Building the Sense and Respond Company

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Supply chain management reshapes the future of leading companies while attracting a lot of C-level attention along the way.

Dr. Sandor Boyson, chief information officer, co-director of the Supply Chain Management Center; and research professor at the University of Maryland's Robert H. Smith School of Business, doesn't like to speak abstractly about the potential impact supply chain management can have on a company's business. Instead, he prefers to tell stories.

In this case, he'd rather talk about two very different companies in two very different industry sectors—the Procter & Gamble Co. and Sun Microsystems. Despite their differences, both companies believe beyond all certainty that their future depends, in large part, on real-time supply chain management.

P&G, the consumer products giant known worldwide for such household-name products as Tide detergent, Bounty paper towels, and Crest toothpaste, was founded in 1837 and reported 2003 sales of $44 billion. The company has 250 brands, 13 billion-dollar brands, employees and operations in 80 countries, and five billion consumers in 140 countries around the world.

"There are two moments of truth in P&G's world: the moment when the shopper makes a choice in the market and the moment when the shopper uses the product," Boyson says. "The consumer's experience in both these instances drives re-purchase of that product.

"The first moment is based on availability of goods in the store. On average, 10 to 15 percent of the time the consumer finds the desired product out of stock in the retail store. So the key is having product available on store shelves. With only a two-percent profit margin in the industry as a whole, P&G cannot afford stockouts.

"About half of P&G's sales come from events or promotions that are disruptive," Boyson says. "Because of these promotions, which are out of P&G's control, the last three months of sales trends and data will look nothing like the sales trends of today or of the next three months. P&G may experience a sales spike in one store or region where a retailer is promoting certain P&G products, but next month the spike will move to another region."

Historically, P&G's business was driven by internally generated sales forecasts. Today, the company is moving toward becoming a consumer-driven supply network.

In this new business model, "P&G is trying to sense and respond to consumer demand, and collaborate with its supply base to ensure that product is always in stock at the retail level," Boyson explains. "P&G, in effect, is trying to line up real-time supply with real-time demand."

This means, among other things, that P&G and its suppliers must collaborate to manage sales events. The company has developed the online capabilities to ultimately give 80 percent of its suppliers visibility into its manufacturing operations.

"P&G is trying to build a 72-hour product-to-consumer cycle, where real customer orders drive internal processes to achieve integrated execution response," Boyson says. "P&G wants to focus on events or promotions that are responsible for two-thirds of the errors in its corporate forecasting.

"The company is trying to develop a more collaborative relationship with its sales outlets as to demand," he says. "The goal is to align disparate demand teams into a single entity that collaborates to replenish customers based on actual demand, and at the same time optimizes the supply network."

Here Comes the Sun

Sun Microsystems, founded in 1982 with 2003 revenues of $11.4 billion, never touches 90 percent of what it sells. In fact, the Silicon Valley company operates a near-completely virtual supply chain that provides fast, predictable delivery of its highly perishable computing products.

"This virtual supply chain has enabled Sun's economic survivability in very tough times," says Boyson.

Over the last several years, Sun reduced its planning cycle time from 15 to five days, slashed inventory levels in half, cut raw material costs by $350 million, and shortened transit time to the customer by one day by shipping orders direct from suppliers to customers.

How did Sun accomplish these changes? Technology holds much of the answer. "Sun consolidated its technology framework from 50 different information management systems to a single global ERP profile linked to a huge data warehouse for knowledge management and business intelligence," Boyson says.

The company now operates a single global process for order management, receivables, and data fulfillment. "This gives Sun better data integrity, better knowledge management, and tremendous visibility across its supply chain," he notes.

As far as product and material goes, Sun consolidated 80 percent of its spend with 40 suppliers, thereby reducing supply chain complexity enormously.

"Suppliers own and maintain inventory in a shared-supplier distribution hub, and Sun pulls product from the hub to fill customer orders," Boyson explains. "Every five days, suppliers can log on to Sun's portal and look into the company's forecasts to see a 26-week materials requirement plan. Suppliers and sub-suppliers all have visibility into key product component demand.

"Essentially," Boyson says, "Sun created a model whereby goods flow directly from outsourced production agents to Sun customers." The high-tech company does very little to interrupt the demand signal from the customer. Through crossdocking and direct shipping, Sun cut out inefficiencies in the supply chain and compressed response time dramatically.

What Sun does do is provide suppliers with access to a master business intelligence warehouse so they can reposition their response based on dynamic market events. This supply chain coordination through a business intelligence warehouse has resulted in almost complete virtualization of Sun's supply chain.

"These two examples tell us that supply chain management is becoming institutionalized as a high-level function," Boyson says. "CEOs look to supply chain management to reduce costs, confront volatility in the marketplace, and maintain margins in the face of this volatility. In effect, they use the supply chain for risk management.

"In addition," he notes, "by connecting more closely with customers and suppliers, companies such as Sun are using the supply chain as a market antenna for designing, redesigning, and modifying products on the fly.

"Companies that know, in real time, exactly which items are and are not selling can build products with the desired feature sets and stop production on items that are not selling," he says. "Supply chain management is becoming an extension of the design process, and is, in fact, fueling real-time product development.

"This means that the supply chain is not just about distributing product," Boyson says. "It is a view into the synapses and brains of the consumer. It's the spider web that binds the company to the customer's mindset."

Caterpillar Beats Recession

Caterpillar Inc., a leading manufacturer of construction and mining equipment, diesel and natural gas engines, and industrial gas turbines accomplished a remarkable feat during the just-ending global recession.

"At the low point or trough of the recession, we generated a profit of $2.20 per share," says Steve Wunning, group president, Caterpillar Inc. "On 2003 revenues of $22.7 billion, we generated a profit of $1.1 billion.

"In the early 1990's recession, by contrast, we lost a significant amount of money," Wunning recalls. "In the recession before that, in the early 1980s, we lost about $1 billion. This time around, however, we were profitable. As a result, Caterpillar has been handsomely rewarded.

"In the first quarter 2003, our stock low point was trading at $42 a share. Our share price reached $85 during the fourth quarter 2003. A major reason is that we were able to show an acceptable profit during a deep worldwide recession," he says.

With the global economy recovering rapidly, demand for Caterpillar's product is accelerating.

"Our outlook for this year and beyond is positive," Wunning says. "Our challenge is to demonstrate that we can make an attractive profit during a global recovery.

"Our previous chairman, Glen Barton, talked about Caterpillar becoming a $30-billion company by the end of this decade. If world economic growth continues to be sustained at three percent or better, we think we can become a $30-billion company sooner than that, and at the same time become an even more diversified company," he says.

Why was the 79-year-old Peoria, Ill.-based company able to make a profit during this recession, when it could not do so in the previous two? The answer lies in better supply chain management.

"Caterpillar is more diversified today, with Cat Logistics and Cat Financial becoming bigger businesses. That certainly helped," Wunning says. "But the biggest reason we performed so well is because of our focus on cost reduction—including throughout our global supply chain—and the application of Six Sigma methodologies throughout the company."

Caterpillar sells products on all seven continents, in almost every country in the world. It operates 250 Caterpillar facilities, has almost 70,000 employees, maintains 200 privately held dealerships, and does business in almost 200 countries.

In 2000, Caterpillar merged its internal logistics operations with the external logistics services that subsidiary Cat Logistics was providing to other companies on an outsourced basis. Wunning was one of the original drivers of Cat Logistics in 1987, and served as its president for 10 years until moving to his current position earlier this year.

"We established bold goals for cost savings," he recalls. "Our goals hit every element of Caterpillar's supply chain, and were so aggressive that we were almost afraid to talk about them. Well, we not only met our bold goals for savings, but we surpassed them."

Just where did the savings come from? These three key areas:

Inventory. "We set very aggressive goals for improving our inventory turnover and customer service," Wunning says. "We ended up reducing our inventory by 20 percent, while providing customers around the world with better service."

Transportation. Caterpillar spends hundreds of millions of dollars a year on transportation. "Our bold goal," Wunning says, "was to reduce transportation costs by 10 percent within three years. We exceeded that goal."

Warehouse operations. "Through operational process improvements," Wunning reports, "we simplified warehouse operations and ran them in an almost assembly-line fashion. We drilled those productivity improvements down to all 90 of our facilities, with each facility having its own goal. In the end, we improved productivity throughout our worldwide warehouse operations by between five and 100 percent, depending on the process."

"Combining all our supply chain initiatives, we reduced the cost to distribute Caterpillar parts to our dealers by 20 percent. These specific supply chain savings efforts, combined with Caterpillar's Six Sigma process improvements, helped the company take more than $1 billion out of the cost structure since 2000. That's a number that made investors and analysts take notice," Wunning says.

Attacking the Supply Chain

While accomplishing aggressive savings and improvement goals was a challenge, it was just the beginning.

"The sequel effort we're now on will be an even greater challenge," Wunning says. "Mary Bell, new president of Cat Logistics, is eyeing the entire supply chain—suppliers and their suppliers, factories, dealers, and dealer customers. That's where we have an opportunity to reduce more costs in a much bigger pie, and at the same time improve service."

How will Caterpillar do this? The company is investing in IT solutions that will give it better visibility across the supply chain, and is working on additional process improvements.

"Our philosophy is 'Simple systems and elegant process,'" Wunning says. "We want to spend our brain power more on the processes and not so much on systems."

In addition, Caterpillar is getting its channel partners involved in working toward common improvement goals.

"If everyone works independently, often costs are transferred to someone else in the supply chain," Wunning notes. "The greater opportunity is to take a holistic view of reducing costs throughout the supply chain. That's the tricky, but most rewarding, part."

Caterpillar is focusing its attention on several areas, including:

Global sourcing. "We have a tremendous opportunity to reduce costs through global sourcing," Wunning says. "We're looking at sourcing from Asia, Eastern Europe, and Latin America.

"Logistics is a big part of the risk of global business," he adds. "We need to understand our global manufacturing strategy; look at the supply base to feed our global manufacturing plants; and look at total landed costs. This includes acquisition, transportation costs, duties and customs fees, inventory costs, and longer lead times. Once we know our manufacturing blueprint, then we can look at our customers and decide where the supply base should be."

Total supply chain logistics. Caterpillar is working to optimize its supply chain as a whole. "We no longer look at logistics as a plant-by-plant issue," Wunning explains. "In the old days, our plant in East Peoria worked to optimize its supply chain, as did our plant in Decatur. But their efforts may have sub-optimized the total supply chain opportunity. Now we look across all these plants and optimize our whole manufacturing supply chain.

"That was a huge switch," he says. "It required trust and confidence. Our manufacturing plants didn't want to give up control of their supply chains. They feared that logistics glitches would shut down the assembly line. But we demonstrated that we could take substantial cost out of the supply chain and enable the plants to operate more effectively. That took a lot of proving. Today plants come to us asking for our help."

What do these accomplishments mean to Caterpillar as a company?

"There is a growing awareness among our executive office and board of directors that supply chain and logistics can have a tremendous impact on our competitiveness," Wunning says. "I've had the opportunity to hear our board of directors talk about how our logistics strength can improve Caterpillar's competitiveness. The Caterpillar board now talks fluently about logistics and how it enables the company to be more competitive."

Hewlett-Packard Pushes the Supply Chain Envelope

Hewlett-Packard has the largest supply chain in the high-tech industry. It is a global company, operating in 178 countries and serving one billion customers. The company spends $50 billion a year on supply chain operations—including material—out of roughly $80 billion in revenue. HP spends $2 billion a year on outbound logistics.

"We sell a large portfolio of products and services," says Dick Conrad, Hewlett-Packard's senior vice president, Global Operations Supply Chain. "At any one time, we have more than 200,000 salable SKUs. These products range from paper, toner cartridges, printers, desktop PCs, notebooks and high-end UNIX servers all the way to huge data centers that power 95 percent of the world's stock exchanges.

"Our product lifecycles range from three months to more than 10 years. We introduce 600 to 700 new products a year, or about two a day. We have four basic customer types: consumers, small-to-medium businesses, enterprise, and public sector. We serve them through direct and indirect sales channels. We derive roughly 60 percent of our revenue from customers outside North America."

Annually, HP ships roughly 25 million PCs, 43 million printers, 2.5 million handhelds, two million servers, and more than one million disk arrays.

Because of the complexity of HP's business, the company does not have one single supply chain. Instead, it has designed five generic supply highways capable of serving the breadth of its customer segments.

"The point of all these statistics," Conrad says, "is to underscore the necessity for HP to have robust supply chain processes and systems. You can't sustain these volumes profitably by operating on Excel spreadsheets. We have supply chain systems, ERP systems, supplier collaboration systems, forecast demand management and planning, logistics e-visibility, and in-transit tracking systems to manage this scope of business.

"Our key challenges are the same as those faced across any industry and any size supply chain," Conrad notes. "HP must push the envelope in cost management, we continually have to focus on our processes to reduce and optimize our costs for both material and ongoing supply chain operations."

Given HP's size and scale, the company believes it must continually simplify its physical network, and rationalize its supply chain and provider base as well as its internally owned physical assets.

"We believe less is more," says Conrad. "We reduced our provider base by 70 percent. We concentrated 90 percent of our direct materials spend with our top 36 suppliers. This is a huge concentration of spend."

In addition, HP must be able to adapt quickly to new markets and technologies, customer demands, and geopolitical events such as SARS and terrorism. "This is always a challenge," Conrad notes. "Speed and rapid adaptation can lead to success in a market, so they are critical."

HP believes collaboration offers tremendous opportunity to cut costs company-wide.

"I'm not talking about just shifting cost up and down the supply chain," Conrad says. "We want to use collaboration to take cost out of the supply chain entirely. So we ask ourselves, 'What changes can I make that will make life easier on my partners and provide some economic value to both of us?

"We've started on that journey, and with certain suppliers and technologies, we have made a lot of progress. But we still have a long way to go."

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