Latest trend in high-tech Supply Chain

It is really exciting to learn that US market is already showing an upward trend in demand. However an extremely conservative supply chain design by managers running the show is not allowing the complete benefits to be realized. 

Here is an interesting article in Wall Stree Journal where Phred Dvorak documents how Best Buy is unable to support the entire demand because of inadequate supply by the equipment manufacturers.

http://online.wsj.com/article/SB124260855682928885.html 

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Vendor Managed Inventory: How long do we need this?

Vendor Managed Inventory (VMI) or Supplier Managed Inventory is one of the several business models that have been made popular by Walmart since it asked P&G to provide this service at it's distribution centers all across US. Just to make sure we are in the same page, here is a definition of VMI* (It is a family of business models in which the buyer of a product provides certain information to a supplier of that product and the supplier takes full responsibility for maintaining an agreed inventory of the material, usually at the buyer's consumption location (usually a warehouse or a DC). It is often described as a symbiotic relationship where both vendor/supplier (Procter & Gamble) and the buyer (Walmart) have something to gain from it. From a buyer (Often a retailer, but can be a Contract manufacturer) perspective, the values are rather obvious. It relinquishes the responsibility of managing the inventory at DC, cutting PO and worrying about the entire process of making sure that the desired items are available for sales or consumption. Does this come free to it! Often times it has to commit to sharing all the market insights (Forecast collaboration) of the demand to it's vendor. Of course it looses any direct control over the inventory to it's suppliers. 

Supplier in turn gets to plan the inventory based on perfect visibility to actual demand and it's own production capacity. The big "value" comes from the fact that supplier having visibility to both demand (through forecast collaboration) and supply (of it's own manufacturing capacity) can do a better job of planning the inventory than the Retailer itself. Hence the supplier having better access to all the relevant information both at demand and supply side, can manage the process optimally with lesser inventory compared to the retailer. Hence the "value" boils down to the supply chain visibility (i.e. information) that allows optimal decision making and consequently a more efficient supply chain. Now if all those desired information (i.e. visibility) is made available to the Retailer, can it get the job done with equal efficiency? I am always intrigued by this last question and would like to explore it a little bit here.

In the present environment it is rather foolish to assume that "All" the relevant information of the vendor will be available to the retailer. The existing relationship between trading partners does not allow this kind of collaboration. This is because the retailer than can use the information to its own advantage at the expense of the vendor. Since the vendors are already aware of this possibility they are unlikely to provide all the details necessary for the retailer to make the best possible decision. Both parties in fact are aware of this reality and hence we have VMI. 

Does a firm like Toyota having an excellent reputation for developing trust based relationships, need this sort of model? May be not! When businesses worldwide would improve their processes to the extent that VMI would be considered redundant, than it would be safe to assume that we have reached the pinnacle of collaboration in our extended supply chain. Until than VMI is going to stay with us.

* Note: Click here for the Wikipedia site for VMI. 

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Risk Modeling: Can we blame Analytics for the current status of economy?

Scenario analysis in business involves investigating multiple alternative events and their impact on the final outcome. For example if I am trying to predict the revenue of Motorola in US based on growth in demand for a certain high-end model, than I need to look at alternative growth figures to create several possible scenarios and predict revenues for each of those scenarios. Hence if the likelihood of revenue growth is 8% this quarter based on a 15% growth in the new model, than I must look at all other possible growth figures in addition to the 15% number.This will provide alternate figures of revenue growth. Such analysis is quite common in the industry and decision makers often look at these alternatives and plan accordingly. 

Banks and other financial institutions whose business are dependent on prices in the "real estate" market must have looked at multiple scenarios of price change. Now the question is how do we determine these alternative growth numbers? Historically the housing market has experienced steady growth (in prices) due to persistent government policy of encouraging higher house ownership tom-toming it as a sign of prosperity. If the growth number is always positive and varies for example between say 1% to 15% on average, than an analyst is going to use only these numbers in the stress test. Consequently he/she will most likely miss out the -25% drop in average price that we have experienced in the last year. 

Now any decision based on the lowest growth of 1% is unlikely to cover the risks associated with a 25% drop in price. Is this how our sophisticated analysis failed to prepare the banks adequately for the present slump in real estate price and account for the risks associated with it? I am neither an expert in this process nor aware of the exact data that are used to perform the risk analysis. However inability to visualize an event which has never occurred is really a difficult situation. It is a challenge for the analytics community to look beyond historical data in a significant way, and apply those scenarios into the decision making process. 

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Inventory Collaboration: Why Commercial Airlines are struggling to make it happen?

Commercial airlines in US are holding some of the most expensive MRO items in their balance sheet. From high-speed turbines to impellers, high-speed bearings, landing gears and other mechanical devices, the total inventory by some estimate was more than $250b in US alone in year 2000. Since there are very few OEM's who manufacturer these aircraft components, the inventories are mostly the same items. For example engines are mostly built by GE, Pratt-Whitney, Rolce-Royce or sometimes Bombardier. Moreover these spares are often located in same cities like Chicago, New York etc. which happens to be the hubs of the major airlines. One of the most obvious approach to reduce the inventory of these common parts in co-located hubs is to collaborate and pool these items. The benefits of reduced working capital and higher service level is rather obvious. The question is why it is not happening! Several attempts in the past, particularly in Europe to pool the inventory even among airlines-alliance partners did not materialize! If the investment in working capital is so huge and benefits are a no-brainer, than why airlines are struggling to make this happen?

This problem has been studied extensively in the past, both by academics and by practitioners. One of the most common causes was the poor relationship between the competing airlines due to fierce competition among the large players such as American and United in Chicago or United and Delta in Denver. Consequently they are reluctant to share their operational data, particularly in the absence of any third party MRO service provider which can potentially stock and distribute these items from a central warehouse. 

Here I want to bring two other operational issues which I think are very important and must be addressed in order for the collaboration to see the day-light. I would illustrate my point here using a very simple example. 

Let us consider we have only 3 airlines United, American and Delta operating in Chicago's O'hare and they are planning to collaborate on a Honeywell made 'landing gear'. Suppose the existing number of spares for the 3 airlines are 100, 60 and 40 respectively. When these 3 parties approached a consultant, he studied the demand variability and came up with a pooled inventory of 150 (Present inventory is 100+60+40 = 200) at a single warehouse to support the combined demand while ensuring the minimum prescribed service level. Now the question is how do we allocate this 150 among the 3 players. The simplest approach is to go for a proportional allocation. The existing numbers are in the ratio of 100:60:40 (i.e. 5:3:2); hence the new numbers can also be split in the same ratio. Hence each airlines would now pay for 75, 45 and 30 units respectively. However this does not make any sense! The smallest airlines (in this case the one with 40 units originally) is going to have 150  units potentiall available for use, a significantly large number to boost it's service level really high. However for the largest airlines, the benefits in service level (when inventory jumps from 100 earlier to 150 now) is not that high. Hence this allocation mechanism does not make sense and provides very little incentive for the largest incumbent to participate.   

Another challenge would arise when the inventory for some reason drops to say only 1 unit and right at that time 2 different airlines have the demand for that item. Now how to determine who should get the access to this last unit!

I strongly believe that unless these seemingly simple but fundamental challenges in designing a fair and equitable allocation are addressed, inventory collaboration would be rather difficult. I would propose a possible solution to this issue in my next posting. 

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Leverage and it's Role in the downfall of Economy

Leverage is a very simple concept which is used by most business and individuals. Before looking at some of the applications, I would like to bring the core concept here. 

Suppose I buy a house by paying $5K upfront as equity and get the rest $95K as loan from the bank. This is where I am using leverage to own a property by paying a minimal down payment myself and getting the rest as a debt. If I can sell the house at $105K after a year, than I will make a profit of $5K. After returning the loan of $95K to the bank, I will make a profit of $5K on my $5K investment, that is a 100% margin! However if the price drops to $95K in a year, than I loose my entire equity after paying the debt of $95K. If the market drops to less than $95K, than I can not pay back my debt and can potentially become bankrupt. This is how real estate and many other businesses use leverage; sometimes it can be highly profitable, but it comes with its own set of risks. 

Most investment banks and hedge funds have generated more than normal profits in last several years by using leverage as high as 1:30 or even more. They were banking heavily on real estate market which was growing continuously for years. Hence even when an owner defaults because of some personal challenges, the bank would occupy the house and sell it back at a higher price. However in last 1 year, the price has crashed by more than 20% (average) and hence banks were unable to salvage anything out of these non-performing assets. Since house owners often started with very little equity in the house (some times less than 1% now), banks had to bear all the losses. And this is when the real estate market brought the financial sectors down. 

For a more technical discussion on leverage, please click here!

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Innovation at Nano: Tata's dream car

Not many companies in India are known for innovation in product design. Management of entire product life cycle from concept to design, development, launch through end-of-life is mostly a new challenge for a majority of corporations. However Tata's through Nano have turn the tide in Automobile, considered to be one of the most matured industry segments in the world. Here is an excellent article in BusinessWeek on how Tata is bringing some of the most innovative practices into design, development and supply chain of Nano.

Click here for the article!  

Another interesting podcast on their supply chain "Behind the Scenes: The Tata Motors Story" can be found here. The article is the 2nd one from the top. 

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Price of Popcorn in Movie Theater

We often wonder why the price of popcorn is so high in a movie theater specifically where we are not allowed to bring our own food or drink. Here is an very interesting book by Professor Richard B. McKenzie titled: 

Why Popcorn Costs So Much at the Movies: And Other Pricing Puzzles

The book discusses about popcorn price and many other such challenges in Pricing and revenue management. Click here to listen to a small podcast where the author provided a sneak peak of the title. 

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Deflation, is it good?

Inflation is a term widely used to describe rise in prices of a specific set of goods and services. It is measured using CPI (Consumer Price Index) which estimates the price of a basket of items on a specific date. A fall in CPI over a given period is called "Deflation" and an unchanged CPI is called Stagflation. Fast growing developing economies like India, China and others experience high inflation continuously for decades. Hence one of the major parameters which is monitored religiously by their Central banks is Inflation which is meticulously monitored and kept under control. This is specifically true in democracies where a price rise can create popular pressure on government to intervene immediately. During the present economic slow-down when consumers are rapidly loosing their purchasing power, it seems quite logical to have deflation (negative inflation), because producers would invariably try to lower the prices in order to maintain the revenue coming at the expense of lower margin. So is this good for the economy? More importantly will it help to reverse the downward shift we are experiencing right now?

Certainly not! Even though at a micro level such price reduction can help both the buyer and seller, at a macro level it is extremely harmful for the overall economy. A deflation creates an expectation of fall in price in the future and encourages consumers to push their buying decision. For example, suppose I am planning to buy a car. I came to know that the prices of car is going to fall and read an article in WSJ in support of that. I will obviously postpone my procurement decision expecting to get a better deal in future. Most other consumers in my circumstance would also follow the suite and this will impact the car manufacturer's present sales. In general if prices of goods and services are predicted to move southwards than most consumers would postpone their buying and this can slow down the economy rapidly. This is exactly what happened to Japanese economy in early 90's and it took several years for them to get out of it. Economists generally prefer a moderate inflation and accordingly tweak the money supply to the economy.

Click here for detail discussions on Deflation and Consumer Price Index.

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Is archaic Law and Order system pulling India behind?

Despite India's meteoric growth in last couple of decades, there is very little evidence to believe that the country has successfully eradicated the fundamental challenges such as illiteracy, hunger, poor health care and inadequate infrastructure to least a few. Government and political parties often describe the issues in their partisan way, claiming some exaggerated figures of success and blaming lack of resources to achieve anything better. Experts have always challenged this assertion and blamed the administration for high-level of corruption and inadequate accountability as some of the key reasons for failure. I would add here that a very poor legal infrastructure is a key factor contributing to this mess.  

Over the last two decades, liberalization coupled with a focus on reducing license raj has helped the country to grow at a faster pace allowing the economy to break away from the historical Gandhi rate of growth. Consequently the government has collected more tax income which translated to new projects in education, health care and infrastructure which were considered priorities. Even though visible progress has been made in most of these areas, the country is far behind other developing and BRIC nations. One thing which however has barely made any progress and that is our Legal system. Millions of cases both in civil and criminal courts pending over more than 10 years have created a huge logjam and ensured that "going to court" to address an issue is practically not an option for majority of common people.  This lack of faith in the system has forced citizens to take the law to their own hands and this has resulted in unavoidable anarchy all across the country.  

Recently Tata had to move the production of it's small car Nano from West Bengal because of months of violent protest. Administration at state and central level allowed the opposition to take it's own course without any interventions. Courts were never involved, because neither the protesters nor the government believed that there is any value in bringing this up to the constitution. I was really astonished by the prolong drag of negotiations followed by violence which ultimately forces Tata to exit. 

At any day, newspapers in India would have stories about mass protests and in many cases even  violent opposition to some kind of projects. It can be a new manufacturing plant in Orissa or modernizations of airports or any other large projects. In a smaller scale also petty crimes such as forcible collection of rent, extraction of money from non-paying credit card holders and many other instances of people assuming the power of a police are quite commonplace. 

I think it is high time, government takes immediate actions to modernize the archaic justice system and get rid of all the pending cases. This would allow citizens to use court as a medium to address their grievances and discourage them from indulging into violence. At the same time, criminals or other law-breakers will also have enough disincentives to indulge in illegal activities.

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Strategy: Revenue growth or Proftability (or both!)

Price is an excellent lever which allows firms to manage their revenue and profitability simultaneously and hence is extremely crucial to a firm's long term strategy. The million dollar question is where do want to set it; to maximize revenue, to maximize profitability or some combination of both. The importance gets further magnified during economic slowdown when firms experience pressure from customers to reduce the price in order to sustain a level of revenue growth.

An increase in price (or during the downturn a reluctance to reduce the price) in general will ensure profitability (Gross margin) and may come at the expense of potential loss of revenue. Many firms commit to a certain level of average profitability as part of their corporate goal and indicate the target in their annual report. Equity analysts religiously follow these numbers and a loss in margin impacts the stock price. Managers at the behest of owners (stock-holders) stick to the margin target by systematically getting rid of low margin business (products, customers, geography, channels etc. ). However such initiatives adversely impact potential growth in revenue. Alternatively a reduction in price usually brings more business (read Revenue growth) to the firm, but with a erosion in margin. The third approach is a combination strategy which can be an optimal price for a certain minimum margin or minimum revenue growth.

Now the question is what should a firm do? An obvious response is it depends on it's individual objective and long term strategy? Yes, this is the best answer. Here I want to discuss only about those firms who in their long term strategy highlight a desire to compete with relatively larger players in the market. Analog Devices is a semiconductor device manufacturer which wants to grow and at some point compete with larger players like Texas Instrument; however one of their corporate objectives is make sure that they operate at a gross margin of at least 65%. Hence they religiously monitor their profitability at the device (product) level and try to get out of low margin business. Consequently they often loose their market-size and never able to scale up and become large enough. This is an example of incompatibility between long term strategy and short term objectives. The short term objectives of the firm even if it is entirely successful will not be able to lead it towards the long term goal. Several IT outsourcing firms in India are also making the same mistake now; focusing rigidly on their margin target in spite of having the long-term vision to compete with IBM or Accenture which are at least 5 times bigger than them. The present downturn in economy brings an opportunity for them to aggressively promote their low-cost model in front of clients and steal business away from their Big-5 competitors. However the scare of drop in profitability and too much focus on quarterly results (read myopic view) are not allowing them to pursue their long term strategy.


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