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Question 1:

What does Lee mean by the term, “Triple-A Supply Chains?” Explain Lee’s use of this concept to explain how supply chains can give companies a sustainable competitive advantage.

What are the forces that prompt or cause movement along the Triple-A Supply Chain?

Do you have any personal experience with these forces operating in the Triple-A arena, either with your firm or among your firm’s suppliers or customers? Please elaborate

Question 2:

Fisher essential says that based upon product types–functional or innovative—supply chains require either an efficient or responsive supply chain or risk being mismatched. Do you agree or disagree with Marshall Fisher’s viewpoint? Please explain your position.

He also implies that there is a trade-off between an efficient and a responsive supply chain. Do you agree? Explain

www.hbr.org

The Triple-A Supply
Chain

Hau L. Lee

The best supply chains aren’t

just fast and cost-effective.

They are also agile and

adaptable, and they ensure

that all their companies’

interests

stay aligned.

Reprint R0410F

For the exclusive use of A. Bregante, 2020.

This document is authorized for use only by Anthony Bregante in SCM 850 Spring 2020-1-1 taught by NORMAN AGGON, The Pennsylvania State University from Jan 2020 to Jul 2020.

http://www.hbr.org

http://harvardbusinessonline.hbsp.harvard.edu/relay.jhtml?name=itemdetail&referral=4320&id=R0410F

The 21st Century
Supply Chain The Articles

HBR Spotlight

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Managing the modern supply chain is
a job that involves specialists in manu-
facturing, purchasing, and distribution,
of course. But today it is also vital to
the work of chief financial officers, chief
information officers, operations and
customer service executives, and cer-
tainly chief executives. Changes in sup-
ply chain management have been truly
revolutionary, and the pace of progress
shows no sign of moderating. In our
increasingly interconnected and inter-
dependent global economy, the pro-
cess of delivering supplies and finished
goods (and information and other
business services) from one place to
another is accomplished by means of
mind-boggling technological innova-
tions, clever new applications of old
ideas, seemingly magical mathematics,
powerful software, and old-fashioned
concrete, steel, and muscle.

An end-to-end, top-to-bottom transfor-
mation of the twenty-first-century
supply chain is shaping the agenda for
senior managers now and will continue
to do so for years to come. With this
special series of articles,

Harvard Business
Review

examines how corporations’
strategies and structures are changing
and how those changes are manifest in
their supply chains.

The Triple-A Supply Chain

by Hau L. Lee
October 2004

The best supply chains aren’t just fast and cost-effective. They are also agile and adaptable,
and they ensure that all their companies’ interests stay aligned.

Reprint R0410F;

OnPoint 8096

Leading a Supply Chain Turnaround

Reuben E. Slone

October 2004

Five years ago, salespeople at Whirlpool said the company’s supply chain staff were “sales
disablers.” Now, Whirlpool excels at getting the right product to the right place at the right
time—while keeping inventory low. What made the difference?

Reprint R0410G

Aligning Incentives in Supply Chains

by V.G. Narayanan and Ananth Raman
November 2004

A supply chain stays tight only if every company in the chain has reasons to pull in the
same direction.

Reprint R0411F; OnPoint 8363

Rapid-Fire Fulfillment

by Kasra Ferdows, Michael A. Lewis, and Jose A.D. Machuca
November 2004

Spanish clothier Zara turns the rules of supply chain management on their head. The result?
A superresponsive network and profit margins that are the envy of the industry.

Reprint R0411G

Building Deep Supplier Relationships

by Jeffrey K. Liker and Thomas Y. Choi
December 2004

Two Japanese automakers have had stunning success building relationships with North
American suppliers—often the same supplier companies that have had contentious dealings
with Detroit’s Big Three. What are Toyota and Honda doing right that their American
counterparts are missing?

Reprint R0412G

We’re in This Together

by Douglas M. Lambert and A. Michael Knemeyer
December 2004

If your latest supply chain partnership failed to live up to expectations, as so many do, it’s
probably because you never stated your expectations in the first place.

Reprint R0412H

For the exclusive use of A. Bregante, 2020.
This document is authorized for use only by Anthony Bregante in SCM 850 Spring 2020-1-1 taught by NORMAN AGGON, The Pennsylvania State University from Jan 2020 to Jul 2020.

The Triple-A Supply
Chain

by Hau L. Lee

harvard business review • october 2004 page 1

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The best supply chains aren’t just fast and cost-effective. They are also

agile and adaptable, and they ensure that all their companies’ interests

stay aligned.

During the past decade and a half, I’ve studied
from the inside more than 60 leading compa-
nies that focused on building and rebuilding
supply chains to deliver goods and services to
consumers as quickly and inexpensively as
possible. Those firms invested in state-of-the-
art technologies, and when that proved to be
inadequate, they hired top-notch talent to
boost supply chain performance. Many com-
panies also teamed up to streamline processes,
lay down technical standards, and invest in in-
frastructure they could share. For instance, in
the early 1990s, American apparel companies
started a Quick Response initiative, grocery
companies in Europe and the United States
touted a program called Efficient Consumer
Response, and the U.S. food service industry
embarked on an Efficient Foodservice Re-
sponse program.

All those companies and initiatives persistently
aimed at greater speed and cost-effectiveness—
the popular grails of supply chain manage-
ment. Of course, companies’ quests changed
with the industrial cycle: When business was

booming, executives concentrated on maxi-
mizing speed, and when the economy headed
south, firms desperately tried to minimize
supply costs.

As time went by, however, I observed one
fundamental problem that most companies
and experts seemed to ignore: Ceteris paribus,
companies whose supply chains became more
efficient and cost-effective didn’t gain a sus-
tainable advantage over their rivals. In fact,
the performance of those supply chains
steadily deteriorated. For instance, 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.

Evidently, it isn’t by becoming more effi-
cient that the supply chains of Wal-Mart,
Dell, and Amazon have given those compa-
nies an edge over their competitors. Accord-
ing to my research, top-performing supply

The Triple-A Supply Chain

harvard business review • october 2004 page 2

chains possess three very different qualities.
First, great supply chains are agile. They react
speedily to sudden changes in demand or sup-
ply. Second, they adapt over time as market
structures and strategies evolve. Third, they
align the interests of all the firms in the sup-
ply network so that companies optimize the
chain’s performance when they maximize
their interests. Only supply chains that are ag-
ile, adaptable, and aligned provide companies
with sustainable competitive advantage.

The Perils of Efficiency

Why haven’t efficient supply chains been able
to deliver the goods? For several reasons.
High-speed, low-cost supply chains are unable
to respond to unexpected changes in demand
or supply. Many companies have centralized
manufacturing and distribution facilities to
generate scale economies, and they deliver
only container loads of products to customers
to minimize transportation time, freight costs,
and the number of deliveries. When demand
for a particular brand, pack size, or assortment
rises without warning, these organizations are
unable to react even if they have the items in
stock. According to two studies I helped con-
duct in the 1990s, the required merchandise
was often already in factory stockyards,
packed and ready to ship, but it couldn’t be
moved until each container was full. That
“best” practice delayed shipments by a week
or more, forcing stocked-out stores to turn
away consumers. No wonder then that, ac-
cording to another recent research report,
when companies announce product promo-
tions, stock outs rise to 15%, on average, even
when executives have primed supply chains to
handle demand fluctuations.

When manufacturers eventually deliver ad-
ditional merchandise, it results in excess inven-
tory because most distributors don’t need a
container load to satisfy the increased demand.
To get rid of the stockpile, companies mark
down those products sooner than they had
planned to. That’s partly why department
stores sell as much as a third of their merchan-
dise at discounted prices. Those markdowns
not only reduce companies’ profits but also
erode brand equity and anger loyal customers
who bought the items at full price in the recent
past (sound familiar?).

Companies’ obsession with speed and costs
also causes supply chains to break down during

the launch of new products. Some years ago, I
studied a well-known consumer electronics
firm that decided not to create a buffer stock
before launching an innovative new product. It
wanted to keep inventory costs low, particu-
larly since it hadn’t been able to generate an
accurate demand forecast. When demand rose
soon after the gizmo’s launch and fell sharply
thereafter, the company pressured vendors to
boost production and then to slash output.
When demand shot up again a few weeks later,
executives enthusiastically told vendors to step
up production once more. Five days later, sup-
plies of the new product dried up as if some-
one had turned off a tap.

The shocked electronics giant discovered
that vendors had been so busy ramping pro-
duction up and down that they hadn’t found
time to fix bugs in both the components’ man-
ufacturing and the product’s assembly pro-
cesses. When the suppliers tried to boost out-
put a second time, product defects rose to
unacceptable levels, and some vendors, includ-
ing the main assembler, had to shut down pro-
duction lines for more than a week. By the
time the suppliers could fix the glitches and re-
start production, the innovation was all but
dead. If the electronics company had given
suppliers a steady, higher-than-needed manu-
facturing schedule until both the line and de-
mand had stabilized, it would have initially
had higher inventory costs, but the product
would still be around.

Efficient supply chains often become un-
competitive because they don’t adapt to
changes in the structures of markets. Consider
Lucent’s Electronic Switching Systems division,
which set up a fast and cost-effective supply
chain in the late 1980s by centralizing compo-
nent procurement, assembly and testing, and
order fulfillment in Oklahoma City. The supply
chain worked brilliantly as long as most of the
demand for digital switches emanated from
the Americas and as long as Lucent’s vendors
were mostly in the United States. However, in
the 1990s, when Asia became the world’s fast-
est-growing market, Lucent’s response times in-
creased because it hadn’t set up a plant in the
Far East. Furthermore, the company couldn’t
customize switches or carry out modifications
because of the amount of time and money it
took the supply chain to do those things across
continents.

Lucent’s troubles deepened when vendors

Hau L. Lee

(haulee@stanford.edu) is
the Thoma Professor of Operations,
Information, and Technology at the
Stanford Graduate School of Business in
Stanford, California, and the codirector
of the Stanford Global Supply Chain
Management Forum. He is the coeditor
(with Terry P. Harrison and John J. Neale)
of

The Practice of Supply Chain Man-
agement: Where Theory and Applica-
tion Converge

(Kluwer Academic Pub-
lishers, 2003).

mailto:haulee@stanford.edu

The Triple-A Supply Chain

harvard business review • october 2004 page 3

shifted manufacturing facilities from the
United States to Asia to take advantage of the
lower labor costs there. “We had to fly compo-
nents from Asia to Oklahoma City and fly
them back again to Asia as finished products.
That was costly and time consuming,” Lucent’s
then head of manufacturing told me. With
tongue firmly in cheek, he added, “Neither
components nor products earned frequent-
flyer miles.” When Lucent redesigned its supply
chain in 1996 by setting up joint ventures in
Taiwan and China to manufacture digital
switches, it did manage to gain ground in Asia.

In this and many other cases, the conclusion
would be the same: Supply chain efficiency is
necessary, but it isn’t enough to ensure that
firms will do better than their rivals. Only
those companies that build agile, adaptable,
and aligned supply chains get ahead of the
competition, as I pointed out earlier. In this ar-
ticle, I’ll expand on each of those qualities and
explain how companies can build them into
supply chains without having to make trade-
offs. In fact, I’ll show that any two of these di-
mensions alone aren’t enough. Only compa-
nies that build all three into supply chains be-
come better faster than their rivals. I’ll
conclude by describing how Seven-Eleven
Japan has become one of the world’s most
profitable retailers by building a truly “triple-A”
supply chain.

Fostering

Agility

Great companies create supply chains that re-

spond to sudden and unexpected changes in
markets. Agility is critical, because in most in-
dustries, both demand and supply fluctuate
more rapidly and widely than they used to.
Most supply chains cope by playing speed
against costs, but agile ones respond both
quickly and cost-efficiently.

Most companies continue to focus on the
speed and costs of their supply chains without
realizing that they pay a big price for disregard-
ing agility. (See the sidebar “The Importance of
Being Agile.”) In the 1990s, whenever Intel un-
veiled new microprocessors, Compaq took
more time than its rivals to launch the next
generation of PCs because of a long design cy-
cle. The company lost mind share because it
could never count early adopters, who create
the buzz around high-tech products, among its
consumers. Worse, it was unable to compete
on price. Because its products stayed in the
pipeline for a long time, the company had a
large inventory of raw materials. That meant
Compaq didn’t reap much benefit when com-
ponent prices fell, and it couldn’t cut PC prices
as much as its rivals were able to. When ven-
dors announced changes in engineering speci-
fications, Compaq incurred more reworking
costs than other manufacturers because of its
larger work-in-progress inventory. The lack of
an agile supply chain caused Compaq to lose
PC market share throughout the decade.

By contrast, smart companies use agile sup-
ply chains to differentiate themselves from ri-
vals. For instance, H&M, Mango, and Zara

Building the Triple-A Supply Chain

Agility

Objectives:

Respond to short-term changes in demand or
supply quickly; handle external disruptions
smoothly.

Methods:

•

Promote flow of information with suppliers
and customers.

•

Develop collaborative relationships with
suppliers.

•

Design for postponement.

•

Build inventory buffers by maintaining a
stockpile of inexpensive but key components.

•

Have a dependable logistics system or partner.

•

Draw up contingency plans and develop
crisis management teams.

Adaptability

Objectives:

Adjust supply chain’s design to meet struc-
tural shifts in markets; modify supply network
to strategies, products, and technologies.

Methods:

•

Monitor economies all over the world to
spot new supply bases and markets.

•

Use intermediaries to develop fresh
suppliers and logistics infrastructure.

•

Evaluate needs of ultimate consumers—
not just immediate customers.

•

Create flexible product designs.

•

Determine where companies’ products
stand in terms of technology cycles and
product life cycles.

Alignment

Objective:

Create incentives for better performance.

Methods:

•

Exchange information and knowledge freely
with vendors and customers.

•

Lay down roles, tasks, and responsibilities
clearly for suppliers and customers.

•

Equitably share risks, costs, and gains of
improvement initiatives.

The Triple-A Supply Chain

harvard business review • october 2004 page 4

have become Europe’s most profitable apparel
brands by building agility into every link of
their supply chains. At one end of their prod-
uct pipelines, the three companies have cre-
ated agile design processes. As soon as design-
ers spot possible trends, they create sketches
and order fabrics. That gives them a head start
over competitors because fabric suppliers re-
quire the longest lead times. However, the
companies finalize designs and manufacture
garments only after they get reliable data
from stores. That allows them to make prod-
ucts that meet consumer tastes and reduces
the number of items they must sell at a dis-
count. At the other end of the pipeline, all
three companies have superefficient distribu-
tion centers. They use state-of-the-art sorting
and material-handling technologies to ensure
that distribution doesn’t become a bottle-
neck when they must respond to demand
fluctuations. H&M, Mango, and Zara have all
grown at more than 20% annually since 1990,
and their double-digit net profit margins are
the envy of the industry.

Agility has become more critical in the past
few years because sudden shocks to supply

chains have become frequent. The terrorist at-
tack in New York in 2001, the dockworkers’
strike in California in 2002, and the SARS epi-
demic in Asia in 2003, for instance, disrupted
many companies’ supply chains. While the
threat from natural disasters, terrorism, wars,
epidemics, and computer viruses has intensi-
fied in recent years, partly because supply lines
now traverse the globe, my research shows
that most supply chains are incapable of cop-
ing with emergencies. Only three years have
passed since 9/11, but U.S. companies have all
but forgotten the importance of drawing up
contingency plans for times of crisis.

Without a doubt, agile supply chains re-
cover quickly from sudden setbacks. In Sep-
tember 1999, an earthquake in Taiwan delayed
shipments of computer components to the
United States by weeks and, in some cases, by
months. Most PC manufacturers, such as Com-
paq, Apple, and Gateway, couldn’t deliver
products to customers on time and incurred
their wrath. One exception was Dell, which
changed the prices of PC configurations over-
night. That allowed the company to steer con-
sumer demand away from hardware built with
components that weren’t available toward ma-
chines that didn’t use those parts. Dell could
do that because it got data on the earthquake
damage early, sized up the extent of vendors’
problems quickly, and implemented the plans
it had drawn up to cope with such eventuali-
ties immediately. Not surprisingly, Dell gained
market share in the earthquake’s aftermath.

Nokia and Ericsson provided a study in
contrasts when in March 2000, a Philips facil-
ity in Albuquerque, New Mexico, went up in
flames. The plant made radio frequency (RF)
chips, key components for mobile telephones,
for both Scandinavian companies. When the
fire damaged the plant, Nokia’s managers
quickly carried out design changes so that
other companies could manufacture similar
RF chips and contacted backup sources. Two
suppliers, one in Japan and another in the
United States, asked for just five days’ lead
time to respond to Nokia. Ericsson, mean-
while, had been weeding out backup suppli-
ers because it wanted to trim costs. It didn’t
have a plan B in place and was unable to find
new chip suppliers. Not only did Ericsson
have to scale back production for months
after the fire, but it also had to delay the
launch of a major new product. The bottom

The Importance of Being Agile

Most companies overlook the idea that
supply chains should be agile. That’s un-
derstandable; adaptability and alignment
are more novel concepts than agility is.
However, even if your supply chain is
both adaptable and aligned, it’s danger-
ous to disregard agility.

In 1995, Hewlett-Packard teamed up
with Canon to design and launch ink-jet
printers. At the outset, the American
company aligned its interests with those
of its Japanese partner. While HP took on
the responsibility of producing printed
circuit boards (or “formaters”), Canon
agreed to manufacture engines for the
LaserJet series. That was an equitable di-
vision of responsibilities, and the two
R&D teams learned to work together
closely. After launching the LaserJet, HP
and Canon quickly adapted the supply
network to the product’s markets. HP
used its manufacturing facilities in Idaho
and Italy to support the LaserJet, and

Canon used plants in West Virginia and
Tokyo.

But HP and Canon failed to anticipate
one problem. To keep costs down, Canon
agreed to alter the number of engines it
produced, but only if HP communicated
changes well in advance—say, six or
more months before printers entered the
market. However, HP could estimate de-
mand accurately only three or fewer
months before printers hit the market. At
that stage, Canon could modify its manu-
facturing schedule by just a few percent-
age points. As a result, the supply chain
couldn’t cope with sudden fluctuations in
demand. So when there was an unex-
pected drop in demand for the LaserJet
III toward the end of its life cycle, HP was
stuck with a huge and expensive surplus
of printer engines: the infamous LaserJet
mountain. Having an adaptable and
aligned supply chain didn’t help HP over-
come its lack of agility.

The Triple-A Supply Chain

harvard business review • october 2004 page 5

line: Nokia stole market share from Ericsson
because it had a more agile supply chain.

Companies can build agility into supply
chains by adhering to six rules of thumb:

• Provide data on changes in supply and de-
mand to partners continuously so they can re-
spond quickly. For instance, Cisco recently cre-
ated an e-hub, which connects suppliers and
the company via the Internet. This allows all
the firms to have the same demand and supply
data at the same time, to spot changes in de-
mand or supply problems immediately, and to
respond in a concerted fashion. Ensuring that
there are no information delays is the first step
in creating an agile supply chain.

• Develop collaborative relationships with
suppliers and customers so that companies
work together to design or redesign processes,
components, and products as well as to prepare
backup plans. For instance, Taiwan Semicon-
ductor Manufacturing Company (TSMC), the
world’s largest semiconductor foundry, gives
suppliers and customers proprietary tools, data,
and models so they can execute design and en-
gineering changes quickly and accurately.

• Design products so that they share com-
mon parts and processes initially and differ sub-
stantially only by the end of the production
process. I call this strategy “postponement.”
(See the 1997 HBR article I coauthored with Ed-
ward Feitzinger, “Mass Customization at
Hewlett-Packard: The Power of Postpone-
ment.”) This is often the best way to respond
quickly to demand fluctuations because it al-
lows firms to finish products only when they
have accurate information on consumer prefer-
ences. Xilinx, the world’s largest maker of pro-
grammable logic chips, has perfected the art of
postponement. Customers can program the
company’s integrated circuits via the Internet
for different applications after purchasing the
basic product. Xilinx rarely runs into inventory
problems as a result.

• Keep a small inventory of inexpensive,
nonbulky components that are often the cause
of bottlenecks. For example, apparel manufac-
turers H&M, Mango, and Zara maintain sup-
plies of accessories such as decorative buttons,
zippers, hooks, and snaps so that they can finish
clothes even if supply chains break down.

• Build a dependable logistics system that
can enable your company to regroup quickly in
response to unexpected needs. Companies
don’t need to invest in logistics systems them-
selves to reap this benefit; they can strike alli-
ances with third-party logistics providers.

• Put together a team that knows how to in-
voke backup plans. Of course, that’s only possi-
ble only if companies have trained managers
and prepared contingency plans to tackle cri-
ses, as Dell and Nokia demonstrated.

Adapting Your Supply Chain

Great companies don’t stick to the same sup-
ply networks when markets or strategies
change. Rather, such organizations keep
adapting their supply chains so they can adjust
to changing needs. Adaptation can be tough,
but it’s critical in developing a supply chain
that delivers a sustainable advantage.

Most companies don’t realize that in addi-
tion to unexpected changes in supply and de-
mand, supply chains also face near-permanent
changes in markets. Those structural shifts usu-
ally occur because of economic progress, politi-
cal and social change, demographic trends, and
technological advances. Unless companies
adapt their supply chains, they won’t stay com-
petitive for very long. Lucent twice woke up

Adaptation of the Fittest

Many executives ask me, with a twinkle
in their eye, if companies must really
keep adapting supply chains. Compa-
nies may find it tough to accept the idea
that they have to keep changing, but
they really have no choice.

Just ask Lucent. In the mid-1990s,
when the American telecommunications
giant realized that it could make inroads
in Asia only if had local manufacturing
facilities, it overhauled its supply chain.
Lucent set up plants in Taiwan and
China, which allowed the company to
customize switches as inexpensively and
quickly as rivals Siemens and Alcatel
could. To align the interests of parent
and subsidiaries, Lucent executives
stopped charging the Asian ventures in-
flated prices for modules that the com-
pany shipped from the United States. By
the late 1990s, Lucent had recaptured
market share in China, Taiwan, India,
and Indonesia.

Unhappily, the story doesn’t end

there, because Lucent stopped adapting
its supply chain. The company didn’t re-
alize that many medium-sized manufac-
turers had developed the technology
and expertise to produce components
and subassemblies for digital switches
and that because of economies of scale,
they could do so at a fraction of the inte-
grated manufacturers’ costs. Realizing
where the future lay, competitors ag-
gressively outsourced the manufacture
of switching systems. Because of the re-
sulting cost savings, they were able to
quote lower prices than Lucent. Mean-
while, Lucent was reluctant to outsource
its manufacturing because it had in-
vested in its own factories. Ultimately,
however, Lucent had no option but to
shut down its Taiwan factory in 2002
and create an outsourced supply chain.
The company’s adaptation came too late
for Lucent to regain control of the global
market, even though the supply chain
was agile and aligned.

The Triple-A Supply Chain

harvard business review • october 2004 page 6

late to industry shifts, first to the rise of the
Asian market and later to the advantages of
outsourced manufacturing. (See the sidebar
“Adaptation of the Fittest.”) Lucent recovered
the first time, but the second time around, the
company lost its leadership of the global tele-
communications market because it didn’t
adapt quickly enough.

The best supply chains identify structural
shifts, sometimes before they occur, by captur-
ing the latest data, filtering out noise, and
tracking key patterns. They then relocate facili-
ties, change sources of supplies, and, if possi-
ble, outsource manufacturing. For instance,
when Hewlett-Packard started making ink-jet
printers in the 1980s, it set up both its R&D
and manufacturing divisions in Vancouver,
Washington. HP wanted the product develop-
ment and production teams to work together
because ink-jet technology was in its infancy,
and the biggest printer market was in the
United States. When demand grew in other
parts of the world, HP set up manufacturing
facilities in Spain and Singapore to cater to Eu-
rope and Asia. Although Vancouver remained
the site where HP developed new printers, Sin-
gapore became the largest production facility
because the company needed economies of
scale to survive. By the mid-1990s, HP realized
that printer-manufacturing technologies had
matured and that it could outsource produc-
tion to vendors completely. By doing so, HP
was able to reduce costs and remain the leader
in a highly competitive market.

Adaptation needn’t be just a defensive tac-
tic. Companies that adapt supply chains when
they modify strategies often succeed in
launching new products or breaking into new
markets. Three years ago, when Microsoft de-
cided to enter the video game market, it
chose to outsource hardware production to
Singapore-based Flextronics. In early 2001,
the vendor learned that the Xbox had to be in
stores before December because Microsoft
wanted to target Christmas shoppers. Flex-
tronics reckoned that speed to market and
technical support would be crucial for ensur-
ing the product’s successful launch. So it de-
cided to make the Xbox at facilities in Mexico
and Hungary. The sites were relatively expen-
sive, but they boasted engineers who could
help Microsoft make design changes and
modify engineering specs quickly. Mexico and
Hungary were also close to the Xbox’s biggest

target markets, the United States and Europe.
Microsoft was able to launch the product in
record time and mounted a stiff challenge to
market leader Sony’s PlayStation 2. Sony
fought back by offering deep discounts on the
product. Realizing that speed would not be as
critical for medium-term survival as costs
would be, Flextronics shifted the Xbox’s sup-
ply chain to China. The resulting cost savings
allowed Microsoft to match Sony’s discounts
and gave it a fighting chance. By 2003, the
Xbox had wrested a 20% share of the video
game market from PlayStation 2.

Smart companies tailor supply chains to the
nature of markets for products. They usually
end up with more than one supply chain,
which can be expensive, but they also get the
best manufacturing and distribution capabili-
ties for each offering. For instance, Cisco caters
to the demand for standard, high-volume net-
working products by commissioning contract
manufacturers in low-cost countries such as
China. For its wide variety of mid-value items,
Cisco uses vendors in low-cost countries to
build core products but customizes those prod-
ucts itself in major markets such as the United
States and Europe. For highly customized, low-
volume products, Cisco uses vendors close to
main markets, such as Mexico for the United
States and Eastern European countries for Eu-
rope. Despite the fact that it uses three differ-
ent supply chains at the same time, the com-
pany is careful not to become less agile.
Because it uses flexible designs and standard-
ized processes, Cisco can switch the manufac-
ture of products from one supply network to
another when necessary.

Gap, too, uses a three-pronged strategy. It
aims the Old Navy brand at cost-conscious con-
sumers, the Gap line at trendy buyers, and the
Banana Republic collection at consumers who
want clothing of higher quality. Rather than
using the same supply chain for all three
brands, Gap set up Old Navy’s manufacturing
and sourcing in China to ensure cost efficiency,
Gap’s chain in Central America to guarantee
speed and flexibility, and Banana Republic’s
supply network in Italy to maintain quality.
The company consequently incurs higher over-
heads, lower scale economies in purchasing
and manufacturing, and larger transportation
costs than it would if it used just one supply
chain. However, since its brands cater to differ-
ent consumer segments, Gap uses different

The best supply chains

identify structural shifts,

sometimes before they

occur, by capturing the

latest data, filtering out

noise, and tracking key

patterns.

The Triple-A Supply Chain

harvard business review • october 2004 page 7

kinds of supply networks to maintain distinc-
tive positions. The adaptation has worked.
Many consumers don’t realize that Gap owns
all three brands, and the three chains serve as
backups in case of emergency.

Sometimes it’s difficult for companies to de-
fine the appropriate markets, especially when
they are launching innovative new products.
The trick is to remember that products em-
body different levels of technology. For in-
stance, after records came cassettes and then
CDs. Videotapes were followed by DVDs, and
almost anything analog is now or will soon be-
come digital. Also, every product is at a certain
stage of its life cycle, whether it’s at the infant,
ramp-up, mature, or end-of-life stage. By map-
ping either or both of those characteristics to
supply chain partners, manufacturing net-
work, and distribution system, companies can
develop optimal supply chains for every prod-
uct or service they offer.

For example, Toyota was convinced that the
market for the Prius, the hybrid car it launched
in the United States in 2000, would be differ-
ent from that of other models because it em-
bodied new technologies and was in its in-
fancy. The Japanese automobile maker had
expertise in tracking U.S. trends and geograph-
ical preferences, but it felt that it would be dif-
ficult to predict consumer response to a hybrid
car. Besides, the Prius might appeal to particu-
lar consumer segments, such as technophiles
and conservationists, which Toyota didn’t
know much about. Convinced that the uncer-
tainties were too great to allocate the Prius to
dealers based on past trends, Toyota decided to
keep inventory in central stockyards. Dealers
took orders from consumers and communi-
cated them via the Internet. Toyota shipped
cars from stockyards, and dealers delivered
them to buyers.

Although Toyota’s transportation costs rose,
it customized products to demand and man-
aged inventory flawlessly. In 2002, for exam-
ple, the number of Toyotas on the road in
Northern California and the Southeast were
7% and 20%, respectively. However, Toyota
sold 25% of its Prius output in Northern Cali-
fornia and only 6% in the Southeast. Had Toy-
ota not adapted its distribution system to the
product, it would have faced stock outs in
Northern California and been saddled with ex-
cess inventory in the Southeast, which may
well have resulted in the product’s failure.

Building an adaptable supply chain requires
two key components: the ability to spot trends
and the capability to change supply networks.
To identify future patterns, it’s necessary to fol-
low some guidelines:

• Track economic changes, especially in de-
veloping countries, because as nations open up
their economies to global competition, the
costs, skills, and risks of global supply chain op-
erations change. This liberalization results in
the rise of specialized firms, and companies
must periodically check to see if they can out-
source more stages of operation. Before doing
so, however, they must make sure that the in-
frastructure to link them with vendors and cus-
tomers is in place. Global electronics vendors,
such as Flextronics, Solectron, and Foxcom,
have become adept at gathering data and
adapting supply networks.

• Decipher the needs of your ultimate con-
sumers—not just your immediate customers.
Otherwise, you may fall victim to the “bullwhip
effect,” which amplifies and distorts demand
fluctuations. For years, semiconductor manu-
facturers responded to customer forecasts and
created gluts in markets. But when they started
tracking demand for chip-based products, the
manufacturers overcame the problem. For in-
stance, in 2003, there were neither big inven-
tory buildups nor shortages of semiconductors.

At the same time, companies must retain
the option to alter supply chains. To do that,
they must do two things:

• They must develop new suppliers that
complement existing ones. When smart firms
work in relatively unknown parts of the world,
they use intermediaries like Li & Fung, the
Hong Kong–based supply chain architects, to
find reliable vendors.

• They must ensure that product design
teams are aware of the supply chain implica-
tions of their designs. Designers must also be fa-
miliar with the three design-for-supply princi-
ples: commonality, which ensures that products
share components; postponement, which de-
lays the step at which products become differ-
ent; and standardization, which ensures that
components and processes for different prod-
ucts are the same. These principles allow firms
to execute engineering changes whenever they
adapt supply chains.

Creating the Right Alignment

Great companies take care to align the inter-

The Triple-A Supply Chain

harvard business review • october 2004 page 8

ests of all the firms in their supply chain with
their own. That’s critical, because every firm—
be it a supplier, an assembler, a distributor, or
a retailer—tries to maximize only its own in-
terests. (See the sidebar “The Confinement of
Nonalignment.”) If any company’s interests
differ from those of the other organizations in
the supply chain, its actions will not maximize
the chain’s performance.

Misaligned interests can cause havoc even
if supply chain partners are divisions of the
same company, as HP discovered. In the late
1980s, HP’s integrated circuit (IC) division
tried to carry as little inventory as possible,
partly because that was one of its key success
factors. Those low inventory levels often re-
sulted in long lead times in the supply of ICs
to HP’s ink-jet printer division. Since the divi-
sion couldn’t afford to keep customers wait-
ing, it created a large inventory of printers to
cope with the lead times in supplies. Both di-
visions were content, but from HP’s view-
point, it would have been far less expensive to
have a greater inventory of lower-cost ICs and
fewer stocks of expensive printers. That didn’t
happen, simply because HP’s supply chain
didn’t align the interests of the divisions with
those of the company.

Lack of alignment causes the failure of
many supply chain practices. For example, sev-
eral high-tech companies, including Flextron-
ics, Solectron, Cisco, and 3Com, have set up
supplier hubs close to their assembly plants.
Vendors maintain just enough stock at the
hubs to support manufacturers’ needs, and
they replenish the hubs without waiting for or-
ders. Such vendor-managed inventory (VMI)
systems allow suppliers to track the consump-
tion of components, reduce transportation
costs, and, since vendors can use the same hub
to support several manufacturers, derive scale
benefits. When VMI offers so many advan-
tages, why hasn’t it always reduced costs?

The problem starts with the fact that suppli-
ers own components until they physically
enter the manufacturers’ assembly plants and
therefore bear the costs of inventories for
longer periods than they used to. Many suppli-
ers are small and medium-sized companies
that must borrow money to finance invento-
ries at higher interest rates than large manu-
facturers pay. Thus, manufacturers have re-
duced costs by shifting the ownership of
inventories to vendors, but supply chains bear
higher costs because vendors’ costs have risen.
In fact, some VMI systems have generated fric-
tion because manufacturers have refused to
share costs with vendors.

One way companies align their partners’ in-
terests with their own is by redefining the
terms of their relationships so that firms share
risks, costs, and rewards equitably. For in-
stance, the world’s largest printer, RR Donnel-
ley (which prints this magazine) recognized in
the late 1990s that its supply chain perfor-
mance relied heavily on paper-and-ink suppli-
ers. If the quality and reliability of supplies im-
proved, the company could reduce waste and
make deliveries to customers on time. Like
many other firms, RR Donnelley encouraged
suppliers to come up with suggestions for im-
proving processes and products. To align their
interests with its own, however, the company
also offered to split any resulting savings with
suppliers. Not surprisingly, supplier-initiated
improvements have helped enhance RR Don-
nelley’s supply chain ever since.

Sometimes the process of alignment in-
volves the use of intermediaries. In the case of
VMI, for instance, some financial institutions
now buy components from suppliers at hubs
and sell them to manufacturers. Everyone ben-

The Confinement of Nonalignment

It’s not easy for executives to accept that
different firms in the same supply chain
can have different interests, or that in-
terest nonalignment can lead to inven-
tory problems as dire as those that may
arise through a lack of agility or a lack of
adaptability. But the story of Cisco’s sup-
ply chain clinches the argument.

All through the 1990s, everyone re-
garded Cisco’s supply chain as almost in-
fallible. The company was among the
first to make use of the Internet to com-
municate with suppliers and customers,
automate work flows among trading
partners, and use solutions such as re-
mote product testing, which allowed
suppliers to deliver quality results with a
minimum of manual input. Cisco out-
sourced the manufacturing of most of its
networking products and worked closely
with contract manufacturers to select

the right locations to support its needs.
If ever there were a supply chain that
was agile and adaptable, Cisco’s was it.

Why then did Cisco have to write off
$2.25 billion of inventory in 2001? There
were several factors at play, but the main
culprit was the misalignment of Cisco’s
interests with those of its contract man-
ufacturers. The contractors accumulated
a large amount of inventory for months
without factoring in the demand for
Cisco’s products. Even when the growth
of the U.S. economy slowed down, the
contractors continued to produce and
store inventory at the same pace. Fi-
nally, Cisco found it couldn’t use most of
the inventory of raw materials because
demand had fallen sharply. The com-
pany had to sell the raw materials off as
scrap.

The Triple-A Supply Chain

harvard business review • october 2004 page 9

efits because the intermediaries’ financing
costs are lower than the vendors’ costs. Al-
though such an arrangement requires trust
and commitment on the part of suppliers, fi-
nancial intermediaries, and manufacturers, it
is a powerful way to align the interests of com-
panies in supply chains.

Automaker Saturn’s service parts supply
chain, one of the best in the industry, is a great
example of incentive alignment that has led to
outstanding results. Instead of causing heart-
burn, the system works well because Saturn
aligned the interests of everyone in the
chain—especially consumers.

Saturn has relieved car dealers of the bur-
den of managing service parts inventories. The
company uses a central system to make stock-
ing and replenishment decisions for dealers,
who have the right to accept, reject, or modify
the company’s suggestions. Saturn doesn’t just
monitor its performance in delivering service
parts to dealers, even though that is the com-
pany’s only responsibility. Instead, Saturn
holds its managers and the dealers jointly ac-
countable for the quality of service the vehicle
owners experience. For example, the company
tracks the off-the-shelf availability of parts at
the dealers as the relevant metric. Saturn also
measures its Service Parts Operation (SPO) di-
vision on the profits that dealers make from
service parts as well as on the number of emer-
gency orders that dealers place. That’s because
when a dealer doesn’t have a part, Saturn
transfers it from another dealer and bears the
shipping costs. The SPO division can’t over-
stock dealers because Saturn shares the costs
of excess inventory with them. If no one buys a
particular part from a dealer for nine months,
Saturn will buy it back as obsolete inventory.

That kind of alignment produces two re-
sults. First, everyone in the chain has the same
objective: to deliver the best service to con-
sumers. While the off-the-shelf availability of
service parts in the automobile industry ranges
from 70% to 80%, service part availability at
Saturn’s dealers is 92.5%. After taking transfers
from other retailers into account, the same-day
availability of spare parts is actually 94%. Sec-
ond, the right to decide about inventory re-
plenishment rests with Saturn, which is in the
best position to make those decisions. The
company shares the risks of stock outs or over-
stocks with dealers, so it has an interest in
making the best possible decisions. Fittingly,

the inventory turnover (a measure of how effi-
cient inventory management is, calculated by
dividing the annual cost of inventory sold by
the average inventory) of spare parts at Sat-
urn’s dealers is seven times a year while it is
only between one and five times a year for
other automobile companies’ dealers.

Like Saturn, clever companies create align-
ment in supply chains in several ways. They
start with the alignment of information, so
that all the companies in a supply chain have
equal access to forecasts, sales data, and plans.
Next they align identities; in other words, the
manufacturer must define the roles and re-
sponsibilities of each partner so that there is
no scope for conflict. Then companies must
align incentives, so that when companies try to
maximize returns, they also maximize the sup-
ply chain’s performance. To ensure that hap-
pens, companies must try to predict the possi-
ble behavior of supply chain partners in the
light of their current incentives. Companies
often perform such analyses to predict what
competitors would do if they raised prices or
entered a new segment; they need to do the
same with their supply chain partners. Then
they must redesign incentives so partners act
in ways that are closer to what’s best for the en-
tire supply chain.

Seven-Eleven Japan’s Three Aces

Seven-Eleven Japan (SEJ) is an example of how
a company that builds its supply chain on agil-
ity, adaptability, and alignment stays ahead of
its rivals. The $21 billion convenience store
chain has remarkably low stock out rates and
in 2004 had an inventory turnover of 55. With
gross profit margins of 30%, SEJ is also one of
the most profitable retailers in the world. Just
how has the 9,000-store retailer managed to
sustain performance for more than a decade?

The company has designed its supply chain
to respond to quick changes in demand—not
to focus on fast or cheap deliveries. It has in-
vested in real-time systems to detect changes
in customer preference and tracks data on
sales and consumers (gender and age) at every
store. Well before the Internet era began, SEJ
used satellite connections and ISDN lines to
link all its stores with distribution centers, sup-
pliers, and logistics providers. The data allow
the supply chain to detect fluctuations in de-
mand between stores, to alert suppliers to po-
tential shifts in requirements, to help reallo-

The Triple-A Supply Chain

harvard business review • october 2004 page 10

cate inventory among stores, and to ensure
that the company restocks at the right time.
SEJ schedules deliveries to each store within a
ten-minute margin. If a truck is late by more
than 30 minutes, the carrier has to pay a pen-
alty equal to the gross margin of the products
carried to the store. Employees reconfigure
store shelves at least three times daily so that
storefronts cater to different consumer seg-
ments and demands at different hours.

SEJ has adapted its supply chain to its strat-
egy over time. Some years ago, the company
decided to concentrate stores in key locations
instead of building outlets all over the country.
But doing so increased the possibility of traffic
congestion every time the company replen-
ished stores. The problem became more acute
when SEJ decided to resupply stores three or
more times a day. To minimize delays due to
traffic snarls, the company adapted its distribu-
tion system. It asked its suppliers from the
same region to consolidate shipments in a sin-
gle truck instead of using several of them. That
minimized the number of trucks going to its
distribution centers, which is where SEJ cross-
docks products for delivery to stores. The com-
pany has also expanded the kinds of vehicles it
uses from trucks to motorcycles, boats, and
even helicopters. The effectiveness of the com-
pany’s logistics system is legendary. Less than
six hours after the Kobe earthquake on Janu-
ary 17, 1995, when relief trucks were crawling
at two miles per hour on the highways, SEJ
used seven helicopters and 125 motorcycles to
deliver 64,000 rice balls to the city.

Fundamental to the supply chain’s opera-
tion is the close alignment between Seven-
Eleven Japan’s interests and those of its part-
ners. The incentives and disincentives are
clear: Make Seven-Eleven Japan successful, and
share the rewards. Fail to deliver on time, and
pay a penalty. That may seem harsh, but the
company balances the equation by trusting its
partners. For instance, when carriers deliver
products to stores, no one verifies the truck’s

contents. That allows carriers to save time and
money, since drivers don’t have to wait after
dropping off merchandise.

When Seven-Eleven Japan spots business
opportunities, it works with suppliers to de-
velop products and shares revenues with them.
For instance, two years ago, SEJ created an e-
commerce company, 7dream.com, with six
partners. The new organization allows con-
sumers to order products online or through
kiosks at SEJ stores and pick up the merchan-
dise at any Seven-Eleven. The partners benefit
from SEJ’s logistics network, which delivers
products to stores efficiently, as well as from
the convenient location of stores. By encourag-
ing partners to set up multimedia kiosks to
produce games, tickets, or CDs in its shops,
Seven-Eleven Japan has become a manufactur-
ing outlet for partners. The company could not
have aligned the interests of its partners more
closely with those of its own.

• • •

When I describe the triple-A supply chain to
companies, most of them immediately assume
it will require more technology and invest-
ment. Nothing could be further from the
truth. Most firms already have the infrastruc-
ture in place to create triple-A supply chains.
What they need is a fresh attitude and a new
culture to get their supply chains to deliver tri-
ple-A performance. Companies must give up
the efficiency mind-set, which is counterpro-
ductive; be prepared to keep changing net-
works; and, instead of looking out for their in-
terests alone, take responsibility for the entire
chain. This can be challenging for companies
because there are no technologies that can do
those things; only managers can make them
happen.

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Joan Magretta

Harvard Business Review

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Supply Chain Challenges: Building
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What Is the Right
Supply Chain for Your
Product?

Marshall L. Fisher

A simple framework can help

you figure out the answer.

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What Is the Right
Supply Chain for Your
Product?

by Marshall L. Fisher

harvard business review • march–april 1997 page

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A simple framework can help you figure out the answer.

Never has so much technology and brain-
power been applied to improving supply
chain performance. Point-of-sale scanners
allow companies to capture the customer’s
voice. Electronic data interchange lets all
stages of the supply chain hear that voice and
react to it by using flexible manufacturing, au-
tomated warehousing, and rapid logistics. And
new concepts such as quick response, efficient
consumer response, accurate response, mass
customization, lean manufacturing, and agile
manufacturing offer models for applying the
new technology to improve performance.

Nonetheless, the performance of many sup-
ply chains has never been worse. In some
cases, costs have risen to unprecedented levels
because of adversarial relations between sup-
ply chain partners as well as dysfunctional in-
dustry practices such as an overreliance o

price promotions. One recent study of the U.S.
food industry estimated that poor coordina-
tion among supply chain partners was wasting
$30 billion annually. Supply chains in many
other industries suffer from an excess of some

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 be-
cause the specific items they had wanted to
buy were out of stock.

Why haven’t the new ideas and technolo-
gies led to improved performance? Because
managers lack a framework for deciding
which ones are best for their particular com-
pany’s situation. From my ten years of re-
search and consulting on supply chain issues
in industries as diverse as food, fashion ap-
parel, and automobiles, I have been able to
devise such a framework. It helps managers
understand the nature of the demand for
their products and devise the supply chain
that can best satisfy that demand.

The first step in devising an effective supply-
chain strategy is therefore to consider the na-
ture of the demand for the products one’s com-
pany supplies. Many aspects are important—

What Is the Right Supply Chain for Your Product?

harvard business review • march–april 1997 page 2

Marshall L. Fisher

is the Stephen J.
Heyman Professor of Operations and
Information Management and co-
director of the Fishman-Davidson Cen-
ter for Service and Operations Manage-
ment at the University of Pennsylvania’s
Wharton School in Philadelphia. His
current research focuses on how to
manage the supply of products with
hard-to-predict demand.

for example, product life cycle, demand pre-
dictability, product variety, and market stan-
dards for lead times and service (the percent-
age of demand filled from in-stock goods). But
I have found that if one classifies products on
the basis of their demand patterns, they fall
into one of two categories: they are either pri-
marily functional or primarily innovative. And
each category requires a distinctly different
kind of supply chain. The root cause of the
problems plaguing many supply chains is a
mismatch between the type of product and the
type of supply chain.

Is Your Product Functional or
Innovative?

Functional products include the staples that
people buy in a wide range of retail outlets,
such as grocery stores and gas stations. Be-
cause such products satisfy basic needs, which
don’t change much over time, they have sta-
ble, predictable demand and long life cycles.
But their stability invites competition, which
often leads to low profit margins.

To avoid low margins, many companies in-
troduce innovations in fashion or technology
to give customers an additional reason to buy
their offerings. Fashion apparel and personal
computers are obvious examples, but we also
see successful product innovation where we
least expect it. For instance, in the traditionally
functional category of food, companies such as
Ben & Jerry’s, Mrs. Fields, and Starbucks Cof-
fee Company have tried to gain an edge with
designer flavors and innovative concepts. Cen-
tury Products, a leading manufacturer of chil-
dren’s car seats, is another company that
brought innovation to a functional product.
Until the early 1990s, Century sold its seats as
functional items. Then it introduced a wide va-
riety of brightly colored fabrics and designed a
new seat that would move in a crash to absorb
energy and protect the child sitting in it. Called
Smart Move, the design was so innovative that
the seat could not be sold until government
product-safety standards mandating that car
seats not move in a crash had been changed.

Although innovation can enable a company
to achieve higher profit margins, the very new-
ness of innovative products makes demand for
them unpredictable. In addition, their life
cycle is short—usually just a few months—be-
cause as imitators erode the competitive ad-
vantage that innovative products enjoy, com-

panies are forced to introduce a steady stream
of newer innovations. The short life cycles and
the great variety typical of these products fur-
ther increase unpredictability.

It may seem strange to lump technology
and fashion together, but both types of innova-
tion depend for their success on consumers
changing some aspect of their values or life-
style. For example, the market success of the
IBM Thinkpad hinged in part on a novel cur-
sor control in the middle of the keyboard that
required users to interact with the keyboard in
an unfamiliar way. The new design was so con-
troversial within IBM that managers had diffi-
culty believing the enthusiastic reaction to the
cursor control in early focus groups. As a re-
sult, the company underestimated demand—a
problem that contributed to the Thinkpad’s
being in short supply for more than a year.

With their high profit margins and volatile
demand, innovative products require a funda-
mentally different supply chain than stable,
low-margin functional products do. To under-
stand the difference, one should recognize that
a supply chain performs two distinct types of
functions: a

physical

function and a

market me-
diation

function. A supply chain’s physical
function is readily apparent and includes con-
verting raw materials into parts, components,
and eventually finished goods, and transport-
ing all of them from one point in the supply
chain to the next. Less visible but equally im-
portant is market mediation, whose purpose is
ensuring that the variety of products reaching
the marketplace matches what consumers
want to buy.

Each of the two functions incurs distinct
costs. Physical costs are the costs of production,
transportation, and inventory storage. Market
mediation costs arise when supply exceeds de-
mand and a product has to be marked down
and sold at a loss or when supply falls short of
demand, resulting in lost sales opportunities
and dissatisfied customers.

The predictable demand of functional
products makes market mediation easy be-
cause a nearly perfect match between supply
and demand can be achieved. Companies that
make such products are thus free to focus al-
most exclusively on minimizing physical
costs—a crucial goal, given the price sensitiv-
ity of most functional products. To that end,
companies usually create a schedule for as-
sembling finished goods for at least the next

What Is the Right Supply Chain for Your Product?

harvard business review • march–april 1997 page 3

month and commit themselves to abide by it.
Freezing the schedule in this way allows com-
panies to employ manufacturing-resource-
planning software, which orchestrates the or-
dering, production, and delivery of supplies,
thereby enabling the entire supply chain to
minimize inventory and maximize produc-
tion efficiency. In this instance, the important
flow of information is the one that occurs
within the chain as suppliers, manufacturers,
and retailers coordinate their activities in
order to meet predictable demand at the low-
est cost.

That approach is exactly the wrong one for
innovative products. The uncertain market re-
action to innovation increases the risk of
shortages or excess supplies. High profit mar-
gins and the importance of early sales in es-
tablishing market share for new products in-
crease the cost of shortages. And short
product life cycles increase the risk of obsoles-
cence and the cost of excess supplies. Hence
market mediation costs predominate for
these products, and they, not physical costs,
should be managers’ primary focus.

Most important in this environment is to
read early sales numbers or other market sig-
nals and to react quickly, during the new
product’s short life cycle. In this instance, the
crucial flow of information occurs not only
within the chain but also from the market-
place to the chain. The critical decisions to be
made about inventory and capacity are not
about minimizing costs but about where in
the chain to position inventory and available
production capacity in order to

hedge against

uncertain demand. And suppliers should be
chosen for their speed and flexibility, not for
their low cost.

Sport Obermeyer and Campbell Soup Com-
pany illustrate the two environments and how
the resulting goals and initiatives differ. Sport
Obermeyer is a major supplier of fashion ski-
wear. Each year, 95% of its products are com-
pletely new designs for which demand fore-
casts often err by as much as 200%. And
because the retail season is only a few months
long, the company has little time to react if it
misguesses the market.

In contrast, only 5% of Campbell’s products
are new each year. Sales of existing products,
most of which have been on the market for
years, are highly predictable, allowing Camp-
bell to achieve a nearly perfect service level by

satisfying more than 98% of demand immedi-
ately from stocks of finished goods. And even
the few new products are easy to manage.
They have a replenishment lead time of one
month and a minimum market life cycle of six
months. When Campbell introduces a product,
it deploys enough stock to cover the most opti-
mistic forecast for demand in the first month.
If the product takes off, more can be supplied
before stocks run out. If it flops, the six-month,
worst-case life cycle affords plenty of time to
sell off the excess stocks.

How do goals and initiatives differ in the
two environments? Campbell’s already high
service level leaves little room for improve-
ment in market mediation costs. Hence, when
the company launched a supply chain program
in 1991 called

continuous replenishment,

the
goal was physical efficiency. And it achieved
that goal: the inventory turns of participating
retailers doubled. In contrast, Sport Oberm-
eyer’s uncertain demand leads to high market-
mediation costs in the form of losses on styles
that don’t sell and missed sales opportunities
due to the “stockouts” that occur when de-
mand for particular items outstrips invento-
ries. The company’s supply chain efforts have
been directed at reducing those costs through
increased speed and flexibility.

Although the distinctions between func-
tional and innovative products and between
physical efficiency and responsiveness to the
market seem obvious once stated, I have found
that many companies founder on this issue.
That is probably because products that are
physically the same can be either functional or
innovative. For example, personal computers,
cars, apparel, ice cream, coffee, cookies, and
children’s car seats all can be offered as a basic
functional product or in an innovative form.

It’s easy for a company, through its prod-
uct strategy, to gravitate from the functional
to the innovative sphere without realizing
that anything has changed. Then its manag-
ers start to notice that service has mysteri-
ously declined and inventories of unsold
products have gone up. When this happens,
they look longingly at competitors that ha-
ven’t changed their product strategy and
therefore have low inventories and high ser-
vice. They even may steal away the vice pres-
ident of logistics from one of those compa-
nies, reasoning, If we hire their logistics guy,
we’ll have low inventory and high service,

Before devising a supply

chain, consider the

nature of the demand for

your products.

What Is the Right Supply Chain for Your Product?

harvard business review • march–april 1997 page 4

too. The new vice president invariably de-
signs an agenda for improvement based on
his or her old environment: cut inventories,
pressure marketing to be accountable for its
forecasts and to freeze them well into the fu-
ture to remove uncertainty, and establish a
rigid just-in-time delivery schedule with sup-
pliers. The worst thing that could happen is
that he or she actually succeeds in imple-
menting that agenda, because it’s totally in-
appropriate for the company’s now unpre-
dictable environment.

Devising the Ideal Supply-Chain
Strategy

For companies to be sure that they are taking

the right approach, they first must determine
whether their products are functional or in-
novative. Most managers I’ve encountered al-
ready have a sense of which products have
predictable and which have unpredictable
demand: the unpredictable products are the
ones generating all the supply headaches. For
managers who aren’t sure or who would like
to confirm their intuition, I offer guidelines
for classifying products based on what I have
found to be typical for each category. (See the
table “Functional Versus Innovative Prod-
ucts: Differences in Demand.”) The next step
is for managers to decide whether their com-
pany’s supply chain is physically efficient or
responsive to the market. (See the table
“Physically Efficient Versus Market-Respon-
sive Supply Chains.”)

Having determined the nature of their
products and their supply chain’s priorities,
managers can employ a matrix to formulate
the ideal supply-chain strategy. The four cells
of the matrix represent the four possible com-
binations of products and priorities. (See the
exhibit “Matching Supply Chains with Prod-
ucts.”) By using the matrix to plot the nature
of the demand for each of their product fami-
lies and its supply chain priorities, managers
can discover whether the process the com-
pany uses for supplying products is well
matched to the product type: an efficient pro-
cess for functional products and a responsive
process for innovative products. Companies
that have either an innovative product with
an efficient supply chain (upper right-hand
cell) or a functional product with a responsive
supply chain (lower left-hand cell) tend to be
the ones with problems.

For understandable reasons, it is rare for
companies to be in the lower left-hand cell.
Most companies that introduce functional
products realize that they need efficient chains
to supply them. If the products remain func-
tional over time, the companies typically have
the good sense to stick with efficient chains.
But, for reasons I will explore shortly, compa-
nies often find themselves in the upper right-
hand cell. The reason a position in this cell
doesn’t make sense is simple: for any company
with innovative products, the rewards from in-
vestments in improving supply chain respon-
siveness are usually much greater than the re-
wards from investments in improving the
chain’s efficiency. For every dollar such a com-

Functional Versus Innovative Products:
Differences in Demand

Aspects of Demand

Product life cycle

Contribution margin*

Product variety

Average margin of
error in the forecast at
the time production is
committed

Average stockout rate

Average forced end-of-
season markdown as
percentage of full price

Lead time required for
made-to-order products

Functional
(Predictable
Demand)

more than 2 years

5% to 2

low (10 to 20 variants per
category)

10%

1% to 2%

6 months to 1 year

Innovative
(Unpredictable
Demand)

3 months to 1 year

20% to 60%

high (often millions of
variants per category)

40% to 100%

10% to 40%

10% to 25%

1 day to 2 weeks

* The contribution margin equals price minus variable cost divided by price and is expressed as a
percentage.

What Is the Right Supply Chain for Your Product?

harvard business review • march–april 1997 page 5

pany invests in increasing its supply chain’s re-
sponsiveness, it usually will reap a decrease of
more than a dollar in the cost of stockouts and
forced markdowns on excess inventory that re-
sult from mismatches between supply and de-
mand. Consider a typical innovative product
with a contribution margin of 40% and an av-
erage stockout rate of 25%.

The lost contribu-
tion to profit and overhead resulting from
stockouts alone is huge: 40% x 25% = 10% of
sales—an amount that usually exceeds profits
before taxes.

Consequently, the economic gain from re-
ducing stockouts and excess inventory is so
great that intelligent investments in supply
chain responsiveness will always pay for them-
selves—a fact that progressive companies have
discovered. Compaq, for example, decided to
continue producing certain high-variety, short-

life-cycle circuits in-house rather than out-
source them to a low-cost Asian country, be-
cause local production gave the company in-
creased flexibility and shorter lead times.
World Company, a leading Japanese apparel
manufacturer, produces its basic styles in low-
cost Chinese plants but keeps production of
high-fashion styles in Japan, where the advan-
tage of being able to respond quickly to emerg-
ing fashion trends more than offsets the disad-
vantage of high labor costs.

That logic doesn’t apply to functional prod-
ucts. A contribution margin of 10% and an av-
erage stockout rate of 1% mean lost contribu-
tion to profit and overhead of only .1% of
sales—a negligible cost that doesn’t warrant
the significant investments required to im-
prove responsiveness.

Getting Out of the Upper Right-
Hand Cell

The rate of new-product introductions has sky-
rocketed in many industries, fueled both by an
increase in the number of competitors and by
the efforts of existing competitors to protect
or increase profit margins. As a result, many
companies have turned or tried to turn tradi-
tionally functional products into innovative
products. But they have continued to focus on
physical efficiency in the processes for supply-
ing those products. This phenomenon ex-
plains why one finds so many broken supply
chains—or unresponsive chains trying to sup-
ply innovative products—in industries such as
automobiles, personal computers, and con-
sumer packaged goods.

The automobile industry is one classic ex-
ample. Several years ago, I was involved in a
study to measure the impact that the variety of
options available to consumers had on produc-
tivity at a Big Three auto plant. As the study
began, I tried to understand variety from the
customer’s perspective by visiting a dealer near
my home in the Philadelphia area and “shop-
ping” for the car model produced in the plant
we were to study. From sales literature pro-
vided by the dealer, I determined that when
one took into account all the choices for color,
interior features, drivetrain configurations, and
other options, the company was actually offer-
ing 20 million versions of the car. But because
ordering a car with the desired options en-
tailed an eight-week wait for delivery, more
than 90% of customers bought their cars off

Physically Efficient Versus
Market-Responsive Supply Chains

inimize

Primary purpose

Manufacturing focus

Inventory strategy

Lead-time focus

Approach to choosing
suppliers

Product-design strategy

Physically Efficient

supply predictable
demand efficiently at the
lowest possible cost

maintain high average
utilization rate

generate high turns and
minimize inventory
throughout the chain

shorten lead time as long
as it doesn’t
increase cost

select primarily for cost
and quality

maximize performance
and minimize cost

Market-Responsive
ProcessProcess

respond quickly to
unpredictable demand
in order to m
stockouts, forced
markdowns, and
obsolete inventory

deploy excess buffer
capacity

deploy significant
buffer stocks of parts
or finished goods

invest aggressively
in ways to reduce
lead time

select primarily for
speed, flexibility, and
quality

use modular design in
order to postpone
product differentiation
for as long as possible

What Is the Right Supply Chain for Your Product?

harvard business review • march–april 1997 page 6

the lot.
The dealer told me that he had 2 versions of

the car model on his lot and that if neither
matched my ideal specifications, he might be
able to get my choice from another dealer in
the Philadelphia area. When I got home, I
checked the phone book and found ten dealers
in the area. Assuming each of them also had 2
versions of the car in stock, I was choosing
from a selection of at most 20 versions of a car
that could be made in 20 million. In other
words, the auto distribution channel is a kind
of hourglass with the dealer at the neck. At the
top of the glass, plants, which introduce inno-
vations in color and technology every year, can
provide an almost infinite variety of options.
At the bottom, a multitude of customers with
diverse tastes could benefit from that variety
but are unable to because of dealers’ practices
at the neck of the glass.

The computer industry of 20 years ago
shows that a company can supply an innova-
tive product with an unresponsive process if
the market allows it a long lead time for de-
livery. In my first job after college, I worked
in an IBM sales office helping to market the
System/360 mainframe. I was shocked to
learn that IBM was then quoting a 14-month
lead time for this hot new product. I asked
how I could possibly tell a customer to wait
that long. The answer was that if a customer
really wanted a 360, it would wait, and that
if I couldn’t persuade it to wait, there must

be something seriously lacking in my sales
skills. That answer was actually correct: lead
times of one to two years were then the
norm. This meant that computer manufac-
turers had plenty of time to organize their
supplies around physical efficiency.

Now PCs and workstations have replaced
mainframes as the dominant technology, and
the acceptable lead time has dropped to days.
Yet because the industry has largely retained
its emphasis on a physically efficient supply
chain, most computer companies find them-
selves firmly positioned in the upper right-
hand cell of the matrix.

That mismatch has engendered a kind of
schizophrenia in the way computer compa-
nies view their supply chains. They cling to
measures of physical efficiency such as plant
capacity utilization and inventory turns be-
cause those measures are familiar from their
mainframe days. Yet the marketplace keeps
pulling them toward measures of responsive-
ness such as product availability.

How does a company in the upper right-
hand cell overcome its schizophrenia? Either
by moving to the left on the matrix and mak-
ing its products functional or by moving down
the matrix and making its supply chain respon-
sive. The correct direction depends on whether
the product is sufficiently innovative to gener-
ate enough additional profit to cover the cost
of making the supply chain responsive.

A sure sign that a company needs to move
to the left is if it has a product line character-
ized by frequent introductions of new offer-
ings, great variety, and low profit margins.
Toothpaste is a good example. A few years ago,
I was to give a presentation to a food industry
group. I decided that a good way to demon-
strate the dysfunctional level of variety that ex-
ists in many grocery categories would be to
buy one of each type of toothpaste made by a
particular manufacturer and present the col-
lection to my audience. When I went to my
local supermarket to buy my samples, I found
that 28 varieties were available. A few months
later, when I mentioned this discovery to a se-
nior vice president of a competing manufac-
turer, he acknowledged that his company also
had 28 types of toothpaste—one to

match

each of the rival’s offerings.

Does the world need 28 kinds of toothpaste
from each manufacturer? Procter & Gamble,
which has been simplifying many of its prod-

Matching Supply Chains with Products

Functional Products

R
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si

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p
ly

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ai
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Ef
fi

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Su

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Innovative Products

mismatch

mismatch match

match
For the exclusive use of A. Bregante, 2020.
This document is authorized for use only by Anthony Bregante in SCM 850 Spring 2020-1-1 taught by NORMAN AGGON, The Pennsylvania State University from Jan 2020 to Jul 2020.

What Is the Right Supply Chain for Your Product?

harvard business review • march–april 1997 page 7

uct lines and pricing, is coming to the conclu-
sion that the answer is no. Toothpaste is a
product category in which a move to the left—
from innovative to functional—makes sense.

In other cases when a company has an un-
responsive supply chain for innovative prod-
ucts, the right solution is to make some of the
products functional and to create a respon-
sive supply chain for the remaining innova-
tive products. The automobile industry is a
good example.

Many suggestions have been made for fix-
ing the problems with the auto distribution
channel I have described here, but they all miss
the mark because they propose applying just
one solution. This approach overlooks the fact
that some cars, such as the Ford Fairmont, are
inherently functional, while others, such as the
BMW Z3 roadster (driven in the James Bond
movie

Golden Eye

), are innovative. A lean, effi-
cient distribution channel is exactly right for
functional cars but totally inappropriate for in-
novative cars, which require inventory buffers

to absorb uncertainty in demand. The most ef-
ficient place to put buffers is in parts, but
doing so directly contradicts the just-in-time
system that automakers have so vigorously
adopted in the last decade. The just-in-time sys-
tem has slashed parts inventories in plants
(where holding inventory is relatively cheap)
to a few hours, while stocks of cars at dealers
(where holding inventory is expensive) have
grown to around 90 days.

Efficient Supply of Functional
Products

Cost reduction is familiar territory, and most
companies have been at it for years. Neverthe-
less, there are some new twists to this old game.
As companies have aggressively pursued cost
cutting over the years, they have begun to
reach the point of diminishing returns within
their organization’s own boundaries and now
believe that better coordination across corpo-
rate boundaries—with suppliers and distribu-
tors—presents the greatest opportunities. Hap-
pily, the growing acceptance of this view has
coincided with the emergence of electronic net-
works that facilitate closer coordination.

Campbell Soup has shown how this new
game should be played. In 1991, the company
launched the continuous-replenishment pro-
gram with its most progressive retailers. The
program works as follows: Campbell estab-
lishes electronic data interchange (EDI) links
with retailers. Every morning, retailers elec-
tronically inform the company of their de-
mand for all Campbell products and of the
level of inventories in their distribution cen-
ters. Campbell uses that information to fore-
cast future demand and to determine which
products require replenishment based on
upper and lower inventory limits previously es-
tablished with each retailer. Trucks leave the
Campbell shipping plant that afternoon and
arrive at the retailers’ distribution centers with
the required replenishments the same day. The
program cut the inventories of four participat-
ing retailers from about four to two weeks of
supply. The company achieved this improve-
ment because it slashed the delivery lead time
and because it knows the inventories of all re-
tailers and hence can deploy supplies of each
product where they are needed the most.

Pursuing continuous replenishment made
Campbell aware of the negative impact that
the overuse of price promotions can have on

How Campbell’s Price Promotions
Disrupted Its Supply System

C
as

es
o

f C
h

ic
ke

n
N

o
o

d
le

S
o

u
p

800,000

shipments

consumption

600,000

400,000

200,000

0
0

July 1

Weeks

June 30

10 20 30 40 50

What Is the Right Supply Chain for Your Product?

harvard business review • march–april 1997 page 8

physical efficiency. Every January, for example,
there was a big spike in shipments of Chicken
Noodle Soup because of deep discounts that
Campbell was offering. Retailers responded to
the price cut by stocking up, in some cases buy-
ing a year’s supply—a practice the industry
calls

forward buying

. Nobody won on the deal.
Retailers had to pay to carry the year’s supply,
and the shipment bulge added cost throughout
the Campbell system. For example, chicken-
boning plants had to go on overtime starting
in October to meet the bulge. (See the graph
“How Campbell’s Price Promotions Disrupted
Its Supply System.”) Recognizing the problem,
Campbell required its retail customers on the
continuous-replenishment program to waive
the option of forward buying at a discounted
price. A retailer that promotes Campbell prod-
ucts in its stores by offering a discounted price
to consumers has two options: it can pay
Campbell an “everyday low price” equal to the
average price that a retailer receiving the pro-
motional deals would pay or it can receive a
discount on orders resulting from genuine in-
creases in sales to consumers.

The Campbell example offers some valuable
lessons. Because soup is a functional product
with price-sensitive demand, Campbell was
correct to pursue physical efficiency. Service—
or the in-stock availability of Campbell prod-
ucts at a retailer’s distribution center—did in-
crease marginally, from 98.5% to 99.2%. But
the big gain for the supply chain was in in-
creased operating efficiency, through the re-
duction in retailers’ inventories. Most retailers
figure that the cost of carrying the inventory of
a given product for a year equals at least 25%
of what they paid for the product. A two-week
inventory reduction represents a cost savings
equal to nearly 1% of sales. Since the average
retailer’s profits equal about 2% of sales, this
savings is enough to increase profits by 50%.

Because the retailer makes more money on
Campbell products delivered through contin-
uous replenishment, it has an incentive to
carry a broader line of them and to give them
more shelf space. For that reason, Campbell
found that after it had introduced the pro-
gram, sales of its products grew twice as fast
through participating retailers as they did
through other retailers. Understandably, su-
permarket chains love programs such as
Campbell’s. Wegmans Food Markets, with
stores in upstate New York, has even aug-

mented its accounting system so that it can
measure and reward suppliers whose prod-
ucts cost the least to stock and sell.

There is also an important principle about
the supply of functional products lurking in
the “everyday low price” feature of Campbell’s
program. Consumers of functional products
offer companies predictable demand in ex-
change for a good product and a reasonable
price. The challenge is to avoid actions that
would destroy the inherent simplicity of this
relationship. Many companies go astray be-
cause they get hooked on overusing price pro-
motions. They start by using price incentives to
pull demand forward in time to meet a quar-
terly revenue target. But pulling demand for-
ward helps only once. The next quarter, a com-
pany has to pull demand forward again just to
fill the hole created by the first incentive. The
result is an addiction to incentives that turns
simple, predictable demand into a chaotic se-
ries of spikes that only add to cost.

Finally, the Campbell story illustrates a dif-
ferent way for supply chain partners to inter-
act in the pursuit of higher profits. Functional
products such as groceries are usually highly
price-sensitive, and negotiations along the sup-
ply chain can be fierce. If a company can get its
supplier to cut its price by a penny and its cus-
tomer to accept a one-cent price increase,
those concessions can have a huge impact on
the company’s profits. In this competitive
model of supply chain relations, costs in the
chain are assumed to be fixed, and the manu-
facturer and the retailer compete through
price negotiations for a bigger share of the
fixed profit pie. In contrast, Campbell’s contin-
uous-replenishment program embodies a
model in which the manufacturer and the re-
tailer cooperate to cut costs throughout the
chain, thereby increasing the size of the pie.

The cooperative model can be powerful,
but it does have pitfalls. Too often, companies
reason that there never can be too many ways
to make money, and they decide to play the co-
operative and competitive games at the same
time. But that tactic doesn’t work, because the
two approaches require diametrically differ-
ent behavior. For example, consider informa-
tion sharing. If you are my supplier and we are
negotiating over price, the last thing you want
to do is fully share with me information about
your costs. But that is what we both must do if
we want to reduce supply chain costs by assign-

Functional products

require an efficient

process; innovative

products, a responsive

process.

What Is the Right Supply Chain for Your Product?

harvard business review • march–april 1997 page 9

ing each task to whichever of us can perform it
most cheaply.

Responsive Supply of Innovative
Products

Uncertainty about demand is intrinsic to inno-
vative products. As a result, figuring out how
to cope with it is the primary challenge in cre-
ating a responsive supply process for such
products. I have seen companies use four tools
to cope with uncertainty in demand. To fash-
ion a responsive supply process, managers
need to understand each of them and then
blend them in a recipe that’s right for their
company’s particular situation.

Although it may sound obvious, the first
step for many companies is simply to

that uncertainty is inherent in innovative prod-
ucts. Companies that grew up in an oligopoly
with less competition, more docile customers,
and weaker retailers find it difficult to accept
the high levels of demand uncertainty that
exist today in many markets. They have a ten-
dency to declare a high level of forecast errors
unacceptable, and they virtually command
their people to think hard enough and long
enough to achieve accuracy in their forecasts.
But these companies can’t remove uncertainty
by decree. When it comes to innovative prod-
ucts, uncertainty must be accepted as good. If
the demand for a product were predictable,
that product probably would not be suffi-
ciently innovative to command high profit
margins. The fact is that risk and return are
linked, and the highest profit margins usually
go with the highest risk in demand.

Once a company has accepted the uncer-
tainty of demand, it can employ three coordi-
nated strategies to manage that uncertainty. It
can continue to strive to

reduce

uncertainty—
for example, by finding sources of new data
that can serve as leading indicators or by hav-
ing different products share common compo-
nents as much as possible so that the demand
for components becomes more predictable. It
can

avoid

uncertainty by cutting lead times
and increasing the supply chain’s flexibility so
that it can produce to order or at least manu-
facture the product at a time closer to when
demand materializes and can be accurately
forecast. Finally, once uncertainty has been re-
duced or avoided as much as possible, it can

hedge against

the remaining residual uncer-
tainty with buffers of inventory or excess ca-

pacity. The experiences of National Bicycle, a
subsidiary of Matsushita Electric, and of Sport
Obermeyer illustrate the different ways in
which these three strategies can be blended to
create a responsive supply chain.

National Bicycle prospered for decades as a
small but successful division. But by the mid-
1980s, it was in trouble. Bicycles in Japan were
functional products bought mainly as an inex-
pensive means of transportation, and sales
were flat. Bicycles had become a commodity
sold on the basis of low price, and Japan’s high
labor costs left National Bicycle unable to com-
pete with inexpensive bikes from Taiwan and
Korea.

In 1986, in an attempt to salvage the situa-
tion, Matsushita appointed as president of Na-
tional an executive from another division who
had no experience in bicycles. The new presi-
dent, Makoto Komoto, saw that the division
had many strengths: technical expertise in
manufacturing and computers, a highly skilled
workforce, a strong brand name (Panasonic),
and a network of 9,000 dealers. Komoto also
noticed that National Bicycle had an innova-
tive product segment that enjoyed high profit
margins: sports bicycles that affluent custom-
ers bought purely for recreation. He concluded
that National’s only hope was to focus on that
segment and use the division’s strengths to de-
velop a responsive chain that could supply
sports bikes while avoiding the high risk of
overproduction that resulted from their short
life cycle and uncertain demand.

According to Komoto’s vision, a customer
would visit a Panasonic dealership and choose
a bike from a selection of 2 million options for
combining size, color, and components, using a
special measuring stand to find the exact size
of the frame that he or she needed. The order
would be faxed to the factory, where com-
puter-controlled welding equipment and
skilled workers would make the bike and de-
liver it to the customer within two weeks.

Komoto’s radical vision became a reality in
1987. By 1991, fueled by this innovation, Na-
tional Bicycle had increased its share of the
sports bicycle market in Japan from 5% to 29%.
It was meeting the two-week lead time 99.99%
of the time and was in the black.

National Bicycle’s success is a good example
of a responsive supply chain achieved through
avoiding uncertainty. National has little idea
what customers will order when they walk into

There is a kind of

schizophrenia in the way

computer companies

view their supply chains.

What Is the Right Supply Chain for Your Product?

harvard business review • march–april 1997 page 10

a retail shop, but that doesn’t matter: its pro-
duce-to-order system allows it to match supply
with demand as it happens. By radically in-
creasing the number of choices from a few
types of bikes to 2 million, it can induce the
customer to sacrifice immediate availability
and wait two weeks for a bicycle.

National’s program is part of a new move-
ment called

mass customization:

building the
ability to customize a large volume of prod-
ucts and deliver them at close to mass-produc-
tion prices. Many other companies have
found that they, too, can benefit from this
strategy. For example, Lutron Electronics of
Coopersburg, Pennsylvania, became the
world leader in dimmer switches and other
lighting controls by giving customers an es-
sentially unlimited choice of technical and
fashion features. Says Michael W. Pessina,
Lutron’s vice president of manufacturing op-
erations, “With our diverse product line, cus-
tomer demand can be impossible to predict.
Yet by configuring products at the time of or-
der, we can offer customers tremendous vari-
ety and fill orders very quickly without having
to stock a huge amount of inventory.”

Mass customization is not without its chal-
lenges. For example, what does National Bicy-
cle do with its plant during the winter, when
no one is buying bikes? It builds an inventory
of high-end sports bicycles. In addition, mass
customization is not necessarily cheap. Na-
tional’s custom production requires three
times more labor than assembly-line mass
production of bikes. Interestingly, one of the
main reasons why Henry Ford in the early
1900s moved in the opposite direction—from
craft to mass production—was to slash labor
costs, which he succeeded in doing by a factor
of three. So what has changed to make cus-
tom production viable now? Affluent con-
sumers are willing to pay for high-margin, in-
novative products; and those products require
a different, more expensive, but more respon-
sive production process than the functional
Model T did.

Sport Obermeyer, which is based in Aspen,
Colorado, designs and manufactures fashion
skiwear and distributes it through 800 spe-
cialty retailers located throughout the United
States. Because 95% of its products are new
each year, it constantly faces the challenges
and risks of demand uncertainty: stockouts of
hot styles during the selling season and left-

over inventory of “dogs” at the end of the sea-
son. In 1991, the company’s vice president,
Walter R. Obermeyer, launched a project to at-
tack those problems by blending the three
strategies of reducing, avoiding, and hedging
against uncertainty. To reduce uncertainty,
Sport Obermeyer solicited early orders from
important customers: the company invited its
25 largest retailers to Aspen each February to
evaluate its new line. Sport Obermeyer found
that the early orders from this handful of re-
tailers permitted it to forecast national de-
mand for all its products with a margin of error
of just 10%.

Although it was helpful to get this informa-
tion several months before Sport Obermeyer
was required to ship its products in September,
it didn’t solve the company’s problem, because
long lead times forced it to commit itself to
products well before February. Obermeyer
concluded that each day shaved off the lead
time would save the company $25,000 because
that was the amount it spent each day at the
end of September shipping products by air
from plants in Asia to have them in stores by
early October—the start of the retail season.
Once that figure was announced to employees,
they found all kinds of ways to shorten the
lead time. For example, the person who had
dutifully used standard mail service to get de-
sign information to the production manager in
Hong Kong realized that the $25 express-mail
charge was a bargain compared with the
$25,000 per day in added costs resulting from
longer lead times caused by mail delays.
Through such efforts, Sport Obermeyer was
able to avoid uncertainty on half of its produc-
tion by committing that production after early
orders had been received in February.

Nevertheless, the company still had to
commit half of the production early in the
season, when demand was uncertain. Which
styles should it make then? It would stand to
reason that they should be the styles for
which Sport Obermeyer had the most confi-
dence in its forecasts. But how could it tell
which those were? Then the company noticed
something interesting. Obermeyer had asked
each of the six members of a committee re-
sponsible for forecasting to construct a fore-
cast for all products, and he used the average
of the six forecasts as the company’s forecast.
After one year of trying this method, the com-
pany found that when the six individual fore-

Campbell Soup has

shown how

manufacturers and

retailers can cooperate to

cut costs throughout the

system.

What Is the Right Supply Chain for Your Product?

harvard business review • march–april 1997 page 11

casts agreed, the average was accurate, and
when they disagreed, the average was inaccu-
rate. This discovery gave Sport Obermeyer a
means of selecting the styles to make early.
Using this information as well as data on the
cost of overproduction and underproduction,
it developed a model for hedging against the
risk of both problems. The model tells the
company exactly how much of each style to
make early in the production season (which
begins nearly a year before the retail season)
and how much to make in February, after
early orders are received.

Sport Obermeyer’s approach, which has
been called

accurate response,

has cut the cost
of both overproduction and underproduction
in half—enough to increase profits by 60%.
And retailers love the fact that the system re-
sults in more than 99% product availability:
they have ranked Sport Obermeyer number
one in the industry for service. (See “Making
Supply Meet Demand in an Uncertain World,”
by Marshall L. Fisher, Janice H. Hammond,
Walter R. Obermeyer, and Ananth Raman,
HBR May-June 1994.)

Companies such as Sport Obermeyer, Na-
tional Bicycle, and Campbell Soup, however,
are still the exceptions. Managers at many
companies continue to lament that although
they know their supply chains are riddled with
waste and generate great dissatisfaction
among customers, they don’t know what to do
about the problem. The root cause could very
well be a misalignment of their supply and
product strategies. Realigning the two is hardly
easy. But the reward—a remarkable competi-
tive advantage that generates high growth in
sales and profits—makes the effort worth it.

1. The contribution margin equals price minus variable cost
divided by price and is expressed as a percentage. This type
of profit margin measures increases in profits produced by
the incremental sales that result from fewer stockouts. Con-
sequently, it is a good way to track improvements in inven-
tory management.

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National Bicycle’s success

is a good example of a

responsive supply chain

achieved through

avoiding uncertainty.

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