Overhauling your supply chain can be a Herculean task. Here are some strategies for tackling the challenge.
March 1 2004 by Erik Sherman
Autonomy had always been good to Sysco. The Houston-based food distributor is one of the country’s largest, serving restaurants and institutions. Its 145 independent distribution companies, run as wholly owned subsidiaries, traditionally made their own decisions on product mixes, marketing and strategies in an industry that is highly regional. “We could run full trucks of produce into our Grand Rapids operating center, for example, then pick up another truckload and bring it over to Detroit, then swing over to our location in Cincinnati,” says Rick Schnieders, who has been chairman and CEO for just over a year. No arguing with success: The company’s revenues topped $26 billion in the last fiscal year; its operating margin (5.1 percent) is high for a distribution business.
But a strength, when uncontrolled, can turn into a weakness. Sysco’s distribution companies became too independent at times. Because each of the distribution centers was charged with improving its own operations and bottom line, that’s exactly what they did. “You’d have the logistics manager in Detroit say, €˜I’m not going to play; I can do much better on my own,’” Schnieders explains.
So a few years ago the company embarked on a strategy of creating regional distribution centers. The move was designed to shave transportation and purchasing costs and reduce inventory while at the same increasing the number of products available to customers. To carry it out, Schnieders needed the support of the distribution company presidents, who were compensated on their individual performances.
In selling his plan internally, Schnieders could argue that the investment would reduce costs that each of the distribution companies would have faced in trying to grow their businesses. Even so, the cost of instituting the reform was steep. Sysco’s first new regional distribution center-built in Front Royal, Va., to serve the Northeast and scheduled to go online in late fall-will cost $120 million. The software needed not only for that center but also for others to come is $280 million.
In the end, Schnieders got cooperation, but only after a year of education and discussion. The lesson: Supply-chain reform can’t be pulled from a textbook. “It’s cultural,” Schnieders says. “It’s a complex, very dynamic process. Changes happen all the time; motivations shift.”
Schnieders confronted an increasingly common dilemma. Supply-chain improvements can offer enormous returns, in some cases a savings of 40 percent of revenues or more. However, because of its sprawling nature, a company’s supply chain is difficult to overhaul. After all, the system involves an interlocking series of steps that begins with obtaining raw materials and components, moves through manufacturing and extends into distribution. The variables are many: parts availability, factory schedules and future customer demand, to name a few. To make it all work, the CEO has to balance the needs of different groups, because a move in one area tugs on the chains that bind another. All too often, savings in one area yield larger losses in another.
There’s also a tug of war between the company and its suppliers and customers. A business must have the right number of vendors and the right relationships with them to cut costs and ensure a smooth flow of products. For that reason, it cannot allow the pursuit of supply-chain efficiency to harm these critical relationships.
It’s not just an issue for big-company CEOs. Smaller companies also can benefit from supply-chain reform. For example, Austin-based Golfsmith International has revenues of $260 million to $300 million selling golf equipment through stores, catalogs and the Internet. When Jim Thompson took over as CEO nearly 18 months ago, after stints with Circuit City and CompUSA, he discovered a fragmented supply chain. “There was a level of attention being paid to it, but I don’t think there was a broad strategic initiative looking at merchandise flow from the vendor to the end consumer,” Thompson says. Instead of a big-picture approach, different people would oversee different things, such as inventory replenishment, warehouse management and freight costs.
Because of the company’s size, Thompson was able to rally support relatively fast. Institutional politics didn’t get in the way. “For us, it was bringing a broader view of the importance of supply chain and bringing the leaders together,” he says. “They started to understand the interface between their roles. Last year, we saved hundreds of thousands of dollars in the really easy, fundamental stuff.”
An €˜Emerging Practice’
The process isn’t always so smooth. To realize the costs in a supply-chain overhaul, you have to be willing to wring the fabric of your entire company. “Most CEOs in any reasonably sized company have an officer dedicated to each function,” says Gene Long, president of UPS Consulting, the newest subsidiary of United Parcel Service. But supply-chain management, he notes, is an “emerging practice.” There’s almost never one senior manager charged with overseeing it. Many CEOs find that their supply chains do not fully support corporate strategies. Sometimes, they go against them. Long recalls a client that was scaling back operations in a declining market segment yet was pouring money into it at the same time because its various supply-chain leaders were operating under outdated metrics.
When companies do pay attention to their supply chains, the payoff can be huge. Lucent Technologies, which was in dire need of good financial news, launched a massive supply-chain initiative in 2001, overhauling its entire operations. Inventory plummeted from $8 billion to $806 million-a 90-percent drop. It now turns over nearly seven times a year instead of only one and a third times. Through outsourcing, the company reduced its number of warehouses from more than 300 to just 54. Instead of doing 40 percent of its purchasing with over 1,000 suppliers, the company consolidated its ordering: 80 percent of its buying is done with 60 key suppliers. That means large purchasing volumes and significant cost savings. In addition, Lucent’s on-time rate for deliveries improved from 80 percent to 96 percent.
The biggest single challenge to supply-chain reform is that, historically, supply-chain management was never a practice in itself. Instead, purchasing fell under the CFO, warehousing was under operations and vendor relations was divided between purchasing and marketing. Only distribution was sometimes a function unto itself. (See chart, below.)
In overhauling a supply chain, half measures usually prove half-witted. In engineering and mathematics, there is a term called suboptimization. It refers to a situation where the parts of a system are tuned to run as well as they can individually but where the whole suffers. A good analogy would be the classic scene from “I Love Lucy” in which Lucille Ball works in a factory packaging candy. All is fine until her supervisor cranks up the production line to full speed. Suddenly crÃ¨mes and nougats are whizzing by and Lucy is cramming them into her mouth in a failed attempt to keep up. It’s funny and also instructive, because it is far closer to how many businesses are run than their CEOs would like to think.
In other words, someone has to make sure that the goods don’t get produced slower or faster than they can be sold. A company that misjudges demand might buy or manufacture either more products than customers will purchase, creating an inventory glut that sucks up cash, or fewer products, disappointing customers who might go elsewhere.
Equally important is to work with vendors to develop ways to save on manufacturing and delivery. TorPharm, the largest generic pharmaceutical manufacturer in Canada, involved its suppliers intimately in its supply-chain reform. TorPharm had been receiving the appropriate quantities of raw materials to meet customer demand less than half the time. The problem stemmed in part because many of the company’s suppliers were in China and India, creating long lead times. As a result, TorPharm was keeping more than six months inventory on all ingredients, including some that cost as much as $50,000 a kilogram. That meant that millions of dollars of raw materials were sitting on inventory shelves.
Getting Vendor Support
TorPharm’s breakthrough wasn’t a new software program or an arm-twisting of its suppliers, although those strategies helped. Rather, says David Coffin-Beach, TorPharm’s president, the company’s purchasing group conducted “vendor education sessions” and “basically opened up the books.” Together, the company and its vendors developed purchasing and delivery strategies to ensure that more than 99 percent of the time the right quantities of raw materials arrived when expected. Yearly turns of inventory jumped from two to 12. Then TorPharm worked with its customers, namely pharmacies in the United States, to improve its on-time delivery rate of products from as low as 60 percent to 95 percent or better.
Coffin-Beach is admittedly not a logistics expert, but he can see where the money lies. “I would say we have a 25- to 30-percent improvement in profits,” he says. “If we take inventory out of the system, that goes right to the bottom line. My goal would be to turn stuff every two weeks; a lot of our customers do.” But he cautions that focusing on supply chain, and the extensions to business partners, takes serious work. “Too many people read Ken Blanchard and The One Minute Manager or this or that instead of taking a comprehensive look,” he says. “We’ve been 20 months in this journey; it’s a lifelong journey. You’ve got to look at yourself in the mirror and really say, €˜Am I prepared to do this?’”
CEOs also must know whether their business partners are ready for significant change. John Edwardson, chairman and CEO of CDW, the nearly $5-billion computer retailer based in Vernon Hills, Ill., offers a story from his experience in the banking industry decades back. “Sears was already doing 30 years ago what Wal-Mart is today,” he says. “We had a maxim at the bank that you never wanted to lend money to a company that was a sole Sears supplier, because they never made any money.”
Now, Edwardson admits, pressure on vendors can help them as well as the company doing the pressing. CDW turns over its inventory 26 or 27 times a year and works with suppliers that can provide product within 24 hours. That allows CDW to offer 80,000 product units for sale at any one time, while keeping only 15,000 of them on hand. And the CEO hasn’t written off further improvements. “When do you get the last nickel out of the supply chain, and how much more of this can we do?” he asks rhetorically. “I think there’s a lot more we can do.” Large vendors may be fairly efficient, he adds, but the small- to medium-sized operations have a long way to go.
Of course, in striving for profits, it’s possible to push vendors too far. “It’s that age-old game of leaving enough on the table to make sure others think it’s worth their while to do what you need them to do while remaining competitive,” Edwardson says.
In some industries, large players are starting to encounter resistance from vendors. Wal-Mart is known for squeezing its vendors for enormous efficiencies. But recently the giant retailer tried to have all its vendors place radio frequency tags on all products, a technology still in its early-and expensive-phases. The vendors complained so loudly that Wal-Mart scaled back its demands.
Stories about vendors revolting against major customers might become more common. “I’m hearing a lot of rumblings from suppliers who are dealing with overly aggressive retailers that there is only so much that they can take,” says Dave Simbari, CEO of Optum, a White Plains, N.Y., software company that provided key components in Lucent’s supply-chain reform. “Many of them are at that threshold.” If a critical vendor gets upset enough to walk, a company can find itself with a missing link in its supply chain. Keeping vendors happy may become as important as caring for customers.
Taking all of these elements together, revamping a supply chain is a Herculean task. But clearly it is something few CEOs can avoid. Either a company enters this pivotal leg in the race for efficiency, or it watches as its competitors storm past.