B U S I N E S S P E R F O R M A N C E M A N A G E M E N T
C R E D I T S
T I T L E
IMA®would like to acknowledge the work of Gene Tyndall,Executive Vice-President, Tompkins Associates, Inc., onwhose work this SMA is based, as well as Brenda Enney,Principal, Tompkins Associates, Inc., who provided assis-tance. Thanks also go to Gregory A. Harris, Ph.D., P.E.,
director, Alabama Technology Network and deputy direc-tor, Office for Economic Development, The University ofAlabama in Huntsville, who served as reviewer and toRaef Lawson, Ph.D., CMA, CPA, IMA director of research,who serves as series editor.
I . EXECUTIVE SUMMARYThe evolution of supply chains has been dramat-ic over the past several years, with more andmore companies moving to sourcing overseas,distributing finished goods to overseas markets,and increasing their international operations.Seeking low-cost country sourcing, optimizingmanufacturing, and exporting products and ser-vices have created new challenges to demandforecasting and supply chain planning. Whereassome new supply chain solutions have beendeveloped, financial management for globaliza-tion issues and opportunities has not kept pacewith management’s need to understand the fullimpacts of globalization, to improve companyperformance, and to have visibility into what hasbecome widely referred to as “the new 12,000-mile supply chains.”
By their very nature, global supply chains addchallenges and complexities to developing com-plete and accurate costing. Long lead times,multiple trading partners and service suppliers,international duties, tariffs, taxation, andincreased risks are but a few of the critical fac-tors that must be accounted for and understood.The rapid increases in international trade haveoccurred faster than the tools and techniques forcomplete and accurate costing have evolved.While several new software solutions that sup-port international trade and include many costingelements are available, management account-ants cannot rely on these alone. Individual com-panies have different supply chains and differentoperational strategies. Software can support andenable better decisions, but it cannot manageglobal supply chains alone.
This SMA suggests guidelines for managementaccountants and others to improve their under-standing of what is involved to accomplish com-plete and accurate costing of global supply
chains. It also provides the rationale for develop-ing complete and accurate costing to supporttheir companies and management in theimprovement of supply chain performance and inmanaging the inherent risks of sourcing and sell-ing across borders and internationally.
I I . INTRODUCTIONIt is widely understood that the world of businessis becoming more and more global. In manyindustries, companies must operate their supplychains on a global scale in order to compete. Itis estimated that the current overall value ofglobal trade is approaching $400 trillion. In fact,world trade (imports and exports) in NorthAmerica continues to grow at a much faster ratethan overall GDP.
Most executives understand the need to bothbuy (procure) and sell (distribute) in world mar-kets. The rapid growth in the level of offshoringand outsourcing by North American manufactur-ers, retailers, and distributors has been reportedfrequently in various media. According to theU.S. Department of Transportation, some 46.3million TEUs (20-foot equivalent units) passedthrough U.S, ports in 2006, more than doublethat of a decade earlier. The number of contain-ers entering the U.S. alone in April 2007approached 1.4 million, which means that over35,000 sea containers arrived each day at thenation’s global seaports. China alone exportedover 12 million TEUs to the United States in2006. It is estimated that another 10% of thisamount of freight arrives on cargo and passen-ger aircraft.
This remarkable growth in international trade isnot likely to end in the foreseeable future. Whileeconomic conditions, political events, and otherfactors may slow the growth in certain countriesat certain times, the overall scenario will not like-
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ly change. Global sourcing of products and com-ponents, combined with the opening of new mar-kets, creates more and more of what are oftenreferred to in international trade as “12,000-mile supply chains.” With these long supplychains come new complexities in how compa-nies deal with the resulting costs, risks, financ-ing, and lead times.
In many industries, markets have truly becomeglobal; thus, companies have and will continueto increase their degree of international sourcingand product distribution. The business environ-ment in which most companies operate haschanged significantly. Decisions affecting inter-national operations and profitability must bemade with accurate, timely, and comprehensivecost information.
In no area of the business is this more importantthan in Supply Chain Management (SCM).Decisions are being made to “go global” withoutthe benefit of accurate and comprehensive costinformation, which can affect profitability andshareholder value in many adverse ways. Globaloperations can easily add weeks to the valuechain, tying up as much as 30% of product pricein working capital alone. Moreover, constantlyevolving trade regulations, quotas, and tariffscan create additional layers of costs associatedwith compliance.
Supply Chain Management, broadly defined, is theintegration of key business processes from enduser through original suppliers that provides prod-ucts, services, and information for customers andother stakeholders. Within each individual compa-ny, this definition will include the processes ofsource, produce, move and store, deliver, and cus-tomer service, as well as planning. While SCMalso includes interactions with sales, finance, andother processes, as well as integration with other
trading partners in the supply chain, this SMAdoes not address cost management methods andpractices for those activities.
The accurate definition, measurement, and man-agement of costs for supply chain operations areessential for the successful operations of thebusiness. Since global supply chains can reflectas much as 90% of a company’s cost base, com-plete knowledge and understanding of thesecosts are critical for effective business manage-ment and company performance. As companiesstrive to become “lean enterprises” with compet-itive cost advantages, planning and budgeting forSCM is increasingly value-based. Yet the totalrisks created by establishing global supplychains are not fully understood, accurately cost-ed, or sufficiently managed.
Finally, full compliance with the Sarbanes-OxleyAct of 2002 (SOX) requires a broad and deepunderstanding of how to capture, record, control,and report supply chain costs. This is especiallyimportant for order-to-cash and procure-to-payprocesses, in addition to overall cash manage-ment practices.
I I I .SCOPESupply Chain Management has an enterprise-wide scope that also includes interactions withtrading partners. The business processes orfunctions included in Supply Chain Managementare:l Purchasing, procurement, and sourcingl Production planningl Transportationl Distribution, warehousing, and storagel Order fulfillmentl Customer servicel Supply chain planning and budgetingl Supply chain finance and working capital
management
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Exhibit 1 shows a simplified graphical represen-tation of international supply chains.
Earlier SMAs have addressed the costs ofdomestic logistics (Cost Management forLogistics, integrated supply chain management(Implementing Integrated Supply ChainManagement for Competitive Advantage); and theassociated tools and techniques (Tools andTechniques for Implementing Integrated SupplyChain Management). These SMAs are all relevantto this topic and provide the basics for supplychain activity-based costing, supply chain/logis-tics performance measurement, and supplychain/logistics information for cost management.
This SMA addresses the special impacts of glob-al supply chains on cost management and per-formance management. It also addresses theglobal financial supply chain and the expandinginterest among importers, exporters, logisticsservice providers, and financial institutionstoward it.
This statement also includes a section on man-aging the total costs once they are identified.Global supply chain costs are more likely toincrease relative to revenues than are domesticsupply chain costs, thus it is even more impor-tant to put cost management processes inplace. This section discusses best practices—both for processes and for technology support—for cost control in global chains.
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A
2. Warehouse receivingStorage as required
3. Constainer stuffing
4. Customs – origin6. International transport (Land, Sea and/or Air)
7. Customsdestination 5. Port services – origin
9. Container de-stuffingand warehouse receiving.Storage as required
10. Truckloading
Z
• Short product life cycles
• Global span for a single product
• Multiple origins
• Multiple Destinations
• Multiple Partners
• Multiple Chains
• “Spaghetti” network of partners
• Manual interfaces
• Tremendous amount of variables
• Increasing complexity to manage
• Supply chain gains strategic importance
• Need for End-to-end visibility
• Need for cost savings, shorter lead-times
and synergies
• Increased Investments in technology and
people11. Final deliveryand Value addingservices
1. Loading ofgoods
8. Port services – destination
EXHIBIT 1. INTERNATIONAL SUPPLY CHAINS: AN EXAMPLE OF GOODS FLOW
Source: DHL
IV. PERFORMANCE MANAGEMENTFOR GLOBAL SUPPLY CHAINSAccurate and comprehensive cost informationfor global supply chains is fundamental to themanagement of performance. Managers who areresponsible for the efficiency and effectivenessof global supply chains need to view perfor-mance metrics that are timely, complete, andactionable. Thus, global supply chain costingbegins with the primary objective of providingappropriate information for management.
The responsiveness required to keep inboundsupply chains flowing with materials and prod-ucts and to keep store shelves filled, for exam-ple, is challenging. Effective SCM requires reduc-ing costs, increasing inventory velocity, and com-pressing cycle time, but these three may not becompatible or consistent. Moreover, the productcategory can change the relative objectives, ascertain products require more speed while oth-ers, such as commodities, require lower cost.
SCM flows across the organization, crossingmany departmental boundaries, while traditionalaccounting is oriented toward transactions, with
its focus on identifying functional or verticalactivities. SCM extends into trading partners andservice providers while accounting stays withinthe company facilities (for example, supportingglobal trade requires as many as 25 handoffsand an equal number of supporting documents).Because products are always flowing, SCM iscontinuous. Accounting, however, recognizescosts in locations, periods, and discrete buck-ets. See Exhibit 2 for a comparison betweenSCM and traditional accounting.
These differences can be especially constrainingwith global supply chains, which by their verynature involve multiple parties, long lead times,continuous flows, and variable costs of up to 50or more cost elements for each supply chain.
Managers of global supply chains need perfor-mance metrics that address supply chain objec-tives and issues, such as:l Inventory velocity, turns, and yieldl Total landed and delivered costsl Cycle times: cash-to-cash, order-to-pay,
procure-to-pay, etc.
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EXHIBIT 2. SCM VS. TRADITIONAL ACCOUNTING
Crosses multiple departmental boundaries
Includes costs within organization as well as costsincurred by trading partners and service providers
Ongoing
Transaction-oriented, based on functional or verti-cal activities
Only concerned with inter-company facilities
Recognizes costs in a certain place, at a certain time,and in discrete buckets
SCM Accounting Traditional Accounting
l Product and customer profitability, includingtrue total delivered costs
l Capital efficiency: cost of capital, fixed andworking capital, and trading partner cost ofcapital
l Integrated global visibility: a 360 degree viewof the company’s world in terms of its materialand product, information, and financial flows.
These examples of key performance indicators(KPIs) are important for global supply chain per-formance measurement, and they help form thebasis for supply chain excellence. Accurate andcomprehensive supply chain costing is core toeach metric used to define each of these per-formance objectives or indicators.
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EXHIBIT 3. A COST ELEMENT CHECKLIST FOR OFFSHORING
3 net materials costs 3 increased information for visibility3planning and contracting 3 demand planning and forecasting3 inventory planning and deployment 3 international taxes3 manufacturing labor 3 staffing additions for managing the supply chain3 manufacturing plant overhead 3 communications challenges--time zones;
interpretations, etc.
3 bill of material changes 3 financial risks--over/under payments, duties, com-pliance, access to working capital; receivable dis-counting facilities, etc.
3 fixed plant costs 3 foreign exchange costs--direct and indirect, localcurrency costs vs. input costs (i.e., dollars or euros,etc.)
3 site inspections/certifications 3 enterprise capital costs3 costs of quality and fixing mistakes 3 transfer pricing3 returns and reverse logistics 3 costs of lost business--duty reductions, free-trade
agreements, etc.
3 scrap 3 costs of internal controls3 warranty recovery 3 costs of information technology3 inventory carrying/working capital 3 costs of inaccurate data3 storage and handling 3 costs of import/export customs compliance and
documentation
3 response to changing market demands 3 duty drawback/restitution3 changes to production schedules 3 participation in security programs (e.g., C-TPAT)3 expediting 3 total landed cost3 transportation--inbound to supplier 3 total delivered cost3 transportation--outbound to port of origin 3 supply chain disruptions--labor, weather, etc.3 transportation--port to port of destination 3 cycle time (order to delivery)3 transportation--port to storage to plant 3 time delays in the chain3 duties and tariffs (customs)
V. IDENTIFY ING COSTS IN GLOBAL SUPPLY CHAINSCosts are incurred from the start of planning foreach global supply chain throughout its execu-tion and, therefore, are incurred along the entireend-to-end chain, from the supplier’s supplier tothe customer’s customer. These basic principlesdrive the identification of global supply chaincosting. When a new supply chain is planned—e.g., the company makes a sourcing decision toprocure components from an overseas supplierfor a domestic assembly plant—costs areincurred to plan and design how the supply chainwill work. The expected amount to be purchased,delivery dates, routing, any storage, whether ornot it can be consolidated with other purchases,etc., all have to be planned, costed out, and bud-geted. Once this source is in operation, the totaloperating costs from the source to the consum-ing point (the assembly plant) must be quanti-fied, controlled, and reported, along withchanges that will occur to the plan.
Exhibit 3 is a checklist that identifies the totalcost elements that are affected by this decision.All too often these types of offshoring decisionsare made without considering many of thesecosts. Either some are not identified, or they arenot readily available or easily measured, andthus they are ignored.
Lower labor costs are but one element of thetotal delivered cost. While it and a few others willundoubtedly result in lower costs, the vast major-ity of cost elements will likely increase overthose of a domestic source. This is not meant todiscourage offshore sourcing, only to highlightthat true costs cannot be determined by one ele-ment alone. Complexity, risk, and variability existwith any such choice, and they need to be under-stood and considered.
There are certain costs particularly unique to thenature of global supply chains that are impera-tive for both performance and cost management.Here are five of the most critical, along withguidelines for identifying and managing them:
1. Total landed cost: all the cost elementsrequired to land a product in a destination geog-raphy from different origin geographies, takinginto account different currency exchange rates.Customs tariffs and VAT taxes, carrier rates,inland transportation at origin and destination,agency fees, logistics service provider fees, andthe cost of funds are all included.
Capturing and actively reporting on these costsrequires not only full costing of the procurementbut all associated logistics and regulatory costsbased on both country of origin and final destina-tion.
2. Total delivered cost: all the required cost ele-ments above plus the costs of overhead, capitalefficiency, allocations, and other costs that areincurred up to point of purchase. Capturing andactively reporting on these costs adds to thecomplexity of global sourcing, as the costs ofoverhead, capital efficiency, taxes, allocations,etc., will vary by country, risk factors, supplychain, transit times, and inventory deploymentpractices.
3. Working capital: the cost of trade receivablesplus inventory minus accounts payable. Thismeasure of asset efficiency, along with the cashconversion cycle, can be significantly decreasedby the global supply chain. New measures ofworking capital that take into account the cashconversion cycles of the entire supply chainmust be considered. Days of working capital, forexample, are measured as period-end net work-ing capital divided by sales per day. If inventory
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levels increase dramatically, as in the case oflong supply chains, then the costs of operationsand/or goods sold may be as much as 30% ormore higher.
Related working capital costs are measured by:l Days Sales Outstanding (DSO): Period-end
trade receivables net of allowance for doubtfulaccounts plus financial receivables, divided bynet sales per day
l Days Payable Outstanding (DPO): Period-endtrade payables divided by sales per day
l Days of Inventory (DIO): Period-end inventoriesdivided by sales per day.
Cash moves according to events that happen inthe physical supply chain. Payment terms aretriggered by events, then by information, whichmay be delayed. For example, the announcementthat goods are onboard a vessel might come twoto three days after the loading, which delays themovement of capital or, in this case, payment.The traditional practice of using Letters of Credit(LOC) to finance international trade has donevery little to alleviate such delays. Today, morecompanies are moving toward an open accountwith established suppliers. This improves supplychain visibility and, as a result, speeds up cashflow. Eliminating LOCs, however, requires thatnew forms of financing be substituted for suppli-ers. Supply chain financing (SCF) is addressed inSection IV.
4. Cycle Time: This measure of the total timerequired from order to delivery is also significant-ly altered by the global supply chain. The lengthyglobal supply chain adds substantial lag timebetween product (or component) procurement toreceipt. The time varies by country of origin anddestination due to customs clearances, countryinfrastructure, carrier capacity, etc., but it alsovaries by the type of commodity, whether it is
shipped by air or sea, containerized or not, andother factors including variables such as latesailings or arrivals, bottlenecks, congestion, dis-ruptions, weather, security delays, or mishandledshipments. Transit times vary by routings. Forexample, China to Los Angeles/Long Beach bysea followed by an intermodal move to Chicagorequires a different transit time than China toSeattle by sea followed by trucking to Chicago.All-sea routes from Asia through the Suez orPanama canals to the east coast of the U.S.require different transit times than routingsthrough west coast ports that then use landtransport to the east.
Global carrier (ocean liner) reliability is also animportant factor in transit cycle time. A recentsurvey by Drewry Shipping Consultants reportedthat, during the first quarter of 2007, less than50% of container ship arrivals on 20 of the majortrade routes were on time. This means that ship-pers have to build more buffer time into theirsupply chains to deal with the demanding risk ofvariability in liner schedules, which translatesinto higher supply chain costs.
Cycle times can be measured from order to deliv-ery; cash-to-cash; procure-to-cash; plan to execu-tion; in increments of land or sea, or any otherfeasible measure. Since extra time translatesinto higher costs and risk mitigation measures(i.e., inventory build-ups), however, it is a signifi-cant factor in supply chain costing.
5. Costs of customs, taxes, and security compliance: International shipments, or thosethat cross multiple borders, incur extra costsassociated with customs, taxes, and securitycompliance that do not apply to domestic supplychains. These evolving costs are complex, vari-able, and transaction-driven. Fortunately, numer-ous information technology solutions are avail-
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able, including ERP systems that enable the plan-ning and tracking of these costs and provide nec-essary documentation. However, managementaccountants and supply chain managers shouldnot solely rely on information systems. Shipmentroutes, transit time, and the quantity of goodsmoved are decided by supply chain managers,and costs are determined and triggered by thesedecisions. Furthermore, violations of customslaws governing valuations and tariff classification,country-of-origin declarations, and duty paymentscan lead to significant cost penalties. The costsof security compliance are likely to increase asgovernments require more container inspectionsand other security protections. While scanningand tracking technologies are improving, thesewill add costs to global supply chains.
The use of a third-party, or logistics, serviceprovider (LSP), in global supply chain manage-ment is increasing. As supply chains becomemore complex and trade volumes increase, it isexpected that companies will outsource much ofthis movement to specialists. The global marketfor LSPs is estimated to be over $200 billion,with at least 65% of it for international trade.These companies are also known as freight for-warders, customs brokers, third-party logistics(3PLs), LSPs, and others.
It is important for management accountants andsupply chain managers to understand and knowthe true costs of their global supply chains andnot to rely solely on the outsourced providers.While payment terms for logistics outsourcingservices differ—e.g., cost plus fixed fee, per unitbasis, volumes, etc.—the fact is that each com-pany’s supply chain strategies and choices formthe basis for their service costs. “Open-bookcosting” is a good practice for sharing knowledgeand information relative to the actual costs ofproviding the services.
A best practice for identifying global supply chaincosts is to “map” the supply chains and developprocess models that describe what is takingplace in the company’s supply chains. Mappingthe flows of logistics, information, and cash isvery important for planning and management.Moreover, mapping key events, hand-offs, andtimes, is invaluable for identifying total costs andthe opportunities to reduce or control them.These activities can and should be performedwith the help of the LSPs for validation and completeness.
V I . GLOBAL SUPPLY CHAINF INANCINGIt is commonly assumed that certain types ofglobal sourcing and production outsourcing havehelped many companies reduce overall operatingcosts. Plants, equipment, and other capitalexpenditures in many cases have shifted fromthe brand owners and original equipment manu-facturers (OEMs) to their trading partners, whoare increasingly offshore.
As some costs elements are reduced, however,others will increase, including those associatedwith the capital efficiency of the value chain. Forexample, inventories often get pushed down-stream to suppliers, who often have a highercost of capital. Global operations can add weeksto the supply chain, tying up as much as 30% ofproduct price in working capital. These factorsand their associated risks have given rise to newstrategies for financial supply chain manage-ment, such as:l optimize use of working capitall reduce product unit costs by taking advantage
of arbitrage opportunities due to the highercost of capital in emerging markets
l extend days payables outstanding (DPO)
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l Reduce supply base risk by enabling fasterand more predictable payments to emergingmarket suppliers.
The phrase “financial supply chain” refers to theflows of funds associated with the movementand storage of goods throughout the chain. Itincludes the business processes of exchangingpayments, related documents, and informationbetween buyers, sellers, financial institutions,and other involved parties. It also includes thecost of capital structure of the trading partnersinvolved—in that the cost of capital of a givensupply chain becomes the weighted cost of cap-ital of all partners.
Supply Chain Finance (SCF) incorporates bothoperational and financial management related topurchase orders, invoices, chargebacks, settle-ments, and the financing/credit managementbetween trading partners and their financial insti-tutions. This has given rise to new SCF solutionproviders who play an intermediary role betweenbuyers and sellers in the supply chain by provid-ing visibility into financial supply chains (forexample, purchase order/invoice/payment sta-tus) by greater access to capital, by electronicsettlements, and through other related services.
Visibility into global supply chains helps bothbuyers and sellers manage their cash flows. Thiscan reduce excess cash balances and financingcosts.
These providers can help reduce or control sup-ply chain costs by focusing on the key metricsdiscussed above, such as:l Working capital—extending Days Payables
Outstanding (DPO)l Cost of goods sold—early payment discount
program
l Cost of financing—capitalizing on arbitrageopportunities with costs of capital
l Inventory carrying costs—third-party in transitor in storage inventory financing, whether rawmaterials, work-in-process, or finished goodsinventories; it may also include financing ofsupplier managed inventories
SCF solution providers include banks, invest-ment banks, and technology companies.Technology companies provide improved informa-tion to speed up decision making while banksprovide financing and payments.
One form of SCF that is gaining momentum isearly payment programs. The sale of supplierreceivables at the buyer’s lower rate helps allevi-ate the higher cost of capital of offshore ven-dors. Many such programs are subject to thecredit capacity of the lenders, so it is importantto consider scale and capacity. Capital-market-funded programs mitigate this risk, especially forlarger companies with significant amounts ofdirect material spend and payables.
With these new SCF programs, companies nolonger need to own their entire supply chains.Instead they can create value and reduce totalcosts by leveraging the core competencies oftheir trading partners. While global sourcing, pro-duction outsourcing, and distribution complicatevalue exchange, increasing the quantity, velocity,and complexity of trading partner transactionswill also open up opportunities for collaborativewin-win arrangements.
A successful SCF strategy and program involvesa cross-functional team of finance, purchasing,supply chain, and sales and marketing man-agers. As with managing the physical and infor-mation flows of the supply chain, collaborationwith key suppliers and outside service providers
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is essential. Knowledge of the true total costs ofsupply chains is fundamental regardless of theprograms adopted. Collaborative processes willhelp identify the true costs, where and why theyoccur, and how they can be jointly managed orreduced.
Improved supply chain financing is facilitated bybetter knowledge and control of accurate supplyinformation on costs, times, and events. Theinverse is also true. Through improved tradingpartner collaboration and integration of financialinformation with physical supply chain informa-tion, the appropriate strategies and methods canbe put in place to enable true global supply chaincost management.
V I I . A CASE EXAMPLEGlobal supply chain costing excellence willimpact key corporate financial measures andshareholder value. The following provides a caseexample developed by the author and colleaguesto illustrate the issues and opportunities in man-aging global supply chains, along with its impacton company financials. While the name—ActionApparel—is fictitious, the example is based on
real composite information from the apparelindustry. The principles and methods are applica-ble to many industries.
As shown in Exhibit 4, Action Apparel has salesof $2 billion, a 68% cost of goods sold ratio($1.36 billion), SG&A costs of 26% of sales($520 million), and net profit from operations of$120 million, or 6% of sales.
Action Apparel also achieves six inventory turnsper year, resulting in an average inventory level of$226 million, based on inventory cost ($1.36 bil-lion divided by six). It is assumed that 100% ofits products are sourced offshore. It is alsoassumed that Action Apparel incurs a sourcingoverhead of 5% of COGS (an average for theindustry), or $68 million. This amount may increase depending on the degree of regular sitevisits to the offshore suppliers or the number ofemployees needed in the countries of origin.
Action Apparel has the opportunity to reducecosts in several critical areas. Estimates for thisexample are shown in Exhibit 5.
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EXHIBIT 4. ACTION APPAREL SUMMARY INCOME STATEMENT
Revenue
COGS
Gross profit
SG&A
Operating income
$2000
$1360
$640
$520
$120
All figures in $000s
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EXHIBIT 5. ESTIMATED SAVINGS POTENTIAL FOR ACTION APPAREL
Cost Element % Improvement Dollar Impact How Achieved
COGS 0.5% $6.8 million
Objective total landedcost calculation, reduced
transportation, and expediting costs
Inventory reduction 16% $32.4 million inventory
reduction
Increasing of inventoryturns from six to sevenper year based on lowerbuffer inventories due toimproved visibility
SG&A Reduction 15% $10.2 million
Process improvementand automation of coretasks reduce overheadcosts from 5% to 4.25%of COGS
EXHIBIT 6. COST IMPROVEMENTS
COGS reduction from improved sourcing decisions and processes: $6.8 million
COGS reduction from reduction in inventories: $6.15 million($32.4 million in inventory reduction times 19% inventory carrying cost)
SG&A reduction: $10.2 million
Total operating expense savings: $23.15 million
To calculate the impact of these improvementson company financial and stock performance,assume a real inventory carrying cost of 19%.This number reflects the combination of noncap-ital inventory costs (warehouse, obsolescence,shrink, damage, taxes, etc.) of 10% and a cost ofcapital of 9%. While each company calculates itsinventory holding costs differently, these num-bers reflect current best practice.
The cost improvements are shown in Exhibit 6,and the total impact on the income statement isshown in Exhibit 7.
With a net profit margin of 6%, this $23.15 mil-lion total cost decrease would provide the sameimprovement in financial performance as anincrease of over $385 million in top-line revenuegrowth. In addition to the substantial improve-ments in the bottom line available to Action
Apparel, equally dramatic results can be realizedin terms of cash flow and, ultimately, sharehold-er value.
The impact on cash flow from operationalimprovements can be calculated, such asincreasing inventory turns and reducing the costof goods. The effect that the improvement incash flow has on increases in stock valuationcan also be measured.
The right investments to improve supply chaincosting can generate significant increases inshareholder value, in addition to improvementsindicated on the income statement. The improve-ments in COGS, SG&A, DSO, inventory turns, andpayables (working capital), all contribute to freecash flow, which in turn affect market capitaliza-tion and thus stock valuation.
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EXHIBIT 7. REVISED ACTION APPAREL SUMMARY INCOME STATEMENT
CurrentWith Global
SourcingImprovements
Revenue $2000 $2000
COGS $1360 $1347.05
Gross profit $640 $652.95
SG&A $520 $509.80
Operating income $120 $143.15
Dollar improvement NA $23.15
Percent improvement NA 19.20%
All figures in $000s
VI I I . MANAGING THE TOTALCOSTS Managing the total costs of global supply chainsinvolves many of the same principles as doesmanaging domestic supply chains. These includeactivity based costing (ABC), process mapping,operational budgets and spend controls, the useof appropriate technology support, and other.The differences, however, are significant, as hasbeen shown in this statement.
First, there is the issue of completeness. Withdirect costs, global supply chains involve highercosts and complexities of transportation; longerlead times; extended uses of working capital;customs, duties, and taxes; and other costs ofmoving and storing goods and inventories. Forindirect costs, as exhibit 3 delineates, a host ofadditional costs are involved that are associatedwith offshoring.
Second, there is the issue of complexity. Globalsupply chains are inherently complex, as theend-to-end points of goods flow initiate inland inone country. Thus there are more uncertainties,more parties involved, higher variability, and high-er volatility.
Third, there is the issue of risk. Domestic supplychains are highly controllable and predictable,while international supply chains have inherentrisks of weather delays; natural disasters; securi-ty and customs delays; acts of terrorism, theft,and counterfeiting; labor actions; congestion atlogistics hubs; currency fluctuations; and others.This issue also requires more intensive manage-ment focus, and improved scenario planning forcost and customer service purposes.
The largest cost of global supply chains is thatassociated with logistics. Containing internation-al freight spend, contracted freight rates, expe-
dited freight, and related costs of moving goods,fortunately, has been facilitated by new andimproved technologies and related data qualityservices.
These new information systems and technolo-gies focus first on visibility and agility; in otherwords, providing shippers and customersimproved views into which shipments are movingthrough the chains and how, where they arelocated, and when they are expected to arrive attheir intended destinations. Global transporta-tion management systems (TMS) exist that pro-vide much of the capability, along with electronicdata interchange (EDI) and web portals asmodes of communication with trading partners.
In addition to TMSs and web portals for tradingpartner information sharing, a new generation of“Global Trade Management (GTM) Systems” hasdeveloped.
These systems enable managers to better con-trol import/export costs, reduce risk and expo-sure to penalties, and comply with the everchanging customs and security regulations inover 150 countries. GTMs also can automatethe information exchanges associated with thecross-border movement of goods, such as ship-ment documentation, customs entry filings,screenings, etc. They also provide necessaryaudit trails for protection of trade privileges andother financial control purposes.
Recent surveys by Aberdeen Research (seeReferences) indicate that increasing internation-al freight costs are the number one cost pres-sure, that improved visibility is the first priority tomanage costs, and that best-in-class companiesare twice as likely as other companies to employa TMS and/or a GTM for managing internationalfreight and the associated costs. This includes
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the capability of tracking “total landed costs”,which was discussed earlier in this statement,as well as the ability to compare these to fore-casted or budgeted costs. As more is learnedabout what actually comprises total landed costs(as described in this statement), it can beexpected that these systems will be expanded.
Controlling or containing other costs—such asworking capital invested in inventories beingmoved and stored—is more complex and lessautomated. This begins with demand-supply bal-ancing (i.e., forecasting what is needed for saleand when) so that purchase orders can beplaced for just the right products or componentsat just the right time. Most ERP systems, andother supply chain solutions, provide support for“sales and operations planning (SOP)”.However, the forecasting process is far from per-fect and safety stocks need to be provided,which increases inventories. Moreover, a com-pany’s logistics strategy and network of facilitieswill determine how goods flow and where theyare stored in global supply chains. Many compa-nies—having now recognized the increasingcosts of global chains—are re-evaluating theirglobal supply chain strategies and networks,hoping to reduce inventories, order to deliverylead times, and excess costs created by lowerinventory turns.
Controlling indirect costs—such as the SG&Aexpenses associated with strategic sourcing andinternational distribution—involves employing sim-ilar methods as that of domestic supply chains,such as planning and budgeting, activity-basedcosting, and expense controls. As mentioned,above, however, the complexities are different withinternational supply chains, as is the need foradditional checking and active management.
As more experience is gained with global supplychains, and quantitiative performance data andbest practices are shared, we can expect bench-marking and best practices services to be moreavailable to companies within industry seg-ments. These will help planners and manage-ment accountants compare and contrast costlevels with others.
IX . SUGGESTED ACT IONS FORGLOBAL SUPPLY CHAIN COSTMANAGERS Determine which global practices are outsourcedin your company and how to improve the manag-ing of costs with the right partners. While mostcompanies outsource anything from the basicprocesses of freight forwarding/customs broker-ing to the total logistics of the business, all toooften the service providers do not collaboratewith their customer enough to provide total land-ed costs and other necessary information. Thisshould be a standard requirement in outsourcingagreements. l Perform the process mapping work mentioned
previously in this SMA. It is very important tounderstand how processes work that controlwhat and how much is sourced, how and whereit flows, and how it is tracked and managedthrough international supply chains. Effectiveprocess mapping will include who does what,when, and where… as well as the performancemetrics that are associated with the process –metrics of cost, time, volumes, and quality(accuracy). After mapping is completed,process models can be defined which delin-eate the work flows and interactions needed.These process models can then be used for:(1) determining process improvements; (2) resource and training requirements; and (3) defining the business requirements to
use for evaluating and selecting technolo-gy investments.
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l Determine the information technologies andsystems most appropriate for your businessprocesses and for collaborating with your trad-ing partners. Regardless of whether your com-pany or your lead logistics provider employ aTMS, you need to have access to its transac-tions and reports. Furthermore, use of GTMwill enable you to better operate cross-bordermovements. This system is probably moreadvantageous to have internally, as long as itinter-operates with your service providers.
l Work on data quality. This issue is challengingeven when an ERP is employed, due to ever-changing data systems and data exchangingamong trading partners, yet it is essential forprocess improvements, which lead to bettercost management.
l Work on total landed costs and total deliveredcosts. These two cost measures serve as thebasis for global strategies as well as supplychain execution. It is critical to adopt the com-plete template for identifying and trackingthese, then plan and forecast them for everysupply chain. Compare and contrast theseamong your product groups, and use outsidebenchmarking services when available.
l Adopt a performance scorecard for your globalsupply chains that tracks actual costs againstplanned and forecasted expenses. This is theonly way to achieve true continuous improve-ment. While plans and budgets can be flexibledepending on events, actual expenditures andcosts incurred—reported in total—reflect thetrue costs of international sourcing and distri-bution. These are essential for considerationsin product pricing and capital expenditures,along with work-class cost management.
X . CONCLUSIONGlobal supply chains are being recognized morewidely as significant generators of higher costs.The continuing increases in international trade,
globalization of sourcing, production, and distri-bution, along with the inherent longer lead timesand complexities, have resulted in serious chal-lenges among financial and managementaccountants to understand and keep up with theoperational changes and their impacts on finan-cial management.
Complete and accurate costing of global supplychains is complex, but it is essential for the plan-ning, budgeting, and control of global supplychains. Complete and accurate costing is funda-mental to understanding company operations andto achieve dramatic supply chain improvements.
As presented in this SMA, management account-ants should gain an understanding of the compa-ny’s global supply chains—their purpose,processes, and geographies—and, with the helpof supply chain managers and logistics serviceproviders, map performance in terms of vol-umes, costs, time, and the key activities thatdrive them. Then management accountantsshould become familiar with the total costs ofglobal supply chains (as shown in Exhibit 3) anddetermine how and where to find or estimatethese costs. Again, supply chain managers andservice providers can be helpful in this process.
Once the total costs are identified, and the keyactivities that drive them are determined, man-agement accountants can advise company man-agers on methods to manage and control them.In many cases, improved business processeswill be needed to better reflect the completenessand complexities of international operations.Also, in most cases, an interdisciplinary team ofmanagement accountants, logistics, supplychain, sales, sourcing and other internal special-ist will be needed, and with the assistance of
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service providers, to develop a working manage-ment model for planning, budgeting, and thenmanaging the total costs.
Improved information technologies are now avail-able that enable better understanding and man-agement of global costs. Management account-ants should assist with evaluating these newersolutions and advising on their selection andapplications to best meet the business requirements.
Next, management accountants should assesstheir supply chain financing providers and oppor-tunities in order to complete the total cost profileof the physical, financial, and information chains.Once these actions are completed, new strate-gies for supply chain cost reduction and profitcontribution can be devised.
REFERENCESAberdeen Group, “The International
Transportation Management Report”.October 2007.
Drewry Shipping Consultants, Survey Results,Container Shipper Insight, May 2007.
Enslow, B . “New Strategies for Financial SupplyChain Optimization,” Aberdeen Research,November 2006.
Enslow, B. “Global Supply Chain BenchmarkReport,” Aberdeen Research, June 2006.
Gilmore, D. and Tyndall, G. “Global CommerceManagement: The Executive Case forOperational Excellence,” Supply Chain Digestwhite paper, 2006.
Hartley-Urquhart, R. “Managing the FinancialSupply Chain,” Supply Chain ManagementReview, September 2006.
Tyndall, G., Gopal, C., Partsch, W. and Kamauff,J. Supercharging Supply Chains: New Ways toIncrease Value through OperationalExcellence, John Wiley & Sons, Hoboken,N.J., 1998.
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