In the final blog in this series, we’re now going to look at Complexity, Costs and Capital
It is lazy thinking to suggest that growth automatically adds complexity. Scale is not necessarily the problem, it is the multiplier effect when poorly designed processes, systems and organisational structures are compounded.
Briefly pausing to reflect on potential causes of complexity in the business as it gears for growth is likely to be time well-spent. Homing in on the variables that drive complexity in your business will allow these to be proactively managed.
From a supply chain prospective, the main sources of complexity are:
- the range of products and services
- the number of operating entities in the network
- the variety of information systems and transfers between data media.
Of these, the range of products and services is by far the largest complexity driver. Portfolio management and the new product introduction process needs to be fully cross-functional with objective criteria for the inclusion and removal of products from the range. Without this, stock-keeping units have a strong tendency to grow with limited or no control.
A factor in scaling operations is the need to relinquish manual oversight on many decisions and actions. What may once have been within the capacity and capability of a supply chain manager to directly review, now needs to become exception based. The opportunity to grow a data-driven approach is significant and should form an essential part of scale up planning. If ever there is a time to enshrine digital ways of working, it is in this phase if it is not already a core facet of the business.
Scaling up an operation will increase cost. Tracking costs against budget is more challenging when demand estimates are uncertain. This increases the need to understand the nature of costs and how they are driven.
How fixed are fixed costs? At what timeline could they be considered variable? Is there a portion of apparently variable cost that is fixed? For example:
- adding a third working shift to two-shift operation; effectively a 'semi-fixed' cost, and if additional staff are hired on temporary contracts, labour cost has a variable option
- energy costs likely have a fixed portion with usage dependent on throughput volumes, a 'semi-variable' cost
- contracts for service provision may assume a base utilisation or have a retainer element.
An understanding of the break-even point for an expanded operation should a clear milestone in the programme. Having a clear picture on costs will help pinpoint when sales less variable cost equates with fixed costs and the business can move to profit.
Just as important for operations, if not more important however, is identifying contribution margin at capacity bottlenecks. It is likely that across the operation there is some form of bottleneck; that is, a constraint that sets a threshold on the demand the operation can satisfy within customers expected lead times. During growth, bottlenecks might move between activities in the supply chain. Here it is imperative for decision making, and profitability, to assess unit contribution margin per unit of scarce resource. For example, consumption of machine time for a unique process by product, where this process is required for most, if not all, products. Bottlenecks can sometimes be difficult to spot, but in a system, there is only one at a time and a common giveaway is the build up of inventory at the ‘entrance’, that is, just prior to this activity or process.
Given the supply chain is an interrelated network of activities, managing costs is inherently about identifying the main activities and how they consume costs. Understanding what is driving the activity and what factors cause change, is integral to effective management. An activity-based costing approach need not be cumbersome; a pragmatic judgement of the key activity drivers for your business and market sector will get you most of the way in what is more often an art than a science.
With a grasp on fixed and variable cost elements, together with pragmatic insight to activity costs, supply chain managers can make informed operational decisions and leadership teams can maintain control on cost development as the business grows. Adjustments to capacity plans can be made as demand and operational performance uncertainties reduce.
Capital investment will no doubt be assessed and form part of the decision to expand the operation. Fixed assets may well increase although as mentioned earlier, there may be options to collaborate with others as well as outsource some activities until volumes achieve defined thresholds. Measuring asset utilisation and throughput efficiency will allow operational performance to be aligned with the monitoring of return on investment. Particular attention should be paid to the difference between total capacity and effective capacity that determines asset efficiency. What constitutes unavoidable losses of capacity can be subject to debate; some reasons to reduce capacity that need monitoring include:
- capacity 'cushions' for demand fluctuations. This may relate more to poor forecasting and failure to share key information rather than as a buffer to volatility
- changeover times in production. Whilst flexibility is important in a growth phase particularly, if this becomes 'firefighting' based on who is shouting loudest, then leadership action is needed
- maintenance losses related to quality issues. Reduced yields, or worse, returns from customers, that drive downtime in the operation may signal an ongoing problem that needs to be tackled.
Performance measurement that tracks asset utilisation and efficiency over time, with due allowance for the stage of business development, should form part of an ongoing supply chain ‘dashboard’. Working capital development can also be planned and tracked as part of the dashboard. Inventory, accounts payable and receivable, the ‘cash to cash’ cycle, forms another critical output of the supply chain design and ongoing supply chain management.
Supply chain design and management can be an engine of growth. We have touched on key dimensions that need to be drawn together to form a structured, coherent plan to scale up an operation and its attendant supply chain. With clear, fact-based insight and understanding, a tailored transformation programme can be developed that:
-maps out the key decision points, the options available, with associated probabilities and risks
- combines design analysis with critical change planning
- sets a control dashboard that aligns operational performance with financial outcomes.
Plans need to adapt, ever more so when scaling up operations, but there are essential elements that need to be included to increase the chances of success and provide guiderails in a journey to supply chain excellence. The 7 C’s are a great starting point.