Identify Hidden Costs From Total Acquisition Cost

For any rational consumer who makes a purchasing decision for a product or service, total acquisition cost (TAC) is often part of the decision process.  The goal is to obtain the best product or service with the least total costs for the long term.  These kind of decisions happen every day in our daily life,  from a decision whether we should buy energy saving light bulbs, to a more expensive but gas efficient car, or to a much more pricey new house but with much less requirement of future maintenance. In the business world, the theory is the same.

The definition of Total Acquisition Cost (TAC) can vary. But generally speaking, TAC in supply chain management should be the sum of total costs associated with receiving and using of a product or service, including ordering administration costs, ordering size costs, product costs, inbound shipping costs, assembling or conversion costs, quality costs and maintenance costs.  Unfortunately, many companies tend to focus on product costs and quality costs as their procurement success measurement, which are obvious and easy to measure and capture, but overlook other hidden costs in TAC.

In this article, I will use two examples to explain where we can identify some hidden costs from total acquisition cost.

Logistics costs as hidden cost

This is a very straight forward case of embedded cost analysis for the company using vendor managed inventory (VMI). The analysis is simple but requires significant trust, transparency, and collaboration between the company and their suppliers. The suppliers are asked to breakdown cost components for VMI raw materials as below:

  • Product costs
  • Shipping costs
  • Revolver hub costs (warehouse costs)

The embedded costs are hence broken down into different phases of the supply chain. In this case, the product cost is not the focus, but the logistics costs, which is hidden as part of the final pricing. After understanding the embedded logistics costs of raw materials, the Logistics team goes to its logistics providers for a quote, including shipping and warehousing, on the condition of meeting the same logistics service level used by suppliers. Once a lower logistics cost is identified, Procurement uses it as leverage to negotiate with suppliers. Suppliers need to either match the logistics costs or use the recommended 3PL by the company. This is a great example showing collaboration with suppliers for cost reduction. I believe many companies are conducting similar exercises to identify hidden logistics costs in their purchased materials.

Administration cost, order size costs as hidden costs

The costs of ordering administration, order size or assembling are difficult to capture and often not part of acquisition consideration. But those costs can become surprises some day and hurt the company bottom-line. It can potentially damage the relationship between suppliers and customers.

I’m using a case of pallet rentals in a logistics operation to illustrate those costs. A pallet is not a key material for many companies but it’s utilized in everyday operations to carry and ship important products. Pallet pooling is not a new concept. It allows companies to focus on their key supply chain activities and enjoy a lower logistics cost through renting pallets, instead of buying. The value proposition for this system is to decrease logistics costs, while supporting environmental sustainability.

It’s a great business model if there were no other hidden costs.

For any company using pallet pooling, the additional administration costs can come out of the blue. It’s not a simple activity of placing PO. It includes all other activities of “reporting, reconciling, correcting, and possibly conducting your own audit.” (Andrew Mosqueda, A Cost Analysis of Rental vs. White Wood Pallets). There is a lot of room for reporting errors or variables in a pooling system because pallets float from upstream 2nd or 3rd tiers of suppliers to downstream wholesales or retails. It can cause substantial effort for companies to maintain the program. If companies lose track of pallets because of shipping them to clients outside the rental network, the costs of “loss of equipment” will end up more than buying new pallets.

Ordering size requirement is another invisible cost in TAC. If there is a fuel surcharge for a full truck order or LTL surcharge, the inbound shipping cost per unit becomes higher for small batch orders. If companies choose to increase order sizes in order to lower surcharge costs per unit, inventory carrying costs will increase, such as storage, insurance, tax, and extra rental fee for this rental case.

It might be extreme to use a rental case to explain ordering related costs. The point is that intangible costs, such as ease of doing business, suppliers’ flexibility and services, are definitely part of total acquisition cost. In the long run, all of those hidden costs either pass along to consumers to decrease your competitiveness in the market, or hit bottom-line to reduce your profitability. Hence, for companies that would like to trim down total acquisition cost for their procurement, start with identifying hidden costs first before jumping into negotiate new pricing with suppliers.

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Key drivers of profitability and competitiveness in supply chain

Since the recession began, supply chain management has been back on the agenda of companies’ boardroom. There is no doubt that it’s the perfect time for company leaders to exam their supply chain model, supply chain network and identify the hidden costs in the chain. By reshaping the supply chain strategy of companies, the supply chain can become the “cash” chain.
The below chart represents key drivers of profitability and competitiveness in the supply chain. There are three aspects that supply chain can do to drive “cash”: reduce expense, increase revenue, and improve assets liquidity. Companies should look into all aspects, encourage innovation and risk taking. Companies can not only streamline the processes to achieve a lean and efficient organization, but also make their supply chain organization into a revenue stream.

Supply chain as cost drivers

This is the first thing that every company will jump into. “Cutting costs” becomes the slogan of the company. Many companies assign certain dollar amount to each individual as performance objectives. There is nothing wrong with that, except company leaders need to be aware of the existence of functional silos, and commit to transparency communication within the organization. As we all know, there are many tradeoff decisions to be made within supply chain, such as the traditional tradeoff between warehouse and transportation. Remember, pressure can increase the political level inside the organization and sometimes force people to make a decision based on making their numbers. High level leaders are responsible for the big picture of the whole supply chain and support the least total cost decisions for the organization. Unreasonable measurements or targets can discourage employee morale, damage organizational heath and sometimes lose supply chain talents for future growth.

Below is analysis for key drivers for supply chain as expenses and opportunities for cost reduction:
a. Transportation
There are many areas to be looked at in transportation to achieve cost savings. It has been discussed in detail in my article “Five Ways to Achieve Cost Savings in Transportation”.

b. Inventory carrying costs
It’s an area that many companies overlook and don’t even calculate and understand their inventory carrying costs. As standard rule of thumb, inventory carrying cost is 25% of inventory value on hand. When high inventory level is unavoidable during a recession, it’s a great opportunity for the company to look into their inventory carrying costs to identify opportunities. Below charts present all components for inventory carrying costs. I will discuss more into details in a separate article.

Inventory carrying cost

c. Variable production and warehousing cost
Variable costs are cost of labor, material or overhead that changes according to the change in the volume of production units. I believe many companies conduct ABC (Activity Based Costing) analysis to find out standard variable cost. Variable cost reduction can be done through process improvements to reduce wastes in production and warehouses, such as waiting time, movements, etc.

d. Raw materials
Raw material is considered as part of inventory. It includes direct and indirect raw materials. Collaboration and partnering with suppliers can lead to total inventory reduction in the chain to achieve a win-win situation, such as VMI or ERP. Scrutinizing suppliers in a difficult time will jeopardize companies in the long term.

Supply chain as revenue driver

Many companies recognize their supply chain as cost driver, but fail to see the prospect of supply chain as a critical role to drive revenue.
a. Supply chain service
Supply chain service level directly impacts customer satisfaction. Order fulfillment and on-time delivery are two major service metrics to measure company supply chain efficiency and effectiveness. Higher service levels bring higher customer satisfaction which prevents loss of revenue and leads to future sales. It’s worth noting that there is an exponential relationship between service level and cost. However, there is normally a predefined service level agreement between companies and their customers or trade partners.

b. Supply chain solutions
When business development is trying to break into a new sales channel, supply chain supporting capacity can often be brought up as a question. Example: A company wants to enter into a new market which can only order small LTL orders, but at much higher frequency. If the company has become accustomed to TL orders all the time, those LTL orders will become a market entry barrier due to increased logistics cost. Under this kind of circumstance, supply chain, as its supporting role to revenue increase, needs to be flexible and innovative to provide a solution as an enabler for market expansion without hurting the company’s bottom line. In this case, working with 3PL for LTL consolidation can often be the solution for the challenge.

c. Recycling or reverse logistics.
It’s one area that is easily neglected by many companies. Recycling, picking up disposed goods from the customers and reselling, can not only improve customer satisfaction and lead to new purchase, but also bring the company a new channel of revenue by reselling disposable goods to a safe recycling channel. It also helps companies to fulfill their social commitment for environment sustainability.

Supply chain as assets management

Asset management can be the most challenging task for supply chain because it would take a much longer time to make changes in company assets, such as leasing contracts for warehouses. Better asset management in supply chain will require will require organization transparency and a communication from upstream to downstream to minimize functional silo.

a. Fixed cost of DCs and docks
For a company with excess inventory, it’s costly to acquire more space for storage. For companies with extra space due to less demand, it won’t be easy to close DC in the short term and there is also a risk for a higher acquiring cost when the market is back. So companies can seek partner opportunities with each other to overcome the difficult time together. A project I worked on in the past is to provide a customer storage solution. With certain incentives, the customers purchase several months of inventory shipped directly from the manufacturer. They utilize their empty spaces to make storage revenue and the products are used for their future demand. While the company with excess can avoid the cost of new warehouse space and one leg of transportation from storage to the customers. Certainly this kind of process needs to be carefully managed to avoid skewing demand and other possible negative impact.

b. Fixed cost of plant
This is the most difficult part of all costs reduction opportunities because it may lead to the close of a factory or downsizing the workforce. It’s the last thing I like to see and propose because I’m also one of the millions who lost their job during the recession. The company should try their best to use other methods such as work sharing or payroll reduction to work with employees to overcome the difficult time together. However, as a business person, I can also understand “competitive advantage”. If closing a plant is the best thing for long term growth and efficiency, we just need to face the reality and move on.

c. Cost of private fleet
It’s very similar to the fixed cost of DCs and docks. When it’s not possible to reduce the size of the private fleet in the short term, partner with suppliers or customers to share the capacity to reduce costs.

d. Inventory management
Inventory is the biggest issue to any company during a recession when consumption drops dramatically. It’s a big topic and there are many things that can be done in inventory management. It not only requires day-to-day tactical inventory management to minimize inventory DOS and maintain a targeted customer service level, but also requires some strategic decisions from higher levels to achieve inventory goals.
I. Use demand driven forecast, instead of sales & marketing driven. Many companies include their marketing goal in their demand forecast which produces an inflated the demand forecast. Inventory overflow is unavoidable when the market is down. Face the reality, and forecast based on customer demand.
II. Centralize inventory management, instead of decentralize. A decentralized ordering or inventory management can normally cause higher inventory in the entire supply chain. Centralized inventory management will lead to better forecasting at an aggregate level and hence result in a lower inventory.
III. Inventory optimization and classification. ABC classification can improve inventory turn while maintaining fulfillment service levels. Optimization will lead to SKU reduction so companies can focus on their critical products for better service and lower cost.

Established metrics leads to total supply chain excellence

Besides all of these actions and factors to enable supply chain to become the “cash” chain, leaders should not forget to establish well-designed metrics for the entire organization to achieve total supply chain profitability and competiveness. Company leaders need to be aware that high costs in some areas are normally the symptoms of root causes, and many times, those problems are caused by the wrong metrics in the organization. Requesting cost savings without removing the root causes and establishing accurate performance metrics, the cost savings initiatives can be a failure. For example, production cost per unit is a great measurement of manufacturing efficiency, but it can result in high inventory when manufacturing ignores other cost components in supply chain and over produces in order to reduce cost per unit to meet their metric. This kind of story actually happens every day, and it’s a daily battle for many supply chain professionals. The right metrics convey the right positive incentives and drive the right decisions. When overhauls in supply chain need to be done at a strategic level to achieve day-to-day tactical operational efficiency, company leaders have the obligation and responsibility to face reality and to make the right strategic decisions for the organization.

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RFID-GPS Hybrid Tag

It was a product development paper when I was at busienss school two years ago, co-writen with my teammates Somnath, Reagan and Brad.  It maybe very immature from eyes of experts since we finished the paper in a very short period of time. Since then I haven’t done much research about RFID-GPS tag market. But I like to post the article here for sharing and for my further research.

Mission Statement

The new RFID-GPS hybrid tag will include both RFID & GPS advantages to apply to or incorporated into a product, animal, or even person for the purpose of tracking and location navigation. It will locate the objective no matter it’s in door or out door. The tag user can log into internet to track the object location, or the tracking information can be fed into customer tracking system. The product cost will be the biggest concern for the customers. The hybrid tag will be priced at the same level of the traditional RFID. Hence the new product provides the customer additional value of GPS tracking by paying the same cost of RFID. It can be considered as 2nd generation of RFID tag.

Key Customer Benefits

It combines the advantage of both RFID and GPS. RFID can be used mainly for indoor tracking. GPS in the tag is used for outdoor movement tracking and short-term storage of recent location history. Through web portal, the customer can track the objects in real time in 24/7. The hybrid tag will improve the customers’ inventory management, asset management and enhance their operational efficiency to achieve cost saving.

1. Key Business Goals

  • Time to Market – One year
  • Desired financial performance – be profitable in 3 years
  • Quality requirements – small size tag but store and transmit reliable data for product tracking

2.  Target Market

  • Retail – it will enhance the supply chain management by providing inventory visibility no matter the products are in door or on the road. It helps retail to improve their customer service by providing accurate product availability information.
  • Tool, container and equipment pooling industry – the hybrid tag can help to track the location and leasing length of the leased products. The information will help them on asset management and also help them charge the customer accurately based on the exact leasing time.
  • Livestock industry and pets owner – track the location of the animals

3. Assumptions and Constraints

The assumption for RFID-GPS hybrid tag development is that we don’t have R&D cost constraint. The major constraint for future development and production is the supplier power because we will rely on our hardware suppliers and software suppliers to achieve our cost objective for this new product.

4. Stakeholders

  • Suppliers – Suppliers of RFID and GPS, and the software developer.
  • Partners – GPS cellular communication service to send tracking information
  • Customers – users of RFID-GPS hybrid tag for their product
  • Customer employees and consumers – concern of personal privacy

Market Analysis

Potential market size

The market size is huge because the tag can be broadly used on merchandise, leasing tooling and equipment, and animals. In 2008, RFID market size will reach $7.26 Billion, which can be translated as future market size of RFID-GPS hybrid tag. Similar to the launch of RFID tag, we can work with the retail, such as Wal-Mart, to launch the hybrid tag.

Currently there are researches for RFID-GPS hybrid tag, but there is no product in the market yet. If we can be the first producer of the tag, we can be the leader in the market. Our goal is to obtain 20% of the $7.26 billion market before other competitors follow up, so time to market is very critical for us to win.

The customer requirements are:

  1. Low cost. Although RFID-GPS hybrid tag can provide the customers tremendous benefits from improved supply chain and asset management, the customers are still concern the cost of implementing new tag.
  2. Small size. The size of the tag is important for merchandise. The smaller, the better is for the customer to replace the tag in the products.
  3. Tag memory capacity. The customer will like comprehensive information to be stored in the tag for intensive movements tracking recording.
  4. GPS navigation accuracy. Only the accurate location information can provide the customer value added information, otherwise, it will mislead the direction and create unnecessary waste.
  5. Easiness for information tracking and data collection. We need not only to provide the hardware quality and price, but also to provide convenience and easiness for the customer to obtain tracking information and data thought web portal. If the customers requires, we can also feed the information directly to their information systems.

Price target

The customer is concerned that additional tagging system will be transfer the cost to the consumers, although they understand the advantage of a fully implemented item-level tagging system to help to increase inventory visibility and reducing shrinkage due to theft, damage, etc and expiry of perishable. The biggest disadvantage of traditional RFID tag is the distance range of the RFID reader, while GPS resolves this problem, especially when the product is on the road. Thus the additional GPS tracking system in the tag will help the customer to achieve deeper cost saving.

Currently traditional RFID tag price is ranged widely based on memory capacity. It can be as low as 5 cents per tag. The low cost will allow the tag to be used at unit level. Since we’re the first one to launch RFID-GPS hybrid tag, the competitive product is the traditional RFID tag. We need to price the hybrid tag comparable and competitive to RFIF tag in order to convert the customers from traditional RFID tag to RFID-GPS hybrid tag. We will price our new product to be as same as the traditional RFID tag but providing additional value of GPS tracking. While a monthly service fee will be applied to the customers for GPS cellular communication service.

Product Definition

Both RFID (Radio Frequency Identification) and GPS (Global Positioning System) are existing technologies. With the price drop in 2006, RFID tag is becoming inexpensive, especially for the merchandise. But RFID has limited tracking range because its position is tied to location of the antenna or reader. GPS, in the other hand, has the advantage to locate and measure the movement of an object by utilizing satellites transmitted signal. The RFID-GPS hybrid tag will combine the advantage of both technologies and allow the user to track an object at real time without geographic barriers.

The bill of material of RFID-GPS hybrid tag will include RFID memory chip, an antenna for receiving and transmitting the signal, GPS reader and GPS logger, which will store movement data. Currently there is a technology called chipless RFID allowing for discrete identification of tags without an integrated circuit, thereby the tags can be printed directly onto assets at lower cost than traditional tags. The biggest challenge will be the power supply for GPS. An alternative solution need to be provided as power supply in order to receive and send GPS signals. At the same time, we need to develop the internet portal to provide customers the tracking information and data, or develop a software program to feed information to the customer’s tracking system.

The compelling value of the RFDI-GPS hybrid tag is the real-time tracking capability for the object in door and out door without geographical barrier. The tag will help the customer to reduce their over all cost by completed inventory pipeline visibility, improved asset management and streamlined operations efficiency.

Product Development Plan

In order to be the winner of the new product, we need to be quick to get into the market. Both RFID and GPS are existing technologies, but it would still be challenging to implant both of them into one single small tag. The target product development lead time is one year through close partnership with our suppliers and partners. Below is the estimate timeline for the development phases:

  1. Portfolio and concept approval: 2 month
  2. Program approval and prototype: 6 month
  3. Pilot and launch – 4 month

The schedule is tight because we also need to source reliable suppliers and contract the partners at the same time. But establishing an aggressive goal of time-to-market will help us to be the leader of 2nd generation of RFID tag.

Currently there are plenty of RFID & GPS receiver suppliers in the market and many of them are located in low cost countries. Since many of merchandises are also produced in low cost countries. The tag, as a component of the finished goods, would be reasonable to be produced in low cost countries, close to our customers’ sourcing locations. For software development, we can utilize current RFID web portal program to include location and movement information through GPS tracking. At the same time, we need to negotiate a partner of cellular communication network to provide GPS tracking service.

In terms of resource required for this new product, other than R&E and development investment, we need engineer talents knowing the technologies of RFID and GPS to design the tag and work with our suppliers to develop the product. The procurement team will help to source reliable manufacturing suppliers. We also need information and communication system engineers to develop the web portable.

Market introduction will target to the retail and tooling leasing companies. Wal-Mart was the first one to adapt RFID technology and we believe they will be interested in the new hybrid tag. Tooling leasing company, such as CHEP, has been applying RFID to monitor their assets utilization. Again, the new tag will enhance their asset management. We can partner with them to launch and test the new products.

Financial Considerations

The estimated market size of traditional RFID tag is going to be $7.26 billion in 2008. When hope to capture 10% of the market, revenue of $1.45 billion for the first year, 20% in the second year and expand to 30% of the market share in the third years to $2.18 billion. Another revenue stream is the monthly fee for GPS cellular communication. We can negotiate with the network partner to share the monthly fee revenue. The monthly service fee can be structured based on the size of GPS data transfer. The customer will pay a fixed monthly fee first to cover a fixed amount of data transfer and then pay addition fee based on actual additional data. The estimated service fee will be $5 million annually.

Since it’s a start-up business, the fix cost to support future business need to be included when we calculate NPV. We estimate $40 million as the initial investment for product development. The variable cost for the future business will be the tag production cost. The SG&A cost will include web supporting, data transfer cost and marketing & administration cost. The estimated net income will be 10% of our revenue. But we might experience a declining gross margin when the competitors follow and will drive our net income margin down to 8% in the third year and remain this rate going forward. With an annual interest rate of 10%, NPV shows positive as 3 million at the end of forth year. At the sixth year, NPV of this business reaches to $22 million. GPS service fee income will be the incremental income for the company.

Regulatory, External Considerations

The major risks of this product development are the competitors’ entry and continuous product improvement because we don’t have our own manufacture and reply on the supplier for manufacturing. We can patent our design but the competitors can develop their own design for the similar product. In order to remain our competitive advantage, we need to differentiate us by providing continuous product development, and the world-class web tracking and data transfer service for our customers.

Another concern is the privacy of the customer employees and consumers. Because of the 24/7 real time tracking, the employees, such as truck drivers who carry the objects, will be monitored all the time. In retail, when the merchandises with tag are sold, the tracking signal needs to be removed from the tag through a signal remover. So the process of signal removal needs to be followed to avoid any consumer concern.

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From Coffee to Business Process Improvement: A Story of Office Coffee

Employees on the third floor were not happy, especially in the early morning. The coffee kettles, two for regular and one for decaf, in the breakroom were always empty! It’s almost unacceptable for an anxious coffee drinker to wait even five minutes for a freshly brewed cup in the morning. Even worse was that there are others waiting in line in front of you so you might even need to wait for the next kettle to brew. So, people are cranky, unhappy, and even cursing because coffee was not available when people needed it. Time is money, but without coffee in the morning, work won’t be efficient!

It’s totally a supply chain breakdown issue, so a few Six Sigma Black Belts set out on a mission to fix it. The new process is focused on regular coffee because there is much less demand for decaf. Many sigma tools can be applied in this analysis, such as normality analysis of waiting time per person, fishbone analysis, Pareto, regression and correlation analysis between waiting time vs. office hours. A typical six formula can be developed such as Y(coffee waiting time)=Xs of (number of kettles, office hours, number of  coffee addicts, coffee grounds and filter availability, etc. )

According to the rumor, there were quite a lot of hours involved with group brainstorm and heated discussion among Black Belts. A rather complicated new coffee making process, which is like the two-bin system of supply chain management, was produced. The company generously paid for a big desktop mat with nicely printed color coded flow and process. Below is my simplified version to illustrate the idea.

Coffee Making Process

The mat was placed in front of the coffee kettles so it’s very eye catching for everyone serving coffee. The kettles were also relabeled with clear signs of “regular” vs. “decaf”. People were laughing at the change. Many felt it’s a waste of resources in designing the process and printing the mat, but people started to follow the process flow. You know what? The fresh coffee availability was much more improved! The chances of being out of coffee in the early morning were decreased dramatically. Whoever craved coffee in the early morning could now be blissfully caffeinated. Yes, there were still times of process breakdown when a few were not following the process to make a new kettle when the first one was empty, or coffee availability tends to be lower in the afternoon. But overall, the situation is getting better and employees on the third floor were happier. The company was happier too, by investing a little bit of printing cost, the total office productivity improved!

It’s a coffee making process implementation in the office breakroom, but it reflects some supply chain, LEAN and business process improvement disciplines and practices:

  1. When a two-bin replenish system is implemented, the re-ordering process, when and how, is the key to maintaining high stock availability.
  2. Obvious signs, colors or labels are always useful in LEAN implementation.
  3. When a change is implemented, it’s not always welcomed at the beginning. Change management may be necessary in many cases.
  4. Any process improvement opportunity should be encouraged. It might be a small improvement but result in a huge increase of customer satisfaction.
  5. I think the Human Factor is the most import learning from the office coffee making process. Human factor is the most critical X in Y, no matter if the Y is fresh coffee waiting-time in the office, or products availability for our consumers. A well-designed process can be easily broken because of human manipulation and interruption. The coffee making process relies on many individual coffee drinkers to brew coffee when the first one is empty. Like any processes in the real business world, the expected outcome of a well-designed process relies on many individual employees consistently following instructions. For many manual processes, training and retraining are always required for process enforcement in order to achieve the same standard outcome. Cross-functional communications are always critical to make sure information flows properly and that following the steps can be executed in a timely manner. On the other hand, employees are those who will develop continuous improvement opportunities to streamline processes to achieve better result with a shorter lead-time.

OK, enough learning from this office coffee process. Now it’s time for me to make a coffee for myself at home. Waiting time: 2 minutes.

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Will Home Depot Achieve Its inventory Goal Through Supply Chain Transformation?

I just read two articles regarding Home Depot supply chain transformation. Home Depot’s supply chain overhaul to free up cash, improve inventory by Rachel Ramos at Atlanta Journal-Constitution dated Sep, 2008. Another article Aggressive Supply Chain Transformation at Home Depot by Dan Gilmore, editor of SupplyChainDigest, dated Jun 2009.

Both articles discussed that high inventory at Home Depot stores forced the company to transform its supply chain network from the previous direct-to-store model to a traditional RDC model. The direct-to-store model made sense to Home Depot in the past because of its high sales in each store. With network expansion and competition, per store sales dropped and a decentralized ordering model caused high inventory problems for Home Depot. The aggressive supply chain transformation started in early 2007 and should be able to help Home Depot improve their current inventory turn from 4 to a higher number.

Out of curiosity, I looked up the financial reports of both Home Depot and Lowes to get their inventory turns data. I used the standard formula of inventory turn of COGS/average inventory. The below table shows the result:


What can those numbers tell me?

First of all, there was not much improvement in last two years compared to 2006. In the first two quarters of 2009, Home Depot had inventory turn lower than 1 in both quarters, which can translate to an annually turn lower than 4. It can be explained due to current economy downturn. The RDC model didn’t seem to fix the inventory problem. So, if inventory is not in stores, they might be accumulated in RDCs.

Second, we see a declined number from Lowes. Same story for first two quarter of 2009, Lowes even had a lower inventory turn number than Home Depot did. Lowes has had the traditional RDC model since the beginning. So, I can conclude that the RDC model will not be the only fix to improve its inventory turn.

Supply chain network remodeling to RDC model can definitely help Home Depot to improve the right level of inventory at stores and offer consumers a cleaner shopping environment. It will also help to improve forecast accuracy at an aggregate level. However, Home Depot seems to have more to do in order to increase their inventory turn from 4 to 5. From my point of view, there are at least two more things that Home Depot should do beside supply chain network redesign:

1. Inventory optimization through SKU ABC classification.

70% of 35,000 SKUs having a lower than one sales one store per week represents an opportunity. Even though Home Depot doesn’t plan to cut any SKU to meet customer satisfaction, it can use traditional ABC classification and establish different inventory turn targets for different types of SKUs. Those 70% of SKUs normally will represent about 20% of sales for Home Depot. They should be classified as B or C SKU, which can be allowed a lower inventory turn to reduce ordering administration. However, for A SKU, which normally account for 20% of SKU but about 80% of revenue, should be closely monitored to meet a much higher inventory turn target. From SKU ABC classification, Home Depot can focus on their key SKUs to improve overall inventory turn and at the same time to satisfy customers’ needs.

2. Supply chain technology enhancement.

I agree with what Mark Holifield, SVP of SC, said that the biggest challenge is culture change. However it might be a good time for Home Depot to invest on a robust supply chain system to accurately reflect customer demand at each store in a timely manner and hence result in a better demand driven forecast. Wal-Mart had a surprising inventory turn of 8.8 in 2008 and looks like to be able to achieve the same level based on the number of tuns in the first two quarters of 2009. As we all know, Wal-Mart is a huge pusher for supply chain technology and RFID. I’m a believer that utilizing technology will drive workflow automation and thus drive process and culture changes. An advanced supply chain information system will give Home Depot the competitive edge in the competition.

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When “Green” encounters “Efficiency”- What supply chain executives can do to achieve both

I enjoy reading the article Can You Have a Lean-Green-Global Supply Chain by Mollenkopf, Tate and Ecklund. It explains the possible conflict and synergy between lean and green supply chain. At least it gives me a very clear definition of “sustainability”, which I often misused as well.

Like the authors say, “green” or “sustainability” are buzz words for today’s business environment. To be green means to avoid negative impact to the environment, including air, land and water, and sometime even creating positive impact. But when “green” encounters “efficiency”, companies often choose “efficiency” over “green”. In the end, executives need to be responsible to the stockholders for company bottom line. Going “green” becomes something nice to have as part of a company’s social commitment. I had personal experience that a famous warehouse club resists to optimize truck in order to keep their dock loading efficiency. But actually, many components in supply chain can provide companies with “green” opportunities and at the same time help companies achieve cost and efficiency objectives. Below are some of my thoughts:

  1. Use “green” material for product design and packaging. Companies can choose to use green materials which can be recycled and reused, which will not impact the environment negatively. Using recycled pallets is a good example in packaging. It’s more challenging to substitute direct materials of the products. However with the green initiatives from governments, there is more and more R&D invested in developing “green” materials. That is true that green substitutes can be more expensive today. However, working with suppliers closely in product development and increasing the economic scale of the material can optimally reduce the material cost and achieve “green” prospective.
  2. Reduce unnecessary movements in operation and logistics. It’s back to Lean concept to reduce waste of movements. In a factory or warehouse, layout improvement can eliminate unnecessary travel of the workers and forklift trucks, and improve efficiency. Postponing inventory deployment can ship the products to the right locations to meet customers demand, thus avoiding possible stock transfer movements among different regions. For unavoidable small batch or LTL orders from the customers, the efficiency can be achieved through LTL consolidations. All of those reduced movements will not only save significant transportation cost, but also resulting CO2 omission reduction and contribute to a greener environment.
  3. Improve reverse logistics. Reverse logistics hasn’t been paid too much attention by many companies. But how to reuse, return or dispose of the defective products will have a huge impact on both “green” and logistics costs savings. Companies need to re-examine their reverse chain for more value creation. For examples, instead of shipping the consumers returned products directly to the overseas or local suppliers for inspection and repair, the company can source local service providers to sort the returned products, resell the nondirective ones and then send the defective ones to repair, locally if possible. There is additional service fee incurred, but the savings from unnecessary shipping is tremendous. Just thinking about it, most of returned products from the consumers are actually not defective products. When disposal or scrape is avoidable for end-of-life products, the company should be socially responsible to make sure the wastes are properly handled by the recycling service provider. The goal is to create zero landfill. And keep in mind, any hazardous disposal will damage the company’s reputation and cost more for damage recovery.

Going green is not just a slogan. Going green in supply chain can help a company achieve cost savings or cost avoidance. Executives need to commit to support green initiatives and engage their employees to identify any green opportunities inside and outside the company. As the article says, companies embracing green, lean and global supply chain strategies may in fact continue to gain momentum and find themselves poised on the leading edge of competitiveness.

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Five Ways to Reduce Transportation Costs

I’m reading the articleCorporations Review Transport Operations as Pressure Grows to Reduce Expensesby Daniel P. Bearth. The article discussed the pressure that executives are facing today to reduce transportation costs.  There are a few fundamental ways that companies in any industry can do to reduce their transportation costs.

1. Truck Load Optimization. It sounds like a non-brainer to optimize the empty truck space to reduce the average cost per unit. TL optimization not only reduces the overall transportation costs per unit but also removes the trucks required over the road, which contribute to CO2 omission reduction. So, when the transportation cost savings weight more than inventory holding cost, ordering at a full truck load will be the proper action to take.

2. Milk-run. When LTL order is necessary to reduce inventory holding cost or due to warehouse space limitation, milk-run will be the best option to reduce transportation cost. Milk-run is to consolidate multiple LTL orders in one truck and stop to deliver for multiple customers. It’s the best solution to resolve the LTL challenge. It also provides customer satisfaction at the same time because it gives customers flexibility to order small batches. The challenge of executing milk-run is to plan the delivery route. Unless it’s a repetitive route at the same schedule, it can involve a lot of manual planning and coordination between logistics personnel, carriers and the customers in order to optimize the truck space. But the savings from LTL consolidation can be significant.

3. Fleet utilization. Improving fleet utilization is another way to save transportation costs. Fleet, no matter private or public, is more cost efficient to serve within a distance of average 150 miles. For distances greater than 150 miles, line haul will have a lower cost per mile. So, by utilizing fleets for transportation movements within that distance will lower the fleet fix cost significantly. On the other hand, the fleet planning is necessary to make sure a correct fleet capacity. Unused fleet capacity or idle trucks are wastes to transportation.

4. Stock transfer reduction. The cheapest way for transportation is not to move it. When companies have a lot of internal stock transfer movements within their supply chain network, it’s time to review their regional supply and demand planning. For traditional FDC/RDC distribution network, the regional deployment should be postponed to the last minute to meet just in time requirement. During this economic downturn, there are many excess inventories existing in the supply chain network.  Transportation can be avoided by an effort of selling the inventory locally, instead of moving them to a different location for storage.

5. Backhaul for reverse logistics. The last but not the least, the transportation costs saving opportunity can be identified through evaluating reverse logistics network. Companies should collaborate and partner with their carriers, suppliers or customers for any backhaul opportunities. The carrier’s cost can be reduced because of equipment utilization from this close looped network. This cost savings benefits should be shared among supply chain partners.

As a conclusion, above are five ways to reduce transportation costs – nothing out of the box but basic logistics management theories. But as always, getting back to fundamentals is often the best solution to tackle supply chain challenges.

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