White up what you learned from Chapter and Video

Chapter 2 • Supply Chain Performance: Achieving Strategic Fit and Scope 25

Predictable supply and

demand

Predictable supply and uncertain demand, or uncertain supply and predictable demand, or somewhat

uncertain supply and demand

Highly uncertain supply and

demand

Salt at a supermarket

An existing automobile

model

A new communication

device

FIGURE 2-2 The Implied Uncertainty (Demand and Supply) Spectrum

Supply uncertainty is also strongly affected by the life-cycle position of the product. New products being introduced have higher supply uncertainty because designs and production processes are still evolving. In contrast, mature products have less supply uncertainty.

We can create a spectrum of uncertainty by combining the demand and supply uncertainty. This implied uncertainty spectrum is shown in Figure 2-2.

A company introducing a brand-new cell phone based on entirely new components and technology faces high implied demand uncertainty and high supply uncertainty. As a result, the implied uncertainty faced by the supply chain is extremely high. In contrast, a supermarket selling salt faces low implied demand uncertainty and low levels of supply uncertainty, result- ing in a low implied uncertainty. Many agricultural products such as coffee are examples of supply chains facing low levels of implied demand uncertainty but significant supply uncer- tainty based on weather. The supply chain thus has to face an intermediate level of implied uncertainty.

STEP 2: UNDERSTANDING THE SUPPLY CHAIN CAPABILITIES After understanding the uncer- tainty that the company faces, the next question is: How does the firm best meet demand in that uncertain environment? Creating strategic fit is all about creating a supply chain strategy that best meets the demand a company has targeted given the uncertainty it faces.

We now consider the characteristics of supply chains and categorize them based on differ- ent characteristics that influence their responsiveness and efficiency.

First, we provide some definitions. Supply chain responsiveness includes a supply chain’s ability to do the following:

• Respond to wide ranges of quantities demanded • Meet short lead times • Handle a large variety of products • Build highly innovative products • Meet a high service level • Handle supply uncertainty

These abilities are similar to many of the characteristics of demand and supply that led to high implied uncertainty. The more of these abilities a supply chain has, the more respon- sive it is.

Key Point

The first step in achieving strategic fit between competitive and supply chain strategies is to understand customers and supply chain uncertainty. Uncertainty from the customer and the supply chain can be combined and mapped on the implied uncertainty spectrum.

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26 Chapter 2 ◆ Achieving Strategic Fit in a Supply Chain

We now categorize supply chains based on different characteristics that inf luence their responsiveness and efficiency.

First, we provide some definitions. Supply chain responsiveness includes a supply chain’s ability to do the following:

• Respond to wide ranges of quantities demanded • Meet short lead times • Handle a large variety of products • Build highly innovative products • Meet a high service level • Handle supply uncertainty

These abilities are similar to many of the characteristics of demand and supply that led to high implied uncertainty. The more of these abilities a supply chain has, the more respon- sive it is.

Responsiveness, however, comes at a cost. For instance, to respond to a wider range of quantities demanded, capacity must be increased, which increases costs. This increase in cost leads to the second definition: Supply chain efficiency is the inverse of the cost of making and delivering a product to the customer. Increases in cost lower efficiency. For every strategic choice to increase responsiveness, there are additional costs that lower efficiency.

The cost-responsiveness efficient frontier is the curve in Figure 2-3 showing the lowest possible cost for a given level of responsiveness. Lowest cost is defined based on existing tech- nology; not every firm is able to operate on the efficient frontier, which represents the cost- responsiveness performance of the best supply chains. A firm that is not on the efficient frontier can improve both its responsiveness and its cost performance by moving toward the efficient frontier. In contrast, a firm on the efficient frontier can improve its responsiveness only by increasing cost and becoming less efficient. Such a firm must then make a trade-off between efficiency and responsiveness. Of course, firms on the efficient frontier are also continuously improving their processes and changing technology to shift the efficient frontier itself. Given the trade-off between cost and responsiveness, a key strategic choice for any supply chain is the level of responsiveness it seeks to provide.

Supply chains range from those that focus solely on being responsive to those that focus on a goal of producing and supplying at the lowest possible cost. Figure 2-4 shows the responsive- ness spectrum and where some supply chains fall on this spectrum.

Responsiveness

Cost

Low High

Low

High

Figure 2-3 Cost-Responsiveness Efficient Frontier

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Chapter 2 • Supply Chain Performance: Achieving Strategic Fit and Scope 27

Highly efficient

Somewhat efficient

Somewhat responsive

Highly responsive

Integrated steel mills: Production scheduled weeks

or months in advance with

little variety or flexibility

Hanes apparel: A traditional make-to- stock manufacturer

with production lead time of

several weeks

Most automotive production:

Delivering a large variety of products

in a couple of weeks

Seven-Eleven Japan: Changing merchandise mix by location and

time of day

FIGURE 2-4 The Responsiveness Spectrum

STEP 3: ACHIEVING STRATEGIC FIT After mapping the level of implied uncertainty and understanding the supply chain position on the responsiveness spectrum, the third and final step is to ensure that the degree of supply chain responsiveness is consistent with the implied uncertainty. The goal is to target high responsiveness for a supply chain facing high implied uncertainty, and efficiency for a supply chain facing low implied uncertainty.

For example, the competitive strategy of McMaster-Carr targets customers who value having a large variety of MRO products delivered to them within 24 hours. Given the large variety of products and rapid desired delivery, demand from McMaster-Carr customers can be characterized as having high implied demand uncertainty. McMaster-Carr has the option of designing an efficient or responsive supply chain. An efficient supply chain may carry less inven- tory and maintain a level load on the warehouse to lower picking and packing costs. If McMaster-Carr made these choices, it would have difficulty supporting the customer’s desire for a wide variety of products that are delivered within 24 hours. To serve its customers effectively, McMaster-Carr carries a high level of inventory and picking and packing capacity. Clearly, a responsive supply chain is better suited to meet the needs of customers targeted by McMaster-Carr even if it results in higher costs.

Now, consider a pasta manufacturer such as Barilla. Pasta is a product with relatively stable customer demand, giving it a low implied demand uncertainty. Supply is also quite predictable. Barilla could design a highly responsive supply chain in which pasta is custom made in small batches in response to customer orders and shipped via a rapid transportation mode such as FedEx. This choice would obviously make the pasta prohibitively expensive, resulting in a loss of customers. Barilla therefore is in a much better position if it designs a more efficient supply chain with a focus on cost reduction.

From the preceding discussion, it follows that increasing implied uncertainty from customers and supply sources is best served by increasing responsiveness from the supply chain. This relationship is represented by the “zone of strategic fit” illustrated in Figure 2-5. For a high level of performance, companies should move their competitive strategy (and resulting implied uncertainty) and supply chain strategy (and resulting responsiveness) toward the zone of strategic fit.

Key Point

The second step in achieving strategic fit between competitive and supply chain strategies is to under- stand the supply chain and map it on the responsiveness spectrum.

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28 Chapter 2 • Supply Chain Performance: Achieving Strategic Fit and Scope

Responsive Supply Chain

Responsiveness Spectrum

Efficient Supply Chain

Certain Demand

Implied Uncertainty Spectrum

Uncertain Demand

Zo ne

of

St rat

eg ic

Fi t

FIGURE 2-5 Finding the Zone of Strategic Fit

The next step in achieving strategic fit is to assign roles to different stages of the supply chain that ensure the appropriate level of responsiveness. It is important to understand that the desired level of responsiveness required across the supply chain may be attained by assigning different levels of responsiveness and efficiency to each stage of the supply chain as illustrated by the following examples.

IKEA is a Swedish furniture retailer with large stores in more than 20 countries. IKEA has targeted customers who want stylish furniture at a reasonable cost. The company limits the variety of styles that it sells through modular design. The large scale of each store and the limited variety of furniture (through modular design) decrease the implied uncertainty faced by the supply chain. IKEA stocks all styles in inventory and serves customers from stock. Thus, it uses inventory to absorb all the uncertainty faced by the supply chain. The presence of inventory at large IKEA stores allows replenishment orders to its manufacturers to be more stable and predictable. As a result, IKEA passes along little uncertainty to its manufacturers, who tend to be located in low- cost countries and focus on efficiency. IKEA provides responsiveness in the supply chain, with the stores absorbing most of the uncertainty and being responsive, and the suppliers absorbing little uncertainty and being efficient.

In contrast, another approach for responsiveness may involve the retailer holding little inventory. In this case, the retailer does not contribute significantly to supply chain responsive- ness, and most of the implied demand uncertainty is passed on to the manufacturer. For the supply chain to be responsive, the manufacturer now needs to be flexible and have low response times. An example of this approach is England, Inc., a furniture manufacturer located in Tennessee. Every week, the company makes several thousand sofas and chairs to order, deliver- ing them to furniture stores across the country within three weeks. England Inc.’s retailers allow customers to select from a wide variety of styles and promise relatively quick delivery. This imposes a high level of implied uncertainty on the supply chain. The retailers, however, do not carry much inventory and pass most of the implied uncertainty on to England, Inc. The retailers can thus be efficient because most of the implied uncertainty for the supply chain is absorbed by England, Inc., with its flexible manufacturing process. England, Inc., itself has a choice of how much uncertainty it passes along to its suppliers. By holding more raw material inventories, the company allows its suppliers to focus on efficiency. If it decreases its raw material invento- ries, its suppliers must become more responsive.

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Chapter 2 • Supply Chain Performance: Achieving Strategic Fit and Scope 29

The preceding discussion illustrates that the supply chain can achieve a given level of responsiveness by adjusting the roles of each of its stage. Making one stage more responsive allows other stages to focus on becoming more efficient. The best combination of roles depends on the efficiency and flexibility available at each stage. The notion of achieving a given level of responsiveness by assigning different roles and levels of uncertainty to different stages of the supply chain is illustrated in Figure 2-6. The figure shows two supply chains that face the same implied uncertainty but achieve the desired level of responsiveness with differ- ent allocations of uncertainty and responsiveness across the supply chain. Supply Chain I has a very responsive retailer who absorbs most of the uncertainty, allowing (actually requiring) the manufacturer and supplier to be efficient. Supply Chain II, in contrast, has a very res- ponsive manufacturer who absorbs most of the uncertainty, thus allowing the other stages to focus on efficiency.

To achieve complete strategic fit, a firm must also ensure that all its functions maintain consistent strategies that support the competitive strategy. All functional strategies must support the goals of the competitive strategy. All substrategies within the supply chain—such as manu- facturing, inventory, and purchasing—must also be consistent with the supply chain’s level of responsiveness. Table 2-4 lists some of the major differences in functional strategy between supply chains that are efficient and those that are responsive.

Extent of Implied Uncertainty for the Supply Chain

RetailerManufacturerSupplier

Retailer absorbs most of the implied

uncertainty and must be very responsive.

Manufacturer absorbs less implied

uncertainty and must be somewhat

efficient.

Supplier absorbs the least implied uncertainty and

must be very efficient.

Supply Chain I

Supply Chain II

Retailer absorbs the least implied uncertainty and

must be very efficient.

Manufacturer absorbs most of the implied uncertainty and must be very

responsive.

Supplier absorbs less implied

uncertainty and must be somewhat

efficient.

RetailerManufacturerSupplier

FIGURE 2-6 Different Roles and Allocations of Implied Uncertainty for a Given Level of Supply Chain Responsiveness

Key Point

The final step in achieving strategic fit is to match supply chain responsiveness with the implied uncer- tainty from demand and supply. The supply chain design and all functional strategies within the firm must also support the supply chain’s level of responsiveness.

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32 Chapter 2 ◆ Achieving Strategic Fit in a Supply Chain

The better the available information, the less uncertainty the retailer faces with regards to antici- pated customer demand. Given the uncertainty of demand and the level of service planned for its customers, the retailer must decide on the level of inventory to start the season with. This will depend on the available supply capacity and the time taken by the supplier to fulfill a replenish- ment order. The more the available supply capacity and the quicker that a replenishment order arrives, the less the starting inventory required by the retailer. As the season progresses, the retailer may decrease prices to spur demand if the available inventory seems to be too high. Find- ing the right combination of actions in each of the five levers is critical for the retailer’s success. As shown in Figure 2-7, a supply chain achieves strategic fit by finding the right balance between these levers to respond to the implied uncertainty it faces.

We now discuss each of the levers and the role they play in dealing with uncertainty.

CAPACITY A combination of excess capacity and flexible capacity can help a supply chain deal with uncertainty. An example of both is the paint mixer found in paint stores in most parts of the world. The mixers are flexible and can mix paint in a large variety of colors. This allows the paint store to deal with the uncertainty of which color a particular customer may want to buy. The capacity of a mixer is large enough that it helps the paint store deal with the uncertainty of the num- ber of customers who will arrive at any time looking for paint. A supply chain must consider the cost of excess capacity and flexibility when using capacity as a lever to deal with uncertainty.

INVENTORY Holding inventory is one of the most common levers used in practice to deal with uncertainty. Most of the inventory sitting at a Chanel store is held because there is uncertainty about the product that customers walking into the store may purchase. A dealer holds a variety of cars in inventory because demand is uncertain. A supply chain must consider the cost of holding inventory when using this lever to deal with uncertainty.

TIME A combination of speedy supply and the willingness of customers to wait can help a sup- ply chain deal with uncertainty. Zara uses its ability to replenish its stores quickly to reduce the underlying uncertainty of demand. Its ability to replenish its stores within 48 hours leaves it vulnerable to uncertainty of demand only over that 48-hour period. In contrast, customers at an integrated steel mill often wait weeks for their product to be delivered. The long promised lead times allow the steel mill to aggregate demand over a long period of time, thus reducing its uncertainty. A supply chain must consider the cost of speedy supply and the potential loss of customers by making them wait when using time as a lever to deal with uncertainty.

Capacity Inventory Time Information Price

Supply Chain

Uncertainty

Figure 2-7 Five Key Levers to Deal with Supply Chain Uncertainty

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