Maximizing value in the supply chain.

THE ONCE HUMBLE ACTIVITY OF LOGISTICS HAS MORPHED INTO A FORMIDABLE STRATEGIC PRACTICE OF SUPPLY CHAIN MANAGEMENT. AS CEO PARTICIPANTS ATTEST, IT IS RIGOROUS DISCIPLINE, BUT WORTH THE PAYOFF IN UNLOCKED VALUE.

In the grand management ball of ideas, logistics is no longer a wallflower. Instead, dressed in the party frock of supply chain management, she has suitors queuing up to sign her dance card. The relentless push for increased efficiencies--and the inability to simply pass on cost increases in the form of higher prices--has forced companies to reexamine their relationships with suppliers and vendors. Over the last decade, power has shifted from producers to retailers to end users. Enlightened self-interest dictates that when end users are unhappy, suppliers will be miserable. And the cost of keeping unnecessary inventory on hand has become prohibitive. In short, producers, distributors, and sellers have had to examine every step in the chain by which a product is made, value is added, and both are delivered to the ultimate user. Many organizations have succeeded in selected areas by outsourcing such things as transport and physical delivery. Health-care company Baxter International, for example, mixes in-house supply, outsourcing, and electronic links with the customers of its hospital supply division to dominate its market. Heavy equipment manufacturer Caterpillar uses an extensive dealer network tuned for quick parts supply anywhere in the world as a competitive weapon over arch-rival Komatsu.

What remains is the need to extend such practices across the total supply chain. The latest evolution of supply chain management seeks to integrate a number of processes whereby companies:

* Build alliances with suppliers that work closely together to improve forecasting, order fulfillment, planning, scheduling, packaging, delivery, and inventory control.

* Outsource those functions that can best be performed by those who are most efficient.

* Use logistics and distribution to ensure that handling costs are minimized and that time to market is maximized.

* Reduce cycle times between and among producers.

* Shift from a stock inventory to a continuous process flow.

* Use information technology to link each step in the value chain and eliminate non-value-added steps. Now that technology allows a company to direct its entire distribution network, it makes little sense to own all or even parts of it if capital can be used more productively elsewhere.

Dedicated logistics is said to be the last frontier of cost reduction; supply chain management is the horizon of global strategic advantage. Procter & Gamble, for example, developed a three-step supply chain system built around a continuous replenishment program. Under CRP, the reorder process was simplified by eliminating nonvalue-added costs. Under this system, customers send orders via electronic data interface to P&G's distribution centers. P&G also knows from incoming data on point-of-sale transactions what to anticipate even before an actual order is generated by the customer. Orders are periodically aggregated to establish the best reorder quantities. After adjusting for special promotions and other activities, specific orders are directed to manufacturing plants for production. After required stocks are produced, replenishment goods are sent through prescheduled distribution to P&G distribution centers. New goods, along with on-hand inventory, are sent to individual stores as specified by the customer. Retailers such as Wal-Mart benefit from increased inventory turns and reduced administrative costs. P&G enjoys 30 percent better order volumes and increased market share of more than four percentage points. Planning is greatly streamlined. Disposable diapers, for example, are subject to wide swings depending on the type being sold, such as regular, absorbent, or super absorbent. With its CRP process, P&G can replenish lean retailer shelves, because plants get early warning when a particular product is pulled out of the system.

In the following roundtable, held in partnership with UPS Logistics, CEOs concentrated on how best to implement SCM, as well as how to exploit the value chain for strategic advantage. Main barriers to full SCM optimization are familiar. It requires overturning long-held corporate practices such as treating suppliers like adversaries instead of partners. Many companies still try to wring concession from suppliers based on the belief that the savings gained at gunpoint are permanent. Despite lip service to the contrary, it remains a standard practice for many--and one that ultimately can lead to ruin.

NO MORE MISSING LINKS

Dan DiMaggio (UPS Worldwide Logistics): What is supply chain management exactly? Supply chain management is a process-oriented view of your business. It means finding out how to get value-added products to the customer at the right time, the right place, the most reasonable cost--then driving that back through the food chain.

We participated in a two-year study with Michigan State University to evaluate best practices and what a company has to do to demonstrate world-class logistics in supply chain characteristics. You could count on one hand the number of companies that exhibited world-class logistics throughout all functions. The reason lies in the difficulty of execution. The customer-service group wants all the inventory to be available all the time. The finance people worry about having too much inventory and tying up working capital in it. And global sourcing is a problem from a cost perspective.

Success comes down to being able to do a quality implementation and sustaining the change that cuts through every silo in the company. Maintaining quality is a particularly thorny issue when you begin outsourcing in a supply chain environment, because you're ceding control of something you've overseen for years.

Alan D. Weinberger (ASCII Group): The problem is that any creator of a product or service wants to control the entire channel. And the end user, the customer, wants uniform service and support around the world. In the computer industry, the biggest problem is that everything is outsourced on the reselling end. The direct sales forces of old don't exist anymore. Some 90 percent of PC products go through independent resellers, and that's where the manufacturer loses control.

Alfred J. Battaglia (Becton Dickinson IL Co.): There's a danger of outsourcing and supply chain management becoming synonymous. You can't outsource the concept of supply chain management and what it is going to do for your business--whether that means improving your service, reducing the cost, or improving the quality of products and services. These are the kinds of strategic issues the CEO normally wrestles with, so you can't delegate the responsibility to an overworked traffic manager. SCM first has to be put on the CEO's agenda. Ultimately, the CEO must decide who will manage and implement this new concept.

Nishan Teshoian (Keystone International): In the last 30 years I've been in manufacturing, it seems the answer to all topics is, "The CEO has to be the advocate and have a strategy and a business plan." Part of the reason supply chain management and outsourcing are off to a slow start is that many things have evolved over the years that try to do the same thing, and the CEO has been bombarded. It all started with manufacturing resources planning, which aimed to change the manufacturing process. Then it was MRP-2, which sought to change the process of deliverables to satisfy customer requirements. Then quality initiatives were attached to both approaches. At the end of the day, the CEO is trying to articulate a macro vision for the organization, and the organization is saying, "Here it comes again. We've heard this before."

J.P. Donlon (CE): How do you break through that?

Teshoian: You must have the right kind of organization, people, and strategy. We can try to sell supply chain management to the organization 'til the cows come home, but if it's not on the CEO's short list of priorities to implement, it won't happen.

Steve Weinstein (Logistix): You're right. Because companies are redefining businesses as they look at supply chains, almost all operational issues become candidates for outsourcing. The traffic manager is not going to be able to make decisions about whether the company ought to have assets in machinery or not--that's the CEO's job.

Richard L. Bogen (UPS Worldwide Logistics): Commitment and total involvement by senior management in the outsourcing process is critical. I don't think senior management yet recognizes the impact outsourcing has on the entire organization, including suppliers and customers.

Successful outsourcing projects at our company have always involved project teams composed of our people and our customers' people who are involved in the process. We work together on the re-engineering process, and senior management lets all the employees know where they will fit into the grand scheme of things. People skills and communication are two of the most critical factors here.

Weinstein: That's important, because when the employees who used to do that job haven't been prepared for the outsourcing and haven't been told what will happen to them, they resist it. And no matter how wise the folks sitting at the boardroom table are, outsourcing won't work if the employees below resist it.

Bogen: Microsoft has done a good job in this area. In Europe, we are managing the transportation, warehousing, distribution, and customer service of Microsoft's computer mice and ergonomic keyboards. Microsoft was experiencing many problems related to not having the right product in the right place at the right time. The sales force was upset because it was losing sales opportunities. By working closely with the people from Microsoft--from headquarters in Redmond, WA, throughout Europe--we were able to re-engineer the process, satisfy the customer, and make a significant change in sales, all without being sabotaged by people internally.

Jim Ivy (Savin Corp.): In many companies, the employees involved basically worked in the back room. The warehouse was only important to the guy who ran operations, and nobody else knew what was going on. When you start to educate employees and show them how customers can benefit from supply chain management, salespeople can sell more, marketing people can promote more products and services, and everybody starts to generate more volume. That's when employees begin to embrace the idea. But you have to bring it out of the back room and into the forefront of the company.

J. Brady Young (Alternative Risk Solutions): Does the existing logistics manager or traffic manager usually champion supply chain management or is it necessary to bring in someone from the outside?

Bogen: An existing traffic manager can successfully champion one link or a couple of links in the chain. But I haven't seen any evidence of a traffic manager being able to champion a whole sale chain capacity.

Ivy: That requires the involvement of the whole company--from senior management to marketing to information systems. One person can facilitate it, but you need a team effort in all the functional areas to make it work.

GETTING TO THE NEXT LEVEL

Donlon: How can the CEO take SCM to the next level and integrate the various links of the chain?

Battaglia: Supply chain management is not logistics; it is an integrating process. So, first, you must have a concept of strategic planning to figure out what part of the chain you need to work on and where the opportunity is. If a company's strategy is to open up the Chinese market, then it would worry about activities pertaining to the supply chain in China. If, on the other hand, the derivation of a critical part of a company's product were important, it would be on the other end of the supply chain, worrying about supply issues.

Teshoian: Do most companies start with the customer and build back to the supplier rather than the other way around?

Weinberger: Absolutely. There's no other safe way to do it. You have to start with customers.

Weinstein: The customer doesn't drive the chain, per se, but the chain must be designed starting with the customer. The problem is that if everybody waited for their customers to tell them what they wanted, they'd just be reactive. To differentiate yourself and offer a better value proposition, you have to ask customers what they need rather than wait for them to come to you with problems.

Battaglia: At Becton Dickinson, we've reduced inventories by $100 million a year on a $400 million base as a result of smoothing out the supply chain with help from transportation partners, warehouse management partners, and freight-forwarding partners.

Donlon: Have you connected all the links in Becton Dickinson's supply chain, from beginning supplier to end user? Battaglia: We had to. We're the world's largest supplier of syringes, blood collection tubes, and blades. If there's one broken link in the chain, we have a major problem. Some links are weaker or stronger than others, so depending on the situation, we might be spending more time on a particular portion of the supply chain. For example, we are starting up an operation in China, and I went over there to see about setting up the supply chain to provide the kind of services that w ill be expected there.

Becton Dickinson's supply chain management strategy is built on a service strategy platform, meaning we can manage services the way we manage the development and production of the product via optimization of information and product flow. Good services can differentiate even a commodity product--who wouldn't pay 5 percent more for a plumber who returned their telephone call and showed up on time for the appointment? That's where you get your premium, not simply with the best product and delivery services, but with maintenance, training, and other services.

Now you don't want to give these services away. You want your sales and marketing people to identify the selling arguments that make this a value-adding activity and present them to customers. Our sales and marketing people understood their role in introducing new products, but they didn't know what our customers' service requirements were. They thought if we had the sharpest needle, everything would be fine. But that's not the whole story. We have to ensure that the sales force understands the role it can play in pleasing our customers.

OUTSOURCING DECISIONS

Weinstein: Over the years, we've found that there are some cases where the company can save money operationally by outsourcing a function, but that may not be a good idea. For example, customers often have a vision of the characteristics they want suppliers to have instead of just considering the attributes in the value proposition. So before outsourcing, a company must ensure that there won't be a customer objection. This often entails doing some customer re-education before entering into the agreement.

Harry E. Gould (Gould Paper Corp.): There's no cookie-cutter formula for making an outsourcing decision. It's relatively easy to decide to outsource payroll or computer programming or freight forwarding, but it becomes more difficult when the customer gets involved. When we started our second operation in Dallas, I was easily convinced to let an outsourcer provide the labor, the space, and warehouse distribution operation. As we grew, local management said we needed a control to make sure our customers got serviced properly, meaning we needed our own warehouse, people, and trucks.

When another outsourcer approached us for our Mid-Atlantic division in Philadelphia, the manager had a fairly easy decision, because his bonus was dependent on pre-tax income, and the outsourcer would save him a certain amount of money. But we said, "Not so fast." When you're in a service business--especially one such as paper, where there's nothing unique about it--if our customer doesn't get the paper when he needs it, we're out of business. And when you turn over the operation to an outsourcer, it doesn't have quite the same urgency or concerns.

Teshoian: In the manufacturing business, we have partnerships with our suppliers. But we also have a responsibility to the customer to have the product there when he wants it. That can lead to problems, because the CEO's attention is primarily focused on the customer relationship, not the supplier relationship. Thus, the question becomes how to satisfy the customer without alienating the supply partner with an impossible logistics request.

DiMaggio: In the PC market, everything is changing so fast that a new product comes out every 90 days, and chip prices are falling. As the logistics company, we put together a model that did not take into account this 90-day turnover, meaning the supply chain was based on historical trends rather than what's happening now and what will happen in the future. The answer is to design less rigid warehouse walls, so to speak, and improve our information capability.

Donlon: Was your mistake attributable to a lack of long-term thinking, relative ignorance, or just being early in your learning period?

DiMaggio: In supply chain management, you have to understand what your partner understands. I'm not sure there is an outsource company that really understands the high-tech industry at this point.

John J. Burns Jr. (Alleghany Corp.): I am skeptical that there is a "logistic" firm out there now that is big enough, tough enough, and smart enough to handle everything for everybody. I think it will start incrementally. I learned from my transportation days that the low rate gets the freight. If this thing is going to work, it will start from the bottom and work its way up.

Arnold B. Pollard (CE): There probably are some situations that are difficult to successfully outsource or establish a paradigm for a supply chain that stands still long enough to develop a relationship.

Weinstein: I challenge that notion. I think virtually every function can be outsourced. The biggest challenges are in determining the robustness of the pricing structure and contractual arrangements, and anticipating all the possible eventualities. Since the world has not been used to this level of outsourcing, that expertise has not been developed in many places. The world of contracts and agreements has not yet caught up with the way people are doing business today. So companies that do this are inventing the wheel--and often a little too late. They find themselves in a big struggle because they haven't done enough work up front.

A company that is about to outsource a function has a lot of inventory, employees, and factories in place. All the resources and inventories have already been deployed. It is easy to get into a horrible debate over who owns that inventory and who bears the risk associated with it. However, the solution is to create a simple formula. For example, if the agreement includes a provision that the outsourcer is going to buy the inventories, the terms for payment and that inventory can be tied to shipments to the original equipment manufacturer. So the payments never come due unless the company demands the product. The fact that it's sitting in the warehouse and is on the supplier company's books is not relevant. Then, knowing that the product site and life cycles are such that if it's over a year, it must be dead, you can set a cut-off of 12 or 18 months, at which time the invoices are abandoned.

Ivy: We've been experiencing a problem in which the basic contract with our logistics and warehousing outsourcer was written in such a way that it encourages the company to be inefficient. It was compensated with too much space, too much product movement, too many transactions. There was no incentive for it to be more efficient. The solution is to hold the outsourcer to the same standards against which your customers measure you.

DiMaggio: That's true. You can't just tell the outsourcer to go out and do it; you must constantly monitor and measure the performance of the implementation.

AN INTERNAL APPROACH

Peter McCausland (Airgas): Airgas is taking a different approach to outsourcing and supply chain management. We're internally outsourcing everything from purchasing to warehousing and distribution. We have purchased companies that have a strong local presence in their markets, that sell high value-added products on a local level, and have wonderful customer relationships.

Our strengths are customer relationships, sales and marketing, and the technical services we deliver with our products. We are not good at the whole ball of wax of supply chain management. We also are decentralized, with 40 different subsidiaries. So we decided to form an industrial distribution division comprising three or four companies that would act as our database for all our customer information for the 40 subsidiaries. We're investing a lot of money in the best experts and information systems. We're also going to hire a dream team of the best supply chain managers we can find.

Bogen: Are you going to continue to invest in those information systems to stay ahead of the competition?

McCausland: Yes, and it could be a problem, especially when you consider that our strategic plan is to sell other products and services to our 750,000 customers. As we add other products and services, this supply chain management capability is going to have to expand to accommodate them. But we have to make some decisions up front about building flexible systems and do the best we can.

I hope we'll end up with a common infrastructure that is constantly investing to provide greater supply chain management services to the various channels through which we sell our products.

Donlon: How much investment in information systems and technology will this entail?

McCausland: We're looking at around $10 million out of the box to invest in information systems and state-of-the-art warehouses, plus training and leasing the properties.

PEOPLE, PLANS, AND PRIORITIES

Donlon: What does the CEO have to get right to mesh all the links and realize the supply chain potential?

Battaglia: The CEO must realize that he or she won't find the necessary body of skills in the obvious places such as warehouse systems or traffic management. Chances are, the right people will have been small product business managers and plant managers. We're looking for a new type of skill. And companies have to invest in it.

Ivy: The CEO has to bring the concept to the forefront of the company. For example, we started bringing the people who handle our supply side of the business to our marketing meetings and involving them in various task force committees. You also have to get the customer involved in the process early on. Designing your systems at least around your larger customers' goals, systems, and needs could avoid a lot of wasted time and expense.

Then you have get your people from new areas, such as marketing and sales involved, so you're building a cohesive package. You also might consider moving people around, assigning the traffic manager to a different position, for example. We put someone who was in finance and marketing into the traffic manager's job. He took a whole different view toward improving efficiency.

Young: It all comes down to getting the right buy-in and handing the ball off to the right person. Otherwise, supply chain management won't happen.

Teshoian: CEOs should try to maximize the value of what they've already invested in--MRP, Statistical Process Control, etc.--and link it to the supply chain process. A CEO who tries to substitute supply chain management philosophy for what's already in place is going to cause an awful lot of upheaval in the organizational structure.

In addition, we must figure out how to link supply chain management with what's already been done to satisfy the customer's requirements. Then we must find the best people to address the issue. In many instances, if you stick the traffic guy in charge of the initiative, you're sending a signal that the project's not that important. Once you start implementing the program, you have to identify the person who has the organization's respect and let him or her go forward with the project.

Weinstein: It all starts with clarifying the company's business design and communicating it throughout the organization. That means the CEO has to know and articulate the critical things the business has to do internally. Only then should the outsourcing decisions be made. At that time, the CEO must ensure that the internal people who will be affected by the outsourcing know what is going to happen. Then the company must develop, hire, train, or do whatever is necessary to gain great outsourcing skills, meaning people who can write good contracts, make agreements, and implement good metrics to ensure that the outsource supplier is performing as planned, and continuously improve the relationship.

DiMaggio: The CEO must maintain the mind-set that from the day the plan is put down on paper, it will evolve into something else. In addition, the CEO needs to measure the full process, not just the functionality of each piece of it, but what it costs and what the quality is.

Bogen: CEOs must recognize the criticality of supply chain management if their companies are going to survive into the next millennium. Next, they must recognize that two core competencies are required in supply chain management: information technology and management expertise. Finally, they must ensure that they have best-in-class people to execute these core competencies. That's the only way it will work.

RELATED ARTICLE: A Who's Who OF Roundtable Participants

Alfred J. Battaglia is group president of Franklin Lakes, NJ-based Becton Dickinson & Co., a $2.7 billion medical supplies company.

Richard L. Bogen is president of UPS Worldwide Logistics in Atlanta, GA, a global supply chain management unit of $500 million UPS Logistics Group.

John J. Burns Jr. is president and chief executive of New York-based Alleghany Corp., a $1.8 billion insurance and minerals concern.

Dan DiMaggio is senior vice president and chief operating officer of UPS Worldwide Logistics.

Harry E. Gould Jr. is chairman and president of Gould Paper Corp., a New York-based printing paper distributor with $830 million in revenues.

Jim Ivy is president and chief executive of $275 million Savin Corp. in Stamford, CT, an office equipment subsidiary of $12 billion Ricoh Corp.

Peter McCausland is chairman and chief executive of $838.1 million Airgas in Radnor, PA, a distributor of industrial, medical, and specialty gases and industrial supplies.

Nishan Teshoian is chairman, president, and chief executive of Houston, TX-based Keystone International, a $597 million industrial products company.

Alan D. Weinberger is chairman and chief executive of privately held ASCII Group in Bethesda, MD, a computer buying group.

Steve Weinstein is CEO of $290 million Logistix, a Fremont, CA-based integrated supply chain management company.

J. Brady Young is president of Lexington, MA-based Alternative Risk Solutions, an insurance and risk management subsidiary of Arkwright Mutual Insurance Co., which has $374.1 million in revenues.