Seven Principles |
| 1. Segment customers based on service needs. |
To balance customers' demands with the need for profitable growth,
many companies have moved aggressively to improve supply chain
management. Their efforts reflect seven principles of supply chain
management that, working together, can enhance revenue, cost
control, and asset utilization as well as customer satisfaction.
Implemented successfully, these principles prove convincingly
that you can please customers and enjoy profitable growth from
doing so.
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Managers increasingly find themselves assigned the role of the
rope in a very real tug of war—pulled one way by customers'
mounting demands and the opposite way by the company's need
for growth and profitability. Many have discovered that they can
keep the rope from snapping and, in fact, achieve profitable growth
by treating supply chain management as a strategic variable.
These savvy managers recognize two important things. First, they
think about the supply chain as a whole—all the links involved in
managing the flow of products, services, and information from their
suppliers' suppliers to their customers' customers (that is, channel
customers, such as distributors and retailers). Second, they pursue
tangible outcomes—focused on revenue growth, asset utilization,
and cost reduction.
Rejecting the traditional view of a company and its component parts
as distinct functional entities, these managers realize that the real
measure of success is how well activities coordinate across the supply
chain to create value for customers, while increasing the profitability
of every link in the chain. In the process, some even redefine the
competitive game; consider the success of Procter & Gamble .
Our analysis of initiatives to improve supply chain management
by more than 100 manufacturers, distributors, and retailers shows
many making great progress, while others fail dismally. The
successful initiatives that have contributed to profitable growth
share several themes. They are typically broad efforts, combining
both strategic and tactical change. They also reflect a holistic approach,
viewing the supply chain from end to end and orchestrating efforts
so that the whole improvement achieved—in revenue, costs, and
asset utilization—is greater than the sum of its parts.
Unsuccessful efforts likewise have a consistent profile. They tend to
be functionally defined and narrowly focused, and they lack sustaining
infrastructure. Uncoordinated change activity erupts in every
department and function and puts the company in grave danger
of "dying the death of a thousand initiatives." The source of failure
is seldom management's difficulty identifying what needs fixing. The
issue is determining how to develop and execute a supply chain
transformation plan that can move multiple, complex operating
entities (both internal and external) in the same direction.
To help managers decide how to proceed, we revisited the supply
chain initiatives undertaken by the most successful manufacturers
and distilled from their experience seven fundamental principles
of supply chain management.
Adherence to the seven principles transforms the tug of war between
customer service and profitable growth into a balancing act. By
determining what customers want and how to coordinate efforts across
the supply chain to meet those requirements faster, cheaper, and
better, companies enhance both customersatisfaction and their own
financial performance. But the balance is not easy to strike or to
sustain. As this article will demonstrate, each company—whether
a supplier, manufacturer, distributor, or retailer—must find the way
to combine all seven principles into a supply chain strategy that best
fits its particular situation. No two companies will reach the same
conclusion.
Principle 1: Segment customers based on the service needs
of distinct groups and adapt the supply chain to serve these
segments profitably.
Segmentation has traditionally grouped customers by industry, product,
or trade channel and then taken a one-size-fits-all approach to serving
them, averaging costs and profitability within and across segments. The
typical result, as one manager admits: "We don't fully understand the
relative value customers place on our service offerings."
But segmenting customers by their particular needs equips a company
to develop a portfolio of services tailored to various segments. Surveys,
interviews, and industry research have been the traditional tools for
defining key segmentation criteria.
Today, progressive manufacturers are turning to such advanced
analytical techniques as cluster and conjoint analysis to measure
customer tradeoffs and predict the marginal profitability of each
segment. One manufacturer of home improvement and building
products bases segmentation on sales and merchandising needs
and order fulfillment requirements. Others are finding that criteria
such as technical support and account planning activities drive
segmentation.
Viewed from the classic perspective, this needs-based segmentation
may produce some odd couples. For the manufacturer in Exhibit 1,
"innovators" include an industrial distributor (Grainger), a do-it-yourself
retailer (Home Depot), and a mass merchant (Wal-Mart).
Research also can established the services valued by all customers versus
those valued only by certain segments.
Then the company should apply a disciplined, cross-functional process
to develop a menu of supply chain programs and create segment-specific
service packages that combine basic services for everyone with the
services from the menu that will have the greatest appeal to particular
segments. This does not mean tailoring for the sake of tailoring. The goal
is to find the degree of segmentation and variation needed to maximize
profitability.
All the segments in Exhibit 1, for example, value consistent
delivery. But those in the lower left quadrant have little interest in the
advanced supply chain management programs, such as customized
packaging and advance shipment notification, that appeal greatly to
those in the upper right quadrant.
Of course, customer needs and preferences do not tell the whole story.
The service packages must turn a profit, and many companies lack
adequate financial understanding of their customers' and their own
costs to gauge likely profitability. "We don't know which customers
are most profitable to serve, which will generate the highest long-term
profitability, or which we are most likely to retain," confessed a leading
industrial manufacturer. This knowledge is essential to correctly
matching accounts with service packages—hich translates into revenues
enhanced through some combination of increases in volume and/or price.
Only by understanding their costs at the activity level and using that
understanding to strengthen fiscal control can companies profitably
deliver value to customers. One "successful" food manufacturer
aggressively marketed vendor-managed inventory to all customer
segments and boosted sales. But subsequent activity-based cost
analysis found that one segment actually lost nine cents a case on
an operating margin basis.
Most companies have a significant untapped opportunity to better
align their investment in a particular customer relationship with
the return that customer generates. To do so, companies must analyze
the profitability of segments, plus the costs and benefits of alternate
service packages, to ensure a reasonable return on their investment
and the most profitable allocation of resources. To strike and sustain
the appropriate balance between service and profitability, most
companies will need to set priorities—sequencing the rollout of tailored
programs to capitalize on existing capabilities and maximize customer
impact.
Principle 2: Customize the logistics network to the service
requirements and profitability of customer segments.
Companies have traditionally taken a monolithic approach to logistics
network design in organizing their inventory, warehouse, and
transportation activities to meet a single standard. For some, the
logistics network has been designed to meet the average service
requirements of all customers; for others, to satisfy the toughest
requirements of a single customer segment.
Neither approach can achieve superior asset utilization or accommodate
the segment-specific logistics necessary for excellent supply chain
management. In many industries, especially such commodity
industries as fine paper, tailoring distribution assets to meet individual
logistics requirements is a greater source of differentiation for a
manufacturer than the actual products, which are largely
undifferentiated.
One paper company found radically different customer service
demands in two key segments—large publishers with long lead
times and small regional printers needing delivery within 24 hours.
To serve both segments well and achieve profitable growth, the
manufacturer designed a multi-level logistics network with three
full-stocking distribution centers and 46 quick-response cross-docks,
stocking only fast-moving items, located near the regional printers.
Return on assets and revenues improved substantially thanks to the
new inventory deployment strategy, supported by outsourcing of
management of the quick response centers and the transportation
activities.
This example highlights several key characteristics of segment-specific
services. The logistics network probably will be more complex, involving
alliances with third-party logistics providers, and will certainly have to
be more flexible than the traditional network. As a result, fundamental
changes in the mission, number, location, and ownership structure of
warehouses are typically necessary. Finally, the network will require
more robust logistics planning enabled by "real-time" decision-support
tools that can handle flow-through distribution and more time-sensitive
approaches to managing transportation.
Even less conventional thinking about logistics is emerging in some
industries, where shared customers and similar geographic approaches
result in redundant networks. Combining logistics for both
complementary and competing firms under third-party ownership
can provide a lower-cost industrywide solution.
As shown in Exhibit 2, the food and packaged goods industry might
well cut logistics costs 42 percent per case and reduce total days in the
system 73 percent by integrating logistics assets across the industry,
with extensive participation by third-party logistics providers.
Principle 3: Listen to market signals and align demand
planning accordingly across the supply chain, ensuring
consistent forecasts and optimal resource allocation.
Forecasting has historically proceeded silo by silo, with multiple
departments independently creating forecasts for the same
products—all using their own assumptions, measures, and level
of detail. Many consult the marketplace only informally, and few
involve their major suppliers in the process. The functional orientation
of many companies has just made things worse, allowing sales forecasts
to envision growing demand while manufacturing second-guesses how
much product the market actually wants.
Such independent, self-centered forecasting is incompatible with
excellent supply chain management, as one manufacturer of
photographic imaging found. This manufacturer nicknamed the
warehouse "the accordion" because it had to cope with a production
operation that stuck to a stable schedule, while the revenue-focused
sales force routinely triggered cyclical demand by offering deep discounts
at the end of each quarter. The manufacturer realized the need to
implement a cross-functional planning process, supported by demand
planning software.
Initial results were dismaying. Sales volume dropped sharply, as
excess inventory had to be consumed by the marketplace. But today,
the company enjoys lower inventory and warehousing costs and
much greater ability to maintain price levels and limit discounting.
Like all the best sales and operations planning (S&OP), this process
recognizes the needs and objectives of each functional group but bases
operational decisions on overall profit potential.
Excellent supply chain management, in fact, calls for S&OP that
transcends company boundaries to involve every link of the supply
chain (from the supplier's supplier to the customer's customer) in
developing forecasts collaboratively and then maintaining the required
capacity across the operations. Channel-wide S&OP can detect early
warning signals of demand lurking in customer promotions, ordering
patterns, and restocking algorithms and takes into account vendor
and carrier capabilities, capacity, and constraints.
Exhibit 3 illustrates the difference that cross supply chain
planning has made for one manufacturer of laboratory products.
As shown on the left of this exhibit, uneven distributor demand
unsynchronized with actual end-user demand made real inventory
needs impossible to predict and forced high inventory levels that
still failed to prevent out-of-stocks.
Distributors began sharing information on actual (and fairly stable)
end-user demand with the manufacturer, and the manufacturer began
managing inventory for the distributors. This coordination of
manufacturing scheduling and inventory deployment decisions
paid off handsomely, improving fill rates, asset turns, and cost
metrics for all concerned.
Such demand-based planning takes time to get right. The first step is
typically a pilot of a leading-edge program, such as vendor-managed
inventory or jointly managed forecasting and replenishment, conducted
in conjunction with a few high-volume, sophisticated partners in the
supply chain. As the partners refine their collaborative forecasting,
planned orders become firm orders. The customer no longer sends
a purchase order, and the manufacturer commits inventory from
its available-to-promise stock. After this pilot formalizes a planning
process, infrastructure, and measures, the program expands to include
other channel partners, until enough are participating to facilitate
quantum improvement in utilization of manufacturing and logistics
assets and cost performance.
Principle 4: Differentiate product closer to the customer
and speed conversion across the supply chain.
Manufacturers have traditionally based production goals on projections
of the demand for finished goods and have stockpiled inventory to offset
forecasting errors. These manufacturers tend to view lead times in the
system as fixed, with only a finite window of time in which to convert
materials into products that meet customer requirements.
While even such traditionalists can make progress in cutting costs
through set-up reduction, cellular manufacturing, and just-in-time
techniques, great potential remains in less traditional strategies such
as mass customization. For example, manufacturers striving to meet
individual customer needs efficiently through strategies such as mass
customization are discovering the value of postponement. They are
delaying product differentiation to the last possible moment and thus
overcoming the problem described by one manager of a health and
beauty care products warehouse: "With the proliferation of packaging
requirements from major retailers, our number of SKUs
(stock keeping units) has exploded. We have situations daily where
we backorder one retailer, like Wal-Mart, on an item that is identical
to an in-stock item, except for its packaging. Sometimes we even
tear boxes apart and repackage by hand!"
The hardware manufacturer in Exhibit 4 solved this
problem by determining the point at which a standard
bracket turned into multiple SKUs. This point came when the
bracket had to be packaged 16 ways to meet particular customer
requirements. The manufacturer further concluded that overall
demand for these brackets is relatively stable and easy to forecast,
while demand for the 16 SKUs is much more volatile. The solution:
make brackets in the factory but package them at the distribution
center, within the customer order cycle. This strategy improved
asset utilization by cutting inventory levels by more than 50 percent.
Realizing that time really is money, many manufacturers are
questioning the conventional wisdom that lead times in the supply
chain are fixed. They are strengthening their ability to react to market
signals by compressing lead times along the supply chain, speeding
the conversion from raw materials to finished products tailored to
customer requirements. This approach enhances their flexibility
to make product configuration decisions much closer to the moment
demand occurs.
Consider Apple's widely publicized PC shortages during peak sales
periods. Errors in forecasting demand, coupled with supplier inability
to deliver custom drives and chips in less than 18 weeks, left Apple
unable to adjust fast enough to changes in projected customer demand.
To overcome the problem, Apple has gone back to the drawing board,
redesigning PCs to use more available, standard parts that have shorter
lead times.
The key to just-in-time product differentiation is to locate the
leverage point in the manufacturing process where the product is unalterably
configured to meet a single requirement and to assess options, such a
postponement, modularized design, or modification of manufacturing
processes, that can increase flexibility. In addition, manufacturers must
challenge cycle times: Can the leverage point be pushed closer to actual
demand to maximize the manufacturer's flexibility in responding to emerging
customer demand?
Principle 5: Manage sources of supply strategically to reduce
the total cost of owning materials and services.
Determined to pay as low a price as possible for materials, manufacturers
have not traditionally cultivated warm relationships with suppliers. In the
words of one general manager: "The best approach to supply is to have
as many players as possible fighting for their piece of the pie—that's when
you get the best pricing."
Excellent supply chain management requires a more enlightened
mindset—recognizing, as a more progressive manufacturer did:
"Our supplier's costs are in effect our costs. If we force our supplier
to provide 90 days of consigned material when 30 days are sufficient,
the cost of that inventory will find its way back into the supplier's price
to us since it increases his cost structure."
While manufacturers should place high demands on suppliers, they
should also realize that partners must share the goal of reducing costs
across the supply chain in order to lower prices in the marketplace and
enhance margins. The logical extension of this thinking is gain-sharing
arrangements to reward everyone who contributes to the greater profitability.
Some companies are not yet ready for such progressive thinking
because they lack the fundamental prerequisite. That is, a sound
knowledge of all their commodity costs, not only for direct materials
but also for maintenance, repair, and operating supplies, plus the dollars
spent on utilities, travel, temps, and virtually everything else. This
fact-based knowledge is the essential foundation for determining the
best way of acquiring every kind of material and service the company
buys.
With their marketplace position and industry structure in mind,
manufacturers can then consider how to approach suppliers—soliciting
short-term competitive bids, entering into long-term contracts and
strategic supplier relationships, outsourcing, or integrating vertically.
Excellent supply chain management calls for creativity and flexibility.
For one manufacturer whose many divisions all were independently
ordering the cardboard boxes they used, creativity meant consolidating
purchases, using fewer and more efficient suppliers, and eliminating
redundancy in such processes as quality inspection. For many small
manufacturers, creativity means reducing transportation costs by
hitching a ride to market on the negotiated freight rates of a large
customer. For the chemical company in Exhibit 5,
creativity meant tackling the volatility of base commodity
prices by indexing them (rather than negotiating fixed prices),
so supplier and manufacturer share both the pain and
the gain of price fluctuations.
While the seven principles of supply chain management can achieve
their full potential only if implemented together, this principle may
warrant early attention because the savings it can realize from the
start can fund additional initiatives. The proof of the pudding: Creating
a data warehouse to store vast amounts of transactional and
decision-support data for easy retrieval and application in
annual negotiations consolidated across six divisions cut one
manufacturer's operating costs enough in the first year to pay
for a redesigned distribution network and a new order management system.
Principle 6: Develop a supply chain-wide technology
strategy that supports multiple levels of decision making
and gives a clear view of the flow of products, services, and
information.
To sustain reengineered business processes (that at last abandon the
functional orientation of the past), many progressive companies have
been replacing inflexible, poorly integrated systems with enterprise-wide
systems. One study puts 1995 revenues for enterprisewide software
and service, provided by such companies as SAP and Oracle, at more
than $3.5 billion and projects annual revenue growth of 15 to 20
percent from 1994 through 1999.
Too many of these companies will find themselves victims of the
powerful new transactional systems they put in place. Unfortunately,
many leading-edge information systems can capture reams of data but
cannot easily translate it into actionable intelligence that can enhance
real-world operations. As one logistics manager with a brand-new
system said: "I've got three feet of reports with every detail imaginable,
but it doesn't tell me how to run my business."
This manager needs to build an information technology system that
integrates capabilities of three essential kinds. (See Exhibit 6.) For
the short term, the system must be able to handle day-to-day
transactions and electronic commerce across the supply chain and
thus help align supply and demand by sharing information on orders
and daily scheduling. From a mid-term perspective, the system
must facilitate planning and decision making, supporting the demand
and shipment planning and master production scheduling needed to
allocate resources efficiently. To add long-term value, the system must
enable strategic analysis by providing tools, such as an integrated
network model, that synthesize data for use in high-level "what-if"
scenario planning to help managers evaluate plants, distribution
centers, suppliers, and third-party service alternatives.
Despite making huge investments in technology, few companies
are acquiring this full complement of capabilities. Today's enterprisewide
systems remain enterprise-bound, unable to share across the supply chain
the information that channel partners must have to achieve mutual success.
Ironically, the information that most companies require most urgently to
enhance supply chain management resides outside of their own systems,
and few companies are adequately connected to obtain the necessary
information. Electronic connectivity creates opportunities to change
the supply chain fundamentally—from slashing transaction costs through
electronic handling of orders, invoices, and payments to shrinking
inventories through vendor-managed inventory programs.
A major beer manufacturer learned this lesson the hard way. Tracking
performance from plant to warehouse, the manufacturer was pleased—a
98 percent fill rate to the retailer's warehouse. But looking all the way
across the supply chain, the manufacturer saw a very different picture.
Consumers in some key retail chains found this company's beer out of
stock more than 20 percent of the time due to poor store-level
replenishment and forecasting. The manufacturer now is scrambling
to implement "real-time" information technology to gain store-specific
performance data ... data that is essential to improving customer service.
Without this data, the manufacturer cannot make the inventory-deployment
decisions that will boost asset utilization and increase revenue by reducing
store-level stockouts.
Many companies that have embarked on large-scale supply chain
reengineering attest to the importance of information technology
in sustaining the benefits beyond the first annual cycle. Those that
have failed to ensure the continuous flow of information have seen
costs, assets, and cycle times return to their pre-reengineering levels,
which undermines the business case for broad-based supply chain programs.
Principle 7: Adopt channel-spanning performance measures
to gauge collective success in reaching the end-user effectively
and efficiently.
To answer the question, "How are we doing?" most companies look inward
and apply any number of functionally oriented measures. But
excellent supply chain managers take a broader view, adopting
measures that apply to every link in the supply chain and include
both service and financial metrics.
First, they measure service in terms of the perfect order—the order
that arrives when promised, complete, priced and billed correctly,
and undamaged. The perfect order not only font>
Second, excellent supply chain managers determine their true
profitability of service by identifying the actual costs and revenues
of the activities required to serve an account, especially a key account.
For many, this amounts to a revelation, since traditional cost measures
rely on corporate accounting systems that allocate overhead evenly
across accounts. Such measures do not differentiate, for example, an
account that requires a multi-functional account team, small daily
shipments, or special packaging. Traditional accounting tends to mask
the real costs of the supply chain—focusing on cost type rather than the
cost of activities and ignoring the degree of control anyone has (or lacks)
the cost drivers.
Deriving maximum benefit from activity-based costing requires
sophisticated information technology, specifically a data warehouse.
Because the general ledger organizes data according to a chart of
accounts, it obscures the information needed for activity-based
costing. By maintaining data in discrete units, the warehouse provides
ready access to this information.
To facilitate channel-spanning performance measurement,
many companies are developing common report cards, like
that shown in Exhibit 7. These report cards help keep partners working
toward the same goals by building deep understanding of what each
company brings to the partnership and showing how to leverage their
complementary assets and skills to the alliance's greatest advantage.
The willingness to ignore traditional company boundaries in pursuit of
such synergies often marks the first step toward a "pay-for-performance"
environment.
Consider the manufacturer of scientific products who kept receiving
low marks from a customer on delivery—even though its own measures
showed performance to be superior. The problem was that the two were
not speaking the same language. The customer accepted only full
truckloads; anything brought next week because it wouldn't fit onto
the truck this week was deemed backordered. To the manufacturer,
however, this term did not apply.
A common report card can also help partners locate and capitalize
on synergies across the supply chain—as a manufacturer of health
products did by working with a major customer to develop a joint
return-on-invested-capital model and then used it to make such
decisions as where to hold slow-moving inventory most cost effectively.
Of course, such success is possible only between partners who begin with
deep understanding of their own financial situation.
Translating Principles into Practice
Companies that have achieved excellence in supply chain management
tend to approach implementation of the guiding principles with three
precepts in mind.
- Orchestrate improvement efforts
The complexity of the supply chain can make it difficult to envision the whole, from end to end. But successful supply chain managers realize the need to invest time and effort up front in developing this total perspective and using it to inform a blueprint for change that maps linkages among initiatives and a well-thought-out implementation sequence. This blueprint also must coordinate the change initiatives with ongoing day-to-day operations and must cross company boundaries.
The blueprint requires rigorous assessment of the entire supply chain—from supplier relationships to internal operations to the marketplace, including customers, competitors, and the industry as a whole. Current practices must be ruthlessly weighed against best practices to determine the size of the gap to close. Thorough cost/benefit analysis lays the essential foundation for prioritizing and sequencing initiatives, establishing capital and people requirements, and getting a complete financial picture of the company's supply chain—before, during, and after implementation.
A critical step in the process is setting explicit outcome targets for revenue growth, asset utilization, and cost reduction. (See Exhibit 8.) While traditional goals for costs and assets, especially goals for working capital, remain essential to success, revenue growth targets may ultimately be even more important. Initiatives intended only to cut costs and improve asset utilization have limited success structuring sustainable win-win relationships among trading partners. Emphasizing revenue growth can significantly increase the odds that a supply chain strategy will create, rather than destroy, value.
- Remember that
As this list of tasks may suggest, significant enhancement of supply chain management is a massive undertaking with profound financial impact on both the balance sheet and the income statement. Because this effort will not pay off overnight, management must carefully balance its long-term promise against more immediate business needs.
Advance planning is again key. Before designing specific initiatives, successful companies typically develop a plan that specifies funding, leadership, and expected financial results. This plan helps to forestall conflicts over priorities and keeps management focused and committed to realizing the benefits.
- Recognize the difficulty of change
Most corporate change programs do a much better job of designing new operating processes and technology tools than of fostering appropriate attitudes and behaviors in the people who are essential to making the change program work. People resist change, especially in companies with a history of "change-of-the-month" programs. People in any organization have trouble coping with the uncertainty of change, especially the real possibility that their skills will not fit the new environment.
Implementing the seven principles of supply chain management will mean significant change for most companies. The best prescription for ensuring success and minimizing resistance is extensive, visible participation and communication by senior executives. This means championing the cause and removing the managerial obstacles that typically present the greatest barriers to success, while linking change with overall business strategy.
Many progressive companies have realized that the traditionally fragmented responsibility for managing supply chain activities will no longer do. Some have even elevated supply chain management to a strategic position and established a senior executive position such as vice president-supply chain (or the equivalent) reporting directly to the COO or CEO. This role ignores traditional product, functional, and geographic boundaries that can interfere with delivering to customers what they want, when and where they want it.
The executive recruited for this role must have some very special attributes—the breadth of vision needed to understand and manage activities from receipt of order through delivery; the flexibility required to experiment and make mid-course corrections, coupled with the patience demanded by an inherently long-term effort; the superior communication and leadership skills essential to winning and sustaining commitment to the effort at every level of the organization, including the translation of intellectual commitment into financial commitment.
Reaping the Rewards of Excellent Supply Chain Management
The companies mentioned in this article are just a few of the many that have enhanced both customer satisfaction and profitability by strengthening management of the supply chain. While these companies have pursued various initiatives, all have realized the need to integrate activities across the supply chain. Doing so has improved asset utilization, reduced cost, and created price advantages that help attract and retain customers (and thus enhance revenue).
At the same time, these companies have recognized the importance of understanding and meeting diverse customer needs. Such tailoring of products and services enhances the effectiveness of the supply chain and thus wins customer loyalty. This loyalty translates into profits—Xerox has found satisfied customers six times more likely to buy additional Xerox products over the next 18 months than dissatisfied customers.
By simultaneously enhancing customer satisfaction and profitability, the seven principles of supply chain management can turn these once warring objectives into a formula for sustainable competitive advantage.
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