Also interested to have Bram as a speaker on your event? YES!

In his foreword to my book and in earlier linkedin posts, Frank Vorrath, talks about the evolution towards a supply chain ecosystem. The idea was initially launched by Prof Martin Christopher from Cranfield University that we are no longer competing companies against companies, but as supply chains, as networks of companies creating a supply chain ecosystem. When linking that to our book “Supply Chain Strategy and Financial Metrics” it triggers the obvious question whether our triangle still holds in the supply chain ecosystem?

Within the company boundaries, the supply chain triangle captures the suboptimal results generated by functional KPIs. Purchasing may source in the Far East to lower cost but ignore the impact on inventory. Marketing may expand the product portfolio to boost sales but ignore the impact on cost or inventory.

The same holds true across company boundaries. Many companies have improved their working capital by increasing the payment terms of key suppliers, which is simply shifting the burden to the suppliers. In a bid to keep inventories low, many distributors demand short lead times and high availability from their key suppliers, again shifting the burden upstream in the supply chain. In many traditional supply chains each of the partners will try to optimize their own supply chain triangle and try to shift the burden either upstream or downstream. It is a battle in which the dominant partner wins.

Within company boundaries the triangle learns us that instead of fighting each other, different departments should evaluate the impact on the shareholder value as measured by the ROCE. If sourcing in the Far East is improving ROCE it should be done, if a line extension is improving ROCE it should be done as well.

Likewise, if we want to optimize across company boundaries, we should have a metric that captures the value generated in the network. This could be the network ROCE. Companies should look at the Supply Chain Ecosystem Triangle instead of managing their individual triangles.

Instead of focusing on the On Time In Full delivery performance of a supplier towards its distributors, it is more relevant to look at the product availability at the distributor and his OTIF performance towards the final customer. Maybe I didn’t deliver on time or in the requested quantity but as long as there is no shortage at the end of the chain there is no issue. If I am willing to relax the heavy constraints on the timing and the quantity of the delivery upstream in the chain, I create opportunities to better synchronize shipping with production or to better consolidate my freight before the actual shipping. Just as an example, Vendor Managed Inventory takes advantage of exactly this opportunity. By relaxing some of the internal constraints we can optimize the value generated in the network.

The challenge of VMI or other types of supply chain collaboration may be that the benefits are not equally distributed. In the case of VMI the benefits may be primarily on the supplier’s side. If it is to work, part of the benefits will need to be shared within the network. That remains the result of a negotiation, but starting from a different perspective, being “which value can we generate within the network” or “how can we improve the network ROCE”?

In summary we believe the triangle remains valid when looking at the supply chain ecosystem. Instead of optimizing our individual triangles we should focus on optimizing the value generated in the network as measured by the network ROCE. If we want the collaboration to be sustained, we’ll have to share the benefits throughout the network.

Another question is whether the companies in a supply chain ecosystem need to follow the same strategy. Read more about that in the following recent blog.

In an earlier blog we have already analyzed that different strategies lead to different supply chains and that supply chain is often mistaken for operational excellence or lowest cost only. In this we analyze whether all partners in a Supply Chain Ecosystem share the same strategy. Why? Or why not?

Within the company boundaries we have shown that strategy defines the balance in the supply chain triangle. Different strategies are in fact different routes to generate the same ROCE. If I am a lowest price player, I’ll need to have the lowest cost. To have to lowest cost I will ban complexity. I will not carry a long tail of products as these cannibalize on my efficiency and efficiency means cost. As a result I will have less inventory and be able to put my assets at a higher use or in general work with less assets. A lowest price player will work with minimal margins but will compensate for that by employing less capital. If I differentiate, for instance by having the best total solution, a customer intimacy strategy, for sure I will have a long tail and need more inventory. As an investor I’m indifferent as long as you compensate for that with a higher EBIT. The challenge for the customer intimacy player is to drive a premium from his customers which compensates both the higher cost and the higher capital employed generated by the extra complexity.

When taking strategy across the company boundaries, if I am a product leader, should my suppliers be product leaders as well? Well, it depends. Kraljic has taught us we need to segment suppliers according to ‘how important is the supplier to me’ and ‘how important am I to the supplier’? Part of my spend may be on commoditized product with many alternatives. In this case I will go for the lowest cost, and the supplier will add value by having the lowest price, matching with an operational excellence strategy. On the other hand, if I want to have the newest, the latest and the highest specification product, I will need to work with some suppliers that have the newest, the latest and the highest specification raw materials or components. I will not be able to realize my product leadership strategy without having key suppliers that follow the same product leadership strategy. These suppliers are more unique and harder to replace. As a result they will be a firmer part of our supply chain ecosystem.

The same holds true on the customer side. Not all of my customers will have the same willingness to innovate. Some may still try to buy from me based on price instead of product quality or performance. I may want to keep some of these customers as they bring volume to the business. Just like I do a supplier segmentation, I need to do a customer segmentation. I will more deeply connect into customers following the same strategy. The ties with other customers will be more transactional and more opportunistic. In the given example, as soon as I no longer need the price-buyers I will drop them, as they will drop me as soon as they get a better deal elsewhere.

So in summary, our supply chain ecosystem has the strongest connections with suppliers and customers following the same strategy. By sharing the same strategy and the same operating model, we reinforce our common position in the market. Our ecosystem will contain suppliers and customers with different strategies, but these connections will be more opportunistic and change as market conditions change. They deliver strength as they generate temporary value, but they are less important to our strategic positioning.

How much inventory do you really need? Companies try to answer in 2 ways: top-down and bottoms-up. In a top-down approach, we define an ‘overall’ target for our business unit, based on a benchmark, or based on last years’ performance. In a bottoms-up approach, we start by calculating per SKU-location what is the required safety stock, cycle stock, anticipation stock, strategic stock, and in-transit or work-in-process. By summing up across locations and across multiple echelons, we also come to the overall target. Do we need both? And how is strategy impacting these calculations?

In my book ‘Supply Chain Strategy and Financial Metrics’, I describe at length how strategy influences the financial targets and why benchmarking should be done in 2 dimensions using so-called orbit charts. To have the lowest price in the market, the operational excellence players need to have the lowest cost, which in turn makes them cut complexity. They will not carry a long tail of products. They focus on the fast moving core which gives scale and efficiency. They may work at minimal margins, but they compensate for that by employing less capital. They have lower inventories and employ less assets, or stated differently, they will have a higher utilization rate. As explained in earlier white papers, customer intimacy players and product leaders add complexity and as a result require more inventory, which from a ROCE perspective is fine, as long as they can drive a higher premium from their customers and show a higher EBIT.

From a target setting perspective, the important conclusion is that as a product leader, I do not necessarily need to be the best in inventory turns. I know the operational excellence player will always have higher turns. As a product leader I need to be the best in gross profit. 2-dimensional benchmarking as explained in the book better reveals these strategic trade-offs. We also refer to an earlier blog for a more in depth discussion on how different strategies require different supply chains, and how these supply chains all require excellence, but with a different focus.

So do we need top-down target setting? The answer is yes, and you need to take control. If you don’t take control and do a proper top-down target setting, your CFO or your board of directors will. They may not account for the strategy and you may land yourself the target of the Operational Excellence player while being a Product Leader. This will cause both chaos and frustration.

Do we need bottoms-up target setting? The answer is yes. If your target for inventory turns is 3 and your actual inventory turns is 3, that does not ensure you have the right inventory balance. You may be carrying too much of some products and not enough of others. Calculating an inventory target per SKU-location is needed to monitor your ‘inventory health’ or your ‘inventory balance’.

How does strategy impact the bottoms-up calculation? As introduced above, the Operational Excellence player will focus on the fast moving core. The Customer Intimacy player, to be able to offer his “Best Total Solution”, will introduce a long tail of products. The long tail is slow moving, so the average inventory turns will go down. The Product Leader is focused on the “best product”. The complexity of the product leader is typically in the product itself. He has a more complex Bill of Material, may have a longer and more difficult production process, may be obliged to work with niche suppliers, will typically have a long tail in the raw material or component inventory. Instead of Make-To-Stock, the product leader is more likely working Make-To-Order. Customers may be willing to wait for his higher specification product. This shifts the inventory challenge from finished product to intermediates, raw materials and components.

Summarizing the impact of strategy on the bottoms-up calculation we may say that regardless of the strategy you will need to calculate safety stocks, lot sizes and the like. For Operational Excellence players it will be simple as they focus on the fast moving core, for Customer Intimacy players we will see a long tail of finished products, and for Product Leaders we will see a shift towards the intermediates, raw materials and components and manage a long tail over there.

So yes, we need both a top-down and a bottoms-up calculation. Make sure to take ownership of your top-down calculation or you may land either incremental or unrealistic targets. The bottoms-up is required to monitor inventory balance and depending on the strategy you may see a long tail on the finished products, or more focus on the intermediates, raw materials and components and a long tail there. Combining both will lead to more realistic targets and a better control.

Today at the ‘Dag van Inkoop & Logistiek’ of VIB in Antwerp, I came across Timmy Thijs, who is teamleader inventory management at Atlas Copco for the aftermarket operations. The challenges for managing aftermarket inventories are multiple, so I thought it was worthwhile listing some of them and linking them to the supply chain triangle.

Let me start by sharing some of my experiences with aftermarket inventories: they are slow movers, or even non-moving over longer periods of time. Many companies have automatic rules to write-off inventories based on when the inventory last moved, which makes spareparts a major cause of write-offs. Looking at the supply chain triangle, this implies they are heavy on the cash side of the triangle, and via the write-offs also weighing on the cost side of the triangle or the EBIT in the P&L. That easily makes them a thorn in the eye of the CFO or the BU president.

Cleaning up this inventory in general is a difficult and tedious process. As the inventory is moving slowly, any attempts to rightsize inventories, for instance by improving the calculations of inventory parameters like safety stocks, will take a lot of time, and may have a limited impact. Killing SKU’s and reducing the number of parts may be difficult, as throughout the years, sales has been promising high service and immediate response over a 10 to 15 year period. Many aftermarket supply chain managers are squeezed between the inventory reduction targets pushed by finance and the service promises made to key customers that seem to be cast in stone.

Is there a quick fix? Well the best I have seen is pushing sales to sell off part of the inventory. Much of it seems unsellable unless sales people start focusing on it. If you are manufacturing equipment, their primary drive will be selling the equipment. It will be hard to get to your target by selling off spares. If you want this to happen, it will have to be a top-down initiative and you may have to adapt bonus schemes. If you are in need to deliver short term benefits, try to get this running.

A second option might be trying to upsell new machinery, or even proposing customers switching to a newer product for free. If the aftermarket costs are excessive, the only way to stop the cost may be to create incentives for customers to switch to newer technologies.

While these two options help, it remains ‘after the facts’. The real fix, as often, is on the longer term. In my experiences, people selling equipment are after the quick money. If I need to promise some service to get an expensive machine sold there are little obstacles to do so. First the full ‘life-cycle cost’ is unknown so nobody will be challenged, second, the excessive cost of servicing the machine over a 15 year period, will only pop up only long after the sales person has moved on. There is work for aftermarket people to quantify and visualize the cost of service proposals and make sure they are accounted for in the evaluation of the margin of the sales proposals.

What will also help is the gradual shift to leasing models instead of purchasing models. Assume you’d lease the same machine to that same customer over a 15 year period. Would you make a fixed price contract for 15 years? Most probably not. Though in many cases it seems impossible to confront customers with the excessive cost of for instance keeping parts for 10-15 years in this world of fast changing technologies.

Linking this to the triangle, we could say that when selling the product, some of the life cycle effects such as expedited shipments and slow moving spare parts inventories are not taken into account, leading to an unfair judgment of the resulting margin over the resulting capital employed. As we’ve seen with other examples, for instance when talking about growth, it is not that the triangle doesn’t play in these circumstances, on the contrary, we should use the triangle to challenge the sales people and ensure we reveal the true life cycle margin over the true life cycle inventory or more generally capital employed.

3 questions to Timmy Thijs, teamleader inventory management at Atlas Copco, for the aftermarket operations

• Which elements of the above ‘aftermarket struggle’ do you recognize?

“For sure our organization also struggles with slow or non-moving aftermarket inventory and yes, this weighs on the cost side of the triangle, making it visible in management reports. Another struggle lies in the fact that 2 pillars in my team’s mission might seem conflicting. On one hand we have the service factor where part availability is key, on the other hand we have the inventory value which needs to be kept below target. Third attention point are our colleagues from Equipment, who continuously launch new innovative machines, which is a good thing, but increases the spare part portfolio and so the inventory level.”

• How have you tried to tackle them at Atlas Copco?

“We actively work on reducing our slow and non-moving stock, by investigating most optimal way forward. This is a time-consuming effort and should be evaluated continuously to which extent it makes sense to do so. Must admit we did realize good results by dedicating time to this.”

“Balancing part availability with inventory value is a continuous process, where it is key to adjust inventory parameters based on demand patterns and stage in the life cycle to avoid ending up with non-moving stock”

“Within our organization we also involve aftermarket in the design of new equipment, making sure new machines are not only easy to service, but also make use of existing parts to limit increase of the part portfolio.”

• Will you be using the concept of the supply chain triangle in the future and how?

“The fundamentals of the Supply Chain triangle are embedded in our group’s Vision and Mission. We are a customer focused, Product driven organization, securing high service, low cost and an optimal use of capital. Off course we need to keep focus and make sure all departments stay aligned. As there’s always a better way, we continuously try to improve our business and the concept of the Supply Chain triangle can assist us in that.”

SUPPLY CHAIN STRATEGY AND FINANCIAL METRICS DISCUSSION TOPICS INCLUDE:

• Which financial metrics to use and how to define targets
• How to account for ‘strategy’ and ‘complexity’ when setting targets for the supply chain
• Supply chain’s role in corporate vision and strategy development

About Vlerick Business School

Vlerick Business School is an international business school located at the heart of Europe and is ranked number 1 in the Benelux for Executive Educational Programs and 19 in Europe.
More than 7.250 executives from all regions and countries join the customized educational programs on Digital Transformation, Healthcare, Energy & Financial Services or Entrepeneurship & Innovation. For more information, visit https://www.vlerick.com/en.

SUPPLY CHAIN STRATEGY AND FINANCIAL METRICS DISCUSSION TOPICS INCLUDE:

• Which financial metrics to use and how to define targets
• How to account for ‘strategy’ and ‘complexity’ when setting targets for the supply chain
• Supply chain’s role in corporate vision and strategy development

About Intent Group

A senior network community with a wealth of experience who share insights on how to overcome challenges through bespoke forums on discussions.
Members include Total, Samsung, Heineken, Johnson & Johnson, Mars, Kimberly Clark, Campari, Kraft Heinze, John Lewis, Superdry, Mayflex, SC Johnson and many more!
For more information, visit their website https://www.intent-group.com/.

This blog discusses the impact of sustainability on strategy and the supply chain triangle. It is based on a discussion with Mathias Fahy, sustainability expert at MÖBIUS, a European management consultancy. Mathias was preparing a workshop on sustainability, for a technology company that historically qualifies as a true product leader (in the definition of Treacy & Wiersema). Discussion with Mathias was how to link sustainability to the supply chain triangle. In the end it was clear that sustainability not only links to the supply chain triangle, but also to strategy.

Starting point of the discussion was that current initiatives were focused on reducing the CO2 footprint by shifting cargo to slower transportation modes, for instance from air to sea. This was lowering the CO2 footprint, but also lowering the cost per m³. One of the issues was that slower transport modes are increasing the in transit inventory, and the inventory at destination, as safety stocks need to be increased. The company has strict inventory targets, leading to an obvious conflict in our supply chain triangle.

How to ‘solve’ the conflict? Well, the guiding metric in the triangle is the return on capital employed or ROCE. Questions to answer are: “What is the EBIT impact? What is the inventory (or more generally capital employed) impact? What is the resulting impact on ROCE?” If ROCE goes up, we should go with the decision, if ROCE goes down, we don’t.

While on the one hand the triangle helps in managing this type of discussion, the true conflict in this discussion is the conflict with the company strategy as a product leader. As discussed in a previous blog, as a product leader you need flexibility and adaptability (using SCOR terminology), and sea freight is bluntly conflicting with these objectives.

The discussions with the supply chain team were on which type of products would qualify for the modal shift. This would certainly need to be high volume, low value products, preferably with a stable demand. In the discussion with Mathias we added ‘a low number of engineering changes’ as an extra parameter. If there is a lot of changes to the product, you want to keep the supply chain short, to ensure a fast time-to-market. Adding up these criteria would provide a good fit for an operational excellence company, but the intersection might be empty at a product leader.

So how could a product leader then work on sustainability? Our belief grew that we need to look for options that, on the one hand reduce CO2 footprint, but at the same time reinforce the core strategic positioning of the company. An example for a product leader might be going to regional manufacturing, as opposed to centralizing into a single manufacturing plant. Local sourcing and manufacturing will reduce CO2 and reduce customer order lead time.

One of the examples discussed was to have a local assemble-to-order on different continents, whereas some of that was currently done in only 1 central location. The reason we don’t easily come up with this solution, is because it increases cost … but that should not necessarily be an issue. If it reinforces our strategy, the question becomes ‘what extra value does a shorter time to market generate’? If we can do a local assemble-to-order instead of flying stuff in, we can probably shorten the lead time with 1 week, and more easily offer a broader product portfolio. What are customers willing to pay for this? What will be the impact on sales volume? What will be the impact on the sales price? Yes, as supply chain we’ll need to involve sales in the discussion, which is not necessarily our favourite, but this type of ‘strategy-reinforcing’ initiatives, across sales and operations, may drive much more CO2 reduction and value creation compared to seemingly ‘easier’ initiatives.

As a product leader, branding is important. We might use the CO2 reduction to enhance the branding of our product. Giving a green edge to our products, could enhance the perceived value, and as such boost volumes and margins.

In summary, as a product leader, you might not be looking for a modal shift but for regional sourcing and production when trying to reduce your CO2 footprint. More generally, when thinking about sustainability or reducing CO2 footprint, look for initiatives that reinforce your core strategic positioning. That may be modal shift for an operational excellence player, but it could be different for a product leader. So yes, you’ll need the triangle to balance the impact of service, cost and cash when evaluating sustainability initiatives, but make sure to watch the strategy impact. The strategy impact may indicate ‘where is the real value’ and ‘how to ensure adoption’.

Last week I had the opportunity to introduce the key concepts of my book “Supply Chain Strategy and Financial Metrics” to a group of senior production managers in the Netherlands. When I introduce strategy using the model of Treacy & Wiersema, time and again I get the question whether supply chain is more important if your strategy is operational excellence. The answer is NO. Every strategy deserves an excellent supply chain. The focus of that supply chain will be different though, as will be its level of cost, working capital and fixed assets.

Think about which type of supply chain a product leader requires. Think about Apple launching the iWatch. How many pieces are you going to sell? You can easily be off by a factor 10. As such, before all, the supply chain of a product leader will require upward/downward flexibility and adaptability (using some SCOR terminology). That flexibility and adaptability will increase the cost, and will increase the assets significantly over that of the operational excellence player. Some people will argue that Apple has outsourced its manufacturing exactly for that reason. Well don’t be fooled, that makes Apple’s suppliers part of its supply chain. They will need to deliver exactly that type of flexibility and adaptability. In summary, the key objectives of the product leader supply chain will be about ‘scalability’ and a short ‘time-to-market’. To excel, a product leader will need an excellent supply chain, delivering these promises to its customers.

So why would we think supply chain is more important if our strategy is operational excellence? This is based on a monumental misunderstanding. The problem is that we mistake supply chain for cost and efficiency. As supply chain professionals, we’ve been raised with that mantra and beaten with that stick. If your strategy is operational excellence, then indeed the focus of your supply chain will be on cost and efficiency. Operational excellence is about having the lowest price in the market, and you can only get to the lowest price by getting to the lowest cost first. But why is nobody mentioning that product management, or marketing and sales are focused on lowest cost and efficiency in this case as well? Or why do we have the urge to state that the supply chain of a product leader needs to create agility but always at the lowest possible cost, while again not mentioning R&D should develop the newest and the best but also at the lowest possible cost? We should stop the confusion that supply chain equals cost and efficiency. Not supply chain, but operational excellence equals cost and efficiency, and for all functions, not just for the supply chain!

And what about the supply chain of the customer intimacy players? To deliver their “best total solution”, for sure they will carry a broader product portfolio. As a result the supply chain will need to be excellent in managing a long tail of slower moving products, by using enhanced forecasting and inventory management systems, but also by closely watching and monitoring SKU contributions and product portfolio health. Another element in the customer intimacy supply chain may be “staging” operations where multiple inputs need to come together, either at the customer site, or at a forward stocking point. Again, a customer intimacy player will require an excellent supply chain that knows how to ‘bring it all together’ and ‘make the magic happen’ when it delivers, installs and services its best total solution at the customers’ site. Carrying a long tail of products will require more inventory. More complex customer logistics for sure will carry a higher cost. The excellence for a customer intimacy player is in delivering complex solutions, better than any competitor. The customer intimacy player will require an excellent supply chain for that, but that will not necessarily be measured in terms of cost and efficiency.

In summary, we believe companies mistake supply chain for cost and efficiency, where cost and efficiency is actually operational excellence, and where it holds for all functions, not just for supply chain. Every strategy requires an excellent supply chain. For a product leader the excellence is shown in time-to-market and scalability. For a customer intimacy player the excellence is shown in delivering, installing, operating and servicing complex solutions better than any competitor. Oh, and yes, for an opex player, we need excellence in cost and efficiency, in the supply chain, but in all other key functions as well. The conclusion is that supply chain is about more than cost and efficiency. It is a key part of the operating model supporting the chosen strategy. Its key focus will depend on that chosen strategy.