Creating Value through Supply Chain Integration
By Hau L. Lee -- Supply Chain Management Review, 9/1/2000
In the midst of the Asian economic crisis, one shining star has bewildered investors and has beaten all odds by posting record profits. Seven-Eleven Japan, a major retail chain in that country, has been so successful that its stock value appreciation in recent years has even surpassed that of Dell Computer, a darling of Wall Street. Of course, Dell is a legendary company in its own right, with sales, profits, and stock prices head and shoulders above its competition in a fiercely competitive and saturated market.
Interestingly, Seven-Eleven Japan and Dell Computer represent two of the most innovative companies in the management of their supply chains. They both have created new ways to operate their supply chains, defined new rules of the game, and maintained supply chain excellence as part of their strategic competitive edge. They are among the leaders in successfully integrating their supply chains.
The results that supply chain leaders like Seven-Eleven Japan and Dell have achieved are clearly impressive. Cost reduction is one highly desirable result but not the only one. Supply chain integration also creates profits, increases market share, strengthens competitive position, and enhances the value of the company.
These benefits also can be seen at Lucent Technologies. Two years ago, the company revamped its supply chain strategy in Asia by realigning the missions of its manufacturing sites in Asia and North America, linking with local suppliers, and redesigning products and processes to support supply chain management. Shortly thereafter, the Taiwan government deregulated the telecommunications industry and opened up the telecommunications equipment market to global competitors. Lucent won 100 percent of the market share of switching systems in Taiwan—an unbelievable achievement attributed to the company's new supply chain strategy.
Large, global corporations like Lucent, Wal-Mart, Procter & Gamble, and Sun Microsystems have demonstrated that value can be created through supply chain integration. But small and medium-size companies can gain such value, too. Sport Obermeyer, for example, worked to tightly integrate its overseas manufacturing bases with its customers and retailers. This effort resulted in a 60-percent increase in profits and a top ranking in customer satisfaction surveys for several consecutive years. National Bicycle, a Japanese bicycle manufacturer, applied innovative supply chain strategies to create a new product and penetrate market segments that no one else in the industry was able to do. The result was a doubling of market share in a matter of years.
The success of these companies is a result of an integrated supply chain that makes smart use of information to orchestrate the activities of the chain. Their supply chains are not static but evolve continuously based on the changing market and customer needs. Companies in the semiconductor, natural resources, process, telecommunications, consumer goods, and services sectors are all discovering similar value from information-smart supply chains. No wonder top executives of innovative companies like Xilinx, Hewlett-Packard, and Quantum all have identified supply chain management as a top priority in their overall strategy.
Today's Supply Chain EnvironmentSupply chain management involves the flows of material, information, and finance in a network consisting of customers, suppliers, manufacturers, and distributors. (Exhibit 1 gives an overview.) Material flows include both physical product flows from suppliers to customers through the chain and reverse flows via product returns, servicing, recycling, and disposal. Information flows involve order transmission and delivery status. Financial flows include credit terms, payment schedules, and consignment and title ownership arrangements. These flows cut across multiple functions and areas both within a company and across companies (and sometimes industries). Coordination and integration of these flows within and across companies are critical to effective supply chain management.
Because of the network complexity, communication between entities and accurate and timely transfer of information can be extremely difficult. In particular, the multiple layers in a supply chain can distort demand information. This distortion can lead to excessive inventory, idle capacity, high manufacturing and transportation costs—and increasingly dissatisfied customers. Achieving supply chain efficiency requires accurate and timely information. And the more complicated the chain, the greater the requirement.
In today's environment, customers are less forgiving of poor customer service and more demanding of customized products or services. As the competition continues to introduce new offerings tailored to the special needs of different segments of the market, companies have to respond by offering similar custom-made and highly personalized offerings. The ensuing proliferation of product variety for multiple countries, customer segments, and distribution outlets creates headaches in forecasting, inventory management, production planning, and after-sales service support.
Finally, product life cycles are getting shorter and shorter. The expected life of a high-technology product such as a personal computer now is nine to 12 months. Additionally, technology is changing rapidly and products are rolling over constantly. As a result, the number of products offered by a company has increased significantly because product life cycles for successive products often overlap in time. The success of the product line, as well as the company, depends on effective management across the supply chain of both new product introduction and old product phase-out.
What Constitutes Supply Chain Integration?Effectively managing these increasing customer demands and product offerings in complex global supply chains requires tight integration between partners. What constitutes supply chain integration? There are three key dimensions: information integration, coordination, and organizational linkage. (Each of these dimensions is described in Exhibit 2.)
Coordination refers to the redeployment of decision rights, work, and resources to the best-positioned supply chain member. To illustrate: A company that historically has developed its own replenishment plans may opt to give up its decision rights and let the supplier replenish on its behalf. The supplier may be in a better position to do the replenishment because of its superior knowledge of the product, the overall market, and forecasting techniques. This is the basis of programs like VMI (Vendor Managed Inventory) and CRP (Continuous Replenishment Programs).
Companies also may shift the actual work they perform in order to improve overall supply chain efficiency. Channel assembly in the personal computer industry is one such example. Currently, PC manufacturers allow distributors to do the final product configuration and testing for the consumers, tasks that used to be "owned" by the manufacturers. Finally, resources can be redeployed, consolidated, or shared, so that multiple players in a supply chain benefit. Shared warehouses, inventory pooling, and supplier hubs are examples of this.
Integration is not complete without tight organizational relationships between companies. Supply chain partners need to define and maintain their channels of communication—whether those channels involve EDI (electronic data interchange), Internet exchange, account teams, or executive briefings. The performance measures for the supply chain members also need to be specified, integrated across the chain, and monitored. Thus, one supply chain member may be held accountable for certain performance measures of another. Also, there may be some joint performance measures for which multiple organizations are jointly held accountable. Such extended performance measures encourage closer collaboration and coordination. Finally, organizations in a supply chain can work closely for the same goal only if the incentives of the multiple players are aligned. Incentive alignment requires mechanisms assuring that the associated risks and gains of integration efforts are equitably shared.
Integrating a supply chain along the information, coordination, and organizational dimensions positions the network for ongoing success. With the integration foundation in place, the responsibilities of the members can shift dynamically based on changing customer needs. Partners can enter and exit the network with minimal disruptions and costs. Such evolving networks can result in much greater efficiency and responsiveness.
The Information FoundationInformation integration is the foundation of broader supply chain integration. For companies to coordinate their material, information. and financial flows, they must have access to information reflecting their true supply chain picture at all times. Without information integration, few gains can be made in overall supply chain integration.
The first level of integration is the sharing of demand-driven information among supply chain partners. In fact, some people like to refer to supply chain management as "demand-chain management" to emphasize that all activities in a supply chain must be based on actual customer need. Customer orders are what ultimately drive all actions in the rest of the chain.
Information sharing is the most effective way to counter the problem of demand distortion in a supply chain—the well-known "bullwhip effect." (The bullwhip effect is depicted in Exhibit 3.) In an ideal situation, a downstream site could share with an upstream site the sales information of its customers or its customers' customers. The greater the extent of information sharing, the lesser the potential for the harmful bullwhip effect.
The next level of information integration is the exchange of knowledge among supply chain partners. This is clearly a deeper relationship. It demands a greater degree of trust among partners than does the simple sharing of data.
Knowledge exchange is the basis for Wal-Mart's collaboration with Warner-Lambert (now part of Pfizer) on the forecasting and replenishment of pharmaceuticals and health-care products. Retailers such as Wal-Mart usually have the best knowledge of local consumer preferences through their interactions with customers and their possession of point of sale (POS) data. Pharmaceutical companies know about the properties of the drugs they produce and can make use of external data, such as weather forecasts, to help project demand patterns. Both parties contribute their respective knowledge and collaborate closely to determine the right replenishment plan.
Similarly, through extensive collaboration with its suppliers and its stores, Seven-Eleven Japan created new, highly customized products. The company also replenished stores rapidly to meet the personal needs of many customer segments in different locations and at different times of the day or week. Such a high degree of customization (almost like a one-to-one marketing effort) enhances customer relationships. In fact, it is a key factor behind the success of Seven-Eleven Japan.
Another example of successful knowledge sharing can be seen in CPFR (Collaborative Planning, Forecasting, and Replenishment), a major initiative in the grocery industry. The exchange of knowledge about markets and products helps retailers and manufacturers devise the best promotion plan and the best new-product introduction plans. In some cases, CPFR enables retailers and manufacturers to design new products jointly.
What About Coordination?With shared information and knowledge in place, the supply chain partners are positioned to move toward a deeper level of integration. They are ready to start coordinating their efforts by exchanging decision rights, work, and resources. To begin exchanging decision rights, the members require not only information integration as a foundation but also a higher level of trust and dependency. One supply chain partner may be in a better position to make a decision usually made by another. If that decision is delegated from one partner to the other partner, then overall supply chain efficiency should improve.
Coordination initiatives in the grocery industry, to cite one example, have had that desired effect. Responding to information distortion from the bullwhip effect, this industry has aggressively started to pursue CRP and VMI programs. These programs shift the replenishment decisions from the retailer to the manufacturer. Rather than having the retailer make the ordering decision, the manufacturer does, based on the POS and inventory information provided by the retailer. These programs have resulted in significant savings. When the giant Italian pasta manufacturer Barilla SpA started implementing such a program with one of its largest distributors, Cortese, the result was instant success. Inventory dropped by 46 percent, while the stockout rate dropped from 6–7 percent to almost zero! (Exhibit 4 shows the benefits of the VMI initiative at one of the company's distribution centers.)
Here's another good example of coordination: 3M joined in a VMI program to replenish the tapes it provides for Procter & Gamble's Pampers product line. The replenishment was based on P&G's production plan and inventory position. Given that P&G already had a VMI program running with Wal-Mart, there is now a three-partner VMI program in the Pampers supply chain: 3M, P&G, and Wal-Mart.
The exchange of decision rights in VMI programs is not simply for the sake of dampening the bullwhip effect and improving forecasting and replenishment decisions. It also recognizes that the vendor is in the best position to analyze and coordinate the optimum shipment plans for replenishing goods to customers. For example, the vendor may coordinate the replenishment plans of multiple customers to maximize the number of full truckloads. This leads to significant savings in freight costs while at the same time providing more responsive customer service.
The next level of coordination is the realignment of work. Here, physical activities are redistributed among supply chain partners, based on the best interest of the overall supply chain. Such redistribution is possible with the availability of information and the sharing of knowledge.
The PC industry offers a good example of work realignment. Traditionally, final product configuration was done by the manufacturer, which also stocked finished products. The distributors and resellers (what we refer to as the channel) ordered products from the manufacturer and then stockpiled them. End-customers came into contact with the channel and took possession of the products from the channel.
Today, however, there are many variations on this traditional supply chain structure. For example, the two key sets of activities—sales and customer interactions, and product customization and delivery—have been redistributed to the manufacturers and the channel, depending on the particular situation. (See Exhibit 5.)
The sales agent model has the channel responsible for the sales and customer interaction activities, while the manufacturer performs the physical customization of the product. In this model, the product is delivered directly to the customers from the manufacturer. Computer manufacturers like Hewlett-Packard and Compaq are using such a model for their PC servers to counter the success of their competitors' direct sales model. In this case, the product is complex enough that the channel is needed for sales and customer interaction activities. The high value of the products makes it more attractive to have the manufacturer build to stock and ship direct to the customers rather than stock inventory in the channel.
As an example of a channel assembly program, on the other hand, a company like IBM might make a "plain vanilla box." The channel is responsible not only for the sales and customer interactions but also for the product configuration to meet customer needs. The channel is in a position to interact closely with customers, which allows participants to build the options that meet customers' specific needs. Both the manufacturer and the channel, however, provide after-sales service. Because customers usually have registered for a warranty, they can contact the manufacturer directly with any service requirements. Manufacturers actually desire such contacts because the information gained through service calls can provide valuable feedback for design improvements. But the manufacturers typically lack the extensive service network needed to respond speedily to requests to repair customers' computers. The channel members are actually in a much better position to do so, since they have geographically dispersed facilities. So , for example, while HP provides an 800 number for customers to call for service needs, the actual repair of the home PC is handled by a distributor.
Finally, the outsourcing model finds the manufacturer responsible for sales and customer interactions, while the channel handles product customization and delivery.
This work realignment is being accelerated by the rapid advances of consumer-direct, Web-enabled buying programs; manufacturers increasingly are assuming order-fulfillment roles traditionally played by distributors and retailers. The distributors and retailers, for their part, will have to redefine their roles in the new supply chain.
In addition to realigning decision rights and work, supply chain partners can coordinate and share their resources jointly to gain synergistic advantages. For example, to mitigate the high risk and cost of building a new semiconductor wafer fabrication laboratory, Xilinx, a leading fab-less semiconductor company has co-invested with UMC, a Taiwan-based foundry, to build a new state-of-the-art fab. Automobile dealers also routinely share their spare parts inventory, which enables them to improve customer service and inventory utilization at the same time.
The Importance of Organizational LinkageInformation integration and coordination by themselves cannot sustain full supply chain integration. The organizational component also needs to be in place.
Organizational relationship linkage starts with the right set of performance measures used across the supply chain. As companies become more and more integrated, the traditional internal performance measures appear increasingly inadequate. First, with purely internal measures the interface activities between companies can fall through the cracks because neither partner may be actively measuring the performance of those activities. Second, as companies begin to share information, exchange knowledge, and delegate decision rights, it is extremely difficult to define an activity as completely internal to one company. For example, in VMI programs where a vendor is responsible for replenishing customer stock, inventory management also should be part of the vendor's performance measure. Traditionally, it has been considered an internal company measure.
Joint or extended performance measures are necessary to account for the integrated activities properly. Both supply chain partners are responsible and accountable for the joint performance measures. This level of integration requires an integrated information system that tracks an extended set of performance measures and allows for multiple supply chain partners to gain access to these measures.
Performance measures within the organization have to be integrated as well. The following example underscores the point.
Pacific Bell, the West Coast telecommunications services provider, was faced with a performance measure problem in its service operation. The problem related to the plug-in parts used to replace broken equipment. The stock manager of the plug-ins was measured on the items' inventory levels, while the field engineers were measured on the time that it took them to complete a repair. The result of these contrasting performance measures was that the stock manager tended to understock, which led to a scarcity of parts when the field engineers needed them. The field engineers then began to stockpile the plug-ins so that they could complete the repairs quickly without having to depend on the warehouse's stocking positions. The widespread practice of holding private stocks led to exceedingly high levels of decentralized inventory, ultimately resulting in service degradation. When Pacific Bell changed its policy and made both the stock manager and the field managers jointly accountable for both inventory and service completion rates, the problem of incentive misalignment disappeared.
Extended performance measures have to be coupled with the correct alignment of incentives. Mechanisms for the sharing of risks, costs, and rewards must be in place to give partners the incentive to participate and maintain supply chain integration activities.
A good example of this can be seen in Saturn's JMI (Jointly Managed Inventory) program. Saturn's Service Parts Operation is responsible not just for the timely replenishment of service parts to the retailers (car dealers) but also for the ultimate repair completion rates for the end-customers. The JMI program aligns its partners' incentives by redistributing the risks between Saturn and its retailers. Although the manufacturer and the retailers jointly manage the retailer inventory, it is the retailers who face real customers and who pay, up front, for service parts. Thus, retailers have to deal with the consequences of both excess inventory and service part stockouts. Because replenishment decision rights have now shifted from the retailers to Saturn, the risks and costs of not matching supply with demand at the retail level must be shared.
To this end, a system was designed that shares the risks of Saturn under- or over-stocking the retailers. In the case of stockouts, Saturn has an elaborate support system for emergency demand situations. When a retailer is out of stock, Saturn makes use of its centralized inventory system to identify a backup source of supply. This could come from a nearby retailer, Saturn's central warehouse in Spring Hill, Tenn., or some other stocking location anywhere in the country. The manufacturer then expedites the resupply to the retailer in need of the part. The costs of such transfers are born primarily by Saturn. Hence, a retailer's risk and the cost of a stockout are shared with the manufacturer.
As part of this risk-sharing approach, Saturn also has instituted a policy whereby retailers can return a part that has not moved in nine months for a full purchase-cost credit.
The Time to Act Is NowMany industry gurus have chronicled the competitive evolution of the past few decades. The 1970s were characterized as the decade when companies concentrated on quality. A heightened interest in techniques like Total Quality Management and Zero Defects was evident during this time. In the '80s, quality was no longer a source of competitiveness. It was a basic requirement, and you simply could not survive without it. The competitive emphasis then turned to manufacturing efficiency. In the '80s, concepts such as lean manufacturing, design for manufacturability, just in time, and stockless production began to take hold. Through the 1990s, most companies were able to apply these manufacturing techniques to squeeze the excess fat out of their operations.
Going forward, the biggest opportunities lie outside of the four walls of the manufacturing plant. Where do you source your materials? Where do you process or convert them? What channels of distribution do you use? How do you build a strong relationship with your suppliers and customers? How do you get direct information from your end-consumers? What logistics structure should you impose? How do you coordinate your information flows and systems globally? And how do you set up incentive systems for all of your partners in the supply chain to optimize overall performance?
The field of competition has now shifted to management of the global supply chain. As indicated at the top of this article, the success of companies like Procter & Gamble, Hewlett-Packard Company, Dell Computer, and Wal-Mart is testimony that a well-orchestrated, tightly integrated supply chain is crucial to the competitiveness of an enterprise.
Supply chain integration is neither a simple nor an easy task. But the payoff can be handsome. Companies that have mastered integration have benefited from higher profit margins, improved customer-service performance, and faster response time. They have drastically reduced inventory investment and write-offs while at the same time doubling returns on assets. Perhaps most importantly, their shareholder values have multiplied.
Those who ignore the forces of supply chain integration will only see the gap between them and the leaders widen. The risks of not moving forward are huge.
| Author Information |
| Hau L. Lee is a professor at the Graduate School of Business and the School of Engineering at Stanford University. He is a member of Supply Chain Management Review's Editorial Advisory Board. |
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