In this next series of postings (i.e. 6 posts) I am going to present Appendix 5 from Bruce Nelson and my book Epiphanized: Integrating Theory of Constraints, Lean and Six Sigma. I also want to give credit to Bruce Nelson for writing this appendix, as he did all of the appendices in our book. Bruce is a gifted writer and I thank him for co-authoring this book with me.
Theory of Constraints Replenishment Model and Supply Chain
The Supply Chain
Most, if not all, businesses are linked one way or another to some kind of supply chain. They needs parts or raw materials from somebody else in order to do what they do and then pass it on to the next system in line until it finally arrives at the end consumer. Depending on what you make and how fast you make it, the supply chain can be your best friend or worst enemy. If it works well, it’s your best friend. If it doesn’t work well, it’s your worst enemy.
The fundamental problem with most supply-chain systems is that they have remained stagnant in their thinking through time, while business reality has flexed in a cycle of constant change—sometimes at an exponential rate. There are many new supply-chain software applications, each proposing that it will solve the problems associated with the supply chain. These new software applications have come about mostly because of advances in computer technology, but few have solved the real issues of the supply chain. It is true that these systems can provide an enormous amount of information very fast, but sometimes system speed is less important than having access to the correct information. What difference does it make how fast you get the information if it’s the wrong information?
The new business reality has caused a need for change in supply-chain systems, but most systems have not changed. Businesses now are required to build products more cheaply, have higher quality and deliver those products faster. These are the new rules of competition. You either play by the rules or get out of the way. The rules in business have changed, and yet many businesses insist on doing business the same “old” way. How come? Usually, the most common answer given is—“Because that’s the way we’ve always done it.” The old system and the old rules may have worked for some period of time, but times are changing. If the supply- chain system has not changed to align with the new rules, then the gap between supply-chain output and system needs will grow even larger. If the supply-chain system is not changed to meet future needs, then there is very little hope of getting different results. Many supply-chain systems were designed to solve a problem, and the problem they were trying to solve was the needed availabil-ity 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. Then and now, managing the supply chain is a tough job. There are many variables that can require constant attention. 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. This constant negative cycle of sometimes too much and sometimes too little has persisted through time. The supply problems encountered years ago are still the problems being encountered today.
The Minimum/Maximum Supply Chain
For many companies the supply chain/inventory system of choice is one often referred to as the minimum/maximum (MIN/MAX) system. Parts (or inventory) are evaluated based on need and usage, and some type of maximum and minimum levels are established for each item. The traditional rules and measures for these systems are usually quite simple:
- Rule 1: Determine the maximum and minimum levels for each item.
- Rule 2: Don’t exceed the maximum level.
- Rule 3: Don’t reorder until you go below the minimum level.
The foundational assumptions behind these rules and measures are primarily based in Cost Accounting (CA) and commonly referred to as cost-world thinking. In order to save money and minimize your expenditures for supply parts/inventory, you must reduce, or at least hold in check, the amount of money you spend for these items. In order to reduce the amount of money you spend on these items, you must never buy more than the maximum amount. Also, in order to reduce the money spent on these items, you must not spend money until absolutely necessary, and order parts only when they reach the minimum level.
These assumptions seem valid, and if implemented correctly and monitored should provide a supply system that controls dollars and maintains inventory within the minimum and maximum levels. However, most systems of this type, even in the perfect world, don’t seem to generate the desired results that are required. For some reason, there always seem to be situations of excess inventory for some items and of stock-out situations for others. There always seem to be constant gyrations (variation) between too much inventory and too little inventory. The whole operational concept behind the minimum/maximum systems was supposed to prevent these kinds of occurrences from happening, and yet they still do. How come?
In my next posting we will answer this question and discuss the consequences of Cost Accounting Metrics that often present themselves when dealing with replenishment of parts/inventory using the minimum/maximum replenishment system.