SOSO Inventory

As a major provider of medical supplies, Johnson & Johnson serves many hospitals and pharmacies. Because the demand for its products ebbs and flows with the flu, hay fever, and cold seasons, as well as outbreaks of various diseases, J&J keeps safety stock in several warehouses for use when demand for any of its products exceeds the forecast. One of J&J's customers is the Pentagon. Normally, the Pentagon buys medical supplies in predictable patterns that J&J can supply from its manufacturing plants and warehouses. In case of a war or a major disaster, however, the Pentagon knows that it will need huge amounts of medical supplies very quickly.

For that reason, J&J is under contract with the US government to stockpile certain quantities of medical supplies. (Indeed, the US government has increased funding for the strategic stock-piling of vaccinations and medications from $US41 million in 2001 to $US400 million in 2005.)

To meet this contractual obligation, J&J has two major challenges: how to keep the extra inventory fresh and up-to-date, and how to ensure that the extra inventory will not infect its processes with sloppiness, leading to expensive quality problems. J&J solves the problem with a "sell one stock one" (SOSO) inventory discipline.

Under the SOSO strategy, J&J does not let the Pentagon's inventory moulder in a dedicated warehouse; instead, the inventory is commingled with the rest of J&J stock. To keep its commitment, J&J defines a "red line" for each product; when the inventory for a particular product falls to the red line, J&J computers signal the ordering hospital or pharmacy that J&J is out of stock. Because going below the red line requires Pentagon approval, this inventory cannot be used to compensate for day-to-day variations. Consequently, J&J's everyday processes have to operate as if such inventory does not exist, thereby reducing the danger of sloppiness.

Using a SOSO strategy can mitigate some of the costs of keeping extra inventory. Commingling ensures that the stock is fresh, and requiring high level approval (CEO, board, or the Pentagon in the case of J&J) for tapping into the SOSO inventory ensures that the inventory will not undermine the company's quality processes.

In many regards, the Pentagon is using J&J's SOSO stock in the same way that the Department of Energy uses the Strategic Oil Reserve. These reserves were not established to mitigate price fluctuations; rather, they serve as backup inventory of a critical material in case of a national crisis.

Naturally, when companies are aware of potential disruptions, they can accumulate inventory to cushion the effect. This can be in anticipation of either a one-time phenomenon or a continuing situation. For example, prior to the West Coast port lockout in October 2002, Wal-Mart stockpiled some three to five weeks' worth of inventory to prevent the disruption from affecting holiday sales, and NUMMI accumulated several days' worth of parts supply. And when companies enter into an agreement with a supplier whose deliveries are less than predictable (because of distance, location, or process peculiarities), those companies can change their policies to increase inventory by using a higher "reorder point" in their inventory management. Unilever, for example, increased its North American safety stocks of Q-Tips by 10 percent as part of contracting all the production to a Puerto Rico plant.

Redundant Capacity

Instead of using inventory for redundancy, some enterprises use redundant capacity for mission-critical business units. Boston Scientific manufactures an array of high-tech medical devices such as drug-coated stents that prop open the arteries of heart patients and help keep them blockage-free. For these specialized products, the company uses an array of sophisticated manufacturing systems to laser-cut nickel-titanium tubes into the delicate yet strong meshes that then receive the company's patented coatings. The nature of the product, and FDA regulations, specify meticulously clean and controlled production conditions. Each lot of stents must be traceable, requiring some 40 pages of paper-work to certify when, where, and how the devices in the lot were manufactured.

Were Boston Scientific to suffer from a disruption of its manufacturing facilities (eg, a fire, industrial accident, or contamination), the company knows that the time to fix and recertify a disrupted facility could leave the company without a major portion of its revenues and profits and allow its aggressive competitors to take Boston Scientific's market share.

After assessing its vulnerabilities, Boston Scientific built redundant production lines for some of its most important products. These alternative manufacturing facilities are kept FDA-certified and ready to go in the event of a disruption. The company also has personnel who maintain the skill levels needed to operate those redundant lines. Although such redundancy is not inexpensive, the company realized that failing to maintain redundancy risks the entire company and decided to protect itself against that risk. Other companies aim for less than 100 percent capacity utilization rates on their existing production lines, reasoning that the unused capacity acts as a cushion to absorb unanticipated large orders.

Yet other companies, such as Helix, a maker of high-performance vacuum pumps, rely on their suppliers to provide extra capacity. Helix used Demand Flow Technology, in part, to segment its manufacturing processes into short, easily taught steps that in an emergency can be transferred to others. Having analyzed the capacities and capabilities of suppliers, Helix knows that it could quickly teach certain suppliers to make its products.