I was recently asked this question on the popular Q & A forum QUORA. Sometimes, when the question is really good, I take my time formulating my thoughts and putting them in a more elaborate format so that later I can expand on the answer in an article or a blog.
The article below is based on my response.
This is a very good question. Let me add a few things about the question itself before I proceed to answer this question in full.
Firstly, I think I am very well qualified to answer this question because I co-founded the world’s first STRATEGY consulting boutique company which specialised purely in supply chain management. Since the year 2000 (when most people struggled to pronounce supply chain management) I have led hundreds of global projects with large multinationals on reducing or handling complexities in their business using supply chain management. That is the reason why my clients, who are Presidents and Managing Directors of multi-billion dollar companies, call me Mr Supply Chain.
I have already given you a clue about another way to look at your question.
Are you looking to reduce supply chain complexity? Or, are you looking for a way to handle or reduce your business complexity USING supply chain to its best effect?
If you are just looking to reduce supply chain complexity - my question would be why? What purpose would it serve? Good supply chains are complex for a reason. Great supply chains are even more complex for the same reason.
And the reason is that complex supply chains allow you to handle or reduce all sorts of complexity in your business. If you did not have complex supply chain models running your decision making (such as forecasting, production planning, inventory targeting, fulfilment execution etc) you would have to rely on rough rules of thumb - which would be sub-optimal (you would leave a lot of money on the table for others to pick up - your company would be their favourite customer and supplier).
On the other hand, if you looking for a way to handle or reduce your business complexity USING supply chain to its best effect then read on. This will be vitally important as top supply chain guns seize the moment in their businesses post COVID-19.
I devote an entire chapter to this discussion in my book THE 5-STAR BUSINESS NETWORK, along with diagrams pictures and tables. Here, I will only provide a snapshot, in order to keep it short and sweet.
When you over-service some undeserving customers, at the same time you will under-service other more deserving customers.”
- The 5-STAR Business Network
Two of the most frequently encountered complexities in businesses are:
- Product proliferation
- Unprofitable customer proliferation
Here is the information on how supply chain allows you to handle both at the same time. First let's look at the context for this complexity.
Activity-Based Costing (ABC) was a major advance in the 80s
When Activity Based Costing (ABC) became popular in the late 80s and early 90s, partly as a result of the Balanced Scorecard Drive, it was seen as a major step forward from traditional cost accounting. For the first time, Value Engineering became possible by designing products and services based on only those activities that the customers considered valuable. This revolution was not just a result of the concept of ABC, but also of increased computing power available through the newer client server computers and Manufacturer Resource Planning (MRP and MRP II) applications. In retrospect, there were still many limitations of the decision making capability with which most readers are quite familiar - except, perhaps, those readers who continue to use these models today.
Cost-to-Serve analytics by customer or product segments advanced the ability to differentiate service offerings
As the computing power exploded further, and the mega-systems like Enterprise Resource Planning (ERP and ERPII) were put into service, data capture and storage capability multiplied enormously. At the same time, data manipulation capability grew significantly and newer decision support systems (DSS) (with sophisticated data manipulation capability) became available allowing the users to forecast, plan priorities and monitor activity. In theory, these systems should allow the businesses to know the cost-of-service for each customer or SKU instantly by pressing just a few buttons and generating either a standard report or an ad-hoc report. However, in most instances, we have found many problems. Suffice it to say that an enormous amount of data cleansing and manipulation is necessary before we can calculate the cost-of-service for a customer or an SKU. In many cases, even where the ERP systems have been in use for more than two decades, this is simply impossible without going back to manually linking each transaction to its source paper document and tracing key data associated with that transaction which was not recorded in the ERP system, simply because the system was not set up to record that data. As the business networks expand and are reconfigured on the almost continual basis this limitation of ERP type systems is exacerbated. That is the reason why we still continue to see businesses struggling to understand the true profitability of their customers or products and continue to over-service some customers or carry unprofitable products/services in their offerings.
However, many businesses possess this ability - to scientifically differentiate a good customer from a bad customer; to quantifiably differentiate a good product from a bad product - in terms of profitability. Either they set up their ERP systems to provide that information with a reasonable accuracy, or they continue to tinker with the system, or information till the information is of reasonable quality. While it must be obvious what to do with this information, good companies are very disciplined about how to graduate their products and customers to higher levels of profitability through efficient use of service policies.
The old 80/20 rule applies to customers and products in most cases
How do they do that? For those readers who have not done this before, let us look at an example of a company that found that while its star 20% customers and products contributed to 80% of its profitability, there was a sizeable proportion of customers and products that were simply unprofitable. When shown as a graph of cumulative profitability these customers and products formed the right most value-destroying part of the spectrum, as shown in the figure below.
Figure 1: Customer and Product profitability analysis
In the figure above, As are clearly the profitable stars, Bs are the solid middle guard, Cs are barely profitable stragglers while Ds are the clear value destroyers. Many people continue to carry Ds only because of their connection with the rest of the business or because the sales-people continue to make such connections. Many others are determined to get rid of Ds at any cost.
All customers and products do not deserve the same service
The company in question, however, embarked on a different tack. They were determined to reward their best customers with their best service. At the same time, we were also determined that all products and customers must pay their full way in terms of cost. This meant differential service levels for different customers and products - where A customers got the best service for A products and slightly less costly service for B products, and so on. The resulting 4x4 service matrix looked like figure 2.
Figure 2: Service Matrix - Customer and Product profitability analysis
The service matrix can get very sophisticated and complex depending upon how many layers the cake contains - the figure above merely illustrates four service frontiers based on a relatively simple and static analysis. Service frontier I might involve same day delivery in metropolitan areas and next day delivery in non-metropolitan areas while the service frontier IV might involve a promise to order the product from suppliers when the customer places an order and communication of delivery time within 72 hours (enough time to order, plan and calculate the lead time).
Obviously there can be many more service frontiers and the exact definition of each service level will depend entirely on the nature of the business and requirements of the its customers.
In this case (a specialty chemicals company), the customers ranged from large auto makers to small school labs, and most adjusted to the new service policies quite rapidly in most cases.
A crucial question remains - how frequently to update the customer service policies? On one hand, too frequent updates confuse the customers, especially the smaller customers. On the other hand, as customer behaviour evolves as a result of new policies, the profitability data itself will continue to change rapidly. There is no easy answer, and this is one of the questions each business decides based on its customer/product segmentation mix.
When you over-service some undeserving customers, at the same time you will under-service other more deserving customers
Consider, then, how sophisticated is your own business' cost-of-service capability and how fact based your segmentation and service policies are. We use some very sophisticated and dynamic tools which can be used for diagnostic purposes, which are particularly useful in organizations where considerable differences of opinions exist on these questions. Many executives and CEOs are surprised by the answers because of the tendency of the subordinates towards selective information dissemination.
There is a lot more to be said about Complexity - its causes, signs and costs to the business. I will leave that for future discussions. However, this articles already gives a very good roadmap for moving forward to cut complexity.
A word of caution towards the end. In the discussion above I have included some of the pitfalls and road blocks on the way. In reality, we found many more.
If you get stuck, or encounter a roadblock, make a comment below, or send me an email and I will try to give you some guidelines remotely.