Recession-Proof Your Business

Dell trounces its rivals, even as PC sales plummet. Cisco writes off nearly $2.3 billion in excess inventory. What do soaring success and dismal fiasco have in common? Supply chain management software—which can be a culprit or cure, depending on the hand that wields it.

For many companies, supply chain management (SCM) software buffers the pain of an economic downturn. "The way recessions used to work is that there would be a rapid fall-off in demand, resulting in inventory pileups," says Mike Bauer, a partner at Computer Sciences Corporation and coauthor of E-Supply Chain: Using the Internet to Revolutionize Your Business (2000, Berrett-Koehler Publishers). "One of the differences today is that you can adjust for that more rapidly."

At the same time, getting it wrong can be disastrous. Nike got slammed with $100 million in lost sales because of an SCM software foul-up in early 2001. Likewise, Hershey's set off a nationwide chocolate shortage scare when it came up short on Kit Kats and Rolos one week before Halloween 1999. The problem wasn't chocolate. It was software.

Used correctly, SCM software keeps inventory low without exposing an enterprise to supply shortfalls. The effects are felt across the company. When the bottom fell out of the PC market early this year, Dell sliced some 5,000 employees from its payroll. Painless? Hardly, but considering that rival Compaq planned to lay off 8,500 before it announced plans to merge with Hewlett-Packard, Dell's SCM system let the company take over the top spot in market share, and it saved jobs.

SCM isn't new. Its tools link disparate parts of an organization—from back-office enterprise resource planning systems to front-office customer relationship management systems to ensure that production stays nimble enough to meet changing demand. Although some SCM providers address the entire supply chain, most packages focus on specific points—from demand forecasting to partner relationship management, all the way down to streamlining assembly.

Stuff the Channel

Only recently have executives discovered the recession-proofing powers of SCM. Supply chain streamlining came into vogue in the 1970s, when efficient inventory methods used by the Japanese made toast of the U.S. auto industry. Since then, most supply chain systems have focused on matching supply to real-time demand to prevent products from piling up along the chain.

But fighting overstock is akin to fighting human nature: While companies in a supply chain function as partners, they communicate as competitors. The problem starts when retailers pad popular product orders to prevent selling out and end up overestimating demand.

Cisco's $2.3 billion inventory disaster in the spring of 2001 can be directly blamed on safety stock. Resellers' sophisticated abilities to forecast demand didn't keep them from "stuffing" the channel. "Cisco was so efficient but everyone else around it was not," says Kapi Attawar, former VP of marketing at OnDemand, a demand chain system developer. "Cisco was building to the false forecast [of its resellers] and had no visibility into its channels."

Such persistent miscommunication results in persistent imbalance. "The issue is a mismatch between the supply and demand chains. These two halves of the puzzle are totally divorced from each other," says Attawar. "Even in good times there is a huge cost being borne by manufacturers."

SCM software attempts to foster honesty among channel partners by allowing distributors to monitor product assembly while enabling manufacturers to track product sales. The software also ensures accuracy by doing the hard math necessary to make cost-effective decisions involving everything from transportation to restocking shelves.

"There's a lot of complex mathematics behind all of this," says David Austin, director of industry and alliance marketing for Manugistics, a supply chain software firm. "This is something that no one could possibly calculate by themselves."

OnDemand uses this advanced math to manipulate partners into playing fair through a reward system. "There are very sophisticated forecasting tools out there, but there is no incentive [for resellers and retailers] to forecast correctly," says Attawar. "It's a behavioral problem."

OnDemand rewards honest channel partners with increased visibility or access. Attawar cites the dearth of Sony PlayStation 2 boxes during the 2000 Christmas season as an example of how manufacturers could reward retailers: "People were killing themselves to get the product. I'm sure Circuit City would have given its right arm to have priority over Best Buy in receiving it."

Increased visibility, efficient business practices, and honest communication allow for just-in-time manufacturing, which helps prevent channel stuffing. "The moment of actual manufacturing and actual sale are coming closer together," says Gisela Wilson, director of the product supply chain program at international consultancy IDC. "It pushes inventory requirements down the supply chain so that manufacturers no longer have to keep all that inventory."

SCM also works to increase inventory "turns" while synchronizing them between channel partners. Retailers like Wal-Mart turn inventory as many as 40 times a year, while the manufacturers that stock its shelves are stuck with as few as seven inventory cycles. The result is undesirable for both parties: Either the retailer runs out of popular products too soon or it overstocks to buffer against the manufacturer's slower cycles. If the retailer overstocks an item that doesn't sell well, the manufacturer ends up paying for it. "The ideal is to do one for one," says Attawar. "For every turn that Circuit City does, Palm does one as well."

Increasing inventory turns leads to less price protection, added retail cost designed to pad manufacturers' bottom line against discounts at the end of product life cycles. "Increasing inventory turns by just one can reduce the inventory write-off at the end of a product's life cycle by 50 percent," says Attawar.

Sell Now, Build Later

Dell remains the revolutionary and undisputed leader for inventory management. Why? Its negative cash-to-cash cycle has been a model for dozens of other companies to follow.

"Dell communicates customer demand to suppliers in real time and actually builds a product only after the customer has ordered it," explains Andy De, director of product marketing and supply chain management for i2, which codesigned Dell's SCM system. "Where most hardware manufacturers have a month to a year of inventory lying on the shop floor, Dell has no more than five to six hours of inventory at one time," says De. Dell's operating margin is more than 7 percent, compared with the industry average of 2.3 to 4 percent.

But don't expect SCM software to give your creaky production line Dell's efficiency overnight. "Supply chain management is a real opportunity, but the key performance metrics vary," says Manugistics' Austin. "In retail, that metric is inventory-carrying costs. For electronics and high-tech, it's customer service. At a distribution company it would be transportation costs. Regardless of the need, though, SCM can positively impact those numbers."

To meet individual needs, SCM software must be highly customizable, which adds to its cost and complexity. Even without customization, SCM software isn't cheap. Companies can pay at least $1 million in licensing costs alone.

"The hope is that the software does about 80 percent and then you have implementers and consultants to help you with the other 20," says IDC's Wilson. Consultants can cost as much as five times the initial investment in the software, but even customizing it in-house doubles SCM's cost. Just ask executives at Nike. In March, the company publicly blamed $100 million in lost sales on its in-house customization of i2's apparel manufacturing module. Needless to say, you'll want your SCM system to be configured by experts.

Nike's decision to tweak i2's ready-made configuration makes plain that in some cases changing the business is easier than changing the software. "The biggest decision that needs to be made when you put in systems like this is whether or not to follow existing business rules or do what the software package makes it easy to do and possibly change an existing business process," says Brent Habig, president and founder of Tigris, a supply chain customization firm.

Along the way, Austin adds, you must look at process flow within your company and be ready to retool those processes around practices that actually work. "You never want to automate a bad business process," he says.

Habig and Austin state the obvious. The practical solution lies in using SCM to target specific parts of the supply chain. OnDemand, for example, deals only with the demand end of the chain. Some packages narrow their scope even further, focusing on just one business area, such as procurement.

While large firms like i2 and Manugistics provide software for every point along the chain, using them is not just a matter of flipping the on switch. Each task requires careful setup and integration. Integrating multiple configurations across a large corporation all at once can result in problems from communication to scheduling. And at each stage, costs rise.

What's more, efficiencies typically depend on sharing shop-floor data with suppliers, which most companies resist. Jennifer Chew, an analyst with Forrester Research, believes that such cooperation is essential. "If one company lowers inventory or improves demand forecasting, then those benefits will be passed on to all the partners in the network," she says.

No More Downturns?

If software can claim its 15 minutes of fame, Federal Reserve Chairman Alan Greenspan gave it to SCM software in testimony before Congress early this year. "New technologies for supply chain management and flexible manufacturing imply that businesses can perceive imbalances in inventories at a very early stage," Greenspan crowed in his semiannual speech. "It means that imbalances are not allowed to build until they require very large corrections."

This endorsement suggests there is truth to claims that the software can recession-proof your business, and many managers seem eager to believe. In an August survey of 150 executives, 38 percent picked SCM software as the most "beneficial new technology investment" of the last two years, according to Accenture. And SCM software placed third behind CRM and wireless as the technology voted most likely to be the next killer app for business.

Still, even software makers admit that SCM has its limits. "I don't think there's anything that's 100 percent recession-proof, but what SCM can do is help companies anticipate what's going to happen and deal with it better, or help sick companies become healthier," says Austin.

What's more, using SCM software often requires restructuring business practices, which can create more problems than it was brought in to solve. Hershey's 1999 Halloween debacle was a matter of good software used poorly: There were plenty of Rolos to go around that year, but Hershey's had them routed to all the wrong places. Empty shelves in large cities on the biggest candy day of the year resulted in an 11 percent drop in Hershey's profits that quarter.

Bauer cautions that the software is only as effective as humans allow it to be, pointing again to Cisco's $2.3 billion inventory pileup. "Cisco knew that sales were drying up," he says. "They were given the heads up by their contracted manufacturers who were saying that they didn't see the economic conditions to warrant the large numbers of Cisco's orders. The software worked in that case, but people didn't act on it."

Kayte VanScoy is a Manhattan-based freelance writer.

TOP 5 REASONS To Use Supply Chain Management Software 1. Keep inventory lean and mean. SCM software matches supply to real-time demand so you're never stuck with more than you need—or can afford. 2. Streamline operations to cut costs. Software does the tough math to determine the most efficient ways to order, create, and ship your products. 3. Speed time to market. Slash development and fulfillment lead times to get new products on shelves faster. 4. Keep all parties honest. Track supply-chain partners' activities to ensure straightforward communication and prevent channel stuffing. 5. Improve accuracy. Get the right number of products to the right place at the right time—every time. You'll keep customers happy while cutting costs.

THE SUPPLY CHAIN GANG These top vendors offer systems to streamline your supply chain—from managing suppliers to gauging customer response. Each one offers a range of services, making prices too varied to include here. Provider Customers Include Success Story i2 Dell, Nike, Southwest Airlines, Thomson Consumer Electronics Thomson Consumer Electronics cut its forecasting cycle from 10 days to two days and reduced inventory by 33 percent in the first 12 months. Manugistics Black & Decker, Hewlett-Packard, Mitsubishi HP slashed overall transportation budget by 25 percent and cut inventory at its top three Asia-Pacific resellers by more than half—within just two months. SAP Carlsberg, Lockheed Martin, Mott's In four months, Carlsberg, the Danish beer and soda company, reduced inventory by 30 percent and boosted order accuracy by 20 percent. PeopleSoft Borden Foods, Credit Suisse First Boston, 8x8 Telecom product maker Netergy Networks integrated manufacturing and engineering processes to slash new product time to market by one-third. SynQuest Titleist-Footjoy Worldwide, Ford, Herman Miller Titleist cut manufacturing lead times of its custom golf balls by more than half—from 12 to five days—which lets the company offer two-day express service.

Copyright © 2004 Ziff Davis Media Inc. All Rights Reserved. Originally appearing in Ziff Davis Smart Business.