Monday, October 25, 2010

Lean as a Supply Chain Strategy

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In my last post, I started a series on the conventional supply chain strategies and why they are inadequate to help firms trying to design their supply chains. This continues the series with the focus on lean as a supply chain strategy.

Lean primarily refers to elimination of waste and is the basic philosophy that originated as part of Toyota Production Systems, with its emphasis on the elimination of waste (muda). Therefore, this philosophy is based on reducing the cost by eliminating activities that do not directly add any value. Cost can be reduced in two ways: (1) by identifying and eliminating the wasteful activities that don’t add any value and (2) by enhancing the efficiency of a required activity so that the throughput of the process can be increased. A lot of supply chain activities can directly leverage this thinking. Most execution activities in a supply chain can benefit from lean thinking, such as picking, packing, loading, and unloading in a warehouse; routing of shipments in transportation; labor activities on receiving docks at warehouses, stores, and manufacturing plants; and so on.

Loading a container ship

What does a lean design for a supply chain mean? A lean supply chain design requires that supply chains minimize the cost of operations at all levels. Lean requires that the supply chain uses the least amount of resources to efficiently complete its job. The primary resources in a supply chain are inventory, warehouses, trucks, people, and working capital. A lean supply chain will be designed to have minimal inventories in the system, minimal amount of warehousing space required to store these inventories, and optimized shipments to reduce the cost of moving inventory. A lean supply chain will also be designed to establish long-term, stable supply contracts with the lowest negotiated cost, but typically without any substantial ability to change ordered quantities, delivery destinations, and required need dates after the order has been placed. Lean design will most likely not engage secondary suppliers, because a second tier of suppliers is expensive to maintain. All of these factors will reduce the costs of the supply chain operations, making it extremely cost-efficient, but will also constrain the supply chain’s ability to adapt to any changes in demand, supply, or other resources, due to the built-in rigidity of the design.

And therein, lies the rub: Low inventories make the supply chain vulnerable to not being able to fulfill orders if the demand suddenly spikes or if there are changes in demand that were not foreseen. Inability to change orders with the suppliers also constrains the supply chain’s ability to react to any changes in demand and may saddle the supply chain with unwanted inventory. Having no secondary suppliers also limits the ability of the supply chain to reacting to spikes in demand and/or exposes it to supply failures from the primary suppliers. The focus on being lean prevents this supply chain from building redundancy by design which reduces supply chain’s ability to manage variability.

On the other hand, the only reason for supply chains to exist is to manage variability! So a lean focus ion supply chain design actually goes against the very basic nature of the supply chains. However, if the lean focus is seen simply as the most efficient way to execute business operations (which include a fair amount of agility to respond to natural volatility in demand), then it can be used to design effective supply chains. Also – if lean is a supply chain strategy that is good in certain conditions, I would like to know when is lean not good? When should a firm spend more money than is absolutely required to organize its operations?

Also, most firms have a large assortment of material to be managed: Raw materials, WIP, finished goods, and retail assortments almost always consist of a mixed bag of products when it comes to their demand profile. While some products may have a stable demand profile, others will be more volatile to manage. This means that the enterprise supply chain that must be designed to cater to all these types of products must be lean (to best manage the products with a stable demand) and agile (to manage others with volatile demand) simultaneously. After all, you could not run a business with a lean supply chain with the lowest cost, but that cannot respond to any changes in demand or supply. Since all demand and supply has inherent variability, such a rigidly designed supply chain will quickly build up unwanted and obsolete inventories as it is incapable of reacting to changes in demand and supply. Of course, too much emphasis on creating agility may be expensive and may also not provide the best design as we shall see when we discuss agile as a supply chain strategy.

Finally, the cost focus serves much better a generic business strategy as suggested by Michael Porter because a cost focus can be used effectively to drive any corporate function, such as accounting, human resources, merchandising, production planning, engineering and so on: There is nothing specific about the cost focus that would make it work any extra magic for supply chain than what it can do for any other corporate function, and hence its inability to drive supply chain strategy!

Summarizing,

  • Supply chains must manage variability and an exclusive focus on lean prevents supply chains to be designed effectively for managing natural variability and hence from doing their most important job.
  • As most firms have several products to manage and these products have widely varying demand and lead-time patterns, the enterprise supply chain must be designed to work for all these products without undue focus on a single characteristic.
  • There is nothing special about the cost focus that helps driving supply chain strategy any more than it can do for any other corporate function. To that extent it remains an effective business strategy, but not a supply chain strategy.

If you are looking for an alternate way to design effective supply chains, the answer does not lie in adopting theories in the hope of finding the right answer, but to build supply chain capabilities driven by your business strategy. To find this new approach to build effective supply chains, understand the supply chain sphere of influence, find out what drives your supply chain, and learn about the new design imperative to build supply chain capabilities to support your strategy.

This article is adopted from my book, Supply Chain as Strategic Asset: The Key to Reaching Business Goals. You can continue reading more on the subject in the book.

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© Vivek Sehgal, 2010, All Rights Reserved.

Want to know more about supply chains? How they work, what they afford, and how to design one? Check out my books on Supply Chain Management at Amazon.

6 comments:

  1. PART I
    This is an interesting and thought provoking article Vivek. I believe you are right about the need to reduce inventory and supply chain costs and the financial impacts of doing such. However, I disagree on not focusing on lean in the supply chain.

    If you think focusing on "Lean" in the supply chain means that you must reduce inventories by any means possible then you are right. However, since you did not mention the means used by companies to apply Lean I have to assume your beliefs are formed by some bad experiences with trying to apply lean in the supply chain. As you know, there are many organizations out there that say they are doing “Lean”. But what does that really mean? What are they doing to implement lean? The trap I see in many organizations is that they tend to trade one waste for another so you have this squeezing of a balloon affect in cost reduction campaigns. If they reduce inventory by some means and then fill-rates go down then they just traded one cost for another.

    One of those means, which works very well in my experience, is by implementing a pull or KANBAN system (vs. forecast driven). To prove this point, let me discuss the benefits of kanban in the context of business needs you brought up in your article. I will break my response/comment into four sections since it's soo long.

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  2. PART II
    The benefits of kanban just so happen to be able to solve the specific issues you mentioned in your three summary points at the end of your article:

    1) "Supply chains must manage variability and an exclusive focus on lean prevents supply chains to be designed effectively for managing natural variability and hence from doing their most important job.”
    Conversely, KANBAN (a basic means of applying Lean in the supply chain), improves the supply chains’ ability to absorb bumps and prevent disruptions caused by natural variability. A kanban system acts like a set of natural shock absorbers for your supply chain to absorb all but the largest bumps in demand. This approach is strategic because it allows organizations to focus their efforts in other areas. One of the problems with push based or forecast driven systems is that they not only don’t absorb, but instead amplify the natural variability in demand as is propagates through the extended supply chain. The effect and underlying causes were well documented in 1961 by Jay Forrester, MIT. This is now commonly known as the “Bullwhip Effect” or “Forrester Effect”.

    http://en.wikipedia.org/wiki/Bullwhip_effect

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  3. PART III
    2) "As most firms have several products ... the enterprise supply chain must be designed to work for all these products without undue focus on a single characteristic"

    You are right! This is increasingly true in today's growing consumer and industrial global markets. Kanban satisfies this market need by focusing on a plan for every part. Chances are if you are using any forecast driven (push) approach your forecast is probably not really that accurate. Of course this depends on the time span. Your six months of demand forecast is probably relatively accurate, but when you get down to the week or day it’s relatively much worse. You see, the fundamental problem is not that your forecast is bad; it's the disconnect from plan/forecast to execution of the process. Many times we are focusing too much on improving precision and accuracy while there is a better way to translate the plan into execution. It’s like using a laser to measure a board, then cutting it with a chainsaw. Not to say that forecasting is not valuable. I have seen many examples of planning and forecasting used very successfully for capacity planning and high level long range planning. However, there is a disconnect when you try to use this high-level plan to execute your material replenishment process at the lowest level. As an execution based system, Kanban does not rely on such precise numbers from a daily, weekly, or even monthly forecast so it relieves the constraint in most companies where they think they just need a more accurate forecast. The analogy I like to use is about basketball. I am very tall by most standards at 6'7". However, to most people’s surprise I do not play basketball (at all). Everyone is always asking me “Do you play basketball?” I secretly want to reply “No, do you play miniature golf?”. The reason I do not play basketball is that I could never figure out how to consistently get the ball through that little orange hoop at the other end of the court. Now if someone back then made the hoop (basket) bigger for me, I might improved my scoring rate and perhaps still be playing basketball! You see, kanban, and just in time, is like making a 'bigger hoop' for your execution process!

    Kanban (especially electronic kanban) allows you to break down the replenishment cycle into it's variable inputs such as "Lead Time" and "Transit Time". This not only allows you to define the variation in demand and lead time, but also to execute replenishment to it, track trends and changes, and respond to adverse changes with part level system alerts. There is a direct correlation of variation in consumption to safety stock levels. This might fly in contradiction to the policy of setting safety stock levels based on service levels. In my opinion, doing this assumes that I will run out, but I want to minimize those pesky stock out situations. This does not make sense to me, because it’s like saying: “we will only allow 10 recordable incidents per month”. Why would you have a goal for a certain target level of defects? With kanban, you don’t have to compromise service levels in order to reduce inventory. In fact I’ve seen that moving to a kanban system can save 25-75% of your inventory while eliminating stock outs at the same time.
    Kanban forces you to turn your traditional supply chain thinking upside down and puts the focus on the customer. Many S&OP and advanced planning approaches claim to do this. However, the customer I am referring to is the direct upstream process/customer, not the retail customer taking the product off the shelf. We have learned from Goldratt and Cox in “The Goal” [2] that a bottleneck anywhere in the extended value chain can have ripple affects all the way up and down the chain ultimately affecting the end customer. Upstream suppliers are overproducing do to the bottleneck. Conversely, on the downstream side, we see customer delivery and fill rates suffer.

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  4. PART IV

    3) “To that extent it (cost focus) remains an effective business strategy, but not a supply chain strategy.”

    I agree cost focus should not be a strategy in and of itself. However, if having the lowest cost supply chain is one of your competitive advantages (as did Dell, Wal-Mart, and Toyota) then I would disagree. To be fully successful the strategy should include LEAN as a core belief and focus point. In Wal-Mart’s case, they sell many of the same products as their competitors for lower prices. How do they do this? I don’t think anyone will argue that a lower cost supply chain is a big part of their strategy. Their strategy embodies LEAN by lowering cost more than competitors while preserving, and some cases increasing VALUE. To drive this fact home, let’s face it. Nobody shops at Wal-Mart because they want to look cool, they do so because they perceive the best VALUE. Also, nobody buys a Toyota to look cool or because it’s trendy. Instead, they perceive the best VALUE.

    Lastly, the origin of “Lean” is from the Toyota Production System, which came from Taiichi Ohno [3]. I think in large part the term “Lean” has gotten a bad rap since Jim Womack coined the term in his 1990 book, “The Machine that Changed the World” [4]. Don’t get me wrong, it’s not his fault. I am a huge fan of Mr. Womack. However, since then the term Lean has become synonymous to cost reduction (i.e. inventory reduction and headcount reduction). In reality the philosophy of Lean, in my opinion is: to quote Mr. Taiichi Ohno “The operating system of the Toyota Production System is kanban.” According to his book “Toyota Production System” (1978),Taiichi Ohno devised this system after visiting an American Supermarket. He believed that the supermarket pull process held the key to achieving “Just In Time”, which was one of their goals and one of the two pillars of the Toyota Production System (the other being “autonomation”). Perhaps it is the supermarkets will be where Taiichi Ohno’s pull-based replenishment methods such as KANBAN will see reintroduction as market volatility continues to grow. What do you think?

    [1] Forrester, Jay Wright (1961). "Industrial Dynamics". MIT Press
    [2] Goldratt, Eliyahu M.; Jeff Cox. The Goal: A Process of Ongoing Improvement.
    [3] Taiichi Ohno, (1978). “Toyota Production System”
    [4] Womack, James P.; Daniel T. Jones, and Daniel Roos (1990). The Machine That Changed the World.

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  5. Greg,

    Thanks for your comments, they are all very thoughtful and extend the context of the original post itself. In my mind, I differentiate between business strategy (as that, which manipulates your business model and therefore, drives "all" your business processes) versus functional strategy (as supply chain strategy would be, which is specific to the business function and helps design the processes while aligned with the business strategy). To that extent, like you said, cost/lean/removal of waste - all are applicable across all business functions and therefore qualify as business strategy. While this must drive supply chain strategy, supply chain processes must be designed using a functional strategy that is capable of assessing business requirements, determining gaps, and building capabilities - all within the larger context of business strategy, which can be cost focused.

    Hope you would agree. Thanks again for adding your insights, I appreciate the dialog.

    Vivek Sehgal.

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  6. Hi Vivek. Great article. I was wondering how a fashion retailer or a similar firm can have a lean supply chain whilst remaining agile. As you'd expect, demand in the fashion industry is very volatile so what would be the best practices for a retailer to implement to have a lean supply chain whilst still remaining agile to changes in demand? Thanks. Seb.

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