Should you Make to Order (MTO) or Make to Stock (MTS)?
All manufacturers face this production strategy decision in their quest to keep inventory costs down and meet throughput and on-time delivery (OTD) goals.
This decision is so critical to successful growth that most manufacturers will tell you their preferred choice within five minutes of discussing their operation.
In talking with literally hundreds of different manufacturers across the world – from food companies to high tech to industrial goods to automotive suppliers, most strongly believe that MTO is the best way to go.
Many of them concede, however, that they are currently making to stock while implementing some of the Lean manufacturing techniques that will get them closer to an MTO environment.
Below we discuss the MTO versus MTS dilemma, plus a third alternative – Make to Availability – that can be a superior choice in the right situation. Let’s dive in:
Make to Order (MTO)
As noted above, many manufacturers believe MTO is the most efficient way to run operations.
In a Make to Order production environment, a manufacturer produces the product after the customer places an order.
On the surface, it’s difficult to see the problem with MTO. What could be better than making only what customers actually order?
Advantages of MTO
Many manufacturers believe that MTO is desirable because it minimizes operating costs.
MTO aligns with Lean Thinking: a manufacturing process should strive for perfection by reducing non-value-added time and activities.
In a perfect Lean system, a manufacturing process is capable of satisfying customers’ orders in the shortest possible lead time, with zero defects, and with the lowest level of inventory possible – practically zero for the MTO approach.
But is a perfect Lean / MTO system possible at your plant?
MTO perception versus reality
The reality is that most high volume manufacturers can’t make exactly what customers want because their operation just isn’t flexible enough.
Your equipment is designed to produce more than one unit at a time. Your supply chain variability increases complexity. Can you really order one component? 10 components? 20 at a time?
Plus, MTO puts you completely at the whim of the customer.
You have to produce one or 100 of an item depending on what customers want in a given week.
And the hard truth is that your customers often don’t know exactly what they need, even when they place an order. (More on that below.)
Make to Stock (MTS)
Now let’s take a look at a traditional MTS approach. An MTS production strategy matches inventory levels and production schedule with a forecasted and firm customer demand.
The closer you can get to MTS, the better
The more you can figure out how to Make to Stock, the more control you’ll have over manufacturing batch size and scheduling requirements. It provides all-important stability for your manufacturing floor.
You can produce in the quantity that is good for your operation and you always have available what you need to ship right away.
The key to a successful MTS approach? Carrying small, correctly sized inventory levels and a good forecast.
Designing and managing the right inventory level minimizes operating costs and maximizes availability.
However, to determine your ideal SKU-specific inventory levels, you need visibility to:
- Item transaction frequency
- Related lead times
- Forecast / Consumption-level fluctuations, and more
The beauty of MTS is you should always have product in inventory, so there’s no shipping delays or expedited freight. Firefighting is often reduced. Scheduling becomes far more predictable.
The downside of traditional MTS: forecasting
The main downside of the traditional MTS approach is the need for a forecast.
In our experience, there are only two kinds of forecasts – wrong and really wrong. It is a scientific impossibility to forecast accurately at the SKU (item number) level especially at the longer timeframe – the level at which all manufacturers produce products.
Therefore, making to stock with an inaccurate forecast unavoidably leads to inventory imbalance – too much of the wrong inventory (inventory that your customers don’t need now) and not enough of the right inventory (inventory that your customers do need now).
Again, moving from theory to reality, manufacturers will always have to balance MTO and MTS to some degree, but the closer you can move to MTS the better (assuming your forecast at the SKU level is relatively stable).
The downside of traditional MTO: why do customers still have so many urgent orders?
MTO environments also suffer from negative effects that are strikingly similar to a traditional MTS environment.
This is because many customers don’t know what they really need – contrary to a common assumption.
If customers knew what they needed, and if they ordered accordingly, shouldn’t their own expedited and / or urgent orders be close to zero?
Customer uncertainty about what they need shows up as:
- Frequent emergency orders
- Frequent order changes (quantities or due dates), and
- Surplus raw materials held by the customer.
In fact, most MTO environments end up with too much inventory – the same as traditional MTS environments. The difference is sometimes less visible since under the MTO approach: the inventory may be located at the customer’s site – as raw materials – versus at the supplier’s site, as finished goods.
In both cases, the system has produced too much of the wrong and not enough of the right inventory. This can only happen if your customers’ orders are not a true reflection of what they need, but a forecast – their best guess.
Make to Availability
Now let’s consider a third approach, ‘Make to Availability,” the Theory of Constraints (TOC) evolution of MTS.
What’s the difference? Why is it important? Let’s dig in :
Make to Availability (MTA) is a term coined by Eli Goldratt, author of The Goal.
The MTA model reflects a manufacturer’s commitment to ensure the availability of certain items at a certain location, and to the production policies required to achieve it.
It follows the principles of Demand-Driven Replenishment (DDR), a TOC approach to supply chain management that enables a better response to customer demand in real-time.
Moving from MTS to MTA
MTA is an alternative to a MTS environment that simultaneously reduces a manufacturer’s cost and many of the negative issues customers face. So how do you get there? The answer is to stop using the SKU level forecast when deciding how much to make.
Dynamic inventory stock buffers
Instead, the manufacturer establishes a dynamic buffer of inventory between themselves and the customer. This inventory buffer is sized to protect for the maximum use or consumption from your customer over your replenishment time.
The preferred location for this buffer is at your customer’s site, but your own finished good warehouse can work too. You must ensure the inventory buffer remains close to your target inventory level as your customer consumes the products. No orders are placed: instead, your customer frequently communicates their consumption of products and you create replenishment orders to maximize your own efficiency, both in production and in shipping.
The size of this inventory buffer is minimized due to two reasons. First, producing and shipping to your customer’s actual consumption drastically reduces the variability in the order size – since you are no longer producing to your customer’s forecast. Second, you embark on activities to reduce your replenishment / production time (primarily using TOC and Lean manufacturing techniques).
In order to convince customers that their service levels will improve without ordering, manufacturers may offer a performance guarantee based on ensuring excellent product availability. This performance guarantee demonstrates the seriousness of the offer and blocks competitors from naively making the same promise. This is the key to unlocking sales growth.
Visibility to manage your full inventory position
Here’s another way that MTA is different from MTS:
With MTS you are managing what’s in your warehouse (“what’s in stock” or “what’s on hand”) similar to a kanban approach within lean systems.
MTA, on the other hand, is a combination of inventory on hand AND inventory on the way.
It gives you broader visibility to manage your full inventory position in the supply chain, capturing not only what’s in your warehouse but what’s coming to it.
This is an important distinction because it allows you not only to minimize what you have in stock but also to trigger more orders sooner and ensure better delivery to respond to changing customer demand and supplier / delivery variability.
MTA works best in variable and complex production environments with repetitive products where your customer tolerance time is less than your production time. The MTA approach allows you to account for and respond to factors such as seasonality, promotions, customer demand variability and supplier delays.
All those factors affect the size and design of your inventory stock buffer – the sum of what’s in stock and what’s on order.
MTA delivers an average 25% growth in revenue
Based on our experience, at Montera we are proponents of Make to Availability – the Theory of Constraints approach to DDR.
Why do we prefer this approach to Make to Stock? Simply because it provides best availability, reduces manufacturing costs and maximizes revenue.
Manufacturers using our MTA/DDR approach have achieved significant results:
Shortages and urgent orders from their customers drop, leading to fewer expedites and less overtime in the plant. Fewer expedites lead to an increase in predictability, shorter lead times and lower costs.
However, the biggest benefit for manufacturers is an average 25% sales increase coming from their customers’ revenue increase. When your customers have what they need, they can sell more. Plus, customers’ surplus inventories are almost eliminated.
How to put MTA/DDR into practice for thousands of SKUs
Accounting for all these variables can be complicated when you are managing thousands of SKUs. Your MRP can’t do it because it is designed to manage inventory in the warehouse (with a min / max or safety stock approach) but not in the broader, dynamic MTA sense.
To address this gap in MRP functionality, Montera built software with full MTA capability that works with any ERP.
Our Roadrunner Rx inventory management software module uses an algorithm that accounts for your unique and dynamic situation, incorporating seasonality, promotion, supply chain reliability, minimum order quantity and other variables to calculate the size of the “stock buffer wall”.
This approach requires alignment of your purchasing team and production planning and execution with the signal from your MTA-based inventory stock buffers.
The pay-off? Manufacturers are able to:
- Reduce stock on hand (minimizing inventory costs, increasing cash flow)
- Increase availability, inventory turns and throughput (usually quite dramatically)
- Minimize production and operating costs
- Maximize revenue and profitability
Customer service wins drive sales and profitability
When our manufacturing clients focus on reducing customer shortages, expedites and urgent orders using the MTA/DDR approach, they achieve significant growth in their sales and profit – an amount far in excess of the cost reduction potential.
Even better, with our full Roadrunner Rx Inventory Management Service, we take care of it all for you.
With Roadrunner Rx Inventory Management Service, you’ll know exactly what to order, at the right time and in the right quantities for the bottom line results that everyone wants.
Find out more about Roadrunner: Get in touch and let’s start the conversation: Contact us