There is a rather timely debate and discussion occurring within our community that reflects on the S&OP (sales and operations planning) process and its interaction with IBP (integrated business planning).  In a recent posting on The 21st Century Supply Chain blog, Trevor Miles of Kinaxis puts forth an argument that for many manufacturers, the annual budgeting process is broken, and rather than a static mechanism, should rather be a continuous process driven by a consensus operations forecast, namely the S&OP process. Trevor brings forward a number of evidence points to support his argument, which readers can review and comment upon.

I thought I would take a slightly different perspective and reflect on what has been occurring across North American and global supply chains thus far in 2011, and reflect on whether a static annual budget would still serve as a barometer as we reach the half way mark of 2011.

To begin, we should set some context among supply chain operations and financial teams.  As we began 2011, Supply Chain Matters noted that the two significant global supply chain management challenges in 2011:

  1. Exploding inbound material costs which could prove difficult to offset by higher prices of further cost reductions.
  2. Rapidly changing markets and market dynamics forcing many supply chains to be more agile and responsive to explosive demand coming from emerging regions or hot product sectors.

On the financial side, many global manufacturers, while experiencing fatter profit margins, declared top-line revenue and market share growth as a key 2011 objective.  Annual budgets were set accordingly.

To provide a contrast of what can happen in just four months, we can reflect on two reports: The Institute of Supply Management (ISM) Semiannual Economic Report released this month, and the HSBC Purchasing Managers Index for China released in April.

The ISM economic outlook predicts that manufacturing growth among U.S. manufacturers is much better than expected.  The majority of respondents predicted revenues will be 13.2 percent higher in 2011.  In December, these same respondents predicted a 5.6 percent increase in 2011 revenues.  In four months, revenue expectations have more than doubled.  In terms of capacity, purchasing and supply managers report a current level at 83.2 percent of normal capacity, 3 percentage points higher than December, and coming close to capacity levels achieved in December 2006. In December, manufacturers were planning a 5.2 increase in capacity for 2011, but that capacity is now expected to increase to 8.1 percent for the remainder of this year.  Significant changes in a matter of months.

Turning to China, the manufacturing engine of the global economy, respondents note a lackluster growth in new business, a decrease in export orders, and a slower expansion of manufacturing production. Further noted is that manufacturers are cutting back on purchases and inventory noting a subdued rate of new order growth. Manufacturers in China and the U.S. are managing different business needs as well as different operating assumptions that are changing by the month.

Other key changes noted on both the U.S. and China reports are indeed rapidly increasing inbound prices and mounting parts shortages.  With the U.S., purchasing managers anticipated a 2.7 percent increase in prices in December, and have now noted that actual price increases have doubled to reflect on average, 6.1 percent increases. The majority of purchasing respondents now expect prices to increase 9.1 percent compared to end of 2010 levels.  Similar price increase concern is also reflected in the China. report. ISM specifically asked respondents what percentage of inbound material costs increases could be realistically passed along in higher prices.  The response was an average 34 percent, meaning the remaining portion would have to be offset by other factors. Earlier this year, senior managers might have been more optimistic regarding a strategy of offsetting costs with price increases.

At the beginning of this year’s budgeting cycle, nobody could have predicted a major earthquake and tsunami hitting Japan, and its subsequent impact on industry supply chains.  Both the U.S. and China reports make mention of initial indicators of impact and consequent parts shortages occurring.  ISM noted 23 percent of manufacturers anticipating that they will experience some supply chain related delays as a result of the Japan impact.

Our point in highlighting just these two examples of data is that business assumptions are indeed changing at a much more rapid rate.  The data and assumptions made just four months ago regarding key aspects of production, capacity, costs and availability are changing constantly, along with unforeseen events such as the earthquake in Japan, floods in the U.S. Midwest, or other natural catastrophes to come.  They all, at least in our view, reinforce thinking that budgets and operating plans will never be static and will always be changing.

Ultimately, the rapidly changed clock speed of business has impacted the iterations of the business planning and S&OP processes, and the sooner senior management and cross-functional teams acknowledge this, the better we can all move on toward determining the best means to manage needs for a much more flexible business planning and supply chain response management process.

Bob Ferrari