Business Strategy & Supply Chains

[Click here to learn more about my book on Enterprise Supply Chain Management or to buy it.]

What do supply chains have to offer to the business strategy? It turns out, a lot.

To understand, let us review some of the basic concepts of strategy. Strategy was initially postulated as a balancing act between the external and internal forces in a corporation where the firm matched its (internal) strengths and weaknesses against the (external) opportunities and threats. Since then, many researchers have added their own work to the field of defining what is corporate strategy, how to think about it, how to formulate good strategy, and have provided various frameworks to help the evolution of the concept of corporate strategy. In short, the goal of any corporate strategy is to create competitive advantages for the business in its industry segment so that it is well-positioned for financial success.

Porter’s three generic strategies

Porter’s three basic strategies were suggested by him in 90s and have become a mainstay of the strategy literature. These three strategies are based on pursuing cost, differentiation, or focus as the main strategy and then adopting the policies, investments, and projects around that. The cost strategy is based on pursuing the cost leadership so that the firm has a definite cost advantage over the competition. If the firm is successful in achieving cost that is below the average cost of products/services offered in a segment, then it allows the firm to either be more profitable or expand its market share. Differentiation strategy postulates that firms can have competitive advantages over the others in their segment if they can develop unique features in their products or services that are valuable to its customers. Of course, for this strategy to work, the cost of developing these unique features must be less than the premium that the buyers are ready to pay for these features. The third generic strategy is the focus strategy that primary postulates creating a niche within the segment to achieve competitive advantage. These niches are created when the product is specifically designed and targeted at a well defined customer segment. The firm must identify the customer segment it wants to target and then define the unique features that will be valuable to this segment – note that cost itself may be one of those unique features that appeal to this segment, so can be other product features. There are many styles of strategies now defined that are primarily combinations and variations of these three generic strategies. That makes sense because a company may adopt different strategies for different business units or products depending on its current positioning in that segment, its strengths, available resources, and skills required to address the demands of a strategy.

Resource based view of strategy

A Resource-based View (RBV) of the competitive advantages emerged on the premise that it is only the resources of a firm that create the competitive advantages. When a firm possesses resources that are unique to it and can create value for its buyers, then the firm has competitive advantages. These resources can be direct such as cash and assets, indirect such as brand value, or firm’s capabilities such as its supply chain processes.

Capability based view of strategy

Then, there is the concept of competing on capabilities. This became a prevalent way of thinking about strategy after some Harvard researchers provided examples using Wal-mart and how its capabilities won the company the top spot in its industry segment.

It is a little ironic that capabilities came last in the evolution of thinking on corporate strategy since this is so basic to the success of corporations as well as to the successful implementation of any strategy the firm may have picked up to pursue. After all, any strategy that remains unexecuted does not deliver. Executing a strategy necessarily means that firms create capabilities that are demanded by the strategy. Take, for example, the cost strategy that Wal-mart has followed since its inception – it is the capabilities that Wal-mart developed to pursue the low-cost strategy that allowed it to reduce costs across its value chain. If Wal-mart was unable to create and maintain such functional capabilities then simply having a strategy to pursue low costs does not do any good. To pursue low cost, Wal-mart analyzed its whole value chain and developed capabilities in all business functions where such potential existed – such as store operations, distribution, warehousing, inventory management, and even merchandising functions such as seasonal merchandise and pricing optimization.

The same remains true for any other strategy that a firm might select. For example, differentiation strategy may lead to developing capabilities in product design, manufacturing, delivery, or customer service. Consider Kindle: this is a clear example that has propelled Amazon to develop capabilities in innovative product design which was not its mainstay as a retailer! Also consider the delivery model of the books using Kindle that provides another clear differentiator to Amazon compared to its competitors.

While the resource strategy considers direct and indirect resources as enabling competitive advantages and that is true, the fact is that these resources themselves are a result of functional capabilities that, over time, have delivered these resources in addition to their direct contribution to creating the competitive advantages. If Coke as a brand is valuable today, it is because the company developed superior marketing capabilities in the past years that have consistently worked towards creating the brand that now can be leveraged as a competitive advantage. Same is true for cash assets that Wal-mart may have – these assets themselves are a result of their functional capabilities allowing cost reduction rather than the other way around. Therefore, I see the direct & indirect resources simply as byproducts of a successful strategy that drives functional capabilities to create competitive advantages and also delivers these benefits in terms of direct/indirect resources which can be leveraged in advancing these competitive advantages. Remember that these resources alone are not sustainable by themselves and continue to depend on the original functional capabilities that created them in the first place.

The capabilities based competitive advantages, therefore, just happens to be the core precept of creating and maintaining strategic edge in an industry.

What do the supply chains have to offer to corporate strategy?

Now that we have refreshed the basic concepts of strategy, let us see what can supply chains offer to corporate strategy? Supply chains primarily focus on the operations of a firm; supply chain council defines the five basic supply chain functions as Plan, Source, Make, Deliver, and Return. Depending on the industry you are in, all or some of these functions will be part of your supply chain. All the supply chain functions primarily offer the firm cost reduction opportunities directly or indirectly. Supply chain functions like warehouse automation and transportation optimization direct reduce their cost of goods sold (COGS), and other functions like inventory optimization reduce the requirements for working capital thus increasing return on assets (ROA). All these options provide opportunities for creating competitive advantages for a firm. These supply chain functions can direct affect the cost basis and provide the firm with the cost advantages. You can read more about the financial impact of supply chain functions in this article here.

Then, there are other supply chain functions that can provide differentiators through process integration, such as those in the order fulfillment area. These functions not only add to the operational efficiency but can also provide differentiation in customer service through perfect order fulfillment and ability to track and communicate the customer order status throughout the fulfillment process.

Better planning through better demand forecasting can affect all the operations in a supply chain in a made-to-stock or retail situations. These planning functions can substantially reduce the cost basis by reducing inventory, increasing manufacturing operations efficiency, increasing distribution operations efficiency, and in reducing plan volatility that stabilizes the operations.

Optimization based supply chain solutions such as manufacturing planning, scheduling, and sequencing; inventory optimization, transportation optimization, purchase planning, etc. make use of powerful mathematical models to represent the real-life supply chain constraints with the objective of reducing cost or increasing throughput. Both of these (reducing cost or increasing throughput) can help organizations create and sustain competitive advantages by creating cost, delivery, and customer service differentiators.

Summary

Firms should analyze their corporate strategies and dissect their value chain (operations) to establish the functional capabilities that will help them achieve the goals set by such strategies. Supply chain functions, specifically, provide many such opportunities and combined with standard packages solutions can help the companies achieve their strategic goals systematically when these efforts are aligned with the strategic goals through the identification of required functional capabilities.

 

Technorati Tags: supply chain,supply chain strategy,vivek sehgal,business strategy

Enterprise Supply Chain Management

It is a great pleasure for me to introduce my first book on supply chain that was launched recently. The book is titled, "Enterprise Supply Chain Management: Integrating Best-in-class Processes" and available at Amazon as well as other book stores.

This book presents a functional view of the supply chain across the enterprise and covers all processes of demand management, supply management, warehousing, transportation, supply chain network design, and partner collaboration. This book is targeted at supply chain managers, technology managers managing supply chain projects, and students interested in learning about supply chains. If you like books that are written in a lucid, short, succinct manner, you will like it. This book does not go into the theory behind supply chain solutions, but points out what these processes can do for you, the inputs and outputs required by these processes, and their interaction with each other.

This book essentially covers the following:

• A primer on supply chain and finance
• Elements of a supply chain model
• The scope of the supply chain
• Demand and supply planning
• Supply chain network design
• Transportation and warehouse management
• Supply chain collaboration
• Reverse logistics management
• Supply chain technology

Hope you will enjoy this book.

Technorati Tags: supply chain,supply chain strategy,vivek sehgal

Need Working Capital? Try Inventory Optimization.

What can inventory optimization actually do for you? How about financing more than half of your working capital?

Here is a simple exercise using the financial data easily available through the corporate annual reports. I selected the two largest retailers in the world and went through their annual reports from FY2000 through FY2006, comparing the cost of inventory and the amount of working capital. The results, though hypothetical, are eye popping.  

Why select inventory above anything else? Two reasons: (1) inventories are reported on the balance sheets and therefore  their values can be reliably found, and (2) one of the two companies have almost made it their religion to run their business with optimized inventories as the cornerstone strategy.

Here are the two companies considered for this analysis: Wal-mart (WMT), and The Home Depot (THD).

Methodology:

Step 1: For the purposes of the analysis, I needed the inventory turnover as the key data element. The basic data to work with was taken from these companies  published annual reports from FY2000 through FY2006. This specific time period for analysis was selected because I wanted to leave out any disruptive effects of the recession that officially started in December 2007, but might have started impacting The Home Depot as the housing bubble broke earlier. A brief note on the fiscal year definitions for the two companies: both the companies use Feb-Jan as their fiscal year, however, their designation differs. For example, the period between Feb. 2000 through Jan. 2001 is FY2001 for The Home Depot, and FY2002 for Wal-mart. I made sure that the data used in comparisons refers to the same calendar period and have adopted The Home Depot's FY label for the exercise.

Here are data elements considered and the reasoning behind their selection.

• Cost of Sales: Required as this is part of the Inventory Turnover calculation, obtained from the income statements
• Inventories: Required for the Inventory Turnover calculation, obtained from the balance sheets
• Inventory Turnover: Calculated as Cost of Sales divided by the Inventories

The core financial data for the two companies is presented below:

Step 2: Next, I recalculated the amount of inventories that The Home Depot would have carried in a hypothetical situation if it was able to achieve the same inventory turns as Wal-mart did in the same year. The following data elements were used for this exercise.

• Cost of Sales: As above, obtained from the income statements of THD
• Assumed Inventory Turnover: Assumed to be same as that of WMT in the same year, copied from the above table
• Recomputed Inventories: Calculated as Cost of Sales divided by the Assumed Inventory Turnover
• Actual Inventory: As above, obtained from the income statements of THD
• Potential Dollars Available through Inventory Optimization: Calculated as Actual Inventory minus Recomputed Inventories

This data is presented in the table below:

Step 3: Finally, I collated the working capital numbers for THD from their annual reports. We will see how the working capital numbers compare with the (1) actual and the (2) recomputed inventories from the table above. 

• Working Capital: As reported in the annual reports for THD
• Assumed Inventory Savings: Adopted from the above table, the Potential Dollars Available through Inventory Optimization row -- as it signifies the potential cash flow that the lower inventories would have infused into the THD working capital
• Recomputed Working Capital Required: Calculated as the Working Capital minus Assumed Inventory Savings
• Percent Savings in Working Capital: Calculated as (Working Capital minus Recomputed Working Capital Required as a percent of Working Capital)

This data is presented in the table below:

The numbers in the table above really say it all. The improvement in the inventory turns would have financed more than 70% of all the working capital requirements at the Depot for 5 out of the seven years considered!

Can the Depot Do It?

There is definitely a case to be made on the inventory turns based on the different categories of merchandise carried by the two retailers. After all, potential inventory turns depend on merchandise mix carried by the retailer. Grocers like Publix and Kroger typically operate with 10 or more inventory turns over the year. Therefore, let us review the merchandise mix for the two in the example.

Wal-mart has a much larger assortment, but the hard-lines comprise a big percentage of Wal-mart merchandise. In the 10K statement filed by Wal-mart on 4/1/2009, the company reported hard-lines being one of their strategic merchandise categories that accounted for 12% pf Wal-mart sales. In the same statement, Wal-mart reported annual sales of $401B, that would make their hard-lines to account for nearly $50B. This compares well with THD sales of $71B with their hard-line assortment.

Wal-mart does have a large grocery assortment which provides them with a natural advantage when it comes to inventory turns, but it is almost certain that THD can do much better on their inventory turnover than they are currently able to do.

Conclusion:

The data overwhelmingly suggests that inventories make most part of the working capital requirements for the retailers and it can be substantially trimmed by adopting a good inventory optimization system. For learning more about what an inventory planning system does, what data does it require, and the underlying process, you can read this article here.   

 

Technorati Tags: supply chain strategy,supply chain,inventory optimization,inventory planning,walmart,vivek sehgal,working capital

Business, Functional & Deployment Strategy Alignment for Supply Chains

Business strategy alone can direct, but does not deliver. It can set the direction, provide objectives, specify the desired corporate goals, but does not take you there. That important step is left to the strategy execution. What does that consist of: converting the business strategy into the functional and deployment strategies, and converting them further down to individual plans and projects that can be executed. If each of the functional strategies are aligned with the business strategy and support the goals set by the business strategy, then it becomes a powerful roadmap for achieving the desired results. The rest of the discussion deals with the functional and deployment level strategy and execution, and tries to establish the correlation and the need for alignment among these three levels of strategies.

I am using the words "functional strategy" to emphasize the fact that functional capabilities provide functional competencies that allow the corporations to achieve their strategic goals, as well as establish competitive advantage in most cases. This is also the premise of competitive advantage that Porter talks about in his strategy discussions. The "deployment strategy" is primarily a reference to technology strategy since technology has become the de-facto enabler for the business processes, and it directly affects the cost of creating, enhancing and maintaining such capabilities. This (enabling technology) is generally seen as a support activity in conventional strategy literature, but the acute dependence on technology for day-to-day operations has changed the way companies must plan for technology today.

Functional strategies most important to a retailer would be the strategies for supply chain, merchandising, and store operations. Depending on the business of the corporation, this focus may change. In retail or manufacturing industries, supply chains will remain a huge focus area for developing process competency through strategy planning, as a very large part of the corporate operations fall within the scope of supply chain management processes. Ensuring that the supply chain strategy is aligned with the business strategy not only helps reach these goals, but also provides an objective method for prioritizing the supply chain initiatives within other organizational and functional constraints. An example of such organizational constraint can be the available funds that must be spread across all functional initiatives including the supply chain. An example of a functional constraint can be the unavailability of consistent item master data across various stores, that may then constrain the ability to correctly plan for the optimal inventory across the enterprise. A functional strategy defines the guidelines for the prioritization of functional areas where the development of organizational competence will get the biggest rewards.

Consider a retailer whose business strategy revolves around providing value pricing. This strategy can be achieved through merchandising functions by changing assortments to cheaper products that functionally serve the same utilitarian function as a more expensive product, or by creating store brands where costs are closely controlled by the retailer. The same strategy can also be achieved through improving supply chain functions that reduce the cost of operations like better inventory planning, transportation optimization, cross-docking; by having a lower cost basis, the savings can then be passed on as value based pricing. The strategy objectives can also be reached through enhanced store operations like better labor planning, reducing floor associates through installation of price checking stations, product finder stations, and self-service POS lanes; again the savings can be passed to the customers in the form of value based pricing.

Which one of the above is the best course of action? This question can only be answered by rising above individual functions and considering all of the following:

• What is the target for value based pricing? How much difference does the retailer wish to maintain with the competition?
• Is changing assortment for pursuing the value based pricing even feasible? This could be true for commodity items, but not where consumers value the brands.
• What is the potential of each strategy for providing the value based pricing, which one provides the largest profitability potential?
• What is the cost and time for implementation of each of the functional strategies?
• What other benefits each of the strategies provide? As none of these solutions work in isolation, they do have other consequences as well. For example, reducing knowledgeable store associates does affect customer service negatively.
• What strategies produce synergies with other corporate goals? For example, improving demand and inventory planning may also support more flexibility in refreshing assortments more frequently.

A functional strategy establishes the direction for creating, enhancing, and maintaining the functional competence within the functional area. Such a strategy will not only support the business strategy, but may also provide options to consider that may not be available in absence of a specific functional competence. For example, once the competitive price collection and analysis capability is established as part of the functional strategy execution, then value based pricing may have another option of defining store specific value pricing using the regional competitive data, rather than having a chain-wide pricing strategy. Either way, the functional strategies establish the direction for the evolution of functional competence, and a functional strategy that is fully aligned with the business strategy is always most desirable.

As almost all functional processes are enabled and supported by technology, having a technology strategy that is aligned with the business and functional strategies is equally necessary. Technology strategy is driven by the business strategy, but in turn, it also drives the business strategy. For example, a business strategy for developing inventory planning capabilities drives the technology solution to be pursued, but the technology pursued may drive the need for establishing common master data across enterprise divisions to effectively deliver the inventory planning capabilities. This introduces another level of complexity in aligning the three strategies and prioritizing the investments. I call this a "process sequencing constraint" where a process capability cannot be developed without first developing another process capability. These constraints can be soft when they can be worked around, or hard when they cannot be worked around. In the above example, having a common item master is desirable, but by developing an interim solution for mapping several divisional item masters, the problem can be solved to an extent. However, if the functional strategy wanted to pursue transportation optimization, but master data on the shipping attributes of the items/orders was missing, it would almost be a hard constraint. Therefore technology strategy also affects the business strategy as much as it supports it. 

In fact, as most of the investments for creating a functional capability remain in technology, it has the potential to become a real constraint, limiting the flexibility of the business, if it has not been thought through, and aligned with the other two.

Technology strategy establishes the direction for the applications (custom, packaged, SaaS, etc.), information (master data, meta-data, business intelligence, etc.), and technology (hardware, software, vendors, open source, SOA, etc.). These decisions, in turn, affect the cost of deploying functional strategies, as well as the TCO for creating and maintaining the process capabilities and organizational competence.

In summary, it pays to have functional and deployment strategies closely aligned to the business strategy. It provides a roadmap for organizational evolution, as well as a practical tool for prioritization of spend on developing process competencies mandated by the business strategy.

Technorati Tags: supply chain strategy,business strategy,supply chain,vivek sehgal,strategic planning

Do it Right: Don't Undermine Your Investments in Supply Chain Technologies

In my last post, I talked about why it is important to have the people with the right skills to fully leverage the supply chain technology investments. In this blog, let me expand that equation further to see what are the other factors that corporations must ensure in order to fully leverage their supply chain solutions and the promised returns on their investments.

The following picture represents the main reasons why most of the failed technology/solution investments do not pay off.

People:

Supply chain planning solutions typically are built as decision support systems with complex algorithms underneath. These solutions require people with the right skills for configuration, tuning, reviewing and resolving errors, and maintaining the planning parameters for the system to function at its best. Depending on the solution, these skills may vary from statistics, to mathematical programming, to data mining, etc. People can acquire these skills through training, academic background, and/or prior professional experience. However, the key is to plan for the people with right skills and not undermine the solution capabilities for want of a few good people. Also remember that we are talking about only a handful of super users that would fall in this category, since the large majority of the users, using the output of such systems don't have to be specialists at all! Read more about this aspect of supply chain solutions in my previous post.

Process:

Most corporations believe that their processes are unique, and therefore provide them with competitive advantage that others in the same industry do not have. The truth is that for most part, it is a myth. Very few processes in an enterprise actually have the potential of providing such competitive advantage, while most others will be just fine as long as they are efficiently planned, executed, and reviewed. Being open to review the old processes in an unbiased way, and adopting the standard process supported by the solution not only shortens the implementation timelines, it also saves money, and resources. And usually, it provides a standard way of doing business with other partners in the industry using similar solutions. Be open to evaluate all processes and adopt changes where such changes make sense.

Infrastructure:

Successfully implementing complex business applications requires proper infrastructure planning. With infrastructure in this context, I mean hardware as well as software infrastructure. An example of software infrastructure will be ability to manage common master data among many business applications; ability to extract, cleanse, consolidate, govern, and publish such data to all applications that need them; ability to analyze information; ability to collaborate; have automated alerts, and event based messaging to prompt user action when required. often these capabilities are not planned as part of the supply chain solutions since they are not mandatory. However, they allow the enterprise to fully leverage the core solution while absence of these capabilities truly constrains the ability to reap any substantial ROI. To a large extent, this can also be said about the hardware: having centrally hosted servers with proper back-up, disaster recovery plans that are routinely tested, high speed network among corporate locations, RF terminals, large monitors, etc., does add to the overall productivity, usability, and adoption of these applications. Only such investments with the right processes ensure business continuity in natural or man-made disasters. Having the correct infrastructure for a supply chain technology initiative requires holistic planning, the kind that is mostly missing from IT-centric project planning exercises.

Customization:

This is another huge factor affecting successful implementation and adoption of new supply chain solutions. Unless a solution is custom built to your requirements, chances are that your processes will never map a 100% to the process supported by the packaged solution. However, to avoid functionality gaps that may be truly constraining, you must determine these gaps prior to the investment in the solution. Since most of the bigger software vendors would have years of experience with similar customers, it is also a good opportunity to question all such gaps and determine if they are real gaps, or merely entrenched habits that are hard to break. Remember, every custom enhancement to the solution costs money to develop, pushes back the project timelines affecting ROI, becomes a permanent constraint to solution upgrades, increases on-going maintenance fees, and adds to testing and validation costs for original deployment and every upgrade thereafter. This is a sure TCO killer.

Metrics:

What gets measured, gets delivered. Therefore, define clear expectations on prospective operational improvements through well-defined metrics. What is it that the technology is expected to deliver: higher inventory turns, higher number of orders processed per buyer, higher fulfillment rates? Also make sure that you have the historical data on these metrics to compare the new numbers against. All ROI is questionable unless it can be established through consistent trend on the defined metrics, against a historical data set. Finally, make sure that these new metrics are aligned with the people's individual goals. Many a times, personnel goals are tied to the operational metrics, and when these operational metrics get revised due to new technology, the revision of the personnel goals is easily forgotten. But remembering to realign the two will make sure people have no hesitation in adopting the new technology, since the new technology is going to help them with their new set of goals.

 

Technorati Tags: supply chain,supply chain strategy,supply chain technology,vivek sehgal,supply chain solution,supply chain solution adoption

Make People Part of Your Equation on Supply Chain Technology

As awareness around supply chain functions has grown, so has the software applications available to address these functions. In fact the supply chain has been among the most expanded solution area for ERP companies during the last decade.

However, unlike the transaction processing ERP systems, the supply chain functions tend to provide a decision support tool that can be complex. Consider demand forecasting, inventory planning, replenishment planning, transportation planning, bid optimization -- these are all areas that actually provide the users with modeling, evaluation, and analysis tools for real-life scenarios rather than simply automating transaction processing. Therefore, these and other supply chain solutions routinely utilize techniques such as statistics, time series analysis, linear programming, mixed integer programming, dynamic programming, decision trees, probability, queues, data mining and so on.

Putting the power of real science to work behind these solutions improves the solution quality, and allows these solutions to model real-life scenarios closely, consider a large number of parameters that may affect the results, and leverage ever expanding computing capabilities to provide solutions within minutes making close to real-time changes possible.

But it also increases the complexity of these solutions, and requires that companies employ people with the right skills who are capable of using such solutions through training, academic background, or both. And that is where most companies appear to lose all their commonsensical ability to judge the value of their investments. There are far too many implementations where the businesses have chosen to spend millions on the best of breed solutions but then pulled back when it came to invest in quality of people who would be using these solutions and actually make possible the solution ROI. No wonder ROI on software solutions has always been questionable even though real results can be achieved with some common sense.

Suppose you spent a few millions buying a jet, you would most certainly invest in an experienced jet pilot, rather than trying to teach your chauffeur on how to fly that damn plane. Almost all large corporations own their private fleet of jets these days, and the pilots and other crew to go with these planes -- always without question. Now consider the same corporation investing the same few millions on a high-end demand forecasting system that utilizes sophisticated statistical forecasting techniques, and requires a few people with doctorate or masters in statistics to set up the system, tune the forecasting parameters, review the forecasting errors/trends from time to time to ensure that the system is running at its very best and providing good forecasting projections. While most of the users of this system could be people with average academic and professional experience, but a few of the super users controlling and tuning the system had to be statisticians. Suppose also that the solution vendor is naïve enough to mention this during the sales pitch, where do you think it would go? Chances are such an open admission of skills required to run the system will not go down well, and such naïveté will cost the solution provider the business.

How many times have you heard the refrain that if the system requires a PhD to be run, then that is a problem. But the fact is that some systems are complex, and they do need highly skilled people to run them, tune them, and keep them in good shape. And just like the example with the jet above, these systems do pay back in terms of saved time, increased data accuracies, objective decision support, scenario playing and other similar capabilities that are impossible to achieve manually, or by using systems that don't quite provide the capabilities to keep them simple.

On the other hand, not everyone may need a jet either. Therefore evaluate your needs clearly, and if you do need a system with all the power of science and mathematics behind it, go for it, but also remember to plan the right people and skill-set to go with that!

Don't undermine your technology investments, make sure they are leveraged with the right people behind them.

Technorati Tags: people and technology,supply chain technology,undermine technology investment,vivek sehgal

A Framework for Measuring Supply Chain Costs

In defining the long term trends in the environment that will impact supply chain strategies, I talked about two main changes happening in the environment. One was the costs and redistribution of costs/incomes; and second was environmental consciousness.

Let us explore what constitutes the supply chain costs and the specific processes that impact these costs. Some of the supply chain costs are crisply defined, readily available, and widely used in the industry. Others are less well known, and tend to get lost in the heaps of corporate data. However evaluating supply chain costs requires that we understand them, invest in defining them as clearly as possible, have processes to capture, report, and analyze them. Only such a complete picture of supply chain costs can truly drive new initiatives, find gaps in existing processes, and help in continually improving the cost and efficiency of the supply chain operations.

To clearly understand the impact of supply chain costs, corporations need to develop a "cost framework" to define, develop, and measure these costs. The discussions below helps in understanding what such a framework should look like, the scope of such costs, and how they affect the total supply chain costs for an enterprise.

To understand the scope of these costs, we will organize them into three categories as in the picture below. Grouping these costs into these categories will not only help us understand the source of these costs, but also provide an understanding of how to measure them and how to optimize them to make the supply chain more efficient and cost effective. In doing so, though one must use caution, as a single minded focus on cost alone may not be the most optimal supply chain strategy. Since supply chains must address the twin objectives of cost and flexibility (or responsiveness), supply chain performance must be measured using metrics that allow capturing both of these aspects. However, in the current discussion, we will focus on the cost aspects alone, and leave the flexibility for another day.

Direct Costs

These are the direct costs of merchandise, and services. These are easy to capture, understand, and report. Examples of these costs are the cost of merchandise (purchase orders), cost of freight (load tenders), cost of warehousing services (3PL warehousing costs), and so on. As most of these costs are captured through standard enterprise transactions like purchase orders, or load tenders, they are easy to capture and measure at the corporate level. The complexity arises when there is a requirement to allocate these costs across organizational entities such as product groups, or regions, etc. Such cost allocation is not unusual, and helps in establishing profitability of separate business groups, merchandise portfolios and so on. Though a well thought out accounting structure should be able to support such allocations objectively.

Spend Analysis directly focuses on this aspect of the supply chain costs. Consolidating all direct spend costs across the enterprise, helps in understanding the total spend layout with the vendors and service providers, and allow the enterprises to negotiate better deals and volume discounts.

• Consolidate all spend by merchandise category, vendor, and service providers. Look for volume discounts, and negotiate on other costs such as credit terms, returns, quality, etc.
• Analyze the merchandise demand, establish long term contracts for merchandise with stable and predictable demand. Implement software systems for bid evaluation and purchase planning when multiple suppliers are viable.
• Evaluate possibility of using traditional and reverse auctions for one time and/or seasonal purchases where product attributes allow for such purchasing strategies.
• Implement transportation optimization systems to directly impact the freight costs from the cost equation.
• Evaluate all service provider contracts with transaction based fee and analyze historical usage for possible reductions by converting these transaction-fee contracts to fixed-fee contracts.

Process Costs

Process costs relate to the organizational teams that directly support supply chain processes. These processes may provide critical supply chain decisions to support operations, and support compliance requirements for regulatory purposes. Examples of such processes are demand management (forecasting, inventory planning, and replenishment teams), supply management (purchasing, expediting teams), logistics (shipment planners, load & route planners, and dispatchers), and global trade teams supporting imports and exports. These are direct personnel costs and can be impacted positively by improving process efficiency that leads to smaller teams handling the same volume of transactions. Such efficiency improvements can be a result of process automation, processes simplification, or process elimination.

• Evaluate if the process can be automated through a system, completely or partly. Most IT applications provide automation for the transaction processing, some do so for the planning processes as well. Supply chain planning solutions routinely provide optimization based algorithms that can provide decision support for complex situations, such as determining optimal inventory levels at various locations. Such systems make processes efficient, as well as more effective by handling large amounts of data and computations that are otherwise impossible to be processed manually. They also allow more frequent reviews of supply chain policy parameters (such as inventory levels, flow-paths, seasonal inventory management, forecasting parameters, etc.) to keep them aligned with the changing demand and supply scenarios.
• Evaluate if the process steps can be simplified, or eliminated. For example, consider whether all purchase orders need managerial approvals, or is there is a possibility that purchases within defined constraints (purchase value, vendor status, resulting inventory level etc.) can be made without such approval. Evaluate processes where all transactions are currently reviewed manually, and consider defining transaction profiles so that the system can identify exceptions for manual review while automatically processing the rest. Replenishment planning, purchasing, load tenders are all examples of processes where exception based management can be effectively implemented and manual effort can be reduced.

Technology Costs

The last category of supply chain costs are technology costs. Some examples of these costs include the software & hardware costs of deploying supply chain systems at the corporate office, dimensioning system & RF handheld units at the warehouse, and the geo-location tracking units on the trucks. The technology enables faster processing time for planning, near real-time execution, continuous visibility of inventory and operations from end-to-end, and enables decision support systems that leverage complex mathematical models to provide optimal results. But all the technology adds its own cost to the supply chain. As technology continues to play ever bigger part in supply chains, managing technology costs becomes more important. This is a difficult area as it straddles the business and IT groups, and requires that both collaborate closely to measure, contain, and evolve a technology strategy that allows for a cost-aware technology evolution with flexible supply chain solutions. This is easier said than done, however, these costs must be measured before they can be contained.

• Establish an existing and to-be technology roadmap for supply chain. Create a checklist of business best practices and establish the gaps in current technology, prioritize new technology, and plan a purposeful adoption rather than an ad-hoc reactive evolution.
• Establish costs of all technical resources, software, hardware and people. Establish maintenance and projected upgrade expenses. Clearly identify what the technology costs, and what it provides in return.
• Evaluate technology diversity -- while diversity in general is good, it may not be so in technology. Too many technologies quickly become expensive to maintain due to specialized skill requirements, hardware requirements, and annual maintenance fees. Consolidate common standards for technology stacks across applications, adopt SOA architecture for custom developed applications, evaluate annual license renewals for continued need, consolidate hardware vendors, virtualize, have consistent application & technology architecture, have business readiness plans in place through backups & disaster recovery. Empower enterprise architecture.
• Measure, question, evaluate, evolve!

Most corporations do not have a consolidated view of costs of their supply chains. This constraints their ability to accurately identify opportunities and problem areas, prioritize supply chain investments, and constrains their ability to execute simple profitability analysis accurately. Creating a broad cost view of the supply chain requires careful analysis, planning, and processes to gather data, however, it allows for quickly analyzing the impact of changes, even predict such changes, and manage an ever-evolving supply chain for the optimal corporate efficiency.

© 2009, Vivek Sehgal, All Rights Reserved

Technorati Tags: cost framework,supply chain,supply chain costs,lean supply chain,direct costs,process costs,technology costs

Multi-channel Retailing: Are You Up To the Challenge?

Almost all big retailers today will consider themselves as a multi-channel retail company. Web-commerce has taken a strong hold on the retail landscape, and emerging user habits continue to point to an ever increasing share of retail spend on the web.

Retail is one of the largest sectors in the US economy. The U.S. Bureau of Economic Analysis reported the 2007 GDP of the country to be $14,000 billion, out of which $4,041 billion was retail (http://www.census.gov/mrts/www/data/html/08Q1.html). That makes retail account for almost a third of the total economic activity in the nation. Within retail, the CAGR for conventional retail is approximately 4.8%, while the online retail sector has grown at a CAGR of 25.4%. While the online growth must plateau out with time, it is still reported to be anywhere between 11 to 17%, with Forrester Research estimating the online retail to cross $200 billion this year. The point is, online retail is here to stay; most retailers have invested heavily in the technology to support online retail channels; and will continue to so as this is the most logical growth channel at present time.

Given the above scenario, the question in the title seems funny to ask. Till you consider the the gaps between an ideal multi-channel retaining operation, and the current deployments at some of the largest retailers.

Having the ability to sell through multiple channels is simply the start. Multi-channel retailing offers so many potential opportunities for the traditional retailer to create synergy, enhance operational efficiencies, reduce costs, and enhance user experience that it is an obvious choice to implement these changes, that would allow a retailer to achieve most of the above.

On-line retailers have given tough competition to traditional retailing, however, traditional retailers have a lot more going for them if they choose to leverage their assets when planning a multi-channel play. The three main areas to consider are as under.

Integrated Assortment Planning:

1. Do you have integrated assortment planning capabilities for physical and virtual channels?
• That supports consolidated assortment planning, and therefore supports corporate level merchandise planning objectives.
• That supports compatible assortment spread, with core assortment defining the core category attributes, and extended assortment supporting the cores assortment and extending these category attributes.
• That allows for integrated product and category portfolio analysis for profitability, affinity, market basket, and similar analysis.
• That allows for aligning all the channels with the customer segmentation, and product positioning approach supporting corporate strategy and goals.
2. Do you have clearly identified core and extended assortments?
• Core assortment that is common to physical stores, and the virtual channels. The core assortment is targeted at the core customers of the retailer, and depending on the retailer's product positioning, this may be generic, or highly differentiated.
• Extended assortment expands the core assortment, and is typically only available through non-store channels. This further accentuates the targeted segmentation and positioning of the retailer.
• Core assortment is best suited for leveraging common logistics planning, execution, and operations. This is typically not a candidate for vendor drop-ship operations.
• Extended assortment should be evaluated for fulfillment options that may be fully owned, or operated by the retailer. Such options include vendor drop-ship where the volumes are low, and/or product differentiation is high; VMI (vendor managed inventory), 3PL fulfillment options, etc.
3. Clearance & price realization.
• Having a common assortment also supports pricing strategies for best price realization, seasonal ramp-up and downs, regional changes in demand across channels, and categories.

Integrated Supply Planning:

1. Do you have the capabilities for consolidated demand and supply planning?
• That allows to plan for all the merchandise demand together irrespective of the channel that would finally sell it?
• That allows you to have a consolidated view of all forecasted demand, on-hand, and on-order inventories? 
• That allows you to have an enterprise-wide view of inventory layers?
2. Do your processes support consolidating sourcing, negotiating, and ordering?
• That allow you to leverage total demand across channels, and therefore allow you to have a clear view of the total projected spend with a vendor for all categories of merchandise?
• That help you negotiating the right contracts, at the right prices, and optimize the contract terms?
• That help you raise and manage common purchase orders for the common merchandise, across all the channels; while simultaneously allowing you to allocate dynamically as the vendor acknowledgements, ASN, and merchandise arrives?
• That help you construct and leverage a consolidated projected inventory view?
3. Do you have common warehousing, and distribution operations?
• That allow you to leverage the same inventory stock for replenishing stores, as well as for fulfilling online demand?
• That allow you to provide in-store pick-ups for core as well as extended merchandise?
• That allow you to leverage your dedicated fleet to make multi-stop multi-leg deliveries on their daily routes combining store, and customer deliveries when such opportunities exist? How about picking up customer returns? 
4. Do you leverage consolidated inbound shipments planning?
• To reduce the total inbound shipment expense on transportation?

Integrated Store Operations:

1. Do you have the capabilities for supporting a unified customer experience across all your channels, call, click, mail, or visit?
• That supports a common customer view?
• That supports a common order, and fulfillment view?
• That supports a common pricing, will-call, delivery options?
• That supports a seamless "customer case management" for enhanced customer satisfaction? 
• That supports a common product catalog, that is dynamically configurable for supporting a call center customer service rep, a web store front, or a store kiosk?
2. Can your systems support endless aisles?
• By having a common catalog across channels, physical stores, and web-stores?
• By having a consolidated near real-time view of all inventory across all channels & stores; and the ability to view, reserve, and open inventories across these entities?
• By having all the capabilities available to all associates supporting customers irrespective of their location, channel, and store affiliations? 
3. Can you leverage all the channels, and fulfillment options for product clearance and final disposition events to optimize your realized average prices?
• By dynamically moving inventories where desirable?
• Or by deploying multiple fulfillment methods, and selling channels that support direct delivery to customer, or store pick-ups?

Technorati Tags: multi channel retail,assortment planning,demand and supply planning,integrated store operations,online retail,web commerce

Recession, Deflation: What is it to Supply Chains?

Here are some of the signs of our times.

• Recession, we knew it all along except that now it is official!
• Deflation, the stories are everywhere even though they don't add up. See this article for more information, though let us assume some deflationary pressures may actually exist and continue for some time.
• Credit crunch, less said the better. This is probably the root cause of major financial failures for many a companies. Fed is throwing reams of dollars at the problem but it is still out there threatening businesses, large and small that need debt for short term and long term obligations.

What does this mean to retailers? Pretty much the same thing, as all of the above conditions result into low demand for goods and services, pressure on pricing power, and tight credit for consumers as well as retailers. This adds up to the following net results.

• Top line impact. Low top line growth as consumers cut their spending due to recessionary pressures, job losses, uncertain financial conditions and tight consumer credit. All of these will result into low to no top line growth, and in some cases it may very well shrink.
• Bottom line impact. Low profitability, fueled by increased competition, too little demand, too little disposable income that all adds up to pressure on cutting prices further to retain the sales, and hurts the bottom line.
• COGS impact. Higher cost of operations, driven by the tight credit and higher cost of money when it is available. Add to that the volatility of demand, and the desire to maintain good inventory levels to service customers when they do step in and buy.

So what is a retailer to do?

There really are not many options. In good times, you could follow a top line growth strategy effectively, but when the sales tank due to depressed consumer demand, there is only one strategy that works: laser sharp focus on the Cost and Efficiency. For the financially inclined, COGS and Asset Turnover.

A good supply chain strategy can deliver on both these fronts.

In fact, supply chains are all about costs and efficiency. Anything you do better in your supply chain management is bound to affect either of the two. Take for example, inventory planning processes. If enhancements to this process results in lower inventory, your inventory turnover goes up affecting the Asset Turnover positively. Assuming that the process improvements result in better fulfillment but do not affect inventory levels, the cost of operations for fulfillment and cost of lost sales goes down through better inventory deployment. Either way you come out ahead. Take transportation optimization, you reduce the miles, and have a direct impact on cost of transportation and hence COGS. Take forecasting improvements to have higher accuracy, and once again you save the cost of lost sales through better planning and deployment of inventories.

In fact any supply chain process improvement whether it is in planning or execution, network design or supply planning, demand planning or warehousing; all lead to either direct cost savings affecting the COGS, or more efficient use of assets affecting the Asset Turnover.

The next question of course is which is more important? Cost or Efficiency? Well that really depends!

It depends on what does the retailer want to achieve? If the retailer has good operating cash flow (and hence no need to borrow funds from the market), your efforts should be more focused on direct cost savings that will translate into the bottom line gains. If operating cash flow is an issue; and, it is if your survival depends on it, then profitability is a secondary consideration, and efficient use of resources may make more sense specially in a market where credit is either not available or the cost of servicing credit is simply unacceptable.

Rather than closing all initiatives, corporations should analyze and understand the impact of each current supply chain initiative. Then they should re-prioritize using the analysis, and their current needs. For reprioritization, follow the steps below.

• List all your current supply chain initiatives. Note where in their deployment life-cycle these initiatives are, what are the sunk costs, and what are the estimated costs to finish them?
• Classify these initiatives into those affecting Costs, and those affecting Efficiency.
• For those affecting costs, determine the impact on COGS; for those impacting efficiency, determine the impact on Asset Turnover.
• Establish the immediate organizational priority between Costs & Efficiency.
• Re-prioritize the current initiatives based on the above information.

 

Technorati Tags: deflation,recession,supply chain strategy,vivek sehgal,COGS,Asset Turnover

Deflation: Should you Worry?

If you have tuned into the news during the last few days, you must have heard the coverage on deflation, and how spiraling deflation is getting out of control. But if the prices are really falling, it never felt like that at the grocery store, or at the departmental store, or toy store, or at the dentist. So why are the analysts worried sick? I believe they are trying to find news where none exists -- as yet.

While deflation may be a definite economic evil, the numbers so far do not add up to the extremes pointed out by the mainstream media or the analysts. But then, you could not blame them really -- an inflation report within normal limits won't make the news, would it?

Let us go to the source, and look at some numbers provided by the Bureau of Labor Statistics.

Here is the graph for Consumer Price Index - All Urban Consumers, Not Seasonally Adjusted, available at http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CUUR0000SA0&output_view=pct_1mth.

The graph above shows data for ALL ITEMS. And that is a key difference because when you exclude the prices of food and energy, the prices actually rose as seen the picture below. This is available at http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CUUR0000SA0L1E&output_view=pct_1mth. Now we have all seen the prices at the gas pump fall dramatically after their equally dramatic and unexplained rise in summer this year, and that is a big part of the deflationary data being touted as a real concern.

Again, if the prices are really falling, why are we not feeling any reprieve? Because year over year inflation is UP, by 3.7% even when you include the recent big drops in gas prices, (http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?data_tool=latest_numbers&series_id=CUUR0000SA0&output_view=pct_12mths). See below.

Here is a break-up of inflation numbers, and these are really helpful in understanding where the problem lies, rather than painting a broad-brush picture of impending doom due to deflation. All numbers are available at: http://www.bls.gov/news.release/cpi.t07.htm. The numbers below are for based on chained Consumer Price Index for All Urban Consumers (C-CPI-U): U.S. city average, by expenditure category and commodity and service group, with December 1999=100.

Expenditure category	Unadjusted Relative Unadjusted percent change to importance, indexes Oct. 2008 from-Oct, 2007	Unadjusted Relative Unadjusted percent change to importance, indexes Oct. 2008 from-Sept, 2008
All Items	3.3	-0.8
Food & Beverages	5.9	0.5
Housing	3.0	-0.3
Apparel	0.1	1.0
Transportation (read: Cars and autos)	3.6	-4.5
Medical Care	2.7	0.2
Recreation	1.1	0.0
Education & Communication	2.7	0.1
Other goods and services	3.9	0.3
Energy (read: Gas)	11.4	-9.8

There you see the two categories that are causing the biggest deflationary pressures, cost of energy (we know gas is down), and cost of transportation (cars and autos). Neither of them is exactly news, sales of big ticket items is down, and is expected to be slower with the continuing credit crunch.

Should you worry? Decide for yourselves!

Technorati Tags: deflation,inflation,CPI,economy worries,prices