are Collaborating to Create Competitive AdvantageHow Progressive CFOs and the Supply Chain

Close collaboration between finance and the supply chain enables firms to focus on the tradeoffs between inventory and Total Landed Cost and create actionable insight from operational data

A CALIFORNIA BANK TRUST BUSINESS SERIES WHITE PAPER

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The Current State of CFO-Supply Chain CollaborationFor those employed in supply chain finance or participating in the sales and operations planning process, the idea that the supply chain and finance should collaborate deeply and often is a given. However, for many other corporate managers, this concept is not conventional wisdom. This is particularly evident in how many firms’ functional goals and incentives are structured.

For finance, the goal is to make the company as profitable as possible using the fewest assets. And in fact, the supply chain as a whole has the same goals. But within the silos of the supply chain, the tradeoffs are appallingly complicated and oftentimes in conflict. For example, procurement might be driving lower unit costs, logistics may require flexible warehousing space, distribution may strive to build full truckloads, while fulfillment is incented on high service levels. Those who have worked in or with any of these functions know that such a scenario can easily result in low quality materials, costly or far away warehousing, excessive late deliveries, and/or high expedited freight or parcel costs.

Christopher EdmondsSenior Vice President – Commercial BankingCalifornia Bank & TrustChristopher.Edmonds@calbt.com

Casey MorkManager - Supply Chain Design and Innovation Group UTi Supply Chain Design and Innovation GroupCMork@go2uti.com

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A recent Ernst & Young study found that companies with a strong CFO and supply chain partnership reported better results than those without such a business relationship. Specifically, 48% of respondents to the study reported EBITDA growth increases of more than 5% in their company over the past year, compared with just 22% of those with a more “traditional” (less collaborative) relationship. The reasons why companies with strong CFO and supply chain relationships tend to outperform those who don’t aren’t difficult to imagine. Consider the following two scenarios that result from misaligned incentives between the finance and supply chain functions and their alternate outcomes:

Scenario 1 A large customer retention initiative eliminates an ongoing SKU reduction program in order to maintain the broad product offering demanded by the company’s large customers.

Common ResultSales and marketing retain a broad product portfolio and revenues continue to increase as key customer accounts grow. However, the supply chain struggles with increasing SKU obsolescence, higher warehousing costs and difficult to forecast products.

Alternate ResultThe supply chain creates a cost-to-serve dashboard to aid decision-making on the company’s most and least profitable customers and products. The analysis discovers that some large customers and popular SKUs are in fact not profitable when fully costed. Unprofitable products’ prices are increased, and some segments of customers are provided full pallet discounts.

Key Customer Retention Initiative

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One conclusion from the preceding two examples is that the supply chain too often fails to control for its own silos and incentives. After all, its overall strategy is the same as that of finance: to maximize profit with the fewest assets. Yet that conclusion is overly simplistic, as incentives are driven from outside the supply chain as much as they are from within. Further complexity is introduced when goals are broken down between short and long term (department KPIs vs. EPS growth), and explicit and implicit incentives are considered (achieving one year of bonus within one’s function vs. climbing a multi-functional corporate ladder).

The simple yet elusive insight – that collaboration with the finance function is the key to long-term, supply chain driven profitability – is what the next generation of supply chain performers focus on. These companies drive greater internal collaboration between the finance and supply chain functions using a Total Delivered Cost approach and design the supply chain to deliver a value-based, rather than a purely cost-based contribution to the business.

Scenario 2 Finance creates an enterprise-wide inventory reduction program to avoid a looming working capital shortfall.

Common ResultThe supply chain trims inbound supplier orders and accelerates promotional activity through the S&OP process. Discounting pushes warehouse stock out to customers, resulting in higher unit transportation costs because partial truckloads are used to fulfill partial customer orders. In addition, unit costs for inbound supply increase as lot discounts disappear. The company succeeds in freeing up working capital but increases costs and reduces gross margins.

Alternate ResultThe supply chain agrees that inventory reduction is a key opportunity. Rather than driving flat percentage cuts, the supply chain mines its inventory data to select segments of SKUs that can maintain service levels while reducing safety stock. In addition, the supply chain creates customer segments based on historical order data that may agree to more frequent case level deliveries, rather than monthly pallet deliveries, in exchange for a price increase.

Working Capital Improvement Initiative

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THIS ARTICLE WILL DISCUSS THREE TACTICS THAT LEADING SUPPLY CHAIN AND FINANCE FUNCTIONS ARE USING TO DRIVE PERFORMANCE AND PROFITABILITY.

Tactic 1 Inventory Optimization and Data Driven PlanningMost firms that sell, distribute or manufacture physical goods use at least one form of planning system for materials, warehousing, distribution, transportation, or any other component of an Enterprise Resource Planning (ERP) system the business might require. These systems are primarily used to drive standardization, task automation, and process discipline throughout an organization. Such systems were funded by finance across the 1980s and ‘90s with the understanding that an organization would become more efficient and scalable and, in some ways, succeeded in doing so.

But these planning systems that companies use to operate their business tend not to address either the SKU-specific or enterprise level tradeoffs that the supply chain faces when attempting to optimize for profitability. To address this very large opportunity, dozens of integrated demand and supply planning, forecasting and inventory optimization packages have cropped up since the mid-2000s. Yet, few companies have been able to harness the power of such systems for two reasons. First, the business case for the supply chain to acquire an inventory optimization system is unlikely to succeed in front of finance, given that the above systems currently in place were, in many cases, marketed to achieve this same inventory efficiency. Second, the optimization systems themselves are only half the equation; a small team of data scientists and planners is also required, possibly increasing fixed costs.

Until recently, only giant retailers were able to justify the large human capital and software investment in an inventory optimization program. But with today’s plethora of highly value oriented, modular, and ERP agnostic inventory optimization engines, the mass market is able to access the same multi-echelon inventory planning efficiencies as a large retailer. Companies with supply chains that manage spare parts, products with batch production or expiry requirements, discrete life cycles and semi-predictable demand or supply, have been able to remove 30% or more of the inventory from their systems while increasing availability. Such large returns are enabled by either in-house or outsourced data scientists and planners who continually automate the buying of low risk or easy to forecast SKUs and isolate higher value SKUs or families for further review.

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Tactic 2 Extend and Automate Supplier PaymentsIts no secret to CFOs that extending supplier terms as long as possible is a straightforward way to generate cash. Companies struggle in the execution phase because so much of the purchasing function is yet to be automated. The human element often overcompensates in attempts to appease suppliers and/or avoid fees by paying well prior to a due date. Few companies will be able to make meaningful progress here without adopting a payables automation program.

A simple yet effective solution for some expenses is a commercial credit card, which can extend and automate payments to suppliers. The monthly balance may be paid on the last available date just as consumers have done for years with their credit cards, extending payments by up to 45 days. Purchasing activity for technology such as hardware, software and telecom; travel and entertainment; fleet; facilities supplies and maintenance; and even staffing agencies are candidates for such a solution. These expenses can add up quickly in even a moderately sized business. To quantify the opportunity, which may include volume driven cash back or points, most credit card companies will run a match (free of charge) against existing suppliers currently accepting credit cards.

Though it may seem like an obvious tactic, very few companies actually use a commercial credit card to pay suppliers. Far fewer take advantage of complimentary payables automation programs. Using this tactic, not only can a company extend payment terms by up to 45 days, but valuable time is also preserved to focus on strategies such as inventory optimization, data driven planning and collaboration with customers. Coupled with the right bank to underwrite the unsecured credit risk, a commercial credit card can be an effective way to extend and automate supplier payments.

A simple yet effective solution for some expenses is a commercial credit card, which can extend and automate payments to suppliers.

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Tactic 3 Collaborating with Customers and SuppliersThe features and benefits of a collaborative supply chain are most evident in the functions that interact with both customers and suppliers (logistics, procurement, customer service, planning, etc.). Today, sharing data between customer and supplier is low cost and largely automated. The difficulty is in convincing the customer or supplier to share data, resources or make concessions. When it comes to implementing a collaboration concept between customer and supplier, the final barrier is oftentimes finance approving the internal business case (e.g. a price increase, discount, or even consignment/VMI situation).

If competitive issues are set aside, there are few practical reasons the supply chain cannot receive and interpret a customer’s own forecast. Feeding customer forecasts into the S&OP process can increase overall forecast accuracy and service levels. For example, progressive, agile supply chains are using customer forecasts to refine their own internal supply plans. Finance and the supply chain together might compare key customers’ buying forecasts with the internal manufacturing or inventory plan and track the gap over time. Identifying customer forecast bias can help the company proactively identify orders that are likely to expedite or cancel.

Progressive customer service and logistics functions are able to generate data enabling the supply chain to build a quantitative profile of SKU or customer level profitability. On the supplier side, such a picture of SKU profitability can be used to negotiate with suppliers. For example, firms that can harness the large amount of data available on inbound supplier shipments can approach their supply chain partners to identify buyer-supplier consolidation opportunities based on shipment frequencies, container utilization and transit times. Collaboration with finance (or at least implicit sponsorship) is vital in a consolidation project, as days of inventory might increase in exchange for even larger transportation savings.

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The Goal: A Total Delivered Cost ApproachThe preceding three tactics are a few of many that highly collaborative finance and supply chain functions can use to elevate their organization’s effectiveness. The longer term goal for many companies that have strong finance and supply chain collaboration is to understand, and then optimize, a supply chain segment for profit according to Total Delivered Cost.

Only organizations that have deep cost and supply chain visibility and influential, supply chain minded finance functions can use Total Delivered Cost as a decision driver. The difference between managing according to Total Delivered Cost and managing by functional incentive is that tradeoffs become more important than a function’s goal. In such an example, Procurement would not necessarily purchase the lowest cost transportation option but the most reliable carrier or solution fitted to the specific supply chain or customer. In addition, the sales function would be armed with the necessary data to convince a customer that its best interest is in receiving higher cost but smaller lot deliveries. Finance and warehousing would also agree that the higher inventory cost is also advantageous, as the availability of a specific SKU drives a very profitable customer segment.

In sum, Total Delivered Cost does not become actionable until the supply chain and finance collaborate and understand each other’s goals on a level more deeply than being able to read the KPI.

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What Can CFOs and Supply-Chain Leaders Do Now?The next generation of inventory and supply efficiencies will result from collaboration between finance and the supply chain. The above outlined techniques are just some of many that firms are using to use data and collaboration to create competitive advantage. Achieving these efficiencies will depend on convincing internal business partners, suppliers and customers to add value or innovate rather than offer price concessions.

1. The CFO should sit down with the head of global Supply Chain to create a back of the envelope pipeline of three types of projects. One, long-term projects that span products and locations. Take these ideas back to each other’s functional leads, and to business partners, and begin internal collaboration with one to two business units. Start small, and use data.

2. Review selected supplier payment terms. For certain indirect purchasing, evaluate the feasibility of extending credit terms using a procurement charge card with a commercial bank (California Bank & Trust is one option). Indirect procurement is a ripe area for such financial innovation, including parcel shipment, indirect materials, or technology such as hardware, software or telecom.

3. Examine how logistics data is used to negotiate with suppliers. If certain SKUs have unfavorable total delivered cost profiles, the supplier should be asked to provide greater volume discounts, or consolidate freight with other suppliers, rather than ship partial containers on collect freight terms.

4. Consider Total Delivered Cost, including inventory costs. This is particularly important when designing the supply chain for difficult to forecast or heavy inventory risk product families. To do so, ask logistics, distribution and warehousing partners to share the data needed to help build a total landed cost profile for each supply chain. Consider each function’s incentives when evaluating contribution to a product’s Total Delivered Cost. “Partnering for Performance Part 1: The CFO and the Supply Chain,” Ernst & Young, 2013. http://www.ey.com/GL/en/Issues/Managing-finance/Partnering-for-performance---CFO-and-the-supply-chain

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