Putting it All Together: What is the Right Supply Chain?

To this point, we have discussed building blocks of supply chain management and have seen them put together in different ways to serve different environments. Which model is better: the QR philosophy (keeps manufacturing design flexible, don’t focus on minimizing transportation costs) or the ECR philosophy (fix design, control costs tightly)? Both are pull systems, but differ in how and when they react.

Physical Efficiency versus Market Responsiveness: A good starting point is the nature of demand for a brand. A functional brand is of a product that is a staple which people buy in many outlets and which serves basic stable needs. Thus, the brands have stable, predictable demand and long life cycles. This invites competition, which creates low margins. In contrast, an innovative brand of a product is new and different. This enables it to earn higher margins. But the sales cycle of the product-brand is short and unpredictable, in part, because such brands are quickly imitated, and their advantage dissipated. Fundamentally, an innovative product faces unpredictable demand, has a short product life cycle, and is hard to forecast. It has high margins but also higher markdowns and stock outs (due to changing tastes and forecast errors). And, because these products are differentiated, they often exist in many variations. Functional products have the reverse profile. Figure 16.4 summarizes the contrasts between these two endpoints of a spectrum.

The key to supplying functional goods is to hold down three types of costs:

• Manufacturing,
• Holding inventory, and
• Transportation

These observable physical costs all involve handling a good and accountants to track them. Efficient manufacturing and logistics are crucial. They matter first because low margins make cost consciousness important and second because predictable demand simplifies decision making. ECR fits in this spirit, as do many manufacturing methods based on tight planning and management of supplies. Here, the most important information flow occurs inside the chain from retailers back to suppliers of manufacturers.

Supply chains for these products need to be physically efficient. At the factory, this means running at high capacity; in the warehouse, fast-turning inventory. Products are designed once and for all to make them easy to manufacture and to maximize their performance. Cost and quality are the criteria used to select suppliers.

Innovative goods demand the opposite. The greatest risk with these products is to miss the market by having the wrong item at the wrong time at the wrong price. The key to innovative goods is speed: Demand can’t be estimated, only noted as it begins to surge. Hence, the point of sale is a critical information flow. For innovative goods, the opportunity cost of a stock out is very high, given the high margins. And by the time the stock out is rectified, the item may have lost favor, leaving the supplier with drastically devalued stocks.

Supply chains for innovative products need to be market responsive. To do this, product design must be modular to postpone final assembly as long as possible. Performance and cost are less critical here and can be sacrificed somewhat to achieve modularity. Suppliers are selected for quality and flexibility, not lowest cost. The manufacturing system keeps buffer stocks of supplies, just in case. An obsession exists with reducing the lead time needed to fill an order, even though this raises transportation and fulfillment costs.

Market responsiveness and physically efficiency are two end- points on a continuum, along which a supply chain philosophy can be fitted.

An intriguing element here is that where a brand falls on the spectrum from highly functional to highly responsive depends on the brand’s marketing strategy. Thus, the same product category can have more innovative or more functional brands, each calling for a different supply chain. For example, in cars, some brands are very conservative and stable, often appealing to a buyer who resists change (Cadillac Seville, Ford Fairmount). Others have an ephemeral, faddish appeal (the BMW Z3 roadster, the Mazda Miata). The more functional brand needs a more physically efficient supply chain and doesn’t need to be so market responsive. The more innovative one needs somewhat more market responsiveness and can afford somewhat less physical efficiency in its supply chain.

Two Kinds of Supply Chains

	Physically Efficient Supply Chain   (Functional Goods)	Market-Responsive   Supply Chain (Innovative Goods)
Objective	Cut costs of manufacturing,   holding inventory, transportation	Respond quickly as demand materializes
Consequences of Failure	Low prices and higher costs   create margin squeeze	Stock outs of high-margin   goods Heavy markdowns of unwanted goods
Manufacturing Goods	Run at high capacity utilization rate	Be ready to alter production   (quantity and type) swiftly Keep excess production capacity
Inventory	Minimize everywhere	Keep buffer stocks of parts   and finished goods
Lead Times	Can be long, because demand is predictable	Must be short
Suppliers Should Be	Low cost Adequate quality	Fast, flexible Adequate quality
Product Design	Design for ease of manufacture , and to meet performance   standards	Design in modules to delay final production