What is Covered in this Article?
- The definition of lot size.
- How lot size is used in SCM-APO.
- What are some approaches to setting lot size.
- How lot sizes are often set in reality.
Definition
Lot size is one of the most important concepts in supply chain management. While doing some research I was looking for an online definition of lot size. I was disappointed in what I found, so I thought I would write a post on the topic. Let us start with the definition I developed. As this site is dedicated to software, the definition will have a software orientation or bias. It applies to SAP SCM-APO, but applies equally to any supply planning application.
The lot size is the order batch quantity which is implemented in the system to control and conform production orders and purchase orders to the objectives of the company. The lot size prevents orders from being created in non-economic quantities, and serves to batch orders. - Shaun Snapp
Finding a Good Definition in the Literature
However, it is often beneficial to check several definitions to get a full idea of a topic. Of the books I am familiar with, I like Marc Hoppe’s chapter on lot size in “Inventory Optimization with SAP,” the best.
Hoppe’s Explanation
Hoppe explains the lot size well as a trade-off between inventory management and production or between inventory management and procurement. I have a graphic below, which is a common graphic for lot size it demonstrates the relationship as two points of emphasis fighting against each other, with the best solution being somewhere in the middle.
Understanding The Basic Concept of Lot Size: A Formula of Tradeoffs
Both production and procurement incur costs per procurement order or per manufacturing order. Meanwhile inventory management incurs holding costs for inventory, and of course sales incurs a cost of a lost sale if too little inventory is carried. Because lost sales are not quantified by many companies, this cost tends to get overlooked, however it is a real cost and efforts should be made to quantify its cost. This can be as simple as having order takers enter order requests that are made but can not be fulfilled.
An additional cost which is often not considered is the transportation cost – inventory management cost trade-off. As explained in the book “Managing the Supply Chain,” larger orders incur a smaller per unit transportation cost — generally.
What is Meant by the Term “Economic” with Respect to Lot Size
Generally speaking, when different costs are used to derive a lot size, the lot size is said to be “economic.” This is only one of many ways of determining lot size. Other methods include:
- ABC Guidelines (where A items may have 1-5 days of supply, while B items may have 20 days of supply – this method is strongly financially driven)
- Manual discretion
How Lot Sizes are Often Set in Reality
Optimally, and industry is far away from optimality, the lot size – which is the order amount should be determined by the trade-offs between inventory holding costs and production and procurement costs. This is called economic lot sizes rather than deterministic lot sizes. Deterministic is a fancy operations research term meaning predictable or static.
Reality
What happens in reality is quite embarrassing, as executive compensation driven by short-term stock options promotes many companies to run with too inventories that are simply too low, often times justified by Lean consultants as a “best practice” or by various Lean initiates internal to the company. The following post describes some of the problems with the application of Lean to supply planning.
http://www.scmfocus.com/failedsupplychainconcepts/2009/11/does-lean-make-sense-for-supply-chain/
A second reason economic lot sizes are not used is because they are more complex to implement than static lot sizes. While this discussion is outside of the scope of this article, it is important to note that the academic or strictly technical approach to inventory control is not applied at very many companies.
SCM
In SCM-APO as with other supply planning applications, the lot size approach has a tremendous impact on the results of the plan. It is one of the major ways of creating order batches that are economical. I have seen several occasions where an overemphasis on configuration and detailed planning has been placed into SCM, only to have the output disaggregated by overly small lot sizes. It’s important to get the different parties on board with the lot size selected. Lot size discussions and meetings are intensely political, but they must be held. Taking say, just inventory management’s view into account in order to reduce argumentation (which I have seen done) is not going to result in a happy and accepted SCM implementation. In fact, no matter how esoteric and pliant the SCM configuration, without cross departmental agreement on the simple lot size, implementations have a serious problem with buy in.
Dynamic Lot Sizes
Because of the issues related in the paragraph above, dynamic lot sizes make a lot of sense. In fact, unless the project is quite limited in its budget, the only justification for fixed lot sizes I can see are for minimum order quantities (such as pallets) or supplier minimum quantities that are larger than the economic based lead times would recommend. This condition is far more common in service parts, so for finished goods planning, dynamic lot sizes should be the rule.
Economic Lot Sizes
The difference between economic and dynamic lot sizes can be confusing. Both are desirable. However, and economic lot size simply means that the trade offs between inventory and stock out costs and production and procurement costs have been calculated. However, dynamic lot sizes simply mean that the lot size value is changed over time. It does not mean that the lot size was quantitatively determined with any consideration for economic order quantities. The ultimate desired state is to have lot sizes that are both dynamic and economic. One perfect example of the benefit of both economic and dynamic lot sizes is in the event of price changes or temporary discount. Without the ability to have economic and dynamic lot sizes, companies either lose the ability to take advantage of temporary discounts, or must rely upon their planners to manually increase the order quantities.
Lot Size in Cost Optimization
There is a particular way that the lot size can be adjusted in the SNP cost optimizer. Not wanting to make this article too long, I have included the link to how this works in the post below:
http://www.scmfocus.com/sapplanning/2011/11/05/how-soft-constraints-work-with-soft-constraints-days-supply-and-safety-stock-penalty-costs/
Lot Size in SAP ERP and SCM
Both SAP ERP and SCM have lot size fields. Since only critical materials should be planned in SCM, all other non-critical materials will go out on the lot size entered into he SAP ERP Material Master. For those items planned in SCM, the value entered in the Lot Size Unit field of the Product Master overrule any value that is entered in SAP ERP.
Here is the tab for lot size in the SCM Product Master
However, in addition to the Product Master, lot sizes can be set in the PPM.
Fixed lot size: The SNP optimizer considers the value you specified for the fixed lot size as the minimum lot size. Every time the PPM is executed, the PPM output quantity (the output component quantity) corresponds to this fixed lot size. – SAP Help Super Advanced Lot Sizing and SNC
Conclusion
Lot sizes are one of the major master data elements to SAP SNP, and to supply planning and production planning systems generally. At a high level the lot size is a value that prevents the company from procuring or producing in quantities that would not be economic. However, there are a variety of ways of setting the lot size.
References
http://books.google.com/books?id=d9yLF6HG9asC&pg=PA85&dq=lot+size+supply+chain
http://books.google.com/books?id=v3TyIkU5aScC&pg=PA2&dq=lot+size+supply+chain
http://books.google.com/books?id=dUKGHB_YjFQC&pg=PA36&dq=lot+size+supply+chain
http://www.amazon.com/Inventory-Optimization-SAP-Marc-Hoppe/dp/1592290973
http://help.sap.com/saphelp_scm41/helpdata/en/fc/217d3cf7ffd118e10000000a11405a/content.htm
