Like Toyota in the 1960s and 1970s, today’s most effective companies break constraints rather than live within them. Consider a more recent example, the Dell Computer Corporation. By eliminating the retailer as an intermediary and building directly to customer order, Dell broke a constraint punishing almost every other manufacturer: the bullwhip effect of increasing demand variation and forecast error in the upstream supply chain. Dell holds less than three days’ inventory and collects payment for sales more than 30 days faster than it pays suppliers for components. As a result, Dell’s cash conversion cycle is a negative 37 days, compared with a positive 30 to 60 days for its competitors.
The Booz Allen survey, which was conducted in the fourth quarter of 2002 and received nearly 200 responses from manufacturing and industrial companies worldwide, provides hard evidence of the value of breaking constraints. Companies that break constraints reported 36 percent greater savings in customer cost-to-serve and 55 percent greater savings in purchasing than those that make adjustments within the existing supply chain structure. Yet most companies still feel constrained by existing channel relationships or prior investments in fixed assets. Accordingly, they pursue incremental rather than step-function improvements.
The second enduring principle of SCM is that companies must analyze trade-offs holistically. Because we live in an imperfect world, even with clear strategic objectives and policies, tactical trade-offs remain. For example, how should the company respond to a buildup of inventory in the distribution channel due to lower-than-expected sales? Should the plant shut down for a week, or should the company offer a discount to increase sales? Such trade-offs should not be addressed with a narrow functional view. Instead, functional managers must step above their individual performance measures to objectively prescribe a solution offering the best bottom-line impact for the company as a whole.
During SCM’s “intracompany” period, the original supply chain innovators initiated weekly or monthly cross-functional meetings to drive tactical trade-off decisions. Variously referred to as sales and operations planning (SOP) or production, sales, and inventory (PSI) meetings, these cross-functional decision-making forums today are commonplace in many companies.
Without a structured forum, a typical company suffers from countless dysfunctional decision processes. For example, the production department regularly adjusts (or even ignores) forecasts from sales and marketing, judging them overly optimistic. Instead, production tries to avoid changeovers and keep facilities running at the same level year-round to minimize cost. Distribution routinely delays replenishment of key items to ensure full-truckload shipments, resulting in unfulfilled, and often lost, customers. Though functional priorities might remain in conflict, an SOP/PSI forum ensures that each group understands the full implications of its decisions.
Current supply chain innovators are attempting to broaden this tactical decision-making process to encompass the extended enterprise, through a process called collaborative planning, forecasting, and replenishment (CPFR). Though it does not necessarily require the physical meetings that characterize SOP/PSI, CPFR attempts to ensure that customers and suppliers are working on the same assumptions and have a common understanding. Retailers such as Kroger Company coordinate with suppliers such as Unilever PLC to synchronize promotional plans and route shipments to minimize total cost — for example, by taking shipments directly from the manufacturing plant to avoid unnecessary handling by the distribution center.
Despite the increasing acceptance of SOP/PSI and now CPFR, most companies struggle to see sustained benefits because they have failed to provide the appropriate strategic framework mandated by the first principle. Instead, they have institutionalized “firefighting” at the tactical level without addressing the strategic root causes.
Leading companies are moving toward an approach we call federated planning. Drawn from the Federalist view that shaped the governance of the United States, our model recognizes that members of an extended enterprise are independent entities with unique goals. However, just as the original states banded together to form a federal government for mutual benefit, members of an extended enterprise can collaborate around a set of shared goals.