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Focus: Supply Chain Trends/Issues

Feature Article from Our Supply Chain Trends and Issues Subject Area - See All

From SCDigest's On-Target E-Magazine


Feb. 16, 2011

Supply Chain News: Understanding the "Operations Rules" (Con't)


Similarly, no firm can be both extremely efficient, and thus compete on price, and at the same time highly responsive, and thus provide its customers with a large set of choices in a speedy manner while maintaining an extraordinary service level. These are conflicting objectives, an issue that is discussed in the next section.

The Challenge

Traditional operations strategies have often focused on efficiency or responsiveness or a combination of the two. In operational efficiency, the firm focuses on low-cost strategies across all functional areas. This includes supplier selection, manufacturing, product design, and distribution and logistics. Typically, in such a strategy, production and distribution decisions are based on long-term forecasts, inventory of finished goods is positioned close to market demand, and supplier selection is based mostly on component costs. Hence, sourcing from low-cost countries is often the mantra.

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Ignore these rules, and you will find yourself heading toward failure. Follow them, and you will steer yourself away from predictable problems and toward an operations strategy that drives real business value.
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By contrast, a responsive strategy focuses on speed, order fulfillment, service level, and customer satisfaction. Here, the objective is not necessarily to squeeze as much cost out of the supply chain as is humanly possible but rather to eliminate stockouts and satisfy demand by competing on response time and speed to market. Typically, in such a strategy, product variety is high and product lifecycle is short, manufacturing or product assembly is based on realized demand rather than forecast, products may be customized, a buffer inventory of components is emphasized, and sourcing, supplier selection, and transportation strategies all rely on speed rather than only on low cost.

Although seasoned operations and supply chain executives understand the difference between efficiency and responsiveness, many are confused about when to apply each strategy. Worse still! Senior managers typically spend a considerable amount of time and energy on customer value but may be ignorant about the connection between the consumer value proposition and operations strategies. 

At the heart of the problem is the question “What drives operations and supply chain strategies?” The research reported in this book shows that the customer value proposition, channels to market, and product characteristics are the key drivers of an appropriate operations strategy.  Implementing a strategy that does not match these drivers leads to inefficiencies, unnecessary expenses, and poor customer service at best or to an eventual business failure in the worst case.

Even those who understand the need to match operations strategies with the drivers reported above are faced with three independent challenges.

The first is the existence of mismatches between the strategies suggested by different product characteristics. That is, managers often find that some product attributes push the operations strategy in one direction while other attributes pull the strategy in a different direction.  The second challenge exists after identifying the appropriate strategy.  At that time, executives often discover that different products, channels, or even customers require different types of supply chains. Thus, they need to decide whether operations should establish a single supply chain and, if so, which one. If multiple supply chains are required, should these supply chains operate independently, or is there a way to take advantage of synergies across the various supply chains?

The third challenge emerges as executives grasp for a better understanding of the drivers of their operations strategy. Operations affect three measures of performance: cost, time, and service levels.  Unfortunately, these are conflicting objectives, as is illustrated in the figure below, where the solid curve represents trade-offs between efficiency and responsiveness. This curve, sometimes referred to as the efficient frontier, represents a range of possible strategies, each with a corresponding cost (efficiency) and response time (responsiveness). Indeed, a high efficiency level, that is, a low-cost operations strategy, typically increases time to serve customers and does not emphasize a high level of service. Alternatively, a highly responsive strategy increases cost but reduces customer response time.

Taken together, the three challenges impose enormous barriers for managers looking for strategies that differentiate them from the competition and create a sustainable competitive advantage. Addressing these challenges requires a shift from best practice to a more systematic and scientific approach that links customer value, product characteristics, and market channels directly with operations strategy.  The term best practice refers to the achievement of a specific outcome—higher level of service, lower cost, shorter response time, or any other performance measure—by following accepted management principles. 

For example, best practice led a major supplier in the automotive industry to invest in demand forecasting technology and associated processes to reduce inventory levels. The intuition is clear: accurate forecasts reduce safety stock and hence overall inventory. But as appealing as it was, the forecast improvement had no significant impact on this supplier’s inventory levels. At the heart of the inventory crisis the company was facing was not poor forecast accuracy—as suggested by accepted management principles—but rather a poor choice of where inventory was positioned in the supply chain. Repositioning stock led to a 30 percent reduction in inventory levels while maintaining the same level of service and response time.

This story suggests that there is a need for deeper understanding of what drives operations strategy. For this purpose, the book converts ideas, observations, and research into a set of rules that management can follow to achieve a quantum leap in operations performance. These rules, which I refer to as the engineering of operations and supply chains, are at the heart of powerful frameworks that allow executives to match strategies with customer value propositions, channels, and product characteristics.

Ignore these rules, and you will find yourself heading toward failure. Follow them, and you will steer yourself away from predictable problems and toward an operations strategy that drives real business value.

Trade-offs and Rules

When establishing a business strategy, the firm takes a market position on the customer value proposition: price, experience and relationships, product innovation, branding, or choice. Since it is impossible to excel in all dimensions of customer value, firms need to choose. For example, Wal-Mart dominates in price but not necessarily in a large variety of products, while Amazon dominates in choice and product availability but not necessarily in price.

A business strategy thus characterizes a company’s unique position in the market and distinguishes the firm’s value proposition from that of its competitors. Such a unique market position drives and depends on operations and supply chain strategies. Unfortunately, no company can be both highly efficient (delivering low cost) and extremely responsive (delivering short response times and dazzling customer satisfaction). This is where the need to make trade-offs emerges.


(Supply Chain Trends Story Continues Below)



Of course, trade-offs need to be made not only between efficiency and responsiveness but also between flexibility and cost, cost and exposure to risk, inventory and service levels, and between quality and price. Each of these trade-offs entails a diagram similar to figure below..  Operations and supply chain innovation is about improving performance despite these trade-offs. Consider this graphic, and assume that your current strategy corresponds to point A on the solid efficient frontier curve. This strategy invests in a deliberate trade-off between efficiency and responsiveness.


The Trade-ff Between Efficiency and Responsiveness



Source: Dr. David Simchi-Levi, MIT

Imagine now that you devise a new strategy that somehow pushes the efficient frontier downward. If this is possible, then for the same level of efficiency, you can improve response time (point B). Alternatively, for the same level of responsiveness, you can improve operations efficiency and hence reduce costs (point C). More importantly, there is a range of strategies between B and C where the firm improves both efficiency and responsiveness.

This insight is the motivation behind many of the rules and associated concepts featured in this book. Indeed, they enable this shift in the tradeoff curve. Examples include the concept of push-pull, risk sharing contracts, process and technology integration, and flexibility.

This is the essence of PBG’s newly established operations strategy.

Prior to collaborating with MIT, PBG focused on supply chain efficiency.  But faced with shifts in consumer preference, PBG needed a new approach that eliminated the stockout crises the firm faced during periods of peak demand but that did not increase and in fact even decreased supply chain costs. Thus, PBG was not trying to move along its existing efficient frontier but rather push its efficient frontier downward and thereby eliminate stockouts and decrease costs.

Other rules are designed to help companies match operations strategy with product characteristics, channels, and customer value. Examples include rules regarding channels, price, product characteristics, and value-added services, procurement-strategy rules, and rules associated with IT strategy.  The origin of all the rules in this book is scientific. They are all based on either mathematical or empirical approaches. By mathematical, I refer to rules derived from detailed mathematical models.

These rules are universal laws that are always true, independent of geography, culture, or products. Examples include principles that govern the relationships between variability and supply chain performance, between inventory, capacity, and response time, between redundancy and supply chain cost, and between information, lead time, and variability.  The empirical approach devises rules based on carefully conducted research that observes the strategies and performance of various companies. 

Such rules are also universal, but like any empirical research, and unlike mathematical models, they need to be considered within the context of the origin of the data. Examples include principles that explain the relationships between operations strategies and channel characteristics, product attributes, customer value, and IT capability.  Together, the two approaches complement each other and generate a set of principles that transform operations and supply chain management from a discipline that is based on gut feelings, anecdotes, and best practice to a true engineering discipline.


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