Keeping Operations Out of the Critical Path

I remember in college, which was longer ago than I care to admit, studying a technique called PERT. PERT stands for Program Evaluation and Review Technique. It is a method for controlling and analyzing a system or project using critical path analysis. Usually there are multiple paths through a project, with each step of each path requiring a certain amount of time and money.

Think of building a house. There is framing, plumbing, electrical, finishing etc. One of the paths takes the longest and is thus known as the critical path. Unless you shorten that specific path, you don’t change the completion date of the overall project. Managing the critical path is the key to improving the results of the process or project.

To me, a key objective of Operations is to not be in the critical path. Operations should not be the element that delays performance for customers. By creating and maintaining a flexible, Lean, effective Operation and Supply Chain, some other area of the organization becomes the critical path. Ideally, it should be Sales. That way, revenue and profitability can be maximized. So, a key objective for Operations is to be as flexible and effective as possible thus keeping Sales in the critical path.

© 2011 – Rick Pay – All Rights Reserved

Total Cost of Ownership: A Closer Look at Part Cost in the Decision to Go Off-shore

Total Cost of Ownership is a model that breaks the part cost into three major segments: pre-transaction, transaction, and post-transaction costs. Today I’d like to take a closer look at pre-transaction costs with a particular focus on China as a supplier. In a recent survey of 750 Supply Chain Managers worldwide, 37% cited China as their leading source of manufactured parts and materials outside their home country.

Pre-transaction costs

This includes engineering and design, materials requirements, supplier sourcing, visiting your suppliers before you start buying from them, and continuing to visit at least twice a year. Many companies calculate the cost at $3000-5000 for a week in China including airfare, lost time, hotels, food, etc.


Tooling in Asia tends to be extremely inexpensive, for example plastic injection molds can be one-tenth the cost compared to the US. The good news is that most injection molders are getting their tools built in Asia and then bringing them back to the US to run, so they can manage the whole process for you. The trick is in making sure the supplier is good so if there’s a problem you can get it fixed onshore.


Contracting can be very difficult. When I went to China I was fortunate to have an attorney who was both a judge in China and held a JD from an American university. We asked him to translate all our contracts into Chinese, and then translate them back. We discovered that there are sometimes no equivalents for technical terms, so our challenge was to come up with words that were descriptive and accurate in both languages. Things can literally get lost in translation.

Additional Considerations

Plans for adapting various systems, from computers to monetary systems and social structures like holidays – everything shuts down for Chinese New Year, and Europe closes up shop during August – are also part of your pre-transaction costs.

In my next post I’ll address the transaction itself and post-transaction costs.

© Rick Pay, 2011 – All rights reserved

Communication Helps Reduce Costs

I am working with a client to visit suppliers to find out if further cost reductions and service improvements might be available. One of the questions I ask is “is there anything the company can do to help you (the supplier) better serve them and reduce costs?” One answer comes up over and over again. It is “yes, they can tell us what their forecast is!” The suppliers often have to find out what demand for their products and services will be from people in the shop/warehouse.

In supplier partnerships, purchasing should have an open communications channel to suppliers to share information such as planned new products, significant changes in the company and sales forecasts. Suppliers can better plan their own labor and materials flow if they get monthly, quarterly and annual updates/plans from the purchasing department. Information can be shared either electronically, or in quarterly planning/review meetings. Open communications is vital to improved service and cost reduction.

© 2010 – Rick Pay – All Rights Reserved

Supplier Partnerships Really Work!

One of my clients retained me to see if I could find cost reductions in their second tier of suppliers.  These are suppliers that are significant but do not provide my client’s vital materials. The suppliers had been somewhat ignored over the past year due to staff turnover and the expectation for cost reduction was low. I met with the first two today and presented an approach that included increased volume through supplier consolidation; increased visibility through vendor managed inventory; a high expectation for shipped on time, product quality and service; and increased communication through use of blanket purchase orders, quarterly reviews and frequent visits from supplier personnel to be sure that service levels are being met.

The benefit to my client would be reduced inventory, increased service levels, reduced stock outs, reduced numbers of invoices and overall cost reduction. The benefit to the supplier would be much higher volumes, a sole source relationship, much longer planning horizons and potentially a broader range of product offerings.

The suppliers responded with estimated cost reductions of 10% to 18%; much higher than I expected!

© 2010 – Rick Pay – All Rights Reserved

Is The “New Normal” Something To Plan For?

Reading newspapers and business magazines, one sees the term “new normal” thrown around like a baseball at a sandlot game.  I am already tired of that term and put it in the same category as “paradigm shift” which should long ago have been buried.

But, the new normal is stirring a lot of attention.  What it represents is the great amount of uncertainty currently in the business arena.  Articles and speeches are being written and delivered on how to deal with the new normal, and much is being made of making the shift to working in the environment of the new normal.  I suggest the new normal is no normal.

There really is no normal when it comes to business, especially when one deals with operations and supply chain issues.  Things are constantly changing and there never really has been certainty as to what comes next.  Take a look at China.  It has only been about 15 years since China appeared as the great disruptor, changing the competitive landscape for US based manufacturers and distributors.  Recently, that has begun to reverse as managing for Total Cost of Ownership and rising labor costs in China have become more prevalent.

To truly respond to no normal companies need to become as agile and flexible as they can.  They need to be ready for anything that comes at them.  As Heraclitus, the Greek philosopher said, the only constant is change.  We need to be ready for it through leading edge Operations and Supply Chain strategy that builds on agility and flexibility.

© 2010 – Rick Pay – All Rights Reserved

Is Freight The Tail That Wags The Dog?

Many purchasing people I talk to place a very high level of importance on the cost of freight. As they develop purchase orders, the cost of freight often drives the size of the PO. In an effort to reduce freight cost, they often increase the size of the order significantly to “make freight”. Making freight might include getting to a full truck load for a cheaper rate or getting to an order size where the supplier pays for the freight. However, if you look at total freight as a percent of total materials purchased, while the dollars add up, it is most often a very small percentage of the total. If you factor in the cost of holding inventory, especially warehousing costs and obsolete inventory (see my article “Avoiding Obsolete Inventory…” on my web site); freight can become the proverbial tail that wags the dog.

The following graph (prepared by one of my clients), shows the impact of warehousing and logistics on total costs. As you can see, once you get to a certain point, order size gets counterproductive, and the freight cost you save can drive up other costs to the point where they are far greater than freight. Be careful to keep freight costs in perspective.

Inventory Logistics Costs

© 2010 – Rick Pay – All Rights Reserved

The Tide Is Turning On China

I was just listening to one of the business news networks and they mentioned that American Eagle (the clothier) is moving a significant amount of their production back to the western hemisphere.  They also mentioned that The Gap is moving from China to India.

I also recently had lunch with an operations manager whose company has sourced many of their raw materials in China, and this manager said they were having problems with lead times moving out, costs rising and quality declining (three strikes!).  As I talk to operations executives, this is becoming a consistent theme.

The news suggests that labor costs are rising in China, raw materials prices (i.e., cotton) are rising and the Yuan will be slowly revalued.  Many of the companies moving out of China are looking for speed more than cost reduction and thus are coming back to North and Central America.  That would suggest being close to the customer with your plants and distribution centers is an important consideration.

The tide is turning.  It is time to be looking at your supply chain strategy to make sure it is up to date in meeting the overall strategy of your company and your Operations objectives.

© 2010 – Rick Pay – All Rights Reserved

Supply Risk – Managing for Confidence

There have been a number of recent issues that have increased attention to supply chain risk.  The volcano in Iceland, the riots in Greece, and the political unrest in Thailand all have had significant potential negative impact on supply chains.  The more typical issues of buildings burning down, labor strikes and weather all are cause for concern in maintaining a free flow of materials from your suppliers.  So, what are the vital things to do to help prepare for such situations?

First, identify your critical suppliers.  These may certainly be the ones where you spend most of your supply dollar, but they may also be suppliers that provide critical parts, parts that are hard to find, or parts where the supplier has some Intellectual Property interest.  Normally, this may be 10 to 25 suppliers.

Second, meet with the suppliers to explore what their risk management plan is.  Explore how they plan to maintain or restore your supply chain.

Third, review it periodically to be sure it stays updated.  Regular meetings should occur with key suppliers anyway, and part of the agenda should be review of the risk management program.

Managing supply risk is a critical yet often overlooked part of strong supply chain management.

© 2010 – Rick Pay – All Rights Reserved

The Art of Off-Shore Buying for Long Term Profitability

Many companies today are outsourcing the purchase of materials, parts and end products overseas believing that they are saving a lot of money. Upon examination, I find that they are comparing the item cost of on-shore suppliers to the item cost of off-shore suppliers. This is often referred to as PPV buying, for Purchase Price Variance. PPV is the difference in cost between what the bill of materials says an item should cost with what the item actually costs. In many cases, especially if there is a large labor component, off-shore sources are significantly less expensive than on shore based on PPV.

Enter the world of Total Cost of Ownership or TCO. TCO includes all of the costs associated with sourcing an item including freight, customs/duties, inventory holding costs, quality, sourcing itself (e.g., trips to Asia), supplier selection and support, etc. TCO can add significantly to the cost of a part, many times more than off-setting the savings achieved on a PPV basis.

I see many companies ignore the TCO element of off-shoring often because the responsibilities for many of those costs are dispersed throughout the company. If Purchasing is not responsible for those costs, they can overlook them when doing the cost trade-off studies for off-shore supply. With labor costs in Asia rising, TCO may suggest that on-shore supply is now actually cheaper. Be sure to look at the Total Cost picture when making off-shore decisions.

© 2010 – Rick Pay – All Rights Reserved

Do High Inventory Turns Lead to Low Service?

An article in the April 26, 2010 issue of Bloomberg Businessweek (formerly just Businessweek) discusses how John Deere customers are unhappy with Deere’s ability to ship more quickly and meet customer demand. It seems that Deere, one of the leading farm equipment producers in the world, responded to the recession, in part, by improving its inventory turns to 12.3% of sales (8.1 turns). The article infers that such high turns (among the highest in the industry!) are reason to believe Deere cannot service their customers on time. Many of its distributors are complaining that they cannot get the equipment they need to meet orders. It seems the “inventory squeeze” thus caused bad feelings with their customers and led many to seek out competitors.

Well, I guess this suggests you cannot sell out of an empty wagon, even if it is a John Deere wagon! I say, hog wash (pun intended)! Having high inventory turns has little to do with weak service levels. All one has to do is look at Dell with over 100 turns and a shipping lead time of about 7 days to know that there are other reasons that service levels are low, such as poor planning, weak supply chains and waste in production just to name a few. I have a client that went from 6 turns to over 11 in just six months while reducing their order lead-time from over 90 days to below 30 and significantly improving their shipped on time. If you are having service level issues, look in the right places. Inventory is only one area to “till” for possibilities.