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Identifying the ROI of a Software Application for SCM Part 1: We Need To Know Now

Written By: Mark Wells
Published On: July 13 2001

Identifying the ROI of a Software Application for SCM

Executive Summary   

The competitive environment for every industry grows increasingly intense. Fast, reasonably accurate information about the impact of a software investment decision grows more critical. Many decision-makers look for an exact forecast of return on investment (ROI) from the purchase of a supply chain management application. At least four very real challenges make such perfect information elusive. Commonly, executives meet these challenges with responses that are not carefully considered. The challenges and the corresponding reactionary refrains are as follows:

  1. Limited time exists to perform analysis - "We need to know now!"

  2. Business analysis skills are lacking - "We are looking for the vendor to tell us!"

  3. The data to perform the analysis are almost always not available in the corporate databases - "We have tons of data, but we don't have it broken down like that."

  4. It is always difficult to predict the future … like forecasting, certain laws about a prediction of ROI will forever hold true…

    • the prediction will always be wrong

    • the prediction will always change for as long as the analysis continues

    • someone is going to be held accountable for the prediction

    - "Just give us the bottom line!"

After a quick look at these issues, one might question the effort to undertake the analysis to predict an ROI, as well as the validity of the outcome. Perfect, or even complete, information may not be feasible, but if a few basic principles are followed, some analytical work can provide an understanding of the potential for bottom line impact. It can also yield insight into the root causes of undesirable symptoms from which your business may be suffering.

The reactions of some decision-makers to each of the four challenges that are listed above provide a convenient outline for exploring a more thoughtful and strategic approach to evaluating a potential investment in supply chain management software.

About This Note: This is a four part note, each part addressing one of the four challenges. Part Four contains links to the prior parts.

Part 1. "We need to know now!"   

Managers must make quality decisions with increasing velocity. The tools that support detailed analysis have gone a long way toward making more informed decisions a reality. It is usually true that the incremental benefit of additional information decreases as one moves along the continuum from no information toward the goal of perfect information about the future. However, it is also true that you will reap significant benefit from knowing with some certainty what you can do in a 2-6 week period. So the idea of a bit of rigorous analysis should not be shortchanged.

If you truly do need to know something with immediacy, here are some tips for a quick, cursory approach to identifying the potential return from an investment in several aspects of supply chain management software.

Collaborative Product Design   

Compare your company with key competitors along these lines:

  • Are your competitors leading with new products and gaining market share?

  • If competitors are leading, is that hurting your sales?

  • When your company leads with new features, are they quickly copied and surpassed by competitors?

  • When a new product is released for production, is it plagued by numerous engineering change orders?

  • Do suppliers have trouble meeting quality specifications?

If the answer to one or more of these questions is yes, then you probably have some opportunity to reduce costs and increase the rate and quality of innovation through a collaborative design process within your enterprise, as well as among you, your suppliers, and your customers.

Collaborative Forecasting and Planning   

If you track the accuracy of your forecasts, then you have some idea whether or not your company anticipates marketplace requirements well. However, you must look beyond the aggregate annual revenue projection. To understand the impact of demand planning on operations, it must be examined at a level that can be executed. In other words, are you accurately anticipating the requirements for parts, people and processing at a fairly detailed level? If significant forecast misses regularly occur, then working together with your major customers to plan for demand may have a notable impact on your operating costs.

Your suppliers may levy additional charges because you have passed on abrupt corrections in your demand for their products and services as a response to changes in your own demand profile. These additional charges derive from additional setups, work-in-process inventory, and lost material incurred by the vendor on your behalf. If the structure of your industry prohibits suppliers with less bargaining power from passing on these charges, they are still no less real a cost. Everywhere that the supply chain generates unnecessary costs, a savings opportunity exists for the members of the supply chain. In this case, such savings can be acquired by extending the collaborative planning loop to include not only your customers, but also your suppliers.

Optimized Manufacturing Planning   

Optimized manufacturing planning entails the use of linear programming to choose the least cost combination of plant, equipment, personnel, and material that will meet planning objectives that may include one or more of the following examples:

  • Maximizing inventory turns

  • Maximizing on-time delivery

  • Maximizing revenue

  • Maximizing profit

  • Maximizing throughput

Because optimized manufacturing planning provides decision support that considers multiple tradeoffs and constraints, it may not be easy to point to one indicator that demonstrates the potential for improvement through implementation of this powerful technique. However, clues can be found in your manufacturing cost variances, and in your performance against the business metrics that corresponds with the objectives you want to maximize.

Inventory Planning and Optimization   

Look at your financial reports and make a judgment as to whether your balance sheet or your income statement will be positively affected by the decision. For example, examine inventory levels relative to your revenue. Calculate inventory turns by dividing revenue by the annual ending (or better yet, 12-month average) inventory. Compare your turns with your competitors. If that information is not available, you can use a general industry measure that is publicly available from Standard & Poors or other sources. The higher the turns, the more working capital you have to invest elsewhere and/or the less total interest you pay the bank for the working capital that you borrow.

Gauge your company's interest expense. If turns are low and interest expense seems high, then you probably have some significant room for improvement in the way that you make decisions about acquiring and producing inventory.

Does your company keep a financial reserve account against inventory assets (a contra account)? Does the proportion of your inventory that may have to be written down at the end of the year indicate that your company is making enough of the right decisions around purchasing, distribution and manufacturing? If the reserve account seems high, that underscores the importance of having the right inventory at the right time in the right place. It means that obsolescence is becoming an issue because your planning process is not keeping pace with the volatility or lead-time of demand.

Synchronized Planning and Scheduling   

Does your company pay the freight for the product or do your customers pay it? Perhaps it varies by customer. It may be that you are paying a significant amount of premium freight in order to meet customers' demand. If the premium freight you have paid each month for the last several months is anything but negligible, there may be an opportunity to eliminate most of that expense through tools that facilitate synchronized planning and fast planning cycles.

Take a walk through the plant. Do you see a lot of inventory that is partially completed? Are there piles of work-in-process inventory that are not being rapidly used up, either on the shop floor, or in the warehouse? That is an indication of a planning problem. It may be that the distribution, purchasing and scheduling requirements are not synchronized. Or, perhaps there are bottlenecks that the plant manager can not deal with systematically because he does not have the right tools. There could also be significant setup times that can be eliminated with more sophisticated planning algorithms.

Accurate Order Promising   

Tally up the amount of charge backs you have received from customers in the last 12 months for late delivery. If you are consistently getting charge backs for late deliveries or short orders, that is another area of cost savings that may be available to you. Accurate order promising that considers your real capabilities might eliminate a portion of those charges.

The sales force may also have a feel for orders that they lose because they cannot accurately commit to customers in real time. An application that provides that capability might yield a competitive advantage.

Transportation Planning   

There may be savings available through transportation planning. If you have any significant level of less-than-truckload shipments, you may be paying too much for freight. The challenge of determining the least cost route when many alternative groupings of multiple stops into routes must be considered requires the rapid use of advanced mathematics and/or algorithms to be sure of an optimal or near optimal solution.

If most of your shipments are to consumers, almost every pair of order lines that ship separately to a customer within a given 24-hour period is an opportunity for improvement through co-packing.

Statistical Process Control   

Another place to look is in the area of returns. Unless you are an electronic retailer or a mail order house, returns should not be a significant cost of doing business. How are they trending? Then talk to manufacturing, distribution, customer service, or all three, and you will get an understanding of how often things come back and why. You may find an indication of a quality problem in manufacturing, packaging or distribution processes (shipping and handling, or possibly sortation).

This concludes Part One of a four part note.

About the Author   

MARK WELLS has extensive experience on many aspects of supply chain management from within the industry, as a supply chain consultant, and as part of a software development organization. He has CPIM certification and an MBA from Drexel University where he has also taught operations management and operations research. He currently works for the applications development division of Oracle Corporation, focusing on supply chain planning.

He can be reached at mark.wells@oracle.com.

 
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