challenging the lead time issues in global supply chains

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Paper for the Logistics Research Network Annual Conference 2007, 5 -7 September 2007 in Hull, UK.

CHALLENGING THE LEAD TIME ISSUES IN GLOBAL SUPPLY CHAINS Johan Woxenius Division of Logistics and Transportation, Chalmers University of Technology, Göteborg, Sweden Tel: +46-31-7721339, Email: [email protected], and Blekinge Institute of Technology, Karlshamn. Abstract Focusing on flows of components and sub-assemblies, this conceptual paper identifies structures and analyses the effects of the options for coping with the increased lead times when connecting manufacturing steps into global supply chains. The rendering takes the perspective of final assembly firms in Western Europe and it is structured along the optional approaches of transferring the problem, as well as applying changes in the domains of transportation, sourcing, logistics and manufacturing and product design. Using the traffic modes complementarily, producing intermediary stock, abandoning buildto-order, sourcing consciously, restructuring the supply chain and re-engineering the product are examples of such options, but simply moving the problem to the partners upstream or downstream on the chain is also applied by the stronger actors. Keywords: Global supply chain, logistics, product design, sourcing, traffic modes. Introduction Although raw materials and finished products have been traded globally since antiquity, the manufacturing stages of highly integrated supply chains still rarely reach outside mature economic regions like the EU-15, the USA, Canada, and Japan. Contemporary logistics theory and practice generally apply to production networks of a corresponding spatial reach, especially for the manufacturing stages. The concept of just-in-time (JIT) deliveries, for instance, presumes a relative proximity among the activities (van Egeraat and Jacobson, 2005). Fawcett and Birou (1992) found that two-thirds of their survey’s respondents felt that JIT and global sourcing were incompatible, and Das and Handfield (1997) found only a few examples of companies seeking to combine them. As an example, the automotive industry can be described as many specialised second-tier suppliers sending daily truckloads of components to a few first-tier suppliers’ pre-assembly shops, which deliver small quantities in sequence and within strict time windows to the nearby assembly plant. Simpler and non-variant-specific parts are, however, supplied in a less strictly time-controlled manner as bulk or in batches. This practice is now challenged when components and sub-assemblies which also have a low priceto-weight ratio are increasingly sourced over longer distances. When changing the spatial configuration of supply chains, the trading partner’s nationality also changes. The discussion departs from mature economic regions and extends to adjacent, nearby, and distant partners. From a Western European perspective, adjacent partners are found in the twelve newest EU member states, nearby partners in candidate countries in the Balkans, Turkey and in the CIS states, and the distant partners mainly in China and India. This migration toward distant trading partners is a reality. South Korea, Mexico, and Eastern Europe— current component suppliers to Japan, the USA, Canada, and EU-15, respectively—now face competition from China and India. In a survey among U.S. manufacturing companies, Taninecz (2004) found that 45% of them sourced components and material from China in 2004, and most firms stated that China is already a link in their supply chain. Over a few years, General Motors (GM) has plans to increase its sourcing twenty-fold from China (Garsten, 2005) and eight-fold from India (Kühl, 2005), but that will still only account for single-digit percentages of GM’s auto parts. Moreover, Ford plans to source half of its parts to European assembly plants in low-wage countries (LWCs) in 2010 (Howes, 2005), but Eastern Europe is likely to capture the bulk of it. In a research review on the location aspect of global sourcing strategies, Murray (2001) found that most literature is descriptive and predominantly addresses cost advantages and business interactions. The logistics effects for operations often seem to be neglected. The phenomenon has attracted substantial scientific attention since then, but Kumar et al. (2006) and Meixell and Gargeya (2005) state that there is still a lack of literature taking a holistic approach. According to Deardorff (2005), theories of international trade often assume that transportation is costless and instant, or they are simply treated as an add-on. This may be too pessimistic, but neither of the shippers seems to fully realise the importance of transportation as part of supply chains. As an example, Lindau et al. (2004) found a prevailing attitude of treating transport services as “a given infinite commodity available at a market price” among Swedish manufacturing firms. This attitude toward transportation may suffice for short distances when choosing among hauliers, but the issue must be addressed much more consciously 1

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when it constitutes an increasing share of the supply chain’s lead times, costs, and environmental impacts. Supply chain managers are generally trained and accustomed to solving lead time issues by contracting the chain geographically and connecting the nodes with road transport. Structuring truly global supply chains based on the lowest possible labour cost for each refinement step then involves true challenges by re-introducing long transport lead times. In an earlier article (Woxenius 2006), the issue of time in global production networks was elaborated on by defining the elements of transport time, order time, timing, punctuality and frequency, and the effects of sourcing components from first adjacent, then nearby and finally distant areas were analysed. Just using air transport to maintain short lead times when spatially extending the supply chain is obviously not a universal solution. As a follow-up to the previous article analysing the lead time effects of spatially extending supply chains, this is a conceptual paper identifying, structuring and analysing the measures for dealing with the increased distances. The focus is on components and sub-assemblies rather than on raw materials and finished products and the article takes the perspective of final assembly firms in Western Europe. It focuses on practical and economic issues related to global trade and does not particularly question the trade for environmental reasons such as done by Tavasszy et al. (2003). The work is mainly based on logical deduction, but the examples are drawn from the literature and interviews. The rendering is structured along the approaches that the supply chain actors can choose from or combine, graded according to the degree of changes needed in their own operations. The list of approaches includes transferring the problem, transportation, logistics, supply chain structure, manufacturing philosophy and product design. In the following sections, some approaches for dealing with the increased distances when sourcing globally are suggested with most attention paid to the measures requiring least adaptation from the manufacturing firms. The transfer-the-problem approach The simplest, and thus most often applied, option for the dominant actor along the chain, often the final assembler, is to encapsulate his own activities and require that the other actors solve the problems; i.e., move the problem along the supply chain rather than solve it. The obvious price paid is that the sought benefits from production in LWC are not fully realized. One example is Volvo, which is regarded as representative of a global manufacturing company. Volvo’s business unit for trucks is the world’s second largest manufacturer of heavy-duty vehicles and it sources components to plants in 18 countries spread over virtually all continents. In 2005, 215,000 trucks were produced according to the principle of time-based mass-customisation with a planning horizon of 19 calendar days. Deliveries of sequenced components and sub-assemblies follow a very strict schedule, presented in Table 1 below. Since regular air transport is only economically justified for some electronics systems, most sequenced parts must be pre-assembled in the vicinity of the assembly plants. Second- and lower-tier suppliers, however, can produce components in any LWC, but must carry the cost of storage and the risk of obsolescence. Batch-delivered parts can be produced and delivered from adjacent regions, but for nearby and distant regions, the supplier must store the parts at a pick-up point within the set time distance (Sjögren, 2005). The low unit cost and non-variant specificity of bulk-delivered small parts enables production anywhere, as summarised in Table 1. Table 1 Volvo Truck’s lead time demands and the possibilities for supplying the assembly plants from different regions (adapted from Woxenius, 2006). Delivery type Sequence Batch Bulk

Time demand for component deliveries To chassis: 8h, To cabs: 3h Normal: 3d, Back-up: 1d Normal: 3h

Deliveries from economic regions Same Adjacent Nearby Distant Parts of Only components in second and lower tiers ------------Yes --------Yes, but stored at pick-up point ----------Yes, but delivered from distribution centre---------

Legend: h=hours, d=days.

Volvo sees a huge challenge in reconciling its customers’ demands for short lead times with the cost advantages of global sourcing. It organises batch-deliveries from adjacent regions, but for sequenced and small parts and for nearby and distant regions, it actually just moves the problem to its suppliers by defining where they must locate production or distribution centres. Deardorff (2001) points out that it is the risk of obsolescence rather than the capital or storage costs that deters firms from sourcing from regions involving a long transport time. This is particularly true for components to masscustomised products such as trucks. Volvo also transfers the risk of obsolescence to its suppliers by

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buying sequenced and small parts on an assembly plant use basis, whereas ownership of batchdelivered parts is transferred at the pick-up points (Alftrén, 2006). The transportation domain Another way of addressing the problem of prolonged supply chains without changing the companies’ operations is to buy faster transportation. According to Hummels (2001), faster transport services by air and sea have reduced the tariffs on manufactured goods from 32% in 1950 to 9% in 1998, facilitating space/time convergence (Hesse and Rodrigue, 2004). Time is, however, generally disproportional to the increased distance when sourcing in global markets. While transport systems are reasonably well developed, administratively and technically homogenous, and harmonised within the mature economic regions, sourcing from adjacent, nearby, and distant LWCs most often implies a significantly longer transport time. Limitation to a few traffic modes, lack of well-developed and connected infrastructure, insufficiently integrated transport services and tedious border crossings are common reasons for time consumption. This inertia obviously prevents global trade of many types of low-cost components and it also implies that suppliers can be sought only in areas served with good transportation services. For component deliveries from distant regions, air is sufficiently fast and sea offers large and sufficiently cheap capacity. Hence, the focus is to close the supply gap between air and sea in terms of time, costs and capacity. The supply gap can be closed by cutting costs and capacity constraints for air, but absent propulsion technology breakthroughs, together with cost-prohibitive fuel prices and environmental concerns make it more realistic for the transport industry to improve the speed of sea transport. Measures for speeding up services include improving the operations, finding new routes and combinations of traffic modes, and implementing faster vessels at sea. Congestion in ports is a true nuisance and with the steeply increasing size of container ships, handling times are considerable. Giving time-critical containers priority during port handling (last-in, first-out) might cut handling time by a day or two, though. The more likely scenario is to see transport time cut by a number of days when increased flows allow shipping lines to operate direct ships between one port in each continent or increase the frequency. So far, however, the larger flows have been managed by larger ships rather than by fewer port calls or higher frequency. A potential option is using the North-East Passage that is 7,400 kms shorter between North Asia and Europe than through the Suez Canal. The shipping line Hapag-Lloyd, which has investigated the option, deemed it unprofitable, since it can be used only during the few summer months. It also requires ice-breaking ships that are more costly, heavier and must be operated at slower speeds, due to the ice risk. In addition, they would consume excessive fuel when used in southern routes during winter. Furthermore, there are no intermediate ports of call, and the potential reduction in transport time is less significant for China and South Asia (Hapag-Lloyd, 2000). The combination of sea and air; e.g., through Dubai, is regarded as relatively mature, but Mediterranean ports like Gioia Tauro, Italy, and Barcelona, Spain, offer options of combining sea with road and rail for cutting a few days to Northwest Europe compared to doubling the Iberian Peninsula. The inland transport system in China, which is currently very slow, is rapidly modernised at a budget of $240 billion for each mode (Kühl, 2005). This will obviously cut time for deliveries from inland suppliers. The Trans-Siberian Railway (TSR) is often mentioned as a viable alternative between air and sea in regard to time and costs. TSR is primarily competitive for transit time for transport from Western China to Eastern Europe (Peetermans, 2004), but a train moved fifty-two 40-foot containers with computer components from Shenzhen in the more industrialised Southern China, to Pardubice in the Czech Republic in just 17 days, roughly half of the time required for sea transport (X-Rail News, 2007). However, test runs for Dynapac, a Swedish manufacturer of construction equipment, importing containers with components from China, resulted in a lead time reduction of just two days to one week, at a tripled transport cost compared to sea transport. The delays mainly occurred west of Moscow (Wendel, 2005). To speed up the transit time, the European Conference of Minsters of Transport has approved an Action Plan containing measures on border crossings, rail transport, simplifying the legal framework and new information and communication technologies (ECMT, 2005). Although TSR may be competitive in terms of time and costs, there are doubts about its capacity. According to the Government of Poland (2004), the capacity of TSR, after modernisation, is limited to 600,000 containers a year, compared to the 10 million twenty-foot equivalents (TEU) that are expected to transit between Europe and Asia in 2015 (ECMT, 2005). Hence, container ships will dominate the EU-Asia trade for many years to come, but the TSR is at least an option for reducing the supply gap between sea and air. The TSR can also be instrumental in developing the southern parts of the CIS

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along the TSR into a sourcing region for western firms (ECMT, 2005), using the 36 intermodal terminals along the route with the capacity to handle up to 40-foot containers (Dynkin, 2002). One result of the increased distance compared to RoRo shipping within regions is, however, that the speed of vessels is comparatively more important than terminal times. Nuclear propulsion has been a hope, and four merchant nuclear ships have been built (described by country, cargo, year commissioned, and speed): the NS Savannah (USA, general cargo, 1962, 21 knots), the Otto Hahn (Germany, ore/later rebuilt for containers with diesel engines, 1968, 17 knots), Mutsu (Japan, research, 1990, 16,5 knots) and Sevmorput (Soviet Union, LASH/containers, 1988, 20 knots), but they have not proven to be of any commercial success (Radiationworks, 2007) and actually offer slower speeds than the 25 knots typical of contemporary post-panamax container vessels. Nevertheless, there is a technical potential, since nuclear-powered aircraft carriers, matching the size of container giants at 100,000 tons, cruise at up to 35 knots (Radiationworks, 2007), although at prohibitive cost. Currently, it is regarded as unrealistic to renew plans for commercial nuclear vessels for both economic and public opinion reasons. Neither significantly increasing speeds with current diesel engine designs, nor fitting ships with steam turbines, like the Sea Land Commerce that crossed the Pacific at 33 knots average speed in 1973 (US Navy, 2007), would be economically justified. It remains to be seen, however, what potential fuel cell technology has for fast and economical sea transport. The sourcing domain The sourcing domain, which might also be referred to as the supply chain design (Meixell and Gargeya, 2005) domain, regards which actors are part of the chain and predominantly the localisation of the intermediate nodes and to some part more definite location of suppliers such as investigated by Eberhardt et al. (2004). It also concerns the localisation of own plants (Allen, 1991; Venables, 1999). One option is to balance demand over the season and the production life cycle by taking the same item from geographically separated facilities. A manufacturing firm in Western Europe can then place a base order of components matching the lowest forecasted sales volume from distant countries, complementing order over the season or product life cycle from nearby countries and emergency orders from a supplier in adjacent countries or within Western Europe. With short product life cycles, the first batches of components might be sourced in the relative vicinity of the assembly plants and then sourced more distantly when the product matures in the market. A similar distinction can be used for different types of components. The firm will then buy generic components in distant countries, semi-generic from nearby countries and successively move the sourcing closer to the assembly facility as the components are more unique. A contradiction is that generic components are often heavy or voluminous products with comparatively low labour content, which are not the ones with most benefits from sourcing in LWCs. These measures imply different levels of integration with the suppliers. Taninecz (2004), for example, finds that firms with the least integration with their suppliers and the most integration with their customers are less likely to source from China. The reason for the latter is believed by Taninecz (2004) to be JIT delivery commitments, but another interpretation might be that tight integration means that the supplier develops the components and then the assembly firm cannot just use other suppliers. The logistics and manufacturing domain In the logistics and manufacturing domain, the obvious--but for some industries painful--option is surrendering from build to order (Gunasekaran and Ngai, 2005) and use prognoses to produce to stock again. Buffering components at different stages and applying the postponement principle might also be approaches for coping with longer lead times. One aspect of logistics regards the demand side of transport services, i.e., the choice of traffic mode and how these are used and combined based on standard offers as investigated by, for instance, Kiesmüller et al. (2005). Examples are to change traffic mode over seasons or the product life cycle, use air transport for solving occasional problems and adapt consignment sizes and departure frequencies to the transport offer. The sourcing strategies today generally take the supply gap between air and sea into account. Either low cost, generic components are sent by container shipping or more costly components are sent by air. Volvo Cars, for instance, primarily buy comparatively expensive parts like electric cable systems from China and fly them to European assembly plants (Sjögren, 2005). The product design domain In the longer run, the product design domain will be further affected by the globalisation of supply chains. The measures include over-delivering, i.e., building in all “optional” equipment in the standard model such as the Japanese car manufacturers did when they first challenged the Western European manufacturers on their home markets. Another way is to modularise the product to lower the width of varieties and hence lower the dependency on accurate prognoses (Doran, 2005; Frigant and Lung,

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2002), which was acknowledged early and mastered by the Swedish truck manufacturer Scania. To really reap the benefits of sourcing from LWCs, manufacturers are likely to increase the share of generic components, design the product for postponement, or at least lower the value of the unique parts that must still be sourced comparatively locally. Increased focus on economies of scale in component manufacturing also fosters this development. Japanese producers of electronic calculators, for instance, used the same printed circuit card for several calculators in the 1980’s; just differentiated by the available buttons on the calculator cover. Coming back to a Volvo example, the V70 models with 140 and 170 hp engines differ mostly in the engine control software. This is a typical example of postponement where the final programming decides which model the customer receives and it can also be changed afterwards if allowed by the authorities. Nevertheless, the obvious and commonly cited example is Benetton’s dyeing of t-shirts following how the colours sell in their stores. Implications and conclusion The above rendering is summarised in the conceptual model in Figure 1. It is admittedly a clear simplification that the magnitude of change increases to the right in the figure. A new product design might, for instance, imply very small changes if consciously done when changing product generations whereas changing suppliers might imply severe strains on the work in the purchasing department and the reliability of deliveries will affect the assembly operations. Other measures might not be at hand at all; transferring the problem is obviously no option for assembly firms with a weak supply chain position and also strong firms will probably pay a price in one way or another.

Figure 1. Measures for coping with increased distances and lead times in component supply. It is still believed that this conceptual discussion and attempt of structuring the situation can inspire manufacturing firms to act more rationally when sourcing globally than seems to be current practise. In fact, statements like “moving 25% of sourcing to LWCs within five years” are far too common for assuming that all global sourcing decisions are consciously taken after careful investigation of the consequences although methods are available (Lowson, 2002; Nassimbeni and Sartor, 2007). Combining global sourcing with mass-customisation of products is simply not an easy task! References • Alftrén, H. (2006), "Future Logistics Strategy of Volvo Truck Corporation," Chalmers Logistics Update, 2 February. • Allen, K. M. (1991), "The role of logistics in the overseas plant selection decision of United Statesbased multinational corporations," Journal of Business Logstics, 12(2), pp. 59-72. • Das, A. and Handfield, R. (1997), "Just-in-time and logistics in global sourcing: an empirical study," International Journal of Physical Distribution & Logistics Management, 27(3/4), pp. 244-254. • Deardorff, A. (2001), "Time and Trade: The Role of Time in Determining the Structure and Effects of International Trade with an Application to Japan," Analytical Issues in the Trade, Foreign Direct Investment, and Macro/Financial Relations of the USA and Japan, Tokyo, 18-19 May. • Deardorff, A. (2005), "The Importance of the Cost and Time of Transport for International Trade In: ECMT: Time and transportt," European Conference of Ministers of Transport, Round table 127, Paris. • Doran, D. (2005), "Supplying on a modular basis: an examination of strategic issues" International Journal of Physical Distribution & Logistics Management, 35(9/10), pp. 654-663. • Dynkin, B. (2002), "Comments on the regional railroad network and power grid interconnection," Second Workshop on Power Grid Interconnection in Northeast Asia, Shenzhen, China, May 6-8. 5

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• Eberhardt, M., Mclaren, J., Millington, A. and Wilkinson, B. (2004), "Multiple forces in component localisation in China," European Management Journal, 22(3), pp. 290-303. • ECMT (2005), "Time and transport," Round table 127, Paris. • Fawcett, S. and Birou, L. (1992), "Exploring the logistics interface between global and JIT sourcing," International Journal of Physical Distribution and Logistics Management, 22(1), pp. 3-14. • Frigant, V. and Lung, Y. (2002), "Geographical proximity and supplying relationships in modular production," International Journal of Urban and Regional Research, 26(4), pp. 742-759. • Garsten, E. (2005), “GM pushes its suppliers to tap China,” The Detroit News, 7 April (accessed 11 October, 2005). • Government of Poland (2004), "Euro-Asian Links: activities related to the development of EuroAsian transport links," UN Economic and Social Council, Working Party on Transport Trends and Economics, 20-21 September. • Gunasekaran, A. and Ngai, E. W. T. (2005), "Build-to-order supply chain management: a literature review and framework for development," Journal of Operations Management, 23(5), pp. 423-451. • Hapag-Lloyd (2000), “North-East Passage no real alternative,” press release, 20 April. • Hesse, M. and Rodrigue, J.-P. (2004), "The transport geography of logistics and freight distribution," Journal of Transport Geography, 12(3), pp. 171-184. • Howes, D. (2005), “Ford looks abroad for half of parts,” The Detroit News, 14 September. • Hummels, D. (2001), "Time as a Trade Barrier," GTAP Working Paper No. 18, Purdue University. • Kiesmüller, G. P., de Kok, A. G. and Fransoo, J. C. (2005), "Transportation mode selection with positive manufacturing lead time," Transportation Research Part E: Logistics and Transportation Review, 41(6), pp. 511-530. • Kumar, N., Rehme, J. and Andersson, D. (2006), "Logistics and trade effects on business and industries," Logistics Research Network Conference, Newcastle, 6-8 September. • Kühl, M. (2005), "The dragon spreads its wings," DB Logistics, Issue 3, pp. 8-18. • Lindau, R., Woxenius, J. and Edlund, P. (2004), "Verkstadsindustrins logistik - en innovationssystemanalys (The logistics of the manufacturing industry - an innovation system analysis)," Meddelande 120, Department of Logistics and Transportation, Chalmers University of Technology, Göteborg. In Swedish. • Lowson, R. H. (2002), "Assessing the operational cost of offshore sourcing strategies," International Journal of Logistics Management, 13(2), pp. 79-89. • Meixell, M. J. and Gargeya, V. B. (2005), "Global supply chain design: A literature review and critique," Transportation Research Part E: Logistics and Transportation Review, 41(6 SPEC. ISS.), pp. 531-550. • Murray, J. Y. (2001), "Strategic alliance-based global sourcing strategy for competitive advantage: A conceptual framework and research propositions," Journal of International Marketing, 9(4), pp. 30-58. • Nassimbeni, G. and Sartor, M. (2007), "Sourcing in China: a typology," International Journal of Production Economics, 107(2), pp. 333-349. • Peetermans, E. (2004), "Intermodality Europe-Asia: Relevance and Potential," ECMT-UNECE Seminar on Intermodal Transport between Europe and Asia: Opportunities and Challenges, Kiev, 27-28 September. • Radiationworks (2007), "Nuclear powered ships," www.radiationworks.com/nuclearships.htm, accessed 3 June. • Sjögren, H. (2005), Acting manager, Global development inbound, Volvo Logistics, Telephone interview 7 October. • Taninecz, G. (2004), "Partially made in China," Industry Week, 253(10), pp. 31-32. • Tavasszy, L. A., Ruijgrok, C. J. and Thissen, M. J. P. M. (2003), "Emerging Global Logistics Networks: Implications for Transport Systems and Policies," Growth and Change, 34(4), pp. 456–472. • US Navy (2007), "Fast Sealift Ships," www.navy.mil/navydata/, accessed 2007-06-03. • van Egeraat, C. and Jacobson, D. (2005), "Geography of production linkages in the Irish and Scottish microcomputer industry: The role of logistics," Economic Geography, 81(3), pp. 283-303. • Venables, A. J. (1999), "Fragmentation and multinational production," European Economic Review, 43(4-6), pp. 935-945. • Wendel, R. (2005), Logistics manager, Dynapac Compaction Equipment, Interview 23 September. • Woxenius , J. (2006), "Temporal elements in the spatial extension of production networks," Growth & Change: A Journal of Urban and Regional Policy, 37(4), pp. 526-549. • X-Rail News (2007), “ERS connects China with Europe,” Newsletter, June.

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