How to Simplify Supply chain complexity

how to reduce supply chain complexity and how to measure supply chain complexity and supply chain complexity dealing with a dynamic system
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Published Date:25-10-2017
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Complexity and the supply chain 8 M M The sources of supply chain complexity M M The cost of complexity M M Product design and supply chain complexity M M Mastering complexity We have several times in previous chapters suggested that rather than refer to supply chains we should talk instead about networks. The idea of a chain suggests a series of linear one-to-one relationships whereas the reality is that the focal firm lies at the centre of a complex web of interconnected and interrelated yet inde- pendent entities. Partly as a result of outsourcing activities that previously were performed in- house combined with the trend to offshore manufacturing, many companies have found that they have added to the complexity of their operations because the degree of interdependency across the network has increased. Thus an event or action taking place in one part of the network will often have unforeseen impacts somewhere else in the network. The unpredictability of these events is heightened by the growing volatility that characterises today’s business environment. The well-known ‘butterfly’ effect seems to typify much of today’s supply chain turbulence. The idea is that a butterfly, flapping its wings somewhere over the Amazon basin, can cause a hurricane thousands of miles away Whilst this exam- ple of what is sometimes described as ‘chaotic’ effects may be a little far-fetched, it provides a useful reminder of how the ‘law of unintended consequences’ applies to today’s highly interconnected supply chains. In April 2010 a previously dormant volcano in Iceland erupted, sending a plume of ash into the upper atmosphere. A cloud of ash and debris from the eruption began to drift across the skies of Northern Europe. Because of a concern for air- craft safety most airports in the region were closed for the best part of a week. Whilst there was a considerable impact on individuals’ travel plans – many thou- sands of people were stranded away from home – there was also a less visible, 159 but significant, impact on a number of supply chains. Many time-critical com- ponents are sent by air freight or air express and as major hubs in the UK and continental Europe were forced to close, the ‘butterfly effect’ was felt around the world. The extract from The Times below illustrates some of the problems caused by a volcano a long way from the factories that were affected, and thus highlights the increasing interconnectedness of global supply chains. Parts shortage starts to choke production The impact of the ash cloud has been felt on the economy for the first time, with manufacturing companies warning that they will have to shut down production because of a shortage of components. Airbus, the aircraft manufacturer, said yesterday that its wing assembly facility in North Wales would have to slow or shut production within days if the airspace did not reopen. The company, which employs 11,000 people in Britain, has been unable to get parts into the country. It has also been unable to fly completed wings to Airbus’s other factories in Hamburg and Toulouse, which could result in the final assembly of aircraft grinding to a halt. The impact on the globalised nature of industry has affected Nissan. Two fac- tories in Japan will stop production of cars from today after running out of a key component sourced from the Irish Republic. The closure of airspace is estimated to be costing the European economy about £400 million a day in lost productivity. SOURCE: ROBERTSON, D. AND DEROUX, M., ‘PARTS SHORTAGE STARTS TO CHOKE PRODUCTION’, THE TIMES, 21 APRIL 2010 In its strictest sense, complexity does not mean complicated (although complex systems often are complicated) but rather it describes a condition of interconnect- edness and interdependency across a network. A good example of a complex system is the weather. Many different influences combine to create a specific weather condition; each of those influences are themselves the result of interac- tions and hence a small change in one element can fundamentally affect the final outcome. Hence the difficulties faced by weather forecasters trying to predict even tomorrow’s weather. Therefore the outcome of complexity in a supply chain, as with the weather, is uncertainty and with that uncertainty comes an increased likelihood that forecast error will increase in line with complexity. This growing uncertainty brings with it a serious challenge to the classic practice of running the business on the basis of forecasts. It will be apparent that in conditions of stability – and hence lower uncer- tainty – forecast accuracy should generally be high. Equally, the converse will be true, i.e. as uncertainty increases so too will forecast accuracy reduce. Hence the LOGISTICS & SUPPLY CHAIN MANAGEMENT 160 argument that if uncertainty is to be the norm – at least for the foreseeable future – then a new approach will be required. Indeed, the challenge that organisations now face is how to reduce their dependence on forecasts and to become increas- ingly demand- and event-driven. The sources of supply chain complexity Complexity in a supply chain can arise from a number of sources and some of the most common causes are detailed below. 1 Network complexity The more nodes and links that exist in a network then clearly the more com- plex it becomes. As a result of outsourcing non-core activities many companies are today much more reliant on external suppliers of goods and services. Those external suppliers also are dependent upon a web of second tier suppliers, and so on. There is a strong likelihood that the focal firm at the centre of the network will not even be aware of many of the second or third tier suppliers that feed their upstream supply chain. The potential for unexpected disruptions to the supply chain is clearly heightened by these extended networks as evidenced by the fol- lowing example. Following the shut-down of Dell’s American assembly line within days of the September 1999 earthquake in Taiwan the company set out to understand why this had happened. To do this Dell studied where their tier-one suppliers did their shopping and this in turn soon yielded the first important answer – the Taiwan Semiconductor Manufacturing Corporation (TSMC). Dell’s executives realised that they were in fact buying hundreds of millions of dollars of chips each year from TSMC indirectly. Source: Abridged from Lynn, B.C., The End of the Line, Doubleday, 2005 2 Process complexity Underpinning every supply chain are innumerable processes – processes internal to the firm as well as those processes managed by upstream and downstream partners. Often these processes have been developed in a haphazard way and have been added to and modified to reflect current requirements and as a result have become more complex. This complexity is manifested in processes with mul- tiple steps, often performed in series rather than in parallel. Lengthy processes containing many different activities will not only create extended lead times but are also more prone to variability in performance. COMPLEXITY AND THE SUPPLY CHAIN 161 The more steps in a process and the more ‘hand-offs’ that exist, the greater the likelihood that there will be frequent discrepancies between planned and actual outcomes. There is a need for a constant review of process structure and a consequent re-engineering if this pervasive source of supply chain complexity is to be kept to a minimum. When end-to-end supply chains are examined in detail it usually transpires that the majority of time is non-value-adding time. More often than not this non- value-adding time is idle time – in other words time spent as inventory. This non-value-adding time is itself generated by the processes that underpin the supply chain. 3 Range complexity Most business organisations find that the range of products and/or services that they offer to the market has a tendency to grow rather than reduce. The rate of introduction of new products or services, new pack sizes or variants and brand extensions seems to outpace the rate at which existing products or services are eliminated. The general effect of this mushrooming of the product/service portfolio is to extend the ‘long tail’ of the Pareto distribution. Typically as more variants are added to a range the demand per variant will reduce, with a subsequent impact on forecast accuracy. Consider the difference between the Ford Motor Company at the time of Henry Ford I producing a single model – the Model T, with the reputed offer of ‘any colour you like as long as it’s black’ – with the company today. Ford, even in today’s troubled markets, offers a vast range of models with extensive options. In theory there are possibly millions of different variants This multiplication of the product range means that, inevitably, the average demand per variant is very low. Hence the difficulty of forecasting at the individual variant level and thus the typically large inventories that build up as a result of forecast error. 4 Product complexity The design of products can have a significant impact on supply chain complexity. It can be argued that the supply chain begins on the drawing board in that deci- sions on the choice of materials and components can directly or indirectly impact total life cycle costs as well as agility and responsiveness. Product complexity can arise because the number of components or sub- assemblies is high, or because there is little commonality across the Bills of Materials for different products. The less the commonality at the Bill of Materials level the less the flexibility to vary product mix or volume. A further unforeseen impact of product design decisions is that if compo- nents or materials are specified which happen to have lengthy replenishment lead times then the ability to respond rapidly to changes in demand for the product will be impeded. LOGISTICS & SUPPLY CHAIN MANAGEMENT 162 By involving logistics and supply chain planners early in the design process much of the subsequent complexity can be avoided. For example, at Motorola all 1 new product ideas are screened for complexity before they can be considered for commercialisation. In the past at Motorola there was often little commonality of parts across the range. For a single mobile phone there could be over 100 possible configurations, i.e. four different colours and 30 software choices. Furthermore, these product vari- ations were made ahead of demand to a forecast that was only accurate 3 per cent of the time To tackle this problem Motorola devised a ‘Complexity Index’ for each product, which included the number of components, the degree of commo- nality, lead time of supply and so on. Ideas for new products with high scores on the Complexity Index tend not to be proceeded with. 5 Customer complexity Customer complexity arises as a result of too many non-standard service options or customised solutions. The costs of serving different customers can vary signifi- cantly. Each customer will exhibit different characteristics in terms of their ordering patterns, e.g. frequency of orders, size of orders, delivery requirements and so on. These differences will be increased further as a result of the availability of different service options or packages and/or customisation possibilities. Gottfredson and Aspinall give an example of how too extensive a service offer can add complexity to the sales process: One telecommunications company, for example, has used the power of information technology to slice and dice its service set into ever more finely differentiated options. The firm hoped it would boost revenues by more precisely fulfilling the needs of every imaginable buyer. But offering so many options has had the opposite effect. The company’s customer service reps are now forced to sort through more than a thousand promotion codes whilst they’re talking to a potential customer. Most of the promotions offer distinct levels of discounts and 2 product benefits. Making sense of them all is an overwhelming task. Even though from a sales and marketing perspective there may be advantages to be gained from offering a range of options to customers, these decisions must be tempered by a detailed knowledge of their cost and agility implications. Ultimately the only complexity that can be justified is that complexity which delivers real value for which customers are prepared to pay. A problem that is faced by many businesses is that they have a limited under- standing of the true costs of servicing individual customers. It is quite possible that because some customers generate a high cost-to-serve and order products with relatively low margins they could actually lose money for the company. Using tools such as activity-based costing can help identify those customers whose cost-to- serve is high relative to the revenue that they generate. Using this information, alternative service options might be devised that could improve the profitability of those customers. COMPLEXITY AND THE SUPPLY CHAIN 163 6 Supplier complexity The size of the supplier base can add to supply chain complexity by increasing the number of relationships that must be managed as well as increasing total transaction costs. Because one of the pre-requisites for agility is a high level of collaborative working with key suppliers, this implies a high level of active supplier management and supplier involvement in process integration. It is unlikely that this degree of closeness can be achieved across a diverse supplier base and hence the need for rationalisation. The implications of such a supply base rationalisation are profound. Clearly careful regard must be paid to the effect of a smaller number of suppliers on the resulting supply chain risk profile. Too high a level of depend- ence on just a few critical suppliers can be dangerous. Instead a better option, if available, is to have a lead supplier across a category of products who takes responsibility for the management of that category across a number of suppliers, for example in the same way a logistics service company such as UPS might co- ordinate a number of logistics and transport providers for a client company. With a smaller supplier base, a company can more proactively manage supplier relationships through ‘supplier development’ programmes. Typically such pro- grammes involve the company working closely with individual suppliers to identify opportunities to improve not just product quality, but also process quality and to work jointly on cost-reduction initiatives. 5 Organisational complexity Most businesses have traditionally organised around functions and departments and their organisation charts have many levels and tend to be hierarchical in their structure. Such ‘vertical’ organisational arrangements are no doubt administratively convenient in that there can be a ‘division of labour’ between functions as well as effective budgetary control. However, they tend to inhibit agility because they are, of necessity, inwardly looking with a focus on efficiency rather than customer facing with a focus on effectiveness. A further problem is that over time the functions have a tendency to become ‘silos’ with their own agendas and they can lose sight of the fundamental purpose of the business, i.e. to win and keep profitable customers. The challenge is to find a way to break through these silos and to re-shape the organisation around the key value-creating and value-delivery processes. Such process-oriented businesses are ‘horizontal’ rather than ‘vertical’ in their orienta- tion. They are cross-functional and hence there is a stronger emphasis on teams and on process improvement in terms of speed and reliability. As organisations grow, either organically or through merger and acquisition, the likelihood is that they will become more cumbersome and less able to respond rapidly to change. Consequently there is a constant need to re-engineer existing processes and to root out the complexity that will inevitably arise if things are left to themselves. Organisational complexity can also be exacerbated by having to work across time zones and cultures as a result of the globalisation of business. Frequently this added complexity is an unintended consequence of low-cost coun- try sourcing and/or cross-border mergers. LOGISTICS & SUPPLY CHAIN MANAGEMENT 164 8 Information complexity Today’s supply chains are underpinned by the exchange of information between all the entities and levels that comprise the complete end-to-end network. The volume of data that flows in all directions is immense and not always accurate and can be prone to misinterpretation. Visibility of actual demand and supply condi- tions can be obscured through the way that information is filtered and modified as it passes from one entity or level to another. The so-called ‘bullwhip’ effect is a manifestation of the way that demand signals can be considerably distorted as a result of multiple steps in the chain. As a result of this distortion, the data that is used as input to planning and forecasting activities can be flawed and hence fore- cast accuracy is reduced and more costs are incurred. In a sense, information complexity in a supply chain is directly or indirectly influenced by the preceding seven sources of complexity. Network and process complexity will impact the number of stages, steps and levels through which the information must pass; range and product complexity add variety and lead to mul- tiple Bills of Materials and hence more data; customer and supplier complexity means that the exchange of data increases significantly and organisational com- plexity implies more levels through which information must pass as well as more hand-offs from one function to another. The antidote to information complexity is firstly a reduction in the other seven sources of complexity as well as greater visibility. A key to that visibility has to be a greater level of collaborative working across the supply chain where information transparency is seen as a vital pre-requisite for a more efficient and effective value delivery system. The cost of complexity It can be argued that an increasing proportion of total end-to-end costs in the supply chain are driven by complexity in one form or another. Often these costs may not be readily transparent as they are hidden in general overheads or the costs of carrying inventory, which as we observed in Chapter 3 are not always properly accounted for. Underlying much of the cost of complexity in the supply chain is the Pareto Law (the so-called 80:20 rule). Vilfredo Pareto (1848–1923) was an Italian industrialist, sociologist, economist and philosopher. In 1909 he identified that 80 per cent of the total wealth of Italy was held by just 20 per cent of the population. Thus was born the 80:20 rule that has been found to hold across many aspects of social and economic life. In Chapter 2 it was suggested that an 80:20 relationship exists with regard to customers and products, i.e. typically 80 per cent of the profit derives from 20 per cent of the customer and likewise 80 per cent of the profit comes from just 20 per cent of the products. Generally this 80:20 relationship applies across most elements of the supply chain and is a key contributor to complexity and hence cost. Most businesses will find if they perform an 80:20 analysis that they have a ‘long-tail’ of customers who, whilst significant in numbers, actually contribute very COMPLEXITY AND THE SUPPLY CHAIN 165 little to overall profitability – indeed some may actually make a loss. Likewise, the same conclusions would probably emerge from an 80:20 analysis of products. Sometimes when performing the 80:20 analysis across the product range, it is tempting to suggest that where a ‘long tail’ exists it should be removed through product rationalisation. However, there may be strategic reasons for maintaining a high level of variety or indeed there may be opportunities to use alternative strate- gies to manage the slow movers to make them profitable. For example, it has been suggested that if an Internet distribution channel is available then the ‘long tail’ can 3 become a source of profitable business. Because the ‘long tail’ represents such a large number of products, even though individual item sales levels are low, if inven- tory and distribution costs can be reduced by creating a single, virtual inventory through working with partners across multiple channels, the economics may be trans- formed. To a certain extent this is the approach that Amazon has taken, enabling it to offer a vast range of book titles (and other products) but with minimal inventory. However, for most companies it is likely that a selective rationalisation of slow- moving lines will have a positive impact on overall profitability. Product design and supply chain complexity It is important to recognise that often a significant source of supply chain com- plexity is the actual design of the product itself. It has long been known that a large part of total through-life costs are determined at the drawing board stage 4 – sometimes as much as 80 per cent. There are a number of ways in which prod- uct design decisions can impact subsequent supply chain complexity and hence costs. These are some of the ways that product design decisions can affect supply chain complexity: M M Time-to-market and time-to-volume Decisions on the functionality of products can increase manufacturing complexity and reduce flexibility and responsiveness M M Added complexity through lack of commonality Decisions on product design impact the Bill of Materials. Low levels of component commonality will add complexity. M M Increased replenishment lead times Some design decisions will determine the choice of supplier and therefore could impact replenishment lead time, e.g. where the supply source is offshore. M M Supply chain vulnerability Again, if the design decision involves unreliable supply sources this could potentially increase the chance of supply chain disruption. M M After sales support For those products requiring after sales support, e.g. service parts, the design of the product will have implications for inventory levels. LOGISTICS & SUPPLY CHAIN MANAGEMENT 166 M M Late stage customisation The ability to postpone the final configuration or the packaging of a product will be enhanced or constrained by product design decisions. Mastering complexity Because supply chain complexity is such a major source of total end-to-end pipe- line cost as well as being a significant inhibitor of responsiveness, it is essential that complexity reduction becomes a priority. It can be argued that today’s supply chain managers need to be ‘complexity masters’, such is the importance of containing and removing this impediment to enhanced profitability. Figure 8.1 sug- gests a five-stage process for bringing the supply chain under control. Figure 8.1 Complexity management Understand the sources of complexity Undertake Pareto 80:20 Analysis Focus on the ‘long tail’ Which elements of complexity add value and which do not? Seek to eliminate non-value adding complexity The first step in managing supply chain complexity is to understand where it is coming from. A good starting point to identifying the source of complexity is to review the eight categories previously identified, i.e. network, process, range, prod- uct, customer, supplier, organisational and information complexity. Network and process complexity can be identified through the use of map- ping procedures such as those described in Chapter 7. Because networks and processes are not often managed holistically, i.e. they tend to be managed by COMPLEXITY AND THE SUPPLY CHAIN 167 individual activity rather than as a whole, the likelihood is that they will contain the potential for unnecessary complexity, e.g. too many echelons, poorly managed interfaces and too many activities that do not add value. Network simplification and process re-engineering should be on-going in every supply chain that seeks to become less complex. Range, customer and supplier complexity can be identified through Pareto analysis. In other words what proportion of total revenue, spend or inventory is accounted for by what proportion of customers, suppliers or SKUs? By focusing on the ‘long tail’ previously discussed, it should be possible to identify opportuni- ties for rationalisation. Again, it should be stressed that such rationalisation needs to be addressed cautiously with regard to the wider business strategy and financial consequences. Product complexity will be revealed through a detailed analysis of the Bills of Materials of each product in the range. The goal is to both minimise the number of components in each product and to maximise the commonality of components, sub-assemblies and platforms across the range. Organisational complexity is partly driven by the number of levels in the busi- ness and by the decision-making structure. Typically organisations with many levels and with many functional ‘silos’ tend to be slow to respond to changed con- ditions and slow in new product development and introduction. One effective way to reduce this source of complexity is by a greater emphasis on working across functions, particularly by creating process teams – an idea to which we shall return in Chapter 12. It should however, be recognised that not all complexity is bad. In some respects it is through complexity that organisations differentiate themselves from their competitors. For example, customers often seek product variety, they are not prepared to settle for the previously quoted Henry Ford I offer of ‘any colour you like as long as it’s black’ The challenge for supply chain managers is to understand the value that cus- tomers seek and to find ways to deliver that value with least complexity. Also it can be argued, perhaps paradoxically, that a focus on complexity reduc- tion could increase supply chain risk. For example, an over-ambitious programme of supplier rationalisation could leave the company vulnerable to disruption if, for whatever reason, a critical supply source were to fail. Complexity management in the supply chain has to be a careful balance between over-simplification on the one hand and a focus on cost and efficiency on the other. The aim should be to reduce or eliminate any complexity that does not add value to the customer or that does not protect against supply chain risk. The impact that complexity can have on supply chain risk is well illustrated by the case of the Boeing 787 described below. LOGISTICS & SUPPLY CHAIN MANAGEMENT 168  The Boeing 787 Dreamliner: an outsourcing nightmare On 15 December 2009, over two years later than originally planned, the Boeing 787 – the so-called ‘Dreamliner’ – made its maiden test flight. The 787 was a radically new concept embodying highly innovative technology and design features. The market positioning of the aircraft had proved to be highly successful with pre-launch sales options from airlines around the world in the region of 850 planes. With a passenger capacity of up to 330 and with a range of 8,500 nautical miles the 787 would use less fuel and operate at a cost per seat mile approximately 10 per cent less than other comparable aircraft. These savings were enabled primarily by the lower weight of the 787, which was achieved through the use of novel composite materials, and new engine technology. Even though most industry commentators expected that in the long term the 787 would be a great success, there was no doubt that the delay in the launch had impacted negatively on Boeing’s financial performance. Clearly, a design as innovative as the 787 brought with it many challenges as much of the technology was untried and untested. Beyond this, however, there were a number of risks that were systemic, i.e. risks that arose as a result of decisions taken by the company on the precise form of the chosen supply chain architecture. Traditionally Boeing has built most of its aircraft in its own facilities in Washington State, USA. In the case of the 787 the only part manufactured in the Washington factory is the tail fin (and even this manufacturing is shared with another facility outside Washington). The other parts of the aircraft are manufactured as sub- assemblies by a myriad of external suppliers around the world. For example, the forward fuselage and nose are made by Spirit AeroSystems in Witchita, Kansas, whereas parts of the midsection are manufactured by Alenia in Italy and the wings and a further fuselage section are built by companies in Japan. The final assembly of the aircraft takes place in Boeing’s facilities in Everett, Washington and Charleston, South Carolina. Not only has the manufacture of most of the sub-assemblies been outsourced but those same suppliers were also involved in much of the detailed design of the sections/systems they were responsible for. Perhaps not surprisingly a number of problems were encountered. Many of the suppliers found that the innovation involved challenged both their design and their engineering capabilities. Boeing had to send its own staff to help the suppliers sort out these problems. Often sub-assemblies would arrive at Everett incomplete or wrongly manufactured, requiring disassembly and rebuilding. Months were lost in the process of putting things right. These delays had financial conse- quences and the cost of additional design, rework and penalty payments ran into billions of dollars. The paradox is that the business model adopted by Boeing, i.e. outsourcing the design and manufacture of sub-assemblies to supply chain partners, was moti- vated by the aim of speeding up time-to-market. The original view at Boeing was that using external specialists would enable a more flexible supply chain, capable COMPLEXITY AND THE SUPPLY CHAIN 169  of responding more rapidly to customer demand. In the event the outcome was a significant delay in time-to-market and a major cost over-run. Undoubtedly a product as innovative as the 787, embracing as it does entirely new materials and technology, would always face significant challenges. However, beyond this, Boeing’s experience highlights the fact that whilst companies might outsource the execution of an activity they should never outsource its control. SOURCES: ‘DREAMLINER MAKES HISTORY WITH PLASTIC, OUTSOURCING, DESIGN – AND DELAYS’, THE SEATTLE TIMES, 12 DECEMBER 2009 ‘JET BLUES: BOEING SCRAMBLES TO REPAIR PROBLEMS WITH NEW PLANE’, THE WALL STREET JOURNAL, 7 DECEMBER 2007 References 1. Whyte, C., ‘Motorola’s battle with supply and demand complexity’, Supply and Demand Chain Executive, 12 August 2004. 2. Gottfredson, M. and Aspinal, K., ‘Innovation vs complexity: what is too much of a good thing?’, Harvard Business Review, November 2005. 3. Anderson, C., The Long Tail : Why the Future of Business is Selling Less of More, Hyperion, 2006. 4. Appelqvist, P., Lehtonen, J.M. and Kokkonene, J., ‘Modelling in product and supply chain design: literature survey and case study’, Journal of Manufacturing Technology Management, Vol. 15, No. 7, 2004. LOGISTICS & SUPPLY CHAIN MANAGEMENT 170 Managing the global pipeline 9 M M The trend towards globalisation in the supply chain M M Gaining visibility in the global pipeline M M Organising for global logistics M M Thinking global, acting local M M The future of global sourcing Global brands and companies now dominate most markets. Over the last two decades there has been a steady trend towards the worldwide marketing of prod- ucts under a common brand umbrella – whether it be Coca-Cola or Marlborough, IBM or Toyota. At the same time the global company has revised its previously localised focus, manufacturing and marketing its products in individual countries, and now instead will typically source on a worldwide basis for global production and distribution. The logic of the global company is clear: it seeks to grow its business by extending its markets whilst at the same time seeking cost reduction through scale economies in purchasing and production and through focused manufacturing and/or assembly operations. However, whilst the logic of globalisation is strong, we must recognise that it also presents certain challenges. Firstly, world markets are not homogeneous, there is still a requirement for local variation in many product categories. Secondly, unless there is a high level of co-ordination the complex logistics of managing global supply chains may result in higher costs and extended lead times. These two challenges are related: on the one hand, how to offer local mar- kets the variety they seek whilst still gaining the advantage of standardised global production and, on the other, how to manage the links in the global chain from sources of supply through to end user. There is a danger that some global compa- nies in their search for cost advantage may take too narrow a view of cost and only see the purchasing or manufacturing cost reduction that may be achieved through 171 using low-cost supply sources. In reality it is a total cost trade-off where the costs of longer supply pipelines may outweigh the production cost saving. Figure 9.1 illustrates some of the potential cost trade-offs to be considered in establishing the extent to which a global strategy for logistics will be cost-justified. Clearly a key component of the decision to go global must be the service needs of the market- place. There is a danger that companies might run the risk of sacrificing service on the altar of cost reduction through a failure to fully understand the service needs of individual markets. Figure 9.1 Trade-offs in global logistics Transport (source to user) Materials Inventory Production Localised Global Degree of globalisation (production/sourcing/marketing) The trend towards global organisation of both manufacturing and marketing is highlighting the critical importance of logistics and supply chain management as the keys to profitability. The complexity of the logistics task appears to be increasing exponentially, influenced by such factors as the increasing range of products, shorter product life cycles, marketplace growth and the number of supply/market channels. The trend towards global organisation of both manufacturing and marketing is highlighting the critical importance of logistics and supply chain management as the keys to profitability. There is no doubting that the globalisation of industrial activity has become a major issue in business. Articles in the business press, seminars and academic symposia have all focused upon the emerging global trend. The competitive pres- sures and challenges that have led to this upsurge of interest have been well documented. What are less well understood are the implications of globalisation for operations management in general and specifically for logistics management. LOGISTICS & SUPPLY CHAIN MANAGEMENT 172 Costs At the outset it is important that we define the global business and recognise its distinctiveness from an international or a multinational business. A global business is one that does more than simply export. The global business will typically source its materials and components in more than one country. Similarly it will often have multiple assembly or manufacturing locations geographically dispersed. It will subse- quently market its products worldwide. A classic example is provided by Nike – the US-based sportswear company. The company outsources virtually 100 per cent of its shoe production, for example, only retaining in-house manufacturing in the US of a few key components of its patented Nike Air System. Nike’s basketball shoe, for example, is designed in the USA but manufactured in South Korea and Indonesia from over 70 components supplied by companies in Japan, South Korea, Taiwan, Indonesia and the United States. The finished products are sold around the world. The trend towards globalisation and offshore sourcing has been growing rap- idly for several decades. There has been a transformation from a world where most markets used to be served from local sources to one where there is a grow- ing worldwide interdependence of suppliers, manufacturers and customers in what has truly become a ‘global village’. 1 Early commentators like Levitt saw the growth of global brands and talked in terms of the growing convergence of customer preferences that would enable standardised products to be marketed in similar fashion around the world. However, the reality of global marketing is often different, with quite substantial dif- ferences in local requirements still very much in evidence. Thus, whilst the brand may be global, the product may need certain customisation to meet specific coun- try needs, whether it be left- or right-hand-drive cars or different TV transmission standards or local tastes. A good example is Nescafé, the instant coffee made by Nestlé, which has over 200 slightly different formulations to cater for preferences in taste country by country. The trend towards globalisation in the supply chain Over the last 50 years or so the growth in world trade has tended to outstrip growth in global gross domestic product. In part this trend is driven by expanding demand in new markets, but the liberalisation of international trade through World Trade Organization (WTO) accords has also had a significant effect. Once, companies established factories in overseas countries to manufacture products to meet local demand. Now, with the reduction of trade barriers and the development of a global transportation infrastructure, fewer factories can produce in larger quantities to meet global, rather than local, demand. Paradoxically, as the barriers to global movement have come down so the sources of global competition have increased. Newly emerging economies are building their own industries with global capabilities. At the same time techno- logical change and production efficiencies mean that most companies in most industries are capable of producing in greater quantity at less cost. The result of all of this is that there is now overcapacity in virtually every industry, meaning that competitive pressure is greater than ever before. MANAGING THE GLOBAL PIPELINE 173 To remain competitive in this new global environment, companies will have to continually seek ways in which costs can be lowered and service enhanced, mean- ing that supply chain efficiency and effectiveness will become ever more critical. In developing a global logistics strategy a number of issues arise which may require careful consideration. In particular, what degree of centralisation is appro- priate in terms of management, manufacturing and distribution, and how can the needs of local markets be met at the same time as the achievement of economies of scale through standardisation? Three of the ways in which businesses have sought to implement their global logistics strategies have been through focused factories, centralised inventories and postponement. 1 Focused factories The idea behind the focused factory is simple: by limiting the range and mix of products manufactured in a single location the company can achieve considerable economies of scale. Typically the nationally oriented business will have ‘local-for- local’ production, meaning that each country’s factory will produce the full range of products for sale in that country. On the other hand the global business will treat the world market as one market and will rationalise its production so that the remaining factories produce fewer products in volumes capable of satisfying per- haps the entire market. One company that has moved in this direction is Mars. Their policy has been to simultaneously rationalise production capacity by seeking to manage demand as a whole on at least a regional level and to concentrate production by category, fac- tory by factory. Hence M&Ms for sale in Moscow are likely to have been produced in the United States. In a similar fashion, Heinz produces tomato ketchup for all of Europe from just three plants and will switch production depending upon how local costs and demand conditions vary against exchange rate fluctuations. A further example is provided by Procter & Gamble which manufactures its successful prod- uct Pringles in just two plants to meet worldwide demand. Such strategies have become widespread as ‘global thinking’ becomes the dominant mindset. However, a number of crucial logistics trade-offs may be overlooked in what might possibly be a too-hasty search for low-cost producer status through greater economies of scale. The most obvious trade-off is the effect on transport costs and delivery lead times. The costs of shipping products, often of relatively low value, across greater distances may erode some or all of the production cost saving. Similarly the longer lead times involved may need to be countered by local stock holding, again possibly offsetting the production cost advantage. Further problems of focused production may be encountered where the need for local packs exist, e.g. with labelling in different languages or even different brand names and packages for the same product. This problem might be over- come by ‘postponing’ the final packaging until closer to the point-of-sale. Another issue is that created by customers ordering a variety of products from the same company on a single order but which are now produced in a number LOGISTICS & SUPPLY CHAIN MANAGEMENT 174  of focused factories in different locations. The solution here may be some type of transhipment or cross-dock operation where flows of goods from diverse localities and origins are merged for onward delivery to the customer. Finally, what will be the impact on production flexibility of the trend towards focused factories where volume and economies of scale rule the day? Whilst these goals are not necessarily mutually incompatible it may be that organisations that put low-cost production at the top of their list of priorities may be at risk in markets where responsiveness and the ability to provide ‘variety’ are key success factors. In response to these issues a number of companies are questioning deci- sions that previously were thought sound. For example, Sony used to manufacture digital cameras and camcorders in China, attracted by the lower labour costs. However, they came to recognise that because life cycles were so short for these products, it was better to bring the assembly back to Japan where the product design took place and, indeed, where most of the components originated. Other high-tech companies are also looking again at their offshore production and sourcing strategies for this same reason. Typically less than 10 per cent of a high- tech company’s costs are direct labour. Hence the decision to source offshore, simply to save on labour costs, makes little sense if penalties are incurred else- where in the supply chain. All in all it would appear that the total logistics impact of focused production will be complex and significant. To ensure that decisions are taken which are not sub- optimal it will become even more important to undertake detailed analysis based upon total system modelling and simulation prior to making commitments that may later be regretted. Centralised logistics at Lever Europe Lever, part of the global corporation Unilever, manufacture and market a wide range of soaps, detergents and cleaners. As part of a drive to implement a European strategy for manufacturing and the supply chain they created a centralised manu- facturing and supply chain management structure – Lever Europe. A key part of this strategy involved a rationalisation of other production facilities from a total of 16 across western Europe to 11. The remaining facilities became ‘focused factories’, each one concentrating on certain product families. So, for example, most bar soaps for Europe are now made at Port Sunlight in England; Mannheim in Germany makes all the Dove soap products, not just for Europe but for much of the rest of the world; France focuses on machine dishwasher products and so on. Because national markets are now supplied from many different European sources they have retained distribution facilities in each country to act as a local consolidation centre for final delivery to customers. Whilst some significant production cost savings have been achieved, a certain amount of flexibility has been lost. There is still a high level of variation in require- ment by individual market. Many countries sell the same product but under different MANAGING THE GLOBAL PIPELINE 175  brand names; the languages are different hence the need for local packs; some- times too the formulations differ. A further problem is that as retailers become more demanding in the delivery service they require and as the trend towards just-in-time delivery continues, the loss of flexibility becomes a problem. Even though manufacturing economies of scale are welcome, it has to be recognised that the achievement of these cost ben- efits may be offset by the loss of flexibility and responsiveness in the supply chain as a whole. 2 Centralisation of inventories In the same way that the advent of globalisation has encouraged companies to rationalise production into fewer locations, so too has it led to a trend towards the centralisation of inventories. Making use of the well-known statistical fact that con- solidating inventory into fewer locations can substantially reduce total inventory requirement, organisations have been steadily closing national warehouses and amalgamating them into regional distribution centres (RDCs) serving a much wider geographical area. For example, Philips has reduced its consumer electronics products ware- houses in western Europe from 22 to just four. Likewise Apple Computers replaced their 13 national warehouses with two European RDCs. Similar examples can be found in just about every industry. Whilst the logic of centralisation is sound, it is becoming increasingly recog- nised that there may be even greater gains to be had by not physically centralising the inventory but rather by locating it strategically near the customer or the point of production but managing and controlling it centrally. This is the idea of ‘virtual’ or ‘electronic’ inventory. The idea is that by the use of information the organisation can achieve the same stock reduction that it would achieve through centralisation whilst retaining a greater flexibility by localising inventory. At the same time the penalties of centralising physical stock holding are reduced, i.e. double handling, higher transport charges and possibly longer total pipelines. One of the arguments for centralised inventory is that advantage can be taken 2 of the ‘square root rule’. Whilst an approximation, this rule of thumb provides an indication of the opportunity for inventory reduction that is possible through hold- ing inventory in fewer locations. The rule states that the reduction in total safety stock that can be expected through reducing the number of stock locations is proportional to the square root of the number of stock locations before and after rationalisation. Thus if previously there were 25 stock locations and now there are only four then the overall reduction in inventory would be in the ratio of 25 to 4 , or 5:2, i.e. a 60 per cent reduction. Many organisations are now recognising the advantage of managing worldwide inventories on a centralised basis. To do so successfully, however, requires an information system that can provide complete visibility of demand from one end LOGISTICS & SUPPLY CHAIN MANAGEMENT 176 of the pipeline to another in as close to real time as possible. Equally such central- ised systems will typically lead to higher transport costs in that products inevitably have to move greater distances and often high-cost air express will be necessary to ensure short lead times for delivery to the customer. Xerox, in its management of its European spares business, has demonstrated how great benefits can be derived by centralising the control of inventory and by using information systems and, in so doing, enabling a much higher service to its engineers to be provided but with only half the total inventory. SKF is another com- pany that for many years has been driving down its European inventory of bearings whilst still improving service to its customers. Again, the means to this remarkable achievement has been through a centralised information system. 3 Postponement and localisation Although the trend to global brands and products continues, it should be recog- nised that there are still significant local differences in customer and consumer requirements. Even within a relatively compact market like western Europe there are major differences in consumer tastes and, of course, languages. Hence there are a large number of markets where standard, global products would not be suc- cessful. Take, for example, the differences in preference for domestic appliances such as refrigerators and washing machines. Northern Europeans prefer larger refrigerators because they shop once a week rather than daily, whilst southern Europeans, shopping more frequently, prefer smaller ones. Similarly, Britons con- sume more frozen foods than most other European countries and thus require more freezer space. Although the trend to global brands and products continues, it should be recognised that there are still significant local differences in customer and consumer requirements. In the case of washing machines, there are differences in preference for top-load- ing versus front-loading machines – in the UK almost all the machines purchased are front loaders whilst in France the reverse is true. How is it possible to reconcile the need to meet local requirements whilst seek- ing to organise logistics on a global basis? Ideally organisations would like to achieve the benefits of standardisation in terms of cost reduction whilst maximising their marketing success through localisation. One strategy that is increasingly being adopted is the idea of postponement discussed earlier in this book. Postponement, or delayed configuration, is based on the principle of seeking to design products using common platforms, compo- nents or modules but where the final assembly or customisation does not take place until the final market destination and/or customer requirement is known. The advantages of the strategy of postponement are several. Firstly, inventory can be held at a generic level so that there will be fewer stock keeping variants MANAGING THE GLOBAL PIPELINE 177 and hence less inventory in total. Secondly, because the inventory is generic, its flexibility is greater, meaning that the same components, modules or platforms can be embodied in a variety of end products. Thirdly, forecasting is easier at the generic level than at the level of the finished item. This last point is particularly rel- evant in global markets where local forecasts will be less accurate than a forecast for worldwide volume. Furthermore the ability to customise products locally means that a higher level of variety may be offered at lower total cost – this is the principle of ‘mass customisation’. To take full advantage of the possibilities offered by postponement often requires a ‘design for localisation’ philosophy. Products and processes must be designed and engineered in such a way that semi-finished product can be assem- bled, configured and finished to provide the highest level of variety to customers based upon the smallest number of standard modules or components. In many cases the final finishing will take place in the local market, perhaps at a distribution centre, and, increasingly, the physical activity outsourced to a third-party logistics service provider. Gaining visibility in the global pipeline One of the features of global pipelines is that there is often a higher level of uncer- tainty about the status of a shipment whilst in transit. This uncertainty is made worse by the many stages in a typical global pipeline as a product flows from fac- tory to port, from the port to its country of destination, through customs clearance and so on until it finally reaches the point where it is required. Not surprisingly there is a high degree of variation in these extended pipelines. Shipping, consolidation and customs clearance all contribute to delays and var- iability in the end-to-end lead time of global supply chains. This is highlighted in the example shown in Table 9.1. This can be a major issue for companies as they increasingly go global. It has the consequence that local managers tend to com- pensate for this unreliability by over-ordering and by building inventory buffers. Table 9.1 End-to-end lead-time variability (days) From Freight Arrive in Customs Transit to Total point of forwarding/ country of clearance point of elapsed origin consolidation destination use time to port Maximum 5 7 15 5 5 37 Average 4 3 14 2 4 32 Minimum 1 1 12 1 2 17 One emerging tool that could greatly improve the visibility across complex global supply chains is supply chain event management. LOGISTICS & SUPPLY CHAIN MANAGEMENT 178

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