When it comes to cooking, it's easy to jazz up a favorite recipe with different herbs or spices to create something qualitatively new and different. In culinary circles, that's called constructive tension.

Supply chain and logistics experts have an opportunity to apply a similar type of constructive tension right now to create value for their companies as the global economy grows. Supply chains and core functions like logistics will need to rise above the traditional confines of national borders, factory walls, and corporate departments to create competitive capabilities. The key to doing this, to applying 'constructive tension,' is to integrate logistics with overall supply chain operations in a cost-efficient, customer-oriented way.

To begin, we need to clearly define and differentiate the terms supply chain and logistics, since many people, including CXOs, tend to think they're the same thing.

More than suppliers, customers, factories, warehouses, and trucks

Supply chain management is the process that unites core operational disciplines such as planning, sourcing, manufacturing, order management, and service operations. Supply chain integration occurs both internally and externally in connection with the Original Equipment Manufacturer (OEM).

For example, a large consumer electronics manufacturer wants to launch a new hybrid communications device that comprises a mobile phone, PDA, and MP3 player before the "back-to-school" season. A successful launch-the right product at the right price in the right locations-could significantly improve key business metrics such as revenue growth, market share capture, profit, and share price. But a glitch in the material supply processes, such as a supply shortage of critical components or delayed material delivery, that adds extra steps and time to the process could significantly impact the launch.

Supply chain management (SCM) practices define the underlying strategy, systems, procedures, defined roles and responsibilities, and the management control mechanisms that enable a successful product commercialization. SCM weaves together the material, information, and personnel between the channel, the OEM, the manufacturing partner, and key suppliers.

Logistics, on the other hand, is the task of managing and linking assets in such a way that inventory velocity is maximized at the lowest cost, from the time an order is placed to when a product is put into use. Logistics is much more than inbound and outbound trucks delivering products. OEMs need to decide where inventory will be located from supplier through to the channels. The OEM must consider where and how its inventory will be managed, as well as the processes and systems that move the inventory throughout the system. The wrong logistics partnerships or ill-defined logistics processes can leave inventory pooling in the network, which in turn brings logistics and supply chain to the CXO's attention and prompt questions like, "Why is Flash Wireless calling me for the third time this week? We have inventory but haven't shipped the XYZ-9000 from Singapore! Why?"

Beyond function optimization

A decade ago, operations oversaw a disparate group of disciplines like procurement, materials management, production, and logistics, and managed them separately. Then, the drive was to optimize processes and systems within each defined function. This created friction between departments and processes-but not constructive tension as each functional lead fought for resources and management attention.

Without recognizing it, these same leaders often sub-optimized the company's operational infrastructure. Purchasing tried to increase lots to get price breaks, while materials tried to decrease inventories. The emphasis on switching supply to the lowest purchase cost item introduced yield issues in manufacturing. IT systems did not talk to one another; procedures did not synchronize. Each department was winning on its own turf but the company was losing the war.

In the late 1990s, with the onslaught of outsourcing, management recognized that integrated operations were critical to success. Companies such as Dell and Wal-Mart began to redefine their respective industries by optimizing end-to-end supply chains. The business world took notice and companies started to staff internal supply chain organizations. Disparate operations departments were integrated into one organization, and information technology (ERP and APS) was used to speed and synchronize access to key operating data. For the first time, CXOs looked at operations in its entirety and saw a benefit in enterprise optimization.

During this time, significant change occurred from a performance perspective. For the average company, total supply chain management costs, such as those associated with material acquisition, order management, inventory carrying cost, and supply chain planning, fell from 12.7% to 9.6% of revenues in less than a decade. ¹ Not only did costs drop, but the overall value delivered increased significantly. Ten years ago, companies were largely domestic, with fledgling overseas operations. Today, practically every product we buy has global content and implications. The lower costs cover a far more complex operating environment.

But even when affiliated with the supply chain, logistics is still often viewed as a semi-independent variable. Executives continue to ask, "Why aren't we getting better freight rates?" while simultaneously wondering how product delivery can be accelerated. Many companies are zeroing in on inbound and outbound logistics operations costs as a cost center. Traffic managers are motivated to apply strategic sourcing methods to negotiate better rates or, with the current increase in fuel costs, to stabilize rates, and to consolidate shipments to get full truckloads (FTLs). Algorithms are written to optimize the steps between shipping modes. To be sure, these efforts are starting to bear fruit. Logistics costs, defined as a portion of material acquisition, order management, and inventory carrying costs, fell from 4.5% to 3.6% of revenues between 1995 and this year.

But there are even greater reductions and process improvements possible if executives force the business to start its analysis at the strategic level. Instead of focusing logistics solely on cost reduction and supply chain on globalization, management leaders need to understand the actual processes that drive overall costs. As described in Strategic Supply Chain Management: The 5 Disciplines for Top Performance, PRTM has identified an additional 40% cost reduction for logistics and overall supply chain operations when process complexity as reduced. This complexity extends beyond the number of nodes in the network to every process and relationship a company has, ranging from product proliferation, to strategic partnerships, to product development.

Without combining supply chain and logistics to address the problem of complexity and increased cost, CXOs lose the benefit of constructive tension.

Complexity-based constructive tension

The first axis of constructive tension is the degree to which an organization undertakes the creation of cross-functionality. Many logistics departments combine planning, purchasing, operational, and IT capabilities to address the movement of material under one roof. Within logistics, the department has the resources to streamline inbound, outbound, and warehousing operations. For integrated logistics departments, IT and infrastructure investments are demonstrating a positive ROI with an average cost decrease.

This, though, is only the first step. If the company can incorporate the perspectives of supply chain, from strategy to daily execution, along with product management and engineering, it can tackle the real driver of supply chain cost-which is complexity.

One of the most significant drivers of overall supply chain costs is complexity. Companies introduce complexity into their operations through various means: acquisitions, mergers, global supply bases, outsourcing, offshoring, product proliferation, and ever decreasing product life cycles. Today's supply chain executive needs to understand how strategic and tactical decisions influence overall complexity.

The automotive industry is a prime example, where costs are highly influenced by operational complexity. Automotive companies operate at the speed of consumer companies while managing a complex global, capital-intensive operating base.

PRTM looked at leading U.S. automotive companies and compared their transportation methods to gauge effectiveness relative to supply chain complexity. One notable predictor of overall cost performance was the distance in miles traveled per end item shipped. PRTM aggregated the total number of miles, from inbound to outbound, that the individual sub-systems traveled for specific, high-volume vehicles. We found that companies working aggressively to simplify their supply chain network, increase their reliance on value-added outsourcing, and achieve greater labor flexibility, had lower total miles traveled and therefore lower supply chain costs.

Right people in the right places

As more departments get involved and are contributing to the strategic agenda, tension between groups increases. One group may be forced to make sacrifices for the overall goal of simplicity. For example, the supply chain group may have to factor in more inventory days of supply to achieve better overall cost performance (Supply Chain 1, Materials Management 0). Or product management might need to prune its product portfolio to improve delivery performance (Supply Chain 1, Product Marketing 0).

The second point of tension is people-based . Too few companies have the right people in place to manage today's global operations. Often, companies keep personnel hired for the prior generation operating model who don't understand the current scope of operations. Managers recognize too late that the resources they have in place were fine for handling traditional buy-sell transactions, but in today's highly outsourced environment, they lack the general management skills to drive effective, timely transformation.

It is critical to address the importance of inherent tension involved in cross-functional efforts and personnel decisions to make substantive business changes. As Spencer Johnson and Kenneth Blanchard discussed in Who Moved My Cheese?, effective change management coupled with the willingness to think and act big will allow even the most entrenched companies to find new ways to compete. Executives need to drive integration beyond the obvious and force the business to overcome these obstacles.

Conclusion

Virtually every market is undergoing globalization, ranging from customer care to supply chain to manufacturing base. Companies that approach operations from two independent perspectives-(1) supply chain for material planning and conversion, and (2) logistics for material movement-can expect to do no better than average on a total cost basis. These companies will be the ones to tackle the integration of supply chain and logistics, to reduce complexity, and achieve best-in-class performance.

Returning to the cooking analogy, food isn't as threatening as global competition. Don't be afraid to challenge convention and take advantage of constructive tension.

Sidebar: Case Studies

CASE STUDY: Cross-Functional Creative Tension
A medium-sized industrial products company that services the HVAC market recognized the benefits of multi-dimensional cross-functional process improvement. Over the previous decade, the company had grown through repeated acquisitions. As each acquired company came under the brand, certain aspects of the operation were consolidated while others were left alone. At the corporate level, there was an integrated supply chain management and sourcing function, but each remaining operating group had its own logistics function. Independently, the logistics groups selected carriers and negotiated rates. One group used a national carrier while another group would only work with a local carrier. As part of its annual strategic plan, management noticed that aggregate logistics costs on a per shipment basis had accelerated over the previous year.

The initial solution called for each logistics manager to be assigned cost reduction targets. After working with PRTM, the executive team recognized that an enterprise-wide solution was needed. Instead of limiting participation to each division's logistics group, we encouraged that corporate procurement, supply chain, finance, and IT be added to the work sessions. Additionally, we invited the Chief Technology Officer, who was responsible for global process improvement, and select members of the corporate leadership team.

By looking at the entire enterprise network, we found some interesting patterns. While many divisions had between 5% and 15% of their products sourced locally, the majority of supply came from more than 1,000 miles away. Given that some of the shipments were LTL from that distance, the associated costs were not in line with our new targets. None of the divisions was working together to aggregate materials and move to FTL or even rail.

Here is where the broader supply chain vision came into play. In order to optimize the loading and movement of inbound trucks, enterprise planning systems needed to be synchronized. Additionally, enterprise-wide changes to the computer systems were required-for reporting, exception management, and routing notification. Cost data, which was only visible at the aggregate division level, needed to be further broken down so logistics managers could conduct trade-off analyses. Finally, the corporate sourcing function helped to coordinate a carrier consolidation program coupled with rate re-negotiations. Each division had to migrate toward using more national carriers, but the corporate group pointed out that better methods were required to address poor cost performance quickly.

In the end, each operation had to give a little to get a little. The resulting solution was enterprise-wide and increased the expected benefits by a factor of two.

CASE STUDY: People-Based Constructive Tension
A national service provider of enterprise voice and data solutions went through many configurations as it bought companies and sold divisions. It combined internally managed logistics with shared responsibilities for repairs. Easy repairs stayed in-house whereas all other repairs went to various service partners.

Over the years, the company had tuned its logistics and service function to offer outstanding service to its customers at any cost. If field engineers needed a part overnight, the logistics group worked overtime to pick-pack-and-ship it, incurring overnight freight charges to get the material there in time even if the materials sat on-site for an additional week or two. If a customer decided not to keep a cabinet and backplane, the company returned it to the warehouse, usually without charging a restocking fee, all the while acting under the assumption that the customer was a strategic account and deserved special treatment. Over time, logistics lost its ability to influence the operation and to achieve a truly low cost method of delivery.

After a new management team was put in place, attention immediately turned to the overall cost of logistics and service operations. The executive team set an aggressive target of cutting logistics costs by 30% with minimal impact on service levels to the field. The internal team, proud of the infrastructure it built, struggled to find the necessary cost savings. Suggestions ranged from increasing the amount of in-sourced repair to consolidating warehouse operations. When benchmarked against comparable operations, PRTM found that productivity would need to improve by a factor of three to remain competitive, but none of the required infrastructure was in place.

The company opted to outsource its logistics and repair operations. The decision required that the selected service provider offer integrated logistics and repair services, and take responsibility for managing central stocks through district stocks. Once initial objectives were met, the selected service provider took full responsibility for the assets.

While evaluating whether the existing staff could be re-trained for the new operating model, we worked with the company to identify general manager-caliber personnel. We were looking for someone that had a deep knowledge of logistics and service operations-warehousing, traffic, distribution planning, and repair logistics-as well as experience managing outsourced operations. Due to the challenge in finding an experienced executive with this skill set, we found it more expedient to hire externally while retraining internally.

The net result was a more capable, integrated operation that garnered respect from the business. The new executive director of supply chain operations helped to coach select individuals retained from the prior operation. The former director of logistics was retrained to oversee the 3PL's operation and his former manager of repair operations now directs repair activities at an executive level.

Achieving the 40% cost reduction, which exceeded management's goal by 33%, required personnel to overcome the tensions surrounding downsizing and re-tooling. Bringing in an external executive, while at first perceived as demoralizing, came to be viewed as a key part of professional development by the organization. Taking advantage of the tension created by the personnel changes and the outsourcing strategy resulted in a payback period of two months.