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A R T I C L E

The Triple-A Supply Chain

by Hau L. Lee

Included with this full-text

Harvard Business Review

article:

The Idea in Brief—the core idea

The Idea in Practice—putting the idea to work

1

Article Summary

2

The Triple-A Supply Chain

A list of related materials, with annotations to guide further

exploration of the article’s ideas and applications

12

Further Reading

Product 8096

The 21st Century Supply Chain The Articles

HBR Spotlight

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Managing the modern supply chain is a job that involves specialists in manu- facturing, purchasing, and distribution, of course. But today it is also vital to the work of chief financial officers, chief information officers, operations and customer service executives, and cer- tainly chief executives. Changes in sup- ply chain management have been truly revolutionary, and the pace of progress shows no sign of moderating. In our increasingly interconnected and inter- dependent global economy, the pro- cess of delivering supplies and finished goods (and information and other business services) from one place to another is accomplished by means of mind-boggling technological innova- tions, clever new applications of old ideas, seemingly magical mathematics, powerful software, and old-fashioned concrete, steel, and muscle.

An end-to-end, top-to-bottom transfor- mation of the twenty-first-century supply chain is shaping the agenda for senior managers now and will continue to do so for years to come. With this special series of articles,

Harvard Business Review

examines how corporations’ strategies and structures are changing and how those changes are manifest in their supply chains.

The Triple-A Supply Chain

by Hau L. Lee October 2004

The best supply chains aren’t just fast and cost-effective. They are also agile and adaptable, and they ensure that all their companies’ interests stay aligned.

Reprint R0410F; OnPoint 8096

Leading a Supply Chain Turnaround

by Reuben E. Slone October 2004

Five years ago, salespeople at Whirlpool said the company’s supply chain staff were “sales disablers.” Now, Whirlpool excels at getting the right product to the right place at the right time—while keeping inventory low. What made the difference?

Reprint R0410G

Aligning Incentives in Supply Chains

by V.G. Narayanan and Ananth Raman November 2004

A supply chain stays tight only if every company in the chain has reasons to pull in the same direction.

Reprint R0411F; OnPoint 8363

Rapid-Fire Fulfillment

by Kasra Ferdows, Michael A. Lewis, and Jose A.D. Machuca November 2004

Spanish clothier Zara turns the rules of supply chain management on their head. The result? A superresponsive network and profit margins that are the envy of the industry.

Reprint R0411G

Building Deep Supplier Relationships

by Jeffrey K. Liker and Thomas Y. Choi December 2004

Two Japanese automakers have had stunning success building relationships with North American suppliers—often the same supplier companies that have had contentious dealings with Detroit’s Big Three. What are Toyota and Honda doing right that their American counterparts are missing?

Reprint R0412G

We’re in This Together

by Douglas M. Lambert and A. Michael Knemeyer December 2004

If your latest supply chain partnership failed to live up to expectations, as so many do, it’s probably because you never stated your expectations in the first place.

Reprint R0412H

The Triple-A Supply Chain

page 1

The Idea in Brief The Idea in Practice

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The holy grails of supply chain manage- ment are high speed and low cost—or are they? Though necessary, they aren’t suffi- cient to give companies a sustainable com- petitive advantage over rivals. Consider these disturbing statistics: Though U.S. sup- ply chains became significantly faster and cheaper between 1980 and 2000, product markdowns owing to excess inventory jumped from 10% to 30% of total units sold—while customer satisfaction with product availability plummeted.

But some companies—Wal-Mart, Amazon.com, Dell Computer—have bucked these trends. How? Their supply chains aren’t

just

fast and cost-effective. They’re also:

•

Agile:

They respond quickly to sudden changes in supply or demand. They han- dle unexpected external disruptions smoothly and cost-efficiently. And they recover promptly from shocks such as natural disasters, epidemics, and com- puter viruses.

•

Adaptable:

They evolve over time as economic progress, political shifts, de- mographic trends, and technological ad- vances reshape markets.

•

Aligned:

They align the interests of all participating firms in the supply chain with their own. As each player maximizes its own interests, it optimizes the chain’s performance as well.

To achieve sustainable competitive advan- tage, your supply chain needs

all three

of these qualities. Apply the following prac- tices to create agility, adaptability,

and

alignment.

AGILITY

Objective:

Respond to short-term changes in demand or supply quickly.

Methods:

•

Continuously provide supply chain partners with data on changes in supply and de- mand so they can respond promptly.

•

Collaborate with suppliers and customers to redesign processes, components, and products in ways that give you a head start over rivals.

•

Finish products only when you have accu- rate information on customer preferences.

•

Keep a small inventory of inexpensive, non- bulky product components to prevent manufacturing delays.

ADAPTABILITY

Objective:

Adjust supply chain design to ac- commodate market changes.

Methods:

•

Track economic changes, especially in de- veloping countries.

•

Use intermediaries to find reliable vendors in unfamiliar parts of the world.

•

Create flexibility by ensuring that different products use the same components and production processes.

•

Create different supply chains for different product lines, to optimize capabilities for each. For example, with highly customized, low-volume products, use vendors close to your main markets. For standard, high-vol- ume products, commission contract manu- facturers in low-cost countries.

ALIGNMENT

Objectives:

Establish incentives for supply chain partners to improve performance of the entire chain.

Methods:

•

Provide all partners with equal access to forecasts, sales data, and plans.

•

Clarify partners’ roles and responsibilities to avoid conflict.

•

Redefine partnership terms to share risks, costs, and rewards for improving supply chain performance.

•

Align incentives so that players maximize overall chain performance while also maxi- mizing their returns from the partnership.

Example:

Convenience-store chain Seven-Eleven Japan (SEJ) builds supply chain

agility

by using real-time systems to detect changes in customer preferences and track sales and customer data at every store. Satellite con- nections link stores with distribution cen- ters, suppliers, and logistics providers. SEJ reallocates inventory among stores and re- configures store shelves three times daily to cater to different customer groups at differ- ent hours.

SEJ’s

adaptability

is legendary. Within six hours after the 1995 Kobe earthquake, SEJ overcame highway gridlock by mobilizing helicopters and motorcycles to deliver 64,000 rice balls to its stores in the belea- guered city.

SEJ fosters

alignment

by making partners’ incentives and disincentives clear. For ex- ample, when carriers fail to deliver on time, they pay a penalty. But SEJ also helps carri- ers save money by forgoing the typical time-consuming requirement that store managers verify all contents of each deliv- ery truck.

The Triple-A Supply Chain

by Hau L. Lee

harvard business review • october 2004 page 2

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The best supply chains aren’t just fast and cost-effective. They are also

agile and adaptable, and they ensure that all their companies’ interests

stay aligned.

During the past decade and a half, I’ve studied from the inside more than 60 leading compa- nies that focused on building and rebuilding supply chains to deliver goods and services to consumers as quickly and inexpensively as possible. Those firms invested in state-of-the- art technologies, and when that proved to be inadequate, they hired top-notch talent to boost supply chain performance. Many com- panies also teamed up to streamline processes, lay down technical standards, and invest in in- frastructure they could share. For instance, in the early 1990s, American apparel companies started a Quick Response initiative, grocery companies in Europe and the United States touted a program called Efficient Consumer Response, and the U.S. food service industry embarked on an Efficient Foodservice Re- sponse program.

All those companies and initiatives persistently aimed at greater speed and cost-effectiveness— the popular grails of supply chain manage- ment. Of course, companies’ quests changed with the industrial cycle: When business was

booming, executives concentrated on maxi- mizing speed, and when the economy headed south, firms desperately tried to minimize supply costs.

As time went by, however, I observed one fundamental problem that most companies and experts seemed to ignore: Ceteris paribus, companies whose supply chains became more efficient and cost-effective didn’t gain a sus- tainable advantage over their rivals. In fact, the performance of those supply chains steadily deteriorated. For instance, despite the increased efficiency of many companies’ supply chains, the percentage of products that were marked down in the United States rose from less than 10% in 1980 to more than 30% in 2000, and surveys show that consumer satisfaction with product availability fell sharply during the same period.

Evidently, it isn’t by becoming more effi- cient that the supply chains of Wal-Mart, Dell, and Amazon have given those compa- nies an edge over their competitors. Accord- ing to my research, top-performing supply

The Triple-A Supply Chain

harvard business review • october 2004 page 3

Hau L. Lee

([email protected]) is the Thoma Professor of Operations, Information, and Technology at the Stanford Graduate School of Business in Stanford, California, and the codirector of the Stanford Global Supply Chain Management Forum. He is the coeditor (with Terry P. Harrison and John J. Neale) of

The Practice of Supply Chain Man- agement: Where Theory and Applica- tion Converge

(Kluwer Academic Pub- lishers, 2003).

chains possess three very different qualities. First, great supply chains are agile. They react speedily to sudden changes in demand or sup- ply. Second, they adapt over time as market structures and strategies evolve. Third, they align the interests of all the firms in the sup- ply network so that companies optimize the chain’s performance when they maximize their interests. Only supply chains that are ag- ile, adaptable, and aligned provide companies with sustainable competitive advantage.

The Perils of Efficiency

Why haven’t efficient supply chains been able to deliver the goods? For several reasons. High-speed, low-cost supply chains are unable to respond to unexpected changes in demand or supply. Many companies have centralized manufacturing and distribution facilities to generate scale economies, and they deliver only container loads of products to customers to minimize transportation time, freight costs, and the number of deliveries. When demand for a particular brand, pack size, or assortment rises without warning, these organizations are unable to react even if they have the items in stock. According to two studies I helped con- duct in the 1990s, the required merchandise was often already in factory stockyards, packed and ready to ship, but it couldn’t be moved until each container was full. That “best” practice delayed shipments by a week or more, forcing stocked-out stores to turn away consumers. No wonder then that, ac- cording to another recent research report, when companies announce product promo- tions, stock outs rise to 15%, on average, even when executives have primed supply chains to handle demand fluctuations.

When manufacturers eventually deliver ad- ditional merchandise, it results in excess inven- tory because most distributors don’t need a container load to satisfy the increased demand. To get rid of the stockpile, companies mark down those products sooner than they had planned to. That’s partly why department stores sell as much as a third of their merchan- dise at discounted prices. Those markdowns not only reduce companies’ profits but also erode brand equity and anger loyal customers who bought the items at full price in the recent past (sound familiar?).

Companies’ obsession with speed and costs also causes supply chains to break down during

the launch of new products. Some years ago, I studied a well-known consumer electronics firm that decided not to create a buffer stock before launching an innovative new product. It wanted to keep inventory costs low, particu- larly since it hadn’t been able to generate an accurate demand forecast. When demand rose soon after the gizmo’s launch and fell sharply thereafter, the company pressured vendors to boost production and then to slash output. When demand shot up again a few weeks later, executives enthusiastically told vendors to step up production once more. Five days later, sup- plies of the new product dried up as if some- one had turned off a tap.

The shocked electronics giant discovered that vendors had been so busy ramping pro- duction up and down that they hadn’t found time to fix bugs in both the components’ man- ufacturing and the product’s assembly pro- cesses. When the suppliers tried to boost out- put a second time, product defects rose to unacceptable levels, and some vendors, includ- ing the main assembler, had to shut down pro- duction lines for more than a week. By the time the suppliers could fix the glitches and re- start production, the innovation was all but dead. If the electronics company had given suppliers a steady, higher-than-needed manu- facturing schedule until both the line and de- mand had stabilized, it would have initially had higher inventory costs, but the product would still be around.

Efficient supply chains often become un- competitive because they don’t adapt to changes in the structures of markets. Consider Lucent’s Electronic Switching Systems division, which set up a fast and cost-effective supply chain in the late 1980s by centralizing compo- nent procurement, assembly and testing, and order fulfillment in Oklahoma City. The supply chain worked brilliantly as long as most of the demand for digital switches emanated from the Americas and as long as Lucent’s vendors were mostly in the United States. However, in the 1990s, when Asia became the world’s fast- est-growing market, Lucent’s response times in- creased because it hadn’t set up a plant in the Far East. Furthermore, the company couldn’t customize switches or carry out modifications because of the amount of time and money it took the supply chain to do those things across continents.

Lucent’s troubles deepened when vendors

The Triple-A Supply Chain

harvard business review • october 2004 page 4

shifted manufacturing facilities from the United States to Asia to take advantage of the lower labor costs there. “We had to fly compo- nents from Asia to Oklahoma City and fly them back again to Asia as finished products. That was costly and time consuming,” Lucent’s then head of manufacturing told me. With tongue firmly in cheek, he added, “Neither components nor products earned frequent- flyer miles.” When Lucent redesigned its supply chain in 1996 by setting up joint ventures in Taiwan and China to manufacture digital switches, it did manage to gain ground in Asia.

In this and many other cases, the conclusion would be the same: Supply chain efficiency is necessary, but it isn’t enough to ensure that firms will do better than their rivals. Only those companies that build agile, adaptable, and aligned supply chains get ahead of the competition, as I pointed out earlier. In this ar- ticle, I’ll expand on each of those qualities and explain how companies can build them into supply chains without having to make trade- offs. In fact, I’ll show that any two of these di- mensions alone aren’t enough. Only compa- nies that build all three into supply chains be- come better faster than their rivals. I’ll conclude by describing how Seven-Eleven Japan has become one of the world’s most profitable retailers by building a truly “triple-A” supply chain.

Fostering Agility

Great companies create supply chains that re-

spond to sudden and unexpected changes in markets. Agility is critical, because in most in- dustries, both demand and supply fluctuate more rapidly and widely than they used to. Most supply chains cope by playing speed against costs, but agile ones respond both quickly and cost-efficiently.

Most companies continue to focus on the speed and costs of their supply chains without realizing that they pay a big price for disregard- ing agility. (See the sidebar “The Importance of Being Agile.”) In the 1990s, whenever Intel un- veiled new microprocessors, Compaq took more time than its rivals to launch the next generation of PCs because of a long design cy- cle. The company lost mind share because it could never count early adopters, who create the buzz around high-tech products, among its consumers. Worse, it was unable to compete on price. Because its products stayed in the pipeline for a long time, the company had a large inventory of raw materials. That meant Compaq didn’t reap much benefit when com- ponent prices fell, and it couldn’t cut PC prices as much as its rivals were able to. When ven- dors announced changes in engineering speci- fications, Compaq incurred more reworking costs than other manufacturers because of its larger work-in-progress inventory. The lack of an agile supply chain caused Compaq to lose PC market share throughout the decade.

By contrast, smart companies use agile sup- ply chains to differentiate themselves from ri- vals. For instance, H&M, Mango, and Zara

Building the Triple-A Supply Chain

Agility

Objectives:

Respond to short-term changes in demand or supply quickly; handle external disruptions smoothly.

Methods:

•

Promote flow of information with suppliers and customers.

•

Develop collaborative relationships with suppliers.

•

Design for postponement.

•

Build inventory buffers by maintaining a stockpile of inexpensive but key components.

•

Have a dependable logistics system or partner.

•

Draw up contingency plans and develop crisis management teams.

Adaptability

Objectives:

Adjust supply chain’s design to meet struc- tural shifts in markets; modify supply network to strategies, products, and technologies.

Methods:

•

Monitor economies all over the world to spot new supply bases and markets.

•

Use intermediaries to develop fresh suppliers and logistics infrastructure.

•

Evaluate needs of ultimate consumers— not just immediate customers.

•

Create flexible product designs.

•

Determine where companies’ products stand in terms of technology cycles and product life cycles.

Alignment

Objective:

Create incentives for better performance.

Methods:

•

Exchange information and knowledge freely with vendors and customers.

•

Lay down roles, tasks, and responsibilities clearly for suppliers and customers.

•

Equitably share risks, costs, and gains of improvement initiatives.

The Triple-A Supply Chain

harvard business review • october 2004 page 5

have become Europe’s most profitable apparel brands by building agility into every link of their supply chains. At one end of their prod- uct pipelines, the three companies have cre- ated agile design processes. As soon as design- ers spot possible trends, they create sketches and order fabrics. That gives them a head start over competitors because fabric suppliers re- quire the longest lead times. However, the companies finalize designs and manufacture garments only after they get reliable data from stores. That allows them to make prod- ucts that meet consumer tastes and reduces the number of items they must sell at a dis- count. At the other end of the pipeline, all three companies have superefficient distribu- tion centers. They use state-of-the-art

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