Fixing an Underperforming Supply Chain
By Foster Finley and Chap Kistler -- Supply Chain Management Review, 11/1/2005
"Best in class!" "Cutting edge!" "Innovative!" Accolades such as these are used to describe many of the supply chains we read about these days.
If only it were so. In practice, the supply chains at many organizations are hard-pressed to keep up with the fast-changing demands of the business. In recent years, other studies and reports in this magazine have gauged the performance gap between high-performance supply chains and the many that can be considered average. In some cases, supply chain operations perform so poorly that it's fair to label them "distressed." By our calculations, those supply chains exert such a drag on the company's operations that they can be considered to be liabilities. As such, they need to be fixed fast.
This article defines the characteristics of distressed supply chains and then proposes a "SWAT team" approach to identifying the root problems and initiating gains within six months. It is not our intent to provide an off-the-shelf solution as there is no such thing. But we firmly believe that there are core symptoms common to most distressed supply chains and concomitantly, there are broadly applicable principles that can do much to restore the effectiveness of failing supply chains.
Complexity Drives ConcernIt's reasonable to ask why underperforming supply chains are a matter of concern now. Perhaps the most powerful driver is that supply chains are becoming much more complex—longer, multi-tiered, and containing more inventory. This complexity is driven by the continued decline in U.S. manufacturing and the gathering momentum of production in Asia. Adding to that complexity is the trend towards outsourcing, evidenced by the quite visible expansion of third-party logistics providers (3PLs).
Concurrently, product lines have expanded significantly, especially among consumer goods manufacturers. In turn, product proliferation has led to rapid growth in safety stocks, prebuilds, and stocking locations as well as to higher reverse logistics costs as more products are returned.
As the threshold for "good" or even "adequate" supply chain performance rises steadily, there are signs that many companies cannot keep up. But why do some supply chains perform so poorly? It may simply be that aggressive and innovative competitors raise the bar rapidly, as Dell has done in the personal computer business and Best Buy has done for consumer electronics retailing. But it can also be because investment decisions are too risky, or business practices are too inflexible, or there is too little data for managers to be able to make smart decisions. Exhibit 1, on page 48, lists some of the root causes of supply chain disrepair.
Underperformance DefinedBefore we begin to address some repair efforts, it's important to say exactly what we mean by "underperformance." Essentially, it means that the supply chain's performance poses a competitive liability, negatively affecting returns to shareholders or putting relationships with key suppliers or customers at risk. Performance has deteriorated to the point where corrective actions must be directed toward re-establishing a stable platform before further improvements are possible. We identify three dimensions of supply chain distress: inadequate service, poor asset effectiveness, and high variable operating costs.
Poor service is the most obvious external sign of an underperforming supply chain. If customers are complaining loudly and regularly about missed commitments and other service deficiencies, the cat is already out of the bag. Sales and marketing staff know it, and it's likely that your competitors know it too and are exploiting the problems at your expense. Telltale indicators include the following: poor product availability, sluggish or no response to changes in demand, long cycle times, high product-damage levels, inflexibility, unreliable forecasts, unexplained shrinkage, and an inability to reliably commit to customers on when things will improve.
Of course, for these indicators to be meaningful, they must be expressed in relation either to a competitor's data or a suitable benchmark. The absence of such reference points is a telling sign in itself. In lieu of confirmed statistics, it is vital to talk to a few customers who are defecting to competitors.
Unproductive supply chain assets are slightly easier to hide than service issues but not by much. These include both fixed assets and working capital such as massive warehouses with miles of conveyor belting, racking, and leased fork trucks; idled tractors and trailers in the yard; and dust-covered inventory of products that have been returned, discontinued, or overproduced in anticipation of huge demand that never quite materialized. These assets are depreciating, and their dwindling value is showing up on the balance sheet every quarter. The two key measures to focus on are inventory turns and return on assets. Each, however have their weaknesses. Inventory turns can usually be assessed from the financial numbers but often lack the detail needed to support intervention. Return on assets can be very misleading at aggregate levels due to complicating transactions such as salebacks/leasebacks, outsourcing, or an inability to separate supply chain assets from other productive assets. Industry-specific benchmarks are also useful, although they provide gross comparisons only.
Unfortunately, most underperforming supply chains exhibit failings along more than just one dimension, highlighting the close interrelationships between service, asset effectiveness, and cost management. When managers are unable to get believable answers to the service, asset, and cost questions, it is almost always due to a general lack of data. Data is the life-blood of a supply chain. An inadequate infrastructure for collecting, organizing, analyzing, and controlling a supply chain is a red flag. If core supply chain activities are tracked on spreadsheets, or if they are dependent on faxes or phone calls, the supply chain is, by definition, compromised.
While supply chain managers need to focus intensely on the data, they cannot ignore the "gut feeling" of their people on the front line. Those involved daily with supply chain operations best appreciate how bad things really are. They have typically borne the brunt of customer dissatisfaction, feel a sense of hopelessness when another request for needed investment is turned down, and will roll their eyes at the prospect of another grand "supply chain transformation" program. However, if perpetual frustration has not caused them to give up, they can be the best sources for immediate improvement ideas.
The Value of a Six-Month Repair PlanAssuming that supply chain managers and their bosses are quite clear that repairs are essential, how do they begin to plan the necessary overhaul? By this point, there is typically little tolerance from either senior executives or trading partners for long-term projects that involve painstaking proof-of-concept phases and consume valuable time and resources. The emphasis has to be on action and on quick wins. In our experience, there is great value in putting a six-month "time-to-benefits" requirement on a supply chain turnaround effort and focusing on discrete operating challenges rather than enterprise-wide changes.
Why six months? In our experience, stakeholders become skeptical and impatient if there isn't evidence of at least modest results within this time frame. We also have found that you need to generate positive cash flow quickly so that the repair program is at least self-subsidizing within two fiscal quarters. Anything longer puts too much of a strain on organizations that are often cash-strapped.
Launching and sustaining an effective supply chain improvement program rests on three elements: (1) the right team leading the effort, (2) the right fact-set on which crucial decisions are based, and (3) clear objectives around quick cash generation.
Selecting a team and designating a leader often prove to be the most crucial decisions of the whole recovery effort. There is no universal rule that "an outsider" to the existing supply chain organization should have the lead. But our experience suggests that an outsider not only comes with a fresh perspective to challenge the status quo but also has the advantage of a critical 90- or 100-day honeymoon in which to effect change. During this grace period, this individual enjoys more influence, attention, and decision-making sway than would a supply chain incumbent. However, the outside leader still must have a foundation in the supply chain basics, a relentless focus on cash generation, a willingness to make and stick to tough decisions, a sense of urgency, and an appreciation that underperforming supply chains must first be stabilized before being optimized.
The composition of the supporting team must reflect the challenges facing the supply chain in question. At the top of the list is representation from the finance department. Many underperforming supply chains are part of financially distressed organizations that require close attention to financial alternatives, investments, and liquidity needs. Even when access to cash is not a hurdle, demonstrating fiscal control will still prove essential. Next on the list is having a customer-service envoy. It's critical to have a prominent voice to interpret and balance upstream supplier constraints and internal capabilities with customers' requirements. The third and most obvious element is supply chain knowledge. The savvy leader will involve key players from the supply chain organization.
The second element is the need for comprehensive, credible, and accessible data—the fact-set upon which decisions will be made. Resourceful managers often must construct adequate baselines on imperfect data. So the improvement team's first job should be to decide how to compensate for likely data deficiencies. The trick is to gauge the amount of effort appropriate for collecting data. That means not trying to collect all available data going back as far as records have been kept. The best approach is to try to create a baseline that, at a minimum, captures discrete data points over no less than six months and no more than 18 months (unless there is a compelling business reason to do otherwise). Quantitatively oriented individuals will always prefer more detail and greater specificity. However, the time and effort necessary to reach this level is more than offset by the speed of decisions and rapid results obtained from only using a stripped-down view of key data points.
The data points include active SKUs by relative volume; major product flow paths and associated costs per unit; seasonality or at least peak-to-average ratios (in the retail sector, this can become a significant undertaking); geographic demand points with relative growth rates; profiles of major supply chain participants such as carriers and 3PLs; upcoming changes (new product introductions, gain or loss of an account, site opening/closings, recalls, and so forth); and market value for major supply chain investments.
The third fundamental for improving underperforming supply chains centers on clarity of objectives. In particular, successful turnaround programs have objectives that focus squarely on near-term cash generation. Clear cash-generation objectives form the underpinnings of a successful turnaround program. These programs demonstrate a compelling balance between incremental effort (of which time is a component) and specific, measurable benefits. They include practical, high-impact thrusts that have quick benefits and conspicuously demonstrate both progress and self-sufficiency. Initiating a series of quick gains signals a change and builds or restores confidence in the supply chain organization, giving its members license to make subsequent improvement investments. It also generates cash that can be reinvested in the next project or employed for other business needs. And perhaps most importantly, it generates momentum and boosts morale for employees who have lived through difficult circumstances.
Why is cash generation so important? Simple: Distressed organizations need it and cannot afford to take many long shots. Even in organizations with troubled supply chains and liquid balance sheets, the cash is often used to mask or compensate for the poor performance rather than to address the underlying problems. Over time, both these types of organizations begin to look more and more alike!
Five High-Impact LeversClearly, every underperforming supply chain is unique, requiring a tailored approach to meet its business goals. But we have found that there are five improvement steps that are highly effective in repairing those supply chains. Applied individually or in systematic combinations, they can produce substantial short-term gains and restore a platform of stability. Let's review each one.
1. Set Appropriate Service LevelsMany substandard supply chains are chasing service levels that they can no longer afford to support. In such situations, avoid spending on service that does not provide a demonstrable business return. Fortunately, there are almost always areas where service can be reduced with little or no impact on the customer. For instance, Domino's Pizza no longer "guarantees" delivery within 30 minutes, yet the company is still viewed as the industry leader in fast delivery service. Similarly, major U.S. airlines have backed off efforts to be "first in on-time arrivals" and have refocused on avoiding being in the bottom third of performers. The reason: Studies have shown that being at the top is not nearly as important as avoiding a ranking near the bottom.
But be prepared for fierce resistance from your sales and marketing teams. They are conditioned to offer more and better service levels to all customers all the time. Customers are always asking for more, and competitors are always offering more. When it comes to determining the proper investment in service performance, the challenge for supply chain improvement teams is threefold: 1) clearly understand how "service" is positioned within the company's overall business strategy, 2) understand the costs of each component of your service offering, and 3) know each customer's needs in enough detail to avoid spending on services that are not valued.
A good place to start is with service-level objectives. Does the company's strategic objective require industry norms for service offerings? Or is service the core element that will set the company apart from all others in its market? Once the service objectives are clear, the company can establish appropriate offerings and identify the supply chain approach. At Wal-Mart, for instance, the emphasis is on value for money, not premium service. On the other hand, Lowes invests heavily in sales-floor associates, product specialists, and project planners because service is viewed as a key differentiator. Neither Wal-Mart nor Lowes spends unnecessarily on its service objectives.
Once the strategic elements are known, understand the total cost of your service programs. There is little room for wasted investments, so knowing both your costs and how your customers perceive your service offerings is critical in determining spending levels. We find that companies typically show three weaknesses: unrealistically high goals, imperfect measures to track service, and no business case to support specific service levels. Customer service must be actively managed as a portfolio of ever-changing offerings based on solid intelligence of both cost and customer feedback.
We think of customer service risk in terms of the phrase "only and exactly." Customers want "only and exactly" what they want. Anything more is wasteful; anything less is poor service. A monolithic approach to service means that all customers are offered everything in the service portfolio, and customer-service costs consequently spiral out of control. By segmenting customers according to their needs and truly understanding those needs, service can be matched much more closely to overall business goals.
2. Convert Unproductive Inventory into CashFor many producers, better management of inventory can be a highly productive area for gains. Identifying and disposing of excess inventory can have quick and positive effects. Proven techniques that can be applied here include consolidating inventory-stocking points, discontinuing an item, and shifting a product from make-to-stock to make-to-order and in the process, deferring raw material costs and rebalancing leadtimes.
Consider the case of a process-industry manufacturer where long product lead times were the norm. An executive mandate to grow the business sparked a sustained inventory build. The key metric under examination became net sales. Costs to deliver the goods were equated with asset utilization—again favoring high output. Highly skilled and knowledgeable operations practitioners watched in disbelief as inventory swelled to meet the demand that was promised to be just around the corner, while their orders called on them to keep lines working near full practical capacity. After 18 months, the damage was done.
With bloated inventory levels and a declining top line, the board of this manufacturer challenged the strategy that had created the situation. A review of the financials highlighted the largest controllable problem: inventory. Senior management got the message loud and clear and set about rectifying matters as quickly as possible without impeding the remaining business. As a first step, finished-goods days of sales were recalculated based on the on-hand levels using a simple, six-month rolling rate of demand. (Exhibit 2 shows the picture that emerged indicating finished goods with well over a year on hand. In the exhibit, each line represents one finished-goods item.)
Transportation seems to be on everyone's mind these days. With near-record fuel costs, a general shortage of drivers, regional capacity shortages, and continuing debate over the U.S. Department of Transportation rules about truckers' hours of service, many shippers have resigned themselves to paying premium costs and high accessorial charges as a matter of doing business.
But even under such conditions, a closer look at transportation practices can uncover potential savings or even cost avoidances. Several areas can be rich sources of potential gains: the range of carriers used, variations in lane costs, application of accessorials, basic network configurations, and freight-payment processes, for example.
In one shipper case example, the company's highly decentralized managerial structure led to enormous variations in carrier costs. The company had many facilities nationwide, and transportation management functions all over the United States. But there was little coordination between regions, leading to highly variable lane rates. An analysis of the situation revealed huge cost differences in truckload lane rates between two relatively close metropolitan areas: Charlotte, N.C., and Atlanta.
This analysis uncovered a roughly three-time difference in cost between the low-cost and high-cost carriers on this lane. It also showed that eight separate providers were in use, with the most commonly engaged carrier being two-and-a-half times more expensive than lowest-cost alternative. When discussing the situation with the company's senior transportation manager, several factors became clear: the data necessary to construct this view was difficult to collect and maintain, the manager's local chain of command was far more concerned with service levels than with cost, and the lower-cost carriers were chosen when they had equipment available on a short lead-time basis. No attempt was made to preconfigure shipment routings for higher availability of the low-cost carriers. Further, because of the large number of lanes to manage, relatively little effort was directed at carrier negotiations.
In this situation, many transportation specialists might be tempted to prescribe a core-carrier program. But that is not at all appropriate for fixing a distressed supply chain. A broad, all-encompassing program (all geographies, all modalities, all carriers, all locations) can consume a great deal of time and will rely heavily on large teams and supporting technology. Moreover, financial results won't show up for well over six months.
Rather in this example, the important step was to prioritize the few, highest-leverage sites and to focus exclusively on the areas of opportunity that would produce the greatest benefits fastest. Since lane optimization is localized by nature, it lends itself to replication at other sites (especially in environments where transportation management is decentralized). While it is true that some duplication of effort is possible when and if a broader core carrier program is launched, the benefits of early cash and operational gains are too compelling to ignore.
Additional benefits of this approach include: learning intimate operational details and unique service requirements at a granular level, better preparation for a future core carrier program, and identifying the hidden "stars" within the transportation community whose early engagement will further ensure success.
4. Quickly Decide What to Outsource (and What to Keep In-House)Today, companies can easily find competitive and highly capable third-party providers for some or all of the supply chain activities being done in house. When considering outsourcing, however, don't just look at one, rolled-up cost for outsourcing, also look at the cost of outsourcing each discrete component. Furthermore, supply chain conditions are continually changing, so it is important to perform this analysis again as conditions change.
Take the example of a national distributor that was considering outsourcing its outbound supply chain activities. Outsourcing the bulk of these functions to best-priced 3PLs promised a 22 percent savings over the budget numbers for the distributor's in-house strategy. (See Exhibit 3.) But by charting out the relative costs of the different components—warehousing compensation, outbound freight, general and administrative expenses, occupancy, and maintenance—the company was able to see an even greater advantage in selecting only a few of those activities for outsourcing. Specifically, it exploited the largest portion of available gains by outsourcing just the warehousing activities (which yielded savings of 40 percent) and the outbound freight function (which produced almost 10 percent savings). (See Exhibit 3.)
A final note on outsourcing: The most successful outsourcing arrangements come about when stable operations are being transitioned to capable and experienced providers. If the activities to be outsourced are out-of-control, you risk having a for-profit logistics provider become your supply chain's "Mr. Fix-It." That typically results in a high-cost outsourcing arrangement that does not live up to anyone's expectations. The lesson is: Outsource steady-state operations, not problems you have not yet fixed.
5. Drive Quick Efficiency Gains in the WarehouseSupply chains are often modeled as a series of nodes (warehouses) and links (lanes) that extend from points of origin to ultimate destinations. The variable operating costs and fixed investments of the nodes that we call "warehouses" can be staggering. In a multi-warehouse network, there are bound to be variations in performance. These can be attributable to local labor costs, scope of operations, and management effectiveness, among many other factors.
Quick gains are often possible by identifying and contrasting major cost drivers. While it may not be practical to take a worst-performing site and drive a step-change improvement, it may be possible to do one or more of the following: focus on localized performance enhancement, relocate work from one site to a more preferable one, use unacceptable performance levels as a negotiation lever, or just create positive competition between locations of the same network.
Here's a quick-gain example: A major distributor inherited many new facilities following an aggressive regional acquisition campaign. But the integration process became complicated: wide variations in operating practices, work ethics, warehouse management system utilization, and product assortment soon began to hurt overall performance and call into question the strategy on which the acquisition program was based. Exhibit 4 shows the huge variations in receiving cost per case among operating locations. Other analyses showed similar cost variations for case selection, case loading, and various other major cost drivers.
Armed with this information, the supply chain operator fashioned an improvement program that was targeted at high-cost locations with high activity volumes to quickly bring about large gains. Four groups—SWAT teams, in effect—worked in parallel with the locations that presented the greatest opportunities and quickly drove down outlying costs to suitable levels before moving on to the next highest opportunity area. This cost-driven prioritization formed a stabilized foundation for subsequent improvement activities and ultimately was used to fund the selection and implementation of a new warehouse management system.
Go for the "Base Hits"
When supply chain performance has deteriorated to the point of distress, the steps toward successful and sustained recovery are precise: assemble a strong team to drive the improvement program, collect only enough data to support the key decisions, and focus on near-term, cash-generating activities.
The ideal projects focus on high-leverage, operational areas—"base hits," if you like. That means focusing efforts on target areas that affect cash flows and stabilize pain points. We have never witnessed (nor even heard of) a grand enterprise-wide supply chain transformation project or major systems solution implementation that has succeeded in turning around a substandard supply chain. To continue the analogy, it's better to focus on getting players on base and in scoring position rather than on having heavy hitters swing for the bleachers at every pitch.
A key milestone has been reached when you've re-established the stability of the supply chain. When you can say with certainty that your supply chain now fully supports the needs of the business and performs at a cost and capital investment that is consistent with strategic objectives.
One final thought: Let everyone know about the turnaround plan! While progress may seem agonizingly slow—and meet with resistance at every turn—it is very helpful if the project's kickoff gets plenty of fanfare. It marks that a commitment has been made and a major repair effort has begun. And it creates self-reinforcing expectations and conveys the required sense of urgency —that is worthwhile all by itself.
| Author Information |
| Foster Finley and Chap Kistler are directors in the Performance Improvement Practice of AlixPartners LLC. |
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