the fatal flaw in ERP?

There's a mathematical flaw in every enterprise resource planning (ERP) system, and Mark Payne says he can prove it. More important perhaps, Payne, who is vice president of worldwide operations for Linksys, has demonstrated in his own operation that correcting this flaw can lead to big savings.

What's the flaw? According to Payne, the problem lies in the algorithms ERP systems commonly use to calculate the volume of goods a company must manufacture in order to meet demand.

As he explains it, there are three basic variables in the output equation: demand, production, and inventory. The flaw in the ERPs' approach, he says, is that they use inventory as the constant in the equation. That's led to widespread problems among ERP users in synchronizing demand with supply for companies that build products to replenish stock.

"If you hold inventory constant, you get overselling or underselling of products in the demand side of the equation, which creates the same variations in the production side of the equation," Payne says. "This variation smacks your production line. That's why everybody has been saying 'If we just had a flexible supply chain, we wouldn't have these inefficiencies.'"

Payne believes he has a better idea. He has proposed an alternate formula, one that makes production—not inventory—the constant and treats demand and inventory as variables. If companies would let inventory levels fluctuate while holding production steady, he says, they'd obtain the supply chain flexibility they seek.

Although Payne laid out his argument in a 2007 book, Make the Numbers, Don't Chase the Numbers, he still faces skepticism from many quarters. "Traditional supply chain people just don't believe it," he says. "They believe total inventory will go up …when in fact inventory goes down."

His thesis would remain theoretical except that Payne put his ideas into practice when he went to work for Irvine, Calif.-based Linksys, a division of Cisco that makes routers and networking hardware.When Payne joined the company in 2006, forecast accuracy was 20 percent for the entire product portfolio, which played havoc with Linksys's capacity planning. And because production was out of sync with demand, Linksys ended up air-freighting nearly 40 percent of its shipments (at a cost of $5 per $50 router).

Payne contracted with Palo Alto, Calif.-based Symphony Metreo to develop a software application using a formula in which production is held constant and inventory fluctuates (within a defined range) according to demand. The sales and operations planning group at Linksys currently uses this software to monitor inventory levels for each stock-keeping unit.

As a result of the shift in its approach, Linksys has been able to cut its own weeks of inventory on hand by 35 percent. Smoothing out the peaks and valleys in production has also helped the company do a better job of shipment planning. To date, expedited shipments have plummeted from 35 percent to 3 percent of orders, resulting in a 90-percent reduction in these costly shipments.

Incidentally, the current application did not displace the company's ERP system; in fact, Symphony Metreo's Finance, Sales & Operations Planning Manager solution uses data from Linksys's Oracle ERP system. "We run the production signal through the ERP system, and tell the ERP system exactly what to execute," Payne explains. "The difference is that we do not allow the ERP system to think or solve; we give it the answer and let it do what ERP systems do best... transact!"

Editor's note: The book Make the Numbers, Don't Chase the Numbers is published by Penworth Publishing of Humble, Texas. It is available for $24.95. For ordering information, visit www.makethenumbers.com.