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Supply chains throughout our economy will experience volatile shock waves of product supply and demand over the next year or more. Most companies' automated supply chain systems are incapable of handling this level of volatility.

The result will be chaos in both customer fulfillment and supplier replenishment—unless managers adopt a completely different way of managing their supply chains.

Huge Disruption

Today's supply chain shock waves reflect the wide variety of companies and consumers throughout each industry. Because each company and individual has a unique demand and supply pattern, and each entity will be shutting down and ramping up in a different way, the net effect will be chaotic. This will last for at least a year or more, especially as the economy restarts in a non-uniform way.

The situation is further exacerbated by the nature of consumption after the economy restarts. In the past couple of months, tens of millions of people have become unemployed. In the pre-crisis period, our economy was buoyed by strong consumption fueled by debt and a pervasive lack of retirement savings. In the great depression, a generation of formerly unemployed workers became "depression babies," focused on saving and afraid to spend money. The same effect will shape our economy for years to come.

The net effect of this economic situation is to create extremely volatile and unpredictable patterns of supply and demand in supply chains throughout our economy.

Most supply chains have been designed over the past decade to be extremely "lean"—with just-in-time and other innovations aimed at compressing cycle time, reducing safety stock inventories, and boosting intercompany coordination to lower costs.

These lean supply chains require that the information exchanged between customers and suppliers be highly accurate, and that the product flow remain within a relatively small range of variance, often 5-10%. Without rapid, accurate forecasts and controlled product flow, a just-in-time supply chain quickly becomes a "just-in-case" supply chain, often with three times the safety stock needed to meet uncertain demand.

That situation has created a perfect storm in which radically increased supply and demand volatility has generated constant streams of shock waves in supply chains throughout our economy. Our existing supply chain systems and processes simply cannot handle this level of unpredictability and disruption.

Supply Chain Shock Waves

Today's chaotic supply chains are making headlines in daily newspapers. This situation reflects the interaction of propagating shock waves and supply chain system limitations.

Propagating Shock Waves

Consider the example of a company facing rapidly declining demand. To save cash, management draws down its inventories, especially for slow-moving products. After weeks of drawing down these inventories, the company is forced to replenish its stock. Its automated replenishment system requisitions double its normal order so it can rebuild its safety stock while meeting current demand.

The company's distributor sees several weeks of no demand for these products, followed by a more than double amount of demand. The distributor is unable to infer the actual demand, so it ships all of its stock to this customer. Its replenishment system interprets this as a major spike in demand, so it raises its internal demand forecast and safety stock, then sends the resulting increased order to its supplier, a manufacturer.

The manufacturer's system interprets this greatly increased demand as a trend, so it changes the factory's production schedule to urgently make much more of these slow-moving products. This reduces its capacity for making its faster-moving products, creating stockouts throughout the downstream supply chain.

The distributors and their customers panic because these fast-moving products generate most of their remaining cash flow, so they give urgent reorders to their suppliers, who in turn are unable to fulfill them. This lack of available fast-moving products causes their systems to double their reorders, eventually creating a pile-up of products throughout the supply chain with companies hoarding all available stock.

The result of this vicious cycle is that the companies throughout the supply chain will wind up with warehouses full of the wrong products and little cash to rectify their situations. Because the ultimate demand does not stabilize, the imbalance gets worse and worse, sending larger and larger shock waves throughout the supply chain.

Supply Chain System Limitations

Most automated supply chain replenishment and order acceptance systems are unable to handle the supply chain shock waves that are roiling our economy today because they are designed to operate with relatively small demand variance.

Data throughout today's supply chains fails to reflect actual underlying demand. Moreover, to the extent that the end consumers are hoarding scarce goods, their purchasing habits fail to reflect their actual consumption, making the problem worse.

For companies with thousands of customers and products, the demand pattern and replenishment calculations are extremely complex. Supply chain managers, no matter how experienced, are unable to make effective ad hoc manual adjustments to enable the systems to operate acceptably. That leads them to fall back on failed old rules of thumb like first-come first-served, resulting in customers' perceiving that getting fulfilled orders is a random event, leading them, in turn, to chronically over-order and hoard products.

This chaotic situation has become the "new normal" in industry after industry, and it will stay that way for a year or more. It will take a long time for consumption patterns to stabilize and for supply chains to be reconfigured.

Managing Your Shock Waves

Companies can manage their supply chain shock waves and avoid being overwhelmed by them by adopting a three-step process:

  1. Plan for paradigmatic supply chain change.
  2. Prioritize your customers and suppliers.
  3. Adjust your current systems.

Managers can deploy this practical process rapidly, but all parts of their companies' organizations must become involved.

Plan for paradigmatic supply chain change

To effectively manage a company's supply chain shock waves, its top management team must understand the strategic nature of the problem—how supply chain shock waves are generated, and the concrete steps needed to master them. Doing so is extremely urgent today, when demand volatility is accelerating rapidly. Without this understanding, events will simply overwhelm managers throughout the economy, freezing their ability to respond effectively.

In a nutshell, managers must supplement their automated systems with a process that (1) prioritizes customer and supplier segments; (2) focuses manual interventions only on selected priority customer segments; and (3) sets customer order allocations to reflect segment priority. That requires both organizational and system changes.

The most effective mechanism for creating and overseeing this process is a top-level team composed of the heads of Sales, Supply Chain, Supplier/Product management, and Finance. Together, they will be able to manage and coordinate the actions that will enable their company to successfully tame its supply chain shock waves and position itself for success both in the immediate crisis and in the prolonged recovery period that follows.

Prioritize your customers and suppliers

The starting point in prioritization is to segment your customers by profitability. By developing a full P&L on every transaction (needed because prices and costs vary widely from customer to customer and product to product, even within customers), managers can identify their profit peak customers (large, high-profit), profit drain customers (large, money-losing), and profit desert customers (small, little-profit).

Typically, profit-peak customer represent about 10-20% of the customers and contribute 150% or more of would-be profits; profit-drain customers represent about 15-30% of the customers and drain perhaps 40-50% of the profit peak customers' contribution; and profit-desert customers account for fully 50-75% of the customers but do not contribute significant profits.

Your profit-peak customers warrant allocations of 100% of historical demand. However, their replenishment systems probably are over-ordering, so company managers need to meet with them weekly (by phone or Web) to review the situation and agree on orders.

Profit-drain customers are prime candidates for cost reduction, often through costless operational adjustments, so company managers should also meet with them weekly to review and agree on orders—with allocations of perhaps 75-80% of historical demand if costs are not reduced, but full historical demand if they become profit peaks.

The profit-desert customers should be served through automated systems, with menu offerings, and they should get perhaps 60% of historical demand.

This prioritization aligns your fulfillment allocation commitments with each profit-based customer segment's importance, while it systematizes and minimizes the need for manual system interventions.

However, once you have agreed with a customer on allocation amounts, it is very important to be extremely reliable. The essence of great customer service is to always keep your promises, but you do not have to make the same promise to every customer.

Adjust your current systems

Some existing supply chain systems are capable of specifying order fulfillment gates, such as limiting fulfillment of orders from specific customers if they are above a certain percent of the customer's historical demand (without manual override). Similarly, some systems have the capability for specifying replenishment requisition gates such as preventing requisitions to certain suppliers of amounts exceeding a particular percentage of historical supply requests from these suppliers (again, without manual override).

Most supply chain managers are not familiar with these system capabilities, as they are rarely used in the normal course of business. It is imperative that a company's systems experts be urgently assigned to investigate whether the company's order fulfillment and replenishment requisition systems have this capability and, if so, to actively manage these settings.

Companies with systems that do not have this gating capability need to urgently assign their best systems experts and operating managers to develop a set of ad hoc procedures that will accomplish the same gating capability, with the ability to change the settings as events unfold.

In crises, supply chain managers quickly encounter a dilemma: Their automated supply chain systems cannot operate without extensive manual interventions, but the business is too complex for managers to constantly intervene on an ad hoc basis in every order from every customer for every product. Instead, they need to organize and prioritize this process.

With this prioritization and agreed-upon weekly orders, the customers can submit orders at the agreed amounts, and the company's automated systems should accept these orders. By getting ahead of the key customers' order-development process, a company's supply chain managers will be able to regain control over the situation.

Managing the Process

Implementing this management process is complex. It affects nearly every part of a company's organization, and it has many moving parts: teams working with profit peak customers, other teams working with profit drain customers, and yet others working with profit desert customers. A set of parallel teams have to work with the three analogous sets of suppliers. This interaction must occur on both a weekly and a longer-term basis—tracking and managing both individual customer and supplier situations, as well as following and reacting to longer-term secular trends.

This process is practical and manageable, and it can be developed relatively quickly. Managers who accomplish this will ensure their company's success and their customers' loyalty both in today's period of crisis and in the years beyond.


ABOUT THE AUTHOR
image of Jonathan Byrnes

Jonathan Byrnes is a senior lecturer at MIT, where he has taught for 30 years. He is the founding partner and chairman of Profit Isle, a profit-acceleration SaaScompany with proprietary analytics. He is the author of Islands of Profit in a Sea of Red Ink and a co-author of the upcoming Choose your Customers: How to Compete Against the Digital Giants and Thrive (McGraw Hill).

image of John Wass

John Wass is CEO of Profit Isle, a profit acceleration SaaS company with proprietary analytics. He is a co-author of the forthcoming book Choose your Customers: How to Compete Against the Digital Giants and Thrive (McGraw Hill).

LinkedIn: John Wass