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LEI's indicator that can't lie: Doing the math

Jim Womack
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I got a wave of reactions to my recent note about inventory turns as the best indicator of a lean transformation. No one argued with my basic point, but some thought I was using the wrong numbers in the numerator or denominator. Many others simply asked how they should make the calculation at the company and plant level, rather than at the industry levels given in the charts displayed at inventory turns Chart.

So I thought I should just give an example. Delphi (formerly Delphi Automotive) has been a partner with LEI in developing our workbooks and we’ve had a great opportunity to watch their progress since lean thinking took hold in 1997. 

For inventory turns calculations, Delphi defines their sales as the annualized "cost of goods sold" from Delphi factories before any overheads for selling and administration are added. (In the charts at www.lean.org, I use annual sales to customers as the numerator because government data are only available for company sales, not for cost of goods sold. The denominator used there is inventories on hand at the end of the calendar year.) For inventories, Delphi counts the value of its raw materials, work in process, and finished goods as a beginning of the month average during the fiscal year. 

Dividing its cost of goods sold by average inventories, Delphi calculated its turns at 10.5 in 1996 before the lean campaign got underway. Turns increased steadily through the 1990s to 14.5 in 2000. In 2001 the recession had a slight negative effect (as recessions always do) and turns fell to 14.3. In the first quarter of 2002 (now dividing the cost of goods sold at an annualized rate by average inventories at the end of the quarter) the positive trend resumed and turns increased to 14.8. 

These figures are for all of Delphi’s worldwide operations, but many of you manage individual facilities. inventory turns are a great indicator here as well. Delphi’s Rochester, New York, facility also started a lean transformation in 1997 and has had remarkable success in increasing the velocity of its operations. In 1996, inventory turns (annual cost of goods sold divided by average inventories) stood at 17. By 2001, despite the recession, Rochester’s inventory turns had risen steadily to 35. (During this time, Rochester’s annual cost of excess and obsolete goods fell by 95% from $10 to $0.5 million because overproduction was largely eliminated, another benefit of a lean transformation that you may want to track.) 

So, Delphi has improved from 10.5 to 14.8 turns (41%) at the whole company level and from 17 to 35 turns (106%) in one plant, providing strong evidence that Delphi really is making a lean leap. 

One final point before leaving the Delphi example: Although Rochester’s inventory turns are considerably better than Delphi as a whole, it does not automatically follow that Rochester is better managed than the average Delphi plant. Caution is in order in making comparisons because each plant may conduct a different type of operation and run at a different volume, with low-volume plants conducting many fabrication activities generally having much lower turns than high-volume plants only doing assembly. Thus inventory turns can vary widely within a company even if all plants are equally lean. What is undeniably impressive about Rochester is that its percentage increase in turns since 1996 has been much higher than Delphi as a whole - 106% versus 41%. This is the really important trend to track if you want to do plant-to-plant, plant-to-company, or company-to-company comparisons. 

I hope (a) that you know your trend in inventory turns at the company and plant level and (b) that they are going up even faster than Rochester’s! I would love to hear about your improvements - I’ll even include them in a future e-mail! - along with any additional thoughts on how to keep score as we all try for a lean leap.

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KHallberg October 25, 2012
Would you recommend inventory turn as a measure for a very seasonal business as well or something else?