By Rick Batty
Sales & Operations Planning (S&OP) is frequently a flawed process. While S&OP may succeed in balancing supply and demand, it does not help maximize profits. Why not? The problem lies in the fact that no true profitability metric is included in the process. The actual S&OP process typically consists of a logistical negotiation between the production team and sales & marketing to make the products in the quantities that sales & marketing have forecast. In preparing their forecast, sales & marketing may have used margin per unit of product to rank all products and the customers to whom these products are sold. In fact, they probably used margin as a metric to decide where to spend marketing dollars to increase demand.
Once the S&OP process itself is embarked upon, no profitability metric is incorporated at all. But why is profitability not maximized by sales & marketing’s use of margin in their forecasting efforts? The answer lies in the fact that in both the forecasting process and the S&OP one, no attention is given to the speed at which products are produced, i.e. production run rates. Why is this important? Well, the primary goal of a for-profit business is to generate as much profit as possible for the company shareholders in a specific period of time, typically the quarter or fiscal year. Margin per unit does not reflect how fast cash is being generated by a product. Only by incorporating production run rate, or production velocity, with margin can one create a metric that reflects the true profitability of a product or customer.
There exist a finite number of production minutes in the fiscal year. It therefore makes perfect sense that, in order to maximize profits, one needs to maximize the profit per production minute. This means that a product that does not have the highest margin per unit but runs through the production facilities quickly may actually be the most profitable product. In other words, ranking products by margin and then planning in the S&OP process to make as much of the highest margin ones as possible does not lead to optimal profits. Only by ranking them by profit per minute can this be achieved. Using profit per minute in the S&OP process itself to decide which products to make for which customers and where to make them will ensure that the planning process returns optimal results to shareholders.