vestments in improving the chain’s efficiency. For
every dollar such a company invests in increasing
its supply chain’s responsiveness, it usually will
reap a decrease of more than a dollar in the cost of
stockouts and forced markdowns on excess inven-
tory that result from mismatches between supply
and demand. Consider
a typical innovative product
with a contribution margin of 40% and an average
stockout rate of 25%.
1
The lost contribution to
profit and overhead resulting from stockouts alone
is huge: 40%
3
25% = 10% of sales–an amount that
usually exceeds profits before taxes.
Consequently, the economic gain from reducing
stockouts and excess inventory is so great that in-
telligent investments in supply chain responsive-
ness will always pay for themselves – a fact that
progressive companies have discovered. Compaq,
for example, decided to continue producing cer-
tain high-variety, short-life-cycle
circuits in-house
rather than outsource them to a low-cost Asian
country, because local production gave the com-
pany increased flexibility and shorter lead times.
World Company, a leading Japanese apparel manu-
facturer, produces its basic styles in low-cost Chi-
nese plants but keeps production of high-fashion
styles in Japan, where the advantage of being able to
respond quickly to emerging fashion trends more
than offsets the disadvantage of high labor costs.
That logic doesn’t apply to functional products. A
contribution margin of 10% and an average stock-
out rate of 1% mean lost contribution to profit and
overhead of only .1% of sales – a
negligible cost that
doesn’t warrant the significant investments re-
quired to improve responsiveness.
Getting Out of the
Upper Right-Hand Cell
The rate of new-product introductions has sky-
rocketed in many industries, fueled both by an in-
crease in the number of competitors and by the
efforts of existing competitors to protect or increase
profit margins. As a result, many companies have
turned or tried to turn
traditionally functional
products into innovative products. But they have
continued to focus on physical efficiency in the
processes for supplying those products. This phe-
nomenon explains why one finds so many broken
supply chains – or unresponsive chains trying to
supply innovative products – in industries such as
automobiles, personal computers, and consumer
packaged goods.
The automobile industry is one
classic example. Several years ago,
I was involved
in a study to measure
the impact that the variety of op-
tions available to consumers had on
productivity at a Big Three auto
plant. As the study began, I tried to
understand variety from the cus-
tomer’s perspective by visiting a dealer near my
home in the Philadelphia area and “shopping” for
the car model produced in the plant we were to
study. From sales literature provided by the dealer,
I determined that when one took into account all
the
choices for color, interior features, drivetrain
configurations, and other options, the company
was actually offering 20 million versions of the
car. But because ordering a car with the desired
options entailed an eight-week wait for delivery,
more than 90% of customers bought their cars off
the lot.
The dealer told me that he had 2 versions of the
car model on his lot and that if neither matched
my
ideal specifications, he might be able to get my
choice from another dealer in the Philadelphia area.
When I got home, I checked the phone book and
found ten dealers in the area. Assuming each of
them also had 2 versions of the car in stock, I was
choosing from a selection of at most 20 versions of
a car that could be made in 20 million. In other
words, the auto distribution channel is a kind of
hourglass with the dealer at the neck. At the top
of the glass, plants,
which introduce innovations
in color and technology every year, can provide an
almost infinite variety of options. At the bottom,
a multitude of customers with diverse tastes could
benefit from that variety but are unable to because
of dealers’ practices at the neck of the glass.
The computer industry of 20 years ago shows
that a company can supply an innovative product
with an unresponsive process if the market allows
it a long lead time for delivery. In my first job after
college, I worked in an IBM sales office helping to
market the System/360 mainframe.
I was shocked
to learn that IBM was then quoting a 14-month lead
time for this hot new product. I asked how I could
possibly tell a customer to wait that long. The an-
swer was that if a customer really wanted a 360, it
would wait, and that if I couldn’t persuade it to
wait, there must be something seriously lacking in
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