Production planning, for many companies, is still akin to a miscalculated speculation. Their production is based on a forecast, and they build according to that forecast -- which is rarely right. As a result, too many companies end up building product that they don't sell and selling product that they didn't make. This impacts the company's working capital. In addition, the inventory that the Asset lenders rely on to secure their loans may not be worth what they believe they're worth.
Instead of trying to predict the future, I suggest that companies should use Lean Manufacturing principles to establish proper inventory levels. Many companies claim they do this, but may be doing it incorrectly. They establish inventory levels based on average usage without regard to replenishment time and variation in customer demand. Since many companies establish a fixed inventory level, every sales order triggers a production requirement. This leads to excessive changeovers and downtime of the production lines. In addition, rarely does management have the visibility into current inventory levels, and, even if they knew the inventory levels, many don't know what the inventory is versus their open sales. Critical decisions are being made by planners that should be made by upper management.
Generating a Need Report
One step in addressing this issue is the creation of a "Need Report" --- a document generated each day which provides a visual snapshot of the company's inventory levels, where open orders stand against inventory, and whether the inventory level is below the reorder points established for each product.
Past sales for each product code are analyzed to determine the average usage and the week-to-week variation. Reorder points are established for each product code. Reorder points are the inventory levels at which a signal to produce more product is sent to production. They are based on the time required for manufacturing to replenish the inventory times the average usage plus a certain amount of safety stock which is usually based on the amount of demand variation.
For example if the average usage is 1000 units per week and the replenishment time is 3 weeks then the reorder point will be 3000 units plus the safety stock. Based on a 95% confidence level, the safety stock should be 1.65 times the standard deviation. Therefore, if the standard deviation is 1000 units, then the safety stock should be 1650 units and the reorder point would be 4650 units. The goal is for production to replenish the inventory before the inventory level reaches zero. The greater the company's sensitivity to out of stock conditions the greater the safety stock.
Reorder quantities are determined based on the frequency the company wants to produce the product, which is usually based on an ABC analysis and an economic order quantity. ABC analysis is an analysis that categorizes each product code as an A item (high volume code), B item (medium volume code) or a C item (low volume code). Economic order quantities are based on changeover time and other economic factors, such as minimum buys.
For example, if a certain product requires a large changeover time then the company may choose to make that product only once every 10 weeks. If the average usage is 1000 units per week, then the reorder quantity would be 10,000 units. Many companies establish min/max levels and continuously build to the max level even when the production quantity is not economically viable.
Blaming the Planning Group
Many times, companies blame the planning group when there is not enough inventory to cover orders. Since forecasts are usually wrong, planners are always reactive, constantly fighting fires. They need to manage everything and cannot be proactive. By creating a planning process with reorder points and reorder quantities, planners only need to manage exceptions. They can then be more proactive to manage change in customer demand and to change reorder points and reorder quantities accordingly.
Reducing Replenishment Time
In order to reduce inventory levels and free up cash for marketing, research and development or even capital equipment, companies must continue to focus on reducing the replenishment time through the elimination of waste in their processes and through the use of one-piece flow manufacturing. As companies reduce the batch size and eventually get to one-piece flow, they reduce the manufacturing cycle time and are therefore able to replenish the inventory faster. In addition, companies need to reduce the changeover times of their equipment using Lean principles, such as SMED (single minute exchange of dyes) to reduce the reorder quantities. This will also reduce the replenishment time due to shorter runs and less down time of the equipment. By following these principles companies can react faster to the ever changing demands of their customers. At the end of the day it's all about satisfying the customer.
The Unobvious Downside of Continuous Machine Operation
It should be noted that many companies ignore the concepts of Lean when they keep their expensive machines operating despite the fact that their inventory levels exceed their needs. Companies feel compelled to absorb the overhead of their expensive equipment, and keep the machines running because they don't want their investment to sit idle. In the meantime, their warehouses are overflowing, their raw materials are being consumed and their workforce is getting paid for unneeded work. This creates a strain on working capital. These manufacturing-driven companies need to break this type of company culture and become sales-driven companies, i.e. make product to meet the demand. If there were less strain on working capital, companies would have the funds to invest in new product development and sales and marketing.
For many companies it is difficult to change the company's culture without outside help. For sustainable change to occur, however, the change process must also involve the company's workforce, who will keep the Lean principles, as they keep the company's products, moving through the system smoothly and painlessly.
Fred Langer is a Managing Director for Getzler Henrich & Associates LLC. He heads up their Lean Manufacturing/Six Sigma group. Getzler Henrich & Associates is a turnaround firm which helps companies improve operational effectiveness, restore financial stability and enhance and preserve value. Please see www.getzlerhenrich.com for more information.