End-to-end supply chain models for apparel industry

41 Pages·2015·1.3 MB·English

by  Shardul Phadnis

End-to-end supply chain models for apparel industry

Dr. Shardul S. Phadnis
Assistant Professor and Director of Research
Malaysia Institute for Supply Chain Innovation
2A, Persiaran Tebar Layar, Bukit Jelutong
40150 Shah Alam, Malaysia

Prof. Charles H. Fine
Chrysler Leaders for Global Operations Professor of Management
Professor of Operations Management and Engineering Systems
Sloan School of Management, Massachusetts Institute of Technology
77 Massachusetts Ave, E62-466
Cambridge, MA 02139 USA

Comments are welcome.
Please do not circulate or cite without the authors’ permission.
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End-to-end supply chain models for apparel industry
ABSTRACT
This paper seeks to answer one of conference theme questions about re-shoring, on-shoring, and
off-shoring of apparel manufacturing from a conceptual lens. It examines the tradeoffs in
sourcing strategies by considering them jointly with sales strategies, as the components of a
firm’s supply chain strategy. We compare four end-to-end strategies—combinations of offshore
vs. near-shore sourcing and online vs. brick-and-mortar retailing—under various scenarios of the
business environment by drawing insights from a numerical exercise. The key finding of this
work is that sourcing and sales strategies are not completely modular—an ideal sales strategy can
be influenced by the parameters of the sourcing strategy—and hence may be beneficial to decide
jointly. Our analyses show that a change in a single dimension of the business environment—
such as, the variation in geographic distribution of demand—can cause a supply chain strategy to
get dominated by one conventionally thought to be its inferior. By identifying such conditions,
our model sheds light on the scenarios in which the successful supply chain strategies pursued by
firms today could become vulnerable to those considered inferior.

Keywords:
Procurement/Sourcing/Purchasing; Offshoring; Demand Chain Management

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End-to-end supply chain models for apparel industry
This paper seeks to answer one of conference theme questions about re-shoring,
on-shoring, and off-shoring of apparel manufacturing from a conceptual lens. It
examines the tradeoffs in sourcing strategies by considering them jointly with
sales strategies, as the components of a firm’s supply chain strategy. We compare
four end-to-end strategies—combinations of offshore vs. near-shore sourcing and
online vs. brick-and-mortar retailing—under various scenarios of the business
environment by drawing insights from a numerical exercise. The key finding of
this work is that sourcing and sales strategies are not completely modular—an
ideal sales strategy can be influenced by the parameters of the sourcing strategy—
and hence may be beneficial to decide jointly. Our analyses show that a change in
a single dimension of the business environment—such as, the variation in
geographic distribution of demand—can cause a supply chain strategy to get
dominated by one conventionally thought to be its inferior. By identifying such
conditions, our model sheds light on the scenarios in which the successful supply
chain strategies pursued by firms today could become vulnerable to those
considered inferior.
INTRODUCTION
The twin forces of globalization and e-commerce have dramatically changed supply chains in the
last two decades. Globalization has provided firms a choice in their sourcing and operations
strategies to either produce close to their home countries and markets or to seek lower costs from
more distant sources. The growth of the internet and widespread connectivity has created a
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powerful new sales channel, where firms can sell goods directly to the consumers through online
stores instead of through brick-and-mortar stores. However, firms around the world still pursue a
range of sourcing as well as sales strategies, so that one cannot assert the emergence of a
dominant design for 21st century’s supply chains (Utterback & Abernathy, 1975).
Nonetheless, firms in the Western countries have outsourced a large share of production
to lower-cost countries in Asia. McKinsey (2014) showed that one-third of all goods produced in
2012 (36 percent of global GDP), crossed national borders. The United States alone imported
$2.3 trillion worth of goods for local consumption. On the other hand, some firms have started
bringing some of their offshored production back into the home country. Boston Consulting
Group (2013) found that 54% of the surveyed executives from firms with revenues of $1 billion
and above were actively considering shifting production back from China to the U.S.; more so,
this number had increased from 37% in a similar survey a year earlier.
On the sales side, e-commerce has grown as an alternative to brick-and-mortar stores.
The share of e-commerce sales in the U.S. retail sector rose to 6.6 percent in the third quarter of
2014, a 16.2 percent growth from a year earlier (U.S. Census Bureau, 2014); this trend is
expected to continue and e-commerce is likely to account for 11 percent of all retail sales in the
U.S. by 2018 (Forrester Research, 2014). Although, the growth in e-commerce channels has been
linked to the demise of established brick-and-mortar stores—such as Borders Book Stores and
Circuit City—this trend does not necessarily spell absolute doom for the brick-and-mortar sales
channels. In fact, the pioneer of online retailing, Amazon.com, opened its first brick-and-mortar
store in New York City in 2014 (WSJ, 2014).
The plurality of supply chain strategies is not observed just at the macroeconomic level,
but can also be seen in numerous industries. The global apparel industry provides one vivid
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example of this apparent state of experimentation in end-to-end supply chain strategies. This
industry is a poster child of globalization: in 2013, apparel manufacturers alone generated $577
billion in revenue, more than 75% of which was generated from goods produced for export
(IBISWorld, 2013). International Apparel Federation, the leading federation of apparel designers,
manufacturers, retailers, and the related companies, boasts a membership of 150,000 companies
employing more than 5 million people in 40 countries. Despite its size, no dominant supply chain
design has yet emerged for the apparel industry. Equally successful apparel brands in the West
have either outsourced the production to low-cost contract manufacturers in Asia or tightly
integrated with producers located close to the market (e.g., Ghemawat & Nueno, 2003; Pisano &
Adams, 2009; Caro, 2011). Similarly, numerous clothing brands have chosen to sell through
brick-and-mortar stores as well as via online stores. This plurality of practices raises two
questions: Why does a multiplicity of supply chain configurations prevail in a competitive
industry? And, under what circumstances do the different configurations outperform others?
The tradeoffs between different sourcing and sales strategies have been examined in the
literature. In general, an offshore source has lower direct, out-of-pocket costs, but may be less
responsive compared to a near-shore source (Farrell, 2005; de Treville & Trigeorgis, 2010).
Firms cite lower cost as the reason for shifting production to or sourcing from an offshore
location; however, there is a tendency to overestimate the cost benefits when the tasks relegated
to an offshore source have a high degree of interdependence with those retained in-house
(Larsen, Manning, & Pedersen, 2013). On the sales side, the online channel can offer lower
prices due to its lower cost structure compared to the brick-and-mortar channel. However, this
comes at the expense of a lack of pre-purchase product experience for the consumer and results
in a higher proportion of returned sales for the online channel (WSJ, 2013)
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Although the tradeoffs between the sourcing and sales strategies have been studied in the
operations and supply chain management literature, the two have not been studied together for
consideration of end-to-end supply chain strategies. This lack of a systemic approach may be due
to the association of these decisions with different functions in firms or academic units in
business schools, or could be a result of the preference for studying parsimonious models of
managerial decisions (Williamson, 2008). Regardless, a joint exploration of the sourcing and
sales strategies is likely to provide novel insights if the two possess a high degree of
interdependence (Larsen, et al., 2013). These two strategies seems to possess such a
complementarity as evidenced from the superior performance of the firms choosing holistic
supply chain strategies (while they suit the business environment), such as Zara (Ghemawat &
Nueno, 2003), Dell (Dell & Fredman, 1999), or Toyota (Womack, Jones, & Roos, 1990).
This paper develops a model of an end-to-end supply chain to explore these
complementarities. The model assumes that a firm chooses its end-to-end supply chain strategy
by defining its sourcing and sales strategy once, and then makes two operational decisions in
each season: it decides the quantity to procure for a particular selling season and allocates the
procured quantity to the store(s). In the model, the firm may source the products from an
offshore or a near-shore supplier; it may sell the products through an online store or a number of
brick-and-mortar stores. We compare the performance of four end-to-end supply chain
configurations under various scenarios as defined by the product’s contribution margin, cost
advantage of offshore supplier, forecast accuracy, change in forecast accuracy over lead time,
geographic variation in demand, product returns rate, and the online returns penalty. The
performance of each end-to-end strategy is defined by the expected profit generated under the
specified scenario.
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The rest of this paper is organized as follows. We begin with a review of the relevant
literature. Following this, we present the end-to-end supply chain model, analyze the model, and
describe the numerical exercise performed to compare profitability of the four end-to-end
strategies. This is followed by the presentation of the results of the numerical exercise. The key
insights obtained from the exercise are codified into a set of propositions. Finally, we conclude
the paper with a discussion of the results and their implications for theory and practice.
LITERATURE REVIEW
This paper studies firms’ end-to-end supply chain strategies, where the factors influencing the
sourcing decisions are considered jointly with those affecting sales performance. The question of
what makes a good supply chain strategy was addressed by Fisher (1997), who noted that
products with different demand characteristics were best served by different supply chain
strategies. Lee (2002) extended Fisher’s argument by explaining how supply side uncertainties
should be considered in developing a supply chain strategy. These two conceptual papers lay the
foundation for studying end-to-end strategies in detail. However, they do not provide analytical
comparisons of the tradeoffs involved in different sourcing and retailing choices.
A large body of literature examines the tradeoffs in sourcing decisions. At least three
different streams can be identified in this literature. One stream studies the topic of supplier
selection using the lens of operations research and economics (Elmaghraby, 2000). The papers in
this domain develop models to explore the tradeoffs between choosing a single vs. multiple
suppliers (e.g., Anton & Yao (1989); Seshadri, et al. (1991)), compare sourcing strategies over
multiple periods in presence of learning and entry costs (e.g., Klotz & Chatterjee, 1995; Li,
2013), and specify auction mechanisms to mitigate the limitations of information asymmetry
(e.g., Klemperer, 1999; Chen, 2007). Typically, these works assume the principal-agent dynamic
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between a buyer and its supplier(s), and explore strategies to overcome its negative impact on the
buyer or the supplier.
A related, and large, body of literature studies the design of contracts to align a buyer’s
and a supplier’s interests (Cachon, 2003). The interactions between a buyer (retailer) and a
supplier are examined using game theoretic models, and contractual mechanisms are prescribed
to coordinate their actions to maximize profit for the entire supply chain. Many of these works
assume that the retailer faces newsvendor demand and suggest contracts that make it optimal for
the retailer to order the quantity that is optimal for the supply chain. Several extensions of the
basic newsvendor models—considering cases of price-setting retailer (Bernstein & Federgruen,
2005), retailer promotions (Krishnan, Kapuscinski, & Butz, 2001; Taylor, 2002), retailer
competition (Lippman & McCardle, 1997; Dana & Spier, 2001), etc.—are studied in this stream.
More recent works extend these models by incorporating the effects of competition for either the
buyer or the supplier (Li, 2013; Wu & Zhang, 2014).
A third stream of research on sourcing strategies examines the strategic reasons and
implications of outsourcing for the buyer firm (e.g., Williamson, 1971; Reitzig & Wagner, 2010;
Larsen, Manning & Pedersen, 2013). In contrast to the research works in the above two streams,
which seek to engineer mechanisms to improve buyer-supplier coordination, the research in this
stream examines the buyer-supplier relationship with a descriptive lens. They examine the
implications of outsourcing in terms of parameters, such as cost, quality, responsiveness, R&D
productivity, and so on (Poppo & Zenger, 1998; Reitzig & Wagner, 2010). One finding from this
stream of empirical research of particular interest to the present work is that the benefits of
offshoring—from lower cost—are overestimated due to the difficulty of understanding the
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interdependence between the tasks offshored and those retained in-house (Larsen, Manning, &
Pedersen, 2013).
A substantial body of research also exists for the other side of the supply chain, i.e., the
sales strategy. Pricing has been studied extensively as a means of revenue optimization.
However, price is only one dimension of a sales strategy. Emergence of the Internet as a strong
alternative to brick-and-mortar stores has made it necessary for retailers to understand
consumers’ reasons for choosing a particular sales channel (Myers, Pickersgill, & Van Metre,
2004). Balasubramaniam (1998) presents the seminal model of inter-channel competition; this
model describes the optimal pricing strategies and their market share implications for one mail-
order and multiple brick-and-mortar retailers competing with each other. Subsequent empirical
research shows that increase in the density of local stores significantly reduces the demand for
popular products from the mail-order and the Internet channel; however, the impact of store
density on the Internet-based channel is smaller than that on the mail-order channel
(Brynjolfsson, Hu, & Rahman, 2009). Furthermore, the inter-channel competition is seen as
being limited to popular products and is not observed for niche products (ibid). Another mode of
interaction between multiple channels, besides direct competition, is where the consumers use
one channel to obtain information about a product (i.e., shop or browse) and then use another
channel to purchase it. This is has become an important issue for the brick-and-mortar retailers,
because their stores get treated, in effect, as showrooms for the online channels that sell the same
product for a lower price. This phenomenon, termed ‘showrooming,’ has been linked to the
demise of companies such as Borders Book Stores and Circuit City, and is now seen to affect
luxury fashion retailers as well (Passariello, Kapner, & Mesco, 2014). Balakrishnan, Sundaresan,
and Zhang (2013) model this phenomenon and describe the optimal pricing strategies for the
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competing brick-and-mortar and online retailers under different scenarios based on consumer
characteristics, such as, cost of shopping at a B&M vs. an online store and probability of liking
an unknown product.
The showrooming effect results from the consumers’ desire to experience a product
before deciding whether to purchase it. The remote channels—i.e., the mail-order and the
Internet—seek to mitigate any negative effects of the inability to experience their products before
making the purchase decision by offering lenient returns policies. Experimental evidence shows
that lenient returns policies reduce the amount of conflict in the purchase decision as well as
signal higher product quality (Wood, 2001). However, the optimal returns policies are found to
be the ones that allow for only a moderate amount of product returns (Petersen & Kumar, 2009)
or offer only partial refund (Su, 2009). Insights from mathematical models suggest that the
traditional buyback contracts may no longer coordinate the supply chain between a manufacturer
and a retailer in presence of returns, and need to be modified either by differentiating the unsold
and the returned products bought back by the manufacturer or by giving the manufacturer
visibility of the retailer’s sales (ibid).
This brief overview of the vast literature on the sourcing and retail strategies shows that
the two strategies have largely been studied in isolation. Given the existence of multiple end-to-
end strategies practiced by firms competing successfully in the same industry, we seek to
understand the conditions under which the different strategies work better than the other. To this
effect, this paper contributes to the literature on supply chain strategy (Fisher, 1997; Lee, 2002)
by examining the tradeoffs between different sourcing and retail strategies by considering them
jointly as the firm’s end-to-end supply chain strategy.
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