SUPPLY CHAIN MANAGEMENT

Chapter 1: Introduction to Supply

Chain Management
 Content

1. Differentiating between logistics and supply chain management

2. What is a supply chain?
3. What is supply chain management?
4. Definitions of supply chain management
5. The supply chain network
6. The benefits of supply chain management
7. Technology and supply chain management
8. Supply chain management: New business models and challenges
9. Key issues in supply chain management
10. Supply chain management – industry standard
1.1 Differentiating between Logistics and Supply
Chain Management
• Logistics is an element of the supply chain,
while scope of SCM encompasses logistics
management activities and others
– What are those of logistics management?
• A supply chain is, in effect, the integration of
various logistics chains with various
strategic issues. What are they?
 Differentiating between Logistics and Supply
Chain Management (C)
• SCM focuses on integration of business processes
and activities aiming at enhancing customer value,
rather than on particular business functions
– What about logistics?
• It is a set of approaches utilized to efficiently
integrate suppliers, manufacturers, warehouses, and
stores, so that merchandise is produced and
distributed at the right quantities, to the right
locations, and at the right time, in order to minimize
system wide costs while satisfying service level
requirements (Simchi-Levi et al. 2008)
Differentiating between Logistics and Supply
Chain Management (C)

Source: Gattorna (2006)

 1.2 What is a Supply
Chain?
• The interrelationship, through which
information, physical goods, and services flow
back and forth, consisting of business entities
that undertake value-creating activities involved
in supplying necessary materials, transforming
various supplies into valuable goods and
services, and distributing the final outputs to
customer markets (Kim 2005)
 What is a Supply Chain? (C)

Raw materials WIP Final assembly Distribution Customers

Component Option
Subassembly N. America
Component Hong Kong

Europe
Finished goods Chicago
Raw material
Subassembly Amsterdam Asia/Pacific
Component
Peripheral Nairobi
S. America

Raw material
Subassembly Accessory Africa/M.East
Component
1.3 What is Supply Chain Management
anyway?
• Supply Chain Management encompasses the
planning and management of all activities involved
in sourcing and procurement, conversion, and all
Logistics Management activities. Importantly, it also
includes coordination and collaboration with
channel partners, which can be suppliers,
intermediaries, third-party service providers, and
customers. In essence, Supply Chain Management
integrates supply and demand management within
and across companies.
(Council of Supply Chain Management
Professionals)
 What is Supply Chain Management anyway?

• The study of how to manage the supply chain in an

optimum way to create maximum value for customers (Kim
2005)
• The management of upstream and downstream relationships
with suppliers and customers to deliver superior customer
value at less cost to the supply chain as a whole in order to
achieve a more profitable outcome (Christopher 1998)
• The objective of managing the supply chain is to
synchronise the requirements of the customer with the flow
of materials from suppliers in order to effect a balance
between what are often seen as conflicting goals of high
customer service, low inventory management, and low unit
cost (Stevens 1989 in Mentzer et al. 2001, p. 6)
What is Supply Chain Management anyway? (C)

• Supply chain management is a set of approaches

utilized to efficiently integrate suppliers,
manufacturers, warehouses, and stores, so that
merchandise is produced and distributed at the
right quantities, to the right locations, and at the
right time, in order to minimize system wide
costs while satisfying service level requirements

(Simchi-Levi, Kaminsky and Simchi-Levi 2008)

What is Supply Chain Management anyway?
(C)
• Mentzer et al. (2001, p. 8) list SCM activities
as:
– Integrated behaviour
– Mutually sharing information
– Mutually sharing risks and rewards
– Cooperation
– The same goal and the same focus on serving
customers
– Integration of processes
– Partners to building and maintain long-term
relationships
 1.4 Supply Chain Management Evolution

Further Refinement
of
SCM Capabilities

SCM Formation/
Extensions

JIT, TQM, BPR,

Alliances

Inventory Management/Cost
Optimization

Traditional Mass Manufacturing

1950s 1960s 1970s 1980s 1990s 2000s Beyond

Source: Simchi-Levi et al. (2008)
 1.5 The Supply Chain Network

• Recall that the ultimate goal of SCM is to

provide value to the end customers
• Each player in the SC thus take outputs from an
upstream player as their input then transforms
it to value/output to the next downstream
player
• Value in SC is created in this process though
production, and/or storage, and distribution
• SC network is a result of these activities
 The Supply Chain Network (C)

• Elements of the SC network:

– Facilities (nodes)
– Transport systems (links)
– Inventories
– Information systems

• Spanning those elements are SCM issues at

both strategic, tactical and operational levels
The Supply Chain Network (C)
 The Supply Chain Network (C)

• 12 areas of SCM activity (Pyke and

Johnson 2001):
– Location
– Transport and logistics
– Outsourcing and logistics alliances
– Sourcing and supplier management
– Marketing and channel restructuring
– Inventory and forecasting
– Service and after sales support
– Reverse logistics and green issues
 The Supply Chain Network (C)

– Product design and new product introduction

– Information and electronic mediated environments
– Metrics and incentives
– Global issues

• The focus on each issue is on either achieving

a globally optimised supply chain or managing
uncertainty in the supply chain, or both
The Supply Chain Network (C)

Source: Simchi-Levi et al. (2008)

 Goals of Supply Chain Management

• Supply chain management is concerned with the

efficient integration of suppliers, factories, warehouses
and stores so that merchandise is produced and
distributed:
– In the right quantities and quality
– To the right locations, right time and customer
– At the right cost
• In order to
– Minimize total system cost
– Satisfy customer service requirements
What makes Supply Chain Management difficult?

• All of the advanced strategies, techniques,

and approaches for Supply Chain
Management focus on followings:

– Global Optimisation: minimising

systemwide cost & maintaning systemwide
service level

– Managing Uncertainty
 Global Optimisation

• Why is global optimisation difficult?

– The supply chain is a complex network
– Different facilities often have different, conflicting
objectives
– The supply chain is a dynamic system that evolves
over time: customer demand, supplier
capabilities, relationships
– The system varies over time: although demand may be
known, planning needs to factor in seasonal
fluctuations, advertising & promotion, competitors’
strategies, etc.
 Global Optimisation (C)

• Conflicting objectives in the supply

chain:
1. Purchasing
 Stable volume requirements
 Flexible delivery time
 Little variation in mix
 Large quantities
2. Manufacturing
 Long run production
 High quality
 High productivity
 Low production cost
 Global Optimisation (C)

• Conflicting objectives in the supply

chain:
3. Warehousing
 Low inventory
 Reduced transportation costs
 Quick replenishment capability
4. Customers
 Short order lead time
 High in stock
 Enormous variety of products
 Low prices
Tools and Approaches for Global Optimisation

• Everything for optimization, plus…

• Strategic Alliances/Supplier
Partnerships

• Supply Contracts/Incentive
Schemes
 Managing Uncertainty

• Why is uncertainty hard to deal

with?
– Matching supply and demand is difficult
– Forecasting doesn’t solve the problem
– Inventory and back-order levels typically fluctuate
widely across the supply chain
– Demand is not the only source of uncertainty:
 Lead times
 Manufacturing yields
 Transportation times
 Natural disasters
 Managing Uncertainty (C)

• Supply chain variability: Manufacturer Forecast

of Sales
Volume

Actual
Consumer
s

Retailer Warehouse Demand

Retailer Orders to Shop

Production Plan

Time
Source: Tom Mc Guffry, Electronic Commerce and Value Chain Management, 1998
 Managing Uncertainty (C)

• What management wants:

Volume

Production Plan
Consumer
Demand
s

Time
Source: Tom Mc Guffry, Electronic Commerce and Value Chain Management, 1998
 Managing Uncertainty (C)

• What management gets:

Volume

Consumer
Demand
s

Production Plan

Time
Source: Tom Mc Guffry, Electronic Commerce and Value Chain Management, 1998
 Managing Uncertainty (C)

• Tools and approaches to deal with uncertainty:

– Pull Systems
– Risk Pooling
– Centralization
– Postponement
– Strategic Alliances
– Collaborative Forecasting
 1.6 The Benefits of Supply Chain
Management
• According to Simchi-Levi et al. (2003), in
1998, American companies spent $898 billion
in supply-related activities (or 10.6% of gross
domestic product)
– Transportation 58%
– Inventory 38%
– Management 4%
• In the US market alone, the market size of the
third-party logistics industry is about $225
billion, with the average industry growth rate of
5.2% during the 2015–2020 period (IBISWorld,
2020)
The Benefits of Supply Chain Management (C)

• It is estimated that the grocery industry could

save $30 billion (10% of operating cost) by
using effective logistics strategies
– A typical box of cereal spends more than three months
getting from factory to supermarket.

• A typical new car spends 15 days traveling

from the factory to the dealership, although
actual travel time is 5 days
The Benefits of Supply Chain Management (C)

• Procter & Gamble estimates that it saved

retail customers $65 million through logistics
gains over the past 18 months.

“According to P&G, the essence of its approach lies in

manufacturers and suppliers working closely together ….
jointly creating business plans to eliminate the source of
wasteful practices across the entire supply chain”.
(Journal of business strategy, Oct./Nov. 1997)
The Benefits of Supply Chain Management (C)

• In 10 years, Wal-Mart transformed itself by

changing its logistics system. It has the
highest sales per square foot, inventory
turnover and operating profit of any discount
retailer
• Dell Computer has outperformed the
competition in terms of shareholder value
growth over the eight years period, 1988-1996,
by over 3,000% using
– Direct business model
–
 The Benefits of Supply Chain Management (C)

• Reducing non-value adding time improves service and

reduces cost (Christopher 2005 )
Val u e a d d e d
Time, place C u s to m e r
and form Delivery
utility F in is h e d R e g io n a l
Stock stock

Manufacturing In transit

Raw
M a t e r ia ls

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

Raw F in is h e d C u s to m e r
Manufacturing In transit R e g io n a l
M a t e r ia ls Stock Delivery
stock
Cost Added over Time
Production, storage an d transportation costs an d the time cost of m o n e y
 The Benefits of Supply Chain Management (C)

• According to Pilliglio, Rabin, Todd and McGrath (in

Gould 1998, p. 66), benefits from integrating the supply
chain include:
– 16%-18% improvement in delivery performance
– 25%-60% improvement in inventory reduction
– 30%-50% improvement in fulfilment cycle time
– 25%-80% improvement in forecast accuracy
– 10%-16% improvement in overall productivity
– 25%-50% improvement in supply chain costs
– 20%-20% improvement in fill rates
– 10%-20% improvement in capacity realisation
1.7 Technology and Supply Chain Management

• Technology is central in modern supply chain

management, a ‘rocket science’ (Metz 1998)
• IT enables communication, allowing better decision
making and better coordination – both within and
between the individual businesses in a supply chain
• There have been advancements in communication,
manufacturing and transportation technologies enabling
advanced supply chain management
• Most important business and supply-chain-related
technologies have some information technology-related
function, i.e. RFID, tracking tools, etc.
 1.8 SCM: New Business Models & Challenges

• The emphasis is now on collaborative business

relationships instead of adversarial relationships with
suppliers and customers
• “Virtual enterprise”
• IT is the key enabler
• Challenges:
– Intra- versus inter-organisational integration
– Demand management: shift from forecast to real-time
demand driven manufacturing & inventory management
policies
– Management in uncertainty: push versus pull
– Short lifecycle and rapid obsolescence
 1.9 Key Issues in SCM

• Issues span
– Strategic: long term objectives and with long lasting
effects. Decisions include location of various
facilities, including the manufacturing plant,
distribution warehouses and the structure of the
distribution channel
– Tactical: concerned with purchasing and production
functions, inventory policies and transportation
strategies.
– Operational: day to day management of activities
such as scheduling, routing and vehicle loading etc.
 Key Issues in SCM (C)

• Key issues of SCM according to Kim (2005) and Simchi-

Levi et al. (2003):
– Structural dimension:
 Distribution network configuration
 Inventory control
 Logistics/distribution strategies
– Infrastructural dimension:
 Information sharing
 Supply contracts/smart pricing
 Strategic partnering
 Outsourcing and procurement strategies
 Innovation – product design and development
 Improvement: quality, process
 Information technology and Decision Support Systems
 Key Issues in SCM (C)

• Key issues of SCM according to Kim (2005)

and Simchi-Levi et al. (2003):
– Supply chain performance:
 Customer satisfaction
 Financial performance
 Value creation to customers
• The focus on each issue is on either achieving
a globally optimised supply chain or managing
uncertainty in the supply chain, or both
 1.10 Supply Chain Management – Industry
Standard
• The Supply Chain Operations Reference – model (SCOR)
has been developed and endorsed by the Supply–Chain
Council (SCC) as the cross-industry standard for supply
chain management.
• The SCC was formed in 1996 as an independent, not-for-
profit, global corporation with membership open to all
companies and organizations interested in applying and
advancing the state-of-the-art in supply-chain
management systems and practices.
• The SCC was merged in 2014 into APICS (the American
Production and Inventory Control Society)
• In 2019, APICS launched the Association for
Supply Chain Management (ASCM)
Supply Chain Management – Industry Standard
(C)
• The Supply Chain Operations Reference – model (SCOR)
provides methodology, diagnostic and benchmarking tools that
help organizations make dramatic and rapid improvements in
supply chain processes
• SCOR is a part of the APICS body of knowledge used to foster
the advancement of end-to-end supply chain management
• The SCOR model is part of an enterprise portfolio describing
the critical elements in a value chain.
• Including SCOR, the APICS framework portfolio consists of the
Product Life Cycle Operations Reference model (PLCOR),
Customer Chain Operations Reference model (CCOR), Design
Chain Operations Reference model (DCOR), and Managing for
Supply Chain Performance (M4SC)
Supply Chain Management – Industry Standard
(C)

Source: ASCM
Supply Chain Management – Industry Standard
(C)
• SCOR:
– Links processes or supply chain activities to performance
measures, best practices, and software requirements
– Provides a systematic approach for identifying,
evaluating, and monitoring supply chain
performance
– Has a broad scope beginning with a demand forecast or
order placement and ending with final invoice and
final payment
– Has a six-component framework of Plan, Source, Make,
Deliver, Return and Enable
– Incorporates five performance measures of Reliability,
Responsiveness, Agility, Costs and Asset
Management Efficiency (Assets)
Supply Chain Management – Industry Standard
(C)

Source: ASCM
(2017)
Supply Chain Management – Industry Standard
(C)

Source: ASCM
(2017)
SUPPLY CHAIN MANAGEMENT

Chapter 2: Customer Value in Supply

Chain Management
 Content

1. The shift of thinking about business in SC

2. The purpose of a business
3. The value chain
4. Understanding customer value
5. Strategic pricing and customer value
6. How is customer value measured?
7. Information technology and customer
value
2.1 The Shift of Thinking about Business in
SC
• One of the most significant breakthroughs in
management thinking in recent years has been the
realisation that individual businesses no longer compete
as stand-alone entities, but rather as supply chains
(Christopher 2005)
• Consider Dell’s Direct Business Model: from vertical
to
virtual integration: why is this happening?
• What is the focus of this paradigm shift? Why does it
matter in the supply chain?
 2.2 The Purpose of a
Business
• What is the purpose of a
business
– Making profit?
– Satisfying customers?
– Etc.?
• And what about:
– Being “a good citizen”?
– Delivering values to shareholders?
– How are profits allocated?
– Etc.?
 The Purpose of a Business (C)

• Business activities involve parties to exchange

resources & work co-ordinately to achieve better
outcomes
• Stakeholder value becomes more focused in
business,
i.e. employees, shareholders, public, etc.
• All parties are members in the “business ecosystem”,
‘an economic community supported by a foundation of
interacting organisations and individuals – the
organisms of the business world’ (Tapscott, Ticoll and
Lowy 2000)
• So why is it relevant in the supply chain?
 The Purpose of a Business (C)

SCM is similar to the business ecosystem

concept since it looks at the interconnection
between key processes both within firms and
between firms. SCM crystallises the business
ecosystem idea by providing a process
framework that enables firms to engage in co-
evolvement rather than competition. (Bechtel
& Jayaram 1997, p. 15)
 2.3 The Value Chain

• How do firms create value to their customers?

• The ultimate value a firm creates is measured by the
amount buyers are willing to pay for its products or
service – Buyer value (Porter 1990)
• Firms’ profitability is determined by buyer value &
costs (value > costs), and their competitive advantage
(cost, differentiation)
• Activities performed in competing in a particular
industry can be grouped into categories forming up a
value chain
 The Value Chain (C)

Firm Infrastructure
(e.g. Finance, Planning)

Human Resource
Support Management
Activities
Technology Development
M
Procurement a

r
g

i
n
Inbound Operations Outbound Marketing After-Sale
Logistics (Manufacturing) Logistics & Sales Service

Primary Activities

Source: Porter (1990)

 The Value Chain (C)

• How many value chains are there in a

particular supply chain?
• Is the concept of value chain another way
to understand the purpose of a business?
• The value chain concept is not about being able
to tangibly measure or see value at every step
in a production process or supply chain, but?
• And what does it imply from the above to
managers and employees in a supply
chain?
 2.4 Understanding Customer Value

• How should a company measure the value of

its products or services?

• The emphasis has moved from internal measures

such as quality to customer satisfaction
measures

• The supply chain has a huge impact on

perceived customer value:
– Prices vs. service?
– Delivery speed vs. price?
– Specialization or one-stop shopping?
 Understanding Customer Value (C)

• Recall that responding to customer

requirements is a basic part of supply chain
management

• Customer value drives changes in the supply

chain, and is a critical input in determining
the type of supply chain for a particular
product

– Large inventories
– High level of customization
Understanding Customer Value – The Dimensions
• Conformance to requirements
– Offer what the customer wants: anywhere, any time
– Demand impacts the supply chain: predictability, customer
access (ways of product penetration & arrangement)
• Product Selection
– A proliferation of options makes the supply chain difficult to
manage. How does it contribute to customer value?
– Three successful business trends
• Specialty stores
• Megastores
• Specialized Megastores
– Dealing with the proliferation:
• Build-to-order
• Centralized inventories (risk pooling)
• A fixed set of options covering most customers
Understanding Customer Value – The Dimensions
(C)
• Price and Brand
– Pricing, together with level of service, is a key part of the
customer experience
• Although price may not be the only factor to consider, there
may be narrow price range for certain products, i.e.
commodities
• Thus, companies can achieve cost advantage through supply
chain innovation
• Wal-mart, Coles (i.e. price rewind), Woolworth
– Brand works hand in hand with price
• As the number of salespeople decreases, the value of brand
increases
• This is particularly true on the internet
• Brand name may mean quality and prestige in customer’s
mind
• Good brand name may command higher price, which can offset
increase in supply chain cost due to higher service level (supply
Understanding Customer Value – The Dimensions
(C)
• Value Added Services
– It is hard to compete on price alone; remember sources
of competitive advantage?
– Value added services, such as support & maintenance, are on
the rise due to
• Commoditization of products
• The need to get closer to the customer
• Improving information technology that make offering value
added activities possible
– Customer access to their own data is an important value-
added service, i.e. account details, etc.
• Relationships and Experiences
– An increased connection between the firm and its
customers thru a relationship
– Learning relationship: using data mining to learn about
customers’ behaviour and suggest sales
– Mass customisation, unique experience
 2.5 Strategic Pricing and Customer Value

• Study these examples:

– Dell:
• Same product is sold at a different price to different
consumers (private/small or large
business/government/academia/health care)
• Price of the same product for the same industry
varies
– Amazon: Books.com had a lower price than Amazon
99% of the time, yet Amazon had 80% of the
market in 2000 while Books.com only 2%
• Nikon, Sharp, etc.: Mail-In-Rebate, asking consumers to
mail coupon directly to manufacturers
•
 Strategic Pricing: Revenue
Management
• A method integrating pricing and inventory strategies to
influence market demand, thus boosts revenue
• “Selling the right inventory unit to the right type of
customer, at the right time, and for the right price so as
to maximise revenue or yield (Simchi-Levi et al.
2003)
• Traditional Industries:
– Airlines
– Hotels
– Rental Car Agencies
– Retail Industry
 Strategic Pricing: Revenue
Management

• Example:
– A cruise ship with C=400 identical cabins
– The Price-Quantity relationship: P=2000-2Q
– What is the price that the company should charge to
maximize revenue?
 Strategic Pricing: Revenue Management
(C)

2000
Price P=2000-2Q

1000

No. seats
 Strategic Pricing: Revenue Management
(C)

Price

Revenue=480,000

P0=1200

C=400 No. seats

 Strategic Pricing: Revenue Management
(C)
Money on the Table=160,000
Price
Among 400 passengers, 200 are
willing to pay 1600, and 100
out of these 200 can pay 1800;
P0=1200

C=400 No. seats

 Strategic Pricing: Revenue Management
(C)

Price
Revenue=1600(200) + 1200(400-200)=560,000

P2=1600

P1=1200

Q2=200 Q1 =400 No.

seats
 Strategic Pricing: Revenue Management
(C)
Price

P3=1800 Revenue=1800(100) + 1600(200-100)

+ 1200(400-200)=580,000
P2=1600

P1=1200

Q3=100 Q2=200 Q1 =400 No.

seats
 Strategic Pricing: Revenue Management
(C)
• How can firm prevent customers from
moving from one class to another in the
airline?
Sensitivity to Duration
Sensitivity to Flexibility
Leisure No
Low Travelers Demand

No Business
Traveler
Offer
High s
Sensitivity
to
High Low Price
Source: Simchi-Levi et al. (2003)
 Strategic Pricing: Revenue Management
(C)
• How can firm prevent customers from
moving from one class to another in the
airline?
• Traditional requirements:
– Perishable inventory
– Limited capacity
– Ability to segment markets
• early-bird booking
• over the weekend
– Product sold in advance
– Fluctuating demand
 Strategic Pricing: Smart Pricing

• Customised pricing: to distinguish

customers according to their price
sensitivity
– Dell: private, small vs large businesses, etc.
– Sharp and Nikon: mail-in rebates
• What is the manufacturer trying to achieve
with the rebate?
– Why the manufacturer and not the retailer?
• Should the manufacturer reduce the
wholesale price instead of the rebate?
Strategic Pricing: Smart Pricing
(C)
 Strategic Pricing: Smart Pricing (C)

• Customised pricing

• With no rebate: retailer finds a price & order

quantity to maximise profit; manufacturer’s
profit is proportional to wholesales price

• With mail-in rebates: manufacturer influences

customer demand & provide an upside
incentive to retailer to increase order quantity
 Strategic Pricing: Smart Pricing
(C)
• Customised pricing: managerial insights:
– Mail in Rebate allows supply chain partners to move
away from sequential strategies toward global
optimization
• Provides retailers with upside incentive
– Mail in Rebate outperforms wholesale price
discount for manufacturer
– Other advantages of rebates:
• Not all customers will remember to mail them in
• Gives manufacturer better control of pricing
 How is Customer Value measured?

• Remember that customer value is based

on customers’ perception of firm’s
offerings
• Typical measures are service level & customer
satisfaction
• Supply chain performance measures are
important since they contribute to
customer value
– Remember SCOR – performance metrics?
 How is Customer Value measured? (C)

• Service level:
– Typically means ability to satisfy a customer’s
delivery date
• i.e. % of orders sent on or before promised
delivery date
– There is direct relationship btw service level &
supply chain cost and performance
• i.e. demand variability, manufacturing & information lead
time determine level of inventory
– Customer value implies service levels
• i.e. some customers may be more sensitive to price
while others are to time
 How is Customer Value measured? (C)

• Customer satisfaction:
– Customer surveys are often used to measure
customer satisfaction
– However, they may not be the best way to learn
about customer value. Why?
– Customer loyalty is easier to measure and more
reliable to reflect customer satisfaction. How?
– Learning from customer defection can also provide
good lessons about their satisfaction
 Information Technology and Customer Value

• Customer benefits: changed compared to traditional

approach:
– Info. Tools, i.e. kiosk, voice mail, etc. increase
customer value while reducing costs (ATM,
automatic tellers, electronic transactions, etc.)
– Increased importance of intangibles, i.e. brand name
& service capability
– Increased ability to connect & disconnect
– Increased customer expectations
– Tailored experience, i.e. using data mining for mass
customisation
Information Technology and Customer Value (C)

• Business benefits:
– Using info. captured in SC (data mining) to create
new offerings
– Creating, & no longer responding to demand
– Learning about customers using the above makes it
difficult to switch vendors
• Business-to-business benefits:
– Performance & collaboration of firms’ suppliers &
service providers can be improved (i.e. Dell)
– Strategic partnering relies heavily on information
sharing → increased SC efficiency → enhanced CV
SUPPLY CHAIN MANAGEMENT

Chapter 3: Network Planning

 Content

1. The supply chain network

2.Supply chain and facility costs in supply chain
network configuration
3.Supply chain network design and decision
support systems
1. Data and a network model
2. Model and data validation
3. Solution techniques
4. Key features of a network configuration
DSS
 3.1 The Supply Chain Network

• Different firms have various supply

chain networks
• However, the basic structure of any SC network
consists of:
– Facilities: plants, warehouses, DC, retail outlets
– Transport systems: inbound, outbound
– Information network: communication link &
databank
– Inventory: inventories hold at facilities & in
transit
2. The Supply Chain Network: Network
Design Model

• Several products are produced at several plants

• Each plant has a known production capacity
• There is a known demand for each product
at each customer zone
• The demand is satisfied by shipping the
products via regional distribution
centres
• There may be an upper bound on
total throughput at each distribution
centre
 The SC Network: Network Design
Decisions
• Logistics/Supply chain systems should
be designed based on 4 areas (Ballou
1993):
– Customer service levels: product availability, lead
time, product condition, accuracy of order fulfilling
– Location of facilities and demand allocated to them
(connection)
– Inventory policy
– Transport decisions
• Network design considers layout of
facilities (location, spatial) & flow of
materials thru facilities (allocation,
The SC Network: Network Design Decisions
(C)
• Types of decisions involved in network design &
planning (Chopra and Meindl 2001):
– Facility role: What role should each facility play?
– Facility location: Where should each facility be
located?
– Capacity allocation: How much capacity should be
allocated to each facility?
– Market and supply allocation: What markets should
each facility serve? Which supply sources should
feed each facility?
The SC Network: Network Design Decisions
(C)
The objective is to balance customer service level
against
• Production/ purchasing costs
• Inventory carrying costs
• Facility costs (handling and fixed costs)
• Transportation costs
That is, we would like to find a minimal-annual-cost
configuration of the distribution network that satisfies
product demands at pre-determined customer service
levels
Supply Chain & Facility Costs: The Trade-offs

• Costs are dependent on:

– Number of facilities
– Locations of facilities
– Capacities allocated among facilities
• For instance, trade-offs of having
more warehouses:
– Improved service level
– Increased inventory costs
– Increased overhead and setup costs
– Reduced outbound transport costs
– Increased inbound transport costs
3.3 Supply Chain Network Design & Decisions
Support Systems
• In SCM and Logistics, network design is
often carried out with the aid of a DSS
• DSS-based network design configuration
is based on the following methodology:
– Build an extensive database with quality data for all
relevant elements of the supply chain
– Build a model of a logistics network with appropriate
solution technique
– Validate the data and model against current
configuration
– Seek decision support guidance from the
DSS
 Supply Chain Network Design & Decisions
Support Systems: Data Aggregation
• Why aggregate?
– The cost of obtaining and processing data
– The form in which data is available
– The size of the resulting location model
– The accuracy of forecast demand
• Aggregating customers:
– Customers located in close proximity are aggregated
using a grid network or clustering techniques
– All customers within a single cell or a single cluster
are replaced by a single customer located at the
centre of the cell or cluster (customer zone)
 Supply Chain Network Design & Decisions
Support Systems: Data Aggregation (C)

• Aggregating products:

– Companies may have hundreds to thousands of

individual items in their production line
• Variations in product models and style
• Same products are packaged in many sizes
– Collecting all data and analyzing it is impractical for
so many product groups
 Supply Chain Network Design & Decisions
Support Systems: Data Aggregation (C)

• Strategies for aggregating products:

– Place all SKU’s into a source-group

• A source group is a group of SKU’s all sourced from the
same place(s)
– Within each of the source-groups, aggregate the
SKU’s by similar logistics characteristics
• Weight
• Volume
• Holding Cost
 Supply Chain Network Design & Decisions
Support Systems: Transport Costs
• A key component of network planning
• Associated with both inbound and outbound
• Calculation of transport costs for fleet
managed internally is different from external
fleet
• Network planning requires transport rates
for various distances in network model
• Rates are quite linear with the distance,
not volume
 Supply Chain Network Design & Decisions
Support Systems: Transport Costs (C)

• Mileage estimation: distance has to be

considered with transport rates to
calculate transport costs
• Mileage can be estimated by using:
– Street network (road map, distance tables,
etc.)
– Straight line distance (Calculation with latitude &
longitude)
– Technology (programming, GPS, etc.)
 Supply Chain Network Design & Decisions
Support Systems: Warehousing Costs
• Facility (warehousing, DC) costs:
– Fixed costs: i.e. building, etc., not proportional to the
amount of material that flows through the
warehouse
– Handling costs: labor costs, utility costs
– Storage costs: proportional to the inventory level
• It is easy to calculate handling costs, but we
need to use inventory turnover ratio (Annual
sales/average inventory level) to estimate
storage and fixed costs
• Storage costs = inventory turnover ratio
x inventory holding (carrying) cost
 Supply Chain Network Design & Decisions
Support Systems: Warehousing Costs (C)
• Fixed costs is based on space required, which is
twice that of average inventory level
• Calculating needed storage space:
– Convert units into space requirements
– Allow for growth
– Allow for adequate aisle space for materials handling
equipment
• Types of space needed:
– Space for storage
– Space for the transportation interface
– Space for order-picking
– Space for recouping, office, and miscellaneous
Supply Chain Network Design & Decisions
Support Systems: Warehousing Costs (C)
 Supply Chain Network Design & Decisions
Support Systems: Facility Locations
• Why does facility location matter?
• Location problems are, in general, very
difficult problems
• The complexity increases with
– the number of customers,
– the number of products,
– the number of potential locations for facilities, and
– the number of facilities located
• Facility location decision should be based
on both qualitative & quantitative factors
 Supply Chain Network Design & Decisions
Support Systems: Other Issues
• Service level requirements:
– A very important consideration in network design
– Can be defined in terms of distance (also representing time &
cost) of a facility from a customer
– Target service level is to serve a certain % of customers with a
specific customer service level
• Future demand
– A critical factor, as network design is a strategic, long-term
decision
– Future growth, i.e. sales, demand have to be considered
– NPV can be utilised according to various scenarios
 Supply Chain Network Design & Decisions
Support Systems: Model & Data Validation
• After data are collected, how do we ensure data &
model accurately reflect network design
problem?
• Typical way is to
– reconstruct existing network configuration using
model &
collected data
– Compare model’s output to existing data
• Questions in model validation:
– Does model make sense?
– Are data consistent?
– Can results fully explained?
 Supply Chain Network Design & Decisions
Support Systems: Solution Techniques

• Mathematical optimization techniques:

– Exact algorithms: find optimal solutions
– Heuristics: find “good” solutions, not necessarily
optimal

• Simulation models: provide a mechanism to

evaluate specified design alternatives created
by the designer
 Supply Chain Network Design & Decisions
Support Systems: Solution Techniques

• Mathematical optimization techniques:

– Exact algorithms: find optimal solutions
– Heuristics: find “good” solutions, not necessarily
optimal

• Simulation models: provide a mechanism to

evaluate specified design alternatives created
by the designer
Suply Chain Network Design & Decisions Support
Systems: Solution Techniques (C)
• Consider the following distribution
system (Simchi-Levi et al. 2008)
– Single product
– Two plants P1 and P2
• Plant P2 has an annual capacity of 60,000 units
– The two plants have the same production
costs
– There are two warehouses W1 and W2 with identical
warehouse handling costs
– There are three markets areas C1,C2 and C3 with
demands of 50,000, 100,000 and 50,000, respectively
 Supply Chain Network Design & Decisions
Support Systems: Solution Techniques (C)
Table 1
Distribution costs per unit
Facility P1 P2 C1 C2 C3
Warehouse
W1 0 4 3 4 5
5 2 2 1 2
W2

Source: Simchi-Levi et al.(2008)

• Objectives: finding a distribution strategy specifying product

flows
 through from suppliers to market areas
 without violating product capacity of plant P2
 Satisfy market demand, with lowest total distribution costs
 Supply Chain Network Design & Decisions
Support Systems: Solution Techniques (C)

$0 $3
D = 50,000
$4 $2

$5 $5
D = 100,000
$4 $1
$2
Cap = 60,000
$2 D = 50,000

Production costs are the same, warehousing costs are the same
 Supply Chain Network Design & Decisions
Support Systems: Solution Techniques (C)

• Traditional approach 1: choose cheapest

warehouse to source demand, then cheapest
plant for the warehouse
D = 50,000
$2 x 50,000

$5 x 140,000 D = 100,000

$2 x 60,000 $1 x 100,000
Cap = 60,000
D = 50,000
$2 x 50,000

Total Costs = $1,120,000

 Supply Chain Network Design & Decisions
Support Systems: Solution Techniques
(C)

• Traditional approach 2: choose warehouse

with lowest total delivery cost to & from it
• Thus, consider: P1→W1→C1;
P1→W2→C1; P2→W1→C1; P2→W2→C1
for C1, and similarly for C2 and C3

• The cheapest solution is using W1 for C1,

and W2 for C2 and C3
 Supply Chain Network Design & Decisions
Support Systems: Solution Techniques (C)

• Traditional approach 2: choose warehouse

with lowest total delivery cost to & from it
$0 x 50,000 $3 x 50,000
D = 50,000

$5 x 90,000 D = 100,000

$2 x 60,000 $1 x 100,000
Cap = 60,000
$2 x 50,000
D = 50,000

Total Cost = $920,000

 Supply Chain Network Design & Decisions
Support Systems: Solution Techniques (C)

• Heuristics do not produce the best, least-

cost strategy
• Optimisation model used to solve this,
specifically using Linear Programming
(LP)

Let
xijpw : the flow from plant i to warehouse j

jk  the flow from warehouse j to market

x wm
k
Supply Chain Network Design & Decisions
Support Systems: Solution Techniques (C)
min : 0 x pw
 5x pw
 4x pw
 2x pw
 3x wm  4 x wm
1,1 1,2 2,1 2,2 1,1
1,2

 5 x wm  2 x wm  1x wm  2 x w m
1,3 2,1 2,2 2,3

subject to the followings :

p w
x 2 ,1  x 2 , 2  6 0 ,0 0 0
pw

pw
x 1,1  x 2p,1w  x1,1
wm
 1, 2 x w 3m
1,

xx 1,wp2wm  x 2p, w2  x 2w,1m  x 2w,m

3

ww m 2 ,2
xx 1,1m  xw m
2 ,1

 51 00 ,00,00 00 0
x 1,w 2m  x w
2 ,m2

x 1,w 3m  x w2 ,m3  5 0 , 0 0 0
Al l f l o w s a r e n o n - n e g a t i v e
 Supply Chain Network Design & Decisions
Support Systems: Solution Techniques (C)
Table 2
Distribution
Facility strategy
P1 P2 C1 C2 C3
Warehous
e
W 140000 0 50000 40000 50000
1 0 60000 0 60000 0
W
The total
2 cost for the optimal strategy is
740,000.

Source: Simchi-Levi et al. (2008)

• Using Excel Solver

• What is the optimal distribution strategy?
 Supply Chain Network Design & Decisions
Support Systems: Solution Techniques (C)
• Simulation model:
– Not optimisation model; taking into account
dynamics of the system
– Provide an output based on input and the
mathematical relationship of the various elements
• Which techniques to use? Hax and Candea (in Simchi-
Levi et al. 2008) suggest:
– Use an optimisation model to generate a number of
least-cost solutions at the macrolevel, taking into
account the most important cost components
– Use a simulation model to evaluate the solutions
generated in the first phase
 3.4 Key Features of a Network Configuration
Decision Support System (DSS)
• Main features of a DSS used in network configuration
– flexibility to incorporate in the model all relevant elements
of a particular supply chain and all possible options
– means of incorporating managerial decisions regarding
service
level
• DSS is to help the manager with decision effectiveness
(Ballou & Masters 1999)
– user friendliness,
– technical support,
– optimality of solution and data interface,
– faster processing time and flexibility.
SUPPLY CHAIN MANAGEMENT

Chapter 4: Supply Chain Integration

 Content

1. Information and supply chain integration

2. Effective forecasts and supply chain integration
3. Information for the coordination of systems
4. Lead time reduction
5. Information and the synchronised supply chain
1. Information and supply chain integration

• The bullwhip effect

• The reasons for bullwhip effect
• Quantifying the bullwhip effect
• Information centralisation and the bullwhip
effect
• Bullwhip effect: Managerial insight
• Reducing bullwhip effects
 Food for
Thoughts
• “In modern supply chains, information replaces
inventory”
– Why is this true?
– Why is this false?
• Information is always better than no
information. Why?
• Information
– Helps reduce variability
– Helps improve forecasts
– Enables coordination of systems and strategies
– Improves customer service
– Facilitates lead time reductions
– Enables firms to react more quickly to changing
 Food for
Thought
• Recall that SCM is built on the notion
of integration
• It is competition between supply chains
that matters
• An integrated approach of managing
critical supply chain functions is needed,
thus

• Information is KEY to supply chain

integration
 The Bullwhip Effect

• Consider a simple supply chain with a

manufacturer, a distributor and a retailer
• The retailer keeps inventory to serve its
customers and initiates a replenishment
order according to inventory policy
• The distributor receives the orders from the
retailer and initiates its own replenishment
order to the manufacturer
• Bullwhip effect occurs as demand
information gets distorted as it travels
upstream
The Bullwhip Effect (C)

Source: Mason-Jones & Towill (2000)

 The Bullwhip Effect (C)

• As the Effect occurs, order variability is

amplified up the supply chain;
upstream echelons face higher
variability

• Consequences of the Effect:

– Increased safety stock
– Inefficient allocation of resources
– Increased transportation costs
– Increased warehousing and inventory
carrying costs
 Bullwhip Effect: The Reasons

• Demand forecasting:
– Standard forecasting techniques often used for
production scheduling, capacity planning, inventory
control and materials requirement planning
– Order history often used as a proxy for demand from
the firm’s immediate customers
– Forecasting can be subjective and possesses errors;
order information can be subjectively biased &
projected
– As more data are observed, Mean (M) & Standard
deviation (STD) of demand in forecasting model are
modified more, leading to higher variability in
order quantity
 Bullwhip Effect: The Reasons
(C)
• Lead time:
– Safety stock level & reorder point are functions of M,
STD, and lead time. Thus,
– With longer lead time, small change in demand
implies significant change in safety stock & reorder
level, thus a significant higher variability of order
quantity
• Batch ordering:
– Firms in SC often order periodically in batches when
reorder point is reached → upstream firms see
larger order variability
– Other reasons can be for volume and transport
discounts
 Bullwhip Effect: The Reasons
(C)
• Price fluctuation due to promotional sales:
– If price fluctuates (due to special promotions and
price discounts from manufacturers or
suppliers), retailers & wholesalers buy & stock
in large quantities

• Inflated order:
– If customers, wholesalers and retailers suspect that a
product will be in short supply, they may order in
large quantities with the expectation that they will
receive a greater allocation of products
 Quantifying the Bullwhip Effect

• Consider a two-stage SC: single retailer, single

manufacturer
– Retailer observes customer demand, Dt
– Retailer orders qt from manufacturer

Dt qt
Retailer Manufacturer

L
 Quantifying the Bullwhip Effect (C)

• Retailer reviews inventory level every period

and places order to bring it up to a target level –
The order-up-to point (Re-order Point):

ROP  ( AVG  L)  (z  STD

L)
– AVG & STD are average & standard deviation of
customer demand
– L is the lead time
– Z: safety factor, to ensure that probability of
stockouts during lead time is equal to specified
 Quantifying the Bullwhip Effect (C)

• Retailer and other chain members may

employ the moving average forecasting
technique
• Bullwhip effect is given as the ratio between
variances in retailer orders to manufacturer
Var(q)
(q) and retailer demands 2L(D) 2L2

1 
Var(D) P P2
– Where: P is the number of recent most periods used
in the forecasting (moving average) to determine the
order quantity
 Quantifying the Bullwhip Effect (C)

• Moving Average method: Example 3-Month

Moving Average Forecasting
Total demand 3-month
Demand for during past 3 moving
Month, i month, i months average
. . . .
. . . .
. . . .
20 120 . .
21 130 360/3 120
22 110 380/3 126
23 140 360/3 .67
24 110 380/3 120
25 130 126
26 ? .67
Source: Ballou (1999)
 Quantifying the Bullwhip Effect (C)

• Bullwhip effect is magnified as we increase lead time

and/or decrease P
14
L=5
12

10

8 L=3
6

4 L=1
2

0 L=1
0 5 10 15 20 25 30
Information Centralisation and Bullwhip Effect

• Bullwhip effect causes distortion in demand

information, amplified as it travels
upstream
• Frequently suggested solution to reduce
this effect is to centralise demand
information (Simchi-Levi et al. 2003):
– Provide each stage of SC with complete info. on
actual customer demand
– Each stage of SC can use this info. to create more
accurate forecast
 Bullwhip Effect with Decentralised Demand
Information
• SC members act independently without sharing
information: retailer does not pass along actual
demand data to wholesaler; wholesaler
estimate demand based on past orders from
retailer, etc.
 Bullwhip Effect with Decentralised Demand
Information (C)
• Suppose that due to bullwhip effect demand
variation amplified by 1.2 at wholesaler, 1.4
at distributor and 1.5 at manufacturer
• If order variation at retailer as Var(D), then:
– Var(Q1)/Var(D) = 1.2 or Var(Q1) = 1.2 Var(D)
– Var(Q2)/Var(Q1) = 1.4 or Var(Q2)/Var(D) = 1.4 x 1.2
=1.68
– Similarly, Var(Q3)/Var(D) = 1.68 x 1.5 = 2.52
k 
Var(qk )
  1 
i i2
2L 2L 

Var(D) P P2
i1 
 Bullwhip Effect with Centralised Demand
Information
• Firms share demand information across
the supply chain:
– Retailer transmits order his forecast mean demand to
wholesaler
– Wholesaler uses this forecast mean demand
information to calculate his inventory position and
order up to level
– Distributor receives order from wholesaler, but his
order to next level is again based on retailer’s
forecast demand
 Bullwhip Effect with Centralised Demand
Information (C)
• The order at any stage of the SC, when
compared with the retailer demand, has
incidence of total lead time up to that stage

k
 k 2
Var(qk ) 2  Li 2   Li 
 1 i1
  i1 
Var(D) P P2
• The effect is additive
Information Centralisation and Bullwhip Effect (C)

Dec, k=5

Cen, k=5

Dec, k=3
Cen, k=3

k=1

Source: Simchi-Levi et al. (2003)

Managerial Insights on the Value of Centralised
Information
• Bullwhip effect exists, in part, due to the retailer’s
need to estimate the mean and variance of
demand
• The increase in variability is an increasing
function of the lead time, and a decreasing
function of the number of observations used in
demand forecasting
• The more complicated the demand models and the
forecasting techniques, the greater the increase
• Centralized demand information can significantly
reduce the bullwhip effect, but will not eliminate it
 Reducing Bullwhip Effects

• Reducing uncertainty by information

visibility across the supply chain
– POS
– Sharing information, using IT i.e. EDI, XML
– Sharing forecasts and policies
• Reducing variability in customer demand: if
variability seen by retailer is reduced,
variability seen by wholesaler also reduced
despite of bullwhip effects
– Eliminate promotions
– Everyday Low Pricing (EDLP)
 Reducing Bullwhip Effects (C)

• Reducing lead times results in reduced

bullwhip effect
– EDI: for information lead time (time it takes to
process an order)
– Cross-docking: for order lead time (time it takes to
produce and ship the physical product)
• Eliminating echelons in the supply chain to
reduce time delays and information
distortion
• Strategic partnerships
– Vendor Managed Inventory (VMI): making the
supplier responsible for inventory levels at customer
locations
– Data sharing
– Quick Response (QR)
 Example of Quick Response: Benetton

• Benetton, the Italian sportswear manufacturer,

was founded in 1964. In 1975 Benetton had
200 stores across Italy

• Ten years later, the company expanded to the

U.S., Japan and Eastern Europe. Sales in
1991 reached 2 trillion
• Many attribute Benetton’s success to successful
use of communication and information
technologies
 Example of Quick Response: Benetton (C)

• Benetton uses an effective strategy, referred to as

Quick Response, in which manufacturing,
warehousing, sales and retailers are linked
together. In this strategy a Benetton retailer
reorders a product through a direct link with
Benetton’s mainframe computer in Italy.
• Using this strategy, Benetton is capable of
shipping a new order in only four weeks,
several week earlier than most of its
competitors
 Example of Benetton: How it
work?
1. Integrated Information Systems
 Global EDI network that links
agents with production and inventory
information
 EDI order transmission to HQ
 EDI linkage with air carriers
 Data linked to manufacturing
2. Coordinated Planning
 Frequent review allows fast reaction
 Integrated distribution strategy
 4.2 Effective Forecast and Supply Chain
Integration
• One of the main causes of uncertainty is
forecasting error inherent in any
forecasting system
• Information leads to more effective
forecast
• Effective forecasting has been found to be
strongly co-related with information sharing
& collaboration among partners
– Issues i.e. pricing, promotion, new products, etc.
affecting customer demand are controlled by
retailers, distributors, manufacturers
– If info. about these issues are available to all partners,
forecasting will be more accurate
– CPFR addresses these issues: sharing & using same
forecasting tool
4.3 Infomation for the Coordination of Systems

• A SC system is made up of many independent

subsystems: manufacturing, storage,
transport, distribution, retail systems
• As different subsystems have different
operational objectives, managing any one
of them involves complex trade-offs
• As these systems are connected, e.g. outputs of
one are inputs for the other, it’s important to
have a holistic view of the supply chain and a
mechanism by which the integration process
can become a win-win situation for all
participants
Infomation for the Coordination of Systems (C)

• Ex: cheaper freight rate for truck load quantities

might encourage a retailer to order in truck load
quantities even when the inventory level built
up as a result would be too high for the retailer
under normal circumstances
• This will tend to hide real demand
information and will create uncertainty in the
supply chain, pushing upstream members to
keep additional inventory
• It is thus not sufficient to find trade-offs for any
one stage, which is true whether or not there is
a common owner of systems in SC
Infomation for the Coordination of Systems
(C)

Source: Kim (2005)

Infomation for the Coordination of Systems
(C)
• Questions:
– Who will optimize?
– How will savings be split?

• Information is needed:
– Production status and costs
– Transportation availability and costs
– Inventory information
– Capacity information
– Demand information
 4.4 Lead Time Reduction

• Why?
– Customer orders are filled quickly
– Bullwhip effect is reduced
– Forecasts are more accurate
– Inventory levels are reduced
• How?
– EDI
– POS data leading to anticipating incoming orders
– Etc.
Information and the Synchronised Supply Chain

• A winning supply chain is an integrated system:

– each stage of SC has different business processes and
operational economics
– their immediate goals and operational objectives are
different
• System approach requires that the supply chain
is optimised at the integrated system level
where all stages are considered together
• What about the conflicting goals and
objectives?
Information and the Synchronised Supply Chain
(C)
• Lot Size – Inventory trade-off:
– Advanced manufacturing systems, i.e. Kanban
– POS data for advance warnings:
• If info. is available, manufacturer has time to react to need
of downstream SC members
• If retailer or distributor can observe factory status &
inventory, they can quote lead time to customers more
accurately
• Inventory – Transportation trade-off:
– Advanced production control systems to manufacture
items as late as possible
– Information systems for combining shipments
– Cross-docking
– Advanced DSS
4.5 Information and the Synchronised Supply
Chain (C)
• Lead Time – Transportation trade-off:
– Lea time can be reduced if items are transported
immediately instead of waiting for accumulation
– Methods used can be:
• Use of advanced production control system to manufacture as
late as possible
• Improved forecasting to lower other order lead time
components
• Product Variety – Inventory trade-off:
– Delayed differentiation/postponement
• Cost – Customer Service trade-off:
– Direct shipping from warehouse to
home of retail
customer requires information about
warehouse
 Some final Notes

• Overall, why does information matter?

• Do you think it is easy to quantify the

bullwhip effects? Why or why not?

• What do you think as the key issues of

supply chain excellence in future:
managing information or inventory, or
both?
SUPPLY CHAIN MANAGEMENT

Chapter 5: Strategic Partnering &

Collaboration in Supply Chain
 Content

1. Some initial observations

2.A framework of strategic partnering &
collaboration
3. Supply chain partnership models
– Manufacturer and supplier partnership
– Strategic partnering with logistics service
providers
– RSP or retailer supplier partnership
– Distributor integration
 5.1 Some Initial Observations

• Recall that it is supply chain competing

against supply chain, not individual firm against
firm in business world today
• It thus makes sense for firms to collaborate so as to
maximise ‘strength’ of SC
• Four basic ways to assure business function
completion:
– Internal activities: vertical integration
• Perform activities in-house using internal resources
& expertise
• Require large & capable firms
 Some Initial Observations (C)

– Acquisitions:
• Acquire another firm that has expertise & resources
in other areas
• Full control gained, but culture may clash, effectiveness
of acquired company may be lost
• Management is more important than ownership in
achieving goals
– Arm’s-length transactions:
• For many times, this is the most effective arrangement as
specialised firms (suppliers) have economies of scale
• Goals & strategies may not match
• Does not lead to long-term strategic advantage
 Some Initial Observations (C)

– Strategic alliances:
• Multifaceted, goal-oriented, long-term partnership
between companies
• Risks and rewards are shared
• Aiming at achieving long-term supply chain goals
• Eliminating acquisition downsides, while more resources
committed for mutual goals
• Leading to long-term strategic benefits for both partners

So why is it critical to supply chain

success?
5.2 A Framework for Strategic Partnering and
Collaboration
• The most obvious purposes of strategic partnering &
collaboration are to reduce cost & enhance better
product/service quality
• This takes advantage of learning & innovation
(coordination & collaboration) between partners
• With partnering firm would be able to focus more
on their ‘core competence’
– activities in which it can achieve definable pre-eminence
and provide unique value for customers
– activities which are central to a company’s business, and
which it can perform more effectively than its
competitors
 A Framework for Strategic Partnering and
Collaboration (C)
• What Does It Take to Have an Area of Core
Competency?

Source: Coyle e al. (2003)

 A Framework for Strategic Partnering and
Collaboration (C)
• Strategic alliance or partnership may help
achieve benefits in the followings (Simchi-
Levi et al. 2008):
– Adding value to products –Ex: improved time to
market, distribution times, partnerships between
companies with complementary product lines can
add value to both companies’ products
– Improving market access – Ex: better advertising or
increased access to new market channels, e. g.
consumer product manufacturers cooperate to
address the needs of major retailers, increasing sales
for everyone
A Framework for Strategic Partnering and
Collaboration (C)

– Strengthening operations – Ex: improve operations

by lowering system costs and cycle times,
efficiently and effectively use facilities and
resources
– Adding technological strength – Partnerships in
which technology is shared can help add to the skills
base of both partners
– Enhancing strategic growth –Partnerships might
enable firms to pool expertise and resources to
explore new opportunities by overcoming high entry
barriers
 A Framework for Strategic Partnering and
Collaboration (C)

• Enhancing organisational skills –

Alliances provide a tremendous opportunity
for organisational learning
• Building financial strength
– Ex: income can be increased and administrative costs
can be shared between partners or even reduced
owing to the expertise of one or both of the partners.
– But, alliances also limit investment exposure by
sharing risk
A Framework for Strategic Partnering and
Collaboration (C)

Source: McLaren, Head & Yuan (2002, p. 355)

 A Framework for Strategic Partnering and
Collaboration: The Value of Information
• What and how information is shared?

Source: Matchette and Siekel (2005, p. 1)

 5.3 Supply Chain Partnership Models

• Two types of partnership:

– Vertical partnerships: spanning different businesses
in a common supply chain
• Ex: partnership between suppliers & retailers,
manufacturer & 3PL, etc.
• Streamlining existing capabilities
– Horizontal partnerships: spanning different supply
chains
• Ex: partnership between shipping companies,
airlines, 3PLs, etc.
• Creating new strategic capabilities, access to new
markets, new products and services, and the like
Supply Chain Partnership Models (C)

End Users

Ve r t i c a l
P a r tn e r s h ip
Physical flow in the supply chain

Horizontal
P a r tn e r s h ip s
Supply Chain

Our Supply
Another

Chain
 Supply Chain Partnership Models (C)

• Four types of vertical partnership

in consideration are:
– manufacturer and supplier partnership

– manufacturer and 3PL service

providers partnership

– manufacturer and distributor

partnership

– suppliers and retailers partnership

Supply Chain Partnership Models: Manufacturer-
Supplier Partnership
• Traditional adversarial relationship between
manufacturer and supplier shifted to a
collaborative relationship
– manufacturer and supplier interact like partners
• Main tangible benefits
– integrated SCM through integration of business
processes & information
– ‘transparency’ in information and ‘cooperation’ in
activities
• Example: Dell with “virtual integration”
Supply Chain Partnership Models: Manufacturer-
Supplier Partnership (C)

• Partnership with suppliers came originally from

Japanese business culture, keiretsu, a sort of
supplier cooperative or association, was found
to be linked with each major manufacturer

• Examples:
– Dell: with ‘virtual integration’
– HP
– Chrysler Corporation
Supply Chain Partnership Models: Partnership
with 3PL
• The use of an outside company to perform all or part of
the firm’s material management and distribution
functions
• 3PL relationships are truly strategic alliances: long-term
commitment, not based on transactions, multi-
functional
– Not simply trucking or warehousing
• Most prevalent among large companies
– Ex: Whirlpool Corporation’s inbound logistics
handled by Ryder Dedicated Logistics, IKEA &
Maersk, NIKE & PONL (Now MAERSK), etc.
Supply Chain Partnership Models: Partnership
with 3PL (C)

Source: Brown & Allen

Supply Chain Partnership Models: Partnership
with 3PL (C)

• Advantages of 3PL partnership:

– Concentrating capital investment & management on
core competencies
– Gaining access to the latest technology and
equipment employed by the third-party provider
– Proving other flexibilities, i.e. geographic locations,
in-service offerings, etc.
– The need for investment in new equipment and
premises is avoided
Supply Chain Partnership Models: Partnership
with 3PL (C)

– Potential cost reductions, for example:

• shared use may give better utilisation of vehicles and

warehouses, leading to lower unit costs due to the
consolidation of different customers’ demands;

• the specialisation of the contractor may allow volume

buying of vehicles, warehouses, and mechanical
handling equipment and systems;

• the labour costs of a third-party operator may be

lower
Supply Chain Partnership Models: Partnership
with 3PL (C)

• Disadvantages of 3PL partnership:

– Cost issue:
• Operations at cost plus could be run more cheaply in-
house
• Monitoring and control of costs is easier when
the distribution function remains in-house
• The cost of monitoring the performance of the
logistics can
be high
• Some companies do not have necessary information or
expertise to assess which logistics providers are
Supply Chain Partnership Models: Partnership
with 3PL (C)
– Control issue:
 In-house logistics and distribution operations can
provide the company with more control over important
customer service considerations
 Flexibility of operations is also seen as a possible
advantage of retaining an in-house distribution
function, with the loyalty of the distribution operation
not torn between several customers
 There is also the concern that outsourcing could result in
a loss of security and that confidential information will
be passed to competitors
Supply Chain Partnership Models: Partnership
with 3PL (C)
• Fourth-party Logistics (4PL) or supply chain logistics,
or Lead Logistics Provider (LLP):
– Manages and runs complex logistics operations including
resources, control room, and architecture/integrator
function
– Thought of as supply chain integrator, a firm that
“assembles and manages the resources, capabilities,
and technology of its own organization with those
of complementary service providers to deliver a
comprehensive supply chain solution.”
– Developed from 3PL but covering the broader scope
including 3PL, information technology (IT) services, and
business process management
Supply Chain Partnership Models: Partnership
with 3PL (C)
• Fifth-party Logistics (5PL):
– Developed to serve the e-business market
– Are those 3PL and 4PL providers managing all the
parties in the supply chain on e-commerce
– The key to success in this area is the information
technology and system
 Supply Chain Partnership Models: Issues &
Requirements in Partnership with 3PL
• Know your own cost, compared with cost of using
outsourcing firm
• Customer orientation of the 3PL: how a 3PL fits into
the firm’s strategic logistics plan, e.g. flexibility,
reliability, cost saving, etc.
• Specialisation of 3PL: 3PL whose roots lie in particular
area relevant to logistics requirement in question should
be considered
• Asset-owning versus non-asset-owning 3PL:
- Asset-owning 3PL: significant size, access to HR, large
customer base, economies of scale & scope, etc. but
bureaucratic, long decision-making cycle
- Non-asset-owning 3PL: limited resources, lower bargaining
power, but more flexible, be able to tailor service, etc.
Supply Chain Partnership Models: Implementation
Issues in 3PL Partnership
• Enough time to start-up considerations should
be devoted:
⁻ The firm must identify exactly what it needs
⁻ The firm must provide specific performance
measures & requirements
⁻ The 3PL must discuss these requirements (including
their realism & relevance)
• Effective communication is essential:
⁻ Within the firm, managers must communicate to
each other & employees on why to outsource & what
to expect
⁻ Communication between the firm and its 3PL is
critical, e.g. between information systems, etc.
Supply Chain Partnership Models: Implementation
Issues in 3PL Partnership(C)
• Other important issues for
successful implementation:
– Respect of confidentiality of data shared
– Specific performance measures must be
agreed upon
– Specific criteria regarding subcontractors should be
discussed
– Arbitration issues should be considered
– Escape clauses should be negotiated
– Methods to assure achievement of performance goals
should be discussed
Supply Chain Partnership Models: Factors for
Success in 3PL Partnership
• Five factors that are critical to the success of
a logistics partnership:
– Selective matching: All organisations have compatible
corporate cultures and values
– Information sharing: Partners openly share strategic and
operational information
– Role specification: Each party in the partnership is clear
about the specifics of its role
– Ground rules: Procedures and policies are clearly spelled
out
– Exit provisions: A method for terminating the partnership
is defined
Supply Chain Partnership Models: Other Factors
for Success in 3PL Partnership
• Trust
– the most significant factor to succeed in outsourcing
logistics because companies have to share information,
benefits, and risks to each other
• Performance evaluation:
– the major factor to measure the success and maintain
the achievement after outsourcing starts
– If the performance is not satisfied, the outsourcing can be
ceased or failed because the objective of outsourcing is
not achieved
– To maintain the alliance and succeed in the long term, it is
necessary to measure or evaluate the performance
regularly
Supply Chain Partnership Models: Other Factors
for Success in 3PL Partnership (C)
• Sharing information & maintaining communication:
– This leverages the efficiency and effectiveness in logistics
outsourcing because both partners know what they want and
provide the relevant information
– Lack of information sharing and communication maintaining
can fail the outsourcing especially in strategic partnership
• Top management’s commitment & support:
– If top management are fully committed and support staff in
performing their jobs, the whole company will function in a
defined direction and thus achieve concrete goals
– The lack of commitment and support from top management
will discourage the operations level’s decision in management,
sharing information, and communication
Supply Chain Partnership Models: Other Factors
for Success in 3PL Partnership (C)
• Having clear goals, vision, and roles:
– Goal, vision and roles are required to avoid confusion
between staff and staff, and between two companies
– They should be clarified at the early stage and updated
from time to time to prevent the risks that the partners
may work in the different directions
– Other key critical factors can be relationship
commitment, sharing benefits and risks, flexibility, etc.
– Both sides may have to consider these issues in their
specific condition and context
 Supply Chain Partnership Models: Retailer-
Supplier Partnerships (RSP)
• Types of RSL: Quick Response, Continuous
Replenishment, Advance Continuous
Replenishment, VMI
• Quick Response:
– Vendors receive POS data from retailers, and use this
information to synchronize production and
inventory activities
– The retailer still prepares individual orders, but the
POS data is used by the supplier to improve
forecasting and scheduling
 Supply Chain Partnership Models: Retailer-
Supplier Partnerships (C)
• Continuous Replenishment: Vendors receive
POS data and use it to prepare shipments at
previously agreed upon intervals to maintain
agreed-upon levels of inventory
– Wal-Mart, Kmart
• Advanced Continuous Replenishment:
– Suppliers may gradually decrease inventory levels at
the retailer’s store or distribution center as long as
service levels are met
– Inventory levels are thus continuously improved in a
structured way
– Kmart
 Supply Chain Partnership Models: Retailer-
Supplier Partnerships (C)

• Vendor Managed Inventory (VMI):

– Supplier/vendor is usually manufacturer, but can also be
a distributor
– Supplier/vendor is in charge of ordering & inventory
replenishment decisions, thus reduce cost & improve
service level through information sharing & eliminating
factors of bullwhip effect
– It also leads to better manufacturing scheduling, supplies
to retailers, improved service level with coordinated
distribution & transshipment of inventory between
retailers
Supply Chain Partnership Models: Requirements
for Effective RSP
• Advanced information systems on both sides
• Top management commitment
– Information must be shared
– Power and responsibility within an organization
might change (for example, contact with customers
switches from sales and marketing to logistics)
• Mutual trust
– Information sharing: manufacturer serves many
competing retailers
– Management of the entire supply chain: inventory
of manufacturer and retailers
– Initial loss of revenues
Supply Chain Partnership Models: Important RSP
Issues

• Inventory ownership:
– Traditionally retailer owns inventory when received
– In VMI supplier owns the goods until they are sold
(consignment relationship)
 Why would a firm do this?
• Performance measures must be agreed upon: POS
accuracy, fill rate, inventory level, inventory turns, lead
time
• Confidentiality
• Communication & cooperation
Supply Chain Partnership Models: Advantages
and Disadvantages of RSP

• Fully utilize system knowledge

– Consider the partnership between White-Hall
Robbins (W-R), who makes over-the-counter drugs
such as Advil, and Kmart
– W-R initially disagreed with Kmart about forecasts,
and in this case, it turned out that W-R forecasts were
more accurate because they have a much more
extensive knowledge of their products than Kmart
does
– This implies the ability to control the bullwhip effect
Supply Chain Partnership Models: Advantages
and Disadvantages of RSP

• Other advantages:
– Decrease required inventory levels
– Improve service levels
– Decrease work duplication
– Improve forecasts
• Disadvantages:
– Expensive advanced technology is
required
– Supplier/retailer trust must be developed
– Supplier responsibility increases
– Expenses at the supplier often increase
• Why?
Supply Chain Partnership Models: Distributor
Integration (DI)
• Manufacturers treat their distributors as partners
– Value of distributors & their relationship with end users
are appreciated
– Manufacturer can use information about customer needs
& wants acquired by distributors
– Necessary support, i.e. parts & services are provided to
distributors by manufacturer
• In modern distributor integration, expertise & inventory
located at one distributor is available to the others
• Example: Caterpillar & their dealers
Supply Chain Partnership Models: Distributor
Integration (C)
• DI is used to address both inventory-related & service-
related issues
– Parts are shared across the distributor network
– Specialized service requests are steered to appropriate
dealers or distributors
• Each distributor can check inventories of others; they
are also contractually bound to exchange parts for
agreed-upon remuneration
– How does this improve supply chain performance?
– What does it need to be realised?
Supply Chain Partnership Models: Distributor
Integration (C)

• Issues in DI
– Incentives for dealers – are they giving away
competitive advantages?
– Skills and responsibilities are taken from some
dealers/distributors
• What is required?
– Trust, e.g. be assured about long-term alliance
– Guarantees from the manufacturer, in terms of
commitment of resources & effort
– Advanced information systems
SUPPLY CHAIN MANAGEMENT

Chapter 6: Inventory Management &

Risk Pooling
 Content

1. Basic concepts and rationale for inventory holding

2. Types of inventory
3. Inventory costs
4. Inventory management approaches
5. Classifying inventory
6. Inventory management support systems
6.1 Basic Concepts and Rationale for Inventory
Holding

“Every management mistake

ends up in inventory.”

Michael C. Bergerac
Former Chief Executive
Revlon, Inc.

What is inventory then?

 Basic Concepts and Rationale for Inventory
Holding (C)
• When a company provides a specific customer service, it
has to invest in necessary resources
• They will not get paid back until product or service is sold;
capital invested in resources generates costs which grow as
time passes by
• During this period resources are called inventory: Raw
materials, Finished products, Component parts, Supplies,
Work in process, etc.
• High level of customer service → high level of
product/service availability →high level of inventory
• Ultimate challenge is to balance supply and demand for
inventory
• Inventory investment can represent from as high as 20% of
manufacturer’s to over 50% of wholesalers’ and retailers’
total assets
 Basic Concepts and Rationale for Inventory
Holding (C)

• Where are inventories?

Material Inbound Production Outbound Finished goods Customers
transportation transportation warehousing
sources

Receiving
Production
materials

Inventories
in-process

Shipping
Finished goods

Inventor
y
location
s
 Rationale for Inventory Holding: Batching
Economies/Cycle Stocks
• To achieve purchasing, production and
transportation economies of scales
– Result in trade-offs between large purchases
qualifying for quantity discounts and costs of storing
inventory; storage costs are often less than savings
from buying in bulk, so supplies are stockpiled
– Transportation rate discount with larger quantity
– Production economics favour long production runs,
resulting in cycle stock that must be stored
 Concerns are inventory carrying cost for finished
goods and its obsolescence
 Rationale for Inventory Holding:
Uncertainty/Safety Stocks
• To protect against uncertainty: companies
accumulate safety stock to buffer
themselves against uncertainty
– If inventory is needed for demand fluctuation at
the demand side, it is also true at the supply side
– At the supply side, there may be uncertainty about what
is needed from the vendors or suppliers, how long it
will takes for fulfilment of the order, transport delivery
reliability, etc.
– Safety stocks are more challenging and complex to
manage for many firms
Rationale for Inventory Holding: Time/In-transit
and WIP Stocks
• Inventory generated due to time associated
with transportation or product assembling
• Time-related trade-offs from using slower to
faster transport modes
– Faster modes cost more but may save a larger
amount in inventory carrying costs
• Work-In-Process inventory should be examined
for possible trade-offs especially in the
production of high value goods
– Scheduling and actual production times can be
closely examined to reduce inventory
Rationale for Inventory Holding: Seasonal
Stocks
• To help link demand requirements with
production capability: inventory is required for
a firm to balance its supply capability & market
demand
– Seasonality can occur on the inbound and/or
outbound side of the firm’s logistics
systems (perishable supply & seasonal
demand)
– Demand of many products/service is by nature
changeable and volatile:
 Cost of keeping production at peak level of demand is
extremely high, while substantial idle capacity occurs
at low period
Rationale for Inventory Holding:
Anticipatory Stocks
• To speculate against anticipatory events or make
profit at favourable market conditions
– In some cases, companies anticipate that some
forecasted event will negatively impact the
production cycle
– For example, labor strikes, shortage of supplies due
to weather or political event, or significant price
increases may prompt the firm to build inventory
levels higher than normal
– Risk assessment is important in these cases
Rationale for Inventory Holding: Other
Reasons
• To provide specific customer service:
– High level of product availability means high level of
inventory
– If immediate delivery is the norm, high level of inventory
is required
– If company only manufacture product when order is received,
inventory level in form of finished product is reduced,
although not necessarily in form of raw materials or parts
• To produce ageing: some products need to be stored in
inventory so that value will be generated rather than
cost (i.e. wine, etc.)
Importance of Inventory in other Functional
Areas
• Marketing uses inventory to provide strong customer
service
• Manufacturing uses inventory to schedule longer
production runs
– Long production run may cause shortage of
products needed by marketing to satisfy customer
demand
• Finance wants inventory turnover ratios to be kept high
so that risk of inventory loss is reduced and rate of
return on assets kept competitively high
 6.2 Types of Inventory

• Production inventory:
– Resulting from production or industrial
transformation process
– Production or assembly needs time thus resources are
held in inventory
– This inventory is not available for sale until
production process finishes
• In-transit inventory:
– Items that are en route from place A to B
– May be considered as part of production
inventory
 Types of Inventory (C)

• Safety inventory:
– Extra stocks held in anticipation of demand and lead
time uncertainties
• Speculative inventory
– For purpose of speculation or avoiding losses in
fluctuating market situation
• Seasonal inventory
– Inventory held to offset seasonal variations
• Obsolete/Dead inventory
– Inventories that are of little or no value due to being
out of date, spoiled, damaged, etc.
6.3 Inventory Costs: Why are they so
important?
• Although there are good reasons for
holding inventories, they must be carefully
managed because they represent a
significant cost

• Inventory costs are important because:

– First, inventory costs are a significant portion of total
logistics costs for many firms
– Second, inventory levels affect customer service
levels
– Third, inventory cost trade-off decisions affect
inventory carrying costs
 Inventory Carrying Costs

• Costs relevant to holding of inventory over time

• 4 major components: capital cost, storage
space/warehousing cost, inventory service
cost, inventory risk cost
• Capital cost:
– Opportunity cost associated with investing in
inventory, or any asset
– What is the implicit value of having capital tied up in
inventory, instead of some other worthwhile
project?
 Inventory Carrying Costs
(C)
• Storage space/warehousing cost:
– Fixed cost: investment cost in infrastructure in facilities &
equipment
– Variable cost: varying with kind and amount of product
stored, i.e. handling, rent, heating, ventilation, etc.
– If firm does not own warehouse, warehousing cost
becomes the only variable cost
– In the case of leased warehouse, storage space cost,
i.e building depreciation becomes fixed cost
• Inventory service cost:
– Insurance and taxes on stored goods
– Varies according to the value of the goods
 Inventory Carrying Costs
(C)
• Inventory risk cost:
– Largely beyond the control of the firm
– Due to obsolescence, damage, shrinkage

Capital Inventory investment cost

costs

Warehousing variable costs

Inventory Warehousing
Warehousing fixed costs
carrying costs
costs
Taxes and insurance costs
Inventory
service costs
Obsolescence costs
Inventory
risk Damage costs
costs
Shrinkage costs
 Calculating the Cost of Carrying
Inventory
• Step 1 - Identify the value of the item stored in
inventory (i.e. $100)
• Step 2 - Measure each individual carrying cost
component as a percentage of product value (i.e.
25%)
• Step 3 - Multiply overall carrying cost (as a
percentage) times the dollar value of the product
(e.g. $100 times 25% = $25 inventory carrying cost
per year)
 Order/Setup Cost

• Order costs
– Preparing and processing purchase orders and
receiving reports
– Inspecting and preparing inventory for sale
• Setup Costs
– Incurred when production changes over from one
product to another
• Order costs and inventory carrying costs
respond in opposite ways to increases in
volume
 Expected Stockout Cost

• Cost of not having product available when a customer

wants it
– Includes backorder costs (special order)
• Losing one item profit by substituting a competing
firm’s product
• Losing a customer permanently if customer finds they
prefer the substituted product and/or company
• Possible to handle this by adding safety stock
• In a manufacturing firm, a stockout may result in lost
hours of production until the item is restocked
 In-transit Inventory Carrying
Cost
• Any product inbound to the firm using F.O.B. origin
should be counted
• Any product outbound from the firm using F.O.B.
destination should be counted
• In-transit carrying cost is generally less than for regular
inventory because some cost components are not
present
– No storage costs, no taxes, and reduced risk of
obsolescence
• Trade-off between inventory in transit and transport
should be considered
 6.4 Inventory Management

• 3 basic questions about inventory

– What to order?
– How many to order?
– When to order?
• 2 important issues in inventory
management:

– Demand forecasting
– Order quantity calculation
 Inventory Management Objectives

• Maximum customer service

• Minimum inventory investment
• Maximum efficiency (min. Cost)
• Maximum profit
• Highest return on investment
• To use inventory for strategic advantage
→ Good inventory management is a careful
balancing act between stock availability and
the cost of holding inventory
 Inventory Management Objectives
(C)
• By effectively managing inventory:
– Xerox eliminated $700 million inventory from its
supply chain
– Wal-Mart became the largest retail company utilizing
efficient inventory management
– GM has reduced parts inventory and transportation
costs by 26% annually
• By not managing inventory successfully
– In 1994, IBM continues to struggle with shortages in
their ThinkPad line
 Inventory Management Approaches
and Techniques
• Approaches:
– Fixed Order Quantity (Economic Order Quantity–
EOQ) Approach
– Fixed Order Interval Approach
• Techniques:
– JIT, Square Root Law
– Demand pull approaches: Continuous replenishment,
VMI, ECR
 Fixed Order Quantity under
Certainty
• It involves ordering a fixed amount of product each time
reordering takes place
• Firms need to develop a minimum stock level to
determine when to order (reorder point)
• Amount ordered depends on product’s cost and demand,
along with inventory carrying and reordering costs
• Stock ordering level (reorder point) depends on time it
takes to get new order and product demand or sales rate
during that period
– Ex: new order takes 1 week to arrive and firm sells 14
units per day → reorder point is 140 units
Fixed Order Quantity under Certainty
(C)
 Fixed Order Quantity under Certainty
(C)
• Inventory decision under certainty requires trade-off &
balancing of ordering costs against inventory carrying
costs
– As ordering costs are constant per order, unit cost falls as
quantity order increases:
Cost per unit (C) = Order cost (O)/Order quantity (Q)
– So, ordered quantity should be big!
– However, inventory carrying costs grow as quantity ordered
increases
• The most economical order quantity is when total of
inventory carrying costs & ordering/setup costs is
minimised
Fixed Order Quantity under Certainty: Simple
Economic Order Quantity (EOQ) Model
Fixed Order Quantity under Certainty: Simple
EOQ Model (C)
Fixed Order Quantity under Certainty: Simple
EOQ Model (C)
Fixed Order Quantity under Certainty: Simple
EOQ Model (C)
• Simple EOQ Model Variables
– R = annual rate of demand
– Q = quantity ordered
– A = order or setup cost
– V = value or cost of one unit in dollars
– W = carrying cost per dollar value in %
– S = VW = annual carrying cost in $/unit per year
– t = time in days
– TAC = total annual costs in dollars per year
Fixed Order Quantity under Certainty: Simple
EOQ Model (C)

TAC = QVW + AR or TAC = QS + AR

2 Q 2 Q

First term is the average carrying cost

Second term is order or setup costs per

year
Fixed Order Quantity under Certainty: Simple EOQ
Model – Sawtooth Model of Average Inventory

Source: Coyle (2003)

Fixed Order Quantity under Certainty: Simple
EOQ Model (C)
TAC = QVW + AR or TAC = QS + AR
2 Q 2
Q
Solving for Q gives the following
expressions:

Q = √ 2 RA/VW or Q = √ 2RA/S

Optimal Quantity =

√(2*Demand*Order Cost)/carrying cost

Fixed Order Quantity under Certainty:
Simple EOQ Model Example

Where R = 3600 units V = $100;

W = 25%; S (or VW)= $25;
A = $200 per order

Q = √ 2RA/S =

√ 2*3600*$200 / $100*25%
= √ 2*3600*$200 / $25 = 240 units
Fixed Order Quantity under Certainty: Reorder
Point
• Knowing when (reorder point) to order is as
necessary as knowing how much to order!
• Reorder point depends on inventory level
• Under certainty, firm only needs enough inventory
to last during replenishment time/lead time
• So, with a known lead time, multiplying lead time
length by daily demand determines reorder point
Fixed Order Quantity under Certainty: Reorder
Point (C)
• The reorder point is a function of:
– The Lead Time
– Average demand
– Demand variability
– Service level
• Notation:
– R = average daily demand
– STD = standard deviation of daily demand
– LT = replenishment lead time in days
– W = holding/carrying cost of one unit
– A = fixed cost (order/setup cost)
– SL = service level (for example, 95%). This implies that
the probability of stocking out is 5% of SL
Fixed Order Quantity under Certainty: Reorder
Point (C)
• The reorder point (s) has two components:
– To account for average demand during lead time:
LTR
– To account for deviations from average (we call this safety
stock)
z  STD  LT
where z is chosen from statistical table to ensure that
the probability of stockouts during leadtime is 100%-
SL.
• ROP: LTR + z  STD  LT
Fixed Order Quantity under Certainty: Average
Inventory Level

• Average inventory level:

{(z  STD  LT) + (Q + z  STD  LT)}/2
= Q/2 + z  STD  LT

In that: Q = √ 2 RA/VW or or Q = √ 2RA/S

Fixed Order Quantity under Certainty:
Example

• The distributor has historically observed

weekly demand of:
R = 44.6 STD = 32.1
Replenishment lead time is 2 weeks, desired
service level SL = 97%, order cost is $4500,
unit cost is $250, annual inventory carrying
cost is 18% of unit cost
• When should the distributor reorder and
how much inventory should he keep on
average?
 Continuous Review Policy

S Inventory
Position
Inventory

Lead
Time
Level

0
Time
 Periodic Review Policy

• Inventory level is reviewed periodically, at regular

intervals, and appropriate quantity is ordered after each
review
• Each review period, inventory position is raised to the
base-stock level
• The base-stock level includes two components:
– Average demand during r+L days (the time until the
next order arrives, with r be length of review period):
(r+L)*AVG
– Safety stock during that time:
z*STD* r+L
 Periodic Review Policy
(C)

r r

L L L
Base-stock
Level Inventory
Inventory Level

Position

0
Time
 6.5 Classifying Inventory

• Inventory classification is usually a first

step toward efficient inventory
management
• ABC Analysis: ranking system
– Developed in 1951 by H. Ford Dicky of General
Electric
– Suggested that GE classify items according to
relative sales volume, cash flows, lead time, or
stockout cost
– Most important inventory put in Group A
– Lesser impact goods put in Groups B and C
respectively
 Classifying Inventory (C)

• Pareto’s Rule (80-20 Rule)

– Based on a nineteenth century mathematician’s
observation that many situations were dominated by
a very few elements
– Conversely, most elements had very little influence
in most situations
– Separates the “trivial many” from the “vital
few”
• The 80-20 Rule has been found to explain
many phenomena that interest managers
– For example, 80% of sales come from 20% of
customers; and vice versa
Classifying Inventory (C)
 Kanban

• JIT versus traditional inventory management:

– Reduces excess inventories
– Shorter, more frequent production runs
– Minimize waiting lines by delivering materials when
and where needed
– Short, consistent lead times through proximate
location
– Quality stressed throughout supply chain
– Win-win relationships necessary to a healthy supply
chain
Inventory at Multiple Locations – The Square
Root Law
• Used to reduce inventory at multiple locations
• As locations increase, inventory also
increases, but not in the same ratio as the
growth in facilities
• The square root law (SRL) states that total safety
stock can be approximated by multiplying the
total inventory by the square root of the
number of future facilities divided by the
current number of facilities
Inventory at Multiple Locations – The Square
Root Law (C)
• X2= (X1) * √(n2/n1)
• Where:
– n1 = number of existing facilities
– n2 = number of future facilities
– X1 = total inventory in existing
facilities
– X2 = total inventory in future facilities
• Example:
– Current distribution 40,000 units
– Eight facilities shrinking to two
– Using the square root law:
– √
X2 = (40,000) * (2/8)
– X2 = 20,000 units
Demand Pull Approaches to Managing
Inventory
• Demand pull approaches focus on lowering costs
while also improving service to customers
• Example: Dell uses pull strategies for its inbound
and outbound logistics system, but push strategies
for parts in its supply chain

• Approaches: continuous-replenishment systems,

quick-response systems, vendor-managed inventory
(VMI) systems, efficient consumer response (ECR)
 Vendor-Managed Inventory (VMI)

• Vendor Managed Inventory (VMI):

– Supplier/vendor is usually manufacturer, but can also be
a distributor
– Supplier/vendor is in charge of ordering & inventory
replenishment decisions, thus reduce cost & improve
service level through information sharing & eliminating
factors of bullwhip effect
– It also leads to better manufacturing scheduling, supplies
to retailers, improved service level with coordinated
distribution & transshipment of inventory between
retailers
 Inventory Management Best
Practices
• Top best practices:
– Periodic inventory reviews
– Tight management of usage rates, lead times and
safety stock
– Reduce safety stock levels, e.g. by lead time
reduction
– Introduce or enhance cycle counting
practice
– ABC approach
– Shift more inventory, or inventory ownership, to
suppliers
– Improved forecasting, etc.
 6.6 Inventory Management Support
Systems
• Bar Coding:
– Bar codes are commonly based on the universal
product code (UPC)
– Bar codes use the thickness and separation between bars
to code information
– The result of using bar codes is efficient movement of
stock from supplier to customer and a drop in the amount
of stock that has to be stockpiled
– Increasingly, containers are tracked through terminals by
scanning the bar codes on them as they proceed on their
journey, often without stopping at the gate
 Inventory Management Support Systems (C)

• Wireless Tracking (RFID):

– It uses small transponders and readers that are linked
to an information management system
– The technology is applied in a wide range of logistics
operations, from automatic handling in terminals and
warehouses to production line functions
– The fundamentals of the working of this technology
are that the transponder responds to a signal from
an antenna and sends back a signal
– This permits automation in a wide range of activities
and keeps operating costs low and tracks tagged
items in real time
 Inventory Management Support Systems (C)

• Global Positioning Systems (GPS):

– These systems use an array of satellites to produce
very accurate location coordinates
– GPS is widely used to track vehicles, ships, aircraft,
containers, and shipments
– The use of this system allows, in conjunction with
the organisation’s management communications
systems or the Internet, the availability of real-time
tracking and location of items or shipments
SUPPLY CHAIN MANAGEMENT

Chapter 7: Distribution Strategies

 Content

1. Transportation and distribution

2. Push versus pull systems
3. Impacts of the Internet on Supply Chain strategies
4. Distribution strategies
5. Centralised versus decentralised control
6. Central versus local facilities
 7.1 Transportation and Distribution

• Together with inventory, transportation is a key

logistics & SC management aspect
• Efficient and effective management of
transportation at each stage of SC is crucial
for both cost management and service level
guarantees
 Transportation and Distribution (C)

• Transportation and distribution management affects

– order fulfilment cycle time and
– is one of the main determinants of the service level and
costs associated with SC
• How should transport and distribution managed in SC?
 Transportation and Distribution: Modes

• Transport provides time and place utility of

a product
• Intermodal transport can be used for
inbound transportation and distribution of
the product
– What factors affecting the decision?
• In recent years there has been a
tremendous growth in air freight
– Why is this happening?
– What products should be moved by air?
 Transportation and Distribution: Inbound
Transport

• Inbound transport decisions are often

neglected in SCM literature. Why is this?

• Management of inbound transport can be

however quite crucial for firms trying to
achieve a JIT manufacturing process
 Transportation and Distribution: Outbound
Transport - Distribution
• Firms are more concerned about distribution as:
– Most large manufacturing firms are in control of the
distribution of their products and find it logical to
implement plans to streamline distribution to decrease
cost and to improve service
– The quickness with which a firm can respond to customer
orders is greatly dependent on the firm’s distribution
ability. It is therefore a measure of the firm’s customer
responsiveness
– The finished products are usually of greater value
compared to raw materials
 7.2 Push versus Pull Systems

• Recall that SCM is built on the notion of integration

• The challenge is to coordinate activities across SC,
especially customer demand to production and
manufacturing
• Recall also that information plays a critical role in SC
integration:
– SC must be designed to make information available,
or
– SC strategy must be designed to take advantage of
information that is already available
Push versus Pull Systems: Push-based Supply
Chain
• Production & distribution decisions are based on long-
term forecasts
• Firms typically base demand forecasts on order received
from immediate customer in downstream SC
• What are the problems with push strategies?
– Inability to meet changing demand patterns
– Obsolescence
– The bullwhip effect:
 Excessive inventory
 Excessive
production
variability
 Poor service levels
Push versus Pull Systems: Push-based Supply
Chain (C)
• Due to bullwhip effects, resources are
not utilised efficiently:
– It is not clear how production capacity is determined:
peak demand, or average demand?
– It is also not clear on how to plan transport capacity:
peak demand, or average demand
• In a push-based SC:
– Transport is often increased
– Inventory level is high
– Manufacturing costs are high
Push versus Pull Systems: Pull-based Supply Chain

• Production is demand driven

– Production and distribution coordinated with true
customer demand
– Firms respond to specific orders (e.g. use of POS
data)
• Pull Strategies result in:
– Reduced lead times (better anticipation of
orders)
– Decreased inventory levels at retailers and
manufacturers
– Decreased system variability, better use of
resources
– Better response to changing markets
 Push versus Pull Systems (C)

• What are the advantages of push systems?

• What are the advantages of pull systems?

• Is there a system that has the advantages of

both systems?
 Push versus Pull Systems: New SC Strategy
Paradigm
• A shift from a Push System...
– Production decisions are based on forecast

• …to a Push-Pull System

– Initial portion of the supply chain is replenished
based on long-term forecasts
• For example, parts inventory may be replenished based
on forecasts
– Final supply chain stages based on actual customer
demand.
 For example, assembly may based on actual orders
 Push versus Pull Systems: Push - Pull Supply
Chain

The Supply Chain Time Line

Customers
Suppliers

PUSH STRATEGY PULL

STRATEGY
Low Uncertainty High Uncertainty
Push-Pull Boundary
Source: Simchi-Levi et al. (2008)
 Push versus Pull Systems: Push - Pull Supply
Chain (C)
• The push-pull system takes advantage of
the rules of forecasting:
– Forecasts are always wrong
– The longer the forecast horizon the worst is the
forecast
– Aggregate forecasts are more accurate
 The Risk Pooling Concept, i.e. demand for a component is
an aggregate demand for all finished products that use it
• Delayed differentiation is another example
Push versus Pull Systems: Selecting the best SC
Strategy
Demand
uncertainty

Pull H
I II

IV III
Delivery cost
Unit price
Push L

L H Economies of
Scale
Pull Push
Source: Simchi-Levi et al. (2008)
Push versus Pull Systems: Selecting the best SC
Strategy (C)
• Higher demand uncertainty suggests pull
• Higher importance of economies of scale suggests push
• High uncertainty/EOS not important such as the
computer industry implies pull
• Low uncertainty/EOS important such as groceries
implies push
– Demand is stable
– Transportation cost reduction is critical
– Pull would not be appropriate here
Push versus Pull Systems: Selecting the best SC
Strategy (C)
• Low uncertainty but low value of economies of scale
(high volume books and CD’s)
– Either push strategies or push/pull strategies might be
most appropriate
• High uncertainty and high value of economies of scale
– For example, the furniture industry
– How can production be pull but delivery push?
– Is this a “pull-push” system?
Push versus Pull Systems: Characteristics and
Skills

Raw
Material Customers
Push Pull

Low Uncertainty High Uncertainty

Long Lead Times Short Cycle Times

Cost Minimization Service Level

Resource Allocation Responsiveness

Push versus Pull Systems: Locating the Push-Pull
Boundary
• The push section:
– Uncertainty is relatively low
– Economies of scale important
– Long lead times
– Complex supply chain structures
• Thus
– Management based on forecasts is appropriate
– Focus is on cost minimization
– Achieved by effective resource utilization – supply
chain optimization
Push versus Pull Systems: Locating the Push-Pull
Boundary (C)
• The pull section:
– High uncertainty
– Simple supply
chain structure
– Short lead times

• Thus
– Reacting to
realized demand
is important
– Focus on service
level
Push versus Pull Systems: Locating the Push-Pull
Boundary (C)
• The push section requires:
– Supply chain planning
– Long term strategies
• The pull section requires:
– Order fulfillment processes
– Customer relationship management

• The push-pull boundary should be postponed

as late as possible
Push versus Pull Systems: Locating the Push-Pull
Boundary (C)

What is the impact of pushing the push-pull boundary

from right to left?
Impacts of the Internet on Supply Chain
Strategies
• E-business strategies were supposed to:
– Reduce cost
– Increase service level
– Increase flexibility
– Increase profit
• Reality is different: for example, Furniture.com
– launched in 1999, with thousands of products
– $22 Million in sales the first nine months
– Over 1,000,000 visitors per month
– Died November 6, 2000: Logistics costs too high
 7.3 Impacts of the Internet on Supply Chain
Strategies (C)
• Dell example:
– Dell Computer has outperformed the competition in
terms of shareholder value growth over the eight
years period, 1988-1996, by over 3,000 %

• So why are some firms so successful why

others are not in their new business models?
 Impacts of the Internet on Supply Chain
Strategies: What is E-Business?
• E-business is a collection of business models and
processes motivated by Internet technology, and
focusing on improving the extended enterprise
performance
• E-commerce is the ability to perform major commerce
transactions electronically
– e-commerce is part of e-Business
– Internet technology is the driver of the business change
– The focus is on the extended enterprise:
 Intra-organizational; Business to Consumer (B2C)
 Business to Business (B2B)
• The Internet can have a huge impact on supply chain
performance
 Impacts of the Internet on Supply Chain
Strategies: The Book Industry Example
• From Push Systems...
– Barnes and Noble
• ...To Pull Systems
– Amazon.com,
1996-1999
– No inventory, used Ingram Book Group to meet most
demand
– Why?
• And, finally to Push-Pull Systems
– Amazon.com, 1999-present
• 7 warehouses, 3M sq. ft.
– Why the switch?
 Impacts of the Internet on Supply Chain
Strategies: Transport and Fulfillment
• How have strategies changed?
– From shipping cases to single items & smaller size
shipments
– From shipping to a relatively small number of stores
to highly geographically dispersed end users
– Importance and complexity of reverse logistics have
increased
– Parcel delivery and LTL industry benefited
 Impacts of the Internet on Supply Chain
Strategies: Transport and Fulfillment (C)

Traditional Supply Chain e-Supply Chain

Supply Chain Strategy Push Push-Pull

Shipment Type Bulk Parcel

Inventory Flow Unidirectional Bi-directional

Reverse Logistics Simple Highly Complex

Destination Small Number of Stores Highly Dispersed Customers

Lead Times Relatively long Short

Source: Simchi-Levi et al. (2008)

 7.4 Distribution Strategies

• Warehousing: traditional approach

• Direct Shipping
– No DC needed
– Lead times reduced
– Transport costs increased, due to “smaller trucks” to
more locations
– no risk pooling effects, as there is no central
warehouse
• Cross-Docking: items distributed continuously from
suppliers thru warehouse to customers, with less than 12
hours in warehouse
 Distribution Strategies: Cross-Docking

• In 1979
– Kmart had 1891 stores and average revenues per
store of $7.25 million
– Wal-Mart was a small niche retailer in the South of
US with only 229 stores and average revenues under
$3.5 million
• 10 Years later
– Wal-Mart had
 highest sales per square foot of any discount retailer
 highest inventory turnover of any discount retailer
 Highest operating profit of any discount retailer.
Distribution Strategies: Cross-Docking
Distribution Strategies: What account for Wal-
Mart’s Success?
• A focus on satisfying customer needs
– providing customers access to goods when and where
they want them
– cost structures that enable competitive pricing
• This was achieved by way the company replenished
inventory and made it the centerpiece of its
strategy
• Wal-Mart employed a logistics technique known as
cross-docking
– goods are continuously delivered to warehouses
where they are dispatched to stores without ever
sitting in
inventory.
• This strategy reduced Wal-Mart’s cost of sales
Distribution Strategies: Characteristics of Cross-
Docking
• Goods spend at most 48 hours in the warehouse
• Cross-Docking avoids inventory and handling costs
• Wal-Mart delivers about 85% of its goods through its
warehouse system, compared to about 50% for Kmart
(Simchi-Levi et al. 2008)
– Private satellite communication system
– POS data continuously sent to vendors
– Fleet of 2000 trucks, purchasing full truck load
• Stores trigger orders for products
Distribution Strategies: Characteristics of Cross-
Docking
• Cross-Docking is very difficult to manage:
– Requires advanced IT systems so that DCs, suppliers
and stores are electronically linked to guarantee that
any order is processed and executed in a matter of
hours
– Needs a fast and responsive transportation system.
Why?
– Forecasts are critical, necessitating sharing of
information
– Effective only for large distribution systems with
large numbers of vehicles delivering & picking up
goods at facilities
Distribution Strategies: A
Comparison

Strategy Direct Cross Inventory at

Shipment Docking
Attribute Warehouses
Risk Take
Pooling Advantage
Transportation Reduced Reduced
Costs Inbound Costs Inbound Costs
Holding No Warehouse No Holding
Costs Costs Costs
Demand Delayed Delayed
Variability Allocation Allocation

Source: Simchi-Levi et al. (2008)

 Distribution Strategies: Transshipment

• A transhipment occurs when a facility satisfies

demand from a territory other than its own
– Shipment of items between different facilities at the
same level in SC to meet some immediate need

• Effective transhipment results in reduced

safety stock requirement and fewer stock outs
Distribution Strategies: Transshipment (C)
 Distribution Strategies: Transshipment (C)

• Transshipment makes sense if (and Why?)

– Appropriate information system exists to facilitate
visibility
– Transport costs are reasonable, weighed against the
gains
– Players at the same level have same owner
• So why does it make sense?
• What if players at the same level do not have
the same owner?
7.5 Centralised versus Deccentralised Control

• In the centralised system, decisions are made at a central

location for the entire SC
• Centralised decision making can reduce total
systemwide costs while maintaining CS level
– Easy to see if network is owned by a single
entity
– Benefits realised otherwise in the case there are various
owners; but there should be contractual mechanism in
place
• Centralised control leads to global optimisation; whilst
decentralised control leads to local optimisation
• Keys are sharing of information, IT systems, i.e.
 7.6 Central versus Local Facilities

• Distribution strategies are intrinsically linked with

location and number of facilities
• Centralised versus local (decentralised) facilities:
– Safety stock: less in centralised due to risk pooling
– Overhead: less in centralised due to EOS
– EOS: can be realised in manufacturing
– Lead time: distribution lead time is reduced in
decentralised
– Service: longer shipping time in centralised
– Transport costs: with local facilities, more costs from
plants to warehouses, but less from warehouses to
customers
SUPPLY CHAIN MANAGEMENT

Chapter 8: Supply Chain and Product

Design Issues
 Content

1. Matching the supply chain to the product

2. Design for logistics

3. Mass-customisation and supply chains

4. Supply chain issues and the push-pull

boundary
 Food for
Thought...
• Recall the two main objectives of SCM?
• These aim at achieving key main goal of SCM:
provision of customer value to end-users
• This value is mainly attributed by
– Cost of the products, and
– Product availability
• Thus, they are related to firm’s transport & inventory
decision, as well as policy making
• So, how is product related to its SC? And how does
product design help to achieve the goal?
8.1 Matching the Supply Chain to the Product

• Note that, to satisfy customer’s demand of finished

product at minimum cost & maximum profit
– All processes, e.g. procurement, manufacturing,
logistics, & distribution should be
continuously improved
– Thus, matching supply chain strategies to product
design is important
• Recall how strategies may change along PLC?
• Product design is another critical aspect when
contemplating supply chain strategies
Matching the Supply Chain to the Product (C)

• Recall that every SC is unique: they can be different

even between firms in an industry
• However, SC strategies are related to product:
depending on type of products & product design
• Two broad product categories (Fisher 1997):
– Functional product: reasonably long life cycle, fairly
predictable demand, low profit margin, low obsolescence
rate, fairly long lead time
 Ex: commodities, refrigerators, boats and ships, vehicles, etc.
– Innovative product: short life cycle, high profit margin,
high rate and cost of obsolescence, fairly short lead time
 Ex: seasonal fashion products, MP3, cellular telephones,
personal computers, etc.
Matching the Supply Chain to the Product (C)

• What supply chain strategies are appropriate to each

type of product?
– Push versus pull, or push-pull?
– Lean versus agile, or leagile?

• And what is main focus for these strategies

corresponding to each type of product?
 Matching the Supply Chain to the Product

• Fisher (1997) classifies SC as:

– Physically efficient SC: focusing on cost
minimisation by streamlining inventory,
manufacturing and distribution
– Responsive SC: focusing on quick response to
changing market demand, thus requires short lead
time and excess buffer inventory in the system to
respond quickly to changing market conditions
• So what type of SC strategies are appropriate
for functional and innovative products?
Matching the Supply Chain to the Product (C)

Source: Fisher (1997)

Matching the Supply Chain to the Product (C)
 Some Observations

• The manufacturing environment:

– Rapid changes
• New products rapidly introduced
• Short, unknown product life cycles
– High variety of products
– Long Production Lead Times
– Increasing storage and transportation costs
– Difficult to forecast demand
 Some Observations (C)

• Goals of manufacturing
system:
– Responsiveness
– Competitive pricing
– Efficiency
– Customer service

Conflicting Goals!
 Some Observations (C)

• So why do these goals conflict?

– Forces for keeping low inventory

• inventory expensive
• low salvage values
– Forces for keeping high inventory
• long lead times
• customer service is important
• demand is hard to predict
• reduction in transportation quantity
 Some Observations (C)

• Product and process design are key cost drivers of

product cost
• Major supply chain costs include transportation costs,
inventory costs, distribution costs, etc.
– Especially as inventory must be kept fairly high to
ensure high service level
• As SC can be efficient or responsive, product value can
be enhanced through product design activities
associated with logistics, or design for logistics (DFL)
 8.2 Design for
Logistics
• Design for Logistics (DFL) refers to product & process
design approaches that help to control logistics costs
& increase customer service level (Simchi-Levi et al.
2008)
• DFL uses product design to address logistics costs
• 3 key components of DFL
– Economic packaging aimed at easier transportation,
handling and cheaper transportation
– Using concurrent and parallel processing in
manufacturing to reduce manufacturing cycle time
– Using standardisation to better manage demand
 Design for Logistics: Economic Packaging &
Transportation
• Design products so that they can be efficiently packed
and stored
– Products compactly packed are cheaper to
transport
• Design products to efficiently utilize retail space
– Efficient storage reduces handling costs, rental,
etc.
• Design packaging so that products can be consolidated
at cross-docking points
– Shipping goods in bulk & only completing final packaging
at
warehouse or retailer saves transport cost
 Design for Logistics: Economic Packaging &
Transportation - Examples
• Ikea
– World’s largest furniture retailer
– 131 stores in 21 countries
– Large stores, centralized manufacturing, compactly
and efficiently packed products
• Rubbermaid
– Food containers - designed to fit 14x14” Wal-Mart
shelves
• Shipping containers
– Revolutionising transport world
Design for Logistics: Concurrent and Parallel
Processing
• Focusing on modifying manufacturing process,
which may require modification of product design
• Objective is to minimize manufacturing lead
times
– Most manufacturing process involves sequential steps
– Pressure of shorter PLC
• Achieved by redesigning products so that several
manufacturing steps can take place in parallel
– Lower inventory cost through improved forecasting,
reduced safety stock, etc.
• Modularity is key to implementation
– Physically separated components
– Enables different inventory levels for different parts
Design for Logistics: Concurrent and Parallel
Processing – Example of Network Printers

Board Printer
Customer
Stage 1
(Europe)
(Europe) Stage 2
Integration (Far East)

Stage 1
(Europe) Board
Printer
Stage 2 Customer
(Far East) (Europe)

Integration (Europe)
Plastics,
motors, etc.
Source: Simchi-Levi et al. (2008)
 Design for Logistics:
Standardisation
• Shortening lead times is not always possible
• Standardization of products and processes
may help by
– Product modularity
– Process modularity
• These approaches make it possible to delay
decisions about which product to be
manufactured until after some of
manufacturing or purchasing decision have
been made
 Design for Logistics: Standardisation
(C)
• Product & process modularity are key drivers enabling
standardisation strategies
• Modular Product:
– Can be made by appropriately combining the different
modules
– It entails providing customers a number of options for
each module
• Modular Process:
– Each product undergo a discrete set of operations making
it possible to store inventory in semi-finished form
– Products differ from each other in terms of the subset of
operations that are performed on them
 Design for Logistics: Standardisation
(C)
• Some examples of modularity in product
& process:
– Semiconductor wafer fabrication is modular since the
type of chip produced depends on the unique set of
operations performed
– Oil refining is not modular since it is continuous and
inventory storage of semi-finished product is difficult
• Are modular products always made
from modular processes?
 Design for Logistics: Standardisation
(C)
• Four different approaches to standardisation:

– Part standardisation

– Process standardisation

– Product standardisation

– Procurement standardisation
 Design for Logistics: Standardisation
(C)
• Part Standardisation
– Common parts are used across many products
– Reduce required part inventories and costs. How?
– Product redesign might be necessary
• Process Standardisation
– Standardising as much of the process for different
products as possible, making a generic or family product
– Then customising products as late as possible
– Called “Delayed differentiation”, “Postponement”
 Design for Logistics: Key Concepts
of Postponement
• Delay differentiation of products in the
same family as late as possible
• Enables the use of aggregate forecasts
• Enables the delay of detailed forecasts
• Reduces scrapped or obsolete inventory,
increases customer service
• May require new processes or product
design with associated costs
Design for Logistics: Example of Postponement -
Benetton
• Benetton is a world leader in knitwear
• Massive volume, many stores
• Logistics
– Large, flexible production network
– Many independent subcontractors
– Subcontractors responsible for product movement
• Retailers
– Many, small stores with limited storage
Design for Logistics: Example of Postponement –
Benetton (C)

• Business goals
– Increase sales of fashion items
– Continue to expand sales network
– Minimize costs
• Flexibility important in achieving these goals
– Hard to predict what items, colors, etc. will sell
– Customers make requests once items are in stores
– Small stores may need frequent replenishments
Design for Logistics: Example of Postponement –
Benetton (C)
• It is hard to be flexible when...
– Lead times are long
– Retailers are committed to purchasing early orders
– Purchasing plans for raw materials are based upon
extrapolating from 10% of the orders

How to be flexible?

Postponement
Design for Logistics: Example of Postponement –
Benetton (C)
• Old manufacturing process:

Spin or Purchase Yarn

Dye Yarn

Finish Yarn

Manufacture Garment Parts

Join Parts
Design for Logistics: Example of Postponement –
Benetton (C)
• New manufacturing process:

Spin or Purchase Yarn

Manufacture Garment Parts

Join Parts

Dye Garment This step is postponed

Finish Garment
Design for Logistics: Example of Postponement –
Benetton (C)
• Why the change?
– The change enables Benetton to start manufacturing
before color choices are made
• What does the change result in?
– Delayed forecasts of specific colors
– Still use aggregate forecasts to start manufacturing
early
– React to customer demand and suggestions
• Issues with postponement
– Costs are 10% higher for manufacturing
– New processes had to be developed
– New equipment had to be purchased
 Design for Logistics: Standardisation
(C)
• Product Standardization: using a
process called downward substitution:
– A large variety of products may be offered, but only
a few kept in inventory
– Produce only a subset of products (because
producing each one incurs high setup
cost)
– Guide customers to existing products
– Substitute products with higher feature set for those
with lower feature set, if the lower-end product is out
of stock
– Ex: business class seat versus economy class seat
 Design for Logistics: Standardisation
(C)
• Procurement Standardization: standardising the
procurement of equipment, even when product is not
standardised
• Consider a large semiconductor manufacturer
– The wafer fabrication facility produces highly
customized integrated circuits
– Processing equipment that manufactures these wafers are
very
expensive with long lead time and are made to order
– Although there is a degree of variety at the final product
level, each wafer has to undergo a common set of operations
– The firm reduces risk of investing in the wrong equipment by
pooling demand across a variety of products
Design for Logistics: A Framework
for Standardisation

Source: Simchi-Levi et al. (2008)

 8.3 Mass Customisation and Supply Chains

• Mass customisation is built on the concept of

postponement
– Providing customers with custom solutions, exactly what
they want
– Providing this with same efficiency achieved in mass
production
• The delivery of a wide variety of customized goods at
low cost
• The key is modular products and processes, so that
customer requests can be met
• How does mass customisation enhance value?
Mass Customisation and Supply Chains (C)
 Mass Customisation and Supply Chains (C)

• Critical factors for success of mass customisation

(Simchi-Levi et al. 2008):
– Instaneousness: modules & processes must be linked
together very quickly
– Costless: linkages must add little if any cost to
processes
– Seemless: linkages & modules should be invisible to
customers
– Fictionless: network or collection of modules must
be formed with little overhead
• Can you think of any other?
 Mass Customisation and Supply Chains (C)

• An advanced supply chain is essential

– Many approaches/techniques for effective SCM are
critical for successful mass customisation
• This is particularly true when “modules”
extend beyond a single company
• Consider
– Postponement for regional customisation
– The value of strategic partnerships and
collaboration
– Example: Dell
8.4 Supply Chain Issues and Push-Pull Boundary

• Recall push and pull systems?

• And also lean and agile systems?
• Why is pull system is not always practical to
implement, and thus a push-pull approach is often
adopted?
• Where should the push-pull boundary lie?
• What does it mean by leagile supply chain?
• And how do the above apply to the concept of mass
customisation?
Supply Chain Issues and Push-Pull Boundary (C)

Lean Agile

 Forecast at generic level  Demand driven

 Economic batch quantities  Localised configuration
 Maximize efficiencies  Maximize effectiveness

Strategic
Inventory

Source: Christopher
(2005, p. 121)
SUPPLY CHAIN MANAGEMENT

Chapter 9: Building a responssive

supply chain
 Conten
t
1. lean thinking and supply chain
management
2. the elements of lean
3. agile - agility
4. the agile supply chain
5. lean or gile
6. leagile
7. competitive and supply chain strategies
8. achieving strategic fit
9. tailoring the supply chain for strategic fit
9.1 LEAN THINKING & SUPPLY
CHAIN MANAGEMENT
 Lean thinking, closely related to Just-in-Time (JIT),
describes a philosophy incorporating tools that seek
to economically optimize time, human resources,
assets, and productivity, while improving product
and service quality.

 Quality assessment and improvement is a

necessary element of lean production.
LEAN THINKING & SUPPLY
CHAIN MANAGEMENT
 The objective of supply chain management is to
balance the flow or supply of materials with
downstream customer requirements throughout the
supply chain, such that costs, quality, and
customer service are at optimal levels.
 Lean production emphasizes reduction of waste,
continuous improvement, and the synchronization
of material flows from within the organization and
eventually including the organization’s first-tier
suppliers and customers.

 Supply chain management seeks to incorporate

lean thinking across entire supply chains.
9.2 THE ELEMENTS OF
LEAN
 Waste Elimination
 Lean Supply Chain Relationships
 Lean Layouts
 Inventory and Setup Time
Reduction
 Small Batch Production
Scheduling
 Continuous Improvement
 Workforce Commitment
Waste
Elimination
 Eliminating waste is the primary concern of lean
thinking. This includes reducing excess inventories,
material movements, production steps, scrap
losses, rejects, and rework.
🞑 Waste is any nonvalue-adding activity

 The Seven Wastes

 The Five-Ss
The Seven
Wastes
The Five-Ss (Five-
Why)
Lean Supply Chain
Relationships
 When the focal firm, its suppliers, and its customers
begin to work together to identify customer
requirements, remove wastes and reduce costs,
while improving quality and customer service, it
marks the beginning of lean supply chain
relationships.

 Firms can use lean thinking with their key

suppliers and customers.

 Mutual dependencies and mutual benefits occur

among all of these lean supply chain
relationships, resulting in increased product value
and competitiveness for all of the trading
Lean
Layouts
 The primary design objective with lean layouts
is to reduce wasted movements of workers,
customers, and/or WIP inventories, while
achieving smooth product (or customer) flow
through the facility.

 Lean layouts are very visual, meaning that lines of

visibility are unobstructed, making it easy for
operators at one processing center to monitor
work occurring at other centers.

 Lean layouts allow problems to be tracked to

their source more quickly as well.
Inventory and Setup Time
Reduction
 In lean thinking, excess inventories are considered a waste,
since they can hide a number of purchasing, production,
and distribution problems within the organization.
🞑 Firms must then either find a way to resolve the
supplier’s
delivery problem or find a more reliable supplier.
🞑 Another way to reduce inventory levels is to
reduce purchase order quantities and production
lot sizes.
 Setup times can be reduced in a number of ways including
doing setup preparation work while the previous production
lot is still being processed, moving machine tools closer to the
machines, improving tooling or die couplings, standardizing
setup procedures, practicing various methods to reduce setup
times, and purchasing automated machines that require less
setup time.
Small Batch Production
Scheduling
 Small batch scheduling drives down costs by reducing
purchased, WIP, and finished goods inventories,
and it also makes the firm more flexible to meet
varying customer demand.
 Moving small production batches through a lean
production facility is often accomplished with the
use of kanbans.
 When manufacturing cells need parts or materials,
they use a kanban to signal their need for the
items from the upstream manufacturing cell,
processing unit, or external supplier providing the
needed material. In this way, nothing is provided
until a downstream demand occurs. That is why a
lean system is also known as a pull system.
Small Lot Sizes Increase
Flexibility
A Kanban Pull
System
Continuous
Improvement
 To make the lean system work better, employees
continuously seek ways to reduce supplier delivery
and quality problems, and in the production area
they solve movement problems, visibility
problems, machine breakdown problems, machine
setup problems, and internal quality problems.
 In Japanese manufacturing facilities, this is known
as
kaizen. A literal translation of kaizen is “good
change”.
 Some firms embrace what is known as a kaizen
blitz, which is a rapid improvement event or
workshop, aimed at finding big improvements quickly.
Most kaizen improvements though, are small individual
events, emphasizing creativity.
Workforce
Commitment
 Since lean systems depend so much on waste
reduction and continuous improvement for their
success, employees must play a significant role in
this process.

 In lean manufacturing systems, employees are cross-

trained on many of the various production processes
to enable capacities to be adjusted as needed
when machines break down or when workers are
absent.
 Most employees who work for lean companies enjoy
their jobs; they are given a number of
responsibilities and are considered one of the
most important parts of a successful lean
9.3 AGILE -
AGILITY
 As competitive pressures force more frequent product
changes and consumers demand greater variety
than ever before.
 An organization needs to be able to adjust
output quickly to match market demand and to
switch rapidly from one variant to another.

 A key to agile response is the presence of agile

partners upstream and downstream of the focal
firm.
9.4 THE AGILE SUPPLY
CHAIN
THE AGILE SUPPLY
CHAIN
 The agile supply chain is market-sensitive. By
market- sensitive is meant that the supply chain is
capable of reading and responding to real
demand.
 The use of information technology to share data
between buyers and suppliers is, in effect, creating a
virtual supply chain. Virtual supply chains are
information based rather than inventory based.
 Supply chain partners can only make full use of
shared information through process alignment, i.e.
collaborative working between buyers and suppliers,
joint product development, common systems and
shared information.
 This idea of the supply chain as a confederation of
partners linked together as a network provides the
9.5 LEAN OR
AGILE
LEAN OR AGILE - GENERIC
SUPPLY CHAIN STRATEGIES
9.6 LEAGILE - DECOUPLING
POINT
LEAGILE - DECOUPLING
POINT
LEAGILE - ROUTEMAP TO
THE RESPONSIVE BUSINESS
9.8 COMPETITVE AND SUPPLY
CHAIN STRATEGIES
Competitive strategy of a company defines, relative to
its competitors, the set of customer needs that it
seeks to satisfy through its products and services.

 The competitive strategy is defined based on how

the customer prioritizes product cost, delivery
time, variety, and quality (customers’ priorities).

 Competitive strategy targets one or more customer

segments and aims to provide products and
services that satisfy these customers’ needs.
COMPETITVE AND SUPPLY
CHAIN STRATEGIES

Figure 1: The Value Chain in a

Company
COMPETITVE AND SUPPLY
CHAIN STRATEGIES
A product development strategy specifies the portfolio
of new products that a company will try to
develop. It also dictates whether the development
effort will be made internally or outsourced.

A marketing and sales strategy specifies how the

market will be segmented and how the product
will be positioned, priced, and promoted.
COMPETITVE AND SUPPLY
CHAIN STRATEGIES
A supply chain strategy determines the nature of
procurement of raw materials, transportation of
materials to and from the company, manufacture
of the product or operation to provide the service,
and distribution of the product to the customer,
along with any follow-up service and a
specification of whether these processes will be
performed in-house or outsourced.
 Supply chain strategy specifies what the operations,

distribution, and service functions, whether

performed in-house or outsourced, should do
particularly well.
ACHIEVING STRATEGIC
FIT
Strategic fit requires that both the competitive and
supply chain strategies of a company have
aligned goals.

 It refers to consistency between the

customer priorities that the competitive
strategy hopes to satisfy and the supply chain
capabilities that the supply chain strategy
aims to build.
9.8 ACHIEVING STRATEGIC
FIT
Step 1: Understanding the customer and supply
chain uncertainty

Step 2: Understanding the supply chain

capabilities Step 3: Achieving strategic fit

Step 1: Understanding the
customer and supply chain
uncertainty
 Identify customer demand (customer needs)
in focused segment
 Demand uncertainty vs. Implied demand
uncertainty
🞑 Demand uncertainty reflects the uncertainty of
customer demand for a product.
🞑 Implied demand uncertainty, in contrast, is the resulting
uncertainty for only the portion of the demand that the
supply chain plans to satisfy based on the attributes
the customer desires.
 Implied demand uncertainty is correlated with
customer needs and other characteristics of
demand
Step 1: Understanding the
customer and supply chain
uncertainty

Table 1: Impact of Customer Needs on Implied

Demand Uncertainty
Step 1: Understanding the
customer and supply chain
uncertainty

Table 2: Correlation Between Implied Demand

Uncertainty and Other Attributes
Step 1: Understanding the
customer and supply chain
uncertainty

Table 3: Impact of Supply Source Capability

on Supply Uncertainty
Step 1: Understanding the
customer and supply chain
uncertainty

Figure 2: The Implied Uncertainty (Demand

and Supply) Spectrum
 Step 2: Understanding the supply chain
capabilities
 Supply chain
responsiveness vs.
Supply chain
efficiency

 Cost-responsiveness
efficient frontier

Figure 3: Cost-
responsiveness efficient
frontier
Step 2: Understanding the supply chain
capabilities

Figure 4: Responsiveness
spectrum
 Step 3: Achieving strategic
fit

Figure 5: Finding the zone

of strategic fit
 Step 3: Achieving strategic
fit

Figure 6: Different Roles

and Allocations of
Implied Uncertainty
for a Given Level of
Supply Chain
Responsiveness
 Step 3: Achieving strategic
fit

Table 4:
Comparison
of Efficient
and
Responsive
Supply
Chains
9.9 TAILORING THE SUPPLY
CHAIN FOR STRATEGIC FIT
 Appropriate tailoring of the supply chain helps a
firm achieve varying levels of responsiveness for
a low overall cost. The level of responsiveness is
tailored to each product, channel, or customer
segment.
 The concept of tailoring to achieve strategic fit is
important in industries such as high-tech and
pharmaceuticals, in which innovation is critical
and products move through a life cycle.
 Considering changes in demand and supply
characteristics over the life cycle of a
product.
TAILORING THE SUPPLY CHAIN
FOR STRATEGIC FIT
 New products are typically introduced using
flexible capacity that is more expensive but
responsive enough to deal with the high level of
uncertainty during the early stages of the life
cycle.
 Mature products with high demand are shifted to
dedicated capacity that is highly efficient because
it handles low levels of uncertainty and enjoys the
advantage of high scale.
 The tailored capacity strategy has allowed firms to
maintain strategic fit for a wide range of products
at different stages of their life cycle.
SUPPLY CHAIN MANAGEMENT

Chapter 10: Risk Management in

Logistics and Supply Chains
 Content

1. Overview of risks
2. Principles of risk management
3. Risk Management Process
4. Country analysis and political risk assessment
5.Risk management in global logistics and supply
chains
6. Supply chain risk management framework
7.Supply contracts as a tool of risk minimisation and
sharing
 Some Food for thought

The risk inherent in the new supply chains has

raised supply chain decisions to the strategic level.
More companies are sourcing products from global
markets and reducing the number of suppliers for
each raw material component, or assembly. At the
same time, they are reducing inventories of safety
stocks to lower overall costs. These longer, leaner
supply chains may be unable to react to customer
demand due to major disruptions in supply chain
performance. Part of supply chain management
becomes risk management to ensure materials are
available to meet customer demand.
(Lummus & Demarie 2006, p.
40)
 10.1 Overview of risks: What is RISK?

• This is the Chinese

character for ‘‘risk’’.
The first symbol is
the symbol for
“danger”, while the
second is the symbol
for “opportunity”
• Risk is seen as
danger and
opportunity
combined
 What is RISK? (C)

• Risk exists everywhere and in every activity

– risk has been with the mankind’s whole history since the
Stone Age
– Risk applies to a wide range of systems
• It is uncertainty that we can not comprehend
completely, since without uncertainty there can be
no risk
– uncertainty about the possible variability in result
• Risk is involved with the uncertainty about the
potential outcome, and is related to the threat that
hazards will probably happen and affect the
organisation
 What is RISK? (C)

• Risk therefore contains two main components:

– the probability or frequency of failing to achieve a
particular outcome or objective, and
– the consequence that may occur to the organisation
due to that failure
• It is the probability associated with losses (or
failure) of a system multiplied by the dollar
loss if the risk is realised
Risk magnitude = Frequency (F) x Consequence
(C)
What is RISK? – Risk Matrix
 What is RISK? – Some Characteristics

• Risks exist in most business activities and

socio- economic contexts
– (1) Risk cannot be completely eliminated
– (2) Risk can change from one form to another
• Hence, when a decision taken to make an
activity/system more safe and secure, another
activity/system may become less safe and
secure
• Effective risk management therefore depends
on how well managers perform risk analysis
What is RISK? – Some Examples of
Consequences
• The huge earthquake in 1994 at Kobe, Japan made
California-based Kelly Micro Systems, a manufacturer
of automobile audio systems, and several other small
companies lost their parts supply

• After the 11/9 event, some automobile manufacturers

were short of parts supply, since trucks from suppliers
in Canada were delayed at the border. Ford had to close
some assembling plants as a consequence.
What is RISK? – Some Examples of
Consequences (C)
• During 11-day closure at 29 major ports of
US West coast during Sept – Oct 2002:
⁻ Port authorities estimated loss of $ Bil 19.4 with the
loss extrapolated every day

⁻ An estimate of 1-month disruption in US West coast

ports would reduce exports from Asia about 0.4%
GDP, in which the negative impacts on Hong Kong,
Singapore and Malaysia to be about 1.1% GDP
 Managing Risk in the Supply Chain: Some
Examples of Consequences (C)
• Events such as terrorism and the spectre of terrorist
acts create uncertainty which increases perceived risk
and negatively affect supply chain
⁻ there are indirect costs to a supply chain without security
confidence
⁻ such a supply chain may be less cost-efficient due to higher
freight and insurance rates
⁻ companies without security confidence may have to abandon JIT
or lean inventory processes, apply a higher inventory level policy
to safeguard against unexpected security breaches and supply
chain disruption
⁻ increased inspections would likely add cost to the final product,
cause delays, and thus lengthening the time it takes goods to the
market
⁻ Ex: after Sep 11th, Ford shut down five of its U.S. plants, in part
because the company could not get enough engines parts from
suppliers in Canada due to delays at border
10.2 Principles of Risk Management -
Definition
• RM is the process of identifying, analysing, measuring,
controlling and economically treating risks which may
threaten a firm’s assets and business objectives and
outcomes
– Why “economic control & treatment”?
• RM is to ensure that any potential loss/damage due to
risks will not jeorpardise the firm’s business continuity
• The essential of RM is to formulate and implement an
appropriate Risk Management Process
 10.3 Risk Management Process – Risk
Identification
• It is important to identify all potential risks, both
controllable and uncontrollable
• It is to create a full list of sources of potential risks
(what can happen, when & where) and examine possible
causes and contexts (how & why)
• Tools: mind mapping (within the firm or with industry
experts), cause-effect diagram (fishbone or Ishikawa
diagram), Event Tree Analysis (ETA), etc.
Risk Management Process – Risk Identification (C)
Risk Management Process – Risk Identification (C)
 Risk Management Process – Risk Analysis

• The likelihood and potential consequence of

a threat are integrated into levels of risk

• Levels of risks can be estimated based

on historical information and data

• Tools: risk matrix, ETA with assigned

probabilities
Risk Management Process – Risk Analysis
(C)
 Risk Management Process – Risk Evaluation

• The firm needs to decide which risks to treat and

treatment priorities

• Decisions on risk treatment needs to take into

considerations the firm’s business objectives and
potential opportunities associated with a risk

• Note that risks with potential high loss may also be

associated with potential high benefits; hence
appropriate risk treatment depends on specific
firm’s context
 Risk Management Process – Risk Treatment
Strategies
• Some specific risk treatment strategies:
– Risks with low likelihood and low consequence
should be retained (The firm is to accept);
– Risks with low likelihood and high consequence
should be transferred (via insurance policies);
– Risks with high likelihood and low consequence
should be minimised via effective loss management
measures;
– Risks with high likelihood and high consequence
should be avoided by terminating activities
associated with their sources, or arranged via
insurance policies
10.4 Country Analysis and Political Risk
Assessment

Source: Rugman and Collison (2009)

Country Analysis and Political Risk Assessment
(C)
• Focus of assessment:
– The political system in which the company will be
doing business
– The goods to be produced and the operations to be
carried out
• Online sources:
– www.doingbusiness.org
– www.worldbank.org/data/countrydata
– www.countryrisk.com
– www.economist.com/countries/
Country Analysis and Political Risk Assessment:
Quantifying Risk Vulnerability
• The political/legal, economic, socio-cultural and
technological environment of a foreign country has
different implications depending on the type of
international business that a firm is evaluating
– For example: export restrictions are more important
if a firm is seeking to set up a plant to produce
goods for exports than if the products are for the
local market
 Weighted Country Risk Assessment Model
Country Analysis and Political Risk Assessment:
Quantifying Risk Vulnerability Example

Sources: Conklin, “Analyzing and Managing Country Risks,” Ivey Business Journal, vol. 66, no. 3 (January/February 2002)
10.5 RM in Global Logistics and Supply Chains:
Some Important Sources of Risk
RM in Global Logistics and Supply Chains: Some
Important Sources of Risk (C)
• Risks inherent from global business:
– Suppliers’ capability, forecasting accuracy, etc.
– Although an important reason for firm expanding
globally is to take advantage of low-cost labour in
some countries, these countries may possess
 Poor logistics networks, outdated IT systems
and unskilled manpower sources,
 Political instability or lack of stable political
and economic institutions
– These drawbacks may negatively affect supply chain
management objectives
RM in Global Logistics and Supply Chains: Some
Important Sources of Risk (C)

• Risks inherent from global business (C):

– Due to diverse landscape of international business &
its supply chain, risks are mainly introduced as
 Supply uncertainty, and
 Lead time variability
– Ex: long sea transport time facilitates business
planning & demand estimation on long-term forecast
 This however works against SCM fundamentals
– Goods with short PLC may require new sourcing
closer to markets, whereas high-value & high-tech
products imply transport by air
RM in Global Logistics and Supply Chains: Some
Important Sources of Risk (C)
• Risks inherent from global business (C):
– Global supply chains create many challenges in terms
of marketing & distribution
 Differences in terms of legal framework, administrative
controls, economic stability, etc.
 Changing policies of foreign governments

– Foreign exchange fluctuations make accurate cost

estimation very difficult
RM in Global Logistics and Supply Chains: Some
Important Sources of Risk (C)

U.S. $ Value U.S. $ Cost Yen Cost of

Scenario In Japanese of 5000- U.S. $1,000
Yen Yen Item
Item

A 100 $ 50.00 100,000 yen

B 120 $ 41.67 120,000 yen

C 130 $ 38.46 130,000 yen

Source: Coyle et al. (2003)

 RM in Global Logistics and Supply Chains:
Strategies

1. Speculation strategy
– Bet on a specific situation
– Ex: Japanese automobile manufacturers during late 1970s -
early 1980s made a bet that, compared to keeping all
manufacturing activities inshore, the benefits from low
labour and land costs abroad might well offset risks
associated with these countries
2. Hedging strategy (risk pooling)
– Loss from activities in a geographical area is traded
off by gains in other areas
– Ex: Volkswagen has assembling plants in the US,
Germany, Brazil, etc.
 RM in Global Logistics and Supply Chains:
Strategies (C)

3. Flexible strategy
– Implement a flexible supply chain
• Use many suppliers
• Use many facility locations
• Use many distribution channels

– The implementation of this strategy may be costly

• Initial capital investment required
• Lost of EoS advantage
 RM in Global Logistics and Supply Chains:
Strategies (C)

4. Building an agile supply chain

– Sharing information with SC partners
– Strategically aligning/collaborating with key
suppliers using methods such as VMI (Vendor-
managed Inventory)
– Seeking to reduce complexities: product categories,
package sizes, cumbersome procedures, etc.
– Delaying final manufacturing/assembling to the final
destination to avoid demand forecasting, etc.
 10.6 Risk Management Framework

• The management of international supply chains

requires:
– a sophisticated information and logistics network to
ensure information visibility and short transit times
– a strategic business approach towards managing risk by
portfolio management of supplies and financial risk
management strategies
– an innovative approach towards product design to
maintain and leverage an extended international
SC
• Framework needed for: product development,
purchasing, production, demand management,
order fulfilment (Simchi-Levi et al. 2008)
 Risk Management Framework (C)

• Product development:
– Design products to be modified easily for major
markets & manufactured in various facilities
– An international design team may be helpful
• Purchasing
– Management team responsible for purchasing
important materials from many vendors is necessary
– This is to ensure quality, compatibility of delivery
options & price comparison, as well as sufficient
number of suppliers at hand
 Risk Management Framework (C)

• Production:
– Excess capacity & plants in several regions is essential
– Effective communication systems must be in place
– Centralised management is essential, and centralised
information must be available
• Demand management
– Marketing & sales plans, although carried out on
regional basis, should have at least some centralised
components
– Communication is thus critical
 Risk Management Framework (C)

• Order fulfillment:
– A centralised system must be in place to ensure efficiency of
deliveries to regional customers from global supply chain
• Additional guidelines (Christopher 1998):
– Strategic structuring and overall control of logistics flows
must be centralised to achieve worldwide cost optimisation
– Control and management of customer service must be
localised against the requirements of specific markets
to ensure competitive advantage is gained and
maintained
– As the trend towards outsourcing everything except
core competencies increases, then does the need for
global coordination
– A global logistics information system is the prerequisite for
enabling the achievement of local service needs whilst
seeking global cost optimisation
 10.7 Supply Contracts

• Supply contracts are needed to minimise variability of

supply (capacity, lead time), and beyond
• They address issues between seller and buyer, i.e.
manufacturer or retailer
• Issues to be agreed upon:
– Pricing and volume discounts
– Minimum and maximum purchase quantities
– Delivery lead time
– Product or material quality
– Product return policies
 Supply Contracts: Example

Fixed Production Cost

=$100,000 Variable Production
Cost=$35
Wholesale
Price =$80 Selling Price=$125
Salvage
Value=$20
Manufacturer Manufacturer DC Retail DC

Stores

Sources: Simchi-Levi et al. (2003)

Supply Contracts: Example (C)
 Supply Contracts: Example (C)

• Retailer’s optimal order quantity is 12,000 units

• Retailer’s expected profit is: $470,700
– How is this calculated?
• Manufacturer’s profit is thus $440,000
– How is this calculated?
• Supply Chain Profit is $910,700
• The question is: Is there anything that the distributor
and manufacturer can do to increase the profit of
both?
Supply Contracts Example: Buy-back Contract

• Manufacturer agrees to buy back unsold goods from

retailer for some agreed-upon price
• This allows manufacturer to share the risk with retailer,
thus motivates retailer to increase order quantity
• Using the same example, suppose that manufacturer
offers to buy unsold products from retailer for $55/unit
– In this case, retailer has incentive to increase order quantity
to 14,000 units, for a profit of $513,800 → How is this
calculated?
– Manufacturer’s average profit will be $471,900 → How is this
calculated?
– Supply chain profit will be $985,700
 Supply Contracts Example: Revenue-sharing
Contract
• Retailer shares some of its revenue with
manufacturer, in return for a discount on wholesale
price
• Using the same example, suppose that manufacturer
agrees to decrease wholesale price from $80 to $60
in return for 15% revenue from retailer
– In this case, retailer has incentive to increase order
quantity to 14,000 units, for a profit of $504,325 →
How is this calculated?
– Manufacturer’s average profit will be $481,375 → How
is this calculated?
– Supply chain profit will be $985,700
 Supply Contracts Example: Other Types

• Quantity-flexibility contracts
– Supplier provides full refund for returned (unsold)
items as long as number of returns is no larger than a
certain quantity

• Sales Rebate Contracts

– Provides a direct incentive to retailer (buyer) to
increase sales by means of a rebate paid by supplier
for any item sold above a certain quantity
Supply Contracts: The Example of
Blockbuster
• Demand for a movie newly released video cassette
typically starts high and decreases rapidly
– Peak demand last about 10 weeks
• Blockbuster purchases a copy from a studio for $65 and
rent for $3
– Hence, retailer must rent the tape at least 22 times
before earning profit
• Retailers cannot justify purchasing enough to cover the
peak demand
– In 1998, 20% of surveyed customers reported that
they could not rent the movie they wanted
Supply Contracts: The Example of Blockbuster
(C)
• Starting in 1998 Blockbuster entered a revenue sharing
agreement with the major studios
– Studio charges $8 per copy
– Blockbuster pays 30-45% of its rental income

• Even if Blockbuster keeps only half of the rental

income, the breakeven point is 6 rentals per copy

• The impact of revenue sharing on Blockbuster was

dramatic
– Rentals increased by 75%
– Market share increased from 25% to 31%