Opportunities for Action in Industrial Goods. Curing Supply Chain Indigestion

Transcription

1 Opportunities for Action in Industrial Goods Curing Supply Chain Indigestion

2 Curing Supply Chain Indigestion The pressure to improve supply chain performance has never been greater. The rise of e-commerce as well as intensifying competition in general have dramatically raised the benchmarks for speed, reliability, customization, and quality. In response, companies have been investing huge sums in new information technology, equipment, and processes. But many companies have invested and reengineered without fully understanding supply chain dynamics and economics. As a result, they have not come close to realizing the improvements they anticipated. To avoid supply chain indigestion, companies need to understand the interactions among the five elements of supply chain performance: volume, velocity, variety, volatility, and value (see Exhibit 1). Two companies pursuing different supply-chain strategies will have to optimize and balance the Vs in different ways. Most managers underestimate the systemic effects of the five Vs: how the elements interact to affect costs and benefits. They tend to focus on one or two of them at most and give the others short shrift. The widespread failure to take a holistic approach to the five Vs goes a long way toward explaining why so many efforts to improve supply chains fall short. In a survey of enterprise initiatives, such as enterprise resource planning (ERP) and supply chain management, The Boston Consulting Group found that fewer than 33 percent of such efforts created significant value. Using computing technology to generate a lot more information and get it more quickly to a lot more people will add little value if the elements of the supply chain are out of balance. It is understandable why so few companies have mastered the five Vs. The interactions among them are

3 Exhibit 1. The Five Vs Element Volume Velocity Variety Volatility Value Description Scale of, for example, factories, warehouses, and distribution. Volume of products flowing through the system. Speed, as measured by, for example, lead times, order-to-delivery times, inventory turns, and product development times. Product variety, including product configurations, stock-keeping units (SKUs), platforms, component SKUs, and brands. Process variety, including number of production lines, facilities, and processing technologies. Demand variability, inventory variability, schedule stability, supplier reliability, and production yields. Price realization adjusted for markdowns, incentives, and obsolescence. Amount of cost built into inventories and work in process, including materials, value added, facilities, handling, and financing. extremely complex, which makes it difficult for managers to figure out exactly what they should do to improve overall performance. And conflicting management incentives can make the challenge even tougher. One often finds that the head of manufacturing is focused on maximizing, say, volume, while the head of marketing is pushing to maximize the variety of products that the company offers. In such cases, they end up working at cross-purposes, increasing volatility and destroying value.

4 Even when managers take a cross-functional view, they often fall into traps. One is focusing on one or two Vs with benefits that appear so large that worrying about the rest of the Vs doesn t seem worth the effort (see Exhibit 2). A second trap is designing the capa- Exhibit 2. Getting the Five Vs Wrong Behavior An overemphasis on maximizing volume An overemphasis on maximizing velocity An overemphasis on maximizing variety An overemphasis on dampening volatility An overemphasis on maximizing value Common Result Reduced velocity, increased volatility, increased but unprofitable variety to fill up the factory, and a dramatic loss of value in inventories, markdowns, and obsolescence. Lower value as a result of suppliers holding too much just-in-case inventory to deal with volatility or lower volume due to suppliers stockouts. Overly narrow product line, resulting in lower volume and an inability to extract maximum value from price points and segments. A small incremental increase in volume but a decrease in volatility and velocity. An extensive risk of locking up value in inventories of slow-selling products. Reduced velocity, a reemergence of volatility somewhere else in the supply chain, and the potential to miss out on value-creating opportunities that require a rapid response. Potential to rely too much on standard accounting estimates without considering systemic effects, resulting in actions that don t truly maximize value.

5 bility for variety or volatility into some portions of the supply chain but not in all critical links. A third is misconstruing the nature of the demand for a company s products. Most managers realize that the demand for functional commodities tends to be predictable, while the demand for innovative or fashion-oriented goods tends to be volatile. But because many products are not purely one or the other, managers often make the wrong calls and design supply chains that are ill suited to meet demand. Balancing Volume and Variety The automotive industry is a classic example of an industry whose managers did not adequately balance the five Vs. For decades, most companies in the industry designed and operated their supply chains as if the vehicles they produced were functional commodities rather than fashion-oriented goods: they focused too much on maximizing volume and minimizing short-term volatility, and too little on managing variety, velocity, and value. The result of that imbalance was high inventory levels, a misguided reliance on sales incentives, and long lead times to get inflexible factories to achieve two conflicting objectives: long production runs and tremendous product variety. This approach exacerbated the mismatch between capacity and the demand for individual models. It exaggerated the peaks and troughs in sales. It saddled dealers with thousands of vehicles with feature and color combinations that customers did not want. Consequently, it produced billions of dollars of waste throughout the supply chain. Industry executives tended to assume that these dynamics were immutable. Toyota, of course, proved otherwise. The world s lowest-cost auto manufacturer,

6 Toyota has flexible capacity that can accommodate demand for multiple models. The company boasts relatively short order-to-delivery times, adequate variety, and low dealer inventories, and it rarely resorts to sales incentives. The fact that these are the capabilities required to prevail in the Internet era has not been lost on Toyota s competitors. Witness their plans to overhaul their supply chains so that they can deliver the exact car each customer orders within two weeks. But as these automakers pursue variety and velocity, many of them appear to be underestimating the degree to which they will need to revamp capacity, processes, and management practices that were designed for the pursuit of volume and low cost. Balancing Variety, Value, and Velocity The experiences of a global appliance manufacturer illustrate how another seemingly logical set of assumptions and strategic moves can misfire. Facing a stalemate in its struggle to improve market share and profitability, the company embraced an ambitious strategy to increase unit volume: it would break out of the pack by offering products, features, and brands aimed at many narrow customer segments. But the company failed to foresee the degree to which its focus on variety and volume would hurt value, velocity, and volatility. Drawing on extensive consumer research and discussions with retailers, the company sliced the market more finely than it had and identified segments that seemed to have the potential to contribute to growth and earnings. It then introduced new brands and a host of new models with features aimed at those segments. Finally, when competitors tried to create new niches, it responded by introducing products with features similar to theirs. As a result of these incremental

7 moves, product variety exploded the number of stock-keeping units (SKUs) roughly doubled while volume grew only slightly. For each proposed product configuration, the company s managers considered the standard costs of materials, manufacturing, logistics, and overhead. However, they failed to anticipate the systemic costs of managing so much complexity the greater number of parts, SKUs, platforms, processes, organizational entities, and market segments. As a result, the costs of overhead, materials handling, quality, and warranties soared, and direct-labor productivity and the effectiveness of the company s sales force dropped. The company also didn t take into account the impact of all this variety on its supply chain and on consumers. For suppliers, the costs of managing greater complexity were considerable. Like the manufacturer, they needed more time to produce and deliver components for the full range of products. Retailers found it difficult not only to maintain high inventory turns but also to sell an expanded line of products with relatively minor differences in features. Consumers were bewildered by the array of choices. Because forecasting demand for individual SKUs was extremely challenging, everyone in the supply chain increased lead times and buffer stocks, and tried to control volatility by freezing schedules. But these actions slowed the supply chain to a crawl, tied up extensive value in unproductive inventories, and dramatically increased markdowns and obsolescence. A BCG analysis found that variety drove somewhere between 5 and 20 percent of the total cost of individual products, and one-third to one-half of that cost was not required to serve customers needs.

8 The manufacturer realized that it could compete much more effectively by decreasing variety. It decided to offer a more limited line of well-designed, attractively styled products with a clear progression of features and corresponding price points. Consequently, the manufacturer was able to increase parts commonality, streamline processes, and boost labor productivity. These actions ultimately allowed the manufacturer to increase value its profitability grew by more than 5 percent maintain volume, increase velocity, and decrease volatility. Strategy and the Five Vs As the appliance company came to realize, a robust supply-chain strategy requires a deep understanding of the interactions among the five Vs. Such knowledge may overturn long-held assumptions about the nature of the industry and the cost of doing business. It will help companies make much wiser choices when they undertake initiatives to improve supply chain performance. Managers can embrace the five Vs by taking the following steps: Understand how the interactions among the five Vs underpin the economics of the supply chain. This involves extensive statistical and activity-based analyses of operational and financial data both within the company and with all supply-chain partners. The rich insights that these analyses yield should be distilled into simple rules of thumb that managers can use to understand tradeoffs, formulate a strategy, and translate that strategy into operating decisions. Address the five Vs explicitly in the business strategy and the supporting supply-chain strategy. This means

9 figuring out how the Vs have to be configured to support a given business strategy and how or whether that balance can be achieved. Conduct strategic initiatives to calibrate and balance the five Vs. This is the point at which a company should set priorities and objectives for ERP and supply chain initiatives. A company should also develop clear metrics for tracking the initiatives, monitor the results, and make corrections when necessary. Mastering the five Vs understanding how to balance them so they support the business strategy will help some companies outperform competitors pursuing similar strategies. Other companies will balance the Vs in radically new ways and rewrite the rules of competition in their industries. The advent of online marketplaces and e-commerce in general is creating an abundance of opportunities. In the battle to exploit those opportunities, mastering the five Vs could make all the difference. Barry Saeed Tom King Barry Saeed is a manager in the San Francisco office of The Boston Consulting Group. Tom King is a vice president in the firm s Toronto office. You may contact the authors by at: saeed.barry@bcg.com king.tom@bcg.com The Boston Consulting Group, Inc All rights reserved.

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