The Big Payoff

Business has always devoted itself to selling—spending billions on sales tools and strategies, on packaging and marketing, on advertising and perfecting the pitch. But outside the automotive and high-tech industries, few companies have devoted any real thought or money to improving the (cheap) beer-and-a-handshake way they buy things—a process also known as procurement.

   Procurement. The name alone is enough to scare off all but those hard-nosed types who enjoy doing the work of salesmen in reverse—except without the yearly bonus, the fancy car or the expense-account steaks.

Procurement is one of those dark dungeons in the corporate castle that actually houses engines critical to business success. After all, the average manufacturing company spends 50 percent of its yearly revenue buying stuff to make its products and to keep its offices flush with pads, pencils and computers.

But now procurement, the poor stepchild of the company, along with the other equally invisible pieces of the supply chain—order processing, inventory and warehouse management, delivery, and fulfillment—has emerged as the next great economic opportunity for business, the ultimate ROI.

Procurement is one of those business functions that has long cried out for automation, for a systematic, repeatable way of carrying out those identical transactions that happen every day, week and month. But until recently, high cost and complexity of creating computerized links to suppliers has kept procurement in the shadows. Only since the arrival of cheap, networked computing—a.k.a. the Internet—have companies looked beyond the brews over which buyer and supplier have done their business for hundreds of years.

The numbers—and the potential—are staggering. According to Boston-based AMR Research, in 1999 U.S. companies spent more than $9 trillion on costs of goods sold (which includes labor, overhead and material costs) and more than $2.5 trillion in sales, and general and administrative (SG&A) costs. Reducing costs of goods sold spending by 9 percent could yield $330 billion annually—the equivalent of the combined sales of the last 100 companies on the Fortune 500 list. A 2 percent improvement in SG&A cost could yield $21 billion.

And savings in procurement have a way of thundering, rather than trickling down to the bottom line. Take the average company in the Standard & Poor’s Register with $5 billion in revenue. If that hypothetical company could reduce the cost of supply chain management by just 5 percent, that would increase the annual profits by $20 million and the market value by approximately $450 million, according to Stephen G. Timme, president of FinListics Solutions, a consulting company based in Atlanta.

These numbers are enough to move the flintiest CFO to tears of joy, but the gains won’t come without pains. These potential

savings are almost completely dependent on developing technology links with customers and suppliers through the Internet so that manually controlled supply chain processes can be automated. The savings also depend on suppliers, distributors, customers and manufacturers giving each other direct access to sales forecasts and cost structures as well as manufacturing and inventory management processes. Though making the technology changes will be difficult, getting suppliers and manufacturers—traditional adversaries—to trust each other enough to share their most sensitive supply chain information in real-time over the Internet will demand heroics. There are internal barriers too. Managers of the various pieces of the supply chain have always been rewarded according to how they optimize their specific link in the chain. For example, warehouse managers are warned not to let their shelves go bare (lest a salesman’s order go—horrors! —unfulfilled), so they pile up inventory to prevent stock-outs, which dramatically increases inventory carrying costs. In order to

rationalize the supply chain, companies are going to have to begin thinking about it as a single system rather than as a conglomeration of amalgamated functions. The job will require someone who knows how to change people and technology at the same time, and right now no other executive has as much experience doing that as the CIO. This is the golden apple that IT has been waiting for for 30 years—the big payoff—the moment when IT can really show how much technology can help the business both save money and build new revenue. Don’t let the hype fool you: B2B is nothing more than supply chain management as presented by the marketing and sales folks, and it requires the same sort of dogged effort as ERP did before it. But the opportunity won’t last long. The supply chain is too valuable not to be fought over by every business unit vice president with an ounce of ambition. CIOs have to act now. Welcome to your automated supply chain

The first step toward understanding this new discipline is to forget about the old supply chain, with its step-by-step, linear march from raw materials to managing inventory to delivering final products to customers. The new, automated supply chain is more like a network, with many different steps taking place simultaneously, morphing that rigid march into a frantic but tightly scripted dance.

“Supply chain over the Web lets a single event like a customer order trigger simultaneous multiple actions across the supply chain, which has a big impact on compressing the time cycle,” says Sandor Boyson, research professor and codirector of the Supply Chain Management Center Logistics, Business, and Public Policy at the Robert H. School of Business at the University of

Benchmarks

What you need to know about supply chain performance

Maryland, College Park. Adjusting the choreography, as Boyson calls it, is where the biggest supply chain payoff lies, allowing companies to slash inventories, improve on-time deliveries to customers and collapse the order-to-cash cyclethe time that passes between when a customer places an order and your company collects payment for it (see “Benchmarks”).

Cisco Systems, the San Jose, Calif.-based networking equipment maker, is one of the most accomplished Internet supply chain dancers. Over 90 percent of the company’s orders come in over the Internet, and of those, fewer than 50 percent ever touch the hands of a Cisco employee. Cisco has a network of component suppliers, distributors and contract manufacturers that are linked through Cisco’s extranet to form a virtual, just-in-time supply chain.When a customer orders a typical Cisco product (say a router, which directs Internet traffic over a company network) through Cisco’s website, the order triggers a flurry of messages to contract manufacturers of printed circuit board assemblies, for example. Distributors, meanwhile, are alerted to supply the generic components of the router, such as a power supply. Cisco’s contract manufacturers, some of whom make subassemblies like the router chassis and others who assemble the finished product, already know what’s coming down the order pipe because they’ve logged on to Cisco’s extranet and linked into Cisco’s own manufacturing execution systems.

Soon after the contract manufacturers reach into Cisco’s extranet, the extranet starts poking around the contractor’s

assembly line to make sure everything is kosher. Factory assemblers slap a bar code on the router, scan it and plug in cables that simulate those of a typical corporate network. One of those cables is a fire hose for Cisco’s automated testing software. It looks up the bar code, matches it to a customer’s order and then probes the nascent router to see if it has all the ports and memory that the customer wanted. If everything checks out—and only then—Cisco’s software releases the customer name and shipping information so that the subcontractor can get it off the shop floor.

And there you have it. No warehouses, no inventory, no paper invoices, just a very nosy software program that monitors Cisco’s supply chain automatically, in real-time, everywhere, simultaneously. The chain runs itself until there’s a problem, in which case the system alerts some poor human to get off his duff and fix something.

The success of this kind of network depends on American companies letting go of a near-and-dear notion—that the company knows best how to supply its assembly line and make its products. Companies like Cisco have blown away that traditional view of vertical integration by handing off manufacturing wherever possible. As a result, entire industries have formed around the specific chunks of the high-tech supply chain—populating a circuit board with the right components, for example, or building PC and router chassis. Without having to worry about any of the other steps in manufacturing, such as supply and delivery, these companies can, theoretically anyway, get better at what they do.

And Cisco can get better at what it does. After all, it’s a lot simpler to push a chassis manufacturer to make more chassis than it would be to build a new chassis plant yourself. Freeing itself to add people only where they are most needed—in engineering and marketing rather than in chassis making—Cisco’s productivity numbers have soared. In 1999, according to AMR Research, Cisco brought in $713,000 per employee, compared with the Fortune 500 average of $192,000. Cisco claims that it has reduced the administrative overhead for processing and shipping a product from $100 per order to between $5 and $6.

Cisco is the first to admit that it is technology—specifically the Internet—that has made this possible. Such heavy dependence on suppliers and contract manufacturers requires a cheap, fast way to keep them all working smoothly. “When we envisioned this years ago [Cisco started taking Internet orders in 1995], we realized that if we were going to do this with faxes and phone calls, if we were going to do it by putting quality inspectors in every plant, if we were going to do it with old business processes, it probably wouldn’t make sense,” says Cisco’s CIO Pete Solvik. “But if we could control this entire process over the Internet, we thought that we could achieve the same or higher levels of quality, faster levels of scalability and growth, and higher levels of customer satisfaction at a lower cost than if we tried to do it all ourselves.”

Sweet fruit of the ERP tree

In case you’re thinking that all this supply chain stuff is nice, maybe a bit pie-in-the-sky and, ultimately, optional, consider the case of Vanity Fair Corp., a Greensboro, N.C.-based clothing manufacturer. In early 1999, VF was approached by three of its big customers: the Army Corps of Engineers, the U.S. Fish and Wildlife Service, and the National Park Service. They informed VF Vice President of Global Processes Tim Lambeth that if he wished to continue doing business with them, he would need to set up separate, secure websites for each agency with individual accounts for employees who order uniforms from VF. VF would also need to track individual spending on the sites so that employees would not overspend their clothing per diem. And by the way, it would all need to be up and running by October 2000.

“That really got us focused,” Lambeth says, deadpan. “By the end of this year we will have between five and 10 such sites in our work wear coalition,” which includes five different uniform makers owned by VF.

In essence, what Lambeth’s government clients were asking for was access to his supply chain. And why was VF able to comply and keep their business? Because Lambeth has been busting his butt for years implementing an ERP system.

By suffering through the ERP wars of the early and mid-’90s, Lambeth discovered where all of VF’s customer order and inventory records were buried. In order to even contemplate a supply chain automation effort, companies need to gather this data, make sense of it (in other words, get rid of the five different part numbers across the company for the same widget and agree on one), digitize it and make sure it’s easily reachable via Internet technologies.

“Everything you read today says ERP is pass, but I think it’s more critical than ever,” says Lambeth. “If you are going to begin to collaborate with your suppliers, you will have to have real-time information available to them. If Wal-Mart wants to come into my system to place or track orders, it expects my system to tell it precisely what I can do and when I can do it.”

Lambeth has been struggling for three years to install a special version of SAP’s R/3 ERP software for the apparel industry, and, truth to tell, he’s still not done. He professes no regrets, however, because the effort forced the seven different VF business units to standardize the ways they described customers

and inventories in their computers and the ways they exchanged that information with headquarters. All of which makes VF ready and able to approach its suppliers and customers with standard, repeatable ways to access its different businesses’ inventory and ordering systems.

Lambeth’s experience suggests that companies that aren’t ready to bring their supply chain to the Web will be forced into it by customers. “I’d rather have customers come to me and say, ‘Here’s what you need to do to keep our business,’ instead of ‘Here’s why we won’t be doing business with you anymore.'” “The most important thing is to get your own systems in order first,” he adds.

Who do you trust? Most of the stress in the new internet-based supply chain will occur between humans, not computers. Communication is the sine quo non of good supply chain management. And the key to good communication is trust.

But you can’t trust your supply chain partners if you don’t know them.

Kevin Holian knows all about that. Two years ago, Holian, vice president of supply chain programs for Staples, began sitting down with the Framingham, Mass.-based office supply giant’s major supply chain partners to discuss ways to improve performance. Holian wanted to know, for example, why Hewlett-Packard demanded a 21-day lead time for orders.

“The guy from HP looked at me and was dumbfounded,” recalls Holian. “Finally he said, ‘We thought you wanted the 21-day lead time.'”

Turned out, neither Staples nor HP needed the 21-day lead time; it was a process zombie, the unholy spawn of some over-the-beers deal that didn’t know enough to die. Just by identifying the walking dead, Hewlett-Packard and Staples cut the lead time for computer orders to seven days. The ripples of this reduction include fewer stock-outs for Staples and less need to hold extra safety stock. The Palo Alto, Calif.-based HP, of course, reduced its order-to-cash cycle.

Transactions that require little trust between a company and its suppliers are already on the Web. Web procurement vendors like CommerceOne and Ariba have built fortunes on the fact that their clients don’t really care where they get their pens and pencils, they just want the best price. Companies hook into Ariba or CommerceOne’s indirect procurement catalogs on the Web, and

suddenly all the different business units that used to buy three dozen pens from three different office supply stores are buying them from one vendor at a reduced price. That’s called supply chain leverage.

But transactions that affect the products that a company makes and delivers to customers will take longer to move to the Web.

Up to now, collaborative supply chain partnerships just haven’t taken hold outside of Asia. It shows in the predominantly American B2B exchanges that have flooded the Internet over the past year. “They seem to be mostly focused on cost reduction and pitting suppliers against one another,” says Cisco’s Solvik. Collaboration and relationship building seem to be taking a back seatat least for now. Which is why companies like Cisco, which long ago adopted the supplier-manufacturer partnership model that has held sway in Japan for decades, are staying out of exchanges.

Cisco does what companies like Honda and Toyota have been doing for years—building capacity and reducing costs by scratching suppliers’ backs rather than whipping them. “We have goals, and [the suppliers] have goals,” says Solvik. “If we help them reach some of their goals then we can count on them to give us priority when we have problems.” Specifically, Solvik says Cisco may help out by becoming an “anchor tenant” in a new factory that the supplier wants to build, for example, or become an early buyer for a new product offering. Meanwhile Cisco may ask for help in making an emergency assembly line switchover to supply a new Cisco product that is selling far better than expected—or shutting down a line sooner than expected for a

poor selling one. The Internet adds a new dimension to this give-and-take manufacturing model. It puts the relationship, which has traditionally focused on a lot of personal hand-holding and meetings, online. For example, Cisco puts prototype specs for products that are still under development on its extranet. By knowing in advance the components that will most likely be part of the final Cisco product, suppliers can plan their own manufacturing earlier and more accurately, while Cisco can get an early heads up if a few of those components are going to be too dear when it comes time to begin making the new product. “We’re taking the engineering process and linking it as early as possible to the manufacturing cycle,” says Solvik. “We want to impact the design of products before they’re set in stone to make sure the product that’s being designed is going to be of high quality, efficient in terms of cost and able to ramp up quickly in terms of supply chain.” But sharing information about products in the development pipeline? That takes a lot of faith.

“Supplier-vendor relationships have always been about showing what information you needed to show to get the best deal. Now you’ll be playing more with your cards face up,” says Lambeth, who’s in the process of showing his hand to Cone Mills in Greensboro, N.C., a 30-plus-year supplier of denim to VF’s jeans coalition, which includes VF-owned companies like Lee and Wrangler. Despite all those years together, Lambeth, a 32-year VF veteran, doesn’t know how Cone responds to incoming orders. It’s time, he realizes, to find out.

“Together, we’re sitting down to go through how we generate an order for them and how they handle that order. We don’t want both of us to do anything twice,” Lambeth says. If the companies can begin sharing real-time inventory and order information, the savings “will be huge—in the millions of dollars to us and to them,” he says, relying on studies by VF’s supply chain software vendor, Dallas-based i2 Technologies. Real-time is the operative phrase here, because demand forecasts go dead faster than a beer left sitting on a windowsill. “We’re getting POS [point of sale] information continually from our retailers and we have dynamic sales forecasting in the company,” says Lambeth. “We share this information with our vendors periodically, but it’s haphazard, and it’s always a little dated by the time they get it.” It is planning based on history rather than reality.

Eventually, Lambeth wants to post VF’s real-time demand forecasts on a secure website where suppliers can access them anytime they want. “They can come in and say based on VF’s plan right now they will need 100,000 yards of fabric. And looking three months out, they can have a slightly better idea of what VF needs rather than just putting their thumbs in the air,” he says.

Staples’ corollary to the thumb-in-the-air approach is called safety stock, the extra computing and office supply products it holds in its warehouses to fill in for unexpected lapses in deliveries from its suppliers, or for unexpected demand surges. Staples’ suppliers’ situation isn’t much better. Without access to Staples’ customer demand data, the suppliers must base their own forecasts on Staples’ past orders and build in their own levels of safety stock to be able to respond to Staples’ demands, as well as all of the other major office supply retailers they deal with. The problem, known as the bullwhip effect, costs Staples and its suppliers millions in extra inventory holding costs and lost sales.

Staples dipped a toe into the trust pool two years ago, when it began flying its biggest suppliers to its Framingham

Benchmarks

What you need to know about supply chain performance

headquarters each quarter and showed them their supplier metrics report cards. The effort wasn’t really technology driven, because Staples already did 99 percent of its ordering to suppliers through EDI. It was more to see what real supplier discussions could yield in savings. “It’s strange,” recalls Holian, “but we treated the metrics information almost as if it was a secret.” Once the suppliers got a look at the metrics (see “Benchmarks”), they wanted to see their report cards more often, especially after Staples announced it would push them harder on each of the metrics.

“We created a website where they can access the metrics anytime they want,” Holian says. “Each supplier gets a password so that it can’t access other suppliers metrics. Though the Web communication is mostly one-way for now, it creates a basis for deeper discussions and connections with suppliers.”

CIOs have a special opportunity to lead these deep discussions about sharing, trust and supply chain processes. If the trials of ERP have taught CIOs anything, it’s that the changes in people and the ways they work are more important to business and even project success than software installation. CIOs now have a deep knowledge of ways to mix technology implementations and process redesign so that the two work together. ERP, now so out of favor with the media and the pundits, brought a type of ROI that no one sees outside the companies that have done it: readiness.

Readiness to begin the difficult work of ripping apart decades-old supply chain practices and remapping them for e-commerce. Unlike ERP, the ROI of that effort won’t be difficult to find or to prove. Supply chain is the big payoff.