As the holy grail of operational excellence, true and quantifiable customer value delivery continues to elude many supply chain designs through excessive inventory investments, rampant SKU proliferation, limited customer profitability indices and inadequate customer behavior modeling. Far too often, these four attributes combine to defeat true value delivery and invariably inflate total supply chain costs, while decreasing operational efficiency. That’s the bad news.
The good news? Savvy supply chain executives have discovered several simple, practical and cost-effective tools to radically transform their supply chain capabilities into customer value delivery vehicles, properly balanced across all key objectives including service excellence, cost-effectiveness and customer profitability. By relentlessly focusing on four simple concepts, executives can better focus their continuous improvement dollars on those investments providing the greatest returns in customer value, loyalty and increased spend:
- Adopting portfolio-based SKU rationalization methods to maximize total value
- Routine, continuous customer segmentation for hyper-focused profit targeting
- Supply chain cost-to-serve analytics balanced against a “right mix” SKU portfolio
- Digital twin modeling to relentlessly pursue the optimal inventory investment profile
Armed with the right toolkit, supply chain leaders can abandon traditional analytics and one-size models in order to achieve highly tailored supply chain solutions providing cost-effective routine value delivery and greater customer profitability. These four tools can sharpen supply chain agility and accelerate value delivery to the customer.
The defeat of traditional supply chain design
Conventional supply chain wisdom holds that extensive inventory investments are the single best risk management strategy for customer service delivery. In a world dominated by daily (if not hourly) consumer demand patterns and buying behavior shifts, stockpiling strategies destroy overall agility and significantly inflate supply chain costs. While the phrase “supply chain transformation” is widely overused (and often poorly understood), world-class supply chain leaders have acted.
In the competitive and globalized supply chain space, organizations often focus on unattainable goals without understanding the full consequences. Customer demand acts as a moving target; rather than using inventory buffers to prepare for unexpected events, organizations can look internally to optimize their processes as a front line for ever-changing shifts.
World-class supply chain leaders have not only discovered the right mix of value-delivery tools, but have also institutionalized them as the vanguard for cost-effective customer service excellence. In nearly all cases, highly successful organizations have discovered the right tools to launch their supply chain transformation.
Acting in concert, each of these tools builds upon the others for a holistic approach to success. Starting with the simple notion of embedding the customer within your supply chain, the right concepts and actions stand out:
- The simpler the SKU portfolio, the easier it is to enhance and optimize
- Redefine the value of each SKU and eliminate those that do not make the financial cut
- Merge the emerging SKU portfolio against customer analytics to highlight overlaps
- Deploy digital modeling to assess final impacts and confirm the optimal solution
The result proves itself in a simpler, stronger SKU portfolio as the backbone of customer reach, in turn reducing high costs-to-serve and clearing the excess information so the digital twin can operate.
Though linked heavily to marketing, the responsibility to tailor products and services to the customer also falls to the supply chain, which has the dual purpose of consistently meeting customer expectations and delivering on the promise of operational excellence and cost effectiveness. Dedicated “customer-first” strategies are always worth the time and effort, and can be enriched with a digital twin — used only to a limited extent today — wrapped with a breadth of possibilities to enhance the customer-facing supply chain.
Demand-driven SKU management
Today’s consumers are hyper-informed, quick to judge, impatient and, with COVID-19 impacts forcing ever more focus on price, demand value-laden options ranging from delivery speed to highly personalized features. Such demands often go unanswered because many organizations respond with unfocused SKU management models that are invariably overstocked with yesterday’s leftovers, not today’s chef’s specials.
Organizations known for aggressive, agile SKU management constantly reevaluate their SKU portfolios. They are leaders in flexibility, prepared for rapid technology changes and shifting demands. Traditionally, organizations wanted presence in each market, driving up inventory count and costs. To reduce SKUs, those companies often executed a standard Pareto analysis with the initial tendency to “cut the tail” and remove the underselling SKUs. However, basing discontinuation solely on one metric often has unintentional consequences including the defeat of customer centricity through inaccurate SKU portfolio adjustments.
Forward thinkers concentrating on today’s needs and tomorrow’s trends account for a wider view of SKU impact, understanding the long-term effects of discontinuation and the power of customer perception of the company. They anticipate and react to foreseeable change, understand the financial and logistics implications, and alter their management of SKUs accordingly with full awareness of the effects.
Rationalization’s unintentional disregard of customer segmentation
The inclination to discontinue SKUs originates from the bottom line. Organizations should look past the financials and ask themselves the following questions:
Answers to these will round out the SKU analysis. Today, various software offerings, data visualization tools and digital twins allow organizations to view dynamic graphs of the product portfolio with options to disaggregate by product family, industry or international channel, illustrating the relationships and dependencies between SKUs. Traditional spreadsheet analytics do not provide the answers; knowing the customer segment and its tendencies, paired with core financial data, provides sufficient insight for organizations to execute SKU rationalization.
Segmentation benefits for inventory management
Customer segments drive an organization’s market and business strategy. Companies use patterns of feelings and predispositions to enhance the accuracy of their unique, customized response to each segment. Innovative industry leaders use two key methods of customer segmentation — segmenting by customer value and segmenting by customer need. Knowing and actively reassessing the customer segment size, value and personalized approach will position the organization for greater customer retention, increased segment profitability and a greater ROI.
Soon after integrating this customer segmentation strategy, organizations uncover key information and achieve more accurate forecasting. With a stronger forecast, warehouses will not need to stretch capacity requirements or alter production plans to accommodate the imbalance of supply and demand. The increase in worthwhile information acts as a substitute for excess inventory, and the cutting-edge organizations that use this strategy will realize the benefit of less inventory to manage a faster, more agile response.
ROIC’s impact on inventory management and customer strategy
Segmentation strategy, forecasting and inventory management decisions all intertwine and overlap, and the success of one benefits the others. Traditional companies view return on invested capital (ROIC) with a heavy focus on physical equipment and investments. They, however, miss the indirect methods that are vital to developing a resilient strategy.
With fewer SKUs, transportation and inventory costs decrease at each supply chain echelon, and the nucleus company receives an increased ROIC — the warehouses, manufacturing sites and plant equipment all become more cost-effective. In an organization with multiple products and/or services, the portfolio should be analyzed for how to best manage it (account for different order management, inventory and forecasting operating practices). Proactive supply chains understand the need to respond in unique ways, based on the nature of the product and service.
Supply chain costs, strategic customer decisions
Many organizations cope with poorly managed product cost parameters, causing difficulty in decisions such as lowering SKU volumes. Key parameters to assign to SKU costs are bill of materials, labor costs, overhead costs, cost to serve customers (cost channel strategy) and variable contribution (the balance between variable and fixed costs).
As organizations optimize the profitability of their product portfolio, understanding cost indicators and the ROI of each product supports managerial decision-making. Executing a cost-discovery phase will help identify and segment your portfolio ROI and perform a product- and SKU-level analysis to develop an improved supply chain management (SCM) strategy.
A well-known approach to supporting this cost calculation, and to inform the decision-making process, is activity-based costing (ABC), which focuses on the activities that cause costs to increase. Traditional activity-based costing uses transaction-based drivers (i.e., number of orders received and assigning costs to each activity), while a better suited method is time-driven activity-based costing. This approach allows managers to directly estimate resource demands per transaction, product or customer, rather than allocating resource costs first to activities and then to products or customers. For each group of resources, estimates of only two parameters are required:
- Cost per time unit of supplying your resource capacity
- Unit times of using resource capacity by products, services and customers
These two parameters provide an estimate of resource demands per transaction, product or customer. Time-driven ABC works well for customer segmentation and SKU rationalization because it can support complex calculations. It increases the organization’s understanding of overhead and other cost drivers, and makes costly and non-value-adding activities more visible, allowing managers to reduce or eliminate them entirely.
Identifying individual product margins and driving supply and distribution efficiencies can present a real challenge to organizations. Methods such as activity-based costing and process value analyses effectively enable companies to identify product margins down to the SKU level. Conducting a total-cost-to-serve analysis after the company performs SKU rationalization and a customer segmentation breakdown enhances the information and intelligence that the data provides. This provides the organization with an understanding of what the company needs to move forward with its strategy, realize cost reductions and improve product margins.
Decision accuracy through digital twin modeling
One solution to managing SKU use is leveraging a digital twin solution. A digital twin is a virtual model of a physical-world process, product or service. The mirroring of the physical world allows organizations to conduct data analysis and system monitoring without impacting the day-to-day operations. It can prevent certain issues from happening through simulation development of worst- and best-case scenarios. Although the idea of using a digital twin for simulations is not a new concept, organizations are not utilizing its full potential.
Key benefits of digital twin integration include:
- Decreased risk of equipment failure, achieved through real-time response to digital twin analyses and alerts, allows for greater ROI and improved customer service.
- Ability to act upon new opportunities as a result of multivariate test analyses that digital twins can present to supply chain management, allowing the organization to continuously plan inventory.
- By using customer data, digital twins can continuously be updated to support the organization’s customer portfolio and reflect customer’s actions, thoughts and feelings.
Digital twins can play the role of acting on behalf of connected manufacturing physical equipment by sending notifications and alerts to employees who require this real-time information. This allows the end users to act upon new opportunities or risks to which their assets are exposed (e.g., condition of system, state of machinery).
One company currently in the development and implementation of its digital twins is Chevron Corporation. The company, according to supply chain management association APICS, will use the technology to predict and prevent maintenance issues with its high-value equipment. Entering and growing in the energy industry requires high entry costs including substantial capital investments in plant, refinery and other facility equipment. One piece of equipment that needs maintenance can create a bottleneck and cause the company to delay production, resulting in a loss of time and money. Chevron believes that with the integration of digital twins, the company will save millions of dollars each year.
A digital twin in supply chain allows an organization to continuously manage inventory, as well as the entire physical network. In a demo-context, the twin can be used to run a variety of test scenarios and understand how the twin (and physical organization) will respond. In the physical world, an assembly line can, by receiving visual triggers, instantly act. By leveraging customer data and using it in a digital twin solution, inventory can be managed continuously and adjustments can be made in the physical world, with real-time notifications of changing demands.
Create a single, holistic model
Today’s supply chains operate in a pressure cooker environment, which will only get worse as customers continue to demand greater speed and variety. To effectively manage continual change and institutionalize supply chain agility, supply chain executives can take four simple actions today to manage the onslaught:
- Rapidly execute a voice-of-the-customer SKU rationalization process to determine the overall “fit and function” of each SKU in the portfolio
- Conduct a customer segmentation analysis to enhance the understanding of the company’s types of customers and their overall contribution to profitability
- Execute a comprehensive cost-to-serve analysis on the evolving SKU portfolio to determine the overall profitability (and margin contribution) each SKU provides and the extent to which operating expense tools are required to eliminate waste and lower the cost-to-serve
- Conduct a comprehensive supply chain cost-to-serve analysis, with attention to often-overlooked cost parameters and their impact on each SKU
- Deploy digital twin technologies to run a variety of test scenarios and understand how the twin (and physical organization) will respond and illustrate the potential benefits and enhanced ROIC gained
With a single, holistic model, supply chain executives can access far greater clarity on SKU profitability, customer retention issues and cost-to-serve reduction opportunities. These analyses and their associated outputs, when conducted in concert, have the potential to drastically improve a company’s overall supply chain performance through healthier inventory management practices, high-performing customer relationships and overall cost savings.
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