What Is the Supply Chain?

How Does It Affect the Economy?

Apple controls its supply chain
Apple controls its supply chain to maintain high standards of design. Photo by Cristina Arias/Cover/Getty Images

What Is the Supply Chain?

The supply chain is how a company turns raw materials into finished goods and services for the customer.

What Is Supply Chain Management?

Businesses manage every step of the supply chain  to make sure it is the most efficient. As a result, many companies outsource jobs to countries like China that have a lower cost of living. By 2013, Asia accounted for 26.5% of global manufacturing output of products that are part of the supply chain.

China was responsible for half of global intermediate output. For more, see "A Tightening Grip," The Economist, March 14, 2015.

Many companies vertically integrate to get control of the supply chain. This gives them more control of the production process and costs. A great example is Apple, which maintains its high design standards through vertical integration from design through retail. This gives the company enough of a competitive advantage that it is nearly a monopoly when it comes to high-end, innovative computers, smart phones, and music players.

But vertical integration is a disadvantage when it restricts flexibility. For example, newspaper companies invested hundreds of thousands of dollars in expensive printing presses. In 2000, internet companies like Monster.com started stealing help-wanted advertisers from them. Newspapers were stuck with the bill and the need to keep those presses running.

They tried to compete by adding other paper-intensive media, like magazines, free press circulars, and community papers. Their investment in printing presses kept them focused on a dying medium.

How Does It Affect the Economy?

Managers decide where to locate the company based on costs of production. That led to a lot of jobs outsourcing in technology to India and China, and call centers to India and the Phillippines.

Natural disasters can disrupt any part of the supply chain, thus slowing global growth. In 2011, Japan's earthquake and resultant tsunami damaged enough ports and airports to halt 20% of the world's supply of semiconductor equipment and materials. The wings, landing gears and other major airline parts are also made in Japan, so the quake disrupted production of Boeing's 787 Dreamliner. U.S. GDP slowed in 2011 as 22 Japanese auto part plants suspended production.

How Supply Chain Financing Saved Companies During the Financial Crisis

The global credit crisis forced banks and corporations to find innovative ways to raise cash to keep businesses running. Many turned to supply chain financing, which is like a pay-day loan for businesses. Suppliers use the invoice for a shipment as collateral to get a low-interest loan from a bank. Banks know that they will get paid due to the credit-worthiness of the business receiving the goods. This helps small suppliers get better financing terms. Even banks that are reluctant to lend to each other are willing to lend against approved purchase orders and invoices with companies that have a good shipping record.

Corporations became more efficient in their operations, which also helps to free up cash.

In addition, corporation Treasurers became more focused on making sure the cash they had was invested in "safe havens," such as U.S. Treasuries, municipal bonds and even their own stocks in "stock buybacks." They became more savvy about foreign exchange and interest rate risk. In other words, good companies squeezed cash out of their operations and cash management, since they couldn't rely on banks. (Source: Global Finance, Banking on innovation, November 2008)

What Better Cash Management Means

Government efforts to pump liquidity into the global financial world restores confidence. But the public sector can only do so much. It is up to the banks and their corporate customers to solve the credit crisis through new, improved ways of doing business. Innovation got us into this mess, and innovation will get us out.

When the dust settles, it will be companies that have developed innovative cash management systems, efficient operations and good relationships with their business partners that will rise from the ashes. Those will also be the same companies that value their employees and foster an innovative culture.