Critical Success Factors for SCM-luxe

The supply chain for luxury goods has a unique set of critical success factors as opposed to traditional industrial supply chains or consumer products. Factors like Fill rates, supply chain costs etc are of less importance. Let us look at some CSFs for SCM-luxe (please note we are looking at CSFs for the supply chain and not brand or marketing mgmt here)

1. Quality:
• The numero uno CSF for SCMluxe - we see that the product quality, finish and packaging is of prime importance for luxury goods (vis a vis the cost say for a consumer product). Hence we would need to look at return rates, defective % of goods/parts etc in assessing the performance of this CSF
2. Country of Origin:
• We've all heard of champagne from Bordeaux and sparkling wine from everywhere else. But country of origin decisions include sourcing strategy for raw materials, assembly, local vs. overseas suppliers, design location etc besides location of manufacture or production
3. Supplier Relationship Mgmt:
• Given the low volumes and high costs, supplier management becomes crucial. Unlike the supply chain for industrial goods where SRM indicates establishing uninterrupted supply lines, negotiating favourable costs and credit terms - SCMluxe would need to focus on getting supplier buy in on the ethos of the brand and value of the product. This means having fewer or sole suppliers who agree to stand by the standards of quality in production of the luxury good
4. Design:

Leonardo Da Vinci's custom design
 for flying machine circa 1490

• The actual design of a luxury product takes into account lifestyle, aesthetic needs and brand consciousness very much unlike the product design for a consumer good or engineering product which is all about functionality, ease of use and technical features. Hence the design function of SCMluxe must be particularly geared to these parameters (customer lifestyle, brand, etc) and work closely with the marketing team
5. Distribution and Sales:
• The sales process including display of product must be strictly controlled (showcased in premium packaging with the right display and messaging on prominent high streets - not shabby cul-de-sacs in an undesirable part of town). Similarly decisions on distribution channel will also impact the performance of SCMluxe - do we go for separate counters in department stores or multi brand boutiques or mono brand boutiques?
6. After Sales Service:
• Sale and After sales service is important for a luxury customer. The experience of buying and getting repairs (yes! a Rolex mechanical watch would require annual maintenance as much as all antique furniture) should be premium and of high calibre
7. Production methods:
• Here we look at decisions on mode of production - hand crafted vs machine made, limited editions vs. higher volume products, individually made vs assembled. All these parameters are interlinked - for instance a limited edition luxury product (say a silver dinner service) would benefit from handcrafting the product with moulds being destroyed after production of set volume rather than setting up expensive machinery and permanent moulds to manufacture the product whereas a longer running product may require setting up a more permanent or mechanized manufacturing process

 These are some of the critical success factors for ensuring the superior performance of a luxury goods supply chain. Ideas or factors to be included in this list would be appreciated and added to SCMluxe - so feel free to write in...

The golden circle of strategy for meeting customer needs for luxury goods

Customers of luxury have two clear needs from their luxury products:

·         Need to satisfy their inner id, their quest for comfort, satisfaction and aesthetic sensibilities. This is represented by need for product "Excellence"

·         Need to satisfy their ego, their quest for recognition of their status in society and recognition of their success and represented by need for "Status"

The Golden Circle

These two needs are generally met by product quality in the first instance and price in the second. Let us see the consequences of these strategies:

·         Simply increasing the price of a product is one of the most simple and easy strategies to put in place (with some additional branding and marketing effort to justify the cost). However this strategy is also the most easily replicable – a competitor can easily launch a variation of his product with a higher price and roll out the brand and marketing communication to this effect very quickly nullifying the advantage of having a higher price and hence a higher peer recognition of status for a product. The perfume “Joy” is a good example of the price strategy quickly being copied and cutting a products lifecycle short.

·         Building an intrinsic quality into a product on the other hand will take time, money and effort. However customers for these products are much more loyal, thus ensuring a longer product life cycle. Just think of Channels No.5 perfume as a quick reference point.

We must note that there will always be consumers who need peer recognition along with product excellence – though these will be in fewer no. they cannot be ignored. Also as human nature suggests, a component of social stratification is desired in any product, even by a customer firmly entrenched on principles of excellence while buying a luxury product. Thus it makes sense to plan a strategy within the charmed golden circle wherein excellence is the focus but the needs of status and social stratification is also considered albeit to a smaller degree

location! location! location!

Country of origin, the location of the high street store and the roots of a luxury product have  extraordinary importance to the success of a luxury product and in some cases have regulatory requirements built around them to protect the brand and industry – say champagne for the Champagne district in France has the right to call itself so…the rest being delegated to the rather insipid nomenclature of “sparkling wine”. The country of origin will define the perceptions around brand value as well as seen from special caviar or cheese just as the location of the store in a suitable high street defines the prestige of the brand. Kapferer & Bastien go one step further and state that the roots of the product and its manufacturing location also define the luxury associated with a luxury product. They state that a luxury product such as Burbery associated with Britain but manufactured in China will negatively impact brand perception. Similarly the Mini though owned by a German company (BMW) still is produced in Britain to retain its appeal in the customers mind. See article below on how the “Made in China” label can effect even local markets in China/India

http://www.chinadaily.com.cn/cndy/2011-06/15/content_12698001.htm

We need to understand the extent to which the region of manufacture affects the brand and whether a trade off is worthwhile before deciding on the supply chain strategy for the luxury goods. The benefits of low cost country production facilities (say a China, India or Vietnam) is obviously lower prices due to cheaper labour and maybe taxes. The disadvantages besides brand appeal could be many:

·         A negative impact on brand

·         lack of skilled resources in these countries

·         lack of cultural affinity of the producing country with the market in which the product is being sold leading to faulty design/packaging/quality etc

·         More difficult to control the supply chain (we’ve all heard of luxury goods being manufactured by unscrupulous contractors in sweatshop conditions)

·         higher taxes and customs duties

·         Higher logistics costs and  lead times

·         Risk of Patent and copyright violations – high rate of pirated production of designs and counterfeit material in local production centers

Inspite of all the obvious disadvantageous, we still find that outsourcing to lower cost countries is popular and working well for some luxury brands. Lets now look at why this might be so:

·         The great push East – a growing market in China, India etc makes it imperative to have production facilities here (and when there, why not have economies of scale and produce for the western markets as well?)

·         Nullifying effect of duties and taxes – using free trade agreements like NAFTA (eg. Maquiladora products where products are made with cheaper labour in Mexico and shipped to USA with low or nil duties) or simply importing CKD (Completely Knocked Down) and SKD (Semi Knocked Down) and assembling them in the market country typically lowers taxes/duties – this is specially seen in the automotive sector

·         The growing maturity of supply chain and logistics systems – 3 PLs, supply chain software/technology and strategy  and logistics companies have now matured to better control and deliver products across continents with precision and lower lead time

·         Developing local talent in LCC (low cost countries) or splitting the supply chain – with talent being groomed in LCC, certain aspects of design and manufacture are being developed locally. However the major strategy is to retain brand development and design in country of origin while outsourcing only the production to LCC

Obviously the major argument for moving production away from country of origin will be COST and against it will be loss of BRAND value and issues in copyright and patent protection – something that must be closely considered before we decide on the supply chain strategy

Luxury - the point of no return

An interesting point Kapferer and Bastien bring about in their seminal work on luxury (The Luxury Strategy) is the non-return effect or Ratchet effect. Simply stated this means that once someone has tasted luxury in whatever area, it is very difficult for them to go turn away from it even when their financial circumstances have gone down hill and spending on luxury items are no longer feasible. Luxury has also been defined as something that extraordinary people find ordinary. There can be any number of examples to illustrate this – the tycoon now in tough times who would prefer to keep his expensive to maintain mansion and sell off his less expensive apartments in the city, the stockbroker with a series of bad investments who would prefer to keep his Ferrari in his garage but cycle to work under the pretext that cycling is good for the health and the environment, the heiress with a dwindling fortune who would prefer to cut down on social engagements than having to travel to them in a commercial airline, wearing last year’s fashion and  staying in a non-luxury hotel…and the list goes on. It’s easy to dismiss this phenomenon as the ego of the privileged  but one must remember it goes beyond the ego or status and luxury defines a sense of security, comfort and well-being which is psychologically a necessity for the user (a case of the extraordinary becoming the ordinary for the customer). I was intrigues by this phenomenon and decided to look at how this would impact the supply chain? One obvious impact would be on the sales or revenue side where demand in luxury goods is seen to be stable even in recessionary times. However another impact would be on the after sales services for luxury goods. Often neglected, this could be a good revenue booster as well as help in customer retention by providing the customer with alternatives to buying newer versions or increasing after sales service levels till the tough times pass.



Sotheby's  auction of the interiors of
Versace's Lake Como Villa 



What could these after sales services be? Some could be as simple as providing for an easy warranty and repair and replacement service (servicing your Rolex or re-stitching your custom fitted leather shoes) or more complex returns services coupled with a cross or upsell (trade in your Matisse for that rare Ming vase that you always wanted but came up for auction at that inconvenient time of the year when liquid funds were in short supply). The important points to consider in designing a strategy around the ratchet effect would be:

 

·    Ensure customer discretion (nobody likes the world to know that one is flying in a private jet to file for bankruptcy)

·    Custom design the after sales service to suit the product strategy – simple or complex schemes

·    Design all strategies around the longer time horizon when the customer will bounce back into happier economic climes  - this might mean small sacrifices on the margins in the short term in view of the longer term market potential

Very few industries have the benefit of  ratchet effect, and the luxury industry being one of the lucky few, must define strategies to exploit this effect to its fullest in order to retain its already small customer base vis a vis other industries

Carbon Footprint Labels for luxury goods

Labels drive the luxury industry. But are more tactical labels such as carbon footprint labels of any consequence to the luxury goods industry. Let’s first take a look at what such labels mean and what their contribution is in the consumer goods industry.

Carbon footprint labels basically indicate the quantity of carbon dioxide emissions associated with the production and transportation of a product, mainly food products and initially was designed to move customers to more local products and reduce the environmental impact of transporting essential goods across the globe with a view on reducing costs.  Standards for carbon printing are defined by various agencies like France’s AFNOR and Britain’s PAS 2050, though it is the latter that is gaining prominence. PAS 2050 requires that  carbon footprint  to be tracked not only in its production and manufacture but also in its use. This definition has posed problems for manufacturer’s who will now have to estimate the “use phase” emissions for a product such as a shampoo which will depend on other things, the consumer’s bathroom fixtures (boiler) and how long he takes to have a bath!

From a consumer point of view carbon labels as expected have had limited success – fewer than 20% of British consumers recognized a carbon label, leave alone change their buying behavior because of it. The benefits from carbon labeling come not from the “sell” side but curiously from the “buy” side of the supply chain. Manufacturers need to investigate their supply chain and buying process (and suppliers J) to get their carbon footprint. This investigation provides ample scope for improvement as shown by this company manufacturing potato crisps. Walkers bought its raw material from potato farmers  and paid for it by gross weight. Farmers in a bid to increase the value of their potato’s stored them in special humidifiers to increase their gross weight. Walkers also ended up having to fry them for a longer period of time to drive out the moisture and get a perfect crispy crisp! The unusually high carbon footprint sent supply managers on an investigative path which ultimately resulted in Walkers procuring its potatos in dry weight. This was a win-win situation since the farmers saved on the costs of humidifiers and Walkers on the extra costs of procurement and frying them for longer times. An added benefit was a reduction in carbon footprint by 7%



Carbon footprint averages for Timberland footwear



This very same investigative nature of mapping the carbon footprint will help the luxury goods industry reduce costs or in some cases justify them. Location has always been one of the major contributors to a luxury goods brand value (more of this in another post). By having a carbon footprint show your leather was sourced and finished locally rather than halfway across the world will provide additional brand value to your designer bag or shoes.  For an interesting article on Timberlands quest to map the carbon footprint of its shoes and the contribution of leather from its Chinese suppliers, please see link to Wall Street Journal http://online.wsj.com/article/SB122304950601802565.html

Food sourced from specific areas also add value – beluga caviar, kobe beef etc. Who know what might be uncovered when a carbon footprint is being mapped out for high fashion Marchesa gown or a Phantom Rolls Royce. Though currently the costs of mapping the carbon footprint for a single product  at around $30,000 is very high for industrialized consumer products, its not a high proportion of the product costs for most luxury goods with their smaller product portfolios. Therein lies the opportunity for luxury goods industry to explore their carbon footprint and benefit from improving their supply chains.  Besides labels such as “conflict free” diamonds and “fair trade” coffee has helped the industry and this is one way of the luxury industry doing its bit for the environment (and adding a larger bit to its bottomline!)

Mass Customization - an example from the fragrances industry

Luxury customers want products customized to their individual needs, typically delivered yesterday and are willing to pay for it! Though the first two are almost always true, we must remember that luxury customers also are much more discerning and will want value for their money (be it in fulfilling needs in quality, brand value or status/ego). Lets take a look at the basic elements of mass customization and see how it can be put to work in the luxury industry

The main premise of mass customization is to converge dual systems in manufacturing, i.e hand crafted made to customer order and mass production manufacturing systems. Obviously the benefits of small scale hand crafted or customized manufacturing is more suited to the luxury industry with its insistence on catering to individual customer needs and preferences. However this leads to a proliferation of SKUs (stock keeping units), large inventories and lack of economies of scale - all contributing to increase in costs of operations which will either have to be passed on to the customer or absorbed by taking a cut in the gross margins for the product. We see this happening very frequently when multiple product variations are created for the customer - fashion in multiple sizes, bags/shoes in multiple colours/materials etc leading to a huge finished goods inventory which in the case of luxury goods cannot be cleared with a gigantic Christmas discount sale!

Mass production however relies on eliminating product variety, standardizing the product and churning out huge quantities of the product in an industrialized conveyor belt fashion. This means economies of scale in procurement, manufacture etc and lower inventories and hence lower costs of operation. This also means lower potential for customizing to customer needs and lower customer satisfaction - definitely not a strategy for the luxury sector

However is there a way we can marry the two strategies to enable benefits of both systems? Yes, and Mass Customization" is the answer. Let us look at the elements of a mass customization strategy:

• Modularize Production - here the production system is drastically changed to make the manufacturing "assemble to order". Creating different modules of the product which can be combined in various forms to give us product variety in the finished goods. Eg: Bags are manufactured wherein variation in buckles and belts can be added as separate modules adding product variety when order is placed (Pull orders)
• Postpone Production - Postpone the ultimate assemble of the product till the order is placed allowing for customization to be incorporated and avoiding the build up of finished goods inventory. For eg. Zara keeps its T-Shirts and cashmere sweaters in a neutral shade and colours it when customer orders for a particular colour come in. Hence unnecessary stock in non-moving colours are avoided - fashion being a fickle business to forecast demand accurately, this move would save them $000,s in obsolete stock or shrinkage
•  Standardize Components - Generic components in the product or those utilized in its production can be standardized so that they can be utilized across product variations and even across product lines. This enables reduction in component inventory and the risk of production stoppage due to the unavailability of a small (but critical) component. For eg: Zippers or lining used in fashion can standardized across product variations (product lines, if the design team can be co-opted:)), thus saving costs in maintaining separate inventories for each product variation. Though the cost of this component inventory may be small, it prevents the risk of stopping an entire production line due to the unavailability of a simple generic component costing a few dollars (a zipper?) in a $1000 outfit

Lets look at the example of a fragrances company and how they put "Mass Customization" in practice:

A luxury boutique launched its new collection of perfumes "Seasons"  in 4 variations - Summer, Spring, Autumn and Winter. Instead of manufacturing all four variations and taking it to market, it put together the 3 elements of mass customization is some very simple steps:

Vintage concept of Standardize?

• Modularize: The mixing of the fragrance was altered to ensure that the base remained the same and the notes, colour and distinguishing elements to each seasonal variation were added last. Thus only the overall demand needed to be forecasted accurately to ensure correct inventories and "season" variations could be handled at the assembly stage. 
•  Postpone: The assembly of the product was postponed till the order rolled in with its "season" component. A fine example of Pull system of manufacture
• Standardize: Components such as the spraying mechanism, nozzle and screw tops were standardized across the four variations, thus ensuring minimal inventory and reducing risks of non availability of this critical component

The benefits from this approach was threefold:

• Reduced finished goods inventories, shrinkage and loss in working capital
• Ability to meet customer demand for product variety and yet manage costs effectively
• Better ability to tackle demand volatility across the product varieties

An important factor to keep in mind when implementing "mass customization" for the luxury sector is that it has to be done in close cooperation with the design, marketing and production teams. A joint decision will have to be made on which components of the supply chain will be "mass customized" after a due process of cost/benefit analysis

Consignment stocks - an option worth exploring?

Consignment stock started off as an offshoot of Vendor Managed Inventories (VMI) and typically Ownership of consignment stock is passed only when the stock is used (issued). Unused stock in a warehouse may be returned to the manufacturer. As ownership of consignment stock is not transferred until use, invoicing is not immediate. To account for a replenishment of consignment stock at a customer site, a manufacturer must credit inventory and debit customer consignment stock. Only after a customer actually uses the consignment stock may an accounts payable be created. A very common practice in industries where margins are thin and price pressures high (Walmart for instance is well known for variations on this theme of holding suppliers responsible for inventory), it might not seem at first glance suitable for the luxury industry.

But surprisingly the jewellery industry has been one of the pioneers in inventroy strategies built around consignment stocking. Known popolarly as selling "on memorandum" which is another way of saying selling on consignment. Bullion companies especially will ship precious metal bullion to the consignee or jeweller (the recipient of the goods) to sell. The supplier or the bullion or mining company retains title to and ownership of the merchandise until the precious metals are used in the manufacture of jewellery or sold. The jeweller makes payment to the mining or bullion company only when the goods are sold.  This passes the onus of managing and accounting for the inventory on the supplier leaving the jeweller of blocking his working capital on some very expensive inventory.

Gold Bullion


Its very easy to see why a consignee (the jeweller in this case) would prefer to maintain stock on consignment - lower working capital, lower price variation risks, lower security and risks in managing high value inventory etc. But what is in it for the consignor or supplier? Typically not much since he will get his money only when the good is sold and an memoradum invoice is made. But it provides a much needed outlet for his stocks which the supplier cannot take to his end customer otherwise and typically bullion rarely depreciates and the value of his stock is bound to increase with time. However its the relationship between the supplier and seller and the terms of thier long standing trust in each other that typically drives the arrangement


But is there a possibility to incorporate this model for other luxury goods? It would look very lucrative for almost every sector in the luxury space, be it fashion, wines and spirits, fragrance etc. However small volumes and supplier resistance will prove a roadblock. Besides undue pressure on suppliers already squeezed margins may reflect on quality, besides the fact that most small speciality suppliers may simply be unable to have the systems and infrastructure in place to maintain and manage consignment stock globally. The benefits of consignment stocks are definitely exponential but the pitfalls also dire and hence a strategy that must be evaluated in length and used only sparingly in practice