Cost of Sales and Supply Chain Competence

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Supply chain competence affects your bottom-line in more direct ways than you might realize. In an earlier article, I covered the role of inventory and how the ability to define and control inventory in the supply chain affects your financials. In this article, let us review the role of controlling cost of sales through supply chain competencies and its effect on the corporate financial statements. 

The cost of sales appears on the income statement right below the revenues. The difference between the revenues and the cost of sales is the gross profit. Therefore, the cost of sales directly determines the gross profit of a firm and that is directly responsible for the firm’s bottom-line. It has several aliases: it may be called cost of goods sold, cost of products, cost of products sold or something else similar in connotation. That is not important. What is important is what constitutes the cost of sales. Typically, for manufacturers and retailers, it is also the second biggest number on the income statement after the revenues. In fact, for the financial year 2009, the COGS was 50% of 2009 revenues for P&G, 76% of the total revenues for Wal-Mart, and 70% of sales at Target for FY2009. Therefore, if one had to start looking at reducing costs, COGS fits the bill nicely. This is the largest pie of expense in an organization and even a small reduction in this will naturally generate a large impact on the firm’s bottom-line.

What does cost of sales consist of?

Cost of sales generally includes all direct expenses related to the products or services that a firm sells. For manufacturers, this typically includes the cost of raw materials and purchased sub-assemblies, cost of conversion to the finished goods like the direct labor used to run a plant, depreciation of the plant and machinery, or things like the coolant oil needed to cut metal on the turning centers, cost of freight to transport raw-materials to its factories, warehousing costs to maintain the finished-goods stocks and shipping costs to ship them to their customers. In a retail scenario, the cost of sales will include the cost of merchandise and the cost of freight from its suppliers to its warehouses, and the cost of distribution from its warehouses to its stores. In summary – include all direct expenses related to the value-adding activities of the firm in the cost of sales.

So how can supply chain competency affect the cost of sales?

Almost all expenses related to the value-adding activities are controlled through the supply chain processes and the efficacy of these processes determines the cost basis of the activity. Take the warehousing costs, for example, automating the warehouse planning and execution activities through a warehouse management & execution system can increase the number of cases handled on inbound and outbound shipments for every labor-hour employed. The freight costs can be reduced by employing a better process for planning shipments – that can reduce the miles driven, enhance the equipment utilization rates, or consolidate shipments to reduce freight. Any way you look at it, developing supply chain process competencies affects the process efficiencies that in turn, affect the cost of sales and hence your profitability.

Following are some of most common expenses included in the COGS and the supply chain process that can potentially optimize it.

Cost Component of COGS

Supply Chain Process Managing the Cost Component

Financial Metrics Affected

Direct Materials and Supplies, Cost of Raw Materials and Inputs (for manufacturers), or Merchandise (for retailers), etc.

Forecasting, Replenishment, Inventory Management (raw materials), Sourcing, Purchasing

Gross Margin, EBITDA, Inventory, Inventory Turnover, Current Assets, Working Capital, Return on Assets.

Direct Labor, Cost of Transformation (production, manufacturing, processing, etc.), Depreciation, Direct Manufacturing Overheads, etc.

Production Planning, Factory Planning, Resource Planning, Inventory (work-in-progress) Management

Gross Margin, EBITDA, Working Capital, Return on Capital Employed.

Cost of Freight (all inbound, outbound, and intra-facility transfers of material)

Transportation Management

Gross Margin, EBITDA, Working Capital.

Cost of Warehousing, Inventory Shrink, Obsolescence, Mark-downs, Handling, Inventory Carrying

Warehouse Management, Labor Management, Inventory Management (finished goods or merchandise)

Gross Margin, EBITDA, Working Capital.

As the Table 1 shows, the major components that constitute the cost of sales are the cost of merchandise or raw materials, cost of distribution, cost of manufacturing, and the cost of labor. The supply chain capabilities that can help reduce these costs are as follows.

  • The cost of materials, whether raw materials or merchandise, can be reduced through strategic sourcing, bid optimization, and supplier contracts-based optimization. Good demand and supply management practices also help in reducing the cost of materials by reducing obsolescence. Obsolete inventory typically results in merchandise clearance and write-offs both of which increase the total costs of materials.
  • Distribution costs primarily consist of warehousing and transportation. Supply chain processes that can help reduce these costs are network planning, warehouse management, and transportation management. The warehousing management capabilities reduce the warehousing costs through better use of space, better inventory management in the warehouse, automation, and optimized labor scheduling. Network planning can reduce the cost of distribution through optimal positioning of the distribution centers with respect to the suppliers and stores. Transportation management capabilities help reduce the distribution costs by optimizing shipments that reduce the total miles driven and enhance the container and trailer volume utilization. Better fleet management capabilities can increase the efficiency of the fleet and freight invoice automation can reduce the expenses related to validating and paying for freight.
  • Manufacturing costs can be reduced through better scheduling and factory planning processes. Supply chain optimization solutions that allow modeling of the demand, available inventory, available resources, operations, and sequencing constraints are typically used to produce feasible manufacturing schedules that can optimize the usage of assets and resources to produce manufacturing schedules that drive most profitable product-mix for the given demand or maximize the demand fulfillment for given orders. Increasing the asset utilization reduces need for investing in capital assets thus reducing long-term debt used to finance capital investments. In turn, it positively impacts return on capital employed by reducing the total current liabilities.
  • Major labor costs for the retailers occur in the warehouses and the stores, and for manufacturers, they are in the factories. Warehouse management processes can help directly reduce the labor costs in the warehouses, by better labor planning, scheduling, and task tracking. Better demand forecasting in the stores helps in streamlining the labor plans in the stores. Manufacturing labor costs are minimized through better scheduling and factory planning capabilities that can model the material and asset constraints to produce feasible labor plans.

Any reduction in the cost of sales directly translates into increased margins assuming the other factors remain constant.

 

© Vivek Sehgal, 2010, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

 

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The Answer is a Resounding Yes

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Of course, the question is: does supply chain excellence pay off?

As reported in this article in the latest issue of Supply Chain Management Review, researchers at Michigan State compared the supply chain leaders with their nearest competitors and found that the supply chain leaders reported better financials across the board. For the data from 2004 through 2007, companies with leading supply chain capabilities reported:

  • 50 percent higher net margins

  • 20 percent lower operating and SG&A (Sales, General & Administration) expenses

  • 12 percent lower average inventories (days of sales)

  • 30 percent less working capital expenses/sales

  • Twice the ROA (return on assets)

  • Twice the ROE (return on equity)

  • 44 percent higher economic value added

  • Twice the returns on stock prices

  • 2.4 times the risk-weighted stock returns, and

  • 46 percent greater market value-to-assets ratio

Not surprising, but this potentially addresses the question of proving with data what most of the supply chain practitioners knew through personal experience. In fact, all supply chain capabilities have the potential to reduce the costs either directly or by increasing the efficiencies. In each case, they affect the corporate financials positively. The relationship between the corporate financials and supply chain functions is very direct. There are two things that appear on the financial statements that effective supply chain practices directly control.

  1. The first is the inventory. It appears under the current assets in the corporate balance sheets. Supply chains control inventory and can reduce it significantly without affecting the revenues of a firm. Inventories add to the current assets, which is part of total assets of a corporation. Between two companies with the same revenue, the one with lower total assets will have higher asset turnover – the equation is that simple! My book on supply chain processes shows a graphic view of how the corporate financials are affected directly by supply chain functions. Lower inventory directly affects the inventory turnover (reported above as days of sales), and higher asset turnover positively impacts the ROA, ROE, and the working capital to sales ratio.
  2. The second is cost of sales. Cost of sales consist of direct costs such as the cost of merchandise, cost of raw materials, cost of direct labor, and so on; it also has some indirect cost components such as the cost of distribution including the freight and warehousing costs. Most of these costs are controlled through supply chain processes and good processes can directly reduce most of these costs. A detailed analysis of the Cost of Goods Sold is presented in my previous article here. Cost of sales appears in the corporate P&L statement right under the Revenues. This number drives the gross margin that a firm can report. Higher gross margins typically lead to higher net margins, lower operating and SG&A, and lower working capital to sales ratio.

However, supply chain is simply an effective tool, and most firms need to also develop teams of people who can deploy this tool successfully to produce the financial results typical of companies with excellent supply chains.

 

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

 

Strategic Plans Lose Favor, Really?

Here is an article from Wall Street Journal proclaiming the death of strategic plans. Really? You can believe it only at your own peril. Unless of course, you never really knew what strategic planning was all about, which seems to be the case about WSJ.

Strategic plans are not about annual budget planning and it seems to me that is exactly what WSJ is talking about. Strategy is primarily about creating competitive benefits – if that is not what it is doing for you, sorry to say, but you don’t have a strategy. Strategy is also about assessing risks and having contingency plans. The competitive advantages don’t last forever, they erode over time. They can erode because they become commonplace (and everyone develops those capabilities), they can erode because the environment changes (what was a competitive advantage once is not any more), and they can erode because an expected situations arises (a risk for which the company has no contingency plans). It is the job of strategic planning to ensure that your business always has competitive advantages – creating new ones when the old ones erode.

Strategic plans are about positioning the business for growth and profitability; not about annual, quarterly, or monthly financial reviews to pore over the cost/revenues picture.

That said, the strategic plans are deployed through their attendant plans. Financial planning and budgeting is a prime example of one of those types of attendant plans. No less important, but they do not substitute the strategic planning. Almost all companies do have financial plans, but not all of them have strategic plans. Having a five year or three year financial plan does not equate to having a strategy. It only equates to having a broad understanding of revenues and expenses. It is an important tool towards realizing the business strategy, but it is not business strategy.

The WSJ article quotes, “a few even set up “situation rooms,” where staffers glued to computer screens monitored developments affecting sales and finances” – this is a clear symptom of the argument above. They are worried about revenues (sales) and expenses (finances), not strategy. It also quotes Accenture saying, “Strategy, as we knew it, is dead. Corporate clients decided that increased flexibility and accelerated decision making are much more important than simply predicting the future”, and Boston Consulting Group as saying, “more business leaders will start to rely less on static five-year strategic plans and more on rough “adaptive” strategies that consider multiple scenarios”. The emphasis in italics is mine, but the point is simple: if your strategic plans did not have risk assessments and contingency plans for each identified risk, such as recession, decline in demand, low pricing power, supply failures, and so on, then all you were doing was financial planning as usual – there was nothing “strategic” about it other than, probably the long horizon.

As far as the frequency of reviewing plans is concerned, it has been shrinking for a long time now. For good reasons too – it is now possible to reduce the frequency of reviews and assess the plans more often. Where collecting and crunching the data from several thousand stores, divisions, regions, and factories used to take months, it is now a matter of minutes, sometimes a day or two, if you have the right infrastructure. Whether you have the right infrastructure or not is a matter of strategy – if your company believed that making decisions objectively and expediently was a competitive advantage, you would have invested in the right areas of infrastructure to make that type of objective decision-making possible, if not, you are probably going to have to set “situation rooms” and throw in a few bodies to monitor the “situation”. This is the typical fire-fighting mode for companies focused on next quarter’s analyst call more than developing any real business strategy!

These days, it is neither impossible, nor uncommon for corporations to establish real-time business intelligence systems that not only guide their financial plans but also provide valuable inputs to their business strategy. The financial reviews and controls also don’t have to be on a pre-defined frequency, in fact, it is entirely possible to simply set-up triggers for change in a set of pre-defined metrics that should initiate a review of financial plans whenever the triggers are tripped. Examples of such triggers can be demand, supplies, resource usage, inventories, payroll, overtime pay, or anything else that matters for the business and most of them can be computed much more frequently than a month.

But of course, setting up such infrastructure is completely a matter of strategic planning: mere long-term financial planning is not going to get you there, no matter how frequently it is reviewed.

 

© Vivek Sehgal, 2010, All Rights Reserved.

 

Want to know about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

Who is Your CFO’s Best Friend?

Look at your P&L closely and you will find it in the first two lines. After sales is the cost of sales. And their difference is the gross profit. So what is the big deal? Big deal is that cost of sales determines the gross profit and gross profit is the starting point for the famous bottom-line.

Cost of sales has aliases. It may be called cost of goods sold, cost of products, cost of products sold or something else similar in connotation. That is not important. What is important is what constitutes the cost of sales. Here are some explanations from the annual reports:

  • From P&G’s annual report 2009: “Cost of products sold is primarily comprised of direct materials and supplies consumed in the manufacture of product, as well as manufacturing labor, depreciation expense and direct overhead expense necessary to acquire and convert the purchased materials and supplies into finished product. Cost of products sold also includes the cost to distribute products to customers, inbound freight costs, internal transfer costs, warehousing costs and other shipping and handling activity.”
  • From Wal-mart’s annual report 2009: “Cost of sales includes actual product cost, the cost of transportation to the Company’s warehouses, stores and clubs from suppliers, the cost of transportation from the Company’s warehouses to the stores and clubs and the cost of warehousing for our Sam’s Club segment.”
  • From Target’s annual report 2009: “Total cost of products sold including Freight expenses associated with moving merchandise from our vendors to our distribution centers and our retail stores, and among our distribution and retail facilities; Vendor income that is not reimbursement of specific, incremental and identifiable costs; Inventory shrink, Markdowns, Outbound shipping and handling expenses associated with sales to our guests, Terms cash discount, Distribution center costs, including compensation and benefits costs.”

Typically, almost all the components of cost of goods sold (COGS) fall within the scope of supply chain processes. COGS also makes the largest part of company’s costs. The COGS compares to 50% of 2009 sales for P&G, 76% for Wal-mart, and 70% of sales at Target for FY2009. Therefore, if you had to start looking at reducing costs, COGS fits the bill nicely. This is the largest pie of expense in an organization and even a small reduction in this will naturally generate a large impact on the firm’s bottom-line. Following are some of most common expenses included in the COGS and the supply chain process that can potentially optimize it.

image

So who is your CFO’s best friend? If the answer is chief supply chain officer (CSCO), you are already ahead of the pack. However, AMR reports that from about 90 organizations that they surveyed, only 38% of respondents identified a chief supply chain officer (CSCO) or equivalent executive vice president as their highest ranking official. Furthermore, of the 38% that stated they had a CSCO or equivalent, only 33% of them report directly to the CEO. This means only about 12.5% of the organizations they surveyed have a CSCO that reports directly to the CEO. (Read the AMR article: Driving Supply Chain Transformation Through the Chief Supply Chain Officer).

Perhaps, time to rethink the organization!

 

© Vivek Sehgal, 2009, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

 

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 image 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.

 

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:

image

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:

image

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:

image

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.

image

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.   

 

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.

image

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.