Jan Fransoo

From demand forecasting to actual demand planning: In times of Corona this is now for real

Over the decade, the profession of demand forecasting has been renamed many times to reflect the broader designation of the role. Demand management has been a term that has often been deployed. The term suggests that this is not just about forecasting, but also includes the shaping of demand, for instance by pricing and management of promotions. Als the term Demand planning has been frequently deployed as well. This term suggests that the role also involves the allocation of supplies to the demand, or maybe even actively planning or shaping demand to meet supply.

In reality, however, many companies that have deployed alternative names for the forecasting role have not done more than actual demand forecasting, i.e. the estimation of future demand – often based on some algorithm that uses past sales information augmented with some human judgment. The current Coronacrisis however presents both a need and an opportunity to really develop this function.

With drastic demand changes, algorithms need to be shut off

Demand forecasting algorithms that are deployed are based on time series of previous sales. Most of these are using relatively simple statistical methods that extend and smoothen previous time series. In the last few years, there has been much promise of machine-learning (sometimes dubbed as “Artificial Intelligence”) that takes additional external information, such as the weather or the pricing of competitors, into account when determining the forecast. With any of these algorithms, the basic presumption is that the underlying system does not change: relationships between independent variables (previous sales, assortment, weather, etc) and dependent variables (future demand) remain unchanged. Obviously, this is not the case in the current circumstances. Hence, it makes perfect sense to switch off your automated forecasting support tools, especially if they are “hands-of-the-wheel” linked to orders being placed by your replenishment system without any human interference.

When will demand go back to normal?

This is of course the million-dollar question that everyone is facing. In all cases, it is important to first estimate when the situation may go back to more normal patterns of demand. This time estimate is difficult, but there are some basic elements that you can work with:

  1. Remaining time of the governmental measures that cause you drastic demand change. From the China situation, we know that this may likely be at least 3 months; maybe longer if the hospital capacity is really stressed.
  2. Lead time between you and the consumer market: the is the cumulative lead time that a molecule, part, or product leaves your plant and is being consumed by a final consumer. For a retailer, this is a just a few days, while for a chemical producer this can easily be half a year.

Demand changes at the consumer level will roughly take the sum of these two times to reach you. However, they are affected by inventory adjustments:

3. Cumulative surplus or shortage of inventory in the supply chain: if your customers or consumers have a shortage of inventory now compared to how much they would stock normally, this will need to be brought back to “normal”. This could imply additional orders in case of shortages, or reduced orders in case of surpluses. For instance, consumers will likely not buy toilet paper for a while in many countries, while the shortage of electronic parts in the automotive supply chain will need to be replenished. Such inventory replenishment requests will reach you more or less instantaneously and will not face the delay above. We have learnt this from the recovery after the credit crisis.

Finally, all of this will be exacerbated by the infamous bullwhip effect. Again, from the credit crisis we may reasonably estimate that the order inflation may easily be in the tens of percentage points, with this inflation being larger if you are further upstream from the consumer.

Real demand planning requires strategic choices and subsequent analytics

Current demand planning requires both strategic choices and subsequent operational analytics. The strategic choices depend on whether your market is currently facing (huge) drops in demand or (huge) increases in demand, or whether there are significant demand shifts between products or channels.

Currently facing drops in demand

Of course you are currently looking to serve alternative markets or trying to make alternative products for which there may be demand. But in many cases this may not be feasible. Then what remain is trying to estimate when demand will go back up, which I have discussed above. It makes sense then to decide whether you want to build up inventory in advance. If you have the financial means to do so and your products are not perishable, this may be a very sensible strategy. Demand will go up, and more than you expect, as discussed above, but the exact timing is hard to tell. What is critical is to involve your sales force in this plan. They need to be aware of the constraints of supply.

Currently facing demand increases

You are currently scrambling to make supply meet demand. Several companies have reduced assortment size in order to keep capacity up (by saving on changeover times). At some point, demand will go back down. In order to avoid a bullwhip, it is really important to keep a very clear picture of the actual consumer demand and the accumulated inventories between you and the consumer. Thinking cumulatively rather than incrementally makes a lot of sense. From a planning perspective, you will need to ask from your sales force to do something they don’t like to do: sensing in the market how demand will go down eventually. Your sales force needs to understand that if they are too late with their sensing, they will be causing potentially large amounts of unsold inventory somewhere in the supply chain.

Currently facing demand shifts

In particular channel shift have been happening: from out-of-home to supermarkets and from in-store to online. The first question of course is how much of that remains after the crisis eases. I am reading many reports that this is the definite breakthrough of online grocery. I seriously doubt this. I am definitely not a marketing expert but the current online experience is poor with extensive delays in delivery and many out of stocks. Also, after having been locked down for months, I can imagine that going out to a store will be a great experience for many. Hence, the argument could just as well be made that online sales will drastically decrease after the crisis eases. Hence, I think it makes sense for any supplier to hedge their bets: a bit of additional inventory makes sense, and building the ability to shift demand between channels or products is a worthwhile investment.

I seriously doubt the many reports that this is the final breakthrough of online grocery shopping

In conclusion

All of the above implies that companies will need to set up true interdisciplinary demand planning teams that actually have the ability to plan. Such teams should be able to make (or prepare) strategic choices and be able to conduct analytics of the consequences of such choices. This requires different information than just prior demand; it requires knowledge of the full state of the supply chain. And much of this requires humans to do the job.

Disclaimer: This is not the direct result of any specific academic study. The above is my current analysis and interpretation based on prior research conducted by me and others in the area of supply chain management, inventory management, and demand forecasting during crises. It is not an advise for anyone specifically. 

This article was published on LinkedIn on April 3, 2020

Jan Fransoo

Making your (retail) distribution center Corona-resilient

Now that the Coronavirus has reached most of Europe and North America in sizeable numbers, preparations at many companies are in full swing to do whatever they can to try and be resilient to infections in their distributions centers. Here, I provide an overview what can be done, even at this late stage, to try and contains the effects on supplying your customers.

1. Take care of your associates

Your employees’ health is of critical importance to them and their loved ones. It is also critical to your operations, since infected associated may force you to close your facility. Much has been written about hygiene matters and access control checks, and I will not repeat them here. However, specifically for distribution centers, there is more that you can do. In many cases, distribution centers are staffed with temporary contract workers. In Western Europe, they are often workers from other parts of Europe that often change jobs and live in shared housing. Work with your temp agency to increase hygiene across these sharing housing facilities. Your responsibility in this case extends beyond your fully employed associated, also in your own interest. If you do home delivery to consumers, your associates will be in touch with many people, further increasing their and your risk. You will need to provide hand hygiene materials in your delivery vans.

2. Make sure you have sufficient supply

As trivial as it sounds, this is less than obvious. Many retailers have followed policies to try and limit inventories to reduce inventory cost. Instead, they require suppliers to hold inventory and only replenish when there is an immediate need. Given the likelihood of some disruption occurring due to facilities being temporarily closed, you want to pull in inventory to your locations rather than leaving them at your suppliers. Having the inventory in hand gives you more control in case of shortages and disruptions. Obviously, you should avoid creating a bullwhip further upstream but providing transparency to your suppliers that this is not demand-driven, but driven by an analysis of the supply chain risk. In all cases, it is important to be transparent and communicate intensively with your suppliers about such actions.

3. Distribute your inventory across multiple locations

Given the likelihood of disruptions, it is now more critical then ever to keep inventories at at multiple locations. Most companies tend to have more locations downstream rather than upstream, so moving inventory downstream makes all the sense in the world. With a virus like Corona around, traditional inventory risk-pooling suddenly becomes more risky rather than less risky. If you pool your inventory in a single location, your are unable to deliver if that location needs to be isolated. Spreading inventory across multiple locations increases the likelihood of regular out-of-stocks in each of the locations, so you need to equip your distribution network with options for lateral transshipments between locations. In the same line of thought, you need to be able to serve markets from alternate distribution centers. This may require making arrangements with logistics service providers. In case of regulated products, such as pharmaceuticals, this may require permission from the relevant authorities. It could be a good idea to obtain such permissions in advance.

4. Improve robustness in your warehousing operation

Warehouse staffing is typically fully flexible. Moving order pickers across the warehouse provides such flexibility and lowest cost. However, is also provides for maximum contact and infection risk. An option could be to virtually compartmentalize your warehouse, and assign pickers to a certain compartment only. A friend of mine relayed this to me as an option, which I think is highly interesting and where others could benefit. Slightly more cost, but much less risk.

This article was published on LinkedIn on March 6, 2020

 

 

Jan Fransoo

Smart mitigation investments can help the European petrochemical industry manage supply chain disruptions

The 2014 incidents and subsequent outages at the Shell Moerdijk plant received a lot of media and industry attention. Incidents like this significantly affect the petrochemical market, both in terms of price and product flows. In general, 2015 showed unprecedented production issues in the European chemical supply chain, over 50 force-majeures had been declared across all polymers. Given the age of the European petrochemical production sites, operational reliability remains recognized as a major challenge to the industry today.

Given this operational environment, there is a strong desire to obtain quantitative insights in the long-term effect of supply disruptions on the value, forecastability and volatility of EBITDA and the effect of potential mitigation options. However, chemical supply chains are highly integrated networks, implying that a disruption in one plant affects operations throughout the entire supply chain. Therefore, mitigation measures need to be evaluated coherently. Furthermore, there is high uncertainty about the location, timing, and impact of the next major disruption, adding additional challenges to the investment decisions. After all, ‘nobody gets credit for solving problems that did not happen’.

To improve the insight in supply disruptions and potential risk mitigation options, our latest published research – jointly conducted with my former student André Snoeck and my former colleague Maximiliano Udenio – provides a methodology to identify, categorize and quantify risks and the impact of disruptions. A specific risk mitigation option impacts several risks, whereas a specific risk can be mitigated by several mitigation options. The kernel of the project is the development and use of a two-stage stochastic optimization model to analyze these complex interdependencies and dynamics in an integrated way.

We draw three main conclusions based on our research:

1.      Supply chain risk mitigation investment trade-offs in the uncertain and interconnected chemical industry are not trivial and require advanced quantitative methods, such as stochastic optimization.

2.     Smartly placed small investments may outperform a much more expensive poorly placed investment. For instance, a combination of small buffer inventories with reduced response times for external supply might outperform multiple investments in redundant processing capacity.

3.     Investments that mitigate multiple disruptions are undervalued when considering disruptions and mitigation options in isolation. For instance, individual disruptions might not justify investing in decreasing lead times of external supply. Our advanced model that captures the entire supply chain shows the aggregate value that the investment provides to the network.

4.     There exists a trade-off between long-term expected costs minimization and short-term risk minimization, where the latter leads to a more aggressive investment policy. This implies that an increased focus on a stable and forecastable quarterly EBITDA actually justifies larger investments in supply chain mitigation options compared to a long-term focus on expected future EBITDA. Ironically, this implies companies under private equity aiming short-term returns may need to invest more in mitigation measures than companies aiming long-term returns.

There is a clear need for the European petrochemical industry to take supply chain disruptions seriously. Chemical supply chains are integrated, interdependent, and complex systems and evaluating risk mitigation investments should be complemented by advanced quantitative models. Such methods are not new to the chemical industry, advanced models are being used to optimize cracker operations for years. Leveraging this capability when dealing with supply chain disruptions will positively impact the value, forecastability and volatility of EBITDA.

This article was published on LinkedIn in January 2019

Note

The text above has been written for ease of public access, and may contain texts that have been simplified for this purpose at the expense of scientific rigor. In-depth and verified information can be found in our peer-reviewed journal article published in the European Journal of Operational Research. The article is based on a Master Thesis completed at Eindhoven University of Technology. 

Jan Fransoo

Could a Brexit bullwhip cause turmoil in European industrial production?

Last week, the UK newspaper Guardian reported that in the UK companies have started massive stockpiling. While this is seen as a measure to counter uncertainties around a potential hard Brexit, little has been said about the additional production needed to pile up this inventory and the effects of a substantial decrease in production next year once the inventories are sold off. Linking such active inventory decisions to supply chain understanding can only tell us one thing: even a small inventory adjustment may lead to years of instability across European supply chains.

In the Guardian article, “industry representatives” are quoted to have said: “Frozen and chilled food warehouses, storing everything from garden peas to half-cooked supermarket bread and cold-store potatoes are fully booked for the next six months, with customers being turned away”. Not just fresh and frozen food is being stockpiled. British manufacturers are also storing ingredients. UK food manufacturer Premier Food announced two weeks ago that it is building up about 10 million pounds’ worth of ingredients inventory, and British Tobacco company Imperial Brands said it would add about 30 million pounds worth of inventory.

Of course, this is good business for those leasing out warehouse property. Apparently, in many places in Southern England it is very difficult to even find qualified food-grade warehouse space. Seems like a good opportunity to bring over some reefer containers to the island as my bet is that these may be leased at a premium in the upcoming months.

However, an aspect of stockpiling that has not received any attention in all of this is the bullwhip effect that it may cause in European industrial production. Exactly ten years ago, we conducted research that showed that the sudden decline in inventories caused by the collapse of Lehman Brothers led to massive global fluctuations in industrial output for many years. This so-called “bullwhip effect” was well-known in the literature and to anyone operating a supply chain, but common knowledge was that this was exclusively caused by demand fluctuations. Our work demonstrated that sudden, coordinated inventory adjustments would cause such fluctuations as well. I believe that this is what we will also see as a consequence of Brexit: the Brexit bullwhip.

What is a Brexit bullwhip?

I believe a Brexit-bullwhip could be facing us. The reasoning would be as follows:

  1. Inventories of raw materials, intermediate products, and consumer products are all built up in the UK over a relatively short period of time. (Note: this is not just happening in the UK, as UK exporters will build up inventories on the continent, but I have left this out of scope in my analysis for now).
  2. These inventories need to be produced; this leads to additional industrial production for those products sourced from the EU.
  3. Manufacturers observe an increase in demand for their products, and hence also order more supplies from their suppliers. This surge in demand propagates upstream in the supply chain. Since supply chains are long and not very transparent, these suppliers are unlikely to relate their increase in orders to stockpiling in the UK.
  4. At some point, the stockpiled inventory will reach their targeted level. Orders will go back to their “normal” level. It takes some time, however, before the supply chain adjusts. Cumulatively, across manufacturers, their suppliers, and again their suppliers, inventories could easily amount to a year’s worth of sales. As a consequence, manufacturers further upstream in the supply chain may only feel the consequences of the original stockpiling decisions many months later. Just like if you turn up the heating in your house; it takes some time for the system to respond and you may overheat your house.
  5. Some time next year or in 2020, hopefully supply chains will have been adjusted to post-Brexit border controls and inventories will start to be reduced again. This will further amplify the Brexit bullwhip, leading to a huge decline in industrial production.

How large could the Brexit bullwhip be?

This is not easy to estimate. Inventory records in national statistics are not very good. Also, the complex supply chain relationships are not captured in detailed statistics. But we should be able to make a first-order estimate of the effect.

First we estimate UK imports of (physical) goods from the EU27 to be about 300 billion euros annually (1) with corresponding inventory levels to be at about 6 weeks across the board (2). This would value inventory related to UK imports from the EU at around 34 billion euros.

Second, we estimate how much additional inventory is likely to be built up as part of the stockpiling process. For this, we can only rely on anecdotal evidence from the various newspaper reports, suggesting that this is an additional month of inventory, so about 25 billion euros of additional imports from the EU, most of them likely to be purchased in this quarter (Q4 2018).

Next we estimate total European industrial production, including the processing of agricultural products. Based on (3), we will work with a figure of about 2,500 billion euros.

Assuming these numbers are more or less correct, this implies that the inventory build-up in the UK would be 1% of European industrial production. Since virtually all of this would have been produced in the last quarter of 2018, the last quarter would then see an additional production of about 4%. That would be a massive number.

Note that none of this includes an additional bullwhip of overreaction. Our studies of the 2008 financial crisis suggest significant overreaction since it is not clear to companies further upstream in the supply chain what causes the increase in demand.

A huge drop in 2018?

If this were all more or less true, the rebound on the bullwhip in 2019 could be huge, with drops in import figures that would go well beyond the growth in the current quarter.

Obviously, this is an effect analyzed in isolation, and without any modeling at this stage. There are many other effects surrounding the Brexit which I am sure are receiving extensive analysis by economists in the UK, EU and elsewhere. Just today, the Bank of England released such an analysis. The Brexit bullwhip however deserves to be part of this analysis. If anyone has better numbers, I am happy to adjust my calculations accordingly.

Updates and comments after publication

(29 Nov 2018) Gaston Cedillo of the Mexican Institute of Transportation shared an interesting study where they studied the consequences of the variability at the US-Mexican Border. They show that additional safety stock will be needed to deal with the varaibility of the border process itself.

(29 Nov 2018) I received information that the demand for ADR (dangerous chemicals) containers has been increasing significantly. This would suggest that also further upstream in the supply chain (chemicals are typically upstream), companies start preparing for adding inventory.

(6 December 2018) The London Evening Standard today published an article based on this blog

(2 January 2019) The Netherland PMI, after slowly sliding in the past months, suddenly revamped in December. It is attributed to higher exports to the UK, indicating stockpiling.

(2 January 2019) The Guardian today published an article that also British manufacturing is working at full capacity to help build inventories ahead of the Brexit.

Sources and disclaimer

For the order-of-magnitude analysis, I have received assistance from my valued colleague Alan McKinnon. We rely on publicly available sources and realize our estimates may not be very accurate. However, even if we are 50% off, the Brexit bullwhip will be large. If you have any further or better data that we can easily incorporate, please get in touch. I thank Alan for his help; of course, all errors remain mine.

(1)   The source my colleague Alan McKinnon helped me use for this data is aParliamentary briefing document on UK – EU trade. This gives a figure of £341 bn for UK imports of goods and services from the EU in 2017 – at current exchange rate around €390 bn.  The briefing report does not give a breakdown of goods and services. According to a BBC report the value of service imports from the EU was £81.2 bn in 2016 or €92 bn. Assuming this value did not change much between 2016 and 2017 €300 bn might be a reasonable estimate for the value of goods imports.

(2)   Total value of product sales by UK manufacturers was £385bn in 2017 (https://bit.ly/2yZXbYj) while the value of physical inventory in manufacturing industries (analysis by Alan McKinnon based on British statistics) (in current prices) at the end of that calendar year was £62.4bn – i.e. 16.2% of sales – average inventory rotation of 6.2 annually. This is about 2 months worth of inventory. Retail inventory may be a bit less, but is unlikely to be less than one month of inventory currently. Hence, we assume 1.5 months of inventory on average.

(3)   Eurostat suggest that EU GDP was €15373 bn in 2017 (in current prices) of which the UK contributed €2332 billion (15.2%). Removing the UK, reduces EU GDP to €13040 bn. Manufacturing represents around 16% of EU GDP, which using the Eurostat GDP figure for 2017, would yield a figure of €2460 bn. I am not sure at this stage what exactly is included in “industrial production” and whether this covers all of the producing sectors to export to the UK. At the same time, it definitely won’t include all of the wholesalers and traders in between, that may further aggregate the bullwhip. For now, we’ll work with the 2500 bn.

Disclaimer: the current analysis is not based on peer-reviewed research specifically focused on Brexit or Brexit-based numbers. We rely on simple order-of-magnitude calculations as a contribution to the debate.

Note: This blog appeared on LinkedIn on 28 November 2018

Jan Fransoo

Ever thought about your supply chain’s water risk? It could harm your business unexpectedly.

Industrial production in the Indian State of Maharashtra, where Mumbai is located, got a major hit in 2016 when water supplies were short. In the same year, about half of the manufacturing companies in the Bolivian city of Cochabamba were affected by water shortages, leading to a decrease of 15% in industrial output. Last year, India’s apparel industry was heavily affected by water shortages, and this year even Cadbury and Jaguar in the UK had to temporarily close down their factories due to freshwater supply problems.

Water shortages are commonly seen to affect agricultural production and household water supply in underdeveloped parts of this world. Due to the globalization of sourcing, also manufacturing companies are increasingly faced with problems due to water shortages somewhere upstream in their supply chain. While supply disruptions due to natural disasters or terrorism have received substantial attention and more and more companies have been mapping their risk, few companies have realized that they may have a little time-bomb ticking at one of their (maybe far-away) upstream suppliers. A new research article in the Journal of Cleaner Production (“Water Risk Assessment in Supply Chains” – free download until 9 December 2018 at this link; after that, please contact us to request a copy) by my co-authors Torben Schaefer, Maximiliano Udenio, Shannon Quinn and myself sheds light on this risk and provides a methodology for companies to take action in mapping their supply chain’s water risk.

What is water stress?

The availability of clean water is one of the most important sustainability challenges we are facing today. It is a challenge that is expected to increase in the future; and yet, its visibility by supply chain managers community is limited. An area is said to be experiencing water stress when the amount of clean water available is smaller than the amount of clean water required. Clean water is a precious resource. Civilian populations need clean water to live, agriculture and farming need water to produce our food, and virtually every industrial process needs clean water to function. However, even though clean water is a universal requirement, in the face of its unavailability the response is clear: the priority for securing access to clean water will always be for civilian populations and food production. There are numerous examples in recent years where governments divert limited water resources such that water is allocated to civilians. In such cases, industries must continue without water, or shut down. In a globalized world, production in any particular location often depends on raw materials or components sourced from across the globe. Supply chains literally span the earth.

What should you do as a supply chain director?

For firms interested in reducing their exposure to water risk, this means that they must monitor the situation of their entire supply chains. If your suppliers, the suppliers of your suppliers, or the suppliers of the suppliers of your suppliers are located in an area that runs the risk of access to clean water, you run the risk of supply or production disruptions due to access problems with clean water.

In our new article we term this risk, relevant for firms across industries and across the world, water risk.

It is not easy for a company to understand your exposure to water risk: data is difficult to collect, and even when data is available, it is difficult to compare the different dimensions of the problem to come up with a metric that summarizes their risk exposure. Therefore, we developed a new index intended for companies to measure and understand the water-risk of an entire supply chain. Our risk index is composed of 6 base indicators that each measure a different dimension of either “physical” water risks (baseline water stress, seasonal variability, and drought severity) or “amplifying” water risks (external dependency ratio, governance and regulation, and infrastructure). 

Given a geographical location, our risk index quantifies the water risk using a single number, by taking into account the aforementioned components, and experts’ assessments to weigh each of these components into the single water risk indicator. Looking at the problem from a strategic perspective, our water-risk index allows firms to assess geographical areas in terms of water-risk. This allows you to, for example, compare geographical locations of potential new suppliers, or forecast the water risk of your current supplier base for the next decades.

Moreover, our risk index allows for tactical analysis of the water risk at the level of individual processes, products, or manufacturing locations. In this way, you can identify the products or processes with the highest water footprint and consequently analyze its supply chain to detect water risks.

Application at Procter & Gamble

We worked together with Procter & Gamble and applied our methodology with them. From a tactical perspective, we were able to immediately identify some suppliers of a critical raw material that are located in areas with high water risk. Moreover, the water risk in these areas is expected to increase in the coming years. From a strategic perspective, we mapped the water risk of their more than 1000 suppliers to identify the suppliers and areas with highest risk today and in the future.

Procter & Gamble have not only realized the potential of water risk assessment for the reliability of their supply chains, but also for the communities where their supply chain’s plants are located. Consequently, in its recent new sustainability strategy, specific targets have been included for reducing the company’s water footprint, and with that, likely also the company’s water risk.

Including water risk in your supply chain risk analysis is critical. The great news is that acting on this will not only reduce the vulnerability of your supply chain, but also make many communities that face water shortages a better place to live.

Notes:

  1. This blog has been written with the purpose of making our research accessible, sometimes at the expense of nuance and methodological limitations. A full evaluation of our work should only be based on the peer-reviewed article itself.
  2. This blog has appeared first on LinkedIn on November 26, 2018.