F. Barry Lawrence, Ph.D., Texas A&M University

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F101 Optimizing Supplier Alliances Best practices in formulating, formalizing, and

effective supply chains, capture more market share, and optimize profitability.

1 F101 Optimizing Supplier Alliances Best practices in formulating, formalizing, and leveraging strategic suppliers are cutting edge and understood by only a few distributors. This session will explore how best practice supplier relationships create more effective supply chains, capture more market share, and optimize profitability. The best practices will be supported with case study results from Texas A&M s many research projects with best practice firms. F. Barry Lawrence, Ph.D., Texas A&M University 3/12/2010, 9:30 a.m.

2 Session Objectives Develop business process framework Develop financial framework Link business processes and shareholder value Implement best practices Quantify impact of best practices on profitability 2

3 Return on Investment Opportunity Quantify impact of best practices on profitability Prioritize improvement opportunities Increased EBITDA and RONA 3

4 Additional Resources Optimizing Distributor Profitability available from the NAW. Educational Programs from the Thomas and Joan Read Center for Distribution Research and Education at Pricing Optimization Optimizing Distributor Profitability Certificate in Distribution Management Custom Programs Research from the Supply Chain Systems Laboratory tamu 4

5 The ROI Equation Financial Statements 5

6 Business Process Framework Key Performance Indicators (KPIs) Supply Chain Planning Supplier Customer Source Stock Store Sell Ship Support Services Information Management Human Resource Management Finance Managemnet 6

7 Financial Drivers 7

8 Step 1 Identify Gap Sample Assessment Report 8

9 Step 2: Map Shareholder Value Distributor Profitability Framework 9

10 Supplier Performance and ROI 10

11 Step 3: Assess Profitability Supplier Lead Time Variability Safety Stock Average Inventory GMROII % RONA 11

12 SOURCE Process Group Suppliers Key Performance Indicators (KPIs) Supply Chain Planning Supplier Customer Source Stock Store Sell Ship Support Services Information Management Human Resource Management Finance Managemnet 12

13 Source Processes Distribution Source Stock Store Sell Ship Support Services Supplier Management Supplier Selection Supplier Performance Supplier Stratification Supplier Relationship Right # Suppliers 13

14 Supplier Stratification Best Practices Good Practices Pe erforma ance Common Practices Segmentation based on COGS by supplier Pareto framework (80%-20%) Loyalty, Profitability, Services, Performance Risk/Exposure supply availability, technical requirements, financial factors, technological factors and environmental issues Landed Cost (TCO) Combination Methodology Purchase price variance Landed dcost Lacks segmentation framework Time 14

15 Supplier Stratification Relationships 15

16 Supplier Management Best Practices Good Practices Perform mance Common Practices On time delivery Lead time Quality & Delivery completeness On time delivery Lead time Quality & Delivery completeness Lead time variability Combination methodology - Supplier Performance Index (SPI) No supplier performance measurement On time delivery (Reactive measurement only) Quality Time 16

17 Supplier Performance Ranking Criteria Sample ranking criteria for supplier performance factors Factors A B C D Lead Time Average < 2 weeks 2 to 4 weeks 4 to 8 weeks > 8 weeks Lead Time Variability (COV) <= > 0.75 On-Time Index >= <= 0.25 Completeness Index >= <=

18 Supplier Performance Final Rank Weighting approach to combine individual ranks Supplier List 20% 30% 25% 25% Lead Time Average Lead Time Variability On-Time Index Completeness Index Final Rank Supplier 1 A A B A A Supplier 2 A A B D A Supplier 3 A D C A C Supplier 4 B A B C A Supplier 5 B C C A B : : : : : : 18

19 Lead Time Variability Schematic Basic Input Parameters Additional Revenue EBITDA Lead Time LT Var. Expected Turns P&L and Bal. Sheet Safety Stock Average Inventory % of reinvestment YES Re-invest? NO RONA GMROII Turns 19

20 Financial Statements Typical Distributor Income Statement Fixed Variable Net Sales $ 148,265, % Cost of Goods Sold $ 110,902, % 0% 100% Gross Margin $ 37,363, % Employee Compensation - Outside S $ 9,059, % 25% 75% Employee Compensation - Others $ 9,385, % 90% 10% Warehouse Expenses $ 4,477, % 50% 50% Delivery Expenses $ 4,536, % 20% 80% Other Operating Expenses (G&A) $ 2,194, % 25% 75% Total Operating Expenses $ 29,653, % 0% Operating Margin $ 7,709, % Other Income $ - 0.0% Other Expenses $ - 0.0% EBITDA $ 7,709, % Balance Sheet Assets By Total Assets Inventory $ 17,470, % Accounts Receivables $ 18,829, % Cash & Marketable Securities $ 1,990, % Other Currrent Assets $ 1,978, % Total Current Assets $ 40,268, % Fixed & Non-current Assets $ 6,153, % Total Assets $ 46,421, % Liabilities & Net Worth By Total Liabilities & Net Worth Accounts Payables $ 9,884, % Notes Payable (Short-term Debt) $ 1,427, % Other Current Liabilities $ 2,404, % Total Current Liabilities $ 13,716, % Long-term Liabilities $ 4,991, % Net Worth Or Owner's Equity $ 27,714, % Total Liabilities & Net Worth $ 46,421, % 0% 20

21 Financial KPIs Typical Distributor Financial KPIs Current CASH FLOW DSO 46.4 DPO 32.5 DOI Cash Conversion Cycle 71.3 Working Capital as a % of rev 17.9% PROFITABILITY Gross Margin % 25.2% EBITDA Margin % 5.2% Personnel Productivity it Ratio (PPR) GMROI % 214% % change in EBITDA $ GROWTH Revenue Growth % 5.3% ASSET EFFICIENCY Asset Turnover 3.19 Receivables Turnover 7.9 Inventory Turnover 6.35 RONA (EBITDA/Net Assets) 23.57% 21

22 Critical Information Current inventory = $ 17,470,663 6 critical suppliers account for 77% inventory Inventory considered = $ 13,452, (77%) Number of SKUs considered = 5,237 Objective is to reduce lead time variability by 10% 22

23 Input Parameters For a top selling item Supplier Parameters Average Lead Time 28 Days Lead Time Variability (Expressed as standard deviation) 7 Days Unit Cost $ Distributor Parameters Monthly Demand 12,050 Units Cycle Service Level (CSL) 85% Forecast Accuracy 80% Order Quantity (OQ) 2,400 units Calculation Cycle Inventory (Half of OQ) 1,200 Units Safety Inventory 4,416 Units Average Inventory (Cycle + Safety) 5,616 Units 23

24 Impact of LT Variability on Inventory Lead Time Varibility (Days) Safety Stock (Qty) Average Inventory (Qty) % of Current Inventory 7 4,416 5, % 6.3 4,201 5, % 5.6 3,998 5, % 4.9 3,811 5, % 4.2 3,641 4, % 3.5 3,491 4, % , , % 2.1 3,260 4, % 1.4 3,184 4, % , , % 0 3,122 4, % This implies a reduction in inventory for this SKU by 3.8% Let s extend this savings to the remaining SKU s Inventory reduction = 3.8% X $ 13,452,410 = $ 514,978 24

25 Lead Time Variability - Schematic Basic Input Parameters Additional Revenue = $ 514,978 X 6 / (1-25.2%) = $ 4,130,839 EBITDA Lead Time LT Var. Expected Turns 6 turns P&L and Bal. Sheet Safety Stock % of re- investment YES 100% RONA GMROII Turns Average Inventory Re-invest? NO $ 514,978 25

26 Impact on Income Statement Profitability Analysis - Income Statement Income Statement Current Scenario By Sales % Fixed Variable To-Be Scenario Formulae Column A B C D E Net Sales $ 148,265, % $ 152,396,718 New Net Sales Cost of Goods Sold (COGS) $ 110,902, % 0% 100% $ 113,992,745 (A * C) + (New Net Sales * B * D) Gross Margin $ 37,363, % $ 38,403,973 (New Net Sales - COGS) Employee Compensation - Outside Sales $ 9,059, % 25% 75% $ 9,248,341 (A * C) + (New Net Sales * B * D) Employee Compensation - Others $ 9,385, % 90% 10% $ 9,411,378 (A * C) + (New Net Sales * B * D) Warehouse Expenses $ 4,477, % 50% 50% $ 4,540,005 (A * C) + (New Net Sales * B * D) Delivery Expenses $ 4,536, % 20% 80% $ 4,638,059 (A * C) + (New Net Sales * B * D) Other Operating Expenses (G&A) $ 2,194, % 25% 75% $ 2,240,187 (A * C) + (New Net Sales * B * D) Total Operating Expenses $ 29,653, % $ 30,077,971 Operating Margin $ 7,709, % 5.2% $ 8,326,002 Gross Margin - Total Operating Expenses Other Income $ - 0.0% $ - Other Expenses $ - 0.0% $ 62,954 Interest expense for additional accounts 12% EBITDA $ 7,709, % $ 8,263,048 26

27 Impact on Balance Sheet Profitability Analysis - Balance Sheet Balance Sheet Current Scenario To-Be Scenario Formulae Assets By Total Assets Inventory $ 17,470, % $ 17,470,663 No change in inventory since re-allocated Accounts Receivables $ 18,829, % $ 19,354,383 Days Sales Outstanding * (New Net Sales / 365) Cash & Marketable Securities $ 1,990, % $ 1,990,029 Other Currrent Assets $ 1,978, % $ 1,978,468 Total Current Assets $ 40,268, % $ 40,793,543 Fixed & Non-current Assets $ 6,153, % $ 6,153,034 Total Assets $ 46,421, % $ 46,946,577 Liabilities & Net Worth By Total Liabilities & Net Worth Accounts Payables $ 9,884, % $ 10,159,781 Notes Payable (Short-term Debt) $ 1,427, % $ 1,427,456 Other Current Liabilities $ 2,404, % $ 2,404,335 Total Current Liabilities $ 13,716, % $ 13,991,572 Long-term Liabilities $ 4,991, % $ 4,991,618 Net Worth Or Owner's Equity $ 27,714,159, 59.7% $ 27,963,387, Total Liabilities & Net Worth $ 46,421, % $ 46,946,577 Days Payable Outstanding * (New COGS / 365) 27

28 Impact on Financial Metrics Key Metrics Current Potential Inventory Turns (Asset Efficiency) RONA (Asset Efficiency) 23.6% 25.1% Cash Conversion Cycle (Cash Flow) 71.3 Days 69.8 Days GMROII (Profitability) 214% 220% EBITDA (Profitability) 52% 5.2% 54% 5.4% 28

29 Potential Profitability - Typical Distributor 40% Potential Profitability Curve SOURCE RONA % MINIMUM RONA % MAXIMUM RONA % Typical Distributor 36.73% 30% 31.54% 31.79% 29.03% 28.22% 28.50% 25.08% 25.55% 26.28% 24.53% 25.72% 26.00% 23.57% 20% Base Case Lead Time Lead Time Variability Completeness Index Payment Terms 29

30 Potential Profitability - Typical Distributor Impact of SOURCE best practices on EBITDA % Typical Distributor 5.2% 5.8% 5.8% 5.5% 6.0% Base Case Lead Time Lead Time Variability Completeness Index Payment Terms 30

31 Potential Profitability (RONA) Impact of SOURCE, STOCK, SELL, STORE & SHIP best practices on RONA Typical Distributor 75.2% 61.2% 67.7% 85.0% 23.6% 33.4% Base Case Source & Stock Store & Ship Sell Combined Combined Best Practices Best Practices MIN MAX 31

32 Potential Profitability (EBITDA) Impact of SOURCE, STOCK, SELL, STORE & SHIP best practices on EBITDA % Typical Distributor 5.20% 9.32% 7.17% 11.41% 10.29% 11.52% Base Case Source & Stock Store & Ship Sell Combined Best Practices MIN Combined Best Practices MAX 32

33 Action Plan Step 1: Properly segment suppliers. Step 2: Measure supplier performance. Step 3: Develop scorecard and share results with suppliers. Step 4: Demonstrate impact of supplier performance on shareholder value 33

34 Summary POTENTIAL for improving profitability exists Process and financial performance can be MEASURED to assess potential AONE-to-ONE connection can always be established for processes and shareholder value This connection can be QUANTIFIED and PRIORITIZED Best practices can be ACHIEVED Education will ENABLE distributors to realize POTENTIAL profitability 34

35 Thank You For Attending F101 Optimizing Supplier Alliances F. Barry Lawrence, Ph.D. Please submit the Session Feedback Form To receive NASBA credits, please be sure to complete the Session Feedback Form and sign the class roster in the back of the room Total Solutions For Industrial Distributors and Manufacturers Thank You! For more info please visit: 35

F. Barry Lawrence, Ph.D., Texas A&M University

F. Barry Lawrence, Ph.D., Texas A&M University Keynote Gaining Competitive Advantage Through Lean Distribution The cutting edge in gaining distribution competitive advantage is lean. Many customers and suppliers are implementing lean procedures and