In the last article we looked at the various performance measures we can use for Supply Support in Performance Based Contracts including grouping them into 3 main types; demand satisfaction performance measures, inventory holding performance measures and customer wait time performance measures. In this article we are going to look at demand satisfaction performance measures in more detail.
Demand Satisfaction Performance Measures
At the highest level of integration with the buyer’s business demand satisfaction performance measures focus on contracting for satisfaction of the buyer’s demand. These represent by performance measures such as Demand Satisfaction Rate (DSR) or DIFOT which is simply the number of successful demands as a percentage of total demands (e.g. 98% DSR means the seller satisfied 98% of buyer demands based on the right number, type and delivery location of all items within the agreed timeframe).
A demand satisfaction performance measure gives the seller freedom of how to meet the demand in terms of quantity and location of items being demanded whether through:
- just in time procurement, manufacturing or repairs;
- holding stock in single or multiple warehouses; and
- whether to allow sharing of stock between buyers using the same items (e.g. pooling spares).
However, to do this, the seller must have a good understanding of buyer demand profile, and importantly, the demand profile must be stable and accurate. The seller then uses this information, through a process called “spares determination” which typically involves dedicated software tools such as OPUS10, to balance the number and location of items vs. total cost of the inventory (including storage).
So while demand satisfaction performance measures seem a good outcome for both buyer and seller, the same aspects that makes it attractive also causes limitations that need consideration.
Specifically, what if we only have limited knowledge on the buyer demand profile resulting in high level of uncertainty and inaccuracy? For example, what if the seller bases their support on 50 demands per month, however, they are getting 100 demands per month? Does the buyer expect that the seller can support this and if not, can the buyer apply commercial consequences (e.g. withholding profit) for a failure to satisfy these demands? What about if it is the other way around with the seller expecting 100 demands but only getting 50 demands. Does the buyer expect the seller to give back this reduction in cost? At first glance you may think this is OK since the seller is easily meeting the demand satisfaction requirements. However, what if those extra (spare) items have a shelf-life, like food, or become obsolete like ICT items (e.g. laptops and mobile phones)? The reduced consumption now leads to waste and was this considered in the seller’s pricing or is this a cost for the buyer?
Additionally, unless the overall performance measure hierarchy includes lower level supply support performance measures, by only using demand satisfaction performance measures the buyer has limited insight and confidence into future performance.
Finally, while the buyer may agree to a very high level of satisfaction (e.g. 98%) this allows 2% failed deliveries. But what if those few deliveries result in a severe or catastrophic consequence such as the only reason a large expensive container ship in port cannot leave or a passenger airline cannot make it’s scheduled departure? So what happens now?
The use of demand satisfaction performance measures sometimes requires that either the seller is given certain protections (e.g. if buyer demands go above a certain level they are not held accountable) or the seller places a higher price on the delivery of items reflecting this dependency, which in some circumstances, may make it unaffordable to the buyer. In these situations, it is important that both buyer and seller understand the conditions placed on the performance measure.
Success in using demand satisfaction performance measures is highly dependent on knowledge, accuracy and certainty of the buyer’s demand profile. Given this dependency is best to use demand satisfaction performance measures where there is certainty and stability of demands. Additionally, demand satisfaction performance measures are best used for higher numbers of demands where there are no severe consequences for small numbers of failed delivery. Otherwise, the PBC practitioners should consider the next two types of Supply Support performance measures.
In the next and final article in this series (Part 3), we’ll look at the remaining 2 groups of Supply Support performance measures (inventory holding performance measures and customer wait time performance measures) and give a simply diagram summarising which ones you should use and when.