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How will we work together on these new processes? What benefits are we expecting to achieve and what do you expect from my people? What training and support will be available?
Throughout the project the Deloitte team leveraged the combined capabilities of the firm to bring services and expertise to Sony in a number of areas, including enterprise risk services, EDI technology, vendor managed inventory strategy and executive alignment. Better forecasts, less inventory, major savings Sony conducted a manual pilot test of the new concepts while helping to implement the project. The test results exceeded expectations in all areas including inventory levels and turns, revenue and margin improvements and customer service level improvements. Sony is now implementing the new system throughout Canada and expects the pilot results to be replicated across the country. Said Brown: It was a leading edge project for a leading edge company using leading edge technology.
being improved), you are probably going to want to implement this practice. Back to McDonald's. McDonald's has found something that allows them to improve quality and lower costs. Let's take a look at how it does both. Improved Quality I think benefits of a better tasting burger should be fairly apparent. Unless of course you prefer aged burgers, the fresher burger is going to be higher quality if made fresh just for you. The less obvious benefit is the higher quality customer service that arises from the JIT burger assembly. When McDonald's waits for you to order the burger, they do a few things to improve customer service. First of all, when you place a special order, it doesn't send McDonald's into a panic that causes huge delays. Now that McDonald's is in the practice of waiting until you order a burger until they make it, they don't freak out when they have to make a special order fresh just for you. This higher quality customer service is subject to McDonald's ability to actually produce faster. Without this ability, McDonald's ordering costs would be sky-high because the costs associated with ordering would be the loss of customers tired of ordering fast food that really isn't fast. Second, JIT allows McDonald's to adapt to demand a little bit better. Seemingly, lower inventory levels would cause McDonald's bigger problems in a higher demand because they wouldn't have their safety stock. However, because they can produce burgers in a record time, they don't have to worry about their pre-made burger inventories running out in the middle of an exceptionally busy shift. Lower Costs The holding costs for burger parts (beef, cheese, buns, whatever other garbage they put on their burgers) are fairly high because of their spoilage costs. Frozen ground beef that's good today might not be so good in a few months. Once cooked, the same ground beef's spoilage rate shoots through the roof. Instead of having a shelf life of months or weeks, the burger needs to be sold within 15 minutes or so. The holding costs go from roughly 20% per week to 100% per hour. In other words, under McDonald's old system, they produced at a level that gave them high inventories so that food would be available fast, which is the main benefit of fast food. Unfortunately, food that was unsold after a short period of time was scrapped. Food that was sold was forced to be sold at a higher price in order to absorb the scrap costs of unsold food. Ultimately this meant higher costs for McDonald's. For McDonald's, the benefits of JIT are fairly clear. For Dell, it was the same way. So what is it that both of these firms have in common, and ultimately, when is JIT a good system to implement?
Why JIT Economic Order Quantity Savings A large benefit of JIT is that it reduces the total cost of ordering and holding inventory. Let's quickly recap three firms that have achieved this and how they did so. Dell and McDonald's High holding costs are the nature of the computer and fast food industries. JIT system allowed them to exploit the savings that were realized by holding less inventory. Wal-Mart Instead of having particularly large holding costs, Wal-Mart recognized that they were in a position to make ordering costs very small. Because of their importance to their suppliers, along with their software made affordable through economies of scale, Wal-Mart has made ordering a very small percent of their overall costs. By lowering ordering costs, Wal-Mart has made ordering small batches with greater frequency a profitable reality. High holding costs and low ordering costs are the factors that drive JIT. Generally, it's the ability to lower ordering costs that make it a feasible solution. McDonald's and Dell were both slaves to the high holding costs. It was just the nature of their industry. The solution for them was that while they couldn't lower holding costs, they could lower ordering costs. Wal-Mart didn't even have particularly high holding costs, but they realized it would be profitable to lower ordering costs which led to high holding costs as a ratio of holding costs to ordering costs. What McDonald's, Wal-Mart, and Dell have in common is very high holding costs in comparison to their ordering costs. Ultimately, this, coupled with the ability to lower safety stock, is when JIT is effective. EOQ determines how much you should order and there are two factors that drive economic order quantities down: low ordering costs and high holding costs. Depending on the product and the industry, one or both of these qualities may exist in your operations. If they do, JIT may be right for you. Without the ability to make ordering costs low as a percentage of holding costs then there is no need for JIT. In fact, the increased frequency in ordering will result in cost increases. Safety Stock Reductions The other aspect of JIT is the drastic reduction in safety stock. My previous article on safety stock discussed the two reasons safety stock exists: variability in demand and variability in lead times from suppliers (in McDonald's case, the supplier is the internal production process). It is because of this variability that safety stock exists in the first place. What JIT does is tries to reduce the lead times and variation in lead times in order to help reduce safety stock. Let's revisit the safety stock formula to figure out why this is: Safety Stock: {Z*SQRT(Avg. Lead Time*Standard Deviation of Demand^2 + Avg. Demand*Standard Deviation of Lead Time^2}
The first term is Lead Time*Standard Deviation of Demand^2. This is the inventory needed to account for fluctuations in demand during the lead time. If lead time is shorter, which JIT tries to accomplish, then this part of the safety stock is smaller, this lowering safety stock inventory. Wal-Mart and Dell accomplished this by using better software and communication with their suppliers. McDonald's accomplished this by creating a system that allowed a faster burger production (remember, McDonald's lead times are internal). The second term is Avg. Demand*Standard Deviation of Lead Time^2. This is the inventory needed to fill demand because of lead time variance. If lead time has no variance or is reduced then this term can be eliminated or at least reduced. Again, this is what JIT try to accomplish. Wal-Mart accomplishes this by demanding it, Dell by working with suppliers, and McDonald's by standardizing production. In order to accomplish the tasks of shortening lead times and reducing their variances, a considerable amount of work needs to be done with suppliers/internal operations. For some firms this is worth the trouble, for others, it is not. Conclusively, there are two major parts to JIT inventory operations: lowering the ratio between ordering costs and holding costs and shortening lead times. What results is a firm with such high holding costs that ordering very small batches very frequently is the most profitable solution. This eliminates average inventory above the safety stock level. Then, if lead times and lead time variability can be decreased, safety stock can be decreased. The result is inventory coming in as it needs to come in. In other words, it comes in just-intime
Higher premiums needed to insure extra inventory. Potentially, the inventory could spoil, expire, or become outdated and lose value. Oppurtunity costs. What else could you have invested the money and warehouse space in had you not been spending it on inventory? Remember, companies have a limited amount of assets available to them. These assets are aquired from money raised through equity and debt. Excessive inventory is a misuse of these assets because it essentially an investment in something that is just going to sit around. So why hold inventory? The simple answer is that inventory is held in order to fill unexpected changes in demand and deliveries from suppliers. If there were never any changes in demand and if suppliers could constantly deliver supplies in the quantities needed, then there would be no need for inventories (excluding work in process inventories and negligible day's end inventories waiting for outbound shipping). However, demand does fluctuate, as do lead times from suppliers. Because demand fluctuates companies are not sure how much of a certain good to produce on a given day. Companies can make predictions, but the fact of the matter is, predictions typically only give a rough estimate of what will be needed on any particular day. One solution to this problem is to maintain a workforce with a very high unutilized capacity and to simply not use it most of the time, but to have it available in the event of a day with high demand. The other solution is to carry inventory. Inventory is a way or preserving excess capacity. On the days when demand was light, the workforce overproduced. Their work was stored as inventory and now if there is a day with very high demand that is beyond the capacity of the workforce, the inventory is there as a safety net against backorders. So why not hold loads and loads of inventory? Well, don't forget about those damn holding costs. So why not maintain a workforce with a ton of slack capacity? As much as the work staff would enjoy this, you can imagine this would be very expensive to maintain. (On a side note, this is essentially what service sectors of the economy have to do. I remember I worked as a hotel valet when I was younger and there would be plenty of times when it would be so dead I wouldn't park a car for hours. But when it got busy, boy would it get busy. You can't inventory services and the ramifications of a stock out (in this case that would mean that there is no one to get your car) are too costly to deal with in many service positions.) So how much inventory should I hold?
This is subject to a wide variety of conditions. Simply put, you need to evaluate your holding costs, your backorder costs, and your demand. From there, it gets pretty tricky and I unfortunately already named this article "A Simplified Look at the Pros and Cons of Inventory" so as much as I'd like to help you, my hands are tied...what with the tiltle already being up and all. Luckily some of my previous posts deal with some of the mathematics involved in determining some facets of optimized inventory levels. ***********************************************************************
Dells Inventory Turnover Data Year 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Inventory Turnover 4.79 5.16 9.4 9.8 24.2 41.7 52.40 52.40 51.4 63.50 Week's Inventory 10.856 10.078 5.532 5.306 2.149 1.247 0.992 0.992 1.012 .819
Key point to notice here is that Dell was carrying over 10 weeks worth of inventory in 1993. By 2001, Dell was carrying less than 1 week's worth of inventory. This essentially means that inventory used to sit around for 11 weeks and now it sits around for less than 1 week. So what does this mean for Dell? Remember, computers lose 1 percent of their value per week. This isn't like the canned food industry where managers can let their supplies sit around for months before anyone bats an eye. Computers arent canned goods, and as Kevin Rollins of Dell put it, computers rot. The longer a computer sits around, the less it is worth. That said, due to depreciation alone, in 1993 Dell was losing roughly 10% per computer just by allowing computers to sit around before they were sold. In 2001, Dell was losing less than a percent. Based on holding costs alone, Dell reduced costs by nearly 9%. Since 2001, Dell has continueed to lower inventory. Looking at their latest annual reports, day's inventory has dropped by approximately a day. Hopefully this article provided you with a practical example that demonstrates the positive effects lower inventory can have on a firm's overall costs. For more information regarding lawyers in the Texas area, check out Dallas Fort Worth trucking accident attorney.