Hard sell

You know logistics contributes to your company's bottom line by cutting costs, increasing revenues, and boosting profitability. Now sell that to your boss.

By Jim Thomas -- Logistics Management, 2/1/1999

To professionals working in the field, the benefits of effective logistics management are abundantly evident and the potential bottom-line payback compelling. A short list might include reduced costs in such areas as inventory management, warehousing, and transportation; enhanced revenues through programs that assure higher product availability and more customized products; and significant improvements in corporate profitability. Yet these same managers still wrestle with the question of how to convince senior management that logistics is vital to a company's financial performance and therefore deserves continued investment.

Though it may seem obvious that logistics--the one function that is connected to all links in the supply chain--can do a great deal to create value for a corporation, it's not easy to get that point across to top-level executives, says Robert A. Novack, associate professor of business logistics at Pennsylvania State University. "Logistics reaches all the way back to suppliers, through the enterprise, and out to customers. However, logistics' value doesn't always sell," he observes. "It's not because the logistics organization lacks operational skills; it's because the logistics organization is bad at convincing others of the value of its initiatives."

To communicate the value logistics can bring to their organizations successfully, managers must be able to show that logistics is vital to their companies' financial performance. James K. Wilson, president of Quantum International, a consulting firm based in Longmont, Colo., uses the following example: "Let's say your company earns a dollar of profit for every $10 of sales. If logistics [efficiency] can save you a dollar without changing sales figures, then in effect you just went out and earned another $10 in sales," he says. "So an efficient logistics operation can deliver the value of another entire business division without ever making one additional sale. That's a message you need to communicate."

Dr. Stephen G. Timme, president of Atlanta-based FinListics Solutions Inc., which develops seminars on finance and logistics, agrees. "By lowering costs and increasing asset utilization, the logistics manager frees up cash," he says. "This manager can go to his board of directors and say, 'If you want to expand your business, let me go get the money for you.'"

That approach commands attention in today's business environment, where senior management must improve earnings across an entire enterprise or supply chain in order to earn the kind of returns that keep shareholders happy. It also offers a solid incentive for companies to continue investing in their logistics organizations. "Over the last 10 years, there has been increased pressure on companies to make a good return for their shareholders because the shareholders fund the company," Timme says. "They will let you reinvest profits in logistics only if they believe you will give them a good return."

Demonstrating Returns

Before logistics managers can sell value, of course, they must create it--and there are several ways to do this. Whirlpool Corp.'s logistics organization, for example, takes a three-pronged approach to contributing to the company's financial performance, says J. Paul Dittmann, vice president of global logistics. "We look at reducing operating costs. We also look at reducing working capital, which generally means lowering inventory. And we improve customer service through our ability to serve our dealer network and trading partners through such services as the 'perfect order,'" he explains.

Whirlpool defines the perfect order as one that is shipped complete, on time, and undamaged. It also must be invoiced correctly. "If we fall down in any one of these four areas, then we've disappointed our partners," says Dittmann. Senior management understands the importance of the perfect order because the financial implications of disappointing a trading partner include the reduction or loss of business.

Another way logistics managers can demonstrate logistics' impact on profits is to focus on asset utilization. "Most shareholders understand that if you reduce inventories, you reduce costs," says Timme. "But few understand that if you are more efficient with your assets, that affects how you price goods and the markets you go after."

He cites the example of Dell Computer. According to Timme, Dell utilizes its assets two to three times more efficiently than its competitors. "Therefore, Dell can price things slightly lower, advertise more, and remain more profitable than its competitors," he explains.

Managers may even be able to sell logistics as a tool for increasing sales. C. Donald Wiggins, president of consulting firm Business Evaluation Inc. in Jacksonville, Fla., cites the example of an appliance manufacturer that implemented a rapid-delivery system to serve its dealers. The new system included the development of a regional warehousing network, which allowed the manufacturer to cut delivery times to between 48 and 72 hours, says Wiggins, who also is a professor of accounting and finance at the University of North Florida. "The rapid-delivery system reduced inventory levels and improved product mix for the appliance dealers. Even if dealers kept the same level of dollar inventory, they got a better product mix," he notes.

Improvements in a company's distribution network can translate into increased sales, contends Wiggins. "If you demonstrate better delivery times, more rapid turnover of product, better inventory levels, and increased customer satisfaction, you can persuade a dealer to move a percentage of sales from a competing manufacturer to your company," he says.

Question of the Century

One of the biggest roadblocks to selling logistics value to upper management, says Dittmann, is the "business question of the next century: How do you create value in logistics--the ultimate horizontal, cross-functional process--when we are all organized vertically in functions?"

The answer, he says, is to hold everyone accountable for meeting common objectives and financial-performance measurements. Those measurements should apply throughout the supply chain, Dittmann believes.

One challenge companies pursuing that strategy face is determining how to implement a measurement system that balances service- and cost-based objectives. "We don't want to drive performance in one area at the expense of another," Dittmann says.

Getting a broad-based overview of how logistics affects a company's overall financial performance can help resolve that dilemma. At Whirlpool, senior management gets that macro view by using EVA, or Economic Value Added, a trademarked financial-performance measurement developed by Stern Stewart & Co. of New York City. In simple terms, EVA represents the after-tax operating profit minus the cost of capital used to generate that profit. The cost of capital includes charges for both debt and equity. Under EVA, which basically measures how efficiently companies use capital to create wealth, shareholder value increases when an investment earns more than the cost of capital.

Another term for the same concept is "economic profit," which Timme defines as the net operating profit after taxes minus the capital charge. Economic profit increases through improvements to revenue drivers, expense drivers, net working capital drivers, or fixed-asset drivers--all of which can be influenced to some extent by logistics performance, Timme says. (See Figure 1 for details.)

"Whether it's called EVA or economic profit, more and more companies are using some type of return measure that ties together revenue, operating costs, and capital," says Timme. "If your company announces that it is going to be managed by economic profit, then you can do great things. Why not get up to speed on the concept so you can be in a position to tell your CFO how logistics can increase economic profit?" he suggests.

Ultimately, Timme concludes, the message logistics managers must convey to corporate leaders is this: "Logistics is not about cutting costs. It's a growth story."

Editor's Note: For more information, see the following articles from previous issues of Logistics: "The Value Imperative" (Dec. 1998); "Panning for supply chain gold" (Nov. 1998); "The solid gold supply chain" (April 1997); "Selling logistics!" (Nov. 1996); and "Does your logistics operation add value?" (Dec. 1995). You can find them on our Web site (www.logisticsmgmt.com).

Logistics Affects Key Drivers of Value Creation

Revenue

Capacity utilization

Product speed to market

Stockouts

Customer service

Expenses

Inventory-carrying costs

Transportation

Warehouse productivity

Outsourcing

Capital utilization