Ask Gemba: Volume and Variability in Demand Segmentation

Joe asked an interesting question:

I am doing some research on demand segmentation and found some rather conflicting information from two credible resources. According to The Toyota Way Fieldbook when leveling production you produce High Volume products to stock while you make the Low Volume products to order. Then according to Ken Koenemann , Practice Leader, Lean Value Chain Practice for TBM Consulting Group, one would make Low Order Variability/High Volume and low variability/low volume products to demand while high variability/low volume and high variability/ high volume items are make to stock. Am I missing something because of the fact that the Toyota way does not take into account frequency between orders and only looks at volume? I think this would be a great post topic as smoothing is the base of the Toyota Production System but yet it there is some rather conflicting information out there.

Well Joe, it’s possible you’re missing something but I can’t say for sure without seeing the full context of the TBM explanation. You’ve caught me in the field without my Fieldbook, so I can’t look it up to provide the context. I ask our readers to help out with this question also.

Both sources know what they are talking about so if there is a contradiction it’s likely that they are not talking about exactly the same thing. Before we get into it, let’s clarify that you mean “make to order” where you’ve used “make to demand” (you use both). So the two options are make to order and make to stock. Also, for the sake of this discussion “leveling” and “smoothing” will both be synonymous with “heijunka”, which we will define as “the averaging of both volume and mix over a specified time window”.

Leveling your demand can be for either make to order production or make to stock production, or a combination of the two. It is simply a question of where you hold inventory to set the trigger point. Many think lean means “no finished goods” but this is not so, especially when having enough of the right demand at or near finished goods can help level the demand and reduce total cost down the supply chain by reducing the bullwhip effect of demand variability that amplifies as changes travel down the supply chain.

The Toyota Way Fieldbook is specifically discussing production leveling or heijunka. In that example it is correct to say that you perform an ABC analysis and focus the leveling of demand on the items that are repetitive and higher volume. Since all of this low-low high-high talk gets abstract rather quickly, here is a 2 by 2 chart to visualize it.

The question of whether you can make to demand or to stock starts with the relationship of the order fulfillment lead time as compared to the required lead time. Regardless of whether it is low-low, low-high, high-low or high-high, if you have capacity and can fill an order in less time than the required customer lead time, you should make it to demand. But this is where you need to do the ABC analysis or similar segmentation to see just how much of each type you have. Of course this assumes that both your processes and customer orders are both stable and not variable. Both of these are likely true or true enough to be valid working assumptions at Toyota, which could explain the Fieldbook explanation above.

Leveling requires a lot of work to stabilize processes, shorten changeover times and reduce lot sizes. However heijunka is not strictly speaking necessary for successful demand segmentation. If you had enough capacity and scalability you could chase demand. If the cost of inventory was sufficiently low, or if you faced severe seasonality issues you may not want to level load at all. So one possible source of this contradiction is that the Toyota Way Fieldbook is talking about heijunka and leveling, not the broader topic of demand segmentation.

The context in the TBM example seems to be more of a discussion of make to order versus make to stock, or true demand segmentation rather than heijunka. Again, these are actually two related but different discussions. Hopefully this clarifies the apparent confusion.

Our friends over at the Lean Six Sigma Supply Chain blog have written some good, brief, visual examples of demand segmentation. The point by the LSSSC folks is also that variability of that demand should be factored when deciding whether to make to stock to order. Repetitive demand that is highly variable may not be appropriate for a make to stock model, while a low volume, highly predictable and reliable demand item may be good for make to stock. It depends on many factors of the business model such as the margins of the product, the comparative cost of lost sale versus total cost of ownership of the inventory, the relative speed of the fulfillment lead time versus the required lead time by the customer, and also your current capacity utilization.

The curves below are typical, but this can get really skewed if your product margins are very high, making it very attractive to optimize around limiting the cost of lost sales rather than the sum of various operational costs. This should also be taken into account when doing design segmentation to design the fulfillment model.

Heijunka, in other words, is not for the light of heart. Demand segmentation requires you to take a broader look at your business model and understand the levers that drive it so that all of the parameters are properly considered.

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