Supply chain lessons from Japan

The devastating earthquake and tsunami in Japan have again raised the issue of supply chain robustness to disruption risk, and in particular, are they too fragile? FT.com (3/15/2011) asserts that  “Strategies that look rational for individual manufacturing companies… can create big macro-level vulnerabilities…”

The reality is that it is too costly to source every component from multiple locations throughout the world just to hedge natural disaster risks. But that doesn’t mean that companies should turn their back to the problem. The best companies follow a few intuitive steps to make their supply chains more robust. I’ll offer two.

First, map your supply chain. If you know your Tier 1, Tier 2 and Tier 3 suppliers, then you won’t have to spend one week figuring out whether you will run out of a part. Most companies know their Tier 1 supply chain, but do they know the other tiers? Do they keep track of changes to the supply chain? This information is crucial because the company that is first to work the phone to find alternative  supplies is most likely to be able to secure those supplies.  This information also gives you information that you can use to make downstream adjustments to your production. For example, should you eliminate an overtime shift or not? Should you redirect scare parts from one plant to another? Those are difficult decisions to make and are made much more complicated if you don’t even know if you have a problem – why shut down a plant for a potential part shortage that may not materialize?

Second, before disaster strikes, map out vulnerabilities. Some components can be sourced in many locations. Some components have several months of buffer inventory. You don’t need to worry about those. But if the amount of buffer inventory is limited and it is sourced in a few locations, especially a few locations that happen to be close to each other, then you need to consider finding alternative sources or alternative parts. Maybe the conclusion is that the company needs to bear the risk – there are no effective alternatives. But maybe the conclusion is that a substitution to a less risky part is actually feasible.  Finding this substitute is less costly before the disaster. There have been reports of companies that are scrambling to qualify additional suppliers, but that could have been done before disaster struck.

Finally, one risk that will hit many companies, even if they don’t have a shortage of parts, is the risk of exchange rate fluctuations – the Yen has just hit a post WWII high against the US dollar.

Robots or people?

Maybe the biggest challenge for e-commerce retailers is dealing with the huge surge in sales in the fourth quarter.  How can you build enough capacity cheaply enough to satisfy the rapid growth in demand during October, November and December, only to have most of that demand disappear by January? The traditional approach is to hire lots of seasonal workers. The trick with this is to be able to train them quickly enough for them to be productive in time for when they are actually needed. The Wall Street Journal reports that one company, Kiva Systems, has a different idea – instead of hiring workers, install robots (Dec 19, 2010).  To see these robots in action, check out the video (click here).

You might assume that these robots would “walk” around a warehouse picking products, putting them into a basket and bringing them to a place to be packaged. That is what humans do. Instead, these robots move shelves of inventory around. (See the photo – the robot is the orange contraption at the bottom of the shelf.) One advantage of this system is that you don’t need permanent aisles between the inventory – the shelves can be packed in tightly with the computer controlling the sequence (so that the one pink doll you need isn’t buried deep within a sea of shelves).

The next thing you may notice is that these robots are not particularly fast. It is not like the robots move product through the warehouse at twice the speed a human can walk. However, assuming these things are reliable (e.g., treads don’t need replacing every couple of days) they don’t need to take breaks, and they are instantly trained. One downside of this system is that the robot must move the entire shelf and not everything on the shelf may be needed at one time. Humans pushing a cart around a warehouse only put into their cart what is needed at the time.

But the point of the article is how to deal with the holiday surge in demand. While a robot might replace a human, it doesn’t eliminate the problem – the company simply needs a lot more capacity in the 4th quarter. If it buys these robots, then they are likely to be idle most of the rest of the year. Seasonal employees are just that – seasonal – that is, they go into the deal with the expectation that their work will be temporary.

The article ends with an idea for making the robots more cost effective for the retailer – Kiva Systems will rent the robots to the company for just the peak demand period. But I don’t see why this solves the problem – now Kiva Systems is sitting on expensive and idle capacity for most of the year (even in the Southern Hemisphere, Christmas falls in December).  Rental systems work well when potential customers need the product at different times. Given that the 4th quarter is the same for all retailers, I am not seeing this as an idea that works. Interestingly, the founders of Kiva Systems worked previously at Webvan. If there was ever a company that invested too much in replacing human workers with technology, it was Webvan – they may have survived if they didn’t blow all of their capital on hugely expensive warehouses. That said, I suspect there are surely applications of the Kiva Systems for some retailers. But as a solution to the 4th quarter demand surge, I am skeptical.

Apple’s amazing run

Apple just announced some impressive profit numbers: it’s first quarter with $20 billion in revenue and profits that exceed those of  IBM, HP and Intel.  Only Microsoft had higher profit, but not a higher market capitalization.  The following graphic comes from the WSJ 10/19/2010:

The focus in the popular press on Apple’s success has been on how the consumer market loves their products and technology.   For example, the WSJ article discusses how Apple’s bet on the consumer market has paid off relative to IBM’s focus on the business market. I agree that Apple has been remarkable at design. But to me, they don’ t get enough credit for how well they execute.

Consider the iPad. It went on sale April of 2010. We have sales numbers from the first two quarters – by the end of Q2 (Jun 26) they sold 3.3 million and in Q3 (ended Sep 26) they sold 4.2 million.  That is 7.5 million units in the first 6 months of selling a product.  The fact that they sold that many units means that they were able to produce that many units, which is the amazing untold story.

How many iPads might they be able to sell in Q4 of this year. Let’s look at the sales history of the iPod.  Notice that they sold about 2.5 times as many iPods in Q4s as they did in the previous Q3. That means that Apple is on track to be able to sell about 10-11 million iPads in Q4.  How can they ramp up the necessary capacity to make all of them? They don’t talk about their capacity management strategy, but I suspect the following are the keys to their strategy. First, they must be tracking sales weekly if not daily and making updated forecasts and comparing them to previous sales trajectories, like those of the iPod.  Second, they have outsourced production to a flexible firm who can switch labor from other products to the iPad if necessary. Third, either they are securing component supplies or their supplier (Foxconn) is securing component supplies – you cannot assemble a product if you don’t have the components. Fourth, the iPad must be made with components that are either standard (hence there is lots of available capacity in the market) or easy to make (in the sense that the yields are high and stable already). On the last point, if the iPad were made with a component that is unusual or hard to make, Apple simply would not be able to ramp up production as quickly as they seem to be able to do.

Apple executes so well that they make it look simple. But it is a mistake to assume it so simple. To relate this to baseball, Mariano Rivera (the closer for the Yankees, i.e., the pitcher that comes in very late in the game with the job of defending a small lead)  has two pitches that he throws with deceptive ease. It might be tempting to conclude that there should be many pitchers that could throw Mariano’s two pitch combo. Many can, but none have thrown them as successfully as Mariano. Quality execution is often underrated. 

 

 

Vaccines – producing more by starting sooner

The annual flu season provides many interesting lessons and observations for operations management. It was reported today in the WSJ (10/8/2010) that Novartis has teamed up with Synthetic Genomics to develop a process that will allow them to reduce the lead time to produce flu vaccines. The traditional process takes about 6 months from the time the WHO identifies the flu strains for the coming season to the time the flu vaccine hits the market.  “If Novartis’s venture is successful, the time savings would be dramatic, analysts say”.

The idea behind the new technology is to do some pre-processing. Novartis will “develop a bank of synthetically constructed seed viruses ready to go into production as soon as the WHO identifies the flu strains”. In short, they will artificially create a bunch of potential viruses in the hope that one of them will turn out to be the useful one for production.

What will this extra time give them? The biggest advantage seems to be additional capacity. If a facility can make X doses per week, then adding 4 weeks to the schedule means 4x more doses for the season, pretty much with the same overhead as before.

It is also important to note what this doesn’t give them – they still face forecast uncertainty and this extra time doesn’t seem to help them on that dimension. Nevertheless, the extra capacity lowers the cost to produce each dose, which makes forecast uncertainty less costly (the lower the cost, holding the selling price fixed, the less costly are demand/supply mismatches on a per unit basis).

Forecasting and going lean – the inertia to change

There was an article in the WSJ this week about changes that Furniture Brands is making due to the recession (WSJ 9/20/1010).  (They make several lines of furniture, including Broyhill, Thomasville, and Lane Home Furnishings.) The first has to do with their forecasting and design process.

In the past, apparently, each year they would make a bunch of designs, show the designs to dealers at trade shows and then hope those designs would sell. In effect, they relied on dealers to have a sense of what their customers wanted. With the new system, they test their designs on consumers first, then show a more limited set of designs to dealers. They claim this approach has improved sales considerably.

There are reasons to believe that there new approach could be better. Dealers are supposed to have a good sense of what their local customers want. But if dealers are casual about their forecasting process, i.e., they rely on memory and gut feel, then it is likely that dealers could make bad choices. Furniture Brands’ customer testing process is more systematic and therefore potentially more reliable.

This reminds me of when vendor managed inventory (VMI)  was first introduced to the consumer packaged goods industry.  I worked with Campbell Soup to evaluate their VMI system in which they decided what to ship to their client retailers. They were able to lower their retailers’ inventories by about 2/3rds and raise their fill rates at the same time. What made that achievement remarkable was that their system was quite simple, painfully simple – forecast sales for the next few days based on a rolling average of sales in the previous weeks, choose an order up-to level that would achieve a given fill rate assuming a reasonable level of demand volatility. That’s it. The data Campbell Soup used could have been used by the retailer to achieve exactly the same result. There was no theoretical need for Campbell Soup to do it, but either they did it or the retailers, for whatever reason, would not. Hence, by applying a bit of systematic thinking, Campbell Soup was able to dramatically improve the supply chain. It is possible that this is what is going on with Furniture Brands consumer testing idea.

The article also mentions that Furniture Brands has made a strong push towards lean manufacturing starting in 2009. Their version of lean includes cross training worker to perform multiple tasks so as to avoid bottlenecks on the line. This idea has been well established to be effective since at least the mid 1980s. Why has it taken them so long to implement this? Why is the diffusion of lean manufacturing so slow? Good question. My only answer doesn’t seem adequate to me – because people won’t change unless motivated to change by “clear and present danger” (i.e., the recession). Inertial can indeed be strong.

Blockbuster – doomed by its own medicine

Blockbuster filed for bankruptcy protection this week, which was expected for quite some time (NY Times, 9/23/10).  Blockbuster surely had a good run, but ultimately was doomed by its own medicine.

Blockbuster grew to dominate the video tape/DVD rental business by providing convenience to its customers – many well-located stores and many copies of the movies/shows customers wanted to see. If you took the time to go to a Blockbuster, you knew you would find something worth watching.  This convenience was provided in large part by negotiating revenue sharing contracts with the movie studies, thereby allowing Blockbuster to stock a large inventory even when at item was first released.

Fast forward to today. I live two blocks/200 yards from a Blockbuster but I was surprised to discover a couple of weeks ago that it was gone.  My 15-year old son explained it to me – “why would I walk to Blockbuster to pay $5 for a movie when I can download the same movie to my PS3?” I had no idea that a PS3 could do that (isn’t it a game machine?) – clear evidence that the generation gap I swore I would avoid is right there in front of me. But I digress. The point is that Blockbuster is no longer as convenient as the alternatives – RedBox, Netflix, etc. It is no longer as important to have many copies of new releases in a store because customers don’t feel the need to leave their home. It is true that Blockbuster makes content available sooner to customers, but that doesn’t seem to have the value that it use to have – my kids troll around for movies of all ages and don’t  rush to see the latest thing.

It is unlikely that Blockbuster will ever regain the dominance it once had. Surely, it will not do it via its 3000 stores, a number that will have to decline. The fall of movie rentals has been predicted for at least a decade – the technology has finally advanced to the point to make it happen.

Do we need a Manufacturing Czar?

President Obama has named Ron Bloom as a special advisor to tackle the problem of declining manufacturing in the United States (see NY Times 9/10/10):

The President said “We’ve got to get back to making things.” Do we?

Here are the arguments why the decline in manufacturing is a problem:

• Without manufacturing we won’t be able to take advantage of emerging markets in green technology “I don’t want to see new solar panels or electric cars or advanced batteries manufactured in Europe or in Asia. I want to see them made right here in the U.S. of A. by American workers” says President Obama.
• Without manufacturing there will not be research and development in the U.S. (which are presumably higher paying).  The argument is that R&D and manufacturing have to be co-located.
• If R&D declines because of a lack of manufacturing, then innovation will decline and innovation is the engine of productivity growth.

And what are the causes of the problem:

• Unfair trade practices by China and others.
• Private equity only invest in firms that manufacturer in China because the U.S. is not “where you make things”.
• Large U.S. companies don’t want to promote domestic production because they now produce everywhere.

So what do they plan to do about the decline? Here the specifics are thin. They have ruled out subsidies. They will focus on trade diplomacy and improved export-import financing.

Unfortunately, for Mr. Bloom, I strongly suspect he will not be able to reverse the trend, nor do we want him too. But if he wanted to reverse the trend, he is not pulling the right lever.

To fix a problem requires identifying the cause. There are two reasons why manufacturing has declined in the U.S. First, although not mentioned in the article, transportation costs have declined.  If it costs a lot to move parts and finished good around, you need to do things locally. When you can start shipping and training and trucking things for cheap, your options as to where to manufacture expand. Second, things are much more modular than they use to be. Henry Ford’s designers had to be very close to the manufacturing process because I suspect design was an iterative process – design something, try to make it, redesign it, try to make that, etc. Now, computers, telecommunications and precision machinery means that for many things the design and the production can be decoupled – an Apple engineer can dream up the next Iphone in her office and send the specs over to China without fear that what she created will be costly to make.

So if the causes are cheaper transportation and let’s call it decoupled R&D, then what could be done to reverse the trend? We wouldn’t want to ban computers to prevent the former. But maybe we should make transportation more expensive. At least that would have an environmental benefit. But if it is expensive to move stuff from China to the U.S., then it is expensive to move it from the U.S. to Europe, i.e., it cuts both ways. Which brings me back to an earlier point – should we care? Our decline in manufacturing has also occurred during a period of increased productivity and standard of living. Where is the evidence that we have been hurt by the decline in domestic manufacturing?

And let’s consider the geo-politics of trying to break manufacturing ties with other countries. If we purchase nothing from China and China purchases nothing from us, will they be more or less inclined to use their military? (For that matter, how about the U.S.’ inclination to use its military.) The answer seems clear – as long as countries are linked together via trade, the world will be a safer place.

America should promote innovation and we should make things in America that make sense to make here (like cars). But we have better things to worry about than manufacturing’s declining percentage of the economy.

Finally, a retailer pools inventory

When Amazon became a real threat to Barnes and Noble (and other brick and mortar retailers) in the late 90s, the natural prediction was that the B&Ns of the world would integrate their online and store inventories to provide customers with a better experience that an online only provider couldn’t match.  But that never really happened. However, the NY Times reports today that Nordstroms has taken a big step in that direction (8/24/2010).  Apparently, when you shop Nordstroms.com you have access not only to their online warehouse’s inventory, but also to the inventory across all of their 115 full-line stores.

What’s the big deal? Well, while this might seem easy to do, it’s not. A huge difference between inventory in a store and inventory in a warehouse is that the warehouse inventory is in a much more controlled environment. Store inventory sits around consumers and consumers have a way of moving things around and not putting them back. Store employees are focused on making sales and quick check outs, so they don’t always keep proper records of what is actually in the store. In other words, to make the Nordstrom system work, the company needs to know with a high degree of precision exactly how many units it has in each store. Even in the day of barcodes and RFID tags, that is not easy.

And then there is the cost. If you sell an online customer a handbag that is sitting in a store, you are selling a bag that was needlessly shipped to the store and you are shipping it from a facility that is not designed to ship packages efficiently.

But the big upside is increased service – if it works, customers will love it – which should lead to higher sales, which leads to higher inventory turns, which leads to fewer markdowns, which means better gross margins.

So should B&N try to implement a system like this? Probably not. I suspect this works for Nordstrom because they are selling expensive items that can more easily be tracked. If you are selling a handbag for $850, then you have plenty of margin and incentive to keep an accurate record of your in-store inventory. If you are selling a $12.50 book, the economics are not nearly as attractive to provide sufficient motivation for accurate inventory tracking. But there are plenty of product categories where I suspect the economics make sense, such as appliances, electronics, high margin sporting equipment (golf clubs, not basketballs), etc.

Sayonara to “stack ’em high, watch ’em fly”

Inventory management has been changing at Polaris (WSJ 5/24/10) – they have been dropping their dealers’ inventories for the last four years.  With the old system dealers orders twice per year and were given generous incentives to stock up, in short, trade promotions. The article doesn’t mention some key details, like while dealers  ordered twice per year, dealers probably took deliveries throughout the year.  And, dealers probably ordered at the same time, rather than staggered throughout the year.

The new system has dealers ordering once every two weeks. The match between supply and demand with this new system should be much better. With the old system, each dealer had to guess what they would need over the next six months (assuming Polaris didn’t build in anticipation of the next set of dealer orders). Invariably, they would make some mistakes – ordering too much of some products, not enough of other products. To correct errors, dealers probably swapped inventory during the six month cycle, but that isn’t the most efficient way to move inventory around.

Enter the new system. Now dealers order every two weeks and so their orders will far better reflect what they actually need and what is actually selling. In short, the system should be able to reduce dealer inventories *and* better meet demand, unless demand is picking up across all dealers faster than Polaris can produce.

According to the article, this is a trend in the industry – all firms are moving to shorter order cycles. Why? It may reflect competition among suppliers – this is a great deal for the dealers and so to keep a dealer you need to be more attractive. It also may reflect a calculus that the sales incentive of the channel stuffing strategy is not worth the better supply-to-demand matching of the current system. One thing is for sure, Polaris has certainly made some big changes in how it trades with dealers:

Managing Sewage Demand and Holiday Demand

When it rains it pours – that is, sewage overflows into streams, rivers and lakes and then into our beaches and drinking water (yuck!).   (NY Times 11/22/09)  For example, cases of serious diarrhea at one Milwaukee hospital increase when local sewers overflowed.

The problem with our old sewage systems is that they are capable of handling normal “loads”, but when it rains, the demand on the system exceeds capacity. With no place to inventory the excess water, it is spilled into local waterways.

So what is the solution when peak demand exceeds capacity? The knee jerk reaction is to increase capacity. But this can be foolish – it can be very costly to increase capacity when it will be used only at peak demand times. A better strategy is to smooth out the demand peak.  Of course, we can’t control rain, so that won’t work. But we can slow down the flow of rain into the sewage system by how we design our cities. In particular, planting trees helps to absorb the flow of water (maybe we can interpret this as an increase in capacity). Planting organic roofs can also slow down the flow of water – instead of rushing off the roof, it drips from the roof.  Or, if we could design sewage systems so that rain water was processed in a different system than toilet water, then the peak demand problem is solved – peak rain water can be safely spilled into the river and it would be unlikely to have a coordinated demand peak of toilet water, i.e., separate smooth demand from the variable demand. (I never did believe the stories about the problems induced when too many people flush during a Super Bowl commercial.)   

So what is the connection between sewage and holiday demand? Retailers face the peak demand problem in spades. The following graph plots sales of general merchandizers from 1992 to 2008 and clearly illustrates the annual holiday spike in demand

An interesting feature of this paper, contrary to what you hear in the press, is that the end-of-year spike is actually getting smoother. To illustrate, the following graph shows the % of annual demand that occurs in November and December:

From a peak of 25%, the fraction of annual sales occurring in November and December has been steadily declining, and now is about 21%.  Why is this? It could be that consumers want to smooth their consumption (they can’t wait for that holiday present) or it could be that retailers are encouraging this demand smoothing (via pricing). 

Another change in the data is the “back to school effect” – August’s sales relative to September’s sales has been showing a steady increase. Back-to-school is now the mini-Christmas of the year.