The ABC's of Supply Chain Management

Learning supply chain basics is as easy as A-B-C.

Luis Alvarez / Taxi / Getty Images.

Supply chain “experts” – like any experts – like to make the laymen who dare to tackle supply chain concepts feel overwhelmed.  Why?  Well, we “experts” have made a career out of justifying our own existence.  So if you want to know what we supply chain geeks – er, I mean, supply chain professionals – are up to inside our dark cubicles… look no further than this simple-to-use ABC explanation of all things supply chain.

A: ABC analysis.  The ol’ “80-20 rule” is at the heart of the ABC analysis.  That is, 80% of your inventory’s value comes from 20% of your part numbers. So it follows that you should figure out a way to identify those top 20% of your part numbers. Enter the ABC analysis. You can ABC your inventory by dollar value or revenue potential or any way you want.  It’s your inventory.  Identify the top 20% of your parts (as dollars or sales or whatever).  Those are your “A” items.  The next 30% are your “B” items.  The bottom 50% are your “C” items.  Make sure you have 100% accuracy of your “A” items (see Cycle Count below) and you’ve got a working ABC analysis. 

B: Back order or backlog?  One of these is good and the other one is not-so-good.  Your backlog is all the open customer orders that you have left to ship.  It does not imply that those orders are late.  If you have a customer that placed a $100,000 order for you to ship in 3 months (first of all, good for you!), that $100,000 is part of your backlog.

  A high backlog is good.  Your back orders are your orders that you are late on.  If in 4 months, you haven’t shipped that $100,000 yet (well, bad on you), that $100,000 is now back ordered.  And you probably have serious customer relationship management issues to deal with.  A high back order total is not-so-good.


C: Cycle count.  How do you ensure that you know exactly what you have on hand?  You can conduct a 100% physical inventory (see Physical Inventory below).  That means counting everything that consider an inventory item.  This is an important thing to do, but it’s also extremely time consuming.  Most companies can only do a 100% physical inventory once every year.  Cycle counting is a way to ensure you maintain 100% inventory accuracy between physical inventories.  Start with your “A” items (see ABC analysis above).  If you have 60 “A” items, you’re in luck – you have about 60 working days in a quarter.  Count one “A” item every day and start over the following quarter.  By ensuring you have 100% accuracy of your “A” items, you’re ensuring that 80% of your most valuable inventory is accounted for. 

D: Drop ship.  Do you ever receive an item from a supplier and then ship it to a customer?  And do you wonder where your value add is?  That’s what drop shippers have figured out.  Your supplier ships directly to your customer.  That usually saves time and dollars.  Your supplier invoices you and you invoice your customer.  The risk is that your customer and supplier might develop a direct relationship and cut you out.

  But if you supply many different parts to your customer, they may value you as a key supplier and accept drop shipments without considering cutting you out. 

E: ERP.  This is your Enterprise Resource Planning System.  Sometimes companies call these “the computer” or “the system” or “I can’t get this thing figured out.”  ERP systems can be big (like the ones made by Oracle and SAP) or medium-sized (like the ones made by Aptean and Great Plains) or can be an Excel spreadsheet.  ERP’s typically incorporate customer demand, production planning, inventory management, cost of goods, accounting, finance and other business functions (HR, work flow planning, etc.).  An optimized, installed and up-to-date ERP system will help planners plan, accountants account and buyers buy. 

F: FOB.  “Freight on board” or “free on board”.

  When you order something, the payment terms might state an FOB location.  Likewise, when you sell something, you should define those terms with your customers.  The FOB location is the point up to which the seller pays for the goods and their logistics (shipping costs, loading costs, etc.).  FOB factory means that the customer pays for freight once the goods leave the loading dock of the supplier’s factory. 

G: Gross margin.  This is how much you make by selling a product, minus the direct costs of making or acquiring it.  This is not your profit.  You still need to account for the indirect costs of running your business. 

H: Humans.  These are the things that run your supply chain.  These humans analyze data, negotiate with suppliers, manage inventory, place purchase orders and otherwise drive how optimized or un-optimized your supply chain.  As such, much of the success of your business depends upon the quality of these humans

I: Inventory.  You can either own inventory or you can conduct an inventory.  If you’re conducting an inventory, you’re counting all the items that you own that are either, 1) the things you sell, or 2) components of or raw materials that go into the things you sell.  Sometimes this includes packaging and sometimes it doesn’t – depending upon how your cost of goods and bills of materials are set up.  The inventory you own is the stuff you’re counting during physical inventories and cycle counts (see above).  The value of your inventory doesn’t normally include maintenance items or cleaning suppliers.  Your inventory is valued based on the parts you own that you will end up selling – or hope to sell – to your customers someday. 

J: JIT.  “Just in time.”  Suppliers like to ship you their products before you need them.  But to keep costs down, sometimes you can ask for them JIT.  While, theoretically, this means you have less inventory to manage – it means that you might have less inventory in the event of a spike in demand, quality issue or other blip that typically causes supply chain folks to run around and wag their fingers with an “I told you so” grimace.  JIT processes are not for the faint of heart. 

K: Kanban.  A close English approximation of what the Japanese word “Kanban” means is “queue limiter.”  Kanban processes work to reduce the waste associated with waiting on the next thing to happen…

L: Lead times.  Your company has many lead times.  Manufacturing lead times.  Shipping lead times.  Inspection lead times.  Raw material and component acquisition lead times.  All of these add up to the time it takes your company to supply its customers.  Lead times are critical in understanding how to optimize supply chains – but they need to be considered in their totality. 

M: MRP.  “Manufacturing resource planning” or “materials requirements planning”.  Your MRP system is likely a subset of your ERP (see above).  Your purchasing and planning teams use your MRP to drive supplier purchases and optimize inventory levels. 

N: Net landed cost.  You might buy something from a supplier that costs you $10.  The net landed cost of that something is not $10.  Net landed costs include the freight, logistics, customs and other costs that it takes for it to land in your hands.  If you sell your $10 item for $14, you might think you’re making $4 profit on each one.  But if it cost you $5 to get that item to your warehouse, then you’d be wrong. 

O: On-time delivery.  Either from your suppliers to you or from you to your customers, on-time delivery is one of the most important metrics in supply chain.  Measuring on-time delivery is no clear cut task.  Make sure you and your suppliers or you and your customers are using the same guidelines when driving toward your on-time delivery goals.

P: Physical Inventory.  Conducting a physical inventory is usually a task that a company takes once per year.  It takes a lot of heavy lifting to do one of these accurately – and, in most cases, you can’t ship to your customers or receive from your suppliers when a physical inventory is happening (for obvious reasons).  Are you counting from floor to sheet or sheet to floor?  Do you have count teams, count supervisors, audit teams and data input teams?  Absolutely crucial to getting and maintaining 100% inventory accuracy, physical inventories require attention to detail and inspired leadership.

Q: Quality.  If you ship your customer’s order on-time and you get it there by spending as little money as possible, you’ve failed if the quality of your product wasn’t what your customer ordered.  Quality is to supply chain what oxygen is to animal life.  You can only last so long without it.

R: RFQ.  “Request for quote.”  Customers and prospective customers will send out RFQ’s (or RFP’s or RFI’s – requests for proposals and information) to suppliers in order to initiate a sourcing project.  If you want to reach out to multiple suppliers and provide a level playing field for those suppliers to provide pricing, delivery, innovation and quality standards – a standardized RFQ is the way to do this. 

S: Safety stock.  Safety stock and re-order points and are not the same thing.  Well, unless they are.  In everyday terms, if you have a policy that you fill up your car’s gas tank when it gauge gets to a quarter tank, that quarter tank mark is your re-order point.  Your safety stock is the amount of gas you have below the “E” on your gauge.  Your safety stock level and your re-order would be the same if your policy is to refill your tank when you get to “E”.  In life and in supply chain – this typically isn’t good policy.

T: Total cost of ownership.  So, yes, you have the price you pay your supplier for Part A.  And you have the net landed cost (see above) of the Part A.  But that isn’t what Part A actually costs you.  Total cost of ownership includes the cost to inspect Part A, and re-inspect it, if necessary.  And rework it.  And fly to the factory to fix the underlying manufacturing issue.  And the back and forth with your customer because Part A isn’t exactly what they expected.  By calculating total cost of ownership, you can figure out if sourcing Part A from the cheapest supplier was a deal after all.

U: UOM.  “Unit of measure.”  Try to avoid “eaches”, if you can.  Or if you are using “eaches”, make sure you and your suppliers (or you and your customers) agree on what an “each” is.  If you went to the grocery store to buy an “each” of milk and you brought the $2 you believe an each costs, you better hope that the grocery store each is what you think it is.  It might be a carton or it might be an ounce, pint, half gallon, carton, case or gross. 

V: Value stream mapping.  What is your current process (to plan production or purchase from suppliers or receive inventory into your warehouse or anything)?  Map it on a whiteboard or butcher paper or someplace where the end to end process is visible.  Have the employees who work every step of that process go over it with a fine tooth comb.  Have people who don’t work within the process look at it.  Those people will tell you where your waste is.  And help you find leaner ways of doing things.  That’s value stream mapping. 

W: Waybill.  When you ship something – or have something shipped to you – by a common carrier, a waybill is the document that details what’s in the shipment, who shipped it, who they shipped it to and other port or airport or identification information.  A waybill isn’t a logistics contract or an invoice.  It’s a document to record the shipment and to maintain control of the shipping process. 

X: X-docking.  Or cross-docking.  In a hurry to ship something to a customer, but it hasn’t arrived from your supplier yet?  Try cross-docking.  That means, you never put it away in your warehouse.  You receive it and move it into an outbound truck without it every sitting on a shelf.  But be careful to make sure you receive it systematically, so that it’s transacted correctly within your inventory and accounting systems. 

Y: Yield.  Your shop floor has a work order for 100 pieces.  Your customer has ordered 100 pieces.  Sweet.  Except your shop floor’s yield is 98%.  Which means you better hope your shop floor started with 103 pieces, so that they yield 100 pieces.

Z: Zootopia.  Was “Zootopia” one of the most successful movies of 2016 because of its spot-on supply chain storytelling?  Yes. Yes, it was.