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Sometimes it pays to procrastinate: using an inventory postponement strategy to balance supply and demand.

Walk into any store that sells house paint and two things become apparent. The number of available colours seems to be growing exponentially, and the colours are not mixed until the customer orders a specific colour. Paint retailers have long known that postponing the completion of the product is an effective way of controlling costs when there is great uncertainty in demand. Completing the product only as it is demanded, and completing it as near to the customer as possible, can reduce inventory holding costs and stockout costs.



Postponement vs. make-to-stock and make-to-order strategies

The make-to-stock model in which a company manufactures a variety of products in sufficient quantities to meet anticipated customer demands seeks to minimize stockout costs. Production usually takes place in one or a few centralized plants, allowing for economies of scale, and the finished inventory is held or sent to distribution centres where it awaits customer orders. The drawbacks are the high carrying costs associated with this strategy and the potential for large amounts of unsold inventory.

The make-to-order, or just-in-time model seeks to minimize carrying costs by manufacturing products only after orders have been received. This model reduces forecast risk by minimizing the dependency on forecasting. The primary benefit is the reduced risk of unsold products, but at the risk of increased stockout costs associated with limited amounts of finished goods that can be quickly shipped to customers. Manufacturing to order also gives up .some of the benefits of mass production since goods are often produced in smaller batch sizes with more customization.

The postponement strategy falls between the make-to-stock and make-to-order models by delaying as many of the processes that differentiate products for as long as possible. This allows the manufacturer to mass produce work in process, but delay completion until customer orders are received. Therefore, some tradeoffs of costs are inevitable. The potential benefits, as well as the potential costs, depend on the form of postponement employed.

In labelling postponement, goods are completed except for labeling. The primary benefit of labelling postponement is the reduction in finished goods inventory that needs to be maintained. The manufacturer only needs a small safety stock of "generic" unlabelled product instead of stocks of each brand that the product is sold under. The advantages to this method include reduced risk of unsold goods resulting from over-forecasting demand, faster response time as goods only need to be labelled as opposed to being produced from scratch, and less rework related to unlabelling and relabelling products when one brand is over-forecast and another is under-forecast. The disadvantages include increased manufacturing cost and complexity as labelling is no longer an integral part of the production process. Instead, goods must be temporarily stored then moved to the labelling process when needed, thereby increasing handling and reducing efficiency. This problem is compounded if labelling is performed at decentralized locations, requiring duplication of the process at each location. Other disadvantages include stockout cost and slower response time. The lack of pre-labelled goods means customer orders cannot be immediately filled from stock. The resulting delay may or may not be significant to the customer.

Packaging postponement, in which goods are completed, but not packaged, has the potential for even greater cost savings. Errors in forecasting demand for different package sizes and brands are avoided and inventory carrying costs are reduced because the product is stored in bulk until the demand for the various package sizes is known. This results in reduced space requirements and reduced shipping charges since the product can be shipped in its bulk form to distribution centres near the customers and packaged at that point. As with labelling postponement, disadvantages include interrupting the manufacturing process to store or ship bulk product, then resuming the process to package and label the product, lost economies of scale if multiple packaging facilities are used, and increased time to fill orders compared to a make-to-stock system.

Assembly postponement delays intermediate or final assembly processes until orders are received. The advantages and disadvantages are similar to those of labelling and packaging postponement--carrying costs, stockout costs, etc. Long lead times for assembly may result in lost orders, while in other cases, response time may be reduced, particularly if final assembly is performed near the customer as opposed to a distant centralized assembly facility because the time required for assembly is offset by reduced time needed to ship the product to the customer. Decentralized final assembly points provide quick response time, but they also incur additional costs due to duplication of equipment and effort, loss of economies of scale, etc. Transportation costs may also be reduced when decentralized facilities are used since shipping unassembled components to decentralized assembly/distribution points is usually less expensive than shipping completed products to customers.

Manufacturing postponement derives the greatest benefit when ubiquitous materials and decentralized facilities close to customers are involved. The primary savings are in transportation and storage of materials and finished products. Locally available materials reduce the transportation of materials and need to stockpile large amounts, and proximity to customers reduces the shipping distance of finished goods. As with assembly postponement, foregone economies of scale give rise to increased manufacturing costs as smaller lot sizes are manufactured at numerous locations.

Implementation of a postponement strategy requires substantial up-front costs, the extent of which is determined by the extent of postponement. These may include costs related to changes in product design, production facilities, supplier and distribution networks, etc. The cost of these modifications may be significant or even prohibitive in light of the potential benefits.

Offshoring considerations

The world-wide distribution of products increases the opportunities for postponement. The risk of forecasting errors increases as companies respond to country-specific demands for foreign language labelling, local content, etc. Longer distribution channels increase the cost of balancing inventory supplies by shipping products from over-supplied markets to under-supplied ones. An effective postponement strategy can alleviate some of these problems.

Shipment or generic or bulk products to foreign markets, with labelling or packaging occurring once the local demand is known, reduces the risk of forecasting errors since the manufacturer does not "localize" the product with manuals, power supplies, etc. until the final destination is known.

Postponement to offshore locations can result in numerous cost savings, with labor cost being the most commonly cited. North American companies, in particular, find that labor in foreign markets is significantly cheaper than in the domestic market. Transportation costs can be reduced because bulk products or components can frequently be shipped in smaller physical volumes than finished products. Even greater savings are possible if materials are sourced in or near the destination country. Unfinished products or components may also be subject to lower import duties than finished products, and manufacturing or assembly in the destination country aids in compliance with local content laws.

Offshore postponement also has its drawbacks. Labour may be cheaper, but finding sufficient workers with required skill levels may be difficult. Significant costs may be incurred to establish offshore facilities for product completion, and decentralized operations tend to be more costly to administer, especially in foreign countries. One final, difficult to quantify cost is the impact on company reputation of sending "local" jobs overseas.

Is a postponement strategy right for your company?

A postponement strategy is not right for every company, nor is each type of postponement applicable to companies that do adopt a postponement strategy. Uncertainty of demand is the overriding determinant of the need for a postponement strategy. Uncertainty increases the risk of stockouts, and attempting to compensate by producing large amounts of inventory results in large holding costs. Inventory value should also be considered. High value products may benefit more from a postponement strategy than low value products.

Labelling postponement may be appropriate for firms that sell products under several different brand names, in different countries where language is an issue, or that experience high sales fluctuations between brands. Packaging postponement is best utilized when the product is sold in several different package sizes and the sales fluctuations of the different sizes makes forecasting difficult.

Assembly postponement may benefit companies manufacturing goods which share a number of common components, but are differentiated during the final assembly process, or when the assembled product is much bulkier than the unassembled components. Products made from ubiquitous materials or which are too bulky or costly to ship are candidates for manufacturing postponement. Acquiring the materials and manufacturing the product near the customer is more cost effective than shipping finished products.

Manufacturers attempt to balance inventory holding costs and stockout costs, a problem compounded when forecasting customer demand is difficult. Postponement strategies allow manufacturers to defer the completion of work in process inventory until demand for the individual finished products becomes clear. While this strategy involves foregoing economies of scale in exchange for certain diseconomies of scope, careful application can result in significant cost savings and better response to customer needs.

Bibliography/additional resources

Lee, Hau and Corey Billington, "Designing Products and Process for Postponement," in S. Dasu and C. Eastman (Eds.) Management of Design: Engineering and Management Perspectives, Kluwer Academic Publishers, Norwell, Massachusetts, (1994), 105-122.

Zinn, Walter, "Should You Assemble Products Before and Order is Received?" Business Horizons. 33 (1990), 70-73.

Zinn, Walter and Donald J. Bowersox, "Planning Physical Distribution with the Principle of Postponement," Journal of Business Logistics. 9 (1988), 117-136.

David M. Bukovinsky, PhD., CPA (inactive) is associate professor, department of accountancy, Raj Soin College of Business, Wright State University. Gregory A. Graman, PhD, is assistant professor of operations management, School of Business and economics, Michigan Technological University.
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Author:Bukovinsky, David M.; Graman, Gregory A.
Publication:CMA Management
Date:Jun 1, 2010
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