Supply chain management (SCM): Definition and FAQs

What is supply chain management?

Supply chain management (SCM) enables enterprises to source the raw materials or components needed to create a product or service and deliver that product or service to customers. The six components of SCM include:

1. Planning—Enterprises need to plan and manage all resources required to meet customer demand for their product or service. They also need to design their supply chain and then determine which metrics to use in order to ensure the supply chain is efficient, effective, delivers value to customers, and meets enterprise goals.
2. Sourcing—Companies must choose suppliers to provide the goods and services needed to create their product. After suppliers are under contract, supply chain managers use a variety of processes to monitor and manage supplier relationships. Key processes include ordering, receiving, managing inventory, and authorizing supplier payments.
3. Making—Supply chain managers coordinate the activities required to accept raw materials, manufacture the product, test for quality, package for shipping, and schedule for delivery. Most enterprises measure quality, production output, and worker productivity to ensure the enterprise creates products that meet quality standards.
4. Delivering—Often called logistics, this involves coordinating customer orders, scheduling delivery, dispatching loads, invoicing customers, and receiving payments. It relies on a fleet of vehicles to ship product to customers. Many organizations outsource large parts of the delivery process to specialist organizations, particularly if the product requires special handling or is to be delivered to a consumer’s home.
5. Returning—The supplier needs a responsive and flexible network to take back defective, excess, or unwanted products.  If the produce is defective it needs to be reworked or scrapped.  If the product is simply unwanted or excess it needs to be returned to the warehouse for sale.
6. Enabling—To operate efficiently, the supply chain requires a number of support processes to monitor information throughout the supply chain and assure compliance with all regulations. Enabling processes include finance, HR, IT, facilities, portfolio management, product design, sales, and quality assurance.

For a more detailed outline of these steps, check out the nonprofit Supply-Chain Council's website.

What's the role of supply chain management software?

The goal of supply chain software is to improve supply chain performance. Timely and accurate supply chain information allows manufacturers to make and ship only as much product as can be sold. Effective supply chain systems help both manufacturers and retailers reduce excess inventory. This decreases the cost of producing, shipping, insuring, and storing product that cannot be sold.

Roadblocks to installing SCM software may include:

Gaining trust from your suppliers and partners. As a result of the spread of television in the 1950s, manufacturers were able to build so much consumer awareness of their brands that retailers were forced to carry certain products. Unfortunately, executives in some national brands were quite arrogant and used their power to extract concessions from retailers.

Over the next thirty years power shifted from manufacturers to retailers. The explosion of broadcast television channels and the advent of cable television made it more difficult for manufacturers to have as much influence with consumers. During the same period, retailers gathered new insights about consumer purchasing habits from their point of sale (POS) systems. Eventually, Walmart grew powerful enough to dictate terms to manufacturers. Although smaller retailers lacked Walmart’s power, they realized that information about consumers was exceptionally valuable.

This power shift created friction, making many manufacturers and retailers reluctant to share information. While this cultural divide remains in many grocery and consumer products companies, it is fading as retailers realize they have to cooperate with manufacturers or supersize retailers like Amazon will render them irrelevant.

Internal resistance to change. If selling supply chain systems is difficult with customers and suppliers, it isn’t much easier with internal staff. Few people embrace change enthusiastically; in fact, most resist new processes, interfaces and job responsibilities.

An effective organizational change management program can help. The goals should be to convince everyone from front-line operations people to senior staff that the new processes and supporting software make jobs easier. Said another way, the program should help everyone understand, “What’s in it for me.”

What are some supply chain management examples?

Walmart and Procter & Gamble began to work together in the late 1980s and are the classic example of supply chain collaboration. Before these two companies began working to connect their supply chains, retailers and manufacturers shared little information. After Walmart and P&G demonstrated that shared information reduced cost, other retailers became more willing to consider the possibility. In the early 1990s Walmart formalized its Retail Link system and cajoled (some would say strong armed) other retailers to connect.

Over time, the Walmart POS system was able to aggregate sales of individual P&G products at each store. When the POS indicated that inventory for a particular product had fallen to a predetermined threshold, the Walmart distribution center was notified to ship additional product to the store. As inventory in the Walmart distribution center fell to its threshold, the P&G distribution center was automatically alerted to ship additional product.

Today, this continuous flow of information helps P&G to determine when to manufacture and ship products to Walmart. By avoiding manufacturing too much inventory and by automating the billing and payment process, both firms enjoy low costs.

What is the importance of supply chain management?

Over the last twenty years, the supply chains of manufacturers and retailers have become ever more tightly linked. In many industries, retail sales trigger replenishment orders to manufacturers. Manufacturers with a well-tuned, just-in-time supply chain can automatically restock retail shelves as products are sold.  As collaboration has increased, additional data from supply chain partners has allowed companies to use advanced analytic tool to further improve results. Examples include:

• Identifying potential problems before they occur. When a customer orders more product than the manufacturer can deliver, the traditional response has been to short the order. This leaves the buyer feeling unimportant and convinced the manufacturer’s service is poor. Manufacturers who anticipate the shortage before the buyer is disappointed may be able to offer a substitute product or other incentive to keep the buyer happy.
• Optimizing price dynamically. Seasonal products, particularly fashion products, have a limited shelf life. Any that don’t sell by the end of the season are scrapped or sold at deep discounts to empty the warehouse. Airlines, hotels, and other companies with a limited, but perishable product, adjust prices dynamically to meet demand. While this is more difficult with clothing and other products where the supply can vary widely, similar forecasting techniques can improve margins.
• Improving the allocation of available to promise inventory. Today’s tools dynamically allocate resources and schedule work based on the sales forecast, actual orders, and promised delivery of raw materials. Manufacturers are able to confirm a product delivery date when the order is placed, significantly reducing incorrectly filled orders.

What is the extended supply chain?

The extended supply chain includes all companies that contribute to a product. This means that the extended supply chain includes the suppliers to your suppliers as well as the customers of your customers.

When companies encounter supply chain problems, the initial action is to ask the supplier about the situation. However, organizations that monitor the extended supply chain have the option of reaching back through the primary supplier to the company that supplies components to the primary supplier. As an example, if a popular baseball hat is not available from the manufacturer, the normal reaction of the store manager is to contact the manufacturer. However, if the retailer monitors the extended supply chain, the store manager would know the manufacturer was having trouble getting the brim. If it appears that additional brims will not be available to the manufacturer quickly, the retailer would have time to seek a different supplier.

What is the impact of globalization on the supply chain?

Twenty-five years ago, one of the main reasons companies created global supply chains was to take advantage of lower wages in other countries. In general, it was fairly easy to off-set the increased shipping costs resulting from remote manufacturing. However, salary arbitrage advantages are eroding as wages in lower cost countries are rising, improved process and robotics allows plants to be operated with far fewer people, and local firms are becoming strong competitors in virtually every industry.

One of the advantages of the global supply chain has been the ability to scatter patents and manufacturing sites around the globe. This allowed companies to report profits in countries with low corporate taxes. However, many of these arrangements are being challenged. In 2016, the European Commission ordered Apple to pay Ireland €13bn in back taxes, ruling that Apple’s tax agreement with Ireland amounted to illegal state aid. The antitrust chief of the European Union, Margrethe Vestager, recently began investigating Amazon’s European tax practices. Google and other technology firms are also being investigated by the EU.

How will IoT affect the supply chain?

Today, RFID is deployed widely in most industries to help manufacturers track raw materials, products, pallets, and any other supply chain components. With the explosion of internet connected sensors, RFID is starting to be viewed as a part of the internet of things (IoT).

The hype surrounding supply chain IoT is very similar to the promised benefits of RFID ten years ago.  Advocates focus on object traceability, improved inventory tracking, and POS self-service. In fact, the power of the internet, combined with sensor and cloud technologies, should enable continuous monitoring of all parts of the supply chain.

How do legislation and regulation complicate the global supply chain?

The U.S., the European Union and others have created, over the last few years, new reporting requirements for large companies that manufacture or handle physical products. These reporting requirements can apply even if the company engages a third party to manage its supply chain. Complying with these regulations requires very robust SCM systems making supply chain management ever more difficult. At a minimum, the supply chain team needs to understand the following legislation:

• Dodd-Frank requires companies covered by the SEC’s Exchange Act and which either manufacture or have “actual influence” over the manufacturing process to report if their product contains gold, tin, tantalum, tungsten or other “conflict minerals.” Conflict minerals are mined in the Democratic Republic of Congo or other war zones with the profits used for continued fighting.
• California’s Safer Consumer Products Regulation is part of that state's Green Chemistry Law and covers products that contain a “Chemical of Concern.” Manufacturers, importers, assemblers and retailers must notify the Department of Toxic Substance Control of potentially dangerous products and must determine how to limit exposure to them.
• California’s Transparency in Supply Chains Act seeks to eliminate human trafficking. Retailers and manufacturers operating in California and selling more than $100 million, have to include statements on their web site describing their, “efforts to eradicate slavery and human trafficking from [their] direct supply chain for tangible goods offered for sale.”
• The U.K.’s Modern Slavery Act contains a Transparency in Supply Chain provision that attempts to eliminate slavery. Companies doing business in England and Wales with sales exceeding £36 million have to include a description, on their website, of their efforts to make sure slaves are not used in any part of their supply chain.
• The EU’s Regulation on Registration Evaluation, Authorization and Restriction of Chemical (REACH) covers any chemicals in paint, clothing, electronic products, furniture, etc. that might be dangerous. Companies making or selling products in the EU with a restricted chemical, needs to show the European Chemicals Agency that the product offered for sale is safe.
• Washington State’s Children’s Safe Product Act requires manufacturers of children's products to disclose if the packaging or the product contains formaldehyde, benzene or any other “Chemicals of High Concern to Children.”

Similar regulations are emerging in Denmark, China, South Africa, Malaysia, and other countries, and virtually all focus on keeping products safe, reducing human trafficking, or prohibiting profits from being used to continue fighting. Unfortunately, enforcement processes are not coordinated and data is not shared among different governments. Worse, reporting requirements will probably change as war zones shift and conflict materials list lengthens.

Although the objectives are commendable, additional reporting requirements make supply chain management even more difficult.

For more on this see Supply chains danger ahead

What is the impact of Amazon on the supply chain?

Amazon is disrupting many retail categories by delivering a broad array of products very quickly and often at a lower price than available in a retail store. Amazon operates 24/7 and typically delivers in one to two days. By adopting continuous fulfillment rather than overnight fulfillment, Amazon is able to offer same-day delivery in some markets.  Many retailers without a well-defined and profitable niche, have already been driven out of business. No doubt, others will fail over the next few years.

Amazon is creating its own delivery service. The company has leased airplanes and created its own fleet of branded trucks to move products among its distribution centers. In addition, Amazon has created Flex to deliver packages to consumer homes. It is not hard to imagine Amazon doing what they did with AWS and creating a new business from excess capacity.  If this happens, Amazon could compete directly with UPS and FedEx.

In addition, Amazon could offer a full suite of logistics services for small consumer products vendors.

If these vendors outsource manufacturing and rely on Amazon to manage ordering and delivery, the vendor’s business could be limited to creating and sourcing products. They would not need the manufacturing or distribution infrastructure that large consumer products companies have created over the years.

How should the supply chain be measured and monitored?

Well-run supply chains are measured in a variety of different ways. Metrics help people focus on the most important activities and improve existing processes. Critical metrics support regulatory compliance, safety, or contractual obligations. Other metrics monitor and improve efficiency, improve service, and produce greater profits.

Supply chains rely on a variety of metrics. Common metrics include:

• Perfect orders – the percentage of orders that are error free
• Cash to cash cycle time – the number of days between paying for raw materials and getting paid for the final product
• Order cycle time – The time from order receipt to product delivery
• Fill rate – The percentage of orders that are delivered as ordered on the first shipment.

In reality there are hundreds of supply chain metrics. The art is to find the right ones for your industry and your business.

What impact do blockchain and smart contracts have on the supply chain?

A smart contract automates the “if this happens then do that otherwise do something else” part of traditional contracts. Computer code behaves in a predictable way without suffering from the linguistic nuances of human languages. In theory, a smart contract allows enterprises to sign a normal paper contract that includes a pointer to computer code encapsulated in a blockchain. The parties agree that both will abide by the results the code produces as long as the contract is in force.

The objective of the smart contract is to reduce the time and cost of contract enforcement by defining contract terms so precisely that they can be enforced by a set of computer rules. This eliminates the lawyers, notaries and other middlemen who facilitate the creation, storage, and administration of legal documents. Even better it minimizes the opportunity to sue, since contract terms have to be standardized and precise in order to render them as computer code; no clauses can be left to human interpretation.

Smart contracts have a great deal of potential. However, widespread use is some time away.  Few smart contracts have actually been put in place and few people have real experience turning contract terms into computer code.

While proponents remain optimistic, there is a growing realization that legal-to-computer translation is a difficult problem. Concerns include:

• It is difficult to anticipate every detail of all possible events that could happen under the terms of all but the simplest contracts. This level of specificity is needed to convert a written legal contract into computer code.
• A blockchain must be completely deterministic, with no opportunity for differences. Since smart contracts are executed by every blockchain node independently, if the blockchain requires data for processing that is not already present in the blockchain, it is difficult to guarantee that each node will receive the same data. For example, if an external source provides different answers depending on the time the request is received, blockchain consensus will fail, resulting in contract failure.
• Smart contracts have been hacked. In theory, a contract encapsulated in a blockchain should be more secure than a paper contract. Unfortunately, the Distributed Autonomous Organization (DAO), a leading proponent of smart contracts operating on the Ethereum blockchain, has been hacked several times.

For more on blockchain and smart contracts, see Getting started with blockchain smart contracts.

How is electronic data interchange (EDI) impacting the supply chain?

The Transportation Data Coordinating Committee was formed in 1968 to develop EDI formats for shipping companies that operated ocean going vessels, railroads, airlines, and trucks to exchange electronic messages.

EDI has matured over the years. The Accredited Standards Committee maintains the EDI X12 standard (sometimes known as ASC X12), which is widely used in the U.S. for supply chain, health care, insurance, government, and transportation. In addition, the ASC contributes to the UN’s EDIFACT messaging schema that is widely used outside of the U.S. Other EDI standards include The Organization for Data Exchange by Tele Transmission in Europe (ODETTE), VDA which supports the German automotive industry, and GS1 for global retail, healthcare, and transportation.

EDI will continue to speed communication through the supply chain. Messaging standards are well defined and incorporated in supply chain software. Standards committees continue to expand message types and keep the technology up to date.

Related reading:

• 4 ways retailers can improve supply chain management
• Brexit creates supply chain uncertainty
• Data science key to Monsanto improving its supply chain
• The power of inventory management means service with a virtual smile
• Self-learning supply chains? The store of the future? A conversation with an expert about what comes next

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