Make to Stock versus Make to Order

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When designing an inventory management plan, every purchased and manufactured item should be evaluated for whether it should be held in stock or purchased/produced as needed.

Definition of Make to Stock (MTS) versus Make to Order (MTO)

Make-to-stock items are consumed on a regular basis and are therefore held in inventory and always available. Defining what is meant by “used on a regular basis” varies based on the business. Some manufacturers stock items that are used at least weekly and others carry items used at least on a quarterly cadence.

Make-to-order items are only in stock when there is a valid customer order for the item, and therefore the item in stock is for that specific order. These are generally items that are produced infrequently or that are customized for each customer order. Note that “customer order” also refers to internal demands driven by a customer order, such as the demand for an internal sub-assembly required for a specific customer assembly.

The MTS/MTO discussion is an integral part of the concept called “plan for every part,” or PFEP (pronounced PEE-fep.) Before we can confirm a reasonable inventory plan for an item, we must first select the philosophical approach for that item. In additional to evaluating the frequency of demand, an item’s plan depends on how customer orders will be filled and therefore how associated material must be managed. Will customer orders be filled from finished goods inventory? Or, will WIP be held in stock and converted to finished goods when a customer order is received? Is it possible that raw material is the only inventory held in stock, and manufacturing occurs only after a customer order is received?

The decision of where to hold inventory throughout a site depends on how much time is allowed from customer order to shipment for standard items.

  • If customers expect shipment the same day as the order is placed or soon after, it might be necessary to hold finished goods in inventory, plus raw material and possibly work-in-process items that will be used to replenish finished goods as they are consumed.
  • If customers allow slightly more time, hold WIP that can be converted to the correct finished goods within the allowed time, plus the raw material that backfills WIP as it is consumed.
  • If customer lead times are longer, hold raw material in stock and process it only when a specific customer order is received. This implies that the only WIP and finished goods that are in stock at any given time are for specific orders.

 

Assign MTS to the Right Items

Start by defining where inventory should be held, i.e., which processes should hold finished goods, WIP, or raw material in stock to meet customer lead times.

Next, evaluate individual items wherever inventory is supposed to be in stock to determine if all items are used frequently and should be in stock, or if perhaps some items are used infrequently and can be made to order. This might be manual analysis, or it might be streamlined if demand data can be downloaded into monthly or weekly buckets. For example, if the threshold for MTS items is anything that is used at least monthly, download six months of demand data into monthly buckets and eliminate items with zero demand in one or more months.

HINT: Any finished goods item that is held in stock should drive the appropriate levels of WIP and raw material stock, so that when that FG is consumed it can be refilled. This is basic “pull” or kanban logic.

Once the population of MTS items has been identified, define the correct inventory solution for each item, including the replenishment method to be used (kanban, VMI, consignment, or MRP) and the individual replenishment solution, such as 2 cards at 100 each.

Click here to read about how kanban works.

replenishment-methods-flowchart

Replenishment Methods

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There are four basic methods that can be used to trigger replenishment orders for items that are held in stock.

MRP – Materials Requirements Planning

Materials Requirements Planning (MRP) is one of the most common replenishment methods. It uses system data to generate MRP recommendations or take automated actions to order purchased or manufactured items. The logic for MRP is simple:

Demand during the defined time period – current balance – expected receipts in the time horizon = required quantity to order.

The GIANT weakness in any MRP system is the complete dependence on system data: errors in customer orders or forecast, on-hand balance, bills of material, or incoming receipts can result in the wrong MRP recommendation.

Other common weaknesses include the inability to round for minimum order or standard package quantity limits, so it creates an order that supplier won’t accept, or logic that can assign a due date that the supplier can’t meet.

Kanban

Kanban is a visual replenishment system based on actual consumption, not system data. Kanban activity occurs at point of use (POU) and therefore it covers many of the errors that derail MRP (e.g., on-hand balance, backflushing, tracking open orders) because it puts the replenishment process in the midst of consumption activity, especially if kanban orders are triggered at point of use.

The biggest challenge or weakness in most kanban systems is the sizing process, or getting correct kanban solutions.

Kanban generally uses a visual signal, such as a kanban card or empty tote, to signal the need for replenishment.

VMI – Vendor-Managed Inventory

Vendor-managed inventory (VMI) is on-site inventory that is reviewed and refilled by the supplier on a defined cadence, generally once or twice a week. VMI is similar to kanban because refilling the bin is based on actual consumption, with no system dependence.

The biggest potential weakness for VMI is allowing over-sized bins to be over-filled by an over-eager supplier, thereby increasing on-hand inventory.

Consignment

Consignment inventory isn’t owned by the operation until it’s “opened” or pulled into use. This reduces on-hand dollars by delaying the ownership transaction, but no space reduction occurs. In fact, required space often goes up if the supplier prefers to ship larger quantities.

Consignment can work well for overseas suppliers that want to save freight by shipping full containers, and they are willing to delay invoicing as product is pulled into production.

The biggest risk or weakness with consignment inventory is managing the transfer of ownership. To meet financial requirements and to be fair to the supplier, inventory must become the property of the receiving site before it is consumed, and not at the time it is backflushed.

Which method?

Consignment reduces the financial impact of on-hand inventory, which is a huge benefit.

VMI reduces the effort required to manage inventory, which is a productivity benefit.

Kanban is a streamlined way to manage inventory and it also protects on-hand inventory from system errors.

MRP should be the last choice.

replenishment-methods-flowchart