The Case for a Revolution in Supply Chain Management
Prime Advantage has invited industry experts to share their insights on the present and future of manufacturing success. In this post, Chad Smith of Demand Driven Institute discusses the new approaches that must be implemented for supply chain management success in today’s marketplace.
In Part 1 we discussed the accelerating rate of company failures, the key to reversing that failure rate (embracing a flow-based strategy) and the four prerequisites required for gaining visibility to relevant information. Part 1 is available here.
For review, the four prerequisites for relevant information are:
Prerequisite #1: Understanding Relevant Ranges
The concept of relevant range comes from economics and management accounting. Relevant range refers to the time period in which assumptions are valid. The assumptions and information that are valid and relevant within these ranges will differ dramatically and these differing ranges will be utilized by different personnel. For example:
- Forecasts are relevant for the longer range, not the shorter range
- Fixed expenses are variable in the longer range, not in the shorter range
- Work order delays are relevant for the short range, not the long range
- A machine breakdown is relevant in the short range, not the long range
Trying to force fit assumptions (and metrics derived from those assumptions) into an inappropriate range directly results in distortions to relevant information and materials and thus a break down in flow. Three types of relevant ranges will be discussed later in this paper.
Prerequisite #2: A Flow-Based Operating Model
A flow-based operating model revolves all operational activity around flow. Flow becomes the common basis for decision making in day to day operations. When we look at the various parts of Operations we can see a clear connection to each of their objectives and flow. First and foremost, policies, metrics and decisions in the operating model should be based on flow – nothing else unifies and aligns the organization in the same way.
Synchronize supply and demand
Ensure material/component availability
Create brand awareness and demand
Sequence activity to meet commitments
Prerequisite #3: Flow-Based Metrics
The metrics must take into account the three previous metrics prerequisites; differing relevant ranges, flow-based operating model and tactical reconciliation. Force fitting non flow-based metrics will directly lead to conflicts and distortions throughout the organization – it will obscure what is relevant! Obscuring what is relevant directly leads to more variability which in turn directly inhibits the flow of relevant information and/or materials. Thus, there must be a set of flow-based metrics that connects all relevant ranges in the flow-based operating model.
Prerequisite #4: Tactical Reconciliation between Relevant Ranges
While the assumptions and information that are relevant for decision making differ between these ranges there is still an absolute need to reconcile them on an ongoing and iterative basis. Strategy must be influenced by operational capability and performance as well as how the model might perform under predicted conditions. Operational capability must be influenced by predicted conditions and/or strategic expectations in future time periods.
These prerequisites define what it means to think, communicate and behave systemically – the only way to protect and promote flow. If an organization and its personnel do not have this “thoughtware” installed, then the flow of relevant information and materials will always be impeded to varying degrees. This directly leads to poorer ROI performance. Thus, before companies invest huge amounts of money, time and energy into new hardware and software solutions they should first consider investing in the proper thoughtware in order to gain visibility to what is relevant.
Convention and the Prerequisites for Relevant Information
The conventional approach to managing a company involves strategic, tactical and operational perspectives. Strategy is typically set by a Sales and Operations Planning (S&OP) process. S&OP feeds a forecast to a Master Production Schedule (MPS) which is essentially a tactical filter to prevent the forecast from driving MRP directly. The MPS is a statement of what can and will be built recognizing available capacity. The MPS then sends planned orders to Material Requirements Planning (MRP) for supply order generation involving date and quantity synchronization through a level by level explosion.
Convention and Relevant Ranges: The conventional approach definitely understands the need for relevant ranges but fails to manage them properly. One clear example is using fully absorbed unitized cost metrics for operational decisions. Fully absorbed unit cost means that all of the manufacturing costs are absorbed by the units produced. In other words, the cost of a finished unit in inventory will include direct materials, labor and overhead costs. Direct materials are variable costs. Variable cost is tied to unit volume NOT resources. Variable costs rise and fall with unit volume but DO NOT change on a per unit basis. Labor and overhead are fixed costs. Fixed costs are NOT affected by changes in activity level within a relevant range. Using fully absorbed unit costing metrics creates the false impression that fixed costs vary within the short range. They do not and that is why they are called fixed costs. This causes a significant distortion in relevant information.
Convention and Flow-Based Operating Models:
There are no shortages of flow based operating models that have been proposed within the last fifty years. The very essence of Material Requirements Planning (MRP) is to perfectly synchronize supply and demand while netting inventory to zero. Lean proposes a flow based model utilizing kanbans, supermarkets and heijunka boards. Theory of Constraints advocates yet another flow based model using drum-buffer-rope scheduling and time, capacity and stock buffering. Yet these flow-based models tend to have many tenuous, even conflicting assumptions, limiting each from fully achieving expectations. Most planners use spreadsheets to work around the MRP system to determine what to really order and when. Most Lean and TOC implementations are isolated to specific areas of an organization and constantly struggle against imposed corporate metrics and policies as well as the legacy MRP system. It is fair to say that convention has been lacking a practical, sustainable and adaptable flow-based operating model that meets the needs of all operational players.
Convention and Flow-Based Metrics:
Make no mistake, there are important flow-based metrics in use in conventional approaches. Metrics like on-time delivery and fill rates are flow-based. Their use, however, is countered with conflicting cost-based metrics. These conflicting metrics obscure what is relevant and introduce self-imposed variability within organizations as personnel oscillate between protecting flow and protecting cost performance. Ironically, when flow is promoted and protected, costs are under control. The inverse, however, is not true.
Convention and Tactical Reconciliation:
In convention tactical reconciliation is not bi-directional – it is a one way street. This limits the ability to drive any meaningful adaptation in the system and additionally, reconciliation is incredibly painful. Every MRP run results in massive cascading schedule changes as date and quantity changes at higher levels effect all connected lower level components. Monthly S&OP updates create massive shifts at the beginning of every month that are compounded by the MRP run.
This brings us to the real problem statement regarding a company’s inability to embrace flow:
We lack an effective organizational model, metrics and communication system that enables the ability to implement, sustain and evolve flow-based operating models at the complex enterprise level.
This problem has become more acute with the increasing level of complexity, uncertainty and volatility in today’s supply chains and the continued drive to keep attempting the optimization of old and inappropriate rules. We must have a framework to utilize the appropriate thoughtware.
Striving for Coherence
Before we get to specifics about a framework, we should recognize leadership’s basic challenge in a complex world. There are three things that management must always be carefully thinking about and managing in order to avoid organizational collapse:
- The first is working capital which we will define as inventory, cash and credit.
- Contribution margin is essentially the rate at which the company generates cash. It is selling price minus variable costs.
- Finally there is something that we will simply call customer base. This is market share, sales volume, service levels and quality – things connected to ensuring and growing a solid base of business for the enterprise.
In this graphic with these three critical considerations we see concentric circles. The outer circles are the biggest area of concern. As we move farther out we get to what can be called the edge of chaos – a real threat to the organization. The very outer ring is collapse – organization fails. Any one of these considerations going past the edge of chaos can cause the organization to fail.
Thus when any one of these considerations moves into that edge of chaos ring, signal strength will intensify, the organization will call, “All hands on deck!” to deal with that specific threat. Of course there is a tension and connection between the three. Organizations must be careful not to over compensate in one area in way or for a duration that might drive another over the edge. Management must constantly fight this battle in our highly complex and volatile environment now and in the future – that is their primary job! Some teams are much better at it than others – especially when they have a framework to tell them what is relevant.
Here are three scenarios. In each case the relative positions of each of the three considerations are plotted. Which scenario is healthier? The first scenario may represent a company that is performing relatively well with regard to contribution margin and the market but is suffering from a working capital crisis. The second scenario depicts a company that is failing to generate cash and is suffering from a working capital crunch. The third scenario is a company that is generating a high amount of cash, has abundant working capital and a well defended and growing base of customers. It should be pointed out that all three of these scenarios are simply a point in time reference; it could be the same company just at different points in time. The position and tension between our three important considerations is constantly shifting. But how can we hope to manage this highly complex picture in a complex and volatile environment?
Managing this complexity is about striving for something called coherence. Coherence is a key term in the emerging science of complex adaptive systems. “A complex adaptive system’s “success” depends on coherence of all of its parts. A subsystem’s purpose has to be in alignment with the purpose of the greater system in order for there to be coherence. Without that alignment the subsystem acts in a way that endangers the greater system it depends on. Coherence must be at the forefront of determining the signal set, triggers and action priorities. To keep coherent, adaptive agents must ensure both their signal sets contain the relevant information to direct their actions and are not at cross-purposes with the goals of the systems it depends on.” (Demand Driven Performance – Using Smart Metric, Smith and Smith, McGraw-Hill, 2013, p. 197)
With our understanding of coherence we need to then examine what the typical risks to coherence are in the modern industrial landscape something often referred to as “The New Normal”. A 2016 article in the Harvard Business Review by Martin Reeves, Simon Levin, and Daichi Ueda identified six potential risks to coherence:
- The COLLAPSE risk – a change from within or outside the industry renders the firm’s business model obsolete.
- The CONTAGION risk – shocks in one part of the business spread rapidly to other parts of the business.
- The FAT-TAIL risk – rare but large shocks, such as natural disasters, terrorism, and political turmoil.
- The DISCONTINUITY RISK – the business environment evolves abruptly in ways that are difficult to predict.
- The OBSOLESCENCE RISK – the enterprise fails to adapt to changing consumer needs, competitive innovations, or altered circumstances.
- The REJECTION RISK – participants in the business’s ecosystem reject the business as a partner.
Yet all of these risks can be managed if a business uses a framework that provides relevant information. But do most businesses even have the basics required for this visibility?
Visibility to relevant information is not just an enabler for flow, it is key for survival. Obscuring, distorting or blocking relevant information risks coherence. Here are some questions you can ask about your organization with regard to visibility and coherence:
- Are people in your organization trained to think systemically? Without the capability to think and problem solve systemically, innovation and adaptation will be severely limited.
- Do they have a common systemic language and framework to think and work within? With different vernacular, nomenclature and modes of operation for similar activity across different areas it becomes difficult for one area to relate to another – there must be constant translation.
- Do people in your organization understand the connections between departments, resources and people? Without understanding these connections, personnel cannot understand the total picture of flow. They may take actions that seem locally good but is devastating to general flow.
- Are people given enough visibility to understand the connections between departments, resources and people? Without tools and processes to ensure visibility, personnel cannot keep evolving their knowledge of the system.
- Are people discouraged from thinking and offering solutions outside of their operating area? If people are discouraged from thinking globally they will only think locally.
- Do people understand how the different forms of variability effect the enterprise and FLOW through it? Without the ability to understand where to manage variability and what variability to manage people cannot take the necessary steps to protect flow in the system.
How does your organization score with these questions? Creating visibility to relevant information and managing the risks to coherence is no trivial task but it is the only path to sustainable organizational success. The more relevant information our organization has; the more immediate and enduring success it will have – it is that simple.
Companies need an operating model, smarter metrics and a communication system that promotes visibility to the relevant information for the promotion and protection of flow and maintenance of coherence at the enterprise level. They need a blueprint and a step by step path to install appropriate the thoughtware. The Demand Driven Adaptive Enterprise model was designed as a result of this need.
The Demand Driven Adaptive Enterprise (DDAE) Model
The Demand Driven Adaptive Enterprise model is a management and operational model designed to enable enterprises to adapt to complex and volatile environments. The model utilizes a constant system of innovation and feedback between three primary components; a Demand Driven Operating Model, Demand Driven S&OP and Adaptive S&OP. A Demand Driven Adaptive Enterprise focuses on the protection and promotion of the flow of relevant information and materials across the strategic, tactical and operational relevant ranges in order to drive sustained return on equity performance.
It is neither simply right-to-left nor simply left-to-right in nature. It is both at the same time. It is a bidirectional system that seeks to drive adaptation through a cycle of configuration, feedback and reconciliation through the three components.
In Part 3 of this series will we explore the Demand Driven Adaptive Enterprise in depth.