A Brief History of Supply Chains

In ancient times, transportation technology was basic and the cost of moving goods was an important determinant of the production and distribution of a product. Thus, goods were put together close to the source of raw materials. Then, these products made their way in a largely linear chain to their end consumer.

Ancient trade routes like the Silk Road through Central Asia and the Spice Route over the Indian Ocean were mostly linear chains that took a finished product to its ultimate destination. Moreover, given the high costs, long-distance trade was limited to high-value items such as spices, weapons and luxury goods.

The production and consumption of most items was local. This meant that producer and consumer could directly communicate with each other, and the customer could specify exactly what he or she wanted. This was the world of the village weaver, potter, blacksmith and cobbler. The bulk of pre-industrial artisan manufacturing, therefore, was customized to the needs of the end consumer.

It was only in the 18th century that shipping technology improved enough to allow the large-scale functioning of an international production network. Interestingly, the first product to be put together with a truly global supply network was rum. Slave labor was imported from West Africa to the Caribbean in order to grow sugarcane (a plant originally from India). Sugarcane molasses were then shipped to New England where distilleries in Massachusetts, Rhode Island and Staten Island turned it into rum.

Some of the drink was consumed locally, but much of it was then sold in bottles and barrels in Europe and all over the Atlantic. It is said that the distillation of rum was the single biggest industry in colonial America — although its importance is now all but forgotten except in popular tales about pirates.

Shipping to the world

As the Industrial Revolution took shape in the late 18th century, production networks took on a totally different scale. The cotton industry was the center of this shift. Prior to the technological innovations of the Industrial Revolution, India was the cotton manufacturing center of the world and exported its textiles all over the world. Competition from imported cotton was a major cause of resentment for the traditional wool industry in Britain.

We have records of heated debates in Parliament in the 1600s and early 1700s about how to restrict the use of cotton. A law passed in 1699 stipulated that “all magistrates, judges, students of the universities, and all professors of the common and civil law… [must] wear gowns made of woolen manufacture.” There were even laws that stipulated that corpses had to be buried wearing sheep’s wool.

By the end of the 18th century, however, technological shifts dramatically changed the cotton industry. The spinning jenny patented by James Hargreaves in 1770 increased the amount of yarn spun by a worker by several orders of magnitude even as the flying shuttle revolutionized the speed of weaving the yarn into cloth. Meanwhile, the American inventor Eli Whitney invented the cotton gin that mechanized the process of separating cotton wool from the seeds.

All these changes were complimented by improvements in ship design and, by the mid-19th century, the introduction of steamships. As a result of all these innovations, a global supply network emerged that involved shipping cotton grown in the southern United States (often using slave labor) to the cotton mills in England. The finished cloth was then shipped out to the rest of the world.

Over the next century, transportation technology witnessed major breakthroughs that included the railways, trams, bicycles and the Suez Canal. By the time of World War I, we also had the Panama Canal, automobiles and even early airplanes. As a result, the cost of transporting goods dropped sharply. Ocean freight rates, for instance, fell 70% between 1840 and 1910.

The improvements in transportation also improved communications — steamships and railways could also carry letters — but there were few independent improvements in communications with the single exception of the telegraph. In other words, communications was the poor cousin of transportation until World War I.

A world with good transportation, but relatively underdeveloped communications, strongly influenced the industrial structure and supply networks of the early 20th century. Production was centralized at major transportation hubs, and Fordist production lines were used to mass manufacture goods. Vertically integrated industrial structures were needed to minimize communication gaps between various segments of the production process.

As mass manufacturing was ramped up, it was no longer possible for individual customers to specify requirements. The supply chain responded by standardizing products. Ultimately, even downstream distribution networks succumbed to standardization. This shift is best summarized by Henry Ford’s famous comment, “Any customer can have a car painted any color that he wants so long as it is black.” Retailing shifted in favor of large department stores that could house a large selection of standardized products, with price and variety substituting for customization.

Postwar technological changes

The Second World War witnessed the pinnacle of the Fordist production system. By 1950s, a new generation of technological changes began to alter the structure of global supply networks.

As a break from the past, communications began to influence developments independently of transportation. The telephone was patented by Alexander Graham Bell in 1876, but it would be well into the 1920s before phones were commonplace in the United States. The first transatlantic call between London and New York took place in 1926, and another two decades would pass before long-distance telephony was common in the rest of the world.

Meanwhile, transportation also went through another major innovation — containerization. Most people tend to ignore the importance of this innovation, but it was a radical idea. Until the 1950s, ships had to be manually loaded piece-by-piece. Industrial cables had to be carefully stacked next to boxes of delicate porcelain and perhaps a basket containing fruit.

This was not just time consuming, it was also very expensive. The cost of port handling accounted for almost half the transportation cost of shipping a truckload of medicine from Chicago to Nancy, France. Moreover, the system was prone to breakage and theft. It was not uncommon that the shipment got lost — and it was very difficult to trace it.

In the 1950s, entrepreneurs like Malcolm McLean began to revolutionize shipping — and logistics in general — by introducing standardized containers that could not merely be sealed and loaded into ships, but also could be seamlessly passed on to the truck and rail network. Both ships and ports were redesigned to handle containers.

Ships purchased in the early 1970s could carry four times the cargo capacity of traditional ships. Their faster speeds and turnaround time in port allowed them to make six round trips a year between Europe and the Far East, compared to three-and-a-half for the older ships.

Interestingly, western countries persisted with building old style ports well into the 1970s. They already had large existing fleets and other infrastructure from the pre-container age and could not easily adopt full containerization. Bureaucratic persistence and political pressure from port workers’ unions also slowed the shift.

Thus, it was Asia that wholeheartedly adopted containerization and built large new facilities. Hong Kong and Singapore asserted themselves as major ports and clearinghouses for containerized shipping. These two ports had established themselves as the world’s largest container ports by 1990 — and Asian ports continue to dominate to this day.

Communications revolution

The combination of containerization and telephones (and related technologies like the fax) caused the next shift in supply networks. Improved communications meant that it was possible to exactly specify components and products. Containerization meant that these components could be transported cheaply and be delivered “just-in-time.”

In turn, this allowed the production process to be neatly modularized and contracted out. Ironically, one of the first companies to take advantage of this was the U.S.-based toy manufacturer Mattel, which used it to produce the Barbie. Despite Barbie’s All-American image, the doll was produced abroad from its very inception in 1959. The earliest Barbie factories were in Japan and Taiwan, and today it is put together by a complex network spanning the world.

Although the technologies and practices related to the new supply chains originated in the United States, it was Japan that leveraged them to fundamentally change production systems. Dubbed “lean production,” the Japanese production system was both more flexible as well as able to sharply reduce the need to carry inventory. It made the vertically-integrated Fordist assembly line obsolete.

Many of the elements of the new system evolved originally in the automobile industry, but they were soon being applied in other sectors too. The electronics industry turned out to be especially well-suited to the decentralized production process.

By the late 1980s, the whole world was trying to copy the Japanese system. Nonetheless, it was East Asia that best internalized the network-based production system. There were many reasons for this. First, much of the infrastructure in the region was new. In many cases, the infrastructure was specifically created to support supply chains for Japanese companies. Second, geography helped since most of the key economic hubs could be linked by sea. This was a key advantage since transportation by ship is much cheaper than by rail or road.

Third, East Asia had a very heterogeneous mix of skills and wages. This meant that different countries could specialize into different parts of the modular production chain. The addition of Southeast Asia and China’s special economic zones to the supply chain meant that the production network could remain within the region even after wages began to rise in Japan, Hong Kong, Singapore, Taiwan and South Korea.

By the 1990s, much of the world’s manufacturing had shifted to the new system, but the decade will be remembered for what is best described as the “Communications Revolution.” Within a few short years, technologies such as mobile telephony and the internet went from being barely known to being ubiquitous. The efficiency of transportation networks also improved but, in a role reversal, these gains were now driven mostly by improvements in communications technology.

The cost of real-time international communications had been prohibitive in the 1930s and barely affordable in the 1960s, but became irrelevant by the end of the 1990s. This not only made lean manufacturing ever more efficient, but allowed the creation of international production networks in a completely new area — services.

Around 1993, the management of American Express noticed that the cost of running their credit card operations in India was significantly lower than that for comparable businesses elsewhere. So when the bank decided a year later to consolidate their finance functions in three locations around the world, India was chosen to anchor the Asia-Pacific operations. Very soon companies like British Airways and GE Capital were setting up large outsourcing units in India. Thus was born the global services outsourcing business.

Meanwhile, the efficiency gains of “just-in-time” and lean production were making their way downstream and being applied to distribution networks. One of the results of this change was the rise of hyper-markets like Walmart and Carrefour. By leveraging scale, logistics and lean inventories, they were able to bring down retail prices as well as provide consumers with unprecedented choice.

Into the cloud

The lean production model was the result of innovations in containerization and fixed-line telephony. Although production was decentralized, we are still dealing with a pyramid of rigid industrial relationships (such as the Japanese keiretsu). The communications revolution fundamentally changed this environment by making it possible for everyone to contact everyone, specify a requirement and negotiate a price. This model retained most of the advantages of lean production, but was far more flexible and adaptable. The supply chain was no longer a chain but a cloud — an evolving ecosystem where economic agents could collaborate in one sphere and complete in another.

The production of Apple’s iPhone and iPad are good examples of this new production network. The iPhone is made up of inputs sourced from around the world that are then assembled together by Foxconn in China. The product never passes through an Apple facility during its production. Yet, Apple receives 66% of the price of an iPhone while Foxconn, the final assembler, receives a paltry 2.5%. Moreover, it is also worth noting that Samsung is a major supplier of the iPhone’s components, even though it completes directly with Apple in the mobile phone and tablet markets.

Now watch as the distribution end of the chain also dissolves into a cloud.

Editor’s note: This article was adapted from “Transportation Versus Communications: What is Next?” from the Wide Angle series published by Deutsche Bank.