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JIT savings - myth or reality? - just-in-time management
Business Horizons, May-June, 1995 by Jitendra Chhikara, Elliott N. Weiss
The just-in-time management philosophy is not new to manufacturers. Though it was initially developed and justified on cost reduction and quality improvement dimensions, managers today have extended its definition to mean the "elimination of waste" in the manufacturing process. This includes any non-value-added activities in the production process.
In this article, we challenge the measurement of the dollar benefits of JIT manufacturing and offer the admonition that blindly following the JIT caravan may lead to benefits that are only a mirage. Specifically, we address the issue of lot-size reduction associated with JIT shipments to customers and assert that, unless changes in the accounting and financing of inventories are made concurrently with changes in production, inventory cost savings are only a illusion.
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The JIT Paradigm
Just-in-time manufacturing techniques have become the conventional wisdom of manufacturers all over the world. The success of Japanese manufacturers in the global economy in the 1980s has been attributed to this system. Indeed, JIT encompasses various types of activities; Sakakibara, Flynn, and Schroeder (1993) provide a framework and measurement instrument for JIT manufacturing that includes initiatives as varied as setup time reduction, equipment layout, training, and accounting adaptation to JIT.
Pundits often claim that JIT benefits are more apocryphal than real. The basis for this argument has been that a downstream manufacturer merely displaces its inventory-holding requirements to upstream suppliers, thereby decreasing its own costs while increasing supplier costs. Although this statement may be true, the astute supplier will use the information obtained from its customers to alter its production system and thereby lower its costs. Subsequently, that supplier will work with its own suppliers backward through the supply chain, eventually resulting in reduced system costs.
Still, even with this coordination throughout the supply chain, the benefits of JIT may not be realized unless financing and operational decisions are addressed. The point of the three examples that follow is that, when costs are fixed and cash-flow changes do not accompany changes in production scheduling, savings from inventory reduction are often overestimated.
The Receivables Myth
Consider the following visit of the authors to an automotive OEM (Original Equipment Manufacturer) supplier. As we walked through the plant, we could not help admiring how neat and clean the shop floor was. We were also intrigued by the amounts of vacant space stacked with empty bins. When we asked our host about this, she proudly replied, "Oh, this is the result of the JIT program we instituted a year ago. We have succeeded in reducing finished goods inventory levels from five days to one day as a result. Of course, we now have to machine smaller batches of the components before assembly, but we figured the savings in inventory holding costs more than offset the additional expense of performing more frequent setups. The program has been very successful."
This description sounded like a textbook example of the advantages of JIT, so we pressed our host further: "How does your customer pay you?"
"Why, they pay us by check every 15 days. Our payment terms are net 15."
"You mean every 15 days you receive a check for shipments made 15 days or more earlier?"
"Sure, they do try their best to get some additional float, but then who doesn't? Why do you ask?"
If Cash Is King...
Managers are constantly bombarded by the notion that cash flow is what really matters. MBA students are often implored: "When in doubt, do a spreadsheet and look at the cash flows." Cash flow analyses are quite easily performed for macro financing and investing decisions. But evaluating the cash flow impact of micro operating level decisions is not as easy. Functional walls in many organizations prevent the effects of these decisions from being traced, so managers, by necessity, evaluate operating decisions based solely on how they affect those managers' immediate areas of influence.
To do this, managers are forced to use a proxy for cash flows. When analyzing production and inventory management decisions (based on traditional EOQ models), for instance, managers use material flows as a proxy for cash flows and hope that by minimizing inventory levels they will be able to optimize cash flows. Although Cavinato (1988) addresses the issue of cash flow, he does not explicitly relate it to production lot-sizing decisions.
... JIT Is an Impostor to the Throne
Take the example of the investment made by an OEM supplier to introduce a JIT manufacturing system. Management anticipated that the investment required to increase the flexibility of the equipment would be offset by the resulting reduction in inventory holding costs. But the company did not realize the majority of these savings. Here's why:
Alpha Corporation machines several types of steel components that are packed in "kits" before they are shipped to customers. Beta Corporation is its principal customer and accounts for about 85 percent of total sales. Before they were bitten by the JIT bug, manufacturing managers attempted to maximize machine use by running large lot sizes. The plant would build up the finished goods inventory for five days, and at the end of the fifth day the finished goods would be shipped to Beta.
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