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Turn Supply Chain Inefficiencies into Concrete, Bottom-Line Dollar Value

by Paul Hofmann | SAPinsider

January 1, 2004

by Paul Hofmann, SAP SAPinsider - 2004 (Volume 5), January (Issue 1)
 

Nothing provides a concrete, objective view of your supply chain’s strengths and weaknesses like benchmarking your performance against the competition. But this is more than just an exercise in determining how your supply chain stacks up — it can also translate into significant, tangible savings. For example, did you realize that by taking your supply chain pulse and engineering your supply chain to top performance, you could reduce your inventory carrying costs by as much as 63%, adding a 1.7% revenue improvement to the bottom line?

A recent benchmarking study commissioned by SAP has already shown that SAP customers enjoy a net profit 75% better than the market average.1 But it also suggests that most companies can achieve even greater efficiencies. For instance, companies that have used mySAP Supply Chain Management (mySAP SCM) solutions to move to more advanced, mature supply chain practices — embracing processes that go beyond individual departments for integration inside and outside the enterprise — achieve higher levels of supply chain performance and measurable cost savings.

Before we explore the full implications of the benchmarking study, let’s take a look at the business value of performance measures.

Make the Connection Between Performance Measures and Cost Savings

Benchmarking against the market overall, as well as against best-in-class performers in your industry, requires key performance indicators (KPIs) that measure your business as a whole. Level 1 KPIs (like the Level 1 KPIs defined in the SCOR model2) define the basis of industry-wide comparison and help a company set business-wide performance targets that can be linked to the income statement, either directly or indirectly.

Some Level 1 KPIs that Directly Influence the Income Statement

  • Operating Margin

  • Return on Assets

  • SCM Costs (e.g., Inventory Carrying Costs)

  • Equity Ratio

  • Procurement Spend to Sales

  • Delivery Performance (e.g., Delivery to Request Date, or Delivery to Commit/Promised Date)

  • Order Fulfillment Lead Time (OFLT)

  • Cash-to-Cash Cycle Time

  • Inventory Days of Supply

  • Asset Turns

  • Strategic Supplier Count

  • Capacity Utilization

Internal (cost-relevant) Level 1 KPIs, like those listed in the sidebar at the right, typically reflect a dollar value (e.g., SCM Costs) or a ratio of values (e.g., Asset Turns). Customer-facing (revenue-relevant) KPIs are closely associated with a measure from which a dollar value can be derived. In the examples in the sidebar below, you’ll find indicators that, although at first glance do not elicit dollar value measures, still directly relate to a business’s income statement.

Two Examples of Customer-Facing KPIs that Significantly Impact Business Revenue

Delivery Performance

An improvement in Delivery Performance generally results in an increase of revenue. Experience and benchmarking studies tell us that a company will gain market share if it improves its service. Even if the market is shrinking, improving service is a sure strategy to gain market share.

Order Fulfillment Lead Time (OFLT)

Reducing OFLT may immediately reduce inventory. In general, there will be less holdup as WIP3 if you reduce your Order Fulfillment Lead Time; Little’s Law4 states this fact as a mathematical relationship based on some simple assumptions.

However, even if these assumptions don’t apply and reducing OFLT does not change the inventory level, faster order fulfillment still increases supply chain responsiveness and, as a result, revenue. For instance, reducing order backlog in a factory will lead to shorter OFLT and greater flexibility for changing the production schedule; production changes will, on average, be realized faster since there are fewer orders waiting in the pipeline. In a situation where a company must quickly bring a new product to market, gaining even a few extra days of response time can mean a lot of additional revenue.

What This Study Can Tell You About Your Supply Chain

The benchmarking study commissioned by SAP, conducted in 2002 and 2003 by the management consulting firm PRTM, shows that companies using mySAP SCM advanced planning functionality achieved superior overall business performance results, both in internal and customer-facing metrics. The study also looks further into the relationship between processes, systems, and business performance. According to this study, even with best practices in place, if you forego the advanced technology and solutions to automate, integrate, and enable those practices, you’re leaving something on the table.

The study evaluates the supply chain performance of more than 100 global SAP customers compared against the performance of the market.5 Then, for a more in-depth glimpse at supply chain performance of SAP customers, the study analyzes the performance of more than 60 SAP customer companies6 worldwide representing 75 supply chains.

  Note!
For some customer-facing Level 1 KPIs, the state of a company and industry will determine whether a change in KPI translates into real value. After all, in a market where demand is shrinking, increasing Capacity Utilization (i.e., increasing Asset Turns) won’t bring bottom-line value. Time gained in production can be used for training of personnel or maintenance of plants, but it elicits no “hard” value in this scenario.

In other words, while improving most Level 1 KPIs will lead to clear-cut, bottom-line benefits, don’t lose sight of market forces and your company’s performance requirements when determining your SCM strategy.

The study uses a balanced supply chain performance scorecard based on the SCOR model. The study also examines how the maturity of supply chain planning practices and enabling systems correlates with supply chain performance. “Mature” supply chain practices and systems were defined as those enabling integration within the extended enterprise and with external business partners — for example, sharing forecasts via the Internet or creating exchanges with customers and partners (see Figure 1). In addition to showing that mature SAP customers’ net profit averages 14% compared to the 8% market average (75% higher),7 the study also found that:

Figure 1
Stages of Maturity as Defined by the Benchmarking Study

  Across all planning functions, companies that have reached a high level of maturity enabled by SAP’s advanced planning solutions see an average 17% better On-Time Delivery Performance to Request Date and an average 7% better On-Time Delivery to Commit Date than companies using immature (e.g., Excel) or no supply chain planning practices and systems.8 According to a previous PRTM benchmarking study, a 17% increase in On-Time Delivery Performance to Request Date would lead to a 3.4% increase of revenue.

  These companies also show a more than 45% shorter Order Fulfillment Lead Time, enabling them to deliver products in a little over 4 days, compared to an average of 6 days for companies overall. According to Little’s Law (see the sidebar on the previous page), a 45% decrease in OFLT can lead to inventory reduction by as much as 45%.

  While the results clearly show the benefits of mature practices, the biggest gains to be made are when ensuring that mature systems support those practices (see Figure 2). When it comes to the Inventory Carrying Costs shown in Figure 2, the study also shows that the biggest factor in lowering these costs is reducing obsolescence.9

Figure 2
Example of How Mature Practices and Systems Together Boost Supply Chain Performance

When studying inventory costs, we can gather that rather than blindly reducing inventory levels across the board, mature companies are able to reduce their Inventory Carrying Costs by having the right inventory available at the right points along the supply chain.

For example, interchangeability10 is one approach to preventing obsolescent inventory and improving fill rates. Because a product can be substituted with a similar one (e.g., an 80GB hard disk can be chosen from a number of manufacturers), inventory across the various demand chains is used more efficiently and reduces the likelihood of “dead” items. Having all the information for product interchangeability on hand in real time during product allocation — finding the right inventory to fulfill an order in the various demand chains and allocating it according to customer priority — can only be realized with strong systems support, typically from an advanced optimizer.

Apply a Maturity Model to Optimize Supply Chain Practices and Systems the Right Way

This study took the innovative step of applying a maturity model in conjunction with benchmarking data. By analyzing both the performance and the level of advancement of your supply chain, you can improve your supply chain in two key ways:

  Take the Right Next Step in Aligning Business Processes with Enabling Systems

Consider a global company where demand planning data is only integrated within the systems at company headquarters (Stage 2 in the maturity model). However, demand/supply balancing is integrated and synchronized across all the company’s production sites worldwide and even, in some cases, performed in collaboration with main suppliers (Stage 3). Missing regional and market data and the lack of comprehensive forecasts will inevitably lead to error-ridden supply plans and incorrect demand data provided to suppliers, causing stock-outs and other serious problems across the entire supply chain. By first identifying and then aligning the maturity of practices and systems across the supply chain, a company can sidestep such problems.

  Identify Areas for Improvement in Supply Chain Architecture

Maturity models also facilitate strategic decisions about supply chain solutions and design. A supply chain may be very cost-efficient, but if its architecture is wrong, it can lack the flexibility and speed to succeed in today’s market. Supply chain design — a strategic make or buy decision, determining the number and location of warehouses, or choosing which IT systems best support supply chain operations — is the precursor to successful supply chain management.

We all know of the bullwhip effect: the further upstream a company is, the higher the demand volatility the company will face. On the other hand, industry clockspeed11 increases the further downstream a company is: a PC producer has a shorter product life cycle than the semiconductor manufacturer further up the supply chain. Inevitably, downstream companies are under greater pressure to shorten their product development times.

In response, companies can take one of two approaches: concurrent engineering (i.e., to design a product for optimal manufacturability) or modularization. Modularization reduces complexity and enables faster development. It also supports outsourcing, which can be a strategy for increased speed-to-market and faster technology innovation. But to realize the profits from this competitive advantage, you must establish collaboration with the outsourced suppliers and partners.

As in-house production of core components shifts to suppliers and partners, an internal, perhaps even informal, exchange of information and data must be transformed into a more formal one between customer and supplier. Extending enterprise collaboration like this relies on practices and systems that support exchange and coordination of information with suppliers and partners — moving your supply chain from maturity Stage 2 to Stage 3.

Manufacturers of complex medical imaging systems like magnetic resonance imaging (MRI) and computerized tomography (CT) have taken this step. With modularization, these companies have taken the highly complex computer system required to handle signal and image processing in their products and outsourced it to a supplier of those systems for the aerospace and defense (A&D) arena (spy planes and submarines). Now both the medical manufacturers and the A&D customers benefit from faster, profitable upgrades of the imaging technology developed by the supplier.

This is just one example of how, by integrating supply chain design with the product and manufacturing design processes, a manufacturer can benefit from innovation in other industries, achieve a faster time-to-market, and thus cope with fast industry clockspeed. Analysis using benchmarking and a maturity model helps you gain insight into your supply chain process to meet challenges like these.

Conclusion

The faster the supply chain changes, the more important supply chain design becomes. By combining benchmarking with a maturity model, you can devise intelligent reactions to supply chain changes and challenges and create an adaptive supply chain.12 If SAP solutions are already in place in your organization, you’re well on your way.

As a next step, benchmark your supply chain processes and follow a maturity model to progress to the next maturity level and phase of performance. Then look for the results in greater supply chain efficiencies and, ultimately, in the bottom line.

For more results of the benchmarking study, visit
www.sap.com/ solutions/scm/newsevents/index.asp?pressID=2425
. For details on participating in the SAP Supply Chain Planning Benchmarking Study, a service available to qualified SAP and non-SAP customers in the automotive, high-tech, consumer products, chemicals, pharmaceuticals, and mill products industries, please visit www.sap.com/solutions/scm/businessbenefits/benchmarking.asp.


1 According to the study “PRTM/SAP Benchmarking Study 2002-2003: Supply Chain Planning.” See further discussion later in the article.

2 SCOR is used as a cross-industry supply chain process reference model and was adopted by the Supply-Chain Council Inc. The SCOR model delineates three levels of KPIs: Level 1 KPIs measure overall business performance used for benchmarking studies, such as the one described here, and are the focus of this article. Level 2 KPIs measure performance of an individual division’s supply chain processes (e.g., plan, make, source, or deliver processes). Level 3 metrics are diagnostic KPIs taken at the process element level (e.g., Order Entry Cycle Time, Direct Labor Utilization). For more information on the SCOR model, see www.supply-chain.org.

3 Work in process.

4 Inventory = Output (product units/day) x Lead Time.

5 Market average information was gathered from a PRTM database of 400 companies.

6 Although information gathered from more than 100 SAP customer companies was used in the study, comprehensive data was available from 60 SAP customers.

7 This refers to SAP customers within Level 2 maturity and higher. See “PRTM/SAP Benchmarking Study 2002-2003: Supply Chain Planning” at www.sap.com/solutions/scm/newsevents/index.asp?pressID=2425.

8 In the excerpt of the study, you’ll see the most important findings for demand and supply planning practices. See www.sap.com/company/press/pdf/ PRTM_SCM_Benchmarking.pdf.

9 For instance, the costs of holding on to phased-out or expired inventory (in other words, products that can’t be sold).

10 For example, product supersession/discontinuation and form/fit/function requirements — grouping interchangeable parts that are identical with respect to their technically relevant properties.

11 See Charles Fine’s 2000 article “Clockspeed-based Strategies for Supply Chain Design” in Production and Operations Management (Vol. 9, No. 3), pp. 213-221.

12 See the book Adapt or Die (John Wiley & Sons, Hoboken, New Jersey: 2003) by SAP Executive Board Member Claus Heinrich and industry expert Bob Betts for more on the adaptive supply chain.


Paul Hofmann studied Chemistry and Physics at the University of Vienna, and received his Ph.D. in Physics at the Technical University at Darmstadt. He was a faculty member at the Technical University in Munich and at Northwestern University in Chicago, Illinois, USA. In the IT division of BASF in Ludwigshafen, Germany, he headed the development of object-oriented production planning and scheduling software for BASF’s plants. Before joining SAP in 2001 as Director, Global Strategic SCM Initiative, he was Plant Manager at BASF’s Catalysts Global Business Unit. He is the author of numerous publications, including a book on SCM and environmental information systems, and is also a presenter and speaker at SCM conferences.

 

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