This is the first of a 2-part series on target lead-times and order quantities.
Importance of Calculating Target Lead-Time in Kanban Planning
Proper kanban planning requires inventory managers to define each item’s ideal kanban plan in addition to its recommended kanban plan. The purpose of calculating ideal kanban plans is to have a quantified optimal future state for both ourselves and our suppliers to work toward achieving, as well as a point of reference for comparing our actual recommended kanban plans against.
A vital parameter for developing ideal kanban solutions is Target Lead-Time (TLT). TLT can be thought of as “perfect” lead-time. TLT directly influences Target Minimum Order Quantity (TMQQ) and Target Standard Package Quantity (SPQ).
Target Lead-Time (TLT) assists kanban planning in 4 key ways:
- TLT helps define the proper order quantity to be used in a perfect 2-card kanban solution.
- TLT determines whether a multi-card kanban solution is necessary in order to reduce inventory of those items with short target lead-times and long actual lead-times.
- TLT assists in prioritizing items to negotiate better lead-times with suppliers.
- TLT helps in benchmarking groups or classifications of parts when conducting kanban inventory improvement analysis. ABC classification is one common frameworks.
TLT determines ideal order quantity for an item. Anything other than the ideal order size is undesirable. As actual order quantities deviate from ideal order quantities, the result is higher cost in the form of either excess inventory or excess transactions.
Each item’s TLT is often greatly influenced by the item’s ABC classification. ABC class is based on the Pareto principle, an economic observation that in most systems, the small minority of system inputs drive the large majority system outputs.
In inventory systems, the Pareto principle often manifests in the following way: “A” items are the small minority (e.g. 5%) of SKUs representing the majority (e.g. 80%) of inventory dollars. “B” items are the roughly 15% of SKUs accounting for about 15% of inventory spend. “C” items are the 50% to 70% of SKUs (and associated management efforts) representing roughly 5% of inventory dollars. Yes, “C” item management is extremely inefficient.
Inventory ABC class influences target lead-time in many ways:
- A-items cost the most to stock annually, so they tend to have the shortest TLT.
- B-items have an average TLT and cost an average amount to stock annually.
- C-items cost the lead to stock annually, thus tend to have the longest TLT.
Transaction Cost vs. Carrying Cost
Target lead-times represent equilibrium between the cost of inventory getting (transaction cost) inventory having (carrying cost). Unfortunately, while lower carrying cost is the result of shorter lead-times, lower transaction costs are the result of longer lead-times.
While it’s often difficult to clearly see all inventory-related costs, on-hand dollars are typically the exception. The result, in most organizations, is a disproportionate focus on reducing on-hand dollars (improving cash flow) while neglecting other inventory-related costs, such as the cost of inventory transactions. Savvy inventory managers recognize that it’s vital to take both transnational costs and on-hand inventory dollars into consideration when developing reliable, resilient, replenishment plans.
Carrying inventory ties ups precious resources such as cash, and, storage space, and can increase material handling costs due to having to manage more material. To reduce the cost of having inventory, one solution is to buy less inventory that requires long-term storage. Of course, this often, necessarily means an increase in the number of inventory transactions.
Transaction costs account for all costs related to ordering and receiving items whether the items are procured externally or internally. Consider that every purchase order and manufacturing order requires significant time to specify, enter, issue, and track.
That’s just for starters. Every order also requires time to make (if manufactured), receive, place into stock, and log in the system. Some of these costs remain the same or nearly the same regardless of order size, whether you’re ordering 1 unit or 1 million units.
Other transaction costs some with different order sizes, but benefit from “economies of scale”. For example, it might take more time to stock 1 million parts but it probably doesn’t take 1 million times longer than it takes to put away 1 part.
The key take-away is that there is a real cost-benefit to minimizing the total number of inventory transactions. In other words, low-quantity orders drive up over-all inventory transaction costs. Likewise, high-quantity orders drive down inventory transaction costs.
This principle is a key reason why low-cost C-class items tend to be purchased in huge quantities. After all, it would be ridiculous for a C-item’s transaction cost to be greater than its purchase price. That said, bulk ordering C-items is often sloppily executed, and with little thought. It’s truly amazing what a finely tuned replenishment plan can to do to reduce management costs even for C-items.
Kanban Quantity Transaction Cost
The ideal Kanban Order Quantity (KOQ) for a 2-card kanban item is defined by the item’s replenishment trigger-method. If replenishment is triggered when the last unit of a discrete order quantity has been consumed then you’ll use the Empty-a-Bin (EaB) kanban solution.
By contrast, if replenishment is triggered only when a new discrete order quantity has been opened then you’ll use the Break-a-Bin (BaB) kanban solution. The formulas for determining the ideal KOQ for each kanban trigger method are below.
- 2-card EaB KOQ: (TLT x Demand in a day) + Target Safety Stock / (2 cards – 1)
- 2-card BaB KOQ: (TLT x Demand per day) + Target Safety Stock / (2 cards)
The keen eye will recognize that EaB triggers result in order quantities that are exactly twice the ideal order quantity for BaB triggers. Thus, EaB order quantities have lower associated transaction costs. This is good to know when reducing transaction costs is a goal of inventory management efforts.
Vendor Managed Inventory & Consignment
Consignment and Vendor-Managed Inventory (VMI) items typically facilitate shorter lead-times than is normally the case with purchased items. For those items which have their replenishment managed by a supplier, you will want to account for the associated supplier’s defined replenishment cycle. For example, if an item’s supplier replenishes inventory at least once every two-weeks, then a target lead-time of 5 days might make sense for the item. Obviously, other factors such as proximity, replenishment method, and total spend with a supplier may make a given target lead-time more or less realistic.
Regardless, always ensure that ABC classifications have been reviewed and updated prior to defining target lead-times.
In part 2 of this 2-part series, we explore target lead-time further, including how to define lead-time thresholds when conducting kanban analysis. Next, we look at how to use target lead-times to define target order quantities, before wrapping up with a few order quantity rules to always keep in mind when defining order quantities.