How to run a global supply chain
Technology advances set stage for further disruption of ingrained management practices; electronics industry, Solectron are good examples
By Kevin Parker, editorial director -- Manufacturing Business Technology, 1/1/2005 12:00:00 AM
Technology makes globalization possible: it's computerization that caused the cost of enterprise transactions to drop like a rock, so companies can outsource even manufacturing. Given telecommunications advances, there's no reason why outsourcing can't be to India or China.
So today when IBM puts its PC business up for sale, it's reportedly selling a supply chain that for a $2,500 laptop gets its memory and display screen from South Korea; case, keyboard, and hard drive from Thailand; wireless card from Malaysia; graphics controller chip from Taiwan; and microprocessor from the United States. Assembly takes place in Mexico.
"You have specialization in the electronics industry because much of the work, beginning with design, can be modularized. There are options for 'loosening' at different stages in the value chain, and within each stage," says Dr. Dieter Ernst, senior economist at the East-West Center, Honolulu—an organization established by U.S. Congress to promote an Asia-Pacific community in which the U.S. is a leading partner.
The electronics industry has gone from vertical integration—where a single entity owns productive capacity through multiple stacked tiers—to horizontal aggregation of the production means. But the tiers must still closely interact to coordinate design, manufacture, and distribution. This arrangement has advantages. Contract manufacturers attain quantities of scale by making like things for multiple customers. Brand owners have more product line flexibility since they're not married to their production facilities.
Yet all is not necessarily rosy in the electronics industry. It's a low-margin business in many of its sectors, and despite concentration of industry power among a limited number of global companies, market positions are highly volatile and even leaders are not guaranteed survival, according to Ernst.
And who can forget what happened when the bubble burst in the spring of 2000? It turned out the entire industry had been playing blindman's bluff with its trading partners, gaming the system in hopes of a market share grab. The result was unprecedented inventory write-offs of soon-to-be obsolescent product.
Even today, inventories for raw materials, parts, work-in-process, and finished products held by manufacturers and in the supply chain are relatively large compared to most equipment manufacturers, according to Electronic Business magazine.
For all manufacturing, excluding electronics, the 2004 inventory/sales (I/S) ratio—month-end inventory divided by monthly sales, the lower the better—was 1.19, down 26 percent from the 1992 average. For electronic components, the current ratio is 1.74, down 14 percent. The exception was computers and peripherals, with a current ratio of .815, down 56 percent, due to the already established, extreme commodity nature of that industry segment.
Technology dialectics
Technology loosened the ties between tiers. Will new technology deliver the visibility, collaboration, and synchronization—amounting to shared, inter-enterprise business processes—needed to avoid recent mistakes and garner long-term profitability?
Electronic manufacturing services (EMS) provider Solectron, Milpitas, Calif., for one, says it has tools to support complex collaborative relationships. Others, such as Ernst, warn management challenges could impede emergence of inter-enterprise business processes.
"The bursting of the Internet bubble and all that followed from it has led to a more cautious attitude, but we're optimistic about growth," says Dave Cooper, Solectron VP of supply chain solutions. "To be ready, we encourage our OEM customers to enter into more collaborative relationships with us."
Issues related to evolving global supply chains are of more than local interest, as the electronics industry is seen as a leading indicator of what's happening in all manufacturing. It costs plenty to coordinate complex supply chain transactions. Business success may depend on well-managed use of IT as a means to reduce those costs.
For example, when the railroad and telegraph were introduced, historical studies show it took time to see evidence of their productivity benefits. This suggests you have to learn how to take advantage of new technology.
"At the end of the bubble we were still stuck in the prior stage of management practices," says Ernst. To coordinate complex networks, "we need to develop new capabilities."
Manufacturers work hard to find the right management balance. To start, some companies do too little; some do too much.
"A company realizes design and marketing are its core capabilities," says Cooper. "Yet it doesn't want to totally divorce itself from management structures in place for in-house manufacturing. Parallel structures and duplication of effort result. When you have too much middle management, they find ways to justify their existence. It's better to agree upon a real division of labor that stipulates who's responsible for continued reduced costs and those sorts of things."
Chris Smith, president of RiverOne, a supply chain solutions vendor to the electronics industry, says another kind of duplicated process may be procurement functions, as companies move to electronically based vendor-managed inventory. "The procurement function in that case need only manage exceptions. Why have procurement managers when suppliers are managing my inventory?"
On the other hand, Ernst says, even if you outsource all manufacturing, you need to retain a mass of services to integrate the various disciplines. "Ericsson was a company that in-sourced so much, it was like a Korean conglomerate. So when they did begin outsourcing, there was a tendency to overshoot. The immediate cost reductions that follow from the initial stages of outsourcing are so great it's difficult to resist, but you have to retain management structures for knowledge integration."
What's needed
The question then is, what management concepts allow for best use of the installed technology base, and what new technologies will best further management's purposes?
"The financial model in the electronics industry is typically a cost-plus arrangement where profits are minimal for the OEM and flat for the EMS provider," Cooper says. "What's needed are new business models that focus on a shared set of objectives and closely aligned incentives."
Increased IT-based integration among tiers leads to "a relationship model of joint decision-making and problem-solving based on a growing foundation of trust. Processes for effective collaboration are developed, and the associated tools are implemented globally," says Ajay Birk, Solectron VP of information technology.
Solectron believes it has a role to play here because of knowledge gained as it acquired companies and applied its own protocols for information sharing. According to its 2003 annual report, Solectron has more than 50 operations and services facilities around the globe providing electronic supply chain services to OEMs. Its revenues from continuing operations for fiscal-year 2004 totaled $11.6 billion.
"We've learned about standards, tools, and technologies that lead to inter-enterprise business processes," says Cooper. "These tools bring down total landed costs and make global outsourcing truly efficient. Our open IT platforms allow us to take information in a supplier's format and share it with other business partners in whatever format required, for forecasts, inventory, and exception management."
Information sharing sets the stage for collaboration on demand signals that the entire supply chain can respond to, rather than "just a forecast that is thrown over the wall. This can eliminate some of the serious problems that arose when the bubble burst," says Cooper.
Solectron has brought three core technology capabilities together as part of its supply chain service offering (see sidebar). RiverOne furnished the portal technology used in Solectron's suite, and Smith says it's at this point that you start moving from doing transactions to shared business processes.
"Procurement focuses on cost and delivery. That's not necessarily the goal with outsourcing. You need to respond to demand variability, and to do that you need to know what's going to happen next. You need an infrastructure extending across time zones that includes workflows, routings, and all the elements of an extended supply chain," he says.
Yet even with the necessary tools in hand, will the electronics industry enact the management practices, based around shared business goals, to make it work?
Everyone recognizes opportunistic behavior has long-term costs, says Ernst, and developing a demand picture in common might be the best way to protect against a repeat of 2000, "but we're not living in an ideal world. Stock exchanges and margin considerations drive these issues. These relationships are between unequal players, and given constant price pressures, it's understandable that companies act as they do."
Another problem, says Smith, is inventory liability. "OEMs want to keep it in the rawest form possible, but suppliers don't want to make it unless they know it will be bought. Liability today depends on a negotiated settlement."
Nevertheless, says Ernst, an infrastructure for collaboration is evolving. "We're much better off than we were five years ago, and there is a movement toward trust amongst a community of interested parties. People are talking about these issues intensively, and in that sense I'm optimistic."
No more games
Cooper says given the real-time visibility a portal environment delivers, OEMs, EMS providers, and suppliers will have no choice but to be honest with each other.
Yet closer relationships entail increased risks for all parties, and can be deleterious if not managed correctly, he says. "An OEM may not be comfortable with such a close relationship and may do things like continue to issue RFQs [requests for quotes] even though the investment it has made in its relationship with its current provider may make it difficult to switch. But it's a benefit if you can eliminate the cost of RFQs."
Cooper sees an evolution in outsourcing relationships taking place. To start, companies saw the efficiencies involved, but often, total landed costs weren't reduced as much as they could have been. In addition to the temptation to keep parallel manufacturing management structures in place despite outsourcing, Cooper says other important interfaces include those between design engineering and manufacturing, and from the service cycle back to engineering and manufacturing.
"If design is done in isolation, you're missing opportunities for greater profit." says Cooper. "It's tough enough to get this right with in-sourced manufacturing. What's learned in the service cycle, and feeding that back to manufacturing and engineering, makes products sustainable over time. IT has an important role here."
Silicon Valley speaks a very different language than does Singapore, concludes Ernst. "With the degree of specialization found in the industry and cultural barriers as well, you need to define very precisely the languages used to communicate across a tier, or between tiers. The degree of abstraction found in computing environments necessitates retraining and has profound policy and management implications."
Cooper, for one, is convinced things are changing in the electronics industry. "Yes, it's starting to turn. OEMs are more and more convinced that the model needs to change." And Solectron must "demonstrate that it is capable of using IT to promote visibility, adaptability, and flexibility in an environment that is both real-time and based on exception management," concludes Birk.
