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May 26, 2009

Resolving the puzzle of achieving Higher Service Levels and Lower Inventory Levels through Faster Demand Sensing!!

I had talked about how to do forecasting during recession in my earlier blog here. During my discussions with end users the common feedback has been that frequent forecasting can help in faster sensing of demand, it doesn’t help in reducing inventories. Some of the most common questions emerging from end users on short term frequent forecasting are –  

• How to deal with lead times which are longer than the forecasting period?
• How do I change my safety stock levels? Do I need to?
• How will my service levels will be affected?
• How shall I deal with larger demand variation in granular level forecasting?

It is of utmost importance for Supply Chain Practitioners to provide resolution to these pertinent end user concerns. Hence I thought I would share my perspectives at answering these questions through this blog. For explanation, I have designed an illustration taking a cue from a real business scenario, and skinning out all complexity to bare minimum in an effort to explain the main concept.

For understanding, let’s assume that business planning is done on quarterly basis. Demand for the quarter is 300 units. Forecasting frequency is once a month and monthly demand is arrived at by multiplying quarterly demand with weighted average of a month. Let’s say, the monthly demand is 100 units. Variation in demand is 20%. Existing service levels are at 90%. Lead time for the order delivery is 15 days. Safety stock definition is arrived at looking at lead time, and hence, kept as two weeks (~15 days).

The inventory held for this scenario by the planning manager was, 50 units (inventory to meet demand for two weeks)+ 20 units (on account of variation on 100% demand) + 50 units (safety stock calculated for two weeks) = 120 units. With this calculation, the planner was able to achieve 9 to 10 inventory turns and desired service levels. Hence, he believed that this was an efficient arrangement and will not benefit significantly from weekly forecasting.

Let’s investigate, if the planning manager starts doing weekly forecasting where variation in demand jumps from 20 t0 30%, how can he still reduce his inventory and increase the service levels? The demand for Week 1 is 15, week 2 is 20, week 3 is 30 and week 4 is 35. Weekly forecast is not equal to monthly forecast divided by 4. Each week’s forecast is, in effect, is calculated through history.

Earlier, Safety stock = Lead Time = 2 weeks. Lead time is a key factor affecting safety stock but so as service levels. In fact, Safety stock can be determined as a product of Service Factor x Variation in Demand. For the value of Service Factor (SF) = 1, we can achieve 84% of service levels. For 98% service level, the value of SF = 2.

Note on Service Factor : Service factor is calculated by using inverse of the standard normal cumulative distribution with mean zero and standard deviation of 1. Too difficult to understand? Just use NORMSINV function in excel. If your desired service levels is 92%, take NORMSINV (92%) = 1.41.

For the new inventory scenario, we will be ambitious and aim at achieving 98% of service levels. The Service Factor value will be 2. So, Safety Stock = Service Factor x Variation in Monthly Demand = 2 x 20 = 40 units. We will also have to factor lead time in the calculations. Earlier, lead time of two weeks was less than the forecasting frequency of four weeks, hence, it is agreeable to hold safety stock equivalent to the lead time. However, now the forecasting period is less than the lead time, we need to account this using Lead Time Factor. Hence, we will replace Lead Time stock of two weeks with Lead Time Factor = Square root (Lead time / Forecast period). For this illustration, this factor will be square root (2/1) = 1.414
Lead Time Factor x Safety Stock = 1.414 x 40 = 57 units.

Summarizing both scenarios in a snapshot:

Scenario 1:

 Monthly ForecastInventory Units
Forecast100 50 (2 weeks)
Demand Variation20% 20
Order Lead Time2 weeks -
Safety Stock2 weeks 50
Total Inventory120 Units

Scenario 2:

Weekly Forecast Forecast Demand Variation (30%) Safety Stock Lead Time Factor * Safety Stock Total Inventory Order Qty
Week – 1 15 5 40 57 77 Q1
Week – 2 20 6 40 57 83 Q2
Week – 3 30 9 40 57 96 Q3
Week – 4 35 10 40 57 102 Q4

The calculation shows that little back-of-the-page work can instantly realize the benefit of frequent forecasting through 15-20% inventory savings, yet improving service levels. It accounts for demand variation on both – weekly and monthly levels and provides enough inventory buffer to meet the demand. A planner can choose to consider only one of the demand variation and tighten the inventories further. The concept of demand pacing can be used very efficiently with such planning. Forecast for every week will be tweaked upwards or downwards based on the actual consumption data. Order quantity and frequency can be changed every week to pace the demand for the month and subsequently, for the quarter.

For discussion, I have tried keeping the illustration as simple as possible. More complexity can be added by introducing lead time variation, constraints on order frequency and order lot size, order cost, different service levels for different customers etc. However, it is certain that organizations doing more frequent forecasting will be benefited through it. As shown in the illustration above, in spite of reducing inventory, it allows organizations to achieve higher service levels. Both of them are, critical during recessionary times!!

May 19, 2009

Is Supply Chain Planning still the top most priority of investment during uncertain times?

In the current downturn, organizations are typically looking at spending only on sustenance and not wanting to start any new projects/initiatives- however there are organizations which have a clear focus of ensuring that they make the right investments in a downturn to overcome the challenges faced and also be ready when the economy revives. Organizations are always thinking of planning and optimizing their investments and this is more relevant in the current economic scenario. Areas of investment in Supply Chain during the current dark period’ gave us some interesting outcome.

A recent poll on "Key Supply Chain investments areas in your organization" conducted on our blog concluded that more than 50% of the respondents mentioned supply chain planning (demand planning and supply planning) as the focus area in such an environment. Let me give you my perspective on the same.  Demand and supply planning becomes a key in this situation compared to the normal hay period. Demand and supply balancing will have an impact on the corporations working capital requirements. Hence an accurate demand forecast holds key which will ensure that supply will be in tune with the demand forecast and corporations do not carry excess inventory and minimize the working capital requirements. It is important to note that no sophisticated demand forecasting tool would have been able to forecast this downturn as there was no such occurrence in history to support this. However tools which could react faster to the declining sales in previous months and forecast accordingly would have helped corporations– this would have needed the support of human intelligence for forecast adjustments. The holistic  objective of getting the correct forecast numbers  seem to top the priority list  of corporations and hence investment in robust processes and tools in the demand planning area in the downturn. Along with good demand planning, supply planning also gains importance as corporations should relook at supply plans. Also getting this forecast right will help the fortunes of the company when the economy is on an upswing and hence the investment in the planning area is for all times.

Areas of Investment

Other investment areas are on expected lines. However I thought that Transportation management would have been higher on the investment agenda as the savings incurred are faster. In hindsight it could be that since demand has reduced therefore correspondingly there is reduction in shipping of supply and  the view may be not to invest in transportation management in a downturn.

Geographically there is slight difference in the thinking of the corporations. Corporations in US and EMEA have Planning and Strategic Procurement as the top 2 investment areas while corporations in the rest of the world have Supply Chain Risk Management as the key area for investment after Planning. One of the reasons could be that corporations in the US and Europe already have  addressed Supply Chain risks as quite a few of them have built global supply chains and hence may have addressed the supply chain risk aspect.

Investment by Geo

I would like your point-of-view on areas of investment organizations are adopting or should adopt in this down turn to thrive in the future. 

May 16, 2009

Alignment in Supply Chain – is it really possible?

Recently I read a great news article in Supply Chain Digest titled “Triple-A Supply Chain” that actually talks about the article published in Harvard Business Review in the year 2004 by Hau Lee. I am sure most of you would have read it but for those who haven’t, I sincerely suggest that it is a must-read for all supply chain practitioners. Although the article is more than four years old, it is very pertinent in current business environment. Let me just provide the objectives of the three A’s mentioned in the postingf and then, I would like to share my viewpoints with respect to one of the A’s that I feel is the ‘most relevant and critical’ capability for all the companies. The three A’s that have been talked about are:

a)      Agility – it is about how quickly a company can respond to any change in its business environment. It refers to short-term changes.

b)      Adaptability – it is the capability of a company to adapt to business changes that are more permanent in nature and therefore, it is strategic and has a long lead time.

c)      Alignment – it is the ability to have common and shared interests across the supply chain including vendors and customers.

The description for each capability is pretty simple and straightforward but in practice, it is extremely difficult to achieve excellence in building these capabilities. I have observed that most of the supply chain performance improvement initiatives can be directly or indirectly mapped to one of more of these capabilities, and I strongly feel that it is an evolving exercise. Companies need to continually gauge their current performance, sense the future to-be scenario and quickly mould its supply chain, in order to sustain its competitive advantage. Talking about the three A’s, I feel that ‘Agility’ and ‘Adaptability’ are still under the company’s control to an extent, but building ‘Alignment’ as a capability involves close interaction with supply chain partners. And since, it is partner-driven, in my opinion, it becomes challenging to deploy and control activities or institutionalize any change that affects multiple parties. On top of this, as the business environment changes such as the economic crisis we are in today, where we have slowdown and demand de-growth in almost all the sectors, it becomes extremely challenging to sustain the ‘alignment’ of objectives and have mutually beneficial business policies.

Let me explain the concerns and pain points with the help of three real-life examples:

I recall one incident from my prior experience that’s worth mentioning. I was in charge of demand planning function for a region and we were facing problems such as poor order forecast accuracy and high inventory in days with one of our big distributors (in Asia region). Since our entire planning was based on demand forecast, it was very important to include such big customers right in the demand planning process and incorporate the events that occur at distributor level in refining the demand forecast. In order to facilitate this process, I travelled to meet the team at distributor’s end and had detailed discussions with the Planning manager, who was responsible for maintaining the distributor inventory. To my surprise, I realized that his personal KPIs of inventory targets were not aligned to our objectives and that became a constraint in implementing the improved process. We couldn’t influence his superiors to change his KPIs and had to resort to some work-around, but my point here is that “Alignment” of goals, objectives and probably, incentives is not complete unless and until changes are done at the ground  level. People tend to follow their internally set targets and what their superiors tell them to do. The key decision makers in the hierarchy greatly influence the priorities that are set in the supply chain. In fact, this is equally applicable within the company as well and it takes a toll to align interests of conflicting groups. In my opinion, people that belong to the same supply chain team including partners need to have alignment in their ‘thinking’ and ‘approach’ and that’s really an ‘art’ and probably that’s the reason why companies fail to do so.

Another instance that I would like to cite here is wherein one of our vendors wanted to improve its operational performance but lacked people with right skills. We had to go through multiple rounds of discussions to convince the leadership team to hire a person that finally helped in achieving the desired results. So, I feel that there should be some level of alignment in the ‘skill quotient’ of the supply chain partners; else it is very painful and difficult to adopt best practices across the supply chain on a continual basis.

And the last example is about a company that I have worked closely with, in supply chain planning domain. This company is an industry leader in adopting advanced supply chain practices and technology. They were moving at a fast pace to adopt CPFR practices with its key distributors in developing markets/regions, to have common and shared goals. They even went a step further to align the distributor’s KPIs with their planner’s KPIs to avoid any resistance and gain mutual consensus to make the execution successful. But in the last few months, I got to know that since their sales have got deeply impacted by the global economic slowdown, the business team lost its focus on this initiative and planned go very slow in taking it forward. Moreover, at distributor’s end too, the focus is more to control costs and put all such initiatives in the back-burner.

So, is it really possible to achieve alignment in supply chain? Not easy though, there are companies who have done this and continue to be competitive in business.

I would like to have your opinion on this topic. Any experiences, suggestions, feedback and ideas are more than welcome.

May 1, 2009

An Approach to Effective APO Demand Planning Design

APO Demand Planning offers great set of functionalities tuned to very popular business requirements. The key is to come up with a design that takes care of multiple dimensions including Scale & Scope management, Product Life-cycle Management and finally a platform to manually att value to the Statistical Forecast planning process. APO Demand Planning also offers extensions and customizations that can meet some of the complex and atypical business requirements. The end objective of a DP implementation is to make sure that the planners use the tool and make them more productive than before. These thoughts have been summarized in an insightful technical white paper prepared specially for different stakeholders in a DP project.

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