Chain of demand

We examine the complex questions involved in managing the supply chain and the lessons learnt from the recession

What is the supply chain?

The supply chain is the name given to the process of managing the supply of goods from their original source materials to their final destination on the shelves of supermarkets and high street stores. This involves a complex network of suppliers, factories, storage facilities, distributors and retailers that participate in the production of a given product. Supply chain activities result in raw materials being converted into products and then distributed to the end consumer.

The extended supply chains that we see today are a direct result of globalisation. In the last 25 years, major new markets have emerged (in China and Russia, for example). As trade barriers fell, retailers and manufacturers were quick to discover that it was cheaper to source goods and materials in the developing world and ship them overseas than to produce them locally.

The supply chain manager is responsible for making sure that all goods and materials arrive in the right place at the right time, and in the correct quantities. This involves an inevitable compromise between keeping costs low on the one hand, and maintaining flexibility and speed on the other. The chain will be built around a specific business model. The Spanish clothes retailer, Zara, for example, defies most of the current conventional wisdom about how a supply chain should be run. Sending a half-empty truck across Europe or paying to airfreight coats to Japan twice a week may not seem like the height of efficiency. But Zara relies on creating urgency amongst shoppers by producing clothes in limited quantities and regularly replacing stock with new designs. By keeping almost half of its production in-house, it can design, produce and deliver a new garment to its 600-plus stores worldwide in a mere 15 days. It manages all aspects of the process itself, including design, warehousing, distribution and logistics. Many of its competitors outsource some or all of these functions. But the business model appears to work. Consumers in central London visit the average store four times a year. In the same period, Zara's customers visit its shops an average of 17 times. This high in-store traffic reduces the need for advertising: Zara devotes just 0.3 per cent of its sales revenue to advertising, ten times less than most of its rivals. During the recession the store has maintained a steady annual growth rate of 20 per cent.

Purchasing and risk

Globalisation has made the role of acquiring goods and materials all the more complex. For a confectionary company to decide how much cocoa or sugar to buy at any given time requires an in-depth knowledge of the futures markets and the variables that affect crop yields. Some food companies have begun to invest heavily in sustainable farming in developing countries to guarantee long-term supplies at low prices. This is a direct response to the wake-up call they got in early 2008, when prices of staples such as wheat, milk and cocoa started to rise unexpectedly after almost 20 years of stability.

Cocoa is a particular cause for concern, as 60 per cent of the world's supply comes from just two countries: the Ivory Coast and Ghana. This makes it particularly vulnerable to price fluctuations. In addition, both these areas suffer from underinvestment and ageing crops. Some companies are taking active measures to counteract these risks. Nestlé, for example, plans to spend over £280 million over the next decade to boost its supply of sustainably sourced cocoa and coffee. They will provide farmers with millions of disease-resistant plants. Ethical and political issues also have a bearing on supply costs. Fairer trade often means paying more to suppliers. How should companies incorporate the added costs without simply passing them on to the consumer?

And then there are the problems created by the financial markets. In the recent crisis many companies suffered as sole suppliers of critical components went bust. Take, for example, the case of German car manufacturer Porsche. While the core business was spared from the worst of the recession which crippled other manufacturers, the company was forced to suspend production for two weeks earlier this year following the bankruptcy of the firm which supplied the thread for its seat belts. In a similar case, BMW was forced to intervene when Edscha, a German manufacturer of sunroofs, door hinges and other car parts, filed for insolvency at the beginning of the year. The car-maker was about to introduce its new Z4 convertible - and Edscha supplied the roof.

Predicting demand

A supply chain manager must match demand with supply. They must be able to predict demand in order to adjust to sudden changes. If, for example, a surge in demand is predicted, they can stockpile necessary materials. Forecasting can involve complex decisions and any misjudgements will inevitably damage profits. Order too little stock and potential revenues are lost, whilst overproduction ties up working capital and wastes money on unnecessary storage. For confectioners, one of the biggest challenges is coping with Christmas and Easter. These represent huge surges in demand, for example 60 per cent of Thorntons' sales take place during the Christmas period. A spokesman for Nestlé told The Gateway: "It's vital to get Easter and Christmas right - it is a highly competitive market place, and bad planning would be disastrous. So we work all year on getting both the demand and the supply plans as accurate as possible. Supply chain will work closely with purchasing, factories, co-packers, customers and sales teams to ensure these demands are met."

Moving the heavy stuff

A key part of planning ahead is predicting the cost of transporting goods from their place of manufacture, first to a storage location and then to market. Recent fluctuations in trade volumes have made this more difficult. For example, the cost of transporting containerised goods by ship is currently a fraction of what it was just 18 months ago - when booming freight rates and high fuel prices sent the cost of transporting cargo rocketing. This volatility obviously has a major impact on the overheads of producers and manufacturers, which is often passed on to the consumer.

Companies have ways to mitigate against these risks. Firms transporting large quantities of goods, for example food and drink manufacturers, often employ the services of a third party logistics firm (3PL, also known as a "freight forwarder") such as a GAC or Palapina. These companies may use their own planes, trucks and ships, or charter those of another firm.

Retailers can also turn to futures markets to hedge their exposure to huge price spikes. A future is a financial instrument which allows the client to buy a particular product in advance, for a pre-arranged price. When transporting goods by ship, a retailer can buy a freight forwarding agreement (FFA): a contract to have cargo delivered for a set fee at some point in the future, regardless of the market price at the time.

The future - breaking the chain?

As a result of the financial crisis and environmental concerns, many companies may soon abandon extended, global supply chains in favour of smaller, regional models.

The US is expected to make a concerted effort to address its huge trade deficit with China by encouraging more goods to be produced domestically. This will have the added effect of reducing both the costs and the carbon emissions involved in transportation. Ernst & Young have pointed out that 70 per cent of a manufacturing company's carbon footprint can come from transport and other costs involved in the supply chain.

Joining the chain

What does working in supply chain management involve? The Gateway spoke to Chrissy Blythin, head of supply chain at Nestlé Professional, about their graduate programme.

"After a comprehensive induction from both Nestlé UK and Nestlé Professional, our supply chain graduates are given real responsibility from the outset. The induction will see the graduates undertaking a wide range of tasks, from spending time with our chief executive, Paul Grimwood, to jumping on a lorry and spending a day with a delivery driver. Graduates are appointed for three six-month placements to gain hands-on insight into the various businesses, the brands and the role of supply chain.

One of the roles graduates could undertake is that of demand planner, which is based in our confectionery division in York. Demand planning is sometimes called the engine for our business. Graduates might be required to take orders from customers or run a warehouse shift to ensure a hundred vehicles go out on time each day. This might involve working with factories across Europe.

We settle our graduates into their role with training and a "buddy" for day-to-day support. We also have a strong network with graduates across other parts of the business. There's plenty of networking opportunity in the UK, across Europe and the rest of the world. One thing they can be sure of is that a world of opportunity is there for the taking. The supply chain director for Nestlé Canada, for instance, started their career on the graduate programme, as did the UK Nespresso supply chain manager."

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