11. Mitigating Demand-Driven Imbalance

Today’s great achievements do not guarantee tomorrow’s successes. Similarly, a business built strictly to address our current realities may be poorly prepared for the challenges presented by our transforming world years down the road. Perhaps the greatest challenge for future supply chain managers, which we have saved for our final discussion, will be to build the flexible and adaptable supply chains that companies can use to detect, combat, and even manipulate demand-driven imbalances. Failure to aggressively manage demand spikes or change directions can lead to future companies’ demise, especially in light of the uncertainties brought about by the world macrotrends. You only need to consider the failure of former consumer electronics giant Circuit City to see how the inability to proactively recognize and manage customer demand problems can wipe out a major player.

About a decade ago, Circuit City was the second-largest consumer electronics retailer in the U.S., with over 700 retail outlets. But it filed for bankruptcy on November 10, 2008. The question is, why? According to Time magazine’s Anita Hamilton, the primary reason Circuit City perished was “good old-fashioned bad management.” Unlike rival firm Best Buy, Hamilton suggests, Circuit City did not make the necessary moves to understand and react to dynamic demand patterns in the volatile and highly competitive consumer electronics market.¹ According to the Time story, Circuit City’s first blunder was failing to secure prime real estate for its stores, which were often located in out-of-the-way spots that inconvenienced ever-hurried retail customers. Rival Walmart, on the other hand, is regarded as a maven of real estate wheeling and dealing, acquiring properties and devising developments that draw other businesses and consumers, alike. Circuit City also made some serious blunders related to consumer trends in the retail electronics market. For instance, it stopped selling kitchen appliances during the late 1990s, just as one of the largest housing booms in U.S. history took flight. This resulted in a drop in revenue of almost 14% where much was available to be gained.² The company neglected to establish a serious Internet presence, instead attempting to use the Web merely to drive sales for its brick-and-mortar locations. Customers knew these stores were staffed by aggressive salespeople that online shoppers could avoid. During its death spiral, Circuit City’s customer service standards virtually fell apart. Although the company strategy was to compete as a specialized or differentiated provider, it fired over 3,400 of its most experienced service representatives and replaced them with lower-wage workers. Ironically, this 2007 cost-saving move essentially ensured the retailer’s demise.³

What went so very wrong? Overall, Circuit City became complacent and failed to evolve when consumer preferences underwent wholesale change.⁴ But how does a company that once ranked #160 on the Forbes 500 end up in liquidation only two years after having sold over $10 billion worth of consumer electronics? During its postmortem, Forbes authors Benton et al. outlined five demand-side lessons that can be learned from Circuit City’s path to destruction:

• Recognize your consumer base. Circuit City failed to overhaul its selling methods. It was slow to move into the Internet retail space, never fully leveraged the power of electronic retailing, and kept its pushy salespeople. Customers became savvy, relied on online product reviews, and avoided salespeople by buying online.

• Appreciate the competition. Walmart and Target moved into the retail-electronics market and stole business from Circuit City. They used their existing supply chains, locations, and websites to capture market share, and Circuit City did little to respond.

• Maintain strategy implementation consistency. Circuit City claimed to have a differentiation and specialty strategy, but actually it implemented cost efficiency practices. It also suffered from a poor cash-to-cash cycle and too much inventory. In the end, it couldn’t compete with Walmart and Amazon on cost efficiency, and it lagged behind Best Buy’s differentiation and innovation approaches.

• Pay attention to demand trends, and forecast accurately. Circuit City not only quit selling appliances during the U.S. housing boom, but it also spun off CarMax, which went on to be a huge success. The retailer also built a large number of stores right before the 2008 financial crisis hit.

• Don’t apply a bandage to a gaping wound. The company’s response to its demand and supply problems was too little and too late. Circuit City was overconfident in a model that no longer matched demand trends, and it made operational changes only to copy BestBuy. Major strategic changes were needed for its supply chain to succeed.

Because it failed to recognize and address these problems, Circuit City closed its doors and liquidated its inventory in 2009, just as its competitor CompUSA had done two years before. Today, experts wonder if the days of the giant electronics retailer are completely over, noting that BestBuy (which posted a $1.7 billion loss in the fourth quarter of 2011) might be the next to collapse.⁵ As of this writing, BestBuy is trying to carve out its space with wily competitors Walmart and Amazon skillfully encroaching. Regardless, the above noted companies failed (or are struggling) because they were unable to adjust to changing demand, did not fully understand the implications of future trends, and were left in the dust by a market that rapidly was redefined by new paradigms.

The lesson to be taken from the Circuit City story within the specialty retail electronics market is that business in the changing world will require demand-focused and demand-shaping supply chain strategies that influence and redirect demand to match supportable supply levels. Chapter 10, “Mitigating Supply-Driven Imbalance,” focused on potential disruptions and mitigation strategies for moving upstream or supply-side activities into alignment with known demand. This chapter looks at strategies that move demand into alignment with the firm’s known supply functions. These activities are designed to preempt or mitigate problems created by an imbalance between demand and supply by moving the company’s demand levers. Our focus is primarily on micro-level or firm-based strategies to integrate supply and demand via demand-side balancing. Nevertheless, it is important to also recognize that the macro-level environment in which firms operate is also changing based on both social and geopolitical forces that attempt to “shape” demand. In the transforming world, we expect forces at the micro and macro levels to exert pressure on the future demand for products and services, and thereby on companies’ supply chains as a whole.

Demand Shaping in the Transforming World: Macro and Micro Issues

This book’s primary contribution to knowledge has been integrating macro-level forces that will impact the world greatly in the future with leading-edge supply chain thought from the present. Moving forward, the demand implications of these forces will have great bearing on how end users consume products, and therefore how supply chains must be designed to satisfy their increasingly differentiated and potentially chaotic demand. We see the macrotrends as impacting future consumer demand patterns in a number of ways. First, societies might want to consciously curb demand of some products in recognition of the planet’s limited supply and capacity of natural resources. For example, “green” and “sustainability” initiatives are often aimed at protecting the planet and its resource base, including activities such as shifting demand to environmentally friendly products and packaging. Additionally, initiatives designed to reclaim land and grow crops closer to consumption locales are aimed at reducing transportation distances and expenses. In one recent essay, three preeminent marketing academics call for the “mindful consumption” of goods and resources in the future to keep from overwhelming the supply and to allow for the building of a more sustainable demand stream in the future.⁶ However, while such ideas may be feasible in developed nations and regions, on a global level such societal initiatives often fall short of limiting demand to match current levels of supply due to more pressing consumer needs. In some cases, political and governmental activity may determine the rules under which supply chains of the future operate. For instance, although several European countries have mandated recycling of certain packaging wastes, it seems unlikely that similar laws will take hold in less-developed nations. There the costs of collecting and processing recyclables could be viewed as impractical and infeasible.

Governments also sometimes create regulations and policies to change the playing field under which businesses and society operate. China’s well-known initiative to limit family sizes is aimed at controlling population growth and, therefore, the resulting consumption levels of its citizenry. In fact, some economists believe that controlling population growth and accelerating wider demographic transition to lower fertility levels will be the primary method of achieving sustainable economic growth in the future.⁷ Regardless of whether governments initiate further radical changes to limit populations, the trend toward increased geopolitical activity is increasing, as described in Chapter 5, “Geopolitical and Social Systems Disruptions.” Governments have instituted and will continue to devise laws and policies that limit demand for sensitive renewable resources. These include limits on timber cutting, fishing regulations, and export quotas that limit the amount of demand that can be filled for key strategic materials such as rare-earth metals. Future lack of resources, combined with backlash against regulatory activities, may create increased conflict among sovereign nations, regional trade groups, and international organizations such as the World Trade Organization (WTO). These conflicts, if not managed proactively, can lead to war when societies with unfulfilled demands employ more drastic means to find a suitable resource supply. Within the macro-level limits placed by government and society, firms themselves will need to actively manage the demand side of their supply chain.

However, at the micro/organizational level, the problems are more situation-specific and pronounced. From a practical standpoint, these macro-level issues mean that, fundamentally, firms will more frequently find themselves unable to match demand with current supply levels. Thus, they will seek economic solutions to more closely shape (i.e., “right-size”) demand. The idea of right-sizing demand seems anathema in capitalistic societies, where generating infinitely more revenues is often viewed as the path to success. But in fact, we consider these sorts of imbalances just as damaging as rote supply shortages. To see why, it is first important to understand that the business activities of individual firms can influence the size and direction of demand in the marketplace. For example, market leaders and other innovative niche firms often seek to revolutionize the marketplace by looking for new ways to provide utility to customers. When such innovations succeed, they effectively destroy the demand for older products. Taken to the extreme, they can create entirely new industries and market segments that allow the most innovative firms to realize a sustainable (or at least semipermanent) competitive advantage. These types of transformations have been dubbed “creative destruction.” Examples include the rise and success of e-commerce and the subsequent birth of Information Age firms such as Apple, Dell, Amazon, and Google.⁸ Though such transformations typically add great value to customers’ lives, they also play havoc with the systems designed to provide supply and can generate suboptimal profits even while increasing revenues dramatically. Barnes & Noble’s Nook e-reader is a prime example. As of July 2012, the Nook occupied a solid position in the growing product segment with a 27% share, second only to Amazon’s Kindle.⁹ Expert and consumer reviews were quite positive, yet the Nook division reported a $286 million loss in 2012, following a $230 million loss the previous year. On the heels of this news, the company announced a 10% price cut to remain competitive in the increasingly crowded marketplace. Clearly, the supply chain must innovate and adapt to sustain this sort of business strategy in hopes of achieving any margins under such competitive pressures.

We strongly suggest revisiting (and, if necessary, revising) company strategies such that both demand and supply are key considerations when pursuing customers. This is based on the idea that shortages of supply and surpluses of demand are equally suboptimal situations. Though many companies have traditionally been concerned with the former, with the latter regarded as a “pleasant problem” that the supply chain operations will just have to figure out how to handle. We argue that the right-sizing of demand is a key consideration for companies of the future, because the pursuit of extraneous demand in the face of limited supply inevitably creates inefficiencies. These inefficiencies will actually reduce overall enterprise profitability as orders and revenues grow past a critical point. In effect, we are describing the notion of demand shaping: the migration of demand to customers who are the most profitable to serve, and for the products that are most appropriate and available for serving them. Theoretically speaking, demand is often reshaped by the substitution of products/goods/services that deliver similar but distinct bundles of consumer utility. Chapters 7 and 10 briefly discussed the use of supply substitution—using a different raw material to make the same finished good. But the opposite strategy can also be effective when conscientiously devised and employed. Finding alterative end products that provide the same utility can afford the same benefits by shaping demand to match limited available supply sources. This competency will become even more important in the business environment of the future. Furthermore, short of substitution, there are also other intermediate ways to influence and shape demand to more closely match available supply. Chapter 1 described this demand-shaping strategy as Demand-Supply Integration (DSI). We explore this critical concept further.

The Case for Demand/Supply Integration

As a business approach, DSI provides a theoretical but practical means of supporting organizational strategy with structure. DSI also integrates the voice of the customer with the constraints placed on supply chain operations within the organization. Overall, DSI includes the coordination of processes that reflect the firm’s customer focus with the operational supply-side activities that make demand fulfillment attainable. By employing DSI as an operational philosophy, firms can maximize relevant revenue streams from “customers of choice”—customer segments whose value best aligns with the actual organizational capabilities that will generate the most profit for them.¹⁰ For example, consider Dell Computer. Dell has initiated rules within its customer service management process to redirect customers to products that are in stock rather than taking an order for a product that is not in stock and that will result in an immediate lost sale or stockout. The rules are predetermined. Dell’s call center staff is empowered, when necessary, to offer-higher quality products that are currently in stock as substitutions for those that are in short supply or stocked out. Demand-shaping activities such as these are also prevalent in companies such as Lowe’s, which works with key suppliers such as Whirlpool to reshape demand. Lowe’s and Whirlpool use face-to-face meetings to stimulate demand for products the supply chain can more readily fulfill. They also promote products that are in greater supply in the short run and adjust the pipeline of supply and transportation for fast-moving products in nearly real-time reaction to changes in demand.¹¹

Recent research on DSI¹² illustrates how companies pursuing cost leadership strategies tend to focus on operational efficiency but sometimes fail to hear the “voice of the customer.” Alternatively, firms pursuing differentiation strategies tend to focus on the customer, but sometimes to the detriment of supply chain operational excellence. In other words, they fail to hear the “voice of the business.” DSI addresses these imbalances by uniting and integrating demand-side and supply-side functions within the firm. They align the missions of product development, sales, marketing, and demand planning with procurement, logistics, production, and supply chain planning. This alignment allows companies to achieve higher levels of both efficiency and customer service.

As shown in Figure 11.1, only by using a DSI strategy can firms avoid being “stuck in the middle”¹³ by balancing both sets of interests to maximize profits. Via the adoption of a DSI philosophy, companies can become more flexible and adaptive and thereby achieve high levels of customer service and high levels of operational efficiency. Toyota achieved such a milestone when it introduced a radically redesigned version of its popular Siena minivan in 2004. The new model was larger and more fuel-efficient and offered performance features and quality attributes that would set the standard for the minivan market. Although the conventional wisdom for such product launches is to release the new and improved item at a premium price point, Toyota offered the revamped vehicle at price that was 6% below the old model.¹⁴ Such a feat could be attained only by achieving innovations in the supply chain that permitted healthy margins at such competitive prices. The company would later raise prices on the Sienna and other vehicles as a sort of “mercy” provision. In fiscal year 2004 the company racked up a record profit of $11 billion. Rival General Motors, on the other hand, would incur roughly this same sum in losses in 2005 despite generating record sales volume. GM’s record losses on record sales were “achieved” with deep price discounting in a desperate ploy to maintain market share.¹⁵ Unfortunately, GM’s supply chain was unable to operate on comparably discounted costs.

Figure 11.1. Using Demand-Supply Integration for strategic advantage

We believe that DSI will be especially important in a world defined by transportation congestion, geopolitical activity, environmental damage, and growing/migrating consumption. Firms will have to take a hard look at exactly what demand they are most capable of fulfilling and will have to make hard choices about where and in what capacity they try to please a limited set of “customers of choice.” In the end, companies that employ a DSI approach will co-create value with supply chain partners through both goods and service capabilities. Sometimes this means sacrificing effectiveness for efficiency, and other times it means sacrificing efficiency for effectiveness. The choice depends on the demand articulated by customers and the costs and assets required to deliver on those needs.¹⁶ Thus, DSI strategies will be critical in a transforming world where adaptation and flexibility will be the key to survival. Such approaches may not be as cost-efficient in the short term as a rigid “lean” system, or as accommodating in customer service as an agile system. However, they will achieve levels of flexibility needed to mitigate the risks of an increasingly uncertain world and will ensure the long-term survival and sustainability of future firms.

As an aside, we should mention that in many industries, businesses have begun to look at supply chain strategy a little too ubiquitously. The “Go Lean” mantra has converted many—perhaps too many—businesses to a strategy that worships cost efficiency and implements mass customization of products across global markets. We caution that such a strategy assumes unlimited supplies, no-fault transportation, and relatively stable demand variation. It is important to remember that lean systems¹⁷ were originally built for repetitive automotive manufacturing by Toyota and later were adapted to numerous other supply chain contexts. Although they have achieved monumental success within many settings, such strategies are not well suited to all future realities. We believe in the lean model when deployed in the right scenarios and suggest that its uses are many. But we also warn that it will be challenged by supply disruptions in future decades and will strain to meet high levels of consumption and respond to higher levels of variation in demand. Agile strategies that give up some cost efficiency to obtain high levels of customer service may better aid in demand shaping and fulfillment, but at the expense of higher transportation and fulfillment costs.

Let’s return to the case of Circuit City. The company set out to be a specialty store with unique talents and a differentiation strategy. But in the end, it could not compete on differentiation with Best Buy. It also failed to beat the cost efficiency of Walmart, Target, and the other mass retail outlets that moved into the consumer electronics space.¹⁸ Instead, Circuit City found itself stuck in the middle, between supply and demand-side focuses—a doomed situation that management guru Michael Porter famously points out will result in fewer customers and poor performance.¹⁹

Implementing DSI to Mitigate Demand-Side Imbalances

To deploy DSI for the purposes of eliminating demand-side imbalances, first you must distinguish between two seemingly similar—but behaviorally distinct—types of demand that occur in the supply chain. Independent demand comes directly from end-user preferences. It is traditionally concerned with the volumes and assortments of consumer products that are desired. As we have shown, this will vary more widely and frequently in the coming years. For example, the number of bicycles sold annually at a bike shop represents independent demand and can be readily forecasted using past data adjusted for future trends expectations. But the extent of those future changes will certainly factor in as costly error. Alternatively, dependent demand stems from independent demand by way of supporting end-user preferences. Traditionally, dependent demand reflects needs for parts, accessories, or components of finished goods whose independent demand levels have been determined. For example, only a subset of children buying a bicycle will purchase a helmet, and some helmet buyers will not purchase a bicycle. In this way, dependent demand is correlated with independent demand, but not perfectly. Typically, dependent demand is less flexible in how it is filled by a components supplier and is more variable or “lumpy” in nature.²⁰ However, independent demand generally is less variable than dependent demand, and there is more flexibility in how a company serves this demand.

These types of demand must be addressed very differently by organizations that want to engage a DSI philosophy across four different demand attributes that are susceptible to the macrotrends. As shown in Figure 11.2, both independent and dependent demand imbalances stem from, and are affected by, demand volume, demand variety, channel/location, and product form/functionality. Each of these factors is expected to be difficult to predict because of population, economic, environmental, and geopolitical effects. When considered together, the demand attributes and types converge to form eight unique demand imbalance statuses that will increasingly challenge companies as the macroenvironment continues to evolve.

Figure 11.2. Demand imbalance statuses

The eight scenarios call for unique approaches to DSI and will require different managerial resources and capabilities. We define the eight demand imbalance statuses as follows:

• Finished-goods imbalances reflect a situation in which the amount of finished-goods inventories available is either insufficient or extraneous when compared with actual demand. These imbalances reflect typical stockout or overage situations and generally can be predicted within a reasonable margin of error.

• Component imbalances are misalignments in which a dependent demand volume is available, but actual demand is unpredictable because the demand itself is derived at least somewhat from the sale of other products. As a result, this type of demand falls within a partially predictable range yet it is susceptible to more extreme deviations within that range. As an added complication, the demanded components often are laden with high variable costs. Consider, for example, computer chip makers, which must provide component supplies in anticipation of computer sales. If an ample supply of chips is not available, the shortage can substantially delay delivery of the computers. The advanced supply of chips, then, serves as an insurance policy against stockouts. Yet the risk of holding chips that are highly susceptible to obsolescence given the short life cycles of high-tech products makes inventory holdings particularly expensive. Chip suppliers, therefore, seek volume commitments and risk sharing provisions with computer makers as a way to offset the actual and prospective expenses.

• Product line imbalances reflect situations in which independent demand is difficult to predict—not because of sheer volume, but because the variety of available SKUs is large, and the SKUs cannot be converted to other types. For example, a department store may feel confident that it will sell a certain volume of men’s hiking boots in a given period, but it may be unsure which brands and sizes will be specifically demanded.

• Parts line imbalances are found when (dependent) supplies are unavailable in the proper assortment to feed the necessary supply for finished goods. The likely scenario is that of a bottleneck, or one item in short supply that holds up production of the finished good. Also, given that products are often sold today in assorted bundles, shortage of any one item can keep the assortment from coming together. Lean guru Taiichi Ohno famously quipped, “The more inventory a company has, the less likely they are to have what they need.” Ohno was suggesting that companies often become complacent when they have large supply stocks, yet those supplies are no guarantee that they are holding the right inventory types (the parts that are actually needed to build end products to serve customers). This observation proves both poignant and true.

• Channel imbalance indicates that goods and services are available, but not at the proper location(s) to meet demand. Planning-based systems that allocate the supply of finished goods in advance of demand, like distribution requirements plans, are prone to error. They can misallocate inventory when history fails to serve as an accurate predictor of future demand locations. In these instances, the goods must be transshipped from the available supply to the desired location, often using expedited transportation to achieve this balance.

• Supply chain imbalance refers to the imposition of inputs to meet the needs of independent goods/services as a result of being at the wrong location when demanded. As with the other forms of imbalance involving dependent supplies, having inputs in the wrong location delays or prevents the assembly of demanded finished goods from occurring at the time of demand. Rush parts shipments are often the costly remedy for such imbalances.

• Utility imbalance implies the mismatch between the desired attributes and realized performance of the goods and service offered. This imbalance is critical, because it reflects the prospect of disappointing customers when their expectations go unfulfilled. Customer dissatisfaction with realized performance is difficult for companies to overcome today since customers—both industrial customers and consumers—tend to be less tolerant and more unforgiving of suppliers that fail to live up to expectations. Global competition that provides customers with more alternatives and rising expectations, as well as income levels of global customers, raise the ante for companies seeking to retain loyal customers.

• Fit imbalance speaks to the misalignment of supply qualities to meet the needs of the finished goods for which they are inputs. Consider the supply of tires for an automobile. The provision of high-performance sports car tires for an economy car used as a city commuting vehicle represents a mismatch. There is little need for a V-speed-rated tire engineered for speeds of up to 149 miles per hour to be used on a car that will rarely exceed 35 miles per hour. This would represent a waste. Yet more disconcerting would be the use of an S-speed-rated family sedan tire on a Porsche racecar. Clearly, both circumstances impart their own risks.

Based on the eight demand imbalance statuses shown in Figure 11.2, we can derive generic approaches toward mitigating the imbalances. The mitigation approaches are arranged around the axes of Figure 11.3 and are described in the following sections.

Figure 11.3. Demand-imbalance mitigation strategies by demand status

Quantity Adjustment Approach (for Volume)

Market differentiation and customer differentiation strategies distinguish the most valuable customers from the crowd. These customers are deemed most worthy of the highest priority when limited supply forces allocation decisions to be made. The GSCF process of customer relationship management (CRM) provides several different dimensions by which customers can be segmented and relative importance assigned. The profitability of the customers (profits that each customer generates for the focal company) should be among the primary bases for segmentation. Additional key factors might include the customer’s competitive position, his or her influence in the marketplace, and the account’s growth potential. Taken together, the focal company must assess the upside opportunities and the downside risks associated with providing elevated service to choice customers, particularly when nonselect customers conclude that they are cheated in the process. Demand management must be employed to minimize the likelihood and severity of shortages by seeking a match in supply and demand.

Variety Adjustment Approach (for Variety)

Product mix and part mix strategies seek to reduce undue variety that leads to confusion and the opportunity for imbalances in product lines and parts lines. The proliferation of goods and parts is among the most common ailments facing supply chain managers. Companies generally are much more eager to introduce new products than to “sunset” old ones. To some extent, getting rid of obsolete items implies an inability to maintain relevance and sustainment for that item as customers shift demand to alternatives. In another regard, companies, in their eagerness to keep innovation cycles running at full speed, incite the obsolescence of their own goods and services as a means of driving evolution in customers. When products become obsolete, their subcomponents often become obsolete as well. Hence, the relationship between independent and dependent demand is present in the part-product relationship. Product and part mix strategies impart reduction in undue variety and complexity that confound both the buyer and seller and force the seller to be burdened with risky inventory. Rather, firms are encouraged to counter the tendency to proliferate in products and parts and instead employ design for manufacturability (DFM) practices, which underscore part standardization, modularity, design simplification, and a reduction in the number of components. These considerations should factor into the product development and commercialization process that spans the functions of R&D, marketing, sales, purchasing, production, and logistics, among others, in the focal company while including select customers and suppliers when their inputs are merited. Demand management also factors significantly in the struggle to minimize complexity and enhance flexibility in operations.

Network Adjustment Approach (for Location)

Channel selection and supply chain selection strategies seek to ensure that the fundamental provision of “the right product at the right place at the right time” is delivered. Missing the mark on serving customers given a lack of presence is difficult for companies to accept in an age when physical distance seems to have shrunk as a result of enhanced connectivity. Yet, most products must still navigate the dimensions of time and space successfully to fulfill time and place utilities. Two ubiquitous companies approach this problem in distinct ways. Starbucks uses a saturation strategy by flooding the market with locations. Can you fathom that the company has over 140 stores in the Houston, Texas, area alone? Why? The merchant known primarily for coffee can meet demand pretty economically by operating small stores in a variety of formats (stand-alone stores, strip mall storefronts, kiosks). Furthermore, the stores carry a fairly limited assortment of inventory that presents relatively low costs and few risks. Walmart, on the other hand, while aggressive in the intensity of its physical network, cannot achieve the same intensity as Starbucks. The footprint and investment in a Walmart Supercenter store preclude the company from locating in small lots or vacant storefronts. This retailer holds an estimated $23.5 billion of real estate on its books. These expansive stores average close to 200,000 square feet and require something in the range of a 40-acre lot to accommodate the store, parking space, and shipping/receiving.

Network adjustment calls for the company to match the network, location, and channel structure with the right-sized logistics footprint. What works for Starbucks will not work for every company. In fact, the rationing of locations is sometimes the solution. In other words, the company reduces store locations and keeps only the most profitable ones. It reduces floor space and infrastructure at existing stores that are not sufficiently profitable. Furthermore, the company looks to alternative channels such as the Web or futuristic ways of meeting demand without a physical presence. As noted in Chapter 9, “Implications for Transportation/Logistics: Congestion and Infrastructure Decay,” online retailers like Amazon are starting to leverage the physical locations of non-competing retailers, like 7-Eleven stores. Lockers are installed in the stores to provide consumers with a secure pickup point where they can collect their merchandise. An element of convergence is occurring among virtual and physical storefronts, with many companies looking to bypass the conventional physical channels. The order fulfillment process is at the forefront of these determinations.

Substitution Approach (for Form)

Product substitution and part substitution address the “form” imbalances for items that experience independent and dependent demand, respectively. A utility imbalance for independent goods is particularly “touchy” for companies since it represents a performance mismatch in the eyes of customers. Fault is not necessarily found in the product development and commercialization process for such a mismatch. An inability to understand customer expectations or to effectively communicate instructions for product use can sometimes be at fault with this imbalance. Therefore, you must look to customer relationship management to help understand customer needs and direct them to products and services that best fulfill those needs. Furthermore, customer service management fulfills the obligation of properly informing customers of instructions for use and anticipating issues that the customers might face with the focal company’s products or services.

Part substitution is more functional in nature and can present some added challenges under dependent demand. Parts demand often experiences “lumpy” demand patterns since production typically is performed in batches. The methods of filling demand are relatively fixed because the end-product attributes typically are fixed. Therefore, the availability of methods to respond to dependent demand sometimes is more limited, making changes in how dependently demanded parts are fulfilled less flexible compared to finished-goods demands. Though the part may not be as visible to the end customer, you must determine whether the substitute part performs the same function as its predecessor. Manufacturing flow management and supplier relationship management are likely to be significant factors in these determinations.

Each demand imbalance status has two generic mitigation approaches. These combine to form a specific demand-side imbalance mitigation strategy for each status. Next we will briefly describe each of these strategies and how they might be applicable to a future world that is being transformed by population growth, geopolitical change, economic leveling, and communication connectivity.

Customer Differentiation

For the dependent demand for parts, a firm supplying parts or components will strategically adjust the volumes it supplies to a set of relatively fixed end-product makers. The firm will make certain decisions about the different volumes that go to different customers (manufacturers) in its downstream supply chain. Essentially, for customers of choice, firms will be able to maintain or even increase component volumes. It is assumed that these will be the most strategic and profitable firms. Other firms that do not provide enough value or profit will have volumes reduced and will not receive priority allocation of inventory volumes and/or shipments of key products. A firm’s supply chain relationships with downstream manufacturers will dictate who gets preferred volumes and service. Other companies may receive only a limited or rationed share of the parts volumes that can be made. In a transforming world, it will be difficult to supply all the parts and components demanded by all customers. Therefore, firms will have to make strategic choices about who to serve with large quantities of parts and who will have their volume cut so as not to exceed the available supply.

Market Differentiation

Similarly, using a utility and quantity adjustment approach for independent customer demands, a firm employing a market differentiation strategy will not serve every end customer the same. Companies must determine a subset of customers of choice that can be served efficiently and effectively to make a profit within the social, political, and economic (scarcity) limits placed on them. Trying to create utility for all end customers may simply not be a profitable endeavor, so firms will have to make hard choices about whom they can serve in a profitable manner. Then finished goods volumes should be adjusted downward for nonpriority customers. Over the same period of time, select customers will receive higher fill rates and be authorized higher levels of available inventory. Such a strategy is aimed at selectively using available supply sources and serving the most profitable demand centers and end customers. We believe the world of the future will not allow a company to be everything to everyone, or to dominate an entire global market. Additionally, metrics such as “market share” to measure a company’s strength will be replaced with more productivity-oriented measures, such as profit per strategic market segment served or profit per volume supplied.

Part Mix

This strategy combines a variety adjustment approach with a functional approach needed for dependent demand. As part of the manufacturing flow management process, firms should aim to adjust the variety in their parts lines to match the most important demands within available supply constraints. Supply levels simply may not allow for continued parts proliferation in the future that eats up key natural resources that will continue to become more scarce. Firms might start by eliminating nonessential traits that cause increased variety, such as color and fashion, which may be the first to go. Additionally, in the future, it will be important for firms to create process technologies for parts manufacturing that can accomplish more with less and reduce the aggregate demand for supplies. Additionally, firms using the parts-mix strategy should aim to create a limited set of available parts to serve the functional requirements of key supply chain customers (manufacturers). This limited parts mix should meet only the most important demand attributes (but not all of them) for the most profitable segments while staying within near-term and long-term supply constraints. The use of standard parts that can be used in multiple end products will also continue to be an important concept for matching demand to supply.

Product Mix

Combining a utility approach with a variety adjustment strategy results in a product mix strategy. For independent end customer demand, firms will actually have more flexibility in how they choose to meet customer utility in comparison to parts-demand scenarios. Therefore, firms can aim to build the smartest mix of products to satisfy customers within given supply constraints. This can include flexibly manufacturing single products that meet a variety of end customer demand requirements, thereby getting the most out of available supply levels. Additionally, initiatives such as standardization and design for manufacturability can be used to reduce product variety. This puts less strain on available supply sources while still meeting the most important requirements of “customers of choice.” Using a product mix strategy, a firm’s product design and commercialization process will have to focus on shaping demand for different product varieties and optimizing the right product mix to maximize profit for a select set of customers. For example, following the economic downturn of 2008, companies such as Kroger, Walmart, Procter & Gamble, and Walgreens greatly reduced the assortments offered in their retail stores to cut supply chain costs.²¹ In the future, we believe that continued downward adjustments to the variety of products that a company offers will be critical to staying within the growing constraints and limits of a transforming world. Implementing a product mix strategy that shapes demand to match supply will help firms build a more sustainable and long-term ability to meet end customer demand.

Supply Chain Selection

As demand-shaping activities based on just volume and variety reduction fail to achieve the right balance between supply and demand, firms may choose to use a locational approach to determine where and how to serve parts and component demand. For these dependent demand items, firms need to select which supply chains and industries they will choose to take part in. Not all industries or geographic locations will provide the right levels of profit to justify serving the market, especially considering the limits on supply and resources that are expected in future decades. Firms will have to carefully select the supply chains they enter, keeping an eye on the focal firm in the supply chain that controls the actual end customer demand. This firm often has the most power in that supply chain. Firms that supply parts and components in the dependent demand arena may choose “supply chains of choice” and elect to leave other markets where they cannot make a profit. For example, in the computer industry in the late 1990s, Intel made a strategic decision to leave some military aircraft computer markets. This was primarily due to the low volumes and profits Intel could achieve in comparison to the booming commercial PC market. In the future, firms may have to make similar decisions about what supply chains to leave when low profits and volumes do not justify the use of limited supply resources.

Channel Selection

For serving end customer demand, firms may choose to use a channel-selection strategy that combines a location adjustment approach with the utility approach used for independent demand. In doing so, firms must make critical decisions about what target markets and end customers to serve and, more importantly, how to serve them. As seen in the Circuit City example, holding onto a large number of physical brick-and-mortar locations with large inventories may not be smart in a transforming world defined by information, computers, and quickly changing demand. Firms will have to find the optimal mix of physical locations, virtual and electronic sales channels, and outsourced licensees to sell their products and services. Similar to selecting customers of choice, firms will have to find “locations of choice” where they will aim to sell a limited supply of goods and services. They cannot attempt to serve every location in the same manner and will often have to make downward adjustments to the number and size of locations in their network. For example, during the economic crisis of 2008, firms such as outdoor retailer Cabela’s Inc. had to delay store openings and downsize new stores that were already being built to account for the new economic realities.²² Similarly, firms may have to look for flexible ways to adjust the size and location of their networks and the demand they aim to serve. Additionally, in the future, the sale of knowledge by firms may replace the manufacture of goods and services that are currently transported over long distances. Firms of the future may use the global communications networks to sell and transfer information about how to make a product to local, on-site production facilities. Here the product will be made on demand, with limited need for speculative finished goods inventory. Technologies such as three-dimensional (3-D) printing may redefine channels for serving demand and help shift the economy to more regionalized and local manufacturing. Such changes would help account for the expected transportation congestion and supply constraints of the future.

Part Substitution

When volume, variety, and locational changes do not accomplish the needed demand-shaping effects, parts suppliers may have to initiate parts substitutions to meet demand from manufacturers. Firms will have to find part substitutes that meet the same form, fit, and function needed in the end product being manufactured. This will be especially important because some current end products may become unsupportable in the future due to limited resources, unavailable parts, and the related increasing costs. Therefore, technologies that create cheaper part and component substitutes out of available resources will be necessary. Firms may be encouraged to shape parts demand by changing configurations and substituting parts that are more easily manufactured with given supply. In addition, firms may choose to adapt to local supply sources and find substitutions that will decrease costs and risks associated with increasing supply and transportation constraints. Additionally, supplier relationship management processes will need to encourage suppliers to find newer, more sustainable ways to support parts demand for customers of choice by finding substitutes that rely less on global transportation and therefore reduce the energy footprint.

Product Substitution

In the most extreme and well known of these strategies, firms may aim to achieve full end product substitution. This strategy aims to provide utility to end customers in a different way. In a transforming world, this may include substituting products made locally that meet 95% of customer service requirements and do so within supply, transportation, and customer service limits. Such a DSI strategy includes the trade-offs discussed earlier between efficiency and effectiveness. For example, firms may implement product substitutions that are not as effective at meeting utility but that maintain supply-side efficiency and viability. Additionally, in the transforming world, this may mean using the returns management process to reclaim, reuse, and recycle more products. These efforts should be aimed more at balancing demand and supply and responding to natural resource scarcity, where current efforts have been more about short-term efficiency improvements and marketing a green supply chain.²³ In shaping demand, customers of choice may still receive virgin or preferred products. Others may have to take substitutions that include refurbished or used products that have been reclaimed from the reverse supply chain. In doing so, demand will be shaped to meet supply.

Finally, as alluded to in the preceding sections, there is a continuum among these strategies. A company may first choose to reduce volumes, then limit varieties, then change channels, and finally institute substitutions. The result may be an entirely different strategy for fulfilling either independent or dependent demand. For example, suppose an auto manufacturer originally made ten types of cars that were stocked at 100 units at ten locations. It might incrementally move to replace them with three types of helicopters that take only 20 units for each type and are sold at three locations. Such an example would include a simultaneous downshift in volume, variety, and location and is also a full product substitution. However, in the end the firm’s decisions have allowed it to meet customer utility (demand for transportation). The firm does so by matching the customer with available supply and potentially using fewer resources. Such decisions are not only strategic in nature, but may prove to be critical in the transforming world. Unlike Circuit City, firms that can adapt and flexibly change on both the demand and supply side of the supply chain will have the best chance of profitably surviving in an uncertain future.

Applying the Demand-Imbalance Mitigation Strategies

The eight demand-side imbalance types present unique challenges for future supply chain managers to consider. Using the mitigation strategies we offer, firms of the future and their supply chain managers should have a leg up when assessing demand-driven imbalances. In conclusion, let’s consider what might have happened had Circuit City availed itself of our strategies during its struggles with customer demand. In all fairness, the company got many aspects of supply management right. But its demand management function suffered because its supply chain planners and managers paid inadequate attention to rapidly changing customer behavioral trends. In its heyday, Circuit City had built a vast retail network of stores and distribution facilities that could have been considered state of the art by mid-1990s standards. Its products were popular and sold vigorously through over 700 physical outlets. By many accounts, customers were happy with its service and selection. And then—things changed. Some early macrotrend-related effects began to influence Circuit City’s customers.

The most prominent of these was the advent of electronic commerce. In the early ’90s consumer electronics industry competitors relied exclusively on brick-and-mortar locations as their ubiquitous channels of distribution. Some adopted electronic channels more quickly and with greater depth than others. Stores such as Best Buy, realizing the technological savvy of their customers, quickly adapted, but Circuit City didn’t. The company made no channel/location adjustment, sticking with bricks-and-mortar stores to the bitter end. In so doing, it missed the boat on website sales. Its persistence with using the web as almost purely a marketing tool, rather than a demand-generation vehicle, caused its inventory to grow stale and its brand to suffer.

At the same time, the company was insensitive to the different physical product formats that customers were beginning to demand. It failed to notice market trends toward smaller and more portable products. In essence, the company made no form adjustment. The marketing group failed to eliminate older desktops and laptops and lagged or missed out on new technology trends such as handhelds and touch-screen technology. This was especially damaging in light of competitors such as Apple’s innovative products. Relatedly and perhaps more importantly, the company failed to shape demand for the stagnating products it was holding in inventory.

Additionally, its inability to understand the demand it was receiving caused Circuit City to suffer from overbearing inventory costs, which stifled liquidity and led to a rigid rather than innovative market presence. With over 700 physical store locations and several regional and national distribution hubs, the Circuit City inventory pipeline was wide, deep, and filled with expensive assets. The company held massive amounts of inventory at both stores and distribution centers and didn’t adjust volume and variety to meet demand in innovative ways. Rather than minimizing inventory and selling to availability, the company stacked expensive units high and deep to cover up long lead times and poor forecasting and absorbed massive inventory costs. It ended up with too much dead or dying stock when trends shifted.

Recognizing the problem, the company tried to go lean, but in its exuberance for cost efficiency it fired over 3,400 of its most experienced sales reps. This action made Circuit City even less effective at generating and meeting demand. The result, which we’ve already shared, was calamity. The company flailed, seeking new ways to sell old products, when what it needed to do was adapt and actively manage the demand and supply imbalances in its supply chain system. A strategy of lean and postponed inventory, shorter lead times, demand shaping to blow out dying stock, and aggressive customer sensing would have led to a radically different result, we believe.

As more time passes, the continuing changes to our business environment are expected to be dramatic. Firms need to consider both the supply-imbalance and demand-imbalance mitigation strategies we offer in this book to build an adaptive enterprise that will be prepared and ready to proactively handle the changes ahead. Using a DSI strategy to manage the supply chain is an option for many companies. Doing so will facilitate the development of the innovative and adaptive enterprise that will thrive in a transforming world.