Nelson
M. Nones CPIM is the Director of Global Marketing for CIM Vision International,
Inc. (www.cimvision.com)
Overview
Inflation occurs when an abundance of money exists in relation to goods.
This creates artificial demand as consumers accelerate their purchases
to avoid future price increases. Suppliers, competing to meet this demand,
confront temporary capacity shortages that they alleviate by shifting
resources to higher-margin goods and raising the prices of lower-margin
goods. In addition, they accelerate purchases of material to avert shortages
and avoid future price increases. These actions create additional demand
for goods, perpetuating the inflationary cycle.
Today's
ERP systems originated from Material Requirements Planning (MRP) and Manufacturing
Resources Planning (MRP-II) techniques developed in the 1970s and early
1980s. They focus on improving the accuracy, speed and visibility of short-
to medium-term resource planning and allocation decisions, thereby improving
management's ability to confidently make profitable commercial decisions.
They also focus on minimizing operating costs, and maximizing short- to
medium-term revenues, through improved coordination and execution of daily
sales, engineering, procurement, production, logistics, maintenance and
accounting activities. In short, they are designed to maximize profits
by timing business events so exactly that productive resources are committed
as late as possible, but never too late to miss profitable sales opportunities.
These
are very important business problems during inflationary times, because
one or two avoidable, critical resource shortages could mean a missed
sale and reduced ability to recover fixed costs. For example, accidental
over-commitment of a bottleneck work-center or shipping vessel may delay
the arrival of finished goods and cause upstream work-centers to shut
down until the backlog is cleared. The cost of underutilized upstream
capacity is still incurred, even if production or shipping delays cause
lost or delayed revenues.
Prices stabilize or fall when an abundance of goods exists in relation
to money. This artificially reduces demand as consumers postpone their
purchases in anticipation of even lower prices. Suppliers, challenged
to recover their fixed costs, now have excess capacity. They respond by
cutting the prices of goods, especially their high-margin products, in
order to stimulate sales. In addition, they decelerate their own purchases
of material to use-up existing stocks, and await future price decreases.
These actions further postpone the demand for goods, setting the stage
for a deflationary cycle.
At
this writing, Asia and other developing regions are slowly recovering
from an acute recession and strong deflationary pressure, while other
regions (notably, the United States) continue to enjoy robust growth and
modest inflation. This disequilibrium has created a combination of inflationary
as well as deflationary pressures throughout the world. For instance,
demand for goods remains strong in the United States because buyers there
still have inflationary expectations. Asian suppliers have cut prices
in order to boost export sales and utilize excess capacity.
If,
as many believe, the world is in transition from inflation to price stability
or perhaps deflation, how will business priorities be affected before,
during, and after the transition? How will changes in business priorities
affect ERP system requirements?
Trading
Just-in-time (JIT) principles became standard business practice during
inflationary times. In essence, repetitive purchasing and JIT delivery
are tactics for hedging against price increases while minimizing inventory-carrying
costs. Buyers negotiate fixed-price repetitive-supply contracts that are
fulfilled and paid for over the life of the contract through periodic
shipments timed to meet the actual need for goods.
Price
stability makes such hedging unnecessary, and deflation makes it highly
unprofitable. But buyers will be under even greater pressure to keep inventories
low, since the value of inventories remains the same or depreciates in
relation to cash. As a result, buyers will insist upon immediate delivery
of small quantities whenever they can, at spot prices, although some suppliers
will succeed in selling large quantities for immediate delivery by offering
"temporary" price reductions, especially during the transitional period.
For all these reasons, discrete (order-based) procurement and fulfillment
systems can be expected to regain popularity lost to repetitive (schedule-based)
systems during inflationary times.
At
the same time, buyers and sellers can be expected to monitor competitive
spot prices more vigilantly than before. The growing popularity of reverse
auctions, data warehousing and data mining testify to the increasing demand
for such market intelligence. Demand will increase rapidly for powerful
search engines and business-to-business electronic commerce technology
to solicit and extract the right information at top speed.
The
importance of forecasting systems for short- to medium-term planning is
likely to diminish. During inflationary times, suppliers used forecasts,
customer orders and future repetitive schedule commitments to anticipate
capacity as well as material shortages. Forecast accuracy is critical
to the proper timing of business events when capacity shortages exist,
but becomes irrelevant when unused capacity is abundant.
Inflation
made it profitable for suppliers to be selective about what they sold,
and to whom. When persistent capacity shortages exist, profits are maximized
by discontinuing low-margin products and rewarding high-margin customers.
Performance measures such as Economic Value-Add (EVA), employed in sophisticated
sales, product profitability and customer profitability reporting systems,
evolved to address this requirement. Suppliers are likely to abandon these
tactics when confronted with excess capacity, the sooner the better, and
"hunt" instead for as many new customers as they can.
Demand
will grow for data warehousing, search engines, opportunity management
(OMS), customer relationship management (CRM) and collaborative electronic
commerce systems to help the sales force identify and qualify new customers
fast. Improved sales incentive, sales engineering and product configuration
tools will also be needed to find and close new customer business faster
than the competition.
During
inflationary periods, non-interest-bearing money owed by trade debtors
should be collected as soon as possible in order to maximize its purchasing
power, and non-interest-bearing money owed to trade creditors should be
paid out as late as possible. In between, this money can be invested in
short-term financial instruments or commodities bearing relatively high
rates of return, since inflation goes hand-in-hand with higher interest
rates and commodity values. Over time, many sophisticated remittance processing,
money-management and hedging tools have evolved to meet this requirement.
In
periods of steady or declining prices, there is no particular incentive
to collect any more money from solvent trade debtors than is needed to
meet current obligations. The relative benefits of sophisticated remittance
processing, money-management and hedging tools are further diminished
on account of the lower interest rates typically associated with price
stability. But demand for improved credit management tools and up-to-date
creditworthiness data is likely to increase, because of the risk that
more customers will be in financial difficulties. Strong demand for sophisticated
financial hedging tools can also be expected during the transition, because
of arbitrage and currency instability caused by inter-regional disequilibria.
Logistics
Demand for logistics systems grew rapidly during inflationary times, in
support of JIT business practices. These systems cut shipping costs and
minimize in-transit inventory investment by coordinating available shipping
capacity with production schedules and procurement requirements, improving
management's visibility of current shipping schedules and freight rates,
and automatically raising and tracking the necessary paperwork. The value
of all these benefits is likely to increase during periods of steady or
falling prices.
Persistent
excess capacity rewards suppliers who can deliver goods faster than the
competition, on short notice. Earlier, it was demonstrated that buyers
would insist upon immediate delivery of small quantities, at spot prices
inclusive of freight, instead of negotiating long-term repetitive supply
contracts. In markets characterized by steady or declining prices, a supplier
who is able to deliver the goods exactly when they are needed will win
the sale at today's spot price that in no event will be lower, and perhaps
will be higher, than tomorrow's.
The
supplier's ability to honor such commitments profitably, however, requires
immediate knowledge of material availability, production status, shipping
schedules, best available freight rates and available shipping capacities.
Thus, in addition to conventional supply-chain management (SCM) systems,
suppliers are likely to demand collaborative electronic commerce systems
to help locate the best available means of transportation, carriers and
rates. They will also require improved manufacturing execution (MES) and
warehouse management (WMS) systems to get an up-to-the-minute picture
of their internal production and logistics operations, and to further
reduce inventory investment.
As
prices stabilize or fall, suppliers will face increasing pressure to minimize
logistics costs. This is best done through a combination of advance planning
and solicitation of competitive spot-market bids for shipping services.
Thus, demand for logistics planning and cost accounting systems can be
expected to remain strong.
Overhead
Cost Control
Overhead costs are distorted immediately, and dramatically, by surplus
capacity. Labor-intensive producers can adjust fairly rapidly through
labor-force reductions, but capital-intensive producers cannot. Liquidating
properties or fixed assets can eliminate the cost of persistent surplus
capacity, but the assets may be difficult or impossible to sell. Manufacturers
can be expected to implement a variety of short- to medium-term accounting
tactics and longer-term financial tactics in order to minimize the adverse
consequences.
Tactical
accounting changes can be anticipated in the areas of fixed asset accounting,
overhead cost allocation and inventory valuation. Possible financial tactics
include restructuring of operations to minimize fixed costs, asset liquidation
and, worst case, asset write-offs.
Fixed
overhead costs are typically governed by original acquisition costs and
pre-determined amortization schedules. The periodic amortization cost
thus accrued is divided by production volumes to determine overhead costs
per unit. Excess capacity drives these costs up as ever-smaller production
volumes absorb constant amortization costs. In markets experiencing falling
prices, real overhead costs will constantly increase over the long run
because deflation increases the purchasing power of the original investment.
Businesses
tend to amortize their fixed assets as rapidly as allowed during periods
of inflation and high capacity utilization. This minimizes short-term
tax liabilities by reducing pre-tax profits, and reflects the tendency
of equipment to wear-out faster the more it is used. But businesses competing
in markets characterized by stable or falling prices can be expected to
lengthen the amortization schedules of their existing fixed assets as
much as allowed, because equipment is not being utilized as much and because
there are smaller pre-tax profits to shelter. This tactic has the salutary
effect of reducing overhead cost per unit, reducing cost of sales, boosting
short-term profits and strengthening the balance sheet, thereby improving
apparent business performance. Many of today's fixed asset accounting
and cost-allocation systems, however, lack the flexibility to implement
such changes quickly. Strong demand for flexible replacement systems can
therefore be anticipated.
Related
inventory valuations and the resulting cost of sales per unit will be
affected, too. During inflationary periods, businesses tend to maximize
cost of sales as much as allowed, chiefly to minimize pre-tax profits
and the value-added tax base. In the future, however, financial controllers
will be pressured to change their inventory valuation methods by whatever
means necessary, and allowable, to minimize cost of sales, in order to
further boost short-term profits and strengthen the balance sheet. As
with fixed assets, many of today's inventory management systems lack such
flexibility. Replacement systems will be needed to the extent that surplus
inventories are being cleared in the short- to medium-term, and to whatever
extent a minimum inventory investment is required to operate the business
over the long run.
During
inflationary times, automation of plant, warehouse and office operations
became an important tactic for minimizing ever-increasing labor costs.
Capital resources could be substituted for labor, and written-off in constant,
periodic amounts that declined in real value over time as inflation eroded
the purchasing power of money.
This
approach is unnecessary during periods of price stability, and downright
unprofitable during a deflation, because the purchasing power of money
will stay the same or increase over time while the cost of labor stays
the same or declines. Further, replacing fixed assets with variable labor
resources gives manufacturers far greater ability to control operating
costs in the short- to medium-term. Thus, it is probable that labor's
proportion of total operating cost will increase, even if the total labor-force
is smaller than before. This trend would likely accelerate as existing
fixed assets are retired, liquidated or written-off. As a result, steady
or declining demand for plant, warehouse and engineering automation systems
can be anticipated. This includes robotic, programmable logic controller
(PLC), automated storage and retrieval (ASRS), computer-assisted design
(CAD), computer-assisted manufacturing (CAM), statistical process control
(SPC) and integrated laboratory management (LMS) systems.
Were
a prolonged worldwide deflation to occur, demand may shrink so much that
suppliers are forced to shut down parts of their operations, or shutter
entire facilities. Attempts will be made to sell the idle properties and
equipment for the best-possible price, with attendant capital losses written-off
immediately.
Sale
of assets is most likely to occur while inflation is subsiding, and before
the onset of widespread deflationary pressure, because the assets will
appear cheap to investors who continue to have long-term inflationary
expectations. Liquidations and write-offs will have an immediate, and
beneficial, effect on cost of sales, to the extent that periodic amortization
costs are significantly reduced in relation to production volumes.
These
tactics would not require any significant changes to existing business
information system capabilities, but the number of general business systems
in-use can be expected to decline as operations are scaled back and facilities
closed. These include functions such as general ledger, accounts payable,
accounts receivable, inventory control, production control and cost accounting.
Reduction
of overhead costs at remaining operations is likely to be a key priority,
as well. Older general business systems tend to incur relatively high
operating and maintenance costs. Meanwhile, information technology costs
have fallen dramatically. As a result, some manufacturers will replace
their older general business systems with newer, less-expensive versions,
especially if doing so will enable the other tactical changes described
in this article to be implemented faster. But many older business systems
have already been replaced to address recent Y2K concerns, so the ongoing
need for replacement systems is likely to be limited, at best.
Labor
Cost Control
During periods of persistent surplus capacity, manufacturers can be expected
to reduce their variable labor costs as much as possible. This may be
done through elimination of overtime, shift reductions, work-hour reductions,
temporary or permanent pay cuts, temporary or permanent layoffs, and reduction
of employee benefits. Further, operations may be scaled back or eliminated
at high-cost union shops, as well as within high-cost or restrictive labor
markets such Germany and labor markets characterized by low unemployment
such as the United States.
These
effects will be moderated by substitution of variable labor for fixed
assets in the drive to control overhead costs, as previously demonstrated.
In doing so, however, manufacturers are likely to accelerate the redeployment
of productive capacity from high-cost, capital-intensive locales such
as the United States to low-cost, labor-intensive regions such as Asia
or Central and South America.
These actions may have adverse and increasing social effects, as dramatized
by recent protests in Seattle and Washington, D.C. against the International
Monetary Fund and World Trade Organization. Worker demands for improved
economic security may lead to renewal of isolationist policies in some
locales, which would effectively reverse the economic liberalization and
globalization trends of recent years.
Business
models designed to optimize performance in the previous climate of unrestricted
free trade will have to be adjusted to take account of the artificial
incentives and penalties created by any new government regulations. This
is likely to create new demand for localized regulatory compliance systems
that address taxes, duties, tariffs, prohibited goods and foreign exchange
controls. At the same time, reduced demand can be expected for general
business and supply-chain management systems designed to integrate the
unrestricted operations of multinational enterprises.
Business
Planning and Improvement
A variety of tools and techniques evolved during inflationary times to
improve productivity and maximize profits. These include material requirements
planning integrated with capacity requirements planning (MRP-II), advanced
planning and scheduling (APS), activity-based costing (ABC) and total
quality management (TQM). All of these techniques address business problems
created by limited capacities. MRP-II and APS tools are designed to maximize
the utilization of existing capacity through improved coordination of
individual production and procurement activities, without necessarily
improving efficiencies or yields. ABC and TQM are essentially diagnostic
tools for identifying the root-causes of inefficiencies and defects, and
enable management to monitor the effectiveness of corrective actions.
Used together, these tools allow management to wring maximum productivity
from its existing capital investment, before additional long-term capacity
investments are considered.
In
a period characterized by stable or falling prices, fewer new long-term
capacity investments will be considered. Instead, gradual disinvestment
of existing capacity may occur. Before disinvestment, there will be little
or no real benefit from using capacity requirements planning, APS, ABC
or TQM tools except to improve the coordination and efficiencies of a
smaller labor force. But even in so far as labor utilization is concerned,
greater business benefits will accrue from short- to medium-term adjustments
to the number of resources employed, rather than continuous long-term
improvement of labor efficiencies.
Materials
management is likely to remain a top priority, for reasons demonstrated
earlier. After clearing excess stock, suppliers will be under intense
pressure to keep inventories to an absolute minimum, since their value
will remain the same or depreciate relative to cash in the event of a
deflation. Expanded use of discrete (order-based) master scheduling (MPS),
material requirements planning (MRP), manufacturing execution (MES) and
warehouse management (WMS) tools can be expected in order to properly
schedule and manage materials in small quantities, on a JIT basis. Continued
deployment of quality assurance and control tools for the purpose of improving
finished product yields and minimizing waste can also be expected.
Summary
Manufacturers' business priorities will change significantly if a worldwide
transition from inflation to price stability or deflation occurs. Many
new priorities will be the opposite of those followed during inflationary
times. This will have a major impact on market requirements for enterprise
systems. The most likely impacts are listed below.
Significant
decreases in marketplace demand can be expected for:
- Repetitive
purchasing, order-entry and release management systems
- Sales
forecasting systems
- Capacity
requirements planning (CRP) and advanced planning and scheduling (APS)
systems
Some reductions
in new marketplace demand can be expected for:
- Industrial
automation devices and systems (robotic equipment, programmable logic
controllers, computer-integrated laboratory instrumentation)
- Warehouse
management and automated storage and retrieval (ASRS) systems
- Computer-assisted
design and manufacturing (CAD/CAM) systems
- Statistical
process control (SPC) systems
- General
business systems (general ledger, accounts payable, accounts receivable,
inventory control, production control and cost-accounting)
- Sales
analysis systems
- Advanced
remittance processing and money-management systems
- Activity-based
costing systems
- Global
supply-chain management systems
Some new
marketplace demand can be expected for:
- Interactive
inventory-control systems
- Interactive
pricing and promotional systems
- Logistics
planning, execution and cost-accounting systems
- Flexible
inventory valuation systems
- Localized
regulatory compliance systems
- Quality
assurance and control systems
Significant
new marketplace demand can be expected for:
- Discrete
(order-based) purchasing and customer order-entry systems
- Interactive
electronic commerce (Internet) technology for product catalogues, price
lists, reverse auctions, collaborative purchasing, customer order acceptance
and payment, shipping schedules, shipping rates and shipping capacities
- Data-warehousing
and data-mining engines for competitor prices, prospective customers
and customer creditworthiness
- Sales
engineering and product configuration systems
- Opportunity
management, customer relationship management, sales force automation
and commissioning systems
- Flexible
fixed asset accounting systems
- Flexible
overhead cost allocation systems
- Order-based
master scheduling (MPS), material requirements planning (MRP), manufacturing
execution (MES) and warehouse management (WMS) systems
About
the Author
Nelson M. Nones CPIM is the Director of Global Marketing for CIM Vision
International, Inc. in Long Beach, California, USA. Mr. Nones has over
25 years' professional and managerial experience as both a developer and
implementer of Manufacturing Execution (MES), Warehouse Management (WMS),
Enterprise Resources Planning (ERP), logistics, Manufacturing Resources
Planning (MRP-II) and general business accounting software. He has lived
and worked in the United States, Asia and Europe, pursued advanced studies
in Economics and Geography, and was a market research consultant for the
first 8 years of his career. He was Certified in Production and Inventory
Management (CPIM) in 1986 by the American Production and Inventory Control
Society.
You
can contact Mr. Nones through the CIM Vision website:
www.cimvision.com