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The Supply Chain Triangle: Balancing Service, Cost & Cash
Without a doubt, we are living in interesting times. We are evolving into an ecosystem-driven economy, where companies are not only competing against other companies but where success depends on the ability to create a strong and sustainable ecosystem.
To be able to cope with the flow of goods, as well as the information and cash returning within the ecosystem in, in a fast and flexible way, strategic supply chain management will be crucial.
Breaking Down the Silos
Originally, I wanted to write an inventory book. However, I soon saw how companies lacked an understanding of some basic inventory principles, which boil down to strategic choices, so decided to take a different approach.
If over the past five years a company’s sales have remained flat, but the number of Stock Keeping Units (SKU) increased by 50%, chances are that the inventory went up. Instead of understanding this after the fact, strategy-driven companies realize this upfront and evaluate what can be done to avoid it.
I believe that a fundamental shift is required to stay on board in the changing world. We must finally break through the functional silos. That’s why I thought up the Supply Chain Triangle of service, cost and cash.
The Supply Chain Triangle Concept Explained
The Triangle Concept captures the idea that organizations deliver different types of services, which come at a certain cost and require a certain amount of inventory, or, more generically, cash.
The balancing of these three might be the essence of supply chain management. However, the concept is actually about maximizing shareholder value via sustainable growth. This means that the whole organization has the same goal, and shares a common interest in aligning the three corners of the Supply Chain Triangle.
The difficulty is that decisions in one corner of the triangle impact the others. That creates a tension, caused, among other things, by opposite incentives.
Sales and Marketing Managers are typically on the service side, while Production, Purchasing and (partially) Supply Chain are pulling on the cost side. A Sales Manager will typically receive a bonus on the achieved turnover, while a Supply Chain Manager will be judged on their efforts to squeeze the inventory. If Sales see the broadening of the product portfolio as a strategy for increasing turnover, this brings tension into the triangle, since a wider product range will negatively impact the inventory.
The answer to relieving that tension lies in taking an investor’s perspective.
From Finance to Strategy
Service is a driver of net sales, but investors are not only concerned about the top line. They’re also interested in metrics such as EBIT, which combines the service and cost aspects.
And it doesn’t stop there, if an investor compares two companies, both with €100 million of EBIT, then the company with €50 million of capital employed (cash-side) will be a more attractive investment than the one with €75 million of capital employed.
In the end, investors are looking at the EBIT generated over the capital employed. This is expressed by the financial metric ROCE (Return on Capital Employed). Different supply chain strategies can be seen as various routes to deliver the same shareholder values using ROCE to measure this.
In Supply Chain Strategy and Financial Metrics I explain how to map the different sides of the Supply Chain Triangle in order to make financial metrics understandable to top management, making it clear how different strategies lead to different supply chains. This is just one of the ways in which I hope to give supply chain managers ammunition to be seen as a more strategic partner.