Supply Chain Management

Here is how it works. When a consumer buys a product with a buying pattern that does not match his consumption pattern, he creates a small flutter of variability. The flutter amplifies a little as the retailer tries to translate it into his sales requirement. The already amplified flutter amplifies further as he translates his sales requirement into a manufacturer order. The manufacturer, though, sees the amplified flutter as a normal demand, and uses that to forecast his future sales, in the process doing his own bit of amplification. The end result- you guessed it- a small flutter has now snowballed into huge swings in the demand on the manufacturer. Similar to the game of Chinese Whispers, the degree of distortion of a demand signal is dependant upon the degree of variability in the input demand and the effectiveness of the transmission mechanism.

However, this is where the similarity ends. While a game of Chinese Whispers provides a wholesome source of entertainment to the players, it is seen as a costly nuisance in the world of business. Demand variability or demand swings are extremely harmful to the supply chains of the manufacturers and the retailers alike. They affect every aspect of planning, namely, capacity planning (production, storage, transportation and manpower), deployment planning and product mix planning, resulting in tied up working capital in excess inventory and unused capacity, reduced ability to react to changes in market activities and loss of revenue due to poor order fulfillment metrics or lost sales.

No doubt, demand variability needs to be tamed. In this post, we will look at how the retailer and the manufacturer contribute to this phenomenon.

Demand variability induced through retailer actions

1. Marketing triggered consumer demand variability- variation in consumption pattern or buying pattern is the genesis of demand variability. While changes in the consumption pattern can happen due to unforeseen events and can be corrected through better market intelligence and planning, changes in the buying patterns are caused due to corporate actions that aim towards increasing short term sales. When a product is under promotion, consumers react by changing their buying behavior, sometimes without corresponding shift in their consumption behavior. When the buying pattern deviates from the consumption pattern in an unsystematic manner, it becomes difficult to predict, causing demand to become variable.

Similarly, Hi-Lo pricing strategies by retailers create fluctuations in demand as consumers postpone their purchase waiting for the right deal. Lenient return policies also result in unpredictable negative demand with a timing offset.

2. Out of stock at the shelf-   When the consumer does not find a product at the shelf, due to either store out of stock or shelf out of stock reasons, it may results in consumer brand switch. Depending on the sales rate of the product, and the duration of out of stock, there is a corresponding lost sale. Lost sales cause gap in the demand pattern. When out of stocks occur frequently, the gaps in the sale make the demand lumpy and cause it to become variable.

3. Order batching and forward buys – Large orders result in higher variance. Orders larger than immediate requirements can be placed in order to reduce ordering costs, to take advantage of transportation economics or to benefit from sales incentives given by the manufacturer.
 
Also, trade promotions by manufacturers may result in opportunistic buying by the retailers. Since the resulting excess inventory provides a higher degree of forward coverage to the retailer, future orders on the manufacturer will show a deviation from the historic pattern. When the manufacturer tries to forecast their future sales using the variable pattern, it would result in higher forecast errors for the manufacturer.

4. Shortage gaming- During short supply situations, retailers know that manufacturers will resort to rationing. Rationing often happens based on fair share allocation that is in proportion to the retailer order, which means the retailer who places a bigger order gets bigger share of the available supply. In order to cover their demand, retailers try to order more than they require hoping to get at least what they really require. This provides a false picture of the true demand to the manufacturer when the short supply situation is over.

5. Lack of communication with the manufacturer- Promotions, new product introductions, product discontinuations or Plan-o-gram changes provide the highest contribution to demand variability for the retailer. When such actions are taken without the cognizance of the manufacturer, demand variability gets transmitted and get amplified in the process.

Demand variability induced through manufacturer actions

6. Sales incentives contributing to demand variability- Sales targets when applied to an extended period such as a quarter often cause demand to skew up during the end of the period causing demand to be distorted.
 
7. Independent forecasting of demand- No forecast is without an error. It is the degree of error that counts. Forecast error results from forecasting process as well as inherent variability in the historical demand. When the manufacturer tries to forecast his demand based on the retailer shipments or retailer orders, the error is further amplified with respect to the actual consumption pattern. Additionally, manufacturer’s lack of processes and capabilities to communicate with the retailers for joint planning of demand or order execution may lead to further demand variability.

8. Handling of supply issues- As discussed earlier, manufacturers contribute to demand variability through their product allocation practices during short supply situations.

The problem of demand variability is being addressed by the retailers and manufacturers, often working together, through several policy and process measures. We will discuss some of these measures in my next post.