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October 25, 2014
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Strategy

Seven signs your supply chain needs a redesign

Because supply chain redesigns are expensive and time-consuming, they often get deferred. But if your company shows any of these warning signs, then you probably can't afford to put it off any longer.

A supply chain redesign is the type of project that often gets deferred, especially when budgets are tight. It is complex and time-consuming, and many organizations lack the needed skills and experience. Moreover, a thorough analysis may be expensive, which can be hard to justify in the current economic climate—even though in our experience, such analyses typically identify savings ranging from 12 percent to 20 percent of total warehousing and transport costs. In addition, it is difficult to determine before embarking on the project what benefits a supply chain redesign project will uncover.

These potential drawbacks deter many companies from initiating a supply chain redesign project. But there are times when a redesign deserves a higher priority. Here are seven signs that it's probably time to rethink your supply chain network, along with some ideas about alternative network configurations.

1. You have objectives rather than strategies. The first sign that it may be time for a redesign is that you are focused on supply chain objectives but lack a clear strategy.

Often objectives are derived by taking last year's cost metrics, like cost per case delivered, and reducing them by a few percent. What's more important, however, is how your group will achieve these objectives; in other words, what is your strategy? If your answer involves cheerleading speeches about "stretch goals" and hoping your team will execute more efficiently or effectively, then it's clear that you have objectives but no strategy.

Identifying a strategy everyone can agree on is important. That's because focusing the multiple functions on a single, universally agreed strategy is more likely to bring success than having the organization begin work on multiple, possibly conflicting, initiatives in parallel.

You and your group probably will have many ideas about what the strategy should be. But in order to effectively evaluate the various options, you should use supply chain design tools, also known as network modeling software. This software makes it possible for managers to model, simulate, and fine-tune many different supply chain strategies. Senior managers can then assess each one in terms of costs, benefits, and difficulty of execution. Once they have identified the workable strategies, they can prioritize which ones to implement first.

These network modeling tools are especially good for designing multi-echelon supply chains—that is, supply chains that comprise suppliers' warehouses, manufacturing plants, and central, regional, and local warehouses. Skilled users of the software can determine how many warehouses—and at which locations— will minimize total supply chain costs. (Note that you do need skilled users who can accurately estimate the costs of new transport lanes and warehouses in different regions.) In addition, the tools calculate the minimum total inventory investment needed for the new supply chain in light of lead times, required service levels, and forecast uncertainties. Good tools also identify the products that should be held only at the primary distribution center (DC) and those that should be stocked at both primary and secondary DCs.

There are many strategies these tools can assess, including those for managing seasonality, manufacturing, and sourcing, to name just a few.

Strategies for managing seasonality are relatively simple to assess. An important consideration is how best to manage the trade-off between building stock in advance of the peak sales season versus paying overtime for manufacturing to meet demand as it develops. Good tools also allow managers to compare the cost of temporary warehousing versus operating throughout much of the year with excess space. Another factor to model is the forecast accuracy for each product. It can be wiser to build inventory of seasonal products for which demand is more certain—that is, stock the products that you know will sell—rather than hold inventory of products that may or may not sell.

Supply chain design software can assess some manufacturing strategies, such as where manufacturing should place the customer-order decoupling point (the point in the manufacturing process where a customer's order rather than a forecast determines an activity). Such an analysis would allow you to compare the costs and delivery performance of late customization in the warehouse as well as make-to-order, assemble-to-order, or make-to-stock/pick-to-order manufacturing strategies.

Supply chain design tools can also help formulate global sourcing strategies and assess "make versus buy" decisions. Ideally, these decisions should not be left solely to the purchasing function. Instead, the supply chain organization should first ascertain the impact of sourcing decisions on such factors as lead times, inventory, and customer service levels, and then work with purchasing to determine the best decisions, taking all of those factors into account. Often, however, the supply chain and purchasing groups have been handed different objectives, which hinders collaboration. For example, purchasing earns bonuses for reducing the price per unit, while supply chain cares about total costs and delivery performance.

Supply chain design tools are very helpful in such situations. They can quickly assess the impact of purchasing decisions and produce accurate numbers that will lead to more productive discussions. Even better, the supply chain group can model suppliers' costs and look for ways to reduce them so that purchasing can then negotiate discounts. For example, perhaps your company could utilize existing backhaul opportunities to pick up a supplier's goods; this would reduce the supplier's costs and open the way for lower prices.

Good tools generate "pictures" that help you communicate your chosen supply chain strategy to senior managers and other department heads. When all the decision makers fully understand how certain choices will affect costs and operations, it becomes easier to align the company's strategy with your chosen supply chain strategy. It's critical, in fact, that those strategies be aligned lest the supply chain organization and the company end up following different—and therefore very costly—paths. Failure to align strategies can result in a situation such as the supply chain group consolidating two divisions' supply networks, only to discover later that the board is selling off one of those divisions.

2. People ask: Why do we do things this way? The second sign that it may be time for a redesign is that few people in your organization recall exactly why your company's warehouses are located where they are. It may mean that the current supply chain configuration is no longer fit for today's requirements.

Perhaps a number of years ago your predecessors designed your company's supply chain to optimize the supply of products for delivery to customers. Since then, both the product mix and the customer base have changed. Moreover, longstanding customers have probably relocated their inbound warehouses. The result: Your current supply chain design is no longer optimal for today's product range and ship-to locations.

Or maybe a senior manager asks, "Why are we shipping from high-labor-cost countries to low-labor-cost countries?" This may have made sense many years ago, when sales into low-labor-cost countries were relatively small. However, these economies have grown rapidly in recent years, and sales volumes may now be significant with the potential to increase.

Frequently things that should change often stay the same because managers tend to focus on short-term, monthly changes and miss the long-term, year-onyear trends. They also tend to apply established assumptions to new challenges. For instance, traditionally holding stock was expensive and transportation was cheap. These days, with fuel costs continually rising and the cost of capital and warehousing declining (at least for the time being), that assumption no longer holds.

It is time to test many long-accepted assumptions. Is it still better to purchase stock when it is required, or to hold stock? Is it appropriate to incur the higher costs of expedited delivery in order to reduce stockholding costs during a period when interest rates are low? Are the labor, transportation, and distribution costs at your manufacturing sites still the most advantageous for serving your current markets, or would it be more cost-effective to manufacture and/or distribute from neighboring countries?

3. The number of products and customers is growing faster than your budget. The third sign is that your budget is not growing as fast as your product range and customer base.

Budgets often are set as a percentage of company revenue or spend without understanding the effects of changing demand or supply profiles on supply chain costs. Consider this scenario: Every few weeks, the marketing or research and development staff comes trotting along, excitedly describing their latest product that's bound to be a best-seller. Similarly, the sales team is forever in the bar, celebrating winning yet another new customer. Meanwhile, your logistics team is stuck wondering how to handle the extra costs associated with the additional stock-keeping units (SKUs) and new customers, which weren't accounted for in their budget.

How to address this problem? A colleague once resorted to configuring his company's enterprise resource planning (ERP) system to allow only 25,000 products. Although this was a radical and perhaps crude solution, it at least forced the company's marketing department to think about dropping an existing product whenever a new one was launched.

Once again, modeling with supply chain network design software can help you foresee the cost and service impact of change. Managers can simulate how keeping or dropping particular customers and products will affect profits. Be prepared for some pushback when you present those figures, though. Marketing will argue that particular customers give you much of their business because your company supplies them with a low-volume, specialized product, so that product must stay in the catalog. They'll also argue that other customers have potential—perhaps because they are a high-growth business or the sales team has just won a foothold by offering a huge discount—and therefore the pricing for that customer cannot be changed. Regardless of the response your simulation elicits, remember that supply chain design tools generate accurate numbers that support a rational discussion.

4. Consolidation or collaboration is coming. An impending acquisition, collaboration with another company to share resources, or centralization of previously decentralized supply chain functions all suggest that a network redesign is probably in order.

Typically companies form merged, collaborative, or centralized supply chains with objectives such as achieving economies of scale in warehousing, better utilizing transport, and increasing freight purchasing power. Using supply chain network design software to perform a supply chain redesign before such a large strategic change will give companies a better sense of just how feasible these objectives are.

In a merger or acquisition, for example, the acquiring company sometimes pays too much because management overestimates the level of supply chain savings and efficiency improvements. Acquirers often justify paying a high acquisition premium because they expect that eliminating redundant supply chain functions will lead to a high level of savings. But in practice such rationalization can be difficult, largely because both parties have implemented different processes using different information systems. In such cases, supply chain network design software can develop a realistic estimate of the cost savings from merging companies' distribution chains.

Collaborative supply chains, in which unrelated and even competing companies share distribution and transportation resources, are generating some interest, particularly in Europe. Although the concept is an attractive one, to date only a handful of supply chain collaborations have been consummated. To succeed, both parties must understand their costs. Supply chain design tools are helpful for modeling collaborations because they enable both parties to understand their current costs, project how collaboration will affect their cost structure, and estimate their partners' costs.

Centralization of supply chain functions, often driven by a shift from country-based to regional management, is another common trigger for a network redesign. A good example of a regional approach can be seen in North America, where U.S. companies have long regarded that continent as a single market and manage their supply chains on that basis. In Europe, by contrast, it is really only in the last decade that companies began to replace the traditional nationally designed and managed supply chain functions with pan-European ones. That has required major shifts in transportation and distribution patterns. It's common nowadays for a European supply chain design to encompass manufacturing in China, importing via Rotterdam, a primary distribution center in the Benelux countries, and secondary DCs some distance away, in places like Spain, Northern Italy, or Romania. For a company to do this properly, it must first model its supply chain to determine the optimal location for manufacturing, primary DCs, and secondary DCs as well as transportation routes.

5. You experience a major service failure. An important customer has just called and expressed dissatisfaction concerning a service failure. If this is not the first time that problem has occurred, then you may have a systemic problem, and a redesign could help prevent it from happening again.

A common cause of supply chain service failures is a lack of robustness in supply chain design. Lean supply chains in particular can be fragile, as by definition there is little stock to buffer things going wrong.

This lack of redundancy or buffer stock can make it difficult for companies to manage variability, a situation that can also cause service failures. This is especially true when there is variability in multiple factors, such as demand levels, on-time delivery rates, and manufacturing uptime. You may not worry much when each individual factor's variability is a standard deviation away from the average levels you assumed when designing your supply chain. But if demand is higher than normal, suppliers' deliveries aren't as prompt as usual, and a critical production machine breaks down at the same time, then problems emerge.

Supply chain design tools can help simulate, to an extent, such variability in supply, production, and demand. Although the tool does not provide the solution to those problems, it enables managers to evaluate variability and assess the performance of their supply chains under real-life, rather than average, conditions.

It's also possible to assess the impact of solutions you could adopt to better manage variability. Examples of these solutions include postponement and late customization in the distribution center and other "to-order" strategies. Vendor-managed inventory or supplier-managed inventory can also be effective. Yet another option is to manufacture base products or components that enjoy stable demand and then locally customize, to order, each variant that experiences more variable demand.

6. Fear is in the air. Your company's own practices and processes are in good shape, yet the CEO is nervous. What's worrying him or her? The things the company can't control, like supply chain disruptions that will affect profits and investors' earnings. When that's the case, it's time for an assessment (or a reassessment) of potential risks to your supply chain and perhaps a network revision that will reduce the potential for disruption.

Conducting such an evaluation will require you to identify risk factors and assess each one's probability of occurrence and its likely impact. Having that information will focus management's attention on developing appropriate mitigation plans for the key risks.

Supply chain design tools can help managers to assess the impact of some, but not all, risk factors as well as to model mitigation plans. A simple example would be the impact of rising interest rates on inventory holding costs. If interest rates increase, then inventory holding costs also rise. To mitigate these increased costs, managers typically choose to hold less stock, but that could result in more frequent deliveries, which would drive up transportation costs. Good supply chain design tools will produce a model that optimizes both operating and inventory holding costs. From this model, managers can then estimate the total cost increase after they have partially mitigated the impact of rising interest rates.

To an extent, it is even possible to model natural disasters that close transportation lanes or nodes. Predicting the impact of something like the eruption of a volcano (think of Eyjafjallajökull in Iceland, which disrupted European air transport) is relatively easy. This is because alternative transport modes can still operate, although initially they will be constrained by capacity and time issues, and there are relatively few secondary impacts.

However, modeling the effects of a wider disaster is much harder because today's multitiered supply chains involve so many "layers" of suppliers and subcontractors, some of whom dominate their product niches. Consider the secondary impacts of the recent Japanese earthquake, tsunami, nuclear plant breakdowns, and power shortage. Few people knew, for instance, that the market for the resin that bonds microchips in smart phones is almost a duopoly between Mitsubishi Gas Chemical and Hitachi Chemical, both of whose plants were damaged. That is why the resulting slowdown in smart phone production came as a surprise to many buyers.

Supply chain design tools can evaluate most nodes of a multitiered inbound chain. They can assess, for example, whether it would be better to buy from two different sources of specialized components even though doing so will raise operating costs. Another option might be to negotiate something akin to an insurance policy, such as paying a premium for a guarantee of preferential treatment in the event that another supplier fails to perform. And if your company is a very important customer for one of your suppliers, then you may want to encourage that supplier to open a plant in a completely different geographic location in order to hedge against risk. To properly develop and evaluate these and similar solutions, procurement must understand the risks in the supply chain and the value of any mitigation strategy. Supply chain design tools help calculate both of those factors and communicate the results.

7. It's time to renew a third-party logistics contract. It is difficult to revise your supply chain when your company is tied into long-term contracts with third-party logistics (3PL) partners. Best practice, however, is to review your network design every three to five years, which tends to be in line with the length of third-party logistics contracts. Thus, about a year before a contract is scheduled for renewal is a good time to begin reconsidering your supply chain configuration. This gives you time to obtain support for change within the organization and to negotiate contracts for new lanes or locations.

A network review is also timely if you are putting a 3PL contract out to bid. In order to submit accurate bids, potential suppliers need forecasts of freight volumes and lanes, inventory volumes, and desired service levels. Supply chain design tools also consider that same type of information, and when the company's sales forecast is included, they can generate the forecasts that 3PL bidders require.

While your current network might be optimized to suit the 3PL's resources when the previous contract was signed, your incumbent 3PL may be unwilling to change to meet the proposed redesigned supply chain, or it might lack the infrastructure to provide a better solution. Hence, a planned network redesign may show managers that they should put the contract out for bid and seek other, more appropriate logistics service providers.

Why wait?
If suppliers always delivered on time, production always adhered to its plan, and customers always ordered what your forecasts said they would order, then supply chain management would be simple. But it is not, because business conditions and circumstances are constantly changing, therefore no company can afford to establish a supply chain network and simply assume that it will always be the optimal design.

Fear of the time and cost involved often encourages supply chain managers to postpone an evaluation and redesign. In practice, however, most such projects start with a quick estimate involving perhaps 20 days of work. This initial stage is a time for roughly assessing the potential for alternative designs and for determining that there is indeed a business case for changing your current configuration. The second step typically requires between 50 and 100 days to accurately calculate the cost of change and the potential reduction in supply chain costs.

Supply chain design tools are particularly versatile and are invaluable in performing the necessary assessments. For a wide variety of important issues, these tools provide insight and analysis where once only opinion prevailed. Now management can make better decisions that have been rigorously assessed and justified. Managers can assess the merits of multiple scenarios, knowing that they are comparing like with like. This is because supply chain design tools deliver an optimum solution for each scenario. This rigorous justification helps win over colleagues across the organization and thus speeds implementation of the new supply chain configuration.

Simon Bragg is a principal with the consulting firm SCi3. Richard Stone is a principal with the consulting firm SCi3. Julian van Geersdaele is a principal with the consulting firm SCi3.

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