Efficiency and Effectiveness in Operations of businesses are decidedly different concepts when considering the outcomes of focusing on one or the other too much.
To understand this let’s talk about Supply Chain Efficiency versus Effectiveness, using the auto industry as an example. Few industries have a more efficient supply chain from a cost and inventory perspective that that exemplified by the auto OEMs and Tier 1 suppliers.
Just in-time inventory deliveries and wide use of consignment in the supply chain with their suppliers, along with aggressively off-shoring supply sources over the years has resulted in a very lean and efficient engine. I recently participated in conducting a study of the Auto Interiors industry focusing on Tier 1 competitors in North America to examine closely the days-on-hand of total inventory across competitors, along with assessing the best practices in play.
For these multi-billion-dollar organizations we learned many operated with less than 15 days of total supply in value, including raw materials, work in process and finished goods. Some do much better at less than 10 days. 10 days on-hand translates to 36 or more inventory turns annually, allowing them to operate with much less cash tied up than say, a major consumer appliance manufacturer who may be getting 6 turns of inventory per year. Even better for the auto community if they ask for and get 90 to 120 days payment terms to their vendors, the effectively are being financed by their suppliers, allowing them to operate successfully with thin margins.
On the other hand, the auto industry has been severely hampered by the microchip shortage that has continued the last two years and may not abate for some time to come. With such an efficient supply chain, what went wrong?
For most auto OEMs they have an efficient system for providing planning data and buy commitments over a 6 to 12-week lead-time horizon, which they commit they will buy if the bottom drops out for sales. Call it material and fabrication authorization levels.
During the early months of the COVID pandemic in most countries, assembly plants were shut, producing no vehicles. The automakers proceeded to slash their supply commitment numbers to all their suppliers – including the Asian micro-chip manufacturers. They assumed that when things got better the chip folks would kowtow to them like their other suppliers have done in the past.
Wrong. As it turns out the pandemic generated a massive lift in demand for in-home products because of stimulus money flooded to Americans and the massive shift to a stay-at-home reality and most people working from home. With no restaurants to go to everyone discovered they needed a lot more home appliances than ever before.
Happily, for the chip manufacturers, they were able to sell all their capacity to the appliance industry. At better pricing and payment terms that they could get with the automakers. When the auto industry folks tried to place orders they were informed ‘Sorry, Charlie”, we have no capacity for the foreseeable future. This has led to auto.
OEMs building and selling vehicles without chips for non-essential functions (like running a sunroof) with a promise to install them later when they get chips… Wonder what that will cost?
Back to the notion of Operational Effectiveness vs. Operational Efficiency, the foregoing story is illustrative of what happens when focusing on an efficient supply chain, versus one that is effective – meaning careful planning for the long run is in place to protect supply from shortages of crucial parts. This was an un-forced error for many automakers related to microchips.
There are three key areas where we must carefully balance our decisions about efficiency and effectiveness in all operations.
In my next discussion on this topic I will be expanding on each of these in turn, as each has unique aspects to consider.
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