Redefining How The Game Is Played In The Distribution Industry Part Two

1. Redefining How The Game Is Played In The Distribution Industry Part Two

2. Executive Summary • This is Part Two of our thoughts on how the business of the distributor is being redefined. Part One enumerated the five imperatives, which have evolved over the last thirty years, for all distributors. These imperatives are to: • Fully understand the customers’ needs and wants and how those needs and wants change over time, so as to engage your customers over time at a profit; • Only perform those activities that are valued by your customers, suppliers, employees, and other stakeholders; • Continually improve the effectiveness and efficiency of those activities you must perform; • Develop competencies and capabilities in your people, processes and systems; and • Effectively manage your resources • In Part Two, we will focus on the distributors’ stakeholders, in particular suppliers and employees, and how distributors can continually be “in the loop” as to their stakeholders’ changing needs and wants (imperatives 2 and 3). Our focus is not only on identifying the stakeholders’ needs and wants and the activities that satisfy them, but is also on performing those activities over time at a profit. • All distributors are urged to consider how their stakeholder relationships are structured. The traditional transaction based relationship, the “bow tie”, is contrasted with a multi- and cross-functional structure of the “diamond”. The benefit of the diamond structure is illustrated through numerous examples (slides 5 through 14) • Utilizing the diamond structure for its stakeholder relationships, the distributor is positioned to enable its organization to understand the needs and wants of its stakeholders as they change over time. With this insight the distributor can focus its resources only on those activities that enable it to most effectively and efficiently serve its customers over time at a profit. • Continually improving the effectiveness and efficiency of the activities the distributor must perform is a requirement for serving customers over time at the optimum level of profit. This thinking piece offers a high-level road map for the distributor wishing to transition its way of doing business to a longer term view of continuous improvement and activity level management. There is also a caution to the distributor about the role of information technology in the process and activity management. (slides 15 through 20) • Finally, a new overall view of the interrelationships between the distributor and its stakeholders is presented (slide 21)

3. Focusing On The Stakeholders • Part Two addresses the second and third imperatives: • “Only perform those activities that are valued by your customers, suppliers, employees, and other stakeholders; • Continually improve the effectiveness and efficiency of those activities you must perform.” • Our focus will be on the distributors’ stakeholders, in particular suppliers and employees, and how distributors can continually be “in the loop” as to their stakeholders’ changing needs and wants. Our focus is not only on identifying the stakeholders’ needs and wants and the activities that satisfy them, but is also on performing those activities over time at a profit.

4. Serving Stakeholders At A Profit • In order to “Only perform those activities that are valued by your customers, suppliers, employees, and other stakeholders, and then continually improve the effectiveness and efficiency of those activities you must perform,”you must: • Think and act cross-functionally, not only within your own company but across the companies within your channel of distribution; • Continually understand the changing needs and wants of your stakeholders; • Continually act to eliminate or reduce non-valued or less-valued activities, at the same time you add new activities or augment existing activities; • Constantly keep in mind why you are doing the above - to serve your customers over time at a profit. • Effectively manage your resources

5. The Bow Tie And The Diamond • The bow tie and the diamond are graphic depictions of two different ways of doing business • The bow tie represents a transactional approach with one point of contact between the distributor and a stakeholder (slide 6) • This approach optimizes at the point of the transaction • Goals are achieved within a functional silo • This approach is traditional • The diamond represents a systems or team approach with many points of contact between the distributor and stakeholder (Slide 7) • This approach optimizes across the many points of contact within the relationship for a particular series of transactions or a set of transaction types • Optimization considers all dimensions surrounding the transaction, defined as the relationship • Optimization is multi- and cross-functional • Our examples focus on suppliers and employees (slides 8 to 14)

6. Distributor Team Supplier Team Buyer Sales Rep Traditional Supplier Interface The traditional relationship between distributor and supplier looks like a bow tie, with the distributor’s buyer and the supplier’s salesperson at the midpoint of the tie – only communicating directly with each other across the companies. Each of the “opponents” are attempting to reach the best “deal” they can, despite the transaction’s impact on the rest of the organization. For example, the supplier might have a 12-pack on special and the distributor’s customers’ only order 3-packs. The buyer gets a great price per unit, but the warehouse is left the task of repacking the goods into 3-packs. Looking at another dimension of the same transaction, the distributor’s accounts payable department spends a significant amount of time reconciling receiving reports to purchase orders and to invoices because of incomplete information. Because of the lack of the “right” information, the accounts payable detail does not reconcile to the total amounts due as claimed by the supplier. This results in the payments, sent by the distributor to the supplier, having incomplete cash remittance information. This in turn results in the supplier’s accounts receivable department expending additional time reconciling the distributor’s account.

7. Distributor Team Supplier Team --- IT --- - Transportation - -- Product Development -- - Sales/Purchasing - -- Accounting -- -- Warehouse -- Enhanced Supplier Interface A different approach is to turn the bow tie inside out so the interaction with the supplier looks more like a diamond, with a number of points of contact between the companies. There are two benefits with this approach. First, the buying and selling processes become multi-functional. This affords visibility to the impact of buying decisions across the company. In our previous example of the 12-pack special, the receiving department would be able to provide input on the disruption and additional cost required to repackage the goods. This would give purchasing a more holistic context for the buy decision on the special. The second benefit with this approach is the opening of direct communication lines across the points of contact between the supplier and distributor. In our previous example, additional man-hours are being incurred in the account reconciliation process because the accounts payable department of the distributor does not have the “right” information. This lack of the right information is driving behavior in the distributor, which in turn causes additional man-hours to be incurred in the supplier’s accounts receivable department. Opening the communications lines across the companies could eliminate this additional work for both parties.

8. The Diamond And Suppliers The Problem A consumer products distributor owed a large amount to a key supplier, and it was significantly past due. The reason the large balance was in arrears was the numerous unreconciled errors in the account transactions detail, which were attributed to perceived invoicing problems at the supplier. The situation had escalated to the point the supplier slowed its shipments to the distributor and was threatening to stop all shipments until full payment was received. The Cause Both the VP of Sales and the VP of Purchasing were feeling the product squeeze from the supplier and decided to visit the Accounts Payable Manager and Controller. What they heard from the Accounts Payable Manager was that the supplier was not providing the “right” information to support the invoiced amounts. And, no payments would be made of balances not fully supported. The Solution Internal and External Events - The Controller took the lead. He arranged a meeting, with the assistance of the VPs of Purchasing and Distribution, with the buyer assigned to the product line provided by the supplier and with the manager of the Receiving Department. They found that part of the missing “right” information was in the Receiving Department, but the rest of it was with the supplier. (Changes were made in the internal business processes to ensure the right information in house would start flowing to Accounts Payable.) Next, the Controller called the Controller at the supplier. A conference was set for the appropriate Credit and Accounts Receivable personnel at the supplier and the Controller and Accounts Payable personnel at the distributor. At the conference all the details of who had what information were understood.

9. The Diamond And Suppliers Cross-Company Problem Solving and Process Simplification - A week after the conference, a second meeting was held. This meeting included representatives from the Sales Department, Shipping Department and Customer Service Department, in addition to the accounting personnel at the supplier. From the distributor, in addition to the accounting personnel, the Receiving Department manager and Buyer were in attendance. For this meeting, all brought the business process maps from their departments and close attention was focused on the interfaces of information between the departments and the two companies, i.e. between shipping and receiving, between accounts receivable and accounts payable, etc. Glitches were found in the information hand-offs both within and across both companies. Actions were taken to remedy the causes of the errors. The account transaction errors were reconciled, and new business process activities were put in place to ensure the errors do not arise again. While this example is from what may be considered a mundane dimension of the relationship between supplier and distributor, a lack of attention to these details can cause major headaches. Attention to them can result in a stronger more efficient and effective relationship between distributor and supplier.

10. Business Forecast Sales Plan Production Schedule Inventory Plan Order Release Plan Warehouse Plan Demand Information (POS Data) The Diamond And Suppliers The Sought For Advantage A distributor of health care products was operating in an industry segment undergoing rapid and massive consolidation. Competition was cutthroat, cost pressures were monumental. The distributor was looking for ways to create barriers to competitors by leveraging its relationship with one of its primary suppliers. The distributor had access to POS data from a number of its customers, but had not really ever used this information. The Opportunity The distributor and supplier held a series of meetings to identify ways in which they might work together to reduce the total cost of the distributors’ product to his customer. They both understood that the supplier’s lowering of the product acquisition cost (one component of total cost) was not a practical solution for the supplier. The distributor and supplier decided to form a team of IT personnel from both companies. This team took the demand data (POS information) over time and performed a series of sophisticated data mining and analytical exercises. Through this work the team identified consumer purchase behavior patterns within various SKUs, demonstrated during certain days of the week and months. From this work the team created a tool for crafting a sales forecast for over one-half of the SKUs the distributor purchased from the supplier for the distributor’s customers.

11. Business Forecast Sales Plan Production Schedule Inventory Plan Order Release Plan Warehouse Plan Demand Information (POS Data) The Diamond And Suppliers Cross-Company Problem Solving and Process Simplification Next, a team of personnel from the Sales Department of the supplier and the Purchasing Department of the distributor began to review the historic demand data and the results of the IT team’s work. This team compared how the distributor had purchased from the supplier historically, against the amounts the distributor’s customers were actually selling to their customers. They noted how the purchasing patterns were historically out of synch, gaining visibility into both long and short stock positions of the distributor’s customers. They also could see how scheduling their business using the forecasting model (which is based on the weekly demand data) could potentially smooth out the flow of product through the supply chain, reducing inventories for the supplier and distributor. Interestingly, they developed a six-month sales forecast, inventory level and turnover goals for each of them, and a schedule of planned order releases against the sales forecast. They shared each other’s goals and held each other accountable for the attainment of each others goals. The distributor then took this data and analysis to the Distribution Center manager. They began to discuss how the change in product flow patterns would impact the work in the DC. The DC manager began to consider smaller unit, more frequent deliveries from the supplier and began to think of ways the supplier could package the inventory at shipment to make it easier on the DC manager’s receiving and put-away processes. It was decided another team should be created. This team would be made up of the DC managers of the supplier and distributor. The DC manager of the distributor invited representatives of the receiving and put-away work groups to join this team. The DC manager of the supplier invited representatives of the pulling and shipping work groups to join the team. From a series of meetings with this team it was concluded that new product packs could be designed for the distributor. It was also determined that with better information they could eliminate the backorder method of purchasing/receiving and change to a fill or kill method. This not only speeded up the receiving process, but also eliminated major tracking and reconciliation issues in both inventory control and accounting.

12. Business Forecast Sales Plan Production Schedule Inventory Plan Order Release Plan Warehouse Plan Demand Information (POS Data) The Diamond And Suppliers Cross-Company Problem Solving and Process Simplification (continued) Seeing how these teams worked to impact inventory levels, receiving and shipping activities, and the activities in the inventory control and accounting areas, it was decided that cross-company multifunctional communication was good. Accordingly, a weekly telephonic Sales and Operations Planning meeting is now held with representatives of all the departments in both companies to review the weekly sales forecast for the distributor’s customers. Decisions are made from the information shared at that meeting on what product to move through the supply chain and what work to schedule in both DCs. The result is that inventory levels and over-time are both down. Extending the Opportunity Now that the distributor is comfortable managing the flow of product from the supplier to himself, he is getting ready to turn toward his customers. He wants to extend his command over the flow of product and the management of transaction related costs from the supplier to his customer. He wants to anchor his management of product flow in demand planning and be the driver of the supply chain, managing and controlling the information necessary to do this effectively.

13. Distributor Team Supplier Team --- IT --- - Transportation - -- Product Development -- - Sales/Purchasing - -- Accounting -- -- Warehouse -- The Diamond And Employees The gains that can be obtained by effectively and efficiently linking business processes between the distributor and the supplier are very tangible. The gains typically improve productivity, i.e. reduced man-hours of effort per unit of work, lower manning levels, and elimination of unnecessary activities and related work. In addition to the business process efficiencies to be gained, there are less easily measurable gains to be obtained from the employees of both the distributor and supplier. Employees are given an opportunity to contribute to the improved efficiency of their jobs by changing the causes of inefficiency at the source. They are working outside the bounds of their traditional jobs making change to improve the methods used to perform their work. They become ambassadors of the company working for improvements across company boundaries. Relationships are formed; open communications are fostered; and employee satisfaction improves. This environment should have two tangible results. First, the employee turnover levels should decrease. Second, the cross-company relationships should create barriers to entry for other suppliers. This is because the relationship is built around the interaction of a many multi-functional personnel versus one sales person and one buyer.

14. The Diamond And Employees The Situation An industrial products distributor collected warranty returned units from its customers and returned them to the supplier for credit. Returns were picked-up from customers, held at the branch until certain minimum quantities were accumulated, then sent to the regional DC for consolidation with units from other branches, then periodically sent to the main DC for further consolidation and return to the supplier. Transfer transactions were recorded at each step of the physical movement of the units to be returned. These transactions were processed by the distributor’s accounting department moving the inventory from one location to another, and eventually claiming the return to the supplier. The supplier was receiving the returns and issuing the appropriate paperwork to the distributor. This business process had been in place for twenty years. Cross-Company Problem Solving and Process Simplification For the first time, at its annual key supplier meeting, the distributor invited its accounting personnel and the supplier brought its accounting personnel. As the two groups of accountants met, the topic of warranty returns and the laborious process associated with processing the activity at the distributor became the focus of the discussion. As the accountants commiserated, a larger issue emerged, that being, the cost to the distributor to move the returns from the customer through the main DC and on to the supplier. The distributor’s accountants took ownership of the effort to review and change the way returns were processed. After a series of meetings with product, distribution, and transportation personnel at the distributor and product, distribution, and transportation personnel at the supplier, the accountants modeled a new process to transfer returns from the branches directly to the supplier’s DC. In addition to the change in the physical flow of the returns, the accountants also clarified a number of the return “rules” that were complicating the processing activity between the supplier and distributor.

15. Process And Activity Management Eliminate All Activities That Do Not Contribute To Serving The Customer At A Profit Over Time • Eliminate nonvalue added activities • Augment valued activities • Adjust over-performing activities • Allocate resources to critical areas • Part One outlined a technique for mapping customer preferences to activities performed by the distributor. • Elimination of nonvalue activities is required, but all distributors should be adjusting those activities valued by the customer to the minimum levels required by the customer. • It is not the intent of this thinking piece to review the theory of process simplification and management. The next slides will focus on • Presenting a high-level road map that distributors can use to begin to think about the process of activity based management. (slides 16 and 17) • One all to common error made when attempting process simplification. (slides 18 to 20)

16. Focus Define Analyze Improve A Road Map To Change • The focus of process management is on the management of the distributor’s business processes for long-term continuous improvement. Its logic in anchored in only doing the “right” things and doing those things effectively and efficiently. That is, serving the customer over time at a profit. To do this effectively the distributor must adopt a longer-term view of management and adopt a methodology for creating and maintaining the organization’s effort so as to deliver change on a continuing basis. Our suggested methodology is systematic and has four phases. • Focus - There is a familiar story about a blind man feeling around the side of an elephant attempting to determine what it is. Thinking about process management in a distributor is a similar experience. The first step in the methodology is to start to “chunk down” the business processes within the company (assuming you have them defined), identifying those areas where you believe there is opportunity for improvement. Identifying these areas is a big step, for from there you can begin to identify business issues related to the opportunities and to identify who should be responsible for the further investigation. • Define - This second phase in the methodology suggests that the group you have assigned responsibility for further investigation bounds the opportunity for improvement. This means the group more fully describes the designated business process and how it fits across the organization, identifying what the inputs and outputs are, what a standard of performance might be, and what measures would be best to determine if the performance standards are being achieved. • Analyze - This phase is where the suggestions for change arise and are implemented. • Improve - This phase is the continuous improvement phase. The enhanced process is monitored and further opportunities for improvement are identified.

17. Focus Define Analyze Improve • Identify business concerns and opportunities • Obtain input and determine issues • Prioritize issues • Determine processes that effect the issue • Determine responsibility for processes • Deploy to appropriate area of responsibility • For a managed process, describe the process • Establish boundaries of responsibility • Identify standards that address requirements • Develop measures with respect to standards • Streamline/standardize the process • Design data-gathering procedures • Collect data • For each measure, is the process consistent • If inconsistent, address special causes • If consistent, evaluate process acceptability • If acceptable, monitor for opportunities • If unacceptable, monitor for opportunities • Maintain continuous feedback A Road Map To Change The key elements of each of the high-level road map steps in the process management methodology are illustrated above. (Again, this methodology assumes you have your business processes mapped.) Changing the way a distributor does business through impacting business processes is not a two week exercise. This truly represents a change in the way business is viewed and conducted on a day-in and day-out basis. As seen in the diagram, the underlying logic in this way of doing business is as simple as the four steps described and as complex as all the communications and cultural change that underlies the effort. When considering all of the dimensions of change for the distributor, this undertaking will likely seem daunting. As daunting as it may seem, there is likely not an alternative.

18. Technology Is Not The Silver Bullet • Information Technology Does Not Drive Sustainable Competitive Advantage • When asked how distributors can best create sustainable competitive advantage in today’s environment, one immediate response is information technology. • First, competitive advantage is not sustainable. This is relatively easy to see. Just recall Federated Department Stores, Eastern Air Lines, Kodak. None of these organizations had true sustainable competitive advantage. Today, markets continue to redefine themselves and what was good yesterday, does not “carry the mail” today. • Second, information technology makes a difference. It has obliterated former sources of advantage by making customers and suppliers more powerful and by increasing the speed and discontinuity of change. By having this impact, information technology is making process, organizational knowledge and leadership more critical. In fact, the critical and scarce organization resource is now people and the knowledge they carry about how things get done. • People And Business Process Drive Sustainable Economic Improvement • Information technology does not drive business process optimization. While by definition, there are business process and work flow inherent in the logic of software applications, these applications do not rationalize business processes surrounding the applications. • The processes surrounding the applications are those that need to be integrated and focused on serving customers profitably over time. • It is this integration and focus,which drives down the number of errors and the cost of doing business. It is this integration and focus, which ensures information to be used by management for making critical decisions is accurate and reliable. • Process can be rationalized and redirected, then supported by technology, but sustainable economic improvement comes from people serving customers over time at a profit.

19. Technology War Stories Technology to Ensure Timely, Consistent and Accurate Information - A national industrial products distributor with over 300 branches had grown by opening new branches and acquiring other distributors. The company installed the same POS system into the newly opened/acquired branches, but the accounting, purchasing and other primary business functions resided in three different legacy systems. The distributor decided it was time to streamline its business activities in order to eliminate non-essential activities and to improve the accuracy and speed with which transactions were processed. (This was driven by demands from vendors and customers for more timely and accurate information, and by the need to reduce costs.) The IT manager suggested that it was also time to look at new ERP software to replace the different legacy systems. The IT manager suggested that the software installation process be the driver for the changes in business processes across the company. IT consultants were engaged, software was selected and the installation process was initiated. After nine months the system was ready to go live. The switch was flipped, and it was 45 days before the next invoice was generated by the system. The problem was two fold – (1) business processes surrounding the sales and invoicing process/activities were not changed to reflect all of the changes demanded by the new software, and (2) people were not adequately trained in the linkage of business processes and the new system requirements. Technology to Solve Operational Efficiencies - A consumer products distributor was growing rapidly due to tremendous product acceptance and its sales force’s success with a number of large customers. The growth was straining the operations in the distribution center as new customers brought new demands and volumes increased. To remedy the problem, the distributor purchased a new warehouse software application. One-hundred and twenty days after installation, headcount was up, overtime was up and shipments were late. The problem – the bottlenecks and operational strains were not being caused by the old system, but were being driven by the business processes employed by the people in the DC. The old system was just a very visible target to assign blame.

20. Technology Is An Enabler Process People Technology Information technology will not catapult the distributor ahead of others in any reliable way. However, the distributor can find sustainable advantage in process and people. The definition of business processes and the simplification, augmentation and elimination of the activities that make up the business processes will increase transaction speed and lower costs. The building of capabilities within people will enable them to execute the business processes in a way that drives increases in accuracy, speed and customer satisfaction. The integration of technology into the platform of well defined and managed business processes and capable people will bring faster and cheaper information for the people to assimilate into the performance of their business processes. All three: people, processes and technology should help to ensure that customers are served over time at a profit.

21. A Shifting Mindset The distributor’s view of his business and the roles of all of those in the channel with him are being redefined. And, the rate of this change is increasing. A primary driver of this change is the estimate that $.25 of every dollar expended in the supply chain is expended on redundant activities. The major cost components of these activities are: inventory holding costs, selling costs, and transaction costs. The potential cost efficiencies to be gained by rationalizing and optimizing these areas are too great to be ignored. The signs that this change is upon distributors can be seen in the current emphasis in the literature and by consultants on demand planning and in the boundary spanning software applications which are being introduced. If the distributor does not take the lead in driving this change, the supplier or the customer will. If this occurs, the fate of the distributor will become even more tenuous.

22. MAY WE BE OF ASSISTANCE Berling Associates has been providing an array of proven services to the distribution industry for over 25 years. Our perspective, forged over time, can assist executives to redefine how they play the game.

23. CONTACT INFORMATION Rob Berling Berling Associates 550 Pharr Road Suite 212 Atlanta, GA 30305 Tel. 404.365.9836 Fax. 404.365.9837 Email: rberling@berlingassociates.com Website: www.berlingassociates.com