Those Fickle Links in the Supply Chain

You’ve heard it said: “A [supply] chain is only as strong as its weakest link.” Let’s consider this aphorism within the definition of supply chain management (SCM). I define SCM as the linkage of various organizations in order to fulfill a common strategy. Basically, the summed market values of the linked organizations are higher than each would be on its own; that is, unhooked links don’t make much of a chain. Furthermore, the linkages need to make business sense. Each organization should feel itself dependent on, and yet serving, all of the other links.

There are two ways to create a supply chain: through merger and acquisition (M&A) or through contracts with vendors and customers. Each has its place. Of course, post-WWII globalization lead to two phenomena: (1) a drive to cost-control in the face of foreign competitors; and (2) a wider choice of vendors to buy from and customers to sell to. The rise of the Internet lead to two more phenomena: (1) access to information in order to make it easier to control costs; and (2) access to information in order to faster vet more vendors and customers. The implication of all four points is that M&A has lost ground to contracting. M&As are more stable but less flexible while contracts are more flexible yet less stable. It’s an important trade-off to be aware of. So, we have a world made up of millions of supply chains--- many sharing common nodes--- and each subject to the uncertainties of contract negotiation, renewal, and cancellation.

Strengthening supply chains are necessary to mitigate these uncertainties. With contracts it’s obvious that the organization’s vendors need to be vetted very carefully and customers (to whom the organization is now in the role of vendor) need to be fulfilled through appropriate customer service. But, most importantly, each organizational link must think and act like a chain--- and it’s not that easy. Ideally, costs should be borne by the supply chain partner better able to bear them. Would your organization follow such a protocol?

Looked at from a single organization, for example, why not just “do more with other people’s money?” Demand quicker payments of accounts receivable; and hold off on dealing with accounts payable. This makes for net cash inflows. Hold less inventory on the books by making upstream vendors store it for you. In this way inventory carrying costs are defrayed and obligations for product security rest with the vendor. This makes for increases in the organization’s return on assets (ROA). There are plenty of other examples of this common, yet narrow, thinking. Firms with market power and numerous choices for vendors may be able to get away with this. And it’s tempting to do this because steady net cash inflows and a growing ROA look good to your shareholders. Of course, this gets us to the strategy of SCM.

Which is a better and more sustainable strategy: (1) looking good to shareholders (who are often concerned with the performance of a larger, mixed portfolio); or (2) looking good in terms of supply chain performance? Sometimes point (2) would require an organization taking on more cost or more risk in order to relieve pressure on upstream and downstream supply chain partners. Strategy is, after all, a long-run concept and SCM needs to be thought of as such.  

Now there is a “wild card” in all supply chains. Who is it? It’s the retail customer. They’re at the end of multiple supply chains, with each retailer competing for his time, his money and, nowadays, his personal data. What makes them a “wild card” is that, unlike his upstream suppliers, he’s governed more so by his psychology of consumer preferences, his susceptibility to targeted marketing, and his reaction to peer-pressure. For these reasons a well-honed supply chain is not viable unless it signals quality and time/place utility to a critical mass of these end customers. This is what makes SCM so challenging, yet fun: the laws of physics govern the production process and the logistics of raw materials, sub-assemblies, and final goods; but the malleability of psychology governs the end customer’s wallet. Revenue is, indeed, more fickle than cost.

So, let’s remember a useful paradox attributed to Stanislaw Jerzy Lec: “The weakest link in a chain is the strongest because it can break it.”