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MANAGEMENT

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LOGISTICS & SUPPLY CHAIN MANAGEMENT

MARTIN CHRISTOPHER

FOURTH EDITION

LOGISTICS & SUPPLY CHAIN M ANAGEM

ENT M ARTIN CHRISTOPHER

Effective design and management of supply chain networks can cut costs and enhance customer value. The supply chain can be a sustainable source of advantage in today’s turbulent global marketplace, where demand is diffi cult to predict and supply chains need to be more fl exible as a result.

In fact, the real competition today is not between companies, but between supply chains. The winning approach to supply chains is an integrated perspective that takes account of networks of relationships, sustainability and product design, as well as the logistics of procurement, distribution, and fulfi lment. Logistics & Supply Chain Management examines the tools, core processes and initiatives that ensure businesses can gain and maintain competitive advantage.

This updated fourth edition of the bestselling Logistics & Supply Chain Management is the practical guide to all the key topics in an integrated approach to supply chains, including: • The link between logistics and

customer value

• Logistics and the bottom line – measuring costs and performance

• Creating a responsive supply chain

• Managing the global pipeline

• Managing supply chain relationships

• Managing risk in the supply chain

• Matching supply and demand

• Creating a sustainable supply chain

• Product design in the supply chain

Martin Christopher is Emeritus Professor of Marketing and Logistics at Cranfi eld School of Mangement, a leading UK business school. He has written numerous books and articles and is on the editorial advisory board of several professional journals. Until recently he was co- editor of The International Journal of Logistics Management and his latest books have focused upon relationship marketing, logistics and supply chain management.

He has held appointments as Visiting Professor at universities around the world. Professor Christopher is a Fellow of The Chartered Institute of Marketing, The Chartered Institute of Logistics and Transport and The Chartered Institute of Purchasing & Supply. In 1987 he was awarded the Sir Robert Lawrence medal of The Chartered Institute of Logistics and Transport for his contribution to the development of logistics education in Britain. In 2005 he was awarded the Distinguished Service Award of the USA Council for Supply Chain Management Professionals. In 2007 he was designated as Foundation Professor by The Chartered Institute of Purchasing & Supply. Martin has also worked as a consultant for major international companies in North America, Europe, the Far East and Australasia.

www.martin-christopher.info

‘For many years now, Martin Christopher’s book has been my default recommendation to anyone seeking to acquire a quick yet comprehensive grasp of supply chain issues and management. Whether you are a recent entrant to the fi eld or a seasoned practitioner looking for inspiration, this book is for you!’ Bjorn Vang Jensen, Vice President, Global Logistics, Electrolux

‘You must read this book for his assessment of the challenges that lie ahead.’ Dr John Gattorna, supply chain ‘thought leader’ and author of Dynamic Supply Chains

‘A powerful book for executives and practitioners. It emphasises the “end-to-end” view of supply chains, focusing on both cost effi ciency and value creation. The principles and concepts are illustrated with practical examples and applications. It is a great contribution.’ Professor Hau Lee, Stanford Graduate School of Business, USA

Design: Dan Mogford

The fourth edition has been updated and now contains four new chapters covering:

• MANAGING SUPPLY CHAIN RELATIONSHIPS

• PRODUCT DESIGN IN THE SUPPLY CHAIN

• MATCHING SUPPLY AND DEMAND

• CREATING A SUSTAINABLE SUPPLY CHAIN

Logistics & Supply Chain Management

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Logistics & Supply Chain Management

Fourth Edition

Logistics & Supply Chain Management

Fourth Edition

M A R T I N C H R I S T O P H E R[ ]

PEARSON EDUCATION LIMITED

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First published in Great Britain in 1992 Second edition 1998 Third edition 2005 Fourth edition 2011

© Pearson Education Limited 2011

The right of Martin Christopher to be identified as author of this work has been asserted by him in accordance with the Copyright, Designs and Patents Act 1988.

All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without either the prior written permission of the publisher or a licence permitting restricted copying in the United Kingdom issued by the Copyright Licensing Agency Ltd, Saffron House, 6–10 Kirby Street, London EC1N 8TS. This book may not be lent, resold, hired out or otherwise disposed of by way of trade in any form of binding or cover other than that in which it is published, without the prior consent of the Publishers.

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ISBN: 978-0-273-73112-2

British Library Cataloguing-in-Publication Data A catalogue record for this book is available from the British Library

Library of Congress Cataloging-in-Publication Data Christopher, Martin. Logistics and supply chain management : creating value-adding networks / Martin Christopher. -- 4th ed. p. cm. Includes index. ISBN 978-0-273-73112-2 (pbk.) 1. Business logistics--Cost effectiveness. 2. Delivery of goods--Management. I. Title. HD38.5.C46 2011 658.5--dc22 2010033709

11 10 9 8 7 6 5 4 3 2 1 14 13 12 11 10

Typeset in Swiss Light 9.25 pt/12 pt by 30 Printed and bound in Great Britain by Henry Ling Ltd, Dorchester, Dorset

Martin Christopher is Emeritus Professor of Marketing and Logistics at Cranfield School of Management in the United Kingdom. His work in the field of logistics and supply chain management has gained international recognition. He has pub- lished widely and his books have been translated into many languages. Martin Christopher co-founded the International Journal of Logistics Management and was its joint editor for 18 years. He is a regular contributor to conferences and work- shops around the world. In addition to working with many companies in an advisory capacity he is also a Visiting Professor at universities in the UK, Australia, Spain and Sweden. Martin Christopher is an Emeritus Fellow of the Chartered Institute of Logistics and Transport. He is also a Fellow of the Chartered Institute of Purchasing and Supply and a Fellow of the Chartered Institute of Marketing. He is the recipient of the Distinguished Service Award of the USA Council of Supply Chain Management Professionals.

About the author

v

About the author v

Preface x

Publisher's acknowledgements xi

1 Logistics, the supply chain and competitive strategy 1 Supply chain management is a wider concept than logistics 2 Competitive advantage 4 The supply chain becomes the value chain 9 The mission of logistics management 11 The supply chain and competitive performance 13 The changing competitive environment 15

2 Logistics and customer value 27 The marketing and logistics interface 28 Delivering customer value 29 What is customer service? 31 The impact of out-of-stock 33 Customer service and customer retention 34 Market-driven supply chains 38 Defining customer service objectives 42 Setting customer service priorities 46 Setting service standards 50 3 Measuring logistics costs and performance 57 Logistics and the bottom line 58 Logistics and shareholder value 62 Logistics cost analysis 66 The concept of total cost analysis 67 Principles of logistics costing 70 Customer profitability analysis 72 Direct product profitability 78 Cost drivers and activity-based costing 80

4 Matching supply and demand 83 The lead-time gap 83 Improving the visibility of demand 85 The supply chain fulcrum 87 Forecast for capacity, execute against demand 89 Demand management and planning 89 Collaborative planning, forecasting and replenishment 94

Contents

vii

viii contents

5 creating the responsive supply chain 99 Product 'push' versus demand 'pull' 104 The Japanese philosophy 109 The foundations of agility 112 A routemap to responsiveness 116

6 strategic lead-time management 121 Time-based competition 121 Lead-time concepts 125 Logistics pipeline management 129

7 the synchronous supply chain 141 The extended enterprise and the virtual supply chain 142 The role of information in the virtual supply chain 144 Laying the foundations for synchronisation 147 'Quick response' logistics 150 Production strategies for quick response 153 Logistics systems dynamics 154

8 complexity and the supply chain 159 The sources of supply chain complexity 161 The cost of complexity 165 Product design and supply chain complexity 166 Mastering complexity 167

9 Managing the global pipeline 171 The trend towards globalisation in the supply chain 173 Gaining visibility in the global pipeline 178 Organising for global logistics 180 Thinking global, acting local 184 The future of global sourcing 185

10 Managing risk in the supply chain 189 Why are supply chains more vulnerable? 190 Understanding the supply chain risk profile 193 Managing supply chain risk 198 Achieving supply chain resilience 206

11 the era of network competition 211 The new organisational paradigm 212 Collaboration in the supply chain 214 Managing the supply chain as a network 217 Seven major business transformations 218 The implications for tomorrow's logistics managers 220

viii

contents ix

Supply chain orchestration 222 From 3PL to 4PL™ 223

12 overcoming the barriers to supply chain integration 227 Creating the logistics vision 228 The problems with conventional organisations 228 Developing the logistics organisation 232 Logistics as the vehicle for change 236 Benchmarking 237

13 creating a sustainable supply chain 241 The triple bottom line 241 Greenhouse gases and the supply chain 243 Reducing the transport-intensity of supply chains 245 Peak oil 247 Beyond the carbon footprint 248 Reduce, reuse, recycle 250 The impact of congestion 252

14 the supply chain of the future 257 Emerging mega-trends 258 Shifting centres of gravity 259 The multi-channel revolution 261 Seeking structural flexibility 264 2020 vision 266

Index 269

ix

Preface

When the first edition of this book was published in 1992, supply chain management as an idea was still in its infancy and relatively few companies had made it a priority. The same was true for logistics management, although its precursor, distribution management, was increasingly being recognised as important both in terms of cost and for its potential impact on sales. In the intervening years from the first to the fourth edition, many things have hap- pened. Firstly, there is now a much greater understanding of the role that supply chain management plays in creating competitive advantage. Whereas previously the focus was primarily tactical with a concern for optimising costs, now there is much more of a strategic focus with the emphasis on value creation and delivery. The second major change is the recognition that supply chain management is not just an extension of logistics management, but rather that it is about managing relationships across the complex networks that today's supply chains have become. A third significant change over that period is that the business environment has become a lot more volatile and hence less predictable. This transition from a rela- tively stable world to one that is much more turbulent requires supply chains to be capable of changing rapidly to meet changed circumstances. These changes are reflected in the additional material included in this new edition. Thus complexity management and the challenge of making the transition from a forecast-driven to a demand-driven business model are given greater emphasis. As ever, I have been greatly influenced in my thinking by the ideas and contri- butions of colleagues. I have had the privilege over the years to work with many academics and practitioners around the world who have provided me with inspira- tion as well as feedback on my ideas on how modern supply chains should be designed and managed. Long-standing collaborators include Alan Braithwaite, Chairman of LCP Consulting, Professor John Gattorna of Macquarie University, Australia, Professor Douglas Lambert of Ohio State University, USA and Professor Denis Towill of Cardiff University, UK. More recently I have benefited greatly from sharing ideas with Dr Omera Khan of Manchester University, UK, Dr Matthias Holweg of Cambridge University, UK and Dr Janet Godsell and Dr Uta Jüttner, both colleagues at Cranfield University. I thank them all. Finally I want to thank Tracy Stickells who has skilfully managed the production of the manuscript for this book – a complex logistics process in itself.

MARTIN CHRISTOPHER EMERITUS PROFESSOR OF MARKETING & LOGISTICS

CENTRE FOR LOGISTICS AND SUPPLY CHAIN MANAGEMENT CRANFIELD UNIVERSITY, UK

x

xi

Publisher's Acknowledgements

We are grateful to the following for permission to reproduce copyright material:

Figures Figure 1.7 from Competitive Advantage, The Free Press (Porter, M.E. 1985), Reprinted with the permission of The Free Press, a Division of Simon & Schuster, Inc., from COMPETETIVE ADVANTAGE: Creating and Sustaining Superior Performance by Michael E. Porter. Copyright © 1985, 1998 by Michael E. Porter. All rights reserved.; Figure 1.9 from Integrating the Supply Chain, International Journal of Physical Distribution and Materials Management, 19 (8) (Stevens, G.C. 1989), International Journal of Physical Distribution and Logistics Management by Scott, C. and Westbrook, R. Copyright 1991 by EMERALD GROUP PUBLISHING LIMITED. Reproduced with permission of EMERALD GROUP PUBLISHING LIMITED in the format Textbook via Copyright Clearance Center. ; Figure 2.2 from 'Stock-outs cause walkouts', Harvard Business Review, May (Corsten, D. and Gruen, T. 2004); Figure 3.10 from Logistics – The Battleground of the 1990s, A.T. Kearney (Hill, G.V.); Figure 3.11 from Managing the Supply Chain: A Strategic Perspective, Macmillan Press (Gattorna, J.L. and Walters, D.W. 1996); Figure 6.13 from 'New strategic tools for supply chain management', International Journal of Physical Distribution of Logistics Management, 21 (1) (Scott, C. and Westbrook, R. 1991), Emerald; Figure 9.3 from Supply Chain Resilience, Report on behalf of the Department of Transport, Cranfield School of Management (2003)

Tables Table on page 74 from 'The Customer Profit Centre', Focus, 2 (2) (Hill, G.V. and Harland, D.V. 1983), Institute of Logistics and Distribution Management; Table 10.1 from Supply Chains in a Vulnerable, Volatile World, A.T. Kearney (2003)

Text Quote on page 136 from The Scotsman, 14/02/2007; Extract on page 160 from The Times, 21/04/2010; Extract on page 186 from Disenchanted companies begin moving production back to UK, The Times, 30/12/2009; Article on page 195 from Supply Chains in a Vulnerable, Volatile World (A.T. Kearney 2003); Article on page 244 from 12,000-mile round trip to have seafood shelled, Daily Telegraph, 16/11/2006, © Telegraph Media Group Limited 2006; Extract on page 244 from Mastering Carbon Management: Balancing Trade-Offs to Optimise Supply Chain Efficiencies, IBM Global Services (Butner, K., Geuder, D. and Hittner, J. 2008), Reprint courtesy of International Business Machines Corporation, © 2008 International Business Machines Corporation; Extract on page 252 from Supply Management, 15 February 2007, www.supplymanagement.com; Extract on page 254 from 'Intelligent Transport Systems', Postnote, January, No. 322 (UK Parliamentary Office of Science and

Technology 2009), Crown Copyright material is reproduced with permission under the terms of the Click-Use Licence; Extract on page 260 from 'Global Trends in Energy', The McKinsey Quarterly, January 2007 (Bozon, I.J.H., Campbell, W.J. and Lindstrand, M.), Excerpt from “Global Trends in Energy”, January 2007, McKinsey Quarterly, www. mckinseyquarterly.com. Copyright (c) 2010 McKinsey & Company. All rights reserved. Reprinted by permission. ; Article on page 261 from Web-savvy housewives sabotage efforts to save Japan's economy from stagnation, The Times, 02/04/2010

In some instances we have been unable to trace the owners of copyright material, and we would appreciate any information that would enable us to do so.

Publisher's acknowledgementsxii

1

Logistics and supply chain management are not new ideas. From the building of the pyramids to the relief of hunger in Africa, the principles underpinning the effec- tive flow of materials and information to meet the requirements of customers have altered little. Throughout the history of mankind wars have been won and lost through logistics strengths and capabilities – or the lack of them. It has been argued that the defeat of the British in the American War of Independence can largely be attributed to logistics failure. The British Army in America depended almost entirely upon Britain for sup- plies. At the height of the war there were 12,000 troops overseas and for the most part they had not only to be equipped, but fed from Britain. For the first six years of the war the administration of these vital supplies was totally inadequate, affecting the course of operations and the morale of the troops. An organisation capable of sup- plying the army was not developed until 1781 and by then it was too late.1

In the Second World War logistics also played a major role. The Allied Forces’ invasion of Europe was a highly skilled exercise in logistics, as was the defeat of Rommel in the desert. Rommel himself once said that ‘… before the fighting proper, the battle is won or lost by quartermasters’.

Logistics, the supply chain and competitive strategy

1 MM Supply chain management is a wider concept than

logistics

MM Competitive advantage

MM The supply chain becomes the value chain

MM The mission of logistics management

MM The supply chain and competitive performance

MM The changing competitive environment

However, whilst the Generals and Field Marshals from the earliest times have understood the critical role of logistics, strangely it is only in the recent past that business organisations have come to recognise the vital impact that logistics man- agement can have in the achievement of competitive advantage. Partly this lack of recognition springs from the relatively low level of understanding of the benefits of integrated logistics. As early as 1915, Arch Shaw pointed out that:

The relations between the activities of demand creation and physical supply … illustrate the existence of the two principles of interdependence and balance. Failure to co-ordinate any one of these activities with its group-fellows and also with those in the other group, or undue emphasis or outlay put upon any one of these activities, is certain to upset the equilibrium of forces which means efficient distribution. … The physical distribution of the goods is a problem distinct from the creation of demand … Not a few worthy failures in distribution campaigns have been due to such a lack of co-ordination between demand creation and physical supply … Instead of being a subsequent problem, this question of supply must be met and answered before the work of distribution begins.2

It is paradoxical that it has taken almost 100 years for these basic principles of logistics management to be widely accepted. What is logistics management in the sense that it is understood today? There are many ways of defining logistics but the underlying concept might be defined as:

Logistics is the process of strategically managing the procurement, move- ment and storage of materials, parts and finished inventory (and the related information flows) through the organisation and its marketing channels in such a way that current and future profitability are maximised through the cost-effective fulfilment of orders.

This basic definition will be extended and developed as the book progresses, but it makes an adequate starting point.

Supply chain management is a wider concept than logistics

Logistics is essentially a planning orientation and framework that seeks to create a single plan for the flow of products and information through a business. Supply chain management builds upon this framework and seeks to achieve linkage and co-ordination between the processes of other entities in the pipeline, i.e. suppliers

LOGISTICS & SUPPLY CHAIN MANAGEMENT2

It is only in the recent past that business organisations have come to recognise

the vital impact that logistics management can have in the achievement of

competitive advantage.

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 3

and customers, and the organisation itself. Thus, for example, one goal of supply chain management might be to reduce or eliminate the buffers of inventory that exist between organisations in a chain through the sharing of information on demand and current stock levels. It will be apparent that supply chain management involves a significant change from the traditional arm’s-length, even adversarial, relationships that so often typified buyer/supplier relationships in the past. The focus of supply chain man- agement is on co-operation and trust and the recognition that, properly managed, the ‘whole can be greater than the sum of its parts’. The definition of supply chain management adopted in this book is:

The management of upstream and downstream relationships with suppliers and customers in order to deliver superior customer value at less cost to the supply chain as a whole.

Thus the focus of supply chain management is upon the management of relation- ships in order to achieve a more profitable outcome for all parties in the chain. This brings with it some significant challenges since there may be occasions when the narrow self-interest of one party has to be subsumed for the benefit of the chain as a whole. Whilst the phrase ‘supply chain management’ is now widely used, it could be argued that it should really be termed ‘demand chain management’ to reflect the fact that the chain should be driven by the market, not by suppliers. Equally the word ‘chain’ should be replaced by ‘network’ since there will normally be multiple suppliers and, indeed, suppliers to suppliers as well as multiple customers and customers’ customers to be included in the total system. Figure 1.1 illustrates this idea of the firm being at the centre of a network of sup- pliers and customers.

Extending this idea it has been suggested that a supply chain could more accu- rately be defined as:

Figure 1.1 The supply chain network

LOGISTICS & SUPPLY CHAIN MANAGEMENT4

A network of connected and interdependent organisations mutually and co-operatively working together to control, manage and improve the flow of materials and information from suppliers to end users.

Source: J. AITkEn3

Competitive advantage

A central theme of this book is that effective logistics and supply chain manage- ment can provide a major source of competitive advantage – in other words a position of enduring superiority over competitors in terms of customer preference may be achieved through better management of logistics and the supply chain. The foundations for success in the marketplace are numerous, but a simple model is based around the triangular linkage of the company, its customers and its competitors – the ‘Three Cs’. Figure 1.2 illustrates the three-way relationship.

The source of competitive advantage is found firstly in the ability of the organisa- tion to differentiate itself, in the eyes of the customer, from its competition, and secondly by operating at a lower cost and hence at greater profit. Seeking a sustainable and defensible competitive advantage has become the concern of every manager who is alert to the realities of the marketplace. It is no longer acceptable to assume that good products will sell themselves, neither is it advisable to imagine that success today will carry forward into tomorrow. Let us consider the bases of success in any competitive context. At its most elemental, commercial success derives from either a cost advantage or a value advantage or, ideally, both. It is as simple as that – the most profitable competitor in any industry sector tends to be the lowest-cost producer or the supplier provid- ing a product with the greatest perceived differentiated values.

Customers

Needs seeking benefits at acceptable prices

Cost differentials

Assets and utilisation

Assets and utilisation

Company Competitor

Va lue

Value

Figure 1.2 Competitive advantage and the ‘Three Cs’

Source: Ohmae, k., The Mind of the Strategist, Penguin Books, 1983

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 5

Put very simply, successful companies either have a cost advantage or they have a value advantage, or – even better – a combination of the two. Cost advan- tage gives a lower cost profile and the value advantage gives the product or offering a differential ‘plus’ over competitive offerings. Let us briefly examine these two vectors of strategic direction.

1 Cost advantage In many industries there will typically be one competitor who will be the low-cost producer and often that competitor will have the greatest sales volume in the sector. There is substantial evidence to suggest that ‘big is beautiful’ when it comes to cost advantage. This is partly due to economies of scale, which enable fixed costs to be spread over a greater volume, but more particularly to the impact of the ‘experience curve’. The experience curve is a phenomenon with its roots in the earlier notion of the ‘learning curve’. Researchers in the Second World War discovered that it was possible to identify and predict improvements in the rate of output of workers as they became more skilled in the processes and tasks on which they were working. Subsequent work by Boston Consulting Group, extended this concept by demon- strating that all costs, not just production costs, would decline at a given rate as volume increased (see Figure 1.3). In fact, to be precise, the relationship that the experience curve describes is between real unit costs and cumulative volume.

Traditionally it has been suggested that the main route to cost reduction was through the achievement of greater sales volume and in particular by improving market share. However, the blind pursuit of economies of scale through volume increases may not always lead to improved profitability – the reason being that in today’s world much of the cost of a product lies outside the four walls of the business in the wider supply chain. Hence it can be argued that it is increasingly through better logistics and supply chain management that efficiency and produc- tivity can be achieved leading to significantly reduced unit costs. How this can be achieved will be one of the main themes of this book.

Cumulative volume

R ea

l c o

st s

p er

u ni

t

Figure 1.3 The experience curve

LOGISTICS & SUPPLY CHAIN MANAGEMENT6

2 Value advantage It has long been an axiom in marketing that ‘customers don’t buy products, they buy benefits’. Put another way, the product is purchased not for itself but for the promise of what it will ‘deliver’. These benefits may be intangible, i.e. they relate not to specific product features but rather to such things as image or service. In addition, the delivered offering may be seen to outperform its rivals in some func- tional aspect. Unless the product or service we offer can be distinguished in some way from its competitors there is a strong likelihood that the marketplace will view it as a ‘commodity’ and so the sale will tend to go to the cheapest supplier. Hence the importance of seeking to add additional values to our offering to mark it out from the competition. What are the means by which such value differentiation may be gained? Essentially the development of a strategy based upon added values will normally require a more segmented approach to the market. When a company scrutinises markets closely it frequently finds that there are distinct ‘value segments’. In other words, different groups of customers within the total market attach different impor- tance to different benefits. The importance of such benefit segmentation lies in the fact that often there are substantial opportunities for creating differentiated appeals for specific segments. Take the car industry as an example. Most volume car manufacturers such as Toyota or Ford offer a range of models positioned at different price points in the market. However, it is increasingly the case that each model is offered in a variety of versions. Thus at one end of the spectrum may be the basic version with a small engine and two doors and at the other end, a four- door, high-performance version. In between are a whole variety of options, each of which seeks to satisfy the needs of quite different ‘benefit segments’. Adding value through differentiation is a powerful means of achieving a defensible advantage in the market. Equally powerful as a means of adding value is service. Increasingly it is the case that markets are becoming more service-sensitive and this of course poses particular challenges for logistics management. There is a trend in many markets towards a decline in the strength of the ‘brand’ and a consequent move towards ‘commodity’ market status. Quite simply this means that it is becoming progres- sively more difficult to compete purely on the basis of brand or corporate image. Additionally, there is increasingly a convergence of technology within product cate- gories, which means that it is often no longer possible to compete effectively on the basis of product differences. Thus the need to seek differentiation through means other than technology. Many companies have responded to this by focusing upon service as a means of gaining a competitive edge. Service in this context relates to

Logistics and supply chain management can provide a multitude of ways

to increase efficiency and productivity and hence contribute significantly to

reduced unit costs.

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 7

the process of developing relationships with customers through the provision of an augmented offer. This augmentation can take many forms including delivery serv- ice, after-sales services, financial packages, technical support and so forth.

Seeking the high ground In practice what we find is that the successful companies will often seek to achieve a position based upon both a cost advantage and a value advantage. A useful way of examining the available options is to present them as a simple matrix. Let us consider these options in turn.

For companies who find themselves in the bottom left-hand corner of our matrix (Figure 1.4) the world is an uncomfortable place. Their products are indistinguishable from their competitors’ offerings and they have no cost advantage. These are typi- cal commodity market situations and ultimately the only strategy is either to move to the right of the matrix, i.e. to cost leadership, or upwards towards service leadership. Often the cost leadership route is simply not available. This particularly will be the case in a mature market where substantial market share gains are difficult to achieve. new technology may sometimes provide a window of opportunity for cost reduction but in such situations the same technology is often available to competitors. Cost leadership strategies have traditionally been based upon the economies of scale gained through sales volume. This is why market share is considered to be so important in many industries. However, if volume is to be the basis for cost leadership then it is preferable for that volume to be gained early in the market life cycle. The ‘experience curve’ concept, briefly described earlier, demonstrates the value of early market share gains – the higher your share relative to your competi- tors the lower your costs should be. This cost advantage can be used strategically to assume a position of price leader and, if appropriate, to make it impossible for higher-cost competitors to survive. Alternatively, price may be maintained,

Va lu

e ad

va nt

ag e

Cost advantage

Low High

Lo w

H ig

h Service leader

Cost and service leader

Commodity market

Cost leader

Figure 1.4 Logistics and competitive advantage

LOGISTICS & SUPPLY CHAIN MANAGEMENT8

enabling above-average profit to be earned, which potentially is available to further develop the position of the product in the market. However, an increasingly powerful route to achieving a cost advantage comes not necessarily through volume and the economies of scale but instead through logistics and supply chain management. In many industries, logistics costs rep- resent such a significant proportion of total costs that it is possible to make major cost reductions through fundamentally re-engineering logistics processes. The means whereby this can be achieved will be returned to later in this book. The other way out of the ‘commodity’ quadrant of the matrix is to seek a strat- egy of differentiation through service excellence. We have already commented on the fact that markets have become more ‘service-sensitive’. Customers in all industries are seeking greater responsiveness and reliability from suppliers; they are looking for reduced lead times, just-in-time delivery and value-added services that enable them to do a better job of serving their customers. In Chapter 2 we will examine the specific ways in which superior service strategies, based upon enhanced logistics management, can be developed.

One thing is certain: there is no middle ground between cost leadership and service excellence. Indeed the challenge to management is to identify appropriate logistics and supply chain strategies to take the organisation to the top right-hand corner of the matrix. Companies who occupy that position have offers that are distinctive in the value they deliver and are also cost competitive. Clearly it is a position of some strength, occupying ‘high ground’ that is extremely difficult for competitors to attack. Figure 1.5 clearly presents the challenge: it is to seek out strategies that will take the business away from the ‘commodity’ end of the market towards a securer position of strength based upon differentiation and cost advantage. Logistics management, it can be argued, has the potential to assist the organi- sation in the achievement of both a cost advantage and a value advantage. As Figure 1.6 suggests, in the first instance there are a number of important ways in which

R el

at iv

e d

iff er

en tia

tio n

Relative delivered costs

High Low

Lo w

H ig

h

Figure 1.5 The challenge to logistics and supply chain management

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 9

productivity can be enhanced through logistics and supply chain management. Whilst these possibilities for leverage will be discussed in detail later in the book, suffice it to say that the opportunities for better capacity utilisation, inventory reduction and closer integration with suppliers at a planning level are considerable. Equally the prospects for gaining a value advantage in the marketplace through superior customer service should not be underestimated. It will be argued later that the way we service the cus- tomer has become a vital means of differentiation.

To summarise, those organisations that will be the leaders in the markets of the future will be those that have sought and achieved the twin peaks of excellence: they have gained both cost leadership and service leadership. The underlying philosophy behind the logistics and supply chain concept is that of planning and co-ordinating the materials flow from source to user as an inte- grated system rather than, as was so often the case in the past, managing the goods flow as a series of independent activities. Thus under this approach the goal is to link the marketplace, the distribution network, the manufacturing proc- ess and the procurement activity in such a way that customers are serviced at higher levels and yet at lower cost. In other words the goal is to achieve competi- tive advantage through both cost reduction and service enhancement.

The supply chain becomes the value chain

Of the many changes that have taken place in management thinking over the last 30 years or so perhaps the most significant has been the emphasis placed upon the search for strategies that will provide superior value in the eyes of the

Value advantage

Logistics leverage opportunities:

• Tailored services • Reliability • Responsiveness

Cost advantage Logistics leverage opportunities:

The goal: superior

customer value at less cost

• Capacity utilisation • Asset turn • Synchronous supply

Figure 1.6 Gaining competitive advantage

LOGISTICS & SUPPLY CHAIN MANAGEMENT10

customer. To a large extent the credit for this must go to Michael Porter, the Harvard Business School professor, who through his research and writing4 has alerted managers and strategists to the central importance of competitive relativi- ties in achieving success in the marketplace. One concept in particular that Michael Porter has brought to a wider audience is the ‘value chain’:

competitive advantage cannot be understood by looking at a firm as a whole. It stems from the many discrete activities a firm performs in designing, producing, marketing, delivering, and supporting its product. each of these activities can contribute to a firm’s relative cost position and create a basis for differentiation … The value chain disaggregates a firm into its strategically relevant activities in order to understand the behaviour of costs and the existing and potential sources of differentiation. A firm gains competitive advantage by performing these strategically important activities more cheaply or better than its competitors.5

Value chain activities (shown in Figure 1.7) can be categorised into two types – primary activities (inbound logistics, operations, outbound logistics, marketing and sales, and service) and support activities (infrastructure, human resource management, technology development and procurement). These activities are integrating functions that cut across the traditional functions of the firm. Competitive advantage is derived from the way in which firms organise and per- form these activities within the value chain. To gain competitive advantage over its rivals, a firm must deliver value to its customers by performing these activities more efficiently than its competitors or by performing the activities in a unique way that creates greater differentiation.

Firm infrastructure

Human resource management

Technology development

Procurement

Support activities

Outbound logistics

OperationsInbound logistics

Marketing and sales

Service

Primary activities

M a

rg in

Figure 1.7 The value chain

Source: Porter, M.E., competitive Advantage, The Free Press, 1985

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 11

The implication of Michael Porter’s thesis is that organisations should look at each activity in their value chain and assess whether they have a real competitive advan- tage in the activity. If they do not, the argument goes, then perhaps they should consider outsourcing that activity to a partner who can provide that cost or value advantage. This logic is now widely accepted and has led to the dramatic upsurge in outsourcing activity that can be witnessed in almost every industry. Whilst there is often a strong economic logic underpinning the decision to outsource activities that may previously have been performed in-house, such decisions may add to the complexity of the supply chain. Because there are by definition more interfaces to be managed as a result of outsourcing, the need for a much higher level of relationship management increases. The effect of outsourcing is to extend the value chain beyond the boundaries of the business. In other words, the supply chain becomes the value chain. Value (and cost) is not just created by the focal firm in a network, but by all the entities that connect to each other. This ‘extended enterprise’, as some have termed it, becomes the vehicle through which competitive advantage is gained – or lost.

The mission of logistics management

It will be apparent from the previous comments that the mission of logistics management is to plan and co-ordinate all those activities necessary to achieve desired levels of delivered service and quality at lowest possible cost. Logistics must therefore be seen as the link between the marketplace and the supply base. The scope of logistics spans the organisation, from the management of raw mate- rials through to the delivery of the final product. Figure 1.8 illustrates this total systems concept.

The scope of logistics spans the organisation, from the management of raw

materials through to the delivery of the final product.

Suppliers

Materials flow

Procurement Operations Distribution Customers

Requirements information flow

Figure 1.8 Logistics management process

LOGISTICS & SUPPLY CHAIN MANAGEMENT12

Logistics management, from this total systems viewpoint, is the means whereby the needs of customers are satisfied through the co-ordination of the materials and information flows that extend from the marketplace, through the firm and its operations and beyond that to suppliers. To achieve this company-wide integration clearly requires a quite different orientation than that typically encountered in the conventional organisation. For example, for many years marketing and manufacturing have been seen as largely separate activities within the organisation. At best they have coexisted, at worst there has been open warfare. Manufacturing priorities and objectives have typically been focused on operating efficiency, achieved through long production runs, minimised set-ups and change-overs and product standardisation. On the other hand, marketing has sought to achieve competitive advantage through vari- ety, high service levels and frequent product changes. In today’s more turbulent environment there is no longer any possibility of manufacturing and marketing acting independently of each other. The internecine disputes between the ‘barons’ of production and marketing are clearly counter- productive to the achievement of overall corporate goals. It is no coincidence that in recent years both marketing and manufacturing have become the focus of renewed attention. Marketing as a concept and a phi- losophy of customer orientation now enjoys a wider acceptance than ever. It is now generally accepted that the need to understand and meet customer require- ments is a prerequisite for survival. At the same time, in the search for improved cost competitiveness, manufacturing management has been the subject of a massive revolution. The last few decades have seen the introduction of flexible manufacturing systems (FMS), of new approaches to inventory based on materials requirements planning (MRP) and just-in-time (JIT) methods and, perhaps most important of all, a sustained emphasis on total quality management (TQM). Equally there has been a growing recognition of the critical role that procure- ment plays in creating and sustaining competitive advantage as part of an integrated logistics process. Leading-edge organisations now routinely include supply-side issues in the development of their strategic plans. not only is the cost of purchased materials and supplies a significant part of total costs in most organisations, but there is a major opportunity for leveraging the capabilities and competencies of suppliers through closer integration of the buyers’ and suppliers’ logistics processes. In this scheme of things, logistics is therefore essentially an integrative concept that seeks to develop a system-wide view of the firm. It is fundamentally a planning concept that seeks to create a framework through which the needs of the market- place can be translated into a manufacturing strategy and plan, which in turn links into a strategy and plan for procurement. Ideally there should be a ‘one-plan’ men- tality within the business which seeks to replace the conventional stand-alone and separate plans of marketing, distribution, production and procurement. This, quite simply, is the mission of logistics management.

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 13

The supply chain and competitive performance

Traditionally most organisations have viewed themselves as entities that exist inde- pendently from others and indeed need to compete with them in order to survive. However, such a philosophy can be self-defeating if it leads to an unwillingness to co-operate in order to compete. Behind this seemingly paradoxical concept is the idea of supply chain integration. The supply chain is the network of organisations that are involved, through upstream and downstream linkages, in the different processes and activities that produce value in the form of products and services in the hands of the ultimate consumer. Thus, for example, a shirt manufacturer is a part of a supply chain that extends upstream through the weavers of fabrics to the manufacturers of fibres, and downstream through distributors and retailers to the final consumer. Each of these organisations in the chain are dependent upon each other by definition and yet, paradoxically, by tradition do not closely co-operate with each other. Supply chain management is not the same as ‘vertical integration’. Vertical integration normally implies ownership of upstream suppliers and downstream customers. This was once thought to be a desirable strategy but increasingly organisations are now focusing on their ‘core business’ – in other words the things they do really well and where they have a differential advantage. Everything else is ‘outsourced’ – in other words it is procured outside the firm. So, for example, com- panies that perhaps once made their own components now only assemble the finished product, e.g. automobile manufacturers. Other companies may also sub- contract the manufacturing as well, e.g. nike in footwear and sportswear. These companies have sometimes been termed ‘virtual’ or ‘network’ organisations. Clearly this trend has many implications for supply chain management, not the least being the challenge of integrating and co-ordinating the flow of materials from a multitude of suppliers, often offshore, and similarly managing the distribu- tion of the finished product by way of multiple intermediaries.

GANT: creating value across a virtual network A good example of a virtual organisation is the Swedish clothing brand GAnT. At the centre of the network is Pyramid Sportswear AB, which directly employs fewer than ten people. Pyramid contracts with designers, identifies trends, uses contract manufacturers, develops the retailer network and creates the brand image through marketing communications. Through its databases, Pyramid closely monitors sales, inventories and trends. Its network of closely co-ordinated partners means it can react quickly to changes in the market. The network itself changes as requirements change, and it will use different designers, freelance photographers, catalogue producers, contract manufacturers and so on as appropriate.

Source: CHRISTOPHER, M., PAYnE, A. AnD BALLAnTYnE, D., reLATIoNSHIP MArKeTING: creATING STAKeHoLDer VALue, BUTTERWORTH HEInnEMAnn, 2002

LOGISTICS & SUPPLY CHAIN MANAGEMENT14

In the past it was often the case that relationships with suppliers and downstream customers (such as distributors or retailers) were adversarial rather than co- operative. It is still the case today that some companies will seek to achieve cost reductions or profit improvement at the expense of their supply chain partners. Companies such as these do not realise that simply transferring costs upstream or downstream does not make them any more competitive. The reason for this is that ultimately all costs will make their way to the final marketplace to be reflected in the price paid by the end user. The leading-edge companies recognise the fallacy of this conventional approach and instead seek to make the supply chain as a whole

Material

flow

Customer

service

Stage one: baseline

Purchasing Material control

Production Sales Distribution

Material

flow

Customer

service

Stage two: functional integration

Materials management

Manufacturing management

Distribution

Material

flow

Customer

service

Stage three: internal integration

Manufacturing management

Distribution

Material

flow

Customer

service

Stage four: external integration

Suppliers Internal supply chain

Customers

Materials management

Figure 1.9 Achieving an integrated supply chain

Source: Stevens, G.C., ‘Integrating the Supply Chain’, International Journal of Physical Distribution and Materials Management, Vol. 19, no. 8, 1989

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 15

more competitive through the value it adds and the costs that it reduces overall. They have realised that the real competition is not company against company but rather supply chain against supply chain. It must be recognised that the concept of supply chain management, whilst rel- atively new, is in fact no more than an extension of the logic of logistics. Logistics management is primarily concerned with optimising flows within the organisation, whilst supply chain management recognises that internal integration by itself is not sufficient. Figure 1.9 suggests that there is in effect an evolution of integration from the stage 1 position of complete functional independence where each business function such as production or purchasing does its own thing in complete isolation from the other business functions. An example would be where production seeks to optimise its unit costs of manufacture by long production runs without regard for the build-up of finished goods inventory and heedless of the impact it will have on the need for warehousing space and the impact on working capital. Stage 2 companies have recognised the need for at least a limited degree of integration between adjacent functions, e.g. distribution and inventory manage- ment or purchasing and materials control. The natural next step to stage 3 requires the establishment and implementation of an ‘end-to-end’ planning framework that will be fully described later in this book. Stage 4 represents true supply chain integration in that the concept of linkage and co-ordination that is achieved in stage 3 is now extended upstream to suppli- ers and downstream to customers. There is thus a crucial and important distinction to be made between logistics and supply chain management.

The changing competitive environment

As the competitive context of business continues to change, bringing with it new complexities and concerns for management generally, it also has to be recognised that the impact on logistics and supply chain management of these changes can be considerable. Indeed, of the many strategic issues that confront the business organisation today, perhaps the most challenging are in the area of logistics and supply chain management. Much of this book will be devoted to addressing these challenges in detail but it is useful at this stage to highlight what are perhaps the most pressing currently. These are:

MM The new rules of competition MM Globalisation of industry MM Downward pressure on price MM Customers taking control

The new rules of competition We are now entering the era of ‘supply chain competition’. The fundamental dif- ference from the previous model of competition is that an organisation can no

LOGISTICS & SUPPLY CHAIN MANAGEMENT16

longer act as an isolated and independent entity in competition with other similarly ‘stand-alone’ organisations. Instead, the need to create value delivery systems that are more responsive to fast-changing markets and are much more consistent and reliable in the delivery of that value requires that the supply chain as a whole be focused on the achievement of these goals. In the past the ground rules for marketing success were obvious: strong brands backed up by large advertising budgets and aggressive selling. This formula now appears to have lost its power. Instead, the argument is heard, companies must recognise that increasingly it is through their capabilities and competencies that they compete.6

Essentially, this means that organisations create superior value for custom- ers and consumers by managing their core processes better than competitors manage theirs. These core processes encompass such activities as new product development, supplier development, order fulfilment and customer management. By performing these fundamental activities in a more cost-effective way than com- petitors, it is argued, organisations will gain the advantage in the marketplace. This principle is powerfully expressed in the words of Jorma Ollila, the past Chairman and CEO of nokia:

our experienced and unique way of operating is what we see as increasingly putting us ahead of the competition. As we move forward in this complex industry, winning will be less about what we do and more about the way we do it.

For example, one capability that is now regarded by many companies as funda- mental to success in the marketplace is supply chain agility. As product life cycles shorten, as customers adopt just-in-time practices and as sellers’ markets become buyers’ markets then the ability of the organisation to respond rapidly and flexibly to demand can provide a powerful competitive edge. This is a theme to which we will return in Chapter 5. A major contributing factor influencing the changed competitive environment has been the trend towards ‘commoditisation’ in many markets. A commodity market is characterised by perceived product equality in the eyes of customers resulting in a high preparedness to substitute one make of product for another. Research increasingly suggests that consumers are less loyal to specific brands but instead will have a portfolio of brands within a category from which they make their choice. In situations such as this actual product availability becomes a major determinant of demand. There is evidence that more and more decisions are being taken at the point of purchase and if there is a gap on the shelf where Brand X should be, but Brand Y is there instead, then there is a strong probability that Brand Y will win the sale. It is not only in consumer markets that the importance of logistics process excellence is apparent. In business-to-business and industrial markets it seems that product or technical features are of less importance in winning orders than issues such as delivery lead times and flexibility. This is not to suggest that product or technical features are unimportant – rather it is that they are taken as a ‘given’ by the customer. Quite simply, in today’s marketplace the order-winning criteria are more likely to be service-based than product-based.

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 17

A parallel development in many markets is the trend towards a concentration of demand. In other words customers – as against consumers – are tending to grow in size whilst becoming fewer in number. The retail grocery industry is a good example in that in most northern European countries a handful of large retailers account for over 50 per cent of all sales in any one country. This tendency to the concentration of buying power is being accelerated as a result of global mergers and acquisitions. The impact of these trends is that these more powerful customers are becoming more demanding in terms of their service requirements from suppliers. At the same time as the power in the distribution channel continues to shift from supplier to buyer, there is also a trend for customers to reduce their supplier base. In other words they want to do business with fewer suppliers and often on a longer-term basis. The successful companies in the coming years will be those that recognise these trends and seek to establish strategies based upon establish- ing closer relationships with key accounts. Such strategies will focus upon seeking innovative ways to create more value for these customers. Building competitive platforms that are grounded in this idea of value-based growth will require a much greater focus on managing the core processes that we referred to earlier. Whereas the competitive model of the past relied heavily on product innovation this will have to be increasingly supplemented by process inno- vation. The basis for competing in this new era will be:

Competitive advantage = Product excellence × Process excellence

Figure 1.10 suggests that traditionally for many companies the investment has mainly been on product excellence and less on process excellence. This is not to suggest that product innovation should be given less emphasis – far from it – but rather that more emphasis needs to be placed on developing and managing proc- esses that deliver greater value for key customers.

In today’s marketplace the order-winning criteria are more likely to be service-

based than product-based.

P ro

d uc

t ex

ce lle

nc e

(% )

Process excellence (%) 100

100

Revised emphasis

Current emphasis

Figure 1.10 Investing in process excellence yields greater benefits

LOGISTICS & SUPPLY CHAIN MANAGEMENT18

We have already commented that product life cycles are getting shorter. What we have witnessed in many markets is the effect of changes in technology and con- sumer demand combining to produce more volatile markets where a product can be obsolete almost as soon as it reaches the market. There are many current examples of shortening life cycles but perhaps the personal computer symbolises them all. In this particular case we have seen rapid developments in technology that have first created markets where none existed before and then almost as quickly have ren- dered themselves obsolete as the next generation of product is announced. Such shortening of life cycles creates substantial problems for logistics and supply chain management. In particular, shorter life cycles demand shorter lead times – indeed our definition of lead time may well need to change. Lead times are traditionally defined as the elapsed period from receipt of customer order to delivery. However, in today’s environment there is a wider perspective that needs to be taken. The real lead time is the time taken from the drawing board, through procurement, manufacture and assembly to the end market. This is the concept of strategic lead time and the management of this time span is the key to success in managing logistics operations. There are already situations arising where the life cycle is shorter than the strate- gic lead time. In other words the life of a product on the market is less than the time it takes to design, procure, manufacture and distribute that same product! The impli- cations of this are considerable both for planning and operations. In a global context the problem is exacerbated by the longer transportation times involved. Ultimately, therefore, the means of achieving success in such markets is to accelerate movement through the supply chain and to make the entire logistics system far more flexible and thus responsive to these fast-changing markets.

Globalisation of industry A further strategic issue that provides a challenge for logistics management is the continued trend towards globalisation. A global company is more than a multinational company. In the global busi- ness materials and components are sourced worldwide and products may be manufactured offshore and sold in many different countries, perhaps with local customisation. Such is the trend towards globalisation that it is probably safe to forecast that before long most markets will be dominated by global companies. The only role left for national companies will be to cater for specific and unique local demands, for example in the food industry. For global companies like Hewlett Packard, Philips and Caterpillar, the man- agement of the logistics process has become an issue of central concern. The difference between profit and loss for an individual product can hinge upon the extent to which the global pipeline can be optimised, because the costs involved are so great. The global company seeks to achieve competitive advantage by identifying world markets for its products and then to develop a manufacturing and logistics strategy to support its marketing strategy. So a company like Caterpillar, for example, has dispersed assembly operations to key overseas markets and

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 19

uses global logistics channels to supply parts to offshore assembly plants and after-markets. Where appropriate, Caterpillar will use third-party companies to manage distribution and even final finishing. So, for example, in the US a third- party company in addition to providing parts inspection and warehousing attaches options to fork lift trucks. Wheels, counterweights, forks and masts are installed as specified by Caterpillar. Thus local market needs can be catered for from a stand- ardised production process. Globalisation also tends to lengthen supply chains as companies increasingly move production offshore or source from more distant locations. The impetus for this trend, which in recent years has accelerated dramatically, is the search for lower labour costs. However, one implication of these decisions is that ‘end- to-end’ pipeline times may increase significantly. In time-sensitive markets, longer lead times can be fatal. ‘Time-based competition’ is an idea that will be returned to many times in later chapters. Time compression has become a critical management issue. Product life cycles are shorter than ever, customers and distributors require just-in-time deliver- ies and end users are ever more willing to accept a substitute product if their first choice is not instantly available. The globalisation of industry, and hence supply chains, is inevitable. However, to enable the potential benefits of global networks to be fully realised, a wider supply chain perspective must be adopted. It can be argued that for the global corporation competitive advantage will increasingly derive from excellence in managing the complex web of relationships and flows that characterise their supply chains.

Downward pressure on price Whilst the trend might not be universal there can be no doubting that most markets are more price competitive today than they were a decade ago. Prices in the high streets and the shopping malls continue to fall in many countries. Whilst some of this price deflation can be explained as the result of normal cost reduction through learning and experience effects, the rapid fall in the price of many consumer goods has other causes. Figure 1.11 shows the comparative rate at which VCR and DVD player prices fell in the Uk market. The striking feature is that whilst it took 20 years for a VCR to fall in price from £400 to just over £40, it took only five years for a DVD player to fall by the same amount, and at the time of writing a DVD player can be bought in the Uk for £20! The same phenomenon is apparent in markets as diverse as clothing, home furnishings and air travel. A fundamental change in the global competitive landscape is driving prices to levels that in real terms are as low as they have ever been. A number of causal fac- tors have contributed to this new market environment. Firstly, there are new global competitors who have entered the marketplace supported by low-cost manufacturing bases. The dramatic rise of China as a major producer of quality consumer products is evidence of this. Secondly, the removal of barriers to trade and the deregulation of many markets has accelerated this trend, enabling new players to rapidly gain ground. One result of this has been

LOGISTICS & SUPPLY CHAIN MANAGEMENT20

overcapacity in many industries. Overcapacity implies an excess of supply against demand and hence leads to further downward pressure on price. A further cause of price deflation, it has been suggested, is the Internet, which makes price comparison so much easier. The Internet has also enabled auctions and exchanges to be established at industry-wide levels, which have also tended to drive down prices. In addition, there is evidence that customers and consumers are more value conscious than has hitherto been the case. Brands and suppliers that could once command a price premium because of their perceived superiority can no longer do so as the market recognises that equally attractive offers are available at sig- nificantly lower prices. The success of many retailers’ own-label products or the inroads made by low-cost airlines proves this point. Against the backdrop of a continued downward pressure on price, it is self- evident that, in order to maintain profitability, companies must find a way to bring down costs to match the fall in price. The challenge to the business is to find new opportunities for cost reduction when, in all likelihood, the company has been through many previous cost-reduction programmes. It can be argued that the last remaining opportunity of any signif- icance for major cost reduction lies in the wider supply chain rather than in the firm’s own internal operations. This idea is not new. Back in 1929 Ralph Borsodi expressed it in the following words:

In 50 years between 1870 and 1920 the cost of distributing necessities and luxuries has nearly trebled, while production costs have gone down by one-fifth … What we are saving in production we are losing in distribution.7

The situation that Borsodi describes can still be witnessed in many industries today. For example, companies which thought they could achieve a leaner oper- ation by moving to just-in-time (JIT) practices often only shifted costs elsewhere

1984

50

1986 1988 1990 1992 1994 1996 1998 2000 2002 2004

100

150

200

250

300

350

400

Year

P ric

e (£

) VCR 1984 £400 2004 £45

DVD 1999 £400 2004 £40

VCR DVD

Figure 1.11 Price deflation in consumer electronics (UK high street prices)

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 21

in the supply chain by forcing suppliers or customers to carry that inventory. The car industry, which to many is the home of lean thinking and JIT practices, has certainly exhibited some of those characteristics. One analysis of the west- ern European automobile industry8 showed that whilst car assembly operations were indeed very lean with minimal inventory, the same was not true upstream and downstream of those operations. Figure 1.12 shows the profile of inventory through the supply chain from the tier 1 suppliers down to the car dealerships.

In this particular case the paradox is that most inventory is being held when it is at its most expensive, i.e. as a finished product. The true cost of this inventory to the industry is considerable. Whilst inventory costs will vary by industry and by com- pany, it will be suggested in Chapter 3 that the true cost of carrying inventory is rarely less than 25 per cent per year of its value. In the conditions in which the automobile industry currently finds itself, this alone is enough to make the differ- ence between profit and loss. This example illustrates the frequently encountered failure to take a wider view of cost. For many companies their definition of cost is limited only to those costs that are contained within the four walls of their business entity. However, as has been suggested earlier, since today’s competition takes place not between com- panies but between supply chains the proper view of costs has to be ‘end-to-end’ since all costs will ultimately be reflected in the price of the finished product in the final marketplace.

D ay

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120

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100

80

60

40

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p ar

ts

R aw

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Inbound logistics

Vehicle manufacturers

Outbound logistics

First tier supplier

Maximum Average Minimum

Distribution and retail

Figure 1.12 Inventory profile of the automotive supply chain

Source: Holweg, M. and Pil, F.K., The Second Century, MIT Press, 2004

LOGISTICS & SUPPLY CHAIN MANAGEMENT22

The need to take a supply chain view of cost is further underscored by the major trend that is observable across industries worldwide towards outsourcing. For many companies today, most of their costs lie outside their legal boundaries; activities that used to be performed in-house are now outsourced to specialist service providers. The amazing growth of contract manufacturing in electronics bears witness to this trend. If the majority of an organisation’s costs lie outside the business then it follows that the biggest opportunities for improvement in their cost position will also be found in that wider supply chain.

The customers take control So much has been written and talked about service, quality and excellence that there is no escaping the fact that the customer in today’s marketplace is more demanding, not just of product quality, but also of service. As more and more markets become in effect ‘commodity’ markets, where the customer perceives little technical difference between competing offers, the need is for the creation of differential advantage through added value. Increasingly a prime source of this added value is through customer service.

Customer service may be defined as the consistent provision of time and place utility. In other words, products don’t have value until they are in the hands of the customer at the time and place required. There are clearly many facets of customer service, ranging from on-time delivery through to after-sales support. Essentially the role of customer service should be to enhance ‘value-in-use’, meaning that the prod- uct becomes worth more in the eyes of the customer because service has added value to the core product. In this way significant differentiation of the total offer (that is the core product plus the service package) can be achieved. Those companies that have achieved recognition for service excellence, and thus have been able to establish a differential advantage over their com- petition, are typically those companies where logistics management is a high priority. Companies like Xerox, Zara and Dell are typical of such organisations. The achievement of competitive advantage through service comes not from slogans or expensive so-called customer care programmes, but rather from a combination of a carefully thought-out strategy for service, the development of appropriate deliv- ery systems and commitment from people, from the chief executive down. The attainment of service excellence in this broad sense can only be achieved through a closely integrated logistics strategy. In reality, the ability to become a market leader depends as much upon the effectiveness of one’s operating sys- tems as it does upon the presentation of the product, the creation of images and the influencing of consumer perceptions. In other words, the success of McDonald’s, WalMart or any of the other frequently cited paragons of service

The customer in today’s marketplace is more demanding, not just of product

quality, but also of service.

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 23

excellence is due not to their choice of advertising agency, but rather to their rec- ognition that managing the logistics of service delivery on a consistent basis is the crucial source of differential advantage.

Managing the ‘4Rs’ As we move rapidly into the era of supply chain competition a number of principles emerge to guide the supply chain manager. These can be conveniently summa- rised as the ‘4Rs’ of responsiveness, reliability, resilience and relationships.

1 Responsiveness

In today’s just-in-time world the ability to respond to customers’ requirements in ever-shorter time-frames has become critical. Not only do customers want shorter lead times, they are also looking for flexibility and increasingly customised solutions. In other words, the supplier has to be able to meet the precise needs of customers in less time than ever before. The key word in this changed environment is agility. Agility implies the ability to move quickly and to meet customer demand sooner. In a fast-changing marketplace agility is actually more important than long-term planning in its traditional form. Because future demand patterns are uncertain, by definition this makes planning more difficult and, in a sense, hazardous. In the future, organisations must be much more demand-driven than forecast- driven. The means of making this transition will be through the achievement of agility, not just within the company but across the supply chain. Responsiveness also implies that the organisation is close to the customer, hearing the voice of the market and quick to interpret the demand signals it receives.

2 Reliability

One of the main reasons why any company carries safety stock is because of uncertainty. It may be uncertainty about future demand or uncertainty about a supplier’s ability to meet a delivery promise, or about the quality of materials or components. Significant improvements in reliability can only be achieved through re-engineering the processes that impact performance. Manufacturing managers long ago discovered that the best way to improve product quality was not by qual- ity control through inspection but rather to focus on process control. The same is true for logistics reliability. One of the keys to improving supply chain reliability is through reducing proc- ess variability. In recent years there has been a considerable increase in the use of so-called ‘six sigma’ methodologies. The concept of six sigma will be discussed in more detail in Chapter 10 but in essence these tools are designed to enable variability in a process to be reduced and controlled. Thus, for example, if there is variability in order processing lead times then the causes of that variability can be identified and where necessary the process can be changed and brought under control through the use of six sigma tools and procedures.

LOGISTICS & SUPPLY CHAIN MANAGEMENT24

3 Resilience

Today’s marketplace is characterised by higher levels of turbulence and volatil- ity. The wider business, economic and political environments are increasingly subjected to unexpected shocks and discontinuities. As a result, supply chains are vulnerable to disruption and, in consequence, the risk to business continuity is increased. Whereas in the past the prime objective in supply chain design was probably cost minimisation or possibly service optimisation, the emphasis today has to be upon resilience. Resilience refers to the ability of the supply chain to cope with unexpected disturbances. There is evidence that the tendencies of many compa- nies to seek out low-cost solutions because of pressure on margins may have led to leaner, but more vulnerable, supply chains. Resilient supply chains may not be the lowest-cost supply chains but they are more capable of coping with the uncertain business environment. Resilient supply chains have a number of characteristics, of which the most important is a business-wide recognition of where the supply chain is at its most vulnerable. Managing the critical nodes and links of a supply chain, to be discussed further in Chapter 10, becomes a key priority. Sometimes these ‘critical paths’ may be where there is dependence on a single supplier, or a supplier with long replenishment lead times, or a bottleneck in a process. Other characteristics of resilient supply chains are their recognition of the impor- tance of strategic inventory and the selective use of spare capacity to cope with ‘surge’ effects.

4 Relationships

The trend towards customers seeking to reduce their supplier base has already been commented upon. In many industries the practice of ‘partnership sourcing’ is widespread. It is usually suggested that the benefits of such practices include improved quality, innovation sharing, reduced costs and integrated scheduling of production and deliveries. Underlying all of this is the idea that buyer/supplier relationships should be based upon partnership. Increasingly companies are discov- ering the advantages that can be gained by seeking mutually beneficial, long-term relationships with suppliers. From the suppliers’ point of view, such partnerships can prove formidable barriers to entry for competitors. The more that processes are linked between the supplier and the customer the more the mutual dependencies increase and hence the more difficult it is for competitors to break in. Supply chain management by definition is about the management of relation- ships across complex networks of companies that, whilst legally independent, are in reality interdependent. Successful supply chains will be those that are governed by a constant search for win-win solutions based upon mutuality and trust. This is not a model of relationships that has typically prevailed in the past. It is one that will have to prevail in the future as supply chain competition becomes the norm. These four themes of responsiveness, reliability, resilience and relationships provide the basis for successful logistics and supply chain management. They are themes that will be explored in greater detail later in this book.

LOGISTICS, THE SUPPLY CHAIN AND COMPETITIVE STRATEGY 25

References

1. Bowler, R.A., Logistics and the Failure of the British Army in America 1775–1783, Princeton University Press, 1975.

2. Shaw, A.W., Some Problems in Market Distribution, Harvard University Press, 1915. 3. Aitken, J., Supply Chain Integration within the Context of a Supplier Association,

Cranfield University, Ph.D. thesis, 1998. 4. Porter, M.E.,Competitive Strategy, The Free Press, 1980. 5. Porter, M.T.,Competitive Advantage, The Free Press, 1985, p.33. 6. Stalk, G., Evans, P. and Shulman, L.E., ‘Competing on capabilities: the new

rule of corporate strategy’, Harvard Business Review, March–April 1992; Prahalad, C. and Hamel, G., ‘The core competence of the corporation’, Harvard Business Review, May–June 1990.

7. Borsodi, R., The Distribution Age, D. Appleton & Co, 1929. 8. Holweg, M. and Pil, F.K., The Second Century, MIT Press, 2004.

27

Earlier in Chapter 1 the mission of logistics management was defined simply in terms of providing the means whereby customers’ service requirements are met at lowest cost. In other words the ultimate purpose of any logistics system is to satisfy customers. It is a simple idea that is not always easy to recognise if you are a manager involved in activities such as production scheduling or inventory control which may seem to be some distance away from the marketplace. The fact is of course that everybody in the organisation has a stake in customer service. Indeed many successful companies have started to examine their internal service stand- ards in order that everyone who works in the business understands that they must service someone – if they don’t, why are they on the payroll? The objective should be to establish a chain of customers that links people at all levels in the organisation directly or indirectly to the marketplace.1 Xerox is a com- pany that has worked hard to implement the idea of the internal customer. They have even extended the idea to the point of linking bonuses to an index of customer satisfaction. In organisations like Xerox, managing the customer service chain through the business and onwards is the central concern of logistics management.

Logistics and customer value 2

MM The marketing and logistics interface

MM Delivering customer value

MM What is customer service?

MM The impact of out-of-stock

MM Customer service and customer retention

MM Market-driven supply chains

MM Defining customer service objectives

MM Setting customer service priorities

MM Setting service standards

The marketing and logistics interface

Even though the textbooks describe marketing as the management of the ‘Four Ps’ – product, price, promotion and place – it is probably true to say that, in practice, most of the emphasis has always been placed on the first three. ‘Place’, which might better be described in the words of the old cliché, ‘the right product in the right place at the right time’, was rarely considered part of mainstream marketing. There are signs that this view is rapidly changing, however, as the power of cus- tomer service as a potential means of differentiation is increasingly recognised. In more and more markets the power of the brand has declined and customers are more willing to accept substitutes; even technology differences between products have been reduced so that it is harder to maintain a competitive edge through the product itself. In situations like this it is customer service that can provide the dis- tinctive difference between one company’s offer and that of its competitors. Two factors have perhaps contributed more than anything else to the growing importance of customer service as a competitive weapon. One is the continual increase in customer expectations; in almost every market the customer is now more demanding, more ‘sophisticated’ than he or she was, say, 30 years ago. Likewise, in industrial purchasing situations we find that buyers expect higher levels of service from vendors, particularly as more companies convert to just-in- time logistics systems. The second factor is the slow but inexorable transition towards ‘commodity’ type markets. By this is meant that increasingly the power of the ‘brand’ is diminishing as the technologies of competing products converge, thus making product differences difficult to perceive – at least to the average buyer. Take, for example, the current state of the personal computer market. There are many competing models which in reality are substitutable as far as most would-be purchasers are concerned. Faced with a situation such as this the customer may be influenced by price or by ‘image’ perceptions but overriding these aspects may well be ‘availability’ – in other words, is the product in stock, can I have it now? Since availability is clearly an aspect of customer service, we are in effect saying that the power of customer service is paramount in a situation such as this. This trend towards the service-sensitive customer is as apparent in industrial markets as it is in consumer markets. Hence companies supplying the car industry, for example, must be capa- ble of providing just-in-time deliveries direct to the assembly line; similarly a food manufacturer supplying a large supermarket chain must have an equivalent logis- tics capability, enabling it to keep the retail shelf filled whilst minimising the amount of inventory in the system. The evidence from across a range of markets suggests that the critical determinant of whether orders are won or lost, and hence the basis for becoming a preferred supplier, is customer service. Time has become a far more critical element in the competitive process. Customers in every market want ever shorter lead times; product availability will overcome brand or supplier loyalty – meaning that if the customer’s preferred brand is not available and a substitute is, then the likelihood is a lost sale.

LOGISTICS & SUPPLY CHAIN MANAGEMENT28

LOGISTICS AND CUSTOMER VALUE 29

Delivering customer value

Ultimately the success or failure of any business will be determined by the level of customer value that it delivers in its chosen markets. Customer value can be defined quite simply as the difference between the perceived benefits that flow from a purchase or a relationship and the total costs incurred. Another way of expressing the idea is:

Perceptions of benefitsCustomer value = –––––––––––––––––––––––– Total cost of ownership

‘Total cost of ownership’ rather than ‘price’ is used here because in most trans- actions there will be costs other than the purchase price involved. For example, inventory carrying costs, maintenance costs, running costs, disposal costs and so on. In business-to-business markets particularly, as buyers become increas- ingly sophisticated, the total costs of ownership can be a critical element in the purchase decision. ‘Life-cycle costs’, as they are referred to in the military and defence industries, have long been a critical issue in procurement decisions in those markets. Figure 2.1 shows the ‘iceberg’ effect of total costs of ownership where the immediate purchase price is the only aspect of cost that is visible, whereas below the surface of the water are all the costs that will arise as a result of the purchase decisions.

Acquisition cost

Management cost

The total cost of ownership

Maintenance cost

Inventory cost Technical support

cost

Training cost

Disposal cost

Operating cost

Figure 2.1 The total cost of ownership

LOGISTICS & SUPPLY CHAIN MANAGEMENT30

In the same way that the total cost of ownership is greater than the initial purchase price so too the benefits that are perceived to flow from the purchase or the rela- tionship will often be greater than the tangible product features or functionality. For example, there may be little difference between two competitive products in terms of technical performance, but one may be superior to the other in terms of the cus- tomer support that is provided. One way to define ‘competitive advantage’ is simply that the successful companies will generally be those that deliver more customer value than their com- petitors. In other words, their ratio of benefits to costs is superior to other players in that market or segment. Logistics management is almost unique in its ability to impact both the numera- tor and the denominator of the customer value ratio. This point becomes clearer if we expand the ratio as follows:

Quality × ServiceCustomer value = –––––––––––––––––– Cost × Time

Each of the four constituent elements can briefly be defined as follows:

Quality: The functionality, performance and technical specification of the offer.

Service: The availability, support and commitment provided to the customer.

Cost: The customer’s transaction costs including price and life cycle costs.

Time: The time taken to respond to customer requirements, e.g. delivery lead times.

Each of these four elements requires a continuous programme of improvement, innovation and investment to ensure continued competitive advantage. One company that has built a global leadership position in its markets is Caterpillar, marketing machines and diesel engines for the construction and mining industries. Caterpillar has for many years focused on developing not just its man- ufacturing capabilities and innovative products but also its customer support and responsiveness. Underpinning these initiatives has been a continuing emphasis on creating superior logistics and supply chain management capabilities. Caterpillar has developed a world-class reputation for customer support, in particular its guar- antee to provide 48-hour availability of parts no matter how remote the location. In the industries where Caterpillar’s equipment is used, the cost of ‘down-time’ can be significant, hence the importance of responsive service. Through close partnership with its worldwide network of dealers and distributors and through advanced inven- tory and information management systems, Caterpillar offers levels of customer support – and thus customer value – that few companies in any industry can match.

Source: Johansson, H.J., McHugh, P., Pendlebury, A.J. and Wheeler, W.A., Business Process Reengineering, John Wiley & Sons, 1993.

LOGISTICS AND CUSTOMER VALUE 31

What is customer service?

It has been suggested that the role of customer service is to provide ‘time and place utility’ in the transfer of goods and services between buyer and seller. Put another way, there is no value in the product or service until it is in the hands of the customer or consumer. It follows that making the product or service ‘available’ is what, in essence, the distribution function of the business is all about. ‘Availability’ is in itself a complex concept, impacted upon by a galaxy of factors which together constitute customer service. These factors might include delivery frequency and reliability, stock levels and order cycle time, for example. Indeed it could be said that ultimately customer service is determined by the interaction of all those factors that affect the process of making products and services available to the buyer. In practice, we see that many companies have varying views of customer service. LaLonde and Zinszer2 in a major study of customer service practices sug- gested that customer service could be examined under three headings:

1 Pre-transaction elements

2 Transaction elements

3 Post-transaction elements

The pre-transaction elements of customer service relate to corporate policies or programmes, e.g. written statements of service policy, adequacy of organisational structure and system flexibility. The transaction elements are those customer service variables directly involved in performing the physical distribution function, e.g. prod- uct and delivery reliability. The post-transaction elements of customer service are generally supportive of the product while in use, for instance, product warranty, parts and repair service, procedures for customer complaints and product replacement. Table 2.1 indicates some of the many elements of customer service under these three headings.

Table 2.1 The components of customer service

Pre-transaction elements

For example: MM Written customer service policy

(Is it communicated internally and externally? Is it understood? Is it specific and quantified where possible?)

MM Accessibility (Are we easy to contact/do business with? Is there a single point of contact?)

MM Organisation structure (Is there a customer service management structure in place? What level of control do they have over their service process?)

MM System flexibility (Can we adapt our service delivery systems to meet particular customer needs?) 

LOGISTICS & SUPPLY CHAIN MANAGEMENT32

Table 2.1 Continued

Transaction elements

For example: MM Order cycle time

(What is the elapsed time from order to delivery? What is the reliability/variation?) MM Inventory availability

(What percentage of demand for each item can be met from stock?) MM Order fill rate

(What proportion of orders are completely filled within the stated lead time?) MM Order status information

(How long does it take us to respond to a query with the required information? Do we inform the customer of problems or do they contact us?)

Post-transaction elements

For example: MM Availability of spares

(What are the in-stock levels of service parts?) MM Call-out time

(How long does it take for the engineer to arrive and what is the ‘first call fix rate’?) MM Product tracing/warranty

(Can we identify the location of individual products once purchased? Can we maintain/extend the warranty to customers’ expected levels?)

MM Customer complaints, claims, etc. (How promptly do we deal with complaints and returns? Do we measure customer satisfaction with our response?)

In any particular product/market situation, some of these elements will be more important than others and there may be factors other than those listed above which have a significance in a specific market. Indeed the argument that will be developed later is that it is essential to understand customer service in terms of the differing requirements of different market segments and that no universally appro- priate list of elements exists; each market that the company services will attach different importance to different service elements. It is because of the multivariate nature of customer service and because of the widely differing requirements of specific markets that it is essential for any busi- ness to have a clearly identified policy towards customer service. It is surprising perhaps that so few companies have defined policies on customer service, let alone an organisation flexible enough to manage and control that service, when it is considered that service can be the most important element in the company’s marketing mix. A considerable body of evidence exists that supports the view that if the product or service is not available at the time the customer requires it and a close substitute is available then the sale will be lost to the competition. Even in markets where brand loyalty is strong a stock-out might be sufficient to trigger brand switching.



LOGISTICS AND CUSTOMER VALUE 33

The impact of out-of-stock

One study3 identified that a significant cost penalty is incurred by both manufactur- ers and retailers when a stock-out occurs on the shelf. The research found that on a typical day a shopper in the average supermarket will face stock-outs on 8 per cent of items in the categories studied. The reaction of customers when faced with a stock-out was highlighted by the same study. As Figure 2.2 illustrates, over a quarter of shoppers bought a different brand and 31 per cent said they would shop elsewhere for that product. This represents bad news for both the manu- facturer and the retailer. Even worse, other research4 has suggested that over two-thirds of shopping decisions are made at the point of purchase, i.e. the pur- chase is triggered by seeing the product on the shelf. If the product is not on the shelf then the purchase will not be triggered. Persistent stock-outs can also drive customers away from the brand and/or the store permanently. The potential loss of business for both manufacturers and retailers caused by out-of-stock situations is clearly significant.

In industrial markets, too, the same pressures on purchasing source loyalty seem to be at work. It is perhaps not surprising that as more and more companies adopt ‘just-in-time’ strategies, with minimal inventories, they require even higher levels of response from suppliers. The demand is for ever shorter delivery lead times and reliable delivery. The pressure on suppliers is further increased as these same customers seek to rationalise their supplier base and to do business with fewer suppliers. Becoming a preferred supplier in any industry today inevitably means that a high priority must be placed on delivering superior customer service.

It is because of the multivariate nature of customer service and because of

the widely differing requirements of specific markets that it is essential for any

business to have a clearly identified policy towards customer service.

Do not purchase item

Delay purchase

Substitute different brand

Substitute same brand

Buy item at another store

9%

15%

19%

31%

26%

Figure 2.2 Shopper behaviour when faced with a stock-out

Source: Corsten, D. and Gruen, T., ‘Stock-outs cause walkouts’, Harvard Business Review, May 2004

LOGISTICS & SUPPLY CHAIN MANAGEMENT34

Many companies have suffered in this new competitive environment because in the past they have focused on the traditional aspects of marketing – prod- uct development, promotional activities and price competition. However, whilst these are still necessary dimensions of a successful marketing strategy they are not sufficient. Equally damaging has been the focus on cost reduction that has driven many companies’ operational and logistics strategy – particularly as a result of recession. Cost reduction is a worthy goal as long as it is not achieved at the expense of value creation. Low-cost strategies may lead to efficient logistics but not to effective logistics. More often than not today the order winning criteria are those elements of the offer that have a clearly identifiable positive impact upon the customers’ own value-creating processes. One powerful way of highlighting the impact that customer service and logis- tics management can have on marketing effectiveness is outlined in Figure 2.3. The suggestion here is that customer service impacts not only on the ultimate end user but also on intermediate customers such as distributors. Traditionally market- ing has focused on the end customer – or consumer – seeking to promote brand values and to generate a ‘demand pull’ in the marketplace for the company’s prod- ucts. More recently we have come to recognise that this by itself is not sufficient. Because of the swing in power in many marketing channels away from manufac- turers and towards the distributor (e.g. the large concentrated retailers) it is now vital to develop the strongest possible relations with such intermediaries – in other words to create a customer franchise as well as a consumer franchise.

The impact of both a strong consumer franchise and a customer franchise can be enhanced or diminished by the efficiency of the supplier’s logistics system. It is only when all three components are working optimally that marketing effectiveness is maximised. To stress the interdependence of these three components of com- petitive performance it is suggested that the relationship is multiplicative. In other words the combined impact depends upon the product of all three.

Customer service and customer retention

It will be apparent from what has been said that organisations that compete only on the product’s features will find themselves at a severe disadvantage to those companies that augment the basic product with added-value services. It was one

Consumer franchise

Customer franchise

Supply chain efficiency

Marketing effectiveness

• Brand values • Corporate image • Availability

• Customer service • Partnership • Quick response

• Flexibility • Reduced asset base • Low-cost supplier

• Market share • Customer retention • Superior ROI

× × =

Figure 2.3 The impact of logistics and customer service on marketing

LOGISTICS AND CUSTOMER VALUE 35

of the leading thinkers in marketing, Theodore Levitt, who first said that ‘people don’t buy products, they buy benefits’.5 The idea behind this statement is that it is the totality of the ‘offer’ that delivers customer value. A simple example would be that a finished product in a warehouse is the same as a finished product in the hands of the customer in terms of its tangible features. Clearly, however, the product in the hands of the customer has far more value than the product in the warehouse. Distribution service in this case has been the source of added value. Figure 2.4 develops this idea with the concept of the ‘service surround’.

At the centre is the core product, which is the basic product as it leaves the fac- tory. The outer ‘halo’ represents all the added value that customer service and logistics provide. Clearly it is not only customer service and logistics activ- ity that add value; in many cases advertising, branding and the packaging can all enhance the perceived value of the product to the customer. However, it is increasingly evident, as we have seen, that it takes more than branding to differen- tiate the product. This idea underpins the current emphasis on seeking to create strategies that focus on ‘servitisation’, i.e. converting a product into a service. The example of Rolls-Royce aero engines, highlighted below, provides powerful support for this idea.

Se rv

ice

Core product

Surround

• Quality • Product features • Technology • Durability, etc.

• Delivery lead time and flexibility • Delivery reliability and consistency • Order fill • Ease of doing business • After-sales support, etc.

Figure 2.4 Using service to augment the core product

LOGISTICS & SUPPLY CHAIN MANAGEMENT36

One of the classic definitions of marketing is that it is concerned with ‘getting and keeping customers’. In practice, if we look at where most organisations’ market- ing efforts focus, it is on the ‘getting’ of customers, rather than on the ‘keeping’ of them. Thus an examination of the typical marketing plan will show a bias towards increasing market share rather than towards customer retention. Whilst new cus- tomers are always welcome in any business it has to be realised that an existing customer can provide a higher profit contribution and has the potential to grow in terms of the value and frequency of purchases. The importance of customer retention is underlined by the concept of the ‘life- time value’ of a customer. The lifetime value of a customer is calculated as follows:

Lifetime value = Average transaction value × Yearly frequency of purchase × Customer ‘life expectancy’

Clearly if customers can be persuaded to remain loyal to a supplier, their lifetime value can be significantly increased. A further benefit comes from the fact that the longer the customer stays with an organisation the more profitable they become. A study by consulting company Bain and Co.6 found higher customer retention rates correlated strongly with profitability. The reasons for this are that a retained cus- tomer typically costs less to sell to and to service. Also as the relationship develops there is an increased likelihood that they will give a greater part of their business to a supplier whom they are prepared to treat as a partner. This is the idea of ‘share of wallet’, whereby the goal is to increase the total spend that is captured by the com- pany. Furthermore, satisfied customers tell others and thus the chance increases that further business from new customers will be generated through this source. A simple measure of customer retention is to ask the question: ‘How many of the customers that we had 12 months ago do we still have today?’ This measure is the real test of customer retention. It can be extended to include the value of purchases made by the retained customer base to assess how successful the company has been in increasing the level of purchasing from these accounts (see Figure 2.5).

Power by the hour Rolls-Royce Group plc is a UK-based manufacturer of gas turbines and is one of the major suppliers of engines to the aviation and energy industries. Typically these engines will cost several million pounds and require periodic and expensive main- tenance and upgrading. In the past most airlines having bought an engine would assume responsibility for the servicing of that engine and holding the necessary inventory of spare parts. Clearly the cost of this was significant and also the unpre- dictability meant that a global service and repair capability was required. Realising that what their customers really wanted was not the engine per se but rather the guarantee of performance led Rolls-Royce to develop the idea of ‘power by the hour’. Under this arrangement Rolls-Royce takes responsibility for remotely monitoring the ‘health’ of the engine throughout its working life and providing all the necessary service and support wherever it is needed around the world. For this ‘Total Care’ package the customer pays Rolls-Royce by the flying hour.

LOGISTICS AND CUSTOMER VALUE 37

A prime objective of any customer service strategy should be to enhance cus- tomer retention. Whilst customer service obviously also plays a role in winning new customers it is perhaps the most potent weapon in the marketing armoury for the keeping of customers. There is rapidly emerging a new focus in marketing and logistics on the creation of ‘relationships’ with customers. The idea is that we should seek to create such a level of satisfaction with customers that they do not feel it necessary even to con- sider alternative offers or suppliers. Many markets are characterised by a high level of ‘churn’ or ‘promiscuity’ amongst the customer base. In these markets custom- ers will buy one brand on one occasion and then are just as likely to buy another on the next occasion. The principle behind ‘relationship marketing’ is that the organisation should consciously strive to develop marketing strategies to maintain and strengthen customer loyalty.7 So, for example, an airline might develop a frequent-flyer pro- gramme, or a credit card company might award points based upon the value of purchases made with the card that can then be redeemed for cash or awards. At the other extreme, a company like IBM will consciously seek to develop long-term relationships with its customers through training programmes, client seminars, fre- quent customer communication and so on.

No. of customers 12 months ago

No. of customers today

Retained customers

New customers

(a)

Value of purchases 12 months ago

Value of purchases by retained customers

£

(b)

£

Figure 2.5 Customer retention indicators

LOGISTICS & SUPPLY CHAIN MANAGEMENT38

Market-driven supply chains

Most traditional supply chains were designed to optimise the internal operations of the supplying company. Thus a manufacturer might be motivated to establish supply and distribution arrangements that would enable production efficiencies to be max- imised. Typically this would entail manufacturing in large batches, shipping in large quantities and buffering the factory, both upstream and downstream, with inventory. In this way the goal of becoming a ‘low-cost producer’ could be achieved. Whilst this approach was fine from the perspective of the manufacturing organi- sation, it clearly did not come anywhere close to being ‘customer-centric’, in the sense of designing the supply chain around the needs of the customer. With the continuing transfer of power in the distribution channel from the producer to the consumer, this conventional philosophy has become less and less appropriate. Now, instead of designing supply chains from the ‘factory outwards’ the challenge is to design them from the ‘customer backwards’. This new perspective sees the consumer not at the end of the supply chain but at its start. In effect this is the philosophical difference between supply chain man- agement and what more properly might be called ‘demand chain management’. As one author has suggested:

Managing demand chains is … fundamentally different to managing supply chains. It requires turning the supply chain on its head, and taking the end user as the organization’s point of departure and not its final destination.

SOURCE: S. BAKER8

Figure 2.6 suggests an appropriate sequence of actions to create a market-driven supply chain. This sequence begins with an understanding of the value that customers seek in the market in which the company competes. This customer insight will enable the identification of the real market segmentation, i.e. the clusters of customers who share the same value preferences. The Spanish fashion chain Zara provides an excellent example of how market understanding and supply chain excellence can create real value for its target customers.

ZARA: linking supply chain processes to the value proposition Zara is one of world’s most successful clothing manufacturers and retailers. They have achieved this leadership position through creating a value proposition around the idea of ‘Fast Fashion’. Almost uniquely they have developed supply chain proc- esses that enable them to capture ideas and trends in the apparel market and to translate them into products in amazingly short lead times. Zara’s target time to take an idea from design to store is between three and four weeks. To achieve this quick response capability Zara have developed an agile network of closely integrated company-owned and independent manufacturing facilities that have the flexibility to produce in small batches at short notice. Whilst this is not the cheapest way to make a garment, it ensures that they achieve their value proposition.

LOGISTICS AND CUSTOMER VALUE 39

Identifying customers’ service needs It is important to remember that no two customers will ever be exactly the same in terms of their service requirements. However, it will often be the case that custom- ers will fall into groups or ‘segments’ that are characterised by a broad similarity of service needs. These groupings might be thought of as ‘service segments’. The logistics planner therefore needs to know just what the service issues are that dif- ferentiate customers. Market research can be of great assistance in understanding this service segmentation and it is often surprising to see how little formal research is conducted in this crucial area. How might such a research programme be implemented? The first point to emphasise is that customer service is perceptual. Whatever our own ‘hard’ internal measures of service might say our service performance is, perceptions are the reality. We might use measures which, whilst providing useful measures of productivity, do not actually reflect the things the customer values. For example, whilst ‘stock availability’ is a widespread internal measure of perform- ance, a more appropriate external measure from the customer’s viewpoint could be ‘on-time delivery’. Hence it is critical that we develop a set of service criteria that are meaningful to customers.

Identify value

segments What do our customers value?

Define the value

proposition

How do we translate these requirements into an offer?

Identify the market

winners

What does it take to succeed in this market?

Develop the supply chain

strategy

How do we deliver against this proposition?

Figure 2.6 Linking customer value to supply chain strategy

LOGISTICS & SUPPLY CHAIN MANAGEMENT40

The approach to service segmentation suggested here follows a three-step process:

1 Identify the key components of customer service as seen by customers themselves.

2 Establish the relative importance of those service components to customers.

3 Identify ‘clusters’ of customers according to similarity of service preferences.

1 Identifying the key components of customer service

A common failing in business is to assume that ‘we know what our customers want’. However, the truth is that it is easy to become divorced from the reality of the marketplace when management is consumed with the day-to-day pressures of running a business. How should we know which aspects of service are most highly rated by the customer? Given the complexity of the market that the typical com- pany serves how might it better understand the segmentation of those markets in terms of service requirements? What does it take for a company to become the supplier of choice? Clearly it is important to develop an understanding of the service needs of cus- tomers through detailed research. The first step in research of this type is to identify the key sources of influ- ence upon the purchase decision. If, for example, we are selling components to a manufacturer, who will make the decision on the choice of supplier? This is not always an easy question to answer as in many cases there will be several people involved. The purchasing manager of the company to which we are selling may only be acting as an agent for others within the firm. In other cases his or her influ- ence will be much greater. Alternatively if we are manufacturing products for sale through retail outlets, is the decision to stock made centrally or by individual store managers? The answers can often be supplied by the sales force. The sales repre- sentative should know from experience who the decision makers are. Given that a clear indication of the source of decision-making power can be gained, the customer service researcher at least knows who to research. The question remains as to which elements of the vendor’s total marketing offering have what effect upon the purchase decision. Ideally once the decision-making unit in a specific market has been identified, an initial, small-scale research programme should be undertaken based upon personal interviews with a representative sample of buyers. The purpose of these interviews is to elicit, in the language of the customers, firstly, the importance they attach to customer service vis-à-vis the other marketing mix elements such as price, product quality, promotion, etc., and secondly, the specific importance they attach to the individual components of customer service. The importance of this initial step in measuring customer service is that relevant and meaningful measures of customer service are generated by the customers themselves. Once these dimensions are defined we can identify the relative impor- tance of each one and the extent to which different types of customer are prepared to trade off one aspect of service for another.

LOGISTICS AND CUSTOMER VALUE 41

2 Establishing the relative importance of customer service components

One of the simplest ways of discovering the importance a customer attaches to each element of customer service is to take the components generated by means of the process described in step 1 and to ask a representative sample of custom- ers to rank order them from the ‘most important’ to the ‘least important’. In practice this is difficult, particularly with a large number of components, and would not give any insight into the relative importance of each element. Alternatively a form of rating scale could be used. For example, the respondents could be asked to place a weight from 1 to 10 against each component according to how much importance they attached to each element. The problem here is that respondents will tend to rate most of the components as highly important, especially since those compo- nents were generated on the grounds of importance to customers in the first place. A partial solution is to ask the respondent to allocate a total of 100 points amongst all the elements listed, according to perceived importance. However, this is a fairly daunting task for the respondent and can often result in an arbitrary allocation. Fortunately a relatively recent innovation in consumer research technology now enables us to evaluate very simply the implicit importance that a customer attaches to the separate elements of customer service. The technique is based around the concept of trade-off and can best be illustrated by an example from everyday life. In considering, say, the purchase of a new car we might desire specific attributes, e.g. performance in terms of speed and acceleration, economy in terms of petrol consumption, size in terms of passenger and luggage capacity and, of course, low price. However, it is unlikely that any one car will meet all of these requirements so we are forced to trade off one or more of these attributes against the others. The same is true of the customer faced with alternative options of distribution service. The buyer might be prepared to sacrifice a day or two of lead time in order to gain delivery reliability, or to trade off order completeness against improvements in order entry, etc. Essentially the trade-off technique works by presenting the respondent with feasible combinations of customer service elements and asking for a rank order of preference for those combinations. Computer analysis then deter- mines the implicit importance attached by the respondent to each service element.9

Whatever technique is used it is important to understand which are the ‘qualifi- ers’ and which are the ‘order winners’ amongst the different customer groups. This understanding must then drive the design of the supply chain processes that will enable success in the marketplace.

3 Identifying customer service segments

Now that we have determined the importance attached by different respondents to each of the service attributes previously identified, the final step is to see if any similarities of preference emerge. If one group of respondents, for example, has a clearly distinct set of priorities from another then it would be reasonable to think of them both as different service segments. How can these customer service segments be identified? One technique that has been successfully used in this connection is cluster analysis. Cluster analy- sis is a computer-based method for looking across a set of data and seeking

LOGISTICS & SUPPLY CHAIN MANAGEMENT42

to ‘match’ respondents across as many dimensions as possible. Thus if two respondents completed the step 2 trade-off analysis in a similar way their impor- tance scores on the various service dimensions would be similar and hence the cluster analysis would assign them to the same group. One study in an industrial market suggested that the traditional way of seg- menting customers according to ‘Standard Industrial Classification’ (SIC) had little relevance to purchasing behaviour. The classic categorisation of custom- ers according to industry sector did not correlate with the attributes they sought from suppliers. Instead it seemed that some companies were very time-sensitive in terms of delivery reliability – a ‘just-in-time’ segment – regardless of the indus- try they were in. In the same way there was a very clear ‘price’ segment, which also cut across conventional industrial classifications. A further segment was much more responsive to a ‘relationship’ approach, valuing technical support and close supplier liaison much more highly. As a result of this research the supplier was better able to focus its marketing efforts and to re-engineer its supply chain strat- egy to achieve a better match with customer requirements. The challenge to logistics management is to create appropriate supply chain solutions to meet the needs of these different value segments. More than likely there will be the need for multiple supply chain solutions since ‘one size will not fit all’. This issue will be dealt with in detail in Chapter 5 where the concept of supply chain agility is discussed.

Defining customer service objectives

The whole purpose of supply chain management and logistics is to provide cus- tomers with the level and quality of service that they require and to do so at less cost to the total supply chain. In developing a market-driven logistics strategy the aim is to achieve ‘service excellence’ in a consistent and cost-effective way.

The definition of appropriate service objectives is made easier if we adopt the concept of the perfect order. The perfect order is achieved when the customer’s service requirements are met in full. Clearly such a definition is specific to individ- ual customers, but it is usually possible to group customers into segments and then to identify, along the lines described earlier, the key service needs of those segments. The perfect order is achieved only when each of those service needs is met to the customer’s satisfaction. The measure of service is therefore defined as the percentage of occasions on which the customer’s requirements are met in full. Normally this percentage would be measured across all customers over a period of time. However, it can also be

The whole purpose of supply chain management and logistics is to provide

customers with the level and quality of service that they require and to do so

at less cost to the total supply chain.

LOGISTICS AND CUSTOMER VALUE 43

used to measure service performance at the individual customer level and indeed at any level, e.g. segment, country or by distribution centre. One frequently encountered measure of the perfect order is ‘on-time, in-full’ (OTIF). An extension of this is on-time, in-full and error-free. This latter element relates to documentation, labelling and damage to the product or its packaging. To calculate the actual service level using the perfect order concept requires per- formance on each element to be monitored and then the percentage achievement on each element to be multiplied together. For example, if the actual performance across all orders for the last 12 months was as follows:

On-time : 90%

In-full : 80%

Error-free : 70%

the actual perfect order achievement would be:

90% × 80% × 70% = 50.4%

In other words the likelihood that a perfect order was achieved during the period under review was only 50.4 per cent!

The cost benefit of customer service All companies have to face a basic fact: there will be significant differences in profitability between customers. Not only do different customers buy different quantities of different products, but the cost to service these customers will typi- cally vary considerably. This issue will be explored more fully in Chapter 3. The 80/20 rule will often be found to hold: 80 per cent of the profits of the busi- ness come from 20 per cent of the customers. Furthermore, 80 per cent of the total costs to serve will be generated from 20 per cent of the customers (but probably not the same 20 per cent!). Whilst the proportion may not be exactly 80/20 it will generally be in that region. This is the so-called Pareto Law, named after a nine- teenth century Italian economist. The challenge to customer service management therefore is, firstly, to identify the real profitability of customers and then, secondly, to develop strategies for serv- ice that will improve the profitability of all customers. What has to be recognised is that there are costs as well as benefits in providing customer service and that there- fore the appropriate level and mix of service will need to vary by customer type. The basic relationship between the level of service and the cost is often depicted as a steeply rising curve (Figure 2.7). The curve assumes that demand for the item is ‘normally’ distributed, i.e. it takes on the classic bell-shape. A feature of the normal distribution is that once its two key parameters, the mean (x–) and standard deviation (s), are known, the probability of a given value occurring can be easily calculated. Thus, as Figure 2.8 shows, if the distribution depicted describes daily sales for a particular product, it can be calculated that on approximately 68 per cent of occasions total demand

LOGISTICS & SUPPLY CHAIN MANAGEMENT44

would be within plus or minus one standard deviation either side of the mean; on approximately 95 per cent of occasions total demand would lie within plus or minus two standard deviations either side of the mean and on 99 per cent of occa- sions three standard deviations either side of the mean.

In calculating how much safety stock is required the inventory manager is only concerned with those occasions when demand is greater than average. If sales are approximately normally distributed, demand will be lower than average approx- imately 50 per cent of the time, and thus a 50 per cent service level would be maintained with no safety stock. It is on those occasions when demand exceeds the average that safety stock is required. In other words we must focus attention on the area of the curve to the right of the mean. Thus, by setting a stock level one

Service level 100%0

C os

ts o

f s er

vi ce

Figure 2.7 The costs of service

–2σ

68.3%

Average sales

–3σ –σ σ 2σ 3σ

95.4% 99.7%

Figure 2.8 Probability of level of sales being within given limits

LOGISTICS AND CUSTOMER VALUE 45

standard deviation greater than the mean, the manager can achieve a service level of approximately 84 per cent. By setting the level two standard deviations greater than the mean the service level would be approximately 98 per cent and with three standard deviations it would be 99.9 per cent (Figure 2.9).

What this highlights is that, as the desired service level rises, it takes a disproportion- ate investment in inventory to achieve small incremental improvements in availability. The table below illustrates this effect:

Inventory level Service level

x– 50%

x– + s 84%

x– + 2s 98%

x– + 3s 99.9%

MM If inventory equivalent to average expected daily demand (x–) is held then the service level would be 50 per cent.

MM If safety stock equivalent to one standard deviation of demand (s) is held then the service level would be 84 per cent, etc.

However, if it is possible to find alternative service strategies for servicing cus- tomers, say, for example, by speeding up the flow of information about customer requirements and by using faster modes of transport, then the same level of serv- ice can be achieved with less inventory – in effect pushing the curve to the right (Figure 2.10). This is the idea of substituting information and responsiveness for inventory. In other words if we can gain earlier warning of customer requirements and our lead times are short, then we can reduce our reliance on inventory.

σ 2σ 3σ

99.9% 98%

84%

Figure 2.9 Service levels and the normal distribution

LOGISTICS & SUPPLY CHAIN MANAGEMENT46

Setting customer service priorities

Whilst it should be the objective of any logistics system to provide all customers with the level of service that has been agreed or negotiated, it must be recog- nised that there will inevitably need to be service priorities. In this connection the Pareto Law, or 80/20 rule, can provide us with the basis for developing a more cost-effective service strategy. Fundamentally, the service issue is that since not all our customers are equally profitable nor are our products equally profitable, should not the highest service be given to key customers and key products? Since we can assume that money spent on service is a scarce resource then we should look upon the service decision as a resource allocation issue. Figure 2.11 shows how a typical company might find its profits varying by cus- tomer and by product.

0 100%Service level

C os

t of

s er

vi ce

Figure 2.10 Shifting the costs of service

15%

5%

80%

20% 30%50%

'A' 'C''B'

% Products/customers

% S

al es

/p ro

fit s

Figure 2.11 The ‘Pareto’ or 80/20 rule

LOGISTICS AND CUSTOMER VALUE 47

The curve is traditionally divided into three categories: the top 20 per cent of prod- ucts and customers by profitability are the ‘A’ category; the next 50 per cent or so are labelled ‘B’; and the final 30 per cent are category ‘C’. The precise split between the categories is arbitrary as the shape of the distribution will vary from business to business and from market to market. The appropriate measure should be profit rather than sales revenue or volume. The reason for this is that revenue and volume measures might disguise consider- able variation in costs. In the case of customers this cost is the ‘cost to serve’, and we will later suggest an approach to measuring customer profitability. In the case of product profitability we must also be careful that we are identifying the appropri- ate service-related costs as they differ by product. One of the problems here is that conventional accounting methods do not help in the identification of these costs. What we should be concerned to do at this stage in the analysis is to iden- tify the contribution to profit that each product (at the individual stock keeping unit (SKU) level) makes. By contribution we mean the difference between total reve- nue accruing and the directly attributable costs that attach as the product moves through the logistics system. Looking first at differences in product profitability, what use might be made of the A,B,C categorisation? Firstly it can be used as the basis for classic inventory control whereby the highest level of service (as represented by safety stock) is pro- vided for the ‘A’ products, a slightly lower level for the ‘B’ products and lower still for the ‘Cs’. Thus we might seek to follow the stock holding policy shown below:

Product category Stock availability

A 99%

B 97%

C 90%

Alternatively, and probably to be preferred, we might differentiate the stock holding by holding the ‘A’ items as close as possible to the customer and the ‘B’ and ‘C’ items further up the supply chain. The savings in stock holding costs achieved by consolidating the ‘B’ and ‘C’ items as a result of holding them at fewer locations would normally cover the additional cost of despatching them to the customer by a faster means of transportation (e.g. overnight delivery). Perhaps the best way to manage product service levels is to take into account both the profit contribution and the individual product demand. We can bring both these measures together in the form of a simple matrix in Figure 2.12. The matrix can be explained as follows.

LOGISTICS & SUPPLY CHAIN MANAGEMENT48

Quadrant 1: Seek cost reductions

Because these products have high volume it would suggest that they are in fre- quent demand. However, they are also low in profit contribution and the priority should be to re-examine product and logistics costs to see if there is any scope for enhancing profit.

Quadrant 2: Provide high availability

These products are frequently demanded and they are more profitable. We should offer the highest level of service on these items by holding them as close to the customer as possible and with high availability. Because there will be relatively few of these items we can afford to follow such a strategy.

Quadrant 3: Review

Products in this category should be regularly appraised with a view to deletion from the range. They do not contribute to profits (or at least only marginally) and they are slow movers from a sales point of view. Unless they play a strategic role in the prod- uct portfolio of the firm then there is probably a strong case for dropping them.

Quadrant 4: Centralised inventory

Because these products are highly profitable but only sell at a relatively slow rate they are candidates for centralised management. In other words, they should be kept in some central location, as far back up the supply chain as possible in order to reduce the total inventory investment, and then shipped by express transport direct to customers.

(1) Seek cost reduction

(2) Provide high availability

(3) Review

(4) Centralised inventory

Low

Lo w

H ig

h

Vo lu

m e

(b y

S K

U )

Profit contribution (by SKU)

High

Figure 2.12 Managing product service levels

LOGISTICS AND CUSTOMER VALUE 49

This concept of service prioritisation by product can be extended to include customer priorities. Because the same 80/20 rule applies to customers as it does to products, it makes sense to focus resources on key accounts as well as key products. Figure 2.13 shows that if the 80/20 rule applies both to products and customers then all businesses are actually very dependent upon a very few customers buying a few high profit lines. Indeed the arithmetic is easy:

20% of customers buying 20% of the products = 4% of all customer/product transactions

Which provides:

80% of 80% of total profit = 64%

In other words, just 4 per cent of transactions (measured order line by order line) gives us 64 per cent of all our profit!

How can we make use of this important fact? The first thing is obviously to offer the highest levels of service and availability to key customers ordering key products. At the other end of the spectrum we should constantly review the less profitable customers and the less profitable products. In between there is scope for a degree of pragmatism, perhaps based upon the ‘critical value’ of an item to the customer. This is particularly relevant when developing a service strategy for spare parts. The idea is that if certain items are essential for, say, the operation of a machine where the downtime costs are high then those parts would be accorded a high critical

Develop

Review

A B

P ro

d uc

ts

Customers

Maintain

Develop

C

C

B

A

Key products, key accounts (protect)

Figure 2.13 Customer service and the 80/20 rule

LOGISTICS & SUPPLY CHAIN MANAGEMENT50

value. If appropriate a ‘weight’ could be assigned on the basis of criticality and the 80/20 ranking based on profit could be adjusted accordingly. Table 2.2 provides an example.

Table 2.2 Critical value analysis

Products Profitability rank order

Critical value to customers 1 2 3

Rank × Critical value

Order of priority for service

C 1 x 3 1

P 2 x 4 2 =

R 3 x 6 5

B 4 x 4 2 =

X 5 x 5 4

Y 6 x 18 8

Z 7 x 14 7

H 8 x 8 6

J 9 x 27 10

K 10 x 20 9

Critical values: 1 = Sale lost 2 = Slight delay acceptable 3 = Longer delay acceptable

Setting service standards

Obviously if service performance is to be controlled then it must be against prede- termined standards. Ultimately the only standard to be achieved is 100 per cent conformity to cus- tomer expectations. This requires a clear and objective understanding of the customers’ requirements and at the same time places an obligation upon the sup- plier to shape those expectations. In other words there must be a complete match between what the customer expects and what we are willing and able to provide. This may require negotiation of service standards since clearly it is in neither par- ty’s interest to provide service levels that would lead to a long-term deterioration in profitability – either for the supplier or the customer. What are the customer service elements for which standards should be set? To be effective these standards must be defined by the customers themselves. This requires customer research and competitive benchmarking studies to be con- ducted so that an objective definition of customer service for each market segment may be identified.

LOGISTICS AND CUSTOMER VALUE 51

However, for the moment we can indicate some of the key areas where stand- ards are essential:

MM Order cycle time MM Stock availability MM Order-size constraints MM Ordering convenience MM Frequency of delivery MM Delivery reliability MM Documentation quality MM Claims procedure MM Order completeness MM Technical support MM Order status information

Let us examine each of these in turn.

Order cycle time

This is the elapsed time from customer order to delivery. Standards should be defined against the customer’s stated requirements.

Stock availability

This relates to the percentage of demand for a given line item (stock keeping unit, or SKU) that can be met from available inventory.

Order-size constraints

More and more customers seek just-in-time deliveries of small quantities. Do we have the flexibility to cope with the range of customer demands likely to be placed upon us?

Ordering convenience

Are we accessible and easy to do business with? How are we seen from the cus- tomers’ viewpoint? Do our systems talk to their systems?

Frequency of delivery

A further manifestation of the move to just-in-time is that customers require more frequent deliveries within closely specified time windows. Again it is flexibility of response that should be the basis for the performance standard.

LOGISTICS & SUPPLY CHAIN MANAGEMENT52

Delivery reliability

What proportion of total orders are delivered on time? It is a reflection not just of delivery performance but also of stock availability and order processing performance.

Documentation quality

What is the error rate on invoices, delivery notes and other customer communica- tions? Is the documentation ‘user friendly’? A surprisingly large number of service failures are from this source.

Claims procedure

What is the trend in claims? What are their causes? How quickly do we deal with complaints and claims? Do we have procedures for ‘service recovery’?

Order completeness

What proportion of orders do we deliver complete, i.e. no back orders or part shipments?

Technical support

What support do we provide customers with after the sale? If appropriate do we have standards for call-out time and first-time fix rate on repairs?

Order status information

Can we inform customers at any time on the status of their order? Do we have ‘hotlines’ or their equivalent? Do we have procedures for informing customers of potential problems on stock availability or delivery?