Supply chain's growing pains

By strategy+business
Special to CNET News.com
October 25, 2003 6:00 AM PDT

Over the last few years, companies in a wide variety of industries have created increasingly senior executive positions in supply chain management.

Lucent Technologies, ChevronTexaco and H.J. Heinz Co. are among the many that now have a chief procurement officer serving alongside the COO, CFO and CIO.

Other companies have created even broader positions. DuPont has a position entitled "Vice President--Global Sourcing & Logistics and Chief Procurement Officer." IBM last year named a "Senior Vice President, Integrated Supply Chain," a new position the company says encompasses "end-to-end supply chain operations, including procurement, systems manufacturing, logistics and customer fulfillment processes."

This "entitlement" of corporate executives is not surprising, given the cost and complexity of managing a global supply chain. Businesses worldwide spend more than $19 billion annually on information technology for supply chain management (SCM), according to market researcher IDC.

The business media, long trained to follow the money, have also become supply chain savvy. A search of ABI/Inform, a leading database of global business publications, shows that more than five supply chain articles were published each day last year, up from fewer than one article per week a decade earlier, and only one per month five years before that.

Unfortunately, the attention has not been matched by satisfaction. Nearly half of the respondents to a recent global survey by Booz Allen Hamilton indicated disappointment in the results achieved by their investments in SCM systems. To this day, SCM remains a primary case study subject--read "problem"--in business schools, and a headache in headquarters. A look at its history, from best practice to worst, may provide some insight.

Born to run
Both the term and the discipline it describes have evolved considerably during the past two decades. Indeed, by today's standards, the original scope of supply chain management appears quite narrow. Initially, SCM applied only within the boundaries of a single company. The challenge was simply getting production, sales, finance, marketing, and distribution to operate in concert in order to focus on the movement and availability of finished goods.

It's hard to believe that management's perspective could have been so limited--until you consider that the origins of SCM predate the 1993 publication of Michael Hammer and James Champy's "Reengineering the Corporation: A Manifesto for Business Revolution" by nearly a full decade. Although it's the norm today, focusing on cross-functional processes inside a company was a radical concept in the early 1980s.

When SCM began to look outside the company's four walls, the first place attention alighted, naturally, was on customers. Since the late 1990s, however, many leading companies have placed greater emphasis on cost reduction and innovation at the supplier end of the chain. With this evolution, SCM's scope has expanded well beyond the movement of materials. Now the term supply chain management encompasses such concepts as strategic sourcing and supplier involvement in product development.

The change in the way managers consider supply chain issues reflects an evolution in how they think about the complexities of business. Originally, SCM addressed the suboptimal deployment of inventory and capacity caused by inherent conflicts among functional groups within a company. Today, it addresses the risk of suboptimal deployment of capabilities caused by inherent conflicts both within functions and among companies. Yet despite this expanded scope, SCM's underlying principles have actually remained consistent--and relevant:

• Set supply chain policies strategically.
• Analyze trade-offs holistically.
• Employ cross-functional support systems.

The failure by companies to internalize these principles has generated much of the disappointment among SCM practitioners today.

Set strategic policies
First and foremost, a company must define its strategic objectives and establish supply chain policies to meet them. During the period when SCM applied largely to the deployment of finished-goods inventory, advanced companies took a strategic perspective on key issues such as delivery lead times, in-stock service levels and utilization of manufacturing capacity.

These policies resolved some inherent functional conflicts. One such conflict: the tension between marketing's desire to hold stock of everything to maximize revenue and manufacturing's efforts to make everything to order (with long lead times, if possible) to maintain capacity utilization and keep production costs low.

Dell holds less than three days' inventory and collects payment for sales more than 30 days faster than it pays suppliers for components.

Today, leaders in the field take a broad perspective of the "extended enterprise" to address strategic issues such as logistics outsourcing, global sourcing, and even new product strategy. The functional biases often remain, but the range of options has grown dramatically, thanks to the broader scope of SCM.

Unfortunately, too many companies have resolved the functional conflicts by making compromises rather than breaking constraints. Breaking strategic constraints opens the door for new business models and ultimately can create competitive advantage.

By eliminating the retailer as an intermediary and building directly to customer order, Dell broke a constraint punishing almost every other manufacturer: the bullwhip effect of increasing demand variation and forecast error in the upstream supply chain. Dell holds less than three days' inventory and collects payment for sales more than 30 days faster than it pays suppliers for components. As a result, Dell's cash conversion cycle is a negative 37 days, compared with a positive 30 days to 60 days for its competitors.

The Booz Allen survey, which was conducted in the fourth quarter of 2002 and received nearly 200 responses from manufacturing and industrial companies worldwide, provides hard evidence of the value of breaking constraints. Companies that break constraints reported 36 percent greater savings in customer cost-to-serve and 55 percent greater savings in purchasing than those that make adjustments within the existing supply chain structure. Yet most companies still feel constrained by existing channel relationships or prior investments in fixed assets. Accordingly, they pursue incremental rather than step-function improvements.

Analyze trade-offs
Because we live in an imperfect world, even with clear strategic objectives and policies, tactical trade-offs remain. For example, how should the company respond to a buildup of inventory in the distribution channel due to lower-than-expected sales? Should the plant shut down for a week, or should the company offer a discount to increase sales?

Such trade-offs should not be addressed with a narrow functional view. Instead, functional managers must step above their individual performance measures to objectively prescribe a solution offering the best bottom-line impact for the company as a whole.

Leading companies are moving toward an approach we call federated planning. Drawn from the Federalist view that shaped the governance of the United States, our model recognizes that members of an extended enterprise are independent entities with unique goals. However, just as the original states banded together to form a federal government for mutual benefit, members of an extended enterprise can collaborate around a set of shared goals.

The federated planning model does not depend upon a utopian dream that ignores the inherent conflicts between supply chain partners (such as the need to maximize returns to their separate shareholders). Rather than assuming this extended enterprise can be "optimized" as a single entity, federated planning accepts that each will ultimately optimize alone. But this need not result in suboptimal solutions. Supply chain partners can collaborate to address the trade-offs and possibly even break constraints across the extended enterprise.

Even current supply chain management leaders face new challenges.

For example, rather than leave the product flow to a series of one-off ordering decisions, Kroger and Unilever--or Ahold USA and Procter & Gamble--could agree to strategically reshape their distribution networks and eliminate some of the redundant regional facilities that each operates independently, potentially loosening the tight grip Wal-Mart Stores has on both competitors and suppliers throughout the grocery supply chain.

Another principle underpinning SCM is to employ cross-functional support systems, especially in information technology. Just like the first two principles, this one focuses on breaking the functional perspective at both the strategic and tactical levels; companies need process-oriented support systems that link across functions. Having independent systems for each functional area--too often the norm--encourages suboptimal decisions.

In the early 1980s, business systems were designed to support only narrow functional decision making, usually within single departments. Companies might have a distribution requirements planning system to determine a finished-goods ordering pattern, to minimize distribution cost. Simultaneously, a production, planning, and control system would independently optimize the manufacturing plan to produce the goods--quite possibly out of sync with the distribution requirements. The procurement department would issue purchase orders to suppliers with limited insight into manufacturing plans and no understanding of supplier economics. Often these systems were developed by separate software vendors, and linked only loosely, if at all.

Thanks in part to the fears of Y2K bugs, which persuaded companies to upgrade their IT systems, most major companies in the 1990s started to think outside the box. They implemented enterprise resource planning (ERP) systems to link and coordinate their disparate systems in support of an improved process orientation. Today, software vendors tout "eERP" for linking systems among customers and suppliers over the Internet.

Though integrated systems represent an appropriate evolutionary step, we remain concerned that too many companies treat these systems as an unmanaged "black box"--a device that provides answers through an unknown process, forgetting the old computer adage of "garbage in, garbage out."

For example, in a recent engagement for a kitchenware supplier, we found that its multimillion-dollar investment in a new, state-of-the-art ERP system was going to waste. Like many other companies, this client had fallen prey to the overhyped promises from software vendors claiming that the newest system would solve all supply chain woes, virtually automatically.

More than three-quarters of the items in the purchasing system had default values for the order quantity rather than an analytically derived order size. To address the problem, the consulting team loaded the system with appropriate targets while implementing a sales-and-operations planning process; this drove a 20 percent reduction in inventories while simultaneously improving service levels by 5 percent to 10 percent.

Rather than investing in black box transactional systems with ever-more-sophisticated algorithms, leading SCM practitioners are turning to specialty software providers such as Viewlocity (which merged with SynQuest in 2002) and Jonova. These relatively small companies have developed tools to support tactical trade-off decisions across the extended enterprise with rigorous but comprehensible analysis. In our view, a separation of the tactical tools from transactional controls offers the best long-term answer to growing software complexity.

Though many companies can reap rewards simply from following the original underlying principles of supply chain management, even current SCM leaders face new challenges. The dot-coms heightened customer expectations about rapid delivery, and the Internet continues to fundamentally change customer behavior. Traditional manufacturers such as IBM and Lucent have aggressively pursued outsourcing in response to nimble competitors such as Dell and Cisco Systems. Competition from emerging economies such as China and Vietnam puts pressure on global supply chains. Constraints continue to be broken by supply chain innovators, but new constraints always emerge, presenting opportunities for the next generation of innovators.

Thanks to the collective efforts of executives, practitioners, academics, software vendors, and consultants, we anticipate a long--though sometimes chaotic--life for supply chain management

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Reprinted with permission from strategy+business, a quarterly management magazine published by Booz Allen Hamilton.

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