Getting ahead through

Six PracticesPractice 2

Using segmentation to battle complexity

The Six Practices that bring competitive advantage

McKinsey & Co, with Georgia Tech College of Management, have identified six ‘leading practices’ that drive supply chain performance and that allow companies which excel in these areas to dominate in terms of service, cost and inventory. Here, Derek Thomason, Martin Green and Martin Haynes of Unipart Expert Practices look at how the second of these practices – Segmentation – can be implemented. Many companies are facing increasing complexity in their supply chains. as the customer base becomes more international, this raises the need to meet local requirements, while within these markets, individual customers will have their own individual specifications. this will involve different products delivered to different service levels through different channels. Most companies understand that this places increased demands on the supply chain and the business in general. in spite of this many businesses limit themselves to a ‘one size fits all’ approach to their supply chain. as a result, few understand exactly what drives cost and

how, through ‘prudent pruning’ and/or supply chain segmentation, significant improvements in cost and service can be made.

Many businesses have customers that they suspect (intuitively) are uneconomic, but few take the extra step to ask themselves if there is a better way of serving that segment.

the challenge is how to construct ‘tailored value-delivery systems’ whilst still getting economies of scale and synergies from combined operations. to achieve this it is necessary to understand the costs associated with each value-delivery system. this will enable the business to reduce the cost to Serve to a level where it is economic to serve a particular sector. conversely, it is also about making disciplined well informed decisions about those sectors which should be served and those which should not.

Most organisations will already undertake a degree of segmentation of their supply chains, some of which will be both self evident and forced upon them. For example, it is obvious that ambient, chilled and frozen supply chains need to operate separately, both physically and very often in process and systems. But

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segmentation may be beneficial if applied to a range of different axis. there are three dimensions worth considering for segmentation of the supply chain:

Physical characteristics Market and sales characteristics Product range characteristics.

Physical characteristicsas mentioned above, some segmentation may be forced upon us by a range of circumstances such as, temperature regimes, weight and/or bulk, value/risk of theft, legislative constraints (for example hazardous chemicals), and risk of taint or contamination.

in a business where there is, for example, a wide range of products with different value/bulk characteristics - such as a builders’ merchant, handling everything from nails and screws to roofing insulation and electrical components - the different types of product could well justify different routes to market. Segmenting in this way may result in significant cost savings, not only on logistics costs but also in terms of reduced damage due to the use of more appropriate equipment, reduced inventories and better customer service.

Market and sales characteristicsMost businesses serve more then one market sector. For instance, food manufactures tend to serve both the retail and the food service sectors. retailers themselves may serve both their stores and a home delivery channel. these different channels will have different characteristics in terms of order sizes, product range and volatility. Many companies fail to make these distinctions and use a ‘one size fits all’ approach. this can result in additional cost, constant fire fighting and failures in customer service.

Similar arguments can be applied to manufacturing where benefits can be achieved by segmenting factories by the demand characteristics of the products. For example, certain factories may focus on high volume, predictable products, while another specialises in low volume, unpredictable products and short run lengths.

the most advanced companies recognise these characteristics and adopt appropriate approaches. More importantly, they also recognise that products may move between categories and employ different processes accordingly. For example, a weekly planning cycle may be adequate for products with a stable demand. However, once the product goes on promotion, a weekly planning cycle is unlikely to be adequate and a different, more responsive, approach is called for.

Product range characteristicsthe final characteristic is in terms of product range and the velocity of movement. Supply chains with high volume and a wide product range, like many retailers or wholesalers, will need to develop complex and sophisticated supply chains. For example, it may be appropriate to distribute fast moving and slow moving products through different routes. Manufacturers of capital goods will require a very different approach. the complexity comes with businesses that operate in a number of sectors. Failure to segment properly can drive significant cost into the supply chain as well as compromise service. in particular, there is a regular discussion in businesses between the marketing need for an extended product range and the supply chain desire to simplify and reduce complexity. Decisions are frequently based on ‘instinct’ or on marketing requirements. However, detailed analysis often reveals that many lines - especially slow moving lines - operate at a loss. this is not to say that all such lines should be deleted – rather that ranging decisions should be made on the basis of robust analysis and the choice of appropriate channels rather than ‘instinct’.

Often, however, the best ways to segment are not so obvious and analytical techniques are required to identify the most appropriate approach.

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The Cost To Serve / Service (CTS)ctS is based on the concept that cost is dictated by a limited number of ‘activity’ drivers within a business. these ‘activity’ drivers in turn have a cost (per unit of activity) associated with them. therefore, if we understand the activity/cost drivers within a business we can not only calculate the cost to serve a particular segment but we will also see how changing complexity is likely to impact the cost base. We can then direct investment and process improvement resources to where they will have the most benefit - or alternatively determine the benefits of complexity reduction.

The Cost of Complexity (CoC)the cost of complexity is used to understand the ‘real’ cost and profitability of each product in the range with the aim of highlighting opportunities for range rationalisation and product substitution. it is important to differentiate between short-term fixed costs and variable costs because as range is reduced the variable costs tend to decline - however, fixed costs remain constant. therefore, in addition to understanding the cost of complexity, plans are needed which detail how short-term fixed cost can be eliminated, for example, by plant rationalisation.

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the ctS & coc analysis can often be used to challenge current supply chain practice. For example, if a company were to adopt a ‘postponement’ technique, it both reduces complexity (while maintaining variety) and changes the shape of the cost curves. it would also need to redesign its physical infrastuctures and this requires specialist tools and techniques.

the most common approach is Pareto analysis. i.e to segment on the basis of volume. For example: the 20% of products that represent 80% of the volume may take one route the next 30% of products that represent 15% of volume may take another route and: the remaining 50% of products that represent the remaining 5% of volume may take another route

However, this approach fails to take into account the full cost of handling these products. as a result, product ranges are allowed to proliferate without an understanding of the full impact on the business. two analytical tools, cost to Serve and cost of complexity inform these discussions.

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For more information contact:Unipart expert Practices

Unipart House, Garsington roadcowley, Oxford

OX4 2PG

tel: +44 (0) 1865 384690 uep.enquiries@unipart.co.uk

or visit our website:www.unipartlogistics.com/consulting

Supply Chain DesignSupply chain design tools (such as caSt and cLaSS) use activity Based costing (aBc) principles to develop fulfilment and planning strategies to serve the needs of particular segments. For example, this might include different production (MtS, MtO, Mtr), warehousing (single, multi-order or batch pick and sortation) and logistics strategies (FtL, LtL, Pallet or Parcel).

While these tools and techniques help us understand the cost of complexity and inform the most appropriate way of segmenting our supply chains, many business’s fail to address this issue in an integrated way. the most appropriate way of doing this is through an integrated planning process such as S&OP.

Sales and Operation Planningalthough S&OP forms only a small part of the overall supply chain and business planning hierarchy it is important in that it provides a forum for reviewing, accommodating and/or eliminating complexity. S&OP is management’s ‘handle’ on the business and therefore should direct resources necessary for improvement to where they will have the most benefit. it is also the forum where decisions on the product, channel and asset portfolio should be decided.

ConclusionsSupply chains are complex. Many have grown ‘a bit like topsy’ as businesses have grown and as mergers and acquisitions have happened. as a result, for many organisations, the supply chain that is currently operated is likely to be sub-optimal. there is therefore a need to review the operation to ensure that ‘one size is not being made to fit all circumstances’. Proper segmentation of the supply chain, using sound analysis enables managers to operate a portfolio of processes appropriate to the needs and characteristics of particular circumstances. the result will be lower costs and improved service levels

We will look more closely at Supply chain Design in the 3rd of the Six Practices and at S&OP when we consider the 5th of the Six Practices, World class integrated Planning.

Previous articles in this series, together with any other publications from Living Logistics are available from the thought Leadership section of the web site:-

www.unipartlogistics.com/consulting