Organizational Opportunities from the Frontline Story 3: Understanding Customer Demand | Operational Excellence Quick Hits

Speaker 1: (00:06)
In today’s session, we’re going to continue on the organizational opportunities stories from the front lines. In this example, we’re going to talk about understanding customer demand. So the background is it was a manufacturing company that made electronic components and what they were seeing was increased demand from their customers and also customers were sending in forecasts that were showing increase in demand. So the actual demand was increasing, forecasted demand was increasing. They loaded that information into their ERP system and what happened is it started to push out lead times. So when it started pushing out lead times, what they did is they communicated to their customers that hey, our lead times are going up. So you better take that into consideration. So the companies that were their customers were entering in those longer lead times into their ERP system, which increased the planning window and it said hey, we need to order more stuff.

Speaker 1: (01:04)
So they started getting more orders for stuff because of the increased lead time and then of course, that placed more demand on their system, which caused increases in lead times again. They communicate those lead times to their customer and more orders start coming in. So all of a sudden they’re getting inundated with orders because of these longer lead times and their lead times are going out to 52 weeks. So they started to see this increase in demand that was pretty much fed by the constant increase of orders due to longer lead times in their system.

Speaker 1: (01:43)
So how do we stop that from happening? So let’s talk about that a little bit today, but that was the situation that we saw and the customer was going crazy because their demand was going through the roof and exponentially increasing. So when we look at it, what happens when we have forecasted demand and increases in demand, and what happens is the lead times become longer and longer. Then of course the planning horizon becomes longer and then when those planning horizons become longer, it says hey, we need to place more orders to cover those longer lead time, those longer planning horizons and then they place more orders. The cycle just continues and it gets worse and worse and worse until what point? Until the customer can’t accept that long of lead time and they go find either a substitute product or they find the competitor that they can buy the product from with a shorter lead time.

Speaker 1: (02:38)
So you’ll actually start losing business because of long lead times. So if we look at it, what happens is it’s created the bullwhip effect. So the bullwhip effect is due to demand amplification in the supply chain. What happens is the distortion of demand increases then becomes more volatile and the further back in the supply chain, the worse it gets. So each link in the supply chain is artificially increasing due to uncertainty, which creates more demand and up upstream links in the supply chain. That’s exactly what was happening with this company.

Speaker 1: (03:13)
So how do we counter that? So let’s first understand what is the replenishment cycle? So the replenishment cycle is the time from when inventory shows up in a location until inventory of that same item shows up at the same location and that point in the supply chain. So in this case, we take this point in the supply chain, we say, okay, inventory shows up, we start the clock. Okay. Then what happens is we start consuming inventory until we hit some reorder point and when we hit that reorder point, that becomes the order lead time.

Speaker 1: (03:49)
So then we place the order for those items either to a outside supplier or we create a new order internally and that has to go through and be made. So that’s the supply and production lead time. Then of course, there’s got to be transported back to the point of consumption and we have the transportation lead time. The threes of the replenishment cycle are the order lead time, supply and production lead time and the transportation lead time.

Speaker 1: (04:14)
So how do we use that to our advantage? So first we want to reduce the replenishment cycle. So the focus should always be on reducing the replenishment cycle. So to counteract the bullwhip effect, we need to constantly focus on reducing that replenishment cycle. The opportunity is in the order lead time because our production lead times or supply lead times are pretty consistent. So the opportunity is to reduce the order lead time.

Speaker 1: (04:40)
So what we want to do is we want to move away from forecast and move towards a consumption based replenishment model. We want to cut batch sizes. So we want to run smaller batches more frequently, that’ll help reduce replenishment cycle. We want to eliminate the causes of just in case inventory. So carrying excess inventory just in case. There’s a whole bunch of just in case reasons and we want to eliminate the cost reduction mindset. So we don’t want to focus on cost reduction. We want to focus on flow.

Speaker 1: (05:10)
Also we can replace strategic inventory. So we can understand where inventory could be held strategically in what form to not disrupt the flow and not become a constraint. That’s our best situation and we can do that by using demand aggregation concepts and that’s where the leverage is. If we can aggregate demand, then we can reduce the overall inventory in the supply chain and actually respond quicker to actual customer demand.

Speaker 1: (05:35)
So what is demand aggregation? So just a simple concept here. Let’s just say we have three products that we produce. Each product has different demand over time, and you see there’s different variability in the demand of these three products. If those three products use similar raw materials, what we can do is we can aggregate that demand back to the raw material level and actually the demand becomes less volatile. So you can look on the internet about concepts of demand aggregation, but this is the basic concept. We pull the inventory back, we hold it in a more generic state and that total variation that we see in that aggregated state is less than the total variation that we see in the product level. So that’s the basic concept of demand aggregation.

Speaker 1: (06:23)
That’s our session for today. This is something that you can use in your organization to get stability in the supply chain.