Bauer Supply Chain Spring 2015 Symposium Supply Chain Complexity March 6, 2015
Agenda • Complexity facing companies today • Quantifying the impact of complexity • Eliminating and managing complexity Wilson Perumal & Company, Inc. 2
Agenda • Complexity facing companies today • Quantifying the impact of complexity • Eliminating and managing complexity Wilson Perumal & Company, Inc. 3
The world has changed! Pre-Industrial Age Industrial Age Post-Industrial Age “Individual productivity” “Economies of Scale” “Complexity” Cost Volume Volume Complexity Dominated by Dominated by Dominated by variable costs fixed costs complexity costs Wilson Perumal & Company, Inc. 4
Complexity and its impacts grow exponentially Characteristics of Complex Systems 1. Non-linear reactions 2. Emerging properties 3. Feedback loops 4. Unknown interactions These characteristics make Complex Systems almost impossible to predict and control Wilson Perumal & Company, Inc. 5
Complexity is stretching companies’ capabilities PRODUCTS AND SERVICES MORE COMPLEX TECHNOLOGY IS MORE COMPLEX X PROCESSES MORE COMPLEX ORGANIZATIONS MORE COMPLEX X MARKETS MORE COMPLEX X X X REGULATIONS MORE COMPLEX Wilson Perumal & Company, Inc. 6
Many companies are passing a complexity threshold Costs and operational risk grow exponentially with complexity COST & RISK (exponential growth) $ An increasing number of companies are here Many companies VALUE are here (diminishing returns) Few companies are still here Level of complexity you can support Complexity Wilson Perumal & Company, Inc. 7
Complexity impacts all aspects of your business Cost & Business & Growth & Operations Operational Risk Innovation • Hidden costs • Grows • Slows new product exponentially with development • Exponential complexity growth • Overwhelms • Cannot anticipate customers • Cross subsidization all points of failure • Distracts sales • Most products are force unprofitable Wilson Perumal & Company, Inc. 8
Product, Process & Organization Complexity interact to drive higher costs & risk The Complexity Cube Non-value add Product Process Value add Number of Number of products and processes, steps, services you offer handoffs, etc. Organization Organization Number of assets, facilities, entities, partners, etc. Wilson Perumal & Company, Inc. 9
Complexity impacts all aspects of supply chain performance Complexity-driven supply chain challenges Bloated Inventories More Poor S&OP Supply Accuracy Chain Disruptions Slower Increased Response NVA Cost/ Times Overhead Wilson Perumal & Company, Inc. 11
Agenda • Complexity facing companies today • Quantifying the impact of complexity • Eliminating and managing complexity Wilson Perumal & Company, Inc. 12
How do you allocate costs? By “Volume” By “Item” Total Total cost cost Volume Volume Unit Unit cost cost Volume Volume Wilson Perumal & Company, Inc. 13
Complexity costs follow a square root of volume relationship Most NVA costs fall in between “by volume” and • Cost rises with volume but not as much as in “by volume” approach “by unit” extremes • Unit cost drops off with volume but not as much We see the SQRT relationship over and over as in “by item” approach Wilson Perumal & Company, Inc. 15
Cost allocation methods Costing approach By actual costs By allocation • Best approach • But not always practical By ‘volume’ By ‘SQRT vol.’ By ‘item’ (e.g., activity-based costing) • In between “by volume” • Costs divided equally Cost allocated in and “by item” methods between products, proportion to either stores, regions, etc. # units, revenue, • Higher-vol. items receive regardless of volume cost, etc. greater aggregate cost I.e., “Peanut butter • Lower-vol. items receive spread” greater unit cost • NVA/complexity costs follow the “SQRT of volume” relationship • Without this tool, most companies allocate these costs using the “by volume” method, leading to over-costing of high-volume items and under-costing of low-volume items Wilson Perumal & Company, Inc. 16
EXAMPLE: Square root costing Scenario: • Product “A”: volume of 1 unit “In between” is not simply the average • Product “B”: volume of 50 units of the two extremes • Total cost to allocate = $50 Allocation “By Volume” “By SQRT Vol.” “By Item” method: $25 Unit cost: $6 $1 $1 $0.88 $0.50 Wilson Perumal & Company, Inc. 17
Only complexity-driven costs are allocated using square root costing • Unmasks cross- Variable subsidization Variable ( α Vol.) ( α Vol.) • Corrects for under- costing small volume items/activities SQRT costs • Corrects for over- estimating potential for Fixed fixed cost leverage Fixed Traditional “Square Root” Allocation Allocation Categorization Categorization Wilson Perumal & Company, Inc. 18
Reallocating costs Annual Costs ($M) Allocate only those costs driven by 1058 9611 NVA complexity 11% 1316 14% 920 10% 1860 19% 3413 100% 36% 1044 11% Brewing Packaging Conversion Distri- Marketing Corporate Total Materials Materials Costs bution Spend SG&A Costs Wilson Perumal & Company, Inc. 19
The powerful impact of complexity cost allocation % Operating Margin 30% 26% Typical standard costing Complexity-adjusted costing 20% 14% 14% 13% 9% 10% 19% 14% 10% 9% 5% 0% Budget Below Premium Premium Craft Average Vol. (bbls): 12.5M 16.4M 44.3M 4.8M 78.0M Wilson Perumal & Company, Inc. 20
Agenda • Complexity facing companies today • Quantifying the impact of complexity • Eliminating and managing complexity Wilson Perumal & Company, Inc. 22
Complexity creates a vicious cycle Wilson Perumal & Company, Inc. 23
.. But ultimately, mastering complexity requires a two- pronged approach QUESTION: Brand Operating Material elimination model consolidation redesign Reduce Or make Process Product/ Vendor, dealer, flexibility amount of complexity less service distributor, supplier rationalization consolidation complexity? expensive? Dynamic modeling Management Geography System or market High rationalization Reliability Culture ANSWER: Both • • We do not live in a “plain vanilla” world (we need variety) • Customers demand good prices (we need cost-competitiveness) • But no real operation is lean enough to support infinite variety Wilson Perumal & Company, Inc. 24
Conclusion • Complexity has become a key factor driving performance for many companies… • …but most companies are ill-prepared to identify and manage complexity in their operations • Companies can better deal with increasing complexity by: – Understanding the sources of complexity and the impacts (cost & performance) – Eliminating NVA complexity and better managing necessary complexity Wilson Perumal & Company, Inc. 29
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