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Creating the Right Supply Chain

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  • 1. “Aligning Supply and Demand: Creating the Right Supply Chain” By: Prof. Marshall Fisher, PhD Video Review for BA 544 Supply Chain Management Prof. Steve DeLurgio © Copyright 2004, all rights reserved except free use without alteration and with full attribution to student reviewers, Bloch School, and BA 544/Stephen DeLurgio First 10 Minutes (Gharst and Drown) Dennis Gharst: Aligning Supply and Demand: Creating the Right Supply Chain - Capture voice of the customer - Performance of Supply Chain has never been worse - $30 Billion loss due to poor supply chains in the Grocery Industry - In some cases 25% of customer orders can not be filled due to out of product/stockouts - The design of the supply chain is unique for each company – do not copy competitors - Improving Supply Chain: not best practices, what is best for the company - What’s most important: o What is the nature of demand for the product(s) o How does demand differ between products - Two types of products: Functional and Innovative - Functional Products (Chicken Soup) o Little demand uncertainty o Low variety o Easily predicted o Supply basic needs o Stable over time - Innovative Products (Sunglasses) o Demand unpredictability o High demand uncertainty o Short life cycles o Little to no time to react to forecast errors o New designs o Errors can be as high as 100% or more Shirley Drown: Aligning Supply and Demand: Creating the Right Supply Chain - Drown 1
  • 2. Part 1 Poor coordination of the supply chain, notably excess costs and unequal supply and demand costs grocery businesses in excess of 30 billion dollars per year. There are a lot of new ideas out there about how to better coordinate the supply chain. This video addresses how firms should decide which of those ideas to pursue. The author lays out a framework for making those decisions. Too often businesses decide to pursue a “best practice” with taking into account the unique characteristics of their business. The first characteristic to take into account is the nature of demand. The nature of demand should influence how that demand is supplied. Supply chains are either responsive or efficient. Products are either functional or innovative. Function products meet basic needs. There is little change in them over time. Demand is steady and predictable. Margins are low. There is little variety and life cycles are long. Campbell’s chicken noodle soup is an example of a functional product. Functional products require efficient supply chains. Innovative products have very volatile demand and higher margins. They may be seasonal and have short life cycles. The cost of lost sales and stockouts is high. There is a lot of variety in these products with many new styles or innovations. Fashion sunglasses are an example of an innovative product. Innovative products are best served by a responsive supply chain. The supply chain fulfills two functions: 1) Physical – movement, storage, display of product 2) Market mediation – advertising, promotion of products, expensive channels of distribution. Second Ten Minutes (Chong and Sand) Yeen-Lee Chong BA544 – Video Summary (2nd 10 minutes) • After understanding the nature of demand and supply chain functions, these two concepts can be placed into a matrix as shown below. Functional Products Innovative Products Efficient Supply Chain Quadrant 1 Mismatch Match Responsive Supply Chain Mismatch Quadrant 3 Match Note that it is possible for a firm to sell both functional and innovative products. For example, a sunglass manufacturer might also produce lens solution for cleaning glasses (like Bosch and Lomb) which is a functional product while its major product, sunglasses are innovative products. 2
  • 3. What a firm should do is to plot each product into the matrix according to its product nature and choose the appropriate supply chain strategy. Those in Quadrant 1 and 3 are matches which the firm has used the appropriate supply chain strategy. Those in Quadrant 2 and 4 are mismatches which are where the problems occur. Therefore, the firm should tackle mismatches. • Matches: Quadrant 1  A functional product should adopt efficient supply chain.  A firm in this Quadrant would use information technology to increase its efficiency. Examples:  Firms would use manufacturing resource software to allocate resources to maximize capacity usage.  Information is shared across different channels. Quadrant 3  An innovative product should adopt responsive supply chain.  An innovative product would have higher margin. The firms in this quadrant should aware that the cost of shortage increases with high margin. The product in this category would get obsolete rather quickly. Due to these characteristics, the firm should be responsive to avoid losing sales. • Mismatches: Quadrant 2  An innovative product adopts efficient supply chain.  When a firm adopts efficient supply chain for an innovative product, the firm is having the opportunity cost not getting the profit due to the stockout. Example: Contribution Margin = 50%, Stockout Rate = 20% Lost Contribution to Profit = 50% x 20 % = 10% of sales When a firm does not adopt responsive supply chain, its possible stockout rate would be higher. For an innovative product with high margin, the firm will jeopardize its chance to earn potential profit due to stockout. Quadrant 4  A functional product adopts responsive supply chain.  Example: Contribution Margin = 15%, Stockout Rate = 1% Lost Contribution to Profit = 15% x 1% = 0.15% of sales Take Campbell as example. The firm only has about 5% of new products per year. The firm already has a short replenishment lead time and thus it actually leaves the firm with a relatively small room for market mediation (responsiveness) improvement. • However, with the fiercer market competition, one thing to take note: traditional functional products like PCs and automobiles have become more and more innovative. So how do we define a product? Klaus Sand: Movie Analysis, Minutes 10 – 20 These minutes in the movie dealt with the classification of different supply chains and products in a 2*2 matrix as follows 3
  • 4. Functional Products Innovative Products Efficient Supply Chain Quadrant 1 Mismatch Match Responsive Supply Chain Mismatch Quadrant 3 Match Functional means a product of everyday use with few or no seasonal changes. It is well established on the market and highly predictable. The video used canned soup as an example Innovative products follow fashion, seasonal occasions and are highly unpredictable. In the video, sunglasses are an example for this product group. A efficient supply chain operates specialized with minimal physical costs. Manufacturer and retailer communicate about inventory, to keep the stocks as low as possible. The production planning level goes further in the future, vendor agreements are long-term based. Responsive supply chain management reacts fast on market changes. It is more expensive and expects rewards from the customer by a fashion premium. Vendor agreements such as the production must be flexible, the product variety is also higher. The colors shall show, that there are two reasonable kinds of supply chain management, the efficient one for functional products and the responsive one for innovative products. A facility manager should classify his products in the matrix. If some of them appear in the upper right or the lower left corner, these rather get shifted into the reasonable areas. Toothpaste was supposed to be an innovative product with regularly new brands and flavors. But with growing market establishment, it gets more and more a functional nature with a steady demand. So the supply chain should become more efficient. Producing functional products on responsive supply chains instead is just waste in production workforce and logistics. Third Ten Minutes (Peace and Huls) Third Ten Minutes Many do not understand that seemingly identical products can be either innovative or functional, and this can affect profitability. Companies innovate in order to raise margins on products they are producing. For example, there are a number of “designer” ice creams on the market now. The newness of these innovative products leads to uncertain demand. Over time, copycats erode market share and profits of these products. As a result, companies must continue to innovate. This all leads to a mismatch between innovation and efficiency. Companies continue to struggle to figure out a successful strategy. There are two issues companies face: 1) How do you get out of the upper right corner (2)? 4
  • 5. Become functional or become more responsive. Examples include computer manufacturers. Apple, Toshiba, Compaq and IBM (functional) are different from Dell and Gateway (responsive). 2) How do you decide which direction to move? If you have low margins (like toothpaste), move to the left (1). There are no significant benefits to the variations offered in the products. If you have high margins, move down (3). Automobiles—how do you consider variety from the customer’s perspective? There are many possible combinations of options for each vehicle type. 90% of customers, however, buy off the lot, from a very small number of combinations. There is an 8-week lead-time on special-order vehicles. The bottleneck appears at the dealer level. Plant (infinite variety) Dealer (bottleneck) Customer (can’t get desired variety) Huls: 3rd 10 Minutes of Marshall Fisher’s Video Some products can be functional and innovative such as coffee and autos. Companies introduce innovations into these product lines to increase profit margins and establish new product lines. The life cycle of innovation is short so companies have to continually introduce new innovations. The companies don’t realize what is happening when their new functional products do not perform well and so they continue to stress supply chain efficiency causing the product to continue in a downward spiral. What has happened is the company does not realize that the new product is actually innovative, even though it may just be a new flavor of coffee, and that they should be working in a the bottom right quadrant, instead of the normal upper left, to make it take off. Getting out of the upper right quadrant Innovative products geared toward efficiency should try to work towards getting out of this quadrent and moving toward the more appropriate mode of action. For example, a computer company that is trying to maintain an efficient supply chain when the market demands responsiveness is operating in the upper right quadrant when they should be in the lower right. Dell is a company that realized this and took action successfully. Companies can also go the other direction and make products functional again. The Profit margin is what dictates what direction the company should take. For example, Proctor and Gamble realized there is no reason to carry 28 kinds of toothpaste when the ingredients were virtually the same and the packaging was different. They took the initiative and brought this functional product back to the efficient side of the matrix. The auto industry is an interesting phenomenon with the variety of options and productivity being like an hourglass. There is an enormous amount of option combinations that plants can produce, but the dealers only stock a few types. Customers want the millions of options that are available, however they do not have this luxury due to the trickling down through the dealerships. 5
  • 6. Fourth Ten Minutes (Novotny and Farrier) Chris Farrier: Some products are inherently functional where others are innovative. Innovative products do not fit a JIT inventory system. There is a temptation to use a single supply chain with the same priorities for different products. The best way to manage these products would to be to use plants as dual facilities. Services do not typically fit in the product matrix, yet in some instances you can draw parallels. Reference the emergency room example. Efficient supply of functional products. - Efficiency and cost reduction are common company goals. - The greatest opportunity to increase profits are by maintaining good relationships within the supply chain. Fifth Ten Minutes (Wilson and Carter) Wilson: Video – Fifth Ten Minutes A. Soup is a functional product 1) Efficiency 2) Fill 98.5% - 99.2% demand 3) Continuous Replenishment a. Cut inventory on hand to 2 weeks from 4 weeks i. Accomplished this by knowing what inventory was on hand in grocery stores b. Decreased cost of storing inventory c. (2/52) * 25% = 1% Increase of sales i. Grocery level 1. Average profits = 2% 2. 3% with continuous replenishment 3. 50% profit increase by improving physical efficiency d. Resulted in more and better shelf space e. Increased sales 4) Cambell’s price promotions resulted in forward buying a. Concentrated demand in one period and lowered it in another i. Increased stress on supply chain ii. Increased cost of supply chain 5) Consumers of functional products want good products and a good price 6) Promotions increase spikes in buying, but not an overall increase in sales 7) Promotion Addiction a. increases cost 8) Continuous Replenishment a. increases profits to be distributed 9) Information sharing a. Creates problems when you try to be cooperative, but competitive when negotiating prices i. Does not work Bryan Carter Video: “Aligning Supply and Demand Section 5 Improving the match between organizational strategy and supply chain strategy 6
  • 7. -Focus on better coordination between suppliers and vendors (Example: Campbell’s Soup) -Electronic sharing of sales data, allowing continuous replenishment. -Lead time cut from 4 weeks to 2 weeks. -Benefit to retailers: Less inventory/inventory expense, leading to 50% profit increase. -Benefit to Campbell: Increased sales due to retailers selling product cheaper; retailers increased space dedicated to Campbell’s product. -Better match between manufacturer and retailer: -Determine who can perform which functions cheaper. -Allows for an everyday low price instead of periodic discounted pricing. -More predictable demand/fewer spikes in demand. -Less cost to manufacturer; more profit for retailers. -Downside: Retailer/manufacturer competition for increased profits (as a result of less costs) -Size of “profit pie” is larger, but there is competition for who gets that increased profit (manufacturer or retailer). -Companies are forced to play cooperative and competitive roles; more profits but more conflict in who gets those profits. This portion of the video focused on improving the match between organizational strategy and supply chain strategy by expanding that strategy to suppliers, vendors, and customers. The example of Campbell’s Soup expanding their strategy to grocery retailers focused on their ability to lower retailer inventories and inventory cost by creating a continuous replenishment system based on their cooperation in sharing sales information. The retailer benefited through lower inventory cost and Campbell benefited through greater sales as a result of grocery retailers selling their product cheaper and devoting more retail space to Campbell. Additionally, Campbell was able to eliminate spikes in demand and gain a more predictable demand as a result of being able to offer an “everyday low price” as opposed to seasonal price discounts. The final point the video mentioned in improving strategic match is finding who can perform what supply chain functions the cheapest. In Campbell example, it was more profitable for Campbell to supply in a manner that would eliminate excess retailer inventory than it was for the retailer to carry that inventory. The problem mentioned in the video with expanding strategic match between different organizations was in cooperative and competitive roles the companies played. Although Sixth Ten Minutes (Widura and Tip) Widura: Innovative product is located on the right side of the matrix. The difference between functional products and innovative product is the nature of uncertainty of innovative product. Innovative product has to be pair with responsive supply chain; therefore it fits to respond the uncertainty of demand. Why people interested in selling innovative products that have uncertainty of demand? It is because of the higher profit. Uncertain demand is risk. However, highest profit comes from highest risk. It is more difficult to control products with demand that is uncertain but there is a big possibility that the product would deliver higher profit. How to respond to it? First of all we have to reduce the uncertainty. Improving the forecasting method is one way to respond to it. The improvement of forecasting method would lessen the possibility to have an under stock and over stock in inventory. Second of all, try to avoid the uncertainty. Reducing lead-time would help to have more responsive products. Lastly, after we have done the two methods above, hedge against the remaining uncertainty. Calculate the product availability to lessen the possibility of over stock or under stock. 7
  • 8. Locating the retailers and the supplier would also help product’s responsiveness to demand. It would also differ the cost of supply chain that would differ the price of the product. The key for using this method successfully is short lead-time or less variety of products. Tip: Part 6 Responsive supply This theory is for the products that have high margins and are not in the lower right side in the supply chain matrix (they are mismatched in the upper right quadrant). The company needs to approve it strategy by increasing responsiveness. -Know the nature of the product: less competition and increase demand uncertainty since we can’t predict demand. Ways to manage the demand uncertainty are 1. Continue to decrease demand uncertainty -Find more data source to be able to get better demand forecast. 2. Decrease lead time and increase flexible supply to avoid uncertainty such as mass customization For example the bicycle company in Japan, since it can’t compete with competitor over sees they have to improve strategy by They look at company own strength-high technology, good skill and labor that work hard. Because they product have high margin they will focus on responsiveness. They come up with the customize bicycle with 2 weeks lead-time. The supply chain of they customize bicycle. They have prepare all the raw material before hand at the factory then customize while assembly and colored each bicycle after receive order from retailer. Because of their high skill and work hard labor they are able to complete they bicycle within time limited and deliver it within 2 weeks lead time. 3. hedge the rest of the uncertainty in demand. Seventh Ten Minutes (Chalmers and Buwono) Chalmers: Aligning Supply and Demand: Creating the Right Supply Chain – Video Notes for 7th ten minutes – Brent Chalmers. • National bicycle’s program is called mass customization - the ability to customize a large volume of products and deliver them at relatively low prices. • Challenges of mass customization: • What does National Bicycle do during the winter? o It builds an inventory of high end bicycles • Mass customization is not cheap o This custom production uses three times more labor than their assembly line mass production • Henry Ford went from craft to mass production to reduce labor costs o Why is custom production possible now:  Wealthier consumers are willing to pay for innovative products.  These products require a more expensive and more responsive production process than the Model T 8
  • 9. • Sport Obermeyer: o Based in Aspen, Colorado o Manufactures skiwear and distributes it through 800 US retailers o Since 95% of its products are new each year  Faces demand uncertainty o In 1991, the company's vice president, Walter Obermeyer, started a project to deal with those problems by using three strategies:  Reducing, avoiding, and hedging against uncertainty  To reduce uncertainty, Obermeyer requested orders early in the year from important customers  These early orders helped them achieve a significantly improved forecast for the rest of the year o Lead times were still a problem  Concluded that each day cut off the lead time would save $25,000  Because of air shipping products to plants in Asia  Began searching for ways to reduce lead times  Was able to avoid uncertainty on half of its products o Still had uncertain demand for half the products  Used the average of six forecasts • If the forecasts were similar, the forecast was accurate • If the forecasts were dissimilar, the forecast was inaccurate • Using this data, they could hedge their risks o System increased profits by 60% o Made Obermeyer number one in the industry for service. • Conclusion o Companies like this are still the exception o Managers should think about:  Reducing uncertainty.  Avoiding uncertainty.  Hedging against uncertainty. o These steps require energy and patience but the results are worth it. Haryo Buwono Summary (Seventh Ten Minutes) Aligning Supply and Demand: Creating the Right Supply Chain Obermeyer Case: Obermeyer is a ski wear manufacturer with 25 retailers all over the nation. Obemeyer was facing a problem with demand uncertainty on its products. To overcome this issue, the vice president came up with a set of strategies to reduce this demand uncertainty. 1. Early orders from retailers with error less than 10%. 2. Long lead times to start production before February 3. Develop a model that prevents over or under stock. 9
  • 10. Conclusion: In this video, Professor Fisher introduces a framework for supply chain improvement that can be adapted to any companies, based on their situations. He later introduces the matrix for aligning supply and demand as follows: Functional Products Innovative Products Efficient Supply Chain Quadrant 1 Mismatch Match Responsive Supply Chain Mismatch Quadrant 3 Match Based on this matrix, Professor Fisher explains these following steps: 1. Look for mismatch, earning enough margins to justify. 2. Establish performance measure 3. Develop initiative for improvement: - Efficient supply of functional products by supply chain partnerships. E.g. Campbell’s Chicken Noodle Soup: continuous replenishment - Responsive supply of innovative products by learning to manage uncertainty. E.g. National Bicycle: mass customization strategy - Sport Obermeyer: accurate response strategy If the goal is efficiency, then supply chain partnerships should be considered. If the goal is responsiveness, managers must think about reducing, avoiding and hedging against uncertainty. 10

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