Responding to Predictable Variability in the Supply Chain

In Chapter 8, we discussed how companies use aggregate planning to optimally plan supply. Demand for many products changes frequently from period to period, often because of a predict­able influence. These influences include seasonal factors that affect products (e.g., lawn mowers and ski jackets), as well as nonseasonal factors (e.g., promotions or product adoption rates) that may cause large, predictable increases or declines in sales.

Predictable variability is change in demand that can be forecast. Products that undergo this type of change in demand create numerous problems in the supply chain, ranging from high lev­els of stockouts during peak demand periods to high levels of excess inventory during periods of low demand. These problems increase the costs and decrease the responsiveness of the supply

chain. Supply and demand management through sales and operations planning (S&OP) can sig­nificantly improve performance when applied to predictably variable products.

Faced with predictable variability, a company’s goal is to respond in a manner that bal­ances supply with demand to maximize profitability. The goal of sales and operations planning is to appropriately combine two broad options to handle predictable variability:

1. Manage supply using capacity, inventory, subcontracting, and backlogs.
2. Manage demand using short-term price discounts and promotions.

The use of these tools enables the supply chain to increase profitability, because supply and demand are matched in a more coordinated fashion.

To illustrate some of the issues involved, let us consider John Deere, a manufacturer of agricultural equipment such as planters and combine harvesters. Demand for planters is sea­sonal, with most of the corn planting in the United Sates occurring between March and May. John Deere must plan how it will meet the seasonal demand for planters to maximize profit. One way requires John Deere to carry enough manufacturing capacity to meet demand for planters during the peak demand period. The advantage of this approach is that John Deere incurs low inventory costs because no inventory is carried from period to period. The disadvantage, how­ever, is that much of the expensive capacity is unused during most months, when demand is lower.

Another approach to meeting seasonal demand is for Deere to build up inventory dur­ing the off-season to meet demand during the peak months. The advantage of this approach lies in the fact that Deere can get by with a lower-capacity, less expensive factory. High inventory carrying costs, however, add to the cost of this alternative. A third approach is for Deere to work with its retail partners in the supply chain to offer a price promotion to farm­ers before the peak months, during periods of low demand. This promotion shifts some of the peak demand for planters forward into a slow period, thereby reducing the seasonal surge and spreading demand more evenly. Such a demand pattern with a lower peak is less expensive to supply. John Deere uses its S&OP process to decide which alternative maxi­mizes its profitability.

Often companies divide the task of supply and demand management into different func­tions, with sales typically managing demand while operations manages supply. At a higher level, supply chains suffer from this phenomenon as well, with retailers managing demand indepen­dently and manufacturers managing supply independently. Lack of coordination hurts supply chain profits when supply and demand management decisions are made independently. There­fore, supply chain partners must work together across functions and enterprises to coordinate S&OP decisions and maximize profitability. Many studies have shown that whereas top perform­ers adopt cross-functional participation in S&OP across the entire organization, weaker perform­ers have partial adoption at best. The level of cross-functional participation in the S&OP process is one of the biggest differentiators between top performers and other organizations.

First, we focus on actions that a supply chain can take to deal with predictable variability by managing supply.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.