There are essentially two types of supply contracts: Blanket orders and Kan-Bans. Blanket orders are ideal for cyclical and seasonal business cycles. However, the issue with this type of agreement is the replenishment time on finished goods. Kan-Ban agreements are associated with linear demand markets. Unfortunately, very few companies have the demand to run this type of contract successfully. Instead of using one or the other, we'll combine both so that you can provide your customers with quick delivery times on finished goods, while also reducing your replenishment times for the next customer release.
A Better Supply Agreement
Central to this approach is to have finished goods boxed and waiting to ship upon a customer release, semi-finished inventory waiting to replenish the finished goods inventory, and work-in-process inventory waiting to replenish the semi-finished inventory. In order for this to work, you must ensure that you've minimized the number of operations needed to turn the semi-finished inventory into finished inventory.
In running this type of agreement, your customer must accept liability for all three inventory classes. However, this doesn't mean your customer can't make change requests. It just means they must cover the costs of rework and repair. Reworking the boxed quantity is likely not possible, but reworking the semi-finished and work-in-process portions might be possible - depending upon the product your company is providing.
I've included two videos in this post. The first explains the differences between Kan-Bans and blanket orders. The second explains Dell's order fulfillment and supply chain strategy. We are basically borrowing from Dell's approaches in coming up with our own supply contract.
The video above shows the difference between a Kan-Ban and blanket order, while also outlining how to put together a demand-driven supply contract. You can access a sample blanket order here, and a sample Kan-Ban here.
Dell's Push-Pull order fulfillment and supply chain strategy is similar to the supply agreement outlined in this post. You can read more about this strategy by going to: Emulating Dell: Outlining a Small Manufacturer’s Push-Pull Strategies
A Better Supply Contract
The three portions of the agreement are defined below. This is similar to a pull strategy, one where your customer's releases pull all three inventory classes in order to accommodate the customer's demand. You'll be able to immediately ship product to your customer, while minimizing the replenishment time for the next release.
Finished Product: These are products that are boxed and waiting for a release from the customer. The finished quantity must be agreed upon by both parties. There can be no ambiguity as to how many units should be boxed, or when they should be boxed. The lead time for the delivery should be a couple of days at most.
Semi-Finished Product: Like the name implies, these are products in a semi-finished state. They are not completely assembled and are waiting to replenish the boxed quantity. The lead time for the semi-finished inventory to become finished inventory should be a matter of days. Again, it's important to minimize the number of operations needed to complete the product.
Work-in-Process: These are sub-assembly components that are in process. They are about 50% completed and are in a holding pattern until the customer makes a release. Once that happens, the process pulls the semi-finished inventory into finished inventory, and moves the work-in-process into the semi-finished state.
Special Note: If your business is making custom-made products, then make sure to have a condition in your agreement that covers any design or engineering changes. Again, changes can't be made to the units that are boxed. However, changes can be made to the other portions provided your customer covers the costs of repair.
This is an ideal agreement for those companies that use blanket orders, but want to improve the replenishment time on finished goods. This allows the customer to take one release of five units, two releases of ten units, or if need be, 15 units in total for those sudden spikes in demand.
The semi-finished inventory are all in quantities of five - just like the units that are boxed. However, it’s the work-in-process where the volumes are higher. In this case, they're 30 units. If the customer experiences a drastic increase in demand, your company can immediately ship out 15 units, replenish the boxed quantity within days, and increase the semi-finished portion to match the increase in the customer's demand on future releases.
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