Readers who follow macroeconomic trends are aware that during the past two decades the inventory-to-sales ratio in the United States has dropped from around 20 percent of sales to 15 percent. Although this is a positive development, it still indicates an overall turnover in trade inventory of approximately seven times. This, in turn, suggests that the "average" company has around 50 days' worth of inventory.

Inventory is composed of raw material, work-in-process, and finished goods. Indications are that in the last 10 years, the raw material and work-in-process inventory has decreased—in some cases by as much as 50 percent. Yet at the same time, the inventory facing the customer (finished goods) has significantly increased.

What does this all mean to the management of the supply chain? If one of the expected outputs of a more efficient supply chain is lower inventory levels and higher inventory turn, then most companies have been delivering on this promise through closer relationships with vendors and more agile or rational manufacturing processes.

Looking downstream, however, why haven't we been able to reduce inventory along that portion of the supply chain? Techniques such as ECR, QR, CRP, and so on were supposed to help lead us to the promised land. But the industry sponsors of these initiatives still are unable to declare a victory and proclaim a new age of lean inventory.

Certainly, a lack of technology is not the reason for our inability to manage inventory better. Advanced new systems to expand and refine how inventory is used both between and within firms abound today. Thousands of companies are implementing ERP (Enterprise Resource Planning) systems, and many more thousands are installing WMS (Warehouse Management Systems) and TMS (Transportation Management Systems). In some cases, these TMS/WMS systems are "bolt-ons" to an ERP system; in others, they stand alone. One of the important underlying goals of all this advanced technology is greater inventory productivity.

Still the questions persist ... Why is there so much inventory? Why does the average U.S. company have almost two months' worth of inventory? Why have ERP/ECR/QR and all the other acronyms failed to yield the expected returns in terms of inventory productivity? Why haven't most companies been able to deliver on the promise of inventory velocity?

From a view at 30,000 feet, let us speculate on some of the reasons why:

1. The corporate shell game. A wise logistics executive once described the corporate shell game as the art of shifting cost onto someone else's P&L. Today, this sleight of hand can happen when powerful customers shift inventory to suppliers, and the powerful suppliers shift inventory onto their suppliers. For example, we see loaded suppliers' trucks being spotted in the company lot. We observe the emergence of third parties that specialize in holding JIT stocks close to the demand point. This technique often involves double handling, poor asset utilization, short-term warehousing, and other costs of carrying inventory. All of this represents the real "cost-to-serve." In many situations it means higher inventory levels and higher costs of servicing inventory.
2. Lack of faith in the numbers. If you and your channel partners don't believe the numbers, it doesn't matter how slick the ERP or any other system is. You can produce comprehensive inventory reports on an hourly basis or on demand. And yet the system won't work because the decision-maker does not have faith in the numbers. When you extend these reports across the supply chain, you elevate the problem to a higher level—now you're asking a customer or a supplier to "trust the numbers."
3. Mistrust of the partner. Ideally, supply chain partners will align their incentives and behavior to achieve predictable performance in the channel. When this does not happen, the default strategy of choice is to buffer uncertainty with inventory. Sometimes it's a situation where our systems tell us one thing and our "gut" tells us something else. This kind of behavior occurs both inside an organization and between a firm and its partners. In some industries, mistrust of the channel partners is a part of the culture. New systems will not always overcome such embedded culture—and, once again, the safety net is inventory.
4. Misalignment of incentives. When a firm moves to a supply chain/value chain management process, some legacy baggage from the old system typically remains in place. It is most evident in the areas of incentives and rewards. Yet if the incentives and rewards do not change, the plant manager will continue making long production runs of the same items. Because that individual's bonus is based on unit output, why should he or she take the hit for shorter production runs or more lean or agile manufacturing? Similarly, the salesperson (who's taught to believe that "you can't do business from an empty wagon") will still be promising customers any product in any amount for immediate delivery. The message is clear. If incentives do not align with the systems, inventory is used to protect the individual against the company, and the firm against its supply chain partners.
5. Not on my watch you don't. Failure to write off obsolete stock is a common practice in many companies. When inventory is written off or written down, some manager's P&L must take a hit. Here again, the question of alignment of incentives comes into play. In this case, the strategy often is to bury the inventory and hope that you have a new job somewhere else in the organization before you have to face the music. Most manufacturing-based organizations in the United States likely have faced this problem in one form or another. In addition to the expense of holding outdated inventory, warehouse space and other inventory-maintenance costs continue to accumulate. There are a number of quick fixes, but permanent solutions require a realignment of performance goals and corporatewide systems.

To address these issues and fully collect on the dividend in the supply chain process, we must respond to three challenges successfully. The first is to create unified metrics both within the organization and externally. What's needed is a whole new set of "macro metrics" that focus on financial and economic value, and are embraced by all members in the supply chain. The second challenge is to align accountability and incentives in the inventory flow between source and customer. Without such alignment, the inevitable result is additional safety stock—and in many cases multiple locations for pockets of safety stock! The third imperative is to create an environment of trust—both within the company (functions) and between the company and its supply chain partners. It is impossible to optimize inventory flows when the parties to the process lack mutual trust.

The systems and technologies that are available today offer wonderful new opportunities for process improvement in supply chain management. But as coach Woody Hayes of Ohio State used to say, "You win with people—and good blocking and tackling."