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Supply Chain Segmentation

In today's complex and competitive world, firms have a wide variety of customers, suppliers, and products. The “one size fits all” approach is inefficient and not flexible, so companies operate using different supply chains. Companies constantly search for the best Customer-Product-Supplier combination, and segmenting the supply chain is the way to find the optimal combination. In this article, we will focus on the product segmentation and how it affects the decision whether to use ocean or air shipping.

How many segments should a company have? Each case is unique and has its own perfect recipe. Still, there are some rules of thumb:

  • Segments should be mostly homogeneous inside.
  • Segments should be reasonably different from one another.
  • The size of the segment should be big enough to justify its existence.
  • Number of segments should be pragmatic, in a sense that it should be convenient to work with.

We will discuss two methods of segmentation: ABC Analysis and Functional vs. Innovative approach.

ABC Analysis

This method is used to segment available products to three major classes: A, B, and C:

  • A Class products are the ones which have the most impact on the business (company makes profit when these products sell well). Company management should pay maximum attention to this class and actively manage it, as it has a lot of exceptions from the general rules and therefore requires manual influence. For example, iPhone is a clearly Class A product for Apple, that’s why Apple actively manages it, regularly releases updates and upgrades, and ensures fast delivery and availability.
  • B Class includes items that have a medium influence on the company, but don't require such strict attention and can be managed with some pre-established policies and rules. Though sometimes B Class needs active management to adjust the direction. For Apple, Mac Computers are in this group and they are managed accordingly – less frequent major upgrades, some inventory optimization, occasional backorders, etc.
  • C Class is for all the other items. This group has minimal impact on operations and can be managed with rather simple control mechanisms, spending little time and effort. All the various Apple accessories, such as mice, keyboards, and ear buds, can be considered like Class C items and Apple will do its best to optimize these costs.

It's worth noting that this division is artificial and can be extended to more classes (D, E, F etc.). Also the very same product can be Class A item for one company and Class C item for another.

We can use many criteria to base ABC Analysis on: item’s size or weight, complexity to source, perishability etc. The most popular and economically justifiable criterion of course is the money - ether revenue or profit. When using money as a base, we can commonly see the following distribution:

  • A Class items includes approximately 20% of all the item offered by the company and makes approximately 80% of the revenue
  • B Class items are around 30% of SKUs (Stock Keeping Unit) and bring in about 15% of the revenue
  • C Class items are a bigger group, 50% share of the SKUs, but responsible for only about 5% of company revenue

This is a good example of the well-known 80/20 rule (also called Pareto Rule). Of course it's not a strict law – more of a tendency – but ABC analysis regularly shows this type of distribution.

ABC Analysis has an influence on choosing the mode of transportation to use: ocean freight shipping or air freight shipping. Usually, A Class items (because of their huge impact) aren't kept in stock in very large quantities. Hence the need for fast delivery - if it is economically justifiable, firms choose air freight for this group of products. C Class items, on the other hand, are low cost, not very important items so they are capable of being ordered in relatively large quantities and shipped with slower and much cheaper ocean freight.

Functional vs Innovative Segmentation

This method has a different approach to segmentation. First of all we need to identify what kind of product we operate with - functional vs. innovative item. Next we apply the appropriate mode of transportation to it. In the list below there are major features that differentiate these two types of product from each other:

 

Feature Functional Product Innovative Product
Demand Well know Little or unknown
Product Lifecycle Long (2 years or more) Short (1 year or less)
Marginality 5 to 20 percent 20 to 60 percent
Product Variety Low variety High variety
% of Damaged Items 1 to 10 percent 10 to 40 percent
Forced Price Markdown By The End of the Lifecycle Near to 0 percent 10 to 25 percent or more
Example of a Product Hammer; Canned Soup Smartphones; Designer sneakers

 

Although it seems obvious and easy to distinguish which type of product fall into which category, we should always perform a thoughtful analysis, as each type of product can fit either group. For example, a wrist watch can be a cheap electric watch or high end Swiss-made mechanical watch. The first one will probably be labeled as Functional, while second will be Innovative.

The decision of Functional vs Innovative segmentation leads us to the appropriate mode of transportation:

  • The main goal for the Functional Group is to be efficient, and utilize available resources on the highest level to reduce operations cost to minimum. Therefore the natural decision is to use ocean freight shipping.
  • The main goal for the Innovative Group is to match supply with demand as fast as possible, so responsiveness is the decision driver. This leads to the shipping via air.

Use of the segmentation methods

It is worth noting that these methods are not mutually exclusive, but rather complementary to each other. Both are widely used in everyday operations and help supply chain and logistics managers to plan and allocate available resources correctly to satisfy demand and increase company revenue. As the variety and complexity of products increase, it is getting harder to perform the analysis using paper or spreadsheet. This is one of the reasons why companies implement complex ERP systems, which are helpful in making good decisions regarding segmentation.

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