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2015

I recently came across an article entitled “Visibility Is Key when Driving Supply Chain Performance” at Supply & Demand Chain Executive. If you are a regular reader, you know that I am a real hound for “supply chain visibility.” So, I was anxious to read what the article had to say.

 

Sorry to say, I was greatly disappointed by the opening salvo in the article. It reads: “At its heart, supply chain management requires a balancing of operational efficiency, customer satisfaction and quality. Managing the true cost to serve for each and every order is the aspiration to… value creation across the supply chain.”

 

Wow! What a disappointment.

 

I really thought we were starting to get beyond making our supply chain managers and executives “jugglers” in some great circus of enterprise.

SupplyChain Cost-Centric View.png

So, how do those conversations go?

 

I’m always curious to know how, in some organizations, the supply chain executives and managers have those conversations about “balancing” between these three factors.

 

I somehow imagine the CFO saying to the COO: “Look, George, our operational efficiencies have been falling off too much this quarter. The shareholders aren’t going to be happy with the results. So, for the next six weeks or so, let’s allow customer satisfaction to fall off. We’ll let you choose which customers you want to leave dissatisfied—and, frankly, we don’t care if you dissatisfy them with lower quality, late shipments on some products, or increased back-orders. As long as we can get our efficiency numbers up for the quarterly reports, we really don’t care how it gets done.”

 

No, of course, not

 

Even though supply chain managers and executives make talk a good game about “balancing” operational efficiencies, customer satisfaction, and quality, the actual decisions about these factors are almost never made—in the final analysis—in the board room or at a rational meeting. Instead, the exchanges about so-called “balancing” are more likely to made in the heat of the moment.

 

The exchanges are more likely to sound like these:

  • “Listen, Fred, you know as well as I do that ABC Company is one of our best customers. You’re going to get that shipment out the door by tonight! And, I don’t care what your efficiency report looks like at the end of the month!”
  • “Yes, Sam, I know that the quality of those parts we received in the last shipment from XYZ isn’t up to our usual standard, but we can’t afford to wait any longer and disappoint the 30 customers we’ve got waiting for those widgets. We’re just going to have to expect higher return rates than usual. Otherwise, we’re likely to lose some of those customers entirely.”
  • “Frank, if you want me to break my set-up just to get a later order out to your favorite customer, you’re going to have to get approval from the CFO, because my bonus is riding on keeping my efficiencies up to the target.”

What’s wrong with this picture?

 

What’s wrong with this picture is actually buried in the second sentence of the article (quoted above). The reason these supply chain managers and executives feel compelled to “balance” and make trade-offs is because they believe that cost is the driver of business profitability.

 

I’m here to say, probably too bluntly, that cost is not the driver of business profitability!

 

I can prove it one brief thought experiment. If the goal of business is to drive costs down, then the ultimate is to drive costs to zero. How much profit will your supply chain be producing when costs are equal to zero?

 

That’s right: zero!

 

Now, what if we change the central them of our managing?

 

If we put FLOW at the center of our thinking as supply chain managers and executives, look what happens!

 

The entire “balancing act” goes away!SupplyChain Flow-Centric View.png

 

QUALITY

 

When quality increases, FLOW automatically increases. Fewer materials and resources are wasted on rework and scrap. Furthermore, efforts to improve FLOW, will automatically lead to improvements in QUALITY, because it will readily be seen that poor quality is the enemy of FLOW.

 

CUSTOMER SATISFACTION

 

When FLOW improves, customer satisfaction also improves—all else being equal. This is especially true when FLOW is defined—as it should be—as the FLOW of relevant materials and relevant information. Things manufactured, purchased, or moved from place to place that are not connected to actual demand are likely not relevant materials. Similarly, forecasts that are wrong—and they always are—may be close enough to drive capacity planning, but they are not relevant information for driving the production and movement of materials.

 

Finding ways to improve the FLOW of relevant information and, as a result, relevant materials, and customer satisfaction will automatically rise.

 

OPERATIONAL EFFICIENCY

 

When FLOW is improved, operational efficiencies automatically improve when measured at the system level. Measure on a work center-by-work center basis, they may not appear to be better. But, it is the efficiency of the entire system—the entire supply chain—that produces profit by the FLOW of relevant materials and relevant information. Producing and moving about products for which there is no demand is—as Toyota properly identified—waste and inefficiency.

 

The whole team pulling in one direction

 

When FLOW becomes the central theme of supply chain design and management, the whole team can all pull in one direction. This is what it means to become demand-driven (but that does not mean make-to-order).

 

This requires a change in thinking. Chances are new “thoughtware” will need to be installed in your organization. But it can be done.

 

Stop your “balancing” act! Focus on FLOW and discover harmony in your supply chain once again.

 

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Let us hear from you. What are your thoughts regarding COST versus FLOW? Are you confused between demand-driven and make-to-order? They are not the same. Contact us with your questions.

 

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As we said in our earlier article, there only two KPIs (key performance indicators) that are of any significance when measuring the performance of your inventory and supply chain as a Supply Chain Strategy.jpgsystem:

  1. Return on investment (ROI)
  2. Due-date performance

For most companies involved in manufacturing and distribution supply chains, inventory plays a critical role in determining just how healthy those two KPIs are for them.

 

We began by saying that everybody thinks their inventory is strategic. However, when we begin to dig deeper, we are likely to discover that most CEOs, CFOs and supply chain managers cannot linked investments in inventory at the SKU-location (SKUL) level to any real strategy that drives that specific investment.

 

Then, we went on to say that, if an enterprise is going to really have the composition of its overall inventory investment be driven by strategy, then the follow data elements must be known—at the SKUL level—with reasonable accuracy:

  1. Average daily usage (actual demand)
  2. Lead time
  3. Demand variability
  4. Supply variability
  5. Minimum order quantities and multiples, if any
  6. Relationships between SKUs (e.g., bills of material, kit assembly requirements, product affinities)
  7. Unit cost
  8. Customer tolerance time

 

We also suggested that inventory investment is only strategic when it does all three of the following things:

  1. Absorbs variability (demand, supply or both)
  2. Decouples lead times
  3. Provides real (calculable) ROI

How do these eight factors help us decide about inventory investments strategies?

 

To answer this question, we are going to use the following “routing” diagram for two end-items. (This is a manufacturing environment, but you will not have trouble translating the concepts to a distribution environment.)

DDMRP LeadTimeCompression_1.jpg

[Note: This example is adapted from Ptak, Carol A., Chad Smith, and Joseph Orlicky. Orlicky's Material Requirements Planning. Third ed. New York: McGraw-Hill, 2011.]

 

If we begin with no inventory in the system, the cumulative lead time (CLT) for Part 300 is 22 days, consisting of ten days purchase lead time (PLT) for Part 100; five days manufacturing lead time (MLT) for Part 200 (intermediate component); and seven days MLT to produce Part 300. Similarly, the CLT for Part 400 is 19 days: 15 days to intermediate Part 200, plus four days MLT for Part 400.

 

Remember, we have said that inventory is only strategic if it does three things: 1) absorbs variability, 2) decouples lead-times, and 3) provides a hard (read: calculable) ROI.

 

So, let us consider what placing inventory at each of the “buffer” locations indicated in the following figure does for these three factors.

DDMRP StrategicBuffers.jpg

 

Absorbing variability

 

If resource ‘E’ is a capacity constrained resource (CCR), it means that the total throughput for both Part 300 and 400 will be limited by the capacity of ‘E’ to produce. We must also acknowledge that variability—anything that disrupts the flow of production at resource ‘E’—will reduce the total throughput at this resource. Therefore, it is in our best interest to buffer resource ‘E’ from variability wherever and whenever possible.

 

If we place inventory buffers on Parts 50 and 200, we automatically buffer CCR ‘E’ from variability. The buffer on Part 50 buffers ‘E’ from the supply variability from the vendor—including transit time variability; while the buffer on Part 200 absorbs variability in the purchase and manufacturing steps leading to the production that part. Since Part 200 is used in the production of both Part 300 and Part 400, the buffer on Part 200 protects both production routings. Adding a buffer on purchased Part 100 would provide further absorption of external variability.

 

Decoupling lead times

 

Buffers at Parts 50, 100 and 200 also decouple lead times. Even in the absence of shipping buffers on Parts 300 and 400, the positioning of buffers on Parts 50 and 200 decouples the cumulative lead time and reduces the lead time for Part 300 from 22 days to seven days (a 15 day reduction), and reduces the lead time for Part 400 from 19 days to four days.

 

Using the factors to determine buffer sizes

 

The following factors should go into determining the calculated buffer sizes:

  1. Average daily usage (ADU)
  2. Variability in supply and demand
  3. Lead time
  4. Lead time factor (based on whether the lead time is—in relative terms for your business situation—long, medium or short)

 

In another article in the near future, we will discuss the mechanics of how we recommend these factors be applied. For the present, suffice it to say, in order for a truly strategic assessment of inventory investments, your enterprise must have set policies that determine what the average on-hand inventory for each SKUL will be. Furthermore, the four factors listed above should be components of that calculation. Additional essential components would be the length of the replenishment cycle and the reorder point.

 

By employing these factors in a consistent way, we can determine the following for our strategically estimated stock positions for Parts 50, 100, 200, 300 and 400.

 

The strategic calculation and balance

 

If, in our example above, we assume that we must stock Parts 300 and 400, because the customer tolerance time is less than 7 days and 4 days (MLT), respectively, for these SKULs, then we can begin to strategically compare the before and after buffer sizes and resulting average on-hand quantities based on placing buffers at the decoupling points (i.e., Parts 50 and 200).

 

Here is a summary of the strategic inventory calculation:

 

 

Part No. 50

Part No. 200

Part No. 300

Part No. 400

Lead Time BEFORE

7

5

22

19

Lead Time AFTER

7

5

7

4

Avg Qty On-Hand BEFORE

0

0

1,056

628

Avg Qty On-Hand AFTER

676

387

336

132

Unit Cost

$125

$89

$575

$355

Avg Inventory $ BEFORE

$0

$0

$607,200

$222,940

Avg Inventory $ AFTER

$84,500

$34,443

$193,200

$46,860

Net Change in Inventory $

$84,500

$34,443

($414,000)

($176,080)

 

The calculations in the table above assume that all other factors remain unchanged between the BEFORE and AFTER estimates, including lead-time factors, variability factors, average daily usage, and unit cost.

 

The calculated NET CHANGE in inventory for placing inventory buffers on Parts 50 and 200 would be a REDUCTION in inventory investment of $471,137. Taking action to add about $120,000 in inventory on Parts 50 and 200 decouples and compresses lead times on Parts 300 and 400. Since their buffers now need to cover fewer lead-time days, their dollar investment in inventory can be dramatically reduced—by nearly $600,000 ($590,080).

 

Any such reduction in inventory investment provides immediate benefits to cash-flow and longer-term benefits in terms of improved return on investment.

 

We call that becoming really strategic about your inventory investment in your supply chain. No more generic statements about needing to carry more of this, and less of that, based on seat-of-the-pants assessments. Instead, there can be real and effective logic driving decisions about which specific SKUs to stock at what levels and why.

 

If you would like to see the details of the calculations underlying such strategic inventory investments, please feel free to contact us.

 

How do you calculate your inventory investment dollars while protecting customer service levels? Let us know.

So, what is a matrix bill of materials, and why is it important?

 

A matrix bill of materials, or matrix BOM, is typically presented as a grid with produced items across the top of the grid and raw materials as row headings. See the accompanying figure for an example.DDMRP MatrixBillOfMaterials.jpg

 

A ‘1’ or a hash mark in the grid at the intersection of the raw material (row) and produced item (column) indicates that the raw material is a component in the correlated finished good. The raw material may be a component at any level in the BOM for the finished good—not necessarily only in level 1.

 

Why is a matrix BOM an important tool?

 

While “tribal knowledge” within your organization can likely identify those inventory items that are used in lots of end-items, tribal knowledge is probably less clear on precisely which end-items are correlated to which raw materials. The specifics are more difficult to pinpoint than are the generalities.

 

However, in order to calculate with reasonable accuracy the return-on-investment (ROI) value of stocking specific quantities of any given raw material, it is essential to know, not only how many finished goods are affected, but also which finished goods are affected. After all, not all finished goods are created equal. Some finished goods are more profitable than others; some finished goods have greater demand than others; some finished goods have shorter customer tolerance times than others; and, some finished goods have greater variability in demand than others. All of these factors play into calculating the ROI of carrying specific supporting inventories.

 

Leverage points

 

A glance at the accompanying excerpt from a matrix BOM tells us at once that raw material items ‘RTX’ and ‘B5C’ are consumed in the production of eight (8) different end-items. When seeking to maximize the ROI on your inventory investment dollar, carefully evaluating the impact of inventories of raw materials beginning with those that affect the greatest number of end-items and / or largest demand is an excellent place to start. The matrix BOM gives you a clear picture of the order in which to begin your evaluation for maximizing the leverage of your inventory investment dollars.

 

Many systems do not offer a matrix bill of materials out-of-the-box. Nevertheless, with many databases, it is not too difficult to produce one. The figure shown was produced from a Sage 500 ERP system using a Transact-SQL data view using the with cube function, and a Microsoft® Excel™ spreadsheet, where the pivot table capabilities were employed.

 

Please leave your comments or questions below. Do you have a matrix bill of materials available to you? How do you leverage your inventory investment dollar to maximize your ROI?

There only two KPIs (key performance indicators) that are of any significance when measuring the performance of your inventory and supply chain as a system:Supply Chain Strategy.jpg

  1. Return on investment (ROI)
  2. Due-date performance

 

If these two numbers are good, chances are your company is doing well—quite well, perhaps.

 

If either of these two KPIs is in a bad state, then there is a good likelihood that your company is doing poorly—perhaps, very poorly. And, there is also a pretty good chance that you’re on a bit of a downhill slide, too.

 

On the other hand, if your enterprise is like most, chances are these numbers are mediocre. ROI goes up and down a bit, typically reflective of whether you’ve been having good or bad due-date performance over the last several months.

 

Everybody thinks their inventory is strategic

 

Ask any CFO or CEO whether their inventory investment is “strategic,” and they will almost certainly answer with a resounding, “Yes!”

 

Ask them why and how they define the strategy that underwrites their investment of $100 million in inventory, and you will almost certainly find them talking in broad generalities about how “without inventory, we just couldn’t do business.”

 

“Like everyone else in our industry, our supply chains (or manufacturing lead times) are just too long for us to operate as a make-to-order business,” they will say.

 

And, at the highest level, when painted with the broadest possible brush, these executives are 100 percent correct.

 

Digging a little deeper

 

Now, let us imagine a scenario where the inventory investment for a given firm has ranged from $880,937 to $1,263,923 over the last 24 months. This places their average inventory investment at roughly $1.1 million.

 

Let’s ask the CFO this question: “Since you claim your inventory investment is ‘strategic,’ by what strategy did you arrive at the determination that $1.1 million is the proper amount to be invested in your inventory—on average?”

 

What do you think he will say?

 

Here are some possible answers:

  • “Well, we didn’t actually arrive at that number by any strategic calculation. That’s just what it happens to be, and we seem to be doing okay.”
  • “Actually, we believe the strategically correct investment in inventory should be closer to $750,000, but we can’t seem to get there without suffering huge losses in due-date performance.”
  • “Uh. We don’t actually have a strategy by which to calculate the amount of money we should have tied up in inventory; we just know that some level of investment in inventory is necessary for our business to survive.”

Here’s the next test: ask the CEO the same question in the same company. What are the odds, do you think, of his or her giving the same answer as the CFO you just questioned?

 

Did I hear you say, “Almost zero”?

 

Deeper still

 

Okay. Let’s give these executives the benefit of the doubt. We will assume that they actually have some rational answer about their gross inventory average value. They have actually put some thought into the question and they are trying to manage to a strategic inventory value.

 

Now, let us imagine that we ask them this:

 

We note that you have had, on average, $D invested in Product 501P over the last 24 months. For the most part, that investment has been pretty steady—not varying by more than seven to ten percent. Tell us: how did you determine that the strategically correct investment in 501P for your inventory was $D?

 

Be honest with me: what do you think the response will be?

 

I am betting that in more than 95 percent of companies, no one in the organization will be able to tell us by what strategy they arrived at the $D they presently have invested in Product 501P.

 

There is a high likelihood that someone picked a quantity at some time in the past and that quantity became the basis for incremental adjustments ever since.

 

Not strategic

 

Note that I said someone picked a quantity—not a dollar value. Furthermore, I would be almost certain that the number of dollars invested in that quantity was not strategically balanced against the costs or benefits of carrying that inventory.

 

If you are picking quantities for inventory with consideration of the dollar-impact of that investment, then I can almost certainly assure you that your investment in the resulting inventory has not strategy behind. There are only the tactics of trying to see to the immediate impacts of day-to-day operations.

 

We believe that the leading cause for lack of strategic inventory analyses is the lack of good data to support sound strategic decisions about inventory.

 

Essential data for any strategic inventory calculations

 

In order to start getting strategic about inventory, certain information must be known (with reasonable accuracy) about your SKUs:

  1. Average daily usage (actual demand)
  2. Lead time
  3. Demand variability
  4. Supply variability
  5. Minimum order quantities and multiples, if any
  6. Relationships between SKUs (e.g., bills of material, kit assembly requirements, product affinities)
  7. Unit cost
  8. Customer tolerance time

 

Inventory is only strategic when it does all three of the following things:

  1. Absorbs variability (demand, supply or both)
  2. Decouples lead times
  3. Provides real (calculable) ROI

 

We talk more about make your inventory truly strategic in our next article. Stay tuned.

 

In the meantime, leave your comments here. How would your CEO, CFO and supply chain managers answer the questions we posed above?

Recently, one of the founders of the Demand Driven Institute (DDI), Chad Smith, allowed me to ask him a few questions. I was interested to know more about the path that led DDMRP_title_block.jpgChad to the founding of DDI.

 

What he told me is fascinating:

 

I got my start in Supply Chain in 1995, working for Dr. Eli Goldratt author of The Goal.  I was on my way to law school but got sidetracked, distracted and enamored by what he was doing with organizations.


In 1997, when he retired from the Goldratt Institute, I founded a consulting company called Constraints Management Group with some like-minded and very talented people.  We each had very complementary but different skill-sets and we immediately picked up significant consulting opportunities with larger mid-range manufacturers ($250M - $1B).  We sold them on implementing methods primarily focused on the Theory of Constraints, but when they said, “yes” we were like, “OK, now what?” 


We had to figure it out.  These methods had never really been fully implemented at the scale at which we were dealing.  One of the things we constantly fought against was the planning system. 


If you plan to the wrong demand signal, no matter how fast you make the floor move, you simply run the risk of making the wrong things faster.  Additionally, in large complex manufacturing, we had to find a way to compress lead times without holding massive amounts of inventory.


Through the early 2000s we were able to articulate the methods through four key accounts and diverse environments.  Those accounts were:

 

We were actually able to create a piece of software that embodied these methods.  You think you know something?  Write software for it and you will find out how much you do not know.


I had a friend that was in Strategic Account sales for Infor.  I showed him a presentation called “Beyond MRP” and then showed him the software. He actually said (I’ll never forget it), “I don’t know if you were just lucky, or if you meant to do this, but I sell six different ERP products and none of them can do anything like this.”


That got me thinking that maybe the potential application of the method was much broader than I thought.  I reached out to the most knowledgeable person I knew on MRP, Carol Ptak.  I had known Carol since the late 1990s, and she happened to live close to me.  I showed her the method and how it would work in software.  She got excited, and then I got excited.  We decided to write about it and see if we could better articulate it for the planning community.  We wrote our first article and, on a whim, sent it off to APICS Magazine.  Ninety minutes later we had a response, “Can please condense this a bit, it will appear in the July-August 2008 edition.”


We condensed and they published.  What we did not know is that it would be the cover article under the title, “Brilliant Vision.”  APICS told us the response to article was great. Could we do a webinar?  Sure!  We did and 250 companies showed up!  This is when we knew that we had something.  Then McGraw-Hill came to us and asked us if we would like to write the third edition of Orlicky’s Materials Requirements Planning


Are you kidding?  Of course! Most of the rewrite is about conventional MRP, but about quarter of the 562-page book introduces the method that we came to call Demand Driven MRP (DDMRP), and why it is necessary in today’s more complex and volatile environments.


As we were preparing the manuscript, we knew that people, after reading the book, would want to know more about this method.  Furthermore, we felt that some might try to bastardize or try to shoehorn it into something it wasn’t.  Finally, we knew we had to continue researching and articulating.


We wanted to establish an entity that could plant a flag in the ground, advance the DDMRP method, keep it rooted it practical application and create a global consistent standard.  Thus, we founded the Demand Driven Institute in March of 2011 just before the release of the third edition of Orlicky’s Material Requirements Planning.


So, while DDMRP and DDI have deep roots in Theory of Constraints, they are also firmly grounded in the essential elements of traditional MRP. Joe Orlicky’s original tome on MRP—the first edition of Orlicky’s Material Requirements Planning—laid the groundwork for all of the theoretical and practical elements for traditional and conventional MRP. Now, in today’s much different global economy and global supply chains, Demand Driven Institute has taken upon itself the challenges of setting and maintaining the standards that will carry DDMRP (demand driven MRP) well into the future.

 

Tell us about your experiences with traditional MRP—the good, the bad, and the ugly. Also, let us know if you have tried to implement any of the methods associated with DDMRP. We look forward to hearing from you.