Extracting Value from Difficult Supply Chains

These are not fairytales but they do not need to live on as nightmares. There are examples available to us in the industry where companies have reaped huge benefits by working on thier supply chains. On the other hand there are also instances where companies have failed to capitalize on the gains they achieved by those improvements. In this article we study two companies   that reduced their costs and gained market share by implementing innovative methods to manage their supply chains. We also learn that the same companies were unable to derive the benefits when they stopped working on their supply chains.

Cisco - A Supply Chain Phoenix

Cisco’s supply chain story has become a common case study in Supply Chain Management classrooms, both as a good and bad example. Cisco was poised to become the world’s first trillion-dollar company, wielding a market capitalization greater than that of General Electric Company in pursuit of annual revenue growth projected at 30 to 40 percent.

The success

As an industry leader, Cisco was the pioneer of the virtual supply chain model, enabling it a limitless capacity and the ability to provide high reliability to its customer. Cisco concentrated on its core competencies - the design and selling of innovative networking solutions and formed partnerships with suppliers that could provide other key capabilities. This was based on the belief that suppliers add more value than Cisco in areas such as manufacturing. This decision contributed to Cisco’s growing revenues, created shareholder value and also proved beneficial for its suppliers. Suppliers enhanced Return on Assets (ROA) by improving asset turns; Cisco improved returns by decreasing costs, and the supply chain became more competitive with a lowered total system costs and improved responsiveness.

The benefit of the strategy adopted by Cisco was reflected in the numbers. By the end of 2000, more than 75% of the orders for Cisco’s products were being placed over the internet. The net sales grew at an impressive 78% CAGR (compounded annual growth rate), from $2 billion in 1995 to $9 billion in 1998. The company’s fourth quarter revenues in 2000 were $5.7 billion, up 61% from the same period in 1999. Operating profits also went up from $710 million in 1999 to $1.2 billion in 2000.

According to many analysts, Cisco’s Extended Enterprise model played a major role in its success over the years. Since its inception, Cisco demonstrated the power of networking and the benefits it could offer. Cisco owned just 2 of the 40 manufacturing facilities that manufactured its products. It did not own the distribution system that delivered products to its customers, but through its network of suppliers, distributors, partners and customers it successfully coordinated all the activities necessary to provide products to its customers in time.

To enable a virtual supply chain Cisco launched the Cisco Connection Online (CCO) initiative to integrate with its suppliers. CCO connected Cisco with all its suppliers and contract manufacturers online. As a result, when a customer placed an order, it was instantly communicated to all suppliers and manufacturers resulted in real-time communication and reduced operating costs. CCO reduced payment cycles for suppliers and eliminated paper based purchasing. Cisco saved $24 million in material costs, $51 million in labor costs annually and 45% reduction in inventory. Cisco introduced Integrated Commerce Solution (ICS) for its large customers. ICS provided a dedicated server fully integrated into the customers’ or resellers’ Intranet and back end ERP systems.

The Failure

While Cisco was riding high on the wave of success it was oblivious to what was happening externally. Reportedly, Cisco failed to foresee the changing trends in the industry and by mid 2001 had to cope with the problem of excess inventory. As a result, the company had to write off inventory worth $2.2 billion in May 2001. It was the largest inventory write-off in the history of business. Cisco wasn’t able to scale up and down as quickly as it thought it could. Some analysts believe that it was the outsourcing model that Cisco adopted that led to its downfall. The flaw was more likely with how Cisco had implemented the outsourcing model and not in the principles. In an industry where product lifecycles are getting shorter in a volatile economy, a clear understanding of performance expectations, capabilities, and risks will separate the leaders from the laggards. Cisco overcommitted to inventory and capacity as the market was taking off and forecast were rosy. These arrangements led to an inventory pile-up since Cisco’s forecasters had failed to notice that their projections were artificially inflated. As the forecasts vaporized, the company was unable to rid itself of the excesses. As Cisco was committed to honor its agreements with its suppliers, it was caught in a vicious cycle of artificially inflated demand for key components, higher costs, and bad communication throughout the supply chain. Cisco’s inventory cycle reportedly rose from 53.9 days to 88.3 days. Cisco’s system failed to model what would happen if one critical assumption – growth – was removed from their forecasts. It could not fix its virtual production system with inventory, and it couldn’t take out capacity when it most needed to.

The recovery

Having realized these problems, Cisco formed a team to work on an eHub remedial program. Cisco’s eHub system demonstrates a good example of how internet technology, coupled with cooperation among supply chain partners, can be used to provide higher level of customer service. Unlike purely transactional online exchanges – which focus primarily on purchasing efficiencies – eHub connects different operational systems across Cisco’s supply chain to permit real time information flow. Thus eHub enables even tighter integration between Cisco and its supply chain partners, improved collaboration - a key component of Cisco’s virtual manufacturing system.

Learning from Cisco’s example, we need to note that there is nothing wrong with the outsourcing model but a company needs to be careful while implementing it. Strong communication and tight integration with key supply chain partners should be present. Service level agreements should be established and performance levels need to be updated as and when business conditions change. OEMs and CEMs need to step back and reevaluate their relationship, realign the processes, and evolve as the market moves.

Apple

The good Apple

Apple recently celebrated its 30th anniversary, a rare feat for a Silicon Valley company given the tough times the technology industry has been through. With record revenue of nearly $14 billion for fiscal year 2005 and $8 billion in cash they did have a reason or two for celebration. But back in 1996-97, Apple lost nearly $1.9 billion. The credit for bringing Apple back to black went to both  cofounder Steve Jobs and improved management of its supply chain. After taking over in mid-1997, Jobs accelerated the company’s restructuring. Apple discontinued 15 of its 19 products, closed plants and laid off employees. Jobs also brought on board Timothy Cook from Compaq among others to form a new executive team. Under this new leadership, inventory turns increased and order-to-delivery times decreased. Just in time production techniques were adopted and sales forecasting system was completely overhauled. Within two years the company went from holding a month’s worth of inventory, with a value of $437 million, to a few days’ worth, valued at just $25 million. The number of suppliers was reduced dramatically and Apple began collaborating with the remaining ones by sharing forecasts regularly and formed a focused supplier network Apple also changed its business model and started outsourcing manufacturing and assembly work to contract manufacturers. Apple also changed gears and pushed forward innovative products like iPod that revolutionized the digital music industry and iMac, which has converted a lot of loyal Windows users to its ever growing fan base.

The bad Apple

Even among the accolades, Apples is once again still cited for a historically weak link – its supply chain.   Apple had concerns with its PowerBook and iBook products back in 1999 when an earthquake hit Taiwan and Motorola was unable to deliver the G4 processor. Apple also ran into trouble when it introduced iMac and saw higher than expected sales resulting in out of stock situation and delayed deliveries. In 2004 supply chain issues resulted in shortage of G5 processors from IBM, constraining Xserve and Power Mac G5 sales. These inventory issues also delayed the release of the G5 iMac. Apple also struggled to deliver iPod and iPod minis to meet consumer demand. A primary factor has been a shortage of the hard drives that power the iPod. The public response from Apple was that the demand for iPod has been staggering and it is a nice problem to have. Wall Street didn’t agree And  Apple’s stock price took a hit every time it failed to meet demand for it stellar products.

From Apple’s example we can see that supply chain can make or break a brand. Apple must apply their innovative thinking in order to improve their demand planning and inventory management. While it was supply chain improvement initiatives that lifted Apple from a verge of bankruptcy to profitable quarters, it is again ineffective supply chain management that is holding Apple to earn those extra millions of dollars being missed in lost sales. Supply chain requires continuous work. Supply chain improvement should be treated as on going initiative that a company needs to undertake to make sure that it is delivering shareholder value. A company might be doing great in bringing attractive products to the market luring customers away from the competition but if it is unable to meet the demand that it is creating, a huge potential is simply lost.