Drive down cost? What does that really mean in a supply chain world?

Yes all of us are well aware that the global economy is in a downturn. We hear it in the news, on blogs, in articles, and we see it around us with massive layoffs and lower consumer spending. So while we have heard all about these problems, what is the solution to fix these issues from an enterprise point of view?

In the first part of this series of three, I will identify the challenges organizations face when driving their costs down for the supply chain network, as well as look at some strategies to bring down cost in the overall supply chain process. Here I’ll discuss two concepts on cost: cost cutting and cost reducing, and will be using definitions which are in line with Jim Tompkins article The Riddle of Supply Chain Cost Reduction. In the upcoming blogs, I will specifically discuss aspects of inventory management and IT systems and how to implement better business processes to achieve the cost reduction measures in an organization.

Many organizations would like to lower their cost in the entire supply chain, but achieving this is not possible without suitable strategic plans in place. Usually, in cost cutting strategies, organizations don’t look at the entire value chain, but decide to cut for sake of saving some dollars. When you think about cost cutting, is it really a good, strategic plan for the organization in long run? Or should we be looking at reducing non-value added activities and processes from our value chain? In an economic downturn, the latter makes more sense—organization should be looking at the overall, long term objectives and ask what it wants to achieve while maintaining its profitability.

Now the question comes: should organizations be cutting or reducing cost? For some companies there is no difference between cost cutting and cost reducing—however, there is. Let me describe the fine difference between these two strategies. In cost cutting, each department or group within an organization has the mandate from upper management to bring costs down to a minimum. However, this mandate is not based on visibility throughout the entire organization. Cost reducing, on the other hand, cuts out only non-value added activities from their supply chain process.

In general, when a supply chain manager considers cost cutting, he or she is looking solely from the perspective of "where can dollars be saved". And this is often done through quick fixes, without realizing that they are actually much more harmful. Below is a table of typical, cost cutting quick fixes and the potential risk they may have to the overall organization.


The above cutting tactics will lessen cost in the interim, but may also create major issues for the organization in the long run. That is the reason why many organizations won’t realize benefits from cost cutting.

Instead organizations need to adopt the strategy of cost reducing for their overall supply chain in their supply chain network. Cost reducing includes

  • Buying raw materials at the right price from the right strategic partner (supplier) and moving the material in the most effective and efficient manner (channels), while keeping in mind that the objective is to move as little as possible so the material price stays low.

  • Making product in a lean manufacturing facility will reduce waste and increase operation throughput. It will also reduce the overall lead-time to deliver. When doing this, organizations need to keep in mind that quality does not need to be jeopardized to implement this new process. It’s important to measure key cost reducing indicators to see if cost reduction has been achieved.

  • Transportation has a variable cost, depending on mode and location. The best ways to reduce cost is for organizations to establish relationships with its suppliers so they can plan their freight delivery in a manner which will benefit both parties. This also allows organizations to manage the freight delivery of finished goods to distribution centers and customers in the most cost effective and economical manner. Organizations should also use tools to analyze each transportation delivery to understand hidden cost and to build an improved transportation model.

  • Distribution centers need to have a best-in-class facility layout which can reduce the movement of material, as well as reduce the need to store inventory at other locations. Organization should apply the best practices of warehouse management to run the distribution center and remove inefficient labor cost. Organizations should also keep in mind the environmental impact of distribution centers, and strive to reduce the energy consumption and waste of packing material.

  • Inventory should be managed in-house, at stores, and in warehouses. The number of days supply is stored at a location needs to be evaluated on a daily basis so that organizations don’t get stuck with non-conforming inventories. The bottom line is to keep business profitable by having the right inventory, at the right location, at the right time to create satisfied customers.

  • Outsourcing should be evaluated through key indicator metrics, regardless of which activity is being outsourced. The organization should identify the benefits (profit) of outsourcing based on timelines and measure its return on investment.

  • IT systems are just one of the places where organizations need to re-evaluate their current providers. Some systems are out-of-date and need to be replaced or upgraded with new technologies or capabilities. These systems will identify the organization’s obstacles regarding data accuracy, completeness, and timeliness. All IT systems need to be able to integrate with each other, as well with other third party providers and partners.

These areas of supply chain need to be analyzed further for companies to implement a cost reducing strategy. Some, which are simpler and easier to achieve, have already been identified in this blog, but others are harder to achieve without further collaboration with other parties in the supply chain network.

The global economy is going through difficult times right now, but if an organization evaluates its value chain for cost reduction instead of cost cutting, it will come out much stronger than its competition in the end. In the next blog, I will discuss, in detail, aspects of inventory management with reference to business processes and the key functionalities needed in IT systems to achieve cost reducing strategies in this turbulent economy.
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