Value Chain Analysis Efficient Consumer Response

The Value Chain Analysis of ECR Europe, Interpreting A System Innovation in Supply Chains
W. Schiebel Institute of Marketing & Innovation University of Natural Resources and Applied Life Sciences Vienna, Austria A 1190 Vienna, Peter Jordan Strae 82 tel. +43 1 47654/3560 fax +43 1 47654/3562 mailto:schiebel@edv1.boku.ac.at

ABSTRACT INTRODUCTION METHODS AND MATERIALS o Product Category o Distribution Channel o Trading Partners o Tools and Processes o Inter-Related Models RESULTS o Shared vision o Cost reduction o Business growth CONCLUSION REFERENCES

ABSTRACT
The European VCA Study demonstrates the importance of a positive obsession about generating consumer value, balanced by an equitable agreement on rewarding trading partners based on their true contribution to creating this long term value. Implementing ECR will result in a 5.7% reduction in consumer prices for the average business in the grocery supply chain. This reduction is composed of a 4.8% reduction in operating costs and a 0.9% reduction of inventory levels. Of course, this number differs for specific product categories and distribution channels, but in every case, ECR creates significant cost reduction opportunities. Most business growth is related to gaining market share by shifting demand. Delay in ECR implementation risks shifting market share to competitors already adopting ECR. Results from companies already persuing

ECR Category Management suggest that business growth for leading companies could result in three times the normal business growth expected using current capabilities. Key words: Efficient Consumer Response, Value Chain Analysis*, Common language * The author would like to thank Coopers & Lybrand ECR Center of Exellence, Utrecht (The Netherlands) for having the opportunity to recommand to their Final Report and the ECR Board Austria for help.
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INTRODUCTION
Efficient Consumer Response (ECR: Category Management, Product Replenishment and Enabling Technologies) is a global movement in the grocery industry focusing on the total supply chain (suppliers, manufacturers including agriculture, wholesalers and retailers) working closely together to fulfil the changing demands of the grocery consumer better, faster and at less cost. Consumers today are demanding more for less of retailers and manufacturers. But: What does more for less mean ? How do we define consumer wishes ? How do we determine how well we are fulfilling these needs ? How do we assess the potential impact of ECR ? How do we make good choices about where to focus our energy ? Responding to these questions is the purpose of Value Chain Analysis (VCA). VCA has been defined as an integrated set of tools (Activity Based Cost Structure, Proprietary Costs, External Costs and Internal Costs) and processes that are used to define current costs and performance, as well as to assess the potential impact of proposed ECR improvement concepts across the entire supply chain for consumer goods product categories. Additionally these tools and processes work together collectiveley to generate priorities and action plans. In its original version, as developed to support the USA ECR Performance Measurement Operating Committee years ago, VCA was focused on defining current costs and estimating cost reduction opportunities. However, as VCA has matured from hundreds of applications over the last couple of years, ist tools haven been expanded to include (a) the assessment of ECR impact on business growth, in terms of consumer demand and on market share and (b) the definition and communication of a shared vision, both internally and with key trading partners, regarding the impact of ECR on their business. VCA supports these needs by providing a common language that can be used by companies and their trading partners to benchmark currrent performance and set a future for ECR initiatives on vertical cooperations between agriculrute and the grocery industry. The purpose of the European VCA Study, as stated by the ECR Board, was to assess the applicability of the ECR concepts for typical European trading partners in grocery products, while identifying and quantifying the range of benefits that can be expected from ECR implementations.
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METHODS AND MATERIALS

In order to fully understand the value chain analysis tool, an understanding of its scope is necessary. When

conducting a VCA study, several decisions must be made before to beginning. First, companies need an understanding of the interaction of trading partners. Secondly, they must select a croup of product categories to analyse, and finally they must identify the relevant distribution channels that are involved.
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Product Category
The design of the VCA study allows it to examine up to five product categories and their flow through the supply chain. It is important to understand the meaning of product category. Looking at one product category allows for the comparison of data with other companies in the same product category, as well as trading partners in the same product category. An example: A company has decided to look at product category cheese. Cheese is a sub-category of Refrigerated Dairy Products which is a sub-group of Refrigerated Products which is a sub-group of Non-Dry Grocery Products. Product categories are an area of the VCA study which pose problems for companies. At the heart of this problem is typically a different definition of the `category from the retailers perspective as compared to the manufacturers view as well as from the consumers view. An unexpected gain from VCA, that we had not originally anticipated, came from companies re-evaluating their business in this way.
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Distribution Channel
The VCA study examines up to five distribution channels at one time. The distribution channels recognise that product flow is identical at the front and back ends of the supply chain, although between the manufacturer and the retailer's store shelves the flows are very different.
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Trading Partners
Value chain analysis is a comprehensive look at the activities of four trading partners: manufacturers, retailers, wholesalers and suppliers. Understanding the interaction of these trading partners as well as their roles within the supply chain is important in understanding the product and information flow which is integral to ECR. The VCA model would treat the relationship between a retailer and a manufacturer. In this case, the model uses one product group for both trading partners. This allows them to join their individual data sets in an effort to understand the flow of product through their related distribution channels.
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Tools and Processes

VCA has been defined as an integrated set of tools and processes that are used to define current costs and performance, as well as to assess the potential impact of proposed ECR improvement concepts across the entire supply chain for consumer goods product categories. Additionally these tools and processes work

together collectively to generate priorities and action plans. The Activity Based Cost Structure permits companies to look at costs in a standard structure across the entire value chain for each product category, as is illustrated in the exhibit below. 'Proprietary Costs are those costs that are incurred in supporting the business, plus profit margins. These costs fall outside the scope of the VCA study and are captured for the specific company conducting the study - but never carried into the database nor shared with any other party. 'External Costs are funds paid out to other companies for: Ingredients, packaging and products; Advertisement campaigns; Consumer promotions; Trade deals (actual treated as a revenue flow). 'Internal Costs are those costs that are incurred within the company to perform 18 specific activities related to Introduction, Merchandising, Promotion and Replenishment of products. Maturity Profiles allow a company to assess how much progress they have made towards a full implementation of specific ECR concepts, using a standardised scorecard. The scorecard establishes specific measures, which must be met for each of the ECR improvement concept criteria, in order for a company to qualify for a certain level of maturity. This standardisation ensures that when companies benchmark their capabilities against those of their trading partners, they are using the same criteria. Key Performance Indicators (KPIs) are used to benchmark current capabilities and set future non-financial performance goals. They include considerations such as promotion effectiveness, delivery reliability, inventory turns, order fill rates and assortment complexity. It is important to note that the ECR KPIs address the most critical performance measures associated with all four primary business functions: introductions, assortment management, promotions and replenishment. The VCA model uses the grocery industry activity model as a structure to capture current company costs, introduce reduction estimates for those costs, and provide baselines for other trading partners in the supply chain. While many people think of benchmarking as capturing best-in-class information, the practice has a much wider application, and can be used to simply `drive a stake in the ground against which others can be measured. The need for consistency is imperative within the benchmarking process in order to allow comparisons across multiple companies, trading partners, product groups, and so forth. Company benchmarking is important because it allows companies to benchmark their current cost structure to other similar companies. Using the Activity Based Cost structure, a company can easily benchmark itself across trading partners, distribution channels and product categories.
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Inter-Related Models
Using the standardised VCA tools, the unique VCA process can be broken down into four inter-related models: The Grocery Industry Activity Model; The Company Cost Benchmarking Model; The ECR Concept Assessment Model; and the VCA Cost Reduction Estimating Model.

To begin, one must first understand how these models operate separately, and then realise how they function collectively. Because VCA is an integrated set of tools and processes which work together to set priorities and designate action plans, each tool is integral and unique to the VCA process, and must be used properly to ensure the integrity of the data that has been collected. The Grocery Industry Activity Model is used to break down a higher level process or task into the specific activities being performed and to communicate to participants key information about those activities. Costs are captured as either internal costs, external costs and proprietary costs which are then spread across all trading partners. The VCA model uses the Grocery Industry Activity Model to capture current company costs, introduce reduction estimates for those costs and to provide baselines for other trading partners in the supply chain. Primary and secondary activities are defined for the four key business processes: Introduce Products. Merchandise Products. Promote Products and Replenish Products. The Company Cost Benchmarking Model gathers data from two sources - Activity Based Costing (ABC) and Key Performance Indicators (KPIs) - to allow companies to benchmark their current cost structure against those of other similar companies as well as to benchmark themselves across trading partners, distribution channels and product categories. The Concept Assessment Model defines the expected impact of a proposed change on the activities captured in the Grocery Industry Activity Model. For VCA, the Concept Assessment Model draws upon a library of baseline cost reductions defined by product categories and distribution channels. Coopers & Lybrand developed these baseline cost reductions as a result of their world-wide industry experience. The Cost Reduction Estimating Model brings togesther all the collected VCA data, industry benchmarks, and cost reduction estimates. The output of the Cost Reduction Estimating Model is ECR cost reduction estimates specifically for the company performing the VCA. These, in turn, provide a biasis for the ECR priorities and action plans.
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RESULTS
In this section, we will detail (interprete) the findings from the European VCA Study. The key findings in this section will be grouped into three areas: Shared vision, cost reduction and business growth.
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Shared vision
The leading European retailers are already thought to be the most progressive in the world in their implementation of many of the concepts promoted by ECR. These leading retailers are pulling their European manufacturers into more aggressive ECR implementation programs. The European VCA Study demonstrates the importance of a positive obsession about generating consumer value, balanced by an equitable agreement on rewarding trading partners based on their true contribution to creating this long term value. Clearly, in many cases this is easier said than done. Not every company is sufficiently knowledgeable about

its own activities, costs and profitability at the product, distribution channel and customer level to be truly capable of considering its impact on the total value chain. All too often managers spend too little time making the basic trade-offs that are involved in maximising consumer value, such as those between consumer advertising funds, trade deals and product costs for instance. Far too many managers still operate in vertical silos with too little knowledge of how their activities link into the total value chain. Additionally, much activity is still a knee-jerk reaction to competition, rather than a leading edge response to consumer demands. VCA relies on maturity scorecards to assist companies in gaining a stronger understanding of their own activities, costs and profitability. Maturity scorecards encourage managers to look outside their vertical silos in order to understand how their activities are linked to those of the rest of the organisation. As managers look internally and externally, they will begin to focus on and understand the entire supply chain. Beyond maturity profiles, interviews with top management in the participating companies have reinforced the perception that ECR is driving a basic shift in the Rules of the Game for successful companies. Three significant patterns have emerged from the European VCA Study: At the top of the list is a basic shift away from wasting time on adversarial relationships with key trading partners towards one of working more closely together to maximise the value provided to consumers. Hand-in-glove with this shift towards working more closely together is the recognition by businesses that whatever they do must make business sense to each trading partner, and that there must be a willingness to share in both the pain and the benefits from better serving consumers. To realise these benefits, it is clear that changes benefiting only one link in the value chain may in fact be counterproductive from the consumer's perspective, and that the greatest improvements will come from optimising the performance of the entire value chain through focusing on competence and speed for every activity, and on interaction between trading partners.
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Cost reduction
Implementing ECR will result in a 5.7% reduction in consumer prices for the average business in the grocery supply chain. This reduction is composed of a 4.8% reduction in operating costs and a 0.9% reduction of inventory levels. Of course, this number differs for specific product categories and distribution channels, but in every case, ECR creates significant cost reduction opportunities. Looking at the costs for the total supply chain provides an understanding of which trading partner is incurring which costs, either internally or externally. This provides companies with a better understanding of the activity costs that they incur internally and with their trading partners. ECR encourages trading partners to compare and contrast their information, in order to ensure that consistent and high quality information is being used to drive the decisions that are made in the supply chain. Using trade association estimates, the European VCA Study used $572bn as the amount of money European consumers spend annually on grocery products. This money enters the supply chain with the consumer purchasing products from the retailer. Excluding proprietary enterprise costs and operating margins for all

trading partners, the VCA studies captured all costs related to this $572bn in sales. These costs total $491bn or about 86% of total consumer sales. The costs incurred by retailers averages 14.9% of consumer price, or roughly $85bn. Manufacturer costs average 38.0% of the consumer price, or about $218bn, not including the costs of ingredients and packaging which are allocated to the supplier. Raw material and packaging suppliers receive on average 32.8% of the consumer price in revenue from the manufacturers or about $188bn. Since the European VCA Study did not closely examine suppliers, we are unable to show a detailed cost structure. Nonetheless, given that these costs represent a substantial portion of the consumer price, they can not be ignored when pursuing ECR opportunities. It comes as no surprise that the cost structure for a manufacturer is quite different from that of a retailer. Examining the manufacturer's stand-alone cost structure provides an insight into where the costs are incurred. These activity costs can then be used as a universal cost structure in order to drive cost reduction estimates. Manufacturers, on average, spend the greatest amount of their costs on ingredients and packaging (46.4%). Internally manufacturers incur 21.3% of their costs on replenishing products, leaving about 7% to introduce, merchandise and promote products. Funds used for trade deals, advertising and consumer promotions account for a substantial 25.2% of total manufacturer costs. Inventory, expressed as a percent of revenue, accounts for just over 10%. Merchandise and replenish product drive costs incurred by retailers, accounting for over 80% of their total costs. Consumer promotions and advertising account for an additional 17% of the costs. However, as illustrated by the bar chart, it is important to recall that all retailer costs account for less than 15% of the consumer price. Note that retailers view trade deal funds as a revenue, offsetting some of their internal and external costs. On average, inventory accounts for 6% of total revenue. The actual cost reductions that are available are very context-specific, and the division of the pot between alternative courses of action such as lowering retail prices, improving profit margins or investing in demandcreation activities will depend on companies' individual competitive environments. Cost reductions come from two sources: operating costs (4.8% out of the 5.7% total savings) and inventory (0.9% out of the 5.7% total savings). Again, it is worth emphasising the point that the average operating costs and inventory reductions that are available to the grocery industry as a whole are likely to be higher than for this study sample, which was biased towards the larger and more progressive companies. Even taking the average 5.7% figure, this translates into over US$33 billion worth of savings across the entire European grocery industry. Within the participating companies, the largest estimated reduction in operating costs totalled 6.5% of the retail price. Combining this fact with weighted maturity profiles reflecting the average European retailer and manufacturer, the reduction in operating costs for the `average company is calculated to equal 4.8% of the retail price.
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Business growth

Most business growth is related to gaining market share by shifting demand. Delay in ECR implementation risks shifting market share to competitors already adopting ECR. Results from companies already persuing ECR Category Management suggest that business growth for leading companies could result in three times the normal business growth expected using current capabilities. Business Growth has proven to be of equal - if not greater - importance, compared to cost reduction in the implementation of ECR. ECR helps increase sales by ensuring that the right products are at the right place at the right time. Additionally, ECR seeks to increase the sensitivity that exists between manufacturer and retailer by ensuring that consumer expectations are always understood. This permits them to more consistently offer those products that consumers desire. Retailers will see business growth in the form of market share resulting from increased consumer traffic and more purchases per visit. Manufacturer growth from ECR will stem from increased sales of existing products as well as from an increased focus on the effectiveness of new product introductions. Best-in-class companies have outstanding control of Product Replenishment. This excellence in supply chain operations gives these companies three advantages for business growth: they can respond much more quickly to shifting consumer needs; they have eliminated non-value-added replenishment costs which can be used for value-added activities or passed on as price reductions; and they have minimised the capital tied up in inventory, so they can use these funds in much more productive ways.
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CONCLUSION
During a Value Chain Analysis study, a large amount of data is generated, which needs careful interpretation to distil the key messages. How do companies interpret and act upon its findings? It should be stressed, however, that interpretation is not an exact science and it would be wise to seek the help of a skilled VCA practitioner. The European VCA Study key findings in this area were:

the majority of participating companies have as yet failed to establish a sound infrastructure basis for Category Management; both manufacturers and retailers scored lower on infrastructure than on the three other Category Management concepts; manufacturers generally lag behind retailers on introducing a full category-based organisational structure; even leading retailers have weaker information system support than most manufacturers - this could be an obvious opportunity for relationship building; and there are isolated examples of highly advanced, mutually beneficial joint category management programmes occurring.

The European VCA Study showed that:

presently this subject is better understood by the retailer than by the manufacturer; and

sharing data and decision-making power is a common barrier to progress.

The process of implementing ECR within the European grocery industry does not stop with the European VCA Study. Rather, the process will vigorously continue into the future. It is proven time and again, that a common language between trading partners is best provided through a VCA process.
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REFERENCES
1. Coopers & Lybrand and ECR Europe. 1996. European Value Chain Analysis, Final Report, Utrecht 2. ECR-sterreich-Initiative.1999. ECR Handbuch II, Von der Idee zur Umsetzung, Wien 3. Kotler, Ph. 1997. Marketing Management, New Jersey 4. Zickmund, W.G. and DAmico, M. 1996. Marketing, St. Paul

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