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Managing Demand Shifts with Capacity and Flexibility

By John P. Collins, CFPIM, CSCP, and Eric P. Jack, PhD, CFPIM, CSCP | September/October 2013 | 23 | 5

Invest in the right assets

The creation and maintenance of capacity is a unique balance between the ability to meet forecast demand and the unfortunate realization that demand uncertainty has resulted in surpluses or shortages. If it were not for customer demand uncertainty, supply chain management would be fairly straightforward (minus the occasional earthquake, tsunami, or political unrest). However, as demand remains difficult to predict, world-class companies must rely on flexibility and the ability to respond to fluctuating demand without big changes in capacity, cost, or profitability.

Capacity decisions are fundamental to any operation where management must answer three basic questions: how to get it, how to use it, and how to get rid of it. Flexibility, on the other hand, is rather complex because it can represent a significant portion of your capacity that may or may not be used.

How much capacity and flexibility do we need? Unfortunately, there are no easy answers to this question. Therefore, we rely on statistical forecasts to help us make critical decisions. Although forecasting was developed as a statistical tool used to predict customer demand, there are some real challenges in getting accurate forecasts. First, history is not necessarily a good predictor of the future. Second, demand follows tastes, and tastes change. These facts illustrate the familiar saying that the two most prevalent outcomes of forecast predictions are either lucky or wrong. Nevertheless, management makes huge investments based on forecasts. Plants are built, equipment is purchased, and people are hired in hopes of balancing capacity to anticipated demand. When it works out, everyone's happy. When it doesn't, plants close, people are fired, and investors lose money. Even when you’re right, eventually you can turn out to be wrong.

Ups and downs
To some extent, the amount of capacity needed depends on the business model and the amount of risk involved with not meeting customer demand. In a nutshell, you get too much capacity by making bad choices about how to meet demand—choices that may have looked good at one time. Adding capacity seems like such a positive thing. But then you find yourself in over your head. At one time you were right. Now you’re wrong. Suddenly, you are suffering with excess capacity because you thought the good times wouldn’t end, customers wouldn’t change, and the competition wouldn’t wake up.

World-class companies seek opportunities across their entire supply chain to create the appropriate mix of capacity and flexibility. This makes it possible for them to respond to changing consumer demand without incurring the sunk costs associated with facilities, equipment, and too many people. Rather than waiting until you're in trouble, follow the examples of these industry leaders and begin reducing capacity and building flexibility now. You may be surprised that throughput and sales won't be affected nearly as much as you think. In fact, a reduction of capacity might lead to more throughput and sales. Unlike the brick and mortar of new plants or the planned obsolescence of new machinery, flexibility is much less expensive and more valuable when demand shifts. And it will shift. John P. Collins, CFPIM, CSCP, is president of Sustainable Solutions.

He may be contacted at jcollins@ssi-spm.com. Eric P. Jack, PhD, CFPIM, CSCP, is associate dean at the University of Alabama–Birmingham. He may be contacted at ejack@uab.edu.

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