Supply Chain Flexibility
At first, business was good for the sheet metal fabricator. The company, which built parts for four large customers plus a dozen smaller ones, was very responsive to its customers' needs, even to the point of making inventory investments well in advance of customer payment. Palletized cabinet parts for personal computers, a large customer order worth 30 percent of the fabricator's revenue, choked the main aisle all the way to the shipping department. Then disaster - this large firm decided to exit the personal computer business. It was as much a change of business strategy as it was economics. All its open orders were immediately cancelled, leaving the fabricator to deal with a partially finished, customized inventory.
Reeling from the lost revenue, the sheet metal fabricator auctioned off this inventory as scrap. While scrambling to find new business, the fabricator was invited to bid on a package deal of low-volume, high-mix parts for a third-tier supplier to the telecom market who had decided to outsource its own internal metal fabrication. Winning the bid depended on the capital purchase of related machinery assets. The fabricator won the bid; business was good again.
The constantly changing mix of parts and the constant pressure for lower prices drove the sheet metal fabricator to relocate its plant closer to the customer. This move improved face-to-face collaboration and reduced operating costs. The customer pressed the fabricator to invest in 3-D CAD technology, NC tooling, and bar coding. Then the telecom bubble burst, followed by the terrorist attacks of 9/11. Disaster struck again - the customer moved its manufacturing to Southeast Asia. Since it was prohibitively expensive for the fabricator to follow the customer, it learned to adapt in order to survive.
The Three T's
Business as usual is gone from manufacturing. Relationships are no longer static. The three T's of technology, terrorism, and (world) trade are the drivers of change in supply chain networks. Technology, especially Web-based technology, is the great enabler that allows the possibility of new relationships. Terrorism is the recent, serious disruption to existing, once efficient relationships. World trade reflects the market demand dynamics for products and services across all relationships. Whenever a new leapfrog technology or a new policy against terrorism or new economics in world trade occurs, the ripple effect is sure to stress each supply chain network relationship.
Many examples come to mind. As Wal-Mart embraces the new wireless technology of radio frequency identification (RFID), its first-tier supply network is driven to new levels of investment. Wal-Mart suppliers are expected to use RFID tags to track SKU's everywhere throughout the supply chain. As U.S. Customs promotes the Customs-Trade Partnership Against Terrorism (C-TPAT) compliance, network trading partners are driven to new forms of security collaboration. The C-TPAT rewards tighter supply chain security with priority clearance through Customs. As the World Trade Organization clarifies the definition of antidumping duties, the European Union seeks relief from the practice of zeroing. Zeroing overestimates the antidumping fines due from importers because it zeros out times when their export price is higher than their home price. In turn, the three T's make supply chain flexibility more imperative and advanced planning and procurement more complex. Individual trading partners enmeshed in a supply chain network, like the sheet metal fabricator, need a new framework from which to gauge and assimilate continuous change.
A Black Box System
The sheet metal fabricator and the customer are actors on a network stage. Such business organizations succeed or fail through their relationships with other organizations in the network. The upstream echelons of the network are organized around a supply base that can meet the requirements of the product bills of materials. Raw materials are value-transformed into components, value-manufactured into products and value-fulfilled along with services to the end customer. The downstream echelons of the network reflect the channels of distribution required to access each target market. Legally independent business organizations can no longer survive alone outside the context of a competitive supply chain network.
The supply chain network is a system. It is a complex set of organizational relationships interconnected by physical distribution flows, information flows, and cash flows. The system has feedback in the form of planning, collaboration, and performance measures. For someone outside the network looking in, the system is a black box with customer demand and raw materials as inputs and with delivered products and services as outputs. The system produces value for its end customers and for its shareholders. Most relevant to this article is the idea that the network will have a system response to different kinds of stimulus.
Supply chain flexibility is the competitive response from within the network to supply and demand dynamics. It is the middle ground between being responsive and being adaptable. The fabricator loses a major customer, and then expands its capacity with the purchase of capital assets from a new customer. The fabricator cuts logistics costs and improves collaboration by moving its plant closer to the customer. The fabricator opens a satellite plant. Figure 1 traces the fabricator's flexibility in its reaction to each business situation.
Responsive, Flexible, and Adaptive Network Dynamics
When asked, the CEO at the sheet metal fabricator said, "My organization needs to be more flexible." What does this mean? Is this CEO speaking from a network perspective or only from the perspective of an independent supplier company? Stimulus and response pairs are used to describe classes of network dynamics as follows:
Responsive - The stimulus is customer initiated. The response is to accommodate the customer's need through operations planning and scheduling with no change to the network configuration. Some examples include customer requests for product mix change, delivery quantity change, delivery timing change, delivery location change, and product returns.
Supply Flexible - The stimulus is initiated from within the network. The response is to match supply with demand through supply management. This can require changes to product and network configurations. Some examples include asset investment, alternative routings, inventory substitution, outsourcing and insourcing, network substitution, plus centralizing and decentralizing.
Demand Flexible - The stimulus is initiated from within the network. The response is to match demand with supply through demand management. This can require a change to the product pricing. Some examples include dynamic pricing, product promotions, forward auctions, and excess inventory auctions.
Adaptable - The stimulus is environment initiated. The response is to radically change the network configuration. If the external event is too extreme, the network will break and the business will fail. Some examples include leapfrogging product technology, market restructuring, regulatory change, political unrest, financial stress, exchange rate excursions, trade quotas, security breaches, terrorist threats, and environmental restrictions.
Matching Supply With Demand
The throughput of any network is constrained somewhere within the network. It will always be constrained by the capacity of a bottleneck work center. However, it can also be constrained by allocated inventory, by delayed information flow or by a shortage of cash. Matching supply with demand is about identifying the system constraint - be it capacity, inventory, information, or cash - and relaxing this constraint until throughput meets demand. The following are some common means of matching supply with demand:
- Asset investment - Relaxing the system constraint by buying more assets;
- Alternative routing - Relaxing a capacity constraint by manufacturing through a different routing;
- Network substitution - Relaxing a capacity constraint by substituting a different supplier or factory or distribution center into the network for the constrained one;
- Inventory substitution - Relaxing an inventory constraint by substituting a different product, component, or raw material;
- Outsourcing and insourcing - Relaxing a cash constraint by operating under a different cost structure and by redistributing capacity and inventory capital assets across the network; and
- Centralize and decentralize - Relaxing an information constraint by redistributing the information flow.
Matching Demand With Supply
A network capacity constraint that sits idle is perishable. Some kinds of inventory are perishable. Matching demand with supply is about managing demand to consume perishable capacity and inventory when the investment in these capital assets has already been made. Demand management, also known as revenue management, is common practice in the service industries, but is underutilized in manufacturing. The following are some common means of matching demand with supply:
- Product promotions - Creating an incremental demand for existing inventory by building product awareness and offering pricing discounts;
- Dynamic pricing - Creating an incremental demand for existing capacity to conserve its contribution margin by pricing based on the capacity remaining and the time to expiration; and
- Auctions and exchanges - Creating an incremental demand for existing unique inventory by an auction. A forward auction has one seller and many buyers while an exchange has multiple sellers and buyers.
A Flexible Organization
How does a network trading partner, large or small, stay flexible? What makes one organization better at this than another? The answer is analogous to the idea of reusable software built with object-oriented programming technology. Object-oriented programming embeds basic process functionality into a software object, and provides an interfacing standard for software calls made to that object. An example object might be a process that verifies the user's credit card billing address each time a new purchase is made with a credit card. The software algorithm is invented one time in a high level language. Once the software is debugged and proven as to the reliability of its executed function, other programmers can copy and paste this object from an object library to write ever more complex software routines. When an object is reusable, programmers do not have to reinvent the wheel, and software testers do not have to worry that the code in the reused module is buggy. The software object remains flexible for its future applications.
Four attributes contribute to the flexibility of this reusable software object. First, the core functionality of the object is basic and carefully scoped. Second, the object's code is written using exacting interface standards. Third, the execution results and the speed of execution of the object are measurable. Lastly, the object links dynamically to other calling and called objects. This list of attributes has a direct correlation with the attributes that a trading partner needs to stay flexible in a network. Figure 2 and the following list identify the key elements of flexibility:
- Core competency - The organization understands the exact boundary of its core competency. While it has the flexibility to outsource or insource other functionality, the organization will never compromise its own core competency boundary.
- Standard technology interfaces - The organization invests in standardized technology interfaces that allow it the flexibility to easily connect to and disconnect from other network organizations without incremental information technology (IT) investments.
- Common performance measures - The organization embraces industry standard definitions for its performance measures, and it maintains a set of global, or end-to-end, performance measures. This allows the organization flexibility to continue measuring its performance when immersed into different network configurations.
- Dynamic pricing - The organization has resolved its own internal cost structures and pricing policies to the point where it can link to new relationships flexibly using dynamic pricing.
The Role of Technology
The U.S. Army uses basic training to teach its smallest organizational unit, the rifle squad, how to be flexible. There are three components. The first is to scout well beyond the footprint of the squad to keep from being clobbered by an unexpected threat; this is the forecasting intelligence. The second is to be ready to receive new orders from headquarters and to know both the capability of the squad and the equipment immediately at the squad's disposal; this is the customer demand communication, supply capacity, and supply inventory intelligence. The third is to know all the options and to have a practiced Plan B at the ready; this is the planning intelligence. Whether large or small, the network trading partner would do well to develop an early warning system, to have a clear picture of demand and supply, and to know all its options in order to achieve flexibility. Technology plays an enabling role for each of these tasks.
The critical question for any early warning system is whether a change in demand is insignificant, a one-time event, the bullwhip effect, a cyclical swing, or the start of irreversible restructuring? Technologies including streaming market and financial information, econometric forecasting, cross-industrial data warehousing, environmental scanning, and others enable the trading partner, like the rifle squad, to look beyond its own footprint and to correlate its customers' demand patterns with other seemingly unrelated information.
Technology enables the synchronization of demand and supply. Revenue management systems and dynamic pricing systems attempt to stimulate new incremental demand to match perishable capacity. Auctions and exchanges provide an economic alternative for demand to match excess inventory. Enterprise resource planning, supply chain management, warehouse management systems, transportation management systems and others, are examples of technologies that facilitate matching supply with demand.
Reliable real-time information is the key to a trading partner knowing its options. Point-of-sale scanning, radio frequency identification, global positioning systems, Blackberry wireless protocol, supply chain event management, and other technologies, are examples of having the real-time information available to be able to quickly develop a Plan B. Options are developed by knowing the location, readiness state, and prior commitment for each network resource.
Summary
The organization has to will itself to be flexible before it can take the steps outlined in this white paper. It has to have some framework to discern being responsive from being flexible from being adaptive. It has to look within itself and define the set of boundary conditions that describe its core competency, technology interface standards, global performance measures, and willingness to price dynamically. The network trading partner has to invest in technologies that can provide early warning, that can synchronize demand and supply, and that can illuminate its operating options in real time. In the end, flexibility for the network trading partner is achieving a high state of mental readiness for change.
