Supply chain issues can derail profitability and customer satisfaction. Oftentimes, a company will focus their efforts and interactions with suppliers on cost reduction. While cost is important, it is only one of several major aspects of a successful supply chain that fully satisfies customers and the corporation, including:
- Good quality
- On-time delivery: right quantity at committed time
- Reasonable cost
Supply Chain: The Key to Success
Efficiencies and effectiveness within the supply chain can drive an entire company’s overall success. An example of the often-overlooked importance of the supply chain is described in Milton Friedman’s talk: “The Power of the Market – The Pencil.”
He explains that customer satisfaction is directly tied to end-product quality and delivery as well as price. On-time delivery, with the right quantity delivered in accordance with commitment, are key outcomes of supply chains. But these outcomes are sometimes perceived as being in conflict with each other. An alternate approach, however, is to see these outcomes as aligned; they can be co-optimized.
The win/lose paradigm assumes that corporations are pitted against their suppliers – often in the context of cost. Suppliers are asked to reduce the prices of their components – directly affecting their own financial results – so that the corporation can reduce total costs and achieve business success. In other words, suppliers lose while the corporation wins.
However, profitability for the corporation is a function of more than component costs – treated as variable unit costs. In fact, variable unit costs often have much less influence on gross margin than yield and fixed costs. This is particularly true at lower levels of unit volume – as experienced early in the life cycle of the final product, before the product catches on in the market and volumes hopefully surge. The impact on fixed, variable and total unit costs are shown in Figure 1.
In the left chart, fixed cost/unit declines at higher volume. But in the middle chart, variable cost/unit remains fairly constant as volume increases. The chart on the right combines these into total unit costs. At high unit volume, variable unit cost may dominate, but at lower unit volume (and early in transfer into production), fixed cost/unit dominates. The financial summary can be expressed as:
Gross margin per unit sold = price – variable unit cost/yield – shipping cost/unit – fixed costs/volume
Supply Chain as a Network
Think of the entire supply chain as a dynamic, probabilistic system. From this perspective, it does not matter which aspects are internal/within the corporation and which aspects are external suppliers. The whole supply chain system has one goal: Satisfy the final customers.
From that perspective, what matters is having the supply chain network system functioning smoothly, like a well-oiled machine, and understanding that the supply chain is only as strong as its weakest link.
The overall goal of the whole supply chain, to satisfy the final customers, can be flowed down to expectations for cost, quality and yield, cycle time, delivery, and throughput.
The Win/Win Paradigm: Suppliers and Customers as Partners
Optimizing the supply chain as a system involves co-optimizing cost, quality and yield, cycle time, delivery, and throughput for the supply chain. If, as described, cost is primarily a function of yield and volume or throughput, then the corporation and its suppliers have mutual interests in optimizing yield and volume. Optimizing the supplier’s quality and yield also helps the supplier win business with all of its customers. Similarly, optimizing the supplier’s cycle time and percentage of on-time delivery helps the supplier win business with all of its customers.
Optimizing delivery, or rather the probability of on-time delivery, can also involve a cost trade-off in terms of inventory. There are two costs associated with the delivery:
- Inventory trade-off: the cost of holding excessive inventory at some locations in the supply chain
- Holding insufficient inventory, leading to the risk of missed delivery to the final customer
The combination of these two costs is summarized in Figure 2. Choosing an inventory strategy to optimize this combined cost can involve a productive collaborative effort between the corporation and suppliers.
Optimizing yield can provide opportunities for effective collaboration between the supplier and the corporation that is its customer. The corporation can collaborate on using Six Sigma methods to analyze, model and optimize yields at the supplier. Yield is also a function of specification limits provided by the corporation to the supplier – the corporation can also reconsider and optimize the specification limits to optimize profitability. Design for Six Sigma techniques and methodologies can model predictivity in modifications or new processes while Lean Six Sigma can identify and mitigate bottlenecks and inefficiencies in current processes.
There are three pillars to the win/win paradigm:
Motivation throughout the supply chain is required to align the network on supporting the common end goals. Motivation can be as simple as the increased yields goals for both supplier and corporation referenced earlier or more complex to cite specific profit growth on both sides. Contracts with suppliers can codify the benefits for the supplier in achieving goals that mutually benefit the corporation and the supplier – goals such as yield, an inventory strategy and sharing of information. And that brings us to communication.
Communication is simple in concept but extremely important to initial and continued success. Communication barriers between the suppliers and the corporations should be reduced and preferably removed. These boundaries could include language, infrastructure and coding. Open and honest communication, as well as frequent and quantitative data sharing, can help build relationships and support optimization of the supply chain to benefit the final customers. Agreement on common metrics and goals and benchmarks help with both motivation and communication. Standardized methodology for establishing and attaining benchmarks helps align the corporation and the suppliers in the supply chain network and reduce communication issues in terms of different interpretations of data.
The final piece of the win/win paradigm is establishment of business processes, modified to make the win/win paradigm the path of least resistance. This can be accomplished by rerouting production, consolidating operations, aligning goals, metrics and benchmarks, and establishing communication processes. Testing and inspection should be evaluated for appropriate outputs and direct support to the end-product quality and acceptance rates. Any superfluous testing and inspection requirement should be evaluated and either consolidated or eliminated.
There will be roadblocks encountered while approaching a win/win paradigm. The elimination of these roadblocks is key in achieving maintainable success. Corporations will need to reeducate their leads on the importance of clear and open communication with suppliers. Suppliers will need to enable communication chains and, in some cases, begin recording performance and yields so that the data can be shared and efficiencies evaluated. There is a distinct opportunity to decrease costs, increase yields and improve customer satisfaction by working as a unit verses standalone entities.
- Friedman, Milton. “The Power of the Market – The Pencil.” Citeco.com. https://www.citeco.fr/en/milton-friedman-%E2%80%9C-power-market-%E2%80%93-pencil%E2%80%9D. Published December 2, 2011. Accessed March 28, 2021.
- Maass, Eric C. Supply Chain Modeling: Modeling and Optimizing On Time Delivery and Cost through Supply Chains. 2020.
- Maass, Eric. “Predict Your Predictions with Yield and Single-Use Reliability Modeling.” iSixSigma.com. n.d.
- Flaig, John J. “Selecting Optimal Specification Limits,” Quality Technology & Quantitative Management, 3:2;207-216. Published February 9, 2016. doi: 10.1080/16843703.2006.11673110.