Outsourcing: Supply-Chain Stretch

Manufacturers meet growing value-chain challenges with a little help from vendor partners.

Saturday, July 01, 2006
By Jill Jusko

Opportunity and challenge. Both are by-products of globalization for many U.S. manufacturers. New markets open both for finished goods and for the sourcing of raw materials and components -- but the supply chain stretches. Consequently, supplier lead times lengthen; the demand for their products remains now, now, now; and cross-border and international regulations add yet another level of complexity.

On a domestic scale, customers' demands for product on a just-in-time basis continue to challenge suppliers, while manufacturers remain in pursuit of ways to reduce the amount of inventory they carry.

To meet these challenges and opportunities, U.S. manufacturers look increasingly to their value-chain partners for assistance, both by outsourcing logistics efforts to third-party providers and by partnering more closely with their valued suppliers.

StorageTek de Puerto Rico, a company of Santa Clara, Calif.-based Sun Microsystems Inc. and a 2005 IW Best Plants winner, for example, holds approximately 70% of its inventory in its Supplier Logistics Center (SLC), a warehouse or inventory hub operated by a third-party provider and located less than one mile from StorageTek's manufacturing facility in Ponce. That third-party provider handles transactions related to incoming inventory from StorageTek suppliers and delivers inventory to StorageTek in response to pull signals from the manufacturing floor.

The SLC, which began operations late in 2002, is one component of StorageTek's comprehensive lean supply-chain effort driven by pull signals, explains Osvaldo Cruz, materials group manager for the Puerto Rico operations. Among its benefits, he notes, are a reduction in the number of warehouses StorageTek operates, reduced inventories as a result of the lean supply model, and more open space in the factory for additional production. The inventory in the SLC is owned by the supplier until StorageTek pulls it into production.

Additionally, StorageTek employs a third-party financing strategy for inventory received from a Far East supplier. The program temporarily transfers ownership of the inventory from the supplier to the third-party provider until StorageTek pulls it into production, allowing the supplier to get paid more quickly, yet relieving the manufacturer from the costs of carrying inventory. (A more detailed description of the trade payables program is available at http://www.industryweek.com/ReadArticle.aspx?ArticleID=11070.)

3PL Use Widespread

The use of third-party logistics providers is ubiquitous in manufacturing, with all signs pointing to a desire by users for even greater service offerings. The 2005 IndustryWeek Value-Chain Survey, for example, showed that more than half of respondents outsourced -- in whole or in part -- their inbound and/or outbound transportation, as well as customs and export-related functions. More than four in 10 manufacturers who participated in that same study, conducted with research partner IBM Business Consulting Services, also said they outsourced warehousing and distribution functions.

Add to that the results of a separate study, the 2005 Third-Party Logistics (3PL) Study, which showed that approximately 80% of North American survey participants employed third-party logistics providers. Manufacturers represented 70% of the North American respondents to that study, a 10th annual effort by Georgia Institute of Technology, with contributions from consulting firm Capgemini, global logistics provider DHL and technology provider SAP.

"Increased global sourcing is a major force in the use of 3PLs as formerly domestic companies start to learn about the complexities and capacity constraints and regulations involved in international commerce," comments Cap-gemini's Peter D. Moore, vice president, logistics and fulfillment/RFID. "As the need for visibility to inventory is extended beyond the enterprise and over long distances, many companies are seeking partners to help them."

Indeed, John Kivinen, director of supply-chain design, UPS Supply Chain Solutions Consulting Services, says global sourcing has meant increased business, such as "more shipments moving longer distances. This provides an increase in transport volume. But more than that, it increases opportunities to provide end-to-end global solutions that help to minimize the cost and risk that global sourcing creates."

And users want more services. According to the 2005 3PL study, "Although many 3PL providers satisfy user requirements around basic services, such as transportation or warehousing, users continue to identify ongoing development of capabilities as a key issue. The stated need for advanced supply-chain services and for organizations that can serve as 'integrators' has validated a 'strategic service' model in meeting -- and servicing -- the needs of 3PL users."

Results from the IndustryWeek Value-Chain Survey suggest that manufacturers might be well-advised to consider outsourcing their logistics functions. Indeed, survey respondents overwhelmingly reported that their outsourcing of transportation functions was effective in helping achieve business objectives. Nearly 93% identified it as effective, with fully 51% calling it "extremely effective." Similarly, nearly 88% of survey respondents who outsource their warehousing and distribution centers said such outsourcing was effective, with nearly 55% reporting that it was "extremely effective."

Partnering For Improvement

Is it outsourcing or is it partnering? At 2005 IW Best Plants winner Thomas & Betts Corp., Athens, Tenn., Operations, about 70% of raw material components is supplier-managed. It's a partnership between the manufacturing plant and the supplier, says plant manager Herb Bradshaw.

"Our suppliers are now able to monitor current on-hand quantities in our plant and plan their daily deliveries in 24-hour windows. We also maintain projected future demand by component part number based on a 13-week historical usage. This demand can be modified to accommodate any type of special sales scenarios," he explains.

Bradshaw says a once primarily manual system has evolved into primarily electronic inventory and materials management process. Five daily supplier-managed-inventory reports help suppliers plan and deliver stocks daily.

The plant manager said some job elements of internal material management employees have diminished or been consolidated as the supplier-managed inventory program has grown. However, "even though our suppliers are doing an excellent job, we still have responsibility to manage our end of the business," he says. In fact, the plant's materials and production departments were merged to create value-stream supervisors within the facility. Those supervisors still have full responsibility for planning, scheduling and supervising a complete product family. "The fact that our suppliers have become integral to our success through their shared responsibility and inventory management is a key element."

Multiple benefits have accrued as a result of the supplier-managed inventory program. Bradshaw says raw and component inventories have been reduced by nearly 70%; inventory accuracy is very high; stock outages have been minimized or eliminated; and the need for an annual physical inventory has been eliminated, saving about $35,000 each year.

When the chain breaks

The Economist , June 17, 2006 U.S. Edition

Being too lean and mean is a dangerous thing

IT BEGAN on a stormy evening in New Mexico in March 2000 when a bolt of lightning hit a power line. The temporary loss of electricity knocked out the cooling fans in a furnace at a Philips semiconductor plant in Albuquerque. A fire started, but was put out by staff within minutes. By the time the fire brigade arrived, there was nothing for them to do but inspect the building and fill out a report. The damage seemed to be minor: eight trays of wafers containing the miniature circuitry to make several thousand chips for mobile phones had been destroyed. After a good clean-up, the company expected to resume production within a week.

That is what the plant told its two biggest customers, Sweden's Ericsson and Finland's Nokia, who were vying for leadership in the booming mobile-handset market. Nokia's supply-chain managers had realised within two days that there was a problem when their computer systems showed some shipments were being held up. Delays of a few days are not uncommon in manufacturing and a limited number of back-up components are usually held to cope with such eventualities. But whereas Ericsson was content to let the delay take its course, Nokia immediately put the Philips plant on a watchlist to be closely monitored in case things got worse.

They did. Semiconductor fabrication plants have to be kept spotlessly clean, but on the night of the fire, when staff were rushing around and firemen were tramping in and out, smoke and soot had contaminated a much larger area of the plant than had first been thought. Production could be halted for months. By the time the full extent of the disruption became clear, Nokia had already started locking up all the alternative sources for the chips.

That left Ericsson with a serious parts shortage. The company, having decided some time earlier to simplify its supply chain by single-sourcing some of its components, including the Philips chips, had no plan B. This severely limited its ability to launch a new generation of handsets, which in turn contributed to huge losses in the Swedish company's mobile-phone division. In 2001 Ericsson decided to quit making handsets on its own. Instead, it put that part of its business into a joint venture with Sony.

This has become a classic case study for supply-chain experts and risk consultants. The version above is taken from "The Resilient Enterprise" by MIT's Mr Sheffi and "Logistics and Supply Chain Management" by Cranfield's Mr Christopher. It illustrates the value of speed and flexibility in a supply chain. As Mr Sheffi puts it: "Nokia's heightened awareness allowed it to identify the severity of the disruption faster, leading it to take timely actions and lock up the resources for recovery."

There are two types of risk in a supply chain, external and internal. As in the Ericsson case, they can conspire together to cause a calamity. This seems to be happening more and more often. It is not just that inventory levels are getting leaner, but the range of items that companies are carrying is also growing rapidly, points out Ted Scherck, president of Colography, an Atlanta-based logistics consultancy. Just look around a typical supermarket. Where it once stocked mainly groceries, it now also sells clothing, consumer electronics, home furnishings and many other items.

This compounds supply-chain problems. "In many cases shippers have gone too far in implementing the lean supply chain and have found themselves virtually out of business because of a by now annual catastrophic event," says Mr Scherck. As examples, he cites a dock strike in California, a typhoon in Taiwan, a tsunami in Asia and a hurricane in New Orleans. More recently a huge explosion at the Buncefield oil storage terminal in Britain's Hertfordshire caused widespread problems for businesses not just locally but across a large part of England.

In 2003 a number of companies suffered serious disruption because of severe acute respiratory syndrome (SARS). Even though SARS turned out to be not as virulent as influenza, and only 8,000 people got infected, with one in ten dying, it still cost an estimated $60 billion in lost output in South and East Asia. The latest worry is the spread of avian flu. If the virus concerned were to mutate and become infectious for humans, the consequences could be far more devastating.

Sometimes even a political wrangle in Brussels will bring a supply chain to a shuddering halt. Last autumn some 80m items of clothing were impounded at European ports and borders because they exceeded the annual import limits that the European Union and China had agreed on only months earlier. Retailers had ordered their autumn stock well before that agreement was signed, and many were left scrambling to find alternative suppliers. A compromise was reached eventually.

However, most supply-chain disruptions have internal causes, says Vinod Singhal, a professor of operations management at the Georgia Institute of Technology (see chart 3). His research on the effects of supply-chain failures shows that they can be immensely damaging. This emerged from an investigation into what happens to shareholder value when companies announce supply-chain problems, based on a sample of 800 such announcements big enough to generate news in the financial press. The disruptions ranged from a delay in 2000 of shipments of workstations and servers by Sun Microsystems to a parts shortage at Boeing in 1997 that the company said would delay some deliveries.

Typically a company's share price dropped by around 8% in the first day or two after such an announcement. This is worse than the average stockmarket reaction to other corporate bad news, such as a delay in the launch of a new product (which triggers an average fall of 5%), untoward financial events (an average drop of 3-5%) or IT problems (2%). And the effects can be long-lasting: operating income, return on sales and return on assets are all significantly down in the first and second year after a disruption.

"It's like having a heart attack," says Mr Singhal. "It takes a long time to recover." And have the dangers increased in recent years? Like other experts, he believes that some companies may be running their supply chains a little too lean: "It's great when it's working, but too much leanness and meanness can actually hurt you."

The financial information analysed for this study came out before the terrorists attacks on America on September 11th 2001 and the subsequent massive tightening of security around the world, so global supply chains today are subject to many more potential hold-ups. Still, it is impossible for customs officials to search every container, box or package entering every country, so the responsibility for security and import declarations rests with the shipper and the company carrying the goods. In effect, the system works by a process of pre-clearance. The details of everything contained in a shipment now have to be sent ahead electronically, and customs and security officials at ports and cargo hubs divert anything they want to take a closer look at.

Companies that put a lot of effort into ensuring the safety of the goods they are sending, or carrying on behalf of others, are likely to be rewarded by seeing them pass swiftly across borders. Customs clearance is itself a huge business. "Information and technology is the only way to accomplish this," says Ed Clark, chief executive of FedEx Trade Networks. These systems also need to be able to cope with unplanned events. For instance, if a cargo aircraft has to divert to another airport because of bad weather, centrally held electronic versions of the necessary "paperwork" can be transmitted to a new port of entry.

Sometimes even computer systems will not alert a company to a problem. For instance, Toyota is upgrading its business-interruption planning to a higher level in response to the filing for Chapter 11 bankruptcy protection last year by Collins & Aikman, a big American-based supplier of trim items for cars. The parts company had been supplying Toyota in Europe, which had an inkling that something might be wrong and started to arrange alternative supplies to be on the safe side.

"We realised that through good communication and contacts we had managed to identify a risk in good time and take action," says Mark Adams, Toyota's European purchasing manager. It was a lesson the company wanted to apply more widely, so it launched a weekly get-together for managers, sometimes by videoconference, to discuss any new rumours and potential risks梐nd work out a recovery plan just in case.

Toyota builds more than 600,000 cars a year in Europe, where it has some 200 first-tier suppliers operating more than 400 factories. They work with second, third and fourth-tier suppliers, so the overall number grows exponentially the further you go down the chain, where problems can be harder to spot. This means the suppliers themselves have to be involved in the risk-management process.

Mr Adams says a supplier may find it difficult to tell the company that it has a problem. But Toyota emphasises that given the co-operative nature of a supply chain, with early knowledge there is more chance of putting things right. Mr Adams explains that as a first step the company would seek to help its suppliers solve their own problems. "We are hugely more competent at this than we were a year ago," he adds. And so far, Toyota has been able to act swiftly enough to prevent any supply problems holding up production.

Is a lean, flexible and highly outsourced supply chain like Toyota's any safer than the vertically integrated production methods of old, as practised at Henry Ford's giant River Rouge manufacturing complex near Detroit? At its zenith in the 1920s, ships carrying raw materials such as iron ore and coal梠ften from Ford-owned operations梬ould unload directly into the plant. Steel was produced on site, then cast, pressed and machined into all the components needed to assemble a car. The process was inflexible梬hich is why Ford's cars could be any colour as long as it was black梐s well as rather inefficient. Toyota has turned that process on its head, making its manufacturing system far more capable of responding to change. That is one of the best insurance policies a company can have.

"You are always looking for flexibility, particularly as you manage risk," says Cisco's Mr Mendez. Again, transparency is important. "Once you understand where you are, you can begin to design and budget for contingencies," he adds. The risk-management budget should perhaps be seen as separate from the operating and capital budgets, he suggests, to allow risks and their potential costs to be dealt with more directly.

Are competitive pressures pushing companies towards running their logistics operations ever leaner? "They are galloping there," replies Michael Cherkasky, the boss of the company that owns Marsh, the world's largest insurance and risk specialist. "I don't think many understand the risks that are involved." He is concerned that companies are outsourcing not only peripheral activities but many core functions too. That makes it difficult to pick up the pieces when things have gone wrong.

Britain's Cranfield University is running a research programme into the fragility of supply chains, prompted by the British government after protests over high fuel costs in 2000. Lorry drivers blockaded fuel-delivery depots, bringing many businesses to a standstill. "I reckon this was the first time the government realised there were such things as supply chains, and just how fragile they had become," Mr Christopher told a recent conference.

Some people even suggest that supply chains should be regulated, a bit like public utilities, because countries have become so highly dependent on private-sector production infrastructure. Barry Lynn, author of a book on this subject, "End of the Line", thinks that perhaps companies should be required to limit their outsourcing and use more than one supplier of essential items. In his book, he argues that globalisation and outsourcing provide only a temporary benefit to consumers because the companies that form part of supply chains will buy each other up in pursuit of ever greater efficiency, and thus lose most of their flexibility.

There are signs that some companies are already alert to these concerns and may be planning to reorganise their supply chains to make them safer. That process could speed up if disruptions become more common. Mr Sheffi is in no doubt that the best way to achieve a resilient supply chain is to create flexibility梐nd that flexible companies are best placed to compete in the marketplace.

"Customers are rethinking their global supply chains for a lot of their products," says Mr Scherck. For bigger firms, that could mean adopting what he calls the "continental strategy": having a spread of suppliers in different continents for added flexibility, as Dell and Cisco do. Smaller firms may not be able to achieve a geographical spread. But in any case, companies do not want to go back to carrying lots of inventory in different locations. "So you need to do something in-between," concludes Mr Scherck. "You will have to carry a little more cost than an absolutely lean model, but you get protection."

"There are very legitimate, very good business reasons not necessarily to complete and ship from Asia," says Flextronics's Mr Wright. Companies may consider other options in other parts of the world even though these may look more expensive. "Sometimes you might have to go to a higher cost structure to make your supply chain more robust and reliable," observes Mr Singhal.

So the limits of globalisation may end up being defined by the management of supply-chain risk. And unfortunately the world is unlikely to become any safer. There will always be natural disasters, as well as corporate mistakes. In order to insulate themselves from the consequences, companies will have to spread their risks more widely. That does not necessarily mean fewer aircraft will be queuing up to land at Louisville and Memphis, or that fewer container ships will set sail from Asia's bustling ports. But it does mean that in future companies may spend rather more to maintain a number of different supply chains, and some of those may be closer to home.

The Lean Supply Chain

Thursday, June 08, 2006
Stephen Hochman

The principles of lean are universal enough to apply outside the four walls of a company, yet few manufacturers have extended these techniques to their supply networks. Why? Cultural inertia and the complexities of network globalization have stood in the way. To overcome these obstacles, supply chain managers can start by improving true-cost models, value stream maps, and narrow process improvement trials.

Still early in the game



Dan Jones, co-author of The Machine That Changed the World, advises companies to define the scope of their value streams as broadly as possible. Improve only one small piece of your value stream, logic says, and you are sub-optimizing. Look at the whole chain and new, better ideas emerge for how to deliver value to your customers on demand.

So far most companies have failed to extend their lean processes to partners in their supply networks. A recent AMR Research study found that organizations were five times more likely to push inventory cost to their suppliers than they were to co-invest in demand pull (see Figure 1). These companies are saving on direct cost, but leaking profits to lost velocity.

Why is it taking so long?

One reason for the gap between a lean supply chain vision and reality is often the sheer magnitude of the culture shift. It is easy to forget that Toyota started down the lean path back in 1950, well before lean even had a name. For Toyota, lean was just a way to deliver more value at lower cost. The company also had the early advantage of network proximity. Back then, if its procurement managers had an idea for process improvement, they could just walk across town to their suppliers and press the issue.

Add 5,000 miles, 12 time zones, different languages, and different cultural norms—change becomes more difficult. It’s one thing to persuade your management team of the rewards of moving faster at home, but it’s another to convince overseas suppliers to take on new planning models and accept alternate incentives. If you are not at odds with your supply partners over direct costs, you are in the minority. Introduce the idea of shared profit destiny and new metrics tied to flow and speed, and the gate may clang shut. It’s not that your partners don’t want to improve. It’s that the geographic, cultural, and historical obstacles to common understanding are vast.

A second often overlooked reason for the slow pace of lean adoption is the analytical complexity. Inside the four walls of the factory, cellular production techniques and visual kanbans are often all you need to operate a clean, fast, reliable pull process.

Vertically integrate back through raw materials—like Spanish retailer Zara has done—and you may be able to get by with a point-of-sale (POS) feed from store to factory, simple product data management and CAD suites to manage modular material and product designs, and a distribution package to track trucks going from factory to stores in adjacent markets (Zara faces new challenges as it expands overseas, but that’s a story for another time). But most of us face competitive pressures that make more complex supply networks an economic necessity.

Getting down to lean business

Network complexity and cultural inertia are here to stay, but five simple startup tactics can help you begin extending lean out to your supply network:

Step 1: Build consensus on sources of customer value.

Decide which metrics really matter. Sit with your controller or your CFO and start to have the hard conversations about total cost, including the cost of lost time. Collaborate on a simple model to capture key economic assumptions about costs and benefits of velocity. If speed is the biggest profit driver, there will be direct cost tradeoffs to flow past the more intransigent bottlenecks in your supply network.

Develop simple tradeoff scenarios that your CFO can feel comfortable presenting informally to the rest of your senior team. Don’t set out to change the accounting system, but do validate the model with key supply network stakeholders. Use the numbers to gain buy in on the magnitude of the lean supply chain opportunity.

Step 2: Value stream map your network’s current state.

Use your cost-benefit model to persuade functional champions to carve out three uninterrupted days, preferably with a lean/kaizen facilitator, to map out the current state of your supply network.

Choose which metrics will be attached to each box. A general rule is to use elapsed time per process step. The theory says remove non-value-added time and cost will follow. If you have a particularly close supplier relationship, involve that supplier. One company even included a trusted customer in its initial mapping effort. The more parties you have at the table, the more you will gain visibility to the scope of opportunity.

Step 3: Quantify the muda (or waste).

Companies often find that less than 20% of their supply chain work time is value added. One footwear company found that its value-added work time was 6%. Numbers like these catch people’s attention.

Step 4: Map your future state and your ideal state.

The idea of the future state is to go after quick wins and deliver tangible results. For that reason, a future state value stream map generally looks anywhere from three to nine months out.

The ideal state allows you, in parallel, to take the gloves off and think about more dramatic innovation. It sets the guideposts so that your interim future states don’t impede global optimization.

Step 5: Pilot a near-term network improvement.

Now that you’ve defined the ideal vision of your lean supply network, seek a low-cost, high-impact target for improvement. If heavy automation is required, then that’s probably not the right place to start.

One high-tech manufacturer taking on a lean supply chain initiative insisted that all decision support processes be simple enough that any manager could understand why a decision was being made, but sophisticated software tools can help. A subsequent article will address the advantages and pitfalls of applying technology to lean supply chain initiatives.

© Copyright 2006 by AMR Research, Inc.