Economics redefined by channel of supply

By ADAM GIFFORD

The cost of logistics - getting a product to the end user - now exceeds the cost of making it.

New Zealand manufacturers have been forced to deal with this equation for a long time. But in the manufacturing heartlands of Europe and the United States, which in Antipodean terms look luxuriously close to their markets, this shift is more recent.

The consultants and planners who make their money telling companies how to do things more efficiently or effectively came up with a new catch-cry: supply chain management.

Its relevance to businesses struggling to cope in the new economy was evident from the more than 3000 people at IBM's second annual Supply Chain Management conference in Las Vegas last week.

Most attendees were not from the global giants but from companies of similar size to those found here.

Carol Ptak, an executive with IBM's worldwide enterprise solutions group, said much of the effort over the past three decades had been about lowering the costs of production.

That was the focus of material requirements planning, first used in an IBM plant in New York in 1953. It allowed manufacturers to consider plant capacity as well as material needs.

It also involved enterprise resource planning, the hugely expensive systems that were supposed to give businesses an integrated view of their whole production process.

"Competitive advantage in the early 21st century will be based on logistics. It's not about being competitive in the enterprise but being competitive through the value chain," Ms Ptak said.

That was why the supply chain started with the customer.

In true supply chain management, the manufacturer did not make money selling goods to the distributor, and the distributor did not make money selling to the retailer.

"No one makes money until the last guy sells it to the end user."

She said a customer-focused supply chain was not linear, but consisted of many processes happening at the same time. A holistic approach was needed.

"What we have to ask is how we bring value to the customer."

Most importantly, it was not about technology. Drawing from her experience implementing enterprise resource planning systems, she said implementations done as IT projects would usually fail.

"But with a resource planning project that's done as a business implementation process, you're going to get a much higher return on investment because education and training have been a critical part of the whole implementation. It's not about software, it's about practices."

Another speaker, Indian River Consulting Group managing partner Michael Marks, said supply chain management was not about doing anything brilliant.

"It's about doing less stupid stuff. Being world class is measured by how little stupid stuff you do."

His "how to" guide to supply chain management involves combining the financial statements from two or more companies in a channel.

"Make a list of the dumb stuff going on, as if this were really one company. Do less dumb stuff. Cut the price to the end user.

"The only point of doing supply chain management is to cut cost so you can lower your margin and you end up with a lower price for the end user," Mr Marks said.

That was because in the new economy, where customers could send "bots" or automated programmes on to the internet to find what they wanted, price became everything, "and there is always someone dumb enough to give something away."

Mr Marks said concepts such as loyalty were meaningless in the new economy.

"Loyalty is defined as 'lack of a better alternative.' If you want loyalty, buy a dog."

Under the new model, companies needed to identify their core competency and concentrate on that, rather than try to provide full service.

The trick with supply chain management was to reduce the inventory of unsold goods or unassembled materials in the pipeline, he said.

The ideal was no inventory - the customer asked for something and it was made and delivered as soon as possible.

Mr Marks said the reason there was a gap between the promise of supply chain management and the reality was because companies were held back by false beliefs.

False belief number one was that gross profit was good.

The personal computer industry had shown this was not so. In the past 20 years, margins for computers had dropped from the mid-30 per cent region to low single digits, yet companies' return on assets and return on investment had never been higher.

Meanwhile, the affordability of computers meant the market kept expanding.

"The goal is to get a price advantage at the end-user stage. You won't get that if you keep trying to keep your margin up," Mr Marks said.

False belief two was that sales volumes could not be allowed to drop - ever. But if the objective was to reduce inventory in the channel to as close to zero as possible, some drop was inevitable as the channels emptied.

False belief three was that control of markets and channels was good. Not so, said Mr Mark. In the new economy, multiple channels were required.

He said that false belief caused many manufacturers to behave as if a sale to a distributor was a sale.

Computer chip-maker Motorola killed that idea several years ago when it stopped paying its sales staff for sales to distributors. Instead, Motorola put the distributor's money in the bank, demanded the distributor's resale data, and when the resale was recorded, paid its sales people.

At the time Mr Marks was running an electronics distributor.

"Their reps stopped bugging my buyers, and instead went all out on my reps.

"In less than two years every semiconductor manufacturer was doing the same thing, but to this day no one has regained the market share Motorola took in those two years," he said.

"Distributors are not customers, they are channel partners."

Which brought him to the fourth false belief, that incentive programmes defined what was real.

Mr Marks said distributors were afraid of their sales staff and manufacturers did not understand or listen to theirs.

"You must change your pay plans if you are to do this."

Underlying the problem was companies that believed they were measuring the right things, using financial software such as enterprise resource planning.

Mr Marks said too much of it was "accounting junk" using 1960s costing models.

"Chief financial officers are the world's smartest dumb people. Most can't find their butt with both hands in their back pockets."

Mr Marks said what must be measured were market share, the total inventory and working capital in the channel, the cost of capturing, serving and retaining customers, and the return on investment of all channel members.

It was not a process where one part of the supply chain could grab all the benefits.

"The key question is, what is best for the channel? Collaboration and trust are sources of competitive advantage."

* Adam Gifford attended the Supply Chain Management conference in Las Vegas as a guest of IBM.