Financial Optimization of Supply Chains

Dollars of profits and losses are the only metric that matter in the long run for any company. At Lokad, we emphasize a strict financial optimization of the supply chain. This approach should not be confused with short-sightedness and other kinds of pseudo-rational methods which are prevalent when finance gets in charge of the strategy. This approach goes against the idea of service levels, and most of the other KPIs similarly defined through percentages.

Most of the problems in supply chain are driven by its tail - it’s the unexpectedly high demand that generates stockouts, and it’s the unexpectedly low demand that generates inventory write-offs. In the middle, things tick over just fine; inventory rotates gently and asset utilization is more or less what it’s expected to be. At the tail, things can get ugly.

Focusing on service level does take consequences at the tail into account, but not fully. Therefore, we realized that in order for an efficient, thorough optimization to take place, a target is needed. A target that is unified and cross-functional for the company, which led us to understand that putting a monetary figure - be it Dollars or Euros - against each supply chain decisions was the way to go.

How does this work in practice exactly? For example, if you decide to pass a purchase order to one of your suppliers, this means that you are anticipating some sort of future demand, which may or may not come to be due to multiple uncertainties. Therefore, to analyze the profitability of this decision, you can then look at the cost of the purchase, the payback in terms of generated margins, stockout penalties, inventory write-offs, carrying costs, etc. These are mundane supply chain actions, undertaken daily, that all carry a cost.

However, the industry remains highly focused on service levels as a major KPI. To conclude, we go into more detail about why this is an inefficient approach and yet why it is still so prevalent within supply chain nowadays. We understand that it can be a huge undertaking for companies to begin a supply chain optimization that is pushed by financial drivers, so we discuss just how this can be achieved.

Timestamps

00:08 Introduction

00:28 What is the idea behind the financial optimization of supply chains?

05:20 Why is it so important to take this dollar driven approach?

06:31 Why is the industry so focused on service levels? Why are they such an important KPI?

08:57 Why is the dollar driven approach so important?

10:25 Why isn’t the use of economic drivers more standardised across companies?

14:01 If doing a financial analysis is such a big challenge for large companies, what are the areas they need to target then? Where should they start?

18:29 What is the benefit of moving to an economic lead approach? How much does it change the processes of a company?

21:15 Why shouldn’t an employee be intimidated by the inherent complexity of a financial optimization?