Sunday, March 23, 2008

Spend Analysis for Retailers

A little line under the Revenues in the Income Statement of the companies shows COGS, or Cost of Goods Sold. If you are a retailer, this line captures your biggest business expense. For most retailers COGS can add up to 60-65% of their revenues, and largely represents the cost of merchandise purchased over the year.

Spend Analysis for direct (merchandise) purchases helps retailers track and analyze this (largest) expense as well as provides them with a great tool for managing their purchasing decisions. With a little innovation, spend analysis can also help the retailers manage their cash-flows, provide negotiating leverage with the vendors, maintain contract compliance, and keep a close tab at the cost trends.

Total Spend Analysis for Retailers

Total Spend Analysis brings together various important facts related to the direct merchandise spend. It can contain the actual spend, planned/budgeted spend, committed spend, and can also provide projected spend through projected accruals and forecasts. Most of these numbers are simple to calculate and provide a wealth of information into one of the largest COGS items. The total spend is often organized by vendor, item, organization/location and merchandise category. These dimensions (vendor, item, organization/location and merchandise category) can have company specific hierarchies so that the data can be rolled up, or dis-aggregated along the hierarchy levels as required.
  • Actual Spend is simply the value of all order line items that have been “closed” and settled. This can be easily calculated with the PO data available from the PO management systems (or ERPs). This number exists only for current and historical time buckets.
  • Planned Spend (or purchasing budget) is generally sourced from the merchandise financial planning systems. Merchandise Financial Planning (MFP) is a top-down exercise that provides planned spend targets generally required to support the financial plan of the company for revenues, profitability, and inventory. Some MFP solutions also allow a bottom-up approach for setting up these targets, that are then reconciled with the top-down numbers before publishing the final plan numbers. This number exists for historical and future time buckets.
  • Projected Committed Spend is the cumulative cost of all open purchases that are committed to vendors through confirmed purchase orders. This is also a simple calculation that adds up the price on all PO line items that are “open”, and not yet “received” (and therefore not yet accrued). This data is normally sourced from the PO management systems (or ERPs). This number is meaningful only for current and future time buckets.
    Projected Accruals are calculated using vendor acknowledgments, ASN (advanced shipping notices), or simply the need dates on the open purchase orders. This is the spend that is expected to accrue based on projected delivery of inventory from the vendors. If required, a longer term projection for the cash outflow can also be made using statistical projection using the historic data. These numbers are meaningful only for current and future time buckets.
  • Projected Available Spend (or Open to Buy) dollars can then be calculated as the cumulative actual spend till the current time bucket versus the planned (budgeted) dollars for the whole planning horizon or season. These numbers are most commonly used for seasonal products to track and control the seasonal item spend during mid-season. However, the concept is equally applicable for any item with a generic definition of planning horizon.
  • If there are supplier contracts that either have purchase obligations, tier pricing, volume discounts, cash-back rebates, etc., then it also makes sense to bring in the contractual data into such analysis. This is a cumulative value of all purchases made under a specific contract, as well as the contract volume/tier threshold information at which cost changes, or discounts/rebates become available.

Depending on the role, different will use this data for different reasons. However spend analysis provides a powerful decision support system for all users that manage the purchasing activity in an organization.

  • Buyers who are responsible for certain vendors may be interested in spend reports by month by vendor across all vendor-items and locations. If the contract data is available, buyers can compare actual, accrued and committed spend with the contractual obligations to determine compliance, as well as current rebates, discounts and pricing tiers. Buyers can typically use this information to track the total spend; for vendor negotiation; contract compliance; and to avail proper contract pricing/rebates/discounts. When the analysis tool allows projections of the spend into the future (using historical data), it can provide valuable demand information for negotiating future contracts with the vendors, for evaluating bids, and awarding the contracts to maximize the cost-savings. Top and bottom n vendors by spend is another useful report that buyers can use.
  • Merchants may want to see the same spend data by categories managed by them, with the intention of controlling and manipulating the seasonal spend. They can also use the data to determine profitability trends at the merchandise category, vendor or regions. (YOY) Year over year comparison for spend, when combined with the revenues for the same product category provide a clear picture of profitability trends for the merchandise categories. Similarly, spend trending is another useful analysis tool. Trending quickly shows if the costs are going up, down or stabilizing. When the revenue trends are mixed with the cost trends, it provides an easy way to create a powerful visual picture of the profitability by category, regions, or a vendor. Top and bottom n categories by spend is another useful report that merchants can use.
  • Finance Analysts also need this spend data organized by regions with the intention of managing invoices, accruals, settlements, and the cash flow. This analysis can be used for projecting and managing the future accruals and outbound cash flow.

Spend analysis is one of the easier analytics applications to build and use. It primarily requires purchase data that is easily obtained from most ERP, or legacy systems; and can be quickly enriched with other data from financial planning and settlement (AP) systems. The analysis is easy to understand, and directly affects the largest single spend for retailers.

Wednesday, March 5, 2008

Financial Metrics and the CFO

You think your CFO controls your company’s financial performance, think again.

Corporations are economic entities. Most commercial corporations exist with a single motive: to productively engage in economic activity and create wealth for their investors, and value for their customers, and employees. The financial metrics measure the success of these corporations. Conventionally the office of the CFO owns these metrics, and takes responsibility for maintaining healthy financial numbers. Take a deeper look and you will find that there are few of these numbers that the office of the CFO directly controls. And that is where you, me and everyone else comes in – while the CFOs own and report these numbers, it is really everyone who affects them and therefore directly controls them.

Conventionally, BI (Business Intelligence) has looked at metrics as Strategic, Tactical, and Operational. While this view provides a good classification it really is no good from the point of view of answering – “so what”?

Here is an innovative layering of the financial metrics that will help you go in the right direction by providing discrete actionable information.

Indicator (Windsock) Metrics:

The top layer is what I call the Indicator Metrics. These are the top level metrics that provide a quick overview of company’s financial health. They are composite in nature and are made up of other metrics. One key example from this layer is ROA (Return on Assets). ROA primarily measures the effectiveness with which a corporation uses its assets in generating the profits. Metrics similar to ROA in intent are Return to Equity, and Return on Capital, and Margins (gross, net, pre-tax, operating or any other hue of Margins).

Let us look at the ROA. It is typically a product of Margin and Asset Turnover. Margin is simply profit on sales, and directly measures the profitability of the business. Asset Turnover measures how many times the assets are used over to generate the sales – therefore measuring how effectively a corporation uses its assets.

If ROA is a concern comparing with industry averages you can tell whether asset utilization is an issue or profitability. In mature, competitive markets, profitability is less controllable due to external market factors that are hard to predict and control, but asset turnover efficiency can provide a corporation competitive edge.

These metrics generally tell the direction in which a corporation should look for efficiencies, hence the name Indicator Metrics, or Windsock Metrics. There are quite a few other metrics in this layer such as the various Ratios/Liquidity metrics, and some activity and leverage metrics.

Dashboard (Traffic Light) Metrics:

The second layer of metrics is also composite in nature. These metrics form the basis of the top level indicator metrics. However these metrics provide a good indicator of the operations that need review. Continuing from the ROA definition above, we had established Margin as one of the factors (that contributes towards ROA). Margin consists of profit over sales. The profit in this equation is generally NOPAT (net operating profit after taxes). Now NOPAT itself consists of Sales, COGS, SG&A, and Taxes. With the exception of Taxes (taxes also can be managed to an extent), others are directly controllable. Again comparisons to industry averages can quickly establish which of these (say between COGS, and SG&A) have the most potential for improvement.

Major components for COGS for a retail company will be merchandise (purchase) costs, distribution (supply chain) costs, labor (store and warehouse) costs, and other indirect costs (for example the advertising). All these numbers need to be controlled and watched closely to align to the projected/desired COGS target.

I call the metrics in this layer as the traffic light metrics as these metrics can be computed on a more frequent basis, and color coded (like a Dashboard) to be Red/Yellow/Green to drive the prevalent action bias in a corporation.

Actionable (Tuning Knob) Metrics:

Finally the last layer of metrics that touches directly upon the daily operations of the corporation, and therefore provides the “Tuning” ability to affect the higher levels above. Drilling down from our example above, cost of Merchandise is a large component in the COGS for retailers. This cost itself is direct cost of the merchandise, as well as the cost of generating POs, and managing their life-cycles, cost of handling customer returns, cost of wrong shipments (inbound and out), cost of bad quality, cost of measuring process efficiencies (supplier compliance, conformance), cost of settlement, etc. These are distinct costs that arise from distinct business processes. And hence they measure the efficiency (or inefficiency) of these processes, giving the culprits or potential processes to be improved.

These metrics provide the tuning knobs that affect the dash-board and indicator metrics; because these metrics directly point to a business processes that need improvement. For example, if the cost of managing purchase orders is high (compared to industry standards), then the process of creating and managing POs needs to be investigated. The higher costs may exist because of an inefficient PO management process/system, or (surprisingly) reveal a sound PO management; but an inefficient replenishment system that creates an unnecessarily high number of POs. Either way; these metrics provide a directly actionable result and therefore can help in tuning the higher level metrics that are more indicative in nature.

Operational (day-in-life) Metrics:

These metrics help a corporation run their daily business more effectively, like a list of orders to be expedited, or fulfilled. They may not directly point to the weaker processes but provide information for root cause analysis. We will skip these in favor of retaining the basic intent of this article. However we will cover these in a later discussion.

So Who Controls the Financials Then?
With the above context, think again about who really controls the financial performance of your company? The metrics that actually allow you to impact the financial performance are contained in business processes that a corporation adopts. These business processes range from everything in supply chain to merchandising to manufacturing planning and store operations. And none of these functions are planned, strategized, organized, or executed by the CFO’s office. Next time you see a poorly performing number try and dig deeper, you will find what you can do about it by looking at the underlying process(es) and have an impact on your company’s financials. Then of course a progressive CFO’s office can help too by actually supporting such analysis! Pray you have one!

Tuesday, March 4, 2008

Supplier Performance Measurement and Compliance Management

Supplier performance measurement and compliance management go together. Both of these solutions feed from the same data as the supply chain visibility. However the business ownership for the supply chain visibility normally resides with the operations team, while the vendor relationship organization owns the supplier performance scorecards, and compliance. Given this organizational dichotomy, many organizations tend to pursue separate solutions for these two related capabilities. From the solutions point of view, though it is most desirable to pursue a single solution that addresses these needs together.

Three types of solution providers can address such needs...

VAN Providers

These are the VAN (Value Added Network) providers that normally provide the EDI services. In the past few years though, most of the VAN providers have added application functionality to their services that enable visibility across the chain. For supply chain operations, such visibility goes across the purchasing, shipping, distribution, and receiving and settlement functions.
Most of these functions use standard EDI communications. Some very common examples being 850/855/860/856 for purchase orders and ASN; 204/990/214/314 for load tenders and shipping; 110/210/810/820 for invoices and remittance.

As these transactions pass through the VAN, these providers have built applications and reporting to provide the supply chain visibility, vendor performance and compliance metrics. Organizations may need to feed some additional data for receipts as that is generally an internal transaction and may not go through a VAN provider’s network.
All the major providers in this space such as Sterling Commerce, Inovis, GXS etc. provide such capabilities. Most of these vendors also provide charge-back capabilities for non-compliant vendors; pro-active notifications; and web-portal for score-cards as well as dispute settlement are some of the other nice features to consider.

The advantage of this approach is that no extra data interfaces need to be built, and there is very little IT effort involved in standing up this capability once the business metrics have been established. A web-portal is generally part of the solution and on-boarding is provided as an additional service if desired.

The solutions in most cases can be hosted, or brought in-house; or purchased as extended services to VAN, or exclusive of VAN services. Costs must be considered for all the services desired.

ERP Vendors

Next class of solutions in this space comes from the standard ERP vendors. All major ERP vendors cover the functionality as part of their SRM (supplier relationship management) suites. SRM supplier management function collates all the required data from purchasing, receiving, transportation and warehousing modules of the ERP to create and provide the scorecards. Any charge-backs as a result of non-compliance are sent back to the ERP’s finance modules.
SAP, and Oracle are examples under this class of solutions. Some more niche vendors such as i2, and Ariba/Procuri also provide good functionality in the space.

Consider this solution approach if an ERP is already in place, and most of the related supply chain functions have been deployed preferably on a single vendor solution. This option may turn out to be more cost-effective in these cases.

Niche Vendors

Then there are vendors that specialize in this functional area. These are dedicated vendors that provide extended solutions and services in the space. They have well-packaged out of box solutions and can help in situations where business requirements are not well understood, or not yet matured. Consider them to bring on-board the business expertise needed to set up such programs and for a quick packaged solution with well defined footprint.

Some examples in this class of solution providers would be Compliance Networks, Emptoris, Eqos, and TradeCard.

Many more vendors exist in all classes of solution providers above, and the names mentioned have been picked only to exemplify the specific class of solutions.

Pillars of Retail: Supply Chain and Merchandising

Retail is a complex industry to manage. Between the unpredictable seasons, finicky customers, and a volatile economy it presents a worthy challenge. Two foundational business capabilities in Merchandising, and Supply Chain determine a Retailer’s ability to compete. Merchandising gets the Customers, and Supply Chain gets the Products…

At the highest level, it is a simple concept. Buy, Distribute, and Sell. And as long as you can do that profitably, you are in business. That is where the rub is – profitably – an average departmental retail store can have tens of thousands of items to start with. Add to that the number of stores, formats, customer demographics, seasons, fashions, competitor across the road, weather, economy and you have a pretty hairy problem. The sheer number of independent variables that a retailer must contend with, in planning and executing is mind boggling.

However, understanding the two key processes in merchandising and supply chain can make or break a retailer. Building functional capabilities in these areas to flexibly address business needs can give a retailer competitive edge.

Get the Customer’s Attention: Merchandising

Merchandising truly defines Retail. It is what makes a retailer unique, and provides the “niche”. It provides the retailer its “identity”. Walmart shoppers know they will get lowest prices, but not necessarily the service, or variety. Upscale retailers like Neiman Marcus on the other hand are “identified” more with the chic image.

Merchandising has various sub-functions. It has a financial aspect and an assortment aspect.

Merchandise financial planning sets up a Retailer’s plans, for revenues, inventory levels, mark-ups, gross margins, promotions, clearance etc. Planned targets for sales, and inventory are set in this process, so are the budgets for promotions, clearance, and marketing. These plans can be started at the top, and trickle down the organization, regional and product hierarchies. Some companies may also do a bottom up planning for this function and then reconcile the top-down numbers with the bottoms-up numbers.

Next the assortment plans are created. Assortment plans determine what will be sold where. Assortments may vary from store to store based on demographics, competition, weather, fashions, and new products. These plans typically start with the evaluation of the existing product and assortment portfolios, and establish the new assortments for the planning period. These assortment plans are then reconciled with the merchandising plans to make sure that the assortments can actually meet the financial budgets, and projections. These assortment plans are typically available at regional, store cluster, product class and sometimes at item levels.

Further down, the assortment plans then generate the macro and micro space planning. Macro space planning constrains the planning process based on logistics, distribution, and storage constraints in the supply chain. Micro space planning creates planograms that determine the product presentation in the stores, presentation quantities, and other displays.

Merchandise planning is primarily the top-line play for a retailer. This is the most important function in the growth stage for any retailer. Its importance does not diminish for mature retailers, though the strategy for mature companies normally shifts from top-line growth to bottom-line improvement; and therefore, cost control becomes more important than growing the top line. And that is where Supply Chain becomes important.

Get the Right Products at the Right Place at the Right Time: Supply Chain

Supply chain capabilities define the cost basis, and hence directly affect the competitiveness of a retailer. Supply chain efficiencies cut costs all around; inventories, transportation, warehousing. After the cost of merchandise, these (supply chain) costs are the biggest costs for a retailer. Even a small savings on these costs can mean millions of dollars directly going into the bottom line for most retailers. The good news is that unlike the cost of the merchandise, the supply chain costs are directly controllable by the retailer through better planning, optimization, and execution.

Supply chain typically covers the network planning, demand planning, supply planning, logistics, and distribution operations.

The stocking and selling locations together with the supply locations (vendor’s shipping points) make the supply chain network. The supply chain network planning helps in optimally locating the distribution hubs, and supply points within a retailer’s network of facilities. The network evaluation can result in facility relocations, and generally executed yearly, or sometimes less frequently.

Demand planning is the science of projecting future demand that must be replenished at each of the stocking, and selling locations. Sales history is required, and other inputs may allow modeling of seasonal demand, promotions, weather, and price changes. It produces a sales forecast, and accounts for inventory to determine the actual demand.

Supply planning typically covers sourcing, vendor management, inventory planning, replenishment planning, and purchase management. Sourcing establishes the process for finding and selecting vendors that the corporation will deal with. There may be supply contracts and relationship guidelines that are part of the process. Vendor management refers to on-going relationship management, and vendor performance evaluation. Inventory planning determines how much to stock to meet a desired service level, at selling locations, and at stocking locations. Replenishment planning establishes the purchase quantities, typically derived from the projected demand, inventories, and ordering/stocking parameters such as minimum order constraints. Purchasing is the day-to-day purchase order life-cycle management, expediting, analysis, and settlement (also known as purchase to pay, or order to settlement cycle).

Next two areas of supply chain refer to the movement and stocking of goods along the supply lines. Logistics is typically transportation management, and refers to consolidating orders, load optimization, route optimization, carrier selection, tracking and tracing capabilities, and carrier freight management. Warehousing then adds the capabilities for receiving, stocking, pallet/case breaking; cross-docking, staging, packing, shipping, and inventory reconciliation.

The scope of supply chain functions primarily covers all aspects of costs related to inventory levels, stocking, and movement costs. Almost all aspects of supply chain can be modeled using mathematical algorithms, and standard packaged solutions allow these costs to be optimized without sacrificing the service levels. Hence the supply chain management directly plays to the bottom-line for a retailer. As retailers mature, the focus shifts from the revenues growth to cost-containment to continue profitable growth; and optimizing the supply chain provides the key to efficient operations.

Untangling the Supply Chains: Retail vs. Manufacturing

At a high level, supply chains address the same needs for all companies, managing the flow of goods and services in an optimal fashion. However the core supply chain competencies change based on the industry vertical. Understanding these differences enhances a corporation’s ability to leverage their supply chain assets and solutions effectively. Here is a quick summary of such competencies for retail and manufacturing environments.

Investment/Assets:

For Retail, the primary investment is in the merchandise flowing through its network, at rest or in motion. (We exclude any real estate assets from this discussion as these are not core to supply chain operations. Whether a retail company owns the stores, or leases them, does not impact its operations substantially). Therefore managing this asset (inventory in the network) becomes core to a Retailer’s success. That is why the Retail supply chains are distribution focused. After the cost of merchandise, the largest overheads in retail are related to their stocking and distribution of goods. So much so that GMROI for Retailers is quite commonly interpreted and computed as Gross Margin Return on Inventory (as against Gross Margin Return on Investment). A lean distribution chain means optimal services levels between the supplying and consuming network nodes and a higher inventory turns. The level of inventory directly affects the operational cash-flow and ability to service customers – and both these competing needs must be managed effectively.

For Manufacturers, the goods (raw materials as well as finished goods) within the network are a large investment, but another substantial investment is in manufacturing/process equipment, and resources. All equipment gets depreciated over time irrespective of the percentage utilization. However such equipment adds value to a manufacturer’s operations only when it is being utilized. Therefore manufacturers must worry about maintaining optimal levels of inventory to maintain the services levels among the supplying and consuming network nodes but also about keeping the equipment and resources effectively utilized. In doing so the focus of the supply chain changes considerably from being distribution focused to being asset focused (though the relative importance of asset utilization over optimal inventory management will be determined by the cost of raw material to finished goods ratio that represents the value added). This introduces the need for manufacturing planning, scheduling and sequencing so that all manufacturing operations as well as transportation operations are optimally planned for best use of resources.

Size of the Network:

Another difference that accentuates the different core requirements for the Retail and Manufacturing supply chains is simply the size of the network. A retailer’s network typically consists of multiple warehouses, and a large number of retail locations that may run into thousands. A manufacturer on the other hand will normally have only a handful of manufacturing locations and warehouses. Therefore managing the flow of material (merchandise, raw materials, or finished goods) through this network through optimal transportation, and warehouse planning becomes much more important in a retail environment.

Also the sheer number of items dealt within the Retail environments is huge compared to most Manufacturing environments (exceptions exist). This adds a large number of vendor shipping locations to the network making it unwieldy and complex for retailers.

Type of Network:

As above, Retailer’s network primarily consists of storage locations (such as warehouses) and selling locations (such as stores). A Manufacturer’s supply chain network primarily consists of storage locations (warehouses for raw materials, or finished goods), and manufacturing locations (factories). An extended network for both the environments can model the vendor’s shipping points as well.

These nodes represent different activities in the supply chain, and therefore present different planning challenges. While the Retail chains typically emphasize managing inventory and service levels, the Manufacturing chains also manage resource planning and usage.

This also affects the service-time length of supply chains. Manufacturing supply chains usually have longer end-to-end lead times (due to manufacturing process lead times) and therefore inherently less flexible to volatility. Retail chains can be nimble if managed and modeled well though the size of these chains tends to make them harder to optimize.

Capacity Constraints:

In a Retail chain, the capacity constraints are seldom modeled. Most of the capacity can be modeled as infinite as this capacity is mostly an outsourced service. Relevant capacities in Retail that can potentially constrain the supply planning are the supplier capacities, stocking capacities and transportation capacities. As most retailers have multiple suppliers and merchandise that can be easily substituted, the supplier capacities can be considered unconstrained. Same goes for the transportation capacities, as more carriers can be added on routes where required. That leaves the warehousing storage constraints as the only real constraint, but even these are seldom modeled in Retail chains.

In contrast, the Manufacturing chains are constrained by manufacturing capacity (available resources, time, skills, etc.) and this is a real constraint that must be modeled for feasible planning.

As a result, the Retail supply planning primarily consists of propagating demand through the supply chain tiers largely unconstrained, with only the inventory levels and inventory multiples having been modeled. The latter adequately address the need to maintain the desired service levels.

In contrast, the Manufacturing supply planning consists of propagating demand through the supply chain tiers constrained by the manufacturing/processing capacity (the capacity modeling a composite of required resource, skill, and material) at each node, in addition to the inventory levels and inventory multiples that must be maintained for sustaining the desired service levels.

Collaboration with Partners:

In both environments, collaboration with partners can become a true differentiator. However it can provide a substantially higher return in Retail environments than in (most) manufacturing environments. The underlying reasons go back to some of the differences discussed above. In a manufacturing environment, there are quite a few parameters around resource planning that are fully controlled within the corporation’s four walls, and these alone can provide a compelling ROI for a supply planning exercise. For retailers the main asset being managed through the supply planning is inventory, and a fully collaborative chain can allow for last minute changes, diversions, and re-balancing of this asset across the network for most optimal demand fulfillment.

Therefore each supply chain opportunity needs to be evaluated based on the industry vertical, company specific requirements/expectations. The technology solutions then follow the requirements and expectation analysis. There are several vendors available for supply chain solutions, and each one brings specific strengths that companies will do well to understand and apply in their specific situations.