The first in a series of special reports on operations in business                                        Special Report  ...
Contents Creating the Optimal Supply Chain As global competition and advancing technology render borders irrelevant and li...
‘You Can’t Manage What You Can’t Measure’: Maximizing Supply Chain ValueIn the face of increasing complexity              ...
Matthesen agrees that the challenge is measuring          While the concept of understanding what           the right thin...
High                                            different customers for the same item, customers                          ...
“I have directly seen how the smart application of      “CEOs need to engage with their management           optimization ...
Avoiding the Cost of Inefficiency: Coordination and Collaboration inSupply Chain ManagementIt’s no secret that supply chai...
“The days when business was done three doors              few. This forces the company either to dramatically           do...
In fact, a recent report by Supply Chain Redesign          gotten better information. For instance, Wal-MartLLC in Raleigh...
retail outlets like grocery stores, are character-        Which begs the question: Despite increasing           ized by: p...
Flexibility in the Face of Disaster: Managing the Risk of Supply Chain DisruptionWhen it comes to global supply chains,   ...
In a report on “Risk Analysis and Risk Management       do in the risk assessment process is to look at vul-            in...
going feedback to management and supply chain           sources are interrupted — has recently received   participants on ...
Redundancy and Other Strategies for                       depend a lot on what your business margins are                  ...
figure out that there has been a disruption fasterthan others in your industry, you have a lot moreoptions. If you are the...
Supply Chain Enterprise Systems: The Silver Bullet?            Contemporary supply chains stretch                      ben...
manage a business and automate all of the transac-       consignment arrangements. These flows aretions needed to support ...
Bcg supply chain report
Bcg supply chain report
Bcg supply chain report
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Bcg supply chain report

  1. 1. The first in a series of special reports on operations in business Special Report Creating the Optimal Supply Chain •
  2. 2. Contents Creating the Optimal Supply Chain As global competition and advancing technology render borders irrelevant and link companies more closely, supply chains — the network of suppliers, plants, distributors, retailers and others that participate in the sale, delivery and production of goods and services — are growing increasingly complex. No longer simply the domain of the warehouse manager or logistics director, supply chain management is viewed by most companies as a mission-critical element. In this special report, experts from Wharton and Boston Consulting Group (BCG) discuss strategies for maximizing the value of supply chains, avoiding inefficiencies, managing the omnipresent risk of disruption, and evaluating the pros and cons of supply chain enterprise systems. ‘You Can’t Manage What You Can’t Measure’: Maximizing Supply Chain Value 1 Low-cost country sourcing, outsourcing, customization, globalization and more are adding tremendous complexity to supply chains across the globe. But even as companies are rapidly adopting supply chain management strategies in an effort to keep up, experts from Wharton and BCG report that many still lag when it comes to measuring how well they are doing, and balancing the trade-offs involved in keeping service levels high and costs low. Avoiding the Cost of Inefficiency: Coordination and Collaboration in Supply Chain Management 5 The process of getting the right product to the right place at the right time at the right price — the traditional touch- stones of supply chain success — remains a challenging and often elusive goal. According to experts from BCG and Wharton, two key supply chain elements that are often taken for granted — coordination and collaboration — can mean the difference between the merely functioning and the profitable when it comes to procuring goods and services from vendors around the world and delivering them to global consumers as fast and inexpensively as possible. Flexibility in the Face of Disaster: Managing the Risk of Supply Chain Disruption 9 When it comes to global supply chains, the potential for disruption comes in many packages, from large-scale natural disasters and terrorist attacks to plant manufacturing fires, electrical blackouts, and operational contingencies such as shipping ports too small to handle the flow of goods coming into a country. Experts from BCG and Wharton say that managing supply chain disruptions revolves around two goals: first, to thoroughly understand the potential of identified risks; and second, to increase the capacity of the supply chain — within reasonable limits — to sustain and absorb disruption without serious impact. Supply Chain Enterprise Systems: The Silver Bullet? 14 Supply Chain Enterprise Systems — information, communication and management technologies that support supply chain functions — have quickly become a central element of supply chain management strategy. But, implementing these systems is often a difficult undertaking with an uncertain outcome. For application of supply chain technology to be successful, experts from BCG and Wharton argue that certain elements need to be in place: namely, a clearly defined need based on supply chain strategy, as well as clear expectations about what such technologies can and cannot do for a company.
  3. 3. ‘You Can’t Manage What You Can’t Measure’: Maximizing Supply Chain ValueIn the face of increasing complexity • A new level of complexity brought on by more complicated distribution models, increasedin global supply chains, more companies are outsourcing, and “new technologies that promiserealizing that supply chain management (SCM) is efficiency but can increase complexity. ”a mission-critical element, and no longer simplythe domain of the warehouse manager or logistics While supply chains are getting more difficult todirector. But even as companies adopt SCM manage, the competitive environment means thatstrategies in an effort to keep up, experts from most companies need to further reduce costs. InWharton and Boston Consulting Group (BCG) report such an environment, successful SCM “meansthat many still lag when it comes to measuring how getting better results with the same, or fewer,well they are doing, and balancing the trade-offs resources, according to Gerald P Cachon, Wharton ” .involved in keeping service levels high and costs low. associate professor of operations and information management. “It’s like squeezing more juice from a“The major trends in business right now — low-cost lemon, or maybe blood from a stone. ”country sourcing, outsourcing, customization,globalization and more — all create tremendouscomplexities in a supply chain, says Steve ”Matthesen, vice president and global leader for “The major trends in businesssupply chain at BCG. “In most cases, however,companies have not changed how they manage this right now...all create tremendouscritical part of the business. ” complexities in a supply chain.”According to Matthesen, that’s largely because —Steve Matthesen, vice president andmost company executives don’t have a supply chain global leader for supply chain, BCGbackground, and they tend to view the supply chainfunction as “a black box” that they don’t understandor have limited visibility into. “CEOs feel that theirsupply chain costs too much and doesn’t work very Knowing What to Measurewell. They’re quick to ask, ‘How hard can it be to get “You can’t manage what you can’t measure, ”the products to the right place at the right time?’ says Morris A. Cohen, Wharton professor and Co-Well, it can be pretty hard, he says, citing three ” Director, Fishman-Davidson Center for Service andmajor factors that have dramatically increased the Operations Management. “And that’s as true forstress on supply chains: supply chain management as it is for other parts of a business’ operations. ”• Fragmenting customer needs, resulting in a broader selection of SKUs (stock keeping units) He says that many SCM metrics, like inventory aimed at specific consumer segments, different turnover, are already built into a typical accounting price points, shorter product life-cycles, and less system. But some of the more sophisticated predictable demand patterns; benchmarks, including measuring the level of• Increased cost pressures based on global customer satisfaction, take some work to develop. competition and shareholder demands to reduce And a key issue is simply knowing what to measure. working capital; Creating the Optimal Supply Chain
  4. 4. Matthesen agrees that the challenge is measuring While the concept of understanding what the right things. “Most operations groups track a ton performance level customers want sounds simple, of metrics. The issue is whether they are tracking the in practice it is not. Companies have two gaps, metrics that will identify how they are meeting the he says: a true understanding of their current strategic needs of the company and what is relevant performance, and a deep understanding of what to their customers. ” their customers need — and are prepared to pay for. “When I asked a major car manufacturer if it “Every company has metrics that track considered customer satisfaction levels, executives performance, he says. “The key question is ” advised me that they measured their customer whether these metrics really provide visibility service by the fill rate of the vehicles they sent to to performance as viewed by the customer. For dealers, relates Cohen. “Based on that, they said ” example, one company measured itself by the they had a high rate of customer satisfaction. But percentage of orders received that day that were when I asked them to survey the ultimate customer, successfully fulfilled on time. Their performance the buying public, they were shocked to find that against this metric was very high (over 99%). consumers were not satisfied with the quality of However, they didn’t track the time between a the vehicles. ” customer placing the order and receiving their goods. When measured this way, the performance Cohen says, however, that more companies was much lower than expected. The reason was that are beginning to realize that they need end-to- often orders were shipped from the wrong distribu- end visibility in their supply chain management tion center — resulting in longer delivery times and efforts. “SCM is about more than just sensing and higher freight costs.” responding, he explains. “Companies need to ” anticipate demand, since it takes time to respond to Measuring customer needs is perhaps even trickier, demand-side changes. They’re learning, but there’s he notes. “How do you know whether you would still plenty of room for improvement. ” lose business or gain business if you change your service level? In most cases, there isn’t much Matthesen notes there is an inherent trade-off in hard data to work with. It’s also hard to ask your meeting that demand: “How much service level can customers, since they are likely to respond that I give my customers before everyone screams about they want higher service levels at lower costs. You what it costs?” he asks. “If I have a retail store, and need to dive more deeply into how your customers I want to deliver every day instead of twice a week, think about your business and what role you play that will cost me more money. It’s all about service in their lives. [Companies] may also need to run levels: how fast do I get you your product compared some experiments in the field to validate their to when you want it, when you ordered it, when you assessments. ” need it. And what will it cost?” But cost is only one lens, Matthesen argues. “The The Trade-offs Between Service and goal is to maximize overall value. You want to have Costs low costs, but first you need to have a strategy that If the essence of supply chain management is to will let you win in the marketplace. Sometimes that provide the right products in the right amounts to strategy requires spending more cost to get a much the right place at the right time — all at the right higher margin. ” cost — then a concept called the “efficient frontier” To determine this, Matthesen says companies need is a useful way to gage capability. For any business to make sure they have a “crystal-clear view” of function, an efficient frontier can be found by what their customer really wants — what minimum plotting points along a trade-off curve between two service level is required to meet their needs, and or more performance metrics. Applied to supply what they will be willing to pay for superior service. chain performance, “the efficient frontier is a two- Service level here includes all attributes of the dimensional space, with service level and costs supply chain as experienced by customers: in-stock along the two axes, says Mark D. Lubkeman, a ” rates, delivery time, product assortment, etc. senior vice president in BCG’s Los Angeles office. “At one end, you have terrific, wonderful service at a In general, higher performance means higher costs, huge cost. Or you could have lower costs and slow Matthesen notes. “Your company needs to make delivery times. The question is, where do you want sure those costs are justified. ” to fall on the graph?” Boston Consulting Group | Knowledge@Wharton Special Report
  5. 5. High different customers for the same item, customers who have paid a different price and to whom you have made different promises? “It is inefficient to chop up the supply chain for different customers, but exploiting those things keeps you on the Cost efficient frontier, he counsels. “Keeping the supply ” chain flexible is key. ” The efficient frontier is a helpful framework, but BCG’s Matthesen is quick to point out that most Low companies are not getting the full value from Low High their supply chain investments. “Your infrastruc- service level ture investments will have been made based onA company’s strategy should guide its supply chain a trade-off between service level and cost, butdesign, he notes. In addition, many companies need in many cases, companies are actually off theto further segment based on the specific markets efficient frontier — meaning they are getting lowerand customers they are addressing. performance and higher costs — because of how they operate. For example, one of my clientsAs an example, Lubkeman points to appliance found that they often shipped from non-optimalretailing stores. “Retailers who compete from a distribution centers based on a number of factors.broad SKU base have high levels of in-stock goods This meant that they incurred extra freight costswhere the goal is ‘to walk in and get it right there,’” as well as delivered a lower service level to theirhe says. “But what about other appliance retail customers. By addressing this problem they realizedstores with narrower SKU mixes that don’t have a improved performance at lower cost — the elusivelot in stock? They may provide service and attention, free lunch!”and will do what needs to be done to get customersjust what they want. ” Getting to the efficient frontier is not a simple task, notes Cohen. “You may not be managing processesThose two businesses and the supply chains they correctly, not using the right technology; there are arequire are very different, notes Lubkeman. That variety of reasons to explain why some companiesmeans the efficient frontier for each is very different, are not on it and others are. ”too. The goal of any company, then, is to maintain aposition on the efficient frontier that protects both “If you give me a set of parameters, a particularits own interests and acknowledges the interests supply chain structure and an assumed forecast,and needs of its customers. we can find the efficient frontier, says Cachon. ” “But no firm ever has all the information they need.“It’s dangerous for any company to say, ‘We have What are all the costs? What are the demand dis-one frontier,’” Lubkeman advises. “That doesn’t tributions? What are the uncertainties in terms ofmake sense in any business, so why should it in a weather, union strikes, and fires?”supply chain?” He adds that as supply chains become moreThe key, he says, is really to “de-average” the complex, they have more participants, moreefficiency frontier, to take apart the average and locations, and are geographically more dispersed.look at the individual customer segments. “For The amount of information needed to find themost, the efficient frontier is the point on the curve efficient frontier appears to grow exponentially.where you provide the service — no more, no less— that makes the customer happy at minimal cost, ” One important development, the burgeoning arrayhe details. “That’s your frontier. ” of technological tools and software applications, can make it easier for companies to find theirCachon and others note that the trend toward efficient chain product segmentation “generallymeans more complexity, which makes getting to the “Making it to the efficient frontier involves theefficient frontier harder. ” application of optimization techniques which require careful data collection and generally customizationProviding different levels of customization and to the firm’s particular environment, said Cachon, ”variety is tricky for supply chain management says who studies how new technologies can improveCohen. How do you ration your resources and supply chains and consults for companies thatprioritize when facing streams of demand from provide optimization solutions for retail customers. Creating the Optimal Supply Chain
  6. 6. “I have directly seen how the smart application of “CEOs need to engage with their management optimization technology can improve a retailer’s teams to understand how their supply chain works inventory performance, with higher service and today — how it supports the business and how it higher turns.” prevents success. Together, they need to evolve the strategy and supply chain to move the business Lubkeman believes that incorporating new efficient to a position where the supply chain supports and frontier software programs can be a plus. “They enables a winning strategy. This cannot be accom- basically help you optimize transactional decisions, ” plished by the head of supply chain alone, he says. ” he said. But he adds a warning: “Unless you’ve got the underlying understanding of the customers The pay-off is substantial. “A fully aligned supply and articulated the strategies you need to serve chain and strategy delivers a superior business those customers, you run the risk of having the model, Matthesen adds. “Given the difficulties of ” technology drive the strategy instead of the other achieving this, the benefits are often sustainable and way around. ” create real advantage. Your competitors are likely to want to copy pieces of your strategy without Companies on the Frontier realizing how the entire strategy and supply chain work together — and they will not be able to match Hal Sirkin, a BCG senior vice president in Chicago your performance. 3” and leader of its operations practice globally, believes that most companies are operating below the efficient frontier, and don’t realize how to make the tradeoffs that are required to get to it. “I don’t think they understand it, he says. “I think ” they want to improve their supply chain, but I don’t think they know that there is an optimal operating capability and an optimal way to operate their business. ” To improve their position on the efficient frontier, Sirkin suggests that companies take such steps as reviewing out-of-date technology and substituting more efficient programs that provide better data and analysis; reviewing their warehouse locations and designs and changing them as needed to gain greater efficiencies; and reviewing their supply chains for costs. He also says to consider staffing requirements and to look at outsourcing as a way to save money or increase service. Matthesen adds, “While there are improvements possible within the four walls of the supply chain function, the bulk of the benefit comes when you break down the functional silos and better coordinate across the entire business, and your suppliers and customers. Key priorities are aligning ” the supply chain with company strategy, aligning incentives across functions and with external parties, arming people with the right data “so they can make holistic decisions, and building flexibility ” to quickly respond to demand, rather than relying on forecasts. Boston Consulting Group | Knowledge@Wharton Special Report
  7. 7. Avoiding the Cost of Inefficiency: Coordination and Collaboration inSupply Chain ManagementIt’s no secret that supply chain unwanted merchandise found in exit interviews that one-quarter of its customers had left its storesmanagement has moved out of the shadows when empty-handed because the specific items that theyit comes to business strategy. Organizations that had wanted to buy were out of stock. A recent BCG ”once focused primarily on distribution networks, study about supply chain integration for mergingprofit differentiation and improved marketing for companies noted that “any weakness in the systemtheir success have now embraced integrated supply on day one of the new organization’s life can quicklychain management as a pivotal strategy component translate into excess inventory, stockouts, or evenfor growth and profitability in the global economy. lost customers. And the damage can be severe.But the process of getting the right product to the In some industries, a flawed integration can driveright place at the right time at the right price — the inventory levels as much as 40 percent higher withintraditional touchstones of supply chain success a few short months. It can have a similar or even a— remains a challenging and often-times elusive greater impact on distribution costs, timeliness ofgoal. Although supply chains have undoubtedly deliveries, and a variety of other metrics. ”become more sophisticated in the past few decades,a recent study in the Harvard Business Reviewfound that improved performance hasn’t always “The days when business was donefollowed: “Despite the increased efficiency ofmany companies’ supply chains, the percentage three doors down from the supplyof products that were marked down in the UnitedStates rose from less than 10 percent in 1980 to room are over.”more than 30 percent in 2000, and surveys show —Steve Matthesen, vice president andthat consumer satisfaction with product availabilityfell sharply during the same period. ” global leader for supply chain, BCGAnd over time, the real value of efficient supplychains and the true costs of inefficient supply chain Supply chain experts from Boston Consulting Groupmanagement have been clearly documented. In a (BCG) and Wharton agree that a careful coordinationpaper titled “What Is the Right Supply Chain for Your of supply chain elements and a high level of collab-Product, Marshall L. Fisher, professor of operations ” oration are among the primary criteria for creatingand information management at Wharton and co- successful supply chain management. Indeed, in adirector of the Fishman-Davidson Center for Service world of heavy competition, these two supply chainand Operations Management, cited a study of the elements — so often taken for granted — can meanU.S. food industry which estimated that “poor the difference between the merely functioning andcoordination among supply chain partners was the profitable when it comes to procuring goodswasting $30 billion annually. Supply chains in many and services from vendors around the world andother industries suffer from an excess of products delivering them to global consumers as fast andand a shortage of others owing to an inability to inexpensively as possible.predict demand. One department store chain thatregularly had to resort to markdowns to clear Creating the Optimal Supply Chain
  8. 8. “The days when business was done three doors few. This forces the company either to dramatically down from the supply room are over, said Steve ” mark down the items in Miami or ship the parkas Matthesen, a vice president in BCG’s Los Angeles to Denver. Either situation incurs substantial costs, office and a supply chain expert. “Everyone is for no benefit. When a company factors in other pushing for more demanding performances against expenses — misplaced inventory taking up valuable stronger competitors.… My clients are going to retail space for items that would sell, for example broader ranges of SKUs [stock keeping units] in a — you have “a lot of waste built in when you make finer and finer segmentation of customer needs, in an error in your supply chain. In many cases, the order to meet the demands of a growing general underlying cause of the inefficiency lies in decisions consumer trend that says, ‘I want what I want; I want made outside the supply chain organization, but the it cheaper; I want selection; and if you don’t have it, consequences tend to show up there. I’ll go somewhere else to find it.’ The more of this “That said, if you have the right process, kind of complexity you have in a supply chain, the procedures, knowledge and strategy there, you more difficult it becomes for things to work. ” can make it work. You might never get to nirvana, “A complex chain or network of resources has to but you can be smoothly functioning. And the part be managed so that when you go to squeeze your to me that is very interesting is that if you get this toothpaste in the morning, it’s there, said Morris ” to work right, it is a huge competitive lever. Your A. Cohen, professor of operations and information competitors will see that you have an advantage, management and systems engineering at Wharton but it’s hard for them to replicate it. They will pick up and co-director of the Fishman-Davidson Center for on a few things, but they simply won’t get there. ” Service and Operations Management. “The goal Matthesen pointed to Dell Computers and its supply is to match supply with demand at every stage, at chain model of mass customization — a computer every value-added point, so that at the end of the isn’t made until there’s a custom order for it. “Dell’s day there is a customer who has a demand and the whole model is based on a supply chain advantage. supply chain figures out how to get the product to You have Hewlett Packard trying to keep up with that customer at a time and place and a price that them, but it has a different model, and it’s hard to they are willing to pay. ” catch up. For a number of legitimate reasons, HP The elements of coordination and collabora- is not willing to do everything that Dell has done, tion in supply chain management range from even though Dell’s particular supply chain requires the very basic concepts of communication to the all the pieces to work together. If you just take a few most sophisticated technology and electronic pieces, you end up not accomplishing a lot. ” data interchange available, as well as managing or tracking everything from purchase orders to Taking the Holistic View physical logistics of inventory and tracking the flow The experts agreed that any supply chain has its of funds among business partners. particular “pain points, or stumbling blocks that ” prevent the organization from realizing its financial ‘A Huge Competitive Lever’ and growth goals. When a pain point is coordination “The whole supply chain management job is not and collaboration, there are many different elements an easy one, said BCG’s Matthesen, noting that the ” that should come under scrutiny, cautions supply trend toward globalized outsourcing adds layers of chain authority Marin Gjaja, BCG’s vice president complicating factors. “I get calls from companies and director in the firm’s Chicago office. who say, ‘I’ve moved my sourcing to China and my “The first hurdle to coordination and collabora- supply chain is all screwed up’ — as though this is tion is within the four walls of your company, said ” a surprise. They may not know why, but they won’t Gjaja. The basic principle behind supply chain orga- have the right product in the right place at the right nization, namely, “getting the right product to the time. And they start yelling at their supply chain right place at the right time at the lowest possible guys — ‘Why are you doing this wrong?’ Usually, cost, is not something that most companies are the right product is in the wrong place, and too organized to do well. You are cutting across organi- much of the wrong product is everywhere. ” zational boundaries, where individuals may be more For instance, Matthesen said, a company may have interested in local optimization than global supply placed a similar number of ski parkas in both of its chain issues. ” Miami and Denver stores. The Denver store is likely to sell out quickly, while the Miami store will sell Boston Consulting Group | Knowledge@Wharton Special Report
  9. 9. In fact, a recent report by Supply Chain Redesign gotten better information. For instance, Wal-MartLLC in Raleigh, N.C., defines a lack of internal collab- can provide information to Procter Gamble aboutoration and business intelligence as one of the top their store because their incentives are aligned heresupply chain pain points. The researchers note that, — PG doesn’t want its products to be out of stocktypically, “Poor communication between business any more than Wal-Mart does — but there is also aunits and disjointed legacy systems prevent coor- level of trust. Wal-Mart is entrusting PG with a fairdination and alignment of sourcing and logistics amount of operational information. Information isstrategies, and, moreover, “internal business ” one thing; trust is another. Information has facetsperformance plans are not aligned with external — data, understanding of intent, communica-customer demand requirements. ” tion around that, and many sub-dimensions. But trust is fundamentally different. It is based on anTo understand how these issues play out, Gjaja expectation that you need to fulfill your obligationssuggested a quick review of the role of the customer to me as my partner in this work. I think we forgetservice center. “The main job of the customer that collaboration and coordination require that.service center is to keep customers happy. They And when you lose that trust, the friction and thetake calls from customers who are irate, and their transaction costs go up, and you start to experiencejob is to make sure the customer gets off the phone more difficulty in working together. ”satisfied. They will place an emergency order tohave something FedEx-ed to a customer, which The ‘Right’ Supply Chainmeans you have a customer service officer whomakes the customers happy but is costing the For Wharton’s Fisher, the essence of supply chaincompany a lot of money. I have clients who have management problems boils down to “shortagesincurred millions of dollars in shipping and freight, and failure to get the product, and having toowhose customer service departments should much of the product. Prevent that from happeningperhaps be reminded that they shouldn’t ship a $3 at a reasonable cost, and that’s supply chainitem in a $20 package. ” management. Having too much of any supply is problematic. Think about apparel at the end of theTo avoid this, Gjaja suggests that the business take season, or cars at the end of the model year. Youa more holistic view of its procedures, “We talk a lot can give back at lot of money at the end of theabout holistic, end-to-end supply chains looking to season in order to reduce inventory and cut losses.”both meet demand and serve the customer. That isas much an art as it is a science. Most organizations As a supply chain consultant, Fisher has workedare not managing the supply chain holistically, and with an internationally-known and prestigioushow you coordinate every day is a real challenge. jewelry maker, whose single biggest issue wasIf you look at the customer service center example, total availability of product. “Everyone in the storesyou have a mix of business rules, operating told us, ‘Just give us the product. There’s too littleprocesses and incentives that are set up as an product. We can’t sell what we don’t have.’ And theindividual function, and [meeting those] optimums most popular items were frequently unavailable. ”will come at the expense of the company’s global The jewelry maker’s supply chain challenges?optimums. This is at the heart of a lot of internal Reliable, accurate forecasting; better understandingdysfunction in a supply chain, and it really comes of new product demand; and improved inventorydown to establishing cross-functional coordination planning at individual store levels.and collaboration. ” Fisher’s answer to coordination and collaborationWharton’s Cohen agreed. “I would argue, in fact, that problems within supply chain management is toif you haven’t figured out the internal problems — make sure a company finds the right supply chaincollaboration, coordination and information sharing for each product. “The root cause of the problems— you are probably out of businesses, he said. ” plaguing many supply chains is a mismatch between the type of product and the type of supplyA second hurdle comes when a company chain, Fisher wrote in “What Is the Right Supply ”approaches this problem outside the company’s Chain for Your Product?” In the paper, he arguedwalls. “You have fewer levers that you can pull from that products fall into one of two categories:an incentive standpoint when it comes to working primarily functional or primarily innovative.on collaboration and coordination with suppliersand others outside the firm, Gjaja noted. “What ” According to Fisher, functional products, whichis the coordination cost of trying to work with include products like milk and food that satisfysomeone outside the firm? With technology, we’ve basic needs and can be sold in a wide range of Creating the Optimal Supply Chain
  10. 10. retail outlets like grocery stores, are character- Which begs the question: Despite increasing ized by: predictable demand and easily matched attention paid to supply chains, why are very few supply and demand patterns; low profit margins; firms successful at integrating processes and an average stockout rate of 1% to 2%; virtually no aligning incentives? forced end-of-season markdown; and low product Says BCG’s Gjaja: “My suspicion is that the variety. A functional product requires a supply chain complexity of product-based companies where that delivers what Fisher calls a “physically efficient supply chain is relevant is expanding at a faster process, one designed to “supply predictable ” rate than information technology can keep up with. demand efficiently at the lowest possible cost. ” By that, I mean that the number of products and But, said Fisher, innovative products like new different options and customers is expanding — say computer systems, video entertainment products it’s 100 products times 100 customers times 100 and some fashion trends (like jewelry) have unpre- different ways of getting there. You can see that you dictable demand; an increased risk of shortages get this multiplied effect of complexity. The tools or excess supplies; a potential for higher profit you have to deal with it can only evolve so quickly. margins; high product variety; an average stockout It will always be a very difficult challenge — it’s one rate of 10% to 40%; and an average forced end- of those perennial issues in management, one of of-season markdown of 10% to 25%. Innovative those evergreen topics that you just have to stay products require a “market-responsive process” one step ahead of. ” supply chain, designed to “respond quickly to unpre- And Fisher adds that no matter how “synchronized dictable demand in order to minimize stockouts, and seamless you think your supply chains are, you forced markdowns and obsolete inventory. ” are left with the uncertainty of consumer demand. Using sophisticated mathematical analysis and People don’t like the fact that demand is unpredict- extensive data collection, Fisher helped create a able. Even if you have maximum coordination and a company called 4R Systems, Inc., an analytical high degree of communication, the one person you software business designed to improve supply chain can’t coordinate with is the consumer…. With supply forecasts and help companies make better decisions chain management, you have to accept uncertainty. ” about their inventory dollars, particularly for short The optimum answer, according to BCG’s life-cycle products. One of the company’s programs, Matthesen, is to “design a supply chain that is for instance, takes point-of-sale and inventory data based on a sound strategy, ensure all parts of from retail venues in the home fashion industry your supply chain — both internally and externally and converts that into information that enables the — have access to good and consistent data, and company to optimize stock levels from its distribu- empower people to make decisions quickly. Build tion centers to client retail locations. a supply chain that is comfortable with uncertainty Cohen cautions, however, that coordination of and quick to react by taking down the barriers that information doesn’t always solve supply chain prevent success. 3 ” problems, particularly in certain industries where “the information is always changing, due to the nature of the beast when an industry supports so much inherent uncertainty. He cited a study he ” worked on regarding the semi-conductor equipment industry and its relationship with suppliers. “One of the things we found is that due to their business cycle, there is rapid obsolescence in the product, no matter how much information coordination they experience. If they don’t have enough capacity, it’s very expensive, but if they have unused capacity, it’s very difficult to balance, too. With the uncertainty so great, they will never arrive at the best equilibrium just by collaborating. In fact, it is difficult to see equilibrium when everyone is acting in a collabora- tive fashion.” Boston Consulting Group | Knowledge@Wharton Special Report
  11. 11. Flexibility in the Face of Disaster: Managing the Risk of Supply Chain DisruptionWhen it comes to global supply chains, chain disruptions revolves around two goals: first, to thoroughly understand the potential of identifiedthe potential for disruption comes in many risks; and second, to increase the capacity of thepackages, from large-scale natural disasters and supply chain — within reasonable limits — to sustainterrorist attacks to plant manufacturing fires, wide- and absorb disruption without serious impact.spread electrical blackouts, and operational contin-gencies such as shipping ports too small to handlethe flow of goods coming into a country. Today’sleaner, just-in-time globalized supply chains aremore vulnerable than ever before to natural and Disruptions in supply chains “shouldman-made disasters — a reality that creates greater be a high priority topic for seniordemands on companies to keep supply chainsflexible and integrate disruption risk management management and shareholders.”into every facet of supply chain operations. —Paul Kleindorfer, professor of operations“So many companies are trying to get their piece of and information management, Whartonthe global advantage that the operational risks andpossibilities of disruption are pretty high, said Dave ”Young, senior vice president in the Boston office ofthe Boston Consulting Group (BCG). And one of the Identifying the Risksbiggest challenges in managing these disruption Kleindorfer has identified three main categories asrisks “has to do with the fact that global supply the primary sources of supply chain disruption risk:chains are in a state of continuous evolution. ” operational contingencies, which include equipmentLike Murphy’s Law, disruptions in supply chains seem malfunctions and systemic failures, abrupt discon-inevitable — a principle that Paul R. Kleindorfer, tinuity of supply (when a main supplier goes out ofWharton professor of operations and information business), bankruptcy, fraud, or labor strikes; naturalmanagement, argues “should be a high priority topic hazards such as earthquakes, hurricanes, storms;for senior management and shareholders. ” and terrorism or political instability.“Disruption risk has received increasing attention Which category would a company consider the mostin the last few years, Kleindorfer, co-director of ” threatening? “Companies generally focus on theWharton’s Risk Management Decision Processes risks that they can see, said Steve Matthesen, a vice ”Center, wrote in a recently published paper, president in BCG’s Los Angeles office. “And, to be“Managing Disruption Risks in Supply Chains. “The ” honest, most of us focus on those risks that someonereason is undoubtedly that, with longer paths and would hold us accountable for. So when you get toshorter clock speeds, there are more opportunities [a risk such as] political instability or terrorism, mostfor disruption and a smaller margin for error if a people don’t worry about it that much, or they worrydisruption takes place.” but they don’t focus on it. For instance, you generally are not going to get fired for not having a plan if aGiven the high stakes, experts from BCG and terrorist blows up your building. ”Wharton generally agree that managing supply Creating the Optimal Supply Chain
  12. 12. In a report on “Risk Analysis and Risk Management do in the risk assessment process is to look at vul- in an Uncertain World, Howard Kunreuther, co- ” nerabilities in general, and then you have to have director of Wharton’s Risk Management Center, supply-chain-wide visibility of vulnerabilities. ” explains why. “When it comes to developing a Experts note that vulnerabilities need to be analyzed strategy to reduce the risks of future terrorist throughout the supply chain — from critical activities, Kunreuther argues, “we do not know who ” processes and equipment to manufacturing and the perpetrators are, their motivations, the nature warehousing sites, from technology and transporta- of their next attack and where it will be delivered. tion to distribution and management. Granted, this Hence it is extraordinarily difficult to know what is not always easy, Kleindorfer noted, because it protective actions to take. “requires information sharing across supply chain “We know from behavior following natural participants. Typically, a company with “special vul- ” disasters, such as Hurricane Andrew or the nerabilities may have every incentive to hide these Northridge earthquake, as well as technological from other supply chain participants. While current ” accidents, such as the Bhopal chemical explosion or communication and information technologies such the Chernobyl nuclear power plant meltdown, that as ERP (Enterprise Resource Planning) systems individuals and companies are not very concerned and CPFR (Collaborative Planning, Forecasting about these events prior to their occurrence, he ” and Replenishment) methods allow for improved continues. “Only after the event when it is often too information integration and supply chain visibility, late do they want to take protective action. Over “vulnerabilities to disruption are, by their very time this concern dissipates. Thus it is very common nature, more difficult to identify. ” for people to cancel their flood or earthquake At the Wharton Risk Management Decision insurance policies if they have not experienced Processes Center, supply chain experts and industry losses from one of these events in several years. ” leaders have over the last decade developed a multi- But it’s a different story when the supply chain step approach to disruption risk management. It disruption is highly visible and forecast by world- addresses ways to help companies identify vulner- wide trends. For instance, what happens if a abilities, and includes the following four initial steps: company ships products into the ports of Los • “Obtain senior management understand- Angeles, the entry point for almost half of the goods ing and approval, and set up organizational coming into the United States, and gridlock hits just responsibilities for managing the disruption risk before Christmas (as it did in 2004)? George Stalk, management process. Jr., a BCG senior vice president in Toronto, noted in a recent BCG paper on volatile supply chains that • Identify key processes that are likely to be when this very real scenario played out at the Los affected by disruptions and characterize the Angeles-Long Beach ports last winter, “nearly 100 facilities, assets and human populations that may cargo ships floated around cooling their keels and be affected. Key processes typically include new waiting to be unloaded — a process that was taking product development, supply chain operations, up to twice as long as normal. In a case like this, ” and manufacturing. Key assets include both says Matthesen, “the CEO of a company might say, tangible assets (property and inventory) as ‘This is your job, Supply Chain Person.’ And that well as intangible assets (brand image, public person would get flak. ” perceptions). • Traditional risk management is then undertaken Discovering Vulnerabilities for each key process to identify vulnerabilities, Supply chain experts suggest that the key to first triggers for these vulnerabilities, likelihood of mitigating and then managing disruption risks is occurrence, and mitigation and risk transfer understanding a company’s vulnerabilities. activities. This is the heart of the traditional industrial risk management process for “Your turn the problem on its head, says ” disruption risks. Kleindorfer. Businesses determine and review the • Reporting, periodic auditing, management and consequences of various sources of disruption legal reviews of implementation plans and on- to a global supply chain “through the process of going results (e.g., of near-miss management discovering vulnerabilities. Whatever the source of and other disruption risks) complete the business those might be — hazards, strike, terrorists’ bombs process for disruption risk management. The or some unforeseen event — the first thing you audit process . . . is essential to providing on-10 Boston Consulting Group | Knowledge@Wharton Special Report
  13. 13. going feedback to management and supply chain sources are interrupted — has recently received participants on the performance of their facilities a lot of attention and research from supply chain and their compliance with agreed, supply-chain experts. Highlighting the value of contingency wide standards. ” plans, the story of Nokia and Ericsson was incorpo-By taking these four steps, Kleindorfer argued, a rated into a recent Harvard Business Review articlecompany defines its own “risk architecture — which called “The Triple-A Supply Chain. Arguing that ”is a way of looking at the world that allows you not supply chains can no longer afford to be merely fastto be generally worried all the time. ” and cost-effective, author Hau L. Lee argued that “great companies create supply chains that respondContingency Planning and the ‘Triple-A’ to sudden and unexpected changes” by building “Triple-A” supply chains that are agile, adaptableThreat and aligned. Lee outlined objectives and methodsWhat happens when a company that understands its that companies should follow to achieve all threevulnerabilities as well as its overall risk architecture Triple-A goals — a veritable blueprint for disruptionconfronts disaster? Consider the following example. risk management through the pursuit of flexible supply chains:In March 2000, a Philips manufacturing facility inAlbuquerque, New Mexico, was destroyed by fire; • Agile supply chains “respond quickly to suddenthe facility supplied radio frequency chips (RFCs) for changes in supply or demand. What methods ”cellular telephone giants Nokia and Ericsson, and can companies use to incorporate agility inthe way the two companies responded has become supply chains? “Continuously provide supplya textbook case for the dos and don’ts of disruption chain partners with data on changes in supplyrisk management, and a lesson in how the proper and demand so they can respond promptly;approach can turn into a competitive advantage. collaborate with suppliers and customers to redesign processes, components, and productsWhen the fire wiped out the plant, both companies in ways that give you a head start over rivals;instantly lost a key link in their supply chains. As finish products only when you have accuratereported in Business Week: information on customer preferences; keep“Nokia’s response was two-fold. The company a small inventory of inexpensive, non-bulkyimmediately created an executive-led ‘strike team’ product component to prevent manufacturingthat pressured Philips to dedicate other plants delays.”to making the RFCs that Nokia needed. Nokia • Adaptable supply chains “adjust supply chainengineers also quickly re-designed the RFCs so design to accommodate market changes. ”that the company’s other suppliers in Japan and Methods to use? “Track economic changes,the United States could produce them. The plan ” especially in developing countries; use interme-worked: “Through quick action, Nokia was able diaries to find reliable vendors in unfamiliar partsto meet its production goals, and even boost its of the world; create flexibility by ensuring thatmarket share from 27% to 30% — a level more than different products use the same components andtwo times that of its nearest rival. ” production processes; create different supply chains for different product lines, to optimize“Ericsson, however, reacted much more slowly. capabilities for each.”The company did not become aware of the supplyproblems for weeks, by which time its ability • Aligned supply chains “establish incentives forto meet customer demand had been seriously supply chain partners to improve performancecompromised. And because Ericsson relied of the entire chain. Methods to use? “Provide ”exclusively on the Albuquerque plant for the all partners with equal access to forecasts, salesRFCs, Ericsson — unlike Nokia — found itself with data and plans; clarify partners’ roles and respon-nowhere else to turn for these vital components. . sibilities to avoid conflict; redefine partnership. . Ericsson posted a nearly $1.7 billion loss for the terms to share risks, costs and rewards foryear, and ultimately had to outsource its cellular improving supply chain performance; alignhandset manufacturing business to another firm. ” incentives so that players maximize overall chain performance while also maximizing their returnsContingency planning — the act of knowing from the partnership. ”secondary sources to turn to for supplies, manu-facturing, or transportation needs when primary 11 Creating the Optimal Supply Chain
  14. 14. Redundancy and Other Strategies for depend a lot on what your business margins are and what the costs of failure are. For instance, I Flexibility work with a pharmaceutical company that maintains When it comes to maintaining flexible supply two different plants. Either one would serve the chains that can respond to disruption, BCG’s Young entire world of demand for their products. But one suggests that companies plan for the inevitable by plant is located in an earthquake zone; the other is incorporating a few simple steps. “A lot of this is only 25 miles from an airport, and they worry that good old-fashioned block and tackling, but it takes an airplane could conceivably crash into it. So they discipline and segmentation, he said. ” maintain both plants. In their case, they justify the First, companies should carefully segment their expense due to high margins and the human lives products and product lines in order to understand at stake.” which ones are more time sensitive and critical than When it comes to redundancy planning, transporta- others. “If I’m going to spend time thinking about tion options or redundant carrier options are often how I can bullet-proof the supply chain or make it high on a company’s list. To figure out why, look no more resilient, I’m going to do it around products or further than the shipping backlog in Los Angeles last processes where time is most critical, said Young. ” winter. But building in transportation redundancy Second, once these areas have been identified, “you or shipping flexibility is tricky. “If your shipment is want to create a highly detailed assessment of all on one of 50 ships waiting to unload, your choices elements of the supply chain. Identify along that are a bit limited, said Matthesen. Often, companies ” path the sources of greatest risk and look for ways can only hedge these risks by making sure their to manage that — hedging inventories, looking at shipments are last on and first off. redundant carrier options, for instance. You want to In anticipation of rail or trucking strikes, companies build in redundancy for these critical items. ” often split their shipping business in order to build transportation relationships with more than one company. “People do this a lot. They offer 80 to BCG’s Matthesen notes that when 60 percent to one supplier, and 20 to 40 percent with the other. But how important are they if they planning for redundancy, companies are only doing 20 percent of their business with a company? Do you really achieve anything? I have have to ask, “How much protection one client who is a distributor, and we were looking can you take?… It will depend a lot at the level of redundancy they had. We discussed what would happen if you gave all of the business on what your business margins are and to one carrier, and then that carrier had a strike? Shouldn’t you keep two carriers? But the CEO said, what the costs of failure are.” ‘Our margins are low. It makes business sense to sole source, and if we get into a strike situation, well, that will have to be the cost of doing business.’ But, Young cautions, “you can only have time and And I think that this was the right call in that money to build in so much systems’ redundancy. ” situation.” Because building in redundancy isn’t cheap. In a Matthesen allows that the essence of risk recently published newspaper article, BCG’s Stalk and management boils down to adequately appreciating Young wrote that offshore operations often expect the risks that a company is exposed to for different and therefore plan for the unexpected by “building areas of business; identifying the ‘choke points’ redundancy into the system, and probably back home. along the supply chain that would completely harm If such redundancy is included in the initial ‘cost- a business if disruption occurred; and then taking advantage’ calculation, the company may find it will the right set of preventative measures to allow take 2 to 21/2 years to recoup all the start-up costs for some protection, remembering to periodically associated with offshore sourcing and manufacturing. ” review your supply chain plans and risk assessment BCG’s Matthesen notes that when planning for priorities. redundancy, companies have to ask, “How much “But the real story is that you don’t have to run protection can you take? It’s like insurance — only faster than the bear; you just have to outrun the some things are worth insuring against. It will folks you are with, said Matthesen. “If you can ”12 Boston Consulting Group | Knowledge@Wharton Special Report
  15. 15. figure out that there has been a disruption fasterthan others in your industry, you have a lot moreoptions. If you are the first person to come to aFederal Express and say, ‘UPS is going to have aproblem and I need your help’ — you get a goodresponse. If you are the fifth guy to come over,now they have a problem because their capacityis full. This is the case with many disruptions, andthis is the part to me that’s most interesting aboutthe Nokia and Ericsson example. It’s not that Nokiahad all these backup plans, but that they identifiedsomething was up and they acted on it beforeanyone else identified the issue. ”The bottom line? “You can’t protect against everyrisk, said Matthesen. “But if you can be quick ”to identify that there is a problem emerging andyou’ve thought about it a little bit in advance andmobilized your options, that’s the essence of riskmanagement. 3 ” 13 Creating the Optimal Supply Chain
  16. 16. Supply Chain Enterprise Systems: The Silver Bullet? Contemporary supply chains stretch beneath this increased trade is a fantastic ability to manage large volumes of data. ” around the globe — a complicated matrix that reflects the easing of international trade barriers, Virtually nonexistent a decade and a half ago, an increase in global trade, and dramatic growth supply chain enterprise systems affect numerous in business outsourcing and offshoring to low-cost processes, ranging from scheduling orders, suppliers. Needless to say, the trends toward global- managing production, controlling inventory and ization have significantly increased the number of purchasing to sales support and customer relations players involved in bringing a product to a consumer. management. These systems are represented by a seemingly endless alphabet soup of technology “If you were looking down on planet Earth, you acronyms, such as ERP SCM, CRM, and RFID. , would see a lot of ships moving from China to India, Supply chain enterprise application vendors such as from Europe to the United States, along with a huge SAP Oracle, Sage Group and Microsoft, along with , set of domestic activity with truck and rail and also supply chain support vendors like i2 Technologies, internationally with air and cargo to support the 4R Systems, Manugistics and MCA Solutions, sheer volume of international trade, said Paul R. ” have worked to create technological and software Kleindorfer, Wharton professor of operations and solutions that are designed to help improve not information management. only supply chain performance but also corporate financial returns and customer satisfaction. According to AMR Research, corporate investments While there’s no doubt that in enterprise systems totaled more than $38 billion in 2001, with an expected increase of 9 percent by technology has moved front-and- the end of 2004. center in today’s supply chain, While there’s no doubt that technology has moved front-and-center in today’s supply chain, the application of technology has the application of technology has emerged as a emerged as a leading “pain point” in leading “pain point” in the field of supply chain management. According to supply chain experts the field of supply chain management. from the Boston Consulting Group (BCG) and Wharton, applying enterprise systems technology to supply chains is often a difficult undertaking with an uncertain outcome; in reports and cases cited by both BCG and Wharton, companies that But, Kleindorfer acknowledges, there is something have implemented supply chain technologies often “going on simultaneously with this huge set of fail to leverage the new systems for a competitive activity that you may not see. Namely, an equally ” advantage. A recent study from the Georgia Institute dramatic, “absolute revolution” in information, of Technology analyzed the impact on corporate communication and management technologies performance of three commonly used technological that support supply chain functions and are known enterprise systems: Enterprise Resource Planning as supply chain enterprise systems. “The fabric (ERP) systems, which integrate data required to14 Boston Consulting Group | Knowledge@Wharton Special Report
  17. 17. manage a business and automate all of the transac- consignment arrangements. These flows aretions needed to support an entire enterprise; Supply sometimes referred to as the ‘3Bs’ of supply chainChain Management (SCM) systems, implemented management; boxes, bytes and bucks. ”as “add-ons” to existing systems that “look beyond The coordination of these three flows within theenterprise transactions and out into the supply supply chain, Kleindorfer argues, is supported bychain to provide supply-chain-wide planning and three pillars: processes, organizational structures,execution support;” and Customer Relationship and “enabling technologies, encompassing bothManagement (CRM) systems, which “help track process and information technologies. When ”and manage customer information and relation- applied correctly, technology has helped businessesships with the goal of increasing customer loyalty conquer what Kleindorfer calls “arguably the centraland retention. The authors found that with the ” problem in supply chain management” — efficientexception of SCM systems, the enterprise systems coordination of supply and demand.simply do not “positively affect shareholder valueand operating performance. ” And companies seem to recognize the potential of technological tools in managing their supply chains:For application of supply chain technology to be According to AMR Research, the enterprise applica-successful, the experts agree that certain elements tions market (especially ERP and SCM systems) willneed to be in place: namely, a clearly defined need continue to expand, from $20.7 billion in 1999 forbased on supply chain strategy, as well as clear both ERP and SCM markets to nearly $42 billion inexpectations about what such technologies can 2004. And what do these systems promise to deliver?and cannot do for a company. When facing the A lot, judging by the following three examples:typically high cost of these systems, in many casesthe question is not which system to purchase, • SAP a leading supply chain management vendor, ,but whether or not a company will benefit from allows that its supply chain management systeminvesting in one. called “mySAP SCM” helps companies build “adaptive supply chain networks” throughThough the questions are often clear, the answers planning, execution, coordination, and collabora-are not. “Once you get into technology, admitted ” tion. The collaboration function alone promises toSteve Matthesen, a vice president in BCG’s Los enable companies to “share information and setAngeles office and a supply chain expert, “it is a and achieve common supply chain goals throughridiculously huge space.” collaborative planning, forecasting, and replen- ishment (CPFR), support for vendor-managedSupport for the ‘3Bs’ inventory (VMI), and support for supplier-As international trade tops $8 trillion in imports managed inventory (SMI). ”and exports, effective and efficient supply chain • MCA Solutions, founded by Wharton operationsmanagement translates into improved return on and information management professor Morrisassets and a distinct competitive advantage. In A. Cohen, promotes its Service Planning anda chapter on global supply chains in a recently Optimization (SPO) software as a product thatpublished book called The Wharton-INSEAD Alliance helps companies “determine the most profitableon Globalizing: Strategies for Building Successful and efficient supply chain design, forecasting ”Global Businesses, by Cambridge University Press, “parts demand and determination of optimalKleindorfer identifies technology as one of the three stocking lists and stocking levels” and providingmain pillars that support the burgeoning supply chain. parts tactical planning “to meet service level“A supply chain is essentially a network consisting objectives at lowest possible order cost.”of suppliers, manufacturers, distributors, retailers • And then there’s 4R Systems, Inc., an analyticaland customers, wrote Kleindorfer. “The network ” software company designed to improve supplysupports three types of flows that require careful and demand forecasts and help companies makedesign and close coordination: 1) material flows, better decisions about their inventory dollars,which represent physical product flows from particularly for short life-cycle products. Createdsuppliers to customers as well as reverse flows by Marshall L. Fisher, Wharton professor offor product returns, servicing and recycling; 2) operations and information management, 4Rinformation flows, which represent order trans- promises that its products “take the guessworkmission and order tracking, and which coordinate out of product forecasting, replenishment andthe physical flows; and 3) financial flows, which allocation.”represent credit terms, payment schedules and 15 Creating the Optimal Supply Chain