Spartan, who was a leading designer and manufacturer of specialized industrial heat transfer equipment earns sales revenues of $25M. The company has prided themselves on creating a Make-to-Order system that allows customers the option of customizing their orders to their needs. Customization is what gives Spartan the competitive edge over their competitors. Meanwhile, however, countries like Korea and Europe are currently changing industry standards. Korean firms have a low cost base and compete primarily on low cost. European firms have begun to focus on standardizing their product lines to a few high-volume products and compete on delivery lead times and price. Rick Coyne, Materials manager for Spartan, is faced with a proposal of “renewing” Spartans business strategy. Spartan would like to reduce customer lead times for finished products from 14 weeks to six weeks. Second, Spartan would like to move from an inventory turnover rate of 4/year to 20/year. Third, Spartan would like to include some form of standardization in hopes of lowering costs for purchased goods. Issues to be addressed in this procurement project
The Materials Department headed by Rick Coyne has to take a lot of initiatives internally to incorporate various implications of the new strategy, and submit his report to his boss Max Brisco of the changes suggested by him within a week. His major challenges are change from responsive to anticipatory model, keep-up with the increased competition in the industry, inventory turns from present 4 times to 20 times, eliminate material shortages & stock outs, reduce cost of Purchase goods by 10% & Reduction in the custom lead time from 14 weeks to 6 weeks. * Raw materials procurement.
The customization strategy required the presence of many vendors and a high level of inventory in the warehouse. On the contrast, the new corporate strategy reduces variety to 3-4 basic lines for each product category will require less variety of raw material but in higher quantity in respect of each variety, but with a lower inventory average level in comparison with the present situation. This will bring down administration cost, overhead expenses and ordering costs. It will also give the company a higher negotiation power for better overall conditions, including delivery time, transportation cost, price, quality and budget. * Job shop to flow operation
The new corporate strategy implies re-engineering from a job shop method of production to a hybrid method of production. The former involved manufacturing operations with several departments, each of which produced particular components whereas the latter being a flow operation where multiple stations can work simultaneously. This will mainly allow Spartan to increase volume of production, reduce lead time and it will further lead in cutting down the carrying cost of inventory, even though the inventory will be high. * Change in Corporate & Operation Culture.
The new strategy will affect the corporate structure of the company. Earlier the work was based on the specific requirements of the client and it was more of research based but now the focus on research will be less and it will be more on general requirements. Therefore the type of work would shift. The present organizational chart of the SC Department in the company includes two buyers, one material control clerk, one expeditor and two shipper/receivers. This structure was functional to the previous strategy because there was a strong focus on the purchasing function. We believe that in order to maximize the SC Department resources in accordance with the new structure the positions and functions of the people in the SC Department will have to be adapted to strengthen the inventory management function of the company. The company will benefit from having one person responsible for forecasting demand. Processes should be reviewed to ensure that the SC Department has sufficient access to information in order to achieve this task. Re-buying will also be of utmost importance now in order to ensure that there is always sufficient inventory to maintain production going.
* Lead time reduction from 14 to 6 weeks for finished goods. One of the strategy changes is to reduce the lead time from 14 to 6 weeks in order to keep up with the competition in the market. From SC this may be discussed with the vendors at the time of negotiation and should also be a clause in the PO. Now since the process is already standardized, Rick should also insist on improved communication between sales, materials department and vendors will help in the prediction of demand. Additionally, Rick will also have an option of keeping a buffer stock in case of an inconsistent demand. In any case, we believe that this goal can be achieved with an adequate supply chain strategy. The fact that we are reducing the number of vendors required will allow us to be more selective and procure only from the vendors that provide a service in accordance consistently delivered in few days lead time or those who can commit to do so in the future. * Vendor Development (Price Reduction)
A vendor base of 350 can prove to be very beneficial for Spartan. Such a large base of vendors is a clear indication that Spartan has a good market reputation. The new need for a reduced variety of raw material and its variety getting reduced will help Rick to achieve the following goals: a) find and maintain and improve quality, b) find and develop best–in-class supplier, c) standardize the items bought and the processes used to procure them, and d) purchase required items and services at lowest cost of ownership. Another option that Rick will be able to pursue with the new strategy is consignment buying, wherein “… the buyer assumes responsibility for accounting for withdrawals of stock from that consignment inventory, payment for quantities used, and notifications to the supplier of the need to replenish inventory…” This is possible due to the space available in the warehouse since the variety of raw materials has reduced. The mentioned space can be used to keep suppliers inventory under his control, especially for Aluminium which constitutes 40% of the total inventory.
Moreover, working with this strategy will help Rick in another way as he will be able to solve the problem of stock out, specially for the basic raw material i.e. Aluminium. Nonetheless, since Spartan will now need only a fixed variety of raw materials, hence the requirement of a large vendor base will not be required. This will provide Rick more negotiation power for a fixed vendor base, for his basic raw material as explained later on. The new business strategy being formulated for 5 years will give more negotiation power in view of a commitment of a long term relationship. As we previously mentioned, the new strategy of Spartan will enable the Supply Chain Department to restructure the procurement scenario. As we know, purchasing and supply management are critical to the success of a company. The general modern conception regarding procurement is recognizing the importance that, in addition to price, other elements may have in this relation. In this line of thought, we believe that being able to reduce significantly the number of vendors will allow the company to make some considerable advances on vendor development.
Since there will be a less variety of raw materials to purchase and in a larger quantity than previously, due to the new anticipatory approach, the company should aim to establish long term relationship with these fewer vendors. However by no means do we want to imply that purchasing function at Spartan should be any less strategic. We believe that this should continue, but also that some resources can now afford, and will highly benefit, from reallocating some resources to the inventory management function. Additionally, suppliers might also have a strong incentive to cooperate with the company as they can obtain higher revenues due to more bulk orders. We know that reducing the costs will drive profitability up.
Moreover, reducing the purchasing price on raw materials will produce a leverage effect on return on assets. This means that any given reduction that Spartan can obtain on the procurement price of aluminium will translate in an even higher increase in the return on assets. This will be further explained ahead in this paper. A 10% of reduction in the prices from suppliers could be possible by searching new suppliers that offer standardized products of good quality. Spartan should also consider finding an effective logistics route which allows them to reduce costs and they should consider the possibility of consolidating their goods. This will represent a decrease in the expenses that the company has to pay once they receive their goods. * Inventory turnover.
Inventory turnover ratio is used to measure the inventory management efficiency of a business. In general, a higher value indicates better performance and lower value means inefficiency in controlling inventory levels. A lower inventory turnover ratio may be an indication of overstocking which may pose risk of obsolescence and increased inventory holding costs. However, a very high turnover may result in loss of sales due to inventory shortage. Inventory turnover is different for different industries. Businesses which trade in perishable goods have very higher turnover with comparison to those dealing in durables. A comparison would be fair only if made between businesses of same industry. Another part of the corporate strategy is to increase inventory turnover from 4 to 20 times. The formula for inventory turnover is:
Inventory Turnover = Sales/ Inventory
We believe that the transition from customization to specialization, with its reduction in the needs of raw materials and all the implications that we mentioned before on vendors development, will help reducing the inventory turnover. * Training of Manpower & Labour.
The change in corporate strategy will require the employees to get training in accordance with the new product line. There will be two new drivers in respect of personnel. We estimate that the anticipated increase in business will require more staff in the Production Department, so the HR Department will have to recruit more staff. Additionally, adopting a new standardized operation could have the opposite effect in respect of the R&D Department. In respect of the SC Department. the principal effect will be the need to change the organizational chart and functions for each employee as discussed above. Furthermore, the issue of discrepancies can be addressed by training and assigning this responsibility to one of the staff members of the Materials Department. Quantitative Analysis
Inventory Turnover (Purchasing $14M of inventory/year or 56% of revenues) – (Spartan) 4 turns/year: Holding costs of $875,000/year. (3.5M * 25% inventory carry costs) – (Competitors) 20 turns/year: Holding costs of $700,000/year (2.8M * 25% inventory carry costs) Raw Materials
– (Spartan) $3.5M * 40% = $1.4M
Basis of Competition
– (Spartan) Make-to-Order – Customization
– (Competitors) Make-to-Standard – Availability/Delivery Lead Time, Cost Delivery Lead Times
– (Spartan) 14 weeks
– (Competitors) 6 week lead times
– (Spartan) Regular shortages, stock outs, and write-offs
– (Competitors) No inventory stock outs. Finished goods held in stock in anticipation of customer orders.
– (Spartan) Customized design and manufacturing (Requiring 350 suppliers) – (Competitors) Standardization across all product lines: No specialization (Narrow Supply Base) The difference between MTO and MTS is
MTO–> Make to Order
Production is the process where the production order is triggered from a Sales Order. Ex: The Prod process will start only after receiving the sales order from the customer. In this case the product could be customer specific only (Variant) MTS–> Make to Stock
MTS scenario can be accomplished by the following settings
Need to use strategy group 20 in material master MRP view-Strategy group 20 is assigned to strategy 20 Strategy 20 is assigned to Requirement type KE (Individual customer requirement) Requirement type KE is assigned to requirement class 040 (Indiv.cust.w/o cons.) Requirement class has all the parameters where we can define Production order type that will be used to create the prod order. The above link needs to be established.
Based off of the quantitative and qualitative analysis above, Spartan should move towards a more standardized process offering three to four basic lines. Becoming standardized, Spartan can shrink their supply base greatly. Spartan can move from a supply base of 350 to a more manageable supply base of around 20 to 30 suppliers. Spartan will also be able to shrink costs by over $100,000 as mentioned earlier by having 20 turns/year, compared to 4 turns/year. Finally, Spartan can shrink raw material costs up to 10% over the next 12 months. To accomplish this Spartan should follow these steps: 1. Plan out three to four basic lines in each category of production (Similar to competitors) a. Plan/Layout for equipment that may be needed to create standardization
b. Plan to move from batch process or job shop operation to an assembly-line process 2. Create a detailed plan on which materials Spartan will need to purchase a. Specifications: What will be bought, how much will be bought, and when it will be bought 3. With the above planned out, Spartan can plan to eliminate the suppliers that will not be needed a. Contact each supplier that is not necessary for production and discontinue relationship b. Contact each supplier that is necessary for production and submit bill of materials 4. With more stable production lines, Spartan can guarantee a more stable/shorter delivery lead time to customers a. Guarantee customers of a six week lead time (Advertise: If greater than six weeks, offer discount) b. Plan where and how to hold finished goods in anticipation from customers future orders 5. Submit plan to proper departments for approval
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