Adventures in Inventory Management
One of the more significant numbers in the manufacturing sector is the inventory turn. It is by some accounts a central indication of the health of a manufacturing-based company. The number itself is simply the number of days between the arrival of raw inputs (such as a steel coil) and the conversion of those inputs into an output (such as a gutter). On its face, it would seem that this number should be as low as possible. Raw steel is a cost to a gutter manufacturer, but a gutter is a saleable product. Tax calculations, unit costs, inventory-management overhead, and any number of other variable costs are affected by the length of time that inputs sit on the floor.
Looking at this inside out, any number of external factors can lead to changes both positive and negative in the level of inventory turns. If a primary producer of inputs either goes out of business or raises prices significantly, suddenly the manufacturer is left with the decision of slowing input purchases, slowing production by idling workers, or raising prices to its own customers. As everyone knows, these days few producers actually have pricing power.
One last thing—the reason I've been using the terms input and output instead of raw material and product is that the days of Henry Ford smelting the very steel that becomes a bumper are long gone. Now car companies classify suppliers by tiers based on the number of doors that a piece must pass through before it winds up on a car. Tires come from a "Tier 1" supplier because they go directly onto a car, but the company that makes the foam in the seats is on a somewhat lower tier.
Considering that companies in each tier in a supply chain have their own inventory numbers, it's easy to see how this can spiral out of control.
Just-in-Time Inventory (JIT): Fact or Fiction?
Not too long ago, a wise member of the business community advanced a theory forever known as JIT, or just-in-time inventory management, suggesting that manufacturers schedule supply trucks to show up just as the supplied material was due to be run through the production equipment.
My favorite story from the frontlines of this obviously management-driven initiative was the customer that would allow steel-laden trailers to arrive in the parking lot on time, but if the production run was not ready, the trailer steel would not be "received" as inventory for up to a week. And so go the accounting tricks of inventory management.
In this age of intellectual property, where the old rules of business and economics no longer apply, why be concerned with inventory accounting? A business that traffics used CDs from Shokapee to customers in Junction City (while not actually purchasing or selling the product) doesn't have inventory, right?
Well, if you're made it to this point in the article, I'll assume that you a) have experienced a bout—either brief or extended—with manufacturing and can identify wholeheartedly, or b) find my prose so entertaining that you can't click away without the payoff. I'll also accept that you simply want to know what this has to do with software. The burdensome calculations of tens of thousands of green-eyeshade types are beneath us, correct? Watch closely. If you blink, you'll miss the point.
For some time very shortly before the dot-com explosion, a number of people were advancing the notion that the information systems groups of large companies should be allowed to peddle their wares (software) to other companies as a way of proving their worth. The primary reaction of said companies to said notion was uproarious laughter. Just a couple of practical realities missed by this notion include proprietary trade secrets embedded into the software business rules, and the wholesale lack of widespread design capability to satisfy the expectations of internal customers while producing something with a subset worth selling to other companies—preferably not competitors.
For these and many other reasons not covered here, I assert a new paradigm for Internet valuations—the level of J.I.C., or just-in-case inventory. This is the number of days until completion of projects that may not have a single customer waiting.
Just as many years were needed and titanic battles waged to convince executives in financial institutions that the expensive programmers on staff were actually saving them money, so too has it been a trial to convince executives in new-generation companies that their software is an asset that should be treated as saleable inventory—even if a CD containing the product is never intended to leave the door.
Instead of coordinating the efforts of the business departments with the efforts of the production staff (in this case, the well-intentioned web page designers and application engineers) to reduce inventory turns, both internally and for customers, they become isolated in the cycle of partnership and dining-for-dollars, leaving the software to languish.
Once software—even the lowly home page—is treated as inventory with a shelf life and an investment in need of recovery, the mindset changes. Instead of treating revenue as somehow coincidental to the product, as is the case with ad dollars, the product will be seen as the source of revenue. The question then evolves from "Who will give us money to exist?" into "Why would someone pay for our product?"
Common sense dictates that being able to readily answer the second question is far more lucrative than the transient ability to answer the former. If you can't answer the second question, then why do you exist?