Defining customer service levels to keep customers and shareholders satisfied

Résumé du document

If you need to release cash, particularly during a recession period or when sales are falling, you should look to your working capital. Optimization of your working capital will improve efficiency, liquidity and potentially investor ratios like the dividend yield, if the dividend payment can still be maintained.
One of the blockers or reasons not to reduce working capital is the potential effect on customer service levels. Any deterioration of customer service could jeopardize the initiative straightaway, have long-term consequences on revenue due to lost sales, and lead to counterproductive results such as overstock.

For this reason, any inventory and receivables optimization need to go hand in hand with optimal service level targets. Service level in this context means the probability that all customer orders arriving within a given time interval will be completely delivered from stock on hand, that is, without delay.

Often influenced by the sales department, too many companies pursue the same service level target for all their clients. Not only is this unrealistic, it is dangerous, for three different reasons. On a cost basis, margin can deteriorate due to a wide product portfolio, rush orders and express shipments offered to unprofitable and low profitability clients. On a cash basis, a high service level for all clients requires a correspondingly high inventory level of finished goods and components, with cash tied up unnecessarily and a high obsolescence risk. Finally, on a service level basis, there is a risk that low-profit customers will get a higher service than the profitable ones.

Extraits

[...] However, in order to guarantee the widest buy-in and implementation success, service targets need to be validated on a cross-functional basis. Working capital objectives aligned with service level and operating profit objectives can release up to 20 percent of inventory reduction at no expense to customer satisfaction and therefore to revenue. Translating customer service segmentation into management of inventory levels ensures an inventory reduction based on consensus and aligned with sales objectives. Whether the strategy followed is based on volume or profit, what is important is the alignment between both cash and cost and service level objectives. [...]

[...] Ideally, a company could incentivise clients via loyalty scheme, if their contribution to net sales and operating profit is high enough. This method can help all types of companies to increase two sources of free cash flow: the operating income and working capital reduction. Companies can reduce inventory of finished goods and components and optimise receivables while ensuring the optimal allocation of resources to the most profitable customers. With best-in-class service level and additional free cash flow, customers and shareholders will be more satisfied. [...]

[...] Defining customer service levels to keep customers and shareholders satisfied Optimise inventory with service level targets If you need to release cash, particularly during a recession period or when sales are falling, you should look to your working capital. Optimisation of your working capital will improve efficiency, liquidity and potentially investor ratios like the dividend yield, if the dividend payment can still be maintained. One of the blockers or reasons not to reduce working capital is the potential effect on customer service levels. [...]

[...] How should customer service level be defined? The first step towards the definition of customer service targets is the segmentation methodology, which classifies clients based on their contribution to net sales and to operating profit. ABC classification groups the customers into three categories based on the percentage of their contribution to net sales: Contributors to the top 80 percent of net sales: A clients Contributors to the next 15 percent: B clients Contributors to the remaining 5 percent: C clients 1234 classification is used to similarly group the customers into four categories ( based on their contribution to annual operating profit, where the fourth category contains the unprofitable customers. [...]

[...] An innovative use of customer service level all along the supply chain The service level as a target is usually used in the calculation of finished goods inventory level. In order to define the optimal level of inventory, for an item produced on a make-to-stock basis, the service level is a core parameter in the well-known formula for calculating safety stock. What is innovative is the use of the customer service level to calculate the components inventory level using the bill of materials, as presented in figure 3 below. [...]