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Adapt Your Supply Chain—or Die

Unless companies adapt their supply chains, they won't stay competitive for very long. The secrets: trend spotting and supplier change. From Harvard Business Review.

Great companies don't stick to the same supply networks when markets or strategies change. Rather, such organizations keep adapting their supply chains so they can adjust to changing needs. Adaptation can be tough, but it's critical in developing a supply chain that delivers a sustainable advantage.

Most companies don't realize that in addition to unexpected changes in supply and demand, supply chains also face near-permanent changes in markets. Those structural shifts usually occur because of economic progress, political and social change, demographic trends, and technological advances. Unless companies adapt their supply chains, they won't stay competitive for very long. Lucent twice woke up late to industry shifts, first to the rise of the Asian market and later to the advantages of outsourced manufacturing. (See "Adaptation of the Fittest") Lucent recovered the first time, but the second time around, the company lost its leadership of the global telecommunications market because it didn't adapt quickly enough.

The best supply chains identify structural shifts, sometimes before they occur, by capturing the latest data, filtering out noise, and tracking key patterns. They then relocate facilities, change sources of supplies, and, if possible, outsource manufacturing. For instance, when Hewlett-Packard started making ink-jet printers in the 1980s, it set up both its R&D and manufacturing divisions in Vancouver, Washington. HP wanted the product development and production teams to work together because ink-jet technology was in its infancy, and the biggest printer market was in the United States. When demand grew in other parts of the world, HP set up manufacturing facilities in Spain and Singapore to cater to Europe and Asia. Although Vancouver remained the site where HP developed new printers, Singapore became the largest production facility because the company needed economies of scale to survive. By the mid-1990s, HP realized that printer-manufacturing technologies had matured and that it could outsource production to vendors completely. By doing so, HP was able to reduce costs and remain the leader in a highly competitive market.

Adaptation needn't be just a defensive tactic. Companies that adapt supply chains when they modify strategies often succeed in launching new products or breaking into new markets. Three years ago, when Microsoft decided to enter the video game market, it chose to outsource hardware production to Singapore-based Flextronics. In early 2001, the vendor learned that the Xbox had to be in stores before December because Microsoft wanted to target Christmas shoppers. Flextronics reckoned that speed to market and technical support would be crucial for ensuring the product's successful launch. So it decided to make the Xbox at facilities in Mexico and Hungary. The sites were relatively expensive, but they boasted engineers who could help Microsoft make design changes and modify engineering specs quickly. Mexico and Hungary were also close to the Xbox's biggest target markets, the United States and Europe. Microsoft was able to launch the product in record time and mounted a stiff challenge to market leader Sony's PlayStation 2. Sony fought back by offering deep discounts on the product. Realizing that speed would not be as critical for medium-term survival as costs would be, Flextronics shifted the Xbox's supply chain to China. The resulting cost savings allowed Microsoft to match Sony's discounts and gave it a fighting chance. By 2003, the Xbox had wrested a 20 percent share of the video game market from PlayStation 2.

Lucent lost its leadership of the global telecommunications market because didn't adapt quickly enough.

Smart companies tailor supply chains to the nature of markets for products. They usually end up with more than one supply chain, which can be expensive, but they also get the best manufacturing and distribution capabilities for each offering. For instance, Cisco caters to the demand for standard, high-volume networking products by commissioning contract manufacturers in low-cost countries such as China. For its wide variety of mid-value items, Cisco uses vendors in low-cost countries to build core products but customizes those products itself in major markets such as the United States and Europe. For highly customized, low-volume products, Cisco uses vendors close to main markets, such as Mexico for the United States and Eastern European countries for Europe. Despite the fact that it uses three different supply chains at the same time, the company is careful not to become less agile. Because it uses flexible designs and standardized processes, Cisco can switch the manufacture of products from one supply network to another when necessary.

Gap, too, uses a three-pronged strategy. It aims the Old Navy brand at cost-conscious consumers, the Gap line at trendy buyers, and the Banana Republic collection at consumers who want clothing of higher quality. Rather than using the same supply chain for all three brands, Gap set up Old Navy's manufacturing and sourcing in China to ensure cost efficiency, Gap's chain in Central America to guarantee speed and flexibility, and Banana Republic's supply network in Italy to maintain quality. The company consequently incurs higher overheads, lower scale economies in purchasing and manufacturing, and larger transportation costs than it would if it used just one supply chain. However, since its brands cater to different consumer segments, Gap uses different kinds of supply networks to maintain distinctive positions. The adaptation has worked. Many consumers don't realize that Gap owns all three brands, and the three chains serve as backups in case of emergency.

Sometimes it's difficult for companies to define the appropriate markets, especially when they are launching innovative new products. The trick is to remember that products embody different levels of technology. For instance, after records came cassettes and then CDs. Videotapes were followed by DVDs, and almost anything analog is now or will soon become digital. Also, every product is at a certain stage of its life cycle, whether it's at the infant, ramp-up, mature, or end-of-life stage. By mapping either or both of those characteristics to supply chain partners, manufacturing network, and distribution system, companies can develop optimal supply chains for every product or service they offer.

For example, Toyota was convinced that the market for the Prius, the hybrid car it launched in the United States in 2000, would be different from that of other models because it embodied new technologies and was in its infancy. The Japanese automobile maker had expertise in tracking U.S. trends and geographical preferences, but it felt that it would be difficult to predict consumer response to a hybrid car. Besides, the Prius might appeal to particular consumer segments, such as technophiles and conservationists, which Toyota didn't know much about. Convinced that the uncertainties were too great to allocate the Prius to dealers based on past trends, Toyota decided to keep inventory in central stockyards. Dealers took orders from consumers and communicated them via the Internet. Toyota shipped cars from stockyards, and dealers delivered them to buyers.

Smart companies tailor supply chains to the nature of markets for products.

Although Toyota's transportation costs rose, it customized products to demand and managed inventory flawlessly. In 2002, for example, the number of Toyotas on the road in Northern California and the Southeast were 7 percent and 20 percent, respectively. However, Toyota sold 25 percent of its Prius output in Northern California and only 6 percent in the Southeast. Had Toyota not adapted its distribution system to the product, it would have faced stockouts in Northern California and been saddled with excess inventory in the Southeast, which may well have resulted in the product's failure.

Building an adaptable supply chain requires two key components: the ability to spot trends and the capability to change supply networks. To identify future patterns, it's necessary to follow some guidelines:

  • Track economic changes, especially in developing countries, because as nations open up their economies to global competition, the costs, skills, and risks of global supply chain operations change. This liberalization results in the rise of specialized firms, and companies must periodically check to see if they can outsource more stages of operation. Before doing so, however, they must make sure that the infrastructure to link them with vendors and customers is in place. Global electronics vendors, such as Flextronics, Solectron, and Foxcom, have become adept at gathering data and adapting supply networks.
  • Decipher the needs of your ultimate consumers—not just your immediate customers. Otherwise, you may fall victim to the "bullwhip effect," which amplifies and distorts demand fluctuations. For years, semiconductor manufacturers responded to customer forecasts and created gluts in markets. But when they started tracking demand for chip-based products, the manufacturers overcame the problem. For instance, in 2003, there were neither big inventory buildups nor shortages of semiconductors.

At the same time, companies must retain the option to alter supply chains. To do that, they must do two things:

  • They must develop new suppliers that complement existing ones. When smart firms work in relatively unknown parts of the world, they use intermediaries like Li & Fung, the Hong Kong–based supply chain architects, to find reliable vendors.
  • They must ensure that product design teams are aware of the supply chain implications of their designs. Designers must also be familiar with the three design-for-supply principles: commonality, which ensures that products share components; postponement, which delays the step at which products become different; and standardization, which ensures that components and processes for different products are the same. These principles allow firms to execute engineering changes whenever they adapt supply chains.

Excerpted with permission from "The Triple-A Supply Chain," Harvard Business Review, Vol. 82, No.10, October 2004.

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Hau L. Lee (haulee@stanford.edu) is the Thoma Professor of Operations, Information and Technology at the Stanford Graduate School of Business.

Adaptation of the Fittest

Many executives ask me, with a twinkle in their eye, if companies must really keep adapting supply chains. Companies may find it tough to accept the idea that they have to keep changing, but they really have no choice.

Just ask Lucent. In the mid-1990s, when the American telecommunications giant realized that it could make inroads in Asia only if had local manufacturing facilities, it overhauled its supply chain. Lucent set up plants in Taiwan and China, which allowed the company to customize switches as inexpensively and quickly as rivals Siemens and Alcatel could. To align the interests of parent and subsidiaries, Lucent executives stopped charging the Asian ventures inflated prices for modules that the company shipped from the United States. By the late 1990s, Lucent had recaptured market share in China, Taiwan, India, and Indonesia.

Unhappily, the story doesn't end there, because Lucent stopped adapting its supply chain. The company didn't realize that many medium-sized manufacturers had developed the technology and expertise to produce components and subassemblies for digital switches and that because of economies of scale, they could do so at a fraction of the integrated manufacturers' costs. Realizing where the future lay, competitors aggressively outsourced the manufacture of switching systems. Because of the resulting cost savings, they were able to quote lower prices than Lucent. Meanwhile, Lucent was reluctant to outsource its manufacturing because it had invested in its own factories. Ultimately, however, Lucent had no option but to shut down its Taiwan factory in 2002 and create an outsourced supply chain. The company's adaptation came too late for Lucent to regain control of the global market, even though the supply chain was agile and aligned.

Excerpted with permission from "The Triple-A Supply Chain," Harvard Business Review, Vol. 82, No. 10, October 2004.