Bad policies hurt the supply chain

I think just about everyone involved with understanding and managing supply chains agree that the supply chain works best when volatility is minimized. Some organizations go to great pain and expense trying to figure out ways to manage their supply chain when faced with sudden demand changes and volatility.

Nevertheless, many supply chain participants continue to maintain policies that actually increase volatility in their own supply chains. Here are some examples:

1. Short-term promotional pricing
2. Volume discounts linked to shipment batches
3. Period-end promotions
4. Salesperson incentives linked to period-end dates

Short-term promotional pricing

Short-term price promotions contribute to the bullwhip effect and create tremendous inefficiencies all up and down the supply chain. The policy—especially when repeated with some frequency—causes buyers to hoard product. They buy extra-large batches of product when “on sale,” and store it up against the days when the product is not “on sale.”

Some short-term promotions are so predictable that buyers actually delay purchases at regular prices knowing that, if they wait, they can buy at a lower price later.

By the time all of the costs and expenses to the supply chain are added up, it would be difficult—in most cases—to prove that short-term promotional pricing actually adds to the bottom line at all. In fact, studies by some firms specializing in creating and managing pricing mechanisms have shown that consistent pricing at a marginally lower level actually produces more sales and profits than higher prices accompanied by short-term promotions.

Consider a brand like Wal-Mart. This is a firm that has master-crafted its supply chain and built its reputation on consistently lower prices. By doing so, it has—over the last several decades—supplanted previously known giants in the retail industry such as Sears, Penney’s, Kmart and more. Yet, Wal-Mart is not known for “sales” (i.e., short-term promotions). It is known for its consistently lower prices.

Volume Discounts linked to shipment batches

Let me say, off the bat, that there is nothing wrong with volume discounts, per se. The problem is linking volume discounts to transfer batches. In order to realize volume discounts without causing supply chain hoarding and needless volatility, the volume discounts should be separated from the shipment batch.

For example, your customer might get a volume discount if they agree to buy 100,000 units next year, but you might agree to transfer them to them in relatively equal weekly or monthly shipments. This evens out production (on the supply end), warehousing (on the receiving end), and doesn’t make it look like someone sold 50,000 units in March and another 50,000 units in September with little or no activity between.

Period-End Promotions and Salesperson Incentives linked to Period-End Dates

These two are frequently related. Salespeople with the need to reach certain goals for end-of-quarter or end-of-year sales, in order to boost their commissions, begin a big push. This push is usually accompanied by some authority to also offer special discounts.

All up and down the supply chain, prices are being discounted, volatility is being recklessly increased, and, all the while, production lines and warehouses are increasing their operating expenses to meet the boost in demand. Overtime and extra staffing costs are eating up the lion’s share of the profits that might otherwise have been generated if volatility had been reduced, rather than increased, by rational policies.

 

Of course, there are other wrong-headed policies that needlessly lead to higher volatility in our supply chains, but these are a few that come to mind. These are things well within the span of control of executives and managers where corrective action is easy and at little or no cost. It just take rethinking the way we do business and not being afraid to gore some existing “sacred cows.”

Business Processes and Real Management – Part 2

1. (continued) In the second scenario, the owner or chief executive is not in charge of the sales team. In fact, the firm has generally hired an experienced “sales manager” based on this persons history and background of producing sales at some other firm in the same or a similar industry. This person has then hand-selected a team of salespeople, the sales manager often doting over them making certain that each is uniquely satisfied with their particular arrangements. This is a variation on the same prima donna theme, but with a layer of middle management.
   
   In both of these cases, however, the general attitude of top management at the firm is that, while they may give lip-service to something they call their “sales process,” when one digs deeper, it becomes abundantly clear that the “sales department” is really surrounding by mystique. Each hand-picked salesperson has his or her own mystical mojo that is performed in a somewhat ritual-like fashion. This mojo, when properly carried out and when not too much interfered with management and administration produces a life-stream of sales to support the rest of the company.
   
   In these situations, the rest of the company’s executives and managers are under the implicit understanding that “I must not mess with the salespersons’ mystical mojo or things will go badly for the whole company.” Frequently, even top executives fear treading too much on the mojo, for fear there will be bad repercussions.
   
   
2. The second matter is that comes to mind is “sales commissions.” On numerous occasions I have asked executives, “How do you calculate and pay commissions?” A simple question?
   
   To this simple question, I am not infrequently given a simple answer: something along the lines of, “We pay commissions based on gross margins.”
   
   Simple enough, don’t you think? Until you begin to dig into the details. Then one starts hearing things like this: “Well, yes, we do pay commissions based on gross margins. But, if our buyers get a special deal on a purchase, we pay commissions on the ‘regular’ gross margins, not the actual gross margins of the sale of those special purchases.” Or, “Yes, we do pay commissions based on gross margins but, because the contract we signed with salesperson X is different from the deal we reached with salespersons Y and Z, the way we calculate ‘gross margins’ is different for each of salespersons X, Y and Z.”
   

So, I hear you ask, “What is the similarity between my daughter’s situation and the two examples I just mentioned?” The similarity is this: In each case the executive in charge called their decision-making a “process” (or, in the academic world, a “rubric”) or suggested that they were managing “a process” (i.e., “the sales process”). However, close inspection revealed that each decision was being made on a case-by-case basis without reliance upon a process or rubric, at all.
Note, my objection is not to the case-by-case decision-making – although I offer that this is likely not a sound approach to managing a growing SMB. Rather, my objection is to the managers’ beliefs that they are actually managing to a “process” or by “a process.”
(To be continued)
©2010 Richard D. Cushing