Practical Guide to Contingency Planning

We recently posted a blog, “The Crisis in Japan & the need for Contingency Plans”, and have had a few inquiries for more information on contingency plans. Allow us to expound a bit on our view of contingency planning.

There are many definitions for Contingency Planning and Contingency Plans. A representative and comprehensive definition of Contingency Plan comes from The APICS Dictionary, 12th Edition 2008:

contingency planning—A process for creating a document that specifies alternative plans to facilitate project success if certain risk events occur.

While we have great respect for and are members of APICS, the definition exemplifies the problem most of us have experienced with Contingency Plans and Contingency planning. The definition clearly and bluntly outlines the issue.  Most companies view Contingency Planning as a “process to create a document…” When the process is put in place to create a document, that is exactly what the process will yield especially when demanded such by the management team.

The Y2K effort, the mother of all contingency planning exercises, was a document creation effort. Do we have Contingency Plans i.e. do we have documents called Contingency Plans that we can show anyone who asks about them? Yes, we do. Good. Check the box.  Done.

No not done. More like a waste of time and effort.

The purpose of Contingency Planning is, or rather should, be to have a documented plan for business continuation should a high impact low probability of occurrence event happen. The events include but are not limited to fire, earthquakes, civil unrest, or devastating storms that cut off our ability to produce and fulfill orders. The disruption could effect one of our facilities directly or indirectly in that the disruption could have occurred at the facility of a key supplier.

Here is another definition from The APICS Dictionary:

Business continuation plan (BCP)—A contingency plan for sustained operations during periods of high risk, such as during labor unrest.

A Contingency Plan does need to be a documented. It needs to be a document that is focused on ensuring Business Continuation in case of a high impact low probability of occurrence event that disrupts our business.

Another more detailed definition comes from PC Magazine albeit it is focusing more on IT systems:

A plan involving suitable backups, immediate actions and longer term measures for responding to computer emergencies such as attacks or accidental disasters. Contingency plans are part of business resumption planning.

The process of developing such a plan involves convening a team representing all sectors of the organization, identifying critical resources and functions and establishing a plan for recovery based on how long the enterprise can function without specific functions. The plan must be documented and tested until it works effectively. Also called a “disaster plan,” a contingency plan must be updated continuously. 

What was that last sentence? “The plan must be documented and tested until it works effectively.” This is most interesting… the plan should actually be useful i.e. the plan should have a high probability of actually working.

Contingency Plans need to be:

1. Realistic in scope


2. Economic to Implement before the disruption


3. Readily Implementable upon disruption

Realistic in Scope:  First and foremost, the parameters must be well defined. This was a problem in Y2K. Different levels of management would define and re-define the level of disaster that had to be planned for.   

• Is the interruption catastrophic?  Does it cripple all commerce in a region or continent?


• Or, is the interruption localized to just our factory/warehouse or that of a primary supplier or customer


• Are we planning for a specific set of events or anything and everything that might happen?  

These questions will help use decide if we need to spend time working on a contingency plan or not. Here are two examples.

We own and operate a unionized factory or warehouse. The labor contract is to be re-negotiated in Q3 of this year. There is a good chance that the union could strike or management might lock them out. This will cause a potential business disruption. In this case, it makes good sense to have a contingency plan worked out and ready to implement. Such plans often include building up another month or two of inventory and flexing the non-union workforce to operate. In the case of the NFL, for example, the owners original contingency plan was to secure a television contract that allowed them to get paid even if a lockout cancels games in 2011.

Let us consider another extreme. What if a meteor were to fall out of the sky at 10 am on a work day and completely destroy our corporate headquarters and killing everyone inside. Though some might suggest, facetiously, that the business might actually run more smoothly, this will cause a disruption in the business. Is this kind of thing we should spend any time planning for?  In terms of scope is this even something that can be planned for or around? Probably not, so why waste the time and effort just to have “a document.”

In between, these two extremes is an area of grey.  Management teams should discuss and decide various scenarios and determine for which scenarios Contingency Plans should be developed.

Economic to Implement Before the Disruption:  Most plans include some aspect of redundancy that one ensures is in place well before a disruption occurs.  This involves having parallel or back-up capacity or sources in place.  This method is well known and often practiced in our daily lives.  Redundancy is good practice when it is economical and practical.  

Here is an everyday example that illustrates the point exactly.  We carry spare tires in our cars in case we get a flat tire.  The cost-risk benefit analysis usually justifies this redundancy.   Yet, most of us do not keep an extra car, just in case ours does not start one morning.  This spare tire is not expensive nor does it take up much space.  The extra car is a huge expense, takes up a lot of space, and requires maintenance.  The cost-risk benefit analysis here does not justify the redundancy.

Every business carries spare light bulbs but not every business invests in back-up generators should the power go down.  In the US and Europe, back up generation are only used in the most critical operations such as hospitals.  In Latin America where the power grids are less reliable, many more factories and warehouses have back up generation.

Again scope plays a role here.  In terms of back-up generation, the planning is often done for outages lasting hours rather than months.

Readily Implementable Upon Disruption:  If and when a disruption occurs, can the plan be activated and executed or will everyone look at it and mutter, “this thing is useless.”  It makes no sense to invest time and effort into developing a plan that will never ever work.  The PC Magazine definition resonates very well in this regard.  Any contingency plan must be viable and work.  This does not necessarily mean the plan is easy to implement

When possible, and economical, the plan should be tested.  We have fire drills for a reason.  We do not want to test the plan for the first time in the heat of battle or the chaos of a disruption. This does not necessarily mean the plan is easy to implement.  The plan may require lots of manpower operating in a well coordinated way.  Think about salaried personnel operating a plant or warehouse during a strike.  It will not be easy. The factory will not operate at the same efficiency and with the same throughput.  But, it will operate.

Final Thoughts:  Is it ever OK not to have a plan and to admit to not having a plan?  It is better for everyone to know there is not a good viable plan than to simply a document simply to check a box. Consider these to scenarios that are very realistic in today’s supply chains:

• A factory operates 24/7 and is 80% utilized, it will be very difficult to replace some or all of that capacity if the need should ever arise.


• A supplier that is the sole global source of critical material will also be very difficult to replace.


• How much effort does the management team want to invest for some in cases like this to have excess capacity or to develop excess capacity?  Or is it more prudent to take a calculated risk.

To summarize, Contingency Planning is an effective tool when the above mentioned guidelines are acknowledged and used to determine:

• Contingency Planning Scenarios


• Defining the extent and duration of disruptions


• Looking at the economics of redundancy making any preparations well before a disruption


• Testing the plan whenever possible


• Reviewing and updating Contingency Plans on an annual basis

Introduction to DemandCaster Video

Over the weekend we posted our new introduction to DemandCaster video on our home page and You Tube page. This 3-1/2 minute video provides a snapshot view of all the key DemandCaster elements put to music. I have posted it here and would very much appreciate your honest thoughts. Thanks!

The Crisis in Japan & the need for Contingency Plans

On the morning drive yesterday, NPR had a report on supply chain challenges posed by the earthquake, tsunami, and nuclear crisis in Japan.  The report centered on one company Ford Motor Company. They are having trouble sourcing certain paint colors because the pigments are sourced from Japan:

Ford has halted new orders for trucks, SUVs and cars that come in tuxedo black. Ford told dealers that it will continue making the models, but it’s cut back on production of cars and trucks in that color. Production of certain red vehicles will also be reduced.

Luckily, its only paint. They can still make cars and trucks but will only have to limit the offerings of certain colors until alternative sources can be developed.  Perhaps, if the sourcing of the particular Tuxedo Black materials cannot be secured, the automaker may have to settle for a different shade of black.

What if the component was more unique and applied to every vehicle in a particular nameplate?  What if it were something that could not be easily resourced without either moving production or necessitating new tools? What if it were something like fuel injectors or engines? What would you do?

Waiting until a crisis hits and then scurrying around like crazy trying to solve serious disruptions is what statisticians and forecasters call random shocks. Japan has certainly experienced not one but three chatostrophic random shocks in succession.

Though we all know that we should have contingency plans just for such circumstances, the probabilities of these events happening are extremely low. Thus it is hard to get teams motivated to take time from their busy schedules to develop contingency plans.

The worse part is that it is not easy to make meaningful and actionable contingency plans. Most companies have spent lots of time and energy making their supply chains lean and as efficient as possible. Part of being lean and efficient is the concept of sole sourcing. It is more efficient to have one solid supplier with which all of ones volume can be leveraged. Any good contingency plan would involve having alternate qualified sources for goods and materials. If you have a plant, a good contingency plan would have to address bringing production up quickly should the plant be disabled.

With supply from Japan being severely distrupted, contingency planning is on the minds of many business leaders. What should  be done? Should we go through a futile Y2K like exercises? Certainly not. The likelihood of those plans being effective were as low as a catastrophe occurring that would necessitate dusting off such plans.

We recommend the following:

• Management teams should discuss and determine their materials and suppliers critical to the business


• Purchasing and manufacturing teams should then assign risks High, Medium, and Low, similar to the classification done in a Failure Mode & Effects Analysis, to these materials and suppliers in terms of:
  
  
  
  • Importance to the business
  
  
  • Risk of disruption
  
  
  
  


• They should discuss what they would and could do should the source of the High-High materials be disrupted or if the High-High suppliers were to go out of business or not be able to produce.
  
  
  
  • What actions, at what costs, can be taken immediately?
  
  
  • What is the cost-effectiveness of qualifying a second source now?  
  
  
  • Are there design alternatives to employ less critical components such as stock items or commodities?
  
  
  • What actions should be put in place at time of a random shock? Note: Organizing a team to scurry around like crazy trying to solve the disruptions in the event of a random shock may sometimes be the only viable plan
  
  
  
  


• The results should be reviewed with the management team.

This exercise should be done at least once a year.  The objective is to make realistic assessments and actionable plans.  If no viable actions can be established, at least everyone knows the risk.

Does your company have contingency plans in place?  Are the plans viable or just plans in place to check the box? Let us know your thoughts.

A Quick Inventory Opportunity Assessment

When we meet with a company for the first time, we like to ask three simple questions to allow us to make a quick assessment of their inventory status.  We ask:

1. What is your revenue and gross margin?


2. What is your inventory level?


3. What is your average lead time?

These are three relatively easy questions but we do not always get three quick and concise answers. As we are often talking to senior executives or owners, we always get an answer to the first question, which makes total sense as these are the most basic of measures of any business. We generally get a high percentage answering the second question correctly as well.  This also makes sense as most people that talk to us, a company specializing in demand planning and inventory management, do so when they suspect they have an inventory problem.

The third question is where we get our first inkling that there may be an issue at the company.  In our experience, we have found that this question is not as easily answered off the top of the head as the first two.  It is simply because this measure unlike the others is not looked on with as much importance and in many cases is not as easy to derive. Additionally, there is often confusion as to what we mean by lead time.  It is often assumed that we are asking about lead time to their customers.  Though we are as interested in that at the preliminary discussion level, we are more interested in the average lead time from their suppliers of raw, pack, and finished goods to them.

So why do we ask about lead time?

Simply stated, with the average lead time we can do a gross “guesstimation” of actual versus potential inventory turns i.e. If the average lead time is two months, there will be, on average, two months of inventory in the system (assuming the company owns the one month worth of inventory in transit) as a lower limit.  This means six turns per year.  We can calculate the Cost of Goods Sold by subtracting the gross margin from the revenue.  With COGS and Inventory we can estimate the companies average turns.  We can then compare that to the lower bound inventory we calculated based on average lead time and voila… we have a gap that provides a gross estimate of the companies improvement opportunity.

If the average lead time is not available, we already know that there is an opportunity.  

On the other hand, we come across the rare instance where these numbers are known and quickly shared. They may answer: “let’s see, 60% of our goods come from Asia.  Half of that is from China with a lead time of two months.  The remainder is from other countries with a lead time of 3 months.  The rest of our goods are imported equally from the US, Mexico, and Germany with lead times of 2 weeks for the US and 1 month for each of Mexico and Germany.”  In this case, we are first impressed, but then quietly run our back of napkin inventory calculations. If our calculation shows that their performance is not optimal we quickly ask “So, tell me, how volatile is your customer demand?” That of course is a topic for another posting!

Do you know internal, external, and cummulative lead times?  If not, familiarize yourself with these numbers and the consequences of the same.  You may be surprised.

Don't be Naive About Inventory Management

For the first part of this posting, you have to pretend that it is 1975 and not 2011.

You are given a mandate to reduce inventory by 10%. The totally naive thing to do would be to cut inventory across the board by 10%. It is, to the naive, also the easy and apparent thing to do. It has an egalitarian ring to it. It is a quick and easy objective to set and immediately start working on.

But once you get started on the project it somehow gets a bit harder and more complicated than first imagined. To follow this approach means:

• Cut each finished good held by 10%


• Cut each material by 10%


• Cut WIP by 10%


• Cut in-transits by 10%

You learn the hard way that by cutting in-transits, for example, might have a bigger adverse effect on customer service than cutting finished goods or the materials in the raw and pack warehouse.

Believe it or not in the days before ERPs and modern materials management, people managed inventory in this manner. This was even true of many Supply Chain leaders as hard as that is to believe today.

Most people working in the Supply Chain today would never ever take this naive approach. One of the primary reasons we do not succumb to the naive approach is because of the systems capabilities we now use to run our businesses. We have much more data and the systems, especially in ERPs, function on user set parameters. It is for us to determine the parameters to deliver the inventory and customer service results we desire to have.

While we have much more sophistication than we did in the old naive days of cutting everything across the board, we can still make naive errors by relying entirely on the system.

You might be challenged today to reduce inventory by 10% again.  But today you might not make the same mistake because of the sophistication of the systems used to run your business. This is especially true of ERP systems like SAP and Oracle. The catch is you have to know how to use the system to analyze the data. It is still easy to make naive errors.

You are charged to reduce inventory by 10%. The first thing you have to do is make sure all the data in the system is up to date and accurate in terms of:

• All the lead times 


• All changeover times 


• All run rates 


• All minimum order quantities 


• All safety stocks

This is takes out the slack, if any exists, in the system. This will result in the right sized inventory for the current state of your Supply Chain, for the current Physics of your Supply Chain. Further reductions in inventory require structural changes that will alter the parameters of your Supply Chain.

• What to change? 


• What changes will yield the 10% reduction? 


• And, at what expense? 

The expense question is often the most important question. Expense? The expenses include the discount sales of excess inventory and perhaps the write-off of obsolete inventories. These classes of inventory exist because of poor planning or poor business practices. They exist because of past sins. Expenses of this kind come right off of the bottom line and thus not something that the CFO or CEO will easily agree to. They will often encourage selling of the goods if possible. Yet, these goods are excess and obsolete for a reason. They are outmoded, outdated, and perhaps even unsalable. If they can be sold, it is often at a less than desireable margin which will also impact the bottom line. Excess and obsolete items are much easier to create than to eliminate.

When it comes to reducing inventory 10%, we find that we may not be able to touch the Excess and Obsolete stocks. Thus, we can only impact the inventory that is actually moving or the active inventory. To reduce overall inventory 10% will require reducing the active inventory by even more depending on how much of the overall inventory is actually excess and obsolete. Read our posting The E&O and Inventory Turn Relationship to learn more. Active inventory may have to be reduced 12-15% or even more to achieve the overall goal of 10%.

Within the active inventories, we still cannot simply reduce inventories X% across the active inventories. Even within the general class of active inventory, not all inventories are created equal. Some items move faster than others, thus it is well advised to conduct an ABC classification of items and determine:

• If they are sized properly? 


• What can be trimmed or right sized? 


• What can be eliminated? 

It is necessary to study the depth and breadth of the goods and materials to determine which items can be eliminated. If this is not done on a regular basis, and few companies do so, we have found that there are always too many items contributing to unneeded complexity and inventory.

Other aspects must also be evaluated, including:

• Should finished goods be made in-house or contract manufactured? 


• Can the inventory of materials and goods be vendor managed and thus not on your books until needed? This is a popular practice with larger companies that are the number one or two customer of the supplier. Smaller companies may not be able to influence the supplier to participate without paying a premium. 


• Are the inventory buffers in the right place? This applies if you, of course, have one or more buffers. 


• Are you using the right variation to calculate the size of the buffer? Often times, even today, buffers that supply manufacturing lines or intermediate finished goods buffers are sized using sales variation. (This topic itself will be the subject of a future blog.) If you import from Asia (and who doesn’t?), is your supplier integrated into your demand and materials planning? 


• One of the best ways to reduce inventory, is to reduce lead times. If you import goods or materials from Asia, are you saving enough to justify the added inventory the long lead times justify? Is this changing with the spiking oil prices? What would you add to these recommendations? 

These are a few of our ideas. What have you done to reduce inventory that you would recommend to others?