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Negotiating the Value of Flexibility

Analyst Insight: The sales and operations planning process has fairly deep roots in most companies. Research by SCM World shows that many have been able to extend the process across most internal functions. However, few companies have extended the process externally to trading partners. The incentive structure of buyers and sellers tends to set these groups at cross-purposes. Flexibility pricing can shift the incentives in a direction that forces companies to negotiate the value of flexibility. - Barry Blake, Vice President, Research, SCM World

Negotiating the Value of Flexibility

Companies surveyed by SCM World broadly agree on the implementation depth of the S&OP process. Across the product, demand and supply management functions there is consistency on the process maturity achieved by their companies.

As the maturity of the process has increased and extended to most internal functions, so have the benefits and value quantified by practitioners. Moreover, the data suggests a tight correlation between sales ownership of S&OP and the maturity of the process as reflected in the benefits achieved.

The case for trading partner co-operation. While internal alignment has increased, external alignment - either forward or backward in the supply chain - has not. Most practitioners feel the real value of the process will be released when this alignment exists.  When companies do work more closely with their customers, velocity gets designed into the fulfillment process and forecasts tend to improve. Correspondingly, when companies work more closely with suppliers, particularly contract manufacturers, visibility to capacity and lead time information tends to increase, which tightens the nodes across the entire value chain.  

Aligning sales and purchasing incentives. The reason companies struggle to work more closely with trading partners, and reap the benefits of an extended process, is a buyer-seller dynamic that incentivises the opposite of closer integration. When sales reps resist requesting forecasts from their customers, they create significant uncertainty as far as planning is concerned. Revenue, rather than mix, is often the sole perspective on the deal available to supply chain. In addition, sales often accelerates deal closings toward quarter end as a result of customer purchasing tactics. This requires supply chain to accelerate equally as fast, adding to the overall cost of delivery. This pattern of behaviour shortens any discussion on the strategy to fulfill the requirements of the deal.

On the customer side, procurement continues to focus on product unit cost, fragmenting the cost picture of the entire fulfillment process. This hampers the objectives of business operations, since it increases the odds of not having the right supply available to customers. To change this dynamic, companies need to reset the incentives by tying discounts to fulfillment speed and mix information up front in the deal itself.  

A flexible discounting model. The model entails the discount exchanged for information on mix and the length of the fulfillment cycle. The discount decreases as the lead time shortens and customisation increases. These discounts can potentially shift the focus during negotiation by requiring each company to be very clear what it wants out of the deal. The buyer has to begin to pay for its uncertainty (whatever the cause), while the seller must behave in a manner that generates trust by specifying how they will deliver against the deal.

                                            The Outlook

Tilting the incentives of buyers and sellers towards greater collaboration is no easy task, but it is essential to unlocking the value that lies buried in an as-yet-unrealised extended S&OP process. By forcing buyers and sellers to specify the value they place on flexibility in the supply chain, this flexibility becomes a factor in the negotiation process, which in turn increases visibility into mix and delivery expectations.

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