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Executive Insight Eliyahu Goldratt wrote a book titled The Goal, about a factory manager's quest to save his factory from being closed... thumbnail 1 summary
Executive Insight

Eliyahu Goldratt wrote a book titled The Goal, about a factory manager's quest to save his factory from being closed down for lack of profitability. It chronicles the process that the manager and his staff go through as they learn how to save their factory. What they learn is how to apply the principles of what Mr. Goldratt calls the "Theory of Constraints."

Mr. Goldratt and others have realized that the theory of constraints applies equally well to the operation of a whole supply chain as to the operation of a single factory within a supply chain. Lawrence D. Fredendall and Ed Hill in their book Basics of Supply Chain Management (Basics of Supply Chain Management, Boca Raton, Fla., St. Lucie Press, 2001) have put forth a clear explanation for how to apply the theory of constraints to synchronize the operations of a Supply Chain.

The theory of constraints provides a useful model to conceptualize and manage the Supply Chain within a single company or across a collection of companies. The theory of constraints is based upon the idea that all systems have at least one constraint and that it is better to manage constraints than to try to eliminate them. This is because when one part of a system ceases to be a constraint, a different constraint will occur in another part of the system. This is inevitable because the capacities of each part of a system are not all the same. So instead of forever reacting to new constraints or bottlenecks as they appear, why not choose a small group of constraints and manage them deliberately and efficiently?

To apply this model, the first step is to define the goal and decide what measurements will be used to measure progress toward the goal. Mr. Goldratt's definition of the goal for a manufacturing company also works for a supply chain. The goal is defined as "Increase throughput while simultaneously reducing both inventory and operating expense." Throughput is the rate at which sales to end customers occur.
Once a goal has been defined and there is agreement on how to measure progress toward the goal, it is possible to apply the five focusing steps. These steps help clarify the situation being investigated and lead to the decisions necessary to reach the goal. The five steps are:
1.       Identify the system's bottlenecks or constraints -- Trace out the workflows and the paths that materials travel in a factory or a supply chain. Find out where slowdowns and backups occur.
2.       Decide how to exploit these bottlenecks -- Figure out how to maximize the operation of those activities that are bottlenecks. The rate of throughput for the entire system is set by the rate of throughput achieved by the bottlenecks. Ensure the bottlenecks operate at maximum capacity by providing them with enough inventory so that they can continue to operate even if there are occasional slowdowns elsewhere in the system.
3.       Subordinate everything else to the above decision -- Do not try to maximize the operation of a non-bottleneck operation. Additional productivity achieved by non-bottleneck operations that exceeds the capacity of the bottlenecks to process will be neutralized anyway by the slowdowns and backups caused at the bottlenecks. Synchronize all system operations to the rates that can be efficiently processed by the bottleneck operations.
4.       Elevate the system's bottlenecks -- Add additional processing capacity to the bottleneck activities. Since the rate of throughput of the entire system is set by the throughput of the bottlenecks, improvements in the bottlenecks will increase the efficiency of the entire system and provide the best return on investment.
5.       If, in a previous step, a bottleneck has been broken, go back to step 1 -- As the capacity of one system bottleneck is elevated, it may cease to be a bottleneck. The bottleneck may transfer to another operation that could keep up before but now cannot keep up with the new increase in capacity. Watch the entire system to see where slowdowns and backups occur; they may shift from one area to another. If this occurs, start again at step 1.

The theory of constraints says that the throughput of the whole system is set by the capacity of the bottlenecks. One constraint or bottleneck in every Supply Chain is the demand that is generated by the market that the supply chain serves. In many cases, market demand is the only constraint because supply of products equals or exceeds demand. In cases where demand exceeds supply there will be some other constraints elsewhere in the supply chain. If we apply this model to a supply chain we get a powerful method to organize and manage supply chain operations.

A very effective response to the bullwhip effect is to manage the entire supply chain as a single entity and to synchronize it to the timing of actual market demand. This can happen if the supply chain participants closest to the end use Customers share their sales numbers and their sales forecasts with the other companies in the supply chain. Each company can then manage their actions based on the most accurate data about market demand.

Buffers in the supply chain are determined by the degree of uncertainty about future market demand and the service levels required by the market. The lower the uncertainty about demand, the smaller the buffers can be and still maintain high service levels. Companies can manage their buffers by using either productive capacity or inventory, whichever is most cost effective for them.

Synchronized supply chains avoid the volatile waves of demand that are generated by the bullwhip effect. And increased predictability makes the productivity of each company easier to manage and the supply chain as a whole becomes more efficient and profitable.

Collaborative Planning, Forecasting, and Replenishment

To facilitate the coordination that is needed in supply chains, an industry group known as the Voluntary Inter-industry Commerce Standards (VICS) group has set up a committee to investigate collaborative planning, forecasting, and replenishment issues (CPFR). This committee documents best practices for CPFR and creates guidelines to follow for CPFR.

The CPFR process is divided into the three activities of planning, forecasting, and replenishment. Within each activity there are several steps:

Collaborative Planning
·                                 Negotiate a front-end agreement that defines the responsibilities of the companies that will collaborate with each other
·                                 Build a joint business plan that shows how the companies will work together to meet demand
Collaborative Forecasting
·                                 Create sales forecasts for all the collaborating companies
·                                 Identify any exceptions or differences between companies
·                                 Resolve the exceptions to provide a common sales forecast
Collaborative Replenishment
·                                 Create order forecasts for all the collaborating companies
·                                 Identify exceptions between companies
·                                 Resolve the exceptions to provide an efficient production and delivery schedule
·                                 Generate actual orders to meet customer demand
CPFR in Action

For an example of how CPFR can work let's return to the example of Nimble Company. In the section on product design in Chapter 2, we saw how Nimble Company developed a home entertainment system that was much simpler to manufacture than a competitor's system. This simpler design is in turn supported by a less complex supply chain that reduces production costs and increases responsiveness to market demands. All of this is central to the competitive success that Nimble Co. is enjoying.
Nimble Co. has collaboration agreements in place with its Supply Chain partners and has an ongoing planning, forecasting, and replenishment process in place with these partners. Nimble Co. receives POS data that show the actual sales of its systems in retail stores. From these same retailers, Nimble Co. receives regular updates of their sales forecasts and their inventory levels of Nimble Co. home entertainment systems.

Nimble Co. uses this data to plan its production schedule and it also shares this data with the component manufacturers who provide parts for its home entertainment system. This way the component manufacturers can plan their own production schedules. In looking at the sales data and forecasts, Nimble Co. sees that demand for their product is growing faster than anticipated in their yearly plan and they need to increase production. Nimble Co. revises its production schedule for the year and takes the new plan to its key component suppliers to negotiate additional purchases of their components. It turns out that one component supplier cannot quickly ramp up their production but a second supplier has a component that could fill the need with just a slight modification to the design of one part of Nimble Co.'s home entertainment system. Because all affected parties know what is going on and have enough lead time, the design changes are made and production schedules are increased to meet the rise in product demand without any retailers running out of inventory.

The benefits illustrated in this scenario are numerous. To begin with, the bullwhip effect is diminished because all companies in the supply chain can see real time sales data and share sales forecasts. This allows everyone to optimize their production schedules, inventory levels, and delivery schedules. Next there are the benefits associated with Nimble Co. being able to quickly see a real rise in customer demand and coordinate with its suppliers to increase production schedules over previously planned levels. Even though one component supplier was not able to accommodate Nimble Co.'s increased production schedule, another supplier had a workable substitute. Changes were made to the product design, production was increased, and no retailer lost sales revenue due to running out of inventory.

Those companies that can create collaborative supply chains will have a significant competitive advantage. Collaboration is not easy to implement and it will take time to become more common in business. However, prominent companies are already beginning to lead the way. Companies such as Wal-Mart, Dell, and Proctor & Gamble share point of sales data with all the other companies in their respective supply chains. The companies in these supply chains are also starting to share inventory data with each other. Sharing this kind of information provides a basis for each company to make decisions about its own activities that will yield better efficiencies and profits for itself and for the Supply Chain as a whole.”

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