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Deriving Benefit From Supply Chain Complexity

Complexity can be an important source of competitive advantage-- provided you know how to manage it.

PETER VICKERS AND ALEX KODARIN

lobalization has had a profound impact on the supply chains of many companies. To compete successfully, companies are using mergers, acquisitions, and joint ventures to achieve market penetration, product launches to combat the rise in commoditization, and outsourcing to keep costs down--all while improving levels of service to meet the growing expectations of customers. The result: supply chains that are growing increasingly complex, and straining under the extra weight. So should you pick up a saw and start hacking? Definitely not--that approach is too simplistic and potentially dangerous to the business. Why? In many cases, complexity is the source of competitive advantage. For example, a hard discount retailer may only stock 1,000 products, whereas a megastore may have up to 10,000, offering far superior consumer choice--but also requiring different supply chain management practices to ensure the right types and right numbers of product are in stock. Effective management of supply chain complexity is critical to the megastore's competitive differentiation. Companies with more mature supply chain practices manage their supply chain complexity better than less mature industry peers. They are able to reduce costs faster and achieve higher profit margins. This assessment is supported by a recent PRTM cross-industry survey on supply chain complexity management, which indicates that best-in-class companies manage

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the drivers of supply chain complexity in their industry better than the competition. What does good supply chain complexity management involve? It should be viewed as an ongoing, strategic activity that uses complexity to create competitive advantage where possible. At the same time, complexity that isn't considered key to competitive advantage should be eliminated. We've found from our work with clients that three steps are critical: set top-down targets for performance improvements, identify your key complexity drivers, and adopt the practices necessary to manage those drivers most effectively.

Set Targets for Performance Improvements Although most companies acknowledge the importance of managing supply chain complexity, many don't set consistent performance targets or monitor how well they're meeting them. According to our survey, less than 60% of participants said they use key performance indicators to monitor the effectiveness of supply chain management practices. To ensure successful supply chain complexity management, your senior management team needs to set targets for both managing advantageous complexity and reducing disadvantageous complexity. The team should base these targets on the kinds of improvements they want to see in top- and bottom-line performance.

© 2006 PRTM

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Consider the example of a company in the food manufacturing industry. Recognizing that service was a key source of competitive advantage, senior management set a target of 99.9% order fulfilment accuracy--a level of service that no other company that shipped directly to customers could offer. To achieve this goal, the company had to revisit the way it managed its number of ship-to locations, a key source of complexity for its supply chain. By leveraging a direct-store delivery capability it had honed over the years, the manufacturer was able to turn this source of complexity into a strategic advantage. The company implemented a completely automated order entry interface, making it easier to place and fill orders. By managing this key source of supply chain complexity better than anyone else, this manufacturer was able to achieve its best-in-class service targets and grow its top and bottom lines. Top management also needs to provide guidance when the complexity driver creates a strategic disadvantage. For example, while multiple sources of supply may be important for a product line in its growth stage, they may be detrimental as the product matures. In this situation, top management should set targets that will guide the company in reducing the number of suppliers--say, for products that yield margins of 25% or less, the number of suppliers of components should be reduced by 50%. Such targets will encourage those in charge of sourcing to make cuts in the supply base

and negotiate better prices with its remaining suppliers.

quantitative analysis of complexity driver data submitted by the participants has substantiated this finding.

Identify Your Key Complexity Drivers To realize your goals for performance improvement, then, you need to understand which drivers are important to manage. Complexity drivers can be grouped into three categories: Configuration and Structure, the physical network of the supply chain and the organizational structure used to manage it; Products and Services, the portfolio of offerings managed by the supply chain; and Processes and Systems, the processes and systems used to manage the supply chain. Within each of these areas, certain factors play a major role in creating complexity (Figure 1). The more variants there are of a particular driver--for example, the more distribution centers--the more complexity there is to manage. The predominant perception among participants in our survey was that the number of products and services a company has to manage is the single most important driver of complexity. Our Apply the Right Management Practices Once you've identified the critical drivers of complexity for your business, the next step is to adopt the practices you need to most effectively manage them. In some cases, this requires adopting a single practice to address a particular issue. For example, product portfolio management is useful for guarding against excessive product proliferation. More often than not, however, a true breakthrough in business performance requires applying several different complexity management practices across the three areas: configuration and structure, products and services, and processes and systems (Sidebar). A five-billion dollar global chemicals manufacturer, long known for its premium products and superior service, was suffering from eroding profits in its European operations because of commoditization and an increasingly crowded field of com-

Figure 1: The Drivers of Supply Chain Complexity

Configuration and Structure Products and Services Processes and Systems Number of suppliers Number of manufacturing locations Number of distribution channels Number of products/services Number of direct materials Supply chain processes and practices Supply chain organization Number of distribution centers Number of ship-to locations Number of customers Number of shipments Number of orders Manufacturing strategy Number of legacy information systems

© 2006 PRTM

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petitors. The company needed to address two related issues: excessive product proliferation and an overly complex supply chain. To meet the diverse needs of the European market, the manufacturer was accustomed to stocking a large number of language variants. All products were made to stock, regardless of volume, and were stored in each of the company's 26 European distribution centers (DCs). As a result, the supply chain was both inflexible and costly. To solve these problems, the company made important changes in the areas of configuration and structure, products and services, and processes and systems. These changes included consolidating the various DCs into one centralized center, rationalizing the product portfolio, adopting a postponement strategy for labeling some products, and designing a European supply chain organization. The results were significant. Total annual supply chain costs (including transportation, warehousing, and distribution) were reduced by several million, while inventory levels and the associated carrying costs were reduced by 50%. At the same time, the supply chain became more flexible and responsive to changing customer demands. And the company retained its position as a provider of premium products and superior service. High supply chain complexity and the costs that come with it are a fact of life for all companies, regardless of industry. For that reason, it's important to treat complex-

ity management as an ongoing effort that, like any strategic initiative, requires proactive updating as circumstances change. And, like any strategic initiative, you need to establish your targets and ensure they are communicated and reinforced often. Winning companies have learned how to manage the complexity drivers most important for their particular industry, and they've achieved better financial and supply chain performance as a result. As supply chain performance becomes an increasingly more important agenda item in the boardroom, this is knowledge you can't do without.

CONTACTS PRTM Principal Peter Vickers, at [email protected] or +33 (0) 1.56.68.30.30

Alex Kodarin, Vice President of Manufacturing, Weston Bakeries Limited at, [email protected] or +1 416.574.1788

© 2006 PRTM

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Sidebar

Supply Chain Complexity Survey Results

upply chain complexity has a major impact on financial and supply chain performance but can be managed with the right practices. This point is clearly supported by our Supply Chain Complexity Survey, conducted in 2004 and 2005 by The Performance Measurement Group, LLC (PMG), a PRTM benchmarking company. The survey, which was conducted in North America and Europe, included a total of 79 companies from the automotive and industrial, chemicals and energy, communications and electronics, consumer products, and pharmaceuticals industries. Each participant was categorized as either a "low-complexity" or "high-complexity" company vis-à-vis the overall benchmark population depending on the relative value of each of its complexity drivers. For example, a company with a certain geographical scope that used three distribution centers was classified as having low complexity, whereas a company with the same geographical scope but 15 distribution centers was classified as having high complexity. The survey demonstrated a strong correlation between supply chain complexity management and financial performance (Figure 1). We found that low-complexity companies manage supply chain complexity

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better: They deliver the same level of service as high-complexity companies, yet exhibit superior financial and supply chain performance, with a higher inventory turnover rate (49 days vs. 141) and a lower cost-of-goods-sold ratio (COGS/annual revenue). The study also found that while all complexity drivers are present in all industries, the ones to focus on vary from industry to industry (Figure 2). For example, the consumer goods industry has a great deal of complexity associated with product and SKU proliferation, but less complexity resulting from supplier proliferation. By contrast, the automotive industry is less susceptible to product proliferation complexity and much more susceptible to supplier proliferation complexity. And the number of ship-to locations and distribution centers are likely more important for a pharmaceutical company to manage than either SKU or supplier proliferation. Low-complexity companies employ supply chain complexity management practices much more than do high-complexity companies (Figure 3). According to our survey, low-complexity companies consistently made much greater use of 10 different supply chain complexity management practices than their high-complexity peers. For example, they

used product rationalization, a practice that helps to reduce the complexity resulting from product proliferation, twice as much. The implications of this study are unmistakable. Low-complexity companies have recognized the importance of complexity and manage it with practices suited to their particular environment--and achieve better financial and supply chain performance as a result.

--Peter Vickers and Alex Kodarin

© 2006 PRTM

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Figure 1: The Benefits of Managing Complexity

Companies that excel in supply chain complexity management achieve better financial and supply chain performance

Disadvantage Financial Performance · COGS as a percentage of revenue Supply Chain Performance · Inventory days of supply · Percentage of on-time delivery High-complexity companies 75 days 75% Low-complexity companies 51% Average or Median Advantage

Figure 2: The Importance of Drivers by Industry Sector

Average importance Above-average importance Very-high importance Average importance Above-average importance Number of customers Very-high importance

Number of products/services

Number of direct materials

Number of manufacturing locations

Number of suppliers

Number of distribution centers

Number of ship-to locations Automotive and industrial Pharmaceuticals and life sciences Consumer products

© 2006 PRTM

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Figure 3: Use of Supply Chain Management Practices

Dominant Use (Low vs. High) New product introduction process Product lifecycle management Product portfolio rationalization Transport and distribution network optimization Supplier rationalization Cost complexity management Lean manufacturing High-complexity companies Low-complexity companies

© 2006 PRTM

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