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The power of supply chains in implementing innovations

David Zilberman, professor, agriculture and resource economics | March 17, 2016

Many of the products and services we consume today did not exist a hundred years ago (internet, television, modern cars, cell phones, computers, penicillin, McDonalds and Whole Foods). The world thrives on innovation, which is frequently derived from new scientific knowledge, as well as inspiration. Innovations may include (i) a new product, (ii) a new way to produce an existing product, or (iii) utilizing a new location to produce it.

But innovation requires ingenuity and new organizational structures and systems to implement it. Much of my research has aimed to understand how innovations are implemented (especially in agrifood), and in the last few years, I realized that the design of a supply chain, which is the organizational structure and system, is the key to the implementation of a new innovation.

When someone discovers a new product, its production involves several stages. For example, beer requires the use of barley, hops, yeast and water, cooking them together, packing, cooling, and shipping before it can be sold in a can in supermarkets, or in a glass in restaurants. For the most part, economists assume that markets exist and take the structure of supply chains and markets as given. They have emphasized understanding of prices and quantities of products as well as their social and environmental implications.

Economists have also investigated supply chain parameters, which may include the terms of contracts between buyers and sellers. However, markets for new products and services do not exist; in particular, there is a potential demand (that economic theory may help one to estimate), and the physical supply of the product must be established. Over the years, I have come to realize that a major challenge for the success of a new product depends on the design of the supply chain, and I have worked with collaborators to try to understand it.

wine picture

The importance of supply chains became apparent to me when I read the biography of Steve Jobs. The initial Apple supply chain was very simple: a garage, two Steves (Jobs and Wozniak), and some assistants who produced a few computers that were sold to stores. However, there were a lot of dilemmas as the company grew. For a while, Apple began to manufacture their computers using factories that were as beautiful as the computers themselves, but were losing money and realized that they should subcontract production to others.

In the beginning, they sold all their computers and other products through retailers; later on, they decided that they should have their own store in addition to selling to retailers. These types of choices are as important as decisions about prices to charge and quantities to produce. In food and agriculture, these kinds of decisions are very important.

I recently realized this when I started focusing on biofuels. If you want to produce biofuels, you need feedstock (the crops that provide raw material) and then you need to build a refinery. But generally, investors have limited resources to invest, so they have to decide on the size of the refinery, and to what extent they should grow the feedstock themselves, how much to purchase in the market, and how much to contract to others to grow for them.

biofuel refinery

Decisions about the scale of operation and the division of supply of inputs between in-house and external operations are key in the design of a basic supply chain. As economists, we have the ability and tools to analyze these decisions.

Let’s look at the example of an innovation in Kenya: the growth of flowers for export. You, as an investor, may have to decide if you would rather build a big farm and hire people to work for you or build a processing plant and offer farmers or a farmers’ cooperative a contract to produce for you. Another basic supply-chain question is how to distribute output among different channels. For example, a nursery may have to determine its capacity, how much to allocate among different flowers, to what extent they sell the flowers through intermediaries, and how much would be sold directly to consumers (through the internet or at a farmers’ market).

A similar decision may be faced by a winery. They may decide to sell a certain percentage to a supermarket chain, another to restaurants, and the remaining through a showroom (maybe part of a winery tour). These decisions are affected by the innovator’s financial situation, the political and social system, the technology available, etc. The strategy and volume may change over time; the innovator may experiment by starting small and once it has established a production system that works, it may either expand operations or reach out to cooperatives to provide it with inputs.

Understanding these types of decisions require understanding of economics, political systems, as well as basic engineering science and management systems. For example, in some countries international investors cannot own land, so building a large farm for production is out of the question, and the one way to assure supply is to assist in establishing a system of small farmers, possibly through a cooperative. In some cases, credit is available to farmers, and the investor in a supply chain based on refining a product only has to obtain credit for the refinery.

In other cases, the investor may need to finance both the refinery and the farms producing the feedstock, which will generally result in a smaller operation.

chicken

Simply relying on theoretical and analytical techniques to study supply chains is insufficient because there is much to learn from case studies. For example, take the case of Tyson Foods, a large livestock producer, which was started by truckers who were moving chickens from Arkansas to New York. They then decided to provide the grains to the farmers who produced the chickens, and later on, they decided to breed their own line of chickens. Now they process their chickens into packaged parts and sell them to supermarkets throughout the world.

Understanding the motivation of each design decision along the supply chain, and the evaluation of economic, social and environmental implications can be very valuable to others. Similarly, there are many lessons to be learned from critical assessment of the evolution of the supply chain of companies like Whole foods, Nestle, Costco, Mars as well as refineries, farms, and farmers’ cooperatives.

There are definitely lots of lessons to learn about supply chain structures that need to be understood in order to design better strategies in the future. The ongoing evolution of the bioeconomy, where people use biological resources to produce multiple products, will require clever design of supply chains. For example, companies that decide to grow algae and then have a bio refinery to utilize it must decide on their capacity as well as how much of the algae will be used for food, animal feed, fuel and fine chemicals. But, supply chain design is done under uncertainty. In the previous example, the innovators who introduce this supply chain may have uncertainties about how to produce algae efficiently and the size of the market for fine chemicals like beta-carotene. In these cases, the scale of a supply chain may be developed gradually, and the innovator may fine-tune it over time while learning by doing.

Risk management and supply chain design are also important in the context of climate change. When firms are uncertain that they will be able to obtain their supplies from given sources because of climate uncertainties, they may develop redundancies, backup production plans, or operate at different locations to diversify their risks. Some of the uncertainties in the design and operation of supply chains are associated with the capability for partners to meet their obligations, and so supply chains may develop mechanisms to insure against bad performance or mishaps.

cacao-pod-cocoa-beans-and-chocolate

Some of the new and exciting developments in the world are associated with changes in supply chains. One example is the spread of supermarkets throughout the world (I visited bigger and more sophisticated supermarkets in Lima and Dakar than those in Berkeley). The introduction of modern communication systems enabled the expansion the linkages throughout the world, resulting in new forms of supply chains and businesses.

I perceive that better understanding how supply chains are designed, drawing on both theory and real-world experience, is important to business professionals as well as economists and researchers. This year, we are organizing a three day workshop on innovations and supply chains as part of the College of Natural Resource’s International & Executive Programs. I am co-organizing it with Thomas Reardon, who has immense knowledge of agricultural supply chains and supermarkets around the world and the economics associated with it, and Justus Wesseler, who has established an excellent program on the bioeconomy at Wageningen University, the leading agricultural university in Europe.

We have a great lineup of speakers, both from industry and academia, and the conference is aimed towards both practitioners and scholars of business and agriculture, presenting both advanced theory and case studies at the farm, processing, and retail levels from all across the world. I believe that it is the first of its kind, and it will be extremely informative and a lot of fun. I hope that you consider participating and invite others that may benefit from it.

berkeley-campus_4webwellman hallSather-Gate

Comments to “The power of supply chains in implementing innovations

  1. Great outline of this important research scope, David! Good luck with the conference, hope to be able to participate.

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