Most practitioners of Sales & Operations Planning would agree that the focus of an S&OP Process should be on the mid-to-long range horizon, and typically at a volume/aggregate level. However, I am often surprised when some of these same practitioners indicate that backward-looking Demand planning KPIs like Forecast Accuracy and Forecast Bias, as well as safety-stock concepts and tools, have no place in a discussion of S&OP. To the contrary, I would argue that they should be front and center!
Those of us who have worked as Demand Planners, or have overseen the function, are familiar with the saying that there is only one thing that we can say about our demand plans with 100% accuracy: “They are wrong.” This is true, but it is the degree of incorrectness that is important to understand. When we review Product Category plans during the Demand Agreement Process, it is helpful to understand what our bias has historically been. Even where we are fortunate enough to show a history of bias in both directions, it is worth knowing how “close to the pin” we are typically able to operate. This allows us to appropriately guide leadership on the confidence level and margin of error behind our estimates. This becomes even more critical within the Supply Agreement Process where decisions about capacity utilization, and in some cases regarding the expansion or idling of capital assets, are made. Without an understanding of historical bias and its drivers, we may be led astray or worse yet lead others to make bad decisions.
Given this context, some skeptics come around to the usefulness of a “rear view mirror” KPI such as Forecast Bias playing a role in our typically forward-looking S&OP Process. Forecast Accuracy, especially at a SKU level, may be a more difficult KPI to “sell.” It should not be. Better management of working capital and an improved ability to forecast cash flow are almost always cited among the objectives of a S&OP Process. As we look at our working capital, across most industries and companies we will see our inventory fall into five buckets: Safety Stock, Cycle Stock, Decoupling Stock, Anticipation Inventory, and Pipeline Inventory. While the magnitude of that first bucket, Safety Stock, may vary in magnitude relative to the other buckets and company-to-company, it is nearly always significant both in its working capital impact as well as its ability to smooth our operations and deliver customer satisfaction. In most companies safety-stock exists primarily to buffer a specific type of variability, and that is either variability in demand or, more often than not, variability between forecast and actual demand. Therein lies the importance of understanding Forecast Accuracy when working towards a best-in-class S&OP Process.
Having established the relevance of our Demand Planning KPIs, and having recognized the importance of safety-stock in achieving S&OP’s working capital objectives, we can now turn our attention to understanding what a robust Safety-Stock Planning Program should look like. Based on more than a decade of experience across three industries and three continents, as well as extensive benchmarking, I feel it is fair to say that there is no single solution to the challenge of establishing and periodically reviewing safety-stock levels. Instead, it is much more important to match organizational strengths and capabilities to an appropriate method. The much maligned “tribal knowledge” approach to safety-stock can actually be remarkably effective in an organization with tenured staff and a mature product portfolio. Sophisticated IT tools that apply statistical methods to establish safety-stocks at the appropriate nodes in a multi-echelon network can deliver amazing results for a company with the skill set, systems, human resources, and data availability to design and feed such a tool. Other methods including ABC-aligned safety-stocks, service-adjusted safety-stock, review of working capital employed, or simple statistical safety-stock all have applications. The know-how to choose the proper methods for a given organization, at a given point in time, is a skill that any practitioner of S&OP can benefit from!
Erik C. Hjerpe
Senior Director of Supply Chain
Erik Hjerpe recently presented at the 2014 Best Practices Conference at Disney’s Yacht & Beach Club Resort. Erik is Director of Supply Chain at TreeHouse Foods, a Chicago-based organization providing quality food products primarily for the private label and food-service industries. He has over 10 years of global experience across multiple industries managing facets of the supply chain, including sales and operations planning, demand planning, scheduling, logistics and warehousing, customs compliance, lean operations design, and ERP implementation.