Building a Lean Fulfillment Stream Rethinking Your Supply Chain and Logistics to Create Maximum Value at Minimum Total Cost by Robert Martichenko and Kevin von Grabe Foreword by Jim Womack Lean Enterprise Institute Cambridge, MA, USA lean.org April 2010= Lean Enterprise Institute © Copyright 2010 Lean Enterprise Institute, Inc. All rights reserved. Lean Enterprise Institute and the leaper image are registered trademarks of Lean Enterprise Institute, Inc. ISBN 978-1-934109-19.9 Design by Off-Piste Design April 2010 Lean Enterprise Institute, inc. One Cambridge Center Cambridge, MA, 02142 USA (0) 617-871-2900 « (f) 617-871-2989 + lean.orgAcknowledgments This book is dedicated in memory of Jack Leland Hines, founding member of LeanCor LLC. Writing a workbook is a difficult task requiring the efforts of many people. We'd like to thank the team at the Lean Enterprise Institute. In particular, we want to acknowledge the leadership and friendship of Jim Womack, Helen Zak, Dave LaHote, Olga Flory, Rachel Reagan, and Jane Bulnes-Fowles. We also would like to acknowledge our professional friends and colleagues for their support and contribution to this workbook. In particular, we thank the team at LeanCor for their patience and input. We would also like to thank Glen Wright for his support. We are particularly grateful for the unconditional love of our families. A special thanks to our wives, Corinne and Jeanette, for putting up with us throughout this project. And a very special acknowledgement to future lean thinkers Emilee, Abigail, and Kirk Finally, as we complete this arduous process of writing and revisions and writing and revisions, we thank our editors Thomas Skehan, George Taninecz, Michael Brassard, and Tonya Vinas. Here's to building your lean fulfillment stream! Robert Martichenko and Kevin von GrabeWw wv ’ / A\® Foreword ‘One of the most important tasks for any organization is to regulate the flow of products going downstream to customers and the flow of materials arriving from suppliers upstream, Without careful regulation of both flows, itis difficult to stabilize the pace of production within the organization and minimize costs and defects. And it is even more difficult to minimize the amount of finished goods and raw materials that must be kept on hand for timely deliveries to customers. Despite the substantial progress many organizations have made in improving internal operations by using lean techniques, there has been little attention to transforming their external links to downstream customers and upstream suppliers. Historic practice has been for manufacturers to ship products to customers based on erratic orders for large batches, with manufacturers paying the freight. The invention of economic order quantity (EOQ) calculations was a logical consequence in a world where the true costs of large inventories and long response times were poorly understood. Similarly, ‘manufacturers have usually sent erratic orders to their suppliers, telling them to ship within broad windows and to arrange and pay for transport. More EOQ practices inevitably followed. The lean approach is very different. The lean producer asks its customers—whether OEM, distributors, or retailers—to order goods and then to receive them at exactly the pace they are being consumed. Then the lean producer picks up needed items from its suppliers at exactly the rate they are being consumed by its own production, The biggest problem for the would-be lean producer is to explain to customers and suppliers how all parties can win if traditional practices are reversed. This is a difficult conversation, but lean pioneers are now bravely plowing this ground side-by-side with their most important customers. ‘At LEI we have long felt the need to remedy instability in information and order flow to create smoothly flowing streams of products from suppliers to customers. But until we found Robert Martichenko and Kevin von Grabe, we did not have authors who could combine a proven approach to this challenge with an understandable process. Building @ Lean Fulfillment StreamRobert and Kevin bring more than 25 years of experience creating lean fulfillment streams, including the greenfield startup of the Toyota Motor Manufacturing facility in Indiana. There they helped design and implement the operational relationship between Toyota's supply base and the plant. They also helped to integrate the flow of materials in all of Toyota’s North American plants into a series of cross-docks and flow and high transportation routes. This enabled Toyota to implement both I delivery frequencies as successfully as they had in Japan despite dramatically different geography, transportation systems, and supplier capabilities. In the pages ahead, Robert and Kevin will reveal their process for introducing lean into your fulfillment stream using the imaginary ABE Corp. as an example. The example will illustrate both the implementation process and the impact on ABE’s bottom line, We know that few readers of this workbook will be leading or working in organizations exactly like ABE. Your industries will be different, there will be unique challenges, and supplier performance will be more variable. But the principles remain the same. So please look for applications rather than exceptions, We wish you success in turning your current supply chain into a swift, smoothly flowing lean fulfillment stream that delivers consistent value to your customers and a healthier business for your company’s employees, investors, and partners, Jim Womack Chairman, Lean Enterprise Institute April 2010 ForewordTable of Contents Foreword Introduction Part 1: The Lean Fulfillment Stream Part 2: Getting Started and the Current State Part 3: Envisioning the Future State Part 4: Customer Collaboration and Outbound Logistics Part 5: Shipping, Receiving, and Trailer-Yard Management, and Material Ordering Part 6: Inbound Logistics and Supplier Collaboration Part 7: Going Forward About the AuthorsIntroduction Many years ago, Toyota’s Production Control and Logistics Department in Japan set ‘out to optimize the entire fulfillment stream from raw materials to customers. To do so, they pioneered two key concepts: total cost of fulfillment and collaboration across all functions and firms. They supported these concepts with the familiar lean tools of leveled production, pull signals, and just-in-time deliveries. Total cost of fulfillment recognizes that the fulfillment stream is the sum of many parts, and that each part generates costs that ultimately must be paid by the customer. Most companies calculate costs at points within departments: for example, the piece-price paid by che purchasing department to a supplier, the cost of rework in operations, the carrying cost of inventory in a distribution facility, or the cost to transport goods from the firm to its customers. But few companies calculate the total cost of all of these activities across the whole fulfillment stream. Embracing the total cost of fulfillment changes the way managers think, with major benefits for all the firms along the stream. Collaboration across functions and firms becomes an obvious necessity once managers adopt the goal of minimizing the total cost of fulfillment. This goal requires a joint examination of the entire fulfillment stream to determine total costs as the stream currently functions. And it requires a joint effort to envision a better fulfillment stream that can benefit all of the firms involved. Collaborating to create the lean fulfillment stream in Japan was a heroic feat, but Toyota had significant advantages: The Toyota Group of suppliers was (and is) tightly interlocked through shared equity, and the distribution channel also was jointly owned. So Toyota could give firm directions to its suppliers and distributors about adopting new techniques. The suppliers also were tightly concentrated in Toyota City, which cased both logistics and problem-solving, Finally, and perhaps most importantly, Toyota ‘was able to teach its managers—including many transferred to its suppliers and distri- bution channels—to see the fulfillment stream and to fully support lean principles. The challenges for readers of this work book are quite different. Many will be operating within departments with narrow mandates that often cause individuals to work at cross- purposes: ie. the purchasing department focuses on lowest piece-part prices and Introductionvariance analysis while telling suppliers to cover the cost of freight; the production departnient works hard to keep assets—people and machines—fully occupied to cover standard costs, often driving overproduction and extra storage; and down- stream customers usually behave similarly with their logisties, purchasing, and production practices. Is anyone in your organization trying to calculate and minimize total fulfillment costs for the entire stream? The answer is likely “No.” Breaking through this suboptimizing approach requires a new way of thinking and a new way of telling the critically important story of your fulfillment stream, In this workbook we will explore the tools lean-minded leaders can use to engage all of the functions and firms along the fulfillment stream. We will describe the critical principles of a lean fulfillment stream, and show how the total cost of fulfillment can. be visualized, mapped, and calculated. This will bring us to the most important part of the book: how real managers in real firms can collaborate to minimize total costs. As in other LEI workbooks, we will teach by example, showing how the ABE Corp. —a composite of many firms with which we have worked—goes about determining, their current state, envisions a future state, develops an implementation plan, and steadily makes the transition to a Jean fulfillment stream. Let's get started. Robert Martichenko and Kevin von Grabe South Carolina and Kentucky April 2010 Building a Lean Fulfillment StreamPart 1: The Lean Fulfillment Stream What is a Fulfillment Stream? In today’s world, most products move across many companies and through many departments within each company on their way to the final customer. Because the movement of material is so complex, businesses struggle to understand the progression of their products as they move from their suppliers through their own organization into distribution and on to the customer. Certainly work is done by others somewhere, but managers in each firm and facility are often unaware who does what, where, and when beyond their receiving and shipping docks. And many don’t want to think about it. Businesses have traditionally referred to the progression of materials from suppliers to end customers as the “supply chain.” But a chain suggests something heavy and inflexible, prone to kinking and jamming. It’s static rather than dynamic. Within a chain it’s easy for managers to lose sight of the flow of value from start to finish. Instead they focus on optimizing the one link they control, whether it’s a process, a department, or even an entire firm. To capture the lean concept of smooth flow, we find it helpful to envision a steadily advancing stream of materials and the firms and facilities involved as tributaries joining their efforts to serve the customer. We call this flow of parts and finished products a fulfillment stream. It includes all of the activities that move materials and information from suppliers to end customers: planning, sourcing, transporting, manufacturing, inspecting, storing, packing, and consuming, as well as managing the entire process. Once managers understand that they are involved in a fulfillment stream, we find that they can identify the obstacles preventing the stream from flowing smoothly and swiftly, But because no single manager or firm controls the entire stream, new forms of collaboration are necessary to reduce the total cost of the stream while improving its responsiveness to customer needs. To understand how this can happen we will follow in this workbook the experience of a sample company as it learns to focus on its end-to-end fulfillment stream to make it lean. Part 1: The Lean Fulfillment StreamWelcome to ABE Corp. [ABE is a privately owned, mid-sized manufacturer of commercial and residential air conditioning units that are sold through distributors. Even though ABE makes only a moderate range of products, its fulfillment stream from raw materials to customers is lengthy and complex: 160 suppliers ship materials to ABE using 37 different carriers. These materials are assembled in two factories into 40 different completed products. Finished goods are sent to three regional distribution centers via six different carriers. Items are then shipped to 10 national wholesalers using 17 additional carriers. In recent years, ABE responded to demands from its customers for lower prices, higher quality, and more rapid response by implementing lean manufacturing processes. It improved the stability of its production equipment, created high-performance work cells for product families to replace process villages, and reduced batch sizes. The results of these classic lean production initiatives were dramatic, and ABE was able to maintain profit margins while reducing prices. But then customers demanded further price reductions, still higher quality, and even more responsiveness. Prices dropped and sales stagnated. Earnings before interest and taxes (EBIT) fell to practically zero. Some of the company’s board members urged ABE executives to cut costs by relocating production to lower-wage countries, despite longer distances and lead times. (be Suppliers = 160 Truckload carriers = 15 Plante = 2 -Domestic = 150 Less-than-truckload Employees = 1100 eel Lalepalalalaid Raw-material inventory = $25 million Courier providers = 3 WIP inventory = $10 million pianner of Puce Ocean carriers = 4 Finished-goods inventory = $61 million. Inbound transportation ees costs = $5 million : a rd Building a Lean Fulfillment Stream‘The CFO estimated that to remain competitive, ABE needed to reduce overall costs by $20 million within two years at constant sales. (ABE’s financial situation is shown in its income statement and balance sheet on page 4). ‘When ABE’s senior managers met to discuss the situation, they reflected on their process of lean improvements in the preceding years. They had used strategy deployment to prioritize the most important needs of the business and set objectives. They achieved these objectives using A3 analysis and the classic Deming method of plan, do, check, act (PDCA). This allowed creative thinking and problem-solving to flourish in the company, while it maintained and improved process discipline. Given past successes, they easily agreed that this approach should be applied to the CFO's objective. ‘The management team felt that they had implemented lean techniques in the factories to such a degree that a further leap in performance equal to the new challenge wasn't feasible. They also felt that pushing the cost problem back on suppliers—as many of their competitors had done—would provide only temporary relief while jeopardizing the stability of their supply base. Fortunately, several members of the management team were familiar with the concept of the lean fulfillment stream from experiences supplying other lean firms. They suggested that the most promising way to reduce costs to meet the CFO's target within two years was to tackle the total cost of fulfillment. > Outbound > Regional > Outbound > Customer logistics distribution logistics intercompany center LO (se; Of Truckload carriers = 6 Regional DCé ‘Truckload carrie intercompany transportation (Chicago, Atlanta, Dallas) —_Lggg-than-truckload costs = $5 milion Finished-goodo carriers: inventory = $6.25 million Outbound transportation Total space = 250,000 sq.ft. spend = $125milion 12 Customers =10 Ship-to locations = 120 Part 1: The Lean Fulfillment Stream 3ABE Income Statement <2 aie Sales > Rovenus - en Sales '$250,000,000 100.0% Cost of goods sold (COGS) Material purchases '$150,000,000 60.0% Inbound transportation ‘$5,000,000 2.0% Conversion costs '$50,000,000 20.0% Subtotal: COGS '$205,000,000 Operating Profit ‘$45,000,000 18.0% Operating expenses Product development $1,000,000 0.4% Outbound and intercompany transportation $17,500,000 7.0% Distribution center management ‘$5,000,000 2.0% Selling, general and administrative $17,500,000 7.0% Interest (line of credit) ‘$1,500,000 0.6% ‘Subtotal: Operating expenses $42,500,000 17.0% Earnings before income taxes (EBIT) $2,500,000 1.0% ABE Balance Sheet Cash $2,000,000 Accounts receivable ‘$42,000,000 Raw materials inventory $25,000,000 Workin process inventory $10,000,000 _Finishee-goods inventory a $61,000,000 Total current assets $140,000,000 Fixed assets ee 20,000,000 ‘Total assets: $160,000,000 (Uetiitits ind wench equity Ape Raeaee fi enn odes cepsityy x aes wT ce! Accounts payables ‘$50,000,000 Short-term debt (ine of credit) '$20,000,000 '$70,000,000 $20,000,000 $100,000,000 ‘Owners equity $60,000,000 Total liability and owners equity $160,000,000 Building a Lean Fulfillment StreamTotal Cost of Fulfillment The total cost of fulfillment is all of the costs of moving materials from one end of the fulfillment stream to the other. These go far beyond the transportation costs most firms calculate to include the carrying and storage costs of inventory, the cost of material-handling equipment and labor, and the management time devoted to gathering all of the information needed to constantly monitor performance. These costs also include all of the transport, inventory, handling, and management costs incurred by customers and suppliers along the fulfillment stream. The senior managers of every firm in the stream would find the total cost surprisingly large once summed. ‘When the ABE management team committed to reducing the total cost of fulfillment, they realized that this would be an entirely new way of thinking for their suppliers, customers, and ABE’s lower-level managers. The latter had gained an ability to see the value stream within their own facilities as a result of previous lean initiatives. But they had never learned to see the entire fulfillment stream and had no idea of the impact of the stream’s performance on ABE’s financial performance. Their natural reaction was to ask, “What difference does it make what the total cost is? Why can’t 1 focus on controlling costs within my own department?” Suppliers and customers would feel the same way. In considering how to proceed, ABE’s senior managers reflected on their experiences implementing lean techniques in ABE operations. The most successful teams had performed cohesively to achieve collective goals, and took into consideration how their actions affected other teams and departments. These collaborative skills, when set in the context of the financial needs of the whole business, produced the best results. Extending this concept to the lean fulfillment stream would mean looking jointly at the whole stream to achieve maximum value for customers and suppliers at lowest costs while sharing the benefits. ABE managers realized that for a shift to a lean fulfillment-stream perspective to be successful, all departments and companies involved needed to embrace two core beliefs: The customer at the end of the fulfillment stream must define value, and their rate of consumption must set the pace for the entire stream. Doing. this requires managing the entire process as a lean fulfillment stream. * Costs must be managed jointly over the long-term, with a clear understanding of how decisions at different points affect the entire fulfillment stream, in order to minimize the total cost of fulfillment. Part 1: The Lean Fulfillment StreamThe Fulfillment-Stream Council ABE’s managers decided that for the fulfillment-stream participants to work as an effective team an organizational innovation would be needed. They formed a Fulfillment- Stream Council comprised of a senior leader from each functional area of ABE (Finance, Operations, Purchasing, etc.) plus representatives from suppliers and customers. ABE appointed internal members to the Fulfillment-Stream Council, and then enlisted its suppliers and customers to do likewise. The members were expected to serve for an extended period (typically two years, with a minimum of one year and a maximum of three} until the transformation to a lean fulfillment stream was in place, meeting quarterly to review progress. ‘The council would provide vision and leadership for the transformation, but it would not make day-to-day decisions. Instead it would create awareness of benefits of a fulfillment-stream focus, research issues, and challenge business decisions that run. counter to fulfillment-stream thinking. ‘The Fulfillment-Stream Council was responsible for: * Developing, communicating, and promoting guiding principles for managers along the fulfillment stream. + Examining business decisions from a total cost of fulfillment perspective. ‘+ Identifying and eliminating barriers to toral cost of fulfillment thinking, The Fulfillment-Stream Council needed to answer the following question: What is the correct way to run the business in order to minimize total cost? To answer this question the council needed to agree on some simple guiding principles. Guiding Principles Why does fulfillment-stream management require guiding principles? Because a fulfillment stream is lengthy and dynamic and it’s impossible for managers to evaluate every action taken with detailed analysis. For example, Toyota has a guiding principle that reducing lead time is the right thing to do. Managers there don’t spend time doing analysis every time they try to reduce lead time to prove that this is the correct thing to do, Instead they live by the guiding principle, confirmed over several decades, that reducing lead time eliminates waste, improves quality, and reduces costs. Building a Lean Fulfillment StreamEight guiding principles have been shown over many years to be essential for creating lean fulfillment streams: 1, Eliminate all the waste in the fulfillment stream so that only value remains. Creating flow in a fulfillment stream requires all departments and functions in an organization to work in harmony. Focusing on the fundamental lean principle of eliminating waste so that only value remains helps achieve this harmony. The seven types of waste in manufacturing are well known: overproduction, waiting, conveyance, processing, inventory, motion, and correction, The seven types of waste for fulfillment screams are: + System complexity—elaborate scheduling systems and managers working, around mismatches between the formal schedule and actual needs. + Lead time—too much time from one step to the next. + Transport—excessive conveyance among facilities and companies + Space—in liew of processing, space becomes a value factor and excessive space for storing inventories is waste. + Inventory—at any point in the fulfillment stream. + Human effort—fulfillment-stream members working at cross-purposes, which creates rework, confusion, and excessive motion. + Packaging—the wrong types of goods in the wrong quantities resulting in damages, excessive inventories, and corrections downstream. 2. Make customer consumption visible to all members of the fulfillment stream. If customer consumption is visible across the entire fulfillment stream, then it is much easier for every participant to plan work based on the pull of customer demand. 3. Reduce lead time. Reducing inbound and outbound logistics lead times will get orders to the customer faster. When a company can reduce lead times to the point where it can exceed lead: time expectations of the customer, it will no longer need to rely on forecasts and can “pull” material throughout the fulfillment stream. End-to-end fulfillment-stream lead times are reduced when overall inventory in the system is reduced. Part 1: The Lean Fulfillment Stream4. Create level flow. The ultimate goal is to have goods and i and uninterrupted manner based on the actual demand of the customer. This is known as level flow. Level flow reduces variation in processes and tries to spread activities equally over working time. This minimizes the peaks and valleys in movement that create unevenness and overburden, which result in waste. formation move in a predictable, consistent, 5. Use pull systems. Use pull systems when level flow is not possible. A pull system is an inventory- replenishment method (i.e., kanban) in which each downstream activity (customer consumption) signals its need to the next upstream activity. Pull systems reduce wasteful complexity in planning and overproduction that can occur with computer- based software programs such as material resource planning (MRP), and they permit visual control of the flow of materials in the fulfillment stream. 6. Increase velocity and reduce vari Velocity is the speed with which information and material move through the fulfillment stream, Meeting customer demand by delivering smaller shipments more frequently increases velocity. This helps to reduce inventories and lead times, which allows you to more easily adjust delivery to meet actual customer consumption 7. Collaborate and use process discipline. ‘The collaboration of all participants in a fulfillment stream is necessary to identify problems in the stream, determine root causes, and develop appropriate countermeasures. To be truly effective, this collaboration must be combined with standard improvement processes and regular PDCA. 8. Focus on total cost of fulfillment. Make decisions that will meet customer expectations at the lowest possible total cost, —no matter where they occur in the fulfillment stream. This means eliminating decisions that benefit one part of the stream at the expense of others. This is the real challenge of building a lean fulfillment stream, but it can be achieved when all members share in the operational and financial benefits when waste is eliminated. Building a Lean Fulfillment Streamiver of Waste Picture your organization (and your fulfillment stream) as a ship navigating down a river. The river represents your business environment—flowing fast with rocks below the water that can puncture the hull. The rocks are problems and wastes (excessive inventories, transport, space, time, packaging, work, and rework) and the water level is inventory throughout the fulfillment stream that hides the rocks. ‘As you flow down the river, you can do one of three things: + Navigate around the rocks, relying on managers to constantly change course (firefighting). + Raise the water level (inventory) to float freely over of the rocks. + Expose and eliminate the rocks permanently, so the ship can sail safely and with less water (inventory) to its destination (your customers). Managers often raise inventory levels or keep them unnecessarily high because: + Supplier deliveries are unreliable, so they add safety stock to gain a sense of security. + Transportation lead times are erratic, so they add buffer stocks in order to cover variability in lead times. + Companywide teamwork is lacking, so they build up inventories between departments to protect against the perceived incompetence of departments, + Communication with customers is lacking, so they hedge against demand uncertainties and raise finished-goods inventory levels. Inventory only hides these problems. Your company can continue to ignore problems and waste (rocks below the water) and raise the water level (inventory). But eventually excessive inventory will result in a highly inefficient company with uncontrolled internal costs (a boat out of control and thrown over the river's edge by high water), The goal is to gradually create a river that is calm and navigable, removing water slowly to expose rocks without hitting them, and then address each rock (problem) with lean tools to remove them permanently. Part 1: The Lean Fulfillment StreamPart 2: Getting Started and the Current State ‘When the Fulfillment-Stream Council first met to discuss ABE’s lean fulfillment stream and its total cost of fulfillment, the members hit a fundamental roadblock. In looking up and down the stream they knew the average lead times, the amounts of inventory ‘on hand, and the average level of shipments to customers from their own operations. But they didn’t know what was happening along the total fulfillment stream as materials and products progressed toward and then moved beyond their own operations. To. obtain this knowledge in order to make improvements, they needed a current-state map of the entire fulfillment stream. The Fulfillment-Stream Council therefore created a Mapping Team composed of representatives from every company and facility touching the stream, including managers involved in manufacturing, purchasing, materials handling, transportation, and warehousing. (Some members of the Fulfillment-Stream Council also joined the team to draw the initial map, but with the understanding that these are two separate groups with different purposes.) ‘The Mapping Team would observe and record the actual operations of the fulfillment stream. It would “go to the gemba”—to the places work was being done—to see what was really happening, not what was supposed to be happening or what historical data said had happened in the past. The goal was to capture the current reality on a single sheet of paper that everyone touching and managing the stream could see. Choosing Where to Start ‘Where should the Mapping Team start and what part or products should they follow in order to map the fulfillment stream? At ABE, as for most firms, it would be impossible to draw a current-state, fulfillment-stream map for every part going into every product. Fortunately, the problems in a fulfillment stream can be exposed by examining the path of a single part as it moves along the stream and is incorporated into a single Part 2: Getting Started and the Current State "2 finished product. The details of each part and product path will differ, but they are governed by a common logic within each company about batch sizes, transport patterns, and information management systems. Therefore the findings from mapping the flow of one part and product will be applicable to all parts and products flowing through the fulfillment stream, To understand the current state of any fulfillment stream it is necessary to: ‘© Choose one part and product to study, in order to learn about typical fulfillment-stream problems and potential improvements. '* See and agree what is happening as the chosen part and product flow through the fulfillment stream But which product should the Mapping Team select? For ABE, as for most firms, the best approach is to map a stable, high-volume, finished product (often called a SKU, for stock keeping unit) that ships to a customer, as well as a stable, high-volume part that is received from a supplier for assembly into that SKU. The Mapping Team understood that improving the flow of these two items would yield valuable lessons for improving the flow of all ABE parts and products in the fulfillment stream, The coefficient of variation (COV) is a measure of stability of demand. For example, a COV of 0.3 equals a dispersion of + 30% around the mean (average) A small COV identifies stable SKU behavior, and a large COV shows unstable behavior. Specifically: Product A: COV < 0.2 = stable SKU behavior Product B: COV > 0.2 and < 1.0 = moving away from stable SKU behavior Product C: COV > 1.0 = unstable SKU behavior Building a Lean Fulfillment Stream‘There are many ways to identify stable, high-volume SKUs, of which the simplest is to consult sales, logistics, and production veterans. However, ABE decided to use a more rigorous, data-based method that employed a scatter diagram to show the correlation between two critical variables: quantity demanded and stability of demand. ‘The Mapping Team gathered the sales (order) volumes for all of ABE’s 40 finished- goods SKUs over a 10-week period, They determined the quantity demanded in pieces, not in revenue, because a fulfillment stream is about flowing material, not revenue. ‘They recorded the minimum and maximum sales/order volume for all of the SKUs for the 10-week period. They calculated the range (max ~ min), the mean (total volume divided by 10), and the standard deviation for each SKU. Then they calculated the coefficient of variation (COV) by dividing SKU standard deviation by the mean, Then they plotted each SKU’s weekly demand against its COV to create a scatter diagram (sce below). The scatter plots compared the volume and coefficient of variation for each SKU. This analysis identified SKU 426 as a stable, high-volume SKU product that the Mapping Team could use to map the fulfillment stream. After choosing SKU 426 to map the fulfillment stream to the customer, the team needed to select a part assembled into SKU 426 to map the stream back to a supplier. Again, they wanted to identify a stable, high-volume, inbound part. But in addition to these attributes, they also considered supplier performance and attitudes. They wanted to work with a supplier that had a proven record of acceptable performance and a demonstrated willingness to partner for mutual benefit. With this in mind, the team chose Eastern Electronics’ Part No. 5054 as the inbound part to map. ABE’s SKU Classification Scatter Diagram Weekly demand 0.4 0.6 0.8 SKU stability (COV) Part 2: Getting Started and the Current State4 Current-State Information ‘Once the Mapping Team knew the sample SKU and part number, they prepared to map their fulfillment stream. They would map the entire stream—from the shipping, dock at Eastern Electronics to the receiving dock of a SKU 426 customer, Northwest HVAC Distributors. They planned to gather the following information: Total lead time In a fulfillment stream, total lead time is the sum of all processing time, transit time, and time spent as inventory. It represents the time a part needs to travel from the beginning of the stream at the supplier, through operations into a finished SKU, and on to the end customer, Processing time and transit time can be measured in minutes, hours, or days. Total lead time is caluculated with the following components: + Inbound (supplier) lead time: The amount of time from the point of ordering materials from a supplier to the point the material is received and available for use. + Manufacturing lead time: The amount of time it takes to send an order to production planning and for the goods to be manufactured and made available for shipping, + Outbound (customer) lead time: The amount of time it takes for a customer order to be received, processed, and shipped to the customer. Outbound lead time is, important because it gives an accurate measure of how long the fulfillment stream as a system takes to respond to customer demand. This is different from more frequently used measures, such as how long it takes to respond ro a customer from a distribution center near the customer end of the fulfillment stream, + Raw material inventory: The amount of inventory that sits as raw material in front of the manufacturing process, measured in average days on hand (ADOH). + Finished-goods inventory: The amount of inventory that sits in finished goods (measured in ADOH). ‘These figures are then added up to determine the total lead time: Inbound lead time Raw-material inventory ADOH Manufacturing lead time Finished-goods inventory ADOH Outbound lead time Total lead time Building a Lean Fulfillment StreamWhy Use Average Days on Hand (ADOH)? ADOH represents how much inventory a process has stored expressed in terms of how many days that process could sustain activity by consuming the stored inventory. For example, if a production line has enough of one part on hand to supply the line for 30 production days, then the production line’s ADOH for that part is 30 days. ADOH is an appropriate measure of lead time in a fulfillment stream because replenishment is based on consumption, and eliminating the time between consumption and replenishment reduces waiting and increases velocity. Because it is unrealistic to remove all inventory, the goal is to reduce ADOH to minimum levels while sustaining stability of the processes within the fulfillment stream. Most organizations measure inventory using inventory turns. So why do we advocate looking at inventory levels in terms of ADOH? Because doing this enables managers to visualize how much inventory they have relative to one day's activity. For example, if a supplied item has an order-to-delivery lead time of four days, but 20 days are on hand, it’s easy to see that there is five times as much inventory as needed. In addition, many organizations combine raw materials, work-in-process, and finished-goods inventories to calculate overall inventory turns. Our experience is that this does not provide a meaningful picture of inventory velocity for the processes associated with the different types of inventory. We suggest you evaluate raw material and finished-goods inventories independently. Calculating ADOH Use the following formulas to calculate inbound, raw-materials inventory (RMI) and outbound, finished-goods inventory (FGI) in terms of ADOH: RMI ADOH = Average RMI in dollars/average daily usage in dollars. FGI ADOH = Average FGI in dollars/average daily cost of goods sold in dollars. Example: Total annual purchases of all inbound material equals $150 million at a company that operates 250 days a year. According to financial statements, average RMI is $60 million. For this company, the RMI ADOH calculation would look like this: Average daily usage of material = $150 million/250 days = $600,000 per day ‘$60 million/$600,000 = 100 days of inventory or 100 RMI ADOH Part 2: Getting Started and the Current State 1816 Inventory Carrying Cost ‘The Mapping Team wanted to determine the cost of holding inventory at different points along the fulfillment stream. It is important to measure inventory carrying cost because excess inventory—holding more than is needed to meet the rate of consumption of the next process—ties up cash and hides process problems. Knowing the carrying ype of waste in the fulfillment stream and the cost of inventory helps define the s potential benefits of eliminating it. At ABE, the Fulfillment-Stream Council and Mapping Team met with the CFO to calculate the inventory carrying cost. They brainstormed the expenses associated with inventory. Data on some of the expenses were documented in financial statements; others had to be estimated. Then they assigned a percentage of the value of ADOH to each, and added up the percentages to reach a total of 22%. This meant that each piece of stored inventory in the fulfillment stream worth $1 was actually costing $0.22 per year to carry it. (The table below shows ABE’s list of inventory expenses, its percentage of ADOH, and the total percentage of inventory carrying cost.) ABE's Inventory Carrying Costs Gosee Sal ADO Cost of capital 8% (finance dictated as % of ADOH per annum) Inventory damages 3% Insurance on inventory 4% Inventory obsolescence (write downs) 4% Inventory shrinkage 3% Total carrying costs 22% “Includes only risk costs. Other costs, such as transportation ‘and storage, are dealt within detail elsewhere Measuring Inventory Carrying Costs Inventory carrying costs are measured by the dollar value of inventory ADOH multiplied by a predetermined inventory carrying-cost percentage. Many companies struggle to determine this percentage. Breaking the task into two steps helps: identify the elements of inventory carrying costs, and then assign an estimated cost to each element. The challenge is that many of the elements are not visible on traditional financial statements and the costs will have to be estimated based on experience. Building a Lean Fulfillment StreamLean Metrics In addition to oral lead time and inventory carrying cost, the Mapping ‘Team needed to capture the operational variables that might impact or impede lean improvements to the fulfillment stream. They collected the following types of data: Minimum order quantity (MOQ: The smallest amount in which an item can currently be ordered. MOQs can apply to both customers and suppliers. Lot size: The packaging size increment of orders. In a lean fulfillment stream, MOQ should be equal to lot size, and fulfillment-stream members should work continuously to reduce both. Cadence: Cadence is determined by the quantity and the frequency that material moves through the fulfillment stream, The quantity and frequency of customer demand should set the pace for movement along the entire fulfillment stream, Mismatched cadences disrupt the smooth flow of material along the stream. They create unleveled flow, inventory pileups, and process waste. For example, ABE interplant logistics delivers 500 units (quantity) of SKU 426 to the regional distribution center twice a month (frequency). But the regional distribution center ships 250 units to the customer once a week. The quantity/frequency of these ‘two activities are out of cadence (500 units twice a month vs. 250 units once a week), creating unnecessary inventory at the regional distribution center. Cadence Using the term cadence is helpful because it focuses on the role customer demand plays in the fulfillment stream. in a perfect world, you would be able to calculate a precise customer demand rate (takt time) for all processes in the fulfillment stream, and then connect those processes through pull systems that operate to the cadence, or beat, of this demand. In the absence of knowing the exact customer demand rate for each Process in the fulfillment stream, you can rely on your ability to see and understand the cadence of material flow though the stream. Start with customer demand from a quantity and frequency point of view. Then look at processes upstream to see where you are in or out of cadence. Part 2: Getting Started and the Current State uABE Box Score Metric 1 | Value Calculation | Lead time Inventory (ADOH) Total le time Value of wwentory in dollars of SKU 426 and related activities Inventory carrying cost related to SKU 426 Perfect-order execution 72-129 days 89 days 161-218 days $3,034,500, $667,590 8% Total lead time represents the amount of time it takes Part No. 5054 to move | from Eastern Electronics through the entire fulfilment stream as completed product. Total amount of inventory expressed in ADOH that exists in the fulfillment ‘stream. This calculation reveals how much inventory isin the fulfilment stream and its locations. ‘Total lead time is the combination of total process cycle times and inven- tory time (the two numbers above) Total value of inventory sitting at all locations in the fulfilment stream and used to calculate the cost of | carrying the inventory. | the assigned dollar value to the cost of carrying inventory. The team had determined an ABE inventory carry- ing cost of 22% of total inventory in the fulfillment stream, Overall first-time performance across the fulfilment stream. Calculated by multiplying the overall performance of the 8 Right measures. Significant variation in the overall processes in the entire fulfillment stream. Inventories had been placed ata levels ofthe fulfilment stream in order to help protect the organizations from these unstable processes. Inventory at every possible stopping point in the fulfillment stream, representing lead time—this inventory would need to be consumed before new material could flow through the stream. Ifthe team can reduce these inventory levels, it can reduce overall lead time. Considerable total lead time and variation in lead times forthe entire fulfillment stream. Real opportunity exists for lead time and overall process-waste reduction, Considerable money tied up in inventory in the fulfillment stream. Magnitude of all the inventory in the stream, Potential for significant financial gain by reducing inventories. ABE sup- pliers and customers also would benefit. Only six orders of 100 make it through the fulfilment stream without violating any of the 8 Rights. Significant rework and waste exist, since customers stl receive 72% perfect-order execution perform- ‘ance from the ABE distribution center. Building @ Lean Fulfillment StreamMetric Value Calculation ight quantity ight product Right place Right time Right quality Right ight cost (price) Right 60% 81% 79% 52% 3% 94% 61% 68% The right quantity measures multiplied across the fulfilment-stream map. ‘The right product measures multiplied across the fufilment-stream map. ‘The right place measures multiplied across the fufflment-stream map. The right time measures multiplied across the fulfilment-stream map. ‘The right quality measures multiplied across the fulflment-stream map. The right source measures multiplied across the fulilment-stream map. The right price measures multipied across the fulfilment-stream map. The right service measures multiplied | across the fulfillment-stream map. ‘Are packaging, lat size, and MOO policies contributing to right quantity errors? Perhaps customers were not ordering in ‘quantities thet aligned with packaging? ‘Need to make sure that processes in the distribution center were error-proof to ensure the right product is shipped. Need to review processes in customer service. How will they ensure the right information is put in the order right from the beginning? Logistics visibility tools are needed to highlight when an order is at risk of not meeting custamer on-time expectations. Having a planned, proactive environment ‘as opposed to a reactive one would help improve this measure, Need more discipline to identity quality problems before material is passed to the customer. Need to identity critical suppliers and ‘work more closely with them via a formal supplier engagement initiative. Need to take more time to capture the true costs associated with poor per- formance in the fulfillment stream, Need to capture customer needs and concems and create simple and objective measures to show customers how ABE is performing. Part 2: Getting Started and the Current State 2528 | Material ordering Personnel: Parts ordering and planning $150,000 Overhead expenses for parts ordering and planning $35,000 Subtotal $185,000 Inbound logistics Transportation: Inbound from supplier $3,500,000 ‘Transportation: Intracompany inbound related $800,000 Transportation: Inbound expedited freight $1,000,000 Personnel: Salaries for inbound logistics management $250,000 | Overhead expenses for inbound logistics management $25,000 | Subtotal $5,275,000 ‘Supplier collaboration Porsonnel: Salaries for supplier collaboration $500,000 | Overhead expenses for supplier collaboration $50,000 Subtotal $550,000 | Inventory carrying costs Cost of capital (Finance dictated to use 8% of ADOH per annum) $7,680,000 Inventory damages (3%) $2,880,000 Insurance on inventory (4%) $3,840,000 Inventory obsolescence: Write downs (4%) $3,840,000 Inventory shrinkage (3%) $2,880,000 Total inventory carrying cost $21,120,000 Total cost of fulfillment $51,055,000 Total cost of fulfillment as % of sales 20.4% Building a Lean Fulfillment StreamPart 3: Envisioning the Future State On the second day of their mapping event, the ABE Mapping Team met and reviewed their guiding principles, current-state map, and total cost of fulfillment statement. They started applying the principles to the six individual areas of the map to create a future- state vision for the whole fulfillment stream. The six areas were: * Customer collaboration + Outbound logistics Shipping, receiving, and trailer-yard management * Material ordering # Inbound logistics * Supplier collaboration Remember the Gui ing Principles - Eliminate all the waste in the fulfillment stream so that only value remains. .. Make customer consumption visible to all members of the fulfillment stream. 3. Reduce lead time. |. Create level flow. . Increase velocity and reduce variation. . Collaborate and use process discipline, 1 2 3, 4, 6. Use pull systems. 6 7, 8. Focus on total cost of fulfillment. Part 3: Envisioning the Future State30 “The team set to envisioning a future state for the SKU 426 fulfillment stream. In line with the guiding principle of creating level flow based on the pull of customer demand, they started with the customer, Northwest HVAC Distributors. From there they worked upstream all the way back to Eastern Electronics. They wrote their ideas and actions directly on the current-state map. They examined existing problems, considered how to improve different processes, and discussed possible actions for a furure-state fulfillment-stream. They posed the following possible countermeasures for each of the six areas: Customer Collaboration When the Mapping Team looked more closely at their relationship with Northwest, they noticed a clear difference between the quantity and frequency of deliveries to Northwest and how they actually consumed what they received. The distribution center delivered 250 units of SKU 426 once a week, but Northwest consumed an average of 50 units a day. This meant that at one point in the week an inventory of up to 200 units of finished goods sat at the customer waiting to be consumed. ‘They also discovered that Northwest held an additional 400 units of SKU 426 as buffer stock. This meant that as many as 600 units of inventory could be taking up storage space at Northwest. Pull and Level Flow Pull system: A pull system is an inventory-replenishment method in which each downstream activity signals its need to the next upstream activity. Pull systems strive to eliminate overproduction caused by push systems sending centralized instructions, often from @ master schedule without regard to what the next downstream process actually needs. In a pull system, replenishment is triggered by customer consumption. Level flow: Leveling flow reduces variation in processes by spreading activities equally over working time. This combats peaks and valleys that can create unevenness and overburden, which result in waste. Kanban: A kanban is a signaling device that gives authorization and instructions for the production or withdrawal (conveyance) of items in a pull system. Building a Lean Fulfillment StreamDid Northwest really need to keep that much inventory? The team discussed how ABE could signal and time daily deliveries to match actual consumption, and make this consumption visible to everyone in the fulfillment stream. The team proposed installing a pull system to communicate orders directly among, Northwest, the distribution center, and the ABE factory. In this system, if Northwest consumed 50 units of SKU 426 in a day, they would signal this consumption directly to the distribution center. The center would replenish the 50 units for Northwest and send a signal to the ABE factory. And the factory would replenish the 50 units at the distribution center. The team wrote this new ordering-process idea on the current- state fulfillment-stream map. Outbound Logistics If ABE wanted customer demand to trigger material flow in the fulfillment stream, they would have to figure out how to deliver finished goods to the distribution center and Northwest at the daily pace of demand. This would level the flow of materials in the outbound logistics network and still maintain stability. To achieve this, ABE needed to change their outbound logistics from delivering full truckloads (250 units) to Northwest once a week, to delivering smaller lots (50 units) once a day. Daily deliveries would reduce a great deal of SKU 426 finished-goods inventory in the stream. But some buffer stock would be needed to keep the system stable, The team held discussions with managers at the distribution center about order processing and with Northwest about consumption needs, and determined how much inventory to keep and where to keep it. In the current state, as many as 1,600 units were held as inventory downstream from ABE: up to 1,000 units at the distribution center and up to 600 units at Northwest. Clearly, this amount was excessive. In the future state, they proposed reducing buffer stock at the distribution center to 100 units at all times, daily deliveries to keep the inventory at Northwest at 50 units, and reducing finished-goods inventory at ABE from 125 units to 25 units. With a bit of calculation, the team determined that if they could change the delivery of SKU 426 from 250 units once a week to 50 units once a day, and reduce excessive inventory, they could eliminate 18,600 cubic feet of storage space in the outbound logistics network (see SKU 426 Storage Space Analysis on page 32). This would cause the ADOH of SKU 426 to plummet from 34.5 to 3.5 days (50 units equals one ADOH). Part 8: Envisioning the Future State 3SKU 426 Storage Space Analysis wensions Length wath Height Weight 2a" 28" 36" 150 Ibs. ‘Average daily consumption = 60 units I Current state Future state | | Storage Storage ‘Space| ‘space ‘space saved | Location ADOK | (cubiefeet) | ADOH | (cubiefeet) | (cubic feet! Northwest 2 7,200 1 500 6,600 Distrib. Center 20 12,000 2 41200 10,800 ABE plant 25 1,500 05 300 1200 Totals 345 | 20700 35 2,100) 16600 | L . = Shipping, Receiving, and Trailer-Yard Management Shipping and receiving yards traditionally have peaks and valleys of activity. This causes huge amounts of waste as extra people and equipment fill in to handle the peak periods, and often leaves raw material and finished goods sitting in trailers awaiting the next activity. ‘The Mapping Team concluded that if they implemented disciplined schedules for the shipping and receiving functions at each of their facilities, then trailer-yard work would occur in a planned, level, and visible way. More importantly, they wanted to align the schedules to match customer consumption on the outbound side with the pull of manufacturing material on the inbound side. The team knew that this would require significant work, including: * Creating schedules at each facility’s trailer yard based on the rate of customer demand (takt time). Specifically, the amount of work to be done (i.e., the number of trailers received, loaded and unloaded, and dispatched) needed to be planned based on the amount of working time available. * Putting in place a disciplined, visual trailer-yard management process, including arrival schedules, placards for visual management, and detailed diagrams to clearly show where trailers need to be placed at any given time of the day. Building @ Lean Fulfillment Stream+ Establishing standard work for drivers for moving trailers around the yard for loading and unloading. « Shifting existing resources (time and people} to align the shipping and receiving activities with actual customer consumption. Material Ordering To level the flow of material across the fulfillment stream, the Mapping Team needed to march the replenishment of Part No. 5054 from Eastern with the rate of consumption, of SKU 426 at Northwest. This meant ordering (and receiving) smaller lots more frequently from Eastern. If they changed production quantities of SKU 426 from 500 units twice a month to SO units a day, they should also change orders for Part No, S054 from 1,000 parts a month to 50 parts a day. Discussion with people in material ordering and planning revealed that ABE’s supplies- ordering process was erratic. Orders were based on an MRP signal, with minimum order quantities (MOQ) and delivery frequencies based on a four-month rolling forecast. But no one who ordered supplies knew the actual demand for materials. To correct this problem, the team envisioned a future state where: «Each purchased part would have a designated replenishment method. To capture and convey this unique information, they would use a plan for every part (PFEP) database. + An inbound logistics process based on the PFEP would support the flow of material between Eastern Electronics and the ABE plant. * A kanban system between ABE and Eastern Electronics would match order quantities to actual consumption. ‘A Plan for Every Part ‘A Plan for Every Part (PFEP) recognizes that not all parts have the same attributes. Variables such as supplier lead time, part volume, frequency of use, part size, ‘and supplier location all play a role in determining the replenishment process for each part. For more information on PFEPs, see: Rick Harris, Chris Harris, and Earl Wilson, Making Materials Flow (Lean Enterprise Institute, 2003). Part 3: Envisioning the Future State34 Inbound Logistics When looking at inbound logistics, the team recognized that the ABE plant was the customer for Eastern, This meant that they faced the same questions about inventory as they did when planning outbound logistics to Northwest: How much inventory is being kept? How much is actually needed to maintain stability? Where should it be kept? How will it be replenished? In the current state, no fewer than 500 units were held in inventory at any moment. The team wanted to reduce this volume significantly. They decided to create a raw- material supermarker at the ABE plant to hold a buffer stock of 200 units of Part No. 5054. On a daily basis, Production would pull 50 units from the supermarket, signal Eastern that they had consumed 50 units, and Eastern would deliver 50 new units to the supermarket. This would maintain stability for ABE’s production process, and reduce fulfillment- stream inventory of Part No. 5054 (at both Eastern and ABE) from approximately 2,000 units to fewer than 200 units. The Mapping Team recognized that a daily order from ABE to Eastern (rather than a weekly signal) was necessary to keep Eastern aware of any changes that might necessitate a larger or smaller delivery. The new supermarket would be set up as close as possible to the point of use in the ABE factory. The team wanted to deliver the units directly to the production line, but Operations wasn’t comfortable with this idea due to the complexity of its processes. Operations also wanted to keep some buffer stock on hand ducing the transition to lean fulfillment. They feared that jumping directly to flow based on daily consumption might put customer deliveries in jeopardy if Eastern had a problem. Supplier Collaboration To achieve supplier inventory reduction, the team concluded that ABE would work with Eastern to change the delivery frequency of Part No. 5054 from 1,000 parts per month to 50 parts per day. This change would reduce inventory carrying-cost and space at Eastern, But more importantly, it would more closely align the flow of materials from the supplier with the demand of finished goods at the end customer (Northwest). Building a Loan Fulfillment StreamDeveloping an Implementation Plan The Fulfillment-Stream Council was excited by how much the Mapping Team had accomplished in the first two days of the mapping event. Nonetheless, they remained cautious: implementation would require team members to get out and help others make the proposed future state a reality. On the third day of the mapping event, the team looked at the current-state map all marked up with future-state ideas. They saw enormous opportunities for improvement, beginning with a substantial reduction in inventory throughout the fulfillment stream. They believed that both financial and operational performance could be dramatically improved—in some areas by 90% or more. The team documented these opportunities and used them to set improvement goals for the SKU 426 fulfillment stream. On a clean sheet of paper they drew out a future- state fulfillment-stream map (see page 36). They wrote down aggressive numbers for inventory amounts and lead-time reduction. Then they conducted a gap analysis to show potential results, comparing the current-state performance against potential results of the improved future state. Gap Analysis Matrix ee Lead time 72-129 days 8-13.d0ys | 54-116 days /99-90% Inventory - 89 daye “10 days 78 days/00% | | Total ead time 161-218 deys | 16-23 days | 149-195 days /80% Value of inventory ~_ | 83034500 $963,750 | _ $2,660,750/87% | Inventory carrying costs (22%) $667,590 $84,425 $583,165 /87% Perfect-order execution 6% 42% 36 % points Part 3: Envisioning the Future StateABE Future-State Fulfillment-Stream Map ‘Supplier collaboration po Inbound logistics Mater ordering ing, receiving ABE co —— ‘ABE produces Part 5054 production ABE ordere 5O/day Yard and receiving Shipping 250 (week oo operations operstions Order-to-ship = 1-3 days ‘eansit time = 2days Yard arrival to « 1-3 days Endoftine to ship = 0-1 day lead time Inventory (ADOH) =2.5, Inventory (daysin trancit) =1 line delivery Inventory (ADOH) = 1.5 Inventory (ADH) = 0.5 Value of ventory car 49375 rrying cost (22%) = $2,063 $5,750 $025 Value of inventory Carrying coot (22%) Value of nventory= 95.625 Carrying cost (22%) = $1,238 Value of inventory = $86,500 Carrying cost (22%) = $8,030 34 Minimum order quantity 150 plier batch siz 50 Planned order frequency = day Planned delvery frequency = Vay Lotaize= 10) Delivery frequency tine = 5/day Production batch size = 50 Minimum order quanti Perfect-order execution = 85% Perfect-order execution = 92% Perfect-order execution = 89% Perfect-onder execution = BGT Production batch size hao been reduced from 3,000 to 250. Now goalie to reduce it to 50. 36 ‘Asiiwentoryis reduced throughout ‘the pipeline, carver performance becomes more critical Leveling the flow oF inbound material 90 that every day looks ‘the same has improved resources availablity dramaticaly, Production isnow triggered by the removal of frished goods from the supermarket, Notes, SKU 426 is unique to one customer. This customer only has one “ship to” location 250 units of SKU 426 ft on one 53-foot trailer. One Part No. 5054 per SKU 426. One week = 5 business days. Building a Lean Fulfillment StreamOutbound logistics F -B- Customer collaboration > [I 7 distribution | —| ——| 3% ~~ Northwest HVAC ABE ships 100 being stored ABE sips Disertore sells 50/day } roceosing time = day Transietine= tday Order processing tne {day tevanton/(ADOH) 20.5 Inventory (A0OH) = 2 |wertor (200K) mentor (A008) = Value ofinventory= $36,500 Value finventory= $73,000 | corning cst (22m) = #16.060 Valve ofinventory= $73,000 Carrying co9t (22) » $16,060 Carrying covt (22%) = $8,080 Delivery frequency to day ‘the distribution center ‘Average rita/shipment= 50 Planned delivery = Vday frequency ‘Average unt slshipment = 50 Loteize= 1 ‘Average dally consumption = 50 Perfect-order executor Perfect-order execution = 92% Perfect-order execution = 90% ‘The implementation of receiving ‘schedule at che distribution center has dramatically reduced extra Fillrate has improved 10 93%. ‘Static milk run deliveries have been created due to Increased frequency of delivery to the ‘ABE customers receive a perfect order 90% ofthe time fees for delaying tallers. customer base TOTALS Lead time = B13 days Inventory (days in pipeline) 1Odays Totallead time = 18-23 days Value of inventory: $383,750 Carrying cost (22%) 904,425 Perfect-order executios 42% Part 3: Envisioning the Future State38 From Analysis to Implementation Starting with customer collaboration, the mapping team went through each of the six areas relating to SKU 426 and developed a specific action plan for each. They recognized that building the fucure-state fulfillment stream would not be a sequential journey along the stream. Improvements in supplier collaboration could not wait for work in other areas to be completed. Similarly, in working on SKU 426 and Part No. 5054, they would begin to make changes to areas (e.g., yard management) that would set the groundwork for other product fulfillment streams running through ABE. They wanted to get results in all areas while still making sure that overall activities focused on the system at large. They needed a rigorous process to ensure that problems were being fixed at a root-cause level and that the future state was being implemented methodically, step-by-step. Otherwise, they knew that system-focused improvements would be trumped by daily departmental concerns. ‘The team again counted upon important practices already in place in the company— strategy deployment, process discipline, and the use of A3s—to implement the future state across the fulfillment stream. Getting Organizational Support Getting an organization aligned to overall fulfill ment-stream goals will require work and support from all levels of the organization. Mapping teams and fulfillment-stream councils should develop the necessary metrics to manage the stream from a systems perspective. They'll need clear, accurate, and current documentation of what is happening in each part of the fulfill- ‘ment stream where implementation is taking place. A weekly management meeting where everyone gives an “update” of what's going on in each department isn’t good enough. New metrics based on customer demand and reflecting total cost of fulfillment thinking will be needed to measure performance and workforce incentives. For example, is the transportation manager measured solely on transportation costs? This will need to change if you start measuring transportation services ‘on accurate delivery times, right order shipments, and the rest of perfect- order components. Building a Lean Fulfillment StreamWhy is PDCA Important? PDCA (plan, do, check, act) allows individuals and teams to thoughtfully review an operation for problems or opportunities, and experiment with ways to improve the situation. Since PDCA is ongoing, any single improvement is not considered a “solution,” which implies that another experiment and better results won't be pursued in the future. Most companies typically use metrics such as cost, quality, and delivery to track progress and assess improvements. But these are output measures that don't look at what's really happening with processes. If PDCA is in place, problems will be solved before they escalate or show up in output metrics. For example, working through a weekly PDCA session with a customer over existing conditions ‘can bring issues to the forefront fast enough to fix them before they threaten level flow and customer satisfaction. Applying a PDCA cycle requires: + Tools: Measures, reports, formats to identify waste and track activities that should occur. + Procedures: Standard work for how to report and correct problems and waste. + Timing: How often the meetings will occur and when followup on correcting problems occurs. Frequent or constant activities require frequent or constant POCA. In a trailer yard, for instance, a daily PDCA cycle or even one per shift may be needed. + Results and follow-through: This is where use of AS thinking is critical Developing A3 documents will create the project- management discipline required for sustained waste elimination. If a problem surfaces during a PDCA cycle, an A3 can be used to define the problem, why it's important to the organization, and chart various courses of action. For more information on A3s, see: John Shook, Managing to Learn, (Lean Enterprise Institute, 2008). Part : Envisioning the Future StateAppointing an Implementation Leader After conducting the mapping exercises, determining a total cost of fulfillment model, and identifying furure-stace improvements, the Fulfillment-Stream Council appointed a Fulfillment-Stream Leader. This person would be responsible for overseeing all the different elements of improvement across the entire fulfilment stream. This would include educating people about the guiding principles, seeing that the principles are properly applied, solving problems with A3 thinking, implementing countermeasures correctly, reviewing them with PDCA, and assessing accurately the costs and savings of improvements. The Fulfillment-Stream Leader The fulfillment-stream leader role is a major challenge because production control and logistics touches every fulfillment stream in an organization. It’s not possible to fix just one stream. The fulfillment-stream leader works with every group and entity across the fulfillment stream. But they're not entirely alone. Members of the mapping team and the fulfillment-stream. council are embedded throughout the stream to lend both intellectual and physical support. And remember that the leader has “responsibility” for improvements, but not “authority” to make them. Authority rests with those persons in processes and departments addressing issues (using PDCA and A3s), and the leader draws on these individuals as required, Don't get caught up in the title for the leader of the fulfillment-stream implementation. At Toyota, this person is often called the chief engineer (or “shusa”) but they could just as easily be called the “fulfllment-stream officer” or “lean fulfilment leader.” Use terminology with which your ‘company is comfortable, or use none at all. Remember that this person will already have a title defined by your organizational chart, and he or she is simply the leader who is driving the lean fulfillment initiative, Building a Lean Fulfillment StreamImplementing the Future State ABE had a plan to improve the six areas of its SKU 426 fulfillment stream. The efforts are representative of improvements made for other products and parts at ABE. Similarly, the findings and results for each type of improvement—as well as the process and challenges of building a lean fulfillment stream—are representative of what will be encountered in many production environments. Obviously, every fulfillment stream is different and each will require a unique combi- nation of actions and improvements to move from the current state to the future state. ‘As you evaluate ABE’s actions, consider how they can apply to your situation. Keep in mind the following points: * ABE implemented improvements over a two-year period. While some benefits came immediately, others came as the business stabilized over time. For example, a reduction in transportation costs yielded immediate results, while a reduction in inventory-carrying costs occurred gradually over the two years. + For the purpose of clearly showing improvements related to each area, the rollup of benefits on the total cost of fulfillment statement appears in chronological order (one area factored in, then the next, and so on). But, implementation in each area was nor consecutive. An organization must work on different areas simultaneously. For example, ABE concurrently worked on inbound and outbound logistics. Improvements in each area were realized progressively over the two years. + ABE used its total cost of fulfillment scatement to track the operations and financial benefits of its actions to keeping people informed, interest high, and progress on track. ‘Increased productivity did not result in layoffs. ABE relied on natural employee attrition or moved employees into other areas of the business where labor was needed and/or growth anticipated. ‘* ABE leaders understood the value and importance of fulfillment-stream activities. ‘They agreed that inventory reduction, lead-time reduction, and increased manufac- turing flexibility would lead to increased revenues and reduced costs. Part 8: Envisioning the Future State aPart 4: Customer Collaboration and Outbound Logistics Customer Collaboration Companies often view the fulfillment stream from end to end, starting with suppliers and ending with customers. But in reality, the fulfillment stream begins and ends with the customer, because customer-demand rates should set the fulfillment stream’s cadence. Fulfillment streams that are producing to customer cadence from end to end have minimal inventory and wastes. The actions in this area of customer collaboration show how ABE determined the rate at which its customer consumes a product and then implemented a fulfillment system that could consistently flow at that rate. Action items at ABE were: 1, Determine consumption rates and gather voice-of-the-customer data. 2. Determine optimal lot size and delivery frequency. 3. Determine inventory levels to be carried at the customer. 4, Determine the pacemaker point. 5. Implement pull triggers from the customer based on consumption. 6. Develop a weekly PDCA cycle with the customer. 1. Determine consumption rates and gather voice-of-the-customer data. Knowing how the customer actually consumes a product is the critical starting point for implementing pull and flow. A major excuse for not implementing pull systems is that companies believe that variability in customer demand prevents it. In fact, actual customer consumption usually has a stable pattern. The key is figuring out how to determine this pattern. This cannot be done by analyzing shipping and ordering data. Shipping and ordering patterns often result from lot sizes, minimum-order quantities, and transportation planning. But how customers order a product usually differs from how they consume it. Part 4: Customer Collaboration and Outbound LogisticsConsumption rates To determine actual consumption of SKU 426 at Northwest, a team of distribution- center managers reviewed beginning and ending inventory balances, sales, replenish- ment orders, in-transit inventory, and receipts for four weeks. This analysis showed an average consumption of 50 units per day, but inventory at the customer (measured in ADOH) was as much as 12 times larger. They also discovered that ABE received orders from Northwest in 250-unit increments but often held orders until it was able to ship 500 units (twice a month). Consumer Consumption Analysis Goneunnp tian of SHU 425 at Nextt | JEndinventory 450 402 355 300 250 203 154 98 953 S08 453 398 351 302 250 200 155 107 S82 497 Weok 1 Week2 Week 3 Week MtwteMtTwWwteM twtr mM twist F | Beginning 500 450 402 355 300 250 203 154 98 559 508 453 998 361 302 250 200 196 107 552 Inventory Salas 50 48 47 55 50 47 49 56 45 45 55 55 47 49 52 80 45 48 55 55 | Ordered (Moa) 250 20 250 20 | Intransit 500 500 Received 500 m | Beware of Forecasting and Marketing Strategies When researching customer consumption, be sure to review forecasting and marketing strategies. Price discounting or promotions designed to push product into the marketplace will appear to increase “consumption” in the short run, but this rarely lasts for any extended period. Models that use historical sales data to forecast future consumption also can give inaccurate guidance. Lean fulfillment streams are not built on forecasts but on true pull of the customer. Building @ Lean Fulfillment StreamVoice of the Customer In addition to actual consumption, you need to know what the customer considers valuable. Fulfillment streams should focus on delivering only what creates value from the perspective of the customer. To understand this you need to answer two questions: What is the customer's expectation of cost, quality, and delivery? and What is their perception of cost, quality, and delivery? This is best accomplished by determining the voice of the customer (VOC) through face-to-face meetings using a VOC survey. Northwest HVAC VOC Survey Faltiimant-Straam Vision | What is your fulfllment-stream vision? The perfect order from our suppliers and to our customers every time, How does ABE fit into your fulfillment-stream planning? | By supplying us with the perfect order every time and developing best practices that we ccan share with the rest of our supply base. Ghelleages ‘What are your current fulfillment-steam challenges? | (Our ability to forecast customer demand is minimal. Our supply base struggles to react to spikes in customer demand. ‘What are your challenges with ABE specifically? The same as with the rest of our supply base. It seems like we either have mountains of | items or we have shortages. Partareip How do you define a successful relationship with ABE? | Sharing and collaborating as much as possible. Reducing pipeline inventory and lead times ‘and sharing in the benefits once we accomplish those things. Parfommenas ‘What is your perception of ABE's service? ‘Our perception is that ABE is a “good supplier. They do their best to react when we have a shortage of their product, but it seems like, together, we are always fighting fires. ‘What quantitative measures support your perception? We do not have any metrics to measure our suppliers’ performance. We used to track stock-outs some time ago, but the data never seemed accurate. We definitely want to develop amore | robust supplier performance system. Part 4; Customer Collaboration and Outbound LogisticsThe gap between a customer's expectations and their perception is a measure of their satisfaction. Perceived service should match expected service. However, this presents an inherent challenge: Once customer perceptions of service meet their expectations, expectations will increase. This means customer-satisfaction levels are variable and will rise as you successfully serve a customer. This reality is best addressed by using VOC research (see VOC survery used by ABE on previous page) and PDCA to continuously improve customer service. 2. Determine optimal lot size and delivery frequency. One way to improve customer service is to increase the velocity of materials moving through a fulfillment stream. Velocity is determined by lot size and delivery frequency. Higher velocity in a fulfillment stream means lower inventory, less waste, and faster problem identification. Slower velocity means too much variation in delivery processes, excessive inventory, and longer lead times. The most powerful strategy to increase velocity is to move smaller shipments more often. Reducing order lot sizes and increasing delivery frequency not only reduces inventory throughout a fulfillment stream, it also allows the stream to respond faster to market changes and customer demand. To match actual consumption and improve service to Northwest, the ABE team realized that order lot sizes for SKU 426 should be reduced from 250 units to 50 units, and the delivery frequency had to be increased from four times a month to everyday. Milk Runs Increase Velocity A milk run is @ multiple-stop transportation route. The same dedicated truck will pick up at multiple suppliers or deliver to multiple customers. The milk run is an excellent tool to manage transportation costs while reducing lot sizes and increasing delivery frequency. More frequent customer deliveries can often be pooled together in order to attain necessary shipment densities. Much like a milkman delivering his rounds, a delivery milk run will move from customer to customer. Building a Lean Fulfillment Stream3, Determine inventory levels to be carried at the customer. Suppliers usually don’t worry about inventory levels at their customer. However, the lean fulfillment stream is a collaborative system, so it is essential for everyone involved to know about all inventory at every point in the stream. ‘The managers talked to Northwest about how much inventory was kept on Northwest premises (a function of daily consumption, order-to-delivery lead time, and replenish~ ment frequency). They discovered that Northwest kept as many as 600 units of SKU 426 as inventory in its facility. The goal of the future state was to reduce this on-site inventory to one day’s consumption of 50 units. 4. Determine the pacemaker point. [A pacemaker point is an activity within the fulfillment stream that sets the pace for all upstream activities, While it is always necessary to respond to customer demand, not every demand signal needs to be instantly communicated to every upstream activity. Customer responsiveness is increased—and costs dramatically reduced—by leveling, demand at a pacemaker point for the entire stream, with demand communicated smoothly—not precisely—upstream from that point. The challenge is to decide where the pacemaker point should be located. The ABE team determined that the pacemaker for SKU 426 should be an inventory supermarket at its regional distribution center. Setting the pacemaker at that location allowed ABE to maintain some butfer stock to protect against variability in customer demand and supply as it transitioned to a lean fulfillment stream, Ie was also a good, practical approach that could be implemented quickly. Once ABE moved SKUs to the distribution center supermarket—putting all outbound inventory in one spot—it built milk runs to mote customers, not just to Northwest. Pacemaker Process A pacemaker is any process along a fulfillment stream that sets the pace for the entire stream. It should not be confused with a bottleneck process, which unintentionally constrains downstream process due to a lack of capacity. Part 4: Customer Collaboration and Outbound Logistics a5. Implement pull trigger from your customer based on consumption. With a pacemaker point selected, ABE distribution-center managers established a pull tigger to signal upstream replenishment activity. They set their pull trigger at the inventory supermarket in the distribution center. Customer withdrawals from this supermarket (i.e., an order being pulled and shipped to Northwest) sent a kanban signal upstream for replenishment in the exact quantities that were shipped. ‘A kanban is a signaling device that gives authority and instructions for the production or withdrawal of items in a pull system, ABE managers had considered three options for using kanban to create the pull trigger: 1, Manual kanban cards that would stay inside the distribution center at all times. 2. Manual kanban cards that traveled from the distribution center to the ABE factory. 3. Electronic kanban signals from the distribution center to the ABE factory. There are many ways to implement a pull trigger, but the simplest one possible is always the best. The ABE managers chose the manual kanban system that stays inside the distribution center. This method triggered replenishment with actual consumption, and created a valuable, hands-on process for understanding the pull of the customer. The managers had to decide where to place the kanban cards (describing how much to withdraw) within the system. Options included directly on the boxes for the SKUs stored at the distribution center, on a kanban board near the point of shipping, or attached to a post at the supermarket. They chose to use a kanban post because they believed this would reduce the chances of lost cards. Internal Kanban for SKU 426 rontunter | SKU 426 Kanban quantity unit HVAC premier unit Cards in loop Northwest HVAC Lead time = 8 6 e S a c S x w oO < Transit time Building a Lean Fulfillment StreamABE’s simple, visual pull system consisted of the following steps: 1. Material is consumed from the distribution-center supermarket (units of SKU 426 shipped to Northwest HVAC Distributors). 2. Kanban cards show how many units of the SKU are removed from the supermarket {taken from the kanban post) and sent to the distribution center office. For SKU 426, each card represents one unit. If Northwest consumes 45 units in one day, then 45 cards go to the office. 3. A kanban administrator counts the cards in the distribution-center office and sends an order for the exact number of units to be produced to the factory via the ABE production planning system. In this case, the order would be for 45 new units. 4, The kanban administrator then sends the cards to the distribution-center receiving area, where they are held until the units that were ordered arrived from the factory. 5. The production department at ABE receives the order and builds the specified number of units. 6. The plant sends the units to the distribution center. 7. The distribution center receives the units, places them in the supermarket, and returns the kanban cards to the kanban post to reflect the replenished inventory. Distribution Center Kanban Loop Seer M XG sinners @® ‘romkanban post. at the Bulla ‘supermarket, sent to Ea coe § cee J acne somal TH Regi 4 L | asetotton eee comer | | ‘Grea 45 unite => [lg] => wieonsctenay ©) ret stipsssuitero s5uiteretve paced Narthestranoves Gctrvutoncener, ineuermarst 4Stanban (anes) Bane © Tecuedo port. ‘nce Part 4: Customer Collaboration and Outbound Logistics50 Replenishment Intervals and Quantities critical aspect of implementing lean pull triggers is recognizing the relationship between replenishment intervals and quantities. A lean pull trigger system is based on a fixed replenishment interval (a predetermined number of times per day, week, etc.) with variable quantity for each replenishment. For example, Northwest pulled SKU 426 inventory from the supermarket twice a day, and the ‘quantity replenished averaged 50 units a day, but actual units consumed varied. The quantity replenished should match the exact quantity consumed within each pull cycle. This is in contrast to traditional min/max inventory systems that are based on a fixed quantity with variable replenishment intervals. Min/max systems cannot create level flow because of these variable intervals. 6. Develop a weekly PDCA call with the customer. ABE established a weekly PDCA call with every customer. The VOC matrix and related measures set the agenda. For example, ABE managers reviewed fill rates in every PDCA call. This enabled ABE. to measure fill rates in real time and initiate immediate problem-solving when performance expectations were not met. For example, on one call, ABE managers mentioned that they had not seen any consumption of SKU 426 from the previous Friday. This came as a surprise to Northwest, as managers there believed it had been a typical Friday. Upon further review, Northwest discovered that the pull signal had failed to go through. They thanked ABE for bringing this issue to their attention, promised to investigate the failure, and reported back the following week on the cause of the problem and the countermeasures they implemented. Customer PDCA ‘The idea of a regular PDCA call with a customer may seem impractical or even impossible. But organizations looking to improve their fulfillment streams should implement this standard improvement process with rigor and discipline, Weekly PDCA calls are not theoretical exercises or for firefighting customer ‘complaints. These calls are effective in uncovering transportation, distribution- center, inventory, and perfect-order issues. Frequent, regular communication allows customers to inform you about any changes they see coming with their ‘customers, which may cause variation in the stream. PDCA calls can also identify situations where “shared systems” aren't working correctly. Building a Lean Fulfillment StreamABE’s customer PDCA calls also uncovered miscellaneous process waste that can only be found through regular, direct communication and collaboration with customers. On one PDCA call, the Northwest attendees informed ABE staff that only two foam collars (not three) were needed to protect SKU 426 from forklift damage. The elimination of this third collar saved ABE $6,000 a year. It also reduced Northwest's waste and made the shipping process a little greener. Measuring the Customer Fill Rates Fill rates are an absolutely critical part of the lean fulfillment stream because they represent the capability and stability of a supplier, and therefore the customer. Without stable fill rates, you can never implement flow and reduce inventories to optimal levels. The fill rate is the percentage of orders shipped in the right quantity at the right time with the right quality. Fill rate is best measured by line item, which determines performance based on whether each line item in the order was correctly fulfilled, rather than measuring the percentages of pieces fulfilled. Customer fill rate is used to assess suppliers, rather than the broader fulfill- ‘ment stream measure of perfect-order rates, because all facets of the fill rate calculation generally are within the suppliers’ control (e.g., a supplier has no control over the “right source” component of perfect-order rates). The chart below shows how performance differs depending on the technique used to measure fill rate. If the customer measures the supplier by the total quantity of items received, the fill rate would be 85% (85 parts received out of 100 parts requested). However, if the customer measures the supplier based on line-item fill rate, only three of the five lines requested were completely filled, for a fill rate of 60%. We recommend using a line-item fill rate because it com- municates to everyone along a fulfillment stream if an order is fully complete. eee Mg Part 4: Customer Collaboration and Outbound Logistics,Customer Collaboration Improvements for All of ABE’s Finished-Good SKUs The main areas impacted through customer-collaboration improvements were: * Finished-goods inventory: Reduced from $61 million to $54.9 million. This reduction was driven by collaborating with customers and understanding true demand of their product and not just depending on customer orders. « Inventory carrying-costs: Reduced from $21.1 million to approximately $19.8 million as the amount of inventory fell, freeing up cash that was applied to the balance on ABE’ line of credit. * Line-of-credit outstanding balance: Reduced from $20 million to $13.9 million. «* Perfect-order execution rate: Increased from 6% to 8%. This improvement was driven by implementing pull systems, allowing ABE to be more responsive to customers as their demand changed. ‘* Revenues: Increased from $250 million to $260 million. By increasing fill races and improving quality (shorter lead times quickly exposed quality issues), ABE became the supplier of choice for a number of items. This caused an increase in sales of $10 million per year. + Customer-collaboration costs: Reduced from $225,000 to $180,000. Savings came from introducing pull into the fulfillment stream. In addition, ABE. was able to eliminate the forecasting process as well as all the traditional customer- service costs and firefighting work that used to take place. * Total cost of fulfillment: Reduced from approximately $51.1 million to approximately $49.7 million (from 20.4% of sales to 19.1% of sales). Building a Lean Fulfillment Stream‘Total Cask of Fuiilimeng sccm Customer nal performance impact $2,000,000 $2,000,000 Line of credit — outstanding balance $20,000,000 $13,900,000 Raw materials inventory $25,000,000 $25,000,000 Work in-process inventory $10,000,000 $10,000,000 Finished-goods inventory $61,000,000 $54,900,000 Total inventory $96,000,000 $89,900,000 Perfect-order execution 6% 8% | Income statement impact — annualized | Revenue '$250,000,000 _-$260,000,000 Customer Collaboration | Personnel (Customer service and demand planning) $200,000 $160,000 Overhead expenses (Customer service and demand planning) $25,000 $20,000 Subtotal $225,000 $180,000 Inventory carrying costs Cost of capital $7,680,000 $7,192,000 (Finance dictated to use 8% of ADOH per annum) Inventory damages (3%) $2,880,000 $2,697,000 Insurance on inventory (4%) $3,840,000 ‘$3,596,000 | Inventory obsolescence: Write downs (4%) $3,840,000 $3,596,000 Inventory shrinkage (3%) $2,880,000 $2,697,000 | Total inventory carrying cost $21,120,000 $19,778,000 | Total cost of fulfillment $51,055,000 $49,668,000 | Total cost of fulfillment as % of sales 20.4% 19.1% Part 4: Customer Collaboration and Outbound Logistics54 Ina lean fulfillment stream, the inventory strategy drives the transportation strategy. This is new thinking for many people because traditionally it’s the other way round. For example, traditional thinking often calls for moving full truckload shipments— not more shipments in smaller lots. But focusing on minimizing transportation costs with full truckload shipments leads to holding unnecessary inventory. It also carries direct costs (warehousing, obsolescence, damage) and indirect costs—less cash flow, reduced flexibility, hidden quality problems, and uneven flow. To create a pull system with its customers, ABE needed to build a finished-goods supermarket at the pacemaker point in the distribution center. The company had to implement a lean inventory strategy and outbound-logistics network to support this supermarket. To build a lean outbound-logistics network, ABE took five actions: 1. Collect outbound-logisties network data. 2. Map the current outbound-logisties network. 3. Develop an inventory strategy based on flow to the customer. 4, Develop a packaging strategy based on flow to the customer. Create daily logistics design and PDCA. 1. Collect outbound lo: s network data. ‘A team of ABE logistics managers collected key data for the outbound logistics network: ‘Inventory: Where is the inventory in the network? ‘* Transportation: How is inventory transported in the network? ‘+ Warebousing: Where are the distribution centers in the network, and what purpose are they serving? * Payment: Who in the network is paying for transportation? Transportation costs can be paid in three ways: ~ Prepaid by suppliers and added to the customer invoice as a line item below the price of the products. — Prepaid by suppliers and built into the price of the products. ~ Paid by the customer. ‘At ABE, the Production Control and Logistics group was responsible for paying transportaion costs. Building a Lean Fulfillment Stream2. Map the current outbound-logistics network. Mapping your current outbound-logistics network based on accurate data will show you what is actually happening in the network. This will help expose logistics network waste, such as multiple trucks going to the same place, customers being served by far-removed distribution centers, and factories sending products to one end of the country and then back again. This information is used to design a future state to eliminate the exposed waste. ABE’s current-state, outbound-logistics map showed a network focused on minimizing transportation costs. It shipped finished goods infrequently in full truckload quantities. Asa result, finished-good inventories were high, delivery frequency was low, and the ability to react to changing customer demand was poor. (See Outhound-Logistics maps on page 56.) To move to a future-state network, ABE managers planned strategies for inventory (volumes and frequency], transportation, warehousing, and packaging. They examined volumes shipped to multiple customers and utilized milk runs to balance transportation costs, while increasing delivery frequency to its customers to daily. The key step was adding milk runs of small volumes moving to many customers at increased delivery frequencies. This minimized the total cost of fulfillment—not transportation costs— and maximized the velocity of material flow throughout the fulfillment stream. Who Pays for Transportation? Creating a logistics network based on flow requires that decisions on network design and transportation, such as increasing delivery frequencies or consoli- dating less-than-truckload shipments into milk runs, be made by the organization, that pays for transportation. If these decisions are not the responsibility of the organization paying the transportation bill, redundancies and double billings likely will result. Therefore, the group or company paying for transportation should be the one designing the transportation network. Part 4: Customer Collaboration and Outbound Logistics 5556 Outbound-Logistics Maps Ge Favl Eau cae, Wi Current-state & outbound logistics Rasjonal Distribution ‘Cereor Sioux Fats, 8D Jeon | /_ retarstae outbound logistics SiourFale, 80 milk run In the current state, ABE had an outbound network focused on minimizing transportation costs by shipping truckload quantities to customers. As a result, finished-goods inventories were high and ABE’s ability to react to changing customer demand was poor. In the future state, ABE focused on total cost of fulfillment and material flow through the fulfillment stream. It added milk runs to its network and increased delivery frequency to customers. In this example, SKU 426 is delivered daily to the regional distribution center and to the customers. Building a Lean Fulfillment Stream3. Develop an inventory strategy based on flow to the customer. Ideally a Jean fulfillment stream would have no inventory—everything would be produced and consumed at the rate of end-customer demand. Unfortunately, even in the leanest fulfillment streams, inbound (and manufacturing) lead time often exceeds customer order-to-delivery lead-time expectations and varies from process to process. This forces some demand forecasting and building inventory to stock. ‘To implement an inventory strategy based on the pull of the customer you need to determine three things: 1. How much inventory will you keep? 2. Where will you keep the inventory? 3. How will you replenish inventory based on customer pull? There are three types of inventory to consider: * Shipping or cycle stock: This is the minimum amount of goods being, built for the next shipment and protects against average daily demand and demand through replenishment time. The replenishment time can be measured in weeks, days, or hours, depending on the velocity and frequency of replenishment. * Buffer stock: These are goods held to protect against predictable common: cause variation in demand, such as daily changes in usage by the end consumer due to shift patterns, weekends, holidays, etc. * Safety stock: These are goods held at any point in the stream to protect against unpredictable special-cause variation in demand: e.g,, adverse weather, transportation delays, machine downtime. Separating inventory into buffer stock (to absorb customer variation) and safety stock (to absorb supply variation) aids in problem-solving by identifying the source of the cause of abnormal inventory (overstock or understock).. How much inventory will you keep? ‘The goal is to minimize the overall inventory needed to maintain agreed customer- service levels, and then continuously drive inventory down to expose system weaknesses. However, don’t drive inventory so low as to create instability in the fulfillment stream. You want to keep enough inventory to protect against variation experienced by the customer while determining the root cause for the variation and working to stabilize it. Part 4: Customer Collaboration and Outbound Logistics 57Once inventory levels are stable, match the replenishment cycles of the supermarkets to the consumption patterns from the supermarkets. This allows you to manage over- production by never having more inventory than the strategically needed amount. In the example below for the SKU 426 fulfillment stream, ABE logistics managers used the future-state information in the left column to fill in the formulas for cycle stock, buffer stock, and safety stock in the right column, Based on these formulas, total inventory of SKU 426 at ABE’s distribution center was determined to be 100 units. Setting Future-State Inventory for SKU 426 Average daily demand = 50 Cycle stock: 50 x 1 = 50 Replenishment interval = 1 day Standard deviation of demand = 10 Buffer stock: 2 x 10 = 20 Confidence-interval factor = 2 Replenishment interval = 1 day Total replenishment lead time = 5 days Safety stock: 5 x 50 x 12% = 30 Customer-risk factor = 12% Average daily demand = 50 Total supermarket inventory 50 + 20 +30 = 100 Standard deviation of demand: How much of a product's actual demand varies during short periods from its average demand level. Confidence-interval factor: Based on the degree of desired service level, if ABE wants to meet customer demand 98% of the time from existing inventory, the factor is 2 (84% = 1; 93% = 1.5; 99.9% = 3) Customer-risk factor: A multiplier of normal inventory levels determined by causes unique to a customer that requires an additional buffer. For example, a customer in a defense industry could be contractually obligated to keep inventories at some predetermined level during times of war. Building a Lean Fulfilment StreamWhere will you keep the inventory? ‘Where to keep inventory and place supermarkets is largely determined by customer- delivery expectations. An increase in inventory stocking locations will result in an overall increase in safety stock to meet customer demands. This is a direct result of each stocking location requiring safety stock to hedge against customer-demand variation. Consequently, the more stocking locations, the more safety stock in the system. The corollary of this is that as stocking locations are reduced, a company can consolidate and smooth overall customer demand and variation over fewer locations, and therefore serve the customer with less overall safety stock. ‘The law of diminishing returns sets in quickly as you add stocking locations. A company might benefit substantially from delivery-lead-time and distance-to-customer reductions when going from one stocking location to two, but not necessarily in going from four stocking locations to five. Any initiatives that will result in additional stocking locations should be vigorously challenged. The increase in required inventory may not support the gains in customer-response time. ABE logistics managers considered these factors and chose to go with as few stocking locations as possible. They determined the stability of ABE’s products with the scatter diagram used during the mapping event (see page 13), and classified them as A, B, and C. Stable A products were kept in more locations close to the customer, and less stable Band C products were kept in fewer, more centralized locations. In this way, the number of stocking locations was based on the locations of the most stable customers. They also determined that the regional distribution center was ideally suited to be the main stocking location for SKU 426 (an A product). It was close enough to both ABE. and Northwest to meet customer consumption and receive supplier replenishment with daily milk runs. How will you replet wentory based on customer pull? The next step is to figure out how to replenish inventories in the supermarkets once items are shipped to the customer. Ideally, if the customer consumes 100 pieces per day from the finished-goods supermarket, you replenish 100 pieces daily. This is the core of just-in-time delivery—replenishing inventories in the exact quantities and frequencies that they are consumed. Part 4: Customer Collaboration and Outbound Logistics60 Replenishment cycles and batch sizes based on customer consumption will pull product through the fulfillment stream at the pace of real customer demand. ABE incorporated Jean transportation techniques to reduce lot sizes and increase delivery frequency to match the demand at Northwest and other customers. This resulted in lower trans- portation costs due to fewer total vehicles on the road moving ABE parts and SKUs. (For an example of why this happens, see Delivery Frequency Analysis on page 86.) 4. Develop a packaging strategy based on flow to the customer. How finished goods are packaged for transportation plays a significant role in implementing a lean fulfillment stream: * Packaging determines order quantities. Order quantities should be as small as possible, and packaging that is designed for smaller lot sizes improves, the ability to ship to the cadence of customer demand. Shipping larger-than- needed lot sizes often forces customers to order more than they need and at less frequent intervals. + Proper packaging is required to build efficient transportation loads. Although moving smaller lots more frequently will increase inventory velocity and reduce costs, a company must simultaneously manage transportation costs so that they don’t increase as a result of smaller lots and increased frequency. ABE managers conducted a container and trailer cube analysis to check how efficiently its packaging strategy used space in containers and trailers (see page 61). They adjusted the packaging for SKU 426 to improve its space utilization rate in trailers. 5. Create daily logistics design and PDCA. ‘After removing waste in packaging and cube utilization, it is important to review your logistics strategy for overall efficiency. Determining the most efficient strategy to move products and material to achieve flow requires daily (if not hourly) attention and needs to be managed by a person (or department) focused on the design and execution of daily logistics. The mission of this transportation and logistics engineer is to ensure that while the network becomes leaner, costs will not increase With correct data and the proper engineering, ABE logistics managers built integrated routes and consolidations to drive waste and cost from their transportation network. They analyzed efficiencies in real time, including mode selection, trailer-cube utilization, Building a Lean Fulfillment StreamCube Utilization Analysis How Te Caleulate Gulns Utiization | Cube utilization is a measure of how much usuable space in a container actually is boing used. This example is for a 53-foot over-the-road trailer. | Step 1: Calculate usable space in trailer or container i | Usable length= 2.5 ft I Usable width» 98.0 in, This is usable width; actual width could be up to 102 in. Usable height = 104.0 in. This is usable height; actual height is 110 in. ‘Step 2: Change all variables to inches, and then convert to cubic feet and cubic yards Usable space in cubic in. 6,420,960 cubic in 630 in. x 98 in. x 104 in. | _ Usable space in cubie ft 3,716 cubic ft. 6,420,960 = (12x 12x 12) || Usable space in cubic ya. = 138 cubieyd. 3,716 + (3x33) | Cubic ft. Cubic yd, 1,858 69 Average 2415 89 High 2973 110 Key factors to consider 1. A trailer that is full only on the floor is not 100% utilized; it is only 50% utilized. | 2. Returnable containers can help to increase trailer utilization by up to 200%. | to improve trailer util 3. The easiest way to reduce transportation cos! ‘ation. One of the best ways to reduce transportation cost is to maximize trailer-cube utilization. ABE conducted a container and trailer cube analysis to check how efficiently its current packaging strategy used space in containers and trailers. Note that ABE could have based the analysis on weight if that was its major constraint: e.g., products are heavy and transport vehicles reach their weight limit before their cube limit, Part 4: Customer Collaboration and Outbound Logistics 61