Koren Y. The Global Manufacturing Revolution: Product-Process-Business Integration and Reconfigurable Systems
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Example: A retailer buys a product from a supplier at a cost of $5 per unit. The
customer demand for the product is at a constant rate of 100 units per week. The
estimated unit holding cost for the retailer is $4 per week. A trucking company
delivers the ordered products from the supplier to the retailer and charges $200 per
delivery, no matter what the order quantity, Q, is. Determine the optimal order
quantity that the retailer should choose in order to minimize the total cost per week
(assuming zero delivery lea d time). For this order quantity, what is the holding cost
and shipping cost per week?
The EOQ model yields
Q
*
¼ EOQ ¼
ffiffiffiffiffiffiffiffiffiffi
2CD
H
r
¼
ffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
2 200 100
4
r
¼ 100 units
Namely, the retailer should place an order of 100 units, as depicted in Figure 11.4.
Note that the graph is not symmetric around the optimal quantity of 100 units.
For Q ¼ 100, the holding cost per week is h
Q
*
2
¼ 200 and the shipping cost is
C D
Q
*
¼ 200.
11.5.3 Delayed Differentiation
Global supply chains are often designed with delayed differentiation to better manage
a broader variety of products. The common modules of a product (e.g., a computer
mother board), or semi-finished products, are assembled in low-labor-cost countries,
and shipped to the countries where the final assembly is done and the product is sold.
Since the common modules can be included into several final products, the manu-
facturer can delay the final assembly operation until customer orders are actually
placed. Th e principle of this delayed differentiation strategy is
Make-modules-to-stock and assemble-products-to-order
Figure 11.4 The total cost as function of the ordered quantity.
SUPPLY CHAINS 301
Supply chains that include a delayed differentiation strategy save tremendous
inventory cost s in environments where customer product demand is stochastic. This
strategy helps to manage the complexity of adding varieties of products. A simple
example is a printer manufacturer who produces two types of printers in its production
center in China—a mono (B&W) printer and a colo r printer. Without delayed
differentiation, the company ships both types to its warehouse in the United States.
The warehouse must maintain inventory of both printers to meet the product
stochastic demand.
With the delayed differentiation strategy, the printer is designed so that the product
is decomposed into two components with a common interface: a standard printer
body, and a toner module (which can be either for B&W or color toner), as shown in
Figure 11.5. Due to the short time it takes to assemble the printer and toner, the
warehouse can now keep an inventory of just one common printer body and two
different toner modules, and does not assemble these into a final printer until the actual
customer order comes in. Since the inventory cost of toners is much lower than that of
printer bodies, the total inventory cost is substantially reduced only by delaying the
point at which final assembly is completed.
11.5.4 Bullwhip Effect
*
Typical supply chains consist of several tiers of retailer, wholesaler, and manufac turer.
Also, in virtually all industries, consumer demand exhibits some level of randomness.
To be able to meet such a demand, every echelon (or level) of the supply chain holds
inventories and follows various strategies of order replenishment to maintain the
appropriate levels of inventory. Even a moderate fluctuation of demand at the retail
level can propagate into a very high variability effect for the manufacturer. This
Figure 11.5 Modular design.
*
Dr. O. Ceryan wrote the section on Bullwhip Effect.
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phenomenon was first noticed by P&G executives who were surprised to observe that
diaper orders placed by distributors had much more variation than sales at the retailer
stores (level 2). They coined the term “Bullwhip Effect.”
8
Figure 11.6 demonstrates how demand variability may increase as we move from
the end consumer sales (level 1) toward the higher echelons of a supply chain: the
retailer (level 2), the wholesaler (level 3), and finally to the manufacturer. While the
demand from consumer sales is relatively stable with a fluctuation of approximately
2 units over time, the retailer’s orders to the wholesaler indicate a variance of 3
units. As we move further down the supply chain, we observe that manufacturer’s
orders exhibit a variance of 7 units over time.
There are four main causes for the bullwhip effect.
1. Demand Forecast Updating: Forecasting is a process of periodic review and
response to signals from current demand statistics. When a period’s demand is
low, a retailer may lower its forecast for the next period. Similarly, if demand
increases it can lead to an upward adjustment for next period’s forecast. This
process, subject to the lead times required for replenishment, increases vari-
ability from demand that is observed by the higher echelons of the supply chain.
2. Order Batching: In order to reduce various fixed costs associated with order
placement, many firms may choose to aggregate the orders into batches. This
economically justified behavior often leads to placing bulk orders out of sync
with actual demand, and some periods where no orders are placed at all.
Figure 11.6 An example representing the bullwhip effect.
SUPPLY CHAINS 303
3. Price Fluctuations: Price discou nts and special promotions can distort true
customer demand in those periods. This can give retailers the incentive for
stocking large quantities of inventory in promotional periods. However, when
these discounts expire, consumer demand often rebounds below average
creating greater variability.
4. Shortage Gaming: When demand exceeds supply, manufacturers may ration
inventory, leading the consumers to anticipate future shortages and exaggerate
their orders out of proportion with their actual demand. Eventually when a
shortage subsides, it can lead to order cancellations by the consumer and
therefore intensifies variability in the demand process.
Information plays an important role in suppressing the bullwhip effect when
establishing supply chains. At least tw o strategies have been suggested to mitigate the
bullwhip effect.
1. Information Sharing: Sharing point-of-sale (POS) data through technologies
such as electronic data interchange reduces the cost of placing orders and leads
to more frequent orders. Using third-party logistic companies, or shipping an
assortment of products in a truckload, also lowers the shipping costs associa ted
with frequent order deliveries.
2. Vendor Managed Inventory: Centralizing the ordering process for several
echelons provides the efficiencies of a single shorter supply chain. An example
is where a manufacturer becomes responsible for replenishment of its own
products at a customer’s retail store, (e.g., P&G is responsible for replenishment
of its products that are sold at Wal-Mart).
11.6 RESPONSIVE BUSINESS MODELS FOR GLOB AL OPPORTUNITIES
The manufacturing industry is in an era of turbulence caused by globalization. A
responsive business model is one that can quickly adapt to the challenges posed by a
market environment dominated by change and uncertainty.
11.6.1 Global Competition Causes Turbulent Markets
The need for responsive business models is driven by a number of recent changes in
the global business environment, which include:
.
Global Competition —Companies in many countries can produce similar
products, sometimes cheaper, sometimes better; customers can buy products
everywhere.
.
Corporations Become International —Producing and selling in many
countries.
.
Quick Financial Transactions —Money is transferred by electronic systems.
304 BUSINESS MODELS FOR GLOBAL MANUFACTURING ENTERPRISES
.
Rapidly Changing Customer Needs —A global supply higher than demand
creates a buyer’s market where customers change their preferences at a rapid
pace.
.
Increased Customer Purchasing Power —Globalizat ion has increased cus-
tomer salaries in developing countries who now can afford to buy almost any
product, thereby forcing corporations to introduce products at a higher
frequency.
.
Technology Innovations have led to fierce competition in new product devel-
opment as well as in implementing advanced manufacturing systems to produce
these products.
.
Environmental Regulations drive “green” products as well as “greener”
manufacturing systems and processes.
.
Investment in Production Systems has Decreased due to the lower cost of
high-quality machines, thereby enabling building factories in more countries.
.
Information Technology and worldwide information networks make commu-
nication and information instantaneously and universally accessible.
.
New Design Tools, especially computer applications, enable the design of new
products faster and more efficiently, and it can be done by engineers around the
world.
.
Education in many countries has advanced considerably, globally creating a
much larger skilled workforce.
11.6.2 Semiconductor Fabrication
The semiconductor fabrication business is in a turbulence state in the current global
environment. Because of the frequent introduction of new technologies and abrupt
changesinthenumber ofcomponentsused in each end-userproduct, thesemiconductor
market is characterized by extreme instability and large fluctuations in demand.
Therefore, semiconductor manufacturers have increasingly shifted away from the
traditional business model of carrying out the entire production process in-house
aiming toward an outsourcing-based model. Under this new business model, certain
parts of the production process are outsourced to silicon foundries and assembly
sub-contractors located mainly in Asia. To a certain extent, by shifting to such a
production system, semiconductor manufacturers are passing on some of the
cyclical business risk associated with market fluctuations to these foundries and
sub-contractors.
These sub-contractors have responded by adopting manufacturing equipment that
is more reconfigurable and that can respond to fluctuations in the semiconductor
market. For example, the semiconductor industry traditionally uses diamond blades to
cut the wafers. However, recently the sub-contractor industr y started to use laser-
cutting technology that can be integrated more cost-effectively into reconfigurable
sawing equipment. Laser cutting also has the advantage that it can saw hard materials
that are difficult to cut with diamond cutting tools. A reconfigurable laser-based
sawing machine can cut both hard and softer wafer materials.
RESPONSIVE BUSINESS MODELS FOR GLOBAL OPPORTUNITIES 305
11.6.3 Enterprise Reconfigurability
Enterprise reconfigurability is the ability of an organization to change and adjust itself
internally and externally to accommodate rapid changes in the business world. The
driving forces for creating a reco nfigurable enterprise are rapidly changing worldwide
market opportunities and rapidly changing customers’ needs and preferences in
various regions on the globe.
At the internal level, the reconfigurable enterprise requires a new organizational
structure with a more entrepreneurial team culture and empowerment of the work-
force. It also requires communication with customers and better cooperation with
suppliers.
At the external level, reconfigurability means the ability of an enterprise to form
strategic alliances with other organizations in order to gain a competitive advantage.
The rationale behind the creation of strategic alliances is that because enterprises
cannot change their own core competencies fast enough to take advantage of new
market opportunities, they should establish alliances to enhance their competitive
edge. Strategic alliances improve an enterprise’s ability to reconfigure, and accelerate
their responsiveness.
11.6.4 Characteristics of Reconfigurable Business Models
To enable organizations to rapidly create strategic alliances with other organizations,
and dissolve them quickly when the partnership is no longer needed, is a challenge
that requires the formation of organization-wide reconfigurable business models.
With the reconfigurable business model, allied companies can quickly combine
resources to share core competency and respond to new market opportunities, as
depicted in Figure 1 1.7.
When new market opportunities emerge and a new core competency is needed, a
new strategic alliance might have to be formed. The reconfigurable business model
Figure 11.7 Reconfigurable business model.
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BUSINESS MODELS FOR GLOBAL MANUFACTURING ENTERPRISES
enables enterprises to focus on new market opportunities more than on the protection
of their narrow business turf. However, making decisions about market opportunities
is not simple in the case of alliances, because the power to make the decision lies in the
hands of several companies rather than those of a sing le enterprise. Each member
company in the alliance evaluates the risk differently including the potential benefits
and estimat ed costs.
For strategic business alli ances to be est ablished and dissolved quickly, they should
be based on reconfigurable business models that possess the following core
characteristics:
Customizable The alliance structure is customized to make use of a specific
core competency to produce a new line of products
Convertible The alliance’s ability to change its mission and convert
resources to implement the new mission
Scalable The alliance’s ability to add new companies in response to
market changes and mission changes
Modular A unique strategic resource (a module) that can be integrated
into the alliance’s current activity
Integratable The ability to rapidly combine the resources of several firms
in the alliance, and use their synergy to compete
successfully
11.7 PRODUCT LIFE CYCLE BUSINESS MODEL
Theentireproductlifecyclestartswithits conception and design, proceeds through
its manufacturing, assembly, sale, a nd delivery, conti nues with its use and main-
tenance, and finally its end-of-life (EOL) stages of disassembly and reuse, recycling,
or disposal. To respond to environmental concerns of globalization and reduce the
impact of old products at their EOL on the environment, European regulations
require recycling of most products, even automobiles. The European end-of-life
Vehicles (ELV) Directive, enacted in October 2000, defines new standards for car
recycling.
9
It states that manufacturers are responsible for their vehicles from cradle
to grave.
About 8 million vehicles are recycled annually in the 15 countries of the European
Union (2004 data). However, as a result of the ELV Directive, the actual waste from
those ELV vehicles accounts only for about 1% of total waste across the EU member
states. This is due to the fact that parts are reused and a high percentage of the materials
are recycled or recovered. The reuse and recovery rate of 85% enforced as of January
2006 seem s realistic.
10
These European regulations have a major impact on product design, and they
have triggered the search for new business models for automotive companies.
Product design must cope with environmental requirements from materials selection
to final disassembly for recycling. The intention is to design products with reduced
PRODUCT LIFE CYCLE BUSINESS MODEL 307
environmental impacts over their entire life cycle, including their disposal and
recycling.
The automotive sector is seeking greater revenue vitality in this new business
model, and at the same time greater customer satisfaction. One model that aims at
achieving these goals is in Selling Services rather than selling products.
11
This
business model is an expansion of the jet engine service business model or that of
vehicle leasing, but it has important consequences on reducing the amount of
component produced and disposed.
Selling services rather than products calls for the reuse of used components in new
products along with providing extended maintenance contract. It also implies shorter
time between the introduction of new advanced (luxury) product models (extending
the life span of the product components) as well as the manufacturing of a smaller
number of new components (which supports environmental considerations).
An example of just such a business-engineering reuse model is depicted in
Figure 11.8. Let us assume that a car manufacturer has two models that share the
same platform, but market segmentation and brand names enable the manufacturer to
introduce two models: luxury and standard (e.g., Volkswagen has two super-mini
models: the luxury Audi A2 and their standard Polo).
When the luxury product has been used for a while and its performance has
deteriorated, and at the same time a new similar product offering better performance is
introduced, the customer may wish to change the car. The customer’s old car, if not
sold to another customer, enters the EOL phase. The business-engineering model in
Figure 11.8 shows that in this phase, the produc t is disassembl ed, its parts and
components that cannot be reused are disposed of, but the other used components are
inspected, cleaned for reuse, and assembled into a new standard vehicle.
That is well and good, but would you agree to have used components installed your
new car? Probably not! Nevertheless, if the car is on a lease and the manufacturer owns
it and guarantees its performance and service, you might agree assuming that the
leasing fee is reasonable. In this business model, the cars that customers drive are the
property of the manufacturer or leaseholder that sells the serv ice rather than product.
12
In this model, the product design, its manufacturing, assembly, and the business
operation are modules that are integrated into a coherent, environmentally friendly
enterprise that makes its money providing a service. This comprehensive model is a
Figure 11.8 Reuse of old components in less expensive products reduces disposal.
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BUSINESS MODELS FOR GLOBAL MANUFACTURING ENTERPRISES
good example of the design-manufacturing-business integration that this book
advocates (see for example Figure 1.9).
The automotive service-selling business model is not new. It is already being
implemented in photocopiers and high-quality printers, where customers pay for
photocopying and printing services at their facilities but they do not actually buy the
machines.
PROBLEMS
11.1 Can the Sephora model (discussed in Section 11.1) be applied to automobile
sales? Does the customer benefit if new automobiles of the same type, but from
different manufacturers (e.g., all SUVs, or luxury cars, or light trucks), are sold
at one dealership at one location? Is it beneficial to the manufacturer? Is it
possible in this directly challenging business model that people determined to
buy a certain nameplate will change their mind when shoppi ng in such
dealerships?
11.2 For more than a decade, from the late 1980s, Apple’s Macint osh computers had
an operating system that was muc h superior to Microsoft’s operating system.
Still, Apple sales declined, and Microsoft’s profits were boosted. What do you
think went wrong in Apple’s business model?
11.3 A manufacturer has a shortage in its manufacturing capacity (Section 11.4.2).
Their forecasting says that the shortage will last for 1 month. The manufacturer
produces 200 units per day. Should the manufacturer use the rule “Produce the
products with the fewest customization requests first?” Is it a good, long-term
strategy?
11.4 A product is composed of five modules provided by five Tier-1 suppliers in a
supply chain that has two tiers (Figure 11.9). Each of the first-tier suppliers has
10 second-tier suppliers, where each supplies one part (even though only three
suppliers are shown in the drawing). Every supplier in the chain has buffers for
Figure 11.9 The supply chain in Problems 11.4 and 11.5.
PROBLEMS 309
inventories (the second-tier suppliers do not have incoming buffers). Each
buffer may hold an inventory of up to 100 parts or modules.
If each part that is delivered by the second-tier suppliers costs $10, and each
supplier charges for labor and profit 100%, what is the maximum value of all
parts and modules held in the buffers of the entire supply chain?
11.5 For the final assembly of their product, an OEM receives parts from five
suppliers, as depicted in Figure 11.9. Calculate the optimal order quantity (Q)
for the parts shipped by Supplier A and Supplier B. Because of packing
constraints, Supplier A can ship quantities in batches of 50s (namely 50, 100,
150, 200, etc.). Supplier B directs its parts to a buffer, which fills gradually at a
constant rate. For storing the parts in this buffer the OEM pays holding costs.
The cost of each part is $200.
Given:
.
Da ¼ 100 daily demand quantity of part A
.
Db ¼ 500 daily demand quantity of part B
.
Ca ¼ $1480 cost per order (the cost of a truck carrying the parts from the
supplier to the OEM)
.
Cb ¼ $1000 cost per order (the cost of a truck carrying the parts from the
supplier to the OEM)
.
Ha ¼ $10 daily holding cost per part A at the OEM site
.
Hb1 ¼ $6 daily holding cost per part B at the OEM site
.
Hb2 ¼ $4 daily holding cost per part B at the supplier site
11.6 Read CASE STUDY I—“The Rise and Fail of FriendlyRobotics” and answer
the questions at its end.
11.7 Read CASE STUDY II—“He Bet on Botox and Won” and answer the
questions at its end.
CASE STUDY I—THE RISE AND FAIL OF FRIENDLYROBOTICS
By Yoram Koren (November 2002)
Abstract
FriendlyRobotics (FR) was an Israeli start-up company, formed in 1995 and worth
$120M at its peak, which invented a lawn mower robot that is shown in Figure 11.10.
Time magazine selected its lawn mower robot as one of the 10 innovative products of
the decade. In November 2002, it was sold to the vacuum cleaner company, Hoover,
for about a tenth of its former value ($1.5M), before its complete collapse. FR had run
out of money to pay the salaries of its employees. How did its promise become such a
marketing failure?
The Product: The product concept was that instead of using a hand-driven lawn
mower, you turn on your mowing robot and watch it do the work for you. The mowing
robot was equipped with sensors to avoid obstacles and a sophisticated navigation
system. The robot first scanned the lawn area and self-programmed its path to be
310 BUSINESS MODELS FOR GLOBAL MANUFACTURING ENTERPRISES