Chapter 12 Long Live the Revolution

Technological innovation opens the door to new business models, and such models eventually lead managers to develop new processes for matching demand with supply. As a result, changes occur in the supply chain that lead to major shifts in the competitive structure of industries.

Many argue that the effects of e-commerce on supply chain management typify this process and will overturn accepted business models. But to understand the effect of e-business, it is important to recognize that this is not the first time the supply chain has undergone a revolution. Changes at the turn of the 19th century formed the model for manufacturing and distribution throughout the 20th century. It is instructive to examine this revolution in more detail.

The first Revolution

Between 1870 and 1917, a massive reorganization of the economies of developed nations took place. Before this, commerce had been characterized by small companies that operated within a limited geographic space and focused on a thin slice of the value chain. During this period these companies were replaced by large, vertically integrated corporations. Decisions about the allocation of resources that ensured the matching of supply with demand throughout the value chain were removed from the marketplace and placed in the hands of managers. The switch from market allocation to corporate allocation was based on a simple economic reality. The cost of allocation of resources within the company became lower than the cost of using the market. Those who recognized this fact developed business models that took advantage of the opportunity by expanding and integrating operations within the company. The primary areas where changes took place were in the production and distribution of goods — the supply chain. What were the technologies that enabled the movement to the "visible hand" to take place? Most important were the introduction of continental railroad and telegraph systems, and the arrival of high- speed, continuous-process production machinery. In developed countries, it became possible to ship goods and to communicate from coast to coast. For the first time, continental markets could be accessed, both for the supply of raw materials and the distribution of finished products. The scale and complexity of business increased, necessitating the invention of management skills such as scheduling, accounting and co-ordination across many interacting locations. Soon, mass distributors appeared. These companies used national rail networks to make fast, reliable, low-cost deliveries. Heavy use of such infrastructure gave them a high stock turnover for a high volume of goods. The successful distributors set up networks of retail chains and commodity dealerships and came to dominate their regional markets.

The success of mass distributors was based on "economies of speed" whereby a company internalized a high volume of market transactions. The increase in transaction volume led to high stock turnover, which in turn led to rapid cash flow. This cash flow then enabled companies to buy raw materials in large quantities at lower costs, with lower credit cost terms and, thus, to self-finance expansion. Moreover, the economies of speed supported the growth of market share because mass distributors were able to offer more variety at a lower cost to their consumers.

A second technological innovation was high-speed, continuous-process manufacturing equipment. This technology made the most of economies of scale. An example is the Bonsack machine, invented for making cigarettes. In 1881, Mr. Duke of North Carolina acquired the first of these machines in the US. It was capable of producing 70 000 cigarettes a day (as opposed to a maximum of 3 000 a day for the manual rolling of cigars). Fifteen of these machines could saturate the entire US market. Consequently, Duke and his American Tobacco Company had to develop aggressive advertising techniques to persuade consumers to try this new product.

Process technology led to a new type of supply chain. National manufacturing corporations integrated with companies further down the chain to control distribution and marketing. These corporations also integrated with suppliers to manage the Unprecedented flow of raw materials which was required to feed the newly mechanized processes.

Finally, networks of branch sales offices were built to handle the wholesaler function needed to co-ordinate distribution in regional markets. The first movers built empires by financing expansion internally, thus retaining ownership.

The resulting lower unit cost supported a larger market share and higher cash flow, and reduced the cost of capital. By 1917 the revolution was over and many industries in the US and Europe were controlled by large, integrated corporations.

The Second Revolution

Today, the Internet and B2B commerce are fuelling a second supply chain revolution. The seeds of this revolution were sown in the 1990s, the "golden age" of supply chain management. During this period, companies experimented with novel supply chain strategies. For example, companies created finished products as close as possible to the point of customer demand. The success of these strategies was based on the introduction of mechanisms that reduced uncertainty and nonproductive delays, enabled information to be shared and co-ordinated decision-making throughout the supply chain.

Consider an ideal situation in which information, material flow, product attributes and decision-making realize the full potential of e-commerce technologies. Information flows in this ideal world will be accurate, rich and instantaneous Information, moreover, will be based on all supply chain transactions (retail to raw material) and ill be visible throughout the chain. The Internet will reduce search costs to a minimum.

Goods will flow directly between suppliers and end customers, controlled by just-in-time shipment. In this environment, the cost of changing suppliers will be I. Products will become more customized companies might also be able to develop economies of scale in production by adopting automated flexible manufacturing processes.

How realistic is this picture of the future? The technologies that can make it happen exist, along with the profit incentives for companies that can build such ply chains. The combination of unlimited information. Computing power and capacity will make it possible for managers to match supply with demand on a global scale.

Innovative supply chain structures are rapidly emerging. These incorporate expanded access to "e-sources" of supply, which use web-based exchanges and hubs, interactive trading mechanisms and advanced optimization and matching algorithms to link customers with suppliers for individual transactions. Thus, the dream of always providing the right product to the right customer at the right time and place, and at the right price, will very likely become a reality.

It is difficult to predict the final result of the second revolution, but companies are already adopting a range of new supply chain structures and competitive strategies. It is naive to think that one size will fit all or that any firm will restrict itself to a single structure for all of its transactions. Above all, new supply chains must provide diversity and flexibility. The structure of industry, however, will not remain static. As with the first supply chain revolution, the impact on corporate organization and industry structure will be felt far beyond the present advances in supply chain management.

The history of the personal computer industry is a good illustration of this relationship. In the early 1 980s IBM adopted a bold strategy for the design and production of this new product. It outsourced two key components — the operating system and the central processing unit — to Microsoft and Intel respectively. This "supply chain" decision was made at a time when most discounted the potential of the personal computer to overtake the mainframe as the dominant product.

When IBM made this decision, computers were highly integrated products produced in an industry that was essentially vertical. An IBM computer con5isted of specialized components that could not be used in any competing product. The design, production, delivery and after-sales support of components, as well as the assembly of the final product, all took place in premises owned and managed by IBM. Other market leaders in the computer industry, such as DEC and Unisys, had similar structures.

IBM’s seemingly innocuous outsourcing decisions coincided with a fundamental upheaval in the industry. IBM let Intel and Microsoft in. Product design shifted from integral (components are designed only for a specific product and assembled by a single company) to modular (components can be used in a variety of products and have standard interfaces). As a result, components could be supplied by different vendors; the industry moved from a vertical to a horizontal structure.

Another type of supply chain occurred in the computer industry about ten years later. In the 1990s, Michael Dell began building computers to order in his college dormitory in Texas. Each customer could specify a configuration. This meant components could be procured and assembled by Dell with lower cost and shorter lead times than "make to stock" companies because the product design was modular and the industry was horizontal. This simple supply chain strategy is known as the "Dell direct model". It is characterized by low inventory, high profit margins and a very high return on assets.

Since life cycles for computers are short, one of the major costs of storing components is obsolescence. The mass customization process of the Dell model reduces this cost. Through its direct sales channel, Dell can shift a customer’s demand to a configuration with a higher margin and better availability. It might present a choice between a rapid response for components that are in stock (and perhaps more expensive) and a delay for fulfilling the configuration initially requested with components that are unavailable but on order.

Dell’s rapid response and lean asset base is supported by a supplier network that can place components at its assembly plants in Austin, Texas within minutes of the order being made. These "revolver" distribution centres support just-in-time production. Dell’s volume is sufficient inducement for most suppliers to absorb the capital costs and risks associated with supporting Dell’s supply structure.

Recently Dell has shifted much of its sales to the internet and these sales have risen to more than $30 million a day. Purchases made on the Internet have substantially higher margins and reduced costs. Customers make fewer telephone calls (one call, as opposed to five). The original call centre sales model also was limited due to the cost (in time) of providing information to customers. Sales staff have incentives to maximize the margin dollars earned per minute of contact time. They will thus act to conclude a sale with a choice that may not reflect the customer’s willingness to pay for higher margin components. On the Internet, the indecisive customer can surf without limit and may end up buying a more expensive configuration.

What are the lessons we can learn from the PC industry? First, changes in the architecture of computers coincided with a shift in supply chain strategy and a reorganization of the industry. Second, e-commerce can lead to lower costs, enhanced service and higher profit margins. The computer industry has already experienced the type of revolutionary change other industries are now going through.

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