Value Creation: Assessing the Cost-Service Trade-off

Abstract

In the previous chapter, I emphasized the importance of simultaneous product, process, and supply chain design in a dynamic environment where industry structures evolve continuously. In adopting a concurrent design approach along these three dimensions, one must resolve key cost-service trade-offs in each of those dimensions. In other words, one must assess whether investing in a product, process, or supply chain redesign initiative is a value-creating or value-destroying proposition. For instance, if the additional cash flow generated by a new product design due to an increase in the customer’s Wllingness to Pay (WTP) does not lead to a positive net present value to justify an investment of four man-months of additional Research and Development (R&D), this is a value-destroying proposal. To assess these trade-offs in an objective fashion, supply chain professionals need a simple but rich modelling tool. In this chapter, I will formalize the cost-service trade-off, which affects supply chains, through a materials management framework. Such an inventory policy will not only allow us to quantify the cost-service trade-off, but also identify (and cost out) principal levers that one can deploy for mitigating such a trade-off.