Production and Service Systems Operations Spring 2009-2010 Supply Chain Management (SCM) Slide Set #15

What is Supply Chain Management? 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 Today, competition is between “supply chains” of firms

A Simple Supply Chain Example Raw Material Sources Consumers Suppliers Manufacturers Distributors Retailers Customers Material, Information and Funds Flow

A Supply Network Example Distributors and Warehouses Raw Material and Semi-Finished Products Suppliers Manufacturing Centers Consumers Material, Information and Funds Flow

Traditional Management Perspective “Company-centric” thinking Local optimum in major decisions process development inventory control and management structuring the distribution networks price policies contracts Information is an asset which should not be shared with other companies

Supply Chain Management Perspective Supply chain oriented thinking Global optimum in major decisions process development inventory control and management structuring the distribution networks price policies contracts Both upstream companies and downstream companies are partners Information sharing with your partners may improve the performance of all parties in the supply chain

The Objective of SCM The objective of SCM is to minimize related costs while maintaining a reasonable service level customer satisfaction, quality, on time delivery, etc. Focus is on minimizing costs across the whole supply chain not on minimizing local costs Inter- and intra- company integration is essential building synergies by integrating business functions, departments and companies Systems thinking is a must each member of the supply chain has roles in the establishment of the price, quality and customer satisfaction 3 Key words:

Key Components of Supply Chain Analysis Location Transportation and logistics Inventory and forecasting Marketing and channel restructuring Sourcing and supplier management Information and electronic mediated environments Product design and new product introduction Service and after sales support Reverse logistics and green issues Outsourcing and strategic alliances Metrics and incentives Global issues

Supply Chain Management: Key Issues Distribution Network Configuration: for ex: selecting a set of warehouse locations and capacities, determining production levels and locations, flow patterns (from plant to warehouse to retailer) Distribution Strategies (Wal-Mart’s cross-docking strategy, direct shipping) Inventory Control (uncertainty in demand, forecasting) Supply Contracts Supply Chain Integration and Strategic Partnership information sharing operational planning

Supply Chain Management: Key Issues Product Design postponement or delayed differentiation Information Technology and Decision Support Systems main motivation for SCM practice which data to keep and analyze? impact of internet and e-commerce? the primary competitive advantages of IT and DSS? Customer Value measuring the value of a customer to the company measuring company’s contribution to its customer

Decision Making in a Supply Chain Strategic level decisions (long term) location, capacity, new product development, technology management scale: years Tactical level decisions (medium term) inventory policies, distribution channel, resource and product allocation scale: month-year Operational level decisions (short term) scheduling, vehicle assignment and routing, sourcing and production orders scale: minutes-days

Why SCM? What happens in the absence of collaboration, coordination and cooperation ? We will illustrate through two well-known examples bullwhip effect prisoners’ dilemma

The Bullwhip Effect

Bullwhip Effect: Demand Observations Procter and Gamble (P&G) manufactures Pampers diapers Demand at various members of the supply chain observed as follows Wholesaler’s Orders to Manufacturer Time 5 10 15 20 Consumer Sales Order Quantity Retailer’s Order to Manufacturer Manufacturer’s Orders to Supplier Consumer Demand at Retailer Retailer’s Orders to Wholesaler

Variability in Demand Variability in demand for Pampers low at the retailer stage much higher in the upstream stages This result can be observed in the well-known beer game High variability is not preferred because it leads to

The Reasons of Bullwhip Effect Demand forecast updating Long lead times Order batching Price fluctuations Rationing and shortage gaming It is not possible to eliminate the bullwhip effect only through local improvements We need a global perspective that involves all members of the supply chain

Reducing the Bullwhip Effect Avoid demand forecast updates Reduce order batch sizes Stabilize prices Eliminate speculations

1- Avoid demand forecast updates Forecasts are usually based on historical customer orders Whenever there is a change in customer orders, the firms update their forecasts and their MRP hence, the update is reflected in the demand values of the upstream firms as well each firm amplifies the updates One solution is providing the real customer demand data to upstream firms of the supply chain increased visibility through information sharing IBM, HP, and Apple require sell-through data on withdrawn stocks from their resellers' central warehouse

1- Avoid demand forecast updates EDI is common particularly in the retail business reduces the cost of data interchange increases information sharing Vendor Managed Inventory (VMI): The vendor* determines the inventory parameters in the retailer and replenishes accordingly both forecasting and inventory policy are the vendor’s responsibility the vendor has access to the demand and inventory information at retail sites * The “vendor” can be referred to as a “supplier” or a “manufacturer”, depending on the context

1- Avoid demand forecast updates Continuous Replenishment Program (CRP) The retailer itself determines the inventory parameters Manufacturer or wholesaler has access to the demand and inventory information at retail sites and replenishes the inventories without a purchase order Inventory reductions up to 25% are observed Many companies such as Campbell Soup, M&M/Mars, Nestle, Quaker Oats, Nabisco, P&G, and Scott Paper use CRP with some or most of their customers

2- Reduce order batch sizes Companies often batch or accumulate demands before issuing an order EDI can reduce the cost of the paperwork in generating an order ex: P&G has introduced standardized ordering terms across all business units to simplify the process this leads to lower order batch sizes

2- Reduce order batch sizes Transportation costs Differences in the costs of full truckload and less-than- truckload (LTL) may be very high improvements in order efficiency are wasted due to the full-truckload constraint Some manufacturers induce their distributors to order assortments of different products hence, a truckload may contain different products from the same manufacturer instead of a full load of the same product Third-party logistics (3PL) companies help make small batch replenishments economical by consolidating loads from multiple suppliers

3- Stabilize prices : Retailers may buy items in advance of requirements as a result of attractive price offerings when pricing returns to normal, the customer stops buying and waits for the next discount period The customer’s buying pattern does not represent its consumption pattern P&G, Kraft, and Wal-Mart have moved to an

4- Eliminate speculations When demand exceed supply, the supplier rations the product Knowing this, customers exaggerate their need in their orders. This inflates the true need. When demand goes down, customers reduce or cancel orders How to eliminate exaggerated orders? General Motors allocates products in proportion to past sales instead of orders in case of short supply customers then have no incentive to exaggerate their orders

Bullwhip Effect: Summary Initiatives such as Electronic Data Interchange (EDI), Vendor Managed Inventory (VMI), Continuous Replenishment Program (CRP) and Everyday Low Pricing Policy (EDLP) helps in sharing information and increasing visibility achieving supply-chain optimality rather than firm-wide optimality reducing lead times by increasing the speed of data interchange Hence, in reducing the bullwhip effect

Prisoner’s Dilemma

Prisoner’s Dilemma Two people arrested in a crime site. They will be punished if at least one of them confesses that they committed the crime They are kept in two different rooms so that they cannot cooperate Two choices for each prisoner C: Confess, N: Not confess Their utilities, depending on their own action and the other prisoner’s action are as follows Prisoner B Confess Not confess Confess Prisoner A Not confess

Prisoner’s Dilemma -5, -5 0, -10 -10, 0 -2, -2 Prisoner “A” thinks: I do not know what “B” will do, but he can do two things: B confesses: In this case, if I confess my punishment will be 5 years. If I don’t, than it will be 10 years. Better to confess. B does not confess: In this case, if I confess I won’t be punished at all. If I don’t, than I will be punished for 2 years. Better to confess. Hence, for prisoner A, Same thing for prisoner B Prisoner B C N -5, -5 0, -10 -10, 0 -2, -2 C Prisoner A N

Prisoner’s Dilemma Hence, both prisoners will choose to confess a crime that they did not conduct If the prisoners could cooperate the outcome might be different they might both choose not to confess and they might both get less punishment of course, this depends on how much they trust each other This simple example shows how local decision making may lead to socially inferior solutions An application of Game theory Implications for supply chain management?

Back to SCM…

Challenges in SCM Achieving global optimization Managing uncertainty conflicting objectives complex network of facilities system variations over time Managing uncertainty

Conflicting Objectives - 1 Lot size – Inventory trade-off manufacturers prefer larger lot sizes; however, this causes higher inventory levels for distributors and retailers Inventory – Transportation cost trade-off suppliers prefer to ship full truck loads; however, this causes higher shipping cost for retailers (or, customers) cross-docking may be a solution

Conflicting Objectives - 2 Lead time – Transportation cost trade-off suppliers prefer to ship full truck loads, which cause higher lead time for customers Product variety – Inventory trade-off high product variety causes less accurate forecasts and requires higher safety stock levels to offer the same service level delayed differentiation may help SCM and IT tools can mitigate these conflicts

Complex Network of Facilities National Semiconductor Example Production produces chips in six different locations: four in the US, one in Britain and one in Israel chips are shipped to seven assembly locations in Southeast Asia Distribution the final product is shipped to hundreds of facilities over the world 20,000 different routes 12 different airlines are involved 95% of the products are delivered within 45 days 5% are delivered within 90 days

Complex Network of Facilities Globalization of supply chains result in additional complexities mainly due to outsourcing to low cost countries such as China and India Increased transportation costs and lead times Language and cultural differences Currency fluctuations Armed conflicts Customs operations Intellectual property (IP) problems

Variations Over Time Supply chain evolves over time customer demand and supplier capabilities customer-supplier relationship seasonality competitors’ pricing strategies advertising and promotions

Managing Uncertainty Demand is not the only source of uncertainty delivery lead times, component availability, machine breakdowns, natural disasters etc. For example: supply disruptions… September 1999 earthquake in Taiwan. Hewlett Packard and Dell, who source a variety of components from Taiwanese manufacturers, were impacted by supply interruptions 2005 strike in Oakland harbor: Serious blow to San Francisco area (including the Silicon Valley) industry

Matching Supply with Demand Becomes even more difficult when considering the whole supply chain Compaq computer estimates it lost $500 million to $1 billion in sales in 1995 because its laptops and desktops were not available when and where customers were ready to buy them Boeing Aircraft was forced to announce loss of $2.6 billion in October 1997 the reason? “Raw material shortages, internal and supplier parts shortages…” (Wall Street Journal, Oct. 23, 1997)

New Technology: RFID RFID: A technology that uses radio waves to identify objects, such as goods in a supply chain. Two components: RFID tags attached to objects containing a chip and an antenna network of readers RFID tags provide unique identification within the range of a tag reader Similar to bar codes, but better multiple RFID tags can be read simultaneously and automatically

New Technology: RFID RFID can alter supply chain management drastically Eliminates the need for manual counting and bar-code scanning of goods at receiving docks, warehouses and on retail shelves

Outsourcing Outsourcing: Buying goods or services from other companies instead of producing or providing them in the company Started with manufacturing outsourcing Continued with other functions such as procurement and product design Apple Computer example Motivation: Reduce costs and focus on core business an easy way to cut costs

Outsourcing: Advantages & Disadvantages

Supply Contracts The relation between a buyer and a seller (supplier) is administered by a supply contract The contract may specify pricing and volume discounts minimum and maximum purchase quantities delivery lead times product or material quality product return policies The contract may have a powerful impact on supply chain performance determines the incentives of the supply chain members determines how risk is shared between the members

Contract Type Examples : The manufacturer (seller) agrees to buy back unsold items from the retailer (buyer) for some agreed-upon price Quantity-flexibility contract: The manufacturer provides full refund for unsold items, up to a certain quantity of items : The manufacturer makes a rebate payment to retailer for each unit sold above a certain quantity Quantity discount contract : The buyer pays one price to purchase options, and another price to exercise the purchased options. Often used when a buyer wants a supplier to build capacity in advance Revenue sharing contract (see next slide)

Example: Revenue Sharing Contract Until 1998, Blockbuster Video (video rental chain) purchased copies of films for $65 rent them to customers for $3 Because of high purchase price, Blockbuster did not purchase enough copies to cover peak demand (first 10 weeks) Result: Low customer service (product availability) 20% of customers could not get their first choice of movie In 1998: Revenue sharing contract between Blockbuster and movie studios Huge impact on Blockbuster revenue and market share

Supply Chain Product Design Design-for-Logistics (DFL) IKEA: Modular and easily-stored furniture Postponement Postponing the configuration of the final product as long as possible Benetton example before: wool was dyed before knitted now: garments are dyed after they are knitted advantages: additional time before committing to the final mix of colors (better information) HP example printer localization at the distribution centers, rather than in factory

Risk Pooling

Risk Pooling Concept Decentralized system Market 1 Warehouse 1 Supplier Warehouse 2 Market 2 Centralized system Market 1 Supplier Warehouse Market 2 To achieve the same service level, which system will require more inventory? Why?

Risk Pooling Concept Why is pooling advantageous? Intuitively, As the number of locations go up, this likelihood also goes up Let’s analyze risk pooling with a simple example consider a particular product sold at two locations (markets): 1 and 2 97% type-1 service level 1 week delivery lead time from the factory to the warehouse(s)

Example: Historical Data CV=STD/ AVG

Example: The Inventory Policy (Q,R) policy with Q=EOQ Order Q units when inventory level falls to R R= safety stock (SS) + lead time demand (1 week demand) SS = z * std(leadtime demand) where z= 1.9 (approx.) for type-1 service level of 0.97 Average inventory = SS + Q/2

Risk Pooling Example

Observations Risk pooling idea: demand variability is reduced if one aggregates demand across locations Centralizing inventory reduces both safety stock and average inventory level for the same service level This works best for high coefficient of variation, which reduces required safety stock negatively correlated demand between the two locations (markets) This was an example of pooling across different locations delayed differentiation was an example of pooling across different products