Inventory Bloat at Toyota. What Gives?

Answer may lie in the supply chain.

Toyota Motor Corp. was one of a handful of companies to gain ground at the very top of 2003's IW 1000. Financially, the company remains a top performer. Revenues grew 12.5% to $126 billion (as reported in Japan according to Japanese accounting standards and converted to $U.S.), and profits climbed 31% to $5.1 billion in its fiscal year ended March 31, 2002.

Still, the widely admired company continued its long downward slide in terms of overall operational performance.

The key metric: inventory turns, calculated by dividing cost of goods sold by the value of inventory. Toyota's inventory turns, which peaked in the late 1970s and early 1980s at 60 and higher, fell to 11.3 in the most recent year. What's going on?

That's a question Richard Schonberger, long-time champion of world-class manufacturing and the production processes pioneered by Toyota, has been asking a lot lately. Schonberger's long-term analysis of manufacturing companies' financial statements reveals that, despite years of waste-reduction initiatives, the inventory levels of approximately two-thirds have remained flat or increased over the past 15 years or more.

To explain the lack of progress, Schonberger blames job-hopping managers and engineers who aren't paying attention to the basics, top executives focused on the next deal rather than process excellence, and legacy large-lot machines and factories. He also cites complacency born of the economic successes of the 1990s.

To help clarify the issue IndustryWeek asked Schonberger to look at the most recent changes in inventory turnover among the IW 1000, a comparable group to the manufacturing companies that he has been tracking over the longer term. With the global economic crunch, it should come as no surprise that the long-term trend reversed itself over the past three years.

During this period a significant majority of companies did manage to reduce their inventory levels. "The bubble has broken and we're in a recessionary period," says Schonberger. "Companies see the value of wringing cash out of a ready source."

The increased focus internal costs has also raised the awareness of the waste that occurs between organizations on the customer side and within the supply chain.

"There are a lot of good things you can do in the factory that are dwarfed by the opportunities outside of the factory, synchronizing with the supply chain and with the customer chain. Companies don't know how to do that, and the Toyota system doesn't know how to do that. The software is there but the organizational capabilities are still lacking," says Schonberger.

"Dell Computer knows how to do it. Wal-Mart knows how to do it. Everyone else is trying to emulate those two companies."

In a recent message defending Toyota's performance, Jim Womack, the well-known advocate of lean manufacturing, cited globalization as the primary explanation for the company's decreasing inventory turns, and the impossibility of replicating the tightly integrated supply-chain that Toyota enjoys in Japan. Still, other global automotive manufacturers -- most notably Ford Motor Co. (17.9 turns) and General Motors Corp. (14.5 turns) -- have made progress at speeding material flow through their organizations.

Both experts continue to praise Toyota's factories as "paragons of lean." Perhaps the most telling explanation of what's going on comes from looking at a profit leader in another industry. Pfizer Inc., which enjoys some of the highest profit margins in the pharmaceutical industry -- $9.1 billion in net income on sales of $32.3 billion in 2002 -- chalked up a miserable 1.5 inventory turns last year.

One financial indicator does not a complete picture make, but when a company has a healthy bottom line, operational issues can take a back seat. It's scary to think, especially for competitors, how much better Pfizer and Toyota might be doing.

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