Should-Cost Modeling Helps Control Costs

Let’s say you’re the purchasing manager for your company, and you buy a fair amount of customized products.  Word has come down that costs need to be reduced by 15-20 percent.  Oh, and of course you are not allowed to cut corners on quality, performance or any metric.  What to do?

This is a conundrum in which purchasing managers routinely find themselves, especially since the black cloud of the economic downturn took hold.  Increasingly, managers are turning to “should-cost” modeling as a way to gain better insight into costs, as well as a bit of leverage with suppliers during negotiations for customized products.

Should-cost modeling is not new – in fact it was developed by the Department of Defense as a way to try and trim costs of some highly specialized manufacturing products.  While most businesses don’t have the time, manpower and financial resources of the DoD, we can all learn a lesson from their approach.

Should-cost modeling, as defined by Sourcing Innovations, refers to “the process of determining what a product should cost based upon its component raw material costs, manufacturing costs, production overheads, and reasonable profit margins.  Knowing roughly what a product should cost transfers pricing power from a supplier to a purchaser, especially for strategic purchases.”

The should-cost concept is especially helpful for businesses in need of “customized” materials that can’t be cost-compared on the open market.  By drilling down to determine component and other costs, a purchaser can have much greater visibility and awareness of a product’s true costs.

“If the difference between the approximated should-cost and actual cost of a product is roughly 20 percent or more,” Sourcing Innovation notes, then the buyer could have an opportunity for considerable savings.  But if the savings is less than 10 percent, then the quoted price is probably fair.

Tim Reis, sourcing manager for industrial cleaning products manufacturer Continental Commercial Products, says the key to successful implementation of this strategy is to do your homework and make sure you have your facts straight.  This is essential because “you know with 100 percent certainty that the supplier will challenge your assumption in attempt to turn the cost discovery negotiation process back to their side.”  You need to be certain, he added, that a supplier can raise only minor objections to your should-cost model, and will have no choice but to negotiate a new price.

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U.S. Retailers Continue with Canadian Invasion

When upscale department store chain Nordstrom Inc. announced in September that it would open four locations in Canada beginning in the fall of 2014, it joined a growing list of U.S. retail chains that have crossed the border into the Canadian market.  Earlier this summer, retail giant Target announced that it would open at least 125 stores in Canada within the next two years.

With these announcements, Nordstrom and Target join a growing list of U.S. retailers making the move north.  Other retailers are already operating in Canada include:

J. Crew Ann Taylor
Tory Burch Kate Spade
Victoria’s Secret Brooks Brothers
Crate&Barrel Apple
Tesla Motors Lowe’s
Walmart  

While expanding to Canada might seem like a natural move for U.S. retailers, given our shared border and shared language, the move has been more problematic for some chains.  In the past, the New York Times notes, “the Canadian market was hard to crack for many companies.  The Canadian dollar was weak, costs were higher, and with limited real estate development, it was difficult to find space.”  In addition, some businesses learned the hard way that savvy Canadian consumers were not willing to pay higher prices in Canadian stores for identical products available at lower prices either in U.S. stores on online.

Now though, many of those obstacles have been eliminated.  The Canadian dollar is competitive – if not stronger – against its U.S. counterpart.  The Canadian economy is more robust than the comparatively stagnant U.S. economy, and the real estate market is much more inviting.

But perhaps the most enticing reason for U.S. retailers to expand to Canada?  Higher profits.  “Sales per square foot at Canadian malls were almost 50 percent higher in 2011 than sales per square foot in American mass,” the Times reported in citing a Colliers International Consulting survey.

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Mexico Offers Nearshoring Opportunities for Canadian Businesses

While there are no predictions Canadian importers are ready to move away from China as a leading provider of manufactured goods, favorable business and labor conditions in Mexico have resulted in a spike in Canadian interest in the country.  And with good reason.  The “2011 U.S. Manufacturing-Outsourcing Cost Index,” prepared by international business consultants AlixPartners, found that Mexico has become the top location for U.S. businesses looking for low landed costs.  This fact, according to Canadian Transportation&Logistics blogger Laurie Turnbull, “should be of interest to Canadian importers if for no other reason than proximity to [Canada’s] largest trading partner.”

In other words, as Mexico has become more cost efficient and labor effective, and as manufacturers in the U.S. have taken note, so too should Canadian manufacturers interested in manufacturing and supply chain efficiencies.

The Alix study makes note of rising labor costs in China, as well as volatile exchange rates and increased freight costs.  Consider this – in 2008 the hourly wage for manufacturing workers in China was $1.36, a figure that is about 4 percent of the average wage in the U.S.  According to Alix’s forecasting model, wages in China will likely see annual increases of 30 percent.

At the same time, the Alix model assumes that Chinese freight rates will increase by 5 percent annually.  While this is not in and of itself outrageous, the bigger variable is the possibility of rates increasing at a faster pace.  Should that happen, North American businesses could face staggering costs for transporting their “low cost” goods back from China.

So as a growing cloud of uncertainty seems to be settling over China, those same clouds have cleared over Mexico.  Although Mexican labor costs ($6.23 per hour, according to the U.S. Bureau of Labor Statistics) are higher than in China, other factors offset that variable, including reduced transportation costs, greater control over the supply chain, along with heightened quality and accountability.

Mexico has become such a favored source of North American nearshoring, that a separate 2012 survey by AlixPartners found that 50 percent of manufacturing executives said that Mexico was their top option for bringing manufacturing back from China.

“As manufacturing costs have increased in China and elsewhere in Asia,” says AlixPartners director Russ Dillion,  “the cost and time factors involved in shipping goods across vast distances are magnified and, whether it’s in Mexico or the U.S., any company that’s not at least considering alternative manufacturing sources closer to their home market is certainly missing an opportunity.”

Central to this though, is how quickly a business is able to adapt its business plan to take advantage of cost efficiencies found closer to home.  But, as blogger Turnbull points out, locating product suppliers is only the first step.  “Another prime consideration is logistics suppliers, companies capable of providing integrated transportation, distribution, documentation and risk-management/compliance capabilities to support the importer’s objectives in increasing competitive advantage.”

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When It Comes to Supply Chain Data, Is Less More?

There is no disputing that today’s supply chains are data driven, faster and leaner than before, some industry experts are starting to question whether too much data can be counterproductive.  Instead of searching for ways to tap into more information, would time be better spent analyzing existing data to find learnings?

Guy Courtin, director of industry solutions at Supply Chain for Progress Software, took on the issue in a recent issue of EyeForTranport.com.  Noting that “visibility” has become the term du jour among supply chain managers, Courtin wonders if rather than “seeing” or “possessing” more data, supply chain managers might find it more helpful to focus on “what it is we are already observing and how it impacts our supply chain.”

He uses as an example a retailer who wants more POS data.  “What if they could collect greater detailed information about how their stores are doing, what units are selling and at what volume and mix.  If they could get more visibility down to the SKU level…how fantastic,” he writes.

“But,” he adds, “what if that data is too old once they received it?  Have you really gained more ‘visibility’ or just more noise, information that might have once been valuable but now is lost due to a host of factors?”  Instead he posits,  “Supply chains need to focus on the data they are already viewing, understand what they are observing and determine if there are any causalities that can be identified.”

Jace Davis of IBM Sterling Supply Chain Visibility seems to echo that point by arguing that businesses need to focus on “quality” of data rather than quantity.  “The better data you have, the better decisions you can make,” Davis wrote in his The Social Business blog.

He also warns that “today’s complex supply chains create too much data for manual processes to absorb.  This causes a lack of real-time visibility into supply chain events as well as an inability to detect and resolve exceptions in a timely manner.”

So it would seem that businesses looking to build greater visibility into their supply chains should think carefully about the volume and categories of data it needs to capture.  It may well be that “less it more” when it comes to meeting visibility needs.

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Environmental Factors Not a Concern for Most Shippers

Earlier this year, Canada’s Environment Minister Peter Kent announced new regulations to cut greenhouse gas emissions from new on-road heavy-duty vehicles.  The new regulations, according to Kent, would have the equivalent effect of removing 650,000 personal vehicles from the road by 2020.

While this is certainly a laudable goal, and definitely in sync with work by carriers and transportation providers to adopt greener and more sustainable practices into their operations, a new study suggests that all this fuss about the environment may not be registering on shippers’ radar screens.

The results of the 2011 Shipper’s Pulse Survey, conducted annually by the Canadian Industrial Transportation Association (CITA) indicate that carriers’ efforts to minimize their environmental footprints are not a top concern.  The survey, which has been conducted annually since 2005, is intended as a way for CITA to gain “current thinking” of its members, so that it can better represent members’ views to government, media, and other audiences.

With regard to environmental issues the survey found that, when choosing a carrier:

  • 39.2 percent consider environmental factors that reduce greenhouse gas emissions
  • 37.8 percent consider environmental factors that reduce air pollutant emissions
  • 27.0 percent are aware if their carrier uses hybrids or alternative fuels; and
  • 64.9 percent consider the age of the engines in a carrier’s fleet.

The survey also found that 75 percent of respondents admitted to having “very little” or “little” knowledge about transportation greenhouse gas emissions and effects.

One bright spot of the survey, is that nearly 60 percent of shippers say they do have an environmental plan in place, indicating that shippers may be open to learning more about advances in fleet management to reduce greenhouse gases and minimize environmental damage.

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Trucking Capacity Shortage May Finally Be Here

Carriers have been warning for the past two years that the trucking industry is facing a serious capacity shortage, and that it was only a matter of time before that shortage would start to affect operations. Well, that time may be here, with industry analysts and executives stating that capacity has become so tight, that the slightest uptick in the economy could have severe repercussions.

How bad is it?  “Sometime in 2012 there is a reasonable probability of sporadic supply chain failures based on capacity,” freight industry economist Noel Perry recently told an audience at the Council of Supply Chain Management Professionals (CSCMP) annual conference.

The capacity crunch is attributable to two main factors:

  • Continued Recessionary Fallout:  The trucking industry underwent a major retraction during 2007-09, with as many as 3,000 carriers closing up shop in North America alone.   Carriers eliminated underused routes and consolidated wherever possible.  The American Trucking Association reported that demand for service fell by 24 percent, and that the average carrier cut its fleet by 14 percent.
  • Driver Shortage:  Fewer trucks on the road meant fewer drivers, about 150,000 of them.  And now that carriers are in a position to replenish their ranks, they are finding a small pool of willing applicants.  For one thing, life on the road is a demanding gig.  Long stretches away from home and increasing federal scrutiny have chased away many potential applicants.  But, as the industry has responded with higher pay and better benefits, the shortage is expected to gradually ease.

Most shippers did not feel the impact of reduced capacity right away, since volume was down 30 percent at the peak of the recession.  But now that tonnage has rebounded, shippers are increasingly feeling the squeeze.

The capacity crisis “is staring us right in the face,” Mark Whittaker, vice president of transportation for PepsiCo told the CSCMP audience.  “We probably haven’t ever been through what we will be going through in the next four years.”

So how can a shipper protect itself and ensure continuity of service?  American Shipper offers three suggestions:

  1. Consider moving product to a non-peak shipping season;
  2. Be carrier friendly.  Make your business as accessible and efficient as possible by paying bills on time, making sure trucks have immediate loading dock access and by not making drivers handle freight; and
  3. Try to be consistent with your shipping patterns and keep you carrier in the loop with regard to your shipping needs.

Those who are still not convinced that the threat is real should take notice:  Perry warned the CSCMP audience that “It is probable that capacity shortages will last for several years, not just one….  We could easily see sporadic supply chain failures based on capacity shortages.  That’s something we are not used to.”

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Canada/European Trade Agreement A Threat to U.S. Businesses?

Talks between Canada and the European Union aimed at reaching a free trade agreement have reached a critical phase, with final sign-offs expected in the coming months.  And while the expected net benefit for Canada could be an economic boost of as much as $12 billion, and a 20 percent increase in trade wit the EU, questions have been raised about the impact of a Canada/EU agreement on Canada’s trade relationship with the United States.

Canada and the United States are each other’s largest trading partner, with almost $600 billion worth of goods and services crossing the border annually.  The U.S./Canada trade relationship has long benefited from favorable trade agreements, most notably NAFTA, which eliminates most tariffs on domestically manufactured products.  And just last year, in February 2011, President Barack Obama and Canadian Prime Minister Stephen Harper announced an agreement to improve trade relations through enhanced border security processes.

Despite the strength of the U.S./Canada trade relationship, the fact remains that more than 90 percent of the world’s customers live outside of North America.  And, just as President Obama has called on U.S. businesses to double exports by 2015, it is not surprising that Canada is also trying to expand its export base.

According to Canadian Transportation & Logistics, Canada is currently in the ninth round of negotiations toward finalizing a trade agreement with the EU – an agreement known as the Comprehensive Economic and Trade Agreement (CETA).  If approved, the agreement would facilitate access to the 27 member states that comprise the EU and its 500 million consumers.  But would the agreement cause the U.S. to lose its ranking as Canada’s top trading partner?

Jean-Michel Laurin, vice president of global business policy at Canadian Manufacturers and Exporters, explains that although CETA will not offer the same kind of “symbiotic manufacturing and integration” with Europe that Canada has with the U.S., the benefits of a Canada-Europe free trade agreement lie in “removing barriers to trade to help companies grow their business.”

Although still in draft form, the CETA is expected to offer Canadian businesses:

  • Elimination of tariffs
  • Access to the world’s largest government procurement market (valued at $2.4 trillion)
  • Easier entry for Canadian auto parts – that contain U.S. components
  • Easier entry for Canadian beef and pork products

Not surprisingly, the possibility of a Canada/EU trade agreement has sparked a lively debate within Canada, with supporters and detractors filling the media with pros and cons.  The Canadian government has attempted to respond to some of the heated exchanges, by publishing a “Myth vs. Reality” section on its official website.

Many U.S. businesses with strong trade relationships with Canada – auto manufacturers, pharmaceutical manufacturers, software businesses and chemical manufacturers — are certainly following the CETA negotiations closely.  And while it’s often said that competition can be a good thing, you can bet that U.S. manufacturers are paying close attention to any provisions that could potentially affect Canadian sales.

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Businesses Find Revenue in Smart Returns Management

It used to be that customer returns were treated as the ugly duckling of retail management.  Returns were tolerated, because they had to be, but were pretty much tossed aside and seen as a drain on the bottom line.

Not so anymore.  Many businesses now consider returns to be a revenue generator, with returns finding new life in secondary markets including outlets, “pre-owned,” and “overstock” venues.  Businesses are also realizing that proper returns management can be a terrific customer service opportunity.   A few facts:

  • According to the National Retail Federation, consumers returned almost $2.2 billion worth of merchandise during 2011, a figure that accounts for almost 9 percent of all sales.
  • The 2007 National Shopping Behavior Survey, conducted by KPMG LLC financial advisory company, found that 58 percent of consumers said that a company’s returns policy was a factor in their decision whether or not to shop with that retailer.
  • Accenture consultants found that only about five percent of returned merchandise actually have defects, with “defect” defined as something as minor as torn packaging.  While those returned products cannot be resold as new, they can be resold on the secondary market.  The Chicago Tribune reported that during 2007, electronics manufacturers reaped $13.8 billion by repairing, repackaging and reselling returned goods.

Key to a solid returns management process though, is a comprehensive logistics plan that takes into consideration everything from compliance penalties to waste management regulations to packaging mandates.  Inbound Logistics recently included an article by product management business analyst Tamara Dwyer, in which she outlined three “pillars” of returns management – speed, visibility and control.

According to Dwyer, returns management considerations fall within one of these three pillars and, when taken as a whole, will produce an effective returns management supply chain:

Speed

  • Automated workflows: Clearly defined data points must be present throughout the supply chain, including the item’s value and materials, repair scope and cost, return source, and customer service contracts.
  • Labels and Attachments: Supply chain must include process for validating RMAs, and for generating labels and shipping documents.
  • User Profiles:  By capturing key data such as physical locations, payment terms,  and service contracts,  profiles can be created that improve efficiency and reduce errors.

Visibility

  • Web-based portals.  Allow authorized users to perform tasks from any location, at any time.  Integration of data via a web-based portal also allows multiple business partners to have access to relevant information.
  • Carrier integration.  This involves linking RMAs to carrier tracking numbers, as a way to provide shipment visibility.
  • Bar-coded identifiers.  Each item should bear a bar code that includes information including parts, condition, quantity and date.  This will ensure that parts and manpower are available when the product reaches the repair or processing destination.

Control

  • Regulatory Compliance. Dwyer accurately notes that compliance touches all aspects of the reverse logistics process.  A supply chain must take into account everything from federal border clearance processes to state regulations to industry-specific mandates.
  • Reconciliation and final disposition.  This is the process whereby all shipment data – RMA data, accounting data, product data, etc., are brought together  so that a determination can be made with regard to resale potential and value.
  • Quality assurance.  Mechanisms must be included in a returns management plan that allow for feedback across all parts of the supply chain.  By dissecting each step of the process, a business can better understand why certain products have been return, and to determine if there is a design or quality issue that should be addressed.

With most businesses pressed to find efficiencies wherever possible, the spotlight is increasingly turning to the previously overlooked returns sector.  And as the above discussion indicates, a properly managed returns process can be a bright spot, both in turns of revenue and customer satisfaction.

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Your Supply Chain – One Bad Storm Away from Disaster?

One thing every business can agree on, the need has never been greater to safeguard supply chains against the unexpected.  Last year’s harsh U.S. winter, the Japanese earthquake and tsunami, unrest in the Middle East – and even fallout from volcanic ash that drifted over several European cities – were as good a wake up call as most businesses will ever see.   The fact that today’s supply chains are increasingly global lends even more urgency to the need to minimize risk wherever possible.

The good news is the unprecedented level of environmental and political developments that affected global supply chains, has cast a spotlight on the need for risk management.  As a result, several innovative ideas have surfaced, along with reminders about supply chain security that can help guide businesses looking to manage risk in their supply chains.

Logistics Management, for example, reported on several “game changing” non-conventional approaches including:

Enterprise-wide risk management (ERM): This approach requires a business to identify all potential risks throughout its organization, and to then assess those risks in terms of likelihood, impact, response required and monitoring progress.  As LM notes, the ERM model provides a framework that consists of eight elements:  internal environment, object setting, event identification, risk assessment, risk response plan, control activities, information-communication and monitoring.  The enterpise-risk model allows businesses to proactively identify risks, and have plans in place to manage those risks.

Scenario Planning using probabilistic methods: Although the concept of integrating probability into risk-based planning has been around for at least 50 years, it is only now making its way into supply chain risk management.  In its most basic form, this involves a business compiling a comprehensive overview of all potential risk – similar to the enterprise-wide risk management process described above – and then factoring in additional elements including historical patterns and uncertainty of all external factors.  After that, a business would develop “what if” scenarios, as a way to predict the impact of those external factors on their business.  This exercise allows businesses to better understand the impact of external factors on their businesses, to prioritize those risks, and to develop a corresponding response plan.

These strategies are intended to build upon a series of more traditional series of questions that a business must ask before undertaking a risk analysis:

  • Do our primary suppliers meet key financial stability standards?
  • Have we considered multiple source suppliers rather than relying on a single provider?
  • Should we select suppliers located closer to our customers, or to key manufacturing facilities?
  • Do we have alternate suppliers identified in case of emergency?
  • Do our alternative suppliers rely on the same transportation routes, power grids or materials manufacturers as our primary suppliers?

A study by Georgia Institute of Technology Professor Vinod Singhal and University of Western Ontario Associate Professor Kevin Hendricks found that it could take at least two years or more for companies to recover from a supply chain failure.  In addition, as noted in a recent white paper by FM Global, the professors found that businesses that experienced supply chain disruptions saw lower sales growth, higher costs and share price volatility.  These findings would seem to drive home what many businesses have learned firsthand – supply chain disruptions should be avoided at all costs.  And while it is impossible to eliminate all risk from the supply chain, it is possible to manage risk with good planning and forward thinking.

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Canadian Prices Running Higher than US Prices

A growing sense of angst among Canadian consumers has resulted from an inexplicable rise in consumer goods prices, as compared with U.S. prices.  This glaring price gap – which accounts for brand name products costing as much as 40 percent more in Canada – comes despite the sustained strength of the Canadian dollar.

Not surprisingly, the conundrum has result in some high level finger pointing, with legislators blaming retailers for the higher prices, and retailers throwing the fault right back at the government.

The issue has been the subject of a series of hearings convened by the Canadian Senate finance committee – at the request of Finance Minister Flaherty.  Flaherty asked the committee to look into the U.S./Canadian price gap, amidst growing public frustration.

Testifying on behalf of the Retail Council of Canada (RCC), council president Diane Brisebois cited several regulatory and legislative mandates that are affecting Canadian prices – outdated import duties on finished goods, a lack of harmonization of standards and requirements, vendor pricing, and the government’s supply management processes for dairy and poultry prices – were the four “largest contributors” cited, as reported by the Canadian Financial Post.

“We understand that this is a sensitive issue, but if this committee is really going to look at factors that contribute to the differences in pricing between Canada and the U.S., it would be remiss in not address supply management in some way,” Brisebois told the committee.

She also cautioned the panel that “it would be wrong to assume that large, multinational retailers should be able to negotiate one price from suppliers for the products they sell in North America…The reality is that suppliers of these products – those where you would tend to see the greatest difference in pricing – will charge Canadian retailers up to 50 percent more to buy those products than they charge retailers in the United States.”

Financial Post reported that Brisebois told lawmakers that the reasons cited by suppliers for the higher Canadian prices include:

  • Canada is a smaller country than the U.S., and therefore more expensive in which to operate;
  • Prices charged are what the market will allow; and
  • Higher prices are necessary to compensate Canadian distributors and wholesalers.

How bad are the price discrepancies between the U.S. and Canada?  Following is an overview of pricing prepared by the Retail Council of Canada:

Item U.S. Cost Canadian Cost Percent Difference
Soap – 16 pack $6.99 $8.98 43%
Shampoo
(1.5 liters)
$9.33 $12.46 34%
Conditioner
(1.18 liters)
$6.23 $10.00 37%
Automobile Tires $128.21 $169.69 32%
46” LED TV $888.75 $1,001.00 13%
Water Filters – 6 pack $22.77 $26.76 18%
Coffee Maker $127.76 $167.19 31%
Electric Toothbrush $91.29 $100.99 11%
Ibuprophen 200mg
(250 Count)
$10.76 $18.29 70%
Aspirin 81mg low dose
(350 Count)
$10.16 $21.78 114%
Ketchup 2.5 liters $3.93 $6.90 76%
Freezer bags
(150 pk)
$6.10 $9.24 51%
Laundry Detergent
(5 liters)
$11.27 $13.94 24%
Orange Juice
(7.56 liters)
$10.01 $12.66 26%

Not surprisingly, higher prices in Canada have resulted in a spike in cross border sales.  According to Douglas Porter, deputy chief economist with BMO Capital Markets, U.S. businesses can expect to continue to benefit.  “There has been precious little movement in underlying relative prices in the past two years despite the [Canadian dollar’s] record sprint,” he told the Wall Street Journal’s Marketwatch blog.  “They are never going to equalize at today’s exchange rate, though we will see some chipping away at the price gap in the year ahead.

But, he added “I’m not sure even if we stayed at par for years and years and years that the spread would ever completely vanish.”

So while our neighbors to the north continue to ponder the reasons behind their significantly higher consumer prices, savvy U.S. businesses are rolling out the welcome mat for bargain-hungry Canadian shoppers.

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