Strategic Application of SCM in Food Companies: Current Experience and Future Opportunities

Tom Rathje, Research and Development, Danbred North America, Lincoln, NE 68588-0491

Gyu C. Kim, Department of OMIS, COB, Northern Illinois University, DeKalb, IL 60115

I. Introduction.

Firms develop strategy at various levels including Enterprise, Interorganizational, Corporate, Business Unit and Functional/Operational (Digman, 2002). Current thinking suggests that competition within some industries is increasingly between value systems versus individual firms (Lambert et al., 1998). This evolution partially shifts supply chain strategies from the interorganizational to the business-unit level. No longer is it optimal to focus only on efficiencies within internal operations but the firm must now consider the level of efficiency attained by the entire value system. This level of virtual integration can be expected to increase as firms seek new levels of competitive advantage. More importantly, virtual integration will impact the allocation of resources among various members of the value system.

II. Generic Supply Chain Strategies.

The traditional model of a supply chain was described as linear wherein products moved linearly in one direction and information moves linearly in the opposite direction. Two types of technology have become available which have and will continue to support revolutionary changes in supply chain strategies: the internet and computing power (Rosenbaum, 2001). The linear model, described above, can be transformed into an interconnected network wherein each participant is apprised real-time of customer demand and develops an understanding of how that demand impacts their part of the value chain. Advances in computing power are also important to developing efficient supplier networks. Computing power also supports decision support analysis to be deployed across the system. The formation of a networked, integrated supply chain supports numerous strategy initiatives within the modern firm. In particular, many firms state that enhancing shareholder wealth is a core value of the firm. Corporate and operational strategies surrounding supply chains can make significant contributions to this goal (Rosenbaum, 2001), including:

Reducing the working capital demand by replacing inventory with information, improving the flow of cash and, reducing the inventory of supplies for manufacture.

Enhancing revenue through more effective customer segmentation, delivering the right product at the right time, networked product development, dynamic pricing and more efficient handling of customer service.

Cost reduction can be achieved through improved processes such as the support of lean manufacturing concepts (e.g. J.I.T.), creation of the adaptive organization (versus reactionary), and optimization of all logistics costs associated with an order.

Enhanced fixed capital efficiencies mainly through more effective use of available capacity, chain modeling to discover optimum relationships amongst participants and effective outsourcing.

III. The Current State of Supply Chain Management in Food Systems.

The current state of application of supply chain management strategies within the general food industry is widely varied between highly sophisticated and virtually non-existent. An example of a sophisticated system is that operated by Independent Purchasing Cooperative, owned by independent Subway sandwich shop franchisees, which, along with suppliers and distributors to the cooperative, invested in the development of an extranet supply chain management system to better handle $1.8 billion in purchases for Subway stores nationwide (Corbin, 2000). The extranet supports the integration of computer systems among manufacturers, distributors and ultimately Subway stores. The expected savings from the system was in the range of 2-3% of the overall cost of ingredients. The first phase of the plan will permit tracking of orders from manufacturers and suppliers to distributors. The system will permit price and performance comparison among distributors and manufacturers, monitor contract compliance among members of the supply chain and lend support to food safety initiatives. Any product not meeting safety or quality standards can be removed from the supply chain at any time. The above example is represents a general trend in the food industry toward efficient customer response systems (Kurt Salmon Associates, 1993). Efficient Customer Response (ECR) is driven from the ultimate consumer backward through the supply chain enabling retailers to more efficiently meet the needs of consumers, keep costs competitive and insure quality. ECR itself is a generic strategy to leverage information that results in better service to customers. ECR has as its key objectives:

  • Efficient Store Assortments: Optimize the productivity of inventories and store space at the consumer interface.
  • Efficient Replenishment: Optimize time and cost in the replenishment system.
  • Efficient Promotion: Maximize the total system efficiency of trade and consumer promotion.
  • Efficient Product Introductions: Maximize the effectiveness of new product development and introduction activities

ECR is somewhat unique to the foods industry as its development was at the consumer end of the value system prior to any developments further upstream in the food value system.One of the explanations for this development is consolidation within the retail sector and the market power garnered by large food service companies such as Subway, McDonald’s and others (William Reed Group, 2000). As of 2000, 34% of the food market was controlled by the top four grocery store chains. Increasing market power of retailers allows them to place more demands upon processors and food manufacturers. These demands include delivery of product within a specified time period, loading of pallets to specifications set by the retailer, packaging and labeling requirements, product specifications, etc. (Anonymous, Food Manufacturer, 2002). In addition to consolidation, retailers, being closest to consumers, have the advantage of market data and thus the power to make decisions for entire value chain (William Reed Group, 2000). The increasing pressure upon manufacturers and distributors results in manufacturers focusing on the operational strategies of flexibility, efficiency, cost-effectiveness and asset management. Manufacturers must remain flexible to respond to shifting consumer demands and build in efficiencies in order to compete on cost. Asset management becomes important due to the high failure rate of new products and shifting demand of consumers and retailers. Large investments in fixed assets are risky for new products that may fail, resulting more leasing arrangements until a product is established in the market. Gill (1996) explores ECR further describing ECR as the key driver forcing food manufacturers to undergo large restructuring efforts in an attempt to meet the demands of customers (i.e. retailers). Food manufacturers have, and in many cases still do, operate under a decades old business model of purchasing commodities, producing in excess, storing product and waiting for orders to roll in. ECR requires manufacturers to be responsive to customer demands for unique packaging and shipping arrangements along with the flexibility to manufacture in exacting quantities a more diverse array of specialized products. ECR has the benefit for adaptive manufacturers of reducing the cost for commodities and warehouse space because these elements are replaced with customer information. At the front end, food manufacturers need to establish links between their internal distribution, warehouse, logistics, and manufacturing systems with the purchasing and ordering systems of their distribution and retail customers. At the back end, the companies need to integrate their own inventory and ordering systems with the ordering and purchasing systems of their suppliers, those companies that make and market the packaging and basic commodities that go into processed foods. Rosenbaum (2001) describes unique challenges to retail industries wanting to adapt supply chain strategies, many of which are reflective of the experience of food manufacturers. Retailing involves a great deal of promotional activity that acts to distort consumer demand and send invalid signals to the supply chain. The distortion of market demand forces collaborative decision making and information sharing so that suppliers can truly understand consumer demand. Heinz chose IBM’s Continuous Replenishment System to manage daily inventory for its customers and manufacturing plants. This example demonstrates the use of off-the-shelf software to gain information about real market demand. As of the date of the article, 35% of the product movement between Heinz and retailers is handled through the automated system. The above examples and discussion demonstrate the general trend within the food industry of using Efficient Customer Response (ECR) as the driving force for investment in supply chain management. Driven from grocers and wholesalers, such systems largely focus on application of widely applied supply chain strategies such as reductions in inventory, customization of shipping and product labeling, use of electronic data interchange to automate ordering and communication of demand and promotion of joint decision making to insure an available supply of required goods. The interest of the industry in these applications is borne out by examples of the supply chain management tools available to the industry. A search of available software and consulting products for food industry supply chain management supports the conclusion above. Advanced Food Systems markets FoodDISTRIBUTE, as software package geared toward supporting processing, distribution and financial management needs of food manufacturers (

Specifically, this system supports business to business customer management, inventory optimization and activity based accounting. Agribuys, another software firm, produces software focusing on automation of order processing, delivery tracking and logistics for perishable food products ( Parity Corporation offers a similar product to Agribuys call ParityPro designed to integrate sales, distribution, and purchasing, manufacturing and financial information for food companies (paritycorp.com). Integrated Distribution Solutions, located in Omaha, NE, provide a similar line of software products aimed at demand planning and product distribution ( Focusing more specifically on animal based products, Aspen Systems, Inc. delivers a more complete package that includes not only financial and distribution modules but also targets process management and labor, warehouse automation, sales and slaughter management (aspen-systems.com/product/index.html). The slaughter management module handles grower payments, product yields, market pricing and livestock reconciliation. Another animal product-focused company, Data Specialists, Inc., produces a software package aimed at the dairy products industry citing the ability to manage raw material composition and process formulation, the ability to value production based upon dairy markets and movement of production to a particular order or customer (dataspecialists.com). A review of the current state of supply chain management in the food industry reveals strong trends rooted in Efficient Consumer Response (ECR) applications by powerful retail firms. Consolidation among retailers has concentrated power in those firms closest to the consumer. Consequently, supply chain strategies have focused on cost leadership through reducing inventory costs for retailers along with transaction and distribution costs. Consulting and software companies have focused on the consumer end of the food value chain, providing supporting technologies to meet the needs of retailers and concurrently, the demand placed upon food manufacturers by retailers. A very distinct void is the virtually non-existent application of supply chain strategies further upstream from food manufacturing companies.

IV. Opportunities for Future Application of Supply Chain Strategies.

The very nature of food production, rooted in biology and large numbers of relatively small manufacturers, creates unique challenges for application of supply chain management. In its simplest form, effective supply chains supply information about consumer demand to all parts of the value chain. This communication is notably lacking for producers of agricultural products. Because of the fragmented nature of these suppliers, it is challenging to involve producers in integrated networks that communicate required levels of product dictated by consumer demand. Buhr (2000) discussed these challenges. Buhr states that the advent of the virtual supply chain supported by integrated computer networks attaches all members of the value chain to the consumer in way that could never before be accomplished through the linear, physical relationships the existed prior to the advent of internet technology. It can be argued that the recent trends of contracting supply have been utilized by purchasers of commodities to improve communication and quality among producers and growers. However, application of networked supply chains to the producer level will support new and innovative differentiation strategies at the farm level. Previously undifferentiated products can be source verified and non-measurable characteristics such as non-GMO, ‘free-range’ and ‘organically grown’ and be validated through the use of information technology. Networked supply chains permit producers of commodities to leverage their products further into the food value chain if they can clearly demonstrate a differentiated product with quality and price attributes appealing to consumers. Buhr (2000) notes that information technology can have a large impact upon market power relationships dictated largely by who controls the information. The current perception, supported by the literature review presented earlier, is that in food value chains, market power is concentrated in the hands of retailers, closest to the consumer. Market power diminishes as one moves upstream in the food value chain with commodity producers having the least market power. Information and internet technology provides commodity producers with a unique opportunity to pursue differentiation strategies in order to compete more effectively for the rewards to value added along the food supply chain. Choosing carefully which supply chains to participate in dictates access to key consumer information that can be leveraged to improve the value added, and payment received, for a differentiated food product. Another consideration is the simple matching of demand and supply in food systems. Biological systems create unique challenges. Particularly noteworthy is the time lag between the initiation of the production process and availability of raw product. Grains require a complete growing season of 4-5 months. Livestock require longer periods (ten months in pork production, beef production requires 1 year). Meats and produce have the unique problem of being sold fresh meaning that after a relatively extended production period, their storability in fresh form is quite limited. Therefore, the concept of just-in-time takes on a new dimension in that demand must be forecasted much farther in advance than with non-biological products. Currently, the commodity markets serve to communicate supply and demand in the food industry. This may be an effective and perhaps, pure competition market, but it inherently increases the risk associated with producing food. A better communication mechanism would reduce the level of uncertainty in demand and permit producers to more closely match supply with demand. Networked supply chains utilizing internet technology may provide the mechanism necessary to replace the commodity markets as the primary method of communicating demand. Natural biological variation also impacts the available supply. In livestock, animal disease, mating success, weather and other natural phenomena create unpredictability in supply. Similar factors affect the availability of produce and grains. The uncertainty created by this unique aspect of food production must be addressed during the application of supply chain management concepts to producers and growers. Biological variation also produces tremendous opportunity for differentiation. Variation among genetic lines for meat, produce and grains results in products differentiated by superior taste and eating quality. Production systems and practices themselves can support differentiation strategies. For example, consumers are increasingly interested in animal welfare and organically produced food products. Therefore, production systems utilizing ‘free-range’ production practices, for pork fed organically produced grain that is source verified, is a differentiation opportunity that can be leveraged to enhance the value of pork products. Weiss and Fagan (2001) reviewed the application of Burlington Northern’s Coal Forecasting Tool. This tool provides an example of how production of a commodity can be better matched to demand. Using this tool, Burlington Northern was able to alleviate bottlenecks at coal mines by linking the production capacity of mines with demand dictated by utilities. By communicating the information available to the value chain, but formerly unshared with participants, Burlington Northern was able to better stage trains for loading at the mines and ship product in a more timely manner to meet demand by utilities. Extending the railroad example to food producers, one can begin to envision how the key concept of demand for food items can be better communicated to growers such that supply is matched closely with expected demand. Such a system would support more efficient use of natural resources and reduce the cost associated with over and under supply of raw materials.