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Module 4: Executing the Supply Plan
Module 4 covers execution of the supply plan.

Section A discusses the process of buying the supplies and machinery required for manufacturing
processes. It describes how organizations secure manufacturing materials or equipment, starting with
the basic purchasing process and including selection of criteria and suppliers. It then moves on to
discuss how to execute purchases and measure supplier performance.

Section B discusses the processes involved in the actual manufacturing process and how they are
planned and controlled. It starts by discussing production activity control before moving into a brief
discussion of flow processes and calculating takt time. The section concludes with discussions of
intermittent processes, including schedules, dispatch lists, managing bottlenecks, and input and output
control.
Section A: Buy
After completing this section, students will be able to
Describe the general objectives of purchasing
Identify important criteria for material selection
Differentiate between different types of purchases
Develop criteria to select a supplier
Explain how to negotiate a contract
Describe how to manage the purchasing cycle
Describe how to measure supplier performance.

This section describes how organizations secure manufacturing materials and equipment, starting with
the basic purchasing process and including selection of criteria and suppliers. We then discuss how to
execute purchases and measure supplier performance.

Exhibit 4-1 shows where purchasing fits in manufacturing planning and control.

Exhibit 4-1: Purchasing in Manufacturing Planning and Control

Topic 1: Purchasing Participants and Objectives

Purchasing involves the interaction of an organization and one or more suppliers that provide any
number of items, from raw materials to components to manufacturing equipment. This topic discusses
the various participants, types of purchases, the objectives of purchasing, and how purchasing adds
value to an organization.

Purchasing Participants
Purchasing is not simply buying what is needed from a supplier because the organization cannot or
chooses not to make it itself. Purchasing includes monitoring suppliers to ensure that materials flow to
the organization with the proper timing and that services are performed correctly, following up with and
controlling suppliers as needed, and expediting orders. The APICS Dictionary, 16th edition, defines
purchasing and some related terms as follows:

Supplier: 1) Provider of goods or services. 2) Seller with whom the buyer does business,
as opposed to vendor, which is a generic term referring to all sellers in the marketplace.

Purchasing: The term used in industry and management to denote the function of and
the responsibility for procuring materials, supplies, and services.

Procurement: The business functions of procurement planning, purchasing, inventory

control, traffic, receiving, incoming inspection, and salvage operations.

Physical supply: The movement and storage of goods from suppliers to manufacturing.
The cost of physical supply is ultimately passed on to the customer.

Unlike individual purchasing, industrial purchasing covers a wide variety of needs and consumes a
large percentage of total organizational costs, so it can mean the difference between profitable
organizations and unprofitable ones.

Types of Purchases
From a manufacturing perspective, industrial organizations need to make two major types of
purchases.

The first type is capital expenditures. When new property, plant, and equipment is needed, purchasing
may be involved to help screen providers using a request-for-quote (RFQ) process. (In Europe, this
process is called an invitation to tender [ITT].) Capital items that production and inventory control
professionals may be involved in purchasing on a medium-term basis include new equipment and
information technology hardware and software.

The second major type of purchase is for materials, supplies, and services. Materials that are
purchased are simply called raw materials from an inventory management perspective, but these may
include not only raw materials like lumber or petrochemicals but also purchased components or
subcomponents to be assembled. Purchasing may be involved in the purchase of services, some of
which may be directly applied to add value to products, such as the work of contractors who assemble
products at a distribution center. These services would be considered part of direct labor, or the labor
that can be directly attributed to saleable products.

Materials that are directly used in the products to be sold are called direct materials, while those that
are needed in general are called indirect materials. Services here may include consulting, equipment
repair, or building maintenance, and these would be part of indirect labor (labor that cannot be directly
associated with units produced for sale). Products not directly used in saleable goods are called indirect
materials, or maintenance, repair, and operating (MRO) supplies, or simply supplies. These include
spare parts for manufacturing equipment, lubricating oils, and office supplies. While needed, accounting
cannot directly attribute the cost of these services and items to individual units of product, so the
indirect labor and material costs are put in a general category called overhead. The distinction between
direct and indirect costs is important to the value-added role of purchasing.

Value-Added Role of Purchasing and Other Participants

The purchasing function is considered a key area that can strongly impact profit and loss, because
materials often make up a large percentage of a manufacturing organization’s total costs.

Basically, there are two ways to increase profits. The first is to increase sales, and the second is to
reduce costs.

When sales increase, the cost of direct materials and direct labor and some overhead will increase
proportionately. (Most of the overhead will remain fixed.) The costs directly related to the products sold
in a period—called the cost of goods sold—are summed.

An example here can show how cost reduction in purchasing can leverage greater profits than an
equivalent increase in sales. Assume that an organization sells an item for $10 and each item sold
requires direct materials that cost $5 per unit and direct labor that costs $1 per unit. Let’s assume that
overhead is a fixed cost of $3,000 per month and the organization currently sells 1,000 units per month,
resulting in $10,000 in revenue ($10 × 1,000 units). Exhibit 4-2 shows this as the “as is” state of affairs.
It also shows a pair of “to be” scenarios: a 10 percent sales per month increase versus the same sales
per month with a 10 percent reduction in direct materials (DM) cost.

Exhibit 4-2: Sales Increase Versus Cost Reduction Scenarios

Note that in the “as is” scenario, the direct materials and direct labor per unit costs are also multiplied
by the 1,000 units while the overhead is simply a deduction. This results in gross profit (i.e., profit
before deducting certain other expenses) of $1,000 and a gross profit margin of 10 percent (gross profit
divided by revenue, or $1,000/$10,000).

In the first “to be” scenario, increasing sales by 10 percent per month raises units sold to 1,100 units,
and this increases revenue. However, it likewise increases direct materials and direct labor costs
because selling more units requires more materials and labor. Since overhead does not also increase,
there is an increase in gross profit and gross profit margin.

In the other “to be” scenario, purchasing (or manufacturing) can reduce costs. If sales remain at 1,000
units per month and direct labor and overhead also don’t change, just reducing the direct materials
costs by 10 percent (from $5 per unit to $4.50 per unit) still results in a larger increase in profits and
profit margin. Manufacturing can achieve the same amount of leverage by reducing production costs.
Of course, this can also work in reverse. Any increase in manufacturing or purchasing costs will directly
reduce profits.

This cost reduction profit leverage concept is well understood and has shaped the conventional
objectives of purchasing, but naturally one objective is to relentlessly pursue lower costs. Unintended
consequences of this goal may include tradeoffs in quality, high inventory levels, and/or adversarial
relationships with suppliers. To avoid these consequences, purchasing needs other functions to
participate in the process.

Conventionally, purchasing was thought of as the sole responsibility of the purchasing department.
Often this meant that there was a disconnect between marketing, engineers, and production planners
and their supplier counterparts. Marketing needs to ensure that purchases reflect actual customer
requirements. Engineers need to clearly specify these requirements. Purchasers also need to work
alongside production planners and shop floor personnel to ensure that the right things are received
when they are needed to satisfy demand and that costs for rejects, scrap, rework, and inventory are not
more than the money saved in finding cheaper suppliers or ordering in bulk.

At the very least, clearly defining product specifications has become critical to reducing net costs—as
opposed to lowering costs in one area while increasing them in others. Going a step further, many
organizations have started to collaborate with suppliers on product specifications to help reduce costs
while maintaining the needed form, fit, and function of the materials at the right quality levels.
Purchasing may also be directly involved in fulfilling social mandates for sustainable sourcing.

In addition to adding value by reducing net costs, purchasing may be involved in helping find materials
that are order qualifiers (the material fulfills the minimum requirements for purchase consideration) or
order winners (the material has characteristics that differentiate it from what the competition is offering).
Depending on the customer base and the organizational strategy, this could be a product that can sell
for less than the competition’s actual cost or a grade of material that adds more value than it costs.

Objectives
The objectives of purchasing need to link back to strategic objectives. Low-cost-leader products will
have different priorities than products that are designed to be differentiated in other ways. Keep this in
mind as we discuss purchasing objectives.

Conventional Purchasing Objectives

Conventional purchasing objectives include the following:
Purchase the correct goods and services in the specified quality and quantity.
Purchase goods and services at the lowest total cost to the organization.
Minimize delivery lead times and optimize other aspects of customer service, such as delivery at the
right time and place.

All of these objectives are and will continue to be a high priority at any organization. Ensuring that the
specifications for an order are clear and exact is placed as the primary objective, rather than placing
cost above these considerations. When suppliers can meet the first objective, then the second objective
is pursued, to minimize total cost. Rather than working only to minimize purchase price, purchasing
departments often instead focus on the landed cost or the total cost of ownership. The APICS
Dictionary, 16th edition, defines these terms as follows:

Landed cost: This cost includes the product cost plus the costs of logistics, such as
warehousing, transportation, and handling fees.

Total cost of ownership (TCO): In supply chain management, the total cost of
ownership of the supply delivery system is the sum of all the costs associated with every
activity of the supply stream. The main insight that TCO offers to the supply chain
manager is the understanding that the acquisition cost is often a very small portion of the
total cost of ownership.

Both landed cost and TCO include not only the purchase price but also the transportation cost and the
cost of inventory holding. Total cost of ownership is broader, however, and also includes the cost of
poor quality (rejects, scrap, rework, inspections, etc.) and possibly the cost of end-of-life disposal. Cost
analyses such as these may involve, for example, doing benefit-cost analyses on whether to use a bulk
purchase discount plus the ability to ship in full truckload quantities while also accounting for the
increased inventory holding cost tradeoff or to ship just what is needed in more-expensive partial
truckloads.

The last of the conventional purchasing objectives starts with minimizing delivery lead times. This is the
time from when the order is placed until it is delivered to the organization. Shortening lead times can
help to ensure a more timely response to actual demand so the organization can rely less on
forecasting and its inherent errors. Organizations might decide that this is very important for some
materials while prioritizing low cost for others, which might result in these items being shipped by a
slow, inexpensive method such as ocean cargo ship. Other aspects of customer service might include
how quickly the supplier responds to marketing, engineering, and production planning changes as well
as simply having low rates of errors in deliveries.

Supply Chain Management and Lean Purchasing Objectives

Some additional objectives are now critical in this interconnected world, especially at organizations that
have embraced supply chain management concepts or are invested in lean production:
Invest in partnerships with key suppliers for mutual gain by developing their potential and developing
and maintaining ongoing relationships.
Fulfill organizational corporate social responsibility and sustainability goals by extending these
policies to supplier selection and purchases.

A core concept of supply chain management is that the total cost of ownership extends beyond the
walls of the organization. An entire supply chain’s total costs and total value added are reflected in the
final price and value to the consumer. Based on this way of thinking, pursuing cost reductions to the
point where a supplier goes out of business or reduces quality will be a net loss for all participants.
While not every supplier can or should become a trusted partner, organizations are now pursuing these
partnerships to reduce costs over the long term, such as by not needing to inspect incoming shipments
due to high quality. Lean production systems depend on having a few long-term relationships with
dependable suppliers to get perfect quality materials delivered just in time. This is sometimes called
dock-to-stock, which is defined in the Dictionary as follows:

A program through which specific quality and packaging requirements are met before the
product is released. Prequalified product is shipped directly into the customer’s inventory.
Dock-to-stock eliminates the costly handling of components, specifically in receiving and
inspection, and enables product to move directly into production. Sometimes referred to
as ship-to-stock.

Often these partnerships are used for bottleneck materials (items that, if not received, will halt
production) and other critical materials (such as those that constitute order winners). Commodities are
often still sourced using lowest cost, but even here suppliers that offer services like short lead time may
be invited to form closer relationships.

Much like customer relationship management, supplier relationship management is a business

philosophy. Many organizations use supplier relationship management to develop and maintain long-
term supplier relationships. The Dictionary defines supplier relationship management (SRM) as
follows:
 A comprehensive approach to managing an enterprise’s interactions with the
organizations that supply the goods and services the enterprise uses. The goal of SRM
is to streamline and make more effective the processes between an enterprise and its
suppliers. SRM is often associated with automating procure-to-pay business processes,
evaluating supplier performance, and exchanging information with suppliers. An e-
procurement system is often an example of an SRM family of applications.

SRM is often accompanied by software tools of the same name to help not only purchasing but also
marketing, engineering, and production planning to communicate with suppliers regularly as well as to
monitor and control these relationships.

One way to provide assurance on supplier quality is to certify them. Related terms from the Dictionary
follow:

Supplier certification: Certification procedures verifying that a supplier operates,

maintains, improves, and documents effective procedures that relate to the customer’s
requirements. Such requirements can include cost, quality, delivery, flexibility,
maintenance, safety, and ISO quality and environmental standards.

Certified supplier: A status awarded to a supplier that consistently meets predetermined

quality, cost, delivery, financial, and count objectives. Incoming inspection may not be
required.

The corporate social responsibility and sustainability objectives also come from a supply chain
perspective, because organizations are often now held accountable for not only their own actions but
also for the actions of their suppliers. In selecting suppliers and in monitoring and controlling their
activities, purchasing plays a large role in ensuring that these policies are implemented.

Topic 2: Establishing External Supply

When establishing external supply, organizations follow a general process that starts by establishing
specifications and then moves on to selecting suppliers and negotiating contracts. This general process
is discussed in this topic.

External Supply
Depending on where a product is in its life cycle, establishing external supply may require selecting a
new supplier or using one that has previously been relied on.

When the good or service in question has been acquired in the past, a company may choose from a list
of preapproved suppliers.

For new goods and services, the organization must conduct a search, sometimes relying on the advice
of engineering and design functions for suggestions. In addition to that advice, an organization may turn
to salespeople from either the supplier or purchaser company, the internet, or trade magazines and
directories.

Basic Purchasing Process

Exhibit 4-3 illustrates one way to conduct the purchasing process.

Exhibit 4-3: Purchasing Process

Note that the first three steps are considered planning steps. These are the steps required to plan what
to purchase and who will supply it. The next two steps are execution steps, and they are shown side by
side to indicate that they are done concurrently, depending on the type of relationship set up with a
given supplier. Finally, there is a monitoring and controlling step, which involves measuring
performance and then providing feedback to both the suppliers and to the overall process. Giving
feedback to suppliers helps them to correct problems. Providing feedback to the planning process helps
improve specifications and supplier selection and negotiation processes.

Establish Specifications
Specifications might be standardized and simple for commodities or highly detailed and exacting for
complex materials. They are ultimately dictated by customer expectations, but marketing, engineering,
production planning, and others will translate customer requirements into three general types:
Functional
Quantity
Price

Each of these types of requirements is discussed next.

Functional Requirements
Functional requirements, also called functional specifications, are the most important of a product’s or
service’s requirements, because they are the details that indicate the form, fit, and function of the
material or service. Functional requirements specify not only the purpose of the product or service but
perhaps also how it fits with other components, its physical properties such as flexibility or strength, its
packaging, and its look and feel and other aesthetics.

Functional requirements are also quality requirements. Some parts of the APICS Dictionary, 16th
edition, definition of quality are provided in the next two paragraphs (in quotation marks).

Quality is defined by the customer as “fitness for use.” Functional requirements take this into account
when they satisfy customer requirements, and this is addressed during market analysis and product
and service design. Well-designed products will not only be fit for use but fit for use at what the
customer considers an acceptable price based on perceived value. “Value-based quality is the degree
of excellence at an acceptable price.” Value in turn is determined in part by marketing and in part by
functional requirements related to product grade (e.g., durability, dependability, aesthetics, and other
qualities that make a product fit for use). Functional requirements thus specify grade and acceptable
price.

From the perspective of purchasing and manufacturing, quality is defined as “conformance to

requirements.” The purchasing function’s responsibility is to ensure that the supplier can meet these
requirements. When specifying something like required tensile strength or other engineering
requirements, purchasing, marketing, engineering, and production planning will work together to
determine a range of acceptable quality. This might involve, for example, establishing upper and lower
specification limits. Items outside these limits would be rejected. Conformance to requirements is also
critical for subcomponents that need to fit correctly into a larger assembly. The allowed level of
nonconforming items can be specified. For example, six sigma specifies no more than 3.4 defects per
million opportunities for a defect. Tighter limits may affect price, so the limits are often based on actual
required quality levels. Proving conformance may involve setting standards for incoming inspection. In
some cases, materials from trusted suppliers may not be inspected unless a quality issue arises during
manufacturing.

There are many ways organizations can describe functional requirements. They may design every
detail themselves and provide schematics for the units and perhaps the tools and dies needed to make
them, or they can indicate what the product or service needs to accomplish and allow suppliers to
respond to a request for quote with innovative solutions.

When suppliers sell brand-name products, the requirements can be described simply by the brand
name or a product number. While wholesale and retail do this quite often, in manufacturing, industrial
products may be branded when the items are marketed to end users (e.g., Intel inside) or to industrial
customers. It may simply be more cost-effective to buy a brand than to develop detailed specifications,
especially when the brand is patented due to proprietary processes. It may even be the only option,
which is called sole sourcing. When alternatives exist, they should be considered.
Another way to describe functional requirements is to develop detailed descriptions and other
specifications. At one end of the range is simply a description of performance. The result that the
product or service needs to accomplish is indicated, without specifying how to accomplish it. For
example, this could be the ability to pump a certain viscosity of material at a certain rate per minute for
an industrial peanut butter pump. The supplier, with expertise in this specialty, can propose a solution.

The physical and chemical characteristics of an end result could be defined, still without specifying how
the materials are to be made. This might be a chemical formula or the ability of a plastic to bend a
certain amount without breaking. At the far end of this range, even the method of manufacture is
specified, because the method of manufacture will result in different properties. For example, cast iron
will be hard but brittle.

Whenever possible, descriptions of functional requirements should make use of standards.

International standards exist for a large number of industrial processes, and the standards often include
subsets such as how a particular process needs to be performed. These standards eliminate work on
the part of the purchaser, who can simply refer to a particular part of a standard. The suppliers will
typically understand the standards for their industry quite well, so the two organizations will have a
common language to use in discussing the functional requirements. Items made to standards are often
also less expensive, because the supplier can sell them to many buyers. Since standards are based on
extensive testing and input from many with expertise in the area, the items tend to be high in quality
and are more likely to both “conform to requirements” and be “fit for use.”

Functional requirements often take the form of engineering drawings, accompanied by detailed
documentation, when a product cannot be defined in any other way. These drawings define the precise
configuration of every aspect of the product’s functional requirements. Industrial procurement must
often rely on this method, despite the high cost of producing the drawings, for subcomponents that
need to fit precisely into a larger assembly.

Sometimes a buyer will not have a clear way to describe the requirements and will need to work with
the supplier, who can help in defining the need. The buyer could provide samples to the supplier or test
the supplier’s offerings.

Quantity Requirements
Quantity requirements involve determining how many units to purchase per order and how often to
order to balance supply with demand at the best cost. Items that are rarely in demand will be desired in
low quantities per purchase. Standard items already available on the market will be used whenever this
is feasible due to the high cost of make-to-order items. When items are needed in large quantities
frequently, quantity requirements intersect with price requirements, because suppliers will need to have
or develop sufficient economies of scale to produce in volume at low cost. Purchasing will then need to
determine the best purchase quantity to minimize total cost (price discounts for quantity purchases,
discounts for full truckloads, and inventory costs).

Price Requirements
Product price is determined by what the market will pay for the item. Since the final price has little
leeway, the price for any raw material or component used in the product will also face constraints. An
organization will be willing to pay only a certain maximum amount per unit of any given raw material or
component based on the value this adds to the final product in the eyes of the user.

Organizations need to balance the priorities of functional requirements (and quality), quantity, and price,
since they are all interrelated.

Selecting Suppliers
When selecting suppliers, the first consideration is the number of suppliers that will supply the product
or service. Organizations use sourcing to identify suppliers who can provide needed goods and
services. The APICS Dictionary, 16th edition, defines three basic methods of sourcing.

Sole-source supplier: The only supplier capable of meeting (usually technical)

requirements for an item.

Single-source supplier: A company that is selected to have 100 percent of the business
for a part although alternate suppliers are available.

Multisourcing: Procurement of a good or service from more than one independent

supplier.

Most organizations view sole sourcing as necessary but to be avoided whenever possible. Single
sourcing is considered as high risk and to be used only with key, trusted partners. Multisourcing (also
called multiple sourcing) is considered as the desired goal for the majority of supply requirements. In
some cases, an organization will multisource but only with a small number of suppliers—perhaps only
two, which can be referred to as dual sourcing. Using a small number of suppliers may provide the
benefits of closer relationships but at less risk. Using two or more sources can help avoid risks or
issues that could occur when using only a single source, for example, an employee strike, a machine
malfunction, or even a factory fire. If multisourcing were used in these instances, the supply would be
disrupted but not stopped entirely.

When selecting suppliers, organizations often develop selection criteria, since there are many factors
that will be important and many cannot be measured quantitatively. Selection criteria are discussed
next, followed by a discussion of trusted partners and decisions related to how inventories should be
managed.

Selection Criteria
Organizations will typically determine selection criteria and then assign a weight to each factor to
indicate its relative importance to the success of the strategy and the type of relationship. In a situation
in which the buyer is indifferent to the supplier of a commodity, price might be the primary weighting
factor. In a situation involving a potential trusted partner, reliability and manufacturing capability might
be the primary criteria. The weights might be on a scale of 1 to 10, or they might be a percentage
weighting that must sum to 100 percent. Typically, organizations will issue a request for quote (RFQ)
at this point, which the Dictionary defines as

a document used to solicit vendor responses when a product has been selected and
price quotations are needed from several vendors.

Based on the responses, the organization will then rate each supplier for each factor, perhaps also on a
1 to 10 scale. The weight is multiplied by the rank, and the scores per factor are summed. The top-
scoring suppliers might all be selected, or they could be put on a short list for on-site visits,
demonstrations, and negotiations.

Here are some of the selection criteria organizations often consider:

Technical capabilities. Purchasing and engineering determine if the supplier can manufacture the
product per the functional requirements. They may also assess the supplier’s research and
development budget and ability to learn and grow, collaborate on product development, and reduce
cost.

Manufacturing capabilities. Purchasing and manufacturing assess whether the supplier can
manufacture in volume at consistent quality levels with reliable lead times. They may assess the
supplier’s manufacturing planning and control systems, personnel, and quality assurance methods.

Location. Supplier location affects landed cost, or the price plus the cost of transportation to the
plant and carrying cost. It also affects lead times. Suppliers might maintain inventory at or near the
plant to shorten lead times.

Price. In some cases, lowest price will be important; in others, a competitive price will be sufficient so
long as the supplier provides superior value. Often total cost of ownership is used rather than just
price, to account for landed cost plus the cost of quality, inventory, taxes, foreign exchange, etc.

Reliability. Suppliers should be able to deliver on time, neither early nor late, have consistent quality
and quantity, and be financially stable.

Supply chain maturity. Suppliers capable of integrating systems, operations, communications, and
logistics and who continuously improve to reduce waste and add value may be a high priority. Some
suppliers will commit to holding inventory for the buyer, but lean supply chains cannot bear this
 added cost and will desire lean suppliers who minimize inventory but can still deliver small just-in-
time lots.

Service offerings. Services rated may include credit terms, after-sale service, service parts, a
reasonable returns policy, and warranties.

Management attitude and culture fit. Suppliers might be selected based on how well they interact
with the organization, support its policies (such as for sustainability), and so on. Tools like the UN
Global Compact can be used as a common frame of reference for measuring alignment with
corporate social responsibility initiatives. This is especially important for potential long-term partners.

Trusted Partners
A few key suppliers may become trusted partners over time. Often these will be single-source
arrangements with long-term commitments. Contracts can be designed to ensure that both parties work
to integrate further over time. In addition to a long-term commitment, two other things are needed for
these relationships to work: shared vision and trust. Organizations that choose to see the mutual
relationship as a shared destiny will develop a shared vision of what the relationship should
accomplish. They will communicate at every level of management, both formally and informally, to
ensure that these goals are realized. For example, manufacturing professionals in each organization
should promptly share information on material requirements and availability. Trust is not developed
immediately, especially when proprietary technology or financial details are at risk, so this will build over
time as each party fulfills its responsibilities.

The perspective on these relationships needs to be on the supply chain as a whole. Decisions that
reduce costs to the final customer need to take priority over decisions that simply shift costs from one
party to the other. These relationships can become mutually dependent, meaning that together the
organizations get more done than either could independently. They plan together, innovate solutions
together, and work to reduce costs together, often sharing the cost savings equitably. Teams are cross-
functional, meaning that each functional area works directly with its counterparts at the other
organization. Supplier relationship management tools are especially important to use to maintain
relationships with trusted partners.

Lean production environments rely particularly heavily on a few trusted suppliers. Lean emphasizes
perfect quality, allowing incoming inspection to be eliminated. This generally requires that the supplier
have a continuous quality improvement program. (Such programs are the goal even in conventional
manufacturing environments.) The supplier will also need to deliver materials just in time, which
typically requires that they also use a lean production environment. Finally, they will plan their long-term
capacity on the basis of this long-term agreement, so the trust in an ongoing relationship needs to be
mutual.
The benefits of developing a few trusted partnerships can include shorter lead times, shorter product
development times, better quality, and lower total cost. Suppliers will see benefits in terms of regular
business they can rely upon and the ability to plan more effectively, which can help them reduce costs.
If the organizations integrate their information systems, they can also collaboratively forecast together
and eliminate the bullwhip effect, which is the increase in variability in orders that becomes more
pronounced the further upstream one goes in a supply chain when only order information is
communicated. Another way to eliminate the bullwhip effect, managed inventories, is discussed next.

Managed Inventories
When Procter & Gamble (P&G) was having serious issues with its diaper production due to wide
swings in orders (the bullwhip effect), they determined that the root cause was that they were
forecasting based on orders rather than on actual demand. Actual demand was not varying nearly as
much, so they proposed an innovative solution in the days before supply chain management or
integrated information systems. They proposed taking over management of the inventories for their
diapers at retailer stores. P&G decided when to replenish based on actual demand information. This
innovation leveled out their production and reduced inventory levels. It came to be called vendor-
managed inventory. The Dictionary describes vendor-managed inventory (VMI) as follows:

A means of optimizing supply chain performance in which the supplier has access to the
customer’s inventory data and is responsible for maintaining the inventory level required
by the customer. Accomplished by a process in which resupply is performed by the
vendor through regularly scheduled reviews of the on-site inventory. The on-site
inventory is counted, damaged or outdated goods are removed, and the inventory is
restocked to predefined levels. The vendor obtains a receipt for the restocked inventory
and accordingly invoices the customer.

Note that this is not meant to imply that VMI is the only way to mitigate the bullwhip effect.
Organizations can use in-house inventory management policies and controls to smooth out inventory
levels to some degree, for example.

Another way to manage inventories is to sell on consignment. The Dictionary defines consignment in
part as

the process of a supplier placing goods at a customer location without receiving payment
until after the goods are used or sold.

In an industrial setting, consignment takes the form of suppliers storing inventory at the buyer’s plant.
The ownership is transferred when an item is removed from inventory and entered into production.
(Payment is not made until the item is used.) In some cases, VMI will be done on consignment but may
still be called VMI. A supplier representative may be on site with consignment or VMI. Either method
can minimize the bullwhip effect, reduce total inventories, and minimize the chance of stockouts and
can also eliminate the need to make many small material requirements planning order releases.
Another variation of managed inventories is called continuous replenishment. The Dictionary defines
continuous replenishment as follows:

A process by which a supplier is notified daily of actual sales or warehouse shipments

and commits to replenishing these sales (for example, by size or color) without stockouts
and without receiving replenishment orders. The result is a lowering of associated costs
and an improvement in inventory turnover.

Negotiating Contracts
Organizations may negotiate contracts with a short list of suppliers, or, for commodities and standard
items, they may instead use competitive bidding and simply select the lowest price. The selected
supplier is issued a purchase order, which is a type of one-time contract. The first decision in contract
negotiation is therefore the type of contract to pursue.

Longer-term contracts are typically desired for materials with complex functional requirements, items
that might be in scarce supply, and items needed frequently and in high volume. Since it can be costly
to process a new purchase order each time the material requirements planning system generates a
planned order, especially when these are small lot-for-lot purchases, an alternative is to use contract
buying. Contract buying can take the form of a blanket purchase order, which is basically a long-term
contract that allows releases of materials at predetermined delivery dates.

This and even longer-term contracts (such as those for more involved supply chain partnering) might be
used to simplify purchasing for manufacturing.

What can and cannot be negotiated may depend on the relative power of each party in the negotiation.
The supplier will have relatively more power when the item is not available from many other suppliers or
the supplier clearly meets all of the organization’s criteria better than the competition. The buyer will
have more power when there are other good alternatives or they can make the product themselves at a
reasonable cost. In cases where long-term cooperation is desired, the negotiation should work to find
areas of mutual benefit.

In all cases, negotiation requires thorough preparation and skill. Predetermining a best alternative to a
negotiated agreement (what the organization could do if it needs to walk away) is advisable. This might
be negotiating with another supplier on the short list or developing the product in house. Knowing the
cost of this alternative will help when deciding whether it is wise to take a counteroffer.

Depending on the goals of the negotiation, the following categories might be part of a contract
negotiation:

Price. Price is clearly a critical part of any negotiation. It can range from a market price for
commodities and standard products to detailed negotiations on engineer- and make-to-order items
with responses to RFQs (price and other details) from multiple suppliers. Areas for negotiation may
 include locking in future prices for commodities, bulk purchase discounts, or who pays for tooling
costs. Taxes and tax exemptions should be factored into the decision. It is typically not cost-effective
to negotiate for MRO (maintenance, repair, and operating) supplies; the key will be to minimize the
cost of ordering.

Terms and conditions. The APICS Dictionary, 16th edition, defines terms and conditions as “all
the provisions and agreements of a contract.” This includes credit terms, discounts for early payment,
return policy, who pays for defective products, warranties, penalties for late deliveries, exit clauses,
and so on.

Delivery and quantity. Organizations can negotiate who handles delivery and who pays for it, when
ownership (and risk) is transferred, the quantity and frequency of deliveries, package sizes, and the
location of delivery. Allowable variation in quantity may be specified for natural products.
Specifications on protective packaging and proper handling are also needed.

Quality. Organizations specify the grade of goods, the tolerance range for variability, the number of
allowable defects per lot or period, and who conducts quality control.

Legal review is recommended for contracts. Note that, in some cases, it may not be feasible to
negotiate price in advance, and some contracts will be on a cost-plus basis. This type of contract is
high-risk for the buyer but may be needed when it is impossible to estimate costs, such as for many
engineer-to-order materials. Proper auditing of costs needs to be done independently.

Topic 3: Completing the Purchasing Process

Purchasing execution involves submitting orders to suppliers. Purchase process signals, which are
inputs that initiate purchasing, are addressed first in this topic, followed by the purchasing cycle, which
is a general process for ordering low-volume materials using individual purchase orders. Executing
purchasing also includes contract buying, which is repetitive purchasing based on longer-term
contracts, and this is discussed last.

Purchasing Process Signals

Purchasing will generally be able to view the planned order releases from material requirements
planning (MRP) even before the planned orders have been released so that they can plan ahead.
These are usually executed using contract buying through a blanket purchase order or another type of
long-term contract. When MRP data on required due dates are directly used in the supplier’s master
scheduling process, this can also initiate purchasing. This is called supplier scheduling and is another
type of contract buying.
Conventional requisitions originating outside of MRP may also be used to initiate purchasing via the
purchasing cycle, and these are issued for equipment purchases as well as for unique or small-volume
items needed for engineer- or make-to-order production.

Lean production systems use kanban signals (cards, empty bins, etc.) to trigger replenishment need,
and often no purchase order or requisition is needed as per the long-term contract with the supplier.
Instead, a process of backflushing may be used, which determines how many units of each
subcomponent were used based on MRP backflushing rules. Thus, for a door manufacturer purchasing
locksets, the number of units produced is multiplied by the number of locksets per unit to determine the
payment due to the supplier and the number of units to be replenished.

A similar situation is called buffer replenishment. A minimum inventory level is specified as a reorder
point. When the inventory reaches that level, a fixed amount is automatically reordered using contract
ordering or a requisition is generated to begin the purchasing cycle.

Purchasing Cycle
The purchasing cycle is used for low-volume or one-time purchasing. This may include anything from
new equipment or software systems to office and MRO (maintenance, repair, and operating) supplies
such as replacement parts for equipment. It can also be used for unique items needed for engineer-
and make-to-order production. Exhibit 4-4 shows the steps in the purchasing cycle.

Exhibit 4-4: Purchasing Cycle

Each of these steps is discussed next.

Generating Requisition
The APICS Dictionary, 16th edition, defines a purchase requisition as

an authorization to the purchasing department to purchase specified materials in

specified quantities within a specified time.

A requisition is an internal request to initiate a purchase order; it may be on paper or may be electronic
in an enterprise resources planning system. The functional area needing the item will initiate the
requisition. It should provide the functional requirements, quantity, and delivery requirements. A
maximum price may also be specified. Requisitions above a certain dollar amount usually require prior
approval at the appropriate level.

Issuing Purchase Order

The Dictionary defines a purchase order (PO) as follows:

The purchaser’s authorization used to formalize a purchase transaction with a supplier. A

purchase order, when given to a supplier, should contain statements of the name, part
number, quantity, description, and price of the goods or services ordered; agreed-to
terms as to payment, discounts, date of performance, and transportation; and all other
agreements pertinent to the purchase and its execution by the supplier.

Purchasing will select a supplier based on the requisition requirements and issue a PO. Once released,
the PO is considered an open order until the end of the purchasing cycle. Alternatively, purchasing
might use various types of auctions or trade exchange services to find suppliers when price is the
primary criterion (e.g., for commodities). One example is a reverse auction, which the Dictionary
defines as

an internet auction in which suppliers attempt to underbid their competitors. Company

identities are known only by the buyer.

On the supplier side, order processing starts once the customer’s order is received. Order processing
is defined in the Dictionary as

the activity required to administratively process a customer’s order and make it ready for
shipment or production.

Following Up
Purchasing will track the status of the order to ensure that it will arrive on schedule. If it is at risk of
arriving late, purchasing may expedite the order, especially if it will impact production schedules. If the
order will arrive early, purchasing may de-expedite it. Purchasing will also keep the requesting person
or department aware of the status of the order.

Receiving Goods
Receiving will compare the incoming order with the PO and the packing slip. Any necessary inspections
or item counts are also performed at this time. Receipt of full and partial shipments is recorded and
tracked. Damage caused in shipment will result in a freight claim to the carrier, while unacceptable
goods will be addressed per the contract details and may or may not result in a return. The accepted
goods are entered into inventory, and data on actual receipt date, quantities, and quality are tracked for
supplier monitoring and controlling purposes.
Approving Payment
The purchasing department performs a three-way match between the PO, the receiving report, and the
invoice to make sure that quantities and materials are correct. After goods are received and accepted,
the organization approves payment to the supplier and closes the order. Accounts payable is then
responsible for payment.

Contract Buying
Contract buying is the authorization of material releases against a long-term contract. It is used for
high-volume and/or high-frequency purchases such as for material requirements planning (MRP).
Rather than generating a purchase order, purchasing will release orders against the schedule or in lots
as specified in the blanket purchase order or other long-term contract.

For MRP planned orders, often the supplier is given a copy or view of the material requirements plan so
they can produce the units that will be needed. This is called supplier scheduling when the supplier
uses the planned orders directly in their own MRP process. Contract buying is also used with kanban
and buffer replenishment.

Topic 4: Responding to Supply Disruptions and Changes

Supply chain disruptions are commonplace. They may take the form of minor, short-lived, or localized
events or be more widespread and long-lasting. In order to respond to these disruptions, companies
should plan ahead and make supply decisions that enhance flexibility and responsiveness.

Supply Disruptions and Changes

Supply disruptions and changes may occur due to any number of circumstances, from shorter-lived or
region-specific phenomena like labor disputes and tropical storms to long-lasting global events such as
the COVID-19 pandemic, which has affected the supply chain of 94 percent of Fortune 1000
companies, according to Accenture.

Accenture states that organizations must continually cycle through mobilization, sensing, analyzing,
configuration, and operation steps as they respond to disruptions. These steps are marked by the
following actions:
1. Mobilizing includes enacting the initial response plan and establishing rules for how to respond to
further disruptions and manage contingencies. This may involve setting up a dedicated response
team.
2. Sensing involves reprioritization of risks and responses depending on the newly arising challenges.
3. Analyzing is a process of working through what-if scenarios and protocols for sourcing, planning,
manufacturing, and distribution of products as well as any services the organization offers or may
 offer in response to the disruption.
4. Configuration requires the organization to set up the existing supply chain network and product
flows to follow the protocols that were developed in the previous step. Organizations should develop
metrics to track the success of the configuration process and the protocols that have been enacted.
5. Operation is the process of executing the plans and protocols and tracking the results that have
been measured following the organization’s efforts.

Depending on the size and longevity of the disruption, organizations may have to cycle repeatedly
through these steps as the disruption progresses. What an organization chooses to do initially may no
longer be the best course of action as other members of the supply chain respond and the effects of the
disruption change over time.

Wharton University writes that organizations that have prioritized low-cost suppliers may find utility in
supply sources that can be increased to deal with demand fluctuations and supply issues due to
disruptions such as the COVID-19 pandemic. Focusing on resiliency is wise; organizations may do this
by increasing inventories of crucial parts and materials or finding new suppliers.

One example of this may be using local suppliers or suppliers from multiple different global regions
even if some of them may result in increased costs. This could help an organization continue to operate
normally if suppliers in specific countries or regions are forced to temporarily shut down production or
shipping operations.

Wharton University notes that organizations that wait to enact these changes until the disruption occurs
may struggle to find new suppliers or redesign products or processes in time to make a positive impact.
Organizations that have proactively developed response plans are better able to respond to disruptions
that would otherwise threaten organizational viability, remaining in business when others do not.

Topic 5: Measuring Supplier Performance

Organizations must measure how suppliers perform against expectations, both to enhance future
decision making and to protect against theft and fraud.

Supplier Performance
Both the purchasing process itself and the performance of individual suppliers need to be monitored
and controlled. Since purchasing involves large amounts of money, the organization needs checks and
balances and audits to safeguard against fraud. Data on actual results are also provided as feedback to
streamline the process, to ensure that policies and strategic priorities (for example, for sustainable
purchasing or maintaining required quality levels) are being followed, and to continuously improve the
total cost of ownership rather than just the price.
Data on the reliability and quality of individual suppliers are compared to targets, and follow-up is
initiated when there are discrepancies. Failing to follow up will be doing the supplier a disservice
because they will fail to correct problems and may not be given a new contract. In addition to daily
monitoring, long-term progress toward shared goals needs to be assessed. Regular communications
can be used not only to track progress toward goals but also to set new goals for continuous
improvement. Organizations might use a balanced scorecard system or a custom scorecard for these
evaluations. This can allow tracking of multiple goals and actual results across multiple time periods.
Common areas for assessment include
Perfect orders: on time, correct place, correct quantity, correct products, acceptable quality
Correct inventory buffer management or releases against the schedule
Correct administration, such as correct invoicing or pre-clearing shipments with customs
Speed of problem resolution and expediting.
Section B: Make
After completing this section, students will be able to
Define production activity control.
Calculate takt time for flow manufacturing processes.
Describe how to successfully execute dispatching in an intermittent manufacturing process.
Explain how to successfully identify and address bottlenecks in the manufacturing process.
Describe how to use input and output control.

Exhibit 4-5 shows the primary subject of this section: production activity control (PAC), which includes
scheduling, implementation, and capacity control. PAC is, along with purchasing, an execution activity.
PAC transforms the in-house manufacturing requirements of the material requirements plan into
finished goods and services.

Exhibit 4-5: Production Activity Control

Topic 1: Execution and Control

This topic starts with the objectives of production activity control and then describes the overall process
and its inputs.

PAC Objectives
The APICS Dictionary, 16th edition, defines production activity control (PAC) as follows:
 The function of routing and dispatching the work to be accomplished through the
production facility and of performing supplier control. PAC encompasses the principles,
approaches, and techniques needed to schedule, control, measure, and evaluate the
effectiveness of production operations.

Production activity control has the following objectives:

Execute the orders authorized in the master production schedule and the material requirements plan.
Optimize the use of resources, including materials, tooling, equipment, staff, and information.
Provide availability information to production coordinators so they can ensure the availability of
resources when they are needed.
Provide information on work-in-process inventories so planning/operations can maintain the levels
set by inventory policy.
Maintain customer service at the targeted level.

Overview of PAC
Exhibit 4-6 shows how production activity control (PAC) forms a closed-loop system including
scheduling, implementation, the manufacturing shop floor, and capacity control.

Exhibit 4-6: Production Activity Control Components

Starting with scheduling, also called the plan component of PAC, production coordinators verify that
resources will be ready when needed. They also schedule start and completion dates for each shop
order at each affected work center. Production coordinators use load profiles and various scheduling
techniques to devise a feasible schedule that can meet required completion dates.

In implementation, production coordinators gather the information they need to provide to the shop floor
to make the product using what is called a shop packet, verify that resources will be available when
needed, and then release these orders to the shop floor as authorized by the material requirements
plan.

During capacity control (sometimes called just control), production coordinators use a prioritization
process called dispatching to generate a dispatch list showing scheduled start and completion dates for
the sequence of orders at work centers. The process is also used to gather feedback on planned and
actual inputs to and outputs from the work centers to help control work-in-process (WIP) inventory and
queue times, and this also provides information on whether backlogs are increasing or decreasing
relative to their desired level. Capacity control involves monitoring and controlling WIP, lead times, and
queues and preparing various reports for use in longer-term management. The results of capacity
control may require replanning rather than just re-ranking the dispatch list, so this results in a feedback
loop where the process repeats as needed.

Thus PAC is a closed-loop system, meaning that plans and schedules are refined based on actual
results.

Inputs to PAC
Exhibit 4-7 lists the inputs used in production activity control along with a reminder of what each input is
and the types of information each provides. Note that the first five are planning data, while the shop
order file is a control file that is updated as the process proceeds.

Exhibit 4-7: Inputs to Production Activity Control

Input Description Information Provided

Material Authorized production Shop order quantities and order due

requirements plan dates
Item master files Database for each part Part number and description;
number quantity on hand, available, and on
order; manufacturing lead times and
lot size quantities
Bills of material Used by material Shop floor pick lists for shop order
(BOMs, also called requirements planning packet
product structure to determine which
files) options and parts each
order needs
Routing files Series of operations for Operations required, sequence of
a unique part number work centers used, manufacturing
describing how to make lead times, operation capacity
product required (pieces × operation
standard), and tools required
Work center files Work center information Work center number, shifts per
week, machine hours and labor
hours per shift, capacity, efficiency,
utilization, queue time,
manufacturing lead time, and
alternative work centers
 Input Description Information Provided

Shop order files Live document for each Shop order number; shop order
(manufacturing shop order quantities; order due dates;
order files) quantities issued, completed,
scrapped, and balance due; planned
and actual setup and run times; lead
times remaining; cost information

Note that the same type of information is sometimes listed in more than one place, which reflects the
fact that organizations may organize files in different ways.

Scheduling relies on the accuracy of this information. If, for example, the queue, setup, run, wait, and
move times are wrong at a work center, then the schedule will be off and will need correcting. If the root
cause of the schedule variance is determined to be source file inaccuracy, these files should be
updated after verifying that the standard should be changed.

Topic 2: Flow Processes

Flow processes feature products moving from one work center to another at a nearly constant rate with
no delays. They produce similar products and feature specialized machinery and workers with
specialized skill sets. This topic is concerned with the transactional side of flow processes, from an
inventory control perspective. Takt time is one approach to setting the proper production rate in a flow
manufacturing process to match demand.

Calculating Takt Time

The APICS Dictionary, 16th edition, defines takt time as follows:

Sets the pace of production to match the rate of customer demand and becomes the
heartbeat of any lean production system. Computed as the available production time
divided by the rate of customer demand. For example, assume demand is 10,000 units
per month, or 500 units per day, and planned available capacity is 420 minutes per day.
The takt time = 420 minutes per day ÷ 500 units per day = 0.84 minutes per unit. This
takt time means that a unit should be planned to exit the production system on average
every 0.84 minutes.

While conventional manufacturing planning and control also sets a pace for production, usually this is
the rate at which a bottleneck work center can produce units. Takt time synchronizes production with
the rate of customer demand rather than production rate requirements.

Authorizing Backflush and Inventory Release

The APICS Dictionary, 16th edition, defines backflush as follows:
 A method of inventory bookkeeping where the book (computer) inventory of components
is automatically reduced by the computer after completion of activity on the component’s
upper-level parent item based on what should have been used as specified on the bill of
material and allocation records. This approach has the disadvantage of a built-in
differential between the book record and what is physically in stock.

Rather than recording each raw material and work-in-process transaction, lean systems (and also some
conventional manufacturing planning and control environments) use backflushing. At the point where
material requirements planning systems calculate part quantities, lean systems (or other organizations
that use backflushing) use this process for transaction-recording purposes. Lean takes the finished
units coming off the line and backflushes out all the parts required to make the units, accounting for
them all at once rather than after each processing step. The finished units are used to record
withdrawals from raw materials inventory.

This system works if manufacturing lead times are short and the bills of material are accurate. Rejected
or scrapped parts should be rare but do need to be recorded to keep inventory records accurate.
Backflushing can be done at intermediate workstations if more visibility is desired into the work that is in
process.

Topic 3: Batch Processes

This topic discusses how various batch processes are set up and scheduled to ensure maximum
production efficiency, closing with a discussion on input/output control.

Batch Processes
Batch processing is defined in the APICS Dictionary, 16th edition, as follows:

1) A manufacturing technique in which parts are accumulated and processed together in

a lot. 2) A computer technique in which transactions are accumulated and processed
together or in a lot.

Batch processing is considered a type of intermittent manufacturing. This means that the flow of work
through a shop is not consistent and depends on the particular manufacturing requirements for a given
product. This requires flexibility with machinery and workers and can result in long throughput times.

Production Rate or Flow Rate

Flow rate and production rate are defined in the APICS Dictionary, 16th edition, as follows:

Flow rate: Running rate; the inverse of cycle time; for example, 360 units per shift (or
0.75 units per minute).
 Production rate: The rate of production usually expressed in units, cases, or some other
broad measure, expressed by a period of time (e.g., per hour, shift, day, or week).

The production or flow rate tends to be slower in batch processing, due to the lack of specialization of
machinery and workers.

Production and Labor Schedule

The APICS Dictionary, 16th edition, defines production schedule as follows:

A plan that authorizes the factory to manufacture a certain quantity of a specific item.
Usually initiated by the production planning department.

The production plan is designed to meet delivery dates while using manufacturing resources (such as
machinery and labor) in the most efficient way possible. In order to develop the schedule, the planner
must have information on routing, required and available capacity, competing jobs, and manufacturing
lead times for every work center involved in the production of the product being scheduled.

Manufacturing lead time consists of queue, setup, run, wait, and move time. Queue, wait, and move
time are controlled by manufacturing and production activity control (PAC). In batch processing, queue
time may account for 85 to 95 percent of total lead time. PAC can manage the queue by regulating the
workflow through work centers to reduce load.

Priority Control (Operations Sequencing)

The APICS Dictionary, 16th edition, defines priority control and operations sequencing as follows:

Priority control: The process of communicating start and completion dates to

manufacturing departments in order to execute a plan. The dispatch list is the tool
normally used to provide these dates and priorities based on the current plan and status
of all open orders.

Operations sequencing: A technique for short-term planning of actual jobs to be run in

each work center based upon capacity (i.e., existing workforce and machine availability)
and priorities. The result is a set of projected completion times for the operations and
simulated queue levels for facilities.

The master production schedule sets due dates for finished goods, material requirements planning
translates these into due dates for components, and scheduling releases these orders to minimize
capacity or resource conflicts. Priority control is needed at this point because neither supply nor
demand is fully stable in many manufacturing environments:
Customers may request changes in due dates or quantities, perhaps by requesting expediting.
Materials may arrive late or early.
Scrap or quality rejects may be higher than the standard amount.
 Multiple orders may have the same due date, or work centers may need to process multiple orders
by the same operation due date.

Operations sequencing is the method used to control priorities when it is not necessary to resort to
replanning. The process of controlling the priority of orders is called dispatching.

Dispatching
The APICS Dictionary, 16th edition, defines dispatching as

the selecting and sequencing of available jobs to be run at individual workstations and
the assignment of those jobs to workers.

Dispatching uses a dispatch list to notify workers which order numbers to process first. The process of
dispatching uses dispatching rules to determine this order.

Dispatch List
Exhibit 4-8 shows a dispatch list for work center 13, a spot-welding station for a door manufacturer.

Exhibit 4-8: Dispatch List

Production coordinators update the dispatch list at least daily, and work center workers refer to the
dispatch list to determine which shop orders to work on in which order. A dispatch list generally
provides information on the plant, the department, and the work center; the work orders in their proper
sequence; the part numbers being produced; the order quantities for the total order; the standard hours
for setup and run and in total; the quantities completed; the load remaining; and the expected operation
start and finish dates based on the standard hours. It will also list released orders that are scheduled to
begin the next day or further in the future. (Note that Exhibit 4-8 does not show all of this information.)

Dispatching Rules
The dispatch list is generated using dispatching rules that help set the priority of orders. Some of the
rules shown here will perform better than others at meeting due dates, maximizing work center
throughput, or minimizing work-in-process inventory, but no single rule works best at optimizing all of
these objectives. Here are some common dispatching rules:
 First come, first served (FCFS). Jobs are done in the order received. This ignores due dates and
processing times but may work if schedules are well-designed and stable.

Earliest job due date (EDD). Jobs are completed with the earliest end unit due date first, which
conforms to the basic output of a material requirements planning (MRP) system. Thus EDD is a
default option. (The other methods refine or override the MRP output in one way or another.) This
prioritizes the due date without regard to the processing time, meaning that some longer orders might
make shorter orders late.

Earliest operation due date (ODD). Jobs are completed with the earliest operation due date (work
center operation) first. This takes both the due date and the processing time into account, because
the operation due date reflects the amount of processing time.

Shortest process time (SPT). The jobs with the shortest process time are sequenced first. This
ignores due dates but gets the most jobs done overall. (Longer jobs may be delayed, however.)

Critical ratio (CR). Actual processing time remaining divided by lead time remaining (i.e., work
remaining) results in a ratio (see the equation below) that shows the relative priority of the order
compared to other orders at the work center. The rule is to sequence the order with the lowest ratio
first. (Negative values are considered the lowest, with –2 being a higher priority than –1.) Here is
what various ratio values mean:
If the CR is 0 or negative: Expedite. The order is currently late.
If the CR is less than 1.0: Expedite. The order is behind schedule.
If the CR is 1.0: The order is on schedule.
If the CR is greater than 1.0: The order is ahead of schedule.

Slack time. Time remaining for an order minus the sum of its remaining setup and run times. The
order with the lowest slack time is scheduled first. Similarly, slack time per operation is slack time
divided by number of remaining operations, and the lowest value is the highest priority.

The equation for the critical ratio follows, along with an example of order C, introduced in the exhibit
below, where the order due date is manufacturing calendar day 56, the present date is day 48, and the
lead time remaining is 16 days.

In this case, the actual time remaining is half as much as the total lead time remaining for all operations
(comprising their respective queue, setup, run, wait, and move times), meaning that perhaps this
operation had delays, rejected units, and so on. If the critical ratio is used as the rule, this order would
therefore be a higher priority than an order that was on schedule (1.0).

Exhibit 4-9 compares how the first five of these methods would prioritize a set of orders based on their
rules. (Slack time is not shown.) Note how different rules result in different order priorities.

Exhibit 4-9: Comparison of Dispatching Rules

In this example, today’s date is day 48, so order A is already late. Thus it is the highest priority in
several of the methods, especially since it is late at this work center as well. The critical ratio is (47 –
48)/6 or –1/6 = –0.167, which is rounded up in the exhibit. Order B is on schedule: (66 – 48)/18 = 18/18
= 1.0.

Running orders based on priority rules might delay orders that are currently on schedule until they are
also in need of expediting. Note that many of the inputs could also change. Order and operation due
dates might change if orders are expedited or de-expedited. Process times are based on standard
times and so are less likely to change, but they could be temporarily changed due to issues such as
breakdowns. For the critical ratio, the current day and the remaining lead time will change each day as
orders are processed, but if queues are growing longer, for example, lead times could become
problematic quickly. Therefore, many—but not all—of these sequencing priorities could change over
time. However, it may not be wise to change orders that are already being run at a work center due to
added setup time.

An important point about sequencing rules is that since people need to implement them, they should
not be too confusing. Whichever rule is adopted should be the rule that is consistently applied.

Utilization/Capacity Cushion
Utilization refers to the number of actual hours worked compared to the total available hours at a work
center. This will vary from work center to work center, depending on machine maintenance
requirements, breakdowns, lack of required materials, employee breaks, and shift changes.
Capacity cushion is defined by the APICS Dictionary, 16th edition, as

extra capacity that is added to a system after capacity for expected demand is
calculated.

This may also be called safety capacity, and it represents excess available capacity beyond required
capacity. It is used to protect against interruptions due to breakdowns, preventive maintenance, or poor
quality causing rework.

Material Routing and Managing Queues

The route master sheet is described by the APICS Dictionary, 16th edition, as

the authoritative route process sheet from which all other format variations and copies
are derived.

The route master sheet will record step-by-step instructions for how the product is made, including
equipment, tools, setup times, run times, and lead times for each operation required for the
manufacturing process. This will dictate what materials are needed at each workstation for each step in
the process.

Queue management is defined in the Dictionary as

tactics to deal with an excess number of items, such as products or customers, waiting in
line for service.

Queue management is key to reducing work-in-process inventory. An overload of work-in-process

inventory can reduce efficiency and lead to increased production costs.

Nonstandard Demand
Crucial to capturing a complete picture of all product and service demand is accounting for demand that
originates outside of the typical order process. This includes demand that be required to supply
Sample inventory
Displays
Product testing
Prototyping.

Managing Exceptions
The APICS Dictionary, 16th edition, defines exception management as follows:

The practice of responding only to issues or events that fall outside a predetermined
threshold. Managers are prompted to respond to these critical matters first. This practice
 is often applied to management of budgets, projects, and risks. Sometimes referred to as
management by exception.

Input/Output Control in Intermittent Process Types

Types of intermittent processes, including work center and batch processes, can be controlled by
monitoring the inputs and outputs of work centers. The APICS Dictionary, 16th edition, defines
input/output control (I/O) as follows:

A technique for capacity control where planned and actual inputs and planned and actual
outputs of a work center are monitored. Planned inputs and outputs for each work center
are developed by capacity requirements planning and approved by manufacturing
management. Actual input is compared to planned input to identify when work center
output might vary from the plan because work is not available at the work center. Actual
output is also compared to planned output to identify problems within the work center.

The objectives of input/output control include ensuring that the levels of work-in-process (WIP)
inventory and queue times at work centers remain at desired levels. This is done by controlling the flow
of work into the work center and the output rate of the work center—in other words, its capacity. Exhibit
4-10 shows the same funnel metaphor presented elsewhere for capacity; here the inputs to the funnel
are shown and there is a control point.

Exhibit 4-10: Input/Output Control

Controlling inputs involves scheduling and dispatching. Controlling outputs involves finding ways to
increase or decrease capacity (i.e., in the metaphor, making the funnel point smaller or larger to
increase or decrease output per time period), for example, using undertime or overtime or finding and
correcting issues, such as expediting deliveries, making staffing changes, or repairing equipment.
Capacity changes can be difficult and have an upper limit over the short term.
Capacity requirements planning simulates the inputs and outputs of each work center, scheduling
releases orders to optimize this flow, and dispatching adjusts orders based on priority rules. However,
production coordinators still need to monitor the flow of work coming into work centers, the relative
performance of the work centers, and the resulting level of WIP inventory and queue times. This is
accomplished using an input/output report.

Input/Output Report: Cumulative Variances and Planned Versus Actual

Backlog
An input/output report is generated for each work center. Three sets of planned values are compared to
their actual counterparts once the work has been completed for the time period in question and the
actual results have been submitted. Exhibit 4-11 shows an input/output report for work center 13. This
report shows daily results, but weekly results might also be used.

Exhibit 4-11: Input/Output Report for Work Center 13 for One Week

The input section of the report is used to determine how well work is flowing into the work center. A
variance is an actual value minus a planned value, and a cumulative variance sums these variances
over time. Cumulative input variance is calculated as follows (using days 48 and 49 as examples):

The output section of the report is used to show work center performance efficiency, and the cumulative
variance calculation is basically the same. (Day 49 is shown.)

Note how, by convention, the planned value is listed first but the order of subtraction is the opposite
(actual minus planned). Doing the subtraction in the wrong order will result in the wrong answer.
The backlog is the queue. Note that an opening period backlog is shown in the exhibit. This is from the
prior report. The planned versus actual backlog rows are calculated using the following equations (both
for day 52):

When the actual backlog (queue) is growing less than the plan, there is less room for error and there is
a risk that a bottleneck or potential bottleneck could be starved for material. When the actual backlog
(queue) is growing more than the plan, this will result in longer manufacturing lead times and a risk of
missed due dates in addition to an increase in WIP inventory. Given this information, production
coordinators can exercise controls in the form of more or less input or more or less output (capacity).
Increasing or decreasing planned input or output rates are ways to change the planned backlog if the
levels are too high or too low. Increases or decreases in actual output rates will result in increases or
decreases in the actual backlog.

Topic 4: Bottleneck Management

This topic starts with an explanation of product flow analysis. It then moves on to the basics of the
theory of constraints and bottlenecks, followed by a discussion of the types of constraints and the
principles of bottleneck management.

Product Flow Analysis

A product flow analysis indicates the logical flow of manufacturing processes as raw materials are
transformed into finished goods. While the results of this analysis do not require using a particular
manufacturing environment, process type, and layout, the logical flow of materials may be an
influencing factor and so is introduced here.

A product flow analysis is often called a VATI analysis because there are four basic conceptual flows
that materials transformation processes can use at a plant, and the shapes of the letters V, A, T, and I
indicate how materials flow through the process. Exhibit 4-12 shows these flows graphically.
 Exhibit 4-12: Product Flow Analysis (VATI Analysis)

The APICS Dictionary, 16th edition, defines a VATI analysis in part as follows:

In the theory of constraints, a procedure for determining the general flow of parts and
products from raw materials to finished products (logical product structure)... Once the
general parts flow is determined, the system control points (gating operations,
convergent points, divergent points, constraints, and shipping points) can be identified
and managed.

The flows are as follows (with excerpts from the definition in quotation marks):

V-plants. A basic raw material (the bottom of the V) is split off into two or more products that diverge
rather than being interrelated later. “A V logical structure starts with one or a few raw materials, and
the product expands into a number of different products as it flows through divergent points in its
routings.” For example, an organization that harvests trees might make various types of lumber.

A-plants. Various raw materials are transformed in their own production processes and converge (at
the top of the A) into one or more final materials, for example, complex products assembled from
multiple subcomponents. “The shape of an A logical structure is dominated by converging points.
Many raw materials are fabricated and assembled into a few finished products.”

T-plants. Raw materials are transformed using a single logical flow production line, but at some
point, a limited number of basic units can be configured into many different end products (at the top
of the T). “A T logical structure consists of numerous similar finished products assembled from
common assemblies, subassemblies, and parts.”

I-plants. This is a basic linear flow for operations that use a production line or continuous flow
process to produce one type of end product. “An I logical structure is the simplest of production flows,
where resources are shared between different products and the flow is in a straight line sequence
(e.g., an assembly line).”

Organizations that make multiple products might use several of these flows.
Theory of Constraints
The APICS Dictionary, 16th edition, defines the theory of constraints (TOC) as follows:

A holistic management philosophy developed by Dr. Eliyahu M. Goldratt, based on the

principle that complex systems exhibit inherent simplicity. Even a very complex system
comprising thousands of people and pieces of equipment can have, at any given time,
only a very, very small number of variables—perhaps only one, known as a constraint—
that actually limit the ability to generate more of the system’s goal.

The theory of constraints was a revolutionary idea when Dr. Goldratt proposed it, because conventional
thinking at the time was additive, meaning that, due to process complexity, streamlining any part of a
system where improvements could be found would be beneficial to total system output. However,
according to TOC, real gains in efficiency can be made only by finding the part of the system that
constrains total output—the weakest link—and making efficiency improvements to that area and only
that area. Strengthening any other part of the chain will waste effort without resulting in a stronger
chain. Only repairing or replacing the weak link will increase the capacity of a chain to achieve its goal
of being able to pull or lift more weight. TOC is also a better use of time and money; a focused
investment can generate real results quickly.

The Dictionary defines a constraint in part as follows:

Any element or factor that prevents a system from achieving a higher level of
performance with respect to its goal. Constraints can be physical, such as a machine
center or lack of material, but they can also be managerial, such as a policy or
procedure.

A constraint is what creates a bottleneck area. The Dictionary defines a bottleneck as follows:

A facility, function, department, or resource whose capacity is less than the demand
placed upon it. For example, a bottleneck machine or work center exists where jobs are
processed at a slower rate than they are demanded.

A constraint is a limit on throughput, or the rate of production, not on inventory or production. The
Dictionary defines throughput and a synonym, cycle time, as follows:

Throughput: The rate at which the system generates “goal units.” Because throughput is
a rate, it is always expressed for a given time period—such as per month, week, day, or
even minute. If the goal units are money, throughput is an amount of money per time
period. In that case, throughput is calculated as revenues received minus totally variable
costs divided by units of the chosen time period.

Cycle time: 1) In industrial engineering, the time between the completion of two discrete
units of production. For example, the cycle time of motors assembled at a rate of 120 per
hour is 30 seconds. 2) In materials management, the length of time from when material
enters a production facility until it exits.
How does one find a constraint in a complex manufacturing plant? This may be difficult in some
situations, but often it is relatively straightforward. If work-in-process inventory is accumulating before a
process or work center and processes downstream are waiting for inputs, and if the process or work
center is working at full capacity, then it is the constraint.

Types of Constraints
Anything that has an impact on throughput is a constraint and will create a bottleneck—for example,
faulty machinery, insufficient equipment or personnel, or a work center unsuited to the required task.
Constraints can also be behavior-based; these might include specific policies, regulations, and
procedures and management choices and directives that have an impact on operations.

This section will examine the different types of constraints: physical constraints, capacity-
constrained resources, and behavior-based constraints.

Physical Constraints
Physical constraints are related to resources (equipment, labor, materials), or they are market
constraints. Consider the example of a plant with work-in-process (WIP) inventory accumulating before
a work center. What if none of the work centers had WIP inventory accumulating and none were
operating at full capacity but all orders were being scheduled and all raw materials were being released
on schedule? In this case, the constraint is said to be sales, which is a market constraint. The
production process has excess capacity.

Throughput is a rate that might be measured as units per period, or, in the case of an entire
organization, revenue per period, since this is the basic goal of for-profit organizations. If sales is the
constraint, then demand will be less than supply. If sales is not the constraint, then supply will be less
than demand, and a specific part of the system will be keeping supply from increasing to meet demand.

Capacity-Constrained Resources
There may be many areas of a system that could become a constraint, depending on how orders are
scheduled. In this case, the constraint might shift on a regular basis and may be hard to identify. The
theory of constraints identifies a danger area like this as a capacity-constrained resource (CCR),
which is defined in the APICS Dictionary, 16th edition, as follows:

A resource that is not a constraint but will become a constraint unless scheduled
carefully. Any resource that, if its capacity is not carefully managed, is likely to
compromise the throughput of the organization.

Thus a capacity-constrained resource is a potential constraint (potential bottleneck) area, while a

constraint is an active bottleneck: the current weakest link given the current load on the system. The
theory of constraints includes a process of mitigating and removing bottlenecks as they are identified,
but it also emphasizes prevention through careful management of resources and the load placed on
them.

Behavior-Based Constraints
Behavior-based constraints (e.g., the managerial constraints described in the constraint definition
above) are generated by persons and management policies. This can include administrative or other
unnecessary steps that take time away from performing necessary process steps at a bottleneck area.
It could be personnel who do not know they are working at a bottleneck work center and unnecessarily
delay the process, or it could be a management decision not to spend time on improvement because of
past failures.

Behavior-based constraints might also be related to an inability to detect or initiate improvements.

People may not understand the root cause of a problem or how to start addressing a problem that
seems too complex to solve. The theory of constraints emphasizes finding the root cause of the limits
on throughput so that the right fixes can be made. This helps to avoid spending time and money while
failing to show results. Focusing improvements on constraint areas also avoids viewing the system as
too complex to understand, because only one part needs to be studied at a time. Finally, management
will be more likely to fund and staff more improvement projects if such projects generate quick wins.

Principles of Bottleneck Management

The theory of constraints includes a number of principles related to management of bottleneck areas
versus non-bottleneck areas (any part of the system that is not currently a bottleneck).

Principles related to bottlenecks follow:

The rate at which a bottleneck can process work is the rate at which its inputs should be provided to
avoid increasing work-in-process inventory before it. Work centers that depend on the output of the
bottleneck should be scheduled to work at the rate set by the bottleneck.

The capacity of the production process depends on the capacity of the bottleneck, so breakdowns or
slowdowns in this area directly reduce system throughput.

Priority and capacity are interrelated, meaning that priority (demand) for different types of units
promotes more setups, but each new setup at a bottleneck work center is an opportunity cost
because it takes time away from processing, thus reducing utilization.

Output from bottleneck areas should be provided to the next work center(s) in smaller lots than a full
batch size. The amount to move might be the amount finished each day or even more often,
depending on materials-handling costs. This smaller lot is called a split lot or a transfer batch. The
APICS Dictionary, 16th edition, defines a split lot as follows:
 A manufacturing order quantity that has been divided into two or more smaller
quantities, usually after the order has been released. The quantities of a split lot may
be worked on in parallel, or a portion of the original quantity may be sent ahead to a
subsequent operation to be worked on while work on the remainder of the quantity is
being completed at the current operation. The purpose of splitting a lot is to reduce the
lead time of the order.

The goal should be to maximize the total throughput of the plant, in other words, to maximize the
revenue the plant produces by balancing the flow of units produced to maximize the amount of
demand that can be satisfied. This means scheduling capacity-constrained resources to avoid
bottlenecks.

Principles related to non-bottleneck areas follow:

Non-bottleneck capacity improvements do not improve total capacity.

Non-bottleneck areas set their maximum utilization not based on their potential but on the rate
determined at the bottleneck. This means that non-bottleneck areas may be idle at times. However,
when they are run, they should still be run using proper efficiency, quality, and cost principles. (They
run at full speed when running.)

Using a non-bottleneck area 100 percent of the time does not result in 100 percent utilization, since it
would simply build up more and more work-in-process inventory and eventually need to be stopped.

Drum-Buffer-Rope
Drum-buffer-rope (DBR) is the theory of constraint’s method of scheduling to account for bottlenecks.
The APICS Dictionary, 16th edition, defines it and related terms in part as follows:

Drum-buffer-rope (DBR): The theory of constraints method for scheduling and

managing operations that have an internal constraint or capacity-constrained resource.

Drum schedule: The detailed production schedule for a resource that sets the pace for
the entire system. The drum schedule must reconcile the customer requirements with the
system’s constraint(s).

Buffer: In the theory of constraints, buffers can be time or material and support
throughput and/or due date performance. Buffers can be maintained at the constraint,
convergent points (with a constraint part), divergent points, and shipping points.

The drum is similar to but not the same as takt time. It is the drummer’s beat that sets the rate of
production. The drum is the master production schedule for an organization using drum-buffer-rope
scheduling, and it becomes the constraint, because this rate of production is set to match either the rate
of demand (when sales is the constraint) or the rate of the constraint. Note that the drum is intended to
avoid the queue and wait lead times that exist in conventional manufacturing planning and control.
Rather than pre-releasing orders and forming queues before a work center and waiting after the work
center, production is initiated by the drum so queues and waiting should not form. Buffers will instead
provide the similar benefit of reducing uncertainty but in a more deliberate fashion so as not to add to
total lead time.

The buffer, or time buffer, is an amount of inventory maintained before the constraint to ensure that the
constraint never stops due to a lack of inputs. The Dictionary defines a time buffer as “protection
against uncertainty that takes the form of time.” It is a time buffer because the materials the constraint
uses as input are completed earlier than they are needed. Thus the buffer does not consist of an
inventory of general parts but rather parts allocated to future orders. The duration of the time buffer will
be based on the amount of variability in production or purchasing. For example, a three-day time buffer
would require all materials to be at the constraint buffer three days before they are actually needed.
There are often three time buffers: the constraint buffer just before the bottleneck, the assembly buffer
just before final assembly, and the shipping buffer just before shipping.

The rope is like a demand-pull signal, only, in this case, the signal is the throughput rate at the
constraint. One cannot push a rope; one can only pull it. Imagine that all work-in-process inventory is
attached to a long rope and that the constraint process is pulling on the rope at the rate needed to
match its production, neither faster nor slower. This will not only keep the constraint busy, but it will
keep the time buffers from growing longer or shorter, given some active management. If the constraint
speeds up its utilization, it pulls a little faster. If it has more setups or is otherwise delayed, it slows the
pull. However, this is just a metaphor. The scheduler will still need to coordinate the release of materials
into the system to maintain buffers.

Market Demand as Constraint

There are times when the constraint is not internal, for example, when there is insufficient demand for a
company’s product or service—i.e., demand is far below the system’s capacity and the market is
constraining the system’s throughput. This is an external market constraint.

When the market is the constraint, one would use a simplified drum-buffer-rope (S-DBR) for planning
and scheduling. An example of an S-DBR can be seen in Exhibit 4-13.
 Exhibit 4-13: Simplified Drum-Buffer-Rope

When the market is the constraint, there are certain considerations that differ from instances of internal
constraints:
The drum is at shipping and is based on market needs.
The rope connects the drum to the material release point (as in conventional DBR).
The time buffer is only at shipping. This will result in a small bank of finished goods in front of
shipping, which allows for a greater likelihood that the company will meet its order due dates.
The S-DBR assumes that all resources have sufficient protective capacity in the event of a higher-
than-expected market demand.
Based on the example in Exhibit 4-13, resource C has the potential to become the first bottleneck if
production were to increase. It therefore needs to be managed to ensure that it does not become an
active bottleneck.

An important way to address a market constraint is to get sales and marketing operations more
involved. By doing this, the organization can come up with ways to increase sales volume and demand.

One should remember a market constraint does not preclude internal constraints from occurring; the
market will, however, be the most important constraint to address. It is for this reason that the time
buffer exists at shipping, as it allows for the manufacturer to address fluctuations in demand.
Index
A
A-plants [1]

B
backflushing [1]
backlogs [1]
batch processing [1]
behavior-based constraints [1]
bottlenecks [1] , [2] , [3]
buffers [1] , [2]

C
capacity-constrained resources [1]
capacity control [1]
capacity cushion [1]
capital expenditures [1]
CCRs (capacity-constrained resources) [1]
certified suppliers [1]
consignment [1]
constraints [1] , [2]
continuous replenishment [1]
contract buying [1]
contract negotiation [1]
cost(s)
landed [1]
total cost of ownership [1]
CR (critical ratio) [1]
critical ratio [1]
customer requirements [1]
cycle time [1]

D
DBR (drum-buffer-rope) [1]
demand
nonstandard [1]
dispatching [1]
dispatching rules [1]
dispatch list [1]
dock-to-stock [1]
drum-buffer-rope [1]
drum schedule [1]

E
earliest job due date [1]
earliest operation due date [1]
EDD (earliest job due date) [1]
exception management [1]
external supply [1]

F
FCFS (first come, first served) [1]
first come, first served [1]
flow rate [1]
functional requirements [1]

G
goods, receiving [1]

I
I/O (input/output control) [1]
implementation [1]
input/output control [1]
input/output reports [1]
intermittent processing [1]
I-plants [1]

L
landed cost [1]

M
managed inventory [1]
multisourcing [1]

N
nonstandard demand [1]

O
ODD (earliest operation due date) [1]
operations sequencing [1]
order processing [1]

P
PAC (production activity control) [1] , [2] , [3]
partners, suppliers as [1]
payment, approval of [1]
performance measurement [1]
physical constraints [1]
physical supply [1]
POs (purchase orders) [1]
price requirements [1]
priority control [1]
procurement [1]
product
flow analysis [1]
production activity control [1] , [2] , [3]
production rate [1]
production schedule [1]
purchase orders [1]
purchase requisitions [1]
purchases [1]
purchasing [1] , [2] , [3] , [4] , [5] , [6]

Q
quality [1]
quality requirements [1]
quantity requirements [1]
queue management [1]

R
requests for quote [1]
requirements [1]
requisitions [1]
reverse auctions [1]
RFQs (requests for quote) [1]
route master sheet [1]

S
scheduling [1]
shortest process time [1]
single-source supplier [1]
slack time [1]
sole-source supplier [1]
specifications [1]
split lots [1]
SPT (shortest process time) [1]
SRM (supplier relationship management) [1]
standards [1]
supplier certification [1]
supplier performance measurement [1]
supplier relationship management [1]
suppliers [1] , [2]
supply chains
disruptions in [1]
supply changes in [1]
supply external [1]

T
takt time [1]
TCO (total cost of ownership) [1]
terms and conditions [1]
theory of constraints [1]
throughput [1]
time buffer [1]
TOC (theory of constraints) [1]
total cost of ownership [1]
T-plants [1]

V
VATI analysis [1]
vendor-managed inventory [1]
VMI (vendor-managed inventory) [1]
V-plants [1]