Daily Archives: January 19, 2011

Is It All About the P&L?

In a recent editorial piece over on Supply Chain Digest, the Editorial Staff asks if Procurement and Finance [can] Get on the Same Page in Measuring Savings from Supply Management Improvements. The article notes that a major challenge to this effort is the fact that procurement and financial managers are often talking a somewhat different scorebook. While procurement managers focus on savings as cash improvement, finance types tend to focus on profit and loss, and accrue all the while.

However, according to the article, the two don’t have to be fully reconciled for both departments to find common ground. All that is required is a common calculation that both departments can accept. According to the article, this calculation is:

Savings = Secured P&L + Deferred P&L + Mitigated P&L


Secured P&L = savings where favourable terms of purchase are acquired through changes in pricing, mix, demand, or quality

Deferred P&L = measure of the benefit delivered to the balance sheet for the current financial period (through capital purchases or pre-payment scenarios, for example)

Mitigated P&L = savings that come from agreements in which favourable terms of purchase are retained (cost avoidance)


Savings = Cost Reduction + Balance Sheet Improvement + Cost Avoidance

This is a good calculation, but I’m not sure balance sheet improvement captures all of the benefit supply management can bring. Is risk reduction (and minimized disruption costs) captured on the balance sheet? Is working capital optimization captured on the balance sheet? (And is procurement credited for reduced finance charges?) Simply put, the value of good Supply Management is:

Value = Cost Reduction + Cost Avoidance + Profit Improvement


Profit Improvement = Working Capital Improvement + Risk Mitigation + Capital Acquisitions + Market Share Improvement + ….

VFS Level 2: Increase Current Value

Today’s post continues our exploration of the four levels of Value Focussed Supply (VFS) as put forward in a CAPS recent research report on Linking Supply to Competitive Business Strategies and the holistic approach put forward by CAPS to get more value out of your Supply Management Organization.

The next level of VFS, after (most of the) value leakage has been eliminated, is to increase current value. SI is in full agreement here. This should be one of the primary focal points of every Supply Management Organization as it has to be about more than just cost reduction. According to CAPS, the next level of the value curve is obtained by continuing the focus on the four critical components of the balance sheet — revenue, cost, assets, and intangibles — and finding ways to take improvements to the next level. At this level of VFS, this means that a company would:

  • Enhance Revenue
    by increasing market share and improving pricing, which could involve a focus on local markets to tailor products to local taste
  • Understanding Real Cost and Reducing TCO
    by modelling what the costs are, and should be, and focussing on the costs that are too high and “attacking them broadly”; this could include finding alternate, cheaper, sources of supply
  • Increasing Productivity of Fixed Assets
    to get bang for the buck, which could include involving suppliers early in custom component design to improve manufacturability and lower costs or the rationalization of specifications to improve operational flexibility
  • Enhancing Corporate Reputation and Increasing Customer and Supplier Loyalty
    by targeting customer needs or working with suppliers to help them improve processes and lower costs

Probably the best example the report gave to increase current value was to follow Comco’s lead. Comco put engineers on site to help suppliers improve processes (using lean and quality management techniques), opened up 3rd party manufacturing research centers (to help its suppliers innovate and reduce costs while improving quality and reliability), and created cross-functional workshop that spanned internal and external organizational boundaries. These actions not only increased current value in the near term, but increased the value the organization could expect in the future, which began the organization’s progression to the next level VFS (which will be discussed in tomorrow’s post).

Again, SI agrees with all of these recommendations, but believes a few key points were missed that are critical to an organization pursuing additional value. Specifically:

  • Revenue Enhancement
    often begins by cutting unprofitable product lines. If a product line is inherently unprofitable, no amount of supply chain optimization can fix things. Supply Management has to do an impartial profit analysis of all of the product lines and determine which are, or could be, the most profitable, which lines should be consolidated, and which lines should be dropped completely.
  • TCO Reduction
    starts with should-cost modelling, continues with should-cost modelling on a component level, and attempts to identify common costs that can be reduced across categories through component rationalization or direct sourcing of raw materials on behalf of a supplier
  • Fixed Asset Utilization
    should also include a cost-benefit analysis of current fixed assets and whether or not they should be maintained or sold
  • Reputational Enhancement
    by focussing on common customer concerns, such as sustainability, and finding ways to embrace them in a cost-effective manner

SI feels that an organization cannot maximize current value unless it starts by understanding the areas where the value is and focussing on those areas, even if that means it has to pull out of certain other areas. And once an organization has maximized current value, it is ready to move on to the next step of VFS, which is the subject of the next post.