Among companies that manufacture high tech products, total supply chain costs vary greatly. But the gap between the lowest-cost performers and average companies is significant, and growing. While all companies actively work to control supply chain costs, few take a holistic approach that tackles the problem from a variety of fronts. As a result, cost savings often fall short, a problem further compounded by the fact that some controls put in place trigger increased cost in other areas that cannot easily be controlled.

The potential for improving total cost management is large enough that the solutions are worth serious consideration. PRTM's subsidiary, The Performance Measurement Group, LLC (PMG), regularly benchmarks supply chain cost as a percentage of revenue. The benchmark considers 24 cost elements across materials acquisition, order management, distribution, inventory carrying costs, and supply chain information infrastructure, and neutralizes direct materials cost. As the graph shows, the total cost of average performers is often double that of performers in the top 20 percent. For a $500 million dollar company in the business of medical device manufacturing, for instance, the gap between average and best performing cost managers is 4.1 points of revenue, or $20.5 million. This difference goes directly to the bottom line, with a reflected benefit to the balance sheet.

Most senior executives manage their major supply chain costs by optimizing individual contracts and scrutinizing the placement of large purchase orders. These cost management efforts are typically modeled and projected into annualized cost reduction benefits that show progress against cost of goods sold targets and the like. Our experience is that many companies do not manage total cost. By optimizing only specific cost areas, these companies inadvertently sabotage total costs.

Two examples illustrate this point. The business case for outsourcing manufacturing is typically based on manufactured product cost, since this is the cost area that manufacturing is chartered to control. To ensure ongoing cost performance of processes no longer directly controlled, companies that outsource set contracts for guaranteed annual cost reductions in labor, material and/or overhead costs of the product. In time, the contract manufacturer must move production to low-cost countries, usually outside of where the products are sold and serviced. As a result, the total cost of goods sold rises. Why? Because while the manufactured cost of the product has declined predictably, these savings are offset by higher costs related to logistics, inventory management, and other costs that weren't modeled into the sensitivity analysis of the business case.

The second example is in the area of product lifecycle change. Typically, product engineering establishes when changes to a product's bill of materials will occur. Ironically, many of these changes are made to lower the cost of a product or to enhance the product's appeal to new markets, but as often as not these decisions are made independent of a total cost model. As a result, companies risk incurring higher costs and/or diminished top line growth. These risks include excess inventory, costly remedies to maintain regulatory and trade compliance, patent risk, and so forth.

In our work with companies seeking to boost supply chain performance, we've found that the top performers, those that have cut total costs on a sustainable basis, use total cost modeling to identify cost reduction priorities and when launching cost reduction efforts. This approach moves a business away from functionally or regionally optimized cost reduction programs to cross-functionally integrated and, for an increasing number of superior performers, integrated cross-enterprise models.

In the typical company, a functional manager creates a business case for a cost reduction effort. The business case focuses on a few highly related segments of the supply chain that are within the manager's span of control, and the initiative is then chartered. This approach fails to model the cost implications for other areas of supply chain performance; nor does it take into account any initiatives in other areas of the business that have already claimed similar benefits or that could influence the timing of benefits. The result is a spot improvement in performance that is usually just temporary, because the initiative was chartered devoid of context.

For the most part, a cost benefit claimed in such a business case is only a cost displacement to the overall supply chain. At many companies, a non-integrated cost savings program actually winds up adding to the net total supply chain cost by boosting planning and execution costs, and adding the overhead costs related to running the performance improvement efforts.

Total-cost modeling tools and practices can help companies achieve a sustained competitive advantage by considering the primary, secondary, and sometimes tertiary impact of cost reduction programs and by forcing the consideration of alternative programs. For example, one company manufacturing in Asia for European markets needed to sharply improve transportation lead times to meet customer needs. One alternative was to invest in increased semi-finished stock in Europe and configure products locally. The fulfillment team chartering this case determined it needed to invest in an inventory modeling tool and flexible warehousing space and labor to meet this need. It justified the program by pointing to cost avoidance for new customer acquisition and increased market share. In helping to plan the implementation, PRTM found a more cost-effective approach using air freight and direct shipment, which justified phasing out the company's warehouses. The implementation required some changes to order management, use of third-party logistics providers, and participation across functions and businesses. But the net effect was a business case with twice the original benefit, lower business risk, and broader benefit to other product lines.

Effective supply chain cost modeling includes considering the existing supply chain infrastructure, cost drivers of "end-to-end" performance, and a few key external factors. PRTM typically uses just 10 measurement areas as input to modeling, and analyzes both the near-term (3-9 months) and medium-term (9-18 months) impact of cost reduction ideas. Longer-range modeling is not necessary. The value point is found in setting up and then managing a portfolio of integrated cost reduction programs focused on sustaining the total net cost reduction for the on-going business.

Sidebar: New Report Addresses Software for Plant Systems
By Lara L. Sowinski

ARC Advisory Group (www.arcweb.com) released a new best practices study in late July entitled "Best Practices in Acquisition Planning for Software-Intensive Plant Systems."

According to the research and consultancy firm, IT-related delays are increasingly impacting production start-up times and consequently the ability to realize satisfactory time-to-market.

In addition, the ARC Advisory Group says the expanding scope and complexity of the software content of plant floor systems continues to exacerbate the problem.

Nonetheless, "The good news is that the preponderance of contributors to software failure are not technical in nature. This in spite of the vast amount of hardware, software, and communications technology employed in today's production control systems. Instead, the methodology surrounding acquisition planning and execution is the leading determinant," says Chantal Polsonetti, vice president with ARC Advisory Group and the lead analyst on the report.

The research for this latest best practices publication was drawn from a survey of manufacturers and their system providers, plus activities in government, academia, and industry.