Managing On the Other Side

by Dave Garwood

Visualize the supply chain for any goods or service. Demand starts at the top with the ultimate consumer and drives down to the supplier of raw material, along the way passing through retailers, distributors, manufacturers and suppliers. Supply, on the other hand, starts at the bottom, increasing value at each step, before reaching the consumer.

The focus of Supply Chain Management is to simultaneously reduce total costs in the entire chain and make the whole process more responsive to customers' needs. Making supply equal demand at every stage in the chain is critical.

Where, though, has our primary focus been? In most cases, on the supply side of the equation. The old paradigm was, "We manage supply, but demand just happens." Demand has remained a wild card. We've traditionally accepted wild demand variations as a way of life because demand comes from customers and, "we can't control our customers." The new paradigm is we must manage both supply and demand to have an effective, competitive supply chain.

Before you zone out, this isn't an article about getting an accurate sales forecast. This is an article about managing the variation between planned and actual demand. When actual demand is compared to the plan, variations are common. Our goal is to make supply equal to demand. This means we want to make what the customer wants, deliver it when the customer wants it, sell it at a price the customer is comfortable paying and still make a buck! If we have that likely demand variation, what are the alternatives to keep the equation equal?

1. Build inventory to buffer the variations. This works fine as long as we are willing to have large sums of money tied up in products sitting in a warehouse somewhere. It also works only if you inventory the right items -- the items the customers eventually want to buy. Realistically, that often doesn't happen. If we knew what the customer wanted, we wouldn't need to build inventory in the first place. And the hidden costs of moving, storing, tracking, etc. are huge!

2. Vary the customer lead times. Explain to customers that they ordered at the wrong time! Make them wait until the product is available. This may be an open window of opportunity for your competitors.

3. Flex the supply up or down every time demand goes up or down. This may work sometimes, but it can be very costly or impossible to flex the supply enough if the variations are significant.

4. Eliminate the demand variation. Teach the customers to read our forecast. Right! Demand variation may be reduced, but eliminated is a pipe dream!

All of these alternatives have significant downside consequences. The best strategy is a fifth alternative --simultaneously minimize demand variation and develop the ability to flex the supply within reasonable limits. Now let's look at minimizing the demand variation.

Reducing Demand Variability: A Quality Issue

Think of demand planning as a "process." The quality revolution left some valuable lessons to help minimize variation in any process -- including demand planning.

Lesson 1: Defects, defined as variation outside acceptable limits, are not inevitable. Plan to have defects, and you'll get them! An essential paradigm shift here is that both actual supply and demand can be managed, i.e., brought within a reasonable expectation of the plan.

Lesson 2: Every process has variability; therefore, expect actual sales to be above and below the plan. What is an accurate forecast? If given truth serum, I suspect we would say actual sales equal the forecast. It will never happen. No wonder sales people often run for cover when asked to participate in the forecasting process, especially when we measure forecast "accuracy."

Lesson 3: Variation is costly! Reduced demand variation translates into higher customer satisfaction, which means greater profits. It also means sales has more time to sell and spends less time doing damage control.

Lesson 4: A proven process exists to eliminate defects. First, establish a plan, the desired outcome; in this case, the demand plan. Then, measure actual performance; in this case, actual sales. Establish acceptable tolerances; in this case, an anticipated range around the demand plan. If actual demand is not within the range, determine the root causes for the excessive variation, brainstorm solutions and assign responsibility for corrective actions.

Once demand is under control, tighten the "tolerances." Continuous quality improvement, not accuracy, is the goal. Quality of the plan is defined as the number of items where actual demand falls inside the tolerances, not right on the plan. Finding root causes and taking preventive action is the key to getting demand plans under control. Most companies tell us that demand is uncontrollable, because customers are uncontrollable. But in almost every case we examine, many of the wild swings in demand are, in fact, self-inflicted wounds. Often, it's a communications weakness in the supply chain. Sales promotions, quotes or new marketplace activities don't get communicated. Lot sizing can send a cascading message down the chain. The consumer buys one, the store orders a dozen, distribution orders a gross and the factory produces an "economical" truckload quantity. And then no more orders for several months!

Other examples of root causes include financial pressure for end-of-the-quarter sales pulls demand from future months into the current quarter or multiple forecasts. Manufacturing has their forecast, which doesn't even resemble the plan from Sales & Marketing. And Finance doesn't use either plan. Which one do we measure and manage? These steps worked to eliminate defects in the factory and will work to minimize demand variation as well.

Can we bring the demand process down to zero variation? Of course not. We can, however, get the demand plan under control, that is, a predictable variation. Many of the companies we work with report excellent immediate results by virtue of the fact that, for the first time, they are looking at demand planning as a process, rather than a force of nature. Just by eliminating our self-inflicted wounds, we take many of the wild swings out of the demand process. Remember, "defects" are not inevitable, even in demand planning!