Supply Chain and Business Strategy

Please check also the first blog post in this series about Supply Chain.

At the beginning of the industrial age companies focused on efficiency. This is what allowed to mass produce and deliver cheap products to millions of people. Today markets are more competitive, and in many industries being able to respond to changes in customer demand quickly is more important than being efficient. This requires letting go of vertical integration and focusing on core competencies, as well as balancing responsiveness and efficiency.

This is done through a process of aligning Supply Chain and Business Strategy. In this process we try to find the optimal tradeoff between responsiveness and efficiency in a Supply Chain, in order to satisfy customer demand, capture market share and do so while maximizing profit margins. There are three key steps:

1. Understand the market

In order to decide whether to emphasize responsiveness or efficiency. Here are some of the questions that we can ask:

  • What are the average quantities bought in each lot?
  • What response time are customers willing to tolerate?
  • What is the variety of products needed?
  • Are partial deliveries acceptable?
  • How much are customers willing to pay?
  • What is the expected rate of innovation over time?

For example, in a Coach store customers buy small quantities of product, maybe one item at a time. The response time should be short, but it’s OK to take an order for a product out of stock. The variety of products is small, a few hundred SKUs. Partial deliveries are not frequent. Prices are high, with significant profit margins, and the expected rate of innovation is small, typically just small changes from one season to the next.

At an electronics distributor, consumers buy big quantities of product. Response time can extend weeks or months, which may be required to deliver products manufactured abroad. Variety of products can be large and partial deliveries could happen. Customers are price sensitive for most products, as margins are typically small (due to competition from online retailers) and the rate of expected innovation is high. End customers may ask for the latest version of a product as soon as it’s announced and there are advantages for distributors in being able to procure these products as fast as possible.

2. Define the role of the company in the market

A company can participate in multiple supply chains in different roles. But in each case it needs to identify the proper role, and the core competencies that allow it to compete effectively. For instance, a company may decide to compete in the lowest cost, or in the premium segments in that market. It can also decide to focus on manufacturing, distribution or other aspects, to target a local geographical area, or a national or global market, etc.

3. Create a supply chain targeted to that role

Finally, after developing knowledge of the market, and depending on the company strategy, it’s possible to design a supply chain that tries to achieve the correct balance of efficiency and responsiveness. And this is done according to the 5 Supply Chain Drivers I mentioned in the previous post: Production, Inventory, Locations, Transportation and Information. In each of these we can opt for more responsive but more expensive designs (more locations, more extra capcity, building to order, smaller and quicker shipments, etc.), or we can opt for more effective and less responsive designs (one or a few central locations, leverage economies of scale, building to stock, optimal shipment and inventory quantities, etc.).

For instance, a bag manufacturer that tries to capture a low-price market may want to produce in a central location with low cost of labor. Designs for each production run should be prepared well in advanced and remain unchanged for the reason. Stock can be shipped by sea, the company can use central inventory locations, sell at large discount stores and collect only the information that allows it to plan products for next season and sell as much stock as possible. These strategies will allow reducing the total cost per unit for the product.

On the other hand, a luxury bag manufacturer may be able to craft bags in a location with a higher cost of labor or in multiple locations, close to their customers. It can add new designs frequently. It can ship by truck, store in multiple leased warehouses, and sell in luxury boutiques in prime downtown real estate. It can also allow backorders and ship directly via UPS or Fedex to customers. And it may have programs which allow it to collect information about traffic at stores, customer preferences, market trends, real time in-transit inventory location and other data which allows it to be very quick to respond to shifting customer demands. Obviously this responsiveness will come at extra expense that will be reflected in the price of the product.

Written on June 7, 2015