tocip – application for distribution

TOC – Application for Distribution

Presented byRajeev Athavale

Theory of Constraints – Introductory Presentation

(TOCIP)

DistributionProblems, Causes and TOC Solution

What Do We Strive For?

• We strive to have– Right Inventory– At the right place– At the right time

So that we satisfy our customers and our business flourishes!

What Really Happens?

• There is a shortage of fast moving products• Slow moving products are piling up• Lots of cash is tied up in Inventory• Customers are dissatisfied with product

availability• Product variety cannot be increased easily• Lots of products have to be scrapped, or sold

at reduced price

What is the Cause?

Pushing the products in the market with the belief that, more the inventory near the consumption points, better the sales

Wait a minute… What’s wrong with it?

Wait a Minute…

• What’s wrong with it?• Isn’t it an industry norm?• Isn’t it important that our products are always

available in enough quantity so that our customers are not disappointed?

Is there something that we are missing?

Do we know…

• That there are shortages despite our pushing?• That we are not in a position to measure the

impact of such shortages?• Our Inventory Turns are low due to huge

surpluses

The Vicious Cycle

• At the beginning of the year, we have annual forecast and plan in detail as to which product will sell in what quantity when and where

• We set targets accordingly for everyone – Sales, Production, Purchase etc.

• Factory starts producing according to the plan and pushes the product to Distributors; they in turn push them to the Retail Stores

The Vicious Cycle

• However, the market demand fluctuates and sales do not happen as per the detailed plan

• Nevertheless, the Factory continues to produce and push according to the plan given to them

• This creates surpluses in the market• However, it creates shortages also• We are amazed to know that the products which

are in excess in some places are exactly the same products that are not available in other places

The Vicious Cycle

• We take feedback from the market• We pull up everybody for not meeting their

targets• We revise our plan considering what happened

since we last planned and revise the targets• For some time, we find that the sales are

growing; however, after some time, we start seeing the same old problems all over again

The Vicious Cycle

• We find more and more inventory everywhere but despite that, we have more and more shortages

• Now, we have more problems with the Retail Stores who have started demanding more margins and more credit period

• We have a tough time with our suppliers for paying them as per our commitments

• While introducing new products, we have to incur a big loss by scrapping or selling at discount a huge quantity of the old product

• At times, we are late in the market

The Vicious Cycle

• Our sales start falling• Our customers are dissatisfied• Our people start pointing fingers at each others• Once again, we investigate, find the culprits and

punish them• We once again go back to the drawing board and

have fresh forecasts…• And the vicious cycle - the negative loop - continues

The Conflict

We are “stuck between the rock and the hard place”

Can We Invalidate Any of the Assumptions?

• More inventories mean more investment– It is obvious that if we hold more inventories, we will

have to spend more money on creating and holding it– This assumption seems very difficult to invalidate

• More inventories mean more limits on cash flow– More inventories causes more outflow of cash; it does

not guarantee more inflow of cash– That poses more limits since we do not have unlimited

cash– This assumption seems very difficult to invalidate


• More inventories mean more obsolescence– There are certain products that have a limited period

before they expire or they have a limited shelf life– In this case, if we are holding large inventories, the

chances of obsolescence are more– This assumption seems very difficult to invalidate

• Replenish Time is long– Invalidating this assumption means finding a mechanism

to drastically reduce the Replenishment Time– Most suppliers demand higher price for priority delivery;

so it is costly– It takes lot of time to significantly impact OLT, PLT and TLT– This assumption seems very difficult to invalidate


• Demand cannot be predicted accurately– Invalidating this assumption means finding a mechanism to

produce accurate forecasts– It is impossible to accurately forecast at product / Retail

Store level; only trends can be predicted– This assumption seems very difficult to invalidate

• Re-supply (vendors) is not reliable– Invalidating this assumption means increasing the

reliability of vendors– Replacing vendors will improve things only if the existing

vendors are exceptionally unreliable– Educating the existing vendors will take a long time, if at all

it is really feasible– This assumption seems very difficult to invalidate

TOC SolutionTOC Solution shows the way to invalidate the following assumptions:• Replenish Time is long• Re-supply (vendors) is not reliable

• It shows the way to have – 99% availability– Much lower inventory in the system– Improved cash flow– Good response for fluctuations in demand

Before We Talk About the Solution…

Do not discuss the solution unless:• People have understood the problems• The causes and• They are able to relate them to their situation

Before We Talk About the Solution…

• How do we judge a solution to be good?• Dr. Goldratt said that a solution is good if:– It results in excellent benefits– It is a Win-Win-Win for all whose collaboration is needed– The risk (multiplied by damage) is small relative to the

benefits– It is simpler than what we do now– The sequence enables people to come on board – any

cluster of actions brings immediate significant results– It does not self-destruct

SOLUTION

Dr. Goldratt Said:

If we want to reverse a vicious cycle, we need to do at least one thing which is exactly opposite of what we have been doing!

The solution lies here!

Solution in Nutshell

Legends:CDC: Central Distribution CenterRDC: Regional Distribution CenterRS: Retail Stores Flow of products:Flow of Sales Data:

• Imagine that there is inventory laying at each node i.e. CDC, RDC and RS

• Also imagine that there is an invisible string tied between the inventory in RS and the inventory in RDC

• When a RS sells a unit of a product, the invisible string pulls that product from the RDC and brings it to the RS and thereby maintains the level of inventory in RS

• Similarly, imagine that an invisible string has also been tied between the inventory in RDC and the inventory in CDC

• When a RDC dispatches a unit of a product, the invisible string pulls that product from the CDC and brings it to the RDC and thereby maintains the level of inventory in the RDC

• Imagine that there is an invisible trigger tied between the Factory and CDC. When CDC dispatches products to RDCs, it triggers the Factory to produce those products and replenish the level of inventory in the Factory

• The products flow from the Factory to CDC, from CDC to RDCs and from RDCs to RSs as frequently as possible

• The sales data flows from the RSs to RDCs, from RDCs to CDC and from CDC to Factory• This data is treated as an order to supply

for RDCs and CDC• Factory treats this data as an order to

produce

This happens as frequently as possible

In nutshell, this is the solution!

• It is a “PULL” system where the products are pulled by the Retail Stores from RDC and the RDC in turn, pulls the products from CDC.

• Factory produces what has been pulled from CDC

• This is in sharp contrast with the “PUSH” system where whatever is produced by the Factory is pushed through the system

What Do We Need?

We need to:• Operate according to much more accurate forecast– Can we really have accurate forecast?

• Operate with significantly reduced Replenishment Time– How do we do that?

• Increase reliability of re-supply– It is very difficult

• our vendors are not reliable• Our production processes have lots of variability• …

Components of the Solution

Solution Components

• Structure and functioning of Distribution network• Dealing with Forecast• Determine Target Level inventory for each product• Minimizing Replenishment Time• Buffer Zones• Buffer Management

Structure and Functioning of Distribution Network

• Typical Structure– You have a Central Distribution Center (CDC) in place– You have one or more Regional Distribution Centers

(RDCs)– You have many Retail Stores

• What if we have somewhat different structure?• It’s okay; the solution will still apply


• How does this structure functions:– Retail Stores report their daily sales to their RDC• An understanding is developed between the RDC and

Retail Stores that this information of daily sales is to be treated as an order• The RDC quickly fulfills the orders thus received from the

inventory available with it– RDCs in turn report their daily dispatches to CDC• Again, this is treated as an order• The CDC quickly fulfills the orders thus received from the

inventory available with it


• How does this structure functions (Continued):– At the end of the day, the CDC reports their dispatches during the

day to the Factory• Again, this is treated as orders• The Factory quickly produces according to these orders and dispatches the

products to CDC – This structure necessitates that enough inventory is maintained in

CDC and RDCs so that they are able to cater for the demand without waiting for production

– Creating CDC and maintaining a level of inventory there decouples the production lead time that otherwise would have been a hurdle for RDCs

– Creating RDCs and maintaining a level of inventory there protects Retail Stores from the production lead time

Dealing with Forecast

• Forecasting is expected to tell us what to hold where, when and how much

• Is this really feasible?• Narrower the aggregation, the worse the answer

becomes– It means that the question of "how much will be sold

from the product overall?" will yield a much better answer than the question: "How much will we sell a particular product at this Retail Store?"

– Fluctuations average out when aggregated at higher level and not at lower level such as individual Retail Store


• We have different level of accuracy of forecast at different levels in the system; how can we use what we have already?

• What is the level of accuracy of the forecast at Retail Store level?– In one week they may not be able to sell a single

item of a product and in the next week, they may sell 10 items

– The variability is too high

Dealing with Forecast• What about a RDC, that supplies products to many Retail

Stores?– If they have sold 10,000 items of a product this month, it is very

unlikely that they will not sell anything next month; perhaps they will sell 13,000 or 7,000 items of that product (or somewhere between these numbers)

– But the variability is far less• It means the accuracy of the forecast at the RDC is far better

than the accuracy of the forecast at Retail Stores• The accuracy of the forecast improves at the square root of the

number that you aggregate– It means if a RDC is supplying to 100 Retail Stores, its level of accuracy

of forecast at RDC is 10 times better than the accuracy of forecast at Retail Stores level

• That is what the fluctuations are averaging out


• The same thing is true when we are going from the RDCs to the Factory– The demand from the Factory is the aggregated

consumption of all the Retail Stores it feeds– Statistical fluctuations average out– The relative variability of demand at the Factory is

far too smaller than that at the Retail Stores• So, which forecast is less risky and less

cumbersome?


• Traditionally, Distribution system is based on the wisdom of holding inventories close to the consumption points

• We have realized that the prevailing practices cause shortages, surpluses and other problems

• Now we realize that the more reliable places in the Distribution system are the supply points;– The further from the end consumptions, the more

reliable the forecast

Determine Target Level Inventory for Each Product

• It is obvious that the amount of inventory should be proportional to consumption

• But is consumption the only dominant factor?• What about Replenishment Time?– Replenishment Time is the time it takes from the moment a

unit is consumed until it is replenished from the previous link in the Distribution channel

– Replenishment Time is as important as the level of consumption

– The longer the Replenishment Time, each selling point needs to hold more inventories

• Let’s understand “Replenishment Time” in more detail

Replenishment Time• Order Lead Time (OLT) – This is the time it takes from the

moment a unit is consumed until an order is issued to replenish it– This is the frequency of ordering of the same product– It is the time until an order is placed for Replenishment or the

time difference between two orders• Production Lead Time (PLT) – It’s the time it takes to

process an order, plus the time in queue for producing, plus the time to produce the ordered product

• Transportation Lead Time (TLT) – It’s the time it takes to transfer the products to the point of sell– This is the time it takes to actually ship the finished product

from the supplying point to the stock location• Replenishment Time = OLT + PLT + TLT

How Much Inventory to Hold?• If we want to give excellent customer service,

Dr. Goldratt said, we need to hold a level of inventory that is:

“Maximum forecasted consumption within the average replenishment time, factored by the

level of unreliability of re-supply”• It means let us find out the paranoid

consumption during Replenishment Time and factor it by the level of unreliability of re-supply to make it sure that we will always have enough inventory to service the market

How Much Inventory to Hold?• If, for a Retail Store, – The Order lead time is daily and – The reliable supply lead time (from the RDC) is three days, – Then the target level is calculated based on the number of

highest units sold in a 3 day period • If we find that the highest number of units sold in 3 days

were 5, then the target level would be 5• If, by the end of the day, the Retail Store has 3 on-hand,

none on-order, they would simply place an order for 2 units

• The calculation of the order quantity is always equal to Target Level – (On-Hand + On-Order) + Special order quantity (if any)

How Much Inventory to Hold?

• Replenishment Time between the Factory to CDC is not small; let’s say it is two weeks– Here you need to consider the paranoid

consumption of the whole country– That’s not small and you need to multiply it by the

factor that would cover the variability of re-supply– We will have to hold here quite a lot of inventory

• But how much we can trim from the RDCs? How much inventory do we need there?

How Much Inventory to Hold?• Production Lead time is now out of the equation for

the RDCs since we are already holding the inventory at the CDC– We are ordering daily; so Order lead Time is zero– So what happens to the Replenishment Time between the

CDC and RDCs? It shrinks drastically only to the extent of Transportation Time

– So we can now shrink the inventory held there substantially!

• The same logic applies to Retail Stores where the paranoia is very high– But we have reduced the Replenishment Time so drastically

that the Retail Stores don’t need be so paranoid now and can hold much less inventories

How Much Inventory to Hold?• Though in this scheme of things, we need to

hold a lot of inventory at the CDC, the overall inventory in the system goes down dramatically

• The vast experience tells that if you are able to have 85% availability – meaning 85% times when clients need something, you have it – with this system in place, you can raise it to 99% with only 1/3rd of the inventory that you were holding before!

Buffer Zones• We start with the inventory that we calculated using

our formula; let us call it “Target Inventory” or “Buffer”

• The term “Target Inventory” means this is the maximum level of inventory that we intend to hold for a product

• The term “Buffer” indicates that this is the amount of inventory we hold to make sure that we are able to supply the products within Customer’s Tolerance Time

• Now, we divide this Target Inventory in three equal zones and we name each zone as Red, Yellow and Green

Buffer Zones Example

• Suppose that we have calculated the “Target Inventory” or “Buffer” to be say 600 units of a product

• These 600 units get divided into three equal parts of 200 each

• Red: If the quantity goes down to “Red” level i.e. below 200 units, it is an indication that we have low inventory. The inventory at the consumption point is at risk of depletion

• There may be a need to expedite

Buffer Zones Example

• Yellow: If the quantity is between the lower and upper limit of yellow zone i.e. between 200 to 400 units, it is an indication of having adequate or good enough inventory but there is a need to order more units from the upstream supply chain

• Green: If the quantity is between the lower and upper limit of green zone i.e. between 400 to 600 units, it is an indication of having high inventory

• The inventory at the consumption point is high – providing more than enough protection for now

Target / Buffer Zones• Every day, you need to

update the receipts and issues and arrive at the inventory level and map it to the zones in the buffer to know the Buffer status

• When the sales happen, the level of inventory goes down and when they receive the products, the level of inventory goes up

Colors of Buffer ZonesActions to be taken based on the colors:• If the level of inventory has reached zero, expedite orders

in an emergency mode as sales are already lost and will continue to lose until the products are made available

• If the Buffer level for a product is in red, check the order position for such products and expedite, if necessary

• If the Buffer level for a product is in yellow, you need not take any action; the level of inventory is ok, provided that some orders have already been placed

• If the inventory level is higher than the Buffer level for a product, it is an indication of excess inventory. Get rid of this excess inventory

Buffer Management

Buffer management has two different objectives: • Signaling when expediting efforts are required

for a product at a specific location– This is a kind of local decision that should be taken

in the execution phase• Signaling when the buffer is not adequate– This is a planning decision, based on the feedback

coming from buffers

Buffer Management

• Caution: The Buffer levels are not likely to remain static because– Market demand may go up or down– You may anticipate start or end of a season– There could be changes in Replenishment Time – There may also be changes in unreliability factor - If you are really

following the TOC principles, the reliability of re-supply is likely to improve significantly

– You may introduce some new products / models or decide to discontinue some of the old products / models• This may have impact on sale of existing products

– You may acquire new customers and / or spread business in new territories

All these may call for changes in Buffer Levels

Buffer Management• Buffer Management is a future-oriented process• It is the tracking and assessment of the consumption

and replenishment of inventory• It is an execution control method that provides priorities

based on the actual consumption of the buffers• Its purpose is to provide a simple, easy to understand

view of the availability of your products• This is the most important and most useful phase– Here, you collect some real time data and chart it in such a

way that it directs the management attention and action to such areas and products that run the risk of losing sales

Buffer ManagementYou need to take the following actions from time to time: • If the Buffer level for a product remains in red for two

or three consecutive Replenishment Periods, it is a signal to increase the Buffer level– It is recommended to increase the Buffer level for that

product by 30%. You need to place fresh orders for this purpose

• If the Buffer level for a product remains in green for two or three consecutive replenishment periods, it is a signal to reduce the Buffer level for that product by 30%– It is recommended to cancel the existing orders or stop

issuing new orders till the new level is reached

Buffer Management

• When you increase or decrease the buffer level for a product, it may take some time to reach the new level and to have some degree of stability– Wait for two or three replenishment periods to settle it

down; do not change the buffer levels during this period unless there is sudden massive change in demand

• From time to time, you may need to increase or decrease the buffer level in anticipation of start of a season or end of a season

• Also, you may have to take such action when you are launching sales promotions or advertising campaigns

SUMMARY

Expected Results

• Inventory in the system decreases by about 50%• Sales go up by about 20%-30%• Inventory Turns increase – more than double• Fewer cross-shipments amongst RDCs• Obsolescence drops substantially• Operating Expenses stay about the same• Relationship with suppliers and clients improves

significantly

Advantages of TOC’s Distribution Solution

• Better availability of products• Minimizing shortages and surpluses• Ability to react to demand within a peak• Reduction of near expiration / poor quality

product• Faster new product introductions• Ease in opening new sales channels• Fewer cross-shipments

Backup Slides

What is the Impact of the Solution?

Let’s do some calculations for a Retail Store• Let’s assume that a Retail Store is selling some of

your products• The margin that you offer is 20%• Its annual sale of your products is $6000• His Operating Expenses are $900• The level of inventory that he keeps is worth $1000 • Due to the new solution, let’s assume that his sales

go up by $1000 and his inventory goes down to $500

Can we calculate the financial gain?

What is the Impact of the Solution? Sales

$Inventory

$Inv

TurnsThroughput

$Operating

Expenses $Net

Profit $ROI

(NP / INV)Past 6000 1000 6 1200 900 300 30%New 7000 500 14 1400 900 500 100%

• This new profit is significantly larger whereas the investment in inventory has come down to half

• It can go up further if we use the cash freed up to sell our other products

• These numbers leave no doubt that the unique service that your Retail Store gets enables him to make huge profits

New Mantras

• Pull, don’t push• Thrive on aggregating the variability in demand• If you want to service your customers better,

keep the inventory away from them• Order daily replenish frequently• React to the signals from the Buffer Management

System

Learn More…

• Read Theory of Constraints (TOC) Application for Distribution: Learn in Detail

• Theory of Constraints – Do It Yourself Kit for Small & Medium size Enterprises for Distribution: Learn how to implement

• Theory of Constraints (TOC) Basic Concepts and Decision Making: Learn more about TOC

• Visit https://leanpub.com/u/rajeevathavale• For Training and consulting contact:

[email protected]

https://leanpub.com/u/rajeevathavale

https://leanpub.com/u/rajeevathavale

tocip – application for distribution

Leadership & Management