Newsletter of the Stanford Global Supply Chain Management Forum Vol. 10 Issue 4 • Fall 2004

Five Steps to Service FORUM PARTNER MEMBERS Supply Chain Excellence Accenture ADX By Dirk de Waart and Steve Kemper AT Kearney Agile Software Applied Materials For decades, companies have struggled with the seemingly competing forces Cisco Systems of excellent customer service and best-in-class operational cost. The pre- Deloitte Research vailing view dictated that customer satisfaction required a high price and Dow Chemical aftermarket service was a necessary evil. Only recently have companies E2Open realized that they can run their service business as a profit center, making Hewlett-Packard IBM Corporation both their customers and their shareholders happy. The advantages of Ingram Micro Logistics achieving excellence in service supply chain management include increased Intel Corporation customer satisfaction and retention, product sales, and service contract rev- Intuit enue as well as higher margins. Given the higher emphasis of customers on Motorola after-sale support, the importance of excellence in service supply chain Nike Nokia Mobile Phones management—and the risks of not taking proper steps to improve perfor- Nomura Research Inst. mance in this area, are expected to further increase in the future. Oracle This article describes a five-step process to help companies swiftly get on palmOne that road to service supply chain excellence: PeopleSoft Samsung Electronics Step 1: Understand Your Service Supply Chain. The service supply SAP Labs LCC chain is defined as all processes and activities involved in the planning, SeeCommerce movement, and repair of materials to enable after-sales support of the Solectron company’s products. As a first step, companies should move into viewing Sun Microsystems the service supply chain as a cross-functional core process. Currently, UPS Viacore many companies tend to have the service supply chain subprocess owners report into different organizational functions, which typically subopti- AFFILIATED AIM MEMBERS mizes performance. There Advanced Micro Devices Step 2: Determine How to Measure Your Service Supply Chain. Cisco Systems is no single metric that defines the service supply chain’s performance. Ford Motor Corporation This challenge is complicated by the multitude of operational models typ- General Motors Corporation ically in play. It’s essential to choose the right metrics, that are aligned Genentech with the organization’s strategy and balance operational and financial Honda R&D Americas measures, and measure them in the right way. Otherwise, performance is Intel Corporation Sun Microsystems likely to be suboptimized. Toyota Motors Step 3: Develop the Business Case for Improvement. Enhanced service supply chain performance can drive higher business growth or lower

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Upcoming Events Global Supply Chain Management Conferences Date: September 16th Event: Research Roundtable Topic: Design Reliability across the Supply Chain Co-Host: Swiss Federal Institute of Technology Lausanne (EPFL-IPR) Location: Lausanne, Switzerland This year’s topic is “Design for System Reliability across the Supply Chain.” Many products and services today require combinations of hard- ware and software as well as external infrastructure. The roundtable seeks to uncover these challenges in various industries, identify the best practices, and set the agenda for the future collaborative research between Stanford, EPFL, and industries around the world.

Date: October 7th Event: 1-day Conference Topic: Demand-Driven Supply Networks: Innovations for Top-Line Revenue Growth Co-host: Oracle Corporation Location: Stanford University Campus The event will focus on the evolution of the Supply Chain to Demand-driven Supply Networks (DDSN) and the key elements and practices required for making the transformation. The forum will also have an industry focus and will feature an executive roundtable on outsourcing to Asia. Date: October 20th Date: February 9th Event: 1-day Seminar Event: 1-day Conference Topic: Service Management Topic: tba Co-host: Wharton Co-host: Accenture Location: Stanford University Campus Location: Stanford University Campus

Date: November 18th Date: June 2–3 Event: Research Roundtable Event: Annual Symposium Topic: RFID Innovations and Values Topic: Outsourcing and Offshoring Co-host: MIT Location: Stanford University Campus Location: Stanford University Campus European Supply Chain Forum Events Stanford Forum members are invited to attend one of the Eindhoven Forum’s events each year (up to two attendees), space permitting. If you are interested in attending or speaking at one of these events, please contact Christel Nieman ([email protected]). You may also want to visit their general web site at www.tm.tue.nl/efgscm/ Date: October 6–7 Date: November 17th Topic: Intelligent Logistics with RFID Topic: Operational Logistics Alliances & Smart Supply Chains Location: Eindhoven, The Netherlands and Packaging with RFID Location: Copenhagen,

2 oooo The Supply Chain Connection sion, the team listed the future challenges News from the Team in System Reliability. Amongst the top of the list was coordination amongst integra- Professors Hau Lee, Warren Hausman Professor Hau Lee is chairing the orga- tors and supplies during the design stage and Erica Plambeck joined 40 other nizing committee of this year’s Electronic to identify potential failures related to thought leaders in this year’s Supply Supply Network Conference, which will interfaces between system elements. Chain Thought Leaders Roundtable, take place in San Jose, CA on Sept. Identification of mismatch between hard- which was held in Woodstock, Vermont in 27–29. The theme of the conference is ware, software, and controls also emerged July. Professor Plambeck shared with the Agility, Adaptability, and Alignment, as an important challenge to address. group research trends in relationship con- based on Lee’s forthcoming paper in Another research roundtable will take tracts, while Professor Lee presented Harvard Business Review on this topic. place in Lausanne, Switzerland on research opportunities in supply chain Professor Erica Plambeck has received September 16, 2004, co-sponsored by the management in . A few weeks ear- the Presidential Early Career Award for Forum and EPFL-IPR (Swiss Federal lier, Professor Plambeck gave a similar Scientists and Engineers, an award that Institute of Technology Lausanne, talk on “Renegotiation of Supply was created to honor and support the Institute for Production and Robotics). Contracts” at Genentech, an affiliated extraordinary achievements of young pro- The roundtable will focus on Design for member of the Forum through AIM. fessionals at the outset of their indepen- System Reliability across the Supply During her recent visit to INPG dent research careers in the fields of sci- Chain. (National Polytechnical Institute of ence and technology. On Sept. 9 all recip- As in previous years, the Stanford Grenoble), Professor Feryal Erhun has ients of the 2003 Award were honored in Graduate School of Business offered this given on June 28 a talk on “Inventory an award ceremony, attended by President summer its Executive Education course: Control Policies Under Stochastic Bush. Managing Your Supply Chain for Global Quantity Discounts” at ENSGI-INPG, The Manufacturing Modeling Competitiveness. The course was held on Laboratoire GILCO, Grenoble, . Laboratory (MML) hosted a New Product August 22-27 and introduced the best The talk was based on her joint work with Introduction (NPI) Roundtable on practices, innovative ideas, and critical Nihat Altintas (Ph.D. Candidate) and “System Reliability of Product Platforms” thinking of integrative demand and supply Sridhar Tayur, both from Carnegie Mellon to discuss challenges faced by organiza- chain management. Professor Hau Lee University. One of her co-authors, Sridhar tions from different domains on July 16. directed the program, and the faculty Tayur, presented the same paper at the The roundtable, chaired by Professor Kos involved included Professors Bob Manufacturing and Service Operations Ishii, revealed common challenges in pre- Carlson, Warren Hausman, Haim Management (MSOM) conference, which dicting reliability, using failure informa- Mendelson, Evan Porteus and Jin took place on July 1–2 at the Technische tion to improve the reliability for the next Whang. Universiteit Eindhoven in The design, and product platforms. The pre- Holly Lutze, a Ph.D. candidate at the Netherlands. The title of the talk was senters at the roundtable event included department of Management Science and “Role of Quantity Discounts on a Buyer’s Glenn Havskjold from Boeing, Shinya Engineering, has successfully defended Ordering Behavior.” At the same confer- Sekimoto from , Glen Griffiths her dissertation in August. Holly’s disser- ence, Professor Erhun presented a talk on and Marcos Esterman from HP, Gene tation title is “Mitigating Supply Chain “Quantitative Risk Assessment in Supply Wiggs from GE Aircraft Engines, Kosuke Risk: Pooling, Contracting, and Supply Chain Management,” based on a joint Ashihara from Ebara, doctoral student Channel Selection,” and her work was work with Professor Elisabeth Paté- Seung Rhee, and doctoral student Larry supervised by Professor Özalp Özer. Cornell and Ph.D. Candidate Léa Deleris. Chao. During the wrap-up discussion ses-

Educational Seminar Analysis: systems. The event began with a focus on devel- oping the capability to “measure in order Operationalizing Supply Chain to manage” the impact of uncertainty on supply chain performance. Two steps were Risk & Flexibility Management identified as necessary to quantify the On May 12–13 the Forum offered its first flexibility management”, organized by impact of uncertainty on operational and “educational event”, a new type of event Blake Johnson of Stanford’s Management financial performance: initiated in response to interest from the Science and Engineering Department, • The use of “range forecasts” to capture Forum’s members and advisory board in addressed the business value and opera- the range of possible outcomes of key more in-depth, educational coverage of tional challenges of transitioning manage- sources of supply and demand uncer- new or emerging areas in supply chain ment of supply chain uncertainty from tainty (vs. prevailing “best guess” or management. The May event, titled spreadsheets and informal processes to a “one number” forecasts) “Operationalizing supply chain risk and company’s core planning and execution cont. on page 6 The Supply Chain Connection oooo 3 outbound supply chain and enterprise Offshoring: Accelerating and integration application development. As educational levels and the quality of manufacturing processes have risen Here to Stay abroad, so has capability for sophisticated By Amy Nguyen and John Ciacchella, A.T. Kearney R&D. Although much high-end research continues to be performed in the United Although offshoring is a current hot topic requirement. Companies like Cisco and States, Japan, Europe and Israel, compa- in the boardroom and press room, it’s any- Agilent Technologies, for example, must nies in China, , Southeast Asia and thing but new. Lower costs and the need to now compete with new companies in Eastern Europe are increasingly handling be closer to expanding markets prompted Greater China with lower cost structures. research related to product customization manufacturing companies to send func- Increasingly, executives report that cost and development and are beginning to tions overseas decades ago. What is new, advantage is no longer as important as take on more complex functions as well. however, is that globalization, improved proximity to new markets and increased According to the New York Times, one- technology and increasing capabilities of exports. Many also cite better service fifth of Fortune 500 companies have R&D companies to manage relationships across quality, support for global markets, and facilities in India. company and country boundaries have improved capabilities and productivity as What’s not being offshored? Many accelerated and expanded the scope of reasons for going offshore. The money companies still consider core intellectual offshoring. saved is used to fund innovation, product property and some customer-facing sup- According to an A.T. Kearney cross- development, capital investment and other port functions, even in lower-value sup- industry survey, about 65% of U.S. com- areas that increase competitive advantage. port areas, as offshoring risks. Some com- panies used offshore resources in 2003, up From simple to sophisticated. panies have successfully managed the from less than 20% in 2000. The rate of Traditionally, high-tech firms sent manu- risks and have global centers of excel- adoption, however, varies both in industry facturing and product development off- lence in development and other functions, and region. Last year, 70% of U.S. high- shore; firms in other industries, such as but others have brought development or tech firms used offshore strategies. financial services, were willing to send call-center work back in-house after mov- Interviews with executives at semicon- their back-office and processing functions ing offshore too quickly. ductor and software companies in the Bay to foreign locales. However, as companies Getting it right. Before going offshore, Area earlier this year reveal that 94% use become more adept at coordinating off- researching answers to key questions is offshore resources, 3% are exploring off- shore operations and service providers critical. Where should we locate? What’s shore strategies and the remaining 3% gained experience, the type and scale of the best model? How do we move to the plan to offshore as their processes and functions moved offshore became more next stage? While A.T. Kearney’s off- products mature. The statistics suggest complex and business critical, such as shoring location attractiveness index con- that in just one year, the acceleration in “white collar” business processes and IT firms India’s current cost and quality adoption of offshoring has been dramatic, services jobs. (see figure) advantage, other and some regions, like Silicon Valley, are parts of Asia, leading the phenomenon. Eastern Europe and Start-ups are also joining the offshoring beyond should be trend. Until recently, companies ventured considered based abroad only after reaching significant on company or organizational maturity. Today, even function and early-stage software companies are send- region-specific ing functions offshore. New biotechnol- needs. For example, ogy companies are moving clinical trials China has been the overseas to reduce burn rates, speed prod- location of choice uct development and reduce time to mar- for mass production ket. One leading Bay Area venture capital of simple consumer firm is offshoring about 20% of its port- goods but is now a folio, double that from two years ago, and logical choice for plans to increase it to 30-35% over the more complex man- next three years. For example, in IT services, U.S. com- ufacturing. Taiwanese companies are see- Why make the trip? Although the rea- panies with at least one to two years of ing more of “their” electronics manufac- sons for going offshore are still evolving, offshoring experience have reported turing jobs flow to China. For large Bay the primary reason—cost savings—con- developing plant/floor manufacturing and Area semiconductor companies that still tinues to rank high. Companies can realize order management applications overseas, do some in-house manufacturing, 10% of total cost savings of 30% to 70%, and and companies with another year of expe- manufacturing job listings are for posi- those savings are becoming a competitive rience report offshoring of inbound and cont. on page 6 4 oooo The Supply Chain Connection Shared Services, Shared Resources— Flexible Results! By Bob Reary, PeopleSoft, and Rick Beers, Corning

Shared Services is not a new concept. structure, process design, and process • Leveraged Skills such as Negotiating Sharing common business processes measurement but also carrying with it and Cash Management across BU’s. across business units (BU’s) has long more tangible justification. • Tighter Management of Key Assets been a goal of decentralized corpora- Brian Zrimsek, of analyst Gartner, such as IT Infrastructure tions. Such efforts, however, have typi- defines Shared Services in this way: “A • Tighter Control resulting in improved cally fallen short of expectations when central set of processes / functions estab- compliance, error reduction and portions of end-to-end processes (such lished to serve more than one location.” reduced risk as Source to Settle) are involved. In other words, business services (such That Shared Services is a cost reduc- Assigning some of the tasks associated as billing or contracts management or tion opportunity seems clear. But beyond with such processes to a centralized order capture or even master data man- the Efficiency of volume leverage, there function can actually break end-to-end agement) are re-located and re-organized is also Effectiveness. Whereas processes, leading to higher costs and into a new, centralized, stand-alone func- Efficiency is tasked with “doing a thing lowered effectiveness. tion to serve the divisions or BU’s from a right,” Effectiveness is tasked with What is driving the current transfor- new vantage point of their own core “doing the right thing.” What customers mation to Shared Services? What focus competencies. demand globally is consistent service at is this movement taking, and how will the lowest price, no matter the geograph- Mere Reengineering? success be achieved? ical source. Companies are now becom- So, is Shared Services merely the same ing very interested in Shared Services What is “Shared Services”? thing as Business Process Reengineering because they want to leverage volume, Among multi-divisional organizations, (BPR), that hot fad of the 90s? Not at all. present a standard face to their global interest has been steadily growing as While both approaches share the theme customers and better manage and control businesses search for efficiencies and of reducing redundant or non-value- the risk of not achieving these drivers. reduced costs. However, a concept such adding steps, Shared Services also seeks There is also the Financial perspec- as Shared Services, while elegant in the- to standardize and leverage key skills tive. Federal Express has had a Shared ory, is elusive in practice, since such a and capabilities. For instance, a BU may Services initiative under way for some decision depends upon multiple views: experience delay in its cash collection time. One of their motivators is to (1) justification, (2) the business process because each customer order achieve the requirements of real-time process(es) themselves, (3) the type of spans multiple BU’s. BPR would attempt financial information from the operating business model involved and to eliminate the delay, whereas the units and eliminate the “creative (4) the readiness of the enterprise to Shared Services approach would be to accounting” that occurred at the decen- undertake the challenges involved. Most consider moving this critical function tralized BU’s in the past. A Shared importantly, the key challenge for multi- into a new unit chartered with collection Services approach brings standards into divisional organizations is in finding the process excellence. Delays would be the end-to-end processes and causes sweet spot that will let the business real- eliminated, but also other metrics might financial reporting to stand on its own as ize the maximum benefit of enterprise improve, such as cash-to-cash cycle time a measurable aspect of the overall busi- leverage while still promoting the unique and reduction of cross-BU DSO (days ness. requirements of each business unit (BU). sales outstanding). Companies are now re-arranging their So what is “Shared Services”? Here is Driving to Shared Services business processes, using technology a working definition: “Shared Services There are several key drivers behind which was not available in the past, and is the concentration of company func- shared services justification: these new integrated information flows tions and resources to perform similar • Headcount Reduction through are changing the way business works. An activities across the organization in economies of scale by centralizing example is a shared services approach to order to provide a higher degree of ser- non-differentiating common processes Accounts Payable. Paper hand-offs in the vice and lower total cost.” such as Payroll and Billing. past complicated efforts toward central- The Shared Services model goes • Spend Reduction by ensuring that ization (matching, etc.). But with today’s beyond the “Collaboration” models of products and services that are com- ability to pass integrated information recent vintage, with an approach that is mon across BU’s are purchased cen- into a shared services Req-to-Pay unit, much more actionable, requiring signifi- trally. cant change in organizations, IT infra- cont. on page 7 The Supply Chain Connection oooo 5

Educational Seminar cont. from page 3 core supply chain planning activities in appropriate for the specific supply this way, its impact can be managed chain in question? • Quantification of the range of perfor- proactively, resulting in reduced cost and • How can supply chain strategies and mance outcomes that will result from improved performance, and enabling pre- relationships be structured to best com- these prospective supply and demand dictability and control despite unavoidable municate necessary information, estab- outcomes, given a set of supply chain uncertainty. lish incentives, and allocate risk to plans, resources and relationships After covering these core concepts, the ensure all parties are aligned to deliver selected by the company. event turned to games, break-out exer- the desired performance across Once the range of possible supply and cises, and case studies to explore their prospective future supply and demand demand outcomes and the performance application across a range of supply chain conditions? and risk exposures they generate given a domains: The event ended with discussion of risk specific supply chain strategy has been • Industries, including high tech, auto- and flexibility initiatives underway at sev- quantified, the risk and flexibility man- motive, and consumer packaged goods eral member companies, including: agement process can begin. The discus- • Supply chain functions, including • Application areas targeted sion focused on two key components of sourcing, new product introduction, • How the project was initiated, and com- this process: tooling and capacity planning, structur- position of the project leadership team • Goal setting, including objectives and ing and management of sales relation- • Implementation plan, including where trade-offs for risk, flexibility and liabil- ships, and internal cross functional in the organization implementation ity which extend and complement tra- coordination began, and the subsequent expansion ditional cost, service level and inven- • Supply chain characteristics, including trajectory, including timing and key tory metrics custom materials, commodity materials milestones • Development, analysis, and execution high volume, low margin products, and • Lessons learned of supply chain strategies which best low volume, customized, and high mar- Key success factors identified include a meet the goals selected for the specific gin products carefully crafted implementation plan, supply chain in question and its key For each application area, discussion senior management sponsorship, effective sources of uncertainty focused on steps #1 and #2 in the uncer- supporting education and change manage- Both of these steps depend on the abil- tainty management process identified ment efforts, and enabling analytic tools ity to quantify the performance outcomes above: and support. Business results and stake- across prospective supply and demand • What “performance profile”, including holder feedback referenced substantial conditions which will result if specific risks and performance trade-offs across value creation and the opportunity for supply chain strategies are adopted. By performance dimensions and possible competitive differentiation through effec- evaluating the impact of uncertainty in supply and demand outcomes, is most tive management of uncertainty.

Offshoring cont. from page 4 service centers to drive scale economies to ignore. But much of the conjecture is • Deploying centers of excellence with off target. A common misperception, for tions in China, with only 1% in India. regional hubs to coordinate efforts across example, is that offshoring is a zero-sum Recent A.T. Kearney research highlighted the enterprise game, but one job gained in India, China the key role of regional capabilities and • Establishing performance benchmarks or does not necessarily represent their competitiveness in influencing how to improve operational processes, service one job lost in the United States. Recent global trends are affecting the location of quality and cost management studies suggest offshoring can generate activities and jobs. For example, the Bay • Adopting world-class management prac- additional jobs and other economic bene- Area’s astute capabilities in cross-discipli- tices and processes fits. For example, Global Insights found nary research are keeping innovation jobs Next stage issues can be just as chal- that over the next several years, each off- in the region. lenging. For example, some computer shored IT job will generate approximately In terms of business models, three — hardware and industrial manufacturing two non-IT sector jobs. Moreover, jobs Captive, Joint Ventures and Outsourcing companies that moved supply chain appli- lost due to offshoring need to be viewed —represent the major approaches. cation development and integration to off- against jobs gained from onshoring by Technology firms that traditionally shore third party providers now find it is foreign entities and the other key trends deployed captive operations, are now opt- more complex to adjust supply chain underlying job creation and destruction, ing for outsourcing to third-party strategies as changes may require a new such as technology and productivity. providers as these foreign players gain process and/or IT system changes that go Plan well. Companies today need to experience. beyond the skill of the offshore company. understand and be prepared to address the Leading companies are already moving These challenges, however, are also expe- range of strategic, tactical and political to the next stage of operational improve- rienced with onshore providers and can be issues connected with going offshore. In ments in preparation for broader offshore managed with planning. doing so, they will be well-positioned to strategies. Key steps include: The other side of offshoring. The con- capture the benefits of this powerful busi- • Consolidating core activities into shared troversy surrounding offshoring is tough ness strategy. 6 oooo The Supply Chain Connection Shared Services cont. from page 5 high capability in a resource area (such Lessons learned from manufacturing as product or process specification, excellence programs, such as Six Sigma, demand management, replenishment, indicate that similar methods should be the walls that have blocked success for etc.) and a need for and capability of applied when implementing a program so long are falling. high control, that is the traditional of Shared Services. For instance, the For a company with multiple BU’s, Internal model. When a capability is principle of preautomation applies to and especially if they serve disparate or low, but control is (or needs to be) high, Shared Services equally well: design for diverse vertical industries, a climate of that is the External model (aka outsourcing (where controls will be strategic improvement can be achieved Outsourcing). When a capability is low more difficult and so complexity will through Shared Services by leveraging and control is also low, that is the have to be reduced), and then implement common processes, where leverage Turnkey model. When an internal model a simpler solution as a Shared Service. means: improve accountability; contain should be External to the operating BU Summary and lower risk; reduce operating cost; but Internal to the whole business, that is Shared Services is a model that is dri- and share investment in assets and skills. a Shared Services model. ving much interest now, and will for Two factors determine appropriate some time to come. Being a revolution Implementing Shared Services processes for shared services: whose time has come, there are chal- During the course of a Shared Services (1) the degree of process lenges, such as determining what and implementation, an organization’s readi- commonality—the more unique the when to share, and how to measure the ness must be evaluated. There are two processes, the less opportunities for effectiveness of the Shared Services unit over-riding factors that can predict the leverage; and (2) the impact on busi- itself. likelihood of success: ness operations—the more the And Shared Services does not, and • Corporate Governance, including: processes differentiate the Business to should not, relieve the served businesses P&L ownership, Enterprise objectives the marketplace, the more risk of shared of their ownership. As we like to say, and Business “culture” services to the business “There is a difference between owner- • Business Model, including: It is generally believed that a driver for ship and control!” Also, the pitfalls of percentage of shared customers/sup- Shared Services is to eliminate or cen- traditional collaboration models must be pliers; degree of process commonality; tralize the low/non-value-adding activi- avoided. Shared Services is different and processes that are differentiating ties. But this notion is false. The old saw from legacy collaboration, and operates to individual BU’s. of “shared service or outsource for the on the principle if it doesn’t have a con- In other words, the recipe is: non-value-add” really should be “shared tract, it won’t work! Plus, even if Senior (1) Determine what processes are com- service for the non-differentiating!” An Management is behind the Shared mon (2) Determine what processes could example: at Corning, Billing, while a Services program, the businesses must easily be made common without sacri- core activity, is non-differentiating. All still be sold on the concept. Without that ficing “business process excellence” BU’s can utilize the same shared service aspect being covered, success will not be (3) Decide if it makes sense to make the of Billing. So Billing goes to the Shared achieved. process common (in other words, ensure Services unit and is measured as a stand- While the prerequisites of Shared we will not sacrifice customer intimacy) alone function focused on quality of Services can seem severe, the benefits (4) Assess the process capability to over- operations and service to its (internal) can be huge as well. And if an enterprise come cultural issues that will arise. The customers. On the other hand, at really wants to present a single face to its theme should be: all non-core (but nec- Corning, Order Management (by nature internal and external customers for key, essary) activities should be moved to an of the vertical markets the BU’s are in) is select business processes, the alterna- entity where they are core (either inside differentiating by BU, and so this tives to Shared Services can be severe. or outside). This is the essential path to process will most likely not be consid- The application architecture chosen in process excellence. ered for a Shared Services model. support of shared services must be flexi- Implementation challenges include ble so as to avoid such high up-front Other Models Related to determining how to best split business costs that might otherwise pose a barrier Shared Services processes that span the Shared Services to ultimate success. The foundational concept of Shared unit and the BU’s. An example is order Services builds on and is supportive of management, where Shared Services Rick Beers ([email protected]) is the other similar models. The expected process designers must decide how to Director of Business and Process shared service model might be assumed arrange the subprocesses of order cap- Architecture with Corning Incorporated. to be an internally-owned infrastructure ture, order promising, warehousing, Bob Reary ([email protected]) is asset. But this need not be so. Shared shipping, transportation, etc, into a the Director of Supply Chain Strategy with Services also embraces external or “out- seamless whole, still gain the desired PeopleSoft Incorporated. sourced” resources. We call these benefits and make the process transpar- “shared resources”. When a business has ent to customers.

The Supply Chain Connection oooo 7 de Waart and Kemper cont. from cover B) Over investors also invest heavily in ning system. The next step is to assess inventory, but are achieving higher ser- how effectively the planning recom- operating cost, or both. On the revenue vice levels than the money wasters. mendations have been executed. side, service-level improvements may C) Companies in the no priority category Stage 3—Implement structural drive new product sales and differenti- have decided not to invest in achieving changes to move the efficient frontier. ated service offerings. Of course, taking high customer service levels. This is a Changes in network design, processes, service supply chain cost reductions to dangerous strategy because customer organization, policies, and information the bottom line also can be quite lucra- service is increasingly becoming a com- systems should move the efficient fron- tive. The optimal trade-off between cost petitive differentiator. tier downward by reducing cycle times, or inventory investment and service D) Best-in-class organizations achieve optimizing inventory allocations, and level is represented as the efficient fron- high service levels at low cost. minimizing costs. tier (see Figure 1). Step 4: Develop and Execute Service Step 5: Sustain Performance Supply Chain Strategy Improvement Even though differ- Without sustainment, the path to service ent companies oper- supply chain excellence will reverse itself. ate in different seg- To prevent this, every service supply ments of the service chain organization should be involved in supply chain grid, a three levels of activities: generic service sup- • Breakthrough activities result in step- ply chain improve- function improvements in service lev- ment strategy can be els, and service inventory and cost defined based on the • Continuous improvement activities following three exe- result in incremental performance cutable stages: improvements. Stage 1—Improve • Maintenance activities prevent the dete- efficiencies to get on rioration of performance the efficient frontier. All three activities are important; leav- To move onto the ing one out will result in piecemeal—or efficient frontier, no—improvement. inventory levels By following the five steps to service must be reduced supply chain excellence outlined above, a until most—or all— company can achieve what previously Figure 1 of the non-contribut- seemed impossible: It can become a ing inventory is eliminated. Excess and champion both in customer service and in Determining where you are relative to obsolete inventory must be scrapped or shareholder performance. the efficient frontier can be done by liquidated, parts in the wrong locations benchmarking cost, inventory, and service must be redistributed to the correct Dirk de Waart ([email protected]) performance, and is a critical step in iden- stocking locations, and processes must and Steve Kemper ([email protected]) tifying the savings that can be brought to be put in place to quickly move trunk are both with Pittiglio Rabin Todd & the bottom line. The different levels of stock back to the service depots. McGrath (PRTM). The original material cost/service performers include: Stage 2—Determine if further invest- appeared in the January/February Issue A) Money wasters have low customer ser- ments are required and move up the effi- of SCMR (www.scmr.com) and is used vice levels despite investing large sums cient frontier. As a first step in deter- with permission. of money in inventory. mining what inventory to invest in, take a critical look at your service parts plan-

The Supply Chain Connection The Stanford Global Supply Chain Management Forum ...... Editor Design, Layout & Publications Manager Professor Hau L. Lee, Co-Director Barchi Peleg Lesley Sept, William Freeman Graduate School of Business Stanford University Stanford, CA 94305-5015 Copyright© Published by the Stanford Global Supply Chain Management Forum. All rights reserved. No part of this publication E-mail: [email protected] may be reproduced without permission of the copyright owner. Web Site: www.stanford.edu/group/scforum Research: Capacity and Quality Risk in Decentralized Supply Chains by Özalp Özer This article is a compilation of research by ity due to low demand realization (down- Professor Özalp Özer; Dr. Wei Wei, a Ph.D. side capacity risk) or lack of product avail- graduate of Stanford who is now at ability due to high demand realization Morgan Stanley; and Ph.D. student Murat (upside capacity risk). In a decentralized Kaya. Their work explores the risks in the supply chain, lack of proper capacity risk management of decentralized supply sharing exacerbates the cost of capacity chains. For more information, please con- risk. Specifically, to deliver on time, the from the market information that drives the tact Prof. Özer at [email protected]. CM secures capacity in advance of an OEM’s forecast. In this case, improper The coordination of information, as well OEM order. For such a supply chain, if allocation of excess capacity risk creates a as operations and logistics optimization, consumer demand turns out to be high, new incentive problem. For example, has become increasingly more difficult both the CM and the OEM face upside under a wholesale price contract, the OEM with recent increases in supply chain com- capacity risk. However, if consumer may influence the CM’s capacity decision plexity. These higher levels of complexity demand turns out to be low, only the CM by inflating the forecast. Note that inflating are the result of dramatic changes in man- faces downside capacity risk. the forecast does not change the OEM’s ufacturing and distribution, including Double Marginalization downside capacity risk exposure but globalization and outsourcing. As a result, The severity of capacity risk for each party reduces her upside capacity risk exposure. independent firms manage different parts depends on the contractual agreements. Anticipating this, the CM does not con- of today’s global supply chains. Each firm Under a wholesale price contract, for sider the OEM’s forecast information to be in the supply chain sets strategic and oper- example, the OEM pays a wholesale price credible. Hence, under a wholesale price ational goals to maximize its own profit by $w to the CM for each unit ordered and contract, lack of credible forecast informa- using local information such as cost struc- sells the product to the market at $r per tion sharing result in insufficient capacity tures, profit margins and forecasts. Even unit. The CM secures capacity at a unit when the OEM places actual orders. though advances in information technol- cost of $c, which could represent an equiv- Forecast manipulation is widespread in ogy enable firms to collect, process, and alent annual cost of capacity. Hence, the many industries, from apparel to high tech- share information, firms may be reluctant CM’s marginal profit (w-c) is less than the nology. PC and electronics manufacturers to do so because of conflicting incentives. vertically integrated supply chain’s mar- often submit “phantom orders” to induce Aligning incentives improves firms’ prof- ginal profit (r-c). This difference is known their suppliers to secure more capacity. In its and sustains the use of information as double marginalization. The CM, there- 2001 Solectron, a major electronics CM, technology. fore, protects himself by securing less had $4.7 Billion in excess component We attribute incentive problems to two capacity than what would be optimal for a capacity due to inflated forecasts provided major risk imbalances: capacity (inven- vertically integrated supply chain. The by OEMs. Anticipating such forecast infla- tory) risk and quality risk. Because of OEM may eliminate this adverse effect of tion, the CM may discount the forecast these imbalances, the adverse effects of decentralization by sharing the CM’s provided earlier. Unfortunately, this cau- capacity and quality risks are more severe upside capacity risk. Note that the CM’s tion can also lead to huge losses. In 1997, for a decentralized supply chain than for a marginal cost is $c, whereas the OEM’s Boeing’s suppliers were not able to fulfill vertically integrated supply chain. Here, marginal cost is zero. Hence, the OEM Boeing’s large orders because they did not we introduce our ongoing research in can, for example, agree to pay back $p per believe Boeing’s optimistic forecasts. designing contracts to eliminate or miti- unit of unused capacity. This would reduce Structured Agreements gate these adverse effects. We will typify a the CM’s marginal cost to $(c-p) and Through our private conversations with two level supply chain using a contract induce the CM to build a higher capacity, executives from several industries, we con- manufacturer (CM) and an original equip- thus aligning incentives. We refer to this as firmed that the unit cost of capacity and ment manufacturer (OEM). a pay back contract. the degree of forecast information asym- Forecast Information Asymmetry metry are two primary drivers of capacity Capacity Risk The severity of capacity risk also depends risk. Figure 1 maps the level of these Forecasting demand is inherently difficult on demand forecast information asymme- derivers for industries. For example, in the due to short product life cycles and long try. To make the right capacity decision, semiconductor industry, compared to the production leadtimes. Hence, supply the CM must have accurate forecast infor- OEM, the CM knows almost nothing about chains face the risk of either excess capac- mation. Yet, the CM is one step removed cont. on back

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Özalp Özer cont. from other side define quality as the product attributes for strategic relationship management sys- which customers prefer more to less. The tems between OEM and CM is probably a the product’s potential in the marketplace. classical quality literature narrowly good idea in addition to structured and We characterize two types of contracts defines quality as the percentage of prod- legally binding agreements. This strategic that enable credible forecast information ucts that are not defective. Today, OEMs relationship may encourage, for example, sharing. The first contract type is a capac- are outsourcing more advance functions implementation of quality programs such such as strategic sourc- as TQM or Six Sigma. ing, design, and even We refer to the adverse effect of ineffi- research and develop- ciencies caused by immeasurability of ment. The OEMs can both quality effort level and the quality use inspection tech- cost as the quality risk. niques to measure yield In our research, we design procurement and, hence, can enforce contracts that improve CM-OEM profits a certain yield in the by inducing the CM to exert effort to pro- contract. However, duce better quality products when parties when CMs undertake cannot explicitly contract on quality. With more advanced tasks, the help of our study, we characterize the measuring either the value of being able to contract on quality. CMs’ quality effort or We also quantify the value of obtaining their cost to achieve the information on the CM’s quality cost for desired quality level is supply chains in which parties can contract difficult. This difficulty on quality at the expense of writing long precludes the OEM contracts and of conducting extensive test- Figure 1: Capacity Risk Derivers from enforcing the desired quality level ing, inspection and negotiation. Our mod- ity reservation contract, which essentially with a legal contract. els shed light on the value of such activi- holds the OEM accountable for her fore- Not being able to foresee all possible ties. cast information by requiring a fee for contingencies and time to market pres- We also study the effect of the OEM’s reserving capacity. The CM provides this sures are two other reasons that make product-pricing policy on the resulting contract as a menu of fees for correspond- quality difficult to measure. Quality quality of the product. In our correspon- ing capacity level that the OEM may requirements may be better understood dence with executives from the telecom- reserve. The optimal reservation price has after the CM builds a prototype, but this munication and semiconductor industries, the characteristics of a quantity discount. step typically occurs after an outsourcing we were surprised by their two opposing The second contract is an advance pur- agreement is signed. According to a product-pricing strategies. The telecom chase agreement, which provides an Toshiba manager, if Toshiba waited until executive advocated setting market price option to the OEM to place firm orders at they were absolutely sure of every final for his final product in the contract terms an advance purchase price before the CM with his contract manu- secures capacity. This agreement credibly facturer. The semicon- signals the OEM’s forecast and induces the ductor executive advo- CM to secure the necessary capacity. cated pricing the prod- Depending on the per unit cost of uct after receiving com- capacity and the degree of forecast infor- ponents from the CM. mation asymmetry, OEM and CM can Each manager claimed choose among structured agreements that his practice would enable a mutually beneficial partnership induce the CM to pro- as summarized in Figure 2. duce a higher quality For example, when forecast information component. One of our between the parties is highly imbalanced, aims is to shed light on and per unit cost of component capacity is such opposing strate- low, then our analysis shows that the gies. advanced purchase contract generates We hope that this article higher profits for both parties. provokes more thought and instigates action to Quality Risks efficiently manage Controlling quality of a product in a Figure 2:Mutually Beneficial Contracts capacity and quality risk in decentralized decentralized supply chain is a challenge. detail and then wrote a complete contract, supply chains. We are interested in hearing OEMs face the risk of lower quality than they would be 6 to 12 months late to the about and working on related problems in a vertically integrated supply chain. We marketplace. Therefore, establishing that practitioners are facing today.

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