This is the second of a 2-part series on target lead time and target order quantity. Part-1 can be found here.
Actual Lead Time vs. Target Lead Time
All items with a Target Lead Time (TLT) much shorter or longer than their Actual Lead Time (LT) should be flagged for negotiation. For every item you need to know its actual to target lead-time ratio.
LT-to-TLT Ratio = Actual Lead Time / Target Lead Time
Keep in mind, that not all lead-time misses have a large enough impact on inventory performance to warrant significant effort in resolving. You need to use discretion and pick your negotiation battles wisely. In that effort, it’s smart to define lead-time ratio minimums and maximums to help determine which items should be prioritized for further investigation use the following rules as guidance.
- IF LT-to-TLT Ratio > 2.0, THEN work toward shorter lead times.
- IF LT-to-TLT Ratio < 0.5, THEN work toward longer lead times.
Delivery and Target Lead Times
When balancing on-hand inventory and delivery performance, the priority is always clear: Delivery. Always reduce inventory until delivery suffers (at which point analysis might allow for a marginal loss in delivery performance in exchange for a significant reduction in inventory). Unfortunately, when balancing carrying costs and transaction costs, the priority isn’t always so clear cut. By the way, many companies fail to recognize the complexity of choosing between reducing transaction costs and reducing carrying costs.
Consider, carrying costs typically rise at a far faster rate than transaction costs thanks to inventory handling, storing, and transporting costs. More transactions increase associated labor costs, but the additional cost of conducting more transactions is usually small by comparison to the cost of physically managing more inventory.
For this reason, it is generally advised to prioritize shorter lead times. However, for manufacturers that spend an excessive amount of time placing orders, receiving inventory, and putting material away, the costs of accommodating more orders can easily offset any gains from reducing inventory.
Recall, that ABC classification along with internal or external item status helps to determine target lead times. Good target lead times to start with are illustrated in Table 1. Whatever your internal target lead times are for internally manufactured items, a good rule of thumb for external items is 2 extra days of lead-time.
|A||3 Workdays||5 Workdays|
|B||8 Workdays||10 Workdays|
|C||18 Workdays||20 Workdays|
Table 1. Target workday lead-time
When conducting kanban analysis, it can help to segment items according to how actual lead-time compares to target lead time. For example, you might categorize items as having either a “short”, “medium”, or “long” lead time.
Below is a good rule of thumb for assigning lead time categories:
- Short LT: Actual LT < 1.5 x [Purchased A-Item TLT]
- Long LT: Actual LT > 1.5 x [Purchased B-Item TLT]
- Medium LT: All remaining items.
Target Order Quantities
Once target lead times are defined and qualified, we can calculate target order quantities.
Target Minimum Order Quantity
The ideal Minimum Order Quantity (MOQ) equals 1. This scenario allows the replenishment amount to equal the KOQ, no rounding required. Unfortunately, it’s unrealistic for every item to have a MOQ of 1, and often, no items will have an MOQ of 1. Fortunately, standard package quantities prevent rounding up in excess, helping to keep average inventory low.
It makes no sense to define TMOQ thresholds or cutoff limits, since MOQ necessarily varies from item to item. To calculate TMOQ you (or preferably, your spreadsheet kanban calculator) will simply lookup the TLT associated with an item, multiply the item’s TLT by its daily demand, and add the items target safety stock (TSS).
TMOQ = TLT x Daily Demand + TSS
Actual MOQ vs. Target MOQ
Once we’ve calculated TMOQ, we want to qualify the gap between actual MOQ and TMOQ, to determine where we should focus our efforts for negotiating lower MOQs with suppliers. To qualify the gap, we measure the ratio between actual minimum order quantity and target minimum order quantity.
Target MOQ Ratio = MOQ / TMOQ
A good rule of thumb is to flag those items with a Target MOQ Ratio greater than 2 (Actual MOQ is more than 2 times the Target MOQ), for supplier negotiations.
IF MOQ / Target MOQ > 2, THEN flag for supplier negotiation.
Target Standard Package Quantity
Your Kanban Order Quantity (KOQ) is rounded up or down in increments equal to item’s associated standard package quantity (SPQ). With that in mind, a goal should be to negotiate package quantifies that accommodate flexibility in rounding. Ideally, your standard package quantity should be between 10% to 30% the size of the item’s target MOQ. Shoot for Target SPQs to be 20% the size of Target MOQ.
Remember these five helpful order quantity guidelines to ensure the effectiveness of your kanban solutions.
- Kanban Order Quantity (KOQ) must never be greater than Maximum Order Quantity (MaxQ).
- KOQ must never be less than Minimum Order Quantity (MOQ).
- MOQ must never be less than Standard Package Quantity (SPQ).
- SPQ should not be more than 30% the MOQ.
- KOQ must always be evenly divisible by SPQ.
KOQ is based on TLT. Regarding actual lead times, there are solutions for a small KOQ, but not so much for a high KOQ. When an item has a low KOQ, long lead times can be managed with multi-card kanban solutions. However, high order quantities can’t be overcome. For that reason, it’s always best to focus efforts on optimizing minimum order quantities and standard package quantities.
Target lead time is a key factor that must be defined when developing reliable kanban solutions. Typically based on ABC inventory classification, target lead time values are a prerequisite for calculating target minimum order quantities (TMOQ), and target standard package quantities (TSPQ), which prioritize and inform negotiations with suppliers.