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Demand and Supply Planning: Demand Classification and Pareto’s Law (80/20) in Supply Chains and Inventory Management
Demand Classification in Supply Chain Management
- Frequency of demand
- Level of demand
- Demand patterns
- Product lifecycle positioning
- Product classification
Analysis of these classifications will provide critical information for managers to use to optimize the supply chain.
Frequency of demand, as the name implies, relates to how often a certain product is purchased. Fast moving items (like most fresh food items) are purchased regularly, so there is a high frequency of demand. On the other hand, slow moving items (like specialty replacement parts for digital cameras) are in demand less frequently and may often go through periods where there is no demand.
Level of demand is often (but not always) related to demand frequency. A product’s demand level is measured by comparing volume of that product sold to total inventory. For example, in Walmart, gum and soda would have a high level of demand and specialty items like a tire pressure gauge would have a low level of demand.
Demand patterns are a metric for determining how demand varies with time. They can be seasonal, stable, or trending. Seasonal demand patterns are easy to understand: demand for certain items peaks at certain time of the year. People buy more ice cream in summer, and more hot chocolate in winter. Consumers purchase more toys at Christmastime, and more swimsuits in late spring and summer. Stable demand patterns have a relatively constant average over time – items like toothpaste, for example, are used with essentially the same frequency at all points in time, and thus demand is essentially constant. Trend demand patterns are “trending” in a certain direction. For example, whenever a new model of something is released, demand for older versions will trend downward.
Product Lifecycle Positioning: Key Phases and Considerations
Product lifecycle positioning analyzes the five key phases in a product’s life cycle: the launch phase, the emerging phase, the established phase, the decline phase, and the withdrawal phase.
The launch phase is the initial stock buildup before the product is publicly launched. This is one of the most difficult stages of demand planning, because exact demand is uncertain. Producing too few of a product may mean risking lost sales if demand is high, but producing too many can be catastrophically expensive if the product flops.
The subsequent emerging phase describes the growth in demand as the product gains more of a foothold in the market.
The middle phase is the established phase, when the product has definitely established itself in the marketplace. Demand may still trend upwards or downwards, but it is more likely to be stable in comparison to the other phases. Supply chain managers must closely monitor trends to set production levels.
The decline phase occurs as the product ages and begins to lose customers. (Note that this phase does not always occur – for example, toothpaste.) Inventory levels become very important in this stage as well, because products in inventory can quickly turn into “dead” stock.
The withdrawal phase is the final phase of a product’s life cycle. During this stage, the last products in inventory are sold (hopefully!) and no more are produced. At this point, the product is withdrawn from the market and is no longer available to purchase.
Segmentation, The 80/20 Rule (Pareto’s Law), and A B C Item Analysis (Product Classification)
Classifying products based on all of the above factors is important, because certain products will obviously need more attention at certain times than others.
For the purposes of this discussion, it’s important to have a general working knowledge of the business applications of the Pareto Principle, which is also known as the 80/20 rule. This principle stipulates that 80% of effects result from 20% of the causes – in a business context, for example, “80% of profits come from 20% of customers.”
In the case of demand planning, then, it’s reasonable to assume that 80% of turnover comes from 20% of items in inventory – that is, the fast moving items discussed above under “frequency of demand.” The next 30% of items represent 15% of usage, and the final 50% of items are responsible for only 5% of total requirements. (Note that these are rough estimations, and obviously, your mileage may vary in different industries.)
These percentages can be classified into categories: the An item category represents the 20% of items responsible for 80% of sales value, the B Item category represents the next 30% of items, and the C Item category represents the final 50% of items (5% of sales value). From a supply chain manager’s point of view, the “A category” represents the important items that need constant vigilance and focused attention. The “B category” items are slightly less important, and the “C category items” are largely unimportant and should have minimal time devoted to management thereof.
Pareto's Law: Further Reading
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