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.
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
Return on Investment Opportunity Quantify impact of best practices on profitability Prioritize improvement opportunities Increased EBITDA and RONA 3
Additional Resources Optimizing Distributor Profitability available from the NAW. http://www.naw.org/optimizdistprof Educational Programs from the Thomas and Joan Read Center for Distribution Research and Education at http://readcenter.tamu.edu Pricing Optimization Optimizing Distributor Profitability Certificate in Distribution Management Custom Programs Research from the Supply Chain Systems Laboratory http://supplychain.tamu.edu/ tamu 4
The ROI Equation Financial Statements 5
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
Financial Drivers 7
Step 1 Identify Gap Sample Assessment Report 8
Step 2: Map Shareholder Value Distributor Profitability Framework 9
Supplier Performance and ROI 10
Step 3: Assess Profitability Supplier Lead Time Variability Safety Stock Average Inventory GMROII % RONA 11
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
Source Processes Distribution Source Stock Store Sell Ship Support Services Supplier Management Supplier Selection Supplier Performance Supplier Stratification Supplier Relationship Right # Suppliers 13
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
Supplier Stratification Relationships 15
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
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) <= 0.25 0.26 0.50 0.51 0.75 > 0.75 On-Time Index >= 0.76 0.51 0.75 0.26 0.50 <= 0.25 Completeness Index >= 0.76 0.51 0.75 0.26 0.50 <= 0.25 17
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
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
Financial Statements Typical Distributor Income Statement Fixed Variable Net Sales $ 148,265,879 100% Cost of Goods Sold $ 110,902,877 74.8% 0% 100% Gross Margin $ 37,363,002 25.2% Employee Compensation - Outside S $ 9,059,045 6.11% 25% 75% Employee Compensation - Others $ 9,385,230 6.3% 90% 10% Warehouse Expenses $ 4,477,630 3.0% 50% 50% Delivery Expenses $ 4,536,936 3.1% 20% 80% Other Operating Expenses (G&A) $ 2,194,335 1.5% 25% 75% Total Operating Expenses $ 29,653,176 20.0% 0% Operating Margin $ 7,709,826 5.2% Other Income $ - 0.0% Other Expenses $ - 0.0% EBITDA $ 7,709,826 5.2% Balance Sheet Assets By Total Assets Inventory $ 17,470,663 37.6% Accounts Receivables $ 18,829,767 40.6% Cash & Marketable Securities $ 1,990,029 4.3% Other Currrent Assets $ 1,978,468 4.3% Total Current Assets $ 40,268,926 86.7% Fixed & Non-current Assets $ 6,153,034 13.3% Total Assets $ 46,421,960 100.0% Liabilities & Net Worth By Total Liabilities & Net Worth Accounts Payables $ 9,884,392 21.3% Notes Payable (Short-term Debt) $ 1,427,456 3.1% Other Current Liabilities $ 2,404,335 5.2% Total Current Liabilities $ 13,716,183 29.5% Long-term Liabilities $ 4,991,618 10.8% Net Worth Or Owner's Equity $ 27,714,159 59.7% Total Liabilities & Net Worth $ 46,421,960421 100.0% 0% 20
Financial KPIs Typical Distributor Financial KPIs Current CASH FLOW DSO 46.4 DPO 32.5 DOI 57.50 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) 049 0.49 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
Critical Information Current inventory = $ 17,470,663 6 critical suppliers account for 77% inventory Inventory considered = $ 13,452,410 410 (77%) Number of SKUs considered = 5,237 Objective is to reduce lead time variability by 10% 22
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 $201.25 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
Impact of LT Variability on Inventory Lead Time Varibility (Days) Safety Stock (Qty) Average Inventory (Qty) % of Current Inventory 7 4,416 5,616 100% 6.3 4,201 5,401 96.2% 5.6 3,998 5,198 92.6% 4.9 3,811 5,011 89.2% 4.2 3,641 4,841 86.2% 3.5 3,491 4,691 83.5% 28 2.8 3363 3,363 4563 4,563 81.3% 2.1 3,260 4,460 79.4% 1.4 3,184 4,384 78.1% 07 0.7 3138 3,138 4338 4,338 77.2% 0 3,122 4,322 77.0% 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
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
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 $ 148,265,879 100% $ 152,396,718 New Net Sales Cost of Goods Sold (COGS) $ 110,902,877 74.8% 0% 100% $ 113,992,745 (A * C) + (New Net Sales * B * D) Gross Margin $ 37,363,002 25.2% $ 38,403,973 (New Net Sales - COGS) Employee Compensation - Outside Sales $ 9,059,045 6.11% 25% 75% $ 9,248,341 (A * C) + (New Net Sales * B * D) Employee Compensation - Others $ 9,385,230 6.3% 90% 10% $ 9,411,378 (A * C) + (New Net Sales * B * D) Warehouse Expenses $ 4,477,630 3.0% 50% 50% $ 4,540,005 (A * C) + (New Net Sales * B * D) Delivery Expenses $ 4,536,936 3.1% 20% 80% $ 4,638,059 (A * C) + (New Net Sales * B * D) Other Operating Expenses (G&A) $ 2,194,335 1.5% 25% 75% $ 2,240,187 (A * C) + (New Net Sales * B * D) Total Operating Expenses $ 29,653,176 20.0% $ 30,077,971 Operating Margin $ 7,709,826709 52% 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 receivables @ 12% EBITDA $ 7,709,826 5.2% $ 8,263,048 26
Impact on Balance Sheet Profitability Analysis - Balance Sheet Balance Sheet Current Scenario To-Be Scenario Formulae Assets By Total Assets Inventory $ 17,470,663 37.6% $ 17,470,663 No change in inventory since re-allocated Accounts Receivables $ 18,829,767 40.6% $ 19,354,383 Days Sales Outstanding * (New Net Sales / 365) Cash & Marketable Securities $ 1,990,029 4.3% $ 1,990,029 Other Currrent Assets $ 1,978,468 4.3% $ 1,978,468 Total Current Assets $ 40,268,926 86.7% $ 40,793,543 Fixed & Non-current Assets $ 6,153,034 13.3% $ 6,153,034 Total Assets $ 46,421,960 100.0% $ 46,946,577 Liabilities & Net Worth By Total Liabilities & Net Worth Accounts Payables $ 9,884,392 21.3% $ 10,159,781 Notes Payable (Short-term Debt) $ 1,427,456 3.1% $ 1,427,456 Other Current Liabilities $ 2,404,335 5.2% $ 2,404,335 Total Current Liabilities $ 13,716,183 29.5% $ 13,991,572 Long-term Liabilities $ 4,991,618 10.8% $ 4,991,618 Net Worth Or Owner's Equity $ 27,714,159, 59.7% $ 27,963,387, Total Liabilities & Net Worth $ 46,421,960 100.0% $ 46,946,577 Days Payable Outstanding * (New COGS / 365) 27
Impact on Financial Metrics Key Metrics Current Potential Inventory Turns (Asset Efficiency) 6.4 6.5 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
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
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
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
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
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
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
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: http://supplychain.tamu.edu 35