Chapter 16 Lean Supply Chain Management XXX

Chapter 16
Lean Supply Chain

Management
Monczka/Handfield/Giunipero/Patterson, Purchasing & Supply Chain Management, 6 th Edition. © 2016 Cengage. All Rights
Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.
Chapter Overview
• Understanding supply chain inventory

• Right reasons for investing in inventory
• 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 time between when 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 Inventoray
• Types of inventory
• Raw materials and semifinished items
• Work-in-process (WIP)
• Finished-goods
• Maintenance, repair, and operating supplies (M RO)
• Pipeline/In-transit
Raw Material and Semifinished Item Inventory
• Items purchased from suppliers or produced internally to directly support

production requirements
• Bulk quantities
• Unfinished condition
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)
MRO Supplies Inventory
• Used to support production and operations

• Not physically part of finished product
• Critical for continuous operation of plant, equipment, and offices
Pipeline/In-Transit Inventory
• In transit moving to customer

• Located at various places throughout distribution channel
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 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
• 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 × P × 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
Determining Quality Costs
• Difficult to quantify
• Historical neglect of calculating total inventory costs
• Lack of cost accounting systems capable of identifying quality-related costs
• Can use activity-based costing (ABC) to better determine real costs
• New types of ERP systems help to track inventory levels
Inventory – Asset or Liability?
• Historically considered current asset

• Disregarded inventory carrying costs
• Negative impact on cash flow, working capital requirements, and profitability
• Inventory ≠ Cash and Receivables
• Need to translate real impact on organization’s financial measures
• Determine key performance indicators
Linking Inventory and Financials
Impact of Inventory Activities
• Need to determine how inventory management affects….

• Earnings per share
• Economic value-add
• Return on assets
• Working capital
• Cash flow
• Profit margin
Amazon.com Example – Data
Year Net Sales ($M) Inventory ($M) Inventory Turns
1997 $ 148 $9 16.4
1998 $ 610 $ 30 20.3
1999 $ 1,640 $ 221 7.4
2000 $ 2,762 $ 175 15.8
2001 $ 3,122 $ 143 21.8
2002 $ 3,933 $ 202 19.5
2003 $ 5,264 $ 294 17.9
2004 $ 6,921 $ 480 14.4
2005 $ 8,490 $ 566 15.0
2006 $ 10,711 $ 877 12.2
Amazon.com Example
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 (1 of 2)
• Poor quality and material yield

• Unreliable supplier delivery
• Extended order-cycle times from global sourcing
• Inaccurate or uncertain demand forecasts
Wrong Reasons for Inventory (2 of 2)
• Specifying custom items for standard applications

• Extended material pipelines
• Inefficient manufacturing processes
• Most inventory waste comes from underlying problems that management has
failed to correct
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 (JIT)
(non-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 use of people

• Simplify first, and only then apply new technology
• Focus on gradual, but continuous, improvement
• Kaizen
• Minimize waste
• Including poor quality
Inventory Positioned throughout a Supply Chain
Supply Chain after Elimination of Excess Inventories
Lean Supply (1 of 4)
• Commitment to zero defects by both buyer and supplier

• Frequent shipments of small lot sizes
• Strict quality and delivery performance standards
• Closer, even collaborative, buyer-supplier relationships
• Stable production schedules sent to suppliers on regular basis

• Extensive sharing of electronic information between supply chain members
• Electronic data interchange (EDI) capability with suppliers
• Requires effective and detailed supply planning

• Ongoing requirement to establish …
• Financial health of all players
• Ability to grow with the buyer company
• Ability to continuously improve
• Need to colocate supplier engineers and material managers with buyer
• Begins and ends with thorough and well-developed commodity strategies

• Plan for continuous cost improvement establishes critical cost drivers
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
Keys to 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 production card
• Empty container serves as move signal
• Other types
• Color coding of containers
• Designated storage spaces
• Computerized bar coding systems
Requirements for Implementing Lean (1 of 2)
• Management leadership must be committed and involved

• Improvement activities must focus on elements of process that directly
impact business objectives
• Lean takes time, discipline, and effort
Requirements for Implementing Lean (2 of 2)
• Lean production requires people to apply disciplined methodologies to …

• First, drive improvements
• Then sustain them into the future
• Improvement is never finished!
• Decisions must be based on fact and data, not opinions or preferences of
influential individuals
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
Managing Inventory Investment
• Achieve perfect record integrity

• Improve product forecasting
• Standardize and simplify product design
• Leverage companywide purchase volumes
• Use suppliers for on-site inventory management
• Reduce supplier-buyer cycle times
Achieving Perfect Record Integrity
• Agreement between electronic records (ROH) and physical inventory (POH),

regardless of inventory level
• Ideal: ROH = POH
• Any difference equals error
• If error exists, identify source and take corrective action
Questions On Record Integrity (1 of 2)
• Are record errors displaying random or systematic a pattern across SKUs?

• How severe are differences between POH and ROH electronic records?
• Are proper receiving, stock-keeping, and withdrawal procedures and systems
in place?
• Is theft a problem?
Questions On Record Integrity (2 of 2)
• Are suppliers shipping quantities that match their documentation?

• Are effective cycle-counting procedures used?
• Is inventory scrap and obsolescence accounted for correctly?
• Do employees properly move, handle, and disburse material?
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
Standardization and Simplification (1 of 4)
• Fewer part numbers

• Fewer suppliers
• Reduced transactions to support inventory
• Lower inventory management costs
• Reduced product cost

• Lower inventory value required to support customer demand and service
requirements
• May require major organizational culture shift

• Is a strategic decision
• Requires top management support and direction regarding complexity and
SKU proliferation
• Is best accomplished during product design
• Establish premium pricing for customization

• Establish geographic-specific options and standards
• Maintain database of option requests
• Do not eliminate frequently requested options
• Utilize business modeling and TCO tools to support complexity reduction
Product Design Criteria (1 of 3)
• Will item be sole, single, or multi-sourced?

• Does new offering involve a new technology risk item?
• Who are manufacturers, and who are integrators for the parts?
• Where are all the suppliers located, and what is the logistics plan?
• Where are these parts used in industry today and in future, which could
affect overall demand?
• What are expected cost takedown rates?
• What does the product road map look like in terms of possible product
substitutes?
• Are there any key alliances that need to be considered from key suppliers or
competitors?
• What is the flexibility to use a particular part in other product lines, or is part
leveraged from another product?
• Can these parts be sold as aftermarket options or service parts?
Leverage Purchase Volumes
• Consolidated volumes → lower costs

• Reduction in capital tied up in inventory
• Use of supplier-owned consignment inventory
• Defer ownership
• Avoid committing working capital and incurring carrying charges
Use Suppliers for On-Site Inventory Management
• Use of distributors
• Particularly for MRO supplies
• Assignment of on-site supplier personnel to order on as-needed basis
• Stock wider range of items
• Reduction of paperwork to submit order(s)
Reduce Supplier-Buyer Cycle Times
• Expanded electronic capability

• Supplier development support
• Order-cycle time measurement
• Focus on second- and third-tier suppliers
• Result in less safety stock
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
• 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 vehicle load scheduling
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 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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Chapter 16

Lean Supply Chain

• Understanding supply chain inventory

• Efficient and effective inventory management is central to global

• Items purchased from suppliers or produced internally to directly support

• Waiting to be moved to another process

• Used to support production and operations

• In transit moving to customer

• Price that buyer pays for each unit

• Composite costs associated with the release of material order

• Costs related to storage space

Element Average Range

Carrying cost = AI × P × ACC

• Any cost associated with nonconforming items or goods

• Historically considered current asset

• Need to determine how inventory management affects….

• Avoid disruptions in operational performance

• Poor quality and material yield

• Specifying custom items for standard applications

• Focused on eliminating process variance, as well as improving processes

• Lean can be applied to wide range of production and service environments

• Maximize use of people

• Commitment to zero defects by both buyer and supplier

• Stable production schedules sent to suppliers on regular basis

• Requires effective and detailed supply planning

• Begins and ends with thorough and well-developed commodity strategies

• Dispersed supply base

• Efficient movement of goods between supplier and buyer

• Reduce number of carriers

• Use simple signaling mechanisms to indicate when materials should be

• Single card systems

• Management leadership must be committed and involved

• Lean production requires people to apply disciplined methodologies to …

• Amount of physical inventory firm owns at any given time

• Unit cost and total $ value of inventory

• Achieve perfect record integrity

• Agreement between electronic records (ROH) and physical inventory (POH),

• Are record errors displaying random or systematic a pattern across SKUs?

• Are suppliers shipping quantities that match their documentation?

• Higher inventory volumes

• Fewer part numbers

• Reduced product cost

• May require major organizational culture shift

• Establish premium pricing for customization

• Will item be sole, single, or multi-sourced?

• Consolidated volumes → lower costs

• Expanded electronic capability

• Delivered on-time, accurately, and in perfect condition

• Material requirements planning (MRP) system

• Based on independent demand

• Forecasting finished goods inventory

• Responsible for managing inventories regardless of location in supply chain

• Act as liaison between various supply chain components

• Involve computerized material and EDI systems to track inventory flow

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