EIGHT THINGS FIRMS DO THAT DISTINGUISH THEM IN SCM
Firms that aspire to improve their performance through SCM will need to actively focus on these eight initiatives:
1. Manage customer behaviors,
2. Manage product/service offerings,
3. Manage demand, not just the forecast,
4. Manage supply chain flows,
5. Replace assets with information and relationships,
6. Outsource noncore activities (buy versus make),
7. Revamp planning and control systems, and
8. Align recognition and reward systems.
Customers are not all equal. While most firms know who their biggest customers are, they often don't know which customers generate the most profit. They also don't know which ones are unprofitable. Consequently, they can manage customer relationships poorly. The list of active customers should be evaluated annually and segmented based on criteria that differentiate their value to the firm. The segment of highest-value customers should receive the best service. For example, their order lead times could be shorter, their targeted fill rates could be higher, and their deliveries could be made faster than other customer segments. Unfortunately, traditional accounting systems, which rely on period or product costing and cost center allocations, do not provide specific cost information to make evaluations on customer profitability. Activity-based costing (ABC) is needed to be able to associate the cost to serve with the value of service given each customer. ABC involves looking at customer behaviors and the costs associated with serving them. By influencing the customer on what, how much, when, and how they order products and services, the firm can turn unprofitable or marginal customers into profitable ones.
Products and service offerings are not all equal. Just as with customers, the cost to produce and the cost to provide should be evaluated annually using ABC. Most companies will find that a small percentage of its offerings contribute a large share of its profits. Which offerings are unprofitable? Eliminating those or changing the way they are provided to customers to make them profitable will increase overall profitability. As product life cycles and consumer adoption rates dictate strategy changes from build, to hold, to harvest, and to divest, it is important to constantly manage the portfolio of offerings. Most companies learn that by doing less they can earn more, and free up resources to apply to new and more profitable revenue generators.
Forecasting is necessary for most firms, especially those reproducing the independent demand item, or finished good, before orders are received. But forecasting is inexact, and it requires a large investment in buffer inventories. Some firms invest heavily in the forecasting process and the measurement of forecast error, which compares actual demand to forecasted demand. Estimating customer demand to make operating decisions that attempt to balance supply and demand rarely results in zero stock outs and zero safety stocks. However, firms use four methods to attempt to balance supply and demand: (1) change lead times, (2) increase or reduce pricing, (3) build inventory levels, and (4) create production flexibility. If customer demand exceeds current supply, the firm might be able to increase the lead time on that item. The customer can decide to wait, to substitute for something in stock, or search elsewhere. If customer demand is significantly less than current inventory levels for that item, the firm can announce a temporary price reduction, moving future demand forward. It could also announce a temporary price increase, postponing current demand. Building inventory levels, including safety stock, to smooth the effects of both demand and lead-time variability, is a traditional, but expensive method to manage demand and supply imbalances, given production-capacity constraints. Finally, production flexibility, a principle of lean manufacturing, is seen as a solution to demand and supply imbalances. These four methods of managing demand can be used in combination, depending on the level of the firm's interest in utilization of production capacities, safety stock costs, the cost of stock outs, and customer goodwill and loyalty. Managing actual demand is always more important than managing the forecast.
There are numerous flows in the supply chain. These include flows of products, services, cash, and information. Products flow from suppliers through manufacturers, through distributors, through retailers, to final consumers. The flows are triggered by an order from the customer (demand) and flow upstream, or by a previous forecast and flow downstream. These flow in cycles. A retailer will collect product sales' information at the point of sale, or use a reorder point inventory management system, to create orders to send to the distributor. This takes time. The transmission time is very fast if it is electronic, but the time between orders can be days or weeks. The distributor then reviews the orders received, approves them, and assigns them to a shipping location, where the orders are picked, packed, and scheduled to be shipped. This could take hours or days. When the carrier arrives, the order is loaded and transported to the retailer, who receives it into inventory stock or into its retail space. This also takes hours or days. Then the process repeats itself between the distributor and manufacturer, and then again between the manufacturer and its suppliers. When the elapsed times from order to receipt up the tiers of the supply chain are totaled, the overall cycle time is weeks or months. This creates significant, perhaps unnecessary, investments in inventories to cover the lead times and lead-time variability, and also results in out-of-stock and lost sales' opportunities. The entire supply chain flow cycles should be mapped. Process mapping and process reengineering are important tools to reduce cycle times. Sharing information across the supply chain, especially about point of sale, inventory levels, and production schedules, can aid in compressing cycle times significantly, reducing overall cost, and increasing sales and profits.
Assets are expensive. Information is relatively cheap. Significant cost reduction and service improvements can be produced by substituting information for asset investments. The cost of ownership of inventory, plants, equipment, and storage facilities is significant, and to some degree, avoidable. The solution is to use increasingly available and inexpensive information and integrated information technology to reduce investments in expensive assets. Relationships are becoming more important in SCM. Creating and managing relationships with key customers, suppliers, and third-party providers is the very nature of strategic and systemic management of supply chain activities. Governance structures, built through joint planning and decision making and supported by joint investments and shared rewards, are needed for sustainability. Collaboration, connectivity, and integration are essential to improved supply chain performance.
Outsourcing noncore activities is an essential characteristic of SCM. Deciding what is noncore and selecting reliable suppliers to jointly plan the objectives, standards, costs, and shared rewards of successfully outsourced functions is a huge and risky task. It requires committing to a strategic, interdependent relationship. Micro Compact Car AG (MCC), a wholly owned subsidiary of Daimler-Benz, engaged 18 key suppliers in the design and production of the smart car. MCC retains the relationship with the end customer, controls the flow of information, and is able, with little investment, relying on its reliable suppliers, to assemble a customized car in less than five hours, maintaining a two-week lead time from customer order to delivery. This supply chain is based on the proposition of outsourcing noncore activities, and is far superior in performance to any U.S. automotive supply chain. Every firm should examine what functions it could successfully outsource and the implications outsourcing has on its operational and financial performance.
Revamping the planning and control systems to provide alignment and focus throughout the organization will produce significant improvements. It is amazing how little attention the planning function receives in many firms, yet the planning function creates the future of the organization. The last Council of Supply Chain Management Professionals (CSCMP) study on measurement provided the following 10 findings, based on the responses from 355 firms, regarding the overall administration of supply chain measurement:5
1. One-quarter of measures captured were considered not accurate;
2. One-fifth of measures captured were not interpreted similarly within the firm;
3. One-third of measures captured were not interpreted similarly between firms;
4. One-fifth of measures captured were not readily understandable to guide actions;
5. Two-fifths of measures captured were not comprehensive;
6. One-fifth of measures captured were not considered cost effective;
7. One-quarter of measures captured were not compatible internally;
8. One-third of measures captured were not compatible between firms;
9. One-quarter of measures captured were not compatible with cash flow measures; and
10. One-quarter of measures captured encouraged counterproductive behaviors.
Additionally, the study found there was too much emphasis on efficiency measurement (utilization and productivity) and not enough on effectiveness (performance). Just as every process has a customer, who judges its performance, and should have an "owner," who is responsible for its performance, so, too, do measures have customers and owners. Every measure needs an owner, to care about meeting the needs and expectations of the measure's customer, and to initiate appropriate improvements in the activities measured. Any measure lacking either an owner or a customer should be abandoned. Standardized performance reporting should be regularly challenged for need and usefulness, and eliminated where possible. The challenge is not to create more measures, but rather to measure fewer, actionable activities, where customers and owners of the measures can work together to plan the objectives, set the standards for performance, evaluate results, and make improvements. Good administration will eliminate nonproductive measurement activities.
Recognition and reward systems can either motivate or demotivate employees. They should be fair, meaningful, and tied to performance. They can also encourage either appropriate or dysfunctional behaviors. For example, incentivizing customers and rewarding salespeople and for the end-of-quarter, end-of-year sale push that causes spiked workloads and excessive costs in distribution is a practice that is counterproductive. Salespeople, and customers, anticipate the incentives to hold off orders until the end of the period, creating a permanent, unnecessary oscillation in sales that is not directly tied to demand. Experience tells us that people do what gets rewarded. Functional activities should not be rewarded. Instead, cross-functional teams could be rewarded based on the performance of the overall process they manage. Organizations must design and use recognition and reward systems to create alignment and focus on organizational goal and objectives.
NOTES
1 . Forester, Jay. W. (1958), "Industrial Dynamics: A Major Breakthrough for Decision Makers," Harvard Business Review, Vol. 38 (July/August), pp. 37-66.
2. Mentzer, John T., William DeWitt, James S. Keebler, Soonhong Min, Nancy W. Nix, Carlo D. Smith, and Zach G. Zacharia (2001), "Defining Supply Chain Management," Journal of Business Logistics, Vol. 22, No. 2, pp. 1-25.
3. Mintzberg, Henry (1996), "Reading 6.2: The Structuring of Organizations." In H. Mintzberg and J. B. Quinn (Eds.), The Strategic Process: Concepts, Context, Cases (3rd Edition), Upper Saddle River, NJ: Prentice Hall.
4 . Mentzer, John T. (2004), Fundamentals of Supply Chain Management, Twelve Drivers of Competitive Advantage, Thousand Oaks, CA: Sage Publications.
5. Keebler, James S., Karl B. Manrodt, David A. Durtsche, and D. Michael Ledyard (2000), Keeping Score: Measuring the Value of Logistics in the Supply Chain, Oak Brook, IL: Council of Supply Chain Management Professionals.
