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DEMAND DRIVEN S&OP: A SHARP

DEPARTURE FROM THE TRADITIONAL


ERP APPROACH
By Robert P. Burrows III

Enterprise resource planning


(ERP) systems, currently used, do
not work well in a customer-centric
economy what is needed is a
demand-based supply system that
focuses not on minimizing costs
and inventory, but on optimizing
customer value currently
deployed ERP systems churn out
thousands of schedule changes at
the individual SKU level to deal
with the volatile nature of the
demand economy.

FATAL FLAWS IN ERP


SYSTEMS
Over the past quarter century, the ERP

ith the rapid emergence of the


demand economy, appeals for
better planning and forecasting
are intensifying as customers require 100%
on-time performance. Enterprise resource
planning (ERP) systems universally have
scheduling and inventory replenishment
logic dating back to the 1960s. These push
systems fail miserably in the emerging
demand economy. New rate-based
demand planning tools are the solution
because they replace traditional sales and
operations planning (S&OP) logic and
deliver competitive advantage. Continued
reliance on the traditional ERP systems
will substantially erode service levels
and make total cost quite prohibitive.
This article delves into the fundamentals
of rate-based demand planning and
accompanying supporting processes. In
addition, it focuses on customer centricity
throughout the organization and designing
customer-value spaces that help streamline
demand planning.

ROBERT P. BURROWS III


Mr. Burrows is the founder and
managing principal of The OnPoint Group, a firm that applies the
quantitative science of operations
research to supply-chain management
problems. He spent 15 years as a
strategic business unit head of Figgie
International Corporation. Prior to that,
he worked for Booz Allen Hamilton Inc.,
where he consulted to dozens of Fortune
100 international manufacturing companies. Additionally, he has been on
the General Management Council for
Growth Enterprises of the American
Management Association. He holds a
Bachelor of Science in Engineering from
Iowa State University and a Masters
degree in Business Administration from
Case Western Reserve University.

system has become the operational nerve


centerif not the virtual brainof most
companies. And as the marketplace
becomes more competitive, the number of
products expands and customer demands
escalate, suppliers are resorting to more
and more sophisticated add-on software
tools to manage production, logistics, and
payment schedules.
Although billions of dollars have been
invested in ERP systems, they have not
stood the test of time and, in fact, often fail
to meet suppliers needs. It is not unusual to
hear of companies, having spent millions of
dollars on ERP systems, dismantling them
before long. This often occurs because
ERP systems are supply-centric, set up to
minimize costs and inventory. However,
to succeed in the todays demand-centric
world, companies need demand-based
supply systems that are specifically
designed to optimize customer value.
ERP and its associated customerrelationship, supply-chain, and productlife cycle management systems were
built upon the supply-driven logic of the
1960s. This logic, known as time-phased
requirements planning, has never worked
well due to the overwhelming amount of
exceedingly detailed data, rigid inventory
safety-stock floors, and high levels of
change orders. With such logic, supplyprogramming rules are neither flexible
nor sufficiently collaborative. Supplychain systems are hierarchical and supplyfocused; they are not tied to customer
value. Such data are arranged into regions,
states, customers, or products, without
well-defined supply relationships. Further,
the detail required to run the system is

THE JOURNAL OF BUSINESS FORECASTING, FALL 2007

so overwhelming that, once specified, it


becomes a major barrier to change.
ERP systems, as currently deployed,
tend to focus primarily on the make-supply
equation or on managing inventories.
These systems assume that good forecasts
are available, which generally is not the
case. Rapid changes in market dynamics
generate endless forecast updates, and
ERP systems are not equipped to cope.
The ERP systems standard answer
to the make question is stock it and
allow a long lead time for delivery. But
to meet the demands of todays customer
who says, I want something different and
I want it now, the ERP system complies
via change orderslots of them. Further,
ERP systems are highly insensitive to
capacity constraintsso insensitive that
they force schedule changes at the speed
of the computers processor, rendering
plans and timetables instantly out of
date. However, ERPs biggest flaw is the
frequent loss of perspective and control,
as managers dive into oceans of everchanging data. With technology changing,
ERP systems have tripled in size from
megabytes to gigabytes and now terabytes.
With that, high-priced, well-educated, and
talented management professionals have
become just data minders as their ERP
systems churn out thousands of schedule
changes at the individual SKU level in an
attempt to deal with the volatile nature of
the demand economy.
Managers want data that can be easily
converted into usable information. When
combined with a strong understanding
of customer values, data become a real
source of any organizations ability to
sustain competitive advantage. This is the
way a company can transform itself into a
value-delivery enterprise.

A NEW DEMAND-BASED
APPROACH
A more customer-centric form of
networked planning is required.
Such networked planning decreases
purchased cost, which amounts to half

the cost of goods sold, by stabilizing the


master schedule and making purchased
materials predictable. In this article,
we will discuss the critical first steps
towards accomplishing the demand-based
transformation of S&OP.
The needs of a demand-based economy are
vastly different from the traditional supplybased views embedded in ERP systems.
(See Table 1) Here a companys customers
are sorted out by using a value approach, that
is, by how the customer makes a profit from
utilizing the supplying companys products.
This is in lieu of categorizing customers by
the cost of serving them, which is basically
a self-serving and largely demographic
approach.
In addition, demand in the new economy
is vastly more volatile because customers
demand a larger variety of items, in many
cases 10 times more variety than before.
A suppliers product lines will continue to
expand, while overall volume stagnates.
For example, beverage companies have
seen carbonated drinks increase from 10
flavors/types to more than 100 in five years,
while the carbonated drink market share
has not increased at all. Operations must
be simulated using advanced operations
research techniques that model all sorts of
demand using what-if analyses. Finance
must become less focused on traditional
profit and loss (P&L) and concentrate
instead more on understanding cash flows
and cash performance, which requires
a much more sophisticated analysis.
The traditional P&L focus ignores the
equilibrium among capacity utilization,
inventory investment, and cash velocity.
Finally, companies must change their
organizational structure from functional
silos to collaborative cross-functional
teams that are focused on customers in
specific value groups. Likewise, companies
must measure their success holistically
from the customer perspective, rather
than continue to rely on narrow silo-based
operational or marketing measures.
Becoming demand-based requires
embracing forecast variability, new
operations management logic, and planning

systems built on actual transactional data


that have been generated through the ERP,
thereby shedding light on demand. This
demand-based supply (DBS) approach
is a customer-value delivery system that
enables complexity, conserves capacity, and
maximizes throughput. It uses simulation
rather than simple linear programming to
set policies for inventory, supply network,
and deployment. DBS changes operations
from a chain that is yanked by customers
to a network that is orchestrated to manage
demand. (See Figure 1) Furthermore,
under DBS, the focus is customer-centric,
with supply functions tailored to customer
needs, rather than to a one-size-fits-all
approach.
To achieve customer centricity,
companies need a flexible and wellorchestrated supply network that is in
very close proximity to customers. Far
Eastern supply chains are much too
long and inflexible to be of value to
most customers. Operations should be
organized around customer value. Most
companies group customers into three to
five value-described segments. Each value
segment is then subdivided into families
that have a commonality of raw materials
and production resources, as well as
markets. The point of this whole change
in approach is to deliver value and find
profitable ways to grow revenues.
The demand-based approach starts with
defining demand in customer-value terms.
DBS uses value segments and operating
strategies with a time advantage over Far
Eastern producers to achieve customer
centricity and deliver value. The forecast
of demand is just one element of the demand
plan at the beginning of the S&OP process.
Companies need a demand-based process
because the new consumer-driven economy
requires it. Companies have not been doing
everything wrong; rather, the economy
has changed. So, the methods used to
forecast, plan, and operate have to change
too. The new reality is higher product
complexity, more exacting customer
demands, and many suppliers chasing
fewer retailers. To be competitive and
survive in this new environment requires

THE JOURNAL OF BUSINESS FORECASTING, FALL 2007

a major shift in an organizations thinking


and culture. Key elements of this change
are described in the following sections.
The implementation of a DBS system is
more counter-intuitive than difficult to
achieve. To manage demand, forecasts
will reflect much greater flexibility than
has previously been assumed feasible.
Because implementation will take one or
two years to complete, companies should
start the transition promptly, or someone
else may usurp their customers.

THE FIVE FUNDAMENTALS


OF DBS
There are five fundamental principles of
DBS. (See Table 2) These fundamentals
work together to accomplish the overall
goal of the demand-based process,
which is to deliver customer value while
maintaining good operating economies.
Fundamental 1Value Spaces: The first
fundamental principle is to define value
spaces to identify a companys competitive
edge. Value spaces are well-defined
customer groups. They are not traditional
market segments built on customer
demographics and psychographics. Rather,
a customer is defined by how it creates
value in its marketplace. Value spaces are
defined by in-depth analysis of how the
customer uses a product and/or service to
its advantage. Customers are then grouped
by commonality of elements, including
time, complexity, variability, adaptability,
and product features. Table 3 compares
the traditional approach to customer
segmentation by the value approach. The
value segmentation can be performed with
internal data that is readily available from
interviews with the sales force or from
simple Internet research.
For most companies, the DBS process
requires transforming themselves to
be more of a learning environment
where people are open to conversations,
including the kind where the real
work often is accomplishedcasual
conversations around the company water
cooler, over lunch, or simply before
or after sales meetings. For example,

TABLE 1
SUPPLY VS. DEMAND VIEW OF THE ECONOMY
Customers
Demand
Products
Operations
Finance
Organization

Supply View

Demand View

Demographics
Linear, simple
Few, commodities
Reactive
P&L focused
Functional silos

Value factors
Volatile
Exploding variety
Simulated
Balance sheet focused
Collaborative teams

FIGURE 1
DEMAND-BASED SUPPLY APPROACH TO SUPPLY CHAIN
MANAGEMENT
Value Spaces
Time Advantage

Customer
Centric

Delivers Value

Focus
Means
Methods

TABLE 2
FIVE FUNDAMENTALS OF DEMAND-BASED SUPPLY
Fundamental Principle

Improves

Value spaces
Customer centricity
Families
Throughput
Rates of demand

Competitive edge
Goal setting
Communications
Performance metrics
Planning

TABLE 3
VALUE SPACES
Traditional Approach
Business Type
Retail
Food service
Club

Value Approach
Need States
Growth
Mature

Firmographic

Size
Region

Behaviors

Business practices
Cash flow approach

Products/Services

Full line
Broker
Specialty

Attitudes

Aggressive toward
the consumer

Product/Price

Services they relish


Preferred metrics

THE JOURNAL OF BUSINESS FORECASTING, FALL 2007

the entire sales force regularly probes


for actionable intelligence regarding
customers and shares it in a timely manner
with marketing counterparts on the DBS
team. In addition, many vanguard DBS
companies are incorporating point-ofsale (POS) data to measure consumer
take-away. DBS systems provide the
tools that are required to recognize trends
and timing and help manage a precise
response in the supply chain to estimated
demand. So, determining the value space,
at least in its basic form, from internally
generated research, will enable companies
to start developing value solutions for each
customer group and determining how to
differentiate competitive factors.
Fundamental 2 Customer Centricity:
This principle is important because it
converts values into operating goals and
solutions. A DBS process is developed
to cater to the specific requirements of
major customer groups as defined in the
value spaces. For example, a company
will have one approach for a customer
group that uses a companys products
as a simple tool and another approach
for a group that derives competitive
advantage from the products. Customer
centricity inside S&OP means setting
value-derived performance metrics and
making the needed changes in operations
to better serve a particular customer value
space. For example, a company might
fill orders for food-service customers in
three days instead of shipping from stock
as is done for retail customers. The longer
fulfillment time ensures that all items
are shipped together to food-service
customers with the required special
markings and without carrying excessive
inventory. It is this solution design that
establishes the proper framework inside
of which S&OP thrives and accomplishes
value delivery to demand. (See Figure
2) As customers are segmented into
value spaces, the company identifies
how its customers value its products and
services. The company then differentiates
its offerings to match what the customer
values, sets up its supply chain to deliver
that value, and measures its outcome in
terms of that value.

FIGURE 2
CUSTOMER CENTRICITY
(Operational Goals Are Set and Communicated in Four Steps)

Grouping
Customers
by Value

1.
Value
Creation

2.
Value
Differentiation

Values
Desired?

DBS
Setup?

Fundamental 3 Customer Value Communicated by Families of Products:


Families communicate customer value
at an operational level. Value spaces are
subdivided into families that are defined by
commonality of markets, manufacturing
processes, and/or materials. The 80/20
rule is employed to define meaningful
differences. Families of products are made
up of SKUs, but are not built from the
SKU detail. For example, a manufacturer
might stock 2,600 recognizable SKUs.
These 2,600 products at specific stocking
locations typically can be grouped into
about 30 major groups of products, or
major families, and some 20 or so minor
families. These families are determined by
the 3 Ms, meaning that the products come
from the same source (manufacturing
process or supplier), are derived from the
same raw materials (major components or
ingredients), or serve the same markets.
It is critically important that families are
easy to remember by both practitioners
and senior management. In addition,
families will significantly increase crossfunctional communication. They naturally
will be more predictable, simply as a
result of aggregation. Goals, metrics, value
definitions, patterns of demand, production
resource constraints, and all other key
factors can be defined into homogeneous
family groupings and, just as importantly,
can readily be managed.
Fundamental 4 Throughput...The Key
Performance Goal: Throughput is the

THE JOURNAL OF BUSINESS FORECASTING, FALL 2007

3.
Value
Delivery

Metrics?

4.
Value
Solutions

New
Service
Methods?

critical difference between DBS and


other operations strategies such as
manufacturing resource planning (MRP)
or Lean Manufacturing. Under DBS,
throughput is defined as using capacity
now to make only what the customer
is presently demanding, no more and
no less. The goal here is to maximize
throughput. In a make-to-stock business,
some inventory will be built. However, the
inventory management objective changes
significantly in DBS from what is used in
ERP. In DBS, inventory is balanced across
all SKUs such that each SKU has the same
level of stock-out risk, rather than having
some items with excess inventory and
others with exposure to stock outs, which
results from traditional individual SKU
replenishment inside ERP. The balancing
is done in a family each time that family
comes out of production. It is important to
note that inventory is balanced when the
family comes out of the manufacturing
process, not in the planning process, as
is the case with ERP systems. Inventory
for unpredictable familiesthose that
represent 20% or less of demandwill be
high to reduce the frequency of production
and to conserve capacity for the highervolume and predictable demand items.
The Pareto approach to inventory
classification is eliminated in DBS and
replaced by predictability measures and
manufacturing constraint management.
Also, the stratification of inventory is
not done at an SKU level, but at a family
level only. All items within a family

have the same inventory class and are


manufactured together. In DBS, the A
products represent the most predictable
families, not the highest volume.

FIGURE 3
FIVE MANAGEMENT PROCESSES OF DBS

Fundamental 5 Rates of Demand


Improve Planning Accuracy: In DBS,
companies build to an order rate, not to
an order. Conversely, ERP systems, with
their reliance on safety stocks, respond
to an individual customer order, and
order product to be built if any particular
order draws down safety stock below a
predetermined level. The requirement
to produce, therefore, is thrust on manufacturing or on a supplier without any
consideration for critical manufacturing
constraints. This logic flaw highlights the
famous ERP axiom of building to infinite
capacity.
Rate-based planning inside DBS
balances inventory among all SKUs in a
family and allows operations to continue
to produce predictable families to the
demand rate until a very significant shift
in demand is realized. The typical ups and
downs in demand are not considered. DBS
will change the rate of production to match
the rate of demand in organized steps. The
use of simulation to match the production
rate and the demand rate is an essential
element of DBS. The processes required
to implement the rate-based planning
approach are discussed in the following
section.

DBS UTILIZES FIVE


MANAGEMENT PROCESSES
DBS utilizes five processes to manage
to demand. (See Figure 3) Three of the
five processes are of most importance
and constitute the full S&OP process. The
demand-management process (DMP) is
used to balance capacity to demand. The
performance data base (PDB) is used
to correlate data from many different
systems, including ERP, forecasting,
and others, to demand information. The
capacity balancing data (CBD) process
interprets demand, aligning production
plans with actual demand as demand rates
become known. In these three processes,

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Demand
Management

Monthly
By month, by family
Calculates shifts required
Calculates pre-build

Performance
Data Base

Cycle
Planning
Weekly
By shift for three weeks
Sequences families

Capacity
Balancing
Data

Shipments history,
production, and
past plans

Cumulative actual
By family
By season

Rate Mix
Planning

Daily
By family
Into SKU detail

as well as in two other DBS processes used


for deployment, inventory standards are a
critical element and are used as a measure
of demand pressure inside the S&OP. The
three key processes are discussed in some
detail below.
1.

companys operations. The supply


plan must be flexible enough to adapt
to demand while keeping the resultant
operational change costs in line.
The DMP will support constructive
conversation about value delivery
among senior functional management, which previously was rarely so
focused. Typically, marketing talks
about customers by region, demographics, size, or product preferences.
Supply chain talks about products,
warehouses, and production lines.
Procurement talks about key suppliers
and sourcing strategies. There is little
common language between these
silosno standard currency that
permits them to exchange mutually
useful information, let alone measure
the effectiveness of their joint
operations in delivering value to the
customer. No one functional area
or senior executive can really listen
and respond constructively to others.
A DMP is the solution because it
provides a common language and
customer-centric information.

The DMP Makes S&OP Operational. The goal here is to manage


operations and suppliers to actual
demand, not to manage demand
from customers, which is not really
possible. The DMP aligns the demand
planwith all its uncertainties and
variableswith capacity, using a
production cycle plan and an inventory
strategy. Further, the DMP replaces the
traditional ERP functions of capacity
planning, master scheduling, and
inventory management to maximize
throughput and deliver value. (See
Table 4)
Under DBS, the critical balance
between demand and supply can
be planned, and S&OP can become
the one place where marketing and
supply-chain operations can and
should talk and strategize. However,
this conversing and strategizing must
center on how to create (and measure)
value for customers, not on how to
hit metrics of relevance only to the

2.

DBS Systems Work Because of


PDB. (See Figure 4) The PDB is
not another system where alternative
forecasts and plans reside. The PDB

THE JOURNAL OF BUSINESS FORECASTING, FALL 2007

is built directly from the active data


generated by various functional
organizations. Data from all sources is
first screened and mapped into value
spaces and families. The original data
integrity and traceability is strictly
maintained, but new or missing data
is located before the DBS systems use
the updated information. The PDB
eliminates the major reasons why
traditional S&OP systems fail. S&OP
participants no longer bring conflicting
data to meetings. Marketing data are
now coordinated with operational
data such as capacity and inventory
investment. Key performance metrics
are now relevant to overall business
strategy. PDB resolves data conflicts,
coordinates and organizes data into
families, and provides standard
feedback on throughput, as well as on
the value-space-defined performance
metrics.
3.

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Capacity Balancing Data Charts


for Interpreting Actual Demand.
One of the most significant tools
in demand-based S&OP is the use
of capacity balancing data charts
(CBD). These charts align production
plans with actual demand as the
rates of demand become known. The
corrections are made at critical points
in the demand plan as key demand
variables appear. POS information
is a key input to the CBD. Entering
data into the charts transforms it from
just data to actionable information.
The work is done at the family
level, where predictability is the
greatest and the actual capacity plan
is functional. Figure 5 is an example
of how a producer uses capacitybalancing data to respond to changes
in demand over time. The X axis is
the cumulative percent of total annual
demand. The curve is the historical
cumulative demand at the end of each
period, which normally is the end of
the month. The chart is read by noting
the historical cumulative percentage
at the current time in the business
cycle, so at the end of month four, we
would expect to have 35% of the total

TABLE 4
DEMAND-BASED VS. ERP-BASED S&OP
Function

Demand
Management
System (DMS)

Benefit

Current Approach

Demand planning

Families

Relates demand and


supply in events

Focuses on forecast
for demand only

Trend analysis

Capacity balancing

Stabilizes
production using
rates

Not related to
production

Production

DMS

Balanced to demand
within constraints

Assumes capacity is
available
immediately

Inventory
Deployment

Inventory standards

To demand rates
using simulation

To statistical
forecasts at a SKU
level

Inventory
management

Simulation

Allows inventory to
float in a range

Safety stocks that


act as hard floors

FIGURE 4
PERFORMANCE DATA BASE

Data from
ERP,
Marketing
CRM,
DRP,
etc.

Screened to
capture new
and
unassigned
data
Looks for
missing data
and
completeness

All Active
Data
Assigned
by
Family
Value
Space

year shipped. The user would then


divide the actual quantity shipped by
0.35 and compare this to the forecast.
If the forecasted quantity is higher, it
should be reduced; if lower, it should
be increased. The chart is used at
critical points in the supply-chain
production cycle to adjust the thinking
on how much capacity to reserve of a
specific family of items.
CBD charts are enhanced by the
use of a par book, which records the
timing of historical events, such as major
promotions, price increases, or new
product introductions, each of which alters
the shape of the demand curves.

Business Plans
History
Inventory
Shipments
Variable cost
Throughput
Service
Key metric data

Outputs
Graphical
Tabular
Trend
Scatter

IMPORTANCE OF
INVENTORY STANDARDS
Inventory standards are a barometer of
demand. In DBS, inventory is deployed,
rather than replenished. The deployment
calculation is accomplished using
simulation modeling, with the CBD
charts setting the future rates of customer
demand. This simulation sets an acceptable
range for inventory, rather than a fixed
floor like the safety stocks in traditional
ERP systems.
Safety stocks could be the one most
significant reason why ERP systems
continue to perform so poorly, even to the

THE JOURNAL OF BUSINESS FORECASTING, FALL 2007

FIGURE 5
CAPACITY PLANNING CHART
100%

Cumulative % of Total

point of failure. Safety stocks defy master


plans, resist rational responses to demand,
flout logic, and are founded on statistical
error that is compounded by miscalculation
in anticipating demand. Of keen interest to
the demand-based planner is the fact that,
in DBS, safety stock is never utilized.
Use of inventory standards is one of the
techniques that permits master schedules
to retain integrity and allows inventory
to move logically in response to demand
variation. Inventory standards are built
upon the advanced operations research
technique of simulation. Using simulation,
inventory standards can be tested against
common demand and supply variables
and, as a result, a range of acceptable
inventory can be determined. Inventory
standards become a barometer of demand,
replacing the hard, unforgiving, and
splintered floors of safety stocks.
The result of S&OP in a make-to-stock
manufacturing or distribution process
is inventory deployment. Inventory
standards inside DBS will preserve
planning integrity and balance inventory
to demand. (See Table 5) Inventory
standards provide a warning when demand
is indicating a change from pre-planned
levels. This warning gives the DBS planner
time to make a well-considered schedule
change that has the least disruption to the
rhythm of production. In DBS, inventory
deployment is optimized because it uses
new inventory standards and eliminates
the need for safety stock.
With the rise of the demand-based
economy, where customers have greater
negotiating leverage, producers are
forced to get out of their comfort zones,
change their cultures, and operate more
effectively. To retain existing customers,
let alone gain new ones, producers are
being asked to do what once might
have seemed impossible: accept greater
supply complexity and narrower delivery
windows, all without raising prices. Such
requirements are viewed with trepidation
by many in the organization. However, the
economy is forcing the issue. Resistance to
such demands will prove costly. Suppliers

2nd

Should be

Should be

Actual

1st

Actual

0%
1

10

11

12

Time
Note: Starting point is mid point between seasons.

TABLE 5
INVENTORY DEPLOYMENT IN DBS VS. ERP
(Optimizes Inventory Deployment, Uses New Inventory
Standards and Eliminates Safety Stock)
DBS

ERP

Deploys AFTER production


To demand
Balances all SKUs in family
Forward looking
Starts at general (family)
Planned

Deploys BEFORE production


To forecast
Treats each SKU separately
Backward looking
Starts at detail and moves up
Reactive

who meet the requirements of demanding


customers will become category captains,
developing strong collaborative alliances
and competitive advantages.

CONCLUSION
But there is more than enough good news.
The changes outlined here require a shift
in internal organizational culture, rather
than deep structural changes. Orchestrated
planning liberates the organization from
stilted thinking and overprotection of turf.
DBS forestalls the re-engineering of the
physical plant and the organization chart.
If done well, DBS allows a company to

THE JOURNAL OF BUSINESS FORECASTING, FALL 2007

manage in a more streamlined fashion,


with good decisions flowing naturally from
solid information coming from multiple
external and internal sources. Value is
aligned with performance, cost-centered
thinking is eliminated, and capacity is
conserved for making what customers
are actually buying now. The outcome
is improved job satisfaction, enhanced
market share, better service, lower costs,
and improved margins. Further, inventory
reductions will range from 40% to 50%,
cuts in overhead expenses from 30% to
40%, and liberated cash flows from 20%
to 30%.

(rburrows@opgmail.com)

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