During the 1990s, companies across varied sectors of the economy rolled out bold initiatives to improve their supply chains and stay competitive.
Apparel makers called their program Quick Response, the grocery sector came up with Efficient Consumer Response and the food service industry dubbed its system the Efficient Food Service Response. All focused on efficiency and speed.
But supply chains that focus solely on cost efficiency or material speed cannot sustain long-term success. Companies may gain some ground over their competitors in the short run but may not be able to hold it.
The three A's
Companies today face a multitude of supply chain challenges that did not exist a decade ago. Increasing supply-and-demand uncertainties, the accelerating pace of product and technology changes and the electronics industry's continuing "disintegration" all add complexity.
A successful supply chain strategy requires distinct capabilities to meet these challenges. First, as OEMs increase their product variety and customization and penetrate new markets, they need to improve their forecasting, production scheduling and inventory planning. Indeed, the day-to-day uncertainties in demand and supply are much more challenging when you have high product variety.
In addition, businesses are subject to more shocks today than in the past. The terrorist attacks of September 2001, the Longshoremen's strike in California in 2002 and the SARS outbreak in Asia in 2003 are three high-profile examples. Such events cause huge disruptions to supply chains, and companies must learn to respond swiftly.
The dynamics of ultrafast product and technology life cycles mean that the "clock speed" of virtually all industries is increasing. The competitive landscape is constantly changing, and risks and opportunities present themselves rapidly. The right supply chain strategy of yesterday may not be correct today, nor will it be right for tomorrow. And the supply chain that works at the beginning of the product's life cycle most likely will be different from the supply chain at product maturity, and different again at end of life.
Likewise, the pace of the industry's disintegration the outsourcing of everything, from design to manufacturing to services is unprecedented. The result is a rapidly maturing outsourced manufacturing and logistics services sector and a burgeoning ODM sector.
We live in a world where supply chains, not companies, compete for market dominance. But companies often have diverging incentives and interests from their supply chain partners, so when they independently strive to optimize their individual objectives, the expected result can be compromised. The best efforts of one company could be wasted if its supply chain partners don't synchronize their efforts accordingly.
To respond to the high degree of uncertainty associated with product variety proliferation and disruptions due to unexpected crises, supply chains need to be agile and flexible to match demand with supply. And companies need to develop supply chains that are adaptable, that respond to the systematic changes of the market and the customer.
In addition, companies must be ready to adjust their supply chain structures and strategies when change occurs. Given the potentially diverse interests of the many players in the value chain, companies need to align their incentives so each acts in the best interests of the whole and the total supply chain is optimized.
That's where the three A's agility, adaptability and alignment come in. Beyond just efficiency and speed, the three A's form the basis on which superior value can be created within the supply chain and delivered to the market.
Agile supply chains respond to uncertainties in a rapid, flexible, cost-effective and reliable manner. Building agility requires strong supplier relationships, the right buffer inventory, appropriate capacity levels, product and process design with postponement, parts commonality, efficient logistics systems, backup plans for supply and logistics, and an information system that enables fast and accurate information on demand and supply conditions.
These capabilities require tight integration of such functions as design and manufacturing, merchandising and operations, and procurement and logistics.
Consider three agile companies: Zara, Seven-Eleven Japan and Nokia. Zara is a Spanish manufacturer and retailer of fashion apparel that is highly successful in the global market. While most apparel manufacturers were migrating manufacturing to Asia to gain cost efficiency in the 1990s, Zara recognized that speed, flexibility and innovation were key to establishing a stronghold of the market. Although manufacturing in Spain and Portugal has a cost premium of 10 to 15 percent, the local production means the company can react to market changes faster than the competition, ensure tighter connectivity between design and manufacturing, and produce greater flexibility in product distribution.
Zara has a design-to-manufacture-to-retail cycle of fewer than 30 days; its competitors hover at three to eight months. The result for Zara has been sustained sales growth of more than 10 percent a year for the last 10 years, and a net profit margin of 10 percent, compared with an industry average of 3 percent.
Seven-Eleven Japan is the most profitable retailer in that country. Its annual inventory turn rate of 55 is the envy of competitors worldwide. The company makes use of up-to-the-minute demand information point of sales, customer profiles, local events and weather data to drive its replenishment and product development process. And it reorganizes its retail shelf three times a day to meet the changing needs of consumers.
Its logistics system is also agile, utilizing multiple modes of transportation, smart consolidation at distribution centers and flexible but reliable delivery processes.
Nokia's agility is evident in its responsiveness to unexpected supply chain disruptions. In 2000, a Philips Semiconductors RF chip factory in New Mexico went up in flames when it was struck by lightning. Nokia, a Philips customer, had contingency plans in place and a team of executives ready and trained to deal with just such a crisis. The company promptly evaluated the seriousness of the problem, made quick design changes and tapped backup sources.
Contrast this with Ericsson, also a Philips customer. Ericsson's supply chain couldn't cope with the disruption, so the company had to scale back production, which affected handset supply for months. As a result, Nokia was able to grab valuable market share from Ericsson.
For any given product family, OEMs try to design the most efficient supply chain to serve their customers. That includes optimizing the location of suppliers, manufacturing contractors, distribution, logistics systems and retail channels.
When demand or supply conditions change, OEMs must reexamine the supply chain strategy to ensure it's still appropriate. Options include adapting the supply base, relocating manufacturing, using different means of distribution or outsourcing services, offering new sales channels and modifying product designs.
Some companies excel at adaptability. EMS provider Flextronics International Inc. started as a pure contract manufacturer but over time evolved a business model of building industrial parks to accommodate its extensive supply base. More recently, Flextronics' services have expanded to include product design.
Flextronics used its extensive supply network to help Microsoft Corp. launch and ramp production of the Xbox. Microsoft used Flextronics' industrial parks in Mexico and Hungary for the product introduction, since speed and market proximity were critical to a successful launch. But as the product matured, and when faced with strong price cuts from Sony, Flextronics migrated the production of Xbox to China to boost cost efficiency.
Adaptive supply chains are one reason that Flextronics has moved from the 22nd-ranked EMS company in 1993 to No. 1 in the world today.
The weakest link in any supply chain defines the chain's ultimate performance. If one member of the supply chain focuses only on maximizing its own interests, and if those interests are not aligned with the objectives of the entire supply chain, then the overall chain's performance will be less than optimal.
Smart companies have therefore devised relationships and contracts that align their partners' incentives with their own interests to maximize the chain's overall performance. It starts with sharing information and knowledge to form the foundation for a deep supply chain relationship.
The second dimension is the alignment of identity that is, the roles and responsibilities of the partners. Here, such issues as responsibility for replenishment, forecasting, order fulfillment and customer service need to be well-defined and, if need be, realigned.
We find examples of clearly defined roles in vendor-managed inventory, which shifts the responsibility of managing replenishment from the buyer to the seller. Another example is collaborative planning, forecasting and replenishment, where the responsibilities for those tasks are shared. Collaborative design is yet another example.
The third dimension is the alignment of incentives. This requires the creation of risk-, cost- and reward-sharing schemes so supply chain partners work in unison to maximize the overall performance of the supply chain, while each gets a fair and equitable return.
One example of a successful supply chain incentive alignment is Saturn's service operation. The service supply chain works well because the interests of Saturn, its suppliers and its dealerships are aligned. J.D. Power's consumer satisfaction index has consistently ranked Saturn among the top three automobile companies in customer service. Inventory turnover at Saturn dealerships averages more than seven times a year, compared with between one and five for its major competitors.
The Saturn system fully integrates service operations with the parts supply process. Integration here involves shared material flow systems, positioning of parts people within the production facility, use of direct supplier performance metrics, and inventory sharing among production and after-sales logistics to cover emergency shortage situations for either plant production or service delivery. Demand data is also linked with external parts suppliers' data to support production planning.
Saturn has relieved its dealerships of the burden of managing their inventory directly something few did well by creating a retailer inventory system known as Jointly Managed Inventory (JMI). The dealers bought the hardware, but Saturn provided all software implementation, system installation, maintenance and support. All demand transactions at the dealer are transmitted daily to Saturn via satellite. Saturn then generates stocking decisions and replenishment quantities for each dealership location.
Successful implementation of JMI requires proper alignment of performance management and the sharing of risk. Saturn does not simply monitor its service performance in delivering parts to dealers, but the service operation personnel and dealerships are held jointly accountable for the service performance experienced by the vehicle owners. In addition, the Saturn service parts group is measured on the parts profitability of the dealers as well as the frequency of emergency orders needed to support those retailers.
The Saturn system also lets retailers pool inventory. Saturn can transfer inventory from one dealer to another to address a stock-out situation. If demand for a stocked part has not occurred for nine months, Saturn will buy back the part.
Flextronics has also succeeded at supply chain alignment. The EMS provider has low-cost manufacturing sites in several countries, but final-assembly labor cost is actually a small percentage of the total cost of many technology products. A high-quality supply base is essential too.
Thus Flextronics uses the "industrial park" approach at low-cost locations in Hungary, Mexico, China and Brazil. In addition to housing final assembly in the parks, Flextronics invested in developing subassembly and processing facilities, utilities, transportation networks, labor education, logistics support, customs clearance and employee recreation facilities. These investments are a powerful inducement for Flextronics' suppliers to co-locate manufacturing in its industrial parks. The suppliers benefit from Flextronics' investments, and Flextronics ensures the reliable supply base that its customers expect.
Creating capabilities in all three A's involves proper training and the right performance measurement system, business process design, product design, and incentive schemes and contracts with supply chain partners. Companies that work on all three simultaneously will achieve superior supply chain performance. n
Hau Lee (firstname.lastname@example.org) is Thoma professor of operations management at Stanford University's Graduate School of Business and chairman of the Supply Network Conference.