Supply Chain Executive Summary

ΑΡΙΣΤΟΤΕΛΕΙΟ ΠΑΝΕΠΙΣΤΗΜΙΟ ΘΕΣΣΑΛΟΝΙΚΗΣ ΠΟΛΥΤΕΧΝΙΚΗ ΣΧΟΛΗ-ΤΜΗΜΑ ΜΗΧΑΝΟΛΟΓΩΝ ΜΗΧΑΝΙΚΩΝ ΤΟΜΕΑΣ ΒΙΟΜΗΧΑΝΙΚΗΣ ΔΙΟΙΚΗΣΗΣ ΑΚΑΔΗΜΑΪΚΟ ΕΤΟΣ 2004-2005

ΕΞΑΜΗΝΟ:10ο ΜΑΘΗΜΑ:ΕΦΟΔΙΑΣΤΙΚΗ ΑΛΥΣΙΔΑ ΔΙΔΑΣΚΩΝ:, Αναπλ. Καθηγητής Σάνδρος Αλέξανδρος

What is the right supply chain for your product? by Marshall L. Fisher

Executive summary

Θεσσαλονίκη, Μάρτιος 2005

Introduction Much technology and brain power has been applied to improve supply chains. Companies are able to capture customers’ voice by using sophisticated marketing tools. Their goal is the accurate and quick response to market demands. Mass customization, automated warehousing and agile manufacturing are the means leading to that goal. Despite these efforts, many supply chains have never been worse. Adversarial relationships among partners as well as lack of coordination have lead, in many cases, to an unpredictable rise of cost. The excess of one product and the shortage of another is a common symptom. Why companies are unable to improve their supply chain performance? How can you avoid these problems? Is your product functional or innovative? The most crucial issue is the comprehension of the connection between the nature of demand and the type of supply chain you need. The fundamental problem is the mismatch between the type of product and the type of supply chain. Therefore you have to specify, first, the type of your product. Experience has shown that there are two categories of products: functional and innovative. There are some criteria , such as life cycle and t unpredictability of demand, to make up your mind whether your product belongs to the first or the second category. • Functional products Functional products are those which satisfy basic needs, such as food and gas. These products have long life cycles and predicable (usually stable) demand. Due to their stability, functional products attract many competitors who desire a share of the profits. Companies in order to avoid a decrease of their profits, introduce innovative characteristics into their products. For example YOKOHMA, a Japanese tire manufacturer, will soon offer colorful motorcycle tires! Due to innovation, companies achieve higher profit margins and therefore they are forced to introduce a steady stream of newer innovations. The variety of products constantly increases, as well as the unpredictability of demand but life cycles are becoming shorter. In a few words, your functional product becomes more and more innovative. • Innovative products Since I have defined functional products, it is easy to do the same for the innovative. These products have short life cycles and it is very difficult to forecast their demand. Innovative products usually depend on current fashion and life-style and they generate all the supply headaches because of the uncertain market reaction that increases the risk of having shortages or excess supplies. Although the distinctions between functional and innovative products are obvious, the fact that some products which are physically the same can be either functional or innovative, is the reason why many companies find it difficult to understand the exact nature of their product. Therefore to optimize the performance of your supply chain, the first thing you have to do, is to think carefully and decide in which category your product belongs.

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Supply Chains – the ideal strategy There are two types of supply chains: efficient and responsive. As you can probably guess, efficient chains are applied to functional products and responsive to innovative. Let us see why. A supply chain performs two different functions: a physical function and a market mediation function. Each of the two functions incurs costs. Physical costs are these of production, transportation and inventory storage. Market mediation costs arise when supplies do not match with the demand. The predictable demand of functional products makes physical costs much more crucial than market mediation costs. Applying carefully forecast methods you can achieve service level grater than 95%. As a consequence market mediation costs are hold back. So, your primary concern is the physical function costs. To that end, the stable production rate allows the companies to employ MRP software which organizes and supervises the ordering, production and delivery of supplies. As a result, inventory is minimized and production efficiency is maximized. The important flow of information is within the chain in order to satisfy the demand at the lowest cost. Suppliers are chosen for their low cost and not for their flexibility On the contrary, this approach is completely wrong for innovative products. On this occasion market mediation costs are the most important. This does not mean that there are not any physical costs, but compared to market mediation costs are less significant. It is very important for an innovative product to establish market share at the beginning of its life, a fact that leads to the increase of the cost of shortages. Also, the short life cycle increases the risk of obsolesce due to excess supplies. That’s why market mediation costs are so crucial in that case. The important flow of information is not only within the chain but it also is from the market to the chain. It is also desirable, for the coordination of the chain, all the partners receive real time information from the market. Finally, suppliers are not chosen for their low cost, but for their agile production and their short lead times which allow them to respond quickly to the market’s unpredictable demand. Mismatches Companies that manufacture functional products usually realize that they need an efficient supply chain. If their products remain functional over time, companies stick to efficient supply chains. On the other hand, it is very easy for a company to transform its functional product into innovative through the introduction of any innovation, without realizing that change. All of a sudden, service level drops and inventories of unsold products go up. Despite the efforts to decrease inventories and to restore service level, the number of the problems increases exponentially over time. Twenty years ago companies could supply an innovative product with an efficient chain because market was allowing long lead times for delivery. For example, lead times in computer industry were up to two years! Nowadays, the acceptable lead time has dropped to a few days. Inevitably, the consequences are enormous.

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Matching supply chains with products Many companies turned traditionally functional products into innovative products. How can a company overcome this mismatch. There are two obvious ways to achieve that. Either by making its product functional again or by making its supply chain responsive. The correct decision depends on whether the product is sufficiently innovative so that it can justify the cost of making the supply chain responsive. Turning your product from innovative to functional makes sense when the variety offered is not really necessary. For instance, there are 28 types of toothpaste. Who really needs 28 types of toothpaste? P&G has already simplified many of its products. On the other hand, when a company has an efficient supply chain for its innovative products, the solution is to make some of them functional and organize a responsive supply chain for the rest of them. For example, Fiat should not use the same efficient chain to supply Punto and Ferrari F430. It must do so for Punto, but it should also organize a responsive supply chain for the Ferrari. Efficient supply of functional products Companies have putted a lot of effort to reduce physical costs in their production line. Slowly but stably companies realize that better coordination within the chain will increase their profits. All the partners should have access to everyday’s demand, applying an electronic data interchange system, so that they can react properly. Coordination within the supply chain leads to reduction of inventories. As a result service level reaches 100% and profits can rise up to 50%. In thet point, it must be apprehended that consumers of functional products offer companies predictable demand in exchange of a good product in a reasonable price. You should not disturb this honest relationship. Functional products have a price-sensitive demand. Deep seasonal discounts will create spikes on demand which they will reduce the predictability of demand. There are two types of games for a manufacturer to play within the chain: cooperative and competitive. Assuming that chain costs are fixed, partners now, in a competitive chain struggle for a bigger share of the profits. These negotiations can be fierce. In consequence, retailers are not willing to share information about their costs and, as a result, the performance of the chain drops. Everybody cares for a bigger share and not for the enlargement of the pie On the contrary, in cooperative supply chains the manufacturer establishes a flow of information, capable to reassure the responsiveness of the chain. As the retailers make more money on your product, they pay more attention to them, providing more self space for example. For this reason you will realize that your sales are rising up quickly. On a cooperative supply chain, everybody cares for the enlargement of the pie. Responsive supply of innovative products - dealing with unpredictability Due to mass customization, the unpredictability of demand, which is inherent in innovative products, confuses the supply chains. Companies that grew up in an oligopoly do not accept their forecast errors and they tend to push their employees to try harder. In fact, the best to be done is to accept this uncertainty as something

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positive, because risk is connected to profit. High risk declares high profit margins and the opposite. The problem in production scheduling of innovative products, is the unreliability of the forecasts. But if you sum up all the forecasts for your products, the overall forecast you will get, will be credible enough to count on it. That’s the base of our thoughts, concerning the reduction of the unpredictability of the demand. Of course this kind of strategy has huge impacts on the way the supply chain functions. Since you have made the overall forecast, you are able to begin the mass production of products without customizing them. Your products are now in a “grey” form which means that they are as closer as possible to the finished goods but they are not customized yet. The customization is made according to the order that the customer has already given. This policy is called push-pull. Apart from push-pull policy, it is also very important to reduce lead times and have real information from the market as soon as possible. To achieve the first one, it is fundamental to accelerate the exchange of information within the chain as much as possible. Internet can help you a lot in that point. For the second one, in order to have a first sense about the market trends, you have to force your retailers to give you early orders. Based on these information, you can improve your production schedule Finally once uncertainty has been reduced as much as possible, you can deal with the residual uncertainty with buffers of inventory or excess of capacity. Sport Obermeyer, a fashion ski-wear manufacturer, applied these methods and achieved more than 99% product availability as well as an increase of profits by 60% Remarks The importance of the information flow within the chain, has already been explained. Enterprise Resources Planning software help us to get information about the positioning of inventories and the physical costs of the production line. The problem is that the credibility of this software depends on the employee who inputs data into the system. Does he understand the significance of what he does? I am afraid that particularly in Greece, he does not. Many companies are facing problems with their MRP and ERP software and I think that this is one of the root causes. So, before we trust and use the outcomes of these software, we must be sure that they are showing us the real picture. Something else that we must keep in mind, is that all these methods and all these software do not decide instead of us. They offer us valuable information which can help us to evaluate the situation and decide properly. At the end, it is always up to us to decide.

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