BENEFITS OF TURNING SUPPLY CHAIN INTO REVENUE CHAIN IN PRODUCTION COMPANIES
CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
This chapter reviews existing literature on supply chain, operations management and firms’ performance. This involves review of theoretical aspects related to the study, empirical studies that relate to supply chain practices, profitability and research gaps therein.
2.2 Theoretical Review
A Theory is a set of statements or principles devised to explain a group of facts or phenomena especially one that has been repeatedly tested or is widely accepted and can be used to make predictions about natural phenomena (Popper, 1963). Theories are analytical tools for understanding, explaining, and making predictions about a given subject matter (Hawking, 1996). A formal theory is syntactic in nature and is only meaningful when given a semantic component by applying it to some content facts and relationships of the actual historical world as it is unfolding (Zima, 2007). This study will be based on human capital theory, Schumpeterian theory, and Porter’s competitive advantage theory which is discussed below.
2.2.1 Human Capital Theory
Human Capital theory was proposed by Schultz (1961). Schultz (1961) in an article entitled “Investment in Human Capital” introduces his theory of Human Capital. The theory argues that both knowledge and skill are a form of capital, and that this capital is a product of deliberate enterprise growth. The concept of human capital implies an investment in people through education and training leads better supply chain management. Schultz argues that investment in education and training leads to an increase in human productivity, which in turn leads to a high firm’s profitability and excellent supply chain management practices.
This theory emphasizes the supply addition that people contribute to supply chain management function and an organization at large. It regards people as assets and stresses that investments by organizations in people will generate worthwhile returns. The theory is associated with the resource based view of strategy developed by Barney (1991), the theory proposes that sustainable competitive advantage is attained when the firm as a human resource pool that cannot be imitated or substituted by its rival. For the employer investments in training and developing people is a means of attracting and retaining people. These returns are expected to be improvements in performance, productivity, flexibility and the capacity to innovate that should results from enlarging the skills base and increasing levels of knowledge and competence.
From the theory, it can be concluded that having skilled employees, with high education levels and experience will lead to better supply chain management practices. This in turn will lead to supply optimization, reduced costs of operations leading to high profitability. Lack of skilled and qualified personnel will lead to in inefficiencies in carrying out supply chain management function and hence reducing company’s profitability. In conclusion, according to this theory, the objectives of supply chain management cannot be achieved without having the strong human capital.
2.2.2 Schumpeterian Theory
Schumpeter’s (1934) theory has emphasized the role innovations and the seeking out of opportunities for novel supply and generating activities which would expand (and transform) the circular flow of income through risk taking, pro activity by the enterprise leadership and innovation which aims at fostering identification of innovative ways of managing innovations so as to maximize the potential corporate profit. Schumpeterian theory supposes that technological progress comes from innovations carried out by firms motivated by the pursuit of profit, and that it involves what Schumpeter called “creative destruction”. That is, each innovation is aimed at creating some new process or product that gives its creator a competitive advantage over its business rivals; it does so by rendering obsolete some previous innovation; and it is in turn destined to be rendered obsolete by future innovations (Schumpeter, 1934).
Schumpeter identifies the single notion of innovation as paramount, so that changes based upon innovation are the cause of profit. The entrepreneur is for Schumpeter an innovator, who by virtue of his innovation is able to break from the competition, acquire a transitory monopoly in which he can accrue profits until his competitors catch up, but, before they do so, he is able to move on to further innovation in new fields. Schumpeter did not see the firm’s ability to generate surplus supply but rather as a functional reward linked to firm’s innovative ability. Schumpeter saw the model of perfect competition in which different companies sold similar goods at similar prices produced through similar techniques as immaterial to progress. According to this theory, supply chain management objectives cannot be achieved without firm innovating, incorporating technology in operations and coming up with better ways
of managing operations. Innovations lead to better ways of conducting business, leads to superior processes which leads to reduction in supply chain costs and hence leading to high profitability. The innovations include those relating to technology adoption to ensure efficient supply chain management.
2.2.3 Porter’s Theory of Value Chain
The theory was proposed by Porter (1985). Value chain analysis describes the activities within and around an organization, and relates them to an analysis of the competitive strength of the organization. Therefore, it evaluates which value each particular activity adds to the organizations products or services. This idea was built upon the insight that an organization is more than a random compilation of machinery, equipment, people and money. Only if these things are arranged into systems and systematic activates it will become possible to produce something for which customers are willing to pay a price. Porter argues that the ability to perform particular activities and to manage the linkages between these activities is a source of competitive advantage. Porter distinguishes between primary activities and support activities. Primary activities are directly concerned with the creation or delivery of a product or service. They can be grouped into five main areas: inbound logistics, operations, outbound logistics, marketing and sales, and service. Each of these primary activities is linked to support activities which help to improve their effectiveness or efficiency.
The idea of the supply chain is based on the process view of organizations, the idea of seeing a manufacturing (or service) organisation as a system, made up of subsystems each with inputs, transformation processes and outputs. Inputs, transformation processes, and outputs involve the acquisition and consumption of resources; money, labour, materials, equipment, buildings, land, administration and management. How supply chain activities are carried out determines costs and affects profits. In Porter's value chains, inbound logistics, outbound logistics, marketing and sales and service are categorized as primary activities. Secondary activities include procurement, human resource management, technological development and infrastructure; how well the value chains are managed determines the level of efficiency in operations management and determines company’s profits (Porter 1985).
Often multinational enterprises like KenolKobil, have developed global supply chains, investing abroad and establishing affiliates that provides critical support to remaining activities at home. To enhance efficiency and to optimize profits, multinational enterprises must establish a department aimed at ensuring management and optimization of supply chain. According to Porter’s theory management of supply chains and leads to increased profitability.
2.3 Empirical Review
Elijah (2013) studied profitability through effective management of materials in Nigeria. The study found that profitability could be achieved through effective management of materials with particular attention on sourcing, receiving, storing and issuing materials. Prudent management of materials was found to reduce depreciation, pilferage and wastages while ensuring availability of the materials as at when required. Further the study concluded that for firm to achieve profitability the goal of materials management should be properly carried out which goes a long way to affect the profitability of the firm. The study concluded that given the problem that arises as a result of the inefficiencies, breakdown and shut down of the plant, it becomes very necessary to re-organize the materials management department, establish good relationship with suppliers of spare parts in order to minimize losses arising from frequent breakdown and improve profitability.
Adyang (2012) studied the procurement category management among fast moving consumer goods companies in Kenya. The study showed that all the organizations under study had adopted procurement category management; which is a part of operations management. The study also found out that the major benefit associated with category management was sustainable cost savings to the organization while category management had little effect in the use of technology and management information as well as improving the optimal procurement operating model. The cost savings implies increased firms’ profitability. The greatest challenge of implementation the strategy was lack of qualified personnel and the high cost of implementation, costs which could cloud out the benefits of the savings. The study recommended the adoption of category management among companies, government and government agencies who had not implemented procurement category management. The study also suggested an investment in the right human resource, development of the correct change management process and appropriate communication mechanism as the levers to successful implementation of category management.
Rick (2004) studied the challenges of complexity in global manufacturing insights to effective supply chain management. The study analyzed the supply chain synchronization of nearly 600 manufacturers in every major industry segment across North America and Europe, representing 19 countries. Industries represented in the study included aerospace and defence, automotive, life sciences, manufactured consumer products, process and chemicals, high technology and telecommunications, as well as other general manufacturing segments such as metal fabrication, industrial machinery and equipment. The study found that every manufacturer’s supply chain, regardless of size, was the foundation for the company’s planning, sourcing, production, sales, and financial success; its management was driver of firms’ velocity and profitability. Poor management of the operations was found to erode profits, shrinking of shareholder supply and declining market position. Further, more than a third (38 percent) of the 600 respondents to the survey had slim (less than 5 percent) operating margins or losing money on an operating basis.
Nikos (2007) studied the effect of operational performance and focus on profitability of the U.S. airline industry. The study found that both operational efficiency and quality affects profitability. The study also found the relationship between operational performance and profitability to be contingent on a company’s operating model. “Focused” airlines showed a link between late arrivals and profitability, while full- service airlines do not. Also, capacity utilization is a stronger driver of profitability for full-service airlines than for focused airlines. The study recommended that in operations management research, the benefit is more when longitudinal methodology is used, which would enable rigorously testing of operation management theories.
2.4 Summary of Literature Review
Various theories have been reviewed as giving useful insights on operations management and profitability. The human capital theory advocates for investment in human capital through education and training so as to achieve operational efficiency. The theory argues that investment in education and training leads to an increase in human productivity, which in turn leads to a high firm’s profitability and efficiency in carrying out firms operations. Schumpeterian theory highlights the role of innovations and the seeking out of opportunities for novel supply and generating activities so as to
maximize the potential corporate profit. Porter’s theory of supply chain on the other hand describes the activities within and around an organization, and relates them to an analysis of the competitive strength of the organization.
The literature has primarily focused on either the link between productivity and profitability or the link between service quality and profitability. The overall impact of operational performance on profitability in service organizations has been largely neglected. Nikos (2007) found that both operational efficiency and quality affects profitability. Elijah (2013) studied profitability through effective management of materials in Nigeria and found that profitability could be achieved through effective management of materials with particular attention on sourcing, receiving, storing and issuing materials. Rick (2004) studied the challenges of complexity in global manufacturing insights to effective supply chain management. The study analyzed the supply chain synchronization of nearly 600 manufacturers in every major industry segment across North America and Europe, representing 19 countries. Adyang (2012) studied the procurement category management among fast moving consumer goods companies in Kenya. Prior literature has not studied operations management’s impact on profitability been neglected in research irrespective of the importance of operations management on profitability as shown on the discussed studies.
2.5 Conceptual Framework
Mugenda (2008) defines conceptual framework as a concise description of the phenomenon under study accompanied by a graphical or visual depiction of the major variables of the study. It can also be seen as a diagrammatical representation that shows the relationship between dependent variable and independent variables. In this study, the conceptual model will look at the relationship between profitability and
operations management. The dependent variable will be profitability as measured by return on assets while the independent variables will be human capital, technology applied in supply chain management chain management practices.
2.5.1 Human Capital
Empirical research have emphasized that human capital is one of the key factor in explaining enterprise growth. Bruderl et al. (1992) argues that better human capital enhances the productivity of the firm by ensuring that supply chains are efficiently managed which results in higher profits. Moreover highly educated personnel may also leverage their knowledge and the social contacts generated through the education system to acquire required resources in terms of supply chains and new markets (Shane and Cable, 2003). In addition to education, specific human capital attributes of employees, such as capabilities that they can directly apply to the job in the firm, may be of special relevance in explaining enterprise profitability. The specific human capital can be attained through precise trainings and previous experience. More focused business training can provide employees with a specific knowledge, compared to a formal education. This kind of specific human capital also includes knowledge of how to manage operations. In particular, firms with great industry- specific and general business specific human capital are in an ideal position to seize neglected business opportunities and to take effective strategic decisions that are crucial for the success of the firm (Collombo & Grilli, 2005).
2.5.2 Technological Innovation
Innovation is essential ingredient in to generating long term stability, growth of share holder returns, sustainable performance and remains at the leading edge of the organizations’ industry. Innovation is referred to very different kinds of “newness” regarding products, production methods and technologies, markets and organizational configurations (Varis & Littunen, 2010). Innovation is also defined as a new way of doing things that is commercialized, the newness being either technological or market related (Narvekar & Jain, 2006). Internally, firms should be supported by their strategy, structure, system and people. Competences and assets are the function of technological and market knowledge as innovation is the use of new technological and market knowledge to offer a new product or service that customers will want.
2.5.3 Supply Chain
In today’s challenging business environment, when the cost of breaks in the supply chain can cascade across your business, active supply chain management is an enterprise performance management tool. Every firm’s supply chain, regardless of size, is the foundation for the company’s planning, sourcing, production, sales, and financial success. Firm proper management of supply chain reduces supply chain costs and drives profitability. Poor management of supply chain leads to lost firm resources, erodes profits, shareholder supply shrinks, and firms market position declines (Rick, 2004). Poor supply chain management for oil firms like KenolKobil will lead to product dry outs at the stations and lost sales. In addition, it leads to high supply chain costs as the company use more expensive supply chain methods. Lack of supply chain addition at every stage of operations will lead to reduced
CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
This chapter reviews existing literature on supply chain, operations management and firms’ performance. This involves review of theoretical aspects related to the study, empirical studies that relate to supply chain practices, profitability and research gaps therein.
2.2 Theoretical Review
A Theory is a set of statements or principles devised to explain a group of facts or phenomena especially one that has been repeatedly tested or is widely accepted and can be used to make predictions about natural phenomena (Popper, 1963). Theories are analytical tools for understanding, explaining, and making predictions about a given subject matter (Hawking, 1996). A formal theory is syntactic in nature and is only meaningful when given a semantic component by applying it to some content facts and relationships of the actual historical world as it is unfolding (Zima, 2007). This study will be based on human capital theory, Schumpeterian theory, and Porter’s competitive advantage theory which is discussed below.
2.2.1 Human Capital Theory
Human Capital theory was proposed by Schultz (1961). Schultz (1961) in an article entitled “Investment in Human Capital” introduces his theory of Human Capital. The theory argues that both knowledge and skill are a form of capital, and that this capital is a product of deliberate enterprise growth. The concept of human capital implies an investment in people through education and training leads better supply chain management. Schultz argues that investment in education and training leads to an increase in human productivity, which in turn leads to a high firm’s profitability and excellent supply chain management practices.
This theory emphasizes the supply addition that people contribute to supply chain management function and an organization at large. It regards people as assets and stresses that investments by organizations in people will generate worthwhile returns. The theory is associated with the resource based view of strategy developed by Barney (1991), the theory proposes that sustainable competitive advantage is attained when the firm as a human resource pool that cannot be imitated or substituted by its rival. For the employer investments in training and developing people is a means of attracting and retaining people. These returns are expected to be improvements in performance, productivity, flexibility and the capacity to innovate that should results from enlarging the skills base and increasing levels of knowledge and competence.
From the theory, it can be concluded that having skilled employees, with high education levels and experience will lead to better supply chain management practices. This in turn will lead to supply optimization, reduced costs of operations leading to high profitability. Lack of skilled and qualified personnel will lead to in inefficiencies in carrying out supply chain management function and hence reducing company’s profitability. In conclusion, according to this theory, the objectives of supply chain management cannot be achieved without having the strong human capital.
2.2.2 Schumpeterian Theory
Schumpeter’s (1934) theory has emphasized the role innovations and the seeking out of opportunities for novel supply and generating activities which would expand (and transform) the circular flow of income through risk taking, pro activity by the enterprise leadership and innovation which aims at fostering identification of innovative ways of managing innovations so as to maximize the potential corporate profit. Schumpeterian theory supposes that technological progress comes from innovations carried out by firms motivated by the pursuit of profit, and that it involves what Schumpeter called “creative destruction”. That is, each innovation is aimed at creating some new process or product that gives its creator a competitive advantage over its business rivals; it does so by rendering obsolete some previous innovation; and it is in turn destined to be rendered obsolete by future innovations (Schumpeter, 1934).
Schumpeter identifies the single notion of innovation as paramount, so that changes based upon innovation are the cause of profit. The entrepreneur is for Schumpeter an innovator, who by virtue of his innovation is able to break from the competition, acquire a transitory monopoly in which he can accrue profits until his competitors catch up, but, before they do so, he is able to move on to further innovation in new fields. Schumpeter did not see the firm’s ability to generate surplus supply but rather as a functional reward linked to firm’s innovative ability. Schumpeter saw the model of perfect competition in which different companies sold similar goods at similar prices produced through similar techniques as immaterial to progress. According to this theory, supply chain management objectives cannot be achieved without firm innovating, incorporating technology in operations and coming up with better ways
of managing operations. Innovations lead to better ways of conducting business, leads to superior processes which leads to reduction in supply chain costs and hence leading to high profitability. The innovations include those relating to technology adoption to ensure efficient supply chain management.
2.2.3 Porter’s Theory of Value Chain
The theory was proposed by Porter (1985). Value chain analysis describes the activities within and around an organization, and relates them to an analysis of the competitive strength of the organization. Therefore, it evaluates which value each particular activity adds to the organizations products or services. This idea was built upon the insight that an organization is more than a random compilation of machinery, equipment, people and money. Only if these things are arranged into systems and systematic activates it will become possible to produce something for which customers are willing to pay a price. Porter argues that the ability to perform particular activities and to manage the linkages between these activities is a source of competitive advantage. Porter distinguishes between primary activities and support activities. Primary activities are directly concerned with the creation or delivery of a product or service. They can be grouped into five main areas: inbound logistics, operations, outbound logistics, marketing and sales, and service. Each of these primary activities is linked to support activities which help to improve their effectiveness or efficiency.
The idea of the supply chain is based on the process view of organizations, the idea of seeing a manufacturing (or service) organisation as a system, made up of subsystems each with inputs, transformation processes and outputs. Inputs, transformation processes, and outputs involve the acquisition and consumption of resources; money, labour, materials, equipment, buildings, land, administration and management. How supply chain activities are carried out determines costs and affects profits. In Porter's value chains, inbound logistics, outbound logistics, marketing and sales and service are categorized as primary activities. Secondary activities include procurement, human resource management, technological development and infrastructure; how well the value chains are managed determines the level of efficiency in operations management and determines company’s profits (Porter 1985).
Often multinational enterprises like KenolKobil, have developed global supply chains, investing abroad and establishing affiliates that provides critical support to remaining activities at home. To enhance efficiency and to optimize profits, multinational enterprises must establish a department aimed at ensuring management and optimization of supply chain. According to Porter’s theory management of supply chains and leads to increased profitability.
2.3 Empirical Review
Elijah (2013) studied profitability through effective management of materials in Nigeria. The study found that profitability could be achieved through effective management of materials with particular attention on sourcing, receiving, storing and issuing materials. Prudent management of materials was found to reduce depreciation, pilferage and wastages while ensuring availability of the materials as at when required. Further the study concluded that for firm to achieve profitability the goal of materials management should be properly carried out which goes a long way to affect the profitability of the firm. The study concluded that given the problem that arises as a result of the inefficiencies, breakdown and shut down of the plant, it becomes very necessary to re-organize the materials management department, establish good relationship with suppliers of spare parts in order to minimize losses arising from frequent breakdown and improve profitability.
Adyang (2012) studied the procurement category management among fast moving consumer goods companies in Kenya. The study showed that all the organizations under study had adopted procurement category management; which is a part of operations management. The study also found out that the major benefit associated with category management was sustainable cost savings to the organization while category management had little effect in the use of technology and management information as well as improving the optimal procurement operating model. The cost savings implies increased firms’ profitability. The greatest challenge of implementation the strategy was lack of qualified personnel and the high cost of implementation, costs which could cloud out the benefits of the savings. The study recommended the adoption of category management among companies, government and government agencies who had not implemented procurement category management. The study also suggested an investment in the right human resource, development of the correct change management process and appropriate communication mechanism as the levers to successful implementation of category management.
Rick (2004) studied the challenges of complexity in global manufacturing insights to effective supply chain management. The study analyzed the supply chain synchronization of nearly 600 manufacturers in every major industry segment across North America and Europe, representing 19 countries. Industries represented in the study included aerospace and defence, automotive, life sciences, manufactured consumer products, process and chemicals, high technology and telecommunications, as well as other general manufacturing segments such as metal fabrication, industrial machinery and equipment. The study found that every manufacturer’s supply chain, regardless of size, was the foundation for the company’s planning, sourcing, production, sales, and financial success; its management was driver of firms’ velocity and profitability. Poor management of the operations was found to erode profits, shrinking of shareholder supply and declining market position. Further, more than a third (38 percent) of the 600 respondents to the survey had slim (less than 5 percent) operating margins or losing money on an operating basis.
Nikos (2007) studied the effect of operational performance and focus on profitability of the U.S. airline industry. The study found that both operational efficiency and quality affects profitability. The study also found the relationship between operational performance and profitability to be contingent on a company’s operating model. “Focused” airlines showed a link between late arrivals and profitability, while full- service airlines do not. Also, capacity utilization is a stronger driver of profitability for full-service airlines than for focused airlines. The study recommended that in operations management research, the benefit is more when longitudinal methodology is used, which would enable rigorously testing of operation management theories.
2.4 Summary of Literature Review
Various theories have been reviewed as giving useful insights on operations management and profitability. The human capital theory advocates for investment in human capital through education and training so as to achieve operational efficiency. The theory argues that investment in education and training leads to an increase in human productivity, which in turn leads to a high firm’s profitability and efficiency in carrying out firms operations. Schumpeterian theory highlights the role of innovations and the seeking out of opportunities for novel supply and generating activities so as to
maximize the potential corporate profit. Porter’s theory of supply chain on the other hand describes the activities within and around an organization, and relates them to an analysis of the competitive strength of the organization.
The literature has primarily focused on either the link between productivity and profitability or the link between service quality and profitability. The overall impact of operational performance on profitability in service organizations has been largely neglected. Nikos (2007) found that both operational efficiency and quality affects profitability. Elijah (2013) studied profitability through effective management of materials in Nigeria and found that profitability could be achieved through effective management of materials with particular attention on sourcing, receiving, storing and issuing materials. Rick (2004) studied the challenges of complexity in global manufacturing insights to effective supply chain management. The study analyzed the supply chain synchronization of nearly 600 manufacturers in every major industry segment across North America and Europe, representing 19 countries. Adyang (2012) studied the procurement category management among fast moving consumer goods companies in Kenya. Prior literature has not studied operations management’s impact on profitability been neglected in research irrespective of the importance of operations management on profitability as shown on the discussed studies.
2.5 Conceptual Framework
Mugenda (2008) defines conceptual framework as a concise description of the phenomenon under study accompanied by a graphical or visual depiction of the major variables of the study. It can also be seen as a diagrammatical representation that shows the relationship between dependent variable and independent variables. In this study, the conceptual model will look at the relationship between profitability and
operations management. The dependent variable will be profitability as measured by return on assets while the independent variables will be human capital, technology applied in supply chain management chain management practices.
2.5.1 Human Capital
Empirical research have emphasized that human capital is one of the key factor in explaining enterprise growth. Bruderl et al. (1992) argues that better human capital enhances the productivity of the firm by ensuring that supply chains are efficiently managed which results in higher profits. Moreover highly educated personnel may also leverage their knowledge and the social contacts generated through the education system to acquire required resources in terms of supply chains and new markets (Shane and Cable, 2003). In addition to education, specific human capital attributes of employees, such as capabilities that they can directly apply to the job in the firm, may be of special relevance in explaining enterprise profitability. The specific human capital can be attained through precise trainings and previous experience. More focused business training can provide employees with a specific knowledge, compared to a formal education. This kind of specific human capital also includes knowledge of how to manage operations. In particular, firms with great industry- specific and general business specific human capital are in an ideal position to seize neglected business opportunities and to take effective strategic decisions that are crucial for the success of the firm (Collombo & Grilli, 2005).
2.5.2 Technological Innovation
Innovation is essential ingredient in to generating long term stability, growth of share holder returns, sustainable performance and remains at the leading edge of the organizations’ industry. Innovation is referred to very different kinds of “newness” regarding products, production methods and technologies, markets and organizational configurations (Varis & Littunen, 2010). Innovation is also defined as a new way of doing things that is commercialized, the newness being either technological or market related (Narvekar & Jain, 2006). Internally, firms should be supported by their strategy, structure, system and people. Competences and assets are the function of technological and market knowledge as innovation is the use of new technological and market knowledge to offer a new product or service that customers will want.
2.5.3 Supply Chain
In today’s challenging business environment, when the cost of breaks in the supply chain can cascade across your business, active supply chain management is an enterprise performance management tool. Every firm’s supply chain, regardless of size, is the foundation for the company’s planning, sourcing, production, sales, and financial success. Firm proper management of supply chain reduces supply chain costs and drives profitability. Poor management of supply chain leads to lost firm resources, erodes profits, shareholder supply shrinks, and firms market position declines (Rick, 2004). Poor supply chain management for oil firms like KenolKobil will lead to product dry outs at the stations and lost sales. In addition, it leads to high supply chain costs as the company use more expensive supply chain methods. Lack of supply chain addition at every stage of operations will lead to reduced