CHAPTER 3

The Supply-Chain Management Concept

Although supply chains have existed since prehistory when humans began to trade, the formal concept of supply-chain management is relatively new. As recently as January 1997, the APICS Performance Advantage issue had on its cover “Supply Chain Management: What Is It?” Reportedly, the first use of the term supply-chain management (SCM) was in a report in 1982 by consultants Oliver and Webber.¹ Once just-in-time (JIT) introduced the concept of working with one’s immediate customers and suppliers, the extension in both directions to the entire supply chain was a logical concept. The transformation was not easy, as it was necessary to overcome decades of the materials-management concept, which basically considered the customers and suppliers to be the enemy.

Development of Supply-Chain Systems

The idea of managing a supply chain also raised technical problems. Much effort had been put into refining the MRP (material requirements planning)/ERP (enterprise resource planning) concept to make the internal workings of the firm ever more efficient. The late 1960s and early 1970s saw the development of MRP, which merged inventory planning with production planning. It was strictly internal to the firm. The only connections to outside firms were orders from customers and orders to vendors. MRP II added additional modules such as finance, accounting, and human resources but was still contained and operated within a single firm. Adding all internal resources to the MRP II system and merging all data into a single database yielded ERP—still an internal system. The parallel development of the lean systems philosophy in the 1980s meant that firms were beginning to consider supply chains of internal customers and suppliers. This functioned well in the MRP/ERP environment since the systems were still focused on the internal mechanisms of the firm. The integration of external customers and vendors into the supply chain, however, meant that supply chains were functioning as virtual companies—companies that were not legally a part of each other but operated as if they were. This new focus of SCM forced manufacturing and software firms to communicate more efficiently along the supply chain. Large firms might have hundreds of customers and thousands of suppliers with the resulting intertwined supply chains. AT&T estimates that the supply chain for its wireless handset includes “35 manufacturers, 60 to 80 parts suppliers, more than 1000 commodity-part suppliers, and an unknown number of brokers and distributors.”² The technical difficulties in developing software and protocols to make the systems work together are daunting. In addition to the IT protocols, there are more mundane protocols that can cause problems. Should the measurement systems be British or metric? What are the stock-keeping units (SKUs)? In the United States, we often use multiples of 12, such as a dozen or a gross, but the rest of the world generally does not. Which nomenclature and language should be used? How does one assign item numbers to the inventory?

Development of the Body of Knowledge

One of the problems facing SCM professionals was the lack of a body of knowledge on SCM. Organizations such as APICS and the Purchasing Management Association (PMA) had defined bodies of knowledge in their areas that focused primarily on the individual firm. There was not even general agreement on an exact definition for a supply chain. The Supply Chain Council in 1996 was the first organization to develop a widely accepted definition and concept of a supply chain. They are an industry group composed of companies (as opposed to individuals) and initially conceived of supply-chain management as consisting of four processes: planning the entire chain; and, within each link, sourcing (either purchasing from outsiders or producing internally); making (the fabrication or assembly process at that stage in the chain); and delivering (to the customer, who could be anyone from the next workstation to the final customer). The chain (or, using their terminology, the “thread”) itself would consist of five links: from the supplier’s supplier, to the supplier, to the firm in question, to the customer, to the customer’s customer.

A few years later they added returning as a fifth process to account for product returns because of poor quality, the wrong product shipped, the customer changing his or her mind, or recycling. For example, in the European Union (EU), automobiles are required to be 85% recyclable by weight. The manufacturers are responsible for taking back their cars and performing the recycling.³ Clothing sellers often have a large number of returns based on customers changing their minds or incorrect sizing.

Their formulation was dubbed the Supply Chain Operational Reference Model, or SCOR. It has become the de facto standard definition of a supply chain. The SCOR model is more than just a fancy diagram, however. It is a multilayer modeling system for designing new supply chains and improving existing ones. Its three pillars are process modeling, performance measurement, and best practices. The Supply Chain Council offers extensive training in the use of their techniques.

Certification

In the early 2000s, the demand from professionals for certification in SCM knowledge led to APICS offering the certification exam, CSCP (Certified Supply Chain Professional), in 2006. The certification exam (in contrast to the CPIM [Certified in Production and Inventory Management] certification, which has five modules) consisted of one module with four parts:

• Understanding supply-chain management fundamentals
• Building a competitive infrastructure
• Managing customer and suppler relations
• Using information technology

The topics ranged from basic inventory and quality management to the Sarbanes-Oxley Act, to the technical details of data file management. Supply-chain certification has proven to be quite popular, so other organizations have introduced their own designations, such as the Supply Chain Council’s SCOR Professional (SCOR-P) and the Institute of Supply Management’s Certified Professional in Supplier Diversity (CPSD).

Virtual Supply Chains

The concept of virtual supply chains began to arise in the 1990s. As supply chains became more complex, it also became clear that the old models for dealing with suppliers and customers would not work. The lean concept taught practitioners to work more closely with these two groups, and the SCOR model extended this thinking one link further in each direction to the supplier’s supplier and the customer’s customer. The traditional approach involved legal arrangements for either purchasing from a vendor or supplying a customer. Lean moved away from short-term contracts based solely on price but still involved contracts. Contracts generally involve an agreement over a period of time. In the case of lean, it could be a time period of years rather than months. The German firm Modine, for example, received an 8-year contract to build a factory in Toledo, Ohio, to provide cooling systems for the Jeep plant located there. Without a long-term contract, they would have shipped the cooling units from Germany rather than agreeing to build the plant.⁴

As was discussed in chapter 1, vertical integration is another way of forming long-term relationships with suppliers or customers. Vertical integration, however, involves capital investment, since one must take at least a controlling interest in the firm being vertically integrated. Since capital equipment, particularly at the factory or firm level, is not particularly liquid, the firm must go into vertical integration as a long-term investment. The primary reason firms moved away from vertical integration was to share costs with other links in the supply chain. Without a partner such as Modine, for example, Chrysler would have had to build its own factory to produce cooling systems. In addition to Modine, the Jeep complex actually houses three partners—Kuka, Hyundai, and Magna-Steyr—all operating independently but integrated into the production line.

In many industries, however, the so-called long term is very short. Electronics is a prime example, although there are others. Product life cycles are short, and even if a product appears to be the same to the consumer, the components may change frequently during its life cycle. Consumers now buy more laptop than desktop computers; even smaller netbooks made a big impact in the market as an alternative to standard laptops but were soon challenged by tablet computers starting with the iPad; smartphones are adding capabilities once found only in computers. The GSM (Global System for Mobile Communications) standard was the original basis for the Apple iPhones, but when Apple moved to include the CDMA (code division multiple access) technology, the internal components were different even though they looked the same to consumers.

To deal with this rapidly changing landscape, virtual supply chains began to arise. A virtual supply chain is a group of firms that are independent but act as if they were a single firm. Penske and the Indian company Genpact are described as “global outsourcing partners [that] work so tightly that they practically are part of the same organization.” Genpact is described as a “virtual subsidiary.”⁵ Although there may be some contractual arrangements among them, often there are not. The reason is flexibility. Firms want to change when the market changes, not when the contracts expire. The firms in a virtual supply chain will share information, including product and production plans, and expect their suppliers to have parts and materials ready when they are needed without the necessity for formal negotiations and agreements. When the market or technology changes, the virtual supply chain has the flexibility to change quickly at the same time. Firms may be added to or leave the virtual supply chain as they are needed or deemed redundant.

Difficulties With Virtual Supply Chains

Although virtual supply chains provide firms flexibility to operate in a changing environment, there are potential difficulties with them. One is trust. The firms in the virtual supply chain must trust each other to consider the welfare of the supply chain as a whole in their decisions and not just the welfare of their individual firms (remember the U.S. Civil War coffee beans example from chapter 1). One of the principles of supply chains is that only the final customer puts new money into the supply chain. All other transactions simply shuffle around existing money.⁶ If all firms in the virtual supply chain operated according to this principle, trust would not be a problem. In our accounting systems, however, money is not identified as “new” money or “existing” money; it is just money, and the accounting statements reflect what is happening at the level of the individual firm. In theory, the firms in a virtual supply chain should be sharing costs, profits, and risks. In practice, unless the supply chain firms are vertically integrated into a single firm, this is difficult if not impossible.

The second problem is that virtual supply chains do not exist in isolation. Suppliers often have multiple customers, which means they can be part of multiple virtual supply chains. These supply chains may have differing objectives or may be in competition with one another at some level. Electronics is also a good example here. Although there are many firms offering products in the consumer marketplace, there are relatively few contract manufacturers of everything from materials and components to final products such as laptops. If one traces backward through the supply chains for a Dell or an Acer, for example, at some point or points they will intersect (see chapter 2 for specific examples). Bill Walker, who has written widely about supply-chain management, emphasizes that the supply-chain manager must ask if his or her product line is “simultaneously connected to several supply chain networks that operate differently.”⁷ So to expect a virtual supply chain to act as if it is a single firm and share costs, profits, and risks raises significant problems if some of the component firms are members of multiple virtual supply chains offering competing products to the final consumers.

A classic example of this phenomenon was Solectron. Solectron was an electronics contract manufacturer supplying most of the firms in the industry, including Cisco, Ericsson, and Lucent. It was a well-run firm and had won two Malcolm Baldrige Awards for quality. In 2001, the industry was clearly experiencing difficulties. Other contract suppliers had spoken out about the problem. “I’m alarmed about the lack of ownership of the massive buildup of inventories,” said Harriet Green, an executive at distribution giant Arrow Electronics Inc., which saw its own inventory double in 2000 to $3 billion. “Everyone says it’s yours.” The suppliers, including Solectron, had been given the production plans for the end users in the virtual supply chains. From the perspective of the suppliers, seeing all the plans, it was clear that the end firms were overly optimistic in terms of both the size of the total market and their own market shares. When they pointed this out to their customers, they were told basically, “trust us.” According to Ajay Shah of Solectron, you cannot “sit there and confront a customer and tell him he doesn’t know what he’s doing with his business.” Firms like Solectron and Arrow trusted their customers and increased their orders to their suppliers and inventories to supply the production and marketing plans they had been given. When the dot-com bubble burst in 2001, the customers essentially said, “Sorry, we changed our minds.” Solectron and Arrow ended up with large inventories for which they had no customers. The customers they had trusted no longer wanted them. It was too late for Solectron to cancel its orders to its 4,000 suppliers, and its inventories totaled $4.7 billion.⁸ Solectron languished for several years and eventually disappeared, purchased by Flextronics.

A more recent example resulted from the 2010 BP oil spill in the Gulf of Mexico. BP placed and subsequently canceled orders with a dozen or more suppliers who were “suddenly saddled with containers of inventory, canceled orders and no way to pay their mounting bills.” This not only affected BP’s immediate suppliers but also firmed up the entire supply chain.⁹

A third problem is the amount of information available in a virtual supply chain. Although information sharing is essential for a virtual supply chain to function, information has value. Information can range from marketing intelligence, to product plans, to financial information, to intellectual property. As was pointed out in chapter 1, a reason some firms are vertically integrating is to safeguard this information (e.g., Apple safeguarding its intellectual property by moving design in-house). Partners in the virtual supply chains have to trust each other to keep this proprietary information to themselves.

Although it is difficult to find examples in which this has not been the case, since firms are reluctant to disclose where they have been wronged, it is easy to find examples of potential problems. TAL Apparel Ltd. of Hong Kong is a contract manufacturer of men’s shirts. Through its factories in Southeast Asia, it manufactures one in eight men’s shirts sold in the United States. Its customers include JCPenney, J. Crew, Calvin Klein, Banana Republic, Tommy Hilfiger, Liz Claiborne, Ralph Lauren, and Brooks Brothers. Although there has never been a hint of impropriety about TAL, it is easy to see the diligence it must apply in safeguarding marketing and product information for its customers, who are all competitors in the same clothing market.¹⁰

An example in which the information has been misused is in the growth of the so-called expert networks. It became obvious to mutual funds, research firms, investment bankers, and hedge funds that supply chains contained information that they could use to gain an advantage in their trading of shares. These expert networks grew to gather and disseminate (i.e., sell) information about product plans and finances. This has caused a redefinition of “insider information.” It is no longer necessary to find a source inside a firm to get this insider information; the information is available from other members of the supply chain. The U.S. Attorney’s office in Manhattan, New York, has redefined insider information to include this information obtained from outside the individual firm but inside the virtual supply chain.¹¹

Another example is the so-called spying probe at Renault. The company did not release details, but intellectual property involving its electric cars had been threatened through its subcontractors.¹² This is exactly the reason Apple is bringing more design work in-house. Renault later admitted they had been “tricked.”¹³ The whole affair has been described as “a case study in corporate paranoia, distracted leadership—and the perceived threat of an advancing China.”¹⁴ Clearly, global subcontracting contains risks not present in domestic markets.

A final difficulty is the basic inability to share information and data. As was pointed out earlier in this chapter, firms had problems coordinating information systems in relatively stable supply chains. When the virtual supply chain can change members rapidly, trying to maintain secure communications connections can be more difficult. Trying to get all firms or potential partners in a supply chain to use the same information systems and protocols is virtually impossible.

The Chain Master

Supply chains, virtual or otherwise, do not function automatically. Around 2000, the concept of the “chain master” began to be codified. The chain master is the firm or division that controls the supply chain. Control may range from dictating the flow of goods or services through the chain to being a benign controller by virtue of some characteristic that makes it a controller. Firms are not elected or appointed to the role of chain master. They can emerge as the chain master for any one of a number of reasons:

• Market share. A firm may wield power in the chain simply because of its dominance in the market. Suppliers have no choice but to deal with it. A classic example is Walmart, which sells 32% of the disposable diapers in the United States.¹⁵ Any manufacturer of disposable diapers must deal with Walmart or suffer greatly. One consultant was quoted as saying, “The second worst thing a manufacturer can do is sign a contract with Wal-Mart. The worst? Not sign one.”¹⁶
• Size. A firm may not have a dominant market share but may be large enough relative to its suppliers to operate as the chain master. An example is the automobile manufacturers. Chrysler does not dominate its market, but it is still considerably larger than its suppliers. This allows it to dictate many of the terms by which its suppliers will operate. As they outsource more subassemblies and modules to fewer and fewer suppliers, however, they may find their suppliers getting larger and challenging their position as chain master. In 2005, in order to gain bargaining leverage, Lear stopped shipping parts to Chrysler. Chrysler had to get a court order forcing Lear to resume shipment of the parts.¹⁷ Chrysler got its parts, but this was not exactly in the spirit of supply-chain cooperation. Sometimes the same things happen to the larger suppliers. In 2008, Dana Holding Corp., a first-tier supplier for Chrysler and others, had to sue Citation Corp. to force them to ship parts that Dana had ordered. The basic issue was Dana overreaching its chain-master position. A 2004 study by Planning Perspectives Inc. of Birmingham, Michigan, showed that the Japanese manufacturers were less likely than the Americans to abuse their chain-master position. The result was greater cooperation by the suppliers with the Japanese, including collaboration on quality and design.¹⁸
• Technology. A firm may control a vital technology and thus be able to wield the power of a chain master. This control may be through patent protection or through consolidation of suppliers. Many of the chips, circuit boards, and subassemblies in the IT industry are being manufactured by only a few firms. This is because of the specialized knowledge and machinery required to make these parts. When potential chain masters clash, there must be a resolution. Ford, for example, paid Toyota to license its hybrid technology, even though Ford had no intention of using it. The risk of Toyota trying to gain control of Ford’s supply chain by claiming patent infringement was so great (and potentially too costly and disruptive) that Ford “paid off” Toyota.
• Control of channels. Because of particular marketing and sales arrangements in a supply chain, one firm may have control of the channels of distribution. Since the production of products is meaningless until they are sold, the firm controlling the channels controls the supply chain. An example is a firm (which must remain anonymous) that was established in the 1990s as a subsidiary of a major IT company for the purpose of developing a new computer accessory. The firm established a well-organized, efficient supply chain up to the point of distribution. The company was told by the parent company to use the existing sales force. The salespeople had little interest in selling the new product, so it failed to capture market share and the supply chain died. The subsidiary was subsequently disbanded.

In most supply chains, there is a natural chain master, but the firm does not always step up to perform the chain-master functions. In a research project in the early 2000s, four firms were studied to determine their roles in the supply chain. Two were relatively small firms, and two were large. One of the small firms was in a relatively weak supply chain in which the natural chain master played a passive role. The result was difficult production planning and the subsequent buildup of inventories to compensate for poor planning. The second small firm was the natural chain master but failed to act in the role. The result in the supply chain was similar—poor production planning because of a lack of communication among the links in the supply chain and a buildup of inventories in compensation. The first large firm was described earlier. The chain master controlled the channels of distribution and did not consider the product to be sufficiently important, so it failed to get the product to the customers in sufficient numbers to make the supply chain profitable. The second large firm, in the food industry, was the chain master by virtue of its size. It was aware of its chain-master role and had people in charge of the supply chain who understood the role. The result was the sharing of information, the smooth functioning of the supply and production process, and the minimization of inventories.¹⁹

Summary

Supply chains are complex organisms. Managing supply chains involves issues that either might not arise in an internal supply chain or might not arise in the same context or with the same intensity. The effective supply chain manager will do the following:

• Be aware of the evolutionary origins of supply chain management through JIT/lean concepts. The suppliers and customers are partners, not enemies.
• Realize that creating IT links with supply chain partners can be both difficult and risky. They are technically difficult because of partners using different software packages and protocols and risky because now there are more access points to one’s data and information.
• Utilize the resources of industry organizations such as the Supply Chain Council. The council, for example, has over 500 performance measures from which one may choose.
• Participate in virtual supply chains with an appreciation of the risks. Virtual supply chains can provide much-needed flexibility but require close monitoring and a lot of trust.
• Exercise authority wisely if you are the chain master. If you are not, encourage the natural chain master to do so.