Bottom-line: The Key to Surviving the Recession

image_thumb126Top line growth becomes a mirage in every recession. This one is no different. Retail sales have been shrinking. Every major retailer has announced shrinking revenues for past few quarters and none project growth in the coming quarters either. In fact, the data from US Census Bureau shows that the monthly sales in 2009 have actually fallen below the levels in 2007.

So, what is a retailer to do?

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Source: US Census Bureau

Focus on the bottom-line.

That is really not an option. For any retailer to survive the current climate, they must have a laser sharp focus on costs. While cost can always be a strategy for growth, it is all the more important during a recession, because in a recession, it can become a strategy for survival. While the current recession has drawn everyone’s attention to cost, it has been gaining critical importance in recent years due to reasons that are more global in nature. Here are two of the basic reasons for the new found prominence for cost even before the recession started:

  • The first reason is what I term the commoditization of products en-masse. It deteriorates the brand premiums and indirectly deals a blow to product differentiation as a strategy. The face of this commoditization in America is Wal-mart and its assortment of cheap functional products that address the utilitarian functions without the brand premium.
  • The second reason is the new mass markets, increasing the demand for functional products at affordable prices. These markets have been created by the increasing middle classes in the developing countries with aspirations to match the lifestyles in developed countries, but at a fraction of the cost of similar branded products.

Both the above phenomena, that of Wal-mart driving down the costs to expand the markets and of developing countries providing new markets for cheaper utilitarian products have propelled the cost as a strategy to the forefront of the three fundamental strategies suggested by Porter. This process is not limited to America, it is widespread across the globe – with more of the humanity joining the middle class aspirations to improve their life-style from Latin America to Russia and China. BRIC is the new force shaping the markets and the market-strategies for the immediate future.

To this mix, the recession that started in December, 2007, simply added another measure of urgency to focus on cost.

Cost as a Strategy.

If cost is the core strategy of choice, then supply chain becomes the core business function that can help the corporations realize that strategy. Supply chain costs for the retailers are second only to the direct merchandise costs. While the cost of merchandise is only partially under the retailer’s control, the supply chain costs are completely under their control, and if managed well, can show substantial results flowing to their bottom-lines. There are several areas of operations where supply chain processes can help reduce costs:

  • Demand forecasting processes can increase sales and reduce obsolescence. Improvement in demand forecasting can reduce lost sales by making products available when the consumer walks in the store. It can also reduce the cost of clearance & promotions that is otherwise required to clear obsolete products on the floor that nobody wants.
  • Replenishment and purchase planning can improve seasonal merchandise build-up and allows retailers to quickly react when the demand or supply situation changes, eventually helping to avoid discounting costs at the end of the season.
  • Inventory planning can help cut down the cost of inventory in the system. Every dollar spent on inventory in the system is a dollar less in the available working capital to the firm. Good inventory planning processes can reduce overall inventory in the network even while maintaining desirable fulfillment levels for the store replenishments.
  • Transportation planning can reduce the cost of shipments, inbound from the suppliers to the retailer’s warehouses as well as outbound from the warehouses to stores and consumers. Transportation solutions can cut down shipment miles, improve truck utilization, reduce invoice overpayment errors, and improve driver usage efficiency.
  • Warehousing process automation can reduce the labor costs in the warehouses, reduce warehouse inventories, increase order fulfillment, and increase the distribution efficiencies by reducing the overheads. Equipment automation in the warehouses with conveyors, sorting stations, fork-lifts, and so on can further enhance distribution efficiencies in the system. Warehousing solutions typically improve labor utilization in the warehouses, slotting optimization, dock-door and yard utilization, and inventory utilization.
  • Network design for the optimal flows in the supply chain reduces the overall cost of operations by optimally locating the distribution centers with respect to the demand and supply centers in the supply chain network. Though this is not a short-term play, it can definitely pay for itself if planned well along with the projected growth in demand.

At the very least, think of building up the capabilities for collecting and analyzing the cost data. What you know is what you can measure and what you can measure is what you can control, even if you choose to not go beyond the simple execution capabilities at first. Remember that the cost is not limited to the cost of merchandise alone, but has distribution, warehousing, inventory, and other operational aspects to it. It is important to get the complete cost picture to understand where the opportunities for improvement may exist. Compare with the competitors and the industry in general and plan to invest in areas that have the greatest potential for returns.

Where do you start?

Start by assessing your current needs and processes, identifying the process gaps, and then prioritize what competencies are most suited and provide the largest return on the investments. Start early, review often, and track progress. Supply chain initiatives are complex and may require substantial capital investments, but they can still provide you with the competitive advantage to sustain and grow whether your focus is cost or flexibility.

Thinking of cost as a strategy requires more than a mere focus on supply chain processes because cost saving opportunities may exist anywhere in the value chain of the firm. However, starting with supply chain helps, because supply chain processes cover the largest operational foot-print for a retailer and represent the biggest cost component after the cost of merchandise.

© 2009 Vivek Sehgal, All Rights Reserved

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.