Making ECR work
On the analytical side, we have seen that ECR applies a fullycontemporary process and activity analysis to value chains with multiple trading partners.This is a major achievement but analysis, no matter how thorough, does not in itselfimprove a business. Business improvement demands changed behaviour. This is bestunderstood as a breaking down of the barriers that exist both within the company andbetween trading partners.
Fortunately ECR does support changes to behaviour by:
- providing decision support information to managers on why costs occur (i.e. cost drivers) that allows fresh approaches to improve performance
- constructing cost models that allow negotiation around mutually shared benefits, as opposed to a price
- encouraging co-operative approaches to the sharing of information and the standardisation of technologies to permit a more efficient value chain
The change in philosophy proposed is profound, namely tomove from an adversarial relationship where each party seeks to reduce its own costs to aminimum while maximising income, to one where benefits are shared in order that they beenlarged. We now consider the performance improvement tools that have been providedthrough the ECR project, which are based upon Value Chain Analysis (VCA).
Obtaining process improvement
VCA is a well-established technique, predating ECR, that ispart of the activity-based management (ABM) set of techniques for the analysis andimprovement of organisations. We have discussed one benefit of its application to ECR,namely the creation of cost models; other techniques include:
- non-value-added analysis to highlight where effort is wasted
- process and cost driver analysis to understand the underlying influences on cost
- the use of the maturity profiles for benchmarking performance against the industry, and the identification of scope for improvement
- key performance indicators to incentivise new behaviour and track the improvements as changes are made
The most reliable way to obtain improvement is to create aspecific project; this is sometimes called a ‘VCA study’ though identical workis undertaken in an ‘ABM project’. The acronyms are irrelevant of course; theimportant thing is to create an analytical framework that will identify performanceimprovements and permit negotiations for benefits to proceed on a rational basis.
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We now discuss how to use the ECR concepts in negotiations.
Negotiation around a cost model
Basic negotiations, such as those conducted in a bazaar,consider a product and its price. This is essentially a zero-sum game, where the pricestruck will depend on the needs of the two parties. The potential buyer places a value onthe item, possibly with a view to resale, and also has alternative uses to which fundscould be put. The potential seller wishes to liquidate the asset, possibly to recover thecost of production or invest elsewhere. The demands of the moment will influence theprice.
In more developed versions of the game, between perhaps aretailer and a manufacturer, each side will have a number of variables on which they areprepared to bend, e.g. margin, the depth of distribution, the intended position on theshelf, the delivery frequency, the box size etc. This adds new dimensions to thenegotiation however there are still limits to the co-operation. Both sides are essentiallynegotiating blind, feeling their way by each others’ responses to a common ground.What is needed is a means whereby both parties can agree to a way of working for mutualbenefit. This immediately generates a problem however: two companies which are normally inan adversial relationship with each other have to co-operate in a process where there isjoint expenditure for mutual benefits. Inevitably, questions such as Who benefits? arise.
The problems are, however, soluble and have beensuccessfully tackled in some industrial and commercial sectors. In particular successfulpartnerships have been developed in the automotive sector between manufacturers and theirsuppliers.
The approach is to agree to negotiate around a cost modelwhich both sides accept as valid. When proposals are made for a change in working practicethen the impact on cost is then apparent and can form part of the negotiations. Not allparameters can be incorporated in a cost model (e.g. the value of particular shelfposition is very difficult to estimate) but many parameters are susceptible to costestimation.
To do this between a single supplier and customer isstraightforward (but a big step to take). To do it across an industry requires agreementon the principles behind the cost models and ECR can provide a framework for this. Thistype of cost model is really essential and one should question whether a manufacturershould wish to enter such a negotiation without one. Without a cost model the companycould not bargain for its proper share of the mutual benefits that arise from thesenegotiations.
Since ECR is so dependent on co-operation between tradingpartners and this has proved so elusive in the past, it is worth digressing to examine indetail the advantages of partnerships, or partnership sourcing, and then consider thedifficulties that arise when manufacturers and retailers attempt to create them.
Partnership sourcing principles
Partnership sourcing is important because many of thesignificant gains in performance within a value chain cannot be obtained by a single partyacting alone. Instead there has to be a degree of co-operation between trading partners.Partnerships can be introduced both between a retailer and a manufacturer and between amanufacturer and its suppliers.
The first point is that obtaining benefits from partnershipis an iterative process of undertaking analyses and creating trade-offs. The informationflow necessary to support this iterative process is not compatible with traditionalpurchasing and its funnelling of adversarial communication through a sales/purchasinglink. Instead multiple information flows are necessary and the proper management of thisrequires the framework of a partnership.
Developing partnership frameworks can be time consuming socompanies usually restrict the number of partnerships they enter into and generallyundertake an increased volume of business through these trading partners.
For partnerships between a manufacturer and its suppliers,the benefits can include:
- the spreading of development cost and risk amongst participants
- reducing the transaction cost of dealing with many suppliers
- gaining the full benefit of experience curve effects and economies of scale by concentrating production
- encouraging the supplier to invest in more expensive, longer-term equipment to gain higher efficiency and higher quality standards and allowing the supplier to dedicate staff to the partnership
From the view of the supplier, the main benefits are:
- stability, which allows investment to be entered into with confidence
- assistance from its customer in the improvement of its processes
Risk sharing is also an integral part of formingpartnerships, especially in the area of contractual risk. Any reassurances given to asupplier on the expected volume of work and the duration of a contract allows compromisesto be made on price while preserving the value of the contract needed to justify capitalinvestment. The key is for the purchaser not to insist on ‘freedoms’ to switchsuppliers arbitrarily which in practice would not be acted upon if the partnershipdevelops as intended; of course, in the case of non-performance there should be thepotential for an exit by means of non-compliance clauses.
Given the benefits, what needs to be done to bring itabout? We have already said that the ECR cost models provide each side with anunderstanding of the current and proposed costs to be used as a basis for the sharing ofbenefits. On the softer side there is also the matter of trust. While intangible, it canbe encouraged by:
- increasing the amount of face-to-face contact between companies
- retaining continuity – the effectiveness of the previous measure is lessened if staff move on after a short time
The area of partnerships between supplier and manufactureris vital, especially since the European Value Chain Analysis Study identifiedsupplier integration as the most significant performance improvement concept, as measuredby size of operating cost benefit. Similar benefits can also arise from partnershipsbetween retailers and manufacturers though in practice there are special problems which wenow discuss.
Obstacles to partnerships between manufacturers andretailers
Although partnerships have been successfully implemented inother sectors, there are two special obstacles that are likely to impede their adoption bymanufacturers and retailers.
The first is strategic and quite fundamental. In the pastretailers could be considered as simply one element in the manufacturers’ marketingmix, namely distribution. However, in many countries their economic concentration, capitalinvestment and information systems have ensured that they are now significant operators intheir own right, with their own strategies and the power to execute them. They now competedirectly with manufacturers and the most significant sign of this is in their creation ofhigh quality own-label brands. This is of course a major topic in its own right, but thepertinent point is that manufacturers and retailers compete in a way that a manufacturerand its supplier do not. For this reason partnerships are particularly difficult toobtain.
The second factor is cultural but no less potent. ECR andnegotiation around cost models, demand a long-term, business-orientated approach toobtaining performance improvement. Yet in retailing at least, a trading mentality hasprevailed in the past. Gaining adoption of the approach may be difficult though theperformance measure frameworks and the cost driver analysis should encourage longer-termperspectives.
Some, perhaps rightly, dismiss the concept of partnershipsbetween manufacturers and retailers, saying that collaboration is a far more accurateterm. However even collaborators have to work together and divide the benefits. Thisrequires systems that measure the profitability of trading relationships.
Measuring the profitability of tradingrelationships
The financial information systems of many companies areunsuited to the current trading environment. They calculate product or brand profitabilityand divide the company up functional lines but they conspicuously neglect to calculate theprofitability of trading relationships (e.g. through analysing cost-to-serve) or the costsof the processes which underpin the company. Fortunately the techniques to rectify thisare available, in the form of activity based costing.
The absence of cost-to-serve information is the mostserious shortcoming for manufacturers. The power of retailers is such that it is thespecial conditions that the retailer places on the manufacturer that will be the majorinfluence on company profitability, yet many information systems do not collect thisinformation. This absence is especially serious when a manufacturer is invited to join apartnership – without a system to measure customer account profitability there will be noway for the company to confidently negotiate for a share of the gains.
Dividing the benefits
To many of course this will be the most important issue. It isimportant to bear in mind that ECR certainly does not supplant the market. It certainlydelivers benefits to the system as a whole but the party to which they accrue will dependon the market. Although in the US the formal position has been that the benefits of ECRwill go to the consumer (perhaps to avoid the risk of anti-trust actions arising frommanufacturers and retailers co-operating) in practice the benefits can accrue anywherewithin the value chain.
As a guideline one would expect:
- benefits arising from a supplier’s or manufacturer’s proprietary expertise or technology would most likely go to them
- the reverse would happen if the improvement depended on the retailer’s expertise
- if the improvement depended on readily available expertise or technology, the action of the market would cause the benefit to flow to the consumer
The mechanism for the direction of benefits is of coursethe market price at the different trading points within the value chain, which will benegotiated in the same way as occurs at the moment. The difference under ECR is that bothparties recognise their mutual interest in taking a longer-term view on mutual benefitsrather than fighting for immediate short-term gains.
In the original US report on ECR, two thirds of the ECRsavings were projected to arise from co-operation on the demand-side activities, despitethe relatively large potential for savings on the supply side in the US. In Europe andespecially the UK, where the supply activities are more efficient, the demand side, i.e.Category Management, will also be crucial.
Definitions of Category Management abound, but the US ECRBest Practices Committee definition is succinct: ‘A retailer/supplier process ofmanaging categories as strategic business units, producing enhanced business results byfocusing on customer value’. It employs the concept of categories, where a categoryis a group of products, defined using consumer-related criteria, which it is sensible totreat as a strategic business unit.
Its objectives are to improve the three demand aspects ofECR, namely product introduction, product promotion and product merchandising. It requiresmoving away from a traditional structure whereby the manufacturer seeks to build the valueof a brand through its own actions alone, while the retailer seeks to minimise the cost ofeach deal, to a longer term viewpoint where manufacturer and retailer work together tomaximise sales.
In making this transition, the European Value ChainAnalysis Study identifies five stages in development for a manufacturer: traditionalsalesman, advanced salesman, category sales manager, trusted advisor and strategicalliance partner. These classifications may be useful but underlying them is the shift tonew:
- performance measures
- information flows
- organisational structures
These changes were also discussed in the section onpartnership sourcing; Category Management is simply one manifestation of partnershipsourcing within the value chain, namely the co-operation between manufacturer and retaileron demand creation.
Supply chain management
There have been so many supply chain management initiatives,all supported by acronyms, that when ECR arrived it was not surprising that it wasmistaken for another one! Examples include: Vendor Managed Inventory (VMI), Co-ManagedInventory (CMI) and Continuous Replenishment Programmes (CRP).
Rather than define each of these initiatives individuallywhen they are quite similar, to the point that at industry conferences speakersoccasionally position an equals-sign between various acronyms to simplify matters, itwould be simpler to note the common themes:
- a transmission of data down the value chain to the manufacturer (and its suppliers) more quickly so that goods can be transferred up the value chain more efficiently
- the breakdown of functional barriers to achieve more effective supply, e.g. making a manufacturer responsible for inventory levels in a retailer’s outlet
A battery of techniques and technologies is then deployedto bring this about. These include:
- information systems, including bar codes for data capture, which allow manufacturers to monitor consumption, control inventories within the value chain and synchronise their own production accordingly
- forecasting that includes the effect of promotions and also above-the-line activity, e.g. media advertising
- delivery frequencies and timings that minimise non-value-added stock movements
The principles are well established but there is no doubtthat there is more to achieve.
ECR is a comprehensive approach to the improvement of thevalue chain. There has been some uncertainty over the exact scale of the benefits, whichwill vary according to each situation, but there is consensus that they are substantialand will be greater for those companies that act quickly.
To reap these benefits requires improvement in bothCategory Management and Supply Chain Management. To do this, trading partners need toco-operate and for many this will be a change in behaviour. This will be assisted by thevalue chain analysis and performance measures provided by ECR.
A useful first step towards ECR would be for a company toanalyse their own value chain operations, explore the potential for collaboration, andthen invest in the necessary techniques, including information systems which are thebed-rock of a high performance value chain.
1. Efficient Consumer Response – Enhancing ConsumerValue in the Grocery Industry, 1993, Kurt Salmon Associates Inc., published by TheFood Marketing Institute: Washington DC.
2. Supplier-Retailer Collaboration in Supply ChainManagement, Project V, 1994, GEA Consulenti Associati do gestione aziendale, publishedby The Coca-Cola Retailing Research Group-Europe.
3. European Value Chain Analysis Study, 1996,facilitated by Coopers & Lybrand, published by ECR Europe.