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Keep your supply chain healthy—in bad times and good

Comment
Companies need to work with their suppliers, restrain cost cutting, and stick to fundamental supply chain strategies to ensure that their supply chains are ready to move forward when the economy recovers.

In periods of economic distress, it is not unusual for business managers to make drastic changes, such as switching suppliers or downsizing employee headcount to quickly reduce costs. Such swift, dramatic actions may seem right at the time, but in the long term they can do a great deal of harm.

As we know from observing the impact of the "bullwhip effect," when a company overreacts to demand shifts, it can hurt the entire supply chain and leave suppliers unable to respond to customer demand. The consequences can be devastating: when business improves, organizations that have focused on short-term decision making may be poised for demise rather than for recovery.

Article Figures
[Figure 1] Keys to maintaining supply chain health
[Figure 1] Keys to maintaining supply chain health Enlarge this image
[Figure 2] Cobra Metal Works' vision
[Figure 2] Cobra Metal Works' vision Enlarge this image

To avoid "supply chain shortsightedness," managers need to balance the propensity to overreact to extreme fluctuations in demand with decisions that keep the organization and its supply chain healthy and ready to move forward when the economy recovers.

What makes a supply chain healthy, and how do you keep it that way in bad times and good? Through the use of anecdotal evidence and secondary data, we will answer that question by introducing a framework for promoting productive, sustainable supply chain operations instead of the destructive behaviors companies may be tempted to adopt in challenging economic conditions.

What is a healthy supply chain?
One characteristic of a company that has a healthy supply chain is a supply chain orientation. A supply chain orientation is defined as "the recognition by a company of the systematic, strategic implications of the activities and processes involved in managing the various flows in a supply chain."1 This outlook is critical because failing to recognize the importance of the supply chain and its health (as well as that of its key members) can permanently damage an organization's effectiveness.

A healthy, high-performing, sustainable supply chain also applies a systems focus to both internal and external issues, and it has a strategy for the future that will help each organization in the chain adapt to changes in the external environment. In essence, then, supply chain health requires taking care of internal concerns as well as external concerns, which include customers and suppliers. An examination of each of these areas, including examples of companies that have adopted a healthy approach and those that have not, offers some useful guidance.

Taking care of internal concerns
It's not surprising that internal concerns are a top priority when times are tough. After all, companies want to make sure that they survive the economic downturn. But too great a focus on internal issues can be detrimental.

During recessions, profits often dwindle because revenues decline while overhead and associated costs remain constant. The engine manufacturer Cummins Inc.'s response to this situation typifies that of many companies. Reacting to a drop in truck sales of some 70 percent, Cummins cut costs in late 2009, including downsizing its global workforce by 9,000. This strategy was intended to protect earnings, and even when revenues had stabilized, the company had no plans to start spending on new capacity.2 This type of cutback starves the economy of investments needed for growth, often prolonging problems instead of solving them.

Although protecting earnings is indeed important, an organization should not advance its own health at the expense of the well-being of other members of its supply chain. Yet, because supply chain management is frequently viewed as a cost center rather than a potential profit center, this is one of the first places companies look to cut costs.

There are numerous examples of companies employing their supply chains, primarily the sourcing and procurement functions, to contain costs and boost revenues. A 2009 survey of supply chain managers3 cited an immediate need to cut costs as the top economic pressure on their supply chains. An overwhelming 88 percent of respondents representing 22 industries from around the globe had set objectives for purchasing to generate cost savings in the next 12 months. One-third of respondents indicated that they had leveraged supply chain initiatives to reduce costs by between 1 percent and 5 percent in the previous three years. Twenty-seven percent reported realizing even higher cost reductions, ranging from 6 percent to 10 percent.

But heavy cost cutting in times of stress can create more problems when the recovery gets under way. For instance, companies need to keep knowledgeable, well-trained, experienced employees; if they lose these important assets, they will emerge from the recession weaker than before. Moreover, a downturn may actually be the right time to invest in new technology, new marketing campaigns, new people, new products, and new companies instead of making wholesale budget cuts.4

A good example is the decisions by the makers of the iPhone and the BlackBerry. Despite the overall decline in consumer spending, they have achieved extreme growth in sales by investing in new applications. 5 They have been so successful, in fact, that the phrase "I've got an app for that" has become part of the mainstream vernacular. Another example of a company that has responded to a slow market with new spending is Trek Bikes, which has launched a bold, new marketing campaign challenging people to change the world by riding their bicycles more. The company is helping customers track the pounds of CO2 reduced, calories burned, and gas money saved.6

Taking care of customers
It's important, of course, to retain good customers, and that's especially true in a downturn, when business declines. It's also widely known that it is cheaper to keep an existing customer than to acquire a new one. One of the worst things an organization can do, therefore, is to focus so much on cutting its internal costs that it compromises the way it serves its customers, particularly large and important ones.

An example of this approach and how it can backfire occurred last year in the electronics industry, when consumer electronics suppliers scaled back production in response to declining demand. The giant retail chain Best Buy, for instance, reported that its suppliers had cut back so much that the retailer could not keep its shelves properly stocked. If Best Buy and its suppliers had instead focused on meeting demand rather than concentrating on reducing inventory, they could have sold more product. The suppliers also had difficulty restoring production levels to meet rising customer demand. As one company representative noted, "It's easier to turn off the switch than to turn it back on."7

One key to maintaining healthy relationships with customers during tough economic times is to better understand their needs. Companies that succeed in this regard communicate frequently with their customers. They learn how the downturn is affecting their businesses, and they make sure customers know that they want to cooperate with them. They also convey that it is important for customers to communicate with them so they will be prepared to provide support.

Adopting this approach produces benefits even in challenging economic conditions. Consider the case of Honda Motor Company Inc. By listening to its customers, Honda determined that they still wanted compact, fuel-efficient vehicles. The company therefore focused on three automobile models that fit that profile and on its line of motorcycles. The result of this tight focus on what customers wanted was a significant gain in volume and market share in developing countries.8 Moreover, unlike most other auto manufacturers, Honda expects profits to increase in 2009.9

Another example is that of Amazon.com. Amazon, named a top performer in customer service quality in a recent survey, continues to invest in improved technology to provide a better customer experience.10 The online retailer also is seeking ways to better serve its customers through broader product offerings—a major motivation behind its recent acquisition of another customer-service award winner, the online footwear and clothing retailer Zappos.com.11

Taking care of suppliers
Most managers understand that the role suppliers play in the success of a business goes beyond the prices they charge and the quality of their products; it also includes critical intangibles, such as how reliable they are and what kind of support they offer. For that reason, they should take care to consider how their recession-fueled decisions are likely to affect their suppliers.

They should, for example, recognize that when the economy improves, suppliers cannot simply pick up where they left off. U.S. automakers learned that lesson last year when, in their efforts to curtail losses, they stopped ordering parts from suppliers. Those suppliers then began to drastically reduce their own inventories. This caused problems later on when the automakers began ordering parts again in response to signs of economic recovery and to the U.S. government's "Cash for Clunkers" program, which stimulated sales of new cars. Many of their suppliers, however, needed cash infusions to ramp up production, but they could not get funding from banks. David Tull, CEO of Crestmark Bank, highlighted the potential consequences of that situation, commenting, "More companies fail in an expansion, especially an expansion after a downturn."12

What is good for the buyer is not necessarily good for the supplier, as is clear from the case of a large company in the beverage sector.13 This company extended its payment terms to suppliers from 30 days to 60 days. Based on 2009 accounts payable of around US $3 billion, paying all suppliers in 60 days instead of 30 days created a one-time increase in free cash of US $3 billion (bringing their accounts payable to roughly US $6 billion if sales are flat, since the payment time was doubled). This firm is in a relatively healthy financial position, and it has a low cost of capital that became even lower due to the increased cash on hand. As a result of this increase in cash, investors may view its stock as being less risky, and its stock price may even benefit. However, many of this firm's suppliers are small and not as financially strong as their big customer. Because they had to wait twice as long for their money at a time when credit was difficult to get, these suppliers had to cut their costs further, pay higher interest rates, and perhaps squeeze their own suppliers.

Decisions that benefit the buyer but hurt suppliers can not only damage the health of the entire supply chain and hamper its ability to respond effectively in a recovery, but it can also damage the relationships between supply chain members in the long term. To avoid that situation, companies can and should investigate the financial health of their suppliers. If they find it necessary to offer financial or other kinds of help, it is critical that they first support suppliers that are difficult to replace, and then support other good suppliers to the extent possible. This will win their loyalty when the upturn comes along. An example of this approach is General Motors' decision to pay its suppliers weekly instead of monthly. Weekly payouts help both GM and its suppliers by leveling cash flow and helping to ensure suppliers' viability when the recession ends.14

Just as it is important to retain customers in good times and bad, the same is true of suppliers. When business is slow, companies often consider switching suppliers to save money, but unless the new supplier is as reliable and as supportive as the old one, the true savings could be a lot less than they might appear—or there may be no savings at all.15 That is why the Japanese auto parts manufacturer Takata Corporation does not use low-priced Chinese suppliers for its operations in North and South America, according to Fred Heegan, vice president of purchasing for American operations. Sourcing from China creates more than six weeks of inprocess and in-transit inventory, reducing the supply chain's agility and raising overall costs. Local sources, many of which have co-located manufacturing plants near Takata's Mexican operations, provide the company with greater responsiveness and lower total cost of ownership.16

Steps to sustaining supply chain health
As we know from observing excellent companies, a firm's strategy, structure, and processes must fit with and support one another. Yet there is a high risk that organizations will lose sight of this if they focus only on survival during times of economic stress. If, however, the actions they take to ensure survival are consistent with their longer-term strategies, then they will be more successful and will recover more quickly in an upturn.

To avoid permanently damaging the supply chain and to be ready to emerge successfully into the next phase of the economy, companies should follow established business strategies and principles. Even in a recession, the fundamental principles of good supply chain management do not change—although they may need to be adapted slightly to reflect the current situation.

With that in mind, the following recommendations, summarized in Figure 1, will help organizations to sustain the health of their supply chains in a challenging economy as well as in better times to come.

1. Sustain your value proposition
A company's primary value proposition is an important factor in both attracting and retaining customers; compromising that value in the name of cost-cutting risks alienating them. Nevertheless, an economic downturn can be an appropriate time to re-evaluate a value proposition and how effectively a company is achieving it.

That has been the case for Cobra Metal Works, a manufacturer of machined auto parts. Rather than seek to fill its factories with any available business, CEO Anton Hirsh says,17 his company went through some very painful cutbacks beginning in mid-2008, slimming down from five facilities and 300 employees to three facilities and 120 employees. The transition to a smaller organization was difficult, he explains, but the company continues to focus on its core markets, is now smarter about its business structure, and is better able to communicate up and down its supply chain. "It is essential to understand whether the changes you make are temporary adaptations or fundamental structural changes, and to communicate this to your key suppliers and customers," he advises.

A value proposition should mesh with its supporting supply chain structure. Achieving that objective, however, may require modifying the supply chain structure. Amazon.com discovered this when it moved beyond its original value proposition and mission of quickly delivering hard-to-find books at reasonable prices. Hoping to avoid bricks-and-mortar distribution facilities, the online retailer first made significant investments in technology. When the company discovered that it could not effectively maintain its value proposition and service levels without its own distribution and fulfillment operations, it invested in those and became very successful as a result. As the company grew, it implemented supply chain best practices to ensure that it would continue to achieve its customer service and pricing objectives.

2. Communicate with your key suppliers
Sharing information and knowledge among supply chain partners is critical throughout a turbulent economic period. Using information to create transparency in various layers of the supply chain allows each tier to get the best "real" data possible regarding customer demand, rather than the "phantom demand" that occurs as companies replenish safety stock or build inventory in anticipation of demand surges.18

Frequent, honest communication allows companies to anticipate and prepare for difficult situations. One company that understands this and has profited from it is Takata Corporation. As the current recession developed, Takata held a meeting with its largest suppliers to communicate its plans and exchange ideas about how both buyer and suppliers could best weather the economic storm. This meeting also set the stage for open information sharing, including third-party audits of suppliers' financial stability that would help Takata manage supply risk. Thanks to this regular communication, the auto parts maker was able to take action when one of its suppliers was having financial difficulties, and bankruptcy was imminent. The manufacturer worked with this supplier to transition its business to another key supplier in a manner that worked well for all parties.19

As we saw in the earlier example of the automakers and their suppliers, communicating about potential upswings in demand is just as important as sharing information about potential problems. Caterpillar Inc., which was hit very hard by the recession, has done exactly that. The heavy-equipment manufacturer recently informed its steel suppliers that it expects to more than double its steel purchases this year. Part of this boost in demand is simply a matter of restocking and getting inventory back into the dealerships. Caterpillar has also visited some 500 suppliers to communicate its production forecast to them early. The company's main reason for doing so is to ensure that suppliers will be able to ramp up production when needed. In some cases, the company will even help its suppliers get needed financing.20

3. Segment your supply chain partners
Not all customers are alike when it comes to the value they bring to the organization. Thus, not all should be treated equally. Cobra Metal Works, for instance, has its so-called "Ten Commandments" that guides how it treats all customers (see Figure 2), yet the automotive supplier acknowledges that it takes extra care of some customers, such as those with whom it has long-term contracts.21

When considering how to work with customers during a downturn, it's important to view them in terms of their profitability and value as well as their compatibility with a company's future business direction. Otherwise companies run the risk of accepting unprofitable business that may seem attractive now but will prove troublesome when business conditions improve.

Cobra Metal Works subscribes to this principle. Even in these challenging times, it will not take on new business just to keep its plant running. Any orders it accepts must make good business sense. GW Plastics Inc., one of Takata's key suppliers of precision plastic parts, evaluates new customer opportunities very carefully, specifically targets desired customers, and declines new business that is not in line with its objectives and core competency, says Brenan Riehl, president and CEO. The company seeks longterm relationships with market leaders that are looking for supplier capabilities that align with GW's strengths.22

Similarly, not all suppliers are equal. Questions for buyers to consider include: Who are the key suppliers that are critical to your organization's survival? Who can help your organization succeed as it comes out of the recession? Some of the companies mentioned in this article said that they have taken advantage of shrinking business volumes as an opportunity to move business away from suppliers that had not been performing well.

Other types of supplier segmentation may also be relevant. For example, when Caterpillar chose to visit suppliers to talk about its growth plans, it considered the value of the goods it purchased from those suppliers when deciding which ones to visit. (The 500-odd suppliers eventually selected account for 80 percent of Caterpillar's purchases.) Like Takata, which has kept close watch on the financial liquidity of its key suppliers, Caterpillar is also conducting risk assessments of its supply base. It segments them by liquidity and pays special attention to those suppliers that exhibit liquidity risk.23

The economic downturn also presents an opportunity for suppliers to evaluate their customers' behavior. Some questions suppliers might ask themselves include: Which customers have been communicative and tried to share some of the burden of the downturn, rather than expect the supplier to absorb all the losses? Which customers have tried to initiate price wars among competing suppliers for their own short-term benefit? Which customers have made such tough demands that it is no longer profitable to serve them?

While it may not be financially viable to shed a troublesome customer at a time when business is down, suppliers can certainly note such behaviors and take them into consideration as business returns. Can you afford to retain this customer when business is good? Should this customer's priority move down the scale? Could you do well without this customer? These are difficult decisions to make, but they often become much clearer when a relationship has been under stress.

4. Cut back, but don't cut corners
As we have demonstrated throughout this article, when companies cut costs so much that they compromise customer service and product quality, they are doing themselves potentially permanent harm. The companies that will profit over the long term are those that seize the opportunity afforded by recession to make investments that will pay off when business recovers.

In 2009, BusinessWeek's annual evaluation of the best customer-service-oriented companies revealed that the leaders on that list were continuing to invest in customer service even during the recession. "If anything, the tough economy has made starker the difference between companies that put customers first and those that sacrifice loyalty for short-term gain," the researchers wrote.24 Among the winners on BusinessWeek's list were companies like United Services Automobile Association (USAA), JW Marriott Hotels and Resorts, and Charles Schwab & Co. Inc., all of which are crosstraining some of their employees so they will be able to provide improved service where it is needed, when it is needed.25

Refusing to compromise service quality could, in fact, give a company an edge when it comes to acquiring new business. An economic downturn may actually be a good time to win new customers that are not being well-served by competitors that are focusing more on cost control than on maintaining service and product quality.

In difficult times like these, it is important to remember that change includes both the element of threat and that of opportunity. Do not focus only on the threat and thereby miss potential opportunities. Instead, use this economic downturn to make the difficult decisions to shed marginal business, marginal suppliers, and marginal customers, and even marginal employees—without doing harm to the company's value proposition, suppliers, and customers. By doing so, your organization can emerge from the recession lean, agile, and ready to compete.

Endnotes
1. John T. Mentzer, William DeWitt, James S. Keebler, Soonhoong Min, Nancy Nix, Carlo Smith, and Z. Zacharia, "Defining Supply Chain Management," Journal of Business Logistics, 22/2 (2001): 14.
2. Mark Whitehouse and Timothy Aeppel, "Cost Cuts Lift Profits But Hinder Economy," Wall Street Journal, October 13, 2009.
3. 2009 Global Survey of Supply Chain Progress from CSC, Supply Chain Management Review, Council of Supply Chain Management Professionals, and Michigan State University.
4. Dan Farber and Christopher Lochhead, "Tips for Surviving the Market Meltdown," Cnet News. Retrieved from http://m.news.com/2166-1008_310060141-80.html on December 1, 2009.
5. Joe Wilcox, "BlackBerry Shipments Grew Five Times Faster Than iPhone in Q3," Betanews. Retrieved from www.betanews.com/joewilcox/ article/BlackBerry-shipments-grew-five-timesfaster- than-iPhone-in-Q3/1257447229 on December 1, 2009.
6. 1 World, 2 Wheels, "Change the World. Pledge to go by Bike," TREK. Retrieved from http://1world2wheels.org on December 1, 2009.
7. Phred Dvorak, "Clarity is Missing Link in Supply Chain," Wall Street Journal, May 18, 2009.
8. Ian Rowley, "Honda Moves into the Passing Lane," BusinessWeek, (October 8, 2009). Retrieved from www.businessweek.com/magazine/content/09_42/b4151057071523.htm on December 1, 2009.
9. "Honda Nearly Triples Profit Outlook," CNNMoney.com, (October 27, 2009). Retrieved from http://money.cnn.com/2009/10/27/news/international/honda_earnings.reut/index.htm.
10. Heather Green, "How Amazon Aims to Keep You Clicking," BusinessWeek on-line, (2009). Retrieved from www.businessweek.com/magazine/ content/09_09/b4121034637296.htm February 19th, on November 16, 2009.
11. Nick Wingfield, "Amazon Opens Wallet, Buys Zappos," Wall Street Journal on-line, (July 23, 2009). Retrieved from http://online.wsj.com/article/SB124829443610573361.html on November 16, 2009.
12. Ryan Beene and Tom Henderson, "Suppliers in Crisis: Parts Makers Face Peril in Industry Recovery," Crain's Detroit Business, September 28, 2009.
13. Lisa Ellram interview, September 30, 2009. The beverage company requested anonymity.
14. Chrissie Thompson, "Suppliers Ask for Government Aid, Citing More Financial Strife," Automotive News, September 24, 2009.
15. Bill Shrink, "12 Mistakes Business Should Avoid During a Recession," Shrinkage, (June 26, 2009). Retrieved from www.billshrink.com/blog/12-mistakes-businesses-should-avoid-during-a-recession.on December 1, 2009.
16. Lisa Ellram interview with Fred Heegan, Vice President of Takata, on October 26, 2009.
17. Lisa Ellram interview with Anton Hirsh, CEO of Cobra Metal Works, on December 4, 2009.
18. Hau Lee, "Taming the Bullwhip," Journal of Supply Chain Management 46/1� 2010, 4.
19. Ellram interview with Fred Heegan (2009).
20. Timothy Aeppel, "'Bullwhip' Hits Firms as Growth Snaps Back, MANAGEMENT, Wall Street Journal, January 27, 2010. Retrieved January 28 at http://online.wsj.com/article/SB10001424052748704509704575019392199662672.html
21. Ellram interview with Anton Hirsh (2009)
22. Lisa Ellram interview with Brenan Riehl, President of GW Plastics, on November 30, 2009.
23. Aeppel (2010)
24. Jena McGregor, Aili McConnon, and David Kiley, "Customer Service in a Shrinking Economy," BusinessWeek, February 19, 2009. Accessed January 13, 2010, at www.businessweek.com/magazine/content/09_09/b4121026559235.htm
25. Op. cit.

Lisa M. Ellram is Rees Distinguished Professor of Distribution at Miami University (Ohio). Wendy L. Tate is assistant professor of logistics at University of Tennessee, Knoxville. Susan L. Golicic is the director of the Supply Chain Forum and associate professor of management at Colorado State University’s College of Business

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