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Demand Driven Series: Why do small problems magnify in supply chain management?

In the previous blog as part of the Demand Driven series – Time to break out of the traditional mould – I outlined our ability to accurately predict future customer demands and how it is increasingly becoming challenging. Forecast error at SKU level – the level required for planning systems – is under pressure and is underperforming when compared with the efforts employed in improving its accuracy.

Leading supply chains often claim nearly 70-80% accuracy in their forecasts. So, why do we still see working capital pressure in these organisations? Why do perpetual service level pressures exist and why are returns strained on the capital employed, with a forecast error of 20-30%?

At the core of the problem we find that supply chain practitioners have done themselves a disservice. We have allowed our “thinking of” and “approach to” supply chains to be focused on each individual function in a linear fashion. We have not approached the supply chain as a whole system.

Systems thinking is vastly different from linear thinking. A linear approach attempts to optimise each individual function with a goal to achieve the best supply chain performance, but this all too often leads to below par outcomes across an enterprise.

This manifests in our performance metrics and measures, where we regularly drive people and functions across our supply chain into direct conflict with one another, and sadly, also with the customer. We aim to have “balanced scorecards,” but in many cases, KPI’s on these score cards become “conflict generators” and not “coherence drivers”. This results in our teams being placed in a position of conflict and friction.

Consider the following examples:

Cost Reduction KPI’s: Whilst well intended, businesses who heavily focus on cost saving KPI’s at a daily, operational level, negatively impact upstream and downstream supply chain functions.

For example, when focused on reducing the landed cost of goods, we often find a negative trade off in the increase of minimum order quantities (MOQ’s), particularly when sourcing from “low cost” offshore suppliers. This often results in:

  • Increased inventory and the subsequent cash required to fund it
  • An increase in the holding costs
  • Margin loss due to distress sales
  • Increased risk of obsolescence
  • Extended service level failures when volatility arrives
  • Double handling of inventory

These costs impact several other functions, and when compounded, can often exceed the original cost saving objective.

Efficiency Improvement KPI’s: Whist trying to drive efficiency improvements across individual functions, we once again find a below par system outcome.

In the replenishment instance where a downstream warehouse needs 18 units of Product A, but is required to replenish a full pallet from the supplying distribution centre (DC) of 40 units, we regularly observe:

  • The downstream warehouse’s inventory increases unnecessarily
  • Inventory holding costs escalate
  • Stock turns decrease leading to aged stock
  • Unnecessary back/cross shipment costs
  • Potential scarcity of this item across other network locations
  • Possible further replenishment at the DC is triggered

This also occurs when our factories are driven to create longer runs and produce larger batches, less frequently. Management is forced to pull the forecast forward in order to achieve these longer, more “efficient” runs. However, the result is often:

  • At the expense of consuming valuable raw materials
  • A reduction in the ability to respond to short term demand opportunities
  • Missed or double shipments as product availability declines
  • Regular line break-ins

Driving these metrics and measurements – as well as many others – has a negative impact on customer service, inventory health, supply chain resources, and ultimately pressured cash reserves. Ironically, many of these challenges have been identified in scenarios where the highest inventory levels are recorded. What follows is a swift call-to-arms as cost-cutting and blanket inventory reduction targets are set. This rapidly heightens the problem as fast-moving inventory is cut, creating customer service level implications.

In my previous blog, I highlighted that we are currently in a volatile world, now known as the “new normal”. However, we have found that the actions, behaviours, and measurements employed by management are the primary cause for variability, waste and inefficiency in our supply chains. We have simply not built our supply chains to “promote the flow of materials and relevant information.”

When we over-emphasise cost and efficiency metrics at a daily operational level, it encourages and rewards “anti-flow” behaviour. This is a high-risk strategy, which has often proved to be the Achilles’ heel for businesses, especially as seen during the still-evolving pandemic situation.

When supply chains flow seamlessly, costs are brought under control, service level and quality enhance, conflicts reduce, and return on capital employed improves exponentially.

In the next blog in the Demand Driven series, I will discuss the key components required to change, when fixing the issue of a clogged supply chain.