Welcome

Strategies of Network Companies

Jonathan D. Warehamwareham@acm.org

Agenda

When firms cooperate, compete and exchange

problems with traditional supply chain management (SCM) problems this creates for manufacturers problems this creates for their suppliers problems this creates for consumers

improvements to traditional SCM the direct-to-customer model virtual integration with suppliers

Agents

Firms

Networks

Markets

Quiz

? days a box of cereal spends in the supply chain?

Distorted information causes total inventory in the pharmaceutical supply chain to exceed ? days. $? in savings to be realized.

$ ? wasted because of poor coordination in the food industry supply chain

$ ? Boeing write-off in 1997 due to supply chain inefficiencies

Quiz

A box of cereal spends 104 days in the supply chain

Distorted information causes total inventory in the pharmaceutical supply chain to exceed 100 days. $11 billion in savings to be realized

Poor coordination wasting $ 30 billion annually in the food industry

$ 2.6 billion Boeing write-off in 1997 due to supply chain inefficiencies

Defining SCM

SCM is the coordination of material, information and financial flows between and among enterprises participating in the demand fulfillment process for a product or service.

Spans multiple organizations and industries

Coordination and integration of flows essential for the modern enterprise

A digital nervous system is the corporate, digital equivalent of the human nervous system, providing a well-integrated flow of information to the right part of the organization at the right time. A digital nervous system consists of the digital processes that enable a company to perceive and react to its environment, to sense competitor challenges and customer needs, and to organize timely responses.

Gates: Business @ The Speed of Thought

A digital nervous system requires a combination of hardware and software; it's distinguished from a mere network of computers by the accuracy, immediacy, and richness of the information it brings to knowledge workers and the insight and collaboration made possible by the information.

Gates: Business @ The Speed of Thought

Scott McNealy on Gates’ View

He is right - I would be very nervous if my systems were based on their platforms and products!

Beer Game video

Traditional supply chain obsolescence

Direction of flow of demand Direction of flow of product

Raw Material vendor

Tier-II Suppliers

Tier-I Suppliers

Manufacturers Distrib

ution Centers

Retailers Custo

mer Zones

Point of Point of differentiatiodifferentiatio

nnDistribution Distribution

costscostsMarket Market

mediation mediation costscosts

The Bullwhip Effect

Customer Retailer Distributor Factory Tier 1 supplier Equipment

Upstream amplification of demand variationProgression of a brushfire to an inferno!

Machine Tools at Bullwhip Tip

-100%

-50%

0%

50%

100%

1961

1963

1965

1967

1969

1971

1973

1975

1977

1979

1981

1983

1985

1987

1989

1991

Data from United States, 1961-1991 (GDP, vehicle production, and machine tool orders

% C

hang

e, y

ear t

o ye

ar

% change GDP% change vehicle production index% change net new orders machine tool industry

The Diaper Supply Chain!

01020304050607080

Week

Ord

er

FactoryDistributorWholesalerRetailerCustomer

Ripples to tidal wavesStockpiles and stockoutsInsufficient or excessive capacitiesHigher costs

What is the Problem?

The “bullwhip effect” - four key causes Demand signal processing

Currently only order information is shared (not actual sales) Need to instead share POS retail data (sell-through data)

Order batching (retailers only order periodically) Infrequent access to demand information

Order rationing retailers order popular items excessively Hoarding of scare products (inflate demand order of scarce

product to ensure that you have it on-hand) Special Promotions

Alter the normal pattern of product demand from customer; so that it’s impossible to understand the “true” demand

Interorganizational Systems: CRP

P&G

Warehouse 1

Warehouse 2

BIG RETAILER

< 3% stock outs

< 14days inventory

Before CRP

P&G

Warehouse 1

Warehouse 2

BIG RETAILERBudget

Actual

•Volume discounts•New product promos

•Here and now discounts•Trade marketing

•Bonuses….

Interorganizational Systems Integration of supply chain across companies Degrees of integration: information, process,

property rights Increased efficiencies through

1. optimal production/logistics planning 2. lower inventories 3. increased flexibility 4. customer satisfaction

Oh brave new world, this is wonderful…But…

The Economist says…. Look out for proprietary systems with

high specificity Lock-in Sharing processes is optimal from

logistics viewpoint, but remember ‘knowledge of time and place’

Additional information acquired by one party can reduce bargaining power of other. Competitive industries like retailing, grocery and electronics has demonstrated many examples of this….

Excel video

Solutions to Improve Sales Forecasting

Vendor Managed Inventory Collaborative Forecasting and

Replenishment Quantity-Flexible contracts

(as contrasted with rigid contracts)

Buyer allowed to make limited changes to forecast information, which is then shared with suppliers. Supplier only ships enough for the “newest” forecast. Why is this helpful?

Types of Shared Information

Inventory information Transition to echelon-based inventory systems Upstream companies can determine when and

what to produce Downstream companies can improve service

levels with less inventory The Apple-Fritz Supplier Hub

Fritz manages entire inbound logistics for Apple Consolidates freight, clears customs, manages the

hub, manages local transportation to Apple FLEX system

Types of Shared Information

Sales Data Variance of orders greater than that of sales The “bullwhip effect” - four key causes

Demand signal processing Move to sharing sell-through data and POS retail data

Order batching Infrequent access to demand information

Order rationing Hoarding of scare products

Promotions

Types of Information Sharing Production/Delivery Schedule

Improves due-date estimation Expand planning horizons

Other Information Sharing Performance metrics Capacity information

Models of Information Sharing

Information Transfer Model Transfer information to the other who maintains

the database for decision-making

EDI Limitations Multiple industry-specific standards Rigid design for transaction processing Rigid text formats Batch-oriented Installation costs

Models of Information Sharing Third Party Model

Third party collects and maintains supply chain information

Apple- Fritz alliance, with Fritz as the 3rd party

Instill corporation (www.instill.com) in the food services industry

Digital markets (www.digitalmarket.com) in the electronic parts market

Challenges

Aligning incentives of different partners Channel Management Example

Trust and cooperation Confidentiality of shared information Anti-trust implications, such as possible

price fixing behavior Timeliness and accuracy of information Technological constraints

Commercial Uses of New Technologies

Many commercial forms are products of modern technologies

Manugistics, I2, Commerce 1, Ariba

3.1

2.3.3

.7

eCommerce Status? Doing fine….

0

100

200

300

400

500

600

700

800

1999 2,000 2001Billion USD

eCommerce - Where? Manufacturing (18% of all sales)

Transportation equipment Beverage and tobacco Electrical equipment & components

Wholesalers (8% of all sales) Drugs and druggists Motor vehicles, parts and supplies Professional and commercial equipment

eCommerce - Where? (cont.) Services (1% of total sales)

Travel arrangement and reservations Securities & commodities

intermediation Publishing and software

Retail Sales (1% of total retail sales) Books and magazines

Outlook

CommonPresent Sense

Manufacturing 18% 70% Wholesalers 8% 50% Services 1% 20% Retail Sales 1% 30%

• 60-80% of all eCommerce conducted through EDI • x12 & EDIFACT (primarily VANS)

www.census.gov/estats

B2B What Happened ? Estimates that over 1,000 B2B

portal will soon consolidate to < 200.

Less than 15% of all exchanges operating

2 Stories: Vertical Horizontal

Your task….

You would like to buy a 3 year old Honda Prelude. You have 2 options:

1. Buy the car in a private transaction, mediated through the newspaper classifieds, or

2. Buy the car through a used car dealership

Asses the relative advantages and disadvantages of each option.

Intermediaries Up to 25% of the

economy Financial

Intermediaries Dealers &

Wholesalers

What do Intermediaries do?

•Infomediation or Information matching

•Gathering, sorting and arranging information about buyers and producers plans in order to match them.

In addition to information matching, intermediaries also do:

•Economic matching, in which the intermediaries do not have the ability to perfectly match producers’ and consumers’ plans. Therefore they are required to hold inventories and perform logistic functions where perfect matching is impossible. The are therefore risk bearing partners in exchanges. They may also extend liquidity (credit).

Intermediation

If both producers and consumers had perfect information, then they could simultaneously match (infomediate) their plans and transform intermediaries in to useless entities. (Dis-intermediation)

Plan matching remains insurmountable, moreover;

1. Information asymmetries are not just about asymmetric information on plans. Moral hazard and adverse selection problems remain!!

2. Exogenous forces, uncertainty, bounded rationality 3. There is no logical argument that optimal plans will

match. Many consumption decision are instantaneous and not planned;exacerbated through liquidity constraints.

Dis-Intermediation; can it be done?

Information management: compiling and filtering information, informing consumer's knowledge of supply and demand capacity.Logistics management: economies of scale, scope and specialization in conveying goods from production sites to consumption sitesTransaction securitization: controlling and guaranteeing the quality of goods and payments delivered to buyer and sellerInsurance: insurance for the existence of a market for the products, that is, a market making functionLiquidity: extending credit to both sides of the transaction, alleviating liquidity constraints

OK, so what do Intermediaries do?

Morgan Stanley “Collaborative Commerce”

Before the Order Purchase approval and routing Promotions and campaigns Financing Inventory availability Price negotiation

During Fulfillment Order status Partial Shipments Backorder information Substitute products Order explosion to multiple suppliers Scheduling of inventory

After Delivery Warranty and maintenance Replacement parts Asset Management Regulatory Compliance Returns and incorrect ships Settlement Inspection

Amazon, when it started, it was mostly and infomediary. When faced by competition by an actual commercial intermediary, (Barnes & Noble) it was forced to purchase in larger quantities and thus hold inventories. Hence, a commercial intermediary had advantage over infomediary due to holdings of inventories and established, well managed logistics channels. For B&N, their website is an additional display case. Amazon may be forced to become a retail distributor...as was the case for many post order firms at the beginning of the century!!!!

Remember Amazon

Determinants of Choice in Intermediated exchange

Information Management

Transaction Securitization

Liquidity Management

Logistics Management

Insurance

Determinants of Uncertainty

Determinants of Preferences

Hypothetical Decision Path A

Hypothetical Decision Path B

A

B

AB

Figure 1: Determinants of Choice in Intermediated Exchanges

perceived market and environmental uncertainty. information asymmetry, opportunism, moral hazard, adverse selection and perceived and real volatility of supply

temporal sensitivity, immediacy and spatial needs, aversion to search and coordination costs

Relationship to ProfitsTable 4a.Variables and Relationship to Profitability

Variable Expected Identified

Intermediation state

Diversification level

Age

Internet pure-play strategy

Publicly listed

+

+

+

-

+

Positive

None

Weak

None

None

Table 4b. Variables and Relationship to Intermediation State

Variable Expected Identified

Freq. of acquisitions

Freq. of joint venture

Freq. of organic growth

+

-

?

Positive

None

None

Economies of scale in transacting (reduced search, negotiation and implementation costs)Economies of scope (group or bundled transactions) Cross subsidization amongst transactors and transacted goods play off on different buyer's willingness to pay and supplier's opportunity costs. ...Can increase welfare overall.Risk pooling: reduce market uncertainty by holding inventories.Rearrangement of goods. When there is a mismatch between the producer's offering and the buyer's preferences, the intermediary can rearrange them to improve the match.

Centralization Yields…

Is Bigger Better ? Centralization yields: economies of scale

and scope, risk pooling, liquidity, transparency.

Between 1921 and 1983, 180 different futures markets existed, average lifetime of less than 12 years.

Similar patterns with equity markets…yes – size does matter!

Network externalities - natural monopoly 1 or 2 markets per sector/service

B2B Portals: prospects… Recent study shows less than 15% of B2B

exchanges were actively operating markets 1000 should consolidate to 200 Highly standardized products will be

centralized Place for niche exchanges in esoteric, non-

standard products with many attributes Learn from the consolidation in financial

markets Look for fallout & consolidation in

intermediate term

B2B Portals – 2 main typesHorizontal

1 product sector – many industries

Large exchanges Provide liquidity,

transparency, aggregate supply & demand

Require high volume of transactions, small commission base

Additional revenue through value adds like financing, asset management, warrantees

Vertical One industry –many

products Limited membership Eliminate inefficiencies

in specific industry supply chains

Fewer transactions – revenue based on realized savings

Purpose Increase understanding of rent generation

models in electronic intermediaries Implications of network and product

characteristics Evolution of rent accrual mechanisms &

information and relational capabilities Comparative case studies: 2 companies, both

founded in Atlanta in 2000, & backed by large industry incumbents

Omnexus

eGatematrix

Omnexus

Omnexus Plastics Industry one of world’s largest 589 billion dollars in revenue Employs 1.5 million people

BASF Bayer Dow Dupont Ticona/Celanese

Omnexus

•Large marketplace, MCBase •Search on thousands of materials with specific properties•Integration with suppliers ERP systems•Real time inventory and price data•Submission of RFQs•Electronic billing and transaction clearing•Customer Support

Size # of Firms Annual Revenues Market ShareLarge 200 >30 million >50%Medium 2,700 6 million 30%Small 5,000 <$1 million <20%

Segmentation of Resins Buyers

Competition

Evolution

eGate Matrix

Suppliers/ Distributors/ Manufacturers Caterers

Service Providers Airlines

Flight schedule information from airlinesQuality performance feedback from airlines

Flight schedule information from airlinesQuality performance feedback from airlines

Flight schedule information from airlinesQuality performance feedback from airlines

Inventory and service availability updates from all groups

Food products, supplies, materials to caterers or directly to plane

Prepared meals and other supplies to planeEquipment (galley, culinary, etc.) hand-offs between flights

Audio and video supplies/ equipment to plane

Equipment (galley, culinary, etc.) hand-offs between flights

Mark-up payment from airlines for services rendered

Payment from airlines Service charges from airlines

Information Flows

Physical Flows

Financial Flows

http://www.esade.edu/home.php

http://www.esade.edu/home.php

What Happened? Conclusions

Horizontal Many portals built on

information aggregation assumption

Barriers to entry low Too many portals, can’t

generate volume Suppliers weary of

transparency (stick with EDI and Fax)

Most sectors can support 1-3 exchanges (max).

Forget commodities and content - Focus on payment, logistics, & value adds….

Vertical Often very sound

business model Implementation hard

work Barriers to adoption:

legal, organizational, procedural

Slow in the making, but scale well

Most profitable in fragmented markets with customizable products