At The Supply Chain Engineer™, we are keeping a close eye on the Coronavirus, or COVID-19, and the implications it has for your business, particularly your supply chain management. We would like to share with you our insights into how we see this unfolding in the near future as well as things you can do now to harden your supply chain and make it more resilient to this and future disruptions
Anticipated Distribution and Business Effect
There remains much uncertainty around this outbreak and there are several potential outcomes depending on the virus’s seasonality and other variables. What follows is the scenario we expect will play out, although it represents only one among many possible results. Based on several reputable and well-informed analyses, we believe that the US will likely experience between 50,000 and 500,000 cases nationwide, with the majority of these occurring in three to five major cities and several other cities reporting a few dozen cases each. Personal, business, and governmental mitigation behaviors will likely extend for around six-weeks in the harder hit metropolitan areas and three or four-weeks in outlying areas. We anticipate that the virus will follow the typical coronavirus pattern of seasonality in humans and largely dissipate on its own as the seasons warm.
The financial impacts of COVID-19 will result in a global
slowdown, although not a recession. In
the US, we expect that the economy will still grow, but at around 1% to 1 ½% –
about half of last year’s rate. This
will have the greatest impact on small- to mid-sized companies. Aviation, hospitality, tourism, and related
services industries will be hardest hit with consolidations likely to increase
dramatically. As shown below, the impact
will vary across industries.
Courtesy of Resilinc Corporation
Supply Chain impacts have so far been due to Chinese
shutdowns. Presently, outside of Hubei, most of China has returned to more
than 90% production. Hubei will likely not return to that level until sometime
in April. Trucking capacity remains at
only around 80%, causing an eight to 10-day delay getting products to port for
overseas shipping.
This all may result in inventory allocations by key distributors within the United States as their Chinese suppliers ramp up production and attempt to manage their own inventory whiplash. At the same time, consumer demand shocks will continue. Items seen as consumer necessities – non-perishable food products, paper products, bottled water, sanitizers, and antibacterial cleaners – will continue to spike as consumers in areas with outbreaks attempt to prepare for self-quarantine. This transient demand shock will give way to a drop in demand as consumers find themselves temporarily overstocked.
Overall, we expect COVID-19 to result in an
additional 10- to 20 weeks of supply chain disruption
before the recovery is complete. This means we will continue to feel the
effects through mid-May to July.
How to Harden Your Supply Chain Now
Even though it may be too late to anticipate the outbreak,
there is still time to mitigate the impact of COVID-19 and to prepare your
supply chain to withstand future disruptions.
Protect your personnel – This disruption will pass. In order to rebound quickly from any breach of business continuity, you must keep your assets and personnel safe so you can return to full capacity as quickly as possible. The Association for Supply Chain Management recommends, “Follow the Centers for Disease Control and Prevention guidelines. Give your workforce a constant, calm, flow of reliable information. Restricted travel policies are a beginning. Also implement screening protocols, increase workforce hygiene standards, and promote telecommuting and other flexible arrangements. Encourage people with preexisting conditions, who are more susceptible to the virus, to self-declare. Then, proactively shift them to remote work.”
Know your stock coverage – It is critical to know how many days of coverage you have of key materials so you can prioritize the items for which you need to find mitigation solutions.
Keep your suppliers in the loop – In times of crisis you cannot over-communicate with your principal suppliers. This will happen automatically if you have digitized your supply chain, giving you the added advantage of speed. If not, your buyers and commodity managers need to fight for their attention. It is particularly important to keep in nearly daily communication with those suppliers in affected areas in order to stay on top of potential supply shortages.
Identify alternate suppliers, materials, and resources – Once you have identified your material mitigation priorities and coordinated with current suppliers, you will have a concise “shortlist” of essential items that you need to re-source. Look for alternate suppliers and materials. If needed, consider re-engineering the parts to make them easier to source.
Map your Supply Chain – You know where your tier-one suppliers are and if they are in affected areas, but what about your tier-two or tier-three suppliers? Are they directly impacted by the disruption? Are they financially able to withstand the impact (65% of smaller suppliers in China have 2 months cash)? By mapping your supply chain, you will know where your risks are and can receive near-real-time warnings.
Digitize your Supply Chain – Digitizing your supply chain not only reduces transactional costs, it allows you to buffer risk with less expense. Further, digitization automates many functions, reducing errors and increasing speed. And in a crisis, speed is life.
Contact Carl@TheSupplyChainEngineer.com today to discuss how we can help you mitigate your COVID-19 risks and harden your supply chain to increase resilience against future disruptions.
Whether you are reading the
headlines, looking at data trends, or living it in the trenches, it is easy to
see that our world is full of potential and actual disruptions that can affect
business operations. Examples from the
last year include Hurricane Dorian, the UAW strike at General Motors, and the
ongoing threat of tariffs and Brexit, and from today’s headlines we have a new
threat – the coronavirus. Some disruptions like natural disasters come with
little warning, others lurk in the environment and managers struggle to decide
if, when and how they should prepare for them.
Being the proverbial ostrich with your head in the sand does not keep
the disruptions at bay – it just guarantees you will be blindsided by them. In
today’s business environment, it seems managers across all functions need to be
always ready to respond. We call such an
organization ‘resilient’ and we define it as the “capacity of an enterprise to
survive, adapt and grow in the face of turbulent change”. While many focus the resilience discussion on
surviving the disruption and getting “back to normal”, we believe the concepts
of adapting and growth are important elements, as 1) all disruptions are
learning opportunities that can make us better next time; and 2) some
disruptions necessitate changes that put is in a better position for
sustainable future growth.
Our research efforts working with national and multinational companies led us to conceive of resilience as a balance between understanding your vulnerabilities and building appropriate capabilities. Vulnerabilities are the environmental factors that make an enterprise susceptible to disruptions
Figure 1: Balanced Resilience
(more details to follow). We typically think of vulnerabilities as inherent in the environment – not something we can control. Some organizations face a lot of vulnerabilities – others relatively fewer. Capabilities are the management controls that enable an enterprise to anticipate and overcome disruptions. You can think of these as the risk mitigation strategies that managers can choose between. The goal of an organization is to be in a state of ‘balanced resilience’ – that is one where they have developed the right level of capabilities for the level of vulnerabilities they face (see Figure 1). If your capabilities aren’t sufficient for your level of vulnerabilities, you are exposed to risk. If you have built capabilities that go beyond your level of vulnerabilities, you could be eroding profits by over-investing in those capabilities.
Of course, this
is a simplified view because it is also necessary to have the right capabilities. If your organization is highly vulnerable to
cyberattacks, it doesn’t matter how much redundancy you have in your supply
network. So, we have to think about this
a bit deeper to truly help managers with their decision-making.
To dig deeper,
we identified 36 vulnerabilities, which we categorized into 6 categories (see
Table 1). When people discuss risk, they
often focus on vulnerabilities like natural disasters, supplier issues or technology
failures. However, a firm’s risk profile
is determined by far more than these risks.
Let’s take brand awareness as an example. Both Coca-Cola and National Beverage face external
pressure because they make soft-drinks that research has shown increases
obesity and rates of diabetes. However,
the strength of Coca-Cola’s brand makes them more susceptible to public
attacks, and therefore at a higher risk of demand fluctuations if another
research report hits the headlines connecting their products to consumer
health. Similarly, well-known companies
might be more popular targets of cyber-attacks or terrorism than smaller
firms. We must therefore think broadly
about vulnerabilities and even understand how multiple risk areas might
interact.
Table 1: Vulnerability and Capability Factors
We also identified 71 capabilities, which we categorized into 14 categories (see Table 1). As with the vulnerabilities, some of these are often the focus of discussions on risk management – flexibility, redundancy and visibility are all terms that get a lot of attention. Others, like brand loyalty, might not be as obvious, but if Apple delays the launch of a new product because of a supply chain glitch, can they take advantage of their customers’ loyalty? Yes, many of their customers are willing to wait and are less likely to turn to a competitor’s product, so they can weather the disruption better than, say, Nokia might. We have also had many interesting conversations with managers and executives around organizational capabilities. Some organizations (particularly smaller ones) are able to make quicker decisions in a time of disruption because they have empowered decision-makers throughout the organization, or they have better lines of communication between functional areas. One company we worked with credited their strong employee loyalty for how they managed through a data disruption – the employees were dedicated enough to their jobs and the company that they jumped in and took pride in working overtime to see the organization through the crisis. Indeed, resilience capabilities come in many forms.
Figure 2: Resilience Gaps
Now that we have them identified, we are at a point where we can discuss matching vulnerabilities with capabilities. For each vulnerability in Table 1, we have identified the specific capabilities that an organization could build to help them prepare for or recover from a disruption caused by that vulnerability. Think of this as a large matrix with the 36 vulnerabilities down the side and the 71 capabilities across the top. If you are facing a particular vulnerability, you can look across the row and see the menu of capabilities that you could consider building to help mitigate that risk. Or if you are thinking of building a particular capability, you can look down the column and see which risks that might help you mitigate. To further help with decision-making, we have created a tool (SCRAM™) that will help you measure the gap between a particular vulnerability-capability pairing. If you rate a vulnerability as high, and a capability as low, you have a large gap in that corresponding cell. Figure 2 shows the results for a SCRAM™ assessment at the factor level, but it can also measure gaps at the subfactor level. Again, a manager can look at these results across a row or down a column to help determine the menu of capabilities that could be built to match the pattern of vulnerabilities the organization faces, and therefore increase their state of resilience.
SCRAM™ is just one of many tools managers have at their disposal to help develop resilience and be better prepared for the turbulence that lies ahead. Risk registers, business continuity planning, war-gaming, supply chain mapping and simulation are others that can help firms understand the risks they face and develop action plans to mitigate them, or help the efficiency or effectiveness of recovery efforts if a disruption occurs. Regardless of the tool applied, the important thing is to think about risk and disruptions as inevitable – be proactive (don’t be an ostrich) and try to create a state of balanced resilience.
This article is based on the
following published articles, which would also make good further reading:
Fiksel, J., M. Polyviou, K. Croxton, T. Pettit,
“From Risk to Resilience: Learning to Deal with Disruption”, MIT Sloan Management Review, Winter
2015.
Pettit, T., K. Croxton and J. Fiksel, “Ensuring
Supply Chain Resilience: Development and
Implementation of an Assessment Tool.” Journal of Business Logistics. Vol. 34 (1), 2013, pp. 46-76. Winner of an Emerald Citations of Excellence
Award.
Pettit, T., J. Fiksel and K. Croxton, “Ensuring
Supply Chain Resilience: Development of
a Conceptual Framework.” Journal of Business Logistics. Vol. 31 (1), 2010, pp. 1-21. Finalist for the Bernard J. LaLonde Best
Paper Award. Most cited paper of the
decade (2010s).
In Part One we looked at Dr. Joseph Fiksel’s Resilience Model in general and the two slower changing quadrants in particular. In Part Two, we look at the dynamics of abrupt changes in the supply chain and what Fiksel’s Resilience Model suggests.
~~~~~~~~
As we move further to the right on Fiksel’s Model, we
venture into the territory of more abrupt change. This is the business equivalent of full
battle engagement. Sirens wail. Red lights flash. “Battle Stations!” is sounded over the PA. And supply chain professionals don flack
jackets and helmets as they charge toward their bunkers, telephones, and
computers.
To say the least, this is the part where things get a bit
less routine and a tad more interesting.
So, let’s look a little closer at these next two quadrants.
Sense & Respond in Fiksel’s Resilience Model
The Low Magnitude/High Abruptness Quadrant covers those
sudden disruptions you quite often didn’t see coming. These can range from short-term backorders to
the black swan – the rare and unpredictable event – that can have lasting
impact.
Sensing is an important part of this. Companies such as Resilinc
provide supply chain intelligence and monitoring that can alert its client companies
to upstream disruptions early on, allowing time to avoid or mitigate the impact. More on this in the future.
This type of data can be consolidated, visualized, and
utilized to respond to changes in the supply chain ecosystem. A perfect example of this is Flex Ltd.’s (formerly
known as Flextronics International Ltd. or Flextronics) Flex Pulse. Pulse is Flex’s End-to-End software-based, digital
collaboration tool that provides unprecedented levels of inventory visibility
and real-time global intelligence for managing supply chains. This software-based
system combines and interprets live streaming data from multiple sources to
provide intelligence on any global variables that may impact or disrupt
manufacturing supply chains. Flex Pulse also provides a consolidated view that
allows active monitoring of inventory, material quantities, and quality, as
well as transportation tracking, including shipment volumes, delivery times,
and other aspects of order management.
Flex Pulse Center – Photo Courtesy Flex
Flex Pulse Center is a physical location enabled with multiple
collaboration capabilities allowing real-time monitoring of different aspects
of Flex global supply chain.
Currently, there are nine Flex Pulse Centers located at strategic
manufacturing locations in Milpitas (CA), Guadalajara, Tczew, Althofen, Austin
(TX), Chennai, Migdal HaEmek, Wuzhong and Zhuhai.
In addition to Flex Pulse Centers, Flex Pulse is accessed through any
computer, tablet, or smart phone, and serves as a platform for collaboration
between multiple users.
Risk Management & Business Continuity
For most events that fall in this category, having well-defined risk management processes and emergency procedures in place will help mitigate the problem. Melinda McCants, External Supply Risk Management and Senior Resiliency Officer for Amgen, recommends the creation of broadly cause- or scenario-based (i.e., fire, flood, terrorist activity, etc.) playbooks focused on priorities:
Life preservation
Asset preservation
Business continuity
At the business continuity level, things begin to shift to both
a resource-based and more functional point of view. The switch to a resource-based perspective
means we no longer care so much about the situation which caused the disruption
(was it a chemical spill, a plant fire, etc.) to what resource was compromised
or removed from action (e.g., did we lose a fabrication facility, a metal plater,
or all our suppliers along the northeast coast of Japan?). In other words, the effect of the event. Here ISO
22301, Business continuity management systems – Requirements, provides an
internationally recognized standard that practitioners can use to architect their
organization’s business continuity management (BCM) program. From an operational standpoint, this ISO
Standard contains a requirement not previously addressed in business continuity
standards – the need to plan for a return to normal business. Key to this is identifying and maintaining alternate
supplier(s) for mission
critical materials, a plan for personnel substitution or replacement, and Business
Impact Analysis.
When establishing alternate suppliers, it is important to
confirm to the degree possible that these are, indeed, true alternate
suppliers. The point here is that Spacely
Sprockets and Cogswell’s Cogs are not genuinely alternate suppliers if they
both share a common, critical first-tier supplier, Harlan’s Hardware. A plant
fire at Harlan’s cripples both of these suppliers. Clearly, the more upstream suppliers
our suppliers share, the more fragile our supply chain becomes and the accumulation
of additional “alternate” suppliers that share those same upstream vendors adds
little more than further onboarding and maintenance costs.
This is where supply chain visibility comes into the
equation.
Survive and Flourish in Fiksel’s Resilience Model
“The green reed which bends in the wind is stronger than the mighty oak which breaks in a storm.” ― Confucius
The world of the Supply Chain Engineer is complex and
getting more so every day.
Offshoring. Nearshoring, Reshoring. Global suppliers. Regional civil unrest. Inconsistent trade regulations. On and on….
To address the issues associated with the Survive and Flourish quadrant, Fiksel recommends the following functional actions:
Scenario-based planning,
Crisis management,
Opportunity realization.
He also suggests the following structural configuration
changes to support this quadrant:
Asset security and fortification,
Modularity and redundancy,
Business diversification.
Chart Courtesy of Resilinc
Antifragility
With each new layer of complexity comes an exponential increase in risk and vulnerability to disruption. And catastrophic failures in supply chains are consequently becoming increasingly frequent. For this reason, companies can no longer rely solely on risk management and business continuity plans. These are reactive survival tactics, a set of tools to get through a Terrible, Horrible, No Good, Very Bad Day …. They do not, however, do anything proactive to anticipate these disruptions and to build a capacity of resilience. To lift a phrase from Nassim Taleb, traditional risk management and business continuity planning do nothing to make the supply chain organism (SCO) “antifragile”. Taleb defines antifragile as the opposite of fragile. And while Fiksel argues that the term “resilience” incorporates Taleb’s concept of the antifragile, I think they are complementary, but somewhat different, concepts. Going forward, we will use the term antifragile to describe the resilience tools and processes used in the Survive and Flourish quadrant of Fiksel’s Resilience Model.
Taleb says,” Antifragility is beyond resilience or
robustness. The resilient resists shocks
and stays the same; the antifragile gets better. This property is behind everything that has
changed with time: evolution, culture, ideas, revolutions, political systems,
technological innovation, cultural and economic success, corporate survival,
good recipes (say, chicken soup or steak tartare with a drop of cognac), the
rise of cities, cultures, legal systems, equatorial forests, bacterial
resistance … even our own existence as a species on this planet. And
antifragility determines the boundary between what is living and organic (or
complex), say, the human body, and what is inert, say, a physical object like
the stapler on your desk.”[i]
Imbedded in Taleb’s definition are two key ideas:
Antifragile systems can actively benefit from
disruption, chaos, volatility, and uncertainty; and,
Antifragility is the hallmark of the “living”,
complex system and differentiates them from “inert” objects.
When we look at the specific ways to address and
mitigate risks in this quadrant in later posts we will examine these two
features along with a Paleontologist’s view of what happened following the K-T
extinction event 65 million years a
[i] Taleb, Nassim Nicholas. Antifragile (Incerto)
(Kindle Locations 331-336). Random House Publishing Group. Kindle Edition.
In a previous post, I pontificated on what a Supply Chain Engineer (SCEng) does. What I didn’t go into is the idea of the making of a Supply Chain Engineer.
Training a Supply Chain Manager
In general, when we talk about a supply chain management professional,
we think of the Buyer, or the Logistics Specialist, or the Inventory Manager,
etc. While many of the practitioners out
there learned their profession on the job, more and more, employers are looking
for SCM professionals trained through more formal education – Bachelor’s,
Master’s, even Doctoral degrees. In some
cases, a general background in finance and accounting, economics, and business
administration is enough. In others,
training specifically focused on supply chain management, logistics,
operations, and procurement is preferable.
In any case, these programs are business administration degrees. That is to say, they concentrate on the business
of managing the flow of goods and services from raw materials to finished goods
delivered to the end customer.
Training the Supply Chain Engineer
The SCEng’s training is somewhat different in that it is
geared toward developing a business-savvy engineer. The product of this
training is a thorough knowledge of analytic methods, engineering practices
specifically focused on designing and synchronizing highly complex regional,
national, and global supply chains, coupled with enterprise management and
professional practice skills. Here, in
addition to business courses related to SCM, the areas of study include:
Supply Chain Analytics
Machine Learning and Data Mining
Supply Chain Cost and Financial Analysis
Optimization Methods
Designing Logistic and Warehousing Systems
Supply Chain Information Systems and
Technologies
Supply Chain Design
The approach is much more technical. The Supply Chain Engineering degree is
usually (although not always) a Master’s-level degree in Applied Science. It is a true Engineering degree.
Now for the Crazy Idea
The Master’s-level SCEng degree generally consists of around
30 credit hours of training. Come to
think of it, a Bachelor’s degree usually requires about 30 credit hours of courses
in the Major. And even an Associate’s
degree requires around 30 credit hours in the Area of Focus.
Hmmm. It seems to me
that given 30 credit hours of time with a given student, I could likely teach
the same material independent of the setting.
To put a sharper point on that idea, I could teach the same student the
same material whether he/she was attending an Ivy League Graduate School, getting
a Bachelor’s at a State College or even an Associate’s at a local Junior
College. It may not be quite a nuanced and as detailed at
the undergrad level as the graduate program, but fundamentally the same
See where I’m going with this?
So, if they all get the same training, what’s the difference
to the student? Well, after four years
of undergrad work and then an MASc from the Ivy League school, the student
graduates with knowledge of supply chain engineering along with around $300,000
of student loans. The State College undergrad
graduates with the similar subject matter knowledge and about $125,000 of
debt. But the Junior College student graduates
with the same core knowledge and little to no debt.
And how does that impact the company that hires these
grads? Well, let’s assume that the
starting salary of a newly minted SCEng runs around $70k and that we place the
State College grad at that salary. The
Ivy Leaguer would need to earn at least $95k to have the same disposable income
after paying his/her student loan debt.
But the Junior College student could live just as comfortably at around
$55K. So, from a hiring company’s point
of view, what is the advantage of paying 20 – 40% more for the same knowledge? From where I stand, not much. Alternately, you could pay them all the same
base rate (i.e., $70K), but the likely result is that those with the higher student
loans will need to move on to better paying positions faster than those with
lower overhead.
Finally, how does this benefit the profession? Two ways immediately come to mind. First, it allows skilled engineers to go into
the field quickly and replace other, less skilled and less trained individuals masquerading
under the title of Supply Chain Engineer.
Just as the guy who picks up your trash each Thursday is not a true
“sanitation engineer” (or likely any other type of engineer for that matter),
neither are most of the people presenting themselves today as Supply Chain
Engineers genuine engineers. And the longer they can pose as such, the more it
damages the image of the SCEng.
Second, the whole point of an Applied Science degree is just
that – for the practitioners to apply their science. Sure, if you want to be an academic you need
to dive into higher ed for the long run.
You need to memorize the names.
You need to know the details of the profession’s history. You’ve got to really grasp the theories that
underlie the science and technology.
But, if you want to be an engineer, you want to do only one thing –
apply your science. So, by making SCEng
an undergrad program we provide more people the opportunity to enjoy the
satisfaction and sense of contribution that engineering offers.
The Icing on the Cake
I recently discussed this idea with Todd Larson, AVP & Asst. Director Corporate Services at Amica Insurance. Todd posed an interesting concern: will new employees with an undergrad degree be more inclined to ‘jump ship’ quicker than new hires with advanced degrees after they get some experience under their belts? Indeed, most companies look at a two to two-and-a-half-year breakeven point on new hires. If these new engineers are going to come onboard and stay only long enough to get a new line in the experience column of their resumes, that’s going to be a problem.
Thankfully, the US Government helped to provide a little insight. According to the Bureau of Labor Statistics[i], “The median number of years that wage and salary workers had been with their current employer was 4.2 years in January 2018, unchanged from the median in January 2016.” Against that baseline, we then look at the median years of tenure with current employers for employed wage and salary workers by educational level and we find that overall those with Associate’s, Bachelor’s and Doctoral degrees all have the same median tenure, 5.1 years. And when comparing the youngest group, those 25 to 34 years old, the Associates Degree holder had a median tenure of 3.1 years, 2.9 years for Bachelors and 2.8 years for Masters. So, there is no significant difference in early tenure based upon attained education.
To further enhance longevity, some businesses in the US and UK have professional or engineering apprenticeships. These programs involve hiring a new employee into the apprenticeship at an intermediate or other level. This could be the case of someone currently working the business side of SCM, somebody with some college, or a military veteran with military technical training. The employer hires the employee to work in their Supply Chain Management Department, pays them a salary and, so long as they stay with the employer and in the apprenticeship program, for their degree. As the apprentice progresses through their apprenticeship – from Intermediate to Advanced to Higher Apprenticeship to Degree Apprenticeship – both their income and experience increase until they finally graduate and become a full SCEng.
So, there you go – my crazy idea. Supply Chain Engineers can be trained in an undergraduate environment and done under an apprenticeship program to the benefit of the employee, employer, and the profession. You know, when you think about it, it might not be all that crazy after all.
[i] US
Department of Labor, Bureau of Labor Statistics, September 20, 2018 New Release,
“Employee Tenure in 2018”
For me, a key function of the supply chain manager/engineer is to identify the risks his or her supply chain is exposed to, the potential impacts of those risks, and how to build resilience, and manage – even leverage– those risks if they manifest themselves. So, we will be doing a series of posts over time that identifies how those risks can best be classified, mitigated, and managed. This is the first in that series.
In order to reduce the fragility of a supply chain, we need to understand the disruptions to which it can be subjected. Being a graphical thinker, I tend to like to visualize these in matrix form, and the format I personally find most useful in this case is one devised by Dr. Joseph Fiksel. He uses the ubiquitous 2×2 format seen everywhere in business, with the X-axis in this case representing the abruptness of the change or disruption, and the Y-axis the magnitude.
Fiksel’s diagram depicts four types of change, analogous to those experienced in any environmental system, whether organic or manmade. In fact, it is illuminating to examine these strategies through the lens of the supply chain as a living organism. This is not as far fetched as it may at first seem. Consider that Merriam-Webster defines an organism as, “a complex structure of interdependent and subordinate elements whose relations and properties are largely determined by their function in the whole”[ii]. That seems like a reasonable definition of a supply chain to me. So, let’s take a look at Fiksel’s strategies from that perspective.
Natural Selection
Charles Darwin wrote, “…as natural selection acts by competition for resources, it adapts the inhabitants of each country only in relation to the degree of perfection of their associates”[iii]. Put in somewhat more contemporary terms, natural selection results from competition for resources, adapting the members of a given ecosystem against the effectiveness of other competitors in that ecosystem.
In nature, natural selection is a process – sometimes very
gradual, sometimes relatively fast – composed of five basic components.
Variation: Within any population there are
differences – variations – in traits between members. Some are larger, some smaller. Some have more color, some less. And there
are variations in the amount and color of hair, physical strength and speed,
height, etc.
Inheritance: It turns out that some of these traits are genetically heritable, being consistently passed along from one generation to the next, for example, dark skin coloration due to genetic melanin density. Other traits, however, are more a product of environment and as a result are not particularly inheritable, e.g., a dark skin color due to sun exposure and consequent tanning.
Resource Limitations: Most populations have the
capacity to produce more offspring than the local resources will support. Therefore, resource limitations create limits
on population growth.
Adaptation:
Some members of the population will possess traits that are better
suited to what Darwin referred to as, “the struggle for existence,” than
others. What that really means is that
the variation of traits will make certain individuals better suited for the
battle for limited resources. When a heritable trait confers a benefit or
advantage to its possessor in the struggle for resources and, hence survival,
it is called an adaptation
Selection: Those individuals with better adapted
traits will be able to produce more offspring with greater survivability than
the lesser competitors in the population.
Over time, this battle for resources will favor better adapted traits
over others and, therefore, gradually increase the frequency of those traits in
the population. This is selection.
The correlation between these aspects of these evolutionary
components and the supply chain organism (which, due to my dislike of unnecessary
typing, we will refer to as the SCO from now on) seems pretty intuitively clear
and we shall expand on that as we move forward.
Steer and Adjust
In the low magnitude, low abruptness
quadrant we address routine fluctuations and changes. These Fiksel represents with a low amplitude,
regular sine wave. This is the seasonal migration of birds and other animals,
the movement of the grazers and the hunter/gatherers following the easiest
availability of resources. It is, also, the Commodity Manager adjusting to
seasonality in demand and availability. It is the Buyer renegotiating contracts
on commoditized items to take advantage of price and volume variations in the
market. This is daily life in the ecosystem – any ecosystem.
Steer and Adjust is where business lives day-to-day. Naturally, we have plans and procedures in place to ensure our business operates as effectively as possible, but it is during times of routine operation we also need to be doing our continuous improvement. It is through continuous improvement that we derive variation, and it is through variation that we identify tools and methods that improve our ability to acquire resources or reduce our resource overhead. And as these advantages are tested and their benefit to the SCO is validated, they too can be codified in policy and procedure – either replacing less effective methods or adding greater breadth to our portfolio of capabilities and options to different situations. Once these new practices are proceduralized they are, in effect, inheritable, being passed down to each new iteration of the affected processes.
Adapt and Transform the Supply Chain
The next quadrant is the high magnitude, low abruptness
quadrant. Here we see significant but gradual shifts in
the operating environment: the growth of eCommerce and its related B2C
logistics, offshoring/reshoring of suppliers, new markets, new competitors,
etc. If left unaddressed, these can cause the gradual attrition of the
organization’s competitive advantage and brand confidence. To address these concerns, supply chain
managers and engineers need to keep a watchful eye on “drift’ in their supply
chains utilizing tools such as trend analysis, predictive analytics, and
scenario planning to recognize shifting paradigms.
But identifying these changes is quite often the easy
part. Once recognized, adaptation and
transformation become key. This is where those variations we discovered during
the relatively quiet times of the Steer and Adjust period really come into
play. If the SCO has developed a robust
portfolio of capabilities and options, it will have an easier and more
successful time adapting to the evolving environment having a richer range of
pre-tested options to choose from in responding to these changes. If, on the other hand, it lacks depth in its collection
of capabilities, the SCO will be forced to resort to rapid change management
and process re-engineering. While these
tools can be very effective when they occur in an organic and ongoing fashion,
when forced by circumstances and urgent necessity, the SCO is often left scrambling
after the elusive unicorn of business transformation in a last-ditch effort to
secure its survival.
Beth Israel Deaconess Medical Center’s PeopleSoft “Lift and Shift”. In the past, we have discussed supply chain digitization and today we are going to look at a variation on that theme – “moving to the cloud” and specifically, we are going to look at one company’s journey to “lift and shift” their existing application to a cloud platform.
These days we hear a lot about moving to the cloud, but when
it comes to moving an organization’s enterprise resource planning (ERP) system,
it’s a rather nebulous phrase. What
exactly does it mean to move to the cloud? There are, in fact, several options. You could move to a completely “cloud-based”
application such as Oracle Cloud. In
this case, you implement a new ERP system that is designed to operate
exclusively in an internet environment. These applications operate as software
as a service or SaaS.
Alternately, you could use a platform as a service (or PaaS) environment. Here you are basically re-implementing your system, but this time it is on a third-party’s server farm somewhere off-site. This third party provides the computational, storage and networking infrastructure along with operating systems, databases and other applications. They license the applications and effectively lease their use to you. This then means you will need to convert to their environmental design and configurations. In turn, the third-party will manage and maintain the hardware and software for you.
Finally, you can utilize a third-party to provide you
infrastructure as a service or IaaS. In this case, this third-party provides
you the hardware and networking functionality upon which you install the
applications which you license and configure to meet your needs. In this environment, you can literally “lift”
your existing on-premise applications and “shift” them to the new off-premise
environment using either a public or virtual private cloud (VPC).
The following is an account of one company’s journey in
doing a “lift and shift” of their PeopleSoft on-premise to PeopleSoft “in the
cloud” using IaaS.
Lift and Shift at BIDMC
Beth Israel Deaconess Medical Center (BIDMC) is a world class teaching hospital of Harvard Medical School and part of Beth Israel Lahey Health. In addition to being a 719-bed hospital supporting 5,000 births, 35,000 inpatient, 703,000 outpatient, and 55,000 emergency cases each year, BIDMC consistently ranks as a national leader among independent hospitals in National Institutes of Health funding with a $250 Million research portfolio.
BIDMC’s journey began with establishing an IaaS agreement with Amazon Web Services (AWS) and initially moving a test environment there at the beginning of August 2018. Two months later, the remaining non-Production environments completed their lift and shift to AWS as well.
Then came the delay.
It took seven more months until the Inbound Production cXML
server migrated to the VPC, and another two weeks to migrate the remainder of
the Production environment. Why the delay?
Well, there were a number of reasons, both technical and functional.
Functionally timing was the largest issue. Since the test environments completed their
lift and shift at the beginning of the fourth quarter (Q4), there was little
opportunity to complete Production migration until the business had completed 1099
and Year-end processing on the Financial and Supply Chain side of the house.
And the Human Capital Management folks needed to complete W 2 processing, pension
contribution, Open Enrollment, and New Employee Benefit Enrollments before they
could allow Production to migrate.
From a technical perspective, there were two key causes of
the delay. First was the requirement for redundancy on Direct Connect links for
ERP connectivity within the AWS VPC. Direct Connect is a functionality in
PeopleSoft eProcurement that allows a requestor of materials to connect
directly with a supplier-maintained site, browse a catalog of goods approved
for their use, and place a purchase requisition from that catalog. So, BIDMC activated Redundant Direct Connect
in April 2019. And then there was a fiber cut incident near the AWS servers,
causing another delay.
Additionally, there was an issue with nVision performance.
nVision is a reporting tool that retrieves information from a PeopleSoft
database and places it into a Microsoft Excel spreadsheet for analysis and/or
reporting. When BIDMC moved nVision reporting to their VPC, response time of nVision
reporting increased dramatically. In fact, the increase in latency was so
dramatic that it was a showstopper. This
had to be addressed before Production could migrate to the cloud.
Improving latency in the cloud
These latency delays turned out to be caused by something
called “input/output operations per second” or IOPS. The solution to managing
BIDMC’s IOPS issues came down to moving to 3-tier IOPS and sizing their Elastic
Compute Cloud (EC2). EC2 is a web service that provides secure, resizable compute
capacity in the cloud.
The final technical delay was that during this period the
Oracle Database was upgraded from version 12.1 to 12.2. Once these issues and
activities were addressed, it was time to migrate.
Lift and Shift Go-Live
As “go-lives” go, this transition was remarkably quick and uneventful. The team disabled user access to all servers associated with the lift and shift, then brought down the Oracle instances. Following this, they began the two-hour process of synching the on-premise server with the virtual private cloud servers of AWS. Once completed, the Oracle instances were brought back online and the BIDMC PeopleSoft Team performed a brush test (sometimes called a smoke test) to ensure that all data and functionality successfully made the migration. Once continuity was ensured, users were again allowed to access PeopleSoft.
Total downtime: approximately five hours!
But the work didn’t stop there. Once the system was up and
running, the BIDMC team spent the first several weeks utilizing the flexibility
of EC2 to trim and optimize their usage, saving money and enhancing
performance.
Some key areas of optimization included:
Scheduling Non-Production Instances. Non-Production
instances typically represent at least 2/3 of your total cloud cost since you
only maintain one Production environment but keep multiple test instances
operational. Most businesses will need
to keep Production running 24/7, but do not need that kind of coverage for the
test environments. Therefore, BIDMC runs non-production environments from 7am to
7pm Monday through Friday. This resulted in up-time being reduced to 60 hours
versus 168 and resulted in a reduction of EC2 costs by 64%.
Optimize
Production EC2 Instances. By resizing the EC2 servers BIDMC was able to identify
and eliminate excess server capacity, reducing cost without compromising performance
or efficiency.
August
Production HR Database EC2 Instance Change
Change EC2 type from m5.12xlarge to m5.4xlarge
66% cost savings
$26,350 annual savings
August
Production FSCM Database EC2 Instance Change
Change EC2 type from m5.4xlarge to m5.2xlarge
50% cost savings
$6,587
annual savings
Further, using EC2’s flexible scheduling,
BIDMC was able to optimize performance throughout the daily operating cycle.
Tuning and Cost Savings
Conclusion
In the final analysis, BIDMC’s lift and shift of their existing PeopleSoft applications proved to be both cost effective and relatively smooth. The Medical Center realized initial cost savings in real estate, hardware and labor by eliminating their on-premises server farm. And by having a third-party manage their infrastructure those expenses represent ongoing cost avoidance.
After tuning and optimizing the EC2 servers, further cost
savings were achieved. And performance?
While a few operations were slower, most were the same or better than when performed on-premises and overall performance showed a slight improvement.
This is part two of a two-part post on risk and value mapping. In part one, we provided some historical perspective on how procurement has evolved over the past century and how value-based procurement has become increasingly important. In part two we discuss the mechanics of applying risk and value mapping and how it relates to supplier relationship management.
Risk and Value Mapping
One of the primary tools – and a great place to start in
moving your company into greater value-based procurement – is risk and value
mapping your purchases.
The first question we need to explore when doing this type
of effort is to look at our purchases and ask a series of structured questions:
How much do we buy of this item, both in terms
of quantity and total annual spend?
What is the unit cost? The total landed cost?
How critical is this item to the customer
experience? How critical is it to the operation of the enterprise?
How many suppliers are there for this item? How
available is it in the marketplace?
We use the answers to these questions to define the nature
of our relationship with the vendors of these items. First, we need to rank each on the ubiquitous
2×2 matrix – this time one that ranks annual expense of the item on the X-Axis,
and the risk or impact of the item on the Y-Axis.
2×2 Risk/Value Map
As we rank each item we are, in effect, defining how we will
address that item, and potentially its supplier, and our organization’s
relationship with them.
How supplier relationship management changes with risk/value
Those items that represent the lowest risk and values to the
organization and are sourced from simple commodity-type markets will retain a
transactional focus. Here our effort
will continue to be to reduce cost, both in terms of item total landed cost and
transactional cost. The more the
procurement team can reduce the total cost of ownership for these, the better. As
a result, Items in this item quadrant will have short-term contracts to allow
buyers to switch sourcing options frequently. These suppliers also have minimal
involvement with the business in terms of design, item specification or
planning.
At the other end of the spectrum, there are those items that
have a significant impact on the organization and its products/services. These are items that may have direct effect
on the customer experience or that have few substitutes and limited supply in
the market. They can be items that are
unique to, or differentiate, your products or may represent a highly complex
market segment.
As you might expect, the supplier relationship with these vendors
is considerably different. These
represent goods and services that have a significant, potentially vital, impact
on the business. As a result, we want to
create long-term relationships and contracts with these suppliers and include
them in design and strategy considerations.
In fact, the more strategic the supplier the more we should treat them
like partners rather than vendors. It may even be wise in some cases to
co-invest in these. We want to ensure
that they see our organization as a “Keystone Client”, the one they have the
strongest symbiotic relationship with, the one that gets service before the
rest.
A part of that, of course, is to understand the potential strategic
supplier’s relationship with the rest of the market. Are they also servicing our competitors? Will
they properly protect our intellectual property (IP)? Will they continue to see
us as their keystone client in the future?
Using Risk and Vallue Mapping
Our next step is to begin to look at the 2×2 matrix, the Risk and Value Map, first in broad terms and then, more specifically, how we should handle the goods and services that lie in each quadrant.
In our first step, we can quickly see that the products fall
into three general categories:
Low risk items, irrespective of the annual
volume, tend to be generic or commodity-type items. They are simple orders that can be generally
acquired from several different suppliers, so long as the form, fit and
function remains the same.
High Risk/ High Spend items, the upper right
quadrant, are items that define our competitive advantage. These are items that have a significant
impact on the customer experience, that are unique applications of IP, or that
are singles sourced due to technology or resources.
Finally, there are the potential problems, the
upper left quadrant. These are items
that are high risk, but we spend too little on to have enough leverage or
control with our suppliers to protect our firm in the event of disruption or
competition.
Now let’s look at how we should handle the goods and
services that fall within each quadrant
Tactical Spend
These purchases are characterized by high transactional cost relative to the item unit price. For example, a box of 100 U Drive Screws, 1/4 In , #4, Stainless Steel costs $9.22 at Grainger Industrial Supply, but let’s say your Procure-to-Pay cycle cost to buy and stock it is $92, then the transactional cost is about 1000% of the purchase price. Clearly, the focus for items in this category should be on minimizing the transactional cost associated with the item. To do this, we apply two broad strategies:
Streamline Procurement Process
Use eProcurement / eCatalogs
Use Procurement Cards (Pcards)
Use EDI for both the procure and pay cycles
Minimize number of transactions
Optimize inventory order policy
Leverage vendor managed inventory (VMI) and
consigned inventory
Further, we need to view these
products as commodities and therefore minimize time spent communicating with
the supplier. After all, these are low volume goods we can get from several suppliers. For that reason, we want to also keep our vendor
contracts for these items as short as possible, allowing the freedom to move
quickly and often in order to take advantage of price changes in the market.
Leveraged Spend
The Leveraged Spend Quadrant represents those low unit price
items that we buy in such quantity that they account for a large spend in
aggregate. For this group, the key components of our procurement strategy
should be:
Streamline the procurement process
Utilize reverse auctions, allowing the suppliers to compete between themselves for your business
Sealed Bid/First Price auctions. This is the standard request for quote (RFQ)/request for proposal (RFP) approach
Leverage purchasing volume
Consolidate orders across divisions and business units to maximize purchasing volume
Add volume for vendor with Combinatorial Contracts. These are contracts where you include additional products in the quote process to allow the supplier not only economies of scale but also economies of scope
Utilize Industry Portals and/or group purchasing organizations (GPOs). These allow multiple companies within an industrial vertical to consolidate their orders, again with the goal of getting volume discounts
Utilize Spot markets to ensure business continuity. As commodity items, multiple vendors are available. In the event of a shortage from your key supplier(s), don’t hesitate to utilize spot markets to ensure that the needs of the business are met.
In this quadrant our goal is to
minimize not just the unit price, but the total landed cost (TLC). And how we
do that is, in many ways, like what we do in the Tactical Quadrant:
Be prepared to change vendors based on TLC
Continuously be on the lookout for new suppliers
Keep contracts as short and flexible as possible
Strategic Spend
The Strategic Quadrant represents those high volume/high
spend items that give you a competitive advantage and/or have a direct impact
on the customer experience. Failure in this area of the supply chain can have a
long-lasting impact on the brand or the enterprise, and therefore the
associated suppliers and supplier relationships need to be carefully cultivated
and maintained. Consequently, the Strategic Quadrant has a very collaborative
focus. This may incorporate various elements of supplier partnership including:
Long-term Contracts
Partnership Agreements
Co-development of Products and Innovation
Potential Co-investment
To further mitigate risk, you should also consider what
other clients these suppliers serve. Do they
work for your competitors, too? Also, in this quadrant, it may make sense to
consider vertical integration, whether actual or virtual (i.e., contractual). Vertical integration can help reduce risk of
supply chain interruption, protect sensitive intellectual property, and provide
additional sources of revenue.
Here are a couple of other key take-aways on strategic
spend. First, DO NOT use eProcurement
for strategic items. The usefulness in
eProcurement is in its ability to streamline the purchase of routine, low unit
cost items to reduce the transactional cost and minimize time spent interacting
with the supplier. Since strategic items
basically represent the antithesis of that model, we want to stay away from
eProcurement for these items. Instead,
we want to stay in close contact with these suppliers about their shipments of
goods and services. Remember, this is
the collaborative quadrant, so pick up the phone and coordinate with
your strategic suppliers.
Second, while collaboration is the key here, don’t get so
wrapped up in your suppliers that you lose sight of what is best for your
company. Focus on strategic supplier collaboration, but ALWAYS protect the enterprise
first. And you do this, in part, by building resilience through cultivating at
least one alternate supplier where possible, be on the lookout for substitute
parts, and optimize safety stock levels for critical items at a
risk-appropriate level.
Critical Spend
The final area, the Critical Quadrant, is what should keep you
awake at night. These items are where nightmares come from.
You should have one goal with items that lie in the Critical
Quadrant – move them to another quadrant. Any other quadrant. As quickly as possible. These are goods and
services that put your organization at risk and at liability.
How and where do you move them? Each item will need to be
evaluated separately, but here are some general options.
Move to the Tactical Quadrant. In order to make these
items tactical consider looking for more suppliers, thus making them more
commoditized. This may require changing
engineering specifications to allow standardization with other, more common
parts. Also, you may find that the item’s function can be performed just as
well from the customer’s point of view using a less complex part or parts.
Move to the Leverage Quadrant. To make the transition
to a leverage part, may again require reviewing engineering specifications to
identify ways to simplify the item, making it more widely available. You may
also find that the part is used elsewhere in your enterprise. By consolidating purchases across your organization,
you may be able to identify enough total volume to move the item into a
leverage buy. And if not, you may be able to consolidate purchases with other
businesses – notably NOT to include any direct or indirect competitors – or
through an industry-specific GPO to achieve that volume.
Move to the Strategic Quadrant. If the item is
identified directly with your company or brand, or if it has a direct impact on
your customer’s experience of your products or services, or if it’s complexity
cannot be reduced, you must move this item to the Strategic Quadrant. In fact, if any of the above criteria hold,
these items should be your first priority because they represent the most
immediate and significant threat to the organization or brand. These are items
at known risk that are vital to your product. Don’t delay.
To move these items, you may want to include them in
existing contracts with your strategic suppliers to ensure the part’s
availability while strengthening that vendor relationship. Alternately, if the
item must stay with the current supplier you may need to partner with that
supplier. This can be done in several ways.
The quickest is often to agree to pay more per unit or to enter into a
long-term contract with a sole-source vendor to ensure availability and the
supplier, in turn, agrees to maintain a stock of the items and/or the materials
to continue building the item should a disruption occur. You may also want to
explore other ways of partnering with this supplier to form some degree of
vertical integration, whether actual or virtual. However you go about it,
though, moving items to the Strategic Quadrant is likely to incur additional
costs, either through higher unit prices, loss of flexibility in future
sourcing, or investment in partnering with the supplier.
Digitization
No matter what quadrant you are dealing with, however, it is
important to be utilizing the digital tools in your Procure-to-Pay (P2P)
toolbox. Each of these, when properly configured and deployed, can reduce
transactional cost while increasing operational speed.
Digitize all quadrants
Tools like advanced shipment notices (ASNs), Supplier Self-Service
portals, Electronic Invoicing and Electronic Payments cost relatively little to
implement, reduce both errors and touch labor, and therefore, tend to be “low
hanging fruit” that generate quick return on investment (ROI).
94% of successful supply chain digitization
projects directly led to an increase in revenue.
Return on investment (ROI) of supply chain
digitization initiatives is a top motivator for corporates, with 77% citing
cost savings as their top driver for a project.
Other motivating factors include increased
revenues (56%) and the emergence of new business models (53%).
But when planning your supply chain digitization program, it
is important to remember that thorough knowledge and a solid roadmap are
essential for an organization to avoid a poorly selected starting point or a
failed deployment that can destroy momentum and discourage leadership from
further investments.
Conclusion
The importance and function of Procurement have evolved over the past century. In today’s environment, a focus not only on price but even more on value is critical to the enterprise to ensure not only its profitability but its survivability. For these reasons, the ability to identify, map, and address the risk and value of materials is a critical skill for the procurement professional. Along with risk and value mapping skills, the digitization of the P2P process reduces cost, increases revenue and encourages new business models.
[i] PYMNTS.com,
“Corporations Stuck in The Planning Phase of Supply Chain Digitization”,
Dec. 12, 2018
This is part one of a two-part post on risk and value mapping. In part one, we provide some historical perspective on how procurement has evolved over the past century and how value-based procurement has become increasingly important. In part two we discuss the mechanics of applying risk and value mapping and how it relates to supplier relationship management.
________________________________________
Risk and value mapping –
Then and Now: A Brief History of Procurement
Today we are going to briefly discuss the idea of risk and
value mapping, what it is, how it works in procurement, and how it helps
protect your organization. But in order to really get a sense of context, let’s
start by looking back at the evolution of procurement in modern business and
how its role in the organization has evolved.
If we were to step back in time about 90 years ago and find
ourselves in Dearborn, Michigan, we would likely see a scene like this.
Ford River Rouge Complex circa 1927
This is the Ford Motor Company River Rouge Complex. “The Rouge” as it was called, was huge by any standard. It occupies a massive 1.5 square mile footprint along the banks of the River Rouge. And within the complex lie ore docks, sixteen million square feet of manufacturing floor across 93 buildings, and 100 miles of train tracks with 16 locomotives. There were steel furnaces, coke ovens, rolling mills, glass furnaces, and plate-glass rollers. There was a tire manufacturing plant, a stamping plant, an engine casting plant, a transmission plant, a radiator plant, and a tool and die plant. And, oh by the way, they assembled cars here, too.
But there wasn’t much of a procurement operation here. Why? Because Ford owned virtually EVERYTHING. The Rouge was one of the most vertically
integrated operations of all time. Ford
owned everything from the raw material production – such as ore mining –
through final assembly and sales. There was very little bought from outside.
Consequently, the procurement operation added very little value to Ford in
those days.
But times change and with them how markets work. While
vertical integration provides a company ultimate control over its material
suppliers, there are drawbacks. Here are two obvious ones. First, it is
expensive. Second, it induces
brittleness in the supply chain.
It takes a lot of time and money to be great in one
industry, be it automobile, glass, plastics, or steel manufacturing. This fact
is exacerbated by the complexity of today’s products. Compare Henry Ford’s
Model T to even the simplest car rolling off today’s production line. I imagine there are more components in a
car’s cruise control than there were in the entire Model T. And this complexity
brings with it greater barriers to entry at each level of a company’s supply
chain.
Then there is the lack of flexibility. If a company owns its source of supply in any
given area, it is unlikely to have a substantial relationship with alternative
suppliers. That means, when a disruption
occurs within a company-owned supply chain, there is little opportunity for
mitigation beyond their stockpile.
Henry Ford even saw this in 1927. The one raw material he did not control was rubber. That was produced in Southeast Asia and managed exclusively by British agents. So, Ford bought a huge swath of land in the Brazilian Amazon to build his own rubber plantation. The effort, however, was a colossal failure costing Ford a fortune and many workers their lives. Ford, in the end, was forced to return to the British rubber agents.
Over time, most businesses have moved further and further away from the vertical integration model and adopted a much more nimble, flexible and less asset-intensive approach – “We do what we do best and buy the rest.”
And with this change, the locus of cost to the operation moved steadily from wages, salaries and overhead toward goods and services expense. And just as early automation was an attempt to minimize the cost of labor per unit of production, this transition brought with it attention on reducing the cost of materials and services purchased.
This was the birth of Procurement as a critical business
function.
And it is a critical function. In their book “The
LIVING Supply Chain”[i],
Handfield and Linton describe a concept the biologist Sean Carroll termed Serengeti
Rule 1. “(S)ome species exert effects on the stability and diversity of
their community that are disproportionate to their numbers or biomass. These
are termed ‘keystone species’”. Applying
this definition to the departments within an organization, we can certainly say
that Procurement is a keystone department.
Let me illustrate.
Illustrative Example of Impact of Purchase Cost Reduction on Bottom Line
In the example above we are looking at a hypothetical
company with $500M in annual revenue. The Baseline column shows its current
fiscal performance. Each column to the right shows what happens when the cost
of goods and services procured is reduced in 5% increments. All other expenses remain the same. As you can see, each 5% step down in cost
results in about 11 ½% increase in Net Income Before Taxes in this example.
Clearly, this is a case where a department exerts a disproportionate effect on
the performance of the enterprise.
And therefore, we have traditionally pushed Procurement
organizations to reduce costs, reduce costs, reduce costs!
But there are a lot of other factors that remain unseen,
hidden under the waterline of the “Price Iceberg”. Factors like delivery
performance, quality of material handling, production delays, inspection costs,
pre- and post-sales service and support, product training, supplier financial
health, and a host of other risks and opportunities.
The Price Iceberg
While the impact of price negotiation is immediately
apparent on the bottom line, focusing exclusively on price often leaves other
potential risks and values on the table, unaddressed. There are many other
questions we need to be asking beyond, “What is the total landed cost of this
item?”. Questions like:
What other assets/capabilities the supplier can
offer in addition to the product/service procured?
Is the supplier better with existing activities
(e.g., inventory management; after sales support; product development…)?
Can the supplier decrease our risk (e.g.,
reducing bottlenecks/critical parts purchasing; disruption response; exchange
rates)?
Can the supplier provide some other competitive
advantage (e.g., differentiating factor; new product variant)?
Can the supplier help expand the product
portfolio to address new customer needs?
With value-based sourcing, you seek not only to leverage
price, but to leverage the skills and assets of your suppliers to develop and
expand competitive advantage in the marketplace. This means at times you may
pay a somewhat greater per unit total landed cost in order to reap a larger
value for your organization.
Comparison of Traditional vs. Value-Based Sourcing
In shifting from a solely price-based focus to a value-based one, we need to take into consideration not only the total cost of ownership (TCO), but the additional value provided by the supplier. But this requires a bit of a shift in viewpoint and the broadening of a couple of skillsets. The procurement group needs to maintain as lean a purchasing process as possible for low-value items while developing a strategic perspective, both with internal customers and suppliers, to understand where supplier assets and skills can be leveraged to the organization’s advantage.
Value-based sourcing also means that cross-industry
benchmarks have a different purpose.
Instead of seeking to be as good as the benchmarks, with value-based
procurement we seek to be better. Better
and different through using the value the suppliers bring to the table. This is
done, in part, by moving the purchasing position in the organization from one
of tactical and operational specification and delivery to one of strategically
coordinating vendor resources and assets to meet the business’ goals. This
requires the procurement professional to expand his or her skills to encompass
greater general business and finance competencies.
Finally, value-based procurement lends itself to a center-led format. In this particular model, the central procurement organization coordinates enterprise-wide, strategic procurement in direct coordination with the business unit level purchasing organizations which, in turn, provides tactical and operational support to the individual operating units and stakeholders.
Next week in part two of this series we will look at the mechanics of risk and value mapping as well as how you can use risk and value mapping to guide your supplier relationship management strategy.
[i] Robert
Handfield & Tom Linton, “The LIVING Supply Chain”, Wiley, 2017, pg. 11
Healthcare SCM: Indiana University Health has opened a highly automated, state of the art, integrated supply chain service center. With it, they are improving performance, increasing resilience, … and saving money!
Supply Chain evolution differs dramatically by
industry. Manufacturing, particularly
high-tech manufacturing, has always tended to be at the forefront of SCM
change. And the reason is pretty apparent – failure to do so could cost you
your business! Some other industries, however, have been slower in their
evolution. Healthcare is an example. In
healthcare, quality of patient care has always been the focus of attention,
with supply chain management (SCM) being regarded as only a necessary expense.
So, for a couple of decades now, the typical approach has been to use the major
distributors and, where feasible, an industry vertical group purchasing
organization or GPO to aggregate purchasing volumes and negotiate discounts.
But the cost of medical supplies continues to increase and now represents 35 –
40% of the typical hospital’s operating cost.
However, things are changing in healthcare SCM. As hospital
M&As consolidate the market into larger hospital enterprises, some are
beginning to explore opportunities to change the paradigm. Indiana University
Health is one such pioneer.
Last July, IU Health went live initially supporting three
hospitals with its new, 300,000 square foot, $9M Integrated Service Center or ISC
in Plainfield, IN, — and with it introduced a whole new way of doing SCM in
healthcare. In addition to being the
center of operations for procurement and logistics systemwide, the new ISC facility
features a robotic storage and goods-to-person
picking solution with nearly 8000 bin locations; a pick-and-pass module with four
zones; 950 feet of conveyor and sortation; and 21 aisles of rack and shelving
storage with 8,500 full pallet locations and 2,500 case locations.
By last December, the facility was serving all 16 hospitals in the IU Health system, supporting over a quarter of a million units picked per day, and placing the system on track to reap $4.2 million in savings in the first year. That means they will achieve full payback in under 2 ½ years.
The IU Health Integrated Service Center in Plainfield, IN
Recently, I had the opportunity to chat with Dennis Mullins,
Sr. Vice President of Supply Chain Operations, and Derrick Williams, Executive
Director of Supply Chain Logistics, of IU Health. One of the first questions I
asked was how they came up with this dramatic approach. “What we did was a lot
of benchmarking. We went around the country to look at practices from different
hospital system distribution sites like Intermountain Health and Orlando Health.
We also took a look at Amazon, Walmart, and H-E-B down in Texas. We tried to
look at the best practices inside the industry and best practices outside the
industry space.” Williams told us. This process exposed the IU Health SCM team
to the leading practices and newest tools across a broad spectrum of supply
chain environments. And although every industry is unique – and healthcare SCM
is, indeed, a very unique environment – sound business practices and
engineering principals are largely transferable. From the information they
gathered, the team selected those practices and tools that appeared to best fit
the needs of the state’s largest healthcare system and began to develop a plan
for what would ultimately become the ISC.
Having such a large, modern distribution center enables IU
Health to buy in bulk directly from the manufacturer. In fact, 80% of purchased
materials are being removed from a third-party distributor such as Cardinal or
Medline and being shipped directly from the manufacturer to the ISC. Some manufacturers still do not ship directly
to IDNs[i],
but rather require fulfillment through a distributor. This accounts for the remaining 20%, but
long-term, IU Health plans on removing distributors entirely. And with them,
their markup.
In addition to the direct cost savings, another set of benefits of their new self-distribution model comes from risk pooling. Risk pooling, in short, is a statistically based risk management principal. As you aggregate variations in supply and/or demand across multiple locations and items, the standard deviation and the coefficient of variation both decrease. As a purely illustrative example, you may have three stockrooms, A B & C, which have for a given item the following safety stock:
A = 50, B = 80, C = 45 Total
Safety Stock = 175
But if you consolidate these items into a single warehouse
and redo the appropriate buffer stock math, you may find you now need a safety
stock level of 125, reducing your inventory investment by 50 units. And if you
multiply that kind of savings across several thousand SKUs, that can result in
a significant reduction in inventory cost.
IU Health targets maintaining a six-week enterprise-wide
supply of inventory on hand in the ICS. That’s six-weeks of inventory for 16
hospitals and some 500 practitioner offices and surgical centers. That’s a lot
of inventory, so the savings associated with risk pooling alone is indeed
significant.
But there are other, somewhat less easily quantified benefits to this type of consolidation. The first is the inherent resilience this approach lends to the IU Health system. Hospitals and other healthcare organizations that depend on third-party distributors are subject to their allocation decisions when disruptions occur upstream in the supply chain. And those who rely on these distributors to maintain a near just-in-time delivery for PAR location upkeep find that their supply chain is even more brittle as the JIT model maintains very limited on-hand buffer stock. By keeping a 6-week supply in the ISC, IU Health has sufficient stores to ride out most short-term disruptions and a significant time buffer to develop mitigation for longer-term disruptions, even if there is little or no advance warning.
Next is the return of floor space to the operating units. Floor space is something there is never enough
of in a healthy, thriving hospital system, and inventory takes up space. Before
the ISC, each facility kept a 30- to 60-day stock on site. With the ISC’s 6-week supply, the individual
facilities can roll that back to a seven to 10-day on-hand inventory – a 67% to
83% reduction!
But to engage in an operation of this magnitude, you need to
have the right size. Finding adequate savings through self-distribution comes
down to scope. An estimate of that threshold appears to be in the neighborhood
of $200,000,000 in supply spend annually. But the other keys in making a
self-distribution system work are A) developing a systems approach, and B)
having the buy-in of the individual hospitals involved. Supply chain services
in healthcare is an expense to the units it supports, so the business case needs
to show that the related setup and operational costs are an investment in those
business units, and show the users the pro forma and payback in
benefits to them in centralizing not only the warehousing, but all of supply
chain services as a system – the buyers, the contracting, the value analysis,
and the warehousing and logistics. As pointed out at the beginning of this post,
supplies represent 35 – 40% of the cost to a hospital and, as a result, is the
area that can return the greatest savings to the organization. And you need to report regularly to the member
hospitals showing them those tangible benefits they are experiencing
month-to-month to ensure their continued support of the operation.
As more and more hospitals consolidate into integrated
delivery networks, the old models of healthcare supply chain management fail to
scale up. “But we’ve always done it this way,” just doesn’t make it anymore. The
innovative work of forward-looking supply chain leaders like those at Indiana
University Health are helping to pave the way into a new era of healthcare
supply chain management that is adapted to both the unique needs and strengths
of the IDN.
[i]
IDNs, or integrated delivery networks, are large healthcare organizations that
either own or manage multiple points of patient care – such as hospitals,
physician practices, rehabilitation, and long-term care facilities
