What if your margins were incorrect...?
Although you know it, you are not able to measure it precisely: all your customers are not profitable! Depending on the market, we can estimate that up to 20% of your customers lose you money. This is not so much characterized by what they are buying, but as through the way the product or the service is delivered. We are going to share factual cases encountered in the distribution sector and the FMCG industry. Those cases demonstrate how they had to adapt their approach regarding Supply Chain cost in order to make the right decision to drive their margins.
# 1: Better understand your operational costs
This need is higher as the more “customer oriented” approaches developed in the past years have brought huge complexity to the operations of manufacturers and distributors. More and more constraints weigh on the Supply Chain, first and foremost the stake of ultra-reactivity.
For example, companies in the business of food-processing of dried products have seen the frequency of delivery multiplied by 4 in the 10 past years, as the distributors tend to maintain the lowest inventory level. Obviously orders splitting brings higher costs such as freight cost, but they can also generate a cost increase in order preparation and management. Those additional costs are rarely accurately calculated and therefore are not distributed to all the partners of the value chain.
However, it is important to calculate accurately the operational costs; that is, to identify the specific costs linked to a customer or a product range, with the aim at driving their profitability… Most of the time, the consolidated P&L approach hides critical operational facts.
We recommend a 2-step approach:
Prepare a physical and information flows mapping as a VSM (Value Stream Mapping) to get the full picture of the operations, from customer needs to customer delivery, starting with the general framework and adding the specificities.
Analyze and observe in detail each flow in order to characterize and quantify the distribution operations of each single customer. During on-floor measurements, it is pretty common to observe distribution costs ranging from 1 to 3, depending on customer requirements… Distorting significantly the margin calculated for a product range.
Two main types of cost could cause these profitability gaps:
- Operations: packaging, check, picking, specific freight, mark down rate…
- Organization and management process related to the customer: forecasts, after-sale services, range review and rebates…
The question then becomes to reallocate the operational and administrative costs in line with the enforcement of your organization around a customer or another.
# 2: Challenge your referencing
Are you sure that your Marketing teams (Category Management, Market Manager,…) know the real distribution costs related to your customers?
It is more than likely that the step of cost mapping (BP #1) will bring a fresh eye to your analysis of product range strategy. What could you do for the clients with a lack of profitability? The first obvious solution, to increase the selling price, is very rarely sustainable from a commercial perspective.
Therefore all you can do is optimize your Supply Chain costs, consolidating the logistic operations on a reduced number of products. This implies proceeding with a comprehensive analysis of the products mix for each customer and to ensure that their products selection includes the minimum of low profitability references.
We recommend 2 ways to initiate this process:
Range bottom approach
to study the margin for a product and to compare it with the recalculated Supply Chain costs in order to validate whether the product should remain in your offer. This pragmatic and robust calculation enables the internal alignment of the teams and to objectify the range review.
This analysis, led by an FMCG leader, highlighted that 8% of the products from the range bottom have a higher distribution cost than the margin realized for the 12 past months.
Range top approach
to identify the penetration rate of your 20/80 with your class A, B and C clients.
This analysis underlines the customers with exclusive references or even exclusively developed ones, while others reference of the Pareto could meet their requirements. Final objective: develop the consolidation of the product range.
This can of course be triggered by a specific customer request with the purpose of setting yourself apart from competitors, but in fact this is far from being systematic. In the example hereunder of one of our client in the FMCG industry, we were able to suggest an alternative meeting their needs, for 20% of the references. Some specific or mono-customer products have been replaced with references of the 20/80 and thus removed from the product catalogue.
#3: Share the information
A customer cannot figure out the impact of its decisions on your activities, and the related loss of productivity… You must bring up this question.
The best “reflexes” to have:
Share with your customers the operations linked to their specific requests.
Give them information about your costs, in particular the costs having threshold in opposition to linear ones. Keep in mind that your customer cannot figure out the threshold effect. You can work together on min/max parameters that your customers can easily understand and hence accept.
Define internal rules.
For example, are you certain to guarantee a service rate “whatever it costs”? What is the marginal logistic costs of last-minute orders? Re-prioritization, freight offset, reconciliation meeting, we often observe that the process of definition of the ATP (Available To Promise) is not clearly defined…or, if it is formalized, it is not be followed in daily operations.
Finally, make decisions based on factual figures!
The principal of differentiated Supply Chain too often consists in providing the best services to the largest customers. What if you shift the cursor from the size of the customers to their profitability? It makes sense to deliver a higher level of logistic services to your most profitable clients, rather than your larger clients for which you have a limited leverage.
#4: Harmonize and standardize your logistics operations
Do you control the variability of your operations and of the fluctuation of your productivity?
This question can quickly become a complicated one if you consider the processes of picking and order preparation with a large diversity of clients. The main task is to develop a guidelines framework and to harmonize the practices as per the standards. It means to apply Lean Manufacturing methods to your logistics operations. The elimination of the MUDAS enables the achievement of significant productivity gains in the logistic centers as well as a quick achievement of the first improvements.
In non-automatized warehouses where the picking is manual, we observe, by experience, that on average 30% of tasks performed by the operators and the foremen are pure wastes. The implementation of an improvement plan enables waste reduction of 10 to 15%, implying as much for you on your operational margin.
Three main levers can be used to implement such an improvement plan:
Tools & processes
implementation of standards defined with the teams, revision of the overall logistics plan and its associated equipment.
review of the daily timeline, de-partitioning of the process and working expertise…
performance management, objectives cascading, feedback on previous experiences and improvement loop…
#5: Change the negotiation paradigm
It is still very rare to find customer-supplier Supply Chains talking directly together. Most of the time, negotiation goes through the Commercial and Purchasing teams, who do not have the full picture needed to create a transversal Supply Chain.
Fortunately, collaborative initiatives between manufacturers and distributors are more and more frequent. Improvement projects can be summed up in 5 majors themes: forecasts, in-shelf availability, data exchange, supply management, logistics pooling. All those working groups, focusing on customer service, forget to discuss about the global and transversal costs of the supply chain.Source: ECR (Effective Consumer Response).
We regularly support our clients, manufacturers and distributors, in their negotiation process and we often observe that the notion of transversal Supply Chain remains an abstract concept, as each party battles to optimize its own logistic costs against sometimes their global performance. This implies to develop a strategic alliance model and to modify the traditional approach of the buyer-supplier Supply Chain.
The most common optimization axes of customer-supplier logistics:
FOB, enabling work on batch optimization and to get economies of scale; EXW, giving the option to the distributor to optimize the cost – if he has good conditions – without the consideration of MOQ (Minimum Order Quantity)
Revision of the supply chains' organization
stocked flow, cross-dock, short / local distribution network,…
Beyond these two axes, a complete understanding of the Supply Chain costs “beyond the wall” enables to open many other improvement paths. This requires to get the expert persons together to redefine the adequate needs regarding the impact on the distribution costs.
In a difficult economic context, where the negotiation between the manufacturer and distributors are more and more strained (as shown in the situation of February 29th of this year, when 20% of the agreement between suppliers and retailers were not signed off on), it is urgent to change the paradigm and to open the horizon of negotiation. It is clearly in the collaborative Supply Chain approaches that the source of cost optimization lays down.
In this quest of improving customer service, it is essential to survive, to drive and control the distribution costs.
Cost modeling is a compulsory tool to make the right decision in an agile way. The data management, which becomes more and more accurate, enables us to get the logistics costs at the level “offer/client”.
Our clients opt for this approach, Cost-to-Serve, with 3 main impacts for their companies:
- Understand the real profits made by each product range and for each customer
- Identify opportunities to optimize costs for their transversal Supply chain
- Simulate the impacts of potential evolutions of their business models and adjust their Supply Chain accordingly