Best Practice: Managing ROI-Driven Growth










By Dr. F. Barry Lawrence
Texas A&M University

So far, so good, most markets are on the mend and wholesaler-distributors are seeing improvements across the board. A clear message came out of the recession: Managing working capital is the short-term goal; managing return-on-investment (ROI) is the long-term one. To do so, distributors must grow profitably. The concept is deceptively simple, however.

Many business people are trying to understand what is being called the “new normal.” The concept is that business conditions will not be the same after the “Great Recession.” They believe that a new model is emerging, and that those who understand and respond to it will flourish. Those who do not will perish. Okay, we’ve heard that before, and anyone who has been in business since the 1990s is probably somewhat sick of such forecasts. They are nearly always wrong.

The trouble is the people making the claim are not just consultants trying to sell their services this time. They are smart business people at best practice firms. They are not publishing their opinions to gain notoriety. They are changing their business models, however.

The new normal is not yet clearly defined, but a couple of common themes are coming from top business thinkers. They involve growing profitably and sustainability.

Growing profitably or, more accurately, with a solid ROI, is a function of four financial inputs:
• Sales

• Expenses

• Assets

• Risk.

The first three constitute the ROI equation; the last one determines the right outcome.

Steps

• The first step is to determine your risk tolerance.

• The second is to determine your potential opportunities.

• The third is to select the opportunities that match your profile of an acceptable risk/return ratio and rank order them to determine which fit within your resource capabilities.

• Fourth, determine what best practices will apply to the venture.

• Fifth, use those projections to govern the project through to a successful and sustainable part of your firm’s portfolio.

Sustainability means the process will continue to operate efficiently. It also means the firm will continuously introduce new innovation to the process to maintain its appeal to customers. These dual objectives require a corporate culture that embraces change, encourages innovation, documents and standardizes processes, and whose human resources are trained and motivated for the task.

The current No. 1 best-selling NAW Institute for Distribution Excellence book, Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line (available at http://www.naw.org/optimizdistprof), details best practices, their implementation, and ROI. These practices are valid in any economy, but the significance of one best practice versus another may change under different market conditions. Each month in this blog, we have introduced a best practice and how it can improve earnings and/or ROI under current economic conditions. We encourage you as you participate in this blog to ask questions, debate results, and offer your own experiences with such practices, so that we may further the knowledge of the community and the understanding of the science of distribution.

The book breaks business processes into seven groups (SOURCE, STOCK, STORE, SELL, SHIP, SUPPLY CHAIN PLANNING and SUPPORT SERVICES) based on various distributor asset categories. This month, we focus on SUPPLY CHAIN PLANNING as shown in exhibit 1.

Best Practice: Managing ROI-Driven Growth

ROI-driven growth involves identifying opportunities, determining their value, sizing the necessary investment (human as well as financial resources), assessing the risk, and selecting the right options.

The practice levels for ROI-driven growth are as follows:

COMMON practice: (1) Sales force identifies a new application or customer set, (2) Expert (sales) opinion is applied to determine risk and reward, and (3) Selection is made based on biased opinion and force of personality.

GOOD practice: (1) An opportunity assessment is conducted to forecast sales potential, (2) Expenses to support the new opportunity are calculated for varying levels of the forecast, (3) Necessary investments are calculated, (4) ROI is calculated and compared to corporate hurdle rate, and (5) Those activities clearing the hurdle rate are prioritized on perceived risk/return ratio and compared to available resources.

BEST practice: (1) GOOD practice analysis is enhanced with strategy/structure match where the selection is evaluated on its consistency with long-term corporate goals and with existing processes, (2) Sustainability is created by first establishing a measurement system to govern both the implementation and continued process operations and second documenting the process and training to establish a culture of quality and innovation.

The New Normal?

One of the characteristics of the new normal may be shorter, more frequent recessions. JIT (just in time) has reduced supply chain inventories to the point that booms are harder to sustain and recessions cannot last as long. We are still struggling with forecasting this process, but the current recession holds some lessons.

The 2002 recession came as a major shock to most distributors, but they had been working on their inventory processes for quite awhile. Retailers and manufacturers were already running lean on inventory (mostly using the distributor’s inventory), but distributors were still carrying too much. Since they had new inventory processes in place, they adjusted quickly to the downturn. Electronics distributors saw inventory turns drop from 7 to 1 in a matter of months. They stopped ordering and right-sized their inventories quickly, but the impact to manufacturing was horrendous.

2009 brought challenges on a scale not seen since the Great Depression. Distributors were now more agile and manufacturers wasted no time in shutting down operations to control costs in the supply chain. The result was inventory shortages by the summer of 2009, which caused a turn in the economy sooner than most had predicted. Predictions that the economy would have a double dip or a slow climb out were further confounded by the lean distribution inventories. As it sells, it gets ordered, as it gets ordered, it must be produced. When there are any sign that things will soften, manufacturers shut down and distributors stop buying.

Becoming more agile with inventory is a lot easier than closing and opening manufacturing processes, but we should expect manufacturers to make their processes more agile as well. The result could be a new normal of more frequent, shorter, shallower recessions, and less extreme booms. The wild card in this equation is government actions. Programs to overcome the 2002 recession superheated the economy and caused an unwarranted increase in capacity that no doubt contributed to the current recession. Still, whatever the new normal may be, these new, more agile processes make sense.

An interesting outcome of this new normal is that well-run distributors can capitalize on recessions to grow. One distributor described it this way: “When a downturn hits, we reduce inventory and accounts receivables, which increase our available capital. We then use that capital to acquire competitors or launch into new markets when the cost of doing so is very low. Recessions have now become a good thing for us.”

ROI and Growth

A virtuous ROI cycle is illustrated in exhibit 2. A new market opportunity is capitalized on by an acquisition, new product introduction, green field startup, new service model, etc. Sales increase faster than expenses leading to an increase in net margins. If net margins increase at a higher ROI than the firm’s current business processes provide, investors are encouraged to invest more into the new venture.

Another possible model is to improve processes and drive down expenses or assets. The increased ROI allows the firm to decrease pricing or simply capture higher margins. The increase in ROI again encourages investors to put more money into the firm’s improvement efforts.

Exhibit 2: A virtuous ROI cycle.



A Case Study

A small distributor had implemented inventory and accounts receivables management best practices when the recession hit. The distributor continued to manage its assets well and the decrease in inventory together with decreased accounts receivables caused an influx of cash. The firm was very liquid at a time when its competitors were not.

The firm was interested in expanding its territory or service offering. It was not clear which model would work best, so a detailed analysis was conducted using ROI as the driver. The firm was privately owned with a highly competent management team. A new acquisition would be closely supervised, and the firm was experienced in acquisitions. This experience, together with a highly reliable management chain and thorough understanding of the market (the acquisitions would be within 150 miles of their territory), demonstrated a low risk, so the firm set its minimum hurdle rate for ROI at 18%.

Three acquisitions were identified:
• The first was a distributor with an identical business model.

• The second was in a related and complementary product line.

• The third was a service firm that would complement the firm’s existing processes.

Each firm’s sales were tracked and corrected for the recession, and a conservative forecast was put in place for future growth. The forecast was then linked through the income statement of each to determine what their respective expenses would be.

Best practices were compared between the purchasing firm and each acquisition to determine how the merged operation would operate and how any reductions in costs would be captured. This analysis led to estimated net earnings for each of the next five years. The required investment was calculated by a 3X multiple of each firm’s current earnings, plus 75% of accounts receivables and 50% of inventory and adjustments for debt and other assets. The result was a 4- to 5-year payback on each acquisition or an ROI of 20% to 25%.

The firm then assessed the strategy/structure match. The services distributor was determined to be most outside of the firm’s core competency and its low margins were a concern. Service firms have few assets, so while the ROI looked good, the margin for error was small. The distributor with the related product line was less risky, but had a poor record on accounts receivables. The final distributor from the same product/service offering had the overall best ROI, but a large inventory compared to the acquiring firm. The structure was a good match and the proximity of territory meant that assets could be shared, promising opportunities to reduce inventory and other assets (for example, one warehouse was perceived as redundant).

After making the selection, the next step was sustainability. The best practice states that integrating acquisitions should happen as quickly as possible from a human resources standpoint. Delays in eliminating redundancies and creating career advancement opportunities for valued new employees will result in productivity decreases for some and the potential loss of high performers if anxieties are not relieved quickly. High-performing employees are embedded in the actual value of the firm and their loss decreases the value of the acquisition.

The firm treated each asset and new employee as a valued resource and an implementation plan was made to capture the planned ROI with the involvement of key personnel from the acquisition. Training, career path, and involvement were preplanned especially for high-value employees. Transitioning best practices from one firm to the next were planned with metrics to ensure ROI and create sustainability.

Capturing best practices and ROI in standard operations has gone on for some time and is well represented in the Optimizing Distributor Profitability book (http://www.naw.org/optimizdistprof).

Doing the same for growth implies new best practices and new perspectives. If the new normal is as we propose in this blog post, there is a need to manage growth very tightly to maintain the necessary flexibility and capture the opportunities associated with the new business environment. The upcoming Council for Research on Distributor Best Practices (CRDBP) consortium title, “Optimizing Distributor Growth and Market Share” will treat this need as its core mission. The consortium brings together many best-practice companies thereby combining the wisdom of many as opposed to the thoughts of a few. To learn more and to join this consortium, go to http://www.naw.org/crdbp/growth.php.

About this Blog

“Managing in an Uncertain Economy” is a blog created by the Council for Research on Distributor Best Practices (CRDBP). The mission of the CRDBP, created by the NAW Institute for Distribution Excellence and the Supply Chain Systems Laboratory at Texas A&M University, is to create competitive advantage for wholesaler-distributors through development of research, tools, and education. CRDBP encourages readers of this blog to send in comments and e-mail this blog to other interested parties.

Best Practice: Network Optimization









By Dr. F. Barry Lawrence
Texas A&M University

The struggle continues in spite of the light on the horizon. Some are running out of rope, but most have adjusted. One could argue that wholesale distribution was built to overcapacity during the massive expansion associated with the Just in Time (JIT) movement of the 1980s and 1990s and that we’ve been struggling with adjustments in the 2000s. JIT drove a great deal of new business to wholesaler-distributors as manufacturers and retailers sought to decrease inventories, but it also decreased their net margins through an increase in cost to serve.

The initial impact was the 2002 recession, the first indication that the market would not grow continuously. The upturn from 2003 to 2008 gave distributors some relief but most would agree it was not like the 1990s. If distributor growth was not spectacular at that time, we should not have been surprised by how hard the next recession hit. The financial crisis further demonstrated how vulnerable distributors are when our overloaded services (accounts receivables, inventory) strangled cash flow almost instantly.

Going forward, the distributor’s market will grow steadily, but not nearly as rapidly as in the past. For distributors to experience real growth, they will have to provide excellent and innovative services and products. The combination requires best practices in asset management and supplier management. Past blogs have dealt with customer relationships, inventory, transportation, lean processes, and information technology. This blog will address network optimization, the process of aligning all resources in the distributor’s organization to optimize customer service and profitability simultaneously. Network optimization is a very mature best practice but has, to date, not been used extensively by distributors.

The popular-selling NAW Institute for Distribution Excellence book, Optimizing Distributor Profitability (available at http://www.naw.org/optimizdistprof), details best practices, their implementation, and return-on-investment (ROI). These practices are valid in any economy, but the significance of one best practice versus another may change under different market conditions. Each month in this blog, we have introduced a best practice and how it can improve earnings and/or ROI under current economic conditions. We encourage you as you participate in this blog to ask questions, debate results, and offer your own experiences with such practices, so that we may further the knowledge of the community and the understanding of the science of distribution.

The book breaks business processes into seven groups (SOURCE, STOCK, STORE, SELL, SHIP, SUPPLY CHAIN PLANNING, and SUPPORT SERVICES) based on various distributor asset categories. This month, we focus on SUPPLY CHAIN PLANNING as shown in exhibit 1.





Best Practice: Network Optimization

Network optimization involves mathematically modeling the distributor’s operations. The model will include an objective (maximize profitability or minimize cost) and a set of constraints (financial, customer delivery requirements) that may or may not be violated. Management establishes the goals of the firm and the model is based on real conditions. Once the model is created, it can be run repeatedly to determine the optimal configuration of assets in the distributor’s supply chain. Sound difficult? Let’s run through some examples to demonstrate how others have carried out a network optimization.

The practice levels for supply chain network optimization are as follows:

COMMON practice: (1) Experience, (2) Spreadsheet analysis

GOOD practice: (1) Single-asset focused mathematical model (for example, optimizing facility location or transportation)

BEST practice: (1) Multi-asset focused mathematical models (for example, optimizing inventory and transportation together), (2) Stochastic (uncertain) mathematical models

A building materials distributor had acquired one of its largest competitors. The firm’s network went from 50+ to 80+ locations with many redundant facilities. The firm conducted a network optimization with the following parameters:

• Objective: Optimize profitability


• Constraints: Next-day delivery and transportation fleet capacity.

It sounds deceptively simple, but the objective and the constraints are very complex to model. Once modeled, however, the firm was able to run it over and over with different assumptions: changing demand (forecasting), differing levels of transportation capacity (selling or adding trucks), different levels of financial investment (inventory levels), etc. After many runs, a solution began to emerge. The model recommended reducing the number of facilities from 80 to 49. The researchers, however, recommended only eliminating the top 10, since market conditions would change and an operation that was not quite optimal now could be in a few years.

The firm went about consolidating the top recommendations. The most extensive consolidation took place in northern California. Three branches were to be combined into one. The branches were on property valued on the firm’s books at $200,000 each, but could be sold for $1.2 million each (a $3 million windfall). The consolidated center was able to operate on $1.7 million in inventory as opposed to the $3.2 million, which had been scattered through the three branches. The firm had calculated a 40% holding cost, so the bottom line impact for inventory was $600,000 ($1.5 million times 40%), an increase in net margin for the three branches of nearly 100%. Customer service was not compromised, since the model treated it as a “hard” constraint.
Network optimization is to distributors what aggregate planning is to manufacturers. Aggregate planning is the process of determining how manufacturing resources will be used in the coming year. Conducted each year, it ensures that strategic goals for customer service are met with optimal usage of equipment (maximizing ROI). Distributors’ “manufacturing resources” are warehouses, transportation, inventories, accounts receivables, and all other resources engaged in customer service. Network optimization determines how to optimally deploy them. Unfortunately, this process is carried out only by a few distributors and then only after acquisitions or a long period of organic growth that has resulted in an inefficient network of investments.

Best practice states that distributors should conduct network optimization annually or every two years at least. The result would be more efficient use of resources and higher ROI, both necessities in the current market. Growth, in particular, will require higher levels of service or operations in new territories, which will consume additional resources. For most distributors, future investments will require squeezing or at least not wasting someplace else.

Some assume that network optimization is about closing facilities, hub and spoke, or some other consolidation scheme as in the previous example. In fact, it is about the optimal allocation of resources to meet customer needs. Customer requirements still tend to outpace distributor compensation, so the focus is not necessarily about reducing the distributor’s footprint, as it were, but about meeting those requirements as efficiently as possible.

An auto parts distributor was an excellent example of optimizing without closing facilities. The firm served car dealers and had grown rapidly with a highly effective business model. At the time of the network analysis, the firm was delivering twice a day in some markets, daily in others, and every two days in others. Multiple daily deliveries were very expensive in terms of trucking and human resources, so the firm wanted an analysis that would examine new markets for them to grow into and a service versus cost analysis of existing markets to determine if the number of deliveries could be safely reduced in some cases. The analysis showed a need for only one or two new facilities (the present network was very efficient) and made recommendations on service offerings going forward. Sample results can be seen in exhibit 2.

Since network optimization configures the distributor’s service offering, it moves huge resources like facilities, changes customer allocation to operations, determines transportation needs, places inventory and other value processes, and sets customer service levels. The decisions in a network optimization will determine the ability to operate profitably, achieve target ROI, improve cash flow, and optimize growth opportunities.

The process has been and continues to be conducted by best practice wholesaler-distributors, but most distributors are not utilizing network optimization. This lack of adoption puts distributors at risk as suppliers choose their channels to market and customers choose their suppliers. For this reason, network optimization will be further explored to establish more distributor best practices in the upcoming Council for Research on Distributor Best Practices consortium on the topic of “Optimizing Distributor Growth & Market Share.” To learn more and to join this new consortium, go to http://www.naw.org/crdbp/growth.php.

About this Blog

“Managing in an Uncertain Economy” is a blog created by the Council for Research on Distributor Best Practices (CRDBP). The mission of the CRDBP, created by the NAW Institute for Distribution Excellence and the Supply Chain Systems Laboratory at Texas A&M University, is to create competitive advantage for wholesaler-distributors through development of research, tools, and education. CRDBP encourages readers of this blog to send in comments and e-mail this blog to other interested parties.

Best Practice: Technology and Change Management

By Dr. Arunachalam Narayanan, Texas A&M University











and Dr. F. Barry Lawrence, Texas A&M University



Technology implemented and utilized properly is a tremendous asset to any wholesale distribution company. Distributors demonstrate the vast differences in technology adoption indicating many opportunities to implement best practices.

Technology is used for both data capture and systems integration. A company without a good data capture (barcode or RFID) can still utilize technology at the systems integration level (like ERP). The Council of Supply Chain Professionals (CSCMP) conducts an annual survey of supply chain professionals on critical issues pertaining to supply chain. Information technology (IT) and supply chain integration always stand out among the top three challenges for the community. Over the last 3 to 4 years, there has been a shift in the challenge, from just technology and integration to “information leverage.”

This is an important change in perception. In today’s environment, almost all companies have either recently implemented an information system or are in the process of selecting and implementing one. The next step is in understanding how to utilize the system for competitive advantage. Success or failure of the system depends on the ability of the company to utilize technology.

The technology failures of the 1990s are now largely behind us. At that time, firms often reported many disasters and took 3 to 4 years to get their systems functional and 7 to 10 additional years before feeling happy with the change. Recent implementations look a lot better. Distributors adopting new systems now report 2 years of pain and a general satisfaction thereafter. Bolt-ons for significant processes like pricing are now common. In general, the cost of IT adoption or changes has plummeted in recent years. Distributors are giant information machines, so the need to effectively adopt, integrate, and manage systems is not optional, it is the only way to do business.

The popular-selling NAW Institute for Distribution Excellence book, Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line (available at http://www.naw.org/optimizdistprof), details best practices, their implementation, and return-on-investment (ROI). These practices are valid in any economy, but the significance of one best practice versus another may change under different market conditions. Each month in this blog, we have introduced a best practice and how it can improve earnings and/or ROI under current economic conditions. We encourage you as you participate in this blog to ask questions, debate results, and offer your own experiences with such practices, so that we may further the knowledge of the community and the understanding of the science of distribution.

The book breaks business processes into seven groups (SOURCE, STOCK, STORE, SELL, SHIP, SUPPLY CHAIN PLANNING, and SUPPORT SERVICES) based on various distributor asset categories as shown in exhibit 1. The support services group includes human resource management, finance, and technology. This month, we focus on technology, especially systems integration, which is a process under support services. In future posts, we will explore best practices in data capture.



Best Practice: Information Management

Effective information management requires system integration. System integration is one of the many challenges in the IT domain for regional and national distributors. For firms with an aggressive acquisition growth plan, it is essential to integrate systems across the company to realize potential efficiency targets. System integration enables branches and regions to share key distribution resources, such as inventory. It also enhances operating efficiency and enables the firm to become competitive by reducing the cost to serve. The branches/regions will have better visibility, leading to higher productivity and the ability to share internal best practices through improved communication.

System integration directly affects the critical attribute—data integrity—that affects many financial elements. For instance, data integrity is one of the key reasons for an inventory write-off. At times, data integrity causes the wrong tactical or operational decisions that lead to financial losses in terms of write-off or constrained cash flow.

The practice levels for system integration are as follows:

COMMON practice: Individual legacy systems across regions (with little or minimal integration)
GOOD practice: Partial integration across key distribution functions
BEST practice: Bringing all the systems to one platform after taking care of local challenges

A fencing distributor was an early ERP adopter. By the mid 1990s, its system was running effectively and the company was exploring ways to leverage it further. An opportunity came when the company needed to remove inventory from a branch to improve its ROI. The sales force estimated a 40% decrease in sales, which was very reasonable given that 25% of sales were over the counter (retail), and the company believed another 15% would be lost when those customers stopped using fleet deliveries as well. After removing the inventory, however, the branch had a 25% increase in sales! The reason was that product was now coming from a regional distribution center (RDC) that carried a $7 million inventory compared to the branch’s original $600,000. The most important component, however, was the ability of the branch to see the RDC’s inventory in the fully integrated system.

The key benefits of system integration are

• improved communication
• visibility
• productivity
• asset efficiency
• data integrity.

Many companies use “bolt-on” applications. When acquiring new companies, especially at a rapid pace, it’s easier to keep the systems in place, and not too expensive to have an internal programmer create an interface for the bolt-on system to talk to the main system. While one system obviously can’t do it all, this is not an effective long-term solution. When you have too many different software systems, you are not using the full potential of each one, and you may have to run too many interfaces. You may also run into the problem of updates and resource issues. Consider upgrading your laptop running Windows XP to Windows 7. You have to make sure all the other applications are either reinstalled or updated. The same applies for a company. The only difference between the company’s IT infrastructure and a laptop is that instead of an operating system, it’s your enterprise system and instead of applications, it’s your bolt-on.

In the search for a new information system, due diligence requires forming an internal team and hiring outside experts and consultants. The members of the internal team are crucial in deciding the needs of the new system. The team should consist of employees from all related departments, regardless of whether the department actually uses the system or not. A list of possible software systems for any application in an industry is now easily available thanks to the Internet and industry associations. The Distribution Software Guide is one example and can be found at http://www.software4distributors.com/downloads/2010_Distribution_Software_Guide_Email_Blast.pdf.

Post Installation

The other biggest issue in information management is managing expectations. An IT system is not a “magic pill” to solve the problem. Instead, it’s a tool to help achieve certain goals. An interesting survey in CIO magazine (2003, http://www.cio.com/article/29894/The_Value_of_Enterprise_Systems) demonstrates that the major benefits come to those who wait (exhibit 2).

Exhibit 2.


Our interactions with distributors also reiterate the facts of this survey. Patience is key in an IT system implementation. Projects such as these usually have the tendency to exceed budget and timeline. The most obvious place for cutting corners is training and testing, which is a dangerous game, since training is by far the most important and time-consuming part of any system change.

The training challenge has been played out so many times at so many firms. A roofing distributor illustrates this problem. An early adopter of ERP, this distributor did not allocate enough funding for training. Instead, it went with “train the trainer.” The company sent its most capable specialists in functional areas, who had shown an interest in the system, to training at the IT firm. These individuals would then be expected to come back and train others. The problem was that these people still had a job, would be expected to troubleshoot problems for the company, and also conduct training. It was an impossible workload. Then, of course, these specialists were hired away by consultants because of their new skills.

Change Management

A systems integration project leads to a complex change within a company. Ambrose’s 1987 recipe for successful change (Managing Complex Change Pittsburgh: The Enterprise Grp Ltd.) still holds true today. His recipe for change identifies five critical elements: vision, skills, incentives, resources, and action plan. Lack of even one of these elements may lead to confusion, anxiety, frustration, false starts, or slow change as shown in exhibit 3.



So even after more than 20 years of IT implementation, we can say that the greatest potential is still ahead of us. Whether it’s inventory or customer relationship management, warehousing or sales force effectiveness, transportation or customer service efficiencies, all roads lead to the distributor’s information systems. The IT system will define the relationships and operations of the next generation distributor. The next generation will be automated; connected to customers and suppliers; and every asset, human resource, and customer will be wired in (wirelessly).

About this Blog

“Managing in an Uncertain Economy” is a blog created by the Council for Research on Distributor Best Practices (CRDBP). The mission of the CRDBP, created by the NAW Institute for Distribution Excellence and the Supply Chain Systems Laboratory at Texas A&M University, is to create competitive advantage for wholesaler-distributors through development of research, tools, and education. CRDBP encourages readers of this blog to send in comments and e-mail this blog to other interested parties.

Best Practice: Fleet Cost Management



By Dr. Barry Lawrence, Texas A&M University



Senthil Gunasekaran, Texas A&M University










Pradip Krishnadevarajan, Texas A&M University



Transportation is a key wholesale distribution function, in terms of cost and customer service. In some lines of trade, distributors spend more than a third of their gross margins on transportation services. Optimal transportation management is essential to maintaining profitability and gaining a competitive advantage. It carries an even greater importance when you own or lease your transportation fleet. Although private fleets are more expensive, they are sometimes necessary for providing quality customer service. The various processes in transportation management are shown in exhibit 1.



Key findings from a transportation study conducted by Texas A&M University in collaboration with FedEx for the Industrial Supply Association in 2006 (Texas A&M, FedEx, and ISA, 2006), are as follows:

• Cost ranked first. Cost was the top concern regarding the transportation function then and for the next three years, superseding customer service and reliable delivery times. Cost was the most important factor in choosing a transportation provider.
• Technology investment should be leveraged. Technology had finally come to transportation, as many survey respondents said they were using some sort of shipping system. However, most respondents did little more than process orders or pass along invoices and material safety data sheets. Far fewer used IT for any other function, including tracking carrier performance.
• Planning makes a difference. Companies with a formal strategic plan for their transportation function outperformed others. After analyzing the data, one key variable pointed to both a low transportation cost and high customer service level: having a plan for the transportation function. Those respondents with a transportation plan reported lower transportation costs as a percentage of revenue and a higher on-time delivery rate than those companies without a plan.

Compounding these findings, companies that had transportation plans had, on average, more movement of product from supplier to customer than those companies without a plan—a fact that should have resulted in higher transportation costs.

The NAW Institute for Distribution Excellence book, Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line (available at http://www.naw.org/optimizdistprof), details best practices, their implementation, and ROI. These practices are valid in any economy, but the significance of one best practice versus another may change under different market conditions. Each month in this blog, we have been introducing a best practice and how it can improve earnings and/or ROI under current economic conditions. We encourage readers to ask questions, debate results, and offer their own experiences with such practices so that we may further the knowledge of the community and the understanding of the science of distribution.

The book breaks business processes into seven groups (SOURCE, STOCK, STORE, SELL, SHIP, SUPPLY CHAIN PLANNING and SUPPORT SERVICES) based on various distributor asset categories as shown in exhibit 2. This month, we focus on the SHIP group. The SHIP group has seven processes, and we are discussing “fleet cost management” in this blog post.




Best Practice: Fleet Cost Management

An automotive distributor delivered parts to car dealerships. Their market-entry strategy was to provide two same-day deliveries for metro customers/dealers. Over time, the distributor’s inventory management practices deteriorated due to the market strategy. The dealers began relying heavily on the two same-day deliveries and stopped stocking a wide range of parts. This raised the question about the benefits of the two same-day deliveries service; whether it contributed to additional revenue or led to an enormous increase in safety stock / inventory at the distributor’s warehouses. In order to understand the impact of two same-day deliveries service, the distributor began focusing on fleet cost management.

In general, a fleet cost management process consists of two analyses: cost per mile (CPM) analysis and break-even analysis. The practice levels for this process are as follows:

COMMON practice: 1) No CPM calculation is performed 2) Cost groupings at asset level

GOOD practice: 1) Measurement based on major cost categories such as leasing and fuel

BEST practice: Comprehensive methodology that defines two major cost components: 1) Fixed components—leasing, depreciation, insurance, misc., and 2) Variable components—fuel, driver salary and benefits, maintenance, rental

Let’s first look at CPM analysis. This process focuses on identifying cost per mile components and determining the contribution of each component. Best practice recommends data be input into the system to track the following metrics for better decision making:

• Fixed cost breakup
• Leasing: tractor and trailer
• Depreciation: tractor and trailer
• Insurance
• Miscellaneous: licensing, citations, taxes, and so on
• Variable cost breakup
• Fuel
• Driver salary and benefits
• Maintenance: tractor and trailer
• Rental

Both fixed and variable costs are a part of CPM analysis. Considering these costs separately (fixed and variable cost components) can be helpful in designing any cost control measures. CPM analysis is important because this metric drives many critical decisions, such as owning a fleet versus using a third-party carrier. This number can be used to benchmark the firm with the industry. A sample breakup of cost per mile components for a building materials distributor is shown in exhibit 3.



Now, let’s look at break-even analysis. This provides information about the number of miles that has to be traveled by private fleet vehicles to equal the cost of for-hire service. This information allows you to determine which option (private fleet versus for-hire) is most cost effective. A major challenge is that all these analyses are unique to each organization, depending on their business processes. Proper consideration should be given to the level of customer service required, transportation costs, and benefits. Exhibit 4 compares the cost of a private fleet (for company X) with the available cost per mile market rates from various carriers (ranging from 1.25 to 2.25) based on a break-even analysis of one firm’s freight data. The initial investment for the private fleet is indicated as the fixed cost. It also indicates the number of miles that have to be covered in case there are various carrier selections. For instance, company X’s cost line crosses the cost line of a carrier (providing 1.75) at 53,474 miles. This shows that the carrier rate is economical if company X plans to drive less than 53,474 miles. In general, it would be beneficial for a firm to benchmark itself against the market and improve accordingly.




Getting a Handle on 3PL Costs

A large distributor serving small contractors found transportation management to be especially challenging. The distributor maintained its own fleet, but also hired trucking services for deliveries that cost millions of dollars. Company managers found it nearly impossible to keep track of the transportation carriers that the branch operations staff called on, and they also questioned whether their freight bills were accurate. Freight bills are often inaccurate for a few reasons:

• Carriers are often under contract to give a firm discounts under some sort of schedule. However, many times the freight bill may not reflect these discounts.
• If a product carries a lot of risk—for example, it is high-value, fragile, contains hazardous materials, and so on—the freight carrier charges a higher rate. Often, warehouse people will lose the distinction between different rates and send all products at a higher than necessary rate.

To prevent paying excessive freight bills, this distributor employed an outside specialist to do freight bill auditing. The process eliminated a lot of expensive errors. Soon the auditing firm began negotiating freight contracts for the distributor, since they had developed expertise in working with the trucking firms. Questions arose soon, however, when branches discovered that the only freight errors the auditing firm was discovering anymore were from trucking companies that had not signed contracts with them. Trust began to erode between the distributor and the auditing firm and in time the relationship broke down.

Capturing 3PL costs and tracking metrics is vital in transportation management. The opportunity to create cost savings exists whether transportation is outsourced or not, and distributors are among the world’s largest transportation customers. Not understanding cost structures and how to manipulate routes will decrease net margins. Distributors need to apply more science to this practice.

About this Blog

“Managing in an Uncertain Economy” is a blog created by the Council for Research on Distributor Best Practices (CRDBP). The mission of the CRDBP, created by the NAW Institute for Distribution Excellence and the Supply Chain Systems Laboratory at Texas A&M University, is to create competitive advantage for wholesaler-distributors through development of research, tools, and education. CRDBP encourages readers of this blog to send in comments and e-mail this blog to other interested parties.

Best Practice: Process Improvement



By Dr. Barry Lawrence, Texas A&M University



Senthil Gunasekaran, Texas A&M University









Pradip Krishnadevarajan, Texas A&M University



Warehouses form a critical component of the supply chain; as a result, their design and management determines the strength of the supply chain and makes the flow more transparent. Warehouses can also be referred to as the backbone of a supply chain. In the 1990s, companies focused on inventory management because inventory represented such a large asset on the distributor’s books. With the rise of acquisitions, distributors changed their focus to network optimization, facility consolidation, new location identification, and so on. The emphasis was on getting the right number of warehouses in the right places. The next step was to optimize the internal workings of these facilities (called warehouse optimization). We will see this cycle (inventory, network, and warehouse) repeated again and again as acquisitions rise and fall with business cycles.

The four primary resources to any company are inventory, human resources, accounts receivable, and facilities. Inventory, accounts receivable, and human resources have some flexibility and can be reduced or increased at a quicker pace than facilities or other more fixed assets. Most distributors consider facilities to be the most critical of the four resources, because you need the “space” to support your other assets and sustain your business. Warehouse fulfillment is composed of key inbound processes tied to receiving, staging, and put-away. Cycle counting, product placement, location type, location identification, and storage are all related to these activities. Process improvement can be applied to any of the warehouse processes. Distributors have made little progress in improving most of the warehouse processes, primarily because it’s difficult to determine the return-on-investment (ROI) associated with any type of warehouse process improvement.

The NAW Institute for Distribution Excellence book, Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line (available at http://www.naw.org/optimizdistprof), details best practices, their implementation, and ROI. These practices are valid in any economy, but the significance of one best practice versus another may change under different market conditions. Each month in this blog, we are introducing a best practice and how it can improve earnings and/or ROI under current economic conditions. We encourage readers to ask questions, debate results, and offer their own experiences with such practices so that we may further the knowledge of the community and the understanding of the science of distribution.

The book breaks business processes into seven groups (SOURCE, STOCK, STORE, SELL, SHIP, SUPPLY CHAIN PLANNING and SUPPORT SERVICES) based on various distributor asset categories. This month, we focus on the STORE group (see exhibit 1). The STORE group has eight processes and we’ll discuss process improvement.



Best Practice: Process Improvement

In general, process improvement techniques seek to increase process efficiency or throughput. Processes tend to remain status quo if there are no discernable problems. In many cases, we get so used to the process we have been using for years that we fail to recognize and often overlook any improvement opportunities. Many companies bring in lean experts to help identify opportunity areas and train people to use lean tools. This approach has been highly successful, since external experts tend to think “outside of the box” and are not bound by a company’s existing practices.

Process improvement techniques are gaining popularity among distributors, but they often are not applied correctly. The practice levels for process improvement are as follows:

COMMON practice: 1) Local efficiency (2) Efficiency focus (regardless of effectiveness) (3) No SOPs (Standard Operating Procedures) (4) Customer driven process improvement efforts

GOOD practice: (1) SOPs (2) 5S approach—Sort, Stabilize or Systematize, Shine, Standardize, and Sustain

BEST practice: (1) Value stream mapping (VSM) (2) Lean and six sigma (lean focuses on speed and six sigma focuses on accuracy) (3) Theory of constraints (TOC) (4) Cause and effect (5) 5 Whys

Exhibit 2 shows a lean implementation framework developed by researchers at Texas A&M University to assist distributors in process improvement (lean and six sigma) activities.



The 10-step approach is as follows:

1. Any lean initiative should begin by identifying a problem/opportunity area where focus is required. The problem area could be in any area, such as warehouse management, inventory management, demand management, logistics, and so on.


2. Metrics must be defined to track the benefits of switching to a redefined process.


3. Once metrics are defined, a detailed current value stream map (VSM) of the process under consideration should be performed along with a sample time study. If multiple people perform the same process, time studies must be done for each individual and an average time can be used in the VSM.


4. Prior to drawing up a VSM for the future state of the process being studied, lean concepts such as cause and effect, the 5 whys, and so on, must be applied to get to the best scenario of a future-state VSM. Brainstorming with process owners is critical to the success of this activity.


5. The metrics defined in step 2 need to be captured again to see what the changes between “as-is VSM” and “to-be VSM” are, in order to justify moving to a redefined process.


6. When lean improvements are performed, many opportunities are identified along the way; therefore, steps 2 to 5 should be performed for all the processes under consideration.


7. Once to-be VSMs are drawn up for all processes, distributors are faced with an important question: How do you prioritize the improvements during the implementation phase? A few factors to consider are ease of implementation, probability of success, ROI, risk, resource requirements, timeline to implement, and so on.


8. It’s also important to create relevant documentation of any improvements. This is for future reference/analysis, developing standard operating procedures (SOP) for new hires, safety documentation and training, and performance reporting.


9. Sharing documentation with other levels and locations of the organization helps standardize the processes and allows the firm to adopt best practices to get to higher efficiencies.


10. Continuous improvement is critical to the survival of any business venture. The lean framework is applied again from step 1 to keep improving operations further. New areas are targeted for the lean exercise. A customer value-add (CVA) activity at the end of the study might seem like a business value-add (BVA)or non-value-add (NVA) activity after a period of time due to changing customer needs, market conditions, and the advent of new technology.

Best Practice in Action: Do Process Improvements Work?

An electrical distributor projected significant increases in sales for year 2006. Sales had been growing in previous years and the distributor’s warehouse was not expected to handle the projected sales growth of 2.5% for 2006. The company’s CFO started talking to facility lease agencies to identify a new facility. The vice president of supply chain told the CFO that they could handle increased sales with the current warehouse by increasing the efficiency of warehouse processes. The CFO did not believe it would be possible. The vice president of supply chain put together a project team to study warehouse processes—product placement, efficient storage equipment, and material handling equipment. The project team developed an implementation plan based on the 10-step framework and demonstrated how it could handle increased sales. The CFO was convinced, and the distributor is still operating out of the same facility. The vice president of supply chain demonstrated the power of warehouse process improvements when deployed appropriately.

The distributor also applied task interleaving for the cycle counting process to increase cycle count/inventory accuracy and increase productivity (number of lines counted per hour). The increase in accuracy will reduce inventory write-off expenses and improve customer service. This will affect the income statement and hence EBITDA. The schematic diagram to quantify cycle counting using task interleaving is shown in exhibit 3.



The distributor also used task interleaving (the process of combining two or more activities) to improve warehouse efficiency. The fast-moving items (A and B) are most frequently accessed. The more times a product is touched, the greater the opportunity for error. The distributor decided to combine cycle counting for A and B items with the put-away process. Each time the A and B products were put-away, the operators performed cycle counting and resolved discrepancies immediately. This procedure increased overall inventory accuracy and customer service. The frequency of counting A and B items was once in two weeks, and they constituted about 10% of all the stock items. Through task interleaving, the distributor experienced annual savings from write-offs and expenses of $100,911 and $47,314 respectively—a 6.6% reduction in total warehouse expenses.

About this Blog

“Managing in an Uncertain Economy” is a blog created by the Council for Research on Distributor Best Practices (CRDBP). The mission of the CRDBP, created by the NAW Institute for Distribution Excellence and the Supply Chain Systems Laboratory at Texas A&M University, is to create competitive advantage for wholesaler-distributors through development of research, tools, and education. CRDBP encourages readers of this blog to send in comments and e-mail this blog to other interested parties.

Best Practice: Distributor Resource Alignment Analysis



By Dr. Barry Lawrence, Texas A&M University



Senthil Gunasekaran, Texas A&M University









Pradip Krishnadevarajan, Texas A&M University




Distributors choose a customer type and then array resources (inventory, facilities, transportation, people, suppliers, etc.) to meet that customer’s needs. The previous blog posts discussed inventory, customer, and supplier stratification. Stratification is the critical decision for how resources are to be deployed. Prioritizing how customers will be supported and which customers to focus on are keys to profitability. Poorly deployed resources lead to low return-on-investment (ROI). Low ROI ultimately leads to business failure.

This blog post addresses how wholesaler-distributors “invent” themselves by determining what investments will be necessary to be successful. The key resources—inventory, customers, and suppliers—come together to form the distributor’s service offering. Distributors next develop strategies for each inventory/customer/supplier combination. Most distributors do this alignment in some form or fashion, but it is carried out informally. Informal systems are rarely optimal. Best practices dictate a more structured approach.

The new NAW Institute for Distribution Excellence book, Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line (available at http://www.naw.org/optimizdistprof), details best practices, their implementation, and ROI. These practices are valid in any economy, but the significance of one best practice versus another may change under different market conditions. Each month in this blog, we are introducing a best practice and how it can improve earnings and/or ROI under current economic conditions. We encourage readers to ask questions, debate results, and offer their own experiences with such practices so that we may further the knowledge of the community and the understanding of the science of distribution.

The book breaks business processes into seven groups (SOURCE, STOCK, STORE, SELL, SHIP, SUPPLY CHAIN PLANNING and SUPPORT SERVICES) based on various distributor asset categories. This month, we focus on aligning supplier, inventory, and customers as part of SUPPLY CHAIN PLANNING as shown in exhibit 1.



Best Practice: Distributor Resource Alignment Analysis

On a field trip to a popular ice cream manufacturer, a group of graduate students asked the operations manager if the firm had ever had a stock out on their best-selling product vanilla ice cream. He said it had never happened in his time there and that he didn’t want to be there if it ever did. The students were surprised because a 100% fill rate should be impossible—especially for a perishable product, since large inventories would result in obsolescence problems.

A tour of the plant made things clearer. The operations manager pointed to the company’s five manufacturing lines. He said that two ran vanilla and the other three ran all other flavors. The three multiflavor lines could be changed over after cleaning the equipment. The students saw how the 100% fill rate was possible: if there was a chance vanilla could stock out, all five lines would be running vanilla. The solution was to align supplier resources (the manufacturing lines) with the “A” item (vanilla ice cream).

But the operations manager had not told the whole story. As far as the manufacturing operations were concerned, vanilla would not stock out. Once on the truck, however, the firm faced a new challenge. The truck would make a run and might encounter higher than expected demand at customer operations. The driver would allocate the product based on serving the most important customers first and giving smaller amounts to the smaller customers.

The process aligned supplier resources (the manufacturing lines), with the top selling product (vanilla) and core customers. Managing relationships between core customers, “A” inventory and supplier resources are a fundamental part of managing the supply chain. Since no firm can do everything, it is critical to match what matters most up and down the supply chain. The alignment model is shown in exhibit 2.



Based on previous blog posts, here are the different inventory, customer, and supplier groups:
1) Inventory – A, B, C, and D
2) Customers – Core, Opportunistic, Marginal, and Service Drain
3) Suppliers – Strategic partners, Distributor controlled, Out of control, and Vendor controlled

There are about 64 possible combinations based on the above stratification segments. Let’s discuss a few common inventory-customer-supplier combinations and discuss appropriate strategies.

A building materials distributor was running a small door manufacturing plant. The manufacturing plant would buy the “slabs” (the door) and then install windows, hardware (door knobs, hinges, screws) and “hang” the door (put it in its frame). The process was labor intensive and did not allow for high volume operations, since the doors were sold to custom builders and could not be forecasted well. Buying the slabs offered three alternatives: (1) buy the slabs twice a year at a truckload discount (less expensive), (2) buy the slabs three or four times a year at a less than truckload (LTL) rate (more expensive), or (3) buy the slabs for next-day delivery in exact amounts from another distributor (most expensive).

Upon investigation, they found that buying at a truckload rate built huge inventories not justified by the discount. Following the same logic, they found that buying at LTL also created too much inventory. They were about to settle on using the distributor when they discovered that this distributor could deliver the doors completed with hardware and hung. The other distributor was so efficient that it was more cost effective to buy the complete door and close down their door shop.

From a resource alignment perspective, the distributor had a core customer who needed the doors so they had to provide them. The individual doors, however, did not rise to “A” inventory status, since they required too much inventory for too many different configurations. The solution of postponing the final configuration (doing your own door manufacturing) was also not effective since the doors did not command sufficient margins and did not have sufficient volume to allow for efficient purchasing and manufacturing processes. The doors were important to the core customer, however. To properly align resources, the distributor eliminated value add (inventory and manufacturing) on the doors and found a strategic supplier that could support that part of the business, so they could continue to invest in their “A” inventory (molding, trim, etc.).

Resource alignment requires understanding that manufacturing resources are not flexible and require a tremendous investment. Manufacturers of commodity items (low cost, low mix, high volume) require high volume to make up for low margins. Distributors have to smooth out demand and uncover as much business as possible (find and maintain core customers). Their investment in inventory has to be low due to their own low margins, and their market coverage has to be strong. Manufacturers of specialized, high-technology equipment need distributors to be willing to “take a chance” and bring on new items without fully knowing whether they’ll succeed. They must buy in large enough amounts to get manufacturers to sufficient volumes fast.

Electronics distributors meet this challenge by buying new items and then debiting obsolescence costs back to manufacturers. Products decline in value so fast that distributors would be cautious to buy new products in large amounts. The solution is for distributors to buy enough to make manufacturers successful. Then as prices decline with manufacturing efficiency, they can document and debit back to manufacturers. The process allows for manufacturing efficiency and distributor profitability.

Such an arrangement requires alliances with suppliers (strategic partners) and well-understood customers (core customers). Only with this type of arrangement can distributors make the right decisions on the right “A” inventory to align the supply chain.



About this Blog

“Managing in an Uncertain Economy” is a blog created by the Council for Research on Distributor Best Practices (CRDBP). The mission of the CRDBP, created by the NAW Institute for Distribution Excellence and the Supply Chain Systems Laboratory at Texas A&M University, is to create competitive advantage for wholesaler-distributors through development of research, tools, and education. CRDBP encourages readers of this blog to send in comments and e-mail this blog to other interested parties.

Best Practice: Supplier Stratification



By Dr. Barry Lawrence, Texas A&M University



Senthil Gunasekaran, Texas A&M University









Pradip Krishnadevarajan, Texas A&M University



and Dr. Malini Natarajarathinam, Texas A&M University











Distributors choose a customer type, the “core customer” as described in earlier blogs, and then arrayed resources to meet that customer’s needs. In the process, the distributor “invents” itself and determines what investments will be necessary to be successful (inventory, warehouse, equipment, human resources, etc.). One of the earliest and most important decisions is supplier selection.

Suppliers are selected based on their ability to serve the core customer. In the beginning, this is a very positive relationship with the distributor seeking to delight the customer, and the supplier seeking to find new ways to penetrate this new market. Over time, however, the relationship matures and sometimes goes awry. Suppliers may want distributors to broaden their offerings or buy in volumes inconsistent with what the core customer needs, often leading to excess and obsolete inventories. In other cases, supplier performance may decline or not keep up with the market, leading to customer service failures or a need for more inventory investment.

Many best practices have been developed in Supplier Relationship Management, but they are often misdirected in practice. One distributor maintained what the staff called a supplier report card (a well-known best practice). When asked how they used the report card, they said they took it into their pricing negotiation meetings each year with the supplier. This is not a report card; it’s a baseball bat.

The issue surrounds the basic definition of the distributor’s role in the supply chain. Some believe the distributor is the supplier’s customer, while others say the distributor is the supplier’s partner. The distinction is important. A customer is one to be served; a partner collaborates for the betterment of all. A customer seeks to optimize his or her own costs and operations without regard to the supplier’s needs. A partner, on the other hand, acts as the channel to market for his or her key suppliers and facilitates the success of both.

Returning to our original premise, the distributor selects suppliers based upon their ability to support the needs of core customers. The most significant (strategic) suppliers should carry products and skills that set them and the distributor apart. These suppliers must be partners. The ones that fill the small holes in the product offering and are only differentiated by price and by not product features or quality are vendors. To them, the distributor is a customer.


The new NAW Institute for Distribution Excellence book, Optimizing Distributor Profitability: Best Practices to a Stronger Bottom Line (available at http://www.naw.org/optimizdistprof), details best practices, their implementation, and return-on-investment (ROI). These practices are valid in any economy, but the significance of one best practice versus another may change under different market conditions. Each month in this blog, we continue to introduce a best practice and how it can improve earnings and/or ROI under current economic conditions. Using this blog, we encourage you, our readers, to ask questions, debate results, and offer your own experiences with these best practices, so that together we may further the knowledge of our community and the understanding of the science of distribution.

The book breaks business processes into seven groups (SOURCE, STOCK, STORE, SELL, SHIP, SUPPLY CHAIN PLANNING, and SUPPORT SERVICES) based on various distributor asset categories. This month, we focus on the SOURCE group (see exhibit 1). The SOURCE group has five processes, and we’ll discuss “supplier stratification.”






Best Practice: Supplier Stratification

The process of stratifying suppliers based on profitability, distributor services, performance, and loyalty is called supplier stratification. Other factors such as risk, relationship, and growth potential can be used as well. The analysis is spread across all suppliers or it can be limited to the suppliers that account for 80% of annual spend. The objective of supplier stratification is to understand the criticality of the supply base and to allocate key resources accordingly. The stratification helps develop relationships and improve profitability in the long term. Supplier stratification helps the sourcing team see the impact of buying activity on the firm’s profitability.
Supplier stratification techniques are gaining popularity, but they are often not applied correctly. The practice levels for supplier stratification are as follows:

COMMON practice: (1) No formal supplier stratification, (2) Based on purchase price variance and landed cost

GOOD practice: Based on a single factor (1) Volume of Spend $ (Cost of Goods Sold), (2) Pareto Framework (80-20 rule)

BEST practice: Based on multiple factors (1) Profitability, distributor services, supplier performance, loyalty (exclusivity vs. general), risk/exposure, (2) Combination method. A combination method developed by Texas A&M is shown in exhibit 2.



The stratification framework summarizes key supplier relationship factors in a supplier stratification model based on four factors:

• profitability
• performance
• loyalty
• distributor services.

Based on these factors, suppliers can be grouped within four categories:

1. Strategic partners: These suppliers represent strong brand, exclusivity, solid delivery capability, and, together with the distributor, high market control. Profitability is high with this group because sales and margins are high and the cost of doing business is low. Strategic suppliers help distributors sell with their strong brand recognition, at good margins through the exclusive channel, at lower cost-to-serve due to better deliveries, and with greater control of the market by leveraging the alliance.
2. Vendor controlled: These suppliers represent high service intensiveness and low market control, in addition to strong brand and exclusivity. The cost of doing business with this group is high for required services (repair, consulting, programming, and so on), but the suppliers are efficient and don’t drive up logistics and inventory expenses. These suppliers offer exclusivity, but demand high loyalty and good performance to protect their brands. Distributors should seek to develop a more balanced relationship that allows them to determine what services the customer needs and not be dictated to by the supplier.
3. Distributor controlled: These suppliers represent those situations in which the supplier’s brand is weak, but the distributor’s presence in the market is unchallenged. The distributor is able to dictate service levels and manage prices. Although this is an attractive area, it usually is not sustainable for long because the competition will soon arrive. The distributor should help the supplier improve its performance and increase its loyalty or find another supplier that will.
4. Out of control: These suppliers are opportunistic, but they are unwilling to shoulder any of the burdens in establishing and maintaining a market. Distributors should quickly discontinue these relationships.

Distributors want to do business with strategic suppliers. They want loyal/high-performing, vendor-controlled suppliers that can become more effective and loyal in a distributor-controlled environment, and then use the rest of their resources to penetrate new markets. Distributors might have to do business in the rest of the vendor-controlled area due to customer requirements to carry a brand. They also may have to do business in the distributor-controlled area to capture profitability, as well as in the higher end of the “out of control” area just to hit necessary sales numbers. From the start, however, distributors definitely should get out of the worst “out of control” business so that they can keep from losing resources for very poor ROI.

Even though supplier stratification processes influence many business factors, such as brand, exclusivity, and market control, most firms concentrate on two process metrics that affect financial measures:

• Growth potential. This determines the supplier’s ability to scale up shipments when the distributor grows its market share and geographic footprint, affecting revenue growth.
• Lead time and variability. These contribute to inventory levels, depending on a customer’s service-level requirements. Lead times and their variability are countered by the financial element inventory, reflected directly in the financial statements.

Revenue can measure both revenue growth and total asset turnover (asset efficiency). Inventory can be related to GMROII (profitability), working capital (cash flow), and inventory turnover (asset efficiency). These four financial drivers—asset efficiency, cash flow, profitability, and growth—contribute to shareholder value.

Best Practice in Action: Do Suppliers Respond to Performance Measurement?

In order to perform the supplier stratification as per the Texas A&M combination method, you would need to use four different factors as shown in exhibit 2. One distributor that decided to implement the stratification framework for suppliers began with “supplier performance” (one of the four factors in exhibit 2) to perform an evaluation of its top supplier. The top supplier accounted for about 15% of the distributor’s inventory. During initial negotiations with the supplier, contracts were drawn up based on agreed-to lead time variability. If the lead time is 30 days and the supplier often delivers the product between 25 and 35 days, then the variability is 5 days (the deviation from the lead time of 30 days). However, over the years as the supplier expanded its customer base, the lead time variability became 15 days instead of the initial 5 days (as per the contract). When the distributor discussed this with the supplier, the supplier said the variability would get better over time as the supplier increased capacity. However, this did not happen.

The distributor then wanted to understand the impact of increased lead time variability on its inventory levels and customer service. Due to this variability from the supplier going over the agreed-to 5 days, the distributor had to increase inventory levels by more than 20% so that it could still meet the same customer service levels. This increased its inventory investment, reduced warehouse space for new products, increased interest expenses, and so forth. The distributor was taking a heavy toll on its bottom line. Its financial statements became a key concern for top management and shareholders.

The distributor then began to develop a tracking report for supplier performance. The distributor presented the tracking report to the supplier on a quarterly basis. Keep in mind that this was just a report card, and not a baseball bat. The distributor also made the supplier aware of the additional amount of inventory the distributor needed to carry so that it could still meet customer service levels. The supplier then understood the impact of increased lead time variability on the distributor’s bottom line. In the real world, there are various uncertainties that suppliers just have to plan for. Unfortunately, the supplier could not reduce its lead time variability. However, the supplier compensated the distributor by providing price discounts and increasing the payment terms from 45 days to 65 days. As a result, the distributor was compensated for the increase in supplier’s lead time variability. This did not happen overnight, but the point is that the distributor got the message across to the supplier in a way that was beneficial to both parties.

The process of connecting lead time variability to shareholder value is accomplished using exhibit 3.

Most distributors do not believe that suppliers would respond to a measurement system. We’ve observed, however, that in many cases, a scorecard has turned out to be highly effective. In fact, a majority of manufacturers that we’ve encountered are impressed with their distributors’ attention to performance tracking and, as a result, they are willing to work with their distributors for improvement. Quite a few manufacturers also referred to the performance reporting mechanism as one of the value-added services that distributors could offer in general to all suppliers. The critical questions are

• Could distributors offer this performance tracking as a service to suppliers?
• Would suppliers value this offering?
• Could distributors get compensated for this service?

Moreover, if suppliers respond to your measurement system in a positive fashion, the end result is more than compensation; it is a partnership and sustainability.

About this Blog

“Managing in an Uncertain Economy” is a blog created by the Council for Research on Distributor Best Practices (CRDBP). The mission of the CRDBP, created by the NAW Institute for Distribution Excellence and the Supply Chain Systems Laboratory at Texas A&M University, is to create competitive advantage for wholesaler-distributors through development of research, tools, and education. CRDBP encourages readers of this blog to send in Comments and email this blog to other interested parties.