Supply chain management in the economic slowdown

Western economies are facing a slowdown at best and some level of recession at worst during 2008/9. UK retailers are seeing this already in negative like-for-likes and consequential margin pressure. The bottom line impact can be a double whammy and share prices are already factoring in the uncertainty with prices well down from their peaks, blue chip names suffering and a pattern of increased administrations.

CEO’s will be wondering if there is an escape from this situation and what it might be.

In the end there is no substitute for outstanding products, well presented at competitive prices to bring the customers through the door and encourage them to buy. However CEOs and their business teams now face the question in an inflationary supply side market as to how much margin to give away to be competitive and how to cut costs.

Retailers tend to be short-term thinkers; manufacturers will often invest against the cycle to get another level of efficiency. And then there is the question of whether to price for volume or for margin; give away too much and the business can become unprofitably busy. It is a dilemma.

The goal of catching the market by being as broad as possible in customer appeal is almost invariably a false one. It risks the ‘Swiss Army Knife Syndrome’ – doing everything but nothing very well.

Answering the question of whether to cut costs yet further, price more aggressively to drive volume or invest to change the business model is the Holy Grail. Now more than ever as there is now one unchallenged truth, “cash is king”.

Making decisions requires a level of profit understanding and engineering that few business have achieved. Deciding where to cut costs and where to focus investment in marketing, pricing and capability requires a better understanding of the hidden cost drivers in the chain.

As an example, few manufacturers or retailers have adequately assessed the cost and margin impacts of being over-ranged and overstocked, the consequential margin erosion through discounts and marketing promotions, and the results of damage, shrinkage and excess logistics costs.

Work by LCP Consulting has shown consistently that the least profitable parts of the range create costs and margin loss at a rate of up to 10 – 15 times the best products. The variety also causes a loss of focus on the supply chains of the winners and the ability to drive for economies of scale with suppliers. Careful inspection of the public statements of retailers like N.Brown, WH Smith and most recently Woolworths all point to the benefits that can be derived from a ruthless focus on margin and investing to actively managing the cost of complexity and variety. All of these companies have been motivated to such a strategy by being challenged for profits and cash.

The experience is that a category can yield a minimum 50% increase in profitability and for many categories the gain may be higher.

For one distributor, a focus on net profit lead to a 3% improvement in the net margin with some major changes in both supplier base and customer account management. None of the measures taken were visible through the established management accounts.

As the slowdown brings a broader challenge to profitability, this will be a path that others will have to follow: challenging as it is for established and successful organisations. Net profit contribution will be the mantra; achieving it will be a distinctive and competitive competence. Investing in this as a capability should be a priority.

Key features of this approach will be about developing:

A ruthless focus on a manageable number of suppliers to drive price point value and operational compliance – they quickly learn they can grow in the downturn and that it is easy to do business this way
Absolute accuracy on ranging, margin management, forecasting and stock planning to maximise the winners and avoid stock obsolescence and high markdowns
Buying and merchandising processes combined with supplier relationships that enable the business to respond to volatile demand in order to maximise net profit
The whole picture held together with KPIs supported by clear net profit contribution analysis and reporting linked to space, stock and marketing expense

These four points are core supply chain disciplines that go under the banners of ‘Sales and Operations Planning and Cost-to-Serve. Many businesses would claim they have these two processes. The reality is that few are doing them well or have them joined together; few have a management prepared to take hard decisions about products, customers and services based on the conclusions.

If the conditions become as severe as many commentators are predicting, the potential to trade out of it using commonplace price and promotional activity will be reduced. Instead a more precise focus will be needed will be needed on net profitability. Cash is now reality.