PDF Aligning Supply Chain Strategies with Product Uncertainties

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CMR230

04/01/02

Aligning Supply Chain Strategies with Product U ncertainties

Hau L. Le e

California Management Review Re p rin t Se rie s ?2002 by Th e Regen ts of th e Un iversity of Californ ia CMR, Volu m e 44, Nu m ber 3, Sprin g 2002

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Aligning Supply Chain Strategies with Product U ncertainties

Hau L. Le e

Su pply ch ain m an agem en t h as em erged as on e of th e m ajor areas for com pan ies to gain a com petitive edge. Man agin g su pply ch ain s effectively is a com plex an d ch allen gin g task, du e to th e cu rren t bu sin ess tren ds of expan din g produ ct variety, sh ort produ ct life cycle, in creasin g ou tsou rcin g, globalization of bu sin esses, an d con tin u ou s advan ces in in form ation tech n ology. Th e In tern et h as con tribu ted to both th e in creasin g n eeds an d opportu n ities for im proved su pply ch ain m an agem en t. With th e In tern et, com pan ies in a su pply ch ain can be con n ected in real tim e with in form ation an d kn owledge sh ared con tin u ou sly, n ew produ cts an d services can be design ed to fit special m arket segm en ts, an d n ew su pply ch ain stru ctu res can be developed to serve cu stom ers in a m ore direct m an n er.

Wh en a com pan y faces th e pressu re of excessive in ven tory, degraded cu stom er service, escalatin g costs an d declin in g profits, or a poor retu rn on assets, its su pply ch ain is ou t of con trol. On th e oth er h an d, wh en a com pan y m oves in to n ew m arkets or n ew tech n ologies, it m u st h ave its su pply ch ain prepared for th e n ew bu sin ess ch allen ges an d opportu n ities. Alth ou gh th ere are m an y n ew su pply ch ain con cepts an d fads design ed to exploit th e advan tages of th e In tern et, su ccessfu l com pan ies u n derstan d th at th e righ t su pply ch ain strategy is depen den t on a n u m ber of factors:

Th e strategy n eeds to be tailored to m eet specific n eeds of th e cu stom ers.

A produ ct with a stable dem an d an d a reliable sou rce of su pply sh ou ld n ot be m an aged in th e sam e way as on e with a h igh ly u n predictable dem an d an d an u n reliable sou rce of su pply.

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Aligning Supply Chain Strategies with Product U ncer tainties

Th e In tern et can be a powerfu l tool for su pportin g or en ablin g su pply ch ain strategies for produ cts with differen t dem an d an d su pply u n certain ties.

Su pply ch ain strategies th at are based on a on e-size-fits-all or a try-everyth in g m en tality will fail.

T he U ncertainty Framework

A sim ple bu t powerfu l way to ch aracterize a produ ct wh en seekin g to devise th e righ t su pply ch ain strategy is th e "u n certain ty fram ework." Th is fram ework specifies th e two key u n certain ties faced by th e produ ct--dem an d an d su pply. Fish er in trodu ced th e m atch in g of su pply ch ain strategies to th e righ t level of dem an d u n certain ties of th e produ ct.1 Th is article expan ds h is fram ework to in clu de supply u n certain ties.

Dem an d u n certain ty is lin ked to th e predictability of th e dem an d for th e produ ct. Fu n ction al produ cts are on es th at h ave lon g produ ct life cycles an d th erefore stable dem an d, wh ile in n ovative produ cts are produ cts th at h ave sh ort life cycles with h igh in n ovation an d fash ion con ten ts--an d wh ich , as a resu lt, h ave h igh ly u n predictable dem an d.2 Fash ion apparel, h igh -en d com pu ters, th e latest in tegrated circu its, an d m ass cu stom ized goods are exam ples of in n ovative produ cts, wh ile h ou seh old con su m able item s, basic foods, oil an d gas, an d basic cloth in g are exam ples of fu n ction al produ cts. Clearly, differen t su pply ch ain strategies are requ ired for fu n ction al versu s in n ovative produ cts.

Fu n ction al produ cts ten d to h ave less produ ct variety th an in n ov-

ative produ cts, wh ere variety is in trodu ced du e to th e fash ion -orien ted n atu re of

th e produ ct or th e rapid in trodu c-

FIGU RE 1. D emand Characteristics

tion of n ew produ ct option s du e to produ ct tech n ology advan cem en ts.

Funct ional

I nnovat ive

Dem an d for fu n ction al produ cts is m u ch easier to forecast, wh ile

Low demand uncertainties H igh demand uncertainties

dem an d for in n ovative produ cts is

More predictable demand

D ifficult to forecast

h igh ly u n predictable. Du e to th e

Stable demand Long product life Low inventory cost Low profit margins Low product variety H igher volume per SKU Low stockout cost Low obsolescence

Variable demand Short selling season high inventory cost H igh profit margins H igh product variety Low volumes per SKU H igh stockout cost H igh obsolescence

differen ces in produ ct life cycle an d th e n atu re of th e produ ct, fu n ction al produ cts ten d to h ave lower produ ct profit m argin s, bu t th e cost of obsolescen ce is low; wh ereas in n ovative produ cts ten d to h ave h igh er produ ct profit m argin s, bu t th e cost of obsolescen ce is h igh . Figu re 1 su m m arizes som e of th e

differen ces between fu n ction al an d

in n ovative produ cts.

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Aligning Supply Chain Strategies with Product U ncer tainties

Oth er kin ds of u n certain ties

FIGU RE 2. Supply Characteristics

revolvin g arou n d th e su pply side of th e produ ct are equ ally im por-

St able

Evolving

tan t drivers for th e righ t su pply ch ain strategy. A "stable" su pply process is on e wh ere th e m an u factu rin g process an d th e u n derlyin g tech n ology are m atu re an d th e su pply base is well establish ed. An "evolvin g" su pply process is wh ere th e m an u factu rin g process an d th e u n derlyin g tech n ology are still

Less breakdowns Stable and higher yields Less quality problems More supply sources Reliable suppliers Less process changes Less capacity constraint Easier to changeover

Vulnerable to breakdowns Variable and lower yields Potential quality problems Limited supply sources Unreliable suppliers More process changes Potential capacity constrained D ifficult to changeover

u n der early developm en t an d are

Flexible

Inflexible

rapidly ch an gin g, an d as a resu lt

D ependable lead time

Variable lead time

th e su pply base m ay be lim ited in

both size an d experien ce. In a

stable su pply process, m an u factu r-

in g com plexity ten ds to be low or m an ageable. Stable m an u factu rin g processes

ten d to be h igh ly au tom ated, an d lon g-term su pply con tracts are prevalen t. In

an evolvin g su pply process, th e m an u factu rin g process requ ires a lot of fin e-

tu n in g an d is often su bject to breakdown s an d u n certain yields. Th e su pply base

m ay n ot be as reliable, as th e su ppliers th em selves are goin g th rou gh process

in n ovation s. Figu re 2 su m m arizes som e of th e differen ces between stable an d

evolvin g su pply processes.

Wh ile fu n ction al produ cts ten d to h ave m ore m atu re an d stable su pply process, th at is n ot always th e case. For exam ple, th e an n u al dem an d for electricity an d oth er u tility produ cts in a locality ten d to be stable an d predictable, bu t th e su pply of h ydroelectric power, wh ich relies on rain fall in a region , can be erratic year by year. Som e food produ cts also h ave very stable dem an d, bu t th e su pply (both qu an tity an d qu ality) of th e produ cts depen ds on yearly weath er con dition s. Sim ilarly, th ere are also in n ovative produ cts with a stable su pply process. Fash ion apparel produ cts h ave sh ort sellin g season s an d th eir dem an d is h igh ly u n predictable. However, th e su pply process is very stable, with a reliable su pply base an d a m atu re m an u factu rin g process tech n ology. Figu re 3 gives som e exam ples of produ cts th at h ave differen t dem an d an d su pply u n certain ties.

Changing the U ncertainty Landscape

It is m ore ch allen gin g to operate a su pply ch ain th at is in th e righ t colu m n of Figu re 3 th an in th e left colu m n , an d sim ilarly it is m ore ch allen gin g to operate a su pply ch ain th at is in th e lower row of Figu re 3 th an in th e u pper row. Before settin g u p a su pply ch ain strategy, it is n ecessary to u n derstan d th e sou rces of th e u n derlyin g u n certain ties an d explore ways to redu ce th ese u n certain ties. If it is possible to m ove th e u n certain ty ch aracteristics of th e produ ct

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Aligning Supply Chain Strategies with Product U ncer tainties

FIGU RE 3. The Uncertainty Framework:Examples

Low (Stable Process)

Demand U ncertainty

Low (Functional Products)

H igh (Innovative Products)

Grocery, basic apparel, food, oil and gas

Fashion apparel, computers, pop music

H igh (Evolving Process)

H ydro-electric power, some food produce

Telecom, high-end computers, semiconductor

from th e righ t h an d colu m n to th e left, or from th e lower row to th e u pper on e, th en th e su pply ch ain perform an ce will im prove.

Figu re 4 sh ows th e two kin ds of strategies th at im prove su pply ch ain perform an ce th rou gh u n certain ty redu ction --dem an d u n certain ty redu ction an d su pply u n certain ty redu ction .

Demand Uncertainty Reduction Strategies

In m an y cases, alth ou gh th e dem an d of th e produ ct at th e en d con su m er level is stable, distortion of dem an d sign als can occu r u p th e su pply ch ain . As a resu lt, th e dem an d pattern s at th e u pstream portion of th e su pply ch ain cou ld becom e h igh ly erratic. Hen ce, wh ile th e dem an d pattern s at th e en d con su m ption level cou ld be flat with sm all variation s, th e orders placed by th e retailer to th e wh olesaler (or by th e wh olesaler to th e m an u factu rer, or by th e m an u factu rer to th e su pplier, an d so on ) exh ibit in creasin g flu ctu ation s. Th is is th e wellkn own "bu llwh ip effect," wh ich is an am plification of order variability as on e goes u pstream alon g a su pply ch ain .3 In th is way, even th ou gh th e origin al produ ct dem an d is stable, m an y parts of th e su pply ch ain wou ld still be faced with h igh ly u n predictable dem an d, so th at overall cost efficien cy can n ot be ach ieved across th e en tire su pply ch ain . Here, th e observed dem an d u n certain ty of th e produ ct wou ld place th e produ ct in th e righ t colu m n of Figu re 3, alth ou gh it sh ou ld really belon g in th e left colu m n . Wh at is n eeded is a way to m ove th e dem an d u n certain ty back to th e left colu m n .

On ly th rou gh in form ation sh arin g an d tigh t coordin ation can on e regain con trol of su pply ch ain efficien cy. Sh arin g of dem an d in form ation an d syn ch ron ized plan n in g across th e su pply ch ain are cru cial for th is pu rpose. Barilla, an Italian pasta m an u factu rer, is a case exam ple. Pasta is a produ ct th at h as both low dem an d an d su pply u n certain ties. Yet, as a resu lt of th e retailers' over-

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