Speed: The Solution For Margin Myopia

Barbara Christopher
Industrial and Systems Engineering
Contact Barbara Christopher
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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

Days of Inventory
from 2001, 2002 and 2003 for Nokia and competitors Motorola, Ericsson,
and Siemens. These companies are quite different. Siemens, for example
makes everything from cell phones to hydroelectric plants. But the
trend is clear: Nokia's days of inventory are significantly lower
and decreasing.

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


Days of Inventory
from 2001, 2002, and 2003 for Northrop Grumman and competitors Boeing,
Lockheed, and General Dynamics. Northrop Grumman has dramatically
reduced days of inventory over the past 3 years.

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.


Days of Inventory
from 2001, 2002, and 2003 for Samsung and competitors Sony, Panasonic,
and Micron. Samsung consistently maintains fewer days of inventory.

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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School of Industrial and Systems Engineering (ISYE)

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  • Created By: Barbara Christopher
  • Workflow Status: Published
  • Created On: Nov 1, 2004 - 8:00pm
  • Last Updated: Oct 7, 2016 - 11:06pm