Supply chain management, supplier relationships and outsourcing strategies

Part A: Relationships and how they contribute to the effectiveness of supply chains

The contemporary definition of supply chains describe them as processes that are involved in the production of end products and they involve all processes from the collection of raw materials to the availing of such products to the end consumer (Ketchen and Hult, 2006). It therefore incorporates activities such as the sourcing of raw materials, movement of inventory, actual production processes, and distribution of the products to the points of consumption. Supply chain management is therefore the management of these processes in a manner that ensures that they create the desired value for the customers and in a manner that is consistent with the objectives of the organisations. 

Perhaps the most comprehensive definition of supply chain management was the one offered by Mentzer (2001) who defined it as strategic and systematic coordination of business processes in an organisation and within organisations in the supply chain in order to create products that satisfy customer needs. This definition introduces a new perspective to this discussion by highlighting that supply chains could encompass parties outside the main organisation. The supply chain management aims at ensuring that the supply chains are as efficient as possible. According to Hines (2004), supply chain management has in many cases been cited as one of the potential sources of competitive advantage to any given firm. It determines the cost of operation, the consistency between product features and customer needs, and the efficiency with which the products are availed to the end customers (Hines, 2004).

Supply chain management has evolved with time and has passed through several distinct stages that have culminated into focus on the creation of relationships. The traditional operational structures that remained dominant until the 1970s had greatly emphasised the importance of vertical integration with organisations being keen to ensure that their reliance on third party players was kept to a minimum (Esposito and Passaro, 2009). The focus on this approach would be in recognition of its ability to create a strategic advantage for the organisations which would not have to worry about fluctuations in the prices of materials needed. In many cases, such competitive advantage would be realised. However, market developments since the 1980s have seen a progressive move away from the pursuit of greater degrees of vertical integration with companies opting to create relationships with the key players in their supply chains (Esposito and Passaro, 2009). This approach is known to have the capacity to encourage the attainment of equivalent levels of competitive advantage at a much lower cost. Business relationships therefore evolved from the arms length approach to the pursuit of partnerships.

As Power (2005) puts it, the arms length approach can be described as one contained in the ‘us versus them’ attitude. This approach would predominantly adapt the view that the attainment of organisational goals was only possible if the organisation could avoid being vulnerable to the external members of their value chains (Power, 2005). Suppliers would compete on price and quality and would be inclined to take advantage of high demand to raise the prices of raw materials hence affecting the operation costs of the producers. In a similar manner, organisations would remain guarded against their consumers and would engage them only on the grounds of getting them to purchase the goods and services produced (Esposito and Passaro, 2009). The information structures were similarly estranged in the sense that the suppliers would receive supply orders through regular channels with no indication from the buyers of raw materials on whether they would need further supplies and when such a demand was likely to arise. This approach perhaps contributed to the reliance by suppliers on the forces of demand and supply on the determination of the prices for raw materials. This predominant thought lasted until the early 1980s when organisations started to realise the importance of adopting a collaborative approach in the supply chain management systems (Esposito and Passaro, 2009).

Hines (2004) holds that the collaborative approach was introduced in the late 1980s only for it to take root in the mid 1990s. This approach envisions the members of the supply chain as partners who can work to ensure that their mutual goals are fulfilled. The typical members of the supply chains are the suppliers, the customers and of course the producing organisations. The relationship between the organisations and the customers is important due to a number of reasons. To start with, it is the customers that can best understand their needs and their constant communication with the organisations helps in the design and production of goods that best meet these needs (Kouvelis, Chambers and Wang, 2006). The consistency between the product features and market needs is one of the driving forces for performance in the market and it is important that the supply chains factor in all the relevant sentiments from the customers. The second factor that makes relationships with customers crucial is the understanding of demand trends and likely changes in consumption patterns (Kouvelis, Chambers and Wang, 2006). Through strong relationships with customers, the organisations can tell when a product is likely to be needed most and this enables them to adjust their production capacities accordingly. The adjustments can either be done by increasing the number of goods stored in warehouses awaiting distribution; or through increased production for immediate distribution to the points of consumption.

Forecasting of demand must be done accurately as it helps in informed decision making with companies being able to accurately determine the cost implications of either or the approaches outlined above (Larson and Halldorsson, 2004). In the absence of such accurate forecasts, demand may exceed supply and this could lead to organisations losing the opportunity to capitalise in demand surges. Relationships with customers can also help organisations in managing the demand. Organisations can try and spread out demand by providing incentives for customers to avoid purchases during the peak seasons (Larson and Halldorsson, 2004). This is especially so with companies producing highly perishable products, or those whose costs of warehousing and idle capacities are quite high. It must be appreciated that customer relationships help in gathering the much needed market intelligence which is then applied in the design of the supply chains within and across the organisations concerned. Without such relationships, such information would have to be obtained be incurring costs that many organisations may find unfeasible, or at the very least incapacitating (Mentzer, et al, 2001).

The creation of relationships with suppliers is also very important. Suppliers are the sources of the raw materials used for production and they are therefore very important components of the supply chains. Some of the main factors that organisations consider when choosing suppliers is their level of reliability as far as delivery and pricing strategies are concerned (Handfield and Bechtel, 2002). Timely delivery is crucial as it helps in avoiding the occurrence of idle capacity occasioned by lack of the supplies needed for production. This calls for a collaborative approach in managing the procurement systems. The suppliers and the organisations should negotiate and agree on the desired lead times to ensure that production processes are not interrupted unnecessarily. The suppliers should understand their clients’ schedules in order to anticipate orders and prepare to have them dispatched even in occasions where organisational inefficiencies may lead to delays in communication (Handfield and Bechtel, 2002). This calls for the maintenance of trust with the suppliers remaining confident that they are unlikely to lose their clients to competitors. Organisations should be able to provide their suppliers with crucial information on the demand forecasts in order to determine the amount of supplies that would be needed at any particular time (Hoyt and Huq, 2000). This helps the suppliers to prepare in advance for any fluctuations hence reducing the probability of supply shortages that could result in idle capacity at the manufacturing firms.

The other dimension that organisations tend to be concerned with is the cost of raw materials. Where prices are determined by market forces, organisations are vulnerable to market fluctuations and this could force them to adopt a pricing strategy that may make them uncompetitive in the market (Hoyt and Huq, 2000). Some measure of consistency in pricing requires an equivalent level of consistency as far as the cost of raw materials is concerned. This can only be assured through the creation of meaningful relationships with suppliers who would continue to supply at constant prices despite fluctuating market prices. This approach has however been critics who state that the creation of relationships to stabilise the cost of raw materials robs the organisations of the opportunity to make superior returns in cases where the market prices of raw materials plummet (Meier, Williams and Singley, 2004). It is indeed true that such opportunities would be foregone especially where the agreement with suppliers stipulates definite price ranges. However, many organisations have been able to come up with arrangements that allow for limited price adjustments depending on the general price movements in the markets.

For relationships to be meaningful there is need to establish structures for information sharing. This may call for the establishment of intranets that allow for communication in real time. Organisations can also develop systems that refine the procedures of placing orders to ensure immediate recognition and insertion of the orders into the suppliers’ systems (Meier, Williams and Singley, 2004). Such communication structures are also important in ensuring that difficulties experienced by the suppliers are promptly reported for the organisation to take alternative measures to ensure that production is not interrupted. For instance, where a supplier fails to secure the materials needed in time, they should have a mechanism to trigger need for urgent response by the client organisations hence minimising the probability for stalled production. Recent developments in the use of the internet and other crucial procurement and communication technologies have been instrumental in the successful running of such relationships (Ogden and McCorriston, 2007). The structures should also include arrangements for payments. The payment terms must be acceptable to both parties before a relationship can take effect with great levels of collaboration being necessary between the partner organisations to ensure that any differences are dealt with swiftly and in a manner acceptable to both parties.

Trust is the one component that must be developed for supply chain relationships to work. The organisations need to trust that their orders for raw materials would be delivered in time and as per specification. The organisations also need to trust that the suppliers would not want to exploit them when they are vulnerable and in need of large amounts of supplies. Similarly, the suppliers need to have trust that the organisations will fulfil their payment obligations in time and that they are not likely to run to other suppliers in the short run (Ogden and McCorriston, 2007). Trust must be held by both partners for the partnership to be meaningful. Other relationships that may be relevant to the supply chains may be those between the organisations and independent distributors with the efficiency of the distribution systems being a crucial component of the supply chains (Meier, Williams and Singley, 2004).

So, do relationships contribute to the efficiency of supply chains? Several studies have been conducted to discern this fact. Ketchen and Hult (2006) firmly hold that relationships are among the most significant determinants of supply chains’ efficiency. In their study, they outlined relationships as only second to the internal management functions when it comes to the determination of efficiency of supply chains. This position has been reiterated by Larson and Halldorsson (2004) who take the position that it is no longer possible for organisations to achieve competitive advantage using their supply chain management processes without creating meaningful relationships with suppliers, customers and independent distributors. With efficient supply chains, organisations can create a competitive advantage in consistency with the principles of the resource based view of the firm which encourages the use of internal resources and capabilities to enable organisations to compete more effectively in the market (Hines, 2004).    

Part B: Supply chain analysis of Smart Car

Introduction

Smart Car’s supply chain has been designed in a manner that allows for speedy delivery of quality products while keeping the production costs as low as possible. In fact, the level of investment in the production facilities is known to be shared between the organisation and the suppliers. About 80% of the volume of the final product supplied by suppliers with some functions that have traditionally been considered core functions such as product design and internal information systems also outsourced to suppliers. The approach to production and the level of cooperation with suppliers is plausible. However, the extent to which outsourcing is conducted appears to be excessive.

Outsourcing practices at Smart Car

Smart Car production is predominantly done by outsourcing to suppliers where MCC shares the responsibility for the final product with these suppliers. The company involves 7 integrated suppliers who are responsible for the production of between 70 of the volume of the final product. This represents 30-40% of the value of the finished product. The non integrated suppliers also contribute about 20% and this implies that about 90% of the product is entirely made through outsourcing with the remaining 10% of the volume comprising of car parts stored in a warehouse that is also run by a third party. This means that the car is wholly produced with minimal input from MCC. Even the critical functions such as the design of the cars and the coordination of internal logistics are outsourced. The suppliers share responsibility for the success of the final product and have even shared the factory investment outlay with MCC.

The approach taken by MCC has a number of advantages. To begin with, it requires very little investment in terms of acquisition of technical knowhow and the actual cost of purchase and maintenance of machinery. Suppliers bear the responsibility for investment and operation and this is advantageous in the sense that MCC is able to produce high quality products by simply tapping into the capabilities of organisations that are already seasoned in such productions. The maintenance costs are also borne by the suppliers with costs of staffing, warehousing and insurance being taken over by the suppliers. This reduces the overhead costs of MCC to a bare minimum with the main functions being the branding and marketing exercises. The second advantage has to do with the quality of the final products. The suppliers involved are renowned producers of body parts and are therefore in a position to produce the highest quality parts in the market. Given that each body part is supplied by highly skilled suppliers, it translates into the production of a formidable product. These cost factors can make investments decisions very easy as organisations would always be willing to seek gain without having to overspend in terms of capital outlay.

There are risks associated with supply chain designs dominated by outsourcing as the case with MCC. Suppliers are business entities who will always be on the lookout for better opportunities and may want to quit the relationship whenever such opportunities arise. The company attempts to protect themselves from such eventualities by specifying the length of the contracts. Even though the contract lasts for a product cycle, there is little the company can do to enforce the arrangements in cases where incapacity arises on the part of the suppliers. The fact that the organisations in the arrangement are different means that there is always the risk of one party (supplier) radically changing their approach to business and thereby disrupt production. This risk is even made higher by the fact that the main suppliers work along an assembly line with each supplier expected to play their role in the specified times. Differences of opinion and conflicts as far as organisational cultures are concerned are bound to arise from time to time and this could also disrupt production.

Perhaps a more glaring concern is the fact that the organisation has little control over the production processes. They do not have any means of protecting their special capabilities with suppliers in control of almost the entire production. This situation is accentuated by the fact that even the internal logistics are controlled by third parties and it means that MCC could easily get out of touch with the production process and be unable to intervene in time whenever need arises. Moreover, there is always the risk of forward integration. The fact that they do not control any critical part of production means that suppliers can easily forward integrate and be able to produce a vehicle with similar if not more advanced features. This leaves the organisation unable to continue with production; especially when it is taken into consideration that they currently exercise very little control over the process.

There is a lot of wisdom in partial outsourcing. Organisations should identify production processes and determine which ones can be outsourced and which ones must be controlled within the organisations. Production designs are components that must be kept confidential to minimise the risk of duplication by competitors and counterfeiters. Consumers will in most cases purchase products based on their assessment of their uniqueness and replication therefore nullifies such an advantage. The same should be done in the case of production of key components such as the general body construction, painting functions and others which can be considered to be core features in the opinion of the company. This approach comes at a cost in terms of machinery, staff, insurance, warehousing and others. The additional costs are however justified due to the fact that the company can take greater control over the production processes and reduce the risks associated with excessive outsourcing. For instance, the failure of a supplier can only lead to temporary disruptions where a company exercises greater control. Participation in production processes also allows organisations to improve on their internal capacities. MCC would be better off taking over some core functions in the production process. At the very least, they should take over the design and internal logistics function to secure their interest in the production.

References

Esposito, E., Passaro, R., 2009. The evolution of supply chain relationships: an interpretive framework based on the Italian inter-industry experience. Journal of Purchasing and Supply Management, 15(2), pp. 114-126
Handfield, R.B., Bechtel, C., 2002. The role of trust and relationship structure in improving supply chain responsiveness. Industrial Marketing Management. 31, pp. 367-382
Hines, T., 2004. Supply chain strategies: Customer driven and customer focused. Oxford: Elsevier.
Hoyt, J., Huq, F., 2000. From arms-length to collaborative relationships in the supply chain: an evolutionary process. International Journal of Physical Distribution & Logistics Management, 30 (9), pp. 750-764
Ketchen Jr., G., Hult, T.M., 2006. Bridging organization theory and supply chain management: The case of best value supply chains. Journal of Operations Management, 25(2), pp. 573-580
Kouvelis, P., Chambers, C., Wang, H., 2006. Supply Chain Management Research and Production and Operations Management: Review, Trends, and Opportunities. Production and Operations Management, 15 (3), pp. 449–469
Larson, P.D. Halldorsson, A., 2004. Logistics versus supply chain management: an international survey. International Journal of Logistics: Research & Application, 7 (1), pp. 17-31
Meier, R.L., Williams, M.R., Singley, R.B., 2004. Supply chain management: strategic factors from the buyer’s perspective. Journal of Industrial Technology, 20(2), pp. 2-8
Mentzer, J.T. et al., 2001. Defining Supply Chain Management, Journal of Business Logistics, 22 (2), pp. 1–25
Ogden, S.M., McCorriston, E., 2007. How do supplier relationships contribute to success in conference and events management? International Journal of Contemporary Hospitality Management, 19(4), 31327
Power, D., 2005. Supply chain management integration and implementation: a literature review. Supply chain management: an International Journal, 10(4), pp. 252-263