F101 – Optimizing Supplier AlliancesBest practices in formulating, formalizing, and leveraging strategic suppliers are cutting edge and understood by only a few distributors.

This session will explore how best practiceThis session will explore how best practice supplier relationships create more effective supply chains, capture more market share, and optimize profitability. The best practices will be supported p y p ppwith case study results from Texas A&M’s many research projects with best practice firms.

F. Barry Lawrence, Ph.D., Texas A&M University3/12/2010, 9:30 a.m.

Session Objectives

• Develop business process framework

• Develop financial framework

• Link business processes and shareholder value• Link business processes and shareholder value

• Implement best practices

• Quantify impact of best practices on profitability

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Return on Investment Opportunity

• Quantify impact of best practices on profitability

• Prioritize improvement opportunities

• Increased EBITDA and RONA• Increased EBITDA and RONA

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Additional Resources

• “Optimizing Distributor Profitability” available from the NAW.– http://www.naw.org/optimizdistprof

• Educational Programs from the Thomas and Joan Read Center for Distribution Research and Education at– http://readcenter.tamu.edu

• Pricing Optimization• Optimizing Distributor Profitability• Optimizing Distributor Profitability• Certificate in Distribution Management• Custom Programs

• Research from the Supply Chain Systems Laboratory– http://supplychain tamu edu/http://supplychain.tamu.edu/

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The ROI Equation

Financial Statements

5

Business Process Framework

Key Performance Indicators (KPIs)y ( )

Supplier Customer

Supply Chain Planning

Supp e Custo eSource Stock Store Sell Ship

• Information ManagementInformation Management• Human Resource Management• Finance Managemnet

Support Services

6

Financial Drivers

7

Step 1 – Identify Gap – Sample Assessment Report

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Step 2: Map Shareholder Value – Distributor Profitability Framework

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Supplier Performance and ROI

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Step 3: Assess Profitability

SupplierLead TimeVariability

Safety Stock

Average Inventory GMROII % RONA

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SOURCE Process Group – Suppliers

Key Performance Indicators (KPIs)y ( )

Supplier Customer

Supply Chain Planning

Supp e Custo eSource Stock Store Sell Ship

• Information ManagementInformation Management• Human Resource Management• Finance Managemnet

Support Services

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Source Processes

Distribution

Source

Supplier

Stock Store Sell Ship Support Services

Supplier Management

Supplier SelectionSelection

Supplier Performance

Supplier Stratification

Supplier Relationship

Right #

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Right # Suppliers

Supplier Stratification

Best P ti

Good

Practices

ance • Loyalty, Profitability,

Services, Performance• Risk/Exposure – supply

Practices

erfo

rma

Common Practices

• Segmentation based on COGS by supplier

• Pareto framework

p pp yavailability, technical requirements, financial factors, technological factors and environmental issues

Pe

• Purchase price varianced d

• Pareto framework (80%-20%)

issues• Landed Cost (TCO)• Combination Methodology

• Landed cost• Lacks segmentation

framework

14Time

Supplier Stratification – Relationships

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Supplier Management

Best Practices

Good Practices

man

ce • On time delivery• Lead time• Quality & Delivery

completeness

Practices

Perf

orm

Common Practices

• On time delivery• Lead time• Quality &

Delivery completeness

• Lead time variability• Combination methodology

- Supplier Performance Index (SPI)

P

• No supplier performance measurement

• On time delivery

completeness

On time delivery (Reactive measurement only)

• Quality

16Time

Supplier Performance – Ranking Criteria

Sample ranking criteria for supplier performance factors

Factors A B C D

Lead Time Average < 2 weeks 2 to 4 weeks 4 to 8 weeks > 8 weeks

Lead Time Variability (COV) <= 0.25 0.26 – 0.50 0.51 – 0.75 > 0.75

On-Time Index >= 0.76 0.51 – 0.75 0.26 – 0.50 <= 0.25

Completeness Index >= 0.76 0.51 – 0.75 0.26 – 0.50 <= 0.25

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Supplier Performance – Final Rank

“Weighting” approach to combine individual ranks

S li20% 30% 25% 25%

Fi lSupplierList

Final RankLead Time

AverageLead Time Variability

On-TimeIndex

Completeness Index

S li 1 A A B A ASupplier 1 A A B A A

Supplier 2 A A B D A

Supplier 3 A D C A CSupplier 3 A D C A C

Supplier 4 B A B C A

Supplier 5 B C C A Bpp: : : : : :

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Lead Time Variability – Schematic

Basic Input P t

Additional RParameters Revenue

EBITDA

P&L and

Lead Time LT Var.

Expected Turns

Bal. Sheet

% of re-RONA

Safety investment RONA

GMROIITurns

Stock

YES

Average Inventory

Re-invest ?NO

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Financial Statements – Typical Distributor

Income Statement Fixed VariableNet Sales 148,265,879$ 100%Cost of Goods Sold 110,902,877$ 74.8% 0% 100%Gross Margin 37,363,002$ 25.2%Employee Compensation - Outside S 9,059,045$ 6.11% 25% 75%Employee Compensation - Others 9,385,230$ 6.3% 90% 10%Warehouse Expenses 4,477,630$ 3.0% 50% 50%Delivery Expenses 4,536,936$ 3.1% 20% 80%Other Operating Expenses (G&A) 2,194,335$ 1.5% 25% 75%Total Operating Expenses 29 653 176$ 20 0%Total Operating Expenses 29,653,176$ 20.0%Operating Margin 7,709,826$ 5.2%Other Income -$ 0.0%Other Expenses -$ 0.0%EBITDA 7,709,826$ 5.2%

B l Sh tBalance SheetAssets By Total AssetsInventory 17,470,663$ 37.6%Accounts Receivables 18,829,767$ 40.6%Cash & Marketable Securities 1,990,029$ 4.3%Other Currrent Assets 1,978,468$ 4.3%Other Currrent Assets 1,978,468$ 4.3%Total Current Assets 40,268,926$ 86.7%Fixed & Non-current Assets 6,153,034$ 13.3%Total Assets 46,421,960$ 100.0%Liabilities & Net Worth By Total Liabilities & Net WorthAccounts Payables 9,884,392$ 21.3%Notes Payable (Short-term Debt) 1,427,456$ 3.1%Other Current Liabilities 2,404,335$ 5.2%Total Current Liabilities 13,716,183$ 29.5%Long-term Liabilities 4,991,618$ 10.8%Net Worth Or Owner's Equity 27,714,159$ 59.7%Total Liabilities & Net Worth 46 421 960$ 100 0%

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Total Liabilities & Net Worth 46,421,960$ 100.0%

Financial KPIs – Typical Distributor

Financial KPIs CurrentCASH FLOWDSO 46.4DPO 32.5DOI 57.50Cash Conversion Cycle 71.3Working Capital as a % of rev 17.9%

PROFITABILITYGross Margin % 25.2%EBITDA Margin % 5.2%P l P d ti it R ti (PPR) 0 49Personnel Productivity Ratio (PPR) 0.49GMROI % 214%% change in EBITDA $

GROWTHGROWTHRevenue Growth % 5.3%

ASSET EFFICIENCYAsset Turnover 3 19Asset Turnover 3.19Receivables Turnover 7.9Inventory Turnover 6.35

RONA (EBITDA/Net Assets) 23.57%

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( )

Critical Information

• Current inventory = $ 17,470,663

• 6 critical suppliers account for 77% inventory

• Inventory considered = $ 13 452 410 (77%)• Inventory considered = $ 13,452,410 (77%)

• Number of SKUs considered = 5,237

• Objective is to reduce lead time variability by 10%

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Input Parameters – For a top selling item

Average Lead Time 28 DaysSupplier Parameters

Average Lead Time 28 DaysLead Time Variability (Expressed as standard deviation) 7 DaysUnit Cost $201.25

Monthly Demand 12,050 UnitsDistributor Parameters

y ,Cycle Service Level (CSL) 85%Forecast Accuracy 80%Order Quantity (OQ) 2 400 unitsOrder Quantity (OQ) 2,400 units

CalculationCycle Inventory (Half of OQ) 1,200 UnitsSafety Inventory 4,416 UnitsAverage Inventory (Cycle + Safety) 5,616 Units

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e age e to y (Cyc e Sa ety) 5,616 Units

Impact of LT Variability on Inventory

Lead Time Varibility (Days) Safety Stock (Qty) Average Inventory (Qty) % of Current Inventory7 4,416 5,616 100%

6.3 4,201 5,401 96.2%5.6 3,998 5,198 92.6%4.9 3,811 5,011 89.2%4.2 3,641 4,841 86.2%3.5 3,491 4,691 83.5%2 8 3 363 4 563 81 3%2.8 3,363 4,563 81.3%2.1 3,260 4,460 79.4%1.4 3,184 4,384 78.1%0 7 3 138 4 338 77 2%

• This implies a reduction in inventory for this SKU by 3.8%

0.7 3,138 4,338 77.2%0 3,122 4,322 77.0%

p y y %• Let’s extend this savings to the remaining SKU’s• Inventory reduction = 3.8% X $ 13,452,410 = $ 514,978

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Inventory reduction 3.8% X $ 13,452,410 $ 514,978

Lead Time Variability - Schematic

Basic Input Parameters

Additional Revenue

= $ 514,978 X 6 / (1-25.2%) = $ 4,130,839

EBITDA

P&L andBal Sheet

Lead Time LT Var.

Expected Turns

6 turns

Bal. Sheet

% of re-investment RONA

Safety Stock

100%investmentGMROIITurns

A

Stock

YES

Average Inventory

Re-invest ?NO

$ 514 978

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$ 514,978

Impact on Income Statement

Income Statement Current Scenario By Sales % Fixed Variable To-Be Scenario FormulaeColumn A B C D ENet Sales 148,265,879$ 100% 152,396,718$ New Net Sales

Profitability Analysis - Income Statement

Net Sales 148,265,879$ 100% 152,396,718$ New Net SalesCost of Goods Sold (COGS) 110,902,877$ 74.8% 0% 100% 113,992,745$ (A * C) + (New Net Sales * B * D)Gross Margin 37,363,002$ 25.2% 38,403,973$ (New Net Sales - COGS)Employee Compensation - Outside Sales 9,059,045$ 6.11% 25% 75% 9,248,341$ (A * C) + (New Net Sales * B * D)

Employee Compensation - Others 9,385,230$ 6.3% 90% 10% 9,411,378$ (A * C) + (New Net Sales * B * D)Warehouse Expenses 4,477,630$ 3.0% 50% 50% 4,540,005$ (A * C) + (New Net Sales * B * D)Delivery Expenses 4,536,936$ 3.1% 20% 80% 4,638,059$ (A * C) + (New Net Sales * B * D)Other Operating Expenses (G&A) 2,194,335$ 1.5% 25% 75% 2,240,187$ (A * C) + (New Net Sales * B * D)Total Operating Expenses 29,653,176$ 20.0% 30,077,971$ Operating Margin 7 709 826$ 5 2% 8 326 002$ Gross Margin Total Operating ExpensesOperating Margin 7,709,826$ 5.2% 8,326,002$ Gross Margin - Total Operating ExpensesOther Income -$ 0.0% -$

Other Expenses -$ 0.0% 62,954$ Interest expense for additional accounts receivables @ 12%

EBITDA 7,709,826$ 5.2% 8,263,048$

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Impact on Balance Sheet

Balance Sheet Current Scenario To-Be Scenario FormulaeAssets By Total Assets

Profitability Analysis - Balance Sheet

yInventory 17,470,663$ 37.6% 17,470,663$ No change in inventory since re-allocated

Accounts Receivables 18,829,767$ 40.6% 19,354,383$ Days Sales Outstanding * (New Net Sales / 365)

Cash & Marketable Securities 1,990,029$ 4.3% 1,990,029$ Other Currrent Assets 1,978,468$ 4.3% 1,978,468$

$ $Total Current Assets 40,268,926$ 86.7% 40,793,543$ Fixed & Non-current Assets 6,153,034$ 13.3% 6,153,034$ Total Assets 46,421,960$ 100.0% 46,946,577$ Liabilities & Net Worth By Total Liabilities & Net Worth

Accounts Payables 9,884,392$ 21.3% 10,159,781$ Days Payable Outstanding * (New COGS / 365)(New COGS / 365)

Notes Payable (Short-term Debt) 1,427,456$ 3.1% 1,427,456$ Other Current Liabilities 2,404,335$ 5.2% 2,404,335$ Total Current Liabilities 13,716,183$ 29.5% 13,991,572$ Long-term Liabilities 4,991,618$ 10.8% 4,991,618$ Net Worth Or Owner's Equity 27,714,159$ 59.7% 27,963,387$ q y , ,$ , ,$Total Liabilities & Net Worth 46,421,960$ 100.0% 46,946,577$

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Impact on Financial Metrics

Key Metrics Current PotentialInventory Turns (Asset Efficiency) 6.4 6.5RONA (Asset Efficiency) 23.6% 25.1%Cash Conversion Cycle (Cash Flow) 71.3 Days 69.8 DaysGMROII (Profitability) 214% 220%EBITDA (Profitability) 5 2% 5 4%EBITDA (Profitability) 5.2% 5.4%

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Potential Profitability - Typical Distributor

Potential Profitability Curve ‐ SOURCERONA % ‐MINIMUM RONA % ‐MAXIMUM RONA % ‐ Typical Distributor

36.73%

40%

yp

31 54% 31.79%31.54% 31.79%

29.03%28.22% 28.50%

30%

25.08%25.55%

24.53%

26.00%26.28%

23.57%

25.72%

20%

Base Case Lead Time Lead Time Variability Completeness Index Payment Terms

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Potential Profitability - Typical Distributor

Impact of SOURCE best practices on 

EBITDA % ‐ Typical Distributor

5.2%5.8% 5.8%

5.5%6.0%

Base Case Lead Time Lead Time Variability Completeness Index Payment Terms

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Potential Profitability (RONA)

Impact of SOURCE, STOCK, SELL, STORE & SHIP bestImpact of SOURCE, STOCK, SELL, STORE & SHIP best practices on RONA ‐ Typical Distributor

75.2%61.2% 67.7%

85.0%

23.6%33.4%

Base Case Source & Stock

Store & Ship Sell Combined Best Practices 

‐MIN

Combined Best Practices 

‐MAX

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Potential Profitability (EBITDA)

Impact of SOURCE, STOCK, SELL, STORE & SHIP best practices on EBITDA % ‐ Typical Distributor

9.32%7.17%

11.41%10.29%

11.52%

5.20%

Base Case Source & Stock Store & Ship Sell Combined Best Practices ‐MIN

Combined Best Practices ‐MAX

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Action Plan

• Step 1: Properly segment suppliers.

• Step 2: Measure supplier performance.

• Step 3: Develop scorecard and share results with suppliers• Step 3: Develop scorecard and share results with suppliers.

• Step 4: Demonstrate impact of supplier performance on shareholder value

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Summary

• POTENTIAL for improving profitability exists

• Process and financial performance can be MEASURED to assess potential

• A ONE-to-ONE connection can always be established for processes and• A ONE-to-ONE connection can always be established for processes and shareholder value

• This connection can be QUANTIFIED and PRIORITIZED

• Best practices can be ACHIEVEDBest practices can be ACHIEVED

• Education will ENABLE distributors to realize POTENTIAL profitability

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Thank You For Attending

• F101 – Optimizing Supplier Alliances

• F. Barry Lawrence, Ph.D.

• Please submit the Session Feedback Form• Please submit the Session Feedback Form– To receive NASBA credits, please be sure to complete the Session Feedback

Form and sign the class roster in the back of the room

“Total Solutions For Industrial Distributors and Manufacturers”

Thank You!

35For more info please visit:

http://supplychain.tamu.edu