The Balancing Act

While we were discussing the business challenges of a medium sized, $60 million company making specialty polymers, a production planning executive highlighted the age old problem of performing the balancing act between the production/procurement plan with the ever fluctuating sales orders and the regular pains they had to undergo to try to achieve the balance between them. The essential facts of this classic case were as follows.

The company made and sold around 150 polymer grades manufactured out of some hundred odd ingredients. The production runs had to be of specific lot sizes and be planned based on a specific product sequence dependent on the individual polymer grades and their characteristics. The production run had to be scheduled at least three weeks in advance. The raw material procurement lead times could vary from 1 week to 12 weeks. Adding to the complexity, customer orders could come in with lead times of less than a week for out of stock materials and cause disturbance in the existing production schedule. The essential challenge was how to manage the dynamism inherent in the cumulative purchase and production lead times of 4 to 15 weeks versus the 1 week lead time of the unplanned orders.

We decided to further explore the issue by conducting an impact analysis on two fronts.

1. Loss of sales versus better production efficiencies:

A preliminary, but incisive, analysis of the situation brought out that most of the unplanned orders came in from C class customers who accounted for not more than 30% of total sales. The unplanned orders were typically made for some 40 polymer grades and accounted for around 5% of total company sales. The company had an operating profit margin of about 10%, the material cost was around 70% and cost of goods sold typically was 90% of the sale price.

We then asked the question “What if the unplanned orders were not catered to at all? What would be the fallout?” Some quick calculations showed that the real impact on business would be
= $60 million x 5% unplanned order revenue x 10% operating profit margin = $0.3 million.

But on the other side production runs would be smoother with waste reduction of say 1%. This implied a saving of
= $60 million x 70% material cost x 1% saving = $0.42 million

Thus just ignoring the unplanned orders could result in a net business benefit of $0.12 million.

2. Preserved sales versus higher inventory carrying costs:

We decided to push further. What if the safety stock levels of those relevant 40 grades were pushed up to a level that would help satisfy the unplanned orders? Assuming finance costs of 10%, the financial impact of that decision would be
= $60 million x 5% unplanned orders x 70% material cost x 10% finance cost = $0.21 million

Again this has a net savings of $0.09 million

Combine the two impacts, there would be no loss of sales, production efficiencies would be high and the total benefits would be
= $0.3 million (no loss of sale) + $0.42 million (better production efficiency) - $0.21 million (inventory carrying costs) = $0.51 million

Similar impact analysis can be done on the raw material lead times, production plan time fences, warehousing and other relevant aspects to identify potential business improvement opportunities.

Though the situation is much simplified in this example, it can serve as an effective method to further delve into the problem and arrive at relevant business solutions.