Companies that manufacture high-tech products generally have well-developed supply chains and have consistently been recognized for their efficiency. In 2010, for example, six of the top 10 supply chains rated by the research firm Gartner Inc. came from the technology sector.
That is a notable achievement when you consider that the high-tech industry has several unique characteristics that create challenges for supply chain managers. First and foremost, technology products have a short shelf life and a high rate of obsolescence, requiring precise management of inventory and suppliers. Consumer preferences shift rapidly, further compounding this problem and contributing to continued demand volatility. Products like computers and mobile devices, moreover, have relatively high values and require secure supply chains for transportation and distribution.
To address those supply chain challenges and help them compete effectively, technologybased businesses have five "tools," or "levers," at their disposal: adjusting the mix of transportation modes for shipments, postponement of some production steps, regional consolidation of facilities, rerouting shipments, and "rightshoring" operations to bring them closer to consumer markets. High-tech companies can choose the best combination of these tools by taking a holistic view of their businesses, and then defining their most important success factors in both emerging and mature markets. Make the correct choices, and they will be rewarded with supply chain cost savings of as much as 40 percent.
Technology supply chains under pressure
To understand why high-tech companies need to apply those tools today, it's helpful to look at some of the industry trends that are pressuring them to review their supply chain decisions more carefully. These include declining revenue per unit, higher rate of product obsolescence, fluctuating consumer demand, the increasing effect of supply chain disruptions on shareholder value, and changing consumer demographics.
Declining revenue per unit. Consumers worldwide expect low prices, and the resulting continuous reduction in selling prices is clearly reflected in manufacturers' and retailers' revenue per unit. A good example is the market for personal computers, where average selling prices have dropped over most of the last 10 years, from US $795 in November 2007 to a low of $580 in November 2009 before rising slightly in 2010.
Higher rate of obsolescence. The shelf life of high-tech products continues to shrink at an increasingly fast pace. For many electronic devices, an estimated 50 percent of the profit comes in the first six months of their lifecycle. This creates an incentive for companies to constantly innovate, move products quickly, and increase inventory turns. Products increasingly are sold online or built-to-order, while retail channel growth has slowed. A supply chain strategy must be flexible enough to service both without compromising on the needs of either.
Fluctuating consumer demand. Because consumer demand is closely tied to economic conditions, it is vulnerable to significant events such as the global economic downturn. In 2009, for example, personal computer sales worldwide declined by 4 percent. Desktops and servers also saw a 10-percent decline in the number of units shipped. Creating supply chains that can expand and contract with demand has become critical for achieving profitability.
Effects of disruptions on shareholder value. Investors are recognizing the value of an efficient, well-managed supply chain. As a result, supply chain disruptions can have a negative impact on a company's stock price. In the technology industry, for example, such disruptions have caused an average 8.4-percent decline in stock prices, the highest among several industries studied by researchers at the Georgia Institute of Technology.
Changing consumer demographics. The traditional target customer has changed. The technology sector has seen much slower growth in mature markets such as the United States, the European Union, and Japan, while achieving double-digit growth in emerging markets like India and China. Overall sales of mobile devices in emerging markets, for example, are expected to reach a 6.8-percent compounded annual growth rate (CAGR), while developed markets are projected to grow at only a 2-percent CAGR.
This shift of demand to emerging markets requires technology companies to reevaluate their product flows and network strategies. However, there are several supply chain challenges inherent to rapid growth in emerging markets, including lower quality of infrastructure, rising labor costs, environmental considerations, and political, legal, and currency risks.
Five levers for effective supply chains
To balance the tradeoffs, risks, and constraints outlined above and to be prepared for the future, hightech companies must take a comprehensive view of their business. Tradeoffs among cost effectiveness, speed to market, flexibility, and reliability (shown in Figure 1) may lead to different solutions in different regions and countries. It is therefore essential to clearly define and prioritize supply chain objectives along these parameters.
Once the key priorities have been defined, companies should consider using one or more of the levers shown in Figure 2 to optimize their supply chains, depending on their individual situations. These tools should not be implemented in isolation, and often a combination of them is required to achieve optimal outcomes. Let us consider each of them, including real-life examples of improvements that our clients have achieved by employing these recommendations.
Mode mix: Identifying the correct combination of transportation modes (road, rail, ocean, and air) for freight movements can increase the overall cost effectiveness of shipping activities. Based on our company's experience of current international port-to-port rates (and depending on the lane), moving a sample shipment of 1,000 kilograms/4.5 cubic meters via ocean instead of air can result in an 85- to 95-percent reduction in direct cost.
However, any company that switches to a slower transportation mode must have excellent supply chain planning and be sure to take inventory costs into consideration. In the case of ocean shipping, for example, transit time (in days) correspondingly increases by a factor of between 4 and 6 compared to air. For example, in the current market, shifting from air to ocean freight on the Shanghai-to-Los Angeles lane can result in direct savings in freight cost of about 95 percent. However, port-to-port transit time increases from three days (air freight) to 16 days (ocean freight).
Consolidation: The second tool to consider, consolidation, has gained considerable interest as more companies utilize regional supply chains in order to increase flexibility. This can mean establishing operations in suitable locations to reduce the average distance needed to service regional operations, and at the same time consolidating and centralizing some processes (such as manufacturing and distribution) in favorable countries.
In one company's case, for example, consolidating local warehouses located across Asia into a regional distribution center in Singapore allowed for better planning and coordination of product flow so the company could split its supply chain model based on product characteristics.
In another case, a large international consumer electronics manufacturer used consolidation to address high indirect costs in its European supply chain due to overstocking of inventory. The company was able to optimize its European distribution network, including assembly and warehousing, by rerouting shipments and maximizing direct distribution from Eastern European facilities.
In this company's original scenario, items were produced in Asia and shipped to Eastern Europe for final assembly and distribution. After final assembly, products were shipped to warehouses in each country served in Europe. Quick replenishment was required with a lead time of one to three days to deliver products from the assembly plants to the warehouses.
After assessing several options, the company added a central distribution center in Eastern Europe and routed all of its shipments through that facility. Because this new approach allowed the company to better control the product mix in the regional warehouses, it had a positive impact on product shelf life and resulted in only a slight increase in lead time. Additionally, the company was able to ship directly from the central distribution center to a larger number of major retailers. This reduced lead time for certain customers and reduced overall inventory costs. These results are illustrated in Figure 3, and the tradeoffs are shown in Figure 4.
Postponement: Increased use of postponement strategies can reduce volatility in inventory and shipment volume by delaying certain processes and completing them at later points in the supply chain. For example, final boxing and kitting can be completed in the country where the product will be distributed. Minor differentiation in packaging (such as peripherals included with the product) can also be handled in the destination country. In addition, this creates the opportunity to increase local sourcing and reduce transportation costs. For example, a personal computer could be shipped from a manufacturing site in Asia, but peripherals like keyboards, mice, and speakers could be sourced locally and packaged together in the final country of sale.
One consumer electronics company in Latin America, for example, reduced volatility in inventory and shipment volume by postponing boxing and final packaging. Initially, the company supplied Latin America with finished goods that were packaged in Asia, shipped to a distribution center in the United States, and then transported to the ultimate destination. Almost all sourcing was done in Asia, with a small amount from intraregional sources. This process resulted in a lead time of six to 20 days from the date of order entry. The long lead times led to high indirect costs for inventory and obsolescence. More steps in the supply chain also meant a greater risk of disruption.
Increasing local sourcing of components and peripherals from within Latin America led to faster time to market, resulting in a reduction of approximately 30 percent in obsolescence costs. Moreover, postponing assembly and assembling the final product at receiving facilities in the country of sale reduced the lead time to between two and four days after the date of order entry. Overall, the company was able to find cost savings of 40 percent through these measures. These results are illustrated in Figure 5, and the tradeoffs are shown in Figure 6.
Rerouting: Changing the route of a particular supply chain leg can reduce transportation and inventory costs while increasing speed to market. The benefits of this relatively simple change can be substantial. For example, one multinational software company was able to achieve 24-percent cost savings and a 37percent reduction in lead time by routing its shipments more efficiently.
In the original scenario, the company shipped orders daily from manufacturing sites in Asia to storage in Hong Kong, where they awaited weekly shipment to distribution centers in the United States and Europe via ocean freight. The distribution centers served regional markets via truck and rail. As a result of this system, roughly 70 percent of the company's total costs were indirect costs for inventory holding and obsolescence.
With the objective of reducing this percentage, the software maker analyzed the effects of utilizing different levers on optimization scenarios. Those analyses showed that a combination of consolidation and direct shipment would yield the highest potential cost savings. Accordingly, the company rerouted 30 percent of its shipments from the manufacturing facilities directly to European customers, and 70 percent continued to ship through distribution centers as before. The company also changed its shipping frequency so shipments did not need to wait in storage for the vessels on which they were booked, but could instead be transported on the next sailing that had capacity. All of the above measures together resulted in a 37-percent reduction in lead time and a 24-percent savings in total cost, mainly due to reductions in inventory holding and obsolescence costs. These results are illustrated in Figure 7, and the tradeoffs are shown in Figure 8.
Rightshoring: The fifth lever, "rightshoring," involves taking total landed cost into consideration in order to determine the optimal location of distribution centers and plants for serving a particular market. Not only can rightshoring help companies reduce costs in certain cases, but it can also reduce supply chain complexity.
Several factors are causing companies to go down this path: regulatory changes, the need for faster time to market, and erosion of cost or labor advantages in countries such as China and India. For example, we are seeing an increase in sourcing from Mexico into the United States and from Eastern Europe into Western Europe. This effect is further compounded by other factors such as increasing fuel prices and a growing focus on reducing carbon emissions in supply chains.
We estimate that even with a 15- to 20-percent premium compared to Asia, manufacturing in Eastern Europe for Western European markets would still be a viable option. This advantage is mainly driven by lower transport costs and responsiveness of the replenishment cycle.
This strategy is becoming increasingly popular. A recent Financial Times article identified a number of large companies that are investigating locating component manufacturing closer to end markets. Philips, for example, is now sourcing from Eastern Europe, and Boeing is using some Mexican suppliers. In addition, some high-tech manufacturers are already operating a dual sourcing model, manufacturing in both Asia and Europe.
The value of success
High-tech companies today need to achieve faster speed-to-market to reduce losses due to obsolescence. An appropriate combination of the five major tools allows technology companies to optimize their supply chains to achieve prioritized objectives. By using a combination of the five levers described in this article, moreover, they will have the tools they need for tailoring their supply chains to meet the particular needs of each geographical area where they operate and sell their products.
Supply chain managers should not underestimate the potential impact of this commonsense approach. In our experience, and as demonstrated in the customer examples in this article, implementing the right combination of levers can produce a reduction of up to 33 percent in inventory cost mainly due to lower average lead times, and a total possible cost savings of up to 40 percent.