First, two of my great colleagues and friends at INSEAD, David Young and Kevin Kaiser, shaped my thinking about supply chain management by giving me a clear perspective on value-based management. I also had the opportunity to interact with hundreds of supply chain professionals from Asia, Europe, and the Americas, who either attended my courses at INSEAD or who had generously collaborated with me on various breakthrough supply chain projects. They are simply too numerous to mention by name in this limited space. I am grateful to all of them for providing me with a valuable reality check.
Finally, colleagues in my home department of Technology and Operations Management have been a constant source of intellectual stimulation. Writing a book is like having a baby: it takes as much time as you have. I therefore owe a big thank-you to my wife, Jae, and to my children, Elliot and Justine, for their understanding over the time I spent with the manuscript rather than with them. I am also very grateful to my editors at Palgrave Macmillan, who made the publication process a smooth one for me. Based on sustained foreign direct investment FDI , as shown in Figure 1. This is due to both the lower-value products and services produced by these economies and the higher transaction costs engendered by poorer infrastructure in communication and transportation.
With margins rapidly shrinking, there is growing pressure on supply chain managers to minimize procurement, production, and distribution costs. Such a focus on cost reduction in SCM has been typical in many industries facing global competition. Margin 1 2. While one cannot and should not ignore costs, in this book, we have chosen to emphasize the enabling role of supply chains in value creation and value capture.
Working definitions To discuss the role a supply chain plays in value creation and capture, we first need to define these terms. The former includes both procurement costs and internal conversion costs. This definition implicitly captures the fact that a firm can only create value by operating together with its suppliers and customers. As stated above, the difference between WTP and cost is equal to the value created in a supply chain.
While the difference between price and cost determines the margin earned by the firm, the difference between WTP and price the value captured by the customer or the consumer surplus, as economists would refer to it drives the sales volume. The product of margin and volume thus yields the profit, the value captured by the firm. Value created by a firm is an upper bound on the value it can capture. If the firm sets a higher price increasing its margin , it may drive down the volume of sales.
Alternatively, if the firm lowers its price reducing its margin , it may increase its sales volume, achieving the same level of profitability. This challenge of mitigating the cost-service trade-off is the main topic of Chapter 4. A supply chain is a network consisting of suppliers, manufacturers, distributors, retailers, and customers Figure 1.
The network supports three types of flows that require careful planning and close coordination: i material flows, which represent physical product flows from suppliers to customers as well as the reverse flows for product returns, servicing, remanufacturing, and recycling; ii information flows, which represent order transmission and order tracking, coordinating the physical flows; and iii financial flows, which represent credit terms, payment schedules, and consignment arrangements.
Note that all three flows are bi-directional. Traditionally, one used to think that goods and services would go from suppliers downstream through a series of value-adding steps all the way to the final customer. Similarly, information was thought to flow exclusively from the market to all the tiers upstream in a supply chain. Innovative organizations like UPS or Dell have shown the value of providing the customer with real-time information about the status of their package or their order, respectively.
Finally, financial flows are no longer simply based on day payment terms. Facilities ranging from consignment stocks to various risk-sharing arrangements have also made financial flows bi-directional. The supply chain, a platform to coordinate these three flows, is supported by three pillars: i processes, which encompass such value-adding activities as logistics, new product development, order fulfillment, and after-sales service; ii organizational structures, which encompass not only a range of relationships from total vertical integration to networked companies, but also performance measurement and incentive schemes to make such relationships sustainable; and iii enabling technologies, which encompass both process and information technologies.
The above definition hides some important subtleties. First and foremost, modern SCM has deeply benefited from a series of improvement initiatives. Over the past few decades, the waves of just-in-time JIT , 8 Competitive Supply Chains total quality management TQM , and business process reengineering BPR have had a significant impact on the individual components of supply chains, eliminating non-value-adding activities, enhancing productivity, and streamlining workflows, ultimately enabling us to step out from among the four walls of an individual site to focus on the interfaces among these individual stages.
Second, the advances in communication and computation technologies have made it possible to collect, analyze, transmit, and deploy huge amounts of data necessary to run operations on a global scale. Finally, infrastructure investments, along with developments in global transportation and logistics, have greatly facilitated the movement of goods Figure 1.
One big challenge, however, remains. Industry structures, which used to be dominated by vertically integrated organizations, have largely been replaced by networked organizations or loosely coupled ecosystems. In the absence of a clear command and control structure, coordination among the members of a supply chain is not trivial, necessitating the implementation of explicit incentive schemes for aligning the divergent and often conflicting economic interests of its members.
In other words, while the challenge of value creation is shared by the members of an ecosystem, value capture remains a contentious issue. Supply chains perform two principal functions: the physical function of transformation, storage, and transportation, and the market mediation function of matching demand and supply in a highly volatile, uncertain environment. While the physical function has been extensively studied within the Production Control and Inventory Management literature,4 innovative approaches to the market mediation function have recently been emerging.
These approaches, which are classified in Figure 1. The key reason for our focus on market mediation is the drastic consequences of a potential demand-supply mismatch. For manufacturers, the implications were even worse: out of the 6. On the other hand, holding inventory provides limited relief in spite of its high price tag. According to the U. Department of Commerce, retail sales in the U.
Market mediation has two key enablers. Supply chain coordination is concerned with the coordination of the three types of flows over the network. Effective coordination strategies combine a range of approaches for enhancing supply chain transparency through information sharing e. These approaches may facilitate new forms of organizational structures e. Information and communication technologies facilitating closer collaboration and promoting supply chain transparency are crucial for effective coordination. Innovative product and process designs are a prerequisite for operational flexibility.
One of the most visible examples of innovative supply chain practices can be found at the Italian garment manufacturer Benetton. Benetton has been one of the first manufacturers in the industry to collect POS data from key retail stores to determine product mix. More specifically, Benetton adjusted the assortment of colors to be produced by closely tracking retail sales. Such operational flexibility, in turn, was enabled through a product and process redesign, where sweaters were first knit in gray and then dyed to the desired color.
Further volume flexibility was achieved by subcontracting the knitting operations to a network of small textile labs. Supply chain design, therefore, is concerned not only with the configuration of a network, namely, the specification of customer zones, selection of manufacturing and distribution facilities, and allocation of product families to these sites, but also with the prioritization of the capabilities to be developed and retained internally, and the forging of new partnerships with other entities along a supply network.
Just as product design has an enormous impact on manufacturing performance, superior supply chain design offers significant payoffs in supply chain coordination. In the next chapter, we will first introduce the VBM framework that will help us not only to operationalize the concept of value but also to derive performance metrics and cascade them throughout the supply chain. We will then establish how the market mediation function of supply chains can help in value creation and value capture through design and coordination, respectively.
In particular, we will discuss supply chain design for value creation, while the focus of supply chain coordination will be on value capture. Since the key mission of SCM is to develop and deploy effective solutions to enable the deployment and execution of corporate strategies, SCM should also adopt a VBM perspective.
While product innovation may enable the deployment of niche strategies, process innovation may lead to cost leadership. In both cases, however, innovation plays a key role in differentiating a firm from its competitors or in avoiding the commoditization of its products and services. While value creation by a firm is necessary, it does not automatically ensure value capture by the same firm. For example, the Internet has undeniably created tremendous value for the business world.
Researchers conceiving this global network, however, did certainly not capture this value. Similarly, air travel provides a significant amount of value for business and leisure travelers. There are plenty of other examples where an innovation introduced by one firm has been turned into a runaway commercial success by another one. As we will discuss in greater detail in Chapter 3, value creation starts with three-dimensional concurrent engineering 3D-CE : the simultaneous design of the product, of the process, and of the supply chain. Process design, on the other hand, is concerned with the selection of resources that are either dedicated favoring economies of scale or flexible favoring economies of scope.
Finally, supply chain design not only considers the configuration of the supply network, but also focuses on the key make-or-buy outsourcing vs insourcing decisions. Value capture, on the other hand, focuses on the coordination of the firms within the supply chain. This is an inherently difficult task as vertically integrated industries with clear command-and-control structures have been replaced by network structures where each echelon is owned and operated by an independent and economically rational firm.
Alignment of independent players in such decentralized ecosystems is the main challenge in supply chain coordination, including the design and implementation of collaborative practices. In other words, incentives should be designed to enable value capture by a firm that is commensurate with the value it adds to the ecosystem. We will provide such a definition in the next section. Operationalizing the definition of value Businesses should have one paramount goal: the creation of shareholder value.
Such a bold statement may, at first, appear to reflect a cold view of the world as seen from the Wall Street. Some might argue that customers should always come first. Without customer satisfaction, a company may not survive. Others may advocate that without dedicated employees, it is not even possible to bring goods and services to markets. What about the suppliers? The community? The environment? How can one simultaneously satisfy all these stakeholders? Ultimately, one can delight customers by providing goods and services for free.
One can make the employees happy through attractive pay packages and extremely flexible working conditions. Similarly, generous payment terms would always be welcome by the suppliers or the channel members. Sponsorship of local activities is deeply appreciated by local communities. Yet, there needs to be a balanced approach to providing value. The concept of shareholder value provides this necessary balance. Shareholder value is not at all about shareholders; it is simply a measure that strives to establish a balance among all stakeholders.
Depreciation is not a cash flow, but a tax shield; we therefore subtract it first from the revenues to calculate the tax base. The company must then comply with its tax obligations. As depreciation is simply a tax shield, it is added back to calculate the free cash flow after allowing for potential increases in the working capital and for other capital investments.
This free cash flow is what enables the firm to return some cash to its shareholders in the form of dividends or share buybacks. Note that shareholders come last in this calculation, staking a claim to what is left on the table: free or residual cash flow. While there is a legal obligation towards employees, suppliers, channel partners, and creditors, there is no such contract with the shareholders. The latter invest in your company with the belief in your managerial capabilities and, thanks to them, the expectation of earning higher returns than in other investment opportunities.
Hence, as the residual claim, only shareholder value can reflect how well all of the complex relationships within the ecosystem of a firm are managed simultaneously. Put another way, shareholder value is the only measure whose calculation requires complete information. By focusing on shareholder value, one can be sure to properly manage the diverse and often conflicting interests of the other stakeholders of the firm. From a technical perspective, maximizing shareholder value is equivalent to the Value-Based Management 15 maximization of the residual cash flow in an optimization setting, which would automatically strike a balance among its individual components.
By managing for shareholder value, Coca Cola does indeed satisfy all of its key stakeholders, namely its customers, its employees, its suppliers, and, of course, its shareholders. This is indeed the gauge market analysts use in evaluating publicly traded firms. Value-driven businesses have also adopted this model in capital investment appraisal i.
While the maximization of shareholder value, the paramount goal of a firm, is intrinsically able to align the requirements of the various constituencies of a firm, we still need to operationalize this concept. In particular, we need a performance metric that would monitor, encourage, and reward value creation.
Finance professionals have been proposing various such metrics. We will, however, focus on an intuitive one: economic profit EP. Note that EP is different from accounting profit. In that sense, it measures the effectiveness with which companies manage all the resources human, intellectual, material, and financial invested in them. In other words, in her day-to-day decision making responsibilities, a supply chain manager may not necessarily have a direct impact on EP.
A supply chain manager should therefore focus on both strategic and operational drivers that directly influence EP. In other words, liabilities show the source of financing for the assets. For a supply chain manager, fixed assets typically represent strategic supply chain design decisions typically associated with network configuration. From an operational perspective, however, it is necessary to break these high-level financial metrics into their operational drivers and cascade them throughout the organization.
Such an exercise must also be done for a supply chain professional by first identifying the key value drivers within her sphere of responsibility and by designing adequate performance measures that promote value-creating decisions. To get another perspective on ROCE, let us revisit our managerial balance sheet and consider the column of invested capital or net assets. A supply chain manager does not and should not manage cash. This is the task of Corporate Treasury. A supply chain manager, however, should carefully manage the other two components of net assets, namely the WCR and the fixed assets.
While the fixed assets are impacted by the supply chain design decisions, WCR is directly concerned with supply chain coordination. To see the importance of managing WCR, consider the operating cycle of a firm, sometimes referred to as the cash-to-cash cycle, as illustrated in Figure 2. For a typical manufacturing company, the operating cycle starts when the firm purchases materials, parts, and components.
These materials are then transformed into finished products. We refer to the time it takes from the acquisition of input materials to the production of finished goods as the manufacturing period. The products are then sold, which typically requires a sales period, which may include warehousing, transportation, and delivery. Since the product remains within the company as inventory until it is sold, the sum of the manufacturing period and sales period equals the inventory period.
Customers, however, do not pay for the product immediately after delivery. The length of time for the firm to collect cash from customers after a sale has taken place is called the receivables period. Within such an operating cycle, a firm must therefore invest in inventory and receivables. Moreover, the firm might have prepaid expenses such as the rental of extra warehouse space as well as operating cash for day-to-day operations.
The firm, however, is not the only entity that invests into an operating cycle. Suppliers, employees, customers, and even the government contribute. If customers also prepay for their purchases, that money also reduces WCR for the firm. To emphasize the importance of effective WCR management, consider Table 2. The EP perspective therefore compels supply chain managers in fact, all managers to generate competitive returns on WCR, just as it does for cash and fixed assets.
Table 2. From a strategic perspective, the supply chain manager should be responsible for customer service levels, which, in turn, are driven by product, process, and supply chain design choices. The choices made in configuring the Value-Based Management 23 supply chain will have a direct impact on fixed assets. The product and process design choices, in turn, will become constraints on operational drivers that will impact both expenses and WCR.
In other words, Figure 2. NOPAT can be enhanced by increasing revenues and reducing expenses; the operational drivers here typically represent strategic decisions on customer service as well as innovative product, process, and supply chain design initiatives to contain cost-to-serve. The capital charges, on the other hand, can be contained through effective working capital and fixed asset management; the operational drivers here represent tactical initiatives such as materials management, management of receivables and payables, and effective use of capacity. Such a delay caused by complications related to the wiring of A would limit deliveries to just seven airplanes in rather than 25, as was originally planned, pushing the breakeven point for the entire project beyond Motivation Xerox spent most of the s painfully regaining, inch by inch, the market share it had lost so dramatically to new entrants and reestablishing the dominant position it had occupied in the market in the s.
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Central to this comeback was an obsessive dedication to quality and the introduction of JIT manufacturing and distribution. In fact, Xerox spent the second half of s implementing the JIT philosophy in its European manufacturing operations. In this process, Xerox rationalized its supply base, reducing it from suppliers to , enabled direct delivery into the production lines, and closed down all of its national warehouses, centralizing the distribution activities through a European Logistics Center in Holland.
While Xerox has been redesigning its supply chain over a five-year period, a quiet technological revolution was changing the landscape in the copier industry with digital copiers replacing analog ones. Second, with the changing product characteristics, a different distribution channel was emerging. In short, a new supply chain solution had become necessary. Book publishing is another industry that has experienced a similar transformation — though at a slower pace of change or clockspeed. Arguably, book publishing was initially an MTO business, a king or a queen commissioning the writing of the book.
An artist with excellent calligraphy skills would then complete and deliver the manuscript. A technological breakthrough, the invention of the printing press, along with the higher tolerance levels of the Renaissance, has led to the creation of an MTS industry spanning authors, publishing houses, printers, distributors, and corner book stores. Another technological breakthrough, e-commerce powered by the Internet, has drastically altered the architecture of the print supply chain, rendering the retail outlet less significant.
With the recent initiatives in hardware, if e-books ever fulfill their promise and become popular, on-demand publishing will turn this industry into an MTO business once again. Another colossal industry transformation is depicted in Figures 3. In this environment, if a customer purchased an operating system from a particular manufacturer, he was obliged to procure all the hardware and software from the same manufacturer as interoperability was nonexistent among these manufacturers.
In other words, once you chose your camp, you were obligated to stay with it throughout the entire portfolio with no mix-and-match capability. The birth of the PC, however, has drastically modified this industry structure. IBM, which defined the industry inspite of its late entry, made two strategic choices. Unix etc. Moreover, to facilitate coordination within these outsourced relationships, IBM deviated from its tradition of closed and proprietary architectures by adopting an open and modular product architecture for the PC. As illustrated in Figure 3. Supply chain professionals would readily recognize that the supply chain solution that must be deployed to support a vertically integrated industry structure Figure 3.
As we have seen in the previous two examples, industry structures do not remain frozen in a particular state, but evolve from one state to another according to their own clockspeed. This is exactly what we have been observing in the computer industry as well. Consider, for instance, the path taken by Intel.
After establishing its dominance in Value Creation 29 the segment for microprocessors, Intel has widened its footprint not only by incorporating computation and graphics capabilities into its own products, but also by influencing the decisions of hardware designers and application developers on their product lines. Similarly, after dominating the operating system segment, Microsoft has forayed into various other segments ranging from databases to web browsers, from enterprise applications to office productivity tools. One may think that the industry is swinging back to its original vertically integrated structure with an integral product architecture — with a different set of players.
Consider, for example, IBM in the mids, whose products were designed following a closed and proprietary architecture within a vertically integrated industry. On the one hand, to maintain its leading position, IBM had to be at the forefront in all its offerings. On the other hand, due to its own organizational rigidities and highdimensional complexity, the company was slow in responding to Niche competitors Integral product, Vertical industry Modular product, Horizontal industry Supplier market power Highdimensional complexity Pressure to disintegrate Pressure to integrate Organizational rigidities Figure 3.
Proprietary system profitability 30 Competitive Supply Chains challenges by niche players, both increasing the pressure to disintegrate. Once the industry has crossed the threshold and swung to the other side of the double helix to become modular, horizontal, and fragmented, a fierce battle followed for the domination of each segment. Once a dominant player emerged in a particular segment, that player typically started exerting its influence in shaping other segments, as illustrated by Intel and Microsoft examples.
This, in turn, built further pressure to integrate — perhaps around a different set of players. Implementation was left to consultancies. This cohabitation, however, did not last long. As application vendors grew stronger, their footprints expanded from the transactional backbone into the areas of specialty applications and deployment. This evolution is discussed in greater detail in Chapter 6. What drives the pace of change — or the clockspeed — in an industry? Some drivers are quite obvious: competition, technology, and power structure in the channel.
Others may be less so: organizational culture, government regulations, globalization, and economic conditions. Fine proposes three categories of clockspeed metrics: product based e. From that perspective, brewing would be considered a slow clockspeed industry on average, a new brewing process every years , while airframe manufacturing for passenger aircraft would be a medium clockspeed industry on average, one new plane program every decade , PCs and cell phones would be a fast clockspeed industry on average, a new product every six to nine months.
While this is not a concise measurement scheme, an empirical study4 within the electronics industry provides strategic support to the argument. Based on this product-based clockspeed metric, one can then classify the PC industry as a high-clockspeed industry with an average of 24 months for new product introductions with an average of 12 months of development cycle. Medical systems, on the other hand, have a slower clockspeed with a new product introduced on average every 76 months with a development cycle of 24 weeks.
The same study shows that product life cycles are indeed getting shorter. The impact on supply chain design: 3D-CE As a result of these industry dynamics, the discomforting news for the supply chain professional is that just like products and processes, supply chain solutions also have a limited shelf life. Driven by their clockspeed, industries are in constant evolution, ultimately rendering existing supply chain designs obsolete. Supply chain professionals should therefore watch their industry clockspeed closely and be ready to generate alternative solutions as industry structures evolve.
Let us now consider the key interfaces to see how 3D-CE aims to achieve a smoother transition. Concurrent product and process design is now a well-accepted idea, with a vast design-for-X literature, where X could stand for manufacturability, assembly, disassembly, or localization. Intel has launched its new product, the processor, on a proven 1-micron process technology. Once all the product glitches have been resolved, the next generation of the processor was then launched on a new 0.
Once the process technology was mastered, it was used as a basis to launch the new product, the microprocessor. In this fashion, Intel was able to dynamically coordinate the improvements in both the product and the process designs. However, the key question at the product-process interface is how this breadth of product portfolio is achieved. National certainly does not have the different frame geometries that Cannondale offers.
Nor does it have the variety in materials. National achieves variety through colors per model. From a process design perspective, this reliance on colors necessitates a relatively low investment in a scheduling algorithm for the painting process. For Cannondale, however, process design requires quick changeovers and consistently high quality welding for all frame geometries. In addition, if bicycles are offered in different materials such as steel, aluminum, and carbon fibers, separate processes need to be developed; as one cannot weld carbon, an injection moulding process must be developed.
This simple example thus illustrates the importance of making product and process decisions simultaneously. The process—supply chain interface has recently been highlighted through the market mediation role of supply chains. Fast-moving consumer goods are a good example of functional products. A bar of soap with moisturizing cream, a tube of toothpaste with tartar control, and a disposable razor with four blades, however, can be classified as innovative products. Similarly, fashion products, such as ski parkas or designer eyewear, are examples of innovative products.
There is much uncertainty about customer acceptance and their Value Creation 35 WTP; however, if the product is a success, there are significant margins to be made. While cost reduction is the overriding concern in the former family of products, agility is vital for the latter. Key characteristics of these products are summarized in Table 3. While the product—supply chain interface is well understood in a static sense, mismatches creep up as markets evolve.
Consider, for example, a manufacturer selling a commoditized product through a physically efficient supply chain. Suppose that the manufacturer no longer wishes to compete on cost and decides to seek ways for differentiating its product offering by incorporating several innovative features. In other words, the manufacturer has just transformed his product from a functional one into an innovative one.
What we typically observe in practice is that such a product transformation is rarely accompanied by a transformation in the supply chain. Frequently, companies try to push innovative Table 3. The process—supply chain interface is concerned with outsourcing decisions. While such decisions are mostly based on an economic make-vs-buy analysis, one typically ignores their long-term ramifications. Outsourcing the production of an item typically entails the loss of the associated design and manufacturing capabilities.
While the positive financial impact of buying an item at a cheaper rate than in-house manufacturing is felt immediately, the strategic trap, namely the loss of technological edge and manufacturing capability associated with that item, is only revealed at a much later stage when the firm tries to launch the next generation of the product only to find out that it no longer possesses some of the critical capabilities it needs in-house.
The difference with subcontracting is the divestment of assets, infrastructure, people, and competencies. For example, it may be rational for a toy manufacturer to outsource the production of figurines associated with a movie that is currently breaking all records at the box office, while a machine tool manufacturer may wish to keep the production of a component in-house in order not to lose its own tight-tolerance machining capability even if cheaper external alternatives exist. Outsourcing risks became evident in with the crash of the electronics market.
Given that, with shelf lives of around six months, cell phones represented a high clockspeed industry, such outsourcing decisions were quite reasonable. The hiccup occurred when the original equipment manufacturers OEM thought that the forecasted downturn in this market would only affect their competitors with a limited impact on their own sales.
OEMs had therefore told their contract manufacturers CM to continue buying the necessary components and manufacturing cell phones. Such a surplus led to a long and unpleasant discussion on finding a solution to this demand-supply mismatch. CMs argued that with a clearer picture of the marketplace due to their close relationship with the final customer, OEMs should have anticipated the downturn in the market and told them to slow down the procurement and production.
OEMs, on the other hand, argued that the CMs should be in a better position to use the electronics components in stock given that CMs had a diversified customer base across the electronics industry ranging from PCs to medical devices. In an industry where inventory does not age gracefully, each party had to write off a sizeable chunk of the supply chain inventories. In addition to such coordination risks due to the lack of clear governance structures, there are also long-term strategic risks.
Access to latest technology is arguably at the top of the list of such strategic risks. Imagine, for example, the inability of Intel to introduce a new Pentium processor on the 0. Similarly, imagine the inability of automobile manufacturers to launch a hybrid car because investment in hydrogen refueling stations is lagging behind. There is no point in building Ferraris if there are no highways on which to drive them.
Potential risks in outsourcing can be further limited through judicious choices in product design. A modular architecture that enables plug and play capability also provides significant safeguards against outsourcing risks. In a fully decomposable product, individual components can be designed, maintained, and upgraded in isolation. Within this context, outsourced manufacturing of individual components presents limited risk. This, however, cannot be said for products with an integral architecture.
Key trade-offs in organizational dependency and product decomposability are summarized in Table 3. They have as much or more knowledgeand can obtain the same elements you can. You understand it, you can plug it into your process or product, and it probably can be obtained from several sources. It probably does not represent competitive advantage in and of itself. Buying it means you save attention to put into areas where you have competitive advantage.
The result could be failure since you will spend so much time on rework and rethinking. You know how to integrate the item so you may retain competitive advantage even if others have access to the same item. Competitive Supply Chains Table 3.
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Avoiding Surprises 3D-CE encourages the simultaneous consideration of these interfaces. Such concurrent engineering is, in turn, enabled by the architecture of the products, processes, and supply chains. Products can be integral, embodying multiple functionalities e. Processes can be dedicated e. Supply chains can be integral with tightly coupled processes e. In the long run, these choices may support or hinder the dynamic evolution of supply chain designs, as one faces new competition, new technologies, or new legislation.
While one cannot fully anticipate the path of evolution in an industry or the emergence of disruptive technologies, explicitly monitoring industry trends may provide valuable leading indicators. To this end, a three-dimensional 3-D supply chain mapping provides a coherent framework to monitor organizational dependencies. Organizational Supply Chain: Taking either a product or a process view of your organization, enumerate first-tier suppliers who provide components or raw materials that your company uses to provide its products and services.
Next, trace any connections that these suppliers may have with each other. Continue with the subsequent tiers. Technology Supply Chain: This map is aimed at tracing the lines of dependency from your organization upstream and downstream to the suppliers and customers who provide and use the technologies that lie out of your immediate site.
Business Capability Chain: Identify and map key business process capabilities along the chain. This is the most conceptually challenging map. At the heart of these wafer steppers are high-precision lenses produced by Carl Zeiss. Hence, these four organizations are not only members in an organizational supply chain, but they also participate in a technology and capability ecosystem.
These ecosystems are complicated further by two-way dependencies. For example, ASML is not only a key supplier to Intel, but it also relies on Intel chips for the computer control of the equipment they design and build. Using these three maps, the following questions for each element of the chain would provide valuable insights: 1. What is the clockspeed of this chain element and the industry in which it is embedded? What factors e. Value Creation 41 3. What are the prospects for a change in clockspeed in this chain element as a result of expected changes in competitive intensity or in rates of innovation?
Where is the industry located on the double helix? What are the current power dynamics for this element in the chain? Referring back to the mapping in Figure 3. For instance, HP introduces a new PC every six months and a new server every nine months. A new process technology in chip making might totally change the configuration of this industry. Further upstream, the rate at which ASML introduces more advanced equipment that can produce chips with finer line width, which is largely driven by the availability of higher precision lenses, is definitely measured in years.
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On the other hand, the availability of a handful of photolithography equipment manufacturers and lens crafters should be a source of worry for all downstream consumers of these products. An interesting complementary perspective on technology and business capability chains has recently been offered by Adner12 within the context of innovation in ecosystems. Suppose that, in Figure 3. To be able to manufacture the processor, Intel would, in turn, depend on a new generation of photolithography equipment, developed by ASML, which would necessitate a sharper lens from Zeiss.
In addition, if at any one stage, further complications arise and reduce the chance of successful development of that stage, the likelihood that the overall system succeeds becomes drastically lower. As Adner emphasizes, rather than judging whether or not this is too low of a number, one must focus on recognizing the interdependence risk and setting the correct expectations.
While the interdependence risk is multiplicative, the integration risk is additive. One should not forget that adoption is viable at each stage only if the total cost of integrating the innovative components is smaller than the potential benefits at every stage. Yoffie and Kwak,13 as well as Adner, suggest risk-mitigating strategies. Motivation In the previous chapter, we have emphasized the importance of product, process, and supply chain design in a dynamic environment where industry structures evolve continuously.
While we have advocated a concurrent design approach along these three dimensions, one must resolve key cost-service trade-offs in each of those dimensions. In other words, one must assess whether investing in a product, process or supply chain redesign initiative is a value-creating or value-destroying proposition. To assess these trade-offs in an objective fashion, supply chain professionals need a simple but rich modelling tool.
In this chapter, we formalize the cost-service trade-off, which affects supply chains, through a materials management framework. Such an inventory policy will not only allow us to quantify the cost-service trade-off, but will also identify and cost out principal levers one can deploy for mitigating such a trade-off. On the other hand, FNAC operates stores in urban locations 43 44 Competitive Supply Chains where real estate is extremely expensive, necessitating the efficient use of every square meter.
This, in turn, puts a tight constraint on the amount of inventory each retail outlet can hold. In guiding its decisions on store assortment, the retailer must therefore carefully assess the consequences of satisfying the following four business criteria: 1. Criticality of product availability: a. Product contribution b. Product appeal 2. Ease of demand forecasting: a. Average demand rate b. Demand volatility 3. Supplier capability: a. Operational flexibility b. Logistical flexibility 4. Risk in stocking the product: a. Obsolescence b. It would be unthinkable for the retailer not to have a great French classic novel, a current best seller, or a popular video game on its shelves.
This is the first dimension of the criticality of product availability. The second dimension is about margins; hardbound books, video games, and latest electronic gadgets certainly have attractive margins compared to paperbacks. The second criterion is focused on assessing sales volumes and sales volatility. The third criterion focuses on the ease of replenishment.
An out-of-stock book in French can be replenished within 24 hours if the publisher has the book in inventory high logistical flexibility ; however, if the publisher is out-of-stock, then long replenishment lead times are to be expected as the publisher may not immediately print another batch of the popular book low operational flexibility.
On the other hand, if the out-of-stock product is a video game, it would be a matter of minutes to burn new CDs high operational flexibility. However, if the supplier is in Japan, this would necessitate a shipping delay of six weeks low logistical flexibility. Value Creation 45 A cell phone, which may become obsolete in a few weeks, has a relatively small footprint.
A plasma television set, on the other hand, not only becomes obsolete in a few months, but also takes up a lot of expensive real estate. FNAC must therefore design and deploy affordable supply chain solutions to support the above four business criteria. As a prerequisite, FNAC must be able to assess the associated cost-service trade-off. A base stock policy To formally define an inventory policy, consider the scenario depicted in Figure 4. Inventory is replenished by placing orders at the supplier, who produces and delivers the requested quantity after a given lead time.
Note that we distinguish on-hand inventory from inventory position. The latter is the sum of onhand inventory and the pipeline inventory, material ordered but not yet delivered, less any outstanding backorders. The answer to these three questions constitutes an inventory policy. In the absence of any fixed ordering transaction costs, a base stock or order-up-to-S, where S is the base stock level policy has been shown to be optimal. Base stock policies are easy to define and implement: for every p periods, an order for a sufficient number of units is Pipeline stock On-hand inventory Supply Inventory position Figure 4.
In this setting, the frequency with which we review the on-hand inventory and the frequency with which we place orders are fixed. There is, however, flexibility in the order quantity, which reflects the intensity of the demand during the replenishment cycle. Assume that the demand distribution, along with its mean and variance, is known. The replenishment leadtime, say l, is a known constant. As shown in Figure 4. What is then the optimal base stock level? Hence, we would set our order-up-to level to When demand is random, our short-term solution is to place some safety stock to absorb such fluctuations; i.
For example, in the first replenishment cycle in Figure 4. In the second cycle, the observed demand was so high that we not only used up all the safety stock, but also ended up losing sales. In the third cycle, on the other hand, the observed demand was way below our expectations. We then need to determine the right level of safety stock.
Before we develop an adequate expression, let us determine the drivers of safety stock. In the expression for base stock S, the average demand as well as its volatility can be estimated from historical data. Similarly, the length of the review period and replenishment lead time is typically dictated by the production and distribution constraints. It therefore remains to determine the multiplier, z, that reflects the desired customer 48 Competitive Supply Chains service level.
Here, we have two possibilities. One can invoke the newsvendor scenario,1 if a good estimate of the overage and underage costs co and cu, respectively exists. The newsvendor scenario will be formally introduced in the next chapter. In this scenario, the cost of overage is typically easy to estimate reflecting the cost of holding excess stock, the opportunity cost of money tied up to excess stock or the risk of obsolescence. The cost of underage, on the other hand, is harder to obtain as it reflects not only the foregone margin at present, but also the loss of customer goodwill in the long run.
In such cases, we need an alternative approach to determine the multiplier, z. One alternative is to start with a targeted customer service level, measured by, say, fill rates, f, and then determine the multiplier that would achieve the desired service level. To this end, the supply chain specialist would benchmark competing firms with respect to the service levels they offer or would consult with their marketing colleagues regarding the service levels expected by their customers. For example, HP requires relatively high fill rates for its laser printers, as the installed product base is the primary driver of high-margin consumables such as replacement cartridges, paper, and service contracts.
Value Creation 49 How do we then translate the desired service level, expressed in terms of the fill rate f, into the multiplier z? The standard loss function is also provided in the Appendix. In technical terms, this is a conditional expectation: the average demand during the replenishment lead time given that the demand exceeds the safety stock. This quantity therefore represents the average lost sales during the replenishment lead time. The denominator, on the other hand, reflects the average demand during a review period.
The ratio then yields the proportion of lost sales during this cycle; one minus that ratio is therefore equal to the fill rate. The first criterion, criticality of product availability, is directly related to the fill rate, f, that must be set in accordance with the marketing goals. The third criterion, supplier capability, is illustrated by p, which, as the review frequency, reflects its operational flexibility, and by l, which, as the replenishment lead time, reflects its logistical flexibility. FNAC can then assess the cost-service trade-off inherent in various possible supply chain solutions e.
Suppose that you are selling a product whose forecast calls for an average demand level of units per week with a standard deviation of 50 units per week, representing the volatility of demand. This simple framework provides an objective platform to quantify the cost-service trade-off. For example, Value Creation 51 a manufacturer might ask its supplier to modify the frequency with which he can place replenishment orders, i. As such, added flexibility will decrease the required inventory investment hence, the WCR by the manufacturer in a quantifiable fashion, some of those savings can be passed along to the supplier as an incentive to provide such flexibility.
In a similar fashion, the value of reducing the lead times, l, can be assessed. For example, such a calculation would help us to assess whether shipping by airfreight overnight makes sense compared to shipping by sea over six weeks. Or, if the firm is considering alternative investments to reduce demand volatility, this expression enables a quick cost-benefit analysis between the investments required to reduce volatility and the reduced reliance on safety stocks due to lower volatility.
Finally, if the marketing department insists on a certain service level, this expression provides the cost of providing the desired service. In fact, by considering different service levels, one can generate a cost-service trade-off curve, as illustrated in Figure 4. Such a curve would provide further help in segmenting the target market by offering premium and more costly service to top customers. Supply chain professionals can make a sustainable difference, however, by designing products, processes, and supply chains that would shift the trade-off curve, hence mitigating the cost-service trade-off.
Postponement strategies represent one such instrument that would mitigate the cost-service trade-off. In fact, Figure 4. Despite a state-of-the-art JIT factory in Vancouver, Washington, HP was not able to forecast the product demand accurately, resulting in severe stock-outs in some markets, while inventory built up in others.
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Within the base stock framework, supply chain experts at HP were able to assess the cost-service trade-off among various supply chain solutions such as shipping products through air freight reducing l but drastically increasing transportation costs , building another factory in Europe reducing both p and l but necessitating a major capital investment or boosting safety stock levels increasing WCR while hoping to achieve higher fill rates.
The solution that was ultimately adopted and became a benchmark in many other industries is delayed customization or postponement, whereby the Vancouver plant would produce the hardware based on forecasts, which would ultimately be customized in a distribution center close to the customer preferably after a firm customer order has been received.
The cost-service trade-off curve under the postponement strategy is also reflected in Figure 4. HP managers were then able to quantify the savings due to postponement and assess whether the investment in product and supply chain redesign to enable delayed customization capability was indeed a value-creating proposal. Today, postponement is done through a third-party logistics service provider for HP in Europe. AP — Some customers want blue, and some want green. But customers who head to Best Buy Co.
The lime, tangerine and strawberry models have been less popular. Apple recently shifted its policy, shipping four blues with one of each of the other colors. The company did not specify which colors it does not want to stock. But she said that when those run out on store shelves, customers are content to buy whatever is in stock. Best Buy, which has stores in 36 states, may eventually stock the iMacs, Harris said. Consider the inventory levels for Blueberry iMacs at the typical store if Best Buy uses the periodic review, order-up-to policy.
From the appendix, the z value is 1. Consider the inventory levels for Tangerine iMacs at the typical store if Best Buy uses the periodic review, order-up-to policy. From the appendix the z value is 1. Value Creation 55 A marketing executive suggests that Best Buy might carry the iMac in all colors if Apple would offer a per-unit discount on less popular colors to offset the higher effective inventory-carrying cost per unit sold for less popular colors.
Based on the above calculations, what per-unit discount should Apple offer to Best Buy for Tangerine computers in order to make them indifferent between selling computers in Tangerine and Blueberry? You may also assume that Best Buy does not take ownership of computers until they arrive at the retail stores. To calculate the appropriate level of compensation, we need to first determine the inventory carrying costs for the two computers. These numbers, however, are not directly comparable, because the two computers have different annual sales volumes. We could use the annual sales volume to normalize the numbers and make them directly comparable.
Long-term solutions The base stock model that was introduced to quantify the cost-service trade-off can also be viewed as one short-term solution to inventory management challenges. From this materials management perspective, it is worthwhile to open a parenthesis here to seek longer term 56 Competitive Supply Chains solutions. A long-term orientation, in return, requires the identification of inventory drivers, business conditions, and constraints that necessitate inventory holding. Unless these drivers are eliminated through better product, process, or supply chain design, stockless production and distribution is not possible.
USD Sign in to Purchase Instantly. Overview This book emphasizes three key messages; value, alignment and sustainability. The authors believe that SCM is a value enabler with strategic decisions in supply chain design.
Competitive supply chains : a value-based management perspective
The text also argues that economic incentives should be designed to ensure the much needed alignment and supply chain design should be viewed as a dynamic process. His main teaching and research activities focus on manufacturing, telecommunications and service environments. He is a specialist in computer simulation with an emphasis on large-scale industrial applications and performance analysis.
He has also been actively involved in numerous supply chain rationalization efforts in the automotive, white goods, electronics, petrochemical and healthcare industries, as well as e-commerce initiatives. Average Review.
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