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Range-based S&OP: How to Tame Demand Volatility in 3 Steps

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Featured Presenter:
Blake Johnson, Consulting Professor, Stanford University

Demand forecasts are critical input to your business plan, yet forecast error is unavoidable. Supply chain agility can overcome this error with capacity and inventory, but comes at a cost. The solution? Proactively plan for a range of demand and supply within your sales and operations plan.

In this webinar, Stanford Consulting Professor Blake Johnson will share how to implement his “Range-based S&OP” best-practice to answer the following questions:

- How forecastable is demand over the planning horizon?
- What is the right type and amount of supply chain flexibility?
- What level of supply chain flexibility optimizes P&L and customer delivery performance?

Attendees at this session will learn how to:

- Achieve predictable financial and operational results in an uncertain world
- Balance supply chain flexibility vs. financial impact
- Deliver the best possible operating and financial performance

Published in: Technology
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Range-based S&OP: How to Tame Demand Volatility in 3 Steps

  1. 1. Proactively Managing Uncertainty in S&OP Blake Johnson Consulting Professor Management Science and Engineering Stanford University Founder, Aztral, Inc. © Blake Johnson
  2. 2. Successful S&OP and supply chain planning But: Inherently difficult in an uncertain and dynamic world And: Sales incentive issues impact accuracy and bias Forecasts are critical: Drive planning and investment - Supply chain cost is key driver of margins and profits - Supply chain flexibility is critical to mitigating risk of lost sales, excess inventory, under-utilized capacity, expediting… Supply chain must balance cost and flexibility © Blake Johnson But: Supply chain metrics impact willingness to invest in flexibility 2
  3. 3. - Shortages - Inventory and liability - Poorly utilized capacity - Expediting and overtime Profits Revenues Costs Material cost Write-downs / write-offs Inventory holding costs Income statement Profits Revenues Costs Material cost Write-downs / write-offs Inventory holding costs Income statement Assets Inventory Balance sheet Liabilities Material liabilities Capacity Assets Inventory Balance sheet Liabilities Material liabilities Capacity Too muchCost Too little - Ours - Customers - Suppliers - Commitments - Coordination Plan Reality Operating performance - Re-planning - Re-coordinating - Constraints - Fire-fighting - Cost and conflict - Damaged customer relationships - Income statement and balance sheet impact - Lack of control - Lack of accountability Impact of basing plans, coordination and metrics on best- guess forecasts © Blake Johnson Financial performance 3
  4. 4. To date the focus has been trying to make the problem go away 1. Proactively plan for the range (probability distribution) of future demand and supply Eliminate forecast error Impossible in an uncertain environment Perfect “agility” Flexibility and lead time reduction have costs Real question: What is the right level? Solution: “Range” planning © Blake Johnson 2. Quantify and manage operational and financial performance over it 4
  5. 5. The simple logic of “range” planning © Blake Johnson - Too little supply: Lost sales and customer satisfaction, unnecessary cost - Too much supply: Inventory, liability and excess capacity - Sales and marketing - Supply chain 3. How can we proactively plan and manage our business to deliver the best possible operating and financial performance? 1. What is the range of our potential future demand? 2. How is our operating and financial performance exposed across that range? 5
  6. 6. Capability#1: How forecastable is demand over planning horizon? Forecasts: Best available demand information over planning horizon Forecastability varies by: Demand Planning horizon 90th 75th 25th 10th Forecast error percentiles Forecast error by forecast horizon: Accuracy of that information by lead time - Product - Stage of lifecycle - Level of aggregation - Market / geography - Season Customer order lead time Demand known within customer order lead time Now © Blake Johnson 6
  7. 7. Capability #2: What is the right type and amount of supply chain flexibility? “Bucket” at end of “supply chain pipe” Inventory “Supply chain pipe” Materials Production Shipping Finished goods Forecast accuracy lower further in future Match size of “supply chain pipe” to forecast accuracy by lead time - Unless forecast accuracy = 100%, supply flexibility is required to match supply and demand - Lower forecast error  less flexibility required 90th 75th 25th 10th Forecast error percentile Enable supply chain to proactively plan  Minimize cost and risk © Blake Johnson 7
  8. 8. Optimizing planning for high probability portion of demand range Demand Time High probability demand Cost savings opportunity varies by circumstance, but 5-10% is typical Low end of Range Forecast as % of forecast Savings opportunity: Examples Cost reduction opportunity 70% 60% 5% 10% X = Reduction in overall cost (%) 3.5% 6% Use predictability to reduce cost: - Lowest cost, long lead time production - Efficient capacity, materials and production planning - Large batch sizes, full truckloads, ocean vs. air… - Financial planning and risk management benefits © Blake Johnson Certain demand is cheap to serve (100% capacity utilization, no inventory buffer…) 8
  9. 9. Optimizing planning for uncertain portion of demand range Flex Committed volume Flex Committed volume Supply chain planning decisions by lead time Demand Month3 4 5 61 2 Production start Material sourcing Capacity Capacity lead time Material lead time “Right-size” upside by lead time - Minimize cost by pushing flex as far upstream as possible - Manage upside constraints over full planning horizon High quality advanced planning information at each stage of supply chain © Blake Johnson Upside availability known, and delivered at lowest cost Intelligently position “just in case” resources, sized based on cost vs. benefit 9
  10. 10. Source: Venu Nagali, HP, presented at Real-options conference June 2007 Manage risks using structured contracts with suppliers Flexible quantity contract Demand forecast (units) Time Fixed quantity contract 0 100 200 300 400 Uncommitted Hi scenario Base scenario Lo Scenario 1. Quantity Terms: • Fixed Quantity • Flexible Quantity • Percent of HP Demand 2. Pricing Terms: • Market-based with specified discounts • Fixed price • Price caps and floors Structured Contract Terms A combination of objectives from Assurance of Supply, Cost Savings & Cost Predictability can be enabled by mixing & matching quantity and pricing terms
  11. 11. Capability #2: Quantify cost of supply chain flexibility Jan Feb Mar Apr MayJan Feb Mar Apr May Option 1: Low flexibility Option 2: High flexibility Narrower supply chain pipe Wider supply chain pipe  Higher capacity utilization  More inventory turns (materials, WIP, FGI)  Lower cost  Lower capacity utilization  Fewer inventory turns (materials, WIP, FGI)  Higher cost © Blake Johnson 11
  12. 12. Capability #3: What level of supply chain flexibility optimizes P&L and customer delivery performance? Jan Feb Mar Apr MayJan Feb Mar Apr May Option 1: Low flexibility Option 2: High flexibility P&L: Customer service: Low P&L Balance cost of supply chain flexibility with benefits to P&L and customer service  More lost revenue and margin  More inventory and liability  Lower supply chain cost Customer service: High  Less lost revenue and margin  Less inventory and liability  Higher supply chain cost Lost revenue and margin Damaged customer relationships Inventory and liability © Blake Johnson 12
  13. 13. Capability #3: Optimize performance and enable “no surprises, no excuses” alignment and accountability 1. “Dollarize” trade-offs (integrate operational and financial) 2. Create “menu” of performance alternatives for key stakeholders 3. Agree best choice and establish alignment and accountability Demand Demand Vs. “Risk aware” S&OP process: “Range” performance management Plan Demand Today: Flying blind Service level 98% Inventory $2M Cost $11M Gross margin $3M Liability $1.2M Low Plan High ? ? ? ? ? ? Service level 98% Inventory $2M Cost $11M Gross margin $3M Liability $1.2M Low Plan High ? ? ? ? ? ? Service level 100% 99% 97% Inventory $2.2M $1.8M $0.3M Cost $8.3M $11.3M $13.7M Gross margin $2.5M $2.9M $4.1M Liability $2.1M $0.8M $0.3M Low Base High Service level 100% 99% 97% Inventory $2.2M $1.8M $0.3M Cost $8.3M $11.3M $13.7M Gross margin $2.5M $2.9M $4.1M Liability $2.1M $0.8M $0.3M Low Base High Service level 100% 99% 95% Inventory $3.1M $2.0M $0.1M Cost $8.0M $11.0M $13.4M Gross margin $2.6M $3.0M $3.8M Liability $2.5M $0.8M $0.3M Low Base High Service level 100% 99% 95% Inventory $3.1M $2.0M $0.1M Cost $8.0M $11.0M $13.4M Gross margin $2.6M $3.0M $3.8M Liability $2.5M $0.8M $0.3M Low Base High Align sales, supply chain, and external partners on right level of flexibility by lead time © Blake Johnson 13
  14. 14. Managing with a complete view of your business reality © Blake Johnson Maximize savings on predictable demand Secure upside flex at lowest cost Supply chain “range” plan2 Potential supply chain flexibility Quantify impact of supply chain plan on key metrics - Financial, operational, customer - Across potential demand outcomes Service level 100% 99% 97% Inventory $2.2M $1.8M $0.3M Cost $8.3M $11.3M $13.7M Gross margin $2.5M $2.9M $4.1M Liability $2.1M $0.8M $0.3M Low Base High Service level 100% 99% 97% Inventory $2.2M $1.8M $0.3M Cost $8.3M $11.3M $13.7M Gross margin $2.5M $2.9M $4.1M Liability $2.1M $0.8M $0.3M Low Base High “Range” performance 3 Performance of supply chain flexibility over range forecast Demand range forecast Quantify demand uncertainty over planning horizon 1 “Problem to solve” Choose range plan with best overall performance - Cross-functional input, alignment and accountability  “No surprises, no excuses” performance, across demand outcomes 4 S&OP Organizational processes, metrics and accountability (Including uncertainty and your options for managing it) 14
  15. 15. Q&A © Blake Johnson 15

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