Measures and Trust in SCM

Eli Schragenheimelyakim@netvision.net.il

The IT Vision for Supply Chains

• It is predicted that in the future the main competition would be between supply chains

• Every supply chain has to react very fast to the changing tastes and wishes of consumers

• The stumbling block to fast reaction of any 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

A Hole in the IT Vision

• Suppose that company S identifies a rising demand for product P produced by Vendor V and 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 the relevant information to V?

An Inherent Problem in supply chains

• The idea behind SCM is that by acting as one system better results for all would 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 profit from acting within the supply chain’s one big system rules

– This kind of business relationship is frequently referred to as “collaboration”

– Can it work without a win-win culture?– And there is a need to establish trust between all

the links

Business Rules in SCM• The current common business rule: the vendor receives an 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 how 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

Demand for P10 goes up

Seller:How much to order?

Producer:How fast to respond?

Can you deliver 300 P10 in a week?

It'll take 3 weeks

I need it faster

The best I can do is

two weeks

All right, two weeks, and then make it 500 units

Business Rules in SCM

• A new emerged business rule: vendor managed inventory (VMI)

– The vendor is responsible for the inventory at the client

– The client draws from the 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• This is possible only when it enables the seller to spot

new opportunities relying on fast and reliable response

– In the former scheme the seller would refrain from holding inventory for such opportunities

• And less sales are lost due to shortages

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

• 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)

It is in everybody’s interest not to cannibalize any sales and not to ignore any optional sale

The TOC visionary business rules

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 would maintain its own

centralized buffer when the products go to several 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

How to maintain trust between different organizations?

• The win-win agreement is not enough to ensure high performance• We need to measure the performance of each link to establish an overall control that the actions taken 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

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

• A common problem at the seller’s site– Orders that cannot be fulfilled may not

have been registered, even though the specific sale was actually lost

– Hence, the full damage caused by the unavailability of products cannot be directly measured

How should a seller measure the performance of the vendor?

How should a seller measure the performance of the vendor?

• The TDD measurement in this case could be directed to the red-line level of the parts

– The red-line level (emergency level) is defined in the buffer management methodology

– It is usually a certain percentage of the replenishment buffer

– The red-line represents a very high probability of losing sales

– Hence, when the on-hand stock is below the red-line level – the TDD counter ticks

An example: Product P10

T per unit = $60

Replenishment level = 100 un. Red-line level = 30 un.

SellerInventory ready for

immediate sale

Producer

Fast replenishment

On 4/15/2002:

On hand stock = 17 un.

Additional TDD due to P10: (30-17)*60 = 780 dollar-daysOn 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

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 red-line levels are agreed between the seller and the vendor• Whenever the on-hand stock is below the red 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

The TDD measurement for a vendor of a producer

• The differences between a producer who measures his vendor and a seller who measures the vendors

– The producer knows 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

The TDD measurement for a vendor of a producer

• The vendor is responsible for full availability of his products as raw materials at the producer’s site• 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

Link A

Link B

Link C

Inventory A

Inventory B

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 measures B’s performance according to the periodic TDD

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 very low TDD and gain from the supply chain sales

– Hence, there is a need to measure the investment

The finished goods inventory represents an investment on the producer's

part

What products do not sell well?

How much money is stuck in slow

products?

The faster the seller succeeds to sell the more effective is the

investment

SellerInventory ready for

immediate sale

Producer

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

A measured area where inventory items spend

some time

10 items, each worth $50 go in

The 10 items go out after

14 days

Basic calculation of the IDD for an area

On the first day the IDD

for these items is 500 DD

On day 14 the IDD for

these items is 7000 DD

On day 15 the IDD for

these items is 0 DD

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

Link A

Link B

Link C

Inventory A

Inventory B

TDDmeasurement

TDDmeasurement

Every day link A adds to the IDD measure, the value of all its inventory in the supply chain

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

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

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

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