In this discussion I will look at one of the biggest factor in managing Supply Chain costs; Variance. Regardless of what industry you are in having a better understanding of measuring and controlling variance in your Supply Chain will go a long way in accomplishing lowest Total Costs and meeting customer demand.
In a perfect world, we would know the exact customer demand, all shipments would arrive on time, there would be zero defective parts/products, inventory costs would be low and every customer order would be filled in full and on schedule. We all know that this is not the case, so we must learn to understand how to measure and manage variance in order to achieve a Lean Supply Chain.
In contrast to the outdated EOQ model many supply chain managers tend to use Optimal decision models which can take into account Variance of demand and lead times along with the Costs of Level 1 and 2 service failures, Inventory holding costs, quantity discounts, logistics costs, ordering and back-ordering costs, and other factors that might influence Inventory policies like product obsolescence and life cycles.
In order to properly understand the real costs for any supply chain component there are really two things that must be understood: Variance and Costs. Concerning Variance; having data and information from the consumer end of the Supply Chain is hugely important for reducing costs due to variance. Walmart is probably one of best examples for sharing information through their Retail Link Point of Sale database. Walmart was a pioneer of sharing Point of Sale data to their suppliers who knew how to use the data to better understand demand planning. By giving their suppliers access to store level sales data Walmart gave their suppliers the ability to lower cost through-out their supply chain by reducing demand variance. Reducing demand variance leads to reducing supplier variance because as the Supply Chain moves away from the point of consumption the impact of Variance is compounded. Think about a supply chain that has Raw Materials Supplier ==> Level 1 Manufacturer ==> Level 2 Manufacturer==> Wholesaler==> Retailer==> Consumer, in this example assume that the no one is sharing information. The retailer submits orders to the wholesales that varies from 2-10% each order, as this variance travels up stream in the supply chain the variance and resulting safety stocks increase at each level in the supply chain. This adds unnecessary costs through-out the supply chain. Now consider that the Retailer decides to switch from Product A to Product B due to their Category Strategy, the result is there is a tremendous amount of unwanted upstream inventory that now must be liquidated somehow.
The second variance that must be controlled is logistics variance, which is a simple as building and maintaining carrier scorecards, and working with the logistics companies to remove any variance in deliveries.
Concerning costs, these are somewhat more difficult to calculate. Inventory holding costs can usually be easily calculated by understanding what it cost to have money tied up in inventory, warehousing costs, and shrinkage costs due to damages and theft. The cost that are much more difficult to calculate are service level costs, when you are not able to fill an order for a customer, what does it cost to make that right. Do you miss that sale forever? How many back-orders can you have before you might loose a customer? Are there any charge-backs because your customer's customer walks out because your item is not there? These costs can be calculated by coordinating with your marketing and sales team.
At the end of the day it is a good idea to collaborate with your upstream and downstream partners as much as possible in order to create a Lean supply chain because once variance is well managed the cost components typically fall into place.
