PURCHASING & SUPPLY CHAIN MANAGEMENT, 4e

Lean Supply Chain

Management
Chapter 16

CENGAGE LEARNING
Monczka – Handfield – Giunipero – Patterson
 Chapter Overview

 Understanding supply chain inventory

 The right reasons for investing in
inventory
 The wrong reasons for investing in
inventory

Purchasing & Supply Chain Management, 4e

2
 Chapter Overview

 Creating the lean supply chain

 Approaches for managing inventory
investment
 Delivering the perfect customer order

Purchasing & Supply Chain Management, 4e

3
 Inventory Management

 Efficient and effective inventory

management is imperative to global
competitiveness
 Inventory management also applies to
non-manufacturing industries

Purchasing & Supply Chain Management, 4e

4
 High Levels of Inventory

 Result in
 High carrying costs
 Reduced profit
 Diminished market share
 Hide other problems
 Poor material quality
 Inaccurate demand forecasting systems
 Unreliable supplier delivery

Purchasing & Supply Chain Management, 4e

5
 Lean

 Lean – a philosophy that seeks to

shorten the time between when the
customer order and the shipment to the
customer by eliminating waste
 Objectives of lean
 Flow
 Pull
 Striving for excellence

Purchasing & Supply Chain Management, 4e

6
 Lean Objectives

 Flow – inventory moves through the

supply chain continuously with minimal
queuing or non-value-adding activity
being performed
 Pull – the customer order starts the
work process, which ripples down the
supply chain
 Striving for excellence – perfect quality
Purchasing & Supply Chain Management, 4e
7
 Understanding Inventory

 Types of inventory
 Raw material and semi-finished items
 Work-in-process (WIP)
 Finished goods
 Maintenance, repair, and operating
supplies (MRO)
 Pipeline (in-transit)

Purchasing & Supply Chain Management, 4e

8
 Raw and Semi-Finished

 Items purchased from suppliers or

produced internally to directly support
production requirements
 Bulk quantities
 Unfinished condition

Purchasing & Supply Chain Management, 4e

9
 Work-in-Process

 Waiting to be moved to another

process
 Currently being worked on at a work
center
 Lining up at a processing center due to
a capacity bottleneck or machine
breakdown

Purchasing & Supply Chain Management, 4e

10
 Finished Goods

 Completed items
 Available for shipment or future
customer orders
 Environments
 Make-to-stock (MTS)
 Make-to-order (MTO)
 Just-in-time (JIT)

Purchasing & Supply Chain Management, 4e

11
 MRO Supplies

 Used to support production and

operations
 Not physically part of a finished
product
 Critical for continuous operation of
plant, equipment, and offices

Purchasing & Supply Chain Management, 4e

12
 Pipeline and In-Transit

 In transit moving to a customer

 Located throughout the distribution
channel

Purchasing & Supply Chain Management, 4e

13
 Inventory-Related Costs

 Unit costs
 Ordering costs
 Carrying costs
 Quality costs

Purchasing & Supply Chain Management, 4e

14
 Unit Costs

 The price a firm pays for each unit

 The actual costs of making or providing
each unit
 Direct materials
 Direct labor
 Allocated overhead

Purchasing & Supply Chain Management, 4e

15
 Ordering Costs

 Associated with the release of a

material order
 Generating and sending a material
release
 Transportation costs
 Any other cost of acquiring a good
 With internal production, may include
set-up costs
Purchasing & Supply Chain Management, 4e
16
 Carrying Costs

 Cost of capital
 Cost of storage
 Costs of obsolescence, deterioration,
and loss
 Opportunity cost

Purchasing & Supply Chain Management, 4e

17
 Costs of Storage

 Costs related to storage space

 Insurance costs
 Costs of maintaining inventory, i.e.,
cycle counting
 Vary with the level of inventory
 Considered a variable cost

Purchasing & Supply Chain Management, 4e

18
 Inventory Carrying Costs

Element Average Range

Capital cost 15.0% 8 – 40%
Taxes 1.0% 0.5 – 2%
Insurance 0.05% 0 – 2%
Obsolescence 1.2% 0.5 – 2%
Storage 2.0% 0 – 4%
Total 19.25% 9 – 50%

Purchasing & Supply Chain Management, 4e

19
 Calculation of Carrying Cost

Carrying cost = AI x P x ACC

Where:
 AI = average inventory in units
 P = unit price
 ACC = annual carrying cost

Purchasing & Supply Chain Management, 4e

20
 Quality Costs
 Any costs associated with
nonconforming items or goods
 Types
 Field failure costs
 Rework
 Losses due to poor product yields
 Inspection
 Lost production
 Warranty costs
Purchasing & Supply Chain Management, 4e
21
 Determining Quality Costs

 Difficult to quantify
 Historical neglect of calculating total
inventory costs
 Inadequate cost accounting systems not
capable of identifying and assigning true
quality-related costs
 Can use activity-based costing (ABC)
to better determine real costs

Purchasing & Supply Chain Management, 4e

22
 Inventory – Asset or Liability?

 Historically considered a current asset

 Disregarded inventory carrying costs
 Negative impact on cash flow, working
capital requirements, and profitability
 Inventory ≠ Cash and Receivables
 Need to translate real impact on
organization’s financials
 Determine key performance indicators
Purchasing & Supply Chain Management, 4e
23
Linking Inventory and Financials
Firm A Firm B
Sales $200 $200
Profit Margin 6% 7%
Assets
Cash $10 $10
Securities $15 $15
Receivables $ 8 $ 8
Inventory $20 $10
Plant and Equipment $75 $75

Total Assets $128 $118

Inventory turns = Sales / $200 / $20 = 10 turns/year $200 / $10 = 20 turns/year
Inventories

Asset turnover = Sales / $200 / $128 = 1.56 $200 / $118 = 1.69

Total assets turns/year turns/year

ROI = Profit margin x 6% x 1.56 = 9.36% ROI 7% x 1.69 = 11.55% ROI

Asset turnover
 Impact of Inventory Activities

 Determine how inventory management

effects….
 Earnings per share
 Economic value-add
 Return on assets
 Working capital
 Cash flow
 Profit margin

Purchasing & Supply Chain Management, 4e

25
 Right Reasons for Inventory

 Avoid disruptions in operational

performance
 Support operational requirements
 Support customer service requirements
 Hedge against marketplace uncertainty
 Take advantage of order quantity
discounts

Purchasing & Supply Chain Management, 4e

26
 Wrong Reasons for Inventory

 Poor quality and material yield

 Unreliable supplier delivery
 Extended order cycle times from global
sourcing
 Inaccurate or uncertain demand
forecasts

Purchasing & Supply Chain Management, 4e

27
 Wrong Reasons for Inventory

 Specifying custom items for standard

applications
 Extended material pipelines
 Inefficient manufacturing processes

Purchasing & Supply Chain Management, 4e

28
 Creating the Lean Supply Chain

 Just-in-time – a philosophy of
manufacturing based on planned
elimination of all waste and on
continuous improvement of
productivity
 aka as “lean production”

Purchasing & Supply Chain Management, 4e

29
 Elements of JIT

 Have only the required inventory when

needed
 Improve quality to zero defects
 Reduce lead times by reducing setup
times, queue lengths, and lot sizes
 Incrementally revise operations
 Accomplish all of the above at a
minimum cost
Purchasing & Supply Chain Management, 4e
30
 Performance Advantage of JIT

GM Framingham Toyota Takaoka

(non-JIT) (JIT)

Assembly
40.7 hours 16 hours
hours/vehicle

Defects per 100

130 defects 45 defects
vehicles

Average inventory
Two weeks Two hours
levels

Purchasing & Supply Chain Management, 4e

31
 Summary of the JIT Philosophy

 JIT can be applied to a wide range of

production and service environments
 JIT companies can and do use a wide
range of planning and control
techniques, not just kanban
 JIT is closely aligned with TQM and
supplier management initiatives

Purchasing & Supply Chain Management, 4e

32
 JIT and Waste

 Waste – any activity that does not add

value to the good or service in the eyes
of the consumer
 The Eight Wastes

Purchasing & Supply Chain Management, 4e

33
 The Eight Wastes

 Overproduction  Unnecessary
 Waiting inventory
 Unnecessary  Unnecessary or
transportation excess motion
 Inappropriate  Defects
process  Underutilization
of employees

Purchasing & Supply Chain Management, 4e

34
 JIT Example with Inventory

A B C

Manufacturer

= Inventory

Supplier Customer
Purchasing & Supply Chain Management, 4e
35
JIT Example without Inventory

A B C

Manufacturer

Supplier Customer
Purchasing & Supply Chain Management, 4e
36
 JIT Purchasing
 Commitment to zero defects
 Frequent shipments of small lot sizes
according to strict quality and delivery
performance standards
 Closer, even collaborative, buyer-
supplier relationships
 Stable production schedules
 Extensive sharing of information
 Electronic data interchange (EDI)
Purchasing & Supply Chain Management, 4e
37
 Barriers to JIT Purchasing

 Dispersed supply base

 Historical buyer-supplier relationships
 Number of suppliers
 Supplier quality performance

Purchasing & Supply Chain Management, 4e

38
 JIT Transportation

 Efficient movement of goods between

supplier and buyer
 Frequent deliveries of small quantities
 Relies on company-owned or
contracted vehicles on a regular and
repeated schedule (closed loop)

Purchasing & Supply Chain Management, 4e

39
 Keys to JIT Transportation

 Reduce the number of carriers

 Use longer-term contracts
 Establish electronic linkages
 Implement a closed loop system
 Efficiently handle material
 Specialized transport vehicles
 Returnable containers
 Deliver to point-of-use
Purchasing & Supply Chain Management, 4e
40
 JIT Kanban Systems

 Use of simple signaling mechanisms

 Cards or signals
 Synchronization of activities
 Control mechanisms, not planning
tools
 Act as a pull system

Purchasing & Supply Chain Management, 4e

41
 Kanban Methods

 Single card systems

 Color coding of containers
 Designated storage spaces
 Computerized bar coding systems

Purchasing & Supply Chain Management, 4e

42
Three V Model of Inventory

Volume Velocity

Value

Purchasing & Supply Chain Management, 4e

43
 Volume

 Pertains to the amount of physical

inventory a firm owns at a given time
 How much and what types of inventory
do we own?
 Key measures – total units, total
pounds
 Activities affecting volume –
forecasting, consignment inventory
Purchasing & Supply Chain Management, 4e
44
 Value
 Pertains to the unit cost and total dollar
value of the inventory
 What is the unit cost and total value of
the different types of inventory?
 Key measures – total $, period-by-
period unit value changes, ratio of sales
to working capital
 Activities affecting volume –
simplification, standardization, leverage
Purchasing & Supply Chain Management, 4e
45
 Velocity
 Pertains to how quickly inputs become
finished goods that are accepted and
paid for by customers
 How fast do we move inventory toward
the customer?
 Key measures – inventory turns,
throughput, order-to-cash cycle times
 Activities affecting volume – lean
practices, M-T-O production
Purchasing & Supply Chain Management, 4e
46
 Managing Inventory Investment

 Achieve perfect record integrity

 Improve product forecasting
 Standardize and simplify product design
 Leverage companywide purchase
volumes
 Use suppliers for on-site inventory
management
 Reduce supplier – buyer cycle times
Purchasing & Supply Chain Management, 4e
47
Achieving Perfect Record Integrity

 Agreement between electronic records

(ROH) and physical inventory (POH)
 Ideal: ROH = POH
 Any difference equals error

Purchasing & Supply Chain Management, 4e

48
 Questions On Record Integrity

 Are record errors displaying a random

or systematic pattern across SKUs?
 How severe are the differences between
physical stock and electronic records?
 Are proper receiving, stockkeeping, and
withdrawal procedures and systems in
place?
 Is theft a problem?
Purchasing & Supply Chain Management, 4e
49
 Questions On Record Integrity

 Are suppliers shipping quantities that

match their documentation?
 Are effective cycle-counting procedures
used?
 Is inventory in scrap and obsolescence
accounted for correctly?
 Do employees properly move, handle,
and disburse material?
Purchasing & Supply Chain Management, 4e
50
 Downside of Poor Forecasting

 Higher inventory volumes

 Higher inventory carrying charges
 Poor customer service as inventory is
misallocated across locations and
products
 Excessive safety stock levels

Purchasing & Supply Chain Management, 4e

51
Standardization and Simplification

 Fewer part numbers

 Fewer suppliers
 Reduced transactions
 Lower inventory management costs
 Reduced product cost
 Lower inventory levels

Purchasing & Supply Chain Management, 4e

52
Standardization and Simplification

 May require a major organizational

culture shift
 Is a strategic decision
 Requires top management support and
direction regarding complexity and
SKU proliferation
 Is best accomplished during product
design
Purchasing & Supply Chain Management, 4e
53
Standardization and Simplification
 Establish premium pricing for
customization
 Establish geographic-specific options
and standards
 Maintain a database of option requests
 Do not eliminate frequently requested
options
 Utilize business modeling and TCO
tools to support complexity reduction
Purchasing & Supply Chain Management, 4e
54
 Product Design Criteria

 Will the item be sole, single, or multi-

sourced?
 Does the new offering involve a new
technology risk item?
 Who are the manufacturers and who
are the integrators for the parts?
 Where are all the suppliers located and
what is the logistics plan?
Purchasing & Supply Chain Management, 4e
55
 Product Design Criteria

 Where are these parts used in the

industry today and in the future which
could affect overall demand?
 What are the expected cost take-down
rates?
 What does the product roadmap look
like in terms of possible product
substitutes?
Purchasing & Supply Chain Management, 4e
56
 Product Design Criteria

 Are there key alliances that need to be

considered from key suppliers or
competitors?
 What is the flexibility to use a particular
part in other product lines, or is the
part leveraged from another product?
 Can these parts be sold as after-market
options or service parts?
Purchasing & Supply Chain Management, 4e
57
 Leverage Purchase Volumes

 Consolidated volumes  lower costs

 Reduction in capital tied up in
inventory
 Use of supplier-owned consignment
inventory

Purchasing & Supply Chain Management, 4e

58
On-Site Supplier-Managed Inventory

 Use of distributors, particularly for

MRO items
 Assignment of on-site supplier
personnel
 Reduction of paperwork to submit an
order

Purchasing & Supply Chain Management, 4e

59
 Reduced Order Cycle Times

 Expanded electronic capability

 Supplier development support
 Order cycle time measurement
 Focus on second- and third-tier
suppliers
 Result in less safety stock

Purchasing & Supply Chain Management, 4e

60
 The Perfect Customer Order

 On-time, accurately, and in perfect

condition
 Factors
 Supplier delivery problems
 Stock-outs
 Manufacturing delays
 In-transit or delivery delays

Purchasing & Supply Chain Management, 4e

61
 Imperfect Customer Orders

 Inaccurate quantities
 Poor quality of finished goods
 Damage during transit
 Incorrect or missing documentation

Purchasing & Supply Chain Management, 4e

62
Delivering the Perfect Customer Order

 Material requirements planning (MRP)

system
 Distribution requirements planning
(DRP) system
 Supply chain inventory planners
 Automated inventory tracking systems

Purchasing & Supply Chain Management, 4e

63
 MRP System

 Based on independent demand

 Considers period-by-period master
production schedule (MPS)
requirements
 Develops a time-phased set of material,
component, and subassembly
requirements by part number to
support an expected build schedule
Purchasing & Supply Chain Management, 4e
64
 DRP System

 Forecasting finished goods inventory

 Establishing correct inventory levels at
each stocking location
 Determining timing and replenishment
of finished goods inventories
 Allocating items in short supply
 Transportation planning and vehicle
load scheduling
Purchasing & Supply Chain Management, 4e
65
Supply Chain Inventory Planners

 Responsible for managing inventories

regardless of location in the supply
chain
 Use of supply chain planning and
execution systems
 Organized along product lines
 Coordinates movement and placement
of inventory
Purchasing & Supply Chain Management, 4e
66
 Inventory Planner Roles

 Act as liaison between various supply

chain components
 Develop smooth production schedules
 Establish product targets
 Determine inventory deployment at
field warehouses
 Continuously evaluate safety stock
levels
Purchasing & Supply Chain Management, 4e
67
 Automated Tracking Systems

 Involve computerized material and EDI

systems to track inventory throughout
the entire supply chain
 Connect suppliers, production plants,
field distribution centers, and
customers
 Are based on EDI, bar coding, and RFID
technologies
 Provide real-time visibility
Purchasing & Supply Chain Management, 4e
68