Optimization of supply chain performance is always a target for improvement in manufacturing organizations. Theories abound regarding how to minimize inventory and improve supplier performance. Often these initiatives focus on changes within the manufacturer's four walls and underestimate the supplier's willingness to participate in the improvement.

Using a unique approach to vendor-managed inventory and consignment, Hennessy Industries, a Danaher company that manufactures after-market wheel service equipment, and Fastenal, an MRO distributor, formed a cross-functional team. The team objective was to focus on positioning both organizations to better meet the increased demands of corporate executives and shareholders for streamlined operations and reduced costs. We call this approach "pay-on-use."

In this program, vendor-managed inventory takes the form of material delivered directly by the supplier into stocking locations called "Grocery Stores" in the manufacturing plant. The material is not routed through conventional receiving and goes directly onto the shop floor. When needed by manufacturing, material is moved from the grocery store to point of use and finished goods are manufactured.

At the time the finished good is moved from the manufacturing plant into the distribution warehouse, a multilevel back flush executes. This generates usage transactions for the supplier material used in the finished good. This usage is summarized daily and receipts are generated automatically within the ERP system. At this point, the inventory ceases to be consignment and is transitioned into finished goods inventory. However, since the inventory balance is never greater than zero on the raw material, the impact on inventory turns and working capital is profound.

There is no need for the supplier to generate packing slips or perform secondary packaging, no manual receipts are required, and the material is stocked directly by the supplier. In turn, shop floor overhead is decreased — all because the inventory is owned and managed by the supplier.

Weekly invoices are created for all receipts generated during the prior week and the data is transmitted to the supplier via an EDI transaction. The supplier receives the transactions, which include product number and quantity. The transactions are accepted directly into the suppliers billing system. This keeps accounts receivable clerks at the supplier site from time-consuming data entry and likewise for accounts payable clerks at the manufacturing facility.

More than 100 hours will be saved this year by eliminating manual transactions. Inventory is always zero for these products and the product "wait-to-work" ratio is 0:1. In addition, there has been an improvement in working capital and inventory turns. The supplier sees a leveling of demand, reduction in time to customer and a secure business relationship has developed between the companies.

Overall there has been a dramatically improved level of service and the two companies are reaping the benefits of a true business partnership. Pay-On-Use has strengthened an already strong supplier relationship and positioned both companies for future growth.