Planning in an Uncertain World: Managing Performance Trade-offs in S&OP

Sept. 10, 2013
Range Forecast: What is the range of our potential future demand? Range Planning: What is the best way to plan for our range of potential demand? S&OP Performance Trade-Offs: How much flexibility drives the best operating and financial performance?

Planning systems are increasingly irrelevant. Their outputs gather dust because they’re based on best-guess forecasts that can’t deal with the uncertainties that drive business. At any moment sales can bring in a late order for a strategic customer, or supply chain can lose a vendor because of a storm in Thailand. As a result, most companies spend 20% (or less) of their time planning and the rest reacting.

But the importance of planning hasn’t gone away, as it takes time to build capacity, buy materials and ship products. To fill the gap, the operations team is forced to turn to Excel and offline, manual processes. With these ad hoc tools, management loses visibility and control, and with it the basis for accountability. At the same time, operational performance becomes unpredictable, and takes financial performance with it.

The antidote to today’s “best guess” plans are range plans vetted in sales and operations planning (S&OP). This means:

  • Proactively planning for the range (probability distribution) of future demand and supply;
  • Quantifying the operational and financial performance of these “range plans” across potential supply and demand outcomes; and
  • Securing consensus and commitment on this “range performance” across functions (e.g. sales, manufacturing, procurement, finance) and external partners and customers.

By aligning data, people and processes with range-based S&OP, companies can transform both their sales and supply chain planning processes to deliver the combination of agility and predictability today’s volatile business climate requires.

Successful S&OP Range Planning: Step-by-Step

Critical to effective range planning is determining the cost and value of the ability to deliver to a range of potential demand: How far above or below forecast could sales come in? What would that mean for operational and financial performance? Today, few companies can answer these critical questions.

Providing answers with range-based S&OP enables companies to plan for the level of flexibility that optimizes P&L and customer service. This means quantifying how key metrics are exposed across the range of potential demand outcomes, and choosing flexibility to balance these costs of “too much versus too little supply.” The result is plans that ensure high-margin products get the upside they merit, and lower-margin products are managed to minimize cost and margin risk.

Range planning is a common sense idea. We don’t plan our everyday lives around “best guess” forecasts, so why would we plan our businesses that way? For example, weather forecasts tell us a range of possible outcomes, each with different odds, and we plan in order to balance the performance trade-offs. If the chance of rain is 10% we may leave our umbrella at home, but bring it if the chance is 40%. If we’re wearing our new suit to an important job interview (different performance trade-offs), we may bring an umbrella with only a 5% chance of rain. Just as you need to decide whether to bring an umbrella before you leave home, and before you know what the weather will be later in the day, so do businesses need to commit to supply chain decisions before they know what demand will actually be.

Range planning applies the same approach to business planning:

  1. What are the potential forecast outcomes? How likely are they? (Rain or shine?)
  2. What are my planning options? (Bring my umbrella or not?)
  3. What is the cost and benefit of each planning option across potential forecast outcomes? (Carry umbrella, risk of getting wet)

Three Key Steps for Better Planning

Following is a three-point plan for incorporating these steps in your planning process.

1 -- Range Forecast: What is the range of our potential future demand?

Gone are the days of basing critical plans on best-guess, single number forecasts. Today companies need range forecasts that capture the range of potential future demand. To create a range forecast, first look at typical forecast error in different parts of your business: across product lines, and in different markets and geographies. Then factor in the impact of market conditions, such as strength of economy, competition and pricing. Companies understand these factors matter—range forecasts quantify their impact.

2 -- Range Planning: What is the best way to plan for our range of potential demand?

To create the right amount of flexibility at lowest cost, segment the potential demand captured by your range forecast into two parts:

  1. “Certain” demand below the low end, or “worst case,” of the range forecast, and
  2. Uncertain demand between the low and the high end of the range.  

For example, if your best guess forecast is 100, the low end of your range forecast may be 70 – a “worst case” number sales is confident it can hit.  The high end may be 140 – the “best case” if the stars align. 

From a risk perspective, the 70 unit worst case is a sure thing - a level of certainty in an uncertain world.  Supply chain can take cost out on those 70 units by planning with confidence: buy and produce in bulk, use low cost, long lead time sourcing and shipping, etc.

In contrast, between the low and the high end of the range forecast – 70 to 140 units in the example above – demand is uncertain. Flexibility is required to meet this demand if it materializes, and to minimize cost and liability if it doesn’t.  The good news is that the cost savings on the 70 units of “worst case” demand can be used to fund this flexibility. Overall cost can often be held constant by planning differently for these two different types of demand – certain and uncertain.

3 -- &OP Performance Tradeoffs: How much flexibility drives the best operating and financial performance?

S&OP stakeholders understand that too little supply results in unnecessary costs of lost sales and customer satisfaction, while too much supply leads to inventory, liability and excess capacity. Capturing demand uncertainty with range forecasts and minimizing the cost of flexibility with range plans enable S&OP stakeholders to focus on sizing flexibility to balance these costs and optimize performance.

For instance, a product’s margins may justify holding inventory or capacity to meet demand that has a 50-50 chance of occurring, but not demand with a 1 in 4, or 25% chance. When S&OP stakeholders have this information about demand uncertainty, flexibility costs and product margin, they can make these decisions with confidence and clarity.

Getting everyone together to determine the range may in fact be the most challenging part of this process, but is critical to achieve the alignment and accountability for effective range-based S&OP. Once agreed and committed, decisions ensure all stakeholders – across sales, supply chain, operations and finance – know what to expect and what they are accountable for, for each possible demand outcome. 

In the example above, supply chain is accountable for meeting demand up to the level determined to have a 50-50 chance. S&OP stakeholders understand demand above that level isn’t likely enough to justify putting the necessary resources at risk, and if it occurs will therefore go unmet -- just like getting caught in the rain when the forecast said it would be dry: unfortunate, but leaving the umbrella at home was still the best decision. 

In business, range-based S&OP stacks the odds in your favor, and ensures no-surprises and no-excuses performance regardless of demand outcome.

S&OP: Aligning Data, People & Processes around Range Planning

To implement the steps above, S&OP stakeholders need access to the range forecast, range planning and performance management levers referenced. As a highly cross-function activity, S&OP requires a software foundation that can provide access to the required data and analytics. A good example is Steelwedge’s “open apps” S&OP system, which integrates S&OP data and enables “plug and play” integration of analytic apps such as those for range forecasting and range planning.

Planning today is broken, and the only way to fix it is to rebuild it on a realistic foundation of range forecasts and range plans. Doing so provides S&OP stakeholders with a complete view of future performance and risk, the levers to manage it, and no surprises, no excuses accountability.

Blake Johnson is a consulting professor in the Department of Management Science and Engineerng at Stanford University. He is the founder of Aztral, Inc., a provider of software and services for quantifying and managing supply and demand uncertainty in supply chain planning and S&OP. In conjunction with Steelwedge, Johnson has developed a range planning app that enables users to proactively optimize flexibility in planning.

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