Setting up supply chain strategies for innovative products

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Managers readily agree that supply chain strategies ought to be aligned with business strategy. There is even a popular framework that categorizes products as either functional or innovative (Fisher 1997). Functional products require physically efficient supply chains, whereas innovative products require market-responsive supply chains.

While this framework provides a powerful dichotomy, most companies struggle to clearly label their products as purely functional or radically innovative. And failure to clearly map them can have a big impact on supply chain capability. Some innovative products such as Apple iPads have juicy margins. However, it is not possible for companies like Apple to set up a totally market-responsive supply chain because of their large production volume.  

On the other hand, there are some innovative products produced in low volumes, such as pocket mobile projectors mostly demanded by sales representatives who need to make presentations to their clients. Supply chains for these types of products should be extremely responsive since such products have low demand and a high level of uncertainty. While companies like Apple are among the most well-known, it is this latter category that, when combined, accounts for a larger part of supply chain volume. To determine the best route to strategy, supply chain executives need to ask two key questions:  

What types of innovative products do managers need to differentiate when setting their supply chain strategies?  
Which supply chain strategy should managers follow for a particular type of innovative products?  
Today we often divide product innovations into two groups: (1) sustaining and (2) disruptive innovations (Christensen 2013). Sustaining innovations aim to improve the performance of existing products along the dimensions the customers have valued. This type of innovation can be radical, resulting in the development of really new products or incremental, leading to the development of incrementally new products. On the other hand, disruptive innovations aim to develop a new product that helps companies enter a new market. This type of innovation results in the development of niche products that have some features appreciated by some customers, but they are on average inferior to existing products.  

If niche products are nurtured successfully by sustaining innovations, they can be promoted as popular products that create value for most customers. Looking again at the case of Apple, the company entered the portable music devices market with its first-generation iPods in 2001, devices that were developed after a disruptive innovation. The market had been previously dominated by Sony products (e.g., Sony Walkman and Discman) for a long time. Apple sold around 125,000 first-generation iPods worldwide in 2001, 600,000 second-generation iPods in 2002, and 2 million third-generation iPods in 2003. The company achieved a considerable market share in 2005 with fourth-generation iPods whose sales exceeded 20 million worldwide. The second- and third-generation iPods were incrementally newer versions of the first-generation devices. However, the fourth generation was developed after a radical, sustaining innovation, including a color display and click-wheel technology.  

The iPod illustrates how Apple developed a truly niche product, then incrementally revamped it before making a really new product in its fourth generation.  

Before making any innovation decisions, it is important to understand the characteristics of functional and innovative products.  

Functional products are basic products characterized by predictable demand, low profit margin, and long product life cycle. These products require efficient supply chains that help to minimize cost and warrant a positive profit margin.

Incrementally new products are newer versions of existing products, developed after an incremental, sustaining innovation. These products are characterized by moderate demand uncertainty and moderate profit margin. Historical demand data of existing products can be used to estimate the demands of incrementally new products. Such products require a dual supply chain strategy, which is a mixture of efficient and responsive supply chain policies. Companies following a dual strategy utilize their resources efficiently for a considerable portion of demand and deploy a buffer capacity to respond to demand peaks.

Really new products are developed after a radical, sustaining innovation. These products are characterized by high profit margin and high demand uncertainty. Aside from Apple's fourth-generation iPod, another example is the Intel Pentium processor which replaced the Intel DX-486 chips. The Pentium processor was built on a completely new technology, and it required a more advanced fabrication process than DX-486 chips. Really new products are produced in large volumes. Their supply chains should be both efficient and responsive because of high demand uncertainty and large production volume. Therefore, these products require a dual supply chain strategy.  

Niche products are developed after disruptive innovations. These products have some features appreciated by some sophisticated customers, but they are on average inferior to the existing products in the market. Niche products are characterized by high demand uncertainty and high profit margin. Since the number of customers interested in those products is relatively low, they are produced in low volumes. Therefore, niche products require totally responsive supply chains.  

By adopting a dual strategy companies can exploit the cost advantage of efficient resources while responding to market fluctuations. This strategy is highly effective for incrementally new and really new products since those are produced in large volumes. In Table 2, we provide alternative supply chain strategies for different product types.

Companies that place regular orders with efficient suppliers can respond to demand peaks by expediting orders. The suppliers might use air freight or schedule overtime production for expediting orders, leading to an increase in the purchasing cost. This strategy remains profitable for incrementally and really new products since high profit margins for those products offset the cost premium for expediting orders. Quantity-flexibility agreements are composed of firm commitments and options, where suppliers guarantee to deliver up to the sum of firm commitments and options, and retailers purchase no less than the number of firm commitments. This type of model allows suppliers to use their resources efficiently for firm commitments and retailers to exercise options to respond to demand peaks. Multiple sourcing from both low-cost and domestic suppliers helps to achieve both efficiency and responsiveness. Companies should follow time-based, quick-response strategies for niche products. When this is not possible, they might consider offering advance-purchase discounts to resolve demand uncertainty of those products.

Matching innovative products with the right supply chains is highly difficult for most companies since both the variety of innovative products and the complexity of supply chains have increased dramatically in the last decade. Our classification of innovative products highlights the important dimensions that managers should take into account to develop successful supply chain strategies. We suggest that companies could develop successful supply chains for most innovative products by following a dual strategy that exploits both the cost advantage of efficient resources and the agility of reactive resources.

Ralf W Seifert is Professor of Operations Management at IMD and directs the Leading the Global Supply Chain (LGSC) program.

Isik Bicer received his PhD degree in Operations Management from HEC Lausanne and currently works as post-doctoral researcher at EPFL. He is an expert in supply chain analytics, mainly working on the valuation of supply chain investments and the cost of demand volatility.

References
Christensen, Clayton. 2013. The innovator's dilemma: When new technologies cause great firms to fail. Boston, Massachusetts: Harvard Business School Press.  

Fisher, Marshall L. 1997. "What is the right supply chain for your product?" Harvard Business Review 75: 105-117