This post focuses on defining when providing excellent availability makes sense. The main insights behind the proposed solution appeared in the previous post.
Managing stock is always based on forecast that there will be demand for the specific items in the future. Even under that assumption there has to be a reason to take the risk to produce/purchase things without firm orders. Possible reasons are:
- Spare capacity is often tempting to make stock in order to achieve short-term high utilization.
- There are immediate cost advantages that will not be available in the future.
- The stock is absolutely required for selling, but, there is NO commitment to perfect availability.
- Because, storing that much stock is not economical.
- Clients do not really expect perfect availability of specific items and they can find alternatives very easily.
- Maintaining excellent availability as an ongoing objective, answering a real need.
Three key categories of assumptions outline the boundaries of make-to-availability (MTA):
- There is high added-value stemming from providing excellent availability.
- Otherwise, we should consider holding less stock, allowing certain level of shortages, or provide the way to order the item.
- There is continued demand for the specific items for a while.
- Either the item is a standard product sold to many clients with good overall demand.
- Or the item is sold to a single client with good and relatively stable demand.
- Or the client is committed to cover the cost of maintaining certain level of stock.
- The item is an intermediate part in the production-floor required for many end-items, for which the accumulated demand is ongoing.
- The ROI of maintaining stock is considered good enough.
Eventually the above assumptions define when providing excellent availability makes economical sense, making sure it generates real value to potential clients and the cost is not too high. Technically, it is possible to offer any product in excellent availability using the insights from my previous post, but the impact on the bottom-line could be disastrous.
When we evaluate the cost of providing availability of an individual item we need also to consider the impact on the sales of other items! There are few key items that when they are short the sales of other items go down. Other items have similar alternatives, so the damage of a shortage is reduced. These dependencies between different SKUs are usually intuitively recognized and not part of any computerized data. They still need to be included in the analysis of the overall Strategy defining what items to manage to availability and how to offer the others.
The second assumption, having relatively stable future demand, has to be carefully checked all the time! Demand could go down, most of the time gradually, but sometimes it goes to zero very fast. So, there is a point where stopping the replenishment is truly urgent. Sudden changes in the demand are beyond the power of DBM to spot early on. This is where the human intuition and intelligence have to be on guard.
Let’s expand on the ROI angle.
The investment in maintaining excellent availability is the cost (we deal later with the capacity), required to create the stock buffer. This is a standing investment! When sales occur replenishing the buffer keeps the stock buffer constant. So, the investment is not depreciated with time.
The cost of the stock buffer is based on the TVC for the full amount of the buffer. The cost has to include also the expected obsolesces for such size of stock. This is especially critical for products with short expiration time.
The return on the investment is not based on the revenues, but on the annual Throughput (T). The revenues have to finance the TVC to restore the basic investment.
Thus, a key measurement to analyze the ROI of an item managed to availability is:
Annual(T) / (The full cost of generating the stock buffer)
We can use the above formula to derive the individual ROI for one SKU and also the ROI of all the product-mix that is managed to availability.
When an individual ROI is too low we might need to find other ways to sell the item. Fast movers usually have excellent ROI, because the relatively stable sales enable low stock buffers. Slow movers usually have better T/Price ratio, but their sales are sporadic, which means high stock-buffers relative to the sales. Many times it is worthwhile to manage certain slow-movers for-order, but with short lead-time, to keep good enough sales.
The capacity of critical resources is another type of investment. For distribution organizations the relevant capacity is space, especially for retail, and cash invested in stock. The relative priority of items according to their ROI is important when there are trade-offs in the product-mix due to lack of capacity. When there is enough capacity to build all the required stock buffers then we can consider the capacity investment as “free”. However, when there are trade-offs we need to find the best product-mix that maximizes the resulting profit (Total-T minus Total-OE) and the overall ROI. This holistic view of the whole product-mix is a critical part of the overall Strategy of organizations.
It is pretty seldom that offering excellent availability of ALL the product-mix makes sense. It means some items are managed-to-availability, others are sometimes in stock, and others are sold by placing orders. The mechanism for managing stock without commitment to availability still needs to be properly defined.