Production (Economic theory) ; Manufactures ; Inventories

Donald S. Allen

English

Research Papers in Economics

NationalEconomicTrends
April 1998
Improving Production
Management
Manufacturers can be loosely categorized into two
groups:  those that produce to order and those that pro-
duce to stock (in anticipation of demand).  In reality
the distinction is blurry—some firms may do both.  
A firm that produces to order may keep an inventory
of work-in-process that they complete to fill orders.
Conceptually, a “just-in-time” producer neither holds
inventory nor backlogs orders, but instead adjusts pro-
duction “automatically” with demand.  
Because the production process takes time, firms
rely on forecasts of demand to determine production
plans.  The accuracy of those forecasts will determine
how much undesirable variation there is in the produc-
tion schedule, with firms adjusting production if they
realize their forecasts are wrong.
The amount of unfilled orders or inventory relative 
to sales measures the possible mismatch between pro-
duction and sales.  A firm that produces to order will
monitor the backlog of unfilled orders, while a firm that
produces to stock will monitor the level of inventory.  If
unfilled orders rise above some desired level, or inven-
tories fall below some desired level, production is sped
up by increasing overtime, adding new shifts or even
adding new capacity.  If the reverse occurs, production
is slowed down.  If the miscalculation is large enough,
this might even result in temporary layoffs.
As innovations in information technology become
more comprehensively incorporated into the economy,
one would expect that both the forecasting capabilities
and the production management process will improve.
Retailers will get better information about the market,
and improved communication with suppliers should
reduce unwanted inventory, improve delivery times
and reduce backlogged orders.  Even if not all firms
adopt “just-in-time” production, we should observe 
an improvement in the management of production.   
At the manufacturing stage, both unfilled orders 
and inventory as ratios to monthly shipments have fall-
en since the 1990-91 recession (see chart) and are now
at historical lows.  The ratio of manufacturing unfilled
orders to monthly shipments has fallen from 2.31 in
March 1991 to 1.61 in December 1997.  The ratio of
manufacturing inventory to monthly shipments fell
from 1.75 in March 1991 to 1.35 by December 1997.
This suggests that the production process is becoming
more streamlined, and supports anecdotal evidence 
that firms are using information technology to improve
production management.  A lower level of unfilled
orders indicates faster response of manufacturers who
produce to order, and a lower level of inventory to sales
indicates either better forecasts or improved inventory
management.  Errors in predicting demand are thought
to be partly responsible for most post-war recessions.
Improved production management will not only free up
resources that would otherwise be tied up in inventory,
but may even help reduce swings in the economy.
–Donald S. Allen
Views expressed do not necessarily reflect official positions of the Federal Reserve System
Manufacturing Unfilled Orders and Inventory
Ratio to Shipments*
* 3-month moving average Recession
   
1981 1983 1987 1989 1993 1995 1997
1.4
1.6
1.8
2.0
2.2
2.4
1975 1977 1979 1985 1991
Inventory
Unfilled Orders

Improving production management

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Improving production management

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Research Papers in Economics