How to measure inventory and set the target?

One of the questions most of the business head used to ask is, " How do I know my inventory level is high or low? How can I measure Inventory and I track? What is the benchmark for the inventory level?


My answer would be as follows.

Comparing or benchmarking may not give the right approach. As we discussed in the Holistic approach to managing Inventory in small, emerging organizations, Inventory is a function of many factors like your business, trade type, supply chain factors, product mix, lead time, volume vs. variety.
The benchmarking may not give you clarity about all the elements in the benchmarking industry or organization.

Instead, understand your inventory metrics as on today, set a target to reduce it every year from now on.

How should I measure my Inventory?

There are different measures to measure Inventory.

For example, you can measure your inventory value as a % of sales. Every month, you can measure and track your inventory value regarding your sales value.

Another proven method of measuring Inventory is Inventory Turn, which implies your organizational capability of turning Inventory frequently to achieve the sales.

Inventory Turn = Cost of Goods sold / Avg Inventory.

Cost of goods sold = This is the cost to make the goods like raw material cost + manufacturing expenses + any other indirect expenses.

Average Inventory = In a given period, say in a month's time frame, you can take the average Inventory you are maintaining. For example, you can add up all the day's Inventory in a month and divide by the working days. That will give the average Inventory.

Some organization has a practice of taking closing stock or opening stock, but that will be skewed to an extraordinarily high or low value.

For example,

To make an annual sales turnover of 100 lakhs, if you have avg inventory 100 L, Your inventory turn would be 100/ 100 =1
alternatively, for the same sales turnover of 100 lakhs, if you have avg inventory 50 L, Your inventory turn would be 100 / 50 =2
In case, if your avg inventory is 10 L, your inventory turn would be =100/10 = 10

The higher the inventory turn, the more active you are.

If there is a higher inventory turn, that means, with minimal Inventory, you are turning many times to achieve the sales turnover, result in lesser working capital or better cash flow.

Hence, one of the practical measures of Inventory would be " Inventory Turn."

Increasing Inventory Turn is possible only when you look into the root causes of the symptoms and initiating strategic and tactic initiatives.

That is a continuous activity, and you need to benchmark yourself and continuously work on optimizing the Inventory without affecting the delivery performance.

Now the action for your organization is 

1. What is your organizational Inventory Turn?
2. What is the target you are setting for the next year to increase your Inventory Turn?

Difference between OTD and Delivery Actualization

Most of the organizations have been measuring many KPI's related to delivery performance to the customers. Out of many measures, commonly used measures are  Delivery actualization % and Ontime delivery (OTD) %. 

Even though those measures are meant for delivery performance assessment, there is slight difference in the purpose and desirable behavior expected from those measures. In reality, both measures often interchangeably used and sometimes confused.

Given below some clarifications on both the measures (KPI's) and its purpose.

Delivery Actualization %:

This measure is calculated as follows

Delivery Actualization % = Quantity delivered / Quantity committed to the customer

for example,

the customer asked for 1000 pieces/month, and as an organization, you accepted to deliver 1000 pieces/month and if you delivered only 800 pieces/month, then 

Delivery Actualization % would be 800/ 1000 = 80 %

Likewise, for each customer, you can calculate and finally arrive at your average delivery actualization.

This measure will indicate your performance towards meeting the delivering commitment in terms of quantity.

Pl, note that this measure is not concerned about the TIMELINE.

This measure indicates your organizational INTERNAL CAPABILITY towards delivery commitment.

On-time Delivery (OTD) %:

This measure is calculated as follows for each customer

On-Time Delivery % = No of components delivered full qty ON TIME / Total no of components

For example, a specific customer has 30 components that must be delivered in full qty as per the timeline committed either as per PO or by 1-1 mutual agreement.

Out of 30 components, you might have met 25 parts delivered on the EXACT DATE  in full quantity as committed and remaining parts, you might have missed out on the DELIVERY TIME COMMITMENT. 

then , OTD % will be 25/ 30 =83 %

This measure indicates your performance towards meeting customer's requirements on time.

Pl note that in the above example, you might have delivered all the quantity by the month-end and might have achieved 100 % delivery actualization. But you missed the timeline (OTD) target.

from the customer point of view, your timeline commitment is also critical even though you met quantity commitments at the end of the month.

To sum up,

OTD is important from the customer perspective on the timeline

Delivery actualization is important from internal capability and loss of sales perspective.

However, as a business head, you must be sensitive to both measures of delivery even though the intention of each measure is different.

Step by step process in implementing organization wide performance management system

One of the dreams or visions for most of the business head of the small, merging organization is to make the organization a system driven and to implement performance-driven management.


As we discussed the need for an organization-wide performance management system, now let us learn the step by step implementation step to make the performance management throughout the organization.

Step1:

Implementing Business performance management, keeping the second level reportees as stakeholders.


Business  Level Performance Management :

When the organization is small, or the first time, the organization is getting into the performance management system, the logical step would be determining the important business key performance metrics along with some of the functional key performance metrics and start measuring. Key performance metrics can be measured and tracked by the business heads and his/ her second level reportees, mainly functional heads. 

For example, some of the business KPI's like sales turnover, inventory cost as a % of sales, Plant effectiveness, attrition rate, % of NPD contribution over sales can be measured and tracked. This set of performance metrics can be reviewed along with functional heads, and they can be encouraged to work on the action plan to improve the business performance.

This process implementation duration can be one year. 

Benefits of  business-level performance management :

1. Senior leadership team becomes familiar with the process of performance management even though they are not feeling fully accountable for the result and but they feel they are part of the process.

2. Enhances the engagement among functional heads or second level reportees o when the business head reviews along with them every month or weekly 


Step 2:

Implementing Business performance management as done in the first year and arriving suitable functional level performance management, keeping the second level reportees and their team as stakeholders.


Business +Functional Level Performance Management 

Since the organization already familiarizes itself with a business-level performance management system in the first year, now the organization can have Business performance metrics that can be set by the business head and tracked along with the functional head.

In the second level, detailed functional level performance metrics can be set and assigned to the second level or operational head level. The functional performance parameters can have more functional oriented and some of the business metrics as derived from business KPI's from the business head.

For example, the supply chain function can have more functional metrics like no of vendors developed, inventory level at different levels, freight cost as % of sales, and so on. Similarly, for all functions, we can have more functional level metrics which can be assigned to respective functional heads and their team.

The functional heads and teams can be encouraged to present the performance metrics trend and a detailed action plan for the business head every month.


This process implementation duration can be one year. 

Benefits of business + functional performance management :

1. The focus will be given in-depth to the functional effectiveness, by the way, measurements are extended to all functional key activities

2. Since we involve functional heads and their team, their involvement and focus is improved on functional effectiveness

3. Most of the organization covers under different functional metrics and performance measurement system, eventually, there will be an improvement in the communication process, visibility of issues and the solutions approach, understanding the pains of cross functions enhances significantly.

4. Eventually, engagement enhances across functions


Step 3 :

Implementing  Individual-level performance metrics which is derived from business and functional performance metrics 


Business Performance Management  + Functional Performance Management + Individual performance management :

Since the organization already familiarize itself with the business performance management system in the first year and the functional team engaged in the functional performance system in the second year, now the organization widens the performance management net to all the people in the organization. Ideally, it can be extended to executives, first-line supervisors level.

In this process, each individual is given a set of performance metrics that will have linkage with the functional parameters, which is derived from business metrics.

Each individual is accountable for improving their metrics and report the progress. The review period can be once every quarter or monthly basis, depending on the bandwidth of the organization. It is the responsibility of the functional head to review the progress of their team members. 

For example, the individual depending upon the level in the organization can be given performance metrics that are related to his/ her functions. Also, some of the development plans can be added.

By the way, almost the entire organization is governed by performance metrics related to business and functions.

Benefits of  organization-wide performance measurement system:

1. Since the direction is set for the organization at business, functional, and individual levels; it improves the focus and engagement.

2. Eventually, the organization gets clarity of performer and non-performer, and this will help to focus on people developmental efforts 

3. When the rewards and recognitions are based on the performance, it brings visibility, differentiates the performers and non-performers, improves the culture towards self and organizational performance improvement

Overall, performance management brings engagement among people, eases the communication, improves the focus on results or solutions, and thereby culture would become more of winning than blaming or complaining.

Implementing the organization-wide performance management system is a long process and needs to be implemented in a phased manner for sustaining the results and involving all the stakeholders to create performance-based culture!

Why business head should differentiate performer and non performer?

In most of the small, emerging organizations, one of the patterns I observe is that the consistent performer is not getting recognized and rewarded suitably.

When I am saying rewarded means, it could be either monetary benefits or openly recognize his / her work and appreciation or giving more preference for providing exposure to training programs or learning opportunities in the workplace itself.

In some organizations, the business head determines the incentive or salary hike based on the loyalty measures, that who is staying in the organization for longer years.

when the business head does not differentiate the performer and non-performer through different means, it  creates the following impact on the organization

1. The performer is not getting the motivation to give his/ her best as human beings; everyone craves for recognition and appreciation. When his / her extraordinary contribution goes unnoticed, either he/ she loses interest in the work or leave for a better opportunity outside the organization.

2. when all the people are treated equally irrespective of the performance by the business head, it sends the message to all that mediocre performance is acceptable in the organization. Eventually, the organization becomes an average performance organization.

Differentiating the performer and non-performer boosts the morale of the organization and also helps to promote performance culture inside the organization. 

The practice of recognizing and rewarding the performer must be ensured and demonstrated by the business head whenever he/she spots the performance and performer for retaining the talent and to build a performance-oriented organization.!

Need for organizationwide performance management system

As we discussed earlier "what you measure, will get focus and control." Measuring business, functional and individual through performance metrics will drive the behavior and actions. 

Organization-wide performance management systems mean from top of the organization to the bottom of the organization have a COMMON GOAL, deployed to all levels, with a different set of objectives that will have linkages with COMMON GOAL. 

For example, a business goal of achieving X % net profit is to be deployed from top to bottom levels of the organization and everyone will have the same focus to achieve the goal. But the fact is business metrics cannot be populated down the level as such as it is very difficult for the people to understand.

To engage all levels of people, deployment of business objectives to the down the level with supporting objectives are being done. For example, a business goal is further broken down into the functional level goal, in turn, the functional level goal is further broken down as an individual goal. By achieving the goal at the individual level, the functional goals are achieved. By ensuring functional goal achievement, the business goals are achieved.

Given below 
deployment of one performance metric from the business level to the individual level.

Now let us discuss why does the company require organization-wide performance deployment?

1 Organization-wide common performance deployment promotes performance s oriented culture over a period of time.
2. It differentiates performer and nonperformer.
3. It engages individual and the team, and it is a natural team-building process
4. The team understands each other's challenges and helps each other for a common goal.
4. It helps to improve individual / functional efficiency as constraints are exposed.
5. eventually, the organization migrates from functional orientation to organizational goal achievement orientation, and this drives the solutions-oriented mindset among the team.

Driving organization towards solutions-oriented culture is a paramount priority of business head, and organizational-wide performance deployment will help to achieve the mission !!

Importance of Key performance indicators (KPI’s) for organizational transformation and the role of business head

As renowned management guru Peter Ducker says “what gets measured gets improved.”

In an organization, there are so many interactions, activities, transactions are happening across the functions or value chain.At the end of the day, only a few activities result in performance. The performance could be productivity improvement, profitability increase, sales increase, morale improvement etc.Some performances are not negotiable, vital for organizational profitability and growth and those performances are called Key performance indicators (KPI's). That means those performance indicators measure the organizational health. 

Even though key performance indicators will vary industry to industry and organization-specific, but most of the KPI’s fall under the broad categories of productivity, quality, cost, delivery aspects only.

Why is Key performance Indicators (KPI's) required?

Identifying and setting the KPI targets helps the organization 
1. To focus on the important deliverables
2. To bring the people together towards one goal
3. To improve the accountability
4. To improve the communication among the stakeholders
5. To know the reality against the desirables target at any point in time
6. To take course correction based on the reality vs target

How to implement Key performance Indicators or performance management for the organization?

Even though KPI and target setting can be done at the business level, functional level and individual level, the organization (especially SME organization) can start with business level .Once the organization becomes familiar with the business level performance management system, they can further deploy down to functional and individual level.

Assuming that SME organization like to implement the Performance management system at the organization level, the following steps would be useful.

1. Identify the Criteria under which key performance indicators (KPI’s) are measured. For example, SME organization can classify the business objectives into criteria like Productivity, Quality, Cost, Delivery, and Engagement.
2. In each criterion, identify the key performance measurements which are important to the business. For example, under productivity, one of the key performance indicators could be OEE (Overall Equipment Effectiveness) or sales per employee.
3. For each of the KPI’s, realistic target can be fixed.This target can be arrived based on historical performance or futuristic aspirations.
4. For each KPI's, people responsibility can be assigned 
5. Once target is fixed for all key performance indicators in each category, it can be tracked every month against the reality or actual performance

Role of Business head or CEO in performance management 

Setting the business goals and showing the direction is one of the prime responsibilities of the business head or CEO.While setting the target, the head must have done his homework and set the target with conviction. The target should not be too much aspiration and unrealistic, it must be achievable by the team in a given time, resource and capability. Also, the target should not be too lenient with incremental increase as this may not be too much motivation for the team to work upon.

In most of SME’s as we use to observe that the CEO or business head himself not convinced about the target, but would like to push the team by giving too much unrealistic target and sometimes he is also pessimistic about the target achievement and set very low. In both cases, CEO or business head’s communication tone, body language would reflect his uncertainty mindset to the team.

If CEO or business head set the target with conviction, he would be more certain about the target and he would drive them by any means to achieve the target. In addition, his conviction would help to grab the opportunity to meet the target. In addition, the team gets motivated when they are working for real, aspirational goals under the visionary leadership.

For example, in one of our SME client organization, the business head set the production target as 10 T / day with conviction and taking into the confidence of his entire team.In the mid of the financial year, when uncertainty happened in the existing customer's demand, his business plan got disturbed.Since he was very firm and convinced about the production KPI of 10 T / day, he went ahead with a different approach with his new customer in a short time to achieve the target of 10 T/ day.That achievement increased his confidence as well as improved the morale of his team.

       Eventually, Performance management helps to build an organization culture with the winning mindset towards solutions, performance and this will become a competitive advantage to the organization.

Why do some organizations engage in business transformation drive and others are not...?

Unlike large organizations, small organizations are governed and managed by promoter, family members, or the CEO as hand-picked by the promoter. The growth of the organization mostly depends on the mindset, managerial style of the promoter and CEO. We can classify smaller size organizations into three types based on the mindset of the leadership team.

Growth Mindset:

 The leadership  team continually strives for growth and eventually transforms the organization from small to  mid size and large organization. They continuously engage in transformation initiatives across the organizations.

Mediocre Mindset:

The leadership  team focuses more on maintaining the legacy and feel comfort with the status quo, even though they aspire to grow. Occasionally, they drive localized, standalone productivity, cost efficiency initiatives to manage the external demand especially from its customers.

Survival Mindset:

The management team struggles for survival itself due to  deficiency of financial funding or lack of market for product etc. Sooner than never, they disappear from current business or switch to an alternative.

Out of all three types of organizations, more education, facilitation  and hand holding are required for mediocre organizations. They could not drive organizational transformation initiatives  due to the following factors.
  
Before getting into factors, let us  understand the meaning of organizational transformation drive.It is  holistically looking at the value chain of the business with the intention of enhancing value to all stakeholders. In this initiative, the business and functional process would be reengineered  in terms of  performance measurement and tracking , constraints in the entire value chain, roadmap for eliminating the constraints and improving the value, ease of communication process with  both  internal and external customers etc. 

Typically, this organizational transformation effort result in radical change in either one or all of the following aspects 

1.Increase in business sales performance and profitability on a sustainable basis
2.A major shift in delivering the product or service experience to customers
3.Shift in people’s  thinking, engagement  towards business process and results



Organizational transformation happens in stages, after which there is no look back to the previous level.

Organizational  transformation is not a

1. Small, incremental productivity improvement in a localized area
2. Standalone initiative, which brings down cost or  improves product / service quality one time


Factors affecting organizational  transformation Initiatives


The Head of the business or CEO’s belief and involvement is vital for the business transformation initiative.

The following factors contribute to the success of  organizational  transformation initiatives

1. Compelling need or urge to CEO or head of the organization to transform. This need can be SURVIVAL threat or pressure from customers to be competitive.
2. Firm belief in the future prospects of the business 3. Willingness to learn and experiment new methods or practices, ability to forego short-term losses against long-term benefits
4. Belief and support from the second level  management  team about the transformation process
5. External facilitation to teach, facilitate, guide, criticize and handhold the team during the transition.

In the absence of the above, the organization finds difficult to pursue any  transformation initiatives

Solutions approach to bring the mindset change:

There is a need for creating awareness to leadership team  about their management style and its impact on the long-term survival of the organization.

They  need to be educated to diagnose the health of the organization in a quantitative  and qualitative manner, as from our experience with many SME’s, most of the small size promoters or CEO  do  not have the exposure to look at the all business performance from long term perspectives. 

They need to be exposed to the different industries and its practices, lean system thinking, employee engagement practices, modern performance management process and customer relationship practices. Here only the role of business associations, external facilitators, or coaches comes in a big way.

In today’s globalized competitive environment, sustaining the profitability through transformational initiative is no more an option. It becomes a survival need!

Important Steps in OEE Improvement Process

ü  Identify the facility or equipment or line to be measured

ü  Understand the current OEE  level

ü  Collect shift wise/ day wise data for specified period

ü  Identify the loss pattern

ü  Classify the losses in each category

ü  Prioritize the losses

ü  Choose the right lean tool for elimination or reduction of losses

ü  Implement the solution

ü  Monitor the OEE trend and loss 

Overall Equipment Effectiveness ( OEE) -Introduction

What is OEE?

Overall Equipment Effectiveness (OEE) is one of the best METRICs used for monitoring and improving the Efficiency of manufacturing processes.

The manufacturing processes can be machining, fabrication, assembly line etc

OEE is a simple, holistic, and powerful metric.

OEE takes into account the typical sources of manufacturing productivity losses and groups them in THREE categories like AVAILABILITY, PERFORMANCE, and QUALITY. By grouping so in different categories, it distills the complex manufacturing losses into simple metrics .It helps us to understand the losses with clarity and helps to choose the right lean tool for each loss. In addition, it helps us to verify the effectiveness of action against each manufacturing productivity losses

 Elements of OEE :

Availability:

It measures manufacturing productivity losses from down time .i.e. the events that stops planned production like machine breakdown, changeover, material not available, operator not available etc.

Performance:

It measures manufacturing productivity losses from slow cycles .i.e. the factors that cause the process to operate at less than the standard or possible speed.

Quality:

It measures manufacturing productivity loss from manufactured parts do not meet the specification or quality requirements.

Together all three measure like Availability, Performance and Quality combine into one FACTOR as OEE

Score .This one complete measure OEE reflects the manufacturing efficiency and effectiveness.

OEE provides simple, consistent, and proven way of measuring the effectiveness of any productivity initiatives or lean manufacturing programmes or TPM programmes

World class OEE for discrete manufacturing process

Generally, world class OEE for discrete manufacturing process is considered 85 % or greater than 85 %

It is arrived from Availability (90 %) * Performance (95%) * Quality (100 %) = 85 %

Generally, from the study, it is indicated that average OEE score for discrete manufacturing process is around 60 %.If we aim for excellent OEE standard of 85 %, then we can realize that there is so much opportunity to move from 60 % to 85 % through loss elimination or reduction initiatives.

  

Calculating OEE :

OEE is calculated from three categories like availability, performance, and quality

OEE = Availability * Performance * Quality

Pl note that OEE is not calculated as addition or average of three categories, it is calculated by multiplying three categories

For example

Availability = 75 %

Performance =90 %

Quality = 89 %,

Then

OEE= 75 % * 89 % * 90%

       = 60 %

Availability:

Availability is the ratio of actual operating time to planned operating time ….

It measures the downtime loss

Availability = Operating Time / Planned Operating Time

Operating time = planned operating time – downtime loss

For example

Availability =Operating Time (300 min) / Planned Operating Time (400 min)

                   =75 %

Planned Operating time:

Available time per shift – planned shutdown time

Available time per shift

Say 8 hrs i.e. 8 * 60 = 480 min

Planned shutdown time

It is planned shutdown for valid reasons like morning meetings, lunch break; refresh break, scheduled maintenance check etc

For example

Morning meeting – 10 min

Lunch break – 30 min

Refresh break – 20 min

Scheduled maintenance check – 10 min

Hence planned shutdown time = 10 + 30+20+ 10

                                                       =70 min

Hence, planned operating time is 480 -70 = 410 min

Actual Operating Time

Planned operating time – down time

=410 – 110

=300 min

Break up  of down time (110 min ) can be

Machine breakdown -20 min

Operator not available – 30 min

Material not available – 10 min

Changeover loss – 50 min

Hence,

Availability = actual operating time / planned operating time

                   =300/ 410

                  = 73 %

Performance:

Performance is the ratio of actual qty produced during operating time / standard qty can be produced during operating time.

From above example,

Actual operating time = 300 min

Say std time per piece = 3 min

So standard qty can be produced during operating time = 300/3 =100 pieces

Suppose, in a given operating time, actual qty produced is 270 pieces, then

Performance = 270 / 300

                       =90 %

Quality:

Quality is the ratio of good qty produced to total qty produced.

For example,

Total qty produced = 270 pieces

Good qty = 240 pieces

Quality = 240 / 270

             =89 %

Why 1-1 coaching is required for CEO or Business Head ?

            Any transformation in the organization starts with leadership at the top.People follows the leader.Once the leader changes his mindset, beliefs, values, behavior and aligns the action in line with the higher needs, the entire organization starts follow. Even though the leaders are aware of the transformation process from various sources like books, training programmes, interaction with successful people etc still the real change should happen within. For some people, it is difficult to inculcate new thought process and evolve from self.They need trusted external source to guide and facilitate the transformation process with personalized format.The coaching process helps the leader at personal level to get transformed.

                                      

When 1-1 coaching is required:

When the leader wants to take the organization to the next level and willing to make it happen, but there is a gap between what he wants and what he is now.The 1-1 coaching process will help the leader to bridge the gap through personalized support   and professional help.

The following benefits the leader gets during the coaching

• Clarity on what  he really wants to achieve
• Knowing more about the self  in terms of strength, area for improvement
• Identifying the beliefs which are holding or pulling down from achieving goals
• Identifying the behaviors which are affecting the growth
• Getting personalized help to convert the limiting beliefs into empowered beliefs
• Getting hand holding during the change management process
• Getting a constructive critique  on behavior which affects the growth