1. Production and Service Systems Operations
Spring
Supply Chain Management (SCM)
Slide Set #15

2. 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

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

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

5. 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

6. 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

7. 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:

8. 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

9. 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

10. 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

11. 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

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

13. The Bullwhip Effect

14. 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

15. 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

16. 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

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

18. 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

19. 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

20. 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

21. 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

22. 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

23. 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

24. 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

25. 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

26. Prisoner’s Dilemma

27. 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

28. 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

29. 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?

30. Back to SCM…

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

32. 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

33. 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

34. 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

35. 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

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

37. 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

38. 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)

39. 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

40. 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

41. 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

42. Outsourcing: Advantages & Disadvantages

43. 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

44. 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)

45. 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

46. 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

47. Risk Pooling

48. 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?

49. 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)

50. Example: Historical Data
CV=STD/ AVG

51. 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

52. Risk Pooling Example

53. 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