Saturday, February 07, 2009

Building better links in high-tech supply chains

Building better links in high-tech supply chains

As high-tech supply chains increase in complexity, they become harder to manage. Collaboration between OEMs, suppliers, and retailers is the answer.

The supply chains of high-tech companies are globe-spanning marvels. Over the past 20 years, looking for ready sources of components, lower-priced labor, and talented designers and engineers, these companies have ranged throughout the world. In a highly competitive and fast-moving marketplace, they have sought to maximize their strengths and flexibility as products change rapidly and prices continue to fall.

But the sprawl and complexity of such networks have made it harder to manage end-to-end operations smoothly. Many technology companies are grappling with volatility and disruptions across their supply networks, and eliminating waste from duplicative efforts is an ongoing challenge. As product life cycles shrink, we see inventory buildups in the supply chains of some companies, while others cope with rising distribution costs, on-time delivery problems, or delays in getting new products to market.

In fact, high-tech companies have let complexity undermine collaboration in their supply chains: they aren’t working as closely as they could with their supply chain partners—sharing information or streamlining processes—to smooth out volatility and eliminate waste. This failure is surprising. The high-tech industry creates products that promote collaboration, openness, and efficiency. We all know stories about companies in other industries such as retail and consumer-packaged goods that have improved their operations significantly by using technology to collaborate more closely with suppliers—yet high-tech companies have been slow to follow. For a host of reasons rooted in the way they are organized and compete, their executives have been less than enthusiastic about pursuing the benefits of collaboration with their supply chain partners.

This lack of enthusiasm is fast becoming more costly for OEMs. Even as product life cycles shrink, consumers are demanding products with new features (such as mobility, greater storage, and more memory) that make products ever more complex. As this complexity increases, it will become harder to manage supply networks, opportunities will be missed, and supply chain costs will rise. The path to improvement, we suggest, lies in better collaboration with suppliers. To achieve it, companies should address their internal challenges and then deal with key stress points that strain supplier relations.

Roadblocks to better collaboration

Closer collaboration in the high-tech industry is an elusive goal. Difficulties arise from the specific nature of high-tech competition and markets, from cultural barriers, and from organizational flaws. In our work with clients, we find that problems in four areas often prevent successful supply chain collaboration. Managers must understand them more fully to diminish their impact.

Partner complexity and churn

High-tech OEMs need hundreds of components from a broad range of global suppliers, which themselves lie at the center of even farther-flung supply chains comprising second-tier companies that make subcomponents. Products generally have short life spans. One mobile-phone maker, for instance, typically uses more than 20 components from tier-one suppliers alone for products with a life cycle of only nine months. There’s a very small window to make crucial decisions about a product’s design, price, quality, and features, as well as to choose the right array of suppliers. Since everything must happen quickly, building deeper collaboration and partner loyalty become secondary considerations. What’s more, supply chain partners often change as product designs and specifications evolve, so collaborative efforts often fail to survive from one model to the next.

Silos and forecasts

OEMs in many industries organize themselves around functional units. But in high technology (and other assembly industries), units such as manufacturing, sales and marketing, and product development often send conflicting forecasts of demand and production to their partners. Not surprising, supply chain responses are often based on guesswork, and forward planning is difficult. In one variation of this problem, OEM sales reps provide “lowball” estimates of demand rather than a truer picture, so they can more easily beat internal goals. Alternatively, when components are in short supply, forecasts by manufacturing functions often are overly optimistic in a play to maximize the allocation of scarce products from suppliers.

Poor quality of data

OEM forecasts often aren’t granular enough to be useful to supply chain partners. Typically, OEMs set broad targets across a number of product lines rather than provide details on expected unit sales for specific products. That combined with rapid product obsolescence makes getting a fix on true demand difficult. Furthermore, the IT systems that capture data across supply networks often are incompatible, thereby walling off vital information and making information-based collaboration a struggle. The mobile-phone industry provides a notable example of poor data: OEM forecasts of consumer demand, provided only four months out from delivery dates, often misstate actual demand by 400 percent.

The mistrust spiral

Given the intense and unpredictable nature of competition, high-tech executives often believe that they must guard information on their business plans and processes closely. This perceived need for confidentiality—OEMs reason that since their suppliers provide parts to competing OEMs, shared data isn’t secure—directly affects suppliers. The mistrust extends to ODMs (original design manufacturers) as well, which are also considered risky, since they work with the OEMs’ competitors, and even to retailers that distribute those competitors’ products. If OEMs do provide data, it’s often inaccurate. This lack of transparency makes the OEMs’ projections less than believable to suppliers, which then compensate by scaling production downward. That causes additional problems if demand is unusually strong.

Building bridges across the supply chain

Solving these problems is a two-step undertaking in which companies must first change their internal processes and then reach outside the organization to partners. A single approach usually won’t resolve all supply chain impediments: if an OEM has a number of channels for distributing its products and many upstream or downstream partners, it should try a range of collaboration strategies. In some cases “anticollaboration,” with little sharing of information, may actually be a legitimate approach. For example, Apple partners closely with its upstream suppliers to increase access to top product design talent. But the company is wary when it deals with retailers, because it aims for tight control over all aspects of product launches and fears that information may leak into the market in advance.

Breaking down silos

To improve the information flow to supply chain partners, an OEM’s leaders need to enforce transparency and collaboration within their own functional arenas. As OEMs set internal forecasts for demand and production, they need to have a clear understanding of how conflicting and confusing data affect partners. Incentives must dovetail with the needs of the supply chain rather than simply further internal goals. A leading manufacturer of flash memory tackled these issues by creating a sales and operations planning (S&OP) team that united stakeholders from marketing, supply chain operations, finance, and other areas. In mandatory monthly meetings, the group hammered out a single, company-wide demand forecast and made data available across the supply network, using simple IT systems. The team ended practices such as allowing executives to adjust production plans and forecasts to meet financial and bonus targets. Senior management raised this new effort’s profile by including discussions about S&OP on the agenda of monthly staff meetings. Greater collaboration and transparency improved the accuracy of the company’s demand forecasts by 40 to 60 percent, which in turn led to gains across the supply chain. Over six months, on-time deliveries rose 30 percent and inventory costs fell 20 percent.

Improving trust

More information can be shared with supply chain partners, but that calls for new thinking. Often, operational details (such as point-of-sale information, customer forecasts, the location and size of inventories, and production capacity) are readily available, but lack of trust undermines an open exchange. In one instance, the supply chain partners of a global networking OEM perennially doubted the reliability of its forecasts—doubts that led to production and delivery delays. Seeking improvements, senior executives from the OEM and suppliers established a framework for collaboration. They determined which types of information could be shared and which (for instance, pricing) were too sensitive and thus had to be left outside the agreement. The OEM then created a central data repository using basic spreadsheet technology that gave both suppliers and the OEM’s functions the same access to data. After four months, the suppliers’ confidence in the OEM’s numbers improved, encouraging forward planning and ending bursts of last-minute production. Inventories dropped by 45 percent, and the cycle time from order to shipment by 70 percent.

Sharing assets

OEMs and their partners often operate separate distribution networks with overlapping inventory hubs and logistics systems. Simplifying and consolidating these networks can reduce complexity, shave costs, and strengthen partner relationships. A consumer electronics OEM and a large retailer, for instance, each maintained separate product warehouses and distribution systems, in part because neither had sufficient visibility into the workings of its partner’s operations. Leaders at the two companies agreed to overhaul this setup by giving the OEM full responsibility for managing store inventories. The OEM, which in the past had relied on incomplete and less-than-current information from the retailer, gained direct access to store sales data. In effect, the OEM’s supply chain extended directly to the stores, and the retailer could eliminate its redundant distribution facilities. With better information, the supply chain could adjust more swiftly to variations in consumer demand. The availability of products at retail stores improved by 70 percent, and overall supply chain inventories declined by 20 percent. This type of asset sharing is easier to implement for OEMs and retailers but can also be pushed further up the chain to include OEM suppliers.

Joint product development and risk sharing

Short product cycles make a certain amount of supplier turnover inevitable, but high-tech companies can solidify their relationships by jointly developing products with their partners and by sharing risks. Such product collaboration needs to go beyond what is now standard: outsourcing of designs to ODMs. Instead, when an OEM’s engineers design key components, they should work with key suppliers from the outset. Suppliers and OEMs may even jointly own pieces of intellectual property. This type of arrangement gives OEMs access to skills they may not have in-house and allows them to leverage scarce engineering talent. It can also reduce time to market for new products. Suppliers benefit from assured demand and the chance to develop specialized expertise.

In the tech industry, new-product introductions are frequent and inherently risky. The risks are often borne disproportionately, with certain supply chain partners providing most or all of a heavy investment. Some partners with a lower risk tolerance may be hesitant to spend. Apple, for instance, faced such a situation when it worked on its iPod supply chain in 2005. Apple’s major worry was uncertainty over supplies, since industry demand at the time was strong. Few suppliers were willing to make sizable investments just to meet Apple’s needs. Apple reduced the risks by providing up-front payments to partners such as Micron, Samsung, and Hynix.

While fostering collaboration is in the interest of all supply chain participants, creating the internal and then external conditions for change will take time. Most OEMs will first need to launch discussions on the scope and speed of new collaborative efforts and think carefully about which companies will be their closest partners. At the outset, the most suitable ones are major suppliers, for the economics create natural bonds.

Early successes that set the stage for further progress help senior executives think about the longer term. The partners should understand that even if they begin with an appropriate model, they will need to change it, both to build on success and to counter the moves of competitors. 

About the Authors

Gautam Groveris a consultant in McKinsey’s Chicago office, Eileen Lau is a consultant in the Silicon Valley office, and Vivek Sharma is an associate principal in the Chicago office.

The authors would like to acknowledge the significant contributions of Bob Dvorak and Vats Srivatsan to this article.