Demand Driven Supply

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Contents

Introduction

Demand Driven Supply (DDS) is supply management with a heightened focus on customer demand. Unlike the traditional push-driven model where manufacturers plan their operations based on factory capacity and asset utilization, the demand driven supply model operates on a pull-based customer-centric approach and allows demand to drive supply chain planning and execution.

Demand Driven Supply is a model of supply chain planning that is an extension of the Demand-Driven Supply Network (DDSN) model pioneered by AMR Research over the last few years applied to a Total Value Management (e-)sourcing process. AMR Research defines a Demand-Driven Supply Network as a system of technologies and processes that sense and react to real-time demand across a network of customers, suppliers, and employees.

Demand Driven Supply Defined

The ultimate goal of Demand Driven Supply is the management, selection, and shaping of the best mix of customers, products, channels, geographies, and prices for the dynamic marketplace. This requires the identification of emerging, as well as existing, customer and product winners for maximum market penetration.

Companies with a Demand Driven Supply focus often use advanced forecasting applications to improve forecast accuracy and reforecast frequently. They will run what-if scenarios on multiple demand forecast variations to identify market risks and opportunities and determine an overall "best" buy from a value-based perspective. They will continually re-asses the criteria they use for forecasting, product prioritization, and market segmentation to insure that they are using the best criteria possible.

Demand Driven Supply is beneficial as it allows managers to respond proactively to deviations caused by internal and external events instead of spending their time gathering information, responding to problems, or preoccupied by ancillary tasks under demand driven supply.

The Rationale for Demand Driven Supply

The simultaneous convergence of a large number of market forces and supply pressures are increasing the stresses on a business across the board. The increasing globalization of the marketplace, the constant uncertainty of the global economic outlook, rampant inflation in energy and raw material costs, increased product customizations, SKU proliferation, and the ever-increasing rate of new product introductions are all driving a need to improve operations across the board. Add to this shorter product cycles, limited global transportation capacity, increased outsourcing, constrained market capacity, and a plethora of opportunities for supply disruption that include, but are not limited to terrorism, natural disasters, strikes, slowdowns, geopolitical events, and supplier financial failure, and the need for constant supply chain improvements becomes critical. Especially when today's consumer expects that the prices of products and services should continue to decrease.

Traditional Supply Chain Management (SCM), tailored for steady state demand periods of a product life cycle, deals poorly with rapid change. In today's market, supply chain variability is a major threat to profit margins. When one considers AMR Research's finding that companies who fail to adequately focus on customer demand incur an average cost disadvantage of 5 percent of revenue due to poor forecast accuracy, which typically has a large double digit impact on profit margins, the importance of demand driven supply strategies is rising rapidly.

Simply put, traditional SCM, which relies heavily on up-front forecasts, does not incorporate regular forecast revisions or the demand signals necessary to determine when a shift in demand is needed. (This is why the original author promotes Total Value Management and regular demand forecast updates.) A revised sourcing cycle that accounts for variable demand and incorporates demand oriented processes, technologies, and cross-functional teams is needed. SCM is no longer a four-walls activity - it encompasses every area of the business, including suppliers, distributors, and/or retailers. Only the retailers know precisely how fast the product is, or is not, moving and how likely demand is to change as a result of promotions and only the organization's suppliers know precisely how long they need to accommodate variances in demand. Demand Driven Supply can then be viewed as the balancing act of having enough inventory on-hand to meet demand spikes but not so much that sales is eventually forced to mark-down a significant amount of inventory to move it.

In addition, demand driven supply has demonstrated that the long-standing manufacturing belief that long production runs lead to higher profitability is a fallacy and that production runs that are theoretically less efficient may actually post a better ROI under demand driven supply because of the ability to shift manufacturing quickly to the most profitable products.

Demand Driven Supply Statistics

Before discussing the various stages of demand driven supply evolution, it is worthwhile to review some compelling statistics that serve to stress the rising importance of demand driven supply and why an organization needs to take it seriously.

According to the Demand Management Benchmark Report issued in December 2004 by Aberdeen Group, companies that are best in class in Demand Driven Supply outperform their competitors according to the following table:

  Gross Margin Inventory as % of Sales Forecast Accuracy
Industry Norm 12% 15% 17%
Laggards 16% 20% 26%

Furthermore, more then 85% of all companies that have implemented a program to improve demand management have generated significant improvements in performance across the board, including average improvements of 4.7% in gross margin, 24% in inventory turns, and 13% in forecast accuracy. In addition, an enterprise can expect to realize in-stock improvements of 2 to 8% (significant when the average stock-out rate is 8%, or higher), customer service improvements of 18 to 25%, productivity improvements of 13 to 20%, and purchase cost reductions of 9 to 13%.

These statistics have also been collaborated by SAP in their "Demand Driven Supply Networks: Advancing Supply Chain Management" in June of 2006 where they found that demand-driven consumer products companies can:

  • increase fill rates by 3% to 10%
  • increase production efficiencies 1% to 5%
  • decrease freight costs 5% to 15%
  • improve personnel productivity 7% to 12%
  • reduce obsolescence and waste 35% to 50%
  • reduce inventory levels 7% to 15%
  • improve asset utilization 10% to 15%
  • decrease cash-to-cash cycle 10% to 30%

In addition, SAP also found that these companies can reduce deductions by increasing perfect order fill, make better use of promotional funds based on more accurate information, and increase the effectiveness of product introductions and phase outs.

Demand Driven Supply Stages

A review of the literature indicates that there are essentially four steps or stages to DDS proficiency. Although each research group (Aberdeen, AMR Research, etc.) has their own set of terminology for the stages, they essentially agree on the definitions. This wiki will use a generic categorization of novice, beginner, intermediate, and advanced, which will be sufficient for the discussion here-in.

Novices have not yet begun the identification and integration of DDS processes and strategies into their supply chain planning and sourcing function. They still use traditional stovepipe forecasting techniques and are constantly having to react to stock outs and stale inventories.

Beginners have just set out on the DDS journey. They are still in the process of implementing basic (e-)sourcing best practices, they have just completed integration of their enterprise systems, and all key divisions, namely product management / production / R&D, sales and marketing, and sourcing, and are all starting to work collaboratively as a well-oiled team. Although they are still using traditional forecasting methods, each department is working off of the same forecasts and they are updating those forecasts before every pull cycle. Although they have yet to realize significant benefits, they are beginning to notice improvements in inventory turns, productivity, and customer service.

Intermediates have been on the DDS journey for some time. In addition to having interconnected enterprise systems and corporate experience working as one team, they are also externally connected to business partners with whom they are starting to collaborate. Specifically, they are working closely with key suppliers to insure that the suppliers can respond quickly to changes in demand forecasts and with their major distributors and / or customers to collect actual sales data on a regular basis. If necessary, they can shorten or lengthen their pull cycles to minimize the chances of stock outs or stale inventories. Intermediates notice a number of improvements from their demand-driven processes that include improved forecast accuracy, inventory turns, productivity, and margins, although these returns are not as good as their-best in class peers, who are at the advanced stage.

Advanced Practitioners have mastered DDS and have tight interconnected systems with their suppliers, distributors, and major customers with whom they collaborate on a regular basis. They have supply chain visibility on a daily basis and monitors in place that capture significant, unexpected, spikes or drops in demands and automatically alert the sourcing team that they might need to take action, which could be a combination of forecast updates, pull modifications, and / or cycle length updates. They are maintaining significant double-digit percentage improvements across the board.

Regardless of what stage a company is at, it is important for the organization to realize that successful demand driven supply will always require:

  • Harmonization
    Standardized processes, data, and technology.
  • Advanced Planning
    The integration of key supply and demand elements including logistics, production, new product introduction, and trade management as the foundation for the refinement of forecasting techniques and the implementation of advanced planning and scheduling based on optimization.
  • Increased Responsiveness
    This requires a focus on the network and the ability successfully drive forecasting and visibility past the distribution centers to the end sources of demand.
  • Adaptability
    The ability to continuously refine the integrated network capabilities to adapt effectively and quickly to changes.

Thus, any organization that wants to move forward on the demand driven journey will need to master these capabilities as soon as possible.

Demand Driven Forecasting

When forecasting in a demand driven supply model, it is important that the organization focus on channel modeling, use downstream data, and do everything possible to reduce latency.

A recent article from AMR What is Demand Sensing? noted that more than 70% of forecasting processes have been designed to determine what plants need to make and when. This sounds good until one realizes that this type of forecast fails to predict what will be sold in the channel and when. Furthermore, in traditional forecasting processes, demand modeling is based on order and shipment streams when what is really important is sales data. Furthermore, traditional demand modeling tends to based on a small number of discrete data points, which are often taken monthly, or at best weekly, when really a much finer grained view is needed.

Implications of Demand Driven Supply for Manufacturers and Retailers

Manufactures need to

  • be focused on customer service,
  • be prepared for increasing supply network complexity,
  • be as confident in demand processes as they are in their supply processes,
  • be capable of assigning strategic priority to their supply chains, and
  • have a DDS maturity that matches their application deployment.

Retailers need to

  • be slightly better than manufacturers at demand sensing,
  • forecast more frequently, and
  • increase their focus on DDS strategies to cut costs.

In 2007, AMR expects demand-driven strategies to fuel a 4% increase in SCM spending and companies with >1B in revenue will fund 34% of software purchases in the UK and 27% in the US. Furthermore, the market is shifting towards best-of-breed products that support an ERP backbone.

Demand Driven Supply Challenges

As with traditional best-practice sourcing, the first major challenge will be bringing everyone together to work as a single cross-functional sourcing team. Everyone has to work off of the same processes, the same forecasts, and the same plan.

The second major challenge will be orchestrating the implementation of new collaborative web-based technologies that will interconnect the enterprise while connecting it to it's partners on both sides. These new technologies must enable real-time capture of consumption information and new analytical capabilities that can use the regularly updated market data to refine forecasts using advanced prediction techniques.

The third major challenging will be implementing a paradigm shift that transforms reactive demand forecasting to proactive demand management. This extends beyond monitoring consumer consumption on a regular basis to joint promotion management with selected distributors and retailers to allow for anticipation of demand changes before they happen.

Successful demand driven supply sourcing strategies are built on understanding. A successful organization needs to understand its customers, its product, its processes, its performance, and its competitors. Who is the customer, what influences their purchasing decisions, and what can the organization do to increase demand? What is the end-to-end lifecycle of the product and what can be done to improve it? How can processes, systems, and methodologies be improved to allow the organization to be more flexible and agile? How is the organization performing as a whole and where are the bottlenecks? How do competitors compete on pricing, features, functions, delivery, and service and where can they out-perform in the marketplace? Answering these questions will help an enterprise define efficient demand driven sourcing processes.

Best Practices of Demand Driven Supply

Demand driven sourcing processes can also take advantage of a number of best practices.

Identify where the organization is in the demand driven journey and outline precisely what needs to be done from a people, process, and technology viewpoint to get to the next level and work as a team to get there. Bring in external consultants who are experts in demand driven sourcing and change management if needed.

Use an iterative demand management process that generates multiple "what if" scenarios at different demand volumes in the potential demand range to determine the supply strategy with the best overall value using optimization techniques. The best buy is not the supplier mix that is optimal at a specific demand, but the supplier mix that is optimal for most of the potential demands. After all, this is the Foundation of advanced Total Value Management that incorporates Procurement Lead Time Optimization.

Incentivize each member of the cross-functional sourcing team on appropriate metrics that include forecast accuracy, inventory turns, and profit targets. This will insure that everyone works off of one forecast and works together to keep it updated.

The Demand Driven Sourcing Process

As an enterprise progresses through its DDS journey, it must continuously update each step of its sourcing process to have a demand-driven focus. From a macro-level view, the sourcing process will mature as follows.

(1) Spend Assessment, Strategy Formation & Opportunity Prioritization

Price modeling and simulation to determine which products have the most profit potential will be included as an integral component of opportunity prioritization. Opportunities will be prioritized according to which have the best value from a combined bottom line perspective when profit and savings are analyzed collectively.

(2) Project Data Collection & Strategy Formation

An integrated demand forecast that takes into account retailer and market inputs is prepared as well as a methodology for updating the forecast on a regular basis during each pull cycle.

(3) eRFX & Supplier Qualification

Suppliers are qualified according to their demand-driven abilities to participate in demand planning and respond quickly to changes in demand or product cycles in addition to their manufacturing capabilities. Suppliers are also asked about their ability to scale and if they could offer discounts if demand increased beyond a certain (guaranteed) baseline.

(4) Bid Collection & Negotiation

The forecasted demand from phase 2 is updated at the last possible instance before (sealed) bids are collected or the products are put up for auction. Suppliers are asked to bid at multiple demand levels and offer tiered bids or discounts if demand should increase (based on economy of scale).

(5) Decision Optimization

Multiple what-if scenarios are run at different demand levels to determine the "best" mix of suppliers and the optimal demand allocation between the "best" mix of suppliers. The "best" mix of suppliers is the mix that can provide competitive pricing across volume levels, assist in risk mitigation (by way of overflow capacity and the ability to respond rapidly to changes in demand), and work with the organization to facilitate improvements across the board on both sides of the relationships.

(6) Award & Contract

Contracts are defined against a demand range. The buyer will guarantee a certain level of commitment, at the low end of the predicted demand range, in return for the supplier guaranteeing additional availability and discounts or rebates if demand spikes, which will allow the supplier to take advantage of economies of scale.

(7) Contract Monitoring (Performance & Compliance)

Customer consumption will be monitored regularly, at least weekly, and immediate action will be taken if a significant spike or drop in demand is noticed. This will generally be a combination of forecast updates, pull modifications, and / or cycle length updates. Collaboration with suppliers will occur regularly in joint efforts to improve productivity, reduce costs, and increase margins on both sides.

A Selected Bibliography

Building a Better Supply Chain Using the Demand-Driven Supply Network to Improve Efficiecy of Ronald S. Swift

Demand Driven Supply Networks: Advancing Supply Chain Management by SAP, August 2006

(The) Demand Management Benchmark Report: Demand Management: Profitably Dominating Your Target Market by Stanley Elbaum of Aberdeen Group, 2004

Four Fundamental Demand-Driven Steps to Achieving Supply Chain Excellence by SSA Global, March 2005

Global Trade Maturing in Time to Support DDSN by Greg Aimi of AMR Research, August 2004

Market Outlook: Sourcing and Procurement in a Demand-Driven World - A Transformation Guide for Vendors, Service Providers, and BPOs by Mickey North Rizza of AMR Research, July 2007

Next Generation Supply Chain Management: Driven By Demand by Cheryl Krivda, The Custom Publishing Group

Response to Supply Chain 'Pull' Depends on Clarity of Demand Signal by Jean V. Murphy, August 2006

What is Demand Sensing? by Lora Cecere & Robert Bois of AMR Research, March 2007

Authors

Michael Lamoureux, PhD of Sourcing Innovation

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