And the other study by PRTM, now under PWC, came up with these key observations from 350 worldwide companies.<\/p>\n
- \n
- 85% stated they expect complexity to grow significantly over the next three years.<\/li>\n
- 75% expect an increase in number of international customers.<\/li>\n
- 66% expect a higher number of product variations to fulfill customer requirements.<\/li>\n<\/ul>\n
PRTM articulated this parting thought after the study.<\/p>\n
Most participants are looking to international customers for future market growth. Yet few are prepared for the complexity that results from serving global customers with regionally customized products.<\/em><\/p>\n
All these raise the question \u2014 how do we mitigate these risks? Below are three risk mitigation strategies.<\/p>\n
NO. 1 | RISK MITIGATION STRATEGY: PRODUCT PORTFOLIO MANAGEMENT<\/h2>\n
With this data in mind, we can dig into our first of three mitigation methodologies that can improve profitability and mitigate risk. We talk about the propensity of companies to expand products and the inability to cull underperforming SKUs. Over many years of experience and through many studies, a few key statistics stand out across just about all industries.<\/p>\n
- \n
- About 20% of products account for about 80% of revenue and about 82% of contribution margin.<\/li>\n
- About 60% of revenues are generated by 8% of products.<\/li>\n
- About 45% of products contribute only 5% of revenue.<\/li>\n<\/ul>\n
Why is this so prevalent within our product portfolios? We operational professionals, by observation and experience, are very good at introducing new products and getting products out the door at cost and with good delivery service. What we don\u2019t do well is get rid of what APICS-Supply Chain Council calls, \u201cZombie SKUs\u201d. These are products that suck the oxygen out of the entire portfolio. These SKUs are corpses of what used to be good and pro table products. With that said, let\u2019s walk through a typical pattern of product proliferation.
\nExecutives at a company posit the business plan that states: \u201cWe\u2019ll drive an increase in top line revenue by increasing differentiation across diverse categories,\u201d meaning we will add products. So, what happens after that game plan begins? Figure 1 provides a glimpse.
\n![\"figure1\"](\"https:\/\/demand-planning.com\/wp-content\/uploads\/2016\/07\/figure1.jpg\")
\nHere on the \u201cY-Axis\u201d we maintain the number of products from low to high, and on the \u201cX-Axis\u201d we have Time. As you can see in the graph, over time, organizations begin to proliferate products and services. The additional costs to exercise this game plan are:<\/p>\n- \n
- More finished goods, raw and component inventory, and additional product capacity and warehouse space.<\/li>\n
- When product proliferation begins to compromise operating efficiency, companies conduct a rationalization program. When companies exercise this strategy in support of the game plan, they experience \u201cThe Double Whammy!\u201d They now incur still more costs such as commercial risk from lost revenue and share, risk to shareholder equity, write-off costs, costs for rationalizing production and warehousing.<\/li>\n<\/ol>\n
The bottom line is product proliferation, as a strategy, is fraught with financial and strategic risk and must be fully vetted before embarking on that plan. How does a company mitigate this risk? One approach is to utilize Gross Margin Return on Inventory Investment (GMROII). GMROII has been used by many industries that manage a large number of products and services. It can be used to determine the amount of gross profit earned for each dollar invested in inventory on an annual basis. The methodology does have its critiques, but it\u2019s a very good and somewhat simple way to begin the dialogue about under performing SKUs. Figure 2 profiles the calculation, the analysis and the Mitigation Game Plan.
\n![\"figure2\"](\"https:\/\/demand-planning.com\/wp-content\/uploads\/2016\/07\/figure2.jpg\")
\nAs you can see, all that is needed for the analysis is the product\u2019s Gross Margin percent and its ongoing Inventory Turnover Rate. The example goes through three different scenarios with the same product. On an annual basis, a product\u2019s Gross Margin is somewhat stable, so the what-if analysis takes place by \u201ctweaking\u201d the product\u2019s inventory turns, either through lowering the operating inventory, safety stock, or ordering parameters. Therefore, if a company can improve the inventory turns, it can improve the GMROII. Many organizations that utilize GMROII tend to plot every SKU in a category or all SKUs on a 2×2 grid. On the left side of Figure 2 we have that grid.<\/p>\n- \n
- On the \u201cY-Axis\u201d, we have the Inventory Turns from low to high.<\/li>\n
- On the \u201cX-Axis\u201d, we have the Gross Margin from low to high.<\/li>\n
- Once the SKUs are plotted on the grid, we can begin the analysis of SKU evaluation and improvement.<\/li>\n<\/ul>\n
The grid categories are: Highly Suspect, Workable, Constant Evaluation, and Ideal SKUs. The Net-Net of the GMROII exercise is a very quantitative and visual approach to differentiating SKUs and continually evaluating the status of \u201cGood versus Not-So-Good\u201d products, based on their margin contribution and asset impact. This exercise and approach tends to lead to a very logical and less emotional approach to continuous SKU evaluation and perhaps rationalization. The \u201cRule of Thumb\u201d<\/em> for GMROII<\/em> break-even is more than $4.00 annually.
\nOne final note, P&G, the nation\u2019s largest consumer product company, is presently dumping about 90 of its smaller, less popular brands. This was announced in late 2014. The company has maintained about 160 brands. The 90 brands being discontinued represent about 56% of their brand portfolio and about 10% of their revenue. The remaining brands account for about 90% of their ongoing revenue. Sound familiar? At the announcement, their CEO, A.G. Lafley, stated: \u201cWe\u2019re going to create a faster growing and more profitable company that is far simpler to manage and operate\u201d.<\/em> Shares of P&G jumped more than 3% after the announcement, but share price still remained slightly lower for the year. Sound familiar?<\/p>\nNO. 2 | RISK MITIGATION STRATEGY: CUSTOMER VALUE MANAGEMENT<\/h2>\n
Our second of three risk mitigation methodologies is what we call Customer Value Management (CVM). Our bold statement out of the blocks is: \u201cAbout 20% of all customers generate 80% of the profits!\u201d<\/em> This statement is backed up as well with many real- life experiences and multiple studies. The real tragedy here is: \u201cOnly about 5% of all companies segment their customers!\u201d<\/em> Looking at this still another way, almost all companies treat every customer the same, which normally means one or maybe two delivery approaches. This is not an efficient or effective way to deliver goods. Why is this prevalent? Because segmenting or just talking about rationalizing or \u201cFiring\u201d a customer is a very emotional issue. Sales and marketing professionals tend to get \u201cwedded\u201d to their customers. So, with that as a backdrop, how do we move forward with this risk mitigation and profit improvement methodology?
\nOver the years, many companies with exemplar supply chain strategies, including IBM, have embraced this approach. Not initially, but normally in a timeframe such as Stage 3 of the S&OP process. Customer Segmentation is driven by lifetime value to the organization. The most often used methodology is to segment customers into four categories. Those categories tend to be 1) Champions, 2) Demanders, 3) Acquaintances, and 4) Losers. Figure 3 depicts these segments.
\n![\"figure3\"](\"https:\/\/demand-planning.com\/wp-content\/uploads\/2016\/07\/figure3.jpg\")
\nHow do we go about defining value to these categories? The Supply Chain Risk Consortium maintains several complex templates, methodologies, and more. It\u2019s not an easy thing to accomplish and that\u2019s why only a few companies exercise the process. We don\u2019t have the time to dig deeper here but we can provide a few helpful hints in terms of \u201cwhat to do\u201d to better align these customers with their contribution to the bottom line. Several aspects of the segmentation process revolve around: Price Points, Technical Product Issues, Logistics Services, Quality, Collaboration, Self Service, and Distribution. The value segmentation revolves around \u201cWhat to Do and How to Do it!\u201d Some quick-hit thoughts on that are below.<\/p>\n- \n
- Champions\n
- \n
- What to Do: \u201cNurture\u201d<\/em> them.<\/li>\n
- How: Through preferred customer programs, loyalty programs, personal support, and more.<\/li>\n<\/ul>\n<\/li>\n
- Demanders\n
- \n
- What to Do: \u201cGrow and Reduce Cost\u201d<\/em><\/li>\n
- How: With focused marketing, increased volume, providing incentives, and improving customer service.<\/li>\n<\/ul>\n<\/li>\n
- Acquaintances\n
- \n
- What to Do: \u201cGrow Revenue\u201d<\/em><\/li>\n
- How: Stimulate volume through up-selling, cross-selling, bundling, or promotions.<\/li>\n<\/ul>\n<\/li>\n
- Losers\n
- \n
- What to Do: \u201cImprove Profitability\u201d<\/em><\/li>\n
- How: Minimize direct customer care, invoke additional charges for services, minimize direct marketing.<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n
Once a company embarks on the \u201cImprove Profitability\u201d aspects of S&OP by critically reviewing their product portfolio and by segmenting their customer base, they are ready to exercise the third leg of this process: plotting SKUs and customers, enhancing the bottom line and mitigating risk.<\/p>\n
NO. 3 | RISK MITIGATION STRATEGY: TOTAL COST TO SERVE MODEL<\/h2>\n
Our third of three methodologies ties it all together. Figure 4 depicts how this is accomplished. Sometimes called Complexity Management, analytically driven portfolio segmentation schemes can be used to allow companies to effectively manage complexity and free up capacity to serve more profitable customers and products. We\u2019ll touch more on this in the next section. Let\u2019s walk through the graph.
\n![\"figure4\"](\"https:\/\/demand-planning.com\/wp-content\/uploads\/2016\/07\/figure4.jpg\")
\nThe graph depicts a methodology to identify, classify, and plot customers and products.<\/p>\n- \n
- On the \u201cY-Axis\u201d we maintain Product or SKU classification by margin from low to high.<\/li>\n
- On the \u201cX-Axis\u201d we maintain Customer classification by margin as well from high to low, left to right.<\/li>\n
- The first quadrant, top-left section, maintains A&B type products and A&B customers \u2014 \u201cThe Good Guys.\u201d<\/li>\n
- The second quadrant, top-right,maintains A&B products and C, D, & E type customers \u2014 \u201cThe Not-So-Good Guys.\u201d<\/li>\n
- The third quadrant, bottom-left, maintains C, D, & E type products and A&B type customers \u2014 \u201cMarginal Products and Good Customers\u201d.<\/li>\n
- The fourth quadrant, bottom-right, maintains C, D, & E products and C, D, & E type customers \u2014 \u201cMarginal Products and Marginal Customers\u201d.<\/li>\n<\/ul>\n
After all SKUs and customers are plotted, the fun begins! The dialogue normally starts with products and customers within the bottom two quadrants. Companies review those inside what we call \u201cThe Copper\u201d quadrant and attempt to \u201ctweak\u201d both the products and customer profiles, as we discussed in the earlier sections. Next, the dialogue focuses on \u201cThe Coal\u201d quadrant. These are the very unprofitable products and loser customers! The approach tends to be to shove those into one of the other quadrants. If that can\u2019t be done, then hard decisions must be made for the good of the bottom line. Ultimately, the graphic approach allows everyone visibility, and acts as a very good vehicle to make strategic, tactical and operational business and risk mitigation decisions.<\/p>\n
BENEFITS TO BE DERIVED<\/h2>\n
As we mentioned at the outset, companies take this approach to improve profitability and mitigate supply chain risk. Think about it this way. When a company eliminates very \u201cMarginal Products and Loser Customers,\u201d what happens? It tends to free up capacity and resources to make more A&B type products for more A&B type customers. Empirical studies show companies that enact formal portfolio management processes have reported, Earnings-Before-Interest-Taxes (EBIT) performance improvement of 3 to 6 points. Typical EBIT improvements have been in:<\/p>\n
- \n
- Cost to Serve reductions of 1-2 points<\/li>\n
- Capital Improvement of 1-2 points<\/li>\n
- Increased Net Pricing of 1-2 points<\/li>\n<\/ul>\n
Example No. 1: A consumer products company with 5,000 customers and 500 products \u2014 with 57% SKU reduction got equivalent to $7.5 M margin improvement.
\nExample No. 2: A healthcare manufacturer with 5,400 products \u2014 with 26% SKU reduction got equivalent to a 4000% Internal-Rate-of-Return (IRR).
\nThe benefits are quite impressive. The tools, techniques, templates, and methodologies are available, perhaps not within your company at this time, but it begs the point of taking a good hard look, especially if you are managing an S&OP process across a global supply chain landscape, and want to mitigate your supply chain risk and improve your bottom line. Enjoy your journey.<\/p>\n
- How: Minimize direct customer care, invoke additional charges for services, minimize direct marketing.<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n
- What to Do: \u201cNurture\u201d<\/em> them.<\/li>\n
- Champions\n