Working on the margins

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Somewhere in the heart of every retailer lurks an image of the perfect store that offers what the retailer wants to sell when the retailer wants to sell it and is frequented by loyal customers who request and buy the orderly merchandise that is always available. But that image is as out-of-date as the linotype printing press, long since replaced by a dynamic whereby retailers are faced with increasingly complex issues that affect every aspect of the supply chain.

Foremost among those issues is the advent of the multi-channel selling environment. Thanks to technology, virtually every store in the world sells its products by telephone, catalogue and website. This diversity of formats and expansion into fresh channels is driving the need for optimal supply chain management. But unfortunately most retail websites are almost a decade old and their technology lacks the ability to manage the products in each channel.

Second, the old adage about the customer being king is finally an accepted rule. A customer whose demands are not met in a store can easily go to another branch of that store or to its website, which also means they can just as easily go to a competitor’s store or website. To compete, supply chain managers must provide more choice, better quality, improved service and convenience while keeping costs competitive. This means having the facilities to accommodate all the permutations and combinations of customer needs including delivery patterns that adapt to changing demands.

Third, the significant increase in global sourcing from developing markets demands that retailers track the amount and cost of such products, where they come from and when they are due to arrive. Finally, most retailers are struggling to keep up with the reduced life cycle of their products.

All this begs the question – how can retailers improve their supply chains in this demanding environment? The answer is deceptively simple. It lies in flawless execution.

Some supply chain leaders are incorporating supply chain management into their business strategies, recognising the benefits to profitability. One example is Spanish retail giant Zara, where the supply chain is the business model. Zara’s rapid growth and profitability are linked to an uncompromised approach to supply chain management that has delivered a phenomenal three-week ‘design to shelf’ capability and fuelled the company’s 20 per cent annual growth. UK food retailer Tesco is another example. The company has developed continuous, within one day replenishment capabilities to underpin its fresh food offer and deliver on-shelf availability of more than 98 per cent.

Strategic differentiator
For these retailers, the supply chain is a strategic differentiator that delivers business value and competitive edge. They see it as a key element of their business strategy and work with their business partners to design, develop, move, store, sell and service their products with ever greater speed and economy.

In an effort to cut costs and improve levels of supply chain quality, increasing numbers of retailers are focussing on their core business and outsourcing non-core functions. For example, some are outsourcing forecasting and replenishment. Their buyers negotiate deals but an external partner watches inventory levels in the warehouse and matches them with promotions and seasonal changes.

Other retailers are outsourcing transportation. By working with third and fourth party logistics providers, retailers can have smaller shipments delivered to specific stores on a daily basis. Still other retailers are outsourcing entire warehouse operations to third parties. In this model, the third party owns the warehouse and the trucks and hires the employees. But the warehouse only moves merchandise that belongs to the retailer.

Finally, we’re seeing an increase in private label merchandise. Typically manufactured offshore, private label allows retailers to save money by avoiding the middle man. To compete successfully against branded products and entice consumers to purchase these private label goods, deliveries must be on time and quality must be comparable with branded products.

Significant returns
Cost reduction has long been a goal of supply chain organisations, and many retailers have succeeded in ratcheting down their unit supply chain costs. Unfortunately, few of those improvements have been dramatic enough to counterbalance declining prices and, subsequently, declining margins. As a result, supply chain costs as a percentage of revenue are increasing and retailers must formulate fresh strategies for pushing supply chain costs down faster to realise significant returns.

How? The answer lies in a company’s approach to four supply chain components – physical flows, financial flows, information flows and outsourcing. Traditionally, these have been approached individually but identifying and exploiting interdependencies and opportunities to reduce costs within and across the components can enhance the impact.

The key cost-reduction strategy in physical supply chain is to minimise the number of required physical movements. Companies should make reducing these elements a cost-containment goal. Other cost-reduction opportunities include expanding the supply chain itself. Many large retailers have dramatically increased supply chain efficiencies by raising volumes, improving processes and implementing technologies for sourcing management, order management and exception management. As a result, increasing numbers of manufacturers are encouraging those retailers to manage a greater portion of the inbound supply chain. For example, a global retailer might accept a purchased product at the point of manufacture in China and assume responsibility for its shipping and importing. As expertise grows it can yield cost reductions not only for retailers but also for their manufacturers. In fact, close relationships with manufacturers can lead to discussions that reduce manufacturers’ supply chain costs and have a positive impact on retailers’ downstream costs. If a manufacturer redesigns a product to increase units per pallet it can cut warehousing, handling and freight costs, helping reduce retailers’ supply chain costs.

Changing financial models
Since most companies are less adept at managing supply chain costs than they are at controlling other costs, changes to the financial model can also yield cost reduction opportunities. For example, changing the cost structure from a fixed to a variable one is critical to the development of a low-cost supply chain. Traditional thinking, that a fixed infrastructure offers lower long-term costs, tends to obscure the fact that variable-cost infrastructures offer better visibility of true costs and less bureaucratic infighting over cost allocations. These advantages are particularly useful to retailers that are attempting to move away from the traditional supply chain mind-set of maximising volumes over fixed assets. Another opportunity lies in developing new cost-allocation models – rather than implementing complex activity-based costing or management systems, a retailer can align its allocation models more closely with the cost structure and specific cost-reduction priorities to realise cost reductions.

Making better use of information underlies all efforts to reduce supply chain costs. But there is an interesting dilemma – technology costs are fast becoming the most expensive investment component in a typical retailer’s supply chain. Yet without top systems, retailers cannot gain the visibility of data and decision support needed to get closer to customers, manage complexity and flex the supply chain to meet operational and strategic objectives. The reality is that innovative technology investments are critical to reducing supply chain costs. To capitalise on their investments companies should develop a high-level information modelmapping systems, transactions and partner connections to help identify the scope and functionality of supply chain systems. Such opportunities include defining or redefining systems interfaces, consolidating ERP systems, leveraging partners’ IT systems and developing an enterprise integration architecture that features emerging technologies such as service-oriented architecture and web-based messaging.

As noted earlier, retailers increasingly outsource a variety of functions yet poor alignment between the third party’s capabilities and the retailer’s overall supply chain strategy is also common, resulting in duplication of capabilities and responsibility gaps. To help ensure cost reductions and profitable growth retailers must understand their outsourcing partner’s business model. Does the partner have the low-cost supply chain management capabilities the retailer requires? If so, how did it achieve this structure and why is it willing to offer it at a low cost? And can the provider sustain its cost advantage over the longer term? Retailers should also avoid getting locked in by third parties. Outsourcing service providers often seek pricing power by providing ‘sticky’ services that prevent the retailer from switching suppliers. Faced with such a situation, a retailer should insist on plug and play IT interfaces or multi-sourcing contracts upfront.

Understanding and managing interdependencies among the four flows is central to forming the kind of unifying assumptions that hold low-cost supply chain strategies together. To make this happen, leaders of different functional groups must understand the four components, and high levels of cooperation help identify and clarify interdependencies and ensure that they are managed across the organisation. For example, if the finance team understands proposed changes to reduce physical supply chain costs it is more likely to implement the financial process changes needed to achieve savings.

Ensuring measurable results
Or perhaps a retailer is exploring the advantages of outsourcing an activity such as warehouse management. To make this happen, the company should consider the financial flows, eg coordinating process designs, contact negotiations and costallocation processes to ensure outsourcing results are measurable and clearly understood.

Creating change in an existing supply chain can be daunting. Given the breadth and depth of impact, virtually all areas of a business are affected. But as the gap between retail leaders and the rest of the pack continues to widen, companies can spawn opportunities to realise significant cost reductions through flawless execution and greater focus, precision and speed. We may not live in the simpler world of our forefathers but we can maximise the opportunities offered by our own dynamic and complex retail environment.

Andrew Thorndike is a senior executive in Accenture’s Retail Practice in Germany and Dan O’Regan is a senior executive with Accenture SCM Practice UK.

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