Drivers of Supply Chain Performance

The strategic fit discussed in Chapter 2 requires that a company’s supply chain achieve the bal­ance between responsiveness and efficiency that best supports the company’s competitive strat­egy. A supply chain’s performance in terms of responsiveness and efficiency is based on the interaction between the following logistical and cross-functional drivers of supply chain perfor­mance: facilities, inventory, transportation, information, sourcing, and pricing. The structure of these drivers also affects the financial measures discussed in Section 3.1. The goal is to structure the drivers to achieve the desired level of responsiveness at the lowest possible cost, thus improv­ing the supply chain surplus and the firm’s financial performance.

First we define each driver and discuss its impact on the performance of the supply chain.

  1. Facilities are the actual physical locations in the supply chain network where product is stored, assembled, or fabricated. The two major types of facilities are production sites and stor­age sites. Decisions regarding the role, location, capacity, and flexibility of facilities have a sig­nificant impact on the supply chain’s performance. For example, in 2013, Amazon increased the number of warehousing facilities (and, as a result, experienced an increase in PP&E) located close to customers to improve its responsiveness. In contrast, Best Buy tried to improve its effi­ciency in 2013 by shutting down retail facilities even though it reduced responsiveness. Facility costs show up under PP&E if facilities are owned by the firm or under selling, general, and administrative if they are leased.
  2. Inventory encompasses all raw materials, work in process, and finished goods within a supply chain. The inventory belonging to a firm is reported under assets. Changing inventory policies can dramatically alter the supply chain’s efficiency and responsiveness. For example, W.W. Grainger makes itself responsive by stocking large amounts of inventory and satisfying customer demand from stock even though the high inventory levels reduce efficiency. Such a practice makes sense for Grainger because its products hold their value for a long time. A strat­egy using high inventory levels can be dangerous in the fashion apparel business, though, in which inventory loses value relatively quickly with changing seasons and trends. Rather than hold high levels of inventory, Spanish apparel retailer Zara has worked hard to shorten new prod­uct and replenishment lead times. As a result, the company is very responsive but carries low levels of inventory.
  3. Transportation entails moving inventory from point to point in the supply chain. Transportation can take the form of many combinations of modes and routes, each with its own performance characteristics. Transportation choices have a large impact on supply chain respon­siveness and efficiency. For example, a mail-order catalog company can use a faster mode of transportation such as FedEx to ship products, thus making its supply chain more responsive— but also less efficient, given the high costs associated with using FedEx. McMaster-Carr and W.W. Grainger, however, have structured their supply chains to provide next-day service to most of their customers using ground transportation. They are providing a high level of responsiveness at lower cost. Outbound transportation costs of shipping to the customer are typically included in selling, general, and administrative expense, whereas inbound transportation costs are typically included in the cost of goods sold.
  4. Information consists of data and analysis concerning facilities, inventory, transporta­tion, costs, prices, and customers throughout the supply chain. Information is potentially the biggest driver of performance in the supply chain because it directly affects each of the other drivers. Information presents management with the opportunity to make supply chains more responsive and more efficient. For example, Seven-Eleven Japan has used information to better match supply and demand while achieving production and distribution economies. The result is a high level of responsiveness to customer demand while production and replenishment costs are lowered. Information technology-related expenses are typically included under either operating expense (typically under selling, general, and administrative expense) or assets. For example, in 2012, Amazon included $4.54 billion in technology expense under operating expense and another $454 million under fixed assets to be depreciated.
  5. Sourcing is the choice of who will perform a particular supply chain activity, such as production, storage, transportation, or the management of information. At the strategic level, these decisions determine what functions a firm performs and what functions the firm outsources. Sourcing decisions affect both the responsiveness and efficiency of a supply chain. After Motor­ola outsourced much of its production to contract manufacturers in China, for instance, it saw its efficiency improve but its responsiveness suffer because of the long lead times. To make up for the drop in responsiveness, Motorola started flying in some of its cell phones from China even though this choice increased transportation cost. Flextronics, an electronics contract manufac­turer, is hoping to offer both responsive and efficient sourcing options to its customers. It is try­ing to make its production facilities in high-cost locations very responsive while keeping its facilities in low-cost countries efficient. Flextronics hopes to become an effective source for all customers using this combination of facilities. Sourcing costs show up in the cost of goods sold, and monies owed to suppliers are recorded under accounts payable.
  6. Pricing determines how much a firm will charge for the goods and services that it makes available in the supply chain. Pricing affects the behavior of the buyer of the good or ser­vice, thus affecting demand and supply chain performance. For example, if a transportation com­pany varies its charges based on the lead time provided by the customers, it is likely that customers who value efficiency will order early and customers who value responsiveness will be willing to wait and order just before they need a product transported. Differential pricing pro­vides responsiveness to customers that value it and low cost to customers that do not value responsiveness as much. Any change in pricing affects revenues directly but could also affect costs based on the impact of this change on the other drivers.

Our definitions of these drivers attempt to delineate logistics and supply chain manage­ment. Supply chain management includes the use of logistical and cross-functional drivers to increase the supply chain surplus. Cross-functional drivers have become increasingly important in raising the supply chain surplus in recent years. Although logistics remains a major part, sup­ply chain management is increasingly becoming focused on the three cross-functional drivers.

It is important to realize that these drivers do not act independently but interact to deter­mine the overall supply chain performance. Good supply chain design and operation recognize this interaction and make the appropriate trade-offs to deliver the desired level of responsive­ness. Consider, for example, the sale of furniture at IKEA. The primary goal of this supply chain is to deliver a low price and acceptable quality. Modular design and unassembled furni­ture allows IKEA to carry components in inventory at its stores. The low component variety and stable replenishment orders allow IKEA’s suppliers to focus on efficiency. Given the avail­able inventory, low-cost modes of transportation are used to ship densely packed components. In this instance, relatively low-cost inventory at IKEA allows the supply chain to become efficient by lowering transportation and production costs. In contrast, some U.S. furniture makers have chosen to focus on providing variety. Given the high variety and high prices, keeping inventory of all variants at a retailer would be very expensive. In this case, the supply chain has been designed so the retailer carries little inventory. Customers place their orders with the retailer by seeing one variant of the furniture and selecting among the various options. The supply chain is made responsive by using information technology to convey order infor­mation effectively, structuring flexible manufacturing facilities to be able to produce in small lots, and using responsive transportation to deliver the furniture to the customer. In this instance, responsive facilities, transportation, and information are used to lower inventory costs. As the rest of this chapter will illustrate, the key to achieving strategic fit and strong financial performance across the supply chain is to structure the supply chain drivers appropri­ately to provide the desired level of responsiveness at the lowest possible cost.

Doheny et al. (2010) point out that supply chain performance affects nearly 35 percent of the financial performance of apparel retailers. As a percentage of sales, they state that mark- downs, representing 10 to 30 percent of sales, and lost sales, representing 5 to 10 percent of sales, are the dominant drivers of retailers’ financial performance. They further state that trans­portation represents 2 to 5 percent, warehousing 1 to 3 percent, store product handling 3 to 5 percent, and inventory costs 2 to 5 percent of sales. Although the precise fraction will vary for different supply chains, it is evident that supply chain performance along the six drivers has a significant influence on a firm’s financial performance.

Before we discuss each of the six drivers in detail, we put these drivers into a framework that helps clarify the role of each in improving supply chain performance.

Source: Chopra Sunil, Meindl Peter (2014), Supply Chain Management: Strategy, Planning, and Operation, Pearson; 6th edition.

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