Sourcing Strategies

ERP systems, complexity, and RIRO

Author: Adam Fletcher, Chairman of the Electronic Components Supply Network (ecsn)

Many column inches have been written over the past few years relating to supply and demand imbalance in the global electronic components supply network as the global market transitions from ‘Starvation’, through ‘Headache’ to where we are in Q1’24, the ‘Indigestion’ phase, as inventory levels peak before being consumed. In this issue of Procurement Pro, Adam Fletcher, Chairman of the UK’s Electronic Components Supply Network (ecsn) and the International Distribution of Electronics Association (IDEA) provides his thoughts on how our industry got into this mess and what procurement professionals should do now to mitigate a future recurrence, including more diligently managing their ERP systems, increasing their collaboration both up and down their supply network, and improving demand forecasting industry-wide. 

In the early 1900s, pioneers of car production revolutionised their existing small-scale assembly operations with a new idea. They instigated a moving assembly line on which one person did a single task alongside many others also doing single tasks, and thereby created the first mass production system, the forerunner of most manufacturing systems today. Then, as now, these systems were reliant on the correct mix of all necessary components (i.e. a door, two hinges, and eight bolts) being available exactly when and where needed to enable assembly of the finished cars, which were initially only available with black paintwork to maximise ‘variety reduction’. A great deal of effort was expended in ‘time and motion studies’ to determine how all elements of the assembly process could be optimised to reduce costs and increase output. Historically, manufacturing was batched in 100s or 1,000s of units but today the aim is for a batch size of one fully customised product, but this needs ultra-sophisticated computer systems to be achieved.

Enterprise Resource Planning (ERP)

To speed up and automate the replenishment scheduling process that underpins the mass manufacturing process, computer-based Enterprise Resource Planning (ERP) systems were introduced in the 1960s, replacing paper-based procedures. ERP systems have been continually refined over the years as faster, less expensive computer hardware and software became available but are still highly dependent on both fundamental mathematical formulas and on the quality of information fed into them. The failure of ERP systems due to data inaccuracies has been rife leading to the industry acronym RIRO (Rubbish In, Rubbish Out). In practice, the outcome was often ‘RIRO squared’ because computer systems don’t recognise errors that humans can easily spot and merely arrive at an outcome based on the data entered, so the speed of the output from the computer system compounded the errors in production and much rubbish was produced before human intervention eventually corrected the mistake.

Impact of changing components manufacturer lead-times

I’m concerned that many procurement professionals fail to understand the impact to their manufacturing systems of the many data feeds driving fundamental elements of modern ERP systems. The manufacturer lead-time is one such value and plays a critical part in multiple formulas within all ERP systems used for Material Requirements Planning (MRP1), Manufacturing Resource Planning (MRPII), Just-In-Time (JIT) and Lean Six Sigma (6δ) replenishment procedures. An erroneous manufacturer’s lead-time entered into a Systems Integrator/Electronic Manufacturing Services (EMS) customer’s ERP system has an exponential impact on the ‘Economic Order Quantity (EOQ)’, ‘in-house inventory’, and ‘safety stock’ calculations and has a direct impact on the quantity of components to be ordered.

For the past two decades or so procurement professionals in the electronic components supply network have been lulled into believing that electronic component manufacturing lead-times would remain low indefinitely. In the process, confirming their confidence in their organisations ability to securely operate with minimal in-house inventory, safety stock, and order cover on suppliers. As a result, they typically entered a nominal four-week lead-time into their ERP systems. In theory, organisations in the electronic components supply network should regularly update their ERP systems with the latest components lead-time information on at least a monthly basis but reviewing tens of thousands of components even at a general product category level is a time-consuming process, so it’s perhaps understandable that many organisations routinely fail to do so.

Manufacturer Authorised Distributors have been helping their Systems Integrator and Electronic Manufacturing Services (EMS) customers to keep up to date with lead-time changes by providing live updates directly into their ERP systems via Electronic Data Interchange (EDI). They are, however, acutely aware of the implications of amending such critical data in the customer’s systems and only do so in a highly controlled way and with their customer’s explicit agreement. Some independent organisations with an interest in supplying electronic components and/or IT services to Systems Integrators and EMS providers offer to ‘check and cleanse’ Bills of Materials (BOM) information, a service that they often package with lead-times updates and other manufacturing information. At best, the data these primarily Internet-based organisations provide should be considered spurious as they are apparently unaware or unconcerned about the potential impact of inaccurate/erroneous data to their customers, particularly if the outcome benefits their organisation’s objectives.

Four-to-12-week lead times?

Changing a components lead-time from four weeks to 12 weeks changes the mathematical formulas within the Systems Integrators/EMS provider’s ERP systems and can cause it to automatically believe that there is insufficient in-house inventory, in effect a ‘shortage’ situation. In response, the system can as much as triple the customer’s in-house inventory by rescheduling the existing delivery backlog, pulling forward existing scheduled deliveries by (typically) three months, and issuing further order cover increases by as much as a quarter’s average usage just to compensate. Changing the manufacturer lead-time of one or two components would be manageable but if a wholesale change is made the ERP system believes a ‘shortage’ of all classes of components has occurred, although many could be unaffected, and is just another example of RIRO.

12-to-16-week lead times?

What happens when lead times for instance, jump from 12 weeks to 16 weeks? The cycle repeats until at about 26 weeks the components manufacturer becomes unable to meet what is, in reality, mostly ‘fictitious’ demand and refuses to accept any further orders and, as organisations frantically search for alternative sources of supply on which to place their orders, considerably exacerbates the perceived restricted supply situation

A vicious circle

The potential risk to Manufacturer Authorised Distributors as result of increased components manufacturer lead-times is that many of their customers will react at the same time to increase their immediate demand and future backlog, which in turn means they need to increase their order backlog on the components manufacturer and pull forward the deliveries on their existing orders in a bid to ensure that they are able to meet the increased customer demand. As a result, inventory moves from the manufacturer of the component(s) to their authorised distributor – where it is held centrally and available to service the actual requirements of many customers – to the warehouses of the customers who reacted most quickly to ‘defend’ their position. Played out internationally, this vicious circle triggers a huge spike in demand for components manufacturers, which reduces their available manufacturing capacity and in turn, further extends the lead-time for new orders.

The outcome

The global electronic component supply network is now slowing following three years of strong growth, much of which in my opinion was predicated on the ‘fictitious demand’ created by customers’ ERP systems as they sought to secure more inventory than was really required. There are two primary reasons for this failure: the first, and what I believe has caused much of the ongoing disruption, is procurement professionals in many organisations reacting to reports in the media and via their supplier meetings of lead-times changes and potential shortages, and simply updating their ERP systems with the latest electronic components manufacturer lead-time information electronically – i.e. automatically – without considering the impact that the change will make to other data held on their MRP system. Secondly, faced with uncertainly of supply and their ERP systems ‘fictitiously’ highlighting components shortages and demanding stock, some procurement professionals attempted to secure supply by placing multiple orders for the same requirements on multiple suppliers. Both activities had the effect of obscuring the real market for many millions of electronic component types and created a very expensive ‘artificial demand bubble’ for electronic components that can only jeopardise future investment in manufacturing capacity. It all could very easily have been avoided.

Concluding thoughts

Despite the current vastly inflated inventories across the global electronic components supply network, I expect that sporadic shortages of a small, but ever-changing number of specific components will continue. It happens in every industry cycle and this one will be no different. Pundits believe that stronger underlying ‘real’ growth will not return to global electronic components markets until 2025. In the interim it is important that procurement professionals and their supply network partners take time to consider ways to drastically improve their organisation’s ERP systems and regularise their information updates and their demand planning. As we move into 2025 and beyond, I encourage all organisations dependent on our industry to play their part in its continuing success and help mitigate future supply and demand imbalances by collaborating up and down their supply network. Industry collaboration initiatives such as accurate and timely requirement forecasting costs little, but the improvements they make to an organisation’s competitive advantage promises much for them, their business partners in the supply network, and the wider economy.

This article originally appeared in the May issue of Procurement Pro