During times of uncertainties, planning plays a critical role in the survival of businesses, especially the Food Manufacturing industry which heavily relies on external economic and socio-economical factors. An important survival advice I was taught back in days while studying Engineering, it’s always handy to go back to the fundamentals to overcome unexpected situations! We will dig our way though planning by building a planning framework based on supply chain fundamentals.
A Planning Framework?
While all manufacturer implements some form of Manufacturing Planning and Control (MPC) system – which is concerned with the planning and controlling of all aspects of manufacturing, including procurement of raw material, scheduling the production, and shipping to customers -, it is key for the success of the business to implement an effective MPC framework.
Let’s Take a Step Back First!
The main goal of businesses is to maximize the long-term financial performance and the value to their shareholders, with other stakeholders taken in consideration. Financial performance is measured by many metrics, we will focus on one metric called Economic Value Added (EVA) which measures company profits in excess of the cost of capital (debt and equity), which when compared to other metrics, is an internal and management-controllable measure [Source: Kay, I., Madu, M., & Johnson, P. (2020, March 8). Assessment of ISS’s Use of EVA in CEO Pay-for-Performance Model. The Harvard Law School Forum on Corporate Governance.]
There’s no profit unless you earn the cost of capital – Alfred Marshall
Let’s lay it down first, EVA is a measure of Net Operating Profit After Tax (NOPAT), less cost of capital, that measure can be expressed by the Return on Capital Employed (ROCE) and the Weighted Average Cost of Capital (WACC), multiplied by the Capital Employed (CE):
EVA = (ROCE - WACC) x CE ROCE = NOPAT / CE
Ugly Formulas, Pretty Visualization
It’s clear that value won’t be created unless revenue exceeds all costs, including the cost of capital, in simpler terms, ROCE has to exceed WACC, but how can a business achieve that?
In our article, we will focus on measurable and Supply/Demand-related factors such as:
- Higher Revenue
- Lower Cost
- Lower Working Capital
On one hand, in order to achieve high revenue from a demand perspective, businesses in general, and food manufacturers in particular, need to reduce their stock-outs. And to lower their costs, they need to reduce their inventory carrying cost, cost of material, distribution costs, etc.
On the other hand, in order to lower working capital, businesses need to optimize their Cash-to-Cash (C2C) cycle time – a metric describing the average days required to turn a dollar invested in the raw material into a dollar collected from a customer -, and one important factor to optimize the C2C is reducing safety stock levels.
While the 3 factors might look contradictory, this is where MPC comes in place, the effectiveness of an MPC framework is to balance the trade-offs of the 3 factors to support supply chain initiatives and potentially achieve the business’s ultimate goal to increase the value for shareholders.
A Contradiction, Yet Manageable!
Back to our MPC framework, there are 3 main entry points, Demand Management, Sales and Operations Planning (S&OP), and Resources Planning, in our article we will focus on Demand Management and S&OP, and explore an overview of Demand Planning and how technology can add value to the overall MPC framework.
S&OP balances the sales and marketing activities of a company with its production ensuring that manufacturing will support its sales activities and strategy. Demand Management is the business gateway to marketplaces (Customers), it allows businesses to do activities such as forecasting customer demand, order management, communicating back promises of delivery, and orders statuses and changes [Source: Jacobs, Robert F., William L. Berry, Clay Whybark, and Thomas E. Vollmann. 2018. “Demand Management in MPC Systems.” Chap. 3.1 in Manufacturing Planning and Control for Supply Chain Management: The CPIM Reference. 2nd ed. New York: McGraw-Hill Education.].
Demand Management must conform to the business strategy, manufacturing capabilities, and customer needs, and those factors define different MPC environments. A key classification of an MPC environment is something called Customer Order Decoupling Point (CODP).
The CODP is the point in the material flow where the product is tied to a specific customer order [Source: Olhager, J. (2010, December). The role of the customer order decoupling point in production and supply chain management. Computers in Industry, 61(9), 863–868.]; E.g., When a customer buys cereal off the shelf in a retail store, the CODP is the finished good (Cereal), but when a customer orders custom-made cereal (for example, U-RAAW! Health Foods), the CODP is now the raw material, meaning it moved further down the supply chain.
It’s key to understand the role of CODP and different manufacturing situations such as make-to-stock (MTS), assemble-to-order (ATO), make-to-order (MTO), and engineer-to-order (ETO). CODP divides the flow into two categories upstream – forecast driven -, and downstream – customer order driven – allowing manufacturers to adopt different situations for a varity of products.
We will focus on CODP in the dominant manufacturing situation of food manufacturing businesses (MTS) and how it fits within the supply chain planning matrix (Stadtler and Kilger, 2000).
Working Our Way Backwards, Introducing Demand Planning!
To maximize EVA, we mentioned 3 factors, Higher Revenue, Lower Cost, and Lower Working Capital. The main goal of Demand Planning to identify the sweet spot to maintain optimal stock levels that would minimize inventory carrying cost, and material cost.
In the coming article we will explore the tools and techniques of Demand Planning and how we can apply them in Oracle NetSuite, leaving you now with an introduction to Oracle NetSuite Demand Planning:
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