We just lived through a major supply chain disruption which forced business leaders to make very hard choices on tight timelines. Managers who prepared in advance quickly went on the offensive and seized the opportunity to grow their profitability and strengthen their competitive positioning. Those who failed to prepare were forced into a defensive posture and experienced serious losses that were tragically avoidable.
Three cornerstone elements make all the difference between disruption success and rapid failure.
- Know your profit segments;
- Develop and regularly update your supply chain disruption response strategy and playbook;
- Identify your points of potential disruption exposure, and act quickly when needed.
This is an urgent priority: a recent McKinsey study estimated that a typical company will experience a major supply chain disruption lasting one month or more every three or four years.
Supply chain disruptions are complex and affect your whole company. Astute managers decide in advance which customers and products are critical to support and grow, and what pricing to offer to maximize their immediate and long-term profitability. This is particularly difficult because many companies have a six-to-18-month lead time for raw materials in the second and third tier of their supply chain, which necessitates acting quickly and decisively to protect critical flows and prioritize their increasingly scarce resources. Moreover, disruption response programs often must be developed and integrated with broad repositioning programs like relocating factories from one country to another in light of long-term tariff and labor shifts.
On the other hand, supply chain disruptions offer rare opportunities to develop and lock in lasting profit increases and long-term strategic gains. For example, recent studies have shown that products launched during recessions get a head start on the competition, and are more likely to survive to maturity. Similarly, supply chain shortages offer critical opportunities to direct product allocations to secure and grow your best customer segments; to use the offer of full product allocations to reduce the operating costs of your profit-draining customers, turning them into high-profit producers; and to target and capture your competitors’ best customers.
Know Your Profit Segments
The starting point of an effective supply chain disruption program is to develop a granular understanding of the profitability of your customers and products. While much has been written about how to build supply chain resilience, the next critical step is to specify the precise customers and products for whom resilience produces the highest returns on your increasingly scarce resources.
An Enterprise Profit Management solution (EPM) – a SaaS system which creates a full, all-in P&L on literally every transaction (every invoice line, based on precise information pulled directly from a company’s general ledger) – provides the critical financial information that managers need for their supply chain disruption program and can be configured in a few weeks.
Over years of experience with EPM, we have found that virtually all companies have a characteristic pattern of profit segmentation:
- Profit Peak customers – typically about 15% of the customers generate 150% of a company’s profits;
- Profit Drain customers – typically about 20% of the customers erode about 50% of these profits; and
- Profit Desert customers – typically the remainder of the customers produce minimal profit but consume about 50% of a company’s resources.
EPM shows the all-in P&L details of literally every customer and product, enabling you to clearly see where your company is making money, where it is losing money, and why – the information that is essential for developing a high-impact, cost-effective supply chain disruption response program.
For example, a recent EPM analysis conducted by a very successful distributor showed the Profit Peak products bought by Profit Peak customers accounted for 32% of the company’s revenues and a whopping 167% of the company’s profits, while the Profit Drain products bought by Profit Drain customers accounted for a mere 9% of the revenues while eroding an amazing 49% of the profits.
In a very successful retailer, its EPM analysis showed that the company’s Profit Peak customers buying Profit Peak products in Profit Peak stores contributed fully 103% of the profits. Surprisingly, 28% of the order lines provided an amazing 250% of the profits, while 72% of the order lines eroded 150% of the profits.
This Enterprise Profit Management information enables you to make fast, effective decisions in the face of scarce supply.
Develop and Regularly Update your Specific Strategy and Playbook
The two keys to successfully developing and managing an effective supply chain disruption strategy are: (1) develop an appropriate strategy for each profit segment (peaks, drains, and deserts); and (2) prepare your strategy in advance so you can execute it quickly and decisively.
Profit Peaks. These are your most important customers – and potential customers. Even in good times, the most effective companies create a dedicated multi-functional tiger team specifically charged with nurturing and growing these critical customers. This team needs to work with each of these customers to develop a supply chain disruption response program well in advance of the need.
Supply chain disruptions provide an important opportunity to accelerate your relationship with each Profit Peak customer. The key is to offer full allocations of scarce products as an incentive to extend and grow the customer relationship often through integrative devices like vendor-managed inventory and product/service co-design.
A disruptive crisis is a critical time to target and capture your competitors’ Profit Peak customers as well. If your competitor has not utilized an Enterprise Profit Management system to identify and grow its key Profit Peak customers, these customers almost certainly will suffer from the competitor's comprehensive restricted supply policy and related service difficulties. In this crisis time, this competitor’s key customers will be especially open to changing suppliers in response to full product allocations and rapid, certain customer service.
The underlying key success factor is to profile your Profit Peak customers in advance, and to use the profile to target your competitor’s customers that are likely Profit Peaks with highly focused sales and marketing initiatives along with offers of full product allocation (remember that not all high-revenue prospects are Profit Peaks). This is especially productive because in times of supply chain disruption, companies typically reduce their overall sales and marketing spending by at least 10-15%, which effectively reduces your customer acquisition cost.
Profit Drains. In our experience, most Profit Drain customers do not have below-market pricing. Rather, they have above-average costs to serve. The key to success with these important but problematic customers is to create a dedicated tiger team (separate from your Profit Peak tiger team) that will profile these customers and identify each customer’s profit problem. Some problems, like chronic cherry picking and bargaining will be difficult and time-consuming to solve; others, like overly frequent ordering will be relatively easy and fast to change.
Here, the key is to be selective. Work closely with the customers with easily-fixable problems. In crisis times, many will be particularly open to changing minor practices like order patterns and product substitutions in exchange for full product allocations – quickly converting them into long-term Profit Peaks. Other Profit Drains simply will not change, even given the prospect of potentially increased product allocations. For these problematic customers, it is appropriate to set prices at compensatory levels, even with restricted product allocations.
Profit Deserts. A few Profit Desert customers, like promising development accounts and potential major accounts for whom you are a secondary or tertiary supplier, are important to nurture. These customers warrant full product allocations.
Most Profit Desert accounts, however, are numerous, small, and marginally profitable. The key to improvement is typically developing technology-enabled measures like self-service offerings, portals, and automated-response systems. These generally are costly and take a long time to develop. This segment – along with your Profit Drains that are not candidates for conversion to Profit Peaks – should bear the brunt of your product allocation restrictions, which will free up the resources that enable you to grow your Profit Peaks (including targeting and capturing your competitors’ Profit Peaks), and to reverse many of your Profit Drains.
Identify your Points of Potential Disruption Exposure and Act Quickly When Needed
Supply chain disruptions occur when a company experiences major supply-demand imbalances in a significant market. There are several characteristic causes of these challenging events, including:
- Difficulties obtaining critical inputs and production capacity. These can occur, for example, in volatile goods and services like transpacific shipping capacity shortages, or factory interruptions caused by natural events.
- Extended demand spikes relative to historical supply. For example, in many consumer product markets, viral marketing can cause rapid changes in product popularity that suppliers cannot fulfill.
- Interruptions in a rival’s supply caused by input shortages or plant problems. For example, in several industries, labor strikes will cause demand to shift to alternative providers that are not subject to the strike causing an extended supply-demand imbalance for the remaining providers.
- Regulatory changes that require lengthy adjustments. Recent investment and tariff changes affecting Asian suppliers, for example, have caused abrupt shifts in supply and plant locations.
- Product innovations or cancellations that cause abrupt shifts in demand. This is a common issue in technology industries where regular changes in product design cause associated shifts in accessory product demand.
These important causes of supply-demand imbalances are far broader than the simple supply gaps that most companies track. This requires a monitoring program which tracks the full range of potential disruptions.
Effective monitoring programs combine the relative profitability of key customers and products with the exposure to disruptive factors. First and foremost, it is crucial to track the availability of the at-risk products required by your Profit Peak customers, and by your Profit Drain customers that can be converted to Profit Peaks. The supply assigned to your non-critical customers can be balanced through allocations.
Importantly, the correct measure to customer service is whether you are keeping your promises – but you do not have to make the same promises to all customers. Thus, you can promise 100% of historical demand to your Profit Peak customers while promising, say, a supply equivalent to 80% of historical demand to your non-cooperating Profit Drain customers. As long as you keep both promises, you will provide perfect service.
An effective supply chain disruption response program requires the coordinated work of three departments: Sales/Marketing, Supply Chain Management, and Finance. The program has two phases.
In the first phase, the team determines the critical high-priority allocations that it must provide to its key customer profit segments based on the products that they consume. These must be protected at all costs.
Second, the team identifies a representative set of products needed by the high-priority customers, determines the relevant factors that have the potential to disrupt their supply chains, and establishes a monitoring process to detect the early onset of a potential disruption and trigger the allocation process.
Through this two-step process, your tri-partite team will position your company to respond rapidly and effectively to any upcoming supply chain disruption.
Enhance Profits and Take Share
Supply chain disruption response management is a discipline, not a meeting. Disruption events allow you to enhance your profits and take share – if you prepare in advance and act quickly. Importantly, post-disruption periods present critical opportunities to reflect, learn, and get better for next time.
Effective managers who understand that there will always be a next time will continuously accelerate their profitability and widen their lead.