Wednesday, December 3, 2008

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.