A Primer on the Internet Supply Chain
By Steven J. Kahl and Thomas P. Berquist -- Supply Chain Management Review, 9/1/2000
Organizations are rapidly trying to incorporate the Internet into their supply chain practices. Global competitive pressures, heightened shareholder expectations, the emergence of "dot-com" competition ... all of these developments have accelerated the rate of Internet adoption. If your organization does not have an e-business strategy, the reasoning goes, how can you be expected to compete in this new electronic economy?
The rapid pace of change creates a dangerous dilemma: We do not quite understand its impact on the supply chain, but we do know that we need to embrace the Internet quickly. Yet making poor choices can lead to larger problems than sitting idle would.
This article returns to the basics and explores how the Internet commerce platform affects the dynamics of the supply chain. Armed with this knowledge, companies can make better decisions about their e-business strategies.
The Internet Commerce Platform Is DifferentA commerce platform is the infrastructure that enables business and communication to occur between trading partners in a supply chain. The Internet is not the first commerce platform, but its unique characteristics enable it to support more robust collaboration across the chain. To understand the important features of the Internet commerce platform, it is helpful to place it in historical perspective.
First came the phone, fax, and e-mail...
The original commerce platforms were the phone, letter, fax, and eventually e-mail communications between trading partners. For example, purchase orders were placed by phone with acknowledgments sent via e-mail; contracts were negotiated in person or over the phone, signed through fax, and monitored through phone and e-mail communications.
The problem with these forms of communication as a platform is that they are ad hoc; process controls and any formalized performance management is lacking. As a result, these processes are incredibly inefficient, requiring multiple relays of order information throughout the supply chain to build a customer order. Furthermore, what is communicated at the front of the chain may have a different interpretation or effect at the back end. Without controls, maverick buys and unmonitored relationships proliferate. Field operations form relationships with local businesses that may not support the corporate agreements with national accounts. The inefficiency associated with these practices has tremendous financial impact, as companies throughout the chain stockpile inventory and lengthen cycle times to buffer the variability in information. Lastly, this platform does not scale; that is, as supply chain partnerships expand, additional personnel need to be hired.
Then ERP and EDI...
The first wave of technological advancement helped address some of these inefficiencies. Two technologies were of particular importance: enterprise resource planning (ERP) and electronic data interchange (EDI). Originally, ERP applications automated the internal day-to-day operations of an organization, integrating different functional groups such as financial management, human resources, order management, and manufacturing. Because ERP applications focus on the internal operations, they do not provide a commerce platform per se. In the supply chain context, ERP's true value lies in enabling a company to participate in the supply chain network. In essence, ERP helps companies get "their own house in order" to make it easier for supply chain partners to conduct commerce with them. For example, these applications can provide uniform order entry for upstream customers or a more feasible production plan for downstream suppliers.
EDI, on the other hand, provides a platform to conduct commerce between organizations. EDI can be defined as computer-to-computer transfer of transaction information (for example, purchase orders and inventory levels) via standard formats over a proprietary network. From a process standpoint, EDI translates fixed files into these formats, transfers the information to the trading partner typically via a proprietary network, and then translates the information into a recognizable form for the trading partner. As a result, ERP's ability to "clean house" with the EDI network brought structure to the ad hoc supply chain platform.
Yet EDI has its limitations, too. For one thing, it is expensive, requiring outlays for proprietary network translation and integration into back-office systems. For this reason, EDI networks have failed to penetrate the entire supply chain significantly. Many smaller players simply cannot justify the cost of implementing an EDI solution, even though the larger supply chain masters often try to coerce players into supporting their network. In most cases, the end-consumer is not even connected electronically to the network, prohibiting a clear view of demand throughout the chain.
In addition, EDI only supports batch and static transactional data interchange. This means that groups of transactions (say, purchase orders) are collected before being transferred to trading partners. This approach hinders real-time information about production, demand, and pricing. The data transferred typically are transactional in nature—purchase orders, inventory information, invoices, financial payments. The data do not, however, support more value-added collaboration around demand profiles, production planning, and new-product introduction. The information flow is uni-directional; that is, any return communication typically is only an acknowledgment of receipt. If any clarification is needed, the trading partners must resort to the traditional phone, fax, and e-mail methods of communication.
Most importantly, EDI imposes a one-to-many architecture for communications between supply chain members. This means the supply chain network is configured in a hierarchical fashion in which one organization relates to many different trading partners. In many cases, at the center of the network is a larger purchaser integrating with a supply base that had to subscribe to the proprietary network. As a result, the one-to-many configuration typically represents the interests of the "one" as opposed to the "many." The EDI communications network simply cannot support open, robust collaborations throughout the entire supply chain.
And now, the Internet ...
The Internet is the next-wave commerce platform. In many respects, it combines the best qualities of the two earlier platforms. Like EDI, the Internet provides a structured platform for communication. But it also can embrace the unstructured collaboration that occurs in the traditional ad hoc platform. Some of the important features of the Internet commerce platform include:
- Ubiquity and Pervasiveness. Unlike the proprietary EDI networks, the Internet is public domain, which lowers the cost of participation. The costs are lowered because businesses don't have to pay to participate on the network, although there is the cost of integrating the network into back-office solutions. And now even this cost is coming down, with the introduction of packaged software that helps integrate external supply chain activities with back-office applications. This lower cost can increase supply chain participation, especially for the smaller businesses that could not afford EDI. At the same time, however, the Internet puts a premium on performance because with ubiquity and pervasiveness also come lower switching costs.
- Standardization. EDI networks require proprietary data formats (in fact, there are two different standard formats) for transmission across a closed network. The Internet, on the other hand, endorses a common communications protocol (TCP/IP), which lowers integration costs. Furthermore, data transmission is rapidly being standardized through XML (extensible markup language) technology. This standardization is important because it facilitates rapid adoption of supply chain practices. However, the Internet platform can only go so far. At the core, it is only the vehicle that transmits, translates, and integrates the data. Industry participants must support true data standardization in which a supply chain adopts a common classification structure for component parts and finished goods. Today, several industries are developing such standards. The RosettaNet in the electronics industry is one such example.
- Real-Time Communication. To achieve efficiency and lower costs across the proprietary network, EDI operated in batch mode. The Internet, however, is not burdened with this network overhead and supports real-time information transfer. Harnessed properly, real-time information yields greater flexibility throughout the supply chain. Supply chain members can be notified of immediate changes from unanticipated events or can leverage up-to-date information on inventory levels and other key developments across the chain. For example, a large unplanned customer order can come in and the inventory, production requirements, and logistics changes can be immediately propagated throughout the supply chain. Or better yet, the company can proactively decide whether to take on the additional order given current conditions in the supply chain.
- Variety of Data Structures. EDI and ERP focus on capturing transactional data—the information records of business transactions such as purchase order number, quantities, and payment information. However, other types of data are also exchanged between supply chain partners. These can include product designs, market data, Web site links, production plans, and customer profiles. This additional data exchange traditionally has taken place via phone conversations and e-mails. Unfortunately, EDI cannot capture this data transfer because it is less structured than transactional data. The Internet commerce platform can support this variety of data exchange—and in many cases is the source of it. Supporting more robust data transfers enables the Internet to promote collaboration between supply chain members beyond the customary commerce transactions.
- Many-to-Many Network Configuration. EDI only supports a one-to-many supply chain network configuration that imposes artificial restrictions on the flow of information. The "one" dictates the information flow to the "many." However, supply chains do not necessarily operate this way. They are much more complicated. There are multiple suppliers, buyers, service providers, and customers that interact with each other independently and in multiple capacities. A third-party logistics company may provide services to two different suppliers who also have their own direct relationship. In other words, the true network configuration of a supply chain is many-to-many: any one participant has many different relationships with other participants. The Internet itself is built to support a many-to-many configuration. As a commerce platform, its open architecture has the capacity to support the multiple process and data requirements as well as provide a comprehensive picture of the entire network. In turn, the many-to-many network configuration generates greater economies of scale and drives more value. (Exhibit 1 contrasts the two types of network configuration.)
These compelling characteristics of the Internet as a commerce platform have fueled tremendous growth. In fact, we project that over the next two decades, 80 percent of business-to-business commerce worldwide will be conducted online.1 We expect that the worldwide gross value of commerce transactions done online will grow from $225 billion in 1999 to $7.6 trillion by 2005. (See Exhibit 2.) In the face of such rapid growth, practitioners should strive to understand how the digitizing of the supply chain affects their supply chain practices and processes.
Understanding the Internet's ImpactWith an understanding of the Internet commerce platform, we now can assess how it changes the supply chain dynamics. Being aware of the impacts—both short and long term—will help companies make better-informed decisions about their e-business strategies.
A logical starting point in this assessment is to consider the new Internet supply chain entities. When thinking about traditional supply chain participants, the brick-and-mortar companies come to mind—the manufacturers, suppliers, transportation carriers, warehouses, and so on. These are entities that you can see and touch. The Internet, however, has created two nontraditional entities that are changing supply chain dynamics. They are e-marketplaces and Internet supply chain service providers.
e-Marketplaces
Electronic markets are Web sites where buyers and sellers converge to advertise, bid for products in auctions, post catalog information, procure inventory, and manage inventory and fulfillment. An electronic market can be aligned vertically, focusing on the procurement of industry-specific products such as paper, metal, chemicals, agriculture, and energy. Or it can be horizontal, providing products for a diverse range of industries. These markets act as hubs where buyers can procure direct goods and suppliers can market their products. In many respects, the electronic market is a microcosm of the many-to-many supply chain market advocated earlier.
Today, electronic markets deal mostly with transactions related to the procurement of indirect and direct goods, whether they are by auction, request for proposal (RFP), spot electronic procurement, or e-catalogs. The electronic marketplaces offer buyers a consolidated location to procure goods, which lowers the administrative and inventory costs. They provide suppliers with an additional channel to market their goods. The transactions themselves and the integration into the back-office systems of the participants are enabled by the Internet commerce platform. Today, these markets are offered by both pure "dot-com" companies and by industrial companies forming consortia that create and administer the marketplaces. (As of this writing, more than 30 such consortia have been announced).
Over time, as more and more electronic marketplaces emerge in any given vertical, the value of getting buyers and sellers together in a central market to conduct procurement transactions erodes. Thus, many of the electronic marketplaces are beginning to layer on additional value-added services or expand their markets to provide procurement in tangential supply chains. Some of these services are financial in nature—for example, credit checking, arranging insurance, and payment processing. Others are more supply chain oriented, such as logistics services, collaborative planning, and product-lifecycle development.
As these supply chain services expand, the marketplaces themselves will become hubs of valuable information about supplier performance, inventory information, demand patterns, and logistics capabilities. In addition, the marketplace can help improve supply chain decisions by providing industry benchmarks, demand patterns, and best practices. (For example, the marketplace may be able to show a customer that routing a particular shipment through Long Beach as opposed to Seattle may result in lower overall freight costs.) These marketplaces then can leverage the Internet to distribute the information back to participants to improve visibility and efficiency across the chain.
In short, these new entities are not simply a convenient location to conduct commerce; rather, they are a valuable hub of supply chain information and best practices that any one participant can leverage to improve performance.
Internet Supply Chain Service Provider
Historically, most of the providers of value-added supply chain services have been asset-based (for example, many are third-party logistics providers and contract manufacturers). These businesses try to leverage economies of scale and give partners the opportunity to outsource noncore processes.
The Internet offers a new type of outsourcing that is information based. We call these entities Internet supply chain service providers. They focus on the optimization of certain supply chain processes that, though important, are not necessarily a company's core competency. Such processes may include transportation mode selection, route optimization, demand forecasting, international documentation compliance, or logistics planning. A service provider, in turn, contains the domain knowledge and the sophisticated algorithms to optimize these supply chain processes.
The Internet twist is twofold. First, the providers can use the Internet to pull in additional value-added services at a lower cost to enhance the total service package. For example, the service provider could pull in financial services to process letters of credit when handling international shipments. Second, the providers can leverage the Internet to integrate into the back-office systems of the participating companies to obtain and propagate information.
In essence, these new Internet-enabled entities provide an application as a service. Over time, they will contain a wealth of information about best practices in supply chain optimization. This information then can be distributed back to participants through the Internet. The lower cost of the service enables all participants to optimize their supply chain processes, creating a more efficient supply chain overall. This raises the bar for base performance.
From a Chain to a CommunityThe term "chain" is an appropriate description of current supply chain processes because they are linear and sequential. Most inter-business processes today more closely resemble a relay race—one company takes a piece of information, runs with it, and then passes it on to a partner. Any two-way automated communication is usually limited to acknowledgment of information received or some limited type of error processing.
Because the Internet is a more robust commerce platform, however, it shifts the emphasis from connecting business processes to coordinating inter-business processes. What's the difference? Connecting business processes means that internal business processes of various participants are integrated to ensure that each participant operates on the same principle. A coordinated business process, on the other hand, does not reside with each business but is administered on the network. This process, like most processes, requires two-way control and workflow management. In other words, connecting is transaction oriented; coordination is more knowledge and process oriented. Synchronization at this level creates more value across the chain.
To get a better idea of the differences, consider a few examples. In a connected environment, one company may generate a forecast and then pass relevant information to its downstream partners. In a coordinated environment, all interested members collaborate together to generate the forecast. In the connected environment, it is easier for the information to get distorted because of the multiple hand-offs. But in the coordinated environment, each participant has greater visibility into the same base information.
Product design offers another example. In a connected environment, the manufacturer determines the product design and then hands over the product spec to the suppliers to build the component parts. This approach often lengthens the product introduction life cycle because of costly re-designs. In a coordinated environment, the suppliers are pulled into the process earlier, reducing the product-introduction cycle time. (Exhibit 3 depicts the evolution from chain to coordinated e-business community.)
The Internet brings with it one more compelling benefit: It enables companies to advance from optimized to synchronized supply chain management.
Traditional supply chain management operates under a planning methodology. Companies create a sales and operations plan, forecast demand, specify production requirements, and then try to execute against that plan. Changes to the plan typically come at great cost, requiring re-planning, overtime, process changeovers, expedited deliveries, and decreased cycle times. This situation exists largely because adequate information is not captured and shared throughout the supply chain. Organizations do not have the visibility into overall supply chain capacity to respond to change efficiently.
The first iteration of supply chain management software tries to solve this problem by considering more variables and leveraging sophisticated algorithms to build more optimized plans in the first place. With this software, the plans are generated faster, enabling organizations to respond to changes more quickly. Yet this process still operates under the paradigm of optimizing the plan and then executing against it.
The Internet provides a different approach. Rather than working within the confines of the existing system, it goes to the root of the problem—lack of information. The Internet commerce platform can provide a level of information never obtained before. The real-time capture of relevant supply chain information and the effective propagation of this information throughout the entire chain provide better visibility and improve flexibility overall. This is the essence of supply chain synchronization.
Historically, optimized plans have been valuable because they allow the supply chain partners to respond to change. But the cost efficiency and speed of response is nowhere near that of an Internet-enabled synchronized plan. In an environment where trading partners have wider, real-time access to information, the value of the optimized plan diminishes.
From Supply Chain to Supply ChainA founding principle of supply chain management is that companies do not operate in isolation; rather, they are a node within a broader network. Organizations can realize greater value if they coordinate their processes with other interested parties within the chain.
The Internet enables companies to extend this network concept to drive additional value. Just as no business is an island, no supply chain is an island. Any given supply chain may interact with any number of others. Taking this notion a step further, a supply chain should think of itself as a node on a broader network. Consider the automotive industry. It participates in numerous supply chains, including steel, plastics, chemicals, rubber, rail freight, and electronics. Coordinating activities across these various supply chains creates additional efficiencies and revenue opportunities. Of course, we are not advocating one large horizontal supply chain. Instead, we envision tangential supply chains that interact with one another to drive incremental value.
Not surprisingly, supply chain-to-supply chain coordination is anything but widespread. Historically, integration at the supply chain level has proven difficult because of the commerce platforms' architectural limitations. The traditional ad hoc structure is based on individual communication and, therefore, only scales with additional people. This is a cost-prohibitive approach that does little to foster communication between supply chains. The EDI network is a closed network built on one-to-many relationships, meaning that each supply chain may have its own network design. This proprietary design does not facilitate open coordination between supply chains. The open standards and the low-cost access of the Internet, however, better support synchronization. Supply chains that can expand their scope and integrate with other related supply chains will gain competitive advantages and extract more value for the participants.
When practitioners are asked to list those supply chain participants, they typically mention only those entities that touch the product as it passes through the chain—the suppliers, manufacturers, distributors, carriers, retailers, and, ultimately, the customer. This is an operational view of the supply chain. The traditional commerce platforms concentrated on automating and integrating the activities between these entities.
However, significant players such as banks, insurance providers, and regulatory bodies are absent from the traditional list of supply chain entities. Yet these organizations have a profound impact on the supply chain's operational performance. A company's ability to raise debt may affect possible plant expansion, or a customs office may prevent the delivery of a valuable shipment. In many cases, the supply chain contains relevant information for these service providers. For example, the supply chain has valuable partnership, customer, and product information for banks when they consider a loan. Further, real-time information about shipments can enable customhouse brokers to pre-clear shipments in transit, cutting down delivery time. Integration of operational information with these financial and regulatory entities—though not commonly practiced now—can optimize the services they provide for the chain.
Unlike the previous commerce platforms, the Internet enables coordination with entities outside of the traditional operational supply chain. (For a summary of the extended supply chain entities, see Exhibit 4.) The open standards coupled with the lower cost of integration let companies synchronize supply chain operations with the financial and regulatory services.
Living in a Transparent World
The benefits of the Internet-enabled supply chain are manifold. But with some of the advantages there are caveats as well. Transparency is one such example.
The Internet commerce platform dramatically enhances information visibility across the supply chain. Used properly, this visibility can eliminate variability in the chain while improving efficiency, flexibility, and velocity. Yet there's a potential problem here—information may become too visible. Companies may experience a level of transparency in pricing, fulfillment, and overall performance that they have never dealt with before. If they participate in electronic marketplaces, their competitors will have increased visibility into pricing structures (if the bidding process is not blind). Consumers, for their part, can better compare the different fulfillment strategies among suppliers. The new transparency also can create conflicts with the existing distribution channel and challenge the overall brand of the product.
These challenges are radically different from those encountered under traditional supply chain practices. Historically, companies pooled information from customers and suppliers and brokered information between the two. Having relevant information proved to be a strategic advantage. In the Internet environment, however, all the information that traditionally has been pooled can now become transparent. So in addition to coping with the process changes and new Internet entities, companies will have to figure out how to manage their information for strategic advantage in a transparent world.
Creating the Right Internet FitHaving a basic understanding of the Internet's impact on the supply chain is a good start in leveraging the technology for competitive advantage. But it is just that—a start. Companies need to interpret the Internet capabilities discussed here within the context of their overall business strategy. In some instances, the Internet commerce platform will advance that strategy; in others, it may not.
As part of the broad analysis, companies need to look at how the Internet will affect product design and channel distribution, for example. They will need to make hard decisions on the electronic marketplaces, too. Should they create their own, join an existing e-marketplace, or form a consortium?
Companies also need to figure out how (or if) to use the new Internet supply chain service providers. To a large extent, the decision will fall along the classic criteria used in determining whether or not to outsource any capability.
The challenges inherent in these kinds of analyses are not insignificant. But if companies are to make the best business decisions when it comes to the Internet, they have to meet the challenges head on and painstakingly go through the analytical process.
| 1999 | 2000 | 2001 | 2002 | 2003 | 2004 | 2005 | |
| USA | 178 | 395 | 744 | 1,174 | 1,792 | 2,656 | 3,530 |
| Canada | 3 | 13 | 28 | 53 | 84 | 128 | 190 |
| European Union | 44 | 173 | 380 | 713 | 1,122 | 1,708 | 2,527 |
| Japan | - | - | 19 | 76 | 167 | 314 | 495 |
| Latin America | - | - | 6 | 24 | 53 | 102 | 164 |
| Middle East & Africa | - | - | - | 1 | 6 | 12 | 23 |
| Eastern Europe | - | - | 2 | 9 | 20 | 38 | 60 |
| Non-Japan Asia | - | 13 | 54 | 123 | 237 | 378 | 584 |
| World | 225 | 595 | 1,234 | 2,174 | 3,480 | 5,335 | 7,572 |
| y/y Growth Rate | 402% | 164% | 108% | 76% | 60% | 53% | 42% |
| Source: Goldman, Sachs | |||||||
| Author Information |
| Steven J. Kahl and Thomas P. Berquist are vice presidents in Global Investment Research for Goldman, Sachs & Co., where they focus on B2B software. |
| Footnote |
| 1 We define online commerce as all commerce conducted electronically, regardless of platform. So these figures include EDI. However, over time we believe that EDI will decrease as a percentage of total online commerce. |
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