Shortages aplenty: Is Lean the problem or the answer?

Each day it seems there is breaking news of a real or impending inventory shortage affecting consumers. The outrage is palpable and real. While inventory shortages are hardly a nascent phenomenon, they have been exacerbated and garnered much more attention during the COVID-19 pandemic, starting with personal protective equipment, then paper products, cleaning supplies, canned foods, meats, exercise equipment, and, more recently, semiconductors, building materials, and holiday gifts. It is a fact that some of these items have experienced unprecedented surges in demand as well as off-the-charts irrational hoarding and panic-buying behavior.

Regardless of their nature, business problems, described as supply chain problems, lead inevitably to finger pointing and the blame game. A generous share of the blame for recent supply-demand disparities is now being directed to Lean Thinking and more specifically, just-in-time (JIT) inventory techniques. The common critique is that companies in all industries have cut inventories below reasonable levels as a consequence of Lean initiatives with money-saving efficiencies as a desired outcome. As a case in point, a New York Times article titled “How the World Ran Out of Everything” asserts that companies have gone too far in paring down inventories through the use of JIT. In addition, other prominent news outlets have jumped onto this same bandwagon and railed against the widespread adoption of Lean Thinking.

Is this a misguided notion? Perhaps. However, it is an important conversation, and one that should be had with objectivity and deeper analysis.

And so, in the spirit of this objectivity and deep analysis, let’s explore the critical question: Has Lean Thinking played a role in the recent inventory shortages that exist across multiple industries?

At the risk of answering a question with more questions, we need to break the problem down into three sub-questions. These are:

1. Have inventories, in fact, been going down in industry over the last several years?

2. If so, has Lean Thinking played a role in this “reduction of inventory” trend?

3. If so, should Lean Thinking be regarded as a root cause of the most recent inventory shortages and business failures we are experiencing during the global pandemic? 

With these questions as our vectors, let’s get started.

Are year-over-year inventory reductions real? 

There are data that support the assertion that inventory levels have declined as a general rule over the past several years. One key measure, the inventory-sales ratio (IS ratio), tracks inventories across manufacturers, wholesalers, and retailers, dating back to its incarnation in 1992. The IS ratio reached a record low of 1.25 (on a seasonally adjusted basis) in April 2021 and remained in that record-low range throughout the summer.¹ That means that inventory only exceeded monthly sales by 25%. Granted, some items experienced stockouts while others witnessed bloat, but this statistic suggests that available inventories are only outpacing demand by small margins, on average, and that the composition of supplied items is likely missing the perfect match with demanded items.² This leads to substitutions or waiting; neither of which suits today’s infinitely impatient customer.

But while today’s readings showing record lows, the “tale of the tape” is convoluted. Figure 1 illustrates the roller coaster ride of the IS ratio over the past three decades. Check out the negatively sloped line from 1992 to the Great Recession that commenced in December 2007. That downward slope underscores the assertion of declining inventories, but the slope turns upward following the recession, beginning in June 2009, and stays that way until the shock of the pandemic that takes the ratio to the uncharted heights of 1.73 in April 2020.

What transpired during that first segment of time—1992 to 2007—when inventories showed general decline? Yes, the concept of Lean Thinking did gain popularity with the book bearing that title released in 1996 by James Womack and Daniel Jones. We also witnessed widespread implementation of computerization, the advent of the internet, and popular adoption of advanced communicative technologies, like mobile phones. This period also marks a greater interest in supply chain cooperation through efforts like efficient consumer response (ECR); collaborative planning, forecasting, and replenishment (CPFR); and automatic replenishment (AR) schemes. The very term “supply chain management” was coined in this era. Out of these developments, companies increasingly sought to “replace inventory with information”—which was good because the world at the time was also introduced to “big box” retail that could present over 100,000 distinct items to consumers in a single location. So, the ability to serve an ever-expanding basket of goods and services with declining inventory levels is a grand achievement, indeed. An academic analysis covering the years 1981 to 2000 showed that inventories were reduced 2% per year during that period, with work-in-process inventories dropping by 6% per year.³ The study went on to show that firms with slightly lower than average inventories performed best, with favorable abnormal stock returns. 

Let’s set aside the Great Recession with its outlier data and resume our analysis on the far side of it when inventories headed in the other direction—upward. What transpired from 2010 to early 2020? Chief among these forces is offshoring and the globally extended nature of supply chains. The “China Price” became the name of the game and supply chains stretched around the world to tap low-cost country sourcing opportunities. That helped to contribute to everyday low prices and the consumer dollar going further than ever before. But, it takes inventory to support those long, uncertain lead times.

Not far behind the offshoring phenomenon, we would all become obsessed with online shopping. It was no stretch for e-tailers to deliver books and CDs in seven days. But, when the product assortment became limitless and order-to-delivery times shrank to five days, then three to five days, then two days … the premise of having inventory everywhere to meet the consumers’ every whim drove inventory up. (Just wait until the sub-two day delivery becomes the norm!) 

Therefore, the answer to sub-question No. 1 is “Yeah, kinda.” Inventories declined steadily for many years before facing the strains of long supply lead times from distant shores and heightened demand from consumers seeking immense assortment with ever-shrinking lead times. That said, we will answer question No. 1 in the affirmative—inventories are about 15% lower now compared to 30 years ago despite forces that are reversing the trend.

Getting aligned on Lean Thinking

This leads us to sub-question No. 2: Has Lean Thinking played a role in this “reduction inventory” trend?

In order to answer this question, we need to align on what we even mean when we say, “Lean Thinking.” Over time, Lean Thinking has evolved into a collection of strategic beliefs, operating principles, and tactical tools. The term “Lean” itself is now ubiquitous, but the meaning of the word can often be different based solely upon the individual experiences of the person using the term. For purposes of this discussion, it is important to understand Lean Thinking from a cultural, strategic, and tactical point of view. 

From a cultural point of view, Lean Thinking has a goal of developing corporate “learning cultures” by embracing continuous improvement. This is accomplished in many ways, with one important aspect being the creation of business cultures that embrace proactive problem solving. This is counter to the traditional mindset of being blind to problems or avoiding them altogether. Rather, Lean Thinkers go to work and try to expose problems in order to understand how to fix these problems at the root cause. 

The classic “river of waste” analogy depicted in Figure 2, helps to explain how this works. Imagine a ship (an organization) traveling in treacherous waters. Challenges and all the things that can go wrong in a business (such as defects in product and process) are the rocks. Problem solvers do not shy away from the rocks, but rather, are drawn to them. When rocks are identified, they are studied, and then root causes are determined and addressed. The rock is eliminated, and the ship may travel on safely, until the next rock is encountered.

In the analogy, what does the water level represent? Inventory. That is, the water level represents all the inventory, people, resources, space, software, and other capacities required in order to navigate within all the business problems (rocks) that exist within the business environment (the river).

Lean Thinkers are not satisfied with this situation of the water hiding all the rocks. The Lean goal of continuous improvement means we need to make problems visible and, therefore, need to put steady pressure on all resources (including inventory) in order to reduce the water level to make the rocks visible. And so, from this perspective, it would be fair to say that Lean Thinking does, in fact, create a culture where excess inventories may be considered less desirable. 

However, nowhere in the “Book of Lean” does it suggest that we drain the water level in a cavalier manner to create instability. In all cases, the goal of Lean is to maximize customer value and create operational stability. In addition, the downward pressure on inventories (and other wastes) is about exposing problems and not about simply reducing inventories to create financial and balance sheet efficiencies (as many recent articles would suggest). It should come as no surprise, then, that when organizations reduce inventories without first achieving stable, predictable processes, they end up hitting the rocks and instigating shipwrecks.

Consequently, if we ask ourselves, does Lean Thinking have a “cultural goal” of reducing inventories to unreasonable levels in order to simply reduce costs so CEOs can buy back stock instead of servicing their customers?

The answer is a resounding NO.

With this in mind, let’s take a look at Lean Thinking from a strategic point of view. 

Value creation, waste, and lead times 

Building upon our definition of Lean, a common phrase is that Lean is a strategy to maximize customer value at the lowest possible total cost to the business while showing respect to people and communities.

And how do we maximize customer value at the lowest possible total cost to the business? We identify and maximize customer value, and we identify and eliminate waste.

Lean Thinking, as it relates specifically to the Toyota Production System (TPS), introduces the specific wastes that we are attempting to eliminate. These are often introduced in the forms of waste by virtue of DOWNTIME—defects, overproduction, waiting, neglected knowledge, transportation, inventory, motion, and excessive processing.

It might be tempting to do a deep dive into each of these wastes; however, for purposes of our focused inventory discussion, it is important to recognize that inventory is called out as an operational waste. Therefore, it would be easy to conclude that Lean Thinking would suggest that all inventory is evil and must be eliminated at all costs! Before we can make this conclusion, it is important to understand why inventory is considered waste. To do this, we need to review the waste of overproduction—arguably, the worst waste of all. 

Overproduction is defined as building more than you need to service customer demand or building earlier than you need to meet customer demand. From an inbound logistics point of view, overproduction can be defined as ordering more parts than you need or ordering parts earlier than you need. Overproduction is a higher-level waste because it creates all other wastes. That is, as soon as you have material or finished goods that are not required by the customer, you are forced to store, transport, rework, and wait on those goods to be required by the customer.

So, if overproduction is the source for other wastes, why do we overproduce? Because of supply chain lead time dynamics. We can define total lead time as the amount of time it takes for us to order material from our supply base through to when we manufacture and deliver our finished goods to our customer. (A financial definition of lead time would include the time it takes to get paid from the customer after receiving a customer order.)

Building upon this, if you could design the ideal supply chain, it would be a process where you “buy to customer order” (buy to order, or BTO) only. You would carry no inventories and only initiate your inbound supply chain and manufacturing processes after receiving a customer order. The brilliance of BTO is that you eliminate overproduction because you don’t order material from your suppliers or manufacture finished goods until you have a firm customer order. Additionally, there is no need for warehousing or storage of any kind, as you simply flow product to the customer upon completion of the manufacturing process. BTO also eliminates the need for forecasting, which in turn results in the elimination of excess inventories due to inevitable forecasting errors.

BTO is the perfect solution to a waste-free supply chain, but it requires a specific dynamic to be in place to succeed: Total lead time must be less than customer-order-to-delivery lead time expectations. For instance, if a competitive environment states that customers expect to receive a product in 10 days after placing an order, a BTO process would require you to be able to order and receive material from your suppliers, and then manufacture and ship the product to the customer in less than 10 days. Although many of us never will reach the state of perfect BTO, this is the stretch goal for the Lean supply chain.

When we are not faster than our customers, we are forced to guess (forecast) what they may need and when we guess, we will guess wrong. If we can reduce lead time, then we can get closer to our customer demand, and will therefore reduce the horizon of guessing. This will result in less waste of overproduction, as a target is always easier to hit from a shorter distance. 

Therefore, the Lean Thinker is actually working to make supply chains more capable to react to changes in customer demand by focusing on lead time reduction. And Lean Thinkers know that as lead times go up, so do inventories, as lead time and inventories have direct correlations to each other. In addition, as lead times go up, our ability to react to changes in customer demand is reduced. The corollary of this statement is that as inventories go down, so must overall supply chain lead times and, consequently, we improve our ability to react to changes in customer demand.

So, can we claim that Lean Thinking does look to reduce overall supply chain inventories? It’s probably correct to say “yes,” however, not for the reasons that critics have laid out. The truth is, culpability for recent inventory shortages should be placed upon business decisions that added overall lead time into the supply chain. More specifically, the thirst for chasing lower purchase prices in what are deemed low-cost countries (recall: the “China Price”) that lent to extended lead times and, often, higher total costs. As Womack and Jones acknowledge in their book Lean Thinking way back in 1996: “Oceans and Leanness are usually incompatible. This strategy will often be a loser.”⁴

Therefore, it is simply incorrect for Lean critics to blame recent inventory shortages on a failed combination of Lean Thinking strategies mixed with global supply chain strategies. Lean and global lead times are mutually exclusive, even oxymoronic. Any organization truly embracing the Lean supply chain does not concurrently embrace a reckless drive to extend lead times. 

Which takes us to the real heart of this conversation, the discussion of whether Lean supply chains are the root cause of our recent inventory challenges.

Lean Thinking and the end-to-end supply chain

Let’s introduce a definition:

The Lean supply chain is an end-to-end supply chain that is planned, visible, capable, connected, and managed, and it provides an operational-feedback loop. Lean supply chain initiatives relentlessly focus on end-to-end flow, speed, and lead time reduction by identifying and eliminating all nonvalue complexities and waste. This is accomplished through rigorous process discipline, inventory optimization, and first-time quality of processes. The Lean supply chain flows to the pace of customer demand. The goal of Lean supply chain operations is to deliver the highest value to the customer at the lowest possible total cost to the business. 

As conveyed here and depicted in Figure 3, there is a lot to unpack here, with no fewer than 20 operational principles. Some content is particularly appropriate for the current critical conversation.

What’s important to recognize is that the Lean supply chain (and by proxy just-in-time inventory) is not a supply chain where the organization is minimizing inventories to the point that we create operational instability and ultimately fail our customers. Stability and customer satisfaction are core tenants of Lean Thinking. However, it may be argued that the Lean supply chain and just-in-time do not provide for just-in-case. In other words, if our organizations planned for more just-in-case inventory, perhaps we would not be failing consumers today. 

Let’s examine this argument.

From our definition above, we can paraphrase: The Lean supply chain has a principle of inventory optimization, and an optimal inventory flow is set to the pace of customer demand. The operative term here is inventory optimization, not inventory minimization. The refined goal of the Lean supply chain is not to minimize inventories but rather to optimize inventories. Which begs the question, what are optimal inventory levels? 

Optimal inventory levels are those levels that will allow us to be successful as it relates to what we know about current customer demand patterns and our operational capability to fill this demand. From an inventory management point of view, this means optimal inventories are those where the stocking levels are calculated with three types of inventory: cycle stock, buffer stock, and safety stock. We define these as:

Cycle Stock: Inventory required to meet average demand (in days/weeks) and inventory to support demand during replenishment lead time, as prescribed by forecasts.

Buffer Stock: Inventory to protect against common-cause variation in demand (for example, daily variation of usage or demand by the end consumer as a normal course of business).

Safety Stock: Inventory to protect against special-cause variation in demand (for example, protection against severe weather, supplier failure, or transportation interruptions).

As we see from these three variables, two of our drivers—buffer stock and safety stock—are just-in-case inventories. Only cycle stock is just-in-time.}Therefore, and at the risk of talking in absolutes, it is safe to say that Lean Thinking in supply chain planning certainly plans for some variables that can be described as just-in-case.⁵

However, what is now acceptable to inject into the argument is: Okay, then why did we not have enough hand sanitizers, ventilators, surgical masks, and other supplies when they were in serious need?

The short answer is because inventory modeling, in general, does not take catastrophic and unprecedented black-swan events into consideration. For a host of well-intended reasons, both financial and operational, the average for-profit company does not plan for catastrophic emergency inventory, nor should we expect them to do so. Private organizations by design strive to be effective and efficient. Efficiency is what allows an organization to be competitive, and ultimately thrive and survive. Consequently, it would be unreasonable for the general public, or our governments, to hold private enterprise solely responsible to plan, prepare, and pay for emergency inventory for a “potential” health care or empty-shelf crisis. We must ask: Who is willing to pay for that inventory in the off-chance a risk event comes to bear? And, what are the chances that the stored inventory will meet the need at that critical time?

Therefore, to suggest that Lean Thinking created our recent out-of-stock situations is inappropriate and misplaced. Increased demand for many products that stocked out was unprecedented, at times exceeding 100x any reasonable expectation of demand. No organization should or would be prepared for this, with either finished goods inventory or idle manufacturing capacity.

The reality of the situation

It is understandable that recent events have led to some confusion about the association between Lean Thinking and inventory. To some extent, Lean is a victim of its own success. It is a much admired—sometimes envied—approach to gaining efficiencies and benefits. As a result, some people and organizations have tried to implement it too quickly and with too much zeal and not enough discipline or deep understanding of Lean Thinking.

At this point, it’s critical to make the following clear: It’s not acceptable for health care workers to lack the tools they need to do their jobs. It’s not acceptable for hospitals to not have ventilators for the sick; it’s not acceptable for doctors to be forced to decide between two patients and one piece of equipment. In all cases, these situations are deemed a failure of planning, a failure of process, and a failure of operational execution. 

But, again, it is equally unacceptable to believe that efficiently run private businesses (or the government) can be held accountable to react with enough inventory to any and all possible events that may or may not occur at any given time.

Supply chain professionals know that stockpiled inventory can buy some time, but it is not practical or operationally feasible for it to be the sole strategic solution to a health care crisis, a cyber threat, or any other black-swan event that chance might render. Inventory is not a panacea. 

There is an old saying in the Lean world attributed to Taiichi Ohno, the architect of TPS: “The more inventory you have, the less likely you will have what you need.” That is, there is an inverse relationship between inventory quantity and having the right inventory. Sadly, this was a lesson learned the hard way early in the pandemic with the U.S. national stockpile of ventilators. A considerable share of the estimated 13,000 devices were inoperable and in need of extensive maintenance to be usable. Others were not sufficient in design to meet the needs of acute respiratory distress syndrome (ARDS) characterized by severe COVID-19 patients. The U.S. government’s Health & Human Services Department ordered $3 billion worth of ventilators—with almost half of them inadequate in design to meet the needs of ARDS patients. By the time the orders were delivered, the medical community had moved to steroidal treatments that reduced the need for intubation.⁶ In this instance, inventory was literally stockpiled, and it missed the mark. By the time a lax supply chain was jolted into action, it missed the mark, again. We should never allow ourselves to become complacent or to feel confident in meeting customers’ needs because we have loads of inventory on hand. 

Instead, we also need to realize that we have made our businesses more complex in order to meet customer expectations while attempting to remain profitable. Increased complexity (much of it unplanned and wasteful) assumes the form of excessive product variations, long lead times between suppliers and manufacturing locations, and new service offerings (think e-commerce) without sufficient fulfillment competencies. Our management systems have not kept up with this additional complexity; our people’s knowledge has not kept up; our measurement systems have not kept up; and our overall operating principles and management methods have not kept up. This has resulted in an abundance of operational waste and missed opportunities relative to meeting customers’ needs. In the end, we are missing market opportunities while adding costs to the business. This is a problem, as an equation of reduced revenues with rising costs is not sustainable.

Lean Thinking with its focus on reducing waste and identifying value is the way forward. The learnings from the recent past should not be about holding more inventories, but rather, they should be about becoming flexible in our shift toward “buy to order” responsiveness to effectively react to unplanned events. This means we will become “end-to-end thinkers” and focus on eliminating waste and poor business decisions that unnecessarily add lead time into our supply chains. 

And this strategy is at the heart of Lean Thinking.

Notes:

1. Retailers’ IS ratio registered record-low readings of 1.07 to 1.11, April to August 2021, underscoring shortage concerns among consumers.

2. The IS ratio does not necessarily capture how well the supply matches demand, but it is expected that customers must make substitutions more often when the ratio drops below normal levels of, say, 1.35.

3. Hong Chen, Murray Z. Frank, and Owen Q. Wu, “What actually happened to the inventories of American companies between 1981 and 2000?” Management Science 51, no. 7 (2005): 1015-1031.

4. James P. Womack and Daniel T. Jones, Lean Thinking: Banish Waste and Create Wealth in Your Corporation, New York: Free Press, 1996.

5. It should be noted that the automaker that has weathered the shortage of semiconductors better than all others is Toyota, the epitome of Lean Thinking. Toyota did the best job anticipating the shortage and holding just-in-case supplies at the advent of low allocation.

6. Tom Bergin, “The U.S. Has Spent Billions Stockpiling Ventilators, but Many Won’t Save Critically Ill COVID-19 Patients,” Reuters (Dec. 2, 2020).