Daily Archives: March 28, 2010

The Probability of Supply Chain ROI Must Be Considered

As per this recent editorial by Dan Gilmore over on Supply Chain Digest, you can’t overlook the probability of success when considering the ROI of a supply chain project. A 10X ROI isn’t a 10X ROI until the returns and identified and realized. If the new system doesn’t work, or the assessment doesn’t turn up the expected savings, then there is no ROI. And the chances of this happening are dependent upon the probability of success.

Therefore, before you give a project a green light, you need to understand the probability of success. Because a 10X ROI probably isn’t worth pursuing if there’s only a 20% chance of success, especially when you’re sitting on a 5X ROI project that has a 90% chance of success. If you have a lot of options, a good rule of thumb for zeroing in the ones that should be given the most consideration is to multiply the probability of success by the expected ROI and focus on those with the modified ROI. For example, given the above two scenarios, the first one has a modified ROI of 2X (since only one in five similar efforts would succeed) and the second has a modified ROI of 4.5X ROI (since nine in ten similar efforts are expected to succeed).

The reality is that there are probably a dozen high-probability ROI projects you can do right now, no use expending your resources on the wrong one.

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Demand Management, CPO Agenda Style

I found a recent article in CPO Agenda on how to engineer fresh opportunities to control spending quite timely given the extended recession and the limited revenue growth opportunities due to the reduced amounts of disposable income end customers have in their pockets to buy products and services. According to the article, effective demand management is the next logical step to controlling costs and driving down inefficiency and waste, and along with improved inventory management and distribution network design, they’re right.

With a better understanding of the factors at the root of demand for products, services or internal resources, a company can put in place innovative ways to eliminate, reduce or meet demand more efficiently and the result can be considerable savings. And while demand management may be traditionally associated with indirect spend, the greatest savings to be had are usually in direct categories. The key to realizing that is to stop focussing on “savings” and instead focus on “cost avoidance” because, as I said before, “savings” is just money you should not have spent in the first place!

So how do you get started? According to the article, you follow these five steps:

  1. Create a Demand Tree
    This a flowchart that starts with demand origin and documents key drivers. It breaks down the product or service into its constituent parts to aid in a full understanding of the product or service provided.
  2. Calculate Demand
    Based on this flowchart, calculate annual demand for each component.
  3. Calculate Capacity
    Figure out how much you can produce at each production level and the associated costs.
  4. Compare Capacity and Demand
    What capacity level are you at with current and projected demands. Does it make sense?
  5. Create Action Plans
    Once you’ve figured out what level you should be at, you can create a plan to alter demand accordingly. You can ramp up sales and marketing efforts if the product or service has the potential for great profitability at a higher demand level, or shift focus to another product or service if it’s not profitable, or would be more profitable at a lower demand level (because you’ve exceeded optimal capacity and additional units require costly overtime to produce).

In other words, you simply understand where you’re at and figure out where you should be, and then create a plan to get there. Of course, the plan could require a lot of work, but at least you’re taking a step in the right direction.

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