Gearing for growth
There is an opportunity to grow; you have assessed the market, tested demand, perhaps you are trading via a distributor or you have operations on the ground already. Now it seems the time is right to make a bolder step. It could be this is on home turf and you are confident you know enough about your operation to make a big step up; it may be in a new geography, but business is business the world over and you are down the track on establishing new relationships. The supply chain has worked pretty well to date and any issues have been jumped on and solved. What could go wrong?
Scaling up operations and the associated supply chain activities are fundamental decisions; the consequences of getting them wrong are always serious and can be fatal to a firm’s competitive capabilities and survival.
Too much capacity and resources are underutilized, with costs driven up; too little capacity and customer demand cannot be served, and revenues are missed. The risks inherent to strategic capacity planning are in both badly configured resources at the outset and mismanagement of changing capacity over time.
Net cash flows and discount rates rely on estimates of demand and an assessment of the risk associated with the capital investment. It is likely that forecast demand will show a smooth S curve over a defined period (typically a launch period followed by steep growth before volumes start to level out), probably as new capacity comes neatly online to satisfy it. The likelihood of this happening is remote. Uncertainty around demand should be expected; delivering exact levels of capacity at set milestones is also questionable. Estimating the probability of expected demand with maximum and minimum ranges is helpful to support the development of a decision tree; we will discuss how this can be enhanced later. Similar estimates of project risk for new capacity will aid contingency planning.
A key concern is how will the market react to a situation of under or over capacity?
Expanding an operation on a significant scale is a strategic decision; the role of new sites and facilities needs to be considered both in light of the business strategy and the potential opportunity that the site location(s) can bring. Factors such as tariff and trade concessions, reduced labor costs, capital incentives and subsidies are well established in many supply chain designs; important other dimensions such as customer service, supplier development, attracting skilled and talented employees, and the potential to create centers of expertise and excellence should not be overlooked.
Any supply chain is an integrated network of activities. Expansion at one link in the chain needs to be balanced with other elements. Somewhere in the chain is a bottleneck; knowing where this is and, when scaling up operations how this is affected, is critical for success.
All these factors can be weighed in an analysis that links supply chain design to financial trade-offs. Supply chain excellence is about balancing service, cost, and capital to deliver the business strategy and desired return on investment. Operational performance has clear links to revenue growth, cost optimization and capital efficiency.
Planning for a scale up can seem a largely analytical exercise. It many aspects it is, but at the core of excellent supply chain design are people. What skills and capabilities got the business to this stage, along with its culture and way of working, may not be what gets it to the next level.
The culture of an organization can define it and its competitive advantage. Values and beliefs shape actions and decisions. With expansion, it cannot simply be assumed that what works now will work in the future and at scale. New operations and sites mean new employees and potentially different cultural norms. The due diligence applied to planning new assembly lines, factories, distribution centers should be matched in planning the organizational design, roles and responsibilities, performance measures and incentives. Leadership will be pivotal to change and may well need to adapt whilst seeking to maintain the central ethos of the business.
Operating in different countries brings further challenges. It is trite to say there are cultural differences between countries but there are also notable variations in sub-regions; just consider New York and New Orleans.
Operating on a different scale asks new questions of people. Managing projects to develop new operations calls for skills in planning, communication, organization, negotiation and problem-solving to name a few; combining these demands with running day-to-day operations can often be a very tall order. That said, it is a common fallacy that people in current roles cannot develop as the operation grows. A good starting point is to review capabilities with a structured competency framework; this will not only highlight any critical gaps, it can also set motivating development paths. The main supply chain management processes should form the core with essential skillsets for the context of the business and its market completing a framework to support objective judgments.
For some gaps, a good option may be to introduce consultancy and/or interim commanagement support. More flexible working arrangements can certainly mean that expertise and particular skillsets can be called upon as needed.
The types of relationship in the supply network reflect the strategy of the business, its ‘posture’ to collaboration and the dynamics of the market sector. Decisions around what activities are performed in-house and those outsourced should be reviewed as part of planning growth. Those activities deemed critical to the competitive advantage of the business are likely to be performed by the expanding operation but, should it be feasible, some outsourcing of activities can mitigate risk and maintain flexibility in volumes and associated costs.
The analysis outlined for planning capacity can be enhanced with a renewed perspective on collaboration across the supply chain. Applying a design thinking mindset can help to create options and test ideas; those that pass can add to the decision tree to aid growth planning.
It is lazy thinking to suggest that growth automatically adds complexity. Scale is not necessarily the problem, it is the multiplier effect when poorly designed processes, systems and organizational structures are compounded.
Briefly pausing to reflect on potential causes of complexity in the business as it gears for growth is likely to be time well spent. Homing in on the variables that drive complexity in your business will allow these to be proactively managed.
The range of products and services is by far the largest complexity driver. Portfolio management and the new product introduction process need to be fully cross-functional with objective criteria for the inclusion and removal of products from the range. Without this, stock-keeping units have a strong tendency to grow with limited or no control.
A factor in scaling operations is the need to relinquish manual oversight on many decisions and actions. What may once have been within the capacity and capability of a supply chain manager to directly review, now needs to become exception based.
Scaling up an operation will increase cost. Tracking costs against budget is more challenging when demand estimates are uncertain. This increases the need to understand the nature of costs and how they are driven.
An understanding of the break-even point for an expanded operation should a clear milestone in the program. Having a clear picture on costs will help pinpoint when sales less variable cost equates with fixed costs and the business can move to profit.
Just as important for operations, if not more important however, is identifying contribution margin at capacity bottlenecks. It is likely that across the operation there is some form of bottleneck; that is, a constraint that sets a threshold on the demand the operation can satisfy within customers expected lead times. During growth, bottlenecks might move between activities in the supply chain. Here it is imperative for decision-making, and profitability, to assess unit contribution margin per unit of scarce resource. For example, consumption of machine time for a unique process by product, where this process is required for most, if not all, products. Bottlenecks can sometimes be difficult to spot, but in a system, there is only one at a time and a common giveaway is the build up of inventory at the ‘entrance’, that is, just prior to this activity or process.
Given the supply chain is an interrelated network of activities, managing costs is inherently about identifying the main activities and how they consume costs. Understanding what is driving the activity and what factors cause change, is integral.
Capital investment will no doubt be assessed and form part of the decision to expand the operation. Fixed assets may well increase although as mentioned earlier, there may be options to collaborate with others as well as outsource some activities until volumes achieve defined thresholds. Measuring asset utilization and throughput efficiency will allow operational performance to be aligned with the monitoring of return on investment. Particular attention should be paid to the difference between total capacity and effective capacity that determines asset efficiency. What constitutes unavoidable losses of capacity can be subject to debate.
Performance measurement that tracks asset utilization and efficiency over time, with due allowance for the stage of business development, should form part of an ongoing supply chain ‘dashboard’. Working capital development can also be planned and tracked as part of the dashboard. Inventory, accounts payable and receivable, the ‘cash to cash’ cycle, forms another critical output of the supply chain design and ongoing supply chain management.
Calum Lewis is Founder and Principal Consultant at OP2MA. OP2MA creates performance breakthroughs by design; it uses innovative analytics to target the opportunities that supply chain excellence offers and support its clients to achieve sustainable, superior financial results.