Executive Summary

Products are either functional or innovative. Functional products are generally made-to-stock whereas innovative products are made-to-stock or assemble-to-order. Functional products need an efficient supply chain whereas innovative products need a responsive one. But increasing responsiveness also increases cost and complexity. This paper proposes specific frameworks for responsiveness in supply chains with specific reference to the Indian paint industry, since paint is more of an innovative product.

This paper is divided into three parts.

Part 1 is a study of the Indian Paint Industry and shows how Asian Paints has increased its responsiveness, yet lowered costs. It has much lower inventory-carrying and distribution costs than its nearest competitors. This part concludes that the gain is due to a radical shift in process design and shifting the point of differentiation with an efficient distribution network that rivals have not been able to emulate.

Part 2 suggests a framework by which inventories can be reduced even in a responsive supply chain. It provides an appropriate method of material classification by which proper prioritisation can be done. It shows that the ABC classification used by most companies has a number of inherent flaws. The section proves that a judicious mix of ABC and VED analysis together with other factors like variability in demand and supplier reliability is more effective in prioritising materials.

Part 3 gives an option-pricing model for valuing responsiveness with specific reference to the paint industry. The concept is demonstrated using Goodlass Nerolac's 2000 financial figures and some approximate numbers regarding the necessary investments and possible increases in profits. The values of S, X and T in Black - Scholes formulae are calculated by considering the present value of additional profits and savings generated by tinting systems, the cost of setting up the tinting systems and the time after which the investment is made, respectively. With these assumed values, it turns out that the value of the option may be as high as Rs. 171 crores. The various embedded options in such a decision are brought out.

Thus, this paper attempts to demonstrate various methods of increasing the responsiveness of the supply chain by using theoretical formulations and their plausible applications in real-life examples.

Introduction

Before Henry Ford and F. W. Taylor introduced their pioneering 'assembly line' theory and started mass production, general-purpose machines were the order of the day and 'made-to-order' products ruled the industry where craftsmanship and customisation were the USPs. But Ford changed that to zero-variety 'made-to-stock' products and that remained the norm for almost 50 years. The introduction of CNC machines and FMSs meant that there was a shift back towards 'made-to-order' products. Soon there was an attempt to shift the point of differentiation further and build 'assemble-to-order' products. Currently, all three exist simultaneously. Their characteristics are given in Exhibit 1. (Click on Exhibit 1 to view it.)

According to Fisher (3), products can be classified as functional and innovative. Accordingly, the supply chains have to be efficient and responsive respectively. Made-to-order and assemble-to-order products are generally of the innovative type whereas made-to-stock products are functional. Their characteristics and supply chain requirements are given in Exhibit 2. (Click on Exhibit 2 to view it.)

For responsive supply chains due to the large number of SKUs and short PLCs, forecasting becomes difficult. This means more safety stock has to be kept. Some significant costs for each type of supply chain are given in Exhibit 3 (Click on Exhibit 3 to view it). On the other hand, for functional products, methods like Vendor-managed-inventory have been successfully used to reduce inventory.

Need for the Study

Responsiveness in a supply chain leads to increase in costs and complexity. So, a study of a company, which can bring in efficiency in a responsive supply chain, is necessary to understand the best practices in the industry. Also, a framework for reducing costs and complexity is necessary. Finally, increasing responsiveness cannot be valued by traditional capital budgeting methods. So a model is required for valuing such projects with embedded options.

Structure of the Report

This paper is divided into three parts. Part 1 shows a study of the Indian Paint Industry and shows how Asian Paints has increased its responsiveness, yet lowered costs. Part 2 suggests a framework by which inventories can be reduced even in a responsive supply chain. It provides an appropriate method of material classification by which proper prioritisation can be done. Part 3 gives an option-pricing model for increasing responsiveness with specific reference to the paint industry.

Next

* Contributed by -
Rajit Ghosh,
Done MBA from IIM Bangalore,
Currently working with Tata Strategic Management Group as a Consultant.