When you think of industries that are at the cutting edge of supply chain management, manufacturing-focused process industries, such as steelmaking, mining, or chemicals, typically are not the first to come to mind. In fact, the well-established "Gartner Supply Chain Top 25" ranking—which lists the best companies in terms of supply chain management across industries—has not featured any companies from process industries in at least 10 years.
Unlike their counterparts in consumer-focused industries, most companies in process industries have traditionally focused mainly on logistics and cost efficiency. However, the business environment is dramatically changing for process industries due to a host of new challenges, including increasing globalization, plunging commodity prices, shifts in demand to new markets, and technological advances. As a result, companies in process industries are now recognizing that the supply chain can provide a true competitive edge. More and more process companies are taking a holistic approach to supply chain management and are upgrading their capabilities to position their supply chain at the very core of the organization.1
Now companies in process industries are increasingly reorienting their supply chains to have a stronger service focus and to be able to react quickly and reliably to customer requirements. For example, in its response to a survey we recently conducted, the agrochemical company Syngenta said that supply chain management in its industry is undergoing a fundamental change as the industry becomes more of a "service business." Indeed, almost all (98 percent) of the companies we surveyed across a number of industries are currently implementing supply chain-related process frameworks such as vendor-managed inventory or collaborative planning, forecasting, and replenishment (CPFR).
Yet as process industry companies seek to implement supply chain best practices and frameworks, they must be careful. Most of the current supply chain models were inspired by industries that operate close to the end customer. Process industries, however, operate further down the value chain and deal with completely different constraints and planning cycles than do consumer industries.
Not every supply chain management strategy is applicable for every company or industry, and frameworks and best practices designed for consumer industries may not be appropriate for process industries. For instance, consumer electronics and apparel companies such as HP and Nike use offshoring of their manufacturing activities to respond to increasing price pressure. Yet mining firms in the iron ore business—which is also experiencing low prices and cost pressure—cannot apply the same principle. Likewise, the beauty products company L'OrÃ©al addressed excessive demand volatility by collaborating closely with its customers and even directly managing their inventory. By doing so, it succeeded in improving demand forecasting accuracy by 8 percentage points and its overall supply service level by about 3 percent during the period 2010 to 2014. In contrast, Borealis, a major European chemicals company, has to pursue an alternative approach, as it sells a significant share of its products on the spot market to anonymous buyers. So the question remains: How can supply chains in process industries excel?
There is broad agreement that excellent supply chain management starts with an aligned supply chain strategy.2 This means that the supply chain is set up to support the company's commercial strategy while taking internal and external constraints into account.3 The previous research that has documented the importance of supply chain alignment, however, has strongly focused on the consumer industries.4
This article seeks to redress this imbalance by outlining a matrix of four market archetypes that takes into account differences between process industries and consumer industries. Using this matrix, we have drawn from the results of a survey of senior supply chain managers to confirm the importance of market alignment across all industry types, including process industries. We also discuss another finding from our research: that strong demand forecasting capabilities enable excellent supply chain management in process industries. And finally, we suggest some practical actions companies in process industries can take to improve their supply chain performance.
Pricing power and strategic focus
As part of our efforts to develop the market-alignment framework described above, we carried out 24 in-depth interviews with senior supply chain managers in consumer and process industries to identify what factors determine their supply chain priorities. The interviews revealed a number of internal and external factors: supply and demand characteristics of the market, breadth of the product portfolio, customer and supplier requirements, and taxes and regulations, to name but a few. Despite the large number of influencing factors, we found that two predominant characteristics shape and set high-level supply chain strategy: pricing power (which occurs at the industry level) and strategic focus (which occurs at the company level).
In general, pricing power is determined by the degree of product differentiation in an industry. When a company sells commoditized products, the market sets the price of the product, and the company therefore has a low level of pricing power. When they sell differentiated products, companies have more power to set prices. From a strategic supply chain perspective, process industries generally correspond to commoditized products, whereas consumer industries have differentiated products. There are some segments where this rule does not apply. For example, specialty chemicals generally have a rather differentiated product portfolio. Pharmaceuticals, although often considered a process industry, is closer to consumer industries from a supply chain strategy point of view because of its high degree of product differentiation. But in general this characterization seems to hold true.
The strategic focus of a company reflects whether the company considers supply chain management to be a business driver or a cost center. (This is, of course, not set in stone and can change depending on the business context.) As a business driver (sales focus) the supply chain will be used to increase the company's top line, while as a cost center (cost focus) it will be designed to reduce expenditure.
For process industries, the main differentiator that influences whether a company chooses one approach or the other is contribution margin (the selling price per unit minus the variable costs per unit). That's because in process industries, companies generally have a low level of pricing power, and their contribution margin depends significantly on their position on the "cost curve" for that industry; in other words, where they rank among companies in their industry based on their production and transportation costs, which indicates their variable profit margin. Companies with low costs (and therefore high margins) will focus on responding quickly to price swings to increase their average sales price. Companies with high costs (and therefore low margins), by contrast, will focus on lowering their cost base through methods such as creating economies of scale and locating their facilities strategically.
In consumer industries, where products and product prices are differentiated, the decision about whether to adopt a "cost focus" or a "sales focus" is made differently. Companies can either choose to reduce costs related to obsolescence and lost sales through better demand planning, or they can strive to push volumes through customer-tailored offerings.
The four market archetypes
In cooperation with our interview partners, we defined four general types of markets, or market archetypes, based on the primary means of competition for industries within those markets. To reflect this competition aspect, we have termed them as follows: CAPEX Game, Agility Game, Market-Mediation Game, and Differentiation Game.
Next, we conducted a survey of 477 senior supply chain executives across 13 industries and asked them to estimate their industry's position along the two dimensions of pricing power and strategic focus. We then plotted the average for each industry, categorized according to the four main market archetypes. (See Figure 1.) From our research, we gained insights into what successful companies are doing to ensure superior supply chain performance. Below we summarize key considerations for each market archetype and provide some relevant comments from executives we interviewed.
A. CAPEX Game
Companies in process industries with low margin levels generally fit into the CAPEX archetype. (CAPEX refers to expenditures used to acquire and update fixed assets such as plants, properties, and equipment.) These companies focus on having a cost-efficient supply chain, and they will seek to capture economies of scale in terms of production and supply chain management. This can be achieved through producing big batch sizes, which allows them to pool quantities and to run manufacturing at consistently high utilization rates. At a conference, Sam Walsh, at the time chief executive of Rio Tinto's iron ore business, phrased it this way: "If we have excess capacity, we are wasting investment." According to executives at LafargeHolcim, a manufacturer of building materials, strategically choosing facility locations is also crucial. This enables companies to further lower variable costs by optimizing routing and transportation costs.
B. Agility Game
In process industries with high margin levels, companies will seek to increase average sales prices through having a highly responsive supply chain that is able to capture and respond to favorable price swings. Price volatility has reached record levels in several commodity markets in recent years. This is a major threat for many companies and is often named as their main future risk. But some companies in process industries, such as the commodity traders Noble Group and Trafigura, have adapted their business models to price volatility by increasing their responsiveness and reducing their time-to-market.
There are different approaches to responding to volatility, including increasing production flexibility, reducing lead times, building up speculation inventory, and changing to faster transportation modes. The fertilizer industry, in which low manufacturing flexibility meets high demand volatility, is an interesting case. Yara, Norway's largest fertilizer producer, explained that it smoothes demand swings related to increasing seasonal volatility by flexibly allocating volumes across an international footprint.
C. Market-Mediation Game
Consumer industries, such as tobacco, automotive, and apparel and textiles, that experience particularly high market-mediation costs (costs related to lost sales and product obsolescence) put a specific emphasis on improving demand forecasting. For example, the tobacco company Philip Morris International achieves forecasting accuracy of 85 percent at the stock-keeping unit (SKU) level, which is much higher than the 68 percent average for consumer industries. It does so through employing forward integration, incorporating point-of-sale data into its demand planning, and using vendor-managed inventory programs. Many companies in the apparel industry have chosen a different approach to reducing market-mediation costs—they have shortened their time-to-market (for example, by nearshoring and keeping operations in-house) and can rely on more precise, short-term forecasting horizons. As a result of these efforts, market-mediation companies generally have demand forecasting accuracy levels that are 6 percent higher than those of companies that are not in the market-mediation category.
D. Differentiation Game
Consumer industries with a particularly strong focus on customer interaction, such as consumer electronics, consumer goods, and food and beverages, generally fall into the Differentiation Game category. These companies place special emphasis on supply chain services and tailoring their offering to their clients' needs (for example, through smaller batch sizes and shorter delivery times) to push sales volumes. Their supply reliability is on average about 4 percentage points higher and their average delivery time about two days shorter than those of their market-mediation industry peers. Many of the companies we surveyed in these sectors started running key-account management programs to collaborate closely with their most important customers. L'OrÃ©al, for instance, initiated a collaboration initiative to "better manage supply networks and optimize inventory, cost, and service," according to a company executive.
The importance of market alignment
After developing the four archetypes, we used our survey results to investigate whether companies in process industries—like the more well-studied consumer industries—were more likely to achieve superior supply chain performance if they aligned and adapted their supply chain to their market archetype (Figure 2). In fact, we found that companies with a supply chain strategy that is aligned with their market archetype generally have better performing supply chains with better service levels at lower costs.
Respondents were asked to estimate the importance of eight market characteristics (capital intensity, capital costs, transportation costs, delivery time, price volatility, demand uncertainty, gross margin, and lead time) to their supply chain strategy. This ranking was expressed as a percentage—the higher the percentage, the more important is the factor for that market. A company's supply chain was considered to be aligned with a market archetype if at least four of these market characteristics were within a standard deviation of that market archetype's average.
After determining how well a respondent's supply chain aligned with its market archetype, we looked at the company's supply chain performance level. Supply chain performance was considered holistically, taking into account manufacturing (overall equipment effectiveness rate, transportation costs, and stock holding costs), demand planning (forecasting accuracy and portfolio management), market understanding (price forecasting and market monitoring), and service level (delivery time and supply reliability).
Our research found a clear correlation between market alignment and strong supply chain performance. Figure 2 indicates that a process industry company with a supply chain strategy that is aligned with its market archetype has a 125 percent higher likelihood of achieving superior supply chain performance (defined as higher service level at lower cost). This positive effect could be observed for both types of process industries: those with a cost-efficient supply chain (CAPEX Game) and those with a responsive supply chain (Agility Game).
Furthermore, as shown in Figure 2, our research found that the effect of market alignment on performance is considerably stronger for process industries than it is for consumer industries. We assume this is because of the relative importance of supply chain performance to the overall customer experience for process industries. In those industries, where product and supply conditions are standardized and easily comparable, factors such as on-time delivery are even more crucial than for most consumer industries, where many other factors, such as after-sales service, also play a role.
The road to improvement
While our research showed the importance of market alignment, it also indicated significant room for improvement. Currently only about one-third of process industry companies in our survey sample are market-aligned, which is about 40 percent lower than those in consumer industries. This indicates that the improvement potential is substantial.
Indeed, nearly 80 percent of surveyed firms are now reinforcing capabilities in areas where they have the most accentuated misalignments. For example, an African cement producer (considered to be in the CAPEX market archetype) has increased its average delivery times, making it possible to increase batch sizes and reduce transportation costs while improving its supply chain reliability level.
But how can a company in a process industry align its supply chain in practice, when product portfolios are often broad and have distinct requirements? Companies may be operating in some markets that follow more of a CAPEX Game (cost-focused) while at the same time operating in others that require more of an Agility Game (service-focused).
In reality, supply chain alignment has to happen at a granular level. Companies carrying a broad product portfolio and serving a diverse customer base must align their supply chain by product line and customer segment. The fertilizer manufacturer Yara, for example, regularly surveys its customer base to redefine its supply chain service levels. The diversity of its product portfolio and its clients' requirements led the company to run distinct supply chains in parallel (using different transportation modes, for example).
Specialty chemicals and pulp and paper companies are taking the lead in implementing this strategy. Overall, however, only 32 percent of the surveyed companies in process industries are implementing programs to segment their supply chain service levels in cooperation with their clients. Importantly, about 80 percent of these companies have achieved superior supply chain performance.
The importance of good demand forecasting
According to Richard Markoff, corporate supply chain standards and audits director at L'OrÃ©al, "Nothing is more important in supply chain management than demand forecasting." And indeed, as previously noted, the second main success factor we found was strong demand forecasting capabilities. Our research shows that in process industries, too, demand forecasting acts like the proverbial "rising tide that lifts all boats," improving companies' supply chain performance.
This makes sense, as the effects of demand planning on the supply chain are wide-ranging. Stockouts are reduced and delivery times are shortened because of more accurate predictions, safety-stock levels can be reduced because of lower demand uncertainty, and production and transportation costs are reduced because of increased and smoothed manufacturing utilization.
Figure 3 indicates the relationship between forecasting accuracy and the likelihood of great supply chain performance in terms of service and cost. It is clear that companies with superior demand forecasting capabilities achieve higher service levels at lower cost. This holds true not only for the consumer-focused Market-Mediation and Differentiation categories, but also for the cost-efficient (CAPEX Game) and responsive (Agility Game) supply chains that characterize process industries.
The positive impact of improved demand forecasting may be undeniable, but it is difficult to achieve in process industries, where lead times and required forecasting horizons typically are long. A senior operations executive of the specialty chemicals company Clariant International stated, "... in the current market environment, where demand is global and with high price volatility, reaching demand planning accuracy above 70 percent is not feasible for us."
Researchers have developed various frameworks for improving demand forecast accuracy that generally are based either on pooling demand or on reducing the length of the forecasting horizon. However, only some of those principles, which are commonly applied in consumer industries, can effectively be transferred to process industries. For instance, process industries such as steelmaking and mining manufacture their commodities using continuous-flow production. Therefore, principles such as mass customization and postponement (that is, delaying the moment at which a product becomes customer-specific) are not applicable. Another concept, found in the apparel industry, is to constantly rotate the product portfolio and rely on short forecasting horizons. But process industries generally have long product lifecycles and a high percentage of product-specific assets, and therefore cannot simply roll over their portfolios.
But that does not mean process industries cannot improve their demand forecast accuracy. Consider this example from the pulp and paper industry. By reducing lead times as a result of more flexible production equipment (continuous mixers, in this case) and implementing quick-response manufacturing (an approach that emphasizes the beneficial effect of reducing internal and external lead times), pulp and paper companies can achieve more accurate short-term demand forecasts. Another example is portfolio rationalization, which is used by about one in five process industry companies in our sample. The principle is the same as for centralized stock: demand pooling leads to lower variance (on an aggregated demand level), and thus higher forecasting accuracy.
However, the most powerful method we found for companies in process industries to effectively increase their demand planning accuracy was monitoring the market and improving their capability to predict price development of both raw materials and output materials. (See Figure 4.) Companies in our survey were asked about their capability to predict price developments for the coming six months, both for the products they procured and for the products that they sold. We found that, among all the methods companies commonly applied to predict prices, having an internal trading organization that follows the markets closely to enhance their understanding of market dynamics was the strongest lever for improving demand forecasting accuracy. Process industry companies that sell or procure commodities heavily in spot markets often build such organizations.
Discussions with managers revealed that the low pricing power in commodity markets (for example, crude oil) is the reason price prediction is a particularly powerful lever for improving demand forecasting in process industries. The link between supply, demand, and pricing is especially direct in commodity-dependent process industries; in addition, competitors' actions have a direct impact in a market where companies have low pricing power. Companies that monitor and try to understand both the market and their competitors—with the objective of anticipating price movements—inherently gain insights into the demand/supply balance. This ultimately leads to better sales forecasting and superior supply chain management performance.
The transformation is underway
Supply chain management in process industries still lags behind consumer industries when it comes to market alignment and demand forecast accuracy. However, companies in process industries have recognized that the supply chain can be a true competitive edge; accordingly, they are upgrading their capabilities at full speed and are investing the necessary resources to do so. For example, the Saudi petrochemical manufacturing company SABIC told us that it is transforming its logistics unit into a holistic supply chain management function operating at the core of the company. BASF, the German chemicals company, has considerably scaled up its talent pool in supply chain management to support the transformation toward a supply chain segmented by customer and product group. A senior manager from Syngenta mentioned that instead of transferring generalists from other departments into supply chain management positions, today the company invests in hiring managers with degrees from the best business schools specifically for supply chain positions.
As they make such investments, however, companies in process industries need to make sure they are implementing appropriate best practices. Although today there is a lot of emphasis on dynamic supply chain management to keep up with the ever-changing global environment, focus and simplicity are also important, particularly for companies in process industries. We found that those with the most effective supply chains concentrate on leveraging their own functional strengths coupled with meeting the emerging demands of their markets.
To be successful they must also implement models that will work for their particular industry or market segment. Based on our findings, about 80 percent of process industry companies that try to achieve superior supply chain performance by taking a granular approach to product and customer segmentation are successful. An even higher proportion—nearly 90 percent—of process industry companies that are monitoring market and price developments achieve superior supply chain performance. These numbers show that even though they cannot apply all of the same frameworks as consumer industries, process industry companies can still compete strongly in the supply chain excellence rankings.
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