Chapter 4 - Managing Relationships in Networks

The extensive use of suppliers and partners has given rise to the concept of a virtual organization, one in which the brand performs no activities related to the production and distribution of merchandise, but provides oversight and coordination. Even when firms do not go to the extreme, there are still relationships among firms that must be managed in order to ensure the quality of the relationship with the customer.

From Vertical to Virtual

The industrial revolution and specialized labor called attention to the fact that a product can be efficiently fabricated by specialists who do small parts of a job, rather than by generalists who do everything from extracting raw materials, fabricating products, and selling them to customers. For a time, it was believed that quality of profitability would be maximized when a single firm did as much of the value-creating activity as possible.

(EN: I would argue that this is still believed, and firms learned a hard lesson that outsourcing too much can be dangerous, but in the time this book was written, outsourcing was in fashion and the lessons had not yet been learned. I'll continue noting the author's viewpoint, flawed though it may be, having given this word of warning.)

In the authors' time, a different model emerged based on the idea that the tasks in value creation can be individually assessed and assigned to parties, inside or outside of the firm, who could do them most effectively and efficiently. In effect, the firm is managing the supply chain as a whole to create and deliver value.

In this sense, organizations have been managing their affairs in a transactional rather than a relationship model: a garment manufacturer needed buttons, and so long as the buttons were good enough, it didn't matter where they got them. Whomever can provide the quantity needed at the lowest price, right now, was the guiding principle.

The emerging paradigm focuses far more on the relationship, as firms recognized the limitation of the transactional model: having what you need when you need it, without the necessity of negotiating price and inspecting product every time a purchase is made, depends on having a relationship with a reliable provider.

The emergence of the value net

Considers the case of IBM, which suffered substantial losses from 1986-1991 and took many years to regain its foothold, and has not to this day regained its position as the leader in office computing. It's generally accepted that IBM was not nimble enough to keep pace with rapidly changing technology, and the authors attribute this to the firm doing too much work internally.

Specifically, IBM did much of its production work in-house and was devoted to maintaining its factory lines, which turned out standard parts in large quantities and could not quickly be reconfigured to manufacture different components. Other firms, meanwhile, could switch to better and cheaper components simply by changing suppliers.

However, simply switching providers is not enough when it comes to technology: the suppliers must make parts that work together with the parts fabricated by other suppliers - patching them together messily was not a viable option. To do so, IBM needed not only to work in a closer relationship with its suppliers, but to manage the relationships between those suppliers.

Such arrangements also have to be managed carefully to avoid competition - if one partner can gain while the others suffer, it will certainly seek to do so. The author switches to automobile manufacturing, in which suppliers are not paid until the finished car passes inspection and is sold, which encourages them to work together toward perfecting the final product.

Aside of manufacturing information, sales forecasts must also be shared, particularly in volatile markets. If a partner is expected to absorb the cost of waste, he will be inclined to make less than is needed, which can be an impediment to his customer.

To be agile, networks need a number of distinguishing characteristics

"Agility" is defined as the ability to respond to changes - which requires the ability to anticipate nad predict.

In terms of quantity, most organizations are driven by forecasts of demand and take considerable risk that their forecasts may be incorrect. If a forecast is too conservative, the firm fails to make enough to satisfy demand and loses sales it could have made. If it is too liberal, the firm makes more than it can sell and absorbs the cost of waste. This also impacts distribution and sales: even if you manufacture the correct amount, it must be available where it is demanded, not shipped to a location where it is not.

To be successful as a collaborative enterprise, all members in a value network must have access to the same information: predictions of demand, upstream and downstream capacity, production schedules and inventory, and other planning documents must be shared. The people in different firms must communicate openly, and their processes must be aligned to eliminate the seams.

The author provides the example of a Swedish brand of sportswear that employs fewer than ten people. The firm contracts with designers, manufacturers, distributors, and retail outlets for production and distribution, and even works with advertising agencies to handle marketing communication. The firm acts as the conductor of an orchestra of other firms, not merely coordinating their activities, but bringing in niche players and creating redundancies where it is necessary to ensure a seamless performance.

The shift to network competition

The authors posit that the real struggle in the marketplace is not between individual companies, but between supply chains and networks.

Some have noted that supply chains of different brands frequently share common suppliers, who are indifferent to the competition. For example, a plastic bottle manufacturer who supplies both two different soft drink brands cares not whether customers purchase one brand or the other because they sell the same number of plastic bottles.

It's suggested that this is missing the point: the total value of a supply chain is not merely the value of work done by each link, but the unique way in which relationships are managed. The customer purchases the final product, and the identity of the bottle-maker is incidental. (EN: The authors stop short of a significant point - that some activities have nothing to do with competitive advantage while others are crucial to it, and firms should consider this when deciding to partner or outsource.)

It's also noted that collaborative networks require collaborative strategy. A stand-alone business, or one with an incredible degree of channel power, may be able to dictate conditions and demand compliance - but for most firms, it is a matter of negotiation and cooperation.

There is also the notion of complexity in networks - the more numerous the number of players involved, the greater the need for orchestration, and the less that the orchestrator can effectively control. This is another reason that cooperation must be voluntary, with some level of autonomy to each firm, and communication must be constant.

What Makes Networks Work?

The author refers to research done by Industrial Marketing and Purchasing (IMP), an industry group with a solid reputation for its work with industrial markets. Their model focuses on transactions with equal emphasis on buyer and seller, whereas the conventional models tend to concentrate overmuch on the buyer's side of the transaction.

A significant point to their research is that relationships are strongest among firms with similar values and communicate regularly. Trust is a significant factor, characterized by firms that seek mutual benefits and protect one another's interest, and that most relationships fail for lack of trust. The functional importance of the relationship, particularly the difficulty in replacing a partner, is also cited by to a lesser degree.

Another researcher provides a list of factors:

Partnerships: Creating Value through Collaboration

The consideration of the entire value chain, rather than the business as a unit that functions as if in isolation, has changed the nature of competition: it is not the strongest firm that wins in a market, but the strongest value chain.

The authors suggest that Ford used to be a vertically integrated company - not only did it fabricate the components of its automobile, but it also owned a power plant, a steel mill, a glass factory, a rubber factory, and a logging camp. Since then, the firm has divested itself of many businesses, focusing on a few core competencies (designing automobiles, assembling the product, and selling them to customers), seeking to leverage other firms who are more effective in managing raw materials and assembling components.

Every business has a few core competencies at which it greatly excels, and have considerable weakness in all other areas. In a simplistic sense, most manufacturing firms are great at manufacturing but feckless at retail, and chose to let other firms take care of that task for it. More recently, firms are recognizing that they are good at certain parts of manufacturing, and rely on other firms to handle the tasks they are not good at.

In some instances, a firm will stubbornly insist on doing things that others could do better for fear of losing control over the process. One method of addressing this concern is "in-sourcing," in which the personnel and equipment of a supplier are brought onto the premises of a firm. In this way, the line between the supplier and customer is becoming increasingly blurred.

There are even instances in which competing firms will collaborate in order to achieve a common benefit. Sometimes, this consists of collaborating on an efficiency that will benefit all participants equally, such as researching a process improvement all will use, or working together to increase demand for a product category in a given market. Such arrangements can be used to overcome the inefficiency of redundant operations in competing firms to accomplish the same goal.

Creating Collaborative Advantage

The phrase "collaborative advantage" is used to describe cooperation among rivals to achieve goals more efficiently or effectively than would be possible if each worked alone. For example, all soft drink manufacturers work together to increase demand for soda in a new market, then compete for a share of the market they have developed cooperatively.

Collaborative planning, forecasting, and replenishment CFPR)

CFPR is a set of common practices in logistics in which a group of firms in a supply chain coordinate the production and delivery of materials. In essence, it enables each customer to get what they need on time because each supplier knows what they need and when they will need it.

CPFR is focused on the retail environment, to ensure that the product is in stock when customers want to purchase it - reducing sales that are lost when an item is out of stock as well as providing more efficient inventory management. Early pilot studies into CFPR suggest that firms benefit from increased efficiency, which results in cost savings and revenue increases.

Collective strategy determination

The authors speak to the increased potential for innovation when many firms are involved in a supply chain, and advocate the involvement of multiple parties in new product development. Where a firm shares a "link" in the chain with its competitors, it can benefit from the innovations of others.

If we consider that the entire supply chain, not just an individual firm, provides value to the customer, then it logically follows that strategy must be addressed for the supply chain as a whole, rather than the separate parts.

Former models of supply chain management put a firm in a dominant role in the supply chain and considered only how it would influence others to act for its benefit, resulting in a more competitive spirit and a great deal of friction.

The Value-added Exchange of Information

Traditionally, organizations espoused the philosophy that "information is power" and sought to maintain control in relationships by hoarding information, dispensing it on a need-to-know basis. A great deal of inefficiency resulted from firms who were not given access to information because they did, indeed, need it long before it was disclosed to them.

Companies that continue to behave in this manner are inefficient. They must carry higher inventories in order to buffer themselves against uncertainty, which consumes working capital and carries the risk of obsolescence. They are constantly in crisis because suppliers, having no foresight as to what their needs might be, are unable to react fast enough when the information is disclosed. They are unable to react quickly to shifts not only in quantity demanded, but in demand for different features or qualities.

As companies adopt computerized logistics systems, we see this attitude changing: these systems are designed to operate efficiently by eliminating manual data input by electronically communicating with other systems (a retailer to the warehouse, the warehouse to the distribution center, the DC to the manufacturer, the manufacturer to its suppliers, etc.), with a preference for real-time data exchange. Automated systems provide for automatic collaboration.

Working in Partnership

"Relationship marketing is, in effect, relationship management," the authors declare. (EN: I would disagree. There is a significant difference between management and marketing in terms of authority and control, and it is critical to make that decision. Management is giving orders and demanding obedience, marketing is suggestive and seeks to gain voluntary cooperation. Those who don't understand that difference and continue to behave as if they are managing customers and other stakeholders are on their way to obsolescence and extinction.)

The process of partnership begins with a critical decision: with whom to partner. It is not merely a matter of finding the cheapest supplier of a marginally acceptable product, but finding a company with whom you can collaborate. In the long run, it will be evident that a stable and cooperative supplier provides greater benefits to the firm than a fly-by-night operation with a low price tag.

Firms who have a small number of major customers have long practiced "account management" to understand the business and markets in greater detail and provide an attentive level of service that will increase their profitability and, in so doing, increase their loyalty to your firm. The solutions are not merely products, but the level of service provided around that product.

Relationship management applies these principles to each customer, but also looks backward to consider how the firm can be a better customer to its own suppliers, and sharing information that will enable them to serve you better.

A partnership cannot be sustained without the support of both parties - which is to say that they must each recognize the importance of the relationship to accomplishing significant goals, and that it would be more efficient to partner than to attempt to accomplish them on their own.

A Portfolio of Relationships

Business networks may consist of hundreds, even thousands, of suppliers and customers, and it is clearly not practical to develop close relationships with them all, nor is it strictly necessary. It is both practical and practicable to determine which key relationships belong in your portfolio, and manage those relationships carefully.

In some instances, this has led firms to radically reduce the number of suppliers they deal with: purchasing consistently from a single provider, or purchasing multiple goods from the same provider, helps to narrow down the field to make the number of relationships manageable. It's likely there are administrative and logistical advantages to working with fewer suppliers, but this also provides the opportunity to involve suppliers in more tactical and strategic discussions.

A "major British retailer" has developed a model of segmenting suppliers into four stages: ad-hoc, ongoing, operational, and strategic. The company maps out where it wishes its suppliers to be and considers where they actually are, to determine where relationships need to be improved or allowed to atrophy. In one sense, not every supplier must be a strategic partner; and for those who should be strategic partners, some will not show an interest or capacity to fulfill that role.

Managing Network Relationships

A firm must be precise about its own strategy before it begins to assess potential partners, to identify firms whose strengths counterbalance their weaknesses. Also, consider the relative power in the channel, as a means to know whether you are approaching them from a weaker or stronger position. In supply chain contexts, it is particularly important to consider the length and complexity of the value chain, and your ability to manage other parties through a partner.

It's also important to consider partners not merely from the perspective of your present situation, but from that of your future prospects, so that you do not end up developing your closest ties to firms who will anchor you to the past.

There's a final bit on redundancy and substitutability, particularly when a good or service is indispensible, firms seek to have multiple suppliers to ensure stability and sustainability.

Developing the Right Interface Structure

The authors suggest that "experience shows" the quality of relationships is strongly influenced by the structure of the interface between two firms. The authors consider four such structures.

The first structure is a buyer-seller interaction, which focuses on a transaction and the activities surrounding it. It is fairly simple to arrange and does not require the parties to develop much in the way of a connection, except to understand the terms of the transaction and ensure it is satisfactory to both parties.

A second structure emerges between firms that engage in an ongoing series of transactions. Through repetition, the two firms become accustomed to one another, and a closer relationship emerges. The seller is less involved in sales, and more in account management - as the buyer does not need to be sold, merely have orders filled without much discussion about the price or product, but with additional discussion about frequency and reliability.

The third structure attempts to optimize the relationship between companies by greater coordination of the activities of the firms, particularly with an eye toward maintaining the constancy of interaction even if there is employee turnover or organizational changes.

The fourth structure involves a blurring of the lines, where the two firms not only coordinate on day-to-day operations and the transfer of merchandise and payments, but begin to cooperate on strategic issues such as product design, market research, and market development.