Think of Future Changes and Improve Your Supply Chain

A robust and efficient supply chain is foundation to a successful business as it provides a competitive advantage. There are many supply chains that are engineered by best minds in world to capitalize labor-arbitrage opportunities in low-cost regions such as China, India, and Mexico. Uncertainties in today’s world are potential problems for most of the supply chains and these uncertainties put most of the supply chains at a vulnerable position in future. At this point the question arises whether most of global supply chains are able to handle the unfavorable event that can take place due to rapidly changing world. The answer to this question is that many global supply chains are not very well equipped to cope up with the events that may take place in future.

Low-cost manufacturing regions definitely provide immediate advantage to business; however future changes in relative attractiveness of manufacturing regions due to ability to produce larger volume at an economical price may put businesses at risk and leave them dangerously exposed. The factors such as turbulent trade, capital inflows and political/policy changes represent perennial threats to supply chain and most of the times possess even greater threat in developing countries. Although there are factors (rising wealth, emergence of credible suppliers in developing countries) that gives confidence to global firms, yet it will take a significant amount to time for these changes to take effect in completion.

To manage future risks of supply chain companies are adapting two fold strategies. First, companies are “splintering” their supply chain into small, nimble chains where firms are better prepared for higher level of uncertainties. Second, firms are treating their supply chains as hedge by reconfiguring their manufacturing process to withstand a range of future outcomes. The gravity of better managing the supply chain risk can easily be assessed by the statement made by Jin Owens, CEO of Caterpillar “the competitor that is best at managing the supply chain is probably going to be the most successful competitor over time. It is a condition of success.”

Presently most of global supply chains face two fold challenges: (i) uncertain world that has a huge potential to affect the businesses. For example, financial crisis and recessions can dramatically amplify perennial source of supply chain uncertainty – trade and capital inflow. Rising wealth in developing countries is increasing their appetite for more resources (energy, raw material such as steel, iron, and commodities), which is affecting the prices at global level that makes it trickier to configure supply chain assets. Growing worries about environmental regulations will have their own effects on the future of supply chain. Last but not least, growth in developing countries (raising labor cost and depletion of resources) contributes towards the volatility of foreign currency market and in turn has potential to affect future supply chain. (ii) Rising complexity arising due to increasing requirement of the firm’s customers and increasing income level in developing countries that will no longer be manufacturing hubs but also potential customers.

Optimizing the supply chain for all customers and all circumstances is almost impossible and extremely challenging. However, to meet these challenges few forward-looking companies are preparing themselves in two ways. (i) Splintering their supply chain into smaller and more flexible ones (while these supply chains may use the existing channels as the old one, they can be configured to use information more efficiently to cope up with future complexity) and (ii) treat the supply chain as dynamic hedge i.e. make the supply chains more dynamic by consistently looking at future (5 to 10 years ahead) and reconfiguring the supply chain as needed.

By splintering monolithic supply chains into smaller and nimble ones companies can tame the future uncertainties & complexity, save money and better serve their customers. For example assume a company (Comp-A) that has most of its manufacturing in China and is headquartered in North America (with a very small presence) to stay close to its majority of customers. In this situation, increase in volatility of customer demand coupled with product portfolio proliferation (increasing number of SKUs) will put very high strain on Comp-A’s supply chain. This situation may lead to forecasting and service-related problems that may dissatisfy key customers.

This situation is difficult to manage but with some analysis can easily be handled.  To take care of this problem Comp-A should examine its product portfolio along two dimensions: the volatility of demand for each SKU sold and overall volume of SKU produced. After analyzing the situation Comp-A may split its legacy supply chain (one size fits all) into 3 to 4 distinct splinters. For high-volume & relatively stable demand (in most of situations less than 10-20% SKUs that represents majority of revenue) Comp-A can keep manufacturing in China (low cost). High or low volume & high volatile demand should be kept in North America and low-volume & low volatile demand can be divided between North America and Mexico.

By keeping manufacturing of low or high-volume with high volatile demand in North America (USA) Comp-A can serve customers with a very short lead time, which in turn avoid any lost sale. This way Comp-A is no longer required to predict the demand, instead it can manufacture directly to customer order. Other advantage of splintering the supply chain comes from better forecast for high-volume stable demand product as these forecasts will be free of noise generated due to volatile demand products.

Decision on the number of splinter is a tricky one and requires a closer look at the way company uses its supply chain assets to manufacture and distribute its products and strategic goals company has for those products & customers. The requirement seems obvious but it needs some thinking. A good starting point could be analysis of volatility of customer demand for a particular product line against historical production volume then compare it with total cost incurred for different locations. This analysis can provide rough estimate of speed-versus-cost trade-offs and may potentially suggest potential locations of supply chain splinters. The word of caution is that companies must be very careful about these broad analyses and check these against their customer needs.

Other benefit of splintering the supply chain originates from the fact that operational assets can be focused on the tasks they are best equipped to handle. The small size of splinters offers great advantage from flexibility point of view, where senior management may become capable of implementing the improvements that were not possible due to sheer size of traditional supply chain.

Splintered supply chains offers maximum advantage only if they are viewed as a dynamic process. For example, managers will have to assess hypothetical scenarios such as what would happen if crude oil price become $90 instead of $75, what will happen if labor wages in China go up by 20% and so on. The bottom line is that companies should try to design their portfolio of manufacturing and supplier network to minimize the total landed-cost risk under variety of situations. The goal is to identify a robust and stable manufacturing and sourcing point – even if it is not the lowest cost today.

Making these changes are not easy as making any change in a company’s supply chain has its effects throughout the organization because these changes require high level of cooperation and information sharing throughout the organization.

Change is becoming a necessity in today’s uncertain world and to stay ahead in the game companies must learn how to adapt to these changes. Thinking of future and making changes to their supply changes can help companies to survive and maintain their global competitive position because condition for survival is not being strongest, it the adaptability to changes.

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 To learn more about this please refer “Building the supply chain of the future”, McKinsey Quarterly.