Speed: The Solution For Margin Myopia

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Barbara Christopher
Industrial and Systems Engineering
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Margin has long been a key measure of how well a business is doing, and an increase in margin has been seen as the route to success. But focusing on margin alone may prevent companies from tapping into one of the most powerful opportunities to improve their performance: speed. Speed can turn even low margin products into big business.

You need only look at Wal-Mart and Tiffany & Co. to see that margin is neither the only -- nor the best -- yardstick for success. Wal-Mart stores have a margin of less than 4%, and Tiffany & Co. commands an 11% margin. But Wal-Mart's speed -- the revenue it can generate with each dollar of investment -- gives it the higher return on investment (ROI). Tiffany generates only $.96 per dollar of capital invested in its high-end merchandise and upscale stores, while Wal-Mart yields nearly $3.50 in revenue on the same dollar investment. So Wal-Mart's ROI is more than 13% compared with Tiffany's of less than 11%. The reason? Speed. Wal-Mart is simply faster at in turning dollars invested into dollars in revenue.

Speed is even more important than margin for companies that want to capitalize on emerging markets, where margin often must be sacrificed because consumers have less discretionary income and are price sensitive. Yet just because the margin is low doesn't mean that opportunity isn't there. Consider the fact that Colgate sells roughly a billion toothbrushes in China each year, and Unilever sells more than $8 billion of brand-name consumer products in Africa, Turkey, the Middle East, and Latin America.

To create effective strategies for increasing speed, you first have to break down and understand the elements of speed by focusing on components of the capital invested. While supply chain executives do have influence on the capital tied up in good will, property, and plant and equipment, they are primarily responsible for the capital tied up by operations. In particular, supply chain activities influence the cash-to-cash cycle-the time elapsed from when a company pays for raw materials until it collects revenues from the sale of those materials as finished goods.

Supply chain activities that improve order and invoice accuracy, for example, do influence receivables, but generally credit terms on sales and purchases are related more to financial arrangements than to operations. On the other hand, supply chain activities directly influence the time it takes to transform raw materials into delivered finished goods -- a factor represented by the inventory component of the cash-to-cash cycle.

One company doing an excellent job of reducing raw materials inventories is Nokia.

Nokia has reduced raw material inventory through such efficiencies as its global supply web linking Nokia suppliers and plants. This system enables the company to stay in close contact with suppliers and logistics service providers for demand forecasting and order management and tracking. Although Nokia insists that suppliers own component inventory until it is used, the company also supports vendor-managed inventory, which allows the vendor to determine how much inventory is kept on site. And Nokia tracks inventories not only for its own operations but for its suppliers as well. In addition, Nokia uses a single logistics service provider to coordinate all the in-bound transportation to each manufacturing site so that the company can consolidate shipments and exploit economies of scale. The result is a flexible and responsive environment where speed is achieved by reducing days of raw material inventory.

The Toyota manufacturing system operates in a similar manner, but with the added element of small, frequent deliveries. In fact, Toyota assembly plants hold only about four hours worth of component supplies. These are replenished every 37 minutes or so from a cross-docking operation that loads the trucks not with individual parts but with complete car sets -- just enough for the next 37 minutes of production. This strategy has the double advantage of keeping raw material inventories low and of mitigating the risks of supply interruptions. If something happens to one or even a few trucks, the plant can continue to operate smoothly until the next vehicle arrives.

When it comes to work-in-process inventory--transforming raw materials on hand into finished goods--two examples come to mind: Northrop Grumman and Samsung. What makes them even more interesting is that they represent extreme ends of the spectrum.

Northrop Grumman participated in the Lean Aerospace Initiative and launched its own Lean Enterprise Initiative to apply Toyota's method for manufacturing automobiles to the much more complex defense industry (an automobile has about 4000 components compared with the hundreds of thousands of components of a nuclear-powered aircraft carrier, like those Northrop Grumman builds). By implementing a traditional lean production approach, the company was able to reduce throughput time for major systems by 21% to 42%. And they didn't stop there. Northrop also implemented a Supplier Lean Initiative to help its vendors benefit as well.

Beyond the obvious differences in the scale of their products, Samsung differs from Northrop Grumman in that manufacturing in the semiconductor industry is not linear. Wafers return again and again to the same equipment as the different layers of the product are added. Samsung has applied the Theory of Constraints, which focuses on identifying and managing bottleneck processes. It realized that keeping equipment use high on non-bottleneck processes simply produces more inventory, not greater value. So Samsung makes sure that all of the other operations in the process keep pace with the bottleneck.

Finally, speed can be achieved by accelerating the movement of finished goods to the customer. When forecasts are poor and supply doesn't match demand, companies are faced with the unpleasant options of turning the excess goods into scrap or selling at deep discounts, which erodes profits. The goal is to have supply match demand in ways that enhance rather than erode profits.

General Motors is aggressively reducing its order-to-delivery cycle through the way it builds its vehicles. Its objective is to sell the vehicles people want, when they want them, and at full price. The company has focused on reducing the queue of orders waiting to be built, and rescheduling production so that customer orders are moved to the front of the line. In the process, GM has reduced its order-to-delivery window from roughly 80 days in 1999 to between 20 to 30 days today.

That's absolutely critical in an industry where BMW is closing in on a 10-day order-to-delivery capability. In the past, BMW was a build-to-order operation. Production didn't begin until there was an order. Today, the company builds painted bodies for stock and pulls from that stock to build vehicles to order. This simplifies the manufacturing process and, most importantly, shortens the order-to-delivery window.

The ability of companies to increase speed, especially by reducing days in inventory, pays off in their overall success as much if not more than increasing margins. And that can help attract investor dollars for the future. Some of the companies we have mentioned in this article provide compelling examples. Compare Samsung's 406% total shareholder return from January 1, 2000, to January 1, 2004, with that of its competitors Sony (total shareholder return 0%) and Micron (total shareholder return -46%).

Of course, there are other factors at work as well. The fact that Siemens AG enjoyed a 76% total shareholder return from January 1, 2000, to January 1, 2004, compared with Nokia's 10%, Motorola's -96%, and Ericsson's -69% may have more to do with currency and diversification issues than with supply chain performance. Similarly, the fact that Northrop Grumman stock performance has been poor compared with its competitors over the past four years probably has more to do with the $19 billion in good will the company carries on its balance sheet from some ill-timed acquisitions. But while stock performance and total shareholder return depend on many aspects beyond speed and margin, speed is the most direct way supply chain executives can influence them. You can't fix everything, but you can fix speed.

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H. Milton Stewart School of Industrial and Systems Engineering (ISYE)

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Status
  • Created By: Barbara Christopher
  • Workflow Status: Published
  • Created On: Sep 30, 2004 - 8:00pm
  • Last Updated: Oct 7, 2016 - 11:06pm