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July 25 2006 10:20 AM

After a decade or so of the term supply chain management being used, we seem to understand what it is, or at least what it can do for us. We do many things differently now. Some areas, like materials management, are more receptive to change than, for example, accounting. Yet, other areas like customer service level, material and product mix and company overall profitability depend on the ability of the accounting system to provide accurate cost figures.
Rather than an asset, we now consider inventories an investment, and as such, they involve risk. Inventories are undesirable because they tie up cash that could be generating a higher return somewhere else. Inventories are susceptible to obsolescence, damage, loss and pilferage. They also need space to be stored, people to handle them and resources to manage them. Inventories are at the center of SCM�s drive toward creating products that are made in the most efficient way and meet customer expectations. A good materials manager is in a position to save her employer significant amounts of money by first streamlining receiving, inspection, warehousing and distribution of the parts and goods in inventory and then by dramatically shortening the average days of inventory on hand.
Unrelated to ABC accounting, ABC analysis utilizes Pareto�s 80/20 rule. This powerful management tool helps streamline materials, product and customer mixes by forcing us to focus on the most profitable components of our business. ABC inventory analysis, when used for strategic purposes, should focus on the profitability of each SKU rather than on its turnover. Applied to the product mix, ABC analysis classifies the company�s products in terms of their contribution margin. In regards to ABC analysis and customer service, we need to know which customers bring in the most money and which ones involve the opposite � a loss � every time we service them.
ABC analysis is not possible without the availability of accurate cost data. This affects the entire organization, at both strategic and operational levels. SCM needs an accounting system that allows for the allocation of indirect costs in a better way than that allowed by traditional accounting. Activity-based costing provides a good match. Regrettably, and as it sometimes happens with ERP and CRM, the implementation of ABC accounting may generate more headaches than bliss. In fact, many companies end up canceling their implementation of ABC accounting before they can benefit from it.
In any respect, a good supply chain must rest on accurate understanding of all the costs involved.
James U. Carvallo is a lecturer at Cal Poly Pomona and president of Vector Associates. Contact him at