I began mentoring small businesses again this week at Portland State University, and was pondering this question:
How does a small business go about its supply chain planning?
In talking with an old friend, Mr. Anne Bruggink, about this conundrum, we agreed that most have neither the human resources nor the volume to be able to operate the way we did at the large multi-national businesses where we’d worked in the past. Anne went on to say that entrepreneurs tend to be too optimistic in some areas and too pessimistic in others. In my own experience, I’ve found entrepreneurs are brilliant in subjects such as product development, engineering, marketing and manufacturing, but can become dazed when the topic of operating a supply chain effectively comes up.
Most of the time, supply chains grow around product growth, with little focus on optimizing how they actually work. As a result, they become complex, messy and expensive.
Supply chains are typically required to respond to the marketplace. Issues as simple as different countries having different power plugs for electricity or as complex as trade regulations can have a negative impact on the P&L. Entrepreneurs can have brilliant ideas, but the lack of proper execution costs the vital resources of time, money and human capital (which many simply can’t afford).
So how does a business go about planning and executing this complicated equation without killing the spirit and flexibility that created its success to begin with? The answer is through our equation of People, Process, Tools.
A business’s operations always start with its People. Every company has a core set of values that must be authentic and fully supported by its senior leadership team. It is critical that employees grasp these values and actively work to put them into practice.
This means that as its supply chain is designed, a business must make sure these core values are reflected throughout the entire flow of goods and services. There should be a focus on objectives and goals, which concentrates on employee engagement and continuous improvement. This is attained by:
- Prioritizing: Critical business objectives are developed and prioritized
- Aligning: All functional areas are clearly aligned with the goals of the business
- Precision: A disciplined management approach that integrates the business’s objectives and annual goals with the operation of the supply chain
- Accountability: Continually driving accountability for achieving the objectives and goals. Additionally, the focus is to integrate all functions so they are moving in one direction.
Optimizing a supply chain design is about positioning resources in ways that enhance profitability, cash and working capital while producing tangible shareholder value. Customer, supplier and manufacturing strategies — as well as world events — all play into how well a company responds to changes in the marketplace.
A supply chain is the flow of information, goods and cash. It encompasses all functions related to the flow of materials, from a company’s suppliers to its customers, including purchasing, traffic, production and inventory control, manufacturing, warehousing and shipping.
To achieve success and insure that it runs fast, smart, and lean, the supply chain must manage six critical elements:
- People – You must have a team on the field to play the game
- Planning – The management of demand and supply is essential to meeting a business’s goals:
- Financial objectives
- Customer expectations
- Supplier needs
- Operations – A continuous flow of goods from order to delivery
- Finance – Ensuring that what’s been agreed upon is properly executed and accounted for
- Quality – Only Factory Fresh Quality is delivered, on time and defect free
- Technology – Using the right amount to attain the agreed upon mission
The primary goal in designing a supply chain is to make sure that it is aligned with the business strategy. At the same time, it should also reduce complexity and decrease cycle time for all products and services.
The important questions to ask when defining requirements are:
- Is there alignment within the business’s strategy as well as its mission?
- What are the capabilities of the organization?
- What customer service levels are required to meet demand?
- Where should production/distribution be done and who should do it?
- What are the appropriate inventory levels and where should they be maintained?
- Cost: budgeted vs. actual?
- Are there any socioeconomic issues?
- What risk is the business willing to withstand?
A business can fail either because of a lack of strategic fit or a failure to provide the resources needed to support the strategy. It must be designed to fit both customer and product needs: it cannot be all things to all people and expect to survive.
Most people who know me understand that I place my greatest emphasis on the People and Process aspects of operating a supply chain. I do this because it’s 90% of the calculation for success. Far too often I’ve found that an over-reliance on technology masks larger issues within the business. I’ve repeatedly seen that a business can have world class processes and tools, yet be failures at executing. When it comes to supply chain design, the architecture for an operation is often an exercise in mathematics. With today’s complex flows, more analysis is required to keep things simple. The following tools can be applied to any sized operation – small, medium or large.
Value Stream Mapping
Value Stream Mapping (VSM) is an excellent method used to understand the physical, communication and cash flows of a supply chain. It is a simple linear process combined with volumes and resources required to produce a product. Areas to be studied and understood are:
- Timing of information flows
- Supplier and customer lead times
- Supplier cost structures – cost vs. time and inventory
- Manufacturing set-up and execution times
- Choice and cost of logistics mode selection
Determining where a process starts and where it stops is critical to building a proper value stream map. Once identified, improvements for each of these areas can be translated into action plans. A completed Value Stream Map tells the story of a series of activities and identifies waste and opportunities to improve the end-to-end process. From here, the business can determine its best path forward for making improvements.
When a company designs its supply chain, it needs to take into account all elements, including customers, markets, labor, volumes and governmental incentives. Once these elements are understood it is possible to create a model which gives the business more insight into the choices that they make.
When I first started modeling in the late 80s it took a Ph.D. to run the software and me to create the data. Today, analysts can run these powerful tools, with most data being able to be retrieved out of a business’s system.
Total Acquisition Cost
An effective method of managing overall cost is by applying a Total Acquisition Cost (TAC) model. This tool helps in measuring the cost per unit of acquiring material as well as developing the cost as a percentage of sales, which allows a business to equalize the year-over-year, volume and mix changes.
Insource vs. Outsource Decision Matrix
Decisions for insourcing vs. outsourcing are determined by a business’s leadership. Since this can often be a contentious conversation, a decision matrix can be employed to drive a fact-based dialogue rather than having an emotional discussion. A business would never want to give away its “secret sauce” by outsourcing it: still, whatever is not a core competency should be continually reviewed to determine if it adds value. Some of the considerations are:
- With limited resources, is this where a business wants to focus its time, money and manpower?
- What customer service levels are required to meet the needs of the market?
- How much control and flexibility does the business need?
- Does the business have the skills to manage an outsourced partner?
- What is the Total Cost and Return of Investment (ROI) needed to meet the financial goals?
The matrix below was developed by Hendrikje Genung — the director of logistics at Honeywell with whom I had the pleasure of working. We used it to help a newly-acquired business determine whether they should keep a perceived core competency insourced, or whether it should be outsourced.
The questions are very simple, but the matrix helps leadership’s understanding of a very complex situation.
Labor Analysis by Region/Country
A basic understanding of the cost of labor is a fundamental building block of supply chain design. For a business with operations spanning regions and borders, grasping the true cost of an employee (both wages + benefits) is imperative in meeting the financial goals. Illustrated below is a graphic of how, in the past, many of us kept track of our labor cost by country. Jim Murray from Philips Electronics was the creator and keeper of the data. He explained,
“The source of the data was our own labor rate database from the factories. We then added inflation projections from corporate finance for decision making.”
When Jim would reveal this information at our annual planning meetings, we were always amazed at what labor truly cost around the world.
Coupling this together with a Total Acquisition Cost model provides a very impactful tool for decision making.
Other factors to be considered in Supply Chain Design
We’ve covered some of the fundamental tools that a business should use for designing their supply chain. By no means is this meant to minimize the other factors that must be taken into consideration. Here are some of the other critical items to be accounted for as a supply chain grows:
- Marketing – Build them where you sell them
- Product life cycle
- Response time
- Local infrastructure
- Hidden factory cost
- Taxes and Tariffs
- Exchange rates
- Political and regulatory requirements
- Potential for corruption
Accounting For It – Finance’s Role in Supply Chain Design
Management’s principal focus should be on growing a business’s profits and cash flow as a primary driver for creating shareholder value. A business can be profitable — with a strong return on investments — yet may not consistently generate cash. Cash — not earnings — reduces debt, and a business without sufficient cash will ultimately go bankrupt. Freed-up cash can be used for:
- Increasing growth opportunities
- Expansions into adjacent and other industries
- Mergers and acquisitions (M&A)
- Research and development (R&D)
- Retiring debt
- Shareholder dividends
The Finance team understands the cash priorities of the business, protects the company from unethical and illegal behavior, uniformly applies accounts to produce a P&L and protects the transparency for accurate reporting.
During the recession of 2000, many companies developed collaborative relationships between finance and the supply chain. This relationship was further extended with increasing globalization by insuring the business had improved cash management, flexible trade terms and the ability to secure funds from trusted resources around the world. Finance’s role is to create a cadence for the reporting progress. This is established at the outset, with the objective of reporting on each part of the supply chain by bringing parties to the table. In addition, Finance leads the way by ending gamesmanship between functions, as well as by clearly laying out the entire supply chain performance.
Accounting for the cost of the supply chain needn’t be a chilling proposition. A LinkedIn article by Leo Sharkey perfectly reflected my thoughts on employing the right amount of technology to attain the mission:
“Data analytics and Big Data are trendy topics these days that frankly scare most small business owners. Analytics should not be scary, and most businesses can reap tremendous benefits from basic analysis.”
Comparing Year over Year (YOY) P&L activities provides the basic forensics for a business to use to determine the true cost of its operations. From here a deeper dive can be made to understand the dynamics at play. Regularly keeping the supply chain accountable for the agreed upon activities drives the right behaviors for meeting a business’s goals.
Final Thoughts on Supply Chain Design
Designing the Supply Chain is a subject very near and dear to my heart. My advice for all sizes of businesses is to keep it as simple – complexity drives variability, which directly affects cash flow. Additionally:
- Drive the process from a business strategy deployment with ownership by the leadership team.
- Identify all critical value streams (key products or product families) and perform a baseline analysis of end-to-end cycle time for each of these critical streams.
- Integrate cycle time results into Sales, Inventory & Operations Planning (SIOP), with gains linked to inventory, delivery and quality improvements.
- Finally, track it all on the P&L to insure the results hit the bottom line.
Building an FTZ
Over the holiday, I started helping a colleague from many years ago with determining whether she could benefit from operating a business in a Foreign Trade Zone (FTZ). A Foreign Trade Zone is a highly effective way for a business to manage cash and its supply chain when receiving imports and/or re-exporting product. Since I’m writing on Supply Chain Design this week, I thought it a relevant topic for us to review.
The FTZ Concept
An FTZ is a secure facility that is within the geographical boundaries of a country, but that is legally considered to be outside their Customs territory. In an FTZ, merchandise can be warehoused, assembled, manufactured or processed, sampled or mixed, relabeled, re-packed or repaired and/or destroyed. Wendy Armbruster, program manager at Expeditors, shared her company’s article on Foreign Trade Zones with me. It states, “Each country has their own rules for operating, however the goals of operating an FTZ are a streamlined Customs process, reduced exposure to duties and taxes, and the encouragement for the use of local products and services.” The illustration below shows how the process works for a facility in the U.S.
Requirements to Operate an FTZ Are:
The process of creating an FTZ is not always an easy proposition. As with any other practice within the supply chain, creating an FTZ revolves around People, Process, Tools.
- Security measures (including background checks) are implemented to safeguard the merchandise within the FTZ
- Maintenance of all records related to the admittance and removal of merchandise in/out of the zone is required (5 years)
- Use of a Customs approved Inventory Control and Recordkeeping System (“ICRS”) that will monitor all movements and include specific trade data elements with each transaction
- Approval by Foreign Trade Zones board and Customs to operate as an FTZ through the application and activation process
A basic requirement of creating an FTZ for a business is to have six months to one year of accurate trade data. Trade data is the information required for the movement of all raw materials, finished goods, manufactured items, hand-carried items as well as samples to cross a border. In order to use an FTZ, accurate trade data is essential as the first step to a compliant process. The basic elements are:
- Tariff code
- Country of origin
- Export Control Classification Number (ECCN)
- Net weight
- Declared value
This data is also integral for EDI transmissions to customs agencies, the generation of Customs import and export documents, and creation of commercial invoices as well as for export control screening. After insuring that all trade data is accurate (including any 3rd party purchased items), a business can intelligently and legally utilize the FTZ process to manage its vital cash resources.
Estimated Cost Benefits for Opening an FTZ Include:
Lead time for creating this process averages between 9 and 14 months. Additionally, operating an FTZ is not free. People, Processes and Tools are literally required to implement this type of operation.
Some of the costs are:
- Engagement with an outside consultant to assist in FTZ set-up and help secure approvals with Customs and local community
- Staffing to manage the FTZ daily operations, achieve productivity goals and provide adequate back up support to avoid operational disruptions
- Transportation cost for utilizing bonded carriers to the zone
- Software to operate the FTZ
Realized Benefits Include:
- Deferred cash expenditures for companies that import. This is achieved by the deferral of duties (duty is not assessed while merchandise remains in the zone).
- Reduction of brokerage fees – Allows the use of a weekly import filing versus on a per shipment basis, thus reducing the amount of brokerage charges from multiple transactions.
- Elimination of duties – No duties are paid on merchandise exported from an FTZ. Therefore, duty is eliminated on foreign merchandise admitted to the zone that is eventually re-exported. Additionally, merchandise that is destroyed, declared obsolete, or categorized as waste/scrap waste can avoid duties.
- Inverted tariff relief: Manufacturing companies can elect the duty rate of either the imported material or the finished good.
- Taxes – Property imported from outside the U.S. and held in a zone, as well as that produced in the U.S. and held in the zone for exportation, are not subject to state and local ad valorem taxes.
While FTZs are not for every supply chain, they are a highly efficient way for a business to manage its cash. More importantly, a carefully crafted, frequently reviewed supply chain strategy can make a real difference in a small business’s bottom line. Most companies looking to cut costs direct their focus on introducing austerity into areas that negatively impact employee morale and have marginal impact. By using the People, Processes and Tools equation and making incremental changes to the multiple components of the supply chain – in keeping with the company’s core values – you can make a lasting and dramatic improvement, while at the same time improving efficiency and operations.