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colors, and sizes. The manufacturer sends the shirts directly to each Penney store, bypassing the retailer’s warehouses—and corporate decision makers.

TAL is a no-name giant, the maker of one in eight dress shirts sold in the U.S. Its close relationship with U.S. retailers is part of a power shift taking place in global manufacturing. As retailers strive to cut costs and keep pace with consumer tastes, they are coming to depend more on suppliers that can respond swiftly to their changing needs. This opens opportunities for savvy manufacturers, and TAL has rushed in, even starting to take over such critical areas as sales fore- casting and inventory management.

On the weekend Ms. Thurmond made her pur- chase, the same Atlanta store sold two sage-colored shirts of similar size but of another Penney house brand, Crazy Horse. That left none of this size and color in stock at the store. Based on past sales data, TAL’s computers determined that the ideal inventory level for that brand, style, color, and size at that par- ticular store was two. Without consulting Penney, a TAL factory in Taiwan made two new shirts. It sent one by ship, but to get one in the store quickly, it dis- patched one by air. TAL paid the shipping but sent a bill for the shirts to Penney.

Source: Gabriel Kahn. The Wall Street Journal, Eastern Edition, September 11, 2003. Copyright 2003 by Dow Jones & Company, Inc. Reproduced with permission of Dow Jones & Company, Inc. in the format textbook via Copyright Clearance Center.

Made to Measure

On a Saturday afternoon in August, Carolyn Thurmond walked into a J.C. Penney store in Atlanta’s Northlake Mall and bought a white Stafford wrinkle-free dress shirt for her husband, size 17 neck, 34/35 sleeve.

On Monday morning, a computer technician in Hong Kong downloaded a record of the sale. By Wednesday afternoon, a factory worker in Taiwan had packed an identical replacement shirt into a bun- dle to be shipped back to the Atlanta store.

This speedy process, part of a streamlined supply chain and production system for dress shirts that was years in the making, has put Penney at the forefront of the continuing revolution in U.S. retailing. In an industry where the goal is speedy turnaround of mer- chandise, Penney stores now hold almost no extra inventory of house-brand dress shirts. Less than a decade ago, Penney would have had thousands of them warehoused across the U.S., tying up capital and slowly going out of style.

The new process is one from which Penney is con- spicuously absent. The entire program is designed and operated by TAL Apparel Ltd., a closely held Hong Kong shirt maker. TAL collects point-of-sale data for Penney’s shirts directly from its stores in North America, then runs the numbers through a computer model it designed. The Hong Kong company then decides how many shirts to make, and in what styles,

C A S E

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Instead of asking Penney what it would like to buy, “I tell them how many shirts they just bought,” says Harry Lee, TAL’s managing director.

TAL was born in 1947 after Chinese border guards blocked Mr. Lee’s uncle, C. C. Lee, from importing state-of-the-art weaving machines to Shanghai for fear they would hurt the local textile industry. So the uncle set up shop in Hong Kong, then under British rule. With low-cost Asian manu- facturing, TAL thrived. It supplies labels such as J. Crew, Calvin Klein, Banana Republic, Tommy Hilfiger, Liz Claiborne, Ralph Lauren, and Brooks Brothers. Harry Lee, 60 years old, joined the family business 30 years ago after earning a Ph.D. in elec- trical engineering in the U.S. and serving a stint at Bell Labs.

Now, TAL is negotiating a deal to manage Brooks Brothers’ shirt inventory the same way it does Penney’s. For Lands’ End, TAL stitches made-to- measure pants in Malaysia and flies them straight to U.S. customers, with a shipping invoice that carries the Lands’ End logo.

These retailers have been willing to cede some functions once seen as central because TAL can do them better and more cheaply. Rodney Birkins Jr., vice president for sourcing of J.C. Penney Private Brands Inc., describes as “phenomenal” the added efficiency Penney has been able to achieve with TAL. Before it started working with TAL a decade ago, Penney would routinely hold up to six months of inventory in its warehouses and three months’ worth at stores. Now, for the Stafford and Crazy Horse shirt lines that TAL handles, “it’s zero,” Mr. Birkins says.

With decisions made at the factory, TAL can respond instantly to changes in consumer demand: stepping up production if there is a spike in sales or dialing it down if there’s a slump. The system “directly links the manufacturer to the customer,” says Mr. Birkins. “That is the future.”

Retailers across the board have sought to lower the amount of inventory they hold, both to cut costs and to reduce goods sold at a markdown. That means working more closely with suppliers. Wal-Mart Stores Inc. has pioneered a system that opens its computer system to suppliers all over the world. Suppliers can track how their items are selling over- all and even at individual stores. They can anticipate demand and communicate better with Wal-Mart buyers. But Wal-Mart still handles all the warehousing

and distribution, and it stops short of allowing its suppliers to place their own orders.

The degree of power Penney turned over to TAL is radical. “You are giving away a pretty important function when you outsource your inventory man- agement,” says Wai-Chan Chan, a principal with McKinsey & Co. in Hong Kong. “That’s something that not a lot of retailers want to part with.”

Penney, too, was reluctant, and took the step only after building up trust over years of working with TAL. But Penney now has let TAL take the arrangement a step further: designing new shirt styles and handling their market testing.

TAL’s design teams in New York and Dallas come up with a new style, and within a month its factories churn out 100,000 new shirts. For a test, these are offered for sale at 50 Penney stores. Not nearly all will sell, but offering a wide array of colors and sizes helps to provide a true test of consumer sentiment. After analyzing sales data for a month, TAL—not Penney—decides how many of the new shirts to make and in what colors.

Because TAL manages the entire process, from design to ordering yarn, it can bring a new style from the testing stage to full retail rollout in four months, much faster than Penney could on its own.

The system in effect lets consumers, not market- ing managers, pick the styles. “When you can put something on the floor that the customer has already voted on is when we make a lot of money,” says Penney’s Mr. Birkins.

Like the retailer, TAL changed its methods in response to economic pressures. TAL has seen the price of its shirts fall almost 20 percent over five years as low-cost textile manufacturing exploded in China’s Guangdong province. It could jump even more in 2005, when textile-importing nations such as the U.S. must complete a phaseout of import quotas for countries in the World Trade Organization. Most of TAL’s manufacturing is in places with higher wages than Guangdong, such as Thailand, Malaysia, Taiwan, and Hong Kong. So “our customers need a reason to buy from us,” Mr. Lee says.

TAL learned the supply-chain business the hard way. In 1988, a U.S. wholesaler that handled its shirts, Damon Holdings Inc., failed. Mr. Lee, fearing a loss of sales and figuring he understood the whole- saling business, bought Damon. The result was “a big shock.” A manager TAL had put in charge of Damon went on a buying spree, and soon its warehouses were

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crammed with two years’ worth of shirt inventory that was going out of style. Shirts that cost $10 to make had to be sold for $3. By the time TAL closed Damon in 1991, it had lost $50 million.

But the experience started Mr. Lee thinking about a way to do business more efficiently, by linking his Asian factories directly with U.S. stores. “The failure gave us a head start,” he says.

Around the same time, TAL had begun supplying Penney with house-brand shirts. Mr. Lee saw that Penney was holding up to nine months of inventory, twice what most competitors kept. “You didn’t have to be a genius to realize you can do a lot better than that,” he says. Visiting Penney headquarters in Plano, Texas, he floated a radical solution: Why not have TAL supply shirts directly to Penney stores instead of sending bulk orders to a Penney warehouse?

Mr. Birkins was skeptical. But he saw that savings could be huge. It cost Penney 29 cents a shirt to have its warehouse workers sort out orders in the U.S. TAL could do it for 14 cents.

And such a system would let Penney respond more quickly to consumer demand. This had been a problem for the retailer, which often needed months to restock hot-selling styles. Stores ended up missing sales of these styles while holding less-popular mod- els that they had to move at a discount.

Mr. Birkins pitched the idea to his Penney bosses. It met a brick wall. Each division found fault with it. Executives who ran warehousing said the plan could prove disastrous if TAL didn’t deliver on time or to the right stores. Technology people worried that the computer systems wouldn’t be compatible. The plan sat for several years, until a senior Penney manager began a push to improve efficiency by reducing inventory across the board. “We used that as our wedge,” Mr. Birkins says. “That turned it.”

It took TAL a year to set up the system in Asia. Mr. Lee then began by supplying a single Penney store in Kansas City, Mo. He enlisted a Chinese numerologist to choose an auspicious day: June 20, 1997. Factory workers toasted the occasion with champagne. Things went smoothly, and within months, TAL was delivering shirts directly to all of Penney’s stores in North America. Inventory levels dropped.

There was one clear downside: If a store sold out of a style of shirts, it couldn’t quickly get some more from a regional warehouse. So TAL agreed to sometimes send shirts to stores by air freight—a costly step but one TAL would take to keep the customer happy.

Soon Mr. Lee saw another opportunity. Penney’s sales forecasts often missed, sometimes overestimat- ing shirt needs by as much as two months’ worth. Sales forecasting is one of the most difficult tasks for retailers, yet one that’s increasingly important to get right as inventories get tighter. Penney blames the problem on older-generation software.

Convinced he could do better, Mr. Lee pitched an even more outlandish idea: Why not let TAL staff in Hong Kong forecast how many shirts Penney’s stores would need each week? This time, Penney executives were listening.

Mr. Lee was operating on a simple premise. If he could get sales data straight from the stores, he could take the consumer’s pulse and respond instantly, ordering more fabric and increasing production where needed. Penney buyers would just be in the way. “I can do all the pieces of the puzzle,” he says.

He hired dozens of programmers, who designed a computer model to estimate an ideal inventory of house-brand shirts for each of Penney’s 1,040 North American stores, by style, color, and size. Penney provided him with goals for how often stores’ inventory should be replenished, then stepped back and let him do the rest. “It’s on autopilot,” says Mr. Birkins, “and TAL is the autopilot.”

TAL’s computer model began to outpace the Penney system still used for the retailer’s other mer- chandise. For some shirt models, stores could now keep half as much in stock as they had previously.

The system hasn’t been flawless. Ming Chen, a manager at TAL’s Taiwan factory, recalls a few occa- sions when TAL underestimated Penney’s needs sig- nificantly. She says the factory “sacrificed other customers” to rush out Penney’s order first and sent some shirts by air freight to be sure they arrived on time. Costing 10 times as much as ocean shipping, sending shirts by air was “a painful decision,” she says. “But sometimes you have to decide which cus- tomers you’re going to take care of.”

Sitting in his Hong Kong headquarters, in a neigh- borhood whose factories have given way to office space, Mr. Lee is thinking of ways to push his idea to the next level. He would like to form a joint venture with Penney that would manage the supply chain for some other manufacturers that supply the retailer. TAL has already started doing this with underwear. “Why not consolidate it all here?” he asks.

Mr. Birkins says Penney is seriously considering the idea.

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By the end of this chapter, you should be able to answer the following questions: • What is customer value? • How is customer value measured? • How do you match the supply chain to product characteristics and sales strategy? • How is information technology used to enhance customer value in the supply chain? • How does supply chain management contribute to customer value? • How can a company add value to its offering in order to compete?

12.1 INTRODUCTION

In today’s customer-driven market, it is not the product or service itself that matters most, but the perceived value to the customer of the entire relationship with a com- pany. The way companies measure the quality of their product and services has evolved from internal quality assurance to external customer satisfaction and from there to customer value. Internal quality measures, such as the number of production defects, dominated company goals in the era of supply-driven manufacturing. The ability to provide customers with quality product was the main goal. External cus- tomer satisfaction measures were focused on developing an understanding of the com- pany’s current customers, their use of a company’s products, and their impression of its service. This provided valuable information about current customers and generated ideas for areas for improvement within the company. The current emphasis on cus- tomer value goes a step further by establishing the reasons a customer chooses one company’s product over another’s, and looking at the entire range of product, services, and intangibles that constitute the company’s image and brand.

Thinking in terms of customer value promotes a broader look at a company’s offerings and its customers. It requires learning why customers purchase, continue to purchase, or defect from a company. What are their preferences and needs and how can they be satisfied? Which customers are profitable and have potential for revenue growth, and which cus- tomers may lead to losses? Assumptions about customer value need to be examined care- fully to make sure the trade-offs made are the correct ones. Some examples include:

• Does the customer value low prices more than superior customer support services? • Does the customer prefer next-day delivery or lower prices? • Does the customer prefer to purchase the item in a store that specializes in this type

of item or from a large mega-store that provides one-stop shopping opportunities?

These are critical questions for any business, and should be the driving force behind business strategy and performance measures.

Indeed, logistics, previously considered a back-office function, has evolved into the highly visible discipline of supply chain management partly because of this change in perspective. Supply chain management is naturally an important component in fulfill- ing customer needs and providing value. Equally important, supply chain manage- ment determines the availability of products, how fast they will arrive in the market, and at what cost. Our definition of supply chain management (see Chapter 1) implies that the ability to respond to customer requirements is the most basic function of this discipline. This function refers not only to the physical attributes of product distribu- tion, but also to related information, such as production or delivery status, and the ability to access this information.

Supply chain management also can impact the important customer value of price by significantly reducing costs. Dell’s strategy of reducing its supply chain costs by postponing the final product assembly until after the purchase (i.e., by building to

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order) has allowed Dell to underprice its competitors in the personal computer indus- try. Wal-Mart has been able to lower costs by introducing the cross-docking strategy and by engaging in strategic partnering with its suppliers. Finally, the policy of every- day low prices applied by Wal-Mart and other retailers also is motivated in large part by supply chain efficiencies.

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The downfall of Kmart is attributed in part to its strategy of competing on price with Wal-Mart. Wal-Mart’s goal since the early 80s was to provide customers with access to goods when and where they want them, and to develop cost structures that enable competitive pricing. The key to achieving this goal was to make supply chain efficiencies the centerpiece of its strategy. On the other hand, Kmart’s strong desire to keep up earnings discouraged investments in supply chain efficiencies and, in particular, in information technology. By the late 90s, it became clear that Kmart’s supply chain was not as efficient as that of Wal-Mart [195].

The example suggests the importance of linking pricing strategies with supply chain efficiencies. We discuss this issue in Chapter 13.

Customer value drives changes and improvements in the supply chain, some forced by customer and competitor activities and others undertaken to achieve competitive advantage. Furthermore, large manufacturers, distributors, or retailers place certain requirements on their suppliers that force them to adopt supply chains that will make these requests feasible. Specifically, Wal-Mart requires many of its suppliers to practice vendor-managed inventory. More recently, in January 2005, Wal-Mart went live with RFID technology and mandated its use for its suppliers, with the goal of improving replenishment times and decreasing the amount of out-of-stock items, see Chapter 15. Large manufacturers such as Hewlett-Packard and Lucent Technologies require that their parts manufacturers have 100 percent availability of stock for the parts they use. In return, they are willing to commit to a single supplier for the product or service, or at least commit to a minimum volume of purchases from a primary supplier.

Customer value is also important for determining the type of supply chain required to serve the customer and what services are required to retain customers. A company’s supply chain strategy is determined by the type of products or services it offers and the value of various elements of this offering to the customer. For example, if customers value one-stop shopping, that would entail carrying a large number of products and options, even if that is costly in terms of inventory management. If customers value innovative products, then companies who produce them need to apply their supply chain to supply these products efficiently while demand lasts. If a company offers per- sonal customization of its products, then its supply chain needs to be flexible enough to provide the infrastructure for this offering. Thus, the supply chain needs to be consid- ered in any product and sales strategy and could, in itself, provide competitive advan- tages leading to increased customer value.

Finally, the “Made to Measure” case study illustrates the importance of providing innovative services to customers, in this case managing the entire product supply chain. The case also illustrates the importance of developing supply chain management as a core competency and leveraging it to succeed in an extremely competitive business.

12.2 THE DIMENSIONS OF CUSTOMER VALUE

We have defined customer value as the way the customer perceives the entire com- pany’s offerings, including products, services, and other intangibles. The customer perception can be broken into several dimensions:

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• Conformance to requirements. • Product selection. • Price and brand. • Value-added services. • Relationships and experiences.

The list of dimensions starts with the essentials—the first three items above—and goes on to more sophisticated types of features that may not always be critical. However, the less-critical features can be mined for ideas to create a unique way to add value and differentiation to a company’s offering. In this section, we suggest how each dimension is affected by supply chain management and how, in turn, it needs to take into account the customer values inherent in each dimension.

12.2.1 Conformance to Requirements The ability to offer what the customer wants and needs is a basic requirement to which supply chain management contributes by creating availability and selection. Marshall Fisher calls it the market mediation function of the supply chain [72]. This function is distinct from the supply chain physical function of converting raw materials into goods and shipping them through the chain to the customer. The costs associated with the market mediation function occur when there are differences between supply and demand. If the supply exceeds demand, there are inventory costs throughout the supply chain; if demand exceeds supply, there are lost sales and possibly market share.

If product demand is predictable, as in functional items such as diapers, soup, or milk, market mediation is not a major issue. Clearly, efficient supply chains for func- tional items can reduce costs by focusing on reducing inventory, transportation, and other costs. This is the strategy Campbell Soup and Procter & Gamble employ for their supply chains.

However, when dealing with fashion items or other high-variability items, the nature of demand can create large costs due to lost sales or excess inventory. These high-variability products require responsive supply chains, which stress short lead times, flexibility, and speed over cost efficiencies. When the supply chain strategy does not match the product characteristics, there are major implications in the ability to con- form to the market, as illustrated in the following example.

370 DESIGNING AND MANAGING THE SUPPLY CHAIN

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Zara is part of Inditex, which is one of the world’s largest fashion distributors, with eight sales formats and 2,951 stores in 64 countries. The first Zara shop opened its doors in 1975 in La Coruña (Spain), the city that saw the group’s early beginnings and is now home to its central offices. Its stores can now be found in the most important shopping districts of more than 400 cities in Europe, the Americas, Asia, and Africa.

Zara stores are managed with the founder Amancio Ortega’s philosophy that “you need to have five fingers touching the factory and five touching the customer.” Zara’s super responsive supply chain can design, produce, deliver a new garment, and put it on display in its over 650 stores worldwide in 15 days. This ability to provide a large variety of the latest designs quickly and in limited quantities enables it to collect 85 percent of the full ticket price while the industry average is 60 to 70 percent. As a result, its net margins are much higher than the competition’s.

Zara does many things in an unconventional way and defies industry trends. • It keeps half of its production in house instead of outsourcing, as is common. • It intentionally leaves extra capacity in its warehouses. • It manufactures and produces in small batches rather than try to achieve economies of scale. • It manages all design, warehousing, distribution, and logistics itself instead of using third parties. • It holds its retail stores to a rigid timetable for placing orders and receiving stock.

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Conformance to requirements also is achieved through attention to customer access, the ability to easily find and purchase a product. For companies such as McDonald’s, Starbucks, and Walgreens, access involves prime real estate. Providing mail, phone, and Web access in addition to, or instead of, stores can enhance the cus- tomer’s ability to purchase the product conveniently. Finally, access includes the per- ception of providing the consumers with a store or Web site layout that makes it easy to find and purchase the product they are seeking [53]. Grainger’s success in integrat- ing the Web with its older business channels is a good example of the ability to pro- vide customers with the access they need to a company’s services.

E X A M P L E 1 2 - 3

The business that William W. Grainger founded in 1927 has been one of the success stories of the Internet. Grainger wanted to provide an efficient solution to the need for a speedy and consistent supply of electric motors. The MotorBook, as it was originally called, was the basis for today’s Grainger® Catalog. The product line has since expanded to over 220,000 MRO supplies and parts. Grainger is the largest firm in the market for industrial products, with 1999 revenues of $4.5 billion. In 1995, Grainger started its Web initiative with a variety of goals:

• Provide customers with access to all the products Grainger makes available, over 220,000, and not just the 86,500 that could be presented in the paper catalog.

• Provide customers with much better tools for searching, locating, and selecting the product that best suits their needs.

• Deliver products the same day from the branch closest to the customer who placed the order, or ship them from one of Grainger’s five regional distribution centers and have them delivered the next day.

Grainger faces a variety of challenges:

• Grainger offers 65 million different price points so no “one price fits all” and the Internet needs to honor each business account’s unique pricing structure.

• Servicing business accounts requires checking credit and establishing payment guidelines. • Real-time inventory availability—many customers looking for parts cannot wait and need immedi-

ate service. • Compensating the sales force—Grainger decided to pay commissions on Internet orders, thus

getting a buy-in from their sales reps, who have relationships with the customers and can encour- age customers to use the Web, which is more cost-effective than other channels.

The initiative had a huge impact on Grainger. In 1999, Grainger spent $20 million for the devel- opment, marketing, and customer service of grainger.com, which led to $100 million worth of orders. In the first half of 2000, Grainger generated $120 million in revenue with the size of the aver- age order on the Web site being $250, compared with $140 for branch and phone orders [189].

E X A M P L E 1 2 - 2 C o n t i n u e d • It puts price tags on items before they are shipped rather than at each store. • It leaves large empty areas in the stores and tolerates, even encourages, stock-outs.

According to [65], Zara’s Success is due to conformance to a system that is built on three principles: • Closing the communication loop. The supply chain is organized so it can track material and product

in real time but also close the information loop both for hard data and anecdotal. • Sticking to a rhythm across the supply chain. Zara is willing to spend money on anything that will

make its supply chain fast and responsive. • Leveraging capital assets to increase supply chain flexibility. It uses the investment in production

and distribution facilities to make the supply chain responsive to new and changing demand patterns. For instance, it produces the more complicated product in house and outsources the simple ones.

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12.2.2 Product Selection Many products come in a large variety of options, styles, colors, and shapes. For instance, a car may come in five styles, 10 different exterior colors, 10 interior colors, and with automatic or manual transmission—a total of 1,000 configurations. The diffi- culty is that distributors and retailers need to stock most of the various configurations and combinations of products. As explained in Chapter 2, this proliferation of options makes it difficult to predict customer demand for a specific model, thus forcing retail- ers and distributors to build large and diverse inventories.

The contribution of product proliferation to customer value is difficult to analyze and understand. Three successful business trends exist: • Specializing in offering one type of product. Examples include companies such as

Starbucks and Subway. • Mega-stores that allow one-stop shopping for a large variety of products. Examples

include Wal-Mart and Target. • Mega-stores that specialize in one product area. Examples here include Home

Depot, Office Max, and Staples. These trends also have emerged on the Internet, where some sites have been suc-

cessful in offering a large variety of different products while others specialize in a sin- gle offering. For instance, ballsonline.com specializes in sports balls of all types, theworldofgolf.com in all things golf, while amazon.com is a virtual shopping mall with many shopping options beyond books.

One interesting aspect of the Internet is “the long tail” phenomenon that occurs in the almost limitless market of supply and demand that has been opened by the Internet. In this market, as described in The Long Tail, by Chris Anderson [7], the lack of physi- cal or local restrictions allows retailers to focus and make revenue on the less popular items in their catalogues. These items appear as a tail when ranking books or DVDs by popularity. In fact, companies such as Amazon, Netflix, and Raphsody made between a quarter and half of their revenues in 2005 on titles not carried by traditional retailers such as Wal-Mart, which carries only the most popular titles. See Figure 12-1 for a comparison of Rhapsody and Wal-Mart in 2004 and 2005.

FIGURE 12-1 The Rhapsody data—2004 versus 2005. Source: Chris Anderson [7].

28%

March 2005March 2004March 2004

Total demand

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50,000 200,000 Songs ranked by popularity

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Songs available of both Wall-Mart and Rhapsody

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The PC industry has seen significant changes in the way products are sold. In the mid-1980s, PCs were sold through specialized stores such as Egghead. At the beginning of the 1990s, PCs were sold in department stores such as Sears. More recently, however, the direct business model has caught on. Nevertheless, Dell, the leader in the direct busi- ness model, announced in July 2006 that it is opening its own retail stores in order to com- pete with Apple. This suggests that there may be a need for a company to sell its products through various outlets to reach the largest number of customers. In fact, companies such as Circuit City enable customers to shop on the Web and pick up the items at the store.

As observed earlier, the proliferation of products and the difficulty in predicting demand for a specific model force retailers and distributors to hold large inventories.

There are several ways to control the inventory problem of a large variety of con- figurations or products.

1. The approach pioneered by Dell is the build-to-order model, where the configura- tion is determined only when the order comes in. This is an effective way to imple- ment the push–pull strategy discussed in Chapter 6 by employing the concept of postponement introduced in Chapter 11. An interesting way to implement this strategy is described in the following example.

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Amazon.com is the most famous and successful e-tailer. It started in 1995 by selling a huge variety of books and later added music and videos. More recently, Amazon started selling toys, electronics, and other merchandise. Amazon’s fulfillment strategy has evolved over time. Initially, the company did not hold any inventory. When a customer ordered a book, Amazon would transfer the order to Ingram Books. In 1999, however, Amazon established its own seven large warehouses, referred to as fulfillment centers (one warehouse was later closed) and started shipping directly to the cus- tomers. Today, Amazon has 16 fulfillment centers in the United States.

In 2001, Amazon.com shifted its focus to improving its distribution operations in a push towards profit. It has improved its fulfillment costs, which include costs associated with six warehouses, customer service, and credit card fees, to 9.8 percent in the fourth quarter of 2001, down from 13.5 percent of sales in the fourth quarter of 2000. Amazon did this by

• Improving sorting order and utilization of sophisticated packing machines, which allowed Amazon to ship 35 percent more units with the same number of workers as the previous year.

• Using software to forecast purchasing patterns, which allowed Amazon to slash inventory levels by 18 percent in the fourth quarter.

• Consolidated shipping of 40 percent of goods into full trucks driven directly into major cities, bypassing regional postal sorting facilities and cutting transportation costs significantly.

• Partnering to sell goods for other companies such as Toys ‘R’ Us and Target, who pay Amazon for handling distribution and customer service. These partnerships brought in $225 million in revenue with gross profit margins double Amazon’s overall 25 percent margins.

• Allowing other sellers to offer used books, which increased sales during the holiday season by 38 percent. For these products, Amazon’s gross margins were about 85 percent.

By 2006, Amazon has grown its network to a total of 24 fulfillment centers (FCs) worldwide. These consist of two types of FCs: sortable, capable of combining items, and nonsortable, for larger items shipped separately. Amazon also has increased its product line to 34 product cate- gories, some fulfilled by Amazon and some by other merchants.

Amazon.com also has had challenges on the pricing front: Amazon discounts nearly all books over $20 by 30 percent. Amazon once offered discounts of as much as 50 percent on best sellers and 20 percent discounts on other books. Early in 2001, the company started to raise book prices—with 5 percent to 10 percent discounts more common—only to reverse the increases as sales fell. In the book business, few other retailers have offered discounts, other than for best sellers. There is good rea- son Amazon can afford to cut book prices: the average book may sit on the shelf of a store for six months or a year before it is bought. The cost of this inventory in a chain of hundreds of stores is huge. Amazon, on the other hand, can keep just one or two copies in its warehouse—and still make the title available to the whole country—and restock as quickly as customers buy books [94].

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2. A different strategy, suitable for products with long manufacturing lead times, such as vehicles, is to keep larger inventories at major distribution centers. These distribution centers allow the manufacturer to reduce inventory levels by taking advantage of risk pooling (see Chapter 2 and the discussion of inventory pooling in Section 7.2.3) and delivering the vehicles quickly to customers. General Motors has initiated this approach with its Cadillac unit in Florida. Dealers can order cars that they do not have on their lot from a regional warehouse that can ship the car out in a day. Of course, two major issues need to be raised when considering this strategy: • Inventory costs of cars at the regional warehouse. Is the manufacturer (i.e.,

General Motors) going to pay for the inventory at the regional warehouse? If it is, then there is an incentive for the dealers to reduce inventory in their lots and reduce their cost while increasing that of the manufacturer.

• Equalizing small and large dealers. If all dealers have access to the regional warehouse, then there is no difference between the different dealers. Thus, it is difficult to see why large dealers would be interested in participating in such an arrangement, especially if they are going to pay for inventory at the regional warehouse.

3. Another possibility is to offer a fixed set of options that cover most customer requirements. For instance, Honda offers a limited number of options on its cars. Dell offers few options for modems or software that can be installed on its machines, although the overall number of possible configurations remains quite high. Indeed, large product variety is not required in all cases. For example, a dys- functional level of variety exists in many grocery products—28 varieties of tooth- paste, to give one example [72]. It is not clear whether this variety actually adds any value for the customer.

12.2.3 Price and Brand Price of products and the level of service are essential parts of customer value. Although the price may not be the only factor a customer considers, there may be a narrow price range that is acceptable for certain products. For instance, for com- modity products—even relatively sophisticated items such as personal computers are commodities—there is very little flexibility in price. Therefore, companies achieve cost advantages through innovations in their supply chains. As we have seen in Dell’s direct business model, allowing clients to configure their own sys- tems and building a supporting supply chain not only improve customer value but also reduce costs.

Wal-Mart has been a supply chain innovator, which has enabled it to provide low- cost merchandise and undercut its competition (see Example 12-1). In addition, we have seen that the “everyday low pricing” policy applied by retailers such as Wal-Mart and manufacturers such as Procter & Gamble is an important tool in reducing the bull- whip effect (see Chapter 5). This policy appeals to customers who do not have to worry about buying at the wrong time, and to the retailer and manufacturer who do not need to plan for demand variations as a result of promotions.

An important factor affecting the product price is its brand. In today’s market, there are fewer salespeople and more customers looking for supermarket-style shopping [177]. This is true across a wide variety of retail environments, from auto superstores to e-tailers.

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Interestingly, the Internet and its impact on consumer behavior have increased the importance of brand names, because a brand name is a guarantee of quality in the buyer’s mind. Brand names such as Mercedes cars, Rolex watches, and Coach purses can be promoted for high quality and prestige and command much higher prices than products that lack this aura. Furthermore, the higher price in itself may be a large part of the prestige and perceived quality. The product’s high margins will require a focus on service level, and hence the supply chain needs to be more responsive; the increase in supply chain cost will be offset by the higher margin.

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Consider prices for books and CDs sold on the Internet. A study conducted in 2000 found “substan- tial and systematic differences in price across retailers on the Internet. Prices posted on the Internet differ by an average of 33 percent for books and 25 percent for CDs.” More importantly, Internet retailers with the lowest price do not necessarily sell more. For instance, the research found that Books.com had a lower price than Amazon.com in 99 percent of the cases, yet Amazon had about 80 percent of the market at the time of the study, while Books.com had about 2 percent. One way to explain this behavior is through “trust consumers have for the various Internet retailers and the associated value of branding” [30].

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One of the key elements in the rise of Federal Express as the most successful small package car- rier is that it was the first carrier to narrow its focus to overnight delivery, thereby owning the word “overnight” in the market. Even though there are cheaper alternatives, customers are willing to pay a premium to ship by Federal Express because of the brand name and the perception of depend- ability it conveys [177].

In many industries, “product” typically means both the “physical product” and associated “services.” Typically, pricing the physical product is not as difficult as pric- ing services. At the same time, it is quite difficult to compare different services and, as a result, variability in pricing increases. This suggests opportunities for companies that develop new offerings and services that are more difficult to turn into commodi- ties. As we will see below, there is a challenge in turning these opportunities into offerings that customers are actually willing to pay for.

In Chapter 13, we examine strategic pricing, where companies can employ sophis- ticated analysis to align customer service preferences with supply chain costs.

12.2.4 Value-Added Services Many companies cannot compete on product price alone in an economy that has an overabundance of supply. Therefore, they need to consider other sources of income. This drives companies toward value-added offerings that differentiate them from com- petitors and provide them with more profitable pricing structures.

Value-added services, such as support and maintenance, can be a major factor in the purchase of some products, especially technical products. Indeed, many companies are now adding more services around their products [109]. This is due in part to the following:

1. The commoditization of products, where only the price matters and all other fea- tures are identical, reducing profitability and competitive advantage from the sale of products alone.

2. The need to get closer to the customer. 3. The increase in information technology capabilities that make this offering possible.

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A sophisticated service offering is illustrated in the following example.

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Goodyear Tire & Rubber Co. provides truck manufacturer Navistar International Transportation Corp. with an automated supply chain service that includes delivering mounted tires sequenced for just-in-time use on automated assembly lines. Goodyear has a 13-person information technology group dedicated to the tire maker’s materials management division. This division acts as systems integrator on supply chain projects it takes on with wheel manufacturer Accuride, Inc., in Henderson, Kentucky. Under a joint venture called AOT, Inc., Goodyear and Accuride furnish entire wheel assemblies, painted and ready for use, to Mitsubishi Motor Co. and Ford Motor Co. as well as Navistar. Those assemblies include Goodyear’s or competitors’ tires, depending on customer specifications [109].

A recent example of a market with a low entry barrier and many companies initially competing mostly on price is the business-to-business e-marketplace. It only took a few years for many of these market makers to realize that they need to extend their service offerings; they now provide a variety of additional services, including financial, logis- tics, and supply chain services (see Chapter 9 for more detail).

As observed in the previous section, pricing services is not an easy task. For many years, companies such as IBM did not charge for their services, although the company’s slogan was “IBM Means Service.” Today, service provides most of IBM’s income. Companies that have not stressed customer support, such as Microsoft, are enhancing their capabilities in this area. In many cases, there is a charge associated with receiving support, such as a one-time call fee or a service agreement. Service and support not only can generate additional revenue, but, more importantly, they can bring the company closer to the customer and provide insight on how to improve its offering, tailor support, and find the next idea to add value to its products and services.

An important value-added service is information access. Allowing customers access to their own data—such as pending orders, payment history, and typical orders—enhances their experience with the company. For example, it is well known that customers value the ability to know the status of an order, sometimes even more than the actual turnaround time. This capability provides reliability and enables plan- ning. FedEx pioneered the package tracking systems that are now standard in this industry. As we will see below, this not only enhances service, but also can result in large savings for the provider of the information by handing over to its customers some of the data entry and inquiry functions from its own employees.

The ability of customers to access information is becoming an essential require- ment in supply chain management, as visibility of information is what an increasing number of customers expect. The Internet enables these capabilities and companies will need to invest in information systems that support it. In Chapter 14, we consider these issues in more detail.

12.2.5 Relationships and Experiences The final level of customer value is an increased connection between the firm and its customers through development of a relationship. This makes it more difficult for cus- tomers to switch to another provider, since a relationship requires an investment of time from both the customer and the provider. For example, Dell configures PCs and supports them for large customers. When Dell manages the entire PC purchase for a

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large customer, including special custom features, it becomes more difficult for the customer to switch to another vendor.

The learning relationship, where companies build specific user profiles and utilize this information to enhance sales as well as retain customers [168], is another example of a relationship providing customer value. Companies such as Individual Inc., which builds tailored information services, and USAA, which uses its databases to offer cus- tomers other services and products, are examples of this kind of organization.

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Founded in 1989 by brothers Andrew and Thomas Parkinson, Peapod has grown to be one of America’s leading Internet grocers. Peapod is a wholly owned subsidiary of international food provider Royal Ahold and works in partnership with Ahold USA supermarket companies, including Stop & Shop and Giant Food. The company, which operates in Boston, southern Connecticut, Washington, Chicago, and Long Island, New York, serves over 103,000 members. Shoppers browse through Peapod’s offerings on its Internet site through a personalized interface based on their location. Peapod’s computers are linked directly to the databases of the supermarkets from which it purchases the groceries. The shoppers can create their own virtual supermarket by accessing the information according to category and creating customized shopping lists that can be saved for repeated use. At the end of each shopping session, Peapod has the opportunity to learn about its service by asking, “How did we do on the last order?” and using the relatively high response rate of its customers (35 percent) to institute requested changes to its services [168].

The approach used by Peapod Inc. is an example of the one-to-one enterprise con- cept suggested by Peppers and Rogers in [161]. Companies learn about each customer through databases and interactive communications, and sell to one customer as many products and services as possible throughout the lifetime of the customer’s patronage. Indeed, Peapod is using its databases to suggest new offerings to customers, tracking the customer’s preferences and needs, and further tailoring the company’s offering to the customer.

The learning process can take time, but this will make it difficult for competitors to emulate the strategy. In addition, it typically ensures that a customer who considers switching to another provider will have to take into account the investment in time and money required to make the switch.

Indeed, some Internet sites, such as Amazon.com, are applying new modes of learning, with suggestions to customers based on their own previous purchases or those of customers who make similar purchases. Of course, one issue with an Internet service that provides customer reviews and suggestions is that a customer can distin- guish between a Web site where they purchase the product and the Web site in which they receive information about the product. That is, it is not clear that a service offer- ing in which a Web site provides suggestion tools and customer reviews may convince the consumer to purchase the product at that site. The consumer may well receive information from one site and make the purchase on another [30].

A different approach, tailored toward large customers and designed to make it diffi- cult to switch to another vendor, was introduced by Dell. It offers large corporations custom PC configurations loaded with specific software, tags, and other special requirements. Dell also has tailored its Web site so that different types of users can access it according to their needs. In many ways, this approach is a more extensive application of mass customization, which we discussed in Chapter 11.

Beyond relationships, some companies are also designing, promoting, and selling unique experiences to their customers, which, according to Pine and Gilmore [167], is

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a way to differentiate and thrive in a customer-driven economy. The authors define experience as an offering distinct from customer service:

An experience occurs when a company intentionally uses services as the stage, and goods as props, to engage individual customers in a way that creates memorable events [167].

Examples include airline frequent flyer programs, theme parks, Saturn owner gath- erings, and Lexus weekend brunch and car wash events.

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As an extension of its brand experience, Apple operates retail stores in the United States, Canada, Japan, and the United Kingdom. The stores carry most of Apple’s products as well as many third- party products and offer on-site support and repair for Apple hardware and software. The first stores were opened in May 2001 and were designed for two purposes: to stem the tide of Apple’s declining share of the computer market and to counter a poor record of marketing Apple products by third-party retail outlets. As noted in [79], the design of the stores takes into account

1. Creating an experience. This is accomplished through the striking glass staircase, store design, and attention to the line of sight so that it feels more like walking into a hands-on museum than walking into a retail store.

2. Honoring context. The store is organized by the context in which people use the products. With digital cameras, photo printers, and Apple’s iPhoto software set up together, customers can envision using these products in their own lives. By acknowledging this context in the design of the store, Apple encourages its customers to dream about possibilities.

3. Prioritizing its messages. The store is visually spare with product packages kept below eye level and relatively few products on display. The store focuses on a handful of important messages.

4. Instituting consistency. The Apple personality comes through every time the customer encoun- ters the brand, whether on television, in print or outdoor advertising, or through interacting with one of Apple’s products. The Apple stores are no different, and Apple is able to project that per- sonality across all these channels by maintaining rigorous consistency of design.

5. Designing for change. The front window displays are rigged using simple flat panels mounted on tracks and cables. This system allows the displays to be changed quickly and easily while still allowing a diverse range of possibilities for grabbing the attention of passersby.

6. Not forgetting the human element. The people who staff the store form an integral part of the overall experience. Apple Store employees don’t look like run-of-the-mill retail workers. Instead of name tags, they have business cards. And they all carry iPods on their belts, creating the impression that they don’t just work for Apple—they live the lifestyle Apple is selling to cus- tomers. Apple’s retail workers are brand emissaries [79].

The Internet provides other opportunities for creating experiences that have not yet been fully explored. One of the strengths of the Internet is the creation of collaborative communities that can be used to develop relationships between people with similar interests or the desire to collaborate. One such technology is “eRoom,” which is a vir- tual workspace in which multiple parties can view and work with almost any form of unstructured data, such as drawings and presentations that are far too big for e-mail. These can be placed in an eRoom and discussed and walked through with clients or prospects via teleconference and Web demo. In addition, participants can trade com- ments within eRoom with no phone contact at all. Since the room is always there, it works for everyone’s schedule. Companies use the same technology to create “com- munities of interest,” some of which involve only its own employees, others a mix of internal staff and outside partners [122].

As with the initial introduction of services, companies do not yet charge for experi- ences. Before a company can charge for this offering, experiences must be seen by the customer as worth the price. This requires a large investment in making the experience valuable in itself. Disney’s theme parks are the prime example of a successful experience

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that many are willing to pay for. The parks also can be viewed as a means of selling Disney’s products—movies and various spin-off toys and accessories.

The ability to provide sophisticated customer interactions (e.g., relationships and experiences) is very different from the ability to manufacture and distribute products. This suggests the emergence of firms that specialize in providing the former. Patricia Seybold in The Customer Revolution [189] states that thriving when a customer is in control requires that businesses transform into completely customer-centric entities. She outlines eight steps to delivering a great total customer experience:

1. Create a compelling brand personality—a distinct offering that customers can identify with.

2. Deliver a seamless experience across channels and touch points. In other words, make sure that customers’ experience and information are the same no matter what access method they choose to use at a certain point.

3. Care about customers and their outcomes. 4. Measure what matters to customers: the quality of the customer’s experience as

opposed to internal company measures. 5. Hone operational excellence. 6. Value customers’ time. 7. Place customer’s information requirements and needs at the core. This requires the

ability to be proactive; for instance, reminding customers of maintenance require- ments and training opportunities.

8. Design to morph—the ability to change practices based on customer requirements.

Supply chain performance is critical in most of the points above—it can play a role in the branding as well as the seamless experience and operational excellence required to deliver leading customer experience. The “Made to Measure” case study at the beginning of this chapter clearly illustrates many of the points above from creation of a distinct offering to its customers; consolidation of information systems; willingness to pay for expensive freight to handle exceptions; operational excellence; saving its customer the time and expense of running the supply chain, as well as reducing inven- tory levels; and, finally, the ability to change based on the requirements.

12.2.6 Dimensions and Achieving Excellence Our analysis of customer value dimensions clearly shows that companies need to select their customer value goals since the supply chain, market segmentation, and skill sets required to succeed depend on this choice. In the The Myth of Excellence [53], the authors analyze many companies along the lines of how they rank on price, product, service, access, and relationship. Their conclusion is that companies cannot excel along all these dimensions (thus the name of the book). Their analysis shows that, in order to succeed, a company needs to be dominating in one attribute, differentiate itself on another, and be adequate in all the rest. Some of their examples:

1. Wal-Mart stands out on price, as in its motto “Always low prices, Always,” and sec- ondarily in large brand selection.

2. Target competes by emphasizing brand selection before price. 3. Nike Stores emphasize experience first and product second. 4. McDonald’s provides access first (they have stores almost everywhere) and service

second. 5. American Express emphasizes service first and access as a second attribute.

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12.3 CUSTOMER VALUE MEASURES

Because customer value is based on customer perceptions, it requires measures that start with the customer. Typical measures include service level and customer satisfac- tion. Seybold [189] goes a step further and suggests managing companies by addi- tional customer value measures such as growth in number of active customers, customer retention, defections, referrals, acquisition costs, and share of customer’s spending.

Our objective in this section is to introduce various basic measures of customer value, as well as supply chain performance measures. The latter are important since supply chain performance is an important contributor to customer value.

1. Service level. Service level is the typical measure used to quantify a company’s market conformance. In practice, the definition of service level can vary from com- pany to company, but service level is usually related to the ability to satisfy a cus- tomer’s delivery date, for instance, the percent of all orders sent on or before the promised delivery date. Many companies consider this measure so critical to their ability to succeed in today’s markets that they invest heavily in decision-support systems that allow them to quote delivery dates accurately by analyzing informa- tion from the entire supply chain.

There is a direct relationship between the ability to achieve a certain level of service and supply chain cost and performance. For instance, demand variability and manufacturing and information lead times determine the amount of inventory that needs to be kept in the supply chain. Clearly, when setting the level of service that should be used for a particular offering, it is important to understand customer value. For instance, customers may value low cost, information about the delivery date, and the ability to customize the product more than they value immediate delivery itself. This is definitely the case for Dell’s customers, who prefer to wait the additional time it takes to build and deliver the PC, rather than purchase off- the-shelf.

2. Customer satisfaction. Customer satisfaction surveys are used to measure sales department and personnel performance as well as to provide feedback for neces- sary improvements in products and services. In addition, as in the Peapod example, there are other innovative ways to receive information about customer satisfaction. However, customer surveys may not be the best way to learn about customer value. As Reichheld [174] points out, relying on customer satisfaction surveys can often be misleading. These surveys are easy to manipulate and are typically measured at the selling point while nothing is said about retaining the customer.

Indeed, more important than what customers say about their satisfaction is customer loyalty, which is easier to measure than customer satisfaction. This can be accom- plished by analyzing customer repurchase patterns based on internal databases.

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Lexus is a consistent winner of auto satisfaction awards, but it refuses to consider surveys as the best measure of satisfaction. To Lexus, the only meaningful measure of satisfaction is repurchase loyalty. Lexus considers the repurchase activities of cars and services as the only measure for its dealers’ success. Each Lexus dealership has a satellite dish that keeps information flowing back and forth to headquarters, where these measures are constantly tracked [174].

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An additional option is to learn from customer defections. Unfortunately, identi- fying those customers is not an easy task because dissatisfied customers seldom cancel an account completely. Instead, they gradually shift their spending, making a partial defection. However, if this type of tracking is possible, it may provide the key to increasing customer value.

Another example is Charles Schwab (see [189]). The online broker tracks customer asset accumulation, customer satisfaction, customer retention, and employee retention. These are the measures on which managers and employees receive incentives.

3. Supply chain performance measures. As we have seen, supply chain perfor- mance affects the ability to provide customer value, especially in the most basic dimension of availability of products. Therefore, there is a need to develop inde- pendent criteria to measure supply chain performance. The need for well-defined measures in the supply chain stems from the presence of many partners in the pro- cess and the requirement of a common language. This is precisely the motivation behind standardization initiatives such as the Supply-Chain Council’s reference models.

The Supply-Chain Council was organized in 1996 by Pittiglio Rabin Todd & McGrath (PRTM) and AMR Research, and initially included 69 voluntary member companies. In 2006, the Supply-Chain Council had closer to 1,000 corporate mem- bers worldwide and has established numerous international chapters. The Supply- Chain Council’s membership consists primarily of practitioners representing a broad cross section of industries, including manufacturers, services, distributors, and retailers; see [225].

The first model introduced was the Supply Chain Operations Reference (SCOR) model, which uses a process reference model that includes analyzing the current state of a company’s processes and its goals, quantifying operational performance, and comparing it to benchmark data. For this purpose, SCOR has developed a set of metrics for supply chain performance; its members are in the process of forming industry groups to collect best-practice information that companies can use to eval- uate their supply chain performance. Table 12-1 lists examples of metrics used to evaluate supply chain performance in SCOR, based on [138].

TA B L E 1 2 - 1

SCOR LEVEL 1 METRICS

Perspectives Metrics Measure

Supply chain reliability On-time delivery Percentage Order fulfillment lead time Days Fill rate Percentage Perfect order fulfillment Percentage

Flexibility and responsiveness Supply chain response time Days Upside production flexibility Days

Expenses Supply chain management cost Percentage Warranty cost as percentage Percentage of revenue

Value added per employee Dollars Assets/utilization Total inventory days of supply Days

Cash-to-cash cycle time Days Net asset turns Turns

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Once a specific company’s metrics are calculated,they are compared to those of industry benchmarks such as average and best-in-class. This enables identifying the company’s advantages as well as opportunities for supply chain improvement. Examples of these metrics are reported in the “Overall Business Performance” sur- vey conducted by PRTM [80]:

• Total supply chain management costs: This includes the total cost to manage order processing, acquire materials, manage inventory, and manage supply chain finance and information systems. The survey found that leading compa- nies have total costs between 4 and 5 percent of sales. Median performers spend 5 to 6 percent more.

• Cash-to-cash cycle time: The number of days between paying for raw materials and getting paid for product, as calculated by inventory days of supply plus days of sales outstanding minus average payment period for material. The survey shows that best in class have less than a 30-day cycle time, while median per- formers can be up to 100 days.

• Upside production flexibility: The number of days required to achieve an unplanned, sustainable, 20 percent increase in production. This measure is now under two weeks for best in class and even less than a week for some industries. The main constraint is material availability and not internal manufacturing or labor constraints.

• Delivery performance to request: The percentage of orders that are fulfilled on or before the customer’s requested date. The survey indicated that best-of-class performance is at least 94 percent and in some industries approaches 100 percent. The median performance ranges from 69 percent to 81 percent.

More recently, the Supply Chain Council introduced the Design Chain Operations Reference (DCOR) model that provides a framework that links business process, metrics, best practices, and technology features into a unified structure to support communication among design chain partners and to improve the effectiveness of the extended supply chain including the development chain. The original DCOR, inspired by SCOR, was developed by the Business Process Management organiza- tion of Hewlett-Packard and conveyed to the Supply-Chain Council in 2004.

While the SCOR model is organized around the management processes of plan, source, make, deliver, and return, DCOR is organized around the processes of plan, research, design, integrate, and amend. It spans product development, research, and development but does not attempt to describe every business process or activity. Where SCOR addresses the process categories of make to stock, make to order, and engineer to order product, DCOR is focused on product refresh, new product, and new technology as its key execution processes.

The SCOR model is a good example of a set of supply chain metrics and pro- vides a means to compare performance to other companies in the same industry or in others. It has the additional advantage of possibly becoming an industry stan- dard. The DCOR model goes a step further by including supply chain decisions in the design phase.

Despite the widespread use of these models, every company needs to understand its own unique environment and determine its measures based on that insight. For instance, Dell measures inventory velocity, and not the more standard inventory turns.

12.4 INFORMATION TECHNOLOGY AND CUSTOMER VALUE

Information technology has produced many valuable benefits for customers and busi- nesses. We will briefly review three aspects below. The first is exchange of information

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between customers and businesses, the second is the use of information by companies to learn more about their customers so that they can better tailor their services, and the third is enhanced business-to-business capabilities.

1. Customer benefits. Customer service has changed for many reasons. One of the most dramatic is the opening of corporate, government, and educational databases to the customer. This started with kiosks and voice mail and has accelerated signif- icantly with the uniform data access tools of the Internet. These innovations have had the effect of increasing customer value while reducing costs for the supplier of the information. Banks were the first to realize that by installing automated teller machines (ATMs), they could reduce their workforce. Voice mail was at first derided as dehumanizing, preventing interactions with a live person, but it actually allowed unmediated access to a user’s accounts at any time of the day from almost anywhere. The Internet has expanded these capabilities and allows users to access their accounts and perform transactions from any location at any time. This open- ing of the information boundaries between customer and company is part of the new customer value equation, where the information is part of the product.

The Internet also has had some less obvious effects [25]:

• Increased importance of intangibles. Customers have become accustomed to ordering even high-priced products from unseen salespeople over the phone or Internet. This increases the importance of brand names and other intangibles, such as service capabilities or community experience in purchasing decisions.

• Increased ability to connect and disconnect. The Internet makes it easier not only to identify business partners and connect to them but also to disconnect and find new partners. Increasing availability of information, including performance mea- sures and data, reduces the need to develop long-term trust relationships. Companies can rely on accessible, published track records to make decisions on quality of service. This ability is mainly important when there is not a consider- able initial investment in setting up the partnership. If there is, then frequent changes of partners may have a major impact on cost and available resources.

• Increased customer expectations. The ability to compare and the ease of performing various transactions over the phone and the Internet have raised expectations of similar services from every type of business as well as for business-to-business interactions.

• Tailored experience. The ability to provide each customer an individual experi- ence is an important part of the Internet. Amazon.com saves the customer’s information and recommends books and other items based on previous pur- chases. Mass customization can allow users to store their individual preferences or sizes and order custom-fit clothes and shoes from various vendors without having to reenter the information.

2. Business benefits. One way to enhance customer value is to use the information cap- tured in the supply chain to create new offerings for customers. The information now available allows companies to “sense and respond” to customers’ desires rather than simply make and sell products and services. Indeed, as we have seen, learning about customers takes time, requires some of the customers’ time, and eventually makes switching vendors more difficult. The learning process takes many forms from sophisticated data mining methods used to correlate purchasing patterns, to learning about each individual customer by keeping detailed data of preferences and pur- chases. The method applied depends on the industry and business model. Retailers would use the first method while service companies, as in the example below, would be more likely to track individual customer preferences and requirements.

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3. Business-to-business benefits. The “Made to Measure” case study at the start of the chapter illustrates how information technology allows suppliers to provide new services to its customers. Other examples include Dell’s establishment of its private e-marketplace (see Chapter 6) and use of the Internet to improve supply chain col- laboration by providing demand information and production data to its suppliers. Thus, these developments make it possible to outsource important parts of a com- pany’s business, but still keep close control over what it produces or services. For instance, strategic partnering relies heavily on information sharing and enables the partners to achieve supply chain efficiencies (see Chapters 5 and 8).

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In the 1930s, it was difficult for military personnel to obtain reasonably priced insurance, so a group of officers formed United Services Automobile Association (USAA) to provide insurance for military officers. USAA still offers services only to active and former military officers and their families and handles all transactions by mail and phone. USAA has used its extensive databases to expand into financial and shopping services for its members. When a customer calls USAA, the information about him or her can be accessed and updated and the customer can be offered a variety of ser- vices to match his or her needs. For instance, if a customer owns a boat purchased or financed through USAA, he or she could receive an offer to acquire insurance [168].

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Dell’s Direct Business Model Michael Dell started a computer business in his dormitory room in 1984 with this simple insight: He could bypass the dealer channel through which personal computers were being sold and instead sell directly to customers and build their personal computers (PCs) to order. This idea, now called the direct business model, eliminated the cost of inventory and the reselling expenses. The model had other benefits that were not apparent when Dell founded his company, Dell Computer Corporation. “You actually get to have a relationship with the customer,” Michael Dell explains, “and this creates valuable information which, in turn, allows us to leverage our relationships with both suppliers and customers. Couple that information with technology, and you have the infrastructure to revolutionize the fundamental business models of major global companies.”

Dell Computer’s model involves building computers based on components that are available in the market. The decision not to manufacture the computer components has relieved Dell of the bur- den of owning assets, research and development risks, and managing a large number of employ- ees. Spreading the development and manufacturing risk among several suppliers allowed Dell to grow much faster than if these functions were performed inside the company.

Dell’s use of technology and information to blur the traditional boundaries in the supply chain between suppliers, manufacturers, and end users has been named virtual integration. In a tradi- tional computer company, such as Digital Computer, processes were vertically integrated, with all the research, development, manufacturing, and distribution capabilities in-house. This allowed for a high level of communication and ability to develop products based on the company’s interaction with its clients. The disadvantage was the high risk and costs of development and the ownership of assets in a volatile industry. To achieve the advantages of an integrated company, Dell treats suppli- ers and service providers as if they were inside the company. Their systems are linked in real time to Dell’s system and their employees participate in design teams and product launches. Technology enhances the economic incentives to collaborate because it makes it possible to share design databases and methodologies and speed the time to market.

Dell measures inventory velocity, the reciprocal of the average amount of time a product spends in inventory. For this purpose, each component is marked with a date stamp. Accumulating inventory in the fast-moving PC industry is a high-risk proposition since the components can

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Other examples of information sharing between businesses can be found in [150]. The authors describe various arrangements between manufacturers and distributors for sharing information on inventory that results in cost reduction. These arrange- ments, motivated by the risk-pooling concept introduced in Chapter 2, allow manufac- turers and distributors to reduce overall inventory by sharing information about inventory in all locations and allowing any member of the channel to share the inventory.

SUMMARY

Creating customer value is the driving force behind a company’s goals, and supply chain management is one of the important means. Supply chain management strategy affects customer value; its considerations affect every aspect of customer value and must be part of any strategy or plan, not an afterthought. It is important to choose the appropriate supply chain strategy to match customer value with the company’s mar- ket. Excellence in supply chain management translates into customer value in many dimensions, from availability and selection to influencing the price at which a product can be sold.

The supply chain strategy in the Dell example was the business model, and it cre- ated the customer value of low prices. The TAL case study showed that the ability to manage the customer’s inventory created a strong differentiator in a highly com- petitive commodity business. Zara creates a fast-turning supply chain close to its mar- kets in order to stay current and keep shoppers coming back for new merchandise.

Customer access to information about the availability of products and the status of orders and deliveries is becoming an essential capability. This also creates opportunities to learn about customers and their preferences, and to create new modes of interaction. Dell uses this information to enhance its services, TAL uses the access to the customer to better predict trends, and Zara has a simple but effective feedback loop.

Adding services, relationships, and experiences is a way for companies to differen- tiate their offerings in the market and learn about their customers. It also makes it dif- ficult for the customers to switch to another service provider.

become obsolete very quickly. In some cases, such as Sony monitors, Dell does not keep any inventory but has UPS or Airborne Express pick up the monitors from Sony’s Mexican factory, the computer from Dell’s Austin, Texas, facility, and then match and deliver them to the customers. Dell suppliers benefit from the real-time information about demand and a commitment from Dell for a certain level of purchases. The results are impressive. While Compaq, IBM, and Hewlett-Packard all announced plans in late 1998 to emulate portions of Dell’s business model, with various build- to-order plans, all have had difficulty in making the transition. Most are moving to a target inventory level of four weeks, while Dell maintains just eight days of inventory, allowing it to turn over inven- tory 46 times a year.

On the customer side, Dell has segmented its customer base so that it can offer value-added services to different customers. Dell configures PCs and supports them for large customers. It will also load standard software and place asset stickers on the machines based on customer requests. For some clients, Dell has an on-site team that assists in PC purchasing and servicing. “The whole idea behind virtual integration is that it lets you meet customers’ needs faster and more efficiently than any other model.” Furthermore, it allows Dell to be efficient and responsive to change at the same time. By spending time with customers and following technological trends, Dell tries to be a few steps ahead of the change, and even create and shape it.

Source: Based on [128].

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Measuring customer value is at the heart of company goals and objectives, but identifying the appropriate measure is not an easy task. Dell measures inventory velocity, the reciprocal of the average amount of time a product spends in inventory, and not the usual inventory turns.

The ability to provide sophisticated customer interactions (for example, relationships and experiences) is very different from the ability to manufacture and distribute products. Because a distinctive expertise is required for each function, companies will gain by spe- cializing. We observe this trend in consumer product industries, where firms such as Nike and Sara Lee lend their name to products produced by many manufacturing companies.

There is no real customer value without a close relationship with customers. Today, this is possible not only through direct interaction, but also through information and communications technology. By allowing customers to state their preferences and learn- ing from them—a true two-way interaction—a firm can develop the means to achieve greater customer value and therefore loyalty. We have seen that successful companies all value this capability and build it into their business and supply chain model.

DISCUSSION QUESTIONS

1. Discuss the trade-off between product quality and price in traditional and online retailing.

2. Consider dynamic pricing strategies and their impact on profit. Explain why dynamic pricing provides significant profit benefit over (the best) fixed-price strategy as a. Available capacity decreases. b. Demand uncertainty increases. c. Seasonality in demand pattern increases.

3. Discuss how supply chain management decisions impact the ability to excel in cer- tain dimensions. Specifically, consider a. Conformance to requirements. b. Product selection. c. Price and brand. d. Value-added services. e. Relationships and experiences.

4. What is the dominant customer value the following companies bring? a. Starbucks b. The Gap c. Expedia.com

5. What additional experience opportunities does the Internet enable? 6. What measures would you use in a business like Amazon.com to evaluate the

company’s performance? The supply chain?

386 DESIGNING AND MANAGING THE SUPPLY CHAIN

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