This article was first published by Oliver Wyman
Supply chains are at the core of moving physical goods within and between companies. Yet, across industries they often represent one of the largest unaddressed cost blocks, where operational efficiencies are not targeted in a systematic way. That’s because most supply chains are not considered a source of value creation and differentiating advantage, but rather as an execution element. Furthermore, they are inherently complex —a melting pot of operational constraints that have developed organically over time. This often leaves significant untapped EBITDA and cash-flow potential for most companies moving physical goods as well as providing services. Depending on the industry, supply-chain costs range from 10 percent to more than 20 percent of revenues (see Exhibit 1). Mid-sized companies ($0.5-$5B revenue) often overlook these costs, and larger companies ($5B+ revenue) have highly complex operations. In either situation, focused supply-chain optimization can reduce costs by up to 25 percent, more than double what you can expect from most other operational improvement initiatives.
Exhibit 1: Supply chain* cost as % of revenues
With such high value-creation potential, Supply Chain Optimization is a standard element of our Rapid EBITDA approach, which produces reliably high impact results. In our experience, there are eight key levers that should be addressed during a supply-chain diagnostic:
- Demand forecasting. Accurate forecasting is key to the ultimate goal of delivering the right product to the right place at the right time. With improved forecasting, firms can minimize working capital through optimized inventory levels, and placement and adjusted safety stock levels. At the same time, minimum order quantities and procurement practices should be adjusted to achieve the full impact. However, excellent forecasting systems require complex analysis of historical data, macroeconomic factors, and competitive pressures. Leverage advanced analytics and machine learning to minimize forecast errors in volatile market environments.
- Joint value creation with customer. Close collaboration with customers creates incremental value, which neither party could achieve on its own. By exchanging more information with suppliers and customers, both sides can better understand their needs. Customers benefit from receiving the optimal product in the best possible way, limiting required inventory costs and decreased handling costs. Suppliers benefit from optimizing landed cost, better customer service, and increased market penetration. Establish joint processes to share relevant information, which is necessary for optimized planning, replenishment, and inventory management. Vendor-managed inventory is a possible outcome of joint value creation.
- Asset utilization/CapEx investment. The challenge of optimal asset utilization is finding the right balance between full utilization of facilities/machines and meeting customer lead-time demands. In a best-practice approach, optimal production balances customer demand against capital investment, and transportation and inventory costs. Set the capital budget based on a total-cost optimization. Extract as much value as possible from existing assets and strategically invest capital in the most cost-effective projects.
- Sales and operations planning (S&OP). S&OP balances demand-and-supply requirements to optimize operational performance. Optimize production lines based on batch sizes, setup times, and improved forecasting accuracy to achieve EBITDA improvements. Clearly define process steps and responsibilities, and ensure compliance by aligning processes with overall strategy, incentivizing staff through KPIs, as well as ongoing performance monitoring. Successful S&OP requires strong C-level backing to make it considered a core process of the company
- Inventory management. Optimizing inventory levels across regions can be a key lever for reducing working capital. Set the right inventory levels by understanding the required service level and cost-of-capital balance. Adjust product-level strategy and inventory rules based on seasonal factors. Centralize storage of slow movers to handle demand volatility and reduce required safety stock. Cleanse SLOBs (“slow moving and obsolete inventory”) from the network to free up bound cash. The key input for excellent inventory management is accurate forecasting.
- Warehouse operations. Warehouse processes are often the bottleneck in supply chains. Alleviate short-term capacity bottlenecks and optimize inventory throughput with quick fixes: top off capacity through short-term rental space; increase picking efficiency through reorganizing floor-level processes and installing state-of-the-art picking technology; and optimize stock levels through disposition control.
Structural changes can permanently reduce capacity bottlenecks. Deploy real-time algorithms to monitor inventory levels and automatically trigger replenishment orders. If restructuring is too time/capital intensive, rapidly reduce OpEx and CapEx by outsourcing (parts of) the network to third-party logistics providers, such as trucking or warehouse brokers. Build a lucrative incentive system (gainsharing) for cost minimization and a systematic management of third-party logistics partners.
- Transportation. Transportation processes operationalize the strategic actions of the other levers, and are driven by service level and stakeholder requirements. Assess best-practice options for routing and transport efficiency between the supply-chain network nodes. Adapt transportation services to the needs of customers (delivery time windows, pick-up locations, Point-of-Sale services) and suppliers (just-in-time production, appropriate pick-up frequency, load size, and time windows). Regularly review suppliers with rigorous bidding (RFQ) to provide additional impact.
- Network footprint: This should be one of the earliest levers to address when configuring a supply chain, and it offers the biggest potential cost-cutting gains. Determine the optimal network setup according to customer-demand patterns and supplier locations. Design a dynamic network that can respond flexibly to changes in demand. Identify warehouse locations to optimize routing and minimize travel distance between network nodes. In most cases, a restructuWelcome1red network also has positive service-level effects for customers.
Levers 1-4 (see “Levers to optimize supply-chain efficiency”) are enablers, and often have very positive impact on KPIs. Levers 5-8 subsequently address the underlying cost bases and drive savings.
These levers move far beyond traditional procurement and sourcing opportunities, significantly lowering supply-chain costs and the need for working capital. Each lever must be adjusted based on your network-distribution strategy, customer-service level, and the intended cash impact (working cash in hand, depreciation, weighted cost of capital, EBITDA).
Some levers—such as forecasting, warehouse outsourcing, smart-inventory management, and routing optimization—are potential quick wins, yielding EBITDA results within the first year. Others require a mid- to long-term time horizon. Typically, a six-week diagnostic is needed to align on a sound strategy, and create a playbook for the future.
What opportunity is hidden in your supply chain?