Supply chain process
The supply chain is the network involved in delivering products to customers. Broadly speaking, this includes procuring inputs to send products to customers. Meanwhile, if we go into detail, it involves:
- Extracting raw materials or obtaining inputs
- Converting raw materials into products
- Distributing products
- Delivering products to customers
The supply chain does not only involve various activities. But it also involves stakeholders, information, resources, and technology.
Supply chain example
In the manufacturing business, supply chain processes include:
- Procurement – buying raw materials and components from suppliers.
- Inbound logistics – sending raw materials and components to the company’s factories or warehouses.
- Inventory – managing raw materials inventory or final output.
- Production – raw materials and components enter the production process to be converted.
- Outbound logistics – delivering output to customers.
Managing the supply chain requires companies to manage two flows:
- Product flow
- Information flow
The product flow spans from raw materials and components to finished goods. When damaged or returned, they can be transferred back into the supply chain.
Likewise, in the circular economy model, the things we use are not necessarily thrown away. Instead, its components will be recycled into raw materials to produce new goods. For example, plastic waste is processed into pellets to make new plastic products.
The information flow involves sharing data between stakeholders, suppliers, distributors, and customers. It includes data about orders, payments, shipping processes, warehousing, inventory levels, etc. Companies usually manage it electronically through cloud computing and enterprise resource planning (ERP) systems.
Value chain vs. supply chain
If a supply chain is about the systems involved in moving a product from a supplier to a customer. The value chain deals with creating value in each activity carried out along the chain.
The value chain refers to the various activities or functions to which a company can add value. A well-known model is Porter’s value chain.
Porter’s value chain divides value-creating activities into two groups:
- Primary activities
- Support activities
Primary activities include:
- Inbound logistics bring materials or components from suppliers into production facilities or warehouses.
- Operations are involved in processing inputs (materials and components) into outputs.
- Outbound logistics includes sending output to customers, including warehousing management for output.
- Marketing involves selling products to target markets, setting prices, managing distribution channels, and promoting products.
- Services include ensuring products work at their best and maintaining long-term customer relationships, including handling after-sales service and customer complaint services.
Support activities cover:
- Procurement involves purchasing decisions from external parties for raw materials, components, equipment, machinery, and other items in business operations.
- Information technology manages the information flow within the company and with external parties, including equipment, hardware, and software.
- Human resource management involves recruitment, training, development, compensation, layoffs, and industrial relations.
- Infrastructure includes functions such as finance, legal, and public relations.
Difference between Just-in-time (JIT) and just-in-case (JIC)
Just-in-time (JIT) and just-in-case (JIC) are approaches to managing inventory. The two differ mainly in whether the company needs to hold buffer stock or not.
JIT is a modern approach by trying to supply input only when needed. In other words, the company minimizes stock. They don’t hold buffer stock.
The company will supply raw materials and components when needed. They will arrive at the production facility on time and in the quantity required.
Since there is no buffer stock, no money is tied up in inventory. However, this approach requires companies to excel at managing product and information flows, avoiding production interruptions due to issues such as delays or shortages in raw material supplies.
JIC is the opposite of JIT and is a conventional approach. The company holds buffer stocks intended to anticipate production problems or unexpected spikes in demand.
Through JIC, the company ensures sufficient inventory to meet customer demand or consumption in the production process.
JIC offers several advantages:
- Flexibility to meet unexpected demands
- Benefit from discounts because companies can buy in bulk
- Avoid stockouts and production downtime
However, inventory holding costs are high due to having more stock than needed to enter the production process. This means more money is tied up in stock and can’t be used for other purposes.
Inventory control
Inventory control or stock control is about planning inventory carefully to ensure they are available in sufficient quantities and at the right time.
Too much inventory increases storage and administration costs. In addition, the company also bears other costs, such as damage, obsolescence, and theft.
But, too little supply can also be fatal. For example, the production process is disrupted due to delays in raw materials. Another negative impact is suboptimal sales. Or, machines and tools are inefficient because they are not being used at their best.
So, the company has to manage its inventory at an optimal scale. It is influenced by several factors, including:
- Order quantity
- Product types
- Future demand level
- Inventory costs
- Delivery time
- Information flow
Inventory types
Inventory in manufacture includes:
- Raw materials and components
- Work in progress
- Finished goods
- Consumables
Raw materials and components refer to inputs to be converted or transformed through the production process. Factors to consider in managing their inventory include how reliable the supply is, how stable their prices are, what the needs are for the production process, and how big the demand is.
Work in progress is still on the production line and has not been completed. Increasing their inventory is one way to protect production if something goes wrong with other supplies.
Finished goods refer to the output of the production process, which is waiting to be delivered to the customer. Factors to consider for stocking more or less are orders received, future demand trends, and production facility output volumes.
Consumables are items consumed during production or operations, such as fuel and stationery. Companies consider factors such as supply reliability, future prices, and stability to manage their inventory.
Stock control charts
An inventory control chart or stock control chart is a tool to ensure sufficient inventory is available when needed. It reduces liquidity problems by providing details about stock levels, usage rates, order quantities, and delivery times.
Lead time is the time it takes from starting a process to its completion. For example, procurement for raw materials is the time between ordering and delivery.
Buffer stocks are the minimum inventory a company must hold, regardless of production conditions. It aims to ensure the process continues even if there is a delay in delivery or an increase in production levels due to a sudden spike in demand. Also known as the minimum stock level or reserve stock.
Buffer stock binds capital. The higher the buffer stock, the more money is tied up and cannot be used for other purposes. For this reason, companies aim to minimize them.
Reorder quantity refers to how many business orders are to return inventory levels to their maximum point.
Reorder level refers to the stock level at which a business reorders to guarantee sufficient stock and stay above its minimum stock level. It equals the minimum stock level plus the multiplication of the lead time and the demand per day.
The maximum stock level is the highest inventory a business can hold. It varies between companies, depending on their operation size.
The economic order quantity (EOQ) is the lowest point on the total inventory cost curve. Therefore, companies must minimize stock holding costs and ordering costs.
On the one hand, companies can get big discounts when buying in bulk. But that will result in high stock-holding costs.
Conversely, the company cannot optimize discounts if it orders little and therefore holds little stock. Thus, despite low stock holding costs, ordering costs tend to be high.
Capacity utilization rate
The capacity utilization rate measures the extent to which a business utilizes existing resources. It is calculated by dividing actual output by potential output (total productive capacity, full capacity, or total capacity).
- Capacity utilization rate = (Actual output / Potential output) x 100%
For example, a machine has a maximum capacity of 100 units in one year. Therefore, when the machine produces an output of 90 units, the capacity utilization rate of the machine is 90%. Meanwhile, about 10% is the unused capacity (spare capacity).
Ideally, the capacity utilization rate is 100%. That means companies are working at full capacity and using their resources.
However, operating at full capacity is often challenging to achieve for several reasons, such as:
- Low demand
- Production disruption
- Outdated or obsolete machines
- Downtime for routine maintenance
In addition, working at full capacity can create stressful workers and managers. They have to work extra hours and overtime. Consequently, it can lead to errors or lower productivity.
Then, when it is in full production, the company has no spare capacity. Finally, companies do not have the flexibility to meet sudden spikes in demand.
Productivity rate
Productivity rate measures how much a company optimizes inputs to produce output. It shows production efficiency, namely how much output is obtained for each input used. It can refer to the productivity of labor, machinery, or any input we want to measure efficiency.
We calculate the productivity rate by dividing the total output by the total input used.
- Productivity level = Total output / Total input used
Labor productivity rate
Labor productivity is how much output each worker produces. We calculate it by dividing the total output by the number of workers.
- Labor productivity rate= Total output/Number of workers
For example, a company employs 100 workers and produces 1000 units. From these data, the labor productivity rate is 10 units per worker.
Increase labor productivity
Productivity level is important to increase. High productivity means more profit for the company because it can produce more output while bearing the exact input costs. Thus, the more productive the workforce, the lower the costs incurred per output and the higher the profit margin.
Increasing productivity requires companies to push their employees to be more skilled and produce faster. Several ways to increase productivity, including:
- Enhance training to enhance employees’ skills and knowledge, enabling them to work more effectively in their area
- Increase employee motivation to encourage them to work harder through financial and non-financial motivation.
- Encourage innovation and adopt more advanced technologies, for example, by introducing computer-assisted machines.
Efficiency vs. effectiveness
Efficiency means doing the right thing. It is concerned with reducing the costs and resources needed to produce output. We measure it by comparing the total output with the total input used.
Meanwhile, effectiveness means doing things right. It involves doing according to what is intended or its purpose.
Say, a company wants to produce output on a mass scale. In this case, capital-intensive production methods relying more on sophisticated machines are more effective for achieving this goal than labor-intensive methods.
Increased effectiveness often naturally leads to increased efficiency. For example, a high-tech machine could produce more output in the case above. Thus, it allows the company to spread fixed costs (machine costs) over more output, resulting in lower costs per unit.
Cost to buy (CTB) and Cost to make (CTM)
Cost to make and cost to buy is quantitative analysis to decide whether purchasing goods or inputs from external parties or producing them internally is better.
- Cost to make (CTM) = Fixed costs + (Average variable costs x Quantity)
- Cost to buy (CTB) = Price x Quantity
When CTM is lower than CTB, producing goods internally is cheaper. Conversely, buying from external parties is more affordable if the CTB is lower than the CTM.
Relying on decisions based on CTM and CTB is vital in production planning, for example, concerning decisions to outsource production. If companies can buy the same product at a lower price, why should they manufacture it internally, which is inefficient and requires extra resources and effort.
However, CTM and CTB analysis is not the only decision-making tools. Companies may have to consider other qualitative factors, such as:
- Control over goods (such as quality and delivery time)
- Supplier reputation and reliability
- Internal capabilities and resources
- Effect on corporate image
