Return on Relationship: A Different Lens on Business
It has been said that "the best way to predict the future is to invent it." For companies trying to predict the shape of future business, inventing the future means creative development and management of business relationships in the Internet environment.
The far reach and ubiquity of Internet communication and commerce result in both dazzling new opportunities and a bewildering proliferation of options and relationships. The "next economy" business environment is in the midst of seismic transformation wrought by the Internet, as old business models are deconstructed and new ones take their place.
Linear supply chains and hierarchies are being supplanted by multidimensional markets. Competitive strategies are becoming more dependent on cooperation among trading partners, and less focused on singular benefit to individual companies. Flexibility and risk are overtaking the values of stability and predictability.
The traditional management, strategy, and technology tools that have served conventional business models may prove inadequate for managing these sometimes chaotic relationships. In response, a new metric and methodology is emerging: return on relationship (ROR).
ROR Defined
Return on relationship (ROR), a term coined by AMR Research, puts a different perspective on managing, measuring, and analyzing business activities than traditional return on investment (ROI) assessment techniques. ROR analyzes "the investment required of the trading partner, associated financial reward, and risk." As AMR Research's David Caruso notes in his article "Business Demands Continual Business Model Re-evaluation"(1) (Saturday, July 01, 2000):
"While not obsolete, the hard-dollar cost savings ROI models will start to be replaced by market expansion, revenue per customer, and customer satisfaction metrics. Return on relationship is a term that we expect will gain attention as manufacturers move into projects focused on managing new channels, expanding customer self-service, and optimizing marketing initiatives."
But ROR is more than simply an alternate metric. It's a different way of thinking about options, making strategic decisions, speeding transformations, and freeing organizations from imprisoning models and assumptions. An ROR perspective makes evident the necessity and desirability of looking past competing goals and collaborating for mutual benefit, both internally and externally.
Zero Sum Games vs. Collaboration
Supply Chain Management practices and projects of the past have often been referred to as attempting, sometimes successfully, to bridge the silos of internal organizations first, then reaching to span the turbulent cross currents of company-centric objectives and policies later, if ever. If it has been difficult to re-engineer the organization, how much more difficult it surely is to evolve multi-company supply chains from a win-lose zero sum game into win-win cooperative and collaborative operations (note: in a zero sum game, one side's gain/loss is exactly the negative of that of the other side, so that together the two outcomes sum to zero - for example, my gain in cost savings is your loss in revenues).
The problem is that, in business, sacrificing a relationship by zero-sum game practices can jeopardize the possibility for follow-on business, and unforeseen opportunities. This we know from practice. And although the relative magnitude of importance of a supply chain partner (either customer or supplier) may permit one-sided benefits for a time, rarely will the situation last, and the implications can be far-reaching. No one likes to trade with a mean-spirited trading partner!
Internal Silos
The syndrome of non-collaborative imprisonment is unfortunately not limited to the external chain. Companies reward internal silo thinking too often - consider, for example, policies that bonus individual buyers for cost savings on the contracts they negotiate for their departments. Buyers have little incentive to seek greater company-wide savings through cross-department procurement that might result in better quantity breaks; their own bonus motivates against cooperating with other departments.
Silo thinking yields countless similar examples. If we operate this way within the four walls, how can we ever expect to improve our operations with partners on the other side of our walls?
Communities of Interest and the Advent of C-Commerce
The answer lies in communities of interest, as opposed to islands of self-interest. Gartner Group (which coined the original Enterprise Resource Planning tag) has recently minted the term "ERP II," founded on the principal of "Multienterprise recombinant entities, executing core-competency-based strategies the essence of ERP II is the expansion beyond enterprise-centric optimization and transaction processing to collaborate in communities of interest."(2)
Additionally, Gartner states that the term "e-business" is better described as "c-commerce" for collaborative commerce. e-business is often transactional (such as EDI-enabled fulfillment), whereas c-commerce is transformational; while EDI makes transacting more efficient, thus reducing costs, customer or supplier integration via portals makes the chain more competitive, thus enhancing revenue.
Hierarchies vs. Markets
ERP often traded reach - wide access to new markets, geographies, and merging opportunities - for richness - optimization of supply chains and hierarchies across companies as well as within the organization(3). Efficiency was the goal as reengineering stressed minimalism: streamlining, reducing the supplier base, establishing structured chains.
Efficient, yes, but hierarchies are not necessarily effective. If you optimize the wrong variable, you merely expand the cost base - you do not expand the horizon of revenue. Evans and Wurster argue that we are fast moving into the realm of markets. Hierarchies and chains, while supportive of strategy, do not foster flexibility and initiative.
Corning Photonics Division
Corning Photonics Division, providing optical networking component solutions for the telecommunications industry, does take the initiative by being upwardly proactive with key customers, some of whom cannot readily share forecasts due to the dramatic growth and instability of market conditions. They want their customers to expect exceptional design, quality, and response without having to provide rarely accurate forecasts in advance of orders - actual demand. And it's working. Mark Kamstra, Director of Infrastructure at SBC Communications, a global provider of telecommunications services, when asked about Corning, a supplier two levels upstream in his supply chain, observed: "We like Corning. They are an excellent member of our supply chain."
Stability vs. Flexibility
Such flexible methods of collaboration can stand in sharp contrast to the stability-seeking approach that works so well for some companies. Companies must find the point on the flexibility-to-stability continuum that best fits their business model and culture - and always be prepared to re-evaluate it.
The Price of Stability
At a recent symposium of the Stanford Supply Chain Forum, Ko Nishimura, CEO of contract manufacturing powerhouse Solectron, Inc., was asked about the trade-off between stability of operations and flexibility. Ko responded that he collaborates with top customer CEOs in a monthly forecast-freezing exercise, valuing transmission of stability signals to the workforce as a way of dealing with the volume variance component of forecast error. This excellent company, unmatched in the contract manufacturing space and two-time winner of the Malcolm Baldridge Quality award, has many components in their proven method for success. But for many companies, is order-of-magnitude flexibility across new channels too high a price to pay for stability?
New Channel Options and Opportunities
Some companies are experiencing dramatic increases in throughput with disproportionately smaller increases in capital assets through collaborative demand management. Continuing to adhere to the "80-20" rule, that 20% of your customers contribute 80% of the value to your income statement, could either limit markets, or cause a company to fall victim to more nimble competition who are searching out the mid-volume, custom-to-order opportunities. This further reach is provided by Internet-enabled sales and operations planning and execution - CRM (Customer Relationship Management) and SCM (Supply Chain Management). Together these models for business are driving new rules that can make smaller segments very valuable, especially when seen as channel options to fill the uncertain picture of future demand. Using Internet-enabled SCM and CRM methods coupled with strong enterprise performance management analytics, you would begin to see opportunity as it develops, and redirect assets and capital before it recedes.
Going forward, value, that uncertain commodity of past supply chain initiatives, will no longer merely be pursued through IT experimentation, or re-engineering by systems consolidation and competency deconstruction. Instead value will be a cross-company target, collaboratively based, and strategies will emerge, partly in response to planning, but largely in response to the chaos caused by the high-reach landscape of c-commerce.
Too Many Options - and How to Evaluate Them
This c-commerce, multidimensional, non-hierarchical, market-shaped environment presents a looming problem: How do we satisfy all the c-commerce opportunities that are presenting themselves in rapid-fire succession? How to choose? Where to start, and when? Once committed, how to respond to uncertainty and change, as they incessantly hammer home the need for speed and ever-quicker response?
Traditional assessment of projects for capital expenditure has used return-on-investment (ROI) techniques. ROI deployed outside the organization has generally followed this thinking: (1) With suppliers, whatever works to reduce our costs (2) With customers, whatever works to increase our sales. But this is no longer good enough! Why not? Because, as Bob Parker of AMR Research noted in his article "Corporate Finance as Venture Capitalist: Prioritizing E-Business Initiatives,"(4): "Initiatives that rely on the participation of trading partners have a much higher probability of success if the benefits are mutual." Common sense, but certainly uncommon practice in the old economy where "rich" meant stability rather than access.
Further, AMR pointed to the weaknesses of capital budgeting methods in assessing and prioritizing cCommerce initiatives. ROI (return-on-investment) models tend to favor projects with strictly internal benefits, and often disfavor those projects with huge external and win-win potential. Additionally, current models tend to view investments, especially those targeting supply chain operational improvements, as incremental rather than transformational. There is little doubt that the operational initiatives being enabled and driven by the Internet contain some of the greatest disruptive power and potential of any technological advance in history. So how we assess particular projects for launch is critical.
AMR's identification of the ROR concept meets this opportunity. The ROR perspective - "the investment required of the trading partner, associated financial reward, and risk" - stands in stark contrast to the early "collaborative" supply chain initiatives, like Just in Time (JIT) in the 1980s, that merely pushed supply chain problems upstream to suppliers. The JIT hub concept, especially popularized in the 1990s, called for supplier co-location of facilities (often just warehouses) to meet the regular as well as the surge component requirements of the hosting manufacturer in order to reduce that manufacturer's investment and increase inventory turns and return-on-assets.
The real benefits were generally not realized until efforts to carry mutual gain throughout the chain were developed and sustained over a period of time.
Toyota Motor Manufacturing North America
Early champions of this more comprehensive approach included Toyota Motor Manufacturing, a PeopleSoft supply chain customer in North America. Toyota's Supplier Support Center was founded on the assumption that the Toyota Production System, its well-known proprietary flow production methodology, became an even more powerful competitive weapon when shared with suppliers. This supposition is based on the Internet-emergent rule of thumb now known as "Metcalf's Law." This law states that value grows exponentially with the number of nodes/users added to some particular value network.
Real Options - New Thinking about Supply Chains
Beyond the framework of an ROR approach to c-commerce project assessment and measurement, there is also an emerging sea change in thinking about supply chain decision support as well as opportunity investment. It is known as "Real Options." Coined by Stewart Myers of the Sloan School of Management at MIT, the term is founded on the principle "that there is value to waiting for more information" when faced with a series of linked investments, and that this value is not reflected in standard capital investment models like payback, net present value, or internal rate of return (notice that word "internal"?).(5)
A real options approach posits that fixed strategies for long periods of time involve very high risk. By building options into the decision model, risk can be mitigated dramatically and distributed across a portfolio of possible participants (like suppliers) and outcomes (like c-commerce projects to be implemented, or supply chain partnerships to be adopted).
The use of real options in supply chain decision support is really not completely new. In the past decade there has been a rise in programs like continuous replenishment, where a manufacturer manages customer inventory based on "sell-through" in the sales channel. In this way safety stock could be strategically planned and deployed, postponing the exercise of this asset, conserving capital, and mitigating the effects of volume variance by aggregating forecast errors. In the same way, mix errors (variance at the option/color/style/label, etc.) have been managed by supply options afforded by lean manufacturing practices like that embodied in the PeopleSoft Flow Production System, and built to a great extent from lessons learned with the Toyota Production System. Even consumers, on the far end of the spectrum of emerging c-commerce, benefit. Said Jim Bolte, GM of Information Systems at Toyota Motor Manufacturing North America, about the use of ERP II functionality in their parts replacement supply chain, "Toyota was able to effectively implement solutions that are flexible enough to support Toyota's production principles which ultimately benefits the Toyota owner."
Options are also greatly extended through deployment of autosourcing rules, as found in PeopleSoft Purchasing and e-procurement applications. Likewise, constructing bills-of-material with part substitution capabilities allows for far more flexible sourcing options.
Greater value in reversible decisions
Value is much increased in a portfolio of strategies where there is a potential to exercise options. This is because regret is minimized, uncertainty is better managed, and the negative cash flow branches of the unfolding decision tree are chopped off before they can grow. In the past, decisions were more irreversible because the models for assessment, management and measurement did not incorporate the use of options to be exercised along the way as the situation developed.
The historical drive for internal efficiencies led many companies to actually limit their options, and to discount strategic planning in real time. There was a tendency to solidify the path of strategy deployment before launch and then accord success as unwavering from the plan.
in speed
Klaus Schwab, head of the World Economic Forum, says it this way: "We are moving from a world in which the big eat the small to a world in which the fast eat the slow."
As Amram and Kulatilaka state in "Real Options": "Managers using the real options approach will make more irreversible investments, but in small stages, and after waiting for some uncertainty to resolve." Faster to milestone. Faster to review. Faster to learning. Faster to strategy.
and in collaboration.
A lean and demand-centric strategy forces the company to operate closer to the customer. The ideal is to bring customers directly into the company's system, through collaborative demand planning as well as execution. But this has to be convenient, efficient, and meaningful to them - not just an offloading of administration. Tools such as PeopleSoft's eDemand Planning, eStore, and Trade Promotions Management can tip the balance toward demand-driven strategy.
Cybex International
Cybex, a manufacturer of professional-quality fitness equipment, is approaching the one-year anniversary of operating an Internet storefront using PeopleSoft eStore. Says Brian Lyman, Cybex's Manager of e-commerce, "At Cybex our website, eCybex.com, now offers our dealers and distributors around the world real-time access to ordering equipment and service parts as well as viewing the status of any order on their account in our backbone system. The one consistent point we hear from our customers is that they are more efficient in their operations because they can now see the information at their convenience. In the past, all customers had to reach and speak with a customer service rep in one our offices to access that same information. eStore allows our internal customer support groups to be more proactive in working with our customer rather than reacting after the fact to voice mails and faxes."
Summary
Evans and Wurster have pointed out that Internet-enabled applications (such as PeopleSoft's pure Internet architecture, Marketplace market-maker tool set, and self-service portal plug-ins like eBill Payment and eSupplier Collaboration) are exploding the tradeoff between richness - deep content - and reach - broad access. ERP is no more. In its place, ERP II propels the functionality for richness, with strong fulfillment backbone functionality and lean production support.
Return on relationship will become a core metric in this c-commerce environment. ROR implies an underlying system - a portfolio of triggerable decisions with options to proceed or abandon by milestone. It implies virtually-extended operations: trading partners and even less-directly linked collaboration partners two or three steps removed in the supply chain. These relationships will form the organizational "glue" of c-commerce. The nested options of each portfolio, by channel, by product family, by supply chain, will be triggered by predefined states and prevailing conditions.
Defining these will be daunting at first. But quick experience gained will open doors. Decision rules must be established for determining when to exercise options in the supply chain. These rules must use market valuation strategies as well as powerful applications architecture platforms for implementation.
The transformations companies are seeking, for competitive edge in the "next" economy, are at least partially open to traditional strategy and management tools. But success will depend heavily on investing in methods, tools, and technology that will prove to be resilient and easily deployed, and that will increase initiative, flexibility, and response to the often chaotic, but very real options that are fast coming our way.
References
1) "Business Demands Continual Business Model Reevaluation", AMR Research's David Caruso (Saturday, July 01, 2000)
2) Gartner's Bruce Bond, Oct. 16, 2000
3) For more on reach vs. richness, see "Blown to Bits," Philip Evans and Thomas S. Wurster, Harvard Business School Press
4) "Corporate Finance as Venture Capitalist: Prioritizing E-Business Initiatives," January 2000
5) For more information, see Martha Amram and Nalin Kulatilaka, "Real Options," Harvard Business School Press
