Harvard Business Review recently convened a panel of experts to discuss the state of supply chain management. In this excerpt, the panelists discuss how to improve relationships between suppliers and customers. Panel moderator Julia Kirby talks with Robert Porter Lynch, CEO of Warren Company; Scott Beth, VP of Procurement at Intuit; David N. Burt, a professor at University of San Diego; Hau L. Lee, a professor at Stanford University; Chris Gopal, Vice President of Global Supply Chain Management at Unisys; and Sandra Morris, CIO of Intel. –Ed.
Julia Kirby: Robert mentioned that companies are having an easier time with external alliances than with internal ones. How are those external relationships evolving?
Robert Porter Lynch: The best companies I see are beginning to triage the supply chain. In other words, they'll separate vendors that provide commodities from preferred suppliers that they have good relationships with from strategic suppliers that they create alliances with. They manage the supply base through those three different elements in very different ways, using different metrics, different processes, different people, and different mentalities.
Scott Beth: Absolutely. I think that we have to determine, in Intel's case, where contract manufacturers fall along that spectrum. Speaking frankly, I think there's a love-hate relationship between OEMs and contract manufacturers. People don't trust the pricing they get, or there's a sort of bait-and-switch approach, where your prices start out low and then begin to creep up.
Kirby: David, I see you nodding at this reference to trust. I know that issue is dear to your heart. What can you add?
David N. Burt: Trust is the basis of agility, of flexibility. Yet it's an incredible challenge to establish trust and maybe even harder to maintain it. Underlying the challenge is the question of how to institutionalize trust between buyer and supplier. I've got colleagues who maintain that trust can only be established between individuals. But a few souls like Robert and myself say we've got to be able to institutionalize trust. We've got to make it work so that when the founders of the alliance depart, the alliance continues. We've been looking at this at USD for over ten years, and we don't have the answer yet.
| I think there's a love-hate relationship between OEMs and contract manufacturers. |
| — Scott Beth, Intuit |
But it's important. As the world gets more complicated, when I sell a product, I may be selling a solution that requires input from four or five companies. How do they get along with each other? If suppliers don't trust each other, the customer will be whipsawed. Also, trust enables you to make fast decisions, which lets you be more innovative and get rid of unproductive work. Trust is a competitive advantage.
Beth: You also lose out on efficiencies when trust isn't there. A lack of trust causes companies to duplicate activities between its own operations and its outsourced partners. Too often, we outsource an activity and then keep a lot of the management systems for that activity in place to verify that certain things are being done.
Hau L. Lee: The way to build trust and establish a harmonious relationship is the third A of my triple A—alignment—align the interests of the multiple parties so that they have some common values and goals.
A good example of alignment comes from Saturn. Saturn recognized that to provide good service in terms of the end-customer's experience, it wouldn't be enough to be good at replenishing and supporting dealerships, which Saturn calls "retailers." The retailers also needed to have the right inventory. But Saturn understood that the retailers weren't necessarily good at inventory planning and forecasting. So the company asked retailers to let it take over the job of inventory management, and in return it offered to share their risk. If you're out of stock, Saturn will get the part to you from another retailer, overnight. Saturn even measures its own employees on how well the retailers serve their customers, the end-users.
The result is that Saturn is always ranked among the top three in J.D. Power's Customer Satisfaction Index, even though it's competing with luxury cars. And Saturn retailers have a superior inventory performance—its average dealer inventory turn is about 7.5 a year versus the industry average of 2.5. Everybody wins when you have the right alignment.
Chris Gopal: I'd like to add a slightly different perspective. Trust is essential, of course. But before trust comes smart contracting. Trust is predicated on doing things jointly and in an aligned fashion over a period of time with no major surprises. However, to start with, the supply chain folks, who know the environment and the potential risks, need to get together with the people who develop the contracts so that managing risk—planning for alternative scenarios—can be embedded in the strategy and the contract. The next step is metrics. Trust can only be engendered by considering the risks and having joint metrics, with penalties and incentives. And over time, trust develops. I know that Scott Beth does a lot of work in managing risk, working with different types of contracts with suppliers to generate some of that trust. Scott, do you have anything to tell us about this?
Beth: Our expectations for suppliers are changing. In the past, the contract manager would put a contract in front of me and point to a 3 percent price reduction over last year. The vector is right, and it's my only choice, so I'd sign off on it. But now what I expect is a series of choices that trade off price, inventory, and responsiveness. Those are the kinds of tradeoffs that I need to be able to think about.
But on the issue of trust and penalties: We started off with a penalty approach, a clause that says if you don't provide us with a certain level of responsiveness, we'll charge you. And that began to erode trust. So instead we created an escrow account. If either party violates the agreement, money goes into the account, which is then used to reinvest in the relationship—new information systems, joint team education, and travel to get our people together more often. The level of trust went way up when we took this change in perspective.
Burt: These types of contracts and processes are critical. A company in our benchmark study—a large consumer products company—buys, for example, enzymes for its soap from a small company in Denmark. There are numerous intellectual property issues related to developing new chemical enzyme technologies, so naturally there are concerns about sharing ideas. The two companies worked out master agreements ahead of time so that they could develop and share new technologies without always having to go back to the lawyers and sign new legal agreements. They both placed a great deal of emphasis on ethics and had a clear understanding about the procedures, about what was expected from whom. The relationship was so good, and Natalie, the supply chain manager from the American company, fought so hard within her company on behalf of the supplier, that the Danish company named its latest enzyme Natalese for her.
So the relationship counts, but so does the process. They had a clear process governing how to work together, which allowed them to be constantly innovating and kept the relationship healthy.
Sandra Morris: I agree that good contracts are absolutely essential, but we've also seen that you can develop trust over time by increasing access to information and to experts within the company. That's particularly been the case with our e-business efforts, such as automatic replenishment of the factories. It starts with a pilot, with one trusted supplier, and it grows over time to become the standard way we do business.
We've watched the same kind of relationship grow among suppliers as we've created information repositories for fabrication equipment. When we develop a new technology, we work for years and years with both our customers and our suppliers before that technology is available, so products exist that use the technology when it's ready to ship. That sometimes involves a number of suppliers sharing information with each other as well as with Intel. The process, which began with three or four people who were willing to take that risk with us—to be fellow travelers—has now become a common way that we exchange information and develop new products.
Lynch: Picking up on the idea of sharing with your partners in the value chain, there's an avenue of innovation that's just being completely missed, which is innovations that come from your suppliers. Dr. Burt did a study on this; I believe it was last year. And I think the average company said that 35 percent of its innovation came from the supply chain. Now, ask yourself, is that enough? Companies like Toyota are getting 60 percent of all their innovation out of the supply chain.
| Alliance professionals typically find it easier to create alliances with their major competitors than with other divisions in their own companies. |
| — Robert Porter Lynch, Warren Company |
Here's a story. A client told me, "My largest customer is Johnson & Johnson. Every year, they come to me and they want a 5 to 15 percent price cut. I have piles of innovation to bring them. Every time I ask the supply chain manager, 'What about my innovations? Where do I take them?' He says, 'I'm not interested in that.' Why not? Because he's not rewarded for innovation. He's rewarded for cost cutting."
Another example: If you look at General Motors during the 1990s, warranty costs were higher than profits. Why were warranty costs so high? A lot of it is because GM wasn't looking to the supply chain for innovation. Chrysler, meanwhile, took massive amounts of market share because it was taking innovation through the supply chain. So, the questions are: Do we prize it? Do we even measure it? Do we recognize the impact of supplier innovation on our competitive advantage? On customer satisfaction?
Gopal: I'd like to go a level below all of that and say the companies I've seen that innovate best in the supply chain seem to be those that actually have the excellent people focused on the supply chain. I think it's a people issue, an issue of senior management focus and will. Michael Dell and his senior executives used to attend demand/supply-matching meetings. Dell executives are measured on joint metrics—they are (or at least they used to be) all measured on the same things—and that drives their focus on the supply chain as a competitive weapon.
Somebody once asked me about best practices. Well, knowledge is free. Everything that Dell, Wal-Mart, and 7-Eleven do is available somewhere on the Internet. Yet how many people can actually execute on it? The key is putting the system together right and making sure it works—managing risks and planning for contingencies through scenario planning, then executing and changing the strategy based on real-time trends.
Somebody also asked me about worst practices. I think the absolute worst practice is equating technology with the supply chain—the idea that "I buy a technology, so I've got a great supply chain." Nonsense. Innovation comes down to the people, the tools, and what value senior management places on it. I'd like to ask Hau, How many students at Stanford go into management of the supply chain? 