10 Steps to a More Profitable Supply Chain

Understanding customer profitability provides a foundation for better serving your best, and most lucrative, clients


By Richard Davis

Does this story sound familiar? It's 7:00 p.m., your warehouse team has just finished their final picks for the evening, your fleet has been loaded based on standard routing calculations, and you're ready to pack up shop. Then that dreaded moment happens — a member of your sales team calls down to the warehouse: "Our best customer needs more 'x' by tomorrow or they'll go somewhere else."

It turns out, however, that the customer that made your people jump through hoops is, in reality, an underperformer from both a gross margin and gross profit perspective. In fact, unknown to the sales force or anyone else, this "best customer" has been in the bottom quartile of your customer portfolio for several years. Worse, that "critical" sale just cost you more money to process than it produced in profit.

If your distribution business serves a wide variety of accounts across a range of industries, then the question likely is not if this problem is happening, but how often.

The solution to this problem starts with a deeper understanding of customer profitability. It then requires that every team work hand-in-glove to not only execute core tasks — receiving, storage and shipping inventory — but more importantly know how to better manage the intricate network of vendors and customers, as well as each nuance associated with these relationships. Our experience working with midsize wholesale distribution businesses ($50 million to $500 million in revenues) has proved that balancing profitable growth is achieved when you put in place a logical, methodical and well-planned approach to optimizing your supply chain.

Below are 10 practical steps to help get you on the path to profitable growth.

1. Analyze historical trends

Historical transaction analysis can yield tremendous insight into how you have been interacting with your customers. This is your organization's demand profile — the series of indicators that your team can begin to analyze to determine strategies to improve customer profitability at the individual account or aggregate organizational level.

Regardless of your current technology platform, you might be surprised at how much data you actually maintain regarding the history of your relationships on both customer and vendor sides of the supply chain equation. Analyzing sales history is critical: It tells you what your customers buy, while analyzing purchase order histories reveals buying histories from vendors to meet your customer's demand.

This relationship is at the core of your purchasing and sales ROI strategy and shapes the buying behavior of both your procurement function and your sales department's behavior when interacting with your customers. Historical information, although not perfect, is almost always one of the best predictors for future activity.

2. Rank your customers and suppliers on gross margin

Rank both your customers and vendors based upon a straightforward top-to-bottom gross profit analysis of quartiles, then determine which groups account for the greatest percentages of margin. This step has many advantages, as it provides a structure to manage both your procurement and sales function activity in the future and can lead to improved processes that hold your teams accountable regarding customer and supplier performance. Further, posting these quartiles in a visible place in your organization creates transparency so that there is no ambiguity regarding which customers and suppliers have been profitable over time — and which have not, period.

3. Refine your sales channel analysis

Begin by analyzing how your customer orders come in. Break these orders into discrete sales channels. Rather than designating a customer type as "chain," "independent" or "single location," refine the attributes of your sales channels to collect more information about the size and shape of your customers, including number of employees, whether it's family owned, approximate square footage of their locations, even the number of parking spaces at the location.

These factors, plus potentially hundreds more, if identified and captured correctly as part of a more robust sales channel analysis, will give you insights beyond what is observable in your salesperson's informal relationships with your customers. This is a key to understanding where your business really comes from and can help your teams prioritize effort on how to capture more of the markets where your business has strengths in the near term, while working on how to develop other sales channels in the medium-to-long term.

4. Create a multidimensional customer/supplier analysis model

We have found that developing a multidimensional model as a next step can optimize the internal profitability analysis on customers and suppliers. This model should contain both quantitative and qualitative information, such as which customers have the highest gross margin and which ones may give you the key to their storage facility. The numbers alone do not tell the entire story, because you may be able to better prioritize your shipments to a specific customer location without sacrificing service quality or delivery timeliness.

Combine this multi-dimensional analysis with the top-to-bottom view established in Step 2 and your team will have two important views of both your customers and vendors: Where they sit among their peer groups, and where they sit within your entire organization. This creates a "level playing field" and allows for more transparent exchange of information between your sales and operations departments regarding how to make the most profitable decisions for your organization.

5. Respect the 80/20 rule

Eighty percent of your profit will likely come from 20 percent of your customers. Just as important, the opposite is true: 80 percent of your variable (and controllable) operational costs can likely be attributed to the 20 percent as well.

A powerful tool called Pareto analysis can help you make more intelligent decisions using the 80/20 rule. It is a simple technique for determining the best course of action among many possible alternatives involving a grouping and scoring methodology to ascertain which organizational or department changes might result in the biggest "bang for the buck" if implemented. The resulting insights can be a catalyst for organizational change in the way that your procurement and sales teams view their own performance.

If your multi-dimensional model tells you one thing, it will be that much of your variable cost results from uninformed decision-making on both the inbound and outbound ordering sides of your business. A Pareto chart will enable your team to better understand the qualitative internal factors, or interdependencies between your departments, which cost you time and money on a recurring basis. Pareto analysis is a way to prioritize which pieces of your organization will require the most change from a business process or technology perspective, and it will allow you to manage the potential investment needed for change.

6. Use benchmarking data and "key performance indicators" judiciously

Benchmarking data can be incredibly useful. Used improperly, however, it can be frustrating. Therefore, until you have a good handle on which customers and suppliers are core to your gross profit strategy, use benchmarks at the most macro level of your organization first. Understanding your internal cost drivers and specific relationships among your people will make benchmarking data much more useful to your business in the long run. Trying to live up to benchmarks can be a bit like herding cats if you haven't cleaned up your internal processes and data first.

There has been debate over "key performance indictors" (KPIs) and how best to use them. Keep in mind that KPIs can be powerful tools, but it is critical to think carefully about which ones are most relevant to your current situation and which are more applicable for monitoring mid- to long-term trends. Consider developing KPIs around the functional interdependencies among your departments as outlined in Step 5. KPIs designed around the relationship between two or more departments responsible for the supply chain can be more valuable than KPIs designed to measure any single function.

7. Determine a single view of organizational profitability

If you've analyzed your customers and suppliers, quartiled them, ranked them based on a multi-dimensional profitability model, determined the 20 percent that account for the profit and the 20 percent that account for all the problems, and compared your organization to other similar-sized businesses, you're ready to provide a single view of profitability to your employees. Formalize it, post it, report it and set a vision for how business will be done based on the analysis you've performed and why it makes sense for your business.

8. Standardize your processes and create a system of internal controls

Based on your newly designed view of organizational profitability, next take a look at the functional alignment of your organization. You will likely find that unprofitable decisions have roots in a salesperson trying to ensure his "most important customer's" satisfaction, with little understanding on how that one decision, or series of decisions over time, affects profitability downstream.

Gather your managers for sales, procurement, warehouse, customer service and transportation. Your goal is make sure they all have a common understanding of what constitutes a decision that is unprofitable to the business. This is a great opportunity to develop standard processes and internal controls that can help your team understand when they're about to make an unprofitable decision. Give your management team measures to detect decisions that will produce off-strategy results. Map your supply chain from end-to-end, and ensure that everyone has the same view of upstream and downstream events and how they interrelate with one another.

9. Integrate your teams

Depending upon your organization's size, consider developing cross-functional teams to manage customer accounts or industry segments. Get everyone involved and ensure that the team is aware of the goals with respect to managing the customers for which they're responsible.

Imagine hearing a driver who actually delivers products to your customers discuss the potential to increase backhaul opportunities with your procurement team. Believe it or not, your drivers generally see everything that you don't: They are your organization's last touch-point with a customer order, and your suppliers' first touch-point (assuming that you backhaul) when you purchase inventory. Give them the right tools to manage both sides of the relationship and you'll likely find more qualitative data points to help increase the success of your teams.

10. Train your teams on standards, then urge them to develop better processes

At the end of the day, no information system, no matter how robust can be as effective as a well-trained teammate who can understand how to interpret the information. Although powerful information systems can aid in supporting your key business processes, systems are only designed to execute tasks — albeit millions of them.

Training your team involves ensuring a solid understanding of Steps 1 through 7. However, training further implies that you've developed standards and frameworks by which you will measure performance over time. Once you have developed the necessary tools and methods for training your teams, your goal is simple: Paint a clear picture of your organizational objectives and how each of them contributes to the whole. Then, align your performance management systems to your organizational objectives to promote adherence to the standard.

Development and coaching plays a vital role in this step. Allow your teams a voice and create mechanisms to enable them to communicate underlying performance drivers that are inherent in the standards that have been set forth and create a path for continuous improvement. A well-trained team can improve their ability to execute and, in turn, develop new and better ways to execute.

In conclusion, identifying the unproductive, and unprofitable interrelationships among people, processes and technology in your business is something that takes time away from looking at the top line — sales. But — and this is a key point — making the investment to rethink key elements of your logistics model will most certainly pay handsome dividends over time.¦

About the Author: Richard Davis is partner and practice leader for business advisory services based in Grant Thornton LLP's Boston office.

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