Logistics Quarterly Magazine - Volume 16, Issue 1, 2010

Revisiting Supply Chain Design Priorities

In my Logistics Quarterly comments over two years ago (LQ volume 13, issue 4), I discussed the evolution of supply chain design priorities. This month's comments review some of the background comments and then revisit the results.

By David J. Closs

OVER THE PAST FEW YEARSat Council of Supply Chain Management Professionals (CSCMP) annual conferences and Supply Chain Leadership Alliance sessions, executives from a number of industries have reflected upon the challenges of designing and optimizing a supply chain in today's dynamic environment. During executive education sessions, I have reflected on these challenges and how they have changed over time with executives from many firms around the world. While they had often not organized their decision criteria in the same format, most executives operating regionally and globally agreed with the general shift in priorities.

Prior to discussing the shift, it is important to establish the baseline. The shift refers to the prioritization or importance of the factors driving supply chain design. As illustrated in Table 1, the major criteria driving supply chain design in 1990, in order of decreasing priority, include:
1) demand location;
2) labor cost;
3) material cost; and
4) transport cost.

Demand location refers to the geographic location and shipment profile (relative volume, size, and characteristics) of the market. All other things being equal, firms would rather locate production and/or distribution centers near the consumer markets. The fact that demand in Asia, India, South America, and Eastern Europe is growing at double digit rates strongly motivates global firms to shift supply chain activities to these regions. Labor cost refers to the relative cost of production and distribution activities such as manufacturing and handling. This factor is a driver of the move by many firms toward low cost country production such as in China, India, and Eastern Europe. Labor cost country considerations include direct labor rate as well as both benefits and assigned overhead cost. Material cost refers to the total cost of the raw material and components, including both the direct and indirect cost. The direct cost represents the specific purchase cost of the material as well as the tariffs, duties, and packaging. The material indirect cost includes the transaction and risk related costs such as security, obsolescence, and potential intellectual property risks. Transportation cost includes the freight cost required for obtaining raw material, moving material between plants and distribution facilities, and ultimate distribution to customers and consumers.

The previous comments focused on the increasing importance of global and regional tax policy in driving supply chain design. The discussion suggested Ireland and Singapore as examples of countries that have used tax policy (particularly value-added taxes and foreign trade zones) as a means to attract industry. Building on this lesson, many North American regions are using the same approach to attract industry to their states or provinces.

While proximity to market demand is still the primary factor ("location, location, location!"), the recent shift has been to increase the relative importance of overall sustainability with the remaining four factors, which are:
1) tax policy;
2) transportation cost;
3) production cost; and
4) raw material cost.

In many cases, the total cost and service differential resulting from sustainability and tax policy often overwhelms the differences related to other supply chain cost elements.

Increased supply chain risk has resulted in increased consideration of overall sustainability when making supply chain design decisions. Supply chain sustainability has many dimensions, including operating risk, energy, labor, and political risk.

The supply chain operating risk consideration refers to the sourcing and lead time risks associated with global and low cost country sourcing. Since 2000, many firms have increased the use of low cost country sourcing to reduce direct labor and manufacturing cost. In many cases, however, the firms did not understand the total cost or risk implications of global sourcing and have since reduced their risk exposure by sourcing from suppliers that are closer. An example of such a risk is a recent comment by a 3PL operator who cited difficulty in finding available container capacity from Asia to North America. For his clients, the result is longer and more inconsistent lead times which reduced service or increased safety stock. To minimize this operating risk, there is a trend for North American operators to shift to suppliers in Central and South America as well as the Caribbean. In the case of Europe, the shift is to suppliers in Eastern Europe and the Middle East. The general shift seems to be moving toward increased supplier proximity.

A second consideration is the need for reliable and competitive energy. Energy is critical for both operating supply chain facilities and transporting product through the supply chain.

Discussions with plant managers in some regions of Asia have indicated that it is not uncommon to have two to three hours per day without electricity. This obviously creates production scheduling issues and increased labor cost. Another example is the access to reasonably priced fuel to support product movement, particularly via air or motor carrier. An example of this consideration is Walmart's focus on redesigning their food product sourcing to reduce fuel consumption.

A third consideration focuses on access to trained labor. While many countries are experiencing high unemployment, there are some countries, both developing and developed, where many firms cite supply chain talent as an increasing issue. This includes both management and labor. On the management side, the challenge is to find talent that understands the broad dimensions of supply chain, including cross-functional trade-offs, globalization, technology, and strategy integration. While universities in the developed countries are producing more supply chain talent, the demand is growing at a faster rate, particularly for graduates with the capabilities noted above. The demand far outstrips the supply for talent in the developing world.

Recent research by AMR Research regarding supply chain talent illustrates the scope and magnitude of this challenge. On the labor side, the increased use of technology in both developing and developed countries makes it more difficult to find and retain trained talent.

While the talent sometimes exists, there are often not enough trained individuals and the resulting labor turnover is challenging. In my discussions with some plant managers in Asia, they reported 100 percent annual turnover which makes it very difficult to develop and retain expertise. In order to sustain itself, a firm must find and retain skilled managerial and labor talent in the global regions that it chooses to operate in.

A final consideration focuses on a supportive and stable political environment. This environment includes political, regulatory, and financial considerations. The political considerations include a stable government and currency.The stable political environment must also include the policies that attract and retain businesses. Without stable policies, firms are reluctant to take the risk of locating major supply chain facilities in unstable geographies. The regulatory environment includes the financial and operating restrictions placed on activities or labor. This includes limitations on types of activities that can be performed at potential sites, labor culture, access to key resources, and environmental constraints. The financial considerations include currency or tax fluctuations.

Regular currency fluctuations or tax law changes inject too much uncertainty into supply chain operations so supply chain managers try to avoid such environments.

The remaining four factors, tax policy, transportation, production, and material costs continue to be important. Specifically, tax strategy and transportation costs are still very critical as they can have a major impact on current and potential supply chain costs.

However, it appears that production and material costs, while still somewhat important, are declining in relevance due to the reduction in their influence on overall value add.

In summary, once again, the supply chain design challenge for supply chain managers is expanding. Not only must supply chain managers understand the traditional supply chain functional trade-offs, they must also strongly consider sustainability and taxation as well.

Specifically, supply chain managers must develop a deeper understanding regarding an increasing number of risk dimensions, many of which the firm has little or no control over. Simultaneously, it is important that supply chain managers understand the significant impact that the energy, labor, and political dimensions can have on design decisions and how to make appropriate trade-offs. Thus, supply chain managers must again extend their knowledge base to understand the considerations for and the relevant trade-offs for integrated supply chain design.