Management Accounting

Start with Demand

Demand-driven manufacturing is radically altering how some businesses serve customers.
John GoffJanuary 11, 2005

A holiday weekend was fast approaching, and in Lima, Ohio, managers at the Procter & Gamble factory were shutting things down early. The move seemed to make sense. Analysis of purchase orders and historical sales trends indicated that the factory had already cranked out enough cases of Liquid Tide to meet the demand of holiday launderers. Rather than keep idle workers on the clock, managers ordered the facility managers shut down the facility ahead of schedule, giving employees some extra time off.

But during the weekend before the holiday, P&G executives were greeted by a surprise. One of the company’s largest retail customers had placed a sizable — and unforeseen — order for detergent. P&G immediately reopened the Lima plant, but had to pay workers overtime and schedule emergency shipments to meet the retailer’s request. The cost of responding to “the event,” according to P&G global product supply officer Keith Harrison, ran into the seven figures.

P&G is not the only business that gets whipsawed by events. Far from it. When managers rely on sales forecasts — and lack real-time point-of-sales and supplier data — they routinely find themselves in a bind. As one company executive grants: “We sell from stock, and the amount of that stock is based on historical trends. Not surprisingly, we’re often sitting on too much or too little inventory.”

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

The answer? For some, trying to improve forecasting. Certainly, accurate forecasts are crucial when mapping out large manufacturing runs and new product designs. But by definition, sales forecasts are guesses — guesses often shaped by the desire of executives to set audacious goals and hit out-of-the-box numbers. Even managers at businesses with sophisticated forecasting systems have run up against the crystal-ball wall. Says Mitch Myers, vice president of operations at FW Murphy, an instrument maker in Tulsa: “We want to be fast and flexible. We don’t want to be dependent on predictions about what’s going to happen, like some psychic on a 1-900 number.”

A Different Approach

Instead, managers at FW Murphy, along with executives at a growing number of other companies, have adopted a different philosophy: shift the focus from forecasting to reacting. This is no small task. Unlike just-in-time manufacturing — a waste-reduction effort that typically foists inventory risk onto suppliers — demand-driven manufacturing requires a tricky integration of complex computer systems all along the cash-conversion cycle. Point-of-sale data must be funneled into purchase-order systems, which then trigger procurement programs, which eventually push data into supplier portals. In a sense, products become bytes of data. Notes Andy Carlson, vice president of product marketing at business-software maker PeopleSoft Inc.: “Companies are replacing inventory with information from customers and vendors.”

And connecting the two. While supply-chain reengineering is crucial to reacting to unforeseen consumer requests, demand-driven manufacturers go one step further, passing customer data along to suppliers. Dell Inc., long a leader in inventory and supply-chain management, now sends real-time sales data to suppliers every two hours. The Round Rock, Texas-based PC maker has also moved its vendors into shared logistics centers close to the company’s factories — “our buffer between forecasts and reality,” notes Stephen Cook, Dell’s director of manufacturing at the company’s national fulfillment campus in Nashville. P&G is filling retailers’ requests for such diverse products as Pringles and Ivory Soap in less than 72 hours. Ultimately, the Cincinnati-based consumer-goods giant wants to create a real-time, store-shelf-to-supplier system driven by individual consumer purchases. “We want to make what’s actually selling,” explains Harrison, “not what we forecast will be selling.”

Green Bear, Red Bear

For most companies, attaining such a goal will take years. While technology is making it easier for companies to streamline their supply chains, the real world keeps getting in the way. Increased outsourcing has placed a strain on global logistics providers, reportedly delaying shipments for some businesses. Tighter security checks at airports and ports have also slowed deliveries. To cope with these problems, a few companies have hired local parts producers to serve as backups in case of emergencies. Others, like Dell, have attempted to move their suppliers closer to manufacturing facilities. As one industry observer notes, “When you extend your supply chain, you’ve exposed your throat.”

Nonetheless, companies that have embraced demand-driven production are already seeing the fruits of their new approach to labor. According to Boston-based consultancy AMR Research, corporations that have adopted demand-driven supply chains are outperforming their competitors — and by a wide margin (for a ranking of the top 25 demand-driven supply chains, see “WIP It Good,” at the end of this article). Says Kevin O’Marah, vice president of supply chain at AMR: “These companies are smoking the laggards.”

Businesses with demand-driven supply networks get paid 70 days sooner and bring new products to market 70 percent faster than their less-enlightened rivals, says AMR. The consultancy (which advises corporate customers on creating such networks) also found that companies with a demand-driven approach to production have a 92 percent perfect-order rate, as opposed to 81 percent for their competitors. Overall, companies with a demand-centric — as opposed to factory-centric — bent are adding 5 percent to their top lines.

To some, the message is clear. Declares Carol Ptak, vice president and global industry executive at PeopleSoft: “Companies that don’t make the change to demand-driven manufacturing and demand-driven supply chains will die.”

Executives at Russ Berrie & Co. would no doubt concur. Until a few years ago, the Oakland, New Jersey-based maker of specialty gifts manufactured its line of stuffed animals and scented candles based on historical trends. Says Michael Saunders, the company’s chief information officer and vice president of business processes: “We’d guess that a major retailer would need 1,000 green bears and 2,000 red bears. Then we’d make them and ship them.”

But the nature of the business began to change. Suddenly, some of the company’s 50,000 retailers wanted faster turnaround on orders. One major grocery chain requested that Russ Berrie start delivering its products directly to stores rather than to the customer’s distribution centers. What’s more, the customer also wanted Russ Berrie to quickly respond to changing buying habits in each store.

To cope with this new order for orders, Russ Berrie management decided in 2002 to completely overhaul the company’s legacy-information systems. The initiative included consolidating seven enterprise resource planning (ERP) programs into one centralized system. Managers now receive weekly replenishment information based on POS information from the grocery-store operator. Russ Berrie also deployed a model-stocking method at the individual-store level, and the data from that program funnels back into the company’s demand-planning systems. Eventually, purchase orders from individual stores will tie into systems in suppliers’ factories. Right now, though, managers at Russ Berrie are pleased with the company’s progress. Says Saunders: “We’re reacting to purchase orders now.”

Out of Joint

Viewing real-time purchase orders can be a huge change for some managers. Consider the case of National Instruments Corp., an Austin, Texas-based maker of high-end measuring devices. The $500 million (in revenues) company has managed, over time, to cobble together a product-delivery system that’s based on the Oracle 11 I platform. Real-time sales information, says CFO Alec Davern, is pulled from the Oracle ERP program into a data warehouse, built by Cognos. Of note, nearly all of National Instruments’s suppliers are connected to the company’s global ERP program. “We know instantly when we take an order in China that the order will get booked and will create a purchase order with suppliers,” says Davern.

The arrangement seems to be working. In October, 99.5 percent of the company’s shipments reached customers on time — impressive, considering that no account makes up more than 1 percent of National Instruments’s sales. To make sure supplies dovetail with buying patterns, Davern continually monitors a host of inbound-demand indicators on a dashboard on his PC — a setup that would be impossible without the unified data platform and data cube. Every day, the finance chief also looks at a Web-based report detailing order backlogs by country. That allows him to see inbound demand all the way to order entry, purchasing, and planning.

This kind of transparency is hard to attain with disconnected transactional systems. At Russ Berrie, consolidating the ERP systems has made it much easier for managers to see what orders are coming in, and how those orders match up to what’s being produced by outsourcers. That, in turn, is enabling the company to reroute its stuffed bears and scented candles while the goods are still in transit. “We still have to put something on a boat and wait 30 days,” concedes Saunders. “But at least now we know what’s on the boat, and which customer will be getting it when it comes off the boat.”

Of course, some customers can’t wait 30 days. Management at Memphis-based Smith & Nephew Orthopaedics, which began digitizing its product-replenishment process two years ago, has dramatically improved its ability to respond to customer demands. In fact, the company has reduced the turnaround time on one set of medical-implants instruments from six months to two days. Part of that improvement, says vice president of finance Mike O’Connor, has come from better use of technology. Sales personnel, for instance, scan product information into a handheld device as soon as a surgical procedure is completed. The data is then uploaded into the company’s internal purchase-order system.

While speed is important in the medical-implants business, so too is accuracy, says O’Connor. “A doctor can’t open one of our tool kits and go, ‘Oops, we’ve got the wrong hip replacement. Come back tomorrow.’ “

Safe, Not Sorry

To avoid hijinks in the operating room, Smith & Nephew continues to carry some safety stock. Such a buffer is not uncommon. Running out of stock, line managers often point out, is a whole lot worse than having too much stock on hand. “This move to a demand-driven focus, rather than an inventory focus, is very new,” notes PeopleSoft’s Ptak. “A mistake can cost you your job.”

Not surprisingly, managers often err on the side of caution. Getting these executives to focus on throughput rather than inventory will take some doing. Currently, senior management at P&G is working with ERP vendor SAP to flow sales data all the way through to suppliers. But Harrison believes it’s going to require more than improved software to reduce response times to customer requests. “How do you take 50,000 people in an organization and switch them over from the mind-set of maximizing machine runs and carrying lots of inventory?” he asks. “[Reduced inventory and faster turnaround times] are things we used to think of as inconveniences.”

Experts also note that the switch to demand-driven manufacturing can be expensive. For small to midsize companies, upping the speed and accuracy of product deliveries requires sizable outlays on ERP software, which often features customer analytics, purchase-order programs, and fulfillment systems. This is not only costly (one survey puts the average total cost of ownership of an ERP installation at $15 million) but also time-consuming. At National Instruments, CFO Davern says the company’s transformation to a demand-driven, customer-focused operation actually began in 1993, back when it first invested in the Oracle applications. Davern reckons the whole system finally gelled in 2001.

Even after businesses manage to unify their front-end systems, supply chains must be tended to. FW Murphy, for instance, has reduced assembly times on one product line from five days to 1.5 minutes. But Myers points out that slashing production times at a factory doesn’t help much if supply-chain lead times stretch on for months. “This is an exercise in serious constraints,” he adds. “You’re constantly trying to keep multiple gophers down at the same time.”

Time, Money — a Connection?

The mallet-wielding is worth it, however. A manager at one manufacturer estimates that reengineering the company’s supplier network could add $1 billion to the business’s top line. At the very least, better systems integration helps speed inventory turns — and cuts response times to unexpected customer requests.

The ongoing supply-chain makeover at Dell, started in 2000, has helped the PC maker lower inventory to four days’ worth of sales. Eager to enlist all employees in its quest to shorten customer response times, the company has altered some of the metrics its managers look at. According to Cook, the PC maker measures (among other things) “deliver to target.” The ratio essentially gauges how quickly Dell gets products to its customers. Adds Cook: “The whole company is bonused on this metric.”

Demand-driven companies in other sectors are also adopting metrics that reward responding to customers — rather than piling up inventory. P&G recently began measuring both the shelf quality of its products and shelf out-of-stocks. Global product supply officer Harrison says that in the past, managers were more absorbed with turning out quality goods than turning over inventory. While manufacturing winning products remains crucial, he says management now zealously tracks things like supply-chain times and order-response rates. “We’re learning that time really is money,” he notes. “Speed? Speed is the new metric.”

John Goff is technology editor at CFO.

WIP It Good
Accounting rules treat inventory as assets. But as AMR Research’s top 25 supply chains reveal, most demand-driven companies maximize sales while minimizing safety stock. The secret of their success? Replacing inventory with information from customers and suppliers.
Vendor AMR
(40%)* ROA
(20%)** Sales/Inv.
(20%)*** Trailing
12-mo. Growth Composite
Score**** 1. Dell 238 13.7% 126.7 17.1% 20.75 2. Nokia 145 15.0% 25.2 17.5% 13.31 3. Procter & Gamble 188 10.7% 11.9 7.8% 11.70 4. IBM 137 13.5% 29.3 9.8% 11.31 5. Wal-Mart Stores 175 8.5% 9.8 10.9% 11.27 6. Toyota Motor 151 5.7% 14.4 16.6% 11.08 7. Johnson & Johnson 110 15.0% 11.7 15.3% 10.93 8. Johnson Controls 151 5.2% 27.4 12.6% 10.70 9. Tesco 42 5.9% 25.7 27.7% 9.43 10. PepsiCo 101 14.1% 19.1 7.4% 9.10 11. Nissan Motor 51 10.8% 11.8 22.1% 9.09 12. Woolworths 14 11.1% 14.3 27.3% 8.80 13. Hewlett-Packard 33 3.4% 12.1 29.1% 8.30 14. 3M 66 13.7% 10.0 11.6% 8.09 15. GlaxoSmithKline 35 18.8% 10.2 11.9% 7.95 16. Posco 23 9.6% 8.6 23.3% 7.85 17. Coca-Cola 58 15.9% 16.8 7.6% 7.69 18. Best Buy 52 8.1% 9.4 17.2% 7.53 19. Intel 52 12.0% 12.0 12.6% 7.47 20. Anheuser-Busch 70 14.1% 24.1 4.3% 7.45 21. The Home Depot 62 12.5% 7.1 10.1% 7.29 22. Lowe’s 37 9.9% 6.7 16.4% 7.00 23. L’oreal 24 9.9% 12.8 17.6% 6.98 24. Canon 13 8.7% 7.2 22.0% 6.94 25. Marks & Spencer 18 7.5% 20.9 19.2% 6.89

* AMR opinion: based on panel of experts’ forced-rank order against definition of “demand-driven supply network orchestrator”

** ROA: 2003 net profit/2003 total assets

*** Sales/Inventory: 2003 sales/2003 year-end inventory

**** Composite score = [(AMR opinion / 10) x 40%] + [(ROA x 100) x 20%)] + [((sales / inventory) / 5) x 20%] + [(trailing-12-month growth x 100) x 20%]