Supply Chain Management: From Vision to Implementation

1. Supply Chain Management: From Vision to Implementation Chapter 8: Strategic Supply Chain Cost Management

2. Chapter 8: Learning Objectives • Explain what strategic cost management is a port in the company and SC success. • Apply the three elements of strategic cost management to an analysis within your organization. • Explain the relationship between process mapping in strategic cost management.

3. Chapter 8: Learning Objectives • Describe the various types of price and cost analysis strategies applied today. • Select the right type of cost analysis tool to best support a particular SC design situation. • Develop and explain the total cost of ownership analysis.

4. Profit Leverage Effect • Measurable cost savings that don’t hurt sales have a tremendous impact on the bottom line. • Profit impact of cost reduction is much greater than the impact of increased sales. • The lower the average profit margin, the greater the impact.

5. Cost Reduction vs. Sales Increase * Assume no change in operating expenses is required to generate additional sales or cost reduction.

6. Strategic Cost Management Principles Strategic cost management uses cost management techniques to reduce the organizations costs and improve profit while supporting its value proposition. • Three elements of strategic cost management: • Supply Chain Analysis • Value Proposition Analysis • Cost Driver Analysis

7. Supply Chain Analysis Supply chain analysis is the examination of the management of the flow of information, inventory, processes, and cash flows from the earliest supplier to the ultimate consumer, including the final disposal process.

8. Value Proposition Analysis • Value proposition analysis is the essence of a corporation strategy, determining how an organization chooses to compete in its markets. • Generic value propositions include: • Cost leadership • Differentiation strategies

9. Value Proposition Intel is putting the people and resources in place to sharpen our focus on the development of platforms that meet the demands of our customers and provide innovative and exciting new technologies for the marketplace. – Paul Otellini, Intel CEO

10. Value Proposition To use the Internet to transform e-commerce shopping into the fastest, easiest, and most enjoyable shopping experience possible. -Amazon.Com

11. Value Proposition Analysis New approaches for achieving competitive advantage include: • First to market provider: This was a very popular strategy in the late 1990s and continues to be an important approach to doing business today. • Service/solution provider: This has become one of the key ways for organizations to compete in this decade. Being a full-service solution provider requires a high level of understanding of customer needs and flexibility and willingness to meet those customer needs. • Technology Leader: This is a focused innovation approach, whereby the organization competes by providing the latest and greatest technology to its customers.

12. Value Proposition Analysis • Companies may choose a combination of value propositions. • Different strategic business units within the same company may choose different value propositions. • Value propositions may change over the product life cycle.

13. Cost Driver Analysis • Cost driver analysis identifies processes, activities, and decisions that actually create cost for the supply chain. • Cost drivers vary over time and among different products and services.

14. Generic Cost Drivers • Level of outsourcing within a company. Companies that outsource may experience higher costs for additional services than if it had internal operations. Overall costs may be lower when demand is erratic. • Use of nonstandard materials, components and parts. Custom items are more costly because of low economies of scale. Custom parts may have better performance or lower operating costs. • Scale of operations. Very large manufacturing operations must have high stable volume. Small manufacturing operations may be unprofitable at high-volumes due to overtime costs, inefficiency in operations, machine breakdowns and maintenance issues. • High level of finished goods product mix. The more options the organization offers its customers, the more inventory it may have to carry, and the more flexible it production operations must be.

15. Cost Driver Analysis • Cost drivers are not inherently good or bad. • Cost reduction strategies must analyze cost drivers in relation to their impact on the value proposition.

16. Cost-Reduction Considerations • For each product or service, how do you become aware of the value proposition in your organization at any point in time? • What is the value proposition for your organization, product, service? • Does the value proposition vary among business units and products or services? • If so, are you certain you have identified the right value proposition? • Does the value proposition vary over time? • If so, are you certain you have identified the current or future value proposition? • Will current/proposed activities be transparent to the customer? • If not, what in what way will they be visible? • Are these areas that the customer values? • Will the impact be positive, negative or neutral?

17. Example – Southwest Airlines • Utilize secondary airports wherever possible in major cities, for lower cost as well as reduced traffic and congestion to improve on-time reliability. • Standardize on one type of equipment (Boeing 737) to improve the efficiency of pilots and crew, maintenance, flight turn around and equipment substitution, when necessary. • Implement performance enhancing upgrades to the equipment to lower fuel costs, maintenance costs, noise level and improve range, contributing to lower cost and improved customer satisfaction. • Do not use pre-assigned seating, different classes of service or meal service in order to lower cost and speed turn around of airplanes. • Careful hiring and cross training of associates so that employees support the mission of friendliness and customer service, and are flexible to meet the needs of whatever job is required, within reason. • Customer self-ticketing, early adoption of ticketless travel and no use of travel agencies to reduce costs and promote efficiency.

18. Responsibility for Strategic Cost Management • Historically accounting and finance had responsibility for reporting and managing costs. • SCM requires a broader cost perspective. • Corporate Response: • Intel - accounting and finance develop tools, supply managers are responsible for delivering cost savings • SBC - internal consulting groups attack complex problems

19. Strategic Cost Management Tools • Cost analysis: including “should-cost” analysis or zero-based pricing, as well as analysis of service provider cost elements. • Price analysis: understanding the prices available in the competitive marketplace. • Total cost of ownership: analyzing the true cost of acquisition, use, maintenance and disposal of a good, service, capital equipment, or process. • Target costing: determining what the market will bear and working backwards to see how much you can afford to produce the product or service for, and still make a profit.

20. Decision Classification • Once the process has been mapped and a good understanding of the system has been achieved, a decision matrix can be used to determine the appropriate cost management tool. • The decision matrix classifies decisions according to: • Nature of the Buy • Relationship with Supplier

21. Nature of the Buy • Is the cost of the item or service important, perhaps due to high volume? • Is the technology used by the supplier critical to the product’s image, performance or quality? • Does the supplier have a critical brand name or image that you can use to generate sales? • Is the technology used by the supplier critical to future products, line extensions, or the next generations of products? • Is the item critical to getting leverage with supplier for other buys? • Could the item create environmental or safety concerns? • Are there limited good sources available? • Is the item purchase ongoing? • Other issues that complicate the buying situation for your organization at this time?

22. Supplier Relationships Sought • How long would we like to continue to do business with this supplier? • If we desire an on-going relationship, would we like this supplier to be aware of our intentions? • Would we like to share information related to the buy with the supplier? • Would we like the supplier to become involved in our product or service development? • Would we like the supplier to locate one or more of its employees at our facility? • Other issues that affect the nature of the desired relationship with this supplier at this time?

23. Classifying Suppliers/Purchases

24. Classifications of Decisions • Low Impact – low-cost commodity items; focus is on price analysis/comparison • Leverage – large purchases of items in competitive markets; focus is on cost analysis • Strategic Item – large purchases from important suppliers; focus is on continuous improvement • Critical Projects – large dollar volume infrequent purchase; focus is on life cycle cost

25. Tool Selection

26. Commodity Classifications

27. Commodity Classifications

28. Activity-Based Cost Management • Traditional cost accounting systems are used for internal reporting costs. • Ideally, cost accounting would like to use direct costing which determines cost based on actual expenditures. • Overhead, a pool of indirect costs, complicates direct costing.

29. Traditional Cost Accounting • Traditional cost accounting aggregates all indirect expenses into a classification called “overhead”. • Overhead is then allocated to production based on some benchmark activity. • Changes to the benchmark activity may distort true cost performance.

30. Traditional Cost Allocation System

31. Activity-Based Cost Management • Activity-based accounting provides a more accurate alternative to traditional cost accounting. • Activity-based accounting attempts to match indirect costs with the products or services that generate them. • Activity-based accounting allocates indirect costs based on the cost drivers that actually create them.

32. ABC Allocation

33. Activity-Based Cost Management Implementation of an ABC accounting system is a non-trivial event. Organizations may have to rethink: • Pricing strategy • Marketing strategy • Manufacturing strategy

34. Total Cost of Ownership (TCO) Total cost of ownership is defined as a philosophy for understanding all relevant supply chain related costs of doing business with a particular supplier for a particular good/service, or the cost of the process, were particular supply chain design. • Attempts to look at the big picture, considering cost beyond that of the purchase price.

35. Total Cost of Ownership Analysis

36. Step 1: Identification of Benefits Sought The first step in TCO analysis is to determine the benefits sought from the analysis. Reasons to conduct TCO analysis include: • Performance measurement • Framework for cost analysis • Benchmarking performance • More informed decision making • Communication of cost issues internally and with suppliers • Encourages cross-functional interaction • Support external teams with suppliers • Better insight/understanding of cost drivers • Build a business case • Support an outsourcing analysis • Support continuous improvement • Helps identify cost savings opportunities • Prioritize/focus your time on high potential opportunities

37. Good Candidates for TCO Analysis Products and services that match the following criteria are good candidates for TOC Analysis: • The firm spends a relatively large amount of money on the item • The firm purchases the item with some degree of regularity, in order to provide some historical data, but more importantly, to allow opportunities to gather current cost information. • Purchasing believes the item has significant transaction costs associated with it that are not currently recognized. • Purchasing believes that one or more of the currently unrecognized transaction costs is individually significant. • Purchasing has the opportunity to have an impact on transactions costs, via negotiation, changing suppliers, or improving internal operations. • Those purchasing/using the item will cooperate in data gathering to learn more about the item’s cost structure.

38. Step 2: Form a TCO Team Once a project has been identified, a TCO team should be formed. Members should include purchasing, users, and any functional/technical experts.

39. Step 3: Identify Cost Drivers • Begin the analysis by expressly identifying potential costs by mapping the process flow for all aspects of the project. • From the flowcharts, brainstorm key cost drivers. • Gather cost data for all identified cost driver for each alternative.

40. Flowchart - Printer Example

41. Flowchart - Printer Acquisition Example(2)

42. Key Cost Drivers

43. Gathering Cost Data

44. Step 4: Fine Tune • Step 4 allows for fine tuning of the TCO analysis including the use of sensitivity analysis. • Sensitivity analysis allows for testing of “what-if” scenarios. • Decisions that do not change based on changes to assumptions of data are said to be robust. • Managers can have more confidence in robust decisions.

45. Step 5: Present • Step 5 requires that the TCO analysis findings be presented to the appropriate management level. • Format for presentation should include: • Summary of TCO analysis results • Sensitivities • Non-Cost Issues • Recommendation • Presentation should also include “soft” costs

46. A Return to the Opening Story Based on what you have now read and discussed: • Why the companies engage in across-the-board demands for cost-cutting rather than using a strategic cost management approach? • What is a good way to identify promising initial project for strategic cost management? • How do problems with current management accounting systems complicate the strategic cost management process?

47. A Return to the Opening Story • How can a company reduce costs without compromising quality or service? • Who needs to participate in strategic cost management? • What tools can help the firm understand the broad cost implications of its decisions?