The Value Chain

To understand the supply chain, we first discuss the economic concept of the value chain.
Michael Porter,1 the noted economist and author, identified a systematic means for examining all
the activities a firm performs and how those activities interact. The value chain is a tool that
disaggregates a firm into its core activities to help reduce costs and identify sources of
competitiveness. It is part of the value system that consists of a network of value chains. The
value chain and core activities that are performed by any company include inbound logistics,
operations, outbound logistics, marketing and sales, and service.

1Porter, M., On Competition (Cambridge, MA: Harvard School Press, 2008).

Figure 9-1 Value Chain Activities

Source: Based on M. Porter, Competitive Advantage: Creating and Sustaining Superior

Figure 9-1 shows Porter’s value chain. Notice that it is a chain for a single firm; however, the
firm’s suppliers also have value chains. The core activities shown in the figure are termed value-
chain activities because they are the tasks that add value for the customer. If a firm performs
these core functions well, the result is high customer satisfaction. Non-value-chain activities
typically have costs but no effect on the customer and are referred to as the hidden factory. The
hidden factory contains all the bureaucratic processes that are not part of the core activities in
Figure 9-1.

The Chain of Customers

From a quality perspective, an interesting variation of the value chain is the concept of the chain
of customers.2Looking at the activities along the value chain sequentially, we see that the links
in the value chain are really people performing different functions. The chain of customers is
revealed when you view the step in the chain after you as your own customer. This means that if
you work at workstation 4 in a process at the core of the value chain, you will make sure that the
work you do is absolutely impeccable before you release it to your “customer” in workstation 5.
This chain extends from raw materials through supplier firms to the producing firm, with the
final link in the chain being the ultimate consumer of the product. The notion is that if each of us
along a chain works to satisfy our own customer, the final customer will be very satisfied, and
our products and services will be free of defects and mistakes.

2Schonberger, R., Building a Chain of Customers (New York: Free Press, 2007).

Managing the Supply Chain

The concept of supply-chain management extends the economic concept of the value chain.
Figure 9-2 shows a rendering of a supply chain. Notice that it includes several suppliers, plants,
distribution centers, and customer groups. This is a useful extension of the value chain because it
provides a more realistic picture of the value chain. Notice that the value chain focuses on
activities such as inbound and outbound logistics, which are supply-chain activities. One of the
most significant aspects of the value chain is the linkage between a series of suppliers and
consumers. This linkage is especially tenuous because it involves the complex interaction of
logistics, systems, and human behavior. These linkages and relationships between suppliers and
customers have undergone radical changes in the past decade. Much of this chapter focuses on
this linkage.

Supplier Alliances

Managing inbound logistics in the supply chain involves working with suppliers who provide
parts, raw materials, components, and services. As we have already discussed, there has been a
trend toward developing closer working relationships with fewer suppliers. Given this new
approach to suppliers, a big part of quality improvement requires developing and assisting
suppliers so they can provide needed products with low levels of defects, in a reliable manner,
while conforming to requirements. Several approaches to improving suppliers result in what are
called supplier alliances. Inspired by lean purchasing approaches learned from Japanese industry,
supplier–alliance relationships have emerged that treat suppliers as de facto subsidiaries of the
customer organization. We say de facto subsidiaries because as information is shared and
communications are improved, the relationship begins to resemble a parent/subsidiary instead of
separate firms.

Figure 9-2 A Supply Chain

As shown in Table 9-1, a number of systems are used to help develop suppliers. Single sourcing
refers to narrowing down the list of approved suppliers for a single component to just one
supplier. Companies that are uncomfortable with using a single supplier may use dual sourcing,
in which the number of approved suppliers is reduced to just a few. Dual sourcing reduces the
exposures of having a single supplier.

Table 9-1 Supplier Development Approaches

Single sourcing
Dual sourcing
Supplier evaluation
Sole-source filters
ISO 9000
Baldrige Award
Supplier certification or qualification programs
Supplier development programs
Supplier audits
Alliances
Supplier evaluation is a tool used by many firms to differentiate and discriminate between
suppliers. Supplier evaluations are often recorded on report cards in which potential suppliers
are rated based on criteria such as quality, technical capability, and ability to meet schedule
demands.

Sole-source filters that are used in many companies rely on external validation of quality
programs. The external validation comes from outside examiners and registrars that are used in
these processes. This gives customers the comfort that outside authorities have given your
company a sort of seal of approval. Two of the most commonly used filters are the Baldrige
criteria and ISO 9000 (Chapter 3). In these cases, companies must show either that they are using
the Baldrige criteria to improve or that they have become ISO 9000 registered. The ISO 9000
filter is used commonly in the international community.

Many companies perform lengthy inspections of their suppliers that involve long-term visits and
evaluations. These programs are often called supplier certification or qualification programs if
the focus is entirely on evaluation. If the focus is on helping the supplier to improve by training
the supplier over long periods of time, they are termed supplier development programs.

Another tool used often is the supplier audit. It is similar to supplier certification except that a
team of auditors visits the supplier and then provides results of the audit to the customer. The
audits are performed to ensure that product quality and procedural objectives are being met.
Supplier audits tend not to have the developmental component that is found in supplier
development programs.

We should mention that there are drawbacks to single sourcing. When there are few suppliers,
there is more exposure to supply interruption. For example, General Motors experienced a major
shutdown as a result of single sourcing from a single supplier named Delphi. If labor relations
are not solid, single sourcing can have the effect of shifting negotiating power to unions in
supplier plants. Other problems include possible interruptions because of transportation
problems, quality problems, disagreements concerning pricing, or global security problems.

Single-Sourcing Examples

In the 1980s, a defective rate of 5% for a supplier was acceptable. In this new century, parts-per-
million levels of quality are expected from suppliers. In addition, many companies such as
Mercedes-Benz are moving to single-source suppliers. However, outsourcing is not without its
difficulties. Other changes have occurred as well. Purchasing groups were viewed in the past as
in-house experts who expedited orders and solved materials supply problems. The dollars spent
on supply were not critical as long as parts were available for manufacture. Strategies are
different now. The way to develop a supplier is to have adequate communications, linear
production schedules, and time to make necessary changes. Supplier contacts are one way to
ensure adequate communication. Assigning one person or a team to each supplier can reduce the
potential for miscommunication. Another way to communicate is through supplier programs
where the product or service producer ensures supplier access to information. This provides open
communication on mutually critical issues between the customer and the supplier. Another issue
of communication between suppliers and customers is that production schedules must match.
Suppliers constantly must be updated as to when the customers need products with lead times
becoming shorter.

Electronic data interchange (EDI) is a system that aids customer and supplier communication by
linking together supplier and customer information systems. Customers now are helping
suppliers to isolate bottlenecks in the operation, balance production systems, and reduce setup
times in an effort to reduce lead times. For example, suppliers of seats to Chrysler Motor
Corporation must be able to meet the schedule changes within 36 hours. Schedules are
communicated through an electronic data interchange link on a real-time basis.

Single sourcing has changed the landscape of purchasing. Prior to single sourcing, Xerox used
5,000 suppliers. Since implementing single sourcing, Xerox uses only 300 suppliers. Suppliers
were chosen for their current quality practices and their willingness to work with Xerox to
implement a quality improvement program. In Britain, dual sourcing, or multisourcing, has been
chosen by many major customers, predominantly to avoid unfair pricing and the possibility of
the customer’s production being disrupted by suppliers’ labor disputes. Having a limited set of
suppliers also reduces shopping around for the best price.

The Dell Computer Company’s goal was to work with suppliers to figure out how to minimize
the supply chain and hold the least amount of inventory. Personal computer production is
characterized by a tremendous inventory control problem. Suppliers who win in this industry are
suppliers who can help the personal computer producers to overcome this inventory control
problem. Dell is responding by bringing in suppliers who understand the personal computer
production business. If suppliers don’t understand your business, you end up creating buffers that
translate into inventory.

Lockheed-Martin was a defense contractor (now merged with Boeing) that worked closely with
its suppliers. At its Aeronautics Materials Management Center, a special program for suppliers
was developed. This program was called the Star Supplier Program. Lockheed-Martin developed
criteria that each supplier had to meet. Quality was a top requirement. Each Star Supplier was
required to use statistical process control, have a 0% rejection rate at the point of inspection for
six months, and achieve zero nonconformance—documented at the Aeronautics Materials
Management Center. The next requirement was to meet scheduled delivery dates. A supplier had
to maintain a 98% concurrency to contract delivery schedules. Finally, cost criteria were used,
which showed favorably improving price trends and favorable purchase order administration.

Perhaps the most extreme example of supplier partnering comes from the Bose Corporation.
Bose has implemented what it terms JIT II. In this effort, Bose eliminated a large part of its
purchasing department and empowered suppliers to write their own purchase orders. In effect,
this made the suppliers responsible for managing inventories and keeping inventory costs low. It
is now called vendor-managed inventory (VMI).

Supplier Development

Supplier development has to do with the activities a buyer undertakes to improve the
performance of its suppliers. Some of these activities may include supplier evaluation, supplier
training, consultation, data sharing, and processes sharing. Although companies such as Toyota
and Honeywell have become very good at developing suppliers, recent data suggests that many
companies do not have adequate supplier development programs. There is much work left to be
done in this area.

There are seven steps for supplier development. First, identify critical products and services.
This involves identifying strategic products and components (those that are difficult to obtain,
have high costs, or are high volume). Second, identify critical suppliers. They may be suppliers
who provide strategic components but do not meet quality or reliability objectives, or suppliers
who do not meet schedules. Third, form cross-functional teams. The buyer forms a cross-
functional team to work with the supplier. Fourth, meet with supplier top management. This
meeting is held to discuss details of strategic alignment, performance expectations and
measurement, and processes for improving. Fifth, identify key projects. These occur when there
is agreement about how the supplier needs to improve and where. Projects are selected in the
same way Six Sigma projects are selected, by criteria such as impact, ROI, feasibility, and
required investments. Sixth, define details of agreement. This definition involves cost (and
benefit sharing), commitments of resources, metrics for improvement, project charters,
accountability, and deliverables. Finally, monitor status and modify strategies. To ensure
success, management must actively monitor progress and revise strategies as needed.

There are some dimensions of supplier development that have emerged in the literature,
including providing resources for development programs, trying to determine the right numbers
of suppliers to use, and finding ways to measure procurement efficacy.4

4Foster, S. T., “Furthering the Study of Global Supply Chain Quality Management,” Volume 18,
Number 2 Quality Management Journal 18(2) (2011): 7–10.

Note that many companies confuse supplier evaluation with supplier development. They are not
synonyms. Implicit to supplier development is the expenditure of resources designed to improve
supplier performance, which may occur over a long period of time—sometimes months or years.
Many companies couple this with expectations for shared cost reductions. For example, Toyota
sets goals for cost reductions with its suppliers. If the target is 10%, Toyota may ask for a cost
reduction of 5% and provide the other 5% benefit to the supplier. Suppliers who successfully
complete development activities are often designated as preferred suppliers due to their
alignment with customer needs.

Supplier Awards

Many times, companies will provide awards to outstanding suppliers. This provides an
opportunity to celebrate supplier performance that is best of the best. Some of these awards are
based on the Baldrige criteria or are decided by a committee within the buyer’s company. An
example of a supplier award is the Ford World Excellence Award. Its program includes Gold,
Silver, and Recognition level awards.

Supplier Relationship Management System (SRMS)

-Create complete spend transparency.

-Develop a comprehensive, accurate profile of the supplier base.

-Identify opportunities for optimal sourcing of materials, equipment, and services.

-Consolidate and prioritize suppliers based on quality, performance, and on-time delivery.

-Ensure contract compliance and reduce maverick spending.

-Ensure the quality of purchased items.

-Ensure appropriate levels of supply.

A Supplier Development Program: ISO/TS 16949

Now that we have discussed supplier development conceptually, let’s look at a specific example
of a supplier development program: ISO/TS 16949. The goal of developing your suppliers is
based on the need to provide high quality to the customer. Because variability is anathema to
quality, the supplier’s processes must be consistent with those of the customer. In the late 1980s,
U.S. automakers developed certification programs for suppliers. The General Motors program
was called “Targets for Excellence,” and Ford used a program called “Q1.” With the increase in
popularity of ISO 9000, suppliers asked auto companies to adopt a single standard for certifying
suppliers. The result, called QS 9000, provided a common standard for DaimlerChrysler, General
Motors, and Ford. This standard has gone through an update and was supplanted by ISO/TS
16949.

ISO/TS 16949

The ISO/TS 16949 standard applies only to automotive companies. ISO/TS 16949 is an
International Standards Organization (ISO) Technical Specification that aligns existing
automotive quality system requirements within the global automotive industry. ISO/TS 16949
specifies the quality system requirements for the design/development, production, and, where
relevant, installation and servicing of automotive-related products.

ISO/TS 16949 was written by the International Automotive Task Force (IATF). The IATF
consists of an international group of vehicle makers, including Ford, General Motors, and
Chrysler, as well as several automotive trade associations. Representatives and subcommittees of
TC 176 also helped to prepare ISO/TS 16949. We discuss ISO/TS 16949 in more depth later.
ISO/TS 16949 is based on the model in Figure 9-4. This model shows that ISO/TS 16949 is
closely aligned with ISO 9000 in that it is founded on a systems view of automotive production.
This system for continual improvement involves management responsibility; resource
management; product realization; and measurement, analysis, and improvement.

The sections of ISO/TS 169496 are shown in Table 9-2. We discuss sections 4 through 8 in more
detail.

6The facts for this section are drawn from Technical Specification ISO/TS 16949, International
Standards Organization, 2006.

Quality Management System

For the quality management system, suppliers must recognize key processes and document these
processes. They must establish sequences and linkages for these processes. The organization
must determine how effective their operations are; make resources and information available in
sufficient quality and quantity to run the business; monitor, measure, and analyze the business to
ensure effective operations; and take actions to ensure that the planned results are attained and
continual improvements are being made.

Figure 9-4 Model of a Process-Based Quality Management System

Table 9-2 ISO/TS 16949 Sections

0. Introduction
1. Scope
2. Normative reference
3. Terms and definitions
4. Quality management system
5. Management responsibility
6. Resource management
7. Product realization
8. Measurement, analysis, and improvement Annex—Control plan Bibliography

Management Responsibility

For this section of ISO/TS 16949, the extent to which management is committed to the
development and implementation of quality management and continuous improvement is
documented. Management is responsible for developing policy, communicating with the
organization relative to customer service, establishing quality objectives, conducting managerial
reviews, and providing resources. For example, managers with responsibility and authority for
corrective actions will need to be informed when products do not meet specifications and see that
corrective action is taken to ameliorate the problems.
Resource Management

For management to fulfill its responsibility, it must provide resources. These resources are used
to maintain the quality management system and meet customer requirements, including training
and development for human resources. Management is required to provide infrastructure such as
bricks and mortar, equipment, and support systems. They must be planned and implemented
properly; a safe, clean, and adequate work environment is established for worker satisfaction.

Product Realization

Products and processes should be adequately planned, including quality objectives for the
products. Customer-related processes should be designed so that customer needs are fully
considered and regulatory requirements are met. This section considers all aspects of product and
process design as well as purchasing, suppliers, control plans, setups, preventive maintenance,
traceability, and many other aspects of designing and producing products.

Measurement, Analysis, and Improvement

For this requirement, the company needs to provide documentation that it can demonstrate
product conformity, quality management system conformity, and continual improvement of the
quality management system. This requirement includes aspects such as statistical tools,
measurement systems, customer satisfaction measurement, internal audits, and other
considerations.

Building an Understanding of Supply Chain Quality Management

Recent work has been performed in the area of supply chain quality management that is helping
us better understand this field. A question remains: As business and engineering schools place
more emphasis on supply chain management, what impact will it have on how we approach and
teach quality management? Although our understanding is still preliminary, we are beginning to
create a body of knowledge in this area. Supply chain quality management (SCQM) is defined as
a systems-based approach to performance improvement that leverages opportunities created by
upstream and downstream linkages with suppliers and customers.7

7For a review of recent research in supply chain quality, see Journal of Operations Management
26, 4(2008) [special issue on supply chain quality], edited by S. Thomas Foster, Jr.

In a recent study of supply chain quality practices, we asked supply chain managers to rank the
quality tools they used. The ranking is shown in Table 9-3. Note that all of these approaches and
topics are addressed in this book.

Table 9-3 Rankings of Tools for Supply Chain Professionals

Variable Ranking
Training 1
Data management 2
Variable Ranking
Supply chain management 3
Customer relationship management 4
Leadership 5
Benchmarking 6
Project management 7
Surveys 8
Complaint resolution 9
Supplier development 10

Questions:

1. What is the supply value chain? How does the supply value chain help organizations manage
their supply chains?

2. Think about a job you have had or an organization for which you volunteered. Did this
organization have a hidden factory? If so, describe at least two activities that you would associate
with the organization’s hidden factory.

3. Describe the concept of chain of customers. How does this concept benefit the ultimate
consumer of a product or service?

4. What is a supplier audit? How does a supplier audit differ from a supplier certification
program?