December 1996 € Volume 6 € Number 12

Late Deliveries and Dynamic Supplier Relationships

By George Johnson, CFPIM

This department is provided to answer technical questions regarding problems in production and inventory control. Readers are invited to contact George Johnson, APICS National Research Committee, Rochester Institute of Technology

Dear APICS: What is the impact on inventories of late deliveries by vendors?

Reply: This question is going to receive one of those infamous "it depends" responses. If the late inventory isn't really needed just yet, then the result should be lower average inventory and postponement of the cash outflow to pay for it. However, if it really is needed right away, then there are many possible negative effects, depending on the type of inventory in question.

Stockout of a purchased finished good would "empty the wagon," leaving an unhappy customer who may well take future business elsewhere. Meanwhile, marketing might observe the shortfall and decide to order larger quantities for protection in the future. Unfortunately, the increased supply, coupled with decreased demand, may result in future excess inventory. Eventually, this would have to be returned to the vendor for credit (minus return shipping and restocking fees) or written down/off on the books and eliminated by "fire sale" or disposal action.

Stockout of feeder inventory that goes into work-in-process (WIP) can starve assembly, shutting down operations. The immediate effect is to trigger expediting actions, which increase the actual cost of obtaining the missing items. For a short period in a make-to-stock business, related finished goods may decline for lack of resupply. Not wanting to waste good capacity, assembly will try to switch over to other runs, incurring unanticipated setup or changeover costs. If switching is successful, work that is accomplished ahead of time will increase the investment in finished goods inventory. In a make-to-order business, there is no finished goods buffer and the late feeder WIP may affect on-time delivery to the customer as well as the shipping budget and the scheduled mix of work on jobs. A similar argument can be advanced regarding raw materials that feed fabrication.

Suppose the late materials are service parts for equipment that is gradually failing or is down. The service parts inventory obviously is smaller than it would otherwise be. Perhaps more important, though, some process is not working up to capacity or capability. This can logjam the WIP in front of the process and potentially starve the processes that follow. If a starved process is a bottleneck, then capacity is irretrieveably lost, and so is the contribution margin associated with it "per hour of process time." If process capability suffers for lack of the service part(s), then the process may have to be slowed to be effective or the reduced capability may increase scrap and off-specification inventory, which will then need to be examined by a Material Review Board.

Suppose the late vendor delivery involves new tooling or process equipment. Then there may be a delay in the buildup of inventory for pipeline fill. While this reduces planned inventory investment in the short run, it also threatens to undermine a longer-run strategy to penetrate a new market at a particular time. This can be extremely costly in terms of lost market share and forgone profits caused by late market entry.

These are a few of the potential effects on inventory and other aspects of the business which may be caused by late vendor delivery.

Dear APICS: How can a supplier of parts become the supplier of the whole subsystem, not just parts?

Reply: This is a question with some interesting ramifications. One answer is, "By request or demand." The other extreme could be, "Earn an invitation."

Let's take up the request/demand answer, first. There are many stories about this kind of situation. Usually they involve a long-standing customer-supplier relationship between an assembler and, say, a sheet metal shop. Essentially, the shop, which had previously received only detailed specifications, would be provided functional specifications and be expected to develop an add-on module for the end product. This would give the product additional capability-an option customers could elect, if they wished.

Wanting to please its customer, the supplier would comply, adding engineering design capacity-a whole new business function-to its organization. As you might expect, the addition of this function would entail hiring and deploying entirely new kinds of employees, professionals with different skill sets, expectations and levels of compensation, from the traditional work force. It also would result in a changed, more complex cost structure.

Some interesting questions might arise regarding who should pay for the new capability. The customer, since it was the trigger for incurring the added costs? Or would this be an investment by the supplier, with return expected in the form of new business not currently in the revenue stream? Where is the risk and who should absorb how much of it?

Another complication could arise if, based on some sort of projected cost model, the customer had already guaranteed the supplier a certain amount of total business for the year or some other period at a given margin. Because the original sheet metal business and the new add-on module business have entirely different cost structures, the supplier's profitability could be affected drastically if the customer's planned mix of work shifted. The down side would occur if sheet metal work declined and the quantity of engineered modules increased. To avoid this, the projected cost model would have to encompass the new product too, and the customer would have to be willing to adjust its financial dealings with the supplier if the mix changed.

Usually, issues of this nature can be worked out successfully if there is a long-standing, effective customer-supplier relationship in place. If not, adversarial customers could force costly design overhead back onto suppliers just as inventory has sometimes been forced back on them in previous times.

Now, let's take a look at the other extreme-earning an invitation to provide whole subsystems. This amounts to a carefully orchestrated marketing task. To accomplish this, the supplier must acquire a mind-set of selling capability, not just parts.

Smart, aggressive, highly capable suppliers have learned that the better they understand the needs and activities of their customers and, sometimes, their customers' customers, the more insight they gain into how they might help their customers become more successful. Sometimes this idea is discussed in the context of "value-added services."

For example, let's say that a packaging supplier trains its delivery people and its sales people to be astute observers and to report back to home base things they learn that might be of value for additional business. One day on the return trip from delivering packaging to customer A, the delivery person, Rebecca, happens to pass by the plant of the customer's customer, G. She notices that the packaging material delivered to A, which is used to ship A's product to G, ends up in large quantities in G's dumpster. This seems like a waste and maybe an opportunity.

Back at the home plant, Rebecca reports her observation and suggests that, since she drives an empty vehicle back from A, anyhow, she could pick up the used packaging material at G and return it to her own plant. With cooperation from both A and G, the packaging supplier might be able to establish a packaging recycling system that would have benefits for all three companies, and for the environment as well. This would be a service that adds value beyond the original packaging product.

It is this sort of prospecting for additional business opportunity that may enable suppliers of parts to become suppliers of subsystems. They must have a credible, larger capability and they must sell that capability effectively by persuading their customers that utilizing it can make them more successful.