Which Fire to Douse First?

As organizations strive to leverage the power of a seamless supply chain to help them douse the flames burning in the post-recession global economy, they will need to overcome several supply chain challenges. After all, heavily influenced as it is by external factors, Supply Chain Management (SCM) is a constantly evolving area that keeps its practitioners on their toes. It is not surprising that businesses, constantly battling to run their supply chains efficiently, often engage the services of external consultants to keep pace with the challenges.

The foremost and most important task for a consultant is to understand the clients supply chain in its entirety. The due-diligence phase calls for the consultant to balance two diametrically opposite pulls the need for substantial time to execute due diligence versus the need to fast-track this phase to justify billing by the hour. While proprietary frameworks and models can be used to gain traction, the due-diligence activities analyzing current processes, sifting through copious amounts of data, interviewing the client team are both critical and time consuming.

Retaining this delicate balance becomes tricky in light of the numerous challenges inherent in this critical phase. For instance, the vast SCM jurisdiction can blur the consultants focus. Client input on pain points cannot be taken at face value lest a bias creeps in. Usually the consultant relies on the client employees cooperation, which itself can be at a premium. However, the consultant must recognize and accept the following two aspects of human nature while interviewing:

First, the client team often views such interviews as a fault-finding exercise and thus tends to be either defensive or aggressive but never neutral.

Second, probing questions on supply chain processes often yield answers on what ought to happen rather than what is happening. As a result, the consultant can get delayed and/or be misled.

In such circumstances, is there a quick and an easy way to determine where to focus so as to accurately identify the inefficiencies that when corrected yield the maximum benefit? In other words how can the consultant know which fire to douse quickly, easily and accurately. Let us attempt to help the consultant by tying some fundamental financial and supply chain concepts to the practical world of today concepts that when applied will enable the consultant to hit the ground running.

Financial Reports: An external consultant desperate for insight into a clients supply chain can extract a wealth of information provided in the clients financial reports. A mere glance at gross margins gives an idea of where to focus. For instance, a firm enjoying gross margins above 40% can vastly benefit from supply chain initiatives that increase its responsiveness/service as opposed to cost-cutting initiatives. If gross margins are in single digits, knowing the various expense heads (raw material, production or distribution expenses) if available, helps identify the potential areas that need attention. Similarly, a quick look at inventories over several years provides a good handle on whether the firm is internally or externally focused. For instance, a relatively small Work In Progress inventory indicates that the firm has achieved tight internal integration (sourcing, manufacturing and distribution). However, a high Raw Material and Finished Goods inventories suggests external integration inefficiencies. In such a case, our consultant can reap maximum benefits by focusing on the firm-supplier or firm-channel integration. A further deep-dive into financial data can yield insights on working capital productivity and on internal supply chain inefficiencies. The latter is defined as the ratio of distribution and inventory carrying cost to net sales. (A detailed methodology on carrying out the analysis is covered in the research paper, Benchmarking Internal Supply Chain Performance: Development of a Framework, co-authored by Professor Janat Shah, Production and Operations Management faculty at IIM-Bangalore). By benchmarking these measures against industry performance using financial data from sources such as Compustat our consultant can easily spot the areas of opportunities for streamlining.

Product Characteristics: While the client firms financial reports offer an unbiased numerical assessment, its product characteristics offer vital clues on potential improvement opportunities. When supply chain cost reduction is the need of the hour, two areas Inventory and Transportation are often among the top contenders for improvement. However, the predicament where to focus appears tall. The fundamental concept of Value-Density which is the ratio of price (value) of a product to its weight comes handy here. If the business deals in low-value, bulky products, the consultant ought to focus on transportation cost but if the firm is dealing in high value-density products, inventory cost takes precedence. Recently, experts at Intel were faced with the challenge of drastically reducing the supply chain cost for their grain-sized Atom chip. The goal: Reduce supply chain cost from the prevailing $5 per unit to 70 cents a reduction of over 85%. Where did they focus given the acute time pressure they faced? The chips high value-density pointed them toward reducing inventory cost. By cutting down the order cycle time from nine to two weeks, they were able to drastically reduce inventory to meet their goal.

Likewise few other characteristics - product variety and forecast uncertainty - yield additional indicators for our consultant. For instance, a business that faces high forecast uncertainty and has high product variety, begs for exploration of postponement strategy. By delaying the differentiating operation, the business can reduce both inventory and transportation cost while improving customer service and reducing product obsolescence. If the business offers high variety and low value-density products, postponement of assembly operation can drastically reduce transportation cost. IKEA has successfully leveraged this approach to overcome its supply chain issues.

In conclusion, the challenge of optimizing the supply chain in a volatile environment is a daunting one for external consultants. The need to address supply chain problems keeping time and cost constraints in view compounds the challenge. However, financial reports and product characteristics offer useful insights that can guide consultants in identifying the business most raging fire. In todays times when more is expected from less and decisions have to be made quickly, these insights can prove to be the difference between success and failure.

About the author
Amit is a senior consultant at the Supply Chain Management practice of Infosys. He is currently on a sabbatical under-going a one year full-time MBA at Indian Institute of Management Bangalore (IIM-B) where his primary focus is on operations strategy and on the interplay supply chain has with Marketing and Finance. He shares his thoughts on supply chain management at : www.infosysblogs.com/supply-chain