Value-Chain Report -- Don't Overlook The Demand Side Of Supply-Chain Management

Dec. 21, 2004
Supply-chain optimization requires a clear understanding of demand.

Optimized and efficient supply chains are the result of balancing supply and demand.

Often, when companies begin initiatives to improve their supply chains, they focus their efforts internally on production or sourcing issues -- the supply side of the supply chain. Focusing on internal production and sourcing issues is understandable because this is typically an area where supply-chain managers can exert direct control. In many companies, supply-chain managers also operate under the assumption that they do not have the ability to influence customer demand.

However, focusing entirely on the supply side may result in unnecessary capital expenditures, inventory investments or sub-optimal solutions. To best optimize the total supply chain, supply-chain managers must have a detailed understanding of customer demand and then initiate systems and processes to manage this demand.

Understanding Customer Demand

The first step in managing demand is to develop an understanding of the demand patterns of your key customers.

Typically, key customers are those relatively few customers that make up a significant proportion of revenues, although this is not always the case. Other factors may need to be considered. At a minimum, you will want to measure average demand levels, seasonal demand patterns (if appropriate) and the standard deviation of demand at an individual product or SKU (stock-keeping unit) level for the key supply points in your supply chain.

These supply points could include the manufacturing plant or plants, warehouses or distribution centers, and customers' ship-to locations. The time between customer order and final delivery (order lead time), by customer and specific product, also should be measured. Analysis of the resulting data should begin to raise some questions about current practices and suggest potential opportunities for improvement.

For example, you may find that some customers are placing orders far in advance of their required delivery, which may allow your firm to fill these orders through make-to-order or buy-to-order policies, if the customer's ordering practices are longer than your replenishment lead times.

Alternatively, you may find that the longer time window will enable utilization of lower-cost transportation options, such as rail or full truck load, rather than LTL (less than truckload) or parcel shipments. When setting inventory levels, you may find that you only need to include safety stock for customers that typically place orders with short lead times, expecting to be filled from stock. Similarly, you may also find that certain customers tend to have significant fluctuations in demand from order to order, which may cause cost overruns in your plants as a result of overtime, premium freight or other extraordinary requirements.

Understanding these unusual patterns may enable your firm to mitigate the whipsaw effect in your own facilities as a result of strategic inventory management.

Influencing Customer Demand

The next step would be to determine how customer behavior could be influenced to help improve the supply chain. Not possible? Although you may assume that your supply-chain managers don't have any control over your customer demand, that may not be totally accurate. Here are some examples where companies were able to influence customer demand . . . both negatively and positively.

One client company had a very large customer that historically distributed orders between this firm and several other competitors. The customer purchased the product using annual contracts with complex minimum-order agreements. This customer had difficulty managing its obligations under these contracts and was erratically distributing orders between the suppliers to compensate. The client company's supply-chain managers addressed the problem by building an easy-to-use tool to assist the customer in allocating orders among its suppliers. The customer was pleased because the new tool made it easier to comply with the contracts. The supplying company benefited because the tool resulted in a significant improvement in the stability of the large customer's order patterns.

In certain circumstances, price may be used to influence customer behavior. A grocery chain had spent a lot of time planning the distribution of Thanksgiving turkeys in order to minimize transportation and warehousing costs. However, at the last minute, the marketing department decided to boost sales by promoting the turkeys at a "rock bottom" price. Demand skyrocketed and store freezers couldn't be replenished fast enough. As a result, the low-cost transportation plans went out the window. Pricing can also be used to encourage customers to place orders with longer lead times.

For example, we are all familiar with time-based pricing utilized by the airline industry. Passengers who wait until the last minute to purchase tickets may pay a fare quadruple that of passengers who purchase in advance on a high-demand route. On a low-demand route, the opposite can happen, with bargain fares available at the last minute as airlines seek to maximize revenues. Manufacturers can explicitly or implicitly impose price penalties on customers placing rush orders. Adding a premium price for expedited orders will often provide the customer with an incentive to place the majority of its orders with an acceptable lead time.

Supply-Chain Design Reflects Demand

In addition to managing demand by influencing customer behavior, it is also important not to forget the advantages of supplying demand from fewer sources. While you may not be able to change demand patterns for individual customers, supply-chain managers can influence the demand pattern experienced by a supply point. For example, by consolidating slow-moving products from four warehouses into one, overall demand experienced by a single warehouse is likely to be significantly more stable, allowing for a 50% reduction in safety stock. Collaborating with customers to share order data more frequently can effectively increase customer-order lead times. For example, a client company's foreign division was placing its replenishment orders once per month and with short lead times.

As a result, the U.S. plant supplying the foreign division was forced to either stock inventory or pay expedited transportation costs. An agreement to change to weekly replenishment orders effectively added two to three weeks of lead time, allowing the U.S. division to make to order a significantly higher percentage of product and avoid expedited shipments. In summary, customer demand patterns drive the design and efficiency of the supply chain. Don't overlook the opportunity to influence these demand patterns to your advantage. Optimizing supply-chain performance requires a clear understanding of customer demand patterns and working with customers to eliminate ordering practices that add cost.

Kevin O'Brien is managing principal of MidWest Group, a management consulting firm specializing in supply-chain/operations and customer-relationship-management process improvement and related solutions. He can be reached at [email protected]. Brian Springman is founder of Springman Consulting LLC, a management consulting firm focusing on supply-chain improvement for manufacturing and retail firms. He can be reached at [email protected].

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