Monthly Archives: May 2008

Total Value Management (TVM) is the Root of All Value Models

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:

  1. Price Focus
  2. Cost & Value Focus
  3. Total Cost of Ownership
  4. ROIC Focus
  5. 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:

  1. Internal Improvement at Business Unit Level
  2. Alignment of purchases, processing, & shipping
  3. Closer focus on customer satisfaction
  4. Trading partners & suppliers are included
  5. 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.

  1. Supply Assurance
  2. Price
  3. TCO
  4. Demand Management
    • high % spend/sourcing with early demand influence
    • low % maverick spend
    • high internal customer satisfaction
  5. Value Management (ROIC, EBITDA, etc.)

(Manufacturing) Design For X

The April 1, 2008 issue of Theory and Practice from Manufacturing Insights had a great article on Design For X – the practice of incorporating different tangential factors into the design of a product that are intended to better integrate the new product with downstream activity. One of the more familiar DFX practices is, of course, DFM – Design For Manufacturing – where engineers strive to produce a product to be easier, safer and less costly to manufacture.

However, DFM is not the only DFX discipline that product companies need to consider. There is also DFSC – Design For Supply Chain, DFS – Design For Serviceability, DFC – Design For Compliance (& Sustainability), and DFW – Design For Warranty, and each of these is important. However, in today’s economy where costs are rising and discretionary spending is falling, probably the most important consideration in product design is the end cost of production. Since early interaction between design and supply chain is key to making the right build-versus-buy and material selection before design decisions, and associated costs, are locked in – I’d argue that DFSC should be on top of every company’s mind. Especially since, as the article points out, DFSC leads to further optimization and agility in the supply chain and reduces the impact of inevitable late changes and quality problems.

Of course, you cannot ignore DFS, DFC, and DFW. There are always going to be failures, and DFS evaluates design modularity and supply chain alternatives in order to maximize serviceability and enhance the customer ownership with inventory and reverse logistics operations in mind. A good design considers the complex dependencies between product design, reliability, service, inventory planning, and reverse logistics. The expected frequency of repairs and the type of parts that need to be replaced will determine the reverse logistics, depot repair, and part restocking requirements in the supply chain.

Similarly, if you actually want to be permitted to sell your products, you have to adhere to product compliance regulations such as RoHS and WEEE for the European electronics industry and the TREAD act for the American tire industry as well as corporate accounting regulations and overall social responsibility. Compliance cannot be an afterthought – it needs to be taken into account during design, manufacturing, shipment, servicing and decommissioning of products through a total life cycle approach. For example, in RoHS if even one separable component contains more than a minute trace of hazardous material, the entire assembly could be banned – leaving you with millions of dollars of inventory that cannot be sold.

Finally, you need to consider what reverse logistics and repair activities will exacerbate warranty costs and insure that tradeoffs are made to minimize those activities that will be most costly in the design process.

In short, DFX is a total lifecycle design practice that takes into account the costs and benefits of each and every design decision in the different life-cycle phases of a product, considering both the short and long term ramifications, from a Manufacturing, Supply Chain, Serviceability, Compliance, and Warranty viewpoint.

The Financial Reporting Supply Chain

The financial reporting supply chain refers to the peopleand processes involved in the preparation, approval, audit, analysis and use of financial reports. The cycle both starts and ends with the investors and other stakeholders, who want to make informed economic decisions about a company and, therefore, require financial information to do so. The chain includes management, the board of directors, auditors, and regulators – and each have their part to play.

In recent years, there have been numerous efforts, particularly in the USA, to change and improve financial reporting. But to what end? Have the reporting processes become better or worse? Have financial reports become more or less relevant, reliable, and understandable? What needs to be done? These are questions that the International Federation of Accountants (IFAC) attempted to answer in a recent survey (administered in June and July of last year) that was summarized in a Current Perspectives and Directions piece released in March of this year.

The reported summarized results on the issues of corporate governance, the financial reporting process, the audit of financial reports, and the usefulness of financial reports. The results included positives, areas of concern, and improvements that are needed. But per haps the most important result of the study is that while corporate governance, the process of preparing financial reports, and the audit of such reports has clearly improved in the last five years, the financial reports themselves have not become more useful.

Considering the huge financial burden placed on companies to prepare these reports, especially since the introduction of Sarbanes-Oxley, this is troublesome. The reports should be useful to the target user groups, they should address the relevant concerns that shareholders have with respect to corporate governance and auditability, and they should enable the supply chain, not detract from it.

So what can be done? The “areas of concern” identified in the report give some clues:

  • Reduced usefulness due to complexity
    In other words, the reporting requirements need to be simplified.
  • Focus on compliance instead of on the essence of the business
    You comply with laws in the execution of your business, you do not execute your business just to comply with laws.
  • Regulatory Disclosure Overload
    Too much information is required.
  • Use of Fair Value
    What exactly is fair value?
  • Difficult and often changing financial reporting standards.
    Financial reporting standards need to be steady.
  • Lack of forward looking information.
    Companies need to move forward as well as looking back.

However, regulatory changes take significant amounts of time, and in the interim, you need to continue to produce complex reports to meet an ever increasing dizzying area of regulation. So what can you do? the doctor recommends that you:

Automate. Centralize (a copy of) all of the relevant financial data in a central database / data warehouse and acquire applications that automate the production of as many regulatory reports as possible.

Simplify. Use whatever leeway you have in report preparation to design reports that are as clear and easy to read as possible. Consider producing different summaries for different groups to simplify message communication. Extrapolate forward based on past and current performance and paint a full, realistic, picture for the stakeholders.

It won’t solve all of your problems, but it’s a start.

Kill the Left-Suckers! (Bold Leadership for Organizational Acceleration)

By far the best presentation at this year’s 41st Annual Supply Chain & Logistics Canada Conference on Creating a Resilient Supply Chain was Jim Tompkins’ (CEO of Tompkins’ Associates) presentation on Bold Leadership for Organizational Acceleration. (He also gave the keynote, which was a great presentation as well, but this was one of the best presentations I’ve been to in years.)

Not only is Jim a great speaker, and if you haven’t heard him, I encourage you to attend his session the next time you’re at a conference where he is speaking, but he’s also really good at telling it like it is. And in this presentation, where he gave his top three tips to bold leadership success, he didn’t pull any punches. In reverse order, his tips were:

  • Don’t Do Anything Stupid,
  • Focus, and
  • Kill the Left-Suckers.

And I couldn’t agree more! What’s a left-sucker you ask? It’s someone who can’t do his (or her) job, and pulls his (or her) manager away from doing what the manager is supposed to be doing to help the individual who can’t do his (or her) job. Why is this so bad? Isn’t that what managers are for? Well, they are there to help, to teach, and to guide – but they’re not there to do their subordinates’ jobs. When managers are consistently pulled away from their jobs, they don’t get their work done and then their directors have to step in to pick up the slack. When the directors get consistently pulled away from their jobs, they don’t get their work done and then the C-Suite has to pick up the slack. When the C-Suite has to pick up the slack, they aren’t getting their work done, and then the CEO gets pulled into fire-fighting on a daily basis – and instead of the CEO leading the C-Suite in setting strategic direction, he’s bogged down in tactical execution while the company starts burning down around him.

As Jim says, a CEO should have three hours a day to do nothing but focus on the strategic. He needs to think about what the company is doing, what they should be doing in the short and long term, and how they are going to get there over the required time period to either reach the top or maintain their place on the top. If he’s consistently being pulled in half-a-dozen directions, that’s not going to happen. So you need to make sure that it does – by identifying, and eliminating, the source of the problem – the left-suckers!

If you can train them – great! If you can find them another role that they can do – that’s good too. But if you can’t train them, or find a role that they can do without constant supervision and hand-holding, then you have no choice … you have to terminate them. Or they’ll terminate your company. Bravo, Jim. Bravo!

Cutting Carbon Footprints on the Country Level

In 2007, the Intergovernmental Panel on Climate Change IPCC published a report that called for a reduction in annual emissions from just under 50 billion tons of greenhouse gases today to 10 billion tons or less by 2050 to insure that the planet warms by no more than two degrees centigrade because even though there is uncertainty as to precisely how much damage is done by each ton of greenhouse gas that we generate, dramatic weather pattern changes in recent times have demonstrated that GHGs are damaging the planet, and that levels need to be reduced.

As noted in a recent McKinsey Quarterly article that addressed the issue of what countries can do about cutting carbon emissions, this report has spurred political leaders in some countries to action – with the European Union setting targets to reduce GHG emissions by 20 to 30% of the 1990 level by 2020 and some countries aiming to become carbon neutral by 2050.

But what will be required to reduce GHG emissions to that level? And which approaches will be most effective? In an effort to answer these questions, McKinsey has embarked on a multi-year research initiative and, to date, has taken a focused look at what can be done in Australia, Germany, the UK, and the US. To date, they have discovered that each country can reduce its emissions by at least 25% at little or no cost and without a significant change in the daily lifestyle of the populous. If this happened, it would be a great start when you consider that technology improves every year, and that focussed efforts will probably find another 25% in a few more years.

However, what really caught my eye in this article was their statement that many of the initial GHG reduction opportunities they identified are profitable. They noted that most of the reductions in this first 25% can be achieved through improved energy efficiency — better insulation, energy efficient appliances and machinery, and energy-efficient heating and cooling systems — which will also reduce energy requirements and, thus, energy bills. Furthermore, they also noted that there are also low-cost options to reduce GHG as well – coming in at less than $50 / ton. These options include improved fuel efficiency of vehicles (which should be possible, as we’ve all heard stories of non-hybrid and non-diesel test vehicles getting 50 mpg ratings, or twice what the average small sedan gets today), second generation biofuels (and not just energy inefficient corn-ethanol), better GHG emission management, wind power, solar power and, obviously, the planting of more forests. Considering that one hour of the sun’s rays contains more energy than the entire planet uses in a year – the construction of vast solar arrays in deserts could make quite a dent in our energy needs. And since it is the heat from the sun’s rays that causes the temperature differences between the land, water, and air needed to create wind, this energy is available even when the sun isn’t shining — and wind turbine farms can be used to capture even more of this energy. Considering the relatively high levels of carbon dioxide emissions per kilowatt hour in North America, solar and wind energy farms could make a substantial dent in GHG emissions – and pay for themselves over their lifetime (as sunlight and wind is free while the price of coal, oil, and natural gas is now increasing by the day, if not the hour).

Now, as pointed out by the McKinsey article, these cuts are not likely to be sufficient in the long run, but they are a great start and technology that is not ready today, or technology that is still too expensive for widespread adoption today, will improve, and come down in price, over time — and chances are that by the time countries have exhausted the initial low cost options available to them, better technologies enabling more drastic reductions will be available at similar, if not lesser, costs. And there are even more low-cost options than the article mentions. For example, consider new landfill reduction trash processing plants, like the ones being built by Global Renewables, where 75% of the garbage is recycled or processed into a form in which they can be re-used and a considerable portion of the remaining waste is used to power the plant. The ideas being developed today are endless, and statistics dictate that some will be relatively low cost and / or deliver quick payback – making them very low cost in the long run.