Everyone seems to lump together the terms blanket-order and Kan-Ban when they discuss supply agreements. While both help to reduce a company's costs of inventory, they are still different agreements with different parameters. When looking to improve your supply chain, and lower your monthly inventory costs, it’s important to be aware about the differences between these two main supply contracts.
The Difference Between Blanket-Orders and Kan-Ban Agreements
Both blanket-orders and Kan-Ban agreements play a pivotal role in minimizing inventory exposure, reducing finished goods pricing, improving lead time, and reducing a company's inventory costs. The key is to understand the subtle differences between the two and to respect your responsibilities and liabilities as part of any agreement your company enters into.
Blanket-Orders
Blanket-orders specify a set quantity to be purchased over a given business quarter, semi-annual or yearly basis. They allow the customer to use their volumes to negotiate lower pricing, while allowing the vendor to plan out production, sales and their own inventory requirements.
They involve the vendor boxing an agreed upon quantity of finished goods, and then waiting for a release from the customer. Once those goods are shipped, the vendor will immediately start to replenish inventory for the next shipment.
These blanket-order agreements are ideal for cyclical and seasonal demand patterns. For instance, a company may know its quarterly volumes, but it may not know specifically which month the finished goods will be needed. In this case, it's about holding the finished goods until the customer needs to take a shipment.
The above video explains the differences between Kan-Bans and blanket-orders. You can get a sample Kan-Ban agreement here, and a sample blanket-order agreement here.
Kan-Ban Agreements
A Kan-Ban agreement not only involves finished goods inventory, but it also involves maintaining semi-finished and work-in-process inventory in order to meet the strict delivery requirements of this supply contract. These are agreements that require the vendor ship finished goods daily, weekly, or monthly.
Kan-Ban agreements are not only a serious endeavor because of the amount of finished and semi-finished inventory they require to be successful, but also because the vendor will typically allocate labor and production work cells solely for the customer's requirements. In this case, it's a more serious contract and one where liabilities must be properly defined for all parties.
The above outline shows the three main inventory classes found within these types of agreements: They include "work-in-process," "semi-finished" and "finished goods inventory."
Kan-Ban agreements are more ideally suited for linear demand that’s constant on a daily, weekly and monthly basis. Examples of those companies that may use such an agreement include wireless cell phone manufacturers and automotive manufacturers. Of the two, the blanket-order is the least expensive option. So, how do these two approaches by themselves help to reduce your inventory costs?
"These agreements minimize your own inventory exposure, maximize your inventory turnover rates, and help defeat the daily cost of money."
Both of these agreements allow you to minimize your inventory exposure and avoid the monthly carrying charges of holding too much inventory. As such, you only take the parts or materials when you absolutely need them. Minimizing your inventory costs is an ideal way to secure significant savings. These agreements provide savings by ensuring parts and materials are used in a timely and efficient manner. Inventory costs your company money every day you hold it and don’t use it.
Every time you purchase products that go into your inventory, there is a daily cost you must absorb for holding that inventory. When you purchase product, you’ll most likely have 30 days to pay. If you finance your inventory purchases, then you’ll pay a daily interest rate to borrow the money to purchase the parts and materials. The longer you hold inventory, the more expensive it becomes as you extend the time you pay this interest.
If you have inventory for more than one month, then you continue to pay this daily interest rate long after you paid off the 30 day invoice. This is the cost of money and it is very expensive. These agreements allow you to defeat the daily cost of money by ensuring that the parts you take are immediately used and shipped out to your own customers. The less time these parts stay in your inventory, the more you save.
Additional benefits include avoiding the potential of these parts getting damaged in your warehouse, or becoming obsolete and outdated. Therefore, both types of supply agreements allow you make sure you use the inventory quickly, don’t hold it too long for it to accidentally get damaged, and defeat the daily cost of money by making sure you invoice your own customer quicker and get paid faster. This helps cash flow. While you have to pay within 30 days of taking these parts, you also ensure your company itself will be paid within 30 days by your own customers. It all seems very easy doesn’t it? Well, it can be, but there are some important issues to be aware of.
Ultimately, contractual supply agreements are meant to protect your company against holding costs and lost sales. The above video explains both of these costs in detail. You can learn more by going to: Inventory Carrying Costs vs. Lost Sales: Both Destroy Your Bottom Line
You have a responsibility and liability as part of these agreements
It’s not all win for you, and lose for your supplier. While you save on inventory costs by limiting your inventory exposure, your supplier bears the burden of having to carry the inventory for you. In essence, you’ve simply transferred the costs over to your supplier. In all likelihood they are well aware of this and will incorporate the monthly carrying charges into their pricing. Therefore, be ready to negotiate.
Most inventory professionals agree that the monthly carrying charges of inventory are typically 3% of the inventory value. You might be able to negotiate it down to 2% or less with your vendor. If done correctly, you could split the monthly carrying costs. Either way, you must respect your portion of the agreement and never ever try and back out. It’s always best to work out these situations and ensure you work together with your vendor to mitigate any mistakes and misunderstandings.
Taking advantage of suppliers will do nothing more than alienate your company and it will get around to your other vendors. Even though there will be a give and take to these agreements, the benefits to your company are substantial. To summarize these benefits, and include some not yet mentioned, here is a list of the costs that can be reduced as a result of using supply agreements.
1. Defeat the Daily Cost of Capital
As mentioned, inventory costs money, and every day you hold inventory is another day you have to pay for it. Therefore, these agreements help reduce the impact of the daily cost of money by insuring you only take the parts when you need them.
2. Reduce Inventory Damage
While it’s true that you have simply transferred your inventory carrying charges over to your supplier, you are protecting yourself against this inventory being accidently damaged in your warehouse. As long as it remains at your vendor’s facility, they are ultimately responsible for it. Taking it only when you need it helps to reduce the potential for damage. Inventory damage is an important aspect that often drives up the cost of inventory. Eliminating this threat saves you money.
3. Improve Inventory Turnover Rates
Every company has products that sell quickly, and others they sell well, but infrequently. While you may have quick turn around products that don’t need these types of agreements, the other obscure parts can surely benefit from them. You want all your parts and materials in inventory to be used quickly. However, it’s simply not realistic to expect all of them to move at the same rate. Therefore, these agreements are ideal for your more obscure parts.
4. Reduce Freight Costs & Warehouse Overtime
One of the most overlooked aspects that cost you money when managing your inventory, is the cost of freight for the parts you purchase, and the overtime paid to warehouse employees to stay after work to receive and ship urgent orders. When you don’t have these agreements in place and suddenly need the parts, you’ll typically pay a surcharge from your supplier to make the parts, higher expedite fees on freight to get them in quicker, and then overtime for your warehouse employees to receive the parts. Both freight costs and overtime are a significant contributor to your inventory costs. These agreements reduce their impact on your inventory.
5. Improve Cash Flow
Bottom line, the faster you invoice the faster you get paid. When you only take parts you are guaranteed to use, and ship to your own customers, it helps to improve cash flow. The time lag between having to pay your invoice from your supplier, and being paid from your own customer, is shortened.
6. Improve Delivery Times on Finished Goods
Perhaps the biggest benefit of these agreements is that they improve delivery time to your own customers. Improved delivery time of products can be measured in account growth and increased market share.
While kan-ban agreements typically involve intense negotiation and defined liabilities for both parties, they are an excellent tool for those medium sized enterprises with consistent demand for their products. Blanket orders are more for cyclical demand, but also play a pivotal role in reducing inventory costs and exposure. However, both agreements help to reduce inventory costs and ultimately to improve your service to your own customers. At the end of the day, beating your competition means more business for your company.
Dell's order fulfillment and supply chain strategy relies upon pre-manufacturing a large portion of the finished product and then completing the remaining portion after receiving a customer order.
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