This article was originally written in 2009 and later edited in 2011 by Dr. Keivan Zokaei. It examines how supply chains can boost their efficiency and effectiveness by eliminating all too common mistakes.
The economy is rapidly slumping into a deep recession but did it really need to be this way? The Big Three auto manufacturers are in big trouble and even Toyota, the all time legend of efficiency, has dived into the red for the first time since its records began in 1941. Toyota has hit the red as exports screech to a standstill, partly to be blamed on a soaring yen. We are simply used to Toyota always making profit, oblivious to the fact that the volume car makers’ business models are very vulnerable to sudden falls in demand, especially if in the process of expanding capacity like Toyota. An insurance company, or even a chain of supermarkets, doesn’t have the same level of asset specificity that volume car makers have.
Toyota has cash reserves more than enough to cope with the current climate. However, experts such as Richard Schonberger have been warning about falling inventory turns at Toyota alongside many other motor manufacturers all along. The Times now reports that Toyota’s finished cars inventory levels in the US are about “twice the level considered appropriate” , i.e. around 90 days’ worth of cars in stock. I believe Toyota’s inventory levels increased as they expanded into various markets and attempted to deal with what Taiichi Ohno called “market diversification” – or in other words, the ever increasing range demanded by the customers. Ohno, the father of the Toyota Production System (TPS), explained that TPS is capable of coping with market fluctuations in terms of variety and volume even when the overall demand is steady. TPS is designed to absorb these fluctuations through the principles of just-in-time and autonomation .
Yet, even Ohno did not claim that Toyota could cope with sudden slumps in demand, so it is inevitable that Toyota suffers like most other businesses.
But what happened for Toyota to remain profitable through the recessions of the past but not this time round? Let’s revisit the history of manufacturing before the oil shock of 1973. Back then, you could sell practically whatever you were able to produce. In the era of mass production, what seemed to matter was the economy of scale, and what management focused on was the unit cost, i.e. producing in large batches through dedicated processes and monumental machines. Management’s aim was simply to sweat assets. Still much of what is taught in business schools around the world is influenced by the mass production way of thinking. Then came along Toyota, which showed us that we can (and indeed should) lower costs by producing only what the customers want at the pull of the customer. TPS demonstrated that cost is in flow, rather than scale. Management thinker Professor John Seddon of the Lean Enterprise Research Centre (LERC) refers to this as the “economy of flow”. Between the oil shock of 1973 and the recent recession in 2008, the management focus has been on learning the principles of flow thinking, many of which were developed in Toyota during the time before 1973. Sadly, companies and their supply chains are yet to learn some very basic principles and the full scale implications of TPS, as I will explain below.
However, the severity of the current economic shock is suggesting that even flow thinking alone is not a good enough solution and it can be argued that we are progressing into an era of ‘economy of purpose’. Leading companies in different industries are not only producing what the customers demand at the pull of the customer, but are working together with their customers and customers’ customers to gain a deeper understanding of what the end consumers’ requirements are in order to provide the most effective solution to their problem.
Tesco has been one of the leading firms to realize economy of purpose. Its core business purpose is to gain customers’ lifetime loyalty. There is no mention of share of your pocket, cost or efficiency in Tesco’s purpose. It’s all about what consumers’ value; it’s all about effectiveness. In this new age, value enhancement is arguably more important than waste reduction. Tesco rigorously and systematically communicates its core purpose across various levels of the organisation. Its CEO, Sir Terry Leahy, is often quoted as saying: “If you are in doubt, ask the customers”. Tesco deploys Clubcard data to create the most effective supply chain the industry has witnessed, where individual store range and offering depends on the local shopping profile, and promotions are customised to individual shopping needs. As such, Tesco runs a supply chain that dwarfs that of WalMart (ASDA) in both effectiveness and efficiency (see the industry data on sales per square foot). Opportunities are endless; and we have yet to grasp the full-scale implications of the post-2008 economic era.
Against this background, I would like to draw attention to some of the most immediate issues in our supply chains. The reality is that many supply chains are desolately fixated on paradigms and practices of the mass production era. We have fallen desperately short of the TPS standards, let alone getting ahead of Toyota to cope with the current climate (as arguably Tesco has done). On LERC’s executive MSc in Lean Operations programme we set an assignment every year requiring students to analyse their companies’ supply chains and provide practical recommendations for improvement. This is an opportunity for me to visit (or at least read about) the latest state of affairs in both the manufacturing and service sectors of our economy. Students (mostly very senior managers) challenge the way their supply chains operate in the light of lean thinking and the principles of flow economy. Analysis is quick (a few weeks), yet the gains are often enormous.
When it comes to managing the end-to-end supply chain, the situation in both the manufacturing and service industries is bleak. We have introduced many internal lean initiatives and many firms have matured in TPS ways of thinking internally. But this has hardly been the case in the extended value stream. One of our MSc students, a lean leader at an international medical device manufacturer, achieved 80 per cent inventory reduction during only five weeks of supply chain analysis. This was in addition to elimination of quality and delivery problems with the supplier (quality problems were running at 40 per cent and delivery problems at about 30 per cent). Consider how much cash you could release and how much value you could add to your manufacturing in only five weeks! The root cause of the problem in this medical device supply chain was erratic ordering from the customer placed on the supplier, which put sudden strain on the manufacturing at the supplier plant. Orders were accelerated through production to meet erratic orders followed by long periods of lull leading to many quality and delivery issues. The medical device manufacturer collaborated with its supplier on a simple redesign of the manufacturing sequence to postpone the last production sequence until parts were actually called in. This allowed the supplier to produce blank parts and finish them only when ordered by the manufacturer, reducing inventory by about 80 per cent.
Another example, from one of the largest wine and spirits distributors in the world, concerns inventories along the chain for a popular wine category supplied to multiple supermarkets. Wine is often supplied in bulk into the UK and bottled and labeled prior to shipment to customers. This company has recently invested in multiplying its warehousing capacity of bottled wine based on increasing demand during the past few years. Unfortunately, this is a position you don’t want to be in when a recession hits. It’s always cheaper to keep wine in bulk and postpone the bottling until actual orders are received from customers. This will also ensure much higher product availability against customer orders and reduces the need for large amounts of inventory in the chain by keeping the right type of finished goods stock. Supply chain mapping revealed a 170-day lead time for a bottle of wine from winery to sales. There is a considerable amount of inventory within the wine supply network while there are relatively low levels of inventory held by the retailers. Huge savings are possible by simply postponing the bottling until customer orders are received and constantly revisiting the safety stock levels only to keep enough bottled wine to meet small fluctuations in the retail orders. It is sensible to position the inventory just before the point where the product becomes highly varied.
In managing supply chains, we know about the demand amplification effect since the 1950s. Demand amplification exists in nearly all supply chains. Yet I haven’t come across a single one that uses demand amplification as a KPI or one that consistently monitors it with all suppliers. It occurs when small fluctuations in the end user demand become amplified as they are passed upstream, leading to considerable ebbs and flows along the supply chain. Ohno would have called this mura ; indeed recession occurs when we encounter mega-mura. When an international pharmaceutical firm mapped its largest value streams by volume, it found demand amplification resulting from batching and inventory control policies. Whereas customer demand for the selected product was fairly stable (averaging around 800kg per month), demand amplification occurred because of a fixed manufacturing lot size of 2250kg in production, consisting of three containers of 750Kg. The supply chain analysis suggested reducing the lot size to one container and shipping it immediately to the next process without entering the current stages of warehousing. A safety stock could be kept to make up for the difference with customer orders. This removes the wastes of transportation and over-production; but more importantly, producing more closely to the customer demand means exposing quality problems and the opportunity to tackle the root causes much more quickly.
I have seen many examples in service supply chains where the situation is very similar. For example, in the insurance industry, insurers maintain an arm’s length and price-driven relationship with suppliers. Individual insurance firms are encouraged to provide lower-cost solutions leading to supply chain members looking inward to pursue a strategy of optimising own-service delivery. However, optimising costs at a local level can compromise the end-to-end value stream as a whole. Negotiations are considered in isolation with little concern by procurement teams on the impact of decisions by one chain member upon others and to the value chain overall.