Learn about the circumstances that support a made-to-stock production strategy vs. a made-to-order strategy.
Too Much or Too Little
When you think about the different growth stages of a hardware startup, it seems like the most challenging period would be the design phase. You’ve got to do research, coordinate with potential customers, and develop a viable, functioning prototype. Pretty hard work, right? Indeed, but it is this very perspective that causes entrepreneurs to underestimate what is perhaps an equally challenging phase of growth: manufacturing and production. This not only means bringing your idea to life in a scalable way, but producing the right amount of your product as well.
Although making the right amount of your product may sound relatively simple, rest assured that this is not always the case. Producing too much product causes your inventory expenses to skyrocket. If you’ve made updates to newer versions of your product, you may have to sell older excess inventory at a discount just to get it off your shelves. On the other hand, if you produce too little of your product, you may be unable to fulfill customer orders on time. If you have close competitors, you may even miss out on sales altogether. And of course, if your customers have a poor experience ordering from your company, it’s unlikely that they will return and give you a second shot.
As such, manufacturing companies must strategically implement the best production strategy for their specific business model. If you’re involved in production at any point in the value chain, there are two core production strategies that you should know: 1) make-to-order and 2) make-to-stock. We’ll walk you through what each strategy entails so you can ultimately decide which one is best for your business.
Make-to-Order Production Basics
If your company uses a make-to-order (MTO) approach, that means production is only triggered upon receipt of a customer’s order. It’s best to use MTO production if your product cannot be inventoried, or if your product is highly customized. This is also a good strategy to use if prices seem to be declining, if your lead time is pretty quick, or if customers are willing to wait for your product. According to Investopedia, this type of manufacturing strategy is also called a pull-type supply chain operation. The reasoning behind this is that products are only made when there is firm customer demand. This kind of model is often used with assembly operations, when the quantity needed to be produced per product is only one or a few. More specialized industries like construction or aircraft production tend to use this approach. The same goes for companies making complex products, like automobiles or computer servers, that are hard to keep in inventory.
Naturally, the MTO approach generally means that your customers will wait longer to receive their orders. Though this can be seen as a downside, most customers will be relatively understanding if your product involves elements of customization or personalization. When this is the case, customers know that they aren’t able to get what they want straight off of a retailer’s shelves. Thus, the major advantage of MTO is that you can fulfill a customer’s order with their exact product specifications. Additionally, sales discounts and finished goods inventories are reduced, and you can better manage stock obsolescence. Dell Computers is an example of a company that uses the MTO approach – customers can order a fully customized computer online and receive their order in a couple weeks.
Keep in mind that if you’re going to use MTO at your company, you need to pair it with formal demand forecasting. This production strategy is not for everyone, and there are a few of drawbacks associated with this approach. First is timeliness: customers have to wait longer when you begin production once they place their order. Second is the cost of customization. It’s tough to achieve savings from economies of scale when your products involve customizable parts and unique finishes.
Make-to-Stock Production Basics
When using the make-to-stock (MTS) approach, companies produce without waiting for a customer order. They store finished goods and inventory in stock or in an off-site warehouse so they are ready for customers when they want them. It’s a good idea to use the MTS approach if your products are standard and don’t involve much customization. In some cases, MTS is also appropriate if your product requires significant set-up time or capital investment, such that constantly starting and stopping production is not cost-effective. In other cases, your customers might not be willing to wait. If your production process is long, MTS may be a better approach for your business.
As explained by Investopedia, MTS offers a way for companies to anticipate and prepare for variations in customer demand. In fact, the core of the MTS approach lies in the ability to create demand forecasts based on past data to inform inventory and production targets. If your forecast is off, you risk having excess inventory…which means extra costs. Inaccurate forecasts can also lead to stock-outs, revenue losses, or older inventory becoming obsolete. Additionally, if you use an MTS approach, you may have to redesign operations depending on specific times, as opposed to maintaining steady year-round production. These kinds of regular adjustments can end up costing you.
Manufacturing companies often lean towards the MTS method because it can help them prepare for periods of high production. For example, consider a large retailer like Target. They typically generate the majority of their revenue in the last quarter of the year (around the holiday season). As a result, the manufacturers that supply Target with its inventory have to align their production schedules to produce the majority of their outputs in the second and third quarters of the year. They stock their inventory in preparation for what they know will be a significant increase in demand, instead of simply producing an order once Target makes the request.
Production Strategy Matters
No matter how small your startup may be, your production strategy is a critical element of your business. Not only does it impact your customers, but it will also inevitably translate to your bottom line. Think holistically about your business model, the nature of your product design, and the value proposition that you’re promising to your customers before making a decision about what’s right for you.