Wednesday, June 6, 2012

Business Strategy Must Drive Supply Chains

imageIf you had to decide what supply chain capabilities your company should build to create advantage, what would they be? We are all familiar with constantly juggling the conflicting goals of minimizing inventory while establishing the highest service levels, reducing labor while increasing throughput, and reducing supply costs while maintaining stable supplies. We know that a supply chain that is integrated with the rest of the business functions, that senses changes, adapts, optimizes, and works within the context of the larger business strategy without any conflicts would be great. What we grapple with is how a supply chain strategy can be created that is not only aligned, but actually enhances the business strategy. This is not a theoretical discussion: Pioneering companies must continuously evolve their supply chains to create capabilities mandated by their business strategy to create competitive advantages. The failure to do so can be fatal.
So what comprises an effective supply chain? Is it the ability to quickly react to volatile demand? Is it the ability to maintain the highest inventory turnover in the industry? Does it mean having the lowest days of accounts receivable? What about accounts payable? Shortest cash-to-cash cycle? Highest ROA? Agility? Lean manufacturing? Optimal product mix? Highest resource utilization?

In fact, an effective supply chain may do all of the above or none of them. What makes a supply chain effective is unique to each business and determined solely by its ability to support the business strategy of the company. It is only effective for you if it works for you. Therefore, creating a supply chain that is an organizational asset involves creating supply chain capabilities that are aligned with the business strategy. Without such an explicit alignment, there would always be conflicts between what the business seeks and what the supply chain can deliver. Not understanding the intricate and complementary relationship between business and supply chain strategies can lead to missed opportunities and conflicting investment priorities. 

Technology has become the de facto enabler of business capabilities, including those for managing the supply chains. It is great for creating cost effective, streamlined, and standard processes that are largely skill independent. However, technology brings additional complexity. Companies must not only develop effective technology to enable their supply chain processes, they must also ensure that the technology complexity remains manageable and cost-effective at the same time.

Therefore, to create an effective supply chain, companies must understand and articulate their business strategy and use it to pro-actively design and develop their supply chain capabilities. But to do so in the most effective fashion requires that the companies must also develop technology savvy to enable such capabilities and deploy them consistently across their operations.

Consequently, to truly create a competitive asset through its supply chain, companies must strive to align their business, supply chain and technology strategies in a symbiotic and mutually beneficial relationship. If the supply chain strategy is not aligned with the business strategy, the capabilities created by the supply chain may not create the advantages that the business strategy seeks to achieve its goals. If the technology is not aligned with the requirements of the supply chain strategy, the solutions enabling the supply chain processes may not be effective, flexible, and sustainable to create and maintain these capabilities.

To illustrate the point and the disastrous consequences that can come about as a result of the misalignment between the business and supply chain strategies and the inability to leverage technology, we will use the case of Kmart.

Kmart and Wal-Mart were both founded in 1962. Both focused on cost as a business strategy and adopted super-center retail formats. In 1987, Kmart had 2,223 stores and revenues of $25.63 billion to Wal-Mart’s 1,198 stores and revenues of $15.96 billion. When it came to leveraging their supply chains, though, they could not have been more different. Wal-Mart, staying true to their business strategy to cut costs, invested heavily in developing supply chain capabilities that would directly support their business strategy of competing on lower costs. Pro-actively designing their supply chain, Wal-Mart went beyond developing the conventional supply chain capabilities at the time.

Wal-Mart introduced concepts that were unheard of at the time, such as bypassing the whole-sellers to replenish their stores, developing a network of regional and local distribution centers, cross-docking at the warehouses, owning a captive fleet for store delivery, investing in the data-link connecting stores to the headquarters so that demand can be communicated effectively and without delay, and actively collaboration with suppliers like P&G to share demand data. While we take these capabilities as the standard retail staple now, these were pioneered by Wal-Mart in response to developing a supply chain that will support their business strategy.

Kmart on the other hand did not quite understand the value of designing their supply chain to meet the needs of their business strategy. Kmart did not adopt many of these practices mentioned above for over a decade after they had been well established at Wal-Mart. Instead of reducing costs by building a more efficient supply chain, Kmart invested in acquisitions to grow their topline.

Originally conceived as the bargain offshoot of the Kresge department stores, the chain had blanketed the suburbs with stores carrying everything from Tide detergent to clothes, makeup, electronics, and housewares. However, when customers started shunning its poorly made dishtowels, cheap makeup brands, and tacky clothes, instead of reducing costs by building supply chain capabilities (like Wal-Mart), Kmart went shopping, buying Sports Authority, OfficeMax, Builders Square, and Borders.

The Big K and Super K store formats were introduced to lure customers back, but still no concerted effort was made to reduce the underlying cost structure.

Most of Kmart’s investments went into marketing and merchandising capabilities that do not directly help in reducing costs (both of these strategies are targeted toward increasing revenues rather than on reducing costs). The misalignment between the business and functional strategies cost Kmart heavily. In contrast, Wal-Mart chose to invest in the supply chain as a strategic advantage to support its business strategy of being a price leader. In 1991, Wal-Mart sales overtook the sales at Kmart.

By the late 1990s Kmart was heading for bankruptcy and eventually merged with Sears.

The functional strategies at Kmart were clearly not aligned with their business strategy. While the business strategy focused on cost, the functional strategies at Kmart were focused on creating a perceived differentiation through their marketing and assortment, while largely ignoring the cost. Kmart’s inability to create capabilities for direct cost reduction and align their functional competencies to their business strategy eventually led to their bankruptcy.

Wal-Mart started investing in technology in 1966, an innovation that was championed by none other than Sam Walton himself. During the next two decades Wal-Mart invested in several store-based technologies such as computers, electronic cash registers, and UPC scanners for non-grocery items. Wal-Mart continued its investments in technology by building a satellite-based communication system in the mid-1980s and investing in technology that would allow them to get real-time sales and inventory data from their stores. All of these investments by Wal-Mart enabled their legendary supply chain capabilities, including their automated distribution centers, optimized transportation planning, active vendor collaboration, and so on. Wal-Mart leveraged technology in all its business operations and adopted it to enable their supply chain capabilities while directly supporting their ‘‘everyday low prices’’ business strategy.

In contrast, Kmart never quite focused on creating a supply chain that could actually support their cost-based business strategy. Their inability to understand and leverage technology to enable supply chains constrained their capacity to innovate and lead. Kmart’s Ten Deadly Sins states that ‘‘Kmart needed an IT champion at the top and it never had one. Even during CIO Dave Carlson’s tenure, from 1985 to 1995, he worked with a CEO who ‘prided himself on never having used an automated teller machine and used an assistant to print email.’ Such admissions clearly demonstrated that information technology was not a priority for the company.’’ Most likely, it was because Kmart never really understood the role of technology in building their supply chain capabilities, even though they had been investing in it, probably because of competitive pressure. During the 1970s, Kmart was opposed to any major investments in technology and by extension into building any competitive supply chain capabilities.

Kmart did not take up any substantial technology investments until 1978, when it started installing computers in its stores—a full 15 years after Wal-Mart started investing in technology. In the late 1980s, Kmart invested $3 billion in technology that provided them with scanners in 500 of their stores, a satellite-based credit-card processing system, and the ability to monitor sales and inventory. However, this covered only a fourth of their stores, unlike Wal-Mart who had the ability to track sales and inventory in all their stores.

In the 1980s, Wal-Mart invested in electronic data interchange (EDI) for operational collaboration and then created a collaborative network called RetaiLink enabling it to share its current and projected demand data with its suppliers. Kmart adopted EDI only in the early 1990s, pushed into it through their suppliers’ initiatives. Wal-Mart also kept its supply chain strategy keenly aligned with its business strategy to cut operational costs by building a lean distribution network. Company practices such as owning their own fleet and cross-docking drive Wal-Mart’s technology investments in supply chain. In contrast, Kmart had a mixed distribution network and never quite invested in their own fleet for distribution, losing the opportunity to design their own processes or improve operational efficiency beyond what their service providers supplied. 

In addition to their inability to leverage technology, Kmart also simply did not seem to have an explicit alignment between its business and supply chain strategies. While Wal-Mart identified operational efficiencies early on as their key to reducing costs, there is no singular theme in Kmart’s history that can be seen as an equivalent strategy.

In 1990, Wal-Mart sales overtook Kmart for the first time; by then, it was amply clear what Wal-Mart had been doing right—Wal-Mart had invested heavily in the automation of distribution centers, communication between stores and headquarters, real-time sales and inventory visibility, collaboration with vendors, and planned investments in technologies like EDI.

Kmart just did not seem to understand the importance of what Wal-Mart had been investing in. Kmart responded by expanding through unrelated acquisitions such as Borders, Office Max, and Sports Authority—only to have to shed these assets in the mid-1990s. Kmart had tough competition on pricing through Wal-Mart’s laser sharp focus on operations and cost reduction, and on assortment from Target’s high-end image. Whereas technology enabled Wal-Mart to create highly effective logistics and supply chain capabilities, Kmart simply stagnated due to a lack of strategy and antipathy toward technology. While Wal-Mart continues to squeeze value from its investments in supply chain, Kmart simply gave up.

Former CIO Dave Carlson depicts Kmart’s information systems in 1985 as one that was ‘‘cobbled together over time.’’ This is a good example of the organically grown supply chain capabilities rather than explicitly designing supply chain processes to actively support the business strategy.

When Chuck Conaway took over as chief executive of Kmart in 2000, he identified the company’s supply chain as the main target for improvement. In 2001, he announced that Kmart was writing off $195 million of assets that no longer had value. This included $130 million worth of supply-chain hardware and software that was being retired and $65 million for the replacement of two outdated distribution centers. He also had to write off 15,000 trailers full of inventory, sitting behind the stores. The inventory existed because the management did not believe its own information systems.5 Although Conaway got rid of the unwanted inventory, the inherent systems problems continued, consistently showing up as out-of-stocks and pushing customers away from Kmart stores.

In 2002, Kmart announced it would invest $1.4 billion rebuilding and refurbishing its supply chain infrastructure and implementing IT changes. At the time, its spokesperson characterized the investment as being ‘‘more money than Kmart spent in the last decade on IT.’’ While the statement was supposed to underline the big investment, it also says a lot in terms of previously anemic investments in building a competitive supply chain for a company the size of Kmart—which had reported revenues of over $37 billion in 2001. In the meantime, time had run out for Kmart. Their revenues continued to falter and the declining sales resulted in a liquidity crisis and halts in shipments from major vendors, leading the company to file for Chapter 11 bankruptcy protection on January 22, 2002, becoming the largest retailer ever to do so. In March 2005, Kmart was merged with Sears to form Sears Holdings Corporation.

The misalignment between the business and functional strategies cost Kmart heavily.

The supply chain strategies at Kmart were clearly not aligned with their business strategy. While the business strategy focused on cost, Kmart’s inability to create capabilities for direct cost reduction and align their supply chain competencies to their business strategy eventually led to their bankruptcy. Even after their merger with Sears, the company has failed to grasp the importance of proactively developing and leveraging supply chain capabilities to support their business strategy. For example, they have failed to consolidate their supply chain assets to improve operational and capital efficiencies: In 2010, four years after the merger, only 4 distribution centers out of 39 were shared between Sears and Kmart, while others continue to serve Sears or Kmart stores exclusively.

In addition to having a well understood and articulated business strategy that drives the supply chains, it is also important to have a long term focus. Among the many reasons leading up to Kmart’s failure in 2002, another important reason was their lack of a long-term strategy based on a proven business model. While Kmart started with the same low-cost premise as Wal-Mart, they digressed from their stated strategy several times during their long history: among these digressions were the introduction of private label merchandise, unnecessary store format changes, growth through acquisitions (Borders and Sports Authority, among others), and their tentative foray into the grocery business. Most of these initiatives were rolled back by Kmart’s successive leaders, thus failing to create any long-term value for the business.

This lack of consistency also showed up in operations. Quoting from the book Kmart’s Ten Deadly Sins, “Few projects begun under one CIO were ever continued or completed under the next, requiring that work be stopped and restarted with each changing of the guard.” It is quite possible that this volatility in IT was simply a result of the lack of having a consistent and articulated business strategy and consequently a missing supply chain strategy that must have added to the chaos in evolving information technology as an enabler. In absence of a long-term strategy, it would be easy for the new incoming CIO to disregard the work already done and restart the project. Surely, this does not bode well for the capital investments in building business capabilities which typically take years to build and leverage, or for the morale of the team involved as they live through the volatile results of executive decisions made without an obvious reason to change direction. 

Therefore an effective supply chain strategy must focus on aligning the business and supply chain strategies, designing the differentiators to build advantage, and pursuing a coherent technology strategy to support them—we call this supply chain nirvana. Nirvana typically denotes a state of simultaneous stability and dynamic equilibrium which is at peace with oneself and the world. It also denotes a complete awareness of self and the world outside. In the context of supply chain, it typifies a supply chain that is similarly stable, but also in dynamic equilibrium as it reacts to the changes within and outside the firm, and a supply chain that is fully aware of these changes and its capabilities to react to these changes.

But remember that supply chain nirvana is not a static state. It is a continuously evolving, but sustainable state of enhanced alignment of the supply chain capabilities with the objectives of the business strategy. As the business environment changes and the business strategy evolves, it changes the required supply chain capabilities and the expectations of the business from its supply chain. Since such change is frequent, therefore, the state of supply chain nirvana is an ever evolving journey. The keywords in the state of supply chain nirvana are dynamic alignment and sustainability.

Related Articles:
This article is a reproduction from my four-part series on the subject, published by SCMR in June 2012. 
1. Pioneering companies must continuously evolve their supply chains to create capabilities mandated by their business strategy to create competitive advantages. The failure to do so can be fatal.
2. Kmart's demise is a cautionary tale.
3. Wal-Mart started investing in technology in 1966, an innovation that was championed by none other than Sam Walton himself.
4. Wal-Mart had invested heavily in the automation of distribution centers, communication between stores and headquarters, real-time sales and inventory visibility, collaboration with vendors, and planned investments in technologies like EDI.

Want to know more about supply chain processes and supply chain strategy? Check out my books on Supply Chain Management at Amazon.
© Vivek Sehgal, 2012, All Rights Reserved.

No comments:

Post a Comment