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This chapter is from the book

The Ideal Picture of Demand Supply Integration

Figure 1-1 represents an “ideal state” of DSI. The circles represent functional areas of the firm, the rectangle represents the super-process of DSI, the dark gray (dark purple in the e-book) arrows leading into the DSI process represent inputs to the process, and the lighter gray (red in e-book) arrows leading out of DSI represent outputs of the process.

Figure 1.1

Figure 1-1. Demand/Supply Integration: the ideal state

It all begins with the two dark gray (dark purple) arrows labeled “Demand Forecast” and “Capacity Forecast.” As future chapters clearly articulate, the demand forecast is the firm’s best “guess” about what customer demand will consist of in future time periods. It should be emphasized that this is indeed a guess. Short of having a magic crystal ball, uncertainty exists around this estimate of future demand. Of course, the further into the future one estimates demand, the greater the uncertainty that exists. Similarly, the “Capacity Forecast” represents the best “guess” about what future supply capability will be. Just as is the case with the demand forecast, uncertainty surrounds any estimate of supply capability. Raw material or component part availability, labor availability, machine efficiency, and other supply chain variables introduce uncertainty into estimates of future capacity levels.

Let’s begin with a simple example as a way of explaining how the DSI process needs to work. Assume that the “Demand” side of the business—typically sales and marketing, with possible input from channel partners—goes through an exercise in demand forecasting, and concludes that three months from the present date, demand will consist of 10,000 units of a particular product. Let’s further assume that this demand forecast is reasonably accurate. (I know; that may be an unrealistic assumption, but let’s assume it regardless!) Now, concurrently, the “Supply” side of the business—operations, logistics, procurement, along with input from suppliers—conducts a capacity forecast and concludes that three months from the present date, supply capability will consist of 7,500 units. Note that this outcome is far from atypical. The fact is that demand and supply are usually NOT in balance. So, more demand exists than supply. The question is, “What should the firm do?”

Several options exist:

  • Dampen demand. This option could be achieved in a number of ways. For example, the forecasted level of demand assumes a certain price point, a certain level of advertising and promotional support, a certain number of salespeople who are selling the product with certain incentives to do so, a certain level of distribution, and so forth. Any of these demand drivers could be adjusted in an effort to bring demand into balance with supply. Thus, some combination of a price increase or a reduction in promotional activity could dampen demand to bring it in line with supply.
  • Increase capacity. Just as the demand forecast carries with it certain assumptions, so, too, does the capacity forecast. Capacity could be increased through adding additional shifts, outsourcing production, acquiring additional sources of raw materials or components, speeding up throughput, and so forth.
  • Build inventory. Often, the case is that in some months, capacity exceeds demand, whereas in other months, demand exceeds capacity. Rather than tweaking either demand or supply on a month-by-month basis, the firm could decide to allow some inventory to accumulate during excess capacity months, which would then be drawn down during excess demand months.

These are all worthy options for solving the “demand is greater than capacity” problem. The question, of course, is “Which one is the best for solving the short-term problem, while at the same time achieving a variety of other goals?”

The answer is, “It depends.” It depends on the costs of each alternative and the strategic desirability of each alternative. Because each situation is unique, with different possible alternatives that carry with them different cost and strategic profiles, the need exists to put these available alternatives in front of knowledgeable decision-makers who can determine which is the best course of action. This is the purpose of Demand/Supply Integration, represented as the rectangle in Figure 1-1. The “Financial Goal” arrow represents the financial implications of each alternative, and the “Strategic Direction” arrow represents the strategic implications of each alternative. All these pieces of information from all these different sources—the Demand Forecast, the Capacity Forecast, the Financial Goal, and Strategic Direction—must be considered to make the best possible decisions about what to do when demand and supply are not in balance.

This simple example could be turned in the other direction. Suppose that the demand forecast for 3 months hence is 10,000 units, and that the capacity forecast for that same time period is 15,000 units. Now, the firm is faced with the mirror image of the first situation. Instead of dampening demand with price increases or reduced promotional support, the firm can increase demand with price reductions or additional promotional support. Instead of increasing production with additional shifts or outsourced manufacturing, the firm can reduce production with fewer shifts or taking capacity down for preventive maintenance. Instead of drawing down inventory, the firm can build inventory. Once again, the answer to the question of “What should we do?” is “It depends.” Again, the correct answer is a complex consideration of costs and strategic implications of each alternative. The right people need to gather with the right information available to them to make the best possible decision—once again, DSI.

To further illustrate this “ideal state” of DSI, consider another example. This time, assume that the demand forecast for 3 months hence, and the capacity forecast for 3 months hence, are both 10,000 units (an unlikely scenario, but assume it anyway). Further, assume that if the firm sells those 10,000 units 3 months hence, the firm will come up short of its financial goals, and the investment community will hammer the stock. Now what? Now, both demand side and supply side levers must be pulled. Demand must be increased by changing the assumptions that underlie the demand forecast. Prices could be lowered, promotional activity could be accelerated, new distribution could be opened, and new salespeople could be hired. Which choice is optimal? Well, it depends. Simultaneously, supply must be increased to meet this increased demand. Extra shifts could be added, production could be outsourced, or throughput could be increased. Which choice is optimal? Well, it depends. The right people with the right information need to gather to consider the alternatives—again, DSI.

So far we have covered the inputs to the DSI process. An unconstrained forecast of actual demand is matched up against the forecasted capacity to deliver products or services. Within the Demand/Supply Integration process, meetings occur where decisions are made about how to bring demand and supply into balance, both in a tactical, short-term context and in a strategic, long-term context. Financial implications of the alternatives are provided from finance, and strategic direction is provided by senior leadership. However, Figure 1-1 also contains arrows that designate outputs from the DSI process. You should look at these outputs as business plans. Three categories of business plans result from the DSI process, as follow:

  • Demand plans represent the decisions that emerge from the DSI process that will affect sales and marketing. If prices need to be adjusted to bring demand into balance with supply, then sales and marketing need to execute those price changes. If additional promotional activity needs to be undertaken to increase demand, then sales and marketing need to execute those promotions. If new product introductions need to be accelerated (or delayed), then those marching orders need to be delivered to the responsible parties in sales and marketing. The vignette from the beginning of the chapter represented a disconnect associated with communicating and executing these demand plans.
  • Operational plans represent the decisions from the DSI process that will affect the supply chain. Examples of these operational plans are production schedules, inventory planning guidelines, signals to procurement that drive orders for raw materials and component parts, signals to transportation planning that drive orders for both inbound and outbound logistics requirements, and the dozens of other tactical and strategic activities that must be executed in order to deliver goods and services to customers.
  • Financial plans represent signals back into the financial planning processes of the firm, based on anticipated revenue and cost figures that are agreed to in the DSI process. Whether the activity is financial reporting to the investment community or acquisition of working capital to finance ongoing operations, the financial arm of the enterprise has executable activities that are dependent upon the decisions made in the DSI process about how demand and supply will be balanced. Lastly, those signals come back to the senior leadership of the firm that the decisions that have been reached align with the strategic direction of the firm. These signals are typically delivered during the executive DSI meetings, which are corporate leadership sessions where senior leaders are briefed on both short- and long-term business projections.

Thus, in its ideal state, DSI is a business planning process that takes in information about demand in the marketplace, supply capabilities, financial goals, and the strategic direction of the firm, and makes clear decisions about what to do in the future.

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