Impact of more than one Constraint - 4

 

Alan Barnard (at the 2006 TOC-ICO conference) asked the question whether the simple Throughput per Constraint Unit rule is valid with 2 (or more) overloaded resources. Alan used Eli Goldratt’s P-Q thought experiment for his discussion. His question is important because it is common to see businesses reduce ‘excess’ capacities to balance (or almost balance) capacities. The practice often results in two) or more concurrent constraints or ‘almost’ constraints. Since 2006 I have observed several factories that wonder why their output collapses below the theoretical capacity of their (almost) balanced lines.

I plan to show that that the Throughput per Constraint Unit rule continues to be valid using the same P-Q thought experiment. I also want to discuss this result in relation to the real World – how should companies manage resource capacities.

I would like readers to follow Eli Goldratt’s recommendation that they solve the problems – before I provide the solution and before my discussion of results. The learning experience will be greater and readers should be better able to discuss and critique my conclusions. If you are familiar with the thought experiment you can jump to the second part of this article.

The key part of the article comes at the end when the solution used in the P-Q thought experiment is discussed in relation to REALITY. The thought experiment should not lead managers to an easy solution. The tool is useful but requires thought and care.

Interactive Constraints (like machines B and D in our example)

As we have just seen interactive constraints in my little PQ factory cut the maximum possible profit from 300€ per week to just 120€ per week (that is a 60% drop!). This is what interactive constraints can do to your business – they interfere with your capability to get the most from your most constraining resource.

Cost and efficiency pressures cause many business attempts to “balance” capacities – make all resources have about the same capability. This effectively introduces a second and potentially even more constraints into a production system. For most businesses, a collapse of capacity, is the surprising result – they cannot achieve even the original constraint’s capacity. Sales and profits are damaged. Not only do sales and profit suffer because current demand is not met; customers, because of poor delivery performance, leave for the competition, a much longer term loss and probably a much greater damage. 

To maximise profits and profitability most resources must have sufficient protective (or buffer) capacity so that capacity constraints cannot interact to damage the most constraining resource’s capability. Just one bottleneck is already one too many! Because, no matter what the supply chain does – when a demand spike occurs the company must either lose the added sales represented by the spike, or the company must promise delivery it cannot physically do. If a company promises what it cannot do, then the longer-term damage of lost clients will, sooner or later, happen.

To balance capacities is a ‘policy’ (or simply the way a company works). This ‘policy’ is a kind of (fake) constraint because the policy limits how much money the business can make. In such policy constraint cases; it is NOT this (fake) constraint the business must decide how to exploit (the 2^nd step of the 5 focusing steps). The first step must be: change the faulty policy, including the faulty assumption that caused the business to balance capacities in the first place. Change the hidden assumption that resources are independent (operate in isolation) and therefore do not impact other (production) resources. A further assumption, not evident in the P-Q experiment is that resources are not subject to variability. Variability enhances negative effects caused by interactive constraints – if one breaks down the other constraints can easily be starved of work.

Observe this from the point of view of Lean and ask yourself this question: Does it make sense to reduce capacity/capability to balance capacity? Damaging your customers (because you cannot reliably supply) is a huge waste. Think about Lean as focused on maximising Throughput (and profit) and not focused first on minimising cost (waste). Consider lost Throughput as part of the waste you want to eliminate. The obstacle is managers do not view lost Throughput as waste. It is impossible for managers to put a “single definitive” number on Throughput waste – it’s an uncertain number dependent not only on what the company does, but also on client demand. On the other hand, cost ‘saved’ by firing a resource is a number you can easily determine – cost per person is in the ‘system’. (Never forget the impact firing a resource has elsewhere in your factory (because it can create interactive constraints). Also, remember how employees may react to the firing of their colleagues and friends to ‘balance’ capacities. How well will the remaining employees be motivated to help improve the business in the future?)

Observe this also from the point of view of Agile. We know that demand is uncertain, and often very uncertain at the article level. Ask yourself the question: Does it make sense to operate so close to capacity that any small spike in demand must be left to the competition to fulfil? Alternatively, does it make sense that we make promises to customers we cannot keep? To be agile means to be able to capture all demand our uncertain World sends our way. To do that we must be able to respond and capacity or capability is part of the answer.

Here is a second question: Does it make sense to keep a certain amount of protective capacity (“free” capacity) to be able to respond quickly? Protective capacity makes a company more agile, protects current Throughput and gives the business a better chance to gain new (more) Throughput.

You want your business to be Lean, but never anorexic. Lean means enough reserves to respond quickly and correctly to the changes our environment throws at it? Lean means having the stamina to win against your competitors. Anorexia will not do it.

This was some thoughts about interactive constraints and protective capacity. You may want to check out Eli Schragenheim’s blog for more about the importance of capacity buffers.

Manicouagan River Canoe Trip (1958?)  we slept under the canoes on that island … to avoid the black flies. The river is in Québec, islands like the one above are under water due to the Hydroelectric dams built since then.

Strategic Inventory Placement(Pharmaceutical, Agrichemicals…)

In many B-to-B industries suppliers produce the same basic product for several to many customers. The product may be the same, but often the packaging and (or) the labelling will be different. Labelling and packaging is often different from customer to customer, but also within a single customer packaging and labelling might well be different from country to country. Agrichemicals and generic pharmaceuticals are examples.
This variation in packaging causes inventory and availability problems that endanger suppliers’ business since clients can get the same or very similar product from another supplier. Switching does not solve the problem for a client it simply transfers it to another company. Performance is unlikely to improve in any sustainable way.
Suppliers need a solution that makes it possible to guarantee availability, with, at the same time, reducing the amount of stock in the supply chain. A robust effective solution would most probably also take some of the pressure off price.

Are Suppliers & Customers Partners, Competitors or Enemies?

Businesses in a supply chain are really only paid when the final customer, the consumer, has paid for the product – everything else is an advance payment. Every company along the supply chain is competing for that consumer’s dollar. In the B-to-B part of the supply chain a supplier and his customer negotiate price that will, to a large extent, determine profits and return on investment of the B-to-B pair. It is clearly a conflict situation since both the purchasing agent and the salesman concerned are charged with maximizing profit for their company … at least usually. Companies within a supply chain are certainly competitors.
Supply chain collaboration is a buzzword that sounds and real collaboration could be great. Whatever level of cooperation or collaboration is actually achieved, the fact remains that two parties within a chain compete. A level of mistrust is likely to remain.
In many supply chains customers throw orders to their suppliers over a wall– many times as a surprise (in terms of volume or timing). Orders can arrive at really inconvenient times. The supplier may suggest a way to solve the problem – for instance by sharing demand information. A supplier might offer a significant discount for much earlier commitments from clients. Can these proposals work?
Sharing demand information is often problematic because it seems to give away proprietary information that may get into competitors’ hands. On top of that, even if demand forecasts are shared, we all know that these tend to be quite inaccurate. Actual orders are often significantly different. Demand forecasts are inadequate and usually not so useful for suppliers.
A firm order placed well in advance sounds very attractive for a supplier (and for the client if he gets a nice discount). However reality will almost certainly catch up with the client. Close to delivery time he needs a different mix of products. He will request last minute changes to his orders. The supplier loses the discount and gains no stability benefit for his production unit.
Our problem is to find the robust, simple solution to get the best information about near term demand to the supplier’s production unit and to his suppliers. The criteria for such a solution must be something like:

1. Visible, transparent information about current demand for all stocked items (those not made to order).
2. Visibility must be such that all nodes in the supply chain have absolute clarity about the priorities to ensure correct replenishment of stocks in the supply chain.
3. The system must have a simple and dynamic way to adjust target stock levels to current demand as it changes over time.
4. A supply chain must carry stock at the most appropriate strategic locations with the following two targets: a. Minimize stock levels within the supply chain. b. Guarantee near 100% product availability.
5. A monitoring system to provide early warning of an arising capacity problem.
6. The key performance indicators that show the supplier and his customers what their respective performance levels are.

Make for Availability is a process and system that meets the above criteria. If a part of the business is Make to Order, then the two processes can be easily integrated into one mixed mode solution.
In addition to the basic criteria above, the process needs to be able to cope with:

1. Seasonality (Agrichemicals have very seasonal demand).
2. Promotions – especially in retail situations.
3. Sudden peaks in demand – for instance when the supplier gains a new large customer.
4. Sudden loss of a significant account.
5. The need to forecast longer-term demand remains – in order to support decisions about capacity changes.

In today’s business environment the technical challenges to support such a process can easily be overcome.

Selling the Concept

That companies compete for the profit of a supply chain makes the sale (of such a concept) a difficult one. In addition most purchasing personnel and their counterparts from the supplier’s sales organisation do not normally negotiate about inventory, information and availability. They are used to discuss price, product quality, product features and benefits. These people will need to master the core of Make for Availability and the corresponding business offer being made.
Before purchasers and salesmen can even talk about the solution the process must be absolutely clear for a sales or purchasing person to make a coherent offer. The solution may well be a paradigm shift for clients (or suppliers). The process may well indicate that a better location for stocks exists and should be used. There are considerable implications in the way the process must function; who will do what; where will inventories be stored etc. Not too difficult a process to understand, but a purchasing organisation must be in a position to sell the benefits in such a way that will almost certainly gain the clients’ cooperation.

Where should Inventory be located?
Do we need so much?

Below is the text from an email I received in the 90-ies (as a copy). What Chandrashekhar explains is still valid. Anyway, I thought I would post this after I found the email again by accident - especially in relation to my last post "Isn't It Obvious (part of the Learning from Experience series.)

CHICKENS

Hi Luis This is Chandrashekhar from India.

From the inputs what you have provided, ToC’s distribution / replenishment solution is the best solution. To design the solution completely you need to have past data.  I have implemented replenishment solution in the distribution of a Chicken (Shelf life of 24 hrs only).

The case was:

• The supplier had one factory from where he was supplying to more than 200 outlets in the city. All outlets were giving their next day’s requirement by afternoon 3.00 • Live birds then transported to factory by 10.00 in night.• Factory used to start the production late night and complete it by morning 6.00. the finished product was delivered to all outlets in the morning by 10.00• If a shop sells less than what he has ordered, the extra chicken is wasted.• If a shop sells more than he ordered, there is stock out and sale is lost.  17% of the rejections were taking place due to this. Sale lost – no data available

Solution:

• Instead of one delivery, now we are making two deliveries, one in morning, second in evening. • In first delivery (Morning 10.00) we supply 40% of the forecast or ordered quantity by the retailer.• At 3.00 they call up all retailers and take sale figures.
• If sale is less than forecasted, then quantity in second delivery is reduced • If sale is more than forecasted, extra quantity is supplied in second delivery.

This reduced the rejection (chicken coming back from retailers) from 17% to 6%. On one side the rejections came down, i.e. the loss of throughput is arrested on other side the sale improved by 11% i.e. Throughput increased. I hope this example will help you in developing solution for your problem.

 

 

Technorati Tags: Availability, Consumer, Cost Accounting, Distribution, Efficiency, Goldratt, Inventory, Inventory Management, Replenishment, Retail, Sales, Shareholder Value Add, Strategy and Tactics, Supply Chain, SVA, Theory of Constraints, TOC, Value Chain

Learning from Experience II

Friday Nov. 11th,2011 Eli Schragenheim will lead a workshop on Learning from Experience. The purpose is to learn how to understand the cause and effect (the why) of disturbing and unexpected results from our actions AND, more importantly to take and apply the important lessons we learn.

The stories below are all about unexpected effects that someone has experienced and that he or she could not properly understand. With Eli, we will look at such problems (bring your own!) and analyse them.

The Workshop (English) will be at the hotel Schiller in Olching (near Munich) followed by the TOC4U Meeting (mostly German) on Saturday Nov. 12th. You can register here:REGISTER or call +49 6252 795 3070 if you have problems with the German registration page.

“Isn’t It Obvious?”

Eli Goldratt’s latest book (and I think his last) is about retail. The store manager is on his way to work when he receives a call that a water main has burst in the shopping centre and that his storage area is under water. He finds out that until repairs are made he has no storage available within the shopping centre. To further compound his problems the price of other local warehousing has jumped – obviously because the know demand will be high!

The store manager comes to an arrangement with the regional warehouse that they supply he with what he needs on a daily basis to be able to sustain sufficient stock in the store. The two of them work out a system whereby the store locates its inventory at the warehouse and the warehouse replenishes the store based on whatever they order the evening before.

The surprise for the store manager is the sudden jump in performance. Before the burst water main the store was languishing somewhere near the bottom of the performance rankings. Soon after the ‘disaster’ the shop’s performance jumps to the top of the pile – not just in the region, but, for the entire chain. The store manager is at a loss to explain what has happened.

What do you think was the real cause for his sudden spurt in performance?

What can we all learn from the story?

To find out what really happened – read the book!

Technorati Tags: Availability, Consumer, Distribution, Efficiency, Focus, Goldratt, Inventory, Inventory Management, Replenishment, Retail, Supply Chain, Theory of Constraints, TOC, Value Chain

Retail – Is Shelf Space Wasted?

Every shop selling items to consumers has the same set of problems. The visible problem is surpluses of products clients apparently don’t really want. These will sooner or later result in steep discounts and write-offs. The invisible one is shortages of products that clients do want but have to find in a competitor’s shop. Both problems send consumers consciously or unconsciously to those shops where consumers have the highest chance to find what they desire.

The Retailer’s Limiting Factor (Constraint)

The number of clients that want to buy products from the retailer’s shop determine his sales and income. The limiting factor or constraint of every retailer is the number of clients he manages to entice into his store.

The more potential clients, in other words the higher the traffic, a shop has the higher sales and profits will be. Store traffic is what drives profits and every store manager and retailer’s primary concern is how to get more people into his store(s). The choice of products, the best possible location, promotions, advertising and window dressing are all designed to entice consumers into the shop. Every one of these tactics is a way to “exploit” the constraint – the number of customers that enter the store.

The limiting factor (constraint) of every retailer and shop is therefore the consumer traffic in the store(s).

Get the Most from Consumer Traffic in your Shop

Merchandisers spend a great deal of time and effort developing what the hope will be attractive products and offers for consumers. Since they have to decide well in advance they must forecast or guess what will actually attract the consumer – what products, what prices, what colours what sizes and many other parameters. Particularly fashion products (those that change from season to season) are difficult to forecast. Orders for fashion products are placed well before the first sale will be made. A good merchandiser, one that makes good decisions year in and year out is worth his or her weight in gold.

Most retailers and their merchandisers are not fully aware of the penalties of product surpluses and product shortages.

Surpluses take away shelf space from popular items, which damages sales. Surpluses must be discounted to recoup at least the investment made in the stock. Discounting blocks full price sales in three ways – a discounted sale removes the need for the article, discounts and the associated promotions tend to block popular items from view and consumers learn from experience that it is worth it to wait until discounting begins.

Shortages are not usually measured – a sold out item is celebrated as a success while the associated missed sales are often forgotten.  Every extra 100€ of full price sales brings around 50€ to the bottom line. If shortages are about the same quantity as surpluses (say 30% of sales) they represent an enormous loss to the retailer and, at the same time, an enormous potential for bottom line improvement.

Decisions on product, style, price etc. will all remain very important. The decision to have the right products in the right place has already been made by every retailer. How to do this is the concern of every retailer and their merchandisers. So far, from all the evidence of discounts and factory outlets the problem has not been solved. It looks as big a problem as it always was.

Subordinate the Organisation to the above Decision

(The decision is: to have the right products in the right place has already been made by every retailer)

The retailer’s organization, including their suppliers, should take those actions necessary to ensure the right products are in the right place at the right time. This is where most retailers seem to get it wrong. Local optimisation is the culprit. Merchandisers are measured by the prices they achieve. The supply chain is measured by the cost of shipping. Suppliers are under pressure to deliver at the lowest possible cost. It is easy to see how operating decisions are based on cost leading the biggest possible production and shipping batches. Products are often bought to cover the entire season in order to achieve the lowest possible delivered cost. This thinking forgets all about the cost of surpluses and shortages.

This focus on delivered cost is the source of the huge penalties in shortages and surpluses. These penalties are a big multiple of the costs savings due to big batches.

Shouldn’t the supply chain must be charged with minimizing shortages and surpluses first and production and shipping costs second.

Expand

Once the supply chain has reduced shortages and surpluses customers will soon learn that the retailer’s shop is a good place to visit. There is a high chance the consumer will find what he is looking for. Customer loyalty will increase – more clients will be gained than lost. Traffic in shops increases.

Consumers talk to each other. If performance is maintained word of mouth will bring more and more clients to the store. The shop has exploited and expanded its constraint – traffic in the store.

Since profits are so dependent on store traffic the retailer’s returns should soon be far beyond the usual industry returns.

Will the Limiting factor (Constraint) Ever Move?

It is unlikely the supply chain will ever become the constraint. The retailer’s job remains the same – what should be the next step to draw even more clients into his shops.

Maybe a closer partnership with his suppliers – to be able to decide production plans much later and much closer to the real consumer demand.

A shop’s space is limited. It can stock only whatever actually fits comfortably into that space. It is essential that every meter of space produce the highest possible turnover (or sales). Is there a way to partner with suppliers to make sure every shelf has only fast moving popular items on it? How close can a shop get to such an ideal?

How much can shelf returns be improved by thinking just a little bit differently?

 

 

Technorati Tags: Consumer, Cost, Costing, Distribution, Inventory, Make to Stock, Management, MTS, Production, Replenishment, Retail, Sales, Strategy and Tactics, Supply Chain, Theory of Constraints, TOC

Shortages & Surpluses - Consumer Products - IV

 

3. So what can a Consumer Goods Company do?

With long lead-times from Asia retailers have no chance of determining, in advance, which products will be successful and which will not. There is only one response that can be successful – the ability to react quickly when the consumer has started to tell us what he really wants to buy. We want to catch the avalanche as it starts. How can we do that?

Purchases for the season have already been made:

The business has decided what will be in its stores and warehouses before the start of a new season. To a very large extent such a business has committed itself and accordingly will benefit (or suffer) from the consumers’ actual demand. From the supply side the die is largely cast. However …

Even if fashion crazes tend to be global there are many smaller avalanches that are likely to be much more localized. Regions around the country, continent or World will have different avalanches involving different products. Demand is not likely to be uniform across a big enough region. We could react to the differences in demand by making sure regions of high demand for specific articles get what they really need while the other regions that have less demand get less (they will stock other products more heavily – those that sell well in their area).

What this means is 3 things:

• Maintain as much stock as possible in a central warehouse that can respond very quickly when regions show their cards – when the consumer has spoken. (An alternative is cross shipments between stores – which is probably more expensive and slower).
• Replenish each store according to what it has just sold – as close as possible to whatever was sold just yesterday! Only with such rapid response are we truly close to the consumer. The longer we wait the greater the chance the consumer has changed his mind again – which means the retailer should change with him. Effectively this says that what was sold just yesterday is the best possible forecast for tomorrow.
• Return the poor sellers to the warehouse and redistribute them to locations with real demand for them. Don’t block your valuable shelf space with ‘dogs’. If at the start of a season all products are equally represented then very soon – as the hot items are sold out – the dogs will take over the majority of your shelf space. At the same time these same dogs will take more and more of your sales peoples’ time. Instead of selling as much as possible of the popular items efforts are spent getting rid of the dogs, to find substitutes for missing items and, in the end, to sell the remaining slow movers for deep discounts.

Clearly a good salesperson will offer an alternative whenever a desired article is out of stock – and will be successful some of the time. However, substitutions are often disappointments (I did not get what I really wanted). Substitutions take more effort from a salesperson – will they try to sell a substitute when it is clear the store still has stock of the hot product and it is just as clear that a potential substitute is not so popular? Substitution probably takes place only when the ‘hot’ item is sold out. What happens to store traffic when consumers realize a hot item is no longer available?

Substitution is a valid tactic, but better still would be the ability to resort to it as little as possible.

What is the threat if someone finds the solution of how to do the above? What is your benefit if you find it?

Replenish stocks (from suppliers) during the season!

Why buy everything before the season? Why not buy during the season and, as market knowledge becomes available, adjust purchases to whatever is truly selling well. Re-order from suppliers when you can see the avalanche starting!

In many (if not most) industries production lead-times do not need to be many weeks. In fact, many times, the actual ‘touch time’ (the time it takes to physically make an article without considering any waiting time) is very short (measured in minutes?). With TOC (Theory of Constraints) methods it is usually possible to get a production unit to respond within very short lead-times – short enough to react very quickly.

BUT, there is still transportation time from Asia. Shipping is something like 6 weeks – a long time for a season of only 6 months. This transportation lead-time is a fact of life and can be dealt with only by more expensive transport (flying) or by sourcing from low cost regions closer to Europe.

The question is – what will be the impact of such a tactic on revenues and margin, and what will be the added cost of air shipments (or new suppliers)? The result of having to discount much less (we don’t buy so much of the slow movers) and selling considerably more of our hot items must have a much larger impact than the expense of air shipments (that should only be needed at the start of each season) and more frequent smaller shipments by sea – if our greater flexibility is to have a positive impact on our bottom line.

Lets look at a scenario. Instead of buying the forecasted sales for the entire season our retailer buys ‘only’ 2 months of stock delivered in time for the start of the selling period (suppliers that want to sell in huge batches are an obstacle, but technically small batches are possible with little, if any, penalty). Once sales start, the retailer immediately (and then every week) reorders what has been sold from his shops during the week just past. The following will begin to happen (the diagram can be used to help understand the effects):

1. If the retailers initial purchases were a good estimate of demand, then inventory levels will decline towards 2-weeks of supply and stabilize there. That is the point where new orders and deliveries will approximately balance.
2. ‘Hot’ items will deplete stock (much) more quickly. To avoid a stock-out some air shipments will be necessary. By increasing stock levels of these hot items the retailer will eventually also have a 2-weeks supply with weekly replenishments.
3. Since ‘hot’ items are being replenished (rapidly) they will sell much more – increasing sales for both the retailer and his supplier.
4. After the first few weeks some items will be clearly identified as ‘dogs’ or slow movers. These will not be replenished until they reach 2-weeks of stock, or they will not be replenished at all if they are that poor! Stock levels of slow movers will be one third of ‘current’ stocks at the start of a season so there will be many fewer surpluses. Season’s end discounting and outlet sales will be much lower (and maybe at higher prices!).
5. Since there is less discounting, greater sales (of all the hot items that are always in stock) the retailer’s margins must soar. There will be less pressure on supplier prices and margins – much better relationships will be possible. The solution can be fine tuned for even greater benefits for both partners.
6. How much more will a retailer sell? If hot items are sold out within the first 2-months (shops and warehouses) then it looks like as much as tripling sales is possible. Shoppers quickly become aware which shops always have the hot items in stock – traffic increases and even more sales can be made.

If a retailer’s purchase costs are 45% of expected full price sales, then halving surpluses and adding just 10% to sales due to less shortage then return on sales increases from currently 5% to 15%. (In the model fixed costs are 30% of base sales and discounted sales are 40% of base sales volume. Discounts during season end sales are 50%). Should a retailer consider some transportation cost penalty for such an improvement – especially if increases of 30% in sales are possible?  The financial example in the endnotes (in a following post) shows the impact of having the right inventory in stock – Key is being able to respond to actual current signals from the markets. I recommend you create your own model and assumptions.

A book recommendation: "Isn't It Obvious" by Eli Goldratt. Goldratt develops the solution starting from an emergency in 1 store of a retail chain - one that replenishes from the far east. Written as a novel, but it describes the solution and the possible results very well.

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Shortages & Surpluses - Consumer Products - III

 

• Actual Consumer Behaviour

How do consumers behave in reality? We all (every person) have interactions with other people – our family, friends, employees, bosses, sales clerks, TV personalities (even if the interaction is only one way) etc. etc. Over just one day we receive a lot of (mis-) information that in a large part guides us in our actions – including what consumer goods we end up buying. What our contacts tell us play a big role in our day-to-day buying decisions.

The human race is notorious for its herd-like behaviour. We all would like to believe we make rational and informed decisions; but do we? We are all unique, but isn’t there also strong pressure to conform? Look at the stock market – if all decisions were rational why does that market sometimes streak ahead to ever-higher values – values that cannot really be justified? Why, all of a sudden, will every stockbroker and investor turn his or her back on the market - causing a huge crash? Major shifts are relatively rare but definitely important?

Could it be that human behaviour is like the sand mountain children build on beaches around the World**? Watching such a sand mountain grow you see the peak rising towards the sky and then suddenly collapsing. If you watch the process for a longer time you will notice the collapses are not the same – some are smaller, some are huge. The huge ones, like stock market crashes are rare, smaller ones are more frequent. Either way you cannot predict when or where a sand avalanche will occur. You only know that these avalanches will occur and some will be big, many will be not so big. Look at the stock market and consumer buying habits and you can find similar behaviours.

Communication in stock exchanges is extremely rapid. People are close to one another and can see the result of everyone’s actions almost immediately. In retail markets communication may not be quite so rapid but still we see communication of preferred products spread very quickly. Certainly we experience something different from the way forecasters and buyers assume consumers behave – consumers buy in ‘avalanches’ and not at some sort of average. Sometimes a popular item is a huge success (assuming the supplier can maintain supply) and, much more often, popular items are smaller successes – but still large enough to cause shortages. (Could it be that many times we do not really know how big a success could have been – because our stores and warehouses have run out?)

What causes these avalanches of demand? I don’t think we will know the answer to that for a very long time. We can predict they will occur and statistical physics can model the situation and show the frequency of big and small avalanches, but determining in advance what product will get consumers’ blessing is not going to be possible any time soon. However, we do know they occur and that the herd-like behaviour of humans might well result in bigger avalanches –if the article in question continued to be available in our stores.

We know they (avalanches of demand) will occur for sure – we just cannot know when, what it will be, or where the avalanche will start. {Have you ever watched flocks of starlings flying in formation? There seem to be hundreds or even thousands of birds in such a flock – and they all turn almost at the same time – as though there is some supreme controller steering them. But every bird is alone interacting only with its neighbours – each bird cannot possibly see all the rest nor react to all the rest. A local movement spreads almost instantly throughout the flock – not dissimilar to the way an avalanche of demand spreads in our markets}.

We are often ‘surprised’ when a new acquaintance knows someone from our network … ‘it’s a small World’ etc. In fact we are all closely connected – there is a claim that it takes a maximum of 6 links between you and every other person on the planet! So, even if it takes seven links we are close. Interactions between parts of the network will, somehow, influence the rest! When an avalanche starts – it moves quickly.

The ‘Tipping Point***’ describes the phenomena of how an avalanche of demand can occur – but cannot tell us how to predict them in advance. It does tell us how or who might be the triggers for a really big avalanche of demand.

** Critical Mass – how one thing leads to another, by Philip Ball; ISBN 0-09-945786-5

In a sense the whole book is an elaboration of the argument summarised on page 568:  "Society is complex but that does not place it beyond our ken. As we have seen complexity of form and organisation can arise from simple underlying principles if they are followed simultaneously by a great number of individuals." Complex behaviour can result from the interaction of lots of simple parts. This is now well established, but the implied corollary that the complexity we observe is a result of lots of simple interactions (or that it is useful to model this in this way) does not, of course, follow. Grounds for hope does not make it a reality.

*** Tipping Point, by Malcolm Gladwell;

1. The Tipping Point is that magic moment when an idea, trend or social behavior crosses a threshold, tips, and spreads like wildfire. At what point does it become obvious that something has reached a boiling point and is about to tip?
   
2. The possibility of sudden change is at the center of the idea of the Tipping Point -- big changes occurring as a result of small events. If we agree that we are all, at heart, gradualists, our expectations set by the steady passage of time, is it reassuring to think that we can predict radical change by pinning their tipping points? Can we really ensure that the unexpected becomes the expected?

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Shortages & Surpluses - Consumer Products - II

 

Retailers

Retailers appear to accept shortages and surpluses in consumer products as a fact of life. Every season shops run out of the really popular items and at the same time shops must discount large quantities of slow movers that did not sell so well – either during end of season clearances or in so-called outlet stores. These phenomena are well known, but do retailers and their suppliers have to accept them as a fact of life? Can’t a supply chain find a way to dramatically reduce the problem and create for itself a decisive competitive advantage? What happens to the first to be able to do so?

 

Forecasting and Actual Consumer Behaviour:

• Forecasting:

How much retailers expect to sell of any article, group of articles and in each store is usually decided well before a season has even started. To allow time for production and distribution to the stores (often from Asia) the decision on what article and how much to make is made well before the start of a season sometimes a year before consumers see the article in shops. The die is cast well before consumers have seen the article and even longer before the consumer has expressed an opinion about his or her preferences. What will be popular this season becomes clear only after inventory is produced and displayed in stores.

The forecaster has nothing to go on about the future – he can only use history as a guide – plus what ‘experts’ tell him will be the fashion (colours, style etc.) for that type of product in the coming season. He will also know what the fashion experts are saying in the various publications – publications that (try) to guide consumers to the ‘right’ article for them to buy. If a forecaster has the time available he can study all the various opinions and decide for himself how the consumer will react – but will he be right?

The forecaster and buyer are therefore in a terrible dilemma – buy a lot of those articles they believe will sell well and risk being terribly wrong; or buy more or less the same quantity of all articles (in the ratios of sales of similar products last year) to hedge their bets and minimize their risk of standing out – as a failure (or a huge success). How many forecasters and buyers are likely to choose the risky option? They might buy a little more of those items they think will be more successful. Whatever they do it will be a compromise, probably biased towards lower risk!

If this is the case, what is the unavoidable outcome? Clearly every consumer product supply chain will suffer from surpluses of those items that turn out to be less popular and shortages of the popular items. Would the result be much different if everyone took the risky route – to bet all of their purchases on what they believe should be the popular items? Averaging over all buyers the result will be more or less the same since nobody knows what the consumer will actually do – nobody knows what causes consumers to flock to whatever become the popular items next season. Even over time forecasters and buyers that take the risky route would end up near the average – if they were allowed to keep their jobs after a disastrous season*!

So, the need to be safe guarantees forecasters and buyers will take the minimal amount of risk and surpluses and shortages will be perpetuated. This is not news, but maybe it should be recognized and reflected upon by consumer goods companies when they make their strategic and tactical production and distribution plans.

*If forecasting were an accurate science, sales and outlet stores would be a much smaller factor in a retailer’s sales.

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Technorati Tags: Availability, Cost, Cost Accounting, Costing, Distribution, Efficiency, Inventory, Inventory Management, Key Performance Indicator, KPI, Make to Stock, MTS, Replenishment, Risk Management, Shareholder Value Add, Strategy and Tactics, Supply Chain, SVA, Theory of Constraints, TOC

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Shortages & Surpluses - Consumer Products - I

 

Executive Summary:

Consumers (people) behave in a fashion that cannot be anticipated with forecasting (especially not with forecasts done many months before a selling season starts). Retailers do know that there will be ‘avalanches of demand’ for specific products and that most avalanches will be small while really big ones are more rare. The retailer knows this, but will never know in advance, which products will experience an avalanche of demand? Three possible strategic responses to shortages and surpluses in a retail supply chain are to respond by a) using the immediate past to decide what shops should hold ‘tomorrow’; b) holding the maximum possible centrally for immediate distribution to locations where demand for the product exists now; and c) producing as little as possible before the season and as much as possible during it – when we have fresh, much more accurate knowledge of these avalanches of demand.

Being able to respond quickly and reliably seems to be the best direction retailers have to significantly reduce both surpluses and shortages and significantly boost their bottom line. {If a retailers purchase costs are 45% of the expected full price sales, then halving surpluses and adding 10% to sales due to less shortages should result return on sales increases from currently 5% to over 15%. If transportation expense were to remain constant return on sales would increase to over 20%.}

We probably will never be able to forecast what will be the hot item(s) next season; but we can build a highly reactive supply chain that can respond very quickly as actual demand becomes clear – even given long lead-times from Asian suppliers. We can build this highly reactive supply chain without ‘breaking the bank’.

Would such a supply chain result in a decisive competitive edge in the market?

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Technorati Tags: Availability, Continual Improvement, Cost, Cost Accounting, Costing, Distribution, Efficiency, Goldratt, Inventory, Inventory Management, KPI, Make to Stock, MTS, Shareholder Value Add, Strategy and Tactics, Supply Chain, SVA, Theory of Constraints, TOC, Replenishment

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I wish I could still ski like this!!