Measures and Trust in SCM

1. Measures and Trust in SCM Eli Schragenheim Elyakim@netvision.net.il

2. The IT Vision for Supply Chains • In the future the main competition will be between supply chains • Every supply chain has to react very fast to the changing trends in the taste of consumers • The stumbling block to fast reaction throughout the supply chain is lack of information • Current IT technology is capable of very fast B2B communication that would provide full collaboration throughout the supply chain

3. A Hole in the IT Vision • Suppose that company S identifies a rising demand for product P produced by Vendor V. All the relevant information is communicated to V in no time • Would Vendor V immediately start to produce according to the forecast by company S? • Take into account that V is paid so-and-so days after S places an order and gets the delivery • Does V trust S? Who would suffer if the optimistic forecast does not materialize? • Is S truly interested in communicating all relevant information to V?

4. An Inherent Problem in SC • The idea behind SCM is that by acting as one big system better results for all the participants can be achieved • Can it work when some links have not implemented the systemic rules within their own organizations? • Every organization that is part of a supply chain looks for its own benefit • Hence, every link must clearly profit from acting within the supply chain rules • This kind of business relationship is frequently referred to as “collaboration” • Can it work without a win-win culture? • And we need to establish trust between all the links

5. Business Rules in SCM • The regular business rule: the vendor receives a concrete order, and is paid some time after delivery • Being exposed to updated information won’t impact the vendor’s decisions • The vendor has no say regarding the size of the order • If it is too small – then sales will be lost • If it is too high, it will take very long time until the next order is received • It is not clear the vendor can profit from a faster response • On one hand the next link might be able to sell more • On the other hand the next link might order less

7. Business Rules in SCM • Vendor Managed Inventory • The next link draws from the vendor’s inventory when the need arises and this triggers payment to the vendor • All the risk is now placed on the vendor • Now the vendor has a lot to gain from a fast response • Financial benefits to the vendor would occur, if and only if, sales would go up due to the new rule • This is possible if it enables the seller to spot new opportunities and then rely on a secure and fast response • In the former scheme the seller would refrain from holding inventory for such opportunities • And less sales are lost due to shortages

8. The TOC Visionary Business Rules • The objective: • Allow the seller to grab any opportunity that is beneficial to all the links in the chain • Motivate all the links to respond quickly to any market trend • Institute a win-win culture over the entire chain • Let those who have the best knowledge and intuition make the decisions • Each link gets more

9. The TOC Visionary Business Rules • The TOC business rule: • Each producer in the link manages his finished goods inventory at the next link • Payment is made immediately following each daily sale by the seller • Every producer gets: • The truly variable costs (TVC) invested by the producer • A percentage of the throughput (T) • Throughput is the revenues minus the truly variable costs • It is in everybody’s interest not to cannibalize any sales and not to ignore any optional sale

10. Supporting the TOC Scheme • Every link within the chain should manage its operations based on replenishment to the buffers • The inventory at the next link is a buffer • Every producer might maintain its own finished goods buffer when the same product/part goes to different supply chains • Using buffer management as a sensitive tool to identify changes in the market demand • Information on each sale should flow immediately to every link in the chain • But, there is a need to validate that every link in the chain is doing what it should do to allow more business to come in

11. How to Maintain Trust between Different Organizations? • The win-win agreement is not enough to ensure high performance • We need measurements of the performance of each link to establish an overall control whereby the actions truly support the global chain • The downstream links need to ensure fast response to any market opportunity • The upstream links need to validate that sales are generated from what is already in the system • Note that maintaining trust is needed also for the other business rules

12. How should a seller measure the performance of the vendor? • Criteria • Every delay in measured, not just being late but also by how many days • The financial value of the sale should be measured as well • Throughput-Dollar-Days (TDD) • Every day a delay is noted the full T value of the order is added to a counter of TDD • When the order is late by 5 days, its full T value is added to the counter 5 times

13. How should a seller measure the performance of the vendor? • A common problem at the seller’s site • Orders that cannot be fulfilled may not have been registered, even though the specific sale has been lost • Hence, the full damage caused by the unavailability of products cannot be directly measured

14. How should a seller measure the performance of the vendor? • The TDD measurement in this case could be directed to the emergency level of the parts • The emergency level (zone 1 / red-line) is defined in the buffer management methodology • It is usually a certain percentage of the replenishment buffer • The emergency zone represents a very high probability of losing sales • Hence, when the on-hand stock is below the emergency zone – the TDD counter ticks

15. An example: Product P10 T per unit = $60 Replenishment level = 100 un. Emergency level = 30 un. Seller Inventory ready for immediate sale Fast replenishment Producer On 4/15/2002: On hand stock = 17 un. Additional TDD due to P10: (30-17)*60 = 780 dollar-days On 4/16/2002 the on hand stock went down to 5 units Additional TDD = (30-5)*60 = 1500 dollar days Total TDD due to P10 = 1500 + 780 = 2280 dollar-days

16. The TDD as a measure of the performance of a vendor to a seller • The vendor is responsible for full availability of his products at the seller’s site • The replenishment and emergency zone levels are agreed between the seller and the vendor • Whenever the on-hand stock is below the emergency level the TDD counter ticks • The full throughput value of the parts that are missing is added to the periodical TDD measurement • When no stock is available at the seller, the full T value of the whole emergency level as added every day • This measure rises VERY fast when response time drops • The measure institutes the right priorities given both the financial aspects and the duration of the delay

17. The TDD measurement for a vendor of a producer • The differences between measuring the performance of a vendor to a seller and to a producer • The producer knows exactly when lack of materials causes a delay in the internal operations • The financial damage of missing a part is more problematic to measure • The part might participate in a variety of end-items sold by the supply chain • Hence, for every part the vendor is responsible for a “typical end-product T” should be defined • We still assumes that delay in the producer’s operation might cause missing a final sale, even though this is much less straightforward

18. The TDD as a measure of the performance of a vendor to another producer • The vendor is responsible for full availability of his products as raw materials at the producer’s site • The replenishment and emergency zone levels are agreed between the producer and the vendor • Whenever the producer needs to release materials to the floor and a specific part is missing the TDD counter ticks • The exact amount of units missing multiplied by the typical T for the end-products is added every day to the periodical TDD

19. Whenever C needs materials and they are not found in Inventory B, the TDD counter in increased by the T of the end items Link C Inventory B Link C measures B’s performance according to the periodic TDD Link B Inventory A Link A

20. Measuring the performance of the seller • Every link in the chain that is not the seller likes to judge the performance of the seller • This is true even for the traditional business rules • The main focus is how fast products that are stocked at the seller’s site are being sold • And what products are NOT sold! • Every producer that is judged according to TDD has to invest capacity and materials in an effort to maintain the TDD and gain from the supply chain sales • Hence, there is a need to measure the investment

22. Inventory-Dollar-Days - measuring the flow • Every area that contains inventory can be measured according to: • The value of the item – only the raw material purchasing costs are considered • The number of days each item remains in the area • Every item in the measured area carries inventory dollar days equal to its value in dollars multiplied by the number of days it remains in the area • The IDD is a snapshot: how much money is stuck in the area and for how long

23. Basic calculation of the IDD for an area A measured area where inventory items spend some time

24. Using the IDD measurement • Each producer should measure the following areas: • Raw materials from vendors that are not managing their materials • WIP • Every finished goods area that is controlled by the producer • Under the TOC supply chain vision the area that truly measures the performance of all the downstream link is: • From the completion area in the shop until the supply chain sells it

25. Link C TDD measurement Inventory B Every day link A adds to the IDD measure, the value of all its inventory in the supply chain Link B TDD measurement Inventory A Link A

26. IDD and Inventory Turns • Inventory turns is the current common measurement of the effectiveness of inventory in the system • It measures the average of how much inventory waits in a certain area • The dollar value of the inventory is specified separately • Being an average, it misses pointing to the problematical area, and it does not give a clue regarding the variability • The combined effect of time (delays) and money is given only at a very global level

27. Summary • The TOC vision for supply chains provides a new business scheme for real collaboration between the links • All the current business rules for supply chains should maintain trust among all parties • Trust needs to be supported by a measurement system that motivates all the parties to do what is good for the chain as a whole • The measurements need to contain both time and money

28. Summary • Throughput-dollar-days (TDD) measures the performance of the vendors by accumulating the full dollar value of every late order and the length of time it was delayed • Inventory-dollar-days (IDD) measures the flow through the supply chain by measuring how much inventory-money is being held at each area, thus blocking the flow • IDD should be used, among other uses, to check how fast products are being sold

29. Summary • Both the TDD and IDD measurements have uses that stretch beyond measuring the performance of the links in the supply chain • The TDD is an operational performance measurement of the damage caused by failing to meet the market requirements • The IDD is a measure of effectiveness of the operational policies to achieve as low TDD as possible