1. An effective supply chain system is of critical importance,especially to a manufacturing company operating in a highlycompetitive and trend-setting industry. Discuss Nike’s inventorymanagement.
2. What is the importance of integrating new systems with legacysystems and processes in the organization for their effectivefunctioning?
3. What benefits did the company expect to achieve byimplementing a new supply chain system? and What are the risksinvolved in taking up projects of considerable magnitude withoutestablishing effective control systems?
Inventory Problems at Nike
NI KE'S PROFITS FALL
In Febntary 2001, Phil Knight (Knight), the co-founder and CEOof Nike Inc (Nike), announced that the company's profits for thethird quarter of the fiscal year ending May 2001 would fall shortof expectations by almost 24 percen t. The reason for the shortfallwas a failure in the supply chain software that Nike hadimplemented in June 2000. The supply chain software, implemented byi2 Technologies Inc (i2)4 had fa llen prey to technical glitchesthat affected the company's inventory systems adversely, leading toa supply chain failure. Resultantly, Nike's production facilitiesaround the world ended up manufacturing a far greater number of aless popular shoe model and not enough of those models that were inhigh demand.
In the finger pointing that followed, Nike 's management laidthe blame for the prob lem squarely at the door of i2. During apress meet, Knight compEained, "This is what we get for our $400million, h uh?"5 On the other hand, i2 claimed that the mismatchwas a result of Nike's haste in using the incomplete system and itsunwillingness to use i2's standard systems and procedures.Regardless of who was to blame, Nike's reputation in the markettook a beating. The company also lost considerable market share torivals like New Balance6 and Reebok7• One of the leading sportsgoods companies in the world, Nike manufactured high qualityathletic shoes for a variety of sports including baseba ll,athletics, golf, tennis, volleyball and wrestling. In addition tofootwear (which accounted for almost 60 percent of the company'ssales), Nike also manu factured fitness equipment, apparel andaccessory products. The company's products were sold in over 140countries around the world . Headquartered in Beaverton, in thestate of Oregon, Nike had production facilities scattered aroundthe world and had a complicated supply chain system that extendedfrom Nike factories in developing count1ies in Asia to uptownstores in the US and other parts of the developed world.
BACKGROUND NOTE
The future co-founders of Nike met in 1957, when Knight was anundergraduate student and middle-distance athlete at the Universityof Oregon (which was known for having the best trnck program in thecountry) and Bi ll Bowerman (Bowerman), the athletics coach. In theearly 1960s, when Knight was doing his MBA at Stanford University,he submitted his marketing research dissertation on the US shoe manufactiiring indusirry. His assertion was that low cost, highquality running shoes could be imported from labor-rich Asiancount1ies like Japan and sold in the US to end Germany's dominationin the industry.
In 1962, while on a world tour, Knight met the management of theOnitsuka Company (Onitsuka) of Japan, which manufactmed highquality athletic shoes under the brand name ;Tiger'. He airnngedfor these shoes to be imported to th e US for sale under the name'Blue Ribbon Shoes' (BRS). (When the management of Onitsu ka askedhim about which company he represented, he thought up this name.BRS became the forerunner of Nike). ln late 1963, Knight receivedhis first shipment of 200 Tiger shoes. In 1964, Knight and Bowermanformed a partnership, with each of them cont1ibutin g $500, and BRSformall y came into being. The first shoes were sold from thebasement of Knight's house and the backs of trucks and cars atlocal track events. The a.th letes wbo wore the shoes were askedfor feedback to improve future shoe designs. By the end of 1964,BRS had sold 1300 pairs of shoes and generated $.8000 inrevenues.
In 1965, the paitners hired Jeff Jobnson (Johnsoo), the firstfull time employee of BRS. Johnson was formerly a salesperson forAdidas shoes8 bn 1966, Johnson helped open the first exclusive BRSstore in California. Sales of the shoes grew and in 1969, Knightresigned from his job as a professor at the Portland University anddevoted himself to BRS full time. By the end of the 1960s, BRS had20 full time employees and several retail stores.
By 1971, BRS staited manu facturing its own line of athleticshoes in addition to selling Tiger shoes. For the new line ofshoes, Johnson thought up the name Nike9• Carolyn Davidson, anacquaintance of Knight, designed the 'Swoosh ' symbol, which was agraphic representation of the wing of Goddess Nike (ReferExhibit-I). In ret11m for what became one of the most recognizedsymbols in adve1tising, Knight paid her $35.
The first shoe with the Swoosh logo came out in early 1972. Inthe same year, following distribution differences, BRS patted wayswith Onitsuka and from then BRS only sold shoes manu factured underthe Nike brand. T-shirts, wiith the Nike name and logo printedacross them were introduced at the Pre-Olympic trials in 1972,marking the beginning of the company's foray into the apparelbusiness.1n the same year, BRS also introduced the ';Futures"booking program , which allowed production forecasters to "make toorder" and pre-finance while reducing risks of over inventory .Knight was one of the first businesspersons to allow retailers topre-order inventory. This was a revolutionaiy business decisionthat soon became standard among other businesses.
During the first halfof the 1970s, sales of Nike shoes grew from$10 million to $270 million . The growth was facilitated by thecreation of revolutionruy shoe designs like the waffle sole and theair cushioned sole system, known as Nike Air. DUJin.g the 1970s,BRS opened production faci lities in Taiwan and Korea. Sales inother pmts of the world, like Europe, Australia and Asia alsoincreased. In 1978, BRS officially changed its name to Nike Inc, inkeeping with the populaiity of its brand . Nike rapidly expandedits product line during the 1970s and early 1980s and in b·od uceda wide variety of shoes for different spo1ts. Models such asNike-Air and Air Force I for basketba ll, and the Nike-Air and AirAce shoes for tennis were introduced over the years. (By the early1980s, the company had over 200 shoe models in its prod uctline).
In 1980, Nike went for a public issue of 2 million shares ofcommon stock. It also opened a Spo1ts Research and Development Labin Exeter, New Hampshire, US. By 1981, Nike shoes were manufactured in 1 1 coLmtJies around the worldl, and the companyemployed more than 3000 people. In the same year, NikeInternational Ltd. was formed to serve a growing overseas market.At the Olympics in 1984, 58 Nike-sponsored athletes from around theworld won 65 medals in all, generating immense publicity for thecompany.
In 1985, the company signed a contract with Michael Jordan, anNBA 10 player for the Chicago Bu lls11 who went on to become one ofthe most successful celebrities ever to endorse Nike.Nikeintroduced a range of shoes called 'Air Jordan', named after theplayer. In 1986, the revenues of th e company crossed the one billion dollar mark for the first time. In 1987, Nike introduced thefirst cross-training shoe, which could be used for mnning as wellas indoor sports. In 1988, Nike adopted a new punch-line which said"Just Do It". A series of advertising campaigns highlighting thenew punch-line were made.
By 1991, Nike had become the world's first sports andfitness-equipment company to sw·pass $3 billion in total revenues.The year J 992 saw the opening of the first Niketown in Chicago.Niketown was a specialized store showcasing the different productsdeveloped by Nike over the years. Nike Asia was fot1'l'led in 1997.In 1999, tbe company embarked on a huge IT project to implement anew supply chain system and several new applications in CustomerRelations Management (CRM). The new system experienced teethingtroubles, causing Nike to experience some problems in the fiscalyear ended May 200 I. However, the company made necessaiymodifications to bounce back and regain its position as tbe numberone sports goods manufacturer in the world. In the fiscal yearended May 2003, Nike's revenues exceeded $ 10 billion . (ReferExhibit-II for Income Statement).
NEW SYSTEM'S TEETHING TROUBLE S
Nike built its original demand management system in themid-1980s, as it moved towards becoming the number one sports shoesretailer ii n tbe world. During that period, Nike had alsob·emendous ly increased the number of its man u fact11ring unitsaround the world. The demand management system was designed andimplemented by over one hundred information specialists within thecompany.This system was designed to run the Futures programinhuduced by Nike in the 1970s, which was supposed to help Nikemanage invento1y more effectively. Under this system, Nike's retailpartners placed orders with the company six months before therequired delive1y date.These orders were then forwarded to themanufactu1ing units around the world .
The system worked well enough in the initial years. However, asNike grew, it found that the system was not equipped to deal withthe increasingly complicated operations. The number and complexityof orders began increasing at a very fast pace and the length ofthe product line also increased tremendously. Manufacturing ofproducts also became very com plicated and some of thepopulru·models like the A ir Jordan sneaker requi red over 130individual steps to manufacture. ln the meantime, the company hadalso entered into conh·acts with several new manufacturers, all ofwhom had to be incorporated into the system . To deal witb theincreased scope of operations, the system was constantly modifiedover the years by Nike's in-house technicians.The programmers madethousands of adjustments to accommodate busier manufactuiingschedules, tighter shipping dates, and growth in the consumer list.These constant adjustments made the system more complicated andsusceptible to breakdown. "It's been modified thousands andthousands of times. These Little arcane changes had to createseiious prob lems as Nike moved to a whole new system,"said oneformer employee of Nike12•
In 1999, Nike embarked on an IT project that involved thecreation of a new supply chain system that was more suitable to therequirements at hand . The IT overhaul was designed to sb·eamlinecommunications with buyers and suppliers and lower operating costs.The supply chain project was clubbed with CRM applications thatwould help take orders from customers and other systems ofinventory management. The company expected the new supply chainsystem to reduce orde1to delivery time by about 50 percent. Nikecontracted i2, to install the main system, and SAP AG and SiebelSystems Inc. for the other CRM applications. The enti re project,which was to take five years to complete, was estimated to cost$400 million, of which the price of i2's software was $40 million.In implementing the system however, Nike refused to use thetemplates and methodology developed by i2, prefeffing instead tocustomize the system to match its existing demand managementsoftware. Therefore, the new system was customized to accommodatethe eccenh·icities of the oiiginal system . This customization andmodification slowed down the new application considerably and madeit more complicated to use. A nalysts said that these modificationsresulted in users waiting as long as ;three minutes for a singlescreen to load.
In addition to this, increased employee turnover also harmed theproject. For instance, the CIO involved in the decision to initiatethe supply-chafo renovation left the company before the system wasproperly installed.The company also did not use third pattyintegrators to help implement the software and bad troubleintegrating the new system with the company's processes and withthe SAP software being implemented simultaneously.
In 2000, when the project was only a year old, Nike began usingit to send orders to its manufacturers in the Far East. However,because the system was not completely developed, the glitches ledNike to overestimate demand for some shoes while underestimatingdemand for others, creating major invento1y problems.The systemsent flawed data to the manufachJrers in the Far East, causing someof them to receive double orders for the same shoes and not enoughorders for other, sometimes more popular models. "The solutionwasn't stable at the time they slatted using it,"said Katrina Roche(Roche), i2's chief marketing officer13
By late 2000, it was discovered that Nike's manufoctu1ing unitswere producing too many shoes of ce1tain models and not enough ofothers. Therefore, the com pany was also not in a position to meetretailers' demands for some fast selling models. Nike and i2staffers soon tracked down the problems and developed ways to getaround them,either by changing operational procedures or by writingnew softwa re. However, by the time the problems were tracked andrectified, it was too late and Nike found itself with seriousinventory problems on ha nd. In early 200 I, Nike warned that"complications"caused by the implementation of the i2 software hadled to product sho1tages and excesses as well as late deliveiies.Soon after that,Nike posted a profit of $ 97 million for the thirdquaiter ending in Februruy.This was almost 24 percent lower thanwhat was estimated earlier.The prices of Nike shru·es also fellshru"Ply, sending investors into frenzy.
THE CONSEQUENCES OF THE BREAK DOWN
The breakdown of the new system had several adverse consequenceson Nike. It u pset the supply chain system and caused the companyto be bogged down by a large number of unpopular models, while nothaving enough of the popular ones. Not being able to cater to themarket demands, Nike's reputation suffered and it lost considerablemarket share to rivals like New Balance and Reebok. New Balanceespecially gained on Nike in market share. In retail-dollar sneakersales, New Balance went from less than four percent market share inthe first quarter of 1999 to over nine percent in the same quarterof 2000. During that period, Nike's share dropped from over 48percent to about 39 percent. (Refer Exhibit-Ill). "For some reasoa,Nike took its eye off styling content and, when added with theseinventory problems, that has cost the company not only market sharebut valuable shelf space,"said Wells Fargo Van Kasper analyst JohnShanley.14
The huge number of unpopular models manufachtred had to be soldat highly discounted prices, resulting in a decline in profits forthe company. When the scarcity of popular models was discovered,the company had to get them manufactured very rapidly and ship themto retailers to meet at least part of the demand.Consequently, thecompany incurred additional shipping costs as it had to airfreightthe shoes at a cost of $4 to $8 a pair compared with about 75 centsby sea. The liq uidation of the excess inventory took Nike six toeight months. The delay in shipping the shoes also soured relationsbetween Nike and several of its major retailers. Footlocker, thebiggest retailer of Nike shoes in the US, reduced the shelf spaceallotted to Nike in all its stores. fn addition, it also beganselling several Nike shoes at less than half the marked price toliq uidate excess slow moving inventory soon after the suppl ychain fiasco. Footlocker also entered into several lucrativecontracts with Nike's rival New Balance.
Nike laid the blame on i2 saying that the company failed toprovide quali ty service. The supply chain software was supposedto reduce the amount of rubber, canvas and other materials thatNike needed to produce its shoes. It was also supposed lo help Nikebui lt more of the shoes customers wanted and fewer of the onesthey did not. Paradoxically , Nike was left with far too many ofthe wrong shoes and not nearly enough pairs of its hottest sellers.Nike maintained that i2 did not deliver the functionality that itpromised to deliver and that the defective software provided by thecompany was entirely to blame for the delivery of wrong orders thatled to the under manufacturing of some models and theover-manufacturing of others. Officia ls at i2, however, said thatNike did not implement the software properly.They claimed that theapplications generated bad data because Nike refused to usestandard templates and modified the applications in anindiscriminating manner. "We recommend that customers follow ourguidelines for implementa.tion--we have a specific methodology andtemplates for customers to use--but Nike chose not to use ourimplementation methodology," said Roche.15
Analysts opined that another important reason for the failurewas that neither Nike nor i2 brought in a third-partyintegrator.The Nike supply planning application had replaced anolder application that did not meet the requirements any longer.However, the application was implemented in a h urry by the Nikestaffers and the i2 consultants. Neither Nike nor i2 thought ofusing a third-party integrator to adapt the systems to theorganizational processes . Analysts felt that using a third partyintegrator was of critical importance, especially in large scaleprojects like the one at Nike. A neutral third-pa1ty perspectivefrom an integrator would have exposed flaws in the project, whichmight have been overlooked by people closely involved with it.Analysts also felt that both Nike and i2 moved too fast withouttaking the appropiiate cautionary measures. They also did not testthe system, which would have revealed the glitches at a muchearlier stage. Fwther, Nike extended the new system to itsthousands of dispersed suppliers and dish·ibutors simultaneously.Analysts felt that a piecemeal implementation of the system wouldhave reduced the magnitude of the problem considerably.
Another problem was that Nike implemented two major projectssimultaneously. Both projects (supply chain and CRM) werecompany-wide initiatives and had to cover the large number ofsuppliers and customers who interacted with Nike. Each project byitself would have been difficult to implement, but Nike took u pboth of them simultaneously, creating unnecessary complications foritself in the bargain .i2 was also relatively inexpeiienced inproviding .supply chain software for the apparel industry . It hadearlier worked with Dell Com puter Corporation '6, 3M 17, and othermanufacturers and helped them garner considerable cost savings.However, Nike was the first apparel compa ny that it worked with,therefore, it was not prepared to dea.I with the dynamics of theapparel indust1y."The biggest lesson we learned was that we need tohave more communication with the customer before we begin designingthe supply-chain software," said Pallab Chatterjee, president ofsolutions operations at i2."We're su pply-chain experts, not shoeexperts."18 Piene Mitchell, an analyst at AMR Research, suggestedthat the blame rested partly with Nike's control systems. "PhilKnight makes it sound like it's a surpiise to him," he said. "If hedoesn't have checkpoints for these kinds of projects, i f bedoesn't know where $400 million of his company's money is going,then he doesn't have control of his company."19
CONCLUSION
Both, N ike and i2 came out the worse for the supply chainfailure.Analysts felt that, the negative publicity and the washingof dirty linen in pu blic affected both companies even moreadversely than the monetary losses and the productioncomplications.However, Nike continued to work with i2 on thefive-year long project and by the end of 2003 (the proj ect was toend in mid-2004), had made considerable progress. ln September2003, the company announced that its ability to closely monitor themovement of goods from raw materials through factories to retailerswas fina lly paying off.
By 2003, Nike had managed to reduce its inventory levels andboosted gross margins and profits. In the quarter ending August2003, the company obtained gross margins of 43 percent, which wasup from 41 percent in the same quaiter the previous fiscal. Theimplementation of the new system also helped Nike streamline itsorders for footwear. According to a report by BusinessWeek, aleading business magazine, before the new system was implemented,about 30 percent of the total volume of Nike's footwear orders wasbased on speculation and guesswork. By the end of 2003, when thesystem was over 75 percent complete, the orders based onspeculation had reduced to just three percent. The futures ordershad also in.creased by 10 percent over the previous year inmid-2003.Analysts expected Nike to benefit fu1ther after theproject was fully functional.
