By Gustavo Gaeta and Stavros Stefanis
With consumer confidence shaken and spending curtailed, companies are facing some of the most challenging operating environments in history. Companies are realizing that the usual tools to counteract a downturn are not enough. To deliver the results needed, executives now need to focus on the more difficult task of managing complexity throughout the supply chain, and better linking finance and operations.
Although these issues are important at all times, current conditions have made the alignment of financial and operational planning, along with rigorous scenario-based supply chain evaluation, more important than ever.
Many of the more easily addressed operational inefficiencies have already been tackled with some level of success. These opportunities were predominantly focused on single functions, independent departments, shutting down facilities and headcount reductions. These efforts were typically enough in the past, but not now.
Financial pressures are prompting companies to closely manage their operations to optimize cash and liquidity. With cash-to-cash improvements and total cost management a major focus, companies are striving to improve their metrics and financial accountability and better manage complex operations.
Managers seeking a greater level of cost reduction and cash conservation have begun to address processes that span across multiple functions, departments, entities or facilities. These processes are more complex, but can result in substantially higher levels of cost reduction.
As a starting point, executives can focus on improving efficiencies in three critical supply chain areas: integrated planning, supply risk management and demand risk management. (See Figure 1.)
These three areas not only require a great degree of internal coordination and closely aligned metrics but can consume a high level of cash and involve unplanned investments closely tied to fluctuating supply and demand from external suppliers and customers.
Key activities such as sales and operations planning, supplier risk management and customer/portfolio management should be revisited to adapt to the pressing needs of cash availability. (See Chart 1.)
Following is an in-depth look at these three areas and how managers can change their processes to address turbulent conditions.
To better align financial and operational plans, leading companies have relied on a top-down sales and operations planning (S&OP) process. This process is driven by sales and marketing working closely with the operations and finance team to disaggregate the financial plan. The cross-functional information is then used to drive consensus and create the unconstrained and constrained supply plan.
The ability to execute this process effectively has been challenging for companies because of the misalignment of metrics or competing priorities, particularly in today’s dynamic environment. This inability to effectively integrate assumptions, expectations and requirements into a single forecast has helped contribute to a slow response to the crisis and a rapid build-up of raw materials, components, work-in-process and finished goods inventory. As demand has dramatically decreased, many companies have not been able to effectively manage their inventory, leading to excess and, in some cases, obsolete inventory.
Today’s difficult times have exposed inadequacies in enterprise-wide planning in areas such as speed, accuracy, accountability and control. The finance team needs to be more involved in driving the integrated planning process with financial data. The result of this process should no longer be a production plan but a more comprehensive financial plan and cash flow projection, accounting for the risk associated with the suppliers and customers. In order to drive this level of financial and operational integration, some companies are addressing pricing and operational planning priorities in an integrated fashion across business units. As a result, cash flow planning decisions around marketing expenditures and discounts, as well as impact of variable expenses, should become more tightly controlled.
Over time, this shift will have an impact on supporting enabling technology. Traditionally, master planning systems (MPS) horizons have been shorter than those associated with S&OP processes, which drove, to a certain extent, decoupling of the plans. As the need for cash and operational management has increased, and as leading companies strive to conduct more accurate scenario planning, an integrated and frequently updated business and operating plan is required.
Supply Risk Management
The disruptions to a company’s operations and cash position due to supplier shutdowns or key customer bankruptcies can be disastrous. These risks introduce enhanced levels of uncertainty throughout the value chain. And when suppliers or third-party providers experience financial difficulties affecting operational performance and causing slowdowns, it is difficult to understand portfolio and channel margins to appropriately manage capacity requirements while focusing on cash positive production. Furthermore, customer instability can result in the need to reorder allocation priorities and credit terms (i.e., the traditional “best” customer might no longer be the “best”).
When looking at the entire value chain, any substantial delay of parts or components availability can lead to plant closures or even bankruptcy. Consequently, it is critical for companies to monitor and work closely with their suppliers to develop contingency and risk mitigation plans to offset any potential major disruption of critical procured parts or components, as well as inbound material.
These contingency plans should contain at least three major areas of focus. The first area is better identification of critical suppliers or vendors. Companies need to revisit who their critical suppliers and vendors are in light of changing customer buying trends. For example, tooling that may have been critical may no longer be required, or the shift in commodity prices and excess capacity has provided the opportunity to use other material or suppliers that previously would not have been an option.
The second area is better understanding the challenges and major issues facing key suppliers and vendors. Providing production plans and anticipated demand schedules is no longer enough; companies need to understand the viability of critical suppliers and the impact they can have on their operations should failure occur.
In working with suppliers and carriers, managers should evaluate their performance from several perspectives:
- Operational performance, focusing on quality, on-time delivery, capacity issues and flexibility;
- Economic performance, focusing on financial statements and cash position.
This performance assessment should result in an overall rating of suppliers/carriers and the risks the company bears by working with each of these organizations.
The last area of focus is increasing an organization’s awareness of current market and industry forces. This is critical because it enables a company to have better visibility to the pressures and stresses not only within its own organization but also within its suppliers and vendors. Elements like competitiveness, market characteristics, trends, emerging technologies and availability of substitutes provide insight into the positioning of current suppliers/carriers compared to other players in the market.
The mitigation plan, in combination with the risk profile of the company, should enable a quick and comprehensive response should a major supplier, vendor or carrier fail. The result of this exercise could be the consolidation of suppliers, leveraging suppliers across the enterprise, or seeking new companies that can step in when and if needed.
Another element of supply risk management, on a more tactical level, is improving internal cross-functional coordination, as well as external collaboration with the supplier/carrier, by redefining and enhancing certain processes and structures. This includes:
- More frequent communication among the enterprise’s stakeholders to identify potential issues early on. This allows for the integration of response plans and allows for a faster reaction throughout the supply chain. Rapid-response teams can be assigned to specific cross-functional processes or resources to expedite this process.
- Enhanced operating reports, which provide input but also dramatically enhance monitoring and communication (e.g., purchase order delivery status, PO placement status, inventory balances, capacity/load balancing). Comprehensive reports can also provide engineering/technical status (e.g., drawing release status, engineering change order status, test status) and benefit both supplier and customer organizations, as well as cash position.
- Financial status summaries (e.g., receivables, payables, working capital and overall company financial health), used with operational data, provide high-level information to facilitate better decision-making and risk mitigation.
Demand Risk Management
The dynamic economic environment has increased the difficulty in achieving reliable demand forecasts. Reviewing historical sales or seasonal demands does not offer guidance. To deal with this type of uncertainty, companies can turn to scenario-based forecasting.
In scenario-based forecasting, managers define alternative scenarios and identify a range of possible outcomes. Companies develop various forecasts and plans based on these scenarios, which will enable them to act quickly by pulling the alternative that best matches the circumstances they are experiencing.
Scenario-based planning better positions an organization to react to fluctuations in demand and may at times compensate for inflexibility in operations. Some of the key steps of the scenario-based planning process include:
- Determine focus of the evaluation and the key factors/events affecting the focal area;
- Identify the driving forces behind the key factors (credit, competitiveness, cost structure, infrastructure capabilities, environmental trends, etc.);
- Rank critical uncertainties and begin to develop different outcome scenarios;
- Identify early indicators (observable variables, factors or events that suggest a particular scenario is unfolding) of a probable outcome;
- Integrate the results of the particular scenario developed that is currently evolving into the planning cycle.
Companies can establish scenario-based process play books to respond to uncertain environments that enable them to effectively react to varying external pressures and challenges. A great level of flexibility is obtained by tailoring the approach to the specific needs of the company and involving a cross-functional team as in the S&OP process.
No one can accurately predict when the economy will turn around. But what is certain is that when the dust settles, there will be winners and losers, and those companies that can effectively manage demand and supply chain risk will be in a better position. Breaking down silos, with a keen focus on enterprise planning and managing supply risk, will be critical.
About the Authors: Gustavo Gaeta is a principal and Stavros Stefanis is a managing director in KPMG LLP’s Business Performance Services practice, both based in Chicago. The views and opinions are those of the author and do not necessarily represent the views and opinions of KPMG LLP. All information provided is of a general nature and is not intended to address the circumstances of any particular individual or entity.