Align your decision-making with SAP IBP
A supply chain should support a company’s business by setting up a structure that allows people to make consistent planning decisions, an alignment that contributes to support the company’s strategy. But keeping consistency can be challenging because it requires the involvement of several of the company’s organisational functions in the decision-making process – and additionally, decisions must be aligned across all planning horizons and should have a common goal.
While Sales is usually concerned with revenue, market share, customers and discounts, Operations focuses on efficiency, throughput and capacity utilisation, and Finance focuses on net working capital, cash-to-cash cycle and profitability. These different functions tend to use different terms and language and most often also use different plans when they predict future outcomes and which related responses are appropriate.
Moreover, a company’s short-term and long-term decisions are not always aligned. For instance, in the long term, a company could decide to sell a large portion of its volume to certain strategic customers but fail to do so when the daily sales process is executed, prioritising other customers. A company may be harmed if the rules and priorities defined in the longer term are not carefully communicated and followed up on in the short term.
Furthermore, different people sometimes make planning decisions that do not support the supply chain strategy. For example, the supply chain strategy may prioritise efficiency over responsiveness, and thus it would not make sense to expedite goods at premium freight charges with a one-day rush order delivery service.
Conflicting decisions may affect a company’s supply chain performance. Much of this can be avoided by drawing people’s attention to the problems that are relevant to solve and by promoting easy plan sharing between Marketing and Sales as well as Operations and Finance in all planning horizons.
SAP IBP is an advanced supply chain planning tool that can support organisations in this endeavour because it uses a single data model and a single set of numbers that helps communication between different sectors; everybody uses the same language.
In this article, we will refer to a real-life example of a company within the commodity business that has streamlined its planning processes across different horizons to make better, informed and more profitable decisions. For confidentiality reasons, we will refer to this company as Cement2000 and assume they are in the business of producing cement from multiple locations and shipping it worldwide for different uses.
Cement2000 has four production facilities; three in Europe and one in Latin America – and they have several distribution centres in the various markets they serve. Lead times can go from one to eight weeks, depending on the source/destination. Due to the long lead times, Cement2000 must create a forecast and ship their products in each market before the actual demand has occurred.
The planning pyramid (Figure 1) shows how planning decisions are made in the strategic, S&OP, tactical and operational planning horizon. It also shows that they must be aligned at all levels to be consistent with the supply chain strategy. However, the alignment can be challenging because the planning process at each level requires different focus, different people and functions as well as distinct levels of data granularity.
On the strategic planning horizon, a company makes long-term planning decisions that will impact the business for several years. These decisions typically consist of designing a supply chain network that matches the defined competitive strategy. Some key decisions at this level can be broad, such as the choice of using dedicated versus flexible machines to support the need for efficiency or flexibility/agility.
On the S&OP planning horizon, the company focuses on creating a medium-term balanced and profitable demand and supply plan that matches the supply chain strategy. The plan is then communicated to Operations for execution.
The plans made on the S&OP horizon are typically based on product families rather than SKUs, bottlenecks and grouped capacities.
On the tactical planning horizon, individuals in charge look at the short- to medium-term time frame. They maintain a master plan on the finished products that rebalances the supply and demand based on new or existing conditions. Working for the plan requires a certain level of agility because the ratio of available supply and demand is continuously changing. For instance, if the throughput is found to be lower than expected, or if a machine breaks down, it will affect the supply and demand balance. This requires new decisions to be made in order to keep customers satisfied and the impact on profitability as low as possible.
Many companies fail to connect the S&OP planning decisions with the short-term planning decisions because they do not have a suitable tactical planning process in place. But making decisions that do not consider the priorities, rules and parameters that have been defined in the S&OP process can lead to a complete mismatch between the short- to medium-term efforts and the supply chain strategy, which will inevitably lead to lower supply chain performance.
On the operational planning horizon, the company focuses on stabilising the short-term daily or weekly plan and reacting to possible short-term changes. For instance, if the company knows that a truck is departing in two days, they can decide on how many units of a certain product to produce tomorrow on an assembly line to keep a full truck load.
If we now look at Cement2000, they make decisions within each planning horizon that are specific to their industry and the environment in which they operate as well as the supply chain strategy they have chosen to support their competitive strategy.
Cement being a commodity, the market is characterised by high-volume mature products with low supply and demand variability; a rather simple product portfolio, and a fierce competition on price and product availability.
Cement2000 aims to remain competitive in this industry and to provide a high level of product availability at a low price. To do this, they need to design their supply chain in a way that fulfils the above-mentioned competitive strategy at the lowest possible cost. Cement2000 thus needs to sell high volumes at regular time intervals and keep their production, transportation and storage costs under control.
A company in the commodity business needs to make basic decisions on production capacities, outbound logistics, stock levels etc.1 to gain economies of scale and subsequently keep an efficient supply chain that allows high product availability to the customers.
Starting from the production capacities, the company can minimise costs by using some of the following levers:
Cement2000 has invested heavily in keeping its machines running 24/7 with high capacity utilisation and minimal breakdown or off-time. In addition, some machines are dedicated to high-volume products, but others are kept flexible to reduce the risk of inactivity related to changing market conditions.
Concerning the outbound logistics decisions, the company can minimise costs by using some of the following levers:
Cement2000 benefits from low transportation costs because it has decided to ship all its products by vessel, barge or truck, and it also makes one-year contracts with its carriers, sometimes committing to a minimum volume fulfilment.
This is possible thanks to the low variability of the market and supply conditions. If the demand was less predictable, Cement2000 would hesitate before committing to one-year contracts with carriers, even at a low price.
Finally, the company can keep stock levels low, which reduces the net working capital, decreases direct and indirect stocking costs and frees up cash to pay off debt or to finance other activities, but it can also reduce product availability and customer service level.
In a commodity business, the company makes decisions that reflect their need for efficiency, but the supply chain must also ensure high product availability; otherwise customers would probably deal with different suppliers. Considering the low demand variability, it is not necessary to keep a large amount of safety stock at the DCs. Nevertheless, the company must have some stock to buffer for imbalances between demand and supply and avoid the expensive cost of expediting this kind of product from a different location.
In addition to considering these supply chain drivers, a company in the commodity business must also consider the market drivers such as risks stemming from potentially highly fluctuating prices. Various strategies exist to hedge against market risk, but in the case of Cement2000, up to 80% of its volume is allocated to binding contracts with customers. On the one hand, when demand increases, prices increase and the company is obliged to deliver at the agreed lower price, an obvious shortfall. On the other hand, if prices drop, the company can continue to sell the volume at the agreed contracted price.
Another advantage that signing long-term volume contracts is better forecast accuracy, which allows Cement2000 to lower their safety inventory at all locations, reducing the net working capital.
Cement2000 sells the remaining 20% of their volume as “spot deals”, i.e. at the current market price, providing them with the opportunity to steer sales between customers based on the highest net selling price at any time.
In the previous section, we have highlighted some of the main strategic supply chain decisions that Cement2000 is making in the long term, and these will be the input to the S&OP process.
On the S&OP planning horizon, the main decision is the amount of available volume to be allocated to the company’s markets and customers, based on their expected profitability, strategic importance and individual risk.
Initially, Cement2000 identifies the total unconstrained demand for next year, which typically takes a few months. The available supply is usually not sufficient to satisfy the total unconstrained demand, and consequently, the company must choose the customers worth keeping, and how many products they should receive. This requires establishing the total volume to be allocated per region/market. For instance, as Europe is usually more profitable than the emerging markets, more volume is allocated to Europe. Following such top-down decision, Sales should decide the amount of product that each customer within each region should receive. Such a decision is taken jointly with other sales reps and the S&OP process owner on the basis of the customer’s profitability and strategic importance for Cement2000. Finally, it is also at this stage that Sales decides the volume of the product for each customer to be included in a contract, following the general 80/20 guideline.
In the S&OP process, managers are responsible for taking inputs, rules and policies from the strategic decisions into consideration in their own S&OP decisions; otherwise inconsistencies could lead to lower profitability.
In the case of Cement2000, all the decisions related to the share of volume allocated per region or per customer and to the contracts signed are based on the risk level that the company is willing to accept in the long run. As we stated before, the company is willing to provide stable revenues to its shareholders at minimal risk. Therefore, in the S&OP process, a high proportion of the available volume is allocated to developed/more profitable regions and to contracts instead of spot sales.
On the tactical planning level, Cement2000’s priority is to be agile and reactive to changes in the internal and external environment with the aim of preserving high product availability at the lowest cost.
All these situations affect the stock projections, and therefore they require action to be taken to keep the demand and supply in balance, which means changing the planned production mix, changing the mix of spot deals and reallocating the transportation quantities between the different markets. However, because the supply chain must stay efficient, some safety inventory is kept in the network to absorb most of the variability and keep a high service level.
Furthermore, it is also in the tactical planning horizon that Cement2000 makes decisions about the weeks when the exceeding stock is departing from the production sites. It is normally only necessary to know the overall volume to be shipped per week rather than the exact product mix, which can still change until the STO (Stock Transport Order) is created within the operational planning horizon.
In a comparable way as in the S&OP process, in the tactical planning process, managers and supply chain coordinators are responsible for taking inputs, rules and policies from the S&OP decisions into consideration in their own decisions. For instance, the transportation and production plans need to match the demand allocation decisions in the S&OP process so that customers can receive deliveries on time.
Finally, on the operational planning horizon, the company focuses on reacting to the short-term changes and updating the production and delivery plans for the next few days. This also includes creating the sales orders and the STOs required to ship the products out of the production facilities to the distribution centres.
In the next section, we will introduce an advanced supply chain planning tool that can support Cement2000 in making those integrated decisions.
1 Not all supply chain drivers are cited.
SAP IBP is an advanced supply chain planning software that can support companies in making consistent decisions across all planning horizons, with a strong focus on S&OP and tactical planning. SAP IBP runs on a single data model, which means that numbers stay consistent between time periods and organisational functions. For instance, when entering a forecast for a region on a monthly level, the tool disaggregates it down to the lowest level defined, usually product ID, customer ID and weeks, based on the chosen logic. In addition, while Operations can directly work with these volumes, SAP IBP also translates these plans into financial figures to help finance managers estimate whether targets will be reached and take corrective actions otherwise. Despite the strong capabilities of the tool to make fast calculations on a detailed level, managers should keep focus on the right decisions to make in each horizon to avoid being stuck in the “suicide quadrant”, a common pitfall (cf. https://implementconsultinggroup.com/7-viewpoints-on-sop-implementation/).
In the case of Cement2000, Sales enters the monthly volume allocation per market and customer in the S&OP horizon, and the volume allocation is then disaggregated to weeks and days and used by Operations to create a rough shipment and production plan. In the shorter term, Sales updates the plan in IBP by week, and Operations makes the final adjustments to the shipment and production plan. When delays occur, the short-term plans are also updated, and Sales can immediately view the consequences and take the necessary actions. Furthermore, all volumes are translated into financials by a detailed profitability calculation, starting from a gross price defined by region and cement type to a net selling price after rebates and cash discounts are deducted and finally to a measure of the profitability by product and customer. Net working capital elements, such as payment terms and stock travelling time, are also included in the tool by reducing the profitability with a “cost of opportunity”. In this industry with high volumes and a strong correlation between performance and market conditions, the company has reshaped its processes and invested in an advanced planning tool to make better and informed decisions to maximise profitability.
A common challenge in almost every supply chain is to align the supply chain strategy with the organisational strategy. Once the purpose is clear, the supply chain must support this strategy by making a consistent set of planning decisions across various organisational functions and planning horizons to strive towards a common goal.
SAP IBP is an excellent tool to support planning processes and align all planning decisions in the tactical, S&OP and strategic horizons, because every function in the organisation can look at the same plan with different lenses and keep their actions aligned to the desired supply chain strategy.
An interview with Torsten Hagen Jørgensen, Bank Director and COO of the Nordea Group, on the cultural foundation for Nordea's business transformation.
Implement Consulting Group