STOW S COMMITMENT TO AUSTRALIA Leading industry figure joins Stow

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1 MHD Supply Chain Solutions March/April 2016 MARCH / APRIL 2016 STOW S COMMITMENT TO AUSTRALIA Leading industry figure joins Stow INNOVATION AND DIVERSITY What would happen if things were done differently? ABC FOR IBP The common-sense process for effective decision making SPECIAL FEATURE Warehouse equipment 1

2 48 SUPPLY CHAIN ROD HOZACK FOCUSING ON WHAT IS IMPORTANT ntegrated Business Planning (IBP), sometimes described as advanced or next- Sales and Operations Planning Igeneration (S&OP) is a common-sense process designed for effective decision making. It allows senior management to plan and manage the entire organisation over a 24-month horizon or more, aligning strategic and tactical plans each month, and allocating the critical resources people, equipment, inventory, materials, time, money to satisfy customers in the most profitable way. But how do you decide where the process should focus? One key technique is ABC analysis, which divides items (inventory, customers, suppliers, and many other areas), into three separate categories, based upon importance, from the high-value A items to the marginal C items. Of course, these categories will differ from organisation to organisation, and criteria such as lead-times, cost, demand, and procurement, should be used to determine which items are of high importance, and which are not. ABC analysis is traditionally seen as an operations or supply chain activity, and typically is just done at a volume finished-goods level, if at all. Yet, it is virtually impossible to run a business without having some sort of prioritysetting mechanism. With a scarcity of resources in most businesses, people just don t have time to pay attention to every little detail when they need to make a decision, so in the absence of a formal mechanism, they guess, make generalisations, or use their intuition, to get by. An informal process Ask a sales person, material planner, distribution manager, or customer service manager, what their priorities are. They will identify which customers, which product, which channels, etc., are most important to them. If that is the case, why do anything more structured or formal? The Pareto principle, also known as the Law of the Vital Few and the Principle of Factor Sparsity, was first suggested by Italian economist Vilfredo Pareto, who in 1906 observed that 80 per cent of the land in Italy was owned by 20 per cent of the population, and also noticed that in his garden, 80 per cent of his peas came from 20 per cent of pea pods. The Pareto principle can be seen just about everywhere in life and the Universe, and in a business environment, Pareto s law is equally applicable. Sales people will have an 80:20 ratio for customers; distribution will have an 80:20 for logistics routes; production, an 80:20 for products, and on it goes. Without a formal and aligning priority-setting policy and process, people will make their own up, and it is unlikely that it will be aligned to the strategy of the business. Complexity Theory calls this a Self- Organising System. There is nothing wrong with Self-Organising Systems, except they can be unpredictable and uncontrollable. ABC analysis and classification is an excellent tool for identifying and understanding the factors that have the largest impact. In an integrated business planning process, which focuses on the important factors that will make or break the delivery of the annual operating and strategic plans, the use of ABC analysis is vital for ensuring the organisation focuses on the things that matter most. Waiting until a solution, a process redesign, or a system, is available to address 100 per cent of the potential issues or benefits, means nothing will get done. When deployed, the Pareto principle focuses attention on addressing the 20 per cent of the issues that cause 80 per cent of the problems, or 20 per cent of the items that generate 80 per cent of the value. Why should you formalise the process? Working to individuals priority lists will almost certainly create different sets of priorities across the business. ABC analysis is meant to guide behaviour, and in an informal environment, the behavioural outcomes will almost always be different. It is impossible to model and understand the commercial impact of these 48 2

3 SUPPLY CHAIN 49 informal priority decisions, resulting in a lack of whole-of-company perspective. Furthermore, priorities in an informal environment tend to be handed onto new people and the original reason for the priority gets lost over time. Although ABC analysis is most frequently applied on a company s product range with a focus on revenue or profit, it can also be applied to: Business services. Customers and consumers. Salespeople s revenue-generating capability. Distribution channels. Manufacturing materials. Suppliers. Debtors. Creditors. Root-causes of errors. Machine breakdowns. To begin formalising the process, it is best to examine the organisation and make classifications based on: Products. Consumers. Outputs. Locations. Purchases. Suppliers. Once the areas of classification have been agreed and people are working to the behavioural expectations, there needs to be a process in place to make sure it is routinely reviewed and refreshed. This should be done no less than once a year, but preferably once a quarter. It might seem to be far too much work to review ABC of products, customers, suppliers, etc., every quarter, but in reality, if it is part of the routine integrated business planning (IBP) process, it will end up being a relatively swift and painless exception-driven activity. ABC classification The standard definition of ABC classifications are in Table 1. After classification, the outcome is then to communicate where we want to focus attention. While some might want to argue about the exceptions to the rule, the fact is that the B and C overall impact is less than 20 per cent. The weight of the numbers should win the argument, unless proven otherwise. ABC classification then becomes one great-big communication and priority-setting process and set of rules. The astounding fact is that the C tail makes up 50 per cent of the items (customers, products, suppliers, etc.), but accounts for less than 5 per cent of the value (cost, revenue, profit, etc.). Working with clients for more than 30 years has led to the observation of a reciprocal law, which assesses the amount of effort used to manage the splits. As in the case of many organisations, if all items are treated the same, then the table can be expanded to resemble Table 2. In other words, the largest amount of effort is being applied in the wrong place. This has also been validated a number of times in a slightly different way: when applying an activity-based costing analysis on the C tail of products, the typical result is that 50 per cent of those items are losing money. ABC analysis, however, requires a reasonable number of data points to work well. That is not to say it can t be applied with a small number of data points; in such circumstances, a company would need to apply another technique. For example, when using Pareto for root causes of errors for customer service misses, only three errors in a week may occur, which is too small a number to get any meaningful pattern. If, however, numbers are accumulated week to week, developing a rolling quarterly, or even rolling annual set of data, there would be 40 to 50 data points per quarter, or 160 to 200 for the rolling annual data set more than enough to start seeing the Pareto pattern emerge. ABC analysis in practice To demonstrate how effective ABC analysis can be in practice, consider the following example. If a company was to use the volume, the revenue and the margin/profit to classify products, they would create a simple column classification, as depicted in Table 3. This shows that the product with the highest volume of sales is actually not the most profitable. Choosing different lenses to view products can be helpful in accurate classification; in this example, it is not unusual to see changes in classification from volume, to revenue, to profits. Some companies will use a reference code, such as AAC, but it is important not to make the code so subtle that it loses its meaning. Once decisions are made about ABC classification, the communication of behavioural elements can drive a huge cultural shift. If a product isn t making a profit for a company, why make so much of it? However, sometimes things are not so clear-cut. A consumer packaging company that worked with Oliver Wight identified through ABC analysis that a jumbo pack of product was not making a profit, so cut the product line. However, this product was a special item found only at one retailer, and this soured customer relations. By considering the product through the lens or 49 3

4 50 SUPPLY CHAIN category of customer satisfaction, this could have been avoided. It is important to build a clear and complete picture, using both ABC analysis and integrated business planning when making business decisions. Other areas that these concepts have been applied to are in the tables below. Interestingly, working through this break up does not mean holding more inventory for the A Class items and less of the Cs. The reverse is actually true. Holding more safety stock of the Cs makes sure that time spent managing them is minimised, freeing up time to focus on the smaller number, but more important, A Class products. The general logic is that demand for As is usually more consistent, and As can be made more often because of their volume, so are easier to ramp up or down as demand fluctuates. For Cs, the reverse is true, and if Cs make up 5 per cent of the overall volume, then holding a little more inventory of those is still only a little. For the As however, even small percentage movements in inventory can have a significant financial impact. In Table 5, ABC is used to set up the Demand Review, and demand management and forecasting processes. One of the reasons for segmenting in this way for the forecasting system is to reduce the number of data points forecasters have to manage. For example, a forecaster might have the following data set: 250 products. Six channels or customers. 24-month statistical forecast. 24-month projections for this month. 23-months projections from last month. 12-months budget. 12 months for last year. When this is multiplied out, the number of data points ends up being in the hundreds of thousands. The question is: How do you effectively manage that many data points? The answer is you can t; it just isn t possible. Therefore, segmenting in the above way will significantly reduce the number of data points and increase focus on the vital few. Similar to the inventory-holding table, production sequencing can be assessed in the same way, as depicted in Table 6. Oliver Wight often comes across companies that have a policy to make/buy everything every week. The reason is usually because the customer service policy is first come, first served, and so there is no priority-filtering mechanism at the front end to align production and supply. In conjunction with Table 7, it can be argued that it is sometimes reasonable to be a little less responsive to C customers, with the intent of focusing on the A customers. This is not to say that C customers should be ignored or neglected; instead, it is best for a business to establish a set of criteria that C customers know as part of agreeing to order from the company. In reality, moving towards the ABC sequencing model actually improves customer service for all products and significantly reduces inventory at the same time. Getting the down-stream areas performing well is the secret to becoming more strategic in purchasing. If customer service, distribution, and production aren t performing well, then supplier planning and execution just becomes an order-launch-and-expedite function. By calming down the down-stream processes, using ABC as one of the tools, the purchasing function can start to think more strategically about the supplier base and supplierdevelopment programmes. Similar to the other 50 4

5 SUPPLY CHAIN 51 outcomes of ABC analysis, using techniques to minimise the amount of management time on the Bs and Cs so that more time can be freed up to focus on the A items, makes the most business sense. Table 8 shows a few strategies to adopt which can facilitate this. Planning for the future The importance of formalising an inventory-control process is clear, and ABC analysis yields real results. Establishing clarity across the business allows companies to identify strong product lines, and weak ones, and make informed business decisions accordingly. The result? A more organised inventory, with the appropriate levels of stock for each product line, and improved profit across the product portfolio. ABC analysis can be applied to any business in any industry, but it is only the first step; the second is testing against strategy and common sense, and the third is to define the behavioural expectations. The success of the technique is dependent on large amounts of items or numbers, so accumulate data over time if necessary. ABC is an effective technique for ensuring the Integrated Business Planning process focuses time and attention on the right things that will have the largest impact. So when next approaching a business problem, ask the question, Is there an 80:20 ratio in the way things are? Rod Hozack is a partner at Oliver Wight Asia Pacific. Oliver Wight has a 40-year track record of delivering business improvement to some of the world s best-known organisations. For more information call , information@oliverwight-ap.com or visit AUSTRALIAN OWNED AND BUILT SINCE 1956 Omega is the market leader in Australia for Reach stackers, Container Handlers and Heavy Forklifts. Omega trucks are designed and manufactured in Australia by Clark Equipment, with over 50 year s experience in the design, manufacture and support of heavy materials handling equipment. 5