Understanding the profitability (and costs) of each segment can make a dramatic difference in driving organizational alignment and decision making. It can help supply chain leaders determine where to put their best people or financial resources, whether for planning, branding, or other purposes.
So what questions do companies need to weigh when they decide to undertake supply chain segmentation? We see two, pertaining to the segmentation approach used and the parts of the value chain to be segmented.
Which segmentation approach is best? Generally, companies can segment by product, customer, or channel. The vast majority of those we studied (71%) segment by product. Of these, 43% segment products by volume. A large percentage (61%) also segment by customer. However, less than half of this group takes a strategic approach driven by objective factors, such as customer sales volume or location. Most simply react to retailers’ demands.
Product segmentation can be used to gauge demand and drive service levels and production: “A” SKUs, for example, merit higher fill rates and greater immediate manufacturing capacity. It can also guide warehousing policy: “D” SKUs need more inventory since they are produced less frequently.
A dairy producer we interviewed, for example, segments inventory, service, and packaging by customer as well as by product. In service, it created three segments according to customer volume, growth, and profitability. On-time targets are set according to the delivery-stop sequence, while higher targets are set for first stops on a route. The company even creates special packaging for certain big-box customers.
Once a company establishes its approach, it must choose the criteria for its supply-chain design. These range from product velocity and demand volatility to production lead time and shelf life—and, of course, profitability. (See Exhibit 2.) For example, the dairy producer alters its product fill rates by SKU velocity, making adjustments during promotions and other intense sales periods. Segmenting by sales volume and demand volatility is also common in product segmentation.
A leading confectionary company segments its SKUs by velocity and profitability, which influence safety stock and service levels. The company expects segmentation to produce additional insights that will influence decision making throughout the organization and further augment performance.
Which parts of the value chain should be segmented? Next, the company must determine its segmentation strategy. Any number of functions can be segmented. The ones most commonly segmented today are forecasting (54% of the companies we studied use this approach) and warehousing (36%). To boost forecast accuracy and reduce inventory, one company that BCG worked with collaborates with key customers on detailed forecasts. But other companies have gone further, segmenting sales, manufacturing, and even procurement and transportation.
A company’s capabilities, as well as the potential value of the total segmentation effort, will determine how far it can go. Certainly the more end to end the implementation, the more profound the impact and potential value. Functions need to be aligned; that means formally sharing data and setting and tracking targets.