Logistics & Supply Chain Management PDF

CHAPTER 2 LOGISTICS AND CUSTOMER VALUE Chapter outline 1. The marketing and logistics interface 2. Delivering customer value 3. What is customer service? 4. The impact of out-of-stock 5. Customer service and customer retention 6. Market-driven supply chains 7. Defning customer service objectives 8...

CHAPTER 2 LOGISTICS AND CUSTOMER VALUE Chapter outline 1. The marketing and logistics interface 2. Delivering customer value 3. What is customer service? 4. The impact of out-of-stock 5. Customer service and customer retention 6. Market-driven supply chains 7. Defning customer service objectives 8. Setting customer service priorities 9. Setting service standards 2 The marketing and logistics interface Marketing as the management of the ‘Four Ps’ – product, price, promotion and place Two factors have perhaps contributed more than anything else to the growing importance of customer service as a competitive weapon 1- One is the continual increase in customer expectations; in almost every market the customer is now more demanding, more ‘sophisticated’ than he or she was 2- The second factor is the slow but inexorable transition towards ‘commodity’ type markets. 3 Delivering customer value the success or failure of any business will be determined by the level of customer value that it delivers in its chosen markets. Customer value as the difference between the perceived benefits that flow from a purchase or a relationship and the total costs incurred. Another way of expressing the idea is: ‘Total cost of ownership’ rather than ‘price’ is used here because in most transactions there will be costs other than the purchase price involved Example: inventory carrying costs, maintenance costs, running (operational) costs, disposal costs and so on. 4 Figure 2.1 shows the ‘iceberg’ effect of total costs of ownership where the immediate purchase price is the only aspect of cost that is visible, whereas below the surface of the water are all the costs that will arise as a result of the purchase decisions. 5 One way to define ‘competitive advantage’ is simply that the successful companies will generally be those that deliver more customer value than their competitors. In other words, their ratio of benefits to costs is superior to other players in that market or segment. Logistics management is almost unique in its ability to impact both the numerator and the denominator of the customer value ratio. This point becomes clearer if we expand the ratio as follows: 6 Each of the four constituent elements can briefly be defined as follows: Quality: The functionality, performance and technical specification of the offer Service: The availability, support and commitment provided to the customer. Cost : the customer’s transaction costs including price and life cycle costs Time the time taken to respond to customer requirement, e.g, delivery lead times Each of these four elements requires a continuous programme of improvement, innovation and investment to ensure continued competitive advantage. 7 and mining Example industries. Caterpillar has for many years focused on developing not just its manufacturing capabilities and innovative products but also its customer support and responsiveness. Underpinning these initiatives has been a continuing emphasis on creating superior logistics and supply chain management capabilities. Caterpillar has developed a world-class reputation for customer support, in particular its guarantee to provide 48-hour availability of parts no matter how remote the location. In the industries where Caterpillar’s equipment is used, the cost of ‘downtime’ can be significant, hence the importance of responsive service. Through close partnership with its worldwide network of dealers and distributors and through 8 advanced inventory and information management systems, Caterpillar What is customer service? the role of customer service is to provide ‘time and place utility’ in the transfer of goods and services between buyer and seller. 1. The pre-transaction elements of customer service relate to corporate policies or programmes, e.g. written statements of service policy, adequacy of organizational structure and system flexibility. 2. The transaction elements are those customer service variables directly involved in performing the physical distribution function, e.g. product and delivery reliability. 3. The post-transaction elements of customer service are generally supportive of the product while in use, for instance, product warranty, parts and repair service, procedures for customer complaints and product replacement. 9 Table 2.1 indicates some of the many elements of customer service under these three headings. 10 It is because of the multivariate nature of customer service and because of the widely differing requirements of specific markets that it is essential for any business to have a clearly identified policy towards customer service. 11 The impact of out-of-stock cost penalty is incurred by both manufacturers and retailers when a stock-out occurs on the shelf. The research found that on a typical day a shopper in the average supermarket will face stock-outs on 8 per cent of items in the categories studied. The reaction of customers when faced with a stock-out was highlighted by the same study. 12 13  In industrial markets, too, the same pressures on purchasing source loyalty seem to be at work. It is perhaps not surprising that as more and more companies adopt ‘just-in-time’ strategies, with minimal inventories, they require even higher levels of response from suppliers.  The demand is for ever shorter delivery lead times and reliable delivery. The pressure on suppliers is further increased as these same customers seek to rationalize their supplier base and to do business with fewer suppliers.  Becoming a preferred supplier in any industry today inevitably means that a high priority must be placed on delivering superior customer service. 14 um o w h s, ne od ne eo go o y m e m e it so th so od t m is ses is en er r u er com o m e ym  The impact of both a strong consumer franchise and a customer franchise can be enhanced or diminished by the efficiency of the supplier’s logistics system.  It is only when all three components are working optimally that marketing effectiveness is maximized.  To stress the interdependence of these three components of competitive performance it is suggested that the relationship is multiplicative.  In other words the combined impact depends upon the product of all three. 15 At the centre is the core product, which is the basic product as it leaves the factory. The outer ‘halo’ represents all the added value that customer service and logistics provide. Clearly it is not only customer service and logistics activity that add value; in many cases advertising, branding and the packaging can all enhance the perceived value of the product to the customer. However, it is increasingly evident, as we have seen, that it takes more than branding to differentiate the product. This idea underpins the current emphasis on seeking to create strategies that focus on ‘servitisation’, i.e. converting a product into a service. The 16 Power by the hour example lls-Royce Group plc is a UK-based manufacturer of gas turbines and is one of the major suppliers of engines to the aviation and energy industries. Typically these engines will cost several million pounds and require periodic and expensive maintenance and upgrading. In the past most airlines having bought an engine would assume responsibility for the servicing of that engine and holding the necessary inventory of spare parts. Clearly the cost of this was significant and also the unpredictability meant that a global service and repair capability was required. Realising that what their customers really wanted was not the engine per se but rather the guarantee of performance led Rolls-Royce to develop the idea of ‘power 17 by the hour’. Under this arrangement Rolls-Royce takes responsibility One of the classic definitions of marketing is that it is concerned with ‘getting and keeping customers’. In practice, if we look at where most organizations’ marketing efforts focus, it is on the ‘getting’ of customers, rather than on the ‘keeping’ of them. Thus an examination of the typical marketing plan will show a bias towards increasing market share rather than towards customer retention. Whilst new customers are always welcome in any business it has to be realised that an existing customer can provide a higher profit contribution and has the potential to grow in terms of the value and frequency of purchases. The importance of customer retention is underlined by the concept of the ‘lifetime value’ of a customer. The lifetime value of a customer is calculated as follows: Lifetime value = Average transaction value × Yearly frequency of purchase × Customer ‘life expectancy’ The longer the customer stays with an organization the more proftable they become 18 Market-driven supply chains  Most traditional supply chains were designed to optimize the internal operations of the supplying company. Thus a manufacturer might be motivated to establish supply and distribution arrangements that would enable production efficiencies to be maximized.  Now, instead of designing supply chains from the ‘factory outwards’ the challenge is to design them from the ‘customer backwards’.  This new perspective sees the consumer not at the end of the supply chain but at its start.  In effect this is the philosophical difference between supply chain management and what more properly might be called ‘demand chain management’. 19 Figure 2.6 suggests an appropriate sequence of actions to create a market-driven supply chain. 20 ZARA: linking supply chain processes to the value proposition Zara is one of world’s most successful clothing manufacturers and retailers. They have achieved this leadership position through creating a value proposition around the idea of ‘Fast Fashion’. Almost uniquely they have developed supply chain processes that enable them to capture ideas and trends in the apparel market and to translate them into products in amazingly short lead times. Zara’s target time to take an idea from design to store is between three and four weeks. To achieve this quick response capability Zara have developed an agile network of closely integrated company-owned and independent manufacturing facilities that have the flexibility to produce in small batches at short notice. Whilst this is not the cheapest way to make a garment, it ensures that they achieve their value proposition. 21 Identifying customers’ service needs The first point to emphasize is that customer service is perceptual. Whatever our own ‘hard’ internal measures of service might say our service performance is, perceptions are the reality. We might use measures which, whilst providing useful measures of productivity, do not actually reflect the things the customer values. 22 The approach to service segmentation suggested here follows a three-step process: 1- Identify the key components of customer service as seen by customers themselves. 2- Establish the relative importance of those service components to customers. 3- Identify ‘clusters’ of customers according to similarity of service preferences. 23 1 Identifying the key components of customer service How should we know which aspects of service are most highly rated by the customer? Given the complexity of the market that the typical company serves how might it better understand the segmentation of those markets in terms of service requirements? What does it take for a company to become the supplier of choice? 24 1 Identifying the key components of customer service Clearly it is important to develop an understanding of the service needs of customers through detailed research. The first step in research of this type is to identify the key sources of influence upon the purchase decision. The importance of this initial step in measuring customer service is that relevant and meaningful measures of customer service are generated by the customers themselves. Once these dimensions are defined we can identify the relative importance of each one and the extent to which different types of customer are prepared to trade off one aspect of service for another. 25 2 Establishing the relative importance of customer service components One of the simplest ways of discovering the importance a customer attaches to each element of customer service is to take the components generated by means of the process described in step 1 and to ask a representative sample of customers to rank order them from the ‘most important’ to the ‘least important’. In practice this is difficult, particularly with a large number of components, and would not give any insight into the relative importance of each element. Alternatively a form of rating scale could be used. For example, the respondents could be asked to place a weight from 1 to 10 against each component according to how much importance they attached to each element. 26 example from everyday life . In considering, say, the purchase of a new car we might desire specific attributes, e.g. performance in terms of speed and acceleration, economy in terms of petrol consumption, size in terms of passenger and luggage capacity and, of course, low price. However, it is unlikely that any one car will meet all of these requirements so we are forced to trade off one or more of these attributes against the others. 27 3- Identifying customer service segments The final step is to see if any similarities of preference emerge. If one group of respondents, for example, has a clearly distinct set of priorities from another then it would be reasonable to think of them both as different service segments. How can these customer service segments be identified? One technique that has been successfully used in this connection is cluster analysis. Cluster analysis is a computer-based method for looking across a set of data and seeking to ‘match’ respondents across as many dimensions as possible. Thus if two respondents completed the step 2 trade-off analysis in a similar way their importance scores on the various service dimensions would be similar and hence the cluster analysis would assign them to the same group. 28 Defning customer service objectives The whole purpose of supply chain management and logistics is to provide customers with the level and quality of service that they require and to do so at less cost to the total supply chain. The perfect order is achieved when the customer’s service requirements are met in full The measure of service is therefore defined as the percentage of occasions on which the customer’s requirements are met in full. Normally this percentage would be measured across customers over a period of time. 29 all One frequently encountered measure of the perfect order is ‘on-time, in-full’ (OTIF). An extension of this is on-time, in-full and error-free. This latter element relates to documentation, labelling and damage to the product or its packaging. To calculate the actual service level using the perfect order concept requires performance on each element to be monitored and then the percentage achievement on each element to be multiplied together. For example, if the actual performance across all orders for the last 12 On time 90% months was asInfollows: full 80% Error free 70% the actual perfect order achievement would be: 90% × 80% × 70% = 50.4% In other words the likelihood that a perfect order was achieved during the period under review was only 50.4 per cent! 30 The cost beneft of customer service The challenge to customer service management therefore is, firstly, to identify the real profitability of customers and then, secondly, to develop strategies for service that will improve the profitability of all customers. What has to be recognized is that there are costs as well as benefits in providing customer service and that therefore the appropriate level and mix of service will need to vary by customer type. The basic relationship between the level of service and the cost is often depicted as a steeply rising curve 31 The curve assumes that demand for the item is ‘normally’ distributed, i.e. it takes on the classic bell-shape. A feature of the normal distribution is that once its two key parameters, the mean (x–) and standard deviation (s), are known, the probability of a given value occurring can be easily calculated. Thus, as Figure 2.8 shows, if the distribution depicted describes daily sales for a particular product, it can be calculated that on approximately 68 per cent of occasions total demand would be within plus or minus one standard deviation either side of the mean; on approximately 95 per cent of occasions total demand would lie within plus or minus two standard deviations either side of the mean and on 99 per cent of occasions three standard deviations either side of the mean. 32 in calculating how much safety stock is required the inventory manager is only concerned with those occasions when demand is greater than average. If sales are approximately normally distributed, demand will be lower than average approximately 50 per cent of the time, and thus a 50 per cent service level would be maintained with no safety stock. It is on those occasions when demand exceeds the average that safety stock is required. In other words we must focus attention on the area of the curve to the right of the mean. Thus, by setting a stock level one standard deviation greater than the mean, the manager can achieve a service level of approximately 84 per cent. By setting the level two standard deviations greater than the mean the service level would be approximately 98 per cent and with three standard deviations it would be 99.9 per cent (Figure 33 2.9) What this highlights is that, as the desired service level rises, it takes a disproportionate investment in inventory to achieve small incremental improvements in availability. The table below illustrates this effect: If inventory equivalent to average expected daily demand (x–) is held then the service level would be 50 per cent. * If safety stock equivalent to one standard deviation of demand (s) is held then the service level would be 84 per cent, etc. 34 Setting customer service priorities Whilst it should be the objective of any logistics system to provide all customers with the level of service that has been agreed or negotiated, it must be recognised that there will inevitably need to be service priorities. In this connection the Pareto Law, or 80/20 rule, can provide us with the basis for developing a more cost-effective service strategy. Fundamentally, the service issue is that since not all our customers are equally profitable nor are our products equally profitable, should not the highest service be given to key customers and key products? Since we can assume that money spent on service is a scarce resource then we should upon look the service decision as a resource allocation issue. Figure 2.11 shows how a typical company might find its profits varying by customer and by product. 35 The curve is traditionally divided into three categories: the top 20 per cent of products and customers by profitability are the ‘A’ category; the next 50 per cent or so are labelled ‘B’; and the final 30 per cent are category ‘C’. The precise split between the categories is arbitrary as the shape of the distribution will vary from 36 business to business and from market to market. Perhaps the best way to manage product service levels is to take into account both the profit contribution and the individual product demand. We can bring both these measures together in the form of a simple matrix in Figure 2.12. The matrix can be explained as follows. 37 Quadrant 1: Seek cost reductions Because these products have high volume it would suggest that they are in frequent demand. However, they are also low in profit contribution and the priority should be to re-examine product and logistics costs to see if there is any scope for enhancing profit. Quadrant 2: Provide high availability These products are frequently demanded and they are more profitable. We should offer the highest level of service on these items by holding them as close to the customer as possible and with high availability. Because there will be relatively few of these items we can afford to follow such a strategy. 38 Quadrant 3: Review Products in this category should be regularly appraised with a view to deletion from the range. They do not contribute to profits (or at least only marginally) and they are slow movers from a sales point of view. Unless they play a strategic role in the product portfolio of the firm then there is probably a strong case for dropping them. Quadrant 4: Centralized inventory Because these products are highly profitable but only sell at a relatively slow rate they are candidates for centralized management. In other words, they should be kept in some central location, as far back up the supply chain as possible in order to reduce the total inventory investment, and then shipped by express transport direct to customers. 39 This concept of service prioritization by product can be extended to include customer priorities. Because the same 80/20 rule applies to customers as it does to products, it makes sense to focus resources on key accounts as well as key products. Figure 2.13 shows that if the 80/20 rule applies both to products and customers then all businesses are actually very dependent upon a very few customers buying a few high profit lines. Indeed the arithmetic is easy: 20% of customers buying 20% of the products = 4% of all customer/product transactions Which provides: 80% of 80% of total profit = 64% 40 In other words, just 4 per cent of transactions (measured order Setting service standards a complete match between what the customer expects and what we are willing and able to provide. Ultimately the only standard to be achieved is 100 per cent conformity to customer expectations. This requires a clear and objective understanding of the customers’ requirements and at the same time places an obligation upon the supplier to shape those expectations. What are the customer service elements for which standards should be set? To be effective these standards must be defined by the customers themselves. This requires customer research and competitive benchmarking studies 41 However, for the moment we can indicate some of the key areas where standards are essential: 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. Order cycle time Stock availability Order-size constraints Ordering convenience Frequency of delivery Delivery reliability Documentation quality Claims procedure Order completeness Technical support Order status information Let us examine each of these in turn. 42 Order cycle time This is the elapsed time from customer order to delivery. Standards should be defined against the customer’s stated requirements. Stock availability This relates to the percentage of demand for a given line item (stock keeping unit, or SKU) that can be met from available inventory. Order-size constraints More and more customers seek just-in-time deliveries of small quantities. Do we have the fexibility to cope with the range of customer demands likely to be placed upon us? Ordering convenience Are we accessible and easy to do business with? How are we seen from the customers’ viewpoint? Do our systems talk to their systems? Frequency of delivery A further manifestation of the move to just-in-time is that customers require more frequent deliveries within closely specified time windows. Again it is fexibility of response that should be the basis for the performance standard. 43 Delivery reliability What proportion of total orders are delivered on time? It is a refection not just of delivery performance but also of stock availability and order processing performance. Documentation quality What is the error rate on invoices, delivery notes and other customer communications? Is the documentation ‘user friendly’? A surprisingly large number of service failures are from this source. Claims procedure What is the trend in claims? What are their causes? How quickly do we deal with complaints and claims? Do we have procedures for ‘service recovery’? 44 Order completeness What proportion of orders do we deliver complete, i.e. no back orders or part shipments? Technical support What support do we provide customers with after the sale? If appropriate do we have standards for call-out time and first-time fix rate on repairs? Order status information Can we inform customers at any time on the status of their order? Do we have ‘hotlines’ or their equivalent? Do we have procedures for informing customers of potential problems on stock availability or delivery? 45