supplychainstrategy

A Newsletter from Harvard Business School Publishing and The MIT Center for Transportation & Logistics
Article Reprint No. P0504A

Creating Demand-Responsive
Supply Chains
by Yossi Sheffi

This document is authorized for use only in Christian Higa's Planeamiento de la demanda y de la oferta course at Universidad de Lima, from August 2017 to February 2018.
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 S U P P LY C H A I N T R A N S F O R M AT I O N
Creating Demand-Responsive
Supply Chains
In volatile markets, even the best forecasting tools are no longer up to the task of predicting
demand. Today, supply chains must be built to respond to fluctuations on the fly.
T
HE MAIN CHALLENGE facing supply chain managers is to
provide the right products in the right quantity at the
right place and time. Where there is too little inven-
tory, customers walk away empty-handed and unsatisfied;
too much, and discounting and disposal costs mount. The
problem is that, by necessity, products are designed, pro-
duced, and ordered before demand is known.
Plenty of robust statistical models exist to help forecast-
ers, but there are no sure things. And given the increasing
complexity of global markets, the future of forecasting
promises to grow only murkier.
But companies can mitigate the risks inherent in fore-
casting—by building supply chains that assume demand
will change and that have the built-in capabilities to
quickly respond to those changes. The following steps pro-
vide a framework for doing so.
1. Widen horizons with range forecasting
Instead of aiming for a single demand figure, progressive
companies have turned to forecasting a range of potential
outcomes. They estimate the likely range of future
demand, and use the low end and high end to guide con-
tracting terms and contingency plans. The practice also
conditions companies to think in terms of uncertain out-
comes or a range of possible realizations.
Ford, for example, develops a range forecast for product
sales as part of its capital asset planning process. The fore-
casts are updated (monthly, quarterly, or yearly, depending
on the application), typically narrowing the range as the
forecast period draws near. The automaker focuses on
outcomes that have a likelihood of more than 16.7% of
happening. Other companies use range forecasting to cre-
ate three scenarios: most likely demand, high demand, and
low demand.
Range forecasts are also used in flexible contracting and
procurement strategies. Flexible contracts specify a range
of performance expectations, giving the company built-in
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leeway to ramp production up or down according to
demand. In a typical supply contract, Hewlett-Packard
specifies that its suppliers should be able to ramp up pro-
duction by 50% with two weeks’ notice and by 100% given
one month’s notice.
2. Build flexibility with risk pooling
Companies can take several approaches to pooling risk:
Aggregate forecasts.
Aggregate forecasts are more accurate than individual
forecasts because random errors tend to cancel one
another out. In the mid-1990s, Cadillac changed its distri-
bution strategy in the state of Florida, one of its major
markets. Instead of allowing dealers to order the cars they
assumed customers desired, Cadillac shipped only demon-
stration vehicles to these outlets. When a customer placed
an order, the car was shipped overnight from Cadillac’s
distribution center to the relevant dealer. The change
allowed Cadillac to pool demand forecasts across all of
its Florida dealers, rather than rely on the more limited
forecasts provided by individual dealers. The aggregated
forecast was inherently more accurate than any individual
dealer’s forecast.
The result was vastly improved customer service. The
distribution center had exactly the vehicle that the cus-
tomer wanted about 75% of the time, and Cadillac was
able to give its customers overnight service for most orders
and three weeks’ service for unusual orders. Previously,
orders could take eight weeks to be fulfilled. (Cadillac later
discontinued the pooling strategy because the larger deal-
ers were deprived of the inventory that gave them a com-
petitive edge over smaller dealers.)
Product variability reduction.
A large number of product configurations increases
forecasting difficulty. For example, the 2000 Mercedes E
rights reserved. de la demanda y de la oferta course at Universidad de Lima, from August 2017 to February 2018.
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 Demand-Responsive Supply Chains (continued)
Class model came in a staggering 3.9 trillion possible vari-
eties. Clearly, this is beyond what the company can actually
stock. Honda, by contrast, offered just 529 combinations
of its popular Accord model in 2000 by offering “pack-
ages” of options rather than a smorgasbord of add-ons.
The use of packages allows for better risk pooling, lower
variability, and thus better forecasts, resulting in higher
customer satisfaction and lower inventory carrying costs.
The risk pooling in this strategy aggregates the desires
of a large number of potential customers into a smaller
number of product variants. The challenge with this strat-
egy is to make sure that the vast majority of customers can
be satisfied by a more limited range of options.
Part variability reduction.
Another common risk-pooling strategy is to reduce
the number of components used to make products.
When multiple products share common components, the
company can aggregate the forecasts for the products to
create greater accuracy overall. After a thorough analysis
of its component needs across products, Intel’s Systems
Group reduced its requirements from 20,000 different
part numbers to 500.
3. Shorten the forecast horizon
Predicting the future is easier when the time horizon is
shorter. And reducing the lead time from product concep-
tion to introduction into the marketplace shrinks the
period over which the firm needs to forecast.
The main steps involved in getting a product to market
include development, ramp-up, and production and dis-
tribution. To shorten the lead time involved, many firms
focus on rapid prototyping to speed product development,
rapid tooling to speed the ramp-up process, and rapid
manufacturing to speed the production process. These can
be accomplished by performing many development tasks
simultaneously and by involving multiple constituencies at
each step. For instance, the development of each new prod-
uct iteration involves both manufacturing personnel and
suppliers, with input from the procurement and logistics
departments.
Some companies, such as Lucent Technologies, achieve
concurrency by creating a single supply chain organiza-
tion. Others use physical proximity. Luen Thai Holdings
(Hong Kong) is developing a textile “supply chain city” in
the southern China city of Dongguan. This vast campus
houses all stages of the textile supply chain, allowing cus-
tomers such as Liz Claiborne to reduce their time to market.
The aim is to shrink the iterative design process and
decrease the time from concept to retail store from the cur-
rent 10 to 50 weeks to fewer than 60 days.
This supply chain strategy
4 document
| is authorized for use only in Christian Higa's Planeamiento de la demanda y de la oferta course at Universidad de Lima, from August 2017 to February 2018.
A COMBINATION STRATEGY
Combining the ideas of risk pooling and shortening the
forecast horizon, several companies have resorted to a
postponement or late-differentiation strategy.
Consider Hewlett-Packard, which manufactures its
popular Deskjet and Deskwriter printers in its Vancouver
and Singapore plants and distributes them to the United
States, Europe, and Asia. But selling printers in Europe
means forecasting each country’s requirements for
printer configurations: different decals, power plugs,
and manuals. Six printer models and 23 different coun-
try configurations meant that HP had to forecast the
demand for 138 versions of the finished printers, caus-
ing frequent product shortages in some countries and
surpluses elsewhere.
To increase product availability without increasing
inventory carrying costs, HP redesigned the printers
and shipped basic, undifferentiated printers to a Euro-
pean distribution center in Holland. There, the units
were configured to each country once local demand
was known. Thus, HP needed to forecast only the
aggregate European demand over the long lead time it
took to supply Europe with the generic printers and had
a much better handle on the forecast, or even orders at
hand, when customizing the units locally in Holland.
4. Create history with test batches
Fashion retailers such as women’s shoe company Nine
West face a common forecasting challenge: each time a
new style is introduced, demand is unknown because the
model has no historical sales pattern.
For Nine West, the result was that popular styles were in
short supply, while there was an excess of slow-moving
ones forcing the retailer to discount. Unwanted inventory
was channeled to outlet stores and discount retailers.
To improve its forecasts and base manufacturing deci-
sions on sales data, Nine West developed a new process.
The first 1,000 pairs of shoes of a new style were flown to
five representative U.S. stores where their sales were moni-
tored closely for a few days. That information was then
used as an indicator to forecast the sales of the entire line.
The retailer increased production if the sales were above
expectations and decreased it if the sales were lower than
expected. When a new shoe bombed during the test, Nine
West would halt production and send the shoes already
made directly to outlet stores and discounters, saving the
transportation to and from its own stores.
5. Collaborate with trading partners
Trading partners have knowledge that can help suppliers
and customers forecast better. Wal-Mart recognized in the
 Demand-Responsive Supply Chains (continued)
1980s that providing data to its suppliers would help it
become more efficient, reducing its costs and therefore its
prices. To this end, in the early 1990s Wal-Mart developed a
computer application known as Retail Link. The tool, now
Internet based, provides secure access to detailed real-time
daily sales data, trend analysis, and more for Wal-Mart’s
many suppliers.
Actual sales data help suppliers understand the true
demand for their product, regardless of the retailer’s order
pattern, helping negate one cause of the bullwhip effect.
Such data can help suppliers better plan their production,
promotions, and product introductions.
Tackling the difficulties in forecasting requires more
than data sharing—it requires a cooperative process of
identifying discrepancies and fixing the trading partners’
forecasts so that their actions can be aligned. Many such
processes have been developed over the years. The collabo-
rative planning, forecasting, and replenishment (CPFR)
process, developed by an industry consortium of retailers
and consumer packaged goods manufacturers, is one of
the most comprehensive methods. CPFR calls for sharing
sales and order forecasts and creating a process for identi-
fying exceptions where the data does not align. These
exceptions are then resolved and the process repeats.
Superdrug Stores, which operates more than 700 stores
throughout the United Kingdom, launched a CPFR pilot
project with Johnson & Johnson in 2000. The result was a
13% reduction of Superdrug’s inventory levels, an in-store
availability improvement of 1.6%, and a better relation-
ship with J&J.
6. Share risk
While sharing the risk of an erroneous forecast with supply
chain partners cannot improve the forecast itself, it can mit-
This document is authorized for use only in Christian Higa's Planeamiento de la demanda y de la oferta course at Universidad de Lima, from August 20172005
igate the consequences of forecast mistakes and lead to
higher expected profits for all trading partners. Risk sharing
can be embedded in supply contracts in many forms,
including buybacks, revenue sharing, and real option-based
contracts.
One of the most common forms of risk-sharing arrange-
ments is buyback agreements. For example, in the book
industry, publishers buy back unsold books from retailers
and thereby share the risk of having too much inventory.
This encourages the retailers not to be unnecessarily conser-
vative in ordering books, and it increases the profit potential
of both the supplier and the retailer. Similarly, manufactur-
ers in the consumer electronics industry, among others, may
provide reimbursements to retailers when the price of a
product falls due to the introduction of new models.
For retailers, such arrangements are advantageous
because having higher inventory allows them to sell more
if demand is high. At the same time, they receive financial
support from manufacturers if the product is not selling
and must be discounted below cost.
For the manufacturer, these arrangements work
because the manufacturer sells more up front with a better
chance of higher sales. Even if it must bear some of the risk
of low sales, its expected profits are higher. ◆
Yossi Sheffi is professor of civil and environmental engineering and
engineering systems at MIT and is director of the MIT Center for
Transportation & Logistics. He is a widely published author and
cofounder of several companies in third-party logistics, online
exchanges, and transportation software. He can be reached at
SupplyChain@hbsp.harvard.edu.
April to February
| 2018.
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