Make to order or make to stock?

Why talk about distributing inventory all the way to the point of sale at all? Why not simply take orders, make the product, and deliver? Why make it in advance, block working capital in it, and risk damage, obsolescence and write-offs?

Think about two things you buy. When you buy toothpaste, you take it off the shelf. When you go out for dinner, you expect your food to be cooked fresh after you order. For toothpaste, ready stock is a must; you won’t wait for a tube. For dinner, you’re happy to wait, and ready stock isn’t wanted at all.

Two kinds of companies

Every company works in one of two modes:

• Make to order (MTO): it makes and supplies only after receiving an order. Nothing is sold from stock, by design.
• Make to stock (MTS): it makes and stocks finished goods in advance, then supplies against orders.

From the company’s point of view, everyone would prefer MTO: no capital blocked, no risk. From the customer’s point of view, it’s a no-brainer: everything should be available right now, so MTS. Given this tension, why can some companies work to order while others must keep stock?

The two times that decide

The mode is set by the interplay of two times:

• Customer tolerance time: how long the customer is willing to wait.
• Supply lead time: how long it takes to take the order, make the product and deliver it.

When customer tolerance time is longer than supply lead time, a company can work to order. When it’s shorter, the company has no option but to work to stock.

For toothpaste, tolerance is almost zero, and getting a tube made after you ask would take far longer. So stock must be on the shelf. At a restaurant, you’re willing to wait for fresh food, so the kitchen can work to order.

But isn’t it really about the industry, the price, or the product?

It’s tempting to think so. Let’s test each one.

Industry. Buy a mass-market car in a standard colour and you expect it to be in the dealer’s yard; in smaller towns, people drive out of the showroom the same day. Ask for an unusual colour, and you wait. Buy a Rolls-Royce, and it is built after you order. Same industry, both modes. Industry doesn’t decide.

Price. A branded readymade shirt costing two thousand rupees or more is sold from stock. A daily wage worker who buys shirt fabric and has it stitched by a tailor waits a few days, and pays less. The cheaper shirt is made to order; the expensive one is sold from stock. Price doesn’t decide either.

Customisation. When the customer wants something made to their own specification, the product won’t be sitting ready, so they wait. Buy jewellery: many designs are available off the shelf, but a piece made to your taste takes time.

What drives tolerance time, then? Mostly competition and technology. In the 1990s, people took half a day off to withdraw cash at a bank counter; after ATMs, nobody likes queuing outside one. In the licence-raj years, a popular scooter had a waiting list measured in years; once competitors delivered the same product quickly, waiting periods vanished and it became available from stock. As competition rises, businesses converge towards making to stock.

A company can switch modes

You’ve had a meal at a quick-service burger chain. Does it work to order or to stock? You order, the order appears in the kitchen, the food is prepared, and your number flashes on the screen. Make to order.

But at peak hours, the kitchen can’t make everything within your patience; demand outstrips capacity. So before the rush, it makes some of the fastest-selling items and keeps them ready, freeing capacity for the extra demand. Now it works to stock for the fast movers and to order for the rest. To keep food fresh, there’s a strict rule to discard anything unsold after a set time.

To serve customers well, the same business shifts between the two modes as the situation demands. Once a business holds stock, a new question takes over: how much, and where? That’s the distribution problem, in the next lesson.

Check your understanding

Answer all five. Get four right to complete the lesson.

1. A company must make to stock when…

• Its products are expensive
• It is in the automobile industry
• Its forecast is accurate
• Customer tolerance time is shorter than supply lead time

Only these two times decide.

2. A mass-market car maker sells from stock while a luxury maker builds to order. This shows that…

• Cheap products are always from stock
• The industry doesn’t decide the mode
• Luxury buyers are impatient
• Cars are always made to order

Same industry, both modes.

3. A tailored shirt is cheaper than a branded readymade one, yet is made to order. This shows that…

• Price doesn’t decide the mode
• Tailors are slow
• Readymade shirts are made to order
• Customisation never matters

The cheaper item is made to order; the expensive one is sold from stock.

4. What mainly pushes businesses from making to order towards making to stock over time?

• Higher prices
• Government reports
• Competition and technology that shorten what customers will tolerate
• Larger warehouses

ATMs, faster competitors: tolerance falls.

5. A burger kitchen makes fast-selling items ahead of the lunch rush. It is…

• Always make to order
• Always make to stock
• Breaking food rules
• Switching to make-to-stock for fast movers when demand exceeds capacity

One business, both modes, depending on the situation.