Revving up the agri-equipment business
Introduction: the sudden nCOVID break
Agriculture is major part of India’s GDP and the source of livelihood for daily wage earners in rural India. It is also the source of grains, vegetables and other essential items for the nation. The agriequipment businesses play a critical role in this sector by providing necessary equipment and maintenance support for the food value chain. The industry was looking forward to the usual buoyancy in demand during the peak season of April-June, because of healthy monsoons and a good Rabi crop, when the lockdown to contain the spread of COVID-19 was announced. Consequently, in one fell swoop, this industry consisting of agri-equipment manufacturers (OEMs) and their dealerships, lost the month of April, 2020.
Return of healthy demand
However, after the complete lockdown was lifted in May, agricultural operations was given good support to resume quickly and achieve fair normalcy. This is because agricultural cycle was at a crucial point when the country headed into lockdown – agricultural communities were either harvesting or preparing to harvest the Rabi crop which contributes to 50% of the food grain production in the country. After harvest, land must also be prepared for the khariff crop. Any hindrance to either of these activities could not only impact the farmer communities’ livelihood and availability of food grains but also have a direct impact on GDP of the country. Therefore, the Indian government was especially careful to take steps to ensure that agricultural activities are able to proceed as smoothly as possible.
Consequently, the agri-equipment demand too regained its seasonal upswing. Stocks maintained at dealerships rapidly got picked up. By mid-July most had only half (~ 30 days) of their usual levels. So, dealers continue to buy more from companies to replenish their depleting stocks. Many are even offering to pay cash to buy variants required by their customers. Unfortunately, companies are not be able to cater adequately to this rising demand due to significant supply side challenges.
Emergent business challenge
The primary issue for most companies is a severe supply crunch of components for manufacturing and assembly.
Tier 1 suppliers are struggling to ramp up at the pace and expectations of the agri-equipment OEMs. This is due to four factors:
- Sudden lockdown and then the prolonged stoppage of work resulted in non-moving inventory and outstanding payments thereby breaking the working capital cycle of suppliers. Even though agri-equipment OEMs have started placing orders again, it will take time for the working capital situation to stabilize. Moreover, many of these suppliers are also working for auto OEMs, who are facing significantly lower vehicle demand and are neither in a position to place further orders nor completely clear receivables.
- The available capacity of supplier plants is constrained due to limited labour availability and social distancing norms.
- Transportation and logistics from supplier to plant is limited due to lack of vehicles, manpower and transport regulations in lockdown areas (local restrictions on movement and business due to surge in infections).
- Supplier location itself may be under lockdown due to spread of disease.
With limited working capital suppliers are able to buy only limited raw material. Further, the currently dispersed labour and social distancing norms at workplace means that suppliers are forced to operate at lower capacities and have less than 40-50% output; this will increase only gradually. The fact that there is poor availability of manpower for transportation and logistics further reduces reliability of delivery and increases supply lead-time. Even though business has now resumed, any violation of government regulations or emergence of cases of infection at suppliers' premises, could force the supplier to stop operations time to time. Moreover, the suppliers are dependent on their Tier 2 suppliers, who will also face similar issues
The supply issues of agri-equipment companies is aggravated by operational issues that many are facing in their plants and in their distribution channel.
- Struggle to ensure capacity utilization Companies may not be able to scale up manpower to pre-COVID levels because of the new social distancing norms they have to follow. Coupled with erratic supply, this situation has forced companies to operate at significantly low capacity. Since demand is high, it is important for agri-OEMs to ensure ~100% utilization of available capacity. However, supply is erratic, and from time to time, companies see different suppliers becoming bottlenecks. Consequently, the effort and time required for the OEMs to accumulate full-kit of components is humongous, even for utilization of the reduced capacity. So, whenever full-kit is not available, in order to ensure that capacity does not go waste, OEMs see no option but to make those equipment for which the full-kit of components is available, whether there is immediate demand for that particular equipment or not. Unfortunately, this practice not only consumes already limited components (material stealing), it also means that the OEM manufactures variants which are not in schedule and not in demand (capacity stealing). Moreover, there is a more severe impact of this on suppliers.
- Aggravating supplier problems When the OEM changes schedules, it has a ripple effect on its suppliers. Suppliers are forced to make changes to their production and supply plans. This creates multiple problems for Tier 1 suppliers who are already struggling to cope. Firstly, this increases inventory in WIP or in FG for them. Most of this will remain in stock for longer time blocking already limited cash available. Secondly, the increase in set-ups due to expediting by OEMs wastes their already constrained capacity. Finally, this leads to poor OTIF; lead-times for supply tends to be not only high but also highly variable. When the effort required by agri-OEMs to gather full-kit of components for manufacture goes up as a consequence, it again triggers a vicious loop of expediting and chaos in the entire supply chain.
- Hoarding and mismatched inventory in the channel When there is high demand in the market and it is apparent that supply of equipment is unreliable, it naturally triggers hoarding behaviour across the entire distribution channel. Unsure of supplies, dealers will tend to order more than immediate requirement. Within the company too, fear of jeopardy to sales targets, may force branches to corner stocks by padding the demand-forecast they present to the plant. Since the actual demand at an SKU level is likely to be different from the forecast, this will result in excesses and shortages of same SKUs across branches and dealers. In an environment of supply uncertainty, the excesses do not compensate for the shortages as neither the branches nor the dealers with the excess stock will be willing to part with it. Hence, every shortage, at any location or SKU, will create an urgency in the supply chain. Further, as mentioned earlier, manufacturing of excess stock is always damaging because this leads to further shortages in production (due to capacity and component stealing) and creates a cascade of issues at suppliers.
- Loss of sales or blocked working capital for channel partners In this environment of supply issues and shortages, stock levels at many dealerships may drop below earlier levels. Under pressure to recover sale that was missed out due to the lockdown, the company may see this situation as a heaven-sent opportunity to push any available inventory to dealerships, even if these SKUs are not really desired by the dealers. Once stocks have been pushed to retail points, companies will then encounter situations where some dealers have non-moving stock while others face shortage of the same. Due to supply challenges, plants will not be able to respond quickly, and this would lead to loss of sales at the dealers (who have shortages) and in-turn loss of sales for the company. With their working capital blocked in excess stock, dealers may not be able to buy SKUs (and hence, sell) that are in demand. Any effort by dealers to get rid of stock that is not in demand will impact their earnings; a wrong sale may cost the OEM dearly, its brand name, too.
The root cause
When there are a number of dealers buying more than their immediate requirement to corner stock, and the company is pushing available stocks to maximise billing during the month, there is very little inventory left in the system. Without inventory, there is no protection for production against variability in demand as well as uncertainty in supply.
Without protective inventory, any and all urgencies of the market would automatically be escalated to the plant and would often force changes in the agri-equipment OEM's production plans. As a result, the vendors' or suppliers' production system will also remain in a frequent mode of expediting. They will be forced to produce SKUs that are expected urgently by the OEM; this will necessitate an increase in set ups at their (vendors'/suppliers') plant. Often, the components that are WIP or FG will remain uncompensated for/unclaimed by the OEM. This wastage of capacity and cash, especially at a time when both are at premium will hurt. Hyper vigilant about protecting production capacity, suppliers would be keen to minimize set-up changes. They may seek to achieve this by manufacturing the entire visible demand. Monthly plan and procurement schedules received from the OEMs give them the opportunity to take up large batches of a single component. Naturally, this will lead to high and highly variable lead-time for delivery of all components needed by the OEMs. Often times, when all components required for the OEM's scheduled manufacturing plan are not available, the plant manufactures SKUs for which the full-kit of components is at hand, even if the corresponding SKUs are not in immediate demand. This creates excess inventory. At the same time, SKUs thus made, consumes components that could be used for making SKUs that are in demand in the market. So, invariably, this form of 'material stealing' leads to inventory shortage at the retail points. However, sales teams need to meet targets and many dealers in this environment are anxious to stock up their fast depleting inventory, so the whatever stock of FG is available (even if these are not in immediate demand), is sold to dealers. So, time and again, the company finds itself without any protective inventory.
Clearly, “pushing” inventory to retails points leaves the company vulnerable to fluctuations in demand. At the same time, giving visibility to the entire forecasted demand (inaccurate, anyway) is making the company vulnerable to supply side fluctuations. Caught between these two, how then does a company stabilise production? The answer lies in creating a different system wherein OEMs production is buffered from demand spikes and expediting on one side and unavailability of components on the other. For this to also effectively ensure seamless availability without increasing inventory in the system, companies have to shift from “push” based inventory creation and movement to pull based procurement, production and distribution.
Direction of solution
Buffering against variability in demand by holding back the stock at aggregated location(s)
Holding inventory at an aggregated point such as a depot or warehouse helps the company meet dealers’ demands without much delay. In order to protect availability while also preventing hoarding behaviour, any movement of inventory from the OEM’s warehouse to the dealerships should only be based on consumption of inventory up to a maximum limit at each dealer and at each warehouse of the company. Daily production at the OEMs should respond to consumption from the warehouse and not to sales forecasts. This pull-based planning along with a process to periodically recalibrate the target limits on inventory at different nodes (central warehouse, regional depots, dealers etc.) based on changes in the observed sale rate (as compared to supply rate) can ensure seamless availability at dealerships. When an OEM switches to a pull-based movement of inventory at the dealer level, not only does this ensure that the entire system is responding to real demand, it also has the immediate impact of smoothening of load on the plant.
Ensuring full-kit for production
Producing according to consumption requires availability of all components required to assemble any SKU in reasonable quantity. Maintaining buffers of all the components required for production, enough to accommodate the demand during the supply lead-time of component, will protect production from any uncertainty in supply. Procurement triggers should be for refilling buffers alone and not for fulfilling forecasts. Once all components are available on a daily basis, the ability of production to respond to changing requirements is greatly enhanced.
Further, suppliers can also be encouraged to implement a similar system. They can maintain an FG buffer to protect them from variation in consumption at the OEMs and an RM buffer to insulate themselves from Tier 2 supply problems. Instead of adhering to a monthly schedule provided by the OEM, the suppliers will produce to replenish actual off take from their warehouses. Also, they will order RM to replenish their stocks. Implementing pull-based systems will lead to a net reduction in total supply chain inventory for the supplier giving him much needed working capital relief.
Assigning priority for production and supply to next link
When the plant produces a variety of SKUs and supplies to multiple warehouses, quite often it is possible that it may not be able to respond to all the replenishment orders every day. This is also the case with a supplier providing multiple components to a single OEM plant. Not reacting to the right trigger might lead to shortages and, consequently, to urgencies. As the system is wired to protect availability, the risk of a stockout is the right indicator of a legitimate priority. The level of stocks can be used to arrive at priorities for production and supply to the next link. These actions can help companies to create systems that can help stabilize flow of inventory in the entire value chain – from suppliers to dealers. This can ensure seamless availability in the market.
How to rapidly stabilize suppliers
The above actions can help companies to create systems that can help stabilize flow of inventory in the entire value chain – from suppliers to dealers and ensure seamless availability in the market before competition can. However, in the current turbulent circumstances, supplier have neither capacity nor working capital sufficient to meet the entire demand. Capacity of the company too is constrained. So while making a transition, some targeted actions to support suppliers will be required in addition to implementing the pull paradigm to help them ramp up systematically. These are:
- Regulating of portfolio of products:
In the initial phase, the supply of components is unlikely to be adequate to form sufficient fullkits for all varieties of products, especially if the company offers a large number of variants. However, in any portfolio, different products sell at different speeds in the market. So, it makes sense to focus first on the fast sellers, whose absence on the shelves could cause the company to most easily miss sales opportunities. Therefore all the variants in the portfolio should be analysed and categorised into
a. Runner variants: These are regular – high volume SKUs
b. Repeater variants: These are regular – low volume SKUs
c. New/Stranger variants: These are newly launched SKUs with untested demand or infrequently required SKUs
d. Variants under development: SKUs being developed in the NPD division (important to consider only if many new SKUs under development need supplier capacity)
- Resuming production of variants only in phases:
The best way to exploit available capacity and limited quantity of available components in production is to ensure alignment of the supply chain of each variant in a phased manner. In phase 1, companies should focus on stabilizing entire supply chain for runner variants. Once runners have stabilized, then company can tackle and streamline the supplies of repeaters, and new/stranger variants one after the other. The phases of stabilization should be in the following order.
In each of the phases, companies must ensure that every link viz. suppliers, production, dispatch etc. strictly follow the new SOPs
Phase 1 steps:
For OEM's warehouses:
a. Discontinue the practice of 'pushing' inventory to dealers; stop discounts/volume schemes.
b. Create a system where an SKU will move to a dealership only if the same SKU is sold to a customer from the dealership i.e. dealers will only be replenished based on consumption from their inventory.
c. Make target levels for selected runner variants as per expected deliveries in near future.
d. Do not make target levels or plan production of all other variants.
e. Initiate inter-warehouse transfers to redistribute excess stocks of runners.
f. Pull-back stock of other variants to aggregation point to redistribute in future.
g. Once consumption resumes from the warehouse, the urgency for refilling buffers can be indicated using a simple colour mechanism. If an SKU is completely stocked out, which indicates most urgent need for replenishment, it can be indicated as black; if it is reduced to less than one third of the target level and under threat of stock out, it can be considered to be in red; if the available stock is more than one third, it can be considered to be in the yellow zone and if the stock is more than two third, it can be put in the green zone. Stock should not exceed the target levels.
h. Review target levels frequently (at least weekly) and dynamically adjust based on trends in consumption at dealers and respective warehouses.
a. Don't start assembly if full-kits are not available or if there is no visibility of incoming components.
b. Don't produce based on any forecast or estimation even if capacity is idle.
c. Production planning will have to be done daily and should only be to the extent of replenishing stocks at various warehouses by responding to signals from the Black, Red, Yellow, Green colour priority system.
d. Create buffers of components at company stores based on the expected consumption in the supply lead-time.
e. Give visibility to the suppliers as to consumption from these buffers and signal urgency or priority based on colours.
f. Take buy-in of suppliers to align them to respond to these signals; convince them not to follow MOQ in the immediate future.
g. Review component target levels frequently, and dynamically adjust them based on trends in consumption.
Phase 2, 3, and 4 steps will be similar in scope. The only difference is that at each phase one more set of SKUs will be added till all are included. The same SOPs should be instituted and followed for them too. At each phase, start by introducing conservative target levels for variants along with buffers for their specific components
- Triggering the Phases:
When the operations and supply chain confirm the improvement in availability of components, then and only then, the subsequent phases should be triggered.
- The improvement in availability of SKUs at warehouses during each of the phases is good enough indicator to start the next phase.
Helping improve supplier cash flows In order to maintain continuity of business, suppliers need to pay for raw material as well as labour. Given their tight working capital and high receivables situation due to the lockdown (the receivables of suppliers must have increased by about 30-40 days), their business continuity could be seriously jeopardized. This will affect their customers sooner or later. Hence, it is in the interest of larger and more financially stable OEM's interest to facilitate a robust win-win-win 'bill discounting' mechanism with help of a financial institution, by leveraging its own high credit rating. This will help suppliers to get paid faster and also protect the cash reserves of the OEM. How this works Companies can get into an agreement with financial institutions to discount the suppliers' invoices on them and pay the supplier (deducting interest) on their behalf. Companies can later pay this to the financial institution when the suppliers' payment becomes due. For this deal, the financial institution may charge an interest rate slightly higher (10% or 12%) than what it would charge the larger, more financially stable OEMs who enjoy better credit rating, but lower than that applicable for supplier when they borrow directly.
This can be a win-win-win deal for the companies, the financial institution and the supplier. Here's how.
- Supplier gets money earlier at lower interest rate
- Financial institute has guarantee of payment from company
- Financial institute earns 2–4 % more than normal rate for company
- Companies get uninterrupted supply and preferential treatment from suppliers
The post COVID era will be defined by social distancing and sanitization norms. The government may take stringent actions on OEMs as well as suppliers if norms are violated. The risk of disruption would remain even after implementation of the above strategies. Thus, it is in the OEM's interest to be proactive and ensure that their plants as well as their suppliers' facilities are not in violation of the norms.
Create a COVID care Team: a Companies must create a COVID Care Team to ensure that all the safety precautions outlined by the government are strictly adhered to. b On a daily basis, the suppliers must follow the SOP checklist provided by OEMs and update the status of adherence. c Empower the team to help suppliers by regular inspection on adherence to guidelines and assess their COVID Risk Factor. Case study: International Tractors Limited Following the SOPs of a pull-based manufacturing and distribution system can ensure that manufacturing lead-times are reduced to a single day and help increase plant productivity to ~100%. This will help companies align the supply chain, stabilize production and ensure seamless availability in the market far quicker than competition. Case in point is how International Tractors Limited (makers of Sonalika Tractors) has been aggressively growing both sales and market share in the months post lockdown. The company had already implemented a pull system in its operations and were reaping rewards. (Refer to video case study -https://youtu.be/VO4DyrMxrvU). After the pandemic hit, it was able to leverage these Revving up the agri-equipment business processes to respond to market realities with agility. As a consequence, it was able to outrun its rivals by leaps and bounds. In July'20, the company recorded an exceptionally high domestic growth of 71.7% with overall sales of 10,233 tractors, surpassing industry growth of 38.5%.
The principles detailed here can help stabilize operations, ensure shorter lead-times, higher capacity utilization, higher availability in the market and higher profitability in the aftermath of this pandemic. These processes would hold true well into the future and give companies a sustainable competitive advantage even when the business environment return to normal, too. The time is ripe for companies to make the change.
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Vector Management Consulting Pvt. Ltd.
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Mr. Hemal Bhuptani