Time is money: calculating lead time value in SCM

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Deciding optimal supply chain lead times involves calculating a number of difficult tradeoffs. New research makes that calculation a lot easier, allowing firms to gain a more precise understanding of the true value of time in the manufacturing supply chain.

4 min read

de TrevilleSuzanne de Treville is a professor of Operations Management. Her research interests include lead time reduction, process consistency improvement, lean production and just-in-time manufacturing.
Chavez2Valérie Chavez-Demoulin is a professor of Statistics, specializing in statistical methods for quantitative risk management and statistical methodologies applied to operations management.
SchuerhoffNorman Schürhoff is a professor of Finance. His research interests include the cost of trading and investment timing.

Time is money, right? But how true is that popular maxim when it comes to supply-chain management? During the 1980s, time was seen as one of the principle weapons in the battle for corporate supremacy. The Boston Consulting Group championed time based competition, Harvard Business Review published “Time – The Next Source of Competitive Advantage”. In supply change management firms could steal a march on rivals by compressing their supply chains, minimizing the lead time from committing production to delivery.

Then doubts began to surface. In many cases supply chains seemed to be expanding, extending across the globe, with lead times growing longer. The matter was further complicated when some suggested that the value of time depended on the type of product.

The challenge is to increase flexibility and market response times and make sure the customer gets what they want, when they want it. Shorter lead times should make a difference.

Time continued to be regarded as valuable for high-margin products with volatile demand (denoted as “innovative” in a thought-leading article by Wharton’s Marshall Fisher). Volatile demand means there’s always a risk of supply and demand mismatch. Insufficient demand leaves the firm discounting stock to shift it. Too much demand and the firm runs out of stock, forgoes sales, and makes customers unhappy. Here, reducing mismatch costs should pay off. The challenge is to increase flexibility and market response times and make sure the customer gets what they want, when they want it. Shorter lead times should make a difference. Time is valuable.

However, for what Fisher called “functional” products, with stable and predictable demand and long shelf lives, time was less valuable. Steady demand for products means that making the supply chain more efficient and minimizing the physical costs associated with transformation, storage and transportation activities, has more of an impact on profits than shortening lead times.

As a result, research increasingly focused on categorizing products into functional or innovative. Companies sought to create extended but highly efficient supply chains for functional products. The perceived cost advantages of extended supply chains led firms to emphasize eliminating demand volatility — deemphasizing the value of time—through forecasting, modularization, and design for standardization.

Appearances can be deceptive, though. Products cannot always be neatly categorized as functional or innovative. Managers have had difficulties, using the qualitative insights available, evaluating the impact of a decision to move production closer to the market.

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Now, new research has put the issue of time back on the table; even for products that appear to be purely functional. OpLab, headed by Suzanne de Treville, professor of operations management at HEC Lausanne, University of Lausanne, has developed quantitative finance tools that calculate how much cheaper an extended-supply-chain product needs to be to compensate for an increase in mismatch cost arising from a longer lead time.

The true value of lead times

In an article recently published in the Journal of Operations Management, de Treville and her colleagues describe the application of these quantitative finance tools to the supply chains of three global firms: Nissan Europe, GSK Vaccines, and Nestlé Switzerland.

The OpLab results caused senior management to question freezing the production schedule.

Nissan Europe follows the traditional lean-production practice of freezing the production schedule eight weeks before final production to optimize the assembly process. This is expected to reduce production cost by 1% to 2%. Application of the OpLab tools, however, showed that freezing the schedule was unlikely to be cost justified given the level of expected mismatch costs. The OpLab results caused senior management to question freezing the production schedule for the first time, opening the door to new insights about customization and local production.

GSK Vaccines operated its supply chains to minimize production cost – operating at a high capacity utilization and extending the supply chain to allow production to take place at the most efficient facility. As a result, lead times for the filling operation averaged ten months. Much of GSK’s business, however, takes place in a tender structure where GSK only knows if it has tendered successfully two months before delivery. Production had to begin well before the tender outcome was known — with an even chance of winning or losing when production began. The OpLab toolbox was used to quantify the cost of long lead times. As a result lead time reduction has now become a priority for senior management. The goal is to set the average lead time for tendered products to two months, so production can be committed for a specific order once management knows it has won the tender.

The results demonstrated to management that promotional campaigns might well be reducing profits.

At Nestlé Switzerland, a quintessential functional product was — quite surprisingly — discovered to be a major culprit with respect to supply-demand mismatches, with around half of what was produced needing to be salvaged. The OpLab tool was deployed to tease out why mismatch costs were so high. Although the product had a long shelf life and stable demand, promotional campaigns shifted demand in time, thus substantially increasing demand volatility. These results showed that the promotional campaigns made lead time much more expensive for this product, which no longer behaved like a functional product. The production cost under the long lead time would need to be less than half the cost of when production was not committed until demand was known. Cost savings were considerably more modest, so the results demonstrated to management that promotional campaigns might well be reducing profits.

At all three companies, lead times were more expensive than expected. HEC Lausanne has now made the tool described in the paper freely available as a public service. The tool enables supply chain managers to get a more accurate fix on the relationship between demand and time, regardless of whether a product is perceived as functional or innovative. In turn this should allow them to solve the flexibility efficiency trade-off challenge, emphasizing the value of time as factor in competitive advantage.

Learn more about the Cost Differential Tool in this video or try it yourself: http://cdf-oplab.unil.ch

Read the original research paper: Valuing Lead Time, Suzanne de Treville, Isik Bicer, Valérie Chavez-Demoulin, Verena Hagspiel, Norman Schürhoff, Christophe Tasserit, Stefan Wager.

Featured image by Robert Scoble / Flickr CC