How we increased production output by 12% by moving from an overseas vendor to a local vendor and saved $230k in working capital.
Most manufacturing production misses are due to raw materials not being available. That’s from my own experience. Of course, machinery break down, quality issues and communication play a big part but ‘we ran out of (acceptable quality) raw materials’ is always up there on top of the list.
There are two ways of dealing with this. The first is easy, to make sure that you have plenty of raw materials available in your warehouse, but that takes up space and unless you have extended credit or a consignment deal with your vendors, this can eat up a lot of working capital. The second is to develop a relationship with your vendors similar to that of the Tier One Automotive suppliers – Just in Time delivery.
The company* we dealt with was assembling electronic parts for the specialist consumer electronics market. Most of their components came from China who offered the lowest cost but at no credit, FOB terms. Also, all incoming parts needed to be tested before they were sent to the assembly cells. Furthermore, because of transportation costs and long lead time, the company had to bring in 20’ container loads of parts every couple of months. Raw material quality and shipping delays meant that the output was only 65% of production capacity.
We worked with the company and set up a team to try and find local vendors of similar electronic components. The problem was that the cost of the components was generally 10% or so higher than from China but with a much shorter lead time. The companies that they found were all selling into large manufacturers and had excellent Quality Control systems in place. As such, no incoming inspection was required.
- We set up a deal with the vendors to reduce their selling price based on a shorter credit period. The cost was now closer to 5% higher than China with 14 days credit.
- All of the vendors supplied to large manufacturers using ‘milk runs’ – daily deliveries of what was required, direct to their factory. We piggy backed on that and the vendors agreed that they would deliver our requirements daily.
- This had the result of massively reducing the inventory that the factory held and released a huge amount of working capital. Initially, the CFO was not happy with the increased cost of raw materials but was delighted at the amount of freed up cash.
- The manufacturing manager and his team immediately saw a 12% increase in production. Why? For two reasons. One was the availability of raw materials at all times, the second was the increase in quality of the raw materials.
- By the time the bean counters got to work and took into account reduced inventory, increased production the company showed not only an overall cost saving, but was able to deliver goods to the market faster than before.
No costs were incurred in this exercise. It took approximately six months to put the system in place as the new vendors were phased in.
Summary:
By assuring the on time deliveries of quality materials.
Production Output: From 65% to 77% of capacity
Reduction in working capital due to just in time deliveries of raw materials.
Total working capital savings: $230k
Conclusion
It is easy to look at the cost of raw materials as the most important driver. Buying large quantities by container load from overseas looks attractive but ties up working capital and can result in delays when there are quality problems. Just in Time delivery ensures the right materials are ready for assembly in the right quantity at the right time.
*Note that the product and process has been altered to keep client confidentiality. Images are schematic and do not represent the actual client’s factory. The savings and other data in the case history are as at the client’s factory.