Conquering the Supply Chain Effective Frontier

A Study of Supply Chain Excellence

11/27/2017

By Lora Cecere

Founder and CEO Supply Chain Insights LLC and Alina Beskrovna

Research Analyst Supply Chain Insights LLC

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Contents

Research Methodology

Open Content Research

Disclosure

Executive Overview

The Effective Frontier

Trends within Peer Groups

Retail

Apparel Retail

Broadline Retailers

Drug Retailers

Home Improvement Retailers

Restaurants

Manufacturing

Apparel Manufacturers

Auto Parts

Beauty

Chemical Manufacturers

Consumer Nondurables

Contract Manufacturers

Medical Device

Over-The-Counter Drugs

Pharmaceuticals

Semiconductor Manufacturing

Telecommunications

Driving Organizational Alignment to Improve Metric Performance

Recommendations

Conclusions

Other Reports in This Series

About Supply Chain Insights LLC

About Lora Cecere

About Alina Beskrovna

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Research Methodology This report is based on the analysis of public balance sheet information of retailers, manufacturers,

and distributors. The source of the data for this work is YCharts.

Open Content Research This report is shared using the principles of Open Content research. It is intended for you to read,

share, and use to improve your supply chain decisions. Please share this data freely within your

company and across your industry. All we ask for in return is attribution when you use the materials in

this report. We publish under the Creative Commons License Attribution-Noncommercial-Share Alike

3.0 United States, and you will find our citation policy here.

Disclosure Your trust is important to us. In our business, we are open and transparent about our financial

relationships and our research processes; and, we never share the names of respondents or give

attribution to the open comments collected in the research. This research was 100% funded by the

Supply Chain Insights team.

In the development of our research, our philosophy is, “You give to us, and we give to you.” As a part

of this philosophy, we share data with all respondents; and if interested, we will share our insights

with the respondents on a one-hour phone call with their team. We are committed to delivering

thought-leading content. It is our goal to be the place where visionaries turn to gain an understanding

of the future of supply chain management.

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Executive Overview Over the course of the last decade, retailers made more progress on costs and inventory turns than

manufacturers. In the rush for technology adoption, we commonly find companies overstating what is

possible because they are not clear on the historical trends, and often mistakenly coached to

overcommit by industry consultants to justify technology investments.

In studying supply chain metrics, we find that each industry has a definitive pattern. Few are linear.

To set reasonable goals, the definitions need to be very industry specific. That is the goal of this

report.

In developing supply chain strategy, one of the first objectives is defining what is possible. This

involves delineating the metrics, establishing reasonable targets, and rates of improvement. In the

review of strategy documents for clients, we find that most companies are not clear on any of these

critical sets of assumptions. This report is designed to help. We start with the definition of metrics and

then share industry progress for the period of 2006-2016. This report ends with recommendations

and conclusions.

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The Effective Frontier Supply chain teams battle a list of ever-changing goals for growth, profitability, and cycles in the face

of rising complexity. Leadership teams want to do the right thing, but it just isn’t clear what to do to

move forward. Each organization has a unique potential as defined by The Effective Frontier in Figure

1. It is deliberately termed the Effective Frontier, not the Efficient Frontier.

The reason why is simple. It is to avoid confusion. The term efficient frontier is used in economics to

describe the minimization of risk and maximization of reward in investments. In contrast, the term

Effective Frontier is used to define the potential of what is possible at the intersection of supply chain

metrics, over time, within an industry subsector. In this report, we will take a close look at the

Effective Frontier at the intersection of operating margin and inventory turns. We analyzed the

patterns of 25 peer groups, and share results from the five retail and eleven manufacturing industries

that we consider to be the most relevant.

Figure 1. The Effective Frontier

Each company has its own unique potential within an industry. Its potential is determined by products,

processes, technologies, markets, and channels. Within a company, there are finite trade-offs

between interconnected metrics. As complexity rises, the potential of the organization decreases. To

maintain the status quo, and keep pace, companies must constantly redesign operations. This

includes managing product proliferation, simplifying platform complexity, and mitigating changes in

manufacturing operations. Companies are constantly being asked to reduce costs and improve

working capital, and to do more with less, in the face of rising complexity. Most supply chain leaders

do not see it as a set of metrics in a nonlinear system, bounding a finite set of capabilities.

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The Efficient organization is not necessarily the most effective (an efficient organization is usually

defined as one with the highest productivity/employee or the lowest cost per case). The historical

focus was to improve efficiency. The belief was that increasing efficiency would lower costs and

improve performance. However, we see that a singular focus has an adverse effect on operating

margin and inventory cycles in seven of the 11 manufacturing industry sectors, as will be seen in the

orbit charts later in this report.

As shown through our Supply Chains to Admire research, nine out of ten companies are stuck at the

intersection of two important metrics: operating margin (a measurement of cost) and inventory turns

(a measurement of inventory effectiveness). To conquer the Effective Frontier and drive change there

needs to be a focus on outputs, not inputs, while shifting from a focus on functional metrics to define

a balanced portfolio. Most are so entrenched in functional metrics that it’s hard to focus on corporate

performance. For the best-performing companies, it is a series of conscious choices to improve

capabilities and push to a new level of The Effective Frontier. Progress happens slowly. It is only after

achieving balance and resiliency in a current state that companies can push to a new level of

performance. Balance is achieving the optimal values for all metrics in the balanced portfolio, while

resiliency is the ability to have controlled results of that balanced portfolio year after year.

Figure 2. Driving Improvement on the Effective Frontier

Technology is an enabler. It can also be a disruptor. Empowered companies use technologies and

new ways of working to increase potential and move to new levels of the Effective Frontier.

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Companies want to increase or accelerate inventory turns and reduce cash-to-cash cycles. Improving

inventory turns and decreasing cash cycles improves working capital; but, an increase in complexity

will usually decrease margin and increase inventory turns. Complexity shifts and metrics performance

are connected and interrelated. Working these metrics as a complex system, while on the Effective

Frontier, enables companies to build a road map to drive business strategy. Today, there are more

challenges to managing metrics trade-offs while on a frontier than in the past. The pace of change is

rapid. Businesses are larger and more global. Organizations are not aligned. In the last decade,

demand and supply volatility increased. Markets became more competitive. Merger and Acquisition

(M&A) activity was rampant. To meet financial markets’ expectations, companies pushed costs and

elongated the cycles of suppliers. This improved our cash-to-cash cycle by lengthening payables, but

it had an adverse impact on margin.

It is easier to shift costs than improve internal operations. Each organization has its own unique

potential and is operating on its own frontier. A useful technique to understand performance is an

orbit chart plot at the intersection of the metrics on the Effective Frontier.

Figure 3. An Example of an Orbit Chart

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In an orbit chart, the intersection of two metrics is plotted to track performance. Companies that are

moving the portfolio towards the best scenario are improving costs, and driving improvements in year-

over-year performance in inventory turns, are driving improvement. In the case of Bridgestone in the

period of 2006-2016, the trend is upward, moving towards the best scenario. The results at

Bridgestone are resilient with very little swing or variation in metrics performance.

The second step is to compare the company’s performance to the industry. Companies

demonstrating supply chain excellence beat the industry averages within a peer group. For example,

General Mills has an operating margin of 16% compared to the industry average of 11%, and

inventory turns of 7.38 versus an industry average of 6.96. What can be seen in the data?

Consistently, General Mills performs better on cost than its industry peer group, but slightly lower in

inventory turns. However, note the swings. General Mills is less resilient—with larger swings and

deviations at the intersection—than the peer group.

Figure 4. Orbit Chart of General Mills vs. the Food Industry Peer Group of for the Period of 2006-2016

Today, business leaders live in the Information Age. Technologies make new ideas possible. Data

flows quicker and computational power enables quicker assessment of complex problems. Decisions

can be more data-driven, and real-time information enables new capabilities. More and more, metrics

can be measured. Targets can be assessed more quickly. However, this only adds value if the

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technological advancements can be successfully aligned with business outcomes. This is the

challenge.

Why is there a problem? Simply put, companies are new at it. We are only 40 years into the

Information Age. The adoption of technology in the Information Age followed the Industrial Revolution.

The Industrial Revolution was all about mechanization. There was a shift from making things by hand

to the mechanization and adoption of manufacturing processes. The focus was on the management

of physical assets. It was all about the control of financial assets and liabilities. The Information Age

started in 1975 with the widespread adoption of computers. The practices and policies were a stark

contrast to those of the Industrial Revolution that stretched from 1850 to 1975. The impact of the third

Industrial Age on United States Productivity is shown in Figure 5.

Figure 5. Impact of Industrial Revolutions on Productivity

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Trends within Peer Groups To understand what is possible, study the potential of the industry peer groups at the intersection of

operating margin and inventory turns. The patterns tell the story. Industries making the most

improvement have a linear progression towards the “best scenario.” Struggling industries, with less

discipline and market sensing in supply chain management, show a lack of resiliency with wild swings

at the intersection of the metrics.

Retail Within retail, the greatest improvements were in the areas of Drug Retailers and Restaurants. In

general, Retailers made more progress on the Effective Frontier than Manufacturers for the period of

2006-2016.

Apparel Retails, Broadline Retailers, and Home Improvement Retailers lacked resiliency. The

setpoints, or what is a reasonable expectation for performance, also vary widely as shown in Table 1.

In operating margin, the averages for the period of 2006-2016 range from 12% for Apparel Retailers,

to 7% for Drug Retailers, and .1% for Restaurants. For inventory cycles, the averages vary from 75.8

for Restaurants to 4.3 for Home Improvement Retailers. To manage metrics improvement, companies

need to focus on what is reasonable from a like industry.

Table 1. Averages for Retailers for the Period of 2006-2016

Industry Operating Margin Averages for

the Period of 2006-2016

Inventory Turn Averages for the

Period of 2006-2016

Apparel Retailers 12% 4.81

Drug Retailers 7% 6.47

Broadline Retailers 5% 4.98

Home Improvement Retailers 3% 4.30

Restaurants .1% 75.8

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Apparel Retailers Figure 6. Apparel Retailers Orbit Chart for 2006-2016

Broadline Retailers Figure 7. Broadline Retailers Orbit Chart for 2006-2016

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Drug Retailers Figure 8. Drug Retailers Orbit Chart for 2006-2016

Home Improvement Retailers Figure 9. Home Improvement Retailers Orbit Chart for 2006-2016

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Restaurants Figure 10. Restaurants Orbit Chart for 2006-2016

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Manufacturing As shown in Table 2, each manufacturing industry operates at a different level on the Effective

Frontier. Industries like Household Nondurables, Medical Device, and Semiconductor companies are

moving backward on both metrics, while Auto Parts, Chemical, Consumer Nondurables, Over-the-

Counter Drugs, Pharmaceuticals, and Telecommunications are making progress. While the progress

in the Auto Parts industry is linear, progress in the Apparel Manufacturing, Beauty, Chemical,

Contract Manufacturing, Pharmaceutical, and Telecommunications industries is more turbulent with

each showing a lack of resiliency. The low margins in Contract Manufacturing make this industry

especially risky.

Table 2. Averages for Each Industry for the Period of 2006-2016

Industry Operating Margin Averages for

the Period of 2006-2016

Inventory Turn Averages for the

Period of 2006-2016

Pharmaceuticals 22% 2.38

Medical Device 18% 2.47

Consumer Nondurables 16% 5.79

Apparel Manufacturing 12% 3.71

Beauty 11% 2.87

Semiconductor 10% 5.17

Chemical 10% 5.31

Over-The-Counter Drugs 9% 3.32

Telecommunications 8% 10.05

Auto Parts 8% 9.01

Contract Manufacturers 3% 6.87

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Apparel Manufacturers Figure 11. Apparel Manufacturers Orbit Chart for 2006-2016

Auto Parts Figure 12. Auto Parts Orbit Chart for 2006-2016

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Beauty Figure 13. Beauty Orbit Chart for 2006-2016

Chemical Manufacturers Figure 14. Chemical Manufacturers Orbit Chart for 2006-2016

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Consumer Nondurables Figure 15. Consumer Nondurables Orbit Chart for 2006-2016

Contract Manufacturers Figure 16. Contract Manufacturers Orbit Chart for 2006-2016

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Medical Device Figure 17. Medical Device Orbit Chart for 2006-2016

Over-The-Counter Drugs Figure 18. Over-The-Counter Drugs Orbit Chart for 2006-2016

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Pharmaceuticals Figure 19. Pharmaceuticals Orbit Chart for 2006-2016

Semiconductor Manufacturing Figure 20. Semiconductor Manufacturing Orbit Chart for 2006-2016

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Telecommunications Figure 21. Telecommunications Orbit Chart for 2006-2016

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Driving Organizational Alignment to Improve Metric Performance Metrics improvement requires alignment. Progress only happens when there is a cross-functional

alignment. When companies are out of balance in metrics goals, the organization has tension. As

shown in Figure 22, this is especially true between sales and operations teams, and also finance. The

lack of alignment results in inventory of the wrong type.

While companies want to align the functions, often the organization is too functional even to have the

discussion. This work requires leadership, clarity on supply chain strategy, and alignment on goals

and objectives.

Figure 22. Alignment Gaps in Consumer Products Manufacturers

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Recommendations We believe that strength, balance, and resiliency are important components of a high-performing

organization. Reaching this goal requires focus and organizational alignment. Here are seven

recommendations:

Manage Metrics as a Complex System. Design the portfolio of metrics to include the critical elements

of customer service, inventory/cash cycles, profitability, and market share. Understand the

interrelationships and manage the metrics portfolio as a complex system.

Get Clear. Be Concrete. Drive Alignment. Terms like flexible, responsive, agile, efficient, customer-

centric and demand-driven permeate corporate strategy documents, but they mean different things to

different people. Unless the terms are clearly defined and aligned to metrics, they are not actionable.

Take the time to define each term and align the desired outcome to a portfolio of metrics.

Understand Industry and Corporate Potential before You Set Targets. Understand your company’s

potential within your peer group. Study the patterns of industries to determine what is possible. Then

use advanced analytics to determine the potential of your division or company.

Drive Balance in a Metrics Portfolio. Clearly articulate the business outcome and define a balanced

portfolio of metrics to drive improvement. Hold the entire organization accountable for the same

portfolio of metrics.

Make Conscious Trade-Offs. In the analysis and determination of organizational potential, the

interrelationships between growth, profitability, cycles and complexity metrics will become clear. Use

modeling technologies to understand the trade-offs and drive the analysis to make conscious trade-offs.

Evolve. Metrics evolve as organizations mature. Review metrics annually and align with the business

strategy. Embrace technology and product disruptors to move the organization to the next frontier.

Stay the Course. As a leader, avoid knee-jerk reactions and “programs of the month.” Measurements

should not be viewed and managed in isolation. Instead, manage individual metrics as integral pieces

of a complex system. Be Patient. This takes time.

Conclusions Driving performance on supply chain metrics is easier said than done. Setting targets on the balanced

scorecard is Job #1 in the definition of supply chain strategy. To drive improvement, be clear on what

is possible as a goal, and the rate of improvement. Orbit charts of like industries are a good way to

gauge what is feasible.

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Other Reports in This Series Readers may gain added value by accessing complimentary reports on the Supply Chain Insights

website:

Supply Chains to Admire, Published June 2017

Supply Chain Index, Published June 2013

Supply Chain Metrics That Matter Chemical Industry, Published July 2017

Supply Chain Metrics That Matter Automotive Parts, Published August 2017

Supply Chain Metrics That Matter Retail, Published June 2017

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About Supply Chain Insights LLC Founded in February 2012 by Lora Cecere, Supply Chain Insights LLC is in its sixth year of operation.

The Company’s mission is to deliver independent, actionable, and objective advice for supply

chain leaders. If you need to know which practices and technologies make the biggest difference to

corporate performance, we want you to turn to us. We are a company dedicated to this research. Our

goal is to help leaders understand supply chain trends, evolving technologies, and which metrics

matter.

About Lora Cecere Lora Cecere (twitter ID @lcecere) is the Founder of Supply Chain Insights LLC and

the author of popular enterprise software blog Supply Chain Shaman currently read

by 15,000 supply chain professionals. She also writes as a Linkedin Influencer and

is a contributor to Forbes. She has written five books. The first book, Bricks Matter,

(co-authored with Charlie Chase) published in 2012. The second book, The

Shaman’s Journal 2014, published in September 2014; the third book, Supply

Chain Metrics That Matter, published in December 2014; the fourth book, The

Shaman’s Journal 2015, published in August 2015, the fifth book, The Shaman’s Journal 2016,

published in June 2016 and the sixth book, The Shaman’s Journal 2017, published in July 2017.

With over 14 years as a research analyst with AMR Research, Altimeter Group, and Gartner

Group and now as the Founder of Supply Chain Insights, Lora understands supply chain. She has

worked with over 600 companies on their supply chain strategy and is a frequent speaker on the

evolution of supply chain processes and technologies. Her research is designed for the early adopter

seeking first mover advantage.

About Alina Beskrovna Alina holds an M.Sc. degree in Applied Mathematics from Kyiv-Mohyla Academy

and an MBA in Finance from Lehigh University. At Lehigh, she was the recipient of

a prestigious Global Village-Iacocca scholarship.

At Supply Chain Insights Alina contributes to the monthly publication of the Metrics

That Matter Series. She is also in charge of data analytics. In her spare time, Alina

loves active outdoor activities, especially hiking. Her goal is to hike all of the U.S.

National Parks in the next five years.