Strategic Choices Affecting the Supply Chain
9th May 2018 | Bram DeSmet
In volatile times, organizations are typically questioning the strategic choices of the past and the future: should they deliver more services to the customer, develop more of their own R&D to grow in specific niche markets, or play on the cost side by making cuts in non-essential extras?
These strategic choices have a direct impact on the supply chain strategy and will lead to different supply chains. Different strategies will also result in different targets for supply chain metrics.
According to Treacy and Wiersema's competitive strategies, there are three possible corporate strategies to choose from:
- Operational Excellence - offering the lowest price
- Customer Intimacy - striving for the best customer experience
- Product Leadership - delivering the highest quality of products
Mapping Strategy to the Supply Chain Triangle
To develop a more thorough supply chain strategy, we can map the different organizational strategies on our Supply Chain Triangle.
In short, the Supply Chain Triangle concept comes down to the fact that organizations deliver different types of services to their customers, which come at a certain cost and require a certain amount of inventory, or more generically, cash. The balancing of these three sides of the triangle is the essence of supply chain management.
The figure above shows the resulting profiles for the operational excellence, customer intimacy and product leaders. It clearly shows that different organizational strategies will lead to different supply chain strategies.
Linking Finance and Strategy
When setting supply chain targets or comparing them across companies, we cannot disregard strategy. Different strategies are different paths to create profit. To measure the profit of an organization, we take into account the following financial metrics:
- First, inventory can be extended to capital employed. This is the financial term for the sum of fixed assets and working capital (inventory plus the accounts receivable, minus the accounts payable).
- We can combine the service and cost sides of the triangle into a profit metric, like EBIT (Earnings Before Interest and Taxes).
- To include the capital employed, we calculate the ROCE (Return on Capital Employed), which equals the EBIT generated over the capital employed.
What organizations get in return for every invested dollar is thus expressed as the ROCE. From an investor's perspective, this is the key metric to take into account.
We Are All Different, But the Same
Changes in strategy will reflect changes in the EBIT and the capital employed, and different strategies are in fact just different ways to deliver a comparable ROCE. In other words, the metrics will differ between a strategy focused on operational excellence, customer intimacy or product leadership, but, in the end, the return on every dollar invested should be the same.
To be able to guarantee the lowest cost and the lowest price, the operational excellence player will need to focus on a more basic set of services. A product leader will have a higher capital employed than the operational excellence player, because of the higher complexity of the products. It’s fine if the product leader requires a higher capital employed, as long as his EBIT is higher. Likewise, the operational excellence player might work at a lower EBIT, but with also a lower capital employed.
Avoid Flying Blind
The above seems obvious, but many companies are blindly benchmarking inventory turns without taking into account the balance of cost and service, and without linking back to the chosen strategy.
So, next time you are asked to reduce inventory by 30%, have a look at the bigger strategic picture and start the discussion, looking for a better balance with other targets. Afer all, to be successful as an organization, the supply chain and the overall company goals should be aligned.
About the Author
Prof. Dr. Bram DeSmet is author of Supply Chain Strategy and Finacial Metrics the CEO of Solventure where he helps global production and retail organizations in the domain of Strategy, Supply Chain and Operations. Supply Chain Strategy and Financial Metrics is a step-by-step guide to balancing the triangle of service, cost and cash which is the essence of supply chain management.