The Often-Ignored Trade-Offs of Reducing Supply Costs

When it comes to supplying product, optimizing cost, cash, and service in a highly dynamic marketplace is essential. The portfolio and commercial sides of the business have to consider which products should be sold and which should be retired, what markets to serve, which sales channels to use, and what the value discipline and customer service expectations are.

The supply chain must fully understand these strategies to develop its own effective supply tactics and strategy in response. In turn, integrating these decisions must continue to deliver the expected corporate returns.

However, we’ve seen many organizations continue to prioritize driving supply costs down without properly considering the trade-offs.

While the pandemic has exposed the significant risks of offshore sourcing, not everyone is paying attention.

The role of the supply chain

A significant contributor to this policy is the very nature of the corporate environment and the supply chain’s role within it. Every function within a manufacturing organization, except the supply chain, adds dollars to the business, from the president or CEO, through the CFO, to sales, marketing, and product development.

The supply chain is often unfairly regarded as just a cost to the business and an impediment to the organization’s goal of making money. No wonder supply chain decisions often prioritize cost savings and working capital reductions.

Whatever the risks of manufacturing in other countries, if a 35 percent cost savings goes straight to the bottom line, it’s a powerful argument to those at the top.

A case in point

We’ve seen this situation countless times. One Oliver Wight client, a furniture manufacturer, simply wanted to lower its product cost to increase margin. The company chose to move all its manufacturing from Canada to low-cost territories, which did not align with the flexible service strategy product mix.

This meant that the inventory would be tied up for six weeks on the ocean. To maintain product supply flexibility, it had to establish a vast warehouse facility at the port of Los Angeles, massively increasing inventory and warehousing costs in its supply chain. Even though the cost of goods aligned with the supply strategy, this decision damaged customer service, and the business ultimately failed as it couldn’t sustain the cash investment needed to support the new supply network.

Consider the trade-offs

As this example demonstrates, the supply chain is part of trade-off discussions around the cost, flexibility, and control of manufacturing in-house versus outsourcing. The trade-off discussions must consider the long-term implications of any strategies based on assumptions of what will happen over that time.

Some things organizations should consider include:

1. Manufacturing and distribution

Different products will require different resources and distribution methods. Therefore, each supply strategy will differ, and the manufacturing and distribution networks must be planned and managed to support market-driven growth.

2. Technologies

Examine which technologies to invest in, including those that might not have a long-term future but are helpful for the time being. Investing in new technology is likely to be tremendously capital-intensive, and there has to be clarity about future markets and capacity. With technology heading towards obsolescence, it may be better to outsource for the short term.

3. Suppliers

Some products are more suitable for supplier partnerships, while others are a better fit for spot-buying, constantly pursuing the lowest price. In some cases, it’s advantageous to have multiple suppliers, recognizing that this brings additional complexity because they’ll have to be qualified and managed. Conversely, depending on a single supplier carries the risk of that supplier failing.

4. Customer expectations

The supply chain must decide where to meet the customer — with inventory, capacity, or a combination of the two — and this will be determined by the type of manufacturing undertaken: make-to-stock, assemble-to-order, purchase-to-order, engineer-to-order, or design-to-order. Service expectations will differ for each, and each has its trade-offs.

For example, making-to-stock requires a high cash investment to maintain inventory, but lead times will be short. In contrast, for design-to-order, cash investment is low because the inventory and capacity are in the engineering team waiting for the orders to come in.

In the equation of delivering a corporate return on investment, the portfolio and demand teams are responsible for growing the numerator, while the supply team is responsible for managing the denominator, i.e., the cost-to-serve.

However, simply driving down supply costs without considering the trade-offs isn’t the answer. Functional and business unit strategies must be fully integrated; otherwise, the overall corporate strategy is likely to be compromised.

For more guidance on developing effective supply chain strategies, check out our white paper, “The Supply Review,” number four of seven in our series, “Deploying Strategy with Integrated Business Planning.”

Authors: David Goddard and Tom Strohl have used their in-industry experience as supply chain professionals to help companies adjust their business processes successfully and achieve excellent returns for their clients. Both David and Tom have written white papers on supplier scheduling. They have also worked with companies, teaching techniques to enhance supplier relationships, improve schedule stability, and reduce costs. Recently, Tom has taken the helm of Oliver Wight Americas as its president. Learn more at oliverwight-americas.com.