Supply Chain Design and Management （2pages）
reading and answer the question
What are the three A’s? Why is it more important to be Agile, Adaptable, and Aligned than cost effective and fast? Give examples
The 21st-ce
n
tury Supply Chain
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.
by Hau L. Lee
Triple-A
Supply Chain
D
uring the past decade and a half, I’ve studied from the inside
I more than 60 leading companies that focused on building and re-
‘ building 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 companies also teamed up to
streamline processes, lay down technical standards, and invest in infrastructure
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 ser-
vice industry embarked on an Efficient Foodservice Response program.
All those companies and initiatives persistently aimed at greater speed and cost-
effectiveness-the popular grails of supply chain management. Of course, compa-
nies’quests changed with the industrial cycle: When business was booming, exec-
utives concentrated on maximizing 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 com-
panies and experts seemed to ignore: Ceteris paribus, companies whose supply
chains became more efficient and cost-effective didn’t gain a sustainable advantage
over their rivals. In fact, the performance of those supply chains steadily deterio-
rated. For instance, despite the increased efficiency of many companies’ supply
102 HARVARD BUSINESS REVIEW
n
The 21st-Ceiitury 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 con-
sumer satisfaction with product availability fell sharply
during the same period.
Evidently, it isn’t hy becoming more efficient that the
supply chains of Wal-Mart, Dell, and Amazon have given
those companies an edge over their competitors. Accord-
ing to my research, top-performing supply chains possess
three very different qualities. First, great supply chains are
agile. They react speedily to sudden changes in demand or
supply. Second,they adapt overtime as market structures
and strategies evolve. Third, they align the interests of all
the firms in the supply network so that companies opti-
mize the chain’s performance when they maximize their
interests. Only supply chains that are agile, adaptable, and
aligned provide companies with sustainable competitive
advantage.
The Perils of Efficiency
W
hy haven’t efficient supply chains been able to
deliver the goods? For several reasons. High-
speed, low-cost supply chains are unable to re-
spond to unexpected changes in demand or supply. Many
companies have centralized manufacturing and distribu-
tion facilities to generate scale economies, and they de-
liver only container loads of products to customers to
minimize transportation time, freight costs, and the num-
ber of deliveries. When demand for a particular brand,
pack size, or assortment rises without warning, these or-
ganizations are unable to react even if they have the items
in stock. According to two studies I helped conduct in the
1990s, the required merchandise was often already in fac-
tory stockyards, packed and ready to ship, but it couldn’t
be moved until each container was full. That “best” prac-
tice delayed shipments by a week or more,forcing stocked-
out stores to turn away consumers. No wonder then that,
according to another recent research report, when com-
panies announce product promotions, stock outs rise to
15%, on average, even when executives have primed sup-
ply chains to handle demand fluctuations.
When manufacturers eventually deliver additional
merchandise, it results in excess inventory because most
distributors don’t need a container load to satisfy the in-
creased 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 merchandise 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 con-
sumer electronics firm that decided not to create a buffer
stock before launching an innovative new product. It
wanted to keep inventory costs low, particularly since
it hadn’t been able to generate an accurate demand fore-
cast. When demand rose soon after the gizmo’s launch
and fell sharply thereafter, the company pressured ven-
dors to boost production and then to slash output. When
demand shot up again a few weeks later, executives en-
thusiastically told vendors to step up production once
more. Five days later, supplies of the new product dried up
as if someone had turned off a tap.
The shocked electronics giant discovered that vendors
had been so busy ramping production up and down that
they hadn’t found time to fix bugs in both the compo-
nents’ manufacturing and the product’s assembly pro-
cesses. When the suppliers tried to boost output a second
time, product defects rose to unacceptable levels, and
some vendors, including the main assembler, had to shut
down production lines for more than a week. By the time
the suppliers could fix the glitches and restart produc-
tion, the innovation was all but dead. If the electronics
company had given suppliers a steady, higher-than-needed
manufacturing schedule until both the line and demand
had stabilized, it would have initially had higher inven-
tory costs, but the product would still be around.
Efficient supply chains often become uncompetitive
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 component pro-
curement, 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 fastest-growing market, Lucent’s
response times increased because it hadn’t set up a plant
in the Far East. Furthermore, the company couldn’t cus-
tomize switches or carry out modifications because of the
Hau L Lee (tiaulee(p)stanford.edu) is the Thoma Professor of Operations, Information, and Technology at the Stanford Grad-
uate School of Business in Stanford, California, and the codirector of tbe Stanford Global Supply Chain Management Forum.
He is the coeditor (with Terry P. Harrison andfohn }. Neale) of The Practice of Supply Chain Management: Where Theory
and Application Converge (Kluwer Academic Publishers, 2003).
104 HARVARD BUSINESS REVIEW
–
The Triple-A Supply Chain
amount of time and money it took the supply chain to do
those things across continents.
Lucent’s troubles deepened when vendors shifted man-
ufacturing facilities from the United States to Asia to take
advantage of the lower labor costs there. “We had to fly
components 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 set-
ting up joint ventures in Taiwan and China to manufac-
ture 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 ri-
vals. Only those companies that build agile, adaptable,
and aligned supply chains get ahead of the competition,
as I pointed out earlier. In the following pages, 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 dimen-
sions alone aren’t enough. Only companies that build all
three into supply chains become 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
G
reat companies create supply chains that respond
to sudden and unexpected changes in markets.
Agility is critical, because in most industries, 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 disregarding agility. (See the sidebar
“The Importance of Being Agile.”) In the 1990s, whenever
Intel unveiled new microprocessors, Compaq took more
time than its rivals to launch the next generation of PCs
because of a long design cycle. The company lost mind
share because it could never count early adopters, who
create the buzz around high-tech products, among its con-
sumers. Worse, it was unable to compete on price. Be-
cause 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 compo-
nent prices fell, and it couldn’t cut PC prices as much as
its rivals were able to. When vendors announced changes
Agility
Ottjectives:
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.
>Buiid inventory buffers by maintaining a stoci of inexpensive but key components.
>Have a dependable logistics system or partner.
>Draw up contingency plans and deveiop crisis
management teams.
Adaptability markets; modify supply network to strategies, products, and
technologies.
Methods: 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 Methods: and customers.
> Lay down roles, tasks, and responsibilities clearly for sup-
pliers and customers.
>Equitably share risks, costs, and gains of improvement
initiatives.
OCIOHVR 3004 105 st-Contury Supply Chain.
in engineering specifications, Compaq incurred more re- By contrast, smart companies use agile supply chains to Agility has become more critical in the past few years Without a doubt, agile supply chains recover quickly Most companies overlook the idea that supply chains
should be agile. That’s understandable; adaptability and
alignment are more novel concepts than agility is. How-
ever, even ifyour supply chain is both adaptable and
aligned, it’s dangerous to disregard agility.
!n 1995, Hewlett-Packard teamed up with Canon to
design and launch ink-jet printers. At tbe outset, the
American company aligned its interests with those of
its Japanese partner. While HP took on the responsibil-
ity of producing printed circuit boards (or”formaters”).
Canon agreed to manufacture engines for the LaserJet
series. That was an equitable division of responsibili-
ties, and the two R&D teams learned to work togetber
closely. After launching tbe 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 tbe 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 be-
fore printers entered tbe market. However, HP could es-
timate demand accurately only three or fewer montbs
before printers hit the market. At that stage. Canon
could modify its manufacturing schedule by just a few
percentage points. As a result, the supply chain couldn’t
cope with sudden fluctuations in demand. So when
tbere was an unexpected drop in demand for the Laser-
Jet III toward tbe end of its life cycle, HP was stuck witb
a huge and expensive surplus of printer engines: the
infamous LaserJet mountain. Having an adaptable and
aligned supply chain didn’t help HP overcome its lack
of agility.
and implemented the plans it had drawn up to cope with Nokia and Ericsson provided a study in contrasts when 106 HARVARD BUSINESS REVIEW The Triple-A Supply Chain design changes so that other companies could manufac- Companies can build agility into supply chains by ad- • Provide data on changes in supply and demand to part- • Develop collaborative relationships with suppliers and • Design products so that they share common parts and • Keep a small inventory of inexpensive, nonbulky com- • Build a dependable logistics system that can enable pected needs. Companies don’t need to invest in logistics • Put together a team that knows how to invoke backup Adapting Your Supply Chain
reat companies don’t stick to the same supply net- chains so they can adjust to changing needs. Adaptation Most companies don’t realize that in addition to unex- OCTOBER 2004 107 The 2JLst^^iitury Supply Chain.
f the rittest
Many executives ask me, with a twinkle in their eye,
if companies must really keep adapting supply chains.
Companies 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 Ameri-
can telecommunications giant realized that it could
make inroads in Asia oniy if had local manufacturing
facilities, it overhauled its supply chain. Lucent set up
plants in Taiwan and China, which allowed the com-
pany to customize switches as inexpensively and
quickly as rivals Siemens and Alcatel could. To align
the interests of parent and subsidiaries, Lucent execu-
tives stopped charging the Asian ventures inflated
prices for modules that the company 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 com-
pany didn’t realize that many medium-sized manufac-
turers had developed the technology and expertise to
produce components and suhassemblies for digital
switches and that because of economies of scale, they
could do so at a fraction ofthe integrated manufactur-
ers’costs. Realizing where the future lay, competitors
aggressively outsourced the manufacture of switching
systems. Because ofthe resulting cost savings, they
were able to quote lower prices than Lucent. Mean-
while, Lucent was reluctant to outsource its manufac-
turing because it had Invested in its own factories.
Ultimately, however, Lucent had no option but to shut
down its Taiwan factory in 2002 and create an out-
sourced supply chain. The company’s adaptation came
too late for Lucent to regain control of the global mar-
ket, even though the supply chain was agile and
aligned. the global telecommunications market because it didn’t The best supply chains identify structural shifts, some- ver, Washington. HP wanted the product development Adaptation needn’t be just a defensive tactic. Compa- Smart companies tailor supply chains to the nature of 108 HARVARD BUSINESS REVIEW dors close to main markets, such as Mexico for the United Gap, too, uses a three-pronged strategy. It aims the Old jrha_Trlpla-A Supply
fancy. The Japanese automobile maker had expertise in Although Toyota’s transportation costs rose, it cus- The best supply chains identify structural shifts, consumer segments. Gap uses different kinds of supply Sometimes it’s difficult for companies to define the ap- For example, Toyota was convinced that the market for Northern California and been saddled with excess inven- Building an adaptable supply chain requires two key • Track economic changes, especially in developing • Decipher the needs of your ultimate consumers – OCTOBER 2004 109 HBR The 21st-C?entury Simply CShai
manufacturers responded to customer forecasts and cre- At the same time, companies must retain the option to • They must develop new suppliers that complement • They must ensure that product design teams are Creating the Right Alignment
G plier, an assembler, a distributor, or a retailer – tries to Misaligned interests can cause havoc even if supply Lack of alignment causes the failure of many supply The Confinement It’s not easy for executives to accept that different firms
in the same supply chain can have different interests,
or that interest nonalignment can lead to inventory
problems as dire as those that may arise through a lack
of agility or a lack of adaptability. But the story of
Cisco’s supply chain clinches the argument.
All through the 1990s, everyone regarded Cisco’s
supply chain as almost infallible. The company was
among the first to make use of the Internet to commu-
nicate with suppliers and customers, automate work
fiows among trading partners, and use solutions such
as remote product testing, which allowed suppliers to
deliver quality results with a minimum of manual
input. Cisco outsourced the manufacturing of most of
its networking products and worked closely with con-
tract manufacturers to select the right locations to sup-
port its needs. Ifever 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 manufacturers. 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. Finally, Cisco
found it couldn’t use most of the inventory of raw ma-
terials because demand had fallen sharply. The com-
pany had to sell the raw materials off as scrap.
have set up supplier hubs close to their assembly plants. The problem starts with the fact that suppliers own 110 HARVARD BUSINESS REVIEW pliers are small and medium-sized companies that must One way companies align their partners’ interests with Sometimes the process of alignment involves the use Automaker Saturn’s service parts supply chain, one of Saturn has relieved car dealers of the burden of man- _The Triplo-A Supply Chain
vice parts as well as on the number of emergency orders That kind of alignment produces two results. First, Like Saturn, clever companies create alignment in sup- Seven-Eleven Japan’s Three Aces
S vals. The $21 billion convenience store chain has remark- OCTOBER 2004 111 The 2 X s t -Centui^Siipply Chain
one ofthe most profitable retajiers in the world. Just how The company has designed its supply chain to respond Fundamental to the supply chain’s operation is the close When Seven-Eleven Japan spots business opportuni- The message to Seven-Eleven Japan’s partners is times daily so that storefronts cater to different consumer SEJ has adapted its supply chain to its strategy over convenient location of stores. By encouraging partners • * * Reprint R0410F; HBR OnPoint 8096 112 HARVARD BUSINESS REVIEW Harvard Business Review Notice of Use Restrictions, May 2009
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Olijectives:
Adjust supply chain’s design to meet structural shifts in
> Monitor economies all over the world to spot new supply
Objective:
Create incentives for better performance.
>Exchange information and itnowledge freely with vendors
working 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.
differentiate themselves from rivals. For instance, H&M,
Mango, and Zara have become Europe’s most profitable
apparel brands by building agility into every link of their
supply chains. At one end of their product pipelines, the
three companies have created agile design processes. As
soon as designers spot possible trends, they create sketches
and order fabrics. That gives them a head start over com-
petitors because fabric suppliers require the longest lead
times. However, the companies finalize designs and man-
ufacture garments only after they get reliable data from
stores. That allows them to make products that meet con-
sumer tastes and reduces the number of items they must
sell at a discount. At the other end of the pipeline, all three
companies have superefficient distribution centers. They
use state-of-the-art sorting and material-handling tech-
nologies to ensure that distribution doesn’t become a bot-
tleneck 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 mar-
gins are the envy of the industry.
because sudden shocks to supply chains have become
frequent. The terrorist attack in New York in 2001, the
dockworkers’ strike in California in 2002, and the SARS
epidemic in Asia in 2003, for instance, disrupted many
companies’ supply chains. While the threat from natural
disasters, terrorism, wars, epidemics, and computer viruses
has intensified in recent years, partly because supply lines
now traverse the globe, my research shows that most sup-
ply chains are incapable of coping with emergencies. Only
three years have passed since 9/11, but U.S. companies
have all but forgotten the importance of drawing up con-
tingency plans for times of crisis.
from sudden setbacks. In September 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 Compaq, Apple, and Gate-
way, couldn’t deliver products to customers on time and
incurred their wrath. One exception was Dell, which
changed the prices of PC configurations overnight. That
allowed the company to steer consumer demand away
from hardware built with components that weren’t avail-
able toward machines that didn’t use those parts. Dell
could do that because it got data on the earthquake dam-
age early, sized up the extent of vendors’ problems quickly.
such eventualities immediately. Not surprisingly. Dell
gained market share in the earthquake’s aftermath.
in March 2000, a Philips facility in Albuquerque, New
Mexico, went up in flames. The plant made radio fre-
quency (RE) chips, key components for mobile tele-
phones, for both Scandinavian companies. When the fire
damaged the plant, Nokia’s managers quickly carried out
ture 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, meanwhile, had been weeding out backup sup-
pliers 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 line: Nokia stole market share
from Ericsson because it had a more agile supply chain.
hering to six rules of thumb:
ners continuously so they can respond quickly. For in-
stance, Cisco recently created 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 demand 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.
customers so that companies work together to design or
redesign processes, components, and products as well as to
prepare backup plans. For instance, Taiwan Semiconduc-
tor Manufacturing Company (TSMC),the world’s largest
semiconductor foundry, gives suppliers and customers
proprietary tools, data, and models so they can execute
design and engineering changes quickly and accurately.
processes initially and differ substantially only by the end
ofthe production process. I call this strategy “postpone-
ment.” (See the 1997 HBR article I coauthored with Ed-
ward Feitzinger,”Mass Customization at Hewlett-Packard:
The Power of Postponement”; 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 preferences. Xilinx, the world’s
largest maker of programmable logic chips, has perfected
the art of postponement. Customers can program the com-
pany’s integrated circuits via the Internet for different ap-
plications after purchasing the basic product. Xilinx rarely
runs into inventory problems as a result.
ponents that are often the cause of bottlenecks. For ex-
ample, apparel manufacturers H&M, Mango, and Zara
maintain supplies of accessories such as decorative but-
tons, zippers, hooks, and snaps so that they can finish
clothes even if supply chains break down.
your company to regroup quickly in response to unex-
systems themselves to reap this benefit; they can strike
alliances with third-party logistics providers.
plans. Of course, that’s only possible only if companies
have trained managers and prepared contingency plans
to tackle crises, as Dell and Nokia demonstrated.
iworks when markets or strategies change. Rather,
such organizations keep adapting their supply
can be tough, but it’s critical in developing a supply chain
that delivers a sustainable advantage.
pected changes in supply and demand, supply chains also
face near-permanent changes in markets. Those struc-
tural shifts usually occur because of economic progress,
political and social change, demographic trends, and
technological advances. Unless companies adapt their
supply chains, they won’t stay competitive for very long.
Lucent twice woke up 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
adapt quickly enough.
times before they occur, by capturing the latest data, fil-
tering out noise, and tracking key patterns. They then re-
locate facilities, change sources of supplies, and, if possible,
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 Vancou-
and production teams to work together because ink-jet
technology was in its infancy, and the biggest printer mar-
ket 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 Europe and Asia. Al-
though Vancouver remained the site where HP developed
new printers, Singapore 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 production to vendors completely. By
doing so, HP was able to reduce costs and remain the
leader in a highly competitive market.
nies that adapt supply chains when they modify strategies
often succeed in launching new products or breaking into
new markets. Three years ago, when Microsoft decided to
enter the video game market, it chose to outsource hard-
ware 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. Flextronics reckoned that speed to
market and technical support would be crucial for en-
suring the product’s successful launch. So it decided to
make the Xbox at facilities in Mexico and Hungary. The
sites were relatively expensive, but they boasted engi-
neers 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 supply
chain to China. The resulting cost savings allowed Micro-
soft 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.
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 capabil-
ities for each offering. For instance, Cisco caters to the de-
mand for standard, high-volume networking products by
commissioning contract manufacturers in low-cost coun-
tries 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 products itself in
major markets such as the United States and Europe. For
highly customized, low-volume products, Cisco uses ven-
States and Eastern European countries for Europe. De-
spite the fact that it uses three different supply chains at
the same time, the company is careful not to become less
agile. Because it uses flexible designs and standardized
processes, Cisco can switch the manufacture of products
from one supply network to another when necessary.
Navy brand at cost-conscious consumers, the Gap line at
trendy buyers, and the Banana Republic collection at con-
sumers 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 com-
pany consequently incurs higher overheads, 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 different
tracking U.S. trends and geographical preferences, but it
felt that it would be difficult to predict consumer re-
sponse to a hybrid car. Besides, the Prius might appeal to
particular consumer segments, such as technophiles and
conservationists, which Toyota didn’t know much about.
Convinced that the uncertainties were too great to allo-
cate the Prius to dealers based on past trends, Toyota de-
cided to keep inventory in central stockyards. Dealers
took orders from consumers and communicated them via
the Internet. Toyota shipped cars from stockyards, and
dealers delivered them to buyers.
tomized products to demand and managed inventory
flawlessly. In 2002, for example, 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 California and only 6% in the
Southeast. Had Toyota not adapted its distribution sys-
tem to the product, it would have faced stock outs in
sometimes before they occur, by capturing the latest
data, filtering out noise, and tracking key patterns.
networks to maintain distinctive positions. The adapta-
tion has worked. Many consumers don’t realize that Gap
owns all three brands, and the three chains serve as back-
ups in case of emergency.
propriate markets, especially when they are launching
innovative new products. The trick is to remember that
products embody different levels of technology. For in-
stance, after records came cassettes and then CDs. Video-
tapes were followed by DVDs, and almost anything ana-
log is now or will soon become 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 mapping
either or both of those characteristics to supply chain
partners, manufacturing network, and distribution sys-
tem, companies can develop optimal supply chains for
every product or service they offer.
the Prius, the hybrid car it launched in the United States
in 2000, would be different from that of other models
because it embodied new technologies and was in its in-
tory in the Southeast, which may well have resulted in the
product’s failure.
components: the ability to spot trends and the capability
to change supply networks. To identify future patterns, it’s
necessary to follow some guidelines:
countries, because as nations open up their economies to
global competition, the costs, skills, and risks of global
supply chain operations change. This liberalization results
in the rise of specialized firms, and companies must peri-
odically check to see if they can outsource more stages of
operation. Before doing so, however, they must make sure
that the infrastructure 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.
not just your immediate customers. Otherwise, you may
fall victim to the “bullwhip effect,” which amplifies and
distorts demand fluctuations. For years, semiconductor
Spotlight
ated gluts in markets. But when they started tracking de-
mand for chip-based products, the manufacturers over-
came the problem. For instance, in 2003, there were neither
big inventory buildups nor shortages of semiconductors.
alter supply chains. To do that, they must do two things:
existing ones. When smart firms work in relatively un-
known parts of the world, they use intermediaries like Li
& Fung, the Hong Kong-based supply chain architects, to
find reliable vendors.
aware of the supply chain implications of their designs.
Designers must also be familiar with the three design-for-
supply principles: commonality, which ensures that prod-
ucts share components; postponement, which delays the
step at which products become different; and standard-
ization, which ensures that components and processes for
different products are the same. These principles allow
firms to execute engineering changes whenever they
adapt supply chains.
reat companies take care to align the interests of
all the firms in their supply chain with their own.
That’s critical, because every firm – be it a sup-
maximize only its own interests. (See the sidebar “The
Confinement of Nonalignment”) If any company’s inter-
ests differ from those of the other organizations in the
supply chain, its actions will not maximize the chain’s
performance.
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 resulted in long lead times in the
supply of lCs to HP’s ink-jet printer division. Since the di-
vision couldn’t afford to keep customers waiting, it cre-
ated a large inventory of printers to cope with the lead
times in supplies. Both divisions were content, but from
HP’s viewpoint, it would have been far less expensive to
have a greater inventory of lower-cost ICs and fewer
stocks of expensive primers. That didn’t happen, simply
because HP’s supply chain didn’t align the interests of the
divisions with those of the company.
chain practices. For example, several high-tech compa-
nies, including Flextronics, Solectron, Cisco, and 3Com,
of Nonalignment
Vendors maintain just enough stock at the hubs to sup-
port manufacturers’ needs, and they replenish the hubs
without waiting for orders. Such vendor-managed inven-
tory (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 advantages, why hasn’t it aiways reduced costs?
components until they physically enter the manufactur-
ers’ assembly plants and therefore bear the costs of in-
ventories for longer periods than they used to. Many sup-
borrow money to finance inventories at higher interest
rates than large manufacturers pay. Thus, manufacturers
have reduced costs by shifting the ownership of invento-
ries to vendors, but supply chains bear higher costs be-
cause vendors’ costs have risen. In fact, some VMI systems
have generated friction because manufacturers have re-
fused to share costs with vendors.
their own is by redefining the terms of their relationships
so that firms share risks, costs, and rewards equitably. For
instance, the world’s largest printer, RR Donnelley (which
prints this magazine) recognized in the late 1990s that its
supply chain performance relied heavily on paper-and-ink
suppliers. If the quality and reliability of supplies im-
proved, the company could reduce waste and make deliv-
eries to customers on time. Like many other firms, RR
Donnelley encouraged suppliers to come up with sugges-
tions for improving processes and products. To align their
interests with its own, however, the company also offered
to split any resulting savings with suppliers. Not surpris-
ingly, supplier-initiated improvements have helped en-
hance RR Donnelley’s supply chain ever since.
of intermediaries. In the case of VMI, for instance, some
financial institutions now buy components from suppli-
ers at hubs and sell them to manufacturers. Everyone
benefits because the intermediaries’ financing costs are
lower than the vendors’ costs. Although such an arrange-
ment requires trust and commitment on the part of
suppliers, financial intermediaries, and manufacturers, it
is a powerful way to align the interests of companies in
supply chains.
the best in the industry, is a great example of incentive
alignment that has led to outstanding results. Instead of
causing heartburn, the system works well because Saturn
aligned the interests of everyone in the chain-especially
consumers.
aging service parts inventories. The company uses a cen-
tral system to make stocking 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 company’s only responsibility. Instead,
Saturn holds its managers and the dealers jointly ac-
countable for the quality of service the vehicle owners ex-
perience. 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) division on the profits that dealers make from ser-
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 overstock
dealers because Saturn shares the costs of excess inven-
tory with them. If no one buys a particular part from a
dealer for nine months, Satum will buy it back as obsolete
inventory.
everyone in the chain has the same objective: to deliver
the best service to consumers. While the off-the-shelf
availability of service parts in the automobile industry
ranges from 70% to 80%, service part availability at Sat-
urn’s dealers is 92.5%. After taking transfers from other
retailers into account, the same-day availability of spare
parts is actually 94%. Second, the right to decide about
inventory replenishment rests with Satum, which is in
the best position to make those decisions. The company
shares the risks of stock outs or overstocks 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 inven-
tory) of spare parts at Saturn’s dealers is seven times a
year while it is only between one and five times a year for
other automobile companies’dealers.
ply 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 responsibilities of each partner
so that there is no scope for confiict. Then companies
must align incentives, so that when companies try to max-
imize returns, they also maximize the supply chain’s per-
formance. To ensure that happens, companies must try to
predict the possible behavior of supply chain partners in
the light of their current incentives. Companies often per-
form 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 entire supply chain.
even-Eleven Japan (SEJ) is an example of how a
company that builds its supply chain on agility,
adaptability, and alignment stays ahead of its ri-
ably low stock out rates and in 2004 had an inventory
turnover of 55. With gross profit margins of 30%, SEJ is also
has the 9,000-store retailer managed to sustain perfor-
mance for more than a decade?
to quick changes in demand-not to focus on fast or cheap
deliveries. It has invested in real-time systems to detect
changes in customer preference and tracks data on sales
and consumers (gender and age) at every store. Well hefore
the Internet era began, SEJ used satellite connections and
ISDN lines to link all its stores with distribution centers,
suppliers, and logistics providers. The data allow the supply
chain to detect fluctuations in demand between stores, to
alert suppliers to potential shifts in requirements, to help
reallocate inventory among stores, and to ensure that the
company restocks at the right time. SEJ schedules deliver-
ies to each store within a ten-minute margin. If a truck is
late by more than 30 minutes, the carrier has to pay a
penalty equal to the gross margin ofthe products carried to
the store. Employees reconfigure store shelves at least three
alignment between Seven-Eleven Japan’s interests and
those of its partners. 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.
ties, it works with suppliers to develop 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 consumers to
order products online or through kiosks at SEJ stores
and pick up the merchandise at any Seven-Eleven. The
partners benefit from SEJ’s logistics network, which de-
livers products to stores efficiently, as well as from the
clear: Make the company successful, and share the
rewards. Fail to deliver on time, and pay a penalty.
segments and demands at different hours.
time. Some years ago, the company decided to concen-
trate stores in key locations instead of building outlets
all over the country. But doing so increased the possi-
bility of traffic congestion every time the company re-
plenished 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 distribution system. It asked its suppliers from
the same region to consolidate shipments in a single 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 company has also expanded the kinds of vehicles it
uses from trucks to motorcycles, boats, and even heli-
copters. The effectiveness of the company’s logistics
system is legendary. Less than six hours after the Kobe
earthquake on January 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-
to set up multimedia kiosks to produce games, tickets, or
CDs in its shops, Seven-Eleven Japan has become a man-
ufacturing outlet for partners. The company could not
have aligned the interests of its partners more closely
with those of its own.
When 1 describe the triple-A supply chain to companies,
most of them immediately assume it will require more
technology and investment. Nothing could be further
from the truth. Most firms already have the infrastructure
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 triple-A performance. Companies must
give up the efficiency mind-set, which is counterproduc-
tive; be prepared to keep changing networks; and, instead
of looking out for their interests alone, take responsibility
for the entire chain. This can be challenging for compa-
nies because there are no technologies that can do those
things; only managers can make them happen. ^
To order, see page 159.