The 20th Century business model is dead. Companies can no longer become global leaders by just pumping out identical widgets at low prices and marketing them to a mass market. Consumer tastes change too fast, and ideas proliferate quicker than anyone could have imagined 20 years ago, let alone 50 years ago when the rules for traditional industry were formed.
The new model, according to Boston-based AMR Research is the demand-driven supply network (DDSN), which not only provides companies with the agility and efficiency to succeed in a rapidly changing global economy, but that also allows them to beat their competitors, and in some cases to devour them.
To make this point crystal clear, AMR has developed a ranked list of companies that it believes best use this demand-driven model, and that produce world-beating financial performance as a result. AMR recently published its second annual Supply Chain Top 25 list, which appears on Page 34.
"As with the 2004 winners, customers and market demands are driving this year's leaders to ramp up global supply networks in response to opportunity," says Kevin O'Marah, vice president of strategic research for AMR. "All are both excellent operationally and brilliant innovators. They are also relentlessly driven by customers and markets to search for new scalable business opportunities."
For example, O'Marah points to the success of the following Top 25 companies:
• Procter & Gamble (No. 2) acquired Gillette in 2005.
• Johnson & Johnson (No. 6) appears to have acquired Guidant.
• Wal-Mart's (No. 8) U.S. market share grew from 6.8 percent in 1992 to 17.1 percent in 2004.
• Dell's (No. 1) PC market share has grown from 2.7 percent to 18.9 percent since 1995.
• Nike's (No. 21) shoe sales have grown at a 10.1 percent compound annual growth rate (CAGR) since 1995.
According to AMR, what gives these companies a predator's edge is their devotion to a strategy and operating model centered on what the research company calls DDSN. This concept, which AMR has been advocating for several years, is built on the notion that supply chains-and entire extended enterprises-should be driven by actual customer demand, not just forecasts and plans created in the back office.
For example, one Top 25 company on AMR's list is Anheuser-Busch, which O'Marah says has created the most sophisticated demand signal depository he has ever seen. Called BudNet, the online database provides extraordinary visibility for Anheuser-Busch all the way through the distributor network to the retail outlet, so the company can see exactly what is selling, to whom and through which retail chain.
"This tool allows Anheuser-Busch to be extremely responsive with replenishment, new products, promotions and other demand management requirements," says O'Marah.
The demand management system handles millions of transactions that are stored in a NCR Teradata data warehouse. It pulls the data from Anheuser-Busch's order system, from point-of-sale data and from other order and transaction systems throughout the supply chain. The data is available throughout the company's distribution network, so Anheuser-Busch can make very refined decisions about what they sell into which regions and into which channels. "Other companies have demand signal systems, but Anheuser-Busch has taken this concept farther than any other company," says O'Marah. "They have developed a very scalable data management capability that gives them extremely accurate demand signals."
While every company on the AMR list has its own unique tools and techniques for managing its supply chain, O'Marah points to a number of common characteristics shared by all the Top 25 companies.
"Without exception, these companies all have a culture that is customer and market focused," he says. "Every company says that it is customer focused, but in most cases it is just talk. The companies on our list build their organizations, their strategies, their operations around the customer."
For example, O'Marah points to Toyota where every important decision is driven by its customer focus. He quotes Jim Press, Toyota's North American head of sales who likes to say that "Mrs. Jones is our customer and she is my boss."
According to O'Marah, Press's comment is not just talk.
"Toyota really operates on this customer culture," he says, adding that this focus is the key reason that Toyota has taken over the leading global automotive market share position from General Motors.
"GM is preoccupied with its labor issues, its healthcare costs and other internal matters," he says. "GM is not driving its business based on customer needs to anywhere near the degree that Toyota does."
While customer orientation is paramount, O'Marah says that cost management is an important factor, but it is viewed in a broader context. For example, Wal-Mart's entire strategy is based on everyday low prices. The company's mission is in lowering costs, but not for the purpose of meeting some internal operating metric.
"For Wal-Mart, everyday low prices is about giving the customer the value that he or she wants," he says. "Motorola is constantly trying to lower the cost of its phones to $30 or $40 in order to penetrate new markets. But this is not cost cutting for its own sake. Motorola is concentrating on costs to give new customers a value they want and can afford."
Another similarity among the Top 25 is the high degree of communication and integration between people and processes in the organization, according to O'Marah. Managers in engineering, research and development know what supply managers are capable of, so engineering doesn't design products that the sourcing can't support or that manufacturing can't build. Sales is aware of what manufacturing is working on, so they can pre-sell. Conversely, sales can bring back ideas from customers that are useful to R&D.
"IBM is a great example of this type of integrated communication," says O'Marah. "IBM brought their sales organization into supply chain and product development, so the company would made things that customers really wanted, not just what some executives thought they wanted."
Companies with rigid hierarchies that separate distribution, manufacturing, engineering and other functions trap themselves into functional silos that can never develop and execute an integrated strategy like the companies on the AMR list. Instead, O'Marah says companies should think in terms of domains-not departments--as an organizational structure. Instead of departments extending from R&D, through production, to sales in a linear way, DDSN encompasses three overlapping domains:
• Demand, which includes customer service and market creation
• Supply, which encompasses traditional operations, including sourcing, manufacturing, and distribution
• Product, which includes R&D, engineering, design, and all elements of product innovation.
"This domain structure helps to align strategies, operations and tactics," says O'Marah. "Direct communication and sharing of data enhance efficiency and keep everyone focused on the same goals."
The third common denominator among AMR's Top 25 is a commitment to technology. O'Marah is quick to point out that this commitment does not necessarily mean that these companies spend a larger share of revenue on IT than other companies. In fact, there is no correlation between the high performers in the AMR ranking and spending on IT when compared to industry peers.
"It is less a question of how much you spend as how smartly you spend it," he says. "Smart spending is linked to building innovative capabilities that the business needs whether or not that is available as an off-the-shelf product, or whether it requires building it in house."
AMR's research of the global leaders clearly shows how they use IT to improve communication, visibility and decision-making across the three domains of supply, demand and product. Individual IT projects or initiatives connect and integrate work processes to increase speed, quality and profitability of everything from customer orders to new product launches.
"The practicalities of organizing for DDSN require massive amounts of information and constant back-and-forth with customers and partners," says O'Marah. "Everything from full-featured 3D computer-aided design models to electronic data interchange orders depends on the IT stack-from the microchip to the user or to the machine interface."
The actual pieces of this IT structure are solutions such as enterprise resource planning, supply chain management, product life-cycle management. Each may have cost the companies tens or hundreds of millions of dollars.
"There was definitely oversell during the '90s tech boom, and the perpetual license sales model was bad for customers, but the systems these companies implemented largely work," says O'Marah. "DDSN leaders are getting plenty of return on their technology investment, provided they blend best practices and innovative IT applications, and don't rely exclusively on packaged software."
O'Marah says that one of the biggest surprises about the IT strategies of these companies was their wide use of custom-built or heavily modified shelf software to run their operations. Dell, P&G, IBM, Nokia and Toyota-everyone on the list-has done more custom building and IT innovation than their competitors.
"These leading companies all start with a process and then strive for a system to support that process," says O'Marah.
For example, Dell's model is buy-to-plan, make-to-order. That is not a standard module you can buy from any vendor. Dell had to integrate an i2 planning system with its ERP, and then with a customized order management system that allows Dell's processes to work smoothly. They had to do it on their own.
"P&G did the same thing," says O'Marah. "They build a sophisticated specification management system that allows them to avoid buying the same glue from five different suppliers. They used Matrix One as a platform, but they spent four years to get the technology right and to get all of their suppliers to agree on terminology for materials. It saves them hundreds of millions of dollars. So all of the top companies go custom in order to stay ahead of their competitors."
Benchmarking for Success
AMR Research has been analyzing DDSN practices for several years. One of the key findings of its research is that supply chain performance, understood in DDSN terms, is characterized by a hierarchy of supply chain metrics. Combining these metrics with a high-level measurement of product innovation success, like time to value, gives a good picture of both the ongoing profitability of a business and its prospects for future growth. Most of the data needed to analyze company performance at this level is not publicly available.
According to O'Marah, there are four benchmarks that AMR believes are the most important because they are tied to business performance. They include:
1. Perfect order: The percentage of orders delivered in full, on time, undamaged and to the correct recipient with all the correct documentation. Perfect-order rates vary widely by industry. Tier One auto suppliers, even those who are not top performers in their industry, are doing 85 to 90 percent perfect order. The best in class are above 99 percent. In consumer goods, perfect-order rates are much lower.
2. Total supply chain management costs: AMR defines this metric with buckets of costs such as distribution costs, material handling costs, procurement and sourcing administration costs (not the materials themselves)-all of these as percent of revenue. They also vary by industry. "Total supply chain cost is a great way to see how efficiently you run the system," says O'Marah.
3. Demand forecast accuracy: AMR tightly defines this metric as mean absolute percent error in a 30-day rolling forecast, but some companies may look at a longer horizon. "This metric may be the master of all because the higher your forecast accuracy, the better all of your other metrics tend to be," says O'Marah. To achieve high levels of demand forecast accuracy, O'Marah says that companies need demand visibility, usually down to the transaction level. Data must be available from systems for order management, electronic orders, replenishment and other real-time systems. "There are many specialized tools out there to work with these numbers to deal with seasonality, promotions, uplift," says O'Marah. "This is an area that companies need to spend more IT effort on."
4. Time-to-value for new products: O'Marah says that this metric is different from time to market, which just measures the time it takes from when a product is conceived until it is on the shelf, at least in the prototype form. "You haven't reached the value point until you have earned back the development spending," he says. AMR looks at the elapsed time from the moment a company allocates a budget to a new product development effort until its has paid back all development expenses. Sometimes a company never reaches this value point. Companies that have mostly positive and short time-to-value cycles are nimble, market responsive and excel at this metric. For retailers, there is a similar metric, especially if they have a private label business. They can also treat a promotion as a new product. "Their time-to-value for a Halloween special is how quickly from the planning stage to the payback." For example, the Spanish retailer, Zara, designs a new item or line and within weeks, they will have it on the shelf earning sales revenue.
Changes for 2005
AMR's 2005 list experienced some additions, deletions and shifts from the 2004 list. The Korean electronics giant, Samsung, made the list this year because of its very high growth, excellent return on assets and improved inventory turns. In fact, the whole cell phone business had a great year and is well represented on the AMR list. Motorola made the list for the first time, and Nokia had a repeat appearance.
"The cell phone business is one of the most demand-driven industries in the world, " says O'Marah. "Their product life cycles are very short, so they have had to learn how to use real demand signals to drive their businesses."
Hewlett-Packard dropped off the Top 25 list, not because of problems with their supply chain, but for financial reasons.
"HP does great things in supply chain, and their strategy is excellent," says O'Marah. "They dropped off the list because of the financial impact from the earlier Compaq acquisition. Last year, the acquisition pushed up their growth numbers, but this year their growth is down. That is just how our evaluation process works."
In fact, the large financial component to the AMR evaluation process prompted some companies that fell off the list to point out the difficult economic conditions that their industries faced in 2004. Others complained that their industry was more complex or competitive than industries represented on the list.
"We are not judging how good a job a company did," says O'Marah. "We are looking through the lens of the financial investor. Wall Street doesn't care if you are in a tough industry that is having a bad cycle, or that you are doing a better job than your competitors in terms of supply chain. Capital flows to those industries, business models, companies and supply chains that are well tuned to the opportunities. Leading global companies have to be in the right businesses and to come up with strategies that make money regardless of the challenge. Investors don't give extra credit for tough supply chains, and neither do we."
One such example is the grocery business that traditionally has had gross margins as thin as one percent, extreme competition and financial performance generally lower than other retailers.
"There is a systemic issue that is forcing this industry to change or be replaced," says O'Marah. "We see that happening already with grocery market share shifting to warehouse stores, mass retailers and even drugstores. So that tells me that no matter how good a supply chain manager you are, if you are a very conventional grocery store, you may not be able to fix the fundamental economics of the industry."
Many supply chain experts do not like rankings such as the AMR lists because they can obscure the underlying processes and place too much attention on financial data.
"No doubt there are data anomalies that raise questions about which companies should or should not be on our list, but we don't think that is the key take-away from this research," says O'Marah. "We believe that our rankings can elevate the debate and force companies to think about how they are going to get ahead. Companies want to win, and all good companies like to be measured."
Becoming a Top Supply Chain
While the arena for AMR's Top 25 supply chains encompasses only the Global Fortune 500, O'Marah says that any company can learn valuable lessons from observing how these industry leaders operate. He makes the following three recommendations, all based on the DDSN concept of running the supply chain based on real demand signals:
1. Measure for DDSN: AMR Research has a set of benchmarks that many companies have used, but there are plenty of others. The key is to choose metrics that will communicate both operational excellence and innovation. Reporting these metrics publicly should help you with investors and customers.
2. Organize for DDSN. Think about which executives could lead each of the three areas of responsibility-product, supply and demand-and how their responsibilities might be boiled down to time to value, total supply chain costs, and perfect order.
3. Plumb for DDSN: First, look at inventory IT systems in place, especially those that manage hand-offs of information between product, supply and demand. Look at new investment for improvements in these hand-offs rather than deeper specialization in tools.
"If all else fails, at least dip a toe in sales and operations planning," suggests O'Marah. "This effort can be as simple as a cross-functional team meeting. Any progress here is a step toward better visibility, communication and decision-making across the business. Participants quickly come to understand how DDSN principles apply to their business. As a starting point, this understanding is essential."
View the list here:
The AMR Research Supply Chain Top 25 for 2005
Procter & Gamble Uses Consumer Demand Info to Drive Supply Network
IBM's New Transformation: Services Supply Chain
'Customer Centricity' Drives Best Buy's Supply Chain
|Methodology for AMR Research Supply Chain Top 25|
|AMR Research selected its Top 25 from a master list of 212 companies using Fortune's Global 500 ranking, published in July 2005. Industries and companies that do not have supply chains per se, such as financial services, healthcare, and insurance, were eliminated, as were companies with unique characteristics that unfairly distort the metrics used in the ranking such as petroleum and metals that experienced distorted growth in revenue and profit to the point fair comparison to other industries was difficult. |
The Global 500 includes revenue and net income from the most recently completed (and published) fiscal year.
There are two components that make up the composite score for the company and determine its ranking. The first component of the ranking is publicly available financial data and is weighted at 60 percent of the total score. The second component of the ranking is AMR Research's opinion, which is weighted at 40 percent of the total score. The AMR Research voting panel consists of both industry and functional analysts. These two components are combined to create a weighted average score for overall supply chain leadership. Below is the list of financial metrics used and how they are calculated, along with the calculation for the composite score:
• Return on Assets-2004 net income/2004 total assets
• Inventory Turnover-2004 cost of goods sold/2004 year-end inventory
• Trailing 12 Months Revenue Growth (2004 versus 2003)
Composite Score = [(AMR Research Opinion/14) x 40 percent] + [ROA*100) x 25 percent] + [Inventory Turns/5) x 25 percent] + [(TTM Growth x 100) x 10 percent]
Weighting for metric scores was adjusted in 2005 to ROA=25 percent, Inventory Turnover=25 percent, and TTM Growth=10 percent. In 2004, weighting was 20 percent across all three metrics. Companies must receive votes from the AMR Research expert panel to be included in the ranking. Therefore, a company whose composite score fell within the Top 25 based on metric score, but did not receive any votes from AMR Research's expert panel, would not be included in the Top 25 ranking.
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