The Supply Chain Effect: The Strategic Impact of Targeted Supply Chain Improvement on Financial Performance
Executive Summary
The atmosphere of economic crisis that has pervaded the waning days of 2008 has increased the pressure on all businesses in all industries to improve dramatically the effect of their supply chains on their financial performance. Indeed, despite the impact of the economic downturn on businesses large and small, global or primarily domestic, a recent AMR research report stated that “twice as many companies say they will increase spending on supply chain technologies, projecting to grow their budgets by nearly 12 percent in 2008.”[1]
The drivers for this increased strategic focus on supply chain management and supply chain efficiency are many. Over the years, for example, customers increasingly have become acutely price sensitive. With the Internet enabling customers easily to compare prices for any product or service, virtually all products and services have become subject to some degree of commoditization. To meet customer demand for lower prices, companies in turn have been outsourcing more and more of their operations to take advantage of lower labor and resource costs in countries such as India, China, Hong Kong, Bangladesh, and Pakistan, and this trend continues today.
However, in pursuit of the labor and material arbitrage afforded by lower-cost offshore providers, companies have assumed the significant risks of geographic dispersion and the higher costs of running and managing larger and more complex supply chains. In essence, by offshoring work, business traded higher labor and other fixed overhead costs for lower variable costs. Consequently, companies now are faced with the need to manage their service providers more effectively to make those variable costs as predictable as possible while also keeping them as low as possible to preserve profitability.
As a result, supply chain performance—and, more specifically, supply chain costs—truly has caught the attention of senior executives today (Figure 1.) While primarily concerned with how the supply chain can support their company’s growth initiatives, these executives are equally focused on making sure that growth is profitable. And it has been proven that the ability to make targeted improvements to specific supply chain functions, such as distribution and transportation, can help boost a company’s bottom line.
Deciding to improve supply chain performance provides a goal to shoot for; it does not provide a strategic path. The desire to improve performance does not automatically translate into bottom line benefits. Making the changes that supply chain management optimization requires is not a simple matter. In this paper, we examine the obstacles to improvement, identify the ways some companies have overcome those obstacles through the application of a variety of best practices and right behaviors, and describe the financial benefits that companies have reaped from better managing these increasingly complex and value-critical supply chains.
Three Major Obstacles to Better Supply Chain Performance
When companies get serious about improving the supply chain’s contribution to their overall financial performance, senior executives frequently discover three major obstacles standing in their way.
All I Care About Is My Little Silo
One of the biggest obstacles is the silo mentality that afflicts many organizations. Despite the fact that the greatest financial benefits organizations reap from operational improvements almost always derive from cross-functional initiatives—an observation that has been written about, reinforced by research, and broadly accepted for some time—most companies continue to suffer from a distinct lack of coordination among their various functional areas, including within the supply chain itself and in the supply chain’s integration with other enterprise functions (Figure 2.)
A recent survey of Chicago–based CEOs of companies ranging from $50 million to more than $20 billion in annual sales found that only 18 percent said that their functional teams were aware of each other’s responsibilities. About half of the surveyed CEOs were either neutral on or disagreed with the statement that operational and tactical information was regularly exchanged between functional teams in their organizations. Less than one–third (31 percent) indicated that purchasing decisions were based on plans agreed upon by all functional teams, and just 36 percent said all functional teams in their companies used common product roadmaps and other procedures to guide product launches.[2]
The problems caused by the silo mentality in business are legion, but among the most damaging is the fact that it produces metrics that drive decisions and behaviors that are often at odds with the best interests of the enterprise at large.
For example, most procurement professionals are measured on purchase price variance. Therefore, they tend to focus on trying to get good item pricing while making sure their service providers’ rates are as good as their competitors’. But while these measures help the company assess procurement’s performance, they are of only limited value to the enterprise itself. Finding items at low cost is fine, and procuring rates that are as good or better than the competition’s is undeniably desirable, but it would profit the enterprise best if the procurement professionals focused on what provides for the lowest cost of doing business. If procurement was measured on its ability to ensure the lowest total cost of ownership of the inventory being purchased (i.e., the cost to buy or make the product, plus the cost to own it or to convert the asset) while meeting or exceeding customer expectations, procurement would be participating in the operation of the business, not simply the procurement function silo.
This necessarily means devising metrics that can reward people on overall company performance in addition to having some reward for individual and functional performance.
Here’s a great example of the silo effect in action: As part of a project to determine — and subsequently reduce — a manufacturing company’s transportation spend, we asked the company’s purchasing function about transportation costs. Their reply was, “We don’t consider transportation when we’re buying goods.” In other words, because procurement’s performance was measured solely on unit costs, it was leaving it up to the suppliers to determine how to ship the goods to the company, and, in effect, to determine for the company the total cost of the goods it purchased. By taking this narrow, siloed view of the process, procurement—and, by extension, the company—was missing a golden opportunity to lower the business’s overall transportation costs, and its total cost of ownership.
Another example: At a food processor we worked with, functional silos made life difficult for the company’s carriers. To boost sales, the company’s sales people committed to a one–day delivery window for certain customers. This was a great deal for the customers, and a great incentive to do business with the company. However, from a logistics perspective, it presented enormous management challenges. And because of a lack of communications between sales and load planners, the planners generally didn’t learn about these orders until a day or two before they actually had to be shipped. Making matters worse, when the load planners asked a carrier if it could take on a particular shipment, the planners insisted upon receiving an answer within 30 minutes — a totally unrealistic time frame. So not only were the carriers being given extremely short notice of a shipping need, they were also expected to determine within 30 minutes whether they had the capacity available to accept the load.
Not surprisingly, the company’s carriers frequently had to decline such rush shipments, even though as part of their agreement with the food processing company they had promised to accept 90 percent of the loads offered to them. Furthermore, while there was evidence that the one–day delivery commitment was adversely affecting the company’s relationship with its carriers, not to mention resulting in higher total transportation costs when the company had to turn to other carriers to expedite shipments the company’s core carriers could not accept, the sales people—in their sales silo—refused to consider a longer lead time. They felt it compromised their ability to make sales and earn commissions.
As we can see from these two examples, the silo mentality derives from the way a company’s functional areas are measured and rewarded, and it is exacerbated by a lack of communication between areas. It is up to senior management to address these issues by developing new, enterprise–centric metrics, and promote communication — and understanding — between functional units.
Where’s the Data and What Does it Mean?
A second obstacle to supply chain improvement is the lack of capability many companies evince when it comes to analyzing operational and transactional data to make informed decisions. In our experience, some companies lack sufficient (and sufficiently accurate) data, some lack the ability to analyze the data they do have, and still others lack both the data and the capability to analyze it. These shortcomings prevent companies from identifying inefficiencies, overcharges, and other situations that add unnecessary and margin–destroying costs to their logistics operations.
For example, companies, as much as they wish they could, can’t control the price of fuel. But what they can do is use data to ensure that their carriers, brokers, freight forwarders, and agents are not making fuel a profit center for themselves, as has been happening for the past few years.
In 2005 and 2006, for example, the cost of gas topped $3 a gallon in the U.S. and insurance surcharges for carriers hit new highs. Yet despite the rise of these two major cost drivers for trucking companies, those two years, 2005 and 2006, were their most profitable ever. How was this possible? It was possible because the trucking companies were astute enough to know that few of the companies they served had the data or the analytic capability to question a fuel surcharge. Consequently, the carriers leveraged the higher fuel costs to boost their own revenue.
The food processor mentioned earlier is an example of a company that lacked sufficient insight into its transportation costs due to a dearth of relevant data. The company wanted to reduce its transportation costs, believing they had risen too high. But the company’s data was far from what was needed to do the type of analysis that would enable it to pinpoint opportunities for cost reduction. One of the biggest reasons for this was that the company’s bills were being paid by a freight payment service provider, and that provider did not audit its payments in a comprehensive way. So while the provider could give the food processing company an aggregate figure for what it was spending annually on transportation, the provider’s records lacked the level of detail necessary for the company to identify potential areas of waste, overcharges, and the like, and therefore its efforts to reduce its spend were stymied by this lack of data granularity.
On the other hand, the equipment manufacturer previously discussed had plenty of data. Unfortunately, no one in the company spent much time looking at it. The company would get reams of reports from the three freight payment service providers the company used, but the reports went unread for two reasons: no one had time to review them and, frankly, because there were no true transportation professionals in the organization, the data the reports contained didn’t mean much to anyone. Furthermore (and perhaps not surprisingly), the company had no software application that could have helped someone analyze the data. As a result, the company lacked even the most basic understanding of its transportation costs, such as how much the company spent with any individual carrier, or what cost per pound, region, mode, service level, etc., it was spending.
Data without an adequate degree of specificity is useless to an organization. And in an organization that lacks the capability to interpret the information it possesses, the data — no matter how refined — is as good as useless. To optimize its supply chain spend, an organization needs both: comprehensive, granular data and the capability to analyze it. In other words, whether or not an organization owns the process for paying its transportation costs, it must own the relevant information.
No Substitute for Talent
The third obstacle many companies face when attempting to improve their supply chain’s performance concerns the talent available within the supply chain function.
In many companies, particularly those in the $500 million to $3 billion range, we have found that the key supply chain employees tend to have decades of service time with the organization. Such tenure certainly has its advantages. These employees have a deep institutional knowledge of the company’s business, products, and markets. They are steeped in the company’s culture. But, in some cases, they may have steeped too long. Without a continuous infusion of new ideas, new perspectives, and new practices, a company’s processes can grow both stagnant and resistant to change. It is human nature for people to get into—and remain in—a comfort zone. But taking the same basic approach to specific supply chain activities year after year as the world changes dramatically can make it difficult for companies to benefit from the fresh winds of innovation that are invigorating companies around the world.
For example, at a mining company that supplies frac sand (sand pumped into an oil well to keep the fractures created by drilling open) to the oil drilling industry, the senior executives were extremely proud that all the company’s logistics people had been with the organization for 25 years or more. While no one would argue that these professionals didn’t know their company’s business inside and out, they were, unfortunately, years behind their competitors in terms of the practices and tools they used. None of these experienced employees received continuing education or training; they never collaborated with competitors or customers in like businesses, and the technology solutions they employed were outdated. Consequently, their knowledge of their own business, while deep, was not broad, and the company was missing out on opportunities to make operational changes that could have had a major impact on its bottom line.
In another company we worked with, the distribution center manager had been with the company his entire working career. He joined the organization right out of high school and, at the time, he knew nothing about transportation. While he picked it up over the years, eventually rising to become head of the distribution center, the practices and tools he employed were far behind the times. This lag was not evident to the company as its profitability and high customer satisfaction levels obscured the fact that its outdated and inefficient practices were adding millions of dollars of avoidable logistics costs to the company’s balance sheet. In this case, superficial success cloaked a deeper failure, one that would come to the fore if (or more realistically, when) profits began to slip.
Similarly, at the food processor discussed earlier, a major part of the problem with handling the sales department’s one-day shipping requirement lay with the company’s load planners. They were not trained properly to do their jobs or to use the planning system provided to them, making it difficult for them to keep up with specific shipments. Their discomfort with their roles and duties, and their unfamiliarity with the planning system, not to mention other options available to them, led them to insist upon that unrealistic 30–minute response window from carriers asked to accept a load.
Another talent-related issue is the fact many mid–sized companies simply don’t possess enough of the critical skills necessary to run a modern, efficient supply chain. This skills gap most likely can be laid at the feet of generations of top management who historically considered investing in and staffing the supply chain to be a necessary evil, rather than a key lever for dramatically enhancing profitability and financial performance.
For instance, as previously mentioned, the equipment manufacturer had no true transportation management professionals on staff, despite spending tens of millions of dollars annually on shipping. The same was true of another company we worked with, a cosmetics manufacturer, that spent nearly $30 million a year on shipping but had no individual fully accountable and owning that spend, or for making strategic decisions about the company’s transportation function.
But the time when the supply chain can be taken for granted, or viewed as a cost center, managed simply to control overhead, has long passed.
Overcoming the Obstacles
In working with dozens of companies on supply chain improvement initiatives, we’ve found the organizations that are able to achieve the greatest positive impact on the bottom line are those that can collect, aggregate, and synthesize the full range of supply chain operational and transactional data to get a true picture of the company’s cost profile (and what is appropriate for the organization given its market position, growth strategy, and product offerings), and then make the process changes necessary to capitalize on the opportunities the analysis identifies. Only in this way can companies gain a true understanding of their cost drivers and the optimal levels for these drivers, and put in place new practices to capture cost–savings potentials. And this typically requires stepping outside of the constraints of current agreements and terms struck with suppliers and carriers and determining the most favorable arrangements for the company.
One area offering enormous opportunity for improvement is the transportation process (Figure 3.) By attaining a deeper understanding of such elements as freight terms and carrier contracts, and thereby gaining the ability to improve on them, a typical mid-sized manufacturing company can save millions, even tens of millions, of dollars in transportation costs—with every nickel and dime dropping directly to the bottom line. Here are three case examples of companies that were able to save money by addressing and improving their shipping practices.
The Equipment Manufacturer: Leveraging the Data Advantage
As previously described, the equipment manufacturer was receiving plenty of relevant data from its freight payment providers; it simply was not putting it to any good use as it lacked the capability to analyze it. To remedy this situation, and to take advantage of the vast quantity of shipping cost data provided to it by its freight payment service providers, the equipment manufacturer collected in a single database all the data from the three freight payment services it used, as well as from accounts payable for those invoices paid in–house. This gave the company a single, consistent view of all its transportation costs across the entire organization.
After analyzing this data, the company found (among other things) that it was using approximately 100 different carriers, each of which used its own rate base. In other words, the company’s arrangements with its carriers were governed by contracts with little or no commonality, making costs unpredictable and management almost impossible. Armed with this knowledge, the company was able to reduce its carrier base substantially, and renegotiate more favorable freight terms off a common rate base.
In addition, the company began requiring its freight payment services providers to pay only the rate agreed upon between the manufacturer and its core carriers, to conduct regular audits to ensure that the manufacturer wasn’t being overbilled, and to provide weekly data feeds to keep the information in the cost database current. These initiatives, combined with other substantive process changes (including an assessment of inbound purchasing strategies and identifying the total delivered pricing relating to imports), enabled the manufacturer to save approximately $2.6 million annually in logistics costs on an annual spend of $28 million—a stark contrast to the previous situation in which no one at the company knew how much the organization spent a year on shipping, let alone had any idea of how to reduce that spend.
The Food Processor: Rebid, Renegotiate, Bake, and Save
The food processor’s experience was similar to that of the equipment manufacturer’s. To understand how much it was spending on transportation, and where those expenditures were going, the company first collected the cost data that was available to it from its freight payment service provider. Because, as noted above, that data was insufficiently detailed to give the food processor a precise picture of its spending, it was forced to include some assumptions and estimates in its analysis. But even with such limitations, the company was able to discover that its shipping costs were much higher than they should have been due to such problems as an unnecessarily large carrier base (more than 70 companies), inconsistent and varied fuel surcharge scales applied by each of those carriers, and non–standard rate tariffs across each carrier (which made it difficult, if not impossible, for the company to compare shipping costs from one carrier to the next).
Following this analysis, the food processor rebid its shipping contracts and eventually whittled down the number of its carriers to 25, each required to use the same fuel surcharge scale, and each required to use the rate tariff the food processor developed.
The result of these and other changes helped the company save $2 million annually in transportation costs—savings that were augmented by additional benefits generated by other changes. For instance, the company evaluated the logistics–related costs being charged by several suppliers through transactional purchases of raw materials and indirect spend items, which gave the company a concrete understanding of the true cost of inbound purchases and led the company to take control of its inbound transportation activity with numerous suppliers. Furthermore, by more effectively aligning its purchasing processes and master operating plans and metrics, the company realized an additional $1.2 million in savings and began enjoying significant improvements to inventory turns.
The Cosmetics Manufacturer: This Year’s New Look in Transportation Costs
Like the equipment manufacturer and the food processor, the cosmetics manufacturer (that had no individual dedicated to the transportation function), used an analysis of its shipping costs as a springboard to consolidating its carrier base and renegotiating to establish more favorable terms with those remaining carriers. This company also used its findings to identify a number of substantive improvements it could make to both its inbound and outbound shipping processes. These improvements helped streamline shipping activities, thereby reducing time, load handling, and, ultimately, costs.
For instance, this company was able to get better rates from its carriers by adopting a shipper load and count (SL&C) approach in which the company vouches for the accuracy of its own count of the number of items in any shipment on the loading dock. As a result, the carrier’s driver doesn’t have to spend time at the facility counting and double–checking all the items in a shipment before they are loaded onto his vehicle; the driver merely signs for the shipment, taking the company’s word that what it says is, in fact, there—thereby increasing the carrier’s ability to optimize its use of its drivers, and leading to lower costs for the company.
Furthermore, the cosmetics company created a central dispatch function to plan and manage the trucks responsible for moving goods back and forth among the company’s own warehouses. This enabled the company to optimize the use of those assets and, subsequently, reduce the number of trucks and drivers it required. The company also created a method for determining how to more effectively consolidate both inbound and outbound loads to choose the most appropriate (and, generally, least expensive) way to move those loads.
Lastly, the company simplified a number of additional complexities in its “supplier purchase through customer order process chain,” resulting in numerous “soft savings” opportunities.
All told, these changes saved the cosmetics company in excess of $3 million annually out of a $26 million annual logistics spend (Figure 4.)
Key Factors for Supply Chain Improvement Success
The experiences of these and other companies clearly illustrates the benefits that can be reaped by organizations that take a fact–based approach to identifying and capitalizing on opportunities to run their supply chains more effectively and efficiently. But these experiences also highlight some of the factors that can materially influence the extent to which a company successfully executes such key improvement initiatives.
One factor is the degree to which a company’s operations are centralized. Most companies today tend to operate in a decentralized manner, with business units and facilities within the company granted considerable autonomy. While this autonomy can be beneficial, it often can lead to the silo mentality previously discussed, and that can impair a company’s ability to share critical operational and transactional data enterprise–wide to gain a complete picture of an organization’s cost profile. It also can prevent an organization from leveraging its scale to enhance its bargaining power with suppliers and service providers to secure larger discounts and more favorable terms.
Companies with multiple business units or facilities operating in relatively autonomous fashion should strongly consider implementing mechanisms to encourage cross-functional and enterprise–wide collaboration such as knowledge management systems, leadership councils, and metric review boards that align the autonomous operating processes and measurements with the corporate master operating plan.
Closely related to the problem of decentralized operations is the degree to which internal supply chains collaborate. Again, the silo mentality stands in the way of improving supply chain operations in too many companies. One way to begin breaking down those silos, or at least mitigate their impact, is to develop and deploy a formal sales and operations planning (S&OP) process aimed at harmonizing plans across a company’s operations. With a formal S&OP process, a company can develop more accurate sales and production forecasts, refining those forecasts over time as conditions change, to help ensure that the company has the capacity to meet demand effectively. While an S&OP process does not eliminate unforeseen market occurrences, it does enable a company to prepare confidently for a large percentage of its demand and minimize the number of exceptions it must meet in a costly way.
From an external perspective, companies can gain greater efficiencies and lower costs by collaborating more closely with their trading partners, including their carriers. Instead of treating its providers as vendors to be managed on price and service, companies should treat their providers as partners and work with them to help them improve their own operations and lower their own costs. This kind of collaboration provides win-win results. For example, a motor carrier may charge a company a particular rate because it knows that when the driver shows up at the company’s facility, he routinely has to wait several hours before the shipment is collected, counted, wrapped, and readied for loading. This wait time costs the carrier money. If the company worked closely with the carrier to understand the carrier’s cost structure and identify steps the two organizations could take to minimize driver wait time, the carrier would be much more willing to consider setting a more favorable rate for the company, eliminating the buffer fee it charges to cover the cost of having its driver hanging around unproductively at the loading dock.
Getting the right talent in place is a fourth key success factor. We’ve seen too many companies in which supply chain talent is scarce, particularly in organizations that are just now awakening to the strategic importance of the supply chain. Such companies in the past have filled supply chain positions with inexperienced, inexpensive people who don’t now (and perhaps didn’t then) have the requisite job knowledge and skills to manage strategically a modern supply chain. Today, that situation is no longer tenable. The most successful organizations today make it a point to have experienced, talented people filling key supply chain roles, whether those people are hired and on the payroll, are external consultants, or part of an outsourcing arrangement in which a particular activity or function is run by an external service provider.
The impact that experience and knowledge (from internal and external sources) can have on an organization’s supply chain competence can be seen in the case of the mining company discussed earlier. Although the veterans running the company’s supply chain understood the organization’s business, we were able to bring new insights and practices drawn from a multitude of projects we’ve completed for other companies.
For example, simply by using bins to dry the limestone the company mined before loading it onto rail cars for shipment, we were able to load 20 percent more limestone on each car for a savings of $11,000 per load. With five such loads transported every week, the mining company saved $55,000 per week, or more than $2.8 million a year. It wasn’t rocket science that produced these savings, just a fresh perspective and the ability to get out of the box called “we’ve never done it that way before.”
The equipment manufacturer we worked with faced a slightly different problem in that it had no individual accountable for managing its transportation function, and that lack was a major contributor to its high transportation costs. The company ultimately decided to outsource transportation management to gain instant access to the necessary experience and skills it did not have in–house.
Having the right metrics is another success factor (Figure 5.) In many cases, companies either have inappropriate metrics or no metrics at all, which makes it difficult to inculcate best practices or right behaviors, or hold people accountable for their performance. One of the most widely used — and most meaningless — metric is the cost of transportation as a percentage of sales. It’s meaningless, and potentially harmful to the company’s financial performance, because it encourages behaviors that can easily obscure transportation’s true costs. For instance, if a transportation manager is gauged by this metric, all he has to do to make himself look good is to have his suppliers pay for shipping rather than his company, thereby moving a large chunk of transportation costs off the manager’s balance sheet. However, that cost doesn’t disappear; it simply pops up on someone else’s balance sheet in the form of higher charges and premiums from those suppliers passing on those transportation costs to the company at large.
Instead of such narrow and functionally based metrics that often result in higher overall costs to the enterprise, companies should use key performance indicators and benchmarks that focus on broader business outcomes. As a recent study by the MIT Center for Transportation and Logistics found, “focusing supply chains on achieving customer objectives rather than reducing near-term costs and inventories can have a greater impact on a company’s financial performance.”[3]
The last factor that has a major influence on a company’s ability to capitalize on supply chain improvement opportunities is technology, especially given the importance to improvement initiatives of collecting, storing, and analyzing data. There are myriad tools on the market, many of them inexpensive that can help supply chain professionals be more effective in their jobs and make it easier for them to identify specific areas ripe for improvement. These range from enterprise resource planning (ERP) suites (which are not inexpensive) to Excel spreadsheets (which are) that can automate simple analysis activities. In between those extremes lie supply chain management (SCM) software packages that run the cost gamut.
Outside of the office, tools such as GPS devices and RFID chips and readers also are having a major impact on supply chain operations, especially transportation. A GPS device, mounted on trucks and operated for a nominal monthly fee, can transmit invaluable data back to the home office or distribution center on such things as the location, speed, and route of a vehicle, how long a vehicle has been idling, and when the last maintenance on the vehicle was performed—all of which can help a transportation manager deploy his fleet more effectively. And RFID chips can pinpoint the location of individual pallets and products at any point on the supply chain.
The Supply Chain Is More Critical Than Ever
The economic crisis that has affected all industries in autumn 2008, the increased competition from low–cost providers all over the globe, and customers that, enabled by the Internet, are now able to shop on price more efficiently than ever before (and, thus, driving the commoditization of a whole range of products and services), has made it imperative that companies find new ways to control costs and improve their financial performance. One major response of many companies to these drivers increasingly is to outsource more and more functions and operations offshore, seeking the cost benefits that can provide, but at the same time adding heretofore almost unimaginable complexity to their new, globalized supply chains.
Fortunately, one of the most immediate, accessible, and achievable ways to improve a company’s financial performance is by optimizing aspects, such as transportation and distribution, of those ever more critical supply chain operations.
Today, companies everywhere are realizing that their supply chain holds the key to their future success. Yet viewing this critical function only through the cost lens is inadequate to today’s business challenges and a strategic mistake. To be sure, turning the supply chain into a source of savings, profits, and innovation is no longer an option exercised by only the most resource–rich enterprises; rather, it is a key differentiator for all businesses regardless of size, industry, geography or market served.
[1] “Supply Chain Spending on the Rise,” http://www.cio.com/article/168700, Jan. 03, 2008
[2] SCMR 2007 survey, www.scmr.com/article/CA6492752.html?q=survey
[3] “Getting Supply Chain on the CEO’s Agenda,” Richard H. Thompson, Donald D. Eisenstein, and Timothy M. Stratman, Supply Chain Management Review, July 1, 2007, www.scmr.com/article/CA6457959.html?
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