Supply Chain 101

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CORY SANDERSON: Let's start with the basics. We can think of Supply Chain Management, or SCM, as a function in business that starts with inputs from other functions, including marketing, product management, sourcing, distribution channel selection, strategy and management, and financial planning, among others. The goal of SCM is to ensure that the right goods and services are delivered to the right place at the right time and in the right quantities. Ideally, this is done with the lowest cost possible within their selected supply chain strategy.

Let's take a look at two products and how the supply chain strategy differs--

canned soup and phones.

Commodity industries, like canned soup, have such low margins that cost and efficiency are their primary drivers.

For high-margin industries with evolving supply and demand information like smartphones, speed and agility are key. These approaches show that lowest possible cost is a relative term. And cost isn't always the most important objective.

Supply chain management is often used as an umbrella term referring to military logistics, today's multimodal commercial logistics, and the more manufacturing and service industry-specific field of operations management. Consequently, SCM involves coordinating more than just the movement and transformation of raw materials into physical goods.

To borrow a definition from Scott Webster, author of Principles of Supply Chain Management, a supply chain is "two or more parties linked by a flow of resources, typically material, information, and money." It includes five major categories of activities--

buy, make, move, store, and sell. You can see how many parts of a typical company those activities touch.

When looking at the supply chain for even a basic product, like canned soup, there are many entities involved.

Parties like raw material suppliers, component suppliers, cooking and canning facilities, distributors, wholesalers, and retailers all are involved before the product becomes available for the consumer to purchase.

Each of these relationships involves a flow of material, information, and money. All of the costs tied up in those relationships is only part of why companies care about supply chain management.

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PRESENTER: In addition to the money tied up in SCM, businesses also care deeply about their supply chain management strategy. They're constantly seeking to improve, to keep up with increasingly fast product life cycles, reap the competitive advantages of a strong supply chain, and leverage the cost savings that come from an enhanced asset cost structure.

Let's start with the most obvious reason--

money.

At the highest level, inventory in the US accounts for a staggering 14% of GDP, and it's estimated that transportation and warehousing costs average around an additional 10% of GDP.

Even working within a specific firm, supply chain costs and activities such as inventory holding, transportation, order management, supply chain financing, and related IT technology account for about 25% of the average corporate budget. If we were to include the money spent in procurement, that figure rises dramatically.

This becomes even more complex when moving from our canned soup example to a more sophisticated product, like a car. Remember, value is added by each partner in the supply chain. So for a car, you would have a producer that creates custom grades of steel and aluminum for engine and body panel production, a cloth manufacturer that produces raw fabric for the seat manufacturer, and a maker of high-tech components used to create the sound system or engine modules.

By the time these components arrive at the assembly factory, the majority of the direct costs are tied up in the procurement of these components. Comparatively little money is tied up in things like assembly methodologies and labor costs that the vehicle manufacturer can actually directly control.

However, the brand name manufacturer is responsible for setting the retail price of that vehicle. Any savings they can gain by removing inefficiencies and cost from this very deep supply chain gives them a greater ability to be more cost competitive for the consumer.

This may seem obvious now, but it was less so in the late 1960s and early 1970s, when American auto manufacturers dominated the American car market. Meanwhile, Japan was in the midst of changing the way they related to their suppliers, and began partnering with them to find better, cheaper, and more efficient ways of doing things.

Over time, Japan developed such low-cost products that they were able to storm the American market and steal significant market share. This is a great example of where sophisticated supply chain management turned into a major competitive advantage. It spawned a revolutionary change in the way we look at supply chain management, operations management, sourcing, and even quality management.

Another major reason that companies focus on SCM is due to the rapid innovation and product life cycles in many industries. This kicked off most notably with the rise of fast fashion retailers. Before the rise of these fast fashion retailers, apparel brands would have three major selling seasons every year. Clothes were bought by consumers first at retail price, and then were increasingly discounted until sold through.

In today's world of fast fashion, designs can go from drawings to the retail floor in as little as six weeks. This keeps customers coming back, discounts low, and their margins high. The key to making this work is speed.

The speed involved means that more activities have to happen in parallel through design, production, revision, and demand management. This is an area that is ripe for supply chain managers to optimize, and is one of the many reasons that fast-moving and innovative businesses often seek consultative advice on thinking through alternatives.

The pace set in apparel retailing is not present in many industries. Think of all the rapid launches of new smart luggage colorways, or the yearly mobile device cycles. As these trends were emerging, trade barriers were falling, and geographies were honing specialized manufacturing skills.

Another way to think about speed in a supply chain is that it often produces a competitive advantage, which is part of what has elevated supply chain to being a strategic function. If a company is the first or best in meeting evolving market needs, they often have an outsized share of the market. Similarly, supply chains can contribute to and even drive competitive advantage in the form of resiliency, particularly following a disruption.

Finally, let's look at one more key reason that companies care about supply chain management--

leverage. Savings and improvements within procurement and supply chain operations drop straight to the bottom line. In a business with an 8% gross margin, saving $1 in supply chain costs has the same effect on the bottom line as increasing sales by $12.50. Cost control and discipline has a highly leveraged effect on a company's profit and loss statement.

Similarly, improvements to the supply chain management practices of a firm often have a high impact on utilization of their assets, like plant and equipment. Even small improvements in this area have a highly leveraged impact on a financial metric return on assets--

a key performance indicator for corporate managers and stock market valuations.

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For all of these reasons, over the last 50 years supply chain management has played an increasingly pivotal role in corporate strategy. Next, we'll look at how SCM has evolved in the past few decades and which trends we expect to emerge. The basics of supply chain management haven't changed in 50 plus years, but several trends have had tremendous impacts on the practice. The first major trend to discuss is the increasing reliance on data for organizing production and transportation activities.

This has evolved into leveraging data to help optimize supply chains for cost, transit time, speed, and coordination. The use and organization of data in a way that we now recognize as data sets and databases has its roots in the rise of manufacturing resource planning, or MRP, that began in the 1970s. This allowed companies to structure data points like lead time, batch size, inventory records, and bills of material to help with the creation of production schedules, purchase orders, and exception management. This has evolved into what we now know as the Enterprise Resource Planning, or ERP, systems that married that data to demand, financial, and other data points.

These are used to record an auditable transaction record, improving coordination across company functions, often in near real time. With high speed internet, and the rise of the internet of things, this trend has strengthened, and the data is used not only for coordination, but for optimization.