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Supply Chain Matters Tutorial- Pros and Cons of Zero-Based Budgeting

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In the light of this week’s announcement of the mega-merger among HJ Heinz and Kraft, coupled with the new interest in zero-based budgeting techniques, we felt it was timely to provide a brief tutorial on the process.

A Google search can yield ample content and perspectives on this process.

In definition, zero-based budgeting (ZBB) is essentially a financial-driven process where budgetary resources are set to zero every year and must be justified for the new budget period. It was a process originally conceived in the seventies in an era where organizational  bloat among large corporations was rather common. Instead of referencing the previous year’s budget, the slate starts over with managers having to justify their business assumptions and required expenditures for the upcoming period, as if they were a new business or support function. Every budget is viewed from a fresh perspective and evaluated and approved based on relevance to overall corporate goals and expected outcomes.

In context it is rather important to note that ZBB is often a financial-driven process and can be undertaken and applied within companies or organizations that are required to considerably reduce costs and improve profits. As some are now pointing out, that is why it is garnering increased interest in among large consumer product goods producers.

It is rather important that organizations understand the pros and cons of this process. In our effort to do so, we are sharing our perspectives. We certainly encourage our readers to add their perspectives and experiences in the Comments section associated with this posting so that many can benefit.

Pros of ZBB:

  • A mechanism that facilitates much higher levels of cost reduction than traditional budgeting methods.
  • Relate costs to the specific mission and purpose of an organization at a given time.
  • Garner much more detailed understanding of an individual organization’s role and purpose and that organization’s staffing and resource levels.
  • Weed out duplication, ineffective and/or counterproductive activities.
  • Uncover additional opportunities for cost synergies.
  • Provide a means for prioritizing spending cuts
  • Some would argue that it diffuses an entitlement mentality by requiring detailed justification.

Cons of ZBB:

  • Clearly ZBB consumes a tremendous amount of time and organizational energy. Some would argue it can take up the bulk of organizational time, constantly having to justify and re-justify efforts.
  • In many cases, ZBB can stifle bottom-up or supplier based product or process innovation, since there is little time or resource for such efforts.
  • Consensus is difficult and often painful.
  • The impact to employee morale can be substantial, not only in the dimension of perceived perks, but in individual value and promotional opportunities.
  • Pits individual organizations in competition with one another.
  • Cuts can be taken to an extreme.
  • There can be a loss of focus to new, emerging or undiscovered opportunities among business, industry or new markets.
  • Needs to be implemented very carefully and skillfully.

 

Now at this point, you may have discerned that this analyst and consultant may have biases towards the cons of ZBB.  Contrary to the past, many industries and businesses have undertaken initiatives grounded in Six-Sigma, Just-in-Time or Lean Manufacturing methods. Thus, a lot of bloat or excess has already been analyzed and addressed. Some might argue whether these efforts were ultimately positive or detracted from business goal fulfillment or the overall reduction of costs.  Others would argue that the above methods did not effectively address organizational overhead or layering. I believe that on the whole, they were successful.

In my career, I have found that ZBB methods must be carefully and methodically conducted in the light of a well understood mission and clearly articulated strategic roadmap. Talent recruitment, skills development and ongoing career opportunities must not be sacrificed by the process. ZBB can often bring foreword a “survivor” mentality where political skills outweigh either proven years of experience or sacrifice the required leaders of tomorrow. ZBB can sometimes be a panacea for wholesale human resource shifts. The process can further serve as a radical change to supplier relationship and collaboration practices.

The difference today is that certain private equity investment firms such as 3G Capital are setting a different, or perhaps more acute standard.

We now invite our readers to weigh in.  Share your pro and con perspectives

Bob Ferrari

 


General Electric’s New Transformational Start-up Mentality

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Bloomberg BusinessWeek published an article profiling General Electric’s efforts to get the company acting more like a 21st Century startup.  Taking a cue from Silicon Valley’s start-up culture, GE recruited tech entrepreneur Eric Reis, author of the book The Lean Startup, to initiate the company-wide movement titled FastWorks.

Similar to Lean Six Sigma that fueled rallying and transformational efforts in the 1990’s, FastWorks is targeted to motivate GE employees to be more customer focused, speed new product development, reduce costs and improve customer engagement. The Reis philosophy is that faster product innovation is garnered from building imperfect early versions, gaining timely customer feedback, while continuously “pivoting” and adapting products to address market opportunities. The initiative is described by GE Chief Marketing Officer Beth Comstock as “giving employees the freedom to try things that may not prove successful: Fail fast, fail small.”

Easily stated, but with far different implications for a rather large, global based manufacturer.

According to Bloomberg, GE has already trained 40,000 employees in FastWorks. With more than 300 projects underway, the program is described as one of the largest initiatives in GE history. Early product development projects include a high-output gas turbine developed two years faster with 40 percent less cost than would traditional program management would have yielded.  Other product initiatives cited were a light bulb with built-in wireless dimming chip, an oil well flow meter which launched after a year in development and is being commercialized in alliance with an energy company.

In the article, a Harvard Business School professor is quoted as observing that as large companies get bigger and scale, they tend to slow down because they have so many processes, systems and structures. Having worked at large and small companies on technology related projects, and having observed the enterprise and supply chain technology marketplace for over ten years, this author can well relate to the obstacles and bureaucratic inertia of large organizations. Most of the innovation in software has come from smaller, best-of-breed start-ups who were laser focused on customer and supply chain needs. That said, failing fast is quite different in a larger vs. a smaller organization. If the philosophy is an integral fabric of the organizational culture, than teams expect to incur failures, learn quickly and move on.  In larger organizations there tends to be analysis paralysis as to why the failure.

Supply chain transformation initiatives take on similar characteristics. In a previous Supply Chain Matters commentary highlighting the Supply Chain Management Review article, Culture Eats Strategy, authors John D. Hanson and Steven A. Melnyk provide us reminders that organizational attempts for implementing strategies of radical innovation are often stymied by inherent organizational culture.  That includes the spillover of efforts directed at a firm’s value-chain focused processes. If an organization was previously managing suppliers based on cost competitiveness, adding quicker product innovation implies a potential conflict in culture. The article reminds us that the management myth of showing teams a better way and they will embrace it is often de-railed by an inherent organizational culture that can, and often will, resist radical change unless old ways are discredited.

Similarly, many organizational transformational initiatives need to address inherent organizational culture, especially if it detracts from desired outcome objectives, whether they target innovation, efficiency or responsiveness. Is it any surprise that certain enterprise software vendors have embarked on an acquisition frenzy to secure product innovation?

In the case of GE, culture has always been addressed from the top, and down.  The legacy of Jack Welch and the current leadership of Jeff Immelt each demonstrated personal passion toward changing organizational culture.  FastWorks will no doubt include GE’s internal business groups but its value-chain suppliers as well.

The takeaway is regardless of what name and purpose an initiative takes on, it must incorporate strategy and organizational culture needs.

What’s your view?

Are large organizational transformational efforts another means to employ large numbers of teams, or is changing existing organizational culture the prime objective?

Bob Ferrari

 


Canada Attempts to Legislate Solutions to Rail Bottlenecks

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In our recent Supply Chain Matters update on Q1 commodity price trending, we noted that the severe winter conditions that have occurred across the U.S. and Canada, coupled with operational disruptions in the placement and logistics of tank and bulk commodity railcars have led to reported disruptions in supply contracts of inbound bulk commodities. Commodity producers have had to shift to more expensive trucking options to accommodate food production line scheduling.

The government of Canada is now taking more extreme action against its national rail carriers with proposed legislation that would allow bulk commodity producers to switch between Canadian National Railway (CN) and Canadian Pacific Railway (CP) for flexibilities in getting commodity products to designated supply chain customers. 

According to reports, Canada’s current conservative government is getting much more concerned about shipment bottlenecks, especially when it concerns commodity shipments to existing and newer export markets, including the United States. According to a report published by the Wall Street Journal, 150 grain elevators would have access to both rail lines under the proposed legislation.  Currently only 14 grain elevators have such access. For its part, the CEO of CN is quoted as indicated that this legislation will have little impact when considering the extreme winter weather conditions seen this year across North America.

No doubt, the debates concerning government vs. private industry solutions to logistics bottlenecks will continue. In the end, it’s always a demand and supply imbalance problem that needs a solution.


Aerospace Supply Chains: The Good News-Bad News Reality Brings Investor Awareness

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If you have been a loyal follower of our Supply Chain Matters commentaries and predictions concerning Aerospace supply chains, you would be aware of the difficult position these value-chain ecosystems currently find themselves in. Once more, you would have had awareness to these challenges three year ago.

Thus we were somewhat amused to stumble upon this week’s Bloomberg Businessweek article, With Epic Backlogs at Boeing and Airbus, Can Business Be Too Good? 

The article poses a fundamental question. With over 10,600 of firm orders for new aircraft among both Airbus and Boeing– When is order backlog too big?

In a July 2011 commentary, Aerospace Supply Chain Are Now Stressed, we observed that the building multi-year backlog comes amid an industry track record of not so stellar performance in operational consistency, two-way communication and predictability.  Over two years later, although some progress has been made,  many of the same challenges remain.

The question posed by Bloomberg, and indeed the Wall Street investor community, is indeed the appropriate question. As the article points out, if a wait for a new airplane stretches out over too many years, it can fundamentally impact the business model strategies of airline customers.  Some of those dynamics are already occurring surrounding the continued undelivered backlog of Boeing’s new 787 aircraft. It further can motivate these same customers to consider alternative aircraft deployment or procurement strategies.

Another important consideration are the quickly changing economic environments that often drive demand for airline travel.  Airlines from emerging markets are estimated to make-up at least a third of the current order backlog. Current concerns surrounding former booming developing markets are becoming evident in global equity markets as foreign currency tensions, devaluation and and other local economic factors impact business growth within these markets. There will certainly be increased airline travel within emerging economies but this demand needs to be balanced with economic up and down cycles.

In a meeting with Wall Street analysts this week, the CEO of Boeing reported strong earnings for the recent fical quarter but raised some warning signs for 2014 regarding earnings growth. Investors responded by driving Boeing stock down by over 5 percent.

Boeing’s 2014 operational plans call for increasing aircraft deliveries by 10 percent, roughly 715-725 aircraft amid a backlog of 5100 aircraft orders. By the end of the year, Boeing expects to be delivering two new 737 aircraft every day, yet only 10 new 787 Dreamliners monthly. Airbus remains operationally upbeat, empowering localized operational decision-making, yet the realities of a near decade of backlog is hauting.

The new reality is that investors are now becoming aware of the flip side of euphoria- you have to deliver the goods according to customer desires and expectations, and you have to be able to assure required operational on-time performance at customer ship time.

In our most recent commentary regarding Aerospace supply chains, we opined that agility and responsiveness are indeed going to be very important industry differentiators along with on-time and consistent performance for new product development milestones.

An enviable industry position awash with order backlog does not condone business-as-usual. Rather dynamic and responsive capacity management, end-to-end value chain visibility, enhanced supplier collaboration and goal-sharing all come into play.

Each of the major aerospace OEM’s can certainly boast of record performance in 2013, but the real challenges remain as each supply chain ecosystem responds to unprecedented requirements for development and execution. They will each put to the test the real meaning for agile and resilient supply chains.

Bob Ferrari


The U.S. Automotive Industry Needs Updated Finished Goods Benchmarks

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Earlier this week the Detroit Auto Show occurred, an annual event that provides industry players and business media the opportunity to feature multitudes of commentaries regarding the state of the industry and the state of automotive supply chains.

The year 2013 was a good one for the U.S. automotive market as sales rose 7.6 percent to 15.6 million vehicles.  That is quite a comeback from the levels of 2009-2010 when severe recession all but forced the bankruptcy of both Chrysler and General Motors and caused many other automakers severe cutbacks in revenue and profits, not to mention jobs.

As we begin 2014, the U.S. market is now the target for most of the globe’s auto makers as the U.S. economy continues its steady rebound and U.S. consumers are much more inclined to replace or buy a new vehicle. The latest estimates for auto sales in 2014 hover in the 16 million vehicle range, a slight improvement.

Yet, in reading certain news reports, we wonder aloud if the industry has learned some operational lessons regarding inventory management, specifically finished goods inventories management.

On Wednesday, the Wall Street Journal published two articles on the industry.  One of the articles made note that many automotive OEM’s are now considering even more investments in added capacity.  Yet, some seasoned CEO’s such as Sergio Marchionne, CEO of Chrysler and Fiat openly states his constant concern regarding excess inventories. He was quoted as indicating that he watches inventory like a hawk. He should know, since he has been responding to that problem in the European market.  Auto makers are augmenting North America production capacity not only to serve the domestic market but export markets as well.  Today’s more prevalent common platform design strategies coupled with more sophisticated levels of factory automation allow auto makers to exercise far more flexibility in production options from any given plant.

What did catch our attention were reports of current finished goods inventories across various U.S. automotive retailers.  According to Autodata Corporation, auto dealers had 3.45 million cars and trucks in inventory at the end of 2013, which is reported as the equivalent of 63 days of finished goods inventory at roughly $100 billion in value. That number is reported as being considered “optimal” by the industry. Keep in mind that automotive OEM’s book revenue credit at point of shipment to dealers, thus their metrics of revenue are fulfilled, but dealer metrics of unsold vehicles being financed is a different story.

The WSJ published a sidebar article indicating that Mike Jackson, the CEO of AutoNation, one of the largest retail auto dealers in the U.S. was indeed concerned about finished goods inventory levels. Jackson is of the opinion that inventories are much higher, closer to 90 to 120 days of supplies if cars sold to fleets is excluded from the selling rate equation. Thus the value of sales rate is combined for fleet sales and private sales which skews the specific type of product demand.

We applaud Mr. Jackson for his candor.  It strikes us that since 2009, the industry should have learned some very important lessons regarding unsold inventories and conflict of metrics among OEM’s and retail dealers.

Today more than ever, auto markets are driven by a B2C online presence.  Consumers can literally shop and price any make or model vehicle and view current inventory levels from the majority of OEM online sites.  Auto dealers can now view finished goods inventory across wide geographic regions and can electronically swap inventory with other dealers. Some of the luxury OEM’s such as BMW or Mercedes allow consumers to actually order a vehicle to be built at the factory and then arrange to pick up that vehicle when completed.

Now more than ever before, OEM’s and their retail dealers have information available as to what models and options consumers are most interested in and from what specific geographic regions product demand is coming from.  They also have the ability to select and utilize a wide variety of advanced software applications directed at item-level inventory management and optimization that are delivering bottom-line savings in more efficient overall management of inventories.  Technology should not be an issue.

Why then is 60 days of unsold inventory viewed as an acceptable norm?

We obviously suspect it has more to do with conflicting metrics, namely revenue recognition or output performance.  If OEM’s receive some revenue recognition at every shipment, they consequently only care when the pipeline gets bloated. They then turnaround and offer retail dealer’s additional cash selling incentives to motivate them to sell unsold inventory more aggressively. Our household bought a brand new Honda in 2013 and it was very clear that the salesperson was highly motivated to offer the most attractive price if we opted for a vehicle in dealer inventory.

This problem has been the bane of the industry and it is shocking that it continues with so many other options in product demand and inventory management now available.

Supply Chain Matters is therefore seeking input from those within the industry- why does this situation continue?  Is the adage of “push it down the pipeline” still an acceptable norm with so many other alternatives now available? It seems to us that there has got to be a better way of channel distribution.

What are your observations?

Bob Ferrari

 


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