PS-4162 - Trim - Ene-Mar 2022

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4.3 Papers

Estos papers deben ser leídos por todos los estudiantes, y serán evaluados como parte de la materia en los exámenes parciales. También deben ser presentados y discutidos por los Estudiantes durante el curso.

1. Introduction to Supply Chain Management

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To stay competitive, a global business must meet demand through the integrative management of its supply chain. Mastering supply chain management can enable companies to increase market share, reduce costs, improve customer service, and increase market value through improvements in return on assets. In today’s business environment, quality and efficiency are no longer a source of competitiveness but rather expected and required. Thus, opportunities for growth and higher profitability often reside outside the company and within its supply chain. The field of competition has now shifted to the management of the global supply chain. The success of companies such as Procter & Gamble (P&G), Seven-Eleven Japan (SEJ), Dell Computers (Dell), Zara, and Wal-Mart is testimony that a well-orchestrated supply chain is crucial to the competitiveness of an enterprise.

Dell is one of the largest PC manufacturers in the world, and one of the main reasons for Dell’s success is the way it manages its supply chain. Dell’s supply chain model is based on direct sales to customers. This model enables Dell to exert much more control over its supply chain than many other companies, and in addition, get direct information about its customers. Based on this information, Dell can make educated decisions that will affect the entire supply chain. Dell also provides its suppliers real-time information to ensure that they keep the right levels of inventory of the right components. Dell’s close contact with customers as well as its understanding of customers’ needs allows it to develop better forecasts and thus keep lower inventories. This gives Dell several advantages over the competition, including lower cost of capital invested in inventories, the ability to go faster to market with new components (such as Intel chips), and ensuring that defects are not introduced into a large quantity of products.

Zara, the fastest-growing fashion company in the world—located in La Coruna, Spain—has achieved more than 20% annual growth in the years 2001 to 2006. [1] The key to Zara’s success is its supply chain management approach. Zara designed a fast-response supply chain for its products that incorporates all the different stages in its supply chain, from design and manufacturing to distribution and retailing. Due to high demand uncertainty in the fashion industry and the high cost of mistakes, Zara’s supply chain approach enables it to make its design and production decisions within a fashion season instead of well in advance of a season, resulting in better response to demand.

SEJ posted record profits during the Asian economic crisis, and it did this by being one of the most innovative companies in the world in the management of its supply chain. SEJ focused on the demand side of the business and the smart use of information to achieve efficient use of scarce shelf space. This was strategically important because of the high cost of real estate in Japan. The company introduced systems to analyze hourly sales trends each day and make the results available to all stores and suppliers by early the following day. This supported efficient product replenishment: giving stores a high level of stock availability by determining the right quantity of the right products.

By recognizing data as the key to success, and developing elaborate information systems in tandem with agile logistics, SEJ achieved significantly higher sales per store than its competitors. Its systems delivered dividends: low operational costs, low inventories, short cycle times, and high customer service, which resulted in increased sales, better market penetration, higher profits, and superior shareholder returns.

SEJ demonstrates the importance of sharing information, but in this case, information sharing is not that difficult to achieve because the information remains within the boundaries of one organization. More difficult problems arise when it is necessary to share information among different organizations.

Some companies have taken information sharing to sophisticated levels of information coordination and knowledge exchange among supply chain partners. Such knowledge sharing can include capacity plans, production schedules, promotion plans, demand forecasts, and shipment schedules. But seeking a deeper level of information or knowledge exchange demands a greater degree of trust. So the business conditions and supply chain partners will need to support that approach.

A good example of how this can work is the introduction of a program called Collaborative Planning, Forecasting, and Replenishment (CPFR) by US pharmaceutical and health-care products manufacturer Warner-Lambert (now Pfizer) in the mid-1990s. The program’s goal was to streamline product flow by sharing its strategic plans, performance data, and market insights with key retailer Wal-Mart. The program also recognized that the manufacturer could benefit from the retailer’s market knowledge, which was incorporated into the CPFR model. As a result of this demand forecast collaboration, Warner-Lambert increased its products’ shelf-fill rate from 87% to 98%, earning the company about $8 million a year in additional sales. [2]

These examples of large companies such as SEJ, Dell, Zara, and Wal-Mart illustrate two of the key issues for supply chain success: first, coordination and collaboration, and second, the value of information sharing. Coordination and collaboration mean that the whole supply chain operates as one entity. Instead of each party trying to operate in its own interest, the parties will work together in the interests of the whole supply chain. The crucial requirements are the ability to share information among supply chain partners and the alignment of the parties’ incentives.

Next, we provide some definitions for supply chain management. We discuss the issue of supply and demand uncertainty and how to align the supply chain strategy with the product demand and supply characteristics.

Supply Chain Management Definitions

A supply chain comprises all the parties involved in providing a product or service to a customer, either directly or indirectly. (This definition doesn’t reveal whether a customer request is for a product or a service. But when discussing services, sometimes the supply chain is referred to as a value chain.) In this note, we will focus mainly on supply chains for products, although some of the analysis would be equally appropriate for

services.

If a customer walks into a Best Buy store to purchase a digital camera, the store is the final stage in the supply chain (going downstream toward the customer). The store holds an inventory of cameras it has obtained from the previous stage, a distribution center or warehouse, managed by either Best Buy or a third party. That distributor receives its stock from yet another stage, the camera manufacturer, which obtains raw materials for its cameras from a variety of suppliers, whose raw materials may be supplied by lower-tier suppliers (Figure 1).

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Figure 1. Supply chain for digital cameras.

Source: Adapted from Sunil Chopra and Peter Mindl, Supply Chain Management: Strategy Planning and Operation 3rd ed. (Englewood Cliffs, New Jersey: Prentice Hall, 2007), Figure 1.1.

Supply chain management involves asking the following questions about one’s supply chain:

Where are materials sourced? Where are they built?

What channels of distribution are used?

How are strong relationships built with customers and suppliers?

How is customer information gathered and accessed?

How are logistics structured?

How is information coordinated globally?

How might incentives optimize the chain’s overall performance?

Supply chain management is the effective control of material, information, and finance as it flows among and through suppliers, manufacturers, distributors, and customers. Table 1 describes the flows in the supply chain, including flow of product from supplier to the end customer (downstream) and reverse flow (upstream) such as returns, repairs, and servicing.

Table 1. Classification of supply chain flows.

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In order to discuss the flows in Table 1, consider the supply chain for cameras described in Figure 1. The Best Buy store received the finished goods cameras from Sony through the distribution center. Sony receives raw material and intermediate products from its suppliers such as Film Fabricators and Samsung. If a product is defective and a customer returns it to Best Buy, Best Buy returns it to Sony so that the product may be either repaired or recycled.

Key to supplying Best Buy customers with a steady supply of cameras is the information flow. Information about part orders and sales must be shared with the upstream parties, and capacity and delivery schedule information must be shared with the downstream parties. Such information flow is critical to supply chain success. If Best Buy runs a special promotion for Sony digital cameras, it must inform Sony so that Sony builds more inventory, because the promotion will increase sales and deplete the supply. But when Sony makes forecasts for the next period, it should not mistake that sales surge for a purchasing trend. There is also a financial flow of all the different payments and credits in the supply chain, including those among partners.

Every supply chain aims to optimize the overall value it generates. When considering the value created by a supply chain, it is important to note that this value should be equal to the revenue generated for the entire supply chain minus the costs of running that supply chain. Thus it is clear that the customer is the only party that provides a positive financial flow—all the other financial flows described in Table 1 are simply fund exchanges between the different parties in the supply chain. For example, if a customer purchases a digital camera for $500 (which represents the revenue the supply chain receives from the product), the value generated by the supply chain is equal to the difference between $500 and the total costs the supply chain spent on production, inventory, transportation, and so on. This value represents the supply chain profitability from this camera that will be shared by all the different parties within the supply chain. We measure the success of the supply chain by looking at the total supply chain profitability instead of the local profits of the individual supply chain stages. In order to be successful, a supply chain should try to work as one entity to maximize supply chain profitability by managing the different flows described in Table 1 in the most efficient way.

Making the Supply Chain Fit Your Product

As business trends move toward shorter product life cycles, increased variety, globalization, and advanced use of information technology, managing supply chains becomes more and more complex and challenging. A recent survey conducted by Booz Allen and Hamilton showed that one of the key reasons for the failure of companies to benefit from their supply chain is a lack of fit of the overall strategy with the supply chain strategy. [3] A common mistake that numerous companies make is to choose a supply chain strategy that does not match the company’s product characteristics. Many companies believe that the role of a supply chain strategy is to reduce costs and be efficient. This might be true when your product is a low-margin one with low demand uncertainty; however, it could be a devastating mistake to use this kind of strategy for high margin fashion products. Zara’s phenomenal growth and success is due to its ability to choose a supply chain strategy that fits its product and its overall business strategy. This means that when designing a supply chain strategy, managers need to ensure it is aligned with the product it is supporting and more specifically with the uncertainties related to this product. We can divide the product uncertainties into two main types: demand uncertainties and supply uncertainties

Demand-side uncertainty

When considering the demand uncertainty, products may be classified as either functional or innovative. [4] Functional products (such as groceries, basic clothing, food, and oil and gas) have long life cycles, so demand is more stable. Innovative products (fashion apparel, computers, and telecom products.), on the other hand, have short life cycles, so demand is unpredictable.

Table 2 summarizes the differences between functional and innovative products. As can be seen, functional products have lower product variety than innovative products due to the fashion-based nature of those products and the advances in technology that result in frequent introduction of new products. Due to long product life cycles and lower product variety, demand for functional products is much easier to forecast than that of innovative products. However, the simplicity of forecasting and the stability of the product can entice many competitors to enter a functional product’s market, which lowers the cost of obsolescence but also lower profit margins.

Table 2. Characteristics of functional and innovative products.

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Supply-side uncertainty

It is not enough to consider demand uncertainties alone when devising a supply chain strategy. We also need to consider the supply side. Supply processes may be classified as either stable or evolving.5 When the manufacturing process and the underlying technology are mature, and the supply base is well established, the process is considered stable. If, on the other hand, the process and underlying technology are still under development and influx; which implies that the supply base may be limited in both size and experience, we define the process as evolving. Table 3 describes the differences between stable and evolving supply processes.

Table 3. Characteristics of stable and evolving supply processes.

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Data source: Lee, 2002, 107.

As can be seen in Table 3, stable processes usually have low manufacturing complexity since the manufacturing process is streamlined and highly automated with long-term supply contracts, whereas evolving process are more vulnerable to breakdowns and yield fluctuations. In addition, in this case, because the suppliers themselves might be going through process innovations, the supply base will be less reliable than in the case of stable supply processes.

The more functional a product, the more likely its supply processes are stable and mature—but not always. Table 4 provides examples of functional products that have high supply uncertainties. One example would be some food products—especially fruits and vegetables. Even if demand for those products is stable and predictable, the supply might be uncertain both with respect to its quantity and with respect to its quality due to weather conditions.

Table 4. Uncertainty framework examples.

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Supply Chain Strategies

As the uncertainty framework in Table 4 suggests, products can be divided into four groups based on their supply and demand uncertainties. Thus, when devising the supply chain strategy to match the product uncertainties, we have four types of strategies that correspond to those four product types:

Efficient supply chains

Risk-hedging supply chains

Responsive supply chains

Agile supply chains

Table 5 provides the uncertainty framework that matches each of the product types with the right supply chain strategy.

Table 5. The uncertainty framework with matched strategies.

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Efficient supply chains

Efficient supply chains focus on producing the highest cost efficiencies in the supply chain. When a product has both low demand and low supply uncertainty, competition is based on efficiency, and a company should try to eliminate non-value-added activities and leverage information technology to maximize capacity utilization in production and distribution.

Cost efficiency can be achieved through productivity improvements and effective logistics and distribution. Using lean operations, automation, facility layout, or workflow streamlining could help companies realize productivity improvements. Many Japanese manufacturers focus on these types of improvements to cut cost and gain efficiency. With an effective logistics system, products with stable demand and supply processes can be shipped directly to stores.

For example, Longs Drugs, a large US drug store chain, used state-of-the-art scientific replenishment optimization software to plan replenishments to its warehouses and stores, which has resulted in inventory savings of 40%. This enabled Longs Drugs to use the savings to purchase 20 new stores. [6]

Risk-hedging supply chains

To offset supply uncertainties regarding yield, process reliability, and lead time, risk-hedging supply chains focus on sharing resources. Pooled inventory, for example, can prevent fulfillment disruptions, or multiple supply bases might be arranged as backup. The cost of these multiple sources would be justified by the avoidance of supply shortages that might be even more costly.

Companies can make risk pooling more efficient by using the internet to transfer information about supply and demand. One example of the use of the internet is e-marketplaces such as Covisint, which was established by the big three car manufacturers in the United States and later joined by Nissan and Renault. Through this public e-marketplace, the companies can locate many supply sources, which reduces the risk of supply shortages as well as lead times for the components.

Responsive supply chains

Responsive supply chains aim to maintain enough flexibility to respond to shifts in demand. These strategies are suitable for cases when demand is highly unpredictable with a short selling season, which could result in excessive inventory, which in turn, might be very costly for innovative products. A company whose processes and technologies have stabilized is in a position to move away from forecasting and inventory planning and more toward maximizing flexibility through postponement and build-to-order strategies.

One of the best examples for the use of responsive supply chain strategies is the fashion industry. Due to the innovative nature of the product and the stability of the supply processes, companies use responsive supply chain strategies to deal with the fashion gamble, which can result in having too much stock at the end of the season and having to discount steeply to sell it. Fashion companies such as Benetton, Sport Obermeyer, and Zara use the concept of responsiveness in order to cope with this fashion gamble.

By changing the sequence of its sweater manufacturing process from dying whole knitting garments instead of dying the yarn first and then performing the knitting, Benetton was able to postpone the color decisions until more information about demand arrived. This concept later became known as postponement strategy.

Sport Obermeyer, a skiwear manufacturer based in Aspen, Colorado, developed a concept of accurate

response whereby the company first produces the products with more predictable demand before the season

and makes the unpredictable products within the season, after more demand information becomes available. [7]

Similarly, Zara designed a fast-response supply chain for its fashion products incorporating all the different stages in its supply chain, from design and manufacturing to distribution and retailing. Zara’s fast response supply chain involves designing and manufacturing more than 10,000 designs per year—in small batches. Designs that do not sell can be discontinued and transferred to other stores. Zara keeps some capacity in reserve within the season so that it can capitalize on more timely demand information and uses planes and trucks instead of trains and ships, a cost balanced by the reduced inventory costs and avoided losses at the end of the season. Zara can deliver new styles anywhere in the world in two to four weeks, so it can make design and production decisions as trends form, avoiding the need for prediction. The retailers, meanwhile, avoid the need to hold much inventory, receive product soon after ordering, and have something new to sell every two weeks. [8]

Agile supply chains

Agile supply chains maintain responsiveness to customers’ needs but also contend with supply uncertainty by pooling inventories and other capacity resources.

Xilinx, Inc., is a semiconductor company that outsources the manufacturing of its silicon wafers so it can focus on the design, development, and marketing of its high-end integrated circuits. Xilinx arranged for its partners to stockpile the wafers upon manufacture; as demand becomes known, supply partners in Taiwan and the Philippines are able to draw directly from those stockpiles for final assembly and testing. [9]

Another example is Cisco, which leveraged the internet to coordinate planning across the supply chain by linking suppliers at multiple tiers by way of an e-hub. This had the additional benefit of early detection of potential supply and demand problems.

Referencias

1 http://www.inditex.com (accessed Dec. 22, 2008).

2 Hau L. Lee, “Creating Value Through Supply Chain Integration,” Supply Chain Management Review, (September–October 2000), 40–6.

3 P. Heckmann, D. Shorten, and H. Engel, “Supply Chain Management at 21—The Hard Road to Adulthood,” Booz Allen and Hamilton

publications, 2003.

4 M. L. Fisher, “What is the Right Supply Chain for Your Product?” Harvard Business Review (March–April 1997), 105–16.

5 Hau L. Lee, “Aligning Supply Chain Strategies with Product Uncertainty,” California Management Review (Spring 2002), 105–19.

6 Hau L. Lee and Seungjin Whang, “Demand Chain Excellence: A Tale of Two Retailers,” Supply Chain Management Review (January 2001). In 2008, Longs Drugs was acquired by CVS Caremark.

7 M. L. Fisher, J. H. Hammond, W. R. Obermeyer, and A. Raman, “Making Supply Meet Demand in an Uncertain World,” Harvard Business Review (May–June 1994), 83–93.

8 K. Ferdows, M. A. Lewis, and J. A. D. Machuca, “Rapid-Fire Fulfillment,” Harvard Business Review (November 2004), 104–10.

9 Lee, 2002.

2. New Balance Athletic Shoe, Inc. (Abridged)

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H. KENT BOWEN

ROBERT S . HUCKMAN

CARIN-ISABEL KNOOP

On an August 2005 evening, Jim and Anne Davis enjoyed a relaxing dinner at home. However, they could not help but turn their attention to a headline in that morning’s Boston Globe: “Adidas to buy Reebok.” For over 30 years, the Davises had been the sole owners of New Balance Athletic Shoe, Inc., one of the top five producers of athletic footwear in the world. They had suspected for some time that an Adidas-Reebok transaction might be in the works. Nevertheless, the formal announcement caused them to consider the implications for New Balance. By bringing together the second- and third-largest producers of athletic footwear, this transaction would create a juggernaut rivaling industry leader Nike. Although the Davises did not have to answer to Wall Street concerning their competitive plans, they knew that many in the industry—including their own employees— would be asking for their response.

Over the past year, the Davises had focused significant attention on the New Balance Executional Excellence (NB2E) initiative, designed to increase the quality and efficiency of the company’s operational processes through lean manufacturing. NB2E already had provided evidence of improvement, and the Davises did not want to lose the growing enthusiasm for this initiative among New Balance’s 2,600 employees, whom the company referred to as “associates.” Further, they realized the importance of staying true to the private company’s unique operating philosophy, strategy, culture, and history. Nonetheless, they could not help but wonder whether New Balance’s priorities needed to be adjusted in light of the shifting competitive landscape.

The U.S. Athletic Shoe Industry [1]

The U.S. was the world’s largest market for athletic shoes and apparel, accounting for roughly 50% of the $32 billion spent globally each year. Between 2004 and 2009, the number of pairs of athletic footwear sold in the U.S was expected to grow at a 6.3% annual growth rate, reaching 530 million pairs in 2009. One industry trade group projected that the $9 billion branded-shoe market in the U.S would grow by 8% in 2005. Growth was slowing in part because of a maturation of consumer interest in sports and fitness activities. In response, manufacturers had moved to combine fashion and comfort to appeal to a broader range of consumers.

Nike maintained a comfortable lead with 43% of the total global market for athletic shoes and apparel (see Exhibit 1). Within the U.S. footwear market, Nike accounted for 36% of the market, while Adidas, Reebok and New Balance each held a variable 8% to 12% market share (see Exhibit 2).The acquisition of Reebok by Adidas would create a firm that rivaled Nike in size and would boost Adidas’s share to roughly 20% of the U.S. footwear market. The Adidas-Reebok transaction reflected the broader trend toward consolidation in the athletic footwear industry. In July 2003, Nike acquired Converse, a Massachusetts-based manufacturer of court and casual shoes, for $305 million. In June 2005, Stride Rite—the maker of casual footwear brands Keds and Sperry Top Sider—announced its intention to acquire Saucony, a $170 million manufacturer of specialty running shoes and apparel based in Peabody, Massachusetts.

With respect to worldwide marketing, Nike spent $213 million in measured media in 2004, compared to Adidas’ $89 million and Reebok’s $42 million. [2] In contrast, New Balance’s total advertising expenditure was $17.3 million for the first 10 months of 2005. [3] For all companies, most of this expenditure was geared toward the marketing of footwear brands in the U.S. (see Exhibit 2). Unlike New Balance, most competitors produced their shoes outside of the U.S., largely because manufacturing athletic footwear was highly labor intensive and required relatively low levels of worker skill. China was the largest manufacturer of athletic footwear for the U.S. market, commanding 85% of the category. [4] The U.S. trade deficit in shoes had increased about 7% per year since 1999, reaching 379 million pairs in 2004. The deficit was expected to deepen as more manufacturers shifted production offshore. Overall, Americans purchased 2.2 billion pairs of shoes and boots in 2004, enough to give each person in the U.S. 7.7 new footwear options that year. [5]

Distribution Channels

In 2005, the American sneaker market was divided into several retail channels. Foremost among these were the “big box” chains such as Wal-Mart, Target, and Sears which together sold an estimated $12 billion in athletic apparel and equipment each year. [6] The second-largest group by sales volume included national sellers of sports shoes and apparel such as Foot Locker, The Sports Authority, Finish Line, and The Athlete’s Foot. Next were smaller urban chains that maintained strong ties to tastemakers and arbiters of fashion. These chains typically either sold brands at heavy discounts to younger consumers or catered to high-end customers with specific needs (e.g., high performance running). Leading sneaker manufacturers such as Nike and Adidas also maintained showcase stores featuring new products in lavish displays.

With 4,000 stores globally, Foot Locker was the world’s leading retailer of athletic shoes and apparel. Foot Locker contributed slightly less than 10% to Nike’s annual sales, but Nike products represented as much as 50% of sales for Foot Locker. The Sports Authority had 400 U.S. stores, but maintained a broader product base, selling workout equipment, basketball gear, sneakers and sports apparel. Finally, with 598 stores in the U.S., Finish Line, whose primary business was in “closeout” sales, prided itself on offering prices that were typically $5 less than other retailers.

Large retailers held a great deal of sway over the fortunes of sneaker companies. For example, even though Converse sneakers were sold through many retail and on-line outlets nationwide, Foot Locker accounted for roughly 20% of all Converse sales. Any decision by Foot Locker about Converse’s product placement thus could have a material impact on the brand’s sales.

The Making of New Balance

New Balance was founded in Boston in 1906 as New Balance Arch [7] by William J. Riley. In 1934, he partnered with his leading salesman, Arthur Hall, who in 1954 sold the business to his daughter and son-in-law, Eleanor and Paul Kidd. Arch supports and prescription footwear remained the cornerstone of the business until 1961, when the Kidds launched The Trackster, the world’s first performance running shoe made with a ripple sole and available in multiple widths.

During the 1960s, New Balance’s reputation for manufacturing innovative performance footwear available in multiple widths grew through word of mouth and grassroots promotions. When Jim

Davis bought the company from the Kidds on the day of the 1972 Boston Marathon, he committed himself to uphold the company’s values of fit, performance, and manufacturing. He recalled:

I wanted to buy a company, I was young and single. I didn’t have anything, so I had nothing to lose. I looked at it a year before I bought it. At the time, I was in electronics. I passed, because I knew nothing about footwear and not much about sporting goods, other than what I knew from doing sports in college. I got a pair of the shoes, started running in them, and people would come up to me and comment that I must be a good runner. Unable to put a deal together in electronics, with the company still available, I went back, and the guy was desperate to sell it. We paid $100,000 for the company; we put $10,000 down, and the rest of the $90,000 was generated from lowering inventory.

At the time, New Balance was primarily a mail-order business with few retailers. Jim Davis started traveling the country to expand retail distribution, and sales grew from $100,000 to around $300,000 over a two-year period. Anne, who married Jim in 1984, joined New Balance in 1978 and focused on building a distinct culture for New Balance associates and its global partners. New Balance's first international sales office and first European manufacturing facility both opened in 1978. Since then the brand had expanded to Asia, the Middle East, Latin America, and Africa.

In the early 1980s, New Balance set up manufacturing facilities in New England and signed on international distributors. In 1982, the company reached $60 million in sales and debuted the well received 990 running shoe, the first athletic shoe to reach a price of $100. [8] At the time, athletic shoes retailed for about $50. “People said we were nuts,” Jim Davis mused, “but we couldn’t make them fast enough. People learned from that and became more confident in pushing the envelope.” As of 2005, the 990 series was still the top selling product for New Balance, accounting for roughly 3.5% of the company’s sales. In the 1990s, the company unveiled its New Balance Suspension System, which reflected its emphasis on cutting-edge R&D and meeting the needs of performance-oriented runners.

Being Different

Herb Spivak, executive vice president of operations and a 12-year veteran of the company, explained New Balance’s unique features:

Our values have been very, very consistent and reinforced continuously by Jim and Anne Davis. We do not endorse athletes. We aim to make every one of our shoes a performance product as opposed to just a fashion product. We sell every shoe that we make in multiple widths, because we believe that fit is a critical performance characteristic. We maintain a great percentage of our product in inventory for replenishment, so that dealers can continually get fill-ins when they sell and when they need certain sizes and widths. In contrast, competitors pretty much tell retailers, “Ok, tell us six months in advance what you’re going to want to buy and we’ll deliver it. But it’s fixed, and we don’t plan on having future inventory.” These basic factors, combined with our domestic factories, describe what makes us unique.

Because the company was private, Jim Davis felt it could act more nimbly and be more socially responsible than larger and wealthier competitors. “If we were public, I am sure shareholders would say, ‘Close your factories and make the product abroad because you will make more dough for me and my quarterly dividend,’” Jim Davis explained. [9] He also felt the company had high-margin products capable of generating the cash flow required to finance growth. As such, the company’s balance sheet was strong, with a seven-to-one ratio of assets to liabilities.

Beyond financial flexibility, other aspects of the company’s operations and strategy suggested that it was somehow different from competitors. President and COO Jim Tompkins noted, “One thing that sets us apart is that we are manufacturers. But we are mediocre marketers by design. Our marketing spend as a percent of net revenue is much lower than our competitors. The message that we talk about in the marketplace is different from our competitors’ message. And that’s what makes the company unique—we are manufacturing- and operations-based, not marketing-based.”

Jim Davis emphasized this distinction, “In the early to mid-1980s, Nike and Reebok were both becoming major players, and everybody said, ‘You ought to really do this because Nike and Reebok are doing it.’ Well, we tried a couple times with products and programs, and we failed, drastically. So then I woke up one morning and I said, ‘We’re not any good at that. We’re really good at this.’ So we concentrated on doing this instead of that, and thus differentiated ourselves.”

Culture

Like its unique business model, New Balance’s corporate culture developed over time. Teamwork was a critical component. “When you’re young and starting up,” Jim Davis recalled, “you don’t really think in terms of a culture. You just sort of do things a certain way. One day we realized that we were very team-oriented and that we empower people. When we got to a certain size and maturity, we realized that that’s basically what we were all about.” Further, New Balance developed a longstanding commitment to social responsibility that, according to Anne Davis, “made people feel good about dealing with the company.”

The company’s culture was also very entrepreneurial, starting with the owners’ willingness to take risks and encourage others to do the same. Anne emphasized that this culture of change and challenge extended to the factory, noting that manufacturing employees, mostly organized in cross-functional teams, represented one of the greatest forces for change in the company. This spirit was also seen in New Balance’s senior managers. CFO John Withee observed, “continuous improvement is a mantra here. Do the best you can, work cross-functionally, and work towards a common goal.”

Endorsed By No One ™

In an industry dominated by endorsement deals and advertising campaigns featuring celebrity athletes, New Balance put its energies and money into research, design, and domestic manufacturing. New Balance felt it could eschew celebrity endorsements and position itself as a brand for performance-oriented runners less swayed by fashion trends and popular personalities. Despite a U.S. market share of just 3%, New Balance extended its product-focused strategy to its branding efforts in 1992 with its “Endorsed by No OneTM” campaign. [10]

New Balance introduced edgier iterations of the campaign, culminating with an anti-endorsement ad that chided professional athletes for losing sight of the game and focusing disproportionately on endorsement deals. With slightly older core customers (between 25 and 49), New Balance concluded it could afford to take this irreverent tone. The “For Love or Money” campaign was unveiled in February 2005. [11] The slogan felt “natural to us because it was something that only New Balance can stand in front of,” said Paul Heffernan, executive vice president of global marketing. “It’s all about everyday athletes playing for the love of the game.” [12] The New Balance campaign featured a young basketball player admonishing “some of the pros out there,” for their swagger and potentially unsportsmanlike conduct on and off the court. [13]

In addition to 30-second TV spots, the campaign included print, billboard, and online ads that posed a series of questions about athletes’—and by extension, their fans’—core values: “Can a losing coach still be a good coach?” and “Which teaches a player more, winning or losing?” New Balance was reportedly planning to spend $21 million on its 2006 advertising campaign, almost its entire promotional budget for the year. [14]

Product Design

According to Heffernan, New Balance’s focus on width sizing and fit had historically dictated the design of many of its products:

A 15-year-old who wants a pair of Nike Air Jordans might curl his toes or put on six pairs of socks to make that shoe fit. In that case, purchases are made based on how a shoe looks rather than whether it really fits well. The market that is interested in width sizing and fit is a little bit older and more mature; those customers demand a product that is a bit more conservative in its presentation and style. They tend to like a product and buy it again and again and again. It’s like a white button-down shirt. I own a white button-down, it wears out, I buy another white button-down.

New Balance had approximately 60 people in product design and development involved with efforts on two fronts. One was incremental development of existing models. The second involved the incorporation of new technologies such as Absorb EX—a premium, visible-cushioning technology— and Zip, a patented responsive-cushioning technology scheduled to debut in 2006. Both technologies were oriented toward a younger customer base.

Despite New Balance’s desire for long-lived products, Heffernan knew that the company had to remain capable of delivering products to the shorter-cycle, fashion-oriented segments of the market. He noted, “The 991 series—our franchise shoe of 25 years—stays in line three years. With three years to update that shoe, we can afford to take our time and be more thoughtful. But the more fashion oriented products often need to churn every 60 to 90 days, which creates a completely different model for product design. The fashion segment cares less about widths and more about time to market, so we need to work under tighter timelines for those products.”

Jim Davis felt that in the past five or six years, New Balance had “dropped the ball in a few places,

and design is one of them.” He added:

Right now, we are emphasizing design more than we have in the past and are raising the level and stature of design within the organization. Design is going to become more important as time goes on, a much larger factor than it has been. We tend to be a little bit more conservative with design than our competition and stay within a certain realm for a relatively long period of time. Then we find that we might have hit a wall, so we have to come back and reinvent ourselves a little bit and move forward. The manufacturing folks do that every day. The rest of the company is playing catch-up there, and we have to reinvent ourselves a little bit more often than we have in the past.

Sales and Distribution

New Balance historically focused its sales and distribution activities on smaller retailers, running specialty shops, and family footwear shops. Withee explained, “We are heavily focused on supporting the smaller type of service-oriented customer.” New Balance sold through approximately 3,500 retailers representing over 12,000 sites. Its largest retail customer was Foot Locker, a major chain that, on its own, accounted for over 3,000 sites in the U.S. New Balance divided its retailers into two groups—key accounts and specialty dealers (see Exhibit 3). Key accounts were further divided into six strategic accounts and 49 other key accounts. Specialty retailers were subdivided into three major channels: elite running stores (specialty stores for serious runners); independently owned and operated New Balance stores; and other independent dealers (primarily family shoe stores).

Fran Allen, executive vice president for sales and service, noted that strong relationships with both small and large retailers were critical for New Balance, “The importance of independent, specialty retailers to the image of our brand far exceeds their 25% share of our sales volume. Obviously, large accounts are extremely important in terms of their sales volume. Consequently, we give both groups a lot of attention and work hard to give each what they need to be successful.”

In contrast to competitors, New Balance relied on a sales force composed of independent agents. Allen noted, “In the sporting goods industry there is an unwritten rule—or maybe it is just natural selection—that as you get to a certain point in sales volume, you grow out of an independent sales force. You bring the sales organization in house. At New Balance, we do not have any in-house accounts. We prefer using independent, dedicated sales agencies with an entrepreneurial mindset.”

All of the company’s sales agents were independent of—but exclusive to—New Balance. All were compensated through a sales-based commission. Under this system, new salespeople might earn $40,000 to $50,000 per year (from which they would cover their own expenses) while the most experienced salespeople could make several hundred thousand per year. Large retail accounts were managed by a total of 10 head sales agents, six of whom were strategic account managers (SAMs). Specialty accounts were managed by approximately 100 agents, who worked for independent sales agencies but were managed by five regional managers employed by New Balance (see Exhibit 4).

Although these agents were not direct employees of New Balance, Allen—who had been with New Balance 15 years as sales manager—noted that the company was not concerned about these relationships that were unique to the industry. “We have a loyal group of salespeople, and their longevity of service provides us with a distinct edge over our competitors,” he noted, attributing this loyalty to the strength of New Balance’s leadership and culture. Allen continued, “In 1991, my first year at New Balance, the company sold $84 million in footwear in the U.S.; last year, we did a little over $1 billion. One of the reasons Jim Davis liked this sales organization was that he had sales agents who had been with him for 15 or 20 years before I got here and had stuck with the company through some difficult times.”

For smaller, privately owned retailers, New Balance had historically paid an independent sales representative to take product orders and either key them into the New Balance order system or fax them to New Balance’s corporate sales office at company headquarters in Allston, Massachusetts. To speed the ordering process, the company had recently invested in what Withee termed a “state of the art” distribution center and was using technology to leverage this resource, support its retailers, and strengthen its retail relationships.

A new sales force automation system enabled sales representatives to place direct orders remotely, access New Balance’s inventory information, and check on delivery status. Another application promised to enable retailers, particularly smaller ones, to do the same with no sales representative intervention. Withee added, “This application helps manage the flow of product through the supply chain and is about as vital as you can get in determining our performance.”

Going forward, Withee explained, the application would help retailers directly manage basic ordering, thereby freeing up the sales representative to engage with the retailer and make recommendations about new items to carry or options for reducing inventory levels. Jim Davis explained the value proposition for retailers:

If you’ve been selling New Balance shoes for the last 10 years, to sell 1,000 pairs you had 400 pairs in inventory. Assuming you are selling all domestic product, which some of our accounts do, we would say: “We think we can increase your sales next year and lower your inventory at the same time. We will ship to you the day after you order the product, so your inventories can be decreased dramatically. Rather than carrying 400 pairs, you can carry 200 pairs, and sell maybe 1,200 pairs instead of 1,000. And your markdowns are negligible, because your inventory’s so low.” And we think that’s a very compelling argument. We are taking all the risk when we do that.

By shipping quickly and accurately, New Balance offered retailers the ability to build loyal customers of their own. According to Jim Davis, New Balance already had far greater consumer loyalty than any of its competitors. “That translates well for the retailer, especially if that retailer is able to satisfy the customer with a 13EEEE foot size, because that customer always wants that size. He or she will generally go back to that same retailer to get that product. And retailers know that,” he explained.

Supply Chain and Manufacturing

In contrast to Nike and Reebok, which outsourced nearly all of their production to Asian manufacturers, New Balance used outsourcers for 75% of its U.S. sales volume. For the remaining 25%, final product assembly took place in one of New Balance’s five factories in the northeastern U.S. One-third of these domestically assembled shoes were referred to as “cut-through-assembly” product. For these shoes, New Balance imported finished soles and the raw materials for the upper from Asian suppliers. The uppers were then fully manufactured and attached to the soles in the U.S. The remaining two-thirds of New Balance’s domestic product was referred to as “sourced-upper.” For sourced-upper shoes, New Balance imported finished uppers and soles from Asia and completed the assembly by attaching the appropriately sized uppers and soles at its U.S. factories. The more time intensive cut-through-assembly product was manufactured at New Balance’s factories in Lawrence, Massachusetts; Skowhegan, Maine; and Norridgewock, Maine. Sourced-upper shoes were assembled at these three sites, and at another factory in Norway, Maine. [15] (See Exhibit 5.)

Foreign Suppliers

New Balance sourced the soles for most of its shoes from two suppliers in China (suppliers A and B in Exhibit 5). Depending on the shoe, these two firms also supplied either finished-uppers or kits containing a significant portion of the materials required to stitch uppers in the U.S. [16] Finally, these firms provided a limited amount of fully assembled shoes. They shipped to New Balance’s three materials warehouses; two in Skowhegan, Maine, and one in Lawrence, Massachusetts.

Historically, it took approximately one week for New Balance to place a purchase order for components (e.g., soles, uppers, or kits) and have it accepted by the appropriate supplier in China. It then took roughly six weeks for the supplier to manufacture the required components and an additional five weeks to ship them across the Pacific and transfer them for cross-country delivery to the designated warehouse. Until the early 2000s, New Balance tended to place orders for a particular sole on a monthly basis in batches as large as 20,000 pairs. For a single type of sole, each order included roughly 20 different SKUs, reflecting different shoe lengths and widths.

John Wilson, vice president for manufacturing, noted that the company had taken several steps in recent years to reduce the lead times from Asian suppliers. First, New Balance had shifted to placing smaller orders of between 2,000 and 10,000 pairs on a weekly basis. In addition, New Balance made arrangements with these suppliers to enable them to “pre-buy” their own raw materials on behalf of the company, thereby reducing the lead time required to produce an order. These and other efforts reduced the average time from placing a component order with a supplier to having those items available at the New Balance materials warehouses from 12 weeks to approximately nine weeks.

New Balance also contracted with two other Chinese manufacturers for the 75% of its volume that was not assembled in the U.S. Though these firms shipped finished shoes to several of New Balance’s international divisions, most were shipped directly to New Balance’s product distribution centers in Lawrence, Massachusetts and Ontario, California. The order-to-delivery lead time was approximately 12 weeks and 10 weeks for shoes going to Lawrence and Ontario, respectively.

New Balance continued to forge closer partnerships with its suppliers. Jim Davis explained, “What we learn by doing things domestically, we share with our partners abroad. We are focusing on lead-time optimization, asking them to go downstream two or three levels and work with suppliers to react more quickly to us. In other words, we will share with them how many shoes of a particular type that we are forecasting over the next few months so that they can go back to their suppliers to let them know what their requirements are going to be.”

Materials Warehousing, Manufacturing, and Distribution

As of August 2005, the three warehouses in Skowhegan and Lawrence held about $9 million—or 4.5 weeks—worth of raw materials inventory. For shoes assembled in the U.S., each of the five manufacturing plants placed orders for materials to these warehouses for delivery by the next day.

Upon arriving at the factory, materials were held in inventory briefly before moving to production. Sourced-upper and cut-through-assembly shoes followed different flow paths through the factory. (See Exhibit 6.) Industry experts estimated that the labor content for a pair of cut through-assembly shoes was approximately 25 minutes. Labor and overhead each accounted for roughly 25% of total manufacturing cost, while materials accounted for the remaining 50%. Estimates of the total cost for a cut-through-assembly pair of shoes assembled in the U.S. was approximately $13 greater than a similar product fully manufactured in Asia. For sourced-upper pairs, this difference was about $0.50, due to import duties placed on finished goods entering the U.S.

In 2001, the average lead time for a cut-through-assembly batch (typically consisting of 12 pairs of shoes) through a New Balance plant—measured from arrival of the raw materials to loading on the truck as finished product—was roughly 8.5 days. By 2005, the company reached 2.5 days through significant attention to process improvement and work-in-process reduction within the plants. Wilson and his colleagues felt that further reductions in manufacturing lead time were attainable.

Following production, domestically assembled pairs were transported either directly to the retailer (in the case of large strategic accounts) or to inventory in the Lawrence or Ontario distribution centers. Each of those sites received and filled orders from smaller retailers. Combined, these two distribution centers held roughly 6.4 million pairs of finished shoes.

The New Balance Workforce—A Key to Operations Improvement

The Davises believed that improving the production process at New Balance required widespread initiative and involvement from the company’s front line workers. Before joining New Balance, manufacturing employees went through a lengthy selection process. New Balance screened for professional or personal experience in team-based environments, such as participation in high school or college team sports.

New hires were paired up with an experienced employee, known as a “buddy”, and placed in a training team for six to eight weeks until they were comfortable enough to go on a regular production team. “As soon as new employees come in, we train them in the foundations of associate involvement, continuous improvement, and leadership,” Anne Davis explained, “but we don’t want to put them immediately into an existing team and have them intimidated by the skills that the more experienced members already have.”

The company’s U.S. workforce was not unionized, and some employees performed two or three jobs on teams. “If one area of the factory is slow and the other one is loaded up,” Anne Davis explained, “people willingly go to the next area to make their numbers for the day, and we would not be able to do that if they were unionized.” Added Jim Davis, “It’s a flexibility issue. The factories are always changing. The folks on the factory floor are always pushing us to change things so they can do it better. We wouldn’t be able to do that if we were unionized.” He added, “Annie and I are constantly amazed at how flexible these folks are, and how engaged they are in what they’re doing. They go home, and they come to work the next day thinking, ‘How can I do things better? How can I be more productive?’ We’re trying to get the whole company to think that way.”

New Balance’s compensation structure also helped management leverage employee knowledge and initiative. A few years earlier, New Balance briefly moved from individual-based hourly wages to team-based piece rates, but then quickly moved back to the hourly system. Jim Davis explained:

Teammates put too much pressure on each other under the team-based compensation system. If one person was out of work because she had a sick child at home, there would be too much pressure on the rest of the team to perform, and she would come in feeling guilty the next day… We sat down with our supervisors and talked about how we might better accommodate these people, and one of the things that we came up with was hourly pay. We did a pilot run for a month or so, and we found that the production when we were compensating them on an hourly basis was equal to if not better than under the team-based piecework system.

Anne Davis added that hourly compensation encouraged workforce training. “Under the teambased rate, many supervisors saw training as another project, as something that took their people away from the job,” she said. “With hourly pay they were more willing to send people to training. And by doing training early on, people know right away whether or not they fit in the company.”

Lean Manufacturing—New Balance Executional Excellence (NB2E)

In 2004, New Balance adopted NB2E to apply the principles of the Toyota Production System (TPS) to shoe production. One of the key goals was to further reduce the time between a retailer’s order and delivery. Tompkins stated his objective for NB2E, “Our goal is 100% delivery of requested product within 24 hours. It may be impossible, but we are going to work toward something very, very close to that—to a position where, for that two or three percent that we can’t deliver within 24 hours—we can certainly replenish within, say, four days at the most. And that would be only for the worst-case scenario where we got completely surprised by an order.”

According to Tompkins, an essential component of NB2E was moving the company’s manufacturing plants from batch production to pair-by-pair flow. He added, “Over a period of time I would like to know that when a part of an upper gets cut to what pair of shoes that part is heading… And we might be making several different models in a given factory on a given day, but we would still know that that part right there and the one in the other factory over there are going to end up in a shoe that is put on that trailer heading to that customer. That is where I would like to get to.”

Before NB2E, New Balance was required to resort to what Spivak called “brute force”—greatly increasing finished goods inventory to improve product availability. For the company’s flagship shoe, the 991, inventory was doubled to ensure availability for all colors, sizes, and widths. Though there was a significant increase in sales of the 991, the inventory cost was very high. If NB2E was to be successful—approaching Tompkins’ goal of 100% availability within 24 hours while reducing inventory levels—manufacturing cycle times had to be dramatically reduced. These changes required complete realignment of factory operations. Spivak observed:

Our factory had a classic arrangement, with cutting, embroidery, stitching, and assembly departments. Each department did its particular tasks for all styles, and the factory worked on a batch basis. To realign that under NB2E would require a big change. Instead of moving a day’s worth of production, we needed to move toward a more continuous flow. Doing this would require us to reduce work in process significantly and get the line associates and supervisors to embrace that change. The real challenge would be to keep making shoes every day while this transformation was ongoing.

The Marathon

Though New Balance traditionally competed on the basis of its manufacturing, service to retailers, and its ability to build loyalty among a core set of customers for its high-margin, long-lived shoe models, 2005 had not been a stellar year, mostly because of operational issues. “We did a very poor job of executing in the first half of the year,” Jim Davis noted. “We had a lot of quality problems, late deliveries, and late samples, which inhibited the effectiveness of our salespeople.” To Jim Davis, the answer was “basically doing everything we’ve always done before, only doing it better.” Yet as New Balance grew beyond $1 billion, it was important to consider scalability. Withee echoed the concern:

New Balance is very good culturally at knocking down walls to get something done. But then it’s easy to regret that. That may be why we have so many styles and so many SKUs. Everyone’s trying to work harder. You try to do things efficiently and have the right type of metrics, and all of a sudden it’s just too many balls to juggle. And there’s the balance of the entrepreneurial—which is certainly a cultural thing here—and the fact that you wake up and you haven’t got a good handle on your inventory. Your inventory is too high, the wrong color, or on the wrong coast.

The confluence of so many opportunities and challenges forced the Davises to consider how to react to the Adidas-Reebok announcement. Did New Balance need to consider making its own acquisitions, or reducing its domestic manufacturing? Did it need to get better at the promotional tactics used by its competitors? Should the company remain focused on scaling its current business model and improving operational performance via the NB2E initiative? Which option would provide New Balance with an acceptable level of future growth in light of industry consolidation?

Jim Davis believed the impact of the Adidas-Reebok transaction would be felt most by retailers, a fact that would help New Balance. “Before this deal, the industry had one 800-pound gorilla; now there are two. Those big guys tend to dictate a little bit, but they don’t move as quickly as a smaller company, and they don’t really establish the partnerships that we do. We see this as a major opportunity,” he explained. Jim Davis noted that a major customer recently told New Balance that it planned on doing more business with the company after the Adidas-Reebok merger, in part because it knew New Balance—and its stable roster of salespeople and managers—so well.

Exhibits

Exhibit 1 Comparative Data on Major Athletic Footwear and Apparel Companies, 2004

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Exhibit 2 U.S. Athletic Footwear Sales and Media Expenditure by Brand, 2004

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Exhibit 3 New Balance Sales Summary

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Exhibit 4 Organizational Structure of New Balance’s Salesforce

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Exhibit 5 New Balance Supply Chain

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Exhibit 6 Standard Process for a “Cut-Through-Assembly” Conventional Shoe (Flat-Lasted Process)

Materials are received and inspected.

Materials are webbed in the Webbing Dept. This consists of laying several layers of materials, face to face, so when the pieces are cut, they become the left and right parts with one single cut.

Webbed materials are sent to the Cutting Department where all the parts for all styles are cut.

Some shoe parts are sent to the Radio Frequency machine for embossing and bonding of a reinforcing material.

Other shoe parts are sent to Embroidery, where the emblems are embroidered.

All shoe parts are kept together in racks with cases of 12 pairs each in the Pre-Fit Department.

The racks are sent to the Orisol Departments, where many shoe components are stitched together in a single pass. This has helped NB to reduce the cost per shoe.

Some styles require the “N” stitched into each shoe, they are sent to the “N” department.

All the above operations are done in the flat stage, the sewn parts are two-dimensional (2D).

Everything continues to travel in cases of 12 pairs and are sent to the Closing Department.

In the Closing Department, the shoe components begin to take the form of a shoe as the they are being converted from flat shoe components to their 3D shape.

From the closing department, the shoes are sent to the Upper-Prep Department. Here uppers, soles and other shoe components are cased together.

With all of the parts cased together they are sent to the Assembly Department. In this department, the shoes are “Lasted.” Tasks in the lasting department consist of:

Upper conditioning

Slip lasting

Toe Lasting

Side/Heel Lasting

Pounding, which is the act of sanding down any excess material under the shoes

Washing or Priming as recommended by the Bonding Department

Marking the periphery of the sole

Cementing to the sole line

Cement Drying

Sole and Upper cement activation

Sole Setting

Sole Pressing

Extracting the Last

Inserting shoe insert

Lacing the shoes

Cleaning and/or repairing

Inspecting

Boxing the shoes in pairs and in cases of 12 pairs

Source: Company documents.

References

Drawn from “Industry Overview: Freedonia Focus On Athletic Footwear,” The Fredonia Group, April 1, 2005, available on http://freedonia.ecnext.com/coms2/summary_0285-284466_ITM, accessed on February 10, 2006.

Rich Thomaselli, “Adidas Deal Sets Stage For Full-Scale War With Nike; Pooled Might Makes For Fairer Match Up In Bid For Endorsements, Share,” Advertising Age, August 8, 2005, available on www.factiva.com, accessed on February 21, 2006.

Ibid.

Stephanie Nall, “Putting A Fashionable Foot Forward,” Pacific Shipper, September 23, 2005, available on www.factiva.com, accessed on April 17, 2006.

Ibid.

“Doing The Math: Retail Top 100,” Sporting Goods Business, June 1, 2004, available on www.factiva.com, accessed on April 17, 2006.

Business Wire, “New Balance Achieves Its Centennial Year; Global Athletic Manufacturer Recognizes Past Milestones and Looks to Innovative Future,” January 5, 2006, available on www.factiva.com, accessed on March 1, 2006.

Ibid.

Steve Bailey, “Mom and Pop Billionaires,” The Boston Globe, October 6, 2004, available on www.factiva.com, accessed on March 1, 2006.

Joe Pereira, “New Balance Sneaker Ads Jab At Pro Athletes’ Pretensions,” The Wall Street Journal, March 10, 2005, available on www.factiva.com, accessed on March 1, 2006.

Naomi Aoki, “New Balance’s Latest Ads Celebrate The Older Amateur,” The Boston Globe, February 28, 2005, available on www.factiva.com, accessed on March 1, 2006.

Ibid.

Joe Pereira, “New Balance Sneaker Ads Jab At Pro Athletes’ Pretensions,” The Wall Street Journal, March 10, 2005, available on www.factiva.com, accessed on March 1, 2006.

New Balance also had a small factory in Boston, Massachusetts, that manufactured roughly 500,000 pairs of shoes per year for groups that needed particular types of footwear for various occupational uses. This factory completed all aspects of production, including the manufacturing of soles.

Typically, all materials except leather and certain mesh fabrics were sourced from these Chinese suppliers. For models assembled in the United States, leather and mesh were sourced domestically.

3. Paediatric Orthopaedic Clinic At The Children's Hospital of Western Ontario

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Dr. Kellie Leitch glanced at the data on wait times collected from the patients in one of her clinics. As Chief of Paediatric [1] Orthopaedic surgery at the Children’s Hospital of Western Ontario (CHWO), she was very concerned by the long times that the young patients (and their parents) were experiencing in the daily clinic. Long wait times tended to aggravate the already pent-up distress and concern that they were feeling, and parents were understandably irritated at missing significant time at work. Currently, on an average, patients were spending roughly two hours in the clinic.

Patient health was not Dr. Leitch’s only concern. Clinical staff had increasingly complained about being over-extended, yet budgetary pressures to reduce the cost of service continued to mount. She was not convinced that all staff was being effectively utilized, and there was an unresolved request from the Radiology department for more advanced equipment. Dr. Leitch also served on several government task forces. From these, she knew that federal and provincial policy-makers were increasingly concerned with the economic impact that health-care wait times had on national economic productivity.

In a moment of weakness, Dr. Leitch recently had volunteered her clinic to hospital management as a “test case” to demonstrate that patient care could be done in a more timely fashion, without increasing costs. An objective of reducing wait times by 20 per cent was established to show meaningful improvement that would be clearly evident to patients, staff and management. A monthly executive meeting was fast approaching, and expectations were starting to run high that Dr. Leitch would present preliminary recommendations that would offer significant reductions.

PAEDIATRIC ORTHOPAEDIC CLINIC

As part of London Health Sciences Centre, located in the city of London, Ontario, Canada, CHWO was a large, regional health-care centre that provide specialized paediatric services to children. The population of the 10 counties forming the primary catchment area for CHWO was 1.4 million, including approximately 400,000 children. Many of the CHWO’s specialty services also attracted referrals from across Ontario, as well as from neighboring provinces and states in Canada and the United States.

The Paediatric Orthopaedic Clinic was one treatment centre of CHWO that was jointly managed with the Division of Surgery (see Exhibit 1). After experiencing a severe or complex bone trauma — and following emergency treatment elsewhere — a child might be referred to the Clinic for further examination and treatment. Family doctors, walk-in clinics and urgent care centres through the catchment area also sent their young patients needing specialized care to the clinic. Patients typically returned for ongoing treatment as healing progressed.

The Clinic was open for three half-day sessions per week, Monday through Wednesday, from 8:30 a.m. to 1:00 p.m. During the remainder of the week, the facilities were used by other sub-specialties of surgery. Staffed by a surgeon, two senior resident students, three clerks, four registered nurses and a cast technician, the Clinic examined about 80 patients during each half-day session, of which 60 per cent were returning for a follow-up appointment (and so termed follow-up patients). In addition to the staff noted above, other medical students might spend up to one month training in the Clinic.

PATIENT FLOW AT THE CLINIC

Front Desk: Registration & Verification of Documents

The Registration desk was the first point of contact for the patients at the clinic, with the first appointment being scheduled for 8:30 a.m. While the patients rarely were scheduled for an appointment after 11:30 a.m., the last patient frequently went for examination by the scheduled surgeon or senior resident student at about 12:45 p.m. Three clerks managed the Registration desk. As each patient arrived, a clerk noted the arrival against the master schedule, checked the status of the patient’s insurance health card and accepted any referral documents the patient brought along. The patient then returned to the main Waiting Area while a nurse verified the status of his or her medical file.

After a patient registered, three nurses were available to verify any medical documents submitted by the patient. For example, for new patients, a nurse checked the doctor’s referral and made any necessary notes on a generic form that was given to the patient. This document served as an “internal referral” form that identified which X-rays or examinations needed to be done. All new patients were then sent immediately to the nearby Radiology department, located about 25 metres away from the Clinic in another part of the hospital, for an X-ray of the area undergoing treatment.

In contrast, for follow-up patients, a nurse would retrieve their files and note whether a new X-ray was needed during this visit. Only about 85 per cent of follow-up patients needed to be sent for an X-ray. If none was needed, the patient was immediately directed back to the Waiting area, to be later called into an Examination room for consultation when a surgeon or resident student became available.

Radiology Department: Taking and Developing an X-Ray Image

Upon arrival in the Radiology department, the patients submitted the internal referral form at the front desk. This form reported specific information about which part of the body required an X-ray. Patients were required to wait in the Reception area of the Radiology department until an X-ray machine was available. When the patient’s name was called, a technician escorted the patient into one of six imaging rooms. Because parental (or guardian) consent was needed for an X-ray, the technician briefly explained the procedure to the parent and child.

At this point, the X-ray machine often needed major adjustment — depending on the type of X-ray image taken of the previous patient. There were two generic types of X-rays: upper extremity, from the shoulder to the finger (to obtain images of the elbow, lower arm, upper arm, wrist, hand and fingers); and lower extremity, from the knee to the toe (to obtain images of the knee, lower leg, upper leg, ankle, foot and toes). On average, to adjust the machine from one extremity to the other took several minutes. If the previous patient had had the same type of X-ray, the machine needed no major adjustment. The technician then helped the patient to adopt the required posture for the X-ray.

After the X-ray image was taken, the patient returned to the reception area to wait to collect the X-ray image on film. While the patient waited, two activities occurred: first, the X-ray film was developed, and second, a radiologist reviewed and annotated the image to assist later examination of the patient by a surgeon. The development of the film was an automated process, and the X-ray equipment could simultaneously take new images and develop previous images. Following review by the radiologist, the Xray film was given to the patient, who then made the return journey to the Clinic.

In total, the Radiology department had one clerk at the front desk and three radiologists. In addition, six technicians operated six X-ray machines. The department was a shared resource in the hospital. In addition to serving the needs of the patients from the Clinic, it provided X-rays for patients from the Emergency department, the Urology clinic and the Chest clinic. Only about two-thirds of the time between 8:30 a.m. and 12:30 p.m. was allocated to the Paediatric Orthopaedic Clinic. Although patients were generally served on a first-come, first-served basis, exceptions were frequently made for some patients from Emergency who required an X-ray immediately.

Hand-off of X-Ray to Clinic

After returning to the Waiting area in the Clinic, patients passed or handed off the X-ray film (including the radiologist’s accompanying comments) to one of the three nurses at the Registration desk. (These nurses split their time between this activity and the earlier Verification activity.) A fourth nurse was responsible for placing the X-ray film in the patient’s file. This nurse also was responsible for calling patients into particular examination rooms as rooms became available, and for preparing the rooms between patients.

Examination Room

Either the surgeon or one of the two senior residents performed the medical examination of the patient. The surgeon examined all new patients and about 30 per cent of the follow-up patients with greater complexity or complications. A senior resident examined the remaining follow-up patients. (The other senior resident accompanied the surgeon as she or he examined patients. The two residents alternated duties every other day).

Finally, if adjustments or alterations to or removal of a patient’s cast were necessary, the cast technician was asked to come to the patient’s examination room. The cast technician saw about 25 percent of new patients and 15 percent of follow-up patients.

After the completion of the examination, the patient was formally discharged. Depending on the surgeon’s analysis and consultation, the patient might return to the Clinic’s Registration desk to schedule a future appointment. Alternatively, the patient might visit the pharmacy or the caf in the hospital.

DATA COLLECTION

Although Dr. Leitch had heard of some complaints from patients of long waiting times, it was not clear to her how long patients were spending at each activity in the process. Patients were asked to help with the data collection during six half-day sessions over a two-month period. As patients arrived at the Registration desk, their parents or guardians were given a questionnaire to complete during the visit (see Exhibit 2). As each patient moved through the Clinic, the parent recorded the timing, along with her or his impressions of the process. Later, after the treatment was completed for that appointment, the patient returned the questionnaire to the Registration desk. The survey was strictly voluntary, and a total of 218 completed surveys were returned. Given the daytime hours of the Clinic, many parents were forced to take time off work to bring the patient for examination and treatment (the average annual earnings for full-time workers in London were about $44,000 [2]). Aggregate data reported by the patients are tabulated in Exhibit 3, and a sample of their comments is summarized in Exhibit 4. Finally, staff was asked to estimate activity times based on their years of experience and observation (see Exhibit 5).

MOVING FORWARD

While wait times could not be eliminated altogether, Dr. Leitch believed that it was possible to significantly reduce the total time that patients and their parents spent in the Clinic. Staff and patients had offered a number of suggestions, which had been narrowed to three options. First, both patients and nursing staff had observed that patients in the Radiology department were all too often made to wait when Emergency patients had to be X-rayed on short notice. If four X-ray machines (and the required technicians) could be dedicated to the Clinic when it was open, these interruptions could be avoided.

The Radiology department presented a second option: the purchase of an additional X-ray machine. It was difficult to precisely calculate the reduction in waiting time this extra machine would effect, but one estimate was that patients’ wait time in Radiology’s Reception area would be cut by 25 per cent. The capital cost for a new machine was about $30,000, and typically a machine required about $5,000 in annual maintenance costs. The Radiology department would also need another qualified technician to operate the machine, at an annual cost of about $75,000.

Finally, Dr. Leitch wondered if better scheduling of patients’ appointments and assignment of staff in the Clinic might offer benefits. She was unsure if grouping certain types of patients would reduce the waiting times at various activities in the Clinic. As she contemplated her next steps, Dr. Leitch knew that any actions she proposed would come under close scrutiny. And, in the event her recommendations improved wait times in this “test case” at her own Clinic, could they be applied elsewhere in the hospital?

Exhibit 1

FUNCTIONAL AREAS IN LONDON HEALTH SCIENCES CENTRE (LHSC)

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Exhibit 2

PATIENT QUESTIONNAIRE ABOUT WAIT TIMES

Hi there! Thank you for taking the time to fill out this brief survey. The reason that we are asking you to answer these questions is that we are trying to reduce waiting times for our patients and need to collect some data. This will enable us to work to reduce backlogs in any areas that are currently facing them.

What is your hospital ID number? _________________

Front Desk

What time did you register in the Ortho Clinic? _________________

Radiology Department

What time did you go to X-ray department? _________________

What time did you have your X-ray done? _________________

What time did you receive your X-ray film? _________________

Hand-off of X-Ray to Clinic

What time did you hand in your X-ray into the Ortho Clinic? _________________

Examination Room

What time did you get called into the Exam Room? _________________

Did you see a Surgeon, Resident or Cast Technician? (please circle all that apply.) Surgeon / Resident / Cast Tech

References

Paediatric orthopaedics is the branch of medicine that deals with the treatment of injuries to or conditions involving the musculoskeletal system in children.

Statistics Canada, 2001 Community Profiles, London, Ontario (city), Earnings and Income, available online at www12.statcan.ca/english/profil01/CP01/Index.cfm?Lang=E, accessed January 7, 2007.

4. Toyota Motor Manufacturing, U.S.A., Inc.

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On the Friday before the running of the 118th Kentucky Derby, Doug Friesen, manager of assembly for Toyota’s Georgetown, Kentucky, Plant, was approaching the final assembly lines, where shiny Camrys took shape. He heard a cheer go up. Team members on the lines were waving their hand tools towards a signboard that read “no overtime for the shift.” Smiling broadly, Friesen agreed: everyone in the plant surely deserved a relaxed Derby weekend.

The plant had been hectic lately, as it was both supplying brisk sales of the all-new Camry sedan and ramping up station wagon versions for the European as well as North American markets. Overtime also had been necessary early in the week to make up lost production because the line utilization rate was below the projected target. In addition to these immediate problems, a growing number of cars were sitting off the line with defective seats or with no seats at all.

The seat problem had been the subject of an urgent meeting called by Mike DaPrile, general manager of the assembly plant, that morning, May 1, 1992. At the meeting, Friesen learned of the situation firsthand from key people in both the plant and the seat supplier. He then spent the afternoon on the shop floor to learn more about the problem while the issues discussed were fresh in his mind. By the end of the day, it became clear to Friesen that the seat problem needed solving once and for all; the trouble was that trying to do so could hurt line utilization. This was not the first tough question Toyota’s famous production system had encountered, nor would it be the last. But this seat problem was especially delicate and undoubtedly would demand Friesen’s attention in the following week.

Background

In the early 1980s, Japanese automakers contemplated building cars in North America. Japan’s huge trade imbalance had caused political pressure to mount, while the economic feasibility of such investment had improved with a rapidly rising yen. At that time, however, it was unclear whether cars produced outside Japan could live up to their hard-earned reputation of high quality at low cost. This issue was far from settled in 1985 when Toyota Motor Corporation (TMC) unveiled its plan to open an $800 million greenfield plant in Kentucky. (See Exhibit 1.) Thus, the company’s endeavor to transplant its unique production system to Bluegrass Country effectively became a live experiment for the world to watch.

In July 1988, Toyota Motor Manufacturing, U.S.A. (TMM) began volume production on a 1,300 acre site in Georgetown, near Lexington. The plant had an annual capacity of 200,000 Toyota Camry sedans, which would replace the bulk of Japanese imports of the same model. In 1992, TMM was expected to supply 240,000 of the all-new Camrys, whose sales were up by more than 20% since the model change in fall 1991. The new Camry joined the ranks of midsize family sedans, which constituted one-third of the total American car market and returned an average 17% pretax profit margin [1] on a sticker price averaging $18,500. For the first time, in March 1992, TMM started producing wagon versions of the new Camry exclusively within Toyota’s worldwide plant network.

Toyota Production System [2]

Since its inception, Toyota had always striven for “better cars for more people.” This meant producing cars meeting diverse customer preferences with flawless quality. It further meant delivering cars at an affordable price with perfect timing. This ambitious goal had seemed nearly elusive after the Second World War, since most people in Japan could not afford a car even at cost. In addition, the country’s labor productivity was only one-eighth of that of the United States. In essence, Toyota was challenged to cut cost dramatically, but without the scale economies that American firms enjoyed. It needed an entirely new source of economies to satisfy customers with variety, quality, and timeliness, all at a reasonable price. The Toyota Production System (TPS) evolved as Toyota’s answer to this challenge, and served as a common frame of reference among all its employees.

TPS aimed at cost reduction by thoroughly eliminating waste, which, in production environments tended to snowball unnoticeably. Waste of overproduction, for example, not only tied up working capital in inventory, but it necessitated warehouse storage space, forklift trucks to move goods about, material handlers to operate trucks, computers to keep track of inventory locations, a staff to maintain the computerized system, and so on. Furthermore, overproduction often concealed the location of the true bottleneck and thereby invited investment in the wrong equipment, resulting in excess capacity.

Identifying what was waste in reality, however, was no simple matter. Thus, TPS provided two guiding principles to facilitate this critical process. The first was the principle of Just-In-Time (JIT) production: produce only what was needed, only how much was needed, and only when it was needed. Any deviation from true production needs was condemned as waste. The second was the principle of jidoka: make any production problems instantly self-evident and stop producing whenever problems were detected. In other words, jidoka insisted on building in quality in the production process and condemned any deviation from value-addition as waste. TPS defined “needs” and “value” from the viewpoint of the next station down the line, that is, the immediate customer.

These TPS principles reflected two assumptions about production environments. First, true needs would deviate from a production plan unpredictably, no matter how meticulously that plan was prepared: hence the virtue of JIT production. Second, problems would crop up constantly on the shop floor, making deviations from planned operating conditions inevitable: hence the virtue of jidoka. TPS, of course, encouraged continually improving the planning process, but it also strongly emphasized alerting plant people to deviations from any plans about how production was to proceed.

To implement the TPS principles, Toyota employed a variety of tools, many described later in this case. For JIT production, these tools were used to keep information flow as close to the physical flow of parts as possible. Parts were thus pulled from downstream based on actual usage, rather than pushed from upstream based on a planned schedule remote from the shop floor. This arrangement required upstream stations to be capable of changing over among parts with minimal setup time. Hence, creating a flowing production process was a prerequisite for TPS.

The purposes of jidoka tools were to aid immediate problem detection and facilitate visual control. For them to work properly, the normal state of operations had to be well characterized and understood. Therefore, another prerequisite of TPS was standardizing the process and documenting the standard plainly.

Finally, TPS depended on human infrastructure, symbolized by Toyota’s corporate slogan: “Good Thinking, Good Products.” Plants practicing JIT and jidoka principles were extremely prone to shutdowns, and would be paralyzed without people capable of solving exposed problems promptly, completely, and systematically. Toyota thus instilled “good thinking” in all its employees through senior management coaching and internal training programs. These efforts cultivated two strong attitudes that permeated the organization: stick to the facts, and get down to the root cause of the problem. A typical discussion of a problem would start with “let’s go see it” and then converge on the “Five Whys” exercise. This exercise consisted of asking a chain of “why” questions until the root cause was identified and countermeasures determined (see Exhibit 2).

Methodical thinking extended beyond solving problems after the fact. It enabled people to seek kaizen: change for the better. At Toyota, as soon as anyone established a standard way of doing a job, that person set out to demolish it proactively, to install an even better way. Kaizen was indispensable in pursuing TPS goals continuously and indefinitely.

The Georgetown Ramp Up

Developing human infrastructure was TMC’s foremost priority in transplanting TPS to Georgetown, as evidenced by several decisions made early on. First, TMC assigned to TMM the 1987 Camry that was already being mass-produced in its Tsutsumi plant in Japan. Second, it replicated the Tsutsumi line as closely as possible at TMM. And third, it set a deliberately slow ramp up schedule. As a result, TMC could find people in Tsutsumi who, based on their own experience, were able to demonstrate to TMM how to solve the problems encountered in that plant.

While construction was underway at Georgetown in early 1986, TMM initiated a hiring and training program (run out of a trailer office). It began with top managers and proceeded to core operations personnel; these people primarily came from within the industry and formed the nucleus of TMM operations. Their first encounter with TPS occurred during a month-long trip to Tsutsumi, to which Doug Friesen’s reaction was quite typical:

I built cars at Tsutsumi, and couldn’t believe 60% of what I saw there. The line was unbelievably fast-paced, the plant was kind of run down, and the American company I left had more automation. The good things I saw were just common sense and no big deal at all. My eyes weren’t open back then.

Next, TMC sent Tsutsumi people to Georgetown, hundreds of them in all. These trainers-onloan coached TMM supervisory personnel one-on-one and reinforced TPS basics. Every TMM manager was also paired with a coordinator from TMC, who remained in Kentucky for a few years. These coordinators were charged to develop their counterparts only by persuasion - not to do things themselves. This intensely personal approach brought an “eye-opening” moment to most TMM people. As TMC’s plan unfolded in front of them, they could witness actions in the context around them, appreciate unexpectedly positive results, and have their coaches make sense of what lay behind these results. Although everyone had a unique episode that marked a turning point, they converged on one point: “TPS isolates problems from people and thereby enables people to focus on solving problems.”

Fujio Cho, president of TMM and TPS evangelist, described his vision:

We fortunately have not seen any surprises so far. I believe in the universality of TPS and its ability to deliver high quality. To develop TMM, we put safety above all else and began with quality. We then added productivity to our target. Right now, our cars are as good as Tsutsumi’s in quality and we are only slightly behind in productivity. We are currently moving to the next step - worrying about cost and spreading TPS to local suppliers. I am hopeful that we can make TMM a truly American company that contributes to the community.

In early 1992, Georgetown’s huge complex employed over 4,000 people, representing $150 million in annual payroll. In the plant’s backyard, construction was underway to double TMM’s capacity.

Operations

In Georgetown, the powertrain plant supplied engines and axles to the assembly plant, which performed sheet-metal stamping, plastic molding, body welding, painting, and assembly operations. In these direct operations as well as in their support functions (see Exhibit 3), TPS was deployed as a set of management tools to be practiced daily. Mike DaPrile commented:

TPS highlights problems so that people can see them easily. The hard part is teaching it so that people practice it because they want to, rather than because they have to. To teach it well, you have to get to know people very deeply and over time. In the process, we all become students here. In fact, I have learned more in the last five years than I did in the 25 years I spent with another auto company.

Assembly

Assembly operations were performed along 353 stations on a conveyor line, over five miles in length and consisting of several connected line segments: the trim lines, chassis lines, and final assembly lines. Adjacent line segments were decoupled by a few cars, and the entire assembly line was buffered from the powertrain plant and the paint line with about half an hour’s production. The line currently operated on a line cycle time of 57 seconds, down from 60 at the startup.

Assembly and part handling required 769 team members, who were paid an average of $17 an hour (not including benefits), plus a 50% premium for overtime. A team usually had four members and one team leader, who received a premium of 5% to 8%. To supervise these team leaders and team members in two shifts, Doug Friesen worked closely with 10 assistant managers and 46 group leaders (see Exhibit 3). A regular shift lasted 525 minutes, including 45 minutes of unpaid lunch time and two paid 15-minute breaks. When a team member had to leave the moving line, the team leader filled in that position as a line rover.

Every station on the assembly line embodied jidoka and kaizen tools. A standardized work chart was posted adjacent to each workstation on the line, showing the cycle time of that station, the sequence of work tasks, and the timing to perform them within one cycle. Colored tape marked out areas of the floor to specify where just about everything in sight belonged, and promoted the “4Ss (sift, sort, sweep, spic-and-span).” In the resulting work environment, any deviations from normal conditions stood out visually.

A green line and a red line drawn at right angles to the assembly line marked the beginning and the end of each workstation. A team member would start the work for one cycle when a car reached the green line and finish all tasks by the red line. A yellow line in between marked a point by which 70% of the work had to be completed. If the team member was behind at this yellow line or found any other problem, he or she pulled the andon cord: a rope running along the assembly line over the work area. An andon pull turned on a flashing light, triggered loud music, and lit up the work station’s “address number” on the andon board (see Exhibit 4). The team leader then rushed to that workstation to ask what the problem was and, if it was correctable, turned off the lights and music by pulling the andon cord again. If, however, the team leader could not resolve the problem immediately, he or she left the andon on and allowed the line segment to stop at the red line, that is, when the other workstations completed their cycles. This stoppage instantly attracted the group leader’s attention. A team member, on average, pulled the andon cord nearly one dozen times per shift, and typically, one of these andon pulls resulted in an actual line stoppage. Doug Friesen explained:

In our system, every team member is focused on building quality in through andon pulls. We then call on team leaders to respond quickly, and group leaders to take countermeasures to prevent the recurrence of the problem. Our job as managers is to keep the line going, and that means developing people. It’s easy to say “do this and do that,” but nothing happens unless we follow through because people fall back into old habits. Leadership means standing by people for hours to help them acquire the new way. It takes patience

Production Control

The mission of the production control (PC) department was to feed necessary parts into TMM operations so that the right number of cars in the right mix could be delivered to the sales company just-in-time. PC’s task thus involved coordination with TMC, the sales company, and local suppliers. Although TMM made only Camrys whose destinations were limited to North America and Europe, in May of 1992 there were 23 sedan and wagon models, 11 exterior colors, 29 interior variations, and 30 other options like a moonroof. Thus, the number of combinations actually produced reached several thousand.

To meet the challenge of such variety, PC relied on the extensive forecasting and planning that TMC performed for worldwide markets. To prepare for May production, for example, PC first received, in January, a Production Planning Order (PPO) for key specifications from the sales company. This PPO was revised in February and, after one more update, was fixed as a Total Vehicle Order (TVO) by the end of March. While total volume was fixed in late March, the PPO was generally accurate only within 20% of the TVO for most specification categories at that point. Next, the TVO was broken down weekly: by the end of the second week of April it was done for the first week of May. During the third week of April, the initial May week’s information was translated into final part orders for local suppliers as well as a daily production sequence for TMM operations. This procedure left one full week for production preparation.

The planning process reflected JIT principles in two major ways. First, the practice of heijunka called for evening out (balancing) the total order in the daily production sequence. Suppose, for example, a monthly order for 20 working days comprised 20,000 sedans, equally divided between a base model and a luxury model. In conventional auto manufacturing operations, the order would be broken into several production runs, each dedicated to just one model. Daily volume would vary with line changeovers between runs, and a learning effect would occur within one batched run. The heijunka practice, however, would call for 500 base models and 500 luxury models every single day and also demand that a base model and a luxury model be made alternately. Likewise, if 25% of the order specified a moonroof option, one out of every four consecutive cars on the assembly line had to contain that option. Thus, TMM’s assembly line exhibited a variety of shapes and colors, with every car displaying a printout (manifest) that informed team members of the vehicle’s full specifications.

The heijunka practice achieved two purposes. Spreading out the demand for parts as evenly as possible relieved suppliers of a surge of workload and facilitated their JIT production. Without heijunka, a moonroof supplier, for instance, would either become busy just one week every month or engage in level production and live with the risk of order cancellation and inventory obsolescence. With heijunka, the same supplier could stick to a uniform cycle time throughout the month (say, one moonroof every 4 x 57 = 228 seconds) without creating the waste of inventory. Similarly, offsetting cars that required a particular operation against those that did not prevented any particular workstation from becoming a severe bottleneck or remaining unreasonably idle. Heijunka also synchronized the assembly line with the ultimate sales of the cars.

The second JIT principle was reflected in the use of kanban cards. Although all production plans were shared with suppliers to ease their planning, only kanbans triggered part production. A kanban card included a part code number, its batch size, its delivery “address,” and other related information. Every part container sitting on the flow rack along the assembly line held one batch and had its own card. The card would physically travel between this part-use point and the supplier, whether in-house or outside, to signal the actual parts needed. When (and only when) the supplier received a kanban, it began making that part in the stated quantity, and shipped a container full of that part to the proper “address” on the assembly line. Assembly group leaders adjusted the number of circulating kanbans for each part within a set range, determined by the PC department, to avoid having teams run out of parts or containers overflowing onto the plant floor. The PC department monitored the circulation of kanbans closely both to determine the appropriate kanban range and to feed information back to parts ordering for even better inventory control.

Quality Control

TMM’s quality control (QC) department pursued a mandatory routine of setting tough quality standards, inspecting every vehicle against those, and following through on the customer’s experience with shipped vehicles. In addition, QC engineers were called on by assembly group leaders to help them solve assembly quality problems and work out part quality problems with suppliers. Twenty patrol inspectors on each shift also observed problematic items that they had been notified about among the thousands of different parts arriving at the receiving dock.

QC served two other functions as well. The first was providing instant feedback to direct operations including final assembly. On the last stretch of the final assembly line, QC checked assembly quality before cars went off to elaborate shipping inspection, and it “returned” problematic cars immediately to an assembly group. This group then diagnosed the causes of the problems with QC and, while repairing the cars in the clinic area, fed the information back to the appropriate teams. When eight cars filled up this limited clinic space, the assembly line was shut down under a “Code 1” status and Friesen and his assistant managers gathered to discuss countermeasures. This procedure worked as an equivalent of andon pulls for the managers. Mike DaPrile, being used to a much larger repair yard in his previous job, had protested before the ramp up that this clinic area was “way too small” - only to find out that TMC really wanted him to stop production as soon as four cars occupied the area.

QC’s second unique function was proactive: preventing problems from occurring in the first place. As Rodger Lewis, assistant general manager of QC, explained:

We’ve got to go back to the source of the problems because our target moves every year. In the J. D. Power Initial Quality Survey, our Camry was third, with .72 defects per vehicle in 1990, and eighth, with .79 in 1991. The top runner went down from .63 to .47, but it’s O.K. We are trying to build in quality before cars come to the factory. Oh, it’s a joy to work with design people! They want to know any problems we have with their design and consider our inputs a blessing. It’s really nice that we don’t have to fight. We are also trying to get suppliers to go beyond our engineering drawings to preempt problems. We set one goal at a time for the suppliers, though, because that’s the way to build trust.

Purchasing

Because TMM’s PC and QC departments engaged in fire fighting to solve delivery and quality problems directly with part suppliers, upon requests from assembly, the purchasing department was freed up to concentrate on managing costs over the long haul. Kevin Smith, manager of purchasing, elaborated:

For four years prior to joining TMM, I was a buyer for another auto company. My job there was basically to get the lowest price by pitting suppliers against one another. My new boss from TMC introduced me to a totally different world. He couldn’t care less about low price because he knew suppliers always came back to jack up their initial quote. He only wanted low cost suppliers. Without low cost, it’s logically impossible for any supplier to offer low price consistently. Now, how do you estimate a supplier’s manufacturing cost without their cost data? I didn’t know how to do this when I first arrived at TMM. But I’ve learned how to estimate cost, and our company has had good success in encouraging suppliers to share their cost data with us. With costs on the table, I can discuss with suppliers how they can improve their manufacturing process and how we can help them with our kaizen experts. Doing this is a big part of my job now.

The Seat

A Camry seat consisted of several pieces: the front left and right assemblies, the rear seat bench and backrests, and the rear side bolsters. [3] Because of its features, the seat posed several challenges. To final assembly, it was a soft part prone to damage and by far the bulkiest of all the installed parts. To QC, on the one hand, it was a safety item because it had to meet rigorous standards for the car’s crash performance. On the other hand, the seat was a sensory item because the feel of its surface finish had to satisfy customers, yet there were no precise standards in this area. To purchasing, the seat set was the most expensive of all the purchased parts - costing $740, with fabric accounting for almost half that figure.

Manufacturing and Installation

TMM’s sole seat supplier was Kentucky Framed Seat (KFS), [4] with whom it operated on a system of sequential pull. With this system, something truly magical happened. Every 57 seconds, as a Camry passed through one of the final assembly work stations, a seat set exactly matching its model type and interior color popped up by the side of the line. When a blue DX sedan arrived, so did a seat set with blue fabric covering. For the next black XLE sedan, here came a power seat set with gray leather covering - all just-in-time.

This magic was achieved as follows: As body shells emerged from the paint line, one after another, a small transmitter attached to each body sent manifest information to printers at both TMM and KFS. These printouts thus continuously appeared in real time, in the exact sequence in which cars entered the trim line (the first of the assembly line segments), and finalized the entire assembly sequence for KFS’ operations as well as for TMM. The production plan was ignored, for although the body shells entered the paint line according to plan, the sequence was altered because some cars needed to repeat certain loops of the paint process.

KFS’ manifest specified the style and color of the seat, and triggered seat production much like a kanban of lot size one. As cars traveled down TMM’s five-mile-long assembly line, so did all the seat assembly pieces travel down KFS’ own lines. All the matching pieces then merged at the end of the KFS lines to be strapped together, 100% inspected, and loaded onto a trailer in the same order. A truckload consisted of 58 seat sets and arrived at TMM in about half an hour after leaving the KFS factory. Once at TMM’s receiving dock, the seats were unloaded directly from the trailer to the staging line, which was barely big enough to hold one truckload of the seat sets. The seat sets waited here in the exact sequence of the manifest printouts until hoisted up one by one onto the overhead conveyor.

Synchronized with the assembly line, the overhead seat conveyor line ran above panels of steel mesh that shielded cars and people below. After traveling 250 meters or so, the seat sets reached the rear seat loading work station on the final assembly line segment called Final 1. The appropriate seat set was then lowered to the side of the Final 1 line every 57 seconds. This is where the seat met the matching car for the first time. At the rear seat loading workstation, a team member unstrapped the seat set and placed all the rear seat pieces into the car. Meanwhile, the front seat assemblies automatically slid to the side to make room for the next seat set. The front seats were returned to the conveyor line and moved to the proper side of the assembly line a few work stations downstream. At the front seat installation workstations, team members guided the front seat assemblies (left and right) into the car and fixed the four bolts in place with a pneumatic wrench. The rear seat pieces were bolted in the next line segment called Final 2 (see Exhibits 5 and 6).

The Supplier

TMM managers marveled at KFS’ ability to keep up with the sequential pull system. Indeed, KFS had been a rare exception to Toyota’s multi-vendor policy ever since TMC’s advance scout team chose it as the seat supplier in 1986. Moreover, the decision to go with KFS marked a departure from traditional industry practice whereby auto makers assembled seats themselves from purchased components (foam, metal frames, sewn fabric covers, etc.). KFS was unusual for an American supplier for over the years it had accumulated the considerable capabilities needed in supplying the complete seat set. That TMM and KFS were located near each other was coincidental, though the proximity benefited both parties in operating the sequential pull system.

During 1987, KFS applied itself to learning as much as it could from TMC’s Japanese seat suppliers. Meanwhile, Kevin Smith and others in purchasing were determined to spread TPS and worked hard to build good relations with KFS’ managers. TMC’s kaizen expert also helped KFS install visual controls, slash work-in-process inventory, reduce assembly labor content, and master quick changeovers. Despite this thorough preparation, the startup phase was not problem-free; however, TMM’s slow ramp-up schedule enabled KFS and TMM to send QC troubleshooters back and forth, and substantial progress was made. Mike DaPrile noted, “KFS’ line runs like our extension. They have become students, too.”

The next challenge was the fall 1991 model change. Although TMC was careful not to make the process too hard for TMM and its suppliers, it did introduce more challenges than were present in the initial ramp up. This time, KFS had to keep up the sequential pull system until the very last day of the old model production. Then, it had only 10 days to change over its process and 10 weeks to build up to full capacity for the new model. Nonetheless, according to TMM managers, the model changeover process was uneventful, and that description included KFS’ performance as well.

Signs of Problems

Despite KFS’ success with the sequential pull system, by early 1992 there was cause for concern: product proliferation. The old model Camry seat had three styles and four colors; the 1992 Camry offered only three seat colors but had five styles. The problem intensified in March when TMM launched the Camry wagons and became the sole source of these cars for the first time for Toyota worldwide. The wagon models destined for North America added eight seat variations immediately, but producing for the world market added considerably to that number. Indeed, in April, wagons destined for Europe added another 10 variations, and on the horizon was export to Japan and the Middle East, and this would add still another 18 seat variations.

The impact of the wagons for Europe was apparent to Doug Friesen. When he returned from a trip to Japan on April 27th, the run ratio was down to a meager 85%. This figure, which Friesen watched closely, measured the number of cars actually assembled in proportion to the number of cars that could have been assembled with no line stoppages. It had been around 95% when he had last seen it early in the month. This 10-point drop meant a shortfall of 45 cars per shift, which had to be made up with overtime. In addition, on April 30th, Mike DaPrile became concerned by an alarmingly high level of off-line vehicle inventory. Presumably, too many cars needed off-line operations of one type or another before they could go on to shipping. To DaPrile, this situation meant that the sales company was not getting cars on time as promised, and one of the main culprits was the seat. After mulling over the problem, he had asked Rodger Lewis to schedule an urgent meeting the following morning.

The cars with seat problems accumulating off-line reflected TMM’s choice for handling occasional glitches. What if a seat set and car did not match at the magic moment? What if a matching seat set arrived with defects? TMM standardized its response as follows. First, a team member pulled the andon cord to report the problem to the team leader before installing the defective seat. The team leader then pulled the andon cord to signal okay, and tagged the car to alert QC inspectors to the seat problem. The car then went through the rest of the assembly line as usual with the defective seat in it. Upon line-off, the car was driven to the Code 1 clinic area to see if the problem was correctable there. If the problem called for a replacement seat, the car was moved to the overflow parking area where the replacement seat was ordered and the car waited for KFS’ special delivery. Defective seats were returned to KFS. This routine was made an exception to the standard practice of investigating problems on the line, even at the expense of shutting down the line, for three reasons: first, the final assembly people already knew of the problem; second, it was possible to finish building the car without seat assemblies; third, it was felt that stopping the line was too expensive given how long it took to obtain the replacement seat.

May 1, 1992

The meeting Lewis scheduled took place from 10:00 to 11:30 in the overflow parking area. In addition to DaPrile and Lewis, those attending were Doug Friesen; group leader of the clinic and overflow parking area, Jim Cremeens; and PC and QC managers from TMM and KFS. DaPrile began by explaining the situation. Lewis then summed up seat quality trends, recalling the monthly QC meetings between TMM and KFS (Exhibit 7). Cremeens also handed out his data on recent seat problems (Exhibit 8). After some discussion, DaPrile proposed they walk through the overflow parking area to see for themselves the problems just discussed.

Examining sheets of paper under each car’s wiper, the group found 18 vehicles with various seat problems. They also discovered that some cars dated as far back as April 27, a major surprise because cars were supposed to leave this area with retrofit seat assemblies within the same or the following shift. According to Cremeens, his team members faxed a seat reorder form (Exhibit 9) as soon as a car came in, and KFS responded with a special delivery of replacements twice a day. He suggested that KFS sometimes sent the wrong seat assemblies - ones that did not match any of the cars waiting for rework. The group brainstormed about this information, trying to figure out what went wrong. All the ideas remained under consideration, however, when the meeting adjourned.

After the group dispersed, Friesen walked down the aisle between Final 1 and Final 2, determined to learn more about the problem. While studying some data posted at work stations along the lines (Exhibit 10), he found a few people near the front seat installation area and asked them about seats. The only problem they could think of was occasional incidents of cross-threading, that is, when a team member shot a bolt at an angle. Team leaders, however, could fix this familiar problem on-line in 30 seconds with a re-tapping tool. The team members also reminded Friesen of rare incidents when someone would accidentally damage the seat covering with hand tools, but they could not recall any recent occurrences. Being used to seat defects, they looked increasingly puzzled when Friesen kept asking about seat problems.

Friesen then found the group leader of Final 2, Shirley Sargent. She mentioned that she and her team leaders had been busy with the new team members she had received through a rotation program at the beginning of April. Regarding the seat, she drew Friesen’s attention to an ongoing problem since the past fall: during rear side bolster installation, a hook protruding from the back of that part was to be snapped into the “eye” of the body (see Exhibit 11), but the hook sometimes broke off. She suspected that its sharp edge made it brittle, and was curious about the status of an engineering change request she had filed several months ago. Friesen remembered that Cremeens had blamed the design of the 1992 Camry for the hook problem, noting that the hook had been changed from metal to plastic. Later that afternoon, however, Friesen learned three facts from QC: modifying the relevant tooling for the hook would cost KFS about $50,000; Tsutsumi, which used the identical engineering drawings for the part, had not reported the problem; and hook breakage frequency had gone down from about seven occurrences per shift at the new model introduction to one per shift by April.

Leaving Final 2, Friesen tried to sort out all the information he had gathered during the day. He then pondered what he should do next Monday to follow up on the meeting and resolve the seat problem:

I take responsibility for allowing the seat problem to go on this long. It’s clear that we lacked a “system” for recovering from the problem. But, what does it mean to implement JIT and jidoka principles in this situation? More broadly, are we handling seat defects correctly on the line? Is our current routine for handling seat defect cars really a legitimate exception to TPS, or could it be a dangerous deviation from TPS? After all, we swear by building in quality on the line. Yet we know all too well how painful it is to lose production. Maybe there’s a way to kaizen our offline routine. These are all hard questions, but we must begin somewhere.

Exhibits

Exhibit 1 TMM Georgetown Plant

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Exhibit 2 Examples of Five Whys

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Exhibit 3 TMM’s Schematic Organization Chart

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Exhibit 4 The Assembly Line

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Exhibit 5 Seat Installation

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Exhibit 6 Final Assembly Area (Staffed by Group 1-3 plus Assembly Inspection)

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Exhibit 7 An Extract of TMM/KFS Seat Quality Review Reports for the 1992 Camry

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Exhibit 8 Group Leader’s Seat Defect Data (April 14-30, 1992)

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Exhibit 9 Seat Reordering Form

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Exhibit 10 Andon Pulls at Left-Hand Side Seat Installation

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Exhibit 11 Rear Seat Side Bolster

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Glossary

Andon

Andon, a Japanese word for lantern, describes the appearance of the board shown in the bottom half of Exhibit 4. This board hangs over the aisle between production lines and alerts supervisors to any problem. In assembly, the board normally indicates the line name in green at the top. When a team member pulls a cord on the line, the board lights up a number corresponding to the troubled station in yellow, which then changes to red when the line actually comes to a halt. The board also shows whether the line stop is temporary or not, and whether the line is starved (body short), blocked (body full), or stopped by internal problems. This device quickly informs a supervisor of only what he or she needs to know to take immediate actions and thereby allows a small number of supervisors to control a large area; it also prompts supervisors to develop countermeasures for recurring problems in the longer term.

Heijunka

This is Toyota’s terminology describing the idea of distributing volume and different specifications evenly over the span of production such as a day, a week, and a month. Under this practice, the plant’s output should correspond to the diverse mix of model variations that the dealers sell every hour.

Jidoka

The three kanji characters comprising the Japanese word jidoka are “ji” or self; “do” or movement, motion; and “ka” or -ize; thus, a general meaning of jidoka is automation. At Toyota, however, the second character has been modified by adding the element for person (which doesn’t affect its pronunciation). “Do” now takes on the meaning of work (motion plus person). Jidoka at Toyota thus means investing machines with human like intelligence. In TPS, jidoka has both mechanical and human applications. Equipment contains fail-safe features like lights or buzzers that indicate defects; and people stop production when they detect any abnormalities. Overall, by adding the “human element” to the generic meaning of jidoka, Toyota emphasizes the difference between working and moving. This distinction is crucial because merely automated operations can produce both good and defective products “efficiently.” In practice, jidoka at Toyota thereby prevents defective items from being passed on to the next station, reduces waste, and most important, enables operations to build quality into the production process itself.

Kaizen

Kaizen literally means “changing something for the better.” The object of change usually includes the standardized work, equipment, and other procedures for carrying out daily production. The purpose is to eliminate waste in seven categories:

(1) overproduction,

(2) waiting imposed by an inefficient work sequence,

(3) handling inessential to a smooth workflow,

(4) processing that does not add value,

(5) inventory in excess of immediate needs,

(6) motion that does not contribute to work, and

(7) correction necessitated by defects.

Kaizen requires that a process be first standardized and documented so that ideas for improvement can be evaluated objectively.

Kanban

Kanban means “signboard” in Japanese. The one used for a part supplied by an outside supplier indicates the name of the supplier, the receiving area at Toyota, the use-point inside the Toyota plant, the part number, the part name, and the quantity for one container. A bar code is used to issue an invoice based on actual part usage.

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References

Business Week (May 18, 1992) p. 50.

The glossary at the end of the case supplements the explanation of Japanese and Toyota production concepts.

These bolsters provided lateral support for rear seat passengers and concealed the gap between the backrests and the car body.

The supplier's name has been disguised.

5. Walmart: Supply Chain Management [1]

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“Bring it on,” said Walmart U.S. chief executive officer (CEO) Greg Foran, when asked about Amazon.com’s moves to compete with Walmart Inc. (Walmart), the world’s largest retailer. Foran was speaking at the Union Bank of Switzerland (UBS) Global Consumer and Retail Conference on March 7, 2019. “It galvanizes an organization into doing something,” he said. [2] Walmart’s supply chain strategy continued to evolve with its retreat from international markets, [3] a slowdown of retail expansion plans in the United States, [4] and a focus on its growing online business. [5]

With revenues of US$514 billion [6] in the fiscal year (FY) ended January 31, 2019, [7] Walmart achieved 4.2 per cent comparable sales growth in the United States in the fourth quarter of FY 2019, the best performance in the last decade. Its shares jumped 3.9 per cent higher on the news. [8]

As Walmart repositioned itself to grow its online presence, it added 1,000 grocery pickup locations during the past year and grew the number of grocery delivery locations to nearly 800. Walmart was working on the best way to deliver groceries directly to customers—it had a pilot test with Udelv for custom autonomous cargo vans to deliver groceries in Surprise, Arizona [9] and was collaborating with Ford on the development of self-driving cars for grocery deliveries. [10] These were only a few of the changes Walmart was making as it reshaped its supply chain strategy to tackle the “last mile.”

Walmart seemed to have an advantage over Amazon in infrastructure. While Amazon had 75 fulfilment centres and 25 sortation centres in North America, [11] Walmart’s vast store network in the United States was within 10 miles of 90 per cent of the U.S. population. [12] As competition between Walmart and its online and offline competitors continued to heat up, a key challenge facing Doug McMillon, the company’s president and CEO, was deciding what changes needed to be made to Walmart’s ever-expanding supply chain to support its strategic objectives. What supply chain capabilities would Walmart need as its business model continued to evolve?

THE RETAIL INDUSTRY

The top five global retailers in 2018 were Walmart ($514 billion), Amazon ($160 billion), the Schwarz Group in Germany ($102 billion), Carrefour in France ($89 billion), and Ahold Delhaize in The Netherlands ($71 billion). [13] U.S. retail sales, excluding motor vehicles and parts dealers, reached $6 trillion in 2018. Major categories included general merchandise, food and beverage, and health and personal care (see Exhibit 1). In the United States, retailers competed at local, regional, and national levels, with some of the major chains, such as Walmart and Costco, counting operations in foreign countries as well. In addition to the traditional one-store owner-operated retailer, the industry included formats such as discount stores, department stores (selling a large percentage of soft goods or clothing), variety and convenience stores, specialty stores, supermarkets, supercentres (combination discount and supermarket stores), Internet retailers, and catalogue retailers. Online retail sales were rising in importance in the United States, reaching $517.4 billion in 2018, with Amazon accounting for approximately 40 per cent of the total. [14]

There were two broad strategies in global retailing: variable pricing or “hi-lo pricing,” and everyday low pricing (EDLP). Hi-lo pricing, practiced by retailers for decades, involved adjusting the retail price of items to optimize total gross margins. For example, at traditional grocery stores, while most prices of key items— such as milk, sugar, eggs, toothpaste, and detergent—were kept at market rates, a small number of products were discounted at below-market prices as part of short-term promotions. This strategy was used to attract customers with low-price offerings, expecting that they would also buy some of the high-price items, thereby expecting to increase overall profitability despite incurring losses on the few discounted items. Rotating promotional items allowed retailers to shift target customer segments.

On the other hand, an EDLP strategy meant that prices on items were generally consistent from week to week and were kept as low as possible in order to generate high consumer traffic. An EDLP strategy generally required the retailer to focus on opportunities to reduce operational and supply chain costs, which translated into lower retail prices. The goal, in an EDLP environment, was to generate higher aggregate gross profit by increasing the volume of items sold.

An emerging trend was demand from consumers for home delivery, especially from millennials, who prioritized convenience as part of the shopping process. This trend was spurred by the emergence of Amazon and other online retailers. [15]

WALMART STORES, INC.

Based in Bentonville, Arkansas, and founded by the legendary Sam Walton, Walmart was the number one retailer in the world with FY 2019 net income, from continuing operations, of $7.3 billion on sales of $514 billion (see Exhibit 2). Globally, Walmart had 2.2 million associates, conducted business in 27 countries, and served nearly 275 million customers each week in its more than 11,300 stores and numerous ecommerce websites that operated under 58 banners. [16] In the United States, Walmart had 1.5 million associates, and 5,362 stores and warehouse clubs. [17]

Beginning with its “big box” discount store format in the 1960s, Walmart’s store formats around the world had grown to include supercentres, which were a larger version of a discount store that included groceries, merchandise, and apparel. Its strategy was to provide a broad assortment of quality products and services at “everyday low prices.” In the United States, Walmart faced a wide range of competitors, including Target, Home Depot, Ikea, Costco, Kroger, Aldi, Walgreens, and CVS. [18] The company was also facing growing competition for large ticket general merchandise products and from online retailers, such as Amazon.com.

THE DEVELOPMENT OF WALMART’S SUPPLY CHAIN

Before he started Walmart Stores in 1962, Sam Walton owned a successful chain of stores under the Ben Franklin Stores banner, a franchisor of variety stores in the United States. Although he was under contract to purchase most of his merchandise requirements from Ben Franklin Stores, Walton was able to selectively purchase merchandise in bulk from other suppliers and transport these goods directly to his stores. When Walton recognized a new national trend, discount retailing—based on driving high volumes of product through low-cost retail outlets—he decided to open large warehouse-style stores, initially named “Walmart Discount City.” Because many suppliers were not willing to send their trucks to his stores, which were located in rural Arkansas, Walton set up his own distribution operations. [19]

Walmart undertook an initial public offering in 1969 to raise funds to build its first distribution centre (DC) in Bentonville, Arkansas. [20] As the company grew between 1960 and 1990, it benefited from an improved national transportation infrastructure and the slow response of its competitors to changes in legislation, such as the removal of “resale price maintenance,” which had prevented retailers from discounting merchandise. To keep an eye on his growing network, Walton piloted a small single-engine airplane, which he would land at air strips close to his stores.

Walmart’s supply chain, a key enabler of its growth from its beginnings in rural Arkansas, was long considered by many to be a major source of competitive advantage for the company. It was one of the first firms to rely on data to make operational decisions, use barcodes, share sales data with suppliers, control its own logistics and transportation activities, and install point-of-sale information systems that collected item-level data in real time. As the company’s supply chain practices became widely publicized, many of Walmart’s practices were adopted by competitors and became industry standards.

Walmart.com

In the United States, Walmart had three main online programs: Walmart.com (launched in 2000), an online site selling an assortment of goods that were also available in company stores; Marketplace, a seamless platform that hosted third-party sellers on Walmart.com; and, Jet.com, a high-end retailer of consumer goods. The company was also partnering with major retail brands, such as Lord & Taylor and Advance Autoparts, to bring upscale brands to Walmart.com.

Launched in 2009, Walmart Marketplace was a third-party e-commerce platform that allowed independent sellers to sell both new and like-new products on Walmart.com. Many of these suppliers purchased overstocked items which were then resold. Some of the items that were sold by third-party resellers included $3,000 Celine bags, Miu Miu sunglasses, and Chanel perfume. [21]

To differentiate itself from Amazon, Walmart did not charge suppliers setup or monthly fees to list on Marketplace. However, Walmart did not allow its Marketplace sellers to use its supply chain network. Marketplace sellers had to fulfill orders on their own and manage customer service, including returns.

Walmart’s e-commerce capabilities had been augmented when it purchased Jet.com in 2016 for $3.3 billion, positioning the site to target higher income urban shoppers. [22] The acquisition coincided with an effort by Walmart to source a larger variety of goods in an effort to attract a broader range of customers. For example, in 2015, Walmart.com had 7 million different items for sale online. By October 2018, it had over 75 million items online. [23] Doug McMillon indicated that Walmart had purchased Jet.com because of its customer service capabilities, e-commerce foundation, and talent base, along with the belief that both customer bases were complementary. Jet.com focused on urban millennials and offered online features that allowed shoppers to lower prices by opting out of free returns and paying with debit cards instead of credit cards. In contrast, Walmart.com featured low prices and attracted value-conscious buyers. McMillon was looking to grow both online businesses, stating:

We’re in the business of “saving people money so that they can live better.” But the value of our customers’ time cannot be overstated. To win the future of retail, we must save customers both money and time. By combining with Jet.com’s technology, shopping experience, customers, and talent, we will do exactly that. We will exceed their expectations! [24]

In addition to trying to reach a higher income demographic by partnering online with retailers such as Lord & Taylor, [25] Walmart was looking to offer higher-end brands on its site. It purchased Bonobos, an online designer and seller of higher-end men’s clothing; Moosejaw, an online outdoor products retailer; Hayneedle, an online furniture and home decor shop; and Shoebuy, an online shoe retailer. In October 2018, Walmart purchased plus-size digital brand Eloquii and lingerie retailer Bare Necessities. [26]

In May 2018, Walmart purchased 77 per cent of India’s Flipkart, an e-commerce retailer, for $16 billion. Of that amount, $2 billion was earmarked for funding growth. Walmart intended for Flipkart to “. . . support national initiatives and . . . bring sustainable benefits in jobs creation, supporting small businesses, supporting farmers and supply chain development, and reducing food waste.” [27] In February 2019, India introduced new e-commerce restrictions that prevented foreign online retailers from selling their own products online, restricting them to “. . . operate marketplace platforms where others sell goods to retail consumers.” [28] The result was that Flipkart had to pull thousands of products offline. [29]

The combination of an improved Walmart.com website, positioning Jet.com at higher-end customers, and allowing third-party sellers to use Walmart Marketplace resulted in online revenue growth of 40 per cent to $15.7 billion in FY ended January 31, 2019. [30] Amazon’s U.S. e-commerce sales were $206.82 billion in 2018, up 16.3 percent from 2017. [31]

In an effort to raise profits—and recognizing that fulfilling orders online was more expensive—Walmart began raising prices on Walmart.com for basic food and household items. [32] A Morgan Stanley data analysis found that while Walmart dominated the market for lower-income consumers, Amazon attracted higher income consumers. [33]

Procurement

Walmart’s buyers, located in Bentonville, worked with suppliers to ensure that the correct mix of staples and new items was ordered. As Walmart grew, many of Walmart’s largest suppliers opened offices in Bentonville, staffed by analysts and managers supporting Walmart’s business.

Walmart expanded its global sourcing in the mid-1980s by establishing international purchasing offices in China and other countries, and working directly with suppliers to expand the company’s line of private label merchandise. Private-label products were appealing to customers as they were often priced at a discount to brand-name merchandise; for Walmart, the private-label items generated higher margins than suppliers’ branded products. Private-label sales at Walmart, first developed in the 1980s, accounted for approximately 16 percent of revenues, compared to about 25 per cent at U.S. rivals Safeway and Kroger. This was because Walmart’s strategy was to procure top brands in volume and sell them at low prices. [34]

Every quarter, buyers met in Bentonville to review new merchandise, exchange information, and review a fully merchandised prototype store, which was located in a warehouse. In order to gather field intelligence, buyers toured stores and helped associates stock and sell merchandise. In addition to helping coordinate short-term plans for deliveries and inventories, Walmart worked with suppliers on medium- to long-term supply chain strategies, including product trends, capacity management, cooperation with upstream raw materials suppliers, and forecasting.

Globally, Walmart was thought to have approximately 60,000 suppliers, [35] of whom about 200—such as Nestle, Procter & Gamble (P&G), Unilever, and Kraft—were key global suppliers. Walmart wielded enormous power over its suppliers. For example, P&G sales to Walmart represented 15 percent of its annual revenues in 2018 but approximately two per cent of Walmart revenues. [36]

During negotiations with suppliers, Walmart insisted on a single invoice price and did not pay for cooperative advertising, discounting, or distribution. With Walmart’s expectations for data analysis, category management responsibilities, and external research, it was common for key suppliers to have several employees working full-time to provide support. In order to harness the knowledge of its suppliers, “category captains” were introduced in the late 1980s to provide recommendations to improve overall category performance, including shelf space allocation for all suppliers.

Walmart announced in February 2019 that it would allow suppliers, such as P&G, Unilever, and Modelez, to advertise directly to consumers in its stores and online at Walmart.com. [37] The company had approximately 300 million visitors to its U.S. stores per month and the retailer was looking to generate revenues and boost profits. The move came at a time when Amazon was positioned to surpass Microsoft in online advertising revenues, moving into third place behind Google and Facebook in the $111 billion U.S. digital ad market. [38]

Distribution

Walmart’s store openings were driven directly by its distribution strategy. Sam Walton had insisted on saturating the area within a day’s driving distance of a DC in order to gain economies of scale, with an average distance of approximately 130 miles. This “hub-and-spoke” distribution-led store expansion strategy persisted as Walmart expanded from its roots in Arkansas, adding thousands of U.S. stores.

In 2019, Walmart had 173 DCs in the United States with 125.8 million square feet of total space. [39] Its DCs were focused on a variety of roles in the supply chain, including regional general merchandise, full-line grocery, grocery and perishable food, fashion, e-commerce fulfilment centres, specialty products (e.g., export, optical labs, pharmacy, returns processing, tires, print, and mail), import and redistribution, centre point, [40] and Sam’s Club DCs. Approximately 77 percent of store merchandise was shipped through its DC network with the remainder shipped direct-to-store (DSD) by suppliers. [41] Exhibit 3 provides data showing the number and type of U.S. distribution centres.

Walmart announced in January 2019 that it would add consolidation centres to improve supply chain efficiency. The current practice was for domestic suppliers with goods already in the United States to ship goods to one or more of the company’s 42 regional general merchandise DCs. Suppliers sending goods from abroad would send their product to Walmart’s import and redistribution centre points, and goods would then be sent to regional general merchandise DCs. In July 2019, Walmart planned to build its first consolidation centre, a 340,000 square foot high-tech distribution centre to receive product from suppliers. The new technology in the consolidation centre was expected to be three times faster than the manual processes used in traditional DCs. Walmart anticipated that it would add 10 consolidation centres to its supply chain network, which would ship product to regional general merchandise DCs. [42]

The company estimated that incomplete deliveries resulted in one-third of out-of-stock incidents in its stores. As a result, in 2019 Walmart increased requirements for on-time delivery performance. Suppliers shipping full truckload orders were now expected to meet their two-day window 87 percent of the time, up from 85 percent previously. Suppliers delivering less-than-truckload amounts were expected to deliver on time 70 percent of the time, up from 50 per cent. Suppliers who did not meet its “on time, in full” guidelines would be fined 3 percent of the amount invoiced. [43]

The company employed approximately 8,000 truck drivers in the United States, who logged nearly 740 million miles per year. Walmart’s truck fleet included an estimated 6,000 tractors, 53,500 trailers, and 5,600 refrigerated trailers. [44] General merchandise and dry grocery merchandise in the United States was transported primarily through Walmart’s private truck fleet, and the company contracted with common carriers to transport the majority of its perishable grocery merchandise. Walmart invested in capabilities to improve delivery processes, coordinating and deploying the entire fleet as necessary. Uniform operating standards ensured that miscommunication between traffic coordinators, truckers, and store level associates was minimized. [45]

Walmart categorized its inventory into four distinct types: finished goods, and transit, buffer, and anticipation inventory. Finished goods referred to inventory that arrived from suppliers and was shipped, at regular intervals, to stores. Transit inventory referred to goods that were being transported via Walmart’s global supply chain to warehouses. Buffer inventory was extra stock held in stores’ back rooms to account for sudden and unexpected increases in demand. Anticipation inventory referred to goods held in stock for specific periods of high demand, such as Black Friday. [46]

Information Systems

As early as 1966, Sam Walton made information systems a focus at Walmart. The retailer had a central database by the 1980s, point-of-sale systems, and a satellite network. It launched its industry-leading Retail Link system in 1992, which was initially created to share inventory data with key suppliers. By 2019, Retail Link was a comprehensive information system providing all suppliers with access to information and decision support tools. Suppliers were able to use Retail Link to access real-time data on inventories and sales at the stock keeping unit (SKU) level, and download to purchase orders. Incorporating information on product performance and regional consumer demographics, Retail Link provided decision support systems that allowed suppliers to make data-driven decisions in areas such as sales forecasting, route scheduling, and assortment planning. Its capabilities provided even Walmart’s smallest suppliers with tools once reserved for only large companies. [47]

The access to the Retail Link resources also came with increased accountability for suppliers. It allowed Walmart to offload data analysis to suppliers, expecting them to proactively monitor and replenish product on a continual basis, setting targets for supply chain inventories and service levels. The company’s vendor managed inventory (VMI) program required suppliers to manage inventory levels at the company’s distribution centres, based on agreed service levels. In some situations, suppliers owned the inventory in Walmart stores up to the point that the sale was scanned at checkout.

Walmart was an early adopter of RFID (radio frequency identification) tags to ensure cases of product moved efficiently through its distribution system, and it was estimated that Walmart saved $500 million a year by using RFID in its operations. [48]

Store Network

Sam Walton was an original adopter of EDLP at a time when most retailers in the 1960s and 1970s, such as K-Mart, practiced hi-low pricing. EDLP was a strategy that Walmart refined over the decades.

EDLP allowed Walmart to keep its costs low. Steady demand for product allowed management to control inventories and reduce stock-outs. The absence of promotions and discounts meant less spending on advertising. In turn, the company channelled the savings to lower prices. Walmart grew rapidly as customers were attracted by its assortment of low-priced product, as other retailers faltered. Over time, the company copied the merchandise assortment strategies of other retailers. It bought in bulk, bypassing distributors, and passed savings on to consumers.

Similar to its logistics operations, the company strived to optimize the efficiency of its stores through efforts to continually reduce costs. Its stores were simply furnished and constructed using standard materials, and light and temperature settings for all U.S. stores were controlled centrally from Bentonville.

Each Walmart store aimed to be the “store of the community.” The display of merchandise was suggested by a store-wide template, indicating the layout of Walmart’s various departments. This template was created by Walmart’s merchandising department after analyzing data from Retail Link and the profile of the local community. Associates were able to alter the merchandising template to fit their local store requirements. Shelf space in Walmart’s different departments—from shoes to household appliances to automotive supplies—was divided up, each spot allocated to specific SKUs. Thus, two Walmart stores a short distance apart could potentially stock different merchandise.

Retail Link provided Walmart DCs with close to real-time information on stores’ in-stock levels, allowing merchandise to be pulled to stores automatically. In addition, store level information systems allowed suppliers to monitor product sales. In anticipation of changes in demand for some items, associates had the authority to manually input orders or override impending deliveries. To ensure that associates were kept up-to-date, management shared detailed information about day, week, and month store sales with all associates during daily 10-minute long “standing” meetings.

In 2018, Walmart announced that it would raise the hourly wages for entry level associates to $11— providing total compensation including benefits, of more than $17.50—in an effort to attract and retain talent. [49] The company was also experimenting with organizational models that would provide more decision-making power to people on the floor, in areas such as pricing and handling returns, thereby allowing reductions in manager ranks. Other cost-cutting initiatives included the use of automation and robots in stores to monitor inventory, clean floors, and unload trucks more quickly. [50]

In 2019, Walmart was expected to add just 10 stores in the United States as it focused on remodelling existing stores and building its e-commerce capabilities. As part of its focus on online, Walmart had closed 150 U.S. stores in 2015. Exhibit 4 provides a summary of Walmart capital expenditures for 2016–2019.

FOCUSING ON THE SUPPLY CHAIN

Walmart remained focused on improving its supply chain capabilities. In addition to implementing zero based budgeting, the company was evaluating more than 300 technology-enabled initiatives to improve efficiency and to reduce costs. Some recent initiatives included warehouse unloading equipment, shelf scanning robots, electronic shelf-edge labels, and development of new apps. Specifically, senior management had identified two broad areas where supply chain initiatives were critical to support corporate strategy: integrating retail stores and e-commerce to enhance the omnichannel experience of customers, and increasing the use of technology to assist customers and to reduce costs. [51]

Omnichannel

Walmart aimed to provide seamless omnichannel experience to customers, integrating retail stores and ecommerce systems, through services such as Walmart Pickup, Pickup Today, Grocery Pickup, Grocery Delivery, and Endless Aisle. Shoppers could order online, select a pickup time, and pick up their groceries at thousands of stores without leaving their cars. Marc Lore, president and CEO of Walmart U.S. e-commerce, commented on the opportunities at Walmart to integrate its store network with its e-commerce business:

Wal-Mart has some really unique assets that no one else has. To date, we haven’t fully leveraged the scale of Wal-Mart, specifically its 4,600 stores within 10 miles of 90 percent of the population. Fresh, frozen, over 100,000 general-merchandise SKUs are in that proximity. That product gets there in full truckloads—not cases and pallets—and those 4,600 warehouses are profitable. They’re already covering their entire fixed expense. So each marginal dollar that ships out of there comes out at an incredible profit. [52]

Walmart’s foray into grocery pickup and delivery began in 2014 when it introduced curbside pickup. Meanwhile, the U.S. online grocery market was growing rapidly—Forrester Analytics estimated that by 2022, the online grocery market would be valued at $36.5 billion, up from $26.7 billion in 2018. In 2019, Walmart had more than 2,100 grocery pickup locations and nearly 800 grocery delivery locations. [53]

Walmart was hoping that customers would come to the stores for the best deals on inexpensive items and place larger orders online. Speaking to an investor conference, Marc Lore observed that “. . . there’s no cheaper way to get these products to consumers than have them come in the store and pick it off the shelf themselves.” [54]

In April 2019, Walmart announced it had hired 40,000 store workers to pick groceries for online orders. The company was installing 900 pickup towers—each 16-feet high and located in the store parking lots— that would allow customers to pick up online orders without speaking to a store associate. [55] Customers placed orders online at Walmart.com or on the smartphone app and then received a barcode. When the order was ready, customers could go to a pickup tower in the Walmart parking lot, enter a barcode, and then wait for their products to be brought to them via conveyor belts. [56]

In a test in Nashville and New Orleans in September 2018, Walmart worked with Spark Delivery, a crowdsourced delivery platform that matched independent drivers with Walmart delivery orders. Once orders were placed, Walmart’s personal shoppers would pick up the merchandise and hand the orders off to independent delivery drivers managed by Delivery Drivers, Inc., a logistics service provider. [57] In September 2018, Walmart purchased Cornershop for $225 million. [58] Cornershop was a crowdsourced delivery platform for supermarkets, pharmacies, and food retailers in Mexico and Chile. [59] Walmart announced partnerships in January 2019 with Point Pickup, Skip Cart, AxleHire, and Roadie, aimed at providing home delivery services to customers. [60] On June 7, 2019, Walmart announced the launch of a service, Walmart In-Home, which would see employees deliver groceries directly to a customer’s fridge. The service would be available in three cities: Kansas City (Missouri), Pittsburgh (Pennsylvania), and Vero Beach (Florida), and employees would wear body cameras, for security purposes, and enter residences equipped with smart locks that could be remotely unlocked. [61]

However, not all of Walmart’s omnichannel experiments had been successful. In August 2017, Walmart had partnered with Google Express to make Walmart products available on Google’s online marketplace. But Google confirmed via Twitter, on January 22, 2019, that Walmart products had been withdrawn from its online shelves. [62]

In January 2017, Walmart abandoned its effort to create a rival to Amazon Prime. The program, ShippingPass, had been introduced in 2015 and offered free two-day shipping for customers who paid a $49 membership fee. The program was replaced by free shipping for all orders greater than $35. [63]

An attempt by Walmart to turn its U.S. associates into an after-hours delivery workforce was scrapped in July 2018. A report in the industry magazine Chain Store Age noted that “. . . the initiative failed to gain traction in New Jersey specifically, due to employees being required to use their own cars and insurance policies during deliveries. Many also had no prior experience as couriers with a delivery service.” [64]

Technology

In 2019, Walmart was engaged in a number of technology-related initiatives aimed at improving the customer experience and reducing costs. In September 2018, Walmart announced that some food suppliers would need to implement blockchain technology as part of a food traceability program. The objective was to track leafy greens, such as lettuce and spinach, from farm to store to improve food safety and quality. [65]

In April 2019, Walmart introduced robots in 300 U.S. stores to scan shelf inventory and boxes as they were unloaded from trucks. [66] Robotic floor scrubbers were deployed in 1,500 stores after having been tested in stores in 2018. [67] Walmart was also running an experiment with a shelf-scanning robot that travelled up and down store aisles, verifying shelf labels and looking for gaps in shelves signalling that product was out-of-stock. [68] Another robot picked refrigerated and frozen products to assist in filling grocery pickup orders. [69]

The company was also actively developing new apps for customers and store associates. The My Productivity app was designed to improve inventory management in stores. Associates could access the app on their smartphone and review real-time data and sales trends. It allowed associates to reorder specific items and respond to customer questions if needed. The company also launched Dotcom Store, an app that allowed associates to place orders for customers on Walmart.com, if products were not available or if they were out-of-stock. [70] Walmart also launched a detailed mobile store map for customers looking to navigate a particular store and “Check Out with Me”—an app that allowed customers to pay for their purchases while they were shopping. [71]

WALMART’S QUIET TRANSFORMATION

In 2019, Walmart was transforming itself—leveraging its store network and investing heavily in ecommerce— as part of a new strategy. The company had sold its Brazilian operations, while a proposed sale of its Asda chain to Sainsbury had been blocked by Britain’s Competition and Market’s Authority. [72] As it positioned itself to attract higher income customers online and invest in labour-saving technology, there was one part of the market that Walmart seemed to have vacated: the small-town, rural markets where it had started in the 1960s. Meanwhile, a new competitor, Dollar General, had built a strategy of opening its small stores in “. . . damaged inner-city neighbourhoods with basic goods at basic prices.” [73]

Walmart’s supply chain had grown more complex over time (see Exhibit 3). The company had saturated the United States with stores within minutes of 90 per cent of the country’s population while simultaneously improving supply chain operations. Traditional customers still visited Walmart stores to stock up on food and merchandise at low prices. But now the world’s largest retailer was in the middle of a transformation in the face of threat from a new class of competitors—online retailers, led by firms such as Amazon—who were winning over customers with a wider variety of goods and the convenience of home delivery.

While Amazon offered free shipping and other online services, such as streaming music and video, with its $119 annual Prime membership, Walmart provided free two-day shipping for orders over $35 to all customers. [74] On April 26, 2019, Amazon rattled the industry by announcing that Prime members would be getting free one-day delivery. Walmart responded in a tweet: “One-day free shipping . . . without a membership fee. Now THAT would be groundbreaking. Stay tuned.” [75]

As Walmart’s business model continued to evolve, a key challenge facing Doug McMillon was determining how Walmart’s supply chain strategy would need to change to meet the challenges facing the company.

EXHIBITS

EXHIBIT 1: U.S. RETAIL CATEGORIES (PARTIAL LIST) (IN US$ BILLIONS)

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EXHIBIT 2: KEY FINANCIAL INFORMATION FOR AMAZON, WALMART, AND TARGET* (IN US$ MILLIONS)

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EXHIBIT 3: WALMART—U.S. DISTRIBUTION CENTERS—GROWTH 1970–2019*

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EXHIBIT 4: WALMART U.S. CAPITAL EXPENDITURES (IN US$ MILLIONS)

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ENDNOTES

This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives presented in this case are not necessarily those of Walmart Inc. or any of its employees.

Hayley Peterson, “Walmart US CEO Tells Rivals Amazon, Aldi, and Lidl to ‘Bring It on’ as He Offers a Rare Look Inside the Company’s Competitive Strategies,” Business Insider, March 7, 2019, accessed March 7, 2019,

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All currency amounts are in U.S. dollars unless specified otherwise.

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Center Point distribution centres (DCs) were cross-docking terminals. Instead of having suppliers send less-than-truckload (LTL) shipments to normal DCs, the use of centre point DCs allowed Walmart to consolidate these LTL shipments into full truckload shipments. The trucks would then bring the merchandise to the nearest Walmart DC.

Walmart, 2019 Annual Report, op. cit.

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Sarah Nassauer, “Now Featured on Wal-Mart’s Website,” op. cit.

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1. Introduction to Supply Chain Management

Supply Chain Management Definitions

Making the Supply Chain Fit Your Product

Demand-side uncertainty

Supply-side uncertainty

Supply Chain Strategies

Efficient supply chains

Risk-hedging supply chains

Responsive supply chains

Agile supply chains

Referencias