Demand Shaping: The “Bid Model” tool

In this article, I explain an effective technique for shaping demand. This technique can be applied in environments where prices are bid for each job or project. We have found that most organizations have some of this type of demand for most of their S&OP families. I originally published this article in May 2012 under the title; The "Bid Model": A Demand Shaping Tool. Enjoy!

I don’t believe demand planning is a passive part of the S&OP process. Back in the good old days, we called it forecasting and then built our plan based on the forecast. Over the years, we tried all kinds of different forecasting methods: intrinsic, extrinsic, multiple statistical models, expert opinion and ‘gut feel’. The developers of forecasting tools made millions of complex statistical models. Some of us in Operations even felt we knew better, so we took it upon ourselves to adjust the forecast. We all accepted that the forecast, by definition, was wrong and that’s life. Well, we live and learn.

Today, it’s called the Demand Plan, not a forecast, and the difference is not subtle. A demand plan is executed and a forecast is watched. In today’s S&OP process, Sales needs to do more than develop the Demand Plan - they need to execute it. They need to be able to increase or decrease it. Essentially, they need to ‘shape’ it.

Lead-time and pricing are two common demand shaping tools. Lead-time variation usually results from poor demand management. If demand comes in over plan, the backlog increases, increasing the lead-time to customers. Customers who don`t like the extended lead-times take their business elsewhere, thus reducing (or shaping) the demand. Extending lead-times reduces demand but at what cost? In most cases, pricing is a better tool and hence, we get the “Bid Model”.

The “Bid Model” is an effective demand shaping technique that works if you have pricing flexibility. This is the case on “one off” jobs or projects that must be costed and bid. Also, large orders often get special discounts. The same may be true from large customers. In all of these cases, pricing is a variable and it can be used for demand shaping with the objective of maximizing margin while meeting the Demand Plan.

The “Bid Model” uses the relationship between price and the probability of winning the order to calculate a series of probable margins. Everything being equal, the optimal bid would generate the highest probable margin, but more on that later. Let’s look at how to build the model step-by-step.

The "Bid Model": Step by Step

1. Clearly define the scope and cost for the bid. Typically, this is done by an estimating group and at this stage the cost may or may not be shared with Sales. In this example, the cost has been estimated at $60.

2. Develop the price/win probability relationship. This should be done by Sales. Give them a list of price points and have them fill in the win probabilities. The following table shows the values used in the example:

The values for win probability are listed on the right hand axis in the following graph. As the bid price increases, the probability of winning the order decreases.

3. Calculate the margin and probable margin for each bid price. The margin is simply the price less the cost for each price point. The probable margin is the margin multiplied by the win probability. The following table shows the values for this example:

When we add this data to the graph, we see the relationship between probable margin and bid price. All things being equal, the optimal bid is defined as the price that generates the highest probable margin.

4. Shape demand by shifting the bid to the right or left of optimal. Increasing the bid price will reduce demand and also the probability margin. However, if you do win the bid, the margin will be greater. Likewise, reducing the bid price increases demand. In this case, if you win the bid, you will have less than optimal margins. Obviously, there is a price floor you wouldn’t go below.

It Works!

The “Bid Model” is an effective tool for managing demand shaping with price variation. Here are a couple of examples where it was used.

One job shop I worked with used a version of the “Bid Model”. They shared the North American market with four or five major competitors. Most of the competitors had a similar cost structure and product offering. This company calculated bid prices by applying a multiplier to their cost workup. If their backlog was growing (and their lead-times extending), they increased the multiplier, throttling demand but increasing margin. If their backlog was too short, they reduced it to attract more business. Their management reviewed and updated the target multiplier as part of their planning process. It worked.

In another case, a company that used the “Bid Model” was completely overloaded. They had the opportunity to bid on a large project but their General Manager was anxious to reduce demand and balance his resources. Rather than pass on the opportunity, they moved the multiplier from an optimal value of 2.5 to a bid value of 4.0, fully expecting to lose the bid. They won it. Demand was still too high but the increased margins helped ease the pain.

Take Away Points

1. The S&OP Demand Plan is not a passive forecast. The company’s resources have been committed based on this demand plan. It is up to the owners to make it happen. Coming in too high or too low is bad news!

2. There are many tools to shape demand. Pricing, lead-time management, allocation, promotions and advertising are just some of these tools.

3. In the quote or bid environment, pricing can be an effective way to shape demand.

4. The “Bid Model” is an effective tool to formalize the pricing process and demand shaping in this environment.

Don’t just forecast your demand. Manage it.

#DemandPlanning #DuncanMcLeod #Forecasting #SOP #SOPBookings

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