David Johnston has long been involved in developing supply and demand chain planning solutions, particularly for manufacturers of consumer goods. At JDA, he previously served as vice president of forecasting and replenishment and before that he held various positions at E3 Associates, a consulting firm specializing in supply chain and procurement. Earlier in his career, Johnston spent six years working on forecasting and replenishment solutions at IBM. Johnston believes that the global sourcing strategies of many manufacturers are failing to deliver expected benefits and that the extended supply chains built to support these strategies are, in fact, severely straining lean manufacturing initiatives. He talked to GL&SCS about these views and about the steps companies need to take to enable both lean operations and extended supply chains.

Q: Describe for us the conflict that you see between lean initiatives and global supply chains.

Johnston: First we need to define lean manufacturing. Basically, lean is a movement from push to pull or from make-to-stock toward make-to-order. In order to move in that direction, manufacturers have to create a very agile supply chain and reduce overall cycle times. They have to essentially collapse the supply chain so they can respond and react very quickly based on some type of demand signal. Going overseas in pursuit of lower production costs and lower product costs goes directly against these principles. Global sourcing actually extends supply chains and increases cycle times. So this is a conflict; these are competing goals.

The result of extended supply chains is increased supply chain risk. We have seen that played out prominently in recent months with all the problems around pet food and chocolate and toys, which are coming almost solely from China. These events have really highlighted the problem of failing to understand the risks that are introduced when you extend the supply chain.

And there are other risks that people did not foresee. Increases in the price of oil have elevated logistics costs. Security costs have increased significantly since 9/11. And in 2004 we saw the impact that port congestion can have on the delivery of goods.

To mitigate these risks companies typically bloat inventory levels and that adversely affects lean principles.

Q: So companies somehow have to find the balance between these two competing goals?

Johnston: Absolutely. They can't just blindly go after the promise of lower production costs and lower product costs. They really have to understand the risk mitigation that is required to make sure they can both provide competitive products to the market and also meet their customers' service requirements.

This means they must strategically design the most efficient total network model for sourcing materials, producing products, pooling inventories, and distributing finished goods. Strategic network design means understanding where you can flexibly go outside of the network and use contract manufacturing or contract co-packaging to take care of seasonal swings, or identifying those secondary or tertiary plants where there might be excess capacity that you can call on when circumstances warrant. But it also means looking look at where you might need to have an outside storage strategy in place to take care of the seasonal pre-built inventories and what the transportation implications are. Most importantly, you really have to have a handle on the costs associated with all these decisions.

To do this, companies need to be able to model different optimized networks and evaluate the trade-offs. So, if they are considering extending the supply chain, they need to understand the cost of the risk that this move introduces. The cost may be in the area of increased inventories, but it also could come from less efficient utilization of equipment or resources. For example, you might have equipment sitting idle if you don't receive raw materials that you sourced overseas in time for scheduled production.

Doing this right requires a dedicated focus and I think we may well start to see new internal organizations being created within companies whose mission will be to model these different scenarios around collapsing or extending the supply chain-and, importantly, putting contingency plans in place to mitigate risk. So, say a company has a large portion of its finished goods or raw materials supply coming from overseas. What happens if something disrupts that channel of supply? What contingency plans are in place? Can they buy or produce those products domestically at a higher cost to respond to the disruption? What would be the cost of that? All of these questions have to be answered in order for this company to make informed decisions about how it should manage its global sourcing strategies and how it should mitigate risks associated with extending the supply chain. So they need to be able to model different scenarios to help them evaluate their sourcing network, distribution network and their logistics and transportation choices.

Now, it is very important that companies be able to have a very high level of confidence in the results of this modeling. They must be able to rely on what the model tells them because it is simply too costly to implement a network strategy and then learn later on that it is not effective. So they need a modeling tool that they know will give them a firm handle on the costs of a particular strategy as well as on the effects that the strategy will have on the company's responsiveness and customer service. You can't do this on Excel spreadsheets. This is not a case where you can use a guesstimate rather than a scientific result. And this is not an event-driven kind of decision. It's a decision that has to be made on a continuous basis so that you can constantly fine-tune the strategic network design, especially the establishment of contingency plans.

Q: Are companies willing to make the investment necessary for this type of planning?

Johnston: I think they are starting to include this in their budgets. In some cases it may be part of a lean initiative. Virtually every company that we talk to has some money in the budget allocated specifically for lean. Typically this money is for traditional lean projects like reconfiguring work centers or production process steps. But lean projects also may include modeling different optimized network strategies.

Q: What do companies need in addition to modeling?

Johnston: A continued focus on lean manufacturing means removing waste while also improving the supply chain's ability to quickly respond to true changes in demand. So companies need to have the right technology to help them get those early demand signals so they can understand changes in the marketplace. As they see these changes, they can quickly replan the network, from distribution plan to production plan, to respond appropriately. That requires a tighter integration between different processes in the supply chain than exists at most companies today. From an organizational perspective, most companies still have some degree of silos that are not well integrated. And leading companies do not stop at internal integration. We increasingly see industry leaders take real advantage of their access to point-of-sale data as an additional demand stream indicator. This allows them to get much earlier warnings and indications of trends, whether upward or downward, which significantly improves the accuracy of their forecasts, especially in the short term. So if they have built that agile supply chain they can respond very quickly.

Another important step-and this is new to a lot of companies-is to go beyond a weekly understanding of changes in demand patterns and truly get down to daily buying patterns. This is where the leaders are going, especially for their channel master customers. The idea here is to not only understand the forecast patterns of a specific SKU at a single distribution center, but to understand demand down to the customer level on a daily basis. Then you can effectively manage short-term forecasts and provide better service to your customers by reducing out-of-stocks and overstocks, which typically are related to the higher variability associated with seasonal buys and promotional orders.

This is another area where companies have to be able to rely on a high level of accuracy in the forecast in order to truly get to the level of agility that is required. That accuracy comes not only by looking at the firm orders or events, such as planned promotions, but in being able to blend these with overall anticipated demand to understand how forecasts need to change in the short term. So the differentiator here is having the systems intelligence to take the actual orders and match them up with the forecasts. For instance, suppose a channel master customer sends in a promotional order a week earlier than expected-and I am just using a week as an example, it could be any number of weeks-if I don't have a way of automating, with a high level of accuracy, the matching up of these orders with planned events and pulling that forecast that I had for next week back into this week, I will end up with huge overstocks. And the opposite is also true. If the order shows up a week late, then I will be holding inventory for that order that I could have released. So being able to do this kind of order pacing and adapt the forecast down to a daily level are important capabilities.

Q: What pitfalls do companies need to avoid when trying to implement this type of strategy?

Johnston: When trying to strike this profitable balance between lean and extended supply chains, companies need to make sure that they have good analysis and modeling. Otherwise, they will end up putting a strategy in place and implementing it without truly understanding the implications on responsiveness and resources and costs. It goes back to really needing a robust way to model the different scenarios and optimize scenarios before going to a full-blown implementation. It is imperative to first understand the cost implications of implementing that strategy and the expected return. Companies truly need better tools than just cobbled together Excel spreadsheets.

Another pitfall is the failure to put effective contingency plans in place. You need to have a remediation plan ready to go should one of your supply points get cut off or should there be issues with safety or quality. So companies really need to sit down and look at some of the more significant disruptions that could occur and assess what the cost of those disruptions would be. Then put in place a proactive contingency plan and know the costs of that contingency plan as well.

RESOURCE LINK:

JDA Software, www.jda.com