In my last article, I introduced the topic of postponement. This article will cover the subject in more detail and with less regard to software.
Your three most major buyers, Target, Office Max, and Staples account for over 40% of your entire volume. Each of these buyers requires unique packaging. The unique packaging is crucial. Staples will not purchase a unit that has the Target packaging and vice-versa. You woke up this morning only to walk into work and find out that the North American DC (distribution center), located in Detroit, Michigan has a bit of a problem regarding this quarter's orders. It turns out that Staples requested 40,000 additional units, which is 3,500 more than your safety stock of Staples SKUs (stock keeping units). Also a problem, Office Max ordered 10,900 less than expected leaving you with 30,000 additional units when safety stock is included. Target ordered 5,000 more than expected leaving you with 2,000 safety stock units for Target.
Total, you have 32,000 units from Target and Office Max sitting in the DC that you can't sell, and you have 35,000 backordered from Staples that you want to sell. Oh yeah, and to make things a little worse, the lead time from your manufacturer in Thailand is 8 weeks; 1 week of which is assembly, 1 week of which is packaging, and 6 weeks of which is transit. At this point, it doesn't really look like things are going to go too well. Too bad too, I mean you have the right product, but the packaging is all wrong. You're swimming in leftovers from Office Max and Target and you can't fill the order for Staples. Staples is unhappy, and so are their customers. Not to mention you; all of this lost business and leftover inventory all because of a packaging problem.
The DC understands the problem, but what are they going to do about it? They have 1600 other SKUs to get to 3,200 different buyers. These three SKUs only account for three 1% of company revenue and the DC is busy worrying about other issues. Sure, it would be nice if they could change packaging and send out the rest of those 32,000 units cutting the backorder down drastically. Unfortunately, the DC just doesn't have the manpower to turn the distribution center into a packaging plant. Sure would be nice if they could.
What would be the effect if they could?
The manufacturing plant is still in Thailand, so lead time would for total units would be still be 92 days. However, if they were sent over with generic packaging, then the units could be customized at the latest effective moment. Consider the benefits:
Instead of customizing SKUs for each of the three buyers 8 weeks in advance, the generically packed parts could be sent to the DC and then customized only 1 week before they need to be shipped out of the distributor. This effectively cuts buyer-specific lead time down to 1 week. This effectively cuts the lead time from 8 weeks to 1 week for the customized SKUs.
What kind of an effect does this have on safety stock?
Here, safety stock is needed due to variable demand. The formula for this is:
z*SQRT(Lead time)*standard deviation of demand.
(For help on this equation, refer to my article on safety stock)
Really, the only term in that equation that is changing is the SQRT(LT), so we can isolate this term and use it to determine the change in safety stock resulting from postponing packaging until the DC.
LT0=old lead time=8 weeks
LT1=new lead time=1 week
Now we can use this to determine the % decrease in safety.
%Decrease = (LT1-LT0)/(LT0)=(1-2.83)/(2.83)=-65%
This means that by postponing packaging until the DC, there is 65% decrease in safety stock that can take place.
Thinking about what I've written about in previous articles, this should be fairly clear. Safety stock is held because of statistical deviations in lead time and demand. In this case, we're mainly concerned with deviations in demand. If all three SKUs were the same for each of the buyers, then the demand would tend to even out a bit. If Staples ordered more, which they did, and someone else ordered less, then it could be evened out. With different SKUs, you lose the ability to respond to these fluctuations.
Postponing allows you to take advantage of these fluctuations because it effectively turns all of your inventory into generic inventory than can be sold anywhere.
What about the DC?
The DC probably doesn't want to start packaging products. Depending on how much you can benefit from postponement, you might want to change their mind. A 65% reduction in finished goods safety stock for 3 SKUs is fairly high, but certainly not out of the question. Granted, these benefits will be partially offset by the increased demand for WIP inventory that will be held at the DC waiting to be turned into FG, but nevertheless, there will be a decrease in inventory. This is because the pooled risk of the 3 SKUs has a smaller standard deviation on demand, which will be discussed in a future article. Also, WIP has a smaller holding cost than FG.
Back to the DC, it might be a good idea to convince them to package. Localizing the final good might not even as difficult as you think. It could be as simple as slapping a sticker on the final product before it goes out.
Whatever the changes that need to be implented are, the effects of postponement cannot be ignored. By keeping materials generic for as long as possible, inventory can be cut and sometimes this cuts can be drastic.
For ideas on how your firm can postpone production in their supply, please leave a comment with your email address, or email the author.