Just-in-Time Inventory Management
Just-in-Time is an inventory management philosophy that aims to reduce inventories by implementing systems and processes to supply a product or service exactly when it is needed, and how it is needed in the production process. The concept of JIT is widely accepted today by many American manufacturing companies, and it is a means of controlling costs through striving to maintain lean inventories—in fact, the concept of JIT was introduced in the early 1980’s to the U. S. as a concept know as “zero inventories”.
This inventory control concept involves close relationships with vendors or suppliers, who are able to provide components of the product direct to the work-in-process area, in a “pull” type fashion, whereby the components are delivered immediately before they are required. Since the introduction of the JIT concept, it has evolved to become a management philosophy that requires a corporate-wide commitment to do a process right the first time, and to reduce non-value added activities in the manufacturing process.
Because the concept largely centers on this element of focusing on the elimination of waste in the manufacturing process, the JIT concept emphasizes the need for the supplier and the receiver of goods to never have to wait on the other. Ideally, the concept is beneficial to both supplier and manufacturer in this way, because it allows both companies to reduce their Work In Process (WIP) and finished goods inventory, while reducing inefficiencies and bottlenecks in the system—thus cutting costs and improving profitability.
The first article pertaining to JIT discusses practical application of JIT methods in the health care industry, titled “Applying Just-In-Time Systems in Health Care”, from the magazine, IIE Solutions. The article describes the opportunities that exist in health care organizations in general, to implement JIT type practices to help improve profitability and work flow. In general, the opportunities that exist for a service organization to implement a JIT strategy involve an approach that breaks down specific services into “manufacturing like” processes.
There are many opportunities in service organizations to apply JIT concepts, but the health care organizations that are best suited for JIT management or those companies that have operations that are repetitive and reasonably high volume dealing in tangible assets. According to the article, examples of JIT opportunities in health care include: central supply warehouses, materials management and pharmacies, and nursing staff scheduling. The most obvious candidate of these for opportunities to apply JIT management to is the area of materials management and pharmacy, because it clearly involves the flow of material and tangible goods.
In order to help maintain low inventories of medical supplies and pharmaceuticals, hospitals use JIT philosophy to reduce their overall number of suppliers, pick suppliers that are consistent and reliable, and close in proximity to the facility. In addition, many hospitals receive material goods six days a week, and develop a “community” strategy whereby hospitals are networked together to share pharmaceuticals with one another, as well as local pharmacies to ensure that they can deliver life saving drugs to their patients, without stocking high inventory levels.
Accounting implications of using a JIT system in the health care industry are similar to those in a manufacturing organization. According to this article, manufacturing organizations often use process costing, where unit costs are calculated by dividing production costs of a period by the output of that period. In a process costing system, it is important to have homogenous processes, and while certain business activities in a health care system are similar, the clinical aspect of health care are more unique and therefore a challenge to group into a process costing system.
The article concludes with a cautionary perspective on implementing JIT in the health care system. While the fundamental point of any JIT system is to reduce overall cost, in a health care environment (and thus one could infer, in a manufacturing environment), unless the organization can transfer or eliminate costs of operating functions, implementing the JIT program can actually add cost to the bottom line. Considering the fact that the shifting of inventory from the hospital to the supplier is going to raise the supplier’s inventory level, it is reasonable to conclude that the supplier might raise their rates.
In addition, if JIT systems are not managed properly, they inherently raise the risk of stock outages of inventory—in the health care environment, medical supply outages can be life threatening. The second article discussed is titled, “Just-In-Time Inventory Management: Implementation of a Successful Program”, from a 1995 edition of Review of Business. This article describes the basic process of implanting JIT in an organization, and provides an excellent summary of the management philosophy in general, however, it concludes with a similar cautionary note to the first article.
To begin, this article discusses the three basic stages of JIT: Kanban systems, Production planning, and Global management philosophy. Each stage is more advanced than the prior, and the article notes that any organization utilizing any of these levels of JIT, describes itself as a JIT based company. The Kanban, derived from the Japanese words kan (card), and ban (signal), is the most basic form of JIT. The Kanban is a materials movement tracking device that serves as a shop floor control tool, allowing the scheduling of inventory movement through the assembly line.
The second stage of JIT, production planning, focuses on receiving production materials right when they are needed, which allows the manufacturer to keep only the inventory on hand that is needed for production before the next shipment arrives. This process is driven by having a continuous flow of materials to the factory, and by receiving the materials directly to the work area, it eliminates the double handling that can occur when materials are received to a shipping area, then warehoused, then moved to the production floor.
In this form of JIT, lead time from suppliers is dramatically reduced—sometimes to only hours. Because lead times are reduced, forecasting of materials is less important and it becomes easier to determine what is needed for production each day. One of the key elements of production planning is establishing long term contractual agreements with quality suppliers that can be relied upon to supply high quality materials and eliminate in-house processing.
Because it is important to eliminate non-value added activities, it is also critical that the manufacturer implements an in-line quality control process, where every employee is responsible for quality control. According to this article, in the third and most evolved stage of JIT, global management philosophy, the JIT process is embedded throughout the manufacturing environment. It is so effective that inventory tracking is completely eliminated, as the pull system is integrated so well that suppliers react to demand. The embedded JIT philosophy guides facility planning, technology specialization, and resource sharing.
The article provides a terrific framework for implementing a JIT strategy, and documents many of the issues that can arise in transitioning to a JIT system, as well as some best practices for overcoming them. First and foremost, it is critical for companies to have a partnership with their suppliers, and realize that it is a two-way street. The company cannot expect the supplier to automatically bear the burden of just shifting the inventory back upstream. A successful JIT program will realize cost savings at the supplier and the purchaser.
Communication is key, as it is critical for an open and trusting relationship between suppliers and purchasers. In JIT, the supplier often implements supplier certification programs that help to guarantee quality of product and delivery. This is necessary, as in striving to eliminate wasted cost, the JIT based company trusts the supplier to provide a quality product. Because the number of suppliers is usually reduced through JIT, the impact of poor quality can be dramatic, as it can completely shut down a production line and lead to lost profit opportunity.
The article concludes that there is a definitive down side to using JIT, however, if implemented properly, it can significantly impact work in process costs, boost profitability and give a manufacturer a competitive edge. Some of the challenges of JIT included the fact that JIT accounting can be quite difficult because it can be hard to set discrete stocking check points in a system with low in-process inventory, particularly if the manufacturing process is long. In addition, because JIT places such an emphasis on supplier relationships, the company is vulnerable to supplier shut downs.
In addition, an example is cited in this article of a company that halted its implementation of JIT because of its impact on the balance sheet. Since JIT causes inventory (which is counted as an asset) to decrease, the company’s asset-to-debt and asset-to-equity ratios were negatively impacted which was looked at as unfavorable to stock holders and lenders. The third article discussed in this paper is titled “Just-in-Time Under Fire: The Five Major Constraints Upon JIT Practices”, from the Journal of American Academy of Business, Cambridge.
Again, this is an article that is critical of JIT, citing that it is appropriate only for limited economic environments, is ineffective in some organizational cultures, is unattainable by many small suppliers, and in practice, it does not truly reduce an organization’s total costs. It supports this view by describing five major constraints regarding just-in-time philosophy, and supports them with literature and real world examples. The constraints include the following: customer-driven and economic conditions, logistics, organizational culture and conditions, intractable accounting and finance practices, and small supplier difficulties.
The customer-driven and economic condition restraint concludes that JIT is difficult to maintain when raw materials prices are experiencing fluctuations. Corporate capital availability and fluctuation is also cited as a deterrent to JIT cost savings. Customer-driven demand fluctuations clearly impact the success of JIT, as the JIT model assumes a relatively consistent demand in the end product. Should demand suddenly decline, a company will have a sudden build up of finished goods inventory, which could negate the savings associated with the JIT implementation.
Logistics is the second and the most prominently supported constraint in this article. This is obviously the biggest concern of JIT, because the practice is clearly logistic intensive, as it relies so heavily on the assumption that production materials will be delivered to the right place at the right time. Organizational culture and conditions are cited as the third constraint, both internally and with suppliers. Because JIT can be a major shift in the way a company does business, it may not fit with the corporate culture, or be practical for the type of good being produced—particularly for high-end custom type products.
Intractable accounting and finance practices are cited as the fourth constraint, which is supported in a similar fashion to the other articles, citing that the lack of variation in in-process inventory make traditional costing methods difficult. In addition, traditional measures of company value such as ROI and quarterly earnings often deter executive commitment to the long term goals of JIT. The fifth constraint that limits the feasibility of JIT is cited as small supplier difficulties.