Methods of Increasing Productivity Utilizing Inventory Control Systems

I. Introduction

The scope of this research paper is to discuss inventory control systems as they relate to the overall production for a company. I will first discuss production factors for companies and costs associated with high inventories. Then, switch the focus to describe, discuss, and compare Just-in-time (JIT) Production and Material Requirements Planning (MRP) processes as methods to reduce and therefore minimize inventories for businesses.

Productivity can be defined as a common measure of how well a country, industry, or business unit is using its resources. See the equation below for the mathematical relationships used to define productivity.

Productivity (P) = Outputs or Goods and Services produced

Inputs All Resources Used

Expanding on results in: Productivity = Output t

Labor + Capital + Materials

These equations allow productivity to be defined in terms of relative measure. This allows a business to compare current productivity levels against previous productivity levels, or against their competition’s productivity. The company defines what total or partial factors will be considered as output and input in these equations and then uses these values to calculate an initial productivity value. The value by itself is not important but it allows the company to make changes in the business model or operations and see how it affects the productivity of that company.

Now, let’s look at costs associated with inventory. There are four major costs associated with inventory: Holding costs, Setup costs, Ordering costs, Shortage costs. Holding or carrying costs refer to the costs for storage facilities, handling (i.e. moving), insurance, pilferage, breakage, obsolescence, taxes, depreciation and the loss of opportunity costs of capital. These costs can be very significant to the company. Any amount of money spent towards holding costs is capital that is unavailable for other projects, research and development, etc thus the “opportunity loss”.

Setup costs (a.k.a. production change costs) refers to changes in materials, arrangement or equipment, paperwork, costs for time and material involved in moving out one raw material and bringing in the next. Therefore, these costs can be reduced by attempting to minimize loss of time and material involved in changing from one product to another. This allows smaller lot sizes to be produced, which in turn would reduce the required inventory levels needed to produce these lots. One of the major goals of the just-in-time (JIT) system is to reduce the setup costs for a company.

Ordering costs refer to the managerial and clerical costs to prepare the purchase or order. These costs range from routine items such as counting stock and calculating order quantities to detailed process costs like the maintenance costs associated with an order tracking system.

The last inventory cost is shortage costs. This cost occurs when the stock of a particular item has been depleted resulting in orders requiring this stock to be delayed or cancelled. This results in a trade-off between the costs to maintain a “safety stock” and the costs occurring due to running out. Carrying a safety stock would ensure no orders will be lost or delayed due to running out, however, the safety stock would increase the holding costs. Maintaining a safety stock may be preferred when the expected loss of profit, goodwill, customers, or late penalties could be significant or impossible to estimate for the company.

The overall goal for a company is to establish the correct quantity to order and optimal lot size to minimize these four inventory costs. By decreasing the inventory costs, the capital (resource) required for production decreases. This results in the measured productivity increasing for the company as shown:

Productivity = Outputs = (Outputs are unchanged) productivity increases

Inputs (Inputs are less)

II. Just-in-time Production

Just-in-time production is a major breakthrough in manufacturing philosophy. JIT is an integrated process of activities designed to achieve high-volume production using minimal inventories of parts. These parts are planned to arrive at the workstation or production center exactly when needed (i.e. just-in-time) to allow rapid completion. JIT strives to maintain minimal inventories of raw material, work-in-process and finished products. JIT production assumes nothing will be produced until it is needed.

Some elements in the philosophy of JIT can be traced as far back as the 1900’s. Henry Ford’s streamlined assembly line concept and elimination of product waste is the most easily recognizable use of JIT in the pre-World War II era. Japan fully developed and realized the benefits of JIT manufacturing after WWII. Japan manufacturers were able to streamline the flow of materials used in production while maintaining a very high quality of goods and services. The two most identifiable areas using JIT are automotive assembly and consumer electronics. Japan simply focused on importing technology and was thereby avoiding the majority of research and development costs. Japan would wait until a new product was developed in another country and then import it. Their next step would be to focus their production efforts to the factory floor instead of the product design. By combining high product quality, reliability, and elimination of waste with a “respect for people” philosophy the Japanese were able to increase their market share and obtain dominance in several production areas.

Typically, the need signal in a JIT system is created by actual demand for a product. When an item is sold, the system senses the need for a replacement and pulls from the end of the production line. This pull on the end product triggers a need signal from the previous workstation to replace the necessary units. This “upstream station” would then pull from the next “upstream station”… this process continues until the raw materials or vendor is reached. In order for this process to operate smoothly, JIT requires high product quality and reliability at each stage in the process, strong vendor relations for rapid response to demand, and a fairly predictable demand for the end product. JIT is typically applied to repetitive manufacturing when the same or similar items are to be made over and over. JIT does not require large volumes and can easily be applied to any repetitive segments in a business regardless of where they appear. The strong vendor relations would allow for multiple shipments a day to be processed to the purchasing business which in turn keeps lot sizes small and inventory low. The optimal lot size in an ideal or perfect JIT system is one.

The continual goal of JIT is to drive all inventory queues to zero, which consequently minimizes inventory investment and shortens lead times. By keeping inventory levels low, JIT also aids in detecting and correcting quality problems. High inventory levels may hide or mask productivity problems. By reducing inventory levels these productivity problems ranging from machine downtime, vendor delinquencies, backlogs (paperwork, decision, and inspection), excess scrap, design redundancies, etc become visible allowing the company to detect and correct other problems in the production model. These additional corrections to the production model (resulting from low inventory levels enabled from JIT) at the very least will save the company’s input resources and may result in increased company output due to process improvement. Therefore, from the productivity equation previously discussed, a company’s overall productivity would increase from lower inventory costs but may increase due to process improvements associated with JIT production.

JIT utilizes three fundamental concepts to achieve higher production: 1) Elimination of waste by producing only the minimum necessary units in the smallest possible quantities (lot sizes) at the latest possible time, 2) By encouraging employee participation in all aspects of production a company fosters the feeling of ownership and pride, 3) All systems of production need to be integrated to achieve the optimal effects of the JIT philosophy. These concepts together allow the overall goal of JIT, producing what is needed when it is needed and no more, to be realized. Companies that perfect the three fundamental concepts enjoy better quality products, higher inventory turnover, lower production costs, which in turn result in higher productivity. The only possible downside of JIT associated with inventory is that the minimum levels maintained and small lot sizes intrinsically have little allowance for error when dealing with any contingencies that occur.

The concepts of system integration and employee encouragement/respect are essential elements involved in achieving the elimination of waste goal. The Japanese focus on elimination of waste spans into every aspect of a company’s operation and will now be discussed in depth:

a)Focused factory networks allow for smaller specialized plants vs. large vertically integrated production facilities. Large operations tend to have increased bureaucracies and are harder to maintain focus towards the company goals and management style.

b)Group technology, which was originally developed by the United States, has been widely adopted and successful in Japan. This philosophy groups similar parts into families and then groups the process required to make these parts into specialized work cells. This process reduces and may in some cases eliminate movement and waiting (queuing) time between operations. This process results in reduced inventory and reduced number of employees required. However, the process does require retained employees to be able to work several jobs and machines. This increased training and knowledge requirement for employees helps to ensure a business remains focused on employee retention and satisfaction.

c)Eliminate the waste of poor quality. Put simply; make it right the first time and when problems appear, stop the production line and fix it immediately. This waste elimination is also referred to as quality at the source. Factory workers become their own inspectors, focusing on each aspect of the work production. This philosophy not only leads to increased quality, it allows workers to discover quality problems residing in the production system itself. This empowering of employees reiterates management respecting/trusting their employees to work effectively and responsibly.

d)Uniform plant loading smoothes the production flow and dampens the reaction waves that usually occur when scheduling variations occur. By setting up a firm production plan with a frozen output rate for the near future, companies are able to produce the same mix of products everyday even if the quantities of some items are small. This loading enables the firm to make adjustments as small as possible when a change in the final assembly occurs, thereby minimizing the effects on the entire product line and supply chain.

e)Kanban production control systems use a signaling device to regulate flow of material and products in a JIT plant. Kanban (sign/instruction card in Japanese) control in paperless systems can be obtained by using containers or marking signals to regulate product flows.

Note: The Kanban system will be discussed further after the material requirements planning (MRP) discussion in order to compare/contrast the two systems with respect to push/pull systems.

Traditionally, the Japanese stress respect for people and lifetime employment for permanent positions within firms. This allows companies to maintain level payrolls during business expansion and contraction. Permanent workers make up about one-third of the total workforce. These workers have greater job security, tend to be more flexible, remain with the company, and therefore are the driving forces in helping the firm achieve its goals. Unions in Japan foster cooperative relationships with management which helps improve productivity. Management views workers as assets not as machines or liabilities. Company automation uses robotics to perform dull, repetitive, or routine jobs enabling employees to focus their efforts on important tasks such as process improvement, etc. Employees understand that if the company performs well bonuses or other monetary incentives will be given to reward work efforts. This respect for people concept may be one of the biggest reasons that JIT systems have had more success in Japan than in the U.S.

Table 1. Common purchasing differences between Japanese JIT and traditional U.S.

Purchasing ActivityJITTraditional

Lot sizeSmall lot size with frequent deliveriesLarge batch sizes with less frequent deliveries

Selecting supplierSingle source of supply for a given part in nearby geographical area with a long term contractRely on multiple sources of supply for a given part with short-term contracts

Evaluating SupplierEmphasis placed on product quality, delivery performance, and price, but no percentage of reject from supplier is acceptableEmphasis placed on product quality, delivery performance, and price, but about two percent of reject from supplier is acceptable

Receiving inspectionCounting and receiving inspection on incoming parts is reduced and eventually eliminatedBuyer is responsible for receiving counting and inspecting all incoming parts

Negotiating and bidding processPrimary objective is to achieve product quality through a long term contract and fair pricePrimary objective is to get the lowest price possible

Determining mode of transportationConcern for both inbound & outbound freight, with on-time delivery. Delivery schedule left to the buyerConcern for outbound freight and lower outbound costs. Delivery schedule left to supplier

Product Specifications”Loose” specifications. The buyer relies more on performance specifications than on product design and the supplier is encouraged to be more innovative”Rigid” specifications. The buyer relies more on design specifications than on product performance and the suppliers have less freedom in design specifications

PaperworkLess formal paperwork. Delivery time and quantity level can be changed by telephone callsRequired great deal of time and formal paperwork. Changes in delivery date and quantity require purchase orders

Packaging Small standardized containers used to hold exact quantity with exact specificationsRegular packaging for every part and part number with no clear specifications on product content

Although not all companies can use the JIT model for production the above table clearly illustrated were inventory costs and other company savings can be obtained to increase productivity. Toyota, for example, strives to produce the Camry Solara Coupe to customer orders in five days. Typically thirty to sixty days are required to produce custom orders for other automobile manufacturers. Toyota will most likely achieve a significant competitive advantage from this production. First, auto manufacturers typically make estimated guesses on consumer demand. In order to sell models with specification the buyers do not want, auto makers will offer rebates and discounts to get the inventory (car) off the lot. This results in consumers haggling over price and getting a car they really didn’t want and the auto makers losing billions in stagnant inventory costs. Toyota uses uniform plant loading to achieve the five day car. By changing or reducing monthly car style quantities into daily quantities, Toyota can compute a model cycle time or time between two identical units. This enables Toyota to adjust resources more quickly and efficiently to the precise quantity needed.

Toyota adjusts the speed of the production line to produce the needed quantity each day. This production enables Toyota to build a custom made car at a lower cost than their competitor’s batch made cars (once the costs of inventory are taken into account for the competitor’s bottom line). Therefore, the consumer gets what they want at a lower price resulting in a win-win for the company and consumer. Toyota is merely attempting to copy the success of computer manufacturer Dell. Dell’s build to order model is a perfect example of a U.S. company adapting Japan’s JIT strategy with success. Dell struck the market fast and hard and was the first computer manufacturer to make the build to order model. Dell has succeeded in reducing inventory costs (obsolescence is a huge costs in the computer industry) while still providing fast assemble and shipping of products to consumers. These are just two of the many companies that have succeeded in using the JIT production philosophy in today’s economy.

III. Material Requirements Planning (MRP)

In many of today’s manufacturing companies a composite planning process exists to determine the specific technologies and procedures required in order to produce a product or service. Typically, programs control group inputs existing or forecasted orders into a Master Production Schedule (MPS). The MPS is used to generate the amount and dates of specific items required for each order. Rough-cut capacity planning then compares production, warehouse, equipment, facilities, and labor required against suppliers/vendors capacity to provide the materials as needed. At this point, material requirements planning (MRP) takes the end product from the MPS and breaks this data down into component parts and subassemblies to create a materials plan. This plan specifies when production and purchase orders must be placed for each part and subassembly is required to complete the orders on schedule. The MRP is then broken down into a weekly/daily schedule to specify when machines, production lines, work centers and raw materials are needed.

The recent trends toward moving from batch-oriented processing to online transaction processing systems have allowed the role of MRP to expand. This expansion has been a natural evolution of the process to include all aspects of production. The expanded MRP has been called Manufacturing Resource Planning (MRP II), and with the addition of the internet into the fully integrated computer production the term Enterprise Resource Planning (ERP) has become more common. These two concepts will be discussed in depth later. However, the backbone of any new ERP or MRP II manufacturing system continues to be the scheduling function associated with the traditional MRP. MRP systems have been installed in almost every manufacturing firm, large or small. The main reason for this is that MRP is a logical, easy to understand approach to the problem of determining the number of parts, components, and materials needed for each item in addition to when that item is needed.

MRP works well in industries with a job-shop environment. MRP works better for companies involved in assembly operations than companies involved in fabrication. MRP does not work well in companies that produce a low number of highly complex or expensive products due to lead-time uncertainty and complex configuration costs. This makes perfect sense when analyzing from an inventory perspective. Companies with high production rates associated with assembly type operation would receive the most benefit from MRP due to its cost savings in keeping inventory low. The figures below display a typical MRP product tree and weekly schedule for the Widget product. I will use this example to discuss bill of materials, lead-time and production schedules.

The bill of materials (BOM) file contains the complete product description, listing the materials, parts, and components but also the sequence in which the product is created. The BOM is often called the product tree or product structure because it shows how a product is put together. The BOM can list parts two different ways: simple single level or indented structure. The indented structure clearly identifies each item and the manner in which it is assembled because each indentation signifies the components of that item. The simple single level list is used for computer use it is more efficient, otherwise each level would have to be expanded and then summed. The single level list displays each parent component and the number of units needed per unit of the parent. Examples of each are displayed after the product
structure tree. The BOM is one of the three inputs into any MRP program. The other inputs into the MRP system are the Master Production Schedule (MPS) and Inventory Records File.

Given the following: the current inventory, lead time for ordering, safety stock required (if any), and Lot Size, a 7 week production chart with inventory tracked on it will be created below for four of the parts as examples. A Master production schedule would be the combined result of the production schedules for all parts. For simplicity only a couple parts will be shown with separate production schedules.

Note: The Company currently plans to make 15 Widgets per week based on current orders and the following additional data is provided for the discussion.

PartInventoryLead TimeSafety StockQuantityRQMT’s per week

B15201015

C1010Lot-For-Lot15

S201025120

E1853501575

The MPS contains the gross requirements for the week, scheduled receipts (outstanding orders status both purchase and manufacturing), and inventory. Inventory is basically current parts on hand. Lead-time is how long it takes to get the part (in weeks). Safety stock is how much must be kept on hand to handle immediate or add-on orders. (I.E. provide safety or some level of protection against stockouts.) Only part E with an abnormally long lead-time of three weeks was given a safety stock in this example. Quantity is the minimum that can be ordered at one time. Lot-For-Lot is a special case. Lot-For-Lot essentially means as needed or single units can be ordered. An MRP system in which all ordering from suppliers is Lot-For-Lot and lead times trending towards less than a week will operate very similar to JIT systems and will see some if JIT’s benefits as well.

The master production schedule (MPS) is the time-phased plan specifying how many and when the firm plans to build each item. From this schedule the above schedules from each part are projected out. As stated earlier the combination of all the above schedules for all parts would be the MPS, however, the MPS is created first and then broken down into the weekly schedules for each part. Keep in mind the main purpose of a basic MRP system are to control inventory levels, assign operating priorities to items, and plan capacity to load the system. The objective of the inventory management under MRP is to improve customer service, minimize inventory costs and thereby maximize production-operating efficiency. The basic MRP procedure illustrated above is relatively simple. Essentially for each level in the bill of material, beginning with end items MRP does the following for each step:

a)Determine the net requirements by subtracting on-hand inventory and any scheduled receipts from the gross requirements. The gross requirements for the zero level items come from the MPS, while those for the lower-level items are the result of the previous MRP operations.

b)Divide the netted demand into appropriate lot sizes to form jobs.

c)Offset the due dates of the jobs with lead times to determine start times.

d)Use the start times, the lot sizes and the BOM to generate gross requirements of any required components at the lower level(s).

e)Repeat these steps until all levels are processed.

From these basic steps companies can formulate an entire workflow processes to improve effectiveness and efficiency of all manufacturing operations.

IV. Evolution of MRP à MRP II and ERP systems

A material requirement planning is a systematic method for planning and purchasing materials to support production. These ideas have been relatively simple and easy to implement using computers. However, issues such as capacity infeasibility, long planned lead times, system nervousness, etc can undermine the effectiveness of an MRP system. (System nervousness refers to the result of small changes in the Master Production Schedule (MPS) resulting in large changes in the planned order release.) Over time additional procedures have been developed to address these problems. The addition of these procedures has resulted in Manufacturing Requirements Planning (MRP II). Beyond simply addressing deficiencies of MRP, MRP II has incorporated other company functions resulting in a truly integrated manufacturing system. The purchasing function was one of the first functions absorbed into MRP II. The final goal of MRP II is to have a plan that monitors all the resources used by the firm: manufacturing, marketing, finance, engineering, etc. The additional functions of demand management, forecasting, capacity planning, dispatching, input/output control, and capacity requirements planning were added to the traditional master production schedule and rough cut capacity functions of MRP to form MRP II.

MRP II focuses on three phased of planning: long-range planning (forecasting and aggregate production planning), intermediate-range planning (MPS, MRP, BOM, demand management), and short-term planning (job release, dispatching, and I/O control). MRP II is able to combine all of a company’s resource segments with the planning aspect to form a better more functional and efficient system. The forecasting and planning aspects involved in MRP II allow the firm to control inventory levels more effectively resulting in increased production as discussed above. It is important to realize that the gains of MRP II have an initial cost higher than the basic MRP system since all levels of a company must now be integrated. In the years following the development of MRP II, vendors and consultants developed a number of follow-on successors. But none of the suggested names (I.E. MRP III)

Nor any other related acronym seemed appropriate at the time. Finally, with the advent of the Internet combined with computer information systems capable of efficiently and effectively linking business with supply partners and other affiliate offices around the world, enterprise resource planning (ERP) has become the term for today. ERP biggest success has been the ability to link/combine MRP functionality with supply chain management (SCM) and consumer resource management (CRM). The use of intranets within a company to communicate between departments and extranets (dedicated external lines allowing access to a company’s intranet) outside the company to communicate with suppliers and distributors has resulted in dramatic improvements in the company’s productivity. With the emergence of ERP systems many companies are now able to utilize business process reengineering (BPR) to radically change management structure in support of the new software packages. Today many managers feel that one of the benefits of ERP implementation is the chance to reengineer their operations.

Prior to ERP, companies were reluctant to reengineer due to the high risk and inability to predict the end affect on productivity. Now, companies are able to tie all business applications together and visualize where reengineering would dramatically help their business. Many ERP systems have forecasting tools built in that allow companies to make simulated adjustments to the production line and view probable results. SCM has enabled companies to instantly update vendors and strategic partners on order requirements and changes. Immediately, the inventory levels can be adjusted to accommodate increases or decreases in demand reducing inventory costs increasing production. Another added benefit of an ERP system is that it enables easy trend analysis to determine where production is efficient and where it is not efficient. This allows businesses to focus their resources to improving the ineffective portions of any segment monitored by the ERP system (production, accounting, finance, marketing, human resource, etc).

V. Push vs. Pull: Kanban Analysis

This analysis should be very useful in demonstrating how the Kanban system work and how JIT and MRP production systems can be compared. Kanban is the single technique most closely associated with JIT practices. Toyota uses kanban cards to govern the flow of materials through the plant. In order to understand this system I will discuss push and pull systems.

In a push system, such as MRP, work releases are scheduled. In a pull system work releases are authorized. The difference is that a schedule is prepared in advance, while an authorization depends on the production status of the plant at the time. Thus a push system directly accommodates a customers due date, but, the system must be forced to respond to changes in the plant. (I.E. MRP must be regenerated). On the other hand, a pull system (JIT) directly responds to plant changes, but must be forced to accommodate customer due dates. This is accomplished by matching a level production plan against demand and using overtime to ensure production rate is maintained.

In the MRP system, releases into production line are triggered by the MPS. As soon as work on a part is complete at a workstation, it is “pushed” to the next workstation. As long as the job stations and machine operators have parts, they will continue working under the system.

In the kanban system, production is triggered by demand. When a part is removed from the final inventory point, which might be the finished goods inventory, the previous workstation (I.E. last workstation) in the line is given authorization to replace the part that has been used. This workstation would then send an authorization signal to the upstream workstation to replace the part that it just used. Each station would proceed to do the same thing, replenishing the downstream void and sending authorization to the previous or next upstream station to work. In the kanban JIT system the operator requires both the part and the authorization signal (kanban) to work. Toyota uses a two-card kanban system. Other companies use a one-card system. Some companies’ use paperless signals I.E. containers, signs, etc.

VI. Summary

Neither JIT nor MRP can be considered to be simple procedures or techniques that will work for every company. JIT is not always a well-defined coherent management strategy. JIT tends to be more associated with attitudes, philosophies and methodologies that collectively form into the JIT system. Additionally, MRP cannot always be considered an easy alternative to JIT. Both systems work very effectively for their associated business models. Most major manufacturing firms use MRP, however, many in repetitive manufacturing attempt to incorporate JIT techniques to improve operations. With the progression of MRP into ERP, companies in repetitive manufacturing are able to more easily incorporate the JIT “pull” methodology into the execution phase. I.E. use MRP to plan and schedule but use JIT down on the shop floor. This allows MRP companies to utilize JIT practices to control when vendors should deliver material, when product should be produced, and when completed product should be distributed. In this system the shop schedule and kanban system is the interface coupling the MRP and JIT system along with the capacity control and group planning. Regardless of the specific system being used, the common thread between these two systems of management is minimizing company inventory and consequently increasing overall productivity.

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