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Increasing the Value of Your Enterprise Through Improved Supply Chain Decisions Part 3: Conclusion

Written By: Mark Wells
Published On: November 13 2002

Supply Chain Decisions Create Supply Chain Capabilities

Quality decisions relating to inventory and supply chain flexibility (red boxes in Figure 5) cumulate to set the level of capability that your organization (and value network) can achieve in the three supply chain capabilities previously discussed:

  • Reduce costs

  • Optimize cycle time

  • Respond to the marketplace.

This is Part Three of a three-part article.

Part One discussed the Supply Chain in terms of corporate objectives.

Part Two covered the Financial Metrics.

Decisions to Optimize Inventory

Decisions regarding the timing and quantity of stock that is procured, manufactured and stored have a very significant influence on supply chain costs, capital availability and the cost of capital, various cycle times, and market response. For example, targeting inventory supplies so that organizations synchronize the planning and execution along an entire supply chain strand in a value network to produce an appropriate inventory of goods that is where customers need it, when they need it, at a competitive price that yields a good margin will reduce supply chain costs. Expediting costs (premium freight, vendor surcharges) and late charges will be reduced. Costs will not be incurred to carry inventory that will not move. Funds will not be spent on materials, transformation and transportation in vain.

Good inventory decisions also improve cycle time. A long machine run that is producing too much inventory and spending capacity needlessly can impede manufacturing cycle time if sound decisions are not driving how much of what to make and when, while controlling the quality of the process. Poor decisions fill warehouses and other storage areas with goods and material that is not currently needed or of poor quality, making quick access to inventory that is needed more difficult.

Supply Chain Flexibility Decisions

Decisions about the flexibility of the supply chain determine the capability to optimize supply chain cycle time. Fundamentally, increases in flexibility require a reduction in fixed costs and/or in fixed times. Fixed costs include machine setups, minimum quantity purchases, lot or batch sizes, dedicated capital equipment, manufacturing and distribution facilities, and the like. Decisions you make related to the assortment of products and services that can be delivered through a given set of resources, the mobility with which you can switch among the selections in that assortment, and the consistency of performance (or quality) for a given range of operations will determine the effect of fixed costs on supply chain flexibility1. The science of strategic cost and opportunity analysis rationalizes product and market mix with the possible combinations of facilities and equipment. This helps to determine supply chain flexibility and to produce opportunities for increasing return on net assets, and freeing working capital.

Decisions to share planning information among nodes in a value network drive fixed time constraints in the supply chains of which you are a part. Elimination of latency through visibility of requirements across the value network allows proactive managers at all tiers to see challenges before they arrive and plan to meet them with minimal risk.

Smart inventory policies enable supply chain flexibility. Flexibility remains challenging if you move, make or buy too much of the wrong material. Capital isn't available. Facilities and equipment are clogged. Similarly, decisions in the area of flexibility enable better inventory decisions. If setups are faster and cheaper, or minimum batch sizes are smaller, inventory decisions can be more precise.

1 "What Really Makes Factories Flexible", David M. Upton, Harvard Business Review, July-August 1995, p. 74.

From Theory to Practice

Perhaps the most famous examples of supply chain decisions contributing to corporate performance are Dell and Walmart. Both companies have systematically attacked the decision processes around inventory and flexibility with remarkable results. Dell has increased its return on invested capital from 154% to 325% from 1997 to 20012. Days of supply in inventory have decreased from 13 to 5 over the same period of time. While Walmart's return on assets and return on shareholders' equity has declined marginally over the last couple of years, they are still impressive at 8.55 and 20.1%, respectively3. But these examples, while famous, are not alone.

The linkages outlined above mean that improvements in the decision-making process will yield a positive and significant impact on corporate performance. A large television manufacturer in Eastern Europe implemented an advanced planning software package as part of an effort to make better, more feasible, synchronized decisions around the procurement and manufacture of inventory. As a result, on-hand inventory was reduced by approximately $50 million. The balance sheet changed as a result, reducing the marginal (and thereby the weighted average) cost of capital and freeing cash for other uses. Since the cost of capital is a part of the equation for any measure of overall corporate performance, the value of the enterprise increased as a result.

While decisions can be achieved without the implementation of new software in many cases, the complex nature of supply chain decisions, as well as the sheer number of individual obligatory decisions make the use of advanced planning software tools helpful. A large, multi-site manufacturer in Asia implemented such a package and found that they could produce significantly more finished product with the same capacity. This will enable the manufacturer to grow the business, creating the potential to increase market share by 50%. The impact on corporate performance is easy to trace in Figure 3. More sales from the same assets equate to a higher return on net assets (RONA) and, as a result, a higher EVA.

2 Dell Financial Facts Sheet, FY02-Q4, http://www.dell.com/us/en/gen/corporate/investor/investor_000_q4fy01fs.htm
http://www.dell.com/us/en/gen/corporate/investor/investor_000_q4fy98fs.htm

3 Walmart Annual Report, 2002.

Conclusion

There remains no shortage of experts and solutions that purport to have the keys to improving your supply chain. In point of fact, many of these experts and solutions may have their place. However, executives who bear bottom line responsibility for the performance of the enterprise would do well to evaluate every potential new program from the perspective outlined here. The crucial questions are these:

  1. Will a particular program enable the people in your organization to make significantly better decisions in less time with respect to inventory and supply chain flexibility?

  2. If so, how will improved financial performance result through improved supply chain capabilities?

An affirmative answer to the first question may be intuitive. However, some detailed analysis is usually necessary in order to gain an understanding of undesirable symptoms in your supply chain and the root causes of those symptoms4. For example, one undesirable symptom might be excessive premium shipping costs incurred by the shipper. Another might be lost or reduced orders. Potential root causes for the former could be an inability to synchronize various planning activities or poor transportation decisions. The latter could be caused by a failure to gain visibility into your customers' requirements, underutilizing the power of mathematics to optimize inventory decisions, or poor order promising.

The answer to the second question requires a grasp of the linkage between capabilities that you need to develop (fixing the root causes) and the eventual impact on the financial measures outlined above. As a case in point, consider that having stock available when and where it was needed through improved inventory decision-making may eliminate the need for customers to look to other vendors when you are unable to meet their requirements. Further, vendor charges for additional, emergency setups can be reduced by making the strategic decision to gain visibility into your customers' plans (a flexibility decision). While excess premium freight impacts supply chain costs, reduced and cancelled orders affect revenue. Combined, these undesirable symptoms reduce profitability, driving down RONA and reducing EVA.

Improving your ability to decide how much stock of each item to move, make and buy at each location can affect both symptoms. Collaborative planning with your customers can improve the flexibility of your operations, also affecting both symptoms. An example of how negative symptoms, root solutions, and the financial measures affected relate is shown in the Causal Metrics Matrix in Figure 4. All of the rows in the matrix relate to inventory decisions, flexibility decisions, or both.

Figure 4. - Causal Metrics Matrix4


Click here to view larger image

The importance of a foundation of competence in business fundamentals has endured the business buzzword mania of the last few years. Management of the supply chain has always been a competency that is fundamental to increasing the sustainable value of an enterprise. Prioritizing the issues indigenous to supply chain management elevates inventory and flexibility as primary in importance. By focusing on decisions that involve inventory and operational flexibility, you can reap rewards that are disproportionate to the effort required.

About the Author

MARK WELLS has worked for the past 20 years on many of aspects supply chain management from within industry, as a supply chain consultant, and as part of a software development organization. He has held his CPIM certification from APICS since 1989. He holds an MBA from Drexel University where he has also taught operations management and operations research. He currently works for Oracle Corporation, focusing on tools for the supply chain decision maker.

Mr. Wells can be reached at mark.wells@oracle.com.

4 "Identifying the ROI of an Application for Supply Chain Management", Mark Wells, TechnologyEvaluation.com, July 2001.

 
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