A 3 Part Series by Henry Camp, President of Shippers Solutions
Part I: Forecasting is Not Your Only Option
For the last (I don’t want to admit how many) years, I have been delving into supply chains around the world – China, Central America, Germany, Italy, India, Russia, you name it. I’ve developed some insights and expertise over that time because I love to understand how complex systems work – call me crazy. I’ve made money consulting but mostly buying and operating companies. The result of all is Shippers Solutions now offers a new kind of SCAAS (Supply Chain as a Service) approach for both manufacturers and Distributors. We call these offerings Supply Stream and Super Distributor. If you have problems with shortages and surpluses, let us know. We can help, while you focus more on your main business.
Companies often look to Enterprise Resource Planning (ERP) systems to better control availability and inventory levels. Unfortunately, even after spending a great deal of time and money to install and maintain such software, substantial bottom-line damage materializes, because ERP systems rely on forecasting. Expectations were that improved controls and processes would, in and of themselves, drive greater profits. This thinking is analogous to buying a new car and expecting it to both decide where you want to go and drive you there.
The power of ERP systems is collecting data from different parts of a company and sharing it across the company with managers who require it to make decisions. At the end of a month, financial statements are produced which show the results of the whole company and its various divisions. Without such an instant sharing mechanism, management’s decisions would have to be made in the dark or delayed until the requisite information was collected and disseminated.
This all sounds wonderful. If so, why don’t investments in ERP systems reliably deliver stunning returns? In order to boost profits over the long term, a previous limitation must be removed or overcome to some extent. In other words, the company must gain competitiveness or reduce expenses. Since ERPs are both pricey and add significantly to expenses through greater complication, one expects that they allow companies to address the market in ways their competitors will not or reduce the costs of operation.
Of course, sellers of ERP systems readily identify the solution their software delivers. It is the “P” in ERP which stands for planning. With proper planning for the entire enterprise’s resource needs, the system promises to have the right products in stock to allow the company to better serve its customers. Previously, such data could not be gathered and compiled fast enough, even with an army of clerks.
Being in a position to serve customers better is precisely the right goal. After all, the company loses profits every time it is out of stock for longer than a customer is willing to wait for a product. Inventory is the means of protecting sales. To state it more rigorously, the only purpose of the inventory is to protect sales. Holding more than what might be needed until more can be procured or produced means over-investing.
Therefore, inventory is the critical resource for which the ERP system plans. Knowing in advance what customers will buy means perfect availability without holding inventory. The rub is that planning for the needed inventory is based on a forecast that is always wrong. In fact, Chaos Theory holds that it is theoretically impossible for any predictive system to yield convergent outcomes for chaotic systems, such as when and how much customers will buy.
With current supply chain disruptions occurring worldwide, there has never been a more important time to have an accurate forecasting system in place. But this is not the first time we have suffered a crisis of shortages. Many of you will recall that retailers, using the best, most expensive ERP systems available, forecasted their need for consumer goods for the 2008 Christmas season to be far greater than what was sold in 2007. Due to long lead times from suppliers, many of which are located in the Far East, orders were placed months before the financial meltdown of the fall of 2008. The resulting drop in demand caused surplus inventory worldwide, leading to the large and prolonged reductions in purchases that we call a severe recession. That was a major failure in planning. It couldn’t be done accurately back then and it certainly can’t be done today in the aftermath of Coronavirus supply chain disruptions.
At Shippers Solutions we don’t think ERP systems should go away. The ability to gather, compile and share huge amounts of data is still required. However, we concluded years ago that there is an overwhelming need to become independent of their forecasts.
Instead, Shippers’ strategy is to focus on improving flow to manage the pools of inventory that protect sales, to the point that the dual goals of better availability with less inventory are met. Far more powerful than trying to guess what will be consumed is speeding the supply chain’s reaction time to sustain the protective pool of each product.
If products used and sold are replenished quickly, the system becomes much more responsive, especially if its inputs are facts, instead of guesses. In other words, links in the supply chain react to actual customer demand. Customers buy more when they get what they want rather than suffer from forecast-based shortages. Speeding the flows of goods through such a supply chain reliably reduces the inventory investment of its links as well. Everybody wins.
This in no way implies that variability in demand and replenishment times become things of the past. There is still a requirement for inventory to protect against shortages. The question is: how much should be held? Pools of inventory must provide a sufficient buffer during periods when the quantities going out are temporarily in excess of the quantities coming in.
These buffers should be enlarged if the lead time to get more increases or the sales rate improves. Since holding more inventory than what is needed to protect sales is a waste, buffers should also shrink if demand falls off and when suppliers are able to respond more quickly. Likewise, it may be possible to reduce buffers when the variability of either demand or replenishment times diminishes. We will share a typical example in our next blog.