Page: 1 of 9 Upsmoke Corporation: Global Supply Chain Management We are facing dramatic changes in the way we do business. Traditional entry barriers in markets got torn down, competition is fierce and we lose market shares in our most profitable markets. We need to establish supply chain management as a competitive weapon to fight back. - John Black, CEO, Upsmoke Corporation INTRODUCTION Upsmoke Corporation is market leader in the global cigarette industry and is operating in a shrinking market environment. Since 2003 the most profitable markets of European Region, Russia, Gulf Countries and Japan were declining in market volume between 3 to 5%. Revenues could be stabilized by increasing consumer prices at the point of sale and by taking advantages from legal taxation models which foresee the recognition of profits in low tax rated countries. As Upsmoke Corporation is known in the industry to be proactive to the market environment a productivity program called SHINE has been launched within operations to counteract the trend of flat revenues. The SHINE program has the clear objectives to reduce manufacturing costs by consolidating plants and optimize machine and labour efficiency as well as to boost quality to outperform competition. After two years of having launched SHINE program, the expected benefits materialized in manufacturing cost savings of 500 mio US$ and fundamental quality improvements. Upsmoke Corporation has achieved superior manufacturing quality versus competition in 35 out 40 key strategic markets. Although Upsmoke Corporation has realized impressive efficiency gains, the problems of the company seemed not to be solved. One of the core complaints mentioned in almost every management meeting is the low shelf availability of Upsmoke Products at retailers. According to Nilson Corporation, a specialized company measuring the product availability of consumer goods companies at the point of sales, Upsmoke Corporation achieves in key markets a shelf availability of only 90% in contrast to competition which regularly scores at a rate of 95%. As cigarette smokers tend to be product disloyal the result of low shelf availability is immediate lost sales. In addition, key account management complains about the service level of deliveries and freshness of the product. Wilson Smith, key account manager of Germany, brings it to a point: “We are selling products which are 6 months old although we know that freshness is a clear consumer focus. It takes Supply Chain Management 3 months to plan and deliver products that are needed today”. Page: 2 of 9 These global issues are forwarded to the Head of Supply Chain Management Wes Williams, a former manufacturing manager, who does not understand the noise created by his sales colleagues. He justifies the situation from a supply perspective: “Upsmoke Corporation has built up higher inventories than competition to provide a good service level to all of our 180 markets. Our 36 factories are running in a cost efficient mode with capacity utilization beyond 95%. Any production short-fall is immediately compensated by overtime or airfreight shipments to counteract lost sales. The planning lead time of 3 months can be considered as an industry standard and is mainly driven by the long material order lead time of 6 weeks. We are a cost efficient company and yearly productivity gains delivered by the SHINE program prove that!” Two weeks later John Black, CEO of Upsmoke Corporation receives the quarterly financial report which is input for the publication of the quarterly company results to shareholders. The report reveals devastating results. It shows a write-off of 200 mio US$ for LoGD (Loss of Goods Destroyed) due to inefficient management of product distribution and product life cycle management. Furthermore the report highlights working capital requirements of 3000 mio US$ to finance inventories of finished goods. John Black sees a serious threat in company profitability and calls Wes Williams to clarify the situation. Wes Williams does not understand the issue as he is convinced that the overall supply chain is fully optimized and responding in a satisfactory way. The meeting ends in a very unconstructive manner and John Black is convinced that a new Supply Chain Manager needs to be hired to turn around the situation. Two months later John Deere was headhunted from Nestle and appointed as the new Supply Chain Manager at Upsmoke Corporation. John Deere has a very strong background in supply chain management and led the successful supply chain transformation, GLOBE Project, at Nestle. The expectations are high that he will fundamentally improve the supply chain performance at the Upsmoke Corporation and positively contribute to the future success of the company. ASSIGNMENT QUESTIONS: You are John Deere the new Supply Chain Manager at Upsmoke Corporation and have been asked by the CEO, John Black to address the below work items in a written document (MS Word / MS PowerPoint). To improve your understanding on the current supply chain management setup at Upsmoke Corporation, read the full Upsmoke Corporation: Global Supply Chain Management case. Work items: 1. Prepare a SWOT (Strengths – Weaknesses – Opportunity – Threats) analysis on the current Supply Chain Management configuration at Upsmoke Corporation. 2. Prepare an improvement concept which describes at least 5 key ideas to boost the supply chain performance at Upsmoke Corporation. 3. Prepare an implementation roadmap as part of the improvement concept on key activities and milestones to be followed in order to reach expected performance results. 4. Prepare a change management plan on the implementation of proposed improvements: How can the buy-in of the current organization be strengthened to make the transformation a success? Upsmoke Corporation: Supply Chain Transformation Page: 3 of 9 1. COMPANY PROFILE Upsmoke Corporation is the world‟s largest cigarette manufacturer with a market volume of around 750 billion cigarettes and a worldwide market share of 15.7%. The company is operating in more than 180 countries and its cigarettes are produced in more than 50 facilities worldwide. The company‟s key brands include Swift (the world‟s top selling cigarette), Theo, Igor, Drift, Funk as well as popular local brands. Upsmoke Corporation generated in 2007 with its 80.000 employees a revenue of >30 bio. US$ and realized an operating margin of >20%. 2. DESCRIPTION OF THE MARKET PLACE – CIGARETTE CONSUMPTION Worldwide, the production of tobacco and the consumption of tobacco products increased steadily until the early 1990s. Between the early 1970s and the early 1990s tobacco production increased by around 50 per cent in volume terms. Cigarette consumption and production increased at a slightly faster pace. Between 1990 and 1995, production of and demand for cigarettes grew at a more modest rate. Tobacco production reacted to this weakening of demand with a lag. After 1996, consumption appears to have declined. The Asian and the Russian crises dampened demand as did the drastic price increases in the US. On balance, according to the USDA, world tobacco consumption at 6.5 million metric tons and world cigarette production at 5.5 trillion sticks were no higher in 1999 than they were in 1991. Per capita demand for cigarettes in the industrialized countries started to decline in the early 1980s. After 1995, demand growth in the countries outside the OECD area slowed down and no longer compensated for declining demand in the industrialized countries. Average annual cigarette consumption per adult in industrialized countries1 For individual countries and regions, demand for cigarettes is determined by a number of factors, including price, real incomes, macroeconomic developments, government efforts to discourage consumption, as well as a range of structural and cultural factors. Retail price increases and a slowing economy have a negative effect on the demand for or the expenditure on tobacco products. It may, but it need not lead to a reduction in the number of cigarettes consumed. People may simply buy cheaper cigarettes (“down-trading”). They buy local instead of imported cigarettes; popular instead of premium brands.2 1 see WHO (1997) 2 See van Liemt (2002), p. 6 Upsmoke Corporation: Supply Chain Transformation Page: 4 of 9 3. INDUSTRY TRENDS Consolidation Consolidation in the tobacco industry had been taking place for quite some time, but it accelerated in the late 1990s. Also, the size of the “deals” has become steadily bigger. Concentration can make a critical contribution to profitability through marketing (“global” brands), manufacturing and distribution. By producing high volumes at fewer locations, and by merging distribution activities, companies benefit from economies of scale. “The cigarette business needs volume to be profitable”3. Companies with large sales in the quality brand segment are particularly attractive take-over targets as are those with a presence in fast-growing emerging markets. Consolidation takes various forms. Smaller companies have been absorbed by their larger competitors. Austria Tabak took over the cigarette activities of Swedish Match, and was then taken over by Gallaher. Former state monopolies have come under the control of the large multinationals. And, in an effort to broaden their market base, companies that previously were little active abroad have gone on a shopping spree outside of their national market (e.g Reemtsma). In the process, the degree of concentration of the industry has reached high levels, both at the national level and worldwide. In 1999, three companies controlled close to two-thirds of world cigarette production.4 Diversification In addition to taking over competitors, tobacco companies have tried to reduce their dependence on traditional, slow growing markets through diversification. This diversification has several dimensions: diversification by market segment; by target group; by tobacco product; and by geographical region.5 Productivity The cigarette industry has experienced spectacular productivity increases in the past century. The production capacity of the most modern cigarette machines increased from 250 cigarettes per minute (cpm) to 16,000 cpm in less than a century. But such high-speed machines alone cannot ensure high productivity increases. Or, as Mr. Ulrich Herter put it: “... high speed is not an end in itself. It is important to get the right logistics around the machine...”6. The layout of the plant needs to be adjusted to ensure that such high volumes are actually achieved. Production is being concentrated in fewer plants. Reemtsma‟s Berlin plant produced annually 3.65 billion cigarettes when it was inaugurated in 1959. In 2004, it produced ten times that volume with three times the number of employees. Further increase in productivity will lead to production in fewer plants and to greater concentration by company. Large companies are more likely to have the need to produce high volumes, the know-how to organize production efficiently and to invest in more productive equipment.7 3 According to Mr. Ulrich Herter, BAT’s Managing Director in an interview with TJI (3/99, p. 56) 4 See Corrao (2000), p. 64 5 See van Liemt (2002), p. 16f. 6 According to Mr. Ulrich Herter, BAT’s Managing Director in an interview with TJI (3/99, p. 56) 7 See van Liemt (2002), p. 28 Upsmoke Corporation: Supply Chain Transformation Page: 5 of 9 4. IMPACT OF INDUSTRY TRENDS ON SUPPLY CHAIN MANAGEMENT AT UPSMOKE CORPORATION Increased volatility of Sales Forecasts The cigarette industry is dealing with more price sensitive consumers since the 1990s. Brand loyalty is decreasing due to the exchangeability of products and price becomes one of the key purchasing arguments in the consumer mind. The consumer behaviour of switching from premium to medium or cheap price segment is not always a rationale decision taking the limited diversification possibilities of cigarette pack and product taste into account. Brand loyalty is often triggered by competitors‟ activities which try to use price as a selling enabler in marketing activities. BAT and Imperial Tobacco which positioned most of their products in the cheap and medium price segment try to gain market shares from the premium segment which is dominated by Upsmoke Corporation. As smoking incidence and consumption is declining since the 1990s, cheaper priced products are also a mean for the industry to stabilize or even increase Sales. In many markets the price of cigarettes is increased yearly due to a legal tax increase. These tax increases are especially difficult to forecast as they are one time events and the behaviour of distributor, wholesaler and retailer are hard to predict. In many markets trade loadings prior to tax increases are organized by the distributing entities to maximize their profits. Pressure on lead times (time-to-market) The volatility in Sales forecasting combined with fierce competition is driving the need for higher responsiveness of supplying entities. Short total lead-time is getting the key enabler to quickly react on latest demand changes and to achieve a high order fulfilment rate. To ensure lowest possible leadtimes in the information flow, demand forecasts need to be updated and matched with supply plans more frequently. Supply chain planners have to frequently focus on exception management and shortterm issue solving to ensure high responsiveness to market demands and to avoid out-of-stock situations. Accelerated means of transports (e.g. airfreight) in the material flow is another key enabler to avoid a discontinuation of market supply for standard products or to meet competitive deadlines for new product launches. Rapid growth of product portfolio New product launches and promotions are an effective tool to strengthen brand image and to gain market shares from competitors. The increase of the product portfolio has to be managed in an efficient way within the supply chain network in order to cope with the inherent complexity. It is estimated that the number of products within Upsmoke Corporation has increased from 5.000 in year 2002 to over 8.000 in year 2005. Supply chain processes and systems need to be adapted to allow planning of the network in an appropriate manner without boosting the resource requirements. Planning constraints at supplying entities Factories are constrained to achieve a high fulfilment rate of market requirements while balancing cost efficiency of production runs. Traditionally, factories at Upsmoke Corporation target to optimize its resource utilization of machinery and reduce setup times. The reverse sides of this functional optimization of batch runs are high inventories which are considered to be for free to achieve cost efficiency of supplying entities. As a consequence inventories in many supply chain networks are high and the risk of having the wrong product on stock is inherent. Through the increased volatility of demand forecasts, the high inventories and the growing product portfolio, the obsolescence of products and lost sales dramatically impact the performance of the supply chain network. Upsmoke Corporation: Supply Chain Transformation Page: 6 of 9 5. SUPPLY CHAIN CONFIGURATION AT UPSMOKE CORPORATION Upsmoke Corporation is using a make-and-buy manufacturing strategy to fulfil the market demand of 180 destinations. In-house manufacturing is applied for international and high volume products whereas the third party manufacturing strategy focuses on local niche products and on products that have to comply with legal trading agreements. Within 35 owned and 26 Third party manufacturing entities, a yearly volume of 750 bio. Cigarettes with 8000 different product variants is produced and shipped to customers. Products are flowing from continent to continent resulting in 1.450 active factory-market combinations. Around 160.000 twenty feet equivalent container units (TEU) are transported per year. The strategic and tactical duties to configure, maintain and control the global supply chain are arranged centrally by the Global Supply Chain Management department. The main activities include supply chain planning, portfolio management and sourcing. Execution and short-term planning activities are decentralized at an affiliate level which includes production and capacity planning, order processing as well as material and transport disposition. 6. SUPPLY CHAIN INTEGRATION AT UPSMOKE CORPORATION Upsmoke Corporation focuses on the internal supply chain in its activities to optimize the material and information flow between factory, transshipment points and market locations. There is no external integration neither on the supplier side nor on the customer side. The reason for the missing external integration is rooted in the facts that there is still a lot of internal potential to exploit as well as in the functional set-up of departments. In many markets third party distribution companies are engaged who buy products from factories and control the entire supply chain network upstream to the customer. In these markets Upsmoke Corporation has limited accessibility to inventory data and no possibility to infringe in the physical distribution flow. 7. SUPPLY CHAIN TYPOLOGY AT UPSMOKE CORPORATION Sales Type The products sold to customers are standardized products with a medium to low volume, weight and high value per item. The standard products are packaged in different sizes and have a sort of „convergent‟ BOM. The final customer expects to find his preferred brand anywhere at any time. If the desired product is not available, the customer changes his mind and buys a comparable product by another manufacturer. This behaviour is due to the relative low degree of product differentiation predominant in the cigarette industry. Therefore, cigarette manufacturers are forced to produce to stock by means of demand estimates. Since the product life cycle of standard products typically extends over several years, a solid data basis for forecasting is available. However, demand for some products may be subject to seasonal influences or price promotions. Distribution Type Cigarettes are distributed via distributors, wholesalers and retailers to the final customers. The product program of the manufacturer is supplied to the customer by one or a few factories. Thereby, several product types are produced in more than one site. The finished products are stored in the factory warehouse and transported over long distances to regional warehouses (RW). The customers in the vicinity of such a regional warehouse are supplied in one day tours with a delivery service of either 24 or 48 hours. Over the long distance between factories to RW all orders of the respective region are bundled, using a third-party service provider, so that high transport utilization is achieved. Upsmoke Corporation: Supply Chain Transformation Page: 7 of 9 Production Type The production process comprises two production stages, the tobacco processing and the cigarette manufacturing. Tobacco processing is organized in a continuous flow production whereas cigarette manufacturing is a discrete production process organized in production aisles. Each aisle executes all operation steps and is strictly coordinated and planned as a single unit. The manufacturing equipment is highly automated and is very capital intensive. The capacity of the production lines is limited and they utilized up to a level of 95% capacity. Therefore, they represent potential bottlenecks in planning. For the handling of the equipment, well trained operators are necessary. A short-term expansion of working time is normally not possible or has to be planned well in advance. The lines of big manufacturing centres are operating 5 days a week, 3 shifts a day. The final products can be assigned to a few setup families according to the physical appearance of the product. Changeovers within the same capacity categories (Bundle type, pack type, pack content, cigarette length and filter length) are negligible. However changeovers between items of different capacity categories cause high setup costs and setup times. Procurement Type The cigarette products have a rather simple BOM and therefore only few suppliers have to be coordinated. The procurement of the materials comprises standard products with a short and reliable fulfilment. The life cycle of the products is long and stable which result in mid- to long-term contracts. In case of sourcing bottlenecks, the change to another supplier is due to the high degree of standardization relatively easy and can be managed even in the short-term. 8. SUPPLY CHAIN PROCESSES AT UPSMOKE CORPORATION Upsmoke Corporation planning processes can be categorized based on central and local tasks along the supply chain. Historically, planning tasks were local activities as key markets had their own production centres exclusively supplying the domestic market. With the continuous penetration of new markets, these domestic production centres had to change its supply focus towards export markets. With the establishment of this new role, planning tasks of master production planning and distribution planning were centralized to ensure high customer service to export markets and synergies in the resource utilization. The planning cycle for standard Make-to-stock products lasts 40 calendar days. For new products or promotions which are produced Make-to-order the standard planning cycle is extended by another 40 days for material procurement and call-off activities. Within the standard planning cycle the first 20 days of the month are reserved for the market to generate a Sales Forecast and to hand over this plan to Logistics which creates an arrival forecast of products to be delivered by the factory to market distribution centres. On the 20th of the month the local arrival calculations are uploaded to the global supply chain system and sourced to supplying factories. As of the 21st of the month the factories create the mid-term (master) production plan by taking capacities and inventories into account. The first version of the mid-term production plan is finished by the 30th of the month. On the 1st of the following month the mid-term production plan is shared with the production scheduler who assigns production orders to machines and optimizes sequences. On the 10th of the following month the production schedule is finalized and the new plan created. The Global Supply Chain Management team supports the supply chain planning process by checking stock levels and backlog and tries to manage exceptions and problems. If planning constraints emerge, the Global Supply Chain Management team prioritizes production runs and initiates re-sourcing activities to avoid capacity short-falls. Below figure illustrates current planning process configuration. Upsmoke Corporation: Supply Chain Transformation Page: 8 of 9 Current planning process configuration Below graph highlights local and central planning activities. As most of the planning activities are not integrated, the transparency of planning activities and results is not given. Although information exists locally, the collaboration and coordination within the intra-organizational supply chain is limited to the extent of exchanging forecasts and sharing issues which other partners in the supply chain need to resolve. Local and central planning tasks 9. SUPPLY CHAIN SYSTEMS AT UPSMOKE CORPORATION As a result of local supply chain planning processes at Upsmoke Corporation, most of the supportive system solutions are local applications. These applications are uniquely supporting one factory or market for single or multiple planning task(s). It is estimated the company is using more than 150 different system solutions for supply chain planning around the globe. Each of these systems contains an individual configuration and requires expert knowledge in running and maintaining the application. As a result of the disperse system landscape the integration of processes and corresponding data is a key challenge for Upsmoke Corporation. To ensure a first integration of market, factory and central planning entities, the SAP APO Supply Network Planning module has been implemented in 2004. The system supports the global production and distribution planning processes by establishing Month 0 10 20 30 Month 1 10 20 30 Month 2 10 20 30 Month 3 10 20 Shipping Make-to-stock products Shipping Make-to-order products Current Situation  Monthly planning  Lead Time of 3 Months to adapt Market changes 30 Production Planning Production Planning Master Planning Master Planning Distribution Planning Distribution Planning Demand Planning Demand Planning Purchasing & Material Requirements Planning Purchasing & Material Requirements Planning Scheduling Scheduling Transport Planning Transport Planning Demand Fulfilment & ATP Demand Fulfilment & ATP sales distribution production procurement Central planning task Local planning task Upsmoke Corporation: Supply Chain Transformation Page: 9 of 9 transparency on forecast and inventory data. The SAP APO system has been implemented as a stand alone solution receiving data via flat files from more than 180 markets and 50 factories. The enclose figure depicts the current Upsmoke Corporation system landscape for supply chain management and the limited integration among functions and processes. It is also highlighted that there is no existing standard or recommendation for system solutions which can be deployed. For instance more than 30 different sales forecasting systems, including locally developed forecasting algorithms, are deployed for predicting cigarette demands. Local and central Supply Chain Systems References: Corrao, M. A. (2000): Tobacco control country profiles, American cancer society, Atlanta, USA. Herter, U. (1999): Competition in cigarette industry, in: Tobacco Journal International (TJI), ed. 3/99. Van Liemt, G. (2002): The world tobacco industry: trends and prospects, working paper, international labor office, Geneva, Switzerland. World Health Organization (1997): tobacco or health: A global status report, WHO, Geneva. ) Production Planning > 50 Systems incl. SAP, Adaytum , J. D. Edwards, Excel Production Planning > 30 Systems incl. SAP, Adaytum , J. D. Edwards, Excel Master Planning SAP APO system Master Planning SAP APO system Distribution Planning >100 Systems incl. SAP, Excel, Local developments Distribution Planning >30 Systems incl. SAP, Excel, Local developments Demand Planning >100 Systems incl. SAS, SPSS, Cognos , Excel, Local developments Demand Planning >30 Systems incl. SAS, SPSS, Cognos , Excel, Local developments Local MRP Systems >50 Systems incl. SAP, Adaytum , J. D. Edwards, Excel Local MRP Systems >20 Systems incl. SAP, Adaytum , J. D. Edwards, Excel Scheduling >20 Systems incl. STP, Excel Local developments Scheduling >10 Systems incl. STP, Excel Local developments Transport Planning >10 systems Local developments Transport Planning >30 systems Local developments Demand Fulfilment Global SAP R/3 Under development Demand Fulfilment Global SAP R/3 Under development sales distribution production procurement Global system Local system(s