Leap of Faith

[From iSource Business, April 2001] Tim Vaio was ready to make a leap of faith. As director of supply chain solutions for Lucent Technologies' Worldwide Services division, Vaio oversaw a fundamental shift in the way his company fulfills orders and completes installations. Vaio's division, which handles the installations for products sold by Lucent's four other divisions, traditionally had waited for all the materials it needed for a given installation to be sitting in one of the company's warehouses before scheduling the job. Now, using the Internet and a software solution to gain greater visibility into its supply chain, Lucent has moved toward a just-in-time fulfillment model that Vaio believes will help the company cut its inventory holding costs while reducing its order-to-cash cycle. The leap of faith? Scheduling product installations before the company even has its hands on all the parts and materials it needs to complete the job.

Tim Vaio was ready to make a leap of faith. As director of supply chain solutions for Lucent Technologies' Worldwide Services division, Vaio oversaw a fundamental shift in the way his company fulfills orders and completes installations. Vaio's division, which handles the installations for products sold by Lucent's four other divisions, traditionally had waited for all the materials it needed for a given installation to be sitting in one of the company's warehouses before scheduling the job. Now, using the Internet and a software solution to gain greater visibility into its supply chain, Lucent has moved toward a just-in-time fulfillment model that Vaio believes will help the company cut its inventory holding costs while reducing its order-to-cash cycle. The leap of faith? Scheduling product installations before the company even has its hands on all the parts and materials it needs to complete the job.

The movement toward this type of just-in-time, sell-source-ship model (also called S3, or s-cubed) runs counter to the traditional buy-hold-sell (BHS) way of doing business. While the distribution business has been practicing S3 for decades, sell-source-ship is gaining broader acceptance as new technologies make it possible for more businesses to reap the benefits of S3. Challenges and potential pitfalls abound, and not every company is welcoming sell-source-ship as the panacea for their cycle-time issues. But, analysts and practitioners are already pointing to industries where S3 makes sense and to success factors that can make sell-source-ship work for your business. (See the accompanying case studies on communications technology provider Lucent, farm equipment distributor Southern Marketing Affiliates, and construction and agricultural equipment manufacturer Deere & Co. to understand how different companies are using, or thinking about using, sell-source-ship.)

AMR Research, the technology consultancy based in Boston, Mass., is credited with coining the phrase sell-source-ship in the November 1998 report, What about Wholesale Distribution? Under S3 a distributor buys and holds as little inventory as possible in advance, choosing to take inventory on consignment or to quickly source and ship it after the order is received, AMR wrote. S3 represented an about-face from the traditional model of buy-hold-sell under which a distributor would buy goods in advance, typically based on a demand forecast, and then hold the products until they were sold. S3 meant moving from just-in-case to just-in-time.

The whole idea of sell-source-ship is, Let's not ship anything to a customer location until we know what the demand is going to be,' says Theodore Stank, associate professor at Michigan State University's Broad Graduate School of Management. Stank, like other academics and analysts, cites Dell Computers as the classic example of an S3-enabled company, because Dell generally draws components from suppliers and assembles its computer products in response to orders received from customers, all the while maintaining minimal inventory levels.

Of course, the personal computer giant was not the first company to use an S3 model. Wholesale distributors began practicing sell-source-ship, to some extent, long before Michael Dell founded his eponymous company in 1994, according to Marc Wulfraat, director of product marketing for TECSYS, one of a class of solution providers whose software is to wholesale distribution what Enterprise Resource Planning (ERP) applications are to manufacturing. If you go back to the 1970s and 1980s, most industrial distributors have always done sell-source-ship as some part of their business operation, says Wulfraat, who spent 10 years in management consulting on distribution issues before joining TECSYS six years ago.

The distributors resorted to sell-source-ship because they simply could not afford to hold in inventory everything that they wanted to include in their catalogs. A distributor that stocked 50,000 items could include an additional 20,000 (or 30,000 or 50,000) products in the company's catalog and then have the manufacturer supply directly to the customer as orders arrived. Depending on the industry, 10 to 30 percent of their sales were always conducted through direct manufacturer shipments to the end customers, Wulfraat says.

One problem with the buy-hold-sell model is, in a word, inventory. No one wants to hold the inventory, says Chris Newton, an AMR analyst. It isn't just a matter of having to maintain warehouses for goods. Inventory also implies a risk of obsolescence and a cost for depreciation.

Buy-hold-sell also implies extended cycle times. The reason we buy, hold and sell is because, traditionally, we can't respond to demand within the time constraints that customers put on us, says Stank. That puts companies in the business of forecasting what demand will be and holding inventory based on what they think customers will buy. This is wasteful, almost by definition, Stank says, because even today forecasting is only about as good as chance in most industries.

Nevertheless, Henry Bruce, vice president of corporate strategy at White Plains, N.Y.-based solution provider Optum, asserts that companies have become proficient over the last decade in forecasting demand for, and handling the inventory of, fast-moving items for their best customers, in other words, that portion of their product lines that brings in the majority of revenues. Now, for competitive differentiation, companies have started to look for better ways to manage the medium- and slow-moving items, the other 80 percent of my inventory that delivers 20 percent of my revenue, as Bruce puts it. That is where the model has had to shift. It is very hard to forecast those medium- to slow-moving items, so that model of buy-hold-sell doesn't work.

Sell-source-ship has therefore evolved as companies have struggled over the past decade to deal with these dual issues of inventory and cycle times. But, it's really the Internet and the new technologies for connecting trading partners within a supply chain that are enabling the current drive toward S3. By efficiently sharing information on inventory and demand through the Internet, companies essentially bring their suppliers more tightly into their supply chains, making them part of their extended enterprises. Proponents of sell-source-ship contend that this information sharing gives suppliers a hands-on view of real demand based on orders received, empowering them do a better job of fulfilling the orders than the companies themselves could. It's all about sharing what was enterprise-centric information across the supply chain to make better decisions, says Newton. You are trading information for inventory and getting some efficiencies that way.

In addition to greater efficiencies, the suppliers of S3 solutions point to several other benefits of moving to a sell-source-ship model. Optum's Bruce begins his list with increased product availability without heavy investment in inventory. While fast-moving items may already be available on a quick turnaround, many companies want to offer the same availability on medium- and slow-moving items as well. By allowing suppliers to see actual demand for these products in real-time, as opposed to some high-level forecast, the suppliers should be able to respond more quickly to changes in that demand. The increased responsiveness on the part of the suppliers should, in turn, allow the company to reduce its inventory levels.

Bruce cites the example of NCR Corp., the $6.2 billion, Dayton, Ohio-based software and IT equipment provider. In moving to an S3 model, NCR was able to cut its on-hand inventory by more than $100 million over a two-year period, taking those goods out of its supply chain and shifting them back to the suppliers. The benefit to the suppliers is that they get a clearer picture of where demand is in the supply chain. With this information, they can select the best location from which to ship in order to meet that demand, versus sending a part to NCR and having NCR decide where to deploy it in its network.

The increased availability also reduces the order-to-cash cycle: the customer gets the product faster and all parties in the supply chain, at least theoretically, get paid faster as well.

Bruce further asserts that S3 can improve the buyer-supplier relationship and help a buying organization reduce its supply base. Under a sell-source-ship model, the information with which the buyer provides its suppliers allows the latter to be more efficient and profitable in what they make and ship. In an ideal world, the buyer could move toward automatic replenishment, which means that the company would be sending demand orders rather than purchase orders, moving the relationship to autopilot with reduced transaction volume and greater process automation.

But, perhaps the greatest potential benefit from implementing an S3 model could be improved customer service and customer satisfaction, according to Richard Cardozo, director of Retail Industry Solutions for Industri-Matematik International (IMI), a Swedish company with headquarters in Stockholm and U.S. offices in Mt. Laurel N.J., IMS is a provider of software for supply chain event management, which involves extending the enterprise through collaboration with external trading partners. If I can make sure I have the right product at the right time, when the customer wants to buy it, that exceeds any other benefits I can get, Cardozo says.

Analysts and solution providers agree that moving to sell-source-ship is by no means an instantaneous transition. This is not turn on the switch and, overnight, go to a different way of doing business,' says Stank. It's an evolution. Companies moving to S3 must deal with issues of information technologies and culture and process changes, as well as trading partner buy-in.

First, the IT issue. Companies that want to switch to sell-source-ship need real-time inventory information, both for themselves and for their trading partners. This implies a degree of sophistication internally and a high degree of collaboration among supply chain partners. In its 1998 report, AMR cited three classes of providers that offer sell-source-ship solutions. First, distribution-centric enterprise application suppliers offer solutions specifically developed for distribution. Suppliers in this class include Wulfraat's TECSYS, as well as companies such as irista (formerly HK Systems, of New Berlin, Wisc.), daly.commerce (Providence, R.I.), dChain Commerce (Champaign, Ill.), NxTrend (the Colorado Springs, Colo. subsidiary of BuildNet), and Prophet 21 (Yardley, Penn.). AMR notes that solution providers in this class offer products tailored to the requirements of the distribution environment, but they also bring in-depth domain expertise to particular industry verticals.

The major manufacturing and financial ERP suppliers can also provide a degree of support for sell-source-ship. Solution providers such as Oracle, PeopleSoft, SAP and J.D. Edwards offer highly scalable products that are well suited to a global enterprise, although the implementation of their systems can be time- and resource-intensive, and their products may not offer the same specific functionality as those of the distribution-center suppliers.

Finally, AMR highlights a class of supply chain and other component suppliers, including such companies as Optum and IMI. These providers offer applications that address a portion of the supply chain equation, be it warehouse management, customer relationship management or sales force automation.

Regardless of which solution provider it chooses, a company must be able to gain an accurate view of its suppliers' inventory levels in order to move toward S3. The technical challenge here is to ensure connectivity with key suppliers, which is no easy task, particularly with smaller, mom-and-pop shops that don't have sophisticated internal systems and can't afford an expensive new solution. Therefore, whenever the process becomes manual, visibility degrades and the S3 system breaks down. Naturally, as a company is able to gain greater visibility into its supply chain over time, it will be able to trade greater amounts of inventory for information on its suppliers' inventory levels. In the meantime, as AMR's Newton points out, It's not an ideal world, and distributors are still holding some buffer stock to meet unexpected delays in production.

Second, the move to S3 necessitates a shift in corporate culture within all members of a supply chain. The key here is realizing that, in order to exchange information for inventory, trading partners must be willing to hand over data that they previously may have viewed as confidential, including forecasting and demand information. IMI's Cardozo notes that retailers, in particular, traditionally regard the data they collect on customer demand patterns to be their greatest asset. Moving to S3 means giving up control of that information, a step that not every company in a supply chain might be willing to take. To meet this particular challenge, Cardozo says that top-level executive sponsorship is critical for the success of a sell-source-ship initiative.

Executive leadership can also facilitate the business process changes necessary to move to S3. The process changes include automating data flows so that inventory information moves seamlessly down the supply chain and orders flow up the chain. Sell-source-ship also requires closer integration with key suppliers to ensure the flow of information. Stank, of Michigan State University, says that these types of changes can be most difficult for old-line companies. An established industry has an established structure and processes, he explains. Sometimes it's hard to shake that. On the other hand, new companies in such industries as computers and electronics have readily adopted sell-source-ship because they have been able to design their processes from the ground up. Stank cites computer maker Dell and San Jose, Calif.-based technology provider Cisco Systems as two such companies.

Perhaps the greatest challenge involved in moving toward sell-source-ship is ensuring trading partner buy-in. After all, the effectiveness of an S3-based model increases as greater numbers of supply chain partners sign on to the system. The two central issues with the buy-in challenge are cost and customer ownership.

In terms of cost, the danger for trading partners is that the major player in a given supply chain the channel master will impose a sell-source-ship model on them and effectively push inventory back up the supply chain and into the partners' warehouses. Sherry Gordon, president and COO of ValuEdge, a Medford, Mass.-based provider of what it calls management software for the extended enterprise, calls this problem jumbo inventory transfer, when a company striving for just-in-time manufacturing or fulfillment divests itself of its stock at the expense of its suppliers. Such an arrangement clearly would not be sustainable, because it merely pushes the costs back onto the suppliers. Either the suppliers are going to go out of business or they are going to pass the costs back to their customers, negating the savings gained from moving to a sell-source-ship model.

The fact is that moving to an S3 model may indeed cause a back-up of inventory upstream, even for the best-intentioned channel master, according to Optum's Bruce. He says that it takes time for suppliers to adjust to using the demand information flowing back up the supply chain from their customers. With better, more timely information about end user demand, suppliers can become more adept at managing their own inventory levels over time. NCR, for example, implemented Optum's TradeStream product over a two-year period, a timeframe that allowed the company's suppliers to make the adjustment to S3.

AMR's Newton agrees that the overall impact of sell-source-ship is to reduce inventory levels throughout the supply chain. For example, manufacturers brought into an S3 system can more closely align their production schedules to actual demand, which means that they will no longer be flooding the supply chain with what could be unwanted goods or inventory. Of course, a manufacturer drawn into sell-source-ship may also look askance at the possibility of having to handle the ship component of S3. The advantage of the buy-hold-sell model for original equipment manufacturers (OEMs) was that they could both build and ship in bulk, and then they could let the distributors handle the complexities of sending out smaller orders. Most manufacturers are not truly geared up for piece-picking, Wulfraat says. If they do provide this type of service to the distributors, they are likely to get fed up eventually if the volumes get too high. They'll probably start to place add charges onto that type of order.

Another potential drawback of the sell-source-ship model, from the distributor's perspective, is loss of ownership of the customer service experience. Under S3, the distributor is handing over to the manufacturer responsibility for and therefore control over such aspects of customer service as guaranteeing on-time delivery, making sure goods are intact when shipped, and ensuring that the right products get shipped. Further, Wulfraat says that many distributors are concerned about shifting too much volume back to the manufacturers because the latter could subsequently wind up going directly to the end consumer, creating channel conflict. In response, some distributors have opted to sort their products in descending sales dollar sequence and, in Wulfraat's words, knock out the bottom feeders and get those to be shipped direct. Meanwhile, the distributors retain control of more strategic or higher-dollar volume products and continue to sell them using a buy-hold-sell model.

Alternatively, dChain Commerce's solution supports what the company calls sell-source-ship-ship, or S4. Under this model the manufacturer continues to ship goods to the distributor rather than directly to the end customer. The distributor maintains its traditional role of handling the customer-facing side of the supply chain, ensuring control over the end user's experience and also averting any possibility of channel conflict or disintermediation. For other goods or customers, dChain's solution also supports the S3 or buy-hold-sell models.

The decision as to whether sell-source-ship makes sense for a given company largely depends on the types of products it produces, distributes or sells. The electronics industry has certainly been at the forefront here, Newton says, explaining, These products typically have a relatively short shelf-life, especially in the computer and high-tech industries. Consumer packaged goods and food-and-beverage manufacturers are also moving in this direction, although not as rapidly as the high-tech industries have been moving.

Stank agrees that lower value products that have a relatively smooth demand pattern and long product lifecycles so there isn't a new and improved' coming out every six months generally don't lend themselves to sell-source-ship. The profit margins simply do not justify the S3 model. Says Stank: It's generally cheaper to store those products in anticipation of sales than it is to develop the capability of responding to actual demand. You're better off building stocks based on forecasts.

From the distributor's perspective, Wulfraat sees S3's greatest applicability in such industrial distribution segments as electrical; plumbing; heating; and Maintenance, Repair and Operations (MRO), as well as restaurant supply. There are areas in which the number of goods a single distributor can offer far exceeds realistic warehousing capacity. S3 may also be applicable to slow-moving items that are difficult to source and not widely stocked anywhere in the supply chain. In other words, it's the goods for which people are willing to wait.

What makes S3 valuable is the ability of a company to assess whether such a system can work for them. It's adaptable. This adaptability can cause S3 to appear in almost any industry.

Given the vast amount of inventory floating around the economy, it would be an understatement to say that sell-source-ship is still in its infancy. AMR's Newton points to the sales volumes at the S3 solution providers as one sign of this: Some of the big software suppliers that have been pushing this model are still $25 million to $50 million suppliers. That shows that widespread adoption of this hasn't happened yet.

Will S3 wipe out inventory and inefficiencies throughout the economy? Probably not. There are certain inefficiencies out there, and to be honest, I think there always will be, Newton says. You can't rely on manufacturing plant capacity to meet all your orders. There are always going to be buffer stocks. The idea with sell-source-ship is to lower those buffer stocks and to replace some of those stocks with information.

Stank concurs, saying, We will have warehouses and distributors until we have Star Trek replicators. But, he adds, distributors will probably change from being buffer areas for stock to being value-added providers that are constantly moving product through their channels. Some companies may adopt sell-source-ship for some product lines, and they may adopt buy-hold-sell for others. We continue to see companies understanding that they don't have just one supply chain, they have multiple supply chains, depending on the demands of their big customers or customers' segments, Stank says. One customer segment may be managed completely differently from another.

And, like buy-hold-sell, forecasting isn't likely to disappear anytime soon either. Says Cardozo, of IMI: We started with the vision that forecasting went away and you went more toward a one-for-one replenishment model. That works for products that are relatively stable in their demand pattern. But in the United States, we tend to be very promotionally driven, and promotional volume can spike up to 1,500 percent of what the normal turn quantity would be. There is no way to react that quickly when you're getting a 1,500 percent spike in volume from one day to the next.


[Sidebar:] S3 Success Factors


Sell-source-ship may be relatively new, but the S3 solution providers typically have deep domain expertise in distribution. Based on their experience, here is some advice for companies considering sell-source-ship:


  • First, understand whether you and your key suppliers have the capabilities necessary to move to S3. Industri-Matematik International, for example, looks to see whether a potential customer has implemented an Enterprise Resource Planning (ERP) system or at least upgraded its backend transaction systems to handle the sort of information flow that S3 demands.

  • Second, look at your processes. ValuEdge, for instance, expects to release a product called ValuEdge Manager by mid-2001 that will let companies identify bottlenecks in their processes, while Optum will map current and optimal processes for its customers in the course of an implementation.

  • Third, tackle a few key customers and suppliers first. Forget about the big bang approach, advises Optum's Henry Bruce. Instead, go for some quick hits, show results and then expand.

See additional sidebars:

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