They don't build supply chains like they used to--and that's a good thing. Henry Ford's vision of putting iron, rubber and glass in one end of his huge River Rouge plant in Detroit and having cars come out the other was visionary for its time--when communicating with suppliers was costly and transportation was slow and expensive. But no more. In the internet economy, old-fashioned supply chains are disintegrating at a lightning pace.
The web is accelerating the disintegration in every industry by eliminating the cost advantages that used to come with keeping everything together under one roof. Indeed, we are rapidly getting to the point where vertically integrated companies will be at a distinct disadvantage when trying to compete with companies that utilize virtual supply chains. Companies held hostage by in-house suppliers will be slower and less able to respond to changing products and markets.
To understand why this is happening, we need to look at the glues that have held supply chains together for so long. Transaction costs with suppliers are just about the stickiest. The costs of establishing a relationship with a third party, such as qualifying quality, negotiating costs, developing agreements around intellectual property rights and planning for joint investments, can be overwhelming. In fact, simply finding suitable vendors can be a showstopper. For example, in the early days of outsourcing for industries like toys or apparel, managers spent weeks traveling in Asia looking for suppliers.
Once the companies get suppliers on board, there are the routine transaction costs to deal with, such as employing buyers to make the purchases and logistics managers to oversee the flow of materials between the suppliers and the factory. For vertically integrated firms, these transaction costs still exist but are often hidden in overhead structures, giving the impression that it is cheaper to produce rather than to buy.
Digital exchanges are also speeding the disintegration of supply chains by making transaction costs insignificant. They do so by gathering far-flung information together and wrapping that information in value-adding services. Much of the recent excitement around exchanges, such as Freemarkets.com in Pittsburgh, has largely focused on the possibility of reducing material costs by pitting suppliers against each other in the cold vacuum of an internet auction. But these websites will have a much bigger impact on reducing the transaction costs of buying components of a product, making it more attractive to buy from outside suppliers than making it yourself. Freemarkets does this by supporting its buyers throughout the procurement process--from finding vendors and developing requests for proposals to running the auction site on bidding day.
Timing and availability of information has also kept supply chains together over the years. But with the web's ability to move vast quantities of information at ever-lower costs, bulky point of sale (POS) data from cash registers can be shipped more often, making daily forecasting more accurate and reducing inventory requirements throughout the supply chain. This will reduce the need for retailers to own large distribution centers to maintain supply, streamlining the flow of POS material from manufacturers to retail stores. Many of these POS tools are offered as services through easily accessible web portals.
Managing complex interfaces between organizations is another reason that many businesses have been reluctant to disintegrate. In Henry Ford's company, all the functional players from R&D to manufacturing were located on a single site in the interest of allowing spontaneous and unplanned information flow between the different departments. During a new product introduction, manufacturing engineers could stroll down to R&D any time questions arose. In highly dispersed supply chains, it has always been hard to create this kind of informal, spontaneous flow of communication.
But now web-centric product-content management systems are eliminating the complex functional interfaces by giving everyone equal access to shared information. Car companies like Ford generate huge volumes of product content information (the data required to manufacture and distribute a product) for each vehicle. This includes such details as the bill of materials, drawings, lists of approved suppliers for each component and process information needed by manufacturing and distribution to build, test and customize the product. Sharing this information holds immense promise for reducing cost. But it used to be too expensive for many companies, requiring big investments in software and infrastructure. Now it is available through web-based portals for a monthly fee.
PairGain Technologies, a producer of DSL networking systems in Tustin, Calif., has experienced many of the benefits of synchronized product management. In the past, releasing new products and making product changes were manual, paper- driven processes at PairGain. It required many meetings and extensive travel between PairGain and its manufacturing partner SCI Systems based in Huntsville, Ala. The labor-intensive activities slowed product development and caused many expensive mistakes. After adopting a web-centric product management system, the need for frequent design meetings evaporated. Both within PairGain and at SCI's manufacturing plant in Brazil, engineers could interact daily with an ongoing dialogue about product content. Synchronizing the management of product content has helped PairGain reduce component inventories from six weeks of supply to a few days.
Virtual supply chain technologies are not only making it easy to outsource the manufacture and delivery of products, they will also make it possible to move accountability and responsibility for the final product to the suppliers. Information portals--where all partners can view the whole supply chain and be measured and rewarded for overall success--allow individual suppliers to begin to think like a single entity.
For example, automotive companies are modularizing their products and outsourcing the accountability for delivering whole modules to the assembly plants. With early success in easy modules like upholstery and wheels, some manufacturers are taking the idea a step further. Volkswagen is experimenting with complete modularization, breaking a truck or car into several large modules like chassis, frame, engine and body, and outsourcing each of the modules. In a new VW truck plant in rural Brazil, seven key vendors not only produce the modules but also deliver them to the assembly line and attach them to the truck as it moves down the line. Suppliers aren't paid until the finished truck passes final inspection. VW maintains only a couple hundred employees who manage the partners.
With all that's changed, Henry Ford would have a hard time recognizing the auto supply chain of the 21st century.
Think you can stay vertically integrated in the 21st century and win? Brag to us at firstname.lastname@example.org. Eric Johnson does research on information technology's impact on supply chains at the Tuck School of Business at Dartmouth College. He can be reached at M.Eric.Johnson@Dartmouth.edu.