To understand what strategy is about and how it should direct our approach S&OP, a good place to start is the model devised by Michael Treacy and Fred Wiersema in their book The Discipline of Market Leaders.
Market leaders are companies that outperform their competitors over a longer period of time, not 2 or 3 years, but consistently over 10, 15 or 20 years. Their first finding is that market leaders make a choice as to how to compete in the market place – they opt for Operational Excellence where they choose to compete on price, Customer Intimacy where they seek to provide the best total solution, or they go for Product Leadership where they offer the best product.
The second finding is that, once they’ve made a choice, every fiber of the organization focuses on executing that choice. They create a cult-like culture to the extent that when you enter the building and talk to the people, you feel the strategic choice that a company has made. So how does strategy influence the S&OP process?
Strategy 1: Product Leadership
A product leader, whether it is a science company like 3M or a CPG brand like P&G, is often technology driven. They have certain competencies and are continuously looking to combine and recombine them to create superior products.
Whether it is about future or current markets, they look for high growth and high value add niches. They assess risk by understanding technological evolution and potential disruptors. In summary, you could say the segmentation at a product leader is technology-driven.
Strategy 2: Customer Intimacy
A Customer Intimacy player delivers a total solution. Instead of being technology driven, a customer intimacy player is more customer-driven. This strategy involve building total solutions which leads to large portfolios with a lot of SKUs. Some of them may be produced internally others may be bought.
Customer Intimacy players have complex portfolios, so the main complexity is downstream of the supply chain. For such companies it is crucial to segment A, B and C customers. It is equally important to segment products into A, B and C products. This helps to identify the optimal forecasting approach for each segment and which products to prioritize in case of shortages.
Strategy 3: Operational Excellence
Then we come to the Operational Excellence player. Whereas a product leader is technology driven and a customer intimacy player customer or solution driven, an Operational Excellence player is cost and efficiency driven.
Here you segment customers based on the cost-to-serve. Visibility on the cost-to-serve helps to better manage expectations, pricing and margins, which are often razor thin. You segment products based on the total-cost-of-ownership (TCO). Again, better visibility into TCO will help in better managing expectations (for instance availability), pricing and margins.
If we believe every company needs customer-product segmentation to plan effectively, the drivers for the segmentation should be strategy-dependent – technology driven at a product leader, more volume and margin driven at a customer intimacy player, and more cost-to-serve driven at an Operational Excellence player.
Product Management Review According To Strategy
Different strategies also lead to a different focus in the product review. Product leaders have a high innovation rate. Take a company like 3M. They will step out of the market when growth disappears. They aim for least one third of their sales to comes from products developed within the past five years.
This implies a frequent introduction of new product categories, often pulling together completely new supply chains. It could be over existing assets and with existing suppliers with new materials combined in new ways over different sites and partners, and in different variants.
Equally crucial is the scaling down or phasing out of product categories that are no longer delivering the anticipated growth or margins. These are the key challenges for product management at a product leader. You could say it plays at a category level and is about scaling up or phasing out complete supply chains. 3M once was in VHS video cassettes. They stepped out long before it became a commodity.
For a customer intimacy player, it is much more about controlling the complexity of the customer-product portfolios. A good metric is analyzing margin over inventory. That may be negative on an individual SKU but it needs to be positive on a customer level or on a product group level. Complexity creates costs and means extra capital (working capital and/or fixed assets) is employed, such as higher inventories (more slow movers) and more DC space (either owned or rented).
Good complexity adds ROCE (Return On Capital Employed) whereby the margins are high enough to compensate for the increase in complexity. Bad complexity reduces ROCE whereby the margins do not compensate for the increase in complexity. Pruning the customer-product portfolio to keep it healthy is the key challenge of the product management review at a customer intimacy player. You could say that instead of on full product categories, the focus in more on specific SKUs. At a product leader it is about cutting trees, here it is about cutting branches or leaves.
An operational excellence player doesn’t like complexity as complexity drives cost. They will continuously apply the pareto principle where 20% of customers and products drive 80% of the volume.
In this world, fast movers drive efficiency and efficiency keeps costs low. Think about hard discounters like Costco in the US or Aldi and Lidl in Europe. Where a traditional supermarket may have 10,000 to 15.000 SKUs, a hard discounter may have 1,000 – 1,500. They will cut the assortment as much as possible while still offering enough variety to bring traffic. They continually monitor the contribution per m² in the stores or in the distribution centers, focusing very closely on how each SKU sells.
Demand Planning According To Strategy
With regard to forecasting, the key challenge of the Product Leader is forecasting new products. Imagine you are Apple and you are about to launch the Apple Watch. How many do you think you are going to sell? You can easily be off by a factor of 10. Product Leaders will reduce the uncertainty of new product demand by performing market testing e.g., testing at key distributors or by mining data from specialized social media forums.
Product Leaders have a lot of volume uncertainty or volume variability. These are also good candidates to apply judgmental techniques like the Delphi method.
Because of the large customer-product portfolio, customer intimacy players have mix uncertainty or mix variability. Our overall volume may be relatively stable or predictable; the key challenge is predicting the mix. This is where we see collaborative forecasting with A-customers for A-products. That combination may account for 50% of your volume.
You have to get these right. At the same time you don’t want to waste salespeople’s time on forecasting the long tail of C-customers and C-products. Here you want to maximally rely on statistical forecasting or push to make-to-order so you can avoid forecasting on the mix level all together. If you need to take a service hit, you want it to hit the long tail. Segmentation is key to keep the service manageable, at a reasonable cost, and without slow moving inventories or excessive write-offs.
Operational excellence players will try to stabilize the demand with everyday low prices instead of promotions. They will try to work make-to-order to avoid forecasting and reduce uncertainty. Variability and uncertainty create costs and require buffers which is bad for efficiency. Operational excellence players may also be willing to sacrifice service for cost. Availability may depend upon the production schedule.
The more we simplify the portfolio and the better we stabilize the demand, the easier it will be to rely predominantly on a statistical forecast or a demand-driven pull mechanism. So yes, every company needs a forecast, but the challenges are quite different depending on the overall strategy.
Supply Planning According To Strategy
When coming to supply planning, product leaders should organize for upward and downward volume flexibility. If the forecast is 100, the demand could also be 500 or 1000. Equally likely it could be 10.
Think about fashion retailers or high-tech consumer electronics. Customer intimacy players should organize for mix flexibility. How can we shorten production lead times? Are there ways to decouple the supply chain with some intermediates or subassemblies on stock and doing the last step as assemble-to-order? Operational Excellence leaders will be focused on efficiency, and efficiency is driven by larger volumes at a constant loading.
On the flip side of production there is the inventory management. Product Leaders will need to think about strategic inventory buffers. If a business has 5-10 business lines, considering overall inventory limitation, review where the business wants to focus on to achieve efficiency and where to focus on to achieve scalability.
Doubling production in 3-6 months may require placing strategic inventory buffers. Customer Intimacy players have large portfolios with long tails. Their inventory may be driven by high safety stocks for high variability items and high Minimum Order Quantities or production batches for low demand items.
At Operational Excellence players, inventories may be driven by the optimization of production costs. We may decide to keep producing inventory in periods of low demand to keep the assets running. We may decide to produce in bigger batches to keep efficiency up and costs down. We may decide not to disrupt the production sequence even if we’re short on a certain product because breaking the sequence drives costs up.
Inventory is a consequence of cost optimization so it can hardly be managed separately. Just as different strategies drive different types of inventories, inventory management or the inventory review should also focus on different aspects.
Executive S&OP According To Strategy
And let’s finally look at the Executive S&OP. For a product leader it may focus on successful products and how to scale them up faster. It may review failures, assess the unsold inventory and review options on how to sell that off.
Executives at a Product Leader will be keen to know different Scenarios for new product launches and the required scalability. At a Customer Intimacy player, we may review profitability and growth per customer/product segment and how to prioritize in case of shortages so the desired service levels are met.
At an Operational Excellence company, we primarily review efficiency and efficiency distractors. We may decide on mitigation strategies or on cutting parts of the business where we believe sufficient margin cannot be generated.
In summary, different strategies lead to different S&OP processes. We walk the same steps, but we need a different pair of shoes.
This article originally appeared in the Winter 2021 issue of the Journal of Business Forecasting. Become an IBF member here to get the Journal delivered to your door quarterly.