Many chemical manufacturers had already started to consolidate their operations to achieve efficiencies of scale and to reduce costs long before the global financial crisis took hold. Much of this activity has been driven by the high cost of industry participation, with supply chain strategy and security considerations also playing a part. Generally speaking, consolidation in the industry is usually focused on cost-driven initiatives in back-office functions such as supply chain and procurement, rather than site or asset consolidation.
While some chemical manufacturers have found that supply chain consolidation has delivered significant benefits, in our firms experience, many have failed to realize the full value that consolidation can provide. Most commonly, this is a result of four main challenges:
- an insufficient understanding of the baseline processes that support procurement and supply chain efficiency;
- an historically poor record for mapping process changes through to the post-consolidation ‘future state’;
- low appetite within management to consolidate business functions; and
- Fine tuning consolidation initiatives a lack of experience building robust business cases for consolidation initiatives.
In particular, supply chain managers and chemical executives should place a stronger focus on ‘future state’ mapping across the functions that will be impacted by consolidation. In most cases, this will help to ensure a smooth cutover, enabling the business to meet the requirements of their multiple stakeholders without experiencing a drop in service delivery levels.
Companies considering a consolidation of legacy systems into a single ERP platform will want to place additional emphasis in this area. If carried out effectively, the standardization of processes around a single ERP system can be an important enabler of efficiency and cost reduction. At the same time, unnecessary ERP customization can lead to increased complexity and cost, forcing chemical executives to create a fine balance between adopting standardized processes and tweaking their systems to accommodate unique needs.
Chemical executives will also want to consider incorporating robust supporting processes to help increase the success of the consolidation. This should include a focus on effective communications, clear service level agreements and formalized key performance indicators (KPIs). This is especially true in situations where one consolidated function assumes responsibility for providing services to other parts of the business, as is often the case in group purchasing or shared customer service and logistics situations.
The focus on business consolidation has also been driven by the geographical relocation of both capacity and support functions. With a shift in global demand to East Asia (where lower production and labor costs may deliver additional advantage), and the migration of petrochemical capacity to the Middle East (largely in response to feedstock pricing and availability), many chemical manufacturers are discovering opportunities to further consolidate their supply chains. Relocations add additional complexity as key employees and experienced operators may not relocate with the business, thus reinforcing the need for a detailed mapping and documentation of business processes and an enabling ERP strategy.
For the chemical industry in particular, the realization of cost savings through integration cannot come at the expense of the business’ practical and safe operation. Beyond the public safety considerations, consolidation may impact a company’s ability to service global or regional supply chain agreements in an efficient and cost effective manner. For example, in helping a client move from a short lead time for synthetic alcohol to a six week lead time but with a lower purchase price, significant changes to supply chain planning parameters such as order quantities, inventory levels and lead times; together with container handling procedures, were required to help ensure continuity of supply and safe operation. In any consolidation, stakeholder engagement and a sophisticated understanding of supply chain costs are critical to achieving successful global procurement outcomes.
Having worked with a wide range of chemical manufacturers, we believe that a strong mix of global methodologies and process mapping has the potential to deliver long-term cost savings and efficiencies, and may often provide opportunities for competitive advantage.
Chemical supply chain executives may also want to consider transfer pricing opportunities (which may provide tax savings through the alignment of taxation and supply strategies), and legal entity rationalization (thereby achieving savings through headcount reduction and the containment of corporate costs).
The global financial crisis greatly affected the sell side for chemical manufacturers, as customers were forced to dramatically reduce inventories and cancel orders to preserve cash on hand. In turn, this had repercussions up the supply chain, creating excessive inventories and depressing production levels. But as demand resumed, some manufacturers started to see stocks fall below sustainable levels, resulting in reduced customer service.
With many pundits predicting increasing competition in global markets in the near future, chemical companies may want to ‘recalibrate’ their supply chain planning processes to instill a balance between their levels of working capital (i.e. inventory), their base requirements for production stability and their desired customer service levels.
Today, most supply chain ‘best practice’ literature tends to focus on Lean methodologies such as ‘Demand Pull’ and ‘Just in Time’, which aim to achieve high service levels while maintaining low working capital. But – as a general rule – many chemical manufacturing processes (especially those involving continuous production) require assets to be run at steady levels of production, effectively limiting many of the benefits of traditional Lean solutions.
As a result, the benchmark for successful demand planning in the chemical manufacturing sector continues to be an effective and integrated Sales and Operations Planning (S&OP) process.
But – despite the maturity of S&OP as a business process – many chemical supply chain executives continue to deal with a number of challenges related to the operation of S&OP. These include:
- the perception of S&OP as a ‘logistics’ function that does not require integration into the wider business (resulting in perceived failures when, for example, product promotions happen outside of the process, triggering ‘stock outs’ as inventory levels collapse under increased demand);
- the effect of ‘ad-hoc’ or overly- complicated forecasting processes, which divert sales managers from their primary focus of selling product;
- a lack of rigorous processes around inventory and master data management, or insufficient management KPIs; and
- a failure to support S&OP with an integrated planning solution to link orders, forecasts, inventory, production and procurement.
And while some chemical companies have enthusiastically adopted integrated planning, many continue to rely on multiple systems, desktop spreadsheets and excessive manual intervention. However, this is largely a symptom of organizations that have experienced rapid growth by acquisition during favorable economic cycles, rather than the result of a specific strategic decision.
For the chemical industry, therefore, ‘benchmark’ supply chain planning is an integrated system approach, linking manufacturing and materials sourcing with customer demand. There are already a number of examples of this in the chemical industry, such as:
- using S&OP to accurately plan stock levels of intermediates in sulphonation and in the manufacture of urethane polyols, thus enabling tailored products to be manufactured within short lead times (this approach comes very close to a ‘demand pull’ methodology, but requires minimal levels of high-value finished goods that have a higher potential for redundancy);
- the forward staging (supported by telemetry and vendor managed inventory) of ethylene oxide in customer tankage, resulting in higher levels of availability for the customer, more stable production processes for both supplier and customer, and dramatically increased sales volumes for the manufacturer; and
- the use of ‘exception based’ forecasting to statistically identify stock units with unstable demand, leading to reduced manual intervention by sales managers and, in turn, increasing their ‘buy in’ to the forecasting process.
This results in chemical supply chain executives revisiting their supply chain cost optimization strategies, especially in sectors where higher material and logistics costs are depressing margins. Many have found that – while their input costs are often closely aligned to the price of hydrocarbons – their overall supply chain costs have also increased on a number of other fronts including costs of specialist equipment, an increased burden of compliance, and – often – reduced logistical network capacity as a result of cut backs and shut-downs experienced during the global financial crisis.
In response, supply chain leading practices have evolved towards a ‘Cost to Serve’ approach. Rather than the traditional method of cost optimization (where manufacturing unit costs were addressed separately from freight costs), Cost to Serve maps the holistic cost of the unit along the supply chain including logistics, packaging, management overheads, working capital and wastage.
This approach addresses three main challenges prevalent in chemical industry supply chains: eroded margins due to long processing and finishing times for batch-manufactured products; spikes in freight costs related to the emergency delivery of chemical products; and the high disposal costs that are often incurred with redundant chemicals.
Indeed, many supply chain managers may realize that some products that are nominally high margin are actually loss-generators once all of the related costs are considered. Conversely, many commodity products with low gross margins may – once viewed on a ‘dollars per reactor hour basis’ – be highly profitable due to their repeatability, short processing times and their tendency to need less adjustment and finishing.
For example, a ‘Cost to Serve’ analysis on a client’s batch ethoxylation reactor found that a high molecular weight polymer often required days of reaction and adjustment time, yielding low profitability when all costs were considered. The solution was to move this product off the production plan (but replace it with a purchased equivalent on a “Product for Resale” basis), and use the freed-up capacity to manufacture more of an agrochemical surfactant with a shorter reaction time and higher repeatability. The net effect was to significantly increase profitability per reactor hour whilst maintaining seamless supply to customers for both products.
The Cost to Serve approach also provides opportunities for more transparency into the overall costs that can affect the company’s profitability and customer profile. Consider a company that repeatedly incurs financial penalties as a result of failing to meet delivery slots when supplying agricultural adjuvant across Europe within a short lead-time. On conducting a full cost analysis, including the additional expense of express rail freight to meet the contracted deadlines and extensive finishing requirements, the manufacturer concluded that the opportunity to service this customer was far less profitable than initially estimated. This approach also provided the sales function with the data they required to negotiate more reasonable terms and realistic order lead-times.
And while the Cost to Serve approach may generate a more complex view of supply chain costs, it has proven to be very effective at identifying inefficiencies and uncovering opportunities for improvement. For many chemical supply chain operations, this will also require the maintenance of freight tables to help ensure that the correct freight costs are being allocated, as well as clear cost ownership delineation and adherence to formalized KPIs.
Additional benefits may be realized from implementing the Cost to Serve approach by incorporating customer segmentation practices. This may help ensure that decisions that result from the Cost to Serve analysis are made in support of a defined customer or market strategy. Cost to Serve has resulted in some leading chemical companies starting to tailor their commodity supply chain to focus on factors such as cost, quality and compliance, rather than pure customer support considerations.
Chemical executives seeking cost optimization may also want to put more emphasis on the active management of their product’s lifecycle. Many chemical companies have shown a tendency to misjudge the point where their products move from ‘specialty’ to ‘commodity’, requiring fundamental price adjustments to maintain margins for products facing increased competition and price pressures. When combined with the prevalence towards the ‘innovate at all costs’ approach, some chemical companies are increasingly finding themselves with redundant products that carry high storage and disposal costs.
Instead, chemical industry executives may consider conducting annual reviews of their product range by using a Cost to Serve approach in order to highlight opportunities for product deletions, price increases or decreases, or conversion to a ‘Make to Order’ supply arrangement that reduces inventory liabilities. New product development processes must also be integrated into the S&OP process, and should involve representatives from technology and marketing as well as other key divisions. Executives may also consider requiring additional management accountability before the commercialization of any new specialty products.
In summary, chemical industry executives stand to benefit from a clear understanding of the costs, benefits and value of their supply chain decisions. Those that get this right may realize the many benefits of supply chain optimization: increased cost savings, better business insight, and overall sustainable competitive advantage.
KPMG in Australia
+61 (3) 9288 5377
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