© Muckstadt, Murray, Rappold. All Rights Reserved. The Laws of Supply Chain Physics John A. Muckstadt Cornell University December 6, 2001

© Muckstadt, Murray, Rappold. All Rights Reserved. A Typical Supply Chain Raw Material Suppliers (Internal or External) PlantsDownstream Customers Raw Materials Random, Non-Stationary Consumer Demand Time

© Muckstadt, Murray, Rappold. All Rights Reserved. Traditional View of Decision Hierarchy Strategic Planning –Product markets, M&A, Allocation of Assets Tactical Planning –Sales & Operations Planning –Plant Operations Planning Operations –Detailed Scheduling –Execution

© Muckstadt, Murray, Rappold. All Rights Reserved. Planning Issues Customer demand is highly uncertain and non-stationary.

© Muckstadt, Murray, Rappold. All Rights Reserved. Demand Estimates by Quarter Planned Production Capacity Demand Estimates by Quarter

© Muckstadt, Murray, Rappold. All Rights Reserved. Actual Demand by Day Nominal Production Capacity Actual Demand

© Muckstadt, Murray, Rappold. All Rights Reserved. Planning Issues Customer demand is highly uncertain and non-stationary. Product-level forecasts are uncertain over short time horizons.

© Muckstadt, Murray, Rappold. All Rights Reserved. Customer Demand

© Muckstadt, Murray, Rappold. All Rights Reserved. The Effect of Product Level Forecasts on Production

© Muckstadt, Murray, Rappold. All Rights Reserved. Planning Issues Customer demand is highly uncertain and non-stationary. Product-level forecasts are uncertain over short time horizons. Limited production capacity necessitates inventory in certain products in order to meet customer service objectives. Uncertainty in production capacity, yields, and supplier delivery performance also dictates additional safety stock. The supply chain planner must be able to gather and assimilate state-of-the-world data and to make resource allocation decisions under uncertainty that will have far- reaching consequences in future time periods. The supply chain planner must adhere to the laws of supply chain physics.

© Muckstadt, Murray, Rappold. All Rights Reserved. A Typical Supply Chain Raw Material Suppliers (Internal or External) PlantsDownstream Customers Raw Materials Random, Non-Stationary Consumer Demand Time

© Muckstadt, Murray, Rappold. All Rights Reserved. Local optimization results in global disharmony First Law of Supply Chain Physics

© Muckstadt, Murray, Rappold. All Rights Reserved. A Typical Supply Chain Raw Material Suppliers (Internal or External) PlantsDownstream Customers Raw Materials Random, Non-Stationary Consumer Demand Time

© Muckstadt, Murray, Rappold. All Rights Reserved. Second Law of Supply Chain Physics The average amount of inventory in a system is equal to the product of the demand rate and the average time a unit is in the system (Littles Law) L = W

© Muckstadt, Murray, Rappold. All Rights Reserved. The Impact of Uncertainty and Limited Capacity Consider a single plant location subject to random customer demands received periodically. The plant has a finite production capacity in each period. Demand must be satisfied in the period in which it arises. Question: What are the relationships among: –customer service, –inventory requirements, and –production capacity usage? Random customer demand Finished goods inventory Production facility with limited capacity

© Muckstadt, Murray, Rappold. All Rights Reserved. Central Issue How much inventory is required to minimize costs or to support a specific customer service level objective?

© Muckstadt, Murray, Rappold. All Rights Reserved. Mean demand 50 units/period Std Dev 7.1 units/period Max Capacity 58 units / period Period

© Muckstadt, Murray, Rappold. All Rights Reserved. Period

© Muckstadt, Murray, Rappold. All Rights Reserved. Mean demand 50 units/day Std Dev 7.1 units/day Period

© Muckstadt, Murray, Rappold. All Rights Reserved. Mean demand 50 units/day Std Dev 23 units/day Max Capacity 58 units / day Period

© Muckstadt, Murray, Rappold. All Rights Reserved. Mean demand 50 units/day Std Dev 23 units/day Max Capacity 53 units / day Period

© Muckstadt, Murray, Rappold. All Rights Reserved. Example Demand Mean is 100 units/period Demand StdDev is 30 units Capacity Utilization is 85% Need 60 units to support a 90% service level. Need 77 units to support a 95% service level. Need 100 units to support a 98% service level.

© Muckstadt, Murray, Rappold. All Rights Reserved. Capacity Utilization increased to 95% Demand Mean is 100 units/period Demand StdDev is 30 units Capacity Utilization is 95% Need 198 units to support a 90% service level. Need 258 units to support a 95% service level. Need 335 units to support a 98% service level. or roughly 330% more inventory for the same level of service.

© Muckstadt, Murray, Rappold. All Rights Reserved. Inventories are a consequence of supply chain design and customer service objectives. Supply chains are dynamic systems. –Capacity Utilization –Inventory Levels –Customer Service Pick any two, and the other is determined. The exact mathematical representation depends on the forms of the stochastic processes generating demands and governing productive capacity. are NOT independent Third Law of Supply Chain Physics

© Muckstadt, Murray, Rappold. All Rights Reserved. The value of collaboration and information sharing diminish as the capacity utilization is either extremely high or extremely low. Fourth Law of Supply Chain Physics

© Muckstadt, Murray, Rappold. All Rights Reserved. Sources and Effects of Supply Chain Uncertainty Supply chain design and management are significant determinants of operational uncertainty. Uncertainty is often created by the structure and rules employed in the operation of a supply chain. –Lead times –Forecasting mechanisms –Capacity allocation rules –Inventory stocking policies

© Muckstadt, Murray, Rappold. All Rights Reserved. An Example Supply Chain Environment Order Customer Operations Production Lead Time Product Lead Time Downstream BU Consumer Demand ( Mean, Variance ) Order Demand Time Information Sharing Product Information Forecasting mechanism Stocking policies Forecasting mechanism Stocking policies Level of information sharing

© Muckstadt, Murray, Rappold. All Rights Reserved. Customer Demand

© Muckstadt, Murray, Rappold. All Rights Reserved. Central Warehouse Demand

© Muckstadt, Murray, Rappold. All Rights Reserved. Factory Demand

© Muckstadt, Murray, Rappold. All Rights Reserved. Factory Demand with Information Sharing

© Muckstadt, Murray, Rappold. All Rights Reserved. Lead Time Reduction and No Information Sharing

© Muckstadt, Murray, Rappold. All Rights Reserved. Lead Time Reduction with Information Sharing

© Muckstadt, Murray, Rappold. All Rights Reserved. Effective supply chain design will reduce uncertainty dramatically and improve operational and financial performance significantly. However, residual uncertainty will exist and must be effectively considered in a decision support environment. Fifth Law of Supply Chain Physics

© Muckstadt, Murray, Rappold. All Rights Reserved. Historical Demand by Quarter Mean = StdDev = 69.1 Coeff Var = 0.09 units per day Production Capacity Demand

© Muckstadt, Murray, Rappold. All Rights Reserved. Historical Demand by Month Mean = StdDev = Coeff Var = 0.18 units per day Production Capacity Demand

© Muckstadt, Murray, Rappold. All Rights Reserved. Historical Demand by Day Mean = StdDev = Coeff Var = 1.04 units per day Production Capacity Demand

© Muckstadt, Murray, Rappold. All Rights Reserved. Complications All products are not demanded equally. All customers do not behave in the same manner. Operating strategies and implementing decision support systems must contend with these differences and respect the operational trade-offs throughout the supply chain.

© Muckstadt, Murray, Rappold. All Rights Reserved. Distribution of Products

© Muckstadt, Murray, Rappold. All Rights Reserved. Example Product A

© Muckstadt, Murray, Rappold. All Rights Reserved. Example Product B

© Muckstadt, Murray, Rappold. All Rights Reserved. Example Product C

© Muckstadt, Murray, Rappold. All Rights Reserved. Example Product D

© Muckstadt, Murray, Rappold. All Rights Reserved. Accurate item level forecasts are often not statistically accurate for most items over a short-time horizon. Sixth Law of Supply Chain Physics

© Muckstadt, Murray, Rappold. All Rights Reserved. Dealing With Residual Uncertainty: The No B/C Production-Inventory Strategy Store capacity only in items for which it is possible to estimate demand distributions and to use capacity effectively to produce requirements for other items upon demand. Keep inventory to mitigate against the uncertainty in the total demand for capacity. The amount of inventories kept depends on the variation in aggregate demand for capacity and the variation in the available capacity in each time period.

© Muckstadt, Murray, Rappold. All Rights Reserved. Keep your assets in their most flexible form for as long as it is economically and operationally possible. Seventh Law of Supply Chain Physics

© Muckstadt, Murray, Rappold. All Rights Reserved. Summary: Guiding Principles 1.Know customer requirements. 2.Construct a lean supply chain organization. 3.Build tightly-coupled information infrastructures. 4.Build tightly-coupled business processes. 5.Construct tightly-coupled decision support systems.

© Muckstadt, Murray, Rappold. All Rights Reserved. There is nothing more difficult to plan, nor more dangerous to manage, nor more doubtful of success, than the creation of a new order of things. For the reformer has fierce enemies in all who would profit from the preservation of the old, and only lukewarm defenders in those who would gain from the new. This lukewarmness arises partly from the fear of their adversaries, who have law in their favor, and partly from the incredulity of mankind, who do not truly believe in anything new until they have had an actual experience of it. Niccolo Machiavelli