Identifying the ROI of a Software Application for SCM
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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:
- Limited
time exists to perform analysis - "We need to know now!"
- Business
analysis skills are lacking - "We are looking for the vendor to tell
us!"
- 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."
- 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.