Chapter OneKey Concepts of Supply Chain Management
After reading this chapter you will be able to
Appreciate what a supply chain is and what it does
Understand where your company fits in the supply chains it participates in and the role it plays in those supply chains
Discuss ways to align your supply chain with your business strategy
Start an intelligent conversation about the supply chain management issues in your company
This book is organized to give you a solid grounding in the "nuts and bolts" of supply chain management. The book explains the essential concepts and practices and then shows examples of how to put them to use. When you finish you will have a solid foundation in supply chain management to work from.
The first three chapters give you a working understanding of the key principles and business operations that drive any supply chain. The next four chapters present the techniques, technologies, and metrics to use to improve your internal operations and coordinate more effectively with your customers and suppliers in the supply chains your company is a part of. Chapter 7 presents specific ideas for using technologies such as social media and real-time simulation gaming to promote supply chain collaboration.
The last three chapters show you how to find supply chain opportunities and respond effectively to best capitalize on these opportunities. Case studies are used to illustrate supply chain challenges and to present solutions for those challenges. These case studies and their solutions bring together the material presented in the rest of the book and show how it applies to real-world business situations.
Supply chains encompass the companies and the business activities needed to design, make, deliver, and use a product or service. Businesses depend on their supply chains to provide them with what they need to survive and thrive. Every business fits into one or more supply chains and has a role to play in each of them.
The pace of change and the uncertainty about how markets will evolve has made it increasingly important for companies to be aware of the supply chains they participate in and to understand the roles that they play. Those companies that learn how to build and participate in strong supply chains will have a substantial competitive advantage in their markets.
Nothing Entirely New ... Just a Significant Evolution
The practice of supply chain management is guided by some basic underlying concepts that have not changed much over the centuries. Several hundred years ago, Napoleon made the remark, "An army marches on its stomach." Napoleon was a master strategist and a skillful general and this remark shows that he clearly understood the importance of what we would now call an efficient supply chain. Unless the soldiers are fed, the army cannot move.
Along these same lines, there is another saying that goes, "Amateurs talk strategy and professionals talk logistics." People can discuss all sorts of grand strategies and dashing maneuvers but none of that will be possible without first figuring out how to meet the day-to-day demands of providing an army with fuel, spare parts, food, shelter, and ammunition. It is the seemingly mundane activities of the quartermaster and the supply sergeants that often determine an army's success. This has many analogies in business.
The term "supply chain management" arose in the late 1980s and came into widespread use in the 1990s. Prior to that time, businesses used terms such as "logistics" and "operations management" instead. Here are some definitions of a supply chain:
"A supply chain is the alignment of firms that bring products or services to market."—from Lambert, Stock, and Ellram. (Lambert, Douglas M., James R. Stock, and Lisa M. Ellram, 1998, Fundamentals of Logistics Management, Boston, MA: Irwin/ McGraw-Hill, Chapter 14).
"A supply chain consists of all stages involved, directly or indirectly, in fulfilling a customer request. The supply chain not only includes the manufacturer and suppliers, but also transporters, warehouses, retailers, and customers themselves."—from Chopra and Meindl (Chopra, Sunil, and Peter Meindl, 2003, Supply Chain, Second Edition, Upper Saddle River, NJ: Prentice-Hall, Inc., Chapter 1).
"A supply chain is a network of facilities and distribution options that performs the functions of procurement of materials, transformation of these materials into intermediate and finished products, and the distribution of these finished products to customers."—from Ganeshan and Harrison (Ganeshan, Ram, and Terry P. Harrison, 1995, "An Introduction to Supply Chain Management," Department of Management Sciences and Information Systems, 303 Beam Business Building, Penn State University, University Park, Pennsylvania).
If this is what a supply chain is then we can define supply chain management as the things we do to influence the behavior of the supply chain and get the results we want. Some definitions of supply chain management are:
"The systemic, strategic coordination of the traditional business functions and the tactics across these business functions within a particular company and across businesses within the supply chain, for the purposes of improving the long-term performance of the individual companies and the supply chain as a whole."—from Mentzer, DeWitt, Keebler, Min, Nix, Smith, and Zacharia (Mentzer, John T.,William DeWitt, James S. Keebler, Soonhong Min, Nancy W. Nix, Carlo D. Smith, and Zach G. Zacharia, 2001, "Defining Supply Chain Management," Journal of Business Logistics, Vol. 22, No. 2, p. 18).
"Supply chain management is the coordination of production, inventory, location, and transportation among the participants in a supply chain to achieve the best mix of responsiveness and efficiency for the market being served."—my own words.
There is a difference between the concept of supply chain management and the traditional concept of logistics. Logistics typically refers to activities that occur within the boundaries of a single organization and supply chains refer to networks of companies that work together and coordinate their actions to deliver a product to market. Also, traditional logistics focuses its attention on activities such as procurement, distribution, maintenance, and inventory management. Supply chain management acknowledges all of traditional logistics and also includes activities such as marketing, new product development, finance, and customer service.
In the wider view of supply chain thinking, these additional activities are now seen as part of the work needed to fulfill customer requests. Supply chain management views the supply chain and the organizations in it as a single entity. It brings a systems approach to understanding and managing the different activities needed to coordinate the flow of products and services to best serve the ultimate customer. This systems approach provides the framework in which to best respond to business requirements that otherwise would seem to be in conflict with each other.
Taken individually, different supply chain requirements often have conflicting needs. For instance, the requirement of maintaining high levels of customer service calls for maintaining high levels of inventory, but then the requirement to operate efficiently calls for reducing inventory levels. It is only when these requirements are seen together as parts of a larger picture that ways can be found to effectively balance their different demands.
Effective supply chain management requires simultaneous improvements in both customer service levels and the internal operating efficiencies of the companies in the supply chain. Customer service at its most basic level means consistently high order-fill rates, high on-time delivery rates, and a very low rate of products returned by customers for whatever reason. Internal efficiency for organizations in a supply chain means that these organizations get an attractive rate of return on their investments in inventory and other assets and that they find ways to lower their operating and sales expenses.
There is a basic pattern to the practice of supply chain management. Each supply chain has its own unique set of market demands and operating challenges and yet the issues remain essentially the same in every case. Companies in any supply chain must make decisions individually and collectively regarding their actions in five areas:
1. Production—What products does the market want? How much of which products should be produced and by when? This activity includes the creation of master production schedules that take into account plant capacities, workload balancing, quality control, and equipment maintenance.
2. Inventory—What inventory should be stocked at each stage in a supply chain? How much inventory should be held as raw materials, semifinished, or finished goods? The primary purpose of inventory is to act as a buffer against uncertainty in the supply chain. However, holding inventory can be expensive, so what are the optimal inventory levels and reorder points?
3. Location—Where should facilities for production and inventory storage be located? Where are the most cost efficient locations for production and for storage of inventory? Should existing facilities be used or new ones built? Once these decisions are made they determine the possible paths available for product to flow through for delivery to the final consumer.
4. Transportation—How should inventory be moved from one supply chain location to another? Air-freight and truck delivery are generally fast and reliable but they are expensive. Shipping by sea or rail is much less expensive but usually involves longer transit times and more uncertainty. This uncertainty must be compensated for by stocking higher levels of inventory. When is it better to use which mode of transportation?
5. Information—How much data should be collected and how much information should be shared? Timely and accurate information holds the promise of better coordination and better decision making. With good information, people can make effective decisions about what to produce and how much, about where to locate inventory, and how best to transport it.
The sum of these decisions will define the capabilities and effectiveness of a company's supply chain. The things a company can do and the ways that it can compete in its markets are all very much dependent on the effectiveness of its supply chain. If a company's strategy is to serve a mass market and compete on the basis of price, it had better have a supply chain that is optimized for low cost. If a company's strategy is to serve a market segment and compete on the basis of customer service and convenience, it had better have a supply chain optimized for responsiveness. Who a company is and what it can do is shaped by its supply chain and by the markets it serves.
How the Supply Chain Works
Two influential source books that define principles and practices of supply chain management are The Goal (Goldratt, Eliyahu M., 1984, The Goal, Great Barrington, MA: The North River Press Publishing Corporation); and Supply Chain Management, Fourth Edition by Sunil Chopra and Peter Meindl. The Goal explores the issues and provides answers to the problem of optimizing operations in any business system, whether it be manufacturing, mortgage loan processing, or supply chain management. Supply Chain Management, Fourth Edition is an in-depth presentation of the concepts and techniques of the profession. Much of the material presented in this chapter and in the next two chapters can be found in greater detail in these two books.
The goal or mission of supply chain management can be defined using Eli Goldratt's words as "Increase throughput while simultaneously reducing both inventory and operating expense." In this definition, throughput refers to the rate at which sales to the end customer occur. Depending on the market being served, sales or throughput occur for different reasons. In some markets, customers value and will pay for high levels of service. In other markets customers seek simply the lowest price for an item.
As we saw in the previous section, there are five areas where companies can make decisions that will define their supply chain capabilities: production; inventory; location; transportation; and information. Chopra and Meindl define the first four and I add the fifth as performance drivers that can be managed to produce the capabilities needed for a given supply chain.
Effective supply chain management calls first for an understanding of each driver and how it operates. Each driver has the ability to directly affect the supply chain and enable certain capabilities. The next step is to develop an appreciation for the results that can be obtained by mixing different combinations of these drivers. Let's start by looking at the drivers individually.
Production refers to the capacity of a supply chain to make and store products. The facilities of production are factories and warehouses. The fundamental decision that managers face when making production decisions is how to resolve the trade-off between responsiveness and efficiency. If factories and warehouses are built with a lot of excess capacity, they can be very flexible and respond quickly to wide swings in product demand. Facilities where all or almost all capacity is being used are not capable of responding easily to fluctuations in demand. On the other hand, capacity costs money and excess capacity is idle capacity not in use and not generating revenue. So the more excess capacity that exists, the less efficient the operation becomes.
Factories can be built to accommodate one of two approaches to manufacturing:
1. Product Focus—A factory that takes a product focus performs the range of different operations required to make a given product line from fabrication of different product parts to assembly of these parts.
2. Functional Focus—A functional approach concentrates on performing just a few operations such as only making a select group of parts or only doing assembly. These functions can be applied to making many different kinds of products.
A product approach tends to result in developing expertise about a given set of products at the expense of expertise about any particular function. A functional approach results in expertise about particular functions instead of expertise in a given product. Companies need to decide which approach or what mix of these two approaches will give them the capability and expertise they need to best respond to customer demands.
As with factories, warehouses too can be built to accommodate different approaches. There are three main approaches to use in warehousing:
1. Stock Keeping Unit (SKU) Storage—In this traditional approach, all of a given type of product is stored together. This is an efficient and easy to understand way to store products.
2. Job Lot Storage—In this approach, all the different products related to the needs of a certain type of customer or related to the needs of a particular job are stored together. This allows for an efficient picking and packing operation but usually requires more storage space than the traditional SKU storage approach.
3. Crossdocking—An approach that was pioneered by Wal-Mart in its drive to increase efficiencies in its supply chain. In this approach, product is not actually warehoused in the facility. Instead the facility is used to house a process where trucks from suppliers arrive and unload large quantities of different products. These large lots are then broken down into smaller lots. Smaller lots of different products are recombined according to the needs of the day and quickly loaded onto outbound trucks that deliver the products to their final destinations.
Inventory is spread throughout the supply chain and includes everything from raw material to work in process to finished goods that are held by the manufacturers, distributors, and retailers in a supply chain. Again, managers must decide where they want to position themselves in the trade-off between responsiveness and efficiency. Holding large amounts of inventory allows a company or an entire supply chain to be very responsive to fluctuations in customer demand. However, the creation and storage of inventory is a cost and to achieve high levels of efficiency, the cost of inventory should be kept as low as possible.