Today’s ERP systems offer off-the-shelf solution sets to drive forecasting, planning and scheduling functionality. As a result, optimum safety stock levels can be calculated at all stages of the supply chain based on the customer, SKU, service levels and location. The good news is that when properly deployed, these features can significantly improve supply chain performance. The bad news is like the analogous metal chain, a supply chain is only as strong as its weakest link.
A typical ERP solution provides an ATP (available to promise) module that simply assigns product to orders on a first in, first out (FIFO) basis. FIFO—the execution arm of ERP—is the chain’s weakest link and the proverbial Achilles heel for many companies because it places secondary and tertiary customers on an equal order footing with top priority strategic customers. It lacks the same level of sophistication as planning models, rendering opportunities for inventory optimization unattainable. Business leaders, recognizing the need to bridge the organizational gap between planning and execution, demand new approaches that exceed the capabilities of today’s ERP solutions.
Most leading companies place a justifiable emphasis on their critical supply chain planning processes, including forecasting demand and supply requirements, and optimizing production and distribution plans. However, execution of these plans is sub-optimal because it tends to rely on very rudimentary technology that often undoes much of the value created in the supply chain planning process. In the past, the order fulfillment function has been disjointed from the planning process because of its existence in different operational silos that act as barriers to collaboration. Today, however, it is imperative for those involved in these two functions to collaborate in a much more meaningful way.
The reality for most companies is that the forecast, production and distribution plans are accurate only in monthly or weekly time buckets while fulfillment happens in real-time. The descriptive term for this issue is the “forecast gap.” The moment of truth occurs with receipt of an order. If the inventory is inadequate to supply the customer in the order’s timeframe, the forecast gap may be responsible.
Traditionally, the common industry response to the variability and uncertainty caused by the forecast gap is to build costly inventory positions referred to as safety stock, which can have an unacceptable impact on margin. Reliance on safety stock to fulfill orders defeats the purpose and limits the benefits of the sophisticated planning process.
The old adage that “all customers are important but some are more important than others” is as true today as it was in the previous century. The reason: Orders from strategic customers are the most predictable, while the opposite is usually the case for smaller, less strategic customers. Preferred customers usually hold lower inventories, given their sales velocity, and place orders more frequently. Non-strategic customers tend to order more sporadically and in less-predictable volumes. To optimize the order fulfillment process, strategic and non-strategic customers must be differentiated. By properly addressing the forecast gap, better service with significantly lower inventory levels can still be provided for strategic customers.
Whenever an order is received, logistics management faces a delicate balancing act:
- Should an order from a non-strategic customer be filled, and how will that affect the ability to fulfill a critical order to a strategic customer in the future?
- What are the actual inventory needs of the non-strategic customer vs. a strategic customer at a given time?
- Should costly inventory be hard-allocated to strategic customers?
- What is the cost of all of the above to the bottom line?
Utilizing current ERP functionality that assigns product to orders on a FIFO basis is likely to drive up inventory and expenses. A more sophisticated and integrated approach is required.
A New Approach
Order assignment optimization (OAO) optimizes the assignment of inventory (actual and projected) to orders (actual and forecasted). OAO acknowledges the business reality that not all customers equally contribute to a company’s strategic goals or bottom line. The OAO process accesses transaction and master data from the ERP system, including open orders, inventory and planned receipts at the warehouse. Forecasted customer orders are classified by SKU and location level, and are used to hold inventory in anticipation of the arrival of actual orders.
With a view into a customer’s on-hand inventory, sales velocity by SKU and in-transit orders, an accurate assessment of a customer’s product quantity needs can be balanced among all competing orders for the same product. The advanced mathematical algorithms of an OAO optimization engine calculate the best assignment of product to customer orders based upon an organization’s prioritization and business goals—the same priorities and goals that are used to optimize the planning process.
The OAO process gives strategic customers preferred access to the inventory even before they place an order. That is not the case for non-strategic customers who can no longer tie up inventory by placing orders early and preventing shipments to the most important customers who might have a shorter order lead-time policy. With OAO, inventory that was manufactured to meet non-strategic customers’ projected demand is actually used as buffer inventory first. That tactic helps ensure that service level commitments to an organization’s most important strategic customers are always met. This new execution capability offer more options and granular level planning for logistics. The discussion between the planning function and order fulfillment can now turn to service level requirements based upon customer, product, location and consensus on elimination of significant amounts of unnecessary safety stock.
The OAO process increases service levels with lower inventory by giving manufacturers the ability to flexibly pool and assign inventory across potential customers in rapid, short-term cycles. It is important to focus on the sell-through to the end-customer, not just the sell-in to the channel. If a channel is not moving a particular SKU, the low velocity needs to be visible so that other channels with sell-through can be prioritized. An OAO process generates this data in minutes by recalculating the best assignment of inventory (both on-hand and projected to be received). Companies have leveraged the OAO process by running execution level optimization many times per day at each warehouse.
Today’s forecasting and planning applications are very sophisticated and accurate. They are capable of running faster and processing more granular data than was thought possible just ten years ago. Modern planning models account for different service level requirements for different customers down to the SKU, customer and location level. However, the value created by these technologies can easily be lost if orders are not fulfilled with the same sophisticated optimization tools and the same business rules. The OAO process provides that level of sophistication and delivers an order assignment solution that is in sync with an organization’s planning system and customers.
ERP systems are critical to the success of virtually every large business. The value of their integration into critical supply chain functions by providing underlying data to most supply chain planning decisions is unquestioned. Yet, supply chain leaders and planners concede that ERP systems have significant limitations in providing bottom-line value to critical supply and demand planning decisions. What they lack is the same level of sophisticated business rules and optimization capabilities as supply chain planning solutions.
Because of pace and development of the global economy, the time has come when new solutions are emerging to address the forecast gap and allow companies to execute their supply chain with the same expertise they use to plan it.
David Jarvie, Alan Kosansky, Ph.D and Ted Schaefer are senior members of the management team for Profit Point, a provider of supply chain optimization systems. The company provides such services as infrastructure and supply chain planning, scheduling, distribution and warehouse utilization improvement.