Supply Chain Management: Removing Cost from your Supply Chain

Opportunities galore when it comes to pruning down cost in Supply Chains. Firms focus both internally i.e. within their own house and also externally by partnering with their customers and suppliers. But in their singular objective to cut cost, firms often focus narrowly and tend to forget that cost cutting initiatives ought to apply to the whole chain. If a firm benefits at the expense of its suppliers and/or customers, it is power play and gaming at its best (and supply chain partnerships at its worst).

In this context, we often come across a widely quoted analogy. Pardon me for repeating it, but it serves to drive home the point. Aren’t we all particular about keeping our premises clean? But would we do that at the expense of our neighbour’s premises? We better not!! Just imagine, collecting the garbage from our home and dumping it clandestinely into our neighbours’ premises. And since we happen to own the biggest house in the neighbor-hood and thus carry the “big guy” tag, our neighbors take this transgression mutedly.

To lend credence to this analogy, let me recount a case we came across on one of the FMCG majors in India. Facing tremendous pressure on its margins due to stiff competition, the firm aggressively focused on reducing its working capital cycle (the time elapsed between paying its suppliers and receiving money from its customers). Knowing that a reduction in working capital leads to an increase in cash flows besides freeing up capital for investments, the firm aimed for a zero, if not negative, cash cycle. Thanks to its aggressive culture, it achieved its goal and as was expected, showered with praises on effectively managing its supply chain. But a closer scrutiny of its balance sheet revealed that the firm engaged in sheer power equations with its suppliers. While the firm reduced its inventories (kudos to it for doing so), the bulk of the reduction in working capital was as a result of extracting greater credit terms from its relatively smaller suppliers. Such was the extent of the increase in credit that the firm’s operations were, in effect, financed by its suppliers.

While the firm managed to clean its premises, it effectively increased the overall cost of the supply chain. How? Simply because the cost of capital for a small unknown firm (in our case, the suppliers) is much more than that of a major and established name (the FMCG major). Certainly the suppliers would have found another way of recouping the higher cost – either through higher margins or through longer-term contracts. In as much the same way as our dumping on our neighbors premises would dirty the neighborhood and bring a bad name to it; causing the real estate prices to fall. Guess who would take the maximum hit – the biggest house naturally.

The moot point – before embarking on cost cutting initiatives, do consider its impact on the entire supply chain (the big picture view). And be well aware that if you opt for power equations instead of supply chain partnerships, you are bound to get hit sooner or later via some other way.