The choice seemed simple enough. A major third-party logistics provider had been delivering parts to an automotive plant on a just-in-time basis. Along came a regional trucker who promised to do it for 3 percent less, for a savings of $450,000 a year. The plant's purchasing manager, who had recently taken over the job of carrier selection from the logistics manager, promptly went with the cheaper option.
The purchasing manager's euphoria didn't last long. The inexperienced carrier soon began missing scheduled deliveries, causing the plant to book expedited services at triple the cost. Inventory expense rose when the plant manager, unsure of the vendor's ability to deliver on time, began stockpiling parts. Within a few months, the "cheaper" carrier had resulted in more than $1.5m in additional costs.
The incident, witnessed by Brian P. Flood, president of Chesapeake Logistics LLC, based in Arnold, Md., is far from uncommon. "There is a real void today between finance and logistics," he says. After years of giving lip service to supply-chain integration, most companies have yet to unite those crucial functions in all but the most superficial way.
When finance pays attention to logistics, it does so from a day-to-day, transactional perspective, says Lee Geishecker, research director of corporate financial systems for the GartnerGroup in Stamford, Conn. The accounting side looks at how much the company spends on transportation and warehousing, and what are the opportunities for cutting costs through discounts or less expensive vendors. Adopting what Geishecker calls a "scorekeeper" mentality, it captures information largely for the purpose of historical reports.
In the past, transportation and warehousing have served as easy targets for corporate cost-cutters because they were highly visible functions. It seemed an easy matter to require a logistics manager to lop 10 percent off the transportation bill for the greater good of the company. But as the automaker cited by Flood has learned, cost reductions can only go so far. After a point, service begins to suffer.
What's more, companies may have made too much of their ability to influence logistics costs in the first place. While inventory expense has come down steadily over the past decade, experts say the main reason is low interest rates, not internal budget-slashing. That reality places finance - with its emphasis on the price of inventory and money - at the forefront of cost-saving opportunities.
Geishecker calls for a new relationship between finance and logistics that carries a huge potential for lowering costs and streamlining the supply chain. For example, in addition to focusing on the number of days needed to close its books, finance might adopt as a key metric the percentage of accurately shared data. Instead of promoting traditional invoicing and payment terms, enterprises might look to self-service billing and automatic payment via the internet.
In a "collaborative commerce" environment, says Geishecker, financial experts would employ data as a launch point for forming strategic partnerships, both inside and outside the company. They would be in the loop for long-term planning of key elements such as distribution center site selection and core-carrier relationships.
Logistics managers, meanwhile, would have a better sense of how their decisions affect the entire supply chain, not just the daily cost of using a particular carrier or warehouse. And they would begin to factor in the organization's true cost of capital, a bottom-line measure that tends to get buried in corporate balance sheets.
The Third Flow
Conventional wisdom holds that supply-chain management consists of managing two types of flows - product and information. But when it comes to cutting costs in a competitive market, the financial flow mustn't be overlooked.
"The hidden truth is that the costs to finance products moving through the supply chain, over 4 percent of GDP in 1998, approach the costs associated with transportation and distribution," according to a recent paper by Richard P. Palmieri and Jon M. Africk, co-heads of Credit Suisse First Boston's Global Transportation and Logistics Group.
Finance and logistics gather much of the same information, but they do it independently of one another, say Palmieri and Africk. Both, for example, track inventory levels and the movement of product and funds throughout the pipeline. Finance uses the data in part to determine how and when it will extend credit. Logistics needs to monitor customer service in order to hone a competitive edge.
A new relationship between finance and
Rarely do the two sides share the data. According to Palmieri and Africk, financiers' information on product location and status is usually less accurate than that of logistics providers. This uncertainty leads to higher risk premiums and a higher cost of credit. "Owners of this information have a great asset," the authors say, "but they fail to maximize its value."
The solution starts with an understanding of logistics' impact on the entire organization. Many of the links are easy to spot. In the area of receivables, invoice errors slow collections and raise credit costs, says Gerry Marsh, principal and founder of the High Tech Analyst Group in Cupertino, Calif. A real-time order management system, such as that installed by Cisco Systems Inc., can quickly bring down overhead.
The internet can be an especially valuable means of resolving customer queries and disputes - the kind of things that lead to late payments and, ultimately, a loss of business. Yet most financial departments "don't understand the root cause of receivables," says Marsh.
When it comes to accounts payable, logistics and finance managers aren't always thinking about how best to leverage their buying power, which may be considerable. Closer ties to a favored vendor could result in reduced lead times, or less time holding inbound inventory, Marsh says. Through a vendor-managed inventory (VMI) program, the manufacturer might not assume ownership of parts until moments before they are needed on the assembly line - or even later. The impact on the company's balance sheet can be immense.
Information sharing can be a powerful tool for vendor management. Dell Computer provides critical market data to key suppliers so that they can react faster to customer demand. Then it shares some of the economic benefits. As a result, Dell today is one of the few computer makers with a negative working capital position - because of its build-to-order model, it gets paid before assembling the ordered unit - so that growth is essentially funded by vendors.
Opportunities for quick wins abound. Palmieri and Africk talk of the money saved when a computer assembler takes advantage of vendors' prompt-payment discounts, which average 2.5 percent. Previously the manufacturer had ignored that discount because it couldn't or wouldn't pay on time. Through better coordination with its financial end, and establishment of a separate entity to make and receive payments, the manufacturer was able to generate $3.3m of free cash flow a year.
Geishecker's notion of collaborative commerce can be extended to the credit and financing arena. Supply-chain partners usually arrange for financing - whether for equipment, production, inventory or trade credit - individually. They end up duplicating processes and probably getting more unfavorable terms than if they had cooperated up front. According to Palmieri and Africk, "supply-chain partners rarely talk about financing as part of their vendor negotiations, and as a result all pay more."
Part of the problem is a lack of systems that directly address the still-yawning gap between finance and logistics. Flood says there is no software package that can easily demonstrate the full implications of a logistics decision on the company's entire supply chain. While many vendors offer products that manage the front or back end of a supply chain, none has developed a single piece of software to tie them together.
There are numerous tools that allow for "what-if" analyses of supply-chain costs, based on various scenarios related to warehouse placement and carrier choice. In the area of warehouse management, McHugh Software International and EXE Technologies both offer a labor component that measures worker productivity while allowing for the uniqueness of each task, says Steve Banker, director of e-chain management research with ARC Advisory Group in Dedham, Mass. ClearCross has developed a landed-cost engine that purports to show buyers the full cost of shipping product ordered over the internet, including all duties and taxes imposed by foreign governments. SynQuest Inc. offers production scheduling, among other things, from a financial perspective. ABC Technologies helps translate financial into operational data through activity-based costing and performance management.
Vendors in the still-developing area of enterprise application integration, which promotes seamlessness between "best-of-breed" software packages, include Mercator Software, OnDisplay Inc. and WebMethods Inc. Additional systems are being developed by established sellers of enterprise resource planning (ERP) and customer relationship management (CRM) software, says Larry Lapide, vice president and service director of AMR Research Inc. SAP AG and Oracle Corp. are venturing into strategic enterprise management, while PeopleSoft Inc. has dubbed its own effort enterprise performance management, incorporating a whole suite of applications. Geishecker expects the share of ERP vendors that include strategic planning, budgeting and performance management in their menu of applications to rise from 10 percent this year to 80 percent in 2005.
Regardless of where it is acquired, some form of strategic planning and modeling tool is becoming crucial, Banker believes. He says the decision on where to locate a network of factories and distribution centers locks in 80 percent of a company's total logistics cost. That leaves only 20 percent out of which to squeeze additional savings. "Strategic planning is a huge tool for reducing cost," he says, "if you have the will to follow it."
Putting It Together
It remains for software vendors to assemble the pieces into a single tool for modeling, analysis and strategic planning of the total supply chain. Currently, says Flood, "they do a poor job in packaging all these components into a comprehensive report that illustrates for senior management how these changes benefit the company's stock value." Filling that void, he adds, "would greatly contribute to bridging the gap between supply-chain improvements and financial strategy."
Every company today needs certain financial applications - general ledger, accounts payable, accounts receivable and fixed assets. By 2005, says Geishecker, they will need four more: budgeting and forecasting, project accounting, activity-based costing and performance management. Failure to move in that direction, she says, could isolate finance from high-level corporate planning and make it a prime candidate for outsourcing.
Performance measurement has become an indispensable tool for acquiring data that can be used by finance and logistics managers alike. For years, companies lacked the most elemental metrics by which they could track the quality of customer service. Now they are embracing methods that range far beyond basic logistics measures, such as on-time delivery, or financial measures, such as operating profit.
There is no lack of analytical approaches. They include the Balanced Scorecard, which employs a limited number of key metrics related to strategic objectives; the Supply-Chain Council's Supply-Chain Operations Reference (SCOR) model, divided into the four steps of plan, source, make and deliver; activity-based costing (ABC), which measures individual tasks and estimates the level of resources needed to support them; and economic value analysis (EVA), a formula devised by Stern, Stewart & Co, which stresses the need for companies to recover their cost of capital, not just show an operating profit.
Flood has developed a variant on EVA known as LVA, for logistics value added. It incorporates such factors as order-cycle time and on-time delivery of the right quantity of product. Under that model, a company with a lower operating profit than its competition might actually be in better financial shape because it has fewer days of inventory on hand, lower receivables, or a shorter cash-to-cash cycle (the time it takes for a dollar of expenditure on product to become a dollar of revenue).
Such measures are becoming increasingly important to Wall Street, and consequently to corporate directors, says Flood. Despite the gush of red ink from internet start-ups, investors are placing a fresh emphasis on real profitability, including a company's cost of capital. In the process, he says, the gap between high and low performers in the stock market is widening.
All the world's systems won't help a company that continues to rely exclusively on financial accounting principles that date back to the Phoenicians, says Lapide. Marsh agrees that the real obstacle to change may be cultural, especially when CEOs decline to take a hands-on approach to the matter. Too often, he says, the problem is handed off to the chief financial officer, whose options are limited without support and involvement from the top.
The key to success lies in understanding how operational improvements can drive a company's stock price by increasing free cash flow. Says Marsh: "It's not just earnings per share."
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