Michael Harding, C.P.M., CPIM
Michael Harding, C.P.M., CPIM, President, Harding & Associates, Bristol, VT 05443 (802)453-5379.
Every buying organization wants shorter suppliers lead times - a lot shorter. In the past, we have expedited, negotiated supplier-held and consigned inventories, made deals with distributors to stock OEM items, and pushed for supplier partnerships. In the end, the ebb and flow of the economy has had, perhaps, the greatest impact on supplier lead times - lower backlogs mean quicker deliveries.
A TWO PRONGED ATTACK
The anatomy of lead times:
You place an order (for example: small transformers) with your favorite supplier and it is acknowledged with an eight week lead time. Now, you know that it there is not eight weeks worth of labor or process time in the manufacture of the transformers; there is (with curing and testing time) about twelve minutes worth of value-added time. So why the big difference in time? Well, the supplier must order the materials (cores are long lead time items for your supplier), schedule your transformers into their backlog, and the economy of scale dictates that the entire order must be processed at once. From the administrative side, the supplier has quoted eight weeks for several years, so you build eight weeks into your MRP or otherwise have furnished to your production control department and the lead time has been embedded into our (and our supplier's) thinking and planning. It has become a self- fulfilling prophesy.
In our example, we are looking at twelve minutes versus eight weeks or a ratio of 1: 1600 (60 min. X 8 hrs. X 5 days X 8 weeks = 19,200 min. / 12 min. ) minutes process time. Or:
Velocity = Lead Time / Value-added Time = 1600
Let's also assume that this is a recurring order. Every time we place a discrete order, we legitimize and reinvent the supplier's lead time. What if long-term orders (requirements or systems contracts) were used for on-going needs? Would this influence your expectations of the supplier's lead times. It would probably reduce lead times from their suppliers (i.e. cores) but the supplier still has a process time problem. What if you now say to the supplier, "I realize that your value-added time is far smaller than the lead time you are quoting me. I am a reasonable buyer, I will pay you for a ratio of 1:200 (or one week)." The other seven weeks are expensive to the buyer because the supplier must pass on the costs of handling, storage, non- functional testing, obsolescence, administration, and other overhead functions associated with the non-value-added time. The price we pay is, in part, determined how the supplier elects to run his or her business. Later we will want the supplier to reduce the ratio further to further reduce the costs associated with manufacturing. Ratios will vary from one industry to the next. For example, it is common for process industries (petrochemicals, pharmaceuticals, etc.) to have ratios of 1:5 or even 1:3. Adjust your strategy based on the type of process which produces the products you purchase. Often, supplier order administration time is greater than the process time.
2. The cost of lead time:
The longer the supplier lead time, the more inventory the buying organization must carry. We have ordered the transformers eight weeks in advance of our needs (we are not accounting for transportation time, our receiving, inspection, storage and retrieval and let us not forget the ever-popular "safety stock"). What is the cost of carrying this inventory? Barron's, in their book , suggests that the old accounting standard of 20% or two time current interest rates is inaccurate and misleading. The real cost to carry inventory is 75 percent. That means that 1.5 percent (75%/50 weeks) should be added to the supplier's quote for each week of lead time. Assume that the transformer supplier quoted us $12.50 each for 2000 transformers and eight weeks delivery. The new quote, with cost added for lead time, would be $14.00 [($12.50 X.015 X 8) +$12.50]. This puts competition in an entirely new light. What if you had three quotes for this transformer:
Using our cost of lead time/inventory formula, their quotes would now read:
If Able Corp. was our first choice based on price, we might reconsider our selection of sources and Able might reconsider the manner in which they elect to manufacture (if they expect future business from us and other aware buyers).
THE MULTIPLIER EFFECT
The lead time cost problem is compounded in cases where we are buying against forecast and there are very long lead time items. For example, you have an item you must purchase which has a lead time of 20 weeks. Current orders booked in your plant go out only 1O weeks. Production/inventory control (or buyer/planner) rely on and use your company's sales forecast to advance order long lead time components for anticipated orders. Sales forecasts are notoriously inaccurate, you order more than is needed. Inventories increase. But let's not blame sales forecasts. There is no such thing as an accurate sales forecast - if it were accurate it would not be a forecast! "Accurate Forecast" is an oxymoron (mutually exclusive terms) such as "Express Mail," "Liquid Gas," "Working Vacation," or "Military Intelligence." The problem is not that the forecast is inaccurate; the problem is that the further out an organization must guess what customers will want, the less accurate is the guess. The degree of inaccuracy is magnified exponentially with increased time. The problem is lead time.
If suppliers are led to believe that reduced lead times are important to you, you had better assign a value to those lead times and associated inventories and communicate what you believe and are doing to your suppliers. It will not be real for them until they start to loose business to more effective competitors. Only then will they take action to improve.
Rather than changing the way they manufacture, some suppliers offer consigned inventory or OEMs will offer to have a local distributor stock the goods. Guess who pays for this? If you have an unexpectedly large demand which is greater than the numbers stocked, you have the same problem again.
Supplier-held inventories have the same short-comings as those in the preceding paragraph.
Many companies, out of frustration, deal with the symptom and not the problem by using expediters (or making expediters out of buyers). This increases your overhead and does not address the root cause of the problem which means that the problem will recur.
Harding and Harding, Purchasing. (New York, Barron's Educational Series, 1991) p. 205.
Michael Harding is a principal of Michael Harding & Associates a firm specializing in a form of Just-In-Time manufacturing known as Manufacturing Velocity and materials related consulting and education.
Mr. Harding is a former Corporate Manager of JIT Education and Training for Digital Equipment Corporation. Michael has over twenty-six years of industrial experience including positions as Materials Manager, Manager of International Purchasing, Supplier Quality Manager, and Manufacturing Manager with such companies as Texas Instruments, RCA, TRW, General Electric, and Hercules.
His firm works with a number of the Fortune 500 and smaller companies as well to reduce manufacturing cycle times and inventories while substantially improving product quality and cash flow. His clients are located in the North and South America, the Far East and Europe.
Michael holds degrees in business, law, and a Masters in Purchasing and he authored the book Profitable Purchasing and coauthored Purchasing. He has been a guest lecturer at the Beijing Materials College and the Alfred P. Sloan School at M.I.T. Mr. Harding conducts seminars for Clemson University, the University of Wisconsin, Incolda (Colombia) and the National Productivity Board (Singapore). He is certified by APICS (CPIM) and the NAPM (C.P.M.).