How do you decide on demand allocation of inventory to customer orders?
In times of shortage risk, some manufacturers are tempted to hard allocate inventory. The stock is held against the sales order upon order confirmation.
The inventory cannot be consumed for other orders.
All customers are born equal. Yet some are “more equal than others”. Every company has their customers who they place at a higher priority than others.
Isn’t hard allocation the best way to ensure that your most important customers get their product?
If you do hard allocate inventory at the point of order entry, does that eliminate the need to perform MRP runs for that order?
Short answers: Definitely not. Yes, but at a huge cost to flexibility and very little benefit.
I will describe why, and then give you an Excel tool to download that proves it.
The tool is built on our simple Ten Minute Material Planner and it shows you how hard allocation leads to lower performance. Follow this link to download and then return to read the rest of the article.
Demand Planning Service Levels
Best practices in demand planning calls for a service level to be allocated to customers. This method will size stock and capacity to ensure that certain products and customers have a higher availability than others.
However, not all manufacturers can get meaningful results from forecasting at all. Demand planning in medium- to high volume manufacturing is often easier than for high-mix/low volume production.
In a make-to-order business, it is more important to manage the orders you have on hand, rather than trying to reduce uncertainty and predict the future.
It is understandable that manufacturers look to a simple demand planning method. A rule that is easy to understand and ensures the most important customers get their order filled on time.
When Does Hard Allocation Work and When Does It Fail?
Hard allocation of inventory holds aside stock against a customer order. This is also sometimes known as “Hard Pegging”.
Soft allocation (sometimes “soft pegging”) can show the matching of demand with supply at the order level. However, the inventory is not reserved against the order; it is just pegged and visible to the planner. The planning process is free to peg it to a different sales order in a subsequent planning run.
Inventory is best managed with FIFO (first-in-first-out) principles. Hard allocation violates FIFO, because a long lead-time order can consume inventory, even though there may be some demand and supply that comes in between.
Check the following example:
Customer A orders on a long lead-time. There is enough stock to fill the order by hard allocation, even though it is not due for another 4 weeks.
Customer B wants to place a smaller order on a short lead-time. There is a supply order that will arrive in time to supply Customer A, but too late to supply customer B.
Hard allocation clearly reduces availability of stock. If you hold aside the inventory that Customer A needs, then you are unable to supply Customer B. Follow FIFO and keep the stock flexible: Both customers can be satisfied.
This phenomenon arises from a variability in lead-times. If all customers worked to the same lead-time for the same product, then sales orders would be FIFO and hard allocation would still give you a FIFO inventory result.
Wouldn’t give you a better result than no hard allocation. Doing about the same is the best you will get.
Furthermore, uniform lead-times are rarely something you can rely upon.
Demand Planning with Variable Customer Lead-Times
In times of plenty, everyone is happy with standard lead-times. MRP systems hum away. Orders are placed, but not chased. We know straight away what is the best range at which to forecast.
In times of shortage, lead-times go out the window. Even in these current economic times of supressed demand, companies are looking for any way to save cash.
Those days of inventory everywhere are going and they ain’t never coming back.
We might compile data in the item master and place lead-time settings against each part. But if there is a shortage and an urgent customer requirement, do we place an order and wait patiently? Er, no.
We get on the phone with the supplier and expedite. Rush that order through, and maybe go looking for alternatives if they can’t satisfy our needs. And we fully expect our customers to do the same to us.
Download the Example
Each customer has a variable lead-time that is applied if the “Lead Time” is set to variable. Otherwise it is an even 30 days.
Each run is going to be different, based on a random order quantity from a list of sales orders. The menu sheet scores each run with 5 points for an on-time delivery, 3 points for a late delivery and zero points for an out of stock.
Before you download the example, please fill in this quick one-question survey:
Let us know how you get on.