What’s Ailing Supply Chains?

The supply chain and logistics discipline started during World War II when armies needed to be supplied to multiple global theaters beginning from Northern Africa to Europe to small Pacific islands. Sophisticated planning and coordination effort at a period when there were no computers and the world wide web. The ability of military planners to achieve this feat caught the eye of the commercial industry. At the end of the war, they hired the experienced veterans to run their supply chains which had started to span the globe. Now, let us proceed to the current times once we have computers, the internet, and real-time data systems. One would expect to see further strides in supply chain management. Unfortunately, United States Government Accountability Office (GAO) was highlighting for the last several years that “Department of Defense supply chain management as a high-risk area due in part to ineffective and inefficient inventory-management practices.” We’re talking about hundreds of billions of dollars in surplus inventory with substantial back orders. Plainly said, the Government has too much inventory it does not need and too little the things it needs to fight wars leading to several billion dollars of losses to taxpayers each year. More importantly, it compromises military readiness.

Is this problem unique to the Government agencies? No. Any large corporation, whether retail, auto, oil & gas, consumer products, healthcare and any other manufacturing industry will tell you that they experience the same problem. They’ve a massive inventory of items their clients aren’t buying and back order of things that are selling. The issue is quite acute. It is estimated to take Gap, Inc. 9 to 12 months for their new designs to accomplish the marketplace. Imagine attempting to predict fashion trends in advance, and then start the process of procuring cloth and making clothes globally to provide markets. On the flip side, Zara claims it takes them 10 to 15 days to get merchandise from the design stage to stores. They’ve designed a highly responsive and demand driven supply chain which they credit for their achievement.

Before we discuss the root causes of supply chain problems, let’s understand what drives supply chain performance.

 What drives supply chain performance?

A supply chain is a process of accepting material from suppliers through manufacturing and distributing to end users or customers. Below is a simple pictorial that explains the procedure. It would, naturally, vary from industry to industry and depending on the scale of operations can get quite complicated.

Supply Chain

There is a simple metric to comprehend supply chain performance — Total System Cost (the impact of customer service is built in as out of stock or missed opportunity cost). The goal of the supply chain is to minimize the Total System Cost or maximize profit. The costs are lower at suppliers and build up quickly as you get closer to end users or customers. Based on the business, sales cost can range from 20% to 50% of the total system cost. For some industries, the total system cost will go beyond their four walls and might incorporate inventory being held by dealers or wholesalers to provide an overall perspective of the supply chain.

Supply Chain Cost Drivers ver2.jpg

What are the critical challenges with supply chain?

  1. Hidden cost: Because of General Ledger structure in many businesses, costs get allocated to different functions which fail to provide an overall picture to management for decision making. A few expenses like missing sales never appear in GL. In our experience, sales cost is typically computed wrongly as the opportunity cost of lost sales and inventory costs are not well understood.  Inventory cost includes the cost of carrying the inventory, warehousing, obsolescence, pilferage and other expenses. Similarly, missed sales cost should consist of the lost margin and the effects of lost advertising, after sales earnings and possible long-term effects of losing clients to the competition.  Without proper computation of costs, management can end up making decisions that aren’t financially sound. Sometimes decisions are made to hold more stocks or run larger batch sizes without actually understanding its impact on the total system cost.
  2. Silo decision making: Most managers tend to make a decision that optimizes metrics they’re accountable for, without understanding interdependencies and influence on other areas of the business. By way of example, manufacturing might want to increase the batch size to improve throughput without completely taking into consideration inventory and obsolescence costs upstream.
  3. Old planning processes: Companies have implemented ERP systems. Financial transparency and management are the primary focus. The business processes for most other functions have been ported from pre-ERP days to ERP, without fully utilizing the capabilities of the new system. So, the new system instead of being helpful works as a roadblock to achieving business results. To our surprise, we’ve discovered many supply chain planners use Excel to plan their dispatch rather than utilizing the capabilities of the ERP system.
  4. Increasing complexity: Supply chains are becoming complexity. The trend towards globalization has extended supply chain to its limits. It is common now for goods to be manufactured in China, assembled in a third country before being sold in the U.S. The lead times have become longer which directly affects system inventory. Additionally, SKUs have increased due to the desire of companies to customize. One merely has to visit a grocery store to see how many different varieties are available for simple things such as salt or yogurt. Product proliferation significantly raises costs all through the system — more goods have to be manufactured, they have to be held in inventory and higher potential for going out of stock.
  5. Impact of SLAs on costs: Sales organizations might not be fully aware of the financial effect of service levels. In their desire to perform better than the competition, sales teams make promises that could break the bank and the supply chain. At a global telecom company, the sales staff was signing contracts with unrealistic lead time for shipping of equipment. It leads to significant penalties.

What can companies do?

  1. Get total system cost: Finance organizations can put together a high-level total system cost picture that may significantly assist in making educated supply chain choices. The trickiest part is to estimate the sales cost since there are no agreed norms for estimating stock outs and missed opportunity cost.  With some fundamental principles determined (such as stock price as 15% to 20% of inventory value), these could be estimated consistently across product segments or lines.
  2. Ensure company goals drive company metrics: It is vital to link functional metrics to overall organization goals to steer clear of silo decision making. By way of example, for high margin businesses, manufacturing throughput isn’t as critical as responsiveness to orders. There’s a need to know interdependencies better to reduce overall system price.
  3. Move to demand-based planning where feasible: Due to ERP and point of sale technology, demand data are now readily available and can be used to plan for dispatch. But many businesses and government agencies spend enormous time and money attempting to predict customer demand and utilize it in shipment planning. Which one you believe is more accurate, actual demand data or prediction based on historical data?  Procter & Gamble in India implemented demand-based planning which reduced total delivered price from 75% of earnings to 55% of earnings, reduced system inventory from 115 days to 60 days, perfect order (right amount, right time, right billing) in 40% to 90 percent and enhanced quality (PPM) by 30,000 to 5,000.  Then, why demand-based planning isn’t typical?  Well, it requires a significant change in direction. For instance, you need the discipline of not producing more than what’s being demanded by customers. This is tricky when you’re handling organizational silos and older ways of cost accounting.
  4. Manage complexity: We can’t change the move towards increasing complexity — globalization and demand for personalized services are likely to continue. Apple established iPhone with a single version; today it comes in so many different sizes and colors. A better method is to consider how best to manage complexity with supply chain design. Products that have routine demand, it’d be logical to have a streamlined manufacturing and supply chain. But products which have unpredictable demand (for example, cosmetic) an assembly line production won’t be suitable and would require much more flexible manufacturing and supply chain.
  5. Make sure sales team understands the cost implication of service levels: Most companies don’t have a suitable means of assessing the fiscal impact of different service levels. A modeling exercise could provide insights into the cost involved.
  6. Utilize data to identify improvement areas: Data analytics can not only offer timely reporting but also help in modeling and simulation exercises.   For instance, some businesses assume that their network layout is fixed. But, data analytics may offer insights into how to optimize and tweak the system because of market demand changes due to seasonality or changes in customer preference.

Supply chains can provide a significant competitive edge to businesses. Getting total system cost to drive design and improving business processes can resolve the underlying ailments. Processes like demand-based planning, tiering of supply chain based on demand pattern and rationalizing service levels based on customer profitability have shown to boost supply chain performance.

About Author:

Suman Sarkar

Suman’s mission is to help clients achieve a competitive edge in the marketplace. With more than 20 years of international consulting experience, Suman has a proven track record delivering an innovative and strategic approach with outstanding results.

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