New Source for Competitive Advantage: Supply Chain Management

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1 New Source for Competitive Advantage: Supply Chain Management JUNG Ho-Sang Research Fellow, Samsung Economic Research Institute I. Newly-Emerging SCM as a Strategic Tool Supply Chain Management (SCM), which emerged in the early 1990s, is a management technique which seeks optimized decision-making pertaining to supply chains (e.g., optimal levels in inventory) by sharing information and collaborating with business partners including suppliers. In a rapidly changing global production/logistics/distribution environment, it seems that companies cannot obtain sustainable competitiveness without adopting SCM. Recently, leading companies around the world have gone a step further. They have employed SCM as not only an inventory reduction technique but as a strategic tool. Adding to traditional SCM, they are building next-generation SCM (a.k.a SCM 2.0) aimed at securing differentiated competitiveness. Unlike SCM of the past that pursued cost savings through inventory reduction, SCM 2.0 is elastic, green and customer-oriented, three major characteristics that target far greater flexibility. SCM is the successor of Material Requirement Planning (MRP) 1 in the 1970s and Enterprise Resource Planning (ERP) 2 in the 1980s. MRP denotes production input material management while ERP covers the Weekly Insight Concept of SCM Supply Side SCM (Focusing on Supply Chain) ERP (Focusing on Companies) Demand Side Supply Partners Production Sales Distribution Partners Customers Delivery Logistics Partners Logistics Side Flow of Product 1 Material Requirements Planning is a business technique designed to assist production managers in scheduling and placing orders. 2 Enterprise Resource Planning is a business technique which attempts to consolidate all of a company s departments and functions into a single computer system that services each department s specific needs.

2 August 25, 2008 Contrast in Crisis Management of Nokia and Ericsson Nokia Occurrence of Crisis Ericsson Preemptively secured the amount of necessary supply in Philips plants outside the US by forming a task force Due to smooth supply of semiconductor chips, its global market share grew from 27% to 30% in 2001 A fire broke out in a Philips plant in New Mexico in March 2000 (The plant was to produce semiconductor chips for cellular phones) Neglected the seriousness of crisis and suspend supply of components Established a joint-venture firm partnering with Sony in 2001 after posting US$500 million in losses and a withdrawal from mobile phone market management of all company resources. SCM pursues the optimization of internal and external supply chains. In particular, the core of SCM is the decision-making process through communication (information-sharing) and collaboration with business partners in the three major fields of supply, logistics and demand. The primary goal of the system is to reduce inventory throughout the entire supply chain. There are many cases where the level of SCM determines the competitive ranking of a company within its industry. For example, Hewlett-Packard (HP) became the market leader in the PC market in 2006 by upgrading its quality of SCM through the adoption of risk management concepts and the professional/systematic management of distributors. As a result, the company topped the then-market leader, Dell, which had focused on traditional SCM (a.k.a SCM 1.0). II. SCM Strategies of Leading Companies 1. Elastic SCM: Establishment of Supply Chain Crisis Management Systems The more sophisticated SCM becomes, the weaker the response to supply chain crises tends to be. In particular, since manufacturers have now avoided making duplicate investments and stockpiling inventory over a certain level, veering towards an emphasis on leaner management such as Just-In-Time (JIT) 3, their ability to respond to crises has become more limited due to the lack of a buffer. Moreover, as the frequency and destructive power of management crises increases with the advancement of globalization (unexpected fluctuations in demand, bankruptcy of partners, natural disasters and terror), there is an ever growing need for supply chain crisis management systems. A classic example is illustrated in the case of two mobile phone giants: Nokia and Ericsson. Though Nokia and Ericsson faced identical difficulties in early 2000, the difference in crisis management capabilities between the two firms SCM drove the former to the top of the industry and the latter virtually to give up the mobile phone business. Therefore, it is critical to manage supply chain crises in advance not only by establishing effective monitoring systems but also by preparing emergency plans and other viable options. Leading companies of the world 3 Just-In-Time is an inventory strategy that reduces in-process inventory by receiving only necessary amounts of components in the production process. Samsung Economic Research Institute 11

3 Current Status of SCM Adoption by Domestic Manufacturers %, Accumulation ERP(Accumulated) SCM(Accumulated) ERP Demand SCM Demand % Before Note: Figures were unavailable for the pre-2003 period figures were excluded because samples for manufacturing industry were reduced to about 0. Source: Knowledge Research Group, Survey of IT Demand in the Second Half of Changes in Inventory Turnover of Domestic Manufacturers Rotations have recently been redesigning existing supply chains in order to better respond to unexpected jitters in the supply chain. To be specific, these companies are trying to enhance flexibility by making flexible contracts with suppliers and diversifying supply sources. 2. Green SCM: Energy Saving, Waste Recovery and Recycling As environmental and energy-related regulations have strengthened globally, companies have begun to realize the importance of environmentally-friendly management. Due to a series of eco-related regulations such as Restrictions of Hazardous Substances (RoHS) 4 and Waste Electrical and Electronic Equipment (WEEE) 5, 4 Restrictions of Hazardous Substances is an EU directive which went into effect in July 2007 to restrict the use of six hazardous substances including lead, cadmium and mercury in electrical and electronic equipment. 5 Waste Electrical and Electronic Equipment is an EU directive which went into effect in January That requires manufacturers to reuse, recycle and recover electrical and electronic equipment waste. They must meet proportion requirements for recovery by item. establishing eco-friendly supply chains has become a must. Green SCM reflects eco-friendly factors energy saving, waste recovery and recycling in the management of the entire supply chain, ranging from product design and manufacturing to delivery. Companies reflect results obtained from the monitoring of amounts in energy/resource input and output of carbon/waste in each step of the supply chain. They also have adopted Reverse SCM, which recovers and recycles goods that have been damaged, returned or reached the end of their lifecycle. For example, HP succeeded in recycling its computer and printer waste by establishing Reverse SCM while enhancing its corporate image at the same time 6. In the same vein, Intel calculated expected CO 2 emissions in dollar terms and incorporated the results in supply 6 Listed in the top ten most eco-friendly companies by Fortune Magazine in

4 August 25, 2008 chain design and product planning. When choosing partners, Johnson & Johnson puts a priority on whether or not prospective candidates meet a series of environmental requirements and other guidelines in its endeavor to practice green SCM. 3. Customer-Oriented SCM: Establishing SCM That Meets Customer Needs Customer-oriented SCM shifts focus from products to customers; providing customers with products that they want in a timely manner has become more important than providing products quickly and at low cost. Under customer-oriented SCM, therefore, it is essential to collect customer information through various channels such as Customer Relationship Management (CRM) 7 and reflect that information throughout the supply chain. For example, McDonald s started its McCafe business focusing on customers tastes, away from its previous SCM focusing on price competitiveness. This was because the company, which succeeded with its low-price menu in the past through the efficient management of SCM, noticed that customer attention veered from prices to a healthy lifestyle. Instead of defining KFC as its prime competitor, the company targeted Starbucks thereby overhauling its existing supply chain and revising the way in which each store operated in order to provide premium coffee and a health-conscious menu at the same time. Though McCafe coffee is priced from US$1.99 to US$3.29, 60 to 80 cents cheaper than in Starbucks, it has been recognized among customers as equal, if not better, in quality. With such encouraging consumer sentiment, the company decided to expand the McCafe business to about 14,000 stores within the US in January III. Diagnosis of SCM at Korean Compnies (Manufacturing Industry Focus) Considering that the world s leading companies have gone a step further from simply reducing inventory levels to employing SCM as a differentiated strategic tool, it is necessary to review how actively Korean companies are utilizing SCM. 1. Current Status of Firms SCM Adoption in Korea Although SCM seemed to draw much attention when it was first introduced in the late 1990s, demand re- 7 Customer Relationship Management is a business management technique to plan and implement customized marketing by collecting, consolidating and analyzing customer information. mained sluggish until Though, since 2005, it has witnessed a rise in demand, albeit only slightly, as its importance was recognized again by Korean firms. Such low overall popularity for SCM in Korea seems to be the result of contracted investments due to the IT bubble bust and the difficulties firms have had in independently adopting a management technique that is based upon cooperation with other companies. To be specific, only 19.7% of 193 Korean manufacturers with sales revenue exceeding 0 billion won adopted SCM in general (mostly SCM 1.0) as of On a particular note, there exists severe bipolarization of SCM adoption among Korean companies in respect to sales revenue. Although 32.1% of companies with more than 200 billion won in sales revenue adopted SCM, only 4.7% of those with 0 to 200 billion won in sales adopted it. Adopting SCM is a significant burden for companies with less than 200 billion won in sales considering its sheer cost (1 billon won on average) 8 and the fact that Korean firms devote less than 0.5% 9 of revenue to IT investments on average. 2. Achievements Made by SCM Adoption (Based on Inventory Turnover) As the achievements of Korean firms through SCM are not directly measurable, inventory turnover, which indicates levels in inventory reduction, could be used as a proxy to measure their achievements. An analysis using a sample of the 43 largest manufacturers in Korea 11 (out of the top 0 companies listed on the Korea Exchange) shows us that the effectiveness of SCM for Korean firms during the period from 1998 to 2007 has not been pronounced; until 2003, SCM s effectiveness (measured by inventory turnover) improved substantially, only to flatten thereafter. In particular, a huge gap in achievement was found across companies depending on the size of sales revenue and the degree of globalization (measured by the increase rate of inventory turnover ratio from 1998 to 2007). Specifically, companies with large scale sales revenue (more than trillion won) and export-driven companies with overseas sales amounting to twothirds of total revenue showed great performance in this respect, with inventory turnover ratios rising by 180% and 161%, respectively. By contrast, companies 8 Knowledge Research Group, IT Investment Trends The figure excluded financial businesses among the top 500 domestic companies in terms of revenue as of 2005 (Knowledge Research Group, 2008 IT Solution & Consulting Market Perspective ). Inventory turnover is an equation that equals the cost of goods sold divided by average inventory (the higher, the better). 11 Korea Information Service, average revenue is 2.7 trillion won (median). Samsung Economic Research Institute 13

5 with medium- and small-scale sales revenue and domestic-demand-driven companies performed poorly with inventory turnover ratios increasing by 45%, -2% and 19%, respectively. The performance gap between groups with higher and lower revenue has widened over time. The gap between export-driven companies and domestic-demand-driven companies grew larger also. IV. Implications Domestic manufacturers, which are currently suffering from cost pressure due to surging logistics costs and skyrocketing commodity prices, are required to do several things to enhance global competitiveness. First, they need to renew their notion of SCM. To be specific, SCM should be considered an essential management paradigm, not just a simple cost-cutting solution. Second, companies that have not yet seen tangible benefits after adopting SCM should set inventory reduction as a primary goal. Third, it is important to decide on priorities to be achieved through SCM by considering business characteristics and related obstacles including laws and regulations. Accordingly, SCM should be adopted on a step-by-step basis. Last but not least, companies need to strengthen SCM capabilities by continuously monitoring and benchmarking best SCM practices found in other industries.seri 14