Executive Briefings

Planning and Managing Demand: A Modern Supply Chain Imperative

Demand planning is somewhat of a misnomer - it may be better thought of as anticipating demand.  The entire organization is aligned to the expected demand across the product line, and supply chain activity is optimized around an expected level of demand.  However, demand management is sometimes confused with demand planning - and why not? After all, aren't they the same thing?  Demand planning and demand management are very distinct and different activities.  Whereas demand planning looks to determine the expected level of sales within a product line and aligning an organization to support that demand, demand management is the set of activities to manage the channel segmentation and product pricing in order to maximize profit. 

Demand planning and demand management work together to minimize inventory levels, increase margins, and maximize revenue from normal operations.  It is not a substitute for sales and marketing, but rather works in concert with sales and marketing to get the maximum benefit from inventory investments.  It also has the advantage of helping to create unique competitive advantage - advantage as unique as the company itself.

One final point - demand management may affect total demand depending on the customer type.  If a CPG company is selling its product through a retailer, then demand management is about encouraging that retailer to change the timing of purchases, or jointly participating in promotional activity, in order to minimize supply chain costs.  On the other hand, if the customer is an end-consumer, then demand management can increase total demand and overall sales.  When possible, manufacturers should have both channels to market in order to achieve higher revenue, higher profitability and better inventory control.

Demand Planning - Looking Backward to See Forward

Demand planning for existing or replacement products is based on a historical view of demand, and any promotional activities that may be initiated in order to change the demand curve.  For new products, the lack of historical data means that there is greater reliance on the marketing forecast.  Anchoring new product expectations in an existing product's historical demand performance is helpful in creating realistic expectations for future demand.

Creating a realistic view of demand for a given product or product line "de-risks" the buildup of inventory.  In the current economic client, companies are jettisoning unproductive operations and being very cautious about how corporate resources are invested.  Demand planning software tools are available to help in the planning and forecasting process, but software tools alone cannot take the place of a disciplined demand planning process.

Sales and operations planning (S&OP) is the standard process that many companies use to drive more discipline into the planning process.  Whether a company uses a standard S&OP process, or it opts for something else, the key is introducing the necessary discipline and accountability into the overall demand planning process.

By way of contrast, one company with a highly unstructured planning process used aggregate forecasts that were reasonably good but that alone did not translate into good execution.  Lead time was approximately 90 days -- thus factory orders in February were available for customer order fulfillment in May.  Forecast variance was often 50 percent or higher month to month.  The demand planning process the company used was based on bottom-up sales projections, market studies and an expected growth factor year over year.  However, this led to higher inventory levels, higher write-downs, and higher markdown payments to retailers amounting to nearly 10 percent of sales domestically.  While they improved their inventory position year over year, they were only able to achieve two inventory turns.

Implementing a demand planning transformation program can have a measurable impact on business performance.  Significant reduction in network distribution costs of 4 percent to 5 percent have been realized. That translates into 2-percent to 3-percent improvement in earnings before interest and taxes.

So for a given inventory procurement decision, when does demand planning end?  For purposes of this discussion, demand planning ends when the factory order is placed.  Some advocate for a soft freeze for a short period after the factory order is placed, but the key issue is that the demand planning activity for a given inventory decision comes to an end.

Demand Management - Intelligent Application of Incentives

Demand management overlaps demand planning during the pre-factory order period, and continues until product is delivered to a customer.  The fixed assumption for demand management is the expected demand as defined during the demand planning process.  Demand management is used to maximize the profitability of a given inventory investment.  Maximizing profitability means sustaining deal pricing (no unplanned discounts), lowering expenses, or both.  Demand management formalizes the management of incentives used to achieve these objectives.

Consider the following situation.  There are currently 100 widgets in the demand plan with two weeks left to go before a factory order is finalized and sent for fulfillment.  A container can ship 30 widgets at a cost of $60, averaging $2/widget.   Partial containers cost $4/widget. All pricing to customers include freight charges.   Additionally, the selling price for a widget is $15 and unit cost is $5.   Also, the sales pipeline shows that they are expecting to place an order for 50 widgets two weeks after the close of the current factory order.

The operations department has the mandate to drive efficiencies in the supply chain.  They have visibility to all the above information, including the sales pipeline and forecast.  Operations can propose increasing the factory order to 120 widgets, with 20 going into warehouse inventory to take advantage on the lower shipping rates, thus keeping the entire shipment transportation expense at $2/widget.  This approach increases inventory risk, since there is not any specific demand for this inventory.  The level of risk is inversely proportional to the lead time.

Another approach is for operations to look at the sales pipeline and see that a customer is currently in the pipeline and is expected to order 50 widgets.  What if sales approached that customer with an offer of $1/widget price reduction on 20 widgets if they made a decision within two weeks?  Assuming the customer accepted the offer, how much does it impact revenue and profitability?

In the original factory order, total revenue would have been $1,500 (100 at $15/widget).  Cost of the factory order is $630 (90 at $7/widget) plus $90 (10 at $9/widget) for a total of $720.  Margin is thus 52 percent.

What is the situation if the discount offer is accepted?  Total revenue for the order would be $1,500 (100 at $15/widget) plus $280 (20 at $14/widget), or $1,780.  Total cost of the order would be $840 (120 at $7/widget).  Margin increases to 53 percent.  By cutting prices the company ends up making more money.  Notice that it does not impact total demand (since the customer would have made the purchase anyway), but rather it affected profitability and cost, since the customer saved $20, and the company saved an equal amount. 

Making It Work

The first step in the needed transformation is increasing the level of inventory visibility.  Most companies are good at tracking inventory when it has been received inside the four walls, but what about before it reaches the warehouse?  Once a factory order is issued, inventory has been created with an availability date.  Another source of inventory is a customer return.  If a customer wants to return merchandise, that can become another inventory sourcing location.

Transportation planning is the next step for the transformation.  The ability to create multiple planning scenarios will support making win-win incentives as companies offer customer incentives to benefit both the company and customers. 

Finally, a demand planning system will be needed to facilitate the overall demand planning process.  There are a number of good ones out there, and usually they will have a specific focus (e.g. CPG, high-tech, etc.).  They assume a process is in place to take advantage of their functionality.  The key with this system is to get one that works within the context established by the rest of the IT landscape.

Demand planning and demand management are supported and facilitated by these systems and processes.  Senior leadership needs to fully support both demand planning and demand management if they are to succeed.   Because these processes affect marketing, sales and operations, the transformation needs to have the complete backing of senior leadership.

Notes and Observations

Some may ask whether the effort that these processes require to implement is really worth it.  Airlines have been using demand management in their operations for years.  Airlines have been getting passengers to take flights at 1 a.m. in the morning, without a single complaint (aside from culinary and tardiness issues).  These techniques not only work but actually lead to increased customer satisfaction in addition to the tangible business improvements.

Benefits flow right to the bottom line.  While Lean / Sigma efforts have been going on for years, the one issue that gets little attention is the one that causes much of the disruption in the supply chain - changes in customer demand.  Customer demand is often considered to be fixed and can only be stimulated but not controlled.  This approach is a practical way to control demand.

One other point to emphasize: The processes described here to manage demand are not simply sales discount programs.  Discounts are marketing or sales expenses used to bring about other goals, whereas the approach discussed in this article is about influencing customer buying behavior based on win-win incentives.  It requires that sales people have a strong relationship with their customers that allows them to respond quickly to temporary incentive programs, and the discipline not to offer the discounts if the customer does not meet the offer criteria.

DePew can be reached at tom.depew@hasemanassociates.com.

Source: Haseman Associates

Demand planning is somewhat of a misnomer - it may be better thought of as anticipating demand.  The entire organization is aligned to the expected demand across the product line, and supply chain activity is optimized around an expected level of demand.  However, demand management is sometimes confused with demand planning - and why not? After all, aren't they the same thing?  Demand planning and demand management are very distinct and different activities.  Whereas demand planning looks to determine the expected level of sales within a product line and aligning an organization to support that demand, demand management is the set of activities to manage the channel segmentation and product pricing in order to maximize profit. 

Demand planning and demand management work together to minimize inventory levels, increase margins, and maximize revenue from normal operations.  It is not a substitute for sales and marketing, but rather works in concert with sales and marketing to get the maximum benefit from inventory investments.  It also has the advantage of helping to create unique competitive advantage - advantage as unique as the company itself.

One final point - demand management may affect total demand depending on the customer type.  If a CPG company is selling its product through a retailer, then demand management is about encouraging that retailer to change the timing of purchases, or jointly participating in promotional activity, in order to minimize supply chain costs.  On the other hand, if the customer is an end-consumer, then demand management can increase total demand and overall sales.  When possible, manufacturers should have both channels to market in order to achieve higher revenue, higher profitability and better inventory control.

Demand Planning - Looking Backward to See Forward

Demand planning for existing or replacement products is based on a historical view of demand, and any promotional activities that may be initiated in order to change the demand curve.  For new products, the lack of historical data means that there is greater reliance on the marketing forecast.  Anchoring new product expectations in an existing product's historical demand performance is helpful in creating realistic expectations for future demand.

Creating a realistic view of demand for a given product or product line "de-risks" the buildup of inventory.  In the current economic client, companies are jettisoning unproductive operations and being very cautious about how corporate resources are invested.  Demand planning software tools are available to help in the planning and forecasting process, but software tools alone cannot take the place of a disciplined demand planning process.

Sales and operations planning (S&OP) is the standard process that many companies use to drive more discipline into the planning process.  Whether a company uses a standard S&OP process, or it opts for something else, the key is introducing the necessary discipline and accountability into the overall demand planning process.

By way of contrast, one company with a highly unstructured planning process used aggregate forecasts that were reasonably good but that alone did not translate into good execution.  Lead time was approximately 90 days -- thus factory orders in February were available for customer order fulfillment in May.  Forecast variance was often 50 percent or higher month to month.  The demand planning process the company used was based on bottom-up sales projections, market studies and an expected growth factor year over year.  However, this led to higher inventory levels, higher write-downs, and higher markdown payments to retailers amounting to nearly 10 percent of sales domestically.  While they improved their inventory position year over year, they were only able to achieve two inventory turns.

Implementing a demand planning transformation program can have a measurable impact on business performance.  Significant reduction in network distribution costs of 4 percent to 5 percent have been realized. That translates into 2-percent to 3-percent improvement in earnings before interest and taxes.

So for a given inventory procurement decision, when does demand planning end?  For purposes of this discussion, demand planning ends when the factory order is placed.  Some advocate for a soft freeze for a short period after the factory order is placed, but the key issue is that the demand planning activity for a given inventory decision comes to an end.

Demand Management - Intelligent Application of Incentives

Demand management overlaps demand planning during the pre-factory order period, and continues until product is delivered to a customer.  The fixed assumption for demand management is the expected demand as defined during the demand planning process.  Demand management is used to maximize the profitability of a given inventory investment.  Maximizing profitability means sustaining deal pricing (no unplanned discounts), lowering expenses, or both.  Demand management formalizes the management of incentives used to achieve these objectives.

Consider the following situation.  There are currently 100 widgets in the demand plan with two weeks left to go before a factory order is finalized and sent for fulfillment.  A container can ship 30 widgets at a cost of $60, averaging $2/widget.   Partial containers cost $4/widget. All pricing to customers include freight charges.   Additionally, the selling price for a widget is $15 and unit cost is $5.   Also, the sales pipeline shows that they are expecting to place an order for 50 widgets two weeks after the close of the current factory order.

The operations department has the mandate to drive efficiencies in the supply chain.  They have visibility to all the above information, including the sales pipeline and forecast.  Operations can propose increasing the factory order to 120 widgets, with 20 going into warehouse inventory to take advantage on the lower shipping rates, thus keeping the entire shipment transportation expense at $2/widget.  This approach increases inventory risk, since there is not any specific demand for this inventory.  The level of risk is inversely proportional to the lead time.

Another approach is for operations to look at the sales pipeline and see that a customer is currently in the pipeline and is expected to order 50 widgets.  What if sales approached that customer with an offer of $1/widget price reduction on 20 widgets if they made a decision within two weeks?  Assuming the customer accepted the offer, how much does it impact revenue and profitability?

In the original factory order, total revenue would have been $1,500 (100 at $15/widget).  Cost of the factory order is $630 (90 at $7/widget) plus $90 (10 at $9/widget) for a total of $720.  Margin is thus 52 percent.

What is the situation if the discount offer is accepted?  Total revenue for the order would be $1,500 (100 at $15/widget) plus $280 (20 at $14/widget), or $1,780.  Total cost of the order would be $840 (120 at $7/widget).  Margin increases to 53 percent.  By cutting prices the company ends up making more money.  Notice that it does not impact total demand (since the customer would have made the purchase anyway), but rather it affected profitability and cost, since the customer saved $20, and the company saved an equal amount. 

Making It Work

The first step in the needed transformation is increasing the level of inventory visibility.  Most companies are good at tracking inventory when it has been received inside the four walls, but what about before it reaches the warehouse?  Once a factory order is issued, inventory has been created with an availability date.  Another source of inventory is a customer return.  If a customer wants to return merchandise, that can become another inventory sourcing location.

Transportation planning is the next step for the transformation.  The ability to create multiple planning scenarios will support making win-win incentives as companies offer customer incentives to benefit both the company and customers. 

Finally, a demand planning system will be needed to facilitate the overall demand planning process.  There are a number of good ones out there, and usually they will have a specific focus (e.g. CPG, high-tech, etc.).  They assume a process is in place to take advantage of their functionality.  The key with this system is to get one that works within the context established by the rest of the IT landscape.

Demand planning and demand management are supported and facilitated by these systems and processes.  Senior leadership needs to fully support both demand planning and demand management if they are to succeed.   Because these processes affect marketing, sales and operations, the transformation needs to have the complete backing of senior leadership.

Notes and Observations

Some may ask whether the effort that these processes require to implement is really worth it.  Airlines have been using demand management in their operations for years.  Airlines have been getting passengers to take flights at 1 a.m. in the morning, without a single complaint (aside from culinary and tardiness issues).  These techniques not only work but actually lead to increased customer satisfaction in addition to the tangible business improvements.

Benefits flow right to the bottom line.  While Lean / Sigma efforts have been going on for years, the one issue that gets little attention is the one that causes much of the disruption in the supply chain - changes in customer demand.  Customer demand is often considered to be fixed and can only be stimulated but not controlled.  This approach is a practical way to control demand.

One other point to emphasize: The processes described here to manage demand are not simply sales discount programs.  Discounts are marketing or sales expenses used to bring about other goals, whereas the approach discussed in this article is about influencing customer buying behavior based on win-win incentives.  It requires that sales people have a strong relationship with their customers that allows them to respond quickly to temporary incentive programs, and the discipline not to offer the discounts if the customer does not meet the offer criteria.

DePew can be reached at tom.depew@hasemanassociates.com.

Source: Haseman Associates