The McDonough School of Business POM-13

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Georgetown University (rev. Dec 1998)

Supply Chain Management

Ask an assortment of “experts” to define the term “Supply Chain Management” (SCM),
and you will get a variety of definitions. Some might suggest SCM deals primarily with
the logistics of delivering products from the supplier to the manufacturer to the end-user.
Others define the term more broadly to include design of the product, since “design for
supply chain management” can have a significant impact on, for example, inventory
stocking levels at various points within the chain. Still broader is the view that SCM
encompasses strategic decisions regarding the very design and structure of the firm and
the industry. SCM forces companies to re-look at each firm’s role within the chain,
suggesting that even strategic issues such as what to make versus what to buy, and the
appropriate level of vertical integration within the firm and industry, are ultimately within
the realm of supply chain management.

The common thread in any definition is that supply chain management seeks to integrate
performance measures over multiple firms or processes, rather than taking the perspective
of a single firm or process. For example, at MIT, the field of SCM is defined as follows:2

“Integrated Supply Chain Management (ISCM) is a process-oriented,

integrated approach to procuring, producing, and delivering products and
services to customers. ISCM has a broad scope that includes sub-suppliers,
suppliers, internal operations, trade customers, retail customers, and end users.
ISCM covers the management of material, information, and funds flows.”

As evidenced by the last phrase of the above quote, another common thread in most
definitions of SCM is that the field distinctly recognizes not only the flow of materials
within the supply chain, but also the flow of information (and, not so surprisingly, funds).
In fact, it may be precisely the recent advancements in information technology that allow
the firm (or, the supply chain) to achieve some of the performance improvements that are
being reported in successful applications of SCM. Furthermore, advancements in IT may
be even changing the optimal structure of the supply chain, suggesting it may be
necessary to restructure certain elements of the existing chain in order to best make use
of these new information technologies.

In this brief review, we will take the broad view that we must address the issue of make-
versus-buy in discussing SCM, and will identify several topical areas in the field of SCM.

1
This teaching note was prepared by Glen Schmidt, Assistant Professor.
2
As given in “Demystifying supply chain management,” by Peter J. Metz, Supply Chain Management
Review, Winter, 1998.

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A number of readings are identified within each topical area, and a case study is
identified, should the reader want to deliberate a bit in applying the principles to a
specific situation. This list is certainly not meant to be exhaustive, as it offers only one or
two examples of readings in each topical area. The intent is to simply offer, for the
practitioner, a flavor of the issues addressed by SCM, and hopefully whet the reader’s
appetite for further study and exploration.

We begin by looking broadly, at how changes in the way the supply chain can be
managed have effectively created a new paradigm of “virtual integration,” as an
alternative to vertical integration. We then examine some factors that might help
promote this new paradigm, such as supplier management techniques that align
incentives along the supply chain. Next we examine how supply chain management
helps control the devastating impacts of variability. And finally, we look at some
techniques and guidelines for managing product design, and design of the supply chain
itself.

1. Impact of supply chain management on industry structure.

1.1) “The power of virtual integration: An interview with Dell Computer’s Michael
Dell,” Harvard Business Review, March-April, 1998.

1.2) “Strategic sourcing: To make or not to make,” by Ravi Venkatesan, Harvard

Business Review, Nov-Dec, 1992.

1.3) Case study: “HP’s da Vinci project,” by Glen Schmidt, Hau Lee, and Jin Whang,
Stanford Global Supply Chain Management Forum, Dec. 1997.

As suggested by the first article, a new paradigm being used by Dell is that of virtual
integration, as opposed to the traditional concept of vertical integration that has been the
more common feature of modern (20th century) industry. We can examine some possible
reasons for this apparent shift by reviewing a bit of underlying theory.

The existence of vertically integrated firms is presumed to have come about to reduce
“transaction costs” between otherwise separate parties.3 For example, GM bought Fisher
Body because of its frustration in writing contracts with Fisher that would insure a cost-
competitive supply of car bodies. On the other hand, holding production within the firm
has its own disadvantages, including “agency costs.” Agency costs arise because the
goals of individual employees are not aligned with the goals of the corporation.4 For
example, it has been estimated GM stockholders might realize a gain in value of up to
$7.3 billion if the Delphi parts division were spun off into a fully separate company.5

3
Footnoted references are given to properly recognize material sources, but are not part of the core
reading list. For a development of transactions cost theory, see “The modern corporation: Origins,
evolution, attributes,” by Oliver Williamson, Journal of Economic Literature, Dec. 1981, pp. 1537-68.
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For a development of agency cost theory, see “Theory of the firm,” by Michael C. Jensen and William
H. Meckling, Journal of Financial Economics, Vol. 3, No. 4, 1976, pp. 691-719.
5
See the case study “Unbundling General Motors,” Harvard Business School case 9-897-177, 1997.

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One way of reducing transaction costs, and aligning incentives of firms within the supply
chain, is through improved supplier management techniques. Therefore, we will discuss
supplier management in more detail in the next section of this review. Before moving to
this topic, though, a few words regarding strategic sourcing (discussed in the second
article listed above) are in order.

In deciding whether an activity should be outsourced to another member of the supply

chain, the firm should assess whether the activity is “strategic” to its operation. In other
words, is it essential to perform the activity within the firm in order to sustain its
competitive advantage, or would it be more appropriate to have another member of the
supply chain perform that activity? Some firms, such as Sun Microsystems and Nike,
have been able to achieve their competitive advantage while performing relatively little
manufacturing inside the company.

The case study listed with this section addresses HP’s “make-vs.-buy” decision for its
information system. As alluded to earlier, the relative ease with which information can
be provided throughout the supply chain in today’s environment is driving a number of
SCM initiatives. Thus, this case is pertinent to the topic of SCM from not only the
perspective of make-versus-buy, but also from a number of other perspectives.

2. Aligning incentives along the supply chain.

2.1) “How Chrysler Created an American Keiretsu,” Harvard Business Review, by

Jeffrey H. Dyer, 1996.

2.2) “Collaborative Advantage: The Art of Alliances,” by Rosabeth Moss Kanter,

Harvard Business Review, 1994.

2.3) Case studies: “Supplier management at Sun Microsystems (A): Managing the
supplier relationship,” Stanford Business School case S-OIT-16A, and “Supplier
management at Sun Microsystems (B): Managing risk in the supplier
relationship,” Stanford Business School case S-OIT-16B, both by David Farlow,
Glen Schmidt, Andy Tsay, and Charles Holloway.

The first reading in this section documents changes in Chrysler’s supplier management
principles, contributing to dramatic improvement in financial performance of the
company. Chrysler reduced its total number of suppliers, but effectively increased the
total amount of work its suppliers performed. Partnerships were developed, in which the
suppliers were asked to play an active role in product development and process
improvement. A “supplier cost reduction program” (SCORE) was initiated to motivate a
supplier to participate in cost reduction activities that would benefit the entire supply
chain, without undermining the supplier firm’s own profitability.

The second article referenced above, on collaborative advantage, further delineates how
firms can build alliances within the supply chain in order to create competitive advantage.

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Two case studies offer an opportunity to delve directly into issues of supplier
management at Sun Microsystems. The first (denoted as Case “A” in the list above),
outlines a “scorecard” program that has similarities to the SCORE system used by
Chrysler. The second (Case B) discusses possible types of supply contracts that might
reduce risk within the chain.

3. Controlling the impact of variability through supply chain management.

3.1) “The bullwhip effect in supply chains,” Sloan Management Review, Spring, 1997,
by Lee, Padmanabhan, and Whang.

3.2) Case study: “Barilla SpA (A),” Harvard Business School Case Study 9-694-046.

3.3) “Making Supply Meet Demand in an Uncertain World,” Harvard Business

Review, May-June, 1994, by Marshall L. Fisher, Janice H. Hammond, Walter R.
Obermeyer, and Ananth Raman.

3.4) Case study: “Sport Obermeyer Ltd.,” Harvard Business School Case Study 9-
695-022.

3.5) “Managing supply chain inventory: Pitfalls and opportunities,” Sloan

Management Review, Spring 1992, Hau L. Lee and Corey Billington.

One of the key insights derived within the field of Operations Management (OM) is that
variability can have a devastating effect on the firm. In order to compensate for
variability in demand, for example, the firm may be forced to flood the supply chain with
inventory, or possibly build a plant with excess capacity. Thus, a number of initiatives
within SCM are focused on reducing the variability itself, or, alternately, softening the
impact of such variability.

The first paper referenced in this section describes the bullwhip effect, showing how
variability in retail demand is magnified as one moves upstream in the supply chain. The
Barilla case study provides an opportunity to directly examine a situation in this
phenomenon is observed, and to consider possible means of curtailing its effect. One
such means of reducing the magnification in variability is for the manufacturer to
somehow gain access to the actual retail demand data. The manufacturer may observe it
directly by taking responsibility for managing the inventory (vendor managed inventory,
VMI), or by having the retailer pass this information up the supply chain through
electronic data interchange (EDI). In this sense, then, information serves to lessen the
effect of variability.

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This insight is further illustrated in the “OM triangle,” shown in the figure below.6 The
triangle suggests that if a firm is striving to meet a given level of stochastic customer
demand, then it can use information, capacity, and inventory as substitutes. Better
information leads to lesser need for inventory, or allows the firm to operate with less
capacity. Thus, sharing of information reduces the total supply chain cost.

Inventory

Capacity Information

Variability in demand creates uncertainty: If we are less certain of what the actual
demand will be, we need to hold higher inventory or capacity in order to meet a given
service level, just in case the demand turns out to be high. So what we are really after is a
way to reduce, or deal with, uncertainty. This is the topic of the 3rd paper listed above,
“Making supply meet demand in an uncertain world.” The case study on Obermeyer
takes a look at dealing with uncertainty in the fashion goods industry.

4. Design for supply chain management.

4.1) “Mass Customization at Hewlett-Packard: The Power of Postponement,” Harvard

Business Review, Jan-Feb 1997, pp. 116-121, by Edward Feitzinger and Hau Lee.

4.2) Case study: “Hewlett-Packard: Deskjet printer supply chain (A),” Stanford
University Case Study.

4.3) “Benetton – Global logistics in action,” by Peter Dapiran, Asia Pacific

International Journal of Business Logistics, Vol. 5, No. 3, pp. 7-11.

4.4) “What is the right supply chain for your product?,” by Marshall L. Fisher,
Harvard Business Review, March-April 1997.

One way to reduce uncertainty is to simply become better at forecasting future demand.
We can do this by shortening our time horizon: Our forecast is likely to be more accurate
if we are forecasting demand that will materialize in the near future, as compared to
demand that won’t occur until some time in the distant future. An analogy is that of
weather forecasting: We can generally come pretty close in forecasting tomorrow’s daily
high temperature, but are not as likely to be able to accurately forecast the daily high one
year from today.

This forecasting principle is related to the concept of “postponement,” described in paper

4.1 referenced above. To practice postponement, we have to first pay close attention to

6
The OM triangle is presented in teaching note POM-10 of the McDonough School of Business, and
was earlier described in “Integrated operations: A proposal for operations management teaching and
research,” by William Lovejoy, Production and Operations Management, Summer, 1998.

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product design. We design a variety of products around a basic platform: The platform
can ultimately be customized into a variety of end products, depending upon which
specific components are added to the platform in final assembly. We delay, or postpone,
as far as possible the point at which the basic platform fans out into the wide variety of
products. In other words, we have delayed the final assembly so that it more nearly
coincides with the point of final demand, giving us a short time horizon over which we
have to forecast the demand for individual products. The case of the HP inkjet printer
illustrates this concept, as does the article on Benetton.

The final article in the list relates to the design of the supply chain itself, rather than
design of the product. In fact, it addresses a number of facets discussed in this review,
including approaches to choosing suppliers and product design strategy.

Thus, we see that on the one hand, supply chain management consists of specific tools
and techniques. These deal with forecasting, inventory management, and supplier
evaluation, to list several examples. On the other hand, the way the firm applies these
techniques can have high-level strategic implications, for example, in determining what
the firm chooses to make versus what it chooses to buy. Thus, while supply chain
management offers many opportunities for firms, there are also many risks. SCM offers
the promise of a “win-win” outcome for all members of the supply chain. But only by
applying supply chain management principles in a cohesive fashion, and in concert with
the firm’s overall strategy and direction, can this promise be fulfilled.