The Relative Value of Inventory

In addition to space-time and interstellar travel, Einstein’s theories of relativity apply to many things outside of science and physics…including unlikely things like “inventory.” You see, the worth and value of inventory are very much determined by the perspective of the observer. During the early 1990s, the nature and value of inventory changed dramatically. With the publishing of Eli Goldratt’s business novel The Goal, and the multi-author book about the auto industry The Machine that Changed the World, inventory transformed from a crown jewel on which to hang your hat to a manufacturing family’s crazy Uncle Harry. Today, perspectives on inventory have been completely revamped from just 15 years ago and what constitutes inventory in “knowledge work” activities including product development has been undergoing a similar revolution.

Anyone knowledgeable about the concepts discussed in the aforementioned books (Theory of Constraints and the Toyota Production System) knows that they forced executives to take a 180° turn on the subject. Where once a fully stocked inventory of parts or finished goods was considered a hallmark of wealth and prosperity, cyclical economic recessions eventually exposed them as bastions of waste and flipped the metric of capacity utilization on its head. This was an issue where one of the most powerful decision making bodies of a company, the finance department, influenced by shareholder value, used its unique perspective to drive the wrong behaviors.

Since Wall Street and company accountants used inventory assets as a major piece of a company’s valuation (most likely because there existed few, if any, ways to measure a company’s more true, yet intangible, assets), factories were encouraged to keep warehouses full of stock, regardless of sales or market demand. In addition, manufacturers were heavily pressured to keep machines running as much as possible, because maximum utilization gave a better ROI figure for the money spent on those tools, even if the part or product produced was just going to sit on a shelf. A company could be bleeding cash and selling nothing, but relative to the stock market, full shelves and active shop floors meant you had value, even though it may be a short-lived fantasy.

“Just in Time” manufacturing has been around for quite some time, yet many still produce for the shelf rather than a customer. People regress to old ways in times of prosperity, but anyone who espouses full inventories today will recognize the mistake quickly, hopefully before it’s too late. The “Lean Manufacturing” movement has spread slowly, but has done much in showing people how empty shelves and idle tools can represent a lot of hidden shareholder value. Today, many people are also exploring new inventory concepts within product development, engineering and R&D.

Inventory in a product development context is all about knowledge and information. Instead of warehouses and shelves, we have databases, file cabinets, servers, and human brains. Relative to physical inventory, knowledge inventory is fluid, and dynamic—almost a living entity—hence the dramatic difference of discomfort with controlling and managing it as compared to physical inventory. But the value of this inventory is a much greater representation of an organization’s worth, and can have tremendous hidden potential, so it should be a compelling and desirable competitive edge for companies that can tap into it.

Product development knowledge comes in almost infinite shapes, sizes and degrees of worth (e.g., software code, patents, customer requirements analysis, test results, etc.). The most valuable type of knowledge is Intellectual Property (IP), mostly in the form of patents, which can have serious bottom-line impact. As companies innovate and develop new technologies, many R&D groups will file numerous patents, not all of which will have relevance to the project they were originally a part of, but could have huge potential future yields if repurposed on a different opportunity.

Many smart companies develop patent portfolios alongside their product portfolios and have resources dedicated to finding and leveraging these prospects. A good example of this is Dow Corning, whose stated mission is to find every possible use for silicone. Another is Kimberly Clark, which has gone to great lengths to ensure its IP is stored, categorized, and shared internally. More and more companies are finding revenue streams and new business models from such inventories of innovation “by-products.”

Open innovation activities, alliances and partnerships have driven a lot of this focus on IP. First, companies doing joint projects or co-development need to protect their IP from each other as well as competitors (one group that is gaining the most profits from Open Innovation is the legal department that writes joint development agreements). Secondly, many believe that in the wake of our current recession, financial entities will be increasingly measuring IP inventories in a company’s stock market valuation, meaning those who are the most effective innovators could have the highest shareholder value based on their knowledge inventory. Partnerships that help accelerate and multiply your development of and access to valuable IP could be a critical differentiator.

Intangible inventory is tough to get your arms around. A patent that protects your share of a multi-million dollar market is not hard to evaluate, but putting a number on the value of an engineer that has worked for the company 20 years and has irreplaceable expertise is a completely different animal and one that Wall St. will likely ignore for the foreseeable future. Still, the concepts of inventory have been evolving as we have developed new knowledge about what is valuable and what is waste. Every time we put that knowledge to good use could be considered a “knowledge inventory turn.”

It does seem natural that our “information age” be driven by intangible “knowledge inventories,” and that our focus shifts from the physical to the digital or virtual world. What’s important to remember as this happens is the lessons of physical inventory, and not focus so much on knowledge capture that you bury meaningful signals in too much noise and misinterpret a well stocked inventory for a profitable one.