Business, Operations and Supply Chain Strategy (MS 911) Dynamics of vertical supply networks: demand fluctuations and the bullwhip effect

Teaching schedule, topics 7-12 TopicLecture 7Introduction to supply chain strategy 8Determining organisational boundaries: vertical integration and outsourcing 9Drivers of supply chain performance 10Dynamics of vertical supply networks: demand fluctuations and the bullwhip effect 11International issues in supply chain strategy 12Risk management in supply networks; including the design and management of sustainable supply chains 2

Required reading for this lecture Required reading for this lecture on vertical integration and outsourcing: Hayes, Pisano, Upton & Wheelwright (2005), Operations, Strategy, and Technology – Pursuing the Competitive Edge, chapter 5 3

Facilities decisions: multifacility networks (1) Structural decisions: How many different facilities should be utilised?  How large should each facility be? Where should the facilities be located?  Near major markets or customers?  Or near sources of raw materials?  Or near an appropriate supply of labour? 4

Facilities decisions: multifacility networks (2) Structural decisions (continued) : How should each facility be specialised?  Focus by product line (i.e. horizontal network)?  Or focus by production volumes?  Or focus by geographic region?  Or focus by process stage (i.e. vertical network)?  Or maintain a mixed network? Develop an ‘orchestrated’ (i.e. collaborative) network? 5

Trade-offs (1) Horizontal network structure: Facilities are specialised by product family (or by product volume or geographic region within a product family). Sister facilities are relatively independent of each other. Management tends to have a marketing mind-set. Customer service / responsiveness is emphasised. 6

Trade-offs (2) Vertical network structure: Facilities are specialised by process stage. Sister facilities are dependent on each other for key inputs. Management tends to have a engineering mind-set. Resource utilisation / efficiency is emphasised. 7

Managing horizontal networks Horizontal networks tend to be better suited for less complex and less capital-intensive technologies, where flexibility and product innovation are more important than careful planning and tight control. Authority tends to be decentralised, which promotes flexibility and responsiveness. Managing such a network typically requires decisions about the degree of autonomy that individual facilities should be given and about which practices should be standardised across the network. 8

Managing vertical networks Vertical networks are more appropriate for complex, divisible and capital-intensive technologies. Each production facility tends to have little identification with either the final product or its end users, and tends to be treated as a cost centre. The key challenges in managing this kind of network revolve around how to coordinate the flow of materials and products along the supply chain in order to meet delivery promises, minimise the cost of either over-stocking or under-stocking, and facilitate the development and production of new products. 9

Centralisation or not? (1) Benefits of a centralised approach: Standardisation of critical operating decisions. Uniformity (as perceived by customers) of product or service experience regardless of location. Common ethical standards and business practices. Sharing of ‘best practices’. 10

Centralisation or not? (2) Benefits of a decentralised approach: Local autonomy enables greater responsiveness to local customer needs. Local autonomy enables more effective adaptation to local operating conditions. Local autonomy facilitates local experimentation, possibly leading to learning and innovation. 11

Barriers to implementing & maintaining focused facilities Reluctance to split up an existing facility. Different ways to achieve focus. Fear of losing staff with ‘wrong’ expertise. Fear of losing economies of scale. Fear of losing benefits of diversification. Difficulty of measuring financial benefits of focus. Solution: adopt plant charters?! 12

Dynamics of vertical networks The ‘bullwhip’ effect: Each change in final customer demand has an echo that travels up the supply chain (that is, in an upstream direction), with a consistent time lag. Fluctuations in demand for intermediate products become larger as one moves upstream. Factories can be starved for orders for many weeks, even though final customer demand stays the same or even increases. 13

Ultimate cause of the bullwhip effect The bullwhip effect distorts demand information in the supply chain, with different stages having very different views of demand. The bullwhip effect is ultimately caused by inadequate coordination of the supply chain. Each stage manages its inventory independently of the other stages. System Dynamics (continuous simulation) is a good technique to model this effect. (For instance, through playing ‘The Beer Game’.) 14

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Comment on previous example In the previous example, the bullwhip effect was caused by inappropriate inventory decision rules (leading to an increasing distortion of demand information further upstream). Other specific causes are: Effects of lead times at various stages in the supply chain. Effects of different batching decisions. 18

Dealing with the coordination problem (1) To alleviate the bullwhip effect: Reduce the number of stages in the supply chain (dis-intermediation). Communicate final consumer demand directly up the supply chain (EPOS – using Bar-coding or RFID; VMI). Reduce ordering and shipping delays: faster information transmission (EDI; Internet; inter- company ERP), and shorter lead times (through smaller batches), and higher efficiency in operations (Lean Production). 19

Dealing with the coordination problem (2) To alleviate the bullwhip effect (continued) : Reduce practices that de-stabilise demand (promotions, special sales, price discounts). Counter ‘gaming’ by customers during shortages. 20