21st Century Supply Chains Require Demand Driven Rules and Tools

Globally supply chains are becoming more complex. Companies struggle with the increased difficulty to plan and manage. Consider this November 2010 survey from the Aberdeen Group:

“86% of respondents indicate that their management team has asked them to find opportunities to improve their company’s supply chain planning processes and 71% of respondents have indicated the same for supply chain technology improvement.”

What is more alarming is that most are missing the biggest opportunity for a real solution.

What Are We Missing About Supply Chain?

Today, too many people think of supply chain tools as warehouse management systems (WMS), product lifecycle management (PLM) or logistics management packages. This is a huge mistake.

The heart of any supply chain is an interconnected network of “islands” of manufacturing. At the heart of these islands is material requirements planning (MRP). An MRP system creates and connects the demand signals in the “archipelagos” that comprise most supply chains. A universal law in both manufacturing and supply chain is:

All benefits will be directly related to the speed of flow of relevant materials and information.

In order to improve flow and achieve more agility throughout supply chains, we must seriously re-examine the conventional materials planning and execution systems. This is not just about speeding up the antiquated rules and tools that we already have but rather causing a fundamental shift in how companies manage their supply chains.

Today almost every mid-range and large manufacturing company is using MRP tactics and tools that are not enabling this agility. No matter how much money is spent on an ERP product, the planning system is antiquated and fundamentally broken.

A previous challenge within supply chain management was not having visibility into what is being moved and its status; now warehouse management and logistics tools have solved that problem. Now the problem is fundamentally which specific items are actually being moved, transported, located and made. What gets put on lathes, welding jigs, assembly lines, trucks, boats and airplanes is a response to a demand or supply order generation signal.

Today, due to the increasing complexity of the global manufacturing and supply landscape the supply order generation signals that move down through our supply chains have become more and more out of alignment with actual demand. This is referred to as the “bull-whip” effect. The bull-whip effect is not a new term. However the problem is growing worse. The bull-whip effect kills flow and supply chain agility.

Why does this bull-whip effect exist? The traditional planning rules and tools (including forecast based demand generation) employed by most manufacturers and distributors do not fit the highly volatile and variable world we live in. Those rules were constructed under a “push and promote” mentality fueled by production efficiency metrics and a market that was more tolerant of longer lead times and shortages.

The New Normal

The 21st Century is a highly volatile place. Customers demand shorter lead times, more variety and customization. The CFO demands reductions in working capital. The Internet has reduced transactional friction and competition can now come from anywhere on the planet. Supply chains have become extended, more difficult to manage and vulnerable to disruption.

The net effect of all of this is that companies are dealing with more complex planning and supply scenarios than ever before. This is not a temporary phenomenon; it is here to stay. A recent report from Aberdeen Group indicates that companies are beginning to feel the pressure:

“Forty-eight (48%) percent of companies indicate that increased supply chain complexity is a top pressure.”

The traditional MRP rules that were conceived, codified and commercialized in the 50’s, 60’s and 70’s under the old “Push and Promote” mode of operation are now breaking down. This includes the general industry love affair with better forecasting algorithms. Working to forecast has long been compared to driving a car by looking in the rear view mirror. Today, however, we are driving on a narrow mountain road in dense fog. The penalties for error are significant. Paying large sums of money for more sophisticated forecast algorithms simply means you now have a more expensive rear view mirror. Any appreciable gains by these “smarter” algorithms are being more than offset by the rise of volatility.

The Compromises and Effects

This incredible pressure has forced companies into less than acceptable alternatives. In November of 2009 the Aberdeen Group released a survey that showed that, on average, 71% of ERP users were using spreadsheets for demand management rather than their ERP’s planning module. This indicates that planners fundamentally distrust the signals they get from their integrated planning systems.

Utilizing the ease to export data, planners have built work-arounds and ad-hoc mechanisms in order to get a relatively better approximation of real requirements. These tools have limited capability, scalability and transferability.

These antiquated rules and tools and ad-hoc systems lead to a combination of three costly effects in today’s environment: poor inventory performance, poor service levels, and high expedite related expenses.

Poor Inventory Performance

This is characterized as having too much of the wrong while at the same time having too little of the right. This can be illustrated by the graph below. This shows the bi-modal distribution that many companies find themselves in with regard to their most important parts. Inventory is waste under two conditions. First, when there is too little – it translates directly to missed sales and expedites. Second, when there is too much – it means that excess working capital and capacity is tied up in things that are not required. In many companies the parts or SKU that matter the most spend the majority of their time in one of these two extreme positions – or oscillating quickly between both sides.

Poor Service Levels

This is characterized by unacceptable fill rates and missed sales. Most companies recognize the high penalty associated with missed sales. They pay a premium in terms of inventory (too much) or expedites (too little) in order to prop up service levels with today’s inadequate planning and execution and tools. Unfortunately, many companies still have high inventories, lots of expedites and still cannot meet their service targets.

High Expedite Related Expenses

This is often under measured and under appreciated. This is all of the additional effort and money that we employ to make up for shortages in the face of critical service requirements or targets. This includes expedited freight. This is also additional freight because we could only ship partials. It is overtime employed after late components have arrived. It is schedule break-ins in high set-up cost environments.

We surveyed over 150 companies and found that 83% of companies reported one of these effects to a severe degree.

Where Do We Go From Here?

These problems are not going away. Large ERP providers are focused on infrastructure not business application development. Furthermore, the technical magnitude of the problem combined with the direction of the solution leaves a very small group of people with the relevant experience and knowledge to reconstruct the rules and specify the tools. A quote from the Aberdeen Group sums up the problem well.

“Out-of-box ERP tools are too generic to address the complexity of the demand management in terms of representation of multiple levels of the bills of materials, collaboration with several internal and external entities, configuration options and outsourced manufacturing related complexities.”

In our upcoming book, Orlicky’s Material Requirements Planning, Third Edition (McGraw-Hill, 2011) we lay out the blueprint for fundamentally and practically migrating MRP and DRP from the world of “Push and Promote” to the world of “Position and Pull.” This is called Demand Driven MRP (DDMRP).

DDMRP is a multi-echelon demand and supply planning and execution methodology. Multi-echelon means that DDMRP integrates multiple tiers (including the bill of material) in the supply chain in order to provide end to end planning and execution visibility so that flow can be improved and better managed. DDMRP ends the typical bi-modal distribution for the parts/SKU that matter and brings it into the desired alignment.

Early adopters are getting significant results with DDMRP without compromises.

Oregon Freeze Dry

Consider the case of Oregon Freeze Dry, the largest diversified freeze dryer in the world. Prior to implementing DDMRP tactics Oregon Freeze Dry used traditional MRP tactics with standard minimum batches.

In their Mountain House division sales increased 20%. Why? Because fill rates went from 79% to 99.6%. Perhaps the most amazing thing is that this increase in sales and service level was accomplished with 60% less inventory.

In their industrial ingredients division there was a 60% reduction in make to order lead time, no stock-outs and a 20% reduction of inventory.

Finally, with regard to their raw materials, they have had no out of stocks and a reduction of over $2.5M in inventory.

Since OFD started with DDMRP tactics sales of those SKU has grown by over 1300% while inventory related to those items grew by only 200%. This happened with almost no amount of capital investments in capacity.