Positive Management Strategy For Materials Lead Time
Chan K. Hahn
Chan K. Hahn, Professor, Bowling Green State University, Bowling Green, Ohio 43403, 419/372-2946
Thomas Y. Choi
Thomas Y. Choi, Assistant Professor, Bowling Green State University, Bowling Green, Ohio 43403, 419/372-2946
81st Annual International Conference Proceedings - 1996 - Chicago, IL
In any purchasing/materials management system, the materials lead time plays a critical role for the timing and sizing of purchase order decisions. Many purchasing professionals have recognized this importance, and major efforts have been made to accurately predict lead times and to develop strategies for coping with problems created by lead time variations. In spite of its importance, lead time still has generally been treated either as a given constraint or as a random independent variable largely influenced by an uncontrollable external factor such as business cycles.
However, the introduction of the Just-in-Time (JIT) concept of production and purchasing and the new emphasis on the effectiveness of the materials management system have forced managers to re-examine the conventional treatment of the lead time variable and its role in the materials management system. We believe the primary reason for emphasis on passive approaches to lead time management in theory and practice is the lack of research in the subject area. Our knowledge of the characteristics of materials lead time is incomplete. The potential impact of the lead time variable on the effectiveness of the materials management system is not fully understood.
Therefore, the main purposes of this paper are: 1) to identify and analyze the major characteristics of materials lead time, 2) to review the potential impacts of materials lead time on the system's performance, and 3) to suggest several positive strategies for managing materials lead time. The result of this study can provide a useful tool for improving a company's competitive position in the world market place. It is also hoped that the results of this study can be used as a set of working hypotheses for future empirically-based purchasing research.
Components of Materials Lead Time. Materials lead time is defined as the time interval between the placement of an order for a required material or product and the receipt of the order into the system. The materials lead time can be divided into several components representing the different activities and/or tasks necessary for the completion of an order cycle.
The administrative lead time represents the time required to process all the necessary paperwork and to complete any other required actions by the buyer and the supplier. For the buyer, it includes supplier selection time, purchase order preparation, purchase order authorization, and the transmission time for the order to reach the supplier. For the supplier, time is spent on order entry, an inventory analysis, customer credit review, capacity availability analysis, and any other required actions before the order can be released to the shop floor.
Raw Materials Requisition.
The raw materials requisition lead time represents the amount of time needed by the supplier to buy the necessary raw materials from its own suppliers. In a manufacturing-to-order environment, this component of lead time tends to be a significant portion of the total lead time. It should be noted that the supplier also has its own order processing cycle, which consists of similar component lead times.
The manufacturing lead time is the time the supplier requires to produce the necessary items for an order. It typically involves the set-up time, processing time, materials handling time, and queuing time between the stages of production. In a manufacturing-to-order situation, the interoperations time (non-processing time) generally accounts for the majority of the manufacturing lead time. In the manufacture-to-stock environment, the raw materials requisition and manufacturing lead times are eliminated from the purchaser's lead time since the manufacturer produces items in anticipation of future orders. Therefore, the order is met from the supplier's finished goods inventory and the purchasing lead time is shortened.
The transportation lead time represents the amount of time needed to transfer the completed order from the supplier's shipping point to the buyer's receiving point. The length of this component of lead time is directly related to the distance between the buyer's and the seller's locations, the frequency of delivery, and the mode of transportation used.
Receiving and Inspection.
The final lead time component, receiving and inspection lead time, represents the amount of time required to properly receive, count, inspect and move the items to the appropriate locations. Each component of lead time has its own subcomponents and is influenced by different factors and situations. For example, the raw materials requisition lead time has its own administrative, manufacturing, and transportation components based on the supplier.
Factors Influencing the Materials Lead Time.
Typical lead time problems are related to lead time length and reliability. From the buyer's perspective, the ideal situation has both short and reliable supplier lead times. However, for the supplier, longer lead times provide better scheduling flexibility and improved capacity utilization. Actual lead time length and reliability are determined by several factors.
Demand and Capacity Relationship. The length of lead time is primarily determined by the demand and capacity relationship within an industry. If the demand is much smaller than the available capacity and is relatively stable, the manufacturing lead time will be reduced because of less waiting time between operations. Consequently, the total lead time will be relatively shorter and more predictable. When the demand is greater than the available capacity, the manufacturing lead time will increase significantly due to exponentially increasing waiting times. Thus, total lead time will expand considerably and will be less predictable.
The demand pattern (cyclical, seasonal, and random fluctuations) also has a significant impact on the length and reliability of lead time. A fluctuating demand pattern influences the supplier's work load and actual capacity utilization. Randomly arriving orders will cause under- utilization of capacity for the supplier. Because of this condition, the supplier tends to extend its promised delivery lead time in an effort to gain scheduling flexibility and to more effectively utilize its available capacity. Consequently, the length of lead time is increased and its reliability is decreased.
The complexity of the product itself also influences the length and reliability of lead time. The complexity of the product tends to increase the number of levels in its product structure or bill of materials. Therefore, the total cumulative lead time tends to increase as the product complexity increases, and in turn generates more variability in the lead time. A custom product tends to have a longer lead than a standardized product. With standardized products, the supplier need not wait until actual orders arrive before initiating the raw materials requisition and beginning the manufacturing process. As a result, the total materials lead time for the buyer can be shortened.
Fourth, the length and reliability of the materials lead time are influenced by the supplier's materials management policies. Such policies determine target inventory levels, scheduling systems, the relative importance of a customer to the supplier, and the effectiveness and flexibility of a supplier's administrative system. for example, if the supplier is using a conventional reorder point system, it would not match well with the buyer's J-I-T system.
Finally, the length and reliability of lead time are affected by the distance between the supplier's shipping point and the buyer's receiving location, the delivery frequency, and the mode of transportation used. A distant supplier generally means longer lead times with greater variability for the customer.
Impact of Lead Time on Total Costs.
In general, the length and reliability of lead time has a significant impact on the total cost of a product because of its effect on manufacturing and inventory policies. The recent emergence of time-based management concept attests to this effect. For example, the lead time length and reliability influence the capacity and manpower requirements, work load, safety stock level, and productivity. Several important effects of lead time on total cost and product quality can be generalized as follows.
Higher Inventory Levels.
First, a lengthy lead time tends to induce a higher level of inventory and inventory carrying costs. Since the inventory reorder point is directly related to the anticipated lead time for an item, a longer lead time means a higher level of inventory is in the pipeline. Traditional inventory models view the order quantity as a trade-off between the set-up costs and the inventory holding costs. However, in a typical job shop environment where the work-in-process inventory accounts for a major portion of the total inventory, the inventory level is heavily influenced by the lead time.
Greater Safety Stock.
Second, lengthy materials lead time generally means a larger variance or poorer reliability. A long materials lead time is a result of long component lead times each with its own variance. Since the variance for the total materials lead time is estimated by summing all of the component variances, a longer lead time generally means a larger lead time variance.
In order to cope with the lengthy and less reliable lead time, companies frequently carry safety stock. The quantity of safety stock is directly related to the lead time length and its reliability. Long and less reliable lead times increase the safety stock investment and the associated inventory carrying costs.
Longer Planning Horizon.
Third, a longer materials lead time requires a longer planning horizon in the materials management system. In turn, the materials management system is forced to extend its forecasting efforts further into the future which tends to decrease forecast accuracy. As a result, the materials planning system must go through more frequent and extensive schedule changes. The schedule changes negatively impact on manufacturing efficiency.
Unstable Operating Environment.
Fourth, longer lead times create an unstable environment for purchasing/materials management. The timing of order releases into the materials management system is based on the anticipated (or planned) manufacturing lead time and the due date (or need date). A longer anticipated lead time forces the company to release orders into the system further in advance of the actual due date. This increases the work load placed on the system. Since the actual materials lead time is a function of available capacity and existing work loads and variability, the increased work load will cause an increase in the anticipated lead time. Thus, a vicious cycle of ever increasing materials lead time and work loads results. This is commonly referred to as the "lead time syndrome."
In some instances, an increased work load caused by the earlier release of orders is perceived by management as an increase in actual demand which tends to lead to a decision to increase capacity. However, the increased work load results from an artificial increase in demand caused by the early order release rather than an actual increase in the demand rate per period. When the capacity level is increased, the lead time will start to contract. As lead time is shortened, the need for early order releases will diminish. The backlog will disappear and the company will end up with excess capacity. This unstable materials management environment will cause major fluctuations in the inventory level, the capacity utilization, and the effectiveness of the materials management system. Consequently, the total materials cost will increase.
A typical response to a missed delivery or order completion lead time is expediting. In many cases, expediting efforts include using overtime and bypassing some of the company's normal operating procedures. When those procedures are linked to programs such as quality assurance or maintenance, it is possible that the long term quality of the product will suffer. Expediting will cause the total product costs to rise due to increased use of overtime, increased warranty costs and the reduced efficiencies of equipment.
From this brief analysis, it is evident that the materials lead time has a profound impact on the overall efficiency and effectiveness of the materials system. It also illustrates the potential for reducing material costs and improving a product's ability to compete in the market place when materials lead time is reduced and lead time reliability is improved.
Steps for Managing Lead Time. As previously stated, the materials lead time consists of many component lead times which represent the activities or tasks which must be performed. Any attempt to develop a strategy to reduce the lead time length and improve reliability must focus on the component lead times and their interrelationships with other components. These actions can be organized into four steps approach typically used in PERT/CPM method as described below.
The first step is the identification of the relevant lead time components associated with the product involved. Each product requires different combination of parts and materials involving different industries and suppliers. Therefore, it is important to identify all major component lead times relevant for the product.
The second step is to estimate the length and variances of all involved lead time components. The lead time length can be expressed by either an average time or a range of time along with the associated variance. This information is critical in estimating the minimum total lead time for the product and in estimating the reliability of the lead time.
The third step is to determine the interrelationships between the lead time components. The interrelations can be expressed as a diagram linking all component lead times. This concept is similar to chart used in PERT/CPM analysis. Using this diagram, interrelationships between different component lead time can be identified and the minimum time it takes to receive the necessary parts and materials can be determined. The total materials lead time is the cumulative lead time of all the relevant component lead times directly linked together. The minimum materials lead time is the cumulative length of the longest path in the diagram. It is also known as critical path.
The final step is to analyze the possibility of reducing lead time for those components which are on the critical path. Any effort to reduce the length and to improve the reliability of the lead time must be focused on the component lead times found on the critical path. Otherwise, the effort will not produce the desired results, but merely create additional slack in non- critical activities. It should be noted that the critical path is dynamic and it can shift as a result of efforts to reduce the lead time. Thus, it is important to be sure that the component lead time being analyzed is on the critical path.
After completing these steps, each lead time component activity can be analyzed. Appropriate actions can be designed to reduce the length and variance of the components. Several critical factors to be considered when reducing lead time are discussed below.
Positive Strategies for Improving Lead Time Management. As stated previously, most of the existing literature treats lead time in a passive manner. Lead time is a given constraint from which purchasing and materials management policies are derived. Even in the more practical situations, approaches for coping with lengthy and unreliable lead times have centered on passive, reactive strategies like safety stock and expediting. The suggested positive strategies of improving the materials lead time management put the focus on the causes of lead time problems (length and reliability) and attempt to solve the problems at their sources.
Reducing Demand Variability. The length and reliability of materials lead time is largely determined by the supplier's work load and capacity relationship. A fluctuating demand pattern causes similar fluctuations in the supplier's work load. Since the supplier's capacity tends to be fixed and stable in the short run, a fluctuating work load means a longer and less reliable lead time.
This relationship is particularly critical in a manufacturing-to-order situation where the materials lead time tends to be longer. In this situation, any fluctuations in workload must be satisfied through corresponding changes in the capacity level or through changes in the lead time length. In this case, safety stock does not represent a valid strategy. Moreover, since manufacturing establishments strive for effective capacity utilization, the fluctuating demand is most likely to be handled by adjusting the lead time length. This is why the lead times for some manufactured-to-order items (such as castings and forging) tend to fluctuate widely.
The supplier's demand variability is actually caused by the customer's order placement pattern. When the customer (purchaser) changes quantity, timing, or suppliers frequently, the supplier's demand fluctuates accordingly. In turn, the customer order pattern largely depends on its own master production schedule and the timely communication of purchasing's requirements stabilizes the supplier's work load and eventually the lead time. Better forecasting and scheduling efficiency are required for the purchasing organization.
Reducing Set-Up Time. Another important source of lengthy and unreliable lead time is related to the set-up or ordering costs. Conventional production and purchasing theories establish that the optimal order quantity is a function of the relationship between the inventory carrying costs and ordering costs (set-up costs). Since the inventory carrying costs are largely influenced by external factors, such as the cost and availability of capital and the nature of the product, they tend to be fixed in the short run. Therefore, it is reasonable to assume that the set-up costs have a significant influence on the size of the order.
Reduced set-up time increase scheduling flexibility and reduce manufacturing lead time. In fact, one of the most critical aspects of successful Just-In-Time production and purchasing is the ability to reduce set-up time. In a manufacturing situation, reduced set-up time and cost decrease the economic order quantity. In turn, the reduced order quantity increases scheduling flexibility, reduces waiting time and improves utilization. Reducing set-up time involves both the purchasing facility and the supplier. In a typical manufacturing environment, it can be achieved through new capital investment, equipment redesign, and method improvement. More importantly though, the purchasing facility must provide the supplier adequate incentive to justify set-up time reductions.
Reducing Transportation Time. The transportation lead time is largely determined by the distance between the supplier and the customer and the elapsed time between deliveries. Generally, the elapsed time between deliveries (the delivery frequency) accounts for a majority of the transportation lead time. The delivery frequency, in turn, is largely influenced by the distance involved and the economics of transportation (i.e. truck load or car load).
By more extensive use of local suppliers, the transportation lead time can be drastically reduced. Even when reliable sources are not locally available, reductions in the transportation lead time can be made. The transportation lead time can be reduced through a well-coordinated pick up schedule from a set of suppliers or by ordering a family of parts from a single supplier.
Reducing Administrative Lead Time. Administrative lead time can be reduced through improved communication systems and streamlined purchasing operations, both internally and externally. Technological developments allow companies to operate paperless purchasing systems. Production's needs can be communicated through a computer link-up to purchasing, which in turn, can be directly linked with suppliers' order processing and scheduling systems.
In this paper, the importance of lead time management for improving a company's competitive edge was discussed, and some positive strategies for managing the materials lead time were suggested. In the face of ever increasing competition from foreign sources, lead time is one of the more potent competitive weapons remaining for many U.S. manufacturing companies. The degree of success in implementing positive strategies may determine the long-term viability of these companies.
While this paper is still at the conceptual level, efforts are being made to empirically examine the recommended strategies.
- Blackburn, J. H., Jr., "Forecast Error Measurement at Manufacturing Lead Time," Production and Inventory Management, Vol. 22, No. 4, 1981, pp. 1-8.
- Das, C., "Effect of Lead Time on Inventory: A Static Analysis," Operational Research Quarterly, Vol. 26, No. 2, 1975, pp. 273-282.
- Gross, D. and Soriano, A., "The Effect of Reducing Lead Time on Inventory Levels - Simulation Analysis," Management Science, Vol. 16, No. 2, 1969, pp. 61-76.
- Gupta, N. K., "Effect of Lead Time on Inventory - A Working Result." Journal of Operation Research Society, Vol. 30, 1979, pp. 477-481.
- Harris, B. and Jenkins, K., "Unreliable Vendor Lead Times and MRP," Journal of purchasing and Materials Management, 1982, pp. 15-21.
- Huge, E. C., "Managing Manufacturing Lead Times," Harvard Business Review, 1979, pp. 116-123.
- Kanet, J., "Toward Understanding Lead Time in MRP Systems, Production and Inventory Management, Vol. 23, No. 3, 1982, pp. 1-14.
- Kaplan, R., "A Dynamic Inventory Model with Stochastic Lead Times." Management Science, Vol. 16, No. 2, 1970, pp. 491- 507.
- Lau, H. S. and Zaki, A., "The Sensitivity of Inventory Decision to the Shape of Lead-Time-Demand," IIE Transaction, Vol. 14, No. 4, 1982, pp. 265-271.
- Maghaddam, J. M. and Bimerls, C. F., "Managing Manufacturing Lead Time: A Research Report," Proceedings of APICS Conference, 1981, pp. 163-165.
- Vinson, C. E., "The Cost of Ignoring Lead-Time Unreliability in Inventors Theory," Decision Science, Vol. 3, 1972, pp. 87-105.
- Weiter, C. D., "Managing Supplier Lead Times," Journal of Purchasing and Materials Management, 1979, pp. 2-9.