Even before the recent global downturn, a two-speed world was emerging. Its hallmarks: a slow rate of growth and high per capita income in developed regions such as Europe and North America, and far faster growth in emerging economies with low per capita income, such as China, India and Brazil. Now, after the most significant recession since the 1930s, these divergent growth patterns have become even sharper, with implications for every aspect of a global company’s operations.
A key challenge will be to create flexible and adaptable supply chains that can serve both types of markets while optimizing sales and margins. In high-growth emerging economies, this means delivering rapidly increasing volumes of low-cost and sometimes low-margin products profitably — even in the face of poor infrastructure and convoluted distribution channels. In the low-growth developed economies of Western Europe, the United States and Japan, companies must defend or steal market share by providing better, faster innovation and exceptional service without sacrificing profit margins.
In this article, experts from Wharton and The Boston Consulting Group (BCG) discuss how companies can make their global supply chains more flexible and responsive in order to meet the needs of this two-speed world.
Two Worlds, Stark Differences
A close look at high- and low-growth countries reveals sharp differences that can have a major impact on supply chain management, notes Pierre Mercier, BCG partner and leader of the firm’s supply chain group. For instance, the more mature, low-growth economies have well-developed infrastructures, while emerging high-growth countries — with the exception of China — tend to lack the highways, bridges and airports needed to transport goods efficiently.
Developed economies also have more mature distribution systems and highly developed retail industries. In the U.S, for example, major retailers such as Costco and Wal-Mart are configured for high volumes of goods. Huge loading bays and elevated platforms allow forklifts to load pallets of merchandise onto 18-wheel tractor-trailers that take the goods directly to stores — often with thousands of square feet of retail space — where the lion’s share of sales occur. In India, by contrast, goods can be delivered to very small retailers through a chain of wholesalers that keep decreasing in size. “There’s a whole cascade of distribution, where trucks keep getting smaller and smaller. In some cases, the ultimate delivery vehicle might be a bicycle,” Mercier says.
Because “mom and pop” stores still tend to be a huge part of high-growth-rate economies, distribution involves delivering small quantities of products to a staggering number of locations. Large consumer products companies can have millions of delivery points in India compared with just a few thousand in their more developed markets.
Meanwhile, the more fragmented distribution systems and the undeveloped nature of high-growth economies affects forecasting ability, says Senthil Veeraraghavan, a professor of operations and information management at Wharton. Companies operating in those countries lack up-to-the-minute sales metrics generated by the computerized supply-chain-management systems of more developed economies. “In Western countries, you get a lot of aggregated data from retail centers with which you make informed decisions. In developing countries there is less reliable data available,” says Veeraraghavan. “You have to do a lot of guesswork and legwork. I can tell you how many Droid phones were sold in Philadelphia with certainty. I can’t say that of certain regions in India.”
This difference in planning capabilities dramatically changes service expectations among companies and their customers. The typical proprietor of a mom-and-pop store in an emerging economy is quite flexible about schedules and delivery, Mercier says. But retailers in mature economies demand speedy delivery of specific quantities at specified times — and companies that want to hold on to market share must provide good service.
It helps that highly skilled third-party logistics providers are readily available at a reasonable cost. But developing markets generally lack service providers with sufficient expertise. Increasing service levels in these countries calls for either using Western providers or working closely with suppliers to get them up to speed, says Mercier.
Moreover, a company selling in a mature economy can expect to send and receive invoices electronically, order components in advance, share demand forecasts with its suppliers or customers and pay retailers to stock certain goods and carry inventory. In emerging economies, however, businesses stick to the basics and companies are likely to pay C.O.D., buying right off a delivery truck instead of pre-ordering.
These stark differences leave little opportunity for synergy between supply chains of low- and high-growth economies, Mercier says. Synergies are hard to find even just within emerging markets, given the significant variations among economies, says Morris A. Cohen, a professor of management at Wharton who focuses on supply-chain issues. There’s no one-size-fits-all strategy. “Each country has its own unique flavor, with differences in infrastructure, distribution and retail systems. This diversity calls for different supply chains.”
Price, Customization and Service in Mature Economies
So how can companies adapt their supply chains to a two-speed world? In mature, low-growth economies, strategic pricing is integral to profitability. “If you want to make more money without selling more, then you have to maintain or increase price levels,” Mercier says. “Better service and more innovative products allow you to charge a premium.” To that end, companies must be able to move quickly, working with the best suppliers, developing the right products and getting them to market faster than the competition.
Because of these needs, sourcing from low-cost countries isn’t always the best solution. Many companies are rethinking their sourcing networks and looking at “near shore” production. Making or buying goods closer to end markets may cost more, but shorter supply chains result in greater speed, responsiveness, and flexibility — and less risk. Weighing the trade-offs can be complex, however, and companies need to analyze the economics, Mercier says. China or India may be a good source for easily transported goods or those with high labor content. But when factors such as weight, bulk, or shelf life are considered, the conclusion might be to source closer to home. He points to Mattel, which makes its miniature Hot Wheels cars in China and its larger, bulkier Fisher Price ride-on cars — which are more difficult and costly to ship — in Mexico.
Another factor to consider is the degree of customization that a product requires. A commodity-like product can be made in high volume at a large-scale plant in a low-cost country. “But high-end customized products should be made in a local facility that can react quickly to changes in demand,” Veeraraghavan says. A San Francisco-based manufacturer of messenger bags has a dual manufacturing and sourcing strategy. It produces most of its products in a low-cost country, but it uses a local facility for high-end U.S. customers willing to pay a premium for customized products.
In mature economies, efficiencies can also come from combining forces with other companies, Mercier says. Several years ago, two consumer products companies, working through a European logistics group that helps members identify others with similar distribution routes, discovered that 93% of their combined products were being delivered to the same 127 drop-off points. In a pilot effort, they set up shared delivery schedules and created a shared warehouse to supply inventory to their plants and, in turn, to provide finished products for retailers’ distribution centers. The combined volume justified an investment in warehouse automation to reduce handling costs. The result: Inventory fell by 65%, out-of-stocks decreased by 30% and costs were dramatically reduced.
Another part of the equation in mature economies is the need to provide higher levels of service to retailers and end-customers as cost-effectively as possible. “In developed countries, where growth is slow and consumers have many choices, you need to make sure retailers sell your product,” Mercier says. “If you’re not there, your competitors will be.” One solution is to improve systems and processes that can boost service levels. For example, computerized demand-forecasting systems can better determine appropriate inventory levels, lowering costs and creating greater efficiency. Another approach is to communicate more closely with customers and suppliers. This allows you to monitor demand signals more effectively and make the right trade-offs regarding where to re-supply and when, says Mercier. He points to Procter & Gamble, which has a sizable number of employees stationed near Wal-Mart’s Bentonville, Arkansas, headquarters. By collaborating with Wal-Mart’s team on planning and promotions, for instance, P&G is able to respond more effectively, readily increasing or decreasing the supply of particular products as needed.
Emerging, High-growth Economies: Wringing Costs from the System
In low-wage, developing countries, the average consumer cannot afford expensive products, so cost and value are very important. A company’s supply chain must reflect that reality. “In emerging economies, you need a very low-cost, streamlined supply chain,” says Mercier. “If you deliver a truckload of cookies that you sell at 10 cents a pack, it better cost you less than it does to deliver a truckload of cookies that sell for $3 a pack.”
That makes it essential to wring as many costs out of the system as possible. “You need the lowest possible delivery cost because the consumer can’t pay a premium for a product,” Mercier says. One solution is to strip away processes and procedures that work in Western markets but are unnecessary in high-growth areas. “There’s no need for invoicing systems if retailers pay cash on delivery, for instance.” Even pallets — a staple in developed economies for a century — may be an unnecessary investment in developing economies where labor costs are low.
Multinationals also face a growing threat from ambitious local companies, creating even more urgent pressure to tailor systems to local markets, Mercier says. Many of the factories that companies set up in low-cost countries were replicas of their high-cost domestic plants. By not capitalizing on local conditions and capabilities, they never achieved all of the potential savings. “You can use your old manufacturing and sourcing processes for a while, as long as your competition is like you. But if you’re still operating with a largely Western model in a low-cost country, you won’t win against local competitors,” he says.
When wages are relatively low, for instance, companies can create labor-intensive processes to reduce the cost of equipment, technology and automation. Further savings can come from rethinking product design, choosing fewer and simpler features that better suit the market instead of over-engineering. “You can’t change an industrial footprint and supply chain overnight,” says Mercier. “Western companies are still struggling with legacy systems, while local competitors are unencumbered.”
Another way foreign companies can cut costs is to use local suppliers, who pay less for raw materials, labor and other inputs –and can therefore charge less for their parts and components than Western suppliers. But industries with highly complex products or stringent safety requirements face a greater challenge since most suppliers in emerging economies fall short of the quality standards and process excellence of suppliers in the developed world. “In these cases, the risks of using sub-standard inputs far outweigh any potential cost savings,” notes Stefan Mauerer, a BCG principal based in Munich. “Given the need to squeeze out costs, the solution may be to develop the capabilities of key suppliers in these emerging economies.” A focused development program can lead to major improvements in processes, productivity, quality and costs. “Local suppliers can be a source of innovations as well as cost-saving ideas, so building closer relationships can be well worth the effort,” adds Mauerer. Gain-sharing programs can provide an incentive. “When any savings are shared in an equitable way, everyone has an incentive to contribute and collaborate,” Mercier says.
Playing to Local Strengths
Foreign companies should also explore approaches to distribution that play to local market strengths. To reach small villages in India, for example, Hindustan Unilever Limited taps women’s self-help groups. The company provides training in sales and bookkeeping to help these women become direct-to-consumer distributors for Unilever’s soaps and shampoos. About 45,000 agents serve 3 million consumers in 100,000 villages spread out over 15 states.
According to Wharton’s Cohen, the effort involves “one of the most sophisticated supply-chain systems in the world. The company is able to do statistical analysis through sophisticated modeling and access to complex, timely data about goods being sold in remote villages. And so while state-of-the-art data-aggregation systems may not be the norm, innovative thinking can sometimes combine best practices from both mature and developing and economies, further underscoring the need to tailor efforts to local markets.
Increasingly, multinationals may need to think about supply chains in emerging, high-growth economies both as routes into local markets and a source of parts and finished goods to be distributed globally. Again, though, local conditions should dictate the approach. In China, Wal-Mart has two supply chains — one for sourcing and distribution within China, the other for sourcing just about everywhere else, according to Marshall L. Fisher, a management professor at Wharton whose research focuses on China. Wal-Mart China sells products from thousands of small, local farmers to 187 stores in-country, while Wal-Mart Global Sourcing supplies tens of billions of dollars worth of private label goods to Wal-Mart each year, Fisher says. “It’s not a slam dunk to pull this off. It’s easier to move products 20 miles to a port and then ship them to the U.S. than to supply hundreds of Wal-Mart stores in China that want to buy locally,” he says.
Because of the stark differences between slow-growth and fast-growth economies, supply chain synergies will be hard to come by. Moreover, the increasing interdependence of countries in the global marketplace and the lingering uncertainties of the recent downturn present ongoing challenges. The key is for companies to scan the horizon, keep their options open, and respond quickly to opportunities as they present themselves. “A multinational with a truly global strategy can make, buy or sell wherever the customers, talent or resources are, and wherever it makes the most sense from a cost, quality or efficiency standpoint,” says Mercier. “That’s why a flexible, adaptable supply chain is so critical.”