Sometimes, a business can find its share of gross margin within a supply chain squeezed to the point of destroying value. Here I explain how finance can help reverse that effect.
Supply chains exist in a delicate state of equilibrium – especially in difficult times. They involve combinations of businesses producing basic raw materials, using utilities, buying and selling through any number of manufacturing, distribution and wholesale companies. For any such chain, there is an absolute limit to the total amount of gross margin (GM) that can be made – and this must be shared by all the businesses involved. The individual organisations in the supply chain are thus fighting for their share, while anxious to remain in the chain. In a tough economic climate each business in the chain negotiates hard to keep purchasing costs down and sales prices up – but even so, the return on their efforts diminishes. Companies along the supply chain therefore end up just about retaining their proportionate share of an ever-reducing total GM. It is worrying.
Nightmares
What if a product at the point of being ready for sale has accrued such internal costs that the GM at that point has been wiped out? What if products with positive net margin have it all eroded by the costs of serving and servicing the end customers? It is the stuff of nightmares to wonder how many products in the finished goods warehouse have already lost the business money, which ones, why it happened, and whether the situation can be reversed.
Collective blind spot
If you are in a squeezed supply chain, knowing net margins – the true amount of money being made or lost – is a survival issue. And while it is very unlikely anyone will set out to ensure net margins decline, it is surprisingly easy for a collective blind spot to exist where people’s actions and decisions made in good faith can sow the seeds of disaster.
Know where GM is being eroded
Also, many measures of success are often inadvertently making things worse. If your gross margin is being squeezed and efforts to influence input costs and output prices have run out of steam, then general directives to everyone to decrease costs may simply damage the business. Knowing how your hard-won GM is being eroded, knowing what it is worth to reverse the problem and knowing the actions to take should be the most valuable information in the business. The alert finance function will be there to provide it.
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