HBR / Digital Article / A New Approach to Production and Inventory Planning

A New Approach to
Production and Inventory
Planning
How to weather demand and price shocks, supply disruptions, shipping
delays, and labor shortages. by Vishal Gaur
Published on HBR.org / September 27, 2023 / Reprint H07T40

Martí Sans/Stocksy

Production and inventory-planning processes commonly used by

companies, called sales & operations planning (S&OP), require
predictable demand and supply to function properly. In the post-
pandemic world, as uncertainty and disruptions have increased in
frequency, this approach is no longer suited to the job.

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HBR / Digital Article / A New Approach to Production and Inventory Planning

Companies, including small and medium-sized enterprises (SMEs),

need a better system to make decisions when there is uncertainty.
In research studies that my colleagues and I conducted with two
companies, we devised new data analytics methods that are up to the
challenge. They can be performed in Excel but also can be automated,
using SQL and Python programming tools for data management,
computations, and visualization. In this article, I describe how they
work.

The Current S&OP Process

The predictability of demand and supply are necessary for traditional

supply-chain-planning systems to work. In these systems, a manager
or a cross-functional team begins by making forecasts of demand for
the upcoming weeks. Near-term forecasts are frozen and converted into
targets. Production and inventory flows are then planned to meet those
targets at minimum cost. Performance is measured through metrics
such as “days of cover,” the number of days of demand forecast covered
by inventory. For instance, if I have 100 pallets of inventory on hand
and the average forecast of daily demand is four pallets, then I have 25
days of cover. If I then want to increase the days of cover to 30, I will
have to order 20 more pallets.

This system works beautifully when there is limited uncertainty in

demand and supply. If the forecast of demand is accurate and supply
is reasonably certain, the days of cover can be controlled easily,
and the company can focus on increasing cost efficiency, on-time
fulfillment, and capacity utilization. Benefiting from this clockwork
system, companies have been able to create efficient supply chains
reliant on large-scale, global, single-source factories, ports, and shipping
lines.

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HBR / Digital Article / A New Approach to Production and Inventory Planning

This system has the added advantage of simplicity. It does not require
significant data-analytics capabilities because the weekly demand
forecast is a single number and the inventory plan follows from the
forecast. SMEs can run the entire process on Excel spreadsheets.

But even ardent supporters of the conventional S&OP process

acknowledge that plans don’t always succeed. Their response to an
unexpected event is to make a new plan. But this can be challenging.
Consider the previous example: If average weekly demand were still
four pallets but actual demand varied between one to 10 pallets, then
days of cover could be 100 days or it could be 10 days, so it’s difficult to
set a target and determine how much to order.

In the post-pandemic world, when uncertainty arises almost daily from

any number of sources — demand and price shocks, supply disruptions,
shipping delays, and labor shortages — managers need a better system
that doesn’t just whipsaw in reaction to uncertainty but tells them
proactively what to do and what to expect over the medium and long-
term time horizons. Creating such systems requires new data analytics
tools to measure uncertainty and explicitly incorporate those measures
in future planning. Here is how two different companies built new
models of demand uncertainty and price uncertainty to solve this
problem.

A Distributor of Packaged Foods

The U.S. distributor of a multinational sweet baked goods company

imports cakes and croissants from Europe for sales to retail chains in
the United States. Before the pandemic, the company had a predictable
lead time of about 50 days from placing an order to receiving goods in
its New Jersey distribution center, including production (21 days) and
ocean freight (28 days). After receiving a shipment, the company would
distribute product to retail stores throughout the country. Timeliness

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HBR / Digital Article / A New Approach to Production and Inventory Planning

was of the essence because shipments of perishable food products to

retailers must meet a minimum shelf-life requirement.

During the pandemic, shipment lead times grew significantly longer,

more uncertain, and costlier. Due to the resulting uncertainty in inflows
and outflows, the days of cover in the New Jersey distribution center
stopped being a reliable indicator at any point in time. Planning
inventory became akin to guesswork. The result: increased stockouts, an
inability to meet growth targets, higher cost of waste from perishable
food products, and significant senior management time spent on
managing inventory item by item.

To solve this problem, historical demand and shipment data, stored in

Excel spreadsheets, was harvested and used to estimate the standard
deviation of weekly demand forecast and supply lead times. This gave
the company a measurement of the amount of uncertainty that it
needed to incorporate in its plan. Then, days of cover was replaced by
a new inventory planning metric: the target inventory position for each
product — the sum of the forecast of demand over the lead time plus an
inventory buffer for the standard deviations of demand and lead time.

For example, suppose the weekly demand forecast has an average value
of 25 pallets and standard deviation of three pallets, the order lead time
has an average value of 10 weeks with standard deviation one week,
and the company desires a 98% fill rate. Then the average forecast of
demand over the lead time is 25 x 10 = 250 pallets and the desired buffer
is 2 x square root of (3 x 3 x 10 + 25 x 25 x 1 x1) = 2 x 27 = 54 pallets, where
the multiple 2 corresponds to the 98% fill rate and the other numbers
come from the average and standard deviation of demand and lead
time. The resulting target inventory position is 250 + 54 = 304 pallets.

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HBR / Digital Article / A New Approach to Production and Inventory Planning

This approach was superior to days of cover because the target

inventory position was computed from the lead time and uncertainties
via an exact formula, whereas the target days of cover was an arbitrary
number. The process was run weekly. First, data was updated, then
the target inventory position was calculated in Excel, and finally order
quantities were determined to make up the difference between the
target and the actual inventory and checked by a manager.

This new method enabled the company to replace guesswork that

required experience and judgment with a standardized, unambiguous
formulaic approach that workers could execute with little training.
Moreover, as new data came in weekly, the new method automatically
adjusted to changes in the marketplace. If the degree of uncertainty
increased, the inventory target would get revised upwards. Larger
inventory buffers were built for products whose demand was more
uncertain. As uncertainty increased further during the pandemic, the
company found that the advance planning prepared it well for the
challenge.

A Manufacturer of Durable Seasonal Goods

A medium-sized manufacturer of recreational durable goods, such as

barbeque grills, swimming-pool equipment, and camping equipment,
faced a different kind of challenge as its supply chain shifted.
Previously, it sold its products through a network of dealers spread
throughout the United States. Since the products were seasonal,
with most of the demand occurring in May and June, the company
required distributors to place orders six months in advance for optimal
scheduling of manufacturing.

However, a few years ago, when the company’s distributors started

selling online, the consumer market for the products became more
competitive and prices became volatile. The distributors responded by

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HBR / Digital Article / A New Approach to Production and Inventory Planning

placing fewer advance orders and more just-in-time orders during the
selling season. This upended the company’s S&OP process: Inventory
build-ups and ramp-downs could not be planned in advance, and past
sales and cash flows stopped being a predictor of the future.

The novelty of this situation was that it arose from a new variable:
downstream price uncertainty, which the company had previously
not considered. We used daily prices from the online marketplace to
measure price uncertainty and the company’s historical orders data to
measure the timing of orders for each product. The data told us that
products with more price uncertainty received more just-in-time orders.
This gave the company a method to predict when distributors would
place orders as a function of price and demand uncertainty. Thus, the
company was able to obtain more informed internal guidance as well
as be more effective in its negotiations with distributors. In particular,
it could give higher discounts for early orders for products with large
price uncertainty to incentivize distributors to order early, which helped
reduce inventory risk.

In both examples, the companies focused on measuring uncertainty and

directly including it in supply-chain planning. This enabled them to
easily solve problems that previously seemed unmanageable. And the
beauty of the approach is that it was inexpensive and fast to create.
It took only a few months and could be implemented in Excel, which
made it easy to use.

As the number of products and customers grows, a company should

consider automating the analytics in a programming language, such
as Python, to reduce the chances of human errors and improve
productivity. A good supply-chain engineer with knowledge of
programming can create these tools in a few months. Typically, this
would require converting all the manual data management tasks from

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HBR / Digital Article / A New Approach to Production and Inventory Planning

Excel sheets into database management rules in SQL, implementing

the computation of target inventory position in Python, and building
visualization dashboards in Python, Tableau, PowerBI, or an equivalent
tool for performance monitoring and reporting.

An SME organization should automate one step at a time, starting

with building a database and visualization dashboards, then creating
software for estimating demand, price, and lead time uncertainty,
and finally computing the target inventory position. This approach
offers SMEs a fairly inexpensive way to manage their inventory and
production processes in uncertain times.

This article was originally published online on September 27, 2023.

Vishal Gaur is the Anne and Elmer Lindseth Dean and a professor
of operations, technology, and information management at the
Johnson School at Cornell University.

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