KPIs #11 - A Focus on Materials Efficiency

In this Newsletter we will look at another of the Cost related performance measures. These cost measures relate to the four categories of resources involved in the delivery of a process: People, Equipment, Materials and Site costs. Every cent of cost incurred within our Profit & Loss account, or our local site or departmental budget will be aligned to one of these four categories. In this episode we will investigate the third of these, our Materials related costs.

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Materials Resource

Our Materials resources represent an interesting category when it comes to ambitions of efficiency or operating cost improvements. Firstly, the Materials required to complete and sell our products are the only category of resource that are transferred on to the client, in full or in part. If our business trades on retail, the materials we receive into our organisation are the exact items that are then sold on.?

Traditionally, in business terms, we would be seeking the best balance between holding the right range, in the right sizes and right colours with the amount of cash tied up to maintain that retail offering. Options and complexity have only increased in more recent times as much more responsive supply chains allow us to satisfy customer orders within days, and on-line range displays and effective mechanisms for direct delivery and sales or return allow us to dramatically expand our range offering without additional stock holding and cash investment.

For the manufacturer, where we will be receiving materials and parts and then assembling or transforming these into the finished product, the challenges of efficient material management become increasingly complex. There are many different perspectives on materials and stock holdings that we can employ to enable us to better understand current performance and potential for efficiency improvements.?

It is standard practice to classify the value of materials held into Raw Materials, Work in Progress (WIP), and Finished Goods Stock. Many companies will segregate further into value classifications such as A, B and C Class parts based on a range between commodity parts and the high value, high complexity or long lead time items.

Another way to segment our materials holding is into Consumable materials and those that form part of the Bill of Materials for the finished product. Consumables might include things like welding rods and gasses, process tank chemicals, or composite vacuum bags and sealants. A category somewhere between these two would be the materials that could have ended up incorporated into the product, but for one reason or another failed to do so. This might be accidental, with product materials that end up in the scrap bin, or might be somewhat less avoidable, as with nesting losses, clamping allowances, oversize raw material blanks or machining allowances. One thing that I tend to do, even as a rough calculation in my mind, is to consider the weight of materials bought compared with the weight of product transferred to the customer. This can give a rough feel for the scale of losses and potential for improvement.

Finally, when walking through our facility and looking at stored or standing materials and work in progress, we might ask the question of whether there is order cover for all of the materials that we see. Does the batch quantity have over-makes within it, or is the entire batch being made to replenish finished goods stock.

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Materials Resource Measurements

The measurement of our Material Resource Efficiency tends to take a very high-level view of our performance, in order to encompass all of the opportunity angles and perspectives discussed above. The method most often used would be to measure how many times we Turn Over our average value of stock holding within a year. This is referred to as our Stock Turns, or Inventory Turns.

We would typically measure our Material Resource Efficiency, or Stock Turns (ST) using the following formula: -?

A variation on the theme, also commonly used, would be to utilise a measure of Value Added on the top of the formula instead of the full Sales Turnover. In that case we would take away the value of spend on materials over the period from the sales turnover. Either will work well since in most cases we are concerned with the delivery of an improvement rather than a specific value. The measure is a factor, so contains no units, but is relatively quick and easy to maintain and monitor progress. The devil, and therefore the opportunity, is in the detail behind those items on the bottom of the equation, and how necessary they are to securing the sales above.

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The Concepts behind Materials Efficiency

In most cases, efforts to improve materials efficiency will concentrate on reducing the size of the burden on the bottom of the Stock Turns equation. However, we should never discount the potential to improve the top-level sales turnover as well, and the effect that stock holding might be playing in restricting this.?

Whilst there might be an argument that holding an appropriate range of raw materials will allow us to get product into production quicker, reducing lead-time and winning sales from those who need their product now, or holding finished goods stocks for the same reason, these benefits are a two-edged sword, with both categories increasing the bottom of the equation. Consideration needs to be made to the costs and benefits of each. The real toxicity though is in the other category of stock holding, our Work in Progress, which can form the hidden killer to efficiency. WIP is often thought of as an asset, with benefits similar to the above, but counter-intuitively, it can often have a negative effect on the top, as well as the bottom of the equation.

Where WIP levels can restrict our ability to increase sales income will generally come down to our company’s capacity to deliver product at acceptable lead-times, what might be called our dynamic capacity to supply. Conceptually, in a rough approximation, if we were to double the size of each batch in production, or double the number of batches in WIP, we will be doubling the length of waiting and processing time at every step within our production process. There comes a point, as WIP increases, where this increased lead-time equals and then exceeds our standard quoted lead-time, or if we start to increase our quoted lead-time in response, where the quoted lead-time becomes uncompetitive and we start to lose order opportunities. Essentially, we have run out of capacity to take on or achieve more sales whilst, if we do the analysis, it is very likely that most of our individual processes are nowhere near at full capacity. This is why overproduction is often described as the worst of all of the production wastes.

Efforts to reduce the bottom of the Stock Turns equation should be led by intelligent analysis of potential savings. As well as the categories for the segregation of stock holdings discussed earlier we should consider the value held of each component part or material and the length of time in order cover this represents, in other words, the amount of time it would take to run down the stock to zero.

We shouldn’t underestimate the full cost of these stock holdings. Buyers might be tempted by quantity-based price reductions but the impact on total acquisition cost can often be terrible. The material stock we hold ties up significant amounts of cash, we will pay interest on that cash investment, we will need factory space in which to store raw materials, WIP and finished goods stocks, we will need storage media; bags, boxes, and maybe high cost paternoster stores or storage and retrieval systems, we will need additional staff to place the items in store, manage those stores and retrieve and issue the materials when required, we will need an IT system to tell us where things are stored so that we can find them when needed. The more stocks we hold the higher the chances of damage, corrosion, losses, theft, items going out of life, becoming obsolete or superseded by design change, and finally, the greater the chances of employee accidents.

Over the longer term we might look to exploit the opportunities for material or part standardisation. Using common parts reduces the overall? number of part numbers we need to hold and manage. We might look to negotiate shorter lead-times, even if this means at higher prices. Maybe, if we could realise an ambition to have every item on next day delivery, we could eliminate stock holdings entirely and make every product to order. What might this be worth in operating cost reduction? If we are a larger company, we might be able to agree consignment stock arrangements whereby our suppliers provide line-side stock within our site that it still owned by them, payment only becoming due on consumption.

Another obvious area of opportunity relates to material waste and product over-makes. Sometimes these two areas might be in competition, for example where an optimum nest efficiency might encourage nesting more parts than we immediately need. Perhaps we could nest a range of different parts on individual sheet material, particularly if we have actively sought to standardise our raw materials sizes, or maybe retain part used sheets, part nested and issued time after time until used up.

Some companies still operate with a volume of over-makes included on every batch launched. The more we can do to improve quality performance and reduce losses throughout the process the lower this allowance would need to be. If we have no losses, or of our lead-time has been reduced enough to be able to process a replenishment order quickly should we have a loss, then the over-makes should be zero.

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Summary

The management of our Materials Resource Costs, through the deployment of effective performance measures can have an enormous impact on business efficiency. Our Materials Stock represent one of the four categories of resources in which we need to invest to operate our business processes. The other categories being people, equipment and site (including any overheads).

We would typically measure the efficiency achieved in our Materials Stocks through the adoption of Stock Turns (ST) performance measurement. This provides a holistic oversight of Materials Cost efficiency by factoring the volume of sales revenue achieved from the cash currently tied up in raw materials, work in progress and finished goods stocks.

Better understanding of the distribution of our raw material, work in progress and finished goods stock holdings, from both a value and order cover perspective can uncover significant opportunities for operating cost savings, as well as the potential for a one-off cash release. Strategic steps can be taken regarding design policies that encourage standardisation on a lower number of raw materials, components and part finished goods to allow further reductions over time. Trying to negotiate supply contracts that favour reduced lead time and smaller minimum order quantities over price might also release significant efficiency improvements. A continuous effort to reduce batch sizes, lead-time, processing losses and product scrap will also contribute.

The Greybeard Academy is made up of highly experienced, hands-on experts in business performance improvement who have ‘seen it, done it and achieved it’ many times in the past. This means that our advice and support is effective and efficient, saving you time and costly mistakes.

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Karl Smith (M.D.)

The Greybeard Academy