Operations Jul 3, 2018
How “Speed Factories” Help Companies Adapt to Capricious Consumers
For certain trendy products, these local but expensive plants can be a smart investment.
When Adidas launched its Adidas Made for New York City shoe, or AM4NYC, it departed from its normal production process in a couple ways. Unlike most athletic shoes, which are designed to be worn anywhere, this model is optimized for runners in the Big Apple. And unlike the vast majority of Adidas footwear, AM4NYC is produced in the U.S., not overseas.
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The shoes are made domestically at what is known as a “speed factory,” a local-market facility designed to quickly pump out products with shorter life cycles and less predictable demand, like apparel sported by Kendall Jenner or LeBron James that suddenly becomes a must-have item. Speed factories are a growing trend among consumer-goods businesses, and one Jan Van Mieghem, professor of managerial economics and operations at Kellogg, has been researching.
“More companies are focused on localization now, with custom-made products for very small local markets,” Van Mieghem says. Speed factories offer fast turnaround to meet demand in such markets, but they often have higher production costs.
Van Mieghem explores the return on investment in speed factories in a study with collaborators Robert Boute of Vlerick Business School and Stephen Disney of Cardiff Business School. They found that even tiny, quick-turnaround production facilities can indeed be worthwhile, despite their cost, and are best used as part of a portfolio of on- and offshore production.
The Need for Speed
Several factors have motivated consumer-focused businesses to invest in speed factories.
For one, retail customers today expect more immediate gratification, with ever-faster delivery times.
“This is especially true in e-commerce,” Van Mieghem says. “Amazon and fast-fashion trends mean that companies have had to increase their speed from product design to delivering that product to customers. If things must happen in days or weeks rather than months, you can’t be doing that from somewhere in Asia.”
Consumers expect greater customization, too—like the AM4NYC—which is also difficult to handle quickly from offshore, because producers there may not understand local market needs or be able to respond to fast-changing specifications as quickly as a local facility.
Additionally, offshore labor and facilities costs are rising, while increased automation in Europe and the U.S. is reducing the impact of labor costs. This has yielded greater focus on domestic production—often in the form of reshoring at least a portion of manufacturing.
Enter speed factories. Still, such facilities represent just a tiny sliver of production. For example, Adidas only has speed factories in Germany and Atlanta. (The German company refers to them as SpeedFactories.) Of the three hundred million athletic shoes the company produces annually, these factories account for only about one-third of 1 percent. Like its rival Nike, Adidas maintains the vast majority of its production in Asia.
Yet the researchers found that such small, flexible, local facilities can pay off for companies investing in them.
A Matter of Demand
A major reason why Adidas and other businesses allocate such a small percentage of production to an onshore, quick-turnaround facility is rooted in demand forecasting—specifically, the uncertainty of demand for some products.
If exact long-term demand is known—for example, how many of a certain Adidas sneaker will be purchased weekly for the next two months—then it is not a problem if it takes those full two months to produce the shoes in China.
“It’s smart to satisfy base demand with offshore production and address fluctuating demand with speed factories.”
“If you’re confident in that kind of forecast,” Van Mieghem says, “then there’s no reason to produce quickly.”
But if there is unpredictability in the forecast, fast production becomes more important.
“If the market is more capricious, such as when everyone wants the sneakers some celebrity wore yesterday and then wants a different shoe next week,” Van Mieghem says, “then you’ll have a very hard time predicting demand and making everything fast enough in Asia to meet that demand.”
He notes that meeting unpredictable demand also requires maintaining large “safety stocks” of products, which may need to be significantly discounted if they don’t sell.
Speed factories, then, are meant for highly unpredictable demand of potentially high-value products, reducing risk and waste from long lead times.
Offshore, Onshore, and Dual Sourcing
The researchers wanted to understand how companies that have the option to use speed factories can optimize how much they produce domestically versus offshore.
So they created a model with varying levels of product demand, supply-chain costs, inventory service levels, production methods, and other variables, with a focus on when certain types of production—all offshore, all reshored, or some combination—would lead to higher profits.
Under some circumstances, the model showed the value of including speed factories in a business’s production portfolio—or what could be considered “dual sourcing” with both on- and offshore production.
“There’s base demand—or demand that’s always there—and fluctuating demand on top of that,” Van Mieghem says. “We show that it’s smart to satisfy base demand with offshore production and address fluctuating demand with speed factories.”
Speed factories are particularly effective for high-end products that generate sudden demand.
“It’s for the sneakers that cost hundreds of dollars,” Van Mieghem says. “If you’re able to bring the latest and greatest product to market quickly, you don’t have to discount and can command a top-dollar price. It also makes customers more loyal to your brand; they will buy your next product too.”
The study also has implications for forecasting more generally. Specifically, most previous research on production and forecasting assumes that demand will remain relatively stable—what’s known as “stationary” demand.
“There are nice formulas for stationary demand,” Van Mieghem says. “That’s what we teach in our MBA classes. But there’s increasing evidence for ‘nonstationary demand,’ or the kind that has no standard formula to help analyze its impact on supply-chain operating performance.”
This research points to the need to incorporate an understanding of nonstationary demand into company projections. Indeed, there is evidence that nonstationary demand is associated with up to 80 percent of consumer goods, according to Van Mieghem. The authors also find that speed factories become substantially more valuable under nonstationary demand, a factor that conventional stationary models would miss.
Are Speed Factories a Worthwhile Investment?
How do you know if a speed factory is a worthwhile investment for your business?
“Executives need to look at how well they can forecast demand,” Van Mieghem says. “How much confidence do they have in their forecast? How much would business improve if they only had to forecast a week in advance instead of eight weeks? If shorter-term forecasting won’t make a difference, then local production may not improve competitiveness.”
Similarly, unless a speed factory improves time to market significantly over offshore production, extra investment in such would be unwarranted.
Of course, the higher potential investment in a speed factory has to be justified. But heed Van Mieghem’s cautionary advice here: “If you’re looking only at the labor-cost differential, you may be making the wrong decision. The higher costs of a speed factory may still be worth it when you consider total cost,” including capacity and inventory costs.
Finally, it is important to monitor the best mix of products to assign to a speed factory.
“Sometimes you may decide to make production of certain products local,” Van Mieghem says. “But over time, as demand for them becomes more stable, it may make sense to move them offshore. It’s about maintaining the flexibility to bring certain products in and move others out of a speed factory as needed.”
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