Recently my opinion of MIT’s Sloan Management Review, and the supposed gurus behind it, has improved. This week the bubble burst and they’re back in the tank with the rest of the out of touch with reality academes. On Monday there was an entire section of the WSJ penned in collaboration with Sloan, including one article discussing how "high oil prices are upending the way companies should manage their supply chains." Here are some tasty morsels from that article.
As transportation costs become more dominant, it becomes increasingly important to minimize the length of the journey from distribution center to retailer — the final leg of the supply chain — and to ship in large quantities to take advantage of economies of scale. To accomplish this, additional and larger warehouses become necessary, which implies more stock, hence higher inventory levels and costs.
Yowza! Sort of like a flashback to the 80’s for some of us, right? I don’t even know where to start. Yes, minimize the distance by locating close to the customer, but bigger inventories and bigger warehouses and bigger shipments? Perhaps it’s traditional accounting methods at work again, which don’t really count the cost of the cash tied up in all that inventory, the cost of a single quality incident putting a larger inventory at risk… you get the picture. "Economies of scale"…??? Maybe I’ve been immersed in lean a little too long, but I had hoped that traditional accounting terminology had died.
Some companies are trying to cut shipping times and costs by moving factories closer to the markets they serve. This generally makes sense when transportation expenses offset savings generated by making products in low-cost countries.
The problem is that "low [labor] cost" advantages are a myth. Just ask Dov Charney. If he can manufacture t-shirts and underwear in Los Angeles cheaper than at an Asian sweatshop, then anyone can. The real predominant cost in business is unnecessary complexity, not direct labor. Unnecessary complexity from overly convoluted supply chains, for example.
As a growing number of companies seek to serve markets from the closest factory, we predict another trend will emerge: a switch from dedicated to flexible manufacturing strategies. In flexible manufacturing, each factory is capable of making multiple products; in dedicated manufacturing, each plant specializes in making just a few. While dedicated manufacturing reduces production costs through economies of scale and fewer assembly-line set-ups, it can result in higher transportation costs because companies can’t always serve demand from the closest factories. The opposite is true with flexible manufacturing — production costs rise, but transportation costs fall.
The Sloan dudes are right on this, although wrong (again) in their analysis. Just as with supposed low cost labor, "economies of scale" is a myth in the lean world. Production costs do not have to rise with flexible manufacturing.
First, organizations will ship larger lot sizes less frequently or try to package products more efficiently to improve truckload utilization. As reported in CFO magazine, household and personal-care products maker S.C. Johnson & Son Inc. of Racine, Wis., last year saved about $1.6 million and cut fuel use by 168,000 gallons by combining multiple customer orders and products to load the fullest, best-configured trucks possible.
Second, companies will adopt cheaper and sometimes slower modes of transportation. Thus, we project more shipments will move from air to ground and from trucks to rail to cut fuel consumption.
Shipping "larger lot sizes less frequently" has nothing to do with their example of "combining multiple customer orders." Shipping larger lot sizes creates more cash tied up in in-transit inventories and more quality risk. Combining multiple customer orders makes sense. Slower modes of transportation? Once again, increasing the cash tied up in risky inventories.
You get the picture. Read the article for more amusing tidbits. Bring your lava lamp, wear a tie-dyed shirt, and you’ll feel right at home with the flashback. I’d invite anyone that tends to agree with these guys to visit any of the companies we often profile that are competing, globally, by reducing lot sizes at supposedly "high cost" North American factories. T-shirts, for example.
Funny article…they will never learn. I can hardly wait for the big 4 to start touting this “breakthrough”.
I wanted to give you another source for US made underwear, specifically boxer shorts. http://www.cityboxers.com
Made in Maine and I’ve been a customer for years.
Mike Wroblewski says
Nice post Kevin! I would like to see the day when everyone, including the braintrust at Sloan, start looking at the “economies of flow” instead of the “economies of scale”. I still have hope.
Mark Graban says
I think you’re being a bit of an ivory tower purist yourself about some of this, not all of it, but some.
(In the interest of full disclosure, I have a degree from the Sloan School… not that I agree with everything that Alfred Sloan or the school taeaches… so accuse me of defensive, if you must, but I’d say the same things if this was a Wharton prof writing this. Prof Simchi-Levi was also a professor of mine as an IE undergrad).
Nothing about Lean theory completely demolishes the fundamental underpinnings of the EOQ model. One advance of Toyota’s is the recognition that “setup time” is not “fixed” for all time, it can be reduced by SMED. Only by reducing setup time/cost can you then go reducing batch sizes and inventories. Now, EOQ is often misapplied by underestimating “inventory cost” but that doesn’t mean that EOQ is altogether wrong or that Toyota doesn’t respect the EOQ principle.
Qualitatively, it makes complete sense that higher shipping costs will mean you should err on the side of more inventory, IF (and only IF) that decision reduces total cost. Now, superficial readers of Simchi-Levi’s piece might use his argument as an excuse to say “See, JIT doesn’t work!!!” but those people always come out of the woodwork at the slightest whiff of a problem with JIT execution.
Making sure that a truck is full isn’t stupid, at all. If you already have just-in-time deliveries between your plant and a customer, say shipping every two hours with full truck loads, are you really going to ship once an hour? This would double your transportation cost with a very minimal reduction in inventory. If gas is more expensive and that 20 minute drive to your favorite warehouse club is more expensive, you might choose to buy more and hold a bit more non-perishable inventory in you garage if you have the space and the cashflow to afford it.
So to say “economies of scale” is a myth is very incorrect. Economies of scale often gets misapplied, but the logic and math still holds true in some cases. Again, a full truck load in my scenario is more efficient and economical, is it not?
Yes, qualitatively speaking, shipping less frequently leads to more inventory and higher inventory cost. But if SC Johnson’s inventory cost increase was less than $1.6M, then they made money in the bargain, right? Isn’t the primary goal of a business “making profits” instead of “keeping inventory costs low?”
Does Toyota ship one vehicle at a time from their factories? No, they are batched up on a truck. There’s economy of scale for you, right?
Following lean methods of flexible manufacturing, being close to customers, and treating staff with respect doesn’t mean you have to disown EOQ altogether. There’s no need, I think, to be that dogmatic about it.
Pete Abilla says
Having worked in Toyota’s Supply Parts Distribution arm, I can tell you that the question is not between one-piece-flow versus batch, but it’s about “what’s the right batch size.”
The goal is one-piece, but Lean is pragmatic. So, taking into account the fixed costs that come with a less-than-truck load — which is very costly these days — the natural trade-off is ship more with each travel.
What MIT is missing is the added dimension of the following, which is Toyota’s approach:
(batch size : how many trips : takt time)
In other words, as we increase the batch size per trip, we reduce the number of trips BUT, it all has to be still driven by the drum beat of the takt.
The number of trips is a function of takt time, which still gives the enterprise flexibility, reduced inventories, and minimizes transportation costs.