In the face of increasing complexity in global supply chains, more companies are realizing that supply chain management (SCM) is a mission-critical element, and no longer simply the domain of the warehouse manager or logistics director. But even as companies adopt SCM strategies in an effort to keep up, experts from Wharton and Boston Consulting Group (BCG) report that many still lag when it comes to measuring how well they are doing, and balancing the trade-offs involved in keeping service levels high and costs low.

“The major trends in business right now — low-cost country sourcing, outsourcing, customization, globalization and more — all create tremendous complexities in a supply chain,” says Steve Matthesen, vice president and global leader for supply chain at BCG. “In most cases, however, companies have not changed how they manage this critical part of the business.”

According to Matthesen, that’s largely because most company executives don’t have a supply chain background, and they tend to view the supply chain function as “a black box” that they don’t understand or have limited visibility into. “CEOs feel that their supply chain costs too much and doesn’t work very well. They’re quick to ask, ‘How hard can it be to get the products to the right place at the right time?’ Well, it can be pretty hard,” he says, citing three major factors that have dramatically increased the stress on supply chains:

  • Fragmenting customer needs, resulting in a broader selection of SKUs (stock keeping units) aimed at specific consumer segments, different price points, shorter product life-cycles, and less predictable demand patterns;

  • Increased cost pressures based on global competition and shareholder demands to reduce working capital;

  • A new level of complexity brought on by more complicated distribution models, increased outsourcing, and “new technologies that promise efficiency but can increase complexity.”

While supply chains are getting more difficult to manage, the competitive environment means that most companies need to further reduce costs.  In such an environment, successful SCM “means getting better results with the same, or fewer, resources,” according to Gerald P. Cachon, Wharton associate professor of operations and information management. “It’s like squeezing more juice from a lemon, or maybe blood from a stone.”

Knowing What to Measure

“You can’t manage what you can’t measure,” says Morris A. Cohen, Wharton professor and Co-Director, Fishman-Davidson Center for Service and Operations Management. “And that’s as true for supply chain management as it is for other parts of a business’ operations.”

He says that many SCM metrics, like inventory turnover, are already built into a typical accounting system. But some of the more sophisticated benchmarks, including measuring the level of customer satisfaction, take some work to develop.

And a key issue is simply knowing what to measure.

Matthesen agrees that the challenge is measuring the right things. “Most operations groups track a ton of metrics. The issue is whether they are tracking the metrics that will identify how they are meeting the strategic needs of the company and what is relevant to their customers.”

“When I asked a major car manufacturer if it considered customer satisfaction levels, executives advised me that they measured their customer service by the fill rate of the vehicles they sent to dealers,” relates Cohen. “Based on that, they said they had a high rate of customer satisfaction. But when I asked them to survey the ultimate customer, the buying public, they were shocked to find that consumers were not satisfied with the quality of the vehicles.”

Cohen says, however, that more companies are beginning to realize that they need end-to-end visibility in their supply chain management efforts. “SCM is about more than just sensing and responding,” he explains. “Companies need to anticipate demand, since it takes time to respond to demand-side changes. They’re learning, but there’s still plenty of room for improvement.”

Matthesen notes there is an inherent trade-off in meeting that demand: “How much service level can I give my customers before everyone screams about what it costs?” he asks. “If I have a retail store, and I want to deliver every day instead of twice a week, that will cost me more money. It’s all about service levels: how fast do I get you your product compared to when you want it, when you ordered it, when you need it. And what will it cost?”

But cost is only one lens, Matthesen argues. “The goal is to maximize overall value.  You want to have low costs, but first you need to have a strategy that will let you win in the marketplace.  Sometimes that strategy requires spending more cost to get a much higher margin.”

To determine this, Matthesen says companies need to make sure they have a “crystal-clear view” of what their customer really wants — what minimum service level is required to meet their needs, and what they will be willing to pay for superior service. Service level here includes all attributes of the supply chain as experienced by customers: in-stock rates, delivery time, product assortment, etc.

In general, higher performance means higher costs, Matthesen notes. “Your company needs to make sure those costs are justified.”

While the concept of understanding what performance level customers want sounds simple, in practice it is not. Companies have two gaps, he says: a true understanding of their current performance, and a deep understanding of what their customers need — and are prepared to pay for.

“Every company has metrics that track performance,” he says. “The key question is whether these metrics really provide visibility to performance as viewed by the customer. For example, one company measured itself by the percentage of orders received that day that were successfully fulfilled on time. Their performance against this metric was very high (over 99%). However, they didn’t track the time between a customer placing the order and receiving their goods. When measured this way, the performance was much lower than expected. The reason was that often orders were shipped from the wrong distribution center — resulting in longer delivery times and higher freight costs.” 

Measuring customer needs is perhaps even trickier, he notes. “How do you know whether you would lose business or gain business if you change your service level? In most cases, there isn’t much hard data to work with. It’s also hard to ask your customers, since they are likely to respond that they want higher service levels at lower costs.  You need to dive more deeply into how your customers think about your business and what role you play in their lives. [Companies] may also need to run some experiments in the field to validate their assessments.”

The Trade-offs Between Service and Costs

If the essence of supply chain management is to provide the right products in the right amounts to the right place at the right time — all at the right cost — then a concept called the “efficient frontier” is a useful way to gage capability. For any business function, an efficient frontier can be found by plotting points along a trade-off curve between two or more performance metrics. Applied to supply chain performance, “the efficient frontier is a two-dimensional space, with service level and costs along the two axes,” says Mark D. Lubkeman, a senior vice president in BCG’s Los Angeles office. “At one end, you have terrific, wonderful service at a huge cost. Or you could have lower costs and slow delivery times. The question is, where do you want to fall on the graph?”

A company’s strategy should guide its supply chain design, he notes. In addition, many companies need to further segment based on the specific markets and customers they are addressing.

As an example, Lubkeman points to appliance retailing stores. “Retailers who compete from a broad SKU base have high levels of in-stock goods where the goal is ‘to walk in and get it right there,'” he says. “But what about other appliance retail stores with narrower SKU mixes that don’t have a lot in stock? They may provide service and attention, and will do what needs to be done to get customers just what they want.”

Those two businesses and the supply chains they require are very different, notes Lubkeman. That means the efficient frontier for each is very different, too. The goal of any company, then, is to maintain a position on the efficient frontier that protects both its own interests and acknowledges the interests and needs of its customers.

“It’s dangerous for any company to say, ‘We have one frontier,'” Lubkeman advises. “That doesn’t make sense in any business, so why should it in a supply chain?”

The key, he says, is really to “de-average” the efficiency frontier, to take apart the average and look at the individual customer segments. “For most, the efficient frontier is the point on the curve where you provide the service — no more, no less — that makes the customer happy at minimal cost,” he details. “That’s your frontier.”         

Cachon and others note that the trend toward supply chain product segmentation “generally means more complexity, which makes getting to the efficient frontier harder.”

Providing different levels of customization and variety is tricky for supply chain management says Cohen. How do you ration your resources and prioritize when facing streams of demand from different customers for the same item, customers who have paid a different price and to whom you have made different promises? “It is inefficient to chop up the supply chain for different customers, but exploiting those things keeps you on the efficient frontier,” he counsels. “Keeping the supply chain flexible is key.”

The efficient frontier is a helpful framework, but BCG’s Matthesen is quick to point out that most companies are not getting the full value from their supply chain investments. “Your infrastructure investments will have been made based on a trade-off between service level and cost, but in many cases, companies are actually off the efficient frontier — meaning they are getting lower performance and higher costs — because of how they operate. For example, one of my clients found that they often shipped from non-optimal distribution centers based on a number of factors. This meant that they incurred extra freight costs as well as delivered a lower service level to their customers. By addressing this problem they realized improved performance at lower cost — the elusive free lunch!”

Getting to the efficient frontier is not a simple task, notes Cohen. “You may not be managing processes correctly, not using the right technology; there are a variety of reasons to explain why some companies are not on it and others are.”

“If you give me a set of parameters, a particular supply chain structure and an assumed forecast, we can find the efficient frontier,” says Cachon. “But no firm ever has all the information they need. What are all the costs? What are the demand distributions? What are the uncertainties in terms of weather, union strikes, and fires?”

He adds that as supply chains become more complex, they have more participants, more locations, and are geographically more dispersed. The amount of information needed to find the efficient frontier appears to grow exponentially.

One important development, the burgeoning array of technological tools and software applications, can make it easier for companies to find their efficient frontier.

“Making it to the efficient frontier involves the application of optimization techniques which require careful data collection and generally customization to the firm’s particular environment,” said Cachon, who studies how new technologies can improve supply chains and consults for companies that provide optimization solutions for retail customers. “I have directly seen how the smart application of optimization technology can improve a retailer’s inventory performance, with higher service and higher turns.”

Lubkeman believes that incorporating new efficient frontier software programs can be a plus. “They basically help you optimize transactional decisions,” he said. But he adds a warning: “Unless you’ve got the underlying understanding of the customers and articulated the strategies you need to serve those customers, you run the risk of having the technology drive the strategy instead of the other way around.”

Companies on the Frontier

Hal Sirkin, a BCG senior vice president in Chicago and leader of its operations practice globally, believes that most companies are operating below the efficient frontier, and don’t realize how to make the tradeoffs that are required to get to it.

“I don’t think they understand it,” he says. “I think they want to improve their supply chain, but I don’t think they know that there is an optimal operating capability and an optimal way to operate their business.”

To improve their position on the efficient frontier, Sirkin suggests that companies take such steps as reviewing out-of-date technology and substituting more efficient programs that provide better data and analysis; reviewing their warehouse locations and designs and changing them as needed to gain greater efficiencies; and reviewing their supply chains for costs. He also says to consider staffing requirements and to look at outsourcing as a way to save money or increase service.

Matthesen adds, “While there are improvements possible within the four walls of the supply chain function, the bulk of the benefit comes when you break down the functional silos and better coordinate across the entire business, and your suppliers and customers.” Key priorities are aligning the supply chain with company strategy, aligning incentives across functions and with external parties, arming people with the right data “so they can make holistic decisions,” and building flexibility to quickly respond to demand, rather than relying on forecasts.

“CEOs need to engage with their management teams to understand how their supply chain works today — how it supports the business and how it prevents success.  Together, they need to evolve the strategy and supply chain to move the business to a position where the supply chain supports and enables a winning strategy. This cannot be accomplished by the head of supply chain alone,” he says.

The pay-off is substantial. “A fully aligned supply chain and strategy delivers a superior business model,” Matthesen adds. “Given the difficulties of achieving this, the benefits are often sustainable and create real advantage. Your competitors are likely to want to copy pieces of your strategy without realizing how the entire strategy and supply chain work together — and they will not be able to match your performance.”