Review of A Theory of Constraints Replenishment Solution, Part 1
In the first installment of this series, I began a discussion on the current state of replenishment. I explained that although many companies have lots of inventory, they are plagued with stock-outs. I presented the following graphic to simulate many of today’s replenishment systems:
Note: The above figure is from Reaching the Goal by John Arthur Ricketts, a book I recommend.1
In Part 2, I will dive into the replenishment model being used by many of today’s companies and begin looking at why these companies seem to struggle with minimizing inventory and avoiding stock-outs.
The rules and assumptions of the antiquated min/max system
Many companies today are using a traditional replenishment system referred to as the min/max system. The basic rules and measures for these systems are actually quite simple:
- Rule 1: Determine the maximum and minimum levels for each SKU.
- Rule 2: When re-ordering, don’t ever exceed the maximum level.
- Rule 3: Never reorder until you go below the minimum level.
The foundational assumptions behind these rules and measures are primarily based on the belief that, in order to save money and minimize expenditures for supply inventory, you must minimize the amount of money you spend for these items. The assumption here is that the purchase price per SKU (unit) is driven to the lowest possible level by buying in bulk and the company maximizes savings on purchases by buying excessive amounts of materials.
Why doesn’t this system help us to avoid stock-outs?
What we see in reality is that there always seem to be circumstances of excess inventory for some items, while other items are out-of-stock. Even though you may have plenty of inventory, you may also continue to have stock-outs. Why does this happen? Let’s try to answer that question by pointing out the “rules of engagement” for the min/max system.
As specified in the basic rules for the min/max system, the system reorder amount can never exceed the level of the maximum. Many of the supply systems we see today only allow for one order at a time to be in the ordering system for a specific SKU. In addition, total SKU inventory is held at the lowest possible level of the distribution chain—the point-of-use (POU) storage location. SKUs are inventoried once or twice a month and orders are placed, as required. Remember, orders for SKUs are triggered only after inventory levels fall below the minimum value that has been set.
Graphically, the min/max system is as depicted in the figure below:
The min/max system is based on being in a reactive mode
In this reactive mode, we wait for a part to reach the pre-defined minimum stock level before reordering the SKU. This is the common reorder point. Stock-outs occur when the lead time to replenish the part (vendor replenish time) exceeds the minimum stock available. In addition, when variability enters the picture, stock-outs can happen in shorter time periods. This pattern of possible stock-outs repeats itself over time as depicted in the figure below:
This figure demonstrates the negative consequences of the min/max supply system. At times, there are excessive levels of inventory, while at other times SKUs are out-of-stock. The reality is that, in most cases, the most prominent measures for the min/max system are focused in cost-world thinking (i.e., saving money), rather than satisfying the needs of the system. So, what’s the solution?
Coming in the next post
In my next post, I will continue this discussion on a different materials distribution system based upon the Theory of Constraints.
Until next time,
1Reaching the Goal: How Manager Improve a Services Business Using Goldratt’s Theory of Constraints, John Arthur Ricketts, IBM Press, 2007
Epiphanized—Integrating Theory of Constraints, Lean and Six Sigma (TLS), Bob Sproull and Bruce Nelson, North River Press, 2012.
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