Do you also still produce your inventories to order?

Since the eighties we know that customer orders penetrate our company until the Customer Order Decoupling Point (CODP). For the fist time, Hoekstra and Romme made the explicit distinction between production to order and production to stock. With hindsight it seems hard to believe that this was such a big discovery. How difficult can it be? You either make to order (MtO) or make to stock (MtS).

If done correctly, we let us guide by market, product and process characteristics when making the MtO/MtS trade-offs. Having taken the decision to produce to stock, we generally pride ourselves in thinking that with this decision, we are now also protecting production from the immense variability of the market. The peaks and troughs of market demand are buffered by the cushion of inventories now, right?

The reality however is quite different. Why? In traditional inventory models, a requirement is triggered when the inventory drops below the reorder point. In case of high demand this happens very early, when demand is low this will happen at a later point in time. When demand is high therefore, the requirement to produce increases. In case of low demand, this requirement decreases. The longer the lead time and the higher the variability, the worse this bullwhip effect will hit your production. Despite the fact that you assumed that by producing to stock, you would be able to level production volumes. Nothing could be less true though; in fact you are producing your inventories to order now (Make Stock to Order – MStO), be it to internal replenishment orders.

It may be that you have decided to produce to order anyway. However, when looking at it  more holistically, you will find that more often than not, your customer is holding inventories. In this case you are  in fact producing inventories to order (MStO) as well, since you are replenishing the inventories of your customer.

Having started this plea with the statement that our options were limited to MtS and MtO, we now find that in fact we are doing neither, but that we are producing inventories to order (MStO) instead. Which means that we are making each other’s lives much more difficult than necessary. Why? Because we are allowing the full market dynamics to hit our production. Consequences? Low utilisation, long and unreliable lead times, high inventories and frustrations and mutual misunderstanding. The good news? There is a way out!

Truly producing to order, i.e. decoupled of the full variability of the market, requires that the traditional role of the CODP is extended by a function that absorbs demand variability. Next to the traditional lead time stock and safety stock, this requires the introduction of capacity stock. All very technical. The essence is that the producing and inventory holding parties realise that they make each others lives, and therefore their own lives as well, very difficult and that they want to do something about this. There is a very attractive carrot at the end of the required journey: higher utilisation, shorter and more reliable lead times and lower inventories. Unfortunately, capacity stocks are not supported by traditional inventory models like Min/Max and MRP. The good news is that there are best practice examples which demonstrate that with a bit of creativity and perseverance, our vision can still be achieved.

Referring to the original meaning of the CODP, we can only come to the conclusion that there are not two, but three main strategies that can be distinguished: “Make to Order” (MtO), “Make to Stock” (MtS) and “Make Stock to Order” (MStO). Unfortunately in the vast majority of cases, we use the latter and least attractive option. Often unknowingly and therefore without realising the detrimental consequences. Sufficient reasons for a thorough review of our production strategies!

Alex Tjalsma, partner/consultant Involvation