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Supply Chains Mis-managed

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Published: September 20, 2007 in India Knowledge@Wharton

When Martha Stewart, America's diva of décor, was released from federal prison in West Virginia in March 2005, millions of people around the world saw and read about it. Stewart's first public appearance since being imprisoned five months earlier had an interesting and unexpected aside: It created a new fashion trend.

At the time of her release, Stewart wore a grey-and-white poncho that had been knitted by a prison inmate. That garment attracted the interest of many women, and over the next few days, Stewart received numerous requests for the pattern and the type of yarn used to make it. Yarn companies and apparel manufacturers were eager to clamber onto Stewart's "prison poncho" bandwagon. The Lion Brand Yarn Company, a leading yarn-maker in the U.S., later said that in the first few days after Stewart's release, more than half a million people downloaded the poncho's crocheted and knitted patterns from the company's website. Apparel and logistics companies, however, ignored the hubbub. They saw little relation between their business and the emerging wave of business opportunities that the poncho was creating.

Anshuman Singh, chief executive officer of Future Logistics -- the logistics arm of the Future Group, a fast-growing Indian retailer -- spoke about Martha Stewart's poncho at the recent Global Supply Chain Summit 2007 held at the Indian School of Business (ISB) in Hyderabad. His view was that logistics firms had missed out on a huge opportunity. "In the first week after Martha Stewart appeared on her television show wearing this poncho, consumers went wild and demand soared, but neither the apparel companies nor their supply chains were ready," he said. "All around the U.S., there were lost sales."

Various speakers at the conference noted that companies in almost every industry are increasingly turning to supply chain excellence as a critical aspect of competitive strategy, and they are focusing on how to maximize the effectiveness of their supply chain networks to deliver business results.

Take retail, for instance. In categories such as fashion, food, general merchandise and home products, retailers have to deal with very small quantities -- and even individual pieces. Typically, moving an item from the vendor to the store involves at least six physical transactions. The scenario gets much more complicated when multiple vendors across several product categories are involved, each with its own requirements of logistics and supply chain set up. Food retail, for instance, has to deal with issues of freshness and perishable products. Apparel, in contrast, has to operate within a limited fashion time cycle. Household items tend to be either bulky or fragile, and so on.

In countries like India, where most retail stores are located in the heart of the city -- where rents are high and storage space is scarce -- supply chain management has even more serious business implications. Future Logistics, Singh said, now handles 2.5 million SKUs (or stock keeping units) a day across the Future Group's various retail formats around the country. By 2010, this number is expected to increase to more than 30 million SKUs a day. Singh reckons that even with 98% accuracy, some 600,000 pieces will not be delivered correctly, resulting in an estimated sales loss of more than Rs. 40 million ($1 million) a day.

"At Future Logistics, we believe that the biggest driver in consumer logistics will be the need for zero defect. While infrastructure, technology, automation, processes and people will all play an important role, zero defect can only be achieved through vertical integration across the entire supply chain -- from raw material supply, production, wholesale and retail. The different parts of the supply chain will no longer be able to work in silos as they do today," Singh noted.

Nike's Experience

Manufacturers, for their part, have realized that while they may have the best production facilities, compelling products, strong brands and great distribution networks, all of these mean nothing if the products are not available in stores when and where the customers want them. Ravi Kallayil, director of operations at Nike India, said: "Supply chain is one of the most critical aspects of Nike's corporate strategy. The primary goal of our supply chain strategy is to win at the moment of truth. This means that, as a manufacturer, we have to ensure that our products are in stock where and when the consumer shops."

At Nike -- which has $16 billion in revenues today with the goal of getting to $23 billion by 2011 -- process excellence is a key component of the company's supply chain strategy. According to Kallayil, Nike's three businesses -- footwear, apparel and equipment -- have some similarities since most of the products are made in Asia and sold to similar customers worldwide. Their production processes, though, are completely different. Much of this has to do with the fact that from the time Nike began in 1964, it has never owned a factory but has chosen to work through contract manufacturing. Said Kallayil: "We are trying to build our strength in process excellence through standardization. We are doing this through the concept of lean manufacturing, which Toyota has made popular."

Nike is also working towards what it calls "delivery precision." Kallayil explained that Nike conceives its products in the form of collections. A collection could consist of a top apparel, a bottom apparel, shoes, bag, cap, etc. This is how customers typically like to buy products. While Nike designs these products as part of one collection, each category of items is made in different locations. As a result, if supply chain execution goes awry, these products are not available as complete collections, and that leads to loss of sales. "Getting this streamlined is extremely challenging because it involves changing the way contract manufacturers work," said Kallayil.

At Dow Chemical (annual revenues: $49 billion), one of the key lessons the company has learned over the last few years has been that the supply chain strategy needs to support the business strategy. "It needs to be integrated. Otherwise, it is just a side event," said Peter Halloran, director of the supply chain expertise center at Dow Chemical International. "We believe that you cannot really have a successful business strategy unless you have a supply chain strategy underpinning it that allows you to get your products to your customers at the right price and the right time."

Dow has 157 manufacturing locations in 37 countries. It sells some 40% of its products in North America, 30% in Europe and 30% in the rest of the world. While India, China and the Middle East currently account for only 15% of Dow's sales, these regions are where Dow expects most of its growth in the coming years. "This is one of the reasons that we have located our global supply chain design center in Mumbai in India," explained Halloran.

A key business strategy for Dow is to develop joint ventures to source raw materials such as oil, natural gas and salt. (Some 50% of the products that Dow makes are basic material building blocks such as polyethylene, polystyrene, caustic soda, etc., which are used in various industries. The other 50% consists of products, such as adhesives and coatings, meant for specific industries.) Dow recently initiated a joint venture with Saudi Aramco in Saudi Arabia, from where it will be transporting several million tons of products a year to India, China and other parts of the Pacific. The design center in Mumbai is building the entire supply chain to support this venture.

"Our supply chains need to support our different businesses and different business models," Halloran said. "One of our key challenges is to design supply chains that can leverage what is common and use common platforms and, at the same time, customize parts of the supply chain wherever necessary to meet the end needs of the markets."

Dow also designs its supply chains in ways that address security and similar concerns. During the course of its business, Dow moves 50 million tons of products around the world each year, and all these emit greenhouse gases. "The supply chain design we adopt has a major impact on our products' greenhouse gas emissions, and that is key to our business," Halloran noted.

Supply Chains and Services

Information technology services firms have found that key concepts used in conventional supply chains such as demand management, strategic sourcing, inventory management, supply synchronization, project management, use of technology and so on, are also applicable in the services environment. Take inventory, for instance. Clifford Patrao, a senior managing consultant at IBM Global Business Services, pointed out that inventory in services is really "stored capacity" in people. A services organization needs to ensure that it has the right number of people with the necessary skills to build a responsive supply chain without overloading and adding costs. "One needs to use this inventory very effectively. At IBM, if people are on the bench waiting for projects to come in, they spend their time upgrading their skills through e-training courses."

In addition to internal resources, for a services company the supply chain consists of external entities including product vendors, specialist knowledge partners, sub-contractors, universities and educational institutions, etc. "The objective of the services supply chain is to leverage the capabilities of the entire chain to give the best possible solution to the customer," said Patrao. One aspect that makes the services supply chain unique is that the relationships are dynamic. "A partner in one transaction could well be a competitor in another transaction. You need to manage these complexities well. It is important to have role clarity and long-term strategies in place regarding what will be outsourced and what will be done in-house," he added. "At the end of the day, whatever the industry, it is the best supply chains that will win, and not individual companies."

Supply Chains Mis-managed - Page 4

But when companies assess the state of their supply chains, too often they are disappointed by what they see.

To understand how technology companies stack up, we conducted an in-depth analysis of the supply chains at six leading technology companies. We found a wide disparity in both the efficiency and effectiveness of their operations. We also found that these companies lacked the supply chain sophistication of their counterparts in more mature industries. For example, at the technology companies we analyzed, supply chain data typically is so poorly tracked that only two of the six companies were able to provide either a comprehensive or a product segment list of supply chain costs. By contrast, such capabilities are common among consumer products and retail companies.

Lacking basic information is one clear sign that a technology company falls short of achieving its full supply chain potential. Several additional signs are:

  • The company operates a single, undifferentiated supply chain offering across a range of customer and product types.
  • The company lacks clear supply chain targets, and even when targets are in place, there are no specific incentives associated with supply chain performance.
  • The company can't identify the executive ultimately in charge of the supply chain. Governance and accountability are fragmented and unclear across the organization.
  • There is no formalized integration between demand and supply planning-the Sales & Operations Planning (S&OP) process is not effective or is not used.
  • The company lacks integrated systems and automation. So its processes, such as S&OP, include a number of inefficient manual touchpoints and inconsistent baseline data.
  • Finally, the company is not meeting the supply chain needs of its most important customers.

Based on our work with technology companies, we've identified the three most important areas for improvement:

1. Capture actionable data to support critical decisions

Companies need to track key performance metrics for their overall supply chain, as well as for key business segments, while ensuring that data is easily accessible through a single integrated system. The trouble is that most technology supply chains simply don't include sophisticated data capture and management systems.

Among the companies participating in our survey, the difficult benchmarking process typically requires more than five individuals and two to seven weeks to extract and provide key data. Despite IT advances, many supply chains still run poorly integrated legacy systems. There may be disparate systems for demand planning, supply planning, manufacturing and warehousing-with a variety of spreadsheets required to move and analyze data.

When supply chain metrics are tracked, they're often lacking two dimensions. Many metrics may be tracked for specific parts of the organization but not consolidated into a view of the total supply chain costs for the company. Also, while many companies conduct customer-level tracking to comply with service-level agreements, they have limited ability to aggregate the data and differentiate performance and cost-to-serve for different business segments.

To see what works, consider how supply chain metrics typically are tracked in the fast-moving consumer goods (FMCG) industry, which has developed well-honed systems-processes and technology-for tracking data to help executives make better decisions. Decision makers for consumer products companies often have ready access to key supply chain data-an overall supply chain view of costs including people, warehousing, freight and other factors. They can break down costs by segment, if not by unit, which facilitates cost management and service trade-off discussions.

2. Segment your customers and products to define differentiated service offerings

Technology companies lose a tremendous opportunity by not segmenting their offerings based on product type and customer importance. The goal is to provide better service to higher-priority customers or product segments. Companies can't offer their best service to every customer or for every product.

Even though technology companies have for years understood the value of segmenting, few have succeeded in making the most of these opportunities to cater to customers based on their diverse needs. Different customers have different requirements for cost, availability and speed. It's not effective for suppliers to provide the same high-level service to everyone- which is what they usually try to do today. The resulting costs are high, and that level of performance is not necessary for many of their customers.

Leading companies use customer tiering to determine the appropriate fulfillment model and customer service target, breaking customers into three to five groups based on the current revenues they generate and their potential for future revenues. To determine the best fulfillment mode, companies apply a similar tiering model to their products, segmenting according to the level of volume or margin, or by whether they are new, mainstream or end-of-life. Like customers, different products also have diverse needs for cost, availability and speed. Higher-margin products are less sensitive to cost fluctuations but are more sensitive to missing a potential sale. Lower-margin products may be more sensitive to cost increases and, in some cases, less sensitive to availability delays.

Based on the results of their segmenting efforts, companies use three approaches to differentially serve customers. The same customer can receive a different level of service for different product categories.

When it comes to creating a fulfillment model, higher-priority customers can be served through consignment or vendor managed inventory, resulting in a higher level of service. For customers who buy standard products on a relatively predictable schedule, inventory can be reserved- rather than pooled with products that will be distributed to other customers whose demand is not as stable. For lower-priority customers and for low-volume products with less predictable demand, distributors can serve as aggregators of customers or of product demand.

Companies can take advantage of service-level tiering by creating three or four levels of service based on customer priority. For example, top customers can have flexible lead times, better delivery performance and multiple shipping methods. Lower-priority customers will face more rigid lead times, lower delivery performance and limited shipping options.

Customer support can be similarly segmented. For top-priority customers, provide personalized support, supplying direct lines for executives seeking customer service and offering them preference when allocation issues arise. Some companies reserve extra stock to support higher-priority customers or pull inventory back from distributors when supply is constrained. On the other hand, lower-priority customers receive low-touch-or even no-touch-customer support. In some cases, the majority of communication may be from a distributor, not the manufacturer, or through Electronic Data Interchange (EDI)-with support limited to extraordinary circumstances.

Successful segmentation requires multiple process and delivery options to serve the different segments. For example, low-margin products may call for lower-touch supply chain options to ensure profitability. High-volume, low-margin products may use automated pathways and direct-to-customer logistics. High-margin products may have higher priorities in the production cycle to ensure that a sale is never missed.

It's important to be able to provide high- and low-touch supply chain options without creating multiple separate supply chains-and the resulting complexity. Leaders develop different pathways through their supply network to enable flexibility, managing the overall organization centrally to maintain control.

3. Establish operational excellence throughout the organization

Once your company establishes the infrastructure to generate and track data and the processes for a segmented offering, you can use standard supply chain tools to make incremental, but significant, improvements.

Manage the cost base by focusing on optimizing inventory, driving down cycle times and achieving the efficiencies gained through experience and scale.

For example, use statistical safety stock rather than heuristics to establish target inventory levels. Many technology companies still use weeks-of-sales metrics to manage their inventory. They're not adjusting their inventory to consider all the factors that affect the need for buffers, such as demand variability, manufacturing and materials lead-time variability, or required service levels. A weeks-of-sales metric does not account for these variables, but companies often apply it across a wide range of products and customers because it is easy to calculate. A manufacturer might need very little safety stock for a product with stable demand and lead time, but a product with a volatile lead time and unstable demand will require a much higher safety stock to meet service-level targets.

Improve forecasting by leveraging best practices, performing more advanced historical analysis (such as diffusion modeling) and upgrading systems. Technology products have much higher demand volatility and shorter life cycles than more stable consumer products, which may be available in stores for many years. Because this places a lot of stress on the supply chain, any efforts to improve forecasting accuracy will pay huge dividends in both higher availability and lower costs.

Drive down cycle time in manufacturing, materials and planning. Cycle time in semiconductor manufacturing, for example, is particularly long, especially given the lead times for key raw materials. Efforts to eliminate unnecessary touchpoints, hold times or planning delays can have a significant impact on increasing supply responsiveness.

The competitive landscape in the technology sector won't get any easier in the foreseeable future. Focusing on supply chain performance can provide a strategic advantage, helping bring products to market faster, at the right service levels and in a cost-effective way. Done right, the trade-offs among cost, speed and availability will balance real benefits with incremental costs and potential risks, and ensure that investments are carefully scrutinized for a good ROI (return on investment). Decisions must be made based on a solid fact base, incorporating both internal data and external benchmarks. By applying these concepts, supply chain professionals will address many of the challenges they face and put their companies on the path to supply chain leadership.

Sam Israelit is a partner in Bain & Company's San Francisco office. Pratap Mukharji is a Bain partner in Atlanta. François Faelli is a partner in Brussels. Ray Tsang is a partner in Shanghai.

Net Promoter® and NPS® are registered trademarks of Bain & Company, Inc., Fred Reichheld and Satmetrix Systems, Inc.

Many global supply chains are not equipped to cope with the world we are entering. Most were engineered, some brilliantly, to manage stable, high-volume production by capitalizing on labor-arbitrage opportunities available in China and other low-cost countries. But in a future when the relative attractiveness of manufacturing locations changes quickly-along with the ability to produce large volumes economically-such standard approaches can leave companies dangerously exposed.

That future, spurred by a rising tide of global uncertainty and business complexity, is coming sooner than many companies expect. Some of the challenges (turbulent trade and capital flows, for example) represent perennial supply chain worries turbocharged by the recent downturn. Yet other shifts, such as those associated with the developing world's rising wealth and the emergence of credible suppliers from these markets, will have supply chain implications for decades to come. The bottom line for would-be architects of manufacturing and supply chain strategies is a greater risk of making key decisions that become uneconomic as a result of forces beyond your control.

Against this backdrop, a few pioneering supply chain organizations are preparing themselves in two ways. First, they are "splintering" their traditional supply chains into smaller, nimbler ones better prepared to manage higher levels of complexity. Second, they are treating their supply chains as hedges against uncertainty by reconfiguring their manufacturing footprints to weather a range of potential outcomes. A look at how the leaders are preparing today offers insights for other companies hoping to get more from their supply chains in the years to come.

Twin challenges

The stakes couldn't be higher. "In our industry," says Jim Owens, the former chairman and CEO of construction-equipment maker Caterpillar, "the competitor that's best at managing the supply chain is probably going be the most successful competitor over time. It's a condition of success." Yet the legacy supply chains of many global companies are ill-prepared for the new environment's growing uncertainty and complexity.

A more uncertain world

Fully 68 percent of global executives responding to a recent McKinsey survey said that supply chain risk will increase in the coming five years. And no wonder: the financial crisis of 2008 dramatically amplified perennial sources of supply chain uncertainty-notably the trajectory of trade and capital flows, as well as currency values-even as the crisis sparked broader worries about the stability of the financial system and the depth and duration of the resulting recession. While many of these sources of uncertainty persist, it's important to recognize that new, long-term shifts in the global economy will continue to pressure supply chains long after more robust growth returns.

The increasing importance of emerging markets tops the list of these uncertainties. Economic growth there will boost global energy consumption in the coming decade by about one-third. Meanwhile, the voracious appetite of China and other developing countries for such resources as iron ore and agricultural commodities is boosting global prices and making it trickier to configure supply chain assets. Worries about the environment are growing, too, along with uncertainty over the scope and direction of environmental regulation.

These long-term trends have knock-on effects that reinforce still other sources of uncertainty. Growth in developing countries contributes to volatility in global currency markets and to protectionist sentiment in the developed world, for example. What's more, different growth rates across various emerging markets mean that rising labor costs can quickly change the relative attractiveness of manufacturing locations. This past summer in China, for example, labor disputes-and a spate of worker suicides-contributed to overnight wage increases of 20 percent or more in some Chinese cities. Bangladesh, Cambodia, and Vietnam experienced similar wage-related strikes and walkouts. Finally, as companies in developing markets increasingly become credible suppliers, deciding which low-cost market to source from becomes more difficult.

Rising complexity

Manufacturing and supply chain planners must also deal with rising complexity. For many companies, this need means working harder to meet their customers' increasingly diverse requirements. Mobile-phone makers, for example, introduced 900 more varieties of handsets in 2009 than they did in 2000. Proliferation also affects mature product categories: the number of variants in baked goods, beverages, cereal, and confectionery, for instance, all rose more than 25 percent a year between 2004 and 2006, and the number of SKUs at some large North American grocers exceeded 100,000 in 2009.

Meanwhile, globalization brings complexities as rising incomes in developing countries make them extremely desirable as markets, not just manufacturing hubs. Efficient distribution in emerging markets requires creativity, since retail formats typically range from modern hypermarkets to subscale mom-and-pop stores. In Brazil, for example, Nestlé is experimenting with the use of supermarket barges to sell directly to low-income customers along two tributaries of the Amazon River.

Meeting the challenge

In such a world, the idea that companies can optimize their supply chains once-and for all circumstances and customers-is a fantasy. Recognizing this, a few forward-looking companies are preparing in two ways. First, they are splintering their traditional monolithic supply chains into smaller and more flexible ones. While these new supply chains may rely on the same assets and network resources as the old, they use information very differently-helping companies to embrace complexity while better serving customers.

Second, leading companies treat their supply chains as dynamic hedges against uncertainty by actively and regularly examining-even reconfiguring-their broader supply networks with an eye toward economic conditions five or ten years ahead. In doing so, these companies are building diverse and more resilient portfolios of supply chain assets that will be better suited to thrive in a more uncertain world.

From one to many

Splintering monolithic supply chains into smaller, nimbler ones can help tame complexity, save money, and serve customers better. Let's look at an example.

Splintering supply chains: A case study

A US-based consumer durables manufacturer was losing ground to competitors because of problems with its legacy supply chain. Years before, the company-like many global manufacturers-had sent the lion's share of its production to China while maintaining a much smaller presence in North America to stay close to the majority of its customers. One legacy of the move: all of its plants, relying on a unified production-planning process, essentially manufactured the full range of its thousands of products and their many components.

Now, however, increasingly volatile patterns of customer demand, coupled with product proliferation in the form of hundreds of new SKUs each year, were straining the company's supply chain to the point where forecasting- and service-related problems were dissatisfying key customers.

In response, the company examined its portfolio of products and components along two dimensions: the volatility of demand for each SKU it sold and the overall volume of SKUs produced per week. Armed with the resulting matrix (Exhibit 1), the company began rethinking its supply chain configuration.

Exhibit 1

Grouping products by demand volatility and overall volume can shed light on how to optimize the supply chain.

Ultimately, the company decided to split its one-size-fits-all supply chain into four distinct splinters. For high-volume products with relatively stable demand (less than 10 percent of SKUs but representing the majority of revenues), the company kept the sourcing and production in China. Meanwhile, the facilities in North America became responsible for producing the rest of the company's SKUs, including high- and low-volume ones with volatile demand (assigned to the United States) and low-volume, low-demand-volatility SKUs (divided between the United States and Mexico). Ramping up production in a higher-cost country such as the United States made economic sense even for the low-volume products because the company could get them to market much faster, minimize lost sales, and keep inventories down for many low-volume SKUs. Moreover, the products tended to require more specialized manufacturing processes (in which the highly skilled US workforce excelled) and thus gave the company a chance to differentiate itself in a crowded market.

However, the company didn't just reallocate production resources. In tandem, it changed its information and planning processes significantly. For the portfolio's most volatile SKUs (the ones now produced in the United States), the company no longer tried to predict customer demand at all, choosing instead to manufacture directly to customer orders. Meanwhile, managers at these US plants created a radically simplified forecasting process to account for the remaining products-those with low production runs but more stable demand.

For overseas operations, the company continued to have its Chinese plants produce finished goods on the basis of long-run forecasts, as they had done before. The forecasts were now better, though, because planners were no longer trying to account in their models for the "noise" caused by the products with highly volatile demand.

Together, the changes helped the company reduce its sourcing and manufacturing complexity and to lower its cost of goods sold by about 15 percent. Meanwhile, it improved its service levels and shortened lead times to three days, from an average of ten. Quality also improved across the company's full range of products.

How many splinters?

The first question for organizations exploring multiple supply chains is how many are needed. Answering it requires a close look at the way the supply chain assets that a company uses to manufacture and distribute its products matches up against the strategic aspirations it has for those products and their customers.

This requirement seems obvious, but in practice most companies examine only the second half of the equation in a sophisticated way; they can, for example, readily identify which products they see as leaders on cost, service, innovation, or (most likely) some combination of these. Fewer companies seriously examine the operational trade-offs implicit in such choices, let alone make network decisions based on those trade-offs.

Oftentimes, a good place to start is to analyze the volatility of customer demand for a given product line against historical production volumes and to compare the results against the total landed cost for different production locations. This information provides a rough sense of the speed-versus-cost trade-offs and can even suggest locations where supply chain splinters might ultimately be located. A global consumer-packaged-goods maker, for example, quickly saw that two-thirds of the demand associated with a key product line (about 40 percent of the company's product portfolio) could be moved from a higher-cost country to a lower-cost one without hurting customer service.

Of course, companies must carefully check these broad-brush analyses against customer needs. The consumer goods company, for instance, found that packaging innovation was a differentiator for some of its products and thus configured a single production line in the new, lower-cost location to make packaging for several markets quickly. By contrast, in automotive and other assembly-based industries, we find that the customers' responsiveness and the complexity of individual products are important inputs that help determine where supply chains might be splintered.

Second-order benefits

While dividing a supply chain into splinters may seem complicated, in fact this approach allows companies to reduce complexity and manage it better because operational assets can be focused on tasks they're best equipped to handle. At the same time, the added visibility that a splintered approach offers into the guts of a supply chain helps senior managers more effectively employ traditional improvement tools that would have been too overwhelming to tackle before.

After the consumer durables maker divided its supply chain into smaller ones, for example, it was able to use formerly impractical postponement approaches (producing closer in time to demand to keep holding costs low). The company's US plants now combined various SKUs into semifinished components that could quickly be assembled into products to meet customer orders (Exhibit 2). Indeed, the lower inventory costs this move generated partially offset the higher labor costs of the US factories.

Exhibit 2

With better visibility into supply chain operations, companies can achieve bigger efficiency gains.

Likewise, the global consumer-packaged-goods maker found that after splintering its supply chain, it was more successful at applying lean-management techniques in its plants. Among the benefits: much faster changeover times in higher-cost production locations, enabling them to handle product-related complexity more effectively.

Use your network as a hedge

The advantages that multiple supply chains confer are most valuable if companies view them dynamically, with an eye toward the resiliency of the overall supply chain under a variety of circumstances. Will the various strands of a particular global supply network, for example, still make sense if China's currency appreciates by 20 percent, oil costs $90 a barrel, and shipping lanes have 25 percent excess capacity? It's critical for organizations to determine which of the many questions like these are right to ask and to invest energy in understanding the global trends underpinning them. Some companies are already thinking in this way. Nike, for example, long a leader in emerging-market production, manufactured more shoes in Vietnam than in China for the first time in 2010.

In fact, we believe that the ability of supply chains to withstand a variety of different scenarios could influence the profitability and even the viability of organizations in the not-too-distant future. In light of this, companies should design their portfolios of manufacturing and supplier networks to minimize the total landed-cost risk under different scenarios. The goal should be identifying a resilient manufacturing and sourcing footprint-even when it's not necessarily the lowest-cost one today. This approach calls for a significant mindset shift not just from operations leaders but also from CEOs and executives across the C-suite.

At the consumer durables manufacturer, for example, senior executives worried that its reliance on China as a hub could become a liability if conditions changed quickly. Consequently, the company's senior team looked at its cost structure and how that might change over the next five to ten years under a range of global wage- and currency-rate conditions. They also considered how the company could be affected by factors such as swinging commodity prices and logistics costs.

The company determined that while China remained the most attractive manufacturing option in the short term, the risks associated with wage inflation and currency-rate changes were real enough to make Mexico a preferable alternative under several plausible scenarios. Consequently, the company has begun quietly building its supplier base there in anticipation of ramping up its manufacturing presence so that it can quickly flex production between China and Mexico should conditions so dictate.

Similarly, the global consumer-packaged-goods manufacturer is examining where dormant capacity in alternative low-cost countries might help it hedge against a range of labor cost, tariff, tax, and exchange-rate scenarios. The company is also factoring in unexpected supply disruptions, including fires, earthquakes, and labor-related strife.

A North American industrial manufacturer chose to broaden its footprint in Brazil and Mexico to hedge against swings in foreign-exchange rates. In particular, the company invested in spare capacity to make several innovative, high-end components that it had formerly produced only in Europe and the United States because of the advanced machining and engineering required. The investment is helping the company hedge against currency swings by quickly transferring production of the components across its global network to match economic conditions. Moreover, the arrangement helps it better support its supply partners as they serve important growth markets.

Making these kinds of moves isn't easy, of course, since any alterations to a company's supply chain have far-ranging implications throughout the organization. For starters, such changes require much more cooperation and information sharing across business units than many companies are accustomed to. Indeed, the organizational challenges are so significant that for many companies, a hands-on effort by the CEO and others across the C-suite is needed for success (for more, see " Is your top team undermining your supply chain? ").

Nonetheless, the rewards are worthwhile. By creating more resilient and focused supply chains that can thrive amid heightened uncertainty and complexity, companies will gain significant advantages in the coming years.

About the authors

Yogesh Malik and Brian Ruwadi are principals in McKinsey's Cleveland office; Alex Niemeyer is a director in the Miami office.

The authors wish to acknowledge Sebastien Katch for his valuable contributions to this article.

The global downturn's speed and severity have significant implications for the supply chains of global manufacturers. Among steelmakers, chemical players, and some high-tech companies, for instance, order books-and therefore prices-are under tremendous pressure. Output in the steel industry dropped by an unprecedented 30 percent and prices by about 50 percent from June 2008 to December 2008.

That kind of volatility wreaks havoc on traditional supply chain planning: the process for determining production levels, raw-material purchases, transport capacity, and other vital factors, largely by examining historical patterns of demand. "Every month, we produce a rolling three-year plan," said one metals executive recently, "but right now I can't see even three weeks ahead." Indeed, the forecasting challenge is particularly acute because in many upstream industrial settings, as supply partners along the chain anticipate that demand will fall, the supply chain appears to be decoupling from downstream consumption-the focus of most forecasting models.

Against this backdrop, senior executives should reconsider the implications of the "bullwhip effect," first identified in the 1960s and known to generations of business students as the "beer game." In this classic phenomenon, distortions in information snowball along the length of a company's supply chain, propelling relatively small changes in end-consumer demand into much larger and less predictable swings in demand further upstream (Exhibit 1a and Exhibit 1b).

How relevant is the bullwhip effect today? Consider the US inventory-to-sales ratio, which rose sharply from June to December 2008. Exhibit 2, bearing as close a resemblance to a pileup accident as any chart you'll ever see, emphasizes the significant reverberations, up and down the line, of cancelled orders as companies retrench.

Exhibit 2

At the end of 2008, businesses saw a sharp increase in the ratio of inventory to sales caused by-and then exacerbated by-unexpected drops in demand.

Many of the bullwhip effect's classic triggers now operate in full force. Rising commodity prices before the crisis, for example, led to the stockpiling of excess inventory. Now, falling commodity prices give customers an incentive to postpone orders and await better deals. Meanwhile, a new factor-the dash for cash-exacerbates today's difficulties: the evaporation of traditional financing channels leaves companies desperate to shed inventory, reduce working capital, and squirrel away cash. Of course, one company's working-capital reductions are another's cancelled orders.

The good news is that destocking has limits. Over an extended period, upstream orders must equal downstream ones. In the case of steel, for example, unless end-user demand drops by the same 30 percent as did output between June 2008 and December 2008-not impossible, but beyond current demand forecasts of an 8 to 10 percent reduction this year-orders must eventually rise. Yet as the bullwhip metaphor implies, the upswing could be rapid in steel or other industries that have complex, multitier supply chains. Unprepared ones could make companies neglect their customers' needs and lose share to more nimble competitors.

How should manufacturers respond? First, they must make supply chain decisions more quickly: in the face of unprecedented volatile demand, business-as-usual calendars for forecasting, budgeting, and planning won't do. Companies that adhere rigidly to unrealistic plans may find themselves sitting on piles of inventory or fighting price wars.

Some companies are establishing supply chain "war rooms" to make fast decisions across functions. Populated by leaders from production, procurement, logistics, and sales-and furnished with the latest data on purchasing, production, orders, and deliveries-these teams meet weekly or even daily to devise near-term operational plans. A chemical company that created such a team cut inventory levels by 20 percent in just ten weeks, while maintaining high levels of customer service. What's more, by speeding up decisions, the company increased the frequency but reduced the size of its orders from key suppliers. Greater cross-functional cooperation helped it not only to identify new opportunities for using out-of-spec materials (and thus inventory on hand) but also to make better-informed decisions about where and when to discount overstocked products.

As companies rethink the way they plan, they must also learn how to act on the resulting decisions more quickly and flexibly. When raw-material and transport costs and the use of equipment shift dramatically, for example, companies must be prepared to revisit well-understood trade-offs involving, say, minimum batch sizes or optimal process yields. Things can change quickly, as a plastic goods manufacturer found after working hard to reduce the raw-material content of its products. Its strategy of accepting slightly higher defect rates in return for savings on these inputs has become decidedly less advantageous as their cost plummeted.

What companies need now is the ability to deal with changing conditions by making production processes more flexible-shifting manufacturing locations quickly as shipping costs change, for example. One source of lessons on flexibility comes from the process industries, like chemicals or cement, which have long adjusted their mix of fuels (such as coal, fuel oils, or biomass) according to changing prices. Manufacturers that can adjust process yields rapidly to suit changing conditions should have a significant advantage over less flexible competitors.

More effective collaboration with key suppliers is important as well-advice that's surely relevant throughout the business cycle, but particularly now that volatility could undermine their survival. Improved collaboration need not depend on expensive integrated IT systems; in our experience, such projects generally have disappointing results. Simple moves, such as establishing direct communication from planner to planner and running forecasting processes jointly with key suppliers, can reduce "signaling" noise and raise service levels. Smaller but more frequent orders are often an easy way to reduce volatility in demand and therefore inventory levels. So is a better understanding of whether reduced demand results from destocking or from the behavior of end consumers.

Manufacturers should view today's environment as an opportunity. Now they can make changes-renegotiating contracts, consolidating manufacturing and distribution networks, launching aggressive productivity programs-that might not have been feasible earlier and may soon be difficult again. Remember, the bullwhip metaphor implies that the future upturn in demand could come rapidly, even if demand doesn't return to its level before the downturn. For many organizations, a return to growth could, paradoxically, close the window of opportunity to improve the supply chain.

About the authors

Christoph Glatzel is a principal in McKinsey's Cologne office, Stefan Helmcke is a principal in the Vienna office, and Joshua Wine is an associate principal in the Tel Aviv office.

Creating a global supply chain that is equipped to thrive in a world of rising complexity and uncertainty involves more than reconfiguring operational assets and making long-term strategic bets about production-and supply-related risks. Significant organizational challenges are involved, too, since the decisions and activities of a company's supply chain group influence (and are influenced by) the sales team, marketers, and product developers, among others.

The result is a host of thorny trade-offs. Should a company, say, move a product to a low-cost manufacturing facility to save money if that means lengthening delivery times? What if trimming the company's product portfolio to reduce manufacturing complexity and costs could stifle marketing efforts to reach new customers? When do the benefits of improved customer service warrant the additional operating expenses required to deliver it?

Supply chain, sales, and marketing managers invariably view such trade-offs through the lens of their own responsibilities-and this perspective often leads to disagreements or misunderstandings. Indeed, a recent McKinsey survey of global executives cited the inability of functional groups to understand their impact on one another as the most common barrier to collaboration for resolving the major supply chain trade-offs.

Ineffective collaboration has long been a supply chain sore spot, but its costs are set to rise drastically. If it's hard to agree on the right response to a disruption in a supply chain today, it will be more difficult still when companies deal with multiple interconnected supply chains, each possibly requiring a different solution. And consider the short- and long-term supply chain trade-offs executives must balance in a world where one business unit might be asked to shift its manufacturing lines to a more expensive near-shore location today to build capacity as a hedge against potential future spikes in labor or transport costs.

Finding mechanisms to solve these and other difficult supply chain questions will require hands-on attention from the CEO and other company leaders. The process begins when executives work together to identify places where better information sharing and teamwork will generate the most impact. Let's look, then, at three of the biggest collaboration tensions we routinely observe and see how companies are bridging these organizational divides to create more flexible and capable supply chains.

Tension 1: Supply chain versus sales

Supply chain organizations wage a constant battle against volatile demand, and for good reason. An unexpected spike in orders, for example, has expensive consequences in labor and distribution costs. Similarly, inaccurate sales forecasts can lead to stock-outs, lost sales, or excess inventory that must be sold at a discount. Sales and supply chain groups therefore devote significant energy to creating sophisticated planning and forecasting processes in an attempt to predict demand volatility-and blame each other when things go awry.

When these groups work together more closely, they can move beyond the traditional planning-cycle blame game, discover the root causes of volatility, and ultimately begin to influence it. This approach brings tangible business benefits-often quickly. Crucially, over the longer term, the experience that groups gain from flexing their collaborative muscles heightens the ability to react quickly, and in a concerted way, to unforeseen events. That skill will be even more necessary given the increasing uncertainty in the supply chain environment. Here are two examples that illustrate the potential.

The first involves an automotive supplier whose sales teams often scrambled to meet quarterly targets that would guarantee them better performance bonuses. Customers recognized this behavior and, in some cases, were gaming the system by withholding orders until the end of the quarter to secure deeper discounts-creating supply chain headaches and hurting the company's bottom line. The vice president of sales and the supply chain head collaborated to fix this problem and make demand more predictable. One key step: substantially trimming end-of-quarter discounts and instead using a price and discount structure based on sales volumes, product loyalty, and participation in promotional efforts. The company also created new incentives to encourage sales teams to spread sales more evenly across the quarter.

Our second example involves a global manufacturer of consumer packaged goods. This company discovered that promotional activity in just five customer accounts drove most of its demand volatility. Although it carefully planned the promotions to maximize revenues, its marketers hadn't thought about the impact on the supply chain. By staggering the promotions over several months and aligning them carefully with baseline demand patterns, the company reduced the overall volatility of demand by 25 percent.

When the company rolled out the new promotions plan, its managers identified another problem: many customers lacked the resources to manage their order levels efficiently and therefore sporadically placed unnecessarily large orders. The company responded by bringing together its sales and supply chain personnel and working with these customers to create better ordering processes for them. In this way, it smoothed the flow of orders-a move that benefitted both parties.

Problems like these are endemic in many supply chains. By tackling these problems, companies often enjoy immediate benefits while building collaborative capabilities that will be crucial over the long term in the more complex and uncertain supply chain environment of the future.

Tension 2: Supply chain versus service

A second important tension that has long existed, but will become even more acute as companies seek to create more resilient global supply chains, involves the setting of customer service levels. How speedy should deliveries be? Should some customers receive orders faster than others? What levels of product availability should be guaranteed? In our experience, companies traditionally leave these decisions to the sales function, which often makes service-related decisions without understanding the operational implications or costs involved.

When these groups work together to analyze the full impact of a service decision, they avoid this pitfall-a lesson learned by a chemical company whose sales personnel were pushing its logistics team to reduce delivery times to two days, from three. The company achieved this goal, but only by using more warehouse space and labor and by loading its delivery trucks less efficiently than it otherwise would have. All this increased distribution costs by 5 percent.

While this trade-off might have been acceptable under the right circumstances, a closer examination by the heads of the supply chain and sales groups revealed that most customers didn't mind if deliveries arrived in two, three, or even five days. The real breakpoint when service was most highly valued was 24 hours. By extending the delivery window for normal orders back to three days, the company returned its distribution costs to their original levels. Meanwhile, it launched a special 24-hour express service for critical deliveries, for which it charged a premium. The move ultimately raised the company's costs slightly, but this was more than offset by the new business it generated.

As supply chains splinter and companies diversify production to hedge against uncertainty, the importance of making smart trade-offs about service levels and speed can only grow. Companies seeking to cope will have to strengthen partnerships between the leaders of the supply chain, sales, and service.

Tension 3: Supply chain versus product proliferation

Remedying some of the root causes of growing supply chain complexity will be another important benefit of enhanced collaboration in the C-suite. Take the complexity associated with product portfolios. Sales and marketing organizations work hard to create new products, explore new market opportunities, and respond to emerging customer needs. As they do, products and variants tend to proliferate, creating portfolios with long tails of niche offerings. A consumer goods maker we know, for example, recently found that nearly one-third of the 6,400 SKUs in its product portfolio together represented just 1 percent of total revenues.

This complexity comes at a cost, since low-volume products cost more to make per unit than high-volume ones (because of economies of scale). The consumer goods maker, for example, found that production costs for low-volume products were 129 percent higher than those for its best sellers. Low-volume products also require disproportionate effort in sales and administrative processes. Finally, they drive up supply chain costs: a company must hold higher inventory levels to meet agreed service levels across a broad range of low-volume products than it does over a narrow range of high-volume ones. When all these extra costs are taken into account, the impact can be eye opening. One company we studied found that 25 percent of its SKUs actually lost money.

In the face of these numbers, companies might be tempted to take an ax to the long tails of their product portfolios. Yet blind cutting based on sales figures alone often does more harm than good. Some low-volume products have benefits that outweigh their costs, and only through close collaboration across functional boundaries can companies make the right decisions. Such collaboration won't eliminate the need for more carefully segmented supply chain strategies, but it should help ensure that such efforts are well targeted.

Putting it all together

The top of the organization is the right place for most companies to begin negotiating the functional trade-offs we've outlined. But many senior-management teams give precious little attention to supply chain issues. Across the trade-offs our survey explored, for example, no more than 26 percent of the respondents said that their companies reach alignment among functions as part of the supply chain decision-making process. Moreover, 38 percent say that the CEO has no or limited involvement in driving supply chain strategy.

This is a mistake. CEOs set the agenda for their leadership teams, and it is up to CEOs to encourage and facilitate meaningful discussion of important cross-functional supply chain issues. CEOs can go further too. In some of the most impressive supply chains we've seen, the chief executive promotes collaboration and performance improvement with missionary zeal. The CEO of an apparel company, for example, would always make a point, during store visits, of asking shop floor staff how its recent commercial decisions had affected store operations, including logistics. He would bring up this feedback in meetings with purchasing and supply chain teams and continually encouraged his managers to follow up themselves and engage with shop floor staff on similar topics.

CEOs looking to get started can benefit from asking themselves five questions, which in our experience can help leaders begin to ferret out situations where faulty collaboration may be preventing supply chains from reaching their full potential.

  1. Is production capacity being developed in the right locations-both for today and the future?

  2. Is the sales group doing all it can to make demand smooth and predictable?

  3. Are customers offered the service levels they really need?

  4. Is my marketing department calling for too many niche products that may be too costly to supply?

  5. Are our purchasing and sourcing decisions being made with their supply chain implications in mind?

Poor collaboration and silo thinking have long thwarted the efforts of companies to get more from their supply chains. In a future characterized by rising complexity and uncertainty, solving this perennial problem will change from a valuable performance enhancer to a competitive necessity.

About the authors

Christoph Glatzel is a principal in McKinsey's Cologne office, Jochen Großpietsch is a principal in the Barcelona office, and Ildefonso Silva is a principal in the São Paulo office.

When the global economy nearly collapsed in late 2008, some multinational companies reacted by quickly cutting their head counts and technology budgets. As cash flow dried up, some pundits warned that providers of on-demand global trade and logistics technology would face hard times retaining old customers and winning over new ones. It hasn't turned out that way. A growing number of manufacturers and retailers have decided, instead, to streamline their worldwide supply chains for the long haul by signing up for pay-as-you-go logistics services available through the Internet "cloud." These services reduce supply-chain costs by making it faster and easier to share information about shipments with suppliers, transportation providers and end users, and then processing that information with the latest, most powerful software tools.

Experts say that this ongoing boom in transportation and trade-related services -- spearheaded by such independent vendors as GT Nexus, Descartes Systems Group and Management Dynamics -- makes sense for multinationals, which face the challenge of managing increased complexity and variability in their worldwide supply chains. By turning to services available "on demand" over the Internet -- like other cloud-based business software, such as customer relationship management (CRM), e-business and accounting tools from Salesforce.com, NetSuite, BMC Software and others -- these companies gain access to a logistics platform they could never afford to build or maintain by themselves. They also acquire a strategic advantage over those old-fashioned competitors who still rely on inefficient tools like Microsoft Excel spreadsheets, e-mail and Electronic Data Interchange (EDI) formats to manage their trade compliance, transportation and logistics processes.

That kind of advantage can be crucial these days. "We don't compete as individual businesses any more; we compete as supply chains," says Martin Christopher, emeritus professor of marketing and logistics at the Cranfield School of Management in Cranfield, England. The winners, he says, aren't necessarily the companies that have the best products and services, but the ones that have the most efficient supply chains.

Thanks to the cloud, Christopher notes, even companies that operate on a modest technology budget can collaborate with their suppliers to make more accurate delivery forecasts, minimize excess inventory build-ups and avoid nasty last-minute surprises for their end users. "In the old days, companies kept their suppliers at arm's length and even had adversarial relationships with them," he says. "Nowadays, retailers are sharing point-of-sale data with their suppliers," something that was "unthinkable" until cloud-based technology made it possible. Christopher describe the changes as a win-win solution for everyone involved. "We are going to have to re-write the textbooks as we see a significant acceleration in this mode."

To its proponents, the cloud approach is a no-brainer. "The cloud gives you access to a multibillion-dollar technology infrastructure," says Greg Kefer, director of business development at Oakland, Calif.-based GT Nexus, which runs the largest cloud-based collaborative platform for logistics, trade and transportation managers. "All of the computing power is maintained by a third party, the IT director doesn't have to install it [and] the cost is amortized across the network by other users."

Indeed, Kefer, like other proponents, is hopeful that cloud-based logistics management will soon become the norm, not just for Fortune 500 companies but for many smaller companies that continue to rely on more traditional technologies like e-mail, phone and fax to exchange information with their suppliers and end users.

Kefer and others say that the global recession has helped to raise the profile of supply-chain executives in leading global companies. "The supply-chain people are coming out of the basement -- they are no longer pushing the 'down' button on the elevator, but are pushing the 'up' button into the boardroom," Kefer says. Many companies have created senior supply-chain positions that "are right up there with the COO, the CFO and the CEO." They are realizing that a broad strategic vision applies to how you run your operation, Kefer adds, and that they "have paid a price by not looking at this function strategically."

However, even the biggest fans of the supply-chain cloud acknowledge that many companies -- especially smaller ones -- have not yet developed the right mindset for jumping on the bandwagon. Says Christopher: "Some organizations still have an old-school purchasing-management style, in which the idea that we should be more open and transparent is alien." In that kind of company, people tend to think, "If we can switch costs out of our organization to our customers' [organizations], then who cares?" Why worry about your customers when you count most? But that old approach "is not going to work" in the new world of global complexity, warns Christopher, a world in which collaboration is the only strategic solution.

From Vertical to Virtual

The path to the cloud has been two decades in the making. Over that time, global corporations gradually changed the way that they view their supply chains, says Christopher. The biggest change has been to turn away from the vertical supply chain -- based on serving the needs of the vertically integrated corporation -- to the new "virtual supply chain," which enables corporate managers to focus on their core competencies and outsource other capabilities to lower-cost suppliers, no matter where they are located. The challenge of this new approach, notes Christopher, is that since these new global supply chains are fragmented, they must depend on many outside partners in many different locations around the world. "This approach demands an entirely new way of working. There is a much higher level of complexity -- many more nodes and links."

The good side of this complexity, he notes, is that it makes it easier for manufacturers to differentiate themselves by using those partnerships to design and build unique products and services. The bad side is that companies need new kinds of technological processes to manage that complexity -- so they can collaborate and synchronize data about their products with far-flung partners and respond quickly to changes in market demand.

"The increased complexity of global supply chains has led to longer lead times and more pipeline inventory," write Bob Heaney and Viktoriya Sadlovska in a recent report by the Boston-based Aberdeen Group, which studies IT companies and products. "This, in turn, has contributed to increased supply-chain management costs. Reducing costs by driving down excessive inventory and avoiding or quickly responding to disruptions has become critical for companies in today's economy. But before a company can reduce pipeline inventory or landed cost, it needs to have visibility into them."

Not that long ago, according to Kefer of GT Nexus, the "chain of custody" for a typical manufactured product in the United States would last only about three days and would involve only one mode of transportation -- trucks on a domestic route. But with so much production coming out of Asia, that chain of custody is often about 45 days long. When the chain was only three days long, its variability was about one day; a shipment could be delayed by about only that long because of an equipment breakdown, snowstorm or other unexpected event. However, the variability of today's longer supply chains is far greater -- and far more challenging.

A 45-day chain that starts in Asia often involves about 14 days on a freighter and then time on possibly both truck and train. "You could lose three to five to 10 days because of things you never counted on," says Kefer. "But when you're a just-in-time manufacturer, you can't afford delays of five to 10 days." Retailers who need to have the latest hot Asian-made apparel or toy on their shelves in time for a major event such as Christmas cannot afford to fall behind on their delivery schedules. Protecting against variability comes at a very high price -- typically, either by expediting the delayed product via costly express services such as UPS or FedEx or by setting aside large amounts of "safety stock" (excess inventory) in warehouses.

Though few companies have the financial resources to set up their own technology platforms for collaborating with suppliers and transportation providers, even companies on a modest budget can afford the cloud and should consider signing up, says Christopher. The only exceptions to that rule are the dwindling number of companies that deal with a limited number of suppliers and logistics partners in a limited number of geographical locations. "We can't go back to the old vertical supply chain but we need to manage information, and the best way is shared information."

Keeping Complexity at Bay

"Complexity is really the core challenge of our business," says Henning Husmann, director of business development at Hermes-OTTO International, a firm based in Germany and Hong Kong that provides retail sourcing services. "The complexity of our business processes is growing exponentially, and cloud-based technology helps us keep that complexity on the same level" rather than let it get out of hand.

According to Christian Verstraete, chief technology officer for worldwide manufacturing and distribution industries at Hewlett-Packard Company, cloud-based supply-chain management is a next logical step after "lean manufacturing," which removes wasted steps and processes from the factory floor so that managers can easily see just where things are. The problem with supply-chain management is that "you can't just walk through your supply chain and see where your waste is. That's very hard to do with EDI when you have 600 or 700 players in your supply chain."

Cloud-based services make it possible for companies to do just that. "Cloud technology has proved to be a superior way to get technology," says Kefer. "You get more for less -- less risk because you are not buying the technology. It's a quicker path to value." Users come from every industrial and retail sector. For example, GT Nexus's customer list includes such familiar names as American Eagle Outfitters, Del Monte Foods, Home Depot and Restoration Hardware. Leading firms on Management Dynamics's Global Trade Management Platform include Dell Computer, Fairchild Semiconductor, Honeywell and Pfizer.

A decade or so ago, a few manufacturers began to create hubs that linked them with all of their suppliers. At the peak of that trend, during the dot-com boom, there were several hundred such hubs, but today only a half dozen are left, notes Verstraete. The problem with the hub approach, he says, was that all of the costs for creating the hubs were borne by the manufacturers who ran them. That changed after high-speed, low-cost Internet access made it possible for suppliers, manufacturers and other supply-chain partners to share all of that data on the Internet as a pay-as-you-go service. Verstraete says the best analogy for these services is the public electricity grid. "You just plug in your lamp, and you get what you need. You don't know where it comes from, and you don't care."

According to the study by Aberdeen Group, leading companies are 1.87 times more likely than average companies to automate their logistics processes in collaboration with their suppliers, and they are "expanding their reach." Adds the report: "Visibility must extend across the enterprise to embrace suppliers, 3PLs [third-party logistics providers], and customers" if companies are to maximize their opportunities.

For all that, Marshall Fisher, professor of operations & information management at Wharton, warns against overselling the virtues of cloud computing for supply chain management. Some vendors of this software service have latched onto the hot label of "cloud computing" to make it seem fresher than it really is. "Cloud computing doesn't suddenly make possible things that weren't possible before," Fisher says. Delivering via the cloud just makes many of those things easier and less expensive to deliver. "Cloud computing is a hugely important development" that enables companies to access third-party software "in a much more convenient way. You can run software, and it looks like it's on your computer," Fisher adds. "It [cloud computing] is an incremental step, but not necessarily a revolutionary one, although it could be revolutionary in certain kinds of software," yet to be determined.

The idea of closer collaboration with supply chain partners, according to Fisher, "has been going on for a long time" in some sectors, such as the auto industry. Many companies have found that e-mail and Excel are adequate tools for "the robust sharing of retail sales data," he notes. "Certainly, more computing power [via the cloud] won't hurt" the further progress of such trends as closer relationships with supply chain partners and upward mobility of supply chain executives into the executive boardroom. The key is not sharing more and more data but learning how to "make sense of the data." With that goal in mind, some cloud-based vendors provide integrated business intelligence software that makes sense of the data shared on their platforms. Among other things, this software analyzes the performance of their customers' supply chains, slices and dices customers' key performance indicators (KPIs) and metrics by various dimensions, and creates customized reports for distribution to customer's various corporate departments.

The Convergence of Consumer and Business Markets

What lies ahead for cloud-based supply-chain management? Chris Jones, director of product development at Montreal-based Descartes Systems, says there is a growing "convergence of consumer and commercial markets" for cloud-based tools, as production volumes of mobile devices like iPhones grow and prices for such products continue to drop. "These devices are very cheap and powerful, and people are saying, 'Why can't I use that in my commercial world?'"

Descartes' Global Logistics Network, one of the world's most extensive multimodal business software networks, enables customers to manage their international shipments by sea and air, comply with customs requirements around the world and use their mobile devices to track vast amounts of information that are exchanged as shipments pass from one trucking dispatch center to another across North America. Regarding the latter software, Frank Hamerlinck, vice president of R&D for Descartes, says, "This is a complex process to plan because there are so many vehicle breakdowns, traffic jams, missing shipments" and other unpredictable events. In planning the ideal route for truck shipments, the Descartes software considers such variables as the lowest fuel consumption, the fewest stops and the lowest number of drivers.

Early this year, Descartes will be adding technology to its cloud-based platform that will allow several thousand sales and merchandising employees of Kraft Foods to track products over their mobile devices. "Five years ago, you could never do this -- the cost would be too high," says Jones. Now, you'll be able to use any mobile phone with a data plan -- not just iPhones and Android phones, but even Java-based phones. With this kind of software, "I don't just collect data from the field; I make decisions using that real-time data" so that, for example, "I can optimize my routes or not send any more pick-ups to specific locations."

Other powerful cloud-based applications will increasingly move toward mobile platforms, says Hamerlinck: "Mobile devices are not only becoming more mainstream, but more powerful. They have more storage, more computing power and more graphics possibilities." "The cloud will get more and more important" for business users, he adds, as more and more applications are developed for highly specific business-to-business uses. "We are inviting our partners to build some extra features."

According to Hamerlinck, cloud-based logistics providers will also be turning to the model of Facebook and other web-based social communities. Beginning in 2011, Descartes customers will be able to maintain their own profiles and subscribe to services by themselves. "It will be quicker and more automatic to maintain your own profile and allow others to see what you are doing," he says. Members of the network will "discover each other without us always being in the middle."

Supply Chains Mis-managed - Page 12
Supply Chains Mis-managed - Page 13

When I first joined BSR less than a decade ago, the companies investing in supply chain sustainability were primarily in the apparel, footwear, and toy sectors. Today, all industries prioritize supply chain sustainability, including the biggest brands in electronics, consumer goods, transportation, and other industries. The number of standards also has multiplied, reflecting a broader set of topics and participants. In the early 2000s, priorities were wages, working hours, and health and safety. Today, issues also include environmental performance and anti-corruption. Product certifications and labels have also exploded. An entire index exists just to catalogue the number of new eco-labels launched every year. But what progress have we made toward improving the lives of workers in supply chains and protecting the ecosystems that support industry and commerce as well as human survival on this planet? Although supply chain sustainability management practices have evolved significantly, we have an opportunity to re-examine traditional approaches and achieve measurable, dramatic improvements. Here, I suggest four lessons we can take from supply chain sustainability efforts to date, and four ideas we can apply to achieve greater impact going forward.

The Road We've Traveled

It's hard to capture all of the lessons learned during two decades of work on supply chain sustainability challenges, but four stand out as most important. 1. We must go well beyond monitoring. Social compliance monitoring was initiated to hold multinational companies accountable for maintaining good labor practices at supplier facilities. While this did illuminate working conditions and violations, it also spurred unintended consequences, including duplicative and burdensome audits, bribery and phony records, and a pass/fail mentality that drove problems underground. A retailer once told me that his company fired all the in-house social compliance staff in order to root out rampant bribe-taking, which suppliers had come to expect as a condition of doing business with that company. Third-party audit firms also faced challenges to combat bribery in their relationships with suppliers and brands and retailers. Perhaps the biggest problem was that the monitoring approach failed to motivate suppliers to own the sustainability agenda. Among other problems, monitoring didn't revamp management systems to sustain compliance and encourage improvement over time. The increasingly prescribed remedy to this is a " beyond monitoring" approach that includes management-systems assessments and supplier-development programs that address root causes, provide training, set milestones and incentives, and otherwise encourage suppliers to improve their management practices and performance. 2. We need a comprehensive approach to social, environmental, and ethical practices. The range of topics making their way into strategies, policies, assessment and improvement practices, and multistakeholder collaboration has broadened over time, and, happily, there are also a growing number of tools available to help. Energy and greenhouse gas management is now a mainstream part of sustainable supply chain management, with the WBCSD/WRI's Scope 3 emissions standard, the Carbon Disclosure Project's reporting requirements, and the Electronic Industry Citizenship Coalition's Carbon Reporting System representing just a few of the tools for companies to work with suppliers on energy issues. Other supply chain environmental topics include air pollution, waste management, water usage and wastewater management, and impacts on land and biodiversity. Walmart and Procter and Gamble have created supplier scorecards to collaboratively manage a range of environmental impact metrics (in addition to their labor standards programs). H&M, adidas, C&A, Nike, and others have committed to gradually phasing out hazardous chemicals, which follows Greenpeace's high-profile detox campaign. Puma, which also committed to managing chemicals in 2011, released an environmental profit and loss statement this year that quantified and monetized supply chain impacts on greenhouse gas emissions, air pollution, water use, land use, and waste. Over the past few years, due to new standards and legal requirements such as the UN Guiding Principles on Business and Human Rights and the U.K. Bribery Act, many companies have prioritized human rights and ethics. The concept of human rights due diligence and responsibility for managing impacts, no matter where they occur in supply chains, has also found its way into standards such as the OECD Guidelines for Multinational Enterprises (and OECD guidance on conflict minerals specifically), the ISO 26000 CSR Guideline, and the forthcoming update to the Global Reporting Initiative Guidelines. 3. It's important to look beyond the first tier of suppliers for the most significant impacts. The standards described above require companies to better understand their supply chains beyond the first tier. The Guiding Principles, for example, require companies to "prevent or mitigate adverse human rights impacts that are directly linked to their operations, products, or services by their business relationships, even if they have not contributed to those impacts." In practice, this means that poor social and environmental management is now a concern both up and down the supply chain. Specific industries have also launched efforts to move beyond the first tier of suppliers. In 2009, BSR's Mills & Sundries Working Group started developing standards and tools covering labor, health and safety, and environmental impacts of textile mills and button, zipper, tag, and label suppliers. In 2011, the Sustainable Trade Initiative, a multistakeholder process funded by the Dutch government, launched a program in the electronics sector to focus on the second-tier suppliers in Southern China. In addition, some of the most significant impacts from a lifecycle perspective often occur several tiers removed in the materials extraction and processing phases. In the realm of conflict minerals, BSR has discovered the imperative and challenges of working at multiple levels of the supply chain, from raw materials, to processing, to manufacturing, to retailing. 4. Integrating supply chain sustainability into core business practices remains the Holy Grail. The concept of "internal alignment" has become shorthand for ensuring that supply chain sustainability is built into core business strategy-setting and implementation across all departments and functions. In BSR's Beyond Monitoring Working Group, we approached this on the practical level by sharing lessons across industries--for example, how to manage internal deadlines without causing overtime on the factory floor, and which information to review during supplier selection processes. We examined how e-learning and workshops can be used to educate and engage procurement staff, and we heard how companies were building supplier performance metrics into procurement staff evaluation and bonuses. Through our recently launched Center for Sustainable Procurement, we are looking at how to integrate product and supplier sustainability considerations and information into procurement decisions.

The Road Ahead

We now know there is no silver-bullet solution to the complex and deep-rooted challenges in supply chain sustainability. So what does the future look like? At BSR, we encourage companies to focus on four things. 1. Set a vision for achieving positive impact. With both a business case and a morale case driving supply chain sustainability strategies, it is important for companies to evaluate (or re-evaluate) what they hope to achieve. Is it to do no harm? Increase market share of more sustainable products? Protect against business disruption while improving workers' livelihoods? In our experience, companies typically travel through three main phases in their supply chain sustainability focus and objectives, and understanding where your company is currently might provide a useful frame for setting a vision:

  • Risk management: Identify, prevent, minimize, and mitigate risk of negative impacts on people, communities, and the environment. Companies pursuing risk management are usually trying to protect their reputation and minimize business disruption.
  • Supply chain improvement: Develop programs and practices to reduce negative impacts (labor standards violations, energy and water use, air pollution, waste) and increase positive impacts (improved worker well-being and development of healthy communities beyond the factory gates). Companies pursuing this approach are generally interested in achieving improvements in efficiency and productivity as well as maintaining and building their brand reputation.
  • Supply chain transformation: Make changes in products and production systems across the full value chain, from idea to execution. In addition to the benefits of the earlier phases, companies pursuing this approach are using supply chain management and engagement practices to support innovation and competitiveness.

We'll explore each of these in more depth over the next several months. Our vision is to see companies collaborate with their supply chains not just to solve problems but to make positive, systemic, and lasting change. 2. Focus on people, knowledge, and skills. "If only we knew then what we know now" is a familiar refrain. The past 20 years might look very different if we could send a time capsule to the past containing the wealth of experience we've gained. But we can take an important lesson forward: The world changes quickly, and our knowledge at any time is incomplete. We must improve how quickly we adapt our practices, and build teams that have the necessary knowledge and capabilities. To provide a starting point for the learning journey, BSR worked with the UN Global Compact and Maplecroft to develop a high-level supply chain sustainability " Quick Self-Assessment and Learning Tool." The tool helps procurement, sourcing, and other managers quickly and anonymously gauge their company's supply chain sustainability strategy against a set of criteria, such as the existence of clear and established codes of conduct for the company and suppliers, internal roles and responsibilities, and sustainability goals. Our hope is that this tool can help companies speed the process of learning about and shaping an impactful supply chain sustainability approach. 3. Measure impact. In 2009, the Novo Nordisk Responsible Procurement group asked BSR for help defining key performance indicators. To understand how other companies do this, we conducted an online survey and interviewed business leaders, investment analysts, and two NGOs that are active on supply chain labor standards. The results confirmed our hunch: Despite progress in measuring implementation at the customer and supplier levels, impact measurement is still in its infancy. Impact measurement--such as the work conducted by the Sustainability Consortium and the Sustainable Apparel Coalition--helps identify areas for performance improvement and enables open, fact-based communications with stakeholders. We believe these efforts will help us achieve consistent and credible impact measurement for supply chains so that we can establish goals and accountability on the road to sustainability. 4. Get smarter about collaboration. Three priorities in collaboration deserve attention: More comprehensive (and fewer) standards: If only we knew at the outset the problems that would be created by a proliferation of codes and practices for social compliance. Fortunately (and perhaps ironically), new platforms are emerging to enable convergence of these standards. For example, as a result of the European Commission's efforts, it's possible that in the next five years, we'll have "stringent, prescriptive, and technically detailed lifecycle-based guidance" for conducting footprints of products across several environmental impact areas, not just greenhouse gas emissions. Standardization of social impact assessments in supply chains could be on the horizon as well. More "professional" partnerships: In the past, partnerships were a murky area; today, there are clear and helpful practices for setting up and running collaborative efforts on supply chain sustainability, such as the ISEAL Alliance's codes for standard-setting, assurance (certification and accreditation), and impact assessment. More portable data: The number and sophistication of information technology platforms that can link participants in supply chains has grown rapidly over the last few years. The Fair Factories Clearinghouse, Sedex, EcoVadis, Achilles, and Aravo are just a few of the platforms and vendors for sharing information about sustainability performance in the supply chain. There is a real opportunity for technology providers to solve the data problem with easy-to-use, comprehensive, and standardized access to information technology that supports collaboration on supply chain sustainability.

What's Next

As we look forward, it's clear that the world will continue to look smaller and smaller, and that businesses will increasingly face natural resource constraints and social pressure to act responsibly. Businesses will be held accountable for impacts that may be several relationships removed from core operations, but still considered part of companies' supply chain sustainability footprints. And with more standardized measurement and data visibility highlighting the many opportunities for improving sustainability impacts--and more technology applied to solving problems--we will see solutions that we can't yet imagine today. With these big ideas in mind, companies can consider some specific questions to help plan their own next steps:

  • What vision of supply chain sustainability aligns with your organization's goals and objectives?
  • Who are the internal champions who will dare to examine business as usual and identify areas for improvement?
  • Which external allies, from investors to academics to civil society organizations, will join you in addressing supply chain sustainability impacts?
  • What will your supply chain look like in 20 years, and what are the implications for your supply chain sustainability strategy today?

Supply Chains Mis-managed - Page 15