City College

Supply Chain Management

and Strategy Formulation
in a Global Environment
Global Logistics & Supply Chain Management
Ivan Chachevski

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 Introduction

Since its introduction in the 1980’s, and with the ongoing business developments,
supply chains and supply chain management have become an increasingly important
factor in any company’s success. The term supply chain management refers to the
management of the movement and storage of information, resources, raw materials,
inventory, finished goods, services, etc… all of which contribute to serving the end
product to the customer (Stadtler, 2015).

Considering the wide range of influence and control that supply chain management
has on the delivery of the final goods to the customers, it is safe to say that this
managerial branch is a strong influential factor on the competitiveness side of the firm.
Using the full potential of the competitiveness that stems from the management of the
supply chain inevitably creates the need for aligning the business strategy with the
supply chain, and in some cases even developing a business strategy that will fit the
proposed supply chain management system.

The literature review of this research is based on the concepts of supply chain
management and strategy formulation with a reference to firms operating in a global
environment. A review of sourcing, manufacturing and distribution, as key concepts in
supply chains is also done, presenting their importance and different type of influence
they exert on supply chains and their management. Product development as a
business function is also review due to the fact that although it may be seen as distant,
this business function has a distinctive influence and connectivity to supply chain
management, strategy and their success.

The theory from the literature review is applicably presented in the case of Lego’s
supply chain reinvention. Struggling with profit losses in a period of somewhat six years
forced the company to re-evaluate their functioning. The most immediate area for
improvement turned out to be the supply chain of the company as it has been
outdated for almost 10 years. Reinventing the supply chain model and strategy, with
drastic changes done on the manufacturing, sourcing, distribution and product
development activities, enabled the firm to put a stop to the profit losses; concentrate
and work on other relevant challenges; and eventually secured Lego’s position as the
world’s best and most profitable toy making company.

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Table of Contents
Introduction .............................................................................................................................................. 1
Literature Review ...................................................................................................................................... 4
Theory Application: LEGO’s supply chain management and strategy reinvention ................................ 10
Conclusion ............................................................................................................................................... 16
References .............................................................................................................................................. 17

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 Literature Review

As, Perez (2013), states, supply chains enable the end-to-end flow of products,
information and money. Considering this, an organization’s competitiveness in areas as
capital requirements, product cost, service perception and speed to market, is strongly
affected by the way the supply chain is managed. For that reason as well as for
ensuring a high level of business performance, a proper alignment of the business
strategy with the supply chain is essential.

Globalization of supply chains encompasses aspects such as off-shoring of production,

difference in economies, cultures, infrastructure, inventories, politics in the competitive
environment etc. (Mollenkopf, Stolze, Tate & Ueltschy, 2010). Globalization as a
concept provides for increased revenue generation through entry in new markets and
besides the trend of companies shifting operations to lower cost geographies to reduce
manufacturing costs, from a supply side globalization undoubtedly provides access to
suppliers providing inputs and materials less costly and more efficiently than domestic
suppliers.

Stadtler (2015), argues that supply chain management has been developed and driven
by factors such as technological change and market globalization, thus being
stimulated and amplified by the growing power of consumers. Integrating collaboration
with trading partners and inter-organizational processes enables the firm to meet
diverse customer demands encompassing the need to be flexible and efficient.
Consequently, Ross (2013), argues that the way that organizations treat their trading
partners is directly affected by the strategy they chose to compete. In certain instances
of pursuing common goals, supply chain member may chose to leverage a combined
focus on that objective and thus further build their competitive advantage,
differentiating their supply chain by creating a shared value adding capability.

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Also arguing on supply chain strategy are, Qi, Zhao, & Sheu et.al (2011), viewing the
supply chain strategy as an extension of operations strategy. The difference presented
is that while operation strategies pursue the competitive priorities by the firm at hand,
supply chain strategy emphasizes the objectives of the firm in dealing with its supply
chain members, focusing on coping with business activities across organizational
boundaries. Creating this supply chain strategy demands a clearly defined environment
with which the company operates, providing for an overall understanding of the actors
and opportunities this network provides.

Similarly, Klibi, Martel & Guitouni (2010), view strategy as a set of choices faced by firms
in order to match the environmental contingencies they face. The authors also define
strategic positioning as based on choices needed to be made due to fundamental
trade-offs, although many firms also tend to build capabilities in groups or in specific
sequences.

Lo & Power (2010), explore the role that products have in the supply chain strategy.
Given their specific characteristics and according to, Fisher (1997), products are
classified in specific groups as: innovative products, unique products and hybrid
products. As such, depending on the different group that the product belongs to a
different supply chain strategy is assigned to it. These classifications of the products, in
literature, are usually classified due to their characteristics such as: product
architecture, customization degree, product life stages, number of parts, etc. In many
instances although classified as different product types the innovative and unique
products can be assigned the same strategy. Nevertheless, although the product type
and characteristics has a strong impact, there are more factors that influence and
determine the type of supply chain strategy.

An interesting view presented by, Lambert & Cooper, et.al (2000), is that many firms
tend to no longer compete as single entities, but as supply chains affecting their global
operations. Simply put, instead of competing as brand versus brand, the ongoing trend
is competition between supplier-brand-store versus supplier-brand-store, or supply chain
versus supply chain.

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As a separate and key function in every company, new product development when
properly combined and coordinated with the supply chain furthermore guarantees the
success of the product presented and the profitability of the business. Pero, Abdelkafi,
Sianesi & Blecker et.al (2010), argue on the need to balance value creation and value
delivery viewed from the side of the purchasing/logistics manager, as the struggle with
capital tied up in inventory and the complexities related to product turnover are
constantly increasing and pose threats to the business at hand.

Similarly, Klibi, Martel & Guitouni (2010), present us with the need for coordination
between SCM and product development as this aids the successful introduction of
products on the market, ensures that product assortment is updated and that obsolete
products are properly phased out. The authors also argue on the fact that product
development not only enables a proper flow of new products, but also assists activities
related to the commercialization of the product and the ramp-up of certain supply
chain activities, such as distribution, sourcing, manufacturing etc.

Additionaly, Hilletofth & Eriksson et.al (2011), imply that besides marketing, sales and
R&D, incorporating the SCM functions of sourcing, manufacturing and distribution will
provide feedback, from a logistics point of view, during certain developmental stages
of the product. Besides this, incorporating supply chain management in the product
development process provides the opportunity to address in parallel the supply chain
design and new product development, lower the time-to-market and increase
profitability. Practicing this enables the SCM to be involved in the product development
from the beginning with the same level of authority, not just as a clean-up function for
new product development.

Contrary, Jüttner, Christopher & Godsell et.al (2010), argue that product development
should be driven by the identified needs and requirements of the customers, not just by
technological improvements. This implies that SCM and supply chain solutions also need
to be developed according to the customer needs and requirements, meaning that
besides gathering information concerning the need for the new product, companies
need to gather information on the customer services needed and develop their supply
chain solutions accordingly.

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Creating time and place utilities, transportation places itself at the core of the supply
chain strategy (Ke, Windle, Han & Britto, 2015). Linking the operational activities
between shippers and consignees across regions associates transportation and
transportation modes not only with logistics costs but also with supply chain efficiency,
financial cash flows, competitive advantage, customer satisfaction and much more.
Therefore, from the aspect of global supply chain management, transportation has
become a strategically important decision.

Concentrating on the global supply chain distribution, Rushton, Croucher & Baker et.al
(2014), present us with the challenges and the aspects of it. Optimizing the distribution
networks for time and cost savings, companies are forced to analyze outside of the
boundaries of their own organizational network. The result form this analysis in time
would certainly increase control, on time delivery, visibility, as well as decrease costs. Liu
& Papageorgiou (2013), state that when designing the global distribution network the
buyer and supplier need to agree and design a distribution program, with their logistics
service provider, which will best suit their preferences and resolve potential issues of
ownership of goods, leveraging transportation rates and destination logistics services.

Manufacturing certainly plays an important role in the supply chain. The purpose of the
manufacturing strategy needs to extend to the creation of strategic advantages
reflecting on trends and market volatility, not being limited only on operational
efficiency (Merschmann & Thonemann, 2011). Order-qualifying and order-winning
criteria enable this, but to meet these criteria the management needs to analyze
specific areas of the manufacturing strategy such as: supply networks, development
and organization, capacity, process technology. Within these areas structural and
infrastructural issues arise. The structural issues are usually connected to the physical
arrangement and configuration, while the infrastructural connect to the activities that
take place in that operation’s structure. Stemming from this is that the ultimate aim of
the management is to match the performance of these resources with the
requirements of the market.

Analyzing on a global level, Roh, Hong & Min, et.al (2014), argue that global supply
chains are faced with greater demand uncertainty, increased competition and

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increased risks. From this the authors point that the success of the manufacturing
activities of a global manufacturing firm are directly connected to the firm’s flexibility
and ability to adapt its supply chain to the continuous changes in customers’ needs
and preferences. This brings out the need for more responsive supply chain
management. Since responsiveness and flexibility are needed, manufacturing firms that
have realized this tend to enrich their customer information sources and build an
information sharing relationship with their partners.

On the other hand, Janvier-James (2012), analyzes the efficiency-based supply chains
which usually presume that customer demand is stable and predictable. This type of
supply chains is applicable and efficient for more or less standardized products with
longer lifecycles, but viewing from the side of customized products with shorter life
cycle such as: toys, fashionable apparel, automobiles, personal computers, etc.
concludes that these supply chains prove more vulnerable to demand shifts than
responsive supply chains. Contrary, Zhu, Sarkis & Lai et.al (2012), analyze the
responsiveness as being the key element of the responsive supply chain. The authors
conclude that the main aims of the responsive supply chain tend to be improving agility
and responsiveness to customer demand; increase flexibility and centralizing the supply
chain planning to respond to changes in customer demand; but in achieving this a
high emphasis needs to be put on removing potential bottleneck and disruption
sources in the supply chain, as well as removing any unnecessary costs and money
outflows that can be avoided in the manufacturing process.

Sourcing as another function of the supply chain also has a great impact on its
management. Golini & Kalchschmidt, et.al (2011), analyze sourcing on a global setting
and one of their conclusions is that companies with global supply chains protect
themselves from sourcing disruptions by having higher inventory and capacity levels.
According to the different inventory management models the average stock depends
on the supply lead-time and its variability, which on the global level having different
geographical distances implies a longer lead-time and variability. This implies that
problems of long lead-times and increased inventory costs will arise in a global supply
chain/sourcing system, which decreases the amount of on time deliveries. Chiang,
Kocabasoglu-Hillmer & Suresh et.al (2012), argue on different supply chain

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management models that are created to reduce inventories, as one example having
the just-in-time model. Nevertheless analyzing these supply chain management models
on an international level it is evident that their performance cannot be matched to
their performance on a domestic level. Implementing these management models on
an international level require different success factors, such as investments in
communication and coordination, building stronger relationships among suppliers and
customers and exploiting all the benefits.

Christopher, Mena, Khan & Yurt (2011), also analyze the difference between domestic
and international sourcing. Lower costs, or lower inputs price, seems to be the
predominant reason companies chose international sourcing. However considering the
lead-times and variability from global supply chains and their significant impact on
service levels and stock outs, the domestic sources seem less risky as an option.

Sourcing strategies are predominantly influenced by the decision maker in the

company. If autonomous merchants of an organization drive the decision making, their
objectives would likely favor safe levels of stock and making sure that stock outs don’t
occur. Conversely if the predominant driver is the enterprise financial performance the
decision would favor lowering the time that the working capital is locked in the supply
chain (Loppacher, Cagliano & Spina, 2011). Ultimately the authors conclude that the
nature of the company is the decider on how the lead time and inventory costs are
calculated and thus what will the impact on the total results be.

Differing from this is the view of, PrasannaVenkatesan & Kumanan (2012), which state
that the sourcing decision making participants should be consisted of a wider range
from different spheres, such as: finance, procurement, logistics, IT, global sourcing, legal,
risk management, etc. providing a broader point of view on the costs that are to be
encountered.

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Theory Application: LEGO’s supply chain
management and strategy reinvention

Analyzing the toy industry and taking in to consideration the three biggest toy
producers in the world, Mattel, Lego and Hasbro, it is safe to say that Lego is way
ahead from its competitors in many aspects making it the world’s leading and most
successful toy maker in recent times. Lego’s success is attributed generally to the
attraction of millennia parents to the toys being geared towards child development
and levered to entertainment, as well as the company’s success in digital
entertainment with its video games and recent movie. This combined success of the
spheres of functioning brought earnings for Lego greater than the earnings of the two
competitors combined, as presented in Figure 1 (Businessinsider.com, 2015).
Furthermore, in the first half of 2015, Lego’s sales and market share have increased by
23%, or $2.1bn, while Mattel’s sales have dropped by 5% and Hasbro’s have increased
only by 0.2%, or $1.9bn and $1.5bn respectively. Operating profits of Lego have
increased as well by 27%, or $700m, compared to Mattel’s loss of $54m and Hasbro’s
profit of $130m (Financial Times, 2015). All of these success points and the company’s
continuous improvements and innovation have secured Lego’s place as the world’s
biggest toymaker.

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Figure 1

Source: Businessinsider.com, 2015

However, a decade ago, things were not going so well for the company. Although
maintaining a firm grip on the market, generating $1bn in sales in 2004 and maintaining
relevance with the growth and development of the digital age, from 1998 to 2004 the
toy making company was facing losses with peak drops in sales of 30% in 2003 and
further 10% in 2004 plummeting the profit margins at -30% (Oliver, Samakh & Heckmann,
2007). Besides the different hypothesis and speculations about what impaired the
company’s success, such as the popularity of video games and low cost production in
China, many other influential forces from inside the company, such as innovation
capabilities and the supply chain, were the source of the company’s downturn. Having
poor customer service and poor product availability, as well as being almost 10 years
out of date, the company officials reasoned that the supply chain was the best and
most immediate opportunity for improvement considering that a speedy attention to it
would set in motion other improvements and allow them to deal with other challenges.

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As, Oliver, Samakh & Heckmann et.al (2007), argue, the malfunctioning and problems in
the supply chain can be very deceptive and hard to spot. One of the many reasons
that the Lego Group underperformed for years and couldn’t trace the problem to the
supply chain was that those problems arose from the core strengths and advantages of
the company. Commitment to quality and the capacity for innovation were the
strengths that the executives relied on to put a stop to the profitless functioning,
reasoning that the company would innovate itself out of the problem. As such in the
period between 1998 and 2004 the Lego Group moved in to retail stores, video games
and TV series, yet profits continued to decrease and the only thing that was added was
complexity in operations.

With 2004 becoming another year with profit losses and downturn, the company
realized that it had to take drastic measures in order to survive. One of the most radical
decisions was the move of the CEO position from Kristiansen, grandson and family
member of the founder of the company, to Knudstorp, a management consultant that
joined the company as a director of strategic development.

Analyzing every aspect of the company, Knudstorp with his team concentrated on the
supply chain in great detail. The resolution was a move not practiced before. Knudstorp
created a working body made up of senior executives and management
representatives from every relevant department such as: logistics, manufacturing, IT
and sales. The core purpose of this work group was to: analyze the supply chain from
each aspect as product development, manufacturing, sourcing and distribution;
consult on the problems; and work out proper solutions.

Manufacturing

Lego operated on of the world’s biggest injection-molding facilities, with over

800 machines only in its Danish facilities, and yet the production teams operated as
separate entities. Orders were placed irregularly and randomly, changes to those
orders were made frequently, daily operations were chaotic and changeovers were
costly. The fact that the production facilities were placed in high cost countries as

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Denmark, Switzerland and US created further disadvantages. This way of operating led
to an overall capacity use of only 70%, as well as inability to create a sufficient picture
of inventory levels, demand needs and supply capabilities.

Distribution

Managing its distribution centers was weakly performed, as the company paid
the same amount of attention to the thousands of small stores, which generated one
third of its revenue, as it did to the 200 larger chains that contributed to the other two
thirds of the revenue. In order to serve these small shops the company created a
multiple-tier inventory system with local centers, which made it difficult for a proper
product positioning, resulting in high inventory levels and missed sales. Another aspect
of weak management was that Lego permitted its small customers to make less-than-a-
full carton orders, a practice that turned out very labor-intensive and costly.

Product Development

Given Lego’s success over the years due to its innovation, the company took
pride in its innovative ways of product development. However taking a closer look at
the products and the sales it was concluded that each new product, or generation of
products, generated less and less profits while adding more complexities. The reason for
this was primarily due to the over-diversification of the products. The plastic bricks and
elements that were once available only in primary colors now were produced in over
100 different colors. The Lego sets and kits now were becoming much more elaborate,
as each set included 10 different characters each having 10 different leg sets, much
different from the ones available to the previous generations. Such attention to detail
represented the company’s culture of craftsmanship, but it had put aside the costs of
innovation and production leaving them to constantly rise and create further cost
pressures. Furthermore, introducing new products constantly made it difficult for the
company to align it supply chain with its business strategy. As such, 30% of the yearly
products generated 80% of the profits, while the rest of them were partly sold and a

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greater part ended up in inventory as stock-keeping units that increased the backlog
constantly.

Sourcing

A major problem in the companies sourcing sector was the lack of procurement
compliance procedures. Engineers usually had their own favorite suppliers and as
product developers sought new materials the number of vendors increased, ultimately
accumulating to more than 10,000 suppliers. These sourcing practices created great
problems and even greater amounts of waste. Each engineer took the liberty of
ordering unique material that came in special colors. These materials came in standard
orders of few tons while the engineers needed and used few hundred kilos, leaving the
company with excessive amount of materials not used and a great amount of sunk
costs. This type of functioning left the company’s procurement staff powerless in
dealing with suppliers.

Solutions

The first and obvious decision was cutting the number of elements and colors in
the production process. The vast number of machines was then assigned specific molds
for production and regular weekly production cycles. No longer could any machine be
chosen randomly to produce a specific element at any moment. Sales and operations
were obliged to set orders at regular monthly meetings, reducing the constant
changeovers. The leadership also created decision protocols by which it was obliged
that each department down the production line had to be notified of any manual
changes in, for instance machinery set up, ensuring that the impact on other
departments is considered and potential production glitches will not occur. The
manufacturing footprint was also considered as it was decided to halt any further
outsourcing to Chinese markets and move production lines to the Czech Republic. This
was reasoned by the leadership that it will boost efficiency as a plant in Eastern Europe
will get the products to stores in Europe in two or three days, considering that 60% of

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sales are in Europe and 40% are during the Christmas periods (Oliver, Samakh &
Heckmann, 2007). Furthermore, a purchasing officer and a team of analysts were
assigned to evaluate this process, building a cost model that enables the company to
evaluate its option better.

Regarding distribution the Lego also took active measures. Doing what competitors did
long ago, the company cut its logistics providers from 26 to four. This step cut 10% in
transportation costs while still ensuring resilience and gaining greater economies of
scale. An interesting next step in the reconstruction of it distribution system was Lego’s
decision to cut out five distribution centers in Denmark, France and Germany and
move to a single distribution center in the Czech Republic operated by DHL. Although
concentrating your distribution and products in one place might seem as a poor
choice, it turned out that this made it easier for the company to track and manage
inventory and made stock shortages less likely, as well as bringing the company closer
to the larger population centers in Europe, decreasing the distance to market
significantly.

The marketing department and marketing team also took an active approach towards
reconstructing the supply chain. Working closer with the big-box and chain stores that
made up the majority of the companies market, providing them with support, enabled
Lego to make effective joint forecasts, product customization and inventory
management. Lego also made some changes in dealing with smaller sellers, creating
standardized and more regular terms. The company provided discount for early orders
and most importantly it refused to ship less than full cartons, minimizing the costs
significantly. Another step that Lego’s marketers made is allowing the bigger retailers
(customers) take part in its product development, thus making customers happier, but
more importantly allowing the company a better insight in to buyer’s behavior.

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 Conclusion

As time passes by supply chains and their management become an increasingly

important aspect in every business. Manufacturing, distribution, sourcing and in a great
part product development are aspects of the supply chain that bring about its overall
performance and in fact determine the success of the supply chain, its managerial
branch and inevitably the company as a whole.

Lego’s supply chain transformation undoubtedly brought improvements to its financial

position. As presented (Oliver, Samakh & Heckmann, 2007) the company saved $50m
since its supply chain transformation in 2004, and further estimated savings of $150m in
the next two years. This transformation and gains in efficiency enabled the company to
make a 12% increase in inventory turnover and realize its first profits of $61m in 2005,
besides the rising oil and transportation prices of that period. This trend continued in the
next years as Lego’s turnover increased for 11% and its profits were up by 240% (Neate,
2014).

As presented in this research, rationalizing, improving and transforming the supply chain
and its activities ensures its consistency and up-to-date functioning while creating
space and enabling further improvements in the company, thus ensuring the success of
the business. The simple reason behind all of this is that managing to get the right
product, at the right cost, at the right place and in the right time is an important step in
overcoming a number of strategic challenges.

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