Fundamentals of Managing an Outsourced (CM) Value Stream
This article will cover the management of a contract manufacturer (CM) value stream from the perspective of a company that has outsourced the manufacturing of its product. A typical CM model is most likely “turn-key” such that the “Company” purchases the only finished goods from the CM.
Part/component purchases are a shared responsibility between the company and CM. Company-controlled suppliers have negotiated pricing and purchased orders may be placed by the company or the CM for long-lead and specialty items.
Ultimately, the liability for part/component inventory rests on the company. For this reason, minimizing inventory, maximizing inventory turns, and value stream flexibility are some major objectives of managing a CM.
The objective of CM value stream management is to continuously match capacity with demand (even if demand ‘suddenly’ changes).
A value stream map is useful to illustrate the critical functions of this model as follows:
Note that sales forecast accuracy is a key input to operations and usually handled by the Sales & Operating Planning (S&OP) process, which is out-of-scope for this particular article. (Sales forecast accuracy is a KPI for sales or business development during S&OP.)
We’ll be discussing a make-to-stock model, where finished goods inventory is stored at the 3PL warehouse. The map is annotated with numbers and definitions of KPIs as follows:
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Production Plan – provided from the company to the CM which may or may not match the sales forecast (via the Sales & Operating planning process, a decision might be made to reduce production based on the amount of finished goods inventory.) The production plan could be compared with actual (output from CM). If actual quantities are short of the plan, then causes and countermeasures can be determined to bring the value stream up to the desired capacity. |
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Perfect Order Fulfillment – indeed, it is important to measure that customer orders are being fulfilled; however, this could include the quality of order fulfillment. Perfect order fulfillment represents the customers perspective…that we delivered the correct product, to the correct place, at the correct time, in the correct condition and packaging, in the correct quantity, with the correct documentation. The goal is 100% perfect orders. |
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Backlog – this terminology could be reserved for orders that cannot be fulfilled or parts of an order that are unavailable when needed. (Sometimes backlog is presented as pending orders, which can be confusing.) Of course, backlog should be minimized as we don’t want to keep the customer waiting….an obvious KPI: is the customer waiting for something beyond the expected date? |
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Company Operations Resource Loading & Attrition – it may (or may not) take an army of company resources to manage CM value streams. Nonetheless, resource loading is a valid measure of operational efficiency. In addition to production planning & execution, production support resources include quality, manufacturing and test engineers. Ultimately, we’d expect to see fewer resources required over time as the company operational and CM value stream becomes more efficient. |
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CM Value Stream Efficiency – KPIs provided by the CM such as measures of quality, lead time and WIP. (Note that a company objective is supply chain flexibility, therefore long lead times and significant excess inventory and/or WIP is a potential liability if there is a sudden change in demand.) |
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5a.) |
Finished Goods Inventory (FGI) – perhaps one of the most important KPIs since capital is being tied-up in unsold finished product. Is the FGI trend increasing or decreasing? How many months of forecasted demand is represented by the FGI? How long has unsold product been in the warehouse? |
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5b.) |
Inventory Turnover Ratio – measures how efficiently a company uses its inventory by dividing the cost of goods sold by the average inventory value during a set period. Is the inventory turnover ratio increasing or decreasing and which product lines are drivers? A low inventory turnover ratio is usually a sign of excess inventory. |
A summarized list of KPIs presented at a company operations review might therefore include:
- Production plan vs. actual (reasons for shortfall, if any)
- Volume of orders fulfilled and perfect order fulfillment (%)
- Backlog (orders, parts or components of an order which could not be fulfilled)
- Company operations department resource loading and attrition / turnover
- Finished goods inventory volume and trends
- Inventory turns, trend and target
A company operations organization that doesn’t emphasize value stream efficiency could significantly compromise other objectives, such as freeing up resources to support new product introduction (NPI).
Efficiency includes emphasizing balanced resource allocation. For example, there may be a massive amount of finished goods inventory while the CM falls short of the production plan. It may not be worth moving valuable company NPI resources to urgently fix a production plan problem with a large amount of unsold finished goods inventory. A business decision can therefore be made to allow the production plan to fall short for awhile while the shortfall is addressed by the CM.
The right KPIs, focus on operational excellence and balanced resource allocation can help make operations a competitive advantage.