Managing The Value Chain for Growth

Sept. 6, 1999
The challenge facing manufacturing executives? How do they position their firms in the "value chain" -- the entire series of activities that begins with the processing of raw materials and ends when a finished product is in the hands of the end user.

Many manufacturing executives can relate to Deere & Co.'s dilemma. The company's Worldwide Commercial & Consumer Equipment Div. (WC&CED), like many businesses today, has outsourced a significant portion of its production work.

In fact, at the division's Horicon (Wis.) Works, purchased parts represent fully 82% of the cost of goods sold. As a result, WC&CED -- which makes small tractors and commercial mowing equipment -- has grown increasingly dependent on its supplier base. Yet the suppliers' lack of flexibility and long leadtimes presented a problem when the division began to devise a strategy to more closely synchronize its production with seasonal demand, which peaks in April-June and drops off dramatically the rest of the year.

Deere's dilemma is indicative of a larger challenge facing manufacturing executives: How do they position their firms in the "value chain" -- the entire series of activities that begins with the processing of raw materials and ends when a finished product is in the hands of the end user?

Frequently, facing this challenge starts with an examination of the company's core competencies -- the things it does best in creating value for customers. And often the result, as in the case of Deere WC&CED, is to become less vertically integrated -- to outsource production or logistics or other functions.

However, outsourcing can result in loss of control over key capabilities, which, in turn, can affect a company's ability to introduce changes in response to shifts in the marketplace -- or simply to improve its efficiency in serving customers. Consequently, there has been a growing impetus to find ways to manage the "extended enterprise "-- to build collaborative relationships and improve both the flow of materials and information throughout the value-creating pipeline. o

The scope of the challenge extends beyond traditional supply-chain management, although that is a key element. For manufacturers, one distinction of the value chain is that it extends in both directions and encompasses trading partners ranging from the supplier's supplier to the customer's customer. Another is the increasing focus on working with trading partners to collectively increase speed, pare costs, and enhance the end customer's perception of value.

Shaping a strategy that reflects the reality of the downstream marketplace often leads to new approaches to upstream supplier management.

Balancing Demand & Supply

At Deere & Co. the WC&CED team concluded that to get demand and supply into better balance would require a pull-replenishment process tied to customer demand.

For years, the division had based its production on forecasts and pushed products out to dealer locations, typically requiring dealers to stock an entire year's worth of lawn and garden equipment. This helped to level out factory production schedules, but it led to an excessive and costly amount of finished-goods inventory -- which Deere essentially financed -- at the dealer level. And, despite all the equipment that dealers had sitting around, they often didn't have the products that customers really wanted.

"Small tractors are an impulse buy," notes Dave Christensen, WC&CED business-transition facilitator, who spearheaded an order-fulfillment improvement initiative for the division. "If it isn't there when the customer comes in on Saturday morning to get it, he's going to go somewhere else."

Aware that product availability is a key aspect of the customer's perception of value, the division decided to revamp its order-fulfillment paradigm and develop a system that would enable it to replenish products at dealer locations quickly. For example, Deere's Horicon Works, which makes garden tractors, set a goal of seven-day replenishment of any tractor to any dealer in North America -- with a 90% first-time fill rate.

"In the past," Christensen points out, "we operated in a traditional manufacturing push-distribution environment. We focused on factory efficiencies. . . . We didn't chase demand. And we couldn't give dealers a reliable delivery date. Our delivery performance was anywhere from 21 days to never. And we had no idea what [true] demand was."

One step that WC&CED took was to establish a central distribution warehouse in Streator, Ill., where a moderate level of finished goods inventory (FGI) would be maintained to ensure fast and reliable delivery of products to replace those that dealers had sold. (Keeping the buffer inventory at a central warehouse, rather than replicating it at multiple dealer locations, enabled Deere to slash overall FGI levels by more than 50% -- while improving the availability of popular products.)

To support the new replenishment-based system, better demand forecasting and greater flexibility at the manufacturing and assembly levels were required. In turn, suppliers had to become more flexible in synchronizing their production to Deere's optimized build schedules. Thus, Deere stepped up its emphasis on supplier-development activities.

"When we made the decision to change our factory operations, we found out that we couldn't because it wasn't totally within our control. It was within the control of our suppliers," says Paul D. Ericksen, manager of supplier development for the WC&CED unit. "We recognized that, to change our business, we needed our suppliers to change their businesses."

In short, an "extended-enterprise-management" approach was called for -- in which supply-chain partners behave almost as though they are part of a single organization. One of the big questions that manufacturing organizations have to ask themselves, Ericksen asserts, is: "Are our supplier-management strategies facilitating extended-enterprise management?"

Extended-Enterprise Management

For example, supplier-evaluation practices often emphasize such metrics as on-time delivery and quality, which may cause suppliers to rely on strategies that are counterproductive in the long run -- ultimately inhibiting the ability to optimize the entire value chain.

A supplier that stocks excessive finished goods inventory in order to meet delivery requirements may not be implementing lean-manufacturing practices and developing the flexibility that will become increasingly important over time. In deciding where to focus its supplier-development initiatives, the metric that the Deere division zeroes in on is manufacturing cycle time.

"If the cycle time is long, it tells us that there is a lot of opportunity for cost reduction and for quality improvement," Ericksen says. Moreover, working with suppliers to reduce their cycle time improves their ability to respond to changes in product mix and volumes. Where production bottlenecks are found further upstream, the Deere supplier-development engineers are willing to work with second- and third-tier suppliers -- although the company prefers to encourage its suppliers to work with their suppliers.

To date, the WC&CED division has completed time-based improvement projects at about two dozen supplier firms -- with such results as cycle time reductions from 32 days to two days and cost reductions ranging from 5% to 25%.

Deere is just one of many companies that have recognized the importance of synchronizing the activities and better managing the interrelationships between multiple links in the value chain. Other leading manufacturers also are taking a broader perspective. As a result, the issue of value-chain management today commands attention at the highest levels of the corporate hierarchy.

Competitive Advantage: Creating and Sustaining Superior Performance

Harvard professor Michael Porter is widely credited with popularizing the term "value chain" in his 1985 book, Competitive Advantage: Creating and Sustaining Superior Performance. His primary focus was on the sequence of activities that occur within a single corporation -- inbound logistics, operations, outbound logistics, marketing and sales, and service. However, Porter did emphasize that executives must understand how their firms' value chain fits into the industry's overall "value system" -- including supply-side chains and channel-value chains (the sequence of activities and intermediaries through which products reach the end buyer).

In some organizations, the terms "supply chain" and "value chain" are used almost interchangeably. Yet, quite commonly, executives think of supply chains as the flow of incoming materials -- not the outbound links to the end customer. And often their attention is limited to a single connection -- with either an immediate supplier or a direct customer.

"If you focus just on the buyer-seller transaction, or the procurement aspect, or just on the customer-facing part of the organization, a lot of the advantage to be gained from managing value chains is left out of the picture," asserts Gordon Swartz, vice president, Oxford Associates Inc., a Bethesda, Md.-based marketing and sales-strategy consulting firm.

"To provide good value to your customers," Swartz says, "you need to take into account what they are really trying to offer to their subsequent customers."

Optimizing a value chain, he says, might require initiatives "to help immediate customers identify something that they may not realize they value -- but that their end customer values." Moreover, the value equation includes more than the product itself.

"You may have opportunities for tailoring not only the physical product, but also the delivery information in a way that provides greater ultimate value to the end user," Swartz says.

In a lean logistics pipeline, for example, a critical aspect of value might accrue from shipment-tracking systems that provide "hard information on when the stuff is going to show up."

One key difference between supply-chain management and value-chain management has to do with where the emphasis is placed, observes Timothy R. Furey, CEO at Oxford Associates. "Supply-chain thinking has traditionally been efficiency-oriented -- a cost-reduction and productivity sort of thing -- whereas value-chain thinking is effectiveness-oriented," he says.

When companies stress effectiveness, they aren't necessarily trying to reduce costs, but rather "to create the highest value for the customer -- which isn't always the lowest-cost approach.

"Some companies," Furey says, "have done so much to improve the efficiency of their supply chains that service levels -- or the effectiveness of their service offering -- actually went down because they had pared inventories to the bone and couldn't offer product availability. So the question becomes: What is the tradeoff between being able to offer customers solutions that truly meet their unique needs versus doing it incredibly fast and at an incredibly low price?

The Tortoise Beats the Hare

"It is not always the most efficient guy that wins. Sometimes, the tortoise beats the hare."

One aspect of devising a value-chain strategy, Furey asserts, is determining the best means -- or best combination of channels -- to reach end customers. One set of customers may have different requirements than another set, he points out in a new book, The Channel Advantage (1999, Butterworth-Heinemann), co-authored with Lawrence Friedman.

"In some cases, people are going to want high-value, high-cost channels of distribution -- such as meeting face-to-face with a field sales representative. In other cases, people are going to want the lowest-cost, lowest-price, fastest channel of distribution -- which could be e-commerce," Furey says. "Some products will do very well over the Internet.

And some products and services will still require the value that can be provided by a field sales rep. "The channel adds value as much as the product adds value. And no longer can companies control what channels customers buy through. Now the customers make that decision."

A fundamental question in value-chain management is: How is value created? If improved efficiency lowers the cost to the end customer, does that increase the perception of value? If so, then strategies such as lean manufacturing, which reduces inventory carrying costs, have a role to play. Many would argue that improved service- - including reliable on-time delivery -- is also a value component.

"If you are a lean thinker, you would ask: 'How can I add value to the product and at the same time reduce leadtime?'" says Jeffrey Liker, associate professor at the University of Michigan's College of Engineering. "In short, how do you eliminate non-value-adding activity?"

"If I want a value chain that functions well and that has little waste, it is important that suppliers deliver in smaller batches and deliver more frequently. The supplier must be able to respond quickly to my needs -- but without maintaining a huge inventory. I don't want to simply push waste back [upstream] into the value chain."

Forcing the supplier to suboptimize his performance -- by absorbing high inventory costs -- can come back to haunt downstream customers in terms of cost or quality, Liker asserts. In the 1990s, he adds, fast delivery has become an element of value as companies such as Dell Computer Corp. have developed the ability to quickly build computers to order and ship them to individual customers.

"Clock speed has shrunk, and people are not willing to wait weeks or months for products anymore," Liker emphasizes. "So manufacturers have two choices. Either they build huge warehouses, stocked with every possible product, to be able to ship the next day -- or they develop an extremely time-efficient value chain, where they make things to demand and move things quickly through the system."

Understanding how -- and where -- value is determined in the marketplace can lead companies to experiment with new business models, suggests Laurence Ackerman, a senior vice president with Siegel & Gale, a New York-based strategic brand-management consulting firm.

"The message inherent in the value chain," Ackerman asserts, "is that value flows upstream. Value is fundamentally determined at the point of the end user." As a result, companies should be assessing "the economic potential that resides within the needs and desires of human beings -- and then work their way back upstream to understand where they fit and how they create value."

For manufacturers, that may mean seeking out new immediate customers who are serving high-growth market segments. "You also might decide that you want to take your own organization downstream and, in some cases, perhaps compete with your traditional customers," Ackerman says. ". . .There are many, many different business models that begins to suggest."

Value Chain Management in a High-Tech Environment

In today's information-technology-driven business environment, with the Internet playing an ever-expanding role, opportunities abound to restructure value chains to better serve end customers. In some cases, that means disintermediation -- creating e-commerce channels to sell directly to the consumer and eliminate middlemen and their price markups.

"Value-chain management," asserts Tom Brown, president of Management General, a research and publishing firm in Louisville, "means minimizing the connecting links between the concept and the customer, while at the same time maximizing the contribution of each player involved in that [series of] connections.

"Optimizing the chain involves putting the status quo of the existing chain to the test -- asking, 'How many boxes do we really need?' -- and then deciding which boxes can be eliminated or replaced." Half a dozen years ago, Brown notes, many in the computer industry were focused on creating the ideal computer store, "while Dell was thinking about optimizing the value chain. Dell was looking for the ideal way to buy a computer. As a result, today, many people are buying computers online."

In defining their contribution to the value chain, a number of manufacturers have expanded their perception of what they have to offer.

For example, Wainwright Industries Inc. in St. Peters, Mo., not only produces stampings for a General Motors Corp. van-assembly plant about six miles away, but it also operates a warehouse/just-in-time (JIT) sequencing facility dedicated to that customer. In addition to Wainwright products, the operation handles some 1,500 parts made by 50 different suppliers. Every seven minutes or so, a truck leaves the warehouse to make deliveries to the GM plant in Wentzville, Mo., with the parts arranged in racks in the sequence that they will be needed on the assembly line. Items such as consoles are sequenced by color.

"If they put the wrong console in a vehicle, it's our fault," says Don Wainwright, president and CEO. Wainwright coordinates the incoming supplier shipments and can respond to GM's production requirements in as little as two hours. In addition, workers at the JIT-sequencing plant also conduct quality checks on incoming parts from various suppliers -- and if quality problems are detected, they can initiate rework operations on-site.

Vendor-Managed Inventory

In many industries, vendor-managed inventory is becoming a popular value-added service -- one that not only improves inventory control, but also greatly reduces administrative transactions such as purchase orders.

Shell Chemical Co., for example, developed a software program known as SIMON -- for supplier inventory management order network -- to support its efforts to anticipate customer demand and replenish customer stocks.

The software, which runs on a central Lotus Domino server -- and on Lotus Notes clients at customer sites -- enables the sharing of information on inventory and consumption levels, as well as demand forecasts, through Internet or e-mail links. Data can be extracted directly from enterprise-resource-planning (ERP) systems into the SIMON application, which also supports tracking of shipment status, calculations of safety stocks, and preparation of resupply schedules.

Now in use at more than 60 customer sites, SIMON is being marketed to firms outside of Shell's customer base by Shell Services International, a support arm of Royal Dutch/Shell Group created in 1998. "In the chemical industry, and in many commodity industries, there typically has been a wall between the customer and the supplier," says T.H. (Tom) Eade, supply-chain-solutions manager for Shell Services International in Houston.

"You are just passing information back and forth over that wall, including invoices. The result has been a lot of duplication of activity; and inventory levels were based on maintaining safety stock. . . . With SIMON, we're getting all the information into one location -- and taking ownership of the supply chain.

"It is more than just technology. It is linking everything -- all of the work activities and all of the information flows between us, and continually looking for ways to drive the costs out." Besides providing Shell Chemical with a better understanding of customer usage patterns, thus enabling it to plan its production more efficiently, the system helped Shell to capture a larger market share -- by offering to manage customer inventories in return for sole-supplier status.

Within the first year after deployment with top strategic customers, revenues increased by a reported $20 million. Value creation has been enhanced by many information-technology advances in recent years, observes Michael Mohrman, an ERP segment executive with IBM Corp.'s Global Small & Medium Business unit, which offers a supply-chain "opportunity assessment" service to help small and midsized firms understand how integrated supply-chain management can improve their performance.

"There is extraordinary value in all of the tools that can be brought together to work the supply chain," he asserts. The key tools, Mohrman says, are: backbone ERP systems, advanced-planning-and-scheduling (APS) software, customer-relationship management systems, business-intelligence capability, and e-business connections with trading network partners.

Software-based business-intelligence systems, he explains, provide the ability to analyze information in corporate databases to help companies "anticipate what the customer will need next.

"From a manufacturing standpoint, Mohrman says, value can be created by increasing throughput or by improving customer service with more reliable on-time delivery.

"And the breakthrough today is to be able to do it with a lot less inventory than you needed in the past," he stresses. "Five years ago, without APS technology, the only way to significantly increase on-time shipping performance was to carry a lot more inventory. . . . Today, APS is where companies are getting the biggest bang for their dollar." But for APS systems to be effective, he cautions, companies need accurate and timely communications with customers and suppliers.

"For example, you have to be able to give a very accurate portrait of your demand situation to suppliers, without driving them crazy with constant changes.

"On the order-fulfillment side, especially in a make-to-order environment, it is important to have "strong capability to configure the product accurately," he adds, "so that the demand that a new order creates is absolutely on the money" and can be accurately and quickly translated into requirements for suppliers. Electronic collaboration across supply chains -- or "value networks" as they are often described today -- is regarded by many as the wave of the future.

"After companies have optimized business processes internally, they are looking to go beyond that -- at how they can affect value among themselves and their trading partners within that value network," says Wayne Janzen, manufacturing/ERP industry manager for Lotus Development Corp., Cambridge, Mass.

Sponsored Recommendations

Voice your opinion!

To join the conversation, and become an exclusive member of IndustryWeek, create an account today!