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.

Why China – cheap capital?

In 2008 Evergreen Solar opened up a solar panel factory in Devens,  Massachusetts, but they just announced that they will layoff their 800 workers and move production to China (NY Times 1/14/11). Why? Well, of course, it is too expensive to manufacturer in the U.S. And low cost production is critical – the price of solar panels has fallen from $3.39 per watt in 2008 to $1.90 per watt now. Evergreen Solar has reduced its cost to $2.00 per watt, but Chinese manufacturers are producing at $1.00 per watt.

But labor is NOT the reason for the high cost of production in the U.S. – labor is a small portion of the cost to make solar panels. Nor does it seem a lack of technical skills. Instead, the issue is the cost of capital – a solar panel plant can cost $400 million and Chinese manufacturers have access to low cost bank loans.

It it is likely that there will be more movement to China for reasons other than the cost of labor.

Intel to invest in U.S. manufacturing

Intel announced today that it will invest $6-8 billion in the U.S. to build a new plant in Oregon and to improve existing  manufacturing facilities.  (See WSJ 10/19/10).  This investment will give them the capability to produce chips with 22 nanometer circuits, whereas the previous wave of investments gave it 32 nanometer capability. (A nanometer is one billionth of a meter – a couple of billion dollars to produce lines that are a billionth of a meter wide!)

The interesting part of this story is that Intel is sticking with U.S. production.  The potential allure of overseas production is not from the typical “cheap labor” issue, but rather because foreign governments are willing to hand out considerable subsidies for building a chip plant in their territory.  Intel estimates that the potential subsidies are equivalent to $1 billion, a considerable portion of the cost to build the plant.

So why is Intel sticking with the U.S.? Unlike apparel, they are not concerned about “made in America” – they will gain no premium in the market for made in America.  Unlike autos, their product is not expensive to move around the world, so local production to avoid higher transportation costs is not a concern. Nor is there a concern about tariffs or labor unions.

The issue is production yield – when you first start making chips, some of them, maybe even most of them, don’t work. The trick to make an investment in capacity pay off is to improve yields as fast as possible. And yields don’t improve because of better equipment, but rather because the equipment is used more effectively – engineers and line workers need to find out what particular recipe generates the best yield. Thus, improving yields requires intelligent experimentation, i.e., a skilled workforce.  It follows that Intel must believe that a U.S. workforce can improve yields faster than an overseas workforce, fast enough to  justify the additional $1 billion in cost.  It will be interesting to see how long that U.S. advantage can last.

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.

What to do when there is no snail mail?

What should a postal system do if people stop sending to each other letters (OK, they have already done that), junk mail, magazines, and other physical items? If you happen to be running a postal system, this question is probably on your mind. It is in New Zealand, as reported in the New Zealand Herald (June 9, 2010).  Some of options they are considering are: (1) deliver the mail every 2nd day; (2) drop Saturday delivery; (3) increase prices; and (4) develop a two-tier mail system where premium letters cost more and are delivered more quickly; and (5) use electronic mail to make mail delivery more efficient.

A reduction in total volume wouldn’t be a problem if the postal service was already well over the scale needed for maximum efficiency. Apparently, the New Zealand postal system is not at a sufficient scale and so any reduction in volume will decrease its efficiency further. Given that New Zealand has about 4 million people spread out over two large islands, this is not surprising.  But there is reason to believe this is an issue for even large countries with dense populations – delivering door to door is a labor intensive process, so if houses are not getting some mail on each delivery then that means the miles driven per unit of mail increases.

Let’s consider some of the suggested choices:

(1) Deliver every other day? What a mess for consumers! Say the rule is that the country gets mail on even days but not odd days and of course on holidays.  So you get the mail on some Tuesday but not other Tuesdays, depending on whether the Tuesday is an even day or not. Assuming consumers can keep track of that system, it doesn’t seem to be helpful for efficiency. It is possible to hire people to work Monday to Friday, but working every other day is odd.

(2) Dropping Saturday delivery seems like a good start to me. It isn’t a dramatic reduction in capacity and it is a natural day to drop. It will help with Monday and maybe Friday deliveries, but it probably won’t build scale on Tuesday – Thursday deliveries.

(3) Increase prices is an obvious solution but of course, it will lead to further reductions in volume. One could imagine a spiral effect that leads to the demise of the physical postal system.

(4) Two-tiered system? I can’t imagine that they don’t already have this. And it isn’t clear how this addresses the issue of lower volume enough to matter.

(5) Drop delivery to homes, keep mail in central locations and notify people via email when they have received a piece of mail. To some extent they have already done this. When I lived in New Zealand I had to walk 500 yards to the “town’s” general store which held everyone’s mailbox for the town. In other words, instead of delivering to each person’s house, deliver close to each person’s house. The potential savings may be significant without a substantial decrease in the quality of the service. Relative to increasing prices, this option requires serious consideration.