Waste not, want not

April 1, 2004
Waste not, want not Companies spent $19 billion on demand forecasting software and other supply chain solutions in 2002, according to analyst firm IDC

Waste not, want not

Companies spent $19 billion on demand forecasting software and other supply chain solutions in 2002, according to analyst firm IDC (www.idc.com), yet the methodology and approach that companies have been building around that software has not been demonstrating value. In fact, the U.S. economy continues to suffer in part because of the tremendous waste created by inefficiencies in the planning process between retailers and suppliers.

Retailers, on average, carry two months of inventory of their suppliers’ products. On the other hand, suppliers in the consumer packaged goods (CPG) industry carry an average of two to three months of finished goods inventory just to cope with the demand variability created by the retailers and their expectations of high customer service.

With such obvious waste and an already clearly defined need, companies must look at more accurate and efficient ways to create reliable forecasts and manage inventory in the pipeline.

For more than two decades, retail companies and their suppliers have been looking for ways to maximize the efficiency of moving products from the manufacturing plants to the end consumer. In the 1980s, the search for relationships where both retailer and supplier work together to increase joint value brought new replenishment practices such as vendor-managed inventory (VMI), where the suppliers managed their products at the retail outlet.

VMI allows the retailer to avoid technology investments and people costs associated with effective replenishment and inventory management at stores, and it allows the supplier to control its products all the way to the consumer. However, this arrangement often leaves retailers vulnerable to inventory push from suppliers (store jamming) because the supplier alone determined how much inventory to keep on hand and how much to ship to the retailer every period.

Another weakness of VMI is that the typical implementation at store level is not integrated with the rest of the supplier’s supply chain planning processes. In fact, in many cases, VMI and internal supply chain planning were managed by different divisions within the supplier’s organization. The result was excess finished goods inventory — both at retail stores and at supplier warehouses, something every supplier fears.

As we moved into the 1990s, these VMI weaknesses — coupled with findings that demand variability sharply increases as it moves up the supply chain — caused the industry to begin rethinking the integration strategy. The cascading effect of the demand variability and the resulting compensatory inventory replenishment response was coined the “bullwhip effect,” and it negatively impacted inventory levels and overall capacity utilization.

The bullwhip effect was especially severe between retailer and supplier because the supplier did not have the necessary visibility into point-of-sale (POS) information, inventory or replenishment policies established at the retailer’s outlet.

Therefore, VMI gave way to collaborative planning, forecasting and replenishment (CPFR).

In CPFR, each party develops its POS and order forecasts independently. If the forecasts are in discrepancy by more than a predetermined variance, they are reconciled through negotiations between the parties.

The problem has been that historically retailers lacked the capability to produce order forecasts and their POS forecasts were often inaccurate, static and at a high level of aggregation, such as national, making it difficult to use this forecast to drive store replenishment effectively. This, combined with the increase in the overall planning cycle time due to retailer and supplier negotiation needed to get to an agreed upon plan, caused many companies to miss the opportunity to react rapidly to unpredicted demand changes.

Today, while the availability of information to retailers and suppliers is enormous, joint planning initiatives are essentially stalled. Retailers are dumping the VMI status for many suppliers, and traditional CPFR implementations have gone nowhere.

Many retailers are continuing to use unsophisticated planning systems to replenish stores that are unable to produce a forward-looking order forecast. These forecasts are critical from a supplier perspective because it’s the only way a supplier has to plan for anticipated future orders, deploy to the right warehouses and assign production capacity in a timely manner. However, retailers considering investing in more advanced systems should be aware that they can face unworkable scalability issues and doubtful return on investments.

Another challenge is that many retailers — in an environment of increased SKU proliferation and product variety — just cannot dedicate the resources and effort required to do efficient store level inventory management and replenishment. In fact, on average, retailers dedicate one inventory planner for every 30 suppliers. If the average supplier sells 100 products to each of an average of 2,000 stores, this individual will have to manage 6 million SKUs. If the product category is seasonal, this picture looks even bleaker.

With VMI and CPFR not living up to expectations, we have moved into a new world of planning and integration — consumer-driven replenishment (CDR). This model allows suppliers to use actual consumer demand to generate multi-tiered, constrained plans for the entire supply chain, including customer’s stores and distribution centers, as well as the supplier’s own warehouses and manufacturing plants.

A single planning platform, based on advanced planning & scheduling (APS) system technology, is used to generate a plan for every tier in the supply chain — including demand, inventory and capacity planning — from POS information at the consumer end all the way up to the manufacturing plants. Unlike suppliers that plan their supply chains using customer orders or shipments alone, CDR allows their supply chains to react quickly to changes in POS demand, therefore reducing the impact of information lags and the resulting inefficiencies in inventory management.

The best part is that retailers do not need to make significant technology or people investments to make this happen. Also, the CDR program can be implemented in incremental phases, for instance, beginning with a smaller sub-set of SKUs and POS data aggregated over a period of time and moving on to larger sets of SKUs with more real-time POS data feeds.

With the increased emphasis that a number of large retailers are placing on the use of radio frequency identification (RFID) technology by suppliers, there is a growing interest by companies to seek ways to extract greater value from the voluminous amount of data that they will be collecting and tracking. CDR provides an innovative way for both suppliers and retailers to further leverage their RFID investments by utilizing shared information on orders, shipments and sales to improve inventory planning and replenishment decisions across the supply chain.

A critical component to CDR is exception management since the number of SKUs to be planned for and managed is typically very large, therefore requiring an easy mechanism to investigate and to resolve supply chain issues efficiently. The APS solutions offer extensive exception management capabilities that can be tailored for each supply chain requirement, for example, by ABC SKU classifications as well as the severity of exception, such as stockout vs. low stock. The new generations of APS systems are web-enabled and provide easy access and visibility to the plan to both suppliers and retailers.

Unlike CPFR, where several forecasts are provided and compared, in CDR retailers and suppliers reach consensus on a single POS forecast and promotional plan much like traditional sales and operations planning. Metrics and targets are agreed upon at the beginning of the session and monitored regularly.

Because retailers can monitor performance at their outlets accurately, they can hold the supplier accountable for deviations such as large POS forecast errors, lower inventory turns, or poor in-stock service. This can greatly reduce the time that a retailer spends with a supplier discussing replenishment plans.

When compared to VMI or CPFR, where the main focus is in-stock service and forecast accuracy respectively, CDR focuses on profitability metrics such as return on inventory investment. In short, CDR combines the best concepts behind VMI and CPFR. Suppliers know their products better and can dedicate resources to manage inventory at stores efficiently. CDR goes one step further than CPFR since it not only improves forecasting at all levels but also inventory positions at each location of the extended supply chain.

CDR has demonstrated its value to both retailers and suppliers. Suppliers gain control of their product replenishment all the way from the manufacturing plant to the store shelf. They can react quickly to POS changes and minimize demand variability created by existing walls between the retailer and supplier.

Retailers can manage suppliers’ performance through common metrics and vendor scorecards, allowing for healthy competition among them. Reduced cost, provided by focusing on metrics instead of expensive planning, frees up capital for them to invest in their core businesses: increasing traffic to the stores and expanding both locally and internationally. LT

Sundi Aiyer leads the demand and supply planning service line for Cap Gemini Ernst & Young (www.cgey.com) in the Americas. Gabi Ledesma is the solution lead for Cap Gemini Ernst & Young’s consumer-driven replenishment solution. See article archives: “The ins and outs of VMI” and “The problem with programs” for more details on forecasting and replenishment initiatives.

April, 2004

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at a glance
This article looks at consumer-driven replenishment — a strategy designed to improve the level of collaboration between suppliers and retailers.

Copyright© 2004 Penton Media, Inc.