C. F. Lynch & Associates
HOMEABOUTCLIENT SERVICESEXPERT ADVICECONTACT
   
 

Leveraging the Power of Networks for Optimal Supply Chain Efficiencies

By Clifford F. Lynch

Logistics Quarterly, May, 2005

Introduction

Every good supply chain manager realizes that transportation expense is the most significant component of the total cost of logistics; and at no time in recent history has it been as significant as it is now. Increased fuel, insurance, and engine costs, combined with new hours of service rules, an improving economy, capacity constraints and driver shortages have resulted in higher motor carrier rates. Fuel, the economy, and the lack of intermodal capacity have caused rail rates to increase as well. In short, there is a rather painful transportation cost environment and every indication that it will get worse before it gets better.

Most firms have been very proactive in reducing warehousing and inventory costs, but these savings are quickly paling into insignificance when compared to rising transportation expenses. It is absolutely critical that the supply chain manager turn his attention back to the transportation activity and develop creative solutions to the dilemma of rising costs.

Some motor carriers and other logistics service providers share the concern and have arrived at more innovative methods of trying to minimize shippers’ costs even as rates are increasing. They have found that establishing themselves as network connectors or integrators can be an excellent tool to be exploited for the benefit of both providers and clients.

While not a complicated concept, there is some lack of understanding of transportation networks and how they can be valuable to the firms that utilize them. Much of what has been written on the subject has been too academic to inspire even a cursory reading by the average supply chain executive.

 

Exactly What Is a Network?

Many of us think of a network more in terms of the Internet or as a vehicle to find a job, but the principle of the network is as old as mankind itself. Did you ever wonder how early scholars and teachers, without benefit of radio, television, telephones, computers or even mail service managed to spread their teachings throughout the world?

In 1929, a Hungarian, Frigyes Karinthy, in a short story entitled "Chains" advanced the theory that everyone in the world is tied to everyone else by no more than five links. This concept has come to be known as "six degrees of separation," and has been confirmed by subsequent research.1

For example, sociologists estimate that most of us have about 300 acquaintances with whom we are on a first name basis. This suggests that we are only a handshake away from 300 people, two away from 90,000, three away from 27,000,000, etc.2 Over time, the concept has become so popular that a movie, Six Degrees of Separation, was based on this principle in 1993.

Why not, then, apply this same principle to transportation through a network of networks?

Creating a Network of Networks

The value or potential of a network can be defined as the possible connections between its members. The number of potential connections is n (n-1) where n is the number of members in the network. However, if you connect two networks via one connection, each member of each network has access to every member of both networks. In the diagram below, each network has a value of 4x3=12 for a total of 24. Adding a single connection between the two networks increases the network value exponentially. The number of members of the combined networks is now 8 and the value of the new network is, therefore, (7x 8) = 56.

The value of these networks went from 24 to 56 by adding a single connection.

 

 

 

 

 

 

 

 

The Power of the Network

By now, you probably are thinking this is nothing more than some kind of "shell game," but the power, or value, of a network has been well defined by three basic "laws;" i.e., Sarnoff’s Law, Metcalfe’s Law, and Reed’s Law. Each of these laws, in its own way, quantifies network value based upon the connectivity within each.

 

Sarnoff’s Law

Sarnoff’s Law, named for broadcast pioneer David Sarnoff, states that the value of a (television) network grows in proportion to the number of viewers. These are the networks where content is transmitted by one and consumed by many. This is, of course, why the "value" of a television network is substantially higher during the Super Bowl broadcast than during reruns of Gilligan’s Island. That is why the network that broadcasts the Super Bowl will reach over 130 million fans in the U.S. and 1 billion worldwide and can, therefore, charge $2.5 million for airing each one of the sixty-nine 30-second commercials. From a transportation perspective, one shipper broadcasting instructions to many carriers in a one-way communication is a more modest, but applicable comparison.

Metcalfe’s Law

Metcalfe’s Law is one of two laws that have been singled out as the reason for the success of the Internet. (The other law is Moore’s Law, which states simply that processing power will double every 18 months.) Bob Metcalfe, inventor of the Ethernet and founder of 3Com, maintains that the value of a network grows as the square of the number of members (n2), and describes networks where each member of the network can potentially communicate with every other member of the network. It’s important to understand that this deals with potential connections, not necessarily with actual connections. There are networks where the value of the potential connections may be greater than the actual connections due to security issues or business rules.

 

Research into the degrees of separation on the Internet has indicated that any one document is only 19 clicks away from any other.3

 

Reed’s Law

Reed’s Law, developed by Dr. David Reed, explains what he refers to as Group Forming Networks, and states that the value of these networks grows as 2n, where n is the number of groups that can be formed in the network. Dr. Reed, in an article titled That Sneaky Exponential — Beyond Metcalfe’s Law to the Power of Community Building writes:

… perhaps the most important are supply networks that allow access to and bidding among suppliers and distribution networks that allow access to and competition among customers. The structure of these networks or market spaces, especially the value of the connectivity and relationships produced in these networks, can play a crucial role in defining the value of your business.

If you can manage or influence the networks that connect you to suppliers and customers to create more value for all concerned, that extra value can be used as a competitive weapon. So paying attention to network value is a crucial strategic issue, especially as businesses move their customer and supplier relationships into the 'net.4

 

Dr. Reed believes that as the density of the network increases, the value of the network shifts from being defined by Sarnoff’s Law to Metcalfe’s Law and then to Reed’s Law. Therefore, the networks that will produce the greatest returns will be networks that support groups that encourage collaboration among members of the network. This, of course, is the underlying principle of the internet transportation exchanges.

 

The Conventional Paradigm

For the most part, the conventional transportation relationships have been one-on-one. For example, as shown in the diagram below, if three transportation providers want to handle shipments from three different shippers to three receivers, they must make contact with those shippers who in turn would have to connect with each receiver, a total of n(n-2) or 72 potential connections (n=number of members in the network; i.e., 3 providers, 3 shippers, 3 receivers, or 9. The number of potential connections is 9(n-1) or 8 for a total of 72.)

 

 

In this paradigm, therefore, creating a network with a value of 72 requires 72 connections. At best this is cumbersome; and in the worst case, the network simply collapses under its own weight.

 

The Modified Paradigm

How then can we reduce the number of connections while at the same time maintain or increase the value of the network? What if a systems integration process could be inserted between the parties: shippers, receivers or suppliers, and transportation service providers? Each party could make one connection to the integrator and we could still maintain the value of the network. This would require only 9 connections instead of 72, yet the value of the network would remain constant at 9x8 =72.

 

Once a new member connects one time to the integrator, it is therefore connected to everyone in the network. This provides the opportunity for each member to gain and give visibility into their supply chains and to leverage the connectivity of the network. It also provides the opportunity for collaboration among the various members of the network.

 

 

 

 

 

 

 

 

This modified paradigm is the basis for some of today’s more sophisticated logistics service provider offerings. State-of-the-art technology is available through a web-enabled portal, requiring no large investment on the part of the shipper. In addition to avoiding a large capital investment, shippers can

  • access to a managed network of trading partners already connected to a system,

  • minimize implementation time,

  • reduce systems and support costs,

  • pay only for usage,

  • eliminate software obsolescence,

  • reduce transportation and inventory costs through better management of supply chain functions.

 

The Integrator and Metcalfe’s Law

In the diagrams above, there are three classifications of members: shippers, receivers, and transportation service providers. (It should be noted here that these concepts apply equally to inbound or outbound transportation movements.) In addition to these three, a fourth classification includes freight forwarders, customs brokers, consolidators, warehouses, transloaders, and distribution and fulfillment specialists. In its simplest form, the supply chain consists of origins and destinations that create two networks: a demand network and a supply network. The demand network is the freight that has to be moved from point A to point B. The supply network is made up of the transportation service providers and trading partners that execute the movement of that freight.

The Demand Network

The demand network is comprised of either shippers or receivers with their own origins and destinations. Each member of the demand network has its unique independent set of origins and destinations, and when each of these independent networks can be integrated, greater value is created and greater opportunities exist. This is because many suppliers serve the same customers. As an example, a bearing manufacturer may serve all major automotive makers.

The Supply Network

The other network within the supply chain is the transportation service provider’s network. Transportation service providers have certain lanes in which they routinely operate: some local, some regional, and some national. These are their preferred networks, influenced by such things as maintenance centers, operating hubs, and driver domiciles. The transportation service providers, when allowed to operate within their own networks, can offer better rates than when forced to operate outside their networks.

 

As the demand increases, the members of the supply network are presented with more opportunities to carry freight within their own preferred network, reducing the number of empty miles and improving the transportation service provider’s asset utilization. In addition, the increased opportunities mean that the transportation service provider has to spend less money looking for freight within his preferred network. The transportation service provider is able to achieve savings from his cost of sales and at the same time reduce the number of empty miles. These savings then can be reflected in the rate structures.

For the members of the demand network, they get to take advantage of the more efficient rate structures presented by the transportation service providers and reduced administrative costs as a result of reducing the number of required connections. In addition, as shippers and receivers are added to the network, new possibilities for freight consolidation provide opportunities for additional savings.

A limited number of more sophisticated logistics service providers have been able to carry this concept a step forward and leverage the value described by Metcalfe’s law (i.e., the value grows as the square of the number of members). Those that have been able to do so have created the opportunity for suppliers, shippers, receivers, and transportation service providers to connect to a network of networks. In addition to potential freight cost reductions, there are opportunities to better manage inventories, because the providers have detailed visibility of products and shipments moving through the system and can enable their customers to have this same access.

Such portals offer four basic features; i.e.,

  • Customer Management. Customers, suppliers, and receivers can update their core profile information and shipment data via the Internet.

  • Order Management. Shipments can be tracked and viewed via the Internet.

  • Shipping. Order information can be confirmed, and shipping notices sent.

  • Receiving. Arrivals and unloadings can be recorded promptly.

The benefits usually will offset the cost of the service and include

  • Reduced freight costs.

  • Visibility of the complete supply chain.

  • Ability to modify manufacturing schedules due to supply change.

  • Reduced inventory carrying costs.

  • Increased customer satisfaction.

  • Reduced out-of-stocks.

At this point the average reader no doubt is thinking that while this discussion may be interesting to someone, somewhere, there is little practical application. Nothing could be further from the truth.

 

Schneider Logistics, for example, has leveraged the advantages of the network principle into efficient, time-sensitive service to the automotive industry. Service part shipments to dealers present constant challenges in getting necessary repair parts to dealer garages when they need them, usually with very little lead time.

 

Through its convergence network, Schneider, using its parent company or other carriers, can bring parts from the manufacturer or its suppliers to a parts distribution center; and from there, using engineered routes, make the necessary deliveries to dealer facilities according to specific delivery times. Further economies can be achieved by consolidating products of various manufacturers.

 

There is constant visibility, regardless of which carriers are utilized.

 

The value of Metcalfe’s Law to the automotive companies can be seen in the income statement. The value will be reflected either in reduced costs or increased revenue. So, how are these savings reflected on the balance sheet? The answer is in working capital and its critical component - inventory. If you can reduce inventory and the associated carrying costs, you can have a positive impact on your balance sheet, freeing capital from operations to fuel the growth of the business. The above-described program, for example, has resulted in significant decreases in inventory.

A Virtual Community

Reed believes that Group-Forming Networks can create network value even more rapidly than Metcalfe indicates. The virtual community created by the network structure presents an opportunity for both real and potential connectivity for transactions.5 This concept gives every company the opportunity to share information among its suppliers, distributors, and customers and determine ways to collaborate on new products and services. Such collaboration provides the potential to impact the financial results of all the community members.

As each member gains and gives visibility to inventory in the supply chain, the total inventory in the supply chain can be reduced.

The trend is becoming clear: seamless inventory management from supplier to consumption. When a plant manager can see inventory on the floor, in the yard, and in-transit to his plant or distribution center, he is empowered with information to make better decisions about production, referrals, freight diversions, expedited transportation, and safety stock management. From a labor perspective the additional benefits of this visibility can control flow into and within the yard and gain the ability to balance manpower requirements on the receiving dock. 6

Performance Measurement and Management

An ancillary benefit of integrated networks is the ability to measure and manage performance. It begins by leveraging the data captured during the interactivity of network members. This information can then be translated to a form of mutual performance score carding. Score carding is a fundamental element of supply-based management; and the provider can build scorecards on carriers, suppliers, and shippers. They can even measure the effectiveness of electronic transactions between connected members of the extended enterprise.

The scorecard becomes the basis for improving performance for all members of the network, particularly those who are direct trading partners.

Conclusion

Combining the value of integrated networks with the value of information results in the real power of the network – a complex supply chain where connected members receive mutual benefits and financial reward. It will be difficult for the firm to realize these advantages independently, however. These results can best be achieved through a provider that already has a viable network. There are a number of providers that claim strong, far-reaching networks; but in many instances, the reality does not live up to the perception. Careful and informed due diligence is a must.

End Notes

1 Barabasi, Albert – Laszlo, Linked – The New Science of Networks, Cambridge,

MA 2002, pp 26 – 27, 33 – 34

2 Matthews, Robert, Six Degrees of Separation, www.worldlink.com, p 2

3 Barabasi, Albert – Laszlo, Linked – The New Science of Networks, Cambridge,

MA 2002, pp 33 - 34

4 That Sneaky Exponential – Beyond Metcalfe’s Law to the Power of Community

Building, <http://www.reed.com/Papers/GFN/reedslaw.html>, accessed

January 7, 2002

5 <http://www.reed.com/dprframeweb/dprframe.asp>, Weapon of Math

Destruction link, accessed January 8, 2002

6 Braddy, Bill. "Creating New Avenues for Cost Reductions." Inbound Logistics,

January 2002:292

 

 

List all publications

Return to Logistics Advice