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4.3 Papers
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.

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.