Tuesday, January 29, 2008

Lean Manufacturing: Losing weight through VMI

Lean manufacturing treats work in progress (WIP) as a waste. In fact every imperfection in the system creates the requirement to build work in progress in the system. So the WIP is also known as the mirror of wastes in the system.

On the other hand, most of the brand owners and buyers are moving towards a concept called VMI or vendor managed inventory. Basic principle of VMI is managing inventory by the vendor on the behalf of the buyer. By doing this, customers can focus on their core business of selling. Most of the times buyers are prepared to pay some extra money to the vendors for managing their stocks on their behalf.

Vendor-managed inventory (VMI) systems are a proven technique for improving the efficiency of supply chain operations. VMI is made possible by the implementation of an electronic means of exchanging inventory information between the buyers and sellers of products. These electronic links eliminate many of the built-in delays associated with traditional ordering systems and enable the establishment of collaborative inventory management systems. Experience has shown that improvements in these two areas can result in the elimination of between 20 percent and 30 percent of the previously required supply chain inventory. However, in order to achieve this level of success, it is critical for those companies that have not yet implemented VMI to follow a best practice approach.

Successful VMI programs take advantage of a key supply chain relationship that has been reaffirmed many times over. When trust, cooperation, and business integration among trading partners increase, the level of inventory in the pipeline can go down significantly. Assuming normal business conditions, this can be a direct, inverse relationship that leads to significant improvements to the bottom line for all participants.

VMI veterans, as well as newcomers to the process, will eventually agree on one point: existing VMI processes work fine for dealing with predictable demand, but have significant problems dealing with the less predictable flow that results from sales, promotions, and other special activities. This occurs because the electronic data interchange (EDI) transactions that support VMI lack the flexibility to support true inter-company collaboration in planning for these events.

Benefits for the buying organization:

• Lower costs: Much of the inventory planning will be done by the supplier.
• Less inventory: Better planning leads to lower safety stock levels.
• Better fill rate: Fewer stockouts, resulting in better sales and higher customer satisfaction.

Benefits for the selling organization:

• Sticky customers: The implementation of VMI processes leads to a tighter relationship with buying organizations, making them less likely to switch to a competitor.
• Reduced inventory: Increased supply chain visibility enables better inventory planning.
• Reduced cost: VMI enables tighter integration of vendor needs and production planning, resulting in more stable production and fewer "rush" orders.

The most common process used to support VMI is EDI-based exchange of two X12 transaction sets: the “852 Product Activity Transaction” and the “855 Purchase Order Acknowledgement”.

Electronic Data Interchange (EDI)
EDI is an inter-company, application-to-application communication of data in standard format for business transactions. Electronic Data Interchange (EDI) is a set of standards for structuring information that is to be electronically exchanged between and within businesses, organizations, government entities and other groups. The standards describe structures that emulate documents, for example purchase orders to automate purchasing. The term EDI is also used to refer to the implementation and operation of systems and processes for creating, transmitting, and receiving EDI documents.

Electronic Data Interchange (EDI) can be formally defined as 'The transfer of structured data, by agreed message standards, from one computer system to another without human intervention'. Most other definitions used are variations on this theme.

ASC X12 (also known as ANSI ASC X12) is the official designation of the U.S. national standards body for the development and maintenance of Electronic Data Interchange (EDI) standards. The group was founded in 1979, and is an accredited standards committee under the American National Standards Institute (ANSI). The acronym stands for "American National Standards Institute Accredited Standards Committee X12", with the designation of X12 being a sequential designator assigned by ANSI at the time of accreditation with no other significance.

ASC X12 has sponsored more than 315 X12-based EDI standards and a growing collection of X12 XML schemas for health care, insurance, government, transportation, finance, and many other industries. ASC X12's membership includes 3,000+ standards experts representing over 350 companies from multiple business domains.

852 Product Activity Transaction
A warehouse distributor or retailer who advises a trading partner of inventory, sales, and other product activity information can use the Product Activity Data Transaction (852) set. Product activity data enables a trading partner to plan and ship, or propose inventory replenishment quantities, for distribution centers, warehouses, or retail outlets. Each pair of trading partners should determine the frequency of data transmission. Data should be transmitted at least once per planned replenishment cycle, although more frequent data transmission is worthwhile. The balance of data transmission and processing costs must be balanced with the benefit of more frequent data.
Similarly, trading partners should determine whether all part numbers should be included in each transmission or only those with activity. For instance, a monthly transmission could include on-hand balances for each product while weekly transmissions would include only those products having sales, returns, or inventory adjustment activity. The transaction set is constructed to allow up to 200 reporting locations to be included in each transmission, and up to 999,999 products. This guideline recommends minimizing the amount of data being transmitted to satisfy requirements for trading partner automatic replenishment of inventories. After the trading partner processes the data, the receiver of this transaction set would send a purchase order acknowledgment to the sender. The purchase order acknowledgment would include purchase order numbers being assigned for each reporting location, the date the order was processed, and the items and quantities being on order.

855 Purchase Order Acknowledgement
The electronic purchase order acknowledgement will typically contain exception-only information provided by the supplier about the customer’s purchase order, such as:

• A part ordered has been superseded, and the superseding part is being shipped;
• A part ordered is obsolete, and cannot be provided;
• A quantity ordered is being changed to match minimum or multiple quantities offered by the supplier; or,
• A part offered will be shipped from a special distribution point, and won’t be included with the regular shipment.

This information referenced on the purchase order acknowledgment is currently included on the shipment packing slip. However, when the distributor does not know the information until the shipment is received, confusion occurs during the receiving function. Because the supplier knows of these exceptions when the customer’s order is first processed, the exceptions can be electronically transmitted to the customer in advance of shipment receipt. In that way exceptions are greatly reduced:

• Unexpected, superseding parts received are known in advance;
• Other actions can be promptly taken to find obsolete parts;
• Unexpected quantities are known in advance; and,
• Multiple shipment receipts can be planned.

The distributor would likely integrate the purchase order acknowledgment into his purchasing system, and allow an audit modification of the original purchase order. Therefore, receiving operations continue unchanged while exceptions decrease dramatically.


On a daily basis, the retailer organization calculates sales and inventory data for each item and forwards this information to the appropriate suppliers using the 852 Product Activity Data transaction. Upcoming promotional plans can also be forwarded within these electronic documents. Software on the manufacturer’s end calculates the level of retailer inventory required to support the current level of sales activity and planned promotions. The manufacturer’s system creates the corresponding purchase order and sends an 855 Purchase Order Acknowledgment back to the retailer. The retailer feeds this information into its system as if it were an internally generated purchase order. The entire cycle can take less than one day, compared to four to six days under the old system.

Because this electronic exchange of product information enables the entire process to move much faster than the old paper-based system it replaced, both the retailer and the manufacturer can achieve significant cost savings due to reduced supply chain inventory levels. The retailer needs less safety stock inventory in its distribution center(s), and the manufacturer is able to implement better production scheduling to match real demand and, therefore, carry fewer inventories in its distribution center(s).

The retailer also benefits from improved customer service: experience has shown that manufacturers can frequently forecast sales of their products better than the retailer can since the manufacturer has access to sales activities of the same products from multiple retailers and gets a better picture of actual demand and promotional results across a much broader marketplace.

VMI can directly impact the bottom line by reducing inventory levels, but it also improves top-line revenue by elimination of stockouts, which cause customer dissatisfaction in addition to the lost sales opportunity. Helping to drive the top line is often more exciting to top management than cost reduction and assists in making the supply chain function a more equal partner in running the business.

Inventory in finish goods form is harder to manage. But when the inventory is managed by vendors they can manage it in other forms for an example as raw materials and as semi finish goods. Vendors will happy to have a VMI type of orders than a normal order. But the reality is in whatever form inventory is a waste. So in the ideal scenario vendors would manufacture goods as and when the buyer wants it and then will dispatch to the vendor instead of pulling goods from the inventory and sending it to the buyer.

Although VMI or vendor managed inventory have the term "managing the inventory" it does not necessarily mean that vendor should have a huge inventory. A lean manufacturer would be able to get the best advantage of this concept than a traditional manufacturer if managed carefully. Having a front end working in VMI model and the back end of the business working with lean manufacturing makes a powerful combination. Vendors order goods when they want it in small frequent batches. Manufacturers do their manufacturing when they receive the order in small batches with a very short lead-time. Isn’t this the ultimate lean manufacturing system?


Anonymous said...

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Doyel mirza said...

Excellent examples of how excess labor can be used to strengthen processes and deliver more value to customers. Why don't more companies see the value in this? I believe it's because of silo thinking and optimizing the silos instead of looking across the entire value stream. Thoughts? lean manufacturing