Designing Effective

Supply Chains

Chapter 12

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 What is Supply Chain Design?
Supply Chain Design
Designing a firm’s
supply chain to
meet the
competitive
priorities of the
firm’s operations
strategy.

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 Creating An Effective Supply Chain
• Identifying external and internal pressures
– Dynamic sales volumes
– Customer service and quality expectations
– Service/product proliferation
– Emerging markets

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 Creating an Effective Supply Chain
Link Services/Products Link Services/Products
with Internal Processes with External Supply Chain

Service/Product

Processes Supply Chain

Link Services/Products with Customers,

Suppliers, and Supply Chain Processes
Figure 12.1

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 Supply Chain Efficiency Curve
Inefficient
supply chain Area of
operations improved
operations
Total costs

Reduce costs
New supply chain
efficiency curve with
changes in design
Improve and execution
perform-
ance

Figure 12.2 Supply chain performance

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 Service Supply Chain
Flowers: Arrangement
Packaging
Local/International materials

Maintenance FedEx
FedEx delivery
delivery Local delivery Internet
services service
service service service

Flowers-on-Demand florist

Home Commercial
customers customers
Figure 12.3

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 Manufacturing Supply Chain
Tier 3 Poland USA Canada Australia Malaysia Raw
materials

Tier 2 Germany Mexico USA China Components

Major
Tier 1 Germany Mexico USA subassemblies

Manufacturer
USA Assembly

USA Ireland Distribution

centers

East Coast West Coast East Europe West Europe Retail

Figure 12.4

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 Measuring Supply Chain Performance
Inventory Measures
Average Number of Value of Number of Value of
= units of item each + units of item each
aggregate unit of unit of
A typically on B typically on
inventory hand item A hand item B
value

Average aggregate inventory value

Weeks of supply =
Weekly sales (at cost)

Annual sales (at cost)

Inventory turnover =
Average aggregate inventory value

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 Example 12.1
The Eagle Machine Company averaged $2 million in
inventory last year, and the cost of goods sold was $10
million.
The breakout of raw materials, work-in-process, and
finished goods inventories is on the following slide.
The best inventory turnover in the company’s industry is
six turns per year. If the company has 52 business
weeks per year, how many weeks of supply were held in
inventory? What was the inventory turnover? What
should the company do?
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 Example 12.1

Figure 12.5

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 Example 12.1
The average aggregate inventory value of $2 million
translates into 10.4 weeks of supply and 5 turns per
year, calculated as follows:
$2 million
Weeks of supply = = 10.4 weeks
($10 million)/(52 weeks)

$10 million
Inventory turns = = 5 turns/year
$2 million

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 Application 12.1
A recent accounting statement showed total inventories (raw
materials + WIP + finished goods) to be $6,821,000. This year’s
“cost of goods sold” is $19.2 million. The company operates 52
weeks per year. How many weeks of supply are being held?
What is the inventory turnover?
Average aggregate inventory value
Weeks of supply =
Weekly sales (at cost)
$6,821,000
= = 18.5 weeks
($19,200,000)/(52 weeks)

$19,200,000 = 2.8 turns

Inventory turnover =
$6,821,000
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 Measuring Supply Chain Performance

• Financial measures
– Total revenue
– Cost of goods sold
– Operating expenses
– Cash flow
– Working capital
– Return on assets (ROA)

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 SCM Decisions Affecting ROA
Total revenue
Increase sales through
better customer service
Net income
Cost of goods sold
Improve profits
Reduce costs of with greater
transportation and revenue and lower
purchased materials costs
Operating expenses
Reduce fixed expenses by Return on assets
reducing overhead (ROA)
associated with supply
chain operations Working capital Increase ROA with
Reduce working higher net income and
capital by reducing fewer total assets
Net cash flows inventory investment,
lead times, and Total assets
Improve positive cash flows
backlogs
by reducing lead times and Achieve the same
backlogs or better
Fixed assets performance with
Inventory Reduce the number fewer assets
of warehouses
Increase inventory turnover through improved
supply chain design
Figure 12.6
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 Strategic Options for
Supply Chain Design

• Efficient supply chains

– Make-to-stock (MTS)

• Responsive supply chains

– Assemble-to-order (ATO)
– Make-to-order (MTO)
– Design-to-order (DTO)

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 Environments
Factor Efficient Supply Chains Responsive Supply
Chains
Demand Predictable, low forecast Unpredictable, high
errors forecast errors

Competitive Low cost, consistent Development speed, fast

priorities quality, on-time delivery delivery times,
customization, volume
flexibility, variety, top
quality

New-service/ Infrequent Frequent

product
introduction
Contribution Low High
margins
Product variety Low High

Table 12.1

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 Supply Chain Designs
Make-to-Stock Strategy

Order based on forecast Order based on forecast Customer order

Finished
Component
Manufacturer Goods Customer
Supplier
Inventory
Supply to Supply to Ship to
forecasted forecast order
demand

Figure 12.7

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 Supply Chain Designs
Assemble-to-Order Strategy
Customer order

Order based on forecast Supply

as
needed

Component Standardized Customer

Component Fabrication Assembly
Supplier
Inventory
Supply to
Forecasted
Demand

Supply as
needed

Figure 12.8

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 Design Features
Factor Efficient Supply Chains Responsive Supply
Chains
Operation strategy Make-to-stock or Assemble-to-order, make-
standardized services or to-order, or customized
products; emphasize high service or products;
volumes emphasize variety
Capacity cushion Low High
Inventory Low; enable high inventory As needed to enable fast
investment turns delivery time
Lead time Shorten, but do not Shorten aggressively
increase costs
Supplier selection Emphasize low prices, Emphasize fast delivery
consistent quality, on-time time, customization,
delivery variety, volume flexibility,
top quality

Table 12.2

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 Supply Chain Design Link to Processes
Service/Product Characteristics
Customized Standardized

Job
I n cr
easi
Small ng
su p
Batch Resp p ly
o nsive ch a
in fl
Process

Sup p exib
ly Ch i l it y
Large ain
Batch
Effic
I n cr ient
eas Su p ply C
Line ing hain
serv
ice /
pro
d uc
Continuous t vo
lu m
Flow e
Figure 12.9

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 What is Mass Customization?
Mass customization

A strategy whereby a
firm’s highly divergent
processes generate a
wide variety of
customized services or
products at reasonably
low costs.

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 Mass Customization
• Competitive advantages
– Managing customer relationships
– Eliminating finished goods inventory
– Increasing perceived value of services or products

• Supply chain design for mass customization

– Assemble-to-order strategy
– Modular design
– Postponement
• Channel Assembly
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 Outsourcing Processes
• Outsourcing
– Paying suppliers and distributors to perform
processes and provide needed services and materials
• Offshoring
– A supply chain strategy that involves moving
processes to another country
• Next-Shoring
– A supply chain strategy that involves locating
processes in close proximity to customer demand or
product R&D
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 Outsourcing Decision Factors
• Comparative Labor Costs
• Rework and Product Returns
• Logistics Costs
• Tariffs and Taxes
• Market Effects
• Labor Laws and Unions
• Internet
• Energy Costs
• Access to Low Cost Capital
• Supply Chain Complexity
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 Outsourcing Potential Pitfalls

• Pulling the Plug too Quickly

• Technology Transfer

• Process Integration

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 Outsourcing Processes

• Vertical integration
– Backward integration
– Forward integration

• Make-or-buy decision

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 Example 12.2
Thompson manufacturing produces industrial scales for the
electronics industry. Management is considering outsourcing
the shipping operation to a logistics provider experienced in
the electronics industry. Thompson’s annual fixed costs of the
shipping operation are $1,500,000, which includes costs of
the equipment and infrastructure for the operation. The
estimated variable cost of shipping the scales with the in-
house operation is $4.50 per ton-mile. If Thompson
outsourced the operation to Carter Trucking, the annual fixed
costs of the infrastructure and management time needed to
manage the contract would be $250,000. Carter would charge
$8.50 per ton-mile. What is the break-even quantity?
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 Example 12.2
Fm – Fb 1,500,000 – 250,000
Q= =
cb – cm 8.50 – 4.50
= 312,500 ton-miles

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 Solved Problem
A firm’s cost of goods sold last year was $3,410,000, and the
firm operates 52 weeks per year. It carries seven items in
inventory: three raw materials, two work-in-process items, and
two finished goods. The following table contains last year’s
average inventory level for each item, along with its value.
Category Part Average Unit
a. What is the average Number Level Value
aggregate inventory Raw materials 1
value? 15,000 $ 3.00

b. How many weeks of 2

2,500 5.00
supply does the firm
3
maintain? 3,000 1.00
c. What was the inventory Work-in-process 4
turnover last year? 5,000 14.00
5
4,000 18.00
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 Solved Problem
a.

Part Average Level Unit Value Total Value

Number
1 15,000  $ 3.00 = $ 45,000
2 2,500  5.00 = 12,500
3 3,000  1.00 = 3,000
4 5,000  14.00 = 70,000
5 4,000  18.00 = 72,000
6 2,000  48.00 = 96,000
7 1,000  62.00 = 62,000

Average aggregate inventory value =

$360,500

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 Solved Problem
b. Average weekly sales at cost = $3,410,000/52 weeks
= $65,577/week
Average aggregate inventory value
Weeks of supply =
Weekly sales (at cost)
$360,500
= = 5.5 weeks
$65,577

Annual sales (at cost)

c. Inventory turnover =
Average aggregate inventory value

$3,410,000
= = 9.5 turns
$360,500

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