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A primer on supply-chain management (SCM) part I

May 6th, 2008 · 1 Comment

One of our featured companies is eFuture (EFUT), a leading Chinese producer of supply-chain management software (SCM). Here, we will look into what that actually does.

What is a supply chain?
“A supply chain encompasses all activities associated with the flow and transformation of goods from the raw materials stage (extraction), through to the end user, as well as the associated information flows. Material and information flow both up and down the supply chain. (Handfield and Nichols 1999:2)

What is supply chain management (SCM)?
Supply chain management (SCM) is the integration of these activities through improved supply chain relationships, to achieve a sustainable competitive advantage” (Handfield and Nichols 1999:2)

A good place to start is an example from the book Lean Production (Womack and Jones 1996) describing the value chain of a cola can one can buy from the shelves of Tesco, a British supermarket chain.

The journey from bauxite (containing aluminium) to cola can (the ‘supply chain’), involves a huge amount of steps and accompanying of wasting resources, time, and money. It is very instructive to summarise these:

  • There are seven companies involved
  • The total processing time is 3 hours, infinitesimal in relation to the 319 days it takes from bauxite to a cola can in Tesco
  • The waste of transport; the aluminium and cans are picked up and put down thirty times
  • The waste of inventories and excess processing; the aluminium and cans are moved through fourteen storage lots and warehouses, and they are palletized and unpalletized four times
  • The waste of defects and scrap; 24% of the expensive, energy-intensive, aluminium coming out of the smelter never makes it to the customer.

It will be obvious that there is a staggering scope for improvement here. An immediate problem is, that there is no ‘owner’ of a supply chain as most consist of multiple companies that have, to a large degree, antagonistic relationships.

After all, what one company sells the next company in the supply chain buys, so it seems like a series of zero-sum relationships (one party’s gain necessarily comes at the expense of another party).

It only seems so, because if companies would collaborate, substantial gains would become available and could be split. Just think of how the above supply chain would be able to cut waste if it was owned by a single organization, or if the companies would manage to collaborate to cut the waste.

Japanese practices
This is not easy though, ask the big three US car makers. One of the Japanese practises they tried to copy when Japanese carmakers started to make serious inroads into their markets was new supplier policies.

Japanese car manufacturers used to have far fewer suppliers, long-term relations are the norm, and there is considerable mutual collaboration (and there used to be even cross-sharholdership) and technical assistence.

US car manufacturers did have arms-length antagonistic market relationships with their suppliers, not the right environment for successful supply-chain management. The main mechanism instilling discipline in their suppliers was what Hirschman (1970) has called the ‘exit’ option (the threat of a walkout, sourcing from another supplier).

Vertical integration?
Their Japanese couterparts also use a ‘voice’ option, in the form ongoing technical assisstance and collaboration. This is a very modern form, actually. One could ask, if the waste along the supply chain is so large, why not bring the whole supply chain under common ownership, vertically integrating the whole supply chain.

Well, that could be, but vertical integration brings it’s own problems. It’s much less flexible, companies can become big and bureaucratic, it dulls market incentives (parts of the company have captive markets in the form of guaranteed buyers in other parts of the company), and it can forfeit the economics of specialization.

The Japanese manufacturers could enlist the specialist knowledge of their suppliers whilst the American ones gave precise blueprints of the parts they wanted, leaving little room for input of the suppliers.

Also, Japanese manufacturers could practise a particular form of supply-chain management called ‘just-in-time’ (JIT) manufacturing. Basically it means producing parts just in time when they’re needed, cutting inventory and associated cost. (There is actually a lot more to JIT manufacturing, like the need for producing much lower batch sizes and a myriad of changes that have to be made in order to pull that off, but we’ll leave that for another time perhaps).

Between markets and organizations
Supply chains became finely orchestrated machines, and almost behave as a single company, without running into the disadvantages that that would bring. It’s an institutional form between a (single) organization and the market, sharing many of the benefits of both, without having much of their disadvantages.

It’s crucial that the participating companies must be able to resist the urge to get a bigger slice of the gains in the short-term (for instance by forcing lower prices from suppliers), which requires companies to cement longer-term relations.

This, in turn, requires a cultural change, which practices like mutual gain sharing can foster. Only then will the huge amounts of gains the cola can example at the beginning of this article become available.

What we are saying here is that before snazzy software is used, some fundamental organizational changes and practises have to take place. Technology alone is almost never a solution.

Remember that the productivity gains of new ICT only became obvious in the macro figures in the late 1990s, decades after the ICT technological revolution began. It took companies a long while to figure out how best to use all that stuff, and there are a host of case studies which testify to this.

Handfield, R.H. and Nicols, E.L. 1999. Introduction to Supply Chain Management. Prentice Hall.
Hirschman, A.O. 1970. Exit, Voice and Loyalty: Responses to Decline in Forms, Organisations and States. Harvard University Press. Cambridge MA.
Womack, J.P. and Jones, D.T. 1996. Lean Thinking. Banish waste and create wealth in your corporation. Simon & Schuster.

Tags: Economics of stock analysis · EFUT

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