Aligning Supply Chain Strategies with Product Uncertainties

Aligning Supply Chain Strategies with Product Uncertainties

Hau L. Lee

S upply chain management has emerged as one of the major areas for companies to gain a competitive edge. Managing supply chains effectively is a complex and challenging task, due to the current husiness trends of expanding product variety, short product life cycle, increasing outsourcing, globalization of businesses, and continuous advances in information technology. The Internet has contributed to both the increasing needs and opportunities for improved supply chain management. With the Internet, companies in a supply chain can be connected in real time with information and knowledge shared continuously, new products and services can be designed to fit special market segments, and new supply chain structures can be developed to serve customers in a more direct manner.

When a company faces the pressure of excessive inventory, degraded customer service, escalating costs and declining profits, or a poor return on assets, its supply chain is out of control. On the other hand, when a company moves in to new markets or new technologies, it must have its supply chain prepared for the new business challenges and opportunities. Although there are many new supply chain concepts and fads designed to exploit the advantages of the Internet, successful companies understand that the right supply chain strategy is dependent on a number of factors:

? The strategy needs to be tailored to meet specific needs of the customers.

? A product with a stable demand and a reliable source of supply should not be managed in the same way as one with a highly unpredictable demand and an unreliable source of supply.

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Aligning Supply Chain Strategies with Product Uncertainties

? The Internet can be a powerful tool for supporting or etiabling supply chain strategies for products with different demand and supply uncertainties.

Supply chain strategies that are based on a one-size-fits-all or a try-everything mentality will fail.

The Uncertainty Framework

A simple but powerful way to characterize a product when seeking to devise the right supply chain strategy is the "uncertainty framework." This framework specifies the two key uncertainties faced by the product--demand and supply. Fisher introduced the matching of supply chain strategies to the right level of demand uncertainties of the product.' This article expands his framework to include supply uncertainties.

Demand uncertainty is linked to the predictability of the demand for the product. Functional products are ones that have long product life cycles and therefore stable demand, while innovative products are products that have short life cycles with high innovation and fashion contents--and which, as a result, have highly unpredictable demand.^ Fashion apparel, high-end computers, the latest integrated circuits, and mass customized goods are examples of innovative products, while household consumable items, basic foods, oil and gas, and basic clothing are examples of functional products. Clearly, different supply chain strategies are required for functional versus innovative products.

Functional products tend to have less product variety than innov-

ative products, where variety is introduced due to the fasbion-oriented nature of

the product or the rapid introduc-

F I G U R E I. Demand Characteristics

tion of new product options due to product technology advancements.

Functional

Innovative

Demand for functional products is much easier to forecast, while

Low dem,3nd uncertainties High demand uncertainties

demand for innovative products is

Mor^ predictable demand

Difficuit to fonscast

highly utipredictable. Due to the

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

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

differences in product life cycle and the nature of the product, functional products tend to bave lower product profit margins, but the cost of obsolescence is low; whereas innovative products tend to have

higher product profit margins, but the cost of obsolescence is high. Figure 1 summarizes some of the

differences between functional and

innovative products.

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Aligning Supply Chain Strategies with Product Uncertainties

^ , ,. , r

, . ..

Other kinds of uncertainties

revolving around the supply side

of the product are equally impor-

F I G U R E 2 . Supply Characteristics

^^'

stable

Evolving

tant drivers for the right supply

Less breakdowns

Vulnerable to breakdowns

chain strategy. A "stable" supply

Stable and higher yields

Variable and lower yields

process is o n e w h e r e t h e m a n u f a c -

^ess quality problems

Potential quality problems

turing process and the underlying

technology are mature and the

'^

supply base is well established. An

. ,

"evolving" supply process is where

,

r

?

J *i-

the manufacturmg process and the

underlying technology are still

under early development and are

rapidly changing, and as a result

^^^^ ^^^p,^ ^^^^^^

^ ,^, ,

Reliable suppliers

Less process changes

Less capacity constraint

^ ' Easier to changeover ""'^^'b^e Dependable lead time

Limited supply sources

,, . ,, ,

Unreliable suppliers

More pnDcess changes

Potential capacity constrained

Difficurt to changeover '"^^^^'^^^ Vanable lead time

the supply base may be limited in

^

both size and experience. In a

stable supply process, manufactur-

ing complexity tends to be low or manageable. Stable manufacturing processes

tend to be highly automated, and long-term supply contracts are prevalent. In

an evolving supply process, t h e manufacturing process requires a lot of fine-

tuning and is often subject to breakdowns a n d uncertain yields. The supply base

may not be as reliable, as the suppliers themselves are going through process

innovations. Figure 2 summarizes s o m e of t h e differences b e t w e e n stable and

evolving supply processes.

While functional products tend to have more mature and stable supply

process, that is not always the case. For example, the annual demand for elec-

tricity and other utility produas in a locality tend to be stable and predictable,

but t h e supply of hydroelectric power, which relies on rainfall in a region, can be

erratic year by year. Some food products also have very stable demand, but the

supply (both quantity a n d quality) of t h e products depends o n yearly w e a t h e r

conditions. Similarly, there are also innovative products with a stable supply

process. Fashion apparel products have short selling seasons a n d their d e m a n d is

highly unpredictable. However, t h e supply process is very stable, with a reliable

supply base and a mature manufacturing process technology. Figure 3 gives

s o m e examples of products that have different d e m a n d a n d supply uncertainties.

Changing the Uncertainty Landscape

It is more challenging to operate a supply chain that is in the right column of Figure 3 than in the left column, and similarly it is more challenging to operate a supply chain that is in the lower row of Figure 3 than in the upper row. Before setting up a supply chain strategy, it is necessary to understand the sources of the underlying uncertainties and explore ways to reduce these uncertainties. If it is possihle to move the uncertainty characteristics of the product

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Aligning Supply Chain Strategies with Product Uncertainties

F I G U R E 3. The Uncertainty Framework: Examples

Demand Uncertainty

Low (Functional Products)

High (Innovative Products)

Low

(Stable Process)

u

c

i D

High

?- (Evolving Process)

Grocery, basic apparel, food, oil and gas

Hydro-electric power; some food produce

Fashion apparel, computers, pop music

Telecom, high-end computers, semiconductor

from the right hand column to the left, or from the lower row to the upper one, then the supply chain performatice will improve.

Figure 4 shows the two kinds of strategies that improve supply chain performance through uncertainty reduction--demand uncertainty reduction and supply uncertainty reduction.

Demand Uncertainty Reduction Strategies

In many cases, although the demand of the product at the end consumer level is stable, distortion of demand signals can occur up the supply chain. As a result, the demand patterns at the upstream portion of the supply chain could become highly erratic. Hence, while the demand patterns at the end consumption level could be flat with small variations, the orders placed by the retailer to the wholesaler (or by the wholesaler to the manufacturer, or by the manufacturer to the supplier, and so on) exhibit increasing fluctuations. This is the wellknown "bullwhip effect," which is an amplification of order variability as one goes upstream along a supply chain.^ In this way, even though the original product demand is stable, many parts of the supply chain would still be faced with highly unpredictable demand, so that overall cost efficiency cannot be achieved across the entire supply chain. Here, the observed demand uncertainty of the product would place the product in the right column of Figure 3, although it should really belong in the left column. What is needed is a way to move the demand uncertainty back to the left column.

Only through information sharing and tight coordination can one regain control of supply chain efficiency. Sharing of demand information and synchronized planning across the supply chain are crucial for this purpose. Barilla, an Italian pasta manufacturer, is a case example. Pasta is a produa that has both low demand and supply uncertainties. Yet, as a result of the retailers' over-

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F I G U R E 4. The Uncertainty Reduction Strategies

Supp ly Unceritainty

Low {Stable Process)

High (Evolving Process)

Demand Uncertainty

Low {Functional Products)

High {Innovative Products)

?1 ^ t1

.

Demand Uncertainty

>i--? ' Reduction Strategies

1Supply Uncertainty Reduction Strategies

reactions to demand signals, orders that are batched to make full truckloads, promotions, and order exaggerations, a high level of demand fluctuations occur, leading to significant waste and losses. Figure 5 shows the amplification of demand fluctuation of Barilla's product from the distributor to the manufacturer. Through information sharing and coordinated replenishment programs initiated by Barilla, the supply chain efficiency was greatly improved."' Inventory dropped by close to 50%, and stockout rates were down to almost zero as a resuh of the tight coordination. In the end, the bullwhip was "tamed." Indeed, in a recent study conducted jointly by Stanford University and Accenture focused on 100 manufacturers in the food and consumer products industry, companies that reported higher than average profits were the ones who engaged in joint replenishment and planning programs with their trading partners (see Figure 6).

Information sharing and collaborative replenishments up and down the supply chain are best facilitated by the use of the Internet. The grocery industry, which consists of mostly functional products with stable supply processes, is an ideal setting to implement such strategies. Currently, the Voluntary Industry Commerce Standards Committee is working on formalizing the process models and technology framework for collaborative planning, forecasting, and replenishment for the grocery industry. It seeks to have companies utilize the Internet, with electronic bulletin boards, to pursue the collaborative efforts. Nabisco and Wegmans have successfully implemented a pilot, with very encouraging results. The total snack nut category sales went up by 11 % while the corresponding sales at other retailers actually declined by 9% in the test period. Nabisco's leading brand. Planters, saw its sales rise by 40% as a result of better-planned

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