By Matthew Waller | Photo by Caleb Talley
Blockchain technology has the potential to significantly impact the efficiency and effectiveness of the entire supply chain. And since Arkansas has an unusually high concentration of supply chain and logistics expertise, we should be leading the way when it comes to developing applications of the technology, both within existing companies and by starting new ventures that use blockchain to provide a competitive advantage.
For many leaders, blockchain is a mysterious new technology steeped in hype. It’s an underlying component of cryptocurrencies, which makes it a bit confusing. But it’s now being touted as the next great solution to business, which makes it important to understand. Zach Steelman, an assistant professor of Information Systems in the Walton College of Business at the University of Arkansas, provides one of the more straightforward explanations of blockchain when he calls it “the next stage in the evolution of database technologies.” Blockchain, Steelman says, is simply a distributed database that is enhanced with cryptography and consensus capabilities.
Blockchain matters in supply-chain management because it promises to improve visibility, confidence (records of transactions are linked to other records of transactions using cryptography), traceability, collaboration, distribution of information (to all of the specific blockchain users), decentralization (the records are stored on the cloud) and the ability to validate compliance.
Several startups are offering blockchain technology solutions, as are companies like Microsoft, IBM and SAP. No company, however, has done more to advance the supply chain applications of blockchain than Walmart, whose efforts are being led by Frank Yiannas, Walmart’s VP of Food Safety and Health. Walmart has conducted pilots for supply-chain traceability of pork in China and mangos from Central America to the US. Now Walmart is tracking several other products, including lettuce and papayas.
The most commonly discussed business-case benefit for blockchain is that it can improve processes for transfer of asset ownership, providing visibility to products to ensure their safety. Blockchain however, also has the potential to reduce inventories and therefore improve return on assets, which is a significant benefit that’s not often addressed. Let me explain the logic.
Blockchain improves a firm’s ability to manage a supply chain in large part by the ways it impacts inventory costs and the movement of inventory. The technology, for instance, can have a positive impact on the planning, forecasting, budgeting and staffing required to manage costs and services associated with inventory.
For example, consider blockchain’s effect on what’s known as cycle stock – the expected amount of inventory used between replenishments. The more frequent the replenishments, the lower the amount of cycle stock. One of the many different expenses associated with replenishments is “invoice match failures,” which I will use as an example. But blockchain can help reduce or eliminate those failures.
Invoice match failures occur because companies must make sure that invoices match the original order and the receiving document. When they don’t match, the accounts payable department investigates to reconcile the differences, and those reconciliations can take lots of time. These failures don’t occur with every order, of course, but there is a certain probability of them occurring with every order. Thus, the expected cost of an invoice match failure per order is a fixed cost per order. The higher this fixed cost, the fewer orders you want to place in a given year. That means the optimal amount of inventory that you order each time increases as the probability of these failures increases, which increases your average annual cycle stock.
A blockchain would make the reconciliations relatively quick and easy. In fact, incorporating a smart contract within the blockchain could eliminate the need to do a reconciliation. Smart contracts are programming embedded in a blockchain database that automatically trigger specified actions based on the transactions that take place. They are an “if/then” algorithm that the blockchain can execute without the need for human intervention. Using blockchain technology to quickly and accurately reconcile inventory orders can reduce cycle stock by lowering the costs associated with invoice match failures and thereby lowering overall ordering costs. Since blockchain technology, including smart contracts, can reduce or eliminate the expected cost of an invoice match failure, a company can place more frequent orders, thus reducing the annual cycle stock holding cost and quantity. Furthermore, reducing or eliminating invoice match failures could allow organizations to reduce the size of their accounts payable departments. In addition, it has the potential of reducing other fixed costs per order that will compound the effect.
Smaller optimal order quantities also have additional implications for other aspects of logistics: a smaller quantity of units might be shipped per shipment (1) requiring a larger variety of assortment to be shipped in order to maintain full truckloads; (2) if truckload is not the mode used, then the demand for modes optimal for smaller shipments will grow and small parcel shipments should grow (they have already been growing due to e-commerce); (3) pallet configuration may need to accommodate a wider variety of assortment per pallet; and (4) packaging may need to change because the optimal number of units per case may decrease.
Who would think that a reduction or the elimination of invoice match failures could have such pervasive effects? And I’ve only been discussing the impact on one of the ordering costs, so just think of the overall effect of blockchain and smart contracts as we tackle each of the costs associated with orders. Also, as the example illustrates, the implications of blockchain and smart contracts can be subtle and nuanced, so, consequently, it is very easy to underestimate the magnitude and breadth of the impact of such changes.
Safety stock is another type of inventory that will likely see an impact from blockchain technology. Safety stock is extra inventory that is held to deal with uncertainty, primarily demand uncertainty and lead time uncertainty.
If demand is highly uncertain or isn’t visible, then more safety stock is needed to ensure a company doesn’t run out of inventory. Walmart’s provision of point of sale (POS) data is one way the retailer provides demand visibility to suppliers, thus reducing the suppliers’ needs for safety stock. That visibility also allows for better planning of transportation and warehouse labor, thus reducing many other costs, as well.
Blockchain technology could be used to further reduce demand uncertainty. Imagine a blockchain where every block recording a transaction showed the current number of units sold at every relevant point in the supply network, along with forecasts based on a variety of forecasting models and a selection of the “best” forecast based on Artificial Intelligence (AI). So the block could include information such as: (1) 24 units sold yesterday, (2) 13 units sold so far today, (3) average units sold per day over the past week is 19, (4) forecasting model X predicts 21 units will be sold today, (5) forecasting model Y predicts that 17 units will be sold today, (n) forecasting model n predicts that 18 units will be sold today, and (n+1) the AI-based forecast selection is 20 units. These blocks could be permissioned to all those in the blockchain who could improve planning based on the information.
It might seem that all you need is the AI-based forecast selection, but, unfortunately, that is not the case. Humans still need to be involved because we have not perfected the methods of selecting the “best” forecast. If that ever happens, we can completely take the human element out of forecasting, but we are not even close to that solution. Nevertheless, what I’m suggesting here will still reduce safety stock in the supply chain. In addition, and possibly more importantly, it has great potential for reducing the number of out-of-stocks in the supply chain for the same reasons it reduces the need for safety stock.
Not only does safety stock guard against demand uncertainty, it also guards against lead time uncertainty. If demand is completely certain but lead time – the time between when you place an order and when you receive the inventory and make it available for sale – is uncertain, then you need safety stock to reduce the frequency of out-of-stock occurrences. For example, suppose you always sell exactly five units of a particular item every day, place an order from the supplier for five more units at the end of the day and receive them the next morning just before you open. In this case, demand and lead time are both certain and known and there is no need for safety stock. Now suppose that periodically the inventory is not received in the morning, but rather it arrives the following morning. In this case, you might want to keep more than five units on hand for the instances when this longer lead time occurs.
This is a simple example, but it helps illustrate why lead time uncertainty is just as big of a problem as demand uncertainty and why they both drive the need for safety stock. So not only does blockchain have the potential to reduce demand uncertainty, it can also reduce lead time uncertainty. Going back to the example where each block contained sales and forecasting information, those blocks could also include lead time information: (1) the time the order was received at a location in the supply chain, (2) the time between when the order was shipped from the upstream location to the current location, (3) the average time between locations, (4) the variance in time between locations, (5) the time between the origin location and the current location, etc… Again, every permissioned entity in the supply chain could have visibility and thus reduce the lead time uncertainty and the need for safety stock.
These examples are just the tip of the iceberg, but they help explain why blockchain could reduce certain costs by improving supply chain efficiencies. We are years away from full adoption of blockchain in the business world, but the supply chain expertise in Arkansas, both from large companies like Walmart and Tyson and a variety of smaller, forward-thinking companies, means we are well-positioned to do what Yiannas calls “pouring the concrete” that will create the blockchain-based highways of the future.