Supply chains have uncertainty on both the demand and supply side. Demand uncertainty occurs when product demand is unstable and difficult to predict.
Supply uncertainty occurs when there is uncertainty regarding sources of supply and their capabilities. Demand and supply uncertainties are related to the type of product and their supply chains. Understanding these uncertainties makes it easier to manage the supply chain.
FIGURE 6.4 Criteria for using competitive bidding versus negotiation.
COMPETITIVE BIDDING
&Performance criteria and specifications can be clearly defined
&Volume purchased is high
&Products being purchased are standardized
&Many qualified suppliers exist in the marketplace
&Time is available for bid evaluation
NEGOTIATION
&Performance criteria and specifications cannot be clearly defined
&Many criteria exist for supplier selection (e.g., cost, quality, delivery, and service)
&Product being purchased is new or technically complex
&Few qualified suppliers exist in the marketplace
&Suppliers customize the product to buyer
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Two broad categories of products result in very different supply chains and have differing levels of demand uncertainty. Products can be classified as either primarily functional or primarilyinnovative.1Depending on their classifica- tion, they will be sourced differently and will require different types of supply chains. Functional products are those that satisfy basic functions or needs. They include items such as food purchased in grocery stores, gas and oil for transportation and heating, and household items from batteries to light bulbs.
In contrast, innovative products are purchased for other reasons, such as innovation or status, and include high fashion items or technology products, such as those seen in the computer industry.
Functional products typically have stable and predictable demand and long life cycles. It is easier to source for functional products due to this stability. Their supply chains are easier to manage; however, they typically have low profit margins. Innovative products, on the other hand, have highly unpredictable demand and short life cycles. New and innovative products are introduced quickly and their demand is difficult to forecast. Although they have higher profit margins their supply chains are much more difficult to manage.
1Lee, H. L. ‘‘Aligning Supply Chain Strategies with Product Uncertainties.’’California Management Review, 44(3), Spring 2002: 105–119.
G L O B A L I N S I G H T S B O X — F U N C T I O N A L P R O D U C T S C H A L L E N G E
Global Fast Food Markets
Even functional products can experience uncertainty in demand in certain markets. Consider the case of the fast food market in China. Yum! Brands, which includes KFC and Pizza Hut chains, has done extremely well in the Chinese fast food market. However, sales have been dropping at Chinese outlets in the recent past, and there are fears that Chinese tastes may be shifting away from Western cuisine.
Some analysts think that China may be saturated with Western brands, especially in the big cities.
The novelty may have worn off and preferences may be shifting back to local tastes.
Even typically stable products experience demand shifts due to a variety of factors. Yum’s Brand is now experiencing competition it did not have before from local rivals. A few years ago having air conditioning and clean restrooms in China was an order winner and brought in customers. Today, Chinese chains are expanding and offering these same amenities, often with help from global investors. Also, McDonald’s is refocusing in China and planning to open as many as 175 new mainland restaurants and offering free Wi-Fi. What was a predictable product market just a few years ago is changing and requiring Yum to think about repositioning its product offering.
Adapted from: ‘‘Is China Fed Up With The Colonel’s Chicken?’’Business Week, February 22, 2010: 30.
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Just as there are uncertainties on the demand side, there are also uncertainties on the sourcing side. The supply side of the supply chain can be classified as a stableor anevolving supply process. A stable supply process is where sources of supply are well established, manufacturing processes used are mature, and the underlying technology is stable. Consider sourcing apples, lumber, or undershirts.
In contrast, an evolving supply process is where sources of supply are rapidly changing, the manufacturing process is in an early stage, and the underlying technology is quickly evolving. Examples would include alternative energy sources, certain organic food items, or high-end computer technology. It is challenging to manage supply chains with either demand or supply uncertainty. It is especially challenging to manage supply chains with both uncertainties as shown in Figure 6.5.
Efficiency-focused supply chains have both low demand and supply uncertainty and are easiest to manage. These supply chains typically don’t have high profit margins. However, their operations are highly predictable and the gains in these supply chains come from efficiency and elimination of waste.
Responsive supply chains are used for innovative products that have a stable supply base. The primary challenge here is to ensuring being able to quickly respond to customer demands. Mass-customization strategies such as postponement, where the supply chain is designed to delay product differen- tiation as late in the supply chain as possible, are effective here. A good example is the case of HP printers that are kept in generic form as long as possible. They are differentiated with country and language specific labels that are added at the last point in the system.
Risk-hedging supply chains are those with high uncertainty on the supply side. These supply chains must do everything possible to minimize risks of supply disruptions and inventory shortages. These supply chains typically rely on higher inventory safety stocks and engage in a practice where resources are pooled and shared between different companies.
FIGURE 6.5 Demand versus supply uncertainty.
Demand uncertainty
Low (functional products) High (innovative products) Supply uncertainty
Low
(stable process)
Efficiency-focused SC
Least challenging Responsive SC
High
(evolving process) Risk-hedging SC Agile SC
Most challenging
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Agile supply chains are used in cases of both high demand and supply uncertainty. They are the most difficult to manage as they simultaneously must be responsive to an uncertain demand while using strategies to hedge risks to ensure there are no supply disruptions. These supply chains use mass custom- ization strategies on the demand side, while carrying higher safety stock and engaging in resource pooling on the supply side.
S U P P L Y C H A I N L E A D E R ’ S B O X — I N N O V A T I V E P R O D U C T C H A L L E N G E
Apple Computer Corp
Apple Computer Corporation is known for its innovative products and an agile supply chain. Its iPad is a classic example of a high technology innovative product with an uncertain market. Following its launch numerous analysts made estimates of product demand, with an average estimate ranging between three to four million iPads sold in its first year. Estimates were also being made on how Apple would price the iPad, understanding the challenges of estimating the price for such a product.
The research firm iSuppli estimated that the gross margins for the product would likely start at 54% and it would be the envy of the computer business world, allowing room for the product to get cheaper as imitators came along. iSuppli gave the following price breakdown of some of iPad’s parts, giving an idea of what the cost to produce might be. The breakdown is as follows:
&Aluminum case and body $35.30
&Memory $29.50 (for 16GB model) to $118 (for 64 GB)
&Display $80 (9.9-inch color touch screen)
&Battery $17.50
&Wireless $35.15
&Processor $17
&Operating system unknown (proprietary)
Although the gross margin might seem high, given the average selling price being in the range of
$600, one has to consider the risks that the company takes with these innovative products. One strategy that Apple uses to help mitigate these risks is to use versions of the same operating system for its products—including the Macs, iPhones, iPods, and now the iPad—a system it developed in 2000.
It is an unusual strategy for a hardware company to also create its own operating system to run devices. The fact that Apple has such a durable platform that can be used across many products enables it to reduce risks on the supply side and gives it a huge advantage over its competitors.
Adapted from: ‘‘The iPad: More Than the Sum of its Parts. $270 More, Actually.’’Business Week,February 22, 2010: 24.
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