Competitive Supply Chains

Before we dive into the detailed discussions of the key themes of the book, I provide below a complete end-to-end overview of the challenges associated with supply chain design and management with a concrete illustration from agri-business. We can then keep this big picture in mind as we analyze the different dimensions of SCM.

For nearly three centuries, manufacturing industries have been driving economic growth and rising living standards across the globe. As illustrated in Figures 1.1 and 1.2, building a successful manufacturing sector is a prerequisite in national development as manufacturing makes significant contributions not only to individual countries by raising incomes and enabling the construction of modern infrastructure and housing, but also to the world economy by driving global trade, research and development (R&D), and productivity. According to a recent study by the McKinsey Global Institute,¹ manufacturing generates 70% of exports and up to 90% of business spending in R&D. Manufacturing, however, is not monolithic as there are fundamental differences across industries. McKinsey segments manufacturing into five broad buckets based on their sources of competitive advantage and their requirements: the segment of global innovation for local markets, which includes chemicals, pharmaceuticals, transport equipment, machinery and appliances, accounts for 34% of the global manufacturing value added in 2010. Regional processing industries, which include food processing, rubber and plastics, fabricated metal products, and printing and publishing, contribute 28% of value added. Energy and resource-intensive commodities, making up 22% of value added, include wood products, paper and pulp, basic metals, and mineral-based products.

Value-based management (VBM) is playing an increasingly significant role in shaping corporate strategies. Since the key mission of supply chain management (SCM) is to develop and deploy effective solutions to enable the flawless execution of corporate strategies, SCM should also adopt a VBM perspective. VBM-based SCM has therefore two intertwined dimensions, as depicted in Figure 2.1. On the one hand, VBM should enable value creation through product and/or process innovation, both of which should drive a customer’s willingness to pay (WTP). While product innovation may enable the deployment of niche strategies, process innovation may lead to new business models.¹ In both cases, however, innovation plays a key role in differentiating a firm from its competitors and/or in avoiding the commoditization of its products and services.

Xerox spent most of the 1980s painfully regaining, inch by inch, the market share it had lost so dramatically to new entrants from its dominant position in the market in the 1970s. In Europe, for instance, Xerox’s market share tumbled from 18% in the early 1980s to 4% in 1986, stabilizing around 15% in 1989. Central to this comeback was an obsessive dedication to quality, and the introduction of just-in-time (JIT) manufacturing and distribution. In fact, Xerox spent the second half of the 1980s implementing the JIT philosophy in its European manufacturing operations. In this process, Xerox rationalized its supply base, reducing it from 5,000 suppliers to 300, enabled direct delivery into the production lines, and closed down all of its national warehouses, centralizing the distribution activities through a European logistics center in Holland.¹ As emphasized in Figure 3.1, this supply chain rationalization effort was accompanied by a reclassification of the product offerings, ranging from built-to-order high-end products to make-to-stock low-end products with different decoupling points.

In the previous chapter, I emphasized the importance of simultaneous product, process, and supply chain design in a dynamic environment where industry structures evolve continuously. In adopting a concurrent design approach along these three dimensions, one must resolve key cost-service trade-offs in each of those dimensions. In other words, one must assess whether investing in a product, process, or supply chain redesign initiative is a value-creating or value-destroying proposition. For instance, if the additional cash flow generated by a new product design due to an increase in the customer’s Wllingness to Pay (WTP) does not lead to a positive net present value to justify an investment of four man-months of additional Research and Development (R&D), this is a value-destroying proposal. To assess these trade-offs in an objective fashion, supply chain professionals need a simple but rich modelling tool. In this chapter, I will formalize the cost-service trade-off, which affects supply chains, through a materials management framework. Such an inventory policy will not only allow us to quantify the cost-service trade-off, but also identify (and cost out) principal levers that one can deploy for mitigating such a trade-off.

In the personal computer industry, it is customary to talk about the “smiley curve.” The x-axis for the curve shows the various players in this supply chain, namely equipment makers, manufacturers of microprocessors and other components, PC assemblers, distributors, value-added resellers, and service providers. The y-axis reflects the margins made (i.e., the value captured) by each of these players. The “smiley curve” asserts that, while both the upstream (e.g., equipment and microprocessor manufacturers) and downstream players (e.g., service providers) make healthy margins, PC assemblers’ margins are relatively thin. A similar challenge is also present in service industries. Consider, for example, the airline industry. Over the past few years, while full-service European airlines have been struggling to avoid bankruptcy or trying to climb back out of the red zone, aircraft manufacturers, aircraft leasing companies, reservation systems, and airport operators have achieved respectable financial results. Hence, the value captured by different players varies drastically along this supply chain as well. There are many other examples where the value created by the entire supply chain is captured in an uneven fashion by the different players in that ecosystem.

The 1986 Annual Report of the Digital Equipment Corporation (DEC) was setting an ambitious goal: “Our goal is to connect all parts of an organization—the office, the factory floor, the laboratory, the engineering department—from desktop to data center. We can connect everything within a building; we can connect a group of buildings on the same site or at remote sites; we can connect an entire organization around the world. We propose to connect a company from top to bottom with a single network that includes the shipping clerk, the secretary, the manager, the vice president, even the president.¹” More importantly, this goal was not based on some “vaporware” but on a concrete enabling technology, namely a new generation of super minicomputers based on a single computer architecture, VAX. From small desktop machines to computer clusters, VAX-based machines would be fully compatible, use a uniform operating system, and communicate across shared networks.

The Economist defines services as “anything sold in the trade that cannot be dropped on your foot.” According to Levitt,¹ products can be seen as the physical embodiment of the services they deliver. For instance, a smartphone can be viewed as an object delivering a communication solution. In fact, as shown in Figure 7.1, a growing proportion of the active population in developed economies would describe their jobs as a service operation. Yet, with a few exceptions, this book has largely focused on supply chains that produce and deliver physical goods to final customers. The question that must be addressed is what portion of the concepts and ideas developed thus far also apply to service settings.

In this book, I have emphasized three key messages: