Ram Reddy
Recently, I had the opportunity to work on a supply-chain problem from the retail sector. Our group was tackling the problem of excessive inventory buildups at the distribution centers and retail outlets. As part of that engagement, I interacted with many professionals from IT, supply chain, and logistics. We followed good quality principles and tried to do a root-cause analysis, with conflicting results. You’ve heard of the “three blind men and the elephant” problem? Well, we found similar results in our root-cause analysis: The logistics specialist thought it was a logistics problem, the IT specialist felt that a lack of systems integration led to excessive inventory buildups, and so on.
This firm’s previous attempts at solving the excess inventory problem led to numerous initiatives in the logistics, supply chain, and IT areas that exacerbated an already bad situation. Not having a strong background in the retail sector actually helped me drive the group to consensus on the problem’s definition. If you have been fighting the battle over many years, you tend to lose perspective and focus on operational minutiae, forgetting the big picture. In particular, IT professionals (who are analytical by nature) view the “big picture” with a bag of salt. After concluding this project, I talked to numerous IT colleagues and realized that we rarely discuss “big picture” supply-chain issues in our journals and magazines. Supply-chain technology articles rarely address supply-chain business drivers. In this cloumn, I aim to give you an overview of the strategic business drivers in the supply chain that affect system design.
Functional vs. Innovative Products
People traditionally characterize retail sector products as durable or nondurable goods. However, Marshall Fisher (among other supply-chain experts) suggests classifying retail products based on their demand patterns, which leads to two categories: functional and innovative products. This categorization is very useful as it helps determine the appropriate supply-chain design to support differing demand patterns. Even though this classification is simple, it is very powerful in explaining the mismatches between product attributes and supply-chain design.
Functional products are commodities that have predictable demand patterns. Some good examples of functional products are light bulbs and toothpaste; these commodities have many substitutes and typically offer low margins for the retailer. They have long lead times to order from suppliers, rare stock-out situations, and usually insignificant price markdowns (unless it is part of a pricing promotion). Innovative products, however, have relatively high margins, very few substitutes (if any), lead times in days from suppliers, frequent stockout situations, drastic markdowns to clear excess inventory, and unpredictable demand. Some good examples of innovative products include Beanie Babies, Furbies (as long as the craze lasts), and most recently, Pokemon toys. These products are innovative because no historical scanner data exists to project future sales — as is the case for functional products. Thus, innovative and functional products’ characteristics lay the foundation for supply-chain system design.
Supply-Chain Characteristics
Primarily, cost and quality drive supply-chain design for functional products. The entire supply chain’s focus is toward reducing costs and getting the right product to the right place, at the right time. Inventory buildups at any point in the supply are not supposed to occur. Innovative-product supply chains are geared toward supplying products with minimal lead times. This focus on lead times lets retailers respond better to spikes in demand, minimize forced markdowns, and avoid obsolete inventory costs. The characteristics of the two types of supply chains are important, as they lead to different types of relationships with supply-chain partners. For functional products, an arms-length transaction relationship among the supply-chain partners prevails. Innovative product supply chains require a close, trusting relationship among the supply-chain partners to work and often involve partners in product development activities.
As you can see, achieving a fit between the type of the relationship and the type of product is important. Implementing a functional product supply-chain relationship for an innovative product will lead to frequent stock-out or excess inventory build-up situations.
The Dilemma of Product Shifts
Product attributes are dynamic, which makes designing an appropriate supply chain a challenging task. Excess competition may commoditize a hitherto innovative product. In this scenario, quickly changing the supply-chain focus to quality and cost is imperative. The alternative (which I will not discuss here in detail) is altering retailing policies to keep product attributes innovative. Product shifts between categories occur frequently. The consumer electronics area, in which yesterday’s innovations are today’s commodities, illustrates these shifts better than any other area. (Consider the Sony Walkman and Personal Computer products.) Conversely, as a result of such retailing policies as private labels, category management, branding, and so on, a functional product may quickly become an innovative product. Firms frequently overlook this shift or are unable to respond, and continue to use the functional supply chain to support an innovative product. This situation leads to the inevitable stock-outs — or worse, stock excess — and eventually causes obsolete inventory situations. The mismatches between the supply-chain area and product categories have a disproportionately adverse impact on the bottom line.
We also discovered through our analysis that firms providing services suffered from the same problem in their service-delivery systems. The service-delivery system is analogous to the product supply-chain system. Similarly, when a service moves from an innovative status to a commodity status in the service industries, the resulting mismatch in the service-delivery infrastructure leads to lost opportunities and adversely impacts the bottom line. Marshall Fisher’s excellent article, entitled “What is the Right Supply Chain for Your Product?” (Harvard Business Review, March 1997) offers a deeper look into these subjects.
Points to Ponder For the IT Staffer
Best practices for supply-chain management embodied in software application packages for supply-chain planning and execution frequently overlook product category shifts. The best practices implemented in most systems are excellent for products that do not shift between categories. The challenge is to implement a system that is flexible enough to accommodate the change in supply-chain structure needed to satisfy product shifts. This problem is a tough one in light of the lead time needed to change supply-chain relationships and bring them onto the appropriate supply-chain system. Most mature firms have multiple heterogeneous systems that have been part of the organization for a long time. Tying these systems together to enable product shifts in the supply chain is a monumental task. Many of these firms have multiple-item masters that were designed for different functional needs at different points in time. No easy solutions to this problem exist; otherwise, some clever IT staffer would have solved it a long time ago. So what are the options available in this situation? After your root-cause analysis, if you determine that supply-chain mismatches are causing the problem, the following steps show a high-level solution path to formulate an actionable strategy:
•Identify a few products that are firmly in the functional and innovative product categories
•Examine the supporting supply-chain systems and design a transition mechanism from one category to the other (consisting of people, processes, and systems)
•Run a pilot for mismatched products (within four to five months) to validate the transition mechanism and its effect on inventory
•If the model is validated, scale the pilot to other products.
I can say with a high degree of confidence that the technology infrastructure to support your solution will have an application server or enterprise application integration platform at its center, communicating to the various legacy systems. Will this approach guarantee success? As a wise person once said, the only certain events in life are death and taxes. But the approach I’ve outlined minimizes the risk and fallout from failure.
Ram Reddy (ramreddy@tacticagroup.com) is the managing member of Tactica Consulting Group (www.tacticagroup.com); a Midwest-area technology and business strategy consulting firm.
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