Our world is changing and becoming increasingly more volatile, uncertain, complex, and ambiguous (VUCA). What does this mean for top-performing supply chains? To maintain a sustainable competitive advantage over competitors, they need to excel in three qualities:
- They’re agile and can react speedily to sudden changes in demand or supply.
- They can easily adapt to evolving market structures and strategies.
- They always align the interests of all stakeholders to optimize the chain’s performance while also maximizing each stakeholder’s interests.
Allocation planning plays a key role in these three processes. This detailed guide discusses allocation planning, why it’s important in supply-constrained supply chains, and how it can help supply chains achieve agility, adaptability, and alignment in a challenging post-COVID world.
Supply Chains: Supply-Constrained vs Demand-Constrained
In an ideal world, demand and supply would match perfectly, and both customers and suppliers would get what they wanted at the price that suited them both. But in the real world, supply chains are either supply-constrained or demand-constrained.
Supply-Constrained Supply Chain
In 2020, the COVID-19 pandemic shook the world. It caused a global medical crisis that stretched healthcare systems to the breaking point and interrupted supply chains, leading to shortages in everything from toilet paper, sanitizer sprays, and ramen noodles to steel, semiconductors, and electronics components. As many countries adapt to a “new normal” in the post-COVID era, these shortages continue to play a role in global supply chains. And China is once again at the center of these challenges.
As it slowly recovers from the crisis, China’s manufacturing-oriented economy is once again picking up pace. As a result, the country’s appetite for certain raw materials and goods like steel and electronic components is exponentially increasing, causing supply shortages elsewhere. This limits the ability of global producers and supply chains to produce and supply the goods demanded in other markets, resulting in supply-constrained supply chains, where supply is unable to keep up with demand.
Demand-Constrained Supply Chain
Low demand and high supply characterize a demand-constrained supply chain. Since supply overshoots demand, all the demand can be fulfilled, plus there is some unutilized production capacity. This is usually what happens in the modern capitalist world, where demands are met by enough supply for virtually every kind of good, and there’s always some unutilized production capacity – even in a pronounced “boom” period.
A demand-constrained supply chain should move towards the supply-constrained mode to improve its revenue-generating capacity in the long term, either by curtailing its ability to generate excess supply or by increasing demand.
Supply-Constrained Supply Chains in a Post-COVID World
In a post-COVID world characterized by China’s accelerating production and supply-constrained supply chains, the rules of demand/supply are changing very rapidly. Suppliers need to keep up with customers’ evolving demands despite raw material shortages. So how can they fulfill their customers’ demands when they cannot produce enough?
To address this concern in today’s supply-constrained supply chains, producers must think about three critical key aspects:
- Products: Which product should we produce with the raw materials currently available?
- Customers: Which customer’s demand should we fulfill with the products we create?
- Sales channels: What is the best way to sell our products to these customers?
Producers trying to function within a constrained supply chain must make conscious, data-driven decisions based on these three factors to ensure that they optimize the supply chain, meet customers’ demands to the fullest extent possible, and generate the maximum value (i.e. revenues and profits) for themselves and their stakeholders. These decisions are known as allocation decisions.
In our VUCA post-COVID world where demand overshoots supply, only agile, adaptable, and aligned organizations will be able to satisfy customers’ expectations. And to meet this goal, good allocation decisions are crucial. So, if they cannot fulfill all the demands of all their customers, they must determine how many demands of how many customers they can realistically fulfill. For instance, if they aim to serve all customers, they may have to reduce the supply to each. This way, they will serve 100% of their customers, but each customer will have only part of their orders delivered.
We will explore allocation planning in detail a little later. But first, a quick review of allocation in a supply chain.
What is “Allocation” in a Supply Chain?
The SCM portal defines allocation as:
“The practice of rationing customer orders at times of supply shortage.”
Allocation is one of the most important aspects of a supply chain because many business processes rely on smart allocation, including inventory management, sales, order fulfillment, and customer service. That’s why it’s essential to get it right.
Hard allocation: This is when supply is committed to demand and cannot be modified for any reason. It is execution-oriented and more common when delivery dates are not too far away.
Soft allocation: In this scenario, supply quantities and orders can shift as required, depending on demand changes. Since supply is flexible, it is more planning-oriented and usually undertaken when delivery is still a long way off.
Example: Allocation Decisions in the Global Airline Industry
The airline industry provides a great example of allocation decisions in a supply chain to optimize results for the supplier. Here’s how it works.
In any airline, passengers sitting in the same section on the same flight (e.g. economy) often pay different prices for their seats. The airline tries to maximize its revenue by offering a mix of full-fare and various discounted tickets (e.g., part of a special marketing campaign) and, more importantly, by trying to get this mix right. If demand is weak and the airline doesn’t provide enough discounts, it risks too many empty seats and loses revenue.
On the other hand, too many discounted tickets can sell out a flight far in advance. This closes the opportunity to sell tickets to last-minute flyers who might be willing to pay higher fares and thus increase its revenues. To get the balance right, the airline has to decide how many full-fare tickets to offer versus discounted tickets. Here’s where allocation planning plays a vital role.
As the flight date approaches, if many Economy seats are still open, the airline drops its ticket prices to encourage more people to book seats. Since Economy seats account for 80% of the seats on the plane, the airline would like to sell as many of these as possible because if it sells too few, it loses money on that flight. However, this sales push often leads to overbooking on Economy seats. When this happens, the airline may reallocate or “bump” some Economy passengers up to Business class (if seats are available).
The airline’s primary aim is to maximize the potential revenue it can earn from each flight. And to make this possible, it plays around with seat allocation and reallocation based on factors like prices, demand, and time.
In the airline industry, the “target” is usually to maximize its margin from each ticket sold. This is one way of making allocation decisions. However, there are other ways, which might be better suited for supply chains in other industries. We explore these next.
Allocation Decisions in Supply Chains
Every allocation decision starts with identifying the target or goal: what do we want to optimize?
As with the airline industry, maximizing the margin could be one target.
Another could be to prioritize some customers based on specific strategic considerations (e.g. important customers). For example, a supply chain could be set up first to fulfill all orders of frequent repeat customers, then fulfill 50% of orders of occasional but loyal customers, and finally fulfill 25% of orders of first-time customers. By fulfilling the orders of already loyal customers first, the supplier increases its chances of retaining that customer and returning for more repeat orders.
A third way to make allocation decisions is to apply dynamic rules, like profit velocity. This involves looking for bottlenecks in the supply chain, such as constrained capacity, raw materials, components, etc. Then, try to optimize the margin that’s possible to earn from 1 hour of this constrained capacity.
Allocation Planning in Supply-Constrained Supply Chains
In every customer “demand fulfillment” process, the goal is to generate a promise date for a customer order, influencing the order’s lead time and determining whether it will be delivered on time. In today’s competitive buyer’s market, fast order promises and short lead times can ensure customer retention and improve competitiveness. But is it possible to meet these goals in the supply-constrained supply chains of today?
In supply chains where supply cannot fulfill all demand, an old-fashioned first come, first serve demand fulfillment policy is not optimal. When all orders are treated the same, it risks the business’ profitability, customer relationships, and the supply chain’s ongoing performance. That’s why it’s critical to consider the three key factors we mentioned earlier – Products, Customers and Sales Channels to determine allocation planning in a supply-constrained supply chain.
Requirements and Input for Allocation Planning
Allocation planning requires two primary inputs:
- A good forecast (demand plan) of possible future demand
- A strong master plan (master production schedule) created from the forecast
The master plan includes all capacities, status and constraints in the supply chain. It has two critical functions in the supply chain.
First, it provides a strong foundation to optimize all operations and decisions in the supply chain, including decisions related to procurement, production and scheduling (converted into production orders), inventory planning, transportation planning, and distribution.
Second, once a master plan is created, allocation planning starts.
At this point, some predictions are made about the future: What can the supply chain produce in future available-to-promise (ATP) quantity? Here, the ATP represents the current and future supply used to accept and promise new orders. The ATP quantities from the master plan are then allocated for certain purposes, e.g. to ensure that some specific suppliers get the supply, to optimize margin and value in the supply chain.
Here’s what the allocation planning flow looks like:
Forecast -> Master Plan -> ATP -> Allocated ATP
The planning horizon of allocation planning is always shorter than the planning horizon of master planning. How long the allocations are maintained depends on the industry. For instance, in the computer hardware industry, the customer delivery date is only three weeks after order date for 90% of orders. So, in this case, a shorter planning horizon for allocation planning compared to master planning is perfectly acceptable.
The bottom line is that allocation planning in a supply-constrained supply chain requires experimentation with different factors to find the combination that can yield the highest margin, revenues, and profits. Through allocation planning, supply chains can fulfill the three primary conditions of competitive differentiation that we discussed at the start of this article: agility, adaptability, alignment. Since demand is greater than the supply can fulfill, it’s crucial to allocate the available supply to the pieces of demand in the most optimal way possible. This is exactly what airlines do, as we saw earlier.
Optimizing the supply chain’s operations is based on a feasible master plan. Similarly, allocation planning is also based on the same master plan. Synchronizing these two aspects enables supply chains to achieve very high reliability and fulfill all promises made to customers based on allocated ATP. These are two huge advantages in supply-constrained supply chains, where an optimal way to meet high demand is not just a welcome benefit but a critical competitive differentiator.
Allocation planning plays an important bridging role between planning and order fulfillment. In a supply-constrained supply chain, common in the post-COVID world, allocation planning can help ensure that the right supply is being allocated to the right channel partners and reach the right customer in the best possible time. For successful allocation planning, the master plan is critically important. It ensures that the supply chain fulfills its promises and works optimally when demand is high, and supply is low.