A “Make to Stock” company carries finished goods inventory in anticipation of an order. Most such make-to-stock companies promise “off the shelf” shipment: typically either “same day” or “next day.”
The problem, of course, is guessing what, and how much, of each SKU (stock keeping unit, i.e. part number) to keep on hand. Guess too high and you tie up cash and space and also increase your risk of obsolescence.
Guess too low and you may lose a sale because you cannot fill the demand.
There are four primary factors that influence the amount of finished goods carried by a Make to Stock company.
Replenishment time: (your internal lead time) We must carry enough stock to cover the variability of our demand over the replenishment time. For example, assume that our lead time to replenish is three weeks, with average demand of 100 units per week. We have scheduled our production at 100 units per week. We would, therefore, need to carry a “safety stock” level of inventory sufficient to cover the historical variability of demand over this three week period.
If, demand can be as high as 600 units over a three week period, and we wish to fill every order, we would need a safety stock level of at least 300 units (600 unit demand, less the 300 units on order).
The longer the replenishment time, the greater the level of inventory required to achieve the desired service level.
Production Lot Size: If our planned production lot size exceeds the typical order quantity, some amount of finished goods will remain in stock between deliveries.
Let’s assume that our average shipping rate is 100 units per week, and our production lot size is 400 units. On average, we would have 300 units left over when our production lot arrives. These would last for approximately four weeks and obviously effect our level of finished goods inventory. Note that “Order Point” is more thoroughly explained and illustrated in our “Lean Toolkit” article.
The greater the lot sizes, the greater the resulting average inventory level.
Production Reliability (on-time completions): We mentioned, above, a “safety stock” factor. But safety stock needs to consider not only variability of demand, but also reliability of supply.
To continue with our example, we have three weekly deliveries scheduled, 100/week. But what if our reliability of supply (on-time completions) is only 50%? Safety stocks must also attempt to cover for un-reliable supply.
The poorer the reliability of on-time completions, the greater the level of finished goods inventory required to assure the targeted service level.
And, Variability of Demand: Obviously, the amount of inventory required to avoid a stock-out is considerably less if demand varies from 90 to 110 every week, vs, varying from 0 to 300 per week. There are many components that cause variability of customer demand. Some of those components are within our control. Others are controlled by the customer and the marketplace.
What does it take to become a predominantly “Make to Order” company?
It requires: Speed, Flexibility, and Reliability!
Speed is attained by cutting your internal lead times. And, since there is a direct correlation between lead time and Work In Process (WIP) inventory level, reducing WIP becomes a primary focus.
For many companies, the level of WIP is a direct function of our planned lead times and our planned lot sizes (the parameters found in our ERP system). If your company actually uses these parameters to release work to the floor, then these WIP levels are “self fulfilling.”
For example, if we plan on a four week process (planned lead time), the system will suggest that we start the product four weeks before the planned completion date. We will, therefore, have four weeks of other stuff in WIP in front of this order, and it will take about four weeks to work its’ way through the process.
Lot sizes have a similar effect by clogging the WIP pipeline. Lot sizes effect “speed” through the process. This is one place where flexibility is at a premium. You will need the ability to cost effectively produce in small batch sizes.
And, one of the worst offenders is a failure to execute the plan, i.e. a lack of production schedule reliability. By that, I mean not hitting the due dates, splitting orders, expediting, etc.
A typical first step in the lean transformation is an aggressive focus on cutting the amount of WIP and on hitting credible due dates. In a lot of companies this requires a prior step to address order promising so that the internal schedules are, indeed, doable, i.e. there is a reasonable probability that the required raw material and internal capacity will be available.
Once the promise dates are credible, the focus on cutting WIP will generally require:
1) Cut Lead times in the system.
2) Challenge all lot sizing rules (they are generally larger than justified based on actual total costs).
3) Instill discipline to start jobs on time. Not early, and not late.
4) Focus, and measure, internal performance on hitting the due dates.
Note: In many environments there are obvious places where a kanban system will be applicable, and kanbans are generally a preferred scheduling method. Form inter-unit teams and help them set goals to reduce the inter-unit WIP (i.e. continually reduce the inter-unit kanban sizes).
Even in these circumstances it is often wise to focus, first, on improving the parameters and disciplines of the current scheduling system. The reason is that this approach can deliver some quick sizable global gains, i.e. the “low hanging fruit,” by freeing up cash and space.
Step Two is to get reliable. Hit the internal and external due dates.
This will often demand a new operating philosophy: “The day ends when the schedule is done, NOT the other way around” and will also likely require additional capacity flexibility.
Many factors are taken into account when determining the appropriate level of finished goods for a make-to-stock item. As discussed above, three key considerations are “Replenishment Time,” “Lot Size,” and “Reliability of Delivery” (on-time completions).
A reduced lead time, reduced lot sizes, and improved reliability (i.e. hitting our internal completion dates), allows us to reduce our Finished Goods levels and still attain the required off-the-shelf delivery performance.
Note that cutting Finished Goods is almost always a significant net cash generator. Make sure that some of this cash is reserved to resolve the “rocks” (problems) that will surely be uncovered. An investment in SMED (quick set-up for your equipment) may be required to further cut WIP by reducing your set-up costs and lot sizes.
At this stage, many companies can begin to transition from make-to-stock to Assemble-to-Order.
A producer of high pressure valves and fittings client of ours had been a make-to-stock producer. They had over $600,000 of assembled valves in finished goods inventory.
The “value-add” time to assemble and test their product was only a matter of 5-10 minutes. We initiated an effort to move to assemble to order.
Within a few weeks of initiating the effort, the new policy was “any order received by 12:00 noon, was assembled and tested to order and shipped the same day.” After another month, the cut-off was pushed out to 2:00 PM!
All component machined parts were put on min-max control while we moved the focus to further reducing machined parts replenishment times and lot sizes. Lead times were quickly cut from eight weeks to two. We eventually got the machined parts replenishment lead times to five days.
The entire $600,000 finished goods inventory was eliminated, and, as machined parts lead times and lot sizes were reduced, and schedule reliability increased, the inventory of machined parts was cut by 75%. On time delivery was over 98%.
Their customers were pleased with the faster and more reliable delivery.
Our client was also thrilled. Lower costs, higher quality, and considerably higher margins!
Another client of ours produced corrugated containers. Our client had a request from their primary large customer to have a few pallets of each of several SKU’s ready for pickup at 7:00 AM every morning.
The customer would pick up a pallet or two several times during the day. They would do this up until 5:00 PM.
By adjusting the corrugator scheduler’s hours, reducing our change-over costs, cross training operators, and providing some flexible capacity, we were able to replenish any item that was needed overnight. We utilized kanban controls and make-to-order capability to serve a key customer with minimal planning required.
A modification of “Assemble to Order” can be applicable in some process industries. Another client had a steel finishing plant. They quoted a two day lead time to pick and ship packaged coils from stock.
Often, the identical product was held in inventory but could not be shipped because it had already been packed to a different customer’s specifications (eye to the sky, vs. eye horizontal, paper wrapped vs. plastic, palletized, labeling, etc.).
First we made the transition to pack to order.
We then held the common gauges wide, and slit and packed to order.
After a few months we were able to hold wide and do the finish pass to final gauge, slit, cut to length, and pack to order, all within two days from receipt of order!
Even if you fail to get all the way to “Make to Order,” the above steps will allow for the dramatic reduction of finished goods while maintaining or improving your fill rate.
In the case of the steel finishing plant, an entire external finished goods warehouse was eliminated.
A client of ours made customized engraved products. After going through all of the above steps, including radically streamlining the entire order entry process, a heretofore two-week lead time product was ultimately reduced to same day. Orders were received, entered, downloaded to engraving, and produced. Total elapsed time from receipt of order until packed and waiting UPS pickup: Four Hours!
Once you have made the final step in the transition to Make to Order, it may be possible to eliminate an entire category of non-value adding activities; e.g. releasing, tracking, and closing items to Work in Process!
Now that the time that a product spends in WIP has been dramatically reduced, you may be able to move to “Backflush” and eliminate the category of WIP entirely. The categories of “raw” and “WIP” are combined into a new category: RIP: Raw and In Process Inventory.
As products ship, the material control system backflushes the raw material and eliminates it from on-hand raw material. A simple example is that of a bicycle plant that makes to order. As a specific model bike ships, the raw material balances are reduced by the entire bill of material for that bicycle: two wheels, one handlebar, one chain, etc.
It is important to note that it is not necessary to move all products to make to order to reap these gains. Apply the concepts where and when you can. Very few make-to-order companies have their entire product offering on make to order. Most still maintain some select products in finished goods.
The next obvious step in the journey towards world class operating performance, is to establish a responsive base of local suppliers and minimize or, in some cases, eliminate raw material.
Many purchased items may be delivered directly to the point of use on the production line. This is particularly true in the automotive industry.
An example is the seats that go into the automobile. They are produced by a local supplier, and will generally be made to order, in the correct sequence so as to match the automaker’s final assembly schedule. They are produced and delivered, just in time, to the appropriate location.
Seats go directly onto the truck from the seat production line, and come off the truck and go directly into the designated auto on the assembly line.
Look at the efficiency gained by this closely linked supply chain. No finished goods of seats at the supplier’s plant. No seats in raw material at the customer’s plants. Each seat is handled once to put it on the truck and once to take it off the truck and put it in the assembly. No stocking and unstocking.
And, the supplier is paid based on the auto assembler’s completions. “We made 100 Mustangs. We must have used 200 front bucket seats, and 100 rear seats!” Backflush is extended back to the supplier’s payables.
Needless to say, the actual work required to make this very desirable transition from make-to-stock to make-to-order is extensive. The good news is that the transition, if done correctly, is almost always more than self funding.
We can help. Drop us a note or give us a call. There is no charge, and I can guarantee that you’ll find the time “value adding.”