How to Build a Modern Supply Chain
This paper is provided for the companies who are willing to make their supply chain more effective by supplying goods to their customers quickly and more cost effective way. This paper will present three seemingly simple – but proven – elements: Agility, Adaptability and Alignment, to obtain strategic advantage over their supply chain.
Importance of a Modern Supply Chain
Over the past two decades many companies have focused on rebuilding their supply chain to deliver goods to their customers as quickly as possible in the most cost effective way possible. As a part of this process, companies have invested in state of art ERP systems as well as hiring top-notch talent. Many companies have also collaborated to stream line processes across their supply chain by laying down standards and sharing infrastructure. For example, in the 1990s, America apparel started a Quick Response initiative, and grocery companies in the US started a collaboration initiative called Efficient Customer Response. However with time a lot of these companies found that becoming more efficient and cost effective does not necessarily give them a competitive advantage over their competitors. For example, despite increased investments in efficiencies, mark downs rose from 10% in 1980 to 30% in 2000 and at the same time customer satisfaction with product availability has gone down over the same time frame.
Modern supply chains need the following three key elements in order to obtain a strategic advantage over their supply chain: Agility, Adaptability, and Alignment.
Supply chains should be able to react quickly to sudden demand and supply changes. Great companies create supply chains that respond to sudden and unexpected changes in markets. For example, in the 1990s, whenever Intel launched a new processor, Compaq took a lot more time to launch new PCs compared to its competitors. Longer production and design cycles meant the company lost on early adopters and had larger inventory write downs as the market conditions would change again.
Agility can be built into supply chains by adhering to these four rules of thumb:
- Share supply and demand data with business partners and suppliers continuously so they have better visibility to adapt quicker to changes. For example, Cisco created an electronic hub, which shares supply and demand data continuously with its suppliers.
- Treat suppliers and customers as collaborative business partners to design business processes, which work seamlessly across different company. For example, Taiwan Semiconductor Manufacturing Company (TSMC), shares propriety tools and data with its customers so that they can execute engineering design more accurately.
- Products should be designed in such a way that basic components are shared across the product line. This allows the company to finish products when they have better information about customer preferences and quickly react to customer demand changes.
- Keep a small inventory of inexpensive, non-bulky components that are often the cause of bottlenecks. For instance, clothing manufacturers such as H&M and Mango, keep supplies of accessory items such as buttons, zippers and hooks, so that they can finish clothes even if there are disruptions in the supply chain.
Building Adaptability in your Supply Chain
Successful companies do not use the same supply networks when markets conditions change. Rather, such companies continuously adapt their supply chains to changing market needs – this can be tough but it is critical in developing a supply chain that delivers a sustainable advantage. Many companies do not realize that apart from unexpected demand changes, permanent market changes can also affect supply chains. They changes may be due to scientific, economic, political or any other social chain. For example, Lucent was twice caught by surprise, first with the rise of the Asian market, and then by the advantages of offshore manufacturing. The first time it recovered in time, but the second time round caused it to lose its leadership position in the global telecommunication market.
Adaptability is not necessarily a defensive tactic employed by companies. Great companies are often able to modify their supply chain strategy to gain entry into new markets or launch new product lines.
Adaptation needn’t be just a defensive tactic. Companies that adapt supply chains when they modify strategies often succeed in launching new products or breaking into new markets. Microsoft choose Singapore based Flextronics as its outsourced provider when it decided to enter video game market by launching Xbox. When Flextronics learned that Microsoft wanted to launch the product before Christmas, it choose more expensive production centers in Mexico and Hungary as they were closer to target market and had a higher skilled labour pool market, which could quickly respond to the engineering design changes. Microsoft was able to successfully launch Xbox and challenge Sony’s Play station 2. When Sony responded by offering deep discounts, Flextronics responded by moving production to China, which had a lower cost structure. Within 2 years, Microsoft was able to obtain 20% of the market share.
Companies can build adaptable supply chains by following these two guidelines:
- Track economic changes: This is true especially for developing countries, because as countries open themselves to globalization, companies and skill pool in the region become more sophisticated and specialized. This means that companies can outsource more of their supply chain. Global vendors such as Flextronics have become masters at gathering this data and adapting their supply chain. Before embarking on this strategy, companies should make sure that infrastructure linking customers and vendors is in place.
- Understand the needs of the end consumer—not just immediate customers. Otherwise, companies may fall victim to the “bullwhip effect,” which distorts demand fluctuations. Semiconductor companies often faced this problem and ended up with inventory gluts. When they started tracking for chip-based products they were able to overcome the problem. Since 2003 there have not been any inventory buildups.
Companies must keep the option to change their supply chains. To do that, they must do two things:
- Develop new suppliers that complement current ones. When smart companies work in parts of the world, that are unknown to them, they use intermediaries like the Honk Kong based Li & Fung to find reliable vendors.
- Companies should ensure that their product designers are aware of the supply chain implications of their designs. Designers should be familiar with the three key design-for-supply principles: commonality, which ensures that products share components; postponement, which delays the step at which products become different; and standardization, which ensures that components and processes for different products are the same. These key principles ensure that supply chains are adaptable to engineering supply changes.
Creating the Right Alignment
All the companies in the same supply chain should have aligned interests so that when each firm maximizes their interests, the supply chain becomes most optimized.
This is critical, because every firm, whether a supplier, assembler, retailer or distributor tries to maximize their own interests. If the interests are not aligned in the supply chain, it can cause havoc even if they are divisions of the same company. For example, in the 1980s, HP integrated circuit division (IC) had a policy of carrying low inventory for ICs. This meant that the printers division had long lead time to supply printers to its customers. To overcome this problem, the printer division started carrying a bigger inventory of printers to ensure timely supply of printers to its customers. Both divisions were satisfied from their own individual KPI’s perspective. However, for HP as a whole it would have been better to carry an inventory of the lower cost ICs. That didn’t happen, simply because HP’s supply chain didn’t align the interests of the divisions with those of the company.
Many supply chain practices fail because of lack of alignment. For instance, several high tech companies such as Flextronics have setup supplier hubs close to their manufacturing or assembly plants. Vendors maintain enough stock at hubs to meet the assembly plant needs and refill without waiting for customer order. Such systems, often called Vendor-managed Inventory (VMI) in industry parlance allows supplier to track consumption and reduce overall costs as they can use the same hub to supply to other customers and achieve economies of scale. Although, VMI has several advantages, they often have not been able to reduce costs – Why?
The issue is that supplier own the components till it enters the manufacturer’s plant. Therefore, suppliers bear the cost of inventory for a longer period of time. Many smaller suppliers have to borrow money to finance the carrying cost of the inventory. So essentially, the manufacturer have reduced their own cost, but have passed on the inventory carrying costs to its suppliers. These VMI systems often generate friction because manufacturers refuse to share costs.
This problem of alignment can sometimes be solved with the use of intermediaries. In this particular case, suppliers sell their inventory to financial companies, and they in turn sell to manufacturers. Everyone wins because the financial companies often have lower financing costs. This arrangement though requires trust on the part of suppliers, manufacturers and intermediaries. However, it is a powerful way to align interests of the supply chain.
Smart companies like Saturn, create supply chain alignment in several ways. They start with information alignment, so that all the companies in a supply chain have equal access to forecasts, sales data, and plans. Next they align identities. This means, the manufacturer must clearly define the roles and responsibilities of each business partner to minimize chance of conflict. Then incentives are aligned, so that when companies try to maximize returns, they also maximize the supply chain’s performance. To ensure that happens, companies must try to predict the possible behavior of supply chain partners in the light of their current incentives. Then they must redesign incentives so partners act in ways that are closer to what’s best for the entire supply chain.
Credits: Key elements of this article have been adapted from the HBR Article, “The Triple – A Supply Chain written by Hau L. Lee.