Last week Netflix suffered a major disruption to its supply chain last week when its order fulfillment system went offline for several days.  In my opinion, the DVD industry and the broader home entertainment sector consisting of video games and music (CDS) have one of the most complex supply chains of any industry.  The primary challenge surrounds new product introductions.  On average, 80% of the lifetime sales for a new title are sold within the first 2-3 weeks of availability.  To maximize the revenue and profit opportunity entertainment product distributors and retailers must minimize the out-of-stocks for new titles in their retail locations.  They must maintain a high level of inventory precision across thousands of stores without any historical demand data upon which to base their forecasts.  The supply chain issues are further compounded by the proliferation of SKUs for each title.  For example, for each new DVD launch, a retailer must stock widescreen and standard format; the high definition Blu-Ray version and often gift packs or “Special Collector’s Editions.”  See my earlier post for more details on the retail DVD supply chain.

In this post, I will continue the discussion of the DVD supply chain, but focus on the video rental companies such as Netflix rather than the video sales market.  Traditionally, the bulk of video rentals in the US were distributed through national chains such as Blockbuster and Hollywood Video.  Netflix has changed the game in the rental market over its short history.  Netflix’s Internet-based ordering approach and its centralized distribution model are two supply chain advantages I think it has over traditional rental models.

Netflix ships its products from 50 distribution centers located in major metropolitan areas throughout the US.  Netflix claims that 95% of the US population is within close enough proximity to a distribution center to allow for 1-day shipping.   50 distribution centers may sound like a lot, but managing inventory at 50 distribution centers is far less complicated than stocking the 7800 stores Blockbuster operates throughout the country.  Other advantages of the centralized distribution model include:

• Stocking the Long Tail - Netflix has the economies of scale that enable it to stock a much broader range of titles than a traditional retailer.  In aggregate, Netflix maintains an inventory of 69 Million DVDs representing over 90,000 titles.  The deep selection also enables Netflix to offer a personalized merchandising approach in which titles are automatically recommended to subscribers based upon their profile and rental history.
• New Product Introductions – Netflix does not need to concern itself with store-level inventories during the peak sales period following new product launch.  If demand for a particular title exceeds supply there are several options.  Netflix can ship an alternative title to the subscriber based upon what is next in the queue.  Or Netflix can contact one of the local duplicators, which manufacture the DVDs, with a request to burn more copies of the out-of-stock title.

With the growing demand for digital distribution I wonder whether a mail-based replenishment system such as Netflix’ will even exist ten years from now.  More and more consumers are watching video on demand services provided through their cable or satellite subscription.  Others are downloading movies over their broadband Internet connection using services such as Amazon.com’s Unbox.  Netflix has a digital distribution strategy as well.  Subscribers can access a library of 6,000 movies online for viewing on their personal computer.  Additionally, Netflix signed an agreement with LG Electronics to enable subscribers to view movies on their primary television using an Internet connection to the set top box.

The software glitch impacted Netflix shipments on Tuesday, August 13^th and Thursday, August 15^th, but the problems were quickly resolved.  The disruption could not have occurred at a better time for Netflix. Home video rental rates typically decline during mid-August as families take vacation at the beach or other destinations.  And those who were not on vacation were probably watching the Olympics, which is another factor contributing to below average video rentals this month.

Supply chain disruptions are becoming more highly visible, not just to customers, but to investors as well.  I first read about the Netflix issues in the Wall Street Journal.  But there are larger issues than supply chain failures that Internet-based video rental companies need to consider in today’s market.  I think we will witness a significant change in the video rental market in the coming 24 months.  The rapid growth of video kiosks co-located in grocery stores around the US is going to push the supply chain model back towards localized (versus centralized) distribution.  More in a future post…

Steve Keifer

© Copyright 2008 GXS, Inc.  All Rights Reserved.

In my last post I outlined the five primary forces that I think are fundamentally changing the way corporations approach back office finance functions and their banking partners.  However, one of the dynamics I did not explore is the dependency of the business model changes on technology.  Changes to accounting systems and bank connectivity will be critical factors in the success of corporate transformation efforts.  To realize cost efficiencies, A/P organizations must be able to efficiently route payment instructions to their key banking partners using highly reliable, secure and cost-effective communications channels.  To benefit from a centralized treasury, cash managers must be able to obtain detailed, up-to-date account statements from their financial institutions in order to perform end-of-day investment and borrowing activities. 

I have compiled a list of the top five forces I think are transforming the technical interfaces banks and corporate customers use to communicate electronically.  These five forces are the technology changes complementary to the business model changes outlined in my last post:

1.       ERP Consolidation – More multi-national corporations have a project underway to standardize and consolidate the various ERP applications being utilized within their enterprise.  Standardization enables consistent business practices across divisions and the creation of shared service centers.

2.       SWIFT Connectivity – Several hundred large corporations have registered to participate in SWIFT’s corporate access programs (SCORE).  SWIFT connectivity can reduce the costs and complexity associated with corporate banking communications by replacing the mix of web, fax and host-to-host transmissions with a single connection to banks worldwide.

3.       ISO 20022 XML – Otherwise known as the Universal Financial Industry (UNIFI) standard, ISO 20022 XML is designed to replace the myriad of local file formats (e.g. EDI, NACHA) used for payment processing around the world with a single, global message scheme.  See my blog entry on ISO 20022 for more details.

4.       Multi-Bank Cash Reporting – Multi-bank reporting applications aggregate end-of-day and intra-day balances for all accounts onto a single web portal.  Treasury personnel with visibility to all cash positions at bank accounts worldwide are better equipped to perform cash forecasting, borrowing and investment activities.

5.       Bank Relationship Management Software – Bank connectivity has become such a complex issue for corporations that several ERP vendors have introduced specialized software modules to simplify integration.  For example, SAP recently introduced its “Bank Relationship Management” application.  See my blog entry on SAP BRM for more information.

For those interested, I published a more detailed view of the 10 Forces Transforming Corporate Banking Connectivity on the www.gxs.com web site.

SAP recently introduced a new application specifically designed to simplify electronic communications between companies and their financial institutions.  The new application has not received much attention by the press or analyst community, but it should have!   If anyone is well positioned to break down the barriers of straight through processing between corporate and their financial institutions, it is SAP.  In nearly every multi-national account I visit with SAP is already established or will soon become the financial platform of choice for multi-national companies.  SAP should be able to leverage its position as the epicenter of corporate cash management to provide simplified, straight through processing between its ERP modules and the treasury applications of leading banks.

What is SAP’s Bank Relationship Management module? 

So what is SAP’s strategy to simplify bank communications?  The vision revolves around the new Bank Relationship Management application, which is part of SAP’s “Financial Supply Chain Management” suite of software which also includes online bill presentment &payment; cash and liquidity management; collections management; dispute management; in-house cash and treasury & risk management.

How does SAP BRM simplify bank connectivity? 

SAP offers three key integration features that will greatly simplify bank connectivity for multi-national corporations:

1.       ISO 20022 XML support – 20022 is the new Universal Financial Industry standard developed jointly between TWIST, SWIFT, OAG and IFX.  Read my earlier post on ISO 20022 for more background information.  ISO 20022 is a game changer as it offers one file format that corporations can use to communicate payment instructions regardless of geography or financial institution.  Instead of a corporate having to create different file formats such as SWIFT FIN, ANSI X12 EDI, EDIFACT and NACHA for each banking relationship, the company can produce all its payment instructions worldwide in the single ISO standard.  SAP BRM can output payment instructions in this one standard ISO 20022 XML format which can then be directly transmitted to the bank.

2.       SWIFTNet Integration – SWIFT is a bank owned cooperative that operates a highly reliable, secure network designed exclusively for banks to exchange messages and files with one another.  Historically, access to the network has been restricted to financial institutions, but SWIFT has recently opened its services up to non-financial corporations.  Corporate Integration to SWIFT greatly simplifies bank integration by providing a single interface for all banking communications.  Instead of a corporate establishing an individual Internet (or private line) connection with each of its financial institutions, the company can send all of its banking transactions to SWIFT who will perform the routing on the corporate’s behalf.  SAP BRM includes pre-packaged adapters for corporations to connect to SWIFTNet.

3.       Enterprise Application Integration – Leveraging the Netweaver technology, SAP BRM provides tight integration with the other Financial Supply Chain modules such as cash and liquidity management; collections management; in house cash and treasury and risk management.   As a result, corporations do not need configure file transfer scripts and complex maps to route outgoing payment instructions from their financial modules to their banking partners.  Receivables and account statements flow through directly from the bank to the appropriate financial module.  Such an approach is powerful, because corporations using the full SAP financial suite can obtain straight through processing out of the box with minimal integration work.

Will SAP succeed with its ambitious plans to simplify bank communications? Yes and no.  While SAP does offer compelling technology, its solution is limited to software technology.  The challenges with bank connectivity are not the lack of strong technology or for that matter governing regulations or universal standards.  The greater challenges are related to:

• Skill Sets – The new technology paradigms such as SWIFTNet and ISO 20022 XML promise to greatly simplify connectivity processes.  However, there is currently a shortage of IT professionals with practical experience in the new technologies.
  • SWIFTNet - Connecting to SWIFTNet, for example, requires an extensive testing and certification process as well as the purchase of proprietary security technology and the establishment of expensive disaster recovery infrastructure.  Many corporates will not have the budget or expertise to perform SWIFT integration with their in-house IT organizations. 
  • ISO Skill Sets - ISO 20022, much like any XML format, is a complex document structure that requires both specialized functional knowledge to understand the various data fields and advanced technical skills to develop maps.
• Budgetary Pressures – Both corporations and financial institutions have significant investments in the legacy payment technologies and standards.  Corporate treasurers are under pressure to reduce back office administrative costs year-over-year.  Financial institutions continue to experience price erosion due to the perceived commoditization of cash management services.  Consequently, to utilize SAP’s BRM along with SWIFTNet and ISO, both corporate and financial institutions will have to fund expensive modernization projects in an environment of ever decreasing budgets.  
• Recent Investments - Many financial institutions have payment hub projects underway to replace mainframe-based legacy applications with new SOA platforms.  However, these institutions have not necessarily factored the new standards and technologies (e.g. ISO, SWIFTNet, SAP BRM) into their strategies.  Similarly, numerous corporate have established in-house banks with file and messaging gateways in the past five years.  The new corporate banking interfaces were designed to deliver similar functionality to SAP BRM.  Although the prior investment in banking gateways should be viewed as sunk costs, it will be challenging for IT organizations to secure budget to decommission and replace technology platforms they just established.

Over a five year horizon, I predict SAP’s Bank Relationship Management will become the de facto bank communications gateway for multi-national corporations.  However, adoption will be inhibited by the economic, organizational and technological factors outlined above…

Steve Keifer

© Copyright 2008 GXS, Inc.  All Rights Reserved.

In my last post, I made the argument that ERP applications are not designed to support the growing levels of outsourcing in today’s manufacturing ecosystem.  I think what is needed is an “ERP Firewall” for manufacturers to protect their enterprise systems from bad data.  Let me explain this ERP Firewall concept further:

ERP Firewall Defined 

ERP Firewall -         

noun

1.       fire•wall \’fī(-ə)r,wȯl\: an application which permits, denies or takes correction action to electronic data interchanges between an enterprises’ applications and its external business partners systems based upon a configurable set of rules or criteria. 

Restated, an ERP Firewall ensures that bad data from external business partners doesn’t enter your ERP system polluting the quality of information in your enterprise applications.  Much like a normal firewall, an ERP firewall examines all incoming and outgoing data against a pre-configured rule set.  A traditional firewall rule might be to block all incoming clear text FTP traffic on port 21.  Similarly, an ERP firewall rule might be to block all documents which are not in the manufacturer’s list of standardized e-commerce processes.  For example, the firewall might block all ANSI X12 EDI formats which are not 810, 820, 850, 856 or 997 (or EDIFACT formats INVOIC, PAYMUL, ORDERS, DESADV, CONTRL).  As a result, a document such as a 214 or 824 which is not the expected input for any ERP module does not even pass the firewall.    Another example of a rule set might be to route any 810/INVOIC documents without a street address, general ledger code or appropriate tax identifier to an exception queue for manual resolution by the supplier.

Firewall Severity Classes and Actions 

There are four typical actions that an ERP firewall might take based upon its configured rule set.  The action taken will, of course, depend upon the scenario encountered:

1.       Fatal – In this scenario, the electronic document is beyond repair.  Not only will the document fail during later processing, but it could result in financial losses to the company or its trading partners if not stopped.  As a result, the firewall should reject the electronic document entirely by sending a failure notification back to the originator.

2.       Error – The electronic document has a critical error that will fail upon attempted processing.  In this scenario, the error can be remedied, but only with the manual intervention of an end-user at the originating company.  For such scenarios, the firewall should hold the electronic document in an exception queue for the originator to review and repair.

3.       Warning – The electronic document has a minor data quality error that will not disrupt processing, but should be corrected, if possible, in future scenarios.  The firewall will pass the document through to the ERP, but also log the data quality issues in a report.  The logged warnings should be trended for frequency and root cause.  The most common occurrences should be identified and remedied through collaboration with the originating trading partner.

4.       Auto-Fix – In this scenario, the original document has an error that can be automatically corrected by the firewall.  This is the real power of the ERP firewall.   In many cases, bad data can be corrected automatically before reaching the ERP.  For example, missing fields may be looked up in a table, database or via an application web services call.  The original document is then augmented or enriched with the new fields then forwarded for processing.  What other types of auto-fix functionality might exist?  Documents can be split and routed to different ERP systems.  Conversely, outputs from multiple ERPs might be merged into a single document.  A fourth function is data filtering, in which, unnecessary data can be stripped out of incoming or outgoing documents to simplify subsequent processing at the destination.

Manufacturers are investing tens of millions to consolidate, standardize, upgrade and extend their ERP applications to optimize value from their ERP applications.  However, these efforts are undermined and compromised when bad data from business partners corrupts and pollutes the ERP.  An ERP firewall, which can be implemented at a small fraction of the annual maintenance royalty you pay your software vendor, can reduce bad data by up to 50% with just a few simple rule sets.

Steve Keifer

© Copyright 2008 GXS, Inc.  All Rights Reserved.

This week is the annual SAP Sapphire conference in Orlando, Florida.  I didn’t make it to the show this year, but I thought I would offer some insights on ERP and its increasingly interdependent relationship with B2B e-commerce.   The ERP vendors have spent much of the past few years focused on rewriting their applications to support a services oriented architecture approach.  SAP has its Netweaver initiative and Oracle has Fusion.  However, one area I think the ERP vendors have underestimated is the need to redesign their applications to support the extensive level of outsourcing that is becoming predominant amongst their customer base.

The Outsourced Supply Chain

In today’s manufacturing market, outsourcing is becoming more the norm than the exception.  Companies have become more and more specialized within their value chains.  OEMs that traditionally have been manufacturing-oriented are increasingly outsourcing many of their supply chain functions to third parties (contract manufacturers, freight forwarders and third party logistics providers).  Back office functions such as accounts payable, human resources and IT management are being sourced as well to specialized BPO firms.  The overall result of this outsourcing phenomenon is that manufacturers are more dependent than ever on business partners to perform daily operations.  It also means that enterprise IT systems are more dependent than ever on moving data to and from business partner IT applications.  In order to gain visibility to outsourced, external processes, manufacturers must be able to synchronize data in real time with their business partners.  For many manufacturers who outsource critical manufacturing, logistics, distribution and service functions, a growing percentage of the data housed in corporate ERP systems actually originates outside the enterprise.

50% of ERP Data Originates Outside the Enterprise 

I was talking to a customer the other day who told me that over 50% of the data in their ERP system comes from trading partners.  This comment puts in perspective the critical role that B2B integration technologies play in enabling ERP.  It also underscores the need to ensure that bad data isn’t flowing in from external interfaces and thereby corrupting information quality.  Much has been written about the challenges with maintaining what is called “Master Data” for products, customers, employees, assets and suppliers in the past few years.  But I am not referring to bad address information for consumers who move around every few years (i.e. customer master data).  I am referring to non-master, transactional data related to a specific order.  The order data originates from large customer accounts as well as contract manufacturers, third party logistics providers, banking institutions and business process outsourcers.

ERP Needs a Firewall to Protect it from Bad Data 

Who cares about bad data in an ERP?  Both line of business managers and IT personnel should be concerned about the consequences of this growing problem.  Bad data pollutes a manufacturer’s ERP system.  The result is a loss of productivity.  But to be more specific, data quality errors result in three negative impacts to a manufacturing organization:

1.       Longer time to process – Time sensitive processes may be delayed while accounting, warehouse and customer service personnel research and resolve data issues.  For example, if an invoice is posted to an accounts payable system without a general ledger number to apply the cost against, then an accounting clerk must phone the supplier or internal buyer to capture the appropriate data.  If a purchase order is pushed to an order management system with an invalid part number or SKU then the sales organization must contact the customer to discuss an appropriate substitution. 

2.       Higher cost to process – Personnel must spend time and effort manually correcting data in the ERP application or fixing problems resulting from the processing of the bad data.  Higher volumes of manual processing unnecessarily inflate costs and erode margins.  For example, in the retail industry studies have determined that over 60% of invoices have data errors.  And each error costs between $40 and $400 to correct.

3.       More mistakes during processing – The probability of an error increases exponentially as soon as manual processing begins.  By comparison, however, human intervention could be relatively inexpensive when compared with scenarios in which bad data goes undetected.  What are the costs of missing a contract commitment with one of your top 5 accounts?  Or of fulfilling an order incorrectly with the wrong parts shipped to the wrong location? Such data quality errors might seem like insignificant problems when viewed at a microscopic level for each individual order.  However, the costs of increased Days Sales Outstanding from invoice processing delays and customer penalties from failed order fulfillment commitments can quickly compound to have a macroeconomic impact on financial performance.

Why Firewall your ERP? 

Why aren’t ERP applications designed to capture these types of business process and data quality errors?   Actually, SAP and Oracle do provide extensive business logic and data integrity checks within their applications.  When an end user keys in data to a graphical interface the native ERP business logic will detect a wide variety of errors.  However, when the data flows through a B2B gateway and is subsequently uploaded into the ERP database there is very little data checking that occurs. What can manufacturers running ERP do to prevent bad data from corrupting their enterprise applications?  One option would be to hire a systems integrator to develop custom code to enforce data integrity standards for B2B imports and exports.  Additionally, a new set of user interfaces would be required to manage exceptions identified by the data checks.  Any customizations to ERP applications come with a significant overhead.   With each new release of the vendor’s software, the customer must perform extensive regression testing and often software updates.  I think a better option is to deploy an application at the edge of the enterprise that inspects incoming and outgoing documents from trading partners for data integrity issues.  Such an application would effectively be acting as an “ERP Firewall” for bad data.  The firewall would inspect the contents of EDI, XML and other files in a Demilitarized Zone for quality of content.  Bad data would be rejected to the sender or held in a queue for exception processing.  Good data would be passed straight through to the ERP for immediate processing.