Inventory should also be classified by its stage in the value stream. Raw material inventory (RMI) has no value added. Work-in-process (WIP) has some value added, but is not finished. Finished goods inventory (FGI) has all the value that is going to be added. Just as the allocation of inventory should be optimized across buckets of safety stock, lot size, and pipeline inventory; the allocation of inventory to raw material, work-in-process, and finished goods inventory should also be optimized. To reduce inventory carrying costs, the allocation of total inventory value should lean towards raw material inventory. However, supplier, production, and customer response leadtimes and variabilities may dictate that a higher percentage of the inventory be allocated to work-in-process and finished goods inventory. Tax structures and the transition differentials may also dictate a different allocation of inventory value across the stages.
An example inventory stage optimization for a large, high-tech manufacturing client is depicted below. Note in the example that raw material inventory is consistently too high (32% higher than optimal for the highlighted commodities); work-in-process is consistently too low (17% lower than optimal for the highlighted commodities); and finished goods inventory is consistently optimal. In this case the firm had placed a great emphasis on optimizing finished goods inventory, but needed to shift their investment in raw materials to WIP to optimize financial and service performance. Doing so yielded a 12% increase in Inventory Value Added™ and a 5% increase in on-time delivery.
Inventory Stage Optimization for an Engine Manufacturer (RMI = Raw Material Inventory, WIP = Work-in-Process, FGI = Finished Goods Inventory, RS = RightStock™)