The New Competition

The way you manage the supply chain can make or break your company. Some of the most spectacular business successes over the past 20 years have come from finding more effective ways to deliver products to consumers, but there have been some major wrecks along this same road. It’s a high-stakes game, and you don’t have a lot of choice about playing; if your company touches a physical product, it’s part of a supply chain and your success hangs on the weakest link of that chain. Why? Because the nature of competition is shifting away from the classic struggle between companies. The new competition is supply chain vs. supply chain.

The Thrill of Victory

Siemens CT of Forchheim, Germany, makes computed tomography X-ray machines for hospitals and diagnostic labs all over the world. The machines cost about half a million dollars apiece and they are custom-built for each customer. Four years ago, Siemens CT found itself faced with rising costs and price erosion that threatened its position in this lucrative market. The group’s response was to completely reinvent the way they provision, assemble, and deliver their products. They cut out two layers of middle management, switched the entire company to team structures, aligned incentives with supply chain success, and let creativity run rampant. Among other changes, the teams tightened the links with suppliers, eliminated all interim warehousing, adopted just-in-time production techniques, and switched to airfreight deliveries for customers outside of Europe.

Today, Siemens CT has an award-winning supply chain that sets a new standard for best practices in its industry. Lead time for their custom-built machines is down from 22 weeks to just 2 weeks. The rate of on-time deliveries has gone from 60% to 99.3%, and on time now means that deliveries occur within a two-hour window—an impressive feat for a delivery that requires closing off a street and hauling in a crane. The cost of achieving these stellar results? Zero: These gains in performance were accompanied by a 40% reduction in inventory, a 50% reduction in factory workspace, a 76% reduction in assembly time, and a 30% reduction in total costs. The company also managed to double its output to 1,250 machines a year without increasing its head count.

Siemens’ stunning success would be hard to match, but the company is not alone it its willingness to reinvent the supply chain. At the end of the 1990s, the Gillette Company, a $9 billion supplier of consumer goods, found itself losing market share because of escalating costs. In January 2000 it created a new kind of operating group, combining purchasing, packaging, logistics, and materials management in a single organization with the authority to completely rework its supply chain. Over the course of the next 18 months, the group reduced the total inventory in the chain by 30%, eliminating 40 days’ worth of materials costing $400 million. The supply chain organization believes that it is just now getting up to speed, but it has already saved the company $90 million.

Supply chain victories like these make for exciting news, but there is nothing new in the techniques these companies applied. At the end of the 1980s, Chrysler Corporation was on the ropes, ending the decade with a fourth-quarter loss of $664 million. Desperate for a way out of its financial morass, the company decided to experiment with some of the techniques being used by Japanese carmakers. Just as Siemens CT and Gillette would do a decade later, Chrysler formed cross-functional teams bringing together design, engineering, manufacturing, procurement, marketing, and finance, and it gave those teams the authority they needed to reinvent the supply chain. The teams cut the supplier base in half, brought the remaining suppliers in on the design of a new generation of cars, and developed long-term relationships based on trust rather than coercion. Instead of hammering suppliers on price as it had in the past, Chrysler asked for suppliers’ help in finding ways to save the carmaker money. More surprisingly, the company offered to split the savings with the suppliers rather than asking them to pass all the savings on to Chrysler.

Chrysler called its sharing program the supplier cost reduction effort, or SCORE. The company announced SCORE in 1990 to a highly skeptical supply base. But once suppliers realized that this wasn’t a trick—that Chrysler was serious about partnering with its suppliers and sharing the winnings—the ideas came flooding in. By 1995, the company had implemented 5,300 ideas suggested by suppliers, for a net annual savings of $1.7 billion. The cost of developing a new vehicle dropped by as much as 40%, and the time required for the development process fell from 234 weeks to 160 weeks. At the same time, Chrysler’s profit per vehicle leapt from an average of $250 in the mid-1980s to $2,110 in the mid-1990s, an increase of 844%.

Chrysler isn’t the only company that staved off disaster by revamping its supply chain. In 1997 Apple Computer was losing $1 billion a year and was on the verge of bankruptcy. The most visible change the company made was to bring back Steve Jobs, but it was radical surgery on its supply chain that actually saved the company. Among other changes, Apple killed off 15 of its 19 products, adopted justintime production techniques for those that remained, overhauled its sales forecasting system, and began a relentless effort to minimize inventory. Within two years, the company went from holding a month’s worth of inventory, with a value of $437 million, to a few days’ worth, valued at just $25 million. Inventory went down by 94%, gross margins went up by 40%, and Apple is still in business today.

Speaking of still being in business, Amazon.com Inc., one of the few surviving dot-coms, announced its first-ever profit as of the fourth quarter of 2001. This profit was not so much a vindication of the e-commerce model as it was the result of an intensive, yearlong effort to fix the company’s sloppy supply chain. The problems had been so bad that 12% of incoming inventory was routed to the wrong storage location, resulting in a great deal of wasted time and energy as the company scrambled to track down its own goods. A year later, after installing better inventory controls, the company had that figure down to 4%—far from perfect, but no longer crippling. Amazon also started combining its shipments to gain economies of scale, sending 40% of those shipments out in full truckloads and driving them directly to destination cities. The results: an 18% reduction in inventory, removing $31 million worth of idle merchandise from Amazon’s books, and a 17% reduction in fulfillment expenses, for a further savings of $22 million. These savings may be small compared to the preceding examples, but Amazon’s $5 million net profit clearly wouldn’t have been possible without them.

The victories achieved by Siemens, Gillette, Chrysler, Apple, and Amazon illustrate the tremendous impact of supply chain performance on the cost of doing business. These savings are vitally important, and managers know this well: Cost reduction is the number-one reason that companies initiate supply chain improvements. But there’s an even bigger opportunity here: Supply chain improvements are good for the bottom line, but they can be even better for the top line. Getting the supply chain right can give a company a tremendous competitive advantage, and sometimes that advantage is enough to overturn an entire industry structure.

The shining example of this kind of victory is the way Dell Computer systematically dismantled the rest of the personal computer industry. Prior to Dell, personal computers were manufactured in volume, shipped to retail stores, and sold individually to customers—pretty much like washing machines, televisions, and other appliances. It worked, but it required massive amounts of inventory, and customers were limited to a relatively small set of configurations. Dell changed all that by adopting a direct sales strategy, building every PC to order, and shipping it directly to the customer (Figure 1.1). Initially a mailorder house, Dell was one of the first to recognize the potential of the Internet, selling its first computers on line in 1996. Four years later it was doing $50 million a day from its Web site alone. In 2001, Dell became the largest producer of personal computers in the world, a position it surrendered only briefly after the merger of the former market leaders, HP and Compaq.

It’s common knowledge that Dell’s success was built on a combination of direct sales with build-to-order production, but Dell wasn’t the first PC company to try this strategy. What really makes the company so successful is the way it executes the strategy. Dell is absolutely relentless about pulling time and cost out of its supply chain. Suppliers are located right next to Dell’s assembly plants, and they deliver a constant stream of components on a just-in-time basis. Monitors are shipped directly from the companies that make them and merged in transit with Dell’s own shipments, arriving in matching Dell boxes in a single customer delivery (as shown in Figure 1.1). The company has forecasting and planning down to a science, and it enjoys the financial advantage of a negative cash-to-cash time—it actually gets paid for its products before it buys the components. The perfection of techniques such as these gives the company a full five percentage points of profit advantage over its competitors, a virtually unassailable advantage in what is now almost a commodity market.

Figure 1.1 Dell’s Supply Chain Strategy

Supply chains are as old as commerce, but the opportunities they now present are without precedent. Modern manufacturing has driven so much time and cost out of the production process that there is only one place left to turn for competitive advantage. As business-engineering guru Michael Hammer recently put it in his new book The Agenda, the supply chain is the last untapped vein of business gold. The examples in this section make it clear that this vein runs deep, but no one knows just how much gold is in there because the real potential of supply chains is just now being discovered. Today, supply chain management is far more important than manufacturing as a core competence; so much so that it’s possible, as Nike and Cisco Systems have amply demonstrated, to dominate the market for a product without owning so much as a single factory. The future of supply chains looks bright indeed.