The Two Es

The Two Es

The breakdown in the global supply chain can be summarised in two words: efficiency and energy.

Efficiency sounds like a desirable outcome. It implies cost reductions and lower prices for consumers. How can efficiency be undesirable?

All systems require some form of energy, yet energy appears to be plentiful on a global basis, notwithstanding higher energy prices. How can energy be blamed for the breakdown?

These questions present the paradox of complex dynamic systems analysis. The global supply chain is one of the most complex systems ever created. Here’s the explanation of the paradox…

We’ll begin with efficiency.

Supply chains have been part of commerce for as long as there has been commerce. A Late Bronze Age vessel discovered in 1982 by a local sponge diver at Uluburun, off the coast of Turkey, was found to contain cedar from present-day Lebanon, ebony from Africa, oil lamps from Cyprus, amber from the Baltic Sea area, a cartouche from Egypt, and many other tools, weapons, and jars from various points in the Eastern Mediterranean. That vessel was clearly at the centre of an extended supply chain.

Adam Smith wrote extensively about supply chains in his 1776 book The Wealth of Nations. He did this to illustrate the economic role of productivity, the division of labour, and free markets.

Still, the modern science of supply chain management didn’t begin until the 1980s. That’s when the rise of globalisation and the expansion of computing power combined to make supply chains more complex, while offering tools to deal with the complexity.

Supply chains can be thought of as a bundle of costs that manufacturers bear in order to realise revenues (and hopefully profits once the costs are netted against the revenues). These costs include sourcing inputs, transportation, manufacturing processes, labour, equipment, distribution, inventory, and associated legal, administrative, and insurance expenses.

There are limits on what producers can charge for their products based on consumer preferences and competition. Given those limits, one of the most direct ways to increase profits is to reduce costs. Supply chain management takes aim at those costs by creating options, sharing information, eliminating redundancies, encouraging cooperation among supply chain participants, and other innovations.

Techniques to optimise efficiency

These efficiency techniques are numerous and go by many names. Here’s a summary of some of the most widely used techniques…

Lean: This is a technique developed by Toyota in the early 1980s and now almost universally adopted. It is sometimes referred to as the Toyota Production System (TPS). The idea is to run a supply chain with the least amount of time, effort, and money necessary. Specific innovations that have emerged from lean techniques are just-in-time inventory and the idea of minimising shipping costs by co-locating related functions. Lean aims to reduce motion, wait time, and inventory at every step of the production process. It also seeks to eliminate overprocessing (steps that don’t add value) and defects (in part by tapping into the skills and creativity of rank-and-file employees).

Six Sigma: This is a statistical methodology designed to minimise variation in production processes. The idea is to have a smooth process that reduces product defects to the sixth sigma (6σ). Statistically, this translates into 3.4 defects out of 1 million events. Six Sigma is implemented through a five-step process described as: define, measure, analyse, improve, and control. Since this is a process of continuous improvement, it’s sometimes combined with lean into a program called Lean Six Sigma.

Theory of Constraints: This methodology begins with the assumption that every supply chain process is constrained by a single step, which is the slowest in the chain. If an assembly line requires 1,000 tyres per day to produce vehicles at maximum capacity, and the warehouse can only supply 800 tyres per day, then the assembly line must slow down to a point 20% below capacity because of the delivery constraint. Once these bottlenecks are identified, available resources should be used to fix the bottleneck in order to make the entire supply chain run more smoothly and increase output to capacity.

RACI matrix: This is a supply chain management technique used to improve teamwork in solving problems. RACI stands for responsible, accountable, consult, and inform. It’s intended to let every member of a team know what they are responsible for doing, establish benchmarks to hold team members accountable for performing their tasks, encourage consultation among team members to ensure that efforts are coordinated, and inform team members if specific tasks have been accomplished or are ongoing.

DIRECT model: This is a technique used by leaders in supply chain management improvement projects. It’s another acronym that requires managers to: define the objective, investigate the options, resolve on a course of action, execute a plan, change the system, and transition people to new roles once a project is completed.

SCOR model: This is another management tool for those involved in supply chain optimisation. SCOR stands for Supply Chain Operations Reference. It’s a framework for mapping supply chain improvement processes and evaluating results. The high-level elements of an efficient supply chain are defined as: plan, source, make, deliver, return, and enable.

As you can see, there are many different techniques and tools for improving efficiency in supply chains. But what are their hidden costs? Make sure you read my next edition of The Daily Reckoning Australia to find out.

All the best,

Jim Rickards Signature

Jim Rickards,
Strategist, The Daily Reckoning Australia

This content was originally published by Jim Rickards’ Strategic Intelligence Australia, a financial advisory newsletter designed to help you protect your wealth and potentially profit from unseen world events. Learn more here.