Regular readers of this blog will know that I’ve been preaching Total Value Management essentially since the beginning, and with good reason. Not only is it the root of all modern supply and spend management value models, as I will briefly illustrate in this post, but it’s easy to understand and capable of being modeled in a modern strategic sourcing decision optimization solution – which is the key to the extraction of maximum value from the scenario at hand.
As defined in the wiki-paper, TVM is a comparative cost metric that quantifies the overall cost of each acquired unit relative to the overall value of the spend category as it relates to the organization’s sourcing strategy and supply chain goals. Whereas a TCO model looks at the total quantifiable cost – as defined by the direct costs (such as unit, transportation, and tariff), indirect costs (such as switching and transaction), and market costs (such as quality and brand), a TVM model looks at the value to cost ratio by also including the potential impact costs with each decision. For example, a myopic focus on short term savings could actually lead to a loss in future years if the lowest cost supplier today is using antiquated production technology compared to a slightly higher cost supplier who just introduced new production technology that is going to allow for reduced production costs over time. Similarly, a myopic focus on LCCS increases risk and the expected losses associated with your sourcing decisions in future years (since, statistically speaking, some risks are going to materialize). In other words, TVM also looks at impact costs, risk mitigation (by way of constraints), and strategic alignment with the business goals with an emphasis on choosing the decision that is expected to maximize business value in the future.
To see why it’s the root of all value models, we’re going to look at Smock, Rudzki, and Rogers’ corporate value model, CSC’s supply chain evolution model, and Hackett’s five stage model for evolutionary procurement.
Smock, Rudzki, and Rogers’ Corporate Value Model, as found in their recent text about On Demand Supply Management, is a five level model that progresses from a focus on price (or unit cost) to a focus on Return on Invested Capital (ROIC), which is defined as net income minus dividends divided by the invested capital, and Competitive Intelligence. More specifically:
- Price Focus
- Cost & Value Focus
- Total Cost of Ownership
- ROIC Focus
- ROIC & Competitive Intelligence
ROIC is maximized by TVM. TVM is Value (Created) / Cost, and Value Created can be defined as profit / cost, and profit is maximized when the difference between income and external distribution of part of the income (of which dividends are a form) is maximized.
CSC’s model of supply chain evolution starts at the business unit and progresses to interconnected businesses in a value chain, with five stages defined as follows:
- Internal Improvement at Business Unit Level
- Alignment of purchases, processing, & shipping
- Closer focus on customer satisfaction
- Trading partners & suppliers are included
- Automated Connections Between Business
Improvements at the business unit level have about the same impact as PPU cost reductions – not much is saved in the best case, as unit cost is often a small percentage of the total cost of ownership, and significant losses occur in the worst case, as moving the source of supply halfway around the world will cause transportation costs to spike, especially with the cost of oil these days. Alignment of purchases, processing, and shipping will let you use improved systems and methodologies, but all that does is reduce the tactical transactional costs – which, in most companies, are not the biggest savings opportunities. A heightened focus on customer satisfaction starts the company moving towards a TCO mindset as customers are happiest when costs are low and quality is high. Including trading partners and suppliers helps the company to look at the total value, but actually bridging the information sources between partners allows the cost and value elements to be identified and requires the supply chain to embrace the total value management philosophy and evolve from a supply chain to a value chain.
The Hackett Group’s five stage model for evolutionary procurement traces the evolution of the supply management from supply assurance to value management, and, more than anything, this model, by one of the leading think tanks in the space, proves my point on its own.
- Supply Assurance
- Demand Management
- high % spend/sourcing with early demand influence
- low % maverick spend
- high internal customer satisfaction
- Value Management (ROIC, EBITDA, etc.)