Wharton Impact

The efficient flow of materials and finished goods is essential to the success of a manufacturer and its suppliers. Now, with the increasing use of manufacturing strategies such as just-in-time production and quick response, an effective supply chain provides even greater opportunities to increase profits.

Wharton researchers provide insight into the design of a supply chain, from the delivery of parts and materials to the manufacturer, to the distribution of the finished product to retailers.

DEDICATED ASSETS: THE MANUFACTURING EDGE

U.S. automakers are gaining ground on their Japanese rivals by imitating some of their effective production strategies. Much of the success of these Japanese automakers stems from their close relationships with their suppliers. Toyota, Nissan, and others, working closely with lean production networks of parts suppliers, can produce high-quality models quickly and inexpensively.

Jeffrey Dyer, assistant professor of management, compared the production networks of Nissan and Toyota and 96 of their first-tier suppliers, with General Motors, Chrysler, and Ford and 125 of their direct suppliers. He determined the exact impact of customized assets such as plant proximity and dedicated capital on lowering costs, increasing quality, and boosting profits, and described what changes U.S. manufacturers should implement to compete.

Plant proximity. Plant proximity facilitates just-in-time deliveries. As the distance between suppliers’ and automakers’ plants decreases, automakers’ inventory costs drop as well. Toyota’s and its suppliers’ inventories as a percentage of sales are almost a fourth of those of GM, Ford, Chrysler and their suppliers, showing that far less of its capital is tied up in inventory.

Human assets. Japanese auto manufacturers place a high value on face-to-face communications with their suppliers to hold down the frequency of defects. Toyota requires that its suppliers have engineers assigned to the automaker’s plants to better coordinate activities. Direct interaction is also a more efficient way to communicate complex information during the development of new vehicles.

Dedicated capital. Japanese suppliers in Dyer’s study reported that 22 percent of their physical assets were so focused on their primary customer that they couldn’t be redeployed if the automaker walked away. In contrast, U.S. suppliers said only 15 percent of their investments couldn’t be redeployed. Since the activities of the Japanese automakers’ suppliers are so focused on fewer manufacturers, there is improved product integrity and, therefore, higher overall product quality.

Dyer says that the U.S. automakers’ way of choosing suppliers — through competitive bidding — is simply obsolete. A tightly integrated production network, dedicating supplier assets to the customer, will virtually always outperform a loosely coupled production network. He also concludes that managers, in conjunction with other key players in the production network, must strategically locate activities through joint planning for facilities or simply by co-locating key personnel.

Jeffrey Dyer, “Dedicated Assets: Japan’s Manufacturing Edge,” Harvard Business Review, November 1994.

COORDINATION CAN LEAD TO INCREASED PROFITS

Most consumer products flow through a pipeline that begins with plant production and ends with transportation to the retail outlet, perhaps passing through a distribution center on the way. Usually companies manage these two functions independently, with little coordination between production scheduling and product delivery. However, the cost of carrying inventory and the trend toward just-in-time operations are pressuring companies to explore closer coordination along the manufacturing/distribution channel.

Marshall Fisher, professor of operations and information management at Wharton, and Pankaj Chandra, professor of management at McGill University, created two models. One model solves production scheduling and vehicle routing problems separately, and the other model coordinates the two. The models were applied to 132 different scenarios, taking into account such variables as the length of the planning horizon, the number of products and retail outlets, and the cost of inventory holding and vehicle travel.

The researchers found that the value of coordination can be extremely high — anywhere from a 3 percent to a 20 percent decrease in operating costs. The value increased as the length of the planning horizon and the number of products and customers increased.

Pankaj Chandra and Marshall Fisher, “Coordination of Production and Distribution Planning,” European Journal of Operational Research, forthcoming.

BENCHMARKING AFTER-SALES SERVICES

Technological advancements and intensified competition in many industries have forced product prices to drop rapidly while improving product performance. Customer expectations for product reliability have increased as well. As a result, the need to provide superior after-sales service, at a competitive price, has become a vital factor for firms’ competitive survival.

Morris Cohen, chairperson of Wharton’s operations and information management department and co-director of the Fishman-Davidson Center, Yu-Sheng Zheng, associate professor of operations and information management, and Vipul Agrawal of New York University interviewed managers from Hewlett-Packard, IBM, Unisys, and 11 other companies to determine how they coordinate their service parts distribution networks and product maintenance and repairs.

The researchers found that service revenues were 30 percent of product sales, and the cost of providing after-sales service was 39 percent of service revenues. Thus, providing effective service after the sale is vital for strategic performance. The authors recommend certain leading edge practices that can significantly improve a company’s service system. They include:

Service quality measures. To measure service, most companies measure the number of requests for parts filled immediately from existing inventory. But this doesn’t fully capture customer satisfaction, as it can include repairs that aren’t completed because of the lack of needed parts. Instead, companies should be focusing on job completion, or the number of customers’ orders that are completely filled. The difference can be substantial.

Accurate Response Time Measure. Companies must also develop an accurate measure of response time. Many firms just keep track of the length of time between the customer’s call for service and the shipping out of parts. Instead, companies should include the total time it takes for parts to actually get to their customers. The distance between the parts supplier and the customer, as well as the mode of transportation used, have a great impact on response time.

Consolidating the network. Reducing the number of levels and the number of locations at each level will streamline the service parts system. A large number of echelons and locations tends to increase costs and to introduce more inventory into the system. A maximum of three echelons is appropriate in most cases.

Stocking the right parts at the right locations. Parts with a higher cost and a lower demand rate should be stocked at central, higher echelon locations. Companies may be able to reduce their inventory investment by carefully redesigning stocking policies.

Morris Cohen, Yu-Sheng Zheng, and Vipul Agrawal, “Service Parts Logistics Benchmark Study,” May 1994.

SUPPLY MANAGEMENT FOR THE GLOBAL CORPORATION

Global corporations face a daunting challenge in developing an effective supply chain. Managers must consider both structural decisions (such as plant location and technology implementation) and coordination issues as well as tariffs, quotas, and tax differentials between countries when organizing their product flow.

Global companies must also deal with uncertainties, such as exchange rates volatility, when creating their supply chains. Managers need to consider in their global perspective that transactions involving their companies are occurring in different countries and different markets. Where their products are sold or where they acquire products is determined by the local currencies in those countries.

Morris Cohen, chairperson of Wharton’s operations and information management department and co-director of the Fishman-Davidson Center, and Arnd Huchzermeier of the University of Chicago Graduate School of Business, have developed a model analyzing alternative supply chain strategies that takes into account the adjustment of the solution mix based on differing exchange rates. The model allows for contingencies. For example, as market and exchange rate uncertainties arise, the global company can shift sources and production to take advantage of the changing local currencies. A low-valued peso would allow a company with plants in Mexico and the United States to save money, for example, by shifting more of its production to Mexico.

The researchers’ work can help managers develop an optimal supply system. If a company can invest in capacities and capabilities in different areas of the world, and is able to intelligently shift its activities based on fluctuations in exchange rates, the researchers’ model can increase expected returns and reduce risk in the long run.

Arnd Huchzermeier and Morris Cohen, “Valuing Operational Flexibility Under Exchange Rate Risk,” Operations Research, forthcoming.

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