SCM Awareness: Balancing Supply and Demand
A major challenge in planning is finding the balance between supply and demand. An imbalance between the two will have a serious impact on the efficient and profitable running of your business.
Too much supply may result in excess stock or capacity which represent unnecessary cost in the business
Too much demand will put unsustainable pressure back through your supply chain causing strain and breakdowns across the business.
Too much supply. You may think having plenty of stock (above and beyond the planned level set for valid business reasons) and a supply chain with plenty of excess capacity is a good thing. However in reality this sort of excess is a result of bad planning and is a sunk cost. It may result in:
- Excess Capacity having to be “Mothballing”. This means the capacity is taken offline and not used. If it is “mothballed” then that means you have spent money buying the equipment, facilities etc and that money is not being recovered by sales. An extreme example of this happened in the Semi-conductor industry around the time of the “dot-com bubble” in the late 1990s. As a result of that bubble subcontractors invested heavily in new capacity. When the bubble burst these companies faced major financial difficulties repaying the loans they had taken out to fund the expansion and several went out of business. But for many companies the obvious default solution to excess supply remains to cut capacity. That may mean closing lines or even the whole factory for a period. It may also involve cutting staff numbers. This is often the default position but must be managed carefully. Equipment may be quite complex to shut down and start up again. And the trained staff you have left go may find other jobs and not be available when you need to re-hire them.
- Also for accounting purposes you may be told you have no choice but to run the capacity. The argument may be utilize the capacity, build the stock, and the sales team will find a way to sell it. This is a common but questionable strategy however often the Finance Director will hold more sway than the Supply Chain Director at the board of management, so the finance department win the argument. It is key in this case that companies carefully plan what they produce in this case. It is not an ideal situation so don’t make it worse by making poor decisions.
- This will result in building costly excess inventory which will then have to be stored in a facility that one way or another must be paid for. Even if it is internal warehousing there will still the costs associated with heating, staffing, lighting etc. Longer term there is a risk of obsolescence, especially if the stock has an expiry date. And that excess inventory represents a sunk cost of material and resources that must be paid for but for which you will not be paid for some time.
- Another result of too much supply could be discount pricing. A basic law of supply and demand is that in times of excess supply prices will fall. However, your costs and overheads won’t. So, the business will make less profit. Also, if you give a reduced price to a customer today that sets a new expectation with the customer. They may demand that price ongoing.
- Of course, a properly designed system will have flexibility built in. BUT flexibility should mean using the resources for other tasks as much as possible rather than a hard on – off situation. One company I worked with saw peak demand in summer months and then low demand in winter months. We built this seasonality into their plan and during the winter they focused on building frozen products with long shelf life, thus helping to lower demand in the summer. They also redeployed people to work on process improvement projects that helped to increase capacity in the summer. This is the best way to handle excess capacity.
Too much demand is a situation where you cannot fulfil orders. Demand may have come in higher than expected, or you may have had a breakdown in your process, or a supplier may have let you down. Excess demand will result in:
- Unhappy customers who may be forced to give some, or even all, of the business to your competitors. You must manage the relationship with your customers very carefully in a case like this.
- In some industries a dominant customer may insert a clause in their contract to stipulate that their supplier will pay a fine for missed deliveries. One major supermarket chain I have dealt with will fine their suppliers the full cost of lost sales if they are not supplied when they want it. This meant the supplier compensated the supermarket to the tune of what the END customer would have paid for the product at the till.
- Supply shortages almost always result in increased costs as you try “Expedite” your way out of the situation. These costs include elements such as overtime, expedited shipments (both from you to your customer and to you from your suppliers), and paying a premium for access to limited resources.
- This will also put an unsustainable level of pressure on your internal resources. Resources (be they equipment, people, or suppliers) can only operate at 100% of effort for a limited amount of time. If you live in a state of constant shortage, then there will be constant pressure on your staff and equipment and you will start to see higher staff turnover and equipment breakdowns.
- As outlined in the previous slide flexibility will go a long way to helping react to unexpected high demand but there will be a limit to how flexible any company can be and if demand regularly exceeds that limit then you will quickly end up in an unsustainable situation.
So, it is critical that your planning function properly balances supply and demand to avoid this ever becoming an issue.
But to do that they must also have accurate information on supply and demand. We are back to information being the key to properly managing the supply chain. Many problems that will be the root cause of a supply and demand imbalance will be down to poor quality information especially looking to the long-term horizon. Now you may say this can be difficult because of unexpected events such as economic recessions or “Black Swan” events like 9-11 or Covid-19. However, these events account for a relatively small amount of the imbalance in the supply chain. Most of the time imbalances occur when there is no black swan event. Imbalances occur because the information flow has not been effectively managed.