Orchestrating Demand to Work

Vision Magazine, Volume 2-3, 2005

Leading companies are reinventing themselves into demand-driven supply chains–and saving billions in the process.

Manufacturers’ supply chains are becoming enormously complex–the result of intense pressure for cost reduction, the desire to expand into new markets and rapid product innovations. “These elements create an increasingly fragmented network as companies’ engineering and manufacturing activities become more dispersed,” according to Dick Gabrys of Deloitte Consulting, writing in a study entitled “The Challenge of Complexity in Global Manufacturing–Trends in Supply Chain Management.”

Companies are offshoring production and sourcing globally like never before. According to management consulting firm A.T. Kearney's latest Assessment of Excellence in Procurement study, most international companies are not effectively evaluating the risks nor cultivating the necessary skills associated with overseas sourcing.

“The number of companies sourcing from China, Eastern Europe and India has increased significantly in the last five years and will continue to rise in the future,” reports John Blascovich, author of the report. “By 2009, for instance, 72 percent of companies plan to source from China, a rise from less than 30 percent in 1999.”

Only 53 percent, however, have adopted strategies that indicate a clear understanding of the supply chain and logistics costs associated with emerging market alternatives. Organizations also are inadequately assessing the risks and potential costs of doing business in emerging markets. Tom Mentzer, a professor in the Department of Marketing and Logistics at the University of Tennessee, offers this example: “A company that makes a consumer product we all use outsourced its manufacturing to India. Before doing so, it did a landed cost analysis, and calculated that the lower production costs would save the company $3 million a year. In October 2003, however, India had a dock strike, so the company had to fly product to the United States. For the month of October alone, the company spent $10 million on air transportation. So one unplanned event blew the cost savings for three years.”

A small but growing number of companies have come up with a better approach to supply chain management. They view their supply chains from a ’pull’ rather than ’push’ perspective, whereby customer demand rather than factory forecasts drive the show. These same companies deploy the latest technology–visibility and communications tools and systems–to gain insight into and control over the activities of the entire extended supply chain. They manage from a total cost perspective across the entire channel, and avoid the trap of optimizing one part of the chain only to sub-optimize another.

The transformation from push to pull, from silos of cost to total cost management, is difficult. But the rewards, as the discussion below indicates, make the journey well worth the pain.

Out of Touch and At Risk
As traditional ’push’-driven supply chains grow longer and more complex, it becomes more difficult to gauge customer demand. These supply chains are out of touch with actual customer demand, a situation that creates uncertainty at every step in the channel. Companies react to this uncertainty by stockpiling inventory. As of June 2004, according to analysts Kevin O’Marah and Joe Souza of AMR Research, some $3 trillion in inventory was locked up in U.S. and European supply chains due largely to this inventory amplification syndrome.

Inventory liability puts companies at financial risk, with measurable negative results. Poor supply chain performers have an overall cost disadvantage of 5 percent of revenue due primarily to poor forecast accuracy. “These businesses are losing market share and burning up cash with underperforming assets,” say O’Marah and Souza.

In contrast, companies with strong supply chain management deliver higher service levels (5 percent more perfect orders), have lower inventories (66 percent of the days of supply of weaker performers), enjoy shorter cash-to-cash cycle times (60 percent of the time it takes others), and experience lower supply chain costs (as much as 8 percent of revenue).

In an effort to reduce total supply chain costs permanently and improve overall profitability, leading companies are shifting to supply chains driven by actual customer demand. AMR calls this the Demand Driven Supply Network (DDSN). “DDSN is a system of coordinated technologies and processes that senses and reacts to real-time demand signals across a supply network of customers, suppliers and employees to improve operational efficiency, streamline new product development and launch, and maximize margin,” O’Marah and Souza explain. “It simply means building all supply chain processes, infrastructure and information flows to serve the downstream source of demand rather than the upstream supply constraints of factories and distribution systems.”

Companies, say the two analysts, go through four distinct stages on the path to deploying a DDSN strategy: Reacting, Anticipating, Collaborating and Orchestrating (see below).

Making ‘On Demand’ Work
One of the best examples of companies that successfully converted to a ’pull’ business model is IBM. In January 2002, the company set out to transform its supply chain to what it calls ’on-demand business.’

IBM believed this new on-demand supply chain would enable the company to gain market share, grow revenue and profit, improve cash flow and enhance customer satisfaction. At the same time, the company expected to slash up to $2 billion from the nearly $40 billion it spends on its supply chain.

IBM’s results have far exceeded this goal. By 2003, the company pared its supply chain costs by $7 billion, or $27 million a day. It reduced inventory to the lowest levels in 20 years, while at the same time pushing customer satisfaction to an all-time high. No small feat for a supply chain that incorporates 33,000 suppliers, 45,000 business partners, 78,000 products and 13 manufacturing locations in nine countries, and ships more than two billion pounds of products annually.

For IBM, the on-demand supply chain is integrated end-to-end across a company’s entire operations–and with key partners, suppliers and clients–from opportunity to cash. The on-demand supply chain can sense and respond with flexibility and speed to client demand, market opportunity or change in the marketplace–no matter how frequent or sudden.

To build the foundation for its on-demand business, IBM did away with entrenched functional silos, bringing procurement, manufacturing, logistics and client support teams together from almost every division of the company. It created a single business unit, the Integrated Supply Chain (ISC) division, with 19,000 employees spread out across 56 countries worldwide.

In addition, IBM updated its systems infrastructure so that internal (manufacturing, procurement and fulfillment) and external (component and technology providers, carriers and others) partners all have real-time access to what is going on in IBM’s extended supply chain.

To reinforce its commitment to supply chain integration, IBM overhauled its performance measurement and reward system. “We used to measure execution solely within silos,” the company writes in an internal white paper it produced on the supply chain transformation effort. “But today, traditional methods of measuring supply chain performance through purely functional metrics are no longer sufficient.”

IBM adapted its measurement system to tie the entire supply chain together with common goals and objectives. These metrics include:

Customer satisfaction. How well does the company perform end-to-end in meeting the expectations of its clients?
Cost reduction. How much has the cost of doing business decreased through end-to-end operational integration, innovation and increased efficiency?
Cash generation. How well has the company created positive cash flow through end-to-end operational integration, innovation and increased efficiency?
Demand/supply synchronization. How well has the company created true visibility of supply and demand to effectively and efficiently manage the needs of clients and the business?
Cycle time. Has the company been efficient and effective in driving competitive end-to-end process excellence and responsiveness?
Sales force productivity. By minimizing the time the sales force spends on supply-chain-related activities, how much time can the company give back to the sales force to spend with clients?

“We’re not talking about whacking away at the structure and putting the squeeze on our suppliers,” explains the IBM white paper. “This imperative is about taking down the actual cost of doing business, working side by side with the business units to identify and close any opportunity for savings. It’s also about making our cost structure more variable by establishing a strong network of alliances and partnerships.”

IBM’s supply chain transformation effort reduced costs by $5.6 billion and generated more than $4 billion in cash. It improved Days Sales Outstanding by nearly four days (one day equals $250 million in cash). And finally, by synchronizing demand and supply, IBM reduced unfilled orders to the lowest level in the history of the company.

The Path to Change
Clearly, moving toward a more demand-driven, total cost management approach to supply chain management is a complex and long-term undertaking. As IBM and other leading enterprises have found, however, progress toward these goals pays off handsomely–literally in billions of dollars.

While there is no easy path to realizing a demand driven supply chain, consulting firm BearingPoint offers some useful advice:

Push inventory as far as possible back upstream in the supply chain toward the production operation. This puts the largest amount of inventory where the forecast error is least and helps minimize excess inventory.
Shorten the replenishment time as much as possible. The majority of supply chain replenishment time is consumed in waiting. Shipping smaller batches more frequently shortens replenishment time.
Replenish the inventory buffer at each link in the chain as frequently as is practical. Determine and use the shortest practical interval for shipping re-supply orders.
Size inventory buffers based on variation and forecasting error. If a distribution center can expect replenishment at regular, shorter intervals, its inventory buffer need not be larger than required during that short period between replenishments.
Activate the information system capability to each upstream link in the supply chain so actual demand is visible as it occurs–in real time or near real time–at each downstream link. Actual consumption at each retail outlet, for example, is visible daily to the upstream distribution center. The aggregate consumption by the distribution center is visible daily to the manufacturing facility. The manufacturing facility can schedule production in near real time. The result is that each link in the chain is essentially filling holes in inventory buffers caused by actual consumption versus pushing product through the chain.

And finally, BearingPoint recommends doing what IBM did and realigning performance metrics throughout the supply chain to reinforce just-in-time behavior. “Metrics that emphasize minimizing the time value of inventory must replace measures that reinforce ’efficiency’ behavior,” the consulting firm concludes.

Demand Driven Supply Network

Evolution toward DDSN is a function of a company’s ability to work effectively internally within its divisions or departments and externally with its partners. The capability progression takes companies from “reacting to demand” to “orchestrating supply and demand alignment” in the extended network.

In the first stage–reacting–functional groups optimize operations locally in order to meet the dictated-to demand. Stage 1 companies have neither the capability to sense or shape the demand, nor a tie into the overall corporate performance. “Reacting companies have a culture exemplified by the ’expeditor as hero,’ with individual departments working efficiently, but in isolation,” O’Marah and Souza note.

In stage 2–anticipating–companies have internally efficient processes when responding to demand, both long-term planned and short-term reactive, but have little visibility to demand in the downstream channel. These organizations concentrate on bringing order to their internal operations and functions through programs such as Lean or 6 Sigma.

In the third stage–collaborating–companies establish partner relationships that are one level deep to gather sufficient intelligence from the partners, allow forecast deviation, and adjust plans using a structured process.

And finally, in stage 4–orchestrating–supply and demand are coupled into one continuous flow through a multitier network with decisions based on profitability. Planning and execution processes are tied together into a continuous, closed-loop fashion with tight interfaces to new product launch and product transitions. This is where companies start to influence demand patterns based on the supply dynamics needed to increase the supply network performance. “Transition through stage 4 demands much more emphasis on total cost management and rigorous integration of financial data into supply chain decisions,” O’Marah and Souza explain.