Game Changing Trends in Supply Chain: Part II
Article Two in the Game Changers Series
In this second segment in our series on game changing trends in supply chain we’ll review in more depth three of the ten trends:
• Customer service to customer relationship management
• Absolute value for the firm to relative value for the customers
• Managerial accounting to value based management
Game Changing Trend: Customer Service to Customer Relationship Management
We are all familiar with the traditional approach to customer service. We supply chain professionals would simply standardize on one level of service for all customers. We believed that supply chain performance on dimensions such as in-stock availability and on-time delivery were critical to the buying process and thus we developed standard operational capabilities to facilitate standard and uniform levels of service delivery to all customers.
From A High Level of Standard Service to Customized Service
However, the bar today is at a new level. Customizing service offerings that already demonstrate high levels of operational excellence provides an opportunity for a supplier to become an integral part of a customer’s business. A supply chain based on close customer relationships has the greatest potential to generate unique solutions that combine elements of timeliness, availability and consistency in such a way as to exactly match the value desired at a price they are willing to pay.
Creating close customer relationships enable a firm to identify the long-term requirements, expectations, and preferences of current and/or potential customers and markets that enable the firm to develop the operational configurations required to deliver tailored supply chain delivery with optimal profitability. A company may attain a competitive edge through close customer relationships that enable them to become more proactive with its customers, anticipate customer expectations, and measure the extent to which it has satisfied customers’ needs.
Multiple Supply Chain Configurations Are Required
The need to generate a unique delivery value tailored to specific customers or customer segments implies that firms will have to create multiple supply chain configurations to provide unique solutions to support different customers. The major challenge associated with this tailored approach to customer service is the huge investment that is required to establish close relationships and deliver customized value.
Challenges of Prioritizing Service Levels
There are numerous challenges to firms as they seek to focus their resources more on prioritizing service to customers of choice. For example, marketing and sales organizations typically are reluctant to cast any paying customer in a role of “less important.” This often has less to do with desire and more to do with a lack of accurate and timely activity based costs tracked to specific customers to enable a reasonable analysis of customer profitability. If the actual profitability, both current and future, of customers is not clear, prioritizing service could be fatal.
Game Changing Trend: Trend: Absolute Value for the Firm to Relative Value
Our survey of over 150 companies compared to the same data thirteen years ago indicates that firms have made much progress in looking at supply chain performance in a more sophisticated manner.
Performance measurement in many firms is often labor intensive, inconsistent, held together with manual spreadsheets, decoupled from the strategy, and consisting of excessive detail with a false sense of precision. As one executive said, “For us, it seems like death by a thousand metrics.” Simple is better when it comes to setting up a metrics framework. Companies need a clear framework that can be translated to all levels of the organization with clarity for all employees.
From our data on hundreds of companies, we believe that there exists a set of best practices for designing a metrics framework.
Establish the Right Metrics Framework
Based on our database of hundreds of companies, we believe that best in class firms establish a metrics framework using four key principles, which are discussed in the remainder of this article:
1. Create the right cross-functional accountability
2. Establish a driver-based metrics framework
3. Set appropriate goals.
4. Ensure that metrics cannot be easily gamed
Create the Right Cross-Functional Accountability
Measuring something accomplishes little unless the right accountability is established. Good supply chain leaders should always ask themselves if their metrics have been designed with the right cross-functional accountability in place. For example, the accountability for inventory, forecast accuracy and product availability should be shared between the supply and the demand sides of the organization. One executive told us that only the production planning function had the goals for inventory turnover in their PPP (personal performance plan). Yet the planning function controlled neither the input to inventory (manufacturing), nor the output (sales). In this case, planning had all of the accountability and none of the control!
Unfortunately, this situation is all too common. There are few companies in which sales shares accountability for inventory. Yet sales’ strategies tremendously influence inventory levels. This particular issue is one of the greatest organizational accountability flaws in firms today.
Establish a Driver Based Metrics Framework
Are your metrics linked in a logical framework to your overarching goals, or are they simply a laundry list of items with no apparent logic? If the prime goal of the firm is to drive shareholder value, then a framework needs to be established so that the individuals in the organization can clearly see how every sub-metric flows into shareholder value.
We believe that the best practice is to first list the key outcomes you need to achieve, and then identify the drivers of those outcomes. Leading companies use statistical correlational analysis to find the drivers that best link with the required outcomes. Ideally, they find drivers that have a disproportionately positive impact on the big outcomes needed. They then set up a hierarchical framework or “driver tree” to visually show how each metric feeds overall goals.
Set Appropriate Goals
It’s clearly important to select the right metrics and define the associated responsibilities. Establishing goals is an entirely different matter. Too many companies only use internal comparisons (year over year performance for instance) and feel good about achieving an internal goal. This “comparison of yourself to yourself” is very dangerous practice. For example one consumer product manufacturer achieved a 6.7 inventory turnover level on its finished goods inventory, a 15% improvement above the 5.8 level from the prior year. Unfortunately, when doing a competitive assessment, the company discovered that its major competitor had achieved an 8.5 inventory turnover level. The 15% improvement didn’t look so good in light of that statistic!
Ensure That Metrics Cannot be Easily Gamed
Many companies “game” their metrics, often by eliminating data that paints a process or function in a negative light, rationalized to be unfair. Doing so does the organization a great disservice because it communicates one performance level to management that is inevitably refuted by the customer. Supply chain professionals rationalize this data manipulation (e.g. “It would be unfair to include that SKU in our fill rate calculation; we’ve had supplier problems, and can’t get enough of that product”); but in the end it only hurts the supply chain organization, because it hides real performance and creates a disconnect between the company’s perception and the experience of the customer.
In a recent survey we conducted, 81% of respondents believe their company provides superior customer service. Yet, only 8% of customers say they receive superior customer service. Likewise, in a recent analysis of our database, 94% of firms rated themselves above average in satisfying their customers. Since it’s statistically unlikely for 94% of companies to be above average, these respondents are either manipulating or overestimating their capability. Overestimation is more than just naïve; it actually destroys internal motivation because employees hear how well the firm is doing and feel no urgency to surpass competitors or delight customers, thereby giving rivals an upper hand.
In summary, we believe you should design a new set of supply chain metrics which support the new supply chain strategy, follow a logical framework, have clearly defined cross functional accountability, are related to goals set with best practice benchmarking, are customer focused and not easily gamed, and provide effective insights into how the supply chain organization is performing and where improvements can be made. In summary:
1. Create the right cross-functional accountability
2. Establish a driver based metrics framework
3. Set appropriate goals.
4. Ensure That Metrics Cannot be Easily Gamed
Game Changing Trend: Managerial Accounting to Value Based Management
In our survey of over 150 firms, we found much progress from 13 years ago in the commitment to measure individual department performance based on the overall value delivered to the firm versus purely budget focused, functionally specific metrics. The chart below shows much progress, with more opportunity ahead.
The opportunity to improve in this area should not be underestimated. In fact, many firms need to expand their thinking dramatically. The supply chain can be the prime driver of shareholder value (or owner’s equity) in firms, yet most firms have not fully leveraged this pathway to driving value.
Driving Shareholder Value with Your Supply Chain
Given the hype of the last ten years surrounding the supply chain excellence of companies like Wal-Mart, Toyota, and Amazon, why do so many firms still not get it? The success of firms in AMR’s Top 25 ranked supply chains, such as Apple, IBM, and Proctor & Gamble, should have focused everyone on supply chain as the driver of shareholder value. We hear a lot of talk about the importance of supply chain, but actions often do not match the words.
The most neglected pathway to increasing shareholder value (or owner’s equity in privately held companies) runs through supply chain excellence. This isn’t a cost-cutting argument, though supply chain excellence often dramatically reduces costs over the long term. In fact, reaching supply chain excellence is expensive, both in terms of executive attention and actual cash outlays.
Supply chain excellence drives shareholder value because it controls the heartbeat of the firm; that is the fundamental flow of materials and information from suppliers through the firm to its customers. Unfortunately too many companies have a supply chain where this flow is crippled by the lack of a strategy, by the lack of talent, by a misapplication of technology, by internal and external silos, and by a basic lack of discipline in managing change, all issues we address in later releases in this series.
Driving Shareholder Value with Your Supply Chain
In an increasing, but still small number of firms, the CEO and the Board understand the value of the supply chain to their firm. But many other CEOs, battered by an immense range of items competing for their attention, do not see this link clearly. Yet the link is there. Using the expansive view of supply chain described above, in most firms the supply chain controls most of the inventory; manages 60-70 percent of the cost; provides the foundation to generate revenue by providing outstanding product availability; and it manages most of the physical assets of the firm.
Figure: An illustration of how changes in revenue, cost, working capital and fixed capital flow into economic profit and ultimately to shareholder value.
The Great Recession of 2008-2010 increased dramatically the focus on economic profit. In an era of tighter credit, supply chain levers can be used to free cash reserves from balance sheets rather than depending on restricted credit markets. The opportunity to increase shareholder value in the future even more than the past will be to take care of both the income statement and balance sheet through supply chain excellence
Today, a small but growing number of companies are reporting that they leverage their supply chains to make working capital and cash flow improvements to drive economic profit and shareholder value. Supply chain organizations of the future must focus on far more than just driving out cost and improving product availability. Instead, they need to become an engine of overall financial improvement for their companies. Smart companies will use innovations in their supply chain to generate the cash to fund innovations in their product lines and growth in their business.
When the credit markets froze in 2008-2009, a few firms realized that they could free up cash internally without having to go to the banks. And huge amounts of cash exist. A study by AlixPartners showed that $562 billion is trapped in working capital across 1000 companies in 56 different US industries.
A major lesson learned in our work with many firms is that this focus must be driven from the top of the company. Without strong consistent support by the CEO, the CFO, and COO, an initiative like that described in the case study could not have been successful due to the massive alignment of functional silos required. The fundamental learning from the case, surprising in its power, was how supply chain can be used as a lever to dramatically lower working capital and improve cash flow. Since these changes positively affect economic profit, investors reward these efforts as they realize higher shareholder value.
The supply chain will not drive economic profit without a supply chain strategy. After working with hundreds of firms, we have surprisingly found very few that have a real supply chain strategy. The next chapter details how to develop such a strategy as well as the pillars on which to build it. But, a very basic prerequisite exists. The supply chain organization must challenge itself to take a broad economic profit based view, and they must understand his language and the language of the Board.
About the AuthorPatrick Burnson, Executive Editor Patrick Burnson is executive editor for Logistics Management and Supply Chain Management Review magazines and web sites. Patrick is a widely-published writer and editor who has spent most of his career covering international trade, global logistics, and supply chain management. He lives and works in San Francisco, providing readers with a Pacific Rim perspective on industry trends and forecasts. You can reach him directly at [email protected]
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