Over the years, we've seen continuous-improvement programs evolve from manufacturers' shop floors to enterprisewide initiatives in diverse organizations such as the military, medical care, service industries and even government. After all, it's all about process improvement and every organization in the world has processes they use in the delivery of their products and services.
But what comes next? The continuing evolution of business models and strategies has led to many organizations outsourcing more and more of their value-adding activities and becoming more like general contractors in managing their supply chains to deliver products and services to their customers. Just think about the automobile industry where we have moved from the Henry Ford model of owning rubber plantations, making steel and producing all the components for the Model A cars at the Rouge facility in Dearborn to today's model where the major automobile companies have moved to a design, procure, assemble and ship business model. This is happening in many organizations worldwide, both in manufacturing and other types of businesses. The impact is that many manufacturers are seeing the direct labor portion of their cost of goods sold (COGS) drop into the single-digit percentages while purchased components and materials often account for over 60% of their COGS (with overhead at 30% or more). What does this mean for the practitioners focused on lean transformation and continuous improvement? The focus now needs to be on the extended supply chain, both upstream and downstream.
When we look at the cost structure for most businesses today, does it make sense to focus so much of our energy on trying to reduce a cost that constitutes such a small percentage of our COGS? It has been estimated that 80% of the cost of a product is determined in the first 30% of the product development cycle, but how many organizations have their suppliers working with their product development engineers at these early stages of design to incorporate the suppliers' input to reduce product costs? Those companies that do involve their suppliers early in the development process estimate that their product costs are reduced by 30% or more compared with their old, independently designed products, just by involving suppliers and listening to their inputs on design ideas that make it less costly to produce the components. Looking downstream, how can a company's business practices impact the cost of delivery to the end user? Do the compensation plans for your sales force create month-end or quarter-end order spurts that prevent level loading of your factory and whipsaw your suppliers with huge swings in weekly delivery demand? Are distributors required to carry large inventories of your products when they don't have orders for these goods? Are you able to configure your products to order, or are downstream operations required to make modifications or add components prior to delivery to customers? These practices add cost to the supply chain and increase the selling price to the end user. When you do a value stream map of your production process, take it upstream and downstream to see where all the non-value-added waste exists in this extended supply chain, including your materials ordering practices and customer delivery policies.
By focusing on continuous improvement and waste elimination in this extended supply chain, you can often identify cost-reduction opportunities that are much larger than those you can identify within your own four walls. In addition, you will often find waste that contributes to longer lead times and less responsiveness to your end user customers. Expanding your continuous-improvement efforts into the extended supply chain requires the leadership and courage to form true partnerships with suppliers instead of the old-style adversarial relationships that have existed with suppliers for so long. It also requires trusting your downstream distribution channels in serving your final customers. Applying the knowledge and tools of continuous improvement to these extended supply chains is full of opportunity and will be where the action is in the future.
Ralph Keller is president of the Association for Manufacturing Excellence, an organization dedicated to cultivating understanding, analysis and exchange of productivity methods and their successful application in the pursuit of excellence. He has been an operations practitioner for the past 35 years.