Smoothing Customer Demand: Lean Manufacturing Topic of the Day

Variability of demand causes manufacturers a myriad of problems:   Idle time, and overtime;   excess inventory, missed deliveries, and missed sales; idle equipment and overloaded equipment; and the huge hidden cost of complexity.

In a previous posts we discussed some strategies and tactics to compensate for variable demand.
Now we will discuss some of the causes for variability of customer demand, and some techniques to help level it.

Variability of demand can be sorted into two broad categories:   1) those things over which we have some control, and   2) those things that are typically beyond our control.

Some examples of things that can have a significant impact on demand, but are mainly out of our control include:
• Natural disasters:   e.g. Katrina caused huge swings in demand for housing and related items.   Draughts, Floods, Disease (impact on crops, and people), etc.   Such disasters can be national, regional, or local (e.g. a fire at your customer’s plant.)
• National / Religious Holidays:   e.g. Christmas accounts for the vast majority of toy sales in the USA.   It comes once a year, and always in December!
• Price / wage controls, taxes, regulations, and other government intervention that significantly change consumer or public sector demand.
• Wars / civil disruption (riots, embargoes, conflicts, etc.)
• Hoarding (fear of a coming crisis):   Many years ago, comedian Johnny Carson made a joke that there was a shortage of toilet paper.   The next day, there actually WAS a shortage as people grabbed it off the shelves!

For such things over which we have little or no control, mitigating strategies focus on production flexibility: the “Rubber Factory” for flexible capacity, methods and material standardization, vertical integration, cross training, utilities self sufficiency (internal alternate energy sources, water storage, etc.), and the development of a robust, responsive, flexible supplier base.

factors beyond your control

For seasonal items, the strategy includes seeking out and developing counter cyclical products and markets that can be served with your existing plant and equipment.   A toy manufacturer client of ours produced predominantly injection molded parts.   Their workforce had historically gone from 90 employees to 900 employees every year!
We worked with them to find “summer season” products that could utilize their molding equipment and assembly capability.   By adding beach toys, sporting goods, Easter baskets and such, they were able to smooth their production considerably.

Now, Let’s Look at Some Things Over Which we DO Have Some Control

  • Column Pricing, Minimum Order Quantities, “Set-Up” Fees, etc.

    Column pricing is the common practice of providing discounted unit prices based on the volume of purchase.   Buy 5 and the price is $1.00/each.   Buy 100 and the price is $0.90/each, etc.

    Minimum order quantities, and “set-up” fees have a similar effect, making the unit cost less for larger volume purchases.

    These are all parameters that WE control.   And each of these tactics is specifically put in place to encourage lumpy demand!   We choose to save a set-up, so we encourage the customer to order and take delivery of a large quantity, all at one time.

    But do we adequately account for the hidden costs of this lumpy demand?

    Does tying up the machine for an extended run, cause your lead times to be long?   Do long lead times (lack of responsiveness) affect your competitiveness, i.e. your price and/or market share?

    Do you lose any business to agile competitors that can more effectively serve small orders?

    Do you occasionally turn down / lose a lucrative order because the machine is already tied up on a long run?

    How often do you “break into” a set-up to serve your “A” customer, thereby nullifying the planned savings?

    Do you occasionally run a large lot size, but then hold a portion of the inventory until your customer is ready for it?   If so, just how much is that inventory really costing you?

    Causes of Lumpy Demand

    Obviously, we’d like to encourage more sales.   And, offering price discounts based on volume is an excellent incentive.   The solution, however, is to reward ANNUAL VOLUME, and not require the customer to take delivery of large quantities at any one time.

    One way to secure a loyal customer is to get him “hooked” on your speed and delivery reliability.   Take unit price out of the decision process by rewarding annual purchase volume, while providing the convenience and cost savings of quick, reliable, just-in-time delivery.

    The critical skill set is obvious, but not easy.   It is AGILITY.   The ability to cost-effectively and quickly make small quantities, i.e. “just what the customer wants, just when he/she wants it.”

    Mitigating tools, techniques, and tactics are explained in our “Lean Tools” articles.   The most obvious are SMED (quick change-over), 5S (area organization), Cross Training, Standardization, and increasing the availability of your people and equipment.

  • Poor Reliability (late shipments), Excessive or Fluctuating Lead Times:  
    Forces the customer to order extra “Just In Case” inventory and carry extra inventory on their own shelves.   They will also ask for it earlier than needed.   In extreme cases they will even over order, and even double order.   Obviously, this eventually leads to push-outs, pull-ins, and cancelations.

    These guys are always late

    Set goals to significantly cut your lead times.   And, embrace a corporate culture of “On-Time, All the Time.”

  • Threat of a Strike:   Your customer is forced to build inventory in anticipation of a potential strike.   And then deplete inventory, even if the strike is averted.

    You are similarly forced to build and deplete inventory if your key suppliers are union shops.   And, of course, you have even more difficulty anticipating a “wild cat” strike that can occur with little or no warning.
    The solutions are difficult, but extremely important.   They should be strategic in nature.

    If you are not already unionized, take all necessary pro-active steps to remain that way.

    And a key selection criteria for supplier evaluation should be union status.   Select non-union suppliers whenever possible.
    Your company is on the other side of this risk when your “A” customers are union shops.

    Every time your customer is nearing the end of its’ current union contract, he will be increasing his orders so that they can build inventory ahead for a strike contingency.

    Then, regardless of whether there is a strike or not, their orders will fall off dramatically after the strike date as they attempt to reduce their inventory.

    customer strike

    A similar threat exists due to the potential of a Transportation Strike (trucking, rail, ocean freight, UPS, etc.)

    Make sure that this potential interruption of supply is considered when you do your make – buy decisions, as well as when selecting suppliers and transportation service providers .   It should certainly be a factor when looking at foreign suppliers.
    Bottom Line:   Stay local / domestic if you can.   And, develop alternate sources and alternate transportation methods for any “at risk” suppliers.   Make sure that any of these advantages that you have, as a supplier, are emphasized to your customers as well.

    And, your long range strategic planning should consider the union situation of your “A” customers.   It may well impact your “target market” plans as well.   Extended strikes have destroyed suppliers before, and they will do it again.   Be prepared.

    You will also want to seek out alternate shipping methods as a means to protect your own customers.

  • Transportation Constraints:   Sometimes it isn’t your pricing that drives large, infrequent purchases (i.e. lumpy demand).   It is the freight costs.

    The difference between truckload and LTL (Less Than Truckload) freight costs can be substantial. And it is also a burden on your customer: inventory carrying costs, space tied up, etc.

    One method that I used in my own factory, for purchased material, was the “piggy-backing” with another local user of material from the same supplier.   We would coordinate our delivery schedule, when possible, so as to combine our orders for a full truck load shipment thereby saving us both a substantial amount of freight cost.

    Try working with local transportation companies.   See if there are opportunities to provide similar services for your customers.
    Milk Runs may provide another useful alternative.

    Milk Run

    The idea is to run a circuit, where applicable.   This method may allow you to drop off material at customer sites as well as pickup material from suppliers, on a regular frequent basis.   You can utilize your own fleet, or negotiate a similar service with a freight company.

    You might also want to take a look at your standard packaging options.   Some folks dislike buying at Sam’s Club because the quantities are so large.   Make sure you provide the option for small order purchases and reasonably priced shipping alternatives.

  • Customer Internal Issues:   Often, the issues that are driving lumpy demand are internal to your customer:
    • Purchasing people are overloaded, or your product is classified as a “C” class (nuisance) item
    • Buyers are measured and rewarded incorrectly
    • The customer’s transaction costs are excessive
    • Freight costs encourage large shipments
    • De-trashing your packaging materials costs your customer money
    • Corporate policy or mandates inhibit progress
    • Your customer is just plain screwed up, etc.

    customer internal issues

    A typical measurement for buyers is Purchase Price Variance, PPV.   PPV rewards purchasing people for procuring material at favorable prices (compared to standards or historical prices).

    While the idea of PPV sounds reasonable, it has a major shortcoming.   It ignores all of the other costs associated with a purchased item:   Transaction costs,   Freight,   De-trashing (getting rid of packaging material),   Receiving,   Receiving inspection,   Stocking,   Record keeping,   Kitting (pulling the material from stock),   Shrinkage,   Risk of obsolescence,   …

    A more appropriate measurement is the “Total Cost of Purchase” which attempts to provide for the above expenses.

    Similarly, a standard material planning technique is to classify purchased items into “A, B, C” categories based upon extended annual purchase dollars.   The logic is to minimize the transaction costs and the “hassle factor” by carrying a pile of the cheap “C” class items.   This typically results in large, infrequent buys (i.e. lumpy demand upon you, the supplier).
    This same action results when the buyers are overloaded.   When pushed for time, the tendency is to increase the purchase amount so as to reduce the purchasing effort.

    Corporate mandates can also be an issue:   “You must buy from specific vendors,”   “You must use this freight line,”   “You must have multiple sources for each item,”   etc.

    Another disruptive practice is the “annual plant shutdown.”   Once again, the logic behind the practice sounds reasonable.   This is the scheduling of pretty much a complete plant shut down, typically, for a two week period.   The idea is to get all employee vacation time taken care of so that we can have full crews for the rest of the year.

    In actual practice, this philosophy results in scrambling to get customer forecasts, working overtime to fill the anticipated demand prior to the shutdown, excess inventory (items made in anticipation, but not taken) following the shutdown, and quite often at least a partial crew working during the shutdown to fill critical customer requirements.

    The Lean Manufacturing philosophy is to produce just what the customer wants, just when he/she wants it.   An annual shutdown makes that impossible.

    And then there is the corporate policy, in some industries, to pre-announce price increases.   This policy has resulted in some of the most extreme “boom / bust” order patterns that we’ve seen!   Customers stock up inventory prior to the price increase, and then stop ordering for weeks or months afterward while they use up their inventory.

    Overtime is used to fulfill demand prior to the price increase, and idle time is absorbed afterward.   Pure, self-inflicted, pain!   If you feel that you must announce something, announce that you will no longer pre-announce price changes!

    Accounting games can also generate a similar feast / famine syndrome: Your customer depletes inventory at the end of the quarter, and then re-builds it right after the books close!

    Occasionally, the customer’s procurement department truly doesn’t know what it is doing!   You know who I’m talking about.   They’re the ones that are constantly complaining, jerking you about, canceling and expediting orders, paying late, etc.

    If you can’t fix them, consider getting rid of these disruptive customers, or at least significantly raising their prices.   Activity Based Costing (ABC) techniques might well show that you are actually losing money on them.

    tactics to smooth customer demand

  • Tactics to Smooth Customer Caused Demand Surges:
    The first step is to approach the issue with the appropriate level of the customer’s management team;   This may be the Head of Purchasing, the Materials Manager, the VP of Operations, or the CEO.

    In this circumstance, a good Lean Manufacturing Consultant can play a key role.   Educating the customer requires some tact.   It is generally “better received” when introduced by an independent third party.   This is particularly true when addressing potentially politically charged topics like measurement and reward systems, end of quarter syndrome, and policy issues.

    We generally emphasize the benefits that both parties will receive if they implement a lean philosophy, and the appropriate specific lean techniques:   Reduced lead times, lower inventory, reduced administrative costs, etc.

  • The overall objective is to make it extremely easy for your customer to buy from you.

    Reduce the customer’s procurement effort through the use of blanket orders, annual agreement pricing, simple replenishment systems (kanban, min-max), vendor managed inventory, etc.

    Reduce their administrative costs via vendor stocking programs, backflush, pay on shipment, consignment, etc. and simplify their verification process (receipt of material) and accounting systems.

    Get certified for Dock to Stock (the approval to bypass receiving inspection).   Then pursue customer authorization to ship to their point of use.
    Joint participation with your customer on product enhancement efforts and new product design can provide for product simplification.   And a focus on packaging / de-trashing costs can lead to returnable packaging, re-usable packaging (by your company or by the customer), or even packaging that becomes an integral part of your customer’s final product.

    Don’t wait for the customer to initiate such discussions.   Find the appropriate person and start the dialogue now.

    In some circumstances, a viable solution that eliminates both packaging and freight is to literally rent space at the customer’s factory and produce your product on-site.   The classical example is the bottle plant that feeds the appropriate bottles through a “hole in the wall” directly to the filling machine at their customers site.

    You’ll note that such an arrangement makes changing suppliers extremely difficult (you have a “customer for life”)!

    While the above discussion barely touches on the myriad of opportunities to profitably work with your customers, we hope that it will stimulate some actions to smooth your demand curve.

    If you would like to discuss the applicability of these, and other techniques, just 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.”

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