Thursday, January 16, 2014

Focus and Leverage Part 293

Continuing on our series on Constraints Management, today I want to briefly discuss TOC’s replenishment methodology.  Many supply-chain systems were designed to solve a problem, and the problem they were trying to solve was the needed availability of parts, raw materials or inventory— the right part/material, in the right location, at the right time. These systems were designed to hold inventory in check—that is, don’t buy too much, but also don’t allow stock-out situations to occur. You don’t want to run out of parts, and yet, sometimes, you still run out of parts. You don’t want excess inventory, and yet sometimes, you have too much inventory.

For many companies the supply chain/inventory system that they choose to use is one referred to as the Minimum/Maximum (Min/Max) system. Parts (or inventory) are evaluated based on both need and usage and then a maximum and a minimum stock level is established for each item. The typical rules for using the Min/Max System are very easy to follow:

Rule 1: Determine the maximum and minimum levels for each stock item.

Rule 2: When reordering, never exceed the maximum stock level.

Rule 3: Never reorder until you go below the minimum stock level.

This system seems simple enough, but what kind of results can you expect from it?

For some rea­son, using the Min/Max system, there always seems to be excess inventory for some items and of stock-out situations for others. There are typically constant gyrations (variation) between too much inventory and too little inventory. The whole operational concept behind the Min/Max systems was supposed to prevent these kinds of oc­currences from happening, but they frequently occur with many companies using this system.  The roots of this system came from traditional cost accounting where the focus is on saving money, so many companies purchase parts in large quantities to receive a volume discount.  Maybe the minimum and maximum levels are the wrong rules to engage, and saving money is the wrong financial meas­ure to consider?  Even though the Min/Max system appears to control the supply needs and cover the inventory demands, there are some significant negative effects caused by using this system.

First, there is the problem of being reactive to an inventory or parts situation, rather than proactive. When minimum stock levels are used to trigger the reordering of parts, some supply-chain systems will have a difficult time keeping up with the demands being placed upon them. And there is an increased probability that stock-outs will occur, maybe even for long periods of time.  Most of the time, stock-outs happen because the lead time to replenish the part exceeds the minimum stock available.  Depending upon the part, there can be a long amount of time between the stock-out and the arrival of the replacement part.  When this happens, production grinds to a halt and production lines shut down until the needed part arrives.
You may be thinking to yourself that if you simply increase the minimum amount to trigger a reorder sooner in the process, you could avoid a repeat of the stock-out situation. You may be right that this approach could provide some short-term relief, but at the end of the day, this approach will cause inventory levels to go up and stay up.  The Min/Max system is clearly reactive in nature because you are waiting for the part to reach its minimum stock level before reordering it. In many companies the most frequently used parts are managed using this system and it’s not uncommon for these parts to be frequently out of stock.  These stock-outs look like the following image.

This graph demonstrates the negative consequences of the Min/Max supply system and demonstrates why supply-chain systems using this system will periodically create excessive inventory and stock-out situations.

In my next posting, I’ll show you TOC’s replenishment system and discuss why it will always work much better than the Min/Max system.

Bob Sproull




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