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Over the past decade, globalization has helped many companies improve their competitive positions. Organizations that pushed their supply chains to become ever longer were often rewarded with lower input costs and increased sales to emerging markets.
But today, growth in many global economies has slowed, and the economic prosperity of the past several years is being replaced by uncertainty. This reversal of fortune is placing downward pressure on business, causing corporations to seek savings and improved efficiencies. Since a large portion of a company's revenues and expenses flows through its global supply chain, it will come as no surprise that management will expect its supply chain to increase efficiencies during the current downturn.
To guide your company, it is important to recognize where these efficiencies may be found, to understand how leading companies approach their global supply chains, and to take the appropriate actions.
Management expectations: Working with the Economist Intelligence Unit, Ernst & Young surveyed more than 250 senior executives from the world's largest corporations to get a sense of how businesses are approaching cost reduction efforts, and what is expected of their supply chains.
Even prior to today's economic climate, cost reduction had become an essential agenda item with senior executives. Pressure to improve company performance originates from several factors, profitability and globalization being among the foremost drivers. While workforce adjustments may be necessary in extreme times, it is not the primary focus of most cost reduction programs. Overwhelmingly, senior executives expect to achieve savings by improving the business processes of their operations.
However, when asked about expectations regarding supply chain, the survey results indicate a divide between what executives require of their supply chains, and what they believe will be delivered. More than 60% of respondents report they expect supply chain to play a key role in building credibility with investors by delivering a positive impact on the bottom-line. Yet, only half are confident their supply chains are capable of managing many of the business issues that will allow them to achieve this position.
What can be done to achieve the two seemingly divergent goals of reducing cost and improving global supply chain performance? In today's difficult economic environment, realizing these objectives may require a renewed focus on delivering the fundamentals via hands-on management and basic process improvements to quickly yield self-funded benefits.
A balanced approach: A relationship exists between cost reduction, process improvement and success. When faced with difficult market conditions, many organizations focus on cost cutting as a means to achieve savings and margin goals. While this may be necessary, cost cutting alone will not provide growth opportunities, and as depicted by the following graph, cost reduction efforts succeed less than one-third of the time over the long term.
Instead, leading companies take a balanced approach to global supply chain improvement. They focus on high-impact initiatives that can pay off quickly through cost reduction efforts, and they invest in initiatives that optimize and transform the supply chain for longer-term growth and profitability.
Step One: Focus on high impact: As a business leader, your charge is to improve and sustain supply chain performance. In today's difficult economic environment, it may be a lot easier to get money out of your supply chain than out of your banker. With this in mind, we will examine supply chain activities that may provide immediate, high-impact results with regard to cash preservation and cost reduction.
Payables management--Working capital is the lifeblood of a company, and the ability to manage it better becomes even more important in a downturn due to falling sales and restricted access to new funds. Payables management is an important element of any working capital improvement program, and it requires companies to methodically govern supplier payment terms.
A review of the payables management process can produce cash savings from improved payment terms and harmonization of terms. Suppliers should be paid at the right speed based upon their importance to the business and the trade-off between their contracted pricing and payment terms. If the supplier's cost of funds is low, or for the occasional supplier, it may be feasible to slow down payments. If the supplier's cost of funds is higher than the manufacturer's, then rapid payment should earn much lower prices or prompt-pay discounts such as 1% 10 Net 45. If these are the terms, then pay the supplier at the 10th day, not sooner and not later. Perhaps this is common sense, but the real issue arises when a company misses the discount window and loses the benefit because it does not have visibility to the contract terms, or cannot enable the verification and approval processes to move quickly.
Sourcing and supplier strategy--When purchasing and contracting are ad hoc and end-user driven, the number of contracts and orders can increase considerably which is likely to drive up purchased costs and overheads. Instead, a strategic sourcing plan should be implemented, the goal of which is to manage the supplier base more effectively and pre-establish long term, cost-efficient contracts.
As part of this plan, vendors should be re-evaluated and contracts within top commodity categories may be re-bid. Companies should look at the procurement function across the enterprise, including line-operating functions, and decide which supplier relationships to continue based upon overall value performance. To obtain better pricing, the number of suppliers per category should be limited, and the coverage of the contracts within categories should be increased by aggregating purchase volumes. To help manage costs, employees should place orders based upon existing contracts within the supplier base the company has selected whenever possible. These actions alone can produce significant cost savings.
As with the payables management, supplier discounts may be available, but if purchasing does not have visibility to the contract terms or inbound supply volumes, then the negotiated price breaks within commodity categories may not be realized. Companies should consider putting automation and simple processes in place to cut the cost of goods and services purchased In the current economic environment, several percentage points of savings may be achieved relatively quickly if a company re-evaluates its current supply base, looks at spending practices and re-bids its top commodity categories.
Inventory management--Inventory must be carefully monitored to align with slowing demand for products. An examination of this process can release cash to the business through a re-balance of inventory levels. Is supply optimized to current demand levels? How much can safety stock levels be reduced? Are materials held at the optimum point in the supply chain? How many storage facilities can be consolidated or eliminated through step change inventory reductions? Acting on issues such as these can reduce supply chain costs and free up cash that will drop directly to the bottom-line Shrinkage management--From the purchase of raw materials through the distribution of finished products, shrinkage can happen at various points in the supply chain due to breakage or theft. As supply chains extend further upstream and as multichannel distribution networks expand, the growth in business complexity increases the incidence of shrinkage.
The exposure to this risk can have a direct impact on the top line, potentially costing a company up to 2% of its sales. Reducing this kind of shrinkage can produce significant savings in any economic environment.
To address shrinkage, a company must look beyond process review, and focus on data analytics and forensic methods to uncover the sources and size of its issue. Is the size of the issue what was expected? What are the weak points along the supply chain that should be addressed first? Once the size and scope of shrinkage are known, fixes can be implemented that can lead to immediate reduction and savings. To better manage shrinkage over the long term, effective controls over stock, improved stock accounting practices and more robust data visibility systems should be considered.
Step Two: Focus on optimization and transformation: A challenging economic environment can shift attention and energy to short-term, high-impact activities. But it can also present opportunities to create the kind of long term and sustainable supply chain process improvements the executives in our survey expect. These improvements may lead to operating efficiencies that can put a company in a better competitive position as it emerges from the economic downturn. Careful consideration to the planning, visibility, risk management and controls, and accountability functions may provide sustainable performance improvement.
Planning: Planning is the business process which integrates a company's sales, marketing, manufacturing, inventory and financial plans. The goal is to improve operational decision-making in order to achieve targeted business performance. As a company's demand base and supply network expand internationally, so too do the complexities of its planning function. In today's global environment, the traditional country or factory-based approach to planning often fails to meet the requirements of a truly integrated global network and can lead to great inefficiencies.
The increased complexity associated with management of global demand results from an expansion of a company's customer base, as well as regional differences in customer buying behaviors, competitive conditions, tariffs and regulations; whereas the increasing complexity associated with management of global supply often results from an expansion of a company's manufacturing and distribution network, as well as global sourcing of direct and indirect materials.
Global planning challenges--Integrated global supply networks often span conventional business unit and geographic boundaries. Isolated functional planning, where demand and supply are planned independently, results in supply chain inefficiencies manifested in lower customer service, higher inventories and generally a higher cost to operate the supply chain. Where individual business units rely upon the same supply network, isolated planning processes often lead to conflict and limitations in decision-making. For global companies whose demand base and supply network span multiple geographies, a regional bias often emerges to further limit the optimal utilization of global resources. The challenge of global planning is to establish a process, which effectively integrates functional, business and geographic planning, silos into a shared process in order to improve operational decision-making.
Centralized structure--Companies taking a centralized approach have co-located regional and global planners into centers of excellence. Planners are physically located together, allowing better communication and visibility to the overall planning process, which streamlines methods and drives efficiencies. This approach can provide significant efficiencies by allowing the organization to harmonize and standardize systems and data.
Centralization can also benefit a company by providing its planners with a new perspective regarding the transaction of key planning activities. For instance, companies utilizing a centralized structure are re-evaluating what is "core" and "non-core" to planning, and are now outsourcing processes such as baseline forecasting to less expensive external labor that often has better forecasting skills. This allows the company to better leverage its internal resources on promotion planning, for example, where the multitude of variables at play requires the kind of knowledge that only direct industry experience can provide. Replenishment planning is another example, whereby control of policies and parameters can remain an internal function, but the day-to-day transactions can be completed in a low-cost country either internally or through a third party.
Virtual structure--The creation of global virtual teams can provide similar value as centralization over the traditional country or factory-based planning approach. Tax efficiencies are the primary determining factor regarding which global structure to implement. But because planners are located in various physical locations, virtual planning has its own challenges in terms of system requirements, data harmonization and training. Even simple tasks such as determining the time windows when planning runs can be executed may prove challenging.
Global alignment--The most pressing issue to the success of either global structure revolves around how effectively sales and operations planning forums can be driven at a global level. Traditional planning relies on local sponsorship and the local organization to effectively manage itself. Decisions can be made quickly and without regard to organizations outside its limited boundaries. In the new globalized world, getting the proper level of engagement and buy-in across the geographical and functional business units is paramount to success. To work effectively, a new approach must be defined with new governance structures and a common, mandated way of working. When elevating planning to the global level, aligning decision-making authorities and ensuring the proper level of engagement from all affected parties is maintained are key points to manage for a successful global planning function.
Visibility: As globalization is implemented and the physical distance between supply chain partners increases, a process gap can emerge that must be filled. Often, companies will use inventory to hedge against the potential risk arising from multiple points within the extended supply chain. This can be expensive, however. Strengthening partner relationships to increase trust and communication is critical to bridge the cultural and geographic gaps, but it is only a partial solution. A more effective option focuses on increasing the level of knowledge available along the extended supply chain, driving information across partners to enable proactive decision-making. A visibility system allows a user to see the data associated with all components of a supply chain, and is essential to efficiently operate a global supply chain across multiple tiers with partners of varying operating capabilities.
Synchronize the global supply chain--In the past, picking up the phone or driving to a vendor to track down components or materials was possible, as supply chains were locally or regionally designed. Today, suppliers and customers along a global supply chain are located in different time zones, speak different languages and operate disparate systems using a variety of processes. Tight coordination is critical to effectively operate in these conditions. Information visibility establishes an environment that allows all supply chain partners to plug in, coordinate and deliver against their respective responsibilities.
Synchronization brought about by visibility can greatly enhance planning activities for example, by linking supply, demand and forecast expectations across a company's supply chain partners. This level of dexterity is important for day-to-day operations, and is essential if supply chain disruptions are to be quickly identified and resolved before they become costly mistakes.
Know where your goods are--Until recently, the ability to answer management's request regarding the location of an international shipment at any specific point in time was a luxury. If a container fell overboard, the customer routinely would not be aware until the ship arrived at port. If the ship was late, the customer might not be aware until informed by the freight forward company, oftentimes only after the ship had finally arrived. Such late notification might initiate a reactive solution that could be expensive, including airfreighting product that was late, halting downstream production, or even causing the season to be missed.
In today's global markets, it is no longer sufficient to be aware after the fact. Supply chain leaders know precisely where the ship, train, truck or airplane is at any given point in time, and can even see where their shipment is physically located on the transport vehicle. These companies have access to finished goods inventory positions at suppliers located halfway around the world. Armed with visibility technology, companies can use information to execute proactive strategies to better position their products in the market. A company, for example, can save money and reduce stock-outs by using a visibility platform to integrate suppliers, logistics providers and finished goods distribution centers to re-route products in transit from slow moving markets to high-velocity distribution points.
Exception-based management--Visibility also enables exception-based management. As vendors become leaner, and supply chain complexity increases, it is not practical for a company to monitor all activities along the supply chain. With defined business rules, a company can use a visibility platform to identify and notify key resources when an exception occurs along the supply chain. This notification, and the supporting detail, may allow a decision-maker to resolve an exception situation earlier and at a lower cost than might be possible without the use of a visibility platform.
Integrating suppliers, logistics service providers, internal operations and customers to proactively make effective decisions is no longer a luxury, it is critical to the efficient operation of today's global supply chains.
Risk management and controls: Risk can present itself anywhere along the supply chain. For many companies, experience has been a good teacher and the risks associated with a local supply chain are understood. But as supply chains reach farther into remote areas of developing countries, new uncertainties arise regarding vendor selection and management, regulatory compliance, supply chain design and currency fluctuation, among others. These risks can be dramatically different and less anticipated than those associated with a local supply chain.
Recognizing and mitigating risk Oftentimes risk management means risk avoidance through due diligence and the use of controls.
Supplier controls--Headlines regarding the quality of children's toys and baby formula are dramatic reminders that low-cost country sourcing, while it can lower an organization's expenses, can be fraught with risk. One bad headline can erase the savings from a low-cost supplier and impact the company's reputation. It can be difficult to properly identify a qualified supplier in a foreign country where your company is unlikely to have direct experience. The supplier must possess what is required to produce to specification, including raw materials, the human and technical capabilities and the ability to consistently produce to quality standards. Identifying these characteristics in a supplier might be the easy part. How do you know if the supplier is financially viable? Will the vendor open its books? Will the government put the supplier out of business? Once the customer has certified the supplier, controls must exist to ensure the supplier consistently produces at the expected standards.
Inadequate vendor controls can create significant risk for the customer. For example, if the supplier were allowed to dictate inbound supply flow terms, it would likely select the shipping terms that were in its best interest. If the price of fuel were to rise, container ships may slow down to conserve fuel, causing longer lead times. Unfavorable contract terms and improper controls in this case could expose the company to considerable variability in costs and lead times, and could hinder its ability to deliver to its customers.
The manner in which a logistics service provider represents an organization during the customs process can create risk. Errors made while representing the customer could increase customs costs and could damage its reputation. Proper controls must be in place and maintained to mitigate the occurrence of such risks.
Vendor distress--With slowing sales and tight credit markets, today's global economic environment is putting pressure on many companies. Even large, presumably secure global institutions have failed or have been recapitalized by government interventions. Procuring organizations potentially face double the risk. They have to skillfully manage themselves through these difficult times, and they must hope their suppliers can do the same. The unexpected loss of even one key supplier could cause a production delay or stoppage at the manufacturer. Many vendors in today's global supply chains are located in developing nations, and their survival rests upon Western countries whose economies are struggling. What controls can an organization implement to spot the early warning signs a supplier could be troubled? How many suppliers should a company retain? What is the business continuity plan to prevent inbound supply disruption?
Regulatory compliance--The inability to consistently meet complex regulatory requirements can lead to an increased exposure to customs fines, tax burdens and operating inefficiencies. Two manufacturers of competing game stations wanted to sell their respective products in China. One company did not fully understand the tax implications of improperly listing its product as a "home entertainment unit", and ended up putting itself at a competitive disadvantage as it had to pay nearly double the import duty as the other manufacturer.
Supply chain design--Not understanding how an inbound raw material or sub-component can get delayed during international shipment may lead to increased expenses. A consumer products company designed its global supply chain at the local level. As a result of not fully understanding the risks of international shipping, they were not prepared for challenges of inbound delays. Since raw materials were being transported via container ship from Asia to Europe, delivery would take weeks, not days as with the former local suppliers. This unanticipated delay affected working capital as storage tanks had to be built to hold inventory as back up. Cash that could have been put to better use was instead tied-up in inventory and the storage facility.
Currency--In a volatile foreign exchange environment, the inbound supply price agreed upon may not be what is actually paid weeks or months later when the goods are delivered. In which currency should a company trade? How can a company hedge against currency fluctuations? What are the proper controls needed to mitigate this type of risk?
Risk trade-offs: Risk management does not always mean avoiding risk. Oftentimes it is a matter of how a company chooses to deal with risk and the available trade-offs. The consumer product company's primary supplier was in Japan where the capabilities existed to cost-effectively produce the unique liquid compounds to specification. However, because these chemicals could be difficult to procure, the company retained alternate suppliers in Europe. This was not the lowest cost sourcing option, and the local formulations differed causing variations in the end product. However, the company was willing to accept these trade-offs to mitigate the risk of disruption from its primary supplier in Japan.
Accountability: Accountability has traditionally meant writing favorable terms into a contract, monitoring vendor performance and then working with the supplier to uphold its obligations. While favorable contract terms and performance measurement are important, leading organizations are expanding their definition. These companies understand to be successful in today's highly competitive global markets, accountability must be re-defined and built in at all points along the supply chain from supplier to customer.
Metrics must be measured--Negotiating a good contract is only the beginning of the accountability process. If an organization cannot, or does not, measure compliance, how can it extend contract compliance functionality and accountability out to its respective departments or business units?
For example, a paperboard manufacturer requires its raw material supplier to provide bales of waste with a moisture content that does not exceed 15% so they are not paying for water. However, the receiving department is unaware of the moisture content requirement and does not test for it. Not only is the company unaware if it is getting what it has contracted, but it is unable to hold the supplier accountable since it does not measure. Additionally, during the next round of negotiations, the supplier may recognize there may be little chance they will be fully held to the contract they are about to sign.
Common metrics drive common behavior--Leading companies understand they too must be held accountable. It is unproductive for each element of the supply chain to manage to separate metrics that do not take into account the impact they have at subsequent parts of the chain. Creating common metrics that are tied to desirable business outcomes, such as profit, are important to success in today's complex global supply chains.
Some capital-intensive industries fail to fully integrate their sales and operations functions. The sales force may be compensated based upon metric tons sold, while the transportation organization is measured on total shipping cost. These two performance measurements may not align, and could lead to reduced profit margins as a result. The sales force may lock up client contracts without adequately assessing the total delivered cost of these contracts. If these contracts lead to half loads of product being shipped to some customer locations, the transportation cost alone may wipe out most, if not all, of the gross profit. Some organizations know and accept this because they have decided to manage to overall account profitability, not individual customer locations. But oftentimes, an organization may not clearly understand the total cost of a customer contract because they have not linked common performance metrics across the business.
Mutual success--Supplier selection was explored earlier in this paper as a means to quickly reduce costs by limiting the number of vendors per category, and then the issue of risk in the vendor selection process was examined. Once a company has selected its suppliers, the manner in which it views and manages these relationships with regard to accountability can be important to its success. Will the customer exert its dominance, or will it recognize there is much to be gained through cooperation?
An organization that manages its preferred supplier relationships based solely upon cost may not be serving its own best interest. Just as customers have preferred suppliers, suppliers have preferred customers. Leading organizations recognize the benefits of a fully integrated relationship with a preferred vendor go beyond price. These companies make it their business to know their suppliers' businesses and to ensure they maintain adequate levels of profitability. This builds the foundation of a trusted relationship, which can mitigate supplier risk and create a competitive advantage.
Strong supplier networks manifest themselves in a variety of ways in times of need. For example, a supplier to a major auto manufacturer had a fire at its plant and subsequently lost all production for a key component. Although this loss caused the auto manufacturer's assembly plants to shut down, the manufacturer was able to rely on the strength of its supplier network to collaborate with one another to produce the part. Because of the manufacturer's strong vendor relationships, this key part was being delivered again to the assembly lines in less than a week.
Not understanding your supplier's business, and focusing on cost rather than valued performance benefits, may lead to a difficult relationship during challenging times. Some organizations that failed to build strong supplier relationships in the past are now rushing to strengthen them in today's difficult economy through cash injections. They can only hope these efforts do not prove to be too little too late.
Holding customers accountable--Are you managing the customer, or is it managing you? One customer practice that may damage overall profitability is emergency orders. These are typically the symptom of inadequate customer planning, not true emergencies. Accelerating a customer order comes at a price as it can interfere with production runs, can cause expedited shipment costs to be incurred and may cause orders to be late for other customers. Before an organization accepts these orders, it should know the total cost it will incur to fulfill the order. Taking this view will provide management with the information it needs to decide whether to absorb these additional expenses, or to pass them to the customer. A customer's lack of adequate planning should not be considered an emergency order the company must simply accept without first understanding the total cost.
Conclusion: The economies in many parts of the world have slowed. While the business environment has become more challenging, prudent companies are taking an approach to their global supply chains that balances immediate cost reduction needs with long-term process efficiency improvements. This approach is key for supply chain organizations that want to deliver on executive expectations, and help their companies emerge from the downturn in a stronger competitive position.
For some research in this article, the Economist Intelligence Unit, the research arm of The Economist magazine, surveyed 250 senior executives and board members. Respondents were drawn from Asia Pacific (33%), North America (31%) and Western Europe (28%), with the remaining responses from the rest of the world. All executives polled worked for businesses with revenues in excess of US$1 billion and represented a cross-section of various industries.
Ernst & Young
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