Analyzing Mysteries of Implementing Replenishment

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I think, the best of internalizing new knowledge is by analyzing case studies. So instead of just posting insights on this blog, I would like to share a case with you and some questions to ponder at the end of it.

Of course the answer is also provided subsequently, but May I suggest that you spend time and formulate your response before reading on and understanding Vector’s Point of View.

A company sells its products (consumer goods) through a number of distributors who in turn supply to wholesalers and retailers. They started implementing the TOC Distribution solution about a year back and there have been significant challenges posed by the company’s legacy of operating through wholesalers.

They have invested significant time in streamlining the supply side (The company has no manufacturing facilities, it buys its products from a principal). The inventory is down by about 50%, at the same time shortages are down significantly. You look at the company’s PWH and Distributor Buffer Penetration Reports and will be glad to see mostly yellows, with some greens and a few reds and above greens. The promise of high availability at low inventory is coming true!

But the sales implementation is another story though. The distributors are all on offer and are enjoying high ROI, good inventory turns and increased absolute profits. However, a vast majority of distributor’s sales still comes from the wholesalers. The retail reach of the company is not increasing at a fast enough pace and though up from the past, the direct sales to retailers account for roughly 30% of the sales of the distributor. (The other 70% is sold to wholesalers who serve the entire retail population)

Upon reviewing the numbers comes the shocker: The company’s total annual sales (in the recession year) have declined by about 9% year-on-year. They are even more worried because the product mix seems to have suffered. OUt of the company’s range of about 65 SKUs, traditionally, about 5 SKUs used to account for about 80% of the sales.

Now in the last year, even as the overall sales have reduced by 9%, the contribution of the top five products has plummeted and now no less than 9 SKUs account of 80% of the sales of the company! So the top 5 runners must have been the main reason for the sales of the company going down, right?

Undeterred by the seemingly bad picture and goaded by our unshakable conviction in TOC, we must answer these following questions:

1) Why did the sales of the company go down?
2) What is the single biggest Desired Effect that you expect to see for this company? Why should that happen?
3) How can the change in product mix be explained and what is its impact on the Desired Effect above?

Hope your own thinking has been stimulating, Now the Answers:

1) Why did the sales of the company go down?

The first reaction that one would expect is: When you implement replenishment, you do expect sales to go down in many environments where the push has been very high. You know the stuff – sales people have been pushing aggressively in the past, the inventory levels of customers would be high, when we fix norms as per the new RLT, the stocks of most SKUs would be above the norm and thus we will not be able to ship material to the customers as we wait for the excess stocks to flush out. So far so Good.

Even though this explanation seems logical, I have two problems with it:

a) One full year is not a good enough period to flush out and rebound? Was the sales team so good at pushing that they had pushed more than ONE YEAR worth of sales?

b) To me, the explanation of high stocks seems to be a justification put forward by a novice (or lazy?) implementation team

This is neither the ethos nor the philosophy with which Vector implements its projects.

Remember the sufficient assumption of block 3.1 of the SnT Tree?

“To ensure an outstanding start of a major initiative it is vital that the first substantial actions will result in immediate substantial benefits.”

So while the world expects that sales will go down based on the logic that you explained in your responses, it is simply not acceptable to us. Vector’s SOP of trimming that negative is three fold:

1) Immediately increase the range that the distributor is holding. (In a primary sales target plus push sales environment, it is well known that the range at the distributors will be extremely limited compared to the entire range that the company sells.) When we release the capital of the distributor (by not pushing him with stocks of items that are traditionally bought by him) we do not let it go astray but immediately redeploy it in the other SKUs that have a potential. This should arrest some loss in primary sale.

While this is what most text book implementations will do (if they are really done by the book!), it may not be enough. We may not be able to block all the capital of all the distributors to the extent that primary sales do not suffer.

The Vector Approach to implementing replenishment is:

2) Bring distributors on the offer in waves. Select one lot and while you are waiting for their excess stocks to flush out, the rest of the distributors can be used to recoup the sales (after all the sales team are experts at pushing, aren’t they?). Then as the sales of the first lot of distributors on offer, begin to rise as a result of replenishment, choose the next lot of distributors for the offer. And so on. In this phased manner, you can bring the entire universe of distributors on the offer without suffering any dip in sales. At any time, there will be one set of distributors enjoying the fruits of replenishment and ever increasing sales, there will be another who are still being treated traditionally and the small set currently being rolled out will not punch a big enough hole in primary sales to warrant an official statement to the analysts and stock exchanges!

3) The above may arrest the dip in overall primary sales of the company to a large extent but it may not result in a big enough increase in the sales of the distributors on replenishment to give comfort to the company and the distributor. If we want to truly realize Eli’s vision, we have to find ways to dramatically increase the sales of the distributor on offer in a short period of time. Vector insists that all clients invest time in preparation for the offer rollout. Even before they present the offer, a comprehensive market mapping of the distributor’s area is done to arrive at the detailed list of all the retail outlets in the distributor’s area. It is well known that the distributor’s reach is woefully inadequate under the normal circumstances. We will redeploy the released capital of the distributor to immediately increase reach, i.e. cover all potential outlets in the distributor’s area. This will involve hiring dedicated sales people and creating/expanding delivery infrastructure to cover each and every outlet that has the potential to stock and sell our product range. The money for this “added expense” comes from the released capital and the virtuous loop of this step is that as you redeploy the released money to create sales and delivery infrastructure, your sales rise further and you earn more money!

The combined effect of all the above injections is to not only arrest a decline in primary sales, but to ensure that the secondary sales take off on a trajectory leading to high primary sales. A true WIN-WIN.

So the sales of this company declined because it did not move fast enough on expanding its reach. (Remember that though the retail reach increased, the company is still selling 70% through wholesalers)

I also suspect that the company suffered a double whammy. When you implement replenishment and the market gets wind of it, the wholesale segment anticipates that it will be the biggest loser (and rightly so) so they will swiftly start limiting their exposure to the company’s products thus leading to a precipitous drop in the absolute sales through wholesale. If your retail sale expansion is not fast enough, the combined effect is a drop on overall sales of the company.

2) Assuming that the company took no initiative at reducing costs, what two factors could have taken the company from loss to profit?

Two things that led the company from loss to profits:

1) Elimination of discounts/schemes, and
2) A higher contribution of “slow movers” to the sales of the company.

Some people got the first reason easily. Not difficult, right? Because you are no longer pushing, you do not need to give discounts and schemes linked to quantity purchase. The company’s throughput goes up (as there is no erosion of throughput).

The second reason is actually the topic of the case and we discuss it under Question No.3 below.

3) How can a change in Product mix contribution (from the existing portfolio) improve the bottom line of the company?

To answer this question, we have to first grasp the “physics” of business.

In a multiproduct distribution company, there will be fast and slow movers. The “fast movers” are the high volume products where the company commands a decent market share and if you look at your own company (or any other company for that matter) these products traditionally give less throughput than the “average throughput” of the company.

The slow movers are actually those products whose volumes (absolute number of units sold in a month or year) are low. Normally in these product categories, one of the competitors is a leader – what is a low volume product for us is a high volume product for someone else. There may be exceptions to this, but more or less this phenomenon exists. It is also quite prevalent that these low volume products enjoy a high throughput (compared to the high volume ones and also when compared to the average throughput of the portfolio of the company.

(By the way, fast mover and slow mover itself is a myth and I encourage you to read the relevant article posted on the Vector website.)

So when the sales of low throughput items go down AND the sales of high throughput items go up in the same period, the average throughput of the portfolio of products, and also the company, improves. Now whether the profits will increase or decrease is purely a function of how much the sales of high runners dropped vis-à-vis the increase in sales of the low runners.

If the total gains are more than the drop, the company will report an improved bottom line. Very few companies are in control of this eclectic mix, indulging mostly in reactive knee jerk reactions AFTER their bottom line has been hit.

Added to this conundrum of low throughput from high runners and high throughput from low runners is the impact of schemes and discounts.

Companies do try and use prudent commercial sense and try to offer discounts only on the slow movers, but no matter how hard they try, they are mostly “maneuvered” into offering schemes on the high runners too by inclusion of these products also in the scheme/package.

It may be quite shocking to know and difficult to digest but the combined effect of quantity discounts, schemes and other trade promotions can lead to a negative throughput on the high runners!

Imagine: the company loses money on every unit of the high runner it sells! You never realize this during the year as the whole sales team is gung ho about beating the market and meeting the numbers.

Only when the bean counters publish the numbers, the realization dawns on everyone that they have working hard to lose money for the company!

Garnish this with the situation of the company in question, which was literally hostage in the hands of the wholesalers and now you can understand the dynamics, which led to the “turnaround” of the company’s fortunes.

So to answer the question: The combined effect of low throughput, high discounts and schemes were actually hurting the company on its sales of high runners (the five products that accounted to bulk of the sales) and thus the company reported losses in the previous year.

The focus on retail led to the sales of wholesale segment going down and since wholesalers deal mostly with high runners, the sales of the company dropped.

The positive effect of replenishment was to remove the discounts and schemes and increase the throughput of the high runners and bring it to the positive zone.

In addition, due to the rollout of replenishment in retail, the sales of the slow runners went up. Since the throughput of the low runners is quite high, this not only neutralized the drop in sales of the high runners and brought the company to profit.

But for the TOC distribution solution, the company would have continued bleeding by “buying” market share and limiting its range further and further.

Saved by the offer!

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