What Is? is our series of articles deep-diving on supply chain management. We discuss specific questions, discuss root causes and discuss solutions. We hope you gain a deeper understanding of supply chains. And also a deeper understanding of how SupplyChops helps you answer your questions quickly and easily.
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When it comes to supply chain management, many organizations have traditionally focused on minimizing costs as a primary means of improving efficiency.
Optimizing your supply chain network by maximizing profits instead can offer greater long-term benefits for the entire company. This strategic approach aligns with other key business functions such as marketing, sales, finance, and the executive leadership team, fostering collaboration and a shared vision for growth. In this article, we will explore why it is better to optimize your supply chain network by maximizing profits instead of minimizing costs, and how it connects with the rest of the company.
1. Holistic Strategy: Maximizing profits requires a comprehensive strategy that integrates various departments across the company. Marketing, sales, finance, and the executive leadership team must work together to identify opportunities for value creation throughout the supply chain. This holistic approach can lead to innovative products, targeted marketing campaigns, and improved customer experiences.
2. Enhancing Sales Performance: Maximizing profits aligns the supply chain with sales objectives, such as offering competitive pricing, tailored products, and reliable delivery. This collaboration between supply chain and sales teams can lead to stronger customer relationships, higher conversion rates, and sustained revenue growth.
3. Financial Impact: A supply chain optimized for profitability contributes positively to the company's financial health. By focusing on value creation and revenue generation, the supply chain can drive higher margins and improve cash flow. This, in turn, provides the finance team with more resources to invest in other areas of the business.
4. CEO's Strategic Vision: The CEO's strategic vision for the company often includes goals for growth, innovation, and market expansion. A profit-maximizing supply chain aligns with these objectives by prioritizing opportunities that contribute to overall business success. The CEO can leverage the supply chain as a competitive advantage to differentiate the company in the market.
5. Customer-Centric Approach: By focusing on maximizing profits, the supply chain is more attuned to customer needs and preferences. This customer-centric approach can lead to the development of high-value products and services that command premium prices and foster customer loyalty.
6. Innovation and Agility: A profit-oriented supply chain encourages investments in new technologies and process improvements that drive efficiency and growth. This focus on innovation allows the company to stay ahead of industry trends and adapt to changing market conditions.
7. Balanced Decision-Making: Maximizing profits requires a balance between cost considerations and revenue opportunities. This approach involves assessing the impact of supply chain decisions on other departments, such as how a new product line might affect marketing strategies or sales targets.
8. Collaboration and Cross-Functional Teams: Profit-oriented supply chain optimization promotes collaboration between different departments. Cross-functional teams can work together to identify areas for improvement, streamline processes, and develop innovative solutions that benefit the entire organization.
In conclusion, optimizing your supply chain network by maximizing profits instead of minimizing costs offers numerous benefits that extend beyond the supply chain itself. This strategic approach aligns with other key business functions, fostering collaboration and a shared vision for long-term growth and success. By focusing on value creation and revenue generation, companies can achieve sustainable competitive advantage and drive overall business performance.
Modern supply chain are built on logistics. Moving goods around the world is surprisingly cheap and resilient. Many supply chains now span the globe. While transportation is cheap, it is important to understand the different modes of transportation and how to measure and optimize them.
A key concept that underpins transportation optimization is batching. Goods are moved in batches. For ocean shipping, a batch is a container. For road shipping, the batch is a trailer. Carriers charge by the container or trailer whether it is full or not. It is up to you to make sure you make the most of the available capacity. This is where transportation modes come in.
There are three main modes:
Another key concept is that sending goods faster is more expensive than sending them slower. For example, when sending a parcel, it will cost you more to send it same day than next day. It will cost you more to send it next day than within two days, and so on. The less time sensitive the shipment is, the less costly it is to ship.
A final key concept is that sending good a short distance is cheaper than sending them a long distance. The longer the distance, the longer the truck will be used and the higher the charge.
Companies need to keep track of which modes are used and find ways to reduce their logistic costs by using better modes.
There are various reasons why more expensive modes are used. Sometimes the reason is structural: the volume on some lanes may be too low for full truck loads. In this case, a network analysis and a network redesign may help. For example adding a consolidation point can help increase the volume on the lanes and help move to using cheaper modes. Sometimes the reason is operational: an order needs to be expedited via an expensive mode. It could be that the safety stock levels need to be adjusted to avoid such situations. In both cases an analysis of the reasons for using expensive transportation modes can lead to cost improvements.
Consolidation in supply chain logistics involves the aggregation of goods from multiple sources into larger shipments or containers, which can significantly impact transportation modes and reduce costs in several ways:
There are several metrics that are useful to track how transportation modes are used.
Fill Rate
Mode Utilization - Number of Shipments
Mode Utilization - Costs
In the realm of modern supply chains, where logistics form the backbone, the cost-effective and resilient movement of goods across the globe is a foundational principle. As supply chains extend globally, understanding the intricacies of various transportation modes becomes paramount for cost optimization. Key to this optimization is the concept of batching, where goods are moved in containers or trailers, forming the basis for pricing structures. Whether it's Full Truck Load, Less than Truck Load (LTL), or Parcel, the right choice depends on shipment volume and urgency. Time and distance matter — sending things fast or far costs more. A practical strategy to reduce costs is consolidation, grouping goods to use more efficient modes. Metrics like Fill Rate and Mode Utilization help businesses track efficiency. It's a straightforward approach for companies aiming to be lean and cost-effective in global logistics.
Warehouses serve many roles in a supply chain network. We will look at two of them here.
Let's consider a company with 1000 stores and 100 suppliers. A simple supply chain network is to have all suppliers supply all stores. In this setup we have 100,000 lanes (100 * 1000) with each lane carrying one product for one store. While this setup is very simple, it is probably very expensive. First, the volume on each lane is likely small, leading to the use of expensive transportation modes. Second, each store will receive many deliveries (one for each supplier) leading to high labor needs.
Can we do better? One idea is to use a single warehouse as a consolidation point. In this setup, products from all the suppliers are set to the warehouse and products for all the stores are sent from the warehouse. The warehouse is a central hub of product movement. This setup offers the opportunity to save costs in two ways:
A single product is traveling a longer distance when a warehouse is involved. Instead of going directly from supplier to store, the product travels from supplier to warehouse and then from warehouse to store. However on each lane the product is comingled with other units, making it cheaper overall to transport.
The timing of the inbound units can be synchronized between suppliers and with the timing of outbound units. In some cases it is possible to achieve a flow where almost no inventory is kept at the warehouse. The warehouse serves as a trans-shipment point where products are off loaded from inbound trucks, combined into pallets bound to specific stores, and loaded on outbound trucks.
Using a single warehouse is not necessarily the most efficient setup. Using two or more warehouses may be better. For example, if we assume that the products in sold in the USA, having a warehouse on the East Coast and having another warehouse on the West Coast can cut transportation costs further by lowering the mileage from warehouse to store. If we assume that the demand is high enough to keep using cost efficient transportation modes on the inbound side the cost of the additional warehouse may be compensated by the decrease in outbound mileage. A network design analysis can answer the question of how many warehouses to use and where to locate them to minimize overall costs.
Sometimes, combining the demand of stores in not enough to have the volume to use a cost efficient transportation mode. In this case, we may need to aggregate demand across stores and time. That is, we order enough inventory to cover several periods. The amount ordered depends on many factors, including any minimal ordering quantity imposed by the supplier, the cost of transportation and the cost of holding inventory. The more we order, the less frequently we need to replenish and the lower the transportation costs. But the more we order, the more we need to store and the higher the holding costs. The Economic Ordering Quantity (EOQ) formula provides a way to minimize the overall costs by finding the optimal ordering lot-size.
In some cases using warehouses as buffers is necessary:
Using warehouses as buffers can also help smooth out variation in demand by storing safety stock at the warehouse. Unexpected spikes in demand at some stores can be fulfilled by the safety stock. The orders to the suppliers can stay constant which helps run the supply chain smoothly. Also, because the lead time between the warehouse and the stores is usually much shorter than the lead time between the supplier and the stores, having a warehouse can improve the service provided to the stores and enable them to carry less safety stock and a wider range of products.
Warehouses play a vital and varied role in the supply chain. They enable lower transportation costs with consolidation across stores, across products and across time. The number and the location of warehouses can be optimized during the supply chain network design. The lot sizes and the amount safety stock can be optimized by tuning the inventory policies used in the supply chain.
In a different section, we explored the role of warehouses as consolidation and buffer points, highlighting their significance in reducing costs within the supply chain. The prevailing focus on cost-effectiveness often drives supply chain functions, with numerous studies dedicated to identifying the most efficient ways to serve customers.
Imagine you own an e-commerce web site serving customers throughout the United States. You perform a supply chain network analysis and find that the best location for a warehouse is in Nevada. This warehouse can serve customers in the states of Washington, Oregon and (some of) California via 2-day road shipping. This mode of transportation is cheap yet it is also quite fast. Your customers are happy with the 2-day delivery time. You are happy with having a warehouse in an area with cheap land and cheap labor. All is good!
Or is it? What if you have potential customers that want faster (1-day or less) service and are willing to pay a premium for i? You cannot easily serve them. Your network is not designed to provide fast servive at a reasonable cost. What you need is another set of warehouses. These warehouses need to be close enough to your customers to serve them fast. Because they are likely to be in or near population centers (Seattle, Portland, Sacramento) they will be more expensive to operate with higher rent and higher labor costs. But their costs will be offset by the extra revenues that you get from serving new customers.
Supply chain network analysis and design are often focused on cost reduction. They assume that the current customers are the only customers to worry about. Sometimes this approach can be short-sighted. It can pay (literally) to think of ways to create a network that better serves your customers and unlocks new value.
Your network may look very different when targeting different customers. For example you may need to move from a few big warehouses located days from major population centers to many small warehouses located in the city centers.
Providing faster service is great but providing faster service to all customers at all times is probably cost prohibitive. One key to finding the right balance between service and cost to serve is to understand that different customers have different preferences. In some cases the same customer may have different preferences depending on the situation (you may be time sensitive for a birthday gift but price sensitive for other goods).
When designing a supply chain network it is important to segment your customers and products. What is the potential market size when you can provide the products at different service levels and at different costs? Once you have this map of your customers you can start turning it into a map for your warehouses. You should also agree on which customers you are willing to not serve. You may not be in a position to create a network that can cater to all customers. Aligning supply chain strategy with overall business strategy is critical to make these choices.
Warehouses play a vital in serving your existing and potential customers. Do not assume that your current customers are the only customers to serve. By considering other customers, for example those that want faster service, you may be able to unlock new value for your company.
Not all customers are the same. Some need their goods quickly, almost immediately, and are willing to pay for a fast service. Some can wait but want a good price. The modern supply chain is as much about convenience as it is about cost. This is examplified by the offers of faster and faster service from 2-day shipping, to same-day shipping, to 15-minute shipping. The supply chain can play a much more active role in delivering such convenience and the revenues associated with it.
If you treat all customers the same, you will miss profits, miss customer expectations, or both. If you provide fast service for all customers, your prices will need to be high and you will miss cost conscious customers. If you provide slow service for all customers you will miss the ones that require fast delivery.
Providing fast shipping has a cost. Delivering goods in 15-minute requires having warehouses near the customers. You need many of them in expensive locations. The transportation costs are also high, with little opportunities for consolidation. It is important to carefully estimate the cost of providing faster service and to ensure that the extra revenues generated from serving the customers who want fast service cover the added expenses.
Traditionally when optimizing the supply chain the focus is on reducing costs assuming that all demand is treated equally. The question is how to fulfill it in the most cost effectively manner. This is obviously a very important question. However it casts the supply chain into the limited role of a cost center that needs to be minimized. It misses the point of winning customers with convience. It misses the point of extracting profits by providing the right service ro the right customer.
We will discuss how SupplyChops turns the common approach on its head and focuses on creating a supply chain network that is fit for all customer segments.
We will analyze customer segmentation in four steps:
Each step is straightforward so let's dive into each one by means of examples.
The first step is to understand how customers differ in their expectations and their willingness to pay for better service. Also, for each category, we need to estimate how many orders we can expect to serve. In this particular example we will focus on segmentation based on speed of deliveries. We will assume that we have identified three classes of customers: 30-minute customers who need things almost immediately, 2-day customers who wants things in two days or less, other customers who are not time sensitive. For each category we need to estimate how many orders we can expect. This could be done by estimating the number of customers and then multiplying by the expected the number of orders each one will place. Then we need to look at the willingness to pay: can we charge extra for fast delivery? Finally we need to look at the expected margins for the products that will be bought by each category. Items with short delivery times may skew towards specific categories with high or low margins. Knowing these numbers will help us estimate the profitability of serving each category of customers.
Differentiated customers are easily modeled in SupplyChops. Customers are associated with a sales price for each product. We can match the customer's willigness to pay with the price offered for each product.
Once we have identified customer segments we need to identify how we can service them. For 30-minute customers we will need warehouses in the same city (even same neighboorhood) as the customers from which to ship the goods. Having a warehouse in or near a residential area is likely yo be expensive. Also transportation will likely be dedicated to each order (e.g., bike delivery) and may also be fairly expensive. 2-day customers can be served from warehouses that are much further away. Each warehouse could serve many geographies. Much of the transportation can be done by trucks pulling many orders together. Finally for non time-sensitive customers we can ship from farther away if advantageous and fully consolidate shipments. Transportation will be the cheapest of all three categories.
Differentiated resources are easily modeled in SupplyChops. If a customer cannot be served by a warehouse because of time constraint we simply do not create the shipping lane between the warehouse and the customer.
Once the models are created we can run optimize the supply chain. Because SupplyChops optimizes on profits, it will automatically select the right configuration for the supply chain network and the right customers to serve to maximize profits. Customers are not treated all the same and SupplyChops will leverage segmentation to provide better service and better profits where appropriate.
In some cases we may want to investigate the impact of servicing some customers even if they are not the most profitable. SupplyChops let's you define a service level for each customer. By setting the service level to 1, you force SupplyChops to service that customer, no matter the effect on profits. You can run various scenarios by varying which customer segments you want to serve irrespective of profits. You can then compare and contrast the results between the scenarios to deepen your understanding.
Not all customers are the same and treating them as such will lead to poor profits and poor service. SupplyChops offers a new way to model customers, making it easy to create different segments and evaluate how to best service them. SupplyChops enables you to expand your supply chain by providing better service while optimizing for profits. The focus on growth fosters better alignment with the rest of the company. The flexibility to run various scenarios enables you to compare and contrast ways to service your customers.
Supply Chain Segmentation: Best-in-Class Cases, Practical Insights and Foundations