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The buffer zone: finding a happy medium between supply and demand in inventory management.

Anyone who has been involved in inventory management knows what it is like to worry about stock levels. Finding the right balance (not too much, not too little) is critical, and yet often seemingly unattainable.

Most of the problems seen in supply chains can be linked to "push" practices, or efforts to move inventories down the supply chain in hopes that demand will be met when (or if) it materializes. In practice this means using forecasts to manufacture and distribute products well in advance of demand. When the forecast proves to be unreliable, a vendor is forced to produce more than will likely be required, to protect themselves from surprises. Vendors may build and ship seasonal inventory, hoping the supply chain can run these stocks down by the end of the season. Customers may order products early to "reserve" capacity with suppliers, hoping they will use what they get. The effect of either action is the same--manufacturing capacity is deployed well in advance of end-item demand.

Some companies are using an inventory management mechanism called stock buffers to properly integrate the links in the supply chain. Stock buffers address the most serious coordination issue in production ops--replenishment in response to actual demand, prevention and minimization of excess inventories, and the identification of issues that prevent the supply chain from achieving its goals of satisfying market demand while turning an acceptable profit.

Rick Sawyer, the director of supply chain management for Canadian General Tower Ltd. (CGT), is using stock buffers to maintain the company's good customer service record. CGT is the leading North American supplier of flexible polymer cover stocks, including vinyl, for a variety of industries and products like automotive interiors, swimming pools, bookbinding, roofing, and environmental containment.

The automotive supply chain is shrinking lead times everywhere, making quick, reliable response times essential for survival. Compounding the challenge this created for Sawyer to deliver products was the fact that some clients were making unreliable forecasts that often left CGT scrambling at the last minute to finish orders. The company needed to change the inventory management function to lessen the impact of demand variability on the plant. "The automotive industry has been putting more and more pressure on vendors to reduce lead times," says Sawyer. "Because we have many products that we ship repeatedly, stock buffers are a great solution to servicing customers in a demanding environment."

Forecast accuracy is an issue in every business. Some customers provide better forecasts than others. But instead of focusing limited resources trying to fix the forecast, companies should change where they hold inventories in the supply chain and how they decide what to ship. Specifically, they would be in a much better position if:

* the supply chain held inventories where there's still flexibility regarding where products go or what end-items they become;

* everyone in a supply chain took action based only on consumption signals, not forecasts; and

* links in the supply chain not functioning properly are identified so the problems can be fixed promptly.

Where to hold

Good supply chain management means committing less inventory to the end of the supply chain to retain the flexibility to decide where and when to deploy stocks. Logistical systems developed by North American supply chains are excellent at moving products from vendor to customer. They are usually weak at moving products between regional warehouses, or from customers back to warehouses. When a company finds itself with a quantity of products in one location that it would rather have in a different location, a slow, expensive task of cross-shipments between warehouses begins.

Any time a prediction is made about future demand, a company inevitably ends up with the wrong products in the wrong places. Anything that can be done to minimize pushing products down the supply chain will smooth product flow, lower costs, and reduce waste. By committing as little product as possible to the end of the supply chain, companies can respond to actual demand, without risking actions based on questionable forecasts. However, holding products upstream may mean isn't enough time to get products to the places where they are being consumed. This system must be supported with frequent, rapid replenishment.

When and how to replenish

Although a company wants to respond only to actual demand, this still means establishing what sort of minimum amount should be held in any location, and how re-ordering should be done when demand reduces stocks. Implementing stock buffers does this, maximizing availability, minimizing waste and providing feedback on stock concerns so they can be corrected.

A stock buffer is a tool that accommodates elements of demand, supply lead-time, and variability to manage inventories and signal buying decisions. It provides information on which items are in short supply, or in excess supply, and allows the user to investigate what is causing variances from a production plan.

The amount of inventory to manage in a stock buffer is a function of:

* the expected peak level of demand over an interval of time (maximum consumption, or MC);

* the time required to reliably replenish inventories (replenishment time, or RT); and

* the provision of a safety buffer, for unexpected orders (the safety factor, or SF).

As an example, an item may range in demand from between 200 and 500 units per week, with an average of 350 units. The expected peak, or MC, would be 500 units. The time to replenish (RT) is two weeks, which is the time between placing an order and the stock being received and ready to use.

In either of these assumptions, there is the risk that things won't go as planned. Demand could spike even higher than 500 units. An issue could arise at the supplier that delays a shipment for a week or two. Some protection must be provided, as the cost of stocking out is much greater than the cost of holding inventories. A safety factor (SF) of 50% is adequate in most cases.

The quantity of units managed in this stock buffer, will be:

MC x RT x SF, or 500 x 2 x 1.5 = 1,500 units

This quantity represents the total of what will be managed between on-hand quantities at the customer, and on-order quantities at the vendor. Rarely will 1,500 units be present at one location or the other. Instead, there will be a constant movement of stock and orders between the two locations. Expect to have physically on hand between 50% and 60% of the stock buffers.

To create pull, there must be a signal that indicates when there's demand and replenishment is necessary. The signal comes from the stock buffer, when the sum of the on-hand plus on-order quantities drops below 66% of the total buffer. Until demand draws down the buffer to two thirds or less, no replenishment is necessary. The manager of the stock buffer has the discretion to place an order at any time after the signal comes, but never later than when the buffer reaches one third of the total.

When a signal is raised for replenishment, the order quantity is whatever amount is required to bring the buffer up to 100%. For example, in a 1,500-unit buffer, assume that 400 units are on hand and 300 are already on order. To refill the buffer, we would place an order for 800 units (1,500 - (400+300)). The buffer now contains 400 units on hand, and 1,100 units on order.

Where and what to improve

The stock buffer mechanism provides a consistent signal for when to buy and how much to buy. It can also act as a problem-identification tool to improve the management of the inventories on an ongoing basis. Any time that the buffer content drops below the 1/3 level, or into the "red zone," a flag is raised. Sales are at risk, so the stock buffer manager needs to understand the underlying cause. It could be a delayed order from a supplier; it could be inventory inaccuracy; it could be a spike in demand even larger than that provided for in planning the buffer. These reasons are compiled and ranked by their frequency and duration, and the magnitude of sales put at risk. The causes of red-zone holes are thus prioritized, and managers can focus on fixing the most critical issues that are risking (or losing) sales.

The stock buffer mechanism acts as both a replenishment tool and an improvement tool. When stock buffers are placed between links in a supply chain, there are mechanisms to create pull and identify those links in the supply chain that are not acting in accordance with supply chain policies.

Stock buffers perform as well as the data and processes supporting them. "Stock buffers require discipline to develop and maintain, particularly when inventory is managed on legacy systems," says Sawyer at CGT. "Stock buffers require access to purchasing systems and inventory systems to supply important data. The buffers need to be reviewed regularly for seasonality, demand swings, and inaccuracy in inventory records. The management of stock buffers should be the responsibility of a mid-level manager, as the issues raised through the problem-solving process typically cross departmental and organizational boundaries."

After dealing with the challenges during implementation, Sawyer has seen how stock buffers have improved the performance of CGT. "The biggest impact so far is our service to our customers," he says. "On-time deliveries are up, and expedited freight is way down. We used to struggle with 'crash-ins' on a regular basis. Now most of them are treated as regular orders." Most companies also see dramatic declines in inventory levels, as well as a smoothing of demand spikes between supplier and customer.

CGT is now focused on lead-time reductions, both from their vendors and within their own plant. The company hopes to dramatically lower its investment in inventories this year and put some cash to better use.

Any time a company can reduce its reliance on a forecast and act strictly according to demand, it uses its resources more intelligently and serves its customers better. To help the process, shipments should be determined by a stock buffer mechanism, which triggers orders only when demand has reduced the buffer below a certain point. The shipments must be frequent and speedy, to ensure minimal stock requirements where buffers exist. The stock buffers provide feedback to supply chain members on how well links perform and what issues need to be resolved to capture all available sales while minimizing inventory investments.

Peter Milroy, CMA, (petem@cm-sys.com) is a senior consultant. with Constraints Management Systems.
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Author:Milroy, Peter
Publication:CMA Management
Geographic Code:1CANA
Date:Apr 1, 2003
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