126646127-scm-by-chopra

1utdallas.edu/~metin

Supply Chain ManagementIntroduction


Outline

What is supply chain management?

A supply chain strategy framework

Components of a SCM

Major obstacles and common problems

Seven Eleven Japan


Traditional View: Supply Chains inthe Economy (1990, 1996)

Freight Transportation $352, $455 B– Transportation manager in charge

– Transportation software

Inventory Expense $221, $311 B– Inventory manager in charge

– Inventory software

Administrative Expense $27, $31 B

Logistics related activity 11%, 10.5% of GNP

$898 B spent domestically for SC activities in 1998. $1,160 B of inventory in the US economy in the early 2000s.

Transportation and inventory managers


Traditional View: Cost breakdown of amanufactured good

Profit 10%

Supply Chain Cost 20%

Marketing Cost 25%

Manufacturing Cost 45%

Profit

Supply ChainCost

MarketingCost

ManufacturingCost

Effort spent for supply chain activities are invisible to the customers.


What can Supply Chain Management do? Estimated that the grocery industry could save $30 billion (10% of operating

cost) by using effective logistics and supply chain strategies– A typical box of cereal spends 104 days from factory to sale– A typical car spends 15 days from factory to dealership– Faster turnaround of the goods is better?

Laura Ashley (retailer of women and children clothes) turns its inventory 10times a year five times faster than 3 years ago– inventory is emptied 10 times a year, or an item spends about 12/10 months in the

inventory.– To be responsive, it relocated its main warehouse next to FedEx hub in Memphis, TE.

National Semiconductor used air transportation and closed 6 warehouses, 34%increase in sales and 47% decrease in delivery lead time.


Magnitude of Supply Chain Management

Compaq estimates it lost $0.5 B to $1 B in sales in 1995because laptops were not available when and whereneeded

P&G (Proctor&Gamble) estimates it saved retailcustomers $65 M (in 18 months) by collaborationresulting in a better match of supply and demand

When the 1 gig processor was introduced by AMD(Advanced Micro Devices), the price of the 800 megprocessor dropped by 30%


Importance of SCM understood by some

AMR Research:– "The biggest issue enterprises face today is intelligent visibility of their

supply chains-both upstream and down"

Forrester Research:– "Companies need to sense and proactively respond to unanticipated variations

in supply and demand by adopting emerging technologies such as intelligentagents. To boost their operational agility, firms need to transform their staticsupply chains into adaptive supply networks”

Gartner Group:– “By 2004, 90% of enterprises that fail to apply supply-chain management

technology and processes to increase their agility will lose their status aspreferred suppliers”

» Open ended statement. Agility can be increased continuously.


Top 25Supply Chains

AMR research http://www.amrresearch.compublishes reports on supply chainsand other issues.

The Top 25 supply chains report comesout in Novembers.

The table on the right-hand side is fromThe Second Annual Supply ChainTop 25 prepared by Kevin Riley andReleased in November 2005.


SCM Generated Value

Minimizing supply chain costs

while keeping a reasonable service level

customer satisfaction/quality/on time delivery, etc.

This is how SCM contributes to the bottom line

SCM is not strictly a cost reduction paradigm!


A picture is better than 1000 words!How many words would be better than 3 pictures?

- A supply chain consists of

- aims to Match Supply and Demand,profitably for products and services

SUPPLY SIDE DEMAND SIDE

The rightProduct

HigherProfits

The rightTime

The rightCustomer

The rightQuantity

The rightStore

The rightPrice =++ ++ +

- achieves

Supplier Manufacturer Distributor Retailer Customer

UpstreamDownstream


Detergent supply chain:

Customer wantsdetergent

Albertson’sSupermarket

Thirdparty DC

P&G or othermanufacturer

Plastic cupProducer

Chemicalmanufacturer

(e.g. Oil Company)

TennecoPackaging

PaperManufacturer

TimberIndustry


(e.g. Oil Company)


Flows in a Supply Chain

Customer

Material

Information

Funds

The flows resemble a chain reaction.

Supplier


SCM in a Supply Network Supply Chain Management (SCM) is concerned with the management and control of

the flows of material, information, and finances in supply chains.

Supply

Demand

Products and ServicesCash

Supply Side OEM Demand Side

THAILAND INDIA MEXICO TEXAS USN-Tier Suppliers Suppliers Logistics Distributors Retailers

Information

The task of SCM is to design, plan, and execute the activities at the different stagesso as to provide the desired levels of service to supply chain customers profitably


Importance of Supply Chain Management

In 2000, the US companies spent $1 trillion (10% of GNP) on supply-relatedactivities (movement, storage, and control of products across supply chains).Source: State of Logistics Report

Eliminating inefficiencies in supply chains can save millions of $.

Tier 1Supplier

Manufacturer Distributor Retailer Customer

Inefficientlogistics

Highstockouts

Ineffectivepromotions

Frequent Supply shortages

High landed costs tothe shelf

High inventoriesthrough the chain

Low order fillrates

Glitch-Wrong Material,Machine is Down –

effect snowballs


This image cannot currently be displayed.

Supply

Sources:plantsvendorsports

RegionalWarehouses:stockingpoints

FieldWarehouses:stockingpoints

Customers,demandcenterssinks

Purchase

Inventory

TransportationInventory

A Generic Supply Chain


Cycle View of Supply Chains

Customer OrderCycle

Replenishment Cycle

Manufacturing Cycle

Procurement Cycle

Customer

Retailer

Distributor

Manufacturer

Supplier

Any cycle0. Customer arrival1. Customer triggers an order2. Supplier fulfils the order3. Customer receives the order


Push vs Pull System

What instigates the movement of the work in the system?

In Push systems, work release is based on downstream demandforecasts– Keeps inventory to meet actual demand– Acts proactively

» e.g. Making generic job application resumes today (e.g.: exempli gratia)

In Pull systems, work release is based on actual demand or theactual status of the downstream customers– May cause long delivery lead times– Acts reactively

» e.g. Making a specific resume for a company after talking to the recruiter


Push/Pull View of Supply Chains

Procurement,Manufacturing andReplenishment cycles

Customer OrderCycle

CustomerOrder ArrivesPush-Pull boundary

PUSH PROCESSES PULL PROCESSES


Examples of Supply Chains

Dell / Compaq– Dell buys some components for a product from its suppliers

after that product is purchased by a customer. Extreme case of apull process

Zara, Spain’s answer to Italy’s Benetton– Sells apparel with a short design-to-sale cycle, avoids markdowns.

Toyota / GM / Volkswagen, in the course notes

McMaster Carr / W.W. Grainger, sell auto parts

Amazon / Barnes and Noble

Frozen food industry/Fast food industry/5 star restaurants

Internet shopping: Webvan / Peapod


SCM Strategy


Mission-Strategy-Tactics-Decisions

Mission, Mission statement– The reason for existence of an organization

Strategy– A plan for achieving organizational goals

Tactics– The actions taken to accomplish strategies

Operational decisions– Day to day decisions to support tactics


Life Strategy for Ted

Ted is an undergrad. He would like to have a career in business, havea good job, and earn enough income to live comfortably

Mission: Live a good life

Goal: Successful career, good income

Strategy: Obtain a master’s degree

Tactics: Select a college and a concentration

Operations: Register, buy books, takecourses, study, graduate, get a job


Linking SC and Business Strategy

NewProduct

Development

Marketingand

SalesOperations Distribution Service

Finance, Accounting, Information Technology, Human Resources

Competitive (Business) Strategy

Product Development Strategy-Portfolio of products-Timing of product introductions

Marketing Strategy-Frequent discounts-Coupons

Supply Chain Strategy


Strategies:Product Development

It relates to Technologies for futureoperations (via patents) and Setof products/services

Be the technology leaderIBM workstations

Offer many productsDell computers

Offer products for localsTata’s Nano at $2500=100000 rupeesProduction at Singur, West Bengal, India;l x w x h=3.1 x 1.5 x 1.6 meters;Top speed: 105km/hr;Engine volume 623 cc;Mileage 50 miles/gallon;Annual sales target 200,000.


Strategies

Marketing and sales strategy relates to positioning, pricing andpromotion of products/services– e.g. Never offer more than 40% discount

– e.g. EDLP = every day low price» At Wal-Mart

– e.g. Demand smoothing via coupons» BestBuy

Supply chain management strategy relates to procurement,transportation, storage and delivery– e.g. Never use more than 1 supplier for every input

– e.g. Never expedite orders just because they are late

– e.g. Always use domestic suppliers within the sales season not in advance.


Fitting the SC to the customer or vice versa?

Understand the customer Wishes

Understand the Capabilities of your SC

Match the Wishes with the Capabilities

Challenge: How to meet extensive Wishes

with limited Capabilities?


Achieving Strategic Fit: Consistent SCMand Competitive strategies

Fit SC to the customer

Understanding the Customer– Range of demand, pizza hut stable

– Production lot size, seasonal products

– Response time, organ transplantation

– Service level, product availability

– Product variety

– Innovation

– Accommodating

poor quality

Implied (Demand)Uncertainty for SC

Implied troublefor SC


Contributors to Implied Demand Uncertainty

Low High

Price ResponsivenessCustomer Need

Implied Demand Uncertainty

CommoditiesDetergentLong lead time steel

Customized productsHigh Fashion ClothingEmergency steel,

for maintenance/replacement

Short lead times, product variety,distribution channel variety, high rate of innovation and

high customer service levels all increasethe Implied Demand Uncertainty


Understanding the Supply Chain:Cost-Responsiveness Tradeoff

High Low

Low

High

Responsiveness (in time, high service level and product variety)

Cost in $

Efficiency frontier

InefficientFix responsiveness Impossible

Inefficiency Region

Why decreasing slope (concave) for the efficiency frontier?


Achieving Strategic Fit: Wishes vs. Capabilities

Implieduncertaintyspectrum

Responsive(high cost)

supply chain

Efficient(low cost)

supply chainCertaindemand

Uncertaindemand

Responsivenesspectrum

Lunch buffet<Low margin>

Gourmet dinner<High margin>


Loosing the strategic fit: Webvan

Webvan started a merger with HomeGrocer in Sept 2000 andcompleted in May 2001.

Declared bankruptcy in July 2001. Why?– “Webvan was so behemoth that could deliver anything to anyone anywhere

that it lost sight of a more mundane task: pleasing grocery customers dayafter day”.

– Short to midterm cash mismanagement. Venture capital of $1.2 B run out.

– Merger costs: duplicated work force, integration of technology, realignmentof facilities.

Peapod has the same business model but more focused in terms ofservice and locations. It actually survives with its parent companyRoyal Ahold’s (Dutch Retailer) cash.– Delivers now at a fee of $6.95 within a day.


Top 10 Retailers Reported in 2008 – First 4

Source www.deloitte.com/dtt/cda/doc/content/dtt_2008globalpowersofretailing.pdf


Top 10 Retailers Reported in 2008 – First 5-10


Big retailers’ StrategyWal-Mart: Efficiency Target: More quality and service Carrefour: International, ambiance

K-Mart: Confused.– Squeezed between Target and Wal-Mart– Reliance on coupon sales– Do coupons stabilize or destabilize a Supply chain?

K-Mart and Sears merged in November 2004.Now called Sears Holdings.

» K-Mart gets cash» Sears gets presence outside malls


Other Factors Multiple products in a SC. Multiple customers for a given product

– Separate supply chains or Tailored supply chains» e.g. Barnes and Noble: Retailing and/or e-tailing

– Product and/or customer classes» e.g. UTD library loans books for 6 months (2 weeks) to faculty (students)» Customer segmentation by pricing

Competitors: more, faster and global» UTD online programs compete globally

Product life cycle (shortening)– SCM strategy moves toward efficiency and low implied uncertainty as products age

» e.g. Air travel is becoming more efficient e.g. Southwest airlines lead the drive for efficiency e.g. Airbus announced A380 accommodating 555-800 people on Jan 17, 2005.

» e.g. Flat screen TV producer of AU Optronics of Taiwan was looking for ways to make itsSC more efficient in June 2004.

– Replacement sales» Selling to replace broken units.

e.g. AC replacement is about 50% of the market.– Macroeconomic factors for visibility

» Forecasting Home Depot sales from S&P 500 price index. Positive correlation is detected.


Achieving Strategic Fit over a Lifecycle

Responsive(high cost)

supply chain

Efficient(low cost)

supply chainCertaindemand

Uncertaindemand


Integration

Integration is the central theme in SCM

Building synergies by integrating business functions,departments and companies


Strategic Scope

Suppliers Manufacturer Distributor Retailer Customer

CompetitiveStrategy

Product Dev.Strategy

Supply ChainStrategy

MarketingStrategy


Supply Chain Drivers and Obstacles


Drivers of Supply Chain Performance

Efficiency Responsiveness

Inventory Transportation Facilities

Information

Supply chain structure

LogisticalDrivers

How to achieve

Sourcing PricingCross-FunctionalDrivers


1. Inventory

Convenience: Cycle inventory– No customer buys eggs one by one

Unstable demand: Seasonal inventory– Bathing suits

– Xmas toys and computer sales

Randomness: Safety inventory– 20% more syllabi than the class size were available in the

first class

– Compaq’s loss in 95 Pipeline inventory

– Work in process or transit


Little’s lawLong run averages = Expected values

I = R . T

I=Pipeline inventory;

R=output per time=throughput;

T=delay time=flow time

Flow time? Thruput? Pipeline (work in process) Inventory?

10/minuteSpend 1 minute


2. Transportation

Air

Truck

Rail

Ship

Pipeline

Electronic


3. Facilities

Production– Flexible vs. Dedicated

– Flexibility costs» Production: Remember BMW: “a sports car disguised as a sedan”» Service: Can your instructor teach music as well as SCM?

» Sports: A playmaker who shoots well is rare.

Inventory-like operations: Receiving, Prepackaging,Storing, Picking, Packaging, Sorting, Accumulating,Shipping– Job Lot Storage: Need more space. Reticle storage in fabs.

– Crossdocking: Wal-Mart


4. Information

Role in the supply chain– The connection between the various stages in the supply chain

– Crucial to daily operation of each stage in a supply chain» E.g., production scheduling, inventory levels

Role in the competitive strategy– Allows supply chain to become more efficient and more

responsive at the same time (reduces the need for a trade-off)

– Information technology» Andersen Windows

Wood window manufacturer, whose customers can choose from a library of50,000 designs or create their own. Customer orders automatically sent tothe factory.


Characteristics of the Good Information

Information Global Scope

CoordinatedDecisions

Supply ChainSuccess

Strategy Analytical Models $$$

Information

Accurate?

Accessible?

Up-to-date?

In the Correct form?» If not, database restricted ability. How difficult is it to import data into SAP?


Quality of Information

Information drives the decisions:– Good information means good decisions

IT helps: MRP, ERP, SAP, EDI

Relevant information?

How to use information?


Information Technology in a SupplyChain: Legacy Systems

Supplier CustomerRetailerDistributorManufacturer

Strategic

Planning

Operational


Information Technology in a Supply Chain:ERP Systems


Strategic

Planning

OperationalERPPotential

ERPPotential

ERP


Information Technology in a Supply Chain:Analytical Applications


Strategic

Planning

Operational

SupplierApps

SCM

MES

Dem Plan

Transport execution &WMS

APS Transport & InventoryPlanning

CRM/SFA


ERP Systems

Wider focus

Push (MRP) versus Pull (demand information transmittedquickly throughout the supply chain)

Real-time information

Coordination and Information sharing

Transactional IT

Expensive and difficult to implement– About 25% of ERP installations are cancelled within a year

– About 70% of ERP installations go over the budget


IT Push

0

100

200

300

400

500

1965 1973 1981 1989 1997

IT investment($B)


Supply Chain Software PushSee Top 100 under /articles.html

Source Kanakamedala,Ramsdell, Srivatsan (2003).McKinsey Quarterly, No 1.


5. Sourcing

Role in the supply chain– Set of processes required to purchase goods and services in a supply chain

– Supplier selection, single vs. multiple suppliers, contract negotiation

Role in the competitive strategy– Sourcing is crucial. It affects efficiency and responsiveness in a supply chain

– In-house vs. outsource decisions- improving efficiency and responsiveness» TI: More than half of the revenue spent for sourcing.

» Cisco sources: Low-end products (e.g. home routers) from China.

Components of sourcing decisions– In-house versus outsource decisions

– Supplier evaluation and selection

– Procurement process:» Every department of a firm buy from suppliers independently, or all together.

EDS to reduce the number of officers with purchasing authorization.


6. Pricing

Role in the supply chain– Pricing determines the amount to charge customers in a supply chain

– Pricing strategies can be used to match demand and supply» Price elasticity: Do you know yours?

Role in the competitive strategy– Use pricing strategies to improve efficiency and responsiveness

– Low price and low product availability; vary prices by response times» Amazon: Faster delivery is more expensive

Components of pricing decisions– Pricing and economies of scale

– Everyday low pricing versus high-low pricing

– Fixed price versus menu pricing, depending on the product and services» Packaging, delivery location, time, customer pick up

» Bundling products; products and services


Considerations for Supply Chain Drivers

Driver Efficiency Responsiveness

Inventory Cost of holding Availability

Transportation Consolidation Speed

Facilities Consolidation /Dedicated

Proximity /Flexibility

Information Low cost/slow/noduplication

High cost/streamlined/reliable

Sourcing Low cost sources Responsive sources

Pricing Constant price Low-high price


Major Obstacles to Achieving Fit

SC is big:– Variety of products/services

– Spoiled customer

– Multiple owners (Procurement, Production, Inventory,Marketing) / multiple objectives

– Globalization

Local optimization and lack of global fit


Dealing with Multiple Owners / Local Optimization– Information Coordination

» Information sharing / Shyness / Legal and ethical issues

– Contractual Coordination» Mechanisms to align local objectives with global ones

– Coordination with (real) options» Rare in the practice

– Without coordination, misleading reliance on metrics:» Average safety inventory, Average incoming shipment size, Average

purchase price of raw materials, Revenue

Major Obstacles to Achieving Fit


Major obstacles to achieving fit

Instability and Randomness:– Increasing product variety

– Shrinking product life cycles

– Customer fragmentation: Push for customization, segmentation

– Fragmentation of Supply Chain ownership: Globalization

Increasing implied uncertainty


Common problems

Lack of relevant SCM metrics: How to measureresponsiveness?

» How to measure efficiency, costs, worker performance, etc?

Poor inventory status information» Theft: Major problem for furniture retailers.» Transaction errors: Retailers with inaccurate inventory records

for 65% of SKUs» Information delays, dated information, incompatible info. systems» Misplaced inventory: 16% of items cannot be found at a major retailer» Spoilage: active ingredients in the products are losing their properties» Product quality and yield» Lack of visibility in SCs

Do you know the inventory your distribution centers hold? Do you know the inventory your fellow retailer holds?


Common problems

Poor delivery status information» Not knowing the order status

Poor IT design» Unreliable, duplicate data» Security problems: too much or too little

Ignoring uncertainties– “The flight from uncertainty and ambiguity is so motivated that we often

create pseudocertainty.”– Nitin Nohra, HBR February 2006 issue, p.40.

Internal customer discrimination» Giving lower priority to internal customers than external customers

Poor integration Elusive inventory costs

» Accounting systems do not capture opportunity costs

SC-insensitive product design


Summary

Supply Chain Introduction

Competitiveness / Business strategy / SCM strategy

Components» Inventory, Transportation, Facilities, Information, Sourcing, Pricing

Challenges


Seven Eleven Japan (SEJ)

A Case Study


Factual Information on Seven Eleven Japan (SEJ)

Largest convenience store in Japan with market value of $95 B. The third largestretail company in the world after Wal-Mart and Home Depot.

Established in 1974. In 2000, total sales $18,000 M, profit $620 M. Average inventory turnover time 7-8.5 days. Stock value increased by 3000 times from 1974 to 2000. In 1985, there were 2000 stores in Japan, increasing by 400-500 per year. Return on equity 14% over 2000-2004. A SEJ store is about the half the size of a US 7-eleven store,

that is about 110 m2. Sales:

– Products» 32.9% Processed food: drinks, noodles, bread and snacks» 31.6% Fast food: rice ball, box lunch and hamburgers» 12.0% Fresh food: diary products» 25.3% Non-food: magazines, ladies stockings and batteries.

– Services: Utility bill paying, installment payments for credit companies, ATMs, photocopying


More on SEJ

More factual info: Average sales about twice of an average US store SKU’s offered in store: Over 3,000 (change by time of day, day of week, season) Virtually no storage space No food cooking at the stores

Japanese Images of Seven Eleven: Convenient Cheerful and lively stores Many ready made dinner items I buy Famous for its great boxed lunch and dinner - On weekends, when I was single, I went to buy lunch and dinner

SC strategy:Micro matching of supply and demand (by location, time of day, day of week, season)


Seven Eleven - Number of Stores

0

1000

2000

3000

4000

5000

6000

85 86 87 88 89 90 91 92 93 94

Number of Stores

1999: 8,0272004: 10,356


Seven Eleven - Net Sales (B Yen)Sales 1,963 B Yen in 2000

0

200

400

600

800

1000

1200

1400

85 86 87 88 89 90 91 92 93 94

Net Sales


Seven Eleven - Pre tax Profit (B Yen)

0102030405060708090

100

85 86 87 88 89 90 91 92 93 94

Profit


Seven Eleven - Inventory turnover (days)

0

2

4

6

8

10

12

14

85 86 87 88 89 90 91 92 93 94

Inventory


Information StrategyQuick access to up to date information (as opposed to data): In 1991, SEJ implemented Integrated Service Digital Network to link stores, headquarter,

DCs and suppliers

Customer checkout process– Clerk records the customer’s gender, (estimated) age and purchased items. These Point of Sales

(POS) data are transmitted to database at the headquarters.» Store hardware: Store computer, POS registers linked to store computer, Graphic Order

Terminals, Scanner terminals for receiving

Daily use of the data– Headquarters aggregate the data by region, products and time and pass to suppliers and stores by

next morning. Store managers deduce trend information. Weekly use of the data

– Monday morning, the CEO chairs a weekly strategy formulation meeting attended by 100corporate managers.

– Tuesday morning, strategies are communicated to Operation Field Counselors who arrive inTokyo on Monday night.

– Tuesday afternoon, regional elements (e.g. weather, sport events) are factored into the strategy.Tuesday nights, field counselors return back to their regions.


Information Analysis of POS Data Analysis of

– Sales for product categories over time– SKU (stock keeping unit)– Waste or disposal– 10 day (or week) sales trend by SKU

Sales trends for new product– In the early 1990s, half-prepared fresh noodle sales were going up,

new fresh noodle products were quickly developed

Sales trend by time and day– Different sales patterns for different sizes of milk at different times of the day results in

rearrangement of the milks in the fridge. Extreme store micromanagement.» Let us speculate: Flavored milks are put in front of the pure milks in the evening (or the morning?).

List of slow moving items– About half of 3000 SKUs are replaced by new ones every year


Facilities Strategy Limited storage space at stores which have only 125-150 m2 space

– Frequent and small deliveries to stores Deliveries arrive from over 200 plants. Products are grouped by the cooling needs

– Combined delivery system: frozen foods, chilled foods, room temperature and hot foods.

– Such product groups are cross-docked at distribution centers (DC). Food DCs store noinventory.

– A single truck brings a group of products and visits several stores within a geographical region– Aggregation: No supplier (not even coke!) delivers direct

The number of truck deliveries per day is reduced by a factor of 7 from 1974 to 2000.Still, at least 3 fresh food deliveries per day. Goods are received faster with the use ofscanners.

Have many outlets, at convenient locations, close to where customers can walk Focus on some territories, not all: When they locate in a place they blanket (a.k.a.

clustering) the area with stores; stores open in clusters with corresponding DC’s.– 844 stores in the Tokyo region; Seven Eleven had stores in 32 out of 47 prefectures in 2004. No

stores in Kobe.– Success rate of franchise application <= 1/100


The Present and the Future Is food preparation a good idea at 7-eleven locations?

– e.g. Compare microwave heating vs. salad preparation. Why SEJ does not allow direct delivery from suppliers to retailers? Point out which of the following strategies can also be used in US (or Taiwan)

– Information strategy– Facilities strategy

Discuss the differences between the Japanese and US (or Taiwanese) consumers withregard to

– Frequency and amount of grocery purchase– Use of credit cards vs. cash for purchase– 7-eleven inventory turnover rate is 50 in Japan and 19 in the USA.

7-eleven growing rapidly in the US so it aims to be a web depot in both the US and Japan.Does this make sense from a supply chain perspective?– Cost vs. Responsiveness– Business strategy

What is the risk of micro-matching strategy? No direct deliveries to SEJ, what is the potential risk of this strategy if used in the USA?


Deloitte 2008 Global Retailers Survey

Excerpts fromwww.deloitte.com/dtt/cda/doc/content/dtt_2008globalpowersofretailing.pdf

Downloaded on Jan 30, 2008.

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall. 8-1

Chapter 8AggregatePlanning

in the SupplyChain


Outline

Role of aggregate planning in a supply chain

The aggregate planning problem

Aggregate planning strategies

Implementing aggregate planning in practice


Role of Aggregate Planningin a Supply Chain

Capacity has a cost, lead times are greater than zero

Aggregate planning:– process by which a company determines levels of capacity,

production, subcontracting, inventory, stockouts, and pricingover a specified time horizon

– goal is to maximize profit

– decisions made at a product family (not SKU) level

– time frame of 3 to 18 months

– how can a firm best use the facilities it has?


Role of Aggregate Planningin a Supply Chain

Specify operational parameters over the time horizon:– production rate

– workforce

– overtime

– machine capacity level

– subcontracting

– backlog

– inventory on hand

All supply chain stages should work together on anaggregate plan that will optimize supply chainperformance


The Aggregate Planning Problem

Given the demand forecast for each period in theplanning horizon, determine the production level,inventory level, and the capacity level for each periodthat maximizes the firm’s (supply chain’s) profit overthe planning horizon

Specify the planning horizon (typically 3-18 months)

Specify the duration of each period

Specify key information required to develop anaggregate plan


Information Needed foran Aggregate Plan

Demand forecast in each period

Production costs– labor costs, regular time ($/hr) and overtime ($/hr)

– subcontracting costs ($/hr or $/unit)

– cost of changing capacity: hiring or layoff ($/worker) andcost of adding or reducing machine capacity ($/machine)

Labor/machine hours required per unit

Inventory holding cost ($/unit/period)

Stockout or backlog cost ($/unit/period)

Constraints: limits on overtime, layoffs, capitalavailable, stockouts and backlogs


Outputs of Aggregate PlanProduction quantity from regular time, overtime, and

subcontracted time: used to determine number ofworkers and supplier purchase levels

Inventory held: used to determine how much warehousespace and working capital is needed

Backlog/stockout quantity: used to determine whatcustomer service levels will be

Machine capacity increase/decrease: used to determineif new production equipment needs to be purchased

A poor aggregate plan can result in lost sales, lostprofits, excess inventory, or excess capacity


Aggregate Planning Strategies

Trade-off between capacity, inventory,backlog/lost sales

Chase strategy – using capacity as the lever

Time flexibility from workforce or capacitystrategy – using utilization as the lever

Level strategy – using inventory as the lever

Mixed strategy – a combination of one or more ofthe first three strategies


Chase StrategyProduction rate is synchronized with demand by

varying machine capacity or hiring and laying offworkers as the demand rate varies

However, in practice, it is often difficult to varycapacity and workforce on short notice

Expensive if cost of varying capacity is high

Negative effect on workforce morale

Results in low levels of inventory

Should be used when inventory holding costs are highand costs of changing capacity are low


Time Flexibility StrategyCan be used if there is excess machine capacity

Workforce is kept stable, but the number of hoursworked is varied over time to synchronize productionand demand

Can use overtime or a flexible work schedule

Requires flexible workforce, but avoids moraleproblems of the chase strategy

Low levels of inventory, lower utilization

Should be used when inventory holding costs arehigh and capacity is relatively inexpensive


Level StrategyMaintain stable machine capacity and workforce

levels with a constant output rate

Shortages and surpluses result in fluctuations ininventory levels over time

Inventories that are built up in anticipation of futuredemand or backlogs are carried over from high to lowdemand periods

Better for worker morale

Large inventories and backlogs may accumulate

Should be used when inventory holding and backlogcosts are relatively low


Fundamental Tradeoffs inAggregate Planning

Capacity (regular time, overtime, subcontract)

Inventory

Backlog / lost sales

Basic Strategies

Chase strategy

Time flexibility from workforce or capacity

Level strategy


Aggregate Planning atRed Tomato Tools

Month Demand ForecastJanuary 1,600February 3,000

March 3,200April 3,800May 2,200June 2,200


Aggregate Planning at RedTomato Tools

Item CostMaterials $10/unitInventory holding cost $2/unit/monthMarginal cost of a stockout $5/unit/monthHiring and training costs $300/workerLayoff cost $500/workerLabor hours required 4/unitRegular time cost $4/hourOver time cost $6/hourCost of subcontracting $30/unit


Aggregate Planning at Red Tomato Tools(Define Decision Variables)

Wt = Workforce size for month t, t = 1, ..., 6

Ht = Number of employees hired at the beginning of month t,t = 1, ..., 6

Lt = Number of employees laid off at the beginning of month t,t = 1, ..., 6

Pt = Production in month t, t = 1, ..., 6

It = Inventory at the end of month t, t = 1, ..., 6

St = Number of units stocked out at the end of month t,t = 1, ..., 6

Ct = Number of units subcontracted for month t, t = 1, ..., 6

Ot = Number of overtime hours worked in month t, t = 1, ..., 6


Aggregate Planning at Red Tomato Tools(Define Objective Function)

6

1

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6

1

6

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6

1

6

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6

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Aggregate Planning at Red Tomato tools(Define Constraints Linking Variables)

Workforce size for each month is based on hiringand layoffs

.80,6,...,1

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Aggregate Planning at Red Tomato Tools(Constraints)

Production for each month cannot exceed capacity

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Scenarios

Increase in holding cost (from $2 to $6)

Overtime cost drops to $4.1 per hour

Increased demand fluctuation


Increased Demand Fluctuation

Month Demand ForecastJanuary 1,000February 3,000March 3,800April 4,800May 2,000June 1,400


Aggregate Planning in Practice

Think beyond the enterprise to the entire supply chain

Make plans flexible because forecasts are alwayswrong

Rerun the aggregate plan as new information emerges

Use aggregate planning as capacity utilizationincreases

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Aggregate Planning in Excel

Construct a table with the decision variables

Construct a table for constraints

Create a cell containing the objective function

Use Data Analysis Solver

8-24


INVENTORY PLANNING AND ECONOMICTHEORY -ABERRATIONS

Available evidence indicates that Indian industries,by and large do not show any serious concern forinventory ordering and carrying costs. What are themain reasons for their indifference to scientificinventory management techniques?What adaptations of Just In Time (JIT) practices do

you visualize emerging in the Indian environment inthe near future?


Summary of Learning ObjectivesWhat types of decisions are best solved by aggregate

planning?

What is the importance of aggregate planning as asupply chain activity?

What kinds of information are needed to produce anaggregate plan?

What are the basic trade-offs a manager makes toproduce an aggregate plan?

How are aggregate planning problems formulated andsolved using Microsoft Excel?


Chapter 7Demand

Forecastingin a Supply

Chain

7-1


Outline

The role of forecasting in a supply chain

Characteristics of forecasts

Components of forecasts and forecasting methods

Basic approach to demand forecasting

Time series forecasting methods

Measures of forecast error

Forecasting demand at Tahoe Salt

Forecasting in practice


Role of Forecastingin a Supply Chain

The basis for all strategic and planning decisionsin a supply chain

Used for both push and pull processes

Examples:– Production: scheduling, inventory, aggregate planning

– Marketing: sales force allocation, promotions, newproduction introduction

– Finance: plant/equipment investment, budgetaryplanning

– Personnel: workforce planning, hiring, layoffs

All of these decisions are interrelated


Characteristics of Forecasts

Forecasts are always wrong. Should includeexpected value and measure of error.

Long-term forecasts are less accurate than short-term forecasts (forecast horizon is important)

Aggregate forecasts are more accurate thandisaggregate forecasts


Forecasting Methods

Qualitative: primarily subjective; rely onjudgment and opinion

Time Series: use historical demand only– Static

– Adaptive

Causal: use the relationship between demand andsome other factor to develop forecast

Simulation– Imitate consumer choices that give rise to demand

– Can combine time series and causal methods


Components of an ObservationObserved demand (O) =

Systematic component (S) + Random component (R)

Level (current deseasonalized demand)

Trend (growth or decline in demand)

Seasonality (predictable seasonal fluctuation)

• Systematic component: Expected value of demand• Random component: The part of the forecast that deviates

from the systematic component• Forecast error: difference between forecast and actual demand


Time Series ForecastingQuarter Demand Dt

II, 2006 8000III, 2006 13000IV, 2006 23000I, 2007 34000II, 2007 10000III, 2007 18000IV, 2007 23000I, 2008 38000II, 2008 12000III, 2008 13000IV, 2008 32000I, 2009 41000

Forecast demand for thenext four quarters.


Time Series Forecasting

0

20,000

40,000

60,000


Forecasting Methods

Static

Adaptive– Moving average

– Simple exponential smoothing

– Holt’s model (with trend)

– Winter’s model (with trend and seasonality)


Basic Approach toDemand Forecasting

Understand the objectives of forecasting

Integrate demand planning and forecasting

Identify major factors that influence the demandforecast

Understand and identify customer segments

Determine the appropriate forecasting technique

Establish performance and error measures for theforecast


Time SeriesForecasting Methods

Goal is to predict systematic component of demand– Multiplicative: (level)(trend)(seasonal factor)

– Additive: level + trend + seasonal factor

– Mixed: (level + trend)(seasonal factor)

Static methods

Adaptive forecasting


Static MethodsAssume a mixed model:

Systematic component = (level + trend)(seasonal factor)

Ft+l = [L + (t + l)T]St+l

= forecast in period t for demand in period t + l

L = estimate of level for period 0

T = estimate of trend

St = estimate of seasonal factor for period t

Dt = actual demand in period t

Ft = forecast of demand in period t


Static Methods

Estimating level and trend

Estimating seasonal factors


Estimating Level and Trend

Before estimating level and trend, demand datamust be deseasonalized

Deseasonalized demand = demand that wouldhave been observed in the absence of seasonalfluctuations

Periodicity (p)– the number of periods after which the seasonal cycle

repeats itself

– for demand at Tahoe Salt (Table 7.1, Figure 7.1) p = 4


Time Series Forecasting(Table 7.1)

Quarter, Year Demand Dt

II, 1 8000III, 1 13000IV, 1 23000I, 2 34000II, 2 10000III, 2 18000IV, 2 23000I, 3 38000II, 3 12000III, 3 13000IV, 3 32000I, 4 41000

Forecast demand for thenext four quarters.


Time Series Forecasting(Figure 7.1)

010,00020,00030,00040,00050,000


Estimating Level and Trend

Before estimating level and trend, demand datamust be deseasonalized

Deseasonalized demand = demand that wouldhave been observed in the absence of seasonalfluctuations

Periodicity (p)– the number of periods after which the seasonal cycle

repeats itself

– for demand at Tahoe Salt (Table 7.1, Figure 7.1) p = 4


Deseasonalizing Demand

[Dt-(p/2) + Dt+(p/2) + Σ 2Di] / 2p for p even

Dt = (sum is from i = t+1-(p/2) to t+1+(p/2))

Σ Di / p for p odd

(sum is from i = t-(p/2) to t+(p/2)), p/2 truncated to lower integer


Deseasonalizing DemandFor the example, p = 4 is even

For t = 3:

D3 = D1 + D5 + Sum(i=2 to 4) [2Di]/8

= 8000+10000+[(2)(13000)+(2)(23000)+(2)(34000)]/8

= 19750

D4 = D2 + D6 + Sum(i=3 to 5) [2Di]/8

= 13000+18000+[(2)(23000)+(2)(34000)+(2)(10000)]/8

= 20625


Deseasonalizing DemandThen include trend

Dt = L + tT

where Dt = deseasonalized demand in period t

L = level (deseasonalized demand at period 0)

T = trend (rate of growth of deseasonalized demand)

Trend is determined by linear regression usingdeseasonalized demand as the dependent variable andperiod as the independent variable (can be done inExcel)

In the example, L = 18,439 and T = 524


Time Series of Demand(Figure 7.3)

0

10000

20000

30000

40000

50000

1 2 3 4 5 6 7 8 9 10 11 12

Period

Dem

and

Dt

Dt-bar


Estimating Seasonal Factors

Use the previous equation to calculate deseasonalizeddemand for each period

St = Dt / Dt = seasonal factor for period t

In the example,

D2 = 18439 + (524)(2) = 19487 D2 = 13000

S2 = 13000/19487 = 0.67

The seasonal factors for the other periods arecalculated in the same manner


Estimating Seasonal Factors(Fig. 7.4)

t Dt Dt-bar S-bar1 8000 18963 0.42 = 8000/189632 13000 19487 0.67 = 13000/194873 23000 20011 1.15 = 23000/200114 34000 20535 1.66 = 34000/205355 10000 21059 0.47 = 10000/210596 18000 21583 0.83 = 18000/215837 23000 22107 1.04 = 23000/221078 38000 22631 1.68 = 38000/226319 12000 23155 0.52 = 12000/23155

10 13000 23679 0.55 = 13000/2367911 32000 24203 1.32 = 32000/2420312 41000 24727 1.66 = 41000/24727


Estimating Seasonal FactorsThe overall seasonal factor for a “season” is then obtained

by averaging all of the factors for a “season”If there are r seasonal cycles, for all periods of the form

pt+i, 1<i<p, the seasonal factor for season i is

Si = [Sum(j=0 to r-1) Sjp+i]/r

In the example, there are 3 seasonal cycles in the data andp=4, so

S1 = (0.42+0.47+0.52)/3 = 0.47

S2 = (0.67+0.83+0.55)/3 = 0.68

S3 = (1.15+1.04+1.32)/3 = 1.17

S4 = (1.66+1.68+1.66)/3 = 1.67


Estimating the Forecast

Using the original equation, we can forecast the nextfour periods of demand:

F13 = (L+13T)S1 = [18439+(13)(524)](0.47) = 11,868

F14 = (L+14T)S2 = [18439+(14)(524)](0.68) = 17,527

F15 = (L+15T)S3 = [18439+(15)(524)](1.17) = 30,770

F16 = (L+16T)S4 = [18439+(16)(524)](1.67) = 44,794


Adaptive Forecasting

The estimates of level, trend, and seasonality areadjusted after each demand observation

General steps in adaptive forecasting

Moving average

Simple exponential smoothing

Trend-corrected exponential smoothing (Holt’smodel)

Trend- and seasonality-corrected exponentialsmoothing (Winter’s model)


Basic Formula forAdaptive Forecasting

Ft+1 = (Lt + lT)St+1 = forecast for period t+l in period t

Lt = Estimate of level at the end of period t

Tt = Estimate of trend at the end of period t

St = Estimate of seasonal factor for period t

Ft = Forecast of demand for period t (made period t-1 orearlier)

Dt = Actual demand observed in period t

Et = Forecast error in period t

At = Absolute deviation for period t = |Et|

MAD = Mean Absolute Deviation = average value of At


General Steps inAdaptive Forecasting

Initialize: Compute initial estimates of level (L0), trend(T0), and seasonal factors (S1,…,Sp). This is done asin static forecasting.

Forecast: Forecast demand for period t+1 using thegeneral equation

Estimate error: Compute error Et+1 = Ft+1- Dt+1

Modify estimates: Modify the estimates of level (Lt+1),trend (Tt+1), and seasonal factor (St+p+1), given theerror Et+1 in the forecast

Repeat steps 2, 3, and 4 for each subsequent period


Moving AverageUsed when demand has no observable trend or seasonality

Systematic component of demand = level

The level in period t is the average demand over the last Nperiods (the N-period moving average)

Current forecast for all future periods is the same and is basedon the current estimate of the level

Lt = (Dt + Dt-1 + … + Dt-N+1) / N

Ft+1 = Lt and Ft+n = Lt

After observing the demand for period t+1, revise theestimates as follows:

Lt+1 = (Dt+1 + Dt + … + Dt-N+2) / N

Ft+2 = Lt+1


Moving Average ExampleFrom Tahoe Salt example (Table 7.1)

At the end of period 4, what is the forecast demand for periods 5through 8 using a 4-period moving average?

L4 = (D4+D3+D2+D1)/4 = (34000+23000+13000+8000)/4 = 19500

F5 = 19500 = F6 = F7 = F8

Observe demand in period 5 to be D5 = 10000

Forecast error in period 5, E5 = F5 - D5 = 19500 - 10000 = 9500

Revise estimate of level in period 5:

L5 = (D5+D4+D3+D2)/4 = (10000+34000+23000+13000)/4 =20000

F6 = L5 = 20000


Simple Exponential SmoothingUsed when demand has no observable trend or seasonality

Systematic component of demand = level

Initial estimate of level, L0, assumed to be the average of allhistorical data

L0 = [Sum(i=1 to n)Di]/n

Current forecast for all future periods is equal to the currentestimate of the level and is given as follows:

Ft+1 = Lt and Ft+n = Lt

After observing demand Dt+1, revise the estimate of the level:

Lt+1 = αDt+1 + (1-α)Lt

Lt+1 = Sum(n=0 to t+1)[α(1-α)nDt+1-n ]


Simple Exponential SmoothingExample

From Tahoe Salt data, forecast demand for period 1 usingexponential smoothing

L0 = average of all 12 periods of data

= Sum(i=1 to 12)[Di]/12 = 22083

F1 = L0 = 22083

Observed demand for period 1 = D1 = 8000

Forecast error for period 1, E1, is as follows:

E1 = F1 - D1 = 22083 - 8000 = 14083

Assuming α = 0.1, revised estimate of level for period 1:

L1 = αD1 + (1-α)L0 = (0.1)(8000) + (0.9)(22083) = 20675

F2 = L1 = 20675

Note that the estimate of level for period 1 is lower than in period 0


Trend-Corrected ExponentialSmoothing (Holt’s Model)

Appropriate when the demand is assumed to have a level andtrend in the systematic component of demand but no seasonality

Obtain initial estimate of level and trend by running a linearregression of the following form:

Dt = at + b

T0 = a

L0 = b

In period t, the forecast for future periods is expressed as follows:

Ft+1 = Lt + Tt

Ft+n = Lt + nTt


Trend-Corrected ExponentialSmoothing (Holt’s Model)

After observing demand for period t, revise the estimates for leveland trend as follows:

Lt+1 = αDt+1 + (1-α)(Lt + Tt)

Tt+1 = β(Lt+1 - Lt) + (1-β)Tt

α = smoothing constant for level

β = smoothing constant for trend

Example: Tahoe Salt demand data. Forecast demand for period 1using Holt’s model (trend corrected exponential smoothing)

Using linear regression,

L0 = 12015 (linear intercept)

T0 = 1549 (linear slope)


Holt’s Model Example (continued)Forecast for period 1:F1 = L0 + T0 = 12015 + 1549 = 13564Observed demand for period 1 = D1 = 8000E1 = F1 - D1 = 13564 - 8000 = 5564Assume α = 0.1, β = 0.2L1 = αD1 + (1-α)(L0+T0) = (0.1)(8000) + (0.9)(13564) = 13008T1 = β(L1 - L0) + (1-β)T0 = (0.2)(13008 - 12015) + (0.8)(1549)

= 1438F2 = L1 + T1 = 13008 + 1438 = 14446F5 = L1 + 4T1 = 13008 + (4)(1438) = 18760


Trend- and Seasonality-CorrectedExponential Smoothing

Appropriate when the systematic component ofdemand is assumed to have a level, trend, and seasonalfactor

Systematic component = (level+trend)(seasonal factor)

Assume periodicity p

Obtain initial estimates of level (L0), trend (T0),seasonal factors (S1,…,Sp) using procedure for staticforecasting

In period t, the forecast for future periods is given by:

Ft+1 = (Lt+Tt)(St+1) and Ft+n = (Lt + nTt)St+n


Trend- and Seasonality-CorrectedExponential Smoothing (continued)After observing demand for period t+1, revise estimates for level,

trend, and seasonal factors as follows:

Lt+1 = α(Dt+1/St+1) + (1-α)(Lt+Tt)

Tt+1 = β(Lt+1 - Lt) + (1-β)Tt

St+p+1 = γ(Dt+1/Lt+1) + (1-γ)St+1

α = smoothing constant for level

β = smoothing constant for trend

γ = smoothing constant for seasonal factor

Example: Tahoe Salt data. Forecast demand for period 1 usingWinter’s model.

Initial estimates of level, trend, and seasonal factors are obtainedas in the static forecasting case


Trend- and Seasonality-CorrectedExponential Smoothing Example (continued)

L0 = 18439 T0 = 524 S1=0.47, S2=0.68, S3=1.17, S4=1.67

F1 = (L0 + T0)S1 = (18439+524)(0.47) = 8913

The observed demand for period 1 = D1 = 8000

Forecast error for period 1 = E1 = F1-D1 = 8913 - 8000 = 913

Assume α = 0.1, β=0.2, γ=0.1; revise estimates for level and trendfor period 1 and for seasonal factor for period 5

L1 = α(D1/S1)+(1-α)(L0+T0) = (0.1)(8000/0.47)+(0.9)(18439+524)=18769

T1 = β(L1-L0)+(1-β)T0 = (0.2)(18769-18439)+(0.8)(524) = 485

S5 = γ(D1/L1)+(1-γ)S1 = (0.1)(8000/18769)+(0.9)(0.47) = 0.47

F2 = (L1+T1)S2 = (18769 + 485)(0.68) = 13093


Measures of Forecast Error

Forecast error = Et = Ft - Dt

Mean squared error (MSE)

MSEn = (Sum(t=1 to n)[Et2])/n

Absolute deviation = At = |Et|

Mean absolute deviation (MAD)

MADn = (Sum(t=1 to n)[At])/n

σ = 1.25MAD


Measures of Forecast ErrorMean absolute percentage error (MAPE)

MAPEn = (Sum(t=1 to n)[|Et/ Dt|100])/n

Bias shows whether the forecast consistently under- oroverestimates demand; should fluctuate around 0

biasn = Sum(t=1 to n)[Et]

Tracking signal should be within the range of +6,otherwise, possibly use a new forecasting method

TSt = bias / MADt


Forecasting Demand at Tahoe Salt

Moving average

Simple exponential smoothing

Trend-corrected exponential smoothing

Trend- and seasonality-corrected exponentialsmoothing


Forecasting in Practice

Collaborate in building forecasts

The value of data depends on where you are in thesupply chain

Be sure to distinguish between demand and sales


Summary of Learning Objectives

What are the roles of forecasting for an enterprise anda supply chain?

What are the components of a demand forecast?

How is demand forecast given historical data usingtime series methodologies?

How is a demand forecast analyzed to estimateforecast error?


Chapter 5Network

Design in theSupply Chain

5-1


Outline

The Role of Network Design in the Supply Chain

Factors Influencing Network Design Decisions

Framework for Network Design Decisions

Models for Facility Location and CapacityAllocation

The Role of IT in Network Design

Making Network Design Decisions in Practice

5-2


Network Design Decisions

Facility role

Facility location

Capacity allocation

Market and supply allocation

5-3


Factors InfluencingNetwork Design Decisions

Strategic

Technological

Macroeconomic

Political

Infrastructure

Competitive

Logistics and facility costs

5-4


The Cost-Response Time Frontier

Local FG

Mix

Regional FG

Local WIP

Central FG

Central WIP

Central Raw Material and Custom production

Custom production with raw material at suppliers

Cost

Response Time HiLow

Low

Hi

5-5


Service and Number of Facilities

Number of Facilities

ResponseTime

5-6


Costs and Number of Facilities

Costs

Number of facilities

Inventory

Transportation

Facility costs

5-7


Percent ServiceLevel Within

Promised Time

Transportation

Cost Buildup as a Function of FacilitiesC

ost

of O

pera

tion

s


Inventory

Facilities

Total Costs

Labor

5-8


Framework for Network DesignDecisions

Phase I – Supply Chain Strategy

Phase II – Regional Facility Configuration

Phase III – Desirable Sites

Phase IV – Location Choices

5-9


A Framework forNetwork Design Decisions

PHASE ISupply Chain

Strategy

PHASE IIRegional Facility

Configuration

PHASE IIIDesirable Sites

PHASE IVLocation Choices

Competitive STRATEGY

INTERNAL CONSTRAINTSCapital, growth strategy,existing network

PRODUCTION TECHNOLOGIESCost, Scale/Scope impact, supportrequired, flexibility

COMPETITIVEENVIRONMENT

PRODUCTION METHODSSkill needs, response time

FACTOR COSTSLabor, materials, site specific

GLOBAL COMPETITION

TARIFFS AND TAXINCENTIVES

REGIONAL DEMANDSize, growth, homogeneity,local specifications

POLITICAL, EXCHANGERATE AND DEMAND RISK

AVAILABLEINFRASTRUCTURE

LOGISTICS COSTSTransport, inventory, coordination

5-10


Conventional Network

CustomerStore

MaterialsDC

ComponentManufacturing

VendorDC

FinalAssembly

FinishedGoods DC

ComponentsDC

VendorDC Plant

Warehouse

FinishedGoods DC

CustomerDC

CustomerDC

CustomerDC

CustomerStore

CustomerStore

CustomerStore

CustomerStore

VendorDC

5-11


Tailored Network: Multi-EchelonFinished Goods Network

RegionalFinished

Goods DC

RegionalFinished

Goods DC

Customer 1DC

Store 1

NationalFinished

Goods DC

Local DCCross-Dock

Local DCCross-Dock

Local DCCross-Dock

Customer 2DC

Store 1

Store 2

Store 2

Store 3

Store 3

5-12


Gravity Methods for Location

Ton Mile-Center Solution– x,y: Warehouse Coordinates

– xn, yn : Coordinates of deliverylocation n

– dn : Distance to deliverylocation n

– Fn : Annual tonnage to deliverylocation n

k

n n

n

k

n n

nn

k

n n

n

k

n n

nn

n

dFD

dFyDd

FDd

FxD

yyxxd

n

n

y

n

n

x

nn

1

1

1

1

22 )()(

Min FDd nn n

5-13


Models for Facility Location andCapacity Allocation

Phase II– Capacitated Plant location model

Phase III– Gravity location models

5-14


Network Optimization Models

Allocating demand to production facilities

Locating facilities and allocating capacity

Which plants to establish? How to configure the network?

Key Costs:

• Fixed facility cost• Transportation cost• Production cost• Inventory cost• Coordination cost

5-15


Demand Allocation Model

Which market is servedby which plant?

Which supply sourcesare used by a plant?

xij = Quantity shipped fromplant site i to customer j

0

,...,1,

,...,1,

..

1

1

1 1

x

Kx

Dx

xc

ij

i

m

jij

j

n

iij

n

i

m

jijij

ni

mj

ts

Min

5-16


Plant Location with Multiple Sourcing

yi = 1 if plant is locatedat site i, 0 otherwise

xij = Quantity shippedfrom plant site i tocustomer j

1,0;

,...,1,

,...,1,

..

1

1

1

1 11

yy

yKx

Dx

xcyf

i

m

ii

ii

n

jij

j

n

iij

n

i

m

jijiji

n

ii

k

ni

mj

ts

Min

5-17


Plant Location with Single Sourcing

yi = 1 if plant is locatedat site i, 0 otherwise

xij = 1 if market j issupplied by factory i, 0otherwise

1,0

,...,1,

,...,1,1

..

,1

1

1 11

yx

yKxD

x

xcDyf

ij

nij

mj

ts

jMin

i

ii

n

jij

n

iij

n

i

m

jijiji

n

ii

5-18


The Role of IT in Network Design

IT systems help with network design by:1. Making the modeling of the network design

problems easier

2. Containing high-performance optimizationtechnologies

3. Allowing for “what-if” scenarios4. Interfacing with planning and operational

software

5-19


Making Network Design Decisions InPractice

Do not underestimate the life span of facilities

Do not gloss over the cultural implications

Do not ignore quality of life issues

Focus on tariffs and tax incentives whenlocating facilities

5-20


SOCIO ECONOMIC FACTORS IN CHOICE OFFACILITY LOCATION

What role do socio-economic factors play inthe selection of the facility location?

How do state policies aimed at promotingbalanced regional development, shape thesupply chain network designs?


JAIPUR RUGS

How has Jaipur Rugs knitted together thetraditional skills of widely dispersed ruralworkforce, through innovative adaptation ofsupply chain practices that best fit the Indiansocio economic conditions to bring qualityproducts to the international market and ensurefair returns to the artisans?


Summary of Learning ObjectivesWhat is the role of network design decisions in

the supply chain?What are the factors influencing supply chain

network design decisions?Describe a strategic framework for facility

location.How are the following optimization methods used

for facility location and capacity allocationdecisions?– Gravity methods for location– Network optimization models

5-23


Chapter 6Designing

Global SupplyChain Networks


OutlineThe Impact of Globalization on Supply Chain Networks

The Offshoring Decision: Total Cost

Risk Management in Global Supply Chains

The Basic Aspects of Evaluating Global Supply ChainDesign

Evaluating Network Design Decisions Using DecisionTrees

AM Tires: Evaluation of Global Supply Chain DecisionsUnder Uncertainty in Practice



The Impact of Globalization onSupply Chain Networks

Globalization offers companies opportunities tosimultaneously grow revenues and decrease costsThe opportunities from globalization are often

accompanied by significant additional riskThere will be a good deal of uncertainty in demand,

prices, exchange rates, and the competitive marketover the lifetime of a supply chain networkTherefore, building flexibility into supply chain

operations allows the supply chain to deal withuncertainty in a manner that will maximize profits



Total cost can be identified by focusing on thecomplete sourcing process

Offshoring to low-cost countries is likely to be mostattractive for products with:– High labor content

– Large production volumes

– Relatively low variety

– Low transportation costs

Perform a careful review of the production process


Risk Management in GlobalSupply Chains

Disruptions

Delays

Systems risk

Forecast risk

Intellectual property risk

Procurement risk

Inventory risk

Capacity risk

6-5


Tailored Risk Mitigation StrategiesIncrease capacity

Get redundant suppliers

Increase responsiveness

Increase inventory

Increase flexibility

Pool or aggregate demand

Increase source capability

6-6


Discounted Cash Flow AnalysisSupply chain decisions are in place for a long time, so

they should be evaluated as a sequence of cash flowsover that period

Discounted cash flow (DCF) analysis evaluates thepresent value of any stream of future cash flows andallows managers to compare different cash flowstreams in terms of their financial value

Based on the time value of money – a dollar today isworth more than a dollar tomorrow


Discounted Cash Flow Analysis

returnofrate

flowscashofstream thisofluepresent vanetthe

periodsToverflowscashofstreamais,...,,

where

1

1

1

1factorDiscount

10

10

k

NPV

CCC

Ck

CNPV

k

T

T

tt

t

• Compare NPV of different supply chain design options

• The option with the highest NPV will provide the greatestfinancial return


NPV Example: Trips LogisticsHow much space to lease in the next three yearsDemand = 100,000 unitsRequires 1,000 sq. ft. of space for every 1,000 units of

demandRevenue = $1.22 per unit of demandDecision is whether to sign a three-year lease or

obtain warehousing space on the spot marketThree-year lease: cost = $1 per sq. ft.Spot market: cost = $1.20 per sq. ft.k = 0.1


NPV Example: Trips Logistics

For leasing warehouse space on the spot market:

Expected annual profit = 100,000 x $1.22 – 100,000 x$1.20 = $2,000

Cash flow = $2,000 in each of the next three years

471,5$1.1

2000

1.1

20002000

11lease)(no

2

221

0

k

C

k

CCNPV


NPV Example: Trips LogisticsFor leasing warehouse space with a three-year lease:

Expected annual profit = 100,000 x $1.22 – 100,000 x $1.00 = $22,000

Cash flow = $22,000 in each of the next three years

182,60$1.1

22000

1.1

2200022000

11lease)(no

2

221

0

k

C

k

CCNPV

The NPV of signing the lease is $54,711 higher; therefore, the managerdecides to sign the lease

However, uncertainty in demand and costs may cause the manager torethink his decision


Representations of UncertaintyBinomial Representation of Uncertainty

Other Representations of Uncertainty


Binomial Representationsof Uncertainty

When moving from one period to the next, the value of theunderlying factor (e.g., demand or price) has only twopossible outcomes – up or down

The underlying factor moves up by a factor or u > 1 withprobability p, or down by a factor d < 1 with probability 1-p

Assuming a price P in period 0, for the multiplicativebinomial, the possible outcomes for the next four periods:

– Period 1: Pu, Pd

– Period 2: Pu2, Pud, Pd2

– Period 3: Pu3, Pu2d, Pud2, Pd3

– Period 4: Pu4, Pu3d, Pu2d2, Pud3, Pd4



In general, for multiplicative binomial, period T hasall possible outcomes Putd(T-t), for t = 0,1,…,TFrom state Puad(T-a) in period t, the price may move in

period t+1 to either– Pua+1d(T-a) with probability p, or

– Puad(T-a)+1 with probability (1-p)

Represented as the binomial tree shown in Figure 6.1(p. 140)



For the additive binomial, the states in the followingperiods are:– Period 1: P+u, P-d

– Period 2: P+2u, P+u-d, P-2d

– Period 3: P+3u, P+2u-d, P+u-2d, P-3d

– Period 4: P+4u, P+3u-d, P+2u-2d, P+u-3d, P-4d

In general, for the additive binomial, period T has allpossible outcomes P+tu-(T-t)d, for t=0, 1, …, T


Evaluating Network DesignDecisions Using Decision Trees

A manager must make many different decisions whendesigning a supply chain network

Many of them involve a choice between a long-term (or lessflexible) option and a short-term (or more flexible) option

If uncertainty is ignored, the long-term option will almostalways be selected because it is typically cheaper

Such a decision can eventually hurt the firm, however,because actual future prices or demand may be differentfrom what was forecasted at the time of the decision

A decision tree is a graphic device that can be used toevaluate decisions under uncertainty


Decision Tree Methodology1. Identify the duration of each period (month, quarter, etc.) and

the number of periods T over the which the decision is to beevaluated.

2. Identify factors such as demand, price, and exchange rate,whose fluctuation will be considered over the next T periods.

3. Identify representations of uncertainty for each factor; that is,determine what distribution to use to model the uncertainty.

4. Identify the periodic discount rate k for each period.5. Represent the decision tree with defined states in each period,

as well as the transition probabilities between states insuccessive periods.

6. Starting at period T, work back to period 0, identifying theoptimal decision and the expected cash flows at each step.Expected cash flows at each state in a given period should bediscounted back when included in the previous period.


Decision Tree Methodology:Trips Logistics

Decide whether to lease warehouse space for the comingthree years and the quantity to lease

Long-term lease is currently cheaper than the spot marketrate

The manager anticipates uncertainty in demand and spotprices over the next three years

Long-term lease is cheaper but could go unused if demandis lower than forecast; future spot market rates could alsodecrease

Spot market rates are currently high, and the spot marketwould cost a lot if future demand is higher than expected


Trips Logistics: Three OptionsGet all warehousing space from the spot market as

needed

Sign a three-year lease for a fixed amount ofwarehouse space and get additional requirements fromthe spot market

Sign a flexible lease with a minimum change thatallows variable usage of warehouse space up to a limitwith additional requirement from the spot market


Trips Logistics1000 sq. ft. of warehouse space needed for 1000 units of

demand

Current demand = 100,000 units per year

Binomial uncertainty: Demand can go up by 20% withp = 0.5 or down by 20% with 1-p = 0.5

Lease price = $1.00 per sq. ft. per year

Spot market price = $1.20 per sq. ft. per year

Spot prices can go up by 10% with p = 0.5 or down by10% with 1-p = 0.5

Revenue = $1.22 per unit of demand

k = 0.1


Trips Logistics Decision Tree(Fig. 6.2)

D=144

p=$1.45

D=144

p=$1.19

D=96

p=$1.45

D=144

p=$0.97

D=96

p=$1.19

D=96

p=$0.97

D=64

p=$1.45

D=64

p=$1.19

D=64

p=$0.97

D=120

p=$1.32

D=120

p=$1. 08

D=80

p=$1.32

D=80

p=$1.32

D=100

p=$1.20

0.25

0.25

0.25

0.25

0.250.25

0.25

0.25

Period 0

Period 1

Period 2


Trips Logistics ExampleAnalyze the option of not signing a lease and

obtaining all warehouse space from the spot market

Start with Period 2 and calculate the profit at eachnode

For D=144, p=$1.45, in Period 2:

C(D=144, p=1.45,2) = 144,000x1.45 = $208,800

P(D=144, p =1.45,2) = 144,000x1.22 –C(D=144,p=1.45,2) = 175,680-208,800 = -$33,120

Profit at other nodes is shown in Table 6.1


Trips Logistics ExampleExpected profit at each node in Period 1 is the profit

during Period 1 plus the present value of the expectedprofit in Period 2

Expected profit EP(D=, p=,1) at a node is theexpected profit over all four nodes in Period 2 thatmay result from this node

PVEP(D=,p=,1) is the present value of this expectedprofit and P(D=,p=,1), and the total expected profit, isthe sum of the profit in Period 1 and the present valueof the expected profit in Period 2


Trips Logistics ExampleFrom node D=120, p=$1.32 in Period 1, there are four

possible states in Period 2

Evaluate the expected profit in Period 2 over all four statespossible from node D=120, p=$1.32 in Period 1 to be

EP(D=120,p=1.32,1) = 0.25xP(D=144,p=1.45,2) +

0.25xP(D=144,p=1.19,2) +

0.25xP(D=96,p=1.45,2) +

0.25xP(D=96,p=1.19,2)

= 0.25x(-33,120)+0.25x4,320+0.25x(-22,080)+0.25x2,880

= -$12,000


Trips Logistics ExampleThe present value of this expected value in Period 1 is

PVEP(D=12, p=1.32,1) = EP(D=120,p=1.32,1) / (1+k)= -$12,000 / (1+0.1)= -$10,909

The total expected profit P(D=120,p=1.32,1) at nodeD=120,p=1.32 in Period 1 is the sum of the profit in Period 1 atthis node, plus the present value of future expected profitspossible from this nodeP(D=120,p=1.32,1) = [(120,000x1.22)-(120,000x1.32)] +

PVEP(D=120,p=1.32,1)= -$12,000 + (-$10,909) = -$22,909

The total expected profit for the other nodes in Period 1 is shownin Table 6.2


Trips Logistics ExampleFor Period 0, the total profit P(D=100,p=120,0) is the sum of

the profit in Period 0 and the present value of the expectedprofit over the four nodes in Period 1

EP(D=100,p=1.20,0) = 0.25xP(D=120,p=1.32,1) +

= 0.25xP(D=120,p=1.08,1) +

= 0.25xP(D=96,p=1.32,1) +

= 0.25xP(D=96,p=1.08,1)

= 0.25x(-22,909)+0.25x32,073+0.25x(-15,273)+0.25x21,382

= $3,818

PVEP(D=100,p=1.20,0) = EP(D=100,p=1.20,0) / (1+k)

= $3,818 / (1 + 0.1) = $3,471


Trips Logistics ExampleP(D=100,p=1.20,0) = 100,000x1.22-100,000x1.20 +

PVEP(D=100,p=1.20,0)

= $2,000 + $3,471 = $5,471

Therefore, the expected NPV of not signing the leaseand obtaining all warehouse space from the spot marketis given by NPV(Spot Market) = $5,471


Trips Logistics ExampleUsing the same approach for the lease option,

NPV(Lease) = $38,364

Recall that when uncertainty was ignored, the NPVfor the lease option was $60,182

However, the manager would probably still prefer tosign the three-year lease for 100,000 sq. ft. becausethis option has the higher expected profit


Evaluating FlexibilityUsing Decision Trees

Decision tree methodology can be used to evaluate flexibility within thesupply chain

Suppose the manager at Trips Logistics has been offered a contractwhere, for an upfront payment of $10,000, the company will have theflexibility of using between 60,000 sq. ft. and 100,000 sq. ft. ofwarehouse space at $1 per sq. ft. per year. Trips must pay $60,000 forthe first 60,000 sq. ft. and can then use up to 40,000 sq. ft. on demand at$1 per sq. ft. as needed.

Using the same approach as before, the expected profit of this option is$56,725

The value of flexibility is the difference between the expected presentvalue of the flexible option and the expected present value of theinflexible options

The three options are listed in Table 6.7, where the flexible option hasan expected present value $8,361 greater than the inflexible lease option(including the upfront $10,000 payment)


AM Tires: Evaluation of Supply ChainDesign Decisions Under UncertaintyDedicated Capacity of 100,000 in the United States

and 50,000 in Mexico– Period 2 Evaluation

– Period 1 Evaluation


Flexible Capacity of 100,000 in the United States and50,000 in Mexico– Period 2 Evaluation




Evaluating Facility Investments:AM Tires

Dedicated Plant Flexible PlantPlantFixed Cost Variable Cost Fixed Cost Variable Cost

US 100,000 $1 million/yr. $15 / tire $1.1 million/ year

$15 / tire

Mexico50,000

4 millionpesos / year

110 pesos /tire

4.4 millionpesos / year

110 pesos /tire

U.S. Expected Demand = 100,000;Mexico Expected Demand = 50,0001US$ = 9 pesos

Demand goes up or down by 20 percent with probability 0.5 andexchange rate goes up or down by 25 per cent with probability 0.5.


RU=100RM=50

E=9

Period 0 Period 1 Period 2

RU=120RM = 60E=11.25

RU=120RM = 60E=6.75

RU=120RM = 40E=11.25

RU=120RM = 40E=6.75

RU=80RM = 60E=11.25

RU=80RM = 60E=6.75

RU=80RM = 40E=11.25

RU=80RM = 40E=6.75

RU=144RM = 72E=14.06

RU=144RM = 72E=8.44

RU=144RM = 48E=14.06

RU=144RM = 48E=8.44

RU=96RM = 72E=14.06

RU=96RM = 72E=8.44

RU=96RM = 48E=14.06

RU=96RM = 48E=8.44

AM Tires


AM TiresFour possible capacity scenarios:• Both dedicated• Both flexible• U.S. flexible, Mexico dedicated• U.S. dedicated, Mexico flexible

For each node, solve the demand allocation model:

Plants Markets

U.S.

Mexico

U.S.

Mexico


AM Tires: Demand Allocation forRU = 144; RM = 72, E = 14.06

Source Destination Variablecost

Shippingcost

E Sale price Margin($)

U.S. U.S. $15 0 14.06 $30 $15U.S. Mexico $15 $1 14.06 240 pesos $1.1

Mexico U.S. 110 pesos $1 14.06 $30 $21.2Mexico Mexico 110 pesos 0 14.06 240 pesos $9.2

Plants Markets

U.S.

Mexico

U.S.

Mexico

100,000

6,000

Profit (flexible) =$1,075,055Profit (dedicated) =$649,360

100,000

50,000


Facility Decision at AM Tires

Plant ConfigurationUnited States Mexico

NPV

Dedicated Dedicated $1,629,319Flexible Dedicated $1,514,322

Dedicated Flexible $1,722,447Flexible Flexible $1,529,758


Making Global Supply Chain DesignDecisions Under Uncertainty in Practice

Combine strategic planning and financial planningduring global network design

Use multiple metrics to evaluate global supply chainnetworks

Use financial analysis as an input to decision making,not as the decision-making process

Use estimates along with sensitivity analysis


Summary of Learning ObjectivesWhat are the factors that need to be included in total

landed cost when making global sourcing decisions?

What are the uncertainties that influence global supplychain performance and global network design?

What are the different strategies used to mitigate riskin global supply chains?

What are the methodologies that are used to evaluatesupply chain decisions under uncertainty?

How can global supply chain network designdecisions in an uncertain environment be analyzed?


Chapter 3Supply ChainDrivers and

Metrics


Outline Impellers of Supply Chain

Supply Chain Concepts

Drivers of supply chain performance

A framework for structuring drivers

Facilities

Inventory

Transportation

Information

Sourcing

Pricing

Obstacles to achieving fit


IMPELLERS OF SUPPLY CHAIN

Empowered Customer

Developments in Information Technology Tools

Globalisation

3-3


SUPPLY CHAIN CONCEPTS

Systems Concept

Total Cost Concept

Trade off Concept

3-4


Drivers of Supply Chain Performance Facilities

– places where inventory is stored, assembled, or fabricated– production sites and storage sites

Inventory– raw materials, WIP, finished goods within a supply chain– inventory policies

Transportation– moving inventory from point to point in a supply chain– combinations of transportation modes and routes

Information– data and analysis regarding inventory, transportation, facilities throughout the

supply chain– potentially the biggest driver of supply chain performance

Sourcing– functions a firm performs and functions that are outsourced

Pricing– Price associated with goods and services provided by a firm to the supply chain


A Framework forStructuring Drivers

Competitive Strategy

Supply ChainStrategy


Facilities Inventory Transportation

Information


Cross Functional Drivers

Sourcing Pricing

Logistical Drivers


FacilitiesRole in the supply chain

– the “where” of the supply chain– manufacturing or storage (warehouses)

Role in the competitive strategy– economies of scale (efficiency priority)

– larger number of smaller facilities (responsiveness priority)

Example 3.1: Toyota and Honda

Components of facilities decisions


Components of Facilities DecisionsLocation

– centralization (efficiency) vs. decentralization (responsiveness)

– other factors to consider (e.g., proximity to customers)

Capacity (flexibility versus efficiency)

Manufacturing methodology (product focused versusprocess focused)

Warehousing methodology (SKU storage, job lotstorage, cross-docking)

Overall trade-off: Responsiveness versus efficiency


InventoryRole in the supply chain

Role in the competitive strategy

Components of inventory decisions


Inventory: Role in the Supply ChainInventory exists because of a mismatch between

supply and demand

Source of cost and influence on responsiveness

Impact on– material flow time: time elapsed between when material

enters the supply chain to when it exits the supply chain

– throughput» rate at which sales to end consumers occur

» I = DT (Little’s Law)» I = inventory; D = throughput; T = flow time

» Example

» Inventory and throughput are “synonymous” in a supply chain


Inventory: Role in CompetitiveStrategy

If responsiveness is a strategic competitive priority, afirm can locate larger amounts of inventory closer tocustomers

If cost is more important, inventory can be reduced tomake the firm more efficient

Trade-off

Example 3.2 – Nordstrom


Components of InventoryDecisions

Cycle inventory– Average amount of inventory used to satisfy demand between shipments

– Depends on lot size

Safety inventory– inventory held in case demand exceeds expectations

– costs of carrying too much inventory versus cost of losing sales

Seasonal inventory– inventory built up to counter predictable variability in demand

– cost of carrying additional inventory versus cost of flexible production

Overall trade-off: Responsiveness versus efficiency– more inventory: greater responsiveness but greater cost

– less inventory: lower cost but lower responsiveness


TransportationRole in the supply chain


Components of transportation decisions


Transportation: Role inthe Supply Chain

Moves the product between stages in the supply chain

Impact on responsiveness and efficiency

Faster transportation allows greater responsivenessbut lower efficiency

Also affects inventory and facilities


Transportation:Role in the Competitive StrategyIf responsiveness is a strategic competitive priority,

then faster transportation modes can provide greaterresponsiveness to customers who are willing to payfor it

Can also use slower transportation modes forcustomers whose priority is price (cost)

Can also consider both inventory and transportation tofind the right balance

Example 3.3: Blue Nile


Components ofTransportation Decisions

Mode of transportation:– air, truck, rail, ship, pipeline, electronic transportation

– vary in cost, speed, size of shipment, flexibility

Route and network selection– route: path along which a product is shipped

– network: collection of locations and routes

In-house or outsource



InformationRole in the supply chain


Components of information decisions


Information: Role inthe Supply Chain

The connection between the various stages in thesupply chain – allows coordination between stages

Crucial to daily operation of each stage in a supplychain – e.g., production scheduling, inventory levels


Information:Role in the Competitive StrategyAllows supply chain to become more efficient and

more responsive at the same time (reduces the needfor a trade-off)

Information technology

What information is most valuable?

Example 3.4: Andersen Windows

Example 3.5: Sunsweet Growers


Components of InformationDecisions

Push (MRP) versus pull (demand informationtransmitted quickly throughout the supply chain)

Coordination and information sharing

Forecasting and aggregate planning

Enabling technologies– EDI

– Internet

– ERP systems

– Supply Chain Management software



SourcingRole in the supply chain


Components of sourcing decisions


Sourcing: Role inthe Supply Chain

Set of business processes required to purchase goodsand services in a supply chain

Supplier selection, single vs. multiple suppliers,contract negotiation


Sourcing:Role in the Competitive StrategySourcing decisions are crucial because they affect the

level of efficiency and responsiveness in a supplychain

In-house vs. outsource decisions- improvingefficiency and responsiveness

Example 3.6: Cisco


Components of SourcingDecisions

In-house versus outsource decisions

Supplier evaluation and selection

Procurement process

Overall trade-off: Increase the supply chain profits


PricingRole in the supply chain


Components of pricing decisions


Pricing: Role inthe Supply Chain

Pricing determines the amount to charge customers ina supply chain

Pricing strategies can be used to match demand andsupply


Sourcing:Role in the Competitive StrategyFirms can utilize optimal pricing strategies to improve

efficiency and responsiveness

Low price and low product availability; vary prices byresponse times

Example 3.7: Amazon.com


Components of Pricing DecisionsPricing and economies of scale

Everyday low pricing versus high-low pricing

Fixed price versus menu pricing

Overall trade-off: Increase the firm profits


Obstacles to AchievingStrategic Fit

Increasing variety of products

Decreasing product life cycles

Increasingly demanding customers

Fragmentation of supply chain ownership

Globalization

Difficulty executing new strategies


SummaryWhat are the major drivers of supply chain

performance?

What is the role of each driver in creating strategic fitbetween supply chain strategy and competitive strategy(or between implied demand uncertainty and supplychain responsiveness)?

What are the major obstacles to achieving strategic fit?

In the remainder of the course, we will learn how tomake decisions with respect to these drivers in order toachieve strategic fit and surmount these obstacles


Chapter 4Designing

DistributionNetworks and

Applications toE-Business


OutlineThe Role of Distribution in the Supply Chain

Factors Influencing Distribution Network Design

Design Options for a Distribution Network

E-Business and the Distribution Network

Distribution Networks in Practice



The Role of Distributionin the Supply Chain

Distribution: the steps taken to move and store aproduct from the supplier stage to the customer stagein a supply chain

Distribution directly affects cost and the customerexperience and therefore drives profitability

Choice of distribution network can achieve supplychain objectives from low cost to high responsiveness

Examples: Wal-Mart, Dell, Proctor & Gamble,Grainger


Factors InfluencingDistribution Network Design

Distribution network performance evaluated alongtwo dimensions at the highest level:– Customer needs that are met

– Cost of meeting customer needs

Distribution network design options must therefore becompared according to their impact on customerservice and the cost to provide this level of service



Elements of customer service influenced by network structure:– Response time

– Product variety

– Product availability

– Customer experience

– Order visibility

– Returnability

Supply chain costs affected by network structure:– Inventories

– Transportation

– Facilities and handling

– Information


Service and Number of Facilities(Fig. 4.1)

Number ofFacilities

Response Time


Inventory Costs and Numberof Facilities (Fig. 4.2)

InventoryCosts



Transportation Costs andNumber of Facilities (Fig. 4.3)

TransportationCosts



Facility Costs and Numberof Facilities (Fig. 4.4)

FacilityCosts



Response Time

Variation in Logistics Costs and ResponseTime with Number of Facilities (Fig. 4.5)


Total Logistics Costs


Design Options for aDistribution Network

Manufacturer Storage with Direct Shipping

Manufacturer Storage with Direct Shipping and In-Transit Merge

Distributor Storage with Carrier Delivery

Distributor Storage with Last Mile Delivery

Manufacturer or Distributor Storage with CustomerPickup

Retail Storage with Customer Pickup

Selecting a Distribution Network Design


Manufacturer Storage withDirect Shipping (Fig. 4.6)

Manufacturer

Retailer

Customers

Product Flow

Information Flow


In-Transit Merge Network (Fig. 4.7)Factories

Retailer

Product Flow

Information Flow

In-Transit Merge byCarrier

Customers


Distributor Storage withCarrier Delivery (Fig. 4.8)

Factories

Customers

Product FlowInformation Flow

Warehouse Storage byDistributor/Retailer


Distributor Storage withLast Mile Delivery (Fig. 4.9)

Factories

Customers

Product Flow

Information Flow

Distributor/RetailerWarehouse


Manufacturer or Distributor Storagewith Customer Pickup (Fig. 4.10)

Factories

Retailer

Pickup Sites


Cross Dock DC

Customer Flow

Customers


Comparative Performance of DeliveryNetwork Designs (Table 4.7)

Information

Facility & Handling

Transportation

Inventory

Returnability

Order Visibility

Customer Experience

Product Availability

Product Variety

Response Time

Manufacturerstorage with pickup

Distributorstorage with last

mile delivery

Distributor Storagewith Package

Carrier Delivery

ManufacturerStorage with In-Transit Merge

ManufacturerStorage with Direct

Shipping

Retail Storagewith Customer

Pickup

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

2

2

2

2

2

2

2

2

2

2

3

3

3

3

3

3

3

3

3

3

4

4

4

4

4

4

4

4

4

4

4

4

4

5

5

5

5

55

5

6

6

5


Performance of Delivery Networks for DifferentProduct/Customer Characteristics (Table 4-8)

Low customer effort

High product variety

Quick desired response

High product value

Many product sources

Very low demand product

Low demand product

Medium demand product

High demand product

Manufacturerstorage with

pickup

Distributor storagewith last mile delivery

Distributor Storagewith Package Carrier

Delivery


ManufacturerStorage with

Direct Shipping

Retail Storagewith

CustomerPickup

+2

+2

+2

+2

+2

+2

+2 +2 +2

+2

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

0

0

0

0

0

0

0

0 0

0

-1

-1

-1

-1

-1 -1

-1

-1

-1

-1

-1

-2 -2

-2

-2

-2

-2 -2

-2


TRADITIONAL INDIANDISTRIBUTION CHANNELS

What characteristics of the traditional Indian agriculturalproduce distribution channels militate against deliveringsimultaneous benefits to the farmer and the consumer?

What Supply Chain Best Practices do you see as being relevantto the Indian agricultural produce distribution system?

Organised retailing underway in India is likely to impact thetraditional distribution channels and transform the sameradically. What major changes do you visualize taking placein the Agricultural Produce Distribution System in India andhow do you see the existing channels responding to the same?


E-Business and the DistributionNetwork

Impact of E-Business on Customer Service

Impact of E-Business on Cost

Using E-Business: Dell, Amazon, Peapod, Grainger


Impact of E-Business onCustomer Service

Response time

Product variety


Customer experience

Time to market

Order Visibility

Returnability

Direct Sales to Customers

Flexible Pricing, Product Portfolio, and Promotions

Efficient Funds Transfer4-21


Impact of E-Business on CostInventory

Facilities

Transportation

Information

4-22


Distribution Networks in PracticeThe ownership structure of the distribution network

can have as big as an impact as the type of distributionnetwork

The choice of a distribution network has very long-term consequences

Consider whether an exclusive distribution strategy isadvantageous

Product, price, commoditization, and criticality havean impact on the type of distribution system preferredby customers


Summary of Learning ObjectivesWhat are the key factors to be considered when

designing the distribution network?

What are the strengths and weaknesses of variousdistribution options?

How has E-Business affected the design ofdistribution networks in different industries?

What roles do distributors play in the supply chain?


Chapter 2Supply ChainPerformance:

Achieving StrategicFit and Scope


OutlineCompetitive and supply chain strategies

Achieving strategic fit

Expanding strategic scope


What is Supply Chain Management?

Managing supply chain flows and assets, to maximizesupply chain surplus

What is supply chain surplus?


Competitive and SupplyChain Strategies

Competitive strategy: defines the set of customer needs a firmseeks to satisfy through its products and services

Product development strategy: specifies the portfolio of newproducts that the company will try to develop

Marketing and sales strategy: specifies how the market will besegmented and product positioned, priced, and promoted

Supply chain strategy:– determines the nature of material procurement, transportation of

materials, manufacture of product or creation of service, distribution ofproduct

– Consistency and support between supply chain strategy, competitivestrategy, and other functional strategies is important


NewProduct

Development

Marketingand

SalesOperations Distribution Service

Finance, Accounting, Information Technology, Human Resources

The Value Chain: Linking SupplyChain and Business Strategy


Achieving Strategic FitIntroduction

How is strategic fit achieved?

Other issues affecting strategic fit


Achieving Strategic Fit

Strategic fit:– Consistency between customer priorities of competitive

strategy and supply chain capabilities specified by thesupply chain strategy

– Competitive and supply chain strategies have the samegoals

A company may fail because of a lack of strategic fitor because its processes and resources do not providethe capabilities to execute the desired strategy

Example of strategic fit -- Dell


How is Strategic Fit Achieved?Step 1: Understanding the customer and supply chain

uncertainty

Step 2: Understanding the supply chain

Step 3: Achieving strategic fit


Step 1: Understanding the Customerand Supply Chain Uncertainty

Identify the needs of the customer segment beingserved

Quantity of product needed in each lot

Response time customers will tolerate

Variety of products needed

Service level required

Price of the product

Desired rate of innovation in the product



Overall attribute of customer demand

Demand uncertainty: uncertainty of customer demandfor a product

Implied demand uncertainty: resulting uncertainty forthe supply chain given the portion of the demand thesupply chain must handle and attributes the customerdesires



Implied demand uncertainty also related to customerneeds and product attributes

Table 2.1

Figure 2.2

Table 2.2

First step to strategic fit is to understand customers bymapping their demand on the implied uncertaintyspectrum


Achieving Strategic FitUnderstanding the Customer

– Lot size

– Response time

– Service level

– Product variety

– Price

– Innovation

ImpliedDemand

Uncertainty


Impact of Customer Needs on ImpliedDemand Uncertainty (Table 2.1)

Customer Need Causes implied demanduncertainty to increase because …

Range of quantity required increases Wider range of quantity requiredimplies greater variance in demand

Lead time decreases Less time to react to orders

Variety of products required increases Demand per product becomes moredisaggregated

Number of channels through whichproduct may be acquired increases

Total customer demand is nowdisaggregated over more channels

Rate of innovation increases New products tend to have moreuncertain demand

Required service level increases Firm now has to handle unusualsurges in demand


Levels of Implied DemandUncertainty

Predictablesupply and

demand

Salt at asupermarket

A newcommunication

device

Highly uncertainsupply and demand

Figure 2.2: The Implied Uncertainty (Demand and Supply)Spectrum

Predictable supply and uncertaindemand or uncertain supply andpredictable demand or somewhat

uncertain supply and demand

An existingautomobile

model


Correlation Between Implied DemandUncertainty and Other Attributes (Table 2.2)

Attribute Low ImpliedUncertainty

High ImpliedUncertainty

Product margin Low High

Avg. forecast error 10% 40%-100%

Avg. stockout rate 1%-2% 10%-40%

Avg. forced season-end markdown

0% 10%-25%


Step 2: Understanding theSupply Chain

How does the firm best meet demand?

Dimension describing the supply chain is supply chainresponsiveness

Supply chain responsiveness -- ability to– respond to wide ranges of quantities demanded

– meet short lead times

– handle a large variety of products

– build highly innovative products

– meet a very high service level


Step 2: Understanding theSupply Chain

There is a cost to achieving responsiveness

Supply chain efficiency: cost of making anddelivering the product to the customer

Increasing responsiveness results in higher costs thatlower efficiency

Figure 2.3: cost-responsiveness efficient frontier

Figure 2.4: supply chain responsiveness spectrum

Second step to achieving strategic fit is to map thesupply chain on the responsiveness spectrum


Understanding the Supply Chain: Cost-Responsiveness Efficient Frontier

High Low

Low

High

Responsiveness

Cost


Responsiveness Spectrum(Figure 2.4)

Integratedsteel mill

Dell

Highlyefficient

Highlyresponsive

Somewhatefficient

Somewhatresponsive

Hanesapparel

Mostautomotiveproduction


Step 3: Achieving Strategic FitStep is to ensure that what the supply chain does well

is consistent with target customer’s needsFig. 2.5: Zone of strategic fit

Fig. 2.6: Uncertainty/Responsiveness map

Examples: Dell, Barilla


Achieving Strategic Fit Shown on theUncertainty/Responsiveness Map (Fig. 2.5)

Implieduncertaintyspectrum

Responsivesupply chain

Efficientsupply chain

Certaindemand

Uncertaindemand

Responsivenessspectrum


Step 3: Achieving Strategic FitAll functions in the value chain must support the

competitive strategy to achieve strategic fit – Fig. 2.7

Two extremes: Efficient supply chains (Barilla) andresponsive supply chains (Dell) – Table 2.4

Two key points– there is no right supply chain strategy independent of

competitive strategy

– there is a right supply chain strategy for a given competitivestrategy


Comparison of Efficient andResponsive Supply Chains (Table 2.4)

Efficient Responsive

Primary goal Lowest cost Quick response

Product design strategy Min product cost Modularity to allowpostponement

Pricing strategy Lower margins Higher margins

Mfg strategy High utilization Capacity flexibility

Inventory strategy Minimize inventory Buffer inventory

Lead time strategy Reduce but not at expenseof greater cost

Aggressively reduce even ifcosts are significant

Supplier selection strategy Cost and low quality Speed, flexibility, quality

Transportation strategy Greater reliance on low costmodes

Greater reliance onresponsive (fast) modes


Other Issues Affecting Strategic FitMultiple products and customer segments

Product life cycle

Competitive changes over time


Multiple Products andCustomer Segments

Firms sell different products to different customersegments (with different implied demand uncertainty)

The supply chain has to be able to balance efficiencyand responsiveness given its portfolio of products andcustomer segments

Two approaches:

– Different supply chains

– Tailor supply chain to best meet the needs of eachproduct’s demand


Product Life CycleThe demand characteristics of a product and the needs

of a customer segment change as a product goesthrough its life cycle

Supply chain strategy must evolve throughout the lifecycle

Early: uncertain demand, high margins (time isimportant), product availability is most important, costis secondary

Late: predictable demand, lower margins, price isimportant


Product Life CycleExamples: pharmaceutical firms, Intel

As the product goes through the life cycle, the supplychain changes from one emphasizing responsivenessto one emphasizing efficiency


Competitive Changes Over TimeCompetitive pressures can change over time

More competitors may result in an increased emphasison variety at a reasonable price

The Internet makes it easier to offer a wide variety ofproducts

The supply chain must change to meet these changingcompetitive conditions


Expanding Strategic ScopeScope of strategic fit

– The functions and stages within a supply chain that devise anintegrated strategy with a shared objective

– One extreme: each function at each stage develops its ownstrategy

– Other extreme: all functions in all stages devise a strategy jointly

Five categories:– Intracompany intraoperation scope– Intracompany intrafunctional scope– Intracompany interfunctional scope– Intercompany interfunctional scope– Flexible interfunctional scope


Different Scopes of Strategic FitAcross a Supply Chain

Suppliers M anufacturer D istributor R etailer C ustom er

C om petitiveStrategy

ProductD evelopm ent

Strategy

Supply C hainStrategy

M arketingStrategy

Intracom panyIntraoperationat D istributor

Intracom panyIntrafunctionalat D istributor

Intracom panyInterfunctional

at D istributor

Intercom panyInterfunctional


INDIAN RETAIL SECTORWhat different models of supply chains do you

visualize emerging in the transforming Indian retailsector?What trends do you see in in the emerging Indian

supply chain models that suggest conscious attemptsat achieving proper strategic fit between businessstrategies and supply chain strategies?How do you see the Indian retail supply chains

becoming role models for supply chains in othersectors?


Summary of Learning ObjectivesWhy is achieving strategic fit critical to a company’s

overall success?

How does a company achieve strategic fit between itssupply chain strategy and its competitive strategy?

What is the importance of expanding the scope ofstrategic fit across the supply chain?


Chapter 17Coordination ina Supply Chain


OutlineLack of Supply Chain Coordination and the

Bullwhip EffectEffect on Performance of Lack of CoordinationObstacles to Coordination in a Supply ChainManagerial Levers to Achieve CoordinationBuilding Strategic Partnerships and Trust Within

a Supply ChainContinuous Replenishment and Vendor-Managed

InventoriesCollaborative Planning, Forecasting, and Replenishment

(CPFR)The Role of IT in CoordinationAchieving Coordination in Practice


Objectives

Describe supply chain coordination, the bullwhipeffect, and their impact on performanceIdentify obstacles to coordination in a supply chainDiscuss managerial levers that help achieve

coordination in a supply chainDescribe actions that facilitate the building of strategic

partnerships and trust within a supply chainUnderstand the different forms of CPFR possible in a

supply chain


Lack of Supply Chain Coordinationand the Bullwhip Effect

Supply chain coordination – all stages in the supplychain take actions together (usually results in greatertotal supply chain profits)SC coordination requires that each stage take into

account the effects of its actions on the other stagesLack of coordination results when:

– Objectives of different stages conflict or– Information moving between stages is distorted


Bullwhip Effect

Fluctuations in orders increase as they move upthe supply chain from retailers to wholesalers tomanufacturers to suppliers (shown in Figure 16.1)Distorts demand information within the supply

chain, where different stages have very differentestimates of what demand looks likeResults in a loss of supply chain coordinationExamples: Proctor & Gamble (Pampers); HP

(printers); Barilla (pasta)


The Effect on Performance of Lack ofCoordination

Manufacturing cost (increases)Inventory cost (increases)Replenishment lead time (increases)Transportation cost (increases)Labor cost for shipping and receiving (increases)Level of product availability (decreases)Relationships across the supply chain (worsens)Profitability (decreases)The bullwhip effect reduces supply chain profitability

by making it more expensive to provide a given levelof product availability


Obstacles to Coordinationin a Supply Chain

Incentive Obstacles

Information Processing Obstacles

Operational Obstacles

Pricing Obstacles

Behavioral Obstacles


Incentive Obstacles

When incentives offered to different stages orparticipants in a supply chain lead to actions thatincrease variability and reduce total supply chainprofits – misalignment of total supply chainobjectives and individual objectives

Local optimization within functions or stages of asupply chain

Sales force incentives


Information Processing Obstacles

When demand information is distorted as it movesbetween different stages of the supply chain,leading to increased variability in orders withinthe supply chainForecasting based on orders, not customer

demand– Forecasting demand based on orders magnifies demand

fluctuations moving up the supply chain from retailerto manufacturer

Lack of information sharing


Operational Obstacles

Actions taken in the course of placing and fillingorders that lead to an increase in variability

Ordering in large lots (much larger than dictatedby demand) – Figure 17.2

Large replenishment lead times

Rationing and shortage gaming (common in thecomputer industry because of periodic cycles ofcomponent shortages and surpluses)


Pricing Obstacles

When pricing policies for a product lead to anincrease in variability of orders placed

Lot-size based quantity decisions

Price fluctuations (resulting in forward buying) –Figure 17.3


Behavioral ObstaclesProblems in learning, often related to communication in the

supply chain and how the supply chain is structuredEach stage of the supply chain views its actions locally and is

unable to see the impact of its actions on other stagesDifferent stages react to the current local situation rather than

trying to identify the root causesBased on local analysis, different stages blame each other for

the fluctuations, with successive stages becoming enemiesrather than partners

No stage learns from its actions over time because the mostsignificant consequences of the actions of any one stage occurelsewhere, resulting in a vicious cycle of actions and blame

Lack of trust results in opportunism, duplication of effort, andlack of information sharing


Managerial Levers toAchieve Coordination

Aligning Goals and Incentives

Improving Information Accuracy

Improving Operational Performance

Designing Pricing Strategies to Stabilize Orders

Building Strategic Partnerships and Trust



Align incentives so that each participant has anincentive to do the things that will maximize totalsupply chain profits

Align incentives across functions

Pricing for coordination

Alter sales force incentives from sell-in (to theretailer) to sell-through (by the retailer)



Sharing point of sale data

Collaborative forecasting and planning

Single stage control of replenishment– Continuous replenishment programs (CRP)

– Vendor managed inventory (VMI)


Improving Operational PerformanceReducing replenishment lead time

– Reduces uncertainty in demand– EDI is useful

Reducing lot sizes– Computer-assisted ordering, B2B exchanges– Shipping in LTL sizes by combining shipments– Technology and other methods to simplify receiving– Changing customer ordering behavior

Rationing based on past sales and sharing information tolimit gaming– “Turn-and-earn”– Information sharing


Designing Pricing Strategiesto Stabilize Orders

Encouraging retailers to order in smaller lots and reduceforward buyingMoving from lot size-based to volume-based quantity

discounts (consider total purchases over a specified timeperiod)Stabilizing pricing

– Eliminate promotions (everyday low pricing, EDLP)– Limit quantity purchased during a promotion– Tie promotion payments to sell-through rather than amount

purchased

Building strategic partnerships and trust – easier toimplement these approaches if there is trust


Building Strategic Partnershipsand Trust in a Supply Chain

Background

Designing a Relationship with Cooperation andTrust

Managing Supply Chain Relationships forCooperation and Trust


Building Strategic Partnershipsand Trust in a Supply Chain

Trust-based relationship– Dependability– Leap of faith

Cooperation and trust work because:– Alignment of incentives and goals– Actions to achieve coordination are easier to implement– Supply chain productivity improves by reducing

duplication or allocation of effort to appropriate stage– Greater information sharing results


Trust in the Supply Chain

Table 17.2 shows benefits

Historically, supply chain relationships are basedon power or trust

Disadvantages of power-based relationship:– Results in one stage maximizing profits, often at the

expense of other stages

– Can hurt a company when balance of power changes

– Less powerful stages have sought ways to resist


Building Trust into aSupply Chain Relationship

Deterrence-based view– Use formal contracts

– Parties behave in trusting manner out of self-interest

Process-based view– Trust and cooperation are built up over time as a result

of a series of interactions

– Positive interactions strengthen the belief incooperation of other party

Neither view holds exclusively in all situations


Building Trust into aSupply Chain Relationship

Initially more reliance on deterrence-based view,then evolves to a process-based view

Co-identification: ideal goal

Two phases to a supply chain relationship– Design phase

– Management phase


Designing a Relationshipwith Cooperation and Trust

Assessing the value of the relationship and itscontributions

Identifying operational roles and decision rightsfor each party

Creating effective contracts

Designing effective conflict resolutionmechanisms


Assessing the Value of theRelationship and its Contributions

Identify the mutual benefit provided

Identify the criteria used to evaluate therelationship (equity is important)

Important to share benefits equitably

Clarify contribution of each party and the benefitseach party will receive


Identifying Operational Roles andDecision Rights for Each Party

Recognize interdependence between parties– Sequential interdependence: activities of one partner

precede the other– Reciprocal interdependence: the parties come together,

exchange information and inputs in both directions

Sequential interdependence is the traditionalsupply chain formReciprocal interdependence is more difficult but

can result in more benefitsFigure 17.4


Effects of Interdependence on SupplyChain Relationships (Figure 17.4)

Org

aniz

atio

n’s D

epen

denc

e

High

Low

Partner’s Dependence

Low High

PartnerRelativelyPowerful

OrganizationRelativelyPowerful

High Level ofInterdependence

Effective Relationship

Low Level ofInterdependence


Creating Effective Contracts

Create contracts that encourage negotiation whenunplanned contingencies arise

It is impossible to define and plan for everypossible occurrence

Informal relationships and agreements can fill inthe “gaps” in contractsInformal arrangements may eventually be

formalized in later contracts


Designing Effective ConflictResolution Mechanisms

Initial formal specification of rules and guidelinesfor procedures and transactions

Regular, frequent meetings to promotecommunication

Courts or other intermediaries


Managing Supply Chain Relationshipsfor Cooperation and Trust

Effective management of a relationship isimportant for its success

Top management is often involved in the designbut not management of a relationship

Figure 17.5 -- process of alliance evolution

Perceptions of reduced benefits or opportunisticactions can significantly impair a supply chainpartnership


Continuous Replenishment andVendor-Managed Inventories

A single point of replenishment

CRP – wholesaler or manufacturer replenishes basedon POS data

VMI – manufacturer or supplier is responsible for alldecisions regarding inventory

Substitutes

17-30


Collaborative Planning, Forecasting,and Replenishment (CPFR)

Sellers and buyers in a supply chain may collaboratealong any or all of the following:– Strategy and planning

– Demand and supply management

– Execution

– Analysis

Organizational and Technology requirements

Risks and Hurdles for a CPFR implementation

17-31


The Role of IT in CoordinationEnablement of coordination the ultimate goal

Information availability

Use of information available to make decisions

ERP and best-of-breed vendors

17-32


Achieving Coordination in Practice

Quantify the bullwhip effectGet top management commitment for coordinationDevote resources to coordinationFocus on communication with other stagesTry to achieve coordination in the entire supply chain

networkUse technology to improve connectivity in the supply

chainShare the benefits of coordination equitably



What are supply chain coordination and the bullwhipeffect, and what are their effects on supply chainperformance?What are obstacles to coordination in the supply

chain?What are the managerial levers that help achieve

coordination in the supply chain?What are actions that facilitate the building of

strategic partnerships and trust in the supply chain?What are the different forms of CPFR available in a

supply chain?


Chapter 16InformationTechnologyin a Supply

Chain


Outline

The Role of IT in a Supply ChainThe Supply Chain IT FrameworkCustomer Relationship ManagementInternal Supply Chain ManagementSupplier Relationship ManagementThe Transaction Management FoundationThe Future of IT in the Supply ChainRisk Management in ITSupply Chain IT in Practice


Role of ITin a Supply Chain

Information is the driver that serves as the “glue” to create acoordinated supply chain

Information must have the following characteristics to beuseful:

– Accurate

– Accessible in a timely manner

– Information must be of the right kind

Information provides the basis for supply chain managementdecisions

– Inventory

– Transportation

– Facility


Characteristics of UsefulSupply Chain Information

Accurate

Accessible in a timely manner

The right kind

Shared

Provides supply chain visibility


Use of Informationin a Supply Chain

Information used at all phases of decision making:strategic, planning, operational

Examples:– Strategic: location decisions

– Operational: what products will be produced duringtoday’s production run


Use of Informationin a Supply Chain

Inventory: demand patterns, carrying costs,stockout costs, ordering costs

Transportation: costs, customer locations,shipment sizes

Facility: location, capacity, schedules of a facility;need information about trade-offs betweenflexibility and efficiency, demand, exchange rates,taxes, etc.


Role of Information Technologyin a Supply Chain

Information technology (IT)– Hardware and software used throughout the supply

chain to gather and analyze information

– Captures and delivers information needed to makegood decisions

Effective use of IT in the supply chain can have asignificant impact on supply chain performance


The Importance of Informationin a Supply Chain

Relevant information available throughout thesupply chain allows managers to make decisionsthat take into account all stages of the supplychain

Allows performance to be optimized for the entiresupply chain, not just for one stage – leads tohigher performance for each individual firm in thesupply chain


The Supply Chain IT Framework

The Supply Chain Macro Processes– Customer Relationship Management (CRM)

– Internal Supply Chain Management (ISCM)

– Supplier Relationship Management (SRM)

– Plus: Transaction Management Foundation

– Figure 16.1

Why Focus on the Macro Processes?

Macro Processes Applied to the Evolution of Software


Macro Processes in a Supply Chain(Figure 16.1)

SupplierRelationshipManagement

(SRM)

InternalSupply ChainManagement

(ISCM)

CustomerRelationshipManagement

(CRM)

Transaction Management Foundation (TFM)


Customer Relationship Management

The processes that take place between an enterpriseand its customers downstream in the supply chain

Key processes:– Marketing

– Selling

– Order management

– Call/Service center


Internal Supply Chain Management

Includes all processes involved in planning for andfulfilling a customer order

ISCM processes:– Strategic Planning

– Demand Planning

– Supply Planning

– Fulfillment

– Field Service

There must be strong integration between the ISCMand CRM macro processes


Supplier Relationship Management

Those processes focused on the interaction betweenthe enterprise and suppliers that are upstream in thesupply chainKey processes:

– Design Collaboration– Source– Negotiate– Buy– Supply Collaboration

There is a natural fit between ISCM and SRMprocesses


The Transaction ManagementFoundation

Enterprise software systems (ERP)

Earlier systems focused on automation of simpletransactions and the creation of an integrated methodof storing and viewing data across the enterprise

Real value of the TMF exists only if decision makingis improved

The extent to which the TMF enables integrationacross the three macro processes determines its value


The Future of IT in the Supply Chain

At the highest level, the three SCM macro processeswill continue to drive the evolution of enterprisesoftwareSoftware focused on the macro processes will become

a larger share of the total enterprise software marketand the firms producing this software will becomemore successfulFunctionality, the ability to integrate across macro

processes, and the strength of their ecosystems, willbe keys to success


Risk Management in ITInstalling new systems

Revised business processes

Integration

Software glitches

Power outages

Viruses

16-16


Supply Chain InformationTechnology in Practice

Select an IT system that addresses the company’s keysuccess factors

Take incremental steps and measure value

Align the level of sophistication with the need forsophistication

Use IT systems to support decision making, not tomake decisions

Think about the future



What is the importance of information and IT in thesupply chain?

How does each supply chain driver use information?

What are the major applications of supply chain ITand what processes do they enable?


Chapter 15Pricing and

RevenueManagement in

the Supply Chain


OutlineThe Role of Pricing and Revenue Management in a Supply

Chain

Pricing and Revenue Management for Multiple CustomerSegments

Pricing and Revenue Management for Perishable Assets

Pricing and Revenue Management for Seasonable Demand

Pricing and Revenue Management for Bulk and SpotCustomers

The Role of IT in Pricing and Revenue Management

Using Pricing and Revenue Management in Practice



The Role of Pricing and RevenueManagement in the Supply ChainRevenue management is the use of pricing to increase

the profit generated from a limited supply of supplychain assets

Supply assets exist in two forms: capacity andinventory

Revenue management may also be defined as the useof differential pricing based on customer segment,time of use, and product or capacity availability toincrease supply chain profits

Most common example is probably in airline pricing


Conditions Under Which RevenueManagement Has the Greatest Effect

The value of the product varies in different marketsegments (Example: airline seats)The product is highly perishable or product waste

occurs (Example: fashion and seasonal apparel)Demand has seasonal and other peaks (Example:

products ordered at Amazon.com)The product is sold both in bulk and on the spot

market (Example: owner of warehouse who candecide whether to lease the entire warehouse throughlong-term contracts or save a portion of thewarehouse for use in the spot market)


Pricing and Revenue Management forMultiple Customer Segments

If a supplier serves multiple customer segments witha fixed asset, the supplier can improve revenues bysetting different prices for each segment

Prices must be set with barriers such that the segmentwilling to pay more is not able to pay the lower price

The amount of the asset reserved for the higher pricesegment is such that the expected marginal revenuefrom the higher priced segment equals the price of thelower price segment


Pricing and Revenue Management forMultiple Customer Segments

pL = the price charged to the lower price segment

pH = the price charged to the higher price segment

DH = mean demand for the higher price segment

σH = standard deviation of demand for the higher price segment

CH = capacity reserved for the higher price segment

RH(CH) = expected marginal revenue from reserving morecapacity

= Probability(demand from higher price segment > CH) x pH

RH(CH) = pL

Probability(demand from higher price segment > CH) = pL / pH

CH = F-1(1- pL/pH, DH,σH) = NORMINV(1- pL/pH, DH,σH)


Example 15.2: ToFrom TruckingRevenue from segment A = pA = $3.50 per cubic ftRevenue from segment B = pB = $3.50 per cubic ftMean demand for segment A = DA = 3,000 cubic ftStd dev of segment A demand = σA = 1,000 cubic ftCA = NORMINV(1- pB/pA, DA,σA)

= NORMINV(1- (2.00/3.50), 3000, 1000)= 2,820 cubic ft

If pA increases to $5.00 per cubic foot, thenCA = NORMINV(1- pB/pA, DA,σA)

= NORMINV(1- (2.00/5.00), 3000, 1000)= 3,253 cubic ft


Pricing and Revenue Managementfor Perishable Assets

Any asset that loses value over time is perishable

Examples: high-tech products such as computers andcell phones, high fashion apparel, underutilizedcapacity, fruits and vegetables

Two basic approaches:– Vary price over time to maximize expected revenue

– Overbook sales of the asset to account for cancellations



Overbooking or overselling of a supply chain asset isvaluable if order cancellations occur and the asset isperishable

The level of overbooking is based on the trade-offbetween the cost of wasting the asset if too manycancellations lead to unused assets and the cost ofarranging a backup if too few cancellations lead tocommitted orders being larger than the availablecapacity



p = price at which each unit of the asset is sold

c = cost of using or producing each unit of the asset

b = cost per unit at which a backup can be used in thecase of asset shortage

Cw = p – c = marginal cost of wasted capacity

Cs = b – c = marginal cost of a capacity shortage

O* = optimal overbooking level

s* = Probability(cancellations < O*) = Cw / (Cw + Cs)



If the distribution of cancellations is known to be normalwith mean µc and standard deviation σc then

O* = F-1(s*, µc, σc) = NORMINV(s*, µc, σc)If the distribution of cancellations is known only as a

function of the booking level (capacity L +overbooking O) to have a mean of µ(L+O) and stddeviation of σ(L+O), the optimal overbooking level isthe solution to the following equation:

O = F-1(s*,µ (L+O),σ(L+O))= NORMINV(s*,µ (L+O),σ(L+O))


Example 15.5 - OverbookingCost of wasted capacity = Cw = $10 per dress

Cost of capacity shortage = Cs = $5 per dress

s* = Cw / (Cw + Cs) = 10/(10+5) = 0.667

µc = 800; σc = 400

O* = NORMINV(s*, µc,σc)

= NORMINV(0.667,800,400) = 973

If the mean is 15% of the booking level and the coefficient ofvariation is 0.5, then the optimal overbooking level is thesolution of the following equation:

O = NORMINV(0.667,0.15(5000+O),0.075(5000+O))

Using Excel Solver, O* = 1,115


Pricing and Revenue Managementfor Seasonal Demand

Seasonal peaks of demand are common in many supplychains

Examples: Most retailers achieve a large portion oftotal annual demand in December (Amazon.com)

Off-peak discounting can shift demand from peak tonon-peak periods

Charge higher price during peak periods and a lowerprice during off-peak periods


Pricing and Revenue Management forBulk and Spot Customers

Most consumers of production, warehousing, andtransportation assets in a supply chain face the problem ofconstructing a portfolio of long-term bulk contracts andshort-term spot market contracts

The basic decision is the size of the bulk contract

The fundamental trade-off is between wasting a portion ofthe low-cost bulk contract and paying more for the asset onthe spot market

Given that both the spot market price and the purchaser’sneed for the asset are uncertain, a decision tree approach asdiscussed in Chapter 6 should be used to evaluate theamount of long-term bulk contract to sign



For the simple case where the spot market price is knownbut demand is uncertain, a formula can be used

cB = bulk ratecS = spot market priceQ* = optimal amount of the asset to be purchased in bulkp* = probability that the demand for the asset does not

exceed Q*Marginal cost of purchasing another unit in bulk is cB.

The expected marginal cost of not purchasing anotherunit in bulk and then purchasing it in the spot market is(1-p*)cS.



If the optimal amount of the asset is purchased in bulk,the marginal cost of the bulk purchase should equal theexpected marginal cost of the spot market purchase, orcB = (1-p*)cS

Solving for p* yields p* = (cS – cB) / cS

If demand is normal with mean µ and std deviation σ, theoptimal amount Q* to be purchased in bulk is

Q* = F-1(p*,µ,σ) = NORMINV(p*,µ,σ)


Example 15.6 – Long-term BulkContracts versus the Spot Market

Bulk contract cost = cB = $10,000 per million units

Spot market cost = cS = $12,500 per million units

µ = 10 million units

σ = 4 million units

p* = (cS – cB) / cS = (12,500 – 10,000) / 12,500 = 0.2

Q* = NORMINV(p*,µ,σ) = NORMINV(0.2,10,4) = 6.63

The manufacturer should sign a long-term bulk contractfor 6.63 million units per month and purchase anytransportation capacity beyond that on the spot market


The Role of IT in Pricing andRevenue Management

Pricing of perishable assets

Pricing of retail goods in the consumer packaged-goods category

Mark downs of goods as the styles and seasonschange

Linking with other areas and applications

15-18


Using Pricing and RevenueManagement in Practice

Evaluate your market carefully

Quantify the benefits of revenue management

Implement a forecasting process

Apply optimization to obtain the revenuemanagement decision

Involve both sales and operations

Understand and inform the customer

Integrate supply planning with revenuemanagement



What is the role of revenue management in asupply chain?

Under what conditions are revenue managementtactics effective?

What are the trade-offs that must be consideredwhen making revenue management decisions?


Chapter 14Sourcing

Decisions in aSupply Chain


Outline The Role of Sourcing in a Supply Chain

In-House or Outsource

Third- and Fourth-Party Logistics Providers

Supplier Scoring and Assessment

Supplier Selection – Auctions and Negotiations

Contracts, risk Sharing, and Supply Chain Performance

Design Collaboration

The Procurement Process

Sourcing Planning and Analysis

The Role of IT in Sourcing

Risk Management in sourcing

Making Sourcing Decisions in Practice



The Role of Sourcingin a Supply Chain

Sourcing is the set of business processes requiredto purchase goods and services

Sourcing processes include:– Supplier scoring and assessment

– Supplier selection and contract negotiation

– Design collaboration

– Procurement

– Sourcing planning and analysis


Benefits of EffectiveSourcing Decisions

Better economies of scale can be achieved if ordersare aggregated

More efficient procurement transactions cansignificantly reduce the overall cost of purchasing

Design collaboration can result in products that areeasier to manufacture and distribute, resulting inlower overall costs

Good procurement processes can facilitatecoordination with suppliers

Appropriate supplier contracts can allow for thesharing of risk

Firms can achieve a lower purchase price byincreasing competition through the use of auctions


Supplier Scoring and AssessmentSupplier performance should be compared on the

basis of the supplier’s impact on total costThere are several other factors besides purchase price

that influence total cost

14-5


Supplier Assessment FactorsReplenishment Lead Time

On-Time Performance

Supply Flexibility

Delivery Frequency /Minimum Lot Size

Supply Quality

Inbound Transportation Cost

Pricing Terms

Information CoordinationCapability

Design CollaborationCapability

Exchange Rates, Taxes,Duties

Supplier Viability


Supplier Selection- Auctions andNegotiations

Supplier selection can be performed through competitivebids, reverse auctions, and direct negotiations

Supplier evaluation is based on total cost of using asupplier

Auctions:– Sealed-bid first-price auctions

– English auctions

– Dutch auctions

– Second-price (Vickery) auctions


Contracts and Supply ChainPerformance

Contracts for Product Availability and SupplyChain Profits– Buyback Contracts

– Revenue-Sharing Contracts

– Quantity Flexibility Contracts

Contracts to Coordinate Supply Chain Costs

Contracts to Increase Agent Effort

Contracts to Induce Performance Improvement


Contracts for Product Availabilityand Supply Chain Profits

Many shortcomings in supply chain performance occurbecause the buyer and supplier are separate organizationsand each tries to optimize its own profit

Total supply chain profits might therefore be lower than ifthe supply chain coordinated actions to have a commonobjective of maximizing total supply chain profits

Recall Chapter 10: double marginalization results insuboptimal order quantity

An approach to dealing with this problem is to design acontract that encourages a buyer to purchase more andincrease the level of product availability

The supplier must share in some of the buyer’s demanduncertainty, however


Contracts for Product Availability andSupply Chain Profits: Buyback ContractsAllows a retailer to return unsold inventory up to a

specified amount at an agreed upon priceIncreases the optimal order quantity for the retailer,

resulting in higher product availability and higher profitsfor both the retailer and the supplier

Most effective for products with low variable cost, such asmusic, software, books, magazines, and newspapers

Downside is that buyback contract results in surplusinventory that must be disposed of, which increases supplychain costs

Can also increase information distortion through thesupply chain because the supply chain reacts to retailorders, not actual customer demand


Contracts for Product Availability and SupplyChain Profits: Revenue Sharing Contracts

The buyer pays a minimal amount for each unitpurchased from the supplier but shares a fraction ofthe revenue for each unit sold

Decreases the cost per unit charged to the retailer,which effectively decreases the cost of overstocking

Can result in supply chain information distortion,however, just as in the case of buyback contracts


Contracts for Product Availability and SupplyChain Profits: Quantity Flexibility Contracts

Allows the buyer to modify the order (within limits)as demand visibility increases closer to the point ofsale

Better matching of supply and demand

Increased overall supply chain profits if the supplierhas flexible capacity

Lower levels of information distortion than eitherbuyback contracts or revenue sharing contracts


Contracts to CoordinateSupply Chain Costs

Differences in costs at the buyer and supplier can leadto decisions that increase total supply chain costsExample: Replenishment order size placed by the

buyer. The buyer’s EOQ does not take into accountthe supplier’s costs.A quantity discount contract may encourage the buyer

to purchase a larger quantity (which would be lowercosts for the supplier), which would result in lowertotal supply chain costsQuantity discounts lead to information distortion

because of order batching


Contracts to Increase Agent Effort

There are many instances in a supply chain where anagent acts on the behalf of a principal and the agent’sactions affect the reward for the principal

Example: A car dealer who sells the cars of amanufacturer, as well as those of other manufacturers

Examples of contracts to increase agent effort includetwo-part tariffs and threshold contracts

Threshold contracts increase information distortion,however


Contracts to InducePerformance Improvement

A buyer may want performance improvement from asupplier who otherwise would have little incentive todo so

A shared savings contract provides the supplier witha fraction of the savings that result from theperformance improvement

Particularly effective where the benefit fromimprovement accrues primarily to the buyer, butwhere the effort for the improvement comes primarilyfrom the supplier


Design Collaboration50-70 percent of spending at a manufacturer is

through procurement80 percent of the cost of a purchased part is fixed in

the design phaseDesign collaboration with suppliers can result in

reduced cost, improved quality, and decreased time tomarketImportant to employ design for logistics, design for

manufacturabilityManufacturers must become effective design

coordinators throughout the supply chain


The Procurement ProcessThe process in which the supplier sends product in response to

orders placed by the buyerGoal is to enable orders to be placed and delivered on schedule

at the lowest possible overall costTwo main categories of purchased goods:

– Direct materials: components used to make finished goods– Indirect materials: goods used to support the operations of a firm– Differences between direct and indirect materials listed in Table 13.2

Focus for direct materials should be on improving coordinationand visibility with supplier

Focus for indirect materials should be on decreasing thetransaction cost for each order

Procurement for both should consolidate orders where possibleto take advantage of economies of scale and quantity discounts


Product Categorization by Valueand Criticality (Figure 14.2)

Critical Items Strategic Items

General Items Bulk PurchaseItems

Low

Low

High

HighValue/Cost

Cri

tical

ity


Sourcing Planning and AnalysisA firm should periodically analyze its procurement

spending and supplier performance and use thisanalysis as an input for future sourcing decisionsProcurement spending should be analyzed by part and

supplier to ensure appropriate economies of scaleSupplier performance analysis should be used to build

a portfolio of suppliers with complementary strengths– Cheaper but lower performing suppliers should be used to

supply base demand– Higher performing but more expensive suppliers should be

used to buffer against variation in demand and supply fromthe other source


The Role of IT in SourcingDesign collaboration

Negotiate

Buy

Supply collaboration

14-20


Risk Management in SourcingSupply disruption

Increased procurement costs

Intellectual property

14-21


Making SourcingDecisions in Practice

Use multifunction teams

Ensure appropriate coordination across regionsand business units

Always evaluate the total cost of ownership

Build long-term relationships with key suppliers


Summary of Learning ObjectivesWhat is the role of sourcing in a supply chain?

What factors affect the decision to outsource a supplychain function?

What dimensions of supplier performance affect totalcost?

How do you structure successful auctions andnegotiations?

What is the impact of risk sharing on supplier performanceand information distortion?

What are different categories of purchased products andservices? What is the desired focus for procurement foreach of these categories?


Chapter 12Determining theOptimal Level of

ProductAvailability


OutlineThe importance of the level of product availabilityFactors affecting the optimal level of product

availabilityManagerial levers to improve supply chain

profitabilitySetting product availability for multiple products

under capacity constraintsSetting optimal levels of product availability in

practice


Importance of the Levelof Product Availability

Product availability measured by cycle service level or fill rateAlso referred to as the customer service levelProduct availability affects supply chain responsivenessTrade-off:

– High levels of product availability increased responsiveness andhigher revenues

– High levels of product availability increased inventory levels andhigher costs

Product availability is related to profit objectives, and strategicand competitive issues (e.g., Nordstrom, power plants,supermarkets, e-commerce retailers)

What is the level of fill rate or cycle service level that willresult in maximum supply chain profits?


Factors Affecting the OptimalLevel of Product Availability

Cost of overstocking

Cost of under stocking

Possible scenarios– Seasonal items with a single order in a season

– One-time orders in the presence of quantity discounts

– Continuously stocked items

– Demand during stock out is backlogged

– Demand during stock out is lost


Managerial Levers to ImproveSupply Chain Profitability

“Obvious” actions– Increase salvage value of each unit

– Decrease the margin lost from a stockout

Improved forecasting

Quick response

Postponement

Tailored sourcing


Improved Forecasts

Improved forecasts result in reduced uncertainty

Less uncertainty (lower σR) results in either:– Lower levels of safety inventory (and costs) for the same

level of product availability, or

– Higher product availability for the same level of safetyinventory, or

– Both lower levels of safety inventory and higher levels ofproduct availability

An increase in forecast accuracy decreases both the overstocked andunderstocked quantity and increases a firm’s profits.


Impact of Improving Forecasts(Example)

Demand: Normally distributed with a mean of R =350 and standard deviation of R = 100

Purchase price = $100

Retail price = $250

Disposal value = $85

Holding cost for season = $5

How many units should be ordered as R changes?


Impact of Improving ForecastsR O* Expected

OverstockExpected

UnderstockExpected

Profit150 526 186.7 8.6 $47,469

120 491 149.3 6.9 $48,476

90 456 112.0 5.2 $49,482

60 420 74.7 3.5 $50,488

30 385 37.3 1.7 $51,494

0 350 0 0 $52,500


Quick Response Set of actions taken by managers to reduce lead time Reduced lead time results in improved forecasts

– Typical example of quick response is multiple orders in one season for retailitems (such as fashion clothing)

– For example, a buyer can usually make very accurate forecasts after the firstweek or two in a season

– Multiple orders are only possible if the lead time is reduced – otherwisethere wouldn’t be enough time to get the later orders before the season ends

Benefits:– Lower order quantities less inventory, same product availability– Less overstock– Higher profits

If quick response allows multiple orders in the season, profitsincrease and the overstock quantity decreases.


Quick Response: MultipleOrders Per Season

Ordering shawls at a department store– Selling season = 14 weeks

– Cost per handbag = $40

– Sale price = $150

– Disposal price = $30

– Holding cost = $2 per week

Expected weekly demand = 20

SD of weekly demand = 15


Impact of Quick ResponseSingle Order Two Orders in Season

ServiceLevel

OrderSize

EndingInvent.

Expect.Profit

InitialOrder

OULfor 2nd

Order

AverageTotalOrder

EndingInvent.

Expect.Profit

0.96 378 97 $23,624 209 209 349 69 $26,590

0.94 367 86 $24,034 201 201 342 60 $27,085

0.91 355 73 $24,617 193 193 332 52 $27,154

0.87 343 66 $24,386 184 184 319 43 $26,944

0.81 329 55 $24,609 174 174 313 36 $27,413

0.75 317 41 $25,205 166 166 302 32 $26,916


Forecast Improves for SecondOrder (SD=3 Instead of 15)

Single Order Two Orders in SeasonServiceLevel

OrderSize

EndingInvent.

Expect.Profit

InitialOrder

OULfor 2nd

Order

AverageTotalOrder

EndingInvent.

Expect.Profit

0.96 378 96 $23,707 209 153 292 19 $27,007

0.94 367 84 $24,303 201 152 293 18 $27,371

0.91 355 76 $24,154 193 150 288 17 $26,946

0.87 343 63 $24,807 184 148 288 14 $27,583

0.81 329 52 $24,998 174 146 283 14 $27,162

0.75 317 44 $24,887 166 145 282 14 $27,268


Postponement Delay of product differentiation until closer to the time of the sale of the

product All activities prior to product differentiation require aggregate forecasts

more accurate than individual product forecasts Individual product forecasts are needed close to the time of sale –

demand is known with better accuracy (lower uncertainty) Results in a better match of supply and demand Valuable in e-commerce – time lag between when an order is placed and

when customer receives the order (this delay is expected by thecustomer and can be used for postponement)

Higher profits, better match of supply and demand

Postponement allows a firm to increase profits and better match supply and demandif the firm produces a large variety of products whose demand is not positivelycorrelated and is of about the same size.


Value of Postponement: Benetton

For each color– Mean demand = 1,000; SD = 500

For each garment– Sale price = $50– Salvage value = $10– Production cost using Option 1 (long lead time) = $20– Production cost using Option 2 (uncolored thread) = $22

What is the value of postponement?– Expected profit increases from $94,576 to $98,092


Value of Postponementwith Dominant Product

Color with dominant demand: Mean = 3,100, SD = 800

Other three colors: Mean = 300, SD = 200

Expected profit without postponement = $102,205

Expected profit with postponement = $99,872


Tailored Postponement: BenettonProduce Q1 units for each color using Option 1 and QA

units (aggregate) using Option 2

Results:

– Q1 = 800

– QA = 1,550

– Profit = $104,603

Tailored postponement allows a firm to increaseprofits by postponing differentiation only for productswith the most uncertain demand; products with morepredictable demand are produced at lower cost withoutpostponement


Tailored Sourcing

A firm uses a combination of two supply sourcesOne is lower cost but is unable to deal with

uncertainty wellThe other is more flexible, and can therefore deal

with uncertainty, but is higher costThe two sources must focus on different capabilitiesDepends on being able to have one source that faces

very low uncertainty and can therefore reduce costsIncrease profits, better match supply and demand


Tailored Sourcing

Sourcing alternatives– Low cost, long lead time supplier

» Cost = $245, Lead time = 9 weeks

– High cost, short lead time supplier» Cost = $250, Lead time = 1 week


Tailored Sourcing StrategiesFraction of demand fromoverseas supplier

Annual Profit

0% $37,250

50% $51,613

60% $53,027

100% $48,875


Tailored Sourcing: MultipleSourcing Sites

Characteristic Primary Site Secondary Site

ManufacturingCost

High Low

Flexibility(Volume/Mix)

High Low

Responsiveness High Low

EngineeringSupport

High Low


Dual Sourcing Strategies

Strategy Primary Site Secondary Site

Volume baseddual sourcing

Fluctuation Stable demand

Product baseddual sourcing

Unpredictableproducts,Small batch

Predictable,large batchproducts

Model baseddual sourcing

Newerproducts

Older stableproducts


Setting Product Availability for MultipleProducts under Capacity Constraints

Single product order

Multiple product order

Decrease the order size

Allocating the products

When ordering multiple products under a limited supply capacity,the allocation of capacity to products should be based on theirexpected marginal contribution to profits. This approach allocates arelatively higher fraction of capacity to products that have a highmargin relative to their cost of overstocking.


Setting Optimal Levels ofProduct Availability in Practice

Use an analytical framework to increase profits

Beware of preset levels of availability

Use approximate costs because profit-maximizingsolutions are very robust

Estimate a range for the cost of stocking out

Ensure levels of product availability fit with thestrategy


Strategic Capital AssetsMaintenance Support

MRO inventory policies in support of StrategicCapital Assets are governed by stochastic, economicand sourcing considerations. How can companies andorganisations holding such assets ensure minimaldowntimes while keeping inventory carrying andobsolescence costs under control?



What are the factors affecting the optimal level ofproduct availability?How is the optimal cycle service level estimated?What are the managerial levers that can be used to

improve supply chain profitability throughoptimal service levels?How can contracts be structured to increase

supply chain profitability?


Chapter 13Transportation

in a SupplyChain


OutlineThe role of transportation in the supply chain

Factors affecting transportation decisions

Modes of transportation and their performancecharacteristics

Transportation infrastructure and policies

Design options for a transportation network

Trade-offs in transportation design

Tailored transportation

The role of IT in transportation

Risk management in transportation

Making transportation decisions in practice


Factors AffectingTransportation Decisions

Carrier (party that moves or transports the product)– Vehicle-related cost

– Fixed operating cost

– Trip-related cost

Shipper (party that requires the movement of theproduct between two points in the supply chain)– Transportation cost

– Inventory cost

– Facility cost


Transportation ModesTrucks

– TL

– LTL

Rail

Air

Package Carriers

Water

Pipeline


Truckload (TL)

Average revenue per ton mile (1996) = 9.13 cents

Average haul = 274 miles

Average Capacity = 42,000 - 50,000 lb.

Low fixed and variable costs

Major Issues– Utilization

– Consistent service

– Backhauls


Less Than Truckload (LTL)Average revenue per ton-mile (1996) = 25.08

cents


Higher fixed costs (terminals) and low variablecosts

Major issues:– Location of consolidation facilities

– Utilization

– Vehicle routing

– Customer service


Rail

Average revenue / ton-mile (1996) = 2.5 cents


Average load = 80 tons

Key issues:– Scheduling to minimize delays / improve service

– Off-track delays (at pickup and delivery end)

– Yard operations

– Variability of delivery times


Air

Key issues:– Location/number of hubs

– Location of fleet bases/crew bases

– Schedule optimization

– Fleet assignment

– Crew scheduling

– Yield management


Package CarriersCompanies like FedEx, UPS, USPS, that carry small

packages ranging from letters to shipments of about 150pounds

Expensive

Rapid and reliable delivery

Small and time-sensitive shipments

Preferred mode for e-businesses (e.g., Amazon, Dell,McMaster-Carr)

Consolidation of shipments (especially important forpackage carriers that use air as a primary method oftransport)


Water

Limited to certain geographic areas

Ocean, inland waterway system, coastal waters

Very large loads at very low cost

Slowest

Dominant in global trade (autos, grain, apparel, etc.)


Pipeline

High fixed cost

Primarily for crude petroleum, refined petroleumproducts, natural gas

Best for large and predictable demand

Would be used for getting crude oil to a port orrefinery, but not for getting refined gasoline to agasoline station (why?)


IntermodalUse of more than one mode of transportation to move a

shipment to its destinationMost common example: rail/truckAlso water/rail/truck or water/truckGrown considerably with increased use of containersIncreased global trade has also increased use of

intermodal transportationMore convenient for shippers (one entity provides the

complete service)Key issue involves the exchange of information to

facilitate transfer between different transport modes


Design Options for aTransportation Network

What are the transportation options? Which one toselect? On what basis?

Direct shipping network

Direct shipping with milk runs

All shipments via central DC

Shipping via DC using milk runs

Tailored network


Trade-offs in Transportation Design

Transportation and inventory cost trade-off– Choice of transportation mode

– Inventory aggregation

Transportation cost and responsiveness trade-off


Choice of Transportation Mode

A manager must account for inventory costs whenselecting a mode of transportation

A mode with higher transportation costs can bejustified if it results in significantly lower inventories


Inventory Aggregation: Inventoryvs. Transportation Cost

As a result of physical aggregation– Inventory costs decrease

– Inbound transportation cost decreases

– Outbound transportation cost increases

Inventory aggregation decreases supply chain costs ifthe product has a high value to weight ratio, highdemand uncertainty, or customer orders are large

Inventory aggregation may increase supply chaincosts if the product has a low value to weight ratio,low demand uncertainty, or customer orders are small


Trade-offs Between TransportationCost and Customer Responsiveness

Temporal aggregation is the process of combiningorders across time

Temporal aggregation reduces transportation costbecause it results in larger shipments and reducesvariation in shipment sizes

However, temporal aggregation reduces customerresponsiveness


Tailored Transportation

The use of different transportation networks andmodes based on customer and product characteristics

Factors affecting tailoring:– Customer distance and density

– Customer size

– Product demand and value


Role of IT in Transportation

The complexity of transportation decisions demandsuse of IT systems

IT software can assist in:– Identification of optimal routes by minimizing costs subject

to delivery constraints

– Optimal fleet utilization

– GPS applications


Risk Management in Transportation

Three main risks to be considered in transportation are:– Risk that the shipment is delayed– Risk of disruptions– Risk of hazardous material

Risk mitigation strategies:– Decrease the probability of disruptions– Alternative routings– In case of hazardous materials the use of modified

containers, low-risk transportation models, modification ofphysical and chemical properties can prove to be effective


Making TransportationDecisions in Practice

Align transportation strategy with competitivestrategy

Consider both in-house and outsourced transportation

Design a transportation network that can handlee-commerce

Use technology to improve transportationperformance

Design flexibility into the transportation network


INDIAN ROAD TRANSPORT

Nature of fleet ownership and scale of operations

Impact of poor infrastructure on sector performance

Physical, organisational, infrastructural, regulatoryand human resource constraints

Dominance of road transport as preferred mode offreight transportation

Features of Indian Road Transport Sector

OM Logistics-Succeeding against Odds

13-22



What is the role of transportation in a supply chain?

What are the strengths and weaknesses of differentmodes of transportation?

What is role of infrastructure and policies intransportation?

What are the different network design options andwhat are their strengths and weaknesses?

What are the trade-offs in transportation networkdesign?


Chapter 11Managing

Uncertainty in theSupply Chain:

Safety Inventory


Role of Inventory in the Supply ChainImprove Matching of Supply

and Demand

Improved Forecasting

Reduce Material Flow Time

Reduce Waiting Time

Reduce Buffer Inventory

Economies of ScaleSupply / Demand

VariabilitySeasonal

Variability

Cycle Inventory Safety InventoryFigure Error! No text of

Seasonal Inventory


Outline

The role of safety inventory in a supply chain

Determining the appropriate level of safety inventory

Impact of supply uncertainty on safety inventory

Impact of aggregation on safety inventory

Impact of replenishment policies on safety inventory

Managing safety inventory in a multi-echelon supplychain

Estimating and managing safety inventory in practice


The Role of Safety Inventoryin a Supply Chain

Forecasts are rarely completely accurate

If average demand is 1000 units per week, then half thetime actual demand will be greater than 1000, and half thetime actual demand will be less than 1000; what happenswhen actual demand is greater than 1000?

If you kept only enough inventory in stock to satisfyaverage demand, half the time you would run out

Safety inventory: Inventory carried for the purpose ofsatisfying demand that exceeds the amount forecasted in agiven period


Role of Safety Inventory

Average inventory is therefore cycle inventory plussafety inventory

There is a fundamental tradeoff:– Raising the level of safety inventory provides higher levels

of product availability and customer service

– Raising the level of safety inventory also raises the level ofaverage inventory and therefore increases holding costs

» Very important in high-tech or other industries where obsolescenceis a significant risk (where the value of inventory, such as PCs, candrop in value)

» Compaq and Dell in PCs


Two Questions to Answer inPlanning Safety Inventory

What is the appropriate level of safety inventoryto carry?

What actions can be taken to improve productavailability while reducing safety inventory?


Determining the AppropriateLevel of Safety Inventory

Measuring demand uncertainty

Measuring product availability

Replenishment policies

Evaluating cycle service level and fill rate

Evaluating safety level given desired cycle servicelevel or fill rate

Impact of required product availability and uncertaintyon safety inventory


Determining the AppropriateLevel of Demand Uncertainty

Appropriate level of safety inventory determined by:– supply or demand uncertainty

– desired level of product availability

Higher levels of uncertainty require higher levels ofsafety inventory given a particular desired level ofproduct availability

Higher levels of desired product availability requirehigher levels of safety inventory given a particularlevel of uncertainty


Measuring Demand UncertaintyDemand has a systematic component and a random component

The estimate of the random component is the measure ofdemand uncertainty

Random component is usually estimated by the standarddeviation of demand

Notation:

D = Average demand per period

σD = standard deviation of demand per period

L = lead time = time between when an order is placed andwhen it is received

Uncertainty of demand during lead time is what is important


Measuring Demand Uncertainty

P = demand during k periods = kD

Ω = std dev of demand during k periods = σRSqrt(k)

Coefficient of variation = cv = µ /σ= mean/(std dev)= size of uncertainty relative to demand


Measuring Product AvailabilityProduct availability: a firm’s ability to fill a

customer’s order out of available inventoryStockout: a customer order arrives when product is not

available

Product fill rate (fr): fraction of demand that issatisfied from product in inventory

Order fill rate: fraction of orders that are filled fromavailable inventory

Cycle service level: fraction of replenishment cyclesthat end with all customer demand met


Replenishment Policies

Replenishment policy: decisions regarding when toreorder and how much to reorder

Continuous review: inventory is continuouslymonitored and an order of size Q is placed when theinventory level reaches the reorder point ROP

Periodic review: inventory is checked at regular(periodic) intervals and an order is placed to raise theinventory to a specified threshold (the “order-up-to”level)


Continuous Review Policy: SafetyInventory and Cycle Service Level

L: Lead time for replenishment

D: Average demand per unittime

D:Standard deviation ofdemand per period

DL: Mean demand during leadtime

L: Standard deviation ofdemand during lead time

CSL: Cycle service level

ss: Safety inventory

ROP: Reorder point

),,(

)(1

LL

L

LS

DL

L

DD

F

D

ROPFCSL

ssROP

CSLss

L

DL

Average Inventory = Q/2 + ss


Example 11.1: Estimating SafetyInventory (Continuous Review Policy)

D = 2,500/week; D = 500

L = 2 weeks; Q = 10,000; ROP = 6,000

DL = DL = (2500)(2) = 5000

ss = ROP - RL = 6000 - 5000 = 1000

Cycle inventory = Q/2 = 10000/2 = 5000

Average Inventory = cycle inventory + ss = 5000 + 1000 = 6000

Average Flow Time = Avg inventory / throughput = 6000/2500 =2.4 weeks


Example 11.2: Estimating Cycle ServiceLevel (Continuous Review Policy)

D = 2,500/week; D = 500

L = 2 weeks; Q = 10,000; ROP = 6,000

Cycle service level, CSL = F(DL + ss, DL, L) =

= NORMDIST (DL + ss, DL, L) = NORMDIST(6000,5000,707,1)

= 0.92 (This value can also be determined from a Normal probability distribution table)

7072)500( LRL


Fill RateProportion of customer demand

satisfied from stock

Stockout occurs when thedemand during lead time exceedsthe reorder point

ESC is the expected shortage percycle (average demand in excessof reorder point in eachreplenishment cycle)

ss is the safety inventory

Q is the order quantity

LSL

LS

ssf

ssFssESC

Q

ESCfr

1

1

ESC = -ss1-NORMDIST(ss/L, 0, 1, 1) + L NORMDIST(ss/L, 0, 1, 0)


Example 11.3: Evaluating Fill Ratess = 1,000, Q = 10,000, σL = 707, Fill Rate (fr) = ?

ESC = -ss1-NORMDIST(ss/L, 0, 1, 1) +

L NORMDIST(ss/L, 0, 1, 0)

= -1,0001-NORMDIST(1,000/707, 0, 1, 1) +

707 NORMDIST(1,000/707, 0, 1, 0)

= 25.13

fr = (Q - ESC)/Q = (10,000 - 25.13)/10,000 =0.9975


Factors Affecting Fill Rate

Safety inventory: Fill rate increases if safetyinventory is increased. This also increases thecycle service level.

Lot size: Fill rate increases on increasing the lotsize even though cycle service level does notchange.


Example 11.4: EvaluatingSafety Inventory Given CSL

D = 2,500/week; D = 500

L = 2 weeks; Q = 10,000; CSL = 0.90

DL = 5000, L = 707 (from earlier example)

ss = FS-1(CSL)L = [NORMSINV(0.90)](707) = 906

(this value can also be determined from a Normal probability distribution table)

ROP = DL + ss = 5000 + 906 = 5906


Evaluating Safety InventoryGiven Desired Fill Rate

D = 2500, σD = 500, Q = 10000

If desired fill rate is fr = 0.975, how much safetyinventory should be held?

ESC = (1 - fr)Q = 250

Solve

σ1250

LSL

LS

ssf

ssFssESC σσ

0,1,1,

σσ

σ1250

LL

L

ssNORMDIST

ssNORMSDISTss


Evaluating Safety Inventory GivenFill Rate (try different values of ss)

Fill R ate Safety Inventory

97.5% 67

98.0% 183

98.5% 321

99.0% 499

99.5% 767


Impact of Required Product Availabilityand Uncertainty on Safety Inventory

Desired product availability (cycle service level or fillrate) increases, required safety inventory increases

Demand uncertainty (σL) increases, required safetyinventory increases

Managerial levers to reduce safety inventory withoutreducing product availability– reduce supplier lead time, L (better relationships with

suppliers)

– reduce uncertainty in demand, σL (better forecasts, betterinformation collection and use)


Impact of Supply Uncertainty

D: Average demand per period

D: Standard deviation of demand per period

L: Average lead time

sL: Standard deviation of lead time

sD

D

LDL

L

L

DL

222


Impact of Supply UncertaintyD = 2,500/day; D = 500

L = 7 days; Q = 10,000; CSL = 0.90; sL = 7 days

DL = DL = (2500)(7) = 17500

ss = F-1s(CSL)σL = NORMSINV(0.90) x 17550

= 22,491

17500)7()2500(500)7( 222

222

sDL LDL


Impact of Supply Uncertainty

Safety inventory when sL = 0 is 1,695








Impact of Aggregationon Safety Inventory

Models of aggregation

Information centralization

Specialization

Product substitution

Component commonality

Postponement


Impact of Aggregation

C

Ls

C

D

C

L

n

ii

C

D

n

ii

C

CSLss

L

F

DD

)(1

1

2

1


Impact of Aggregation(Example 11.7)

Car Dealer : 4 dealership locations (disaggregated)

D = 25 cars; σD = 5 cars; L = 2 weeks; desired CSL=0.90

What would the effect be on safety stock if the 4 outletsare consolidated into 1 large outlet (aggregated)?

At each disaggregated outlet:

For L = 2 weeks, σL = 7.07 cars

ss = Fs-1(CSL) x σL = Fs

-1(0.9) x 7.07 = 9.06

Each outlet must carry 9 cars as safety stock inventory,so safety inventory for the 4 outlets in total is (4)(9) =36 cars


Impact of Aggregation(Example 11.7)

One outlet (aggregated option):

RC = D1 + D2 + D3 + D4 = 25+25+25+25 = 100 cars/wk

σRC = Sqrt(52 + 52 + 52 + 52) = 10

σLC = σD

C Sqrt(L) = (10)Sqrt(2) = (10)(1.414) = 14.14

ss = Fs-1(CSL) x σL

C = Fs-1(0.9) x 14.14 =18.12

or about 18 cars

If ρ does not equal 0 (demand is not completelyindependent), the impact of aggregation is not as great(Table 11.3)


Impact of AggregationIf number of independent stocking locations

decreases by n, the expected level of safety inventorywill be reduced by square root of n (square root law)

Many e-commerce retailers attempt to take advantageof aggregation (Amazon) compared to bricks andmortar retailers (Borders)

Aggregation has two major disadvantages:– Increase in response time to customer order

– Increase in transportation cost to customer

– Some e-commerce firms (such as Amazon) have reducedaggregation to mitigate these disadvantages


Information CentralizationVirtual aggregation

Information system that allows access to currentinventory records in all warehouses from eachwarehouse

Most orders are filled from closest warehouse

In case of a stockout, another warehouse can fill theorder

Better responsiveness, lower transportation cost,higher product availability, but reduced safetyinventory

Examples: McMaster-Carr, Gap, Wal-Mart


SpecializationStock all items in each location or stock different

items at different locations?– Different products may have different demands in different

locations (e.g., snow shovels)

– There can be benefits from aggregation

Benefits of aggregation can be affected by:– coefficient of variation of demand (higher cv yields greater

reduction in safety inventory from centralization)

– value of item (high value items provide more benefits fromcentralization)

– Table 11.4


Product Substitution

Substitution: use of one product to satisfy the demandfor another product

Manufacturer-driven one-way substitution

Customer-driven two-way substitution


Component Commonality

Using common components in a variety ofdifferent products

Can be an effective approach to exploitaggregation and reduce component inventories


Example 11.9: Value ofComponent Commonality

0

50000

100000

150000

200000

250000

300000

350000

400000

450000

1 2 3 4 5 6 7 8 9

SS


Postponement

The ability of a supply chain to delay productdifferentiation or customization until closer to thetime the product is sold

Goal is to have common components in thesupply chain for most of the push phase and moveproduct differentiation as close to the pull phaseas possible

Examples: Dell, Benetton


POSTPONEMENT PRACTICESINDIAN PAINT INDUSTRY

Nature of Product

Demand Pattern

Variety

Perishability

Finished Product Inventory Costs

Postponement

Dealer Tinting System

11-37


Impact of ReplenishmentPolicies on Safety Inventory

Continuous review policies

Periodic review policies


Estimating and ManagingSafety Inventory in Practice

Account for the fact that supply chain demand islumpy

Adjust inventory policies if demand is seasonal

Use simulation to test inventory policies

Start with a pilot

Monitor service levels

Focus on reducing safety inventories



What is the role of safety inventory in a supply chain?

What are the factors that influence the required levelof safety inventory?

What are the different measures of productavailability?

What managerial levers are available to lower safetyinventory and improve product availability?


Chapter 9Sales and

OperationsPlanning


Outline

Responding to predictable variability in a supply chain

Managing supply

Managing demand

Implementing solutions – Sales and OperationsPlanning - to predictable variability in practice


Responding to PredictableVariability in a Supply Chain

Predictable variability is change in demand that can beforecasted

Can cause increased costs and decreased responsivenessin the supply chain

A firm can handle predictable variability using twobroad approaches:– Manage supply using capacity, inventory, subcontracting, and

backlogs

– Manage demand using short-term price discounts and tradepromotions


Managing Supply

Managing capacity– Time flexibility from workforce

– Use of seasonal workforce

– Use of subcontracting

– Use of dual facilities – dedicated and flexible

– Designing product flexibility into production processes

Managing inventory– Using common components across multiple products

– Building inventory of high demand or predictable demandproducts


Inventory/Capacity Trade-off

Leveling capacity forces inventory to build up inanticipation of seasonal variation in demand

Carrying low levels of inventory requires capacityto vary with seasonal variation in demand orenough capacity to cover peak demand duringseason


Managing Demand

Promotion

Pricing

Timing of promotion and pricing changes isimportant

Demand increases can result from a combinationof three factors:– Market growth (increased sales, increased market size)

– Stealing share (increased sales, same market size)

– Forward buying (same sales, same market size)


Demand Management

Pricing and aggregate planning must be donejointly

Factors affecting discount timing– Product margin: Impact of higher margin ($40 instead

of $31)

– Consumption: Changing fraction of increase comingfrom forward buy (100% increase in consumptioninstead of 10% increase)

– Forward buy


Factors AffectingPromotion Timing

Factor Favored timingHigh forward buying Low demand periodHigh stealing share High demand periodHigh growth of market High demand periodHigh margin High demand periodLow margin Low demand periodHigh holding cost Low demand periodLow flexibility Low demand period


Red Tomato ToolsPlanning example

9-9


Off-Peak (January) Discountfrom $40 to $39


Cost = $421,915, Revenue = $643,400, Profit = $221,485


Peak (April) Discountfrom $40 to $39


Cost = $438,857, Revenue = $650,140, Profit = $211,283


January Discount: 100% Increase inConsumption, Sale Price = $40 ($39)


Off-peak discount: Cost = $456,750, Revenue = $699,560


Peak (April) Discount: 100% Increasein Consumption, Sale Price = $40 ($39)


Peak discount: Cost = $536,200, Revenue = $783,520


Performance UnderDifferent Scenarios

Regular

Price

Promotion

Price

Promotion

Period

Percent

increase in

demand

Percent

forward

buy

Profit Average

Inventory

$40 $40 NA NA NA $217,725 895

$40 $39 January 10% 20% $221,485 523

$40 $39 April 10% 20% $211,283 938

$40 $39 January 100% 20% $242,810 208

$40 $39 April 100% 20% $247,320 1,492

$31 $31 NA NA NA $73,725 895

$31 $30 January 100% 20% $84,410 208

$31 $30 April 100% 20% $69,120 1,492


Implementing Solutions toPredictable Variability in Practice

Coordinate planning across enterprises in the supplychain

Take predictable variability into account whenmaking strategic decisions

Preempt, do not just react to, predictable variability


SEASONALITY OF INPUT PRODUCT ANDCAPACITY UTILISATION OF PLANT

Seasonal agricultural produce such as sugarcane, hasto reach sugar mills for crushing soon after harvestingto avoid sugar yield and quality losses. What stepshave been taken by Simbhaoli Sugars to ensure evenflow of this crop into the mill in line with theinstalled crushing capacity to minimise losses?

Identify the innovative practices adopted bySimbhaoli Sugars Limited and link the same withsupply chain best practices used in process industries.



How can supply be managed to improvesynchronization in the supply chain in the face ofpredictable variability?

How can demand be managed to improvesynchronization in the supply chain in the face ofpredictable variability?

How can sales and operations planning be used tomaximize profitability when faced with predictablevariability in the supply chain?

Copyright © 2010 Pearson Education, Inc. Publishing as Prentice Hall.1-1

Chapter 1Understanding

the SupplyChain


Traditional View: Logistics in theUS Economy (2006, 2007)

Freight Transportation $809, $856 Billion

Inventory Expense $446, $487 Billion

Administrative Expense $50, $54 Billion

Total Logistics Costs $1.31, $1.4 Trillion

Logistics Related Activity 10%, 10.1% of GNP

Source: 18th and 19th Annual State of Logistics Report – Logistics Magazine


Traditional View: Logistics in theManufacturing Firm

Profit 4%

Logistics Cost 21%

Marketing Cost 27%

Manufacturing Cost 48%

Profit

LogisticsCost

MarketingCost

ManufacturingCost


Supply Chain Management: TheMagnitude in the Traditional ViewEstimated that the grocery industry could save $30

billion (10% of operating cost) by using effectivelogistics and supply chain strategies– A typical box of cereal spends 104 days from factory to sale

– A typical car spends 15 days from factory to dealership

Laura Ashley turns its inventory 10 times a year, fivetimes faster than 3 years ago


Supply Chain Management:The True Magnitude

Compaq estimates it lost $.5 billion to $1 billion insales in 1995 because laptops were not available whenand where needed

When the 1 gig processor was introduced by AMD,the price of the 800 mb processor dropped by 30%

P&G estimates it saved retail customers $65 millionby collaboration resulting in a better match of supplyand demand


OutlineWhat is a Supply Chain?

Decision Phases in a Supply Chain

Process View of a Supply Chain

The Importance of Supply Chain Flows



What is a Supply Chain?Introduction

The objective of a supply chain


What is a Supply Chain?All stages involved, directly or indirectly, in fulfilling

a customer request

Includes manufacturers, suppliers, transporters,warehouses, retailers, and customers

Within each company, the supply chain includes allfunctions involved in fulfilling a customer request(product development, marketing, operations,distribution, finance, customer service)

Examples: Fig. 1.1 Detergent supply chain (Wal-Mart), Dell


What is a Supply Chain?Customer is an integral part of the supply chainIncludes movement of products from suppliers to

manufacturers to distributors, but also includesmovement of information, funds, and products in bothdirectionsProbably more accurate to use the term “supply

network” or “supply web”Typical supply chain stages: customers, retailers,

distributors, manufacturers, suppliers (Fig. 1.2)All stages may not be present in all supply chains

(e.g., no retailer or distributor for Dell)


What is a Supply Chain?Customer wants

detergent and goesto Jewel

JewelSupermarket

Jewel or thirdparty DC

P&G or othermanufacturer

PlasticProducer


(e.g. Oil Company)

TennecoPackaging

PaperManufacturer

TimberIndustry


(e.g. Oil Company)


Flows in a Supply Chain

Customer

Information

Product

Funds


The Objective of a Supply ChainMaximize overall value created

Supply chain value: difference between what the finalproduct is worth to the customer and the effort thesupply chain expends in filling the customer’s requestValue is correlated to supply chain profitability

(difference between revenue generated from thecustomer and the overall cost across the supply chain)


The Objective of a Supply ChainExample: Dell receives $2000 from a customer for a

computer (revenue)Supply chain incurs costs (information, storage,

transportation, components, assembly, etc.)Difference between $2000 and the sum of all of these

costs is the supply chain profitSupply chain profitability is total profit to be shared

across all stages of the supply chainSupply chain success should be measured by total

supply chain profitability, not profits at an individualstage


The Objective of a Supply ChainSources of supply chain revenue: the customer

Sources of supply chain cost: flows of information,products, or funds between stages of the supply chain

Supply chain management is the management offlows between and among supply chain stages tomaximize total supply chain profitability


Decision Phases of a Supply ChainSupply chain strategy or design

Supply chain planning

Supply chain operation


Supply Chain Strategy or Design

Decisions about the structure of the supply chain andwhat processes each stage will performStrategic supply chain decisions

– Locations and capacities of facilities– Products to be made or stored at various locations– Modes of transportation– Information systems

Supply chain design must support strategic objectivesSupply chain design decisions are long-term and

expensive to reverse – must take into account marketuncertainty


Supply Chain PlanningDefinition of a set of policies that govern short-term

operations

Fixed by the supply configuration from previousphase

Starts with a forecast of demand in the coming year


Supply Chain PlanningPlanning decisions:

– Which markets will be supplied from which locations

– Planned buildup of inventories

– Subcontracting, backup locations

– Inventory policies

– Timing and size of market promotions

Must consider in planning decisions demanduncertainty, exchange rates, competition over the timehorizon


Supply Chain OperationTime horizon is weekly or dailyDecisions regarding individual customer ordersSupply chain configuration is fixed and operating

policies are determinedGoal is to implement the operating policies as

effectively as possibleAllocate orders to inventory or production, set order

due dates, generate pick lists at a warehouse, allocatean order to a particular shipment, set deliveryschedules, place replenishment ordersMuch less uncertainty (short time horizon)


Process View of a Supply ChainCycle view: processes in a supply chain are divided

into a series of cycles, each performed at theinterfaces between two successive supply chain stages

Push/pull view: processes in a supply chain aredivided into two categories depending on whetherthey are executed in response to a customer order(pull) or in anticipation of a customer order (push)


Cycle View of Supply Chains

Customer Order Cycle

Replenishment Cycle

Manufacturing Cycle

Procurement Cycle

Customer

Retailer

Distributor

Manufacturer

Supplier


Cycle View of a Supply ChainEach cycle occurs at the interface between two successive

stages

Customer order cycle (customer-retailer)

Replenishment cycle (retailer-distributor)

Manufacturing cycle (distributor-manufacturer)

Procurement cycle (manufacturer-supplier)

Cycle view clearly defines processes involved and theowners of each process. Specifies the roles andresponsibilities of each member and the desired outcomeof each process.


Push/Pull View of Supply ChainsProcurement,Manufacturing andReplenishment cycles

Customer OrderCycle

CustomerOrder Arrives



Push/Pull View ofSupply Chain Processes

Supply chain processes fall into one of two categoriesdepending on the timing of their execution relative tocustomer demand

Pull: execution is initiated in response to a customerorder (reactive)

Push: execution is initiated in anticipation of customerorders (speculative)

Push/pull boundary separates push processes frompull processes


Push/Pull View ofSupply Chain Processes

Useful in considering strategic decisions relating tosupply chain design – more global view of howsupply chain processes relate to customer orders

Can combine the push/pull and cycle views– L.L. Bean (Figure 1.6)

– Dell (Figure 1.7)

The relative proportion of push and pull processes canhave an impact on supply chain performance


Supply Chain Macro Processes ina Firm

Supply chain processes discussed in the two views canbe classified into (Figure 1.8):– Customer Relationship Management (CRM)

– Internal Supply Chain Management (ISCM)

– Supplier Relationship Management (SRM)

Integration among the above three macro processes iscritical for effective and successful supply chainmanagement


Examples of Supply ChainsGateway

Zara

McMaster Carr / W.W. Grainger

Toyota

Amazon / Borders / Barnes and Noble

Webvan / Peapod / Jewel

What are some key issues in these supply chains?


Gateway: A Direct Sales ManufacturerWhy did Gateway have multiple production facilities in the

US? What advantages or disadvantages does this strategy offerrelative to Dell, which has one facility?

What factors did Gateway consider when deciding which plantsto close?

Why does Gateway not carry any finished goods inventory atits retail stores?

Should a firm with an investment in retail stores carry anyfinished goods inventory?

Is the Dell model of selling directly without any retail storesalways less expensive than a supply chain with retail stores?

What are the supply chain implications of Gateway’s decisionto offer fewer configurations?


7-ElevenWhat factors influence decisions of opening and closing stores?

Location of stores?

Why has 7-Eleven chosen off-site preparation of fresh food?

Why does 7-Eleven discourage direct store delivery from vendors?

Where are distribution centers located and how many stores doeseach center serve? How are stores assigned to distribution centers?

Why does 7-Eleven combine fresh food shipments by temperature?

What point of sale data does 7-Eleven gather and what informationis made available to store managers? How should informationsystems be structured?


W.W. Grainger and McMaster CarrHow many DCs should there be and where should they be

located?How should product stocking be managed at the DCs? Should

all DCs carry all products?What products should be carried in inventory and what

products should be left at the supplier?What products should Grainger carry at a store?How should markets be allocated to DCs?How should replenishment of inventory be managed at various

stocking locations?How should Web orders be handled?What transportation modes should be used?


ToyotaWhere should plants be located, what degree of

flexibility should each have, and what capacity shouldeach have?Should plants be able to produce for all markets?How should markets be allocated to plants?What kind of flexibility should be built into the

distribution system?How should this flexible investment be valued?What actions may be taken during product design to

facilitate this flexibility?


Amazon.comWhy is Amazon building more warehouses as it grows? How

many warehouses should it have and where should they belocated?

What advantages does selling books via the Internet provide? Arethere disadvantages?

Why does Amazon stock bestsellers while buying other titlesfrom distributors?

Does an Internet channel provide greater value to a bookseller likeBorders or to an Internet-only company like Amazon?

Should traditional booksellers like Borders integrate e-commerceinto their current supply?

For what products does the e-commerce channel offer the greatestbenefits? What characterizes these products?


GOPALJEE How can Gopaljee Supply and Distribution Model be

extended to other business lines in the Indian and SouthAsian context?

Which all socio-economic features of South Asian societiescan be identified as the foundations for building sustainablesupply chains?

How can the existing distribution channels in the SouthAsian region be transformed to maximize the value deliveredto the customer?

How can such indigenously developed SCM Modelsintegrate with and expand into global supply chains?


JAIPUR RUGSHow can small and medium scale industries in the

developing world, leverage the power of supplychains to deliver value to the customers andsimultaneously improve the standard of living ofthe artisans?

How can the involvement of middlemen beminimised, freeing the artisans from exploitationand under payment?

1-34


Summary of Learning ObjectivesWhat are the cycle and push/pull views of a supply

chain?

How can supply chain macro processes be classified?

What are the three key supply chain decision phasesand what is the significance of each?

What is the goal of a supply chain and what is theimpact of supply chain decisions on the success of thefirm?

8-1

Outline Chapter 8: Aggregate

Planning in the Supply Chain

Role of aggregate planning in a supply chain

The aggregate planning problem

Aggregate planning strategies

Implementing aggregate planning in practice

8-2

Role of Aggregate Planning

in a Supply Chain

Basic Assumptions:

– Capacity has a cost

– Lead times are greater than zero

Aggregate planning:

– Is the process by which a company determines levels of capacity,

production, subcontracting, inventory, stockouts, and pricing over a

specified time horizon

– goal is to maximize profit Or, if demand is effectively fixed for all the

decision we can make, we can just minimize costs

– decisions made at a product family (not SKU) level

– time frame of 3 to 18 months (What decision phase are we in?)

» Too late to build another plant

» Too early to get into daily/weekly production issues, SKU level detail

– We need to answer: how can a firm best use the facilities it has?

8-3

The Aggregate Planning Problem

(and role in the Supply Chain)

The Problem: Given the demand forecast for each period in the

planning horizon, determine the production level, inventory level,

and the capacity level for each period that maximizes the firm’s

(supply chain’s) profit over the planning horizon

– Specify the planning horizon (typically 3 to 18 months)

– Specify the duration of each period (typically 1 month for longer horizons)

– Specify key information required to develop an aggregate plan

All supply chain stages should work together on an aggregate plan

that will optimize supply chain performance

– For now we ignore transportation issues and costs and have single facility

– Avoid sub-optimization by silo. We may need to incur more costs (ex.

outsourcing production) in a function to maximize overall profit

– Supply chains usually involve multiple firms. If these firms have close ties,

it may be possible to optimize the efficiency of the entire chain

8-4

Information Needed for

an Aggregate Plan Demand forecast in each period

Production costs

– Machine costs

– labor costs, regular time ($/hr) and overtime ($/hr)

– subcontracting costs ($/hr or $/unit)

– cost of changing capacity: hiring or layoff ($/worker) and cost of adding

or reducing machine capacity ($/machine)

Labor/machine hours required per unit

Material requirements per unit, material cost and availability

Inventory holding cost ($/unit/period)

Stock-out / backlog cost ($/unit/period)

Constraints: physical or policy limits on overtime, layoffs,

capital available, warehousing, stock-outs and backlogs

8-5

Outputs of Aggregate Plan Production quantity from regular time, overtime, and

subcontracted time: used to determine number of workers and

supplier purchase levels

Inventory held: used to determine how much warehouse space

and working capital is needed

Backlog/stock-out quantity: used to determine what customer

service levels can be

– (i.e. do we short customers for a certain time- and how much/how long?)

Machine capacity increase/decrease: used to determine if new

production equipment needs to be purchased

A poor aggregate plan can result in lost sales, lost profits, excess

inventory, or excess capacity

8-6

Aggregate Planning Strategies

There is typically a trade-off between optimizing for

capacity (machine+labor), inventory, and backlog/lost sales

– Chase strategy: sync production with demand, hiring and firing as

needed.

– Time flexibility from workforce or capacity strategy: assumes labor

pool can work variable hours (incl. overtime), has lower inventory&

utilization,

– Level strategy – keep capacity & labor usage constant, either

stockpile inventory or short orders as needed

– Mixed strategy – a combination of one or more of the first three

strategies

…

8-7

Tools for Creating Aggregate Plans

Some companies have not created explicit aggregate plans, and rely only on orders from warehouses or DCs to drive production schedules (pure pull system).

– This is acceptable only if products are not capacity intensive, or if maintaining a plant with low utilization is inexpensive.

– It also assumes material and labor inputs are flexible / available when needed

For simple problems, it may be possible to produce a feasible plan by guessing. (No guarantee of optimality)

What tool is commonly used to produce an optimal aggregate plan?

8-8

Linear Programming

Inherently assumes costs are linear

– Pure unit costs are the easiest

– Increasing marginal costs (e.g. regular labor $20/hour, overtime $30/hour)

– Economies of scale harder to model, but possible (ignored for this class)

Difficulty of solving increases with degree of detail

– Take a 1-year plan for a plant that monitors weekly production of 100 different SKUs. How many variables?

» have 100*52 = over 5000 production decision variables Pi,t

– If we could aggregate SKUs into 5 different product families, with monthly time buckets, how many variables do we have now?

» only have 5*12= 60 decision variables for Pi,t

– Industry aggregate plans often have 10,000 to 100,000 decision variables

» In this class will keep our problem scales well below that of industry (under 200 decision variables, the limit of the built in Excel solver)

8-9

Aggregate Planning Example: Red

Tomato Tools, Inc.

Red Tomato makes a single product, a garden tool that sells for $40

Red Tomato starts with 1000 of these tools in inventory and is expected to end

with at least 500 in stock

Red Tomato can temporarily backlog demand for a cost, but at the end of the time

horizon, they require their backlog to be zero

– This is an important constraint to remember- if we forget it, we will get strange results

Production costs are based on parts and labor with no machine capacity issues

– They start with 80 employees can hire or fire workers for a cost.

– Workers get regular pay whether they are producing or not. There are 20 days of

production per month, each month.

– We can have workers work overtime (no more than 10 hrs/mo per worker) for extra $

– We can also subcontract production out and pay a flat fee (in lieu of labor + materials)

Red Tomato would like to generate a 6 month plan that maximizes profits

(revenue net of costs) – For now we can just minimizing costs, if we have no influence over demand

8-10

Aggregate Planning at

Red Tomato Tools

Month Demand Forecast

January 1,600

February 3,000

March 3,200

April 3,800

May 2,200

June 2,200

Here’s the demand that the book gives us- see the seasonality?

8-11

Aggregate Planning- Costs

Item Cost

Materials $10/unit

Inventory holding cost $2/unit/month

Marginal cost of a stockout $5/unit/month

Hiring and training costs $300/worker

Layoff cost $500/worker

Labor hours required 4/unit

Regular time cost $4/hour

Over time cost $6/hour

Cost of subcontracting $30/unit

Note: subcontracting costs includes all materials and labor

Time to bring up Excel….

8-12

Aggregate Planning

(Define the Decision Variables)

Wt = Workforce size for month t, t = 1, ..., 6

Ht = Number of employees hired at start of month t, t = 1, ..., 6

Lt = Number of employees laid off at start of month t, t = 1, ..., 6

Pt = Production in month t, t = 1, ..., 6

It = Inventory at the end of month t, t = 1, ..., 6

St = Number of units stocked out (backlogged) at end of month t, t = 1, ..., 6

Ct = Number of units subcontracted for month t, t = 1, ..., 6

Ot = Number of overtime hours worked in month t, t = 1, ..., 6

8-13

Aggregate Planning

(Define Objective Function)

6

1

6

1

6

1

6

1

6

1

6

1

6

1

6

1

30105

26500

300640

tt

tt

tt

tt

tt

tt

tt

tt

CPS

IOL

HWMin

Apologies to any Finance gurus but we do not consider NPV here

8-14

Aggregate Planning (Constraints)

Aside from the conditions for the ending level of

inventory and the ending backlog being = 0, we

will have 4 other types of constraints to consider:

1. Balance of workers

2. Production limit

3. Balance of inventory

4. Overtime limit

8-15

Aggregate Planning (Define

Constraints Linking Variables)

Workforce size for each month is based on hiring and layoffs

(# workers employed end of Month 1 = # workers employed

at the start of Month 2) – May end up with fractional # workers, e.g. 73.4, which could be

acceptable if we allow for part-time (Also, even if not with larger

numbers like this, we can get away with approximating for integer)

– Is a Balance constraint. No spontaneous creation or destruction of

workers outside of the hiring and layoff processes

.80,6,...,1

0

,

0

1

1

Wwheretfor

LHWW

orLHWW

tttt

tttt

8-16

Links Between Periods?

Why not create 6 different LPs, each with 1 period of a month?

It would be easier* for the computer to solve, after all!

Why not solve several 1-month problems sequentially? At end

points, such as #workers left at the end of the month 1 and

then use that as the starting #workers for month 2?

* A computer trivial aside from this class: as N increases, the inherent complexity and

required solution time goes up by order of N3 or more)

8-17


Production for each month cannot exceed capacity

(hence, have a limit rather than balance constraint)

.6,...,1

,0440

,440

tfor

POW

OWP

ttt

ttt or

8-18


Inventory balance for each month.

Inventory levels change if we a) produce (P) or sub-contract (C)

more units than we have demand for, either from this period (t) or

the prior one (t-1). It may help to think about what is a “debit”

and a “credit” to the level of inventory….

We can then rearrange the terms to reflect standard form (all

variables on one side). What happens at t=0?

011

11

SISDCPI

SISDCPI

ttttttt

tttttttFor t =1 to 6

8-19


Over-time limit for each month, reflecting policy

that no one worker can put in more than 10 hours

of overtime for the month.

.6,...,1

,010

,10

tfor

OW

WO

tt

tt or

8-20

Further Conditions…

All of the variables are inherently non-negative

We have a starting balance of

– 80 workers

– 1000 tools

– 0 backlog

Thus, the variables associated with these are going to need to be

initialized (put in a value for time period 0)

Reminder: have been told that we are not allowed to have

any backlog and must have at least 500 tools in stock at

the end of the planning horizon

8-21

LP Formulation

We now take a brief digression and look at the formulation in

Excel, including the LP Solver configuration and the reports

Some things to think about:

1. How many variables will we have?

2. Which variables have “memory”- and why do we care?

3. How many different types of constraints (aside from non-

negativity and certain beginning/end conditions)? How

many total constraint equations?

4. What is our overall goal? Why can we take a “shortcut”

8-22

LP Formulation

8-23

LP Formulation: Solver

Decision variables are indexed to 1 thru 6, tp0 exists only for initialization

We have 4 types of constraints, plus 2 ending conditions

Technically we should require variables to be integers (no laying off .2

people or making .3 tools) but for now will leave as linear.

– Real industry LPs have numbers like 300K and 3M, so this is less of an issue

Assume linear model and non-negativity both checked in Options

8-24

What-if Scenarios

Planners often run re-run their models to see how the plan

might change if parameter values are different than expected

Here are some potentially realistic changes that would result

in changes our previously optimal plan at Red Tomato:

1. Increase the seasonal swings in demand (Example 8-1)

2. Raise holding costs (from $2 to $6) (Example 8-2)

8-25

Increased Demand Fluctuation


January 1,000

February 3,000

March 3,800

April 4,800

May 2,000

June 1,400

For chapter 8, we are assuming that demand

is beyond our control to influence.

Demand is still 16000 within the total planning period

8-26

Solution: Comparison of What-If

Scenario 1 –vs.- Base Case

Major changes

– Increases total Costs by $10,583

» Changes come from Inventory and Stock-out

» Base Case costs: $10,233 $1,333

» Larger seasonal fluctuations: $12,400 $9,750

Caveat: The book treats beginning and end periods differently when calculating

the average inventory position (see p. 218, p.220). This is overkill: we can just

use a simple average if we are interested in the inventory position. – Should I ask you to calculate this on a test, either method is correct, but my

method is easier!

– I will focus on minimizing the total inventory COST over the planning

horizon rather than inventory LEVELS at any point in time- ultimately,

inventory levels are measured because of their associated costs

8-27

What-If Scenario #2: Increase

Inventory Costs from $2 to $6

Major changes- costs increase over base case…. In what way?

Reduce inventory carried by….

– engaging in more ”workforce reductions” as pre-building inventory for

peak periods is no longer as cost effective

– subcontracting some demand out in peak periods

We switch from what type of strategy to what?

8-28

More Thoughts on Red

Tomato’s Planning Problem

1. What if our aggregate demand forecasts are incorrect?

– Review/ Reminder: How often are real forecasts 100% accurate?

2. What if demand is greater than anticipated?

– What are some ways we can prepare for extra (either in terms of Safety

Stock or Safety Capacity?)

3. What if demand is less than anticipated- what will happen?

– What is one way to keep costs lower if demand is greatly reduced and

expected to stay low for awhile?

9-30

Managing Supply: Some Possible

Tools to Consider

Managing capacity

– Time flexibility from workforce

– Use of a seasonal workforce

– Use of subcontracting

– Use of dual facilities – dedicated and flexible

– Designing product flexibility into production processes

Managing inventory

– Using common components across multiple products

– Building up inventory of high demand or predictable demand

products

– Inventory strategies are discussed in detail in Chapters10-12

8-31

Aggregate Planning in Practice

If possible, think beyond your enterprise to the entire supply

chain*

Make plans flexible because forecasts are always wrong

– Sensitivity Analysis can be used to show where bottlenecks and potential

improvements may be

Rerun the aggregate plan as new information emerges

– Usually every time period, with revisions and future predictions

Importance of aggregate planning grows as a firm’s capacity

utilization increases

– Less room for mistakes in this era of low margins

8-32

Summary of Chapter 8’s Learning

Objectives

1. What types of decisions are best solved by aggregate

planning?

2. What is the importance of aggregate planning as a supply

chain activity?

3. What kinds of information are needed to produce an aggregate

plan?

4. What are the basic trade-offs a manager makes to produce an

aggregate plan?

5. How are aggregate planning problems formulated and solved

using Microsoft Excel?

9-33

Chapter 9 Outline:

Sales and Operations Planning

In Chapter 8 we focused on managing supply, but now

we are going to consider: Managing demand

Implementing solutions – Sales and Operations

Planning (S&OP) – to manage predictable variability

in practice

9-34

Responding to Predictable

Variability in a Supply Chain

Predictable variability - demand changes that can be forecasted

Can increase costs and decrease responsiveness in the supply

chain (as discussed in Chapter 17- Supply Chain coordination)

A firm can handle predictable variability using two broad

approaches:

1. Manage supply using capacity, inventory, subcontracting,

and backlogs (This is what we did in Chapter 8)

2. Manage demand using short-term price discounts and trade

promotions

9-35

Demand Management

Promotion- increased marketing, product placements, discounts to wholesalers/retailers, etc.

Pricing discounts to consumers

Demand Management and aggregate planning must be jointly coordinated

Factors that should influence timing of promotion/ price discount

1. Product margins: Impact of change in margins

2. Demand changes

3. Cost of holding inventory

4. Cost of changing capacity

Some companies with software or services in this arena: DemandTec, Rapt, KHI

9-36

Effect of Promotions and Discounts

Demand increases can result from a combination of three

factors:

1. Market growth (increased sales, increased market size)

2. Stealing market share (increased sales, same market size)

3. Forward buying (same sales, same market size)

Have you ever “stocked up” on an item that was on a great sale?

Higher demand now offset by demand decrease in later periods

It is crucial to be able to estimate the effect of all these factors,

as their effects will determine what is the best pricing and

promotion strategy

9-37

Example: Effect of

Promotions and Discounts

Red Tomato Example: a $1 discount offered to the consumer

for a month is expected to increase demand that period by

10% because of market growth or stealing share, and also with

20% of demand for the next two months being pulled forward

to the current month

How do we compute the new demand?

How do we modify the aggregate planning problem?

Do we need to revisit our objective function?

– Hint: we are now considering actions that will modify demand between

scenarios, whereas in our prior work demand was assumed to be fixed

9-38

Off-Peak (January) if Discount

Sales Price from $40 to $39


January 3,000

February 2,400

March 2,560

April 3,800

May 2,200

June 2,200

• 10% increase in January

• but forward buying decreases Feb and Mar’s demands each by 20%

• Cost = $421,915, Revenue = $643,400, ->Profit = $221,485

• Profit is better than base case (no discount) profit of $217,725

The next few slides show scenarios from the textbook example

9-39

Peak (April) if Discount

price from $40 to $39


January 1,600

February 3,000

March 3,200

April 5,060

May 1,760

June 1,760

• 10% increase in April

• but forward buying decreases May and June’s demands each by 20%

• Cost = $438,857, Revenue = $650,140, Profit = $211,283

• Profit is worse than either base case or off-peak discount

9-40

January Discount (Sales price $39):

if 100% Increase in Consumption


January 4,440

February 2,400

March 2,560

April 3,800

May 2,200

June 2,200

• Assumes 100% rather than 10% consumption increase • either from overall market growth for product or stealing share from others

• still assume 20% forward buying from Feb and March

• Off-peak discount: Cost = $456,750, Revenue = $699,560, Profit $242,810

9-41

Peak (April) Discount:

if 100% Increase in Consumption


January 1,600

February 3,000

March 3,200

April 8,480

May 1,760

June 1,760

• We still assume we have 20% forward buying from May and June

• Peak discount: Cost = $536,200, Revenue = $783,520

• PROFIT $247,320 better than no promotion or off peak promo

9-42

Performance Under

Different Scenarios Regular

Price

Promotion

Price

Promotion

Period

Percent

increase in

demand

Percent

forward

buy

Profit

$40 none NA NA NA $217,725

$40 $39 January 10 % 20 % $221,485

$40 $39 April 10% 20% $211,283

$40 $39 January 100% 20% $242,810

$40 $39 April 100% 20% $247,320

$31 none NA NA NA $73,725

$31 $30 January 100% 20% $84,410

$31 $30 April 100% 20% $69,120

• Summary of different results (includes a low-margin variation,

where product only retails for a $31 regular price.)

• Based on the effects of different factors, the optimal promotion

time (high verses low demand months) will change

9-43

Factors Affecting Optimal

Promotion Timing

Factor Favored timing

High forward buying Low demand period

High stealing of market share High demand period

High growth of market High demand period

High margin High demand period

High holding cost Low demand period

High flexibility High demand period

• Reverse timing for opposite (Low Margin -> Low demand period best)

• For a combination of factors (i.e. high margin product, but with a high

holding cost) still need to analyze to see which factor dominates

9-44

Implementing Solutions to

Predictable Variability in Practice

Coordinate* planning across enterprises in the supply chain

Take predictable variability into account when making strategic

decisions

Pre-empt (do not just react to) predictable variability

Be proactive, not reactive

Perform a lot of “What-if” analysis BEFORE going live with a

strategy!

9-45


Objectives

1. What factors may comprise an increase in Demand?

2. How can supply be managed to improve synchronization in

the supply chain in the face of predictable variability?

3. How can aggregate planning be used to maximize

profitability when faced with predictable variability in the

supply chain?


Chapter 10Managing

Economies ofScale in the

Supply Chain:Cycle Inventory


Outline

Role of Cycle Inventory in a Supply Chain

Economies of Scale to Exploit Fixed Costs

Economies of Scale to Exploit Quantity Discounts

Short-Term Discounting: Trade Promotions

Managing Multi-Echelon Cycle Inventory

Estimating Cycle Inventory-Related Costs inPractice


Role of Inventory in the Supply ChainImprove Matching of Supply

and Demand

Improved Forecasting

Reduce Material Flow Time

Reduce Waiting Time

Reduce Buffer Inventory

Economies of ScaleSupply / Demand

VariabilitySeasonal

Variability

Cycle Inventory Safety InventoryFigure Error! No text of

Seasonal Inventory


Role of Cycle Inventoryin a Supply Chain

Lot, or batch size: quantity that a supply chain stage eitherproduces or orders at a given time

Cycle inventory: average inventory that builds up in thesupply chain because a supply chain stage either producesor purchases in lots that are larger than those demanded bythe customer– Q = lot or batch size of an order– D = demand per unit time

Inventory profile: plot of the inventory level over time(Fig. 10.1)

Cycle inventory = Q/2 (depends directly on lot size)Average flow time = Avg inventory / Avg flow rateAverage flow time from cycle inventory = Q/(2D)



Q = 1000 unitsD = 100 units/dayCycle inventory = Q/2 = 1000/2 = 500 = Avg inventory level from

cycle inventoryAvg flow time = Q/2D = 1000/(2)(100) = 5 daysCycle inventory adds 5 days to the time a unit spends in the

supply chainLower cycle inventory is better because:

– Average flow time is lower– Working capital requirements are lower– Lower inventory holding costs



Cycle inventory is held primarily to take advantage ofeconomies of scale in the supply chain

Supply chain costs influenced by lot size:– Material cost = C– Fixed ordering cost = S– Holding cost = H = hC (h = cost of holding $1 in inventory for one year)

Primary role of cycle inventory is to allow different stages topurchase product in lot sizes that minimize the sum of material,ordering, and holding costs

Ideally, cycle inventory decisions should consider costs acrossthe entire supply chain, but in practice, each stage generallymakes its own supply chain decisions – increases total cycleinventory and total costs in the supply chain


Estimating Cycle InventoryRelated Costs in Practice

Inventory Holding Cost– Obsolescence

– Handling costs

– Occupancy costs

– Theft, security, damage, tax, insurance

Ordering Cost– Buyer time

– Transportation costs

– Receiving costs

– Unique other costs

10-7


Economies of Scaleto Exploit Fixed Costs

How do you decide whether to go shopping at aconvenience store or at Sam’s Club?Lot sizing for a single product (EOQ)

Aggregating multiple products in a single order

Lot sizing with multiple products or customers– Lots are ordered and delivered independently for each

product

– Lots are ordered and delivered jointly for all products

– Lots are ordered and delivered jointly for a subset ofproducts


Economies of Scaleto Exploit Fixed Costs

Annual demand = D

Number of orders per year = D/Q

Annual material cost = CR

Annual order cost = (D/Q)S

Annual holding cost = (Q/2)H = (Q/2)hC

Total annual cost = TC = CD + (D/Q)S + (Q/2)hC

Figure 10.2 shows variation in different costs fordifferent lot sizes at Best Buy


Fixed Costs: Optimal Lot Sizeand Reorder Interval (EOQ)

D: Annual demandS: Setup or Order CostC: Cost per unith: Holding cost per year as a

fraction of product costH: Holding cost per unit per yearQ: Lot Size, Q*: Optimal Lot Sizen*: Optimal order frequencyMaterial cost is constant and

therefore is not considered inthis model

S

DhCn

H

DSQ

hCH

2*

2*


Example 10.1Demand, D = 12,000 computers per year

Unit cost, C = $500

Holding cost fraction, h = 0.2

Fixed cost, S = $4,000/order

Q* = Sqrt[(2)(12000)(4000)/(0.2)(500)] = 980 computers

Cycle inventory = Q*/2 = 490

Average Flow time = Q*/2D = 980/(2)(12000) = 0.041year = 0.49 month

n* = Sqrt[(12000)(0.2)(500)/(2)(4000)] = 12.24 orders


Example 10.1 (continued)

Annual ordering and holding cost == (12000/980)(4000) + (980/2)(0.2)(500) = $97,980Suppose lot size is reduced to Q=200, which would

reduce flow time:Annual ordering and holding cost == (12000/200)(4000) + (200/2)(0.2)(500) = $250,000To make it economically feasible to reduce lot size, the

fixed cost associated with each lot would have to bereduced


Example 10.2If desired lot size = Q* = 200 units, what would S have

to be?

D = 12000 units

C = $500

h = 0.2

Use EOQ equation and solve for S:

S = [hC(Q*)2]/2D = [(0.2)(500)(200)2]/(2)(12000) =$166.67

To reduce optimal lot size by a factor of k, the fixed ordercost must be reduced by a factor of k2


Key Points from EOQ Model

In deciding the optimal lot size, the tradeoff is betweensetup (order) cost and holding cost.

If demand increases by a factor of 4, it is optimal toincrease batch size by a factor of 2 and produce (order)twice as often. Cycle inventory (in days of demand)should decrease as demand increases.

If lot size is to be reduced, one has to reduce fixed ordercost. To reduce lot size by a factor of 2, order cost hasto be reduced by a factor of 4.


Aggregating Multiple Productsin a Single Order

Transportation is a significant contributor to the fixed cost per order

Can possibly combine shipments of different products from thesame supplier– same overall fixed cost

– shared over more than one product

– effective fixed cost is reduced for each product

– lot size for each product can be reduced

Can also have a single delivery coming from multiple suppliers or asingle truck delivering to multiple retailers

Aggregating across products, retailers, or suppliers in a single orderallows for a reduction in lot size for individual products becausefixed ordering and transportation costs are now spread acrossmultiple products, retailers, or suppliers


Example: Aggregating MultipleProducts in a Single Order

Suppose there are 4 computer products in the previousexample: Deskpro, Litepro, Medpro, and Heavpro

Assume demand for each is 1000 units per month

If each product is ordered separately:– Q* = 980 units for each product

– Total cycle inventory = 4(Q/2) = (4)(980)/2 = 1960 units

Aggregate orders of all four products:– Combined Q* = 1960 units

– For each product: Q* = 1960/4 = 490

– Cycle inventory for each product is reduced to 490/2 = 245

– Total cycle inventory = 1960/2 = 980 units

– Average flow time, inventory holding costs will be reduced


Lot Sizing with MultipleProducts or Customers

In practice, the fixed ordering cost is dependent at least in parton the variety associated with an order of multiple models

– A portion of the cost is related to transportation(independent of variety)

– A portion of the cost is related to loading and receiving(not independent of variety)

Three scenarios:

– Lots are ordered and delivered independently for eachproduct

– Lots are ordered and delivered jointly for all three models

– Lots are ordered and delivered jointly for a selected subset ofmodels


Lot Sizing with Multiple Products

Demand per year– DL = 12,000; DM = 1,200; DH = 120

Common transportation cost, S = $4,000

Product specific order cost– sL = $1,000; sM = $1,000; sH = $1,000

Holding cost, h = 0.2

Unit cost– CL = $500; CM = $500; CH = $500


Delivery OptionsNo Aggregation: Each product ordered separately

Complete Aggregation: All products delivered on

each truck

Tailored Aggregation: Selected subsets of products

on each truck


No Aggregation: Order EachProduct Independently

Litepro Medpro Heavypro

Demand peryear

12,000 1,200 120

Fixed cost /order

$5,000 $5,000 $5,000

Optimalorder size

1,095 346 110

Orderfrequency

11.0 / year 3.5 / year 1.1 / year

Annual cost $109,544 $34,642 $10,954

Total cost = $155,140


Aggregation: Order AllProducts Jointly

S* = S + sL + sM + sH = 4000+1000+1000+1000 = $7000

n* = Sqrt[(DLhCL+ DMhCM+ DHhCH)/2S*]

= 9.75

QL = DL/n* = 12000/9.75 = 1230

QM = DM/n* = 1200/9.75 = 123

QH = DH/n* = 120/9.75 = 12.3

Cycle inventory = Q/2

Average flow time = (Q/2)/(weekly demand)


Complete Aggregation:Order All Products Jointly

Litepro Medpro Heavypro

Demand peryear

12,000 1,200 120

Orderfrequency

9.75/year 9.75/year 9.75/year

Optimalorder size

1,230 123 12.3

Annualholding cost

$61,512 $6,151 $615

Annual order cost = 9.75 × $7,000 = $68,250Annual total cost = $136,528


Lessons from Aggregation

Aggregation allows firms to lower lot size withoutincreasing cost

Complete aggregation is effective if productspecific fixed cost is a small fraction of joint fixedcost

Tailored aggregation is effective if productspecific fixed cost is a large fraction of joint fixedcost


Economies of Scale toExploit Quantity Discounts

All-unit quantity discounts

Marginal unit quantity discounts

Why quantity discounts?– Coordination in the supply chain

– Price discrimination to maximize supplier profits


Quantity Discounts

Lot size based– All units

– Marginal unit

Volume based

How should buyer react?

What are appropriate discounting schemes?


All-Unit Quantity DiscountsPricing schedule has specified quantity break points

q0, q1, …, qr, where q0 = 0

If an order is placed that is at least as large as qi butsmaller than qi+1, then each unit has an average unitcost of Ci

The unit cost generally decreases as the quantityincreases, i.e., C0>C1>…>Cr

The objective for the company (a retailer in ourexample) is to decide on a lot size that will minimizethe sum of material, order, and holding costs


All-Unit Quantity Discount Procedure(different from what is in the textbook)Step 1: Calculate the EOQ for the lowest price. If it is feasible

(i.e., this order quantity is in the range for that price), then stop.This is the optimal lot size. Calculate total cost (TC ) for thislot size.

Step 2: If the EOQ is not feasible, calculate the TC for this priceand the smallest quantity for that price.

Step 3: Calculate the EOQ for the next lowest price. If it isfeasible, stop and calculate the TC for that quantity and price.

Step 4: Compare the TC for Steps 2 and 3. Choose the quantitycorresponding to the lowest TC.

Step 5: If the EOQ in Step 3 is not feasible, repeat Steps 2, 3, and4 until a feasible EOQ is found.


All-Unit Quantity Discount:Example

Order quantity Unit Price

0-5000 $3.00

5001-10000 $2.96

Over 10000 $2.92

q0 = 0, q1 = 5000, q2 = 10000

C0 = $3.00, C1 = $2.96, C2 = $2.92

D = 120000 units/year, S = $100/lot, h = 0.2


All-Unit Quantity Discount:Example

Step 1: Calculate Q2* = Sqrt[(2DS)/hC2]= Sqrt[(2)(120000)(100)/(0.2)(2.92)] = 6410Not feasible (6410 < 10001)Calculate TC2 using C2 = $2.92 and q2 = 10001TC2 = (120000/10001)(100)+(10001/2)(0.2)(2.92)+(120000)(2.92)= $354,520Step 2: Calculate Q1* = Sqrt[(2DS)/hC1]=Sqrt[(2)(120000)(100)/(0.2)(2.96)] = 6367Feasible (5000<6367<10000) StopTC1 = (120000/6367)(100)+(6367/2)(0.2)(2.96)+(120000)(2.96)= $358,969TC2 < TC1 The optimal order quantity Q* is q2 = 10001


All-Unit Quantity Discounts

Suppose fixed order cost were reduced to $4– Without discount, Q* would be reduced to 1265 units– With discount, optimal lot size would still be 10001 units

What is the effect of such a discount schedule?– Retailers are encouraged to increase the size of their orders– Average inventory (cycle inventory) in the supply chain is

increased– Average flow time is increased– Is an all-unit quantity discount an advantage in the supply

chain?


Why Quantity Discounts?

Coordination in the supply chain– Commodity products

– Products with demand curve» 2-part tariffs

» Volume discounts


Coordination forCommodity Products

D = 120,000 bottles/year

SR = $100, hR = 0.2, CR = $3

SS = $250, hS = 0.2, CS = $2

Retailer’s optimal lot size = 6,324 bottlesRetailer cost = $3,795; Supplier cost = $6,009

Supply chain cost = $9,804


Coordination forCommodity Products

What can the supplier do to decrease supply chaincosts?– Coordinated lot size: 9,165; Retailer cost = $4,059;

Supplier cost = $5,106; Supply chain cost = $9,165

Effective pricing schemes– All-unit quantity discount

» $3 for lots below 9,165

» $2.9978 for lots of 9,165 or more

– Pass some fixed cost to retailer (enough that he raisesorder size from 6,324 to 9,165)


Quantity Discounts WhenFirm Has Market Power

No inventory related costs

Demand curve

360,000 - 60,000p

What are the optimal prices and profits in thefollowing situations?– The two stages coordinate the pricing decision

» Price = $4, Profit = $240,000, Demand = 120,000

– The two stages make the pricing decisionindependently

» Price = $5, Profit = $180,000, Demand = 60,000


Two-Part Tariffs andVolume Discounts

Design a two-part tariff that achieves thecoordinated solution

Design a volume discount scheme that achievesthe coordinated solution

Impact of inventory costs– Pass on some fixed costs with above pricing


Lessons from Discounting Schemes

Lot size based discounts increase lot size andcycle inventory in the supply chain

Lot size based discounts are justified to achievecoordination for commodity products

Volume based discounts with some fixed costpassed on to retailer are more effective in general– Volume based discounts are better over rolling horizon


Short-Term Discounting:Trade Promotions

Trade promotions are price discounts for a limited period of time(also may require specific actions from retailers, such as displays,advertising, etc.)

Key goals for promotions from a manufacturer’s perspective:– Induce retailers to use price discounts, displays, advertising to increase sales– Shift inventory from the manufacturer to the retailer and customer– Defend a brand against competition– Goals are not always achieved by a trade promotion

What is the impact on the behavior of the retailer and on theperformance of the supply chain?

Retailer has two primary options in response to a promotion:– Pass through some or all of the promotion to customers to spur sales– Purchase in greater quantity during promotion period to take advantage of

temporary price reduction, but pass through very little of savings tocustomers


Short Term DiscountingQ*: Normal order quantity

C: Normal unit cost

d: Short term discount

D: Annual demand

h: Cost of holding $1 per year

Qd: Short term order quantity dC

C

hdC

dD QQ

d

-+

)-(=

*

Forward buy = Qd - Q*


Short Term Discounts:Forward Buying

Normal order size, Q* = 6,324 bottles

Normal cost, C = $3 per bottle

Discount per tube, d = $0.15

Annual demand, D = 120,000

Holding cost, h = 0.2

Qd = [(0.15)(120000)/(3.00-0.15)(0.2)] + [(3)(6324)/(3.00-0.15)] = 38,236 bottles

Forward buy = Qd – Q* = 38,236 – 6,324 = 31,912 bottles


Promotion Pass Throughto Consumers

Demand curve at retailer: 300,000 - 60,000p

Normal supplier price, CR = $3.00– Optimal retail price = $4.00

– Customer demand = 60,000

Promotion discount = $0.15– Optimal retail price = $3.925

– Customer demand = 64,500

Retailer only passes through half the promotiondiscount and demand increases by only 7.5%


Trade Promotions

When a manufacturer offers a promotion, the goalfor the manufacturer is to take actions(countermeasures) to discourage forward buyingin the supply chain

Counter measures– EDLP (every day low pricing)

– Scan based promotions

– Customer coupons


Managing Multi-EchelonCycle Inventory

Multi-echelon supply chains have multiple stages, withpossibly many players at each stage and one stage supplyinganother stage

The goal is to synchronize lot sizes at different stages in away that no unnecessary cycle inventory is carried at anystage

Figure 10.6: Inventory profile at retailer and manufacturerwith no synchronization

Figure 10.7: Illustration of integer replenishment policyFigure 10.8: An example of a multi-echelon distribution

supply chainIn general, each stage should attempt to coordinate orders

from customers who order less frequently and cross-dock allsuch orders. Some of the orders from customers that ordermore frequently should also be cross-docked.


Levers to Reduce Lot SizesWithout Hurting Costs

Cycle Inventory Reduction– Reduce transfer and production lot sizes

» Aggregate fixed costs across multiple products, supply points,or delivery points

– Are quantity discounts consistent with manufacturingand logistics operations?

» Volume discounts on rolling horizon

» Two-part tariff

– Are trade promotions essential?» EDLP

» Based on sell-thru rather than sell-in


Summary of Learning ObjectivesHow are the appropriate costs balanced to choose the

optimal amount of cycle inventory in the supplychain?What are the effects of quantity discounts on lot size

and cycle inventory?What are appropriate discounting schemes for the

supply chain, taking into account cycle inventory?What are the effects of trade promotions on lot size

and cycle inventory?What are managerial levers that can reduce lot size

and cycle inventory without increasing costs?

1

Facility Decisions

Network Design in a Supply Chain

2

Outline

The Role of Distribution in the Supply Chain



The Value of Distributors in the Supply Chain



3

The Role of Distributionin the Supply Chain

Distribution: the steps taken to move and store aproduct from the supplier stage to the customerstage in a supply chain

Distribution directly affects cost and the customerexperience and therefore drives profitability

Choice of distribution network can achieve supplychain objectives from low cost to highresponsiveness

Examples: Wal-Mart, Dell, Proctor & Gamble,Grainger

4


Distribution network performance evaluated alongtwo dimensions at the highest level:– Customer needs that are met

– Cost of meeting customer needs

Distribution network design options musttherefore be compared according to their impacton customer service and the cost to provide thislevel of service

5


Elements of customer service influenced by networkstructure:– Response time– Product variety– Product availability– Customer experience– Order visibility– Returnability

Supply chain costs affected by network structure:– Inventories– Transportation– Facilities and handling– Information

6

Service and Number of Facilities(Fig. 4.1)

Number ofFacilities

Response Time

7


Local FG

Mix

Regional FG

Local WIP

Central FG

Central WIP



Cost

Response Time HighLow

Low

High

8

Inventory Costs and Numberof Facilities (Fig. 4.2)

InventoryCosts


9

Transportation Costs andNumber of Facilities (Fig. 4.3)

TransportationCosts


10

Facility Costs and Numberof Facilities (Fig. 4.4)

FacilityCosts


11

Transportation

Total Costs Related toNumber of Facilities

Tota

l Cos

ts


Inventory

Facilities

Total Costs

12

Response Time

Variation in Logistics Costs and ResponseTime with Number of Facilities (Fig. 4.5)



13

Design Options for aDistribution Network

Manufacturer Storage with Direct ShippingManufacturer Storage with Direct Shipping and

In-Transit Merge Distributor Storage with Carrier Delivery Distributor Storage with Last Mile DeliveryManufacturer or Distributor Storage with

Consumer Pickup Retail Storage with Consumer Pickup Selecting a Distribution Network Design

14

Manufacturer Storage withDirect Shipping (Fig. 4.6)

Manufacturer

Retailer

Customers

Product Flow

Information Flow

15

In-Transit Merge Network (Fig. 4.7)Factories

Retailer

Product Flow

Information Flow

In-Transit Merge byCarrier

Customers

16

Distributor Storage withCarrier Delivery (Fig. 4.8)

Factories

Customers


Warehouse Storage byDistributor/Retailer

17

Distributor Storage withLast Mile Delivery (Fig. 4.9)

Factories

Customers

Product Flow

Information Flow

Distributor/RetailerWarehouse

18

Manufacturer or Distributor Storage withCustomer Pickup (Fig. 4.10)

Factories

Retailer

Pickup Sites


Cross Dock DC

Customer Flow

Customers

19

Comparative Performance of DeliveryNetwork Designs (Table 4.7)

Information

Facility & Handling

Transportation

Inventory

Returnability

Order Visibility

CustomerExperience


Product Variety

Response Time


pickup

Distributorstorage with

last miledelivery

DistributorStorage with

Package CarrierDelivery



Direct Shipping

Retail Storagewith

CustomerPickup

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

1

2

2

2

2

2

2

2

2

2

2

3

3

3

3

3

3

3

3

3

3

4

4

4

4

4

4

4

4

4

4

4

4

4

5

5

5

5

55

5

6

6

5

20

Linking Product Characteristics and CustomerPreferences to Network Design

Low customer effort

High product variety

Quick desired response

High product value

Many product sources

Very low demand product

Low demand product

Medium demand product

High demand product


pickup

Distributor storagewith last mile

delivery

Distributor Storagewith Package

Carrier Delivery


In-TransitMerge


Direct Shipping

RetailStorage with

CustomerPickup

+2

+2

+2

+2

+2

+2

+2 +2 +2

+2

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

+1

0

0

0

0

0

0

0

0 0

0

-1

-1

-1

-1

-1 -1

-1

-1

-1

-1

-1

-2 -2

-2

-2

-2

-2 -2

-2

21

The Value of Distributorsin the Supply Chain

Distributing Consumer Goods in India

Distributing MRO Products

Distributing Electronic Components

22


The ownership structure of the distributionnetwork can have as big as an impact as the typeof distribution network

The choice of a distribution network has verylong-term consequences

Consider whether an exclusive distributionstrategy is advantageous

Product, price, commoditization, and criticalityhave an impact on the type of distribution systempreferred by customers

23


What are the key factors to be consideredwhen designing the distribution network?

What are the strengths and weaknesses ofvarious distribution options?

What roles do distributors play in thesupply chain?

24

Outline

A strategic framework for facility location

Multi-echelon networks

Gravity methods for location

Plant location models

25


Facility role- flexibility of Toyota since 1997

Facility location- Amazon.com : a single warehouse in Seattle

Capacity allocation- Allocating too much poor utilization

- Allocating too little poor responsiveness, high cost

Market and supply allocation- Amazon.com : built new warehouses due to grown markets

26

Factors Influencing Network DesignDecisions

Strategic – Cost vs. Responsiveness

ex) Apparel producers, Convenience stores, Discount stores

Technological– Economies of scale few high-capacity locations

ex) Manufacturer of computer chips

– Lower fixed costs many local facilities

ex) Bottling plants for Coca-Cola

Macroeconomic– Tariffs, Tax incentives, Exchange rate and Demand risk

Political

27

Factors Influencing Network DesignDecisions (continued)

Infrastructure– availability of sites & labor

– proximity to transportation terminals, rail service, airportsand seaports

– highway access, congestion, local utilities

Competitive – Close vs. Far

ex) Retail stores in a mall, Supermarkets

Logistics and facility costs

28


Local FG

Mix

Regional FG

Local WIP

Central FG

Central WIP



Cost

Response Time HiLow

Low

Hi

29



ResponseTime

30

Where inventory needs to be…

…for a 1 week order response time [1 DC]…for a 5 day order response time [2 DCs]…for a 3 day order response time [5 DCs]…etc

31


Costs


Inventory

Transportation

Facility costs

32

Percent ServiceLevel Within

Promised Time

Transportation

Cost Build-up as a function of facilitiesC

ost

of O

pera

tion

s


Inventory

Facilities

Total Costs

Labor

33

A Framework for Global Site Location

PHASE ISupply Chain

Strategy

PHASE IIRegional Facility

Configuration

PHASE IIIDesirable Sites

PHASE IVLocation Choices


INTERNAL CONSTRAINTSCapital, growth strategy,existing network

PRODUCTION TECHNOLOGIESCost, Scale/Scope impact, supportrequired, flexibility

COMPETITIVEENVIRONMENT

PRODUCTION METHODSSkill needs, response time

FACTOR COSTSLabor, materials, site specific

GLOBAL COMPETITION

TARIFFS AND TAXINCENTIVES

REGIONAL DEMANDSize, growth, homogeneity,local specifications

POLITICAL, EXCHANGERATE AND DEMAND RISK

AVAILABLEINFRASTRUCTURE

LOGISTICS COSTSTransport, inventory, coordination

34


CustomerStore

MaterialsDC


VendorDC

FinalAssembly

FinishedGoods DC

ComponentsDC

VendorDC Plant

Warehouse

FinishedGoods DC

CustomerDC

CustomerDC

CustomerDC

CustomerStore

CustomerStore

CustomerStore

CustomerStore

VendorDC

5-34

35

Tailored Network: Multi - EchelonFinished Goods Network

RegionalFinished

Goods DC

RegionalFinished

Goods DC

Customer 1DC

Store 1

NationalFinished

Goods DC

Local DCCross-Dock

Local DCCross-Dock

Local DCCross-Dock

Customer 2DC

Store 1

Store 2

Store 2

Store 3

Store 3

36




Which plants to establish? How to configure the network?

Key Costs:

•Fixed facility cost•Transportation cost•Production cost•Inventory cost•Coordination cost

37


Which market isserved by whichplant?

Which supply sourcesare used by a plant?


0

..

1

1

1 1

x

Kx

Dx

ts

xcMin

ij

i

m

jij

j

n

iij

n

i

m

jijij

38

Plant Location with Multiple Sourcing

yi = 1 if plant islocated at site i, 0otherwise


1,0;

..

1

1

1

1 11

yky

yKx

Dx

ts

xcyfMin

i

m

ii

ii

n

jij

j

n

iij

n

i

m

jijiji

n

ii

39

Capacity Investment Strategies

Speculative Strategy– Single sourcing

Hedging Strategy– Match revenue and cost exposure

Flexible Strategy– Excess total capacity in multiple plants

– Flexible technologies

40

Summary

Factors influencing facility decisions

A strategic framework for facility location

Gravity methods for location

Network optimization models

Value capacity as a real option

41


What is the role of network design decisions inthe supply chain?

What are the factors influencing supply chainnetwork design decisions?

Describe a strategic framework for facilitylocation.

How are the following optimization methods usedfor facility location and capacity allocationdecisions?– Gravity methods for location– Network optimization models

5-41

42

Location Allocation Decisions

Plants Warehouses

1

2

Which plants to establish? Which warehouses to establish?How to configure the network?

Markets

43

Plant Location with Single Sourcing

yi = 1 if plant islocated at site i, 0otherwise

xij = 1 if market j issupplied from plantsite i, 0 otherwise

1,0,;

1

..

1

1

1

1 11

yxky

yKDx

x

ts

xcyfMin

iij

n

ii

iij

n

jij

n

iij

n

i

m

jijiji

n

ii

44


CustomerStore

MaterialsDC


VendorDC

FinalAssembly

FinishedGoods DC

ComponentsDC

VendorDC Plant

Warehouse

FinishedGoods DC

CustomerDC

CustomerDC

CustomerDC

CustomerStore

CustomerStore

CustomerStore

CustomerStore

VendorDC

45


Ton-Center Solution– x,y: Warehouse

Coordinates

– xn, yn : Coordinates ofdelivery location n

– Fn : Annual tonnage todelivery location n

xx F

F

y

y F

F

i ii

n

ii

n

i ii

n

ii

n

1

1

1

1

Min ])()([ 22 yyxxF iii

Supply Chain Management

Lecture 2

Announcements

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asp?JobNumber=617603• http://www.ballaerospace.com/

Outline

• Last Tuesday– Chapter 1

• Sections 1, 2

• Today– Chapter 1

• Sections 3, 4, 5

• Next week– Chapters 2 and 3

What is a Supply Chain?

• Flow of products and services from– Suppliers– Raw materials manufacturers– Intermediate goods manufacturers– Finished goods manufacturers– Distributors and wholesalers– Retailers– Customers

• Connected through transportation, information, andexchanges of funds

Manufacturer Distributor Retailer CustomerSupplier

Key Observations

• In order to maximize supply chain surplus– Every facility that impacts costs needs to be considered

• Suppliers’ suppliers• Customers’ customers

– Efficiency throughout the supply chain network isrequired using a network level approach


Supply chain management involves themanagement of supply chain assets andproducts, information, and fund flows to

maximize total supply chain surplus


Getting the right thingsto the right placesat the right times

for profit


• “Managing supply and demand, sourcing rawmaterials and parts, manufacturing and assembly,warehousing and inventory tracking, order entryand order management, distribution across allchannels, and delivery to the customer”– The Supply Chain Council

• “The design and management of seamless,value-added process across organizationalboundaries to meet the real needs of the endcustomer”– Institute for Supply Management


• “Supply chain management is a set ofapproaches utilized to efficiently integratesuppliers, manufacturers, warehouses, andstores, so that merchandise is produced anddistributed at the right quantities, to the rightlocations, and at the right time, in order tominimize system wide costs while satisfyingservice level requirements”– Simchi-Levi et al, 2003

• Video– Ford Manufacturing Supply Chain


• Supply chain management is all aboutrelationships– Management of relationships in order to enhance value

and reduce cost– Collaboration is an important part of effective supply

chain management

Evolution of Supply Chain Management

1950s 1960s 1970s 1980s 1990s 2000s Beyond

Traditional Mass Manufacturing

Inventory Management/CostOptimization

JIT, TQM, BPR,Alliances

SCMFormation/Extensions

FurtherRefinement of

SCM Capabilities

Evolution of Supply Chain Management

• Mass production era (1900s – 1970s)– In the early 1900s, Henry Ford created the first moving assembly

line reducing the time to build a Model T from 728 hours to 1.5hours

• Lean manufacturing era (1970s –1995)– In the early 1970s, Japanese manufacturers like Toyota changed

the rules of production from mass to lean. Lean manufacturingfocuses on flexibility and quality more than on efficiency andquantity.

• Mass customization era (1995 – 2010?)– Beginning around 1995 and coinciding with the commercial

application of the Internet, manufacturers started to mass-producecustomized products. Henry Ford’s famous statement “You canhave any color Model T as long as it’s black” no longer applies.

Managing a Supply Chain is Not Easy

• Geographically dispersed complex network• Conflicting objectives across the supply chain• Uncertainty and risk factors• Information distortion


• Geographically dispersed complex network


• Convenience• Short lead time• Large variety ofproducts

• Few stores• Low inventory• Little variety• Close to DCs

• Low inventory• Few DCs

• Large shipments

• Large productionbatches

• Conflicting objectives across the supply chain

Manufacturer Distributor Retailer Customer


• Uncertainty and risk factors– 2005 Hurricane Katrina

• P&G coffee supplies from sites around New Orleans• Six month impact

– 2002 West Coast port strike• Losses of $1B/day• Store stock-outs, factory shutdowns

– 2001 India earthquake• Supply interruptions for apparel manufacturers

– 1999 Taiwan earthquake• Supply interruptions for HP and Dell


• Information distortionManufacturer Distributor Retailer CustomerSupplier

Bullwhip effect

Why Study Supply Chain Management?

The Magnitude

• In 1998, American companies spent $898 billionin supply chain related activities (or 10.6% ofGross Domestic Product)

• Third party logistics services grew in 1998 by 15%to nearly $40 billion

• It is estimated that the grocery industry couldsave $30 billion (10% of operating cost) by usingmore effective logistics strategies– A typical box of cereal spends more than three months

getting from factory to supermarket

The Potential

• In 10 years, Wal-Mart transformed itself bychanging its logistics system. It has the highestsales per square foot, inventory turnover andoperating profit of any discount retailer

• Laura Ashley turns its inventory 10 times a year,five times faster than three years ago– New information system– Centralized warehouse

The Impact

In 1996, Dell held 31 days of inventory. Itnow holds only 4 days of inventory.

The Impact

The Impact

• The Turning Point (The Economist, 9/20/07)– “For such a tiny part of GDP, the contents of warehouses has had a

surprisingly big effect on its volatility. When industries cut or add stocksaccording to demand, that adjustment magnifies the effect of the initialchange in sales. Stock levels were once much larger relative to the size ofthe economy, so a small slip in demand could easily blow up into arecession. But thanks to improvements in technology, firms now havetimelier and better information about buyers. Speedier market intelligenceand production in smaller batches allows firms to match supply tochanging conditions. This makes huge stocks unnecessary and minimizesthe lurches in inventories that were once so destabilizing. The entireinventory of some lean-running companies now consists of whateverFedEx or UPS is shipping on their account.Mr Cecchetti and his colleagues calculate that, on average, more than halfthe improvement in the stability of economic growth in the countries theystudied is accounted for by diminished inventory cycles. That somethingso workaday as supply-chain management could have so marked aneffect might seem a dull conclusion. But dullness is a virtue,because technological improvement is irreversible”

The Impact

Study of Supply Chain Management

• Successful supply chain management requiresdecisions on the flow of information, product, andfunds that fall into three decision phases– Supply chain strategy or design– Supply chain planning– Supply chain operation


TYPICAL DECISIONS

Strategic

Tactical

TYPETIME FRAME

•Supply chain network design (How many plants?Location and capacities of plants and warehouses?)•Supply chain strategies (Sell direct or throughretailers? Outsource or in-house? Focus on cost orcustomer service?)•Product mix at each plant

years

•Workforce & Production planning•Inventory policies (safety stock level)•Which locations supply which markets•Transportation strategies

3 mo.- 1year

Operational•Production scheduling•Decisions regarding individual orders•Place replenishment orders

daily

Study of Supply Chain Management

• A supply chain is a sequence of processes andflows that take place within and between differentstages– Cycle view

• The processes in a supply chain are divided into a series ofcycles, each performed at the interface between twosuccessive stages of a supply chain

– Push/pull view• The processes in a supply chain are divided into two

categories depending on whether they are executed inresponse or in anticipation of a customer order

Cycle View of Supply Chain Processes


Replenishment Cycle

Manufacturing Cycle

Procurement Cycle

Customer

Retailer

Distributor

Manufacturer

Supplier

Cycle viewdefines theprocesses

involved andthe owner ofeach process

Subprocesses in Each Cycle

Supplier marketsthe product

Buyer

Supplier

Buyer placesan order

Supplier receivesthe order

Supplier suppliesthe order

Buyer receivesthe order

Buyer may returnthe product

Cycle View of Supply Chain Processes


Replenishment Cycle

Manufacturing Cycle

Procurement Cycle

Customer Order Process1. Customer Arrival2. Customer Order Entry3. Customer Order Fullfillment4. Customer Order Receiving

Procurement Process1. Component Order Arrival2. Production Scheduling3. Manufacturing/Shipping4. Receiving

Manufacturing Process1. Order Arrival2. Production Scheduling3. Manufacturing/Shipping4. Receiving

Replenishment Process1. Retail Order Trigger2. Retail Order Entry3. Retail Order Fullfillment4. Retail Order Receiving

Push/Pull View of Supply Chain Processes

Customer order arrives

PULLPROCESSES

PUSHPROCESSES

Execution is initiated inresponse to customer orders

(reactive)

Execution is initiated inanticipation of customer orders

(speculative)

Processes are divided based on the timing oftheir execution relative to a customer order

Push/Pull Processes for the Supply chainof Dell

PUSH

PULL

Customer Order Cycle andManufacturing Cycle

Procurement Cycle

Customer

Manufacturer

Supplier

Push/Pull Processes for the Supply chainof Detergent

PULL

PUSH


Replenishment Cycle

Manufacturing Cycle

Procurement Cycle

Customer

Retailer

Distributor

Manufacturer

Supplier

Are the following systems push or pull?

Soda vending machines

Amazon.com

Emergency care

Paint industry

Runway capacity at an Airport

Cycle View Versus Push/Pull View

Which view is more useful whenconsidering operational decisions and

which view is more useful whenconsidering strategic decisions?

Celestial Seasonings

• The herbs were originally harvested by hand in the RockyMountains

• Currently, herbs and leafs come from growers around theworld– “We’ve been working to establish sustainable harvests

and fair wages for more than 30 years”

What advantages does selling tea over the Internetprovide?

What are advantages of having one production facility?

What are disadvantages of having one production facility?

17-1

Outline Chapter 17:

Supply Chain Coordination

Supply Chain Coordination and the Bullwhip Effect

Effect on Performance from Lack of Coordination

The Problem: Obstacles to Coordination in a Supply Chain

The Potential Solutions: Managerial Levers to Achieve Coordination


– Continuous Replenishment (CRP) and Vendor-Managed Inventories (VMI)

– Collaborative Planning, Forecasting, and Replenishment (CPFR)

16-2

Supply Chain Coordination

and the Bullwhip Effect

Supply chain coordination: all stages in the supply chain take actions together (usually results in greater total supply chain profits)

– requires that each stage take into account the effects of its actions on the other stages

Lack of coordination results when:

– The objectives of different stages are conflicting

and / or

– Information moving between stages is distorted

Bullwhip Effect: The distortion of demand information as it is transmitted up the demand chain

16-3

The Beer Game: a B-school Tradition

A Team consists of 4 positions: Retailer, Wholesaler, Distributor and Factory

– Every position can see its inventory now, and expected deliveries for the next 2 periods.

Everyone is trying to minimize their costs, both as a player and as a team

– Inventory costs ($1 holding cost per period)

– Stock-out costs ($2 fee per period shorted)

Obstacles – No advance knowledge of orders

– No knowledge of what the other positions see for demand

– No communication between team positions allowed!

– You can’t cancel backorders

– There is a 2 period lead-time between each stage

See the “getting started” document

16-5

The Beer Game: Details

You have two decisions each period –1) How much to ship? 2) How much to order (or make if you are the factory) ?

– You will be prevented from shipping more than is demanded (current demand plus backordered demand) - No pushing of product is allowed!

– Game will not allow to ship more than you have in inventory

– You cannot cancel an order once placed. (Also, there is no visibility to your past orders. If you wish to record this, you must do so on paper)

You must click on “Submit Button” to enter decision

One everyone has entered all information, the game master (professor) will then advance the clock to the next period

Once that happens, you must ask for a status update

– Refresh your web browser to make sure you are in the right period

16-6

The Beer Game: Interface

Sample of Retailer screen- left part is for decision,

right part provides information:

16-7

Interface Intricacies

Once you enter these and click on the button, if you refresh, you will then see

them reflected, with your on-hand updated.

At the start of a new period the “Current Order” and “Current Shipment” are at 0.

You can re-enter decisions (until the clock is advanced)

See the Before and After screens (just below)

16-8

Final Points to Remember

You can see what your supplier will ship to you, but unless

you are the factory (where you can make as much beer as

you want), you may not get shipped what you want!

» If your supplier shorts you, then it appears as their back-order

(and costs them!)

The “back-order” displayed is from your direct customers.

It never goes away until you satisfy that demand.

– You should try to get rid of it, as it costs you money!

16-9

Beer Game Debrief

Did the system perform as you wished?

– Did you ever have too much or too little inventory?

– Were you ever surprised by the amount ordered by your client or by the

amount delivered from your supplier? Was it ever too high? Strangly

low?

What is realistic and what is unrealistic about the game?

What are ways we might improve the performance of this

supply chain?

16-10

Bullwhip Effect

Fluctuations in orders increase as they move up the supply chain from retailers to wholesalers to manufacturers to suppliers

Distorts demand information within the supply chain – different stages have different estimates of what demand looks like

Results in a loss of supply chain coordination

Manufacturer Warehouses

Retailers Consumers Wholesalers Suppliers Plants

Forecast of

Consumer demand

Forecast of

store demand

Forecast of

DC demand

Forecast of

Regional demand

Forecast of

Plant demand

Variability of demand

16-11

The Effect of Lack of

Coordination on Performance

The bullwhip effect reduces supply chain profitability by making it more expensive to provide to a given level of product availability

– Manufacturing cost (increases)

– Inventory cost (increases)

– Replenishment lead time (increases)

– Transportation cost (increases)

– Labor cost for shipping and receiving (increases)

– Level of product availability (decreases)

– Waste within the supply chain (increases)

– Relationships across the supply chain (worsens)

– Profitability (decreases)

16-12

The Problem: Obstacles to

Coordination in a Supply Chain

1. Incentive Obstacles

2. Information Processing Obstacles

3. Operational Obstacles

4. Pricing Obstacles

5. Behavioral Obstacles

16-13

1. Incentive Obstacles

When incentives offered to different stages or

participants in a supply chain lead to actions that

increase variability and reduce total supply chain

profits – misalignment of total supply chain

objectives and individual objectives

Local optimization within functions or stages of a

supply chain

Sales force incentives (e.g. Pharmaceutical sales)

16-14

2. Information Processing Obstacles

When demand information is distorted as it moves

between different stages of the supply chain, leading to

increased variability in orders within the supply chain

Forecasting based on orders, not customer demand

– As we have seen, forecasting demand based on orders magnifies

demand fluctuations moving up the supply chain from retailer to

manufacturer

Lack of information sharing

16-15

3. Operational Obstacles

Actions taken in the course of placing and filling orders that lead to an increase in variability

Ordering in large lots (much larger than dictated by demand)

Large replenishment lead times

Rationing and shortage gaming (common in the computer industry because of periodic cycles of component shortages and surpluses)

16-16

4. Pricing Obstacles

When pricing policies for a product lead to an increase in

variability of orders placed

Lot-size based quantity decisions

Price fluctuations (resulting in forward buying)

0

100

200

300

400

500

600

700

800

Shipments

Consumption

17-17

5. Behavioral Obstacles Problems in learning, often related to communication in the

supply chain and how the supply chain is structured

Each supply chain stage views its actions locally and is unable to see its impact on other stages

Different stages react to the current local situation rather than trying to identify the root causes

Based on local analysis, different stages blame each other for the fluctuations, with successive stages becoming enemies rather than partners

No stage learns from its actions over time because the most significant consequences of the actions of any one stage occur elsewhere, resulting in a vicious cycle of actions and blame

Lack of trust results in opportunism, duplication of effort, and lack of information sharing

17-18

Potential Solutions: Managerial

Levers to Achieve Coordination

1. Aligning Goals and Incentives

2. Improving Information Accuracy

3. Improving Operational Performance

4. Designing Pricing Strategies to Stabilize Orders

5. Building Strategic Partnerships and Trust

17-19


Align incentives so that each participant has an

incentive to do the things that will maximize total

supply chain profits

Align incentives across functions

Pricing for coordination

Alter sales force incentives from sell-in (to the

retailer) to sell-through (by the retailer)

17-20


Sharing point of sale (POS) data

Collaborative forecasting and planning

Single stage control of replenishment

We will discuss this later in:

– Continuous replenishment programs (CRP)

– Vendor managed inventory (VMI)

17-21

Improving Operational Performance

Reducing replenishment lead time

– Reduces uncertainty in demand

– EDI is useful

Reducing lot sizes

– Computer-assisted ordering, B2B exchanges

– Shipping in LTL sizes by combining shipments

– Technology and other methods to simplify receiving

– Changing customer ordering behavior

Rationing based on past sales and sharing information to limit gaming

– “Turn-and-earn”

– Information sharing

17-22

Designing Pricing Strategies

to Stabilize Orders

Encouraging retailers to order in smaller lots and reduce forward buying

Moving from lot size-based to volume-based quantity discounts (consider total purchases over a specified time period)

Stabilizing pricing

– Eliminate promotions (everyday low pricing, EDLP)

– Limit quantity purchased during a promotion

– Tie promotion payments to sell-through rather than amount purchased

Building strategic partnerships and trust – easier to implement these approaches if there is trust

17-23

Building Strategic Partnerships

and Trust in a Supply Chain

Designing a Relationship with Cooperation and Trust

Managing Supply Chain Relationships for Cooperation and Trust

Move to a trust-based relationship

– Supply chain relationships are based on power or trust

– Ultimately, trust-based relationships better than power-based

Cooperation and trust work because:

– Alignment of incentives and goals

– Actions to achieve coordination are easier to implement

– Supply chain productivity improves by reducing duplication or allocation of effort to appropriate stage

– Greater information sharing results

17-24


Quantify the bullwhip effect

Get top management commitment

– And then devote resources to coordination

Focus on communication with other stages

– Use information technology wisely

Try to achieve coordination in the entire supply chain network

– However, before attempting to change the world, may help to start simple (DC vs. Retail CPFR, pilot studies, etc)

Share the benefits of coordination equitably

Some examples follow….

Continuous Replenishment and

Vendor-Managed Inventories

Over-arching idea: Remove inventory distortions by having a

single point of replenishment

Continuous RePlenishment, CRP – wholesaler, manufacturer

or 3rd party replenishes based on POS data

A type of CRP is VMI – where the manufacturer/supplier is

responsible for all decisions regarding inventory

– Positives: less stockpiling of intermediate inventories, manufacturer

may know more about the product and consumer demand patterns than

retailer, e.g. MGM DVDs at Wal-Mart

– Cons: Requires the manufacturer to have sophisticated IT and/or

logistical support, as manufacturers will ignore other brands that may be

near perfect substitutes, overall inventory levels may be higher

17-25

Collaborative Planning, Forecasting,

and Replenishment (CPFR)

While they may still act individually (unlike CRP/VMI)…

Sellers and buyers in a supply chain can still collaborate along

any or all of the following:

– Strategy and planning

– Demand and supply management

– Execution

– Analysis

Example: Henkel (German detergent) supplied into Grupo

Eroski (supermarkets in Spain)

Common scenarios: Retail event collaboration, assortment

planning (especially for fashion/seasonal goods) DC and/or

store replenishment

Risks and Hurdles for a CPFR implementation 17-26

17-27


What is supply chain coordination and the bullwhip effect, and how does the bullwhip effect hurt supply chain performance?

What are obstacles to coordination in the supply chain?

What are the potential solutions to addressing these obstacles?

What are some ways companies can do this in practice?

13-1

(Shortened) Outline Chapter 13:

Transportation in a Supply Chain

Some of this material is covered in the Sustainable Supply

Chain overview, and we will skip much of the chapter

The role of Transportation in the Supply Chain

Factors affecting transportation decisions

Modes of transportation and their performance characteristics

Trade-offs in transportation design

Tailored transportation

The role of IT in transportation

Risk management in transportation

Making transportation decisions in practice

The Role of Transportation in the

Supply Chain

To move the product through the chain to the end consumer

Some fun facts

– US: freight transport activities account for 10% of GDP

» It is estimated that JIT inventory policies and other efficiencies have been

able to reduce this from historical rates of around ~15%

– Germany: per www.bmvbs.de

» The German freight logistics sector is currently the largest in Europe.

» (In) 2005 …estimated to be around 170 billion euros. …7%of German GDP

» the freight logistics sector comes third after retail trade and the automotive

industry, with an estimated 2.5 million employees, (and is)… growing at a

disproportionately high rate

» “Interconnection of infrastructure, information and organization is a pre-

condition for Germany to master the challenges ….At the same time

Germany must face the challenges of making freight transport more

environmentally-, climate- and resource- friendly”

13-2

http://www.bmvbs.de/

13-3

Factors (and Parties) Affecting

Transportation Decisions

From earlier, we know that there may be three separate parties

involved. All of them have factors to consider:

1. Carrier (party that moves or transports the product)

– Vehicle-related costs, Fixed operating costs, Trip-related costs

– Often incurs huge investments (new fleets, etc…)

2. Shipper (party that requires the movement of the product

between two points in the supply chain)

– May need to balance Transportation costs with Inventory and Facility costs

3. Consignee (party that receives the shipment)

– May have certain responsiveness needs

We should also consider:

4. The owners of the infrastructure (Ports, highways, railroads)

5. Government and/or bodies that set worldwide transportation policy

13-4

Transportation Modes

Trucks

– TL

– LTL

Rail

Air

Water

Pipeline (highly limited by geography and product)

Package Carriers (still using trucks, but the focus is on

delivery of a few packages)

13-5

Truckload (TL) vs. Less than

Truckload (LTL)

TL

Cheaper than LTL for large

shipments


Great for large loads

Low fixed and variable costs

Major Issues (especially when

economies of scale are missing)

Utilization

Consistent service

Backhauls

LTL

Typically used for smaller

shipments


Higher fixed costs

(terminals/consolidation

centers) but low variable costs

Major issues: Location of consolidation

facilities

Utilization can still be an issue

Vehicle routing, other IT

complexities

Customer service

13-6

Rail

Cheapest of the land-based modes

– Uses less fuel, so also greener

Average US haul, load= 720 miles, 80 tons

Key issues:

– Scheduling to minimize delays / improve service

– Off-track delays (at pickup and delivery end)

– Yard operations

– Variability of delivery times

– Ownership of rail network in the US is highly fragmented

– Rail does not and cannot reach everywhere

13-7

Air

Fastest mode, often used for global transit of expensive items

– Use is growing (14% per year in US, see usage in Europe in graph below)

Key issues:

– Complex: Location/number of hubs, Location of fleet bases/crew bases,

Schedule optimization, Fleet + Crew assignment, yield management….

– Expensive, EXPENSIVE, EXPENSIVE

– Most energy/emissions intensive

13-8

Package Carriers

Companies like DHL, FedEx, UPS, USPS, that carry small

packages ranging from letters to shipments of about 150 pounds

Expensive

Rapid and reliable delivery

Small and time-sensitive shipments

Preferred mode for e-businesses (e.g., Amazon)

Consolidation of shipments (especially important for package

carriers that use air as a primary method of transport)

– Interestingly, a lot of package carriers have, through their own need for

such networks, expanded into being full service 3PLs (DHL is world’s

largest)

13-9

Water

Ocean, inland waterway system, coastal waters

– Limited to certain geographic areas

Very large loads at very low cost

– Lowest energy/emission intensity per tonne-km, though some concern

about port pollution

Slowest

– Also subject to bottlenecks at Ports

Dominant in overseas trade (autos, grain, apparel, etc.)

Book example of successful usage: IKEA

» As per 2008: 250 stores in 24 countries, sales: 21+ billion euro

» Internationally sourced goods

» IKEA makes very strong use of water and other low cost transport

13-10

Pipeline

High fixed cost

Primarily for crude petroleum, refined petroleum products,

natural gas

Best for large and predictable demand

Would be used for getting crude oil to a port or refinery,

but not for getting refined gasoline to a gasoline station

13-11

Intermodal

Use of more than one mode of transportation to move a shipment to its destination

– rail/truck, water/rail/truck or water/truck

Grown considerably with increased use of containers

Increased global trade has also increased use of intermodal transportation

More convenient for shippers (one entity can provide the complete service)

Key issue involves the exchange of information to facilitate transfer between different transport modes

13-12

Design Options for a

Transportation Network

What are the transportation options? On what basis do we design

our network?

Consider the tradeoffs:

– Transportation cost vs. inventory cost

» Choice of transportation mode: A mode with higher transportation costs

may be justifiable if it results in significantly lower inventories or is

necessary to maintain strategic level of responsiveness

» Physical inventory aggregation

– Transportation cost vs. responsiveness: temporal aggregation

We won’t cover all the networks in the book, i.e. “milk runs” etc.

– Instead we will look at a transportation LP (SRH students- we don’t even do

this!)

13-13

Tailored Transportation

The use of different transportation networks and/or modes based

on customer and product characteristics

Factors affecting tailoring:

– Customer distance and density

– Customer size

– Product demand and value

Some examples:

– GAP primarily imports from its contract manufacturers worldwide by

cargo ship. However, for some high-margin or otherwise key products,

they may use some air freight for mid-season replenishment

– Keeco, LLC supplies home furnishings. They primarily use trucking to

deliver goods from their warehouse to retail stores, but occasionally they

will use parcel delivery for small replenishment orders instead of sending

out a mostly empty truck.

13-14

Role of IT in Transportation

The complexity of transportation decisions demands

use of IT systems

– Especially crucial with intermodal transportation, need for

cross-enterprise collaboration

Information Technology can assist in many ways:

– Identification of optimal routes by minimizing costs subject

to delivery constraints (such as LPs)

– Optimal fleet utilization

– GPS applications

– Finding backhaul opportunities www.coyotelogistics.com

http://www.coyotelogistics.com/

13-15

Risk Management in Transportation

Three main risks to be considered in transportation are:

– Risk that the shipment is delayed

– Risk of disruptions

» When the International Longshore & Warehouse Union strike/lockout closed 29 West Coast ports for 10 days in 2003, one study estimated it cost the U.S.economy $19.4 billion (that’s almost $2 billion per day!)

» 2011 Tsunami: not only impacting auto manufacturers on the Island, but so are the dealers/repair shops

– Risk of hazardous material issues, theft, terrorism (the dirty secret about dirty bombs….)

Risk mitigation strategies:

– Decrease the probability of disruptions

– Alternative routings

– In case of hazardous materials the use of modified containers, low-risk transportation models, modification of physical and chemical properties can prove to be effective

13-16

Making Transportation

Decisions in Practice

Align transportation strategy with competitive strategy

– Does your transportation strategy balance responsiveness vs.

efficiency?

– Does it consider sustainability?

Evaluate both in-house and outsourced transportation

options

Design a transportation network that can handle

e-commerce, if that is part of your business plan

Use technology to improve transportation performance

Design flexibility into the transportation network

13-17


Objectives

1. What is the role of transportation in a supply chain?

2. What are some of the factors and parties that need to

be considered?

3. What are the strengths and weaknesses of different

modes of transportation?

4. What are the trade-offs in transportation network

design?

Supply/Demand Chain Introduction, Overview and Strategy

These slides address chapters 1 through 3 of the

textbook, with some information already found in the

earlier “Sustainable Demand Chain Management: an

Introduction” de-emphasized

While the slide decks are based on the textbook, they

have been customized for this class

– Additional materials are often included

– Professorial commentary that expresses a different

viewpoint than in the text will be noted in a different color

1-1

1-2

Overview of Course

1. Chapters 1-3 + additional slide deck: Introduction, Overview

and Strategy

2. Chapters 4-6: Network Planning and Distribution

3. Chapters 8-9: Aggregate Planning

4. Chapters 10-11, 13+ additional slide deck: Inventory and

Transportation

5. Chapter 17: Supply Chain Coordination

1-3

Who Needs to Know About this

Topic?

Anyone involved in a manufacturing or service

industry where capacities and raw materials cannot be

obtained or expanded without a time or cost penalty

– Executives and Entrepreneurs must understand the strategic

importance of the Supply Chain

– Managers, Consultants and Software Designers need to be

able to analyze, design, and implement Supply Chain

solutions

1-4

Supply Chain Management is not

Learned just Through a Textbook

The “best” solution to a Supply Chain problem may not win

– An elegant, mathematically complex LP presented such that only Ph.D.s

understand may not be the best practical solution to the problem at hand.

And even if it is, it is not the one that will be awarded the contract!

Supply Chain Practitioners need soft skills

– Work effectively with clients and team members, including being

responsive to questions and requests

– You must package and sell your proposed solution

Supply Chain Practitioners need hard skills

– Lots of data, need to understand processes and interactions with IT

– Work usually involves creating or adapting large-scale computer models

The class is designed for you to practice both hard and soft skills

1-5

Traditional View: Logistics in the

US Economy (2006, 2007)

Freight Transportation $809, $856 Billion

Inventory Expense $446, $487 Billion

Administrative Expense $50, $54 Billion

Total Logistics Costs $1.31, $1.4 Trillion

Logistics Related Activity 10%, 10.1% of GNP

– About 21% of total costs for a manufacturing firm

– Logistical costs percentages are higher in the EU

But supply chain is more than logistics….

Source: 18th and 19th Annual State of Logistics Report – Logistics Magazine

1-6

Supply Chain Management:

Mishaps and Opportunities

Estimated that the grocery industry could save $30 billion (10%

of operating cost) by using effective logistics and supply chain

strategies

– A typical box of cereal spends 104 days from factory to sale

– A typical car spends 15 days from factory to dealership

Compaq estimates it lost $.5 billion to $1 billion in sales in

1995 because laptops were not available when and where

needed

When the 1 gig processor was introduced by AMD, the price of

its previous version, the 800 megabyte processor, dropped by

30%

– What happened to firms who had stockpiled those?

1-7

Chapter 1 Outline

What is a Supply Chain? (We covered this earlier)



The Importance of Supply Chain Flows

A Brief Review of Material to Date

Typical stages: (from a demand chain perspective)

customers<retailers<distributors<manufacturers<suppliers

– All stages may not be present- Can you think of some well

known companies that are missing a stage?

– What stage is always present?

The obvious flow is the movement of products from

suppliers to the customer, but also includes movement

of information, funds, and products in both directions

– Reverse logistics is an important facet of both sustainability

and CRM initiatives, will be discussed later.

1-8

1-9

The Objective of a Supply Chain

Sources of supply chain revenue: the customer

Sources of supply chain cost: flows of information,

products, or funds between stages of the supply chain

Supply chain management is ….

– Book: …the management of flows between and among

supply chain stages to maximize total supply chain

profitability

– Professor commentary: …is the coordination of business

functions within an organization and its channel partners in

order to provide goods and services to fulfill customer

demand responsively, efficiently and sustainably

1-10

Dell Computer: Illustration of

Supply Chain Success

Example: Dell receives $1000 from a customer for a computer (revenue)

Supply chain incurs costs (information, storage, transportation, components, assembly, etc.)

Difference between $1000 and the sum of all of these costs is the supply chain profit

– Time value of money often plays a role

Supply chain profitability is the total profit to be shared across all stages of the supply chain

Supply chain success should be measured by total supply chain profitability, not profits at an individual stage

– In practice this may be difficult when stages are separate firms

1-11

Decision Phases of a Supply Chain

1. Supply chain strategy (also called chain design)

2. Supply chain planning

3. Supply chain operation

1-12

Supply Chain Strategy (or Design)

Decisions about the structure of the supply chain and what processes each stage will perform

Strategic supply chain decisions

– Locations and capacities of facilities

– Products to be made or stored at various locations

– Modes of transportation

– Information systems

Supply chain design must support strategic objectives

Supply chain design decisions are long-term and expensive to reverse – must take into account market uncertainty

Decisions often analyzed first through models and simulations

1-13

Supply Chain Planning

Definition of a set of policies that govern short-term

operations - typically a quarter to a couple years

Fixed by the supply configuration from previous phase

– Typically starts with a forecast of demand in the coming year

Planning decisions:

– Which markets will be supplied from which locations

– Planned buildup of inventories, inventory policies

– Subcontracting, backup locations

– Timing and size of market promotions

Must consider demand uncertainty, exchange rates,

competition over the time horizon

1-14

Supply Chain Operations

Time horizon is weekly or daily

Decisions regarding individual customer orders

Supply chain configuration is fixed and operating policies are determined

Goal is to implement the operating policies as effectively as possible

Allocate orders to inventory or production, set order due dates, generate pick lists at a warehouse, allocate an order to a particular shipment, set delivery schedules, place replenishment orders

Much less uncertainty (due to short time horizon)

1-15


Cycle view: processes in a supply chain are divided

into a series of cycles, each performed at the

interfaces between two successive supply chain stages

– We will not be emphasizing the cycle view in class, as not

all chains have all stages present

Push/pull view: processes in a supply chain are

divided into two categories depending on whether

they are executed in response to a customer order

(pull) or in anticipation of a customer order (push)

1-16

Push/Pull View of Supply Chains

Actions initiated from Suppliers Retail/Customer

Initiated Action

The barrier between push

And pull may vary for different

companies and industries


1-17

Push/Pull View of

Supply Chain Processes

Supply chain processes fall into one of two categories

depending on the timing of their execution relative to

customer demand

– Pull: execution is initiated in response to a customer order

(reactive)

– Push: execution is initiated in anticipation of customer

orders (speculative)

Push/pull boundary separates push processes from

pull processes

– The relative proportion of push and pull processes can have

an impact on supply chain performance

2-18

Outline: Chapter 2 - Chain Performance:

Achieving Strategic Fit and Scope

Competitive and supply chain strategies

Achieving strategic fit

Expanding strategic scope

2-19

Competitive and Supply

Chain Strategies

Competitive strategy: defines the set of customer needs a firm

seeks to satisfy through its products and services

Product development strategy: specifies the portfolio of new

products that the company will try to develop

Marketing and sales strategy: specifies how the market will be

segmented and product positioned, priced, and promoted

Supply chain strategy:

– determines the nature of material procurement, transportation of

materials, manufacture of product or creation of service, distribution of

product

– Consistency and support between supply chain strategy, competitive

strategy, and other functional strategies is important

2-20

The Value Chain: Linking Supply

Chain and Business Strategy

New

Product

Development

Marketing

and

Sales

Operations Distribution Service

Overall Competitive Strategy

Product Dev.

Strategy Marketing

Strategy Supply Chain Strategy

2-21

Achieving Strategic Fit

Strategic fit:

– Consistency between customer priorities of competitive

strategy and supply chain capabilities specified by the

supply chain strategy

– Competitive and supply chain strategies have the same

goals

A company may fail because of a lack of strategic fit

or because its processes and resources do not provide

the capabilities to execute the desired strategy

Example of strategic fit – Dell’s varied sales channels

2-22

How is Strategic Fit Achieved?

Step 1: Understanding the customer and the supply

chain uncertainty

Step 2: Understanding the supply chain capabilities

Step 3: Achieving strategic fit

2-23

Step 1: Understanding the Customer

and Supply Chain Uncertainty

Identify the needs of the customer segment being served

– Quantity of product needed in each lot

– Response time customers will tolerate

– Variety of products needed

– Service level required

– Price of the product

– Desired rate of innovation in the product

– Demand uncertainty: How much does customer demand for a

product vary?

– Are there particular needs related to Sustainability?

2-24

Step 1: Understanding the Customer

and Supply Chain Uncertainty

Key Point: Implied Demand Uncertainty is more than

just Demand Uncertainty

Demand uncertainty: uncertainty of customer demand for a

product

Implied demand uncertainty: resulting uncertainty for the

supply chain given the portion of the demand the supply chain

must handle and the attributes the customer desires from the

product and the experience of purchasing it:

– For example: if customers require very fast service or if they are many

varieties of the product (and customers are picky about what they get)

implied demand uncertainty is higher.

2-25

Impact of Customer Needs on Implied

Demand Uncertainty

Customer Need Causes implied demand

uncertainty to increase because …

Range of quantity required increases Wider range of quantity required

implies greater variance in demand

Lead time required to decrease Less time to react to orders

Variety of products required increases Demand per product becomes more

disaggregated

Number of channels through which

product may be acquired increases

Total customer demand is now

disaggregated over more channels

Rate of innovation must increase New products tend to have more

uncertain demand

Required service level must increase Firm now has to handle unusual

surges in demand

Supply Uncertainty

Now turn away from demand briefly to look at other side of the

coin: Supply

Supply Uncertainty – variability associated with getting the

right amount of the product at the right time

Will increase with….

– Unpredictable/low yields problematic issue from high tech

(semiconductor) to low tech- traditional agriculture)

– Limited/inflexible supply capacity

– Evolving production process

First step to achieving strategic fit is to understand customers

and their inherent implied demand uncertainty, and also

consider effects from Supply Uncertainty, mapping both onto

the implied uncertainty spectrum

1-26

2-27

Implied Uncertainty Spectrum

Predictable

supply and

demand

Salt at a

supermarket

A new communication

device

Highly uncertain

supply and demand

Figure 2.2: The Implied Uncertainty (Demand and Supply)

Spectrum

Predictable supply and uncertain demand or uncertain supply and

predictable demand or somewhat

uncertain supply and demand

An existing

automobile

model

There are exceptions- for example, with salt, think of Fleur de Sel or pink Himalayan salt!

Many firms have attempted to move their products upstream, eg. Fresh Choice: bagged salads

2-28

Step 2: Understanding the

Supply Chain Capabilities

How does the firm best meet demand?

One dimension describing the chain is supply chain responsiveness

– respond to wide ranges of quantities demanded

– meet short lead times

– handle a large variety of products

– build highly innovative products

– meet a very high service level

There is a cost to achieving responsiveness

Supply chain efficiency: cost of making and delivering the product

to the customer

– Increasing responsiveness usually results in higher costs, lowing efficiency

Second step to achieving strategic fit is to map the supply chain on

the responsiveness spectrum

2-29

High Low

Low

High

Responsiveness

Cost

Understanding the Supply Chain: Cost-

Responsiveness Efficient Frontier

2-30

Responsiveness Spectrum

Integrated

steel mill-

Production

scheduled

months in

advance

7-11 Japan,

Changes

merchandise

Mix by location

and time of day

Highly

efficient

Highly

responsive

Somewhat

efficient

Somewhat

responsive

Hanes

Apparel,

Traditional

Make-to-stock

Manufacturer

With lead-times

of several weeks

Most

automotive

Production, large

Variety of products

in a few weeks,

Some customization

So now we have two spectrums (lines)- what do you think is next?

2-31

Step 3: Achieving Strategic Fit

Third Step is to ensure that what the supply chain does well is

consistent with target customer’s needs

All functions in the value chain must support the competitive

strategy to achieve strategic fit

Barilla Pasta and Apple Computer are examples of companies

that are “in the Zone”

– Do you think their supply chain strategies are similar?

Key points

– There is no one right supply chain for all companies

– there is a right supply chain strategy for a given competitive strategy

– In balancing efficiency and responsiveness, it is still critical to

remember sustainability

2-32

Achieving Strategic Fit Shown on the

Uncertainty/Responsiveness Map

Implied

uncertainty

spectrum

Responsive

supply chain

Efficient

supply chain

More

Certain

Highly

Uncertain

Responsiveness

spectrum

2-33

Comparison of Efficient and

Responsive Supply Chains

Efficient Responsive

Primary goal Lowest cost Quick response

Product design strategy Min product cost Modularity to allow

postponement

Pricing strategy Lower margins Higher margins

Mfg strategy High utilization Capacity flexibility

Inventory strategy Minimize inventory Buffer inventory

Lead time strategy Reduce but not at expense

of greater cost

Aggressively reduce even if

costs are significant

Supplier selection strategy Cost and, typically lower

quality

Speed, flexibility, quality

Transportation strategy Greater reliance on low cost

modes

Greater reliance on

responsive (fast) modes

2-34

Other Issues Affecting Strategic Fit

1. Multiple products and customer segments

2. Product life cycle

3. Competitive changes over time

4. Sustainability

2-35

Multiple Products and

Customer Segments

Firms sell different products to different customer

segments (with different implied demand uncertainty)

The supply chain has to be able to balance efficiency

and responsiveness given its portfolio of products and

customer segments

Two approaches:

1. Different supply chains for different products/customers

or

2. Tailor supply chain to best meet the needs of each product’s

demand. Example: W.W. Grainger, MRO

2-36

Product Life Cycle

The demand characteristics of a product and the needs

of a customer segment change as a product goes

through its life cycle

– Examples: pharmaceutical firms, Intel

As the product goes through the life cycle, the supply

chain changes from one emphasizing responsiveness to

one emphasizing efficiency

Supply chain strategy must evolve throughout life cycle

– Early: uncertain demand, high margins (time is important),

product availability is most important, cost is secondary

– Late: predictable demand, lower margins, price is important

2-37

Competitive Changes Over Time

Competitive pressures can change over time

More competitors may result in an increased emphasis

on variety at a reasonable price

The Internet makes it easier to offer a wide variety of

products

The supply chain must change to meet these changing

competitive conditions

– Example Dell used to sell PCs and laptops only via internet,

but now also sells at Wal-Mart

Sustainability

Consider both Ethical as well as Environmental issues

Sustainability policies may be driven by either

regulation or risk factors

– WEEE- EU regulation forced electronics providers to

rethink SCs

– Supplier risk

– Demand risk, consumer expectations

May be complex relationships between

responsiveness, efficiency and sustainability issues

– Sometimes, but not always, involving tradeoffs

2-38

2-39

Expanding Strategic Scope

Scope of strategic fit : The functions and stages within a supply chain that devise an integrated strategy with a shared objective

– One extreme: each function at each stage develops its own strategy

– Other extreme: all functions in all stages devise a strategy jointly

From least to most evolved/expanded….

1. Intracompany intraoperation scope – silos!

2. Intracompany intrafunctional scope

3. Intracompany interfunctional scope

4. Intercompany interfunctional scope - CPFR…

5. Agile Intercompany, interfunctional scope - 3+ companies

Obstacles to Achieving Strategic Fit

In short: today’s business environment is more

challenging for companies

1. Increasing variety of products

2. Shorter product life cycles (technology development, trend)

3. Increasingly picky customers

4. Fragmentation of chain ownership

5. Globalization, on supply-side and also the demand side*

6. Rapidly changing business environment

7. Difficulties with executing new strategies

8. Especially for 2007-2011 timeframe- economic cycle

2-40 *see the P&G Swiffer in Italy story

3-41

Outline: Chapter 3- Supply Chain

Drivers and Metrics

Drivers of supply chain performance

A framework for structuring drivers

Detailed view for each driver and appropriate metrics

3-42

Drivers of Supply Chain Performance

1. Facilities

– places where inventory is stored, assembled, or fabricated

– production sites and storage sites

2. Inventory

– raw materials, WIP, finished goods within a supply chain

– inventory policies

3. Transportation

– moving inventory from point to point in a supply chain

– combinations of transportation modes and routes

4. Information

– data & analysis regarding inventory, transportation, facilities throughout the chain

– potentially the biggest driver of chain performance

5. Sourcing

– functions a firm performs and functions that are outsourced

6. Pricing

– Price associated with goods and services provided by a firm to the supply chain

3-43

A Framework for

Structuring Drivers

Competitive Strategy

Supply Chain

Strategy


Facilities Inventory Transportation

Information


Cross Functional Drivers

Sourcing Pricing

Logistical Drivers

** also includes Sustainability

**

3-44

Facilities

Role in the supply chain- the “where”

– manufacturing or storage (warehouses)


– economies of scale (efficiency priority)

– larger number of smaller facilities (responsiveness priority)

Components of facilities decisions

– Location

» centralization (efficiency) vs. decentralization (responsiveness)

» other factors to consider (e.g., proximity to customers)

– Capacity (flexibility versus efficiency)

– Manufacturing methodology (product focused versus process focused)

– Warehousing methodology (SKU storage, job lot storage, cross-docking)


3-45

Inventory

Role in the supply chain

– Exists because of a mismatch between supply and demand

– Source of cost and influence on responsiveness

– Given Little’s Law, if throughput=demand, then inventory synonymous

with material flow time


– If responsiveness is a strategic competitive priority, a firm can locate

larger amounts of inventory closer to customers

– If cost is more important, inventory can be reduced (or consolidated

further away) to make the firm more efficient

– Example: High-service department store: Nordstrom’s

We will spend 2 chapters in this class on inventory policies!

3-46

Components of Inventory

Decisions

Cycle inventory

– Average amount of inventory used to satisfy demand between shipments

– Depends on lot size

Safety inventory

– inventory held in case demand exceeds expectations

– costs of carrying too much inventory versus cost of losing sales

Seasonal inventory

– inventory built up to counter predictable variability in demand

– cost of carrying additional inventory versus cost of flexible production


– more inventory: greater responsiveness but greater cost

– less inventory: lower cost but lower responsiveness

3-47

Transportation


– Moves the product between stages in the supply chain

– Impact on responsiveness and efficiency

– Faster transportation allows greater responsiveness but lower efficiency

– Also affects inventory and facilities


– If responsiveness is a strategic competitive priority, then faster

transportation modes can provide greater responsiveness to customers

who are willing to pay for it

– Can also use slower transportation modes for customers whose priority

is price (cost)

– Can also consider both inventory and transportation to find the right

balance

3-48

Components of

Transportation Decisions

Mode of transportation:

– air, truck, rail, ship, pipeline, electronic transportation

– Utilization and backhaul rates should be considered

– vary in cost, speed, size of shipment, flexibility, carbon footprint

Route and network selection

– route: path along which a product is shipped

– network: collection of locations and routes

In-house or outsource (see driver #5)


3-49

Information


– The connection between the various stages in the supply chain – allows

coordination between stages

– Crucial to daily operation of each stage in a supply chain – e.g.,

production scheduling, inventory levels


– Allows supply chain to become more efficient and more responsive at

the same time (reduces the need for a trade-off)

– Need to ask: what information is most valuable?

3-50

Components of Information

Decisions

Components of information decisions

– Push (MRP) versus pull (need demand information across

all stages)

– Coordination and information sharing

– Forecasting and aggregate planning

– Enabling technologies include the following:

» EDI

» Internet

» ERP systems

» Supply Chain Management software

» RFID

– Still some tradeoff exists: Responsiveness versus efficiency

3-51

Sourcing


– Set of business processes required to purchase goods and services in a chain

» Examples: contract manufacturers, Transportation/Inventory services- 3PL

– Supplier selection, single vs. multiple suppliers, contract negotiation


– Sourcing decisions are crucial because they affect the level of efficiency and

responsiveness in a supply chain

– In-house vs. outsource decisions- improving efficiency and responsiveness

» Example: Expedited delivery usually requires Parcel Delivery

Components of sourcing decisions

– Perform a task in-house versus outsource?

– Supplier evaluation and selection

– Procurement process

– Overall trade-off: balance profitability (Risk? Ethical issues?)

3-52

Pricing


– Pricing determines the amount to charge customers

– Pricing strategies can be used to match demand and supply


– Firms can utilize optimal pricing strategies to improve efficiency and

responsiveness

– Low price and low product availability; vary prices by response times

Components of pricing decisions

– Pricing and economies of scale

– Everyday low pricing versus high-low pricing

– Fixed price versus menu pricing

– Overall trade-off: Increase the firm profits

We will explore effects from some of these pricing decisions later

Metrics

The performance for these supply chain drivers can be quantified

with metrics. Here’s some examples we will work with during

this term:

1. Facilities: Capacity, Utilization rate, per unit production cost

2. Inventory: Days-OnHand (Dollars-OnHand), Safety Stock, Stockout %

3. Transportation: Fraction transported by mode, inbound/outbound

shipment size, inbound/outbound transportation cost per unit

4. Information: Forecast error, ratio of demand variability to order variability

5. Sourcing: supplier lead time, average purchase price, supplier reliability

6. Pricing: profit margin, fixed cost per order, variable cost per unit

Certain metrics will be more important than others for different

firms with different supply chain strategies

Information Overload: SCOR has over 150+ KPIs

3-53

1-54

Summary of Learning Objectives-

Chapter 1

What are supply chain stages?

What are the three flows within a supply chain?

What are the three key supply chain decision phases

and what is the significance of each?

What is the push/pull view of a supply chain?

What is the goal of a supply chain and what is the

impact of supply chain decisions on the success of the

firm?

2-55


for Chapter 2

Why is achieving strategic fit critical to a company’s

overall success?

How does implied demand uncertainty differ from

demand uncertainty?

How does a company achieve strategic fit between its

supply chain strategy and its competitive strategy?

What are some complications to achieving this fit?

3-56


for Chapter 3

What are the major drivers of supply chain

performance?

What is the role of each driver in creating strategic fit

between supply chain strategy and competitive strategy

(or between implied demand uncertainty and supply

chain responsiveness)?

What are some relevant metrics?

In the remainder of the course, we will learn how to make

decisions with respect to these drivers in order to achieve

strategic fit and surmount these obstacles

4-1

Chapter 4 Outline: Designing Distribution

Networks and Applications to e-Business

The Role of Distribution in the Supply Chain



E-Business and the Distribution Network

4-2

The Role of Distribution

in the Supply Chain

Distribution: the steps taken to move and store a product from

the supplier stage to the customer stage in a supply chain

– Distribution directly affects cost and the customer experience and

therefore drives profitability

Factors Influencing Distribution Network Design: As choice of

distribution network can achieve supply chain objectives from

low cost to high responsiveness:

– Distribution network performance evaluated along two dimensions at the

highest level (and when sustainability is explicitly considered, three):

» Customer needs that are met

» Cost of meeting customer needs

» Affect on sustainability

– Distribution network design options must therefore be compared

according to their impact on customer service and the cost to provide this

level of service as well as any significant sustainability impacts

4-3


DC = Distribution Center (effectively synonymous w/ Wholesaler)

– DCs can be operated by a manufacturer, retailer or completely separate player

– Types of DCs 1. Break-bulk

2. Transport optimizers, especially Cross-Dock

3. Fast response -aggregate inventory (risk-pooling) yet still quick delivery to customer, e.g. MRO

Product, price, commoditization, and criticality (item’s importance) have an impact on the type of distribution system

The choice of a distribution network has very long-term consequences

– Consider whether an exclusive distribution strategy is advantageous

– The ownership structure of the distribution network can have as big as an impact as the type of distribution network (ex. Naya water/CCE distribution)

4-4

A Professorial Aside: Value of

Distributors in the Supply Chain

Are distributors an unnecessary link?

Consolidate small or varied replenishment orders (breaking bulk

orders and centralizing safety stocks)

– Consumer Packaged Goods in India

– Pharmaceuticals: 5-6 distributors in U.S. handle thousands of retailers who

order from hundreds of manufacturers

Sometimes mandated by regulation: For alcohol sales in the US,

the 2nd tier is mandated in 48 states, serves as a tax collection point

Distributors typically have low margins (1%-2%), so are

motivated to be efficient

4-5

Factors Influencing

Distribution Network Design

Elements of customer service (responsiveness) that are

influenced by network structure:

– Response time

– Product variety & availability

– Customer experience

– Order visibility

– Returnability (for both customer service and sustainability reasons)

Supply chain costs affected by network structure (4 of 6 drivers

from Chapter 3):

– Facilities and handling (At the moment, focus is on warehousing facilities )

– Inventories

– Transportation

– Information

» Let’s graph the interactions of these with costs

4-6

Facility Costs and Number

of Facilities

Facility

Costs


4-7

Transportation Costs and


Transportation

Costs


4-8

Inventory Costs and Number

of Facilities

Inventory

Costs


4-9

Transportation

Total Costs Related to


Tota

l C

ost

s


Inventory

Facilities

Total Costs

4-10


Number of

Facilities

Response Time

4-11

Response Time

Variation in Logistics Costs and Response

Time with Number of Facilities



4-12

Design Options for a

Distribution Network

We consider some various network options that move beyond

the traditional model. (Many of these non-traditional networks

have been made more viable by the internet revolution)

Shown in graphic format in next few slides:

– Manufacturer Storage with Direct Shipping

– Manufacturer Storage with Direct Shipping and In-Transit Merge

– Distributor Storage with Carrier Delivery

– Distributor Storage with Last Mile Delivery

Also not explicitly graphed:

– Retail Storage with Customer Pickup- often integrated with traditional

model (Bevmo.com, for example. REI.com and Gap.com also allow

used this model in the US).

– Not discussed: Manufacturing/Distributor storage w/Customer Pickup

4-13

Manufacturer Storage with

Direct Shipping via Parcel Delivery (Fig. 4.6)

Manufacturer

Retailer

Customers

Product Flow

Information Flow

This is also called drop shipping

4-14

In-Transit Merge Network (Fig. 4.7)

Factories

Retailer

Product Flow

Information Flow

In-Transit Merge by

Carrier

Customers

4-15

Distributor Storage with

Parcel Delivery (fig 4.8)

Factories

Customers

Product Flow

Information Flow

Warehouse Storage by

Distributor/Retailer

4-16

Distributor Storage with

Last Mile Delivery (Fig. 4.9)

Factories

Customers

Product Flow

Information Flow

Distributor/Retailer

Warehouse

4-17

Competitive Performance of the

Distribution Network

Table 4-7 in the text shows that each of these distribution

networks has different characteristics with respect to:

– Costs - facilities, inventory, transport, information

– Service/Responsiveness:

» Response time

» Product variety

» Product availability

» Customer experience

» Order visibility

» Return-ability

Performance will change depending on attributes of

– Products: demand level, variety, multiple sources? high value

– Customers: do they desire quick response times? Effort level?

4-18

E-Business and the Distribution

Network

Depending on the firm, the product and core customer base, e-

Business will have different impacts on:

Customer Service (i.e. Responsiveness of Supply Chain):

Response time (non downloadable products), Product variety, Product

availability, Customer experience, Time to market, Order visibility,

Returnability, Direct Sales to Customers, Efficient Funds Transfer,

Costs Facilities , Inventory, Transportation, Information

In general, E-Business provides an easier way to adjust Pricing: Flexible

Pricing, Product Portfolio, and Promotions

Example: Table 4-10 in the text summarizes Dell’s online

business with respect to two different products:

– customized, high-value PCs verses standardized, commodity PCs

Chapter 5 Outline: Network

Design in the Supply Chain

The Role of Network Design in the Supply Chain

Factors Influencing Network Design Decisions

Framework for Network Design Decisions

Models for Facility Location and Capacity

Allocation

5-19


Facility role

– What role should each facility play?

Facility number and location

– How many facilities do we need?

– Where should facilities be located?

Capacity allocation

– How much capacity should be allocated to each facility?

Market and supply allocation

– What supply sources should feed each facility?

– What markets should each facility serve?

5-20

Facility Role-

Classifications of Facilities

In order from lowest cost to highest value, and their strategic roles:

1. Offshore (Low cost facility for export production)

2. Source (Low-cost facility for global production)

3. Server (Regional production facility)

4. Contributor (Regional production facility with development skills)

5. Outpost (Regional production facility used by the firm to gain expertise from the locals)

6. Lead (Model facility that leads the firm in development of new products or technologies)

Factors Influencing


Strategic – Evaluate tradeoffs: place manufacturing close to market -vs.- low cost?

– Should we co-locate facilities with vendors/suppliers?

Technological: Do production technologies have significant economies of scale?

Macroeconomic – Tariffs and tax incentives (i.e. free trade zones), Exchange rate and demand risk

Political: Stability, clear legal system and regulations important for corporations

Infrastructure – Will local infrastructure support a facility? Labor (especially skilled) available?

Competitive: Locate near or far from rivals?

Customer Response time / Local Presence – How important is convenience –vs.- lower cost centralized facilities

– Is “local knowledge” crucial to the business model?

Logistics & facility COSTS – Crucial to consider in setting up or redesigning the supply chain

Sustainability: Are local environmental and ethical practices consistent with corporate need?

5-22


Local FG

Mix

Regional FG

Local WIP

Central FG

Central WIP



Cost

Response Time Slooooow Quick

Low

High

5-23

Infeasible (without

innovation)

Inefficient-

can either

reduce cost or

lead-time

FG- finished goods.

WIP- Work in Progress

How Many Facilities?

Service given Number of Facilities


Response

Time

5-24


Costs


Inventory

Transportation

Facility costs

5-25

Percent Service

Level Within

Promised Time

Transportation

Cost Buildup as a Function of Facilities

Lev

el o

f S

ervic

e


Inventory

Facilities

Total Costs

5-26

Cost

of

Op

erati

on

s

Low

High

A Framework for

Global Site Location

PHASE I

Supply Chain

Strategy

PHASE II

Regional

Facility

Configuration

PHASE III

Desirable Sites

PHASE IV

Location

Choices


INTERNAL CONSTRAINTS

Capital, growth strategy,

existing network

PRODUCTION TECHNOLOGIES

Cost, Scale/Scope impact, support

required, flexibility

COMPETITIVE

ENVIRONMENT

PRODUCTION METHODS

Skill needs, response time

FACTOR COSTS

Labor, materials, site specific

GLOBAL COMPETITION

TARIFFS AND TAX

INCENTIVES

REGIONAL DEMAND

Size, growth, homogeneity,

local specifications

POLITICAL, EXCHANGE

RATE AND DEMAND RISK

AVAILABLE

INFRASTRUCTURE

LOGISTICS COSTS Transport,

inventory, coordination

5-27


Useful tools for both Phase II and Phase IV

Question for Phase II: “In what regions should we source demand in and how do we configure our network?” given:

– Regional demand, tariffs, economics of scale, aggregate factor costs

– Not necessary to go to detail of specific plant locations as we do in later phases

– Need to also consider less quantifiable factors such as political and regulatory climate, competition

Phase IV involves selecting specific existing facilities and allocating capacity within those selected given:

– Fixed facility cost, Transportation cost, Production cost, Inventory cost, Coordination cost

5-28

Example: Using Network Models

for Phase II Decisions

SunOil, a global energy company, needs to determine 1. where to locate facilities to service their demand

2. what size to build in the region (small or large), should they locate a facility there

– They divide the world into 5 different regions: N.America, S.America, Europe, Asia, Africa

– SunOil knows regional demands, transport costs, and facility costs and capacities for each size (and region)

– We will ignore tariffs and exchange rate fluctuations for now, and assume all demand must be met (so we can focus on minimizing costs)

What analytic tool are we likely to use?

What is the “twist” that we need to consider?

5-29

Excel Example: SUNOIL

I’ll email the following document: network-MIP.xls

Turn to the SunOil sheet

The data is shown below

INPUTS

Supply Region N. America S. America Europe Asia Africa fixed cost cap. M fixed cost cap. M

N. America 81$ 92$ 101$ 130$ 115$ 6,000$ 10 9,000$ 20

S. America 117$ 77$ 108$ 98$ 100$ 4,500$ 10 6,750$ 20

Europe 102$ 105$ 95$ 119$ 111$ 6,500$ 10 9,750$ 20

Asia 115$ 125$ 90$ 59$ 74$ 4,100$ 10 6,150$ 20

Africa 142$ 100$ 103$ 105$ 71$ 4,000$ 10 6,000$ 20

Demand total 12 8 14 16 7

production,tax, and transit costs per 1M units from

Supply Region to Demand Region SMALL facility LARGE facility

Capacitated Plant Location Model

n the number of potential sites – As we are considering two different type plants

(small, large) for each region, n = 10

m regions with demand

Dj demand in region j

Ki capacity at plant I

fi fixed cost of keeping plant i open

cij variable cost of sourcing region j from plant i

yi = 1 if plant is located at site i,

= 0 otherwise

xij Quantity shipped from site i to region j

1,0

..

1

1

1 11

y

yKx

Dx

xcyf

i

ii

n

jij

j

n

iij

n

i

m

jijiji

n

ii

ts

Min

5-31

• Can we do this with a pure LP?

• When would a simple LP be acceptable?

While the equations may

look complex, go to the

spreadsheet and look at the

underlying relationships

Excel Example: SUNOIL

Before solving, we can experiment with some configurations.

What are the tradeoffs?

– Often a good idea to experiment to help understand the network model

and the solution

Consider the optimal solution- what are some characteristics?

Food for Thought: what happens if we want to change the

model?

– Force a plant to be located in Europe?

– Avoid locating more than one facility in the same region?

– Force worldwide capacity to be able to accommodate more than current

demand by 5 M…

What the book has for Phase III:


Ton Mile-Center Solution

– x,y: Warehouse Coordinates

– xn, yn : Coordinates of delivery

location n

– dn : Distance to delivery

location n

– Fn : Annual tonnage to delivery

location n

k

n n

n

k

n n

nn

k

n n

n

k

n n

nn

n

dFD

dFyD

dFD

dFxD

yyxxd

n

n

y

n

n

x

nn

1

1

1

1

22

)()(

Min FDd nn n

5-33

Before you pull out your calculator….

Gravity Location Models: Limitations

Professor Opinion, not in Textbook

Assumes that all distances have identical per-mile costs – Assumes homogenous topography

– Ignores limitations of existing ground/water transport network, inter-state/country transit taxes and regulations

Costs of setting up a new facility is often prohibitive compared to revamping an existing facility (even if in a less desirable location) – Especially pertinent given economic and less-quantifiable costs of

shutting down facilities

– The problems I have encountered personally have been to consolidate or revamp facilities, never to set up a completely new installation

For this class, you can assume that you will be provided with a finite number of site locations, and that you will be given all cost parameters ci,j for transit between location i and j

Phase IV: Network Optimization

Models- Allocating Demand



Which plants to establish/keep? How to configure the network?

Key Costs:

• Fixed facility cost

• Transportation cost

• Production cost

• Inventory cost

• Coordination cost

5-35

Example- Modeling a Phase IV

Decision

TelecomOne has merged with High Optic. They have plants in different cities and service several regions. They would like to figure out how to service all demand while keeping costs low:

– The supply cities are Baltimore (capacity 18K), Cheyenne (24K), Salt Lake City (27K), Memphis (22K) and Wichita (31K)

– They have the following monthly regional demands: » 10K in Atlanta

» 6K in Boston

» 14K* in Chicago * per table 5.3 , Book uses 12 K, not 14K for Chicago,

» 6K in Denver although their spreadsheet inserts are okay

» 7K in Omaha

– They will consider consolidating facilities

What sort of tool are we likely to use?

5-36


Answers the questions of…

Which market is served by which plant?

Which supply sources are used by a plant?

Decision variables:

xij = Quantity shipped from plant site i to customer j

Can solve as a simple LP, see sheet “Telecom-all-plants” under network-MIP.xls

But what if we also have the option of not using all facilities…. 0

..

1

1

1 1

x

Kx

Dx

ts

xcMin

ij

i

m

jij

j

n

iij

n

i

m

jijij

5-37

Allocating Demand to

Production Facilities

Decision variables

yi = 1 if plant is located/left

open at site i, 0 otherwise

xij = Quantity shipped from

plant site i to customer j

See Sheet “Telecom-close-

plants” of network-MIP.xls

Look familiar? 1,0

..

1

1

1 11

y

yKx

Dx

xcyf

i

ii

n

jij

j

n

iij

n

i

m

jijiji

n

ii

ts

Min

5-38


Example Results

Before we solve the problem, what can we say about TelecomOptic’s situation?

What does the Excel model indicate should happen with plant configuration? Demand allocation?

What are the ramifications from this solution?

What are some what-if scenarios we might consider?

5-39

Considering Additional Layers: Simultaneously Locating Plants and DCs

Now add cost to transport from suppliers, as well as the

plant and DC/Warehouse costs

yKx

Dx

xcxcxcyfyf

ii

n

jij

j

n

iij

t

e

m

jejej

n

i

t

eieie

l

h

n

ihihie

t

eei

n

ii

ts

Min

1

1

1 11 11 111

..

5-40

suppliers plants DCs

customer1

customer2

customer3

Etc… (Don’t worry- that’s beyond the scope of this class)

Making Network Design Decisions

In Practice

Do not underestimate the life span of facilities

– Production facilities harder to retool than storage facilities

– Consider ethical issues with respect to closing plants

Do not gloss over the cultural implications

– Should Eichbaum (who has a single brewery in Mannheim)

produce beer for the growing Chinese in Shanghai?

Do not ignore quality of life issues

Consider tariffs and tax incentives when locating

facilities

5-41

6-42

Outline- subset of Chapter 6 Designing Global Supply Chain Networks

Due to time limitations, we do not delve into Decision Tree

theory and other analytical models in this chapter, and we

consider only the introductory material in this chapter

The Impact of Globalization on Supply Chain Networks


Risk Management in Global Supply Chains

6-43

The Impact of Globalization on

Supply Chain Networks

Globalization offers companies opportunities to simultaneously grow revenues and decrease costs

The opportunities from globalization are often accompanied by significant additional risk

There will be a good deal of uncertainty in demand, prices, exchange rates, and the competitive market over the lifetime of a supply chain network

Therefore, building flexibility into supply chain operations allows the supply chain to deal with uncertainty in a manner that will maximize profits

6-44


Total cost can be identified by focusing on the

complete sourcing process, not just per-unit cost

Offshoring to low-cost countries is likely to be most

attractive for products with:

– High labor content

– Large production volumes

– Relatively low variety

– Low transportation costs

Perform a careful review of the production process

– Consider use of auditors (verifying workplace conditions)

and quality testing services

Risk Management in Global

Supply Chains

Disruptions

– Topical Example: Honda, Nissan and Toyota have

effectively shut down factories for weeks following the

2011 Tsunami

» Nissan estimates lost profits of over $25 million/day

Delays

Systems risk

Forecast risk

Intellectual property risk

Procurement risk

Inventory risk

Capacity risk 6-45

Tailored Risk Mitigation Strategies

Increase capacity

Get redundant suppliers

Increase responsiveness

Increase inventory

Increase flexibility

Pool or aggregate demand

Increase source capability

6-46

4-47


Objectives

What roles do distributors play in the supply chain?

What are the key factors to be considered when

designing the distribution network?

What are the strengths and weaknesses of various

distribution options, including e-Business enabled

ones?


Objectives

What is the role of network design decisions in the supply chain?

What are the factors influencing supply chain network design decisions?

Describe a strategic framework for facility location

How can network optimization methods be used for facility location and capacity allocation decisions?

5-48

7-1

Outline:

Demand Forecasting

Given the limited background from the surveys

and that Chapter 7 in the book is complex, we will

cover less material.

– The role of forecasting in the chain

– Characteristics of forecasts

– Basic approach to demand forecasting

– Measures of forecast error

– We will skip seasonality and Holt’s and Winter’s

methods. We do not spend any time on static forecasts

7-2

Role of Forecasting

in a Supply Chain

The basis for all strategic and planning decisions

in a supply chain

Used for both push and pull processes

Examples:

– Production: scheduling, inventory, aggregate planning

– Marketing: sales force allocation, promotions, new

production introduction

– Finance: plant/equipment investment, budgetary

planning

– Personnel: workforce planning, hiring, layoffs

All of these decisions are interrelated

7-3

Characteristics of Forecasts

A FORECAST is a statement about the future

– Absatzprognose, Vorhersage

Forecasts are always wrong. Report both the expected

value of the forecast and the measure of error

Long-term forecasts are less accurate than short-term

forecasts (forecast horizon is important)

Aggregate forecasts are more accurate than disaggregate

forecasts

In order to forecast, the past has to have some relevance to

the future

http://www.linguee.de/deutsch-englisch/uebersetzung/Absatzprognose.html

7-4

Forecasting Methods

Qualitative: primarily subjective; use judgment/opinion

Time Series: use historical demand only

– Static

– Adaptive We will only consider adaptive

Causal (or associative): use the relationship between demand and a

factor other than pure time to develop forecast

Simulation

– Imitate consumer choices that give rise to demand

– Can combine time series and causal methods

7-5

Basic Approach to

Demand Forecasting

Understand the objectives of forecasting

Integrate demand planning and forecasting

Identify major factors that influence the demand

forecast

Understand and identify customer segments

Determine the appropriate forecasting technique

Establish performance and error measures for the

forecast

7-6

Components of an Observation

Observed demand (O) =

Systematic component (S) + Random component (R)

Level (current deseasonalized demand)

Trend (growth or decline in demand)

Seasonality (predictable seasonal fluctuation)

• Systematic component: Expected value of demand

• Random component: The part of the forecast that deviates

from the systematic component

• Forecast error: difference between forecast and actual demand

7

Steps in the Forecasting Process

Step 1 Determine the purpose of forecast

Step 2 Pick an appropriate time horizon

Step 3 Select a forecasting technique - Plotting data may reveal patterns

Step 4 Gather and analyze data in detail – State assumptions

– Validate Data: May need to cleanse or filter for past events

Step 5 Calculate forecast

Step 6 Analyze/Monitor the forecast- Measure Accuracy

Are results acceptable?

No: Return to Step 3, revising forecast technique

Yes: Publish forecast

For ongoing forecasting: repeat Steps 4 through 6

Time Series Forecasts Trend - long-term movement in data

– Linear: steady increase (or decrease) over time

– Not all trends are linear. Demand may be exponential, may both increase and decrease over product life cycle: VHS players

Seasonality - short-term regular variations in data – Example: Walgreen’s sales of cold medications over the year

– Not just limited to Fall/Winter/Spring/Summer variations » Weekly demand for reservations at expensive restaurants

» Daily cycle of coffee sales at Starbucks

Irregular variations - caused by unusual circumstances – Infrequent spikes

– i.e. a stock market crash, 9/11 catastrophe

Random variations - caused by chance

Time Series Forecasting Techniques Covered in this Class

Averaging (or Smoothing)

– Moving Average

– Weighted Moving Average

– Exponential Smoothing

- Trend-Adjusted Exponential Smoothing (Holt’s) is not

covered, nor is Winters (trend + seasonality)

Linear Trend Analysis

10

Moving Average

The average of the N most recent observations:

Example: a 4-period MA for time period 7 would be

F7= (A6+A5+A4+A3)/4

The larger N, the smoother the forecast, but the greater the Lag (ability to respond to “real” changes)

n

A

tMA

t

nti

i

n

1

)(

11

General Note: To Write Formula

with Respect to t or t+1

Which is correct?

1. Ft+1 = (blah)At + blah…

2. Ft = (blah)At-1 + blah…

Both are! As long as it’s clear just what t (or t+1) represents,

these can be usable interchangeably

– If you need to calculate the forecast for period 5, be clear whether t=5 or t+1=5

But most important, don’t write:

Ft = (blah)At + blah

12

Weighted Moving Average Premise:The most recent observations might have the best

predictive value. Yet for simple moving averages older data

points have same importance as most recent

We modify to give greater weight to more recent observations.

(Remember: S Wi = 1 or you get bias!)

Advantages: Avoids “oversmoothing” and lag time is

decreased

Weights are arbitrary, often found through trial and error!

1

)(t

nti

iin AWtWMA

13

Exponential Smoothing

Exponential Smoothing is a type of Weighted Moving

Average:

Ft = aAt-1 + a (1-a) At-2 + a (1-a)2At-3 + a (1-a)3At-4+ ...

However, it is much more easily written, computed and

understood as:

Where a is between 0 and 1

11 )1( ttt FAF aa

More Exponential Smoothing

Rearranging the terms shows this method can be viewed as the

previous period’s forecast adjusted by a percentage of the

previous period’s error (Et-1 = At-1– Ft-1)

The quickness of forecast adjustment is determined by the

smoothing constant, a

– The closer a to zero, the greater the smoothing

– How do we pick a? Trial and error or can even optimize for it!

– How to initialize the forecast? Many ways!

» Book: average all the data we have so far

» More practical and repeatable? Start it with F2 = A1

)( 111 tttt FAFF a

15

How to Select a Forecast

To forecast data without trends, we could use a simple naïve

forecast, a MA (still need to pick the window), a WMA (need

to pick both the window and the weights) or an exponential

smoother (need to pick a)

We will get many different answers- how do we pick the one

we feel will have the best chance of being close to what will

happen?

We calculate past forecast accuracy, and we then pick the one

that is most accurate.

Measuring Forecast Accuracy

•Error: difference between actual value and predicted value.

Many different measures exist (we use MAD only)

•Mean Absolute Deviation

(MAD)

• Mean Squared Error

(MSE)

• Standard Error (Standard Deviation)

t

FA

MAD

t

i

ii

t

1

1

1

2

t

FA

MSE

t

i

ii

t

tt

tt

MAD

MSE

*25.1 thumbof rule


If there is a trend, the smoothing filters we have covered will

LAG, resulting in bad forecasts.

Plot the data first- in this example, do you see a trend?

If the trend is linear, we will use Linear Trend Analysis

– Caveat: Not all trends are linear! (We do not cover curvilinear regression in

this class)

sales by week

145

150

155

160

165

170

175

180

0 2 4 6week

sa

les

Linear Trend Equation

Where

a = intercept

b = slope

Looks like a simple line equation, but a and b are determined to minimize Mean Squared Error (MSE)

Yt = a + b*t

140

145

150

155

160

165

170

175

180

185

1 2 3 4 5 6

Graphing the Results

Regressing Sales Against Week

145

150

155

160

165

170

175

180

185

1 2 3 4 5 6

week

sale

s Actual

Forecast

Example:


An intern at Netflix has been tracking weekly rentals of the direct-to-DVD movie “Barney Meets Vin_Diesel: Fossilized!” and, after noticing a pattern, has modeled them with a linear trend analysis. The Excel model gives a= 400, b= -10, where t = 0 was the DVD release week. It is currently week 12

– What is the linear trend equation?

– What are sales predicted to be this week?

– What does the model predict sales will be a half year (26 weeks) after the release?

– When does the model predict sales to stop? Do you believe this model is likely to be accurate for making long term predictions?

Associative Forecasting

What if we think there is a better indicator of future behavior than time?

Use explanatory or predictor variables to predict the future

– E.g. Using interest rates to predict home purchases

The associative technique used in this class is Simple Linear Regression

– Linear Trend Analysis was an example where time t was used at the dependent variable. But now we can use factors other than time

Yt = a + bt Linear Trend Analysis

Yt = a + bXt Associative Forecast

( Xt is used instead of t)

– Again, we use Excel to determine a and b

22

Associative Forecasting:

Linear Regression D

epen

den

t vari

ab

le

Independent variable

X

Y

Actual

value

of Y

Estimate of

Y from

regression

equation

Value of X used

to estimate Y

Regression

equation:

Y = a + bX

23

Associative Forecasting:

Linear Regression

Dep

end

ent

vari

ab

le

Independent variable

X

Y

Actual

value

of Y

Estimate of

Y from

regression

equation

Value of X used

to estimate Y

Deviation,

or error

Regression

equation:

Y = a + bX

24

Example:

Associative Forecast

Sales Advertising

Month (000 units) (000 $)

1 264 2.5

2 116 1.3

3 165 1.4

4 101 1.0

5 209 2.0

a = Y - bX b =

A rotor manufacturer has recorded these sales figures over the past 5

months. They also know the budget spent promoting these parts

1) Is there wide variation in sales?

2) Does this appear to be a good candidate for linear trend analysis?

25

Now Consider Sales

verses Advertising Spend

26

How Strong is the Relationship?

Correlation ( r ), measures strength and direction of the forecast of Y with respect to X (or t for linear trend analysis) – 0 < r <1 Positive correlation (sales of ice cream cones –vs- temperature)

– -1 < r < 0 Negative correlation (sales of sweatshirts –vs- temperature)

You are not expected to compute r by hand! Instead use Regression Analysis in Excel (the “multiple R entry”)

R-Squared ( r2) measures the percentage of variation in y that is “explained” by x – If .8 < r2 < 1, X is a very good predictor

– For r2 < .25, X is a poor predictor- look for something else!

Even if you have a good predictor, remember correlation is not causation

27

Example: Excel Solution

to Linear Regression

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.979565

R Square 0.959547

Adjusted R Square 0.946063

Standard Error 15.60274

Observations 5

ANOVA

df SS MS F Significance F

Regression 1 17323.66 17323.66 71.1604 0.0035

Residual 3 730.3361 243.4454

Total 4 18054

CoefficientsStandard Error t Stat P-valueLower 95%Upper 95%Lower 95.0%Upper 95.0%

Intercept -8.13 22.35 -0.36 0.74 -79.27 63.00 -79.27 63.00

X Variable 1 109.23 12.95 8.44 0.00 68.02 150.44 68.02 150.44

Correlation is not Causation:

An Example The following scatter-plot shows that the average life

expectancy for a country is related to the number of doctors per

person in that country. We could come up with all sorts of

reasonable explanations justifying this, but…

Lurking Variables and Causation:

Another Example

This new scatter-plot shows that the average life expectancy for is

also related to the number of televisions per person in that country.

– And the relationship is even stronger: R2 of 72% instead of 62%

Since TVs are cheaper than doctors, Why don’t we send TVs to

countries with low life expectancies in order to extend lifetimes.

Right?

Lurking Variables and Causation:

An Example

How about considering a lurking variable? That

makes more sense… – Countries with higher standards of living have both longer life

expectancies and more doctors (and TVs!).

– If higher living standards cause changes in these other variables,

improving living standards might be expected to prolong lives and,

incidentally, also increase the numbers of doctors and TVs.

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Documents

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