The Triple-A Supply Chain by Hau L. Lee
The best supply chains aren’t just fast and cost-effective.
They are also agile and adaptable, and they ensure that all
their companies’ interests stay aligned.
During the past decade and a half, I’ve studied from the
inside more than 60 leading companies that focused on building
and rebuilding supply chains to deliver goods and services to
consumers as quickly and inexpensively as possible. Those
firms invested in state-of-the-art technologies, and when that
proved to be inadequate, they hired top-notch talent to boost
supply chain performance. Many companies also teamed up to
streamline processes, lay down technical standards, and invest
in infrastructure they could share. For instance, in the early
1990s, American apparel companies started a Quick Response
initiative, grocery companies in Europe and the United States
touted a program called Efficient Consumer Response, and the
U.S. food service industry embarked on an Efficient
Foodservice Response program.
All those companies and initiatives persistently aimed at
greater speed and cost-effectiveness—the popular grails of
supply chain management. Of course, companies’ quests changed
with the industrial cycle: When business was booming,
executives concentrated on maximizing speed, and when the
economy headed south, firms desperately tried to minimize
supply costs.
As time went by, however, I observed one fundamental problem
that most companies and experts seemed to ignore: Ceteris
paribus, companies whose supply chains became more efficient
and cost-effective didn’t gain a sustainable advantage over
their rivals. In fact, the performance of those supply chains
steadily deteriorated. For instance, despite the increased
efficiency of many companies’ supply chains, the percentage of
products that were marked down in the United States rose from
less than 10% in 1980 to more than 30% in 2000, and surveys
show that consumer satisfaction with product availability fell
sharply during the same period.
Evidently, it isn’t by becoming more efficient that the supply
chains of Wal-Mart, Dell, and Amazon have given those
companies an edge over their competitors. According to my
research, top-performing supply chains possess three very
different qualities. First, great supply chains are agile.
They react speedily to sudden changes in demand or supply.
Second, they adapt over time as market structures and
strategies evolve. Third, they align the interests of all the
firms in the supply network so that companies optimize the
chain’s performance when they maximize their interests. Only
supply chains that are agile, adaptable, and aligned provide
companies with sustainable competitive advantage.
The Perils of Efficiency
Why haven’t efficient supply chains been able to deliver the
goods? For several reasons. High-speed, low-cost supply chains
are unable to respond to unexpected changes in demand or
supply. Many companies have centralized manufacturing and
distribution facilities to generate scale economies, and they
deliver only container loads of products to customers to
minimize transportation time, freight costs, and the number of
deliveries. When demand for a particular brand, pack size, or
assortment rises without warning, these organizations are
unable to react even if they have the items in stock.
According to two studies I helped conduct in the 1990s, the
required merchandise was often already in factory stockyards,
packed and ready to ship, but it couldn’t be moved until each
container was full. That “best” practice delayed shipments by
a week or more, forcing stocked-out stores to turn away
consumers. No wonder then that, according to another recent
research report, when companies announce product promotions,
stock outs rise to 15%, on average, even when executives have
primed supply chains to handle demand fluctuations.
When manufacturers eventually deliver additional merchandise,
it results in excess inventory because most distributors don’t
need a container load to satisfy the increased demand. To get
rid of the stockpile, companies mark down those products
sooner than they had planned to. That’s partly why department
stores sell as much as a third of their merchandise at
discounted prices. Those markdowns not only reduce companies’
profits but also erode brand equity and anger loyal customers
who bought the items at full price in the recent past (sound
familiar?).
Companies’ obsession with speed and costs also causes supply
chains to break down during the launch of new products. Some
years ago, I studied a well-known consumer electronics firm
that decided not to create a buffer stock before launching an
innovative new product. It wanted to keep inventory costs low,
particularly since it hadn’t been able to generate an accurate
demand forecast. When demand rose soon after the gizmo’s
launch and fell sharply thereafter, the company pressured
vendors to boost production and then to slash output. When
demand shot up again a few weeks later, executives
enthusiastically told vendors to step up production once more.
Five days later, supplies of the new product dried up as if
someone had turned off a tap.
The shocked electronics giant discovered that vendors had been
so busy ramping production up and down that they hadn’t found
time to fix bugs in both the components’ manufacturing and the
product’s assembly processes. When the suppliers tried to
boost output a second time, product defects rose to
unacceptable levels, and some vendors, including the main
assembler, had to shut down production lines for more than a
week. By the time the suppliers could fix the glitches and
restart production, the innovation was all but dead. If the
electronics company had given suppliers a steady,
higher-than-needed manufacturing schedule until both the line
and demand had stabilized, it would have initially had higher
inventory costs, but the product would still be around.
Efficient supply chains often become uncompetitive because
they don’t adapt to changes in the structures of markets.
Consider Lucent’s Electronic Switching Systems division, which
set up a fast and cost-effective supply chain in the late
1980s by centralizing component procurement, assembly and
testing, and order fulfillment in Oklahoma City. The supply
chain worked brilliantly as long as most of the demand for
digital switches emanated from the Americas and as long as
Lucent’s vendors were mostly in the United States. However, in
the 1990s, when Asia became the world’s fastest-growing
market, Lucent’s response times increased because it hadn’t
set up a plant in the Far East. Furthermore, the company
couldn’t customize switches or carry out modifications because
of the amount of time and money it took the supply chain to do
those things across continents.
Lucent’s troubles deepened when vendors shifted manufacturing
facilities from the United States to Asia to take advantage of
the lower labor costs there. “We had to fly components from
Asia to Oklahoma City and fly them back again to Asia as
finished products. That was costly and time consuming,”
Lucent’s then head of manufacturing told me. With tongue
firmly in cheek, he added, “Neither components nor products
earned frequent-flyer miles.” When Lucent redesigned its
supply chain in 1996 by setting up joint ventures in Taiwan
and China to manufacture digital switches, it did manage to
gain ground in Asia.
In this and many other cases, the conclusion would be the
same: Supply chain efficiency is necessary, but it isn’t
enough to ensure that firms will do better than their rivals.
Only those companies that build agile, adaptable, and aligned
supply chains get ahead of the competition, as I pointed out
earlier. In this article, I’ll expand on each of those
qualities and explain how companies can build them into supply
chains without having to make trade-offs. In fact, I’ll show
that any two of these dimensions alone aren’t enough. Only
companies that build all three into supply chains become
better faster than their rivals. I’ll conclude by describing
how Seven-Eleven Japan has become one of the world’s most
profitable retailers by building a truly “triple-A” supply
chain.
Fostering Agility
Great companies create supply chains that respond to sudden
and unexpected changes in markets. Agility is critical,
because in most industries, both demand and supply fluctuate
more rapidly and widely than they used to. Most supply chains
cope by playing speed against costs, but agile ones respond
both quickly and cost-efficiently.
Most companies continue to focus on the speed and costs of
their supply chains without realizing that they pay a big
price for disregarding agility. (See the sidebar “The
Importance of Being Agile.”) In the 1990s, whenever Intel
unveiled new microprocessors, Compaq took more time than its
rivals to launch the next generation of PCs because of a long
design cycle. The company lost mind share because it could
never count early adopters, who create the buzz around
high-tech products, among its consumers. Worse, it was unable
to compete on price. Because its products stayed in the
pipeline for a long time, the company had a large inventory of
raw materials. That meant Compaq didn’t reap much benefit when
component prices fell, and it couldn’t cut PC prices as much
as its rivals were able to. When vendors announced changes in
engineering specifications, Compaq incurred more reworking
costs than other manufacturers because of its larger
work-in-progress inventory. The lack of an agile supply chain
caused Compaq to lose PC market share throughout the decade.
By contrast, smart companies use agile supply chains to
differentiate themselves from rivals. For instance, H&M,
Mango, and Zara have become Europe’s most profitable apparel
brands by building agility into every link of their supply
chains. At one end of their product pipelines, the three
companies have created agile design processes. As soon as
designers spot possible trends, they create sketches and order
fabrics. That gives them a head start over competitors because
fabric suppliers require the longest lead times. However, the
companies finalize designs and manufacture garments only after
they get reliable data from stores. That allows them to make
products that meet consumer tastes and reduces the number of
items they must sell at a discount. At the other end of the
pipeline, all three companies have superefficient distribution
centers. They use state-of-the-art sorting and
material-handling technologies to ensure that distribution
doesn’t become a bottleneck when they must respond to demand
fluctuations. H&M, Mango, and Zara have all grown at more than
20% annually since 1990, and their double-digit net profit
margins are the envy of the industry.
Agility has become more critical in the past few years because
sudden shocks to supply chains have become frequent. The
terrorist attack in New York in 2001, the dockworkers’ strike
in California in 2002, and the SARS epidemic in Asia in 2003,
for instance, disrupted many companies’ supply chains. While
the threat from natural disasters, terrorism, wars, epidemics,
and computer viruses has intensified in recent years, partly
because supply lines now traverse the globe, my research shows
that most supply chains are incapable of coping with
emergencies. Only three years have passed since 9/11, but U.S.
companies have all but forgotten the importance of drawing up
contingency plans for times of crisis.
Without a doubt, agile supply chains recover quickly from
sudden setbacks. In September 1999, an earthquake in Taiwan
delayed shipments of computer components to the United States
by weeks and, in some cases, by months. Most PC manufacturers,
such as Compaq, Apple, and Gateway, couldn’t deliver products
to customers on time and incurred their wrath. One exception
was Dell, which changed the prices of PC configurations
overnight. That allowed the company to steer consumer demand
away from hardware built with components that weren’t
available toward machines that didn’t use those parts. Dell
could do that because it got data on the earthquake damage
early, sized up the extent of vendors’ problems quickly, and
implemented the plans it had drawn up to cope with such
eventualities immediately. Not surprisingly, Dell gained
market share in the earthquake’s aftermath.
Nokia and Ericsson provided a study in contrasts when in March
2000, a Philips facility in Albuquerque, New Mexico, went up
in flames. The plant made radio frequency (RF) chips, key
components for mobile telephones, for both Scandinavian
companies. When the fire damaged the plant, Nokia’s managers
quickly carried out design changes so that other companies
could manufacture similar RF chips and contacted backup
sources. Two suppliers, one in Japan and another in the United
States, asked for just five days’ lead time to respond to
Nokia. Ericsson, meanwhile, had been weeding out backup
suppliers because it wanted to trim costs. It didn’t have a
plan B in place and was unable to find new chip suppliers. Not
only did Ericsson have to scale back production for months
after the fire, but it also had to delay the launch of a major
new product. The bottom line: Nokia stole market share from
Ericsson because it had a more agile supply chain.
Companies can build agility into supply chains by adhering to
six rules of thumb:
• Provide data on changes in supply and demand to partners
continuously so they can respond quickly. For instance, Cisco
recently created an e-hub, which connects suppliers and the
company via the Internet. This allows all the firms to have
the same demand and supply data at the same time, to spot
changes in demand or supply problems immediately, and to
respond in a concerted fashion. Ensuring that there are no
information delays is the first step in creating an agile
supply chain.
• Develop collaborative relationships with suppliers and
customers so that companies work together to design or
redesign processes, components, and products as well as to
prepare backup plans. For instance, Taiwan Semiconductor
Manufacturing Company (TSMC), the world’s largest
semiconductor foundry, gives suppliers and customers
proprietary tools, data, and models so they can execute design
and engineering changes quickly and accurately.
• Design products so that they share common parts and
processes initially and differ substantially only by the end
of the production process. I call this strategy
“postponement.” (See the 1997 HBR article I coauthored with
Edward Feitzinger, “Mass Customization at Hewlett-Packard: The
Power of Postponement.”) This is often the best way to respond
quickly to demand fluctuations because it allows firms to
finish products only when they have accurate information on
consumer preferences. Xilinx, the world’s largest maker of
programmable logic chips, has perfected the art of
postponement. Customers can program the company’s integrated
circuits via the Internet for different applications after
purchasing the basic product. Xilinx rarely runs into
inventory problems as a result.
• Keep a small inventory of inexpensive, nonbulky components
that are often the cause of bottlenecks. For example, apparel
manufacturers H&M, Mango, and Zara maintain supplies of
accessories such as decorative buttons, zippers, hooks, and
snaps so that they can finish clothes even if supply chains
break down.
• Build a dependable logistics system that can enable your
company to regroup quickly in response to unexpected needs.
Companies don’t need to invest in logistics systems themselves
to reap this benefit; they can strike alliances with
third-party logistics providers.
• Put together a team that knows how to invoke backup plans.
Of course, that’s only possible only if companies have trained
managers and prepared contingency plans to tackle crises, as
Dell and Nokia demonstrated.
Adapting Your Supply Chain
Great companies don’t stick to the same supply networks when
markets or strategies change. Rather, such organizations keep
adapting their supply chains so they can adjust to changing
needs. Adaptation can be tough, but it’s critical in
developing a supply chain that delivers a sustainable
advantage.
Most companies don’t realize that in addition to unexpected
changes in supply and demand, supply chains also face
near-permanent changes in markets. Those structural shifts
usually occur because of economic progress, political and
social change, demographic trends, and technological advances.
Unless companies adapt their supply chains, they won’t stay
competitive for very long. Lucent twice woke up late to
industry shifts, first to the rise of the Asian market and
later to the advantages of outsourced manufacturing. (See the
sidebar “Adaptation of the Fittest.”) Lucent recovered the
first time, but the second time around, the company lost its
leadership of the global telecommunications market because it
didn’t adapt quickly enough.
Adaptation of the Fittest
The best supply chains identify structural shifts, sometimes
before they occur, by capturing the latest data, filtering out
noise, and tracking key patterns. They then relocate
facilities, change sources of supplies, and, if possible,
outsource manufacturing. For instance, when Hewlett-Packard
started making ink-jet printers in the 1980s, it set up both
its R&D and manufacturing divisions in Vancouver, Washington.
HP wanted the product development and production teams to work
together because ink-jet technology was in its infancy, and
the biggest printer market was in the United States. When
demand grew in other parts of the world, HP set up
manufacturing facilities in Spain and Singapore to cater to
Europe and Asia. Although Vancouver remained the site where HP
developed new printers, Singapore became the largest
production facility because the company needed economies of
scale to survive. By the mid-1990s, HP realized that
printer-manufacturing technologies had matured and that it
could outsource production to vendors completely. By doing so,
HP was able to reduce costs and remain the leader in a highly
competitive market.
The best supply chains identify structural shifts,
sometimes before they occur, by capturing the latest
data, filtering out noise, and tracking key patterns.
Adaptation needn’t be just a defensive tactic. Companies that
adapt supply chains when they modify strategies often succeed
in launching new products or breaking into new markets. Three
years ago, when Microsoft decided to enter the video game
market, it chose to outsource hardware production to
Singapore-based Flextronics. In early 2001, the vendor learned
that the Xbox had to be in stores before December because
Microsoft wanted to target Christmas shoppers. Flextronics
reckoned that speed to market and technical support would be
crucial for ensuring the product’s successful launch. So it
decided to make the Xbox at facilities in Mexico and Hungary.
The sites were relatively expensive, but they boasted
engineers who could help Microsoft make design changes and
modify engineering specs quickly. Mexico and Hungary were also
close to the Xbox’s biggest target markets, the United States
and Europe. Microsoft was able to launch the product in record
time and mounted a stiff challenge to market leader Sony’s
PlayStation 2. Sony fought back by offering deep discounts on
the product. Realizing that speed would not be as critical for
medium-term survival as costs would be, Flextronics shifted
the Xbox’s supply chain to China. The resulting cost savings
allowed Microsoft to match Sony’s discounts and gave it a
fighting chance. By 2003, the Xbox had wrested a 20% share of
the video game market from PlayStation 2.
Smart companies tailor supply chains to the nature of markets
for products. They usually end up with more than one supply
chain, which can be expensive, but they also get the best
manufacturing and distribution capabilities for each offering.
For instance, Cisco caters to the demand for standard,
high-volume networking products by commissioning contract
manufacturers in low-cost countries such as China. For its
wide variety of mid-value items, Cisco uses vendors in
low-cost countries to build core products but customizes those
products itself in major markets such as the United States and
Europe. For highly customized, low-volume products, Cisco uses
vendors close to main markets, such as Mexico for the United
States and Eastern European countries for Europe. Despite the
fact that it uses three different supply chains at the same
time, the company is careful not to become less agile. Because
it uses flexible designs and standardized processes, Cisco can
switch the manufacture of products from one supply network to
another when necessary.
Gap, too, uses a three-pronged strategy. I
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