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Do You Know the True Cost of Your Supply Chain?

Supply Chain Management  
03/18/2019

As globalization continues to expand, many product companies are beginning to see other aspects of supply chain complexity increase as well. In addition to globalization, the growth toward mass customization and greater consumer insistence for accommodations in the speed of production and delivery are placing increased demands on lead times and logistics.

Caught in the middle are demand planners and schedulers who must monitor and control inventory, materials, and supplies for the enterprise. Because of the increased complexity, monitoring inbound materials, managing work in process (WIP) or assembly schedules, maintaining finished goods inventories, and other aspects of forecasting inventory have become more difficult. Luckily, technology advances in supply chain planning are helping to manage the increased complexity. The same is true for the improved logistics capabilities which are aided by the same technology.

The added complexity is also driving up supply chain costs. Many of a fairly good understanding of the price of purchased materials in the supply chain, but the data is often siloed. As a result, the increased complexity makes it difficult to know the true cost of the supply chain that includes both direct and indirect costs.

Using Total Cost of Ownership (TCO) to Determine Supply Chain Cost

Total cost of ownership is defined as  “The combination of the purchase or acquisition price of a good or service and additional cost incurred before or after product or service delivery.”  And while this includes production costs in make to stock (MTS) and make to order (MTO) companies, applying TCO analysis to the supply chain means identifying all direct, indirect, and other associated costs.  

Some areas to consider when tallying total supply chain costs include:

1) Understanding Material Flow:  Depending on whether a product company is MTS, MTO, Assemble to Order (ATO), or is simply a distributor with outsourced production, understanding the mechanisms involved in each will define the flow of materials. For example, in an MTS company, complex staging or multi-pass/multi-level processing may be required in midstream production steps. This increases WIP and affects dollars tied up in total inventory. On the other hand, in distributorships with many product offerings and a high number of SKUs, the focus may be on accurately picking and shipping single unit items. As a result, the cost is tied up almost predominantly in tasks that are supply chain related. Knowing the amount of time, cash, and volume of midstream processes is critical to understanding material flow to accurately assess cost.

2) Flexibility of System: Many organizations rely on manual processes or, at best, fragmented processes to monitor inventory and inventory forecasting. When a company employs a manual-based system, the total cost may not always be well understood as most manual systems possess a high degree of hidden cost. For example, in a company with a large WIP requirement where the WIP cannot readily be tracked and is often moved, staged, or restaged by production staff, those hours of production labor are hidden supply chain costs. Conversely, if the system is highly automated and dynamic, costs in managing material flow can be controlled through rapid adjustments, up or down, due to conditions such as seasonality, sales trends, and changing consumer tastes.

3) Long and Short Supply Chain Legs:  Many product companies source from multiple vendors across large geographic regions. Typically because the prices are cheaper from vendors overseas. In today’s market, it isn’t unusual for a finished product to carry components from many different parts of the world. But sourcing and purchasing on price alone is not always optimal and can affect overall supply chain cost. In product companies where demand planning and scheduling are not highly automated, supply chain costs can be affected in several ways:

  • Lead Time – Materials purchased locally or regionally may only take a few days to receive and can often be purchased in smaller quantities with lower per unit delivery costs. These materials must be balanced and coordinated with other inbound purchases that may be purchased in bulk and in higher volumes. This forces some inventory items to be managed “just in time” (JIT) and others to be managed on a stock basis. Even small inaccuracies in a manual or spreadsheet-based planning system can create shortages, stoppages, or missed deliveries.
  • Carrying Costs – Some companies make the mistake of over or underestimating carrying costs for large volume purchases that come in from distant vendors.  Again, the degree of automation can mitigate this issue, but overall, carrying costs include warehousing costs such as rent and utilities as well as labor, shrinkage, and insurance.
  • Quality – For product companies that source complete finished goods overseas or for those who purchase components for assembly at their facility, quality inspections may be required for incoming components. These costs should also be considered supply chain costs and the inspection time should be factored into planning, production, or distribution schedules.

All these direct, indirect, and associated costs are part of supply chain costs and should be considered in total cost of ownership.

Taking Control

With supply chain complexity on the rise, companies are searching for solutions. They are also beginning to realize that skill sets to manage this complexity may be higher in cost as well. To offset this, the reflexive reaction is to attempt “automation”.  And while that is key to understanding and controlling supply chain costs, it is the type of automation that matters.

To navigate the complexity of today’s supply chains, companies require specialized software that integrates demand planning, inventory forecasting, “what-if” planning, and a host of other siloed tasks into a single view of the truth. The software should also be capable of ERP integration for improved efficiency, accuracy, and also for access to other critical enterprise data.

Adoption of supply chain planning software to manage these functions has several advantages that improve cost-effectiveness:

  • It Allows for Dynamic Changes: Because short-term and long-term scheduling have different levels of accuracy, the ability to make changes that reflect shifts in demand, lead time, logistics bottlenecks, and other factors are critical to controlling the supply chain overall and thus its cost. As supply chain complexity increases, manual and spreadsheet-based systems can become overloaded and inaccuracies will increase.  Specialized software allows for more accurate forecasting in purchasing and inventory and advanced analytics can identify and perform tasks at a faster pace than human analysis over manual inputs, creating a dynamic system that reduces overall cost.
  • It Improves Communication:  As product companies with manual inputs and spreadsheet-based systems often operate on siloed data, changes, adjustments, and revisions to the schedule may not be communicated properly, or at all. With specialized supply chain planning software, such changes and adjustments can be implemented quickly and the associated functions such as inventory control can be automated to calculate and make adjustments automatically.
  • It Increases Efficiency and Agility: Many of the tasks and steps required to manage a manual system can be eliminated with purpose-built planning software. This leads to a higher value-add from the planning process and also lowers cost.

As supply chain complexity increases, companies need to know the true cost of their supply chain to operate efficiently. But once those costs are understood, how those costs are managed are as important as knowing the costs. With manual and spreadsheet-based systems, understanding true supply chain costs can lead to some cost improvement. But there is a limit. And it is only through deploying the right purpose-built software that will remove the final barrier and pave the way for comprehensive cost reductions.

If you are ready to advance beyond spreadsheet-based planning, click here to explore the capabilities of the DemandCaster Supply Chain Planning Suite.

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