Mind the Gap

How manufacturing companies can escape the cycle of fantasy performance planning

It's a familiar situation: drawing up the annual plan, setting targets based on "better than last year" and then reviewing those plans each quarter only to find that the company has dropped behind and the figures need to be adjusted. As the year progresses, the gap between forecast and performance gets ever wider and the measures required to hit target become ever more destructive.

The good news is that it doesn't have to be this way. With a more robust planning structure based on real performance, better information and improved communication, it is possible to achieve targets without nasty surprises. The management consultancy firm Cairnforth has identified three key areas that need to be addressed if companies are to break the cycle of fantasy performance planning.

Break Down the Silos

It's an old adage, but the right arm does need to know what the left arm is doing. It's vital to break down the silos that traditionally build up and operate within organizations, because organizations that have a track record of underperformance tend to have a fatal disconnect between manufacturing and supply chain and the sales and commercial divisions.

Supply chain makes products to a certain cost that it then passes on to commercial to sell at what both hope will be a profit. The problem comes when the commercial group go out and sell those products for what they believe is a good margin only to find that, due to phasing of a promotion, the supply chain group can no longer make it to the original cost and the company makes zero profit or — worse still — takes a loss.

Equally, when capacity is constrained because supply chain has sold capacity to a third party, commercial will sell into retail but supply chain will not have the capacity to manufacture and will then have to buy product in from a third party to meet the demand, further eroding profitability.

What is needed is to create a process where opportunities can be discussed across the business and an optimum solution to this challenge can be found, bearing in mind the needs and constraints of supply chain, commercial and finance divisions.

Avoid Obsessive-compulsive Year-end Disorder

Hand-in-hand with a silo structure, where planning decisions are taken in isolation from other functions of the business you also get "endeavour forecasting." This is based on unrealistic targets that the sales division strives to achieve, but often at the expense of the next year's or quarter's planned sales strategy.

I am not saying you should get rid of targets, but the obsession with year-end figures to the exclusion of other considerations like performance in the following year is hugely damaging to company performance, especially in such times of flux as we are witnessing.

Focusing on year-end targets alone can create some unexpected behaviors with your customers that will destroy value over time. For instance, customers start to understand your promotion cycle and will time their purchases accordingly. In the worst cases, I have seen up to 25 percent of a company's revenue being squeezed into the last month of the financial year. When discounting becomes the norm, volumes have to increase to meet revenue targets and margins are eroded. In essence, your customers are now in charge of your business.

Inventory Insanity

The third deadly sin in the land of fantasy planning is poor inventory management. Invariably, where planning is dysfunctional there will be customer service problems. In an effort to address customer service issues companies will often react by increasing inventories. Traditional thinking goes like this: "If we have too much stock, at least we will never run out, and that way we will keep the customer happy." Assuming you stay in business long enough, that is.

Such an approach may satisfy short-term problems caused by poor control or poor inventory management, but, in my experience, once inventory levels go up they rarely come down again. If too much inventory is in the wrong place at the wrong time there are huge associated costs from moving stock around, keeping it in good condition and financing it in a credit crunch.

Try to understand why inventory is there. If you have a safety stock it is there to be used. If you get variations in demand or supply you expect it to eat into the safety stock — this is a perfectly normal business practice. You don't need to have a knee-jerk reaction and boost inventory levels even further. Know when to intervene and when not to intervene, and get a handle on the real cost of inventory insanity.

Wake-up Call

Illusory targets, silo thinking and devil-may-care attitudes to inventories must now become a thing of the past. Companies should take heed of what is happening in the banking sector to identify better processes and structures that will help align sales forecasting, supply chain capacity and enable the company to finance more effectively.

By putting in place a rigorous system for monitoring and reacting to market changes, you will succeed in creating a better supply and demand balance and will ultimately gain more reliable and predictable business performance.