Safeguard and Build Resilience in Your Supply Chain

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.

Targeting the Next Normal

In a recent analysis of product-centric industries, The Hackett Group found that for a typical company, cost of goods sold (COGS) as a percentage of revenue is 76% (The cost-savings opportunity calculation is based on a company with $10 billion in annual revenue.). 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.

Critical Supply Chain Challenges

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.

The Case for Building High Variability

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.

Moderately impacted industries 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 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.