BCG’s Stefan Gstettner discusses how blockchain can transform supply chain management by automating relationships and building trust.

When does blockchain become a significant technology in supply chain management? Only when it adds value by automating interactions and by building trust, notes Stefan Gstettner, partner and associate director at Boston Consulting Group. Gstettner expects blockchain to have the greatest impact in dispersed networks with many participants. “It will have most impact in complex environments and less impact in, say, one factory.” In a conversation with Knowledge at Wharton, Gstettner discusses how blockchain can transform supply chain management, and some of the myths and realities that surround it.

An edited transcript of the conversation follows.

Knowledge at Wharton: How would you define supply chain management and blockchain?

Stefan Gstettner: Supply chain management isn’t well defined across industries. I like to put it is as “end-to-end synchronization of entire value chains.” There are two new words in this —  “end-to-end” and “synchronization.” Both are important.

End-to-end means we need to think through supply chains from the end-customer perspective. For example, consumer goods companies would want to understand what is happening in the downstream end consumer market, at the point of sale, and also on the upstream side into a multi-tier supplier chain. It’s complex and end-to- end, not restricting our search to one company. Synchronization means reacting to changes in the market. In the volatile world that we all live in, it’s essential that supply chains react to changes in the market and be synchronized with the market.

We have to do this on several levels. For instance, there needs to be strategic synchronization — where do we produce, where do we have our warehouses, what about our transport network, how do we produce make or buy decisions? Then there is mid-term alignment, mid-term synchronization between demand and supply, sometimes referred to as integrated business planning. This is about being ready to serve the market in the mid-term, and also all the short-term synchronization, responding to orders, short-term production scheduling, short-term shipments and so on.

“The assumption is that blockchain is the only solution, and that it is good for everything in supply chain management. This is not at all true.”

Knowledge at Wharton: How would you define blockchain?

Gstettner: Blockchain is a different animal. It’s not really a new concept. It’s a technology that enables users to store data in a decentralized way. The term “decentralized” is perhaps the most important one. Not relying on a single database, but using distributed ledgers, distributed storage opportunities, and then storing the blocks into the network. The advantage is that information is available multiple times in the network, which means that it cannot easily be changed. It’s immutable, it’s trustworthy, and can be used by many parties. There’s one other concept, which is the so-called “smart contracts.” I think these are neither smart nor contracts. It’s about executing some things automatically in the blockchain, which is a good concept, but it’s not particularly intelligent and it’s also not a legal contract.

Knowledge at Wharton: Thank you for clarifying that, because based on the way in which blockchain came into prominence, people tend to equate it with technology that underlies Bitcoins and cryptocurrencies. Could we talk a little bit about your own background and how you got interested in supply chain management, and how blockchains can play a role in transforming them?

Gstettner: My supply chain history is relatively long. I would even argue it’s 25 years long because I did my PhD in something that is now called supply chain management. At that time, we didn’t call it supply chain management, but it was analytical and quantitative, with a lot of algorithmic work and so on — what we now would call digital supply chain management. I realized that supply chain management is the most cross-functional function in industry and in our economy. I find it extremely interesting. I did my PhD, I worked in consultancy for some years, and then I moved over to the new economy with some businesses in retail and wholesale.

For the past seven years, I have been with BCG focusing on digital supply chain transformations. When blockchain came up as a concept, it was mandatory for BCG and for me personally to understand what this technology is all about and why and how it plays a role in supply chain management.

Knowledge at Wharton: What are some of the biggest myths around the impact of blockchain in supply chain management? And how would you separate those myths from the facts?

Gstettner: People, institutions and companies seem to think that there is no alternative technology for some purposes in the supply chain. The assumption is that blockchain is the only solution and that it is good for everything in supply chain management. I think this is not at all true. There are many other technologies around. At BCG, to demystify this we came up with a two-by-two classification metric, which we developed with the MIT Media Lab colleagues. The first one is what we call “value of automation.” In a supply chain environment, how much additional value can I get out of automating relationships between parties in the supply chain? The second dimension is the “value of trust.” Only if both are applicable to a large extent, do we say that this is where the sweet spot applications for supply chain are.

In the early days of blockchain, there was the notion that blockchain can help connect parties in the supply chain. That is in general true. However, if we only want to connect parties that anyway know each other, there are many competing technologies like EDI [electronic data interchange], or what many call a supply chain control tower. The question then is: Why should blockchain be considered a promising competing technology here? We call this the control tower application quadrant, because there must be very good reasons to look for blockchain applications to achieve what competing technologies can achieve. And therefore, I think that’s the main obligation separating the myth from the truth — to honestly ask the question: Are we talking about a use case or an application area where blockchain is a unique opportunity and has big advantages over traditional technologies?

Knowledge at Wharton: Could you explain with an example — from the auto industry, for instance — as to how blockchain impacts and transforms supply chain?

Gstettner: You’ve picked a very interesting industry. We started the discussion around our metrics on automotive supply chain, and I think automotive might even be an example where blockchain is probably not the first technology candidate to drive transformation.

Why is that? Because automotive OEMs (original equipment manufacturers) work with their suppliers in very close collaboration. They are co-engineering. They have very close relationships. So why should they use blockchain as a technology to connect to partners whom they already know? The additional value of trust is relatively limited because they already have a well-established connection and trust each other. Therefore, at present blockchain will not transform the traditional auto industry.

When it comes to electrical cars though, the supplier landscape is substantially different; there are new players in the game with different capabilities. They are not as well known to the automotive OEMs and many new connections have to be established. Therefore, here, blockchain can play a role. The additional value of trust can be established by using blockchain as an exchange protocol. But overall, traditional blockchain applications are not seen in the automotive sector. They are maybe more seen in logistics.

“Blockchain is relevant and has the potential to revolutionize industries such as health care or pharma, where authority applications, like FDA requirements, are becoming stronger.”

Knowledge at Wharton: What if we were to take a different industry? Let’s say retail. How do you think retailers can deploy blockchain technology to make their supply chains more agile and profitable?

Gstettner: I don’t want to be over critical, but I doubt whether the blockchain applications in retail – like what Walmart is reporting — is revolutionizing the way of working. Because what they use it for are things like food traceability, for example. For giving the consumer more confidence that the food is coming from healthy origins and that it can be trusted. Now, is that something that will be adopted by the average user over all of the other certifications? Will somebody really take his iPhone, scan a QR code, go into a blockchain application and try to understand where the tomato is coming from? I am personally not 100% convinced.

Blockchain is relevant and has the potential to revolutionize industries such as health care or pharma, where authority applications, like FDA requirements, are becoming stronger. For instance, in pharma one has to track every single unit of a sale — and we are talking about millions and millions of units. There needs to be a unique identifier on every single package to be able to trace back active pharma ingredients and make sure where it all comes from. The value of trust is high here. We want to trust the critical pharmacy ingredients because our lives depend on them.

Knowledge at Wharton: Which aspects of supply chain management do you think will be transformed the most because of blockchain-based solutions, and why?

Gstettner: Since blockchain is a network play, we will see the biggest impact in situations where there are dispersed networks and where many parties are involved. It will have most impact in complex environments and less impact in, say, one factory.

Knowledge at Wharton: What are some of the main barriers or challenges that companies face in trying to implement this technology? And how can these be overcome?

Gstettner: Since blockchains will unfold their potential in complex networks, the biggest barriers are related to this. That is what we observe with many of our clients and also in other use cases. Which is: How can we roll out this technology to a broad ecosystem? It’s not enough to set up a technology platform. It’s more about involving the stakeholders. The more stakeholders that need to be involved — and that has nothing to do with blockchain — the more difficult it becomes.

For instance, gain share mechanisms or who pays what, who has which advantage, how do we share data, maybe even across competitive environments. So the biggest obstacle in establishing blockchain has less to do with the technology. What makes it difficult to scale is that the number of parties that you need to involve is very high.

Knowledge at Wharton: Could you give specific examples of companies that have succeeded in overcoming this challenge of trying to integrate a large number of players in the network? And what can other companies learn from the way they went about it and their experience?

Gstettner: I don’t think that anybody would claim that they have overcome every single challenge. Everybody still has pain points to overcome. Regarding successful examples, DTC, the Diamond Trading Company (a subsidiary of De Beers), has been involved in building a diamond trading supply chain product called Tracer. The success factor here is that this is a relatively consolidated industry. We are not, at the beginning, talking about thousands or tens of thousands of partners that need to be involved. It’s several big players. I think whenever strong players take the initiative and design a blockchain application that is open enough to be attractive even for competitive players or for other parties in the chain to participate, it has a high likelihood of success.

Another example is TradeLens, the Maersk- IBM initiative [TradeLens is a blockchain-enabled shipping solution] where Maersk is a big ocean player. There is always some fear for other market players to step in, because a big competitor is already participating. But when trust is built that data will only be shared for certain purposes, then there is an effect of scaling this up. The success factor is having a credible setup with a leading player and still designing an open enough ecosystem and a fair enough ecosystem, to be attractive for other ones to participate.

Knowledge at Wharton: How much investment is typically required to implement blockchain-based solutions, compared to some of the other technologies that companies might consider? Does the investment depend on the industry? How are companies thinking about these issues?

“Since blockchain is a network play, we will see the biggest impact in situations where there are dispersed networks and where many parties are involved.”

Gstettner: Since the technical foundation is not the bottleneck, we see a very similar situation in blockchain applications that we see with other supply chain applications. The analogy would be a large supply chain control tower solution. First, a solution needs to be installed, and since everything is on the cloud on the control tower side, there is a license fee attached to it. But it’s not double-digit million amounts. It’s far less.

Does using software make any change? The answer is clearly no, because you need to change very many different things within the company. Now, transferring this to blockchain, establishing something on a blockchain platform and then maybe writing some apps onto this, that’s not the decisive cost factor. The decisive cost factor is to design the ecosystem to drive the change in the system.

That then becomes a bigger project. And the cost for this project is not associated so much to blockchain. That can indeed be relatively cheap. The cost is associated to all the brains and all the people that are involved in the companies to make it happen, to drive the change, and also to think through applications that are written, think through user interfaces and all that. So it can be a multimillion project, but that is not because blockchain technology is expensive. It is because it is complicated to bring something like this to life.

Knowledge at Wharton: Are these kinds of solutions mostly beneficial for large companies in consolidated industries? Or can these also benefit small and medium sized companies?

Gstettner: At present, it needs capabilities to build something like this and it’s the bigger companies that are driving the development. But I do believe that blockchain will be a driving technology some years down the road and smaller companies will be able to participate in established blockchain networks. Over time, blockchain networks may become more readily available and become more a standard of the network economy. However, for the time being, it’s more about the bigger companies.

Knowledge at Wharton: How should companies measure the value or the ROI of investing in blockchain technology for the supply chains?

Gstettner: It’s similar to how you measure the ROI of any supply chain project. It’s dependent on what you want to achieve. For example, you may want to drive customer service, a superior customer experience, and therefore higher revenues and higher margins. In the diamond supply chain, we see an upside if clients can trust that the diamond is ethically sourced. That will drive higher sales, and this has an impact on the ROI.

“The biggest obstacle in establishing blockchain has less to do with the technology. What makes it difficult to scale is that the number of parties that you need to involve is very high.”

You can also measure ROI by way of cost reduction. Whenever transactions are automated or paperwork is reduced resulting in reducing costs, it can be seen as ROI. So the ROI measurement will not differ from traditional supply chain projects. That’s why it is important to have a good use case for a blockchain project and to be very clear about what you want to achieve with the technology.

Knowledge at Wharton: What do you think the supply chains of the future will look like, and how pervasive do you expect blockchain to be in supply chains say in the next three to five years?

Gstettner: At present, we are in an ongoing wave of companies thinking through their supply chain vision. There is still a long way to go for many companies to introduce technologies like artificial intelligence. How can I have a machine learning-driven supply chain? There are also other buzz words like self-driving supply chain and many companies are in their transformation process. I do believe there will be a development with what we call the bionic supply chain, which is the machine-augmented but still human-driven supply chain, and that is happening now.

What I foresee is that the combination of many of those technologies, and adding some other technologies like 3D printing, for example, will lead to a much more networked economy with lower-scale requirements. So you won’t need the mega centers, you won’t need the mega factories, and companies can move closer to their consumers or to their customers, and then can run much smaller network operations.

Blockchain will be the technology to help steer those more and more complex networks. And then it will kick in. But I’m relatively convinced that this will not happen in the next three to five years. Companies have a long transformation journey ahead of them with traditional digital technologies like machine learning, robotics and other automation opportunities. Only after that will blockchain unfold its true potential. I think in 10 years from now blockchain will become a default, especially in networked, smaller scale environments.