safeguard and build resilience in your supply chain

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WHITE PAPER

Safeguard and Build Resilience in Your Supply Chainby The Hackett Group

Does your team have the supply chain visibility, resilience and agility to succeed in the next normal?

This whitepaper by The Hackett Group outlines a practical action plan to fast track the process of optimizing your supply chain. Responding to critical supply chain challenges and creating earlier and better visibility will build the resiliency necessary to mitigate negative impacts and allow companies to quickly bounce back and recover. This requires a keen focus on improving gross margin, reducing costs, managing COGS, protecting from further supply disruptions, managing demand and improving working capital.

Safeguard and Build Resiliencein Your Supply ChainAngela Caswell-LaPierre, Sean Kracklauer, Joshua Nelson, Erik Dorr, Laura Gibbons

BUSINESS DISRUPTEDComplimentary research

The Hackett Group I Supply Chain Resilience I 2© 2020 The Hackett Group, Inc. All Rights Reserved.

The coronavirus pandemic crisis has swiftly swept the globe, with profound effects on the economy, corporate financial positions and supply chain continuity. Impacts and implications have varied widely by industry and even among companies within a sector. The fallout from the pandemic has revealed a dire need to improve visibility across the supply chain, analyze and secure supply, and develop greater agility for adjusting to significant demand shocks.

The immediate response has generally been reactive, requiring decision-making with ambiguous and incomplete information to manage day-to-day disruptions throughout the supply chain. This ad hoc approach has been essential for getting through the crisis, but it isn’t sustainable.

As companies reopen for business, they must be prepared to ensure resiliency in supply chain operations over the medium and long term. Safeguarding measures are part of a broader set of business continuity planning actions designed to keep the business running by ensuring call centers, factories, distribution centers and other services can sustain day-to-day operations.

As we turn the corner during this crisis, companies must proactively plan their recovery and restoration of operations. The recovery path will not be linear. Many companies will face periods of supply and demand imbalance as they begin to resume complex operations at full capacity. It will be critical to reach a new equilibrium with supply chain visibility, resilience and agility to succeed in the next normal.


1 2 3

Stabilize the supply chain. Build resiliency across the supply chain network.

Optimize for supply chain agility.

Stabilize operations (geographic, manufacturing, distribution and supplier footprint).

Move to more granular market-specific forecasts and scenario planning, with weekly refreshes and daily pulse checks for key/significant markets.

Assess inventory coverage across the extended supply chain to identify or predict supply issues.

Improve visibility across the extended supply chain, including first- and second-tier suppliers, to provide a view of product and component availability.

Strengthen ability to manage demand shock.

Realign supply chain footprint based on new demand patterns (e.g., manufacturing footprint, contract manufacturing and alternative distribution channels).

Build multiyear cost and capacity models to optimize the network.

Develop greater flexibility on existing production lines.

Build real-time decision-making capabilities.

Develop a supply base with multiple supply options using standardized production capabilities.

Three near-term imperatives

Optimize production capacity.

Standardize, automate, and optimize processes to improve cycle times and efficiency.

Develop global manufacturing footprint with regional tiering/leveling.

Develop an integrated sales and operations planning (S&OP) process to optimize production and distribution capacity.

Develop strong working capital measurements/key performance indicators.

Institute strategic supplier and direct material management.


In a recent analysis of product-centric industries (see page 6 for more detail), The Hackett Group found that for a typical company,1 cost of goods sold (COGS) as a percentage of revenue is 76%. Our analysis indicates companies will see revenue decline by an average of 21%, which represents COGS of $1.63 billion. We estimate that companies with a highly variable COGS structure will be able to reduce their COGS base by 80% of this number, or $1.3 billion. This translates into gross margin deterioration of $330 million, or 3.3% of revenue. Companies with the least variable COGS structure can only reduce their COGS base by 60%, or $982 million, resulting in gross margin deterioration of $655 million, or 6.6% of revenue.

Managing COGS is critical, but there is more to be done. As companies overcome demand shocks and resulting supply disruptions and move into the next normal, they will need to resize their enterprise cost structure and normalize operational actions to build resilience in the medium and longer term. Beyond normalizing and rightsizing their COGS base, organizations also need to consider scaling down with declines in revenue and aligning with new business expectations. Other relevant steps include rationalizing the manufacturing and distribution footprint, as well as structurally changing manufacturing operations, defining alternative distribution channels, standardizing production capabilities, and optimizing the end-to-end supply chain across manufacturing, logistics, distribution, supply, and customer bases.

Responding to critical supply chain challenges and creating earlier and better visibility will build the resiliency necessary to mitigate negative impacts and allow companies to quickly bounce back and recover. This requires a keen focus on improving gross margin, reducing costs, managing COGS, protecting from further supply disruptions, managing demand and improving working capital. Fig. 1 on the following page outlines steps for mitigating critical challenges.

1 The cost-savings opportunity calculation is based on a company with $10 billion in annual revenue.

Targeting the next normal


IF THE GOAL IS TO: COMPANIES WILL NEED TO:

Improve gross margin

• Improve demand forecasting to be more frequent and granular, confirm inputs, and incorporate predictive modeling. • Assess pricing, price leakage and discounting models.• Evaluate revenue and margin impacts of leading demand scenarios.• Generate and prioritize response options through targeted cost controls and operating model changes.

Reduce costs rapidly

• Review sales, general and administrative (SG&A) costs surgically to identify cost savings and replace highly fixed with more variable cost structures.

• Redefine sourcing and procurement policies and practices to reduce direct and indirect spend. • Develop and implement zero-based budgeting techniques.

Reduce cost of goods sold

• Eliminate waste in operations, including yield and efficiency losses.• Redefine supply and distribution network configuration to improve asset utilization and reduce total landed costs.• Reconsider specification management (e.g., raw material specification and manufacturing tolerances).• Manage strategic supplier and direct material management.

Protect against critical supply disruptions

• Identify end-to-end inventory coverage for raw materials, work-in-progress, in-transit and finished goods.• Mitigate supply constraints (capacity reallocation, product redesign, substitutions and alternate supply points).• Evaluate supply risk across all categories and suppliers, beginning with the most critical components/ingredients.• Increase use of external data to evaluate supplier risk and predict future supply shortages.• Define and negotiate alternative inbound transportation modes (e.g., air transport).• Build manufacturing redundancy across network to hedge against geography-specific supply disruptions.

Manage volatile and uncertain demand

• Increase frequency of S&OP meetings and augment with scenario planning capabilities, building external data into planning.

• Collect regional pandemic data to assess geography-specific demand shocks. • Delay final product configuration (e.g., bulk and custom pack size at distribution locations).• Leverage outsourcing providers (e.g., contract manufacturing).

Improve fixed and working capital asset effectiveness

• Improve S&OP changes designed to integrate sales, operations, and finance.• Improve asset effectiveness, including utilization and efficiency improvements.• Reduce cash conversion cycle through payables, receivables and inventory management optimization.

FIG. 1 Critical supply chain challenges


2 Revenue decline ranges and industry segmentation placement are based on a sampling of company and analyst earnings forecast updates, investor communications, and industry trade group sales impact assessments from the coronavirus pandemic and the most likely recovery scenarios post-crisis. To perform this analysis, we used the midpoint of revenue change for each of the two industry categories – 30% decline for significantly impacted and 15% decline for moderately impacted. For some industries and companies, however, the actual revenue impact for the 2020 calendar year may be far greater. Industries for which no revenue decline is projected are excluded from this analysis since differences in variability of COGS structure will not impact gross margin in these industries.

The case for building high variability

PRE-CRISIS GROSS MARGIN GREEN BAR GRAY BAR RED BAR COGS IMPROVEMENT STAKE

Median industry-level gross margin prior to coronavirus crisis, based on 2019 publicly available financials

Estimated gross margin for companies with a highly variable COGS structure – capable of reducing COGS to 80% of revenue decline

Estimated gross margin for companies with mod-erate variability COGS structure – capable of reducing COGS to 70% of revenue decline

Estimated gross margin for companies with low-variability COGS structure – capable of reducing COGS to 60% of revenue decline

Opportunity stake in moving from moderate to high COGS variability (in $M)

The revenue impact of the disruption may range from minimal in some industries to a reduction of more than 40%. Furthermore, the impact will extend beyond this year – if not permanently for some industries. Businesses must account for this in their long-term strategic plans and accelerate implementation. A key challenge will be scaling down the COGS base and creating a more variable COGS structure to manage through high uncertainty about future demand.

The Hackett Group has modeled estimated 2020 revenue declines and their impact on gross margins versus 2019 performance across two broad industry categories,2 significantly and moderately impacted, based on high, moderate, or low COGS variability – that is, the ability of COGS to rise or fall at a rate similar to revenue change. A highly variable COGS corresponds with the ability to immediately scale down COGS to a level of 80% of the revenue decline. For a low variability COGS, the number is 60%. The moderate scenario is 70% downward scalability of COGS with revenue decline. In Fig. 2-3 (see pages 7, 9 and 10), the industry categorization and related revenue decline ranges provide a directionally accurate view of the near-term impact on revenue and the resulting impact of COGS variability on gross margin.


FIG. 2 COGS variability analysis – significantly impacted industries (20%-40% decline, 30% midpoint)

COGS variability gross margin impact analysis

Gro

ss m

arg

in

$M = additional gross margin value for a typical $10B company within industry segment to optimize for high COGS variability

FIG. 2 COGS variability analysis – industries with significant revenue impact (20%-40% decline, 30% midpoint)

MODERATE COGS VARIABILITY LOW COGS VARIABILITYHIGH COGS VARIABILITY

Automotive parts &aftermarket

Post-crisis gross margin:

Pre-crisis gross margin:

General & specialty retail

Motorvehicles

Office equipment,services & supplies

Oil & gas

23.0%

6.8%

1.8%

11.6% 12.3%

9.1%$250M

$210M

$250M

$220M

$250M

9.8%

20.8%

4.3%

16.7%

25.7%

17.3%

27.2%

11.8%

6.6% 7.3%

18.6%17.5%

21.7%

19.6%

0%

5%

10%

15%

20%

25%

30%


Industries in the significantly impacted category (Fig. 2 on page 7) have been the hardest hit by the pandemic, with forecasted revenue declines that, in some cases, exceed a 60% drop month-over-month from February 2020 forward. In particular, the automotive industry is facing extreme business disruptions due to collapsing consumer demand, and the oil and gas sector, already suffering under a trade war, is now grappling with lower demand and massive supply gluts across the entire downstream distribution network.

The following example uses the automotive industry to illustrate the analysis:

To summarize this example, automotive companies with highly variable COGS – a reflection of variable cost structure and superior supply chain management capability – can mitigate the impact of revenue decline on gross margin and achieve a $250 million gross margin advantage over companies with moderate variability in their COGS. This competitive advantage will remain for a considerable duration because companies with high fixed costs will require substantial effort and time to restructure the supply chain through manufacturing facility reduction, distribution facility consolidation, asset divestitures, use of contract services, and other structural changes.

PRE-CRISIS GROSS MARGIN GREEN BAR GRAY BAR RED BAR COGS IMPROVEMENT STAKE

Median industry-level gross margin for the automotive in-dustry prior to the coronavirus crisis is 16.7%.

Automotive companies with highly variable COGS structure can eliminate 80% of COGS associated with projected 2020 revenue decline of 30%, result-ing in a gross margin target of 11.6%.

Automotive companies with typical variability in COGS structure can eliminate 70% of COGS associated with projected 2020 revenue decline of 30%, resulting in a gross margin target of 9.1%.

Automotive companies with low variability in COGS structure can eliminate 60% of COGS associated with projected 2020 revenue decline of 30%, resulting in a gross margin target of 6.6%.

Automotive companies have a $250 million opportunity by moving from a moderate to a highly variable COGS structure.


FIG. 3 COGS variability analysis – moderately impacted industries (10%-20% decline, 15% midpoint)


Gro

ss m

arg

in

FIG. 2 COGS viability analysis – industries with moderate revenue impact (10%-20% decline, 15% midpoint)

Aerospace &defense

Chemicals Computer hardware &peripherals

10.9%

18.7%

13.5%

25.1%

27.6%

21.3%

16.3%

9.6%

17.6%

12.3%

24.1%26.6%

20.2%

15.1% $120M

$100M

$100M

$100M

$120M

$130M

$110M

13.3%

20.7%

15.9%

27.3%

29.6%

23.7%

18.6%

8.3%

16.5%

11.1%

23.1%

25.6%

19.1%

13.9%

0%

5%

10%

15%

20%

25%

30%

35%

Consumerdurables

Containers &packaging

Electricalproducts

Electronicequipment


MODERATE COGS VARIABILITY LOW COGS VARIABILITYHIGH COGS VARIABILITYPost-crisis gross margin:

Pre-crisis gross margin:


FIG. 3 COGS variability analysis – moderately impacted industries (10%-20% decline, 15% midpoint) (continued)


Gro

ss m

arg

inFIG. 3 COGS viability analysis – industries with moderate revenue impact (10%-20% decline, 15% midpoint)

Machinery Metals &mining

Pulp, paper &forest products

Semiconductors &equipment

Telecommunicationsequipment

0%

5%

10%

15%

20%

25%

30%

Textiles, apparel &footwear

42.9%

$80M

12.9%

$130M10.3%

9.0%7.7%

14.2%

$120M11.6%

10.4%9.2%

34.1%

32.1%31.2%30.3%

24.1%

21.8%

20.7%19.6%

$110M

40.8%

$90M

$80M

41.3%40.5%39.7% 39.2%

38.4%37.6%

35%

40%

45% 42.9%

$80M41.3%40.5%39.7%

14.2%

$120M11.6%10.4%

9.2%

34.1%

32.1%31.2%

30.3%$90M

24.1%

21.8%20.7%

19.6%$110M

40.8%

$80M39.2%

38.4%

37.6%

12.9%

$130M10.3%9.0%

7.7%


MODERATE COGS VARIABILITY LOW COGS VARIABILITYHIGH COGS VARIABILITYPost-crisis gross margin:Pre-crisis gross margin:


In contrast, moderately impacted industries (Fig. 3 on pages 9 and 10) are not suffering catastrophic revenue losses across their entire business but may have certain business segments that are under stress. An example is the aerospace and defense industry, where canceled and deferred orders are affecting the commercial airline segment, while the defense industry is largely insulated due to the longer-cycle federal procurement process. Another example is the computer, hardware and peripherals industry, where decline in investment due to depressed demand conditions in the economy is partially offset by demand driven by infrastructure upgrades needed to support large-scale transition to working from home and cloud migrations. Assuming a revenue decrease of 15% for the year, companies in this category should be able to realign their COGS with lower demand and make deliberate changes to support business segments with 2020 growth prospects.

However, companies with low-variability COGS are more likely to face financial and operational distress. As a result, there may be major shifts in the competitive landscape and a renewed focus on mergers and acquisitions due to differentials in COGS variability and strength of the balance sheet. Companies may make strategic investments that enable them to repurpose assets for alternative products and services that are experiencing demand growth. Finally, companies may make longer-term structural changes to their operating model – consolidating manufacturing and distribution facilities, selling excess capacity, and/or moving production to contract manufacturers.

This analysis underscores the importance of accelerating actions to manage through the ongoing supply and demand shocks and build the supply chain resilience needed to thrive in the next normal. This will require understanding how to align the COGS with projected revenues in a new economic reality. Medium- and longer-term plans should rationalize supply chain capabilities based on new demand patterns and revised revenue. While creating greater elasticity in the cost base is a critical objective, companies must also invest in capabilities that will provide them with a competitive advantage.


Here’s how

+ +

Collect data to baseline performance

• Review demand sensing and predictive modeling capabilities.

• Assess geographic footprint, manufacturing scalability and ability to rapidly retool.

• Evaluate distribution network flexibility and redundancies.

• Understand baseline operations capabilities and cost structures.

• Review key cost drivers and their variability.

• Define upper- and lower-bound demand scenarios (product line, geography, channel, distributor pull through and inventories).

Identify areas of high opportunity that can be achieved rapidly

• Identify throughput/volume rightsizing opportunities.

• Generate heatmap of third-party opportunities.

• Evaluate and define direct material opportunities.

• Determine logistics optimization opportunities.

• Confirm SG&A optimization opportunities.

• Define organizational changes and tools to increase supply chain agility.

• Identify plans to ensure end-to-end inventory coverage across the extended supply chain.

• Review and create initiatives to optimize the S&OP process.

Launch cross-functional team to execute near-term and midterm supply chain improvements

• Frame supply chain optimization improvements, sequencing quick wins to longer-term initiatives.

• Establish the baseline metrics used to measure ongoing success.

• Outline scenarios with financial impact and expected benefit.

• Frame risks for implementation, and create and implement mitigation strategies.

• Structure and launch teams to address each major opportunity area (plan, source, make, deliver).

2 weeks 2 weeks 2 weeks

Baseline – assess next normal readiness Map and gap – define the targets Execute the plan – pull the levers

Fig. 4 outlines a practical action plan to fast-track the process of optimizing your supply chain. In weeks rather than months, you will be able to frame an action plan to execute near-term and midterm improvements that safeguard your supply chain, while also building the resiliency necessary to navigate through future challenges. This approach is designed to rapidly transition from planning to implementation.

FIG. 4 Action plan for building supply chain resiliency


About the authors

Joshua Nelson has 20 years of experience as both a consultant and an executive at multiple Fortune 100 companies.

He specializes in leading supply chain, operations, finance and commercialization teams to deliver solutions for large and complex opportunities. Joshua has demonstrated capabilities and experience leading strategic and tactical initiatives to create service delivery models inclusive of new technology solutions.

Angela Caswell-LaPierre has over 20 years of industry and consulting experience. She has particular expertise in

leading and integrating global business services operations, global finance transformation projects, enterprisewide transformation management offices, global SAP enterprise resource planning system implementations, process reengineering, change management, and enterprise cost reduction programs. Before joining The Hackett Group, Angela held senior leadership positions at Johnson & Johnson, Pfizer and Interpublic Group, and has directed a number of engagements for Fortune 500 companies undergoing transformational change.

JOSHUA NELSON

Associate Principal, Strategy and Business Transformation

ANGELA CASWELL-LAPIERRE

Principal, Strategy and Business Transformation

Over the past 20 years, Sean Kracklauer has advised Global 1000 businesses on strategy, organizational structure and

process redesign. He has worked extensively in finance strategy, business performance management, planning and budgeting, financial reporting compliance, and functional design for business intelligence systems. His fields of expertise include leading large-scale cross-functional projects to improve the effectiveness and efficiency of general and administrative service delivery by identifying the optimal strategy, structure, sourcing and enabling technologies to achieve business objectives. Sean has served clients, with revenue from $5 million to over $100 billion.

SEAN KRACKLAUER

Principal, Strategy and Business Transformation


The Hackett Group1000 Abernathy Road NESuite 1400 Atlanta, GA 30328

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About the authors

Laura Gibbons has industry and consulting experience in areas such as purchase-to-pay, strategic sourcing, payment strategies,

manufacturing operations, economic impact analysis, and organizational and process design. She previously worked in The Hackett Group’s Strategy and Operations consulting practice, where she specialized in sourcing, procurement and supply chain. Before joining The Hackett Group, Laura served as strategy and operations associate at Groupon.

LAURA GIBBONS

Senior Research Director, Procurement Executive Advisory Program

Erik Dorr has over 20 years of experience in consulting, research, and advisory roles in information technology

strategy, enterprise application suites, and business process reengineering. Before being named to his current position, Erik was senior enterprise research director. Prior to joining The Hackett Group, he held a number of senior management positions, including vice president of IT at a global manufacturing company, where he was also a member of the executive leadership team.

ERIK DORR

Vice President, Research

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