Chapter 01 (Supply Chains)

Supply Chains

There is nothing quite like being a satisfied customer. It makes you feel good but, too often, you are surprised when things work really well; an unexpected wow factor hits that overwhelms and has you coming back again and again. Satisfaction takes you to an addictive higher level of enjoyment.

When you purchase a product or service, you hope that your needs will be met and expectations realized. Great companies have found out how to do this. They design and deliver products and services that exceed expectations time and again. This does not happen by accident; these companies put significant effort into the design of their products and supply chains. They want the product and its delivery to align with expectations and create an exceptional experience.

Companies go to great lengths to manage their product designs. They create market and design specifications, fund elaborate R&D programs and hold customer trials; all in an attempt to create the perfect product. When it comes to the design of the supply chain, it is often completely different. Products are frequently squeezed into existing supply chains that have evolved over time without clearly articulated objectives or requirements. In many cases, elements of these supply chains were consciously engineered but other parts evolved by happenstance based on an amalgam of reactionary fixes to previously encountered problems.

This is difficult to understand given the importance of supply chains. Take military as an example of their importance; battles have been lost when munitions or food were not available for soldiers. Companies need to focus as much effort on designing their supply chains to create a superior customer experience consistent with product expectations.  When this occurs, you can feel it – the supply chain is working as designed.

Everything performs as designed. There are good, well thought out designs and then there are the other kind.  Cars perform well on the ground but not when airborne, likewise airplanes do not handle very well on the ground but they are great in the sky.  Extreme examples but they make the point; performance is a function of design. Don’t expect things to operate well in applications that they are not designed for. Everything has a design whether it was created by conscious effort or default.

Supply chains are no exception.  As with all designs, the quality of performance is directly related to the quality of the design.  Good designs operate well, poor ones don’t; sometimes failing with catastrophic consequences and other times causing only irritation.  The failure to get bullets to soldiers in times of war is catastrophic; the waiter’s failure to deliver a hot meal in a restaurant in timely fashion is irritation.

Supply chains must be engineered to specifications and measured for performance. An engineered solution has the best chance of meeting the design intent. Supply chains are made up of companies that work together using enabling processes and rules to create a predictable delivery outcome.  Supply chain design is about defining these rules and processes and selecting the appropriate companies so that it works.  The outcome must meet the expectations of all stakeholders, which include customers, shareholders, employees, governments and the community.

With supply chains, it is important that all of the building blocks – the suppliers, the systems and business practices – be selected and crafted to achieve the design intent. The design intent is captured by the specific performance expectations that it must meet. While the specific targets for each supply chain may vary, it must be able to:

  • Fulfil customer demand on time
  • Meet the customer’s service expectations
  • Scale cost effectively with increases and decreases in demand
  • Perform in all regions and markets of interest
  • Meet corporate citizenship and social responsibility expectations of shareholders and other stakeholders
  • Comply with all government regulations and
  • Achieve overall financial goals of the company

The design must also specify the metrics to be tracked to ensure proper performance.

This book takes a high-level, strategic view of supply chains for electronic products and provides a guide for how effective supply chains are designed to meet the expectations and needs of stakeholders. While many of the ideas and concepts are applicable to other industries the short product lifecycles, high levels of investment and technological complexity make high tech supply chains, the focus of this book, unique.

What are Supply Chains?

The term supply chain is a metaphor for a network of companies tied together to enable the delivery of a product or service to a customer. The term chain congers up the image of a linear, link after link sequence; this is not the case. The supply chain is more of a multipath web. Sometimes linear progressions occur within it but more often it is a mesh with multiple inputs and outputs going into each web node. These web nodes can be companies, organizations, governments or people, with each playing a vital role.

Our definition of supply chain is a mesh of web nodes linked together with systems, communications, and business practices to enable products to be built and delivered to customers. In general, goods move up the supply chain and information and cash go down. Information actually goes in both directions, as communication is critical to good supply chain performance.

Supply chain management begins with a forecast of demand and ends with the delivery of product to a satisfied customer. Between these two ends are a myriad of activities to stage materials, select suppliers, move items from one location to another, ship products, solve issues,  deal with international regulations and requirements and do them all in a manner that meets cost requirements. The best supply chains operate in synergy with the products that flow through them.

Supply chains also need coordination mechanisms and metrics to make sure all activities along the chain are aligned and remain in sync. Today’s supply chains are sophisticated with very tight performance criteria. Some factories, particularly in the automotive industry, want their materials delivered within hours of being used in the production line – but never late. This requires exceptional coordination between the factories, delivery personnel and the customer to ensure that the materials are delivered on time. It is also mandatory that the quality of these materials meet all requirements so that the customer’s factory is never shut down. These are demanding criteria that the supply chain must respond to and deliver on.

In the supply chain, suppliers are providers of materials and services needed by customers. If the customer is an Original Equipment Manufacturer (OEM), the goods and services are required to make, ship and deliver the products. Their suppliers are manufacturers, foundries, distributors, contract manufacturers, original equipment manufacturers, original design manufacturers (ODMs), logistics providers, and anybody else needed to complete the product.

Supply Chain Priorities

The top three supply chain priorities are security of supply, cost and compliance. They all compete for first place and any one of them can stop an operation from meeting its customer commitments. You can’t ship a product that you don’t have, operate a company that cannot make money or ship products that are unsafe or violate laws and social norms.  Security of supply pertains to one’s ability to get the materials and services that are needed when you need them. Cost refers to the total cost associated with building and delivering the product and compliance means conforming to the laws, regulations, rules and expectations of governments, customers and other stakeholders as well as conformance to the supply chain design.

At different times, one of these priorities may dominate and take a supply chain manager’s full attention but the reality is that, at all times, these are the top priorities.  Any decisions and actions must take into consideration the implications for all.

Security of Supply

All endeavours involve some level of risk. Supply chains need to be designed and managed so that they can operate effectively as risks become realities. Supply chain risks usually materialize as shortages in materials or delivery constraints. Proper supply chain design assesses the potential causes of supply issues and puts in place methods and strategies for mitigating risks before they occur.

The design intent is to prevent singles points of failure by ensuring adequate redundancy exists at all points along the chain. If redundancy is not possible then inventory strategies can be employed to provide sufficient time to ride out the crisis that caused a shortage. Generally, in supply chains, inventory is considered bad but, in some cases, it is the only option. Sometimes it can be a business enabler. In any case, inventory needs to be managed carefully as it can quickly get out of hand.

Your ability to manufacture products and deliver them to customers must be able to accommodate shortages in supply with minimum impact. Shortages may be caused by natural disasters like floods, earthquakes and tornados; manmade calamities such as strikes and other forms of social or political unrest; misfortunes like factory fires, explosions, power outages and shipping lane or airport closures. There is also the possibility that a manufacturer loses the recipe and suffers yield loss or poor quality for a period of time. Another, potentially more catastrophic risk, is the financial collapse of a supplier leading to bankruptcy and its eventual nonexistence.

To assess and mitigate security of supply risk it is necessary to distinguish between two kinds of materials sources. There are materials where multiple sources are available and there are materials with only one source (sole source). In the case of multi-sourced materials, manufacturers other than the one you have chosen can make the component. Unfortunately, many manufacturers only qualify one component when alternatives are available and result in a single source situation. With sole sourced components, only one manufacturer can make the device and you must ensure that you have access to this sole source materials whenever you need them, even when supply disruptions occur. Your security of supply solution will be different for each kind.

It is also important to distinguish between different types of suppliers. The terms supplier and vendor can be used interchangeably but suppliers can be manufacturers or resellers. Resellers buy components from manufacturers or other resellers and sell them to end users. Distributors and brokers are resellers. The reason this is important is that having two distributors as sources for a component from the same manufacturer is really akin to having only one source. Two equivalent components from the same manufacturer should also be considered as one source.

In the case of single sourced components, a company has the option of qualifying one of the other manufacturers or using strategies like those for sole sourced components. Qualification means simulating and testing the components in your product and making sure they meet all requirements.  Companies should avoid single source situations and the best time to prevent this situation is during new product introduction.  For components with different manufacturing sources available, multi sourcing is recommended. We are not suggesting that you need to buy from all sources; only that you have them as a qualified source (the buying decision will be discussed later).  Just as one source is too few, seven would be too many. We recommend three as a good target number.

Having multiple manufacturing sources is good but, in itself, may not be an adequate solution; you want these manufacturing sources to be independent and geographically dispersed. Having three capacitor manufacturers with factories siting on the same fault line beside the same nuclear plant is not good. Also, having two manufacturers as second sources that are sole sourced on a raw material must be avoided.

To qualify a manufacturer, as a minimum, one must know:

  • The location of their factories
  • If they have second manufacturing sources for each of their raw materials
  • If any of your components are subcontracted to another company’s factory
  • If they have a history of labor disruptions, power outages or other production disruptions, and
  • If they have a business continuity plan
  • If they is high risk of there being a going concern

Having a business continuity plan indicates that the company has thought through those things which could disrupt its business and has worked out solutions that would minimize their impact. Having a good business continuity plan means it might actually work.

Sole sourced components do not have alternate source options so it is your responsibility to understand the manufacturer’s security of supply strategy. Sole source components tend to be devices with high intellectual property content; these are usually semiconductor components like FPGAs, DSPs or processors. Often the manufacturers of these components are fabless IC companies which means that they do not have their own factories and are using third party factories like wafer foundries, assembly houses and test facilities to make their devices.

With sole sourced companies, you are interested in how they have set up their supply chain. You need to know:

  • Do they have independent and redundant capacity at each step in their manufacturing (Wafer Fab, test and assembly)?
  • How do they manage access to capacity?
  • What inventory strategies do they employ (wafer banks, die banks, channel inventory) that you can access?
  • Do they use customer identifiers in component part numbers, which could restrict access to usable material?
  • Do they have a business continuity plan?

Software is another sole source product that needs special attention. A lot of the hot, differentiating software that can be embedded in your product comes from small, high-risk start-up companies. Unlike component delivery, the issue with software is not that you cannot access a copy of the code as it will be sitting your server. The issue has to do with your legal right to use it and, if the start-up company fails, how you can access the source code to fix bugs or performance issues.

Another security of supply consideration is the breadth of use of the component you are selecting. If you are selecting a new component where there is only one other user and that user is a giant in comparison to you, you have an issue. If that giant discontinues its product or changes from the component you have selected, your manufacturer may be left with an unprofitable product and push for its early demise. In planning your security of supply strategy, you should ask your suppliers if your components are broadly or narrowly used.

With your supply chain design, and depending on your size, you may buy directly from the manufacturer or you may buy through distribution. Distributors bring advantages to the buyer that may include access to inventory and return privileges.  Use of more than one distributor for a component provides access to a layer of inventory that may be able to help you through short-term supply disruptions.

Strategies for security of supply are generally formulated around the impact of the risk, its probability of occurrence and the cost of the mitigation.  For example, if the cost of a supply issue is $1M and you determine that there is a 10% chance of it occurring, then there is a $100K risk to you. If it costs you $50K to eliminate the risk, you need to decide if it is worth $50K to save the $100K.

Alternate sourcing is a good, low cost approach that has additional advantages in price negotiation. Alternate sources should be qualified during new product introduction so that the qualification cost can be part of the product development. This is also the least expensive time to qualify a component because all of the knowledgeable design resources, along with simulation and testing set-ups, are available.

Carrying or having your supplier carry buffer inventory will enable you to ride out short-term supply interruptions but it can get expensive if used to alleviate long-term problems. Last time buys are used when the manufacturer makes components obsolete but in this situation the amount of material purchased depends on your business demand, the time and cost required to design alternate component in or assess other options. Some companies, such as Rochester Electronics, specialize in acquiring the rights to manufacture discontinued products. Using this option bears a premium price but, in some cases, could be the best option.

Cost

Cash is the lifeblood of any company. If a company runs out of cash, it is dead.

Companies have three main ways of getting cash. The first is from selling shares to investors as equity investments. The second is through debt financing with the sale of bonds or taking loans from banks or other institutions. The third way is to generate cash through the sale of products and services. Other options include grants or the sale of assets and business divisions but the point can be made by considering the first three.

Companies must generate or convince investors that they have the ability to generate cash through product or service sales. If they can’t, or if investors lose confidence that they will be able to do this in the future, investors will stop investing and lenders will stop lending. Therefore companies must strive to balance, or show that they will be able to balance, their expenses with their revenues to create earnings and build cash reserves. Companies cannot burn cash forever and expect to survive. The ability to keep costs below revenue is a survival issue.

This must be done in both good times and bad. While some expenses such as R&D or marketing can be viewed as investment, the product cost, that is the cost of its manufacture and delivery to the customer, must be low. Regardless of what kind of market acceptance a company is experiencing, your company must be the low cost producer in the market space in which it competes.

This low cost mindset is necessary for two reasons. First, it increases profits and helps generate cash; second, you never know when a superior product will enter your market at a lower price. Your company must be able to drop its price and compete until it catches up with the new products.

What is critically important is the total cost of a product and its delivery. On financial statements these costs are referred to as the Cost Of Goods Sold (COGS). The difference between the revenue and COGS is gross margin. Gross margin expressed as a percentage of revenue (gross margin %) correlates with stock price (r=~.7). Lower costs increase gross margin, which raises stock prices and improves a company’s ability to raise cash.

Manufacturing costs consist of labor costs, materials costs, depreciation, transportation costs and a bunch of other expenses related to utilities, maintenance, warranty and management. All of the costs associated with planning, sourcing, building, operations training, sustaining and component engineering, shipping, fixing, managing, reworking and repairing are in COGS.  If one chooses to move manufacturing to a low cost region and has to hire 10 more people to manage the production because of its distant location that cost falls under COGS and product cost.

As a supply chain priority, achieving and maintaining competitive costs is at the top because of its importance to cash, gross margin and your ability to respond to a competitive threat.

Compliance

I don’t know if there ever were good old days but today it seems that companies need to comply with an ever expanding myriad of requirements. The good news is that most of these make sense and are for the common good.  They do however come with a cost and, if one fails to comply, penalties that can range from fines, jail time for executives and exclusion from markets to the loss of stakeholder and customer confidence (to name a few).  Your supply chain, particularly your supply base design and control mechanisms, must ensure compliance with these laws, regulations and growing expectations that are becoming social norms.

It is hard to argue in favour of environmental irresponsibility, genocide, child labor, heavy metal contamination or bribery and extortion. The idea of being compliant with regulations resonates favorably with responsible people, but the task of ensuring compliance is not easy. The supply chain must facilitate communication and allow for testing, audit and whatever else is necessary to ensure that what goes into your products comply. The supply chain must enable visibility. This is the first compliance requirement.

An alternate form of compliance is ensuring that your supply chain is used as designed. Are the components in your products actually the ones you specified? Are components being purchased through your approved channels so that you have the tractability your business needs? Are your contracts being honored? Are any of your products making it into countries in violation of UN or national import/exports controls? Are any restricted substances making it into your products without your knowledge?

Your design and supply chain management need to ensure both types of compliance.

Supply Chain Architecture

Architecture is an important part of any design. It defines the structure, look and feel and the performance of what is being created. It brings with it a set of qualities unique to the designer and the times.

Supply chain architecture refers to the manner in which the elements of the supply chain are organized and integrated into an effective delivery vehicle.

One major contributor to the supply chain design is the architecture of the product itself. Product decisions that determine which chip sets are used, what is in hardware versus software, which parts are custom or commercial or if the product self-tests or requires complicated expensive testers shape the supply chain. Other factors such as the aggressiveness in packaging density, the product’s level of performance against bleeding edge and the need for quality and reliability mould the chain by eliminating some supplier and channel options.

Marketing decisions about product options, colors and product configuration add complexity to the supply chain. Other factors, like accessory options and channels to market, structure the supply chains design. Performance criteria, such as always in stock, 24 hour delivery or 8 week lead times, play a role in the supply chain development.

Marketplace expectations of a product’s delivery must be understood before the supply chain design begins. Market specifications are design requirements used to engineer the supply chain. Design specifications will document how the chain is structured and operated as well as have the key performance metrics to be used to confirm that the supply chain operates as expected.

What Matters in a Supply Chain

Two things matter in the supply chain; its design and its management.

As we have discussed, the supply chain needs to be designed to a clear specification and verified that it can meet the expected performance criteria. Once it becomes operational, its management becomes paramount and, as with most operations activities, attention to detail separates great supply chain management from mediocre. Tracking of the metrics specified during the design phase provide confirmation that the supply chain is behaving appropriately.

In its management, communication up and down the chain is essential to it functioning properly. Some communication can be as simple as the transfer of data, like quantity or delivery dates. Other communication requires the support of coordination forums such as periodic business reviews where requirements can be put in context to gain alignment to and support of initiatives.

Why High Tech is Different

High tech, the shortened version of high technology, was introduced in the 1950s (Wikipedia contributors, “High tech”).  The 1950s were an interesting time in electronics. The atomic age had begun during the Second World War. Advances in quantum mechanics led to solid-state electronics with the invention of the transistor in 1948. Successful integration of transistors into an integrated circuit a decade later began the microelectronics revolution. Many of today’s semiconductor companies had their origin during this period. The 1960s and 70s brought forward many new products that saw the integration of hardware and software enabled by new silicon devices. An era began that has fundamentally changed how we work and live. Microelectronics has affected every industry on the planet in some way.

Today, solid-state devices manipulate electrons, photons and electric fields to create amazing new products and capability. The business environment also changed during this period of growth in microelectronics.  New products entered the market at an ever-increasing rate, often having shorter and shorter life cycles, and new capability or features replaced older ones. Investors agreed with these microelectronics companies that the cash generated by the profits should be reinvested and not returned through dividends; investors were rewarded with capital gains from share price escalation. Reinvestment in new technologies and products fueled more growth and advancement.

New products were introduced to the marketplace when the underlying technology was at the bleeding edge. This meant that yields were unstable and margins were low. Consequently, a cycle of yield and cost improvements emerged creating a market of continuously decreasing prices. Higher levels of integration as well as competition drove down costs, feeding price reductions.

The supply chains associated with electronic products had to respond to this new environment and be able to accommodate:

  • Fast time to market
  • Rapid new product introductions
  • Aggressive phase in and phase out
  • Significant short term increases and decreases in demand
  • Short product lifecycles along with traditional long product lifecycles

Concurrently, expectations changed, pushing for increasing quality, reliability and enhanced services.

In some regards the high tech supply chain is not different than others. Many supply chains require fast time to market. The sportswear garment industry is an example. The ski season comes around each year with new fashions and colors. Shops must be stocked and restocked with the most popular styles, but what’s popular is only apparent as the season begins. Garment manufacturers must respond with rapid manufacturing and shipping to keep the shops full during a relatively short window of selling opportunity or be stuck with excess and unwanted inventory. This is a similar problem that a new electronic game or other product manufacturer has in planning their pre-Christmas production.

Other industries are demanding in terms of on time product deliveries; the automotive industry as a previously mentioned example. It is clear to anyone who has seen a new automobile that the majority of a car is now made up of electronics such that every requirement of the automotive industry has now become a requirement of some electronics chains.

What is unusual is the sheer number of competing challenges facing the high tech electronics industry as compared to others which makes the electronics supply chain unique. A short list of these challenges (in no prioritized order) can be found below:

  • Complex technology
  • Mixture of hardware and software in products
  • Low cost of entry for start-up OEM companies; high investment cost for suppliers
  • Wide range of product offerings
  • Heavy use of Contract Manufacturing
  • Heavy use of Distribution
  • Heavy use of service companies with multiple levels of supplier involvement
    • OEM
    • ODM
    • Component Supplier
    • Sub-assembly Supplier
    • Mechanical & Electronic Designers
    • Custom parts (plastics, metalwork, PCBs)
    • Re-branding
  • Product and Market driven requirements
    • Seasonal
    • Short lifecycle
      • Change management
      • New Features improvement
      • Obsolescence
    • Type – Commercial, Military, Medical, Retail
    • Warranty and Repair
  • Regulatory requirements
    • Safety (UL, CCA, CE)
    • Environmental (ROHS, WEEE)
    • Interference (EMC, EMI, RMI)

Works Cited

Wikipedia contributors. “High tech.” Wikipedia, The Free Encyclopedia. Wikipedia, The Free Encyclopedia, 01 Nov. 2016.

Web. 01 Nov. 2016. <http://en.wikipedia.org/wiki/High_tech>

 

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