by Managing the Material Lifecycle
A practical research to improve inventory transparency
and reduce excess inventories at Philips OXB
by Managing the Material Lifecycle
A practical research to improve inventory transparency
and reduce excess inventories at Philips OXB
Author: Willem Waardenburg Student number: 1337149 Telephone: 06 – 14435794
E-mail: willemwaardenburg@gmail.com
University of Groningen
Faculty of Economics and Business MSc Business Administration
Specialization Operations & Supply Chains Supervisors: Gera Welker, Jan de Vries
Preface
This thesis is the final project for finishing the Master Operations & Supply Chains, and with that the study Business Administration at the University of Groningen. The research is conducted and written during an internship at Philips Healthcare. Philips offered me the opportunity to apply theoretical knowledge in practice. Although the complexity of the organization and the focus on results has increased the difficulty of writing this thesis, the practical relevance of it is ensured. I am grateful to the persons that made it possible to get in touch with Philips. Besides, I would like to thank the persons that were directly involved in my research.
Thanks to my supervisor Roel van Zutphen for his input. He emphasized the importance of the research for Philips without obstructing the scientific foundation. The weekly meetings were a good drive to continuously improve practical relevance and come up with new insights.
Furthermore, I would like to thank my supervisors from the University of Groningen. Gera Welker provided useful feedback regarding the structure of the thesis and she emphasized the importance of an extended problem analysis, while a result oriented approach was more rational. I am convinced that your visit to Philips has improved the quality of support. Without your comprehensible and fast feedback, I would not have been able to complete this thesis within four months. Thanks to Jan de Vries for interesting me for the field of operations & supply chains, and for contributing to this thesis by providing feedback with respect to the alignment of the practical research with theoretical approaches.
Finally, I owe thanks to my family for their untiring support during my entire study and for making it possible to start and complete my internship at Philips. I appreciate their priceless efforts to show me the path of life.
Management Summary
Philips Healthcare is one of the leading companies in producing medical systems for the health care market. Operations X-ray Best (OXB) is one of the operations facilities of Philips Healthcare, producing Cardio Vascular, Surgery, and Universal Radiology & Fluoroscopy systems. Within Philips Healthcare the importance of managing inventories has been recognized more and more in the last years.
The management of OXB has identified that the inventories are not transparent enough to manage them effectively and to initiate reduction action. A problem exploration learned that excess inventories are the underlying problem for OXB. Interviews, observations, and a comparison of internal and external objectives with operations strategy, have revealed that four main causes of excess inventories at OXB can be distinguished:
• lack of transparency: it is not clear which materials are held for which purposes, obsolete, end of life (EOL), and inventories determined for service can not be distinguished; • inappropriate material movement administration: materials registered in the
ERP-software do not always correspond with actual physical quantities;
• dependency on other divisions: OXB inventories are influenced by both the business lines and the Service department;
• responsibilities are not clearly defined: it is not clear who is responsible for managing and when required reducing inventories.
Interviews have been conducted with problem-owners, a data analysis has been done, management preferences have been analyzed, and running projects have been identified to reveal the main cause. The lack of transparency has been identified as the main cause for excess inventories. With a lack of transparency is meant that it is not clear which materials are held for which purposes. It is not unambiguous why particular materials are stocked and who is responsible for managing and controlling them.
The framework of Alter (1995) has been used for further diagnosis and redesign of the performance of the inventory system. It can be concluded from the analysis that the following elements influence the transparency of inventories:
• information technology: inappropriate capabilities and limitations of the ERP-software; • participants: the lack of involvement of employees;
• information: the low quality of information.
The improvement of these elements will positively influence the transparency of inventories. When the transparency is improved, excess inventories will be reduced (negative relationship). One of the most important findings of this study is that the transparency of inventories can be improved by redesigning the material lifecycle in both the ERP-software and the organization. The material lifecycle can be used to identify and control the lifecycle phase of stocked materials. A redesigned material lifecycle enables defining responsibilities and initiating aimed reduction actions. Obsolete materials, end of life materials, and materials determined for service can be distinguished from material needed for repeat production. Each material lifecycle phase provides specific information on the reason for holding inventories. Materials that have been developed for production recently obtain the status general release. This lifecycle phase changes at the moment that preconditions have been met to assign the material to one of the following statuses:
Last time buy: Items that are end of life by the supplier and for which a last time buy is done to fulfill future demand. This status is assigned to a particular material when the supplier has reported end of life and a last time buy is conducted. Items with this status are not per se excess inventories. An end of production date should be assigned to the items to enable for appropriate lifecycle management .When the end of production date is passed, the status needs to be changed to end of production.
End of production: A particular item will not be useful anymore to feed repeat production from a given date, but might still be needed to provide service. This status is assigned to a material when the end of production date is passed. When items are not needed anymore to build service assemblies, the status can be changed to end of assembling. In this case, an end of assembling date should be determined.
are needed for service. In this case, an end of life date should be determined and the material can be sold to the service department. Otherwise, it can be proposed to Philips Healthcare Refurbished Systems (PHRS) or in the end set to the status ready for archiving.
Obsolete: Items not useful anymore to feed repeat production or to provide service. When the end of life date is passed, items can be proposed to PHRS. When they are not interested the status can be set to ready for archiving.
Ready for archiving: Items that are not useful anymore to feed repeat production or to provide service and that can not be sold. Items with this status should be scrapped as soon as possible.
The material lifecycle phases have been combined with other fields in the ERP-software to present a transparent overview of inventories. This has been constructed by taking into account business lines, responsible purchasers, production lines, maximum stock levels and an ABC-indicator. The latter is a classification of stocked items in decreasing order of annual dollar volume. Materials have been assigned to statuses and excess inventories have been identified by interviewing purchasers and analyzing ERP data. In total, the top 20 percent most valuable inventory has been analyzed (1600 materials). 80 items with a total value of 2.6 million Euros were identified as last time buys. 291 materials with a total value of 1.3 million Euros were identified as end of production items, and 87 items with a value of 915.000 Euros were identified as end of assembling items. The latter are items that are not needed for repeat production or to build service assemblies. Moreover, stock quantities are compared with upper stock levels according to the ABC-classification to identify excess inventories. The excess value of these materials totalled 8.6 million Euros excess inventories. This value is partly caused by the last time buys and end of production items. Moreover, items with a total value of 461.000 Euros were not allocated to orders or requirements. The following recommendations have been provided to enable OXB to reduce inventories:
Implement and maintain the material lifecycle model: A change request has been formulated
Conformance to ABC stock levels: The conformance to stock levels can be improved by making
the material purchasers responsible for monitoring the conformance to stock levels. When excess inventories are detected, usage and supplier agreements should be checked to reduce them. When problems are caused by a recent delivery, lower batch sizes must be agreed with suppliers.
Initiate aimed inventory reductions: When materials are classified according to the developed
Table of Contents
PREFACE ... 3
MANAGEMENT SUMMARY... 4
1. INTRODUCTION ... 10
1.1INTRODUCTION... 10
1.2ROYAL PHILIPS ELECTRONICS... 10
1.3PHILIPS HEALTHCARE... 11 1.4OPERATIONS X-RAY BEST... 13 1.5EXCESS INVENTORIES... 15 1.6MANAGEMENT PROBLEM... 17 1.7REPORT STRUCTURE... 18 2. PROBLEM EXPLORATION ... 19 2.1INTRODUCTION... 19 2.2THEORETICAL FRAMEWORK... 20
2.3PHASE 2-PERFORMANCE OBJECTIVES... 24
2.3.1 External Objectives ... 24
2.3.2 Internal Objectives... 26
2.3.3 Reconciliation ... 27
2.3.4 Strengths and Weaknesses ... 28
2.4PHASE 3-STRUCTURING DECISION AREAS... 28
2.4.1 Physical Infrastructure and Planning Structure ... 29
2.4.2 Information Architecture... 34 2.4.3 Organizational Embedding ... 35 2.5CONCLUSION... 35 3. RESEARCH DESIGN... 37 3.1INTRODUCTION... 37 3.2MAIN CAUSES... 37 3.3SCOPE... 39 3.4PROBLEM STATEMENT... 40 3.4.1 Research Objective ... 40 3.4.2 Research Question ... 40 3.4.3 Sub Questions... 40
3.4.4 Framework for Diagnosis and Design ... 41
5. DESIGN... 52 5.1INTRODUCTION... 52 5.2INFORMATION TECHNOLOGY... 52 5.3INFORMATION... 57 5.4PARTICIPANTS... 59 5.5CONCLUSION... 60
6. CONCLUSIONS AND RECOMMENDATIONS... 62
6.1INTRODUCTION... 62 6.2CONCLUSIONS... 62 6.3RECOMMENDATIONS... 64 6.4LIMITATIONS... 64 6.5REFLECTION... 65 REFERENCES ... 67 APPENDIX I DEFINITIONS ... 69
APPENDIX II TRANSPARENT MATERIAL OVERVIEW TOOL ... 70
1. Introduction
1.1 Introduction
The research has been conducted within one of the operations facilities of Philips Healthcare. To shape a clear picture of the research context, a top-down organization view will be described in this chapter. This organization description will be presented to provide more information on the context of the organization the research is conducted for. Moreover, the organization structure is complex and must be comprehensible to understand the management problem. The chapter starts with a description of Philips Electronics in general, narrows down to the Philips Healthcare division, and ends up with the operations facility the research is conducted for. The management problem will be introduced by a description of excess inventories, which is the underlying motivation to conduct this research. Inventory levels will be analyzed and will be compared with sales to identify if excess inventories truly exist at OXB. After this description, the management problem will be put forward. This management problem is the basic assumption for conducting the research. The chapter will be concluded with a description of the report structure.
1.2 Royal Philips Electronics
Royal Philips N.V. is founded in 1891 by Frederik Philips and Gerard Philips in Eindhoven. The company started with the production of light bulbs. Nowadays, Philips is one of the top 50 global brands according to Interbrand (2007). Sales in 2007 totalled 27 billion Euros, resulting in earnings before interest and taxes of 2 billion Euros. Philips employs 125 thousand people and operates all over the world. The mission of Philips is: Improve the quality of people’s lives through the timely introduction of meaningful innovations. In a world where complexity grows to touch every aspect of our daily lives, we will lead in bringing sense and simplicity to people. After sales of several divisions and acquisitions of other organizations, Philips has been organized in three market-oriented sectors: Healthcare, Lighting, and Consumer Lifestyle. The research will be conducted within Philips Healthcare, which is described in the next paragraph. Simultaneously with the introduction of the market-oriented sector, the Vision 2010 has been presented. This vision focuses on building a company delivering sustainable profitable growth, leading to a high shareholder value. Three ambitions have been formulated to increase this shareholder value:
1.3 Philips Healthcare
Health care is becoming more and more important in society. The health care sector is flourishing due to an expanding world population, an increasing life expectancy, and a growing prosperity. Philips Healthcare produces medical systems for the health care market and employs 33.000 people worldwide, distributing in more than 100 countries. Development and manufacturing sites are located in the Netherlands, the USA, Israel, Finland, and Germany. The value of the medical systems market is 20 billion Euros. This is mainly realized by the top 3 players: Siemens, General Electric, and Philips. Philips has a market share of [X], with sales totalling [X] billion Euros. The market for medical systems grew steadily over the last few years and the compound annual growth rate is predicted to be 3-4% till 2010. Technology innovation, a growing world population, a higher life expectancy, and emerging markets will contribute to growth in the near future. The US Food and Drug Administration (FDA) plays an important role in the market. Before medical systems can be sold, a pre-market approval is needed for all medical devices. Furthermore, the FDA is responsible for overseeing the manufacturing, and for checking the performance and safety of the medical systems.
The competition in the healthcare market is strong. The main players in the market are all part of huge concerns with several other divisions. This enables them to stay in business when health care sales temporary drop. Philips Healthcare is an important player in the healthcare market, producing different products and services. Five businesses can be distinguished: Clinical Care Systems, Imaging Systems, Healthcare Informatics, Customer Services, and Home Healthcare Solutions. The businesses can be subdivided in several business units, which have been visualized in figure 1.3.1. The figure is explained subsequently.
Clinical Care Systems: Medical systems designed for support in clinical care, composed of: 1. Ultrasound: makes use of sound with a high frequency to visualize muscles, organs, and
foetuses;
2. Cardiac systems: monitor the performance of the heart; 3. Respiratory care: systems related to the respiration of patients.
Imaging Systems: Systems that are built to create images of the human body, composed of: 1. Computed Tomography (CT): makes use of tomography to provide three-dimensional
images of an entire organ, including the heart and brain;
2. Magnetic Resonance (MR): a magnetic field is used to provide detailed images of the human body. MR is primary used for making images of the brain, knees, and spines; 3. Single Photon Emission Computed Tomography (SPECT): gamma rays are used to
provide 3D images. Position Emission Tomography (PET) is a comparable technique; 4. X-ray: x-rays are used to enable radiography, fluoroscopy, surgery, urology, lithotripsy,
and mammography;
Healthcare Informatics:
The Healthcare Informatics business is responsible for providing customer tailored image and information management solutions for both the Cardiology and the Radiology environment. This business develops and supplies software for medical systems.
Customer Services:
When a medical system is ordered by a client, normally a service level agreement is signed for maintenance and repair. Customer Service is responsible for these service level agreements. Simplifying and improving operations is supported by Customer Service as well.
Home Healthcare Solutions:
Healthcare solutions that can be used at home to monitor and support patients from distance, ask for help in emergency situations, and for respiratory care.
Global Sales & Services:
The research will be conducted within Operations X-ray, part of Imaging Systems. The Imaging Systems business is, with [X] billion Euros, accountable for [X] percent of Healthcare sales. Sales are predicted to grow yearly with three and a half percent till 2010. About [X] percent of the sales are realized in the United States.
1.4 Operations X-Ray Best
Operations Ray Best (OXB) is responsible for supplying the Imaging System business unit ray. This business unit is composed of the business lines Cardio Vascular (CV) and General X-ray (GXR). OXB is responsible for producing Cardio Vascular systems for the business line CV and Surgery (SUR) systems and Universal Radiology & Fluoroscopy (URF) systems for the business line GXR. CV systems measure the performance of heart and blood vessels, SUR systems support operative actions, and URF systems provide live images of a patient. With OXB, operations of the former operation units CV, URF, and SUR are integrated.
Each medical system is composed of several components. The business line Components is responsible for developing these. OXB is responsible for producing the following components:
- collimators: shape and filter the x-ray beam, before the radiation hits the patient;
- image intensifier television (IITV): Transforms x-ray shadow images into visible light at
their output window;
- positioning systems: positions the patient, monitors, tubes and detectors in medical (x-ray) equipment (monitor suspension and tables);
- cabinets: components designed for the digital image handling.
In summary, the business line Components develops components for medical systems. Developed components are produced and integrated by Operations X-Ray Best. At the moment the systems are finished, they are provided to the business line Cardio Vascular or General X-Ray. The OXB structure has been visualized in figure 1.4.1.
Figure 1.4.1 OXB Structure in relation to the Business Lines
The relation between OXB and the Business Lines is explained in figure 1.4.1. To obtain more insight in the structure of the organization itself an organigram is drawn in figure 1.4.2. The senior director is supported by persons responsible for Finance & Accounting, Human Resource Management, Supply Chain Assessment & Improvement, and a secretary. A Quality & Regulations officer reports to the business lines. Furthermore, five functions directly supervised by the senior director can be distinguished:
1. operations managers: responsible for a particular production line (building block) or for system integration;
2. manager quality & improvement: responsible for managing quality and improving processes within the organization;
3. manager engineering: responsible for the engineering of the production process;
4. manager realisation: supervisor of the line managers and responsible for realization of production;
The organigram of OXB has been drawn below.
Figure 1.4.2 OXB Structure
1.5 Excess Inventories
The OXB organization, composed of the operations functions of CV, Components, URF, and SUR has been formed by the end of 2007. As stated in the previous sections, OXB is part of Philips Healthcare Imaging Systems. The stakeholders of Philips are dissatisfied about the results of the Healthcare division, because margins are too low in comparison with competitors. In order to increase shareholders value, earnings before interest and taxes must be improved. One of the
methods to realize this is reducing the Net Operating Capital (NOC)1 with fifty percent. As OXB
is part of Imaging Systems they are also responsible for reducing the NOC. In the past, inventory played an important role functioning as a buffer against uncertainty (Baker, 2007). More recently, the disadvantages of holding inventory have been increasingly recognized. This is also the case within OXB; the management has the idea that the NOC is negatively influenced by inventories.
1
Intangible assets (excl. goodwill unconsolidated companies), property, plant and equipment, non-current receivables and current assets excl. cash and cash equivalents, securities and deferred tax positions, after deduction of provisions and other liabilities (Philips definition).
Quality & Regulations
Secretary Finance & Accounting
Human Resource Management
In this section it will be identified if excess inventories truly exist within Imaging Systems and in the end within OXB. This will make it possible to put forward a relevant management problem. According to Zinszer (1996), the efficient flow of inventories is one of the main interests of supply chain management. Control and profits can be gained by solving this issue. Inventories will be compared with sales and with their peers in the past years to reveal if inventories increase and control and profits can be improved. It will first be studied if excess inventories occur at Imaging Systems. The reasons for increasing inventories will be discussed in more detail when the aggregation level is lowered to OXB.
Although sales of Imaging Systems have been declined in the last months, inventories grew steadily. Between January 2007 and May 2008, sales have been declined with almost seven percent. In January 2007 sales totalled [X] billion Euros. This has been decreased to [X] billion in April 2008. Inventories on the other hand have been increased with nearly thirteen percent. The total inventory value totalled [X] million in January 2007. This increased to [X] million in April 2008. This is illustrated in figure 1.5.1.
[Confidential]
Figure 1.5.1 Relationship between sales and inventory within Imaging Systems
When inventories increase and sales decrease, the stock turn is negatively influenced (Harmon, 1993). The stock turn of Imaging Systems has been regressed from [X] to [X] within 15 months. This means that the total sales divided by the average inventory has been evolved negatively. Holding inventory is expensive, lower stock turns result in a less efficient use of capital (Waters, 1992). Reducing OXB inventories will result in a higher stock turn and therefore a more efficient use of capital. In figure 1.5.2 the development of the stock turn of Imaging Systems has been visualized.
[Confidential]
Figure 1.5.2 Stock turns Imaging Systems
than their peers in the first four months of 2006. Therefore, inventories should be broken down to find underlying causes of this increase.
[Confidential]
Figure 1.5.3 Average inventory OXB
Unfortunately, no break down of the data of 2006 is available. Comparing the data of 2007 with the first months of 2008 provides several insights. The work in process (WIP) shows a small decrease, the total value of finished systems sways but is approximately the same, and the purchase parts show an increase of four million Euros. Furthermore, the inventory that is influenced by the business line increases. This is the inventory that is stocked within OXB on instruction of the business line. OXB is not held responsible for it provided that they are able to identify it adequately.
1.6 Management Problem
The previous section described that inventories have been increased recently. The management of OXB has the idea that the total value of the current inventories is higher than necessary to produce medical systems and assemblies for service. In the opinion of the management, this is caused by the lack of transparency of inventories. The following management problem can be formulated: The OXB inventories are not transparent enough to identify excess inventories and initiate aimed reduction actions.
An integral approach towards inventory management will be presented in the next chapter to explore this problem and identify possible causes of excess inventories. This improves the reliability of the research and prevents for aiming the research in a too early stadium.
Preconditions
The research should meet the scientific requirements of the University of Groningen and be of practical relevance for Philips Healthcare. The research will be based on an internship at Philips Healthcare and should be completed before the end of September 2008.
1.7 Report Structure
2. Problem Exploration
2.1 Introduction
In section 1.6 the problem put forward by the management of OXB has been mentioned. The management problem points towards a lack of transparency of inventories. It is not known for which purpose materials are stocked within OXB and who is responsible for managing them. Before an in-depth analysis can be conducted, the management problem must be explored to identify underlying causes. This chapter will unfold to what extent the inventory management concept fits with the operations strategy. Misalignment can result in excess inventories. It is not intended to present an elaborated solution in this chapter. At the moment the problem exploration phase is finished, the main problems will be analyzed in more detail by defining a research question and constructing a framework for analysis and redesign.
The methodology that has been used during the problem exploration phase will be described in section 2.2. A theoretical framework will be presented which will be used to structure the research. A problem-owners analysis will be interwoven in this framework to ensure that the problems that have been mentioned by the problem-owners will be taken into account. Literature in the field of operations management will be used to exemplify the description of the problems that can occur with respect to the inventory management concept.
In section 2.3, the market requirements for OXB will be described to identify to what extent OXB inventories are necessary to satisfy market requirements. This will be compared with internal objectives to identify possible misalignment and to analyze the importance of the inventory system for achieving company goals. This section will be concluded by a description of the strengths and weaknesses of the inventory system.
The underlying causes of the strengths and weaknesses can be found by describing the physical infrastructure, the planning and control structure, the information architecture, and the organizational embedding of the inventory system (de Vries, 2007). This will be dealt with in section 2.4. These underlying causes have been identified during observations, data analysis, and interviews with problem-owners.
2.2 Theoretical Framework
In the previous chapter has been identified that the inventory system of OXB is not sophisticated enough to manage materials. In this section a theoretical framework will be presented to be able to analyze possible causes of excess inventories. This framework will be used to structure the research. The inventory management concept will be analyzed by conducting a problem-owners analysis. To improve the quality of the analysis and verify the statements of the employees, the problem-owners analysis will be extended with a description of the inventory management system and operations strategy. The research methods that have been used to explore the research problem will be described in this section.
Both the problem-owners analysis and the description of the operations strategy will be structured by the diagnosing process of the Inventory Management Concept (De Vries, 2007). The Inventory Management Concept can act as a starting point for redesign actions (De Vries, 2007). This framework will be used as a guide through the problem exploration phase to diagnose the inventory management problems at OXB. This framework has been selected for three reasons. Firstly, the Inventory Management Concept aims at defining an integrated perspective on inventory management systems. This ensures an integral approach towards the management problem and prevents for focusing the research in a too early stadium. Secondly, the inventory management system is leading within OXB, which means that inventory decisions are based on the data that is available in the ERP-software. If it is possible, processes are adapted to the capabilities of the ERP-software. Finally, the management of OXB has pronounced the expectation that a change request will be presented to implement changes in the ERP-software. The diagnosis that can be conducted with use of the framework of De Vries (2007) provides a good starting point for a redesign of the inventory system.
The framework has been drawn in figure 2.2.1. The phases that will be studied during the problem exploration phase have been marked.
Figure 2.2.1 Diagnosing process Inventory Management Concept (De Vries, 2007)
The second phase of the model of De Vries (2007) concentrates on describing the performance of the inventory management system and analyzing its strengths and weaknesses. The performance objectives will be described to identify the influence of a company’s market aspirations on operations strategy (Slack and Lewis, 2002). This approach is chosen because it provides a structured approach to compare external objectives with internal objectives, which can be used to describe the performance of the inventory system. The research will start with describing the external objectives, which is also named the outside-in perspective. The market requirements are satisfied by the level of conformance and the prioritizing of performance objectives. Performing well on one or more of these performance objectives can result in increased market competitiveness. Slack and Lewis (2002) have described five categories, which are listed below:
1. quality: high specification products, error-free products, reliable products; 2. speed: short delivery time, short queuing time, fast response to request;
3. dependability: on-time delivery and arrival of products, knowledge of delivery times; 4. flexibility: frequent new product introductions, wide product range, volume-, and
The influence of these performance objectives depends on market positions, priorities, and order winning and qualifying factors. The market positions and priorities determine which performance objectives need to gain more attention to increase market competitiveness. The order winning factors are things that directly and significantly contribute to winning business, while qualifying factors have to be above a particular level to be considered by the customer (Slack and Lewis, 2002). These external performance objectives should be confronted with the internal objectives to be able to identify misalignment and to analyze the importance of the inventory system for achieving company goals.
Slack and Lewis (2002) combine the performance objectives with the decision areas capacity, supply networks, technology, and development and organization to depict the resource usage within an organization. This perspective is named the inside-out perspective. Because these perspectives do not directly relate to the inventory management concept it is chosen to use the performance objectives of Slack and Lewis (2002) to describe internal objectives. According to De Vries (2007) internal objectives refer to objectives which are considered by the company as being crucial for internal operations. The internal objectives will be derived from internal resources. This will be based on both interviews and on the Operations X-ray Best One Page Strategy 2008. The latter is the strategy that has been formulated by the management to clarify the vision and targets OXB aims for in 2008. Since the operations facility of OXB is expected to pursue these performance objectives it can be analyzed if the total value of inventories is influenced.
Operations strategy is defined by Slack and Lewis (2002) as the reconciliation between market requirements and operations resources. In order to identify possible misalignment between internal and external objectives and to analyze the importance of the inventory system for achieving company goals, internal and external objectives will be compared with each other. The second phase will be concluded by describing the strengths and weaknesses of the inventory management system. These strengths and weaknesses were difficult to determine because the inventory system is managed by an external organization. Moreover, it was not possible to compare the inventory system with other inventory systems within the available time span. For that reason, data gathered during interviews will be used to define strengths and weaknesses.
The structuring decision areas that have been defined by De Vries (2007) are listed below: 1. physical infrastructure: the way organizations produce goods and distribute them;
2. planning structure: the way inventory levels are planned and controlled and how this fits in the overall planning and control framework of a company;
3. information architecture: the information technology being used and the way operations and management processes are supported;
4. organizational embedding: the functions and activities that can be distinguished in relation to the inventory management system and the way planning and control activities are arranged in organisational units and departments.
The description of the physical infrastructure and the planning structure can be described by making use of the characteristic features in logistics and operations management as defined by Schönsleben (2007). This method is preferred because it results in an extended and structured description of the planning and control processes. The features in logistics and operations management as described by Schönsleben (2007) can be divided into three groups:
1. features pertaining to the user and the product or product family; 2. features pertaining to logistics and production resources;
3. features pertaining to the production or procurement order.
The features are valued in consensus with the possible values proposed by Schönsleben (2007). The features pertaining to the user and product family can mostly be observed from the production process. Desk research will be conducted to complete the analysis for this group. Observations will also be used to value the second group of features. Additional information will be collected by interviewing two problem-owners (the manager responsible for planning and execution control and the manager logistics). Production and procurement order features will be valued by means of interviewing the manager logistic, the manager order processing, and a logistic engineer.
Problems with respect to the information architecture will be described based on interviews that will be held with the general manager, the manager material handling, the manager planning & execution, and a logistics engineer. According to De Vries (2007) problems that are commonly experienced with information systems are: a lack of information sharing, information processing obstacles, and the application of different platform technologies. Semi-structured interview will be used to obtain more information about functional and instrumental problems. Examples of questions asked are: How can excess inventories be identified? What are possible causes for excess inventories? What problems do occur in relation to material handling? What platforms are used to register inventory information? Is the inventory data organization-wide available?
The organizational embedding of inventory systems consists of both the superstructure and the structure of positions (De Vries, 2007). Employees from both the upper and the lower level of the organization have been interviewed to identify problems with respect to the organizational embedding. Interviews have been held with the general manager, two employees responsible for new product introduction logistics, the planning & execution manager, the order manager, and several operational purchasers. Examples of question asked are: Who is responsible for reporting obsolete inventories? Who is responsible for the maintenance of the ERP-software? Who takes the decisions to purchase materials?
Phase three will be concluded with an overview of the problems that have been identified during the problem exploration phase. This makes it possible to put forward a problem statement in the next chapter.
2.3 Phase 2 - Performance Objectives
The previous section described which framework has been used during the problem exploration phase. In this section, the management problem will be explored based on the second phase of the framework. The performance objectives that have been described by Slack and Lewis (2002) will be applied to OXB to identify the importance of the inventory system. Moreover, misalignment between external and internal objectives will be analyzed. The section will be concluded by describing strengths and weaknesses of the inventory system.
2.3.1 External Objectives
Quality
Quality can either refer to the ability of an organization to produce goods that are reliable and conform to specifications, or to the specification of a product. The former, conformance quality, is an important aspect in healthcare. Medical systems have to be reliable; patients must feel safe and the x-ray doses must be conform to safety regulations. Nevertheless, conformance quality is not an order winner. Even when an organization produces conform to the FDA specifications, quality problems are seen as inevitable. As long as quality issues are solved very quickly, only costs will be influenced. The high specification aspect of quality, on the other hand, is an order winner. The quality of images is a distinguishing factor. OXB produces typically high end products and invests in the improvement of product features, performance, reliability, and safety.
Speed
Speed is less important. Although customers prefer to receive the medical devices within a short time span, a longer delivery time is usually accepted. Customers always request a delivery date when they place an order. The moment an order is received, OXB checks the possibility to plan the order backwards from the requested delivery date. Otherwise, a new delivery date is being proposed to the customer. This date is almost always agreed by the customer. OXB makes use of production time slots; production capacity can be extended or reduced with twenty-five percent.
Dependability
Dependability is an order winner. On-time delivery of regular products is critical, because the operating room cannot be used until the medical systems are installed. For service parts, dependability is even more important, an operating room will be out of order till the spare parts arrive. OXB delivered on average ninety-three percent of the orders complete and on-time over the first five months of 2008. A catalogue review, daily meetings, a supplier performance monitor, and clear agreements with the sales organizations are initiated to improve this dependability to ninety-eight percent.
Flexibility
important. Philips Imaging Systems has presented some revolutionary innovations such as a new technology to generate images and a 3D x-ray technology. However, innovations are initiated and developed by the business line Components. Because OXB is not responsible for designing new products, this is left out of the scope of this research.
Costs
Costs are, according to Slack and Lewis (2002), the most important performance objective. Costs are an order qualifier in the health care market. Although competing on price is not a key issue in this market, keeping costs low becomes more and more important. Due to increased competition and a low value of the dollar, margins are decreased. Furthermore, low costs can positively influence the other objectives, because costs can be defined as an integral performance objective. Six categories of inventory carrying costs can be distinguished according to Plossl (1995): obsolescence, deterioration, taxes, insurance, storage, and capital. The most important costs for OXB are the capital costs. The capital costs can be reduced by the reduction of the total inventory. Inventory surplus results in a foregone investment opportunity. Reducing this inventory surplus will positively influence taxes-, insurance-, and obsolescence costs. Deterioration costs do not exist and storage costs are fixed.
2.3.2 Internal Objectives
Internal objectives refer to objectives which are considered by the company as being crucial for internal operations (De Vries, 2007). These objectives do not directly link to customer requirements. The following core strategy that relates to industrial excellence has been derived from the Operations X-Ray Best Strategy 2008:
1. faster: focus on speed-, and cycle time reduction; 2. better: focus on quality, benchmarking, and learning; 3. cheaper: focus on cost structure and productivity.
This core strategy can be translated in the following six internal objectives, which are seen as business excellence enablers within OXB:
1. processes should be conform to external rules and regulations; 2. simple and lean: processes should be effective and efficient; 3. product quality and reliability should be improved;
5. reduction of production lead times and variation and improvement of capabilities; 6. continuous reduction of costs.
2.3.3 Reconciliation
Internal and external objectives should be linked to identify the importance of the inventory system to achieve company goals (De Vries, 2007). The external objectives that have been described in section 2.3.1 can be compared with the internal objectives that have been described in section 2.3.2. Reasons for holding inventories will be identified in relation with how OXB tries to deal with them.
The most important external objectives for OXB are quality, dependability and costs. Products with high quality should be delivered on time, while costs remain low. The internal core strategy, on the other hand, shows an emphasis on speed, quality, and costs. Although this points towards misalignment with the external objectives at the first sight, internal objectives correspond with the external objectives. Firstly, from the internal objectives can be derived that the focus is mainly on costs. Processes should be effective and efficient, lead time and variation should be reduced, and costs should be minimized. Moreover, the improvement of speed of the internal processes is not focused on improving delivery lead times, but on cost reduction. The improvement of speed and the reduction of cycle times is explained by the management as an important tool to reduce both stock costs and costs of capital. Finally, quality improvements do also relate to cost reductions. Improved quality of assemblies will not only satisfy the customer but also reduce the lead time of system integration. This will increase the dependability and reduce costs. The importance of dependability is also reflected in targets that have been set with respect to complete and on-time delivery of system at ninety-eight percent. From this it can be concluded that the internal objectives show an emphasis on the reduction of costs.
2.3.4 Strengths and Weaknesses
The strengths and weaknesses of the inventory system will briefly be described in this subsection. The strengths and weaknesses have been found during interviews that have been conducted with the problem-owners. In section 2.4 will be analyzed how the inventory system is embedded in the organization and to what extent the information system is designed in accordance with the operations strategy.
Three important strengths of the inventory system have been identified during interviews. Firstly, OXB makes use of very sophisticated software that is designed by SAP to manage inventories. The inventory system is fully integrated with the material requirements planning system. This means that the planning of purchase requirements is neatly integrated with incoming orders. Moreover, inventory levels are managed by the system based on predefined levels. Secondly, the commitment of the management towards the ERP-software is strong. Decisions are often based on information available in the ERP-software and processes are when possible adapted to ERP settings. Finally, the ERP-software is managed by a third party with high expertise.
The third party management is also one of the weaknesses of the inventory system. Although this simplifies adapting technical requirements, it brings very bureaucratic procedures along. The ERP-software is used within many departments of Philips Healthcare, which makes it more difficult to adapt the software to specific requirements. Changing the functionality of the ERP-software has to be approved by many stakeholders and can take several months up to a year. Another weakness is the inconsistent monitoring of excess inventories and the lack of allocation of responsibilities. Accurate monitoring tools are not available to identify excess inventories and responsibilities for managing and cleaning up excess inventories are not clearly defined. The described strengths and weaknesses of the inventory system will be analyzed in the following section by describing the structuring decision areas.
2.4 Phase 3 - Structuring Decision Areas
architecture and organizational embedding will be described based on interviews with problem-owners, as described in section 2.2.
2.4.1 Physical Infrastructure and Planning Structure
The features of Schönsleben (2007) can be subdivided in three groups: features pertaining to the user and the product or product family, features pertaining to logistics and production resources, and features pertaining to the production or procurement order. In the following subsections these features will be defined according to the definitions of Schönsleben (2007) and will be analyzed one by one to describe the production process and identify possible causes for excess inventories.
Depth of product structure: number of structure levels within the total logistics network. The product structure of the medical systems, built and assembled within OXB, is complex. Since the Bill of Material can be composed of several hundreds of items on many levels, the product structure can be characterized as one with many structure levels. This increases the complexity of planning and the control of inventories.
Orientation of product structure: indicates whether few or various components are used to compose one or various end products. The product structure within OXB can be characterized as convergent. Many components are assembled to build end products. This product structure is difficult to manage, because many different items are needed in production. The ERP-software can contribute to manage this complexity. However, the material quantities stored in the ERP software are often not comparable with reality. People from the shop floor take materials from the warehouse without booking them in the ERP-software, materials are stocked at a wrong location, and runners do not always register the right quantities. This can cause excess inventories.
Frequency of customer demand: number of times within a time period customers demand a product or product family. The frequency of customer demand is regular; it is not the same in every observation period and customers order one system at once. The demand is season dependent but can be approached by predictions. GS&S are not aware of the consequences of wrong prediction decisions regarding inventory value. It occurs that the predictions are not met, which can result in inventories that are higher than necessary.
variants. The production process starts with purchased materials and components and results in medical systems with many possible configurations. Customer specific medical systems can be produced within the borders of a product family. When materials needed for producing product families with many variants are not properly managed, excess inventories occur.
Unit costs: Costs for producing or purchasing one item. The costs between components and items differ largely. Unit costs range from one Euro to tens of thousands Euros. An ABC-classification is developed to distinguish high and low cost items and improve stock levels. The ABC-classification is extended with a D class for slow moving goods (appendix I). This class is added because many items came true to be filtered out with this extra class. The classification is based on total OXB purchase turnover. The items in the classes are responsible for respectively eighty percent, seventeen percent, two percent, and one percent of turnover. Inventory limits have been set as follows:
A: lower limit= 1 wk upper limit=2 wks 125 items in stock
B: lower limit= 1 wk upper limit=2 wks 500 items in stock
C: lower limit= 2 wks upper limit=4 wks 2000 items in stock
D: lower limit= 2 wks upper limit=6 wks 5000 items in stock
By making use of this classification, OXB inventories are better manageable. Items with high costs (A-items) are more and more transformed to vendor consignment stock to reduce inventory value. Upper and lower stock levels are set by the purchasing department. The stock levels are adapted each quarter of a year. This reduces the influence of forecast errors based on the frequency of customer demand, which is described earlier.
Transportability: the difficulty to transport items, based on size and weight of an item. Items produced by OXB are transportable items, but the transport is not very easy. Technical aids are needed for transport. One finished system loads an entire truck, before it will be transported to the final destination by ship or by plane.
A basic form has been drawn to provide more information regarding the location of the inventories within OXB (figure 2.4.1.1). The research will focus on the raw materials (purchase parts). From the figure can be concluded that The Customer Order Decoupling Point (CODP) lies before the start of the actual production.
CODP
Raw materials Semi-finished Products
Finished products Figure 2.4.1.1 Basic form OXB
Depth of product structure in the company: the number of structure levels in the company. The product structure within OXB has a great depth. Structure levels are reduced recently to decrease complexity. More and more components are purchased from suppliers, but different items in the bill of material still have several structure levels. The low-level code identifies the lowest level in the bill of material. For the current stocks the low-level code is on average 5, up to level 11. A deep product structure depth can result in many materials in inventory. When end of production materials are not well administered, lower level materials can not sophistically be scrapped.
Facility layout: physical organization of the production infrastructure, degree of labor division, and the course of orders through work centers. The OXB facility is set up as a product lay-out for single-item-oriented line production. The work centers are ordered along the process and high
value is added in the work centers. The production lines can be characterized as assembly lines. It has been recognized earlier that this assembling process can result in excess inventories.
Qualitative flexibility of capacity: the extent to which capacity can be implemented for various processes. The qualitative flexibility of the production infrastructure is low. Infrastructure is organized around a production line and can be implemented in only one process. The qualitative flexibility of employees is low to medium. Employees have a particular task which they execute for each medical system. In the past, employees often had a broader task and were responsible for building almost a complete component. For that reason, some employees are able to support engineers in subsequent or preceding processes when necessary.
Quantitative flexibility of capacity: the extent to which capacity is temporary flexible. Within OXB the quantitative capacity can be changed relatively easily. Processes are very labor-intensive, machines are not optimally utilized. The production capacity can be expanded with twenty-five percent, mainly realized by the usage of additional employees or by working overtime. This quantitative flexibility reduces the influences of the shortages that are mentioned by several problem-owners. Operations delays caused by shortages can relatively easily be corrected by adapting the capacity.
Frequency of order repetition: number of times a production or procurement order will be made within a certain time period. Medical systems have many possible configurations and are therefore produced without order repetition. Procurement orders are made more frequent. They have been related to assemblies or lower level bill of material items and exist in more configurations.
Flexibility of order due date: the extent to which customers are flexible to stipulate the delivery due date. As mentioned in the problem-owners analysis it is relatively easy to lengthen the delivery lead time. A lead time decrease is more difficult. An order due date is always agreed with the customer at the time the order is received. When an order has not started yet, the order due date can be adapted by adding extra production slots, but this does not occur often. The lead time can only be reduced by transporting the medical system by airplane instead of by ship. This will not influence raw material inventories.
Type of long term orders: the manner in which long-term order planning is done in the logistics network. OXB neither places blanket orders for goods nor for capacity. No long term order planning is appropriate for non-repetitive demand (Schönsleben, 2007). However, the demand for materials and components can be characterized as repetitive. This can result in a lack of efficiency and possibly shortages when materials can not be provided by suppliers. To prevent for this, predictions are sent to the suppliers each quarter to give them an indication of the demand for the next period. OXB is in the end of the supply chain, thus planning capability can not be increased by receiving blanket orders. The only problem is the Service department. OXB builds assemblies that can be used in medical systems or that are used for service purposes. In the latter case, OXB does not know how many assemblies will be needed in the future. Therefore, all items are stocked in the OXB warehouse till an order is received. OXB is responsible for the stocks till they the assemblies are built. These materials influence the inventory value, but it is difficult to identify them because Service does not use the same ERP-software.
Lot traceability: information on the procurement or production of a product or components. Exact material traceability records are not required by law and are therefore not applied within OXB. Nevertheless, it is required to track which materials have been used to build a particular product.
Loops in the order structure: business objects have to be reconsidered an indefinite number of times. No loops occur in the order structure of OXB.
2.4.2 Information Architecture
From the interviews with the general manager, the manager material handling, the manager planning & execution, and a logistics engineer, it can be concluded that materials that have been registered in the ERP-software lack transparency in their composition and origin.
This is firstly due to the ERP-software, which is not utilized adequately to support lifecycle management. The ERP-software provides possibilities to define the lifecycle of materials, but they are not sophisticated enough to manage the inventories. Besides, no unambiguous definitions are known. Therefore, inventory reduction actions can not be focused on materials in a specific phase of their lifecycle.
Furthermore, there are no obvious rules for identifying end of life inventories and obsolete materials from the ERP-software. Revised or replaced materials are not consequently removed from the warehouse, because it is difficult to identify them from the ERP-software. The total value of end of life and obsolete materials is increasing. This is mainly caused by hardware, software, and electronic components. Their lifecycle is very short in comparison with the service time that has to be provided on medical products, which is at least 10 years.
Thirdly, the inventory boundary between OXB and Service is blurred. OXB is obliged to offer materials which are not useful anymore for repeat production to the Service department. Materials can also be proposed to Philips Healthcare Refurbished Systems (PHRS). In reality, inventories are not cleaned up and stocked till Service is asking for the. Since Service does not use the same ERP-software, OXB is not able to identify future requirements.
the ERP-software. This can result in shortages on the shop floor because items can not be found in the warehouse when they are needed.
2.4.3 Organizational Embedding
The organisational embedding will be described based on interviews that have been held with the general manager, two employees responsible for new product introduction logistics, the planning & execution manager, the order manager, and several operational purchasers.
Undefined responsibilities are mentioned by the problem-owners as one of the most important problems. A general procedure to report obsolete or end of life materials is not available and responsibilities regarding updating and removing excess inventories are not clearly defined. No formal procedures regarding the sale or scrap of these materials have been described and no specific responsibilities to manage inventories have been formulated.
Dependency on other division is another possible cause for the excess inventories. At the moment that materials become end of life at suppliers the business line has to decide if the material should be redesigned or a last time buy must be done. When the business line prefers a last time buy OXB becomes responsible for the materials. All materials, necessary to cover future production and service demand, are ordered at once and have to be stocked within OXB. This results in increasing inventories.
Finally, a customer can adapt the configuration or delivery date of the order until five working days before the production process starts. From this moment, the order is frozen. This means that the order should not be changed anymore. However, many orders are rescheduled in the frozen period because GS&S focus primary on obtaining as much orders as possible. In practice thirty percent of the requests to adapt delivery dates are received in the frozen period, affecting the production process. Orders have to be rescheduled or even dismantled to reduce effects on the work in process or finished goods inventory.
2.5 Conclusion
of the OXB targets is to reduce inventories. However, they are difficult to manage within the current production environment given the possibilities of the ERP-software. The medical systems are assembled from many different materials and components. Moreover, the product structure has a large depth and the lifecycle of materials becomes shorter. Advanced ERP-software should be used to support this. However, the analysis of the operations processes shows that the ERP-software is not sophisticated enough to make support the focus on cost reduction. This effect is strengthened by the organisational embedding of the inventory system. OXB inventories are influenced by both the Service department and the business lines. This does not correspond to the cost reduction OXB focuses on.
Because many problems are mentioned by problem-owners and others have been identified by analyzing performance objectives and operations processes, an Ishikawa-diagram is a useful tool to visualize cause-and effect relations. This diagram is drawn in figure 2.5.1.
Figure 2.5.1 Ishikawa-diagram excess inventories
Material movement administration Transparency
Dependency on other divisions
Excess
inventories
Possibilities ERP-software Responsibilities Identification of excess inventories Utilization ERP-software Identification oflast time buys
Rescheduled orders
Incorrect quantities Last time buys
Unauthorized withdrawals
Incorrect location
Incorrect Predictions
3. Research Design
3.1 Introduction
Many causes of excess inventories have been identified during the problem exploration phase. Due to a limited time span, it is necessary to determine the main causes. Causes that are less relevant or that are already being solved by running processes should be excluded to aim the research. Distinguishing between main causes and less relevant causes will be dealt with in section 3.2. To provide intelligibility regarding the reach of the research, the scope will be determined in section 3.3. When the main causes are described and the scope is determined, the research problem can be put forward and a framework for diagnosis and design can be drawn in section 3.4. The research framework that will be used to structure the research will be described in section 3.5. The chapter will be concluded by describing the research methodology that has been used to answer the research question. This methodology describes which approaches will be used during each research phase.
3.2 Main Causes
From the Ishikawa-diagram it can be concluded that many causes have been found that are related to excess inventories. To aim the research, main causes have to be distinguished from less relevant ones. Below is described which part of the Ishikawa-diagram will be researched in more detail. This section is based on the importance of causes as discussed during interviews. Furthermore, causes that are already being solved by running projects will be excluded. Finally, causes that are not possible to be influenced by OXB will not be taken into account. The four main causes that have been visualized in diagram 2.5.1 will be described subsequently.
Lack of transparency
Dependency on other divisions
Regarding the dependency on other Healthcare divisions, three causes of excess inventories have been identified: last time buys, changes in orders that are already confirmed, and incorrect predictions. Last time buys can cause excess inventories. The business lines take the decisions regarding last time buys, while OXB is responsible for them. Inventories can be justified and reduced as soon as it becomes clear what the total inventory value of these last time buys is (transparency). Regarding the changes in orders, OXB already proposed order process improvements by charging a penalty when the order is changed shortly before or within the production process. This request is already running and will therefore left out of the scope. Furthermore, it can be concluded from the analysis that incorrect forecasts can influence inventories. In the past however, actions have been taken to reduce this influence. Two kinds of materials can be distinguished; generic materials that can be used in other medical systems and materials that are purchased for a specific medical system. The first can be stocked and used later, while the latter can only be sold or scrapped. Presently, more and more generic materials are used. This reduces the effect of incorrect forecasts. The effect of incorrect forecasts is further reduced by the introduction of the ABC-classification, a just in time program, quarterly depicted predictions, and vendor managed and owned inventories. The improved prediction methods and the flexibility of capacity have a positive effect on the influence of shortages as well.
Material movement administration
Material movement administration is another identified cause of excess inventories. This is left out of the scope because financial deviations are small and improvement projects are already running. Moreover, purchasing decisions are based on the information provided by the ERP-software and the financial value of inventories is calculated based on this ERP-software. This indicates that an inappropriate material movement administration will not directly influence the financial inventory value. Moreover, an inventory count project is already initiated to improve the data accuracy and since several months warehouse access is only permitted for a restricted group of users. Employees who not need warehouse access to complete their tasks are not authorized. These projects are important steps in order to improve accuracy, and are still running.
Responsibilities
assigned to categories, it becomes more transparent which materials should be removed and who is responsible for excess inventories. Better defined responsibilities will result in a sophisticated implementation of the redesign in both the ERP-software and the organization.
3.3 Scope
Since the main causes have been described in the previous section, it is now possible to determine the reach of the research. This ensures that the research will be concentrated on the relevant objectives and prevents for a loss of focus.
This research will be conducted within the Operations X-Ray Best (OXB) department. Other manufacturing departments or business lines will not be taken into account. It is important to mention that the Service department is not part of OXB, and therefore out of scope for this research. Within OXB several production lines can be distinguished. All production lines make use of the warehouse and stocked materials are used in different semi-finished products. As a consequence, materials located in the warehouse and determined for SUR, URF, CV, and Components will be within the scope of this research.
Furthermore, not all the inventories recorded in the ERP-software can be influenced by OXB. Only the inventories being relevant for this research will be filtered out. A part of the inventory value is caused by last time buys located at suppliers’ warehouses. Those inventories are already separated from the inventories that are possible to be influenced by OXB and will therefore not be taken into account.
Thirdly, Plossl (1995) distinguishes four classes of materials: raw materials, components, work in process, and finished products. Work in process materials and finished components will not be taken into account. A material lifecycle status does not add value for these materials, because OXB produces according the Make to Order philosophy. These materials are already allocated to an order and their destination is known. Raw materials are not yet scheduled into an order or consumed by a higher bill of material level, which makes it possible to sell or scrap excess inventories. Moreover, based on interviews can be concluded that obsolete and end of life inventories occur mainly in the raw material category.
