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Industry 4.0 Allies In the Distribution Chain

By Michael Ford, Senior Market Development Manager, Mentor Graphics Corporation

Dec 01, 2016

Industry 4.0 intrinsically supports onshoring as local Smart manufacturing companies are flexibly creating products to meet immediate customer demand. Discussions I have had with others in the industry around onshoring potential often turn to issues around the raw-materials supply chain, which is now beginning to be addressed with new technologies such as 3D printing.

But in my opinion, opportunities for onshoring related to the distribution chain, the way that products are taken from the factory to their customers, should be given equal consideration as the supply chain. In theory, this is  where the bulk of cost savings can be made with the onshoring business model, and it is the foundation for many business cases. And, interestingly, during these discussions of the changes in distribution, we discovered some allies that can assist with onshoring.

Because we are talking serious business opportunity here, let’s look at an example of a generic high-volume product that we typically assume would be made in China, as opposed to the low-volume or niche products that remain onshore in the existing climate. The manufacturing unit cost, including materials, typically is only a few dollars. The sales price of the device in the United States is likely to be between five to ten times that.

Design and marketing costs are also likely to be fairly low, unless it is a popular product.
Yet, we all hear about how profits on such devices to the OEM are quite small; if this is so, then a large chunk of the product price must be taken up by distribution. Of course, we can add logistics and storage costs, taxes, etc., plus  the profits of the many organizations that will handle the product before it gets into the hands of the customers. Also, the risk represents more cost than people might expect. The key elements of risk are price depreciation and, ultimately, obsolescence.

These are all critical factors when looking at the complete business model of creating, producing, and selling a product in all areas of manufacturing and distribution, but especially food, fashion, and technology. Our latest electronic devices suffer from at least two of these attributes.

Technology change seems to be incessant as devices become faster and more energy efficient and include more features such as IoT connection. Technology also has become more fashionable, with people continuously exchanging adequate devices for the latest ones. The typical life cycle of an electronic product used to have three stages: ramp-up, a steady state, and then end of life.

Ramp-up is a high-risk scenario because the product has to prove itself in the market against the competition, and pricing versus demand is a critical balance. Many products die at this stage as the market effectively rejects them or competing products get to the market quicker or become cheaper, forcing prices and hence profits down. However, for those that succeed, prices remain at a premium, which can be where most of the profit for the OEM is made. The steady state is actually not so steady, because as market forces compete with pricing and marketing campaigns, pricing and demand are balanced to maximize profit.

The end of life is reached when demand can no longer be maintained at a price that is profitable. Then, the challenge is to clear the remaining stock with the minimum net cost. These end-of-life losses are shared with the distribution companies, who have bought the products from the supplier to resell to customers, only to find themselves then sitting on stock that they can no longer sell without a loss or perhaps are unable to sell at all. The pricing model earlier in the cycle has to have compensation built in, which leads to overall higher costs and prices to cover these inevitable risks and costs at end of life.

Today, however, we see that the vast majority of the steady state of the product cycle has disappeared, as the lifetime of products in the market diminish with continuous replacement or upgraded models. The profit-making time has decreased significantly, and so this end-of-life compensation issue has become a significant factor in the business model, both for the OEM and the distributors.

This is a trend that has been happening already for many years, and it has led to a preference for a more direct-sales approach. Online shops, especially the larger ones, do not wish to inherit these risks of distribution. They prefer to act almost like brokers, between the supplier and customer, holding a minimum of stock, unless that stock is paid for by the OEM. Whether it is sophisticated algorithms looking at customer-buying patterns or someone sitting in front of an Excel spreadsheet, the days of ERP managing sales and stock levels in the distribution chain in a simple way, based on a traditional distribution chain, are gone.

The best solution for online retailers, and this applies also for business-to-business products, is to have the product available on an immediate supply-to-order basis. For the factory, that is, the supply chain to the retailer, this means providing a high degree of flexibility for quantities of product delivery, but without sacrificing productivity. Smart Industry 4.0 tools address this situation to make the factory more flexible without compromising performance while providing the opportunity for any factory to be a part of this new paradigm of manufacturing. In this scenario, the only warehousing of products is at the factory.

So where are the allies that I mentioned in all of this? They are the delivery companies, logistics. The trend of ordering products online has led to a revolution in the way that products are delivered to customers. Today, products are delivered using trucks or vans, tomorrow perhaps with drones or self-driven dedicated vehicles. This movement and trend is already in place. A distribution business model depends on “delivery density,” that is, the quantity of deliveries per cost-based geographical region. The more that is delivered into a certain region, the lower the cost per delivery. Online shopping can connect onshored factories to customers for direct deliveries without the need for additional warehouse storage.

The “Smarter” that factories become, retaining high productivity while being flexible, the less stock needs to be stored in the finished goods warehouse area to fulfill the variability of customer demand. This is a huge “win” for local logistics operations, who would push strongly to work with onshored manufacturing because it adds yet more opportunity to their business models.

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