The Salvation Army in Dallas: The Supply Chain

Challenges of a Non-Profit Organization

Arunachalam Narayanan
Teaching Note‡
Case Overview

This case introduces the reader to The Salvation Army, a non-profit humanitarian organization. The
primary mission of this faith-based organization is to rehabilitate people who have lost their self-
direction. This is achieved by providing them a place of hope at The Salvation Army’s adult
rehabilitation centers (ARCs). An ARC provides shelter, food, clothing, medical/psychiatric
assistance, meaningful work or vocational training, and finally fellowship and spiritual guidance. The
main support for the rehabilitation centers come from the sale of donated items at Salvation Army
thrift stores. This case is unique because it deals with community aid humanitarian operations and
sustainability topics, rather than disaster management.
Humanitarian organizations are typically not-for-profit entities, and they operate in both
uninterrupted (development aid) and interrupted (disaster aid) environments (McLachlin et al. 2009).
Development aid is often delivered in places where disruptions are likely, i.e., in environments that
are likely to transition from uninterrupted to interrupted, and back again. Most case studies available
today in the humanitarian and non-profit operations management domain deal with either disaster or
development aid. 1,2 But, humanitarian organizations such as The Salvation Army, Goodwill, and
Feeding America also have a primary mission apart from disaster relief—that is community aid. This
aid relates to hunger relief, eradication of poverty, or rehabilitation of people on a day-to-day basis.
These organizations have strategic, operational, and tactical problems that can be effectively
addressed using operations management tools (Narayanan and Altay, 2012).
These community-aid organizations play an important role in sustainability and recycling. They
divert several billion pounds of clothing and household goods from landfills by recovering the value
in these unwanted materials. Corporations have also partnered with these groups to increase the
impact of their social and sustainable initiatives 3. Along the way, these aid organizations also create
jobs and job training opportunities for people in need of work. Goodwill’s “reduce, reuse, repurpose”
slogan and Salvation Army’s “don’t throw it away – invest it in people” explain their environmental
impact in a nutshell.
The main focus of this case is on the problems faced by Major Carl Earp at his Dallas ARC
facility in Texas. As with every rehabilitation center, his goal is not only to generate enough revenue
from the family and thrift stores to pay for the religious mission at the ARC, but also to send about
31% of the revenue generated to the head office in Atlanta for strategic initiatives. At present, the
Dallas ARC could afford to send only 14% of revenue back to the head office. To add to this burden,
recently one store was lost to a freak accident when a bus ran through the store after being hit by a
wrong-way driver. Unfortunately the driver of the wrong-way vehicle was under insured, so The
Salvation Army lost a store that had been generating $40,000 in monthly sales. Now, Major Carl is
looking for some innovative ways to increase revenue or reduce expenses to reach his goals.

‡
Arunachalam Narayanan of University of Houston prepared this teaching note as the basis for class
discussion rather than to illustrate either effective or ineffective handling of an administrative
situation.
1
http://www.ecch.com/educators/ordering/selecting/featuredcases/inseadhrg
2
http://www.ecch.com/educators/search/results?s=5B0A37D19007B1C66A86BCCDD83BF678 (Search string:
humanitarian; Accessed on March 1st, 2012)
3
http://www.goodwill.org/press-releases/goodwill-and-dell-expand-free-computer-recycling-programs/
Learning objectives

This case is designed to elicit classroom discussion in operations management courses on non-
profit/humanitarian and sustainability topics. The objectives of this case include:

• Demonstrate the challenges of community aid organizations, and understand their conflicting
objectives between social and economic goals.
• Upon completion of the case analysis, students must make recommendations for revenue
generation or expense reduction at the humanitarian organization. They should also provide a
plan of action for implementing it, while keeping in mind their non-profit and social values
aspects.
• Identify and understand the unique role these organizations play in sustainability. In the end,
students should be able to identify new ways of how these organizations could improve their
environmental impact and be a social innovator of sustainability practices.

All of the data for the case analysis included in the case exhibits are provided to facilitate analysis
by the students. The students will have had ample opportunity to acknowledge the unique challenges
and opportunities of a humanitarian organization. This exercise will also provide the students a
platform to hone their skills in developing or evaluating a business plan for a nonprofit organization.

Intended Audience

The case is appropriate for discussion in a class that has a supply chain or operations management
with non-profit or sustainability focus. This case can be administered to juniors, seniors or graduate
students (M.S. or M.B.A.).

Possible Teaching Strategy

There is more than enough material in the case to occupy a 75-minute class period, or even two 50-
minute class periods. Below is a possible teaching strategy for a 75-minute class period. The students
should read the case study in advance. As part of their preparation, the students should have analyzed
the case and show up for class with their recommendations for Major Carl Earp of Salvation Army,
Dallas. This could be ensured by having students, individually or in small groups, turn in a two-page
write up outlining their findings. Note that prior to class the students will typically focus on
operational issues associated with the case, such as increasing the efficiency of the reclamation
process for the donated goods. In class, the instructor must expand the analysis to include the strategic
issues of non-profit organizations in general.

10 minutes: Talk about the unique aspects of humanitarian SCs, and specifically focus on the
distinction between the different relief/aid operations

There are non-profit supply chains that provide aid and relief to people in need. Exhibit TN 1 shows
the three different types of humanitarian supply chains (Narayanan and Altay, 2012). The most
common one discussed in media and literature is disaster relief. These SCs are characterized by a lack
of infrastructure (destroyed by natural or manmade disaster) and a lack of reliable information
regarding need in the region of calamity. There are thousands of decision makers (with no
coordination) and an urgent need of supply materials to save lives. The second one, development aid,
usually takes place after providing immediate relief. This SC relies heavily on local organizations for
distribution and dissemination of information and relief materials. The third one is community aid
SCs, which this case focusses on. They have an established infrastructure (network of local facilities
with materials, people, and logistics equipment) and some amount of demand certainty for their
operations. These organizations also coordinate relatively well and share information with their
donors and other facilities in the region. Examples of such organizations include The Salvation Army,
Goodwill, and Feeding America and its network of food banks. These organizations/SCs also
transition into a relief agency when a disaster strikes, either assisting the aid operations or leading the
relief effort.

Exhibit TN 1. A framework of Humanitarian SCs

High Low
Level of Coordination
High
Low

Disaster Relief

Information (Reliability
Urgency and Uncertainty

and Sharing)
Development Aid

Community Aid

Low High

Lack of Infrastructure
Low High

Adapted from Narayanan and Altay (2012)

10-15 minutes: Discuss the origins, mission, and business model of The Salvation Army (SA)
and its Dallas operation

1. Briefly discuss the distinct role of the organization structure at SA (general, major, captain,
lieutenant, and corps). This will also lead to who works, attends or, utilizes SA’s non-profit
services. Some of the initial human resource issues can be briefly explored in this session.

2. Ask one of the students to draw a financial flow chart of the SA-Dallas ARC. Discuss the
significance of each entity in the flow chart. A typical financial flow of the Dallas operation is
given below.
 Exhibit TN 2. Financial Flow in the Dallas ARC

3. Walk through a donated item’s product flow in the Dallas-ARC supply chain. Stress the
uncertainty in supply and lack of control of demand at the stores. Exhibit TN 3 depicts a simple
supply chain view of product flow at this facility.
 Exhibit TN 3. Product Flow in the Dallas Adult Rehabilitation Center’s Supply Chain

Family/Thrift Store #1
Harry Hines Blvd,
Dallas, TX

Individual donors
(Drop Off Pickup)
Family/Thrift Store #2
K Avenue, Plano, TX

Family/Thrift Store #3
Salvation Army ARC Josey Lane, Farmers
Collection Warehouse Branch, TX
(Near Store#1)

Family/Thrift Store #5
Irving Blvd, Irving, TX

Corporate Donors Family/Thrift Store #6

(T-Shirts,Lost & Buckingham, Garland,
Found items etc) TX

Family/Thrift Store # 4 Family/Thrift Store # 7

Jeffereson Blvd, Dallas Village Fair, Dallas
Lost in July 2011

15-20 minutes: Reclamation process, store stocking policies, and other sources of revenue and
donations

This might be a good time in the class to ask how many students have donated items to a group like
SA and if they know what happened to those items.

1. With classroom contribution, walk through the reclamation process of The Salvation Army.
List possible ways that this process could be improved, such as hiring extra help during peak
seasons to avoid storage issues.
2. Discuss innovative ways of turning inventory at the thrift stores to increase traffic. List the
pros and cons of the discount policy of SA-Dallas. For example, one argument against it
would be that there is not enough shelf display time for making the high-priced sale.
3. With the help of the class, review the auction process of the junk and surplus donated items.
4. Evaluate the recycling effort of SA-Dallas, and identify the underlying opportunities and
resources needed for the effort.
5. Plot the store locations by their preferential order on a Dallas Map, and discuss the store sales
by item types. It is important to point out the income level in the neighborhood and correlate
it to the sales at each location. Keep in mind, the items are sent to these stores based on the
 preferential order decided by SA-Dallas (store # represents that preferential order). This could
be a good point to debate in the classroom with the help of student participation. The table
below should aid in the discussion.

Table TN 1. Store Locations, Sales, and Median Income in the region

Store Address City Zip code Average Median

Annual sales Income

Store #1 5554 Harry Hines Blvd Dallas 75235 $3,694,512 $32,030

Store #2 5900 K Avenue Plano 75074 $1,367,645 $88,195

Store #3 12895 Josey Lane Farmers Branch 75381 $591,185 $59,148

Store #4* 1617 W Jefferson Blvd Dallas 75208 $462,540 $35,135

Store #5 1145 E Irving Blvd Irving 75060 $762,781 $43,682

Store #6 1418 West Buckingham Road Garland 75040 $730,218 $51,679

Store #7 4810 Village Fair Dallas 75224 $672,725 $33,515

*Store destroyed by the accident

10 minutes: Role of these organizations in sustainability

This section can be expanded or shortened based on the course topic. In the US, many individuals and
corporations donate their used, excess, and unwanted items to non-profit organizations such as SA.
For example, HEB in Texas donates its grocery items (excess and close to expiration date) to the
Texas food bank network through their Food Bank Assistance Program 4. Most grocery items come in
cardboard boxes—the box in which Dole bananas arrive are a hot commodity at food banks. HEB and
other grocery retailers donate them to these organizations. Another example of collaboration is
between Dell and Goodwill group. Through the Dell Reconnect program, more than 200 million
pounds of electronics have been collected 5. Even at SA-Dallas, we see an interesting model of
collaboration with a local transportation company for their unclaimed items and lost baggage. Major
Carl Earp estimates revenue in excess of $150,000 per year through this relationship.
These organizations collect the unwanted and used items in circulation and recover some useful
value out of them before recycling or sending them to trash. Goodwill estimates that it collects two
billion pounds of clothing and household goods every year 6. In this specific example, SA disposes
about 700,000 lbs. of trash every month at its central warehouse in Dallas, TX. This should give us an
idea of the amount of material collected. When addressing sustainability in classrooms, it is essential
to describe these organizations. They not only add social value, but they also encourage and enable
sustainable practices.

4
http://www.heb.com/page/about-us/community/community-involvement
5
http://www.goodwill.org/get-involved/donate/donation-acceptance-guidelines/#computer
6
http://www.goodwill.org/about-us/environmental-impact/
10 minutes: Current challenges

This discussion could be a detailed one, or it could be combined with the next section.

1. Walk through the financial statements of SA-Dallas ARC, and identify the opportunities for
additional revenue or expense reduction. Examples include the dump fees and the amount of
revenue generated through junk and auction sales.
2. List the reasons for unsold donated items. Identify ways to increase sales.
3. Discuss the challenges brought by store #4’s accident and the best way to move forward. It is
important to point out that SA-Dallas has not only lost $40,000 in monthly sales, but it has
also lost storage or shelf display space at the store.
4. Briefly discuss the pros and cons of soliciting needed items.

15-20 minutes: Recommendation (revenue generation or expense reduction) and prioritization

1. Tabulate the available options of SA-Dallas on the board (as shown in Exhibit TN 4) and
perform an SWOT analysis for each of them.
2. Do the SWOT analysis, keeping in mind the economic and social impact of each of the
alternatives.
3. Ask questions such as:
a. Why this is a good option?
b. Will this be perceived well by the donors?
c. What are the likely costs involved in this option?
d. What is the time frame for return?
e. Will it benefit our primary mission immediately?
f. Is this aligned with SA’s social mission?
g. Does SA-Dallas have the right resources for this option?
4. Finally, after discussing the options, prioritize these opportunities with the help of the class.
5. Before the end of the class, come up with an action plan for the selected options.

What Happened

Major Carl Earp and Roderic Horton are working with their advisory council for developing a plan of
action for 2012. This includes working with a university group to attract innovative ideas from their
graduating senior students as part of their class work.

Two ideas they are looking to move forward include:

1. Identifying a location for their new store. They are looking at neighborhoods with appropriate
income level, store accessibility, and attractive lease rates.
2. Hiring a young full-time employee or intern to explore the e-commerce and social media
potential in increasing revenue (avenues for selling donated goods) and raising new
donations.

Here are few specific events that happened after the case was written and analyzed by a group of
undergraduate students:

1. Reduction in Expenses
a. Increased use of the trash compactor:
Disposal fees/Dump fees – dropped by 50% from about $9000/month to $4000-
$4500/month, through better utilization of the compactor (initially used only once every
week). By compressing the trash, the number of truck trips was reduced by 50%.
 b. Telephone/communication expense
A telephone consultant identified 14 unused lines and some dead ones. By removing
them, telephone expense was reduced by 33%.

2. Increase in revenue
a. Recycling
There has been a considerable increase in the recovery rate and revenue of recycled
metal.
i. Clothing recycling (rag sales) is up by $162,490 (31.23%)
ii. Books, shoes, mattresses are up by $148,626 (273.01%). This number relates
to the others category in Table 2 of the case study.
iii. Scrap metal (junk) is down to $81,736.00 (40%). It is down partly because of
the types of items donated. The items are either sold in the store as is or do
not have a lot of metal to scrap. Another reason is that SA-Dallas is still not
efficient in this process. The organization is looking at increasing this portion
of revenue by adding labor and establishing standards in the recovery
process.

b. Ebay sales
Since the case was written, this is by far the most interesting development at Salvation
Army-Dallas. SA-Dallas has started to sell used goods through the ebay auction website
(Web address: http://myworld.ebay.com/salvationarmydallasarc). The average revenue
per month is about $5,400, and the best month’s revenue has been $8000. A quick look at
the items reveals that SA-Dallas finally found a way to sell electronics, collectibles
(guitars, silverware etc.), and digital equipment at a good price, rather than selling such
items cheaply at the stores or warehouse sales.

3. New stores
It has been difficult to secure a new location for the new store, as most of the available retail
space in Dallas has restrictions in place for used merchandise stores. These restrictions are
usually found in retail chains’ leases from stores such as Kohl’s, Target, etc. So now SA-
Dallas is looking at standalone locations, rather than a strip mall type of facility.

4. Others
a. Computer products:
Computer products are still processed internally and sold in stores if they are in working
condition. Non-working products are sold in the “as-is” wholesale auction. Corporate
partnerships with companies such as Dell and Goodwill are yet to be explored—and it
would have to be a central level (SA head office) effort rather than regional.

b. Social networking:
SA-Dallas is now listed in Facebook and Twitter and offers special discounts to those
who find the site and “like” them. The organization is also tracking internet search
engines such as Google and Bing for those seeking information on “charity donations,
used clothing, The Salvation Army, auto donations, etc.” Reports on the effectiveness of
search keywords are compiled at the end of every month to track their performance.

c. Technology to aid truck drivers:

The truck drivers are now provided with iPads, which contain their workload (number of
pick-up stops) for the day. This has increased their efficiency in trip planning (map
assistance) and acceptance of donations. The driver can take photos of items deemed
unusable (trash and junk), which are verified by the supervisor for immediate approval /
rejection. This reduces unwanted donations in the stores and warehouses. The driver can
also generate a receipt and email it to the donor.
 d. Repair/Service personnel:
SA-Dallas has not yet made any contacts with The Home Depot, The Container Store,
and others to repair donated appliances and furniture. These relationships are usually
initiated at the national level.

Conclusions and Implications

This case study provides a first-hand view of how a non-profit organization works. It also shows how
difficult it is for administrators to manage the conflict between economic and social objectives. In the
classroom, we always stress efficient and effective management of for-profit supply chains. This case
exemplifies the different needs and challenges in a not-for-profit world. This case is also a good
example of actions when a private corporation’s partnerships with NGOs benefit society.
The student should appreciate the intricacies involved when decisions are made at these
organizations. They could turn away donations that they deem unnecessary because of storage or
human resource constraints, but that decision could have a lasting effect on future donations from the
individual or corporation. They could hire individuals with better management and technical skills,
but that would go against the core mission of providing gainful employment or rehabilitation to
people in need. In the end, students should be able to identify business opportunities and prioritize
them by their feasibility (of adoption) and their economic, environmental, and social impact.
The lessons learned here are valuable in a variety of industries and business scenarios. The case
will help sharpen students’ strategic thinking skills and get them thinking about how non-profit
business ventures operate. Also, it will lead them to think out of the box and appreciate the role of
these aid organizations in creating and promoting sustainability among people and corporations. All
these are critical skills for a successful operations management professional.

References

1. McLachlin, R, Larson, PD and Khan, S (2009), Not-for profit supply chains in interrupted
environments: The case of a faith-based humanitarian relief organization, Management Research
News, 32 (11), 1050-64
2. Narayanan A, Altay N (2012), Humanitarian SCs -A framework to identify and classify research
areas and needs, 23rd Annual POMS Conference, April 2012, Chicago, IL.
Exhibit TN 4. Summary of options considered

Options Strength* Weakness* Opportunities* Threats*

Opening a new store (also where?)

Salvaging the specialty donated items

stocked in the warehouses

Establishing new cooperative models with

private corporations

Selling unsold electronics/appliances and

other collectibles through other means

(Make sure the students mention the

avenues before analyzing its strength)

Use of social networks for soliciting

donations

Improvements (what?) in recycling

Process improvements (what?) in the

reclamation process (this could be by item
type)

Dump Expenses (Ways to reduce or

subsidize them)

HR issues (technicians for repairs)

Corporate relationships for recycling

Any other innovative idea …

*Analyze these options with respect to their economic and social impact, perceived donor perception, and SA-
Dallas’s capability to implement them.
 Perdue Farms: A Vertically Integrated Supply Chain
Ling Li
Teaching Note

I. Case Synopsis

Perdue Farms is a privately owned food processing company. Founded in 1920 by Arthur and Pearl
Perdue, the PERDUE® brand is a household name today. The current chairman and CEO is Jim
Perdue who holds a Ph.D. in fishery. He has guided the company through continued growth and
changes while holding to the values established by his grandfather and father. As Jim Perdue said:

“I’m proud of our company’s heritage and proud to be carrying on our commitment to
quality. I’m proud of everyone in the Perdue organization — our associates and our farm
family partners. Together, we’re building upon our foundation of quality.”

II. Learning Objectives

• Be able to describe a production process.
• Understand the factors that determine the choice of various supply chain configurations, such
as vertical integration, outsourcing, etc.
• Conduct an SWOT analysis.

III. Answers to the questions

1. Have you consumed Perdue Farm’s products? Which one of Perdue’s products do you like best?
Which one you do not really care for?

Answer: this question is to stimulate class discussion.

2. Describe the production process at the chicken processing facility.

Answer:
3. Is the vertically integrated supply chain that Perdue Farms operates the best option for Perdue?
Why?

Answer: Yes. A vertical supply chain is good for controlling food safety in a process industry and
ensures quality starting from eggs. The egg is a Perdue-owned top-secret recipe.

4. Compare the poultry industry’s vertical supply chain model with Dell’s direct model that
outsources most of its operations. Is this the best operations management / supply chain model for
both industries? Why?

Answer:
Perdue Farms’ vertically integrated supply chain
• Competitive priorities: low cost, consistent production quality
• Production nature: process industry, food product
• Product nature: The product is made of raw material (chicks) and is not impacted by
technology advancement.
• Safety requirement: highly regulated
• No after-sales services but nurture loyal customers: Why do customers repeatedly buy our
products?
• Compete on low price, consistent quality, and on-time delivery because it is a process
industry that produces large-volume products based on forecasts using historical sales data.
• Price elasticity
• Message to the Market: “We Do It For You”

Dell’s direct model supply chain

• Competitive priorities: flexibility, delivery time based on due dates, design quality
• Production nature: electronic appliances, discrete production
• Product nature: technology advances very fast, parts & components could change at a
moment’s notice
• Safety requirement: low
• Available and low-cost after sales services
• Managing a large supply network
• Message to the Market: “Have It Your Way”

5. Analyze the entire production lead time, starting from eggs. How does lead time affect production
planning? Are there any risks and bottlenecks?

Answer:
Lead time
• Hatch: 21 days
• Weight grow: 28-42 days (4-6 weeks)
• Processing and packaging: 1 day
• Total production lead time: 50 – 62 days

Risks
• Natural disasters such as floods
• Bird flu
• Transporting chicks to farms and transporting matured chickens to the processing plant
• Food safety

Bottlenecks
• During the evisceration stage of the process, where inspection takes place;
• Or any point during the production.
6. Discuss Perdue’s strengths, weaknesses, opportunities, and threats. What new operational ideas
and changes would you recommend to Perdue management to realize its vision 2020?

Answer:
• Strengths:
o Well-known brand name
o Good quality product
o Using Sam’s Club as a marketing strategy
o Family-owned company, easy to control and make decisions

• Weaknesses:
o Difficult to change customers’ dietary preferences
o Family-owned company, sometimes does not respond to the market needs as fast as
publicly traded companies

• Opportunities:
o Domestic markets
o Low-carb diet
o New product development
o Strategic partnerships with the restaurant industry
o Global markets

• Threats:
o Red meat regaining popularity
o Tyson and other brands
o Natural disasters and bird flu
 Improving Stanford Blood Center’s Platelet Supply
Chain 1
Yenho Thomas Chung, Feryal Erhun, and Tim Kraft
Teaching Note
(An Excel spreadsheet accompanies this teaching note.)

Introduction

A platelet is a particle found in the blood of all mammals that enables the coagulation of blood;
platelets are transfused to patients to treat or prevent bleeding during surgery and other medical
conditions associated with platelet deficiency or function defect. Platelets’ shelf life for transfusion
purposes is up to five days in the U.S.; however, due to testing, platelets are generally not released to
inventory (for distribution) until 48 hours after the collection time. Therefore, usable platelet shelf life
is generally three days. This extremely short product shelf life compared to other blood products
makes the inventory and supply chain management of platelets a challenging task. However, the
challenges are not limited to short shelf life. The unit production cost of platelets, which includes
collection, testing, processing, and distribution costs, is high in general. Thus, losing a platelet unit
due to expiration is a burden for blood centers. In 2004, almost 17% (974,000 out of 5,729,000
processed units) of platelet units that were collected in the U.S. were outdated without being
transfused (AABB 2005). Yet another challenge is the limited pool of platelet donors. There is no
artificial substitute for platelets; that is, platelets can only be collected from human beings who are
altruistic. Finally, platelets cannot be converted to alternative products or kept frozen for future use.
Hence, if there is a mismatch between supply and demand leading to excess inventory, the excess
inventory of platelets is lost.
Motivated by these facts, the goal of this case study is to introduce students to the challenging
task of managing the platelet inventory at Stanford Blood Center (SBC). Specifically, by solving this
case study, students should gain an appreciation and understanding of: (1) supply chain coordination
in a health-care setting, (2) the complexities involved with managing perishable inventory, and (3) the
impacts of supply chain contract design. Students will be exposed to a practical modeling scenario,
where SBC’s objective function is not necessarily to maximize profit or minimize costs but, instead,
to maximize customer service and well-being. The case is flexible enough that it can be taught as an
in-class discussion or homework assignment, and used for either an undergraduate or master’s level
course.

Learning Objectives

• Introducing students to supply chain management concepts in a healthcare setting

• Demonstrating the complexities involved in managing perishable inventory
• Analyzing a supply chain coordination issue with both quantitative and qualitative reasoning
• Introducing students to contract and incentive design

1
This case was prepared by Yenho Thomas Chung (LG CNS Entrue Consulting Partners), Professor Feryal
Erhun (Stanford University), and Professor Tim Kraft (University of Virginia) based on field research of an
actual business situation. Some names, dates, and data are disguised, and some material is fictionalized for
pedagogical reasons. It was written as a basis for class discussion rather than to illustrate effective or ineffective
handling of an administrative situation. The authors would like to thank their collaborators at Stanford Blood
Center and Stanford University Medical Center for their efforts. This case is partly based on the research article
by Fontaine et al. (2009).
Analysis and Solution

Students are charged with developing recommendations for how to reduce the number of outdated
units. To do this, there are three keys areas of potential improvement the students should analyze: the
collection process at SBC, the rotation process at SBC, and the inventory management process at
Stanford University Medical Center (SUMC). Using the data set provided with the case, students
should be able to identify key problems in both SBC’s and SUMC’s processes and use these to
generate recommendations for improvement. Note that the data set provided is only for SUMC and
does not include local hospital data. Also, depending on the pedagogical goals of the course and
instructor, further recommendations may be made regarding the use and design of contracts.

SBC Collection Process

Using either simple pivot tables or basic excel functions, students can determine the average outdate
rate by drawn data. As shown in Figure 1, platelets drawn on Wednesdays through Saturdays have the
highest outdate rate, while platelets drawn on Mondays or Tuesdays have the lowest outdate rates.
Recall that drawn blood samples require two days of testing. Therefore, units drawn on Wednesdays
and Thursdays are primarily available on the weekends, when demand is low. Conversely, units
drawn on Mondays and Tuesdays are available during peak demand times during the week (Figure 2).
The high average outdate rates for Fridays and Saturdays are likely due to SBC drawing extra units on
these days since it does not collect on Sundays.

30%

25%

20%
Outdate Rate

15%

10%

5%

0%
Monday Tuesday Wednesday Thursday Friday Saturday
Draw Date

Figure 1: Platelet Outdate Rate by Drawn Date (Adapted from Fontaine et al. (2009))
 Figure 2: Platelet Availability Schedule (Source: Fontaine et al. (2009))

Figure 3 verifies that platelet demand is significantly lower on the weekends.

35
Mean Number of Transfusions

30

25

20

15

10

0
Monday Tuesday Wednesday Thursday Friday Saturday Sunday

Figure 3: Average Platelet Demand by Day (Adapted from Fontaine et al. (2009))

Student’s Potential Recommendation: Increase the number of collections earlier in the week
and reduce the number of collections later in the week. In doing so, a new collection schedule at SBC
would allow a more appropriate distribution of the platelet donations in response to the hospital
demand.
Additional recommendations students may make include implementing a new ordering policy at
SUMC. By setting different order-up-to levels for weekdays and weekends, SUMC can better balance
its supply and demand. In addition, SUMC may want to consider decreasing its daily orders and
shifting some safety stock to SBC.
SBC Rotation Process and SUMC Inventory Management Process

Second, using the data set provided, students can analyze SBC’s rotation process. Specifically,
students can identify which types of units are most likely to go outdated. As shown in Figure 4, short-
dated units are typically more likely to go outdated. Further analysis of the data reveals that 25%-30%
of these units at SUMC were leapfrogged by a non-expiring unit, that is, an outdated platelet that
could have been transfused when another non-expiring unit was used in its place. This result is not
surprising given the contract agreements between SBC and the hospitals. Under a consignment
contract, the small hospitals have no incentive to use expiring units. In addition, under a cost-sharing
contract, SUMC incurs costs for not using four-days-old or younger units, but SUMC does not incur
this cost for five-day-old units.

35%
3.6%
Percent of Units Received

30%

25% 3.6%

20%
1.2%
15% 30.2%
11.5%
23.7%
10% 18.1%
5% 8.1%
0%
2 days old 3 days old 4 days old 5 days old

Transfused Outdated

Figure 4: Percent of Units Received by Age (Adapted from Fontaine et al. (2009))

Student’s Potential Recommendation: Rotate the units from the small hospitals to SUMC one
day after delivering the units to the small hospitals.
To improve the organization and platelet selection process at SUMC, students may recommend
that SUMC develop better processing, storage, and selection methods to further reduce the risk of
leapfrogging resulting in outdated platelets. This may include implementing an FIFO-type storage and
retrieval system.

Discussion Questions

The following are assignment questions that may be used either during an in-class discussion or for
students’ write-ups.

1. Based on the data provided, are there any potential imbalances between the existing demand
and supply patterns?
2. Identify the characteristics of outdated items at SBC / SUMC. Is there any connection
between these characteristics and any of three processes discussed (i.e., collection, rotation,
and issuing)?
3. To decrease the outdate rate of platelet units, what recommendations should be made to
improve the platelet supply chain between SBC and SUMC? Is there any incentive for either
party to follow these recommendations?
4. Identify at least one problem in each processing area (collection, rotation, and issuing), and
provide a solution for each of them.
Teaching Plan

The following is a sample outline for an in-class discussion.

1. Introduction: The instructor may want to start the discussion with a broad overview of
why SBC’s supply chain is unique compared to a typical supply chain (e.g., a consumer
electronics retailer).
a. What makes SBC’s supply chain unique? How is it different from a typical
supply chain?
i. SBC’s objective is not necessarily to maximize profit
ii. It is non-linear in that SBC constantly must redistribute its supply (Can
you think of other examples where this may occur?)
iii. Given the contracts negotiated – SBC has two “different” customer bases
(Is this a unique? Can you think of other examples where this might
occur?)
b. What aspects of SBC’s supply chain are not unique?
i. Difficult to coordinate as parties may have differing incentives
ii. Requires communication between entities
iii. Uncertain demand and supply – variability causes issues
c. The instructor may also want to discuss the complexities involved in managing
perishable inventory
2. Key Issues
a. What are the key areas that the MS&E team needs to address?
i. SBC’s collection and rotation of inventory
ii. SUMC’s inventory management
iii. Students may also want to address the choice of contracts
b. What do the data tell us?
i. Review the results found in the Analysis Overview
c. What qualitative issues are there?
i. It is important that students incorporate qualitative reasoning into their
analysis
3. Recommendations
a. Review student recommendations
4. Additional: In this setting, how important are the contracts negotiated between the
different entities?
a. The instructor may want to revisit the topic as an opportunity exists to introduce
students to contract and incentive design
b. Can you design a better contract? What is your objective in this new contract?
5. Overview of what happened and key takeaways
What Happened

Source: Fontaine et al. (2009)

To reduce the number of outdated units, it was critical to understand the inefficiencies in the SBC-
SUMC platelet supply chain. A number of areas were examined by the MS&E team, including
inefficiencies in platelet usage and in the ordering and delivery process between SBC and SUMC as
well as between SBC and the smaller hospitals that it serves. The study was performed over the time
period of January to April 2006 (Baseline). Three areas were identified for improvement: (1) the
collection process at SBC, (2) the rotation processes at SBC, and (3) the inventory management
processes at SUMC. The team’s recommendations were first implemented at SBC and then at SUMC
(Phase II). A post implementation analysis (Phase III) allowed the identification of improvements
made to the overall platelet supply chain performance.

The first series of improvements (Phase I) occurred during the summer of 2006 after
implementation of the set of recommendations by the supply chain experts to SBC. To better meet the
platelet transfusion demand at SUMC, SBC increased the number of collections on Mondays and
decreased them on Thursdays; the implementation of the new collection schedule at SBC allowed a
more appropriate distribution of the platelet donations in response to the hospital demand.
Additionally, the rotation schedule of platelet units between SBC and the smaller hospitals was
improved by reducing the rotation at the smaller hospitals from two days to one day to allow a greater
number of fresher units to be sent to SUMC. As a result of these two improvements made in 2006, the
overall outdate rate of platelet units improved significantly from 20% in the first quarter of 2006 to
14% during the first two quarters of 2007 and to 11% in the third quarter of 2007. Based on the
recommendation to improve the platelet-ordering practices to SBC and platelet selection by SUMC
Transfusion Service, a new standard operating procedure for platelet inventory management at SUMC
Transfusion Service (Phase II) was developed. As a result of this second improvement in SUMC
Transfusion Service operations, the overall platelet outdate rate for both SBC and SUMC Transfusion
Service decreased down to 9% in the third quarter of 2008 (Phase II). Furthermore, as a result of the
improvements made to platelet inventory management, the age of the units transfused decreased
significantly, potentially improving the service provided to the patients. The mean age decreased from
4.0 days (in 2006) to 3.8 days (in 2008). The median age decreased from 4.4 days (in 2006) to 3.9
days (in 2009).

The team’s study resulted in improvements in the system performance by reducing the outdate
rates at SBC is apparent. However, it also enabled open communication between SBC and SUMC,
which was quite unlikely at beginning of the study. Both SBC and SUMC now view themselves as
long-term partners and are working together to improve the supply chain.

References:

[1] AABB. Nationwide Blood Collection and Utilization Survey Report. www.aabb.org. 2005.

[2] Fontaine, M.J., Y.T. Chung, W.M. Rogers, H.D. Sussmann, P. Quach, S.A. Galel, L.T.
Goodnough, F. Erhun, 2009. Improving Platelet Supply Chains through Collaborations between
Blood Centers and Transfusion Services. Transfusion, 49(10):2040-2047.
 Financial and Operational Risk Management at Molson
Coors
Dennis Kira, Ahmet Satir, and Dia Bandaly
Teaching Note 1

The development of this teaching note was sponsored by Export Development Canada (EDC). Dia
Bandaly, Dennis Kira and Ahmet Satir developed this teaching note for use with the case study
“Financial and Operational Risk Management at Molson Coors.” The content is not intended to
highlight the actual successes and / or failures of the Company. All figures provided are distorted in a
proportional manner to protect the Company’s data confidentiality. Unless otherwise stated, all
monetary figures are in US dollars. This teaching note is strictly for the exclusive use of
instructors. Suggested responses provided here to assignment questions should not be
distributed to students.

Case Objectives

• to appreciate the challenges in supply chain risk management and to develop a strategy to
overcome these challenges
• to understand the capabilities of financial instruments in hedging the cost of process input
through commodity price and exchange rate hedging
• to be exposed to the capabilities of operational approaches in mitigating risk stemming from
uncertainties in demand, as well as from commodity price fluctuations
• to understand the need for collaborative efforts among various functions within a firm and
among partners across the supply chain for effective supply chain risk management

Case Summary

Molson Coors, a major beer producer in Canada, is exposed to the risk of unexpected changes in input
cost due to fluctuations in prices of commodities, such as aluminum, barley, and grain, which are used
as raw materials in brewing and packaging processes. Changes in input cost also stem from dynamic
foreign exchange rates, as the Company imports some of the input material from the United States
and Europe. These uncertainties at the upstream side of the processes are compounded by demand
uncertainty at the downstream side. Besides demand seasonality that characterizes the beer industry,
the Company is exposed to uncertainties in weekly demand for each of the various brands it sells.
The Company has established a number of financial and operational approaches to mitigate the
risks emanating from the above uncertainties. The Company takes long positions in forward contracts
of commodity futures to hedge against price increases. In other words, the company locks the input
price at the level when the forward contracts are purchased. A similar approach is adopted in order to
hedge against input cost change due to adverse exchange rate movements. The Company also
employs a number of operational tools to manage various operational uncertainties. In this regard, the
Company implements a number of forecasting techniques to minimize the gap between production
quantities and actual demands. For the uncertainty in demand quantities, procurement and
transportation processes ensure continuous flow of input material and end products, in collaboration
with suppliers and service providers.

1
Written by Dia Bandaly, Dennis Kira and Ahmet Satir, from the John Molson School of Business, Concordia
University in Montreal, Quebec, Canada. The authors thank the executives and managers of Molson Coors for
their full cooperation in providing enterprise-specific information and data, as well as verifying the final text in
a thorough manner to ensure factual validity and data confidentiality. The authors express their gratitude to EDC
for initiating the idea for the case subject, providing feedback as to the context and content and sponsoring this
case.
 The emphasis in the case is on the specific implementation of operational and financial
approaches to mitigate the risks pertinent to the inflow of aluminum cans used in packaging beer and
to the outflow of canned beer to the market. The significance of collaborative efforts among
functional divisions of the Company and among the members of the supply chain, namely between
the Company and the aluminum can suppliers, is highlighted. Such collaboration is essential for
effective supply chain risk management.

Suggested Courses

This case can be used effectively to illustrate various issues in collaborative planning and
implementation of operational and financial approaches in supply chain risk management. The case is
suitable for advanced undergraduate, MBA, and executive audiences.

Suggested Readings

Hull, J.C., 2009. Options, futures, and other derivatives. 7th ed. New Jersey: Prentice-Hall. Sections
3.1 and 8.1.

London Metal Exchange (LME) specifications on aluminum futures at:

http://www.lme.com/aluminium.asp

Guide to aluminum options and futures at: http://www.theoptionsguide.com/aluminum-futures.aspx

Any operations management textbook. Chapters on forecasting, MRP, procurement and transportation
would apply.

Assignment Questions

When answering these questions, students should justify their responses. If the information
provided in the case is not sufficient, students should conduct an Internet or library-based search
in order to gather relevant information and data that might assist them in their response. The
instructor may choose to limit the number of questions provided here and / or add new ones of his /
her own.

1. In general, what are the fundamental steps that need to be considered for the risk management
process? Speculate on one Molson Coors-specific aspect in this regard that the Company should
pay extra attention to in managing integrated financial and operational risk. Justify your
response.

nature of question: general; managerial

Suggested response:

An effective risk management process comprises a number of fundamental steps that start with risk
identification and end with evaluating the performance of the mitigation approaches implemented by
the firm. The first step is risk identification that entails recognizing the source of the risk and a clear
understanding and description for the possible events associated with this risk. The second step is
assessment and measurement. The risk is evaluated based on two main dimensions: occurrence
likelihood and impact magnitude. The various risks identified by the firm can be mapped according to
these two dimensions, and accordingly risks are prioritized, completing the third step. The fourth step
is to decide whether to retain the risk or to transfer it to another party. A compromising decision
would be to share the risk with a partner/member of the supply chain. These three decisions are taken
mainly based on the risk assessment and the resources available to the firm. The fifth step is to decide
on the mitigation approach to use. The final step is taken after the adverse event has occurred. The
firm evaluates the effectiveness of the mitigation strategy on risk management.
 As an example, in the case of Molson Coors, the Company would identify the risk of price change
of a major input of the brewery’s process: aluminum cans. The sources of this risk are commodity
price and exchange rate fluctuations, the commodity being the aluminum sheets used in the can
production. The risk is measured and assessed based on the financial and operational dimensions
mentioned above. The occurrence likelihood is function of the daily changes exhibited by the
aluminum price and the exchange rate in the relevant markets. Impact of aluminum price and
exchange rate changes is easily measured by calculating the effects on the cost of cans and
subsequently on the cost of canned beer. In this example, Molson Coors has three options: (1) to
retain the risk, (2) to transfer it to its supplier and (3) to share it with the supplier. While retaining the
risk does not necessitate any action with the supplier as the firm would be willing to bear the
consequences on its own, the other two options require reaching an agreement with the supplier. The
risk can be transferred by entering a long-term agreement with the supplier fixing the purchase price
of the cans for a certain period of time. In this case, the supplier bears the risk emanating from
aluminum price and exchange rate fluctuations. The supplier may increase the can price in order to
absorb this risk. To avoid such an increase in can price, which may not always be in line with the
current market price of aluminum, Molson Coors may opt to share the risk with the can supplier. An
example of a sharing agreement can be to split any increase, according to a predetermined ratio, in
can production cost due to adverse changes in aluminum price and / or exchange rates.

2. Can the Company pass on increases in costs to the market price of the final product?

nature of question: marketing; financial

Suggested response:

Breweries have to keep the selling price of their products at a certain level in order to maintain or
increase their market share. The beer industry is highly competitive. As stated in the section on
‘Competition,’ the Canadian market, for example, is mature, and companies face competition from
large-scale producers, regional breweries and microbreweries. The presence of such a large number of
competitors results in an abundance of substitutes available for customers. These substitutes are
available not only at the same price, but they also have a similar taste. Except for microbreweries that
offer fruit-flavored beer and beer with a high alcohol percentage, major breweries in general cannot
achieve product differentiation due to the nature of the product, since beer is made from same
ingredients using a relatively standard process. Hence, the Company cannot pass on increases in cost
to the final market price, but should rather find the means to avoid such cost increases.

3. Suggest some actions that the Company can take in order to manage the volatility in aluminum
price.

nature of question: purchasing; financial

Suggested response:

As stated in the section on ‘Financial Risk Management,’ long-term supply contracts and financial
hedging instruments can be used to manage aluminum price volatility. A long-term supply contract
with the aluminum can producer allows the brewery to secure a fixed price that protects the firm from
unanticipated increases in the input price for a specific period of time. However, such contracts
deprive the brewery from the upside risk of a potential reduction of production cost in case of a
decline in the aluminum price, and subsequently a possible decrease in the price of cans.
The brewery can also use different financial instruments to manage the commodity price
uncertainty. To secure a stable input cost, the company can buy aluminum futures contracts that allow
the procurement of raw aluminum sometime in the future at a price known at the day of buying the
contract. For example, the aluminum spot price in January is $2,290 / ton, and the brewery is
anticipating certain demand volume in April that requires cans corresponding to 1,000 tons of
aluminum. The brewery can buy 40 contracts of aluminum futures for a futures price of $2,320 / ton
(the aluminum futures contract size is 25 tons). The contract settlement decision is then taken by the
brewery before the contract expiry date in April. Futures contracts require the physical delivery of
aluminum at the contract expiry date, or, if the futures contract holder does not want to receive the
delivery, the futures position can be closed out before the delivery date. If the aluminum price by the
end of March has increased to, for example, $2,340 / ton, the futures contract results in a gain, and
the brewery can settle the contract through either one of the above two alternatives. In the former
option—when delivery is to be made, because the brewery does not have the facility to produce the
cans, it can have an agreement with the can supplier to transfer the aluminum delivery to the can
supplier’s premises to be used for can production. In such a case, the aluminum is physically
purchased in April at a price $20 / ton less than the spot unit price. Alternatively, the brewery can
close out its futures position, achieving a similar gain in the trade exchange. As April is the delivery
month for the futures contract, the futures price would be close to the spot price of $2,340 / ton, and
thus closing the contract would result in the same gain of $20 / ton. In the case of a decrease in the
aluminum price, say down to $2,300 / ton, the brewery would close out its position, resulting in a loss
of $20 / ton on the futures contract, and then it would procure the aluminum from the spot market for
$2,300 / ton, achieving a gain that offsets the loss in the futures market. The net cost would then be
$2,320 / ton, the price that the brewery wanted to lock on in January.
Another financial instrument that can be used to lock the price of aluminum is options on
aluminum futures. Using this instrument, the brewery would have the right to buy the aluminum at
certain price, that is, the options strike price. These options would be exercised when the strike price
is lower than the futures price before the options expiry date. Otherwise, the brewery would let the
options expire unexercised. Such a scenario would take place when the aluminum spot price declines,
in which case the brewery would benefit from this decline by purchasing the aluminum at a lower
price.

4. What organizational approaches can you suggest in order to successfully implement the hedging
strategy you have developed?

nature of question: managerial; collaborative

Suggested response:

To attain the desired outcome of a long-term supply contract, different functions of the firm should
collaborate to come up with the contract terms that improve the performance of the firm rather than
the performances of the individual departments. Different factors such as quality, price, speed of
delivery, and flexibility are thus considered, and the supply contract represents the optimal
compromise among these factors. While the finance department is interested in minimizing the
purchasing price, the quality department tends to ask for the highest quality levels, and the operations
department asks for fast delivery and supply flexibility required to avoid shortages and surpluses.
The financial hedging instrument also necessitates input from various functions of the firm. While
this approach seems to be merely the responsibility of the finance department, effective
implementation would require the involvement of other departments. The marketing department needs
to come up with a proper demand forecast in order to decide on the corresponding quantity to be
hedged. As explained in the suggested response to Question 2, as physical delivery of raw aluminum
may be necessary, the logistics department will then be involved in arranging the transportation and
receipts of aluminum in the supplier’s premises.

5. Critique the process followed in each of the following three operational functions as they are
currently carried out at Molson Coors: i) forecasting, ii) procurement and iii) transportation.
Indicate how you would conduct each function differently.

nature of question: operational

Suggested response:

Forecasting

The demand planning (DP) forecast package used by the Company includes up to four years of
weekly sales history. This extent of historical data allows the detection of seasonal factors that
characterize the beer industry. It also reveals major trends in demand, and this helps the Company
adjust its production plans accordingly. The most common method used by the Company is
exponential smoothing. This method adjusts the new forecast based on the forecast error observed in
the previous period. The DP package used by the Company allows the user to change the smoothing
constant based on updated demand information s/he might receive from the concerned departments.
Exponential smoothing may not prove to be the most appropriate forecasting technique since the
short term (such as, weekly) seasonality may be overlooked. More sophisticated analytical models in
forecasting (such as Box-Jenkins approaches) could be utilized, along with some judgmental
forecasting that facilitates fine-tuning of final forecasts obtained from analytical models.

Procurement

For the case of aluminum cans, the Company evaluates its suppliers based on criteria such as quality,
cost, service, and innovation. While cost and quality are obvious criteria in supplier evaluation, a
high service level is crucial for Company’s operations. Cans, for example, are brought in on just-in-
time (JIT) based practices due to space constraints at the breweries. A highly reliable supplier is
therefore essential to prevent delays in the packaging stage of the process and consequently a delay in
the shipments to customers. Innovation is also a peculiar necessity in the beer industry where the
packaging can sometimes be the order-winning factor. The example provided in the section on
‘Procurement’ regarding the thermo activated Coors Light cans is illustrative in this respect. The
supplier’s flexibility in terms of accommodating sudden changes in order quantity is also vital in the
beer industry. Exhibit 6 depicts high discrepancies between the forecast and the actual demand for
cans by the brewery. With a discrepancy that can go as high as 27% of the forecast, the supplier
should have a high level of flexibility to be able to accommodate such order deviations in its
production plan.
The Company can look into the option of either replacing the American supplier with a Canadian
supplier or coming to an agreement with the existing Canadian supplier to cover all the demand. Both
of these options would protect the Company from exchange rate risk exposure. The second option of
single sourcing, however, can increase Company’s operational risk exposure. In such an event, the
Company needs to take the necessary measures to manage this operational risk.
Even though the case does not elaborate much on the relationship between the breweries and their
suppliers, some collaborative efforts are implied in different parts of the case study. First, the brewery
provides the supplier with a 52-week projected demand on a rolling basis. This practice is one of the
most commonly used information sharing techniques among members of a supply chain. It helps to
reduce the ‘bullwhip effect,’ a phenomenon that results from information distortion as information
moves from downstream to upstream across the supply chain. Second, the supplier manages
aluminum cans in offsite warehouses, before shipping to the breweries on a just-in-time (JIT) basis.
This practice is necessary for an efficient collaborative replenishment system that ensures
uninterrupted flow of material. Third, the brewery is hedging the aluminum price by entering long
positions in forward contracts. Although the Company can manage the risk of fluctuating aluminum
can prices through long-term contracts with suppliers at a fixed purchase price, it nevertheless prefers
to hedge the aluminum price on its own. The above three collaborative practices illustrate the
integration of business processes among various members of the supply chain. Such integration
distinguishes collaborative relationships among members of the supply chain compared to traditional
vendor-supplier relationships.
Transportation

The Company takes necessary actions to achieve efficiency and economies of scale in its
transportation of cans to the breweries in Toronto and Vancouver. In the former case, the Company
avoids idle trips by synchronizing the outbound and inbound material flow using the same trucks. In
the latter case, economies of scale are achieved by collecting cans from different carriers in a central
warehouse and dispatching full truckloads to the brewery.
The Company procures cans from two suppliers, one in Ontario and the other in the Western
USA. It is not clear from the case text if both suppliers dispatch cans to all breweries. If this is the
case, and provided that supplier capacity is not a constraint, one can look into the option of
geographic segmentation, for example, having the American supplier ship to Vancouver but not to
certain breweries in the East, while cutting supply from the Ontario supplier to Vancouver.
The transportation mode may also need to be re-considered. Instead of using long-distance truck
transportation, using rail transportation may be an option that can be evaluated and a cost comparison
can be carried out.
The brewery in St. John’s receives shipments sent from the port of Montreal. One should also
evaluate the option of using this same transportation mode to supply the brewery in Moncton, New
Brunswick. As these two breweries are smaller than the others, their combined can requirements may
be too low for separate shipments to be efficient. Another option would be to deliver by truck, as is
the current practice, the cans required by the two breweries to Moncton, where the cans for the St.
John’s brewery would then be shipped through the nearest seaport. Two main sea ports can be used
for this purpose: the port in Saint John, New Brunswick, which is 160 kilometers from Moncton, and
the port in Halifax, Nova Scotia, which is at 260 kilometers.

6. Speculate on the possible reasons as to why there are significant positive and negative
discrepancies in the usage forecast and actual shipment figures in Exhibit 6.

nature of question: operational; purchasing

Suggested response:

Demand for beer is seasonal. Since July and August are the hottest months of the year in Canada, it is
expected that the beer demand during these two months would increase substantially. Although, such
increases should have been anticipated and taken into consideration in Company’s forecast. Exhibit 6
depicts a difference between the usage forecast and the actual shipment in July 2009 of more than 14
million cans. A possible reason for that discrepancy can be higher-than-expected temperature in July,
a phenomenon that has been observed in previous years. A similar explanation may apply for the
months of January and February when the forecasts were higher than the actual shipments. This may
also be due to unexpectedly low temperatures in these two months. These negative discrepancies may
also be attributed to some aggressive marketing campaigns by competing breweries and by retailers
selling wine, a product having peak sales in January and February.

7. In light of the financial and operational information provided in Exhibits 4-6, critically evaluate
the interfaces between financial and operational risk management techniques used at Molson
Coors for the July-August 2009 and January-February 2010 time periods. Are there opportunities
missed in risk management? What would you do differently to manage risks during these peak-
and low-demand periods?

nature of question: managerial; financial; operational

Suggested response:

Exhibit 4 depicts the financial hedging positions taken by the Company to mitigate the aluminum
price fluctuation risk. Aluminum futures contracts are purchased by the Company to minimize the risk
exposure long before the exposure period. For example, to manage the risk exposure in January 2010,
the company purchased 40 tons of aluminum futures in August 2008. Similarly, Exhibit 5 summarizes
the currency hedging positions entered at different dates, within the previous two years, to manage the
currency fluctuation risk the company would be exposed to in each month of 2009. As the hedged
quantities in Exhibit 4 correspond to future demands, and the hedged currencies in Exhibit 5
correspond to the amounts required for foreign procurements, the hedge sizes need to be effectively
speculated. Thus, close coordination is required between the Finance Department responsible for
entering such futures positions and the Operations Department that generates demand forecasts and
initiates procurement decisions.
According to Exhibit 6, the usage forecasts for cans in the months of July and August were 738
and 694 tons of aluminum, respectively (using the conversion ratio of 13 kg of aluminum per 1000
cans). However, the hedged quantities, depicted in Exhibit 4, for those two months were 1,450 and
530 tons of aluminum. The discrepancies between the forecasted values and the hedged quantities can
be attributed to a lack of coordination between the concerned departments. On the other hand, looking
at the aggregate figures corresponding to the peak-demand period of July and August and to the low-
demand period of January and February, we notice that the decline from the peak-demand forecast to
the low-demand forecast is in line with the reduction in the hedged quantities between those two
periods. Better coordination and information sharing between the concerned departments would help
to match hedging decisions with expected demand.

8. Suppose that the company places an order for 1 million USD on July 1, 2010, to be paid on
December 31, 2010. Determine a probability distribution for the cost in Canadian dollars to the
Company on December 31, 2010, taking into consideration the following assumptions.

The percentage change in the CAD / USD exchange rate follows a normal distribution. The
expected percentage change between the spot rate in 180 days and the current spot rate is 0%,
but the 180-day standard deviation in the percentage change between the spot rate in 180 days
and the current spot rate is equal to 3%. On July 1, 2010, the CAD / USD exchange rate is
1.05027.

nature of question: financial; statistical

Suggested response:

In the case of the July 1, 2010 order valued at 1,000,000 USD, the spot exchange rate between the
Canadian dollar and the US dollar at the time of the order is 1.05027CAD /1USD. If the expected
percentage change in the spot rate in 180 days has a mean of 0%, then the spot rate in 180 days is
expected to be 1.05027CAD / 1USD. Therefore, the expected payment in 180 days is equal to
(1,000,000 × 1.05027 = 1,050,270 (CAD)). However, if the percentage change in the exchange rate
has a standard deviation of 3%, then the probability distribution of the spot rate in 180 days and the
corresponding range of payments in December 31, 2010 would be as follows:
There is a 68% probability the CAD/USD exchange rate in 180 days will be between
1.02CAD/1USD and 1.08CAD/1USD, corresponding to a December payment in Canadian dollars of
between $1,020,000 and $1,080,000. There is a 95% probability that CAD/USD exchange rate in 180
days will be between 0.99CAD/1USD and 1.11CAD/1USD, corresponding to a December 31, 2010
payment in Canadian dollars of between $990,000 and $1,110,000. Assuming a normal probability
distribution with an expected percentage change of 0% for the spot rate in 180 days implies that
Molson Coors is equally as likely to pay less than what was expected as they are to pay more than
what was expected. The Company’s decision as to whether the additional currency risk is acceptable
will depend on its degree of risk aversion. If the additional currency risk is not acceptable, the risk
must be transferred to a third party via some sort of hedging.
9. Discuss the extent of exchange rate risk faced by the company arising from the $1 million USD
June transaction using 180-day Value-at-Risk (VaR) methodology based on a 95% confidence
level when the June 2010 spot rate at the time of the order is 1.05027CAD / 1USD.

nature of question: financial; statistical

Suggested response:

Note that the July 1, 2010, spot rate at the time of the order is 1.05027CAD / 1USD. The July 1, 2010
order is expected to cost 1,050,270 CAD in 180 days. A Value-at-Risk methodology basically
incorporates the time horizon, confidence level, and transaction size to determine a maximum loss on
the value of the position at risk.
The maximum loss is determined by the lower / upper boundary of the probability distribution,
which is approximately two standard deviations away from the mean for a 95% confidence level. The
percentage change in the CAD / USD exchange rate is assumed to follow a normal distribution.
The expected percentage change between the spot rate in 180 days and the current spot rate is
assumed to be 0%, but the 180-day standard deviation in the percentage change between the spot rate
in 180 days and the current spot rate is assumed to be equal to 3%.
To determine the extent of the downside risk faced by Molson Coors using a Value-at-Risk
methodology, the transaction size, time horizon, and confidence level must be given. In the case of the
July 1, 2010 order, the transaction size is 1,000,000 USD, the time horizon is 180 days, and the
confidence level is 95%. The expected payment in 180 days converted to Canadian dollars is
$1,050,270. However, any variation in the exchange rate over the next 180 days gives rise to the
exchange rate risk faced by the Company. The Value-at-Risk (VaR) methodology attempts to provide
a single number summarizing the total risk exposure for a particular transaction. If the percentage
change in the exchange rate is assumed to be normally distributed, then the 95% confidence level for
a 180-day maximum loss is determined by the upper boundary of the probability distribution
approximately two standard deviations away from the expected percentage change in the exchange
rate. This implies a 0.06 change in the exchange rate (2 × 0.03 = 0.06). Since the expected spot
exchange rate in 180 days is 1.05027, a 0.06 change in the expected spot rate in 180 days would result
in an exchange rate equal to 1.11CAD / 1USD: 1.11 = (1.05+0.06). Based on a 95% confidence level,
the maximum price for the 1,000,000 USD July 1, 2010 order would be 1,110,000 CAD. This implies
a 180-day 95% Value-at-Risk equal to 59,730 CAD ($1,110,000 − $1,050,270).

10. Discuss the strengths and weaknesses of paying 1 million USD at the time of delivery rather than
waiting 180 days until the invoice is due.

nature of question: purchasing; financial

Suggested response:

An advantage of paying at the time of delivery is a reduction in the exchange rate transaction
exposure from 180 days to 0 days. However, a number of disadvantages arise, including a lengthening
of the cash cycle due to an elimination of the accounts payable period, an increase in net working
capital requirements, and an increase in effective cost of the order. In order for an early payment to be
beneficial, one would have to negotiate a sufficient cash discount to compensate for the loss of 180
days of free credit.

11. Describe a forward rate hedge that can be used to eliminate (reduce) the exchange rate risk
associated with the July 1, 2010 order valued at 1 million USD. A six-month forward rate at the
time of the order is quoted at a bid price of (1.05435CAD / 1USD) and an ask price of
(1.06100CAD / 1USD) for transactions valued at 1 million USD or more.

nature of question: financial, purchasing

Suggested response:

The July 1, 2010 spot rate is (1.05027CAD / 1USD). A six-month forward rate at the time of the order
is quoted at a bid price of (1.05435CAD / 1USD) and an ask price of (1.06100CAD / 1 USD) for
transactions valued at $1 million or more.
A forward rate contract is an agreement between a corporation and a bank to exchange a specified
amount of currency at a specific exchange rate (forward rate) on a specified date in the future. Using a
forward hedge to lock in an exchange rate implies the future price of the US dollar would in effect be
set today. This type of hedge ensures that whatever the spot rate in the future might turn out to be, the
effective price paid for the shipment of goods would still be that which was agreed upon at the time
the forward contract was established. For example, the exchange rate at the time of the July 1, 2010
order between the USD and CAD was 1.05435, and the six-month forward rate was 1.06100 for
transactions valued at $ 1 million or more. Note the ask price is used in this example because the
Company would be buying US dollars and paying in Canadian dollars. While a bank might quote a
forward rate for a smaller amount, the most competitive forward rates are for larger transactions.
While there are many potential hedging mechanisms available, the most likely vehicles include a
futures hedge or a currency pair spot hedge. Paying early (Question 9) has many disadvantages as
described above. While a money market hedge would eliminate exchange rate risk, the cost of the
hedge is relatively large given the spread between interest paid in Canadian dollars and interest
received from the US dollar deposit. In addition, the money market hedge may artificially inflate the
Company’s balance sheet due to additional deposits and loans used in the money market hedge.
Forward rate hedges, while simplistic, are usually most cost efficient for large transactions ($1 million
or more) and not readily available for smaller transactions. A futures contract hedge provides
flexibility in terms of maturity but in most cases will not provide a complete hedge (over-hedging or
under-hedging) for orders not divisible by 100,000. However, a significant amount of transaction
exposure will be reduced through the futures hedge. A currency pair spot hedge has many advantages
in terms of size (any size order can be fully hedged) and maturity flexibility (no defined maturity
date). A direct comparison of the actual transaction costs (margin requirements and brokerage
commissions for the futures hedge versus the margin requirements and bid/ask spread involved in a
currency pair spot transaction) between a futures hedge versus a currency pair spot hedge would have
to be calculated on a case-by-case basis. However, due to interest rate parity, the difference between a
futures hedge and a currency pair spot transaction is minimal and often is simply a matter of
preference. From an operational perspective, one would have to clearly specify who is responsible for
managing transaction exposure and make explicit any constraints on the use of exposure-management
techniques. Basically, the student should indicate that the Company needs to develop a system of
monitoring and evaluating any risk management activities engaged in.

12. Speculate on possible reasons why the Company hedges against aluminum prices itself rather
than letting the aluminum can supplier conduct this hedging.

nature of question: financial; purchasing

Suggested response:

As stated in the answer for Question 1, Molson Coors may opt to share the risk emanating from the
aluminum price fluctuation with its supplier. Other than splitting the price change between them, the
two parties could have come to an agreement that Molson Coors would hedge the aluminum price on
behalf of the supplier by entering forward contracts. Such a decision may be attributed to two factors.
First, the supplier may not be as vulnerable to the price fluctuation as Molson Coors is. While the
Company has only two suppliers of cans, the suppliers produce cans for other breweries and soft drink
producers. This may put the suppliers in a stronger negotiating position than Molson Coors, thus
allowing the transfer of any change in production cost to the brewery. Second, as depicted in Exhibit
4 in the case study, Molson Coors takes long positions in forward contracts to manage an exposure
taking place for a period ranging from two to twenty-four months following the contract date. Exhibit
4 also shows that the hedging process is dynamic, i.e., more positions are entered into as the exposure
month gets closer. This approach can be related to the forecasting procedure described in the section
on ‘Forecasting’ in the case study. The Company seems to exploit the demand information it
possesses by aligning the demand volumes with the hedged quantities.

13. Comment on the committee structures of CRMT and FRMC. What can you suggest to improve the
decision making process of these committees?

nature of question: managerial

Suggested response:

There is an apparent overlap between CRMT and FRMC in terms of the positions of their
membership within the Company and in terms of the hedging decisions taken by the two groups.
Positions of the corporate team members of the CRMT (assistant treasurer, financial risk management
manager, and senior financial analyst) are represented also in FRMC. The position of the strategic
sourcing manager, from the local procurement team, in CRMT is also represented by sourcing
managers in FRMC. Furthermore, even though CRMT takes into consideration the factor of currency
exchange rates in its decision making, it is the FRMC that makes decisions related to hedging the risk
emanating from this factor.
Overlap in the positions represented in the two groups raises questions about the rationale of
separating them. A possible justification can be that the presence of members from local procurement
in CRMT provides this team with better capabilities to assess and manage commodity risk, as the
impact of this risk is directly related to the specific requirements of each brewery in consuming
various commodities.
The potential overlap in the decisions taken by two groups raises the question about the extent of
coordination between them. Coordination is surely required, as the decision of one group can
influence the decision of the other. For example, as depicted in Exhibit 4, when CRMT had decided to
manage its exposure to the aluminum price fluctuation in the month of October 2008, the Company
took long position in 200 tons of aluminum futures in August 2008. Assuming that the aluminum
futures price in August 2008 was $2,300/ton and the exchange rate was 1.1 CAD / 1 USD, the
Company would have locked the price of 2,300 × (1.1) = CAD 2,530 / ton by taking the long position.
Assuming that the exchange rate in October changed to 1.15 CAD / 1 USD, the locked price would
then be valued at CAD 2,645 / ton. The change in the locked price would be regarded as a failure in
the commodity hedging strategy if considered in isolation of the currency hedging position that the
Company had taken, offsetting the price increase. Thus, contract size and expiry date of the two
positions need to be determined simultaneously in a coordinated manner to ensure an offsetting effect
between commodity and exchange rate hedging strategies.

14. Propose performance measures for risk management at Molson Coors. Justify each measure.

nature of question: managerial; operational; financial

Suggested response:

A number of measures can be employed to determine the performance of operational and financial
methods used to manage various risks faced by the Company.

Managing demand fluctuation risk

As the customers’ demand for beer changes, the Company’s demand for aluminum cans fluctuates.
There will likely be a mismatch between available quantities of cans and actual requirements of
breweries. Different measures can be used to evaluate the Company’s approaches in managing this
risk.
Evaluating forecasting techniques

The Company uses various forecasting techniques to reduce the mismatch gap. Performance of
forecasting techniques as a risk management approach can be measured by ‘forecasting error,’ the
difference between the actual requirements and forecasted quantities.

Forecast error = actual requirement − forecasted quantity

Evaluating inventory management

The Company also maintains an inventory level of two to three weeks in its offsite warehouses to
minimize the shortage risk. As the demand forecast is not accurate, the Company faces either a
surplus or a shortage of cans, and the performance of this approach can be measured as the sum of the
respective costs:

Total cost = Max {(I – D)Ch, 0} + Max{(D – I)Cs, 0}

where,
D = actual demand in period t
I = inventory level maintained for period t
Ch = unit holding cost during period t
Cs = unit shortage cost

Measuring service level

The Company can also evaluate its inventory management approach by measuring the fill rate, that is,
the percentage of customers’ orders that could be satisfied from the inventory on hand:

Fill rate = (satisfied orders / total orders) × 100

Managing aluminum price fluctuation risk

Evaluating futures contracts

As depicted in Exhibit 4, the Company takes long positions in aluminum futures to be able to
purchase a quantity of aluminum sometime in the future (t2) at a locked contract price determined at
the time of position entry (t1). The long positions protect the Company from a sharp increase in the
aluminum price that would subsequently increase the total cost of goods. The performance of this
instrument is a function of the variations in the aluminum spot price and futures price, the hedged
quantity, and the actual demand, and it can be measured using the following formula:

Gain / Loss = (D × (S1 – S2)) + (N × (F2 – F1))

where,
D = actual demand at t2
N = hedged quantity
S1 = aluminum spot price at t1
S2 = aluminum spot price at t2
F1 = price at t1 of aluminum futures for delivery in t2
F2 = price at t2 of aluminum futures for delivery in t2
Managing currency exchange rate fluctuation risk

Evaluating currency hedges

As depicted in Exhibit 5, the Company enters into currency hedge positions at time t1 to manage the
risk of currency rate change that may occur at time t2, when foreign currency needs to be purchased
to procure raw material from a US supplier. The performance of this instrument is a function of the
change in the currency exchange rate, the hedged amount, and the actual amount, and it can be
measured using the following formula:

Gain / Loss = (N – A) × (f2 – f1)

where,
A = actual amount required at t2
N = hedged amount
f1 = currency exchange rate at t1
f2 = currency exchange rate at t2

15. What are some of the Key Performance Indicators (KPIs) for financial flow that Molson Coors
can use to help it manage its financial supply chain? Describe how the Company can make use of
these measures.

nature of question: managerial; financial

Suggested response:

The following KPIs can be used:

Days Working Capital (DWC) = (Average Working Capital / Annual Revenue) × 365

Days Sales Outstanding (DSO) = (Accounts Receivable / Credit Sales) × 365

Days Inventory Outstanding (DIO) = (Inventory Value / COGS) × 365

Days Payables Outstanding (DPO) = (Accounts Payable / Annual Revenue) × 365

Other important characteristics of financial flows are: reliability of payment methods,

predictability of payment inflows and outflows, and improving cash flow information management
(invoice-level data with financial data).
Improvements in supply chain design and operation may pay off in reduced inventory levels,
thereby improving the DIO metric. Furthermore, modern payment systems, such as electronic invoice
presentment payment (EIPP), may result in reductions in both A/R and A/P for companies along the
supply chain and hence improve the DIO and DSO metrics. The benefit of the EIPP in terms of
reduced working capital needs would be measured by the improvement in the DWC metric.

Impact on Inventory

Financial flow processes associated with A/R can result in unexpected delays in cash receipts, forcing
a company to delay ordering of incoming materials due to working capital constraints. This could
result in reduced customer service later on in terms of higher stock outs, lower on-time deliveries, and
decreased revenues.
 Toyota China: Matching Supply with Demand1
Xiaoying Liang, Lijun Ma, and Houmin Yan
Teaching Note

Summary

This case provides a brief overview of the Chinese automobile industry, the largest in the world, and
discusses in particular the supply-demand imbalance problem faced by Toyota China. Due to the
difficulties originating from demand forecasting and production planning, Toyota China is unable to
fully address the imbalance problem when it emerges. With limited allocation, Toyota dealerships
thus have to find their own solutions to retain customers through price discrimination, which can lead
to customer antagonism. This case study analyzes the causes of the problem and can be used as
guidance for designing effective solutions.

Teaching Objectives

The case study is suitable for students who need to understand supply-demand imbalance problems
from the supply chain perspective. Such problems are prevalent in the real world and involve
production, distribution, and sales. The case study can help students to identify possible causes and to
design solutions accordingly. In particular, students can learn the roles of the following factors －
demand forecasting, production planning, inventory allocation, customer management at dealerships,
and information sharing between manufacturers and dealerships － in the operations of automobile
supply chains. The case also provides an opportunity to explore the benefits of using centralized
management and specific customer segmentation strategies to mitigate the imbalance problem.

Questions for Discussion

1. Toyota China uses a multi-level distribution (sales) network, in which a regional sales manager is
responsible for all of the sub-regions within his/her region. One important task of a regional
manager is to determine the quota for his/her region based on projected demand and to allocate
the quota among sub-region dealers. When the demand is realized, the regional manager is also
able to arrange transshipments among sub-region dealers when necessary.

Consider a region consisting of two symmetric sub-regions, SR1 and SR2. Each sub-region’s
demand is an integer uniformly distributed between 0 and 5. For each vehicle sold, the dealer
earns a profit of 5; for each unsold vehicle, the dealer is charged a penalty of 3. Suppose that there
is no cost for losing demand and transshipment.

a) What is the optimal inventory decision for SR1 or SR2?

b) If the demands in SR1 and SR2 are mutually independent, what is the optimal inventory
decision for this region? If the demands are perfectly positively (negatively) correlated, 2 how
would the optimal inventory decision change?
c) Based on the answers to a) and b), discuss the effect of inventory pooling on the optimal
inventory and profit.

1
This note was prepared by Dr. Xiaoying Liang and Dr. Lijun Ma for the sole purpose of aiding classroom
instructors in the use of Toyota China: Matching Supply with Demand.
2
In the case discussed here, a perfect positive correlation means that the two demands always take the same
value. A perfect negative correlation means that the sum of the two demands stays at 5.
Answer:

a) For SR1 or SR2, the optimal inventory level should fall within the 0 to 5 range. To calculate
the expected profit under a given inventory level, , we use the formula
1
Expected profit = × ∑ i =0 [5 × min( x, i ) − 3 × max( x − i ,0)] .
5

6
The expected profits are summarized in the following table.

x 0 1 2 3 4 5
Expected profit 0 3.67 6 7 6.67 5

The optimal inventory level is thus 3, with an optimal profit that equals 7.

b) We use the following formula to calculate the optimal inventory level for the region when the
demands in SR1 and SR2 are mutually independent. For a given inventory level,
,

1
Profit = × ∑ 0≤i ≤5 [5 × min( x, i + j ) − 3 × max( x − i − j,0)] .
36 0≤ j ≤5

The expected profits are summarized in the following table.

x 0 1 2 3 4 5 6 7 8 9 10
Expected profit 0 4.78 9.11 12.78 15.56 17.22 17.56 16.78 15.11 12.78 10

Although the optimal inventory level is still 6 = 2×3, the optimal profit of 17.56 is
substantially higher than when the two sub-regions optimize independently, 2×7=14. This
indicates that inventory pooling can increase profits.
When the demands in SR1 and SR2 are perfectly positively correlated, inventory
pooling becomes ineffective because if a shortage occurs in one sub-region, it also occurs in
the other sub-region. Hence, the optimal inventory level is simply 2×3=6 and the optimal
profit is 2×7=14.
When the demands in SR1 and SR2 are perfectly negatively correlated, the total demand
for the region stays at a constant level of 5. The optimal inventory level is 5 and the optimal
profit is 5×5=25.

c) From the answers to a) and b), we may conclude that inventory pooling is beneficial. The
regional manager can use the excess inventory in one sub-region to compensate for the
shortage in another sub-region. This transshipment helps to reduce inventory and improve
profit.
When demands among sub-regions are more correlated, inventory pooling becomes less
effective. As the correlation increases, shortage (overstock) is more likely to happen
simultaneously in multiple sub-regions, which weakens the effect of inventory pooling. In
this case, the optimal inventory tends to increase, although the optimal profit may not be
monotonically increasing or decreasing, as we can see from the foregoing simple numerical
example. For a more advanced treatment of the inventory pooling problem, we refer readers
to [1].
2. The customer segmentation strategy employed by Toyota China’s dealerships, although
controversial, is effective in achieving a better inventory utilization and improving profit.
Consider a dealer selling a car over a finite period of time with a manufacturer’s suggested
retail price (MSRP) of 10. There are two classes of customers. The first class of customer is price
sensitive but delivery-time insensitive (PS). These customers are only willing to pay the MSRP
but will accept postponed delivery. The second class of customer is price insensitive but delivery-
time sensitive (DS). These customers are prepared to pay a 10% premium in addition to the
MSRP for an immediate pickup. If they cannot get the car immediately, they will simply leave.
The dealer can choose one of the following two selling strategies. The first is first-come, first-
served (FCFS), whereby the dealer serves all customers based on their arrival times and fulfills
their orders immediately, as long as there is on-hand inventory. Once all of the stock is sold, all
PS customers are backordered while all DS customers are lost. The dealer charges all customers
the MSRP under FCFS. The second strategy is to differentiate between classes of customers and
to price discriminate accordingly (DPDS). The dealer fulfills DS customers immediately from the
on-hand inventory at a premium price that equals 11, and it backorders all PS customers with a
promised later delivery.
Suppose that the two classes of customers arrive alternately and the size of each population is
five. The dealer starts with an initial inventory but is able to clear all backorders at the end of the
selling period by placing an additional replenishment order. For simplicity, the procurement cost
and the cost of the initial inventory are both assumed to be 8. Backordering cost, holding cost and
demand-loss cost are all neglected for now.

a) For the initial inventory levels, 2, 4, 6, and 8, calculate the profits earned by the dealer under
FCFS and DPDS, respectively.
b) Calculate the profit improvement ratio by DPDS, and discuss the reasons for the profit
improvement.
c) What other practical concerns should be taken into consideration when implementing the
market segmentation strategy?

Answer:

a) Under FCFS, before the dealer runs out of on-hand inventory, half of the profit earned comes
from PS customers and half from DS customers. After the stock-out, only PS customers can
be retained, and their orders are fulfilled at the end of the selling period. The profit for a
given initial inventory level x can be calculated using the formula

Profit = 2 × x + 2 × (10 – x) / 2.

The profits are summarized in the following table.

Initial inventory 2 4 6 8
Profit 12 14 16 18

Under DPDS, the entire initial inventory is used to fulfill the demand of DS customers,
and the demands of all PS customers are fulfilled at the end of the selling period. The profit
for a given initial inventory level x can be calculated using the formula

Profit = 3 × min(5, x) + 2 × 5.

The profits are summarized in the following table.

Initial inventory 2 4 6 8
Profit 16 22 25 25
 b) The profit improvement ratios are given in the following table.

Initial inventory 2 4 6 8
Profit improvement ratio 33.3% 57.1% 56.3% 38.9%

There are two main reasons for the profit improvement under DPDS. The first is price
discrimination, which allows the dealer to earn more profit on DS customers. The second is
inventory utilization: by reserving inventory for DS customers while postponing PS
customers through backordering, the dealer avoids the demand loss due to stock-out and
thus further maximizes its profit.

c) To implement the DPDS strategy, dealers need to gather information about customers’ price
and delivery-time sensitivity. The pre-classification (Class A, B, C and D) can be used as an
approximation.
In the numerical example, we have omitted several cost factors. In the real world, they
may be important for the performance of the DPDS strategy. The holding cost is more
appropriately understood as a financial cost, which makes dealers prefer to sell fast. The
backordering cost is the cost of retaining customers who are willing to wait. Dealers often
give out small gifts when a delivery is postponed. The cost of demand loss is usually called
loss of goodwill, which can be interpreted as a long-term loss. For example, by losing a
customer, dealers may lose the future revenue from maintenance services. For an advanced
discussion of the inventory optimization problem, we refer readers to [2].
Another practical concern is the customer response to such segmentation strategies,
which can be hard to evaluate precisely. For example, [3] argues that the dynamic pricing
strategy may cause customer antagonism, which is a reason for price stickiness.

3. In the foregoing discussion, we analyzed how dealerships should deal with the supply-demand
imbalance. We showed that dealerships can benefit from inventory transshipment and inventory
pooling, and also from refined market segmentation through delivery-time differentiation. We
now consider the supply-demand imbalance on the production side, and also from a supply chain
perspective. Please provide a qualitative analysis of the possible solutions to the supply-demand
imbalance problem.

Answer:

In short, an effective solution to the supply-demand imbalance problem is to build a flexible and
responsive supply chain, which involves the optimization of each stage in the supply chain and
their inter-connections. This cannot be achieved without the coordination of the whole supply
chain. We highlight several important points below.

a) Network design
The supply chain network of a company can significantly affect the efficiency of the supply
chain. To ensure that goods can move quickly and smoothly within the network, companies
should periodically review and make necessary adjustments to their supply chain networks
according to the dynamic business environment.

b) Product design
Product design plays an important role in achieving flexibility on the production side. For
instance, by adopting a modular design (quite common in the automobile industry) and
creating common modules, manufacturers can reduce costs and increase product variety.
Standardization and customization can be achieved at the same time.
 c) Flexible supplier relationships
With globalization, external suppliers have become an important part of a company’s supply
chain. Companies will demand more flexibility from their contract manufacturers and third-
party logistics providers (3PLs) to reduce risks and cycle times.

d) Simple transaction processing

Ordering processes have become especially cumbersome, with complicated requisition
requirements, multiple approvals, and complex links to the internal budget, resulting in a
long cycle time. Companies can reduce the cycle time by simplifying their transaction
processing. Moreover, a Vendor Managed Inventory (VMI) system can effectively increase
the flexibility of the supply chain.

e) Supply chain connectivity

Coordination, especially information sharing within the supply chain, has a non-negligible
influence on overall efficiency. Many companies are now equipped with advanced IT
systems, but these systems are seldom integrated to ensure smooth information flow within
the same supply chain. Establishing a smooth bidirectional information flow creates a win-
win situation: downstream companies can manage customer demand with better knowledge
of the upstream supply conditions, and upstream companies can arrange production with
more accurate demand forecasting. For the whole supply chain, improved connectivity can
help to reduce costs and cycle time, and thus achieve greater customer satisfaction.

References

[1]. S.A. Lippman and K.F. McCardle. The competitive newsboy. Operations Research, 45(1):54-65,
1997.
[2]. H. Wang and H. Yan. Inventory management for customers with alternative lead times.
Production and Operations Management, 18(6):705-720, 2009.
[3]. E.T. Anderson and D.I. Simester. Price stickiness and customer antagonism. Quarterly Journal
of Economics, 125(2):729-765, 2010.
[4]. G. Cachon and C. Terwiesch. Matching supply with demand: An introduction to operations
management, 3rd ed. McGraw-Hill/Irwin, 2012.
[5]. R. Garber and S. Sarkar. Want a More Flexible Supply Chain? Supply Chain Management
Review, Jan/Feb, 28-34, 2007.
 Cisco Systems, Inc.: Supply Chain Risk Management
María Jesús Sáenz and Elena Revilla
Teaching Note

María Jesús Sáenz from MIT-Zaragoza International Logistics Program and Elena Revilla from the IE
Business School prepared this case as a basis for class discussion.

Case Synopsis

In March 2011, a high-magnitude earthquake, followed by a tsunami, devastated the east coast of
Japan. It was one of the largest disruptions to global supply chains in modern history with
incalculable consequences for world markets. Cisco Systems, Inc., the communication technology
provider, has been leveraging markets and technology for developing its competitive strategy,
evolving to a prevalence of outsourcing and globalization. When the tsunami on the Japanese coast
occurred, it affected the scope of Cisco’s extensive network of suppliers and facilities all over the
world and activated a global complex mechanism with the main purpose of diminishing the tsunami’s
effects on Cisco’s supply chain. This case illustrates the peculiarities of Cisco’s supply chain and their
internal and external vulnerabilities. It also demonstrates the evolution of the supply chain risk-
management approaches at Cisco and examines the reasons behind this evolution.

Learning Objectives

• Analyze the sources of vulnerability of a supply chain.

• Expose students to supply chain risk management.
• Analyze and reflect on the motivations that fostered the implementation of risk- management
practices ahead of events that disrupt the supply chain.
• Expose students to the concept of supply chain resilience by design.
• Illustrate the combination of reactive and proactive risk-management approaches and their
implications.

General Discussion Questions:

1. How has the evolution of Cisco’s supply chain influenced the complexity of its current supply
chain?
2. What are the implications of the different vulnerabilities that Cisco has had to face?
3. Did the supply chain risk management strategy that was implemented after the tsunami in Japan
result in positive outcomes? What worked, what did not, and why?
4. Which comparable and comprehensive metrics have been required to assess supply chain
resiliency capabilities? How can we relate these metrics to the time-to-recovery measurement
for all capabilities?
5. Can Cisco’s supply chain risk management strategy be generalized for any supply chain?
6. Are the supply chain risk-management efforts and budget justified? Does the return on
investment of such efforts provide enough justification for their existence?
7. What lessons can be extracted from the experience of managing these high-magnitude
disruptions? How might Cisco continue to learn to improve the performance of its supply chain
risk management?
Preliminary Discussion

In discussing this case, a good place to start is by understanding what is meant by supply chain
disruptions, supply chain risks, and their differences. There are two fairly distinct broad categories of
risks that affect supply chain design and management: (1) risks arising from the problems of
coordinating supply and demand, and (2) risks arising from disruptions to normal activities. This case
focuses on the second type of risk—supply chain disruptions—and how the different categories of
vulnerabilities impact the threat of a final supply chain disruption as well as different and
complementary strategies for mitigating such effects. Supply chain disruption can be defined as
unplanned, unintended, and exceptional situations that disturb the normal flow of goods and materials
within the chain. Disturbances may cause disruptions in flow of materials and information and/or
finance in one or more companies belonging to the same supply chain. These disruptions may have a
negative effect on a supply chain’s operations and make it vulnerable, thus reducing its performance
and competitiveness.
In order to continue the discussion, some additional facts about what managers say about supply
chain risks could be posed by the instructor. This could help connect with the attendees’ own
experiences:
 A recent study of McKinsey (2011) shows that 70% of executives indicate that supply chain
risks have increased in the past three years.
 Supply chain risks are the second most important issue for executives (IBM, 2009).
 The 80/20 rule is also applicable in relation to managing supply chain risk; 80% are reactive
and 20% are proactive (ChainLink Research, 2011).

Within the context of a potential supply chain disruption, we can define supply chain risk
management as the identification of potential sources of risk and the implementation of appropriate
practices through a coordinated approach among the supply chain risk members to reduce the effects
of a disruption.
Additionally, as part of supply chain risk management, it is important that students identify the
implications of supply chain resiliency. Resiliency can be defined as the capability of a supply chain
and its members to lower the impact of a disruption and return to, or even improve, original
operations.

1-2. How has the evolution of Cisco’s supply chain influenced the complexity of its current
supply chain? What are the implications of the different vulnerabilities that Cisco has had
to face?

Cisco’s supply chain portfolios have been designed under three main principles:
• Outsourcing
• Globalization
• Efficiency.
The evolution of Cisco’s supply chain founded on these principles has supposedly increased the
levels of supply chain complexity. This is represented by certain structural attributes, which imply a
high degree of supply chain vulnerability, such as (refer to Exhibit 1):
• A configure-to-order manufacturing model and the derived constraints for an inventory of
finished goods.
• A wide range of products.
• Almost exclusively outsourced manufacturing, which implies a disperse network of diverse
suppliers.
• A wide range of customers and service implications.
• Constant acquisition integration and the implications of this in supply chain dynamics.
In connection with the case description, the instructor can point out the difference between the two
sources of vulnerability referred to in the Supply Chain Risks section. We can differentiate two
primary categories of supply chain vulnerability, internal and external sources, depending on the
origin of the risk. Internal sources of risk are related to operational contingencies within the supply
chain and can cause a change in operations and processes inside the company as well as with their
partners. In addition to sources of internal supply chain vulnerability, the second, or external, type of
risk occurs by the degree to which exposure to the external environment affects the supply chain, such
as natural hazards as well as economic and market-derived sources. Both internal and external sources
of vulnerability play different roles in a supply chain context, and combinations of both could cause a
variety of effects. The students can offer their viewpoints on the connections between these two
sources of vulnerability and the three main premises of Cisco’s supply chain. Thus, for example, as
supply chains evolve toward greater efficiency and cost reduction, they become less flexible to
respond to non-planned operational changes and thus are exposed to higher internal vulnerability, as
defined by this case. This viewpoint can be contrasted with a supply chain that is designed to offer a
greater market response, providing a higher and faster reaction capability to operational changes. On
the other hand, having a global network of diverse tiers and sub-tiers of suppliers coming from
different world regions implies high external vulnerabilities.
Therefore, the instructor may conclude that Cisco’s supply chain was vulnerable by default, both
from the tension of its internal operations and from exposure to uncertain external environments.

3. Did the supply chain risk management strategy that was implemented after the tsunami in
Japan result in positive outcomes? What worked, what did not, and why?

Cisco has been aware of the increase in its supply chain vulnerability, which has motivated the
development of the company’s supply chain risk-management capabilities.
Now, the instructor can explain the general practices about supply chain risk management from the
experience and effectiveness of dealing with the effects of the tsunami in Japan. The main supply
chain risk-management approaches can be placed into one of two categories: (1) a reactive, incident-
based risk approach, and (2) proactive management, both complementary. These two approaches were
created and further developed in supply chain and product design, resulting in what Cisco calls
“resiliency management innovation,” as depicted in Exhibit 4. The deployment of Cisco’s risk
management approach is based on a robust set of tools and practices that are strongly embraced by the
different business units to provide resiliency in the design of both products and the supply chain. The
evolution of Cisco’s supply chain risk management strategy has accompanied the company’s
evolution from a supply chain focus to a total value chain focus (depicted in Exhibit 1).
Let’s analyze the different practices within the proactive risk management approach for providing
resiliency by design. These practices integrate risk awareness while innovating Cisco’s product and
supply chain.

• Product resiliency: The main aim of product resiliency was to identify Cisco’s product
components with risk qualifications outside the established tolerances and, together with
product development teams and commodity management teams, develop resiliency plans
such as alternate components in bills of material or component risk buffers. This resiliency
has been structured following the nature of the different components and raw materials for
Cisco’s optical-service routers as presented in Exhibit 3. It also implies a change in the
culture of innovation to the design for resiliency upstream.

• Supply chain resiliency: This consists of proactive efforts in the design and execution of the
supply chain in terms of equipment, processes, manufacturing sites, and external services,
with the main purpose to reduce post-disaster recovery. The supply chain resiliency team
works closely with manufacturing operations, partners, and logistics and transportation-
service providers to identify nodes that are outside of risk-qualification tolerances and to
develop resiliency plans for them accordingly.

• Resiliency monitoring: To achieve effective resiliency, transparent, objective, and

comparable metrics were required. See the below discussion about this risk management
practice.
 Although we might think that companies should theoretically promote proactive approaches as
the major actions for risk mitigation, there are always reactive risk management practices to put into
place once a disruptive event occurs, such as the tsunami in Japan. Below are the specific risk
management practices that were deployed according to the nature, location, and magnitude of the
event. Therefore these practices are reactive by definition, but they are correctly aligned and
combined with the proactive approaches analyzed previously.

• Incident management: This entails the 24/7 monitoring of worldwide events that may
impact the value chain. Cisco has developed robust tested crisis playbooks that allow for the
deployment of cross-functional response teams, tailored to the disruption type and expected
magnitude, and aligned with emerging management authorities and operations centers in the
region.
An example of this practice occurred after the tsunami in Japan when Cisco alerted the
critical nodes within 30 minutes of the initial alert of the 9.0-magnitude earthquake. This alert
was issued to all the supply chain risk-management teams as well as senior key leaders. The
result was incident awareness within 40 minutes of the earthquake and escalation of the event
to senior management within 57 minutes.

• Business continuity management: This implies the processes through which to assess
critical value chain partners by means of: (1) identifying key nodes with high-impact
potential, (2) a risk engine based on the likelihood and impact using a simulation to generate
“heat maps”, (3) mapping critical components to supplier sites and, (4) evaluating
preparedness/audits of business continuity-planning procedures with supply chain nodes.
Cisco used a platform for collecting, updating, and utilizing critical supply chain node
information for effective incident response to assess the impact of any disruption and to
illuminate potential vulnerabilities.
Exhibit 6 depicts a map with the tier and sub-tier impact for Cisco optical-server routers
after the tsunami in Japan. The company deployed the evolution of the effects of impact in
terms of both the degree (high, medium, and no impact) as well as the power risk, assembly,
or sub-component suppliers’ damage and nuclear impact. The outcome was that initial
assessment of Cisco’s impacted supplier footprint was achieved within 9 hours, evaluating
critical components and preliminary revenue at risk within 12 hours. Cisco had to manage
complex mitigation as over 1,100 unique components were impacted across 65 suppliers in
Japan, requiring 900+ new manufacturing qualifications that were executed at triple the speed
of the average time to qualify. Several critical points of failure in sub-tiers were quickly
identified and mitigated.

4. Which comparable and comprehensive metrics have been required to assess supply chain
resiliency capabilities? How can we relate these metrics to the time-to-recover (TTR)
measurement for all capabilities?

Cisco created a resiliency index to assess TTR for all capabilities, suppliers, products, and certain
supply chain designs. The index was formed by multiple categories that are weighted depending on
their importance on building resiliency and includes components (30%), suppliers (20%),
manufacturing (30%), and test equipment (20%). Metric development has been part of Cisco’s
continuous learning process. The resiliency scores are reported semiannually to senior management
by the general managers. This assessment system connects the supply chain risk-management team
with the supply chain designers and product designers to maintain awareness of product resiliency as
well as with operations executives for dealing with suppliers’ resiliency.
5. Can Cisco’s supply chain risk management strategy be generalized for any supply chain?

This is an interesting discussion to encourage among students. The instructor can then ask which
students are in favor of generalizing or not and then ask them to justify their position. Students should
identify the following within their arguments:

• The degree of supply chain vulnerability is determined by factors such as:

o supply chain structure
o product standardization
o supply chain integration
o market strategy followed: cost vs. responsiveness, for example
o market dominance or position
o local vs. global supply chain orientation
o external environment: market uncertainty, socioeconomic context, or natural hazards.

• Depending on the role of each company in the supply chain (manufacturer, sub-tier supplier,
wholesaler, retailer, logistics-service provider, etc.), different actions regarding supply chain
risk management should be promoted. In the case of Cisco, the company’s leading role in its
supply chain makes management decide which approaches should be implemented and how
they should be deployed. Their suppliers and logistics service providers should follow these
approaches to be correctly integrated along the supply chain.

• Differences between proactive and reactive supply chain risk-management approaches should
be discussed. While proactive risk management practices can be planned in advance and
tailored to the features of a certain supply chain, reactive practices should be detailed, as they
are deployed when an event is happening and leave little time for preparation. Therefore, only
general guidelines for reactive approaches can be designed and agreed upon in advance;
however, these guidelines need to be adjusted to every circumstance, both from the supply
chain point of view as well as from the kind of event that provokes the disruption.

6. How can the existence of supply chain risk-management efforts and its budget be justified?
Does the return on investment of such efforts provide enough justification for their
existence?

A critical point is reached when the supply chain risk-management team needs to justify its
existence in a supply chain context and every action has a performance and feasibility measurement.
But there are real difficulties in calculating the bottom-line savings that these teams and approaches
achieve by minimizing the impact on their customers.
After the tsunami, there was no or minimal impact on Cisco’s customers due to the efforts of
Cisco’s supply chain risk-management team, in conjunction with their suppliers and other partners.
Cisco estimated that it was able to mitigate over $100M in potential revenue losses as well as avoid
over $20M in additional component mitigation costs.
But maintaining an effective risk-management program is expensive, and a company cannot
establish its value added only from the point of view of return on investment. Now the instructor may
open a discussion about the qualitative benefits of maintaining a full-time supply chain risk-
management team, such as:
• Keeping scarce key product materials and ensuring the running of the supply chain
immediately after a disruption.
• Learning about how a supply chain is affected ahead of unexpected circumstances and having
a forward-looking attitude. This allows a company to better know its supply chain partners
and other stakeholders.
• Taking risks in companies’ market approaches because control mechanisms are in place to
enable more agility within the course of business.
7. What lessons can be extracted from the experience of managing these high-magnitude
disruptions? How might Cisco continue to learn to improve the performance of its supply
chain risk management?

Cisco started dealing with supply chain vulnerability with an incident-based risk approach in which
the main goal was to establish the risk priorities from an analytical point of view. This approach
probed a minimal use of building supply chain resiliency. The continuous learning loop developed by
Cisco between supply chain management teams and the supply chain risk-management team helped
the company to understand the opportunities of building resiliency by design.
At this point, students may propose complementary and alternative strategies for dealing with
supply chain disruptions in the context of Cisco, but they should also discuss other sources of risks
beyond a natural hazard event, such as an economic recession or a strike, among other possibilities.

Additional Readings
• Chopra, S. and Sodhi, M. 2004. “Managing risk to avoid supply chain breakdown.” MIT-
Sloan Management Review, 46 (1):53–61.
• Bremmer I. and Zakaria, F. 2006. “Hedging Political Risk in China.” Harvard Business
Review, November.
• O’Marah, K. 2012. “Collaborative Execution, Speed, Innovation and Profitability.” SCM
World, March 2012.
• Sheffi, Y. 2005. “The Resilient Enterprise: Overcoming Vulnerability for Competitive
Advantage.” MIT Press, Cambridge, MA.
• Sheffi, Y. and Rice, J. 2005. “A supply chain view of the resilient enterprise.” MIT Sloan
Management Review, 47 (1):41–48.
 BESSI: The Importance of Coordinating Product
Development with Supply Chain Planning in the Fashion
Goods Industry
Maria Caridi, Margherita Pero, and Antonella Moretto
Teaching Note

Case synopsis

BESSI is an Italian luxury company developing and manufacturing a wide range of leather goods.
BESSI distributes its products all over the world through more than 200 direct operated stores and
some franchising stores.
The metronome of all BESSI’s activities (design, product development, procurement, production,
and distribution) is determined by collections, concurrent with the deadline of the fashion week that
occurs twice per year. For instance, for the fall-winter collection, orders are collected starting from the
end of January to the first week of February, reorders are collected in April and May, and the first
products are delivered in the middle of April for the American market.
BESSI products are mainly fashion products (new products launched during the collection and not
sent to the market for more than one season), and only 30% of BESSI’s turnover is due to carry-over
products (products proposed almost identically for more than one season). The case describes in detail
the product development process for both product categories.
BESSI’s supply chain is composed of Italian craftsmen, which are almost all located near BESSI.
They are small and captive suppliers. Some of them buy the material themselves, manufacture the
products, and sell them to BESSI. Others manufacture the products starting from materials that BESSI
buys and sends to them. The material procurement lead-time is about 7 weeks, and the production
lead-time is 7 weeks. Thus, the overall lead-time of the product is 14 weeks, independent of the kind
of suppliers.
Three kinds of planners help plan production and procurement:

• Finished product planners: they are autonomous, and they plan finished product suppliers.

• Material planners: they receive the demand forecast from the Style department, and they plan
sourcing activities.

• Production planners (or supplier planners): they plan manufacturing activities.

Material planners’ decisions and production planners’ decisions are tightly linked—without
materials, suppliers cannot produce! Unfortunately, there are problems of coordination between
material and production planners. In fact, material planners determine the plan based on demand
forecasts for 30% of the purchased materials, while production plans are mainly pulled by orders.
Moreover, to define forecasts, the Merchandising department needs the information about the cost of
the product, which is in turn defined by the Costing department. Costing can work only if the
prototype is available, but prototyping is a complex and expensive process, and the prototypes are not
always completed on time.
There is an information system in which planners insert the exact quantities they want the
suppliers to manufacture. Since materials are sometimes not available and would require expediting,
production planners may order twice the necessary quantity. If materials are then actually available,
the corresponding finished product quantity will be produced. Thanks to this mechanism, the
probability of stock out is lower, but inventory levels are too high.
The demand forecast of the Merchandising department has an error ranging from -20% to 40%.
The challenge is therefore to find a solution to this problem.
Case teaching objectives

The case is an interesting case for the following reasons:

• It allows students to understand the necessity of alignment between the product development
process and supply chain planning.

• It provides meaningful insights about the process of product development of a fashion-luxury

company. Several details about the activities performed to develop a collection, the
relationships among different activities, and the actors involved in the process are provided.

• It describes a process (i.e., the product development process) that is particularly critical for
fashion-luxury companies being realized at least twice per year by each company and being
the real value added process for the company.
Case discussion

An effective way to begin the discussion of the case is to describe the product development process,
spending some time analyzing the activities of the processes, the organizational roles involved, the
interconnections among the departments, and the timing of the process (cfr. Appendices 2 and 3). In
this part of the discussion, it is important to illustrate the differences among carry-over and fashion
products.
Moreover, the instructor can describe the company’s supply chain by showing the main actors
(cfr. Figure 1) as well as lead-times. To stimulate the conversation, the instructor can discuss the
position of the decoupling point along the supply chain by highlighting that 30% of materials are
purchased on the basis of forecasts yet 70% are pulled by orders collected through distribution
channels. On the contrary, almost 100% of the production is pulled by orders. Thus, this supply chain
is a hybrid of purchase-to-order (PTO) and make-to-order (MTO) models. To discuss these points, the
instructor can use the Appendix 2, comparing different approaches for different activities.
This preliminary description might take between 20 and 30 minutes by collecting suggestions and
proposals from students.
At this point, the instructor may give the first assignment.

Describe the weak points of Bessi’s planning process.

The class can then work in small groups composed of 4 to 5 people each for around 20 minutes.
Afterwards the instructor can collect the ideas generated by the small groups and synthesize them on
the blackboard. The main results should be:

• There are high inventories but for some items long delays in delivery. This is strange for a
PTO/MTO company.

• The reason for that is the lack of coordination among production planners and purchasing
planners. Since materials are often not available when needed, production planners inflate the
planned consumption of materials. As a consequence, an inflation of finished product quantity
is generated because the finished product quantity corresponding to the new inflated
consumption is manufactured.

• Materials are not available when needed because forecasts are not reliable.

• Forecasts are not reliable because product costs are not reliable. To make a precise forecast,
the planners need the product costs due to the high price elasticity of demand. Some students
may observe that luxury products are expected not to be price sensitive. The instructor can
underscore that within a luxury company, several product lines exist with different
positioning. Usually high-luxury products are not price sensitive, but this does not necessarily
apply to accessible ones.
 • The costs are not reliable because they are determined on the basis of sketches or in-progress
prototypes. This makes the evaluation of product itself difficult. As a matter of fact,
prototypes are delivered too late because they are expensive, and often materials are not
available.
The discussion of the first point might take between 15 and 20 minutes. In this phase, it is
important to collect all of the ideas from students and to encourage debate and investigation of the
reasons behind behaviors.
At this point, the instructors can launch the second assignment. The instructor should also suggest
to students to focus just on fashion products, which are the critical ones.

How can we help Dr. Castelli in carrying out this hard job?

The class can work again in the same small groups composed of 4 to 5 people each for around 30
minutes. The instructor could also recommend developing different groups, compared to the first
assignment, in order to facilitate the dissemination of information and to foster the learning process.
In case this option is followed, some more time could be allocated to students (around 40 minutes).
Afterwards, the instructor can collect the ideas generated by the small groups and synthesize them on
the blackboard. All in all, the main solutions can be grouped in three main “clusters”. We suggest that
the instructor divide the blackboard into three parts because the three clusters must be considered as
complementary solutions and not opposite ones.

1. Reduction of product development process lead times. By reducing lead times, definitive
prototypes are supposed to be available to the Costing department in advance, thus making
more reliable the estimation of product cost. To reach this goal, the class may suggest
different levers, such as:

• Concurrent engineering among the activities within the product development process,
thus reducing lead-time

• Modifications in the structure of the final collection by reducing the number of product
variants and increasing the number of collections per year (through the development of
mini-collections)

• Introduction of virtual prototyping or computer-aided design (CAD) and computer-aided

manufacturing (CAM) systems to reduce the time required having definitive prototypes

• Introduction of a product data management (PDM) system to share data and product
information all along the product development process.
2. Improvement of forecasting reliability by means of the following levers:

• Market research

• Expert panels

• Sales data analysis

• Style testing in flagship stores

• Analysis of historical sales data comparing the sales in normal periods and in discount
periods in order to understand the price sensitivity of consumers

• Sharing information about the actual sales data with the point-of-sales. Some students
could also suggest that data can more easily collected if RFID technology is introduced.
3. Coordination among different processes, such as planning, product development, and costing.
This should be the core element of the discussion, and the instructor should devote most of
 the time to it. The instructor should highlight that the actors that work in the above mentioned
processes have contrasting objectives when defining the priorities for carrying on their
activities, as summarized in the following table. The table might be copied on the blackboard
to clearly illustrate the different priorities among different actors as well as different
processes. We suggest that instructors discuss this point in the middle of the blackboard, thus
graphically highlighting the importance of coordination among different processes.
Table 1: Perspectives of different actors.

Process Actor Priority

Forecasting Merchandising High priority is given to fashion products

Costing Costing High priority is given to low-price
products and carry over
Product development Product development Prototypes are generated according to a
FIFO rule
Style N.A.

The solution is looking for a coordination mechanism to align the priorities of all the actors to the
merchandising one. Products could be classified already in the grid definition (or as soon as possible)
according to priorities identified and shared among all the actors. A possible priority could be related
to forecast uncertainty and sales volumes. Indeed all the material range is purchased on the basis of
both forecasts (30% of volume) and orders (70% of volume). Thus, forecasts of all the kinds of
different products are needed. According to this criterion, higher sales volumes and lower demand
uncertainty imply a lower product priority. As a matter of fact, even though for these products the
definitive prototypes are not available when the product cost is defined and so the forecasts are not
reliable, there is still the possibility open to issue another order. An ABC-ABC matrix can be a useful
tool for this purpose, as shown in the following figure.
Table 2: ABC-ABC matrix.

Sales volume

A B C

A
Mid High High
priority priority priority
Forecast uncertainty

B
Low Mid Mid
priority priority priority
C
Low Low Low
priority priority priority

The discussion of the three clusters mentioned above could take around 45-50 minutes, for
instance: 15 minutes for product development solutions, 10 minutes for forecasting reliability, and 20-
25 minutes for collaboration.
Some students may also suggest other levers:
• Speed up the distribution process to reduce the delivery lead-time and in this way have more
time for manufacturing activities. Some possible practical solutions that can be implemented
in this sense are cross-docking, shipping container marking (i.e., putting multi-language
labels on each finished product), and preparing batches in a way so that clothes are ready to
be put on the shelves in the store.

• Speed up and simplify the production processes by collaborating with suppliers, sharing
information related to sales and production plans with suppliers, and reducing setup time.
 Queuing at eCycle Services
Janice Eliasson and Brent Snider
Teaching Note
(An Excel spreadsheet accompanies this teaching note.)

1. How long should the city trailers be waiting per day/week/month? (At $60 per hour, the
waiting cost can be determined.) Is the $30,000 invoice for last month possibly correct?
What is the “customer”? The trailers
What is the arrival rate (λ)? 3 trailers per day
What is the “server”? The crew unloading the single dock
What is the service rate (µ)? 4 trailers per day (considering an 8-hour day, this means it
takes 2 hours on average to unload a trailer)

Note: values can be calculated manually using the M/M/1 queuing formulas.
What is the “mean time in On average, a trailer is at
1 1
the system” in days for a W= = = 1 eCycle for a full day (8
trailer? μ−λ 4−3 hours).

What is the average λ 3 On average, there are 3

number of trailers in the L= = =3 trailers at eCycle.
μ−λ 4−3
system?

Daily cost of city trailers = average # of trailers on site (L) × 8 hours per day × $60 per hour
= 3 trailers × 8 hours × $60
= $1440 per day

Weekly cost of city trailers = $1440 per day × 5 days per week
= $7200

Monthly cost of city trailers = $7200 per week × 4.33 weeks per month
= $31,176
Conclusion:
A $30,000 monthly invoice from the city is certainly possible!

2. What are the current costs of the unloading “system” (trailers versus employees) per
day/week/month?
Unloading crew costs per day = 2 workers × $24 per hour × 8 hours per day = $384
Unloading Crew City Trailers Total
Daily $384 $1,440 $1,824
Weekly $1,920 $7,200 $9,120
Monthly $8,314 $31,176 $39,490
% of costs 21% 79% 100%
Conclusions:
• Most of the costs are attributed to the trailers (79%).
• If we add more (cheaper) crew members, they may be able to process the more
(expensive) trailers through the system more quickly.
3. How would increasing the crew size impact the total costs? What is the optimal crew size?
Managers must balance the trade-off between providing good service and the cost of waiting.

Note: It will still operate as an M/M/1 system as they will not be adding a “server;” there is
still only one unloading dock. They are increasing the processing speed of the single “server.”

Recall that Kevin said: “Just because two guys can unload four trailers a day, it does not
mean that six guys could unload 12 trailers a day – it would probably be more like 8 trailers
a day.” Based on this, we can infer the unloading rates for the intermediate crew sizes.

Size of Mean Daily Cost of Average Daily Cost of Total daily

Unloading Unloading Crew number of Trailers Cost of
Crew rate trailers in the
system
µ Size × $24/hr λ $60/hr × Crew and
L=
× 8hrs/day μ−λ 8hrs/day × L Trailers
2 4 $384 3 $1440 $1824
3 ? (5) 3×$24×8 = $576 1.5 $720 $1296
4 ? (6) 4×$24×8 = $768 1 $480 $1248
5 ? (7) 5×$24×8 = $960 0.75 $360 $1320
6 8 6×$24×8 = $1152 0.60 $288 $1440

Conclusion:
The optimal crew size
is 4 employees. The
daily cost would be
$1248 compared to
$1824 currently. This
results in a savings of
$576 per day or 32 %
less!

Note that the optimal solution results in a utilization of only 50% (unloading 3 trailers per day
with a capacity of 6 trailers per day). This is because it is better to have the lower-cost staff
waiting than the more expensive trailers.
4. Sensitivity analysis on the optimal solution:
This is easily accomplished by using the accompanying spreadsheet. Change the input parameter
until there is a change in the optimal solution:

Change these input parameters (one

at a time) to see when the optimal
solution (lowest cost) changes.

a. Wage rate – up to what hourly wage rate should we stay with the optimal crew size?
The optimal crew size of four employees holds for a labor rate of up to $30 an hour. Once the
pay rate exceeds $30 an hour, the optimal crew size would drop to 3 employees.

b. Trailer waiting rate – up to what hourly trailer waiting rate should we stay with the
optimal crew size?
The optimal crew size of four employees holds for a trailer waiting rate of up to $96 an hour.
If the city has an hourly trailer waiting rate above $96 an hour, the optimal crew size would
be 5 employees.

c. Arrival rate - what is the optimal crew size if arrivals jump to 4 trailers per day?
The optimal crew size of four employees holds for an average trailer arrival rate of up to 3.5
trailers per day. If we start to receive more than an average of 3.5 trailers per day, the optimal
crew size would be 5 employees. A crew size of 5 employees would also be optimal with an
average of 4 trailers arriving per day.

Conclusions:
• The optimal solution of a four-person unloading crew is not very sensitive to the
hourly rates, for employees and trailers. The four-person crew is optimal unless
wage rates rise above $30 an hour or the city charges over $96 an hour for their
waiting trailers.
• The optimal solution is sensitive to the trailer arrival rate. Any average arrival
increase beyond a ½ trailer per day will cause the optimal solution to change.
5. What are some other process improvement alternatives that are worth investigating
further?
• Renting a second loading dock (adding a second server to the process)
o Rather than a crew of 4 at one loading dock, two separate crews of 2 per dock.
• Faster unloading process
o Provide pallets with strong exterior (metal cage / reinforced cardboard) to the
recycling facilities to fill. This would enable a fork-lift to load and unload the
trailers much faster.
o A conveyor belt/metal rollers that can extend into the trailer. The staff then could
place the CRT displays onto the conveyor rather than shuttling carts back and
forth.
• Flexible crew size
o Have other employees (ex. disassembly team members) temporarily help unload
if there are two city trailers in the system (1 being unloaded and 1 waiting).
• eCycle could purchase its own trucks and pick up the CRT displays from recycling
facilities directly
o The best-case scenario of the current process (no waiting, just unloading) still
requires a monthly payment to the city. Assuming no arrival variation (say the
trailers arrived every 2.5 hours) there would be no waiting time; however, there
would still be 6 hours per day (3 trailers per day unloaded at 2 hours each) of
trailers at the eCycle facility. This results in a best-case scenario daily cost of
$360 (6 hours @ $60/hour), or a monthly cost of $7800 ($360×5×4.3333).
o Perhaps this money could be used to purchase or lease eCycle’s own trucks.
• Set delivery times
o Perhaps approach the city to see if set delivery times (appointments) could be
used. This would prevent the variability of arrivals and reduce waiting times.
Service variability would still exist since the exact contents are unknown.
• Other
Multi-Echelon Inventory Decisions at Jefferson Plumbing
Supplies: To Store or Not To Store?
Amit Eynan
Teaching Note

The main objectives of this case are to illustrate the difference between single-echelon and multi-
echelon inventory systems and to demonstrate the need to coordinate between the echelons. Through
a simple scenario it is demonstrated that:
• Solving for each echelon independently using the traditional EOQ approach is inappropriate.
• The inventory pattern at the warehouse (distribution center) is different than the one at the
store.
• Coordination between the echelons is needed in order to obtain system optimization.
• The optimal solution may be obtained through an EOQ-like expression.

Potential questions:
1. What is the current optimal order quantity and the total (ordering and holding) cost?
2. What will be the cost if the store orders 130 units at a time?
3. What was Alex’s rough calculation?
4. If Jefferson incorporates the warehouse, how many units should be ordered from the supplier
to the warehouse? How many should be delivered from the warehouse to the store?
5. What would you recommend that Alex do? What will the cost be?

Lesson Plan

The session may start by asking students for the optimal practice before the new minimum order
requirement has been established. By using the standard EOQ formula, all students should easily
determine that currently Jefferson orders 45 units, and its (ordering and holding) cost is $447 per year.
Now that it has been verified that 130 units indeed represents about three times what they have
been ordering, the instructor should ask for the students’ advice to Alex: should he use the warehouse
or simply increase the orders to 130? Taking a students’ vote may be appropriate
If Alex simply increases the order quantity to 130, the students will easily determine that the
100 130
annual cost will go up to: 100 + 10 = $727 , a 63% increase.
130 2
Optionally, at this time an investigation regarding the rough calculation that Alex used can be
TC (Q )  Q Q * 
made. It is based on the expression: =  +  2 , where Q denotes the order quantity, Q
*
TC (Q * )  Q * Q 
the optimal order quantity, and TC(Q) the total cost when ordering Q. This expression indicates the
increase in cost due to a deviation from the optimal order quantity.
When exploring the option of incorporating the warehouse, many students will apply the EOQ
formula in its simplest form to the store and warehouse, separately. This will result in the following
quantities and costs (see table). However, these results are neither accurate nor optimal as will be
demonstrated in the session.
 Order Quantity Annual Cost

Store 2 × 50 × 100 100 31

= 32 50 + 10 =
316
10 31 2

Warehouse 2 × 100 × 100 100 141

= 141 100 + 1=
141
1 141 2

Total 457

After these results have been presented, the students may be asked to draw the inventory level
pattern over time. The store pattern is the traditional EOQ (see Figure 1). The challenge (and,
therefore, the opportunity to shift the discussion to the mechanics of multi-echelon inventory systems)
is with the warehouse pattern. Apparently, it is different than the store and not like the one described
in Figure 2. Because each delivery to the store reduces the warehouse inventory by Q units in an
instant, the actual inventory pattern is a step function as depicted in Figure 3.

Figure 1: Store’s Inventory Level

32

Figure 2: Incorrect Warehouse Inventory Level Pattern

141
 Figure 3: Correct (but inefficient) Warehouse Inventory Level Pattern

154
141 122
109
90
77
58
45
26
13

Once inventory levels are determined in Figure 3, the notion of inefficiency is revealed, and
eventually the conclusion will be made that using a simple EOQ is sub-optimal due to lack of
coordination.
The warehouse orders 141 units. When this shipment arrives, 32 units are sent to the store. The
remaining 109 units are held in stock and sent later in batches of 32. After three more deliveries to the
store, the warehouse is left with 13 units (see Figure 3). Thus, when the next shipment of 141 arrives
at the warehouse, inventory rises to 154. Immediate delivery is made to the store, and later three
subsequent deliveries are made. Consequently, warehouse inventory reaches 26. This illustrates that
some units (13 in the first cycle and 26 in the second) should not have been carried. Jefferson paid to
hold them throughout the entire cycle, but they did not total enough to make a store delivery. Hence,
an additional order from the supplier (to the warehouse) had to be placed. In other words, the
warehouse paid twice (once for holding and then for ordering), which was unnecessary.
At this time, students will try to coordinate by making sure that following the last delivery from
the warehouse to the store, the warehouse inventory will drop to zero. Consequently, students will
figure out that the desired coordination is obtained if the quantity that the warehouse orders is an
integer multiple of the store’s order. In that case, the warehouse’s inventory pattern matches that
illustrated in Figure 4.
Define Q to be the store’s order quantity and k the warehouse integer multiplier. Hence, the
warehouse order quantity is kQ. Because the first delivery (of Q units) out of the warehouse to the
store occurs immediately after the warehouse receives a shipment (of kQ), the series of inventory
levels at the warehouse is (k−1)Q, (k−2)Q, (k−3)Q,…,2Q, Q, 0 implying that the warehouse’s
100 ( k − 1)Q
average inventory level is (k−1)Q/2. Hence, the warehouse’s cost function is: 100 + 1.
kQ 2

Figure 4: Efficient (coordinated) Warehouse Inventory Pattern

(k−1)Q
(k−2)Q

2Q
Q
 Most students will now construct a spreadsheet and will either try different values of k and Q or
will apply Solver. More quantitatively inclined students may try to go further and find the expression
for the optimal Q for a given k analytically by taking the derivative of the total cost function with
 100 
2  50 + 100
respect to Q, which will result in Q ( k ) =  k 
. From there, using a spreadsheet will
10 + ( k − 1)1
only involve trying a few values of k (1,2,3,4,5,6) or using Solver to determine the best k.
The optimal solution will be Q* = 34 and k = 4, implying that the warehouse should order 136
units at a time. The warehouse, store, and total annual costs are $125, $317 and $442, respectively.
This suggests that by using the warehouse for this faucet, Jefferson will not experience a cost increase
but rather a small decrease of $5 (1.1%). Clearly, this is a much better solution than an increase of the
store order quantity.
 Global Pharma: Managing Uncertainty
Sourabh Bhattacharya and Surajit Ghosh Dastidar
Teaching Note
(An Excel spreadsheet accompanies this teaching note.)

Synopsis

Global Pharma sells generic drugs in more than 40 countries across the world. Until recently, Global
Pharma has been able to predict the sales of one of its life-saving drugs with sufficient accuracy.
However, the availability of alternate drugs in different markets and intense competition have created
enormous amount of uncertainty for the demand of this drug.
The demand uncertainty for the drug affects the order placement policy of Global Pharma to its
suppliers for the APIs. In the absence of accurate demand information, Mr. Roy, the Director of
Global Pharma, is finding it difficult to determine the order placement policy for one of the critical
APIs for the drug. This critical API has a short useful life, and Global Pharma does not have adequate
technology to preserve this API for a longer period in inventory. On the other hand, unavailability of
this API would adversely affect the timely production of the drug, and that in turn would negatively
impact sales.
Mr. Roy is now contemplating deferring (or postponing) the placement of the order to his supplier
in anticipation of more accurate demand information. However, the decision of postponing the order
placement would have differential implications on the cost structure of both Global Pharma and its
supplier. (The expected implications are discussed in the last section of the case.)

Position in the Course

This case can be used in a supply chain management course (with a focus on inventory management,
principles of postponement, or supply chain coordination) or a supply chain modeling course (with a
focus on inventory management, cost optimization, or simulation). The primary focus of this case is
on supply chain risk and its management through a postponement strategy. The secondary focus is on
basic inventory models, principle of postponement, and simulation.

Teaching Objectives

The main objective of the case is to illustrate the impact of purchasing postponement on the cost
parameters of the buyer and supplier and also to determine the optimal level of postponement so that
the total cost of the supply chain can be minimized. The case enables the students to understand the
concept of demand-side and supply-side risk in a supply chain and how these risks can have a
substantial bearing on supply chain strategies.
The secondary objective is to expose students to the ways of carrying out mathematical modeling
and simulation in the area of supply chain management.

Prerequisite

The case requires students to have knowledge of basic EOQ model of inventory, exposure to
elementary calculus, and a fair amount of experience in working with Microsoft Excel.
Assignment Questions

1. What are the cost parameters for both Global Pharma and its supplier that are likely to be
affected due to the postponement of the order placement decision by Global Pharma?
2. What are the likely effects of the postponement decision on each of these cost parameters?
3. How could these changes be incorporated in the total annual cost of inventory management
for Global Pharma?
4. What is the optimum level of postponement for which the total annual cost is minimized?
5. How would this relationship change with various values of supplier lead time variability?
6. How would this relationship change with various values of demand variability?
7. How would this relationship change with various values of service level requirement?

Additional Readings (Mandatory)

1. BELARMINO A.-D., 1995, “How Many Units will be Short When Stockout Occurs?,”
International Journal of Operations & Production Management, Vol. 16, No. 4, pp. 112-118.
2. CHOPRA S., MEINDL P. (2004). Supply Chain Management: Strategy, Planning and
Operation, 2nd ed., Pearson Education Pte. Ltd., pp. 352-364.
3. STEVENSON W.J., (2005), Operations Management, 8th ed., McGraw-Hill, pp. 482 – 539.

Case Analysis

1. What are the cost parameters for both Global Pharma and its supplier that are likely to be
affected due to the postponement of the order placement decision by Global Pharma?

To get the class started, the instructor may prompt the students to identify the dilemma of Mr.
Roy. Then the students may be asked to list the various cost parameters that are likely be affected
due to his decision of postponing the placement of the order to his supplier. The students should
be able to identify the following cost parameters:

Global Pharma’s Cost Parameters

• Inventory holding cost

• Ordering cost
• Purchasing cost of the critical API
• Stockout cost

Supplier’s Cost Parameters

• Inventory holding cost

• Order processing cost
• Transportation cost

2. What are the likely effects of the postponement decision on each of these cost parameters?

Purchasing postponement refers to delaying purchasing activities until more certain information
about demand is available, so that overstocking/understocking can be avoided and desired service
level is maintained. As we move closer to the demand realization period, the availability of more
accurate information about the demand is likely to increase. In anticipation of such accurate
information, the buyer (i.e. Global Pharma) tries to postpone its purchasing activities by deferring
 the release of orders to its supplier. On the other hand, if such postponement occurs, the supplier
would be required to reduce its lead time of delivery to match the desired service levels. Figure 1
below provides a pictorial representation of the timeline of lead time and order placement. In
order to receive the order at point 4, with no postponement, the order is placed at point 1, and the
supplier’s lead time is LT1. In case postponement occurs, the order is placed at point 2 or point 3,
depending on the number of days that purchasing is postponed. Point 3 suggests a higher level of
postponement than point 2 does. For orders placed at point 2 and point 3, the supplier has to
reduce its lead time to LT2 and LT3, respectively, to maintain the same service level. Such a
reduction in lead time would alter the cost parameters of both the supplier and the buyer.

Order Order Order Order

Placement Placement Placement Receipt

1 2 3 4
LT3

LT2

LT1

Figure 1: Timeline of lead time and order placement

Supplier’s Costs

Inventory Holding Cost: As a result of purchasing postponement, inventory holding cost for
the supplier may go up. In order to maintain the desired service level, the supplier has to keep
higher levels of safety stock as the level of postponement increases. Therefore, for higher
levels of postponement, inventory holding cost is likely to be high. In Figure 1, the safety
stock requirement is expected to be higher for point 3 than for point 2 or point 1.

Order Processing Cost: The available lead time for the supplier decreases for higher levels of
postponement. Keeping the delivery time and the desired service level in mind, the supplier
may have to employ extra resources to fulfill demand. The extra resources could appear in the
form of employing more labor, overtime for machines and labor, sourcing from other
suppliers, or even expanding existing capacity. Hence, a reduction in lead time may cause the
order processing cost for the supplier to increase.

Transportation Cost: With the reduction in lead time, the supplier might have to use costlier
modes of transportation to meet the delivery schedule. Therefore, with higher levels of
postponement, the transportation cost for the supplier is likely to increase.
Buyer’s Costs

Inventory Holding Cost: The inventory holding cost for the buyer is expected to go down for
higher levels of postponement. This is because, as purchasing activities are postponed, the
buyer has to hold the inventory for a fewer number of days and hence will have a lower
inventory holding cost. Moreover, as a result of postponement, demand variance is expected
to come down, which in turn would reduce the safety stock requirement for a desired service
level. Therefore, with an increasing level of postponement, inventory holding cost in terms of
average inventory and safety stock is likely to decrease.

Stockout cost: The probability of a stockout is a function of lead-time variance and demand
variance during lead time. For a higher lead time variance or/and a higher demand variance
during lead time, the probability of a stockout is likely to be higher, as is the cost of a
stockout. In addition, the cost of a stockout would also depend on the value of the product to
the customer. Unavailability of a high-value product would result in higher stockout cost even
though the probability of stockout is not considerably high. As a result of postponement, the
available lead time to the supplier decreases, which may increase its chances of missing the
delivery dates and create a stockout situation.

Ordering/Setup Cost: The impact of purchasing postponement on ordering/setup cost may

not be considerable. This is because the supplier selection processes, such as bid evaluation
and quotations, result in a one-time incurrence of cost, while order processing activities such
as purchase order release, invoice/payment receipt, or acknowledge notes would remain the
same with or without postponement (Thomas and Tyworth, 2006).

Purchasing Cost: As discussed before, purchasing postponement may adversely affect the
supplier’s cost structure. In this case, it is assumed that the supplier will try to transfer the
increase in its inventory holding cost, order processing cost, and transportation cost to the
buyer by increasing the unit price of the product. Hence, postponement of the purchasing
activity may increase the purchasing cost for the buyer.

3. How could these changes be incorporated in the total annual cost of inventory management
for Global Pharma?

Before discussing this question, the following model assumptions need to be highlighted.

i. There is only one product involved.

ii. Demand is spread evenly throughout the year so that the demand rate is reasonably
constant.
iii. Each order is received in a single delivery.
iv. There is no quantity discount.
v. Daily demand and lead time follow a normal distribution.
vi. Daily demand and lead time are independent of each other.
vii. Back-ordering is not allowed.

After highlighting these assumptions, the instructor may demonstrate the basic EOQ model
for inventory management and take the class through following mathematical modeling exercise.
 Mathematical Model

Using the Economic Order Quantity (EOQ) concept, the buyer’s (Global Pharma’s) total annual cost
can be represented as:

Ordering Cost (O) + Purchasing Cost (Pc ) + Inventory Holding Cost (I) 
TC =  
+ Safety Stock Cost (S) + Expected Stock out Cost (SO) 

* h + Z * σ dLT * h + (s * P )* E(Z) * σ dLT

Q
TC = O + PC + (Eq − 1)
2

where,
Q = Economic Order Quantity
h = Inventory holding cost per unit per year
LT = Lead Time in days
σ d2 = Daily Demand Variance
d = Mean Daily Demand
σ 2LT = Lead Time Variance
σ dLT = Standard deviation of demand during lead time

= σ dLT = LT * σ d2 + d 2 * σ 2LT
D = Annual Demand
o = Ordering cost per order
D 
O = Ordering Cost =  * o 
Q 
s = Stock out cost per unit as a percentage of unit price of the product
P = Unit price of the product
PC = Purchasing cost = P * D
E(Z) = Standardized number of units short (Stevenson, 2005 and Belarmino,1995)

In order to study the impact of purchasing postponement on total cost (TC), Eq – 1 has to be
modified for LT , P, and h, as shown below.

i. As discussed earlier, as a result of purchasing postponement, the supplier would be required to

supply in a shorter lead time, i.e. supplier’s lead time would decrease by the number of days that are
being postponed. Hence the new lead time for the supplier can be represented as:
 LT New = LT Normal − LP ( Eq - 2)

where,
L P = Level of Postponement = Number of days by which purchasing is postponed
LT New = Remaining lead time as a result of postponement
LT Normal = Normal lead time the supplier would have if there was no postponement

ii. As mentioned before, due to purchasing postponement, the unit price of the critical API will not
remain the same for the Global Pharma. The new unit price will depend on the level of
postponement (Lp) and the unit change in the price with respect to a unit decrease in the lead time
∆P
(i.e. ). The mathematical expression for the changes in the unit price for Global Pharma can be
∆LT
represented as:
 ΔP
n

PNew = PNormal +  * LP  (Eq − 3)
 ΔLT 
where,
PNew = New unit price as a result of postponement
PNormal or P = Unit price when there was no postponement
ΔP
= Unit change in price w.r.t a unit decrease in lead time
ΔLT

The value of ‘n’ would depend on the functional relationship between ∆P and ∆LT . In most
practical situations, we cannot expect ∆P to change linearly with ∆LT . Instead, a non-linear
relationship (i.e. n>1) may more appropriately describe the changes in the unit price. This is
because, for lower levels of postponement, the increments in the selling price are likely to be less
than those for the higher levels of postponement. In this case, we assume that the supplier maintains
the relationship between ∆P and ∆LT as a quadratic relationship i.e. n = 2. Note that the students
can be asked to simulate the results for various values of n = 1, 1.5, 2, 3 etc.

iii. The inventory holding cost ‘h’ consists of (i) a fixed cost (h0), and (ii) a variable cost. The fixed cost
accounts for the warehousing establishment costs and is represented in Rs./year. Variable costs
include insurance, taxes, depreciation, obsolescence, spoilage, pilferage, breakages, etc. As a
general practice, the variable costs are expressed as a percentage of the unit price of the products. In
the case of Global Pharma, the variable component of inventory holding cost will be as high as 50%
of the purchasing cost of the API. The inventory holding cost ‘h’ can be expressed as:

   ΔP  
2

h =  h 0 + p * P +  * L P   (Eq − 4)
   ΔLT  

where,
h 0 = fixed cost of inventory holding

p = variable cost of inventory holding, as a percentage of unit price of the product

 After incorporating the modifications for LT , P, and h (equations 2, 3, and 4), Eq – 1 can be used
to study the relationship between Total Cost (TC) and Level of Postponement (Lp). For this purpose,
the information in the case is summarized in the Table 1 below. Also, for the purpose of multiple
scenario building, range values of some variables are added.

Table 1: Base and Range Values for Model Parameters

Variable Notation Unit of Values

Measurement

Initial Range

o Rs. per order 100

h0 Rs./unit 1000 -

p Percent 50 -

P Rs./unit 20

d Units 200

σ d2 (Units)2 100 100 - 10,000

LT Days 30

Lp Days 0 0-23

Service Level Percent 98 95 – 99

s Percent 50 1 – 50

∆P Rs./day 0.15 0.15 – 0.20

∆LT

LT_CV 1 Percent 50 20 – 80

1
LT_CV= Lead time coefficient of variation (Used as a measure of lead time variance)
σ LT
=
LT
4. What is the optimum level of postponement for which the total annual cost is minimized?

This can be determined by using a one-variable data table in Microsoft Excel. In Eq – 1, keeping
all other variable values fixed at their initial values, various values of TC can be calculated by
changing the value of Lp from 0 to 23 days, where 0 means no postponement, and 23 is the
highest level of postponement. The following graph can be generated to determine the optimum
level of postponement that minimizes TC. From the graph, it can be observed that the TC is
minimized if Global Pharma succeeds to convince its supplier to delay the order delivery by 11
days.
5. How would this relationship change with various values of supplier lead time variability?

Again, by keeping other variable values fixed at their initial values, the relationship between TC
and Lp can be studied for various values of LT_CV. The graph of this relationship is given below.
It can be observed that, for a particular level of postponement, as the lead time variability
increases, TC also increases. Additionally, Global Pharma would be able to minimize its cost by
postponing the purchase decision for higher number of days if the lead time variability is higher.
6. How would this relationship change with various values of demand variability?

By keeping other variable values fixed at their initial values, the relationship between TC and Lp
can be studied for various values of demand variability. It can be seen from the graph that for
higher levels of demand variability in the critical API, Global Pharma would need to postpone the
purchasing decision by a higher number of days, as it would like to wait for more accurate
demand information so that over-stocking and under-stocking decisions can be avoided.
7. How would this relationship change with various values of service level requirement?

By keeping other variable values fixed at their initial values, the relationship between TC and Lp
can be studied for various values of service level requirement. It can be seen from the graph that,
for higher levels of service level requirement, Global Pharma would need to postpone the
purchasing decision by a higher number of days, as it would like to avoid a stockout situation by
acquiring more accurate demand information.
 Supplier Selection at Kerneos, Inc.
Ling Li, Erika Marsillac, and Ted Kosiek
Teaching Note
Case Synopsis

The Supplier Selection case describes the production planning, sourcing process, and supplier
selection of Kerneos™, a leading manufacturer of calcium aluminate cements and finished products.
Kerneos Inc., the North American subsidiary of Kerneos™, began as a joint venture between
subsidiaries of Lone Star Industries and Lafarge Coppée in 1970. Currently, the company puts an
emphasis on working capital through better supplier support.

Analytical Objectives

The analytical objectives include:

• Understand the supply chain structure of this process industry through graphing the supply
chain process of Kerneos, SA.
• Identify the purchasing process of Kerneos using the data provided in the case.
• Analyze the performance of three vendors by applying the weighted-score method and
interpreting a spreadsheet. This exercise emphasizes students’ ability to analyze and interpret
survey data and creatively employ the weighted-score method.
• Select one vendor based on the results of the weighted-score method.
• Suggest possible evaluation criteria other than those listed as current performance measures.

Case Questions

1. Graph the supply chain structure of Kerneos, SA.

2. Describe and graph the purchasing process at Kerneos, Inc.

3. Of the three vendors that Kerneos, Inc. currently uses, which vendor performed best? Which
vendor should be replaced? Your recommendation should be supported by the average score, the
weighted score, and the total weighted score of each vendor.

Vendor 1
Vendor 2

Vendor 3

4. Are there any additional measures that you think should be considered in the decision process to
keep or replace the current three vendors (other than the current scoring items)?

Other measures or factors that could be considered include a willingness to implement

Collaborative Planning, Forecasting and Replenishment (CPFR) since Kerneos is implementing a
new supply chain strategy by focusing more on production planning requirements, ISO 9000
certificate status, TQM, environmental responsibility, and others.
Kerneos Inc. produces chemical products, which fall under the category of a process industry.
The most important purchasing issue in process industries is raw materials because process
industry companies tend to be vertically integrated with few parts or components. Raw materials
usually account for 70-80% of the production cost. This unique cost ratio will lead to an emphasis
on price/cost when negotiating contracts. Additionally, the quality of raw material is very
important because it contributes to the quality of the finished-goods product. Service, on the other
hand, will be less important to Kerneos because service components in the Kerneos purchasing
process are minimal. After the raw materials are delivered to Kerneos, service is complete. These
priority differences are reflected in the associated weights of the evaluation categories.
 The Interface between Demand Management and
Production Strategies at TractParts
Abhishek Shinde and Dileep More
Teaching Note
(Two Excel spreadsheets accompany this teaching note.)
Solution:

1. Estimate the profit made by TractParts when it follows a level strategy and no discount
is offered to the tractor manufacturing firms.
Answer:

The Excel solution sheet contains the calculations.

Revenue $9,793,000
Cost $6,862,425
Profit $2,930,575

2. Estimate the profit made by TractParts when it follows a chase strategy and no discount
is offered to the tractor manufacturing firms.
Answer:

The Excel solution sheet contains the calculations.

Revenue $9,793,000
Cost $5,601,100
Profit $4,191,900

3. Estimate the profit made by TractParts when it follows a level strategy and a 10%
discount is offered to the tractor manufacturing firms in October.
Answer:

Whenever 10% discount is given in October, there is certain percentage increase in demand
for the same month, followed by a decrease in demand for the next two months.

The Excel solution sheet contains the calculations.

Revenue $9,443,420
Cost $6,681,075
Profit $2,762,345

4. Find out the month having the peak demand in which a 10% discount can be offered to
the tractor manufacturing firms when TractParts follows a level strategy. (Hint:
Estimate the profit made by TractParts when it follows a level strategy and a 10% discount
has been offered to the tractor manufacturing firms in various months.)
Answer:

Mr. Alex can offer the discount in only one period. His goal should be to maximize profit.

The following table shows the results of the various scenarios.

 Total yearly Increase in
Results demand
Revenue ($) Cost ($) Profit ($) demand
Without Discount 9,793,000 6,862,425 2,930,575 34,975
Discount in April 9,863,980 6,893,550 2,970,430 35,373 1.14%
Discount in May 9,826,740 6,884,655 2,942,085 35,175 0.57%
Discount in June 9,796,780 6,865,770 2,931,010 35,030 0.16%
Discount in July 9,765,504 6,851,580 2,913,924 34,913 -0.18%
Discount in August 9,634,800 6,775,365 2,859,435 34,466 -1.46%
Discount in September 9,365,020 6,611,430 2,753,590 33,553 -4.07%
Discount in October 9,443,420 6,681,075 2,762,345 34,205 -2.20%
Discount in November 9,820,720 6,998,250 2,822,470 36,085 3.17%
Discount in December 10,026,520 7,184,460 2,842,060 36,903 5.51%
Discount in January 10,221,960 7,390,635 2,831,325 37,688 7.76%
Discount in February 9,793,000 6,862,425 2,930,575 34,975 0.00%
Discount in March 9,793,000 6,862,425 2,930,575 34,975 0.00%

Considering these scenarios, revenue will be maximized if the 10% discount is offered in
January, when there is a peak demand. However, due to the high cost of managing extremely
variable demand, profit will actually be maximized if the discount is offered in April instead.

5. Estimate the profit made by TractParts when it follows a chase strategy and a 10%
discount is offered to the tractor manufacturing firms in October.
Answer:

Whenever 10% discount is given in October, there is certain percentage increase in the
demand for the same month, followed by a decrease in demand for the next two months.

The Excel solution sheet contains the calculations.

Revenue $9,443,420
Cost $5,481,300
Profit $3,962,120

6. Find out the month having the peak demand in which 10% discount can be offered to
the tractor manufacturing firms when TractParts follows a chase strategy. (Hint:
Estimate the profit made by TractParts when it follows a chase strategy and a 10% discount
has been offered to the tractor manufacturing firms in various months.)
Answer:

Mr. Alex can offer the discount in only one period. His goal should be to maximize profit.

The following table shows the results of the various scenarios.

 Total yearly Increase in
Results
Revenue ($) Cost ($) Profit ($) demand demand
Without Discount 9,793,000 5,601,100 4,191,900 34,975 --
Discount in April 9,863,980 5,656,820 4,207,160 35,373 1.14%
Discount in May 9,826,740 5,640,700 4,186,040 35,175 0.57%
Discount in June 9,796,780 5,611,600 4,185,180 35,030 0.16%
Discount in July 9,765,504 5,594,820 4,170,684 34,913 -0.18%
Discount in August 9,634,800 5,524,640 4,110,160 34,466 -1.46%
Discount in September 9,365,020 5,380,420 3,984,600 33,553 -4.07%
Discount in October 9,443,420 5,481,300 3,962,120 34,205 -2.20%
Discount in November 9,820,720 5,857,300 3,963,420 36,085 3.17%
Discount in December 10,026,520 6,011,020 4,015,500 36,903 5.51%
Discount in January 10,221,960 6,147,220 4,074,740 37,688 7.76%
Discount in February 9,793,000 5,601,100 4,191,900 34,975 0.00%
Discount in March 9,793,000 5,601,100 4,191,900 34,975 0.00%

Considering these scenarios, revenue will be maximized if the 10% discount is offered in
January, when there is a peak demand. However, due to the high cost of managing extremely
variable demand, profit will actually be maximized if the discount is offered in April instead.

Conclusion:

The company can adapt various strategies for its aggregate planning needs (including level or chase
strategies). When determining the best approach, the company should consider demand fluctuations,
inventory holding costs, stock out costs, and hiring and firing costs. With the given parameters in this
example, the profit for TractParts Ltd. was always maximized when it followed a chase strategy. In
addition, we observed that promotions that maximize revenue do not always maximize profit, so
marketing and operations should coordinate their efforts to determine the best timing of promotions.
Excel spreadsheets have been provided that would allow various types of sensitivity analysis to be
performed.
 Analyzing Distribution Network Options at Remingtin
Medical Devices
Yusen Xia and Walter L. Wallace
Teaching Note

This case covers operations and supply chain management topics such as facility location, distribution
network design, and inventory management. Through this case, students can learn various tradeoffs
among facility maintenance costs, transportation cost savings from establishing more distribution
centers, and inventory holding costs reduction due to a better network design.
Remingtin Medical Devices faces two problems. First, inventory is not well organized, and there
is too much in the system. Besides field locations, medical devices are also stored in representatives'
car trunks, garages, hospitals, etc. This is very costly to the company. Each implant part is valued at
approximately $2,000, and a complete kit will be valued at approximately $600,000. Second, the
transportation costs are too high. Currently, various branch locations are directly replenished from the
Atlanta Distribution Center. As the UPS Average Zone rating is as high as 6.12, it is no wonder why
the annual shipment costs are more than twenty million dollars.

Analysis of the Three Solutions:

• Solution 1: Having a second distribution center in Los Angeles

The total cost increase is $213,000 + $3,100,000 = $3,313,000, and the expense savings is
$712,546 + $512,812 = $1,225,358. As the cost increase exceeds the expense savings, this is
obviously not a good choice.

• Solution 2: Having five additional distribution center locations

The total cost increase is $312,871 + $7,123,000 = $7,435,871, and the expense savings is
$4,301,981 + $3,521,654 = $7,823,635. Since the savings exceeds the cost increase, this
choice is profitable.

• Solution 3: Having five additional distribution center locations plus milk runs
The total cost increase is $312,871 + $7,123,000 = $7,435,871, and the expense savings is
$5,601,340 + $4,387,432 = $9,988,772. Since the savings is much greater than the cost
increase, this choice is the best among the three and can increase the company profits by two
and one-half million dollars.

In making the right decision to help Remingtin Medical Devices, students should consider new
facility establishment and maintenance costs, transportation costs, and inventory savings, which can
reduce carrying costs as well as help reduce depreciation values when new products are introduced.
Lastly, students can also consider possibilities of: (1) having the five additional distribution
centers in other cities instead of the one proposed above, and (2) having more than five additional
centers.
 NunaSacha: A Facility Redesign in the Ecuadorian Andes
Verónica León B., Daniel Merchán D., Ximena Córdova V., Carla Tejada L.,
and Giuseppe Marzano
Teaching Note1

I. Summary
NunaSacha Export (NSE) was created in1984. It is located in the southern area of Ecuador in Cuenca
(Exhibit 7). It is a small organization that started as a technical assistance center for nearby Kañari
communities. These communities live via the sales of their agricultural products. For centuries these
communities have been isolated, have had difficult access to transport infrastructure, and have
endured very low income levels. Before the arrival of NSE, communities had very little contact with
the national and international markets, and their production capacity was limited. When they started to
put into practice the techniques and knowledge that NSE was providing, these families began to
improve product quality, their production levels increased, and they just needed to reach the market in
a better way to avoid intermediaries and possibly to make more money.
NSE looked at this necessity as an opportunity to increase its business mission scope. The next
step was to build a storage facility where communities could deliver their products and be paid
directly. NSE studied the market and found national and international clients who highly appreciated
the products from this Ecuadorian region. Coffee, corn, herbs, roots, leaves, and flowers could be sold
locally, nationally and overseas.
By 2004, a young graduate from a local University, Gabriela Santana Flores, was hired as general
manager (Exhibit 1). Gabriela was motivated and had innovative ideas for NSE´s growth. The first
thing she decided to do was to secure an international donation that resulted in a double-reach rack
system to increase storage capacity. The next year, she convinced the board of directors to authorize
NSE to start manufacturing some goods. The only condition was not stopping the initial warehousing
operation. With that approval, Gabriela started with two products for market testing: shampoo and
toasted corn.
The existing facility was adapted, and two production laboratories were built, one for each
product (Exhibits 2, 3 and 4). Even though processes were mostly handmade, the production level was
acceptable. As new clients entered NSE´s portfolio, production volume had to increase, and Gabriela
took the opportunity of applying for machine donations from international NGOs and from a
university. Her donation efforts were successful in establishing semi-automatic processes that allowed
more products to be introduced to the market.
Between 2006 and 2007, NunaSacha Export had two different product categories: packaged food
and cosmetics (Table 1). The first category included the most important product in terms of sales—
toasted corn, and also bulk coffee and corn, vacuum packed corn, and infusions. The second category
included shampoos of a variety of herbs and soap bars made of several natural raw materials (Table
3).
As the number of products increased, so did the need for working space. Initial laboratories
became too small, and some other areas had to be adapted into production areas (Exhibits 2, 3 and 4).
Moreover, production processes were crowded due to new machines arriving to NSE as donations.
By 2008 capacity turned out to be insufficient. The laboratories had limited space, and potential
contamination became more likely because most of the time products were manufactured and stored
in the same laboratory, and material was washed there as well. Gabriela and her staff noticed this soon
enough and decided to take action to improve operations and keep clients content. One solution

1
Professors Verónica León, Daniel Merchán, Ximena Córdova and Research Assistant Carla Tejada of Universidad San
Francisco de Quito (USFQ College of Engineering) prepared this case in collaboration with Professor Giuseppe Marzano
(USFQ Business School). The authors would like to thank Paula Crespo (USFQ) and the CTT-USFQ office for their
valuable assistance through the project. This case is based on a field project carried out by the authors and has been
developed solely as a basis for academic discussion; it is not intended to illustrate effective or ineffective practices. The
authors have disguised names and other identifying information to protect confidentiality.
considered was to obtain Good Manufacturing Practices (GMP) certification, as it warranted sanitary
facilities and harmlessness during production processes.
In 2009, the situation at NSE was critical, and Gabriela was not sure what to do. Product
contamination and backorders became too commonplace. Sometimes it took more than six weeks to
deliver a batch in good quality condition. Even though clients appreciated Kañari products, they were
not willing to accept such long delays. One day Gabriela got a call from an international donor group
wanting to support NSE´s operations. The group had heard very good things about the organization
and its work in helping Kañari communities increase quality of life. Gabriela explained to the donor
group the current situation with capacity and the unsuitable infrastructure. She also explained that a
better facility layout and maybe an expansion would make NSE´s daily operations much better. One
important detail was to communicate to the donor group that NSE had available space, as currently it
was occupying just about 30% of the site. The donor group was happy to help, but the group
demanded to see a good technical facility design analysis to support everything Gabriela had stated.

II. Teaching objectives

This case study focuses on facility design in a real environment. Process organization and
diagramming are complementary techniques that students will need to apply. Background scenario
research will be important because conditions and limitations are numerous in this emerging economy
environment.
Mathematical models and algorithms for layout design could be applied once the students
establish general assumptions based on the information presented in the case. There will not be a
unique answer to solve the organization´s problem. For example, it could be possible to propose to
build an entire new building, reorganize the existing one, or recommend a combination of the two.
The solution presented here is a combination of the two alternatives.
As mentioned above, students will also need to exercise process design analysis skills. Students
will need to propose new productive processes in order to improve product and material flow and also
to satisfy the Good Manufacturing Practices (GMP) certification requirements such as productive
areas isolation, limited flow of materials and people through productive areas, washing raw materials
and uniforms in a separate area, receiving and storage operations restricted to warehouse areas, etc.

III. Teaching plan

a. Ecuador and NSE’s location
Ecuador is a 283,561 sq km country located in South America. According to the 2010 census, 2 its
population is 14,483.499 people comprising several ethnic groups (27). In the southern Andean
region, the Kañari community is the most representative in number of people and commercial
activities (Exhibit 7).
NSE has chosen to build its business in Cuenca, the third largest city in the country, located 60km
away from the communities. This location is relevant for the communities as well as for the clients.
Communities in the Kañari region and in the coffee production zone can easily access NSE offices
and warehouse by bus or truck. Clients in Ecuador or abroad can be reached by land or by plane if
necessary products are taken to the closest international port, Guayaquil.

b. Product categories
NSE has centered its business on manufacturing the most popular raw materials in the region into
natural cosmetics and packaged food.
The conversion of raw materials into finished food products is generally easier than the
conversion of raw materials into finished cosmetics. The representative products for international
sales are coffee and corn that can be either in bulk or in vacuum-packed presentations (Table 1 and
Exhibit 6). Infusions include one or several herbs (Table 3). They were only sold in the national

2
INEC (Instituto Nacional de Estadísticas y Censos) http://www.inec.gob.ec/cpv/
market at product creation stage as all the herbs were well known in Ecuador. Nevertheless, the
international market has grown as customers appreciate the product due to its medicinal
characteristics, price, and origin.
The cosmetics category has grown in terms of product variety and market sales. NSE started with
one presentation of shampoo and, after several developments, the line now has not only two different
shampoos but also five different soap bars. This kind of product is appreciated in the international
market, and NSE´s intention is to extend export markets. New product development is very important
in this category, and NSE will need a new laboratory to work on this (Table 1 and Exhibit 5).
Other activities that workers are in charge of include receiving, warehousing, dispatching,
washing raw materials, cleaning machines, and processing paper work throughout all operations.

c. Production restrictions
Production laboratories were adapted in the existing warehouse, as well as administrative offices
(Exhibits 2, 3, and 4). As product variety increased and new machines arrived, processes became
more complicated and space was limited.
Several raw materials are used in several products, and production processes differ from one to
another. In both categories there are some products that share machines that are located in different
laboratories. This means that workers have to move between areas that are not necessarily next to
each other.
Production capacity has grown through time as new products have been introduced, even though,
since number of workers is limited, there are some products that cannot be manufactured at the same
time. Production planning is established most of the time as customer orders arrive, implying a kind
of make-to-order production system. During low-sales seasons, NSE tries to make-to-stock the less
perishable products such as cosmetics, and it prepares raw materials for food products.

d. Actual process analysis

Production areas are spread throughout the building, requiring workers, materials, and information to
move between floors and outside the building. For example, many raw materials such as corn, coffee,
leaves, and roots have to be dried before manufacturing or packaging. The drying oven is located next
to the main warehouse and is on the opposite side of the main door (see Exhibit 2). These items have
to travel around before, during, and after becoming finished products—potentially causing cross-
contamination.
Cosmetics require longer production processes and more educated workers to perform the
activities. Many raw materials need previous washing and quality control. Some are washed in the
laboratory, while others are washed outside. Quality control is performed at the receiving stage, and
for finished products, quality analysis is necessary and done in the laboratory as well. This is the
reason why NSE asks to the consultant team for another lab.

IV. Example Solution

a. Understanding the information
General information
It is important to identify the organizational structure, not only as a small company, but also regarding
the chaotic growth in sales volume as well as new product development.
NSE´s location has been determined primarily due to suppliers’ proximity, and general
management has well understood the logistical challenges that location has brought to its operations.

Analyzing the actual processes

Process Information: the case provides the process diagrams for the manufacturing processes. It
would be helpful to diagram the procurement, receiving, warehousing, and shipping processes for a
better understanding the material, people, and information flows. By having all processes
diagrammed, one can see that several GMP requirements are not complied with, such as having
finished products quarantined in order to perform a quality control before shipping, disposing of
products that do not meet quality specifications at receiving, and so on.

Information about the existing layout

Functional areas have been adapted as required in the existing building, leaving external areas empty
or underutilized.
In the case, the current layout is shown with identified areas and general dimensions. It is
important to observe that the building actually has two floors and a basement where administrative
and management offices are located. Moreover, bathroom and cosmetics storage are on the second
floor, implying that people and material have to travel around the building all the time.
Regarding warehousing areas and processes, all kinds of materials are stored in the same area that
is close to an oven and stairs, making the production flow very difficult.
Production areas are not isolated as GMP certification would require.

b. Process Evaluation
After diagramming the processes, a value analysis was performed in order to better understand which
activities were adding value and which were not. The methodology proposed by Freivalds, A. &
Niebel, B. (2009) was applied. All activities were classified into the most appropriate category and
identified as to whether the task added value either to the business (VAB) or to the client (VAC). Two
different indicators were calculated.
Here is presented an example of a process chart for the Infusions process.

VAC = 20%; VAB = 86.6%

 c. Productive process proposals
NSE specifically stated its interest in obtaining the GMP certification that requires stricter quality
control and critical areas isolation. In order to comply with these requirements, it is advisable to
design new processes. Presented below is an example of process diagramming for manufactured
products.
Additionally it is advisable to perform a value analysis for the new processes and compare them
with the ones in the current situation.
 d. Facilities design
After process and existing facilities analysis, it is decided to inspect the material, people, and
information flows. As product categories are clearly defined, a family product layout will be proposed
for laboratories, and a product flow layout will be proposed for the entire facility. The optimization
criteria will prioritize the productive areas’ proximity to reduce travel times and cross-contamination
risks.
If the alternative is to keep the existing building and focus the redesign on relocating the
productive areas, a possible approach would be to consider the possibility (maybe unrealistic) to set
up all areas on one floor and then assign each one to the most appropriate place, as the existing
facility is a two-floor building plus a basement. The main problem with this consideration is that the
existing layout limits improvement possibilities, especially regarding GMP requirements.
If the alternative considered is to build an entire new facility, redesign could apply any model that
optimizes the efficiency regarding travel times and contamination, but it will not comply with the
NSE requirement to not stop operations.

Applying two heuristic facility design models

1. SLP (Systematic Layout Planning)
This solution is proposed using the Systematic Layout Planning (SLP) model, developed by Muther
(Tompkins, 2006 pag 306-309).

A. Current situation analysis

a. Information requirements
The SLP model bases its analysis on the processes and their required flow throughout the facility.
Then a relationship matrix is constructed to evaluate the flow between areas or departments. In this
example, the relationship is based in how far one area is to another.
 b. Activities relationship chart (extract)

AREAS PROXIMITY COD.

A ABSOLUTELY NECESARY 4
E VERY IMPORTANT 3
I IMPORTANT 2
O IT IS OK 1
U IT IS NOT IMPORTANT 0
X IT IS NOT CONVINIENT -1

PRODUCTS AND INFORMATION FLOW

1 IMPORTANT PRODUCT FLOW
2 AVERAGE PRODUCT FLOW
3 LOW PRODUCT FLOW
4 IMPORTANT INFORMATION FLOW
5 AVERAGE INFORMATION FLOW
6 LOW INFORMATION FLOW

c. Efficiency calculation

The efficiency was calculated using the following equation (Tompkins, 2006 pag 312):

Where fij = flow between departments i and j;

xij = binary variable, 1 if departments i and j are adjacent, and 0 otherwise.

 The total efficiency of the current facility is 38.6%. It is important to consider the space
requirements each area has depending on the number of operators and machines that will be assigned
to each one.

B. Proposed situation analysis

a. Considerations
The proposal shown in this example takes as a basis the new process designed previously. The
existing layout considered 14 departments, and the new design will have 25 as listed below. The next
step is to develop several alternatives by changing locations to improve the adjacency level. Here is
presented the best alternative found.

Departments New List 13Chemicals storage

1Food laboratory 14Driying area
2Food storage 15Colling area
3Cosmetics laboratory 16Gas área
4Cosmetics storage 17Washing area
5Soap bars laboratory 18Maintenance area
6Soap bars storage 19Cleanning supplies storage
7Bulk product storage (consider an 20Microbiology laboratory
area for each product) 21Quality laboratory
8Herbs storage 22New products development
9Plants storage laboratory
10Other raw material storage 23Restrooms
11Packaging material storage 24Offices
12Final cosmetics product storage 25Operation offices

b. Activities relationships chart (extract)

 c. Efficiency calculation

The efficiency was calculated as explained before, and the total efficiency with this proposal is 82.8%. This is clearly a much more efficient layout.

As explained previously, SLP considers the facility as a single-floor building. In NSE’s case, it is necessary to locate departments on the second floor as
well as in the basement, plus consideration of the possibility of extending the building into the free space behind the existing building.
An example of a block layout constructed with the SLP method is presented next.
SLP BLOCK LAYOUT
2. Graph-based method

This model is a construction type layout algorithm. It is also applied with the optimizing adjacency
criterion. It is necessary to construct an adjacency graph, where each node represents a department and
each arc between nodes is a common side that two departments will share. Each arc will have a weight
score based on the relationship chart. Department’s dimensions are not considered and arcs do not
intersect. (Tompkins 2006, pag 317-321). Once the adjacency graph is constructed, similar to SLP, a
block layout will be found.
An example of the final adjacency applying this method is presented next.
And the block layout corresponding to this graph will be:

GRAPH-BASED METHOD LAYOUT

3. Why a combination is appropriate?
The alternative considered in this example solution is to combine the two previously stated by
reorganizing the existing facility and building new areas if necessary in the free space outside the current
one. This alternative will be able to consider new productive areas that have the necessary isolation
conditions to ensure quality in the products. It also improves the material and people flows within the
facility and, as NSE required, will not stop daily operations.

COMBINED PROPOSAL BLOCK LAYOUT

For further information regarding facility design models and process value analysis, refer to:

Freivalds, A. & Niebel, B. (2009). Methods, Standards and Work Design. (Ed. 12th ). McGraw-Hill
Higher Education.

Bozer, Y., Tancocho, J.M.A., Tompkins, J. & White, J. (2003). Facilities Planning.(Ed. 3rd). Hoboken,
NJ: John Wiley & Sons, Inc. 306, 320.
 Sherman’s Supply Chain Challenge: Stopping the Retailer
from Overcharging for Soda
Chuck Munson
Teaching Note

Case Summary
This short case describes pricing issues in a single supplier/single buyer supply chain. The protagonist,
Shawn, has created a tasty local beverage that is particularly popular among college students. He has
signed a contract to sell the soda exclusively through a regional grocery chain. Shawn initially set a
wholesale price based on cost plus a 50% markup. However, the retailer initially marked up the wholesale
price by 100%, thus earning three times more profit than Shawn the producer.
Subsequently, the retailer undertook a price test for several months, whereby the retail price
continued to be raised. Afterwards, the retailer determined that a $9.00 retail price (per case) would
maximize its profits. Shawn reacted by raising the wholesale price to $8.50, which, in turn, caused the
retailer to react by raising the retail to $11.75. This caused overall consumer demand to drop significantly.
In an effort to then boost demand and increase profits for both his firm and the retailer, Shawn lowered
the wholesale price to $6.75 and requested that the retailer follow up by lowering the retail price to $8.50.
Unfortunately for Shawn, the retailer only lowered its price to consumers to $10.88 per case, which
helped the retailer and the consumers but reduced Shawn’s profits.
With no apparent power to directly control the retail price, Shawn reluctantly raised the wholesale
price back up to $8.50—resulting in a return to the $11.75 retail price and subsequent weak consumer
demand. Shawn was earning a respectable monthly profit, but he was left bothered by his underutilized
capacity, the knowledge that loyal customers simply could not afford his drink on a college student
budget (even though each drink was inexpensive to produce), and a feeling that his firm and the retailer
were leaving untapped money on the table.

Learning Objectives
• Illustrate the impact of double marginalization on members of a supply chain, including
consumers
• Determine optimal prices when faced with linear demand functions
• Demonstrate the power of supply chain coordination
• Discover ways to naturally induce supply chain cooperation

Scope of the Case

While students may need a quick refresher of pricing concepts from their principles of microeconomics
class, the analysis in this case simply applies the concept of maximizing profits by setting marginal
revenue equal to marginal cost. The data in Table 1 reveal that the consumer demand curve is linear, so,
while quite a few different numbers are discussed in the case, their computation is quite straightforward.
The case would be appropriate at the undergraduate or MBA level, and it could be used in courses in
supply chain management, operations management, marketing, and pricing. The case could be assigned as
an independent homework exercise, or the analysis could be completely discussed in a class session of 30
to 60 minutes.

The Core Issue

The long-established concept of double marginalization describes, in general, the idea that each member
of a supply chain tries to take its “share of the pie” by raising the price higher and higher. In the end, the
retail price is too high, and demand is too low, compared to the price point that would maximize profits if
the supply chain were one vertically integrated company. Consumers are worse off as well because they
pay higher prices and consume less.
In theory, the solution is simple: get all members of the supply chain to make decisions as though
they were part of one company. By making coordinated decisions instead of locally optimal decisions,
money is “created out of thin air.” As long as there is some way to share this new money with all
members of the supply chain, everyone should agree to participate.
Why doesn’t the simple solution always get implemented? Perhaps certain supply chain players don’t
recognize the power of joint decision making. Others may not trust their supply chain partners. Still
others may act like the typical participant in the “Prisoner’s Dilemma” from game theory. That game
provides an incentive for each prisoner to not cooperate with each other (i.e. to rat out his partner). So
even though both prisoners would be better off cooperating (“don’t confess”), more often than not they
end up only looking out for their own best interest (“confessing”).
In the Sherman’s Supply Chain case, Shawn has figured out the best price point that will maximize
profits for the supply chain (a retail price of $8.50), but the retailer won’t comply because, from the
retailer’s view, more profits can be earned by charging a higher price. In fact, (as students can figure out
if they take the analysis far enough) the only way for Shawn to induce the $8.50 retail price through
wholesale price reductions would be to lower his wholesale price all the way to his variable cost of
$2.00—leaving the retailer with all of the system profit!

The Analysis
Fixed costs are ignored in this case, so the monthly profit for each party simply equals the monthly
demand times the profit margin. Shawn’s profit margin equals the wholesale price minus his variable cost
of $2.00. The retailer’s profit margin equals the retail price minus the wholesale price that Shawn charges.
In game theory terminology, this is a Stackelberg game where the supplier (Sherman’s Soda) moves first
by setting the wholesale price, and then the retailer reacts accordingly.
The data in Table 1 suggest a purely linear demand function. Some students may observe any two
months and recognize that demand falls by 400 for every $1.00 increase in the retail price. Others may
take a more systematic approach by running a simple regression on the data. Using Microsoft Excel’s
SLOPE and
INTERCEPT formulas, students can quickly determine that the monthly demand function appears to be:

Q = 6,000 – 400P, (1)

where Q equals monthly quantity sold and P equals retail price. In the analysis that follows, W represents
the wholesale price, ΠW represents the supplier’s (Shawn’s) monthly profit, ΠR represents the retailer’s
monthly profit, and ΠS = ΠW + ΠR represents the monthly profit of the whole system (supply chain).

Initial Conditions
W = $3.00; P = $6.00; D = 6,000 – 400($6.00) = 3,600 units
ΠW = 3,600($3.00 − $2.00) = $3,600
ΠR = 3,600($6.00 − $3.00) = $10,800
ΠS = $3,600 + $10,800 = $14,400

The Market Test and Subsequent Pricing

The table below presents the pricing, resulting demand, and resulting profits for the somewhat tumultuous
year that included the market test and the pricing decisions that followed. Instructors can have the
students generate such a table themselves, or it can be provided right away to move straight into class
discussion. Students should be able to see where all of the numbers in the case came from.
The demand for any month is found by plugging the retail price P into Equation (1) above. Retailer
revenue equals demand times the retail price, and retailer cost equals demand times the wholesale price.
Supplier revenue is the same as retailer cost, and supplier cost equals demand times the variable cost of
$2.00 per unit. The supply chain profit column is simply the sum of the retailer and supplier profits.

Whole- Supply
Retail sale Retailer Supplier Chain
Month Price Price Demand Revenue Cost Profit Revenue Cost Profit Profit
Sep. $6.00 $3.00 3,600 $21,600 $10,800 $10,800 $10,800 $7,200 $3,600 $14,400
Oct. $7.00 $3.00 3,200 $22,400 $9,600 $12,800 $9,600 $6,400 $3,200 $16,000
Nov. $7.50 $3.00 3,000 $22,500 $9,000 $13,500 $9,000 $6,000 $3,000 $16,500
Dec. $8.00 $3.00 2,800 $22,400 $8,400 $14,000 $8,400 $5,600 $2,800 $16,800
Jan. $9.00 $3.00 2,400 $21,600 $7,200 $14,400 $7,200 $4,800 $2,400 $16,800
Feb. $10.00 $3.00 2,000 $20,000 $6,000 $14,000 $6,000 $4,000 $2,000 $16,000
Mar. $12.00 $3.00 1,200 $14,400 $3,600 $10,800 $3,600 $2,400 $1,200 $12,000
Apr. $7.50 $3.00 3,000 $22,500 $9,000 $13,500 $9,000 $6,000 $3,000 $16,500
May $7.50 $3.00 3,000 $22,500 $9,000 $13,500 $9,000 $6,000 $3,000 $16,500
Jun. $9.00 $3.00 2,400 $21,600 $7,200 $14,400 $7,200 $4,800 $2,400 $16,800
Jul. $11.75 $8.50 1,300 $15,275 $11,050 $4,225 $11,050 $2,600 $8,450 $12,675
Aug. $10.88 $6.75 1,648 $17,930 $11,124 $6,806 $11,124 $3,296 $7,828 $14,634
Sep. $11.75 $8.50 1,300 $15,275 $11,050 $4,225 $11,050 $2,600 $8,450 $12,675
Shawn’s
Idea $8.50 $6.75 2,600 $22,100 $17,550 $4,550 $17,550 $5,200 $12,350 $16,900

We observe from the price test (October through March) that Suzy was correct. Based on the six
different retail prices during the test, the retailer’s revenue was maximized when charging a price of $7.50
in November. However, Carol was also correct. Suzy should have been focusing on maximizing profit
rather than revenue, and the most profitable month was January with a retail price of $9.00.
Shawn finally caught on in July that the retailer was taking in too large of a share of the profits. By
raising the wholesale price to $8.50, Shawn more than tripled his monthly profit and was now earning the
majority of the channel profits. Notice in July, though, how much worse the supply chain did as a whole.
Shawn’s $6,050 gain was offset by a profit reduction of $10,175 for the retailer. The point to emphasize
with students here is that when a supply chain player looks out only for itself, its own position may
improve, but its actions may be particularly detrimental to the rest of the supply chain. More importantly,
anytime that that profits are added to a supply chain, those profits can be shared by everyone—all that’s
needed is a proper profit-sharing mechanism. This is illustrated when observing Shawn’s idea compared
to the final equilibrium pricing for September. If the two firms could just agree to use P = $8.50 and W =
$6.75, then both parties would be better off than using the equilibrium pricing from September. The
supply chain makes money, so there is more wealth to share. In fact, there was quite a bit of wiggle room
with the wholesale price that might have been open to negotiation. For example, a wholesale price of
$6.50 would have increased the retailer’s profit to $5,200 while still leaving a hefty $11,700 for Shawn.
The key in this situation is to set the proper retail price that maximizes profits for the whole supply chain.
The wholesale price then can represent a profit-sharing mechanism.
However, as we see in August, simply lowering the wholesale price doesn’t work. The retailer, acting
in its own best interest, set P higher than Shawn wanted. That helped the retailer, but it hurt Shawn, and it
left $16,900 − $14,634 = $2,266 on the table that could have been split in some way to make both
companies better off.

Analytical Approach

Starting with Carol in June and Shawn in July, both companies had figured out the way to choose the
prices that would optimize their own profits. Note that, while less elegant, using the Data Table feature of
Microsoft Excel can be a perfectly valid way to determine the best price. The table can analyze many
different values of the price, and it will reveal which one leads to the highest profit. Instructors often
dismiss such an approach, but it ends up being the preferred decision-making approach for many
managers in the real world. For this case, instructors could certainly consider asking students to provide
such an analysis.
Having said that, an analytical approach leads us directly to the best answer, and it can provide
additional insights about the nature of the problem.
From economics, we know that if we express a linear demand function in terms of price as a function
of quantity (inverse demand function): P = a – bQ, then marginal revenue MR equals a – 2bQ (simply the
derivative of total revenue = P(Q)×Q). Profits are then maximized by choosing Q to equate MR with
marginal cost MC, or:

a − MC
Q* = (2)
2b

Plugging that quantity back into the demand function yields the profit-maximizing price:

a + MC
P* = (3)
2

For the problem in the case, the inverse demand function is P = 15 – (1/400)Q. Then in August, for
example, the retailer’s MC = W = $6.75. Using (2), Q* = (15 – 6.75) / (2/400) = 1,650 units (slight
rounding difference); and, using (3), the retail price P* = (15 + 6.75) / 2 = $10.875 (or $10.88).
Shawn’s case is a little bit different. His demand function is actually a derived demand function,
which assumes that the retailer will act in a profit-maximizing way (using (2) and (3)) once W is set by
Shawn. This is determined as follows. We know that the retailer will set its MR = MC, or: 15 – 2(1/400)Q
= W; thus, the inverse demand function that Shawn sees is W = 15 – (1/200)Q. Then using (2): Q* = (15 –
2) / (2/200) = 1,300 units; and, using (3), the wholesale price W* = (15 + 2) / 2 = $8.50. And with this
wholesale price, the retailer, using (3), will set P* = (15 + 8.50) / 2 = $11.75—and this is our equilibrium
solution.
Finally, if the supplier and retailer were vertically integrated, then W would disappear. The optimal
demand, using (2), would be: Q* = (15 – 2) / (2/400) = 2,600 units; and, using (3), the retail price P* =
(15 + 2) / 2 = $8.50. We know that this retail price maximizes supply chain profits at $16,900, but how
should those profits be divided?

Creating the Cooperative Solution

Once the students have been convinced that the best retail price should be the one that maximizes the joint
supply chain profits, the question remains as to how to entice the retailer to use that level. In the case,
Shawn “asked” the retailer to comply, but to no avail. Students can generate a list of possible approaches,
which might include some of the following:

• Lower the wholesale price

• Offer a quantity discount
• Print a manufacturer suggested retail price (MSRP) on the cases of soda
• Sell through other retailers
• “Quantity forcing” (retailer must purchase a minimum quantity—enticing a lower P to boost
demand)
• Vertical integration (sell directly to consumers)
• Show the math (results of cooperation) to the retailer
• Promise to buy back unsold cases (buy-back contract)
• Offer an incentive scheme (profit sharing)
 Several of these approaches may be effective. Perhaps one of the easiest and most effective is to
offer a quantity discount that will ensure that the desired number of units are purchased (essentially
forcing the retailer to set the desired retail price), while compensating the retailer sufficiently for
ordering more than it would on its own with no discount.

The Quantity Discount

As shown above, best wholesale price is $8.50, which would cause the retailer to order 1,300 units.
However, the demand that maximizes supply chain profits is 2,600 units (double marginalization is
cutting demand in half). The retailer will earn $4,225 if it orders 1,300 and sells them to the public at
$11.75 each.
On the other hand, in order to sell 2,600 units, the retailer must set P = $8.50. In that case, P = W, and
the retailer would earn no profit. Therefore, the quantity discount must return at least $4,225 back to the
retailer (this represents the lower bound on the quantity discount amount).
Meanwhile, the supplier’s profits would double if demand doubled, producing a profit gain of $8,450.
This represents the upper bound on the quantity discount amount.
Taken together, the supplier must return to the retailer between $4,225 and $8,450 in the form of a
quantity discount. On a per-unit basis (2,600 units), the discount must be between $1.625 and $3.25 per
unit. Any discount in that range would produce a win-win situation for both parties. A discount that
would equally split the new revenue would be to provide $2.4375 per unit if the retailer orders 2,600
units. Otherwise, the retailer would pay the full $8.50 wholesale price. With this discount, the new
conditions are:

W = $8.50; P = $8.50; D = 6,000 – 400($8.50) = 2,600 units

Quantity discount = $2.4375 for ordering 2,600
ΠW = 2,600($8.50 − $2.4375 − $2.00) = $10,562.50
ΠR = 2,600($8.50 + $2.4575 − $8.50) = $6,377.50
ΠS = $10,562.50 + $6,377.50 = $16,900.00

With this discount, the retailer’s profits increase by about 51%, and the supplier’s profits increase by
25%. Total supply chain profits increase by 33% ($16,900 compared to $12,675).
Finally, students may wonder why the actual quantity discount contract is needed, i.e., why doesn’t
the supplier just reduce the wholesale price by $2.4375 to $6.0625? In this case, the retailer would have
an incentive to optimize its own position. Using (3), P would equal (15 + 6.0625) / 2 = $10.53125 (or
$10.53), inducing a demand of only 1,788 units. The retailer’s profit would be about $7,988 (better for the
retailer), but the supplier’s profit would only be about $7,264 (even worse for the supplier), and the
supply chain would be losing $1,648 by not selling the optimal demand of 2,600 units. In fact, it turns out
that the only way to induce the retailer to order 2,600 on its own by only adjusting the wholesale price
would be to lower that price all the way to $2.00, in which case the retailer would take the full potential
$16,900 supply chain profit, and the seller would earn nothing.

Conclusion
Channel pricing represents one of many examples illustrating how cooperation in the supply chain can
create money out of thin air and make all parties better off. The key is to make decisions as though the
whole supply chain were one company. In a double-marginalization situation such as that faced by Shawn
in this case, a properly designed quantity discount represents a mechanism to automatically encourage the
retailer to make the choice that’s best for the supply chain—eliminating the need for negotiation or other
persuasion techniques.
 Ethical Product Sourcing in the Starbucks Coffee Supply
Chain
Dustin Smith
Teaching Note
The case provides an overview of Fairtrade with a specific focus on coffee. Fairtrade is a certification
system and partnership in which retailers agree to pay above-market prices for goods. In exchange,
producers agree to adhere to production standards that include environmentally friendly practices, safe
working conditions, above-average wages and investments in community development. Coffee became a
major focus for Fairtrade initiatives following the collapse of regulation in 1973. As a consequence of
deregulation, additional producers flooded the market with extra supply and drove coffee prices to
historic lows. This, coupled with extreme price fluctuations, caused significant hardship for many
producers.
Starbucks is the United States’ largest coffee importer (478 million pounds in 2011), yet only 8% of
its imports are certified Fairtrade. This has caused a backlash from activist groups who feel that Starbucks
should further its commitment to Fairtrade coffee. In response, Starbucks has developed its own ethical
sourcing standards called Coffee and Farmer Equity (C.A.F.E.). This system has faced criticism because
it is inherently self-policing and, as an incident in 2006 illustrates, may not guarantee that its coffee is, in
fact, ethically sourced.
The case ends with a question regarding Starbucks’ sourcing policies. Should Starbucks’ increase its
commitment to Fairtrade sourcing, or should it choose to remain on its present course and further invest
in its own C.A.F.E. standards?
The primary teaching objectives are two-fold. First, using the included table, students can calculate
Starbucks’ estimated procurement costs for standard vs. Fairtrade coffee. The results of the analysis can
lay the groundwork for a discussion about the business case for sourcing from Fairtrade. Students should
recognize that demand for Fairtrade coffee in the United States remains weak in comparison to
international markets. A potential avenue for inquiry could relate to the disparity in demand between the
US and the rest of the world. A broader discussion could also be included with regard to the integration of
supply chain and firm-level strategy. Potential questions include:

1. Under what conditions should a business choose to source from Fairtrade?

2. How should such a sourcing policy be supported by the firm?
3. Is it feasible for a large company such as Starbucks to be more selective of its suppliers?

As a potential counter-point to Starbucks, the instructor may wish to mention Green Mountain Coffee
Roasters, a competitor of Starbucks whose policy is to source 100% from Fairtrade producers.
The second avenue of discussion can pertain to the overall morality of ethical sourcing. Sample
questions include:

1. Does a business have a moral duty to source from “ethical” suppliers

2. Are there alternative mechanisms to help the impoverished that would be more effective than
Fairtrade sourcing?
 Tmall, The Sky Cat: A Rocky Road Toward Bringing
Buyers and Suppliers Together
Jianli Hu and Olivia Congbo Mao
Teaching Note
Synopsis

This case, set in 2012, explores how Tmall outpaced its competitors and became the leader in China’s
business-to-consumer (B2C) market. In April 2008, Alibaba Group founded Tmall as a complement to its
popular consumer-to-consumer (C2C) Taobao platform. Due to the low entry requirements for vendors,
Tmall soon was flooded with counterfeits and substandard products. Alibaba announced significantly
modified merchant rules but had to delay the fee increases to appease unprecedented digital protests and
attacks from thousands of small vendors.
Despite the dominance Tmall enjoyed in China’s B2C market, its business model was not flawless.
The massive sales driven by its Singles Day promotion challenged the handling capabilities of the
platform’s network service providers, the vendors, and the package delivery companies.

Suggested Discussion Questions

1. What were the main strengths and weaknesses of Tmall’s business model?
2. What strategies and actions taken by Alibaba have upset its relationship with small sellers? Were
those strategies and actions necessary? Were there any better alternatives that Alibaba could have
considered?
3. Should Tmall continue its Singles Day promotion in the future? What are the main disadvantages of
the temporary discounts and their impacts on inventory management?

Analysis

1. What were the main strengths and weaknesses of Tmall’s business model?

The main strengths of Tmall’s business model include a stable consumer base, zero inventory,
and creative marketing strategies.

Stable consumer base

Tmall started with the advantage of access to the existing 98 million Taobao users. Because
Tmall guarantees product authenticity, offers a seven-day-no-questions-asked return policy, and
promises fast delivery, more customers prefer to purchase from the verified vendors on Tmall.

Zero inventory
Tmall only acts as a B2C platform and doesn’t hold any inventory. Individual sellers manage
their own inventory levels. Compared to other traditional independent B2C platforms such as
Jingdong’s 360buy or Joyo Amazon, who have full responsibility for the storage and delivery of
most goods, Tmall has no inventory risk/cost and enjoys a profit margin greater than 50%.

Creative marketing
“Singles Day” was an unofficial holiday started by Chinese college students to celebrate their
single life on November 11 (11.11, four/for singles). E-commerce companies including Tmall and
Taobao later took it as an opportunity to drive up online sales in the relatively slow selling
season. Tmall organized various promotions such as an online lottery drawing, massive discounts
 (at least 50% off the average selling prices over a 30-day period), and group buying activities to
help online merchants increase sales.

Tmall’s main weaknesses include a loss of control of products and technical handling capability
problems.

Loss of control
Being just a platform, Tmall sometimes cannot match the consistency in sales policies and service
quality provided by the traditional B2C platforms. Tmall also faces toughening competition from
traditional brick-and-mortar businesses that recently also introduced their own online shopping
sites.

Technical handling capability problems

The massive sales generated by the Singles Day promotion challenged Tmall’s network service
providers as well as vendors’ inventory management systems. This issue is further explored in the
analysis for Question 3.

2. What strategies and actions taken by Alibaba have upset its relationship with small sellers? Were
those strategies and actions necessary? Were there any better alternatives that Alibaba could
have considered?

Alibaba announced its drastic fee increases rather suddenly. Many small vendors complained that
they were not consulted initially or informed properly by Alibaba. Due to the fierce competition
between Tmall and Taobao, profit margins were razor thin and many of those vendors could not
afford paying the higher fees to maintain their storefronts on Tmall.
To sustain a healthy development, it was necessary for Tmall to raise entry requirements. As
online shopping has boomed in China, consumers and authorized sellers have been plagued by
counterfeits and substandard products sold over internet. Unlike its sister platform Taobao that
hosts many small vendors offering inexpensive products, Tmall is positioned to be a virtual mall
consisting of brand owners and authorized distributors. However, the differentiation between
Tmall and Taobao became unclear when many small vendors took advantage of the low entry
requirements and started operating on Tmall. Alibaba wanted to drive away inferior vendors
selling shoddy products by increasing the cost of violation through deducting penalty payments
from liability deposits.
There were alternatives Alibaba could have considered (and they had actually later adopted).
After the Chinese government stepped in, Alibaba proposed a revised fee schedule as well as a
nine-month extension for sellers who, based on customer feedback, were not at the bottom 10%.
Alibaba also promised additional funds to help small vendors. These alternatives, if announced
earlier, could have alleviated the tension between the platform and small vendors.

3. Should Tmall continue its Singles Day promotion in the future? What are the main disadvantages
of the temporary discounts and their impacts on inventory management?

Alibaba began to hold a Singles Day promotion in 2009, and it has since grown into quite a
phenomenon in China’s e-commerce market. With more than 10,000 vendors participating last
year, Tmall and Taobao generated total sales of approximately US$3 billion. However, there are
some limitations and problems with the current promotion.
First, most sales were from products with higher profit margins, mostly fashion and fashion
accessories, since sellers needed to offer deep discounts, usually at least 50% off the average 30-
day selling prices, in order to participate in the promotion. Products with lower profit margins
such as electronics and food items were typically excluded.
 Second, with 100 million users entering almost simultaneously at 12:00 a.m. on November
11, 2012, Alibaba’s payment system had problems handling the heavy traffic on Tmall and
Taobao and was unstable for approximately 15 minutes. Regular computer users were not able to
process their orders. Many customers had to use cell phone apps to complete their orders.
Third, because Alibaba doesn’t have its own parcel delivery company, the delivery speed was
greatly impacted with more than 100 million parcels being ordered from the promotion. Even
though last year the company coordinated with several major delivery companies, many parcels
were not delivered until 10-15 days later, compared to the average of 4 days during regular time.
Fourth, many sellers stockpiled inventory using the 1:6 ratio in preparing inventory for the
promotional items, that is, for every one unit sold during regular time, sellers prepared six units in
inventory. Thus, many sellers could be overwhelmed with excess inventory after the promotion.
Although Tmall organized additional promotional activities after Singles Day, customer demand
dropped significantly and overall sales on Tmall and Taobao remained very slow until the
Chinese New Year.
Tmall currently still enjoys explosive growth of the Singles Day promotion. However,
management has also experienced several challenges arising with the promotion. In order to
continue successfully, Tmall needs to improve the capacity of its network and payment systems,
and it must work closer and more creatively with sellers and logistics companies.
 Make to Demand with 3-D Printing: The Next Big Thing in
Inventory Management?
Tom McNamara and Erika Marsillac
Teaching Note

Case Synopsis

The 3-D printing case describes the innovative process of additive manufacturing, a distinct change and
alternative to normal, high-volume production processes. The implementation and adoption of additive
manufacturing can result in substantial changes in how a company manages its inventory.

Analytical Objectives

The analytical objectives include:

• Understand the process of additive manufacturing and use critical thinking skills to assess
potential benefits and consequences of implementation.

• Examine the future of this process change and estimate if 3-D printing will have more
applications in the future.

Questions
1. What are some potential drawbacks and benefits of 3-D (or additive) printing?
The primary drawback of 3-D printing is the high cost of the printers. Another negative factor would be
that its market is presently limited to industries having low volume / high customization product
characteristics, and the raw materials involved can be quite expensive.
One benefit of 3-D printing is the potential reduction in the need for spare part inventories. This
reduction would allow all the capital formerly tied up in inventory to be allocated elsewhere. Instead of
keeping a storeroom of finished products on hand, a manufacturer could also just “print” what it needed at
the last minute, yielding time savings. The 3-D printing process could also be more environmentally
friendly because it uses less material and reduces waste. In addition, because product design changes can
be implemented quickly, product customization or design tweaks have a faster turnaround time, which
can yield higher quality results.

2. Do you believe that 3-D printing has a future? Explain.

While it’s true that 3-D printing is currently a relatively small niche market with limited
applications, it appears that it has a bright future. The size and value of this market has been
growing, with both of these trends expected to continue well into the future. Thanks to better
technology, falling costs, and better quality, 3-D printing should become more accessible and
expand its applications and markets as time passes.
Activity

Visit the website for 3-D Systems (production3dprinters.com). What are some of the industries benefitting
from 3-D printing? What are some of the types of products being made?

Answer:
Some of the industries benefiting from 3-D printing include: healthcare, transportation, consumer
products, automotive, and recreation.
Some of the types of products being made include: custom surgical platforms and prosthetics
(healthcare), replacement body panels for motorcycles (transportation), custom jewelry (consumer
products), custom components for F1 racing cars (automotive), and specialized sprinting shoes
(recreation).
 Airbus’ Overstretched Supply Chain: Just How Far Can
You Go Before Your Supply Chain Snaps?
Erika Marsillac and Tom McNamara
Teaching Note

Case Synopsis

The Airbus case describes the challenges Airbus is experiencing with a simultaneous lean supply chain
and rapidly increasing demand. The implementation of a lean supply chain results in substantial cost
savings from inventory management modifications, but those cost savings come at a price that is paid in
the supply chain’s ability to respond quickly to demand changes.

Analytical Objectives

The analytical objectives include:

• Understand current trends in aviation supply chain management, and use critical thinking skills to
assess potential benefits and consequences of those changing trends.

• Examine potential alternatives to meet the often seemingly incongruent goals of maximizing
revenue management and supply chain flexibility.

Questions

1. What are some current trends among suppliers in the aviation industry?

Lean: Limit or eliminate supplier redundancies, and limit inventory to decrease overall costs.

Consolidation: More and more companies are merging in this sector. This means that when it
comes to sourcing critical components, airline manufacturers may have limited options. These
constraints are, in turn, aggravated by the fact that when there is a sudden industry-wide increase
in demand, there are few or no alternative players, or little or no additional capacity, to pick up
the slack. The problem doesn’t reside so much with the larger tier-1 players, but rather, with the
relatively smaller tier-2 and tier-3 suppliers.

2. What steps is Airbus willing to take in order to rectify problems in its supply chain and help suppliers?

Airbus is willing to help its suppliers by providing financial, technical, and managerial support to
overcome whatever production constraints might be troubling the supplier network. Airbus has
purchased suppliers in the past in order to take a more “hands-on approach” to rectifying the
situation. That said, it appears that Airbus prefers that suppliers solve their own problems and
work things out for themselves.
 How to Keep Your Food Supply Chain Fresh
Tom McNamara and Erika Marsillac
Teaching Note

Case Synopsis

The fresh supply chain case describes the difficulties in sourcing and delivering perishable goods from
around the globe. Comparing and contrasting a push versus a pull system for this market, the benefits of
a modified pull system are explained.

Analytical objectives

The analytical objectives include:

• Understand and describe some of the challenges involved in delivering perishable and fragile goods.

• Understand and differentiate between push and pull systems, and evaluate the benefits of either
system.

Questions

1. What are some of the challenges to delivering perishable goods to customers?

The product itself must be treated with the utmost care because most are fragile, the products
have limited shelf life—so timely delivery is of the essence, and the supply sources for many of
these goods are geographically distant. There are few options for unwanted perishable goods, so
they usually end up as waste. Emerging government regulations may also force changes to the
supply chain system.

2. What is the difference between the push and pull systems? Is one better than the other for this type of
product?

The push system “pushes” product from the source to the customer, regardless of demand. The
pull system waits for customer demand to “pull” the product from the source to the customer.
The pull system has been shown to provide better performance for perishable goods, but it
requires certain modifications to incentivize suppliers to better manage their deliveries.

Activity

Visit NXP’s website and read their white paper on the use of technology to better manage the perishable
food supply chain.
(http://www.nxp-rfid.com/sites/nxprfid.com/files/Carbon%20footprint%20White%20Paper.pdf).
What kind of technology is being used to track food and reduce waste? What does the technology do?

RFID technology is being used to monitor shipping conditions and track food throughout the
supply chain. Some specific applications include: temperature sensors with embedded RIFD tags,
RFID tags attached to cargo containers in order to track the arrival and movement of the
containers in large ports and on trucks, and RFID tags that have been embedded into reusable
totes that allow for better tracking of contents and eliminate the need to throw away empty boxes.
 The End of Lean?: Automobile Manufacturers Are
Rethinking Some Supply Chain Basics
Erika Marsillac and Tom McNamara
Teaching Note
Case Synopsis

The End of Lean case describes some potential drawbacks of lean global supply chains, particularly in the
event of unanticipated natural disasters. Several potential supply chain responses and methodologies are
then reviewed.

Analytical Objectives

The analytical objectives include:

• Understand, and use critical thinking skills to compare and contrast, a lean supply chain (or
operations) with a traditional supply chain (or operations).

• Use critical thinking skills to assess the pros and cons of implementing a lean supply chain.

• Be introduced to and understand the concept of “clustering.” Use critical thinking skills to assess
the pros and cons of clustering.

Questions

1. Briefly explain the difference between a lean supply chain and a traditional supply chain.
A lean supply chain (or lean operations) focuses on limiting or eliminating supplier redundancies
and excess inventory. Some characteristics of lean supply chains include: minimum inventories,
consolidated suppliers, and just-in-time deliveries. A traditional supply chain contains more
excess in the form of redundant suppliers and stockpiled inventory.

2. What are some of the benefits and consequences of lean operations?

Some of the benefits of lean operations include: demand-based operations that result in less
excess inventory and WIP, decreased overall costs, and increased efficiency. Some of the
consequences of lean operations include: less adaptability to respond to quick changes in demand,
less flexibility in the face of catastrophic events, and the potential to miss out on providing high
levels of customer service.

3. What is “clustering”? What are some pros and cons of clustering?

Clustering is the geographical centralization of similar industries and manufacturers with the
intent of positively increasing the depth and scope of technological expertise, increasing the pace
of the learning curve, and achieving economies of scale and scope due to the proximity of supply
chain partners. Unfortunately, a negative consequence of this geographic centralization is that it
increases the risk that a catastrophic event can impact a large portion of an industry or market
sector and therefore potentially increases the vulnerability of firms implementing this model.
A Brazilian Dairy Cooperative: Transaction Cost Approach
in a Supply Chain
Fernanda Pacheco Dohms and Sergio Luiz Lessa de Gusmão
Teaching Note

For this case solution, the instructor should highlight the Cooperative Principles. It is important to avoid
answers that go against the Principles, such as “having agreements with the cooperative member that…,”
that may contradict the “free membership adhesion and free leaving” Principle.
The case analysis should also have at least one solution for each of the five elements of the
Transaction Costs Approach (is not necessary to have one for each of the costs mention in the Case): (i)
Bounded Rationality, (ii) Opportunism, (iii) Frequency, (iv) Asset Specificity, and (v) Uncertainty. The
main discussion that probably will arise will be about the difficulty in mitigating some of these costs.
That may seem obvious for a normal company, but not necessarily for cooperatives because of the
peculiarities of the business rules.

Some possible solutions include the following.

(i) Training courses per region with a focus on small farmers—closer to them/near their proprieties;
Training courses with differentiated milk payment for farmers that have completed a portion of all
courses.

(ii) Create programs to engage big and small farmers with company principles; Programs to
strengthen the company culture among members; Reports with more information, in an easily
understandable way, about revenue, cost, and expenses for the farmers to better understand prices paid on
the farm versus retail price; Auditing company data about associates in order to clean the inactive register.

(iii) Program whereby all farmers have technical assistance visits at least once per year; Inputs offered
at crop time to farmers in a market-based approach or off-season with a discount.

(iv) Structure a catalogue to sell old machinery for farmers that invest in new equipment or to sell the
assets of the farmers that quit this business.

(v) Structure a hedge and risk area for the company with associates’ council; Bonus in milk price for
the farmers that invest and prove production improvement.
 Continuous Process Reforms to Achieve a Hybrid Supply
Chain Strategy: Focusing on the Organization in Ricoh
Mikihisa Nakano
Teaching Note

Discussion points and sample responses

(1) After Ricoh suspended its company-wide structural reforms committee, the performance of its
inventory worsened due to the effects of the Great East Japan Earthquake, the floods in Thailand, and
the financial crisis in Europe. It has subsequently been unable to stabilize the level of its inventory
performance. Can you speculate on the connection between its suspension of a cross-functional
committee and the instability of its inventory performance?

Generally, when process reforms are the responsibility of individual departments, the initiatives tend
to be local-optimal, temporary palliatives. In the case of Ricoh, the worsening of its inventory
performance resulted in each department implementing initiatives designed to reduce inventory
temporarily; thus, the idea of reducing inventory while simultaneously increasing customer
satisfaction was lost. In addition to the changes to its operating environment such as the increase in
risk in its supply chain, and despite the fact that Ricoh needed to develop a new framework with a
long-term perspective, it also lost a venue for information sharing, coordination, and debate when it
suspended its cross-functional committee. Consequently, individual departments’ initiatives ended up
being merely short-term, fire-fighting ones. This is considered the reason for Ricoh’s inability to
stabilize its inventory performance.

(2) What do you think about the organizational elements necessary to implement continuous supply chain
process reforms?

The Ricoh case study shows that strong leadership is extremely important when creating supply chain
process reform projects and ensuring that these projects run smoothly. However, it also suggests that
relying excessively on this leadership creates the danger that the reforms will cease once the
leadership changes. In other words, one cannot say that the presence of a strong leader is a sufficient
condition for successfully implementing continuous process reforms. Moreover, the list of executives
that comprise the cross-functional committee is very significant, as it indicates the commitment of the
top management to implementing the reforms. However, once the reform committee has achieved a
certain level of results, it may not necessarily remain an effective venue for creating a new
framework.
It is apparent from the Ricoh case that one of the preconditions for continuous reforms is a cross-
functional project organization, which is initiated onsite as a forum in which discussions regarding the
directions of company-wide reforms are held. The main purposes of Ricoh’s company-wide structural
reforms committee were to share information and coordinate the reforms. It can be said that the
chairman of the committee had some ideas about what form the reforms should take in the future.
Following the retirement of this charismatic leader, Ricoh re-launched the committee as a venue for
more frank discussions. In other words, it had to become a venue for collective debate, where “two
heads were better than one.”
One other condition is the existence of a process-staff department. In the case of Ricoh, the role
of promoting the reform projects was played by the SCM group. Important elements of its role
included that it advanced cross-functional reform projects that individual departments with specific
functions would have found difficult to advance, and it monitored inventory performance, which is a
task that departments responsible for specific functions would find difficult to carry out.
 As evident from the Ricoh case study, it is not an easy task to stabilize the level of inventory
performance. If the process-staff department has established processes to monitor performance
strictly, it can encourage the departments encountering performance problems to carry out
improvements, and, if more sweeping reforms are needed to address deteriorating performance, it can
debate the matter with project organizations such as the cross-functional committee. Once the reform
projects are created, the process-staff department can promote the implementation and progress of
these reforms. Therefore, continuous process reforms require both a process-staff organization that
works to reinforce preparations and provide logistical support, and a cross-functional project
organization to create new frameworks to be initiated onsite.
Improving Preparedness in Supply Chain Risk Management
at Jacket
Jury Gualandris and Matteo Kalchschmidt
Teaching Note

Case Solution

As a consequence of his renewed knowledge, Ravelli should be able to improve the reliability of inbound
flows through the adoption of several levers.
First, move from single sourcing to parallel sourcing. So far the company has mostly relied on single-
sourcing relationships. Nevertheless, Ravelli should understand that this is no longer the proper way to
manage supplies because the increasing uncertainty surrounding customers’ needs and technology
trajectories might undermine suppliers’ reliability, putting the company at risk. Thus, the parallel sourcing
strategy should be developed according to his assessment. In fact, the company’s suppliers have similar
production capabilities, and each one could produce a wide range of components. This would allow
maintaining supply relationships that are already in place, creating back-ups that are useful in case of
supply problems, and, at the same time, reducing suppliers’ opportunism. This strategy is indeed
consistent with the need to reduce moral hazard by upstream partners.
Second, increase the company’s agility. Jacket should put more effort into the adoption of
manufacturing postponement practices. Working toward the standardization and modularization of both
components and production tasks would help increase agility in two ways. First, the standardization and
modularization of components would allow for a more effective deployment of the parallel sourcing
strategy (i.e., reduced switching costs when disruptions occur and reduced moral hazard in the supply
network because of higher substitutability). Second, the company would be able to easily adapt its
internal configuration to external stimuli (i.e., risks) and re-align its production to serve a particular
purpose (e.g., quality problems or delays in supplies) rapidly. This should be supported by improving
workers’ skills. Production teams could be reorganized in response to production changes.
Third, develop a structured approach to supplier monitoring. Although the company already evaluates
suppliers’ operational performance (i.e., quality), and vendors are characterized by good reliability, the
scorecard of monitoring criteria should accommodate new metrics that can allow Jacket to take into
account suppliers’ innovativeness and capability to address technological changes. Furthermore, a more
frequent assessment is needed (e.g., every quarter). The empowerment of the monitoring system is
necessary in turbulent environments such as the one in which Jacket operates. This enables companies to
identify suppliers that can potentially contribute in terms of innovativeness as well as to identify early
signals of a supplier’s growing vulnerability and plan preventive and reactive measures. Financial criteria
may be not necessary for Jacket, since its suppliers are global leaders with supposedly high financial
stability.

Learning points

The main purpose of the case analysis is to improve the students’ understanding of SCRM. Specifically,
the message is threefold:

1. The proper design and adoption of SCRM practices is an important issue for companies. Firms
with dominant market positions are those that are able to assure continuity in supply chain
operations. Organizations must evaluate their potential exposure to supply risks (i.e., by
assessing the characteristics of their context) and identify which parts of their adoption of SCRM
practices are incongruent. This comparison should guide investments to reduce deviation and
consequently overcome competitors.
 2. There exists a well-defined set of factors that influence companies’ exposure to supply risks.
Main antecedents of supply risks include the difficulty of supply markets (i.e., the degree of
concentration and capacity constraints of supply markets), environmental turbulence (e.g.,
uncertainty of market requirements and technology trajectories), purchasing’s criticality (e.g.,
degree of customization, complexity and economic value of purchases), and global spread of
suppliers. These factors do not imply higher supply risk per se, but they represent environmental
sources of supply risk if they are not adequately managed. Consider, for example, global
sourcing. On the one hand, it can contribute to the company’s competitive advantage (i.e., it
allows for acquisition of better resources, knowledge, and technologies that are not available
locally, and it may reduce product unavailability by operating with responsive suppliers).
Nevertheless, if companies do not strategically approach global sourcing by leveraging selective
and collaborative practices, the result may be higher transaction costs, opportunism in supply
relationships, and higher exposure to unexpected environmental, political and negative economic
events.

3. It has been suggested that managers should bear in mind an acceptable cost-benefit trade-off
when determining the adoption of SCRM practices. Indeed, if on the one hand SCRM practices
can help companies reduce their supply vulnerability, on the other they imply high costs and
could negatively impact performance. An over-adoption of SCRM practices can have a series of
drawbacks, for example:
a. Dual sourcing typically involves additional costs compared to both single and multiple
sourcing. On the one hand, focal firms face higher transaction costs due to the
duplication of procurement processes and the higher potential for friction. On the other
hand, companies buy at higher purchase price (back-up suppliers have to support
specific investments that increase prices and focal firms cannot obtain discounts due to
small ordered quantities). Furthermore, multiple, dual, and parallel sourcing could be
less conducive to suppliers responsiveness’ than single-sourcing strategies would.
b. Developing vendor rating programs and increasing suppliers’ development and
coordination require focal firms to allocate a large amount of resources. Moreover, as
soon as managers engage in selection and coordination, this immediately translates into
the risk of opportunity costs associated with the unselected alternatives.
c. SCRM practices could lead to an increased supply base complexity (e.g., a high number
of suppliers and high competitiveness among them) that in turn might negatively impact
on the innovativeness potential of the supply base.

Introductory material

Supply chain vulnerability can be defined as the exposure of the network to different disturbances that can
lead to obstruction of flows and to a breakdown of supply chain operations. The different disturbances
affecting the network are then defined as supply chain risks. They may come from several sources such as
natural hazards (e.g., natural events such as earthquakes and tsunamis that can shut down flows and
processes), the complexity of the network (e.g., lack of visibility and difficulties in coordinating with
partners along the chain generate negative bullwhip effects), the uncertainty regarding customer demand,
and, last but not least, the behavior of suppliers. Thus, supply chain risk management (SCRM) has been
proposed as the management of supply chain risks through coordination or collaboration among supply
chain partners so as to ensure profitability and continuity.
During the last decades, companies have seen an increase in the dependence from external parties
(i.e., suppliers) in managing their operations. For this reason, the potential upstream vulnerability due to
the harmful behavior of suppliers is now considered a top priority for management. Supply risk can be
defined as the potential occurrence of an incident associated with inbound supply from supplier failure or
the supply market, in which its outcomes result in the inability of the purchasing firm to meet customer
demand or cause threats to customer life and safety.
A company’s exposure to supply risks depends on a number of environmental characteristics (i.e.,
antecedents or sources of supply risks), including:

• Market and technological turbulence. If competitive pressure, uncertain market needs, and
frequent technological changes of product/process are present to a great extent, the relevance of
supply risk will be high. On one hand, this exogenous uncertainty increases the likelihood of a
supplier’s failure. On the other hand, since environmental turbulence requires stronger interaction
between buyer and supplier, disruptions in supply cannot be easily managed (e.g., by turning to
another vendor), thus increasing their negative impact on organizations.
• Business complexity. A supply chain that is geographically dispersed and characterized by a
great number of product families increases the complexity of the business and its exposure to
supply risks by increasing operational uncertainty and reducing the visibility of the network.
• Criticality of purchases portfolio. The criticality of purchases portfolio can be assessed by
considering product and market characteristics of sourced goods. When purchases are critical
(i.e., higher degrees of customization and complexity as well as significant influence on the
performance of the firm’s final product in terms of quality and reliability), companies strongly
depend on suppliers because the transaction-specific investments have increased switching costs.
As a result, in this circumstance the occurrence of supply risks (e.g., a supplier failure to deliver)
results in the inability of the focal firm to continuously satisfy the market. Then, in case of high
supply market concentration and capacity constraints, firms could experience significant
problems in substituting the supply with a contingency source. Thus, when the supply market is
difficult, the supply risk may be relevant because the firm’s room for maneuvering is reduced.

Thus, to manage supply risks, companies have to rely on the following levers:

• Strategic sourcing. Companies should classify purchases (e.g., they can be classified considering
product and market features such as specificity, their contribution to the competitive differential
of final products, and features of the supply markets) and properly choose the right sourcing
strategy (i.e., single sourcing, dual sourcing, parallel sourcing or multiple sourcing).
• Supplier selection and portfolio management. By developing vendor rating programs,
companies become able to identify reliable suppliers with superior capabilities and to
preventively assess negative trends in their performance. Specifically, by focusing on both
operational and financial criteria, companies can avoid adverse selection, anticipate undesirable
events (e.g., suppliers’ failure), and motivate suppliers toward parsimonious conduct. Moreover,
measuring economic and operative performance of vendors over time allows one to control for
the coherence between the degree of collaboration/cooperation involved in the supply
relationships and the degree of supplier attractiveness.
• Manufacturing postponement. Manufacturing postponement refers to situations where
assembly or manufacturing activities may be delayed to the end of the production process. Agility
can be achieved via dynamic teaming (i.e., using modular structures to reorganize manufacturing
teams quickly and link them to necessary resources in response to product design changes),
product modularity (i.e., using product modules so they can be easily reassembled/rearranged into
different functional forms or shared across different product lines), and re-sequencing of
operations (i.e., reordering standardized sub-processes so that activities that use disrupted
components can occur last).
 Supply Chain Strategy at Zophin Pharma
Arqum Mateen
Teaching Note

Learning Objectives

The learning objectives for this case include:

(a) identification and appreciation of customer requirements as well as development of key performance
metrics, and
(b) an understanding of the importance of often neglected issues in operations and supply chain
management such as company policies and the role of human behavior.

Suggested Use in Classroom

This case can be used in a variety of courses such as operations management, supply chain management,
or operations strategy. It does not involve detailed technical analysis. Rather, it focuses on critical
thinking and rational analysis, making it ideal for use at the start of the course.

Case Development

Even though the case is about a fictional company, its development is inspired by the author’s experience
while working at a similar organization. The issues highlighted are based on real-life questions faced by
that company.

In-class discussion

As a context-setting device, instructors may decide to broaden the scope of discussions by including the
concept of generic drugs and strategies for gaining competitive advantage in price-based markets.
This case is suited for short discussion of around 30 minutes. It might be used to open the topics, or it
might be used in the middle of the lecture to further the topic of discussion.

Case Overview

The case is about a drug manufacturing company that is trying to strengthen its position in the domestic
market. The firm decides to hire external experts for rejigging its operations. Discussions between the
external team and the company’s team lead to a critical reevaluation of the nature of the company’s
business and how to best go about serving its customers.
A representative of the external team visits Zophin’s manufacturing plant. He encounters some issues
regarding company policies and practices. He is contemplating how to present the issues to his team
leader and possible solution(s).

Questions for the Case

1. The first question concerns the identification of the ‘customer’ of the company. It is extremely critical
that the company arrives at the correct answer, as its entire functioning has to revolve around
customer requirements. As mentioned in the case, the domestic market is essentially price-based. As a
result, most of the companies are forced to price their products similarly. The company with the
largest distribution footprint is often able to maximize its sales, and, correspondingly, it can leverage
its size advantage.
 Zophin’s mantra should be to make the right product available at the right place at the right time.
The only way to do this is to engage with the distributors and retailers. Thus, Joseph’s observation
that the distributor is the customer of the company seems to be appropriate.
Instructors might want to stress the relevance of the question by juxtaposing it with the usual
situation in which the buyer is treated as the customer.

2. Inventory turnover (IT) has been suggested as the key indicator of performance. It is given by:
Inventory turnover = Cost of goods sold / Average inventory
Here the average of beginning and ending inventory is taken.
IT is a measure of the ‘briskness’ of the business. For a distributor to have higher IT, Zophin will
have to align its operations with the requirements of the distributor. Higher IT for the distributors
would decrease their maintenance and other operating costs and increase their profitability. If Zophin
is able to offer this value proposition to the distributors, they would be more inclined to carry its
products, thereby increasing its availability.
Another measure of relevance for the distributor could be ‘On Time - In Full (OTIF)’. This is
considered a very good measure of delivery performance and works at the micro level, while IT is
more of a macro-level indicator. OTIF measures how often the customers get what they want when
they want it.

3. Due to improper scheduling of the lunch break, a good portion of the day is lost. Workers stop work
around 11:30 am. Their break extends up to 12:30 pm. The supervisors take a break from 12:15 pm
onwards. By the time they get back, it is already around 1:15 pm. Since the workers would be off at 2
pm, often no new production batch is started. The next batch of workers comes in at 2:00 pm, and by
the time they change and start work inside the production modules, it is 2:30 pm. So, around three
hours are lost due to this practice every day. This doesn’t include machine downtime,
planned/unplanned maintenance activity, etc. This represents a colossal loss of productivity for
Zophin.
An alternative arrangement could be to stagger the lunch break by departments. Thus all
personnel associated with the production department can have their lunch between 11:15am and
12:15pm. People from other departments such as packaging, etc. can have their lunch from 12:00 pm
to 1:00 pm. It should be mandated that the transfer of work along different shifts occurs without time
delay.
Generally, the bottlenecks are associated with the production department. Hence, any loss of time
there represents a loss for the firm, while other departments often have resource slack and hence any
downtime might by more manageable.
Instructors might want to encourage students to think about other possible solutions to the
problem. Other associated issues such as engaging with the union for policy changes, role of
bottlenecks in an operation, etc., might also be highlighted.

4. Another point that can be raised during the discussion is whether it makes sense for Ramesh Kriplani
(the plant manager) to generally remain outside the plant and make only sporadic visits. Granted, he
might have to liaison with different departments outside the plant. Yet, he should still be making
regular visits to the plant to get a better grip on the conditions. Additionally, regular interaction with
the workforce is often beneficial as it might bring up hitherto unnoticed issues and at the same time
increase worker morale.
 Waste to Wealth—A Distant Dream?: Challenges in the
Waste Disposal Supply Chain in Bangalore, India
M.Ramasubramaniam and P.Chandiran
Teaching Note

Teaching Objectives:

This case can be discussed in one class session of approximately one-and-a-half hours to two hours
duration. The case can be used for group discussions or presentations as well. The case also lends itself to
a role-playing model, whereby each group plays the role of different stakeholder. The case is designed for
undergraduate or postgraduate students to examine the issues related to solid waste management in
Bangalore. At the end of the case, students learn to recognize the structure of the solid waste management
market in Bangalore. The case ends with a note of need to address the issue from a holistic perspective.

Teaching Note:

• What is the role of stakeholders such as members of society (who dump waste), waste pickers,
BBMP, and NGOs?:
We start by identifying the roles of each stakeholder and their interaction dynamics. Currently,
awareness levels in society for source segregation are poor. Waste pickers form the backbone of
the supply chain, and their role should be emphasized. It can be highlighted that BBMP is
working on a model that is not inclusive and sustainable. The role of local NGOs involved in the
process should be examined, and it can be highlighted that the BBMP does not engage them
actively.

• Understand the current livelihood status of waste pickers:

The current livelihood of waste pickers is poor. They don’t have social security. Solutions
include: (1) providing identity for waste pickers and registering them in BBMP so that they are
brought into formal recycling streams, and (2) forming micro-enterprises by female self-help
groups to make products such as notepads and other small stationeries.

• How could the waste management process be improved?

A holistic approach to problem solving is currently missing. The different stakeholders in the
supply chain must sit together and come up with practical solutions. As a first step towards
improving the waste management process, BBMP could conduct proper training and awareness
programs. Second, they could start practicing the waste segregation process at a community level
such as at large residential apartments, institutions, etc., and take the practice further. Third, they
could involve NGOs in the training process so that better reach will be there. Fourth,
operationally the process could be improved by standardizing the dumping bins and closing them.

• Understand socio-economic issues:

Proponents of privatization would say that privatization is the only solution. However, any move
to privatize the waste management process will marginalize the waste pickers, and they might
resort to criminal behavior, anti-social activities etc.

• We can conclude by describing the future trends in waste management in developing nations that
will develop well-organized inclusive waste management systems. BBMP could also look at
erstwhile models such as Mysore and adopt the best practices.
Discussion Questions:

1. What are the drivers of the waste management problems?

2. What are the various roles of stakeholders in this waste recycle supply chain?
3. Can this supply chain be improved, and through this can all benefit?
4. How should waste pickers be integrated with the system, particularly if private corporations get
involved?
5. How can NGOs help identify solutions to these problems?
6. What steps can BBMP take to improve the current system?
 Transitioning the Supply Network of Chennai Engineering
Ltd to Cloud Computing
N. Chandrasekaran
Teaching Note

Challenge 1:
Identify possible drivers and challenges for adopting a domain-based SCM solution.

Drivers
The key drivers for adoption of a domain-based SCM solution are process and cost efficiencies,
responsiveness, and the growth requirement of CEL. The drivers and challenges are seen at the backdrop
of prevailing macroeconomic conditions affecting the structure of the power industry and at the same time
the resources of the company affecting its capabilities to exploit the prevailing situation.

The underlying dynamics of the business include:

Industry related:
1. A growing power sector characterized by high demand and low supply
2. Very high demand for the BOP (Balance of Plant) segment
3. Less competition in the BOP segment

Company resources and strengths:

1. Good network with suppliers and contractors
2. Deployment of an ERP system that synchronizes with the SCM domain IT system
3. Talented top management

Challenges
The challenges include:
1. Upfront capital cost
2. Maintenance cost of the IT system
3. Need for a business process reengineering study and streamlining of processes to the new system
4. Ensuring acceptance from all suppliers to change over and automate their processes for enabling
sourcing hassle-free

Challenge 2:
What are the benefits and gaps in the solutions adopted for the SCM domain with respect to the ERP
deployed at CEL?

Benefits
1. Reduction in the procurement cycle time by an average of 12 days because of automation of
transactions processing on both sides. Only exceptions in procurement processes were handled
through email alerts and phone follow-up, which was only 10 per cent of all procurements.
2. Faster order processing: RFQs are converted into PO and issued on the same day for many of
the job works.
3. Shorter cash conversion cycle for suppliers: Accounts Payable invoices matching were reduced
by 50 per cent, which made vendors happy since they got paid faster resulting in higher
commitment to schedules.
4. Improved process efficiency by elimination of redundant processes and data entry.
 5. Increased revenue for CEL and suppliers as the transparency helped to release redundancy and
blocking of capacity. Increased business for suppliers as the network was exposed to better
information on their offering and capability.
6. Reduced supply chain risk and scope to delineate risk and handle it better to ensure that there
were no penalties.
7. Flexibility: This solution ensured that there was no platform investment cost for additional
participants and minimum investment in internal resources and training.
8. Reduction in cost: The supply chain cost reduced from 12% to 11% of COGS. There was also a
reduction in other hidden costs such as the cost of meetings and activities.

Gaps
1. Annual maintenance expense of Rs.2 crores for maintaining the IT system.
2. Additional costs are incurred due to constant training of people regarding changes in the IT
system.
3. A new supplier can be only added to the network if it is using the IT system.

Challenge 3:
If the suppliers have to pay per use, how many could they afford? The transaction fee per user could be
Rs.1000 per month; hence, the total cost could be less than what they spend. How this can be explained to
the suppliers and make them transit to cloud?

Following are some relevant calculations in which the economics of IT systems and cloud systems have
been calculated and compared. The suppliers can be persuaded to switch to the cloud system by
explaining to them the difference in transaction costs they are incurring in the IT system vis-à-vis the
cloud system and future benefits because of adoption of the cloud-based solution and their positive
externalities.

Economics of IT implementation at CEL

Direct investment: Rs. 8 Crores
Indirect investment: Rs. 20 Crores
SCM cost: Rs. 240 Crore
Savings in SCM cost of CEL due to the IT system: Rs. 20 Crore
Yearly IT maintenance cost for CEL: Rs. 2 crore p.a.
 There will benefits of cloud, and those benefits will increase over time as tabulated below.

Description Benefits of cloud (based on IDC Economic benefits to suppliers

study)
Capital and operating expenditure
Five-year total cost of 70% less as compared to in-hosted/on- No or substantially less capital
ownership premises expenditure required by supplier
Development and Reduced by 80% as compared to the conventional
deployment cost IT system
Application management Reduced by 52%
cost Reduced operations and
Infrastructure support Reduced by 56% development cost as compared to
cost the conventional IT system
Infrastructure cost Reduced by $1.298
Five-year application Cumulative saving of $ 2.5 mn per
cost application
Benefits
Leveraging cloud system Dependent upon length of time they The transaction cost is
have been using the cloud substantially less per supplier as
explained above. At the same time
$ 3.5 for $ 1 invested for 36 months there are very high positive
externalities, as benefits are found
$ 8.4 for $ 1 invested for 60 months to be correlated with duration of
Average five-year ROI 626% use.

A study by Aberdeen Group in April 2012 reported that the average percentage benefits to the
supplier on six different aspects such as transaction response times, SLA achievements, call to help desk,
ease of use, application availability, and application response time = (15+17+7+5+18+15)/6 = 12.83%.
The suppliers who are doing business of more than Rs. 7795 (1000/.1283) should not have any
problem joining the cloud computing network of CEL because of its multiple advantages. Looking at the
supply chain process flow given in the case, most of the suppliers are power island suppliers that provide
boilers, generators, turbines, and auxiliary equipment. These products are customized according to CEL’s
requirements, and suppliers have expertise in manufacturing these. So, the profit margin of suppliers is as
high as 50-60%. In such cases, suppliers can easily go for the Rs. 1000 subscription fees, if security
measures are provided by CEL.
Once could tell suppliers that future upgrades in the ERP system of CEL will not cost them anything
as upgrading is very easy in cloud computing. Along with this, when it comes to suppliers, there are
various additional cloud solutions that come integrated with SAP as well. This would mean that using the
cloud-based SCM solution would eliminate the need for any sort of manual data entry from the supplier
end or the CEL end.

There are various integrated tools such as:

Purchase Order Management: Through this system one can automate purchase order management in
order to save massive amounts of money in process costs that accrue with every order. Delivery
dispatches are automatically submitted to the supplier’s SAP system.
Vendor Managed Inventory where suppliers control delivery based both upon the current delivery
schedule and their customers’ current forecasts. In this manner, order processes can be completely
eliminated, leading to increased efficiency. This will again save the manpower cost of suppliers. As
suppliers can process documentation operations in a faster and better-coordinated way through cloud
computing, the probable opportunity cost can also be saved.

As is mentioned in the case, 90% of suppliers are located in a cluster community, so it would be easy
for them to integrate into CEL’s cloud computing system.

Challenge 4:
Why would CEL move SCM solutions to cloud? When suppliers switch to CEL for cloud-based solutions,
if they are also working with other vendors and power island players, how would they handle the
technology of different customers? There could be a lot of cluster-driven benefits; how could one quantify
and drive as a movement so that this cluster is ahead of others in technology adaption?

The following are the offerings and CEL’s requirements:

Cloud offerings:
1. Low capital costs on development and deployment, applications management and infrastructure
2. High return on investment (ROI) and increasing returns with time

CEL present and future requirements would include:

At present: cost efficient, responsiveness, supplier empowerment and customer & supplier
satisfaction

In the future: capacity addition, upgrade, flexibility and customer and supplier loyalty.

If CEL moves to cloud, and other suppliers do not move to cloud, there would not be any
compatibility issues if the cloud service provider can provide the mediation layer to do the conversion. If
the service provider doesn’t provide any conversion, then the supplier would have to take additional
measures to upgrade to the same version of software as the cloud or deploy a mediation layer in its
premises.
It will be best if CEL and all of its suppliers move to the cloud as a cluster, since they can mutually
benefit by this technology adoption in following ways:

1. Adding new locations for CEL plants would be lot easier and faster. Since its infrastructure is all
in the cloud, the only thing they would need to bring up for a new plant from the IT perspective is
to get a PC and an internet connection.
2. Similarly, adding new suppliers and new locations for existing suppliers would be a breeze.
3. Migration to newer and better versions of ERP would be seamlessly handled by the cloud service
provider. This would help in adding new features without any downtime or any other hassle.
 Tussle between Maintaining Customer Satisfaction and
Supply Chain Constraints: IGNYS Automotive
Satish Kumar and Dileep More
Teaching Note

Answers given to the questions below are purely from the authors’ perspective. There is no right or
wrong standard answer for the case.

Q1. Identify the undesired effects (UDEs) in the spare parts supply chain of IGNYS. (Hint: UDEs
are the indicators of problems, have negative influence on a system or a subsystem performance
and are not desired on the way of achieving the goal.)

Solution:

There are a number of undesired effects (UDEs) in the spare parts supply chain of IGNYS. A list of
several UDEs is shown below.

UDEs 1 (With respect to the mother warehouse)

 Buyers not sharing data

 Forecasting by sourcing people is wrong, erroneous forecasting

 Space constraints at the warehouse

 OEM is getting preference over the spare parts division

 High attrition rate in the spare parts division

UDEs 2 (With respect to vendors)

 Vendor not delivering on time

 Vendor has capacity constraints

 Vendor asking for frequent price increments

 High bargaining power of suppliers

UDEs 3 (With respect to dealers)

 Bullwhip effect in demand chain management

 Genuine spare parts prices are high relative to market prices of non-genuine parts

 Dealers are not getting material on time

Q2. Identify the core undesired effect(s) in the IGNYS spare parts supply chain (Hint: Core
undesired effect(s) cause most of the UDEs. Here, to identify the core cause, develop a current
reality tree.)

Solution:

There can be a large number of UDEs; however, there are some core UDEs that cause most other
UDEs occurring in the system. The current reality tree (CRT) helps in identifying the core UDE(s)
by developing linkages among the various UDEs via applying cause-and-effect logic. The CRT also
facilitates in communicating the existing solution and the linkages to various managers across the
different levels of the organization in order to agree on the core problem(s).
In the existing process of spare parts management, the core UDE could be (1) buyers not sharing
the data in advance, (2) high bargaining power of vendors, (3) high attrition rate in the spare parts
division, etc. as shown in Figure below.

Q3. Identify the conflicts that can be observed in the supply chain of IGNYS. (Hint: Conflicts could
be alternative or opposite actions or issues having a common goal.)

Solution:

To overcome the core UDE(s), the existing spare parts management system can have a number of
conflicts such as whether to have a centralized or decentralized system of spare parts. Other conflicts
can also be identified.
Q4. Suggest the solution(s)/action(s) to solve the conflict(s) that you have observed in the IGNYS
supply chain. (Hint: Develop a conflict resolution diagram.)

Solution:

The first step is to identify the core conflict and develop the conflict resolution diagram.
Centralization vs. decentralization of spare parts can be the core conflict, which, if resolved, can
overcome the core UDE(s) as well. The conflicts can be resolved in a number of ways. One
possibility would be to apply the globalization approach. Here, for the above conflict, the solution
could be to classify the spare parts into Runner (Cheetah), Repeater (Bear), and Stranger (Hati) and
develop a decentralized system for Cheetah and Bear spare parts and a centralized system for Hati
items. The following figure presents the conflict resolution diagram.

Q5. What would be the negative consequences of the proposed solution(s) or action(s) if
implemented? (Hint: The negative consequences are again UDEs that arise if the solution is
implemented.)

Solution:

Implementation of the proposed solution can cause some negative outcomes or new UDEs. The
solution proposed in the previous answer may not overcome UDEs such as (a) high attrition rate in
the spare parts division, (b) vendors asking for frequent price increments, etc.
Q6. If the players in the supply chain do not agree that the proposed solution will solve the
problem, how will you convince them to implement the solution? (Hint: Develop a future reality
tree (FRT), and apply negative branch resolution (NBR).)

Solution:

For the solution or action being derived from the conflict resolution diagram, develop a future reality
tree (FRT) that predicts the future in terms of desired effects and negative outcomes (UDEs). In
order to convince the players in the supply chain, the negative consequences (UDEs) have to be
trimmed, and accordingly corrective actions would be required to be taken. For instance, for the
negative effect of high attrition rate in the spare parts division, an incentive plan can be
implemented, and in the case of vendors asking for frequent price increments, long-term
relationships can be established. The FRT is shown below.

Q7. Identify the obstacles while implementing the proposed solution(s). (Hint: Use the first part of
developing the Prerequisite Tree –PRT.)

Solution:

Successful implementation of the proposed solution(s) is not an easy job. There are various kinds of
obstacles that may obstruct successful implementation. For the proposed solution (answer for Q4),
the various obstacles can be:
1. HR conflicts with the old system
2. Confidentiality issues
3. Resistance to change by warehouse personnel
4. Sharing of data from vendors
5. High inbound and outbound transportation costs, etc.
Q8. Explain the intermediate objectives and actions to overcome the obstacles that are identified in
Question 7. (Hint: Use the second part of the Prerequisite Tree-PRT.)
Solution:

The intermediate objectives are created at various stages of the PRT in order provide a guide for
taking necessary steps to overcome the obstacles obstructing successful implementation of the
proposed solution(s). The PRT with intermediate objectives, actions, and obstacles is shown below.

Q9. Develop a concrete map considering the intermediate objectives, actions, and the need for the
actions. (Hint: Develop the Transition Tree –TRT.)
Solution:

The PRT identifies the various intermediate objectives to be achieved and actions to overcome the
obstacles in the implementation of the solution(s). In TRT, intermediate objectives, actions, and the
need for taking actions are depicted step-by-step to achieve the final objective, i.e. the proposed
solution.
Q10. How could you achieve ongoing improvement in IGNYS’s supply chain? (Hint: Apply the five
steps of Theory of Constraints).

Solution:

(a) Process of ongoing improvement if space in the warehouse is the constraint

1. Identify the constraint: “space in warehouse”

 Tool used: Process flow diagram

2. Exploit the constraints

 Material: Excess inventory can be reduced

 Idle inventory sitting for many years: Can be removed

 Workers: Still rely on hand work (fewer machines)

 Too much time lost finding storage locations

3. Subordinate

 Parallel work of material finding and material placing

 Involvement of machines for placement of material

 Mark the space for idle inventory and change it

4. Elevate

 ABC Classification of material: A, B, C = 60%, 30%, 10%, respectively, by value

 Cheetah, Bear, and Hati classification and inventory bundling: Based on frequency of
moment

 Runner, Repeater, and Stranger classification: Based on frequency of ordering

 Replenishment model implementation : For Bear/Repeater – Safety Stock can be stored,

and the quantity should be ordered once the stock reaches the reorder point

Runner and Repeater – 50% of Urgent Orders

Runner & Repeater – Relax Ordering
Repeater – 30 %
by Value
Strangers should be made to order and should not be
stored, Runner & Repeater should be replenished
(b) Process of ongoing improvement if orders are not on time

1. Identify the constraint: Orders not on time

 Tools used: Interview analysis/Process flow diagram

2. Exploit the constraints

 Track the order – Commercial/VOR (analyze pattern)

 Divide time buffer in three zone (33% each) – Red, Yellow, Green (act accordingly)

 Inventory classification at dealer end – Cheetah, Bear & Hati

 Permit availability / Credit issue with dealer

 Payment History and Dealer Performance - Communication

3. Subordinate

 Start pre-packaging once the dealer has orders

 Parallel check the permit availability and credit availability

 Minimum order quantity – Keep it in packaged state

 Credit history and dealer buying pattern analysis

4. Elevate

 Classify the dealers on the basis of business

 Classify the high-end dealer into service level

 For low service level – Interview the dealers

 Analyze credit history, permit issue, and buying pattern

 Provide special assistance – as the profit generators

 Permit availability at warehouse/CFA level

 Inventory analysis at dealer end – Replenishment model implementation

 When a Western 3PL Meets an Asian 3PL, Something
Magical Happens
Shong-Iee Ivan Su
Teaching Note

The author has provided some answers to each discussion question according to the case information and
also the author’s personal views. Students may be able to come up with more creative answers through
research using additional information sources. Instructors should keep an eye open for what kind of
answers they may get from students and encourage more discussion on these questions for enhanced
learning effects.
1. Motivations
An advanced 3PL must listen to the voice of the customers and the markets. The motivation to change
to a multiple-service firm can be attributed to a customer-centric culture and a growth intention.
When customers are developing their businesses either domestically or internationally, the logistics
challenges increase, and the need for logistics expertise grows accordingly. An advanced 3PL not
only can observe customer needs but also can grasp the opportunity to develop more business and at
the same time enhance innovation capabilities to surprise customers to gain more trust and future
business. The reason to develop an international logistics network is mainly due to the logistics
requirements of customers who are expanding their foreign markets.
2. Key Success Factors
Partnership is always a challenge for the allying parties involved. It is particularly challenging when a
western company and an Asian company try to develop a true and sustaining partnership relationship.
In the JTS and DEG case, key success factors can be summarized in the figure presented below.
The Figure1 framework depicts the concept that developing a successful 3PL alliance requires a
true commitment of the total organization from multiple dimensions. It is not easy, but it is certainly
possible if all the right factors are in place.

Figure 1: Key success factors for the JTS and DEG partnership (adapted from Negueloua (2011))
3. Lessons Learned
Due to the trend of globalization of many companies, huge demands on good international logistics
services exist. The partnership journey between JTS and DEG has indicated that a strategic alliance
between an advanced 3PL in the western world and an advanced 3PL in the Asian world can deliver
good business results in global supply chains. Future positive outcomes will depend upon proper
encountering between the parties and persistence in abiding by the key success factors.
 Supply Chain Risk Management for Macro Risks
Matthias Klumpp and Hella Abidi
Teaching Note

Case overview
The global supply chain is faced with a high variety of risks that can be categorized into two groups,
namely micro and macro risks. Micro risks are, for example, linguistic and cultural deficits and customs
regulations, transportation delays, and logistics service level differences. Macro risk include (1) natural
disasters (floods, earthquakes, hurricanes, fires, and tornadoes), (2) man-made disasters (war and
economic crisis), and (3) technical disasters (transport accidents, explosions, fire, gas leaks, and industrial
accidents). These are significant and random events that are especially challenging to manage in a global
supply chain.
Therefore, risk mitigation and control should be classified into two groups, proactive and reactive,
because macro risks differ and not all cause catastrophic damage. Because of the increasing number of
natural, man-made, and technical disasters, effective global supply chain management has to implement
measures regarding how vulnerability can be reduced and supply chain resilience can be built. Every
company has to analyze the individual company structure, the supply network, and the locations of supply
chain partners around the globe—including whether these locations are in a countries that can be affected
swiftly by macro risks. These have a high impact and influence on company value as well as turnover in a
supply chain.
This case study presents an event from Europe in 2012. The key actor is a global logistics service
provider based in Europe with a turnover of 19.8 billion Euro and 95,000 employees worldwide (2011
figures). For many years, the logistics service provider has cooperated with a Swiss company that is
active within the electrical and power plant industry. As one type of cooperation, the logistics provider
has introduced a daily transport round-trip from Italy to Germany. Based on a rate agreement, a 20-ton
trailer picks up goods from two warehouses of the Swiss company near Rome (Italy) for further
European-wide distribution. The transported goods from the two locations near Rome have to be trans-
shipped at the logistics provider’s terminal in Milano (Italy) for forwarding to the terminal in Mannheim,
Germany (central hub).
During the nights of February 4 and 5, 2012, a disaster occurred via a very unusual amount of snow
falling and bringing down the very light roof construction of the Swiss company’s plant at one of the two
origin locations near Rome. This caused a dramatic decrease of shipment volume for the logistics service
provider. In particular, the truck from the two locations near Rome to Milano lost three quarters of its
utilization, and the same volume was missing for the main haul carriage between Milano and Mannheim.

Teaching Objectives
 Reconstruction of a supply chain resilience model for a logistics service provider
 Development of a contingency plan for a global logistics service provider
 Highlighting applications of research methods in practice-oriented research
 Underlining practical uses of theory and concept to real-world situations
 Encouragement of critical thinking in students
Case analysis
 Depict and analyze the general set up of the supply chain and the involved partners and locations
(LSP, OEM, warehouses in Rome, Milano, cross dock in Mannheim, various shipment destinations in
Europe—locate on a European map)
 Analyze the economic impact on LSP due to the duration and severity of the crisis (loss in transport
utilization) by showing profit/loss statements absolutely and relatively (percentage of total turnover,
profit)
 Chart out economic and transport reaction schemes (contract discussions with the OEM, options for
interval change in transports, or other possibilities such as bundling with other line services in the
area)
 Discuss and develop general resilience concepts (e.g., from building security checks and prevention
schemes to weather forecast warnings to early warning systems within locations, e.g. sensors)
 Discuss and determine general cost / benefit ratios of such resilience systems (e.g., compare the total
system cost of disaster prevention to losses in the risk case as shown here)

Case Questions

1. What conclusions can be drawn from the supply chain resilience model? (Refer to Exhibit 3.)
2. What concept is best suited for logistics service providers to reduce the impact of macro risks?
3. What advantages and disadvantages result from the implementation of supply chain risk management
systems?
4. For the plant collapse in Italy, can you think of any proactive contingency plans that either the
logistics service provider or the Swiss company could have had in place that might have reduced the
negative implications from the disaster?