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The following appeared in the March-April, 1997, issue of      unwanted      merchandise
THE HARVARD BUSINESS REVIEW:                                   found in exit interviews
                                                               that one-quarter of its
    WHAT IS THE RIGHT SUPPLY                                   customers had left its
                                                               stores      empty-handed
    CHAIN FOR YOUR PRODUCT?                                    because the specific items
                                                               they had wanted to buy
                                                               were out of stock.
        A Simple Framework Can Help
                                                               Why haven't the new
         You Figure Out the Answer                             ideas and technologies led
                                                               to                 improved
                                                               performance?         Because
              BY MARSHALL L. FISHER
                                                               managers         lack      a
                                                               framework for deciding
Never has so much                                              which ones are best for
                                Nonetheless,             the
technology               and                                   their particular company's
                                performance of many
brainpower been applied                                        situation. From my ten
                                supply chains has never
to    improving     supply                                     years of research and
                                been worse. In some cases,
chain performance. Point-                                      consulting on supply
                                costs have risen to
of-sale scanners allow                                         chain issues in industries
                                unprecedented         levels
companies to capture the                                       as diverse as food, fashion
                                because of adversarial
customer's            voice.                                   apparel, and automobiles,
                                relations between supply
Electronic             data                                    I have been able to devise
                                chain partners as well as
interchange lets all stages                                    such a framework. It helps
                                dysfunctional     industry
of the supply chain hear                                       managers understand the
                                practices such as an
that voice and react to it                                     nature of the demand for
                                overreliance    on     price
by      using       flexible                                   their products and devise
                                promotions. One recent
manufacturing,                  study of the U.S. food         the supply chain that can
automated warehousing,                                         best satisfy that demand.
                                industry estimated that
and rapid logistics. And        poor coordination among
new concepts such as                                           The first step in devising
                                supply chain partners was
quick response, efficient                                      an effective supply-chain
                                wasting      $30     billion
consumer         response,                                     strategy is therefore to
                                annually. Supply chains in
accurate response, mass                                        consider the nature of the
                                many other industries
customization,          lean                                   demand for the products
                                suffer from an excess of
manufacturing, and agile                                       one's company supplies.
                                some products and a
manufacturing          offer                                   Many       aspects      are
                                shortage of others owing
models for applying the                                        important - for example,
                                to an inability to predict
new      technology        to                                  product life cycle, demand
                                demand. One department
improve performance.            store chain that regularly     predictability,     product
                                had     to     resort     to   variety,    and      market
standards for lead times       introduce innovations in        Although innovation can
and        service      (the   fashion or technology to        enable a company to
percentage of demand           give      customers       an    achieve     higher     profit
filled    from      in-stock   additional reason to buy        margins,       the      very
goods). But I have found       their offerings. Fashion        newness of innovative
that if one classifies         apparel and personal            products makes demand
products on the basis of       computers are obvious           for them unpredictable. In
their demand patterns,         examples, but we also see       addition, their life cycle is
they fall into one of two      successful           product    short — usually just a few
categories: they are either    innovation where we least       months — because as
primarily functional or        expect it. For instance, in     imitators     erode      the
primarily innovative. And      the             traditionally   competitive      advantage
each category requires a       functional category of          that innovative products
distinctly different kind of   food, companies such as         enjoy,    companies      are
supply chain. The root         Ben & Jerry's, Mrs. Fields,     forced to introduce a
cause of the problems          and Starbucks Coffee            steady stream of newer
plaguing many supply           Company have tried to           innovations. The short life
chains is a mismatch           gain     an     edge    with    cycles and the great
between the type of            designer      flavors    and    variety typical of these
product and the type of        innovative         concepts.    products further increase
supply chain.                  Century      Products,      a   unpredictability.
                               leading manufacturer of
    IS YOUR PRODUCT            children's car seats, is        It may seem strange to
     FUNCTIONAL OR             another company that            lump technology and
       INNOVATIVE?             brought innovation to a         fashion together, but both
                               functional product. Until       types     of    innovation
Functional        products     the early 1990s, Century        depend for their success
include the staples that       sold its seats as functional    on consumers changing
people buy in a wide           items. Then it introduced       some aspect of their
range of retail outlets,       a wide variety of brightly      values or lifestyle. For
such as grocery stores and     colored      fabrics     and    example,     the   market
gas stations. Because such     designed a new seat that        success of the IBM
products satisfy basic         would move in a crash to        Thinkpad hinged in part
needs, which don't change      absorb energy and protect       on a novel cursor control
much over time, they have      the child sitting in it.        in the middle of the
stable,         predictable    Called Smart Move, the          keyboard that required
demand and long life           design was so innovative        users to interact with the
cycles. But their stability    that the seat could not be      keyboard in an unfamiliar
invites competition, which     sold until government           way. The new design was
often leads to low profit      product-safety standards        so controversial within
margins.                       mandating that car seats        IBM that managers had
                               not move in a crash had         difficulty believing the
To avoid low margins,                                          enthusiastic reaction to
                               been changed.
many        companies


                                            2
the cursor control in early             mediation    function.   A               mediation     costs   arise
focus groups. As a result,              supply chain's physical                  when supply exceeds
the               company               function      is    readily              demand and a product
underestimated demand                   apparent and includes                    has to be marked down
—     a    problem     that             converting raw materials                 and sold at a loss or when
contributed      to     the             into parts, components,                  supply falls short of
Thinkpad's being in short               and eventually finished                  demand, resulting in lost
supply for more than a                  goods, and transporting                  sales opportunities and
                                        all of them from one point

               Functional Versus Innovative Products: Differences in Demand
Aspects of Demand           Functional (Predictable Demand)              Innovative (Unpredictable Demand)
Product Life Cycle                 More than 2 years                             3 months to 1 year
Contribution Margin*                   5% to 20%                                     20% to 60%
Product Variety             Low (10-20 variants per category)       High (often millions of variants per category)
Average margin of
error in the forecast at
                                            10%                                       40% to 100%
the time production is
committed
Average stockout rate                    1% to 2%                                     10% to 40%
Average forced end-
of-season markdown
                                            0%                                        10% to 25%
as percentage of full
price
Lead time required for
made-to-order                       6 months to 1 year                              1 day to 2 weeks
products
*The contribution margin equals price minus variable cost divided by price and is expressed as a percentage.



year.                                   in the supply chain to the               dissatisfied customers.
                                        next. Less visible but
With their high profit
                                        equally    important     is              The predictable demand
margins    and    volatile
                                        market mediation, whose                  of functional products
demand,        innovative
                                        purpose is ensuring that                 makes market mediation
products     require     a
                                        the variety of products                  easy because a nearly
fundamentally different
                                        reaching the marketplace                 perfect match between
supply chain than stable,
                                        matches what consumers                   supply and demand can
low-margin      functional
                                        want to buy.                             be achieved. Companies
products      do.      To                                                        that make such products
understand the difference,              Each of the two functions                are thus free to focus
one should recognize that               incurs    distinct    costs.             almost exclusively on
a supply chain performs                 Physical costs are the costs             minimizing physical costs
two distinct types of                   of              production,              a crucial goal, given the
functions:   a    physical              transportation,         and              price sensitivity of most
function and a market                   inventory storage. Market                functional products. To


                                                         3
          Physically Efficient Versus Market-Responsive Supply Chains
                                  Physically Efficient Process     Market-Responsive Process
                                  Supply predictable demand        Respond quickly to unpredictable
                                  efficiently at the lowest        demand in order to minimize
        Primary Purpose
                                  possible cost                    stockouts, forced markdowns, and
                                                                   obsolete inventory
                                  Maintain      high     average   Deploy excess buffer capacity
      Manufacturing focus
                                  utilization rate
                                  Generate high returns and        Deploy significant buffer stocks of
        Inventory strategy        minimize             inventory   parts or finished goods
                                  throughout the chain
                                  Shorten lead time as long as     Invest aggressively in ways to
         Lead-time focus
                                  it doesn't increase cost         reduce lead time
                                  Select primarily for cost and    Select primarily for speed, flexibility,
 Approach to choosing suppliers
                                  quality                          and quality
                                  Maximize performance and         Use modular design in order to
     Product-design strategy      minimize cost                    postpone product differentiation for
                                                                   as long as possible

that     end,     companies                                             other market signals and
                                  That approach is exactly
usually create a schedule                                               to react quickly, during
                                  the    wrong     one    for
for assembling finished                                                 the new product's short
                                  innovative products. The
goods for at least the next                                             life cycle. In this instance,
                                  uncertain market reaction
month       and      commit                                             the     crucial    flow    of
                                  to innovation increases
themselves to abide by it.                                              information occurs not
                                  the risk of shortages or
Freezing the schedule in                                                only within the chain but
                                  excess supplies. High
this       way        allows                                            also from the marketplace
                                  profit margins and the
companies to employ                                                     to the chain. The critical
                                  importance of early sales
manufacturing-resource-                                                 decisions to be made
                                  in establishing market
planning software, which                                                about      inventory     and
                                  share for new products
orchestrates the ordering,                                              capacity are not about
                                  increase the cost of
production, and delivery          shortages.   And      short           minimizing       costs   but
of     supplies,     thereby                                            about where in the chain
                                  product     life     cycles
enabling the entire supply                                              to position inventory and
                                  increase the risk of
chain      to       minimize                                            available        production
                                  obsolescence and the cost
inventory and maximize                                                  capacity in order to hedge
                                  of excess supplies. Hence
production efficiency. In                                               against uncertain demand.
                                  market mediation costs
this      instance,       the                                           And suppliers should be
                                  predominate for these
important        flow      of                                           chosen for their speed and
                                  products, and they, not
information is the one that                                             flexibility, not for their
                                  physical costs, should he
occurs within the chain as                                              low cost.
                                  managers' primary focus.
suppliers, manufacturers,
and retailers coordinate                                                Sport Obermeyer and
                                  Most important in this
their activities in order to                                            Campbell Soup Company
                                  environment is to read
meet predictable demand                                                 illustrate  the   two
                                  daily sales numbers or
at the lowest cost.                                                     environments and how


                                                 4
the
resulting                                 Matching Supply Chains with Products
goals and                                           Functional Products               Innovative Products
initiatives
differ.
                   Efficient Supply Chain                  Match                          Mismatch
Sport
Obermeyer
is a major       Responsive Supply Chain                 Mismatch                           Match
supplier of
fashion
skiwear. Each year, 95% of        product,       it    deploys      the form of losses on
its       products        are     enough stock to cover the         styles that don't sell and
completely new designs            most optimistic forecast          missed sales opportunities
for      which     demand         for demand in the first           due to the "stockouts" that
forecasts often err by as         month. If the product             occur when demand for
much as 200%. And                 takes off, more can be            particular items outstrips
because the retail season         supplied before stocks run        inventories.              The
is only a few months long,        out. If it flops, the six-        company's supply chain
the company has little            month, worst-case life            efforts have been directed
time to react if it               cycle affords plenty of           at reducing those costs
misguesses the market.            time to sell off the excess       through increased speed
                                  stocks.                           and flexibility.
In contrast, only 5% of
Campbell's products are           How do goals and                  Although the distinctions
new each year. Sales of           initiatives differ in the two     between functional and
existing products, most of        environments? Campbell's          innovative products and
which have been on the            already high service level        between              physical
market for years, are             leaves little room for            efficiency                and
highly         predictable,       improvement in market             responsiveness to the
allowing Campbell to              mediation costs. Hence,           market seem obvious once
achieve a nearly perfect          when       the      company       stated, I have found that
service level by satisfying       launched a supply chain           many companies founder
more than 98% of demand           program in 1991 called            on this issue. That is
immediately from stocks           continuous replenishment,         probably             because
of finished goods. And            the goal was physical             products        that       are
even     the   few       new      efficiency. And it achieved       physically the same can be
products are easy to              that goal; the inventory          either     functional       or
manage. They have a               turns of participating            innovative. For example,
replenishment lead time           retailers    doubled.       In    personal computers, cars,
of one month and a                contrast,               Sport     apparel, ice cream, coffee,
minimum market life               Obermeyer's         uncertain     cookies, and children's car
cycle of six months. When         demand leads to high              seats all can be offered as
Campbell introduces a             market-mediation costs in



                                                5
a basic functional product      that he or she actually        "Physically       Efficient
or in an innovative form.       succeeds in implementing       Versus            Market-
                                that agenda, because it's      Responsive         Supply
It's easy for a company,        totally inappropriate for      Chains.")
through      its    product     the    company's     now
strategy, to gravitate from     unpredictable                  Having determined the
the functional to the           environment.                   nature of their products
innovative sphere without                                      and their supply chain's
realizing that anything            DEVISING THE IDEAL          priorities, managers can
has changed. Then its            SUPPLY-CHAIN STRATEGY         employ a matrix to
managers start to notice                                       formulate      the    ideal
that       service       has    For companies to be sure       supply-chain strategy. The
mysteriously declined and       that they are taking the       four cells of the matrix
inventories of unsold           right approach, they first     represent the four possible
products have gone up.          must determine whether         combinations of products
When this happens, they         their     products       are   and priorities. (See the
look       longingly       at   functional or innovative.      exhibit "Matching Supply
competitors that haven't        Most      managers      I've   Chains with Products." By
changed their product           encountered already have       using the matrix to plot
strategy and therefore          a sense of which products      the nature of the demand
have low inventories and        have     predictable and       for each of their product
high service. They even         which have unpredictable       families and its supply
may steal away the vice         demand.                The     chain priorities, managers
president of logistics from     unpredictable     products     can discover whether the
one of those companies,         are the ones generating all    process the company uses
reasoning, if we hire their     the supply headaches. For      for supplying products is
logistics guy, we'll have       managers who aren't sure       well matched to the
low inventory and high          or who would like to           product type: an efficient
service, too. The new vice      confirm their intuition, I     process for functional
president        invariably     offer     guidelines     for   products and a responsive
designs an agenda for           classifying products based     process for innovative
improvement based on his        on what I have found to        products. Companies that
or her old environment:         he typical for each            have either an innovative
cut inventories, pressure       category. (See the table       product with an efficient
marketing        to       be    "Functional          Versus    supply chain (upper right-
accountable       for     its   Innovative        Products:    hand cell) or a functional
forecasts and to freeze         Differences in Demand.")       product with a responsive
them well into the future       The next step is for           supply chain (lower left-
to remove uncertainty,          managers      to     decide    hand cell) tend to be the
and establish a rigid just-     whether their company's        ones with problems.
in-time delivery schedule       supply chain is physically
with suppliers. The worst       efficient or responsive to     For       understandable
thing that could happen is      the market. (See the table     reasons, it is rare for



                                             6
companies to be in the           40% and an average                Company,        a    leading
lower left-hand cell. Most       stockout rate of 25%.1 The        Japanese             apparel
companies that introduce         lost contribution to profit       manufacturer, produces
functional          products     and overhead resulting            its basic styles in low-cost
realize that they need           from stockouts alone is           Chinese plants but keeps
efficient chains to supply       huge: 40% x 25% = 10% of          production       of    high-
them. If the products            sales — an amount that            fashion styles in Japan,
remain functional over           usually exceeds profits           where the advantage of
time,     the     companies      before taxes.                     being able to respond
typically have the good                                            quickly      to    emerging
sense to stick with              Consequently,              the    fashion trends more than
efficient chains. But, for       economic        gain     from     offsets the disadvantage
reasons I will explore           reducing stockouts and            of high labor costs.
shortly, companies often         excess inventory is so
find themselves in the           great     that     intelligent    That logic doesn't apply to
upper right-hand cell. The       investments in supply             functional products. A
reason a position in this        chain responsiveness will         contribution margin of
cell doesn't make sense is       always pay for themselves         10% and an average
simple: for any company          — a fact that progressive         stockout rate of 1% mean
with innovative products,        companies                have     lost contribution to profit
the      rewards         from    discovered. Compaq, for           and overhead of only .1%
investments in improving         example,       decided      to    of sales — a negligible
supply                  chain    continue           producing      cost that doesn't warrant
responsiveness             are   certain         high-variety,     the             significant
usually much greater than        short-life-cycle circuits in-     investments required to
the      rewards         from    house        rather       than    improve responsiveness.
investments in improving         outsource them to a low-
the chain's efficiency. For      cost     Asian       country,       GETTING OUT OF THE
every dollar such a              because local production          UPPER RIGHT-HAND CELL
company       invests       in   gave       the      company
                                 increased flexibility and         The rate of new-product
increasing     its    supply
                                 shorter lead times. World         introductions            has
chain's responsiveness, it
                                                                   skyrocketed     in    many
usually will reap a
                                                                   industries, fueled both by
decrease of more than a          1  The contribution margin        an increase in the number
dollar in the cost of            equals price minus variable       of competitors and by the
stockouts     and      forced    cost divided by price and is
                                                                   efforts      of     existing
markdowns on excess              expressed as a percentage. This
                                 type of profit margin measures    competitors to protect or
inventory that result from
                                 increases in profits produced     increase profit margins.
mismatches          between      by the incremental sales that     As     a    result,   many
supply      and     demand.      result from fewer stockouts.      companies have turned or
Consider       a      typical    Consequently, it is a good way
                                                                   tried to turn traditionally
innovative product with a        to track improvements in
                                 inventory management.             functional products into
contribution margin of
                                                                   innovative products. But


                                               7
they have continued to          million versions of the car.   of dealers' practices at the
focus      on      physical     But because ordering a car     neck of the glass.
efficiency in the processes     with the desired I options
for     supplying     those     entailed an eight-week         The computer industry of
products.              This     wait for delivery, more        20 years ago shows that a
phenomenon         explains     than 90% of customers          company can supply an
why one finds so many           bought their cars off the      innovative product with
broken supply chains —          lot.                           an unresponsive process if
or unresponsive chains                                         the market allows it a long
trying       to      supply     The dealer told me that he     lead time for delivery. In
innovative products — in        had 2 versions of the car      my first job after college, I
industries      such     as     model on his lot and that      worked in an IBM sales
automobiles,       personal     if neither matched my          office helping to market
computers, and consumer         ideal specifications, he       the             System/360
packaged goods.                 might be able to get my        mainframe. I was shocked
                                choice     from    another     to learn that IBM was then
The automobile industry         dealer in the Philadelphia     quoting a 14-month lead
is one classic example.         area. When I got home, I       time for this hot new
Several years ago, I was        checked the phone book         product. I asked how I
involved in a study to          and found ten dealers in       could possibly tell a
measure the impact that         the area. Assuming each        customer to wait that
the variety of options          of them also had 2             long. The answer was that
available to consumers          versions of the car in         if a customer really
had on productivity at a        stock, I was choosing from     wanted a 360, it would
Big Three auto plant. As        a selection of at most 20      wait, and that if I couldn't
the study began, I tried to     versions of a car that         persuade it to wait, there
understand variety from         could be made in 20            must      be     something
the customer's perspective      million. In other words,       seriously lacking in my
by visiting a dealer near       the     auto   distribution    sales skills, That answer
my      home       in     the   channel is a kind of           was actually correct: lead
Philadelphia area and           hourglass with the dealer      times of one to two years
"shopping" for the car          at the neck. At the top of     were then the norm. This
model produced in the           the glass, plants, which       meant      that   computer
plant we were to study.         introduce innovations in       manufacturers had plenty
From      sales    literature   color and technology           of time to organize their
provided by the dealer, I       every year, can provide an     supplies around physical
determined that when one        almost infinite variety of     efficiency.
took into account all the       options. At the bottom, a
choices for color, interior     multitude of customers         Now        PCs      and
features,         drivetrain    with diverse tastes could      workstations       have
configurations, and other       benefit from that variety      replaced mainframes as
options, the company was        but are unable to because      the dominant technology,
actually     offering      20                                  and the acceptable lead



                                             8
time has dropped to days.     the cost of making the          Procter & Gamble, which
Yet because the industry      supply chain responsive.        has    been    simplifying
has largely retained its                                      many of its product lines
emphasis on a physically      A sure sign that a              and pricing, is coming to
efficient supply chain,       company needs to move           the conclusion that the
most computer companies       to the left is if it has a      answer is no. Toothpaste
find themselves firmly        product line characterized      is a product category in
positioned in the upper       by frequent introductions       which a move to the left
right-hand cell of the        of new offerings, great         — from innovative to
matrix.                       variety, and low profit         functional — makes sense.
                              margins. Toothpaste is a
That     mismatch       has   good example. A few             In other cases when a
engendered a kind of          years ago, I was to give a      company         has      an
schizophrenia in the way      presentation to a food          unresponsive        supply
computer companies view       industry group. I decided       chain    for     innovative
their supply chains. They     that a good way to              products,      the    right
cling to measures of          demonstrate               the   solution is to make some
physical efficiency such as   dysfunctional level of          of the products functional
plant capacity utilization    variety that exists in many     and to create a responsive
and     inventory     turns   grocery categories would        supply chain for the
because those measures        be to buy one of each type      remaining        innovative
are familiar from their       of toothpaste made by a         products. The automobile
mainframe days. Yet the       particular manufacturer         industry    is    a   good
marketplace keeps pulling     and present the collection      example.
them toward measures of       to my audience When I
responsiveness such as        went      to    my      local   Many suggestions have
product availability.         supermarket to buy my           been made for fixing the
                              samples, I found that 28        problems with the auto
How does a company in         varieties were available. A     distribution channel I
the upper right-hand cell     few months later, when I        have described here, but
overcome                its   mentioned this discovery        they all miss the mark
schizophrenia? Either by      to a senior vice president      because they propose
moving to the left on the     of        a       competing     applying just one solution.
matrix and making its         manufacturer,              he   This approach overlooks
products functional or by     acknowledged that his           the fact that some cars,
moving down the matrix        company also had 28             such     as     the    Ford
and making its supply         types of toothpaste - one       Fairmont, are inherently
chain responsive. The         to match each of the            functional, while others,
correct direction depends     rival's offerings.              such as the BMW Z3
on whether the product is                                     roadster (driven in the
sufficiently innovative to    Does the world need 28          James Bond movie Golden
generate           enough     kinds of toothpaste from        Eye), are innovative. A
additional profit to cover    each       manufacturer?        lean, efficient distribution



                                           9
channel is exactly right for    coordination         across      for all Campbell products
functional cars but totally     corporate boundaries —           and of the level or
inappropriate            for    with       suppliers   and       inventories      in     their
innovative cars, which          distributors — presents          distribution        centers.
require inventory buffers       the greatest opportunities.      Campbell       uses      that
to absorb uncertainty in        Happily, the growing             information to forecast
demand.       The      most     acceptan
efficient place to put          ce of this     How Campbell's Price Promotions Disrupted Its Supply System
buffers is in parts, but        view has
doing       so      directly    coincide
contradicts the just-in-        d     with
time       system       that    the
automakers      have      so    emergen
vigorously adopted in the       ce       of
last decade. The just-in-       electroni
time system has slashed         c
parts inventories in plants     networks
(where holding inventory        that
is relatively cheap) to a       facilitate
few hours, while stocks of      closer
cars at dealers (where          coordinat
holding     inventory      is   ion.
expensive) have grown to
around 90 days.                 Campbel
                                l    Soup
  EFFICIENT SUPPLY OF           has
 FUNCTIONAL PRODUCTS            shown
                                how this
Cost reduction is familiar      new
territory,   and     most       game should be played. In         future demand and to
companies have been at it       1991,     the       company       determine which products
for years. Nevertheless,        launched the continuous-          require     replenishment
there are some new twists       replenishment        program      based on upper and lower
to this old game. As            with its most progressive         inventory             limits
companies            have       retailers. The program            previously      established
aggressively pursued cost       works       as        follows:    with each retailer. Trucks
cutting over the years,         Campbell         establishes      leave    the     Campbell
they have begun to reach        electronic                data    shipping      plant     that
the point of diminishing        interchange (EDI) links           afternoon and arrive at
returns     within   their      with     retailers.     Every     the retailers' distribution
organization's       own        morning,              retailers   centers with the required
boundaries     and   now        electronically inform the         replenishments the same
believe     that    better      company of their demand           day. The program cut the



                                              10
inventories    of     four    "How Campbell's Price         through the reduction in
participating     retailers   Promotions Disrupted Its      retailers' inventories. Most
from about four to two        Supply            System.")   retailers figure that the
weeks of supply. The          Recognizing the problem,      cost of carrying the
company achieved this         Campbell required its         inventory of a given
improvement because it        retail customers on the       product for a year equals
slashed the delivery lead     continuous-replenishment      at least 25% of what they
time and because it knows     program to waive the          paid for the product. A
the inventories of all        option of forward buying      two-week          inventory
retailers and hence can       at a discounted price. A      reduction represents a
deploy supplies of each       retailer that promotes        cost savings equal to
product where they are        Campbell products in its      nearly 1% of sales. Since
needed the most.              stores by offering a          the    average      retailer's
                              discounted      price    to   profits equal about 2% of
Pursuing        continuous    consumers      has     two    sales, this savings is
replenishment         made    options: it can pay           enough to increase profits
Campbell aware of the         Campbell an "everyday         by 50%.
negative impact that the      low price" equal to the
overuse       of      price   average price that a          Because the retailer makes
promotions can have on        retailer   receiving    the   more money on Campbell
physical efficiency. Every    promotional deals would       products          delivered
January, for example,         pay or it can receive a       through         continuous
there was a big spike in      discount     on      orders   replenishment, it has an
shipments of Chicken          resulting from genuine        incentive to carry a
Noodle Soup because of        increases in sales to         broader line of them and
deep     discounts     that   consumers.                    to give them more shelf
Campbell was offering.                                      space. For that reason,
Retailers responded to the    The Campbell example          Campbell found that after
price cut by stocking up,     offers    some    valuable    it had introduced the
in some cases buying a        lessons. Because soup is a    program, sales of its
year's supply — a practice    functional product with       products grew twice as
the industry calls forward    price-sensitive demand,       fast through participating
buying. Nobody won on         Campbell was correct to       retailers as they did
the deal. Retailers had to    pursue physical efficiency.   through other retailers.
pay to carry the year's       Service — or the in-stock     Understandably,      super-
supply, and the shipment      availability of Campbell      market     chains      love
bulge       added      cost   products at a retailer's      programs       such      as
throughout the Campbell       distribution center — did     Campbell's.      Wegmans
system. For example,          increase marginally, from     Food Markets, with stores
chicken-boning plants had     98.5% to 99.2%. But the       in upstate New York, has
to go on overtime starting    big gain for the supply       even     augmented       its
in October to meet the        chain was in increased        accounting system so that
bulge. (See the graph         operating       efficiency,   it can measure and


                                          11
reward suppliers whose          way for supply chain           competitive games at the
products cost the least to      partners to interact in the    same time. But that tactic
stock and sell.                 pursuit of higher profits.     doesn't work, because the
                                Functional products such       two approaches require
There is also an important      as groceries are usually       diametrically      different
principle about the supply      highly price-sensitive, and    behavior. For example,
of functional products          negotiations along the         consider       information
lurking in the "everyday        supply chain can be fierce.    sharing. If you are my
low price" feature of           If a company can get its       supplier and we an
Campbell's         program.     supplier to cut its price by   negotiating over price, the
Consumers of functional         a penny and its customer       last thing you want to do
products offer companies        to accept a one-cent price     is fully share with me
predictable demand in           increase,              those   information about your
exchange for a good             concessions can have a         costs. But that is what we
product and a reasonable        huge impact on the             both must do if we want
price. The challenge is to      company's profits. In this     to reduce supply chain
avoid actions that would        competitive model of           costs by assigning each
destroy     the     inherent    supply chain relations,        task to whichever of us
simplicity       of     this    costs in the chain are         can perform it most
relationship.          Many     assumed to be fixed, and       cheaply.
companies       go    astray    the manufacturer and the
because they get hooked         retailer compete through         RESPONSIVE SUPPLY OF
on      overusing      price    price negotiations for a         INNOVATIVE PRODUCTS
promotions. They start by       bigger share of the fixed
using price incentives to       profit pie. In contrast,       Uncertainty           about
pull demand forward in          Campbell's      continuous-    demand is intrinsic to
time to meet a quarterly        replenishment      program     innovative products. As a
revenue      target.     But    embodies a model in            result, figuring out how to
pulling demand forward          which the manufacturer         cope with it is the primary
helps only once. The next       and the retailer cooperate     challenge in creating a
quarter, a company has to       to cut costs throughout        responsive supply process
pull demand forward             the      chain,     thereby    for such products. I have
again just to fill the hole     increasing the size of the     seen companies use four
created by the first            pie.                           tools     to   cope    with
incentive. The result is an                                    uncertainty in demand. To
addiction to incentives         The cooperative model          fashion      a   responsive
that      turns      simple,    can be powerful, but it        supply process, managers
predictable demand into a       does have pitfalls. Too        need to understand each
chaotic series of spikes        often, companies reason        of them and then blend
that only add to cost.          that there never can be too    them in a recipe that's
                                many ways to make              right for their company's
Finally, the Campbell           money, and they decide to      particular situation.
story illustrates a different   play the cooperative and


                                            12
Although it may sound            of demand, it can employ         Bicycle prospered for
obvious, the first step for      three           coordinated      decades as a small but
many companies is simply         strategies to manage that        successful division. But by
to accept that uncertainty       uncertainty.       It     can    the mid-1980s, it was in
is inherent in innovative        continue to strive to reduce     trouble. Bicycles in Japan
products. Companies that         uncertainty        —       for   were functional products
grew up in an oligopoly          example,      by      finding    bought mainly as an
with less competition,           sources of new data that         inexpensive means of
more docile customers,           can serve as leading             transportation, and sales
and weaker retailers find        indicators or by having          were flat. Bicycles had
it difficult to accept the       different products share         become a commodity sold
high levels of demand            common components as             on the basis of low price,
uncertainty that exist           much as possible so that         and Japan's high labor
today in many markets.           the       demand           for   costs left National Bicycle
They have a tendency to          components           becomes     unable to compete with
declare a high level of          more predictable. It can         inexpensive bikes from
forecast                errors   avoid     uncertainty      by    Taiwan and Korea.
unacceptable, and they           cutting lead times and
virtually command their          increasing the supply            In 1986, in an attempt to
people to think hard             chain's flexibility so that it   salvage    the    situation
enough and long enough           can produce to order or at       Matsushita appointed as
to achieve accuracy in           least manufacture the            president of National an
their forecasts. But these       product at a time closer to      executive from another
companies can't remove           when                 demand      division who had no
uncertainty by decree.           materializes and can be          experience in bicycles. The
When       it    comes      to   accurately           forecast.   new president, Makoto
innovative          products,    Finally, once uncertainty        Komoto, saw that the
uncertainty       must      be   has been reduced or              division     had      many
accepted as good. If the         avoided as much as               strengths:        technical
demand for a product             possible, it can hedge           expertise                 in
were predictable, that           against the remaining            manufacturing           and
product probably would           residual uncertainty with        computers,     a     highly
not       be      sufficiently   buffers of inventory or          skilled workforce, a strong
innovative to command            excess     capacity.      The    brand name (Panasonic),
high profit margins. The         experiences of National          and a network of 9,000
fact is that risk and return     Bicycle, a subsidiary of         dealers.   Komoto       also
are linked, and the highest      Matsushita Electric, and of      noticed that National
profit margins usually go        Sport            Obermeyer       Bicycle had an innovative
with the highest risk in         illustrate the different         product segment that
demand.                          ways in which these three        enjoyed     high      profit
                                 strategies can be blended        margins: sports bicycles
Once a company has               to create a responsive           that affluent customers
accepted the uncertainty         supply chain. National           bought      purely       for


                                              13
recreation. He concluded      two-week      lead time          lighting controls by giving
that National's only hope     99.99% of the time and           customers an essentially
was to focus on that          was in the black.                unlimited     choice     of
segment and use the                                            technical and fashion
division's strengths to       National Bicycle's success       features. Says Michael W.
develop a responsive          is a good example of a           Pessina, Lutron's vice
chain that could supply       responsive supply chain          president      of     man-
sports     bikes    while     achieved            through      ufacturing      operations,
avoiding the high risk of     avoiding       uncertainty.      "With our diverse product
overproduction        that    National has little idea         line, customer demand
resulted from their short     what customers will order        can be impossible to
life cycle and uncertain      when they walk into a            predict.      Yet        by
demand.                       retail shop, but that            configuring products at
                              doesn't      matter:       its   the time of order, we can
According to Komoto's         produce-to-order system          offer            customers
vision, a customer would      allows it to match supply        tremendous variety and
visit     a      Panasonic    with     demand      as     it   fill orders very quickly
dealership and choose a       happens. By radically            without having to stock a
bike from a selection of 2    increasing the number of         huge       amount        of
million     options     for   choices from a few types         inventory."
combining size, color, and    of bikes to 2 million, it can
components,      using    a   induce the customer to           Mass customization is not
special measuring stand       sacrifice        immediate       without its challenges. For
to find the exact size of     availability and wait two        example,      what      does
the frame that he or she      weeks for a bicycle.             National Bicycle do with
needed. The order would                                        its plant during the
be faxed to the factory,      National's program is part       winter, when no one is
where           computer-     of a new movement called         buying bikes? It builds an
controlled         welding    mass         customization:      inventory of high-end
equipment and skilled         building the ability to          sports      bicycles.      In
workers would make the        customize a large volume         addition,               mass
bike and deliver it to the    of products and deliver          customization      is    not
customer     within    two    them at close to mass-           necessarily           cheap.
weeks.                        production prices. Many          National's           custom
                              other companies have             production requires three
Komoto's radical vision       found that they, too, can        times more labor than
became a reality in 1987.     benefit from this strategy.      assembly-line           mass
By 1991, fueled by this       For    example,     Lutron       production      of     bikes.
innovation,       National    Electronics              of      Interestingly, one of the
Bicycle had increased its     Coopersburg,                     main reasons why Henry
share of the sports bicycle   Pennsylvania, became the         Ford in the early 1900s
market in Japan from 5%       world leader in dimmer           moved in the opposite
to 29%. It was meeting the    switches     and      other      direction — from craft to


                                           14
mass production — was         reduce uncertainty, Sport      the    lead     time.    For
to slash labor costs, which   Obermeyer solicited early      example, the person who
he succeeded in doing by      orders from important          had      dutifully     used
a factor of three. So what    customers: the company         standard mail service to
has changed to make           invited its 25 largest         get design information to
custom production viable      retailers to Aspen each        the production manager
now? Affluent consumers       February to evaluate its       in Hong Kong realized
are willing to pay for        new         line.     Sport    that the $25 express-mail
high-margin, innovative       Obermeyer found that the       charge was a bargain
products;     and     those   early orders from this         compared       with      the
products      require     a   handful       of   retailers   $25,000 per day in added
different, more expensive,    permitted it to forecast       costs    resulting    from
but    more     responsive    national demand for all its    longer lead times caused
production process than       products with a margin of      by mail delays. Through
the functional Model T        error of just 10%.             such      efforts,    Sport
did.                                                         Obermeyer was able to
                              Although it was helpful to     avoid uncertainty on half
Sport Obermeyer, which        get    this    information     of its production by
is    based   in   Aspen,     several months before          committing              that
Colorado, designs and         Sport Obermeyer was            production after early
manufactures       fashion    required to ship its           orders had been received
skiwear and distributes it    products in September, it      in February.
through 800 specialty         didn't      solve      the
retailers          located    company's         problem,     Nevertheless,            the
throughout the United         because long lead times        company still had to
States. Because 95% of its    forced it to commit itself     commit half of the
products are new each         to products well before        production early in the
year, it constantly faces     February.       Obermeyer      season, when demand
the challenges and risks of   concluded that each day        was uncertain. Which
demand         uncertainty:   shaved off the lead time       styles should it make
stockouts of hot styles       would save the company         then? It would stand to
during the selling season     $25,000 because that was       reason that they should be
and leftover inventory of     the amount it spent each       the styles for which Sport
"dogs" at the end of the      day at the end of              Obermeyer had the most
season. In 1991, the          September         shipping     confidence in its forecasts.
company's vice president,     products by air from           But how could it tell
Walter R. Obermeyer,          plants in Asia to have         which those were? Then
launched a project to         them in stores by early        the    company      noticed
attack those problems by      October — the start of the     something       interesting.
blending     the      three   retail season. Once that       Obermeyer had asked
strategies of reducing,       figure was announced to        each of the six members of
avoiding, and hedging         employees, they found all      a committee responsible
against uncertainty. To       kinds of ways to shorten       for      forecasting      to


                                          15
construct a forecast for all     than      99%       product
products, and he used the        availability: they have
average      of    the    six    ranked Sport Obermeyer
forecasts as the company's       number one in the
forecast. After one year of      industry for service. (See
trying this method, the          "Making Supply Meet
company found that when          Demand in an Uncertain
the      six      individual     World," by Marshall L.
forecasts     agreed,     the    Fisher,      Janice     H.
average was accurate, and        Hammond, Walter R.
when they disagreed, the         Obermeyer, and Ananth
average was inaccurate.          Raman, HBR May-June
This discovery gave Sport        1994.)
Obermeyer a means of
selecting the styles to          Companies such as Sport
make early. Using this in-       Obermeyer,         National
formation as well as data        Bicycle, and Campbell
on      the       cost     of    Soup, however, are still
overproduction           and     the exceptions. Managers
underproduction,            it   at    many       companies
developed a model for            continue to lament that
hedging against the risk of      although they know their
both problems. The model         supply chains are riddled
tells the company exactly        with waste and generate
how much of each style to        great        dissatisfaction
make      early     in    the    among customers, they
production season (which         don't know what to do
begins nearly a year             about the problem. The
before the retail season)        root cause could very well
and how much to make in          be a misalignment of their
February,      after   early     supply      and     product
orders are received.             strategies. Realigning the
                                 two is hardly easy. But the
Sport          Obermeyer's       reward — a remarkable
approach, which has been         competitive      advantage
called accurate response,        that     generates     high
has cut the cost of both         growth in sales and
overproduction          and      profits — makes the effort
underproduction in half          worth it.
— enough to increase
profits by 60%. And
retailers love the fact that
the system results in more


                                             16

				
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