Chapter 16

Purchasing &
Supply Chain
Management
7th edition
Chapter 16
Lean Supply Chain Management
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Learning Objectives (1 of 2)
By the end of this chapter, you should be able to:
• Identify the different categories of inventory
• Identify the various costs associated with maintaining supply chain
inventory
• Assess the financial impact of managing inventory more effectively
• Understand the right reasons for maintaining an investment in inventory
Learning Objectives (2 of 2)
By the end of this chapter, you should be able to:
• Appreciate the challenges of creating a lean supply chain
• Identify ways to manage and improve inventory investment
• Recognize the important relationship between inventory management
and delivering the perfect customer order
Chapter Overview
• Understanding supply chain inventory
• The right reasons for investing in inventory
• The wrong reasons for investing in inventory
• Creating the lean supply chain
• Six Sigma
• Approaches for managing inventory investment
• Delivering the perfect customer order
Inventory Management
• Efficient and effective inventory management is central to global
competitiveness
• Inventory management also applies to non-manufacturing and service
industries
• Move towards lean supply chain
High Levels of Inventory
• Result in …
− Higher carrying costs
− Reduced profit
− Diminished market share
• Hide other problems such as …
− Poor material quality
− Inaccurate demand-forecasting systems
− Unreliable supplier delivery
Lean
• Lean
− Philosophy that seeks to shorten the time between the customer order
and shipment to customer by eliminating waste
• Objectives of lean
− Flow
− Pull
− Striving for excellence
Lean Objectives
• Flow
− Inventory moves through supply chain continuously with minimal
queuing or non-value-adding activity being performed
• Pull
− Customer orders start work process, which ripples down the supply
chain
• Striving for excellence
− Supply chains must have perfect quality
Understanding Inventory
• Types of inventory
− Raw materials and semi-finished items
− Work-in-process (WIP)
− Finished-goods
− Maintenance, repair, and operating supplies (MRO)
− Pipeline/In-transit
Work-in-Process Inventory
• Waiting to be moved to another process
• Currently being worked on at work center
• Lining up at processing center because of capacity bottleneck or machine
breakdown
− May need to divert to another work center
Finished-Goods Inventory
• Completed items
• Products available for shipment or future customer orders
• Environments
− Make-to-stock (MTS)
− Make-to-order (MTO)
− Just-in-time (JIT)
Inventory-Related Costs
• Unit costs
• Ordering costs
• Carrying costs
• Quality costs
Unit Costs
• Price that buyer pays for each unit
• Actual costs of making or providing each unit
− Direct materials
− Direct labor
− Allocated overhead
Ordering Costs
• Composite costs associated with the release of a material order
− Generating and sending material release
− Transportation costs
− Any other cost of acquiring a good
• With internal production, may include machine setup costs
Carrying Costs
• Components
− Cost of capital
− Cost of storage
− Costs of obsolescence, deterioration, and loss
• Opportunity cost
− Capital is not available for other uses
• Vary with level of inventory
• Inventory increases risk of theft, damage, spoilage, and obsolescence
Costs of Storage
• Costs related to storage space
• Insurance costs
• Costs of maintaining inventory
− Cycle counting
• Vary with level of inventory
− Considered variable cost
Inventory Carrying Costs
Element Average Range

Capital cost 15.00% 8 – 40%
Taxes 1.00% 0.5 – 2%
Insurance 0.05% 0 – 2%
Obsolescence 1.20% 0.5 – 2%
Storage 2.00% 0 – 4%
TOTAL 19.25% 9 – 50%
Calculation of Carrying Cost
Carrying cost = AI x P x ACC
Where:
AI = average inventory in units
P = unit price
ACC = carrying cost per year
Quality Costs
• Any cost associated with nonconforming items or goods
• Examples
− Field failure costs
− Rework
− Losses because of poor product yields
− Inspection
− Lost production
− Warranty costs
Inventory – Asset or Liability?
• Historically considered a current asset
− Cash or cash-equivalent turned into cash within 12 months
− Disregarded inventory carrying costs
− Negative impact on cash flow, working capital requirements, and
profitability
• Inventory ≠ Cash and Receivables
− Need to translate real impact on organization’s financial measures
• Determine key performance indicators
Right Reasons for Inventory
• Avoid disruptions in operational performance
• Support operational requirements
• Support customer service requirements
• Hedge against marketplace uncertainty
• Take advantage of order quantity discounts
Wrong Reasons for Inventory
• Poor quality and material yield
• Unreliable supplier delivery
• Extended order-cycle times from global sourcing
• Inaccurate or uncertain demand forecasts
• Specifying custom items for standard applications
• Extended material pipelines
• Inefficient manufacturing processes
Creating the Lean Supply Chain
• Just-in-time
− Philosophy of manufacturing based on planned elimination of all waste
and on continuous improvement of productivity
• Evolving to lean thinking
− Way to understand value from customer’s perspective and eliminate
waste processes that do not add value
− Process improvement philosophy
Lean Tools
• Employee involvement
• 5S visual management
• Pull systems
• Continuous flow
• Flexible manufacturing
• Supplier partnerships
Six Sigma
• Focused on eliminating process variance, as well as improving processes
that are not in control
• Relies on statistical and problem-solving tools
• Provides a core set of philosophical underpinnings based from broad
TQM principles
Performance Advantage of JIT/Lean
GM Framingham Toyota Takaoka
(non-JIT) (JIT)
Assembly
40.7 hours 16 hours
hours/vehicle
Defects per 100

130 defects 45 defects
vehicles
Average inventory
Two weeks Two hours
levels
Summary of the Lean Philosophy
• Lean can be applied to wide range of production and service
environments
• Lean companies use a wide range of planning and control techniques, not
just JIT
• Lean is closely aligned with TQM and supplier management initiatives
Principles of the Lean Concept
• Maximize the use of people
• Simplify first, and only then apply new technology
• Focus on gradual, but continuous, improvement
− Kaizen
• Minimize waste (non-value-adding)
− Including poor quality
Inventory Positioned throughout
a Supply Chain
Supply Chain after
Elimination of Excess Inventories
Lean Supply Barriers
• Dispersed supply base
• Historic buyer-supplier relationships
• Number of suppliers
• Supplier quality performance
Lean Transportation
• Efficient movement of goods between supplier and buyer
• Frequent deliveries of small quantities directly to point of use
• Relies on company-owned or contracted vehicles on regular and repeated
schedule (closed loop)
• Long-term dedicated contract carriers
Designing Lean Transportation
• Reduce number of carriers
• Use longer-term contracts
• Establish electronic linkages
• Implement a closed loop system
• Handle material efficiently
− Specialized transportation vehicles
− Returnable containers
− Deliver to customer point-of-use
Just-in-Time Kanban Systems
• Use simple signaling mechanisms to indicate when materials should be
produced or moved
− Containers, cards, or signals
• Provide synchronization of activities
• Control mechanisms, not planning tools
• Act as pull system
Kanban Signaling Methods
• Single card systems
− Single card is the production card
− Empty container serves as the move signal
• Other types
− Color coding of containers
− Designated storage spaces
− Computerized bar coding systems
Three V Model of Inventory
Volume Velocity
Value
Volume
• Amount of physical inventory firm owns at any given time
• Key measures
− Total units on hand
− Safety stock levels
• Activities affecting volume
− Improved forecasting techniques
− Supplier-provided consignment inventory
Velocity
• How quickly inputs become finished goods that are accepted and paid for
• Key measures
− Inventory turns
− Material throughput rates
− Order-to-cash cycle time
− Lean supply chain practices
− M-T-O production
Value
• Unit cost and total $ value of inventory
• Key measures
− Total $
− Period-by-period unit value changes
− Ratio of sales to working capital
− Product simplification and standardization
− Leveraged purchase agreements
Downside of Poor Forecasting
• Higher inventory volumes
• Higher inventory carrying charges
• Poor customer service
− Inventory is misallocated across locations and products
• Excessive safety stock levels
The Perfect Customer Order
• Delivered on-time, accurately, and in perfect condition
• Factors
− Supplier delivery problems
− Stockouts
− Manufacturing delays
− In-transit or delivery delays
Imperfect Customer Orders
• Inaccurate quantities
• Poor quality of finished goods
• Damage during transit
• Incorrect or missing documentation
Delivering the Perfect Customer Order
• Material requirements planning (MRP) system
• Distribution resource planning (DRP) system
• Supply chain inventory planners
• Automated inventory tracking systems
MRP System
• Based on independent demand
• Considers period-by-period set of master production schedule (MPS)
requirements
− Anticipated or booked customer orders
• Develops time-phased set of material, component, and subassembly
requirements to support an expected build schedule
− By part number
DRP System
• Forecasting finished-goods inventory
• Establishing correct inventory levels at each stocking location
• Determining timing and replenishment of finished-goods inventories
• Allocating items in short supply
• Transportation planning and scheduling vehicle loads
Supply Chain Inventory Planners
• Responsible for managing inventories regardless of location in supply
chain
• Use of supply chain planning and execution systems
• Organized along product lines
• Coordinates movement and placement of inventory
Inventory Planner Roles
• Act as liaison between various supply chain components
• Develop smooth production schedules
• Establish production targets
• Determine inventory deployment at field warehouses
• Continuously evaluate safety stock levels
Automated Inventory Tracking Systems
• Involve computerized material and EDI systems to track inventory flow
throughout entire supply chain
− Connect suppliers, production plants, field distribution centers, and
customers
• Are based on EDI, bar coding, and RFID technologies
• Provide real-time visibility

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Purchasing &

Element Average Range

Carrying cost = AI x P x ACC

Defects per 100

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