Today's supply chains aren't ready for the emerging demand economy
We are at the forefront of a profound shift in the ways of commerce: The economic engines of supply and demand are trading places. Demand-based economies are emerging in the United States and Europe. The business of buying is shifting from a centuries-old supply driven construct, moving rapidly to a customer-centric one.
The signs are abundant, once you begin observing. The change is being fueled by the increasingly knowledgeable consumer who has more ready access to an enormous amount of product, price, service and delivery information in combination with ever-lower cost products available from a highly diverse set of sources.
In a supply-based economy, production dictates what is available to purchase, and cost is the key economic driver. Conversely, in the demand economy, customers will dictate what they will purchase, and value is the key. Most businesses are not ready — not primed for managing to demand and availability, but only for optimizing cost and supply. And being the low-cost producer or having the highest market share — strategies which made companies win in the 1980s and 1990s — will no longer succeed. Time-advantaged strategies will win when well defined for a specific market space.
A demand economy looks vastly different from the vanishing supply economy. Customers will insist upon specialized products for unique situations and tastes. Product-line complexity will be broad. Demand variability per product will be higher by orders of magnitude. Seemingly excessive service levels and response times will be the norm. Free cash flow will be under extreme pressure, as customers stretch payments, specialized suppliers from the Pacific Rim ship only on cash, and slow-moving inventory expands.
In such an environment, the supply chains as designed and installed over the past decade in most companies are rapidly becoming obsolete. These supply chains were designed to optimize costs, not value. Long replenishment lead times were tolerated at the expense of the flexibility and responsiveness that soon will be prized. Suppliers are forced to react to a high velocity of manufacturing resource planning (MRP) change orders, rather than become collaborative partners. Supply chains are sequential, linear and resistant to complexity, the latter being the element the demand economy values most.
The supply chain is a delivery mechanism for the old, expiring economy. Continuing to rely on current practices will substantially erode service levels and will make total cost to serve prohibitively high. The problem is an outdated approach toward planning logic and a chain mentality, both of which inhibit collaboration and cripple flexibility. The result is a 10- to 15-percent premium on per-piece purchase price, as well as ballooning inventories, which in turn leads to truncated sales of high demand and seasonal items.
An entirely new operating approach is required to turn emerging problems into strategic advantage, taking a positive step toward sustainable profitability and increased wealth for all stakeholders: planning around networks, rather than chains. These networks will be characterized by orchestration of the actions necessary to meet customer demands. Adaptability, collaboration and networking will be the key design objectives and will become increasingly more valuable. Time advantage will replace market-share advantage as a competitive strategy. Likewise, customer value will replace cost advantage as the key performance metric. There are major implications for organization structure, systems, external relationships and the physical side of the supply operations.
Such networked planning can decrease purchase cost, which amounts to half the cost of goods sold. The alternative — staying cost oriented and supply driven plays right into the hands of the super-low-cost production engines in the Far East. The changes required are extensive and will touch many areas of your organization. Fortunately, implementation is more counter-intuitive than difficult to accomplish. A new, more customer-centric thinking process is essential, along with a fundamental change in culture.
Requirements of the Demand Economy
While the full evolution to a demand economy will take the next five to 10 years, trends like made-to-order jeans, both online and at storefront, show we are in transition right now. Over the next decade, customers will increasingly be able to buy whatever they want, whenever they want it. The pressure for product innovation will grow constantly and will proceed in shorter cycles and at a faster pace than even technological innovation. Consumers will be very adept at trading off price points. There will be remarkably fewer companies: With prices at parity, those not differentiated will be crunched by costs and will become commodity-type companies; they will then experience consolidation or be pushed out by Far-East competitors.
Product complexity will be forced upon producers increasingly and rapidly, and variability in customer demand will get dramatically higher. For example, Target is considering offering folding chairs to its customers ordered via an in-store kiosk. The chairs are now produced in China, available in either brown or green paint in one fabric.
But Target's customers are demanding more. With an in-store kiosk, a wider choice of colors and fabrics would be offered for store pickup in about a week, sourced from a U.S. manufacturer. The Chinese would not be able to compete with the time-advantaged U.S. manufacturer. Further, the variety is transparent to the retailer and easy to accommodate at the manufacturing plant. Inventory risk would be low and sales higher.
Similarly, the mundane and sleepy industrial maintenance, repair and operating (MRO) supplies market is being transformed by new, specialized service providers who have technicians on demand and high-level emergency responsiveness using speedy Internet communications systems that connect on-the-floor parts-dispensing machines with an integrated network of supply partners.
Under such conditions, the role of supply management must change. A collaborative, adaptable and flexible approach will be required. Time-to-market, response time and lead times will be the critical drivers of performance. Long lead times will inhibit the ability to respond to changing customer demands. In addition, global sourcing for cost reduction will be counter-productive to time-sensitive customer demand. Time will also be the enemy in the face of higher complexity and variability.
Costs Give Way to Value
The coming demand economy will create opportunities to identify new strategies to gain competitive advantage based on value and centered on well-defined customer groups. Customer Centricity replaces the supply driven construct of today's operations strategy.
Today, the supply chain is typically aligned not with customer value spaces, but with production capabilities. Further, companies tend to treat their customers as more homogeneous than they actually are. In the coming economy, companies that do not have the features a user wants — and wants right now or in a short time with customization — will be disadvantaged. A reorientation is needed to halt the focus on costs and to move toward thinking in terms of creating value or profit for customers. Companies must re-examine the value propositions they have with customers and state the propositions in supply chain terms.
Strategic Operations Will be Organized Around Value Spaces. Demographically defined market segmentation used primarily for public relations purposes and advertising will be replaced by value spaces used to define value drivers. Value spaces are defined by in-depth analysis of how the customer uses our products/services to his advantage. Grouping customers by customer defined commonality of elements including time, complexity, variability, adaptability and product features will define the new value spaces and how they will achieve competitive advantage.
Similar to the revolutionary factory within a factory concept developed by Professors Bob Hays and Steve Wheelwright of the Harvard Business School, we must now develop multiple value-focused, customer-centric agencies within one over-arching enterprise. The multiple customer intelligent agency organization structure implements the critical customer-centric design elements of orchestration of demand, collaboration of suppliers, and adaptable operations built to enabled complexity and use demand pull balancing to create value. Knowledge workers will be pulled out of functional silos and into the new customer intelligent agencies which are positioned very close to the customers with full functional capability, including marketing, manufacturing, quality, planning, procurement, logistics, finance and human resources. Enterprise-level executives will continue to set overall policy and implement controls to ensure continuity and to provide special technical support such as legal and treasury functions.
Can't Do It Down the Same Chain
In the new customer-centric environment, producers will be meeting a more diverse set of value propositions for a more diverse customer group. In general all of a producer's products will go down one of two routes: commodity or custom. Producers who adopt customer-centric strategies will have U.S.-based production for the U.S. market in either fully automated or highly flexible/adaptable factories.
The value proposition for commodity products is of lesser importance. Products have less variability, usage is standard and the supply chain can be longer. Producers must be willing to compete against the Chinese. As the demand economy evolves, the number of commodity products will decrease from an estimated 60 percent of all products today to around 40 percent in five years. For example, General Electric built a fully automated plant for light bulbs after faced with competitors from Eastern Europe selling bulbs for less than the costs of component raw materials, owing to government subsidies. In response GE removed all direct labor from the manufacture of GE's bulbs, which are now untouched by human hands until the delivery truck door closes. GE kept its high market share.
Products with non-standard usage will travel down the custom route. As the discerning customer moves toward sophistication, under the current system the supply chain lengthens, increasing time. The more demanding the customer is, the more personalization is desired. The new economy will bring products with customer-determined features and an instantaneous fulfillment model, dealing with days, not much longer.
The supply chain for customized products needs to be more adaptable and shorter. For example, Best Buy now boasts a video games center in its A stores, at which customers can configure and order electronic products for delivery in a few days and bundled with appropriate software and service support by the Geek Squad.
Supply management best practices are dramatically different between custom and commodity, and the transition from one to another approach is very tricky and dangerous. Two typical reactions occur: One is to increase stocks of finished goods to be able to respond to variability in demand, which will take an enormous amount of working capital. The other is to outsource to reduce costs, compete on price and ignore the complexity, which will cause lost sales and share. Both will fail.
Companies that stick with the old supply economy structures based on cost and supply will lose market share to ultra-low-cost Chinese manufacturers, as has occurred with PC boards, electronic assembly, knocked-down (KD) furniture, barbeque grills, clothing and very soon auto parts. If the Chinese decide to take a market, it will be done within two years. U.S. producers can control their futures, rather than allow the Chinese to dictate the terms. But companies who move manufacturing to China or other third-world locations — then decide to transition to the demand economy — will be unable to make the transition back to the United States and time advantages, as the infrastructure will have been disabled. The best strategy is to change the rules of market engagement to a time-advantaged strategy based on value creation within a well defined space.
Dynamic Tools to Deal with a Dynamic Economy
To meet the demand economy's needs for flexibility and speed, producers must employ two major strategic actions:
- Restructure the supply chain into a demand network
- Reposition the customer value proposition
Restructuring the supply chain into a demand network. A chain is defined by linkage and dependency; if one link of a chain is pulled, all of them move. Conversely, a network is defined by independent movement and action. It is a more dynamic system to deal with a more dynamic economy. A network represents a different mindset about collaboration and cooperation. Networked people and companies can respond flexibly to opportunities and challenges. Suppliers are brought into the planning process at each level to reduce overall costs, improve supplier economies and reduce actual purchase pricing. The keys are greatly improved supplier communication and data timeliness, sensitivity and accuracy using private information networks, which are far superior to generic electronic data interface (EDI) communications.
Repositioning the customer value proposition. Management must take the lead in realigning organizational resources around providing customer value as defined in the new demand economy. Value does not mean cost; it is much broader. The focus is on recognizing the different value requirements for each customer grouping and then maximizing the value determinants. To get to the answer, several types of questions should be posed to the organization, such as, What products/services will deliver customer value? How can our product be differentiated? How do we insulate this value proposition from competition?
Implementation Requires a Cultural Change and New Tools
We introduced two new strategic actions, the overall producer strategy of networks using collaborative processes and the market strategy repositioning to focus on the new value spaces defined by value proposition modeling.
Implementation will require cultural change and a set of new tools. As was pointed out in the introduction, implementation is more counter intuitive than difficult to achieve. New management concepts need to be introduced, embraced and put into daily use; these include dynamic simulation modeling and demand pull balancing. A new organization structure touched on earlier in this article will be required, and external relationships with suppliers and others must be orchestrated with significantly increased sensitivity to the economics of others.
Organization into Customer Intelligent Agencies. To put customer-centric management into effect, companies must change how the internal organization operates. Closer cooperation and synchronization are the keys. In the traditional structure, manufacturing, distribution, procurement, marketing, product development and sales each worked to their own functional requirements and needs, which seldom were coordinated at all and only loosely coordinated in the best case. Most companies will have multiple value spaces and will need an identical number of customer agencies to produce the values required.
The new agency organization is a ground-level operating group that has singular responsibility to deliver the value propositions defined for a particular customer group or value space. Every member of the team will be required to fully express the value proposition and the methods to be used to achieve competitive advantage. In the new organization, all functions are grouped under one leader who balances conflicting objectives within one value space to achieve the best levels of service, cost, inventory and capacity utilization. Decision makers in the agency are yoked together to serve one set of customers and to deliver the necessary values in concert and from one set of numbers and one set of performance goals carefully crafted to match the value proposition for which they are responsible.
These reassembled teams come from existing functional organizations and have full responsibility and authority to deliver. In the ideal case, specific manufacturing resources are dedicated to each agency. In practicality, some agencies may need to buy capacity from another agency's dedicated resource. Procurement of materials will be the exclusive responsibility of each agency, while master contracts on a global basis may be developed by enterprise level executives. The agencies are focused on on-time service, performance and value with the final decision on sourcing made at the agency level not the enterprise level.
The new agency organization is a group of highly simplified structures with cross training and cross-functional responsibility. In practice, the organizations have implemented time-advantaged strategies that result in very short replenishment and planning horizons. A multiple-month planning schedule will become a three-day to a one-week schedule with a hierarchical planning structure allowing highly simplified data structures with which the team must deal. As a result of the shorter times, simplified data and hierarchical planning structure, the new organizations have significantly fewer people and a maximum number of doers. They are nimble due to the simplification. They are taut due to the singular focus on one set of customer-centric goals. They are significantly lower cost. Typically, a 30 to 40 percent overhead cost benefit comes from these agency organizations.
Systems — True Pull Based on Rate-based techniques. The most destructive element in today's producer organization is the use of old MRP logic for inventory management which is embedded unerringly in all ERP systems and the many support mechanisms associated with or integrated into ERP, including customer relationship management (CRM), supply chain management (SCM), product lifecycle management (PLM) and other newer ones. ERP systems universally have scheduling and inventory replenishment logic that is essentially the same as it has been since the 1960s when manual processes were the rule. Designers of MRP and then MRP II and then ERP, etc., have all been like lemmings, re-using the same logic that Ollie Wight developed in the 1970s — Time Phased Requirements Planning. It has never worked well due to the overwhelming amount of highly detailed data that defeats rational analysis, the rigid inventory safety stock floors and the high level of change orders.
The ERP logic is at its core a push system, which will fail miserably in the new demand economy. It is not surprising that the Asian manufacturers have rejected ERP systems almost universally. Some think this is because they tend to be small and have low cost overhead. My contacts in Asia simply do not trust ERP systems and would rather use direct communications and visual signals, which were used successfully by Toyota. Unfortunately, there are very few companies who have the years' long product life cycles, fixed factory operating rates and ultra-low complexity found in Toyota and other auto manufacturing plants. So, simple manual and visual processes for planning, scheduling and control will not work in the demand economy.
The new approach is demand pull balancing technology. You don't need to throw out all of ERP, just replace the logic streams and keep the communications and data handling structures.
- Demand — Demand drives replenishment, we make what is selling or will very likely sell in the next time period, like next week.
- Pull — The rate of customer demand pulls inventory and resets schedules, all the re-order points and kanbans and min-max systems are removed. Rate-based systems will be used.
- Balancing — The key is to bring elements into balance. Risk of a service failure must be balanced against supplier realities, production resource economics and response rewards.
- Technology — The new tools are computer based and replace the inventory and scheduling logic inside ERP.
The new balancing concept will replace the logic inside logistics, warehousing and procurement systems, as well. Most inventories will be kept only in those items that are guaranteed to sell and sell very soon. Making C items frequently or on demand does not constitute a pull technique. C items should either be non-stock with long replenishment or, if they are more important, kept in inventory and made only infrequently.
External Relationships. The collaborative approach must be spread outside the organization. Management by hammering suppliers will give way to management by collaboration. Decision-making processes throughout the network should be linked, and probabilistic modeling will be relied upon for replenishment and demand balancing. A complete stream of success must be forged with a win-win approach.
Further, the new economy may require a reverse rationalization of a company's supplier base. More rather than fewer suppliers are probably needed to meet the anticipated variability in demand promised by the new economy. A company's sources will depend on its customer value proposition; the more variable the needs, the more flexible the network that will be required. Suppliers should be grouped around value spaces, with different suppliers by space. Overseas sourcing is not necessarily the right tactic, as a longer supply chain is less flexible and may not be able to meet the needs of the new economy.
Physical Network. To meet demand economically and more flexibly, a company should challenge where it holds raw, semi-finished and finished materials, where it sources raw materials and components and the number of distribution centers, among other physical handling factors.
The operations research (OR) professors have long known that making these determinations requires a dynamic modeling technique that deals with demand variability. Dynamic simulation modeling is the correct OR technique. Simulation has been in limited use for network design because the relationships of items to sources to stocking points to customers are so numerous in larger companies. Simulation engines capable of handling millions of relationships have not been available until 2005 when an Ann Arbor software company pulled a partially developed network simulation model out of a failed dot-com business and developed a new engine.
Off-shoring to the Far East is counter-productive in the demand economy. High demand variability coupled with short product life cycles requires ultra-short response time and point-of-demand capabilities. Today, major electronics retailers are forced to source all laptops, hand-helds and the like from Asia due to the demise of the U.S. production capability early in this century. High stock-out rates, high inventory, high air freight costs and low customer satisfaction are pervasive and strategically debilitating for the retailers. Care should be taken to curtail the length of the supply network. The more variable the demand, the shorter the network must be or inventory carrying costs will increase prohibitively, revenues will be truncated and cash flow restricted.
It is time for producer management vanguards to take notice — and mobilize. A move to a demand-based economy — a move from commodity to custom — is on the way. Maintaining the typical approach to supply chain management in an ever-more-customized environment will force up inventories, restrict cash flow and increase costs 20 to 40 percent. Unanticipated global supply chain expenses will erode expected product savings. Investors will demand sustainable free cash flow, but manipulation of it by driving up days' payables outstanding (DPO), forcing fast-moving inventory down and utilizing tricky accounting will no longer be tolerated.
Commodity products will increasingly be supplied solely by Far East providers or very focused, highly automated domestic providers. Custom producers that can meet customer value propositions will put old-line competitors out of business. The answer requires restructuring supply chains into networks, repositioning the customer value proposition, developing a collaborative organization structure, tightening up systems, improving supplier relationships and adjusting the physical network.
The benefits of making such improvements include:
- Enhanced market share
- Better service
- Reduced costs and increased margins
- Inventory reductions of 40 to 50 percent
- Liberated cash flows of 20 to 30 percent
- Continuity of the business
- Overhead reduction of 30 to 40 percent
Tackling these problems can largely be self-funding. In two to three months, a company can design what its supply network should look like. Substantial implementation progress can be recorded in 18 months. Higher profitability and growth will be the rewards.
About the Author: Robert P. Burrows founded the On-Point Group and is its managing principal. He is a leading-edge thinker and sought-after consultant in the areas of operations strategy, demand management, inventory management and collaborative procurement. He can be contacted at firstname.lastname@example.org .