Avoiding the Cost of Inefficiency: Coordination and Collaboration in Supply Chain ManagementPublished: September 06, 2006 in Knowledge@Wharton
It's no secret that supply chain management has moved out of the shadows when it comes to business strategy. Organizations that once focused primarily on distribution networks, profit differentiation and improved marketing for their success have now embraced integrated supply chain management as a pivotal strategy component for growth and profitability in the global economy.
But the process of getting the right product to the right place at the right time at the right price -- the traditional touchstones of supply chain success -- remains a challenging and often-times elusive goal. Although supply chains have undoubtedly become more sophisticated in the past few decades, a recent study in the Harvard Business Review found that improved performance hasn't always followed: "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."
And over time, the real value of efficient supply chains and the true costs of inefficient supply chain management have been clearly documented. In a paper titled "What Is the Right Supply Chain for Your Product," Marshall L. Fisher, professor of operations and information management at Wharton and co-director of the Fishman-Davidson Center for Service and Operations Management, cited a study of the U.S. food industry which estimated that "poor coordination among supply chain partners was wasting $30 billion annually. Supply chains in many other industries suffer from an excess of products and a shortage of others owing to an inability to predict demand. One department store chain that regularly had to resort to markdowns to clear unwanted merchandise found in exit interviews that one-quarter of its customers had left its stores empty-handed because the specific items that they had wanted to buy were out of stock." A recent BCG study about supply chain integration for merging companies noted that "any weakness in the system on day one of the new organization's life can quickly translate into excess inventory, stockouts, or even lost customers. And the damage can be severe. In some industries, a flawed integration can drive inventory levels as much as 40% higher within a few short months. It can have a similar or even a greater impact on distribution costs, timeliness of deliveries, and a variety of other metrics."
Supply chain experts from Boston Consulting Group (BCG) and Wharton agree that a careful coordination of supply chain elements and a high level of collaboration are among the primary criteria for creating successful supply chain management. Indeed, in a world of heavy competition, these two supply chain elements -- so often taken for granted -- can mean the difference between the merely functioning and the profitable when it comes to procuring goods and services from vendors around the world and delivering them to global consumers as fast and inexpensively as possible.
"The days when business was done three doors down from the supply room are over," said Steve Matthesen, a vice president in BCG's Los Angeles office and a supply chain expert. "Everyone is pushing for more demanding performances against stronger competitors. . . . My clients are going to broader ranges of SKUs [stock keeping units] in a finer and finer segmentation of customer needs, in order to meet the demands of a growing general consumer trend that says, 'I want what I want; I want it cheaper; I want selection; and if you don't have it, I'll go somewhere else to find it.' The more of this kind of complexity you have in a supply chain, the more difficult it becomes for things to work."
"A complex chain or network of resources has to be managed so that when you go to squeeze your toothpaste in the morning, it's there," said Morris A. Cohen, professor of operations and information management and systems engineering at Wharton and co-director of the Fishman-Davidson Center for Service and Operations Management. "The goal is to match supply with demand at every stage, at every value-added point, so that at the end of the day there is a customer who has a demand and the supply chain figures out how to get the product to that customer at a time and place and a price that they are willing to pay."
The elements of coordination and collaboration in supply chain management range from the very basic concepts of communication to the most sophisticated technology and electronic data interchange available, as well as managing or tracking everything from purchase orders to physical logistics of inventory and tracking the flow of funds among business partners.
'A Huge Competitive Lever'
"The whole supply chain management job is not an easy one," said BCG's Matthesen, noting that the trend toward globalized outsourcing adds layers of complicating factors. "I get calls from companies who say, 'I've moved my sourcing to China and my supply chain is all screwed up' -- as though this is a surprise. They may not know why, but they won't have the right product in the right place at the right time. And they start yelling at their supply chain guys -- 'Why are you doing this wrong?' Usually, the right product is in the wrong place, and too much of the wrong product is everywhere."
For instance, Matthesen said, a company may have placed a similar number of ski parkas in both of its Miami and Denver stores. The Denver store is likely to sell out quickly, while the Miami store will sell few. This forces the company either to dramatically mark down the items in Miami or ship the parkas to Denver. Either situation incurs substantial costs, for no benefit. When a company factors in other expenses -- misplaced inventory taking up valuable retail space for items that would sell, for example -- you have "a lot of waste built in when you make an error in your supply chain. In many cases, the underlying cause of the inefficiency lies in decisions made outside the supply chain organization, but the consequences tend to show up there.
"That said, if you have the right process, procedures, knowledge and strategy there, you can make it work. You might never get to nirvana, but you can be smoothly functioning. And the part to me that is very interesting is that if you get this to work right, it is a huge competitive lever. Your competitors will see that you have an advantage, but it's hard for them to replicate it. They will pick up on a few things, but they simply won't get there."
Matthesen pointed to Dell Computers and its supply chain model of mass customization -- a computer isn't made until there's a custom order for it. "Dell's whole model is based on a supply chain advantage. You have Hewlett Packard trying to keep up with them, but it has a different model, and it's hard to catch up. For a number of legitimate reasons, HP is not willing to do everything that Dell has done, even though Dell's particular supply chain requires all the pieces to work together. If you just take a few pieces, you end up not accomplishing a lot."
Taking the Holistic View
The experts agreed that any supply chain has its particular "pain points," or stumbling blocks that prevent the organization from realizing its financial and growth goals. When a pain point is coordination and collaboration, there are many different elements that should come under scrutiny, cautions supply chain authority Marin Gjaja, BCG's vice president and director in the firm's Chicago office.
"The first hurdle to coordination and collaboration is within the four walls of your company," said Gjaja. The basic principle behind supply chain organization, namely, "getting the right product to the right place at the right time at the lowest possible cost, is not something that most companies are organized to do well. You are cutting across organizational boundaries, where individuals may be more interested in local optimization than global supply chain issues."
In fact, a recent report by Supply Chain Redesign LLC in Raleigh, N.C., defines a lack of internal collaboration and business intelligence as one of the top supply chain pain points. The researchers note that, typically, "Poor communication between business units and disjointed legacy systems prevent coordination and alignment of sourcing and logistics strategies," and, moreover, "internal business performance plans are not aligned with external customer demand requirements."
To understand how these issues play out, Gjaja suggested a quick review of the role of the customer service center. "The main job of the customer service center is to keep customers happy. They take calls from customers who are irate, and their job is to make sure the customer gets off the phone satisfied. They will place an emergency order to have something FedEx-ed to a customer, which means you have a customer service officer who makes the customers happy but is costing the company a lot of money. I have clients who have incurred millions of dollars in shipping and freight, whose customer service departments should perhaps be reminded that they shouldn't ship a $3 item in a $20 package."
To avoid this, Gjaja suggests that the business take a more holistic view of its procedures, "We talk a lot about holistic, end-to-end supply chains looking to both meet demand and serve the customer. That is as much an art as it is a science. Most organizations are not managing the supply chain holistically, and how you coordinate every day is a real challenge. If you look at the customer service center example, you have a mix of business rules, operating processes and incentives that are set up as an individual function, and [meeting those] optimums will come at the expense of the company's global optimums. This is at the heart of a lot of internal dysfunction in a supply chain, and it really comes down to establishing cross-functional coordination and collaboration."
Wharton's Cohen agreed. "I would argue, in fact, that if you haven't figured out the internal problems -- collaboration, coordination and information sharing -- you are probably out of businesses," he said.
A second hurdle comes when a company approaches this problem outside the company's walls. "You have fewer levers that you can pull from an incentive standpoint when it comes to working on collaboration and coordination with suppliers and others outside the firm," Gjaja noted. "What is the coordination cost of trying to work with someone outside the firm? With technology, we've gotten better information. For instance, Wal-Mart can provide information to Procter & Gamble about their store because their incentives are aligned here -- P&G doesn't want its products to be out of stock any more than Wal-Mart does -- but there is also a level of trust. Wal-Mart is entrusting P&G with a fair amount of operational information. Information is one thing; trust is another. Information has facets -- data, understanding of intent, communication around that, and many sub-dimensions. But trust is fundamentally different. It is based on an expectation that you need to fulfill your obligations to me as my partner in this work. I think we forget that collaboration and coordination require that. And when you lose that trust, the friction and the transaction costs go up, and you start to experience more difficulty in working together."
The 'Right' Supply Chain
For Wharton's Fisher, the essence of supply chain management problems boils down to "shortages and failure to get the product, and having too much of the product. Prevent that from happening at a reasonable cost, and that's supply chain management. Having too much of any supply is problematic. Think about apparel at the end of the season, or cars at the end of the model year. You can give back at lot of money at the end of the season in order to reduce inventory and cut losses."
As a supply chain consultant, Fisher has worked with an internationally-known and prestigious jewelry maker, whose single biggest issue was total availability of product. "Everyone in the stores told us, 'Just give us the product. There's too little product. We can't sell what we don't have.' And the most popular items were frequently unavailable." The jewelry maker's supply chain challenges? Reliable, accurate forecasting; better understanding of new product demand; and improved inventory planning at individual store levels.
Fisher's answer to coordination and collaboration problems within supply chain management is to make sure a company finds the right supply chain for each product. "The root cause of the problems plaguing many supply chains is a mismatch between the type of product and the type of supply chain," Fisher wrote in "What Is the Right Supply Chain for Your Product?" In the paper, he argued that products fall into one of two categories: primarily functional or primarily innovative.
According to Fisher, functional products, which include products like milk and food that satisfy basic needs and can be sold in a wide range of retail outlets like grocery stores, are characterized by: predictable demand and easily matched supply and demand patterns; low profit margins; an average stockout rate of 1% to 2%; virtually no forced end-of-season markdown; and low product variety. A functional product requires a supply chain that delivers what Fisher calls a "physically efficient process," one designed to "supply predictable demand efficiently at the lowest possible cost."
But, said Fisher, innovative products like new computer systems, video entertainment products and some fashion trends (like jewelry) have unpredictable demand; an increased risk of shortages or excess supplies; a potential for higher profit margins; high product variety; an average stockout rate of 10% to 40%; and an average forced end-of-season markdown of 10% to 25%. Innovative products require a "market-responsive process" supply chain, designed to "respond quickly to unpredictable demand in order to minimize stockouts, forced markdowns and obsolete inventory."
Using sophisticated mathematical analysis and extensive data collection, Fisher helped create a company called 4R Systems, Inc., an analytical software business designed to improve supply chain forecasts and help companies make better decisions about their inventory dollars, particularly for short life-cycle products. One of the company's programs, for instance, takes point-of-sale and inventory data from retail venues in the home fashion industry and converts that into information that enables the company to optimize stock levels from its distribution centers to client retail locations.
Cohen cautions, however, that coordination of information doesn't always solve supply chain problems, particularly in certain industries where "the information is always changing, due to the nature of the beast when an industry supports so much inherent uncertainty." He cited a study he worked on regarding the semi-conductor equipment industry and its relationship with suppliers. "One of the things we found is that due to their business cycle, there is rapid obsolescence in the product, no matter how much information coordination they experience. If they don't have enough capacity, it's very expensive, but if they have unused capacity, it's very difficult to balance, too. With the uncertainty so great, they will never arrive at the best equilibrium just by collaborating. In fact, it is difficult to see equilibrium when everyone is acting in a collaborative fashion."
Which begs the question: Despite increasing attention paid to supply chains, why are very few firms successful at integrating processes and aligning incentives?
Says BCG's Gjaja: "My suspicion is that the complexity of product-based companies where supply chain is relevant is expanding at a faster rate than information technology can keep up with. By that, I mean that the number of products and different options and customers is expanding -- say it's 100 products times 100 customers times 100 different ways of getting there. You can see that you get this multiplied effect of complexity. The tools you have to deal with it can only evolve so quickly. It will always be a very difficult challenge -- it's one of those perennial issues in management, one of those evergreen topics that you just have to stay one step ahead of."
And Fisher adds that no matter how "synchronized and seamless you think your supply chains are, you are left with the uncertainty of consumer demand. People don't like the fact that demand is unpredictable. Even if you have maximum coordination and a high degree of communication, the one person you can't coordinate with is the consumer . . . . With supply chain management, you have to accept uncertainty."
The optimum answer, according to BCG's Matthesen, is to "design a supply chain that is based on a sound strategy, ensure all parts of your supply chain -- both internally and externally -- have access to good and consistent data, and empower people to make decisions quickly. Build a supply chain that is comfortable with uncertainty and quick to react by taking down the barriers that prevent success."