Connecting with Customers
As information-technology infrastructure has become cheaper, the cost of connecting with customers has become more reasonable for many companies.
At the same time, firms have had to make decisions about what information to collect, where and how often to collect it, and how to maximize its usefulness.
Should a company establish information links with all its suppliers to track what goods or raw materials are available, in what quantities and how quickly those commodities could be delivered?
Conversely, should it create an information system that monitors the inventory levels of goods held by all its customers? Today, supply-chain managers must grapple with these issues, as they seek new ways to leverage technology to expand their information networks and improve their operations.
However, before a company spends millions of dollars on an IT system, it is critical to determine the real value of the information targeted and whether the results fully justify the expenditure, says Roman Kapuscinski, the Sandford R. Robertson Assistant Professor of Business Administration.
"The expectation of many companies is that information is always very useful," he says. "But the conclusion I have drawn from my research indicates the usability of information varies dramatically, depending upon what type of demand and what kind of cost structure a firm faces."
His findings were reported in an article titled "Value of Information in Capacitated Supply Chains," which appeared in Management Science in 1999. He recently completed a more recent paper, "Advanced Demand Information and Safety Capacity," with two other Business School faculty, Xinxin Hu and Izak Duenyas, which extends many of the findings to firms with uncertain capacities.
To learn about the value of information, Kapuscinski studied a variety of companies with specific IT problems. Then he constructed mathematical models and ran simulations to develop generalized rules about how best to value information across different scenarios.
One of the companies he observed was NSF, a manufacturer based in Pittsburgh. The company, which is the largest supplier on the East Coast, prefabricates hamburgers for McDonald's restaurants and distributes many other goods to fast-food chains.
"Suppose this company decided to build an information system that allowed it to see the levels of inventory at its customers' locations," he says. "Should it target all McDonald's restaurants? Should it target all goods? Or should it target a subset of McDonald's restaurants or a subset of the goods it is providing to those locations?"
Before analyzing the value of the information, NSF might well have decided to target all McDonald's restaurants and all goods. However, after examining the demand for burgers and the costs of either over-stocking or under-stocking inventory, the supplier's decision turned out to be quite different. To illustrate, Kapuscinski offers three possible scenarios for NSF and its McDonald's customers:
- Demand is extremely stable, with 2,000 burgers sold daily.
- Demand is highly volatile, with anywhere from zero to 5,000 burgers sold daily.
- Demand is somewhat volatile, but not extreme, with somewhere between 1,500 to 2,500 burgers sold daily.
Information about inventory levels is most valuable in the third situation, according to Kapuscinski. "My research reveals that inventory information is most useful when a company is dealing with average situations, not extreme ones," he explains.
In the first scenario, the information is not really useful, because NSF already knows what a specific McDonald's store is going to sell on a daily basis. In the second scenario, the sales are so dramatically volatile that NSF will not have time to respond to spikes in demand, other than to keep a large amount of safety stock on hand.
"In the third situation, it is critical for NSF to respond quickly, but there is still time to respond, and that is what makes the system work," Kapuscinski explains. NSF's managers used Kapuscinski's computations and "menu of answers" to guide their decision-making about spending on IT systems.
A slightly different problem arises when inventory is distributed to multiple customers with different valuation criteria, such as expectations for service levels and payment margins.
"When a company has low inventory, it may even choose not to give that inventory to a specific customer, because there is a great likelihood a more profitable customer will request it very soon," Kapuscinski says. "This ration inventory, as it's called, is kept in stock for a special subset of customers and is not given to everybody."
Drawing on his observations at companies with heterogeneous customer classes, he developed a second rule about valuing inventory information, based on the average level of penalty for stock-outs or shortages.
"If the penalty or cost of not having enough inventory is very low, information is not very useful," Kapuscinski says. "If the penalty or cost is extremely high, information also is not very useful; when a company knows up-front about the high penalty for shortages, it will keep a lot of extra inventory in stock. However, if the situation falls somewhere between those extremes, the information on inventory levels is extremely valuable."
A third consideration for gauging the value of information deals with how constrained a company is by its production capacity. At NSF, managers initially assumed that when capacity was tight, obtaining inventory information from their McDonald's customers would be beneficial and help them improve their operations. That conclusion proved to be wrong.
"If a company has tight production capacity, it is nearly useless to have this information because the company cannot respond to increased demand in any case," Kapuscinski says. "On the other hand, if a firm has a lot of capacity, this information can make a huge difference because the firm can respond quickly to sudden needs for extra products and deliver them to specific customers. The more capacity a company has, the greater the value of information."
These rules apply to buying and selling throughout the supply chain, whether manufacturers are marketing products and services directly to customers or suppliers are purchasing raw materials and goods from manufacturers. Across-the-board implementations of information linkages are typically very difficult to achieve, however.
"Although a company may want to connect with nearly all its customers and suppliers, it should start with the most promising ones, using the criteria I've outlined," Kapuscinski advises. "That sequence will produce the maximum benefits and allow the company to calibrate the advantages it could expect to gain by connecting electronically with other groups of customers and/or suppliers."
A manufacturer can coordinate its production schedule to the needs of specific customers. This reduces the cost of stocking extra inventory and avoids the penalty of shortages, which can result in dissatisfied customers, lost sales and second-hand corrections, i.e., expedited orders, overtime, discounts and/or shipments from other facilities.
In addition, a company may be able to maintain its current service level at a lower cost, or increase its service level with little or no increase in cost.
"There are no universal lessons, however," Kapuscinski cautions. "It is important to be aware of the generalized rules for determining the value of information, but each company must be considered on a case-by-case basis."