The 4 Key Items of the Best Supply Chain Program

In this guide, we will explain what a supply chain program is and why any company needs one. We will start from the basics of supply chain to uncover how such a program would work, and how you can apply it inyour specific use case. This is not a master in supply chain of course, but it provides you with all the information a manager (or a newcomer) will need.

What is a Supply Chain Program?

Let’s start with definitions. Even if you think you know this already, read this part, it will ensure we have the same understanding of things.

What is Supply Chain?

Supply chain is a discipline, or area of management, that deals with the supply – the materials and resources you need as a company to produce whatever your sell.

Supply chain is the discipline that takes care of finding and getting the resources you need, so that you have them available in the proper quantity and at the proper time.

We can break down this definition in its key components:

1. Finding resources is about identifying sources of the resources you need in the world and evaluate which ones to use. For example, if you need aluminum rods in your production process (say you are a manufacturer), should you buy aluminum and make the rods your own, or buy the rods already created?
2. Getting resources is the more practical part of the previous step. Once you selected what you want and where to get it, you will need this available in some place and at some time. How do you plan of getting them there? How are you going to pay?
3. In the proper quantity is another crucial concept. Getting the right resources is not enough, you do not want to get too many (you spend too much, wasting money) or too little (you block your production process because it does not have the resources it needs). Even if resources have no expiration date, such as aluminum rod, if you buy 120 tons but they last you one entire year you will have a big expense immediately and will have to think where to store them. Maybe 10 tons per month is better?
4. At the proper time is another key component, you don’t want to get resources too early (because otherwise you paid to have them sit do nothing for a while), nor you want them too late, as this means you will have to wait for them to arrive. You’d want them just in time.

Those concepts can be applied to any resource, not only physical goods. If your company is growing and you need more software developers, how do you plan to hire them in time? Everything is a resource, so the concept of supply chain is broad.

What is a Supply Chain Program?

We know that a program is a collection of projects or initiatives with a common theme or goal. The supply chain program is the combined supply chain effort of your entire company. It is what your company does to ensure the supply chain is healthy.

Finding, getting, timing, and paying for the resources you need – whatever they are – are all part of the supply chain program.

But here we are talking about a program. So, we do not refer to combined supply chain effort with no direction. It means, intentional effort to make and keep supply chain great. A supply chain program is not just about buying some toilet paper at Walmart. It is, instead, about setting up a mechanism where you know you need X rolls of paper every week and plan your trips to the supermarket accordingly, so that you buy enough in advance, but not too in advance).

In this guide, we will see the components of the supply chain program that can apply to most companies.

Set Up Your Own Supply Chain Program

Every company will have different supply chain needs, and not everything will apply in the same way in all cases. Read this part to understand what are the tools you can use, and think for yourself which ones would work best in your own company or team.

Demand Forecasting

Demand forecasting is the centerpiece of any supply chain program. Some companies may also call this supply forecasting, or production forecasting, but the concept is still the same.

The idea is simple: from the time you request something to be produced to the time when you actually receive it, it will pass some time. This is the lead time, and it applies in all cases. If you produce something your own, you will need to account for the time to produce, plus the time to ship (if it was produced in another facility). If you buy something, you will still need to think about the delivery times.

So, if the lead time is 10 days and you want this product on July 31, it means you need to order it no later than July 21, so that you receive it in 10 days. The need to have something is what we call a demand (on supply chain).

Sometimes, you won’t have those 10 days, you will need items now. This is where forecasting comes in, you need to think in advance about what you possibly need and place the orders with some advance notice, before the demand actually comes into existence. Hence the importance of forecasting.

You need to work on two parts here: reduce the importance of forecasting (by reducing the lead time of whatever you need), and increase the precision of forecasting (so that you do not order too much or too little). There are some tools you can use here:

1. Forecast end customer demand. In a supply chain, you have a chain of dependencies. The end customer will want product X, which is composed of parts A, B and C. In turn, A is composed of W, Y, and Z. You know how many of A, B and C you need to make X, and you know how many of W, Y, and Z you need to make A. You should focus on forecasting the demand for X, and calculate everything else. This is not easy, because sometimes, the company selling X is not the same as the company selling A (A is produced by a supplier, and then another company uses it to sell it to the customer after combining it into X).
2. Track the precision of your forecasts. Forecasting is not enough on its own, if you don’t know how accurate it is. After you do the forecast and wait for the actual demand to show up, measure how different it was from the forecast. Over time, you can understand how accurate your forecasts are and act accordingly (if they are not so accurate, you may need some more buffer just to be sure).
3. Involve all the parties in the supply chain. This relates to point #1. If you are not the company interacting with the end customer, or if there are multiple companies in the supply chain, they need to coordinate to forecast end customer demand. This can be problematic if some of the companies are competitors, which is common in supply chain (Walmart will be interacting with end customers and will sell laptops from Acer and HP that are competitors). When you have competitors, the best approach is for the company closer to customer demand to set a category lead that should make forecasts for the entire category, rather than for individual products (in this case, it would be laptops).

Even if the lead time is small, you will still need some minimum amount of demand forecasting. And this is true even in the service industry (for example, if you sell consultancy services to large companies and you need to set up a new team, how long will it take to form the team that will go at the customer’s? Take this into account.

Inventory Management

Another key component of any supply chain program is inventory management. This is particularly important in manufacturing and production companies, but can find applications in service companies. To start describing inventory management, we need to define “inventory” first.

Inventory is the collection of all resources (even unfinished) that the company keeps at hand to make its operation work.

If you are a car manufacturer, at some point you will need to mount four tires onto a car. If you don’t have the tires ready, your unfinished car will be sitting and waiting for them before it can be sold. So you keep some tires at hand, and those are part of the inventory.

Now, to build the car, you will use complex factory equipment, which may occasionally break. When it breaks, you need to replace some of its components to fix it (a chain, an engine, whatever), so you keep these components spare. They are also part of inventory (we call this maintenance inventory because you use them for maintenance, not for your production process).

Even when your car is finished, it will sit doing nothing for a while until you sell it. That is also considered inventory. After all, if you never have any call at hand you are unlikely to sell anything (unless you produce “on demand”).

The problem of inventory is that it has a cost. You, as a company, paid to build the car, but now that is sitting in the parking lot waiting to be sold. Once you sell it, you will get back all the money you invested in making the car, and then some. Yet, until you do, you have all the production value tied up in an item (the car, in the parking lot).

To see why this is important, imagine you have $20k and producing a car costs you exactly $20k, and then you sell it for $25k. You invest all your $20k in producing the first car, and now you have no money left in the bank. Until you sell that first car, you cannot produce any more. So, if you reduce the time the car is in the parking lot, you can produce more cars (because you get back the money faster). The same is true if you reduce the value of your inventory, the amount locked there.

Inventory management is about two things: balancing the cost of inventory with the cost of shortage. Keeping an inventory of a certain size will cost you a given amount. But what if you don’t have enough inventory and then need to forego some potential sales, what would be the cost there? Balance those two values to find the perfect level of inventory. This is what we will see in the next section.

You can apply the same concept of inventory management to the service industry, for example when thinking about hired talent (people) versus deployed talent. You want to have some people at the ready to send to customers so that you do not lose opportunity, but not too many so that they do not become an excessive cost.

Another point worth touching in inventory management as part of your supply chain program is locations. You will need to manage your inventory of different products at different locations, consider where it makes sense to place it, and how to transport it and move it.

Opportunity-Cost Analysis

Opportunity-cost analysis is central in any supply chain program. In the end, supply chain is about weighing the opportunity and cost of various supply chain strategies.

There is one main tradeoff in supply chain: the cost of having some capability ready and then not using it vs. the cost of not having it ready and then have to forego opportunities where you could have used it. This often translates into inventory management: should I buy a larger inventory considering that I will then waste some, or should I keep it small but then be always “sold out”?

As you can imagine, the best way is to do something in the middle. There are specific calculations to identify this number, but they rely on three key components:

1. Incremental cost of inventory: how much does it cost to you to add one more unit of this into your inventory?
2. Cost of lost sale: how much profit are you foregoing if you don’t make a sale (that is, how much profit is there in every sale of this product)?
3. Demand forecast: how many units are you expecting to sell, and with which confidence interval? To say in another way, can you say you are 90% confident you will sell between X and Y of this?

With these three parameters, you can compute the best inventory value. My advice would be to run a Montecarlo simulation based on the demand forecast distribution. That is, using Excel you make a model run for 1k or 10k iteration generating a random number for demand according to the demand forecast distribution. You run this number with the different inventory levels you are considering, and find the one that is better in most cases.

You can also do a simper calculation, for each random value from the demand forecast distribution you calculate the probability actual demand will be higher of this (still run a Montecarlo model and counting how many instances are above) and multiply that by the cost of lost sale. You do the same for the probability of being below, with the cost of inventory. You will then identify the best inventory level overall.

Procurement

Procurement is crucial in any supply chain program, because in the end supply chain is all about procuring goods and services.

Here there are no hardcoded rules. The role of procurement is to select suppliers, assess their trustworthiness and convenience for your company, and ensure there are no critical dependencies (such as being dependent on a single supplier for a specific product). It is the procurement team that negotiates prices with suppliers.

Procurement agents, sometimes called buyers, must ensure the company gets the resources needed on time. But they also need to hold suppliers accountable. See, a key function of procurement is control, ensuring things actually happen in the way they are meant to happen. When setting up a supply chain program, you should consider who is doing procurement, what are the processes to enforce compliance, how you will assess suppliers, and what are the things you do not want (e.g., single source supplier).

Supply Chain Program in Summary

Setting up a supply chain program is not easy, and it is one of the larger tasks a company needs to do. But it is important, and you will need to maintain it over time and ensure it is always current and delivers up to your expectations. To set it up, you will need to influence across your entire company, and the best way to do that is probably with referent power.