1. Supply Chain Management
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Supply Chain Management
Lecture 9
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2. Outline Today Thursday Homework 2 Chapter 6 Skipping
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Outline
Today
Chapter 6
Skipping
3e: Section 6.5 p , 4e: Section 6.6 p
AM Tires: Evaluation of Supply Chain Design Decisions Under Uncertainty
Thursday
Finish Chapter 6 start with Chapter 7
Homework 2
Due Friday February 12 before 5:00pm
If you “save as” .doc and .xls format
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3. Example: Dell Facility Location
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Example: Dell Facility Location ? ? ?
What are the decisions?
What are the constraints?
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4. Example: SC Consulting Facility Location
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Example: SC Consulting Facility Location ? ? ? ?
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5. Making Network Design Decisions in Practice
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Making Network Design Decisions in Practice
Computer models versus sound judgment
Most facility location decisions are based on tariffs and tax incentives
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6. Example: Dell Facility Location
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Example: Dell Facility Location
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7. Example: SC Consulting Facility Location
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Example: SC Consulting Facility Location
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8. Impact of Uncertainty in Network Design
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Impact of Uncertainty in Network Design
Supply chain network design decisions include
Facility location (number of facilities)
Capacity allocation (size of each facility)
Market and supply allocation (distribution)
These decisions, once made, cannot be changed easily in the short-term, they remain in place for several years
Demand, prices, exchange rates, and the competitive market change constantly
A decision that looks very good under the current environment may be quite poor if the situation changes
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9. Supply Chain Risk Supply failure Commodity price volatility
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Supply Chain Risk
Supply failure Commodity price volatility
Internal product failures
Lower consumer spending
Natural disaster
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10. Supply Chain Risks to be Considered During Network Design
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Supply Chain Risks to be Considered During Network Design
Does offshoring increase or decrease these risks?
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11. SYST 4050 Slides
Supply Chain Risk
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12. SYST 4050 Slides
Supply Chain Risk
“Significant supply chain disruptions can reduce your company’s revenue, cut into your market share, inflate your costs, send you over budget, and threaten production and distribution. You can’t sell goods you can’t manufacture or deliver. Such disruptions also can damage your credibility with investors and other stakeholders, thereby driving up your cost of capital”
In a study of more than 800 companies that announced a supply chain disruption between 1989 and 2000, Singhal and Hendricks found that, during a three-year span, regardless of industry, disruption cause or time period, affected companies experienced 33- to 40-percent lower stock returns relative to their peers. Likewise, share price volatility in the year after the disruption was 13.5 percent higher when compared with the volatility in the year before the disruption.
They also determined that, in the year leading up to companies announcing a supply chain disruption, such firms experienced seven-percent lower sales growth, 11-percent higher cost, and a 14-percent increase in inventories.
Source: FM Global – The New Supply Chain Challenge: Risk Management in a Global Economy
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13. Managing a Supply Chain is Not Easy
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Managing a Supply Chain is Not Easy
Uncertainty and risk factors
1997 Raw material shortages
Boeing inventory write down of $2.6 billion
2000 Nike glitch in demand planning software
Shortage of popular Air Jordan footwear
Nike announced a $100 million sales loss
2001 9/11
Trucks full of parts queued up for miles at the US-Canadian border
2002 West Coast port strike
Losses of $1B/day
Store stock-outs, factory shutdowns
2007 Mattel recall
A sub-sub-contractor used lead-based paint from a non-authorized third-party supplier
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14. Impact of Uncertainty in Network Design
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Impact of Uncertainty in Network Design
Supplier
Manufacturer
Distributor
Retailer
Customer
Natural disasters, supplier bankruptcies, labor disputes, information infrastructure breakdown, inaccurate forecasts, exchange rate risks
Uncertainty is propagated through the supply chain(s) and leads to inefficient processes
If there is no uncertainty in the supply chain, the performance can be optimal
The presence of uncertainty stimulates the creation of buffers in time, capacity and inventory to prevent a possible bad performance of the chain. These buffers restrict the operational performances and may cancel the competitive advantage of the organization
Building flexibility into supply chain operations allows the supply chain to deal with uncertainty more effectively
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15. Risk Mitigation Strategies
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Risk Mitigation Strategies
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16. Discounted Cash Flow Analysis
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Discounted Cash Flow Analysis
Supply chain network design decisions should be evaluated as a sequence of cash flows over the duration that they will be in place
Supply chain network design decisions are in place for a long time, so they should be evaluated over an extended period
Supply chain network design decisions should be evaluated as a sequence of cash flows over the duration that they will be in place
as a sequence of cash flows over that period
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17. Discounted Cash Flow Analysis
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Discounted Cash Flow Analysis
Supply chain network design decisions should be evaluated as a sequence of cash flows over the duration that they will be in place
Discounted cash flow (DCF) analysis
Evaluates the net present value (NPV) of any stream of future cash flows
Allows for comparing two or more cash flow streams in terms of their present financial value
Supply chain network design decisions are in place for a long time, so they should be evaluated over an extended period
Supply chain network design decisions should be evaluated as a sequence of cash flows over the duration that they will be in place
as a sequence of cash flows over that period
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18. Discounted Cash Flow Analysis
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Discounted Cash Flow Analysis
The present value of future cash is found by using a rate of return k
A dollar today is worth more than a dollar tomorrow
A dollar today can be invested and earn a rate of return k over the next period
Discount rate: The rate used to discount future cash flows to their present values
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19. SYST 4050 Slides
Net Present Value
Given a stream of cash flows C0, C1, …, CT over the next T periods and a rate of return k
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20. SYST 4050 Slides
Net Present Value
Given a stream of cash flows C0, C1, …, CT over the next T periods and a rate of return k
The net present value (NPV) of this cash flow stream is given by 1
1 + k ( ) t
t=1 T
NPV = C0 + ∑ Ct Ct
(1 + k) t
t=0 T
NPV = ∑
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21. SYST 4050 Slides
Net Present Value
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22. Example: Net Present Value
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Example: Net Present Value
Fulfillment by Amazon
Warehousing and other logistics services
Amazon will pick, pack, and ship your product to your customer
Target.com
Estimated demand 100,000 units for online orders
Required space 1,000 sq. ft. for every 1,000 units
Revenue $1.22 for each unit of demand
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23. Example: Net Present Value
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Example: Net Present Value
Target.com can choose between two options
Spot market rate expected at $1.20 per sq.ft. per year for each of the next 3 years
3 year lease contract at $1 per sq.ft.
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24. Example: Net Present Value
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Example: Net Present Value
Expected annual profit if space is obtained from spot market using discount factor k = Ct = (100,000 x $1.22) – (100,000 x $1.20) = $2,000 C1
(1 + k)1 C2
(1 + k)2
(1 + k)0
NPV = + +
2,000
(1.1)1
1.12
(1.1)0 =
= $ 5,471
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25. Example: Net Present Value
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Example: Net Present Value
Expected annual profit if space is obtained by a 3 year lease using discount factor k = Ct = (100,000 x $1.22) – (100,000 x $1.00) = $22,000 C1
(1 + k)1 C2
(1 + k)2
(1 + k)0
NPV = + +
22,000
(1.1)1
1.12
(1.1)0 =
= $ 60,182
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26. Example: Net Present Value
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Example: Net Present Value
NPV(Spot) = $5,471 and NPV(Lease) = $60,182
The NPV of signing the lease is $54,711 higher
But we ignored uncertainty. Uncertainty in demand and costs may change the outcome
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27. Binomial Representation of Uncertainty
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Binomial Representation of Uncertainty
Multiplicative binomial
Pu5 p
Pu4 p
Pu3
1-p p
Pu4d
Pu2
1-p p
Pu3d Pu p
1-p P
Pu2d
Pu3d2
1-p
Pud
Pu2d2
1-p Pd
Pud2
Value of interest (e.g., P = price)
Changes from period to period
Up by a factor u with probability p
Down by a factor d with probability 1-p
Models
Multiplicative: Pu, Pd
Additive: P + u, P - d
Pu2d3
Pd2
Pud3
Pd3
Pud4
Pd4
Pd5
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28. Binomial Representation of Uncertainty
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Binomial Representation of Uncertainty
Additive binomial
P+5u p
P+4u p
P+3u
1-p p
P+4u-d
P+2u
1-p p
P+3u-d
P+u p
1-p P
P+2u–d
P+3u-2d
1-p
P+u-d
P+2u-2d
1-p
P-d
P+u-2d
P+2u-3d
P-2d
P+u-3d
P-3d
P+u-4d
P-4d
P-5d
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29. SYST 4050 Slides
Decision Trees P
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30. SYST 4050 Slides
Decision Trees
A decision tree is a graphic device used to evaluate decisions under uncertainty
Identify the duration of each period and the number of time periods T to be evaluated
Identify the factors associated with the uncertainty
Identify the representation of uncertainty
Identify the periodic discount rate k
Represent the tree, identifying all states and transition probabilities
Starting at period T, work back to period 0 identify the expected cash flows at each step
Decisions:
Sign a long-term warehousing contract or get space in the spot market?
How much capacity should the facility have? What fraction of this capacity should be flexible?
Multi-period decisions when uncertainty resolves after each period
Sources of uncertainty:
Prices
Demand
Inflation rate
Exchange rates
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31. Example: Decision Tree Analysis
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Example: Decision Tree Analysis
What product to make for the next three years using a discount factor k = 0.1?
Old product with certain demand ($90 profit/unit)
New product with uncertain demand ($85 profit/unit)
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32. Example: Decision Tree Analysis
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Example: Decision Tree Analysis
Old product with certain demand ($90 profit/unit)
Annual demand is expected to be 100 units this year, 90 units next year, and 80 units in the following year
Cash flows for the three periods
C0 = 100*90 = $9,000
C1 = 90*90 = $8,100
C2 = 80*90 = $7,200
NPV(Old)
= 9,000/ ,100 / ,200 /1.12
= 9, , ,950
= $ 22,314
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33. Example: Decision Tree Analysis
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Example: Decision Tree Analysis
New product with uncertain demand ($85 profit/unit)
Annual demand expected to go up by 20% with probability 0.6
Annual demand expected to go down by 20% with probability 0.4
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34. Example: Decision Tree Analysis
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Example: Decision Tree Analysis
Identify the duration of each period and the number of time periods T to be evaluated
Duration of each period is 1 year, T = 3
Identify the factors associated with the uncertainty
Demand D
Identify the representation of uncertainty
D may go up by 20% with probability 0.6
D may go down by 20% with probability 0.4
Identify the periodic discount rate k
k = 0.1
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35. SYST 4050 Slides
Example
Represent the tree, identifying all states as well as all transition probabilities
Period 2
P = 120*85+(0.6* *8160)/1.1 = 19844
P = 12240
Period 1
D=144
0.6
Period 0
D=120
0.6
0.4
P = 8160
D=100
D=96
0.6
P = 100*85+ (0.6* *13229)/1.1 = 24135
0.4
D=80
0.4
P = 5440
D=64
P = 80*85+(0.6* *5440)/1.1 = 13229
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36. Example: Decision Tree Analysis
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Example: Decision Tree Analysis
Three options for Trips Logistics
Get all warehousing space from the spot market as needed
Sign a three-year lease for a fixed amount of warehouse space and get additional requirements from the spot market
Sign a flexible lease with a minimum change that allows variable usage of warehouse space up to a limit with additional requirement from the spot market
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