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.

image

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

Advertisements

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?