Welcome back to our series on quantifying the benefits of Sales and Operations Planning (S&OP). In this series, we are examining the tangible benefits that S&OP can bring to your organization. Our goal is to help you understand how S&OP delivers these benefits and to provide a method for calculating the return on investment (ROI) from implementing S&OP.
If you haven’t already, go back and take a look at the first post in this series, click the link here. In that post, we discussed how S&OP is linked to various business outcomes and introduced an expected improvement table from Tom Wallace, author of the "Sales and Operations Planning: How to Handbook." This table provides a range of potential benefits, including high, low, and expected values, which we will use to guide our analysis of each benefit.
Today, we will focus on operational efficiency and explore how S&OP can enhance this aspect of your business. Tom’s table indicates a broad range of potential improvements, from 2% to 33% in plant efficiency and 20% to 50% in reducing manufacturing downtime. Understanding where you might fall within these ranges requires a closer look at what operational efficiency entails.
Understanding Operational Efficiency
Operational efficiency refers to the optimized use of resources, equipment, personnel, inventory, and investments to better serve the organization. To avoid "double dipping" on benefits, this discussion will concentrate on the improvements in the usage of people and equipment rather than inventory, as inventory reduction was covered in a previous video.
Linking Operational Efficiency to S&OP
S&OP improves operational efficiency by enhancing three key areas:
Predictability of Demand: Accurate demand forecasting supports better planning and introduces stability into operations.
Predictability of Supply: Accurate supply forecasts contribute to stable operations by ensuring that supply matches demand.
Use of Buffers: Buffers, such as inventory, lead times, and flex capacity, help manage variability and maintain stability.
These improvements lead to enhanced efficiency by minimizing the impact of volatility and ensuring that operations are as stable and predictable as possible.
Calculating Savings from S&OP
To quantify the potential savings from S&OP related to operational efficiency, we will break it down into two main areas: reducing overtime and reducing manufacturing downtime.
Reducing Overtime
To calculate savings from reduced overtime, start with your historical overtime costs. For example, if your company has $100 million in sales and $60 million in cost of goods sold (COGS), with 10% allocated to direct labor ($6 million), and you are running about 12% overtime, this amounts to $720,000 annually. By better planning and level loading, you could reduce overtime by 15%, resulting in a savings of $108,000 per year. If you account for overhead costs, the total savings could increase to $216,000.
Reducing Downtime
Downtime can result from various issues such as excessive changeovers, material shortages, or production troughs. To estimate savings, divide downtime costs into categories based on available data. For instance, if the downtime cost is $1.2 million annually, and you can reduce it by 15%, this would result in a cost saving of $180,000 per year.
Adding the savings from reduced overtime ($216,000) and reduced downtime ($180,000) gives a total annual saving of approximately $396,000, or roughly $400,000.
Phasing Savings Over Time
Typically, savings from S&OP are phased over a three-year period to reflect the time required to implement and realize benefits. A common approach is to allocate 20% of the savings in the first year, 80% in the second year, and the full amount in the third year. For our example, this would translate to $80,000 in the first year, $320,000 in the second year, and $400,000 in the third year.
Conclusion
While this analysis of operational efficiency may not fully justify S&OP for your organization on its own, it provides a valuable starting point for understanding the quantifiable returns achievable through S&OP. Stay tuned for future posts in this series as we explore additional significant benefits of S&OP.
If you're wondering where you can start realizing the benefits of S&OP for your organization, I highly recommend taking our S&OP Clarity Compass. This free scorecard only takes 3 minutes to complete and provides you with a personalized report and recommendations for improving your process.
At DBM Systems, our consultants have over 20 years of experience providing S&OP leadership to businesses worldwide. We equip teams with coaching and the tools to quickly start and sustainably run an effective S&OP process. Learn about our process and unlock the power of S&OP in your organization.