Countering the costs

LinkedIn +

These are testing times for supply chain management: increasing global requirements, growing uncertainty, accelerating product complexity and ever more demanding customers. Add in other pressures, such as increasing transportation costs, and for the first time the AT Kearney/European Logistics Association European survey shows companies are projecting that the fall in logistics costs seen over the last 20 years has finished and that costs are on the up. This is a radical change from the past and will pose many challenges.

Supply chain costs have been falling consistently for many years as companies develop and reinvent their supply chains. In the 80’s, cost savings were largely driven by network restructuring as companies moved from multiple local operations to a few central operations. In the 90’s, the cost savings were sustained as companies developed the effectiveness of their European operations with more efficient planning and better logistics procurement – all supported by more effective supply chain systems.

But this wave of continuous cost improvement appears to have crested; for the first time in 20 years, companies do not currently anticipate further reductions in their logistics costs in the coming years and costs are increasing as more value added services are demanded by customers. Supply chain will no longer be a lever to drive cost reduction; instead, increased innovation will be needed to manage an effective supply chain. While this lull in logisticsrelated cost reductions has been anticipated for some time, it is occurring now due to a combination of four factors: more demanding customers, increasing complexity, increasing unit cost and globalising supply chains.

Value added services
More demanding customers: They require more and more value-added services from the supply chain (eg, country-/region-specific packaging, vendor-managed inventory (VMI), collaborative planning, forecasting and replenishment (CPFR), product modifications, etc). While these services can reduce the endto- end supply chain costs, they often increase supplier costs but can be hard to pass on customers. Thus suppliers are in a squeeze, faced with rising costs without any compensating margin increases.

Increasing complexity: Generating sales and creating value requires greater product differentiation. The proliferation of tailored products and services has increased pressure on supply chains, especially as lead time and service expectations continue to increase.

Increasing unit costs: There has been a lot of work in the last few years to drive down unit costs through improved productivity and procurement practices. This seems to have reached the end as companies see costs increasing; for example, two thirds of companies think transportation costs will increase in the next five years reflecting rising diesel costs, regulations that restrict drivers’ hours and increased traffic congestion. The ability to drive costs out through improved effectiveness is no longer there, especially as customers continue to demand more frequent, smaller deliveries.

Globalising supply chains: While the traditional Western European markets will remain an important destination for sales, the share of supply from non- European points is growing fast and is expected to reach 30 per cent in five years time. This trend towards globalisation increases the physical distances materials and goods must travel and extends supply lead times – both of which add to costs and make supply chains harder to manage effectively. As this trend continues, there will be further pressure on supply chains to perform better.

While the leading supply chains examined in the 1998 study were best described as responsive, agile and lean, the latest survey demonstrates the affect that complexity is having, as recent waves of cost reduction appear to have reached their end point. Leading-edge supply chains employ a new set of capabilities to proactively manage complexity, drive performance, and improve competitiveness through the application of three distinct improvements: differentiating supply chains, collaborating with partners and organising around the value chain. Leading companies are able to manage the right capabilities at the right time to exploit supply chain advantages and create value for the company as a whole.

In meeting this ever more challenging environment, differentiation is emerging as a key driver to manage supply more effectively. The focus in the past has been around developing a supply chain that can be all things to all people. This is, however, increasingly not the appropriate model. The lean supply chain for supporting automotive companies with their ‘predictable’ production is not suited to the unpredictable requirements of industries such as high-tech where the focus needs to be on building flexibility. Leaders recognise this and are developing differentiated supply chains to handle different areas of their business. These supply chains can be characterised as having three foci: low cost for supply of simpler products that can be supplied ex-stock, highly integrated for supply of complex products and highly flexible for supply in an uncertain demand area.

These concepts can become very complex as companies look to achieve best-in-class performance with the appropriate levels of differentiation. Many companies have had differentiated supply chains along classical business lines but leaders are looking to differentiate in more diverse ways. For example, in the interviews we noted differentiation of supply within the products – supply the base volumes from Asia Pacific using an efficient supply model and replenish in season at short notice from Europe using a flexible supply model.

Companies that are differentiating their supply chains have driven costs down by around nine per cent from 1998-2003 versus those ‘non-differentiated’ companies, where logistics costs decreased only one percent over that same time period.

The second major trend is the increase in collaboration. Ever since the boom of the late 1990s, there has been a widespread belief in the marketplace that increased collaboration is the future. This trend continues with clear growth in the amount of information shared with suppliers and customers since the last survey in 1998.

However, while information sharing is growing, the information is not always used; although 50 per cent of companies share inventory data with their suppliers, a quarter of them do not think that this is used at all. Thus a lot of the information sharing is not resulting in benefits yet. Collaboration is more than just the provision of data; it involves working with customers and suppliers to ensure that the right data is shared and that it is used appropriately.

Over optimism
Another finding that emerges is the over optimism of companies in their ability to implement collaboration. Companies that are using collaborative tools today are expecting a steady growth over the next five years but companies that do not use them are expecting dramatic increases to levels similar or greater than existing users. For example, companies that use VMI with suppliers today have 24 per cent of their spend managed through VMI and this is expected to rise to 35 per cent in 2008. However, companies that do not use VMI today expect 48 per cent of spend to be on VMI in 2008.

Despite some of the negative aspects about collaboration that emerge, when we look at companies who do it well there is evidence that this is driving improved service performance. Whereas companies employing differentiated supply chains enjoy significantly better cost performance, ‘collaborating’ companies are benefiting from significantly better service performance. Companies with collaborative supply chains have a higher level of on-time order deliveries versus other companies (95 per cent vs. 91 per cent) as well as a better rate of order completeness (95 per cent vs. 92 per cent).

Leading companies need to avoid the complacency that functional excellence can bring and take collaboration even further to manage the entire value chain. Value chain management entails optimising the entire supply chain from product design all the way through to sales, in order to drive profitability and manage the consequences of increasing complexity.

One of the key aspects of value chain management is how to gain the maximum value from supply chain partners, especially third-party logistics providers and contract manufacturers. Outsourcing continues to grow as companies come to rely on external providers for expertise in non-core areas. In some areas with high penetration growth will be quite low, but in areas with much lower penetration, such as warehousing, there are still a lot of companies planning to outsource in the next five years.

When looking at the reasons companies give, both for and against outsourcing, it is clear that there is a major shift in their perception of outsourcing. As companies have undertaken more work with third parties, they are becoming increasingly sophisticated and understand that outsourcing will not automatically lead to cost savings. They are also concerned about loss of control, probably driven by the fact that much of the early outsourcing is now coming up for re-compete.

Greater expertise
However, the largest change is in the perception of greater expertise of the third party suppliers. Over the past five years the number of companies that list access to external expertise as a reason to outsource has nearly doubled (28 per cent to 53 per cent), while the percent of companies citing lack of supplier capabilities as a reason not to outsource dropped from 42 per cent to 19 per cent. Third party suppliers have successfully managed to build their capabilities. Developing and implementing effective relationships to exploit this expertise will be an increasing challenge for value chain managers.

So, what’s the solution? Supply chains are becoming more complex – cost pressures are building and the one-size-fits-all model is breaking down. Companies need to increase their expertise to drive value from supply going forward. While it is important to undertake standard improvement activities, companies need to differentiate, collaborate, and manage the value chain to drive further benefits. 

Mapping requirements
Differentiation entails mapping the supply chain requirements and understanding which supply chain types should be used and when. This requires an assessment of the supply dynamics to understand the drivers and the appropriate solutions.

Applying the wrong supply chain model will result in failure. While looking at the best practices that other industries adopt can be helpful, assuming that those practices are applicable can be dangerous. For example, implementing an automotive-style leancost efficient supply model for telecommunications supply leads to poor performance and high costs.

Collaboration is important in driving forward performance but needs to go beyond data sharing to using the information. The challenge is to make effective use of the information, recognising that some of the integrated end-to-end solutions that have been proposed in recent years are too complex for some industries. Collaboration is not easy and involves fundamental changes in the way the relationships and the processes work – information sharing is the easy part.

Managing the chain
Supply is increasingly about effective management of the extended value chain, not just a company’s individual operations. Developing and implementing effective relationships with partners to leverage their capabilities is becoming a key to success. This requires some fundamentally different thinking that moves away from the ‘sourcing’ mindset, in which agreements drive relationships, to optimising the value chain and using the appropriate supply chain partner for each part of the chain.

Charles Davis is a vice president at global management consulting firm, AT Kearney, and is based in the London office. He is a leader in the European Operations Practice with a specific focus on supply chain.

AT Kearney and the European Logistics Association (ELA) have conducted surveys every five years since 1982 to monitor supply chain trends across Europe, and generate insights into supply chain evolution. The most recent study encompassed 100 companies through a survey and face-to-face interviews.

Share this story: