One of the biggest challenges for supply chain executives is balancing trade-offs between cost reduction and supply chain performance improvement.

The two keys to effectively balancing cost and performance are a sound alignment of the business strategy and clear visibility of supply chain costs.  Many companies focus on alignment with business strategy but fail to understand cost drivers in their supply chains with sufficient granularity for optimal decision-making.

As supply chains become larger and more complex, it becomes increasingly difficult to understand the costs of running a distribution network. This challenge impacts cost-benefit analyses across an organization, from capital investment decisions like truck fleet management to daily choices such as facility staffing or service-level offerings.

Two keys to systematically striking a successful balance between cost effectiveness and supply chain performance are meticulously tracking and allocating costs with a well-implemented ERP and appropriately incentivizing line managers by establishing KPIs that are aligned with their cost and profit center allocations. These two keys are closely linked because the ERP needs to be designed and implemented with the cost and profit center logic in mind, in order to allow for effective cost allocation and visibility.

A well-implemented ERP provides drill down capability into robust cost allocations across the supply chain. These important capabilities can be forgotten when an ERP implementation is not viewed as a critical supply chain enabler, instead prioritizing financial reporting, accounts receivable management or other finance-centric capabilities at the expense of supply chain. When SCM is brought into the ERP implementation process, it can participate in setting up the account structure in order to understand and optimize how costs will be applied to different cost and profit centers, thus ensuring that line managers are able to view, with sufficient granularity, the costs that they control, without being distracted by allocated costs that are incurred outside their purview.

Delineating profit centers and cost centers is critical to effective incentive alignment. Many companies continue to set up parts of their business as profit centers that have no direct ability to impact revenue, such as distribution centers or transportation. These centers should be tasked with managing costs and achieving metrics that are within their control such as On-time, In-Full shipments (OTIF), product availability percentage and inventory carrying costs. Managing DCs as profit centers can lead to DCs optimizing their individual P&Ls, as opposed to optimizing the overall distribution network. DC sub-optimizations can include competing for the same customers, leading to redundant inventory and unnecessary price competition between DCs.

In addition to distinguishing profit centers from cost centers effectively, companies need go one step further to allocate costs to these centers at levels for which they have direct control. This means most profit centers should be accountable for Gross Profit, rather than EBIT. For example, retail locations should be accountable for locally incurred expenses like labor and upkeep by allocating these costs into their COGS, while headquarters expenses should be allocated below the Gross Profit line.  Allocating corporate overhead costs like national advertising to an individual retail location P&L is cumbersome to execute and distracting for local managers.

The Outlook

Companies will continue to struggle to make well-informed supply chain decisions, balancing cost and performance, until their ERP is designed with supply chain optimization in mind. Many organizations that continue to struggle with cost visibility are using legacy ERP systems that are nearing end-of-life.  As these companies assess upgrades to their ERP, the next generation of supply chain leaders will also capitalize on the opportunity to re-design the system to enable supply chain optimization.

Andy Prinz is Associate Partner, Supply Chain Management, and Jack Johnson is Senior Consultant, Supply Chain Management, with InfoSys Consulting.