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12 Dec

Closing the loop

Did you know that IKEA designs its entire supply chain process by working backwards?

Normally, a business would approach its supply chain from the start: it would first calculate costs for sourcing raw materials, transport, factory costs, packaging, and labour required to produce the final product. Once produced, additional marketing costs, distribution costs, and taxes would be added to its price.

However, in IKEA’s case, the opposite happens.

Focus on the numbered labels in the diagram.

Before arriving at the number of units to be manufactured, a forecast of average sales volume over a fiver year horizon is combined with an SKU (Stock-keeping-unit) based forecast with an 84-week consideration.

After objectively arriving at this figure, designers at IKEA decide on the materials, labelled ‘materials planning’ in the figure, that can be used to manufacture furniture with keeping in mind IKEA’s low-cost promise.

At this stage, special attention is paid to the unsold stocks at the retail stores and the prospective demand expected in the coming years to arrive at a quantity that suppliers can manufacture.

At the supplier level, the final quantity to manufacture is distributed among suppliers based on their current capacity. A fixed 18-month time horizon is provided to every supplier so that none of them is under-utilized or overloaded.

In the majority of cases, IKEA either enters into long-term contracts with suppliers or acquires their production facilities at a lower cost via a promise of buying large volumes from the supplier. This further lowers manufacturing costs.

Besides that, you will also see how the materials planning process that dictates sourcing is closely tied to transport planning, warehouse planning, and store planning, where all four influence each other in a closed loop.

Not just that, the production planning also incorporates the natural limitations of a supplier while planning for manufacturing capacity — something that helps IKEA avoid falling prey to the Bullwhip Effect — a phenomenon we will cover in an upcoming issue.

Moreover, because of its global presence, IKEA also optimizes its manufacturing in the following ways:

  • Sourcing materials close to the supply chain to reduce transport costs
  • Building distribution centres (DC) closer to seaports so that it can use ocean transport over road transport
  • Delivering products directly from the supplier to IKEA stores to cut handling costs, and reduce road miles
  • Warehouses attached to retail stores for hyperlocal delivery efficiency
  • Flat-packing the final products, which reduces the chances of damage in transit from the distribution center to customers and also reduces packaging and storage/warehousing costs

And most importantly, observe how instead of deciding on the materials beforehand, they first arrive at the possible demand to be serviced and then engineer their process around it.

IKEA’s manufacturing process is what they call "Management by Objectives."

The essence of this method is that you work out the details backwards. You first decide a target or an objective and then allocate resources to reach the target.

And the resulting manufacturing process reflects the company's dream of making good furniture affordable to many.

The lesson?

The structure and workarounds IKEA makes in its supply chain process and its optimizations are fully aligned and worked backwards from the company's mission statement and final objective.

And if I have to boil it down the only aspect that makes the IKEA manufacturing process stand out, it is that its entire value chain is designed using constraints that are a direct result of its value proposition to its customers, versus some other constraints that do not finally impact the end value delivered to the user.

Estimating demand and optimizing for the cost of products accordingly before you go ahead and manufacture them might sound counter-intuitive at first but it starts making sense the moment you realise how it helps sustain the company's singular and simple vision: affordable and accessible furniture.

And if you had to take one thing out of this example:

Let your final value proposition to customers shape your constraints, versus letting constraints shape your final value proposition. The former leads to more creative solutions and optimizations while the latter is a competitive race to the bottom.

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