Supply Chain ManagementDr Benn Lawson, University of Cambridge

b.lawson@jbs.cam.ac.uk

Veolia Imperial Pathfinder (VIP) ProgrammeVeolia Imperial Pathfinder (VIP) Programme

Today’s Objectives

• Does supply chain performance matter?

• How do you collaborate and build alignment across supply chain partners?

• Key levers for managing supplier relationships

• Power

• Incentives

Automotive Industry: Cost Structure

Source: Holweg and Pil, 2004

Boeing 787 Design Partners

The Typical Construction Supply Chain

Problem in Supply Chains

The Bullwhip Effect - Campbells Soup

With increased volatility from marketing campaign and false demand signals Source: Lee et al (1997)

Is ‘supply chain’ important to the markets?

Empirical evidence suggest a direct relationship between supply chain “glitches” and stock price performance

Source: Hendricks and Singhal (2003, 2005)

-25

-20

-15

-10

-5

0

-61 -49 -37 -25 -13 -1 11 23 35 47 59

Trading day relative to announcement date

Ave

rag

e s

ha

reh

old

er

retu

rns

(%)

Marketing eventsChange in firm name

0.7%Brand leveraging

0.3%Celebrity endorsement

0.2%New product introduction

0.7%Affirmative actionawards

1.6%Delay introduction of

new -5.3% products

Financial eventsStock splits

3.3%Open market share

repurchase 3.5%Proxy contest

4.2%Increasing financial leverage

7.6%Decreasing financial leverage -5.4%

Seasoned equity offerings -3.0%

Operational eventsIncrease in capital

expenditure 1.0%Increase in R&D expenditure

1.4%Effective TQM implementation

0.7% Internal corporate restructuring

1.0% Decrease in capital expenditure

-1.8% Plant closing

-0.7% Supply Chain Disruptions -7.0%

Information technology eventsIT Investments

1.0%

B2C e-commerce

10.5%B2B e-commerce

3.3%IT problems

-1.7%

Hendricks, K. and Singhal, V.R. “Supply Chain Disruptions and Shareholder Value.” January 2005

Stock market reaction to announcement in %, by type

The Red-Blue Exercise

Mr White gets 5 yrs

Mr Black gets 5 yrs

Mr White gets 1 yr

Mr Black gets 8 yrs

Mr White get 8 yrs

Mr Balcke gets 1 yr

Mr White gets 3 yrs

Mr Black gets 3 yrs

Doesn’t confess

Confesses

Confesses

Doesn’t confess

The “Prisoner’s Dilemma”

Mr White

Mr Black

The Evolution of Cooperation – Tit for Tat

• Achieving win-win outcomes requires changing incentives from defection to cooperation

• How might this be achieved?

NiceRetaliatingForgivingNon-envious

Does This Build Trust?

– Suppliers develop design proposals, OEMs send their plans around to get competitive quotes

– OEMs demand immediate 5% price cuts

– OEMs abruptly change policy and make suppliers responsible for tooling cost

– OEMs run reverse auctions in which aggressive bids pushing prices lower can’t be verified later as coming from legitimate suppliers

– Supplier quality problems on major components/ subsystems are perceived by public (and in legal liability cases) as OEM responsibility

Why are (were) the Japanese so much better…?

Source: Liker and Wu 2000

Performance Indicator

Suppliers to US auto plants

Suppliers to Japanese transplants

Suppliers of

Chrysler

Ford

GM

Honda

Nissan

Toyota

Inventory turns

25.4 38.3 28.3 24.4 25.5 38.4 49.2 52.4

Percentage change in manufacturing costs compared with previous year

+ 0.65% - 0.85% + 0.69% +0.58% +0.74% - 0.9% - 0.7% - 1.3%

Percentage of late deliveries

2.96% 1.38% 4.45% 1.70% 3.04% 2.11% 1.08% 0.44%

Emergency shipment costs in US$m

714 371 1,235 446 616 423 379 204

Source: Liker and Wu 2000

Suppliers’ View "The Big Three [U.S. automakers] set annual cost-reduction targets [for the parts they purchase]. To realise those targets, they'll do anything. [They've unleashed] a reign of terror, and it gets worse every year. You can't trust anyone [in those companies]."• Director, interior systems supplier to Ford, CM, and Chrysler, October 1999

"Honda is a demanding customer, but it is loyal to us. [American] automakers have us work on drawings, ask other suppliers to bid on them, and give the job to the lowest bidder. Honda never does that."• CEO, industrial fasteners supplier to Ford, CM, Chrysler, and Honda, April 2002

"In my opinion, [Ford] seems to send its people to 'hate school' so that they learn how to hate suppliers. The company is extremely confrontational. After dealing with Ford, I decided not to buy its cars."• Senior executive, supplier to Ford, October 2002

"Toyota helped us dramatically improve our production system. We started by making one component, and as we improved, [Toyota] rewarded us orders for more components. Toyota is our best customer."• Senior executive, supplier to Ford, CM, Chrysler, and Toyota, July 2001

Evolution from Traditional to Integrated Supply Chains

Relational

Actions

Building Trust

Characteristics of Collaborative Relationships

Joint problem solving

Joint co-ordination of

activities

Mutual Benefit

Long-term commitment

Shared Vision & Objectives

Top Management

Support

Measurement & Evaluation

Information Sharing

Dedicated assets

Closeness of relationship

The Supplier Working Relations Index

Discussion

Given the success of the Japanese model, should one always aim for:

.. long-term supplier relationships?

.. collaborative relationships?

.. single-sourcing?

Power in the Supply Chain

• Everyone in the supply chain seeks to appropriate value for themselves from participation!

• Certain players recognise that they have limited power to appropriate value, but would seek to leverage more value if they could

• Understanding power structures is important for explaining inter-organisational dynamics

• Toyota model:

• Transforming power through creation of hierarchies of structural dominance. Toyota is dominant player, able to control key resources that appropriate value

• Creates dependents (suppliers) who provide no threat to the flow of value appropriation

Source: Cox 1999

Managing Power and Dependence

Hostage(Supplier powerful)

Effective Relationship

(Highly Interdependent)

Apathy(independent)

Domination(Buyer powerful)

Supplier Dependence

Low High

Low

High

Buyer Dependence

Managing Power

Rewards Punishment

Promises Threats

Exercised Power

Un-Exercised Power

Non-CoercivePower

CoercivePower

The Role of Incentives

• Problem - Incentives offered to different stages or participants in a supply chain lead to actions that increase variability and reduce total supply chain profits

= Misalignment of total supply chain objectives and individual objectives (excess inventory, stock-outs, incorrect forecasts, higher manufacturing costs, loss of supply chain innovation)

• Causes –

• Hidden actions

• Hidden information

• Badly designed incentives

• Local optimization within functions or within stages of a supply chain

Aligning Goals and Incentives

How to go about it? (Narayanan & Raman, HBR 2004)

1. Acknowledge that an incentive misalignment exists

2. Diagnose the cause for the misalignment

3. Change incentives (rewrite contracts, reveal hidden information, develop trust) to reward partners for acting in the supply chain’s best interests

4. Review periodically, and educate managers across tiers

• Align incentives so that each participant has an incentive to do the things that will maximize total supply chain profits

Secrets of Effective Relationships

1. Long-term collaboration

• Commitment to shared future

• A fair profit

• Understand the supplier• “Collaboration is not about a photoshoot of people with their arms around one

another. My definition is about the right quality, right time, right supplier, right plan, and right total cost. And if I am not hitting on all of those cylinders, it may be because I am not providing the right information on what we need, or we have great clarity, but they are not interpreting it properly. We need to understand what is going on with their world, their signals, and flows and interpretations of what we are asking them to do.”

- Frank Crespo, Chief Procurement Officer at Caterpillar

2. Tough, but helpful (Toyota, Honda)

• Parallel sourcing to create positive pressure

• Send monthly report cards to core suppliers, feedback

• Supplier development to build capabilities

• Share information intensively, but selectively

3. Improvement is realised in collaboration, not isolation

• Continuous improvement (Kaizen)

• Exchange best practice, Sharing of gains

• Supplier study groups (Dyer, 1996)

Secrets of Effective Relationships

4. Trust, but verify

• Strong supervision of suppliers (scorecards, supplier performance management)

• Supplier evaluation

”We gave away a lot of elements of [design] work that we’d always done in the past, and then didn’t provide the kind of oversight necessary for some of the people that were doing work that they’d never done before”

- Jim Albaugh, Boeing Dreamliner (2007)

Secrets of Effective Relationships

3T’s of Effective Supply Chains

Trust

Trans-

parencyTime

Takeaways

• Effective supply chain management requires seeking global optimum – which may mean sub-optimising at a local level

• Collaboration is a challenge – often the most difficult element of managing supply chains

• Two key drivers of relationship dynamics:

• Power

• Incentives

• Effective relationships have some combination of reward and punishment (ie, tough but helpful)

Further Reading

• Choi, T. and T. Linton (2011). "Don't let your supply chain control your business." Harvard Business Review, 89(12): 112-117.

• Dyer, J. H. (1996). How Chrysler Created an American Keiretsu. Harvard Business Review 74(4):42-56.

• Liker, J. K., T. Y. Choi. (2004). Building deep supplier relationships. Harvard Business Review, December 1

• Liker, J. K. and Y.-C. Wu (2000). "Japanese automakers, U.S. suppliers and supply-chain superiority." Sloan Management Review 42(1): 81-93.

• Lee, H. L., V. Padmanabhan, S. Wang. (1997). The bullwhip effect in supply chains. Sloan Management Review, 38 (3), 93-102.