LLC February 2003 Analytical Outsourcing Adapts Supply Chains To Constant Change Complex Supply Chains Deserve Sophisticated Tools

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1 CHAINalytics LLC Thought Leadership February 2003 Analytical Outsourcing Adapts Supply Chains To Constant Change Applying supply chain optimization can save a firm millions of dollars a year by improving decisions such as the optimal selection of facility locations, inventory placement, and transportation modes. But shifts in cost structures, operations, and customer demand can disrupt even the best made plans. In order to sustain the value provided by these sophisticated analyses, firms need to conduct continuous rather than sporadic analysis. Continuous analysis enables companies to accelerate decision-making, view the supply chain holistically, and answer ad hoc questions with fact based analysis. While traditional approaches of providing continuous analysis are too costly or -consuming for resource-strapped firms today, the new approach of analytical outsourcing enables a firm of any size to reap the benefits. many firms approach these complex problems with only management intuition and crude spreadsheet analysis Complex Supply Chains Deserve Sophisticated Tools Firms are striving to reduce supply chain costs that last year averaged 11% of revenue or nearly $800 billion. i But this is not trivial every company s supply chain is tightly intertwined with internal operations and connected to external partners creating a complex web of trade-offs and dependencies. Unfortunately, many firms approach these complex problems with only management intuition and crude spreadsheet analysis resulting in an oversimplified analysis that offers suboptimal results or even erroneous recommendations. While firms might use these generic tools and approximate approaches to make marginal improvements, in order to maximize supply chain value, they need sophisticated decision sciences tools that: Evaluate all possible alternatives. While spreadsheets can evaluate predetermined alternatives, they can t adequately analyze most supply chain decisions. Why? While deciding between 3 or 4 distribution centers might seem simple, spreadsheets fail to factor all the trade-offs of that decision like which distribution center will serve which customers and stock which items. And when you layer all related costs and constraints into one problem, the alternatives can easily turn to millions of possible combinations far too complex for a spreadsheet. But optimization tools minimize cost while respecting real-world constraints, and thus insure realistic and feasible plans. For example, AMP used an optimization tool to rationalize its manufacturing network. By shifting production closer to demand and concentrating capacity in locations with lower labor costs they were able to reduce annual costs by $100 million. ii Standardize the analysis process. Spreadsheets are recreated by each analyst, leading to different assumptions, costs, and rules with every analysis. By using optimization tools, firms can easily reuse models to perform subsequent analysis more frequently and much faster than with ad hoc approaches. To manage their dynamic supply chain, Dell built an internal team and ongoing process to perform analysis regularly. By using a strategic optimization tool, they were able to constantly evaluate product flow and reconfigure logistics, identifying $1 billion in savings over 4 years. iii Copyright 2003 Chainalytics LLC Page 1 of 5 February 2003

2 Figure 1: The Once-Optimal Supply Chain Atrophies Between Periodic Studies Perform what-if analysis. Spreadsheets can estimate the performance of a predefined hypothesis, but are limited in their ability to optimize a problem requiring firms to already know the answer before an analysis. But often the best solution isn t the one that is most intuitive. As a result, firms need optimization tools to perform sensitivity analyses that evaluate a full range of scenarios. For example, leading companies such as Wal-Mart, Procter & Gamble, Home Depot, and Kraft Foods have used combinatorial bidding engines to determine the optimal carrier assignments for over $10 billion in annual transportation spend. Typically mos. Lost opportunity Figure 2: Continuous Analysis Aligns Supply Chains With Optimal Initial study Even Optimal Plans Have A Limited Shelf Life Traditionally, firms have treated supply chain optimization as a strategic event run every two to five years. This periodic and often sporadic analysis delivers significant value; a firm typically will reduce its overall operating budget by 5-15% upon implementing a network redesign or adjusting its transportation strategy. And while these studies result in significant operating improvements, results begin to depreciate within months (Figure 1). Why? Because firms operate in a dynamic environment where constant change threatens to create an imbalance within their supply chains. To minimize this slow, steady cost increase and service deterioration, firms must quickly adapt to change that is: Deliberate vs. unforeseen. Firms constantly reevaluate their business from product lines to site rationalizations resulting in ongoing fluctuation. While changes to suppliers, products, and locations may be planned, they still drive signification modifications to supply chain strategies. Unexpected changes to commodity costs, customer expectations, or production technologies often catch companies off guard, increase their operational and financial risk, and force them to react with a suboptimal decision. Too often, initiatives undertaken by sales, marketing, or finance are not analyzed in terms of the ramifications on the supply chain. So whether it is deliberate decisions by the enterprise, such as new products that force additional production lines, or unforeseen market shifts, such as increased service requirements that alter transportation modes, all of these changes if left unanalyzed significantly reduce the once-optimal supply chain. Disruptive vs. incremental. While significant changes such as mergers and acquisitions result in a network reconfiguration, seemingly minor shifts in cost structures or lead s often require incremental adjustments to capacity or inventory. So when a firm makes an acquisition, its likely to evaluate overlapping capacity and end up closing facilities or consolidating into new, larger ones. But often minor changes like an interest rate hike, which go unaddressed, also cause supply chain imbalance. As these incremental changes are held in reserve awaiting more significant disruption, the supply chain becomes less optimal. Sporadic Analysis Isn t Enough: Firms Need Continuous Analysis Customers, suppliers, and operations are constantly changing, but firms typically respond to this perpetual evolution with infrequent analysis. While these periodic studies transform suboptimal configurations and result in millions in operational savings, optimally redesigned networks atrophy during the month gap between studies, resulting in a supply chain that grows less optimal with each week. To factor ongoing change and answer tactical questions regarding networks, transportation services, and inventory deployments, firms need a systematic way of performing ongoing analysis. This continuous analysis keeps supply chains in tune with optimal by (Figure 2): Copyright 2003 Chainalytics LLC Page 2 of 5 February 2003

3 firms can use continuous analysis to find the optimal solution to questions as they arise Supporting ad hoc questions as they arise. Periodic studies successfully address strategies regarding supply chain design and inventory rationalization. But tactical questions regarding potential customers or labor negotiations cannot be addressed in an annual analysis these questions come up weekly. Rather than making seat-of-the-pants decisions or postponing them to the next strategic planning cycle, firms can use continuous analysis to find the optimal solution to questions as they arise. But continuous analysis doesn t require a firm to overhaul its network every a vendor modifies its pricing. Instead, by evaluating the impact of tactical changes when they occur, firms can make minor tweaks to strategies and operations that can be implemented in weeks. Accelerating decision cycle. Firms that only reevaluate their supply chain every 2-3 years have to start from scratch each ; changes to personnel and business requirements make previous models obsolete. But firms that constantly analyze maintain models with up-to-date data and analysts well-versed on the existing business. As a result, they reduce the required to analyze decisions. So rather than spending 3 months to determine what to do when energy costs rise, firms can use existing models to answer that question in days. Taking a holistic view of the supply chain. Rather than narrowing and simplifying the analysis to fit into a spreadsheet, continuous analysis enables firms to make holistic, fact-based decisions that consider the trade-offs across the entire supply chain. Using continuous analysis, a firm can quickly assess the precise impact of a refinancing scheme and suggest approaches to leverage the change to improve performance, minimizing the likelihood of lost opportunities. Reducing required and resources. When firms deploy an analytical process infrequently, it requires months of cross-functional support and creates a burden on internal resources day-to-day operating responsibilities. But when firms perform analysis on a continued basis, the information gathering is minimal, allowing firms to rapidly evaluate the impact of changes like an increase in transportation rates due to spikes in fuel costs. Figure 3: The Continuous Analysis Payback Is Immediate Typically mos. Lost Opportunity: $5 $12.5M 5% 2% For every $100 million in annual supply chain cost: first year savings: $1.2M Two-year savings: $4.3M Continuous Analysis Is Difficult To Maintain Continuous analysis is exceptionally compelling: we estimate that firms will create $4.3 million in additional value for every $100 million of supply chain operating costs in the first two years alone (Figure 3). iv And while continuous analysis enables firms to maximize value received from supply chain optimization, many firms can t perform analysis on a regular basis. Why? Because firms: Don t have the resources required. Leading enterprises like PepsiCo and General Mills will realize billions of dollars in value this year from applying optimization to strategic and tactical supply chain problems. But firms with less than $10 billion in revenue will be hard-pressed to dedicate 3 or more resources the minimum to sustain an analytical competency. v Perhaps that s why nearly 70% of large companies prefer to outsource the network design function. vi Even when the world s largest companies decide to invest in these heavily specialized resources, they often find them scarce and difficult to retain. Allow practices to stagnate. A small percentage of firms that dedicate only 1 or 2 internal resources are able to maintain their analytical capabilities past the second year. As these scarce resources are lost to turnover or promotion, the analytical practices quickly evaporate because the firm lacks mentors to maintain the competency. We estimate that less than 50% of companies that have purchased strategic supply chain tools from vendors like i2, CAPS, INSIGHT, and Manugistics still perform analysis internally within 1-2 years after purchase. Copyright 2003 Chainalytics LLC Page 3 of 5 February 2003

4 Using an analytical outsourcer, firms can internalize the capability without internalizing the competency Analytical Outsourcing Is The Answer Firms want to respond to change with fact-based analysis, but often don t have the skilled resources to do so on a continuous basis. These firms should consider using the recurring services of a third party analytical outsourcing firm. Analytical outsourcers provide clients with the dedicated, heavily skilled resources needed to perform ongoing analysis to complement, but not distract, day-to-day operations. Using an analytical outsourcer, firms can internalize the capability without internalizing the competency and thus: Reduce analytical cycle. Using highly concentrated skills, proven methodology, and a well-defined tool and analysis infrastructure enables a firm to establish an easily repeatable process in which models are reused not relearned. And since resources are continuously analyzing the business, spikes in, while not eliminated, are severely reduced in and duration. The result is a supply chain that identifies the impact of any change and can adapt rapidly. Minimize vulnerability to employee turnover. Employee turnover is a fact of life. According to NCR, the average tenure of employees is at an all low 3.6 years and this turnover equates to knowledge loss. vii By using an outsourced service that leverages the experience of an entire organization of supply chain specialists and a repeatable process, a firm can shift this risk of turnover to the outsourcer leaving the firm less vulnerable to a single individual. Increase organizational objectivity. Firms that use outside resources not only gain more specialized ones, but the resources are more objective. Outsourced providers provide fact-based analysis without organizational bias, politics, or departmental incentives, resulting in an unfiltered set of recommendations. Leverage best practices. Since outsourcers have teams of people constantly evaluating the latest tools and transferring practices across industries, a firm that uses their service can leverage the knowledge of analysts working with a diverse set of companies and industries. So if a firm wants to evaluate the impact of seasonality on their operation, they can leverage the experience of the outsourcer who has evaluated and applied the latest tools and approaches like multi-period optimization and can easily identify the risks and increase the success rate of chosen outcomes. Analytical outsourcing provides quantitative analysis at a fraction of the and cost of traditional approaches How To Make It Happen If your firm strives for supply chain improvement, you should immediately evaluate the following 3 opportunities: Opportunity: Analytical tools How to act: Supply chains have complex business requirements that require sophisticated software. So if you re not using decision support tools to analyze your business problems, you need to begin to explore the benefits of strategic and tactical decision making. Opportunity: Continuous analysis How to act: Sophisticated analyses deliver value, but over the results deteriorate. Rather than taking the big bang approach that you will get by using decision support sporadically, you need to migrate towards a continuous analysis that will keep your supply chain optimal. Opportunity: Analytical outsourcing How to act: While expected to provide enormous value, continuous analysis is traditionally expensive to run and difficult to resource internally. If it s a lack of resources that s keeping you from frequent analysis, you should explore the services of an analytical outsourcer. Analytical outsourcing provides quantitative analysis at a fraction of the and cost of traditional approaches, allowing firms of all sizes to capture the benefit of continuous analysis. Copyright 2003 Chainalytics LLC Page 4 of 5 February 2003

5 i According to the April 2001, Corporate Executive Board Report, Optimizing Costs Along The Supply Chain, supply chain management totaled nearly $800 billion in the US last year alone. On average, supply chain costs total 11% of sales revenue. ii Source: 1999 i2 Technologies Annual Planet Conference Speech, Manufacturing Rationalization Using Strategic Planning Tools,by Mark Rockey, Director Operations Research, AMP, A Tyco International Company.. iii Source: 2000 i2 Technologies Annual Planet Conference Speech, Rapid Strategic Planning At Dell, by Wayne Zorn, WW Operational Strategy, Dell Computers and Koray Dogan, Planning and Fulfillment, i2 Technologies. iv This calculation is based on research that concludes that within the first year, supply chains will be 2% away from optimal, 5% within two years based on change that has occurred during that. This estimate includes costs associated with supply chain like transportation and handling costs, but does not include direct materials purchasing costs. v Based on an internal survey of past and existing customers. vi From the September, 2002 ARC Advisory Report report, Beyond Software, Maximizing Value via Outsourcing. vii According to a survey conducted by Teradata, a division of NCR in March Teradata polled 202 IT executives and found that average employee tenure is at an all- low of 3.6 years. In addition, 88% of IT executives believe that when they experience turnover, their knowledge base walks out the door. Chainalytics specializes in providing leading companies advanced consulting and outsourcing services to improve supply chain performance. Specializing in the application of advanced decision sciences technology, Chainalytics supports improved strategic, tactical and operational decision-making in the areas of supply chain strategy, transportation planning and inventory planning. The company's powerful combination of analysis, technology, and methodology enables clients to achieve and sustain double-digit cost reductions and customer service improvements, resulting in millions of dollars of value creation. Chainalytics serves mid- to large-size enterprises with complex supply chains, with special emphasis on companies in retail, wholesale and manufacturing of consumer durable and non-durables. Copyright 2003 Chainalytics LLC Page 5 of 5 February 2003