Julian, a journalist for ‘Big in Business’ magazine, was visiting Orbital Power Tools as research for an upcoming article. After a whirlwind interview with the operations manager, his next stop was the factory itself to meet with the production manager. The production manager, a short man with a long beard, met him at the door to the factory.
“Hi! Julian, right?” he said, extending his hand. “I’m Terry, the production guy here at OPT.”
“Good to meet you,” Julian said, shaking his hand. “That’s right. I’ve just spoken to Tabitha, and she said you could give me a few more details about the changes that you guys have been making.”
Terry nodded and gestured for Julian to enter a small glass-walled office just inside the door. “Let’s talk in there,” he said. “It’s a bit quieter, and we can do the tour after that.”
Once Julian was seated, Terry turned to him with an alert expression. “So, Tabby would have told you that we made some changes to how we maintain stock levels.”
“Yes…” Julian flipped a couple of pages in his notebook, checking what he had written during his earlier meeting. “She mentioned something about… replenishment? Is that right?”
“That’s right,” Terry nodded. “It’s a response to the classic conflict of supply managers everywhere.”
Julian frowned and scribbled another note. “You’re going to have to explain that a bit, sorry.”
“Happy to!” Terry smiled and held out his hands. “As a supply manager, you want to do a good job, right? This means you have to make sure operations don’t run out of input materials, so you need to keep the raw material inventory topped up. On the other hand, though, you also have to keep inventory costs low, so you need to let the raw material inventory run down to a minimum. And, obviously, you can’t both top up the inventory and let it run down at the same time, so the conflict is about which side you choose.”
Terry shrugged. “Most people are more concerned about protecting operations from stockouts, so that’s the side they come down on, but that has negative consequences. Slow-moving inventory ends up being held for a long time, storage space becomes scarce, it’s easy to end up with huge stocks of the wrong things, and to top it all off inventory costs are high.”
“Right,” Julian nodded, “so that’s why people tend to run down their stocks instead. It keeps inventory costs low and stops all that ‘money in chains’ we talk about.”
“Well yes,” Terry said, “but actually no. That approach has problems too. You run out of fast-moving inventory the fastest, there’s a greater risk of stock-outs occurring, and so operations get disrupted because they don’t have the supplies they need.”
“Ah… that’s where the conflict comes in, right?” Julian asked. “There are bad effects no matter which side you come down on. Does your replenishment idea fix that?”
Terry nodded firmly. “Yes,” he replied, then paused for a moment. “Well, it’s not quite perfect – no system ever is – but it’s reduced our stock problems by about 90%. It’s a completely different story now: our inventory costs are stable and low, we have high availability of supply, customer-facing lead times aren’t affected by stock issues, there’s minimal cash tied up in inventory, and because there’s less handling and storage there’s also less incidental damage. Really, there’s no way we would want to go back to how things were.”
When he didn’t continue, Julian prodded him a little. “That sounds really good,” he said. “But I’m still a bit puzzled about what this replenishment idea actually is. Could you explain what you are doing differently, so I can include a description of it in the article I’m writing?”
“Right…” Terry said thoughtfully, “Okay, normal supply management can be summed up as you order a stock of supplies, you use them up, and when you get low you order more. That’s obviously oversimplified, but it’s pretty much how it works. And that system causes problems: you almost always end up ordering too much or not enough. Order too much and it has to be stored, it ties up cash, if your needs change you might be stuck with a room full of stuff you can’t use, and even in storage, it can get damaged. If you don’t order enough, though, that’s just as bad: you might have to stop operations, your lead times extend because you’re waiting for supplies, and even with expediting you can’t fulfil customer requests that have short lead times. With me so far?”
Julian nodded. This all sounded familiar – he’d talked with supply managers at other businesses, and there was nothing new about any of this. “And replenishment is different?” he prompted.
“Yeah,” Terry said, grinning. “What we do is track usage of supplies, same as anywhere else. The difference is that at the end of every day, we put in an order for what we used that day.”
Julian frowned. “Surely daily deliveries must make the freight charges explode,” he said. “And isn’t this really a just-in-time system with a clown suit on?”
“Ah, not quite!” Terry exclaimed. “We order daily, but we don’t get deliveries daily. Our supplier just adds them all up and delivers when they hit a certain threshold. What that threshold is differs from product to product, of course – the point is that we don’t have to guess how much to order, it’s based on actual usage. That alone makes a big difference.”
“Hmm.” Julian thought about it. He could see that this method would reduce the amount of inventory that had to be kept on-hand. But… “You must still keep some stock here,” he said. “Otherwise, your lead times would be even longer. And if you have to do that anyway, is there really much advantage over ordering a whole batch at once?”
Terry nodded firmly. “Absolutely,” he said with conviction. “It’s still much easier and more flexible. It took us a few tries to get the levels right, of course. But our supply lead times are actually pretty reliable – if an order ships, we know pretty accurately how long it’ll take to get to us. The rule of thumb that we use is to have enough stock on hand that 90% of the time, the replacement ‘top-up’ gets to us before we run out of the item being ordered. If we wanted to reduce the risk even further, we could keep more stock on hand, but that 90% figure is good enough for us. The remaining 10% we can cover with expediting if we need to. The reality is that we now find most of our inventory is actually en route rather than being here in the warehouse, and we now get almost continual small volume inward goods deliveries that clear quickly, rather than the more disruptive large deliveries.”
Julian still wasn’t sure he understood properly. “Are there any other situations where this is used?” he said. “Just so there’s another point of reference, you understand.”
“Absolutely!” Terry laughed. “Toilet paper.”
“Toilet – what?” For a moment Julian wasn’t sure he’d heard right.
“Toilet paper,” Terry repeated, and leant forward to explain. “Think about it – it’s something you absolutely don’t want to run out of, right? But you won’t just buy it once a year and keep a whole room full of it, no matter how good the price is. Most people can confidently predict when they’ll be able to get more, so they just buy enough to last them until then, plus maybe a couple of extra rolls just to be on the safe side, right?”
“That… actually makes sense,” Julian said slowly. “That’s a good example!”
“Yeah,” Terry grinned. “Most people actually understand replenishment already, they just don’t know they’re doing it.”
Julian nodded. “Alright. Any advice for people thinking about trying out replenishment?”
“Be prepared for some intense discussions about what stock levels to maintain,” Terry said, grimacing slightly. “People can get pretty sensitive about reducing safety margins if they think they’re going to be held responsible for stock-outs. My suggestion is to start small – choose five or so items and implement replenishment for them, get a feel for how the system works and what sort of stock levels you need, and then choose another five items and do it again. When the debate couldn’t be easily resolved we started tracking actual levels daily to find the highs and the lows, and then halved the excess safety.”
Terry thought for a moment, looking at the ceiling. “Umm, you also probably shouldn’t bother with replenishment for small low-value items. Replenishment does take a bit of admin overhead, and it’s just not worth it for low-value items. For them, just use a 2-bin or 3-bin floor stock system, it’s easier and less fuss.”
“Good to know.” Julian made another note, then looked up. “There’s a couple of other issues I can see, although I imagine you’ve got answers for them.”
Terry shrugged. “Maybe, maybe not. If they’re things we haven’t thought of then it’ll be good to have them pointed out. What’s on your mind?”
“They’re both to do with variability of demand,” Julian said. “Some businesses have seasonal variation. I don’t imagine power tools is one of them, but would replenishment work in those environments?”
“It should do,” Terry responded. “If the seasonal demand is predictable – Christmas or winter sports, say – there’s no reason you can’t just automatically increase the replenishment amounts in those months, and the ones leading up to them, to allow for that. You still wouldn’t have to carry seasonal protection in the off-season.”
“Uh-huh,” Julian said. “And what about if the variability isn’t predictable? Like, what if everyone gets a wild desire for belt-sanders, for example? You’d run out of stock way faster than your replenishment system would allow for.”
Terry laughed again. “Yeah, belt sanders are really one of those fashion items that might take off at any minute! Actually, that’s something we thought about when we were setting all this up,” he said, still chuckling. “It was a sort of an emergency plan in case we hadn’t got the replenishment amounts right, but we decided to keep it in place in case belt sanders get really popular or something. The short version is that for anything on replenishment, we have a stock level which triggers an alert when it goes below 1/3 of what we need to get through to the next reliable replenishment date. When that happens, we put in a rush order for enough to get us back up to two-thirds. It costs a bit more, and we have to deal with different suppliers, which is a pain, but it’s better than having operations grind to a halt.”
Julian nodded, impressed. “It sounds like you’ve covered everything,” he said. “Anything else you want to make sure I cover in the article?”
Terry shook his head. “Can’t think of anything right now.” He stood up and gestured towards the door. “Ready for that factory tour?”
Julian smiled and stood up, putting away his notebook. “Yeah, I think I am. Let’s see what a factory using replenishment looks like!”