The Need for Flow—The True Purpose of Planning
Are we missing something fundamentally important about planning? The required orchestration, coordination, and synchronization are simply a means to an end. That much is quite easy to grasp. What is more difficult for many organizations to grasp is what fundamental principle should underlie orchestration, coordination, and synchronization.
Manufacturing and supply chain management comprise a bewildering and distracting variety of products, materials, technology, machines, and people skills obscuring the underlying elegance and simplicity of both as an integrated process. The essence of manufacturing (and supply chain in general) is (1) the flow of materials from suppliers, through plants, through distribution channels to customers and (2) the flow of information to all parties about what is planned and required, what is happening, what has happened, and what should happen—and of course (3) cash flow from the market to the supplier.
Plossl’s Law
An appreciation of this elegance and simplicity brings us to what George Plossl (another founding father of MRP and author of the second edition of Orlicky’s Material Requirements Planning) articulated as the first law of manufacturing:
All benefits will be directly related to the speed of flow of information and materials.5
“All benefits” is quite an encompassing term. It can be broken down into components that most companies measure and emphasize. These benefits encompass:
• Service. A system that has good informational and material flow produces consistent and reliable results. This has implications for meeting customer expectations, not only for delivery performance but also for quality. This is especially true for industries that have shelf-life issues.
• Revenue. When service is consistently high, market share tends to grow, or at a minimum it doesn’t erode.
• Quality. When things are flowing well, fewer mistakes are made due to confusion and expediting.
• Inventories. Purchased, work-in-process (WIP), and finished goods inventories will be minimized and directly proportional to the amount of time it takes products to flow between stages and through the total system. The less time it takes products to move through the system, the less the total inventory investment. The simple equation is
Throughput * lead time = WIP
where:
Throughput is the rate at which material is exiting the system. Lead time is the time it takes to move through the system. WIP is the amount of inventory contained between entry and exit.
A key assumption is that the material entering the system is proportionate to the amount exiting the system. The basis for this equation is the queuing theory known as Little’s law. More is available on the relationship between queuing and lead time in Appendix B.
• Expenses. When flow is poor, additional activities and expenses are incurred to close the gaps in flow. Examples would be expedited freight, overtime, rework, cross-shipping, and unplanned partial ships. Most of these activities are indicative of an inefficient overall system and directly cause cash to leave the organization. These types of expenses are described later in this chapter (see Figure 1-8) in relation to the bimodal distribution.
• Cash. When flow is maximized, the material that a company paid for is converted to cash at a relatively quick and consistent rate. This makes cash flow much easier to manage and predict. Additionally, the expedite-related expenses previously mentioned are minimized, limiting cash leaving the organization.
What happens when revenue is growing, inventory is minimized, and additional or unnecessary ancillary expenses are eliminated? Return on investment (ROI) moves in a favorable direction! In fact this relationship between flow and ROI can be easily depicted by the equation in Figure 1-3. This depiction first appeared in the book Demand Driven Performance: Using Smart Metrics.6
FIGURE 1-3 Connecting flow to return on investment (from Smith and Smith7)
Explaining this equation requires us to first define the elements and then show how they relate to each other:
• Flow is the rate at which a system converts material to product required by a customer. If the customer does not want or take the product, then that output does not count as flow. It is retained in the system as investment (captured money).
• Cash velocity is the rate of net cash generation: sales dollars minus truly variable costs (aka contribution margin) minus period operating expenses.
• Net profit/investment (captured money) is the equation for ROI.
The deltas and yield arrows in the equation explain the relationships between the components of the equation. Changes to flow directly yield changes to cash velocity in the same direction. As flow increases, so does cash velocity. Conversely as flow decreases, so does cash velocity. As cash velocity increases, so does return on investment, as the system is converting materials to cash in a quicker fashion.
When cash velocity slows down, the conversion of materials to cash slows down. The organization is simply accomplishing less with more. This scenario typically results in additional cash velocity issues related to expediting expenses. Period expenses rise (over time) or variable costs increase (fast freight, additional freight, and expedite fees). This directly reduces the net profit potential within the period and thus further erodes return on investment performance.
A “River” to ROI
We can make a simple analogy to this equation using the manner in which a river works. Water flows in a river as an autonomous response to gravity. The steeper the slope of the riverbed, the faster the water flow. The fewer number of obstructions in the river, the faster the water runs.
In supply chain management, materials flow through the supply chain like water through a river. They are combined, converted, and then moved to points of consumption. The autonomous response of this flow is demand. What else could it or should it be? The stronger the demand, the faster the rate of flow. And like rivers, supply chains have obstructions or blockages created by variability and limitations in the “riverbed.” Machines break down, critical components are often unavailable, yield problems occur, choke points exist, etc. All these issues are simply impediments to flow and result in “pools” of inventory called queues with varying depth.
With this analogy we begin to realize that flow is the very essence of why the Operations component of manufacturing and supply chain companies even exists. Operations is typically divided into functions, each of which has a primary objective that it is responsible for and held accountable to. Figure 1-4 is a simple table showing typical Operations functions and their primary objective.
FIGURE 1-4 Typical functions in Operations
All the objectives in Figure 1-4 are protected and promoted by encouraging flow. In fact if flow is impeded,