Cost Allocation Goes Upstream, but a Weak Link Can Let You Down
The life of the Pacific Salmon is an uphill battle. After years spent at sea, every mature salmon must return to the place where it was born to spawn, and make the arduous journey upstream to get there. Here Alessandro Evangelisti, Finance & Supply Chain Evangelist at Oracle explains to Finance Monthly that in business, the value stream perspective can be beneficial, but weak links are a risk.
As impressive as the physical challenge it faces is the salmon’s innate understanding of exactly how much energy it needs to clear each obstacle along the way while saving enough to finish the journey.
The modern business’ aspirations are not quite as singular as those of a spawning salmon, but there is a lesson to be learned here: efficiencies are found in processes, not in outcomes, and they add up to major gains in the long run.
If a salmon used all its energy at each obstacle, the upstream journey would be too tiring and fewer fish would make it. Similarly, a company that devotes resources to inefficient processes will see its bottom line shrink and jeopardise its future success.
Navigating the value stream
Companies have traditionally built their cost-allocating approach around their products and specific outcomes. However, this driver-based expenditure only allows them to redistribute costs between processes, giving them little hope of uncovering new efficiencies.
This is the same thinking that scares companies into divesting themselves of new product lines even if they show genuine promise, or of holding back on R&D and innovation.
A better approach is to for companies to organise themselves around value streams, which allows them to follow the flow of expenditure throughout their processes and uncover new opportunities for savings.
This is not easy an easy shift. Many CFOs have made their career out of traditional cost allocation, and shaking things up will be as culturally challenging as it is a logistically difficult.
For inspiration, finance leaders can look to supply chain and operations managers, who have adopted value-stream costing because it forces them to focus on productivity, which is key to their success.
Turning to telecoms, Orange France has taken a value-stream approach to managing supplier invoices and preparing financial profitability reports, which has allowed it to spot and clear bottlenecks in these processes. As a result, Orange’s finance, procurement and operations teams have never worked together more closely and deliver better results for customers, all at lower cost.
Three steps for a smooth j upstream journey
The transition to value stream-based costing cannot happen overnight, nor should it. The whole company first needs to be aligned in its approach, and data needs to flow freely between departments if costing is to remain consistent.
What follows are three steps to guide businesses along the way:
Step 1: Know your customers
Knowing what constitutes value for customers puts businesses in the best position to work backwards and develop processes that deliver on peoples’ expectations. From marketing, to warehousing and shipping to manufacturing, each leg of the value stream will be developed with the same focus.
Step 2: Always address the weakest link
Any chain of processes is only as strong as its weakest link. By spotting bottlenecks early in the game, companies can then build systems designed to avoid these. To gain the necessary visibility, businesses require a granular view of their data and of how processes are working together.
This approach has helped some supply chain organisations achieve 20% gains in year-on year productivity.
Step 3: Go digital
It’s no secret digital processes are easier and faster to manage. They can also be automated to help the entire business work faster. With new data from IoT sensors and increasingly automated processes at their disposal, value stream managers have more information than ever to help them overcome any obstacle.
Value begins and ends with finance
In essence, value stream mapping is a form of supply chain segmentation applied to the entire business. As the organisation’s “data impresario” the CFO sits at the centre of its value stream approach.
CFOs therefore need to a close-up view of process data from each line of business. Equally, they need a system that ensures consistent data across every value stream – the disparate systems many companies still use make it almost impossible to scrutinise processes side-by-side. Value stream costing is ultimately about teasing new efficiencies out from processes across the businesses, so a complex system that only allows for a piece-meal approach to change defeats the purpose.
Thinking back to the Pacific Salmon’s uphill battle, the difference between life and death can be a matter of centimetres and relies on how much energy a fish has stored to clear each obstacle (in addition to some luck). In a large business, even the simplest tweak to a manufacturing bottleneck can elevate a product from cost-centre to game-changer. Organisations simply need the strategies, people and infrastructure to spot and clear these hurdles on their way to growth.