SCM by Chopra

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Supply Chain Management
Introduction
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Outline
What is supply chain management?
A supply chain strategy framework
Components of a SCM
Major obstacles and common problems
Seven Eleven Japan
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Traditional View: Supply Chains in
the Economy (1990, 1996)
Freight Transportation $352, $455 B
Transportation manager in charge
Transportation software
Inventory Expense $221, $311 B
Inventory manager in charge
Inventory software
Administrative Expense $27, $31 B
Logistics related activity 11%, 10.5% of GNP
$898 B spent domestically for SC activities in 1998.
$1,160 B of inventory in the US economy in the early 2000s.
Transportation and inventory managers
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Traditional View: Cost breakdown of a
manufactured good
Profit 10%
Supply Chain Cost 20%
Marketing Cost 25%
Manufacturing Cost 45%
Profit
Supply Chain
Cost
Marketing
Cost
Manufacturing
Cost
Effort spent for supply chain activities are invisible to the customers.
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What can Supply Chain Management do?
Estimated that the grocery industry could save $30 billion (10% of operating
cost) by using effective logistics and supply chain strategies
A typical box of cereal spends 104 days from factory to sale
A typical car spends 15 days from factory to dealership
Faster turnaround of the goods is better?
Laura Ashley (retailer of women and children clothes) turns its inventory 10
times a year five times faster than 3 years ago
inventory is emptied 10 times a year, or an item spends about 12/10 months in the
inventory.
To be responsive, it relocated its main warehouse next to FedEx hub in Memphis, TE.
National Semiconductor used air transportation and closed 6 warehouses, 34%
increase in sales and 47% decrease in delivery lead time.
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Magnitude of Supply Chain Management
Compaq estimates it lost $0.5 B to $1 B in sales in 1995
because laptops were not available when and where
needed
P&G (Proctor&Gamble) estimates it saved retail
customers $65 M (in 18 months) by collaboration
resulting in a better match of supply and demand
When the 1 gig processor was introduced by AMD
(Advanced Micro Devices), the price of the 800 meg
processor dropped by 30%
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Importance of SCM understood by some
AMR Research:
"The biggest issue enterprises face today is intelligent visibility of their
supply chains-both upstream and down"
Forrester Research:
"Companies need to sense and proactively respond to unanticipated variations
in supply and demand by adopting emerging technologies such as intelligent
agents. To boost their operational agility, firms need to transform their static
supply chains into adaptive supply networks
Gartner Group:
By 2004, 90% of enterprises that fail to apply supply-chain management
technology and processes to increase their agility will lose their status as
preferred suppliers
Open ended statement. Agility can be increased continuously.
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Top 25
Supply Chains
AMR research http://www.amrresearch.com
publishes reports on supply chains
and other issues.
The Top 25 supply chains report comes
out in Novembers.
The table on the right-hand side is from
The Second Annual Supply Chain
Top 25 prepared by Kevin Riley and
Released in November 2005.
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SCM Generated Value
Minimizing supply chain costs
while keeping a reasonable service level
customer satisfaction/quality/on time delivery, etc.
This is how SCM contributes to the bottom line
SCM is not strictly a cost reduction paradigm!
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A picture is better than 1000 words!
How many words would be better than 3 pictures?
- A supply chain consists of
- aims to Match Supply and Demand,
profitably for products and services
SUPPLY SIDE DEMAND SIDE
The right
Product
Higher
Profits
The right
Time
The right
Customer
The right
Quantity
The right
Store
The right
Price
=
+ + + + +
- achieves
Supplier Manufacturer Distributor Retailer Customer
Upstream
Downstream
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Detergent supply chain:
Customer wants
detergent
Albertsons
Supermarket
Third
party DC
P&G or other
manufacturer
Plastic cup
Producer
Chemical
manufacturer
(e.g. Oil Company)
Tenneco
Packaging
Paper
Manufacturer
Timber
Industry
Chemical
manufacturer
(e.g. Oil Company)
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Flows in a Supply Chain
Customer
Material
Information
Funds
The flows resemble a chain reaction.
Supplier
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SCM in a Supply Network
Supply Chain Management (SCM) is concerned with the management and control of
the flows of material, information, and finances in supply chains.
Supply
Demand
Products and Services
Cash
Supply Side OEM Demand Side
THAILAND INDIA MEXICO TEXAS US
N-Tier Suppliers Suppliers Logistics Distributors Retailers
Information
The task of SCMis to design, plan, and execute the activities at the different stages
so as to provide the desired levels of service to supply chain customers profitably
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Importance of Supply Chain Management
In 2000, the US companies spent $1 trillion (10% of GNP) on supply-related
activities (movement, storage, and control of products across supply chains).
Source: State of Logistics Report
Eliminating inefficiencies in supply chains can save millions of $.
Tier 1
Supplier
Manufacturer Distributor Retailer Customer
Inefficient
logistics
High
stockouts
Ineffective
promotions
Frequent Supply shortages
High landed costs to
the shelf
High inventories
through the chain
Low order fill
rates
Glitch-Wrong Material,
Machine is Down
effect snowballs
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This image cannot currently be displayed.
Supply
Sources:
plants
vendors
ports
Regional
Warehouses:
stocking
points
Field
Warehouses:
stocking
points
Customers,
demand
centers
sinks
Purchase
Inventory
Transportation
Inventory
A Generic Supply Chain
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Cycle View of Supply Chains
Customer Order
Cycle
Replenishment Cycle
Manufacturing Cycle
Procurement Cycle
Customer
Retailer
Distributor
Manufacturer
Supplier
Any cycle
0. Customer arrival
1. Customer triggers an order
2. Supplier fulfils the order
3. Customer receives the order
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Push vs Pull System
What instigates the movement of the work in the system?
In Push systems, work release is based on downstream demand
forecasts
Keeps inventory to meet actual demand
Acts proactively
e.g. Making generic job application resumes today (e.g.: exempli gratia)
In Pull systems, work release is based on actual demand or the
actual status of the downstream customers
May cause long delivery lead times
Acts reactively
e.g. Making a specific resume for a company after talking to the recruiter
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Push/Pull View of Supply Chains
Procurement,
Manufacturing and
Replenishment cycles
Customer Order
Cycle
Customer
Order Arrives
Push-Pull boundary
PUSH PROCESSES PULL PROCESSES
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Examples of Supply Chains
Dell / Compaq
Dell buys some components for a product from its suppliers
after that product is purchased by a customer. Extreme case of a
pull process
Zara, Spains answer to Italys Benetton
Sells apparel with a short design-to-sale cycle, avoids markdowns.
Toyota / GM / Volkswagen, in the course notes
McMaster Carr / W.W. Grainger, sell auto parts
Amazon / Barnes and Noble
Frozen food industry/Fast food industry/5 star restaurants
Internet shopping: Webvan / Peapod
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SCM Strategy
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Mission-Strategy-Tactics-Decisions
Mission, Mission statement
The reason for existence of an organization
Strategy
A plan for achieving organizational goals
Tactics
The actions taken to accomplish strategies
Operational decisions
Day to day decisions to support tactics
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Life Strategy for Ted
Ted is an undergrad. He would like to have a career in business, have
a good job, and earn enough income to live comfortably
Mission: Live a good life
Goal: Successful career, good income
Strategy: Obtain a masters degree
Tactics: Select a college and a concentration
Operations: Register, buy books, take
courses, study, graduate, get a job
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Linking SC and Business Strategy
New
Product
Development
Marketing
and
Sales
Operations Distribution Service
Finance, Accounting, Information Technology, Human Resources
Competitive (Business) Strategy
Product Development Strategy
-Portfolio of products
-Timing of product introductions
Marketing Strategy
-Frequent discounts
-Coupons
Supply Chain Strategy
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Strategies:
Product Development
It relates to Technologies for future
operations (via patents) and Set
of products/services
Be the technology leader
IBM workstations
Offer many products
Dell computers
Offer products for locals
Tatas Nano at $2500=100000 rupees
Production at Singur, West Bengal, India;
l x w x h=3.1 x 1.5 x 1.6 meters;
Top speed: 105km/hr;
Engine volume 623 cc;
Mileage 50 miles/gallon;
Annual sales target 200,000.
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Strategies
Marketing and sales strategy relates to positioning, pricing and
promotion of products/services
e.g. Never offer more than 40% discount
e.g. EDLP = every day low price
At Wal-Mart
e.g. Demand smoothing via coupons
BestBuy
Supply chain management strategy relates to procurement,
transportation, storage and delivery
e.g. Never use more than 1 supplier for every input
e.g. Never expedite orders just because they are late
e.g. Always use domestic suppliers within the sales season not in advance.
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Fitting the SC to the customer or vice versa?
Understand the customer Wishes
Understand the Capabilities of your SC
Match the Wishes with the Capabilities
Challenge: How to meet extensive Wishes
with limited Capabilities?
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Achieving Strategic Fit: Consistent SCM
and Competitive strategies
Fit SC to the customer
Understanding the Customer
Range of demand, pizza hut stable
Production lot size, seasonal products
Response time, organ transplantation
Service level, product availability
Product variety
Innovation
Accommodating
poor quality
Implied (Demand)
Uncertainty for SC
Implied trouble
for SC
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Contributors to Implied Demand Uncertainty
Low
High
Price Responsiveness
Customer Need
Implied Demand Uncertainty
Commodities
Detergent
Long lead time steel
Customized products
High Fashion Clothing
Emergency steel,
for maintenance/replacement
Short lead times, product variety,
distribution channel variety, high rate of innovation and
high customer service levels all increase
the Implied Demand Uncertainty
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Understanding the Supply Chain:
Cost-Responsiveness Tradeoff
High
Low
Low
High
Responsiveness (in time, high service level and product variety)
Cost in $
Efficiency frontier
Inefficient
Fix responsiveness
Impossible
Inefficiency Region
Why decreasing slope (concave) for the efficiency frontier?
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Achieving Strategic Fit: Wishes vs. Capabilities
Implied
uncertainty
spectrum
Responsive
(high cost)
supply chain
Efficient
(low cost)
supply chain
Certain
demand
Uncertain
demand
Responsivenes
spectrum
Lunch buffet
<Low margin>
Gourmet dinner
<High margin>
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Loosing the strategic fit: Webvan
Webvan started a merger with HomeGrocer in Sept 2000 and
completed in May 2001.
Declared bankruptcy in July 2001. Why?
Webvan was so behemoth that could deliver anything to anyone anywhere
that it lost sight of a more mundane task: pleasing grocery customers day
after day.
Short to midterm cash mismanagement. Venture capital of $1.2 B run out.
Merger costs: duplicated work force, integration of technology, realignment
of facilities.
Peapod has the same business model but more focused in terms of
service and locations. It actually survives with its parent company
Royal Aholds (Dutch Retailer) cash.
Delivers now at a fee of $6.95 within a day.
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Top 10 Retailers Reported in 2008 First 4
Source www.deloitte.com/dtt/cda/doc/content/dtt_2008globalpowersofretailing.pdf
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Top 10 Retailers Reported in 2008 First 5-10
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Big retailers Strategy
Wal-Mart: Efficiency
Target: More quality and service
Carrefour: International, ambiance
K-Mart: Confused.
Squeezed between Target and Wal-Mart
Reliance on coupon sales
Do coupons stabilize or destabilize a Supply chain?
K-Mart and Sears merged in November 2004.
Now called Sears Holdings.
K-Mart gets cash
Sears gets presence outside malls
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Other Factors
Multiple products in a SC. Multiple customers for a given product
Separate supply chains or Tailored supply chains
e.g. Barnes and Noble: Retailing and/or e-tailing
Product and/or customer classes
e.g. UTD library loans books for 6 months (2 weeks) to faculty (students)
Customer segmentation by pricing
Competitors: more, faster and global
UTD online programs compete globally
Product life cycle (shortening)
SCM strategy moves toward efficiency and low implied uncertainty as products age
e.g. Air travel is becoming more efficient
e.g. Southwest airlines lead the drive for efficiency
e.g. Airbus announced A380 accommodating 555-800 people on Jan 17, 2005.
e.g. Flat screen TV producer of AU Optronics of Taiwan was looking for ways to make its
SC more efficient in June 2004.
Replacement sales
Selling to replace broken units.
e.g. AC replacement is about 50% of the market.
Macroeconomic factors for visibility
Forecasting Home Depot sales from S&P 500 price index.
Positive correlation is detected.
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Achieving Strategic Fit over a Lifecycle
Responsive
(high cost)
supply chain
Efficient
(low cost)
supply chain
Certain
demand
Uncertain
demand
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Integration
Integration is the central theme in SCM
Building synergies by integrating business functions,
departments and companies
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Strategic Scope
Suppliers
Competitive
Strategy
Product Dev.
Strategy
Supply Chain
Strategy
Marketing
Strategy
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Supply Chain Drivers and Obstacles
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Drivers of Supply Chain Performance
Efficiency Responsiveness
Inventory Transportation Facilities
Information
Supply chain structure
Logistical
Drivers
How to achieve
Sourcing Pricing
Cross-
Functional
Drivers
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1. Inventory
Convenience: Cycle inventory
No customer buys eggs one by one
Unstable demand: Seasonal inventory
Bathing suits
Xmas toys and computer sales
Randomness: Safety inventory
20% more syllabi than the class size were available in the
first class
Compaqs loss in 95
Pipeline inventory
Work in process or transit
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Littles law
Long run averages = Expected values
I = R . T
I=Pipeline inventory;
R=output per time=throughput;
T=delay time=flow time
Flow time? Thruput? Pipeline (work in process) Inventory?
10/minute
Spend 1 minute
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2. Transportation
Air
Truck
Rail
Ship
Pipeline
Electronic
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3. Facilities
Production
Flexible vs. Dedicated
Flexibility costs
Production: Remember BMW: a sports car disguised as a sedan
Service: Can your instructor teach music as well as SCM?
Sports: A playmaker who shoots well is rare.
Inventory-like operations: Receiving, Prepackaging,
Storing, Picking, Packaging, Sorting, Accumulating,
Shipping
Job Lot Storage: Need more space. Reticle storage in fabs.
Crossdocking: Wal-Mart
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4. Information
Role in the supply chain
The connection between the various stages in the supply chain
Crucial to daily operation of each stage in a supply chain
E.g., production scheduling, inventory levels
Role in the competitive strategy
Allows supply chain to become more efficient and more
responsive at the same time (reduces the need for a trade-off)
Information technology
Andersen Windows
Wood window manufacturer, whose customers can choose from a library of
50,000 designs or create their own. Customer orders automatically sent to
the factory.
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Characteristics of the Good Information
Information Global
Scope
Coordinated
Decisions
Supply Chain
Success
Strategy Analytical Models $$$
Information
Accurate?
Accessible?
Up-to-date?
In the Correct form?
If not, database restricted ability. How difficult is it to import data into SAP?
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Quality of Information
Information drives the decisions:
Good information means good decisions
IT helps: MRP, ERP, SAP, EDI
Relevant information?
How to use information?
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Information Technology in a Supply
Chain: Legacy Systems
Supplier Customer Retailer Distributor Manufacturer
Strategic
Planning
Operational
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Information Technology in a Supply Chain:
ERP Systems
Strategic
Planning
Operational
ERP Potential
ERP
Potential
ERP
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Information Technology in a Supply Chain:
Analytical Applications
Strategic
Planning
Operational
Supplier
Apps
SCM
MES
Dem Plan
Transport execution &
WMS
APS
Transport & Inventory
Planning
CRM/SFA
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ERP Systems
Wider focus
Push (MRP) versus Pull (demand information transmitted
quickly throughout the supply chain)
Real-time information
Coordination and Information sharing
Transactional IT
Expensive and difficult to implement
About 25% of ERP installations are cancelled within a year
About 70% of ERP installations go over the budget
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IT Push
0
100
200
300
400
500
1965 1973 1981 1989 1997
IT investment($B)
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Supply Chain Software Push
See Top 100 under /articles.html
Source Kanakamedala,
Ramsdell, Srivatsan (2003).
McKinsey Quarterly, No 1.
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5. Sourcing
Set of processes required to purchase goods and services in a supply chain
Supplier selection, single vs. multiple suppliers, contract negotiation
Sourcing is crucial. It affects efficiency and responsiveness in a supply chain
In-house vs. outsource decisions- improving efficiency and responsiveness
TI: More than half of the revenue spent for sourcing.
Cisco sources: Low-end products (e.g. home routers) from China.
Components of sourcing decisions
In-house versus outsource decisions
Supplier evaluation and selection
Procurement process:
Every department of a firm buy from suppliers independently, or all together.
EDS to reduce the number of officers with purchasing authorization.
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6. Pricing
Pricing determines the amount to charge customers in a supply chain
Pricing strategies can be used to match demand and supply
Price elasticity: Do you know yours?
Use pricing strategies to improve efficiency and responsiveness
Low price and low product availability; vary prices by response times
Amazon: Faster delivery is more expensive
Components of pricing decisions
Pricing and economies of scale
Everyday low pricing versus high-low pricing
Fixed price versus menu pricing, depending on the product and services
Packaging, delivery location, time, customer pick up
Bundling products; products and services
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Considerations for Supply Chain Drivers
Driver Efficiency Responsiveness
Inventory Cost of holding Availability
Transportation Consolidation Speed
Facilities Consolidation /
Dedicated
Proximity /
Flexibility
Information Low cost/slow/no
duplication
High cost/
streamlined/reliable
Sourcing Low cost sources Responsive sources
Pricing Constant price Low-high price
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Major Obstacles to Achieving Fit
SC is big:
Variety of products/services
Spoiled customer
Multiple owners (Procurement, Production, Inventory,
Marketing) / multiple objectives
Globalization
Local optimization and lack of global fit
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Dealing with Multiple Owners / Local Optimization
Information Coordination
Information sharing / Shyness / Legal and ethical issues
Contractual Coordination
Mechanisms to align local objectives with global ones
Coordination with (real) options
Rare in the practice
Without coordination, misleading reliance on metrics:
Average safety inventory, Average incoming shipment size, Average
purchase price of raw materials, Revenue
Major Obstacles to Achieving Fit
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Major obstacles to achieving fit
Instability and Randomness:
Increasing product variety
Shrinking product life cycles
Customer fragmentation: Push for customization, segmentation
Fragmentation of Supply Chain ownership: Globalization
Increasing implied uncertainty
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Common problems
Lack of relevant SCM metrics: How to measure
responsiveness?
How to measure efficiency, costs, worker performance, etc?
Poor inventory status information
Theft: Major problem for furniture retailers.
Transaction errors: Retailers with inaccurate inventory records
for 65% of SKUs
Information delays, dated information, incompatible info. systems
Misplaced inventory: 16% of items cannot be found at a major retailer
Spoilage: active ingredients in the products are losing their properties
Product quality and yield
Lack of visibility in SCs
Do you know the inventory your distribution centers hold?
Do you know the inventory your fellow retailer holds?
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Common problems
Poor delivery status information
Not knowing the order status
Poor IT design
Unreliable, duplicate data
Security problems: too much or too little
Ignoring uncertainties
The flight from uncertainty and ambiguity is so motivated that we often
create pseudocertainty.
Nitin Nohra, HBR February 2006 issue, p.40.
Internal customer discrimination
Giving lower priority to internal customers than external customers
Poor integration
Elusive inventory costs
Accounting systems do not capture opportunity costs
SC-insensitive product design
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Summary
Supply Chain Introduction
Competitiveness / Business strategy / SCM strategy
Components
Inventory, Transportation, Facilities, Information, Sourcing, Pricing
Challenges
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Seven Eleven Japan (SEJ)
A Case Study
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Factual Information on Seven Eleven Japan (SEJ)
Largest convenience store in Japan with market value of $95 B. The third largest
retail company in the world after Wal-Mart and Home Depot.
Established in 1974.
In 2000, total sales $18,000 M, profit $620 M.
Average inventory turnover time 7-8.5 days.
Stock value increased by 3000 times from 1974 to 2000.
In 1985, there were 2000 stores in Japan, increasing by 400-500 per year.
Return on equity 14% over 2000-2004.
A SEJ store is about the half the size of a US 7-eleven store,
that is about 110 m
2
.
Sales:
Products
32.9% Processed food: drinks, noodles, bread and snacks
31.6% Fast food: rice ball, box lunch and hamburgers
12.0% Fresh food: diary products
25.3% Non-food: magazines, ladies stockings and batteries.
Services: Utility bill paying, installment payments for credit companies, ATMs, photocopying
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More on SEJ
More factual info:
Average sales about twice of an average US store
SKUs offered in store: Over 3,000 (change by time of day, day of week, season)
Virtually no storage space
No food cooking at the stores
Japanese Images of Seven Eleven:
Convenient
Cheerful and lively stores
Many ready made dinner items I buy
Famous for its great boxed lunch and dinner
- On weekends, when I was single, I went to buy lunch and dinner
SC strategy:
Micro matching of supply and demand (by location, time of day, day of week, season)
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Seven Eleven - Number of Stores
0
1000
2000
3000
4000
5000
6000
85 86 87 88 89 90 91 92 93 94
Number of Stores
1999: 8,027
2004: 10,356
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Seven Eleven - Net Sales (B Yen)
Sales 1,963 B Yen in 2000
0
200
400
600
800
1000
1200
1400
85 86 87 88 89 90 91 92 93 94
Net Sales
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Seven Eleven - Pre tax Profit (B Yen)
0
10
20
30
40
50
60
70
80
90
100
85 86 87 88 89 90 91 92 93 94
Profit
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Seven Eleven - Inventory turnover (days)
0
2
4
6
8
10
12
14
85 86 87 88 89 90 91 92 93 94
Inventory
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Information Strategy
Quick access to up to date information (as opposed to data):
In 1991, SEJ implemented Integrated Service Digital Network to link stores, headquarter,
DCs and suppliers
Customer checkout process
Clerk records the customers gender, (estimated) age and purchased items. These Point of Sales
(POS) data are transmitted to database at the headquarters.
Store hardware: Store computer, POS registers linked to store computer, Graphic Order
Terminals, Scanner terminals for receiving
Daily use of the data
Headquarters aggregate the data by region, products and time and pass to suppliers and stores by
next morning. Store managers deduce trend information.
Weekly use of the data
Monday morning, the CEO chairs a weekly strategy formulation meeting attended by 100
corporate managers.
Tuesday morning, strategies are communicated to Operation Field Counselors who arrive in
Tokyo on Monday night.
Tuesday afternoon, regional elements (e.g. weather, sport events) are factored into the strategy.
Tuesday nights, field counselors return back to their regions.
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Information Analysis of POS Data
Analysis of
Sales for product categories over time
SKU (stock keeping unit)
Waste or disposal
10 day (or week) sales trend by SKU
Sales trends for new product
In the early 1990s, half-prepared fresh noodle sales were going up,
new fresh noodle products were quickly developed
Sales trend by time and day
Different sales patterns for different sizes of milk at different times of the day results in
rearrangement of the milks in the fridge. Extreme store micromanagement.
Let us speculate: Flavored milks are put in front of the pure milks in the evening (or the morning?).
List of slow moving items
About half of 3000 SKUs are replaced by new ones every year
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Facilities Strategy
Limited storage space at stores which have only 125-150 m
2
space
Frequent and small deliveries to stores
Deliveries arrive from over 200 plants.
Products are grouped by the cooling needs
Combined delivery system: frozen foods, chilled foods, room temperature and hot foods.
Such product groups are cross-docked at distribution centers (DC). Food DCs store no
inventory.
A single truck brings a group of products and visits several stores within a geographical region
Aggregation: No supplier (not even coke!) delivers direct
The number of truck deliveries per day is reduced by a factor of 7 from 1974 to 2000.
Still, at least 3 fresh food deliveries per day. Goods are received faster with the use of
scanners.
Have many outlets, at convenient locations, close to where customers can walk
Focus on some territories, not all: When they locate in a place they blanket (a.k.a.
clustering) the area with stores; stores open in clusters with corresponding DCs.
844 stores in the Tokyo region; Seven Eleven had stores in 32 out of 47 prefectures in 2004. No
stores in Kobe.
Success rate of franchise application <= 1/100
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The Present and the Future
Is food preparation a good idea at 7-eleven locations?
e.g. Compare microwave heating vs. salad preparation.
Why SEJ does not allow direct delivery from suppliers to retailers?
Point out which of the following strategies can also be used in US (or Taiwan)
Information strategy
Facilities strategy
Discuss the differences between the Japanese and US (or Taiwanese) consumers with
regard to
Frequency and amount of grocery purchase
Use of credit cards vs. cash for purchase
7-eleven inventory turnover rate is 50 in Japan and 19 in the USA.
7-eleven growing rapidly in the US so it aims to be a web depot in both the US and Japan.
Does this make sense from a supply chain perspective?
Cost vs. Responsiveness
Business strategy
What is the risk of micro-matching strategy?
No direct deliveries to SEJ, what is the potential risk of this strategy if used in the USA?
75
utdallas.edu/~metin
Deloitte 2008 Global Retailers Survey
Excerpts from
www.deloitte.com/dtt/cda/doc/content/dtt_2008globalpowersofretailing.pdf
Downloaded on Jan 30, 2008.
Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.
8-1
Chapter 8
Aggregate
Planning
in the Supply
Chain
8-2
Outline
Role of aggregate planning in a supply chain
The aggregate planning problem
Aggregate planning strategies
Implementing aggregate planning in practice
8-3
Role of Aggregate Planning
in a Supply Chain
Capacity has a cost, lead times are greater than zero
Aggregate planning:
process by which a company determines levels of capacity,
production, subcontracting, inventory, stockouts, and pricing
over a specified time horizon
goal is to maximize profit
decisions made at a product family (not SKU) level
time frame of 3 to 18 months
how can a firm best use the facilities it has?
8-4
in a Supply Chain
Specify operational parameters over the time horizon:
production rate
workforce
overtime
machine capacity level
subcontracting
backlog
inventory on hand
All supply chain stages should work together on an
aggregate plan that will optimize supply chain
performance
8-5
The Aggregate Planning Problem
Given the demand forecast for each period in the
planning horizon, determine the production level,
inventory level, and the capacity level for each period
that maximizes the firms (supply chains) profit over
the planning horizon
Specify the planning horizon (typically 3-18 months)
Specify the duration of each period
Specify key information required to develop an
aggregate plan
8-6
Information Needed for
an Aggregate Plan
Demand forecast in each period
Production costs
labor costs, regular time ($/hr) and overtime ($/hr)
subcontracting costs ($/hr or $/unit)
cost of changing capacity: hiring or layoff ($/worker) and
cost of adding or reducing machine capacity ($/machine)
Labor/machine hours required per unit
Inventory holding cost ($/unit/period)
Stockout or backlog cost ($/unit/period)
Constraints: limits on overtime, layoffs, capital
available, stockouts and backlogs
8-7
Outputs of Aggregate Plan
Production quantity from regular time, overtime, and
subcontracted time: used to determine number of
workers and supplier purchase levels
Inventory held: used to determine how much warehouse
space and working capital is needed
Backlog/stockout quantity: used to determine what
customer service levels will be
Machine capacity increase/decrease: used to determine
if new production equipment needs to be purchased
A poor aggregate plan can result in lost sales, lost
profits, excess inventory, or excess capacity
8-8
Aggregate Planning Strategies
Trade-off between capacity, inventory,
backlog/lost sales
Chase strategy using capacity as the lever
Time flexibility from workforce or capacity
strategy using utilization as the lever
Level strategy using inventory as the lever
Mixed strategy a combination of one or more of
the first three strategies
8-9
Chase Strategy
Production rate is synchronized with demand by
varying machine capacity or hiring and laying off
workers as the demand rate varies
However, in practice, it is often difficult to vary
capacity and workforce on short notice
Expensive if cost of varying capacity is high
Negative effect on workforce morale
Results in low levels of inventory
Should be used when inventory holding costs are high
and costs of changing capacity are low
8-10
Time Flexibility Strategy
Can be used if there is excess machine capacity
Workforce is kept stable, but the number of hours
worked is varied over time to synchronize production
and demand
Can use overtime or a flexible work schedule
Requires flexible workforce, but avoids morale
problems of the chase strategy
Low levels of inventory, lower utilization
Should be used when inventory holding costs are
high and capacity is relatively inexpensive
8-11
Level Strategy
Maintain stable machine capacity and workforce
levels with a constant output rate
Shortages and surpluses result in fluctuations in
inventory levels over time
Inventories that are built up in anticipation of future
demand or backlogs are carried over from high to low
demand periods
Better for worker morale
Large inventories and backlogs may accumulate
Should be used when inventory holding and backlog
costs are relatively low
8-12
Fundamental Tradeoffs in
Aggregate Planning
Capacity (regular time, overtime, subcontract)
Inventory
Backlog / lost sales
Basic Strategies
Chase strategy
Time flexibility from workforce or capacity
Level strategy
8-13
Aggregate Planning at
Red Tomato Tools
Month Demand Forecast
January 1,600
February 3,000
March 3,200
April 3,800
May 2,200
June 2,200
8-14
Aggregate Planning at Red
Tomato Tools
Item Cost
Materials $10/unit
Inventory holding cost $2/unit/month
Marginal cost of a stockout $5/unit/month
Hiring and training costs $300/worker
Layoff cost $500/worker
Labor hours required 4/unit
Regular time cost $4/hour
Over time cost $6/hour
Cost of subcontracting $30/unit
8-15
Aggregate Planning at Red Tomato Tools
(Define Decision Variables)
W
t
= Workforce size for month t, t = 1, ..., 6
H
t
= Number of employees hired at the beginning of month t,
t = 1, ..., 6
L
t
= Number of employees laid off at the beginning of month t,
t = 1, ..., 6
P
t
= Production in month t, t = 1, ..., 6
I
t
= Inventory at the end of month t, t = 1, ..., 6
S
t
= Number of units stocked out at the end of month t,
t = 1, ..., 6
C
t
= Number of units subcontracted for month t, t = 1, ..., 6
O
t
= Number of overtime hours worked in month t, t = 1, ..., 6
8-16
(Define Objective Function)

6
1
6
1
6
1
6
1
6
1
6
1
6
1
6
1
30 10 5
2 6 500
300 640
t
t
t
t
t
t
t
t
t
t
t
t
t
t
t
t
C P S
I O L
H W
Min
8-17
Aggregate Planning at Red Tomato tools
(Define Constraints Linking Variables)
Workforce size for each month is based on hiring
and layoffs
. 80 , 6 ,..., 1
0
,
0
1
1

W where t for
L H W W
or
L H W W
t t t t
t t t t
8-18
(Constraints)
Production for each month cannot exceed capacity
. 6 ,..., 1
, 0 4 40
, 4 40

t for
P O W
O W P
t t t
t t t
8-19
(Constraints)
Inventory balance for each month
. 500 , 0
, 000 , 1 , 6 ,..., 1
, 0
,
6 0
0
1 1
1 1

I
and
S
I
where t for
S I S D C P I
S I S D C P I
t t t t t t t
t t t t t t t
8-20
(Constraints)
Over time for each month
. 6 ,..., 1
, 0 10
, 10
t for
O W
W O
t t
t t
8-21
Scenarios
Increase in holding cost (from $2 to $6)
Overtime cost drops to $4.1 per hour
Increased demand fluctuation
8-22
Increased Demand Fluctuation
January 1,000
February 3,000
March 3,800
April 4,800
May 2,000
June 1,400
8-23
Aggregate Planning in Practice
Think beyond the enterprise to the entire supply chain
Make plans flexible because forecasts are always
wrong
Rerun the aggregate plan as new information emerges
Use aggregate planning as capacity utilization
increases
Aggregate Planning in Excel
Construct a table with the decision variables
Construct a table for constraints
Create a cell containing the objective function
Use Data Analysis Solver
8-24
INVENTORY PLANNING AND ECONOMIC
THEORY -ABERRATIONS
Available evidence indicates that Indian industries,
by and large do not show any serious concern for
inventory ordering and carrying costs. What are the
main reasons for their indifference to scientific
inventory management techniques?
What adaptations of Just In Time (JIT) practices do
you visualize emerging in the Indian environment in
the near future?
8-26
Summary of Learning Objectives
What types of decisions are best solved by aggregate
planning?
What is the importance of aggregate planning as a
supply chain activity?
What kinds of information are needed to produce an
aggregate plan?
What are the basic trade-offs a manager makes to
produce an aggregate plan?
How are aggregate planning problems formulated and
solved using Microsoft Excel?
Chapter 7
Demand
Forecasting
in a Supply
Chain
7-1
7-2
Outline
The role of forecasting in a supply chain
Characteristics of forecasts
Components of forecasts and forecasting methods
Basic approach to demand forecasting
Time series forecasting methods
Measures of forecast error
Forecasting demand at Tahoe Salt
Forecasting in practice
7-3
Role of Forecasting
in a Supply Chain
The basis for all strategic and planning decisions
in a supply chain
Used for both push and pull processes
Examples:
Production: scheduling, inventory, aggregate planning
Marketing: sales force allocation, promotions, new
production introduction
Finance: plant/equipment investment, budgetary
planning
Personnel: workforce planning, hiring, layoffs
All of these decisions are interrelated
7-4
Characteristics of Forecasts
Forecasts are always wrong. Should include
expected value and measure of error.
Long-term forecasts are less accurate than short-
term forecasts (forecast horizon is important)
Aggregate forecasts are more accurate than
disaggregate forecasts
7-5
Forecasting Methods
Qualitative: primarily subjective; rely on
judgment and opinion
Time Series: use historical demand only
Static
Adaptive
Causal: use the relationship between demand and
some other factor to develop forecast
Simulation
Imitate consumer choices that give rise to demand
Can combine time series and causal methods
7-6
Components of an Observation
Observed demand (O) =
Systematic component (S) + Random component (R)
Level (current deseasonalized demand)
Trend (growth or decline in demand)
Seasonality (predictable seasonal fluctuation)
Systematic component: Expected value of demand
Random component: The part of the forecast that deviates
from the systematic component
Forecast error: difference between forecast and actual demand
7-7
Time Series Forecasting
Quarter Demand D
t
II, 2006 8000
III, 2006 13000
IV, 2006 23000
I, 2007 34000
II, 2007 10000
III, 2007 18000
IV, 2007 23000
I, 2008 38000
II, 2008 12000
III, 2008 13000
IV, 2008 32000
I, 2009 41000
Forecast demand for the
next four quarters.
7-8
0
20,000
40,000
60,000
7-9
Forecasting Methods
Static
Adaptive
Moving average
Simple exponential smoothing
Holts model (with trend)
Winters model (with trend and seasonality)
7-10
Basic Approach to
Demand Forecasting
Understand the objectives of forecasting
Integrate demand planning and forecasting
Identify major factors that influence the demand
forecast
Understand and identify customer segments
Determine the appropriate forecasting technique
Establish performance and error measures for the
forecast
7-11
Time Series
Forecasting Methods
Goal is to predict systematic component of demand
Multiplicative: (level)(trend)(seasonal factor)
Additive: level + trend + seasonal factor
Mixed: (level + trend)(seasonal factor)
Static methods
Adaptive forecasting
7-12
Static Methods
Assume a mixed model:
Systematic component = (level + trend)(seasonal factor)
F
t+l
= [L + (t + l)T]S
t+l
= forecast in period t for demand in period t + l
L = estimate of level for period 0
T = estimate of trend
S
t
= estimate of seasonal factor for period t
D
t
= actual demand in period t
F
t
= forecast of demand in period t
7-13
Static Methods
Estimating level and trend
Estimating seasonal factors
7-14
Estimating Level and Trend
Before estimating level and trend, demand data
must be deseasonalized
Deseasonalized demand = demand that would
have been observed in the absence of seasonal
fluctuations
Periodicity (p)
the number of periods after which the seasonal cycle
repeats itself
for demand at Tahoe Salt (Table 7.1, Figure 7.1) p = 4
7-15
(Table 7.1)
Quarter, Year Demand D
t
II, 1 8000
III, 1 13000
IV, 1 23000
I, 2 34000
II, 2 10000
III, 2 18000
IV, 2 23000
I, 3 38000
II, 3 12000
III, 3 13000
IV, 3 32000
I, 4 41000
Forecast demand for the
next four quarters.
7-16
(Figure 7.1)
0
10,000
20,000
30,000
40,000
50,000
7-17
Estimating Level and Trend
Before estimating level and trend, demand data
must be deseasonalized
Deseasonalized demand = demand that would
have been observed in the absence of seasonal
fluctuations
Periodicity (p)
the number of periods after which the seasonal cycle
repeats itself
for demand at Tahoe Salt (Table 7.1, Figure 7.1) p = 4
7-18
Deseasonalizing Demand
[D
t-(p/2)
+ D
t+(p/2)
+ 2D
i
] / 2p for p even
D
t
= (sum is from i = t+1-(p/2) to t+1+(p/2))
D
i
/ p for p odd
(sum is from i = t-(p/2) to t+(p/2)), p/2 truncated to lower integer
7-19
For the example, p = 4 is even
For t = 3:
D3 = {D1 + D5 + Sum(i=2 to 4) [2Di]}/8
= {8000+10000+[(2)(13000)+(2)(23000)+(2)(34000)]}/8
= 19750
D4 = {D2 + D6 + Sum(i=3 to 5) [2Di]}/8
= {13000+18000+[(2)(23000)+(2)(34000)+(2)(10000)]/8
= 20625
7-20
Then include trend
D
t
= L + tT
where D
t
= deseasonalized demand in period t
L = level (deseasonalized demand at period 0)
T = trend (rate of growth of deseasonalized demand)
Trend is determined by linear regression using
deseasonalized demand as the dependent variable and
period as the independent variable (can be done in
Excel)
In the example, L = 18,439 and T = 524
7-21
Time Series of Demand
(Figure 7.3)
0
10000
20000
30000
40000
50000
1 2 3 4 5 6 7 8 9 10 11 12
Period
D
e
m
a
n
d
Dt
Dt-bar
7-22
Estimating Seasonal Factors
Use the previous equation to calculate deseasonalized
demand for each period
S
t
= D
t
/ D
t
= seasonal factor for period t
In the example,
D
2
= 18439 + (524)(2) = 19487 D
2
= 13000
S
2
= 13000/19487 = 0.67
The seasonal factors for the other periods are
calculated in the same manner
7-23
(Fig. 7.4)
t Dt Dt-bar S-bar
1 8000 18963 0.42 = 8000/18963
2 13000 19487 0.67 = 13000/19487
3 23000 20011 1.15 = 23000/20011
4 34000 20535 1.66 = 34000/20535
5 10000 21059 0.47 = 10000/21059
6 18000 21583 0.83 = 18000/21583
7 23000 22107 1.04 = 23000/22107
8 38000 22631 1.68 = 38000/22631
9 12000 23155 0.52 = 12000/23155
10 13000 23679 0.55 = 13000/23679
11 32000 24203 1.32 = 32000/24203
12 41000 24727 1.66 = 41000/24727
7-24
The overall seasonal factor for a season is then obtained
by averaging all of the factors for a season
If there are r seasonal cycles, for all periods of the form
pt+i, 1<i<p, the seasonal factor for season i is
S
i
= [Sum
(j=0 to r-1)
S
jp+i
]/
r
In the example, there are 3 seasonal cycles in the data and
p=4, so
S1 = (0.42+0.47+0.52)/3 = 0.47
S2 = (0.67+0.83+0.55)/3 = 0.68
S3 = (1.15+1.04+1.32)/3 = 1.17
S4 = (1.66+1.68+1.66)/3 = 1.67
7-25
Estimating the Forecast
Using the original equation, we can forecast the next
four periods of demand:
F13 = (L+13T)S1 = [18439+(13)(524)](0.47) = 11,868
F14 = (L+14T)S2 = [18439+(14)(524)](0.68) = 17,527
F15 = (L+15T)S3 = [18439+(15)(524)](1.17) = 30,770
F16 = (L+16T)S4 = [18439+(16)(524)](1.67) = 44,794
7-26
Adaptive Forecasting
The estimates of level, trend, and seasonality are
adjusted after each demand observation
General steps in adaptive forecasting
Moving average
Trend-corrected exponential smoothing (Holts
model)
Trend- and seasonality-corrected exponential
smoothing (Winters model)
7-27
Basic Formula for
F
t+1
= (L
t
+ lT)S
t+1
= forecast for period t+l in period t
L
t
= Estimate of level at the end of period t
T
t
= Estimate of trend at the end of period t
S
t
= Estimate of seasonal factor for period t
F
t
= Forecast of demand for period t (made period t-1 or
earlier)
D
t
= Actual demand observed in period t
E
t
= Forecast error in period t
A
t
= Absolute deviation for period t = |E
t
|
MAD = Mean Absolute Deviation = average value of A
t
7-28
General Steps in
Initialize: Compute initial estimates of level (L
0
), trend
(T
0
), and seasonal factors (S
1
,,S
p
). This is done as
in static forecasting.
Forecast: Forecast demand for period t+1 using the
general equation
Estimate error: Compute error E
t+1
= F
t+1
- D
t+1
Modify estimates: Modify the estimates of level (L
t+1
),
trend (T
t+1
), and seasonal factor (S
t+p+1
), given the
error E
t+1
in the forecast
Repeat steps 2, 3, and 4 for each subsequent period
7-29
Moving Average
Used when demand has no observable trend or seasonality
Systematic component of demand = level
The level in period t is the average demand over the last N
periods (the N-period moving average)
Current forecast for all future periods is the same and is based
on the current estimate of the level
L
t
= (D
t
+ D
t-1
+ + D
t-N+1
) / N
F
t+1
= L
t
and F
t+n
= L
t
After observing the demand for period t+1, revise the
estimates as follows:
L
t+1
= (D
t+1
+ D
t
+ + D
t-N+2
) / N
F
t+2
= L
t+1
7-30
Moving Average Example
From Tahoe Salt example (Table 7.1)
At the end of period 4, what is the forecast demand for periods 5
through 8 using a 4-period moving average?
L4 = (D4+D3+D2+D1)/4 = (34000+23000+13000+8000)/4 = 19500
F5 = 19500 = F6 = F7 = F8
Observe demand in period 5 to be D5 = 10000
Forecast error in period 5, E5 = F5 - D5 = 19500 - 10000 = 9500
Revise estimate of level in period 5:
L5 = (D5+D4+D3+D2)/4 = (10000+34000+23000+13000)/4 =
20000
F6 = L5 = 20000
7-31
Simple Exponential Smoothing
Used when demand has no observable trend or seasonality
Systematic component of demand = level
Initial estimate of level, L
0
, assumed to be the average of all
historical data
L
0
= [Sum(
i=1 to n
)D
i
]/n
Current forecast for all future periods is equal to the current
estimate of the level and is given as follows:
F
t+1
= L
t
and F
t+n
= L
t
After observing demand Dt+1, revise the estimate of the level:
L
t+1
= D
t+1
+ (1-)L
t
L
t+1
= Sum
(n=0 to t+1)
[(1-)
n
D
t+1-n
]
7-32
Simple Exponential Smoothing
Example
From Tahoe Salt data, forecast demand for period 1 using
exponential smoothing
L
0
= average of all 12 periods of data
= Sum
(i=1 to 12)
[D
i
]/12 = 22083
F1 = L0 = 22083
Observed demand for period 1 = D1 = 8000
Forecast error for period 1, E1, is as follows:
E1 = F1 - D1 = 22083 - 8000 = 14083
Assuming = 0.1, revised estimate of level for period 1:
L1 = D1 + (1-)L0 = (0.1)(8000) + (0.9)(22083) = 20675
F2 = L1 = 20675
Note that the estimate of level for period 1 is lower than in period 0
7-33
Trend-Corrected Exponential
Smoothing (Holts Model)
Appropriate when the demand is assumed to have a level and
trend in the systematic component of demand but no seasonality
Obtain initial estimate of level and trend by running a linear
regression of the following form:
D
t
= at + b
T
0
= a
L
0
= b
In period t, the forecast for future periods is expressed as follows:
F
t+1
= L
t
+ T
t
F
t+n
= L
t
+ nT
t
7-34
Trend-Corrected Exponential
Smoothing (Holts Model)
After observing demand for period t, revise the estimates for level
and trend as follows:
L
t+1
= D
t+1
+ (1-)(L
t
+ T
t
)
T
t+1
= (L
t+1
- L
t
) + (1-)T
t
= smoothing constant for level
= smoothing constant for trend
Example: Tahoe Salt demand data. Forecast demand for period 1
using Holts model (trend corrected exponential smoothing)
Using linear regression,
L
0
= 12015 (linear intercept)
T
0
= 1549 (linear slope)
7-35
Holts Model Example (continued)
Forecast for period 1:
F1 = L0 + T0 = 12015 + 1549 = 13564
Observed demand for period 1 = D1 = 8000
E1 = F1 - D1 = 13564 - 8000 = 5564
Assume = 0.1, = 0.2
L1 = D1 + (1-)(L0+T0) = (0.1)(8000) + (0.9)(13564) = 13008
T1 = (L1 - L0) + (1-)T0 = (0.2)(13008 - 12015) + (0.8)(1549)
= 1438
F2 = L1 + T1 = 13008 + 1438 = 14446
F5 = L1 + 4T1 = 13008 + (4)(1438) = 18760
7-36
Trend- and Seasonality-Corrected
Exponential Smoothing
Appropriate when the systematic component of
demand is assumed to have a level, trend, and seasonal
factor
Systematic component = (level+trend)(seasonal factor)
Assume periodicity p
Obtain initial estimates of level (L
0
), trend (T
0
),
seasonal factors (S
1
,,S
p
) using procedure for static
forecasting
In period t, the forecast for future periods is given by:
F
t+1
= (L
t
+T
t
)(S
t+1
) and F
t+n
= (L
t
+ nT
t
)S
t+n
7-37
Exponential Smoothing (continued)
After observing demand for period t+1, revise estimates for level,
trend, and seasonal factors as follows:
L
t+1
= (D
t+1
/S
t+1
) + (1-)(L
t
+T
t
)
T
t+1
= (L
t+1
- L
t
) + (1-)T
t
S
t+p+1
= (D
t+1
/L
t+1
) + (1-)S
t+1
= smoothing constant for level
= smoothing constant for trend
= smoothing constant for seasonal factor
Example: Tahoe Salt data. Forecast demand for period 1 using
Winters model.
Initial estimates of level, trend, and seasonal factors are obtained
as in the static forecasting case
7-38
Exponential Smoothing Example (continued)
L
0
= 18439 T
0
= 524 S
1
=0.47, S
2
=0.68, S
3
=1.17, S
4
=1.67
F1 = (L0 + T0)S1 = (18439+524)(0.47) = 8913
The observed demand for period 1 = D1 = 8000
Forecast error for period 1 = E1 = F1-D1 = 8913 - 8000 = 913
Assume = 0.1, =0.2, =0.1; revise estimates for level and trend
for period 1 and for seasonal factor for period 5
L1 = (D1/S1)+(1-)(L0+T0) = (0.1)(8000/0.47)+(0.9)(18439+524)=18769
T1 = (L1-L0)+(1-)T0 = (0.2)(18769-18439)+(0.8)(524) = 485
S5 = (D1/L1)+(1-)S1 = (0.1)(8000/18769)+(0.9)(0.47) = 0.47
F2 = (L1+T1)S2 = (18769 + 485)(0.68) = 13093
7-39
Measures of Forecast Error
Forecast error = E
t
= F
t
- D
t
Mean squared error (MSE)
MSE
n
= (Sum
(t=1 to n)
[E
t
2
])/n
Absolute deviation = A
t
= |E
t
|
Mean absolute deviation (MAD)
MAD
n
= (Sum
(t=1 to n)
[A
t
])/n
= 1.25MAD
7-40
Measures of Forecast Error
Mean absolute percentage error (MAPE)
MAPE
n
= (Sum
(t=1 to n)
[|E
t
/ D
t
|100])/n
Bias shows whether the forecast consistently under- or
overestimates demand; should fluctuate around 0
bias
n
= Sum
(t=1 to n)
[E
t
]
Tracking signal should be within the range of +6,
otherwise, possibly use a new forecasting method
TS
t
= bias / MAD
t
7-41
Forecasting Demand at Tahoe Salt
Moving average
Trend-corrected exponential smoothing
Trend- and seasonality-corrected exponential
smoothing
7-42
Forecasting in Practice
Collaborate in building forecasts
The value of data depends on where you are in the
supply chain
Be sure to distinguish between demand and sales
7-43
What are the roles of forecasting for an enterprise and
a supply chain?
What are the components of a demand forecast?
How is demand forecast given historical data using
time series methodologies?
How is a demand forecast analyzed to estimate
forecast error?
Chapter 5
Network
Design in the
Supply Chain
5-1
Outline
The Role of Network Design in the Supply Chain
Factors Influencing Network Design Decisions
Framework for Network Design Decisions
Models for Facility Location and Capacity
Allocation
The Role of IT in Network Design
Making Network Design Decisions in Practice
5-2
Network Design Decisions
Facility role
Facility location
Capacity allocation
Market and supply allocation
5-3
Factors Influencing
Strategic
Technological
Macroeconomic
Political
Infrastructure
Competitive
Logistics and facility costs
5-4
The Cost-Response Time Frontier
Local FG
Mix
Regional FG
Local WIP
Central FG
Central WIP
Central Raw Material and Custom production
Custom production with raw material at suppliers
Cost
Response Time
Hi Low
Low
Hi
5-5
Service and Number of Facilities
Number of Facilities
Response
Time
5-6
Costs and Number of Facilities
Costs
Number of facilities
Inventory
Transportation
Facility costs
5-7
Percent Service
Level Within
Promised Time
Transportation
Cost Buildup as a Function of Facilities
C
o
s
t

o
f

O
p
e
r
a
t
i
o
n
s
Inventory
Facilities
Total Costs
Labor
5-8
Framework for Network Design
Decisions
Phase I Supply Chain Strategy
Phase II Regional Facility Configuration
Phase III Desirable Sites
Phase IV Location Choices
5-9
A Framework for
PHASE I
Supply Chain
Strategy
PHASE II
Regional Facility
Configuration
PHASE III
Desirable Sites
PHASE IV
Location Choices
Competitive STRATEGY
INTERNAL CONSTRAINTS
Capital, growth strategy,
existing network
PRODUCTION TECHNOLOGIES
Cost, Scale/Scope impact, support
required, flexibility
COMPETITIVE
ENVIRONMENT
PRODUCTION METHODS
Skill needs, response time
FACTOR COSTS
Labor, materials, site specific
GLOBAL COMPETITION
TARIFFS AND TAX
INCENTIVES
REGIONAL DEMAND
Size, growth, homogeneity,
local specifications
POLITICAL, EXCHANGE
RATE AND DEMAND RISK
AVAILABLE
INFRASTRUCTURE
LOGISTICS COSTS
Transport, inventory, coordination
5-10
Conventional Network
Customer
Store
Materials
DC
Component
Manufacturing
Vendor
DC
Final
Assembly
Finished
Goods DC
Components
DC
Vendor
DC Plant
Warehouse
Finished
Goods DC
Customer
DC
Customer
DC
Customer
DC
Customer
Store
Customer
Store
Customer
Store
Customer
Store
Vendor
DC
5-11
Tailored Network: Multi-Echelon
Finished Goods Network
Regional
Finished
Goods DC
Regional
Finished
Goods DC
Customer 1
DC
Store 1
National
Finished
Goods DC
Local DC
Cross-Dock
Local DC
Cross-Dock
Local DC
Cross-Dock
Customer 2
DC
Store 1
Store 2
Store 2
Store 3
Store 3
5-12
Gravity Methods for Location
Ton Mile-Center Solution
x,y: Warehouse Coordinates
x
n
, y
n
: Coordinates of delivery
location n
d
n
: Distance to delivery
location n
F
n
: Annual tonnage to delivery
location n

k
n n
n
k
n n
n
n
k
n n
n
k
n n
n
n
n
d
F
D
d
F
y
D
d
F
D
d
F
x
D
y y
x
x
d
n
n
y
n
n
x
n
n
1
1
1
1
2
2
) (
) (
Min

F
D d
n n
n
5-13
Models for Facility Location and
Capacity Allocation
Phase II
Capacitated Plant location model
Phase III
Gravity location models
5-14
Network Optimization Models
Allocating demand to production facilities
Locating facilities and allocating capacity
Which plants to establish? How to configure the network?
Key Costs:
Fixed facility cost
Transportation cost
Production cost
Inventory cost
Coordination cost
5-15
Demand Allocation Model
Which market is served
by which plant?
Which supply sources
are used by a plant?
x
ij
= Quantity shipped from
plant site i to customer j
0
,..., 1 ,
,..., 1 ,
. .
1
1
1 1

x
K x
D x
x c
ij
i
m
j
ij
j
n
i
ij
n
i
m
j
ij ij
n i
m j
t s
Min
5-16
Plant Location with Multiple Sourcing
y
i
= 1 if plant is located
at site i, 0 otherwise
x
ij
= Quantity shipped
from plant site i to
customer j
} 1 , 0 { ;
,..., 1 ,
,..., 1 ,
. .
1
1
1
1 1 1

y y
y
K x
D x
x c
y f
i
m
i
i
i
i
n
j
ij
j
n
i
ij
n
i
m
j
ij ij
i
n
i
i
k
n i
m j
t s
Min
5-17
Plant Location with Single Sourcing
y
i
= 1 if plant is located
at site i, 0 otherwise
x
ij
= 1 if market j is
supplied by factory i, 0
otherwise
} 1 , 0 {
,..., 1 ,
,..., 1 , 1
. .
,
1
1
1 1 1

y
x
y
K
x
D
x
x
c
D
y f
ij
n i
j
m j
t s
j
Min
i
i
i
n
j
ij
n
i
ij
n
i
m
j
ij
ij
i
n
i
i
5-18
The Role of IT in Network Design
IT systems help with network design by:
1. Making the modeling of the network design
problems easier
2. Containing high-performance optimization
technologies
3. Allowing for what-if scenarios
4. Interfacing with planning and operational
software
5-19
Making Network Design Decisions In
Practice
Do not underestimate the life span of facilities
Do not gloss over the cultural implications
Do not ignore quality of life issues
Focus on tariffs and tax incentives when
locating facilities
5-20
SOCIO ECONOMIC FACTORS IN CHOICE OF
FACILITY LOCATION
What role do socio-economic factors play in
the selection of the facility location?
How do state policies aimed at promoting
balanced regional development, shape the
supply chain network designs?
JAIPUR RUGS
How has Jaipur Rugs knitted together the
traditional skills of widely dispersed rural
workforce, through innovative adaptation of
supply chain practices that best fit the Indian
socio economic conditions to bring quality
products to the international market and ensure
fair returns to the artisans?
What is the role of network design decisions in
the supply chain?
What are the factors influencing supply chain
network design decisions?
Describe a strategic framework for facility
location.
How are the following optimization methods used
for facility location and capacity allocation
decisions?
Gravity methods for location
Network optimization models
5-23
6-1
Chapter 6
Designing
Global Supply
Chain Networks
6-2
Outline
The Impact of Globalization on Supply Chain Networks
The Offshoring Decision: Total Cost
Risk Management in Global Supply Chains
The Basic Aspects of Evaluating Global Supply Chain
Design
Evaluating Network Design Decisions Using Decision
Trees
AM Tires: Evaluation of Global Supply Chain Decisions
Under Uncertainty in Practice
6-3
The Impact of Globalization on
Supply Chain Networks
Globalization offers companies opportunities to
simultaneously grow revenues and decrease costs
The opportunities from globalization are often
accompanied by significant additional risk
There will be a good deal of uncertainty in demand,
prices, exchange rates, and the competitive market
over the lifetime of a supply chain network
Therefore, building flexibility into supply chain
operations allows the supply chain to deal with
uncertainty in a manner that will maximize profits
6-4
Total cost can be identified by focusing on the
complete sourcing process
Offshoring to low-cost countries is likely to be most
attractive for products with:
High labor content
Large production volumes
Relatively low variety
Low transportation costs
Perform a careful review of the production process
Risk Management in Global
Supply Chains
Disruptions
Delays
Systems risk
Forecast risk
Intellectual property risk
Procurement risk
Inventory risk
Capacity risk
6-5
Tailored Risk Mitigation Strategies
Increase capacity
Get redundant suppliers
Increase responsiveness
Increase inventory
Increase flexibility
Pool or aggregate demand
Increase source capability
6-6
6-7
Discounted Cash Flow Analysis
Supply chain decisions are in place for a long time, so
they should be evaluated as a sequence of cash flows
over that period
Discounted cash flow (DCF) analysis evaluates the
present value of any stream of future cash flows and
allows managers to compare different cash flow
streams in terms of their financial value
Based on the time value of money a dollar today is
worth more than a dollar tomorrow
6-8
Discounted Cash Flow Analysis
return of rate
flows cash of stream this of lue present va net the
periods T over flows cash of stream a is ,..., ,
where
1
1
1
1
factor Discount
1 0
1
0
=
=
|
'
+
+ =
+
=
_
=
k
NPV
C C C
C
k
C NPV
k
T
T
t
t
t
Compare NPV of different supply chain design options
The option with the highest NPV will provide the greatest
financial return
6-9
NPV Example: Trips Logistics
How much space to lease in the next three years
Demand = 100,000 units
Requires 1,000 sq. ft. of space for every 1,000 units of
demand
Revenue = $1.22 per unit of demand
Decision is whether to sign a three-year lease or
obtain warehousing space on the spot market
Three-year lease: cost = $1 per sq. ft.
Spot market: cost = $1.20 per sq. ft.
k = 0.1
6-10
For leasing warehouse space on the spot market:
Expected annual profit = 100,000 x $1.22 100,000 x
$1.20 = $2,000
Cash flow = $2,000 in each of the next three years
, )
471 , 5 $
1 . 1
2000
1 . 1
2000
2000
1
1
lease) (no
2
2
2 1
0
= + + =
+
+
+
+ =
k
C
k
C
C NPV
6-11
For leasing warehouse space with a three-year lease:
Expected annual profit = 100,000 x $1.22 100,000 x $1.00 = $22,000
Cash flow = $22,000 in each of the next three years
, )
182 , 60 $
1 . 1
22000
1 . 1
22000
22000
1 1
lease) (no
2
2
2 1
0
= + + =
+
+
+
+ =
k
C
k
C
C NPV
The NPV of signing the lease is $54,711 higher; therefore, the manager
decides to sign the lease
However, uncertainty in demand and costs may cause the manager to
rethink his decision
6-12
Representations of Uncertainty
Binomial Representation of Uncertainty
Other Representations of Uncertainty
6-13
Binomial Representations
of Uncertainty
When moving from one period to the next, the value of the
underlying factor (e.g., demand or price) has only two
possible outcomes up or down
The underlying factor moves up by a factor or u > 1 with
probability p, or down by a factor d < 1 with probability 1-p
Assuming a price P in period 0, for the multiplicative
binomial, the possible outcomes for the next four periods:
Period 1: Pu, Pd
Period 2: Pu
2
, Pud, Pd
2
Period 3: Pu
3
, Pu
2
d, Pud
2
, Pd
3
Period 4: Pu4, Pu
3
d, Pu
2
d
2
, Pud
3
, Pd
4
6-14
of Uncertainty
In general, for multiplicative binomial, period T has
all possible outcomes Pu
t
d
(T-t)
, for t = 0,1,,T
From state Pu
a
d
(T-a)
in period t, the price may move in
period t+1 to either
Pu
a+1
d
(T-a)
with probability p, or
Pu
a
d
(T-a)+1
with probability (1-p)
Represented as the binomial tree shown in Figure 6.1
(p. 140)
6-15
of Uncertainty
For the additive binomial, the states in the following
periods are:
Period 1: P+u, P-d
Period 2: P+2u, P+u-d, P-2d
Period 3: P+3u, P+2u-d, P+u-2d, P-3d
Period 4: P+4u, P+3u-d, P+2u-2d, P+u-3d, P-4d
In general, for the additive binomial, period T has all
possible outcomes P+tu-(T-t)d, for t=0, 1, , T
6-16
Evaluating Network Design
Decisions Using Decision Trees
A manager must make many different decisions when
designing a supply chain network
Many of them involve a choice between a long-term (or less
flexible) option and a short-term (or more flexible) option
If uncertainty is ignored, the long-term option will almost
always be selected because it is typically cheaper
Such a decision can eventually hurt the firm, however,
because actual future prices or demand may be different
from what was forecasted at the time of the decision
A decision tree is a graphic device that can be used to
evaluate decisions under uncertainty
6-17
Decision Tree Methodology
1. Identify the duration of each period (month, quarter, etc.) and
the number of periods T over the which the decision is to be
evaluated.
2. Identify factors such as demand, price, and exchange rate,
whose fluctuation will be considered over the next T periods.
3. Identify representations of uncertainty for each factor; that is,
determine what distribution to use to model the uncertainty.
4. Identify the periodic discount rate k for each period.
5. Represent the decision tree with defined states in each period,
as well as the transition probabilities between states in
successive periods.
6. Starting at period T, work back to period 0, identifying the
optimal decision and the expected cash flows at each step.
Expected cash flows at each state in a given period should be
discounted back when included in the previous period.
6-18
Decision Tree Methodology:
Trips Logistics
Decide whether to lease warehouse space for the coming
three years and the quantity to lease
Long-term lease is currently cheaper than the spot market
rate
The manager anticipates uncertainty in demand and spot
prices over the next three years
Long-term lease is cheaper but could go unused if demand
is lower than forecast; future spot market rates could also
decrease
Spot market rates are currently high, and the spot market
would cost a lot if future demand is higher than expected
6-19
Trips Logistics: Three Options
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
6-20
Trips Logistics
1000 sq. ft. of warehouse space needed for 1000 units of
demand
Current demand = 100,000 units per year
Binomial uncertainty: Demand can go up by 20% with
p = 0.5 or down by 20% with 1-p = 0.5
Lease price = $1.00 per sq. ft. per year
Spot market price = $1.20 per sq. ft. per year
Spot prices can go up by 10% with p = 0.5 or down by
10% with 1-p = 0.5
Revenue = $1.22 per unit of demand
k = 0.1
6-21
Trips Logistics Decision Tree
(Fig. 6.2)
D=144
p=$1.45
D=144
p=$1.19
D=96
p=$1.45
D=144
p=$0.97
D=96
p=$1.19
D=96
p=$0.97
D=64
p=$1.45
D=64
p=$1.19
D=64
p=$0.97
D=120
p=$1.32
D=120
p=$1. 08
D=80
p=$1.32
D=80
p=$1.32
D=100
p=$1.20
0.25
0.25
0.25
0.25
0.25
0.25
0.25
0.25
Period 0
Period 1
Period 2
6-22
Trips Logistics Example
Analyze the option of not signing a lease and
obtaining all warehouse space from the spot market
Start with Period 2 and calculate the profit at each
node
For D=144, p=$1.45, in Period 2:
C(D=144, p=1.45,2) = 144,000x1.45 = $208,800
P(D=144, p =1.45,2) = 144,000x1.22
C(D=144,p=1.45,2) = 175,680-208,800 = -$33,120
Profit at other nodes is shown in Table 6.1
6-23
Expected profit at each node in Period 1 is the profit
during Period 1 plus the present value of the expected
profit in Period 2
Expected profit EP(D=, p=,1) at a node is the
expected profit over all four nodes in Period 2 that
may result from this node
PVEP(D=,p=,1) is the present value of this expected
profit and P(D=,p=,1), and the total expected profit, is
the sum of the profit in Period 1 and the present value
of the expected profit in Period 2
6-24
From node D=120, p=$1.32 in Period 1, there are four
possible states in Period 2
Evaluate the expected profit in Period 2 over all four states
possible from node D=120, p=$1.32 in Period 1 to be
EP(D=120,p=1.32,1) = 0.25xP(D=144,p=1.45,2) +
0.25xP(D=144,p=1.19,2) +
0.25xP(D=96,p=1.45,2) +
0.25xP(D=96,p=1.19,2)
= 0.25x(-33,120)+0.25x4,320+0.25x(-22,080)+0.25x2,880
= -$12,000
6-25
The present value of this expected value in Period 1 is
PVEP(D=12, p=1.32,1) = EP(D=120,p=1.32,1) / (1+k)
= -$12,000 / (1+0.1)
= -$10,909
The total expected profit P(D=120,p=1.32,1) at node
D=120,p=1.32 in Period 1 is the sum of the profit in Period 1 at
this node, plus the present value of future expected profits
possible from this node
P(D=120,p=1.32,1) = [(120,000x1.22)-(120,000x1.32)] +
PVEP(D=120,p=1.32,1)
= -$12,000 + (-$10,909) = -$22,909
The total expected profit for the other nodes in Period 1 is shown
in Table 6.2
6-26
For Period 0, the total profit P(D=100,p=120,0) is the sum of
the profit in Period 0 and the present value of the expected
profit over the four nodes in Period 1
EP(D=100,p=1.20,0) = 0.25xP(D=120,p=1.32,1) +
= 0.25xP(D=120,p=1.08,1) +
= 0.25xP(D=96,p=1.32,1) +
= 0.25xP(D=96,p=1.08,1)
= 0.25x(-22,909)+0.25x32,073+0.25x(-15,273)+0.25x21,382
= $3,818
PVEP(D=100,p=1.20,0) = EP(D=100,p=1.20,0) / (1+k)
= $3,818 / (1 + 0.1) = $3,471
6-27
P(D=100,p=1.20,0) = 100,000x1.22-100,000x1.20 +
PVEP(D=100,p=1.20,0)
= $2,000 + $3,471 = $5,471
Therefore, the expected NPV of not signing the lease
and obtaining all warehouse space from the spot market
is given by NPV(Spot Market) = $5,471
6-28
Using the same approach for the lease option,
NPV(Lease) = $38,364
Recall that when uncertainty was ignored, the NPV
for the lease option was $60,182
However, the manager would probably still prefer to
sign the three-year lease for 100,000 sq. ft. because
this option has the higher expected profit
6-29
Evaluating Flexibility
Using Decision Trees
Decision tree methodology can be used to evaluate flexibility within the
supply chain
Suppose the manager at Trips Logistics has been offered a contract
where, for an upfront payment of $10,000, the company will have the
flexibility of using between 60,000 sq. ft. and 100,000 sq. ft. of
warehouse space at $1 per sq. ft. per year. Trips must pay $60,000 for
the first 60,000 sq. ft. and can then use up to 40,000 sq. ft. on demand at
$1 per sq. ft. as needed.
Using the same approach as before, the expected profit of this option is
$56,725
The value of flexibility is the difference between the expected present
value of the flexible option and the expected present value of the
inflexible options
The three options are listed in Table 6.7, where the flexible option has
an expected present value $8,361 greater than the inflexible lease option
(including the upfront $10,000 payment)
6-30
AM Tires: Evaluation of Supply Chain
Design Decisions Under Uncertainty
Dedicated Capacity of 100,000 in the United States
and 50,000 in Mexico
Period 2 Evaluation
Period 1 Evaluation
Period 0 Evaluation
Flexible Capacity of 100,000 in the United States and
50,000 in Mexico
Period 2 Evaluation
Period 1 Evaluation
Period 0 Evaluation
6-31
Evaluating Facility Investments:
AM Tires
Dedicated Plant Flexible Plant Plant
Fixed Cost Variable Cost Fixed Cost Variable Cost
US 100,000 $1 million/yr. $15 / tire $1.1 million
/ year
$15 / tire
Mexico
50,000
4 million
pesos / year
110 pesos /
tire
4.4 million
pesos / year
110 pesos /
tire
U.S. Expected Demand = 100,000;
Mexico Expected Demand = 50,000
1US$ = 9 pesos
Demand goes up or down by 20 percent with probability 0.5 and
exchange rate goes up or down by 25 per cent with probability 0.5.
6-32
RU=100
RM=50
E=9
Period 0 Period 1
Period 2
RU=120
RM = 60
E=11.25
RU=120
RM = 60
E=6.75
RU=120
RM = 40
E=11.25
RU=120
RM = 40
E=6.75
RU=80
RM = 60
E=11.25
RU=80
RM = 60
E=6.75
RU=80
RM = 40
E=11.25
RU=80
RM = 40
E=6.75
RU=144
RM = 72
E=14.06
RU=144
RM = 72
E=8.44
RU=144
RM = 48
E=14.06
RU=144
RM = 48
E=8.44
RU=96
RM = 72
E=14.06
RU=96
RM = 72
E=8.44
RU=96
RM = 48
E=14.06
RU=96
RM = 48
E=8.44
AM Tires
6-33
AM Tires
Four possible capacity scenarios:
Both dedicated
Both flexible
U.S. flexible, Mexico dedicated
U.S. dedicated, Mexico flexible
For each node, solve the demand allocation model:
Plants Markets
U.S.
Mexico
U.S.
Mexico
6-34
AM Tires: Demand Allocation for
RU = 144; RM = 72, E = 14.06
Source Destination Variable
cost
Shipping
cost
E Sale price Margin
($)
U.S. U.S. $15 0 14.06 $30 $15
U.S. Mexico $15 $1 14.06 240 pesos $1.1
Mexico U.S. 110 pesos $1 14.06 $30 $21.2
Mexico Mexico 110 pesos 0 14.06 240 pesos $9.2
Plants Markets
U.S.
Mexico
U.S.
Mexico
100,000
6,000
Profit (flexible) =
$1,075,055
Profit (dedicated) =
$649,360
100,000
50,000
6-35
Facility Decision at AM Tires
Plant Configuration
United States Mexico
NPV
Dedicated Dedicated $1,629,319
Flexible Dedicated $1,514,322
Dedicated Flexible $1,722,447
Flexible Flexible $1,529,758
6-36
Making Global Supply Chain Design
Decisions Under Uncertainty in Practice
Combine strategic planning and financial planning
during global network design
Use multiple metrics to evaluate global supply chain
networks
Use financial analysis as an input to decision making,
not as the decision-making process
Use estimates along with sensitivity analysis
6-37
What are the factors that need to be included in total
landed cost when making global sourcing decisions?
What are the uncertainties that influence global supply
chain performance and global network design?
What are the different strategies used to mitigate risk
in global supply chains?
What are the methodologies that are used to evaluate
supply chain decisions under uncertainty?
How can global supply chain network design
decisions in an uncertain environment be analyzed?
3-1
Chapter 3
Supply Chain
Drivers and
Metrics
3-2
Outline
Impellers of Supply Chain
Supply Chain Concepts
Drivers of supply chain performance
A framework for structuring drivers
Facilities
Inventory
Transportation
Information
Sourcing
Pricing
Obstacles to achieving fit
IMPELLERS OF SUPPLY CHAIN
Empowered Customer
Developments in Information Technology Tools
Globalisation
3-3
SUPPLY CHAIN CONCEPTS
Systems Concept
Total Cost Concept
Trade off Concept
3-4
3-5
Facilities
places where inventory is stored, assembled, or fabricated
production sites and storage sites
Inventory
raw materials, WIP, finished goods within a supply chain
inventory policies
Transportation
moving inventory from point to point in a supply chain
combinations of transportation modes and routes
Information
data and analysis regarding inventory, transportation, facilities throughout the
supply chain
potentially the biggest driver of supply chain performance
Sourcing
functions a firm performs and functions that are outsourced
Pricing
Price associated with goods and services provided by a firm to the supply chain
3-6
A Framework for
Structuring Drivers
C om pe ti ti ve S t r a te gy
S u p p l y C h ai n
S t r a t eg y
E ffi c i e n cy
R e s p o n s iv e n e s s
F a ci li ti e s I n v e n t o r y T r a n s p o r ta ti o n
I n fo r m a ti o n
S u p p l y c h ai n s t r u c t u r e
Cross Functional Drivers
S o u r c i n g P r i c i ng
Logistical Drivers
3-7
Facilities
the where of the supply chain
manufacturing or storage (warehouses)
economies of scale (efficiency priority)
larger number of smaller facilities (responsiveness priority)
Example 3.1: Toyota and Honda
Components of facilities decisions
3-8
Components of Facilities Decisions
Location
centralization (efficiency) vs. decentralization (responsiveness)
other factors to consider (e.g., proximity to customers)
Capacity (flexibility versus efficiency)
Manufacturing methodology (product focused versus
process focused)
Warehousing methodology (SKU storage, job lot
storage, cross-docking)
Overall trade-off: Responsiveness versus efficiency
3-9
Inventory
Components of inventory decisions
3-10
Inventory: Role in the Supply Chain
Inventory exists because of a mismatch between
supply and demand
Source of cost and influence on responsiveness
Impact on
material flow time: time elapsed between when material
enters the supply chain to when it exits the supply chain
throughput
rate at which sales to end consumers occur
I = DT (Littles Law)
I = inventory; D = throughput; T = flow time
Example
Inventory and throughput are synonymous in a supply chain
3-11
Inventory: Role in Competitive
Strategy
If responsiveness is a strategic competitive priority, a
firm can locate larger amounts of inventory closer to
customers
If cost is more important, inventory can be reduced to
make the firm more efficient
Trade-off
Example 3.2 Nordstrom
3-12
Components of Inventory
Decisions
Cycle inventory
Average amount of inventory used to satisfy demand between shipments
Depends on lot size
Safety inventory
inventory held in case demand exceeds expectations
costs of carrying too much inventory versus cost of losing sales
Seasonal inventory
inventory built up to counter predictable variability in demand
cost of carrying additional inventory versus cost of flexible production
more inventory: greater responsiveness but greater cost
less inventory: lower cost but lower responsiveness
3-13
Transportation
Components of transportation decisions
3-14
Transportation: Role in
the Supply Chain
Moves the product between stages in the supply chain
Impact on responsiveness and efficiency
Faster transportation allows greater responsiveness
but lower efficiency
Also affects inventory and facilities
3-15
Transportation:
Role in the Competitive Strategy
If responsiveness is a strategic competitive priority,
then faster transportation modes can provide greater
responsiveness to customers who are willing to pay
for it
Can also use slower transportation modes for
customers whose priority is price (cost)
Can also consider both inventory and transportation to
find the right balance
Example 3.3: Blue Nile
3-16
Components of
Transportation Decisions
Mode of transportation:
air, truck, rail, ship, pipeline, electronic transportation
vary in cost, speed, size of shipment, flexibility
Route and network selection
route: path along which a product is shipped
network: collection of locations and routes
In-house or outsource
3-17
Information
Components of information decisions
3-18
Information: Role in
the Supply Chain
The connection between the various stages in the
supply chain allows coordination between stages
Crucial to daily operation of each stage in a supply
chain e.g., production scheduling, inventory levels
3-19
Information:
Allows supply chain to become more efficient and
more responsive at the same time (reduces the need
for a trade-off)
Information technology
What information is most valuable?
Example 3.4: Andersen Windows
Example 3.5: Sunsweet Growers
3-20
Components of Information
Decisions
Push (MRP) versus pull (demand information
transmitted quickly throughout the supply chain)
Coordination and information sharing
Forecasting and aggregate planning
Enabling technologies
EDI
Internet
ERP systems
Supply Chain Management software
3-21
Sourcing
3-22
Sourcing: Role in
the Supply Chain
Set of business processes required to purchase goods
and services in a supply chain
Supplier selection, single vs. multiple suppliers,
contract negotiation
3-23
Sourcing:
Sourcing decisions are crucial because they affect the
level of efficiency and responsiveness in a supply
chain
In-house vs. outsource decisions- improving
efficiency and responsiveness
Example 3.6: Cisco
3-24
Components of Sourcing
Decisions
In-house versus outsource decisions
Procurement process
Overall trade-off: Increase the supply chain profits
3-25
Pricing
3-26
Pricing: Role in
the Supply Chain
Pricing determines the amount to charge customers in
a supply chain
Pricing strategies can be used to match demand and
supply
3-27
Sourcing:
Firms can utilize optimal pricing strategies to improve
efficiency and responsiveness
Low price and low product availability; vary prices by
response times
Example 3.7: Amazon.com
3-28
Components of Pricing Decisions
Fixed price versus menu pricing
Overall trade-off: Increase the firm profits
3-29
Obstacles to Achieving
Strategic Fit
Increasing variety of products
Decreasing product life cycles
Increasingly demanding customers
Fragmentation of supply chain ownership
Globalization
Difficulty executing new strategies
3-30
Summary
What are the major drivers of supply chain
performance?
What is the role of each driver in creating strategic fit
between supply chain strategy and competitive strategy
(or between implied demand uncertainty and supply
chain responsiveness)?
What are the major obstacles to achieving strategic fit?
In the remainder of the course, we will learn how to
make decisions with respect to these drivers in order to
achieve strategic fit and surmount these obstacles
4-1
Chapter 4
Designing
Distribution
Networks and
Applications to
E-Business
4-2
Outline
The Role of Distribution in the Supply Chain
Factors Influencing Distribution Network Design
Design Options for a Distribution Network
E-Business and the Distribution Network
Distribution Networks in Practice
4-3
The Role of Distribution
in the Supply Chain
Distribution: the steps taken to move and store a
product from the supplier stage to the customer stage
in a supply chain
Distribution directly affects cost and the customer
experience and therefore drives profitability
Choice of distribution network can achieve supply
chain objectives from low cost to high responsiveness
Examples: Wal-Mart, Dell, Proctor & Gamble,
Grainger
4-4
Factors Influencing
Distribution Network Design
Distribution network performance evaluated along
two dimensions at the highest level:
Customer needs that are met
Cost of meeting customer needs
Distribution network design options must therefore be
compared according to their impact on customer
service and the cost to provide this level of service
4-5
Factors Influencing
Elements of customer service influenced by network structure:
Response time
Product variety
Product availability
Customer experience
Order visibility
Returnability
Supply chain costs affected by network structure:
Inventories
Transportation
Facilities and handling
Information
4-6
(Fig. 4.1)
Number of
Facilities
Response Time
4-7
Inventory Costs and Number
of Facilities (Fig. 4.2)
Inventory
Costs
4-8
Transportation Costs and
Number of Facilities (Fig. 4.3)
Transportation
Costs
4-9
Facility Costs and Number
Facility
Costs
4-10
Response Time
Variation in Logistics Costs and Response
Time with Number of Facilities (Fig. 4.5)
Total Logistics Costs
4-11
Design Options for a
Distribution Network
Manufacturer Storage with Direct Shipping
Manufacturer Storage with Direct Shipping and In-
Transit Merge
Distributor Storage with Carrier Delivery
Distributor Storage with Last Mile Delivery
Manufacturer or Distributor Storage with Customer
Pickup
Retail Storage with Customer Pickup
Selecting a Distribution Network Design
4-12
Manufacturer Storage with
Direct Shipping (Fig. 4.6)
Manufacturer
Retailer
Customers
Product Flow
Information Flow
4-13
In-Transit Merge Network (Fig. 4.7)
Factories
Retailer
Product Flow
Information Flow
In-Transit Merge by
Carrier
Customers
4-14
Distributor Storage with
Carrier Delivery (Fig. 4.8)
Factories
Customers
Product Flow
Information Flow
Warehouse Storage by
Distributor/Retailer
4-15
Last Mile Delivery (Fig. 4.9)
Factories
Customers
Product Flow
Information Flow
Warehouse
4-16
Manufacturer or Distributor Storage
with Customer Pickup (Fig. 4.10)
Factories
Retailer
Pickup Sites
Product Flow
Information Flow
Cross Dock DC
Customer Flow
Customers
4-17
Comparative Performance of Delivery
Network Designs (Table 4.7)
Information
Facility & Handling
Transportation
Inventory
Returnability
Order Visibility
Customer Experience
Product Availability
Product Variety
Response Time
Manufacturer
storage with pickup
Distributor
storage with last
mile delivery
Distributor Storage
with Package
Carrier Delivery
Manufacturer
Storage with In-
Transit Merge
Manufacturer
Storage with Direct
Shipping
Retail Storage
with Customer
Pickup
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
2
2
2
2
2
2
2
2
2
2
3
3
3
3
3
3
3
3
3
3
4
4
4
4
4
4
4
4
4
4
4
4
4
5
5
5
5
5 5
5
6
6
5
4-18
Performance of Delivery Networks for Different
Product/Customer Characteristics (Table 4-8)
Low customer effort
High product variety
Quick desired response
High product value
Many product sources
Very low demand product
Low demand product
Medium demand product
High demand product
Manufacturer
storage with
pickup
Distributor storage
with last mile delivery
Distributor Storage
with Package Carrier
Delivery
Manufacturer
Storage with In-
Transit Merge
Manufacturer
Storage with
Direct Shipping
Retail Storage
with
Customer
Pickup
+2
+2
+2
+2
+2
+2
+2 +2 +2
+2
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
0
0
0
0
0
0
0
0 0
0
-1
-1
-1
-1
-1 -1
-1
-1
-1
-1
-1
-2 -2
-2
-2
-2
-2 -2
-2
TRADITIONAL INDIAN
DISTRIBUTION CHANNELS
What characteristics of the traditional Indian agricultural
produce distribution channels militate against delivering
simultaneous benefits to the farmer and the consumer?
What Supply Chain Best Practices do you see as being relevant
to the Indian agricultural produce distribution system?
Organised retailing underway in India is likely to impact the
traditional distribution channels and transform the same
radically. What major changes do you visualize taking place
in the Agricultural Produce Distribution System in India and
how do you see the existing channels responding to the same?
4-20
E-Business and the Distribution
Network
Impact of E-Business on Customer Service
Impact of E-Business on Cost
Using E-Business: Dell, Amazon, Peapod, Grainger
Impact of E-Business on
Customer Service
Response time
Product variety
Customer experience
Time to market
Order Visibility
Returnability
Direct Sales to Customers
Flexible Pricing, Product Portfolio, and Promotions
Efficient Funds Transfer
4-21
Impact of E-Business on Cost
Inventory
Facilities
Transportation
Information
4-22
4-23
The ownership structure of the distribution network
can have as big as an impact as the type of distribution
network
The choice of a distribution network has very long-
term consequences
Consider whether an exclusive distribution strategy is
advantageous
Product, price, commoditization, and criticality have
an impact on the type of distribution system preferred
by customers
4-24
What are the key factors to be considered when
designing the distribution network?
What are the strengths and weaknesses of various
distribution options?
How has E-Business affected the design of
distribution networks in different industries?
What roles do distributors play in the supply chain?
2-1
Chapter 2
Supply Chain
Performance:
Achieving Strategic
Fit and Scope
2-2
Outline
Competitive and supply chain strategies
Achieving strategic fit
Expanding strategic scope
2-3
What is Supply Chain Management?
Managing supply chain flows and assets, to maximize
supply chain surplus
What is supply chain surplus?
2-4
Competitive and Supply
Chain Strategies
Competitive strategy: defines the set of customer needs a firm
seeks to satisfy through its products and services
Product development strategy: specifies the portfolio of new
products that the company will try to develop
Marketing and sales strategy: specifies how the market will be
segmented and product positioned, priced, and promoted
Supply chain strategy:
determines the nature of material procurement, transportation of
materials, manufacture of product or creation of service, distribution of
product
Consistency and support between supply chain strategy, competitive
strategy, and other functional strategies is important
2-5
New
Product
Development
Marketing
and
Sales
Finance, Accounting, Information Technology, Human Resources
The Value Chain: Linking Supply
Chain and Business Strategy
2-6
Achieving Strategic Fit
Introduction
How is strategic fit achieved?
Other issues affecting strategic fit
2-7
Strategic fit:
Consistency between customer priorities of competitive
strategy and supply chain capabilities specified by the
supply chain strategy
Competitive and supply chain strategies have the same
goals
A company may fail because of a lack of strategic fit
or because its processes and resources do not provide
the capabilities to execute the desired strategy
Example of strategic fit -- Dell
2-8
How is Strategic Fit Achieved?
Step 1: Understanding the customer and supply chain
uncertainty
Step 2: Understanding the supply chain
Step 3: Achieving strategic fit
2-9
Step 1: Understanding the Customer
and Supply Chain Uncertainty
Identify the needs of the customer segment being
served
Quantity of product needed in each lot
Response time customers will tolerate
Variety of products needed
Service level required
Price of the product
Desired rate of innovation in the product
2-10
Overall attribute of customer demand
Demand uncertainty: uncertainty of customer demand
for a product
Implied demand uncertainty: resulting uncertainty for
the supply chain given the portion of the demand the
supply chain must handle and attributes the customer
desires
2-11
Implied demand uncertainty also related to customer
needs and product attributes
Table 2.1
Figure 2.2
Table 2.2
First step to strategic fit is to understand customers by
mapping their demand on the implied uncertainty
spectrum
2-12
Understanding the Customer
Lot size
Response time
Service level
Product variety
Price
Innovation
Implied
Demand
Uncertainty
2-13
Impact of Customer Needs on Implied
Demand Uncertainty (Table 2.1)
Customer Need Causes implied demand
uncertainty to increase because
Range of quantity required increases Wider range of quantity required
implies greater variance in demand
Lead time decreases Less time to react to orders
Variety of products required increases Demand per product becomes more
disaggregated
Number of channels through which
product may be acquired increases
Total customer demand is now
disaggregated over more channels
Rate of innovation increases New products tend to have more
uncertain demand
Required service level increases Firm now has to handle unusual
surges in demand
2-14
Levels of Implied Demand
Uncertainty
Predictable
supply and
demand
Salt at a
supermarket
A new
communication
device
Highly uncertain
supply and demand
Figure 2.2: The Implied Uncertainty (Demand and Supply)
Spectrum
Predictable supply and uncertain
demand or uncertain supply and
predictable demand or somewhat
uncertain supply and demand
An existing
automobile
model
2-15
Correlation Between Implied Demand
Uncertainty and Other Attributes (Table 2.2)
Attribute Low Implied
Uncertainty
High Implied
Uncertainty
Product margin Low High
Avg. forecast error 10% 40%-100%
Avg. stockout rate 1%-2% 10%-40%
Avg. forced season-
end markdown
0% 10%-25%
2-16
Step 2: Understanding the
Supply Chain
How does the firm best meet demand?
Dimension describing the supply chain is supply chain
responsiveness
Supply chain responsiveness -- ability to
respond to wide ranges of quantities demanded
meet short lead times
handle a large variety of products
build highly innovative products
meet a very high service level
2-17
Supply Chain
There is a cost to achieving responsiveness
Supply chain efficiency: cost of making and
delivering the product to the customer
Increasing responsiveness results in higher costs that
lower efficiency
Figure 2.3: cost-responsiveness efficient frontier
Figure 2.4: supply chain responsiveness spectrum
Second step to achieving strategic fit is to map the
supply chain on the responsiveness spectrum
2-18
Understanding the Supply Chain: Cost-
Responsiveness Efficient Frontier
High Low
Low
High
Responsiveness
Cost
2-19
Responsiveness Spectrum
(Figure 2.4)
Integrated
steel mill
Dell
Highly
efficient
Highly
responsive
Somewhat
efficient
Somewhat
responsive
Hanes
apparel
Most
automotive
production
2-20
Step 3: Achieving Strategic Fit
Step is to ensure that what the supply chain does well
is consistent with target customers needs
Fig. 2.5: Zone of strategic fit
Fig. 2.6: Uncertainty/Responsiveness map
Examples: Dell, Barilla
2-21
Achieving Strategic Fit Shown on the
Uncertainty/Responsiveness Map (Fig. 2.5)
Implied
uncertainty
spectrum
Responsive
supply chain
Efficient
supply chain
Certain
demand
Uncertain
demand
Responsiveness
spectrum
2-22
All functions in the value chain must support the
competitive strategy to achieve strategic fit Fig. 2.7
Two extremes: Efficient supply chains (Barilla) and
responsive supply chains (Dell) Table 2.4
Two key points
there is no right supply chain strategy independent of
competitive strategy
there is a right supply chain strategy for a given competitive
strategy
2-23
Comparison of Efficient and
Responsive Supply Chains (Table 2.4)
Efficient Responsive
Primary goal Lowest cost Quick response
Product design strategy Min product cost Modularity to allow
postponement
Pricing strategy Lower margins Higher margins
Mfg strategy High utilization Capacity flexibility
Inventory strategy Minimize inventory Buffer inventory
Lead time strategy Reduce but not at expense
of greater cost
Aggressively reduce even if
costs are significant
Supplier selection strategy Cost and low quality Speed, flexibility, quality
Transportation strategy Greater reliance on low cost
modes
Greater reliance on
responsive (fast) modes
2-24
Other Issues Affecting Strategic Fit
Multiple products and customer segments
Product life cycle
Competitive changes over time
2-25
Multiple Products and
Customer Segments
Firms sell different products to different customer
segments (with different implied demand uncertainty)
The supply chain has to be able to balance efficiency
and responsiveness given its portfolio of products and
customer segments
Two approaches:
Different supply chains
Tailor supply chain to best meet the needs of each
products demand
2-26
Product Life Cycle
The demand characteristics of a product and the needs
of a customer segment change as a product goes
through its life cycle
Supply chain strategy must evolve throughout the life
cycle
Early: uncertain demand, high margins (time is
important), product availability is most important, cost
is secondary
Late: predictable demand, lower margins, price is
important
2-27
Product Life Cycle
Examples: pharmaceutical firms, Intel
As the product goes through the life cycle, the supply
chain changes from one emphasizing responsiveness
to one emphasizing efficiency
2-28
Competitive Changes Over Time
Competitive pressures can change over time
More competitors may result in an increased emphasis
on variety at a reasonable price
The Internet makes it easier to offer a wide variety of
products
The supply chain must change to meet these changing
competitive conditions
2-29
Expanding Strategic Scope
Scope of strategic fit
The functions and stages within a supply chain that devise an
integrated strategy with a shared objective
One extreme: each function at each stage develops its own
strategy
Other extreme: all functions in all stages devise a strategy jointly
Five categories:
Intracompany intraoperation scope
Intracompany intrafunctional scope
Intracompany interfunctional scope
Intercompany interfunctional scope
Flexible interfunctional scope
2-30
Different Scopes of Strategic Fit
Across a Supply Chain
S uppliers M anufacturer D istributor Retailer Customer
Competitive
S trategy
Product
D evelopment
S trategy
S upply Chain
S trategy
M arketing
S trategy
Intracompany
Intraoperation
at Distributor
Intracompany
Intrafunctional
at Distributor
Intracompany
Interfunctional
at Distributor
Intercompany
Interfunctional
INDIAN RETAIL SECTOR
What different models of supply chains do you
visualize emerging in the transforming Indian retail
sector?
What trends do you see in in the emerging Indian
supply chain models that suggest conscious attempts
at achieving proper strategic fit between business
strategies and supply chain strategies?
How do you see the Indian retail supply chains
becoming role models for supply chains in other
sectors?
2-32
Why is achieving strategic fit critical to a companys
overall success?
How does a company achieve strategic fit between its
supply chain strategy and its competitive strategy?
What is the importance of expanding the scope of
strategic fit across the supply chain?
17-1
Chapter 17
Coordination in
a Supply Chain
17-2
Outline
Lack of Supply Chain Coordination and the
Bullwhip Effect
Effect on Performance of Lack of Coordination
Obstacles to Coordination in a Supply Chain
Managerial Levers to Achieve Coordination
Building Strategic Partnerships and Trust Within
a Supply Chain
Continuous Replenishment and Vendor-Managed
Inventories
Collaborative Planning, Forecasting, and Replenishment
(CPFR)
The Role of IT in Coordination
Achieving Coordination in Practice
17-3
Objectives
Describe supply chain coordination, the bullwhip
effect, and their impact on performance
Identify obstacles to coordination in a supply chain
Discuss managerial levers that help achieve
coordination in a supply chain
Describe actions that facilitate the building of strategic
partnerships and trust within a supply chain
Understand the different forms of CPFR possible in a
supply chain
17-4
Lack of Supply Chain Coordination
and the Bullwhip Effect
Supply chain coordination all stages in the supply
chain take actions together (usually results in greater
total supply chain profits)
SC coordination requires that each stage take into
account the effects of its actions on the other stages
Lack of coordination results when:
Objectives of different stages conflict or
Information moving between stages is distorted
17-5
Bullwhip Effect
Fluctuations in orders increase as they move up
the supply chain from retailers to wholesalers to
manufacturers to suppliers (shown in Figure 16.1)
Distorts demand information within the supply
chain, where different stages have very different
estimates of what demand looks like
Results in a loss of supply chain coordination
Examples: Proctor & Gamble (Pampers); HP
(printers); Barilla (pasta)
17-6
The Effect on Performance of Lack of
Coordination
Manufacturing cost (increases)
Inventory cost (increases)
Replenishment lead time (increases)
Transportation cost (increases)
Labor cost for shipping and receiving (increases)
Level of product availability (decreases)
Relationships across the supply chain (worsens)
Profitability (decreases)
The bullwhip effect reduces supply chain profitability
by making it more expensive to provide a given level
of product availability
17-7
Obstacles to Coordination
in a Supply Chain
Incentive Obstacles
Information Processing Obstacles
Operational Obstacles
Pricing Obstacles
Behavioral Obstacles
17-8
Incentive Obstacles
When incentives offered to different stages or
participants in a supply chain lead to actions that
increase variability and reduce total supply chain
profits misalignment of total supply chain
objectives and individual objectives
Local optimization within functions or stages of a
supply chain
Sales force incentives
17-9
Information Processing Obstacles
When demand information is distorted as it moves
between different stages of the supply chain,
leading to increased variability in orders within
the supply chain
Forecasting based on orders, not customer
demand
Forecasting demand based on orders magnifies demand
fluctuations moving up the supply chain from retailer
to manufacturer
Lack of information sharing
17-10
Operational Obstacles
Actions taken in the course of placing and filling
orders that lead to an increase in variability
Ordering in large lots (much larger than dictated
by demand) Figure 17.2
Large replenishment lead times
Rationing and shortage gaming (common in the
computer industry because of periodic cycles of
component shortages and surpluses)
17-11
Pricing Obstacles
When pricing policies for a product lead to an
increase in variability of orders placed
Lot-size based quantity decisions
Price fluctuations (resulting in forward buying)
Figure 17.3
17-12
Behavioral Obstacles
Problems in learning, often related to communication in the
supply chain and how the supply chain is structured
Each stage of the supply chain views its actions locally and is
unable to see the impact of its actions on other stages
Different stages react to the current local situation rather than
trying to identify the root causes
Based on local analysis, different stages blame each other for
the fluctuations, with successive stages becoming enemies
rather than partners
No stage learns from its actions over time because the most
significant consequences of the actions of any one stage occur
elsewhere, resulting in a vicious cycle of actions and blame
Lack of trust results in opportunism, duplication of effort, and
lack of information sharing
17-13
Managerial Levers to
Achieve Coordination
Aligning Goals and Incentives
Improving Information Accuracy
Improving Operational Performance
Designing Pricing Strategies to Stabilize Orders
Building Strategic Partnerships and Trust
17-14
Align incentives so that each participant has an
incentive to do the things that will maximize total
supply chain profits
Align incentives across functions
Pricing for coordination
Alter sales force incentives from sell-in (to the
retailer) to sell-through (by the retailer)
17-15
Sharing point of sale data
Collaborative forecasting and planning
Single stage control of replenishment
Continuous replenishment programs (CRP)
Vendor managed inventory (VMI)
17-16
Reducing replenishment lead time
Reduces uncertainty in demand
EDI is useful
Reducing lot sizes
Computer-assisted ordering, B2B exchanges
Shipping in LTL sizes by combining shipments
Technology and other methods to simplify receiving
Changing customer ordering behavior
Rationing based on past sales and sharing information to
limit gaming
Turn-and-earn
Information sharing
17-17
Designing Pricing Strategies
to Stabilize Orders
Encouraging retailers to order in smaller lots and reduce
forward buying
Moving from lot size-based to volume-based quantity
discounts (consider total purchases over a specified time
period)
Stabilizing pricing
Eliminate promotions (everyday low pricing, EDLP)
Limit quantity purchased during a promotion
Tie promotion payments to sell-through rather than amount
purchased
Building strategic partnerships and trust easier to
implement these approaches if there is trust
17-18
Building Strategic Partnerships
and Trust in a Supply Chain
Background
Designing a Relationship with Cooperation and
Trust
Managing Supply Chain Relationships for
Cooperation and Trust
17-19
Trust-based relationship
Dependability
Leap of faith
Cooperation and trust work because:
Alignment of incentives and goals
Actions to achieve coordination are easier to implement
Supply chain productivity improves by reducing
duplication or allocation of effort to appropriate stage
Greater information sharing results
17-20
Trust in the Supply Chain
Table 17.2 shows benefits
Historically, supply chain relationships are based
on power or trust
Disadvantages of power-based relationship:
Results in one stage maximizing profits, often at the
expense of other stages
Can hurt a company when balance of power changes
Less powerful stages have sought ways to resist
17-21
Building Trust into a
Supply Chain Relationship
Deterrence-based view
Use formal contracts
Parties behave in trusting manner out of self-interest
Process-based view
Trust and cooperation are built up over time as a result
of a series of interactions
Positive interactions strengthen the belief in
cooperation of other party
Neither view holds exclusively in all situations
17-22
Building Trust into a
Supply Chain Relationship
Initially more reliance on deterrence-based view,
then evolves to a process-based view
Co-identification: ideal goal
Two phases to a supply chain relationship
Design phase
Management phase
17-23
Designing a Relationship
with Cooperation and Trust
Assessing the value of the relationship and its
contributions
Identifying operational roles and decision rights
for each party
Creating effective contracts
Designing effective conflict resolution
mechanisms
17-24
Assessing the Value of the
Relationship and its Contributions
Identify the mutual benefit provided
Identify the criteria used to evaluate the
relationship (equity is important)
Important to share benefits equitably
Clarify contribution of each party and the benefits
each party will receive
17-25
Identifying Operational Roles and
Decision Rights for Each Party
Recognize interdependence between parties
Sequential interdependence: activities of one partner
precede the other
Reciprocal interdependence: the parties come together,
exchange information and inputs in both directions
Sequential interdependence is the traditional
supply chain form
Reciprocal interdependence is more difficult but
can result in more benefits
Figure 17.4
17-26
Effects of Interdependence on Supply
Chain Relationships (Figure 17.4)
O
r
g
a
n
i
z
a
t
i
o
n
s

D
e
p
e
n
d
e
n
c
e
High
Low
Partners Dependence
Low
High
Partner
Relatively
Powerful
Organization
Relatively
Powerful
High Level of
Interdependence
Effective Relationship
Low Level of
Interdependence
17-27
Creating Effective Contracts
Create contracts that encourage negotiation when
unplanned contingencies arise
It is impossible to define and plan for every
possible occurrence
Informal relationships and agreements can fill in
the gaps in contracts
Informal arrangements may eventually be
formalized in later contracts
17-28
Designing Effective Conflict
Resolution Mechanisms
Initial formal specification of rules and guidelines
for procedures and transactions
Regular, frequent meetings to promote
communication
Courts or other intermediaries
17-29
Managing Supply Chain Relationships
for Cooperation and Trust
Effective management of a relationship is
important for its success
Top management is often involved in the design
but not management of a relationship
Figure 17.5 -- process of alliance evolution
Perceptions of reduced benefits or opportunistic
actions can significantly impair a supply chain
partnership
Continuous Replenishment and
Vendor-Managed Inventories
A single point of replenishment
CRP wholesaler or manufacturer replenishes based
on POS data
VMI manufacturer or supplier is responsible for all
decisions regarding inventory
Substitutes
17-30
Collaborative Planning, Forecasting,
and Replenishment (CPFR)
Sellers and buyers in a supply chain may collaborate
along any or all of the following:
Strategy and planning
Demand and supply management
Execution
Analysis
Organizational and Technology requirements
Risks and Hurdles for a CPFR implementation
17-31
The Role of IT in Coordination
Enablement of coordination the ultimate goal
Information availability
Use of information available to make decisions
ERP and best-of-breed vendors
17-32
17-33
Quantify the bullwhip effect
Get top management commitment for coordination
Devote resources to coordination
Focus on communication with other stages
Try to achieve coordination in the entire supply chain
network
Use technology to improve connectivity in the supply
chain
Share the benefits of coordination equitably
17-34
What are supply chain coordination and the bullwhip
effect, and what are their effects on supply chain
performance?
What are obstacles to coordination in the supply
chain?
What are the managerial levers that help achieve
coordination in the supply chain?
What are actions that facilitate the building of
strategic partnerships and trust in the supply chain?
What are the different forms of CPFR available in a
supply chain?
16-1
Chapter 16
Information
Technology
in a Supply
Chain
16-2
Outline
The Role of IT in a Supply Chain
The Supply Chain IT Framework
Customer Relationship Management
Internal Supply Chain Management
Supplier Relationship Management
The Transaction Management Foundation
The Future of IT in the Supply Chain
Risk Management in IT
Supply Chain IT in Practice
16-3
Role of IT
in a Supply Chain
Information is the driver that serves as the glue to create a
coordinated supply chain
Information must have the following characteristics to be
useful:
Accurate
Accessible in a timely manner
Information must be of the right kind
Information provides the basis for supply chain management
decisions
Inventory
Transportation
Facility
16-4
Characteristics of Useful
Supply Chain Information
Accurate
Accessible in a timely manner
The right kind
Shared
Provides supply chain visibility
16-5
Use of Information
in a Supply Chain
Information used at all phases of decision making:
strategic, planning, operational
Examples:
Strategic: location decisions
Operational: what products will be produced during
todays production run
16-6
Use of Information
in a Supply Chain
Inventory: demand patterns, carrying costs,
stockout costs, ordering costs
Transportation: costs, customer locations,
shipment sizes
Facility: location, capacity, schedules of a facility;
need information about trade-offs between
flexibility and efficiency, demand, exchange rates,
taxes, etc.
16-7
Role of Information Technology
in a Supply Chain
Information technology (IT)
Hardware and software used throughout the supply
chain to gather and analyze information
Captures and delivers information needed to make
good decisions
Effective use of IT in the supply chain can have a
significant impact on supply chain performance
16-8
The Importance of Information
in a Supply Chain
Relevant information available throughout the
supply chain allows managers to make decisions
that take into account all stages of the supply
chain
Allows performance to be optimized for the entire
supply chain, not just for one stage leads to
higher performance for each individual firm in the
supply chain
16-9
The Supply Chain IT Framework
The Supply Chain Macro Processes
Customer Relationship Management (CRM)
Internal Supply Chain Management (ISCM)
Supplier Relationship Management (SRM)
Plus: Transaction Management Foundation
Figure 16.1
Why Focus on the Macro Processes?
Macro Processes Applied to the Evolution of Software
16-10
Macro Processes in a Supply Chain
(Figure 16.1)
Supplier
Relationship
Management
(SRM)
Internal
Supply Chain
Management
(ISCM)
Customer
Relationship
Management
(CRM)
Transaction Management Foundation (TFM)
16-11
Customer Relationship Management
The processes that take place between an enterprise
and its customers downstream in the supply chain
Key processes:
Marketing
Selling
Order management
Call/Service center
16-12
Internal Supply Chain Management
Includes all processes involved in planning for and
fulfilling a customer order
ISCM processes:
Strategic Planning
Demand Planning
Supply Planning
Fulfillment
Field Service
There must be strong integration between the ISCM
and CRM macro processes
16-13
Supplier Relationship Management
Those processes focused on the interaction between
the enterprise and suppliers that are upstream in the
supply chain
Key processes:
Design Collaboration
Source
Negotiate
Buy
Supply Collaboration
There is a natural fit between ISCM and SRM
processes
16-14
The Transaction Management
Foundation
Enterprise software systems (ERP)
Earlier systems focused on automation of simple
transactions and the creation of an integrated method
of storing and viewing data across the enterprise
Real value of the TMF exists only if decision making
is improved
The extent to which the TMF enables integration
across the three macro processes determines its value
16-15
The Future of IT in the Supply Chain
At the highest level, the three SCM macro processes
will continue to drive the evolution of enterprise
software
Software focused on the macro processes will become
a larger share of the total enterprise software market
and the firms producing this software will become
more successful
Functionality, the ability to integrate across macro
processes, and the strength of their ecosystems, will
be keys to success
Risk Management in IT
Installing new systems
Revised business processes
Integration
Software glitches
Power outages
Viruses
16-16
16-17
Supply Chain Information
Technology in Practice
Select an IT system that addresses the companys key
success factors
Take incremental steps and measure value
Align the level of sophistication with the need for
sophistication
Use IT systems to support decision making, not to
make decisions
Think about the future
16-18
What is the importance of information and IT in the
supply chain?
How does each supply chain driver use information?
What are the major applications of supply chain IT
and what processes do they enable?
15-1
Chapter 15
Pricing and
Revenue
Management in
the Supply Chain
15-2
Outline
The Role of Pricing and Revenue Management in a Supply
Chain
Pricing and Revenue Management for Multiple Customer
Segments
Pricing and Revenue Management for Perishable Assets
Pricing and Revenue Management for Seasonable Demand
Pricing and Revenue Management for Bulk and Spot
Customers
The Role of IT in Pricing and Revenue Management
Using Pricing and Revenue Management in Practice
15-3
The Role of Pricing and Revenue
Management in the Supply Chain
Revenue management is the use of pricing to increase
the profit generated from a limited supply of supply
chain assets
Supply assets exist in two forms: capacity and
inventory
Revenue management may also be defined as the use
of differential pricing based on customer segment,
time of use, and product or capacity availability to
increase supply chain profits
Most common example is probably in airline pricing
15-4
Conditions Under Which Revenue
Management Has the Greatest Effect
The value of the product varies in different market
segments (Example: airline seats)
The product is highly perishable or product waste
occurs (Example: fashion and seasonal apparel)
Demand has seasonal and other peaks (Example:
products ordered at Amazon.com)
The product is sold both in bulk and on the spot
market (Example: owner of warehouse who can
decide whether to lease the entire warehouse through
long-term contracts or save a portion of the
warehouse for use in the spot market)
15-5
Pricing and Revenue Management for
Multiple Customer Segments
If a supplier serves multiple customer segments with
a fixed asset, the supplier can improve revenues by
setting different prices for each segment
Prices must be set with barriers such that the segment
willing to pay more is not able to pay the lower price
The amount of the asset reserved for the higher price
segment is such that the expected marginal revenue
from the higher priced segment equals the price of the
lower price segment
15-6
Multiple Customer Segments
p
L
= the price charged to the lower price segment
p
H
= the price charged to the higher price segment
D
H
= mean demand for the higher price segment
H
= standard deviation of demand for the higher price segment
C
H
= capacity reserved for the higher price segment
R
H
(C
H
) = expected marginal revenue from reserving more
capacity
= Probability(demand from higher price segment > C
H
) x p
H
R
H
(C
H
) = p
L
Probability(demand from higher price segment > C
H
) = p
L
/ p
H
C
H
= F
-1
(1- p
L
/p
H
, D
H
,
H
) = NORMINV(1- p
L
/p
H
, D
H
,
H
)
15-7
Example 15.2: ToFrom Trucking
Revenue from segment A = p
A
= $3.50 per cubic ft
Revenue from segment B = p
B
= $3.50 per cubic ft
Mean demand for segment A = D
A
= 3,000 cubic ft
Std dev of segment A demand =
A
= 1,000 cubic ft
C
A
= NORMINV(1- p
B
/p
A
, D
A
,
A
)
= NORMINV(1- (2.00/3.50), 3000, 1000)
= 2,820 cubic ft
If pA increases to $5.00 per cubic foot, then
C
A
= NORMINV(1- p
B
/p
A
, D
A
,
A
)
= NORMINV(1- (2.00/5.00), 3000, 1000)
= 3,253 cubic ft
15-8
Pricing and Revenue Management
for Perishable Assets
Any asset that loses value over time is perishable
Examples: high-tech products such as computers and
cell phones, high fashion apparel, underutilized
capacity, fruits and vegetables
Two basic approaches:
Vary price over time to maximize expected revenue
Overbook sales of the asset to account for cancellations
15-9
Overbooking or overselling of a supply chain asset is
valuable if order cancellations occur and the asset is
perishable
The level of overbooking is based on the trade-off
between the cost of wasting the asset if too many
cancellations lead to unused assets and the cost of
arranging a backup if too few cancellations lead to
committed orders being larger than the available
capacity
15-10
p = price at which each unit of the asset is sold
c = cost of using or producing each unit of the asset
b = cost per unit at which a backup can be used in the
case of asset shortage
C
w
= p c = marginal cost of wasted capacity
C
s
= b c = marginal cost of a capacity shortage
O* = optimal overbooking level
s* = Probability(cancellations < O*) = C
w
/ (C
w
+ C
s
)
15-11
If the distribution of cancellations is known to be normal
with mean
c
and standard deviation
c
then
O* = F
-1
(s*,
c
,
c
) = NORMINV(s*,
c
,
c
)
If the distribution of cancellations is known only as a
function of the booking level (capacity L +
overbooking O) to have a mean of (L+O) and std
deviation of (L+O), the optimal overbooking level is
the solution to the following equation:
O = F
-1
(s*, ( L+O),(L+O))
= NORMINV(s*, ( L+O),(L+O))
15-12
Example 15.5 - Overbooking
Cost of wasted capacity = C
w
= $10 per dress
Cost of capacity shortage = C
s
= $5 per dress
s* = C
w
/ (C
w
+ C
s
) = 10/(10+5) = 0.667
c
= 800;
c
= 400
O* = NORMINV(s*,
c
,
c
)
= NORMINV(0.667,800,400) = 973
If the mean is 15% of the booking level and the coefficient of
variation is 0.5, then the optimal overbooking level is the
solution of the following equation:
O = NORMINV(0.667,0.15(5000+O),0.075(5000+O))
Using Excel Solver, O* = 1,115
15-13
for Seasonal Demand
Seasonal peaks of demand are common in many supply
chains
Examples: Most retailers achieve a large portion of
total annual demand in December (Amazon.com)
Off-peak discounting can shift demand from peak to
non-peak periods
Charge higher price during peak periods and a lower
price during off-peak periods
15-14
Bulk and Spot Customers
Most consumers of production, warehousing, and
transportation assets in a supply chain face the problem of
constructing a portfolio of long-term bulk contracts and
short-term spot market contracts
The basic decision is the size of the bulk contract
The fundamental trade-off is between wasting a portion of
the low-cost bulk contract and paying more for the asset on
the spot market
Given that both the spot market price and the purchasers
need for the asset are uncertain, a decision tree approach as
discussed in Chapter 6 should be used to evaluate the
amount of long-term bulk contract to sign
15-15
For the simple case where the spot market price is known
but demand is uncertain, a formula can be used
c
B
= bulk rate
c
S
= spot market price
Q* = optimal amount of the asset to be purchased in bulk
p* = probability that the demand for the asset does not
exceed Q*
Marginal cost of purchasing another unit in bulk is c
B
.
The expected marginal cost of not purchasing another
unit in bulk and then purchasing it in the spot market is
(1-p*)c
S
.
15-16
If the optimal amount of the asset is purchased in bulk,
the marginal cost of the bulk purchase should equal the
expected marginal cost of the spot market purchase, or
c
B
= (1-p*)c
S
Solving for p* yields p* = (c
S
c
B
) / c
S
If demand is normal with mean and std deviation , the
optimal amount Q* to be purchased in bulk is
Q* = F
-1
(p*,,) = NORMINV(p*,,)
15-17
Example 15.6 Long-term Bulk
Contracts versus the Spot Market
Bulk contract cost = c
B
= $10,000 per million units
Spot market cost = c
S
= $12,500 per million units
= 10 million units
= 4 million units
p* = (c
S
c
B
) / c
S
= (12,500 10,000) / 12,500 = 0.2
Q* = NORMINV(p*,,) = NORMINV(0.2,10,4) = 6.63
The manufacturer should sign a long-term bulk contract
for 6.63 million units per month and purchase any
transportation capacity beyond that on the spot market
The Role of IT in Pricing and
Revenue Management
Pricing of perishable assets
Pricing of retail goods in the consumer packaged-
goods category
Mark downs of goods as the styles and seasons
change
Linking with other areas and applications
15-18
15-19
Using Pricing and Revenue
Management in Practice
Evaluate your market carefully
Quantify the benefits of revenue management
Implement a forecasting process
Apply optimization to obtain the revenue
management decision
Involve both sales and operations
Understand and inform the customer
Integrate supply planning with revenue
management
15-20
What is the role of revenue management in a
supply chain?
Under what conditions are revenue management
tactics effective?
What are the trade-offs that must be considered
when making revenue management decisions?
14-1
Chapter 14
Sourcing
Decisions in a
Supply Chain
14-2
Outline
The Role of Sourcing in a Supply Chain
In-House or Outsource
Third- and Fourth-Party Logistics Providers
Supplier Scoring and Assessment
Supplier Selection Auctions and Negotiations
Contracts, risk Sharing, and Supply Chain Performance
The Procurement Process
Sourcing Planning and Analysis
The Role of IT in Sourcing
Risk Management in sourcing
Making Sourcing Decisions in Practice
14-3
The Role of Sourcing
in a Supply Chain
Sourcing is the set of business processes required
to purchase goods and services
Sourcing processes include:
Supplier scoring and assessment
Supplier selection and contract negotiation
Design collaboration
Procurement
Sourcing planning and analysis
14-4
Benefits of Effective
Sourcing Decisions
Better economies of scale can be achieved if orders
are aggregated
More efficient procurement transactions can
significantly reduce the overall cost of purchasing
Design collaboration can result in products that are
easier to manufacture and distribute, resulting in
lower overall costs
Good procurement processes can facilitate
coordination with suppliers
Appropriate supplier contracts can allow for the
sharing of risk
Firms can achieve a lower purchase price by
increasing competition through the use of auctions
Supplier Scoring and Assessment
Supplier performance should be compared on the
basis of the suppliers impact on total cost
There are several other factors besides purchase price
that influence total cost
14-5
14-6
Supplier Assessment Factors
Replenishment Lead Time
On-Time Performance
Supply Flexibility
Delivery Frequency /
Minimum Lot Size
Supply Quality
Inbound Transportation Cost
Pricing Terms
Information Coordination
Capability
Capability
Exchange Rates, Taxes,
Duties
Supplier Viability
14-7
Supplier Selection- Auctions and
Negotiations
Supplier selection can be performed through competitive
bids, reverse auctions, and direct negotiations
Supplier evaluation is based on total cost of using a
supplier
Auctions:
Sealed-bid first-price auctions
English auctions
Dutch auctions
Second-price (Vickery) auctions
14-8
Contracts and Supply Chain
Performance
Contracts for Product Availability and Supply
Chain Profits
Buyback Contracts
Revenue-Sharing Contracts
Quantity Flexibility Contracts
Contracts to Coordinate Supply Chain Costs
Contracts to Increase Agent Effort
Contracts to Induce Performance Improvement
14-9
Contracts for Product Availability
and Supply Chain Profits
Many shortcomings in supply chain performance occur
because the buyer and supplier are separate organizations
and each tries to optimize its own profit
Total supply chain profits might therefore be lower than if
the supply chain coordinated actions to have a common
objective of maximizing total supply chain profits
Recall Chapter 10: double marginalization results in
suboptimal order quantity
An approach to dealing with this problem is to design a
contract that encourages a buyer to purchase more and
increase the level of product availability
The supplier must share in some of the buyers demand
uncertainty, however
14-10
Contracts for Product Availability and
Supply Chain Profits: Buyback Contracts
Allows a retailer to return unsold inventory up to a
specified amount at an agreed upon price
Increases the optimal order quantity for the retailer,
resulting in higher product availability and higher profits
for both the retailer and the supplier
Most effective for products with low variable cost, such as
music, software, books, magazines, and newspapers
Downside is that buyback contract results in surplus
inventory that must be disposed of, which increases supply
chain costs
Can also increase information distortion through the
supply chain because the supply chain reacts to retail
orders, not actual customer demand
14-11
Chain Profits: Revenue Sharing Contracts
The buyer pays a minimal amount for each unit
purchased from the supplier but shares a fraction of
the revenue for each unit sold
Decreases the cost per unit charged to the retailer,
which effectively decreases the cost of overstocking
Can result in supply chain information distortion,
however, just as in the case of buyback contracts
14-12
Chain Profits: Quantity Flexibility Contracts
Allows the buyer to modify the order (within limits)
as demand visibility increases closer to the point of
sale
Better matching of supply and demand
Increased overall supply chain profits if the supplier
has flexible capacity
Lower levels of information distortion than either
buyback contracts or revenue sharing contracts
14-13
Contracts to Coordinate
Supply Chain Costs
Differences in costs at the buyer and supplier can lead
to decisions that increase total supply chain costs
Example: Replenishment order size placed by the
buyer. The buyers EOQ does not take into account
the suppliers costs.
A quantity discount contract may encourage the buyer
to purchase a larger quantity (which would be lower
costs for the supplier), which would result in lower
total supply chain costs
Quantity discounts lead to information distortion
because of order batching
14-14
Contracts to Increase Agent Effort
There are many instances in a supply chain where an
agent acts on the behalf of a principal and the agents
actions affect the reward for the principal
Example: A car dealer who sells the cars of a
manufacturer, as well as those of other manufacturers
Examples of contracts to increase agent effort include
two-part tariffs and threshold contracts
Threshold contracts increase information distortion,
however
14-15
Contracts to Induce
Performance Improvement
A buyer may want performance improvement from a
supplier who otherwise would have little incentive to
do so
A shared savings contract provides the supplier with
a fraction of the savings that result from the
performance improvement
Particularly effective where the benefit from
improvement accrues primarily to the buyer, but
where the effort for the improvement comes primarily
from the supplier
14-16
50-70 percent of spending at a manufacturer is
through procurement
80 percent of the cost of a purchased part is fixed in
the design phase
Design collaboration with suppliers can result in
reduced cost, improved quality, and decreased time to
market
Important to employ design for logistics, design for
manufacturability
Manufacturers must become effective design
coordinators throughout the supply chain
14-17
The Procurement Process
The process in which the supplier sends product in response to
orders placed by the buyer
Goal is to enable orders to be placed and delivered on schedule
at the lowest possible overall cost
Two main categories of purchased goods:
Direct materials: components used to make finished goods
Indirect materials: goods used to support the operations of a firm
Differences between direct and indirect materials listed in Table 13.2
Focus for direct materials should be on improving coordination
and visibility with supplier
Focus for indirect materials should be on decreasing the
transaction cost for each order
Procurement for both should consolidate orders where possible
to take advantage of economies of scale and quantity discounts
14-18
Product Categorization by Value
and Criticality (Figure 14.2)
Critical Items Strategic Items
General Items
Bulk Purchase
Items
Low
Low
High
High
Value/Cost
C
r
i
t
i
c
a
l
i
t
y
14-19
Sourcing Planning and Analysis
A firm should periodically analyze its procurement
spending and supplier performance and use this
analysis as an input for future sourcing decisions
Procurement spending should be analyzed by part and
supplier to ensure appropriate economies of scale
Supplier performance analysis should be used to build
a portfolio of suppliers with complementary strengths
Cheaper but lower performing suppliers should be used to
supply base demand
Higher performing but more expensive suppliers should be
used to buffer against variation in demand and supply from
the other source
The Role of IT in Sourcing
Design collaboration
Negotiate
Buy
Supply collaboration
14-20
Risk Management in Sourcing
Supply disruption
Increased procurement costs
Intellectual property
14-21
14-22
Making Sourcing
Decisions in Practice
Use multifunction teams
Ensure appropriate coordination across regions
and business units
Always evaluate the total cost of ownership
Build long-term relationships with key suppliers
14-23
What is the role of sourcing in a supply chain?
What factors affect the decision to outsource a supply
chain function?
What dimensions of supplier performance affect total
cost?
How do you structure successful auctions and
negotiations?
What is the impact of risk sharing on supplier performance
and information distortion?
What are different categories of purchased products and
services? What is the desired focus for procurement for
each of these categories?
12-1
Chapter 12
Determining the
Optimal Level of
Product
Availability
12-2
Outline
The importance of the level of product availability
Factors affecting the optimal level of product
availability
Managerial levers to improve supply chain
profitability
Setting product availability for multiple products
under capacity constraints
Setting optimal levels of product availability in
practice
12-3
Importance of the Level
of Product Availability
Product availability measured by cycle service level or fill rate
Also referred to as the customer service level
Product availability affects supply chain responsiveness
Trade-off:
High levels of product availability increased responsiveness and
higher revenues
High levels of product availability increased inventory levels and
higher costs
Product availability is related to profit objectives, and strategic
and competitive issues (e.g., Nordstrom, power plants,
supermarkets, e-commerce retailers)
What is the level of fill rate or cycle service level that will
result in maximum supply chain profits?
12-4
Factors Affecting the Optimal
Level of Product Availability
Cost of overstocking
Cost of under stocking
Possible scenarios
Seasonal items with a single order in a season
One-time orders in the presence of quantity discounts
Continuously stocked items
Demand during stock out is backlogged
Demand during stock out is lost
12-5
Managerial Levers to Improve
Supply Chain Profitability
Obvious actions
Increase salvage value of each unit
Decrease the margin lost from a stockout
Improved forecasting
Quick response
Postponement
Tailored sourcing
12-6
Improved Forecasts
Improved forecasts result in reduced uncertainty
Less uncertainty (lower
R
) results in either:
Lower levels of safety inventory (and costs) for the same
level of product availability, or
Higher product availability for the same level of safety
inventory, or
Both lower levels of safety inventory and higher levels of
product availability
An increase in forecast accuracy decreases both the overstocked and
understocked quantity and increases a firms profits.
12-7
Impact of Improving Forecasts
(Example)
Demand: Normally distributed with a mean of R =
350 and standard deviation of
R
= 100
Purchase price = $100
Retail price = $250
Disposal value = $85
Holding cost for season = $5
How many units should be ordered as
R
changes?
12-8
Impact of Improving Forecasts
R
O* Expected
Overstock
Expected
Understock
Expected
Profit
150 526 186.7 8.6 $47,469
120 491 149.3 6.9 $48,476
90 456 112.0 5.2 $49,482
60 420 74.7 3.5 $50,488
30 385 37.3 1.7 $51,494
0 350 0 0 $52,500
12-9
Quick Response
Set of actions taken by managers to reduce lead time
Reduced lead time results in improved forecasts
Typical example of quick response is multiple orders in one season for retail
items (such as fashion clothing)
For example, a buyer can usually make very accurate forecasts after the first
week or two in a season
Multiple orders are only possible if the lead time is reduced otherwise
there wouldnt be enough time to get the later orders before the season ends
Benefits:
Lower order quantities less inventory, same product availability
Less overstock
Higher profits
If quick response allows multiple orders in the season, profits
increase and the overstock quantity decreases.
12-10
Quick Response: Multiple
Orders Per Season
Ordering shawls at a department store
Selling season = 14 weeks
Cost per handbag = $40
Sale price = $150
Disposal price = $30
Holding cost = $2 per week
Expected weekly demand = 20
SD of weekly demand = 15
12-11
Impact of Quick Response
Single Order Two Orders in Season
Service
Level
Order
Size
Ending
Invent.
Expect.
Profit
Initial
Order
OUL
for 2
nd
Order
Average
Total
Order
Ending
Invent.
Expect.
Profit
0.96 378 97 $23,624 209 209 349 69 $26,590
0.94 367 86 $24,034 201 201 342 60 $27,085
0.91 355 73 $24,617 193 193 332 52 $27,154
0.87 343 66 $24,386 184 184 319 43 $26,944
0.81 329 55 $24,609 174 174 313 36 $27,413
0.75 317 41 $25,205 166 166 302 32 $26,916
12-12
Forecast Improves for Second
Order (SD=3 Instead of 15)
Single Order Two Orders in Season
Service
Level
Order
Size
Ending
Invent.
Expect.
Profit
Initial
Order
OUL
for 2
nd
Order
Average
Total
Order
Ending
Invent.
Expect.
Profit
0.96 378 96 $23,707 209 153 292 19 $27,007
0.94 367 84 $24,303 201 152 293 18 $27,371
0.91 355 76 $24,154 193 150 288 17 $26,946
0.87 343 63 $24,807 184 148 288 14 $27,583
0.81 329 52 $24,998 174 146 283 14 $27,162
0.75 317 44 $24,887 166 145 282 14 $27,268
12-13
Postponement
Delay of product differentiation until closer to the time of the sale of the
product
All activities prior to product differentiation require aggregate forecasts
more accurate than individual product forecasts
Individual product forecasts are needed close to the time of sale
demand is known with better accuracy (lower uncertainty)
Results in a better match of supply and demand
Valuable in e-commerce time lag between when an order is placed and
when customer receives the order (this delay is expected by the
customer and can be used for postponement)
Higher profits, better match of supply and demand
Postponement allows a firm to increase profits and better match supply and demand
if the firm produces a large variety of products whose demand is not positively
correlated and is of about the same size.
12-14
Value of Postponement: Benetton
For each color
Mean demand = 1,000; SD = 500
For each garment
Sale price = $50
Salvage value = $10
Production cost using Option 1 (long lead time) = $20
Production cost using Option 2 (uncolored thread) = $22
What is the value of postponement?
Expected profit increases from $94,576 to $98,092
12-15
Value of Postponement
with Dominant Product
Color with dominant demand: Mean = 3,100, SD = 800
Other three colors: Mean = 300, SD = 200
Expected profit without postponement = $102,205
Expected profit with postponement = $99,872
12-16
Tailored Postponement: Benetton
Produce Q
1
units for each color using Option 1 and Q
A
units (aggregate) using Option 2
Results:
Q
1
= 800
Q
A
= 1,550
Profit = $104,603
Tailored postponement allows a firm to increase
profits by postponing differentiation only for products
with the most uncertain demand; products with more
predictable demand are produced at lower cost without
postponement
12-17
Tailored Sourcing
A firm uses a combination of two supply sources
One is lower cost but is unable to deal with
uncertainty well
The other is more flexible, and can therefore deal
with uncertainty, but is higher cost
The two sources must focus on different capabilities
Depends on being able to have one source that faces
very low uncertainty and can therefore reduce costs
Increase profits, better match supply and demand
12-18
Tailored Sourcing
Sourcing alternatives
Low cost, long lead time supplier
Cost = $245, Lead time = 9 weeks
High cost, short lead time supplier
Cost = $250, Lead time = 1 week
12-19
Tailored Sourcing Strategies
Fraction of demand from
overseas supplier
Annual Profit
0% $37,250
50% $51,613
60% $53,027
100% $48,875
12-20
Tailored Sourcing: Multiple
Sourcing Sites
Characteristic Primary Site Secondary Site
Manufacturing
Cost
High Low
Flexibility
(Volume/Mix)
High Low
Responsiveness High Low
Engineering
Support
High Low
12-21
Dual Sourcing Strategies
Strategy Primary Site Secondary Site
Volume based
dual sourcing
Fluctuation Stable demand
Product based
dual sourcing
Unpredictable
products,
Small batch
Predictable,
large batch
products
Model based
dual sourcing
Newer
products
Older stable
products
12-22
Setting Product Availability for Multiple
Products under Capacity Constraints
Single product order
Multiple product order
Decrease the order size
Allocating the products
When ordering multiple products under a limited supply capacity,
the allocation of capacity to products should be based on their
expected marginal contribution to profits. This approach allocates a
relatively higher fraction of capacity to products that have a high
margin relative to their cost of overstocking.
12-23
Setting Optimal Levels of
Product Availability in Practice
Use an analytical framework to increase profits
Beware of preset levels of availability
Use approximate costs because profit-maximizing
solutions are very robust
Estimate a range for the cost of stocking out
Ensure levels of product availability fit with the
strategy
Strategic Capital Assets
Maintenance Support
MRO inventory policies in support of Strategic
Capital Assets are governed by stochastic, economic
and sourcing considerations. How can companies and
organisations holding such assets ensure minimal
downtimes while keeping inventory carrying and
obsolescence costs under control?
12-25
What are the factors affecting the optimal level of
product availability?
How is the optimal cycle service level estimated?
What are the managerial levers that can be used to
improve supply chain profitability through
optimal service levels?
How can contracts be structured to increase
supply chain profitability?
13-1
Chapter 13
Transportation
in a Supply
Chain
13-2
Outline
The role of transportation in the supply chain
Factors affecting transportation decisions
Modes of transportation and their performance
characteristics
Transportation infrastructure and policies
Design options for a transportation network
Trade-offs in transportation design
Tailored transportation
The role of IT in transportation
Risk management in transportation
Making transportation decisions in practice
13-3
Factors Affecting
Carrier (party that moves or transports the product)
Vehicle-related cost
Fixed operating cost
Trip-related cost
Shipper (party that requires the movement of the
product between two points in the supply chain)
Transportation cost
Inventory cost
Facility cost
13-4
Transportation Modes
Trucks
TL
LTL
Rail
Air
Package Carriers
Water
Pipeline
13-5
Truckload (TL)
Average revenue per ton mile (1996) = 9.13 cents
Average haul = 274 miles
Average Capacity = 42,000 - 50,000 lb.
Low fixed and variable costs
Major Issues
Utilization
Consistent service
Backhauls
13-6
Less Than Truckload (LTL)
Average revenue per ton-mile (1996) = 25.08
cents
Higher fixed costs (terminals) and low variable
costs
Major issues:
Location of consolidation facilities
Utilization
Vehicle routing
Customer service
13-7
Rail
Average revenue / ton-mile (1996) = 2.5 cents
Average load = 80 tons
Key issues:
Scheduling to minimize delays / improve service
Off-track delays (at pickup and delivery end)
Yard operations
Variability of delivery times
13-8
Air
Key issues:
Location/number of hubs
Location of fleet bases/crew bases
Schedule optimization
Fleet assignment
Crew scheduling
Yield management
13-9
Package Carriers
Companies like FedEx, UPS, USPS, that carry small
packages ranging from letters to shipments of about 150
pounds
Expensive
Rapid and reliable delivery
Small and time-sensitive shipments
Preferred mode for e-businesses (e.g., Amazon, Dell,
McMaster-Carr)
Consolidation of shipments (especially important for
package carriers that use air as a primary method of
transport)
13-10
Water
Limited to certain geographic areas
Ocean, inland waterway system, coastal waters
Very large loads at very low cost
Slowest
Dominant in global trade (autos, grain, apparel, etc.)
13-11
Pipeline
High fixed cost
Primarily for crude petroleum, refined petroleum
products, natural gas
Best for large and predictable demand
Would be used for getting crude oil to a port or
refinery, but not for getting refined gasoline to a
gasoline station (why?)
13-12
Intermodal
Use of more than one mode of transportation to move a
shipment to its destination
Most common example: rail/truck
Also water/rail/truck or water/truck
Grown considerably with increased use of containers
Increased global trade has also increased use of
intermodal transportation
More convenient for shippers (one entity provides the
complete service)
Key issue involves the exchange of information to
facilitate transfer between different transport modes
13-13
Transportation Network
What are the transportation options? Which one to
select? On what basis?
Direct shipping network
Direct shipping with milk runs
All shipments via central DC
Shipping via DC using milk runs
Tailored network
13-14
Trade-offs in Transportation Design
Transportation and inventory cost trade-off
Choice of transportation mode
Inventory aggregation
Transportation cost and responsiveness trade-off
13-15
Choice of Transportation Mode
A manager must account for inventory costs when
selecting a mode of transportation
A mode with higher transportation costs can be
justified if it results in significantly lower inventories
13-16
Inventory Aggregation: Inventory
vs. Transportation Cost
As a result of physical aggregation
Inventory costs decrease
Inbound transportation cost decreases
Outbound transportation cost increases
Inventory aggregation decreases supply chain costs if
the product has a high value to weight ratio, high
demand uncertainty, or customer orders are large
Inventory aggregation may increase supply chain
costs if the product has a low value to weight ratio,
low demand uncertainty, or customer orders are small
13-17
Trade-offs Between Transportation
Cost and Customer Responsiveness
Temporal aggregation is the process of combining
orders across time
Temporal aggregation reduces transportation cost
because it results in larger shipments and reduces
variation in shipment sizes
However, temporal aggregation reduces customer
responsiveness
13-18
Tailored Transportation
The use of different transportation networks and
modes based on customer and product characteristics
Factors affecting tailoring:
Customer distance and density
Customer size
Product demand and value
13-19
Role of IT in Transportation
The complexity of transportation decisions demands
use of IT systems
IT software can assist in:
Identification of optimal routes by minimizing costs subject
to delivery constraints
Optimal fleet utilization
GPS applications
13-20
Risk Management in Transportation
Three main risks to be considered in transportation are:
Risk that the shipment is delayed
Risk of disruptions
Risk of hazardous material
Risk mitigation strategies:
Decrease the probability of disruptions
Alternative routings
In case of hazardous materials the use of modified
containers, low-risk transportation models, modification of
physical and chemical properties can prove to be effective
13-21
Making Transportation
Align transportation strategy with competitive
strategy
Consider both in-house and outsourced transportation
Design a transportation network that can handle
e-commerce
Use technology to improve transportation
performance
Design flexibility into the transportation network
INDIAN ROAD TRANSPORT
Nature of fleet ownership and scale of operations
Impact of poor infrastructure on sector performance
Physical, organisational, infrastructural, regulatory
and human resource constraints
Dominance of road transport as preferred mode of
freight transportation
Features of Indian Road Transport Sector
OM Logistics-Succeeding against Odds
13-22
13-23
What is the role of transportation in a supply chain?
What are the strengths and weaknesses of different
modes of transportation?
What is role of infrastructure and policies in
transportation?
What are the different network design options and
what are their strengths and weaknesses?
What are the trade-offs in transportation network
design?
11-1
Chapter 11
Managing
Uncertainty in the
Supply Chain:
Safety Inventory
11-2
Role of Inventory in the Supply Chain
Improve Matching of Supply
and Demand
Improved Forecasting
Reduce Material Flow Time
Reduce Waiting Time
Reduce Buffer Inventory
Economies of Scale
Supply / Demand
Variability
Seasonal
Variability
Cycle Inventory Safety Inventory
Figure Error! No text of
Seasonal Inventory
11-3
Outline
The role of safety inventory in a supply chain
Determining the appropriate level of safety inventory
Impact of supply uncertainty on safety inventory
Impact of aggregation on safety inventory
Impact of replenishment policies on safety inventory
Managing safety inventory in a multi-echelon supply
chain
Estimating and managing safety inventory in practice
11-4
The Role of Safety Inventory
in a Supply Chain
Forecasts are rarely completely accurate
If average demand is 1000 units per week, then half the
time actual demand will be greater than 1000, and half the
time actual demand will be less than 1000; what happens
when actual demand is greater than 1000?
If you kept only enough inventory in stock to satisfy
average demand, half the time you would run out
Safety inventory: Inventory carried for the purpose of
satisfying demand that exceeds the amount forecasted in a
given period
11-5
Role of Safety Inventory
Average inventory is therefore cycle inventory plus
safety inventory
There is a fundamental tradeoff:
Raising the level of safety inventory provides higher levels
of product availability and customer service
Raising the level of safety inventory also raises the level of
average inventory and therefore increases holding costs
Very important in high-tech or other industries where obsolescence
is a significant risk (where the value of inventory, such as PCs, can
drop in value)
Compaq and Dell in PCs
11-6
Two Questions to Answer in
Planning Safety Inventory
What is the appropriate level of safety inventory
to carry?
What actions can be taken to improve product
availability while reducing safety inventory?
11-7
Determining the Appropriate
Level of Safety Inventory
Measuring demand uncertainty
Measuring product availability
Replenishment policies
Evaluating cycle service level and fill rate
Evaluating safety level given desired cycle service
level or fill rate
Impact of required product availability and uncertainty
on safety inventory
11-8
Determining the Appropriate
Level of Demand Uncertainty
Appropriate level of safety inventory determined by:
supply or demand uncertainty
desired level of product availability
Higher levels of uncertainty require higher levels of
safety inventory given a particular desired level of
product availability
Higher levels of desired product availability require
higher levels of safety inventory given a particular
level of uncertainty
11-9
Measuring Demand Uncertainty
Demand has a systematic component and a random component
The estimate of the random component is the measure of
demand uncertainty
Random component is usually estimated by the standard
deviation of demand
Notation:
D = Average demand per period
D
= standard deviation of demand per period
L = lead time = time between when an order is placed and
when it is received
Uncertainty of demand during lead time is what is important
11-10
Measuring Demand Uncertainty
P = demand during k periods = kD
= std dev of demand during k periods =
R
Sqrt(k)
Coefficient of variation = cv = /= mean/(std dev)
= size of uncertainty relative to demand
11-11
Measuring Product Availability
Product availability: a firms ability to fill a
customers order out of available inventory
Stockout: a customer order arrives when product is not
available
Product fill rate (fr): fraction of demand that is
satisfied from product in inventory
Order fill rate: fraction of orders that are filled from
available inventory
Cycle service level: fraction of replenishment cycles
that end with all customer demand met
11-12
Replenishment Policies
Replenishment policy: decisions regarding when to
reorder and how much to reorder
Continuous review: inventory is continuously
monitored and an order of size Q is placed when the
inventory level reaches the reorder point ROP
Periodic review: inventory is checked at regular
(periodic) intervals and an order is placed to raise the
inventory to a specified threshold (the order-up-to
level)
11-13
Continuous Review Policy: Safety
Inventory and Cycle Service Level
L: Lead time for replenishment
D: Average demand per unit
time
o
D:
Standard deviation of
demand per period
D
L
: Mean demand during lead
time
o
L
: Standard deviation of
demand during lead time
CSL: Cycle service level
ss: Safety inventory
ROP: Reorder point
) , , (
) (
1

L L
L
L S
D L
L
D
D
F
D
ROP F CSL
ss ROP
CSL ss
L
DL
=
+ =
=
=
=
Average Inventory = Q/2 + ss

11-14
Example 11.1: Estimating Safety
Inventory (Continuous Review Policy)
D = 2,500/week; o
D
= 500
L = 2 weeks; Q = 10,000; ROP = 6,000
D
L
= DL = (2500)(2) = 5000
ss = ROP - R
L
= 6000 - 5000 = 1000
Cycle inventory = Q/2 = 10000/2 = 5000
Average Inventory = cycle inventory + ss = 5000 + 1000 = 6000
Average Flow Time = Avg inventory / throughput = 6000/2500 =
2.4 weeks
11-15
Example 11.2: Estimating Cycle Service
Level (Continuous Review Policy)
D = 2,500/week; o
D =
500
L = 2 weeks; Q = 10,000; ROP = 6,000
Cycle service level, CSL = F(D
L
+ ss, D
L
,
L
) =
= NORMDIST (D
L
+ ss, D
L
, o
L
) = NORMDIST(6000,5000,707,1)
= 0.92 (This value can also be determined from a Normal probability distribution table)
707 2 ) 500 ( = = = L
R L

11-16
Fill Rate
Proportion of customer demand
satisfied from stock
Stockout occurs when the
demand during lead time exceeds
the reorder point
ESC is the expected shortage per
cycle (average demand in excess
of reorder point in each
replenishment cycle)
ss is the safety inventory
Q is the order quantity
(
(
`
,
,
\
/
+
(
(
`
,
,
\
/
=
=
L
S
L
L
S
ss
f
ss
F
ss ESC
Q
ESC
fr
} 1 {
1
ESC = -ss{1-NORMDIST(ss/o
L
, 0, 1, 1)} + o
L
NORMDIST(ss/ o
L
, 0, 1, 0)
11-17
Example 11.3: Evaluating Fill Rate
ss = 1,000, Q = 10,000,
L
= 707, Fill Rate (fr) = ?
ESC = -ss{1-NORMDIST(ss/o
L
, 0, 1, 1)} +
o
L
NORMDIST(ss/o
L
, 0, 1, 0)
= -1,000{1-NORMDIST(1,000/707, 0, 1, 1)} +
707 NORMDIST(1,000/707, 0, 1, 0)
= 25.13
fr = (Q - ESC)/Q = (10,000 - 25.13)/10,000 =
0.9975
11-18
Factors Affecting Fill Rate
Safety inventory: Fill rate increases if safety
inventory is increased. This also increases the
cycle service level.
Lot size: Fill rate increases on increasing the lot
size even though cycle service level does not
change.
11-19
Example 11.4: Evaluating
Safety Inventory Given CSL
D = 2,500/week; o
D =
500
L = 2 weeks; Q = 10,000; CSL = 0.90
D
L
= 5000, o
L
= 707 (from earlier example)
ss = F
S
-1
(CSL)o
L
= [NORMSINV(0.90)](707) = 906
(this value can also be determined from a Normal probability distribution table)
ROP = D
L
+ ss = 5000 + 906 = 5906
11-20
Evaluating Safety Inventory
Given Desired Fill Rate
D = 2500,
D =
500, Q = 10000
If desired fill rate is fr = 0.975, how much safety
inventory should be held?
ESC = (1 - fr)Q = 250
Solve
(
(
`
,
,
\
/
+
(
(
(
`
,
,
\
/
= =
1 250
L
S
L
L
S
ss
f
ss
F
ss ESC

(
(
`
,
,
\
/
+
(
(
(
`
,
,
\
/
= 0 , 1 , 1 ,
1 250
L
L
L
ss
NORMDIST
ss
NORMSDIST ss
11-21
Evaluating Safety Inventory Given
Fill Rate (try different values of ss)
Fill Rate Safety Inventory
9 7 . 5 % 6 7
9 8 . 0 % 1 8 3
9 8 . 5 % 3 2 1
9 9 . 0 % 4 9 9
9 9 . 5 % 7 6 7
11-22
Impact of Required Product Availability
and Uncertainty on Safety Inventory
Desired product availability (cycle service level or fill
rate) increases, required safety inventory increases
Demand uncertainty (
L
) increases, required safety
inventory increases
Managerial levers to reduce safety inventory without
reducing product availability
reduce supplier lead time, L (better relationships with
suppliers)
reduce uncertainty in demand,
L
(better forecasts, better
information collection and use)
11-23
Impact of Supply Uncertainty
D: Average demand per period
o
D:
Standard deviation of demand per period
L: Average lead time
s
L
: Standard deviation of lead time
s D
D
L D L
L
L
DL
2 2 2
+ =
=

11-24
D = 2,500/day; o
D =
500
L = 7 days; Q = 10,000; CSL = 0.90; s
L
= 7 days
D
L
= DL = (2500)(7) = 17500
ss = F
-1
s
(CSL)
L
= NORMSINV(0.90) x 17550
= 22,491
17500 ) 7 ( ) 2500 (
500
) 7 (
2 2
2
2 2 2
= + =
+ =
s D
L
L
D
L


11-25
Safety inventory when s
L
= 0 is 1,695
L
= 1 is 3,625
L
= 2 is 6,628
L
= 3 is 9,760
L
= 4 is 12,927
L
= 5 is 16,109
L
= 6 is 19,298
11-26
Impact of Aggregation
on Safety Inventory
Models of aggregation
Information centralization
Specialization
Product substitution
Component commonality
Postponement
11-27

C
L s
C
D
C
L
n
i
i
C
D
n
i
i
C
CSL ss
L
F
D D
=
=
=
=
=
=
) (
1
1
2
1
11-28
(Example 11.7)
Car Dealer : 4 dealership locations (disaggregated)
D = 25 cars;
D =
5 cars; L = 2 weeks; desired CSL=0.90
What would the effect be on safety stock if the 4 outlets
are consolidated into 1 large outlet (aggregated)?
At each disaggregated outlet:
For L = 2 weeks,
L
= 7.07 cars
ss = F
s
-1
(CSL) x
L
= F
s
-1
(0.9) x 7.07 = 9.06
Each outlet must carry 9 cars as safety stock inventory,
so safety inventory for the 4 outlets in total is (4)(9) =
36 cars
11-29
(Example 11.7)
One outlet (aggregated option):
RC = D
1
+ D
2
+ D
3
+ D
4
= 25+25+25+25 = 100 cars/wk
R
C
= Sqrt(5
2
+ 5
2
+ 5
2
+ 5
2
) = 10
L
C
=
D
C
Sqrt(L) = (10)Sqrt(2) = (10)(1.414) = 14.14
ss = F
s
-1
(CSL) x
L
C
= F
s
-1
(0.9) x 14.14 =18.12
or about 18 cars
If does not equal 0 (demand is not completely
independent), the impact of aggregation is not as great
(Table 11.3)
11-30
If number of independent stocking locations
decreases by n, the expected level of safety inventory
will be reduced by square root of n (square root law)
Many e-commerce retailers attempt to take advantage
of aggregation (Amazon) compared to bricks and
mortar retailers (Borders)
Aggregation has two major disadvantages:
Increase in response time to customer order
Increase in transportation cost to customer
Some e-commerce firms (such as Amazon) have reduced
aggregation to mitigate these disadvantages
11-31
Information Centralization
Virtual aggregation
Information system that allows access to current
inventory records in all warehouses from each
warehouse
Most orders are filled from closest warehouse
In case of a stockout, another warehouse can fill the
order
Better responsiveness, lower transportation cost,
higher product availability, but reduced safety
inventory
Examples: McMaster-Carr, Gap, Wal-Mart
11-32
Specialization
Stock all items in each location or stock different
items at different locations?
Different products may have different demands in different
locations (e.g., snow shovels)
There can be benefits from aggregation
Benefits of aggregation can be affected by:
coefficient of variation of demand (higher cv yields greater
reduction in safety inventory from centralization)
value of item (high value items provide more benefits from
centralization)
Table 11.4
11-33
Product Substitution
Substitution: use of one product to satisfy the demand
for another product
Manufacturer-driven one-way substitution
Customer-driven two-way substitution
11-34
Component Commonality
Using common components in a variety of
different products
Can be an effective approach to exploit
aggregation and reduce component inventories
11-35
Example 11.9: Value of
Component Commonality
0
50000
100000
150000
200000
250000
300000
350000
400000
450000
1 2 3 4 5 6 7 8 9
SS
11-36
Postponement
The ability of a supply chain to delay product
differentiation or customization until closer to the
time the product is sold
Goal is to have common components in the
supply chain for most of the push phase and move
product differentiation as close to the pull phase
as possible
Examples: Dell, Benetton
POSTPONEMENT PRACTICES
INDIAN PAINT INDUSTRY
Nature of Product
Demand Pattern
Variety
Perishability
Finished Product Inventory Costs
Postponement
Dealer Tinting System
11-37
11-38
Impact of Replenishment
Policies on Safety Inventory
Continuous review policies
Periodic review policies
11-39
Estimating and Managing
Safety Inventory in Practice
Account for the fact that supply chain demand is
lumpy
Adjust inventory policies if demand is seasonal
Use simulation to test inventory policies
Start with a pilot
Monitor service levels
Focus on reducing safety inventories
11-40
What is the role of safety inventory in a supply chain?
What are the factors that influence the required level
of safety inventory?
What are the different measures of product
availability?
What managerial levers are available to lower safety
inventory and improve product availability?
9-1
Chapter 9
Sales and
Operations
Planning
9-2
Outline
Responding to predictable variability in a supply chain
Managing supply
Managing demand
Implementing solutions Sales and Operations
Planning - to predictable variability in practice
9-3
Responding to Predictable
Variability in a Supply Chain
Predictable variability is change in demand that can be
forecasted
Can cause increased costs and decreased responsiveness
in the supply chain
A firm can handle predictable variability using two
broad approaches:
Manage supply using capacity, inventory, subcontracting, and
backlogs
Manage demand using short-term price discounts and trade
promotions
9-4
Managing Supply
Managing capacity
Time flexibility from workforce
Use of seasonal workforce
Use of subcontracting
Use of dual facilities dedicated and flexible
Designing product flexibility into production processes
Managing inventory
Using common components across multiple products
Building inventory of high demand or predictable demand
products
9-5
Inventory/Capacity Trade-off
Leveling capacity forces inventory to build up in
anticipation of seasonal variation in demand
Carrying low levels of inventory requires capacity
to vary with seasonal variation in demand or
enough capacity to cover peak demand during
season
9-6
Managing Demand
Promotion
Pricing
Timing of promotion and pricing changes is
important
Demand increases can result from a combination
of three factors:
Market growth (increased sales, increased market size)
Stealing share (increased sales, same market size)
Forward buying (same sales, same market size)
9-7
Demand Management
Pricing and aggregate planning must be done
jointly
Factors affecting discount timing
Product margin: Impact of higher margin ($40 instead
of $31)
Consumption: Changing fraction of increase coming
from forward buy (100% increase in consumption
instead of 10% increase)
Forward buy
9-8
Factors Affecting
Promotion Timing
Factor Favored timing
High forward buying Low demand period
High stealing share High demand period
High growth of market High demand period
High margin High demand period
Low margin Low demand period
High holding cost Low demand period
Low flexibility Low demand period
Red Tomato Tools
Planning example
9-9
9-10
Off-Peak (January) Discount
from $40 to $39
January 3,000
February 2,400
March 2,560
April 3,800
May 2,200
June 2,200
Cost = $421,915, Revenue = $643,400, Profit = $221,485
9-11
Peak (April) Discount
from $40 to $39
January 1,600
February 3,000
March 3,200
April 5,060
May 1,760
June 1,760
9-12
January Discount: 100% Increase in
Consumption, Sale Price = $40 ($39)
January 4,440
February 2,400
March 2,560
April 3,800
May 2,200
June 2,200
Off-peak discount: Cost = $456,750, Revenue = $699,560
9-13
Peak (April) Discount: 100% Increase
in Consumption, Sale Price = $40 ($39)
January 1,600
February 3,000
March 3,200
April 8,480
May 1,760
June 1,760
Peak discount: Cost = $536,200, Revenue = $783,520
9-14
Performance Under
Different Scenarios
Regular
Price
Promotion
Price
Promotion
Period
Percent
increase in
demand
Percent
forward
buy
Profit Average
Inventory
$40 $40 NA NA NA $217,725 895
$40 $39 January 10% 20% $221,485 523
$40 $39 April 10% 20% $211,283 938
$40 $39 January 100% 20% $242,810 208
$40 $39 April 100% 20% $247,320 1,492
$31 $31 NA NA NA $73,725 895
$31 $30 January 100% 20% $84,410 208
$31 $30 April 100% 20% $69,120 1,492
9-15
Implementing Solutions to
Predictable Variability in Practice
Coordinate planning across enterprises in the supply
chain
Take predictable variability into account when
making strategic decisions
Preempt, do not just react to, predictable variability
SEASONALITY OF INPUT PRODUCT AND
CAPACITY UTILISATION OF PLANT
Seasonal agricultural produce such as sugarcane, has
to reach sugar mills for crushing soon after harvesting
to avoid sugar yield and quality losses. What steps
have been taken by Simbhaoli Sugars to ensure even
flow of this crop into the mill in line with the
installed crushing capacity to minimise losses?
Identify the innovative practices adopted by
Simbhaoli Sugars Limited and link the same with
supply chain best practices used in process industries.
9-17
How can supply be managed to improve
synchronization in the supply chain in the face of
predictable variability?
How can demand be managed to improve
synchronization in the supply chain in the face of
predictable variability?
How can sales and operations planning be used to
maximize profitability when faced with predictable
variability in the supply chain?
1-1
Chapter 1
Understanding
the Supply
Chain
1-2
Traditional View: Logistics in the
US Economy (2006, 2007)
Freight Transportation $809, $856 Billion
Inventory Expense $446, $487 Billion
Administrative Expense $50, $54 Billion
Total Logistics Costs $1.31, $1.4 Trillion
Logistics Related Activity 10%, 10.1% of GNP
Source: 18
th
and 19
th
Annual State of Logistics Report Logistics Magazine
1-3
Manufacturing Firm
Profit 4%
Logistics Cost 21%
Marketing Cost 27%
Manufacturing Cost 48%
Profit
Logistics
Cost
Marketing
Cost
Manufacturing
Cost
1-4
Supply Chain Management: The
Magnitude in the Traditional View
Estimated that the grocery industry could save $30
billion (10% of operating cost) by using effective
logistics and supply chain strategies
Laura Ashley turns its inventory 10 times a year, five
times faster than 3 years ago
1-5
Supply Chain Management:
The True Magnitude
Compaq estimates it lost $.5 billion to $1 billion in
sales in 1995 because laptops were not available when
and where needed
When the 1 gig processor was introduced by AMD,
the price of the 800 mb processor dropped by 30%
P&G estimates it saved retail customers $65 million
by collaboration resulting in a better match of supply
and demand
1-6
Outline
What is a Supply Chain?
Decision Phases in a Supply Chain
Process View of a Supply Chain
The Importance of Supply Chain Flows
1-7
Introduction
The objective of a supply chain
1-8
All stages involved, directly or indirectly, in fulfilling
a customer request
Includes manufacturers, suppliers, transporters,
warehouses, retailers, and customers
Within each company, the supply chain includes all
functions involved in fulfilling a customer request
(product development, marketing, operations,
distribution, finance, customer service)
Examples: Fig. 1.1 Detergent supply chain (Wal-
Mart), Dell
1-9
Customer is an integral part of the supply chain
Includes movement of products from suppliers to
manufacturers to distributors, but also includes
movement of information, funds, and products in both
directions
Probably more accurate to use the term supply
network or supply web
Typical supply chain stages: customers, retailers,
distributors, manufacturers, suppliers (Fig. 1.2)
All stages may not be present in all supply chains
(e.g., no retailer or distributor for Dell)
1-10
Customer wants
detergent and goes
to Jewel
Jewel
Supermarket
Jewel or third
party DC
P&G or other
manufacturer
Plastic
Producer
Chemical
manufacturer
(e.g. Oil Company)
Tenneco
Packaging
Paper
Manufacturer
Timber
Industry
Chemical
manufacturer
(e.g. Oil Company)
1-11
Flows in a Supply Chain
Customer
Information
Product
Funds
1-12
The Objective of a Supply Chain
Maximize overall value created
Supply chain value: difference between what the final
product is worth to the customer and the effort the
supply chain expends in filling the customers request
Value is correlated to supply chain profitability
(difference between revenue generated from the
customer and the overall cost across the supply chain)
1-13
Example: Dell receives $2000 from a customer for a
computer (revenue)
Supply chain incurs costs (information, storage,
transportation, components, assembly, etc.)
Difference between $2000 and the sum of all of these
costs is the supply chain profit
Supply chain profitability is total profit to be shared
across all stages of the supply chain
Supply chain success should be measured by total
supply chain profitability, not profits at an individual
stage
1-14
Sources of supply chain revenue: the customer
Sources of supply chain cost: flows of information,
products, or funds between stages of the supply chain
Supply chain management is the management of
flows between and among supply chain stages to
maximize total supply chain profitability
1-15
Decision Phases of a Supply Chain
Supply chain strategy or design
Supply chain planning
Supply chain operation
1-16
Supply Chain Strategy or Design
Decisions about the structure of the supply chain and
what processes each stage will perform
Strategic supply chain decisions
Locations and capacities of facilities
Products to be made or stored at various locations
Modes of transportation
Information systems
Supply chain design must support strategic objectives
Supply chain design decisions are long-term and
expensive to reverse must take into account market
uncertainty
1-17
Supply Chain Planning
Definition of a set of policies that govern short-term
operations
Fixed by the supply configuration from previous
phase
Starts with a forecast of demand in the coming year
1-18
Planning decisions:
Which markets will be supplied from which locations
Planned buildup of inventories
Subcontracting, backup locations
Inventory policies
Timing and size of market promotions
Must consider in planning decisions demand
uncertainty, exchange rates, competition over the time
horizon
1-19
Supply Chain Operation
Time horizon is weekly or daily
Decisions regarding individual customer orders
Supply chain configuration is fixed and operating
policies are determined
Goal is to implement the operating policies as
effectively as possible
Allocate orders to inventory or production, set order
due dates, generate pick lists at a warehouse, allocate
an order to a particular shipment, set delivery
schedules, place replenishment orders
Much less uncertainty (short time horizon)
1-20
Cycle view: processes in a supply chain are divided
into a series of cycles, each performed at the
interfaces between two successive supply chain stages
Push/pull view: processes in a supply chain are
divided into two categories depending on whether
they are executed in response to a customer order
(pull) or in anticipation of a customer order (push)
1-21
Cycle View of Supply Chains
Customer Order Cycle
Replenishment Cycle
Manufacturing Cycle
Procurement Cycle
Customer
Retailer
Distributor
Manufacturer
Supplier
1-22
Cycle View of a Supply Chain
Each cycle occurs at the interface between two successive
stages
Customer order cycle (customer-retailer)
Replenishment cycle (retailer-distributor)
Manufacturing cycle (distributor-manufacturer)
Procurement cycle (manufacturer-supplier)
Cycle view clearly defines processes involved and the
owners of each process. Specifies the roles and
responsibilities of each member and the desired outcome
of each process.
1-23
Procurement,
Manufacturing and
Replenishment cycles
Customer Order
Cycle
Customer
Order Arrives
1-24
Push/Pull View of
Supply Chain Processes
Supply chain processes fall into one of two categories
depending on the timing of their execution relative to
customer demand
Pull: execution is initiated in response to a customer
order (reactive)
Push: execution is initiated in anticipation of customer
orders (speculative)
Push/pull boundary separates push processes from
pull processes
1-25
Push/Pull View of
Useful in considering strategic decisions relating to
supply chain design more global view of how
supply chain processes relate to customer orders
Can combine the push/pull and cycle views
L.L. Bean (Figure 1.6)
Dell (Figure 1.7)
The relative proportion of push and pull processes can
have an impact on supply chain performance
1-26
Supply Chain Macro Processes in
a Firm
Supply chain processes discussed in the two views can
be classified into (Figure 1.8):
Customer Relationship Management (CRM)
Internal Supply Chain Management (ISCM)
Supplier Relationship Management (SRM)
Integration among the above three macro processes is
critical for effective and successful supply chain
management
1-27
Gateway
Zara
McMaster Carr / W.W. Grainger
Toyota
Amazon / Borders / Barnes and Noble
Webvan / Peapod / Jewel
What are some key issues in these supply chains?
1-28
Gateway: A Direct Sales Manufacturer
Why did Gateway have multiple production facilities in the
US? What advantages or disadvantages does this strategy offer
relative to Dell, which has one facility?
What factors did Gateway consider when deciding which plants
to close?
Why does Gateway not carry any finished goods inventory at
its retail stores?
Should a firm with an investment in retail stores carry any
finished goods inventory?
Is the Dell model of selling directly without any retail stores
always less expensive than a supply chain with retail stores?
What are the supply chain implications of Gateways decision
to offer fewer configurations?
1-29
7-Eleven
What factors influence decisions of opening and closing stores?
Location of stores?
Why has 7-Eleven chosen off-site preparation of fresh food?
Why does 7-Eleven discourage direct store delivery from vendors?
Where are distribution centers located and how many stores does
each center serve? How are stores assigned to distribution centers?
Why does 7-Eleven combine fresh food shipments by temperature?
What point of sale data does 7-Eleven gather and what information
is made available to store managers? How should information
systems be structured?
1-30
W.W. Grainger and McMaster Carr
How many DCs should there be and where should they be
located?
How should product stocking be managed at the DCs? Should
all DCs carry all products?
What products should be carried in inventory and what
products should be left at the supplier?
What products should Grainger carry at a store?
How should markets be allocated to DCs?
How should replenishment of inventory be managed at various
stocking locations?
How should Web orders be handled?
What transportation modes should be used?
1-31
Toyota
Where should plants be located, what degree of
flexibility should each have, and what capacity should
each have?
Should plants be able to produce for all markets?
How should markets be allocated to plants?
What kind of flexibility should be built into the
distribution system?
How should this flexible investment be valued?
What actions may be taken during product design to
facilitate this flexibility?
1-32
Amazon.com
Why is Amazon building more warehouses as it grows? How
many warehouses should it have and where should they be
located?
What advantages does selling books via the Internet provide? Are
there disadvantages?
Why does Amazon stock bestsellers while buying other titles
from distributors?
Does an Internet channel provide greater value to a bookseller like
Borders or to an Internet-only company like Amazon?
Should traditional booksellers like Borders integrate e-commerce
into their current supply?
For what products does the e-commerce channel offer the greatest
benefits? What characterizes these products?
GOPALJEE
How can Gopaljee Supply and Distribution Model be
extended to other business lines in the Indian and South
Asian context?
Which all socio-economic features of South Asian societies
can be identified as the foundations for building sustainable
supply chains?
How can the existing distribution channels in the South
Asian region be transformed to maximize the value delivered
to the customer?
How can such indigenously developed SCM Models
integrate with and expand into global supply chains?
JAIPUR RUGS
How can small and medium scale industries in the
developing world, leverage the power of supply
chains to deliver value to the customers and
simultaneously improve the standard of living of
the artisans?
How can the involvement of middlemen be
minimised, freeing the artisans from exploitation
and under payment?
1-34
1-35
What are the cycle and push/pull views of a supply
chain?
How can supply chain macro processes be classified?
What are the three key supply chain decision phases
and what is the significance of each?
What is the goal of a supply chain and what is the
impact of supply chain decisions on the success of the
firm?
8-1
Outline Chapter 8: Aggregate
Planning in the Supply Chain
Role of aggregate planning in a supply chain
The aggregate planning problem
Aggregate planning strategies
Implementing aggregate planning in practice
8-2
in a Supply Chain
Basic Assumptions:
Capacity has a cost
Lead times are greater than zero
Aggregate planning:
Is the process by which a company determines levels of capacity,
production, subcontracting, inventory, stockouts, and pricing over a
specified time horizon
goal is to maximize profit Or, if demand is effectively fixed for all the
decision we can make, we can just minimize costs
decisions made at a product family (not SKU) level
time frame of 3 to 18 months (What decision phase are we in?)
Too late to build another plant
Too early to get into daily/weekly production issues, SKU level detail
We need to answer: how can a firm best use the facilities it has?
8-3
The Aggregate Planning Problem
(and role in the Supply Chain)
The Problem: Given the demand forecast for each period in the
planning horizon, determine the production level, inventory level,
and the capacity level for each period that maximizes the firms
(supply chains) profit over the planning horizon
Specify the planning horizon (typically 3 to 18 months)
Specify the duration of each period (typically 1 month for longer horizons)
Specify key information required to develop an aggregate plan
All supply chain stages should work together on an aggregate plan
that will optimize supply chain performance
For now we ignore transportation issues and costs and have single facility
Avoid sub-optimization by silo. We may need to incur more costs (ex.
outsourcing production) in a function to maximize overall profit
Supply chains usually involve multiple firms. If these firms have close ties,
it may be possible to optimize the efficiency of the entire chain

8-4
Information Needed for
an Aggregate Plan
Demand forecast in each period
Production costs
Machine costs
labor costs, regular time ($/hr) and overtime ($/hr)
subcontracting costs ($/hr or $/unit)
cost of changing capacity: hiring or layoff ($/worker) and cost of adding
or reducing machine capacity ($/machine)
Labor/machine hours required per unit
Material requirements per unit, material cost and availability
Inventory holding cost ($/unit/period)
Stock-out / backlog cost ($/unit/period)
Constraints: physical or policy limits on overtime, layoffs,
capital available, warehousing, stock-outs and backlogs
8-5
Outputs of Aggregate Plan
Production quantity from regular time, overtime, and
subcontracted time: used to determine number of workers and
supplier purchase levels
Inventory held: used to determine how much warehouse space
and working capital is needed
Backlog/stock-out quantity: used to determine what customer
service levels can be
(i.e. do we short customers for a certain time- and how much/how long?)
Machine capacity increase/decrease: used to determine if new
production equipment needs to be purchased

A poor aggregate plan can result in lost sales, lost profits, excess
inventory, or excess capacity
8-6
Aggregate Planning Strategies
There is typically a trade-off between optimizing for
capacity (machine+labor), inventory, and backlog/lost sales
Chase strategy: sync production with demand, hiring and firing as
needed.
Time flexibility from workforce or capacity strategy: assumes labor
pool can work variable hours (incl. overtime), has lower inventory&
utilization,
Level strategy keep capacity & labor usage constant, either
stockpile inventory or short orders as needed
Mixed strategy a combination of one or more of the first three
strategies

8-7
Tools for Creating Aggregate Plans
Some companies have not created explicit aggregate plans, and
rely only on orders from warehouses or DCs to drive production
schedules (pure pull system).
This is acceptable only if products are not capacity intensive, or if
maintaining a plant with low utilization is inexpensive.
It also assumes material and labor inputs are flexible / available when
needed

For simple problems, it may be possible to produce a feasible plan
by guessing. (No guarantee of optimality)

What tool is commonly used to produce an optimal aggregate
plan?
8-8
Linear Programming
Inherently assumes costs are linear
Pure unit costs are the easiest
Increasing marginal costs (e.g. regular labor $20/hour, overtime $30/hour)
Economies of scale harder to model, but possible (ignored for this class)

Difficulty of solving increases with degree of detail
Take a 1-year plan for a plant that monitors weekly production of 100
different SKUs. How many variables?
have 100*52 = over 5000 production decision variables P
i,t

If we could aggregate SKUs into 5 different product families, with
monthly time buckets, how many variables do we have now?
only have 5*12= 60 decision variables for P
i,t

Industry aggregate plans often have 10,000 to 100,000 decision variables
In this class will keep our problem scales well below that of industry
(under 200 decision variables, the limit of the built in Excel solver)
8-9
Aggregate Planning Example: Red
Tomato Tools, Inc.
Red Tomato makes a single product, a garden tool that sells for $40
Red Tomato starts with 1000 of these tools in inventory and is expected to end
with at least 500 in stock
Red Tomato can temporarily backlog demand for a cost, but at the end of the time
horizon, they require their backlog to be zero
This is an important constraint to remember- if we forget it, we will get strange results
Production costs are based on parts and labor with no machine capacity issues
They start with 80 employees can hire or fire workers for a cost.
Workers get regular pay whether they are producing or not. There are 20 days of
production per month, each month.
We can have workers work overtime (no more than 10 hrs/mo per worker) for extra $
We can also subcontract production out and pay a flat fee (in lieu of labor + materials)
Red Tomato would like to generate a 6 month plan that maximizes profits
(revenue net of costs)
For now we can just minimizing costs, if we have no influence over demand
8-10
Aggregate Planning at
Red Tomato Tools
January 1,600
February 3,000
March 3,200
April 3,800
May 2,200
June 2,200
Heres the demand that the book gives us- see the seasonality?
8-11
Aggregate Planning- Costs
I tem Cost
Materials $10/unit
Inventory holding cost $2/unit/month
Marginal cost of a stockout $5/unit/month
Hiring and training costs $300/worker
Layoff cost $500/worker
Labor hours required 4/unit
Regular time cost $4/hour
Over time cost $6/hour
Cost of subcontracting $30/unit
Note: subcontracting costs includes all materials and labor
Time to bring up Excel.
8-12
Aggregate Planning
(Define the Decision Variables)
W
t
= Workforce size for month t, t = 1, ..., 6

H
t
= Number of employees hired at start of month t, t = 1, ..., 6

L
t
= Number of employees laid off at start of month t, t = 1, ..., 6

P
t
= Production in month t, t = 1, ..., 6

I
t
= Inventory at the end of month t, t = 1, ..., 6

S
t
= Number of units stocked out (backlogged) at end of month t, t = 1, ..., 6

C
t
= Number of units subcontracted for month t, t = 1, ..., 6

O
t
= Number of overtime hours worked in month t, t = 1, ..., 6
8-13
Aggregate Planning
(Define Objective Function)

6
1
6
1
6
1
6
1
6
1
6
1
6
1
6
1
30 10 5
2 6 500
300 640
t
t
t
t
t
t
t
t
t
t
t
t
t
t
t
t
C P S
I O L
H W
Min
Apologies to any Finance gurus but we do not consider NPV here
8-14
Aggregate Planning (Constraints)
Aside from the conditions for the ending level of
inventory and the ending backlog being = 0, we
will have 4 other types of constraints to consider:
1. Balance of workers
2. Production limit
3. Balance of inventory
4. Overtime limit
8-15
Aggregate Planning (Define
Constraints Linking Variables)
Workforce size for each month is based on hiring and layoffs
(# workers employed end of Month 1 = # workers employed
at the start of Month 2)
May end up with fractional # workers, e.g. 73.4, which could be
acceptable if we allow for part-time (Also, even if not with larger
numbers like this, we can get away with approximating for integer)
Is a Balance constraint. No spontaneous creation or destruction of
workers outside of the hiring and layoff processes
. 80 , 6 ,..., 1
0
,
0
1
1

W where t for
L H W W
or
L H W W
t t t t
t t t t
8-16
Links Between Periods?
Why not create 6 different LPs, each with 1 period of a month?
It would be easier* for the computer to solve, after all!

Why not solve several 1-month problems sequentially? At end
points, such as #workers left at the end of the month 1 and
then use that as the starting #workers for month 2?
* A computer trivial aside from this class: as N increases, the inherent complexity and
required solution time goes up by order of N
3
or more)
8-17
Production for each month cannot exceed capacity
(hence, have a limit rather than balance constraint)
. 6 ,..., 1
, 0 4 40
, 4 40

t for
P O W
O W P
t t t
t t t
or
8-18
Inventory balance for each month.
Inventory levels change if we a) produce (P) or sub-contract (C)
more units than we have demand for, either from this period (t) or
the prior one (t-1). It may help to think about what is a debit
and a credit to the level of inventory.

We can then rearrange the terms to reflect standard form (all
variables on one side). What happens at t=0?

0
1 1
1 1

S I S D C P I
S I S D C P I
t t t t t t t
t t t t t t t
For t =1 to 6
8-19
Over-time limit for each month, reflecting policy
that no one worker can put in more than 10 hours
of overtime for the month.
. 6 ,..., 1
, 0 10
, 10
t for
O W
W O
t t
t t
or
8-20
Further Conditions
All of the variables are inherently non-negative
We have a starting balance of
80 workers
1000 tools
0 backlog
Thus, the variables associated with these are going to need to be
initialized (put in a value for time period 0)

Reminder: have been told that we are not allowed to have
any backlog and must have at least 500 tools in stock at
the end of the planning horizon
8-21
LP Formulation
We now take a brief digression and look at the formulation in
Excel, including the LP Solver configuration and the reports

Some things to think about:
1. How many variables will we have?
2. Which variables have memory- and why do we care?
3. How many different types of constraints (aside from non-
negativity and certain beginning/end conditions)? How
many total constraint equations?
4. What is our overall goal? Why can we take a shortcut
8-22
LP Formulation
8-23
LP Formulation: Solver
Decision variables are indexed to 1 thru 6, tp0 exists only for initialization
We have 4 types of constraints, plus 2 ending conditions
Technically we should require variables to be integers (no laying off .2
people or making .3 tools) but for now will leave as linear.
Real industry LPs have numbers like 300K and 3M, so this is less of an issue
Assume linear model and non-negativity both checked in Options
8-24
What-if Scenarios
Planners often run re-run their models to see how the plan
might change if parameter values are different than expected

Here are some potentially realistic changes that would result
in changes our previously optimal plan at Red Tomato:
1. Increase the seasonal swings in demand (Example 8-1)
2. Raise holding costs (from $2 to $6) (Example 8-2)
8-25
Increased Demand Fluctuation
January 1,000
February 3,000
March 3,800
April 4,800
May 2,000
June 1,400
For chapter 8, we are assuming that demand
is beyond our control to influence.
Demand is still 16000 within the total planning period
8-26
Solution: Comparison of What-If
Scenario 1 vs.- Base Case
Major changes
Increases total Costs by $10,583
Changes come from Inventory and Stock-out
Base Case costs: $10,233 $1,333
Larger seasonal fluctuations: $12,400 $9,750

Caveat: The book treats beginning and end periods differently when calculating
the average inventory position (see p. 218, p.220). This is overkill: we can just
use a simple average if we are interested in the inventory position.
Should I ask you to calculate this on a test, either method is correct, but my
method is easier!
I will focus on minimizing the total inventory COST over the planning
horizon rather than inventory LEVELS at any point in time- ultimately,
inventory levels are measured because of their associated costs

8-27
What-If Scenario #2: Increase
Inventory Costs from $2 to $6
Major changes- costs increase over base case. In what way?

Reduce inventory carried by.
engaging in more workforce reductions as pre-building inventory for
peak periods is no longer as cost effective
subcontracting some demand out in peak periods

We switch from what type of strategy to what?
8-28
More Thoughts on Red
Tomatos Planning Problem
1. What if our aggregate demand forecasts are incorrect?
Review/ Reminder: How often are real forecasts 100% accurate?

2. What if demand is greater than anticipated?
What are some ways we can prepare for extra (either in terms of Safety
Stock or Safety Capacity?)

3. What if demand is less than anticipated- what will happen?
What is one way to keep costs lower if demand is greatly reduced and
expected to stay low for awhile?

9-30
Managing Supply: Some Possible
Tools to Consider
Managing capacity
Time flexibility from workforce
Use of a seasonal workforce
Use of subcontracting
Use of dual facilities dedicated and flexible
Designing product flexibility into production processes
Managing inventory
Using common components across multiple products
Building up inventory of high demand or predictable demand
products
Inventory strategies are discussed in detail in Chapters10-12
8-31
Aggregate Planning in Practice
If possible, think beyond your enterprise to the entire supply
chain*

Make plans flexible because forecasts are always wrong
Sensitivity Analysis can be used to show where bottlenecks and potential
improvements may be

Rerun the aggregate plan as new information emerges
Usually every time period, with revisions and future predictions

Importance of aggregate planning grows as a firms capacity
utilization increases
Less room for mistakes in this era of low margins
8-32
Summary of Chapter 8s Learning
Objectives
1. What types of decisions are best solved by aggregate
planning?
2. What is the importance of aggregate planning as a supply
chain activity?
3. What kinds of information are needed to produce an aggregate
plan?
4. What are the basic trade-offs a manager makes to produce an
aggregate plan?
5. How are aggregate planning problems formulated and solved
using Microsoft Excel?
9-33
Chapter 9 Outline:
Sales and Operations Planning
In Chapter 8 we focused on managing supply, but now
we are going to consider: Managing demand
Implementing solutions Sales and Operations
Planning (S&OP) to manage predictable variability
in practice
9-34
Responding to Predictable
Variability in a Supply Chain
Predictable variability - demand changes that can be forecasted

Can increase costs and decrease responsiveness in the supply
chain (as discussed in Chapter 17- Supply Chain coordination)

A firm can handle predictable variability using two broad
approaches:

1. Manage supply using capacity, inventory, subcontracting,
and backlogs (This is what we did in Chapter 8)
2. Manage demand using short-term price discounts and trade
promotions
9-35
Demand Management
Promotion- increased marketing, product placements,
discounts to wholesalers/retailers, etc.

Pricing discounts to consumers

Demand Management and aggregate planning must be
jointly coordinated

Factors that should influence timing of promotion/ price
discount
1. Product margins: Impact of change in margins
2. Demand changes
3. Cost of holding inventory
4. Cost of changing capacity

Some companies with software or services in this arena:
DemandTec, Rapt, KHI
9-36
Effect of Promotions and Discounts
Demand increases can result from a combination of three
factors:
1. Market growth (increased sales, increased market size)
2. Stealing market share (increased sales, same market size)
3. Forward buying (same sales, same market size)
Have you ever stocked up on an item that was on a great sale?
Higher demand now offset by demand decrease in later periods

It is crucial to be able to estimate the effect of all these factors,
as their effects will determine what is the best pricing and
promotion strategy
9-37
Example: Effect of
Promotions and Discounts
Red Tomato Example: a $1 discount offered to the consumer
for a month is expected to increase demand that period by
10% because of market growth or stealing share, and also with
20% of demand for the next two months being pulled forward
to the current month

How do we compute the new demand?
How do we modify the aggregate planning problem?
Do we need to revisit our objective function?
Hint: we are now considering actions that will modify demand between
scenarios, whereas in our prior work demand was assumed to be fixed
9-38
Off-Peak (January) if Discount
Sales Price from $40 to $39
January 3,000
February 2,400
March 2,560
April 3,800
May 2,200
June 2,200

10% increase in January
but forward buying decreases Feb and Mars demands each by 20%
Cost = $421,915, Revenue = $643,400, ->Profit = $221,485
Profit is better than base case (no discount) profit of $217,725
The next few slides show scenarios from the textbook example
9-39
Peak (April) if Discount
price from $40 to $39
January 1,600
February 3,000
March 3,200
April 5,060
May 1,760
June 1,760

10% increase in April
but forward buying decreases May and Junes demands each by 20%
Profit is worse than either base case or off-peak discount
9-40
January Discount (Sales price $39):
if 100% Increase in Consumption
January 4,440
February 2,400
March 2,560
April 3,800
May 2,200
June 2,200

Assumes 100% rather than 10% consumption increase
either from overall market growth for product or stealing share from others
still assume 20% forward buying from Feb and March
Off-peak discount: Cost = $456,750, Revenue = $699,560, Profit $242,810
9-41
Peak (April) Discount:
if 100% Increase in Consumption
January 1,600
February 3,000
March 3,200
April 8,480
May 1,760
June 1,760

We still assume we have 20% forward buying from May and June
Peak discount: Cost = $536,200, Revenue = $783,520
PROFIT $247,320 better than no promotion or off peak promo
9-42
Performance Under
Different Scenarios
Regular
Price
Promotion
Price
Promotion
Period
Percent
increase in
demand
Percent
forward
buy
Profit
$40 none NA NA NA $217,725
$40 $39 January 10 % 20 % $221,485
$40 $39 April 10% 20% $211,283
$40 $39 January 100% 20% $242,810
$40 $39 April 100% 20% $247,320

$31 none NA NA NA $73,725
$31 $30 January 100% 20% $84,410
$31 $30 April 100% 20% $69,120

Summary of different results (includes a low-margin variation,
where product only retails for a $31 regular price.)
Based on the effects of different factors, the optimal promotion
time (high verses low demand months) will change
9-43
Factors Affecting Optimal
Promotion Timing
Factor Favored timing
High forward buying Low demand period
High stealing of market share High demand period
High growth of market High demand period
High margin High demand period
High holding cost Low demand period
High flexibility High demand period

Reverse timing for opposite (Low Margin -> Low demand period best)
For a combination of factors (i.e. high margin product, but with a high
holding cost) still need to analyze to see which factor dominates
9-44
Implementing Solutions to
Predictable Variability in Practice
Coordinate* planning across enterprises in the supply chain

Take predictable variability into account when making strategic
decisions

Pre-empt (do not just react to) predictable variability
Be proactive, not reactive

Perform a lot of What-if analysis BEFORE going live with a
strategy!
9-45
Objectives
1. What factors may comprise an increase in Demand?
2. How can supply be managed to improve synchronization in
the supply chain in the face of predictable variability?
3. How can aggregate planning be used to maximize
profitability when faced with predictable variability in the
supply chain?
10-1
Chapter 10
Managing
Economies of
Scale in the
Supply Chain:
Cycle Inventory
10-2
Outline
Role of Cycle Inventory in a Supply Chain
Economies of Scale to Exploit Fixed Costs
Economies of Scale to Exploit Quantity Discounts
Short-Term Discounting: Trade Promotions
Managing Multi-Echelon Cycle Inventory
Estimating Cycle Inventory-Related Costs in
Practice
10-3
Role of Inventory in the Supply Chain
Improve Matching of Supply
and Demand
Improved Forecasting
Reduce Material Flow Time
Reduce Waiting Time
Reduce Buffer Inventory
Economies of Scale
Supply / Demand
Variability
Seasonal
Variability
Cycle Inventory Safety Inventory
Figure Error! No text of
Seasonal Inventory
10-4
Role of Cycle Inventory
in a Supply Chain
Lot, or batch size: quantity that a supply chain stage either
produces or orders at a given time
Cycle inventory: average inventory that builds up in the
supply chain because a supply chain stage either produces
or purchases in lots that are larger than those demanded by
the customer
Q = lot or batch size of an order
D = demand per unit time
Inventory profile: plot of the inventory level over time
(Fig. 10.1)
Cycle inventory = Q/2 (depends directly on lot size)
Average flow time = Avg inventory / Avg flow rate
Average flow time from cycle inventory = Q/(2D)
10-5
in a Supply Chain
Q = 1000 units
D = 100 units/day
Cycle inventory = Q/2 = 1000/2 = 500 = Avg inventory level from
cycle inventory
Avg flow time = Q/2D = 1000/(2)(100) = 5 days
Cycle inventory adds 5 days to the time a unit spends in the
supply chain
Lower cycle inventory is better because:
Average flow time is lower
Working capital requirements are lower
Lower inventory holding costs
10-6
in a Supply Chain
Cycle inventory is held primarily to take advantage of
economies of scale in the supply chain
Supply chain costs influenced by lot size:
Material cost = C
Fixed ordering cost = S
Holding cost = H = hC (h = cost of holding $1 in inventory for one year)
Primary role of cycle inventory is to allow different stages to
purchase product in lot sizes that minimize the sum of material,
ordering, and holding costs
Ideally, cycle inventory decisions should consider costs across
the entire supply chain, but in practice, each stage generally
makes its own supply chain decisions increases total cycle
inventory and total costs in the supply chain
Estimating Cycle Inventory
Related Costs in Practice
Inventory Holding Cost
Obsolescence
Handling costs
Occupancy costs
Theft, security, damage, tax, insurance
Ordering Cost
Buyer time
Transportation costs
Receiving costs
Unique other costs
10-7
10-8
Economies of Scale
to Exploit Fixed Costs
How do you decide whether to go shopping at a
convenience store or at Sams Club?
Lot sizing for a single product (EOQ)
Aggregating multiple products in a single order
Lot sizing with multiple products or customers
Lots are ordered and delivered independently for each
product
Lots are ordered and delivered jointly for all products
Lots are ordered and delivered jointly for a subset of
products
10-9
Economies of Scale
to Exploit Fixed Costs
Annual demand = D
Number of orders per year = D/Q
Annual material cost = CR
Annual order cost = (D/Q)S
Annual holding cost = (Q/2)H = (Q/2)hC
Total annual cost = TC = CD + (D/Q)S + (Q/2)hC
Figure 10.2 shows variation in different costs for
different lot sizes at Best Buy
10-10
Fixed Costs: Optimal Lot Size
and Reorder Interval (EOQ)
D: Annual demand
S: Setup or Order Cost
C: Cost per unit
h: Holding cost per year as a
fraction of product cost
H: Holding cost per unit per year
Q: Lot Size, Q*: Optimal Lot Size
n*: Optimal order frequency
Material cost is constant and
therefore is not considered in
this model
S
DhC
n
H
DS
Q
hC H
2
*
2
*

10-11
Example 10.1
Demand, D = 12,000 computers per year
Unit cost, C = $500
Holding cost fraction, h = 0.2
Fixed cost, S = $4,000/order
Q* = Sqrt[(2)(12000)(4000)/(0.2)(500)] = 980 computers
Cycle inventory = Q*/2 = 490
Average Flow time = Q*/2D = 980/(2)(12000) = 0.041
year = 0.49 month
n* = Sqrt[(12000)(0.2)(500)/(2)(4000)] = 12.24 orders
10-12
Example 10.1 (continued)
Annual ordering and holding cost =
= (12000/980)(4000) + (980/2)(0.2)(500) = $97,980
Suppose lot size is reduced to Q=200, which would
reduce flow time:
Annual ordering and holding cost =
= (12000/200)(4000) + (200/2)(0.2)(500) = $250,000
To make it economically feasible to reduce lot size, the
fixed cost associated with each lot would have to be
reduced
10-13
Example 10.2
If desired lot size = Q* = 200 units, what would S have
to be?
D = 12000 units
C = $500
h = 0.2
Use EOQ equation and solve for S:
S = [hC(Q*)
2
]/2D = [(0.2)(500)(200)
2
]/(2)(12000) =
$166.67
To reduce optimal lot size by a factor of k, the fixed order
cost must be reduced by a factor of k
2
10-14
Key Points from EOQ Model
In deciding the optimal lot size, the tradeoff is between
setup (order) cost and holding cost.
If demand increases by a factor of 4, it is optimal to
increase batch size by a factor of 2 and produce (order)
twice as often. Cycle inventory (in days of demand)
should decrease as demand increases.
If lot size is to be reduced, one has to reduce fixed order
cost. To reduce lot size by a factor of 2, order cost has
to be reduced by a factor of 4.
10-15
Aggregating Multiple Products
in a Single Order
Transportation is a significant contributor to the fixed cost per order
Can possibly combine shipments of different products from the
same supplier
same overall fixed cost
shared over more than one product
effective fixed cost is reduced for each product
lot size for each product can be reduced
Can also have a single delivery coming from multiple suppliers or a
single truck delivering to multiple retailers
Aggregating across products, retailers, or suppliers in a single order
allows for a reduction in lot size for individual products because
fixed ordering and transportation costs are now spread across
multiple products, retailers, or suppliers
10-16
Example: Aggregating Multiple
Products in a Single Order
Suppose there are 4 computer products in the previous
example: Deskpro, Litepro, Medpro, and Heavpro
Assume demand for each is 1000 units per month
If each product is ordered separately:
Q* = 980 units for each product
Total cycle inventory = 4(Q/2) = (4)(980)/2 = 1960 units
Aggregate orders of all four products:
Combined Q* = 1960 units
For each product: Q* = 1960/4 = 490
Cycle inventory for each product is reduced to 490/2 = 245
Total cycle inventory = 1960/2 = 980 units
Average flow time, inventory holding costs will be reduced
10-17
Lot Sizing with Multiple
Products or Customers
In practice, the fixed ordering cost is dependent at least in part
on the variety associated with an order of multiple models
A portion of the cost is related to transportation
(independent of variety)
A portion of the cost is related to loading and receiving
(not independent of variety)
Three scenarios:
Lots are ordered and delivered independently for each
product
Lots are ordered and delivered jointly for all three models
Lots are ordered and delivered jointly for a selected subset of
models
10-18
Lot Sizing with Multiple Products
Demand per year
D
L
= 12,000; D
M
= 1,200; D
H
= 120
Common transportation cost, S = $4,000
Product specific order cost
s
L
= $1,000; s
M
= $1,000; s
H
= $1,000
Holding cost, h = 0.2
Unit cost
C
L
= $500; C
M
= $500; C
H
= $500
10-19
Delivery Options
No Aggregation: Each product ordered separately
Complete Aggregation: All products delivered on
each truck
Tailored Aggregation: Selected subsets of products
on each truck
10-20
No Aggregation: Order Each
Product Independently
Litepro Medpro Heavypro
Demand per
year
12,000 1,200 120
Fixed cost /
order
$5,000 $5,000 $5,000
Optimal
order size
1,095 346 110
Order
frequency
11.0 / year 3.5 / year 1.1 / year
Annual cost $109,544 $34,642 $10,954
Total cost = $155,140
10-21
Aggregation: Order All
Products Jointly
S* = S + s
L
+ s
M
+ s
H
= 4000+1000+1000+1000 = $7000
n* = Sqrt[(D
L
hC
L
+ D
M
hC
M
+ D
H
hC
H
)/2S*]
= 9.75
Q
L
= D
L
/n* = 12000/9.75 = 1230
Q
M
= D
M
/n* = 1200/9.75 = 123
Q
H
= D
H
/n* = 120/9.75 = 12.3
Cycle inventory = Q/2
Average flow time = (Q/2)/(weekly demand)
10-22
Complete Aggregation:
Order All Products Jointly
Litepro Medpro Heavypro
Demand per
year
12,000 1,200 120
Order
frequency
9.75/year 9.75/year 9.75/year
Optimal
order size
1,230 123 12.3
Annual
holding cost
$61,512 $6,151 $615
Annual order cost = 9.75 $7,000 = $68,250
Annual total cost = $136,528
10-23
Lessons from Aggregation
Aggregation allows firms to lower lot size without
increasing cost
Complete aggregation is effective if product
specific fixed cost is a small fraction of joint fixed
cost
Tailored aggregation is effective if product
specific fixed cost is a large fraction of joint fixed
cost
10-24
Economies of Scale to
Exploit Quantity Discounts
All-unit quantity discounts
Marginal unit quantity discounts
Why quantity discounts?
Coordination in the supply chain
Price discrimination to maximize supplier profits
10-25
Quantity Discounts
Lot size based
All units
Marginal unit
Volume based
How should buyer react?
What are appropriate discounting schemes?
10-26
All-Unit Quantity Discounts
Pricing schedule has specified quantity break points
q
0
, q
1
, , q
r
, where q
0
= 0
If an order is placed that is at least as large as q
i
but
smaller than q
i+1
, then each unit has an average unit
cost of C
i
The unit cost generally decreases as the quantity
increases, i.e., C
0
>C
1
>>C
r
The objective for the company (a retailer in our
example) is to decide on a lot size that will minimize
the sum of material, order, and holding costs
10-27
All-Unit Quantity Discount Procedure
(different from what is in the textbook)
Step 1: Calculate the EOQ for the lowest price. If it is feasible
(i.e., this order quantity is in the range for that price), then stop.
This is the optimal lot size. Calculate total cost (TC ) for this
lot size.
Step 2: If the EOQ is not feasible, calculate the TC for this price
and the smallest quantity for that price.
Step 3: Calculate the EOQ for the next lowest price. If it is
feasible, stop and calculate the TC for that quantity and price.
Step 4: Compare the TC for Steps 2 and 3. Choose the quantity
corresponding to the lowest TC.
Step 5: If the EOQ in Step 3 is not feasible, repeat Steps 2, 3, and
4 until a feasible EOQ is found.
10-28
All-Unit Quantity Discount:
Example
Order quantity Unit Price
0-5000 $3.00
5001-10000 $2.96
Over 10000 $2.92
q0 = 0, q1 = 5000, q2 = 10000
C0 = $3.00, C1 = $2.96, C2 = $2.92
D = 120000 units/year, S = $100/lot, h = 0.2
10-29
All-Unit Quantity Discount:
Example
Step 1: Calculate Q2* = Sqrt[(2DS)/hC2]
= Sqrt[(2)(120000)(100)/(0.2)(2.92)] = 6410
Not feasible (6410 < 10001)
Calculate TC2 using C2 = $2.92 and q2 = 10001
TC2 = (120000/10001)(100)+(10001/2)(0.2)(2.92)+(120000)(2.92)
= $354,520
Step 2: Calculate Q1* = Sqrt[(2DS)/hC1]
=Sqrt[(2)(120000)(100)/(0.2)(2.96)] = 6367
Feasible (5000<6367<10000) Stop
TC1 = (120000/6367)(100)+(6367/2)(0.2)(2.96)+(120000)(2.96)
= $358,969
TC2 < TC1 The optimal order quantity Q* is q2 = 10001
10-30
All-Unit Quantity Discounts
Suppose fixed order cost were reduced to $4
Without discount, Q* would be reduced to 1265 units
With discount, optimal lot size would still be 10001 units
What is the effect of such a discount schedule?
Retailers are encouraged to increase the size of their orders
Average inventory (cycle inventory) in the supply chain is
increased
Average flow time is increased
Is an all-unit quantity discount an advantage in the supply
chain?
10-31
Why Quantity Discounts?
Coordination in the supply chain
Commodity products
Products with demand curve
2-part tariffs
Volume discounts
10-32
Coordination for
Commodity Products
D = 120,000 bottles/year
S
R
= $100, h
R
= 0.2, C
R
= $3
S
S
= $250, h
S
= 0.2, C
S
= $2
Retailers optimal lot size = 6,324 bottles
Retailer cost = $3,795; Supplier cost = $6,009
Supply chain cost = $9,804
10-33
Coordination for
Commodity Products
What can the supplier do to decrease supply chain
costs?
Coordinated lot size: 9,165; Retailer cost = $4,059;
Supplier cost = $5,106; Supply chain cost = $9,165
Effective pricing schemes
All-unit quantity discount
$3 for lots below 9,165
$2.9978 for lots of 9,165 or more
Pass some fixed cost to retailer (enough that he raises
order size from 6,324 to 9,165)
10-34
Quantity Discounts When
Firm Has Market Power
No inventory related costs
Demand curve
360,000 - 60,000p
What are the optimal prices and profits in the
following situations?
The two stages coordinate the pricing decision
Price = $4, Profit = $240,000, Demand = 120,000
The two stages make the pricing decision
independently
Price = $5, Profit = $180,000, Demand = 60,000
10-35
Two-Part Tariffs and
Volume Discounts
Design a two-part tariff that achieves the
coordinated solution
Design a volume discount scheme that achieves
the coordinated solution
Impact of inventory costs
Pass on some fixed costs with above pricing
10-36
Lessons from Discounting Schemes
Lot size based discounts increase lot size and
cycle inventory in the supply chain
Lot size based discounts are justified to achieve
coordination for commodity products
Volume based discounts with some fixed cost
passed on to retailer are more effective in general
Volume based discounts are better over rolling horizon
10-37
Short-Term Discounting:
Trade Promotions
Trade promotions are price discounts for a limited period of time
(also may require specific actions from retailers, such as displays,
advertising, etc.)
Key goals for promotions from a manufacturers perspective:
Induce retailers to use price discounts, displays, advertising to increase sales
Shift inventory from the manufacturer to the retailer and customer
Defend a brand against competition
Goals are not always achieved by a trade promotion
What is the impact on the behavior of the retailer and on the
performance of the supply chain?
Retailer has two primary options in response to a promotion:
Pass through some or all of the promotion to customers to spur sales
Purchase in greater quantity during promotion period to take advantage of
temporary price reduction, but pass through very little of savings to
customers
10-38
Short Term Discounting
Q
*
: Normal order quantity
C: Normal unit cost
d: Short term discount
D: Annual demand
h: Cost of holding $1 per year
Q
d
: Short term order quantity d C
C
h d C
dD
Q
Q
d
-
+
) - (
=
*
Forward buy = Q
d
- Q*
10-39
Short Term Discounts:
Forward Buying
Normal order size, Q
*
= 6,324 bottles
Normal cost, C = $3 per bottle
Discount per tube, d = $0.15
Annual demand, D = 120,000
Holding cost, h = 0.2
Q
d
= [(0.15)(120000)/(3.00-0.15)(0.2)] + [(3)(6324)/(3.00-
0.15)] = 38,236 bottles
Forward buy = Q
d
Q
*
= 38,236 6,324 = 31,912 bottles
10-40
Promotion Pass Through
to Consumers
Demand curve at retailer: 300,000 - 60,000p
Normal supplier price, C
R
= $3.00
Optimal retail price = $4.00
Customer demand = 60,000
Promotion discount = $0.15
Optimal retail price = $3.925
Customer demand = 64,500
Retailer only passes through half the promotion
discount and demand increases by only 7.5%
10-41
Trade Promotions
When a manufacturer offers a promotion, the goal
for the manufacturer is to take actions
(countermeasures) to discourage forward buying
in the supply chain
Counter measures
EDLP (every day low pricing)
Scan based promotions
Customer coupons
10-42
Managing Multi-Echelon
Cycle Inventory
Multi-echelon supply chains have multiple stages, with
possibly many players at each stage and one stage supplying
another stage
The goal is to synchronize lot sizes at different stages in a
way that no unnecessary cycle inventory is carried at any
stage
Figure 10.6: Inventory profile at retailer and manufacturer
with no synchronization
Figure 10.7: Illustration of integer replenishment policy
Figure 10.8: An example of a multi-echelon distribution
supply chain
In general, each stage should attempt to coordinate orders
from customers who order less frequently and cross-dock all
such orders. Some of the orders from customers that order
more frequently should also be cross-docked.
10-43
Levers to Reduce Lot Sizes
Without Hurting Costs
Cycle Inventory Reduction
Reduce transfer and production lot sizes
Aggregate fixed costs across multiple products, supply points,
or delivery points
Are quantity discounts consistent with manufacturing
and logistics operations?
Volume discounts on rolling horizon
Two-part tariff
Are trade promotions essential?
EDLP
Based on sell-thru rather than sell-in
10-44
How are the appropriate costs balanced to choose the
optimal amount of cycle inventory in the supply
chain?
What are the effects of quantity discounts on lot size
and cycle inventory?
What are appropriate discounting schemes for the
supply chain, taking into account cycle inventory?
What are the effects of trade promotions on lot size
and cycle inventory?
What are managerial levers that can reduce lot size
and cycle inventory without increasing costs?
1
Facility Decisions
Network Design in a Supply Chain
2
Outline
The Value of Distributors in the Supply Chain
3
in the Supply Chain
Distribution: the steps taken to move and store a
product from the supplier stage to the customer
stage in a supply chain
Distribution directly affects cost and the customer
experience and therefore drives profitability
Choice of distribution network can achieve supply
chain objectives from low cost to high
responsiveness
Examples: Wal-Mart, Dell, Proctor & Gamble,
Grainger
4
Factors Influencing
Distribution network performance evaluated along
two dimensions at the highest level:
Distribution network design options must
therefore be compared according to their impact
on customer service and the cost to provide this
level of service
5
Factors Influencing
Elements of customer service influenced by network
structure:
Response time
Product variety
Customer experience
Order visibility
Returnability
Supply chain costs affected by network structure:
Inventories
Transportation
Facilities and handling
Information
6
(Fig. 4.1)
Number of
Facilities
Response Time
7
Local FG
Mix
Regional FG
Local WIP
Central FG
Central WIP
Cost
Response Time
High Low
Low
High
8
Inventory
Costs
9
Number of Facilities (Fig. 4.3)
Transportation
Costs
10
Facility
Costs
11
Transportation
Total Costs Related to
T
o
t
a
l

C
o
s
t
s
Inventory
Facilities
Total Costs
12
Response Time
Time with Number of Facilities (Fig. 4.5)
13
Manufacturer Storage with Direct Shipping and
In-Transit Merge
Manufacturer or Distributor Storage with
Consumer Pickup
Retail Storage with Consumer Pickup
Selecting a Distribution Network Design
14
Direct Shipping (Fig. 4.6)
Manufacturer
Retailer
Customers
Product Flow
Information Flow
15
Factories
Retailer
Product Flow
Information Flow
In-Transit Merge by
Carrier
Customers
16
Carrier Delivery (Fig. 4.8)
Factories
Customers
Product Flow
Information Flow
17
Factories
Customers
Product Flow
Information Flow
Warehouse
18
Manufacturer or Distributor Storage with
Customer Pickup (Fig. 4.10)
Factories
Retailer
Pickup Sites
Product Flow
Information Flow
Cross Dock DC
Customer Flow
Customers
19
Comparative Performance of Delivery
Network Designs (Table 4.7)
Information
Facility & Handling
Transportation
Inventory
Returnability
Order Visibility
Customer
Experience
Product Variety
Response Time
Manufacturer
storage with
pickup
Distributor
storage with
last mile
delivery
Distributor
Storage with
Package Carrier
Delivery
Manufacturer
Storage with In-
Transit Merge
Manufacturer
Storage with
Direct Shipping
Retail Storage
with
Customer
Pickup
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
1
2
2
2
2
2
2
2
2
2
2
3
3
3
3
3
3
3
3
3
3
4
4
4
4
4
4
4
4
4
4
4
4
4
5
5
5
5
5 5
5
6
6
5
20
Linking Product Characteristics and Customer
Preferences to Network Design
Low customer effort
High product variety
Quick desired response
High product value
Many product sources
Very low demand product
Low demand product
Medium demand product
High demand product
Manufacturer
storage with
pickup
Distributor storage
with last mile
delivery
Distributor Storage
with Package
Carrier Delivery
Manufacturer
Storage with
In-Transit
Merge
Manufacturer
Storage with
Direct Shipping
Retail
Storage with
Customer
Pickup
+2
+2
+2
+2
+2
+2
+2 +2 +2
+2
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
+1
0
0
0
0
0
0
0
0 0
0
-1
-1
-1
-1
-1 -1
-1
-1
-1
-1
-1
-2 -2
-2
-2
-2
-2 -2
-2
21
The Value of Distributors
in the Supply Chain
Distributing Consumer Goods in India
Distributing MRO Products
Distributing Electronic Components
22
The ownership structure of the distribution
network can have as big as an impact as the type
of distribution network
The choice of a distribution network has very
long-term consequences
Consider whether an exclusive distribution
strategy is advantageous
Product, price, commoditization, and criticality
have an impact on the type of distribution system
preferred by customers
23
What are the key factors to be considered
when designing the distribution network?
What are the strengths and weaknesses of
various distribution options?
What roles do distributors play in the
supply chain?
24
Outline
A strategic framework for facility location
Multi-echelon networks
Plant location models
25
Facility role
- flexibility of Toyota since 1997
Facility location
- Amazon.com : a single warehouse in Seattle
Capacity allocation
- Allocating too much poor utilization
- Allocating too little poor responsiveness, high cost
- Amazon.com : built new warehouses due to grown markets
26
Factors Influencing Network Design
Decisions
Strategic Cost vs. Responsiveness
ex) Apparel producers, Convenience stores, Discount stores
Technological
Economies of scale few high-capacity locations
ex) Manufacturer of computer chips
Lower fixed costs many local facilities
ex) Bottling plants for Coca-Cola
Macroeconomic
Tariffs, Tax incentives, Exchange rate and Demand risk
Political
27
Factors Influencing Network Design
Decisions (continued)
Infrastructure
availability of sites & labor
proximity to transportation terminals, rail service, airports
and seaports
highway access, congestion, local utilities
Competitive Close vs. Far
ex) Retail stores in a mall, Supermarkets
Logistics and facility costs
28
Local FG
Mix
Regional FG
Local WIP
Central FG
Central WIP
Cost
Response Time
Hi Low
Low
Hi
29
Response
Time
30
Where inventory needs to be
for a 1 week order response time [1 DC]
for a 5 day order response time [2 DCs]
for a 3 day order response time [5 DCs]
etc
31
Costs
Inventory
Transportation
Facility costs
32
Percent Service
Level Within
Promised Time
Transportation
Cost Build-up as a function of facilities
C
o
s
t

o
f

O
p
e
r
a
t
i
o
n
s
Inventory
Facilities
Total Costs
Labor
33
A Framework for Global Site Location
PHASE I
Supply Chain
Strategy
PHASE II
Regional Facility
Configuration
PHASE III
Desirable Sites
PHASE IV
Location Choices
existing network
COMPETITIVE
ENVIRONMENT
PRODUCTION METHODS
FACTOR COSTS
GLOBAL COMPETITION
TARIFFS AND TAX
INCENTIVES
REGIONAL DEMAND
POLITICAL, EXCHANGE
AVAILABLE
INFRASTRUCTURE
LOGISTICS COSTS
Transport, inventory, coordination
34
Customer
Store
Materials
DC
Component
Manufacturing
Vendor
DC
Final
Assembly
Finished
Goods DC
Components
DC
Vendor
DC Plant
Warehouse
Finished
Goods DC
Customer
DC
Customer
DC
Customer
DC
Customer
Store
Customer
Store
Customer
Store
Customer
Store
Vendor
DC
5-34
35
Tailored Network: Multi - Echelon
Finished Goods Network
Regional
Finished
Goods DC
Regional
Finished
Goods DC
Customer 1
DC
Store 1
National
Finished
Goods DC
Local DC
Cross-Dock
Local DC
Cross-Dock
Local DC
Cross-Dock
Customer 2
DC
Store 1
Store 2
Store 2
Store 3
Store 3
36
Which plants to establish? How to configure the network?
Key Costs:
Fixed facility cost
Transportation cost
Production cost
Inventory cost
Coordination cost
37
Which market is
served by which
plant?
Which supply sources
are used by a plant?
x
ij
= Quantity shipped
customer j
0
. .
1
1
1 1

x
K x
D x
t s
x c
Min
ij
i
m
j
ij
j
n
i
ij
n
i
m
j
ij ij
38
Plant Location with Multiple Sourcing
y
i
= 1 if plant is
located at site i, 0
otherwise
x
ij
= Quantity shipped
customer j
} 1 , 0 { ;
. .
1
1
1
1 1 1

y k y
y
K x
D x
t s
x c
y f Min
i
m
i
i
i
i
n
j
ij
j
n
i
ij
n
i
m
j
ij ij
i
n
i
i
39
Capacity Investment Strategies
Speculative Strategy
Single sourcing
Hedging Strategy
Match revenue and cost exposure
Flexible Strategy
Excess total capacity in multiple plants
Flexible technologies
40
Summary
Factors influencing facility decisions
A strategic framework for facility location
Value capacity as a real option
41
What is the role of network design decisions in
the supply chain?
Describe a strategic framework for facility
location.
How are the following optimization methods used
for facility location and capacity allocation
decisions?
5-41
42
Location Allocation Decisions
Plants Warehouses
1
2
Which plants to establish? Which warehouses to establish?
How to configure the network?
Markets
43
Plant Location with Single Sourcing
y
i
= 1 if plant is
located at site i, 0
otherwise
x
ij
= 1 if market j is
supplied from plant
site i, 0 otherwise
} 1 , 0 { , ;
1
. .
1
1
1
1 1 1

y
x
k y
y
K D x
x
t s
x c
y f Min
i
ij
n
i
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i
i j
n
j
ij
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ij ij
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44
Customer
Store
Materials
DC
Component
Manufacturing
Vendor
DC
Final
Assembly
Finished
Goods DC
Components
DC
Vendor
DC Plant
Warehouse
Finished
Goods DC
Customer
DC
Customer
DC
Customer
DC
Customer
Store
Customer
Store
Customer
Store
Customer
Store
Vendor
DC
45
Ton-Center Solution
x,y: Warehouse
Coordinates
x
n
, y
n
: Coordinates of
delivery location n
F
n
: Annual tonnage to
delivery location n
x
x F
F
y
y
F
F
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1
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]
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2
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Supply Chain Management
Lecture 2
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Outline
Last Tuesday
Chapter 1
Sections 1, 2
Today
Chapter 1
Sections 3, 4, 5
Next week
Chapters 2 and 3
Flow of products and services from
Suppliers
Raw materials manufacturers
Intermediate goods manufacturers
Finished goods manufacturers
Distributors and wholesalers
Retailers
Customers
Connected through transportation, information, and
exchanges of funds
Manufacturer Distributor Retailer Customer Supplier
Key Observations
In order to maximize supply chain surplus
Every facility that impacts costs needs to be considered
Suppliers suppliers
Customers customers
Efficiency throughout the supply chain network is
required using a network level approach
Supply chain management involves the
management of supply chain assets and
products, information, and fund flows to
maximize total supply chain surplus
Getting the right things
to the right places
at the right times
for profit
Managing supply and demand, sourcing raw
materials and parts, manufacturing and assembly,
warehousing and inventory tracking, order entry
and order management, distribution across all
channels, and delivery to the customer
The Supply Chain Council
The design and management of seamless,
value-added process across organizational
boundaries to meet the real needs of the end
customer
Institute for Supply 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
Simchi-Levi et al, 2003
Video
Ford Manufacturing Supply Chain
Supply chain management is all about
relationships
Management of relationships in order to enhance value
and reduce cost
Collaboration is an important part of effective supply
chain management
Evolution of Supply Chain Management
1950s 1960s
1970s 1980s 1990s 2000s Beyond
Traditional Mass Manufacturing
Inventory Management/Cost
Optimization
JIT, TQM, BPR,
Alliances
SCM
Formation/
Extensions
Further
Refinement of
SCM Capabilities
Evolution of Supply Chain Management
Mass production era (1900s 1970s)
In the early 1900s, Henry Ford created the first moving assembly
line reducing the time to build a Model T from 728 hours to 1.5
hours
Lean manufacturing era (1970s 1995)
In the early 1970s, Japanese manufacturers like Toyota changed
the rules of production from mass to lean. Lean manufacturing
focuses on flexibility and quality more than on efficiency and
quantity.
Mass customization era (1995 2010?)
Beginning around 1995 and coinciding with the commercial
application of the Internet, manufacturers started to mass-produce
customized products. Henry Fords famous statement You can
have any color Model T as long as its black no longer applies.
Managing a Supply Chain is Not Easy
Geographically dispersed complex network
Conflicting objectives across the supply chain
Uncertainty and risk factors
Information distortion
Geographically dispersed complex network
Convenience
Short lead time
Large variety of
products
Few stores
Low inventory
Little variety
Close to DCs
Low inventory
Few DCs
Large shipments
Large production
batches
Conflicting objectives across the supply chain
Uncertainty and risk factors
2005 Hurricane Katrina
P&G coffee supplies from sites around New Orleans
Six month impact
2002 West Coast port strike
Losses of $1B/day
Store stock-outs, factory shutdowns
2001 India earthquake
Supply interruptions for apparel manufacturers
1999 Taiwan earthquake
Supply interruptions for HP and Dell
Information distortion
Manufacturer Distributor Retailer Customer Supplier
Bullwhip effect
Why Study Supply Chain Management?
The Magnitude
In 1998, American companies spent $898 billion
in supply chain related activities (or 10.6% of
Gross Domestic Product)
Third party logistics services grew in 1998 by 15%
to nearly $40 billion
It is estimated that the grocery industry could
save $30 billion (10% of operating cost) by using
more effective logistics strategies
A typical box of cereal spends more than three months
getting from factory to supermarket
The Potential
In 10 years, Wal-Mart transformed itself by
changing its logistics system. It has the highest
sales per square foot, inventory turnover and
operating profit of any discount retailer
Laura Ashley turns its inventory 10 times a year,
five times faster than three years ago
New information system
Centralized warehouse
The Impact
In 1996, Dell held 31 days of inventory. It
now holds only 4 days of inventory.
The Impact
The Impact
The Turning Point (The Economist, 9/20/07)
For such a tiny part of GDP, the contents of warehouses has had a
surprisingly big effect on its volatility. When industries cut or add stocks
according to demand, that adjustment magnifies the effect of the initial
change in sales. Stock levels were once much larger relative to the size of
the economy, so a small slip in demand could easily blow up into a
recession. But thanks to improvements in technology, firms now have
timelier and better information about buyers. Speedier market intelligence
and production in smaller batches allows firms to match supply to
changing conditions. This makes huge stocks unnecessary and minimizes
the lurches in inventories that were once so destabilizing. The entire
inventory of some lean-running companies now consists of whatever
FedEx or UPS is shipping on their account.
Mr Cecchetti and his colleagues calculate that, on average, more than half
the improvement in the stability of economic growth in the countries they
studied is accounted for by diminished inventory cycles. That something
so workaday as supply-chain management could have so marked an
effect might seem a dull conclusion. But dullness is a virtue,
because technological improvement is irreversible
The Impact
Study of Supply Chain Management
Successful supply chain management requires
decisions on the flow of information, product, and
funds that fall into three decision phases
Supply chain strategy or design
Supply chain planning
Supply chain operation
TYPICAL DECISIONS
Strategic
Tactical
TYPE TIME FRAME
Supply chain network design (How many plants?
Location and capacities of plants and warehouses?)
Supply chain strategies(Sell direct or through
retailers? Outsource or in-house? Focus on cost or
customer service?)
Product mix at each plant
years
Workforce & Production planning
Inventory policies (safety stock level)
Which locations supply which markets
Transportation strategies
3 mo.- 1year
Operational
Production scheduling
Decisions regarding individual orders
Place replenishment orders
daily
Study of Supply Chain Management
A supply chain is a sequence of processes and
flows that take place within and between different
stages
Cycle view
The processes in a supply chain are divided into a series of
cycles, each performed at the interface between two
successive stages of a supply chain
Push/pull view
The processes in a supply chain are divided into two
categories depending on whether they are executed in
response or in anticipation of a customer order
Cycle View of Supply Chain Processes
Replenishment Cycle
Manufacturing Cycle
Procurement Cycle
Customer
Retailer
Distributor
Manufacturer
Supplier
Cycle view
defines the
processes
involved and
the owner of
each process
Subprocesses in Each Cycle
Supplier markets
the product
Buyer
Supplier
Buyer places
an order
Supplier receives
the order
Supplier supplies
the order
Buyer receives
the order
Buyer may return
the product
Cycle View of Supply Chain Processes
Replenishment Cycle
Manufacturing Cycle
Procurement Cycle
Customer Order Process
1. Customer Arrival
2. Customer Order Entry
3. Customer Order Fullfillment
4. Customer Order Receiving
Procurement Process
1. Component Order Arrival
2. Production Scheduling
3. Manufacturing/Shipping
4. Receiving
Manufacturing Process
1. Order Arrival
2. Production Scheduling
3. Manufacturing/Shipping
4. Receiving
Replenishment Process
1. Retail Order Trigger
2. Retail Order Entry
3. Retail Order Fullfillment
4. Retail Order Receiving
Push/Pull View of Supply Chain Processes
Customer order arrives
PULL
PROCESSES
PUSH
PROCESSES
Execution is initiated in
response to customer orders
(reactive)
Execution is initiated in
anticipation of customer orders
(speculative)
Processes are divided based on the timing of
their execution relative to a customer order
Push/Pull Processes for the Supply chain
of Dell
PUSH
PULL
Customer Order Cycle and
Manufacturing Cycle
Procurement Cycle
Customer
Manufacturer
Supplier
Push/Pull Processes for the Supply chain
of Detergent
PULL
PUSH
Replenishment Cycle
Manufacturing Cycle
Procurement Cycle
Customer
Retailer
Distributor
Manufacturer
Supplier
Are the following systems push or pull?
Soda vending machines
Amazon.com
Emergency care
Paint industry
Runway capacity at an Airport
Cycle View Versus Push/Pull View
Which view is more useful when
considering operational decisions and
which view is more useful when
considering strategic decisions?
Celestial Seasonings
The herbs were originally harvested by hand in the Rocky
Mountains
Currently, herbs and leafs come from growers around the
world
Weve been working to establish sustainable harvests
and fair wages for more than 30 years
What advantages does selling tea over the Internet
provide?
What are advantages of having one production facility?
What are disadvantages of having one production facility?
17-1
Outline Chapter 17:
Supply Chain Coordination
Supply Chain Coordination and the Bullwhip Effect
Effect on Performance from Lack of Coordination
The Problem: Obstacles to Coordination in a Supply
Chain
The Potential Solutions: Managerial Levers to
Achieve Coordination
Continuous Replenishment (CRP) and Vendor-Managed
Inventories (VMI)
Collaborative Planning, Forecasting, and Replenishment
(CPFR)

16-2
Supply Chain Coordination
and the Bullwhip Effect
Supply chain coordination: all stages in the supply chain take
actions together (usually results in greater total supply chain profits)
requires that each stage take into account the effects of its actions on the other
stages

Lack of coordination results when:
The objectives of different stages are conflicting
and / or
Information moving between stages is distorted

Bullwhip Effect: The distortion of demand information as it is
transmitted up the demand chain
16-3
The Beer Game: a B-school Tradition
A Team consists of 4 positions: Retailer, Wholesaler,
Distributor and Factory
Every position can see its inventory now, and expected deliveries for
the next 2 periods.
Everyone is trying to minimize their costs, both as a player
and as a team
Inventory costs ($1 holding cost per period)
Stock-out costs ($2 fee per period shorted)
Obstacles
No advance knowledge of orders
No knowledge of what the other positions see for demand
No communication between team positions allowed!
You cant cancel backorders
There is a 2 period lead-time between each stage
See the getting started document

16-4
16-5
The Beer Game: Details
You have two decisions each period 1) How much to ship?
2) How much to order (or make if you are the factory) ?
You will be prevented from shipping more than is demanded (current
demand plus backordered demand) - No pushing of product is allowed!
Game will not allow to ship more than you have in inventory
You cannot cancel an order once placed. (Also, there is no visibility to
your past orders. If you wish to record this, you must do so on paper)

You must click on Submit Button to enter decision

One everyone has entered all information, the game master
(professor) will then advance the clock to the next period

Once that happens, you must ask for a status update
Refresh your web browser to make sure you are in the right period

16-6
The Beer Game: Interface
Sample of Retailer screen- left part is for decision,
right part provides information:

16-7
Interface Intricacies
Once you enter these and click on the button, if you refresh, you will then see
them reflected, with your on-hand updated.
At the start of a new period the Current Order and Current Shipment are at 0.
You can re-enter decisions (until the clock is advanced)
See the Before and After screens (just below)

16-8
Final Points to Remember
You can see what your supplier will ship to you, but unless
you are the factory (where you can make as much beer as
you want), you may not get shipped what you want!
If your supplier shorts you, then it appears as their back-order
(and costs them!)
The back-order displayed is from your direct customers.
It never goes away until you satisfy that demand.
You should try to get rid of it, as it costs you money!

16-9
Beer Game Debrief
Did the system perform as you wished?
Did you ever have too much or too little inventory?
Were you ever surprised by the amount ordered by your client or by the
amount delivered from your supplier? Was it ever too high? Strangly
low?

What is realistic and what is unrealistic about the game?
What are ways we might improve the performance of this
supply chain?
16-10
Bullwhip Effect
Fluctuations in orders increase as they move up the supply chain
from retailers to wholesalers to manufacturers to suppliers
Distorts demand information within the supply chain
different stages have different estimates of what demand looks like

Results in a loss of supply chain coordination
Manufacturer
Warehouses
Retailers Consumers Wholesalers Suppliers Plants
Forecast of
Consumer demand
Forecast of
store demand
Forecast of
DC demand
Forecast of
Regional demand
Forecast of
Plant demand
Variability of demand
16-11
The Effect of Lack of
Coordination on Performance
The bullwhip effect reduces supply chain profitability by making it
more expensive to provide to a given level of product availability
Manufacturing cost (increases)
Inventory cost (increases)
Replenishment lead time (increases)
Transportation cost (increases)
Labor cost for shipping and receiving (increases)
Level of product availability (decreases)
Waste within the supply chain (increases)
Relationships across the supply chain (worsens)
Profitability (decreases)

16-12
The Problem: Obstacles to
Coordination in a Supply Chain
1. Incentive Obstacles

2. Information Processing Obstacles

3. Operational Obstacles

4. Pricing Obstacles

5. Behavioral Obstacles
16-13
1. Incentive Obstacles
When incentives offered to different stages or
participants in a supply chain lead to actions that
increase variability and reduce total supply chain
profits misalignment of total supply chain
objectives and individual objectives

Local optimization within functions or stages of a
supply chain

Sales force incentives (e.g. Pharmaceutical sales)
16-14
2. Information Processing Obstacles
When demand information is distorted as it moves
between different stages of the supply chain, leading to
increased variability in orders within the supply chain

Forecasting based on orders, not customer demand
As we have seen, forecasting demand based on orders magnifies
demand fluctuations moving up the supply chain from retailer to
manufacturer

Lack of information sharing
16-15
3. Operational Obstacles
Actions taken in the course of placing and filling
orders that lead to an increase in variability
Ordering in large lots (much larger than dictated
by demand)
Large replenishment lead times

Rationing and shortage gaming (common in the
computer industry because of periodic cycles of
component shortages and surpluses)
16-16
4. Pricing Obstacles
When pricing policies for a product lead to an increase in
variability of orders placed
Lot-size based quantity decisions

Price fluctuations (resulting in forward buying)
0
100
200
300
400
500
600
700
800
Shipments
Consumption
17-17
5. Behavioral Obstacles
Problems in learning, often related to communication in the
supply chain and how the supply chain is structured
Each supply chain stage views its actions locally and is unable
to see its impact on other stages
Different stages react to the current local situation rather than
trying to identify the root causes
Based on local analysis, different stages blame each other for
the fluctuations, with successive stages becoming enemies
rather than partners
No stage learns from its actions over time because the most
significant consequences of the actions of any one stage occur
elsewhere, resulting in a vicious cycle of actions and blame
Lack of trust results in opportunism, duplication of effort, and
lack of information sharing
17-18
Potential Solutions: Managerial
Levers to Achieve Coordination
1. Aligning Goals and Incentives
2. Improving Information Accuracy
3. Improving Operational Performance
4. Designing Pricing Strategies to Stabilize Orders
5. Building Strategic Partnerships and Trust
17-19
Align incentives so that each participant has an
incentive to do the things that will maximize total
supply chain profits
Align incentives across functions
Pricing for coordination
Alter sales force incentives from sell-in (to the
retailer) to sell-through (by the retailer)

17-20
Sharing point of sale (POS) data
Collaborative forecasting and planning
Single stage control of replenishment
We will discuss this later in:
Continuous replenishment programs (CRP)
Vendor managed inventory (VMI)

17-21
Reducing replenishment lead time
Reduces uncertainty in demand
EDI is useful
Reducing lot sizes
Computer-assisted ordering, B2B exchanges
Shipping in LTL sizes by combining shipments
Technology and other methods to simplify receiving
Changing customer ordering behavior
Rationing based on past sales and sharing information to
limit gaming
Turn-and-earn
Information sharing

17-22
Designing Pricing Strategies
to Stabilize Orders
Encouraging retailers to order in smaller lots and reduce
forward buying
Moving from lot size-based to volume-based quantity
discounts (consider total purchases over a specified time
period)
Stabilizing pricing
Eliminate promotions (everyday low pricing, EDLP)
Limit quantity purchased during a promotion
Tie promotion payments to sell-through rather than amount
purchased
Building strategic partnerships and trust easier to
implement these approaches if there is trust
17-23
Designing a Relationship with Cooperation and Trust
Managing Supply Chain Relationships for Cooperation and Trust
Move to a trust-based relationship
Supply chain relationships are based on power or trust
Ultimately, trust-based relationships better than power-based
Cooperation and trust work because:
Alignment of incentives and goals
Actions to achieve coordination are easier to implement
Supply chain productivity improves by reducing duplication or allocation
of effort to appropriate stage
Greater information sharing results

17-24
Quantify the bullwhip effect
Get top management commitment
And then devote resources to coordination
Focus on communication with other stages
Use information technology wisely
Try to achieve coordination in the entire supply chain
network
However, before attempting to change the world, may help
to start simple (DC vs. Retail CPFR, pilot studies, etc)
Share the benefits of coordination equitably

Some examples follow.
Continuous Replenishment and
Vendor-Managed Inventories
Over-arching idea: Remove inventory distortions by having a
single point of replenishment
Continuous RePlenishment, CRP wholesaler, manufacturer
or 3
rd
party replenishes based on POS data
A type of CRP is VMI where the manufacturer/supplier is
responsible for all decisions regarding inventory
Positives: less stockpiling of intermediate inventories, manufacturer
may know more about the product and consumer demand patterns than
retailer, e.g. MGM DVDs at Wal-Mart
Cons: Requires the manufacturer to have sophisticated IT and/or
logistical support, as manufacturers will ignore other brands that may be
near perfect substitutes, overall inventory levels may be higher
17-25
Collaborative Planning, Forecasting,
and Replenishment (CPFR)
While they may still act individually (unlike CRP/VMI)
Sellers and buyers in a supply chain can still collaborate along
any or all of the following:
Strategy and planning
Demand and supply management
Execution
Analysis
Example: Henkel (German detergent) supplied into Grupo
Eroski (supermarkets in Spain)
Common scenarios: Retail event collaboration, assortment
planning (especially for fashion/seasonal goods) DC and/or
store replenishment
Risks and Hurdles for a CPFR implementation
17-26
17-27
What is supply chain coordination and the bullwhip
effect, and how does the bullwhip effect hurt supply
chain performance?
What are obstacles to coordination in the supply
chain?
What are the potential solutions to addressing these
obstacles?
What are some ways companies can do this in
practice?
13-1
(Shortened) Outline Chapter 13:
Transportation in a Supply Chain
Some of this material is covered in the Sustainable Supply
Chain overview, and we will skip much of the chapter
The role of Transportation in the Supply Chain
Factors affecting transportation decisions
Modes of transportation and their performance characteristics
Trade-offs in transportation design
Tailored transportation
The role of IT in transportation
Risk management in transportation
Making transportation decisions in practice
The Role of Transportation in the
Supply Chain
To move the product through the chain to the end consumer
Some fun facts
US: freight transport activities account for 10% of GDP
It is estimated that JIT inventory policies and other efficiencies have been
able to reduce this from historical rates of around ~15%
Germany: per www.bmvbs.de
The German freight logistics sector is currently the largest in Europe.
(In) 2005 estimated to be around 170 billion euros. 7%of German GDP
the freight logistics sector comes third after retail trade and the automotive
industry, with an estimated 2.5 million employees, (and is) growing at a
disproportionately high rate
Interconnection of infrastructure, information and organization is a pre-
condition for Germany to master the challenges .At the same time
Germany must face the challenges of making freight transport more
environmentally-, climate- and resource- friendly

13-2
13-3
Factors (and Parties) Affecting
From earlier, we know that there may be three separate parties
involved. All of them have factors to consider:
1. Carrier (party that moves or transports the product)
Vehicle-related costs, Fixed operating costs, Trip-related costs
Often incurs huge investments (new fleets, etc)
2. Shipper (party that requires the movement of the product
between two points in the supply chain)
May need to balance Transportation costs with Inventory and Facility costs
3. Consignee (party that receives the shipment)
May have certain responsiveness needs
We should also consider:
4. The owners of the infrastructure (Ports, highways, railroads)
5. Government and/or bodies that set worldwide transportation policy

13-4
Transportation Modes
Trucks
TL
LTL
Rail
Air
Water
Pipeline (highly limited by geography and product)
Package Carriers (still using trucks, but the focus is on
delivery of a few packages)

13-5
Truckload (TL) vs. Less than
Truckload (LTL)
TL
Cheaper than LTL for large
shipments
Great for large loads
Low fixed and variable costs
Major Issues (especially when
economies of scale are missing)
Utilization
Consistent service
Backhauls
LTL
Typically used for smaller
shipments
Higher fixed costs
(terminals/consolidation
centers) but low variable costs
Major issues:
Location of consolidation
facilities
Utilization can still be an issue
Vehicle routing, other IT
complexities
Customer service
13-6
Rail
Cheapest of the land-based modes
Uses less fuel, so also greener
Average US haul, load= 720 miles, 80 tons
Key issues:
Scheduling to minimize delays / improve service
Off-track delays (at pickup and delivery end)
Yard operations
Variability of delivery times
Ownership of rail network in the US is highly fragmented
Rail does not and cannot reach everywhere

13-7
Air
Fastest mode, often used for global transit of expensive items
Use is growing (14% per year in US, see usage in Europe in graph below)
Key issues:
Complex: Location/number of hubs, Location of fleet bases/crew bases,
Schedule optimization, Fleet + Crew assignment, yield management.
Expensive, EXPENSIVE, EXPENSIVE
Most energy/emissions intensive

13-8
Package Carriers
Companies like DHL, FedEx, UPS, USPS, that carry small
packages ranging from letters to shipments of about 150 pounds
Expensive
Rapid and reliable delivery
Small and time-sensitive shipments
Preferred mode for e-businesses (e.g., Amazon)
Consolidation of shipments (especially important for package
carriers that use air as a primary method of transport)
Interestingly, a lot of package carriers have, through their own need for
such networks, expanded into being full service 3PLs (DHL is worlds
largest)
13-9
Water
Ocean, inland waterway system, coastal waters
Limited to certain geographic areas
Very large loads at very low cost
Lowest energy/emission intensity per tonne-km, though some concern
about port pollution
Slowest
Also subject to bottlenecks at Ports
Dominant in overseas trade (autos, grain, apparel, etc.)
Book example of successful usage: IKEA
As per 2008: 250 stores in 24 countries, sales: 21+ billion euro
Internationally sourced goods
IKEA makes very strong use of water and other low cost transport
13-10
Pipeline
High fixed cost
Primarily for crude petroleum, refined petroleum products,
natural gas
Best for large and predictable demand
Would be used for getting crude oil to a port or refinery,
but not for getting refined gasoline to a gasoline station
13-11
Intermodal
Use of more than one mode of transportation to move a shipment
to its destination
rail/truck, water/rail/truck or water/truck
Grown considerably with increased use of containers
Increased global trade has also increased use of intermodal
transportation
More convenient for shippers (one entity can provide the
complete service)
Key issue involves the exchange of information to facilitate
transfer between different transport modes
13-12
Transportation Network
What are the transportation options? On what basis do we design
our network?
Consider the tradeoffs:
Transportation cost vs. inventory cost
Choice of transportation mode: A mode with higher transportation costs
may be justifiable if it results in significantly lower inventories or is
necessary to maintain strategic level of responsiveness
Physical inventory aggregation
Transportation cost vs. responsiveness: temporal aggregation
We wont cover all the networks in the book, i.e. milk runs etc.
Instead we will look at a transportation LP (SRH students- we dont even do
this!)
13-13
Tailored Transportation
The use of different transportation networks and/or modes based
on customer and product characteristics
Factors affecting tailoring:
Customer distance and density
Customer size
Product demand and value
Some examples:
GAP primarily imports from its contract manufacturers worldwide by
cargo ship. However, for some high-margin or otherwise key products,
they may use some air freight for mid-season replenishment
Keeco, LLC supplies home furnishings. They primarily use trucking to
deliver goods from their warehouse to retail stores, but occasionally they
will use parcel delivery for small replenishment orders instead of sending
out a mostly empty truck.

13-14
Role of IT in Transportation
The complexity of transportation decisions demands
use of IT systems
Especially crucial with intermodal transportation, need for
cross-enterprise collaboration
Information Technology can assist in many ways:
Identification of optimal routes by minimizing costs subject
to delivery constraints (such as LPs)
Optimal fleet utilization
GPS applications
Finding backhaul opportunities www.coyotelogistics.com

13-15
Risk Management in Transportation
Three main risks to be considered in transportation are:
Risk that the shipment is delayed
Risk of disruptions
When the International Longshore & Warehouse Union strike/lockout closed
29 West Coast ports for 10 days in 2003, one study estimated it cost the
U.S.economy $19.4 billion (thats almost $2 billion per day!)
2011 Tsunami: not only impacting auto manufacturers on the Island, but so
are the dealers/repair shops
Risk of hazardous material issues, theft, terrorism (the dirty secret about
dirty bombs.)
Risk mitigation strategies:
Decrease the probability of disruptions
Alternative routings
In case of hazardous materials the use of modified containers, low-risk
transportation models, modification of physical and chemical properties
can prove to be effective
13-16
Making Transportation
Align transportation strategy with competitive strategy
Does your transportation strategy balance responsiveness vs.
efficiency?
Does it consider sustainability?
Evaluate both in-house and outsourced transportation
options
Design a transportation network that can handle
e-commerce, if that is part of your business plan
Use technology to improve transportation performance
Design flexibility into the transportation network
13-17
Objectives
1. What is the role of transportation in a supply chain?
2. What are some of the factors and parties that need to
be considered?
3. What are the strengths and weaknesses of different
modes of transportation?
4. What are the trade-offs in transportation network
design?
Supply/Demand Chain
Introduction, Overview and Strategy
These slides address chapters 1 through 3 of the
textbook, with some information already found in the
earlier Sustainable Demand Chain Management: an
Introduction de-emphasized
While the slide decks are based on the textbook, they
have been customized for this class
Additional materials are often included
Professorial commentary that expresses a different
viewpoint than in the text will be noted in a different color
1-1
1-2
Overview of Course

1. Chapters 1-3 + additional slide deck: Introduction, Overview
and Strategy
2. Chapters 4-6: Network Planning and Distribution
3. Chapters 8-9: Aggregate Planning
4. Chapters 10-11, 13+ additional slide deck: Inventory and
Transportation
5. Chapter 17: Supply Chain Coordination
1-3
Who Needs to Know About this
Topic?
Anyone involved in a manufacturing or service
industry where capacities and raw materials cannot be
obtained or expanded without a time or cost penalty

Executives and Entrepreneurs must understand the strategic
importance of the Supply Chain

Managers, Consultants and Software Designers need to be
able to analyze, design, and implement Supply Chain
solutions

1-4
Supply Chain Management is not
Learned just Through a Textbook
The best solution to a Supply Chain problem may not win
An elegant, mathematically complex LP presented such that only Ph.D.s
understand may not be the best practical solution to the problem at hand.
And even if it is, it is not the one that will be awarded the contract!

Supply Chain Practitioners need soft skills
Work effectively with clients and team members, including being
responsive to questions and requests
You must package and sell your proposed solution

Supply Chain Practitioners need hard skills
Lots of data, need to understand processes and interactions with IT
Work usually involves creating or adapting large-scale computer models

The class is designed for you to practice both hard and soft skills

1-5
US Economy (2006, 2007)
Freight Transportation $809, $856 Billion
Inventory Expense $446, $487 Billion
Administrative Expense $50, $54 Billion
Total Logistics Costs $1.31, $1.4 Trillion
Logistics Related Activity 10%, 10.1% of GNP
About 21% of total costs for a manufacturing firm
Logistical costs percentages are higher in the EU

But supply chain is more than logistics.
Source: 18
th
and 19
th
Annual State of Logistics Report Logistics Magazine
1-6
Supply Chain Management:
Mishaps and Opportunities
Estimated that the grocery industry could save $30 billion (10%
of operating cost) by using effective logistics and supply chain
strategies
Compaq estimates it lost $.5 billion to $1 billion in sales in
1995 because laptops were not available when and where
needed
When the 1 gig processor was introduced by AMD, the price of
its previous version, the 800 megabyte processor, dropped by
30%
What happened to firms who had stockpiled those?
1-7
Chapter 1 Outline
What is a Supply Chain? (We covered this earlier)
The Importance of Supply Chain Flows
A Brief Review of Material to Date
Typical stages: (from a demand chain perspective)
customers<retailers<distributors<manufacturers<suppliers
All stages may not be present- Can you think of some well
known companies that are missing a stage?
What stage is always present?

The obvious flow is the movement of products from
suppliers to the customer, but also includes movement
of information, funds, and products in both directions
Reverse logistics is an important facet of both sustainability
and CRM initiatives, will be discussed later.

1-8
1-9
Sources of supply chain revenue: the customer
Sources of supply chain cost: flows of information,
products, or funds between stages of the supply chain
Supply chain management is .
Book: the management of flows between and among
supply chain stages to maximize total supply chain
profitability
Professor commentary: is the coordination of business
functions within an organization and its channel partners in
order to provide goods and services to fulfill customer
demand responsively, efficiently and sustainably

1-10
Dell Computer: Illustration of
Supply Chain Success
Example: Dell receives $1000 from a customer for a
computer (revenue)
Supply chain incurs costs (information, storage,
transportation, components, assembly, etc.)
Difference between $1000 and the sum of all of these
costs is the supply chain profit
Time value of money often plays a role
Supply chain profitability is the total profit to be shared
across all stages of the supply chain
Supply chain success should be measured by total supply
chain profitability, not profits at an individual stage
In practice this may be difficult when stages are separate firms
1-11
Decision Phases of a Supply Chain
1. Supply chain strategy (also called chain design)
2. Supply chain planning
3. Supply chain operation
1-12
Supply Chain Strategy (or Design)
Decisions about the structure of the supply chain and what
processes each stage will perform
Strategic supply chain decisions
Locations and capacities of facilities
Products to be made or stored at various locations
Modes of transportation
Information systems
Supply chain design must support strategic objectives
Supply chain design decisions are long-term and
expensive to reverse must take into account market
uncertainty
Decisions often analyzed first through models and simulations
1-13
Definition of a set of policies that govern short-term
operations - typically a quarter to a couple years
Fixed by the supply configuration from previous phase
Typically starts with a forecast of demand in the coming year
Planning decisions:
Which markets will be supplied from which locations
Planned buildup of inventories, inventory policies
Subcontracting, backup locations
Timing and size of market promotions
Must consider demand uncertainty, exchange rates,
competition over the time horizon

1-14
Supply Chain Operations
Time horizon is weekly or daily
Decisions regarding individual customer orders
Supply chain configuration is fixed and operating
policies are determined
Goal is to implement the operating policies as
effectively as possible
Allocate orders to inventory or production, set order
due dates, generate pick lists at a warehouse, allocate
an order to a particular shipment, set delivery
schedules, place replenishment orders
Much less uncertainty (due to short time horizon)
1-15
Cycle view: processes in a supply chain are divided
into a series of cycles, each performed at the
interfaces between two successive supply chain stages
We will not be emphasizing the cycle view in class, as not
all chains have all stages present
Push/pull view: processes in a supply chain are
divided into two categories depending on whether
they are executed in response to a customer order
(pull) or in anticipation of a customer order (push)
1-16
Actions initiated from Suppliers Retail/Customer
Initiated Action
The barrier between push
And pull may vary for different
companies and industries
1-17
Push/Pull View of
Supply chain processes fall into one of two categories
depending on the timing of their execution relative to
customer demand
Pull: execution is initiated in response to a customer order
(reactive)
Push: execution is initiated in anticipation of customer
orders (speculative)
Push/pull boundary separates push processes from
pull processes
The relative proportion of push and pull processes can have
an impact on supply chain performance

2-18
Outline: Chapter 2 - Chain Performance:
Achieving Strategic Fit and Scope
Competitive and supply chain strategies
Achieving strategic fit
Expanding strategic scope
2-19
Competitive and Supply
Chain Strategies
Competitive strategy: defines the set of customer needs a firm
seeks to satisfy through its products and services
Product development strategy: specifies the portfolio of new
products that the company will try to develop
Marketing and sales strategy: specifies how the market will be
segmented and product positioned, priced, and promoted
Supply chain strategy:
determines the nature of material procurement, transportation of
materials, manufacture of product or creation of service, distribution of
product
Consistency and support between supply chain strategy, competitive
strategy, and other functional strategies is important
2-20
The Value Chain: Linking Supply
Chain and Business Strategy
New
Product
Development
Marketing
and
Sales
Overall Competitive Strategy
Product Dev.
Strategy
Marketing
Strategy
Supply Chain Strategy
2-21
Strategic fit:
Consistency between customer priorities of competitive
strategy and supply chain capabilities specified by the
supply chain strategy
Competitive and supply chain strategies have the same
goals
A company may fail because of a lack of strategic fit
or because its processes and resources do not provide
the capabilities to execute the desired strategy
Example of strategic fit Dells varied sales channels
2-22
How is Strategic Fit Achieved?
Step 1: Understanding the customer and the supply
chain uncertainty
Step 2: Understanding the supply chain capabilities
Step 3: Achieving strategic fit
2-23
Identify the needs of the customer segment being served
Quantity of product needed in each lot
Response time customers will tolerate
Variety of products needed
Service level required
Price of the product
Desired rate of innovation in the product
Demand uncertainty: How much does customer demand for a
product vary?
Are there particular needs related to Sustainability?

2-24
Key Point: Implied Demand Uncertainty is more than
just Demand Uncertainty
Demand uncertainty: uncertainty of customer demand for a
product
I mplied demand uncertainty: resulting uncertainty for the
supply chain given the portion of the demand the supply chain
must handle and the attributes the customer desires from the
product and the experience of purchasing it:
For example: if customers require very fast service or if they are many
varieties of the product (and customers are picky about what they get)
implied demand uncertainty is higher.
2-25
Impact of Customer Needs on Implied
Demand Uncertainty
Customer Need Causes implied demand
uncertainty to increase because
Range of quantity required increases Wider range of quantity required
implies greater variance in demand
Lead time required to decrease Less time to react to orders
Variety of products required increases Demand per product becomes more
disaggregated
Number of channels through which
product may be acquired increases
Total customer demand is now
disaggregated over more channels
Rate of innovation must increase New products tend to have more
uncertain demand
Required service level must increase Firm now has to handle unusual
surges in demand
Supply Uncertainty
Now turn away from demand briefly to look at other side of the
coin: Supply
Supply Uncertainty variability associated with getting the
right amount of the product at the right time
Will increase with.
Unpredictable/low yields problematic issue from high tech
(semiconductor) to low tech- traditional agriculture)
Limited/inflexible supply capacity
Evolving production process
First step to achieving strategic fit is to understand customers
and their inherent implied demand uncertainty, and also
consider effects from Supply Uncertainty, mapping both onto
the implied uncertainty spectrum

1-26
2-27
Implied Uncertainty Spectrum
Predictable
supply and
demand
Salt at a
supermarket
A new
communication
device
Highly uncertain
supply and demand
Figure 2.2: The Implied Uncertainty (Demand and Supply)
Spectrum
Predictable supply and uncertain
demand or uncertain supply and
predictable demand or somewhat
uncertain supply and demand
An existing
automobile
model
There are exceptions- for example, with salt, think of Fleur de Sel or pink Himalayan salt!
Many firms have attempted to move their products upstream, eg. Fresh Choice: bagged salads
2-28
Supply Chain Capabilities
How does the firm best meet demand?
One dimension describing the chain is supply chain responsiveness
respond to wide ranges of quantities demanded
meet short lead times
handle a large variety of products
build highly innovative products
meet a very high service level
There is a cost to achieving responsiveness
Supply chain efficiency: cost of making and delivering the product
to the customer
Increasing responsiveness usually results in higher costs, lowing efficiency
Second step to achieving strategic fit is to map the supply chain on
the responsiveness spectrum

2-29
High Low
Low
High
Responsiveness
Cost
Understanding the Supply Chain: Cost-
Responsiveness Efficient Frontier
2-30
Responsiveness Spectrum
I ntegrated
steel mill-
Production
scheduled
months in
advance
7-11 J apan,
Changes
merchandise
Mix by location
and time of day
Highly
efficient
Highly
responsive
Somewhat
efficient
Somewhat
responsive
Hanes
Apparel,
Traditional
Make-to-stock
Manufacturer
With lead-times
of several weeks
Most
automotive
Production, large
Variety of products
in a few weeks,
Some customization
So now we have two spectrums (lines)- what do you think is next?
2-31
Third Step is to ensure that what the supply chain does well is
consistent with target customers needs
All functions in the value chain must support the competitive
strategy to achieve strategic fit
Barilla Pasta and Apple Computer are examples of companies
that are in the Zone
Do you think their supply chain strategies are similar?
Key points
There is no one right supply chain for all companies
there is a right supply chain strategy for a given competitive strategy
In balancing efficiency and responsiveness, it is still critical to
remember sustainability
2-32
Achieving Strategic Fit Shown on the
Uncertainty/Responsiveness Map
Implied
uncertainty
spectrum
Responsive
supply chain
Efficient
supply chain
More
Certain
Highly
Uncertain
Responsiveness
spectrum
2-33
Comparison of Efficient and
Responsive Supply Chains
Efficient Responsive
Primary goal Lowest cost Quick response
Product design strategy Min product cost Modularity to allow
postponement
Pricing strategy Lower margins Higher margins
Mfg strategy High utilization Capacity flexibility
Inventory strategy Minimize inventory Buffer inventory
Lead time strategy Reduce but not at expense
of greater cost
Aggressively reduce even if
costs are significant
Supplier selection strategy Cost and, typically lower
quality
Speed, flexibility, quality
Transportation strategy Greater reliance on low cost
modes
Greater reliance on
responsive (fast) modes
2-34
Other Issues Affecting Strategic Fit
1. Multiple products and customer segments
2. Product life cycle
3. Competitive changes over time
4. Sustainability
2-35
Multiple Products and
Customer Segments
Firms sell different products to different customer
segments (with different implied demand uncertainty)
The supply chain has to be able to balance efficiency
and responsiveness given its portfolio of products and
customer segments
Two approaches:
1. Different supply chains for different products/customers
or
2. Tailor supply chain to best meet the needs of each products
demand. Example: W.W. Grainger, MRO
2-36
Product Life Cycle
The demand characteristics of a product and the needs
of a customer segment change as a product goes
through its life cycle
Examples: pharmaceutical firms, Intel
As the product goes through the life cycle, the supply
chain changes from one emphasizing responsiveness to
one emphasizing efficiency
Supply chain strategy must evolve throughout life cycle
Early: uncertain demand, high margins (time is important),
product availability is most important, cost is secondary
Late: predictable demand, lower margins, price is important
2-37
Competitive Changes Over Time
Competitive pressures can change over time
More competitors may result in an increased emphasis
on variety at a reasonable price
The Internet makes it easier to offer a wide variety of
products
The supply chain must change to meet these changing
competitive conditions
Example Dell used to sell PCs and laptops only via internet,
but now also sells at Wal-Mart
Sustainability
Consider both Ethical as well as Environmental issues
Sustainability policies may be driven by either
regulation or risk factors
WEEE- EU regulation forced electronics providers to
rethink SCs
Supplier risk
Demand risk, consumer expectations
May be complex relationships between
responsiveness, efficiency and sustainability issues
Sometimes, but not always, involving tradeoffs

2-38
2-39
Expanding Strategic Scope
Scope of strategic fit : The functions and stages within a supply
chain that devise an integrated strategy with a shared objective
One extreme: each function at each stage develops its own strategy
Other extreme: all functions in all stages devise a strategy jointly

From least to most evolved/expanded.
1. Intracompany intraoperation scope silos!
2. Intracompany intrafunctional scope
3. Intracompany interfunctional scope
4. Intercompany interfunctional scope - CPFR
5. Agile Intercompany, interfunctional scope - 3+ companies
Obstacles to Achieving Strategic Fit
In short: todays business environment is more
challenging for companies
1. Increasing variety of products
2. Shorter product life cycles (technology development, trend)
3. Increasingly picky customers
4. Fragmentation of chain ownership
5. Globalization, on supply-side and also the demand side*
6. Rapidly changing business environment
7. Difficulties with executing new strategies
8. Especially for 2007-2011 timeframe- economic cycle
2-40
*see the P&G Swiffer in Italy story
3-41
Outline: Chapter 3- Supply Chain
Drivers and Metrics
Drivers of supply chain performance
A framework for structuring drivers
Detailed view for each driver and appropriate metrics
3-42
1. Facilities
places where inventory is stored, assembled, or fabricated
production sites and storage sites
2. Inventory
raw materials, WIP, finished goods within a supply chain
inventory policies
3. Transportation
moving inventory from point to point in a supply chain
combinations of transportation modes and routes
4. Information
data & analysis regarding inventory, transportation, facilities throughout the chain
potentially the biggest driver of chain performance
5. Sourcing
functions a firm performs and functions that are outsourced
6. Pricing
Price associated with goods and services provided by a firm to the supply chain
3-43
A Framework for
Structuring Drivers
Competitive Strategy
Supply Chain
Strategy
Efficiency
Responsiveness
Facilities Inventory Transportation
Information
Supply chain structure
Cross Functional Drivers
Sourcing Pricing
Logistical Drivers
** also includes Sustainability
**
3-44
Facilities
Role in the supply chain- the where
manufacturing or storage (warehouses)
economies of scale (efficiency priority)
larger number of smaller facilities (responsiveness priority)
Components of facilities decisions
Location
centralization (efficiency) vs. decentralization (responsiveness)
other factors to consider (e.g., proximity to customers)
Capacity (flexibility versus efficiency)
Manufacturing methodology (product focused versus process focused)
Warehousing methodology (SKU storage, job lot storage, cross-docking)

3-45
Inventory
Exists because of a mismatch between supply and demand
Source of cost and influence on responsiveness
Given Littles Law, if throughput=demand, then inventory synonymous
with material flow time
If responsiveness is a strategic competitive priority, a firm can locate
larger amounts of inventory closer to customers
If cost is more important, inventory can be reduced (or consolidated
further away) to make the firm more efficient
Example: High-service department store: Nordstroms

We will spend 2 chapters in this class on inventory policies!
3-46
Components of Inventory
Decisions
Cycle inventory
Average amount of inventory used to satisfy demand between shipments
Depends on lot size
Safety inventory
inventory held in case demand exceeds expectations
costs of carrying too much inventory versus cost of losing sales
Seasonal inventory
inventory built up to counter predictable variability in demand
cost of carrying additional inventory versus cost of flexible production
more inventory: greater responsiveness but greater cost
less inventory: lower cost but lower responsiveness
3-47
Transportation
Moves the product between stages in the supply chain
Impact on responsiveness and efficiency
Faster transportation allows greater responsiveness but lower efficiency
Also affects inventory and facilities
If responsiveness is a strategic competitive priority, then faster
transportation modes can provide greater responsiveness to customers
who are willing to pay for it
Can also use slower transportation modes for customers whose priority
is price (cost)
Can also consider both inventory and transportation to find the right
balance
3-48
Components of
Mode of transportation:
air, truck, rail, ship, pipeline, electronic transportation
Utilization and backhaul rates should be considered
vary in cost, speed, size of shipment, flexibility, carbon footprint
Route and network selection
route: path along which a product is shipped
network: collection of locations and routes
In-house or outsource (see driver #5)
3-49
Information
The connection between the various stages in the supply chain allows
coordination between stages
Crucial to daily operation of each stage in a supply chain e.g.,
production scheduling, inventory levels
Allows supply chain to become more efficient and more responsive at
the same time (reduces the need for a trade-off)
Need to ask: what information is most valuable?

3-50
Components of Information
Decisions
Components of information decisions
Push (MRP) versus pull (need demand information across
all stages)
Coordination and information sharing
Forecasting and aggregate planning
Enabling technologies include the following:
EDI
Internet
ERP systems
Supply Chain Management software
RFID
Still some tradeoff exists: Responsiveness versus efficiency
3-51
Sourcing
Set of business processes required to purchase goods and services in a chain
Examples: contract manufacturers, Transportation/Inventory services- 3PL
Supplier selection, single vs. multiple suppliers, contract negotiation
Sourcing decisions are crucial because they affect the level of efficiency and
responsiveness in a supply chain
In-house vs. outsource decisions- improving efficiency and responsiveness
Example: Expedited delivery usually requires Parcel Delivery
Perform a task in-house versus outsource?
Procurement process
Overall trade-off: balance profitability (Risk? Ethical issues?)

3-52
Pricing
Pricing determines the amount to charge customers
Pricing strategies can be used to match demand and supply
Firms can utilize optimal pricing strategies to improve efficiency and
responsiveness
Low price and low product availability; vary prices by response times
Fixed price versus menu pricing
Overall trade-off: Increase the firm profits
We will explore effects from some of these pricing decisions later

Metrics
The performance for these supply chain drivers can be quantified
with metrics. Heres some examples we will work with during
this term:
1. Facilities: Capacity, Utilization rate, per unit production cost
2. Inventory: Days-OnHand (Dollars-OnHand), Safety Stock, Stockout %
3. Transportation: Fraction transported by mode, inbound/outbound
shipment size, inbound/outbound transportation cost per unit
4. Information: Forecast error, ratio of demand variability to order variability
5. Sourcing: supplier lead time, average purchase price, supplier reliability
6. Pricing: profit margin, fixed cost per order, variable cost per unit
Certain metrics will be more important than others for different
firms with different supply chain strategies
Information Overload: SCOR has over 150+ KPIs

3-53
1-54
Summary of Learning Objectives-
Chapter 1
What are supply chain stages?
What are the three flows within a supply chain?
What are the three key supply chain decision phases
and what is the significance of each?
What is the push/pull view of a supply chain?
What is the goal of a supply chain and what is the
impact of supply chain decisions on the success of the
firm?
2-55
for Chapter 2
Why is achieving strategic fit critical to a companys
overall success?
How does implied demand uncertainty differ from
demand uncertainty?
How does a company achieve strategic fit between its
supply chain strategy and its competitive strategy?
What are some complications to achieving this fit?

3-56
for Chapter 3
What are the major drivers of supply chain
performance?
What is the role of each driver in creating strategic fit
between supply chain strategy and competitive strategy
(or between implied demand uncertainty and supply
chain responsiveness)?
What are some relevant metrics?

In the remainder of the course, we will learn how to make
decisions with respect to these drivers in order to achieve
strategic fit and surmount these obstacles
4-1
Chapter 4 Outline: Designing Distribution
Networks and Applications to e-Business
E-Business and the Distribution Network
4-2
in the Supply Chain
Distribution: the steps taken to move and store a product from
the supplier stage to the customer stage in a supply chain
Distribution directly affects cost and the customer experience and
therefore drives profitability
Factors Influencing Distribution Network Design: As choice of
distribution network can achieve supply chain objectives from
low cost to high responsiveness:
Distribution network performance evaluated along two dimensions at the
highest level (and when sustainability is explicitly considered, three):
Affect on sustainability
Distribution network design options must therefore be compared
according to their impact on customer service and the cost to provide this
level of service as well as any significant sustainability impacts

4-3
DC = Distribution Center (effectively synonymous w/ Wholesaler)
DCs can be operated by a manufacturer, retailer or completely separate player
Types of DCs
1. Break-bulk
2. Transport optimizers, especially Cross-Dock
3. Fast response -aggregate inventory (risk-pooling) yet still quick delivery to customer, e.g.
MRO
Product, price, commoditization, and criticality (items importance)
have an impact on the type of distribution system

The choice of a distribution network has very long-term
consequences
Consider whether an exclusive distribution strategy is advantageous
The ownership structure of the distribution network can have as big as an
impact as the type of distribution network (ex. Naya water/CCE distribution)

4-4
A Professorial Aside: Value of
Distributors in the Supply Chain
Are distributors an unnecessary link?

Consolidate small or varied replenishment orders (breaking bulk
orders and centralizing safety stocks)
Consumer Packaged Goods in India
Pharmaceuticals: 5-6 distributors in U.S. handle thousands of retailers who
order from hundreds of manufacturers
Sometimes mandated by regulation: For alcohol sales in the US,
the 2
nd
tier is mandated in 48 states, serves as a tax collection point
Distributors typically have low margins (1%-2%), so are
motivated to be efficient
4-5
Factors Influencing
Elements of customer service (responsiveness) that are
influenced by network structure:
Response time
Product variety & availability
Customer experience
Order visibility
Returnability (for both customer service and sustainability reasons)
Supply chain costs affected by network structure (4 of 6 drivers
from Chapter 3):
Facilities and handling (At the moment, focus is on warehousing facilities )
Inventories
Transportation
Information
Lets graph the interactions of these with costs

4-6
of Facilities
Facility
Costs
4-7
Transportation
Costs
4-8
of Facilities
Inventory
Costs
4-9
Transportation
Total Costs Related to

T
o
t
a
l

C
o
s
t
s

Inventory
Facilities
Total Costs
4-10
Number of
Facilities
Response Time
4-11
Response Time
Time with Number of Facilities
4-12
We consider some various network options that move beyond
the traditional model. (Many of these non-traditional networks
have been made more viable by the internet revolution)
Shown in graphic format in next few slides:
Manufacturer Storage with Direct Shipping and In-Transit Merge
Also not explicitly graphed:
Retail Storage with Customer Pickup- often integrated with traditional
model (Bevmo.com, for example. REI.com and Gap.com also allow
used this model in the US).
Not discussed: Manufacturing/Distributor storage w/Customer Pickup
4-13
Direct Shipping via Parcel Delivery (Fig. 4.6)
Manufacturer
Retailer
Customers
Product Flow
Information Flow
This is also called drop shipping
4-14
Factories
Retailer
Product Flow
Information Flow
I n-Transit Merge by
Carrier
Customers
4-15
Parcel Delivery (fig 4.8)
Factories
Customers
Product Flow
Information Flow
4-16
Factories
Customers
Product Flow
Information Flow
Warehouse
4-17
Competitive Performance of the
Table 4-7 in the text shows that each of these distribution
networks has different characteristics with respect to:
Costs - facilities, inventory, transport, information
Service/Responsiveness:
Response time
Product variety
Customer experience
Order visibility
Return-ability
Performance will change depending on attributes of
Products: demand level, variety, multiple sources? high value
Customers: do they desire quick response times? Effort level?
4-18
E-Business and the Distribution
Network
Depending on the firm, the product and core customer base, e-
Business will have different impacts on:
Customer Service (i.e. Responsiveness of Supply Chain):
Response time (non downloadable products), Product variety, Product
availability, Customer experience, Time to market, Order visibility,
Returnability, Direct Sales to Customers, Efficient Funds Transfer,
Costs Facilities , Inventory, Transportation, Information
In general, E-Business provides an easier way to adjust Pricing: Flexible
Pricing, Product Portfolio, and Promotions
Example: Table 4-10 in the text summarizes Dells online
business with respect to two different products:
customized, high-value PCs verses standardized, commodity PCs

Chapter 5 Outline: Network
Design in the Supply Chain
The Role of Network Design in the Supply Chain
Factors Influencing Network Design Decisions
Framework for Network Design Decisions
Models for Facility Location and Capacity
Allocation
5-19
Facility role
What role should each facility play?
Facility number and location
How many facilities do we need?
Where should facilities be located?
Capacity allocation
How much capacity should be allocated to each facility?
What supply sources should feed each facility?
What markets should each facility serve?
5-20
Facility Role-
Classifications of Facilities
In order from lowest cost to highest value, and their strategic roles:
1. Offshore (Low cost facility for export production)
2. Source (Low-cost facility for global production)
3. Server (Regional production facility)
4. Contributor (Regional production facility with
development skills)
5. Outpost (Regional production facility used by the firm to
gain expertise from the locals)
6. Lead (Model facility that leads the firm in development of
new products or technologies)
Factors Influencing
Strategic
Evaluate tradeoffs: place manufacturing close to market -vs.- low cost?
Should we co-locate facilities with vendors/suppliers?
Technological: Do production technologies have significant economies of scale?
Macroeconomic
Tariffs and tax incentives (i.e. free trade zones), Exchange rate and demand risk
Political: Stability, clear legal system and regulations important for corporations
Infrastructure
Will local infrastructure support a facility? Labor (especially skilled) available?
Competitive: Locate near or far from rivals?
Customer Response time / Local Presence
How important is convenience vs.- lower cost centralized facilities
Is local knowledge crucial to the business model?
Logistics & facility COSTS
Crucial to consider in setting up or redesigning the supply chain
Sustainability: Are local environmental and ethical practices consistent with
corporate need?
5-22
Local FG
Mix
Regional FG
Local WIP
Central FG
Central WIP
Cost
Response Time
Slooooow Quick
Low
High
5-23
Infeasible (without
innovation)
Inefficient-
can either
reduce cost or
lead-time
FG- finished goods.
WIP- Work in Progress
How Many Facilities?
Service given Number of Facilities
Response
Time
5-24
Costs
Inventory
Transportation
Facility costs
5-25
Percent Service
Level Within
Promised Time
Transportation
Cost Buildup as a Function of Facilities
L
e
v
e
l

o
f

S
e
r
v
i
c
e

Inventory
Facilities
Total Costs
5-26
C
o
s
t

o
f

O
p
e
r
a
t
i
o
n
s

Low
High
A Framework for
Global Site Location
PHASE I
Supply Chain
Strategy
PHASE II
Regional
Facility
Configuration
PHASE III
Desirable Sites
PHASE IV
Location
Choices
existing network
COMPETITIVE
ENVIRONMENT
PRODUCTION METHODS
FACTOR COSTS
GLOBAL COMPETITION
TARIFFS AND TAX
INCENTIVES
REGIONAL DEMAND
POLITICAL, EXCHANGE
AVAILABLE
INFRASTRUCTURE
LOGISTICS COSTS Transport,
inventory, coordination
5-27
Useful tools for both Phase II and Phase IV

Question for Phase II: In what regions should we source
demand in and how do we configure our network? given:
Regional demand, tariffs, economics of scale, aggregate factor costs
Not necessary to go to detail of specific plant locations as we do in
later phases
Need to also consider less quantifiable factors such as political and
regulatory climate, competition

Phase IV involves selecting specific existing facilities and
allocating capacity within those selected given:
Fixed facility cost, Transportation cost, Production cost, Inventory
cost, Coordination cost

5-28
Example: Using Network Models
for Phase II Decisions
SunOil, a global energy company, needs to determine
1. where to locate facilities to service their demand
2. what size to build in the region (small or large), should they locate
a facility there

They divide the world into 5 different regions: N.America,
S.America, Europe, Asia, Africa

SunOil knows regional demands, transport costs, and facility costs
and capacities for each size (and region)

We will ignore tariffs and exchange rate fluctuations for now, and
assume all demand must be met (so we can focus on minimizing
costs)

What analytic tool are we likely to use?
What is the twist that we need to consider?

5-29
Excel Example: SUNOIL
Ill email the following document: network-MIP.xls
Turn to the SunOil sheet
The data is shown below

INPUTS
Supply Region N. America S. America Europe Asia Africa fixed cost cap. M fixed cost cap. M
N. America 81 $ 92 $ 101 $ 130 $ 115 $ 6,000 $ 10 9,000 $ 20
S. America 117 $ 77 $ 108 $ 98 $ 100 $ 4,500 $ 10 6,750 $ 20
Europe 102 $ 105 $ 95 $ 119 $ 111 $ 6,500 $ 10 9,750 $ 20
Asia 115 $ 125 $ 90 $ 59 $ 74 $ 4,100 $ 10 6,150 $ 20
Africa 142 $ 100 $ 103 $ 105 $ 71 $ 4,000 $ 10 6,000 $ 20
Demand total 12 8 14 16 7
production,tax, and transit costs per 1M units from
Supply Region to Demand Region SMALL facility LARGE facility
Capacitated Plant Location Model
n the number of potential sites
As we are considering two different type plants
(small, large) for each region, n = 10
m regions with demand
D
j
demand in region j
K
i
capacity at plant I
f
i
fixed cost of keeping plant i open
c
ij
variable cost of sourcing region j from
plant i
y
i
= 1 if plant is located at site i,
= 0 otherwise
x
ij
Quantity shipped from site i to region j

} 1 , 0 {
. .
1
1
1 1 1

y
y
K x
D x
x c
y f
i
i
i
n
j
ij
j
n
i
ij
n
i
m
j
ij ij
i
n
i
i
t s
Min
5-31
Can we do this with a pure LP?
When would a simple LP be acceptable?
While the equations may
look complex, go to the
spreadsheet and look at the
underlying relationships
Excel Example: SUNOIL
Before solving, we can experiment with some configurations.
What are the tradeoffs?
Often a good idea to experiment to help understand the network model
and the solution
Consider the optimal solution- what are some characteristics?
Food for Thought: what happens if we want to change the
model?
Force a plant to be located in Europe?
Avoid locating more than one facility in the same region?
Force worldwide capacity to be able to accommodate more than current
demand by 5 M

What the book has for Phase III:
Ton Mile-Center Solution
x,y: Warehouse Coordinates
x
n
, y
n
: Coordinates of delivery
location n
d
n
: Distance to delivery
location n
F
n
: Annual tonnage to delivery
location n

k
n n
n
k
n n
n
n
k
n n
n
k
n n
n
n
n
d
F
D
d
F
y
D
d
F
D
d
F
x
D
y y
x
x
d
n
n
y
n
n
x
n
n
1
1
1
1
2
2
) (
) (
Min
F
D d
n n
n
5-33
Before you pull out your calculator.
Gravity Location Models: Limitations
Professor Opinion, not in Textbook
Assumes that all distances have identical per-mile costs
Assumes homogenous topography
Ignores limitations of existing ground/water transport network, inter-
state/country transit taxes and regulations

Costs of setting up a new facility is often prohibitive compared
to revamping an existing facility (even if in a less desirable
location)
Especially pertinent given economic and less-quantifiable costs of
shutting down facilities
The problems I have encountered personally have been to consolidate or
revamp facilities, never to set up a completely new installation

For this class, you can assume that you will be provided with a
finite number of site locations, and that you will be given all
cost parameters c
i,j
for transit between location i and j
Phase IV: Network Optimization
Models- Allocating Demand
Which plants to establish/keep? How to configure the network?
Key Costs:

Fixed facility cost
Transportation cost
Production cost
Inventory cost
Coordination cost
5-35
Example- Modeling a Phase IV
Decision
TelecomOne has merged with High Optic. They have plants in
different cities and service several regions. They would like to
figure out how to service all demand while keeping costs low:
The supply cities are Baltimore (capacity 18K), Cheyenne (24K), Salt
Lake City (27K), Memphis (22K) and Wichita (31K)
They have the following monthly regional demands:
10K in Atlanta
6K in Boston
14K* in Chicago * per table 5.3 , Book uses 12 K, not 14K for Chicago,
6K in Denver although their spreadsheet inserts are okay
7K in Omaha
They will consider consolidating facilities

What sort of tool are we likely to use?

5-36
Answers the questions of
Which market is served by which plant?
Which supply sources are used by a plant?

Decision variables:
x
ij
= Quantity shipped from plant site i to
customer j

Can solve as a simple LP, see sheet Telecom-
all-plants under network-MIP.xls

But what if we also have the option of not using
all facilities.
0
. .
1
1
1 1

x
K x
D x
t s
x c
Min
ij
i
m
j
ij
j
n
i
ij
n
i
m
j
ij ij
5-37
Allocating Demand to
Production Facilities
Decision variables
y
i
= 1 if plant is located/left
open at site i, 0 otherwise
x
ij
= Quantity shipped from
plant site i to customer j

See Sheet Telecom-close-
plants of network-MIP.xls

Look familiar?
} 1 , 0 {
. .
1
1
1 1 1

y
y
K x
D x
x c
y f
i
i
i
n
j
ij
j
n
i
ij
n
i
m
j
ij ij
i
n
i
i
t s
Min
5-38
Example Results
Before we solve the problem, what can we say about
TelecomOptics situation?
What does the Excel model indicate should happen with
plant configuration? Demand allocation?
What are the ramifications from this solution?
What are some what-if scenarios we might consider?

5-39
Considering Additional Layers:
Simultaneously Locating Plants and DCs
Now add cost to transport from suppliers, as well as the
plant and DC/Warehouse costs
y
K x
D x
x c x c x c
y f y f
i
i
n
j
ij
j
n
i
ij
t
e
m
j
ej ej
n
i
t
e
ie ie
l
h
n
i
hi hi
e
t
e
e i
n
i
i
t s
Min

1
1
1 1 1 1 1 1 1 1
. .
5-40
suppliers plants
DCs
customer1
customer2
customer3
Etc (Dont worry- thats beyond the scope of this class)
Making Network Design Decisions
In Practice
Do not underestimate the life span of facilities
Production facilities harder to retool than storage facilities
Consider ethical issues with respect to closing plants
Do not gloss over the cultural implications
Should Eichbaum (who has a single brewery in Mannheim)
produce beer for the growing Chinese in Shanghai?
Do not ignore quality of life issues
Consider tariffs and tax incentives when locating
facilities
5-41
6-42
Outline- subset of Chapter 6
Designing Global Supply Chain Networks

Due to time limitations, we do not delve into Decision Tree
theory and other analytical models in this chapter, and we
consider only the introductory material in this chapter

The Impact of Globalization on Supply Chain Networks
Risk Management in Global Supply Chains
6-43
The Impact of Globalization on
Supply Chain Networks
Globalization offers companies opportunities to simultaneously
grow revenues and decrease costs

The opportunities from globalization are often accompanied by
significant additional risk

There will be a good deal of uncertainty in demand, prices,
exchange rates, and the competitive market over the lifetime of
a supply chain network

Therefore, building flexibility into supply chain operations
allows the supply chain to deal with uncertainty in a manner
that will maximize profits
6-44
Total cost can be identified by focusing on the
complete sourcing process, not just per-unit cost
Offshoring to low-cost countries is likely to be most
attractive for products with:
High labor content
Large production volumes
Relatively low variety
Low transportation costs
Perform a careful review of the production process
Consider use of auditors (verifying workplace conditions)
and quality testing services
Risk Management in Global
Supply Chains
Disruptions
Topical Example: Honda, Nissan and Toyota have
effectively shut down factories for weeks following the
2011 Tsunami
Nissan estimates lost profits of over $25 million/day
Delays
Systems risk
Forecast risk
Intellectual property risk
Procurement risk
Inventory risk
Capacity risk
6-45
Tailored Risk Mitigation Strategies
Increase capacity
Get redundant suppliers
Increase responsiveness
Increase inventory
Increase flexibility
Pool or aggregate demand
Increase source capability
6-46
4-47
Objectives
What roles do distributors play in the supply chain?
What are the key factors to be considered when
designing the distribution network?
What are the strengths and weaknesses of various
distribution options, including e-Business enabled
ones?
Objectives
What is the role of network design decisions in the
supply chain?
Describe a strategic framework for facility location
How can network optimization methods be used for
facility location and capacity allocation decisions?
5-48
7-1
Outline:
Demand Forecasting
Given the limited background from the surveys
and that Chapter 7 in the book is complex, we will
cover less material.
The role of forecasting in the chain
Characteristics of forecasts
Basic approach to demand forecasting
Measures of forecast error

We will skip seasonality and Holts and Winters
methods. We do not spend any time on static forecasts
7-2
Role of Forecasting
in a Supply Chain
The basis for all strategic and planning decisions
in a supply chain
Used for both push and pull processes
Examples:
Production: scheduling, inventory, aggregate planning
Marketing: sales force allocation, promotions, new
production introduction
Finance: plant/equipment investment, budgetary
planning
Personnel: workforce planning, hiring, layoffs
All of these decisions are interrelated
7-3
Characteristics of Forecasts
A FORECAST is a statement about the future
Absatzprognose, Vorhersage
Forecasts are always wrong. Report both the expected
value of the forecast and the measure of error
Long-term forecasts are less accurate than short-term
forecasts (forecast horizon is important)
Aggregate forecasts are more accurate than disaggregate
forecasts
In order to forecast, the past has to have some relevance to
the future
7-4
Forecasting Methods
Qualitative: primarily subjective; use judgment/opinion
Time Series: use historical demand only
Static
Adaptive We will only consider adaptive
Causal (or associative): use the relationship between demand and a
factor other than pure time to develop forecast
Simulation
Imitate consumer choices that give rise to demand
Can combine time series and causal methods
7-5
Basic Approach to
Demand Forecasting
Understand the objectives of forecasting
Integrate demand planning and forecasting
Identify major factors that influence the demand
forecast
Understand and identify customer segments
Determine the appropriate forecasting technique
Establish performance and error measures for the
forecast
7-6
Components of an Observation
Observed demand (O) =
Systematic component (S) + Random component (R)
Level (current deseasonalized demand)
Trend (growth or decline in demand)
Seasonality (predictable seasonal fluctuation)
Systematic component: Expected value of demand
Random component: The part of the forecast that deviates
from the systematic component
Forecast error: difference between forecast and actual demand
7
Steps in the Forecasting Process
Step 1 Determine the purpose of forecast
Step 2 Pick an appropriate time horizon
Step 3 Select a forecasting technique
- Plotting data may reveal patterns

Step 4 Gather and analyze data in detail
State assumptions
Validate Data: May need to cleanse or filter for past events

Step 5 Calculate forecast
Step 6 Analyze/Monitor the forecast- Measure Accuracy
Are results acceptable?
No: Return to Step 3, revising forecast technique
Yes: Publish forecast
For ongoing forecasting: repeat Steps 4 through 6
Time Series Forecasts
Trend - long-term movement in data
Linear: steady increase (or decrease) over time
Not all trends are linear. Demand may be exponential, may both
increase and decrease over product life cycle: VHS players

Seasonality - short-term regular variations in data
Example: Walgreens sales of cold medications over the year
Not just limited to Fall/Winter/Spring/Summer variations
Weekly demand for reservations at expensive restaurants
Daily cycle of coffee sales at Starbucks

Irregular variations - caused by unusual circumstances
Infrequent spikes
i.e. a stock market crash, 9/11 catastrophe

Random variations - caused by chance

Techniques Covered in this Class

Averaging (or Smoothing)
Moving Average
Weighted Moving Average
- Trend-Adjusted Exponential Smoothing (Holts) is not
covered, nor is Winters (trend + seasonality)
Linear Trend Analysis
10
Moving Average
The average of the N most recent observations:

Example: a 4-period MA for time period 7 would be

F
7
= (A
6
+A
5
+A
4
+A
3
)/4

The larger N, the smoother the forecast, but the greater the
Lag (ability to respond to real changes)

n
A
t MA
t
n t i
i
n
1
) (
11
General Note: To Write Formula
with Respect to t or t+1
Which is correct?
1. F
t+1
= (blah)A
t
+ blah
2. F
t
= (blah)A
t-1
+ blah
Both are! As long as its clear just what t (or t+1) represents,
these can be usable interchangeably
If you need to calculate the forecast for period 5, be clear
whether t=5 or t+1=5

But most important, dont write:
F
t
= (blah)A
t
+ blah

12
Weighted Moving Average
Premise:The most recent observations might have the best
predictive value. Yet for simple moving averages older data
points have same importance as most recent
We modify to give greater weight to more recent observations.
(Remember: S W
i
= 1 or you get bias!)

Advantages: Avoids oversmoothing and lag time is
decreased
Weights are arbitrary, often found through trial and error!
1
) (
t
n t i
i i n A W t WMA
13
Exponential Smoothing is a type of Weighted Moving
Average:

F
t
= aA
t-1
+ a (1-a) A
t-2
+ a (1-a)
2
A
t-3
+ a (1-a)
3
A
t-4
+ ...

However, it is much more easily written, computed and
understood as:

Where a is between 0 and 1
1 1 ) 1 ( t t t F A F a a
More Exponential Smoothing
Rearranging the terms shows this method can be viewed as the
previous periods forecast adjusted by a percentage of the
previous periods error (E
t-1
= A
t-1
F
t-1
)

The quickness of forecast adjustment is determined by the
smoothing constant, a
The closer a to zero, the greater the smoothing
How do we pick a? Trial and error or can even optimize for it!
How to initialize the forecast? Many ways!
Book: average all the data we have so far
More practical and repeatable? Start it with F
2
= A
1
) ( 1 1 1 t t t t F A F F a
15
How to Select a Forecast
To forecast data without trends, we could use a simple nave
forecast, a MA (still need to pick the window), a WMA (need
to pick both the window and the weights) or an exponential
smoother (need to pick a)
We will get many different answers- how do we pick the one
we feel will have the best chance of being close to what will
happen?
We calculate past forecast accuracy, and we then pick the one
that is most accurate.

Measuring Forecast Accuracy

Error: difference between actual value and predicted value.
Many different measures exist (we use MAD only)

Mean Absolute Deviation
(MAD)

Mean Squared Error
(MSE)

Standard Error
(Standard Deviation)

t
F A
MAD
t
i
i i
t
1

1
1
2
t
F A
MSE
t
i
i i
t
t t
t t
MAD
MSE
* 25 . 1 thumb of rule

If there is a trend, the smoothing filters we have covered will
LAG, resulting in bad forecasts.
Plot the data first- in this example, do you see a trend?
If the trend is linear, we will use Linear Trend Analysis
Caveat: Not all trends are linear! (We do not cover curvilinear regression in
this class)

sales by week
145
150
155
160
165
170
175
180
0 2 4 6
week
s
a
l
e
s
Linear Trend Equation
Where
a = intercept
b = slope

Looks like a simple line equation, but a and b are determined
to minimize Mean Squared Error (MSE)
Y
t
= a + b*t
140
145
150
155
160
165
170
175
180
185
1 2 3 4 5 6
Graphing the Results
Regressing Sales Against Week
145
150
155
160
165
170
175
180
185
1 2 3 4 5 6
week
s
a
l
e
s
Actual
Forecast
Example:
An intern at Netflix has been tracking weekly rentals of the
direct-to-DVD movie Barney Meets Vin_Diesel: Fossilized!
and, after noticing a pattern, has modeled them with a linear
trend analysis. The Excel model gives a= 400, b= -10, where t
= 0 was the DVD release week. It is currently week 12

What is the linear trend equation?
What are sales predicted to be this week?
What does the model predict sales will be a half year (26 weeks) after
the release?
When does the model predict sales to stop? Do you believe this model is
likely to be accurate for making long term predictions?

Associative Forecasting
What if we think there is a better indicator of future behavior
than time?
Use explanatory or predictor variables to predict the future
E.g. Using interest rates to predict home purchases
The associative technique used in this class is Simple Linear
Regression
Linear Trend Analysis was an example where time t was used at the
dependent variable. But now we can use factors other than time

Y
t
= a + bt Linear Trend Analysis

Y
t
= a + bX
t
Associative Forecast
( X
t
is used instead of t)
Again, we use Excel to determine a and b

22
Associative Forecasting:
Linear Regression
D
e
p
e
n
d
e
n
t

v
a
r
i
a
b
l
e

Independent variable
X
Y
Actual
value
of Y
Estimate of
Y from
regression
equation
Value of X used
to estimate Y
Regression
equation:
Y = a + bX
23
Associative Forecasting:
Linear Regression
D
e
p
e
n
d
e
n
t

v
a
r
i
a
b
l
e

Independent variable
X
Y
Actual
value
of Y
Estimate of
Y from
regression
equation
Value of X used
to estimate Y
Deviation,
or error
{
Regression
equation:
Y = a + bX
24
Example:
Associative Forecast
Sales Advertising
Month (000 units) (000 $)

1 264 2.5
2 116 1.3
3 165 1.4
4 101 1.0
5 209 2.0
a = Y - bX b =
A rotor manufacturer has recorded these sales figures over the past 5
months. They also know the budget spent promoting these parts

1) Is there wide variation in sales?
2) Does this appear to be a good candidate for linear trend analysis?
25
Now Consider Sales
verses Advertising Spend
26
How Strong is the Relationship?
Correlation ( r ), measures strength and direction of the
forecast of Y with respect to X (or t for linear trend analysis)
0 < r <1 Positive correlation (sales of ice cream cones vs- temperature)
-1 < r < 0 Negative correlation (sales of sweatshirts vs- temperature)

You are not expected to compute r by hand! Instead use
Regression Analysis in Excel (the multiple R entry)
R-Squared ( r
2
) measures the percentage of variation in y that
is explained by x
If .8 < r
2
< 1, X is a very good predictor
For r
2
< .25, X is a poor predictor- look for something else!

Even if you have a good predictor, remember correlation is not
causation

27
Example: Excel Solution
to Linear Regression
SUMMARY OUTPUT
Regression Statistics
Multiple R 0.979565
R Square 0.959547
Adjusted R Square 0.946063
Standard Error 15.60274
Observations 5
ANOVA
df SS MS F Significance F
Regression 1 17323.66 17323.66 71.1604 0.0035
Residual 3 730.3361 243.4454
Total 4 18054
Coefficients Standard Error t Stat P-valueLower 95%Upper 95% Lower 95.0% Upper 95.0%
Intercept -8.13 22.35 -0.36 0.74 -79.27 63.00 -79.27 63.00
X Variable 1 109.23 12.95 8.44 0.00 68.02 150.44 68.02 150.44
Correlation is not Causation:
An Example
The following scatter-plot shows that the average life
expectancy for a country is related to the number of doctors per
person in that country. We could come up with all sorts of
reasonable explanations justifying this, but
Lurking Variables and Causation:
Another Example
This new scatter-plot shows that the average life expectancy for is
also related to the number of televisions per person in that country.
And the relationship is even stronger: R
2
of 72% instead of 62%
Since TVs are cheaper than doctors, Why dont we send TVs to
countries with low life expectancies in order to extend lifetimes.
Right?

Lurking Variables and Causation:
An Example

How about considering a lurking variable? That
makes more sense
Countries with higher standards of living have both longer life
expectancies and more doctors (and TVs!).
If higher living standards cause changes in these other variables,
improving living standards might be expected to prolong lives and,
incidentally, also increase the numbers of doctors and TVs.

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Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Copyright 2010 Pearson Education, Inc. Publishing as Prentice Hall.

Linear Trend Analysis

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