A-12

Rough-Cut Value Management: Maximizing Business Value With Supply

Capabilities
Stephen T. Desirey, CPIM, and Savas Ozatalay, Ph.D.

INTRODUCTION
Figure 1. Business Resource Planning Process Map
Value chain management is the main process in realigning a company’s
Strategic Financial
resources with customer requirements and expectations. Value chain Plans Plans
management has three components: planning, demand management, Customers
Business
Planning
and supply management. Until recently a great deal of emphasis was • Order Entry
& Promising
given to planning and supply management components. It was assumed • Linking
Sales and Operations
that all of the customer demand should be met one way or another. Demand Planning Manufacturing/
Planning/Fcst Maintenance
However, total demand for a company’s resources has three basic com-
Sales & Demand Rough Cut Development/
ponents: demand that adds value, desirable, and satisfied; demand that Marketing Management Capacity Planning Design
adds value, desired, but not yet met; and demand that does not add Distribution
value, undesired, and should not be met. Demand management is about Replenishment Master
Scheduling
Sourcing

making choices about which basic component describes the incoming Interplant Bills of
Material
Inventory
Records
Demand
demand. Rough-cut value management is used to reconcile the spe- Detailed
Material/Capacity
New Product
cific value of the demand against the business strategy. Development Process
Planning
Capacity
Rough-cut value management measures value in terms other than Steps
Plant & Supplier
just revenue. It is a proactive way of selecting or choosing the custom- Scheduling

ers, product segments, and geographic segments in a way that partici-

pating in this chosen area will enhance the added shareholder value.
The intent of the tool is to identify demand that does not provide ad-
equate strategic value for today’s business needs. This paper will dem-
onstrate how rough-cut value management is used in a decision for
accepting specific customer business. This decision will follow four
steps: (1) Determine the economic value being generated by accepting
this specific demand; (2) Given this value, calculate the percentage of
supply capacity to be consumed by this specific demand; (3) Conduct
a Pareto analysis on the relative value of the demand choices that have
been selected and compare the value as a ratio to supply capacity nec-
essary to deliver that value; and (4) Use the Sales and Operations Plan-
ning Process to address the lowest 20% and improve the relationship.
This approach has been tested in a large DuPont plastics business.
This business wants to support the opportunistic markets, the new geo-
graphic regions, the key customers, the new strategic markets, the high
margin customers, potential growth customers, and other important
customers with high value adding opportunities. In other words they
want to make a decision on how to use their available supply capacity
for the greatest business value. In this paper, the assumptions made,
procedures used in defining value descriptors, scenarios tested, and
the results obtained will be summarized.
BUSINESS RESOURCE PLANNING
Value chain management is operating a business in a formal man-
ner by executing a single and comprehensive operating plan, appli-
cable to and tying together all functions with impact on demand,
supply, and inventory, fully reconciled from the most general to the
most detailed level and driven by a global and regional customer-
focused business strategy. Figure 1 shows a condensed process map
for the value chain management through Business Resource Plan-
ning. This process aligns the demand and supply processes so that
the business can execute against the guiding strategies, achieve its
financial commitments, and maintain a competitive service advan-
tage over other companies that participate in the marketplace. Sales
and Operations Planning establishes the important link between the
strategic plan and business operations. It helps to reconcile demand
and supply into an agreed-on single plan used by all business func-
tions to manage the business. It is also the driver of a time-phased
operations plan.
Delivery
In balancing demand and supply there are some critical questions
to be answered. In the demand side they are:
• What does the customer need?
• How much?
• When?
• Where?
• What is strategic about this demand?
In the supply side, questions are:
• How much do we have?
• What do we need to make? When? Where?
• What does it take?
• How much do we have?
• How much more must we get and when?
Traditionally, businesses always tried to meet all customer orders as
long as there was sufficient plant capacity. Current customer orders
had higher priority over new customer orders. In addition, sold-out
businesses, i.e., businesses using all of their available capacity, stop
going after new potential customers. The total revenue generated from
this customer’s orders determined importance of a customer. In today’s
business environment where there is intense competition and price in-
creases are not welcomed, traditional value management philosophy
does not perform effectively. In this context, managing demand be-
comes as important as managing supply.
DEMAND MANAGEMENT
Demand management coordinates customers, demand planning, sales
and marketing, distribution planning, customer linking, interplant de-
mand, order and entry promising, and new product development. De-
mand management is all about making choices as to which customer’s
orders should be filled. If the business does not make these decisions,
then the competition will. Then, the business will be reacting to the
competition instead of following the market opportunity. Figure 2 sum-
marizes the demand management process. By combining internal fac-
tors (such as price changes, lead times, product promotions, new prod-
ucts, product withdrawal, and senior management objectives, strate-
gies, and expectations) with external factors (such as customer input,
competition, economy, regulations, and market trends) an unconstrained

1998 International Conference Proceedings 359

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Rough-Cut Value Management: Maximizing Business Value With Supply Capabilities

• By unit or gross margin (economic profit margin)

Figure 2. Managing the Demand • By net revenue
• To gain market share where capacity permits
External Factors • For strategic growth in a specific market segment
•Customer Input
•Competition • For strategic growth in a specific geographical region
•Economy • As a pull through for the higher margin products
•Regulation
•Market Trends
• By financial terms and conditions of payment
Internal Factors
• Price Changes • Impact on profitability from “value added” services
• Lead Times • For overall benefit to the business driving total economic value
• Sales Plans
• Product Promotions
Unconstrained over time.
• New Products Demand Once the choices have been made and value measurement criteria are
• Product Withdrawal Forecast
• Senior Management defined, the rough-cut value management process performs the follow-
• Objectives ing steps to determine whether a specific demand should be accepted:
• Strategies
• Expectations History of Demand
1. Determine the economic value being generated by accepting this
• Actual Sales specific demand.
• Unmet Demand
• Unwanted Demand
2. Given this value, calculate the percentage of the supply capacity
that will be consumed by this specific demand.
3. Conduct a Pareto analysis on the relative value of the demand choices
that have been selected and compare the value as a ratio to supply
demand forecast is obtained. In this process the demand history of ac- capacity necessary to deliver that value.
tual sales, unmet demand, and unwanted demand is also considered. 4. Use the Sales and Operations Planning (S&OP) process to address
By using this unconstrained demand forecast, the business must make the lowest 20% and improve the relationship.
certain demand choices. These choices are: 5. The S&OP process also highlights the top 20% as well, as those are
• Demand that adds value is desirable and met the preferred customers.
• Demand that adds value, is desirable, but cannot be met As a business, we speak about doing many things. We want to support
• Demand that does not add value, is undesirable, and should not be met. the opportunistic markets, the new geographic regions, the key custom-
Rough-cut value management process helps businesses in dealing with ers, the new strategic markets, the high margin customers, other favorite
these demand choices. products, potential growth products, and may be the boss’ choice cus-
tomer. Rough-cut value management provides us a process to assure that
ROUGH-CUT VALUE MANAGEMENT everybody in the business is measuring the value the same way.

By engaging rough-cut value management into the demand manage-
ment process, the gain achieved from the strategy development will be
sustained and will be reconciled in the sales and operations planning.
In practice, the rough-cut value management is:
• A diagnostic to get the most value from today’s production asset
capability
• A tool to provide a “sanity check” for determination of real value
growth prior to expanding capacity
• A simple analysis to differentiate the top 25% of the business from
the bottom 25% based on the criteria that the business chooses to
define value so that proper differentiation is made in order not to
lose value in the current offering.
In evaluating the value of a particular customer’s demand, the business
has to make some choices. These choices can be made by
• Market
• Customer
• Profit and/or value to the specific division of the business
• Value to other divisions in the business
• Value to entire business
• Growth potential
• Financial terms and conditions
• Strengthening the competitive position
• Order lead time and customer service level
• What to include in value added.
Considering these choices, the rough-cut value management is rede-
fined as a managing process where value is measured in terms other
than just revenue. It is a proactive way of selecting or choosing the
customer/products in a way that participants in this chosen area will
enhance the shareholder value added of this particular business. By
following this selection process, the rough-cut capacity of the supply
chain is then reconciled with the rough-cut demand value. One of the
very important questions in determining the amount of value added by
the particular customer order is measuring that value. The following
list provides some example as to how to measure value considering the
total offerings:
CASE STUDY
One of the large DuPont plastic businesses used the summarized ap-
proach to determine efficiency of its capacity utilization and their
ranking of the customers. To begin with, the business understood that
they had to have a standard convention on computing margin includ-
ing a knowledge and standardization on types of packaging, freight
costs, responsibility, and abnormal costs of supply for specific prod-
uct styles. Their capacity needs were based on a full seven-day, twenty-
four-hour operation and standard up-time calculations were used. The
rough-cut value management process was accomplished in five steps:
(1) determination of the supply capacity used, (2) obtaining of a de-
mand value for each customer, (3) computation of a demand value/
capacity ratio, (4) conducting a Pareto analysis, and (5) redefining
customer priorities.
The first step was the determination of the supply capacity used
and its distribution among current customers. For each customer/prod-
uct combination the percentage of the total available production ca-
pacity used to fulfill this demand was calculated. For this business,
capacity utilization was very close to 100%. This product is unique
and toll manufacturing is not possible, so capacity is finite. The ben-
efits of using rough-cut value management increases in those compa-
nies where capacity utilization gets closer to 100%. If capacity expan-
sion is not allowed, the only way to increase shareholders’ value is by
replacing some of the current customers with new customers whose
business adds more value or to increase value of the existing not so
well desired customers.
The second step was to obtain a “demand value” for each customer/
product combination. After careful consideration and evaluation of
many factors that have potentials for increasing the shareholders’ value,
four quantifiable factors were chosen. They were
• total revenue generated from each customer/product combination
• total variable contribution
• after tax operating income
• customer/product combination’s growth potential.

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 Rough-Cut Value Management: Maximizing Business Value With Supply Capabilities

The last factor, growth potential, was more difficult to quantify.
Two different approaches were considered. The first approach was en-
tirely subjective. The Sales department, by using its market knowledge
and past history, subjectively assigned growth potential values ranging
from 0 (no growth potential) to 30 (most growth potential) in incre-
ments of 10. The second approach was entirely objective. For each
customer/product combination, last year’s sales volume in pounds was
compared with the next year’s forecast and percent change was calcu-
lated. For those combinations where there was a decline in forecasted
sales, growth potential was set to zero. For all other combinations,
growth potential was represented by the percent increase in sales fore-
cast over last year’s sales. The rough-cut value management model
was run once for each method of growth potential calculation. After
comparing sensitivity analyses resulted from simulation, only the sec-
ond approach was used.
The next task in determining demand value was to assign relative
weights for these four factors. Two different approaches were used.
The first approach included the growth potential in the formula to-
gether with the first three factors. The second approach did not include
the growth potential at all. In that case, the output of the rough-cut
value management was adjusted subjectively by the salespeople. For
each case, the following formula was used to obtain the demand value
for each customer/product combination:
Demand Value = w1 (REV) + w2 (VC) + w3 (ATOI) + w4 (GPOT)
where w1 = relative weight assigned to total revenue, w2 = relative
weight assigned to variable contribution, w3 = relative weight assigned
to after tax operating income, and w4 = relative weight assigned to
growth potential (with growth potential cases only).
Each customer/product combination’s final demand value was cal-
culated as their percentage share in total demand value.
The third step was the computation of a demand value/capacity ra-
tio for each customer/product combination. This was accomplished by
dividing relative demand value obtained in the second step by the rela-
tive supply capacity used obtained in the first step. These ratios were
used in the rough-cut value management model.
In the fourth step, a Pareto analysis was used to separate customers
into three categories: Class A, Class B, and Class C. In each case, cus-
tomer/product combinations were ranked in a descending order by us-
ing the demand value/capacity ratio. Those top ranked combinations
cumulatively using about 50% of the total capacity were classified as
Class A customers. Class B customers cumulatively used the next 30%
of the total capacity, and Class C customers used the last 20%. By
using a simulation model, different weight combinations for the four
factors were used and separate Pareto analyses were performed after
each run. Following a “sanity check” and considering some other fac-
tors which were not included in the model, a combined list, which
distributed all customers among A, B, and C Classes, was prepared.
Figure 3 displays a partial list of the final classification.
In the final step, each customer/product combination was reevalu-
ated to determine the desirability of pursuing additional business or
renegotiating the existing business with them. In Figure 3, there are
five customers in Class A which together use 50% of the total capacity;
there are three customers in Class B which together use 30% of the
total capacity; and there are two customers in Class C which together
use the remaining 20% of the total capacity. Average value/capacity
index for the entire business was 1.26. The largest revenue-generating
customer (Customer 7 with a 21% share) is placed in Class B, and the
third largest revenue-generating customer (Customer 10 with a 16%
share) is placed in Class C. These results indicate that additional growth
with customers 6 and 5 actually drives the total business value down
and prevents capacity to be used for the expansion of other more value-
generating customers or getting new customers.
The Supply Chain should send this information to the Demand Chain
so that additional marketing efforts are made to expand the volume for
those customers that are contributing above average value. At the same
time, current contracts with those customers, which are contributing
below average value, should be renegotiated in order to improve their
added value. If these negotiations are not successful these customers’
business should be discontinued. The rough-cut value management
process should be repeated annually since, every year through cus-
tomer selection, average value/capacity index will increase and some
customers who are desirable now may not be as desirable in the future.
This process requires continuous feedback between the Supply Chain
and the Demand Chain.
CONCLUSION
One of the most interesting results of this rough-cut value manage-
ment analysis is to show that traditional customer ranking by using
revenue only may not generate the best value for the business. Most
businesses consider their largest customers as their best customers and
try to meet all demand coming from these customers. However, the
rough-cut value management process shows that these customers may
not be the most value-generating customers. Figure 4 displays a com-
parison of percentage share in total revenue and percentage share in
value/capacity index for the ten customers used in the example. This
figure shows that these two measurement criteria are not correlated.
This means, using traditional customer valuation measurements will
not maximize shareholders value.
By engaging rough-cut value management into the demand man-
agement process, the lowest value demand will be continually pruned/
renewed, and the business value will sustain profitable growth in the
ongoing process. This value growth would be reconciled monthly as
compared to the Business Strategy in the Sales and Operations Plan-
ning process. The key word in this process is “rough-cut”. Naturally,
there are a number of subjective factors, which cannot be translated

Figure 4. Total Revenue and Value/Capacity Comparisons

25

Figure 3. Partial List of Final Customer Classifications

20
% Of Tot. Rev
Customers Class % Of Tot. Rev. % Of Cap. Used Value/Capacity
15 % Of Tot. Val/Cap
Customer 3 A 7 4 1
1.76
Customer 7 A 9 7 1
1.63 10
Customer 1 A 11 13 1
1.56
Customer 10 A 18 16 1.43
1 5

Customer 2 A 4 2 1.40
1
0
Customer 8 B 3 8 1.31
1
10
4

8
er

er

er

er

er

er

er

er

er

1.28
er

Customer 4 B 21 16 1
om

om

om

om

om

om

om

om

om
m
to
st

st

st

st

st

st

st

st

st
Cu

Cu

Cu

Cu

Cu

Cu

Cu

Cu

Cu

1.13
us

Customer 9 B 7 8 1
C

1998 International Conference Proceedings 361

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Rough-Cut Value Management: Maximizing Business Value With Supply Capabilities

into numbers and formulae. Their role in determining customers’ im-
portance must also be taken into consideration. In addition, this pro-
cess is sensitive to relative weights assigned to factors considered.
Before making a final classification it is recommended that a sensitiv-
ity analysis with varying weights be performed and necessary adjust-
ments made.
ABOUT THE AUTHORS
Stephen Desirey, CPIM, has been with the DuPont Company for 28
years. As a chemical engineer he has been in numerous businesses in
operations and marketing. Currently he is a manager in the Continuous
Business Improvement Center, serving also as a consultant for a num-
ber of DuPont’s global businesses.
Savas Ozatalay, Ph.D., is a professor of management at Widener
University, where he served as the head of the Management Depart-
ment for 12 years. He has a B.S. degree from the Middle East Techni-
cal University and M.A. and Ph.D. degrees from Northwestern Uni-
versity. He is the past president of the Southern Delaware Valley Chap-
ter of APICS. He has made many presentations at APICS International
Conferences, APICS Region IX meetings, and the APICS Southern
Delaware Valley Chapter meetings. Dr. Ozatalay has an extensive list
of other presentations and publications in the field of resource man-
agement.

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