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.
Conventional management practices have tremendous amounts of inertia driven by software, consulting, accounting and academic experts. Many of these practices trace their origins back to the 1930s and 1950s. Yet the world looks nothing like it did at that time. The changing global and industrial landscape is forcing companies to behave differently. But at almost every level of larger enterprises, doing what truly makes sense proves to be nearly impossible and/or career limiting. Why?
The basic physics, mathematics and economic principles are undeniable. Companies must adapt and change or their very existence is threatened. Considering this astonishing data from the Harvard Business Review:
“We investigated the longevity of more than 30,000 public firms in the United States over a 50-year span. The results are stark: Businesses are disappearing faster than ever before. Public companies have a one in three chance of being delisted in the next five years, whether because of bankruptcy, liquidation, M&A, or other causes. That’s six times the delisting rate of companies 40 years ago. Although we may perceive corporations as enduring institutions, they now die, on average, at a younger age than their employees. And the rise in mortality applies regardless of size, age, or sector. Neither scale nor experience guards against an early demise.
We believe that companies are dying younger because they are failing to adapt to the growing complexity of their environment. Many misread the environment, select the wrong approach to strategy, or fail to support a viable approach with the right behaviors and capabilities.” (Martin Reeves, Simon Levin, and Daichi Ueda, Harvard Business Review, January-February 2016)
Intuitively we know that companies must continue to drive change in order to survive. But what to change to? How to change and drive adaptation? Is there a safe and effective path to transform a company from an operating strategy developed in the 1950’s measured by accounting principles developed in the 1930’s to an agile demand driven enterprise capable of keeping pace with today’s hypercompetitive market? The purpose of this article is to show exactly what companies are missing in order to answer these critical questions.
Flow – Common Sense but Not Common Practice
The broad based appeal of “flow” seems to be obvious. George Plossl, a founding father of MRP, in the second edition of Orlicky’s Material Requirements Planning (McGraw-Hill, 1994) declared his “First Law of Manufacturing”:
All benefits are directly proportionate to the speed of flow of information and materials.
Improvement gurus such as Taiichi Ohno (Lean), Eli Goldratt (Theory of Constraints) and W. Edwards Deming (Six Sigma) founded entire improvement disciplines on the concept of flow. Early industrial pioneers such as Henry Ford and Frederick Taylor built large manufacturing empires based on this concept. F. Donaldson Brown defined the basics of management accounting on the concept of flow. Flow just makes common sense.
Plossl’s law can be illustrated by a very simple equation featured in the book Demand Driven Performance – Using Smart Metrics (Smith and Smith, McGraw-Hill, 2013). The equation shows that changes to flow directly yield changes to cash velocity which in turn influences ROI. This equation is easy to grasp for people at any level of the organization and links the velocity at which we move information and materials directly to ROI. Yet, if flow is so important and intuitive why does its effective enterprise-wide implementation prove to be so elusive to most organizations?
Ah, but there is an important caveat to this equation. Organizations cannot just quickly push large amounts of data and materials and expect to automatically reap huge benefits. In fact, the only way that data can become valuable information and those materials can be converted to cash is to ensure that both are “relevant”. Thus Plossl’s law must be amended to “all benefits are directly proportionate to the speed of flow of RELEVANT information and materials.”
With the inclusion of the word relevant, an expansion to the above equation is necessary. This expansion was also featured by Smith and Smith in Demand Driven Performance – Using Smart Metrics. This new component of the equation brings to light why an organizational strategy based on flow proves to be so elusive. It explains the frustrations with Lean, Six Sigma and Theory of Constraints (TOC) implementations and why they so often end up being simply lip service or merely a “program of the year” in larger organizations.
What directly impedes better flow across organizations is variability. The more variable an environment; the worse the flow. In our more complex and volatile world, variability seems to increasing at a faster rate than we can compensate for it. So, must we give up the quest for flow? Is it simply a pipe dream to never be achieved like the pursuit of perfection? The key to managing variability is to create visibility to relevant information. When information is irrelevant, the picture is distorted, variability is exacerbated, flow breaks down and ROI is adversely impacted. Thus, the starting point for any company to transform into a flow-based model is comprehending and gaining visibility to relevant information.
The Prerequisites for Relevant Information
There are four prerequisites to gaining visibility to relevant information that promotes and protects flow:
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. There are two specific relevant ranges that a business executive must understand and connect in a bi-directional adaptive fashion in order to make flow a sustainable and effective reality. These two relevant ranges are the Strategic Relevant Range and the Tactical Relevant Range. The Strategic Relevant Range is typically measured in monthly, quarterly and annual time buckets that covers business planning and strategic direction setting. The Tactical Relevant Range covers the hourly, daily and weekly time buckets encompassing normal operations. The assumptions and information that are valid and relevant within these ranges will differ dramatically. For example:
- Forecasts are relevant for the strategic range, not the tactical range
- Fixed expenses are variable in the strategic range, not the tactical range
- Work order delays are relevant for the tactical range, not the strategic range
- A machine breakdown is relevant for the tactical range, not the strategic 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 a break down in flow.
2. Flow-Based Operating Model
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. Is there a flow-based operating model that can meet all of these diverse requirements and makes sense to all levels of the organization?
3. Flow-Based Metrics
The metrics must take into account the above two prerequisites; the flow-based operating model and the differing relevant ranges. Metrics that are inappropriate and/or directly inhibit the flow of relevant information and/or materials adversely impact ROI. Thus, there must be a set of flow-based metrics for the Tactical Relevant Range and a set of flow-based metrics for the Strategic Relevant Range that are specific to the flow-based operating model.
4. Tactical Range and Strategic Range Communication Loop and Integrated Reconciliation
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.
When reviewing the common sense of a flow-based strategy and its prerequisites we come to the basic problem statement:
Companies lack an effective organizational model, metrics and a 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.
In part 2 of this article we will introduce a new framework for operating complex organizations using flow as the underlying principle. This framework is called the Demand Driven Adaptive Enterprise (DDAE) model. This model incorporates the above four pre-requisites and has a well-established development path for organizations to implement it.