Guide to Supply Chain Management

by David Jacoby

  Saudi Aramco monitors about 50 detailed supply markets on a continuous basis to detect emerging conditions that could affect its production capability and its costs. It has developed metrics and models of suppliers, market trends, costs and prices, and technological developments. Early warning systems trigger management involvement based on the severity and timeframe in which an incident may occur.

  Make a risk management plan

  In conjunction with the business and marketing plans, or other planning process, companies should address risk management and have a plan for measuring, monitoring and executing it. Hasbro, an American toymaker, is one company that has developed an extensive plan for managing and mitigating supply chain risk. The plan articulates the potential dangers and their severity, sets goals and objectives for the risk management programme, and designates a programme leader. It recognises the importance of working collaboratively with suppliers to be successful, and has a budget sufficient for the development of databases (for example, of incidents and risks), tools (for example, risk modelling) and staff (training).

  The plan should address specific action needed in order to conform with legislation such as the Sarbanes-Oxley Act.

  Avoid risk by identifying substitutes or passing on costs

  One way to mitigate the risk of availability or rising costs is to substitute products or services with alternatives. Because of a diminishing supply of barite, a mineral used in drilling for oil, many oil companies shifted to a less pure and less expensive grade of barite in their drilling fluids. The cost of the extra quantities which they had to use was more than offset by the lower price.

  Another way to deal with rising prices is to pass them on to the next party in the supply chain. To analyse the best strategies for purchasing energy following a spike in prices, Boston Strategies International simulated the results that a heavy manufacturer and a retailer would have had using each strategy for oil and natural gas. The analysis took into account the actual energy cost and forecast data, the financial and inventory carrying cost of advance energy purchases, the lost sales that companies sustain by passing on price increases, and the increase in sales they would realise from reducing prices. The results showed that adding an energy surcharge resulted in a cost-neutral position, since cost increases were passed through when they occurred and retracted when they went away. However, embedding the cost increase in the base price created a potentially rich profit centre. It not only shielded buyers from price increases but also resulted in windfall gains as energy prices subsequently declined.

  Hedge risk

  Buyers of long lead-time, expensive items such as capital equipment or multi-year services contracts such as drilling rig construction are highly exposed to changes in prices that affect their revenue and their costs over the period of the contract.

  One strategy for managing risk under these circumstances is to agree on fixed prices in advance. However, if the underlying prices are volatile, the supplier is unlikely to agree to a fixed-price contract. For example, on a contract for steel pipe two years in the future, few suppliers may want to commit to a price. Or they may agree, but at a large price premium to cover the risk that the price would escalate significantly over the two year timeframe.

  An alternative strategy is to hedge the risk by making financial contracts of equal value. If the commodity in question is traded on an exchange, there may be swaps, options and collars available. A swap provides a one-for-one hedge: if the price of the indexed commodity rises during the contract period, the buyer receives the difference, and vice versa. A call option has a strike price. If the buyer calls the option at the strike price, his hedge is over. If he does not exercise the call option, he receives the difference between the strike price and the market price. A collar has a put and a call strike price: if the price is below the put price, the buyer must pay extra if he still wants the floor price; and if the price is above the call price, he receives the extra amount between the call price and the market price.

  Diversify risk

  Diversification of risk is a common strategy in financial management: holding a variety of investments minimises the risk that any one of them will decrease in value, and often some will rise while others fall, effectively balancing out the swings.

  One of the most relevant applications of risk diversification in SCM is choosing how many suppliers of any particular product or service to have. Having too many suppliers means none of them can achieve economies of scale, given their smaller volumes. However, it does provide assurance in case one or more of them experiences difficulty. Since Asian sourcing became popular in the early 2000s, many buyers have had to choose between a low-cost distant supplier with unreliable lead times and sporadic quality problems, and a high-cost nearby supplier with high prices and reliable delivery. Some companies have responded by using some of both. The solution is called dual sourcing.

  Companies like Blyth, a distributor of consumer goods for the home, dual source in Asia and the United States. Blyth dual sources in order to have the flexibility to respond rapidly to demand shifts in the United States.22

  The decision whether or not to single source remains an issue, as companies increasingly consolidate their supply base. Sometimes there is no choice but to go with a single supplier. A leading US medical-device manufacturer single sources many of its original equipment manufacturer (OEM) buys because of long development lead times and stringent technical requirements. Upfront tooling is sometimes so costly that having two suppliers is prohibitive, as is the case at a US manufacturer of semiconductor assemblies. Appearance considerations, batch specifications, mixing and other technical or customer-driven constraints sometimes force the issue. Suppliers may have patent protection or proprietary designs that cannot be duplicated.

  Most companies avoid single sourcing where possible, or at least structure single-sourced contracts carefully, because of the various potential risks of being held captive, including price gouging; quality problems at a sole manufacturing site; product unavailability due to a fire, flood or other natural disaster; equipment unavailability during peak periods; and supplier financial difficulties.

  Minimise risk

  Buyers can minimise risk by buying in advance at the current price and/or signing long-term contracts. For example, Saudi Aramco bought years worth of drill pipe in advance to avoid anticipated shortages and price hikes. Unisys, a US-based systems integration and IT infrastructure consulting company, in one of the longer contracts executed to ensure supplies at a low cost, signed a nine-year contract for packaging to amortise a large upfront investment. Buying in advance takes capital, however, and while it locks in guaranteed rates, buyers could be worse off in later years if the market price decreases.

  Mitigate potential disruption

  All the preventative measures in the world make no difference once disaster strikes, and when it does, mitigation and recovery efforts are what counts. Experts’ recommendations for best practices for guarding against supply chain disruption include screening cargo, communicating frequently with suppliers and using available technologies to enhance visibility to shipments en route.23

  Lean supply chain operations help mitigate the adverse effects of disasters. A rationalised SKU base will limit damage by reducing the speed of response. Postponement will limit the damage by ensuring that the average value of the product in the pipeline is of less value than if inventory were kept in finished goods form. Increased communication between partners will maximise the chance of downtime as a result of any threat, and help get security efforts up and running quicker once the decision is made to deploy them.

  Beretta: synchronisation strategy

  Founded in 1500, according to legend, Beretta is the oldest active gun manufacturer in the world. With 3,000 employees and revenues of €600m ($800m), it is a world leader in such small firearms as pistols, shotguns and rifles, under brands such as Beretta, Benelli, Franchi, Burris, Sako, Tikka, Uberti, Stoeger and MDS. Its headquarters are in
Valtrompia, Italy, the largest specialised firearms hub in the world. With its constellation of artisans and specialised micro suppliers, it is to guns what Toyota City or Detroit is to the automotive industry.

  The product is relatively simple compared with, say, an automobile: auto manufacturers regularly have thousands of components, whereas firearms have no more than 100 parts. Moreover, the technology has remained essentially unchanged since the 1800s, according to Massimo Marchi, director of supply chain and IT.

  If the product is so simple, why is managing its supply chain a challenge? First, the production and transportation lead time is 5–12 months to ensure the necessary quality, performance and aesthetic refinement, so it has to make to stock instead of make to order. The company purchases steel for the barrel and the frame, then hammers the steel via a continuous processing machine in a time-consuming and costly process called cold hammering, which involves hammering sections of the inside and the outside of the barrel 1mm at a time without heat. The laborious process makes the barrels highly shock-resistant. In addition, premium-grade products involve manual fitting and gold inlaying, chisel techniques and artistic engraving.

  Second, more than 15 suppliers and affiliates are involved in the production process. Beretta owns distributors in more than 15 countries and manufacturers in Italy, Spain, Finland, Turkey and the United States.

  Third, firearms manufacture is highly regulated, so process improvement is subject to regulatory scrutiny. Traceability requirements make standardisation of semi-finished components, final customisation, postponement and cross-docking more complex than in less regulated industries.

  Fourth, until recently there were wide differences between the affiliates’ inventory management processes. Each company had different barcodes and inventory levels were not available across companies. Furthermore, when they were available, the standard operating definitions were different, so available inventory might not mean the same thing for any two companies.

  Lastly, paperwork was in each company’s local language; for example, many invoices were in Finnish, which was not understandable to the other companies.

  Beretta’s synchronisation efforts started with Beretta in the United States, followed by its European affiliates. It consisted of five parts:

  Standard operating definitions of supply chain terminology, including cross-references between product codes. English translations were added to each document worldwide.

  An internet-enabled application to centralise order fulfilment information from each company’s enterprise resource planning (ERP) system. The system gathers information on customer orders, sales trends, shipments, delivery schedules and inventory throughout the supply chain, as well as SKU listings and images of products and components. Because it is centralised, the company can cross-reference barcodes and factories, and each company can look at the system in its own language.

  An advanced production scheduling tool that is linked to the materials requirements planning and master production scheduling tools of its sister companies.

  A configurator to create new product configurations. Orders go directly from the configurator, which has the capability to define 800,000 SKUs – from the trigger to finishes – for production without involving the engineering department.

  Executive S&OP meetings involving monthly videoconferences with supply chain partners and the maintenance of five aggregate levels, comprising 8,000 SKUs. The group defines a consensus forecast on a rolling 12–18-month time horizon.

  With all this information available, each distributor can complete the integration of the supply chain information flow and, for example, calculate an available to promise (ATP) date (the date by which the company knows that it can commit delivery, given all the constraints in its sourcing, production and distribution operations) for its customers.

  The main benefits of the supply chain planning system have been a reduction in inventory and increases in service levels and fill rates. Historically, each small company tried to minimise inventory locally, with consequently low fill rates and a high cost of excess inventory because of the lack of risk pooling. Now the process is collaborative, and the company’s supply chain meets the challenging standards set by its customers, such as Dick’s Sporting Goods, Wal-Mart, Cabela’s and Bass Pro.

  8 Customisation: competing on customer intimacy

  For the past decade and a half, companies in every industry have obsessively devoted themselves to managing the supply side of their businesses, from manufacturing through distribution and pricing. We have made enormous improvements in productivity. But opportunities and ideas to drive incremental growth are drying up … Increasingly, companies will be forced to focus on the top line.

  Peter Georgescu, chairman and CEO, Young and Rubicam, quoted in You Can’t Shrink Your Way to Greatness by Tom Peters, 1997

  Honda’s legendary after-sales service operations exemplify a customisation supply chain strategy. While the assembly line focuses on aligning many motions in sequence to deliver a reliably standard product every time, customer service is based on co-ordinating a set of unique customer interactions to deliver a one-of-a-kind product-service experience for each customer, each time.

  Customisation strategy emphasises higher gross margins. Being personal increases value to individual customers, and hence brings in higher prices and profit margins.1 Companies achieve a rapid response capability by better understanding each customer’s value equation, and being able to deliver rapidly, reliably, uniquely and profitably to each customer.

  Avoiding commoditisation

  Customisation helps to avoid commoditisation, the real or perceived state of lack of differentiation except on price, by providing product-specific value, but there is always a finite set of customised options. Mass customisation does better by enabling flexible changeovers between customised product options, thereby eliminating excess inventory of customised product, but from the customer’s point of view it still results in a finite set of options. Customerisation,2 mass customisation combined with customer-specific targeted marketing, offers mass customised products via personalised sales channels such as custom websites. At the extreme, personalisation provides each customer with a unique experience.

  Pure non-goods businesses offer fantastic examples of personalisation even if they do not all have supply chains. Google and other search engines and internet service providers offer customised browsers that allow the user to configure the source of their information. For instance, users can view headlines from The Economist, the New York Times, CNN and Reuters simultaneously and they are updated in real time. Plaxo and other social networking services such as Facebook, LinkedIn, Twitter and Flickr allow people to share information with people they know and meet people through each other’s personal networks, and each application is eminently personalisable. Microsoft operating systems learn the users’ most frequently accessed programs and provide quicker access to them, thus providing a personalised experience without customers even knowing that the experience is personalised.

  Some products facilitate a high degree of personalisation by providing the platform for configurable software, as in the case of the downloadable applications available on mobile phones or personal digital assistants (PDAs). Doug Macmillan of Nokia explains:3

  Personalisation used to be a custom colour case, then a custom ringtone, then the caller’s picture instead of a caller-ID phone number, then the sound file of [the user’s] children, and now it is moving toward new enabling technologies that allow developers to download content from anywhere.

  Nokia is also offering location-based services that use global positioning systems (GPS) and radio frequency identification (RFID) tags to enable the user’s friends and family to track his or her movements through a website. BlackBerry PDAs are also totally configurable, and the more users configure them, the more useful they become.

  Mixed product-service businesses can use supply chain management (SCM) to deliver the special customer experi
ence. Manufacturers deliver customisation and personalisation through value-added services that relate to the product, for example:

  customer-specific delivery conditions;

  customised maintenance and repair programmes and interactions;

  customised or personalised value-added services such as warranties and financing;

  customer-specific outsourced services such as integrated supply, where the supplier provides dedicated onsite support.

  Success factors

  There are five requirements for any customisation supply chain strategy to succeed: customisation, flexibility, intimacy, convenience and speed. These ensure unique value to the customer, and at the same time they provide repeatability and an economically viable execution of the strategy:4

  Customisation – the experience must be unique to each customer.

  Flexibility – the personalised nature of the experience must adapt to the changing needs of the customer and the environment, including product configuration and flexible delivery capability.5

  Intimacy – the customer must feel that he or she is getting something special, and it must increase the brand awareness.

  Convenience – the customisation aspect must not be a burden on the customer and is ideally invisible.

  Speed – delivery must be fast; the customer should not have to wait longer for a personalised solution than for a normal purchase.

  Honda: customer focus

  American Honda Motor Co’s demand-driven philosophy allows it to flexibly match production to customer demand. Its flexible manufacturing systems allow it to rapidly change production to meet current demand. Manufacturing plants can totally change their product mix in 24 hours if necessary to accommodate shifting demand patterns.