Understanding cost-value payoffs in global supply chains

Parts of a supply chain are uniquely endowed; the procurement-heavy part is distinctly different from the customer-heavy part. If the same principles that created success in the former are applied in the latter, it would be a disaster.

The difference between these two lies in the understanding of stakeholders. It is also entrenched in the cost-value payoffs.

A global supply chain spanning several countries and continents have a range of stakeholders to be dealt with, some of them are internal and some external; customers and suppliers form the bulk of the external constituencies with whom relationship is built to create long lasting value.

When you are an exporter, you are moving your produce to a foreign country where you would have to develop the market for your produce. It involves cost to develop these markets, which comes from investments in relationship of all kind.

The economists would see this as a sunk cost, market development costs in a foreign market, as these costs cannot be transferred once the product is withdrawn from that market and moved to some other market.

But it is because of this sunk cost that exports move at a phase lag and respond far too slowly to price signals. Take for example that there is so much talk about tariff barriers and non-tariff barriers but is there any change in the trajectory of prices because of this so-called headwind? Well, no, because the prices are way too sticky because prices take time to adjust even when tariffs are changed.

It is simple to understand. Think of a market where a lot of goods are bought and sold where the original manufacturer could be residing in distant countries. If any change in tariff happens, the end consumer prices do not change dramatically as producers are cautious that there would be a change in demand if prices change abruptly. Thus trade responds slowly to tariff changes.

It is only in markets where there is presence of large monopolies that prices change instantly to the tariff suggestions.

Exporters develop new markets through two kinds of investments, one is on the marketing side which involves building of relationships and the other is on the product R&D side, where applications are constantly researched to provide a unique differentiation. Once these costs are expended, they remain sunk in the market to produce unique value for the long term.

Exporters entering new market also find new partners for sourcing part of their product or service. This is how procurement centers are formed that provides value for sourcing for many other markets.

But if you have an unique offering, you could create enormous value advantage from that offering itself that insulates you from the vagaries in the chain in terms of tariff changes. This is a classic case where the customer-heavy part is making an allowance for the procurement-heavy part.

Parts of a supply chain are uniquely endowed; the procurement heavy part is distinctly different from the customer-heavy part. If the same principles that created success in the former are applied in the latter, it would be a disaster. Therefore it is important to segregate one part from the other and find the unique features that differentiate the value elements from the cost elements.

Cost and value is inter-changeable but while value is multi-dimensional, cost is not. To convert cost into value one must fully construct the pay-off matrix.

Think of the procurement heavy part of the chain, where most of the costs are embedded. On one hand this is the part which has 80% of the costs of a value chain, but it is also the part that drives the maximum value. The value stems from creation of unique competitiveness which otherwise would have been the source of brazen mundane-ness.

The real value of this upstream part of the chain stems from either resource advantages as in mining and metals or from innovations in R&D as in consumer products. For resource heavy supply chains logistics becomes the only driver for value.

Think of the automotive value chain and you will see this unfolding in a myriad of ways. Every automaker has almost the same number of items in the BOM for an equivalent model (some innovative car makers may be having less or more depending on the cost-value payoff matrix). But the cost-value payoff matrix is different for each one of them thanks to innovation.

It is this cost-value matrix that differentiates Toyota with Ford, or GM with VW.

But this is an optimization that touches multiple constituencies from suppliers to employees at large. The decision to replace an item or a supplier is never an easy one. Any change in supply conditions or the product conditions comes with an associated risk. The pay-off matrix would need to be re-constructed and reassigned.

When cost engineering efforts are underway, the new matrix almost always shows up a new total value for the effort. While gauging the effort, the best we can do is paying attention not just on the cost numbers, but the overall change in the value. That is how value needs to be ascertained in a supply chain. Sometimes small changes in costs could give large changes in the value equation.

The customer-heavy part of the supply chain deals with delivery and all its associated endeavors. This is a part that gets neglected the most. The cost of lost sales for every element of service is where the value is embedded.

 

This is my second article on Value in Global Supply Chains.