Supply chain cost visibility
A new perspective to cost management—
a white paper from HP
Manufacturing and Distribution Industry Solutions
Table of contents
The need for cost visibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Integrated cost management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Guiding principles for building a total cost visibility framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Integrated cost management framework . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Solutions beyond traditional cost analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Essential features of a supply chain cost visibility solution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Solution functional areas
....................................................... 8
Total cost visibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
Performance management and alerts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Multi-dimensional analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
Simulation
............................................................... 9
Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
HP operates a vast network of supply
chains worldwide, supporting more
than 370 million customers.
The need for cost
visibility
Tough competition has increased pressure on margins
and shortened the windows of opportunity for new
products. Manufacturers and distributors have responded
by enhancing collaboration with their suppliers and other
partners, necessitating supply chains that are larger, more
complex and far more intimately coupled than ever before.
While this strategy offers strong potential for both lower
operational expenses and dramatically faster time-to-market,
it also presents significant challenges. Current systems
and supporting infrastructure cannot provide a central
point of visibility or comprehensive fiscal accountability
for the activities occurring along the product and component supply chains. Without the ability to adequately and
immediately monitor these costs, decision-making suffers
and even the best-intentioned cost control initiatives may
only result in costs being displaced, rather than reduced
or eliminated. Ultimately, competitive advantage is lost.
It takes more than knowledge; it takes experience
HP understands the problem firsthand. As one of the
world’s largest information technology manufacturing and
distribution organizations, HP operates a vast network of
supply chains worldwide, supporting more than 370
million customers and the interwoven activities of tens
of thousands of supply chain partners. Without strong
controls in place, this supply network would quickly
become unmanageable.
When HP set out to create a strategy framework for
successfully managing these intricate interactions, the
centerpiece of the strategy focused on “Total Cost
Management.” That’s because experience showed that
narrowly-targeted cost reduction measures in materials
purchasing, for example, could actually trigger increases
in the costs of inventory, materials handling, or other
logistics. These displaced costs can quickly wipe out any
gains made in purchasing. Similar examples can be
found throughout the supply chain operations of most
manufacturers.
This white paper will explain our perspective on supply
chain cost management, including the use of an integrated
cost management framework, the drivers for deploying a
supply chain cost visibility solution (SCCV), and an overview
of the required capabilities of such implementations.
3
Figure 1. Cost displacement versus
total cost management
Total supply chain cost
Logistics
costs
Material and production
costs
Logistics
costs
Material production costs
Selling
costs
Overhead
costs
Compliance
costs
Selling
costs
Overhead
costs
Compliance
costs
Service
costs
Cost displacement
and increase
Service
costs
Total supply chain cost
Material and production
costs
Material production costs
Overhead
costs
Selling
costs
Logistics
costs
Logistics
costs
Selling
costs
Integrated cost
management
Today’s deeply integrated manufacturing supply chains
require an equally integrated cost management framework;
to HP, that means one that provides both total cost visibility
and the tools needed to proactively manage those costs
across all phases of the manufacturing and distribution
process. Successfully implementing a total cost visibility
and control strategy depends upon being able to clearly
identify the organization’s actual supply chain costs and
isolate precisely where and why they occur.
Overhead
costs
Service
costs
Compliance
costs
Compliance
costs
True total cost
management
Service
costs
When conducting such an audit, it’s important to break
down the supply chain costs into their component factors,
but our experience shows that there can be considerable
blurring of the ultimate responsibilities for cost. Many
times, costs can masquerade as additional overhead or
reduced revenue in the company’s financial or income
statement. For example, end-of-life (EoL) products may be
subject to deep “fire-sale” discounts, which are likely to
be reported as reduced revenue.
By capturing and conducting a detailed analysis of the
actual costs associated with such “fire-sale” discounting,
the organization can improve the planning process for
EoL products to enhance efficiency. That can mean
considerable reductions in discounting costs, improved
inventory control and lower operational and capital
expenses (OpEx/CapEx).
Figure 2. Components of total
supply chain cost
Supply chain cost
Overhead cost
Logistics cost
Material cost
IT cost
Inventory-driven cost
Warranty cost
Backlog-driven cost
4
Figure 3. Cost liability and ownership
3
1.Vendor owns the cost and is
also liable for it
2. Ex: inventory held by the vendor
to meet the service levels of the
customer
Vendor
liable
1
Company
liable
1. Traditional cost analysis focus
2. Costs impact company’s books
3. Ex: inventory owned by
company at various locations
2
1. Vendor owns the cost but the
organization is fully/partially
responsible
2. Ex: part of inventory held by the
vendor to medium term demand
forecasts is company’s liability
Company
owned
Can be partly
managed by planning
the inventory quantity
and locations
Cost risk for vendor if the
vendor’s inventory planning
processes not mature
Visibility to this impact can
help in vendor
improvement and
certification processes
Vendor
owned
Company risks
‘owning’ this ‘cost’
liability due to
inaccurate forecasts .
So visibility to this risk
is important.
Using its own supply chain optimization experiences
as a roadmap, HP has developed a set of proven best
practices that simplify the critical cost ownership identification process. One aspect of these best practices includes
segregating costs based on liability and the share of
ownership between an organization and its supply chain
partners, which enables far deeper and more accurate
assignation of costs.
The four quadrants depicted in Figure 3 outline the
various cost liability and ownership scenarios common
to the manufacturing and distribution industries. While
traditional supply chain cost considerations populate
Quadrant 1 (Company Owned/Company Liable), the
tightly interwoven supply ecosystems found today are
mostly focused on the cost and liability scenarios found
in Quadrant 2 (Vendor Owned/Company Liable) and
Quadrant 3 (Vendor Owned/Vendor Liable). It is these
scenarios which demand the enhanced visibility made
possible only through implementation of an integrated
cost management framework. Quadrant 4 (Company
Owned/Vendor Liable) isn’t utilized for this discussion
due to the relative rarity of such conditions.
Many organizations correctly consider supply chain partner
profitability to be a key to the success of their own business;
unfortunately, most currently implemented cost management
and analysis solutions do not provide adequate visibility
and analytical capabilities for partner costs.
Guiding principles for
building a total cost
visibility framework
A well-designed supply chain cost visibility solution will
allow targets for cost reduction to be quickly identified
and prioritized for maximum impact. It will provide the
means to measure and monitor costs all along the value
chain. And it will support the ability to model shifting
conditions through a rich simulation environment, enabling
far more accurate predictive analysis. The results can be
faster response to changing marketplace conditions,
improved operating margins, and quicker resolution of
liability issues with suppliers and partners.
HP has identified several core principles for a successful
supply chain cost visibility solution framework, including:
• Objective must be “total cost reduction,” rather than
“cost displacement”
• Solution should be implemented close to the cost
occurrence points
• Focus must be on enabling proactive cost management
and decision support rather than retrospective analysis
• Solution must provide the organization with both
comprehensive cost visibility and highly detailed
contextual analysis
5
Figure 4. Integrated cost
management framework
ate cost
Estim
Impr
ove
co
st
Plan cost
Cost management
framework
ze
Integrated cost management
framework
st
aly
An
co
st
ec
sur
M ea
o
• Concept #3: Identify cost ownership and liability
– Determine how current and future finance and cost
accounting systems record costs; e.g., is a specific
cost only recorded upon transfer to the organization’s
books?
Today, most companies in the manufacturing and
distribution industry have attained the necessary maturity
for internal cost control mechanisms. What’s lacking is the
capability to track and link cost occurrence in their value
chains to operational variables and decisions. They have
neither sufficient visibility nor control over the cost leakages
occurring at the interface points for their upstream and
downstream supply chain partners. Improving the cost
performance of an organization requires a supply chain
cost visibility solution that focuses on the processes and
tools used to identify, track, analyze and optimize costs.
• Concept #4: Estimate cost and impact of business drivers
HP has identified several cornerstone concepts of an effective supply chain cost visibility solution and the key goals
required to achieve them, including:
– Define precisely what constitutes specific high level
costs and disseminate this knowledge throughout the
organization
• Concept #1: Accurately capture and associate costs
– Provide a means to accurately segregate cost and
identify key cost components
– Ensure the organization “measures the right costs and
measures the costs right”
– Determine appropriate cost level measurements to
enable accurate cost association and analysis
– Provide the means for more accurate measurement
and tracking of associated costs through key
dimensions such as product/product line and location
in the supply chain, as well as across all supply chain
processes and activities
– Define and implement a mechanism to proactively
track all possible cost liabilities
– Ensure the organization understands and can
accurately estimate the costs of meeting key business
drivers
• Concept #5: Create and follow an accurate costs
hierarchy
Ultimately, whatever the specific components and business
process details of the supply chain cost visibility solution
might be, these concepts and the goals that support them
help provide an advantage in the competitive
marketplace.
• Concept #2: Integrate the data
– Consolidate and analyze cost data from disparate
internal and external cost databases
– Utilize cost data from the diverse enterprise functions
and supply chain partners to arrive at the “single version
of the truth”
6
Figure 5. Supply chain cost visibility
solution functional architecture
Identify and plan
“all” costs
Plan
costs
• Cost planning best
practices consulting
• New cost codes creation
Measurement
framework,
reduce allocation
Identify cost drivers,
estimate impact
Estimate
costs
Measure
costs
• Cost drivers identification
• “What-if” analysis (simulation)
• Operational reports
• Multi-dimensional reporting
Multi-dimensional
analysis, identify
root causes
Analyze
costs
• KPI reporting
• Metrics drilldown analysis
SCCV business rules
SCCV cost data store
SCV operational data store
Other planning and transaction data
Solutions beyond traditional cost
analysis
As HP sought to improve cost controls all along its own
vast supply chain network, the company saw that a truly
comprehensive supply chain cost visibility framework
was required. That’s because the types of traditional cost
analysis strategies practiced by most organizations in the
manufacturing and distribution industry fail to adequately
measure the total costs incurred across the value chain
and effectively link them to the operational drivers that
impact those costs. Analyzing the links between the supply
chain business events impacting even one platform is
crucial to understanding the root causes of costing trends
throughout the supply chain.
HP design principles identify the key components of a supply
chain cost visibility solution that will enable Total Cost
Management:
HP has identified the key functional areas of a viable supply
chain cost visibility solution suite and their associated end
user features. These will be discussed in greater detail in
sections to follow. Briefly, they include:
• Total cost visibility
– Utilizes an easy-to-understand graphic dashboard
which allows users to easily locate and use “total
cost” information
– Provides the logical linkage and visibility to key cost
components and drivers
• Performance management and alerts
– Furnishes a tracking scorecard for key performance
indicators
– Reveals more than simply the costs themselves; also
provides clear visibility into the operational cost drivers
• Multi-dimensional analysis
• Cost classification and measurement framework
– Allows both “horizontal” and “vertical” drilldowns for
cost component analysis and problem identification
• Cost analysis and action path framework
– Enables trend analysis for costs behavior over time
• Process consulting services
– Provides a platform for “plan versus actual” analysis to
help improve budgetary planning and forecasting
• IT solution for supply chain cost visibility
Essential features of a supply chain
cost visibility solution
One good definition for a supply chain cost visibility solution
(SCCV) is “a business intelligence and analysis suite that
enables stakeholders across the organization to better
understand the various supply chain costs and make more
informed supply chain decisions.”
• Simulation
– Allows users to project the impact of specific trends on
future cost behavior
– Delivers the ability to perform “what-if” analysis to
model shifts in cost driver management on cost behavior
7
Solution functional areas
Total cost visibility
With margins already tight, the focus is on trimming costs
at every point along the value chain. However, the siloed,
point-by-point cost control initiatives that are commonly
implemented often do little more than shift costs from one
area of the supply chain to another. These cost reduction
initiatives typically involve changing a vendor (or the vendor
terms), or perhaps changing specific business processes
within the organization.
For instance, an organization may seek to reduce production
costs by outsourcing manufacturing in low-cost countries.
While this might reduce manufacturing costs, the company
might see increased costs for safety stock inventory, as
well as higher transportation and logistics costs. Another
company might attempt to drive down material costs by
awarding contracts to low cost suppliers, but could see
costs migrating into increased warranty and service expenses.
HP recognizes that the concept of total landed costs is
vital to improving margins and managing change pricing.
Total landed costs are the total of all costs associated with
producing and delivering products to the point where they
produce revenue. This cost is directly related to the demands
that a particular customer or order places on the supply
chain resources. For instance, a high value customer
might require delivery by highly reliable express freight
more than a lower value customer does. In this scenario,
optimizing profits requires a solution with the ability to
analyze the total transportation costs as a percentage
of revenue for each customer or percentage of customer
revenue. Similarly, any analysis of total landed costs should
include the inventory being held to service a customer or
a region and the total inventory-related costs. Without this
ability, calculating the accurate contribution margin from
the region is impossible.
For its own supply chain visibility requirements, HP designed
a simple to use graphical “dashboard,” which enables
users to enjoy an intuitive, panoramic view of supply chain
costs with the ability to analytically traverse the cost paths
to identify all possible areas for improvement. This type of
comprehensive and accurate cost visibility allows a more
efficient cost-benefit analysis and delivers a strong return
on investment through supply chain-wide cost reduction
and business process improvement initiatives.
HP has effectively implemented organized measurement,
tracking and reduction of hidden costs, such as inventorydriven costs (IDC), throughout its supply chain. The definition
of IDC measurements was expanded to include hidden
costs incurred due to inventory in the supply chain, such
as the costs of price protection, product return, component
devaluation and obsolescence. Making these costs a
part of the management metrics dashboards significantly
changed the way HP managers make their supply chain
decisions.
In some organizations, significant costs might lie in internal
or external cost databases; it is essential to have the ability
to accurately segregate costs, roll-up component costs and
logically link these costs for better decision-making. HP
has designed its supply chain cost visibility solutions based
on a logical, scalable data model which allows organizations to consolidate costs across the entire supply chain
and look analytically at the total cost situation throughout
the value chain. Based on a continuous improvement
methodology, organizations can then move towards even
more effective total cost visibility with achievable analysis.
8
Performance management and alerts
It is one thing to have cost visibility—it can be quite another
to get a clear understanding of the factors behind cost
behavior. That’s why HP insists that that any supply chain
cost visibility solution designed for cost performance
management must link that cost performance to the cost
drivers, and it must provide the ability to easily view and
analyze the performance of key metrics against defined
targets.
Cost visibility that occurs close to the operations (i.e.,
sales and marketing operations, supply chain operations,
etc.), provides the most effective view of these operations,
and enables the best possible cost-impact analysis of any
potential decision. For instance, it might be important for
an organization to understand that the cost of discounts
and promotions has increased in the last quarter. However,
it might be even more important to analyze the product
mix that impacted this cost, as well as the possible drivers
for the increase, such as the impact of demand forecasting
process, inventory management, etc.
Further, HP recommends that organizations only consider
solutions with a robust performance management toolset
for cost management. These tools are indispensable for
providing the operations team with the necessary visibility
into the potential cost impact of their decisions. The ability
to continuously view both cost performance and operations
performance, and then measure them against targets
transforms organizations from their accustomed “fire-fighting
mode” to an organization with the ability to systematically
identify, analyze and carry out cost improvements.
Supply chain cost visibility solutions, like those from HP,
should always have a hierarchical set of key performance
indicators for the operational metrics. This hierarchy, when
combined and associated to the cost parameters, enables
users to intelligently view the reasons for the cost drivers,
rather than just the costs themselves. For instance, by linking
transportation and logistics costs over a dimension (such
as a product and a large customer) to an operational
metric (for example, the percentage of “expedited” orders
against the total number of orders shipped to a customer)
could easily reveal the reasons behind the demand for
“rapid ship” orders. Similarly, when viewed in relation to
the forecast accuracy of demand and the components of
order fulfillment lead-time for that large customer, the
information might enable sales and order fulfillment teams
to take corrective actions to avoid such future costs.
HP supply chain cost visibility solutions are designed to
provide visual alerts when the “actual” values of a costrelated metric exceed their target values. This enables
appropriate personnel to quickly perform relevant analysis
based on the amount of deviation from the target—before
costs begin to spiral upwards.
Multi-dimensional analysis
Analyzing costs over multiple dimensions is the first step
to understanding the actual drivers of cost behavior. HP
supply chain cost visibility solutions provide a field-proven,
hierarchical cost analysis methodology coupled with
predefined cost hierarchies specifically developed for the
manufacturing and distribution industry.
9
Figure 6. Multi-dimensional supply
chain analysis
Total supply chain
cost by SBU
Total supply chain
cost by product line
Total supply chain
cost by region
Total supply chain
cost by product
Total supply
chain
cost
Sourcing
cost
Manufacturing
cost
Sales and
distribution cost
Returns and
after-sales cost
The ability to drill down into the costs is important to analyze
and understand the root-cause of the cost occurrence and exception.
Cost drilldown architecture presents two perspectives to costs:
• Horizontal drilldown enables users to understand the cost
behavior across product lines, regions—The same cost being
analyzed across various dimensions.
• Vertical drilldown enables users to understand the key
components of the cost, also termed as drilling down into
Level-2, 3 costs.
Inventory costs can be analyzed by drilling down into
inventory-driven cost components such as devaluation
cost, obsolescence cost and price protection cost, among
others. However, it is important to get a firm grasp on
how these cost components are behaving for various
products or product lines. The impact of these costs may
indicate the need to modify or reconfigure the supply
chains for each of the product lines.
For instance, let’s say a trend is observed where the total
devaluation cost for a product/product line has been
increasing. In that case, the supply chain configuration
could be changed to push more vendor-managed inventory,
while the product design could also be changed to explore
lower cost part substitutes. Using multi-dimensional analysis,
the organization might realize that the transportation costs
for a particular product are high and could direct its design
engineers to improve the form factor to fit more products
per truck.
HP recommends that every supply chain cost visibility
solution provide the ability to perform multi-dimensional
analysis on the overall cost and cost components. Horizontal
drilldown features allow users to better understand the
cost behavior across various dimensions, like product/
product line, region, etc. Similarly, strong vertical drilldown capabilities allow visibility into the cost components,
including which of the cost components has most impacted
the overall cost behavior and which could provide potential
savings opportunities.
Simulation
Proactive beats reactive every time. That’s why HP supply
chain cost visibility solutions provide a powerful platform
for cost impact modeling. Currently, most cost data reaches
operations teams well after the fact, which is a significant
problem, because the operations teams are largely responsible for making the very decisions that drive costs.
Improving visibility into the potential cost impact of these
decisions is key, as is improving the accuracy of predictions
surrounding possible cost exceptions. Only then can truly
accurate cost exceptions-related alerts be generated,
which in turn allow the operations team to make better,
faster and more informed decisions. The result is fewer
unpleasant surprises at the end of cost planning periods.
For instance, if cost impact of inventory is available,
organizations can continuously help the operations teams
make decisions on production and order fulfillment. Visibility into the cost impact of inventory on the marketing
teams can help marketing improve the timing of price
drops by considering the impact of price protection and
other factors.
HP supply chain cost visibility solutions help organizations
gently transition from retrospective cost management
towards genuine proactive cost management. The benefits
are significant:
• Provides more accurate and frequent estimates of costs
incurred
• Eases understanding of the drivers for cost overshoot
• Allows more rapid response and quicker corrective
actions to bring costs within limits
• Enables trend-based cost projections, including the
possible cost impact of inaction
10
As an example, consider that aging inventory is a driver
for inventory driven costs, including devaluation and
obsolescence. By getting an early estimate of the possible
devaluation costs with current sales trends enables the
user to better decide when and how many products should
be discounted to avoid devaluation costs. A successful and
well-planned supply chain cost visibility solution based on
business rules enables users to help simulate operational
cost drivers and to view the impact on the overall cost and
cost components, so that business users can intelligently
see the future from a cost perspective.
Conclusion
Just as the manufacturing and distribution industry gets
more competitive and complex, so too do the supply
chains that support it. Pushed by tight margins and ever
stronger competition, manufacturing and distribution
enterprises are extending their supply chains to encompass
far more suppliers and partners. Many traditional supply
chains are evolving into deeply intertwined relationships
that offer greater efficiencies, but also present tough
challenges to cost visibility.
As the owner of one of the world’s largest and most
complex supply chain ecosystems, HP has extensive and
ongoing experience with the critical issues surrounding
supply chain cost visibility. Seeking faster and more closely
targeted response to shifting marketplace demands, HP
developed its own comprehensive strategy framework for
managing these interactions. Today, that framework successfully supports the daily interactions of more than 370
million customers and thousands of supply chain partners.
At the heart of the strategy is “Total Cost Management,”
a concept that recognizes that supply chain costs are
deeply interconnected, and that the siloed cost control
initiatives typically practiced too often result in cost displacement, rather than cost reduction. The HP strategy framework
includes current readiness and infrastructure assessment
services, business intelligence services, IT infrastructure
components, including servers and storage, software solutions from HP and leading solution partners, and ongoing
technical support. HP experts can manage as much or as
little of the solution design, delivery and integration with
legacy systems and infrastructure as needed.
The HP supply chain visibility solution enables organizations to proactively sense and respond to opportunities
or threats, while tracking total cost and cost component
behavior. Improved decision-making is made possible by
intuitive “what-if” modeling capabilities and the ability to
expose previously ambiguous or hidden costs, all leading
to greater operational efficiencies and helping to ensure
that the total customer experience remains positive.
11
To learn more, visit www.hp.com/go/manufacturing/sc_visibility
© Copyright 2007 Hewlett-Packard Development Company, L.P. The only warranties for HP products and services
are set forth in the express warranty statements accompanying such products and services. Nothing herein should
be construed as constituting an additional warranty. HP shall not be liable for technical or editorial errors or omissions
contained herein. The information contained herein is subject to change without notice. Printed in the USA.
4AA1-0578ENW, February 2007