Lean as a Supply Chain Strategy

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In my last post, I started a series on the conventional supply chain strategies and why they are inadequate to help firms trying to design their supply chains. This continues the series with the focus on lean as a supply chain strategy.

Lean primarily refers to elimination of waste and is the basic philosophy that originated as part of Toyota Production Systems, with its emphasis on the elimination of waste (muda). Therefore, this philosophy is based on reducing the cost by eliminating activities that do not directly add any value. Cost can be reduced in two ways: (1) by identifying and eliminating the wasteful activities that don’t add any value and (2) by enhancing the efficiency of a required activity so that the throughput of the process can be increased. A lot of supply chain activities can directly leverage this thinking. Most execution activities in a supply chain can benefit from lean thinking, such as picking, packing, loading, and unloading in a warehouse; routing of shipments in transportation; labor activities on receiving docks at warehouses, stores, and manufacturing plants; and so on.

Loading a container ship

What does a lean design for a supply chain mean? A lean supply chain design requires that supply chains minimize the cost of operations at all levels. Lean requires that the supply chain uses the least amount of resources to efficiently complete its job. The primary resources in a supply chain are inventory, warehouses, trucks, people, and working capital. A lean supply chain will be designed to have minimal inventories in the system, minimal amount of warehousing space required to store these inventories, and optimized shipments to reduce the cost of moving inventory. A lean supply chain will also be designed to establish long-term, stable supply contracts with the lowest negotiated cost, but typically without any substantial ability to change ordered quantities, delivery destinations, and required need dates after the order has been placed. Lean design will most likely not engage secondary suppliers, because a second tier of suppliers is expensive to maintain. All of these factors will reduce the costs of the supply chain operations, making it extremely cost-efficient, but will also constrain the supply chain’s ability to adapt to any changes in demand, supply, or other resources, due to the built-in rigidity of the design.

And therein, lies the rub: Low inventories make the supply chain vulnerable to not being able to fulfill orders if the demand suddenly spikes or if there are changes in demand that were not foreseen. Inability to change orders with the suppliers also constrains the supply chain’s ability to react to any changes in demand and may saddle the supply chain with unwanted inventory. Having no secondary suppliers also limits the ability of the supply chain to reacting to spikes in demand and/or exposes it to supply failures from the primary suppliers. The focus on being lean prevents this supply chain from building redundancy by design which reduces supply chain’s ability to manage variability.

On the other hand, the only reason for supply chains to exist is to manage variability! So a lean focus ion supply chain design actually goes against the very basic nature of the supply chains. However, if the lean focus is seen simply as the most efficient way to execute business operations (which include a fair amount of agility to respond to natural volatility in demand), then it can be used to design effective supply chains. Also – if lean is a supply chain strategy that is good in certain conditions, I would like to know when is lean not good? When should a firm spend more money than is absolutely required to organize its operations?

Also, most firms have a large assortment of material to be managed: Raw materials, WIP, finished goods, and retail assortments almost always consist of a mixed bag of products when it comes to their demand profile. While some products may have a stable demand profile, others will be more volatile to manage. This means that the enterprise supply chain that must be designed to cater to all these types of products must be lean (to best manage the products with a stable demand) and agile (to manage others with volatile demand) simultaneously. After all, you could not run a business with a lean supply chain with the lowest cost, but that cannot respond to any changes in demand or supply. Since all demand and supply has inherent variability, such a rigidly designed supply chain will quickly build up unwanted and obsolete inventories as it is incapable of reacting to changes in demand and supply. Of course, too much emphasis on creating agility may be expensive and may also not provide the best design as we shall see when we discuss agile as a supply chain strategy.

Finally, the cost focus serves much better a generic business strategy as suggested by Michael Porter because a cost focus can be used effectively to drive any corporate function, such as accounting, human resources, merchandising, production planning, engineering and so on: There is nothing specific about the cost focus that would make it work any extra magic for supply chain than what it can do for any other corporate function, and hence its inability to drive supply chain strategy!

Summarizing,

  • Supply chains must manage variability and an exclusive focus on lean prevents supply chains to be designed effectively for managing natural variability and hence from doing their most important job.
  • As most firms have several products to manage and these products have widely varying demand and lead-time patterns, the enterprise supply chain must be designed to work for all these products without undue focus on a single characteristic.
  • There is nothing special about the cost focus that helps driving supply chain strategy any more than it can do for any other corporate function. To that extent it remains an effective business strategy, but not a supply chain strategy.

 

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© Vivek Sehgal, 2010, All Rights Reserved.

Want to know more about supply chains? How they work, what they afford, and how to design one? Check out my books on Supply Chain Management at Amazon.

Why Should the CFO Worry About Inventory

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As supply chain practitioners, we appreciate the significance of inventory in maintaining the supply chain flows and the service levels. Let us review the importance of inventory towards the corporate financials. Inventory is one of the components directly reported on the corporate balance sheets. It appears under the current assets and gets consolidated in the total assets of a company. Good inventory planning practices can significantly lower the inventory in the supply chain without having adverse effect on the supply chain’s ability to fulfill demand. This is typically achieved by deploying inventory optimization solutions that allow the firms to model their entire network, and the demand and supply at each node along the network with the targeted service levels for all the flows. Good demand forecasting capability forms the foundation of an effective inventory optimization function.

Reducing inventory reduces the current assets of a firm. A drop in the current assets reduces the total asset basis that translates into higher returns on assets, and it reduces the working capital (which is the difference between the current assets and current liabilities) which means lower interest expense on borrowings that are typically used to finance the working capital. Managing inventories through an efficient supply chain can produce all kinds of interesting financial rewards, consider for example, the case of Wal-Mart. In year ending January 31, 2010, Wal-Mart reported current assets of 48.3B and current liabilities of 55.5B. Since working capital is calculated as current assets minus the current liabilities, this means that Wal-Mart has operations that produce more cash than they need to run these operations!

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Inventories affect a few other financial numbers as well (see the figure above):

  • It affects the return on assets (ROA). The ROA measures the profitability of a firm relative to the assets it uses to generate the profits. It is calculated as net-income divided by the total assets of a firm. When the inventories are reduced, the total assets of the firm are reduced, thus increasing the return on its total assets. This is also supported by the SCMR’s survey mentioned earlier in this appendix.
  • Inventory also affects the cash-conversion cycle of a firm. Cash conversion cycle measures the time that the firm takes to convert its investments into return. Cash conversion cycle is generally measured in days as the sum of inventory days (days inventory outstanding) and days receivables (or days sales outstanding) minus days payables (or days payable outstanding). Reducing inventory reduces the days inventory outstanding – keeping the other two terms constant, any reduction in inventory will naturally result in shortening the cash conversion cycle.
  • Since maintaining inventory in the supply chain costs capital, any reduction in the inventory levels reduces the need for working capital. Need for less working capital reduces the interest expenses of a firm. The interest reduction translates into higher net profit, because the interest is deducted from the earnings before interest, taxes, depreciation and amortization (EBIDTA) to calculate net profit. Lower working capital requirements also lead to lower short-term debt. Lower debt levels improve a firm’s debt-ratio as well debt-to-equity-ratio.
  • Reducing inventories increases inventory turnover of a firm. Inventory turnover measures the number of times the company is able to sell and replace its inventory over a period. It is calculated as cost of goods sold divided by average inventory valued at cost. When compared to the peers within an industry, a higher inventory turnover ratio represents strong sales and effective inventory planning and replenishment functions.

There are several supply chain processes that affect inventory and help reduce total inventory in the supply chain while maintaining the fulfillment or service levels to replenish the stores.

Better demand forecasting, inventory planning, and replenishment planning processes together help in reducing inventory in the system. Good demand and supply planning practices with the help of the correct tools have been shown to dramatically reduce inventories. Any reduction in inventory directly reduces the current assets and positively impacts the returns on assets.

Supply chain network optimization can also help reduce inventory levels by optimizing a network that is most efficient for replenishing the stores. This is a one-time benefit, and as the supply chain network consisting of stores, warehouses, and suppliers continues to grow, the supply network must be reevaluated to keep pace with the changes. However, frequent changes to the supply chain network are impractical due to heavy capital costs and long lead-times required to set up distribution centers.

 

 

 

© Vivek Sehgal, 2010, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

Can Your Supply Chain do That?

What are the objectives of your supply chain management? What should they be? In short, the following four capture all that an optimally run supply chain can achieve.

  1. Cost (Lean): The supply chain management processes cover a wide scope of execution operations from managing replenishment orders to transportation and warehousing activities. Depending on the industry, the percentage of these operational costs towards the cost of goods sold can be anywhere up to 20%. Following the processes based on supply chain best practices can directly reduce these costs through better planning, optimization, and execution. Some of the supply chain planning processes also impact costs such as inventory planning. Well planned inventories can not only reduce the amount of inventory in the system thus reducing operational cash-flow requirements, they can also reduce costs by reducing obsolescence, having the right product at the right place, and by reducing the need for clearance pricing. In fact, all supply chain processes either directly impact the COGS or impact the operating cash requirements. And, in most cases, the impact of a better deployed process, automation, or optimization can be specifically calculated for obtaining financial return on the investments made.
  2. Flexibility (Agile): This is the second objective for the supply chain processes. Agility provides a supply chain the capability to react to the changes in demand or supply in an optimal fashion so as to maintain the service-levels and therefore, the top-line revenues. There are several processes that create such agility in the supply chains: cross-docking made famous by Wal-mart is one of them. Ability to push the selection of the destination of the inventory-in-transit to the last possible minute is the underlying concept that enables agility in a flow-based supply chain. This can manifest itself through several possible processes such as consolidation and de-consolidation centers, regional and local distribution centers, cross-docking and so on. Other processes that add to the capability of agility are sourcing and replenishment where the agility can be achieved through better visibility and collaboration among the partners in the inter-company supply chains. 
  3. Risk: Supply chains must manage the uncertainties beyond the volatility of demand and supplies. Risk is primarily the disruption in the supply chain that is not attributable to the natural demand/supply volatility. While the probability of such disruptions is low, their consequences remain disastrous. Risk increases as the supply chains become longer, global, and need several independent corporate partners. Supply chains typically manage risk through better collaboration, visibility, and finally by developing backup plans for alternate sources of supplies if the primary supplies fail.
  4. Visibility: While visibility for its own sake is not an objective of supply chain management — this is a capability that must be developed to support the three primary objectives mentioned above. Visibility can help reduce costs by detecting the most inefficient processes, provide agility through showing available alternatives, and manage risk better by identifying the most critical supply paths and the impact of their failure. 

Evaluating your supply chain processes can expose inefficiencies and gaps that can help achieve or enhance the results in any of above four categories. Metrics can be set to measure the improvements: while the cost reductions can be measured more precisely, the impact of improvements due to increased agility and reduced risk can also be measured by comparing the results to the historical performance of the supply chain.

 

© Vivek Sehgal, 2009, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

 

Affecting Warehouse Efficiencies, Part 2: Inventory

Last week, I talked about the three main categories of warehouse efficiencies. These were operational, stocking, and fulfillment efficiencies. In this series of four posts, I am presenting the levers available to an organization to enhance these warehouse efficiencies. We would be talking about the four main levers to target and affect these efficiencies. These levers being Labor, Inventory, Slotting and Product Flow. In each of the four posts, I will focus on one of these levers and expand upon the functional capabilities that must be developed to enhance warehouse efficiency. In Part 1, the role of Labor was covered, today’s topic is Inventory.

Inventory Management:

Inventories in the warehouse consist of a substantial amount of working-capital tied up in the supply chain to ensure that the demand fulfillment rates can be maintained at desirable levels. Ability to fulfill store and customer orders is central to the existence of warehouses in a supply chain, but this must be balanced against the need to reduce system-wide inventory costs. Fulfillment metrics measure this ability of the supply chains to balance the service levels against the inventory. Inventory efficiency at the warehouse balances between the conflicting requirements of high fill-rates and low inventory costs. The following capabilities can help in maintaining both.

  1. Inventory Optimization: Inventory optimization solutions provide the warehouses with the ability to compute and maintain optimal inventory levels that are sufficient enough to maintain the target fill-rates. The inventory solutions typically work by analyzing the historical variance in demand, supply, and replenishment lead-times. These solutions compute the inventory levels required for the projected demand to maintain the targeted service levels. Optimizing inventory can typically reduce inventory in the system by 10-20% while still maintaining desirable service-levels. The problem becomes more complex when the supply chains have many levels and the inventory must be computed at each stocking point of each echelon of the chain.
  2. Inventory Visibility: Inventory visibility across facilities is another primary tool that replenishment managers can use to enhance warehouse inventory-efficiency. Inventory visibility enables dynamic source-selection for fulfilling demand in the supply chain. The conventional supply chains model stores tied to a specific warehouse for replenishment. This rigid relationship forces higher inventory levels in the system because each order must be fulfilled from a pre-determined source. Inventory visibility makes it possible to source orders from alternate sources, thus allowing lower inventory levels while simultaneously maintaining comparable service-levels. Solutions integrated with logistics can also account for the cost of such changes to make the best decisions.

Better inventory management processes directly affect the fulfillment metrics of the warehouse which are primarily focused on its ability to address demand. The examples of such metrics are fill-rates, on-time fulfillment, pick and ship accuracy, and so on.

Next time, I will talk about the opportunities to enhance warehouse efficiencies through better slotting management in the warehouse that is a primary lever to drive the stocking and operational efficiencies at a warehouse.

 

© Vivek Sehgal, 2009, All Rights Reserved.

Want to know more about supply chain processes? How they work and what they afford? Check out my book on Enterprise Supply Chain Management at Amazon. You will find every supply chain function described in simple language that makes sense, as well as see its relationship to other functions.

 

A Framework for Measuring Supply Chain Costs

In defining the long term trends in the environment that will impact supply chain strategies, I talked about two main changes happening in the environment. One was the costs and redistribution of costs/incomes; and second was environmental consciousness.

Let us explore what constitutes the supply chain costs and the specific processes that impact these costs. Some of the supply chain costs are crisply defined, readily available, and widely used in the industry. Others are less well known, and tend to get lost in the heaps of corporate data. However evaluating supply chain costs requires that we understand them, invest in defining them as clearly as possible, have processes to capture, report, and analyze them. Only such a complete picture of supply chain costs can truly drive new initiatives, find gaps in existing processes, and help in continually improving the cost and efficiency of the supply chain operations.

To clearly understand the impact of supply chain costs, corporations need to develop a “cost framework” to define, develop, and measure these costs. The discussions below helps in understanding what such a framework should look like, the scope of such costs, and how they affect the total supply chain costs for an enterprise.

To understand the scope of these costs, we will organize them into three categories as in the picture below. Grouping these costs into these categories will not only help us understand the source of these costs, but also provide an understanding of how to measure them and how to optimize them to make the supply chain more efficient and cost effective. In doing so, though one must use caution, as a single minded focus on cost alone may not be the most optimal supply chain strategy. Since supply chains must address the twin objectives of cost and flexibility (or responsiveness), supply chain performance must be measured using metrics that allow capturing both of these aspects. However,  in the current discussion, we will focus on the cost aspects alone, and leave the flexibility for another day.

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Direct Costs

These are the direct costs of merchandise, and services. These are easy to capture, understand, and report. Examples of these costs are the cost of merchandise (purchase orders), cost of freight (load tenders), cost of warehousing services (3PL warehousing costs), and so on. As most of these costs are captured through standard enterprise transactions like purchase orders, or load tenders, they are easy to capture and measure at the corporate level. The complexity arises when there is a requirement to allocate these costs across organizational entities such as product groups, or regions, etc. Such cost allocation is not unusual, and helps in establishing profitability of separate business groups, merchandise portfolios and so on. Though a well thought out accounting structure should be able to support such allocations objectively.

Spend Analysis directly focuses on this aspect of the supply chain costs. Consolidating all direct spend costs across the enterprise, helps in understanding the total spend layout with the vendors and service providers, and allow the enterprises to negotiate better deals and volume discounts.

  • Consolidate all spend by merchandise category, vendor, and service providers. Look for volume discounts, and negotiate on other costs such as credit terms, returns, quality, etc.
  • Analyze the merchandise demand, establish long term contracts for merchandise with stable and predictable demand. Implement software systems for bid evaluation and purchase planning when multiple suppliers are viable.
  • Evaluate possibility of using traditional and reverse auctions for one time and/or seasonal purchases where product attributes allow for such purchasing strategies.
  • Implement transportation optimization systems to directly impact the freight costs from the cost equation.
  • Evaluate all service provider contracts with transaction based fee and analyze historical usage for possible reductions by converting these transaction-fee contracts to fixed-fee contracts.

Process Costs

Process costs relate to the organizational teams that directly support supply chain processes. These processes may provide critical supply chain decisions to support operations, and support compliance requirements for regulatory purposes. Examples of such processes are demand management (forecasting, inventory planning, and replenishment teams), supply management (purchasing, expediting teams), logistics (shipment planners, load & route planners, and dispatchers), and global trade teams supporting imports and exports. These are direct personnel costs and can be impacted positively by improving process efficiency that leads to smaller teams handling the same volume of transactions. Such efficiency improvements can be a result of process automation, processes simplification, or process elimination.

  • Evaluate if the process can be automated through a system, completely or partly. Most IT applications provide automation for the transaction processing, some do so for the planning processes as well. Supply chain planning solutions routinely provide optimization based algorithms that can provide decision support for complex situations, such as determining optimal inventory levels at various locations. Such systems make processes efficient, as well as more effective by handling large amounts of data and computations that are otherwise impossible to be processed manually. They also allow more frequent reviews of supply chain policy parameters (such as inventory levels, flow-paths, seasonal inventory management, forecasting parameters, etc.) to keep them aligned with the changing demand and supply scenarios.
  • Evaluate if the process steps can be simplified, or eliminated. For example, consider whether all purchase orders need managerial approvals, or is there is a possibility that purchases within defined constraints (purchase value, vendor status, resulting inventory level etc.) can be made without such approval. Evaluate processes where all transactions are currently reviewed manually, and consider defining transaction profiles so that the system can identify exceptions for manual review while automatically processing the rest. Replenishment planning, purchasing, load tenders are all examples of processes where exception based management can be effectively implemented and manual effort can be reduced.

Technology Costs

The last category of supply chain costs are technology costs. Some examples of these costs include the software & hardware costs of deploying supply chain systems at the corporate office, dimensioning system & RF handheld units at the warehouse, and the geo-location tracking units on the trucks. The technology enables faster processing time for planning, near real-time execution, continuous visibility of inventory and operations from end-to-end, and enables decision support systems that leverage complex mathematical models to provide optimal results. But all the technology adds its own cost to the supply chain. As technology continues to play ever bigger part in supply chains, managing technology costs becomes more important. This is a difficult area as it straddles the business and IT groups, and requires that both collaborate closely to measure, contain, and evolve a technology strategy that allows for a cost-aware technology evolution with flexible supply chain solutions. This is easier said than done, however, these costs must be measured before they can be contained.

  • Establish an existing and to-be technology roadmap for supply chain. Create a checklist of business best practices and establish the gaps in current technology, prioritize new technology, and plan a purposeful adoption rather than an ad-hoc reactive evolution.
  • Establish costs of all technical resources, software, hardware and people. Establish maintenance and projected upgrade expenses. Clearly identify what the technology costs, and what it provides in return.
  • Evaluate technology diversity — while diversity in general is good, it may not be so in technology. Too many technologies quickly become expensive to maintain due to specialized skill requirements, hardware requirements, and annual maintenance fees. Consolidate common standards for technology stacks across applications, adopt SOA architecture for custom developed applications, evaluate annual license renewals for continued need, consolidate hardware vendors, virtualize, have consistent application & technology architecture, have business readiness plans in place through backups & disaster recovery. Empower enterprise architecture.
  • Measure, question, evaluate, evolve!

Most corporations do not have a consolidated view of costs of their supply chains. This constraints their ability to accurately identify opportunities and problem areas, prioritize supply chain investments, and constrains their ability to execute simple profitability analysis accurately. Creating a broad cost view of the supply chain requires careful analysis, planning, and processes to gather data, however, it allows for quickly analyzing the impact of changes, even predict such changes, and manage an ever-evolving supply chain for the optimal corporate efficiency.

© 2009, Vivek Sehgal, All Rights Reserved

Supply Chain Strategy Trend Two: Environmental Consciousness

In the previous post, I highlighted the two emerging trends that will shape the future of the supply chains. This article follows up on the second of these two main trends that affect us. We will call this trend “Environmental Consciousness” as this trend primarily focuses on the changes happening in today’s manufacturing, and distribution industries in response to the enhanced awareness of the impact of these activities on the environment.

While this trend has been in the making for some time, it has gained great momentum in the recent years. The rising awareness of the impact of the human activity on the environment is the subject of discussion in more and more political, social and economic forums. It is also the subject of numerous reports from World Bank’s Environmental Sustainability to Human Development Report 2007/2008 from United Nations.

Manufacturing and Distribution are two activities that affect the environment on a large scale. Manufacturing needs raw materials that come from natural resources in a number of cases, and the manufacturing process invariably needs energy to convert these raw materials into the finished products. Along the way it may produce wastes that must be treated, if toxic, before it can be released back into the environment. Distribution needs energy to move the products from one place to another and is a direct contributor to green house gases and resulting warming.

Supply chains manage manufacturing and distribution processes. And that is what brings them into sharp focus from this point of view.

While there are not many regulatory requirements that constrain the supply chain processes directly at this time, the indicators suggest that such requirements will exist pretty soon. For a look into what the future may look like, review the proposed carbon labeling act in California, http://www.carbonlabelca.org/2.html. Carbon emissions trading is already a reality in EU, and there is active talk of this system as a mechanism to control and govern the environmental effects of the industrial activities in the US as well. (Note that the US has operated cap-and-trade systems for emissions of sulfur dioxide and nitrogen oxides for year now).

Both of the above systems, namely the carbon labeling as well as the trade-and-cap systems can directly contribute towards controlling the environmental effects of manufacturing and retailing activities. Both affect the supply chain functions and its future evolution. The first achieves it through direct consumer discrimination based on the consciousness and the second one achieves it through regulation that affects the competitiveness of enterprises that are less environmental friendly than others.

While some of these measures will be voluntary and others regulatory in nature, it is clear that such measures will effectively change how we as consumers behave and react to products we buy. For example, consider the nutrition labels that were required to show the Nutrition Facts, basic per-serving nutritional information, on foods under the Nutrition Labeling and Education Act of 1990. These were introduced in 1992, and since then it has become an important part of the consumer behavior. It is not uncommon to find people checking the nutrition information in the grocery stores prior to putting the merchandise in their carts. A similar concept for carbon labeling will undoubtedly affect consumer behavior, and hence the retailer’s behavior in how these products are assorted, sourced, processed, distributed and sold.

Carbon Labeling

California’s Carbon Labeling Act of 2008 proposes to “Establish a methodology for determining and communicating the carbon footprint of a consumer product. If feasible, the state
board shall establish standards and methodologies for determining and communicating to consumers on a product label whether a product has a lower carbon footprint than the average comparable product available in the state.”

Chances are that such a methodology will include some measure of (1) energy consumed in the production of a product, and disposal of any harmful byproducts (2) energy consumed in the distribution of a product from the manufacturer to the retailer’s facilities, and finally (3) recycling characteristics of the materials used in production. Most of this information can be collected from the manufacturer and the retailer, and standardized in a format that is easy to understand and discriminate. And such labels will in turn affect the consumer preferences that drive the merchandising, sourcing, purchasing, distribution and stocking processes.

Trade-and-cap

The trade-and-cap system will primarily affect the manufacturing costs and affect the overall price paid by the consumer. Environmentally unfriendly products, even if cheap, will still have some impact in the same way as the allegations of using child labor had in recent years. This combination of regulatory and voluntary pressures will affect the consumer behavior albeit in a slightly indirect manner than the carbon labels. Managing costs eventually affects the same supply chain processes as above: merchandising, sourcing, purchasing, distribution and stocking.

The decision parameters and the metrics that define and measure these processes will change in response to these changes. So far these were primarily back-end supply chain processes that were merely enabling getting the right product at the right place at the right time and quantity. In the new context, they become front and center processes whose decisions affect the ultimate profitability and success of the company.

How will these process emerge in the future? How should they emerge? That is the subject of supply chain evolution strategy that we will continue focusing in the coming weeks.

©2008; Vivek Sehgal

Trends that Will Define Future Supply Chain Strategies

The sands of supply chain strategy planning are shifting again. It has evolved a lot, and changed a lot; and, it is happening again. The imperatives driving the supply chain for the next few years are becoming visible and they will shape this phase of supply chain evolution.

Supply chain was MRP in the 80s, that evolved to constrained based planning in the 90s, giving way to an integrated view of planning and execution currently through corporate-wide visibility and rich analytics.

Still so far, only a handful of companies have treated supply chains as a core part of their corporate strategy. These corporations have seen ample rewards in doing so. But most others had just started to seriously consider investments in supply chain strategy, when the new ground rules seem to be emerging for the next generation of supply chain thinking.

In making these statements, I want to differentiate between the automation of supply chain execution versus a truly strategic thinking that reviews the corporate supply chain from a strategic point of view that drives business functions and decisions.

  • The automation of supply chain transactions simply provides for efficient operations. Its value lies in the productivity enhancements that such systems provide. The business transactions in this category are largely standard, unvaried, and are supported through a multitude of vendor solutions available for all budgets. A good example in this category is warehouse management systems. While they do have a good ROI, these systems do not necessarily provide any competitive edge. These systems are no more elite, but have rather migrated into the “required” category if you wish to do business.
  • The strategic view of the supply chain attempts to view the corporate supply chain as a business strategy that binds together the assortment, sourcing, demand and supply management, planning and operations as a “whole” rather than the sum of its parts (like managing a warehouse). This is where the visionary corporations are focused and should be investing. This is what drives Walmart to review Brazil as a major market, GE to invest in the middle-east, and Halliburton to move their HQ to Dubai.

And it is the latter (strategic view of the supply chain) that is going to undergo major transformation in the coming years as corporations adjust to the environmental changes underway for the last year or so. We will talk about the two overbearing trends that are driving this change. Over the next few weeks, we will go into the details of these trends and the shape of things to come.

Merchandise Costs: “Rise of the Rest”

This trend has been recently highlighted by Fareed Zakaria in his new book, “The Post-American World”. He makes various arguments and illustrates them in multiple ways, but at the core of this trend is the fact that living standards are rising all around the world. The developing countries are growing at a faster pace than ever. And the combination of growth and higher living standards is pushing the wages and cost of production specifically in these regions, and generally all over the world. People have argued that this growth is also pushing the prices of food, commodities, and energy everywhere.

This trend affects the cost basis for everything that is manufactured and distributed, through the increased cost of materials, cost of higher wages, and finally the cost of transportation. The changes in the cost basis will change the outsourcing equation in manufacturing.

The commodities index for all commodities has gone up by 44% from 1998 to 2008 (Source: Bureau of Labor Statistics, Jan 1998 versus Jan 2008). Over the same time period, the index for Metals and Metal Products moved up 65%, and Industrial Commodities by 45%. All the indices were still trending upwards for 2008 at the time of writing.

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The wages in China have nearly doubled in past four years outpacing the growth of GDP. (See the full story at Forbes at http://www.forbes.com/markets/2007/07/02/china-wage-growth-markets-econ-cx_jc_0702markets1.html).

According to the Department of Energy, the cost of diesel fuel has almost quadrupled in the same time from 1998 to 2008, (see, http://www.supplychainmusings.com/2008/05/optimization-transportation-versus.html).

These changes are not isolated spikes in a stable data series anymore. These changes have become trends that will define the cost equations for the decades to come. And these new cost bases will define the sources of our goods and services in the next few years. The change may not be subtle, China may not be manufacturing capital of the world any more, and India may not remain the back-end services capital. Consider some of the recent changes on manufacturing front: BMW starting a manufacturing plant in the US, Inbev buying Anheuser Busch and Chinese investments in manufacturing coming to GA facilitated by the Georgia China Alliance.

Business Costs: Environmental Evolution

The second trend that will shape the supply chains of the future is the environmental awareness, and the social pressure to address the issues related to the environment. This can manifest itself through various legal and regulatory requirements, such as the carbon trading; or in more stringent ways that affect the whole chain of raw materials, manufacturing processes, disposal and recycling. There is talk of “carbon labeling” in the industry that would require the retailers not only to gather the information but also share it with the consumers (see http://www.carbonlabelca.org). These changes, legislative and otherwise, will drive the companies to review their existing processes and enhance them to align with the changes in the external environment.

These changes in the environmental sensitivities have the potential of affecting almost all of the organizational supply chain processes. Some of the processes directly impacted will be assortment planning, sourcing, vendor selection, manufacturing processes, packaging, disposal, distribution.

Over the next few weeks we will dig deeper to find out how these two trends affect the supply chain strategy and planning for the corporations. Till then…

©2008; Vivek Sehgal