Operations Franchise: Leveraging Your Supply Chain for Profitable Growth
By Robert J. Guzak and David M. Hill -- Supply Chain Management Review, 3/1/1998
It is no secret that the competitive landscape in virtually all industries has changed dramatically in the past two decades. New technologies and lower start-up costs have enabled smaller, more efficient upstarts to succeed in taking market share from larger, established companies. Increasingly savvy and discerning customers have become more demanding in terms of what they buy, how they buy, and from whom they buy. Flat population growth in Western Europe and North America has forced many multinational companies to expand their global sourcing and selling operations. And all of these challenges are underpinned by a paradoxical management struggle to simultaneously control costs and generate growth.
Succeeding in such an environment can be difficult even for the most well-run companies. That is why it is so important for manufacturers and service providers to capitalize on all of their strengths to help them attain and secure a position of market leadership for years to come.
One of these strengths—which, in recent years, has garnered considerable attention throughout the business community—is the supply chain. Primarily comprising a company's purchasing, manufacturing, logistics, and order-fulfillment activities, the supply chain is responsible for delivering products and services to customers. It also is held to a high standard of efficiency, playing a leading role in a company's ability to compete on the basis of lower costs.
While the efficient delivery of products or services is desirable and necessary to compete, a few innovative organizations have recognized their supply chain's inherent potential for generating revenue growth. Specifically, these companies believe that their ability to develop operations franchise—the power to create unique marketplace advantages based on the strength of supply chain capabilities—is a key to long-term, sustainable competitive advantage.
"Place": A New AdvantageBusiness professionals likely remember their first marketing classes in which the basic components of brand management were described: promotion, product, price, and place. Many companies today are in the process of substantially changing how they approach the marketplace, using three of these four components to drive growth more effectively:
- Promotions are targeted, specific, and controlled to achieve real sales growth (not merely to line the pockets of intermediaries).
- New products and line extensions now must contribute to quantifiable growth to justify their long-term place in the market.
- Price is no longer the only competitive leverage point: customers now demand real economic value through a bundling of pricing and services.
But what about the fourth "P": place (or distribution)? Where is this being used as an overt competitive advantage? Many companies have worked diligently to increase both their operational effectiveness and efficiency. However, the primary focus of these efforts has been only to reduce costs while providing increasing levels of customer service. In fact, internal operations seldom are seen as a source of competitive advantage beyond this narrow perspective—and certainly not as a means to drive revenue growth.
It is time for companies to expand the meaning of place from distribution to supply chain. In the past 10 years, the focus on supply chains and their capabilities has been enhanced greatly; yet this area still is largely untapped as a source of competitive advantage. Leveraging supply chain capabilities for competitive advantage is the essence of operations franchise.
Operations Franchise Reflects a Changing MindsetLoosely translated from Webster's, the definition of franchise is the right to be, and exercise powers of a corporation; a special privilege. With that definition in mind, one can examine how brand name, share of customer, and (in the future) operations have a unique ability—or privilege—to contribute to top-line performance.
The emergence of Operations Franchise is logical, considering the significant changes that have taken place in the relationships among suppliers, customers, and end consumers. Consider the following progression, which is summarized in the accompanying sidebar:
Historically, businesses have relied heavily on building a brand name to create momentum for growth to occur. Competing on brand name and achieving sales growth through brand-name recognition can be referred to as brand franchise. Keds, Zenith, Xerox, Kleenex, IBM, Cadillac, and Ivory soap are brands that at one time or another could transcend the need to define a unique selling proposition; their names alone ensured sales. Perhaps one of the greatest testaments ever to the power of a brand is the statement traded by information systems professionals in the 1970s and early 1980s: "No one ever got fired for buying IBM."
As time passed, brands began to lose their ability to sustain growth by name alone. In the consumer packaged goods arena, the number of brands per category increased at a staggering rate. Since 1985, the average assortment of products in supermarkets alone has more than doubled. For example, in the laundry detergent category, the Brand Variety Index (number of brands divided by market share of the best brand) has increased five times in a 13-year period. Retail shelf space grows at a rate of 1.5 percent annually, while the number of new items increases at a rate of 16 percent. In 1996, more than 15,000 new consumer packaged goods were introduced. One could go on, but the point is this: As a result of the explosion of brands and of shifting demands from consumers, the strength of selling on brand alone has eroded dramatically in the past 10 years. This has given rise to the movement from a brand-name focus to a "share-of-customer" philosophy.
Interest in understanding and improving the relationship with one's customers—or building Customer Franchise—is the operating model of choice for many companies today. In fact, customer-service initiatives are providing considerable opportunities for organizations to gain competitive advantage and generate growth. Customer-loyalty programs are helping retailers attract and retain shoppers. Product and service providers of all types are implementing elements of mass customization to distinguish themselves from competitors. Furthermore, many companies are tapping into areas such as advances in information technology (especially data warehousing and the Internet)—as well as concepts such as learning organizations, product-service bundling, and "experience" purchasing—to gain share of customer. Peapod, The Ritz Carlton, and The Home Depot are companies that have developed this competitive weaponry well.
The problem is that customer franchise, like brand franchise, is difficult to sustain. There are only so many potential customers, and most of them have a finite spending capacity. When every company has its share of segment, or customer, companies increasingly must rob market share from competitors (or even from themselves) to support "growth." This "growth" often is won at the expense of margin and lasts only as long as the last coupon promotion, fare war, or "inventory clearance sale." Such battling for share—whether it is of market or customer—can be very costly to companies, as cereal manufacturers can attest after the industry lost close to $1.1 billion as a market during the 1996 "cereal wars."1
Building on its brand name and customer base, a company can both generate efficiency and bolster its top line by developing operations franchise. Unlike brand franchise and customer franchise, which are aimed at external conditions that often are difficult to control, operations franchise is based on a company's ability to use its existing internal infrastructure as a competitive weapon. Also unlike brand- and customer-focused philosophies, which typically are concerned with the top line only, operations franchise embraces a goal of profitable revenue growth. By emphasizing profitable growth, operations franchise recognizes that the supply chain should maintain its historic responsibility for efficiency but, at the same time, assume new charges for stimulating customer demand. In other words, whether it is purchasing, manufacturing, transportation, or distribution, a company's complex physical system can be viewed as having unique abilities that can be leveraged to stimulate growth in the marketplace.
The Four Principles of Operations FranchiseProfitable revenue growth, from a supply chain perspective, occurs when an organization can establish a balance between cost containment and demand generation, allowing profit for investment purposes without creating huge debt service. Operations franchise accomplishes this through four important principles:
- Develop a supply chain strategy that supports the business strategy of the company.
- Reinvest operating savings into growth-related initiatives.
- Use opportunities funded by operating improvements to deliver products and services to market in a unique manner.
- Follow a break-even philosophy to drive business decisions and payback, rather than speculative top-line forecasts.
Develop a Supply Chain Strategy
The first step on the road to creating operations franchise is defining an appropriate supply chain strategy. In this case, "appropriate" means a strategy that is fully aligned with the company's mission—one that considers all of the organization's specific strengths and weaknesses, the industry's competitive environment, and the long-term goals of the company.
It is becoming increasingly clear to many companies (including those with effective supply chains) that without this key linkage between their operating capabilities and the goals and objectives of the business strategy, they never will be able to fully develop these capabilities into a competitive weapon to profitably enhance marketplace growth.
Reinvest Savings Into Growth
A second principle of operations franchise is that the philosophy supports the reinvesting of operational savings into the business, with the specific purpose of using these savings or opportunities to drive growth. As Exhibit 1 illustrates, reinvesting internally generates more momentum for profitability to occur in two ways: by funding new growth initiatives or by creating competitive advantage and top-line strength. With healthier profits, cost-reduction and growth initiatives become easier to fund and bear fruit more quickly, which creates the opportunity for more growth...and so on.
The retailer, on the other hand, did sustain growth, but it certainly was not profitable growth. The company's primary focus was on trying to create demand effectively by pursuing revenue growth at all costs. Unfortunately, the company could not manage the details of retail margins because it had become so thinly stretched as it attended to its new acquisitions. Losing money with each sale as a "cost" of doing business, the retailer ultimately divested itself of the specialty chains, most likely as an attempt to cull cash from its reserves.
Deliver Products and Services Uniquely
Using cost savings to bolster existing operations and create market advantage in new or hard-to-reach market channels is where the benefits of operations franchise are seen most readily. A strategic view of a company's operational capabilities will likely highlight a competence that can drive market growth. These capabilities must be nurtured, maintained, and enhanced. The supply chain can contribute to revenue growth and must receive some of the financial benefits it has worked so hard to attain. To view operational requirements for capital dollars as a "necessary evil" is short-sighted and subverts the supply chain's capacity to lead market growth.
Southwest Airlines exemplifies a company that has re-invested substantial amounts of profits into its operational infrastructure (i.e., supply chain). Southwest saw its initial competition as the automobile—not other airlines—and its target market as infrequent airline travelers. Instead of investing in the latest airplanes, passenger frills, and traditional linkages with travel agents, Southwest purchased only Boeing 737s. The concept of using one standard piece of equipment allows maintenance, labor/repair, training, technology, and fuel costs to become easier to manage and predict. With lower operating costs and an internal ticketing system that was developed to be efficient and customer-friendly, Southwest is able to effectively target and sustain service to the budget-minded traveler niche where other airlines' initiatives have failed. A focus on leveraging internal capabilities has created a marketplace differentiation—and a source of revenue growth and competitive advantage—that, not coincidentally, continues to fund internal investment to keep Southwest one step ahead of the competition.
A more recent example of how companies are flexing their operational muscle to create opportunities in the marketplace is United Parcel Service. UPS, the world's largest private carrier of air freight, has more than 180 jet aircraft operating around the world and delivery operations in more than 200 countries and territories. Its planes fly worldwide routes, delivering packages and operating at a high level of capacity during the business week. However, on weekends, this capacity largely sits idle. UPS recognized the tremendous potential of its existing operations infrastructure and set out to find a way to leverage this capacity to gain marketplace growth. In early March 1997, the company began to offer charter flights on five modified Boeing 727-100 freighter aircraft to a variety of resort and vacation destinations in conjunction with cruise line and tour operators. UPS determined that through the use of a "quick change" kit, it could rapidly and economically convert the planes to carry passengers to capitalize on this opportunity.
In a press release, UPS Airlines President Tom Weidemeyer said, "We're using our expertise in logistics management to create additional value with our jet fleet." This increased revenue was not created through a new advertising campaign, value pricing with a corporate customer, or providing better customer intimacy on existing services. Nor was it gained from FedEx or another competitor. UPS staked out new competitive space by better leveraging its operational assets, a concept that represents the core of operations franchise.
Follow a Break-Even Philosophy
Too many companies still adhere to the principle that "any sale is a good sale." Unfortunately, unless the true cost of incremental volume attainment is understood, the opportunity exists for the company to "grow" its way toward bankruptcy. Companies must carefully analyze the implications associated with any alternative involving an opportunity to better utilize supply chain capabilities. Though it may be great to leverage special skills to fulfill customized customer requirements and generate more top-line growth, the bottom-line impact of such actions can be severe. As a result, it is essential that companies wishing to leverage their operational capabilities understand the true costs of doing so.
In this context, a "break-even" philosophy means comparing the incremental top-line revenue and associated contribution with the costs needed to get that revenue growth (people, equipment, and so forth) on a per-unit basis. The desired result is a clear understanding of the volume that must be attained to pay for any incremental costs incurred. At this point, the probability of attaining those volume targets can be assessed and a prudent decision can be made. This is a simple concept, but one that many companies lose sight of in their battle for incremental sales revenue and market share.
By following the four principles of operations franchise, companies can break out of the traditional mindset of viewing their operations as simply areas from which to extract costs, or as just "make and move" mechanisms with no influence on demand creation. The following case study details how one company is applying these principles.
Case Study: Super-Premium Ice Cream ManufacturerA manufacturer of super-premium ice cream enjoys a high-profile brand name, significant market share in its category, and a loyal customer base. This company employs a method of distribution called direct store delivery (DSD) as a means to deliver product to the customer. DSD involves a significantly different—and more expensive—infrastructure from that through which typical warehouse-delivered products travel. In the case of this company, ice cream is shipped to company-owned distribution centers in various geographic locations and then distributed by employees (route salespeople) or third-party distributors through a network of delivery routes—much like a milk run.
Because this infrastructure is more expensive as a percentage of sales than shipping product to customer warehouses, controlling costs is a high priority. Yet to maintain brand image, retain a loyal customer base, and achieve aggressive company goals for introducing new products, top-line growth is important as well. The combination of these demands had the potential to drive the company either to cut costs too far (thus compromising its ability to serve markets adequately) or to give away the store to achieve its sales goals—or worse yet, both.
Realizing that it needed to address both cost and service concerns, the ice cream company opted to apply the operations franchise concept in one of its company-owned service markets in the southeastern United States. In this particular market, the traditional retail channel is saturated with super-premium ice cream brands. However, the company's management team determined that growth opportunities did exist in new and alternative market channels—such as convenience stores, food service, and "mom and pop" grocery stores—and that the brand overall was underdeveloped in a market with an average annual growth rate of 9 percent.
After analyzing its routes and driver responsibilities, the manufacturer realized that it could streamline routes by having someone other than the driver load the trucks, and by utilizing automated routing with inexpensive PC-based routing software (at the time, routing was done manually using the "pins in the map" method). In doing so, the company discovered that it could reduce drive time by two "full-time equivalent" (FTE) drivers—a savings of approximately $100,000 per year. Unfortunately, the two FTEs are spread out over the total number of routes in the network, making it very difficult to "assemble" two human beings from the fractions of time saved. Similarly, removing two routes also would cut across the different types of customers served by those routes and would make it challenging for the remaining routes to pick up future growth. Reducing the sales force, it seemed, was not a viable option.
Taking another tack, this company considered the potential for increased sales with the existing sales-force numbers after routing automation and loading assistance. The company determined that each driver had two free hours per day as a result of the streamlining. If that were true, the company could realize an additional $900,000 in revenue (based on the prevailing rate of case sales per driver). This was an attractive option, for sure, but one that began to lose its luster under closer examination. Because of its hypothetical assumption that every driver would use every free hour every day to sell cases at a constant straight-line rate, this scenario promised benefits that realistically could not be delivered.
Recognizing the impracticality of each of these scenarios, the ice cream company opted to approach the challenge from an operations franchise perspective. In doing so, it closely followed the four operations franchise principles.
Principle 1: Develop a Supply Chain Strategy
The company already had an established supply chain strategy (direct store delivery) that was tied closely to its overall business strategy. The DSD strategy was effective in reaching market channels, largely efficient, and a solid base on which the company could build its operations franchise.
Principle 2: Reinvest Savings Into Growth
The operating savings generated by using loaders and automated routing will be reinvested into delivery methods to well position the brand for growth in new and emerging market channels. For instance, with less time driving and loading/unloading, drivers can spend more time selling. Some of the cost savings engendered by automated routing can be used to launch company-owned routes into areas currently served by distributors. (Growth was identified to be much stronger in areas covered by company-owned drivers than by distributors.) In viewing the situation from a reinvestment perspective—instead of shaving the operating costs by a number that cannot be expressed as a "sum of the parts"—the enterprise stands to gain more as a whole.
Principle 3: Deliver Products and Services Uniquely
The traditional ice cream retail segment is saturated, while alternative channels such as convenience stores, gas stations and mini-marts, and sporting events exhibit promise of growth based on brand and category development indices. To take advantage of these new opportunities, the manufacturer changed its view of DSD dramatically: instead of seeing it simply as a way to bring product to the shelf, the company recognized how it could use DSD to be the first super-premium ice cream in an outlet or gain a strong foothold in new and emerging channels.
Principle 4: Follow a Break-Even Philosophy
Determining the effectiveness of operations franchise in a particular situation entails the calculation of "break-even" points to gauge if projected top-line improvements are realistic. The manufacturer calculated its fully absorbed margins and estimated how many additional cases must be sold (on top of regular volume) to "pay" for keeping the two FTE sales associates—plus the costs of vehicle loaders and a routing package. The result was about a 2-percent increase in volume, which seemed reasonable given the fact that the distribution center in this market was experiencing average annual growth of 7 percent at the time.
But the real benefits of operations franchise come after the additional 2 percent volume is sold, when almost 100 percent of the contribution per case sold is dropped to the bottom line. Add to this the availability of two FTEs to spread among routes to serve channels that were unreachable because of time and resource constraints, and the conditions are perfect for profitable revenue growth. Although there is no way to predict precisely how much incremental volume can be sold, Exhibit 4 illustrates that different scenarios can be analyzed accurately. The kink in the line in the figure represents the increase in profitability momentum when break-even is realized.
Advancing on Two Fronts
The challenges of competing successfully in today's marketplace are numerous and severe. Overcoming these obstacles demands new ideas, innovative concepts, and a sense of adventure—things that are in short supply among those companies content to ride old strategies and operating philosophies into an uncertain future. Most important, sustainable competitive advantage and long-term solvency hinge on a company's ability to achieve that necessary balance between effectively creating demand and efficiently fulfilling it—using all weapons at its disposal.
Operations franchise can help lead a company along the path to profitable revenue growth by leveraging the unique capabilities of the company's supply chain infrastructure. As depicted in Exhibit 5, operations franchise involves taking action both to contain costs and to charge the supply chain with responsibility to create demand—not one or the other (the cause of most failed cost-cutting or competitive-strategy initiatives). Whether undertaking a project as detailed as determining the best distribution network strategy or as broad as defining how to capitalize on supply chain strengths as a strategy for growth in new and developing markets, an organization must keep the end in sight and move ahead along both axes.
Perhaps the concept can be summed up best by one consumer-goods executive, who said "Operations franchise saves money on the supply side, which companies can plow back into their businesses and grow in markets that they couldn't serve before, or go to customers that they couldn't afford to serve. And that's going to allow them to grow more volume at the same or lower cost base—further strengthening their competitive position."
| Author Information |
| Robert J. Guzak is a partner in the national Supply Chain Practice at Computer Sciences Corp., based in the Dallas office. David M. Hill is a senior consultant in the Supply Chain Practice in CSC's Cleveland office. |
| Footnote |
| 1Calculation assumes that Post (Phillip Morris) reduced prices 20 percent on 100 percent of its products. This is used as a basis for the rest of the industry's major players (Kellogg, General Mills, and others). |
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