when it was mentioned casually that the order we were observing was not for a customer but was destined for stock. I understood this to be a make-to-order situation with a substantial backlog of orders, so I was confused. Why were they making this product in lieu of actual orders? Simple - because the raw material was getting old, and was about to be downgraded in inventory value. With the application of some direct labor, the near-obsolete raw material was magically transformed into a brand new asset."

While not all inventory equates to ignorance, most of it does, and this inventory most certainly does.  So if inventory is ignorance, what does that say about Pierre DuPont whose ROI logic put inventory on par with cash in evaluating manufacturing performance?  And what does it say about Alfred Sloan who took that formula and created modern management theory around it?  And what does it say about Donaldson Brown, the 'Father of Modern Cost Accounting' who worked out the details of the system that made the MEP story commonplace?  And what does that say about the overwhelming majority of business school accounting faculty members who continue to teach this system?  And what does that say about the investment community who heaps billions of dollars on companies and senior managers who close plants and outsource manufacturing based on the results of this system?  And what does this say about the people at the IRS and the SEC who have codified the ignorance of inventory into law?

Before 24 hours goes by, better than a thousand lean thinkers from all over the world are gong to click in and read this.  The comment section is wide open.  Can anyone explain how a company can 'kaizen event six sigma black belt Toyota Way culture change' itself to lean while still formally managing itself by this system?

Or is changing the financial system a funamental prerequisite to lean?

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4 Responses to "Inventory Is Ignorance"

  • J. Wilson
    7 June 2006 - 10:20 am

    “Or is changing the financial system a funamental prerequisite to lean?”

    The short answer to your question is yes…assuming that a given company truly wants to be lean. Most only want to use the lean tools to cost cut their way to a little more profit under their old systems. Anybody can tell you that you get the behavior that you measure. What measurement is truly more valued than those put out by the accountants? In the end, it’s all about making money for a lot of companies. Until companies change the way they look at the money metrics, all most of us “lean thinkers” are doing is learning some good Japanese words and earning some pretty belts on the way to reinforcing the good old way to do business.

  • Graham
    9 June 2006 - 4:50 am

    “Or is changing the financial system a funamental prerequisite to lean?”

    The short answer to your question is yes…
    ;o)

    I don’t believe it’s a funamental prerequisite, it’s just a lazy mans way.

    If I build something to sell to a customer for £10 or I build something to put in stock as an asset worth £10 it’s the same difference, no?

    Being able to build junk and have it show up as valuable definitely does encourage lazy thinking – why try harder when you don’t need to.

    In your example where there’s a backlog of orders it was wilful stupidity that led to them building just to use up stock. It also proves that there’s motivation not to keep raw material in stock because it will devalue – a la JIT etc.

  • Getting it right first time.
    9 June 2006 - 4:51 am

    ^^^^^
    damnit, i meant to say “short answer is -NO-“.

  • Costikyan Jarvis
    10 June 2006 - 1:34 pm

    I am going to show my ignorance and see if I am correctly answering “What do we mean by the financial system?”.
    To be simplistic, there are three main financial statements (Balance Sheet, Income Statement and Cash Flow Statement) and they are built on a variety of financial concepts like the Money Measurement Concept (accounting deals only with things that can be represented in monetary terms). These statements attempt to create a common reporting output that all industries (manufacturing, service, non-profit, etc.) can use.
    We use a variety of tools to analyze and draw conclusion from these statements. You could even classify them into categories like Liquidity (do I have enough cash?), Activity (are things under control?), Operating (what is happening to costs and profitability?) and Leverage (is there too much debt?).
    I think that both the statements are analytics are the “financial system” that is being discussed.
    These statements are governed by GAAP and, in my opinion, no matter how much we want to change these statements they are not going to change. I suggest that instead of spending time on the statements, we focus on the analytics.
    I think there are measurements in the current financial system that we like and need. Examples of beneficial measurements are the Quick Ratio, Days Receivable, Inventory Turns, Debt to Equity and Gross Margin. What other measurements are useful? Now we need to look at what we do not like. One that Bill does is constantly harping on is ROI, but are there others?