The use of these tools enables the supply chain to increase profitability, because supply and demand are matched in a more coordinated fashion. One way requires a manufacturer to carry enough manufacturing capacity to meet demand from production in any period. The advantage of this approach is that manufacturer 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 demand is to build up inventory during the off-season to keep production stable year round. The advantage of this approach lies in the fact that Red Tomato can get by with a lower capacity, less expensive factory. High inventory carrying costs, however, make this alter¬native expensive. A third approach is for the manufacturer to work with its retail partners in the supply chain to offer a price promotion before the spring months, during periods of low demand. This promotion shifts some of the spring demand forward into a slow period, thereby spreading demand more evenly throughout the year and reducing the seasonal surge. Such a demand pattern is less expensive to supply. The manufacturer needs to decide which alternative maximizes its profitability through its S&OP process.
Often companies divide the task of supply and demand management into different functions. Sales typically manages 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 enterprises to coordinate these decisions and maximize profitability. The S&OP process facilitates such coordination. We illustrate the value of this coordination through further discussion of Red Tomato.
Planning and Control Steps for Operations and Supply Chain Management:
The basic steps to control the Operations and Supply Chain Management can be summarized as follows. (Some terms described below are defined later.)
- Demand history data are gathered and cleansed. A statistical forecast is run and analyzed for events or outliers that are not expected to repeat in the future.
- The statistical forecast with associated errors is reviewed with the product and brand management, marketing, and sales teams. The teams add information to the demand plan that will improve forecast accuracy.
- The demand plan is finalized with the demand-side teams and passed on to supply.
- The supply team reviews the demand plan and constrains it based on capacity availability.
- Both supply and demand review the constrained plan with the finance team and executive management.
- When the executive S&OP meeting is held, the result is the communication of a single plan: sales sells to the plan and supply produces to the plan.
- The output of S&OP is the production plan, which provides the rate of production at the family level. Resource requirements are evaluated with the resource plan.
- The production plan is the input to master scheduling and its output, the master production schedule. The MPS is typically a weekly plan at the item level with an evaluation of capacity through rough-cut capacity planning.
- Then materials requirement planning uses bill of material data, inventory data, and the master production schedule to calculate requirements for materials, resulting in planned production and purchase orders.
- Production activity control receives the output of MRP and detail planning, and final assembly scheduling is done.
The strategic activities of business planning, resource planning, and S&OP are discussed in more detail next.
The business plan is a thorough and disciplined preview of what the firm hopes to accomplish with its products and services over the long term, with emphasis on the plan year. The business plan is typically stated in dollars and grouped by product family. There may be overly optimistic projections from marketing at some points, but the numbers are there for later review as well as to specify projected revenues, costs, profits, and objectives for the product families all to support the long-range strategy proposed for entering the marketplace. Key inputs to the business plan include the demand plan and its long-term forecasts. Budgets and projected financial statements are key outputs.
A business plan should do the following things:
- Clarify strategy by stating an explicit vision for the business – a reason for being.
- Provide a point of reference for developing the sales and operations plan.
- Describe long-term strategies that will be used to guide shorter-term tactical plans for producing and selling the product.
The next steps after the business plan are development of a long-term resource plan and a near-medium-term sales and planning the Operations and Supply Chain Management, based on the longer term views of the business plan. It’s time to start investing in capacity and then using that capacity to make money and provide the lenders and investors with the return on investment (ROI) they anticipated when they signed on as financial partners in the enterprise.
Resource planning, sometimes called resource requirements planning, takes the longest view of the system’s capacity, typically going out 15 to 18 months but sometimes requiring much longer planning horizons for capital investments. Resource planning is defined as:
Capacity planning conducted at the business and production plan levels. The process of establishing, measuring, and adjusting limits or levels of long-range capacity. Normally based on the production plan but may be driven by higher-level plans beyond the time horizon for the production plan, e.g., the business plan. It addresses those resources that take long periods of time to acquire.
The duration of the planning horizon depends on the lead time of the needed resources, which may be a machine to produce the planned product. The total lead time needed would include not only installation time but also the lead time needed to conduct Operations and Supply Chain Management. Equipment or facility construction with long development lead times may be driven primarily by the business plan, while realigning existing facilities and the workforce to change capacity is more likely to be based on the production plan generated during the S&OP process. Note that capital expenditures in facilities or expensive equipment is an executive-level decision, while the resource planning that is based on the production plan is more likely to be a supply chain management decision. Resource planning is revisited later in the discussion of capacity.
Sales and Operations Planning (S&OP)
Sales and operations planning, which we first looked at in Section A regarding using its meetings to synchronize supply and demand, is discussed further in this section, with an emphasis on the overall S&OP functions and process.
Sales and planning of Operations and Supply Chain Management rests on the assumption that firms wishing to compete in the expanding global marketplace can and must break down the silo walls between functions and break through the barriers separating supply chain partners. In fact, S&OP is intended to be a planning and controlling tool not just for manufacturing but also for the entire enterprise. Breaking down those barriers, however, doesn’t always happen quickly and easily.
The most important consideration is the understanding that the plan to generate enough capacity to match supply with aggregate demand must be created, executed, and monitored in collaboration with sales and other functional areas, not in isolation.
The following aspects of S&OP are explained next:
- S&OP functions.
- The S&OP process.
- Contributions to S&OP.
Sales Functions for Operations and Supply Chain Management:
Functional areas within a company and supply chain partners on the outside are accustomed to developing their own plans, controlling their own information, and determining their own actions. S&OP can’t function if those assumptions, and those barriers, remain in place. The basic premise of S&OP is that there should be one plan to unite all the major functions—sales, operations, and finance. Further, S&OP assumes that key players, including executives, will agree to the unified plan, carry it out tactically, and continuously monitor and adjust it in monthly S&OP meetings. As S&OP consultant and author Thomas F. Wallace puts it, “S&OP is as much about institutionalizing communications throughout the organization as it is anything else.” If, as Wallace states, you “get all the facts on one sheet of paper” reviewed jointly by the key players monthly, communication has to happen, facts have to be recognized, even if they are negative, and decisions have to made, debated, and acted upon—before the next meeting.
S&OP stands both for the sales and operations plan and sales and operations planning. It is both a plan and the process that creates, implements, monitors, and continuously improves the plan. S&OP is all of the following.
- Link between business planning and tactics. S&OP forms a link between the vision in the strategic and business plans on the sales side and the practical details of the tactical plans on the operations and supply chain management side. The executives of the company are responsible to investors and to one another for making the projections in the business plan a reality. S&OP brings the executives directly into the planning process.
- Provides opportunities to be proactive rather than reactive. The monthly meeting is a chance for executives to respond to changes in economic trends and market conditions as they are occurring.
- Definitive short-to medium-term plan. The sales and operations plan is the definitive statement of company plans for the near to intermediate term – typically 12 to 18 months or more. It covers enough time to enable planning for resources and to support the annual long-range business planning process.
- Unified, cross-functional plan and process. S&OP brings together a planning team that reconciles all of the functional business plans—not just sales plans and marketing plans, but engineering and development, manufacturing, sourcing, and financing plans—into one unified plan and one unified process.
- Bridge between customer value and supply chain efficiency. The S&OP process integrates the tactical focus of the Operations and Supply Chain Management side with the customer orientation of the marketing and sales side. There is an inherent tension between the needs of the customer and the evolving quality standards of the supply chain. Reducing cycle times, squeezing out unnecessary inventory, paring down the number of partners, practising lean manufacturing, and focusing relentlessly on quality may result in a swifter, more agile supply chain, but that can come at the expense of the end customer if marketing isn’t there to keep a close eye on the final product. In common terms, cheaper and faster are not always better from the customer’s perspective. After all, quality is “conformance to requirements or fitness for use.” Nor, on the other hand, is the perfect product always affordable from an operational standpoint. S&OP integrates the sales and marketing perspective with the operational perspective so the inherent tension between the two can become a creative force that drives the business.
- Incentive to engage in continuous improvement. Not merely a plan, S&OP’s (usually) monthly meetings incorporate replanning from prior months. This continuous review and improvement should incorporate appropriate metrics for evaluating results against plans.
All functional areas involved in the sales and operations planning process should submit annual budgets for review by finance. The final plan should merge and reconcile all functional area plans and be reviewed by senior management. Budgeting is part of the annual update of the business plan.
S&OP culminates in a monthly executive meeting to get agreement on a plan to balance supply with demand, but it requires two weeks or more of team member preparations and preliminary meetings. S&OP can be run on a different timetable, but monthly data collection, analysis, and meetings are typical.
Wallace created a five-step S&OP process, which is presented next in more detail. Note that the additional meetings discussed by Crum (product review and financial review) may also occur, but to keep the steps consistent with Wallace the product review is discussed as part of the demand planning phase and the financial review is discussed as part of the supply planning phase, though each could be considered to be separate steps. [This lecture is a part of supply chain management courses and logistics management courses, which are covered during the diploma in supply chain management and online mba supply chain management at AIMS]. The monthly S&OP process includes the following steps to review the data and make course corrections as necessary.
Data gathering. Shortly after the end of the month, all the files necessary to develop the new statistical forecast should be updated. This needs to be done quickly to keep the process moving ahead on time. However, timing the S&OP process to begin after the best data are available each month is a best practice.
The demand planning phase. Product and brand management, marketing, and sales representatives review the data and issue an updated medium-term demand plan for current and new products. The demand plan should be reviewed by a senior sales and marketing executive before being entered in the S&OP files. Sometimes this process is called a marketing/ sales handshake because it requires coming to an agreement on a request for product and coordinated demand-influencing activities. The product and demand review meetings discussed in the prior section occur as part of this process.
The supply planning phase (capacity). Based on the demand plan, the supply management team may alter the production plan and revise the S&OP data to meet the demand plan as closely as possible. The role of the supply management team is to identify any constraints that would prevent Operations and Supply Chain Management from being able to satisfy the demand plan. This process is sometimes called the operations handshake because it requires operations professionals to agree on production plan recommendations that could best fulfill the demand plan while keeping Operations and Supply Chain Management profitable. The supply review meeting is used to finalize supply plan recommendations. Based on the demand plan and any alternative supply plans, financial professionals review the demand plan and any alternative supply plans to determine the financial feasibility of meeting the plans and assess how well the plans fulfill the business plan goals. Finance meets in a financial review meeting to recommend the plan that best meets financial goals.
The pre-meeting. Key players assemble to review the data and set the agenda for the final step, the executive S&OP meeting. Team members at the pre-meeting typically include people from prior steps, at least one person from the finance area, and the S&OP process owner, the demand manager. Other pre-S&OP team members might include a number of key supply chain managers and other area managers, such as the plant manager, the logistics manager, the product and brand manager, the customer service manager, and the accounting manager. Again, the purpose of this step is to identify areas where consensus can be reached without needing executive input and to add the more contentious items to the executive review agenda.
The executive meeting. The monthly executive meeting should include the CEO and vice presidents from sales, marketing, finance, operations and supply chain management, and so on. The purpose of this meeting is to provide executives with a broad understanding of supply and demand issues and to allow them to exercise control over the organization’s direction if it is not in line with business plan goals. The assembled executives may accept the decisions and the numbers forwarded from the pre-S&OP meeting, or they may take another path. They will make decisions pertaining to each product family, authorize any decisions with significant financial implications, and compare the demand plan to the business plan to see if actions need to be taken to bring them in line with each other (e.g., additional marketing activities).
Contributions to S&OP
Sales and operations planning approaches tactics at the level of aggregate supply and demand. It deals with overall capacity in the system, gross volumes, and product families. Families are “a group of end items whose similarity of design and manufacture facilitates their being planned in aggregate, whose sales performance is monitored together, and, occasionally, whose cost is aggregated at this level.” Thus this level of planning is at a higher level than individual products and specific work centers. The mission of S&OP is to keep supply and demand in balance, and this balancing act starts at the level of product families.
The specific contributions to S&OP represent the demand side, where sales and marketing take responsibility; the supply side, where operations and supply chain management does the capacity research; and finance, which does the financial goals analysis. The results are merged and reconciled so that aggregate demand and supply are in balance and meet business and financial goals to the extent possible.
Product and Brand Management, Marketing and Sales Contributions in Operations and Supply Chain Management:
The following contributions go into the planning process from the demand organization for review by the full team:
- Demand forecasts. S&OP receives time-phased (e.g., demand per month) forecasts of expected demand (customer orders) arranged by product family.
- Demand plan commitments. Product and brand management, marketing, and sales are responsible for developing and implementing realistic strategies and tactics to achieve the goals and revenue objectives stated in the business plan—for the near and medium term. For example, product and brand management may plan new product launches and determine life cycle impacts of events. Marketing sets pricing strategies and performs competitive analysis. Sales strategy includes number and type of salespeople, sales territories (by geography, product, customer type, etc.), and sales and marketing approaches.
- Demand plan numbers and assumptions. Along with customer order forecasts and commitments to action, the demand organization contributes estimates of the results of their efforts expressed both in the units (e.g., volume, numbers, weights) and the revenue dollar equivalents, along with all underlying assumptions.
- Market analysis. Marketing contributes research and analysis of market opportunities; selection of target market segments; development of strategies for capturing a share of those markets; and development, management, execution, and control of marketing plans, programs, and projects.
Operations and Supply Chain Management Contribution:
Operations and Supply Chain Management makes the following contributions to the plan, to be reconciled with the numbers and strategies from the sales and marketing side:
- Output and resources. Products are grouped into families, with specific output targets for each product family during the planning horizon (usually 12 to 18 months). These targets include the following:
- Overall level of manufacturing output and other activities to meet planned sales levels (by product family, not specific product).
- Inventory levels: make-to-stock.
- Backlog levels: make-to-order backlog is defined as “all the customer orders received but not yet shipped; sometimes referred to as open orders or the order board.”).
- Required plant, equipment, labor, and material resources for each period in the plan (resource planning).
- Product families. For purposes of the S&OP, product families need to be established on the basis of similar operations capacity requirements: “Like capacity” items are grouped together so that the resulting production plan can be used directly by operations and supply chain management. While each part of the organization may create its own product families for internal department planning purposes, such as sales creating families based on similar market appeal, the integrated nature of the S&OP process requires that everyone use the same product families.
- Operations constraints. Given a request for product in the form of a demand plan, a primary input from operations and supply chain management involves evaluating whether there is sufficient capacity over the planning horizon to meet the plan for each product family. Information on site and work center bottlenecks is provided as needed to support recommendations. Constraints can sometimes be alleviated by operating above or below optimal capacity or by altering operations strategies or supply-demand strategies. The latter two are discussed next.
- Operations strategies. The level of output for periods in the plan can be determined according to a level production strategy, a chase production method (also called a chase strategy or chase-demand matching), or a hybrid of the two.
- A level production strategy aims for the same output in each period (e.g., each month). The level amount is based on the average of demand forecasts for each period with some modifications for desired inventory levels. For example, Porta Potty, a portable outhouse manufacturer, has seasonal demand spikes but produces the same number of units all year round. Levelling offers the benefits of simplicity and, from operations’ viewpoint, predictability (no last-minute hiring of temps or layoffs). The tradeoff is the potential for inventory to pile up during periods of low demand or for stockouts if demand spikes upward.
- A chase production method is defined as “a production planning method that maintains a stable inventory level while varying production to meet demand.” This results in demand matching, which aims to match production to demand for each period. For example, restaurants often use chase methods by maintaining a part-time workforce that can be scheduled as needed and altering purchases based on projected demand. Manufacturers sometimes pursue this method by producing different goods for different seasons (e.g., K2 produces skis and in-line skates).
The benefit, if the strategy succeeds in producing only what is demanded, is a reduction of inventory costs. On the negative side, resources must be ramped up during periods when demand is high, with increases in costs for overtime, additional hiring, training, etc. Layoffs may be necessary when demand falls, resulting in loss of competent, trained workers who may not be available for rehiring when demand picks up again. Finally, plant capacity has to be built up to produce at the highest level of demand rather than at an average level.
- A hybrid strategy combines elements of level and chase production to keep the plant running near full capacity for part of the cycle, allowing inventory to build up, and then slows or shuts down to allow the inventory to shrink as customers buy the product. A large number of organizations use hybrid strategies. For example, Lego manufactures toy building blocks using one shift for the first half of the year and adds another shift in the second half of the year for holiday season demand.
- Supply-demand strategies. For each product family there should exist one of three operational approaches for determining when to produce the product in relationship to customer orders (that is, before or after the order). The three strategies are make-to-stock, make-to-order, and assemble-to order:
- The make-to-stock approach is defined as follows:
- A production environment where products can be and usually are finished before receipt of a customer order. Customer orders are typically filled from existing stocks, and production orders are used to replenish those stocks.
- This is essentially a mass-market strategy that works well when demand is stable and products turn over rapidly. For slower-moving products or products with unstable demand, the risk here is inventory build-up and, in some cases, product obsolescence. In the computer industry, for instance, components age rapidly toward obsolescence.
- The make-to-order approach is defined as follows:
- A production environment where a good or service can be made after receipt of a customer’s order. The final product is usually a combination of standard items and items custom-designed to meet the special needs of the customer.
- This is suitable for custom work. If delivery lead time is not an issue, the product can be tailored to a customer’s exact specifications.
- A similar approach to make-to-order is engineer-to-order (or design-to-order). Engineer-to-order products are defined as follows:
- Products [that] require unique engineering design, significant customization, or new purchased materials, depending on customer specifications. Each customer order results in a unique set of part numbers, bills of material, and routings.
- Assemble-to-order (or finish-to-order) is “a production environment where a good or service can be assembled after receipt of a customer’s order.” In addition, package-to-order is “a production environment in which a good or service can be packaged after receipt of a customer order.” Assemble-to-order products are partially manufactured and inventoried to await orders. This allows mass customization of products without long lead times and works well with products that can be tailored to customer taste by exchanging a limited number of modular components. A computer, for example, can be assembled from standard—but highly varied—components. The focus of master scheduling is then on scheduling the manufacture of the modules or components and on final assembly. One of the challenges of the assemble-to-order approach is the need to have “reasonably skilled” labor to do the assembly. Distribution centers are not always eager to train or hire workers to do assembly.
- Actual results and other data for performance metrics. The supply organization provides data on actual production amounts per product family and other historical data such as information on actual capacity limits versus planned limits. They may also provide other data for planning and feedback purposes such as changes to inventory metrics.
As stated in Section A, finance reviews the demand plan and the proposed production plan for financial feasibility and fit with business plan goals (especially financial goals) and may make a recommendation on the plan that makes the most financial sense if competing alternatives exist. With its focus on breaking through functional barriers, the S&OP approach to aggregate planning integrates perfectly with supply chain management thinking. Instead of the traditional practice of first developing a sales plan and then asking operations to develop tactics to implement it, S&OP brings together sales, marketing, finance, operations and supply chain management, and other key players to produce an integrated plan that incorporates and reconciles the views of all functional areas.