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AMR Research

Demand-driven supply networks are replacing factory-based push supply chains as leadingcompanies learn how customer-centered businesses operate. The change is bigger thanyou may think.

Demand-driven supply networks (DDSN) may seem like just another term for supply chain management. Don’t be fooled. DDSN tackles business areas overlooked by traditional supply chain management and promises huge new efficiencies and growth. Proclaiming that the customer is king is not enough. Rebuilding the supply chain is essential for profitable growth in the 21st century business world. This paper will describe how demand-driven supply networks operate differently and how you can design and build one. We start by addressing what is wrong with today’s supply chain; we then define DDSN and its organizational and process components; and finally, we offer a four-stage maturity model to chart your company’s progress.

20th Century Supply Chains Are Based on the Factory, Not the Consumer

The last century was all about the factory. What marvelous advances were made possible through the application of mass production techniques! Henry Ford’s fabled River Rouge auto plant was a legend of productive efficiency – rubber, glass and iron in one end and cars out the other. However, consumers had to be satisfied with “any color you want, as long as it’s black.”

The biggest oversight of this 20th century factory-centered supply chain was management of consumer demand. Current key metrics of supply chain performance indicate that the efficiency of the chain still remains limited by this oversight. Consider the following data:

• Median time to market for a new product in consumer packaged goods: 27.5 months.
• Median days of supply on hand for semiconductor manufacturers: 190 days; and
• Median order error rate for industrial electronic equipment suppliers: 26 percent.

Today’s supply chain still mainly serves the factory, not the consumer. As a result, several critical deficiencies persist:

• The bullwhip effect – Disruptions downstream ripple back ever more loudly, creating tremendous demand uncertainty. Result: about $3 trillion worth of inventory locked in the U.S. and European supply chain as of March 2005.
• Linear optimization techniques – Failing to account for variability is fine in a factory with known task cycle times, but it’s no good across a network of flexible productive nodes. Result: 20 percent order error rate across U.S. industry.
• No support for product innovation – The black box approach to research and development assumes that new products go through the same chain as existing ones. This approach is slow, wasteful and error prone. Result: 75 percent new product failure rate globally.

One big food and beverage company exemplifies what is wrong. Asked about measurement, this company’s supply chain leader described a rich set of manufacturing utilization and throughput metrics, but little or nothing tied to commercialization. In this model, efficiency as well as growth suffers. New products are hard to launch, promotions are impossible to coordinate and margins shrink in a deflationary spiral.

DDSN Pioneers Beat Supply Chain Laggards at the Bottom Line

AMR’s benchmark research proves that laggards have an overall cost disadvantage of 5 percent of revenue due primarily to poor forecast accuracy. Such businesses are still serving the factory first and consumers second.

Meanwhile, leaders’ ROA, earnings per share and profit margin all correlate with the ultimate measure of customer satisfaction – the perfect order.

Next-Generation 21st Century Supply Network Is all About the Consumer

The next century is all about the consumer. Dell is everyone’s favorite example of modern supply chain best practices because it has built a $40 billion business that is fundamentally make-to-order – the exact opposite of 1920s-era Ford Motor Company.

Demand drives a network of 25 key suppliers who account for 75 to 80 percent of total spending and provide 80 percent of the R&D effort that gets new product to market. Dell ships 20 million products per quarter with only three days of inventory. Inventory in this model is a liability (0.6 percent component price declines per week), not an asset.

The business is based on three master performance metrics – growth, profitability and liquidity. The first two measure consumer value; the third measures Dell’s independence from physical assets. This is in fact the perfect business dashboard for the 21st century. Dell is the world’s best-known example of a demand-driven supply network.

Demand-Driven Supply Network Defined

AMR’s definition of the demand-driven supply network is:

A system of technologies and processes that senses and reacts to real-time demand across a network of customers, suppliers and employees.

The key elements of this definition are:

• System – To be effective, the next-generation supply chain must be scalable, comprising technology like software applications and databases with business processes. DDSN needs a system architecture to scale without compromising flexibility.
• Demand – Is demand an order? A forecast? An opportunity? For DDSN to take root, companies must learn to see demand at many levels complete with buyers’ willingness to trade off one benefit, say, availability, for another, like price. “Sense and react to realtime demand” does not simply mean “fill the order.” It means applying business judgment quickly across all demand.
• Network – Contract manufacturers, outsourced design and thirdparty logistics providers are all part of the rapid transformation of the supply chain away from vertically integrated corporations toward core competency-based business networks. For a network to succeed, standards and communication must be pervasive and reliable.

DDSN is about starting at the moment of truth and working backward to instantiate the supply network that best meets demand. The moment of truth may be a consumer at the supermarket shelf making a choice; it may be a replacement part for a commercial jet waiting for clearance to fly; or it may be full-volume production readiness with the hot toy for Christmas this year.

Unlike the left-to-right linear chain based on hard assets, DDSN looks more like a self-renewing interaction between three strategic business domains – demand, supply and product. Visibility and freedom to act in all three domains at once defines the demand-driven business of the 21st century.

Organization and Process, As Always, Come First

In nearly 20 years of working with companies on supply chain strategies, AMR Research has heard the truism “process is more important than technology” thousands of times. Running a close second is the truism that “organizational barriers” derail supply chain projects. So let’s start there.

It’s Not About Order-to-Cash

Processes like order-to-cash or procure-to-pay are red herrings in the design of a DDSN. Although they are operational requirements, they provide no strategic direction. The things that determine where a business will compete and how it will gain share and grow profits are really more domains than processes. They also naturally tie to three traditional poles of organizational power – sales, manufacturing and engineering. The three strategic business domains of a DDSN are demand, supply and product management.

Demand Management: Attract. Sell. Service.

Traditional supply chain has largely overlooked demand management, which is defined as the processes required to shape, sense and respond to demand. These processes include functions in marketing, sales, service, price management and demand forecasting/planning. Research into supply chain tends to forget that half of the supply/ demand balancing problem is demand management.

In a DDSN, these groups collaborate to manage demand – sales’ forecast is a trusted input to operations whose capacity constraints are transparent; marketing collaborates with supply chain for promotions and new launches; and sales and service rely on logistics for order status.

Ongoing demand visibility is also what RFID is all about. Seeing demand pulsing in, rather than batched periodically, gives business a chance to price higher when the customer is willing to pay. Economists talk about “pricing along the demand curve” as a way to maximize profits (something the airlines pioneered). Price management fed with unit-level demand data allows for supplydemand balancing with discounts, tiered pricing and options pricing that do not rely exclusively on physical fulfillment (see AMR Research’s Price Management Model, May 2004, for more on this).

Supply Management: Plan. Source. Make. Deliver.

Common supply management functions include:

• Direct materials sourcing;
• Production operations;
• Manufacturing and assembly;
• Contract management;
• Indirect procurement (excluding back office supplies); and
• Warehousing and distribution.

Production operations may reach deeply into shop floor controls if manufacturing is an important competitive differentiator. For businesses whose core competency is manufacturing-based, these controls will increasingly mean highly flexible automation of production equipment and sensors.

Best practice means lean flow manufacturing in plants, crossdocking, kitting and customized late-stage assembly in distribution centers and optimized parts and labor provisioning in field service.

Product Management: Define. Design. Promote. Supply. Support.

New product innovation is the main source of new profits and growth, especially as product life cycles shorten and global markets accelerate commoditization of existing products. Until recently, most new product development activity was isolated as a cost center in research and development or engineering and largely overlooked as part of supply chain.

Demand-driven businesses are those who proactively manage their product life cycles to introduce new models or product platforms with minimal cannibalization of existing sales. They are also those who assure availability of complementary products essential to acceptance – a prime example being enough game titles to go along with a new Sony PlayStation.

Far from hoping that R&D will come up with the next great product, DDSN requires that product portfolios control customer loyalty; reuse proven technologies, materials and suppliers; and lock out competition. This includes engineering, R&D and product development functions, and demands explicit collaboration on direct materials sourcing and new product promotions, and launch all within stage gate development processes. So how do companies get there?

The DDSN Road Map

Building a DDSN is a transformational journey for most, and a road map is essential. Field research on companies making the journey suggests that leapfrogging to highest performance is not realistic, but that investments made along the way should be accretive to total business benefit.

DDSN Capabilities – Stages of Maturity

AMR has developed a DDSN Capabilities Model (see Figure 3) to describe four stages of maturity:

• Stage 1: Reacting – Classic site-to-site traditional supply chain. Integration barely happens.
• Stage 2: Anticipating – A connected enterprise. Internal integration, clumsy external links.
• Stage 3: Collaborating – A connected network. External integration, still no strategic control.
• Stage 4: Orchestrating – DDSN. Plug-and-play external integration. The ability to create new businesses as opportunity arises.

As organizations progress through these four stages of development, they can institutionalize certain practices. Best practices like design-for-supply, lean manufacturing and sales and operations planning enable migration up the maturity scale.

Who Should Lead?

Supply – The most common executive sponsor of AMR’s supply chain clients is vice president of supply chain. This role is bestsuited to own accountability for such major business metrics as cost of goods sold, perfect order fulfillment rate and inventory turns. To function well it should include purchasing, manufacturing and logistics.

Product – In over six years of product life cycle management research, AMR has seen many different potential leaders for the product domain – engineering, R&D, product development, marketing and even supply chain itself. Product domain leadership is so fundamental to developing a DDSN that general management may need to create a role accountable for time to market, new product contribution and perfect product launch. Some companies have created chief innovation officers that might serve this role.

Demand – The obvious starting point is head of sales. Also critical to managing demand, however, are marketing and service. Appropriate business metrics to assign to this may include market share, total revenue growth and gross margin.

What about the CIO? – CIO has overall accountability for technical infrastructure supporting DDSN. This means enforcing standards, identifying critical enablers and the timing and sequence of their availability. It also means charting a path that leaves existing systems in place wherever possible and managing all new investment by reallocating existing capitalized IT spending.

Recommended Action

• Identify leaders for demand, supply and product domains who are able to drive DDSN; also plan for those who will resist.
• Benchmark current performance on key metrics of DDSN excellence (e.g., forecast accuracy, perfect order performance and time to market).
• Finally, look over your shoulder (or ahead) to competitors who are good at responding to demand to see where you are losing business, money and time.