Getting Lean to Maximize Factory Resources

January 1, 2011

Part 2 – Make to Order

In this article, Part 2 of 2 parts, we will show you how to use Lean methods to produce more bottom line results with another carefully selected single change. If you missed it, please read part 1 first.

Lean manufacturing is all about continuous improvement. In Part 1, we implemented a single change (reduction in transfer batch size) which yielded a $0.5 million reduction in WIP, along with a reduction in plant floor area. Now the astute Plant Manager and CFO are asking: “Are there any other potential savings?” In fact, the big savings are yet to come. We have not yet looked at the potential savings in the Finished Goods (FG) inventory, so let’s do that now.

Second: We will make another single change. We will implement a new operating model, converting our factory from a “Make-to-Stock” (MTS) operation to a “Make-to-Order” (MTO) operation. We can consider doing this only because our last change was successful. By reducing the transfer batch size on our production lines from 100 units to 10 units, we eliminated most of the NVA (Non-Value Added) time from our assembly process. The 8 day production lead time was chopped down to 0.75 days. Now, any order received today can be manufactured today (to order) and shipped tomorrow.

The reduction in production lead time to 0.75 days allows the factory to be converted from a “Make-to-Stock” (MTS) operation to a “Make-to-Order” (MTO) operation while maintaining the customer service level. Since there are also many orders that require custom design, the “Design-to-Order” (DTO) method is a simple extension of the MTO method, since both processes start with a customer order. No stock is needed since any order that we receive today, we can make and ship tomorrow. To realize the financial benefits, we must actually convert our operation from MTS to MTO and then work off the excess FG inventory. We can reduce FG inventory about 99% by reducing stock from 1,000 SKUs to 100 SKUs, and by reducing bin size in the stockroom from 100 units per SKU to 10 units per SKU. In a short time (say 10 months) we can work off most of the FG inventory by reducing manufacturing volume about 35% each month for 10 months while we consume existing stock.

Once again, let’s look at our savings opportunities as a result of this single change. First, the reduction of FG inventory will liberate almost $5.0 million of working capital. Second, we will have a 35% labor surplus for 10 months. If we have backlog (queue of unfulfilled orders), then we can use some of the excess labor to work it off. Additional lean projects can make the labor savings permanent. Third, the recurring expense costs to carry inventory are equivalent to the cost of capital. At 1% per month, this is $50,000 of expense per month which can be saved. All of this financial benefit was systemically locked up as “hidden waste” in the design of our factory.

The financial results from our Lean Initiative completely change the future prospects for our example manufacturing company, which has annual revenues of $17 million. What is the impact of 10 months of 35% direct labor savings and a permanent $50,000 monthly savings in the cost of carrying capital? What is the impact of liberating $5.5 million of working capital as a one time savings? Could these newly available resources be invested in a new manufacturing line or an ad campaign to launch a new product? In tough economic times, this type of financial result can be a lifesaver.

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