On the challenges and opportunities of implementing lean practices in northern Italian manufacturing districts

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1 On the challenges and opportunities of implementing lean practices in northern Italian manufacturing districts Luca Zeppetella, Elisa Gebennini, Andrea Grassi, Bianca Rimini Dipartimento di Scienze e Metodi dell Ingegneria, Università degli Studi di Modena e Reggio Emilia, via Amendola 2, 42122, Reggio Emilia Italy (luca.zeppetella@unimore.it, elisa.gebennini@unimore.it, andrea.grassi@unimore.it, bianca.rimini@unimore.it) Abstract Purpose The study analyses the challenges of the implementation of lean practices in some manufacturing districts of northern Italy. Lean practices aim at waste reduction and quality improvement in order to eliminate anything that does not contribute to the creation of value for the customer. In particular, owing to the highly fragmentation of customer demand which occurred in past decades, the economic sustainability is directly linked to the reduction of inventories and cycle times along the whole supply chain. This is truly relevant and challenging in those manufacturing districts that have been developed in the last years to exploit economy of scale. This strategy has led to a growing trend of outsourcing and, consequently, to the lengthening of supply chains. Longer supply chains result in longer cycle times and higher inventory levels that cannot be reduced by simply exploiting the overcapacity resulting from the current reduction of customer demand. Thus, it is necessary to identify the main economic, operational, and organizational factors characterizing these districts and relate them to the challenges and opportunities of implementing lean practices. This analysis emphasizes the need for some coordination mechanisms and the implementation of lean practices, not locally, but on the whole supply chain. Design/methodology/approach A survey instrument is developed to evaluate the implementation of lean practices within typical business structures characterizing northern Italian districts. These business structures are characterized by a number of economic, operational, and organizational factors that affect the supply chain and, consequently, the customer cycle times. These business factors (e.g., outsourcing policies, business size, technological constraints, economy of scale, overcapacity, ICT pervasiveness) are here identified to support the analyses of the possible advantages and challenges coming from the implementation of different lean practices. Originality/value The assessment seems helpful to clarify the advantages of lean practices in some manufacturing districts of northern Italy. These advantages will help the Italian districts to ensure their economic sustainability in a context where customers require short cycle times, high customization, reduced costs and firms look for low inventories. This exploratory study illustrates the factors that could influence the implementation of lean practices and the extent of their impact is highlighted. Keywords: Economic Sustainability, Lean Manufacturing, Supply chain, Cycle-time, Response Time 1.Introduction This exploratory study focusses on the manufacturing context of the northern Italy. Like the whole western economy these districts are not facing a temporary shock that will quickly pass, but in fact are on the verge of an era of turbulence, that will feature higher variance in key business parameters: from energy cost, to raw materials, and currency exchange rates (Christopher, 2011). Moreover, in turbulence conditions the Supply Chain Management (SCM) practices, which emerged during a period of relative stability, become inadequate. Turbulence means that the market conditions in which many companies find themselves are characterized by volatile and unpredictable demand; hence, there is an increased urgency of the search for agility and sustainability (Christopher, 2000). The sustainability is one of the main aims of the actual organization. However, the economic

2 sustainability is vital to realising any sustainability (Factories of the future 2020) and it necessarily will require a re-design of products, production processes and organizations relationship according to the new market conditions. The European Strategic Research Agenda (SRA, 2005) underline how Small and Medium Enterprises (SMEs) should be capable of continuous, rapid and smooth adaptation of their operations, management and strategies in the continuously changing industrial environment. On one hand this can be true at the company level, in fact, their small and flexible dimension could help this adaptation, but till now the great innovations at Supply Chain (SC) level are usually come from big companies due to a greater power in the SC. The SRA 2005 has already shown that SMEs certainly represent one of the strongest assets for Europe in maintaining sustainable competitive advantage against the emergent competitors. Our study focusses on the districts of northern Italy that in general represents the 55.2 % of the 2011 Italian Gross Domestic Product (GDP) and, in particular, on the SMEs of the Emilia Romagna. These firms constitute the 8.9 % of the 2011 Italian GDP (I.stat). The districts primarily involved mechanical, then plastic injection, food, textile and footwear industries. The mechanical sector is mainly composed by packaging machines, motorcycles, machine tools, industrial automation, food machinery and agricultural machinery. The district in question actually bases its livelihood on the exportations, mainly to Asia, USA, Germany and France (Istat, 2012). Furthermore, last year the export to Brazil and Africa had considerably increased. This study underlines the increased variability of the manufacturing environment of the districts of northern Italy, and in particular, it focuses on an exemplifying aspect that is the increased cycle time due to the batch size and inventory levels reduction. The extension to other variability factors is clearly necessary and could lead to an holistic analysis of the SCs of the districts. Other aspects that really influenced the variability are connected to, for example, the business size, the technological constraints, the pursuit of economy of scale, the over-capacity and the ICT pervasiveness. Thus, it is necessary to extend the identification of the main economic, operational, and organizational factors that affect the variability and relate them to the challenges and opportunities of implementing lean practices. 2.The districts context The past decades were a period of relative stability. In fact, the customer demand was characterized by a limited level of customization. Hence, the volume of production for each single finished product was quite high and smooth. Throughout this study we correlate this context to the emerged structures of the SCs and we also argue why they are now inadequate. Nowadays the market conditions are very volatile: the customers require highly customized products and with shorter lead times. Hence, the volumes of production are lower and it is necessary a very high coordination in order to respect the required customer lead time. Moreover, the global competition has led to a situation of high risks on the SC. In summary, firms deal with a high inbound variability coming from the external environment. 3.Centrality of the cycle time Nowadays the reduction of the cycle time seen by customers is a key aspect. The response time has become a customer decision driver like cost and quality. In the current context of high global competitiveness, it is also necessary to achieve high service level performances. This objective can be achieved focusing on cycle time and the strategies that affect it. On the other hand this hinder the objective of the cost reduction, hence, a tradeoff is essential. With the current level of variability to obtain short response time is difficult, but it is also harder to obtain efficiently. The aim of the study is to promote the investigation on the decisions that influences the cycle time and that were justified by the market context. Hence, illustrate how the changed conditions have made those decisions no more sustainable. In particular, we limit the analysis to the aspect of the inventory level (Work in Process - WIP) throughout the SC related to the batch size and the setup time. 3.1 Implication of current structure on the cycle time During the period of relative stability of the past decades the district in analysis had accepted to store inventories in a great amount and at every stage of the SC. This was justified by stability. The demand was high and smooth and it involved a not so wide range of products (involved a low level of customization). Moreover, the risk of obsolescence is quite low and the organizations among the SCs did not perceive the risk of unsold products. In the past, the actors among the chain also did not need to squeeze their profit and the mark-ups allowed to keep high level of tangible assets in the warehouse. In fact, before the financial crisis, the liquidity risk was very low and firms could easy gain a bank credit. Hence, the advantage of high WIP along the chain allowed the firms to satisfy the customer demand quickly. In this context, usually addressed as the period of the mass production, the strategic decisions naturally led toward investments in rigid and reliable production systems. In fact, the high inventories gave the possibilities of distributing high setup times among a large batch size, so few change-overs were acceptable. This phenomenon was reinforced by the use of the MRP control systems that inherently led to economic lot size policies. MRP is a push system, it controls throughput and observes WIP, but controlling WIP is preferable, since WIP is a robust parameter, while throughput is a sensitive one. In other words, pull systems require a lower level of WIP to reach the same throughput. Thus, controlling the cycle time and implementing WIP control mechanisms become essential. Moreover, by applying Little s law, we can assess that a pull system has an average cycle time that is smaller than the one of a push system. Little's Law assess that, under steady state conditions, the average number of items in a queuing system equals the average rate at which items arrive multiplied by the average time that an item spends in the system (Little et al,. 2008).

3 In the past decades storing inventories at every link of the chain mean that the cycle time seen by the customer could be evaluated applying the Little s Law just at the last link of the chain. Nowadays, in a context in which no one want to keep inventories, and also the high customization makes it impossible, the customer had to wait the cycle time related to the whole chain. In other word the Little s Law must be applied to the whole process. Hence, during the last decades the organizations had focused on the design and production of small portion of the final product. The effect was a district composed by a lot of SMEs with high expertise and deep know-how. Thus, the SCs were usually characterized by: long chains composed by many actors, geographical proximity and long lead times. Evidence of this structure can be also found analysing the square root law of locations. This law asserts that the total inventory in a system is proportional to the square root of the number of locations at which a product is stocked (Maister, 1976). It usually reinforces the discussion about the need of centralized inventories. However, from a different perspective, given the possibility to have a high level of inventories, due to the previous dissertation, this law can justify the extensive use of the outsourcing and the great number of inventory locations. In summary, in the past decades the possibility of bearing complex supply chains gave several advantages to the districts and the customers. In fact, (1) high service levels were guarantee by the inventories, (2) the pursue of economy of scale had reduced the production costs, (3) the fragmentation led to an high expertise and (4) every link of the chain gained satisfying margin. According to the literature the trends toward outsourcing and global sourcing have created more complex and fragmented multi-tier supply chains (Christopher & Peck, 2004; Harland, Knight, Lamming, & Walker, 2005). It is long been recognized that the length and complexity of supply chains can have an impact on economic indicators of performance, such as responsiveness and resilience, but also cost and quality (Choi & Krause, 2006; Christopher & Peck, 2004). Thus, the trend toward outsourcing has really been mining the economic sustainability of the manufacturing districts of northern Italy. 3.2 The cycle time reduction in the turbulent context Zero-stock principles The zero-stock ideal sparks from the necessity of reducing the stock in order to avoid some problems emerged in the last decades. Nowadays the high risk of obsolescence, the high inbound variability coming from the external environment and the high liquidity risk have made the stock a very risky aspect, and indeed one in the chain would keep it. However, we consider that this could be seen just as an ideal trend. In fact, in a system characterized by variability can t work without stocks at all, therefore we prefer to translate the zero-stock concept in the idea of keeping inventories as low as possible in regard to the variability. In recent period, the academicians are deeply interested in the principles of lean/agile manufacturing and the principle of the onepiece-flow. The northern Italian districts have also shared this interest, in order to find a solution for their actual problem of inventory levels. As a result, the final assemblers of the chains are increasingly implementing lean principles obtaining the reduction of the stocks but forcing their supplier to keep higher inventories. This is a crucial point; in fact, the supply base is in great difficulties also for this reason Overcome the batch size policies The first step toward the reduction of the level of inventory could be represented by the reduction of the batch size and more frequent production change overs in order to be more aligned with the customer demand. Hence, an increased impact of the setup time on smaller lots is indeed the negative consequence. From the customer point of view the decision of reducing the batch size and keeping low inventories is revealed in an increased customer lead time, in fact, even if the production lead time was comparable, a greater part of that time has be seen by the customer. Furthermore, managing the supplying processes in an adequate way becomes a vital aspect for the sustainability in this strategic framework Increased Variability We introduce these variables: - te = mean effective process time - σ e 2 = variance of effective process time - c e = coefficient of variation of effective time - t o = mean natural process time - σ o 2 = variance of natural process time - t s = mean setup time - N s = average sequence length of jobs - c a = coefficient of variation of inter-arrival time - r a = arrival rate - u = utilization. Without loss of generality, limiting the analysis to the setup aspect, the average effective processing time characterizing a system can be computed as follows (Hopp et al., 2011): By assuming a constant value for t o and t s, as N s decreases the effective processing time t e increases. Even if the reduction on N s is forced by the current customer demand reduction, it could also offer the opportunity of levelling the production in order to be more aligned with the demand. As a result the system is more responsive and the internal variability is reduced. We can assume, for the sake of simplicity, that the difference between the two environments consist of a reduced value of the average sequence length of jobs between two setups (N s reduction) and an increment in the coefficient of variability in jobs inter-arrivals time, due to the hysteric demand of the present days (c a increase). The utilization can be evaluated as follows (Hopp et al, 2011): (2) Owing to the customer demand reduction of the last years, the arrival rate r a is experienced a reduction, (1)

4 therefore, nowadays, the utilization of the system is far less than in the past. Hence we can assess that in the current situation there is a general overcapacity installed. A SC can be figured as a queue system. Hence, a comparison between a SC of the past context and a SC in the current context can be done through decomposition with a G/G/1 queue model (Subba R., 1992). We also consider a G/G/1 model because it takes in consideration variability, utilization and mean time in an immediate way. Given the cycle time in queue formula in a G/G/1 model (3) (Kingman s equation) and considering that the coefficient of utilization decreases, the queue cycle time should decrease. Therefore the firms should satisfy quickly the demand than in the past, but at the moment the systems are not designed to exploit the overcapacity. In particular, c a is an increasing exogenous parameter, so the firms should reduce the cycle time reducing the effective process time t e and its internal variability, c e,. Along the SC it could be possible through coordination and integration mechanisms. If we also consider the effective process time formula (1) every strategy towards the reduction of the setup time is positive in any case. Moreover the lean principle of the continuous improvement should be applied in order to make improvements and eliminating waste, for example through the product and process design, the so called 3P, Production Preparation Process. 4.Strategies and Opportunities 4.1 Economic sustainability The qualitative analysis illustrates that in the current conditions long supply chains are no more sustainable and they actually threaten the economic sustainability of the firms of the districts. Hence, the study of possible alternative strategic orientations becomes necessary. In fact, in the Italian and European economy the importance of the northern Italian districts is not in question, so, preserving its continuity should be a strategic aim for both the academician and the practitioners. 4.2 Flexibility (3) The high variability could be faced by increasing the flexibility and it can be achieved through the postponement practices or an increased speed throughout the SC. Postponement is defined as the practice of moving forward one or more operations or activities to a much later point in the supply chain (Beamon, 1998; Naylor et al., 1999; Van Hoek et al., 1999). In general, it is nowadays common to distinguish three type of postponement: form, time and place (Van Hoek et al., 1999). In this practice is necessary to declare a strategy about how many steps to postpone and which ones (Beamon, 1998). The second approach refers to the possibilities of reducing the lead time eliminating some source of rigidity. This principle has led to the idea of the Quick Response Manufacturing (QRM) (Suri, 1998) and the development of new production tools and techniques in order to increase the production flexibility. For example the need for large batch size in the traditional steel making facilities has been overcome by the developing of minimills. The general lower and hysteric customer demand led to a low utilization of the installed capacity, so the organizations have usually a overcapacity. Hence, they should not look for efficiency but for flexibility. In fact, usually, the variability can be buffered with overcapacity, with inventories, or accepting larger waiting times, but in the current environment the rigidity of their manufacturing systems makes the overcapacity useless for that aim. 4.3 Towards in-housing Nowadays, multi-tier supply chains negatively impact economic indicators of the firms of the districts. Without the protection owing to the inventory, the firms, pursuing their local optimization, mine the whole SC optimization and increase the risks. Therefore, in order to guarantee their own quality to the customer the organizations need a greater control on the processes of their suppliers. Moreover, not only managing the supplying process is more crucial than in the past but also the presence of international suppliers makes this task harder. These reasons justify the recent change in trend from the outsourcing to the in-housing. 4.4 Physical integration Throughout the study has been highlighted the importance of well managing the supplying processes in order to keep under control the increased risk associated. The principal strategic opportunities are represented by the integration owing to shared information and physical integration. In the international firms the Information Technology (IT) integration is a mature reality. Several studies have investigated this aspect and its extension, for example Samaddar et al., (2005). Nowadays, according to the ERP diffusion, the information sharing is not limited by technology but mainly by the personal inclination of the management. In particular, SMEs of the northern Italian districts already believe that keeping information is a leverage of power, thus, in general, they are reluctant in sharing information. Therefore, sharing information could be the first step and it could lead to the application of other physical integration theories, such as Vendor- Managed Inventory (VMI). Several studies has been focussing on variations of this model, Braglia et al,. (2003) proposed an analytical model for the VMI with consignment policy, while Zanoni et al,. (2012) provided a VMI with consignment considering learning and forgetting effects. The consignment stock inventory policy could also offer economical and logistic benefit to the SC as described by Battini et al., (2010). Moreover, Persona et al., (2005) provide a relevant study about the effect of obsolescence on the consignment stock inventory policy.

5 4.5 Control mechanism With increasing competition, manufacturers are placing greater emphasis on the efficient control of their production systems to improve performance (Subramaniam et al,. 2009) and some manufactures have successfully reduced their inventory levels and lead time through the implementation of the Kanban control system. However, this system born in specific automotive sector presents several limits when applied in other manufacturing sectors. In particular, Hall (1981) observed that Kanban is intrinsically a system for repetitive manufacturing. It will not work in a shop controlled by job orders and for this reason MRP remains the most common control system. The districts should investigate the possible sustainability and capability in implementing alternative mechanisms based on WIP control or alternative forms of integration, such as collaborative forecast and join problem solving. Muris L.J. et al., (2010) provide an interesting literature review regarding variations of the kanban system, in which the author lists more than thirty adaptations emerged till 2002 and concludes that kanban system has many desirable characteristics, but is not appropriate to the new productive organization needs. Spearman (1990) proposed a pull based production system called CONWIP (Constant Work In Process). CONWIP appears to share the benefits of kanban (e.g., shorter flow times and reduced inventory levels) while being applicable to a wider variety of production environments. Framinan et al (2003) provide an integrated review of the technique. Two interesting variations are Synchronized CONWIP (Takahashi, 2005) and m-conwip (Germs et al, 2010). According to Ovalle et al. (2003) that suggest that the utilization of CONWIP in SCM contexts could be a source of potential benefits in the near future, we consider the application of the CONWIP control policy to the supply chains in variable environments an extremely interesting extension. Suri (1998) proposed a different production control systems: POLCA (Paired-cell Overlapping Loops of Cards with Authorization) production control system. POLCA is particularly suitable for make-to-order and engineered-to-order production environments. An interesting adaptation of the POLCA mechanism is the Generic POLCA (G-POLCA) described by Fernandes et al (2006). 5.Conclusion In summary, the study illustrates the importance of rethinking the current SCs in order to overcome the problem due to the turbulent context in which the SMEs of the northern Italy compete. In fact, the reduction of the customer cycle time and the achievement of high service levels could be reached by exploiting the overcapacity installed. It will be possible only through flexibility, coordination and integration. From the idea of supporting the economic sustainability of the district of northern Italy, the association of the entrepreneurs of Reggio Emilia (UNINDUSTRIA) has decided to support a research project on the implementation of lean practices among the supply base of the district of Reggio Emilia. The aim of the project is to develop tools that would support the firms in decision making in a rapidly changing environment and potentially to provide a validation of the lean/agile advantages in the Italian SMEs. The success of the project is strictly connected to the capability of approaching the lean principles more scientifically and making them more suitable for practitioners. Developing adaptation of lean techniques and providing tools helpful in simulating and predicting economic impacts owing to the implementation of lean practices could be a source of advantages for the district. 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