American PC producers and Italian fashion makers are strange bedfellows. But both are world leaders in industries with short-lived products, and both need to excel in supply chain management to keep up with an increasingly dynamic marketplace. Both face ever-shrinking product life cycles, the globalization of sourcing and manufacturing, and a mushrooming of new products. And both are having to cope with more sophisticated customers demanding tighter delivery terms, as well as powerful suppliers dictating long lead times.

Consider fashion. A high-end fashion manufacturer offers up to 2 or 3 million SKUs, 95 percent of which change every six months. Average sales are two or three units per SKU, so that forecasting is inherently unreliable. To make things worse, the typical lead time from fabric manufacturers is a full three months.

How do you manage such a business? Traditionally, the risk in the system was borne almost exclusively by retailers, who were required to place their entire order a full six months before the start of the season. But, as their power grows, retailers are demanding more flexibility and limiting their advance orders to less than 70 percent of their total volume.

Although computers are not as yet fashion goods, the PC industry is experiencing similar market dynamics thanks to the rapid and volatile evolution of supplier technologies. The challenge for PC makers is to integrate multiple unpredictable emerging technologies into a competitively priced "package" for the ultimate consumer. This task is becoming more and more difficult as the pace of technological evolution quickens.

Seventy-five percent of current products of an average PC maker will have been launched less than three months earlier

Over the past decade, the average life cycle of a personal computer has shrunk from four years to less than nine months, while the number of SKUs has more than quadrupled. Seventy-five percent of the current products of an average PC maker will have been launched less than three months earlier. Manufacturers find themselves caught between powerful suppliers capable of imposing lead times as high as four to five months and retailers unwilling or unable to carry high inventories and bear the risk of unsold products.

The PC and fashion industries are not alone. Other industries—mobile phones, consumer electronics, sporting goods, and publishing, to name a few—also face many of the same problems, and may be able to learn from the strategies of leading PC and fashion producers.

For many years, these players focused on the basics: building brands and distribution channels, improving product design, and cutting manufacturing costs. A winners’ circle of companies emerged: Compaq, Hewlett-Packard, Hugo Boss, Ermenegildo Zegna. Throughout the 1980s and early 1990s, most focused on positioning themselves as "high quality" or "latest fashion" companies. But over the past couple of years, they have shifted their focus to building operational excellence as the means to achieve the next quantum leap in competitive performance. Their approach is founded on understanding and trying to minimize two major cost components that are often neglected or undermanaged: lost sales and obsolescence.

Lost sales and obsolescence

Missing a sale means losing a contribution margin that can range from 25 to 30 percent of the producer’s sale price in the PC industry to 40 or 50 percent in the fashion industry. One leading US PC manufacturer underestimated demand for two of its best-selling products; by the time it could gear up supply, it had lost around $300 million in potential sales. Worse still, the market for these products had disappeared.

Obsolescence costs are incurred when finished products or raw materials become obsolete and need to be cleared out. Though present in all businesses, obsolescence is particularly rapid in some. PCs on a shelf lose as much as 10 percent of their value a month, so that after seven months the value of a PC has fallen by 50 percent. In the fashion industry, end-of-season sales can involve discounts as high as 30 to 70 percent, which is why leading operators like The Limited and The Gap handle obsolescence by discounting slow-moving items continuously, rather than waiting to make massive mark-downs at the end of the season. In publishing, today’s newspaper will have no commercial value tomorrow.

Lost sales and obsolescence costs are often so high that managing them effectively could yield huge benefits

Though frequently overlooked, lost sales and obsolescence costs are often so high that managing them effectively could yield huge benefits. For a clothing manufacturer with $1 billion in sales, matching best practice performance could mean an improvement of $80 million in pretax margins (Exhibit 1). Any of the top three PC manufacturers might reap as much as $100 to $200 million on a sales base of over $10 billion by managing obsolescence aggressively.

Lost sales and obsolescence are interdependent. It would be easy to achieve zero lost sales, for example, by stocking everything up to the hilt, but the obsolescence cost of this approach would be formidable. The challenge is to find the optimal tradeoff between the two factors, which will vary from business to business.

In industries with high fixed and low variable costs, obsolescence is not expensive, and the tendency is to "overshoot"—which is why publishers regard unsold goods amounting to 20 percent of a print run as acceptable. By contrast, in industries with high variable costs, the rule is caution. Before the introduction of new models in consumer electronics, for instance, inventory levels of old models are brought down as low as possible, even at the risk of losing sales. Where both variables are important, as in the fashion industry, a delicate balancing act is needed (Exhibit 2).

Traditional methods of logistics management, such as economic order quantity, are not helpful in this respect. They treat highly volatile and unpredictable items in exactly the same way as more predictable ones. As a result, they tend to clog a system with high inventories of the "wrong" products, impairing service and increasing obsolescence.

How is it, then, that the companies that excel in supply chain performance manage to limit lost sales and obsolescence? Essentially, they do five things:

• Measure the "unmeasurable"—namely, obsolescence costs and lost margins on missed sales, both their own and the channel’s
• Minimize complexity while preserving the richness of the ofering
• Rethink product development technology to cut time to market
• Optimize risk-sharing with supply chain partners
• Manage the operating cycle to mitigate forecast error.

Measure the unmeasurable

When manufacturers consider logistics costs, they typically think of warehousing and physical distribution. Many (though not all) measure and control the costs of inventories and their own obsolescence costs for finished goods and raw materials. But few measure the opportunity cost of lost sales, and only the very best are aware of the costs of the channel in both lost sales and obsolescence.

There are a number of reasons why these costs are seldom measured:

• They do not appear in the books directly, and it used to be easy to pass them on to the retailer—so why bother? But as retailers consolidate, grow more sophisticated, and demand better service from manufacturers, passing on costs is becoming much harder. Up to three or four years ago, one leading sports goods manufacturer produced over 90 percent of its volume on the basis of rm orders placed six months in advance. It has since seen the share of this "low-risk production" drop below 80 percent, and continue falling. In PCs, large US wholesalers now reserve the right to return unsold products to the manufacturer.
• Since lost sales are rarely measured, they are usually grossly underestimated—sometimes by a factor of 1 to 5. One apparel manufacturer estimated its lost sales at 5 to 10 percent, but discovered they were actually between 40 and 50 percent.
• Lost sales are hard to measure accurately. However, their order of magnitude is an adequate indicator, and can easily be assessed by asking customers leaving a store what they purchased and whether they will return to buy anything they failed to nd on this occasion.

The best performers in supply chain management adopt a number of measures:

• Running periodic consumer surveys at the exit points of key retailers to estimate lost sales. If they are above 5 to 10 percent, something needs to be done. In fashion, tackling lost sales can boost operating margins. In PCs and most consumer packaged goods, it can not only contribute to pretax prots but also afect market share, which can in turn drive further prot improvements.
• Making sure that estimates of internal obsolescence costs are suciently aggressive and based on actual inventory levels and projected clear-out discounts, not on standard nancial assumptions. One computer manufacturer realized that managing obsolescence by the conventional procedure of taking reserves against inventory meant that it was always reacting to inventory problems ater they had become critical. Its accounting assumptions were almost always out of date, and it underestimated actual gures by 50 percent. Its solution was to impose an internal measure of inventory carrying costs of 40 percent per year. This new metric forced managers to shit slow-moving products before they became a serious drain on margins.
• Obtaining information from key customers about the channel’s obsolescence costs and, if possible, about lost sales. By involving your channel partners in your decision making in these two key areas, you can create benets for both sides. Fixing your own problems will x your retailer’s, as your lost sales are also its lost sales.

  Fixing your own problems will fix your retailer’s, as your lost sales are also its lost sales

Minimize complexity, preserve richness

Weeding out your marginal SKUs and reducing product variety are a couple of conventional wisdoms that simply do not work in either PCs or fashion. Armani cannot offer its suits in just blue or gray. Similarly, if a computer company were to eliminate SKUs that account for less than 5 percent of total volume, it might forfeit sales to entire countries, as with Finnish keyboards or Swedish modems.

In both industries, a high degree of complexity is a necessary cost of doing business. Indeed, manufacturing to a lot size of one is already a reality in fashion, and becoming so in PCs. However, the best companies keep complexity under control, allowing for it only when it makes a perceptible difference to the ultimate consumer—and the consumer is willing to pay for it. These companies avoid changing basic fabrics every season or components every new model, and limit the proliferation of variants to the product segments where the market is willing to pay for the extra choice.

In PCs, a change of 1cm in the width of a laptop display screen can make a huge difference in readability, and consequently in the price the market will bear. In clothing, on the other hand, a centimeter more or less in the shoulder width of a man’s jacket is scarcely even noticeable. The top fashion makers discipline their design process to allow only perceptible changes of a couple of centimeters every two or three seasons. Similarly, the best manufacturers of portable PCs focus their engineering design creativity on features that customers value, such as screen readability and keyboard ease of use, not on things that are unlikely to influence purchase, such as performance at high altitudes.

Rethink product development to cut time to market

Over the past decade, reducing time to market has been a top priority for most industries throughout the world. For PC and fashion companies, getting this process under control has always been a must. If your new fashion collection is not out in time for the trade shows, you go out of business. Being slow to market with the latest PC technology can hurt a manufacturer’s market share and ultimately force it out of entire segments.

Companies are rethinking their underlying product development technology to cut development time by up to 70 percent

Leading companies are rethinking their underlying product development technology to cut development time by up to 70 percent. At present, development can be a lengthy process in some of the short product life industries. In PCs, it ranges between 12 and 18 months; in ski boots, it may exceed 24 months.

With up to two years in development and an eight- to ten-month sales, production, and delivery cycle, new ski boots take almost three years to hit the shelves. This means that they reflect actual consumer preferences that are three ski seasons old—which is rather like commenting on today’s news on the strength of last month’s newspaper.

Nordica, the world’s leading ski boots manufacturer, managed to reduce its development time by roughly two-thirds. It undertook a number of important organizational changes, introducing concurrent engineering, crossfunctional team work, the extensive use of design review, and quality function development and benchmarking. It also radically changed its product development technology.

Product development in ski boots is a trial and error process involving producing, testing, and modifying five or six prototypes one by one. Each mold takes six to eight weeks to produce, so the entire process can take as long as a year. The traditional manufacturing method involves injecting plastics into industrially produced metal molds. The same approach is used in both mass production and prototype production.

Organizational changes and technological innovation allowed Nordica to cut over a year from its development process

To reduce development time, Nordica changed its prototype technology to use molds made from plastic resin that take only one or two days to produce. Combining the organizational changes with this technological innovation allowed Nordica to cut more than a year out of its development process. Product development now takes nine months instead of 24. In the meantime, the company has developed a computer-aided rapid prototyping technology that has shortened the cycle by another two months.

Compaq and other leading PC manufacturers adopt a similar approach to the design of application-specific integrated circuits (ASICs). Traditionally, this involves several iterations between the computer maker and its chip suppliers. Getting the design right usually entails three or four prototype "spins," each requiring silicon fabrication taking four to six weeks. As an ordinary PC contains up to a dozen ASICs, some of them designed sequentially, the development of these circuits takes up much of the total PC development time.

Electronic simulation techniques enabled Compaq to isolate a large proportion of "bugs" early in the design process

By using improved electronic simulation techniques, Compaq can isolate a large proportion of "bugs" early in the design process, before progressing to silicon prototypes. This means that fewer prototype spins are needed to complete the design cycle, and development time is compressed.

Optimize risk-sharing across the supply chain

Passing risk on to the weaker players in the supply chain leaves on the table value that could still be captured

Risk taking is intrinsic to both fashion and PCs. With entire product lines turning over every three to six months and long lead times from suppliers, it is virtually impossible to avoid running out of stock for some "hot" products, and producing some "wrong" products that don’t sell. The traditional approach to managing this risk was to try to get rid of it by passing it on to the weaker players in the supply chain, usually the retailers. But there are several problems with this approach.

First, it leaves on the table the value that both manufacturers and retailers can capture by optimizing the risk along the entire chain. Second, pushing risk to the retailer has become much more difficult as channels consolidate and their bargaining power grows. Consequently, best practice companies focus on the relationships they build with their retailers and suppliers.

Working with retailers makes it possible to minimize the quantity of inventory in the supply chain by changing its nature from finished products sitting at sales outlets to unassembled components or fabrics located with the supplier or manufacturer. Where the remaining finished goods inventory should be placed depends on the relative positions of retailer and manufacturer. In fashion, large retailers are best placed to assess their market, so they should hold a bigger portion of the finished inventory risk. Where smaller retailers are concerned, the manufacturer usually has a better feel for the market; moreover, with its much larger volumes, it faces lower demand volatility. The manufacturer should therefore assume the inventory risk, passing it on to the retailer in the form of higher prices.

The other means of optimizing risk is to reduce suppliers’ lead times and increase their flexibility. This is the only way to improve supply chain performance on fashion items—where there is, indeed, plenty of room for improvement. The average lead time for fabric runs at 90 days, even though the actual production time is roughly two weeks. Similarly, disk drive lead times can be as long as 90 to 120 days, despite average production cycles of less than a week.

Best practice companies in both industries go further than the usual "work with your suppliers" and "exchange information via EDI" practices. In order to slash supplier lead times, they are revolutionizing the way they organize their purchasing, moving from spot purchases to long-term capacity booking, and programming their buying in a way that allows suppliers to be flexible but still keeps costs down and permits economic production of small lots.

This approach relies on the manufacturer having a deep understanding of its supplier’s production processes and economics. Consider an example from the PC industry. To the PC manufacturer, ASIC purchasing represents a conflict of interests with the supplier. The manufacturer is aiming to maintain supply flexibility across a range of chips that are low-volume parts; the supplier’s objective is to maintain high capacity utilization.

The best PC companies understand that the ASIC "fab" process includes multiple silicon "layers," about half of which are common to all ASIC parts. They consolidate their ASIC purchasing with a small number of suppliers—up to three—and commit to minimum "base wafer" volumes. This allows the suppliers to start producing silicon wafers before they know how many ASICs of each type their customer will ultimately require.

Similarly, in fabric production, the chief fixed cost of a manufacturing changeover consists of the set-up time spent in replacing the warp threads. A single warp, however, can be used to make 10 to 20 different fabrics if the weft threads are changed—a much quicker process. Leading apparel manufacturers are shifting their programming from single fabrics to groups of fabrics that can be woven on a single warp. This gives them the flexibility to source otherwise uneconomic lot sizes of 50 to 100 meters.

An intimate understanding of a supplier’s production, allows PC manufacturers to support their sweet spots

Such an intimate understanding of a supplier’s production processes also brings benefits in product design and development. In computers, the manufacturing process for microprocessor chips centers on a specific clock speed "sweet spot," but will yield devices with a range of different clock speeds. The sweet spot clock speed is the one that is the most cost-effective for the supplier to produce—the point of maximum yield. Successful PC manufacturers design their products to support the sweet spots of their suppliers’ production processes.

Manage the impact of forecast error

Forecasting is never perfect. In fashion and PCs, with their legions of SKUs, manufacturers must manage forecast errors that are sometimes in excess of 100 percent. Best practice companies both reduce forecast error and manage it.

First, they use test and sell-out data to improve their sales forecasts. Even fashion goods can be market-tested. "Quick and dirty" test data is particularly helpful in identifying future winners—the products that will become the best sellers in a given product line. The Limited uses some of its retail outlets as dedicated test stores. Coin, Italy’s largest clothing retailer, uses customer focus groups for test purposes.

Sell-out data, on the other hand, is most useful in tracking down slow-moving products. Compaq uses sell-out data from key channel partners to identify items where initial orders are still sitting in retailer inventories and customer sales are below forecast.

One of Italy’s largest apparel manufacturers produces basic low-fashion items such as blue blazers in China

As well as improving the quality of their forecasts, best practice companies in these industries organize their manufacturing and delivery systems to improve flexibility on volatile and fashion products, while maintaining low-cost production for basic, more predictable items. One of Italy’s largest apparel manufacturers, Gruppo Finanziario Tessile, which manages Giorgio Armani’s and Valentino’s main clothing lines, produces basic low-fashion items such as blue blazers in China, but more fashionable garments in Italy, which saves over a month in lead time. The higher labor costs of local production are offset by the flexibility gained by being close to the market.

In the PC industry, Compaq is moving to a production system that builds most of its products only on receipt of a customer order. The company will use the basic products for which there is steady demand to level out factory capacity and smooth day-to-day order volatility.

Finally, the most successful companies proactively manage forecast errors. Even with improved supplier flexibility, PC manufacturers will not be able always to produce exactly what the market wants when it wants it. Some "wrong" products are bound to slip through. So what do you do about it?

Compaq solves this problem by beginning its sales forecast process with a snapshot of its overall supply capabilities. The process establishes a rapid two-way communication between sales and manufacturing. The salesforce devotes its efforts to products where supply exceeds projected demand within lead times, and lets the "hot" products sell themselves.

How can you quickly check whether your company has room to improve its supply chain performance? Here are a few questions that any CEO can ask on Monday morning:

• Does our manufacturing strategy increase product line exibility while continuing to drive down overall production costs?
• When was the last time—if ever—that we measured lost sales to end customers? Could they be more than 10 percent of sales?
• Do we have a company program to get POS data from retailers?
• Are we testing our products with end customers? Do we use the resulting data to adjust our forecasting and supply position?
• Are our retail customers demanding rebates for their mark-downs? Is the ratio of returned orders to sales increasing?
• Does our global operating and nancial planning cycle take over a week to complete?

Achieving excellence in managing the supply chain is not an easy task. It requires specific knowhow and understanding of, for example, supplier and retailer business systems and cost structures. It requires creativity, as the Nordica example illustrates. Above all, it requires the commitment and ability to design and implement complex organizational changes. Becoming world-class in managing the supply chain involves making often radical changes in different parts of an organization, and making sure they all fit together.

World-class performance does, however, confer very substantial benefits, and since it is so difficult to achieve, it provides a competitive edge that is sustainable over a long period of time—and not only in PCs and fashion. With many industries experiencing shrinking product life cycles, proliferating product offerings, and growing retailer power, excellence in supply chain management will become an increasingly important competitive factor. Even "stodgy" industries with low product turnover and stable pricing can gain tremendous operating and financial advantages by adopting some of the practices of the companies that live in the fast lane. The experiences of leading PC and fashion producers therefore provide insights from which all companies can learn.