Unit 1

Topics
Building Blocks of a Supply Chain Network Performance Measures Decisions in the Supply Chain World Models for Supply Chain Decision-Making

To introduce the major building blocks, major functions, major business processes, performance metrics, and major decisions (strategic, tactical, and operational) in supply chain networks To provide an insight into the role of Internet Technologies and Electronic Commerce in supply chain operations and to discuss technical aspects of key ITEC components in supply chain management.
To bring out the role of stochastic models (Markov chains, queueing networks); optimization models (LP, ILP, MILP, GA, Constraint Programming); and simulation in supply chain planning and decision-making. This will provide the foundation for design and analysis of supply chains.

What is Supply Chain Management?

A SUPPLY CHAIN is a network of supplier, manufacturing, assembly, distribution, and logistics facilities that perform the functions of procurement of materials, transformation of these materials into intermediate and finished products, and the distribution of these products to customers. Supply chains arise in both manufacturing and service organizations. SUPPLY CHAIN MANAGEMENT (SCM) is a systems approach to managing the entire flow of information, materials, and services from raw materials suppliers through factories and warehouses to the end customer. SCM is different from SUPPLY MANAGEMENT which emphasizes only the buyer-supplier relationship. Supply chain management has emerged as the new key to productivity and competitiveness of manufacturing and service enterprises. The importance of this area is shown by a significant spurt in research in the last five years and also proliferation of supply chain solutions and supply chain companies (e.g. i2, Manugistics, etc.). All major ERP companies are now offering supply chain solutions as a major extended feature of their ERP packages. Supply chain management is a major application area for Internet Technologies and Electronic Commerce (ITEC). In fact, advances in ITEC have contributed to growing importance of supply chain management and SCM in turn has contributed to many advances in ITEC. 1.2. Two Faces of Supply Chain Management SCM has two major faces to it. The first can be called loosely as the back-end and comprises the physical building blocks such as the supply facilities, production facilities, warehouses, distributors, retailers, and logistics facilities. The back-end essentially involves production, assembly, and physical movement. Major decisions here include:

1. Procurement (supplier selection, optimal procurement policies, etc.) 2. Manufacturing (plant location, product line selection, capacity planning, production scheduling, etc.) 3. Distribution (warehouse location, customer allocation, demand forecasting, inventory management, etc.) 4. Logistics (selection of logistics mode, selection of ports, direct delivery, vehicle scheduling, etc.) 5. Global Decisions (product and process selection, planning under uncertainty, real-time monitoring and control, integrated scheduling) Supply Chain Network A supply chain network consists of physical, financial and information networks that involve the movement of materials, funds and related information through the logistics process, from the acquisition of raw materials to delivery of finished products to the end user. The network shown in Exhibit 10.1 has four levels of facilities. Products flow down stream from vendors to plants, from plants to distribution centres, and from distribution centers to markets. Exhibit 10.1: Supply Chain Network

Stochastic models (Markov chains, queueing networks), optimization models (LP, ILP, MILP, heuristics), and simulation provide the basis for the above decisions. The second face (which can be called the front-end) is where IT and ITEC play a key role. This face involves processing and use of information to facilitate and optimize the back-end operations. Key technologies here include: EDI (for exchange for information across different players in the supply chain); Electronic payment protocols; Internet auctions (for selecting suppliers, distributors, demand forecasting, etc.); Electronic Business Process Optimization; E-logistics; Continuous tracking of customer orders through the Internet; Internet-based shared services manufacturing; etc.

Supply Chain Decisions

We classify the decisions for supply chain management into two broad categories -- strategic and operational. As the term implies, strategic decisions are made typically over a longer time horizon. These are closely linked to the corporate strategy (they sometimes {\it are} the corporate strategy), and guide supply chain policies from a design perspective. On the other hand, operational decisions are short term, and focus on activities over a day-to-day basis. The effort in these type of decisions is to effectively and efficiently manage the product flow in the "strategically" planned supply chain.

There are four major decision areas in supply chain management: 1) location, 2) production, 3) inventory, and 4) transportation (distribution), and there are both strategic and operational elements in each of these decision areas.
Location Decisions The geographic placement of production facilities, stocking points, and sourcing points is the natural first step in creating a supply chain. The location of facilities involves a commitment of resources to a long-term plan. Once the size, number, and location of these are determined, so are the possible paths by which the product flows through to the final customer. These decisions are of great significance to a firm since they represent the basic strategy for accessing customer markets, and will have a considerable impact on revenue, cost, and level of service. These decisions should be determined by an optimization routine that considers production costs, taxes, duties and duty drawback, tariffs, local content, distribution costs, production limitations, etc. (See Arntzen, Brown, Harrison and Trafton [1995] for a thorough discussion of these aspects.) Although location decisions are primarily strategic, they also have implications on an operational level. Production Decisions The strategic decisions include what products to produce, and which plants to produce them in, allocation of suppliers to plants, plants to DC's, and DC's to customer markets. As before, these decisions have a big impact on the revenues, costs and customer service levels of the firm. These decisions assume the existence of the facilities, but determine the exact path(s) through which a product flows to and from these facilities. Another critical issue is the capacity of the manufacturing facilities--and this largely depends the degree of vertical integration within the firm. Operational decisions focus on detailed production scheduling. These decisions include the construction of the master production schedules, scheduling production on machines, and equipment maintenance. Other considerations include workload balancing, and quality control measures at a production facility. Inventory Decisions These refer to means by which inventories are managed. Inventories exist at every stage of the supply chain as either raw materials, semi-finished or finished goods. They can also be in-process between locations. Their primary purpose to buffer against any uncertainty that might exist in the supply chain Since holding of inventories can cost anywhere between 20 to 40 percent of their value, their efficient management is critical in supply chain operations. It is strategic in the sense that top management sets goals. However, most researchers have approached the management of inventory from an operational perspective. These include deployment strategies (push versus pull), control policies --- the determination of the optimal levels of order quantities and reorder points, and

setting safety stock levels, at each stocking location. These levels are critical, since they are primary determinants of customer service levels. Transportation Decisions The mode choice aspect of these decisions is the more strategic ones. These are closely linked to the inventory decisions, since the best choice of mode is often found by trading-off the cost of using the particular mode of transport with the indirect cost of inventory associated with that mode. While air shipments may be fast, reliable, and warrant lesser safety stocks, they are expensive. Meanwhile shipping by sea or rail may be much cheaper, but they necessitate holding relatively large amounts of inventory to buffer against the inherent uncertainty associated with them. Therefore customer service levels, and geographic location play vital roles in such decisions. Since transportation is more than 30 percent of the logistics costs, operating efficiently makes good economic sense. Shipment sizes (consolidated bulk shipments versus Lot-for-Lot), routing and scheduling of equipment are key in effective management of the firm's transport strategy.

Supply Chain Modelling Approaches

Clearly, each of the above two levels of decisions require a different perspective. The strategic decisions are, for the most part, global or "all encompassing" in that they try to integrate various aspects of the supply chain. Consequently, the models that describe these decisions are huge, and require a considerable amount of data. Often due to the enormity of data requirements, and the broad scope of decisions, these models provide approximate solutions to the decisions they describe. The operational decisions, meanwhile, address the day to day operation of the supply chain. Therefore the models that describe them are often very specific in nature. Due to their narrow perspective, these models often consider great detail and provide very good, if not optimal, solutions to the operational decisions.

To facilitate a concise review of the literature, and at the same time attempting to accommodate the above polarity in modeling, we divide the modeling approaches into three areas --- Network Design, ``Rough Cut" methods, and simulation based methods. The network design methods, for the most part, provide normative models for the more strategic decisions. These models typically cover the four major decision areas described earlier, and focus more on the design aspect of the supply chain; the establishment of the network and the associated flows on them. "Rough cut" methods, on the other hand, give guiding policies for the operational decisions. These models typically assume a "single site" (i.e., ignore the network) and add supply chain characteristics to it, such as explicitly considering the site's relation to the others in the network. Simulation methods is a method by which a comprehensive supply chain model can be analyzed, considering both strategic and operational elements. However, as with all simulation models, one can only evaluate the effectiveness of a pre-specified policy rather than develop new ones It is the traditional question of "What If?" versus "What's Best?".

Network Design Methods As the very name suggests, these methods determine the location of production, stocking, and sourcing facilities, and paths the product(s) take through them. Such methods tend to be large scale, and used generally at the inception of the supply chain. The earliest work in this area, although the

term "supply chain" was not in vogue, was by Geoffrion and Graves [1974]. They introduce a multi commodity logistics network design model for optimizing annualized finished product flows from plants to the DC's to the final customers. Geoffrion and Powers [1993] later give a review of the evolution of distribution strategies over the past twenty years, describing how the descendants of the above model can accommodate more echelons and cross commodity detail.

Breitman and Lucas [1987] attempt to provide a framework for a comprehensive model of a production-distribution system, "PLANETS", that is used to decide what products to produce, where and how to produce it, which markets to pursue and what resources to use. Parts of this ambitious project were successfully implemented at General Motors. Cohen and Lee [1985] develop a conceptual framework for manufacturing strategy analysis, where they describe a series of stochastic sub- models, that considers annualized product flows from raw material vendors via intermediate plants and distribution echelons to the final customers. They use heuristic methods to link and optimize these sub- models. They later give an integrated and readable exposition of their models and methods in Cohen and Lee [1988]. Finally, Arntzen, Brown, Harrison, and Trafton [1995] provide the most comprehensive deterministic model for supply chain management. The objective function minimizes a combination of cost and time elements. Examples of cost elements include purchasing, manufacturing, pipeline inventory, transportation costs between various sites, duties, and taxes. Time elements include manufacturing lead times and transit times. Unique to this model was the explicit consideration of duty and their recovery as the product flowed through different countries. Implementation of this model at the Digital Equipment Corporation has produced spectacular results --- savings in the order of $100 million dollars.
Rough Cut Methods These models form the bulk of the supply chain literature, and typically deal with the more operational or tactical decisions. Most of the integrative research (from a supply chain context) in the literature seems to take on an inventory management perspective. In fact, the term "Supply Chain" first appears in the literature as an inventory management approach. The thrust of the rough cut models is the development of inventory control policies, considering several levels or echelons together. These models have come to be known as "multi-level" or "multi-echelon" inventory control models. For a review the reader is directed to Vollman et al. [1992].

Supply Chain Performance Measures

Supply chain performance measures can be classified broadly into two categories qualitative measures (such as customer satisfaction and product quality) and quantitative measures (such as order-to-delivery lead time, supply chain response time, flexibility, resource utilization, delivery performance, etc.). In our study we consider only the quantitative performance measures. Improving supply chain performance requires a multi-dimensional strategy that addresses how the organization will service diverse customer needs. While the performance measurements may be similar, the specific performance goals of each segment may be quite different.

Quantitative metrics of supply chain performance can be classified into two broad categories: Non-financial and financial.

Non-Financial Performance Measures o Cycle time o Customer Service Level o Inventory Levels o Resource utilization Financial Measures

Non-Financial Performance Measures

Important metrics include: cycle time, customer service level, inventory levels, resource utilization, performability, flexibility, and quality. There is a detailed discussion of these in We will focus here on the first four measures.

Cycle time Customer Service Level Inventory Levels Resource utilization

Cycle time Cycle time or lead time is the end-to-end delay in a business process. For supply chains, the business processes of interest are the supply chain process and the order-to-delivery process. Correspondingly, we need to consider two types of lead times: supply chain lead time and order-todelivery lead time. The order-to-delivery lead time is the time elapsed between the placement of order by a customer and the delivery of products to the customer. If the items are in stock, then it would be equal to the distribution lead time and order management time. If the items are made to order, then this would be the sum of supplier lead time, manufacturing lead time, distribution lead time, and order management time. The supply chain process lead time is the time spent by the supply chain to convert the raw materials into final products plus the time needed to reach the products to the customer. It thus includes supplier lead time, manufacturing lead time, distribution lead time, and the logistics lead time for transport of raw materials from suppliers to plants and for transport of semi-finished/finished products in and out of intermediate storage points. Lead time in Customer Service Level Customer service level in a supply chain is a function of several different performance indices. The first one is the order fill rate, which is the fraction of customer demands that are met from stock. For this fraction of customer orders, there is no need to consider the supplier lead times and the manufacturing lead times. The order fill rate could be with respect to a central warehouse or a field warehouse or stock at any level in the system. Stockout rate is the complement of fill rate and represents the fraction of orders lost due to a stockout. Another measure is the backorder level, which is the number of orders waiting to be filled. To maximize customer service level, one needs to maximize order fill rate, minimize stockout rate, and minimize backorder levels. Another measure is the probability of on-time delivery, which is the fraction of customer orders that are fulfilled ontime, i.e. within the agreed-upon due date.

Inventory Levels Since inventory carrying costs can contribute significantly to total costs, there is a need to carry just about enough inventory to satisfy the customer demands. Inventories held in a supply chain belong to four categories [#!factory96!#]: Raw materials, work-in-process (unfinished and semi-finished parts), finished goods inventory, and spare parts. Each type of inventory is held for different reasons and there is a need to keep optimal levels of each type of inventory. Thus measuring the actual inventory levels will provide a useful picture of system efficiency. Resource utilization A supply chain network uses resources of various kinds: manufacturing resources (machines, material handlers, tools, etc.); storage resources (warehouses, automated storage and retrieval systems); logistics resources (trucks, rail transport, air-cargo carriers, etc.); human resources (labor, scientific and technical personnel); and financial (working capital, stocks, etc.). The objective is to utilize these assets or resources efficiently so as to maximize customer service levels, minimize lead times, and optimize inventory levels.

Financial Measures
There are several fixed and operational costs associated with a supply chain. Ultimately, the aim is to maximize the revenue by keeping the supply chain costs low. Costs arise due to inventories, transportation, facilities, operations, technology, materials, and labor. The financial performance of a supply chain can be evaluated by looking into the following items [#!bagchi98!#]:

cost of raw material revenue from goods sold activity-based costs such as material handling, manufacturing, assembling, etc. inventory holding costs transportation costs cost of expired perishable goods penalties for incorrectly filled or late orders delivered to customers credits for incorrectly filled or late deliveries from suppliers cost of goods returned by customers credits for goods returned to suppliers

Typically, the financial performance indices can be put together using the following major modules: activity based costing, inventory costing, transportation costing, and inter-company financial transactions.

Models and Methodologies for Supply Chain Decision Making

Because of the inherent complexity of decision making in supply chains, there is a growing need for modelling methodologies. A large number of manufacturing and service organizations are therefore seeking modelling systems that can help identify and implement strategies for designing and improving their supply chain networks. In the supply chain context, both deterministic and stochastic models are relevant. Also, we are concerned with both descriptive (or analysis) models and prescriptive (or optimization) models. Important

descriptive models for supply chains include: Markov chains, queuing networks, stochastic Petri nets, and simulation. Important prescriptive models include: linear programming, mixed integer linear programming, heuristic optimization models, and simulation. Some of the typical models and methodologies used in supply chain decision making are We now provide a sampling of important problems from Section and the methodologies used in solving them. 1. Supplier Selection

Game Theory Markov Decision Processes

2. Supply Chain Facilities Layout Problem

Integer Linear Programming Mixed Integer Linear Programming

3. Constrained Supply

Linear Programming Simulation

4. Manufacturing Capacity Planning

Non-Linear Programming Assignment Problem Lagrangian Relaxation

5. Inventory Control

Stochastic and Dynamic Inventory Policies Queuing Network Model

6. Manufacturing Strategy

Simulation Queuing and Petri Net Analysis

7. Production Scheduling

Heuristics Game Theory

8. Transportation Strategy

Integer Linear Programming

Optimization Models Analytical Performance Models Simulation Models Software Tools

Optimization Models
Majority of the supply chain literature consists of multi-echelon inventory control models. A multiechelon system is one in which there are multiple levels in the supply chain. The research on this front has a long history. A comprehensive review of these models can be found in Vollman et al. [#!Vollman!#]. These methods generally deal with operational or tactical/operational levels. Multiechelon inventory models have been successfully implemented in industry. Cohen et al. [#!COHEN90!#] describe OPTIMIZER: IBM's Multi-Echelon Inventory System for Managing Service Logistics. They develop efficient algorithms and data structures to achieve large scale systems integration. Ettl et al. [#!ettl96!#] consider a supply network model to generate base stock levels at each store so as to minimize the overall inventory capital and guarantee the customer service requirements.

Analytical Performance Models

Models of supply chains in a dynamic and stochastic environment consider the network as a discrete event dynamic system. Such systems can be studied as Markov chains, stochastic Petri nets and queueing network models [#!VISWA92!#,#!ragthesis!#]. Buzacott [#!BUZACOTT97!#] has used certain well-known queueing models and queueing theoretic formulae to assess the impact of the nine principles of re-engineering enunciated by Hammer and Champy [#!hammer93!#]. The main conclusion of his study is that the re-engineering principles do improve the performance in a marked way, especially under significant variability of activity times. Malone and Smith [#!malo88!#], in their study, have looked at organizational and coordination structures, which constitute a key element of any business process. Again using simple queueing models, they have compared the efficacy of various organizational structures under a variety of conditions. Raghavan and Viswanadham [#!rpifs!#] discuss performance modeling and dynamic scheduling of make-to-order supply chains using fork-join queueing networks. Viswanadham and Raghavan compare make-tostock and assemble-to-order systems using generalized stochastic Petri net models [#!ragOMW!#]. They also use integrated queueing and Petri net models for solving the decoupling point location problem, i.e. the point (facility) in the supply chain from where all finished goods are assembled to confirmed customer orders [#!ragthesis!#]. Models discussed above are high abstraction models for business processes under simplifying assumptions such as Markovian dynamics. To obtain high-fidelity models, one has to represent many realistic details, which is possible in simulation models.

Simulation Models
Development of simulation models for understanding issues of supply chain decision making has gained importance in recent years. Some of the studies are Malone [#!malo87!#], Connors et al.[#!connor!#], and Feigin et al.[#!feigin96!#]. Bhaskaran and Leung [#!bhaskar97!#] describe reengineering of supply chains using queueing network models and simulation.

Simulation models can provide for comprehensive supply chain modeling considering the strategic, tactical, and operational elements. But these models can only evaluate the

effectiveness of a predefined policy. Also the simulation systems take a long time to develop, prototype and implement. Most of the simulation models are built for specific cases. These are very difficult to utilize for similar efforts within the same organization itself. Since simulation models have limited reuse, the simulation tools should provide an environment where reusable software components are combined to construct simulation models for different problems. Feigin and his co-workers at IBM have looked into enterprise modeling and simulation in an object oriented environment [#!feigin96!#]. Similar work has been done by Mujtaba et al. [#!mujtaba94!#] and Chu [#!chu97!#]. But typically developing and implementing object models for a given supply chain takes a long time. A set of generic objects representing various entities of supply chain can greatly shorten this period. Swaminathan et al. [#!SWAMI97!#] have taken this approach.They have built a generic agent framework using which they can build simulation models for a variety of supply chain networks.

Software Tools
A variety of commercial software packages for supply chains indicate the growing importance of this area. The IBM supply chain simulator is a software tool that can help a company or a group of companies make strategic business decisions about the design and operation of its supply chain [#!buckley97!#]. IBM-SCS deploys a mix of simulation and optimization functions to model and analyze supply chain issues such as facilities location, replenishment policies, manufacturing policies, logistics strategies, stocking levels, lead times, process costs, and customer service. The IBM-SCS tool enables evaluation of both financial and non-financial performance reports. Rhythm family of supply chain management products have emerged as leading supply chain products in recent times [#!rhythm!#]. The Rhythm suite of products includes: Supply Chain Planner, Supply Chain Strategist, Supply Chain Scheduler, Global Logistics Manager, and Demand Planner. For a detailed review of supply chain software, refer [#!biswasthesis!#].

Unit 2
Supply Chain Inventory Management
Topics Economic Order Quantity Models Reorder Point Models Multiechelon Inventory Systems

Economic order quantity

Economic order quantity is the order quantity that minimizes total inventory holding costs and ordering costs. It is one of the oldest classical production scheduling models. The framework used to determine this order quantity is also known as Wilson EOQ Model or Wilson Formula. The model was developed by Ford W. Harris in 1913, but R. H. Wilson, a consultant who applied it extensively, is given credit for his in-depth analysis.[1]

Contents

1 Overview 2 Underlying assumptions 3 Variables 4 The Total Cost function 5 Extensions 6 Example 7 See also 8 References 9 External links

Overview
EOQ applies only when demand for a product is constant over the year and each new order is delivered in full when inventory reaches zero. There is a fixed cost for each order placed, regardless of the number of units ordered. There is also a cost for each unit held in storage, sometimes expressed as a percentage of the purchase cost of the item. We want to determine the optimal number of units to order so that we minimize the total cost associated with the purchase, delivery and storage of the product. The required parameters to the solution are the total demand for the year, the purchase cost for each item, the fixed cost to place the order and the storage cost for each item per year. Note that the number of times an order is placed will also affect the total cost, though this number can be determined from the other parameters.

Underlying assumptions
1. 2. 3. 4. 5. 6. The ordering cost is constant. The rate of demand is known, and spread evenly throughout the year. The lead time is fixed. The purchase price of the item is constant i.e. no discount is available The replenishment is made instantaneously, the whole batch is delivered at once. Only one product is involved.

EOQ is the quantity to order, so that ordering cost + carrying cost finds its minimum. (A common misunderstanding is that the formula tries to find when these are equal.)

Variables

= order quantity = optimal order quantity = annual demand quantity = fixed cost per order (not per unit, typically cost of ordering and shipping and handling. This is not the cost of goods)

= annual holding cost per unit (also known as carrying cost or storage cost) (warehouse space, refrigeration, insurance, etc. usually not related to the unit cost)

The Total Cost function

The single-item EOQ formula finds the minimum point of the following cost function: Total Cost = purchase cost + ordering cost + holding cost - Purchase cost: This is the variable cost of goods: purchase unit price annual demand quantity. This is PD - Ordering cost: This is the cost of placing orders: each order has a fixed cost S, and we need to order D/Q times per year. This is S D/Q - Holding cost: the average quantity in stock (between fully replenished and empty) is Q/2, so this cost is H Q/2

. To determine the minimum point of the total cost curve, partially differentiate the total cost with respect to Q (assume all other variables are constant) and set to 0:

Solving for Q gives Q* (the optimal order quantity):

Therefore:

Q* is independent of P; it is a function of only S, D, H.

Extensions
Several extensions can be made to the EOQ model, including backordering costs and multiple items. Additionally, the economic order interval can be determined from the EOQ and the economic production quantity model (which determines the optimal production quantity) can be determined in a similar fashion. A version of the model, the Baumol-Tobin model, has also been used to determine the money demand function, where a person's holdings of money balances can be seen in a way parallel to a firm's holdings of inventory.[2]

Example

Suppose annual requirement quantity (Q) = 10000 units Cost per order (CO) = $2 Cost per unit (CU)= $8 Carrying cost %age (%age of CU) = 0.02 Carrying cost Per unit = $0.16

Economic order quantity = Economic order quantity = 500 units

Number of order per year (based on EOQ) Number of order per year (based on EOQ) = Total cost Total cost Total cost If we check the total cost for any order quantity other than 500(=EOQ), we will see that the cost is higher. For instance, supposing 600 units per order, then Total cost Total cost Similarly, if we choose 300 for the order quantity then Total cost Total cost This illustrates that the Economic Order Quantity is always in the best interests of the entity.

Reorder point
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The reorder point ("ROP") is the level of inventory when an order should be made with suppliers to bring the inventory up by the Economic order quantity ("EOQ").

Contents

1 Continuous Review System [dubious discuss] o 1.1 Example 2 See also 3 References

Continuous Review System

The reorder point for replenishment of stock occurs when the level of inventory drops down to zero. In view of instantaneous replenishment of stock the level of inventory jumps to the original level from zero level. In real life situations one never encounters a zero lead time. There is always a time lag from the date of placing an order for material and the date on which materials are received. As a result the reorder point is always higher than zero, and if the firm places the order when the inventory reaches the reorder point, the new goods will arrive before the firm runs out of goods to sell. The decision on how much stock to hold is generally referred to as the order point problem, that is, how low should the inventory be depleted before it is reordered. The two factors that determine the appropriate order point are the delivery time stock which is the Inventory needed during the lead time (i.e., the difference between the order date and the receipt of the inventory ordered) and the safety stock which is the minimum level of inventory that is held as a protection against shortages due to fluctuations in demand. Therefore: Reorder Point = Normal consumption during lead-time + Safety Stock . Several factors determine how much delivery time stock and safety stock should be held. In summary, the efficiency of a replenishment system affects how much delivery time is needed. Since the delivery time stock is the expected inventory usage between ordering and receiving inventory, efficient replenishment of inventory would reduce the need for delivery time stock. And the determination of level of safety stock involves a basic trade-off between the risk of stockout, resulting in possible customer dissatisfaction and lost sales, and the increased costs associated with carrying additional inventory. Another method of calculating reorder level involves the calculation of usage rate per day, lead time which is the amount of time between placing an order and receiving the goods and the safety stock level expressed in terms of several days' sales. Reorder level = Average daily usage rate x lead-time in days .

From the above formula it can be easily deduced that an order for replenishment of materials be made when the level of inventory is just adequate to meet the needs of production during lead-time.
Example[dubious discuss]

If the average daily usage rate of a material is 50 units and the lead-time is seven days, then: Reorder level = Average daily usage rate x Lead time in days = 50 units x 7 days = 350 units When the inventory level reaches 350 units an order should be placed for material. By the time the inventory level reaches zero towards the end of the seventh day from placing the order materials will reach and there is no cause for concern. Re-order point = Average Lead Time*Average Demand + Z*SQRT(Avg. Lead Time^2*Standard Deviation of Demand^2 + Avg. Demand^2*Standard Deviation of Lead Time^2) Reorder point = S x L + J ( S x R x L) Where

S = Usage in units per day L = Lead time in days R = Average number of units per order J = Stock out acceptance factor The stock-out acceptance factor, `J', depends on the stock-out percentage rate specified and the probability distribution of usage (which is assumed to follow a Poisson distribution).[1]

Multi-echelon inventory theory has been very successfully used in industry. Cohen et
al. [1990] describe "OPTIMIZER", one of the most complex models to date --- to manage IBM's spare parts inventory. They develop efficient algorithms and sophisticated data structures to achieve large scale systems integration. Although current research in multi-echelon based supply chain inventory problems shows considerable promise in reducing inventories with increased customer service, the studies have several notable limitations. First, these studies largely ignore the production side of the supply chain. Their starting point in most cases is a finished goods stockpile, and policies are given to manage these effectively. Since production is a natural part of the supply chain, there seems to be a need with models that include the production component in them. Second, even on the distribution side, almost all published research assumes an arborescence structure, i. e. each site receives re-supply from only one higher level site but can distribute to several lower levels. Third, researchers have largely focused on the inventory system only. In logisticssystem theory, transportation and inventory are primary components of the order fulfillment process in terms of cost and service levels. Therefore, companies must consider important interrelationships among transportation, inventory and customer service in determining their policies. Fourth, most of the models under the "inventory theoretic" paradigm are very restrictive in nature, i.e., mostly they restrict themselves to certain well known forms of demand or lead time or both, often quite contrary to what is observed.

Unit 6 vendor partnership in supply chain

Companies of all sizes are realizing that they no longer have complete control over their market success. This is because they rely heavily on the performance of their supply chain trading partners. Market-leading retailers and OEMs know this, and they are looking for partners that work to ensure their success. Many large companies are now insisting that their small and medium industrial suppliers help them improve supply chain cost, responsiveness and reliability. These market heavy weights are measuring suppliers performance against key indicators and giving preferred status to those who perform well. This puts pressure on many small and medium manufacturers. Those that have not invested heavily in supply chain management (SCM) practices or solutions beyond ERP to date are now driven to seriously consider making the investment. The business justification will rest on traditional cost savings and on revenue and customer compliance issues. Supply chain improvements will not only improve internal performance, but will also create benefits that will ripple through to customers and partners as well. Cost savings through reduced inventory levels, expediting, fulfillment and premium freight costs could allow a company to provider more favorable prices or terms to customers. Likewise, effective planning and execution can help companies and their customers adapt to the markets demand shifts. When the company can purchase, produce and distribute the right products to the right channels in the right quantities at the right time, both supplier and customer will increase revenue capture by channel and region. The Suppliers Role in Supply Chain Performance Larger companies often issue mandates that simply force compliance, without offering smaller partners an active role in improving performance. This type of relationship fosters frustration and deep distrust. Further, it can put smaller firms in the precarious position of being manipulated into the red or being replaced by another supplier. To change the dynamics and give themselves a more powerful role, smaller suppliers need to differentiate themselves. This differentiator may be consistent zero defects, a patented or hard-to-find process critical to the customers success, value added services, vendor managed inventory (VMI) contracts, or the highest delivery performance of any competitor. As those last two illustrate, active participant supply chain performance improvements can give even a small company more clout. Moving from being squeezed to acting as an extension of the large company allows the smaller player to be much more effective. (Figure 1.) Sometimes, all it takes is opening up the discussion. One of the keys to successful supply chain performance improvement is cooperation and mutual decision making between trading partners. Companies that collaborate with customers in demand and replenishment planning have a better chance of meeting demand. Those who give accurate information may also gain visibility of customer requirements and inventory levels. This starts the improvement cycle, as the supplier can then reduce their own inventory stocks. By synchronizing operations with customers, the supply chain is more responsive to the marketplace

with less waste.

Identifying Performance Opportunities

The more value a smaller manufacturer or distributor brings to the customer or supply chain heavyweight, the more flexible and mutually beneficial the relationships. The performance characteristics with the greatest value in a supply chain are accuracy, responsiveness, on time complete deliveries, reduction of inventory and mutual continuous improvement.

Document and Process Accuracy Discrepancies in actual vs. planned or actual vs.
documented order quantities, product specifications, promise dates and pricing cause disruptions in production, costly expediting, and countless hours disputing and settling charges. Unfortunately inaccuracies are common between supply chain parties. This is a result of manual processes, human error, miscommunication and limited checks and balances. Re-designing and automating supply chain processes and inter-company communication can reduce these errors.

Supply Chain Responsiveness Inbound delays and shortages of material wreak havoc
on production schedules, promotional effectiveness and revenues. Suppliers often struggle to produce enough of the right items at the time the customers need them because they cannot build in small lot sizes. This inflexibility stems from a make-to-stock production model and a management focus on equipment utilization measures. Even some companies that are more flexible cannot process demand changes quickly. The focus needs to shift to a build-to-demand model that better supports customers Lean and just-in-time (JIT) production lines. When the company cannot meet a demand shift, it needs an early detection system to avoid the problem or allow customer service or sales to alert customers of upcoming delays.

Continuous Communications Supply chain responsiveness depends on frequent

communication between suppliers and customers. Many buyers are frustrated when suppliers do not acknowledge their purchase orders, revised schedules, and order changes. This leaves customers wondering whether the order or request was received and what they can expect when the shipment of materials arrives. Customers administrative costs are high because they need to track down and resolve issues. If suppliers communicated better and with greater frequency, that would be avoidable. SCM applications can provide assistance with that process issue. Automated acknowledgement saves significant time, yet keeps the customer informed and efficient. Perfect Order Delivery Customers cant afford persistent shortages, errors and defects. They look for zero defects, 100% fill rate and 100% on time deliveries. Few companies have achieved these goals, but a growing number are getting very close. Everyone else must improve their operations to retain their best customers. Perfect delivery requires sound supply chain processes from start to finish from planning through production and execution. Best practice processes and integrated SCM applications can support that smooth operation. Vendor Managed Inventory Customers always want to carry less inventory. Originally, VMI just shifted ownership of inventory in customer facilities onto the backs of suppliers. Now, customers are opening the kimono online and providing visibility into

their operations and inventory levels. This can lead to a real win-win situation. The benefit to customers is the ability to reduce the cost of inbound inventory stores and shortages on their lines. The benefit to suppliers is the ability to plan more accurately based on real demand and thus significantly reduce their own finished goods inventory. Coordinated Continuous Improvement Improvement in one part of the supply chain may not pay off if other parts of the chain cant keep up. Companies have learned this the hard way. They may achieve Lean production in their plants, but if suppliers dont deliver the right parts at the right time, production stoppages often result. There are countless opportunities to reduce waste and costs while improving product innovation, customer experience, quality and throughput. Continuous improvement requires trust, joint processes, common data points, shared data access and mutually viable metrics. Supply chain performance skyrockets when suppliers are in sync with customers, supporting their production requirements on a JIT basis, providing notification of shipment and visibility to order status and item location, responding quickly to requests, and supporting VMI/Kanban programs. All of these characteristics add up to solid support for customers performance programs. (Figure 2.) The increased performance comes from all of the programs and achievements such as accurate documents, perfect orders and VMI. Trust and Supply Chain Value-Add visibility are essential to all of these activities, founded on continuous communications. And coordinated continuous improvement as supply chain partners comes about when both parties recognize the value of the relationship and work to gain the most leverage in the market together. They create a win-win situation. Improving Supplier Performance Some companies have made it their mission to become the best supplier to do business with and improve operational performance. This generally involves making changes in contracts, processes and information technology. Contract Changes: Spot purchase orders come and go. There is no formal agreement to continue doing business together or any guarantee of additional orders. Blanket order contracts, on the other hand, offer an annual or volume-based commitment. These commitments have the potential to facilitate closer relationships, which in turn can lead to collaborative decision making, mutually beneficial VMI programs, and access to information needed to improve internal sales & operations planning. Contracts may require the supplier to be ready to commit to a certain service level and other metrics or suffer penalties but the visibility and trust gained in return can pay off handsomely. Process Changes: Clearly, automating a process that hasnt been redesigned to support new business objectives, supply chain models and performance goals is likely to fail. Suppliers striving to increase their performance in the supply chain are rethinking how they do business, where the non value-add activities take place, and how they can

synchronize their activities with customers. These process changes are often needed to leverage newer technologies and supply chain applications. They also create opportunities to work closely with customers. Technology Changes: Information technology plays a significant role in supporting contract and process changes. The Internet has made it financially viable to integrate operations internally and electronically share information with trading partners externally. In addition, application solutions once built for and sold to larger manufacturers have become easier to purchase, implement and maintain. Not only have prices come down, but more solutions have been designed to specifically meet the needs of midsize and smaller companies. Critical Supply Chain Applications For many companies, ERP is not adequate to improve supply chain performance. They need systems that help them forecast more accurately and use data available from customers to create that forecast. They also need to plan production and promise orders based on real-world constraints, and they need systems support to execute flawlessly. Supply Chain Management (SCM) applications are available that fit smaller companies needs, and they can provide a competitive advantage to those who use them effectively. SCM projects also can illustrate where business processes, contracts, and metrics may need to change for maximum performance. After ERP, the solutions that most suppliers consider to improve their supply chain performance are demand planning, advanced planning and scheduling, supply chain execution and collaboration. (Figure 3.) These applications are available from ERP providers as well as providers either of a single focused application or a suite of SCM software. Demand Planning Studies have repeatedly shown that forecast accuracy is one of the biggest drivers of supply chain and financial success. It is also one of the more challenging aspects of running a manufacturing company. Today demand planning software options are widely available for small and midsize suppliers. The vendors include Demand Works, i2 Technologies, Logility and SSA. Most of the solutions are configurable for consolidating and analyzing changing market demands as they occur not just a statistical forecast based on history. Asking customers for more accurate and timely demand information to feed the demand plan can help open up communications with customers. Advanced Planning & Scheduling (APS) Whether scheduling the plant, making order promises or planning production requirements across multiple sites, constraint-based planning and scheduling (referred to as advanced planning and scheduling) is one of the best ways to dynamically adapt to changing customer demands and production resources. These APS systems differ from the production planning in traditional ERP in that they consider actual capacity of resources and timing of material availability in the calculations. Finite scheduling has been most commonly deployed by smaller manufacturers during the past ten years, but the need for

more accurate promise dates is driving more companies to consider real-time ATP engines from APS vendors Aspen Technology, i2 Technologies, Logility, Manugistics, SSA and Viewlocity and from SCE vendors IMI, Manhattan Associates and Yantra Supply Chain Execution (SCE) Accurate, efficient order fulfillment is also challenging for most suppliers, particularly when customers are constantly changing their order line items, quantities and dates. Warehousing operations must be flexible and highly responsive to customer changes. Customers also value services such as VMI, Kanban replenishment, labeling, RFID compliance, kitting and de-kitting, and immediate notification of any problems. Warehouse management systems from IBS, i2 Technologies, IMI, Logility, Manhattan Associates, SSA, Viewlocity and Yantra support these capabilities and can generally meet the requirements of suppliers. Internal & External Collaboration Collaborating on a decision requires a common definition and understanding of the situation, scope, activities and metrics. This is why collaboration is difficult and has taken years to develop between trading partners. As customers force the issue for collaborative forecasting, planning and replenishment, a growing number of suppliers are striving for internal collaboration to establish a one-number sales and operations plan. This involves reconciling and driving departmental plans to a single set of numbers or a company goal based on a common sales and operating plan. It also leads to more confidence in the collaborative planning process with customers.

Becoming the Strong Link in the Chain

To differentiate themselves, smaller companies must do more than agree to the large customers demands. They must perform well through accuracy, responsiveness, communications, perfect orders and VMI. Doing all of this in a way that is both costeffective and able to improve over time will require new processes, contracts and technology for most companies. All of this is now in reach. Smaller manufacturers may not call the shots, but they do have an opportunity to play a vital role in their supply chains. A simple definition of good supply chain performance is to get the right product to the right place at the right time at the lowest cost. Those suppliers that develop the processes and systems to support that performance goal will be more highly valued and be treated as a premium partner in the network. From this position, small companies can get better visibility from customers to serve them more effectively. What is good for the supply chain becomes good for the company. Costs will go down and revenues will go up as supply chain performance improves. Even in the face of fierce competition, suppliers who participate fully and collaborate effectively will be valued and trusted partners. Smaller suppliers can be the big difference in supply chain performance.

Part 3: Mathematical Foundations of Supply Chain Solutions

Topics

Use of Stochastic Models and Combinatorial Optimization in: Supply Chain Planning Supply Chain Facilities Layout Capacity Planning Inventory Optimization Dynamic Routing and Scheduling

Supply Chain Planning How To Do Strategic Supply-Chain Planning

Senior managers formulate strategy to maximize shareholder value; supply-chain planners run optimization models to minimize costs. Combining scenario planning with supply-chain planning achieves the best of both worlds, which leads to long-term competitive advantage. Any company that has a global supply chain should consider introducing its strategic left hand to its operational right hand. Strategic supply-chain planning that combines aspects of business-strategy formulation with aspects of tactical supply-chain planning can make each far more valuable to the planning effort than either would be alone. Strategic supply-chain planning is the Pegasus of strategy: It can soar, but it also needs to keep its feet on the ground. Although companies routinely weigh long-term supply-chain-related decisions in light of alternative sources of supply, new geographic markets or new products, various levels of management use different approaches, often in isolation. Senior managers make such decisions as part of formulating business strategy; supply-chain planners, as an extension of their tactical supply-chain planning. How should companies ensure that relevant supply-chain details inform the business-strategy formulation and that strategic direction and the supply chain are in alignment? They can do so through early communication between senior managers and supply-chain planners, which shortens strategyimplementation time while letting each group pursue its forte: senior managers formulating strategy to maximize shareholder value; supply-chain planners running optimization models to minimize total supply-chain costs. One Company's Story

Consider a strategic supply-chain planning exercise at a polyvinyl chloride (PVC) manufacturer that we'll call Acme Vinyl Co. Acme's North American revenues came from PVC for building (55%), packaging (15%), consumer goods (10%), the electronic industry (10%), the automotive industry (4%) and from non-PVC products (6%) At the end of the 1990s about 4% of those revenues came from Asia. Acme had been seeing revenue growth for several years, mostly as a result of acquiring other PVC manufacturers. With fragmented spare capacity around North America, a falling stock price and a need to rationalize the postacquisition supply chain, Acme's leaders considered their options. Some favored consolidating manufacturing into one or two new mega-plants; others suggested closing existing plants or lines. Management chose to do a strategic supply-chain planning exercise to assist decision making. The Planning Spectrum Strategic supply-chain planning falls in the middle of a decision-making spectrum that has business-strategy formulation at one end and tactical supply-chain planning at the other. (See "Strategic Supply-Chain Planning and the Planning Spectrum.") With a focus on fundamental changes in manufacturing and distribution capacity, it is long-term in scope and impact but can benefit from detailed optimization models and advanced planning-and-scheduling (APS) technology that is more often associated with medium- and short-term planning. Used in this strategic context, the tools help determine what would be an appropriate supply-chain configuration for sourcing and which plants or distribution centers should be closed or kept open. In contrast, tactical supply-chain planning is short- or medium-term in scope and impact, with supply-chain planners using past demand to make forecasts for the near term and adjusting these forecasts on the basis of market intelligence or planned promotions. Used in this context, optimization models and APS technology help determine where and when to produce what items and how to distribute them. Planning Processes and Optimization Although business-strategy formulation also uses tools and flame-works, it requires much more creativity than

tactical planning. The optimum route to maximizing shareholder value is rarely obvious. It takes creative thinking and freewheeling negotiations to identify, understand and agree upon possible actions. Computers and spreadsheets support analysis, but they don't determine strategy. For tactical supply-chaSWin planning, the decision options and the factors affecting them (production capacity, distribution capacity, variable costs, demand forecast) are clearly defined. The goal of minimizing total supply-chain costs -- for manufacturing, storage and handling, and transportation -- is narrower. Because tactical planners can identify beforehand possible decisions and factors that might affect these decisions -and can build those elements into the software -- they can use optimization models that rely on mathematical techniques. The models make recommendations that both minimize costs and help companies meet forecasted demand without exceeding production and distribution capacity. Advanced planning-andscheduling technologies are available from several companies.(n1) Business-strategy planners can't plug clearly defined factors into software as supply-chain planners do, because strategy formulation is, in part, about trying to identify just what those factors are. But strategic supply-chain planning can benefit from appropriately used optimization models because tactical supply-chain models can be extended to include strategic decisions about closing or opening plants and distribution centers. APS vendors offer software for that purpose. The factors rarely change -- production capacity, distribution capacity and variable costs. The goal of minimizing cost is extended to include the fixed costs of keeping plants and distribution centers open and the one-time costs of opening new ones and closing existing ones. These more strategic computer models can then guide decision making. Optimization models for tactical supply-chain planning and models for strategic supply-chain planning differ only slightly in their design, but markedly in their use. Even if supply-chain planners tweak the production and distribution schedule obtained from tactical models to expedite an order to a key customer, they largely retain the model's

recommendation. In contrast, when using a strategic supply-chain model, managers are trying to determine how much the opportunity cost of a particular decision differs from the model's recommendation. At General Motors Corp., for instance, Electronic Data Systems Corp. consultants found that 90% of the time, GM managers used their models' recommendations to benchmark actions that they were likely to consider.(n2) The candidate decisions were based on qualitative criteria not included in the models. Creating benchmarks in this way is ogramming, a method using advanced mathematics to capture all the constraints, such as capacity, and to find the best possibl