In this series, I’m exploring some of the hard benefits you should expect out of S&OP. The goal is to help you understand how S&OP can deliver these expected benefits and provide a way for you to calculate the ROI of implementing S&OP for your organization.
If you haven’t already, go back and take a look at the first post in this series, click the link here. In that post, I introduced how generally S&OP can be linked to these business outcomes. I also introduced an expected improvement table that comes from research by Tom Wallace, Author of the Sales and Operations Planning ‘How to Handbook.’ Based on this table, Tom provided the high and low values for each of these benefits, and an expected or middle outcome as well. I will be using this to walk through some numbers for each benefit.
Today I’m looking at Expedited freight. There are two main types of expedited freight: Incoming freight and outgoing freight. Let’s look at each and how S&OP will help to reduce these costs.
First, incoming expedited freight. This is freight paid to expedite components or materials in less than the standard lead time. This happens when there are shortages, or changes to the plan, that require expediting. I would put these into three main root causes: First, shortages due to poor quality. Second, shortages due to bad inventory records. Third, shortages due to planning or scheduling changes within lead time.
It is primarily the last one that can be greatly improved through S&OP. In the first post, I covered that a good S&OP process should drive supply predictability. A predictable process is one where there aren’t a lot of changes introduced at the last minute. How does this happen? Start with establishing accountability for the plan and the output of the plan. Measuring output compared to plan and requiring root cause on out-of-tolerance performance. Secondly, document your capability and make sure you are not planning above capability. Third, communicate the operating parameters for the family across the organization. This includes capability and lead-times. It also includes scheduling zones, when can the schedule be changed, and by how much. Fourth, link the S&OP plan to your Master Production Schedule. The volume build plan should come directly from the S&OP process. Finally, extend your planning horizon to cover at least your cumulative supply chain lead time for the family. I recommend extending it for a year to establish volume levels, but it should at least cover the longest lead time of your components. Working on these outputs from S&OP will drive reductions in your incoming expedited freight costs. Now, before showing the calculation let's briefly look at outgoing expedited freight.
Outgoing expedited freight is caused by having to ship products to customers through a non-standard method. The same issues that impact the predictability of supply will impact outgoing expedited freight. Unpredictable supply means we do not meet established promise dates, and either ship late or expedite to the customer. However, we can add to this list; from the demand side, S&OP should involve establishing customer expected lead times and determining the buffers (inventory, upside flex, lead times) that must be established in order to meet this. These are strategic decisions driven out of the communication within the S&OP process.
These “parameters” should be documented as part of the process and adjusted as part of the process in order to meet your strategic customer objectives. Now, to determine the savings from reducing expedited freight, do the following: Determine your annual expedited freight charges. To give it a little more granularity, I like to break it between incoming and outgoing if possible and use an average of the last 2 or 3 years.
(For any of what is being discussed within the next two paragraphs you can look below it for calculations). For this example, I have a company with 100 million in sales. Expedited freight is about 1% of sales or 1 million. This is split between incoming at 60% or 600k, and 40 % or 400k for outgoing. From my slightly modified Wallace table, I am using a number of 20% which is in the middle of his number. You can use something different for incoming vs outgoing, depending on where most of your issues are, however, start simple. Multiplying the 600,000 by 20% gives me $120,000 in annual savings for incoming, and doing the same for outgoing gives me another $80,000 for a total annual savings of $200k
(For any of what is being discussed within the next two paragraphs you can look below it for calculations). For this example, I have a company with 100 million in sales. Expedited freight is about 1% of sales or 1 million. This is split between incoming at 60% or 600k, and 40 % or 400k for outgoing. From my slightly modified Wallace table, I am using a number of 20% which is in the middle of his number. You can use something different for incoming vs outgoing, depending on where most of your issues are, however, start simple. Multiplying the 600,000 by 20% gives me $120,000 in annual savings for incoming, and doing the same for outgoing gives me another $80,000 for a total annual savings of $200k.
Example Calculations:
$100 million in Sales
$1 million Expedited Freight
60% Incoming = $600,000
40% Outgoing = $400,000
$600,000 x 20% = $120,000 for Incoming
$400,000 x 20% = $80,000 for Outgoing
Total Savings = $200,000
Typically, I like to time-phase these returns over 3 years, as it takes some time to implement the process and get to the benefits. I use an annual return of 20% in the first year, 80% in the second year, and 100% in the third year when the process is fully implemented. This would mean savings of $40k in year one, 160k in year two and the full $200k in year three.
This single measurement may not be enough to justify S&OP for your organization, but hopefully this post provides you a good starting point for linking the quantifiable returns you can achieve through S&OP. Stay tuned for the next posts to dig further into where else S&OP can bring significant benefits.
If you're wondering where you can start realizing the benefits of S&OP for your organization, I highly recommend taking our S&OP Clarity Compass. This free scorecard only takes 3 minutes to complete and provides you with a personalized report and recommendations for improving your process.
At DBM Systems, our consultants have over 20 years of experience providing S&OP leadership to businesses worldwide. We equip teams with coaching and the tools to quickly start and sustainably run an effective S&OP process. Learn about our process and unlock the power of S&OP in your organization.