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Learning Objectives
After reading this chapter, you should be able to do the following:
Describe the scope of a global company's supply chain network and
understand what questions are appropriate for the network to function on a
competitive basis.
Understand the three major phases of globalization.
Appreciate the complexity and magnitude of the operations of some
successful global companies and why global expansion is important to their
Explain how technology and service specialists can help companies,
especially small- to medium-size firms, penetrate the global marketplace.
Appreciate the importance and magnitude of the trading partner countries of
the United States.
Understand the nature of global markets and competitive strategy.
Explain the rationale for global security measures and the balance necessary
to ensure that such security measures do not impede trade.
Discuss global transportation options and strategic intermediaries.
82 Chapter 3 Global Dimensions of Supply Chains 83

become proficient with handling purchases from China and other sources. Fran felt that his
Supply Chain Red Fish, Blue Fish, LLP media experience would enable him to develop a good Web site for his new business, which he
Profile decided should be called Red Fish, Blue Fish. He was, however, concerned about working capi-
tal and cash flow.
Fran Fisher was contemplating a significant career and business change. Basically, he was
considering changing a hobby into a new business venture. For many years, he had been in- Andy had offered to invest in the company when Fran told him about the new business.
volved in the media communications business. While his specialty was in radio promotions and Eric believed that they could base their business model on Dell's approach. If they took orders
advertising, he had experience in television not only with promotions and advertising but also via the Internet and immediately contacted their Chinese suppliers they could use overnight air
as a TV "personality" as a broadcaster of college sports events. He developed a small media freight delivery, which would minimize their inventory and the need for working capital. Fran
consulting company which was located in Greensburg, Pennsylvania, about 30 miles from felt that they could operate the business from his current offices. He also felt that business
Pittsburgh. sales, like the one he did for Andy, could be quite lucrative, and the ongoing monthly mainte-
Fran had always been interested in exotic fish and had several large display tanks in his nance fee would help his cash flow situation. He was even considering a collaborative arrange-
office suite and at home in his study. He purchased fish mostly through a Pittsburgh wholesaler/ ment with a local contractor, Jim Beierlein, who would do office and business installations
distributor that also sold to selected individuals. He had also bought some fish through catalog since some remodeling was usually required. Also, Jim could help him with some of the special
offerings, and more recently, he had made some purchases from China via the Internet. packaging if he had sales in Europe or Canada.

Several of Fran's friends had been asking his advice about buying exotic fish and the
necessary equipment to have a setup like he has in his office. He had even been contacted by
a local dentist who was having his office remodeled. The dentist, Andy Zimmerman, had read
in the trade magazine for dentists that fish tanks were becoming popular as decorations and Introduction
seemed to have a soothing impact on patients, especially children. Andy even offered to pay
Fran a consulting fee for his initial advice on fish purchases and wanted him to consider doing Globalization was identified in Chapter 1 as being one of, if not the leading, external
the whole setup-buying fish and equipment and installing the tanks with appropriate com- factors driving change of the economic landscape for not only for-profit companies but
pensation to follow. also for not-for-profit organizations. Global trading has been with us for centuries, but
the scope and magnitude of the product, information, and financial flows today are
Fran's media consulting business was declining, and he was concerned about the future. almost mind boggling. For example, the value of trade between the United States and
New Internet options such as YouTube, Facebook, and others were changing the media busi- China has grown from $285 billion in 2005 to $343 billion in 2006, which represents a
ness, especially for small companies in small market areas. He needed to change his consult- 20 percent increase in one year. This is indicative of the importance of global trade
ing business in some way or look for new opportunities. He decided to take advantage of flows in the world economy and, in particular, to the U.S. economy.

Andy's offer and developed a three-phase proposal-selection of types and quantity of fish,
purchase and setup of tanks and related equipment, and regular cleaning and maintenance of It has been argued that globalization was initially driven_QY,f@lltt:i_~~ (1400-1800)
the tanks. Fran thought that his proposal might be too high priced, but Andy accepted the seeking materials and goods not available in their own land, but they also had imperi-
whole package and seemed pleased with the price that was proposed. alistic objectives of enhancing their economic and political power. ~e_QID_d_.e_r<L. of
globalization (1800-2000) was driven by companies seeking goods and materials,
labor, economies of scale, and markets. This era produced multinational companies
Andy's office was all set up, and he seemed very pleased overall. Fran received some inquiries
from other local businesses and decided to pursue this new venture at least on a part-time basis
with global reach and enormous economic market power?
initially. His wife, Charlotte, had expressed an interest in helping with the fish business with the The development and growth of large multinational companies really moved the
exception of cleaning tanks. Fran had purchased Andy's fish and all the supporting equipment world toward globalization. These companies were the ones that initially asked the fol-
from China. He was actually surprised at how easy it was to search for suppliers via the Internet lowing global questions first posed in Chapter 1:
and the cost savings of buying from distributors in China. His nephew, Eric Lynch, was a logistics
Where in the world should we procure or purchase raw materials, semi-
graduate of Penn State, and he had worked in the transportation business for many years. Eric
finished materials, components, services, etc.?
advised Fran to use Federal Express, which turned out to be a very good recommendation.
Where in the world should we locate plants and/or supporting facilities to
Fran's Internet surfing also exposed him to some U.S. Web sites offering exotic fish for produce products and/or services to meet customer demand?
sale. He was surprised at the differential between the prices he had paid to purchase Andy's Where in the world should we market and sell our products and/or
fish in China and what the domestic Web sites were charging for comparable fish. He thought services?
the differential would provide him enough margin to make a profit on sales in the United
Where in the world should we store and/or distribute our products or
States and even sales in Canada and Europe if he could develop a good Web site to display
fish and related equipment.
What global transportation and communication alternatives should we
Now it was time to address some basic issues about this new business venture. Eric was consider and use?
interested in joining the business to provide logistics and supply chain expertise. Charlotte had What global partnerships or alliances should we establish for collaboration
to improve our efficiency and effectiveness?
Global Dimensions of Supply Chains 85
84 Chapter 3

These questions should not be answered separately. They are too interrelated or
synergistic and require the evaluation of alternative scenarios to answer all the ques- On the Line Adapting to Operating in
tions for the optimal or best alternatives. Low-Cost Regions
The scope of these questions provides an insight into the nature of being truly Including low-cost regions in modern supply chains is now a given. But determining which re-
global. The established, successful multinational companies also created opportunities gions to access for any particular purpose is still as much art as science. Ongoing discussions
for smaller organizations to participate in the global marketplace as they "fine-tuned" with key industry contacts suggest that different locations, countries, and regions have their
their "business models" to improve efficiency and effectiveness. For example, the mul- own specific strengths (and weaknesses), and, even more importantly, regional positions shift
tinationals could purchase component parts needed for the finished products from a over time.
variety of sources in different countries. This became a common practice for auto
Tracking and responding to the relative positions of low-cost regions will be an ongoing
and computer manufacturers. Companies, such as Nike, outsourced all of their
theme for global supply chain managers. Five years ago, China was the source for low-cost
manufacturing. The complexity of global trade sometimes required specialists not only
products; now, Vietnam is competing against inland China and parts of India for that same po-
in transportation but also in more specialized areas such as customs and tariffs. Such
sition. In terms of the importance of market proximity, whether to the United States, Europe, or
arrangements led to growing collaboration in the various supply chains.
emerging urban markets in India and China, it becomes even more necessary to understand
In the second phase of globalization, companies headquartered in developed coun- how an area's character fits with a firm's global supply chain strategies.
tries like the United States, Western Europe, Japan, etc., had an advantage in terms of How can buyers discover where to source materials, components, subassemblies, and fin-
infrastructure, educational systems, capital markets, etc. It has been suggested that the ished goods? What makes a particular area attractive, and how long will it be before the next
world was, figuratively speaking, tilted in favor of the developed countries. The economic "hot" region appears on the horizon? How does a region structure itself to join the world econ-
advantage was such that the citizenry of the less-developed countries tended to migrate omy in a mode that means sustainable growth and improvement for its citizens for years to
to the more developed countries, especially the United States. The well-educated and come? These issues are on the agenda (or destined to be so) of supply and logistics managers
skillful immigrants added to the advantages enjoyed by the developed countries. all over the world.
The third era of globalization is said to have begun around the year 2000. The sig- Supply chain managers are now operating in a global business ecology. As the overseers
nificant characteristic of this era is that it is being powered by individuals and smaller of physical movements in the new economy, they face challenges within countries, between
organizations in contrast to the countries of the first era and the large companies of the countries, and across regions. Researchers and managers need to cooperate so that everybody
second era. 4 The critical ingredients for this new era have been the technological has the tools and insight needed to support continued economic success in a world where bor-
advances, especially in information technology and communications, which have con- ders are still real, but transcending borders is the order of the day.
nected the "four corners of the globe." Thus, with the enabling of more ,broad-based
Source: Arnold Maltz, Arizona State University, World Trade Magazine (January 1, 2007).
participation in the global economy without some of the massive infrastructure previ-
ously required, the world has indeed become flat. Again, the large, multinational com-
panies have created "niche" opportunities for individuals and/or small organizations to
collaborate in their supply chains.
One of the outcomes of this new global era is an "attack" on traditional, hierarchical
organizational structures. 5 Businesses are being transformed into flatter, more horizon- chain. The supply chain also should manage three important flows, namely; materi-
tal, and more collaborative organizations that participate in more supply chains to add als/products, information, and financials. The best supply chains compete very suc-
value and efficiency for consumers worldwide. cessfully on a national and/or global basis.

Chapter 1 argued that the rate of change has accelerated and is being fueled by a Wal-Mart is frequently cited for its supply chain efficiency and effectiveness and
number of major external forces or change drivers. The synergism between globaliza- rightly so. Consider, for example, that a computer manufacturer such as Hewlett-
tion and technology, especially, has permanently changed the dynamics of the world's Packard will sell over 400,000 computers in one day through over 4,000 Wal-Mart
marketplace. The outcry in some quarters about outsourcing is 40 years too late and stores to customers worldwide during the Christmas season. Each of the computers
may be misguided. This new era has and will continue to spotlight supply chains as a has component parts from a number of global providers, and the computers are usu-
critical part of the ability of organizations to compete economically, and it deserves ally assembled in several global locations. The synchronization of the three flows
special discussion. mentioned above that allows this to happen almost seamlessly is an amazing
Consider also that Americans spend over $35 million per hour, 24 hours per day,
365 days of the year in Wal-Mart stores, and the stores stock over 65,000 different
Supply Chains in a Global Economy items a year. 6 None of the above is meant to imply that the supply chains that Wal-
In Chapter 1, a supply chain was depicted as being boundary spanning; that is, it en- Mart is a part of operate perfectly each and every time. In other words, Wal-Mart
compasses a group of interrelated firms that should be focused on delivering the best stores do experience shelf stockouts at times (hence the use of rain checks) or over-
drork~ rof ~romP ~trork--1-PPnina nnit.: (SKTT.:) rorr:o~.:iron:o~11v 7 Howt>ver. considerin2: the
86 87
Chapter 3 Global Dimensions of Supply Chains

le~gth and complexity of some of its supply chains, it minimizes such happenings supply chain management as they move ahead aggressively in the twenty-first century.
usmg the tools, technology, and management skills discussed in this text. The following chapters will address how such success can be accomplished.

The net effect of W al-Mart's success with supply chain management has enabled it, In the next several sections of this chapter, we will discuss the magnitude of global
as indicated in Chapter 1, to become the largest corporation in the world as measured operations and supply chains as well as some of the challenges and types of global supply
by sales dollars of over $350 billion per year. Other companies have also been success- chain services.
ful based to some extent on the efficiency and effectiveness of their supply chains, e.g.,
Apple, Dell, Procter & Gamble (P&G), IBM, Johnson & Johnson, General Electric,
Kimberly-Clark, etc. The Scope and Magnitude of Global Business
~hese comp~nies ~nd others have transformed themselves by changing their supply In Chapter 1, the concept of the world collapsing in terms of time and distance was
chams and the1r busmess models, which, in turn, has significantly changed the busi- presented. Obviously, the distance between New York City and Shanghai, China, is still
ness landscape in the twenty-first century. Consider, for example, that some U.S. com- the same, and these cities have not changed time zones. However, transportation, com-
panies derive over 25 percent of their profit from global sales, which helps to mitigate munications, and computer-related technology are making it much more convenient
declines or instability in domestic markets. for business executives from different countries to meet face to face or via special in-
. ~dam Smith, who is credited with providing the economic rationale for capitalism formation technology. The ability to connect to individuals and companies across the
m h1s famous book, Wealth of Nations, stated that division oflabor or labor specializa- globe and to connect computer information systems on a 24/7 basis has provided un-
tion is limited by the extent of the market or volume of demand. 8 In other words, paralleled opportunity for collaboration horizontally and vertically in supply chains.
economies and companies could improve their "wealth" by allowing specialization of This connectivity has allowed the type of interorganizational cooperation, visibility of
tasks. The automobile assembly line is a good example of specialization wherein each flows, and real time adjustments necessary for efficient and effective supply chains.
individual performs a small task relative to the total product, but the output per indi- The global data presented in this section reflect this new era. Table 3-1 presents
vidual is higher than if individuals each assembled a complete car. Smith's caveat trade data (total of imports and exports) for the top 10 U.S. trading partners. Somein-
whi~h is very relevant here: indicates that the advantage is true as long as you can seli teresting and important relationships depicted in Table 3-1 should be noted. China is
the mcreased volume that 1s produced. We argued in 1976, in our first edition of this now our second largest trading partner, supplanting Mexico, which historically has
text, that an important role of logistics was to help extend the market area of countries been number 2. The trade volume with China was 18.2 percent of the total of the top
or companies through improved efficiency to lower the "landed cost" in new market 10 for 2006, and it increased its trade volume by 20 percent from 2005 to 2006. In
2000, China was number 4 on the top 10 list following Canada, Mexico, and Japan,
The logic of the rationale stated above is even more apropos for supply chains. It and its trade volume with the United States has tripled since that time ($343 billion vs.
can ~e a~gued that supply chains help to establish the limits of what is competitively $94 billion). This increase reflects the comments made previously about the growing
pos~1ble m t~e marke\ In ~~her words, the cost and value at the end of the supply importance of China. The total value of trade with these top 10 trading partners
:ha1~ determme : firm s ab1hty to compet~ in a marketplace. Good supply chains are ncreased by 10.7 percent from 2005 to 2006, and since 2000 it has increased by about
"~us~n~ss pov:er, and g~od supply cham managers are continually pushing the 53 percent in total value. Both of these percentage increases are reflective of the grow-
hm1ts of their supply chams to be viable in both domestic and global markets. ing interdependence and the trade relationships with other countries. The data lend
additional creditability to statements made previously about the importance of global
Operating globally has become easier to accomplish for even individuals and small
supply chains.
companies, as stated previously, because of the advances in information/communica-
tions technology and the continuing improvement of specialists such as UPS, FedEx, India was mentioned in Chapter 1 in the context of globalization but does not
DHL, e:c., that can provide global supply chain services at a very reasonable cost. appear in the top 10 countries listed in Table 3-1. India's strength has been in the area
A growmg number of specialists and continuing improvements in information tech- of information technology services, which tends to understate its importance for global
nology/communicat~ons are contributing to the flattening of the world. Obviously, supply chains. In 2005, 59 percent of U.S. corporate spending (off-shore) for informa-
large global compames are also contributing to this phenomenon. tion technology services was spent in India. 9 Interestingly, China, which is known for
manufacturing various types of products, is attracting U.S. companies to establish re-
It is safe ~o conclude that supply chains and supply chain management play an im- search centers. Microsoft and Intel established research centers in Beijing in 1998, Google
portant role m the global economy and have helped to push the growth and success of 10
in 2005, and Rohm & Haas and Dupont in Shanghai in 2006. The combined popula-
companies that do "supply chaining" very well. The "train (globalization) is out of the tion of China and India, which is in excess of 2 billion people, makes them attractive as
station" and rolling down the tracks at increasing speed. Global supply chains impact all markets and as a source of imports. Consequently, it seems safe to conclude that global
of us. We love the lower prices, the increased array of products, and the convenience supply chain connections to both China and India will continue to grow. Large U.S. con-
(read 24/7, one-stop shopping, etc.), but we are critical of some of the outcomes when sumer product companies and retailers are already connected with sourcing and selling.
individuals lose their jobs, businesses are dosed, etc. Many would argue that the advan-
tages outweigh the disadvantages, e.g., the lower prices have saved consumers billions of Even smaller companies, such as W. W. Grainger, a distributor of maintenance,
dollars in purchase prices. There are tradeoffs (advantages and disadvantages) but there repair, and operating (MRO) products, is "connecting" its supply chain to China as a
~ ........ ~ ""-~ ..... .: ..... _ L __l_ c- _______ f" 1 .. ,,, . __ ' r 1 - L ____ --- ..l - ~~ ...l~.r.-t- _(',....., ..-1~.-.h.;huf-;Yl.IT ~nrl cP.lllna it<;:; nthPr flt"OdUCtS.
88 Chapter 3 Global Dimensions of Supply Chains 89

Table 3-1 Top U.S. Trading Partners On the line Managing the Risk Inherent
in Global Outsourcing
Value of Trade {$ billions)
Many firms see globalization as much more than outsourcing. Additionally, they regard its es-
Country 2005 2006 sence as being to establish a market presence in other regions of the world and to serve as an
Canada $ 499 $ 534 engine for growth. Globalization in this context thus means leveraging various regions of the
world for potential in several areas, which include establishing a presence in the global market
China 285 343 for growth, resource access, and cost savings.
Mexico 290 332 Of course, outsourcing is frequently a key component of the globalization strategy. But all
too often the risk inherent in outsourcing decisions is not effectively assessed or managed, put-
Japan 194 208
ting the firm's business in jeopardy.
Germany 119 130 Unfortunately, many firms have not placed their outsourcing strategy within the context of
90 a complete global strategic plan. Invariably, pressure is exerted from the top to reduce direct,
United Kingdom 99
visible cost. This quickly evolves into an outsourcing strategy to take advantage of the incredi-
South Korea 72 78 ble pool of low-cost labor in other regions of the world, particularly in Asia, Latin America, and
Eastern Europe.
Taiwan 56 61
When pursuing an outsourcing strategy, it is hard for many companies to stop and con-
France 57 61 sider risks because they are blinded by the huge savings potential. A couple of years ago, on a
Singapore 44 43 tour of seven factories in South China, the authors saw some shocking examples of where
these savings are coming from (and the long-term risk therein embodied), including the
Total $1,706 $1,889 following:
Source: U.S. Bureau of the Census, Foreign Trade Statistics, 2007. Factory workers routinely working 11 hours per day, six days per week for roughly
$100 per month
An extremely intense work pace
Challenges and risks are associated with doing business with or in China and India, Competent engineers earning a maximum of $12,000 per year
but the opportunities are enormous. Companies will change their business models be-
In a typical financial analysis, this incredible labor cost savings is balanced with higher
cause of these opportunities. Consider the partnership between IBM and Lenovo for
inventory and transportation costs. But many companies are just now realizing that risk might
IBM's personal computer business or Honda Motor in India which has used different
be the greatest potential cost.
partnering strategies for different product lines.
What are the risks associated with global outsourcing? A few examples include cata-
Once risks are identified, leading companies use a variety of strategies to manage strophic delays in delivery due to force majeure or even terrorism, quality and damage prob-
them. These risk mitigation strategies are selectively applied depending on the impact lems hidden by a long supply line, highly inaccurate forecasts over a long supply line, currency
and probability of each risk Evidence is building that those firms that apply a rigorous swings, and intellectual property issues.
risk management methodology are much more likely to see the promised benefits from
a global outsourcing strategy, as well as realize the payback from their overarching Are these risks causing an outsourcing backlash? There's no clear trend. For example, one
globalization strategy. company discussed withdrawing from China, while another firm described taking everything to
China. What makes the difference between success and failure? We would argue that the dif-
ference is in having a rigorous approach to analyzing and managing outsourcing risk.

Global Markets and Strategy Source: J. Paul Dittmann, Ph.D., University of Tennessee, World Trade Magazine (January 1, 2007).

The global business environment has changed significantly and become much more
conducive to business activity between and among different countries. Companies are
not just importing and exporting products but are also locating plants and other facili- This represents both a threat and an opportunity. Like deregulation of transportation,
ties in other parts of the world. Honda and Toyota used to produce cars in, Japan and some companies have not really responded well and have lost market share or gone out
ship them to the United States. Now their cars are, for the most part, produced in the of business. Other companies have taken advantage of the opportunity and expanded ag-
United States for sale in North America. U.S. companies have also located plants in gressively into global markets, e.g., General Electric, IBM, Wal-Mart, McDonald's,
other countries.
P&G, Kimberly-Clark, etc. Many Fortune 500 companies experience 50 percent or
As indicated in Chapter 1, tariffs and other trade barriers have been significantly more of their sales in global markets. Such sales have helped these companies stabilize
:>mona m:>nv rmmtrif's. allowing a much more comuetitive 2:lobal economv.
rPrlnrPrl their revenues and buffet them against turbulent times in the U.S. marketplace, such as
90 Chapter 3 Global Dimensions of Supply Chains 91

occurred in 2007.u Small- and medium-sized companies have also been able to be In addition to the four areas indicated above, some of the customary strategies used
players in global markets, even a company like Red Fish, Blue Fish, LLP. in the domestic market are also challenged. Reduced order cycle time, for example, has
become an important part of supply chain management since it can lead to lower
Success in the global marketplace, obviously, requires developing a cohesive set of
inventory levels for customers, improved cash flow, and lower current assets/accounts
strategies including product development, technology, marketing, manufacturing, and
receivable. The increased length and complexity of the supply chain make it more
supply chains. Global companies tend to be more successful when their strategies help
difficult to achieve shorter lead times.
them to simultaneously achieve their business objectives at their various global locations.
From a supply chain perspective, this means strategically sourcing materials and compo- Also, demand-driven supply or pull systems that can lower inventory levels signifi-
nents worldwide, selecting global locations for key supply depots and distribution centers, cantly are challenged by the longer distance and complexity of multi-layered supply
evaluating transportation alternatives and channel intermediaries, providing customer chains. Other strategies such as compression and "lean" supply chains are also more
service, understanding governmental influences on global supply chain flows, examining difficult to achieve in the global environment. None of this discussion is meant to im-
opportunities for collaboration with third- or fourth-party logistics companies, and other ply that companies should not be involved in globalization. Rather it is meant to pro-
supply chain issues. We will discuss some of these topics in this chapter, and the remain- vide understanding of the challenges necessary to improve the likelihood of success.
der will be covered in subsequent chapters. A topic that merits special consideration is Without a doubt, globalizing has helped many U.S. companies as previously noted.
supply chain security, which will be discussed subsequently in this chapter. Much higher sales and profits and more revenue stability are some of the advantages
that have been pointed out thus far, but globalization is a two-edged sword that re-
From a customer service perspective, global markets and strategy have four important
quires a company to be nimble and continually proactive in managing and responding
characteristics. First, companies want to standardize to reduce complexity, but they rec-
to change. The topic of the next section, global supply chain security, ties in directly
ognize that global markets need some customization. For example, in contrast to the
with this discussion of global supply chain strategy.
U.S. market where large retail stores buy in volume quantities for delivery to their large
warehouses, third-world countries have tiny retail stores that may only be SO to 100
square feet. This means deliveries of small quantities, more frequent deliveries, different
packaging, etc. P&G recently has made changes in its customer service strategy and re- Supply Chain Security: A Balancing Act
lated areas to customize for these markets. P&G recognizes that the population base is
Global commerce between the United States and the rest of the world came to a halt
such in these countries that the total volume of sales will offset some of the lower econo-
on September 11, 2001, when terrorists attacked the United States. Air transportation
mies of scale at the tiny stores. Customer service levels have to be adjusted for these mar-
into and out of the United States and even some domestic flights were suspended.
kets in terms of delivery schedules, volumes, order fulfillment, and other areas.
Ocean vessels loaded with containers and other freighter ships were prevented
Second, global competition reduces the product life cycle, as previously mentioned, from unloading or loading in the major ports. Many had to anchor off the coast for
since products can be copied or reengineered quickly by competitors. Technology days, waiting to come into the assigned port. Fresh fruits and vegetables rotted, and
companies are faced with this phenomenon even in the U.S. market, but other prod- needed materials did not arrive on time. It was a frightening period but a time when
ucts are faced with similar experiences. Technology companies counteract with con- we saw firsthand how global and interdependent with the rest of the world we had
tinual upgrades and new products. Apple, for example, had great success with its iPod, become. 12
but it quickly followed this with the iPhone to maintain financial momentum. Shorter
Before the events of September 11, 2001, ships would frequently clear U.S. ports in
product life cycles present challenges for inventory management with respect to obso-
a matter of hours. That scenario has changed because of security measures that have
lete items. Customer service levels are also impacted because changes have to be made
been introduced. More cargo inspections, much more paperwork, and a longer time
as the product matures in terms of sales volume and then declines, which reduces
to clear U.S. borders are now a reality. Ships may be stopped and inspected and cargo
product profitability. Usually, companies cannot afford to provide the same level of
inspected and checked. Some ships and items are given very close scrutiny because of
customer service when the product volume declines.
their country of origin. 13
Third, traditional organizational structures and related business models frequently
Given the importance of global trade to the United States, a delicate balance exists
change since companies get more involved in outsourcing manufacturing and some lo-
between security and the efficient flow of global commerce. If security is too tight it
gistical activities such as transportation, warehousing, and order fulfillment. All of this
could impede the flow of needed goods or materials, causing delays and decreased effi-
impacts the supply chain and its related customer service activities. The collaboration
ciency. Ports and border gateways can become congested because of security measures.
indicated requires effective coordination among the various parties to ensure that cus-
Consequently, clearance time has increased from hours to days in some instances.
tomer service levels (on-time delivery, complete orders, reliability, etc.) are maintained. 14
Steps have been taken to improve the flow through border crossing. This is necessary
There are many challenges for supply chain managers.
for our global economy.
Fourth, globalization introduces more volatility, as noted in Chapter 1. It is much
Electronic filing of cargo information has helped to improve the border clearance
more likely that supply chains will experience challenges with weather, terrorism,
times. The Trade Act of 2002 requires exporters to electronically submit shipping
strikes, etc. The need for flexibility and responsiveness is a requisite for customer ser-
documents to U.S. Customs 24 hours after delivery to a port or 24 hours before vessel
vice through the supply chain. The expanded networks cover long distances and are
departure. For imports, the manifest must be filed by the ocean carrier or the consoli-
complex. dator 24 hours before the U.S.-bound cargo is loaded on the vessel in the foreign port.
92 Chapter 3 93
Global Dimensions of Supply Chains

and regulating and facilitating global trade. Partner companies in C-TPAT ~gree to be
Supply Chain Zara Shows How responsible for keeping their supply chains secure to agreed standards and to ~mplement
Technology needed changes. One of the key features of this p~ogram is infon~ation shar~?g of best
practices for security among members. The goal IS to develop a green lane to speed

Zara, the Spanish fashion leader, is an excellent example of a company that has implemen-
ted two different operations models for two different market needs. The industry's fastest
growing company, lara launches more than 11,000 new designs each year. The company has
goods across the border but also to protect the United States and the global supply
chains of the participants. 17

crafted a model in which product development takes three to five weeks, as opposed to the in- Ports
dustry average of nine months; new product introductions arrive in stores every two to three As indicated above, ports are a critical part of global supply chains and also a major
weeks on average.
focus for global security. Every day, thousands of containers from c~untries all aro_und
Because short life cycle fashions represent the bulk of lara's sales and profits, the com- the world arrive at U.S. seaports. Each shipment is usually for a spenfic supply cham-
pany deploys an onshore, rapid-response supply model based on quick feedback from stores. for example, porch furniture from Thailand bound for a St. Louis retailer or shoes from
Each store manager tracks customer opinion using a handheld device and relays the informa- China destined for a Chicago distributor.
tion to the regional manager, who passes the regional data to the product-development team,
America's ports are a vital part of its global commerce. Over $2 trillion in trade value
which can quicllly come up with a new design that meets current trends.
per year passes through U.S. ports, and over $18 billion is collected in industry fees and
For this core model, the company uses mainly onshore manufacturers in Spain and Portugal, taxes. The 50 states utilize 15 ports to handle their imports and exports; a total of about
although its number of suppliers in Asia is increasing to serve growing demand in the Far East. $5.5 billion wmth of goods moves in and out every day. About 99 percent of the interna-
The company books manufacturing capacity in advance, committing to make a certain number tional cargo of the United States moves through its ports, or about 2.5 billion tons ann~
of blouses before it knows the colors and styles. The combination of instantly relaying customer ally. In 1960, international trade accounted for about 9 percent of U.S. gross domestlc
insights and booking onshore capacity in advance means lara can have new products on store product (GDP). Today, it is over 25 percent. 18
shelves within weeks of the moment a store manager detects a fashion trend. Stores in Europe,
the Americas, and Asia are replenished, on average, twice a week; the average product shelf U.S. ports also play a vital role for the cruise industry. In 2005, it was estimated that
life is two to three weeks. there were 8.6 million embarkations through U.S. ports, which was an increase of 21

However, for basic products like t-shirts and underwear-products that collectively make up
Percent from 2003. This flow of passenger traffic has a very positive economic impact
on the U.S. economy because of the expenditures to support t h e crmse . m. d ust ry. 19
less than 30 percent of revenues-lara relies on low-cost offshore or near-shore manufacturers
in countries such as China and Morocco. That basic-product group's larger orders, relatively pre- The ports also play a vital role in national defense and security. The ports are bases
dictable demand, and long shelf life make it possible to source from those lower-cost locales. of operation to deploy troops and equipment. In 2003, the Surface Deployment and
Source: Jaume Ferrer, Johan Karlberg, and Jamie Hintland, "Integration: The Key to Global Success,"
Distribution Command loaded 1.6 million tons of equipment and cargo to support the
Supply Chain Management Review(March 2007): 29 Copyright 2007 Reed Business Information, war effort in Iraq. Port security is very important for military and civilian purp?ses,
a division of Reed Elsevier. Reproduced by permission. and it is a shared responsibility between the public and private sectors. C-TP AT IS an
excellent example of this shared responsibility.
Because of Canada's importance as a trading partner, an expedited procedure (FAST) As indicated previously in this chapter, Canada and Mexico are very iU:porta~t
has been developed to speed up clearance through the U.S.-Canadian border. 15 trade partners for the United States; they ranked number 1 and 3, respectively, ;~
2006. These two countries account for about 30 percent of the total U.S. global trade.
The U.S. Coast Guard was authorized by the U.S. Maritime Transportation Security
Given their importance, the next section of this chapter will discuss the North Ameri-
Act of 2002 to assess the vulnerability of U.S. ports and to deny entry to ships from
countries that do not meet U.S. security standards. This act requires the development can Free Trade Agreement (NAFTA).
of standards for container seals and locks, cargo tracking, identification, and screening
systems for ocean containers. Some of these requirements have been slow in develop- North American Free Trade Agreement
ing to meet standards. The North American Free Trade Agreement was signed by leaders of Canada, the
United States, and Mexico in 1993 and was ratified by Congress in early 1994. NAFTA
In addition, the Customs Trade Partnership Against Terrorism (C-TPAT) was
establishes free trade between these three countries and provides the way the agree-
established under the direction of the U.S. Department of Homeland Security in
ment is to be interpreted. NAFTA states that the objectives of these three countries is
November 2001. This voluntary initiative to secure the global supply chain was started
based on the principles of an unimpeded flow of goods, most favored nation (MFN)
with seven companies; by 2007, some 7,400 corporations were involved in this cooper-
status, and a commitment to enhance the cross-border movement of goods and ser-
ative effort to secure the global supply chain and to facilitate legitimate cargo and con-
vices. MFN status provides the lowest duties or customs fees, if any, and simplifies the
veyance. C-TP AT functions under the U.S. Customs and Border Protection (CBP)
paperwork required to move goods between the partner countries.
Agency, which previously was known as the U.S. Customs Service.
Even though the U.S./Canada Free Trade Agreement has been in effect for some
CBP has responsibility for the traditional role of the U.S. Customs Service, namely,
>11 1 ,.. .. ~ ~ time. certain trade barriers still remain. For examole. manv U.S. companies do not rec-
94 Chapter 3
Global Dimensions of Supply Chains 95

r Figure 3-1 ATypical Truck Shipment Crossing into Mexico border, where a Mexican cartage carrier hauls the shipment across the border to Mexi-
can customs and to the Mexican carrier after shipment clearance. The U.S. domestic
freight forwarder submits shipment documents to the Mexican customs broker, who
Delivers a submits them to Mexican customs. Mexican customs inspects the documents, collects
U.S. carrier loaded trailer
to a U.S. duties, inspects the goods, and clears the shipment. The Mexican cartage carrier delivers
customs broker the shipment to a Mexican trucking company, which delivers it to the consignee.
The supply chain constraints will eventually be eliminated as NAFTA experience
i grows. Computerized customs information systems are currently operating in the
United States and Canada, with Mexico a few years behind. The electronic transfer of
Hires Mexican Presents Presents
U.S. freight customs If----.! cartage agent to
information for NAFTA shipments into Mexico will speed the border crossing and im-
forwarder documentation documents to documents to prove logistics service.
drive trailer . - - - -
from shipper U.S. customs Mexican
across border for clearance customs broker In the long run, the goal of NAFTA is to create a better trading environment; but,
for clearance
in the short run, it has created some confusion due to the record keeping required to
Presents prove the origin of the product to obtain favorable tariff treatment. NAFTA's goals in-
documentation volve making the needed structural changes to operate a borderless logistics network in
customs broker
to Mexican North America. Information systems, procedures, language, labels, and documentation
customs agents
are being redesigned. As new markets and supply sources develop, new transportation
and storage facilities as well as intermediaries will need to be developed.

Moves trailer to Moves trailer to Maquiladora Operations
first stop in
Cartage agent customs to
second customs Delivers trailer A concept that has become popular among U.S.-based firms is to use Mexican
stop to approve Inspection? to inspection Proceeds out
verify trailer, If---+!
and clear the o---Yi--~ 1 manufacturing/production facilities for subassembly or component manufacturing, or
es station of customs
chassis, and import for final assembly of products such as electronic devices or television sets. While this
license numbers documents has been occurring for some time, U.S. firms have begun to include such Maquiladora
operations (named for the region of Mexico in which many of these plant operations
are located) as formal components of their manufacturing and supply chain systems.
Inspection? Proceeds out Delivers trailer Essentially, in a Maquiladora operation, a U.S. manufacturer either operates or sub-
No of customs to Mexican contracts for a manufacturing, processing, or assembly activity to be performed in
Mexico. Mexican production and labor costs are lower than those in the United States,
~! and the operations involve no local content issues. U.S. firms often send semifinished
product to Mexico for final assembly, for example, and then have the finished product
shipped to the United States. This concept appeals to many companies: U.S. manufac-
Mexican carrier 11-----+l Delivers goods turers operate more than 2,000 Maquiladora facilities in Mexico.
11-----+l Returns trailer
to consignee to border
One feature that adds to the feasibility of such an approach is the limited tariff
duties. The importing, storing, manufacturing, and subsequent export of goods have
virtually no net payment of customs duties or import charges. The duties are limited to
the value-added portion of the goods, primarily labor, returning from Mexico. Effec-
tively, this contributes to the economic efficiency of supply chain alternatives such as
Trade th M 1
WI exico a so poses some trade constraints that NAFTA di.d t l. . Maquiladora operations.
The 1 h b no e Immate
. supp ~ c am arners mclude a poor transportation infrastructure . . .
foreign capital rules, and customs rules The Mexican h. h . ' restnctrve Successful Mexican Maquiladora operations have served as role models for this con-
. . Ig way system Is poor whe
compared to that existmg in the United States and Canad M . I h .n cept's further exploitation in Central and South American countries. Coupled with the
;~:~~t~~~: is owned ~nd .operated b~ the government. ~her:x:r: ~:yna~:o~:~ 1::~~ prospect of closer trade relations between the United States and Mexico, these alterna-
. .a~ (LTL) t~ucking compames, and
air transportation is limited to the few
tives offer advantages to the firms utilizing them. There are some constraints in South
airport~. Foreign trucking companies are restricted from hauling intracount h. America because ofless than amicable relations with some countries.
ments m all three countries; these are known as cabotage restrictions. ry s Ip-
Asian Emergence
theFj~::d3;!a:~s0:~ot~e~~~~~~~:e ~.~~~lr~~c~~~~i~~::a:;o;:~e~r~c~<s~~:;:~~\!r~;:; In perhaps the most significant trend of the past 25 years, Pacific Rim countries have
emerged as important players in the global business environment. While Japan has
96 Chapter 3 Global Dimensions of Supply Chains 97

achieved a dominant position in global financial markets, other Asian countries

account for significant portions of global trade growth. Hong Kong, South Korea, Table 3-2 Top 10 Ocean Carriers Ranked by Capacity
Singapore, and Taiwan have all assumed leadership positions in certain markets and
product types, and they are among the top 10 trading partners of the United States (see OCEAN CARRIER 2000 2006
Table 3-1). This trend is likely to accelerate in the future.
A. P. Moller 1
Many Asian countries have become preferred sources for many raw materials and
components. These countries have become trusted suppliers of finished goods such as Mediterrian Shipping Co. (MSC) 5 2
apparel, furniture, consumer electronics, and automobiles. The advantages many of CMA CGM Group 12 3
these countries offer are low labor cost and high quality.
Evergreen Group 2 4
New Directions Hapag-Lioyd 14 5
Aside from establishing product sources in other countries, global companies are locat-
ing plants and key logistics facilities in countries that use or consume their output. For China Shipping (CSCL) 18 6
example, Japanese-based firms such as Toyota have located plants in the United States. APL 6 7
Similarly, U.S. automobile manufacturers such as Ford and General Motors have lo-
cated plants in other countries. Hanji!Senator 4 8

Some global manufacturers are using a strategy known as focus production in COSCO Container Line 7 9
which a given plant produces one or two items of the company's total product line. NYK 8 10
The plants are typically located in different countries, requiring a global logistics sys-
tem to tie the focused plant to the customer, who may be located within the producing Source:
countly or a different country.
An important dimension of any supply chain is transportation links. Transporta-
tion can be depicted as the glue that holds the supply chain together. Global supply
chains are very dependent upon efficient and effective transportation and the related Liner carriers offer set schedules over specific routes. They also offer set tariffs and
services of channel intermediaries discussed next. accept certain standards of liability. Liners usually carry break-bulk shipments of less-
than-shipload size. Most container and roll-on, roll-off (RO-RO) ships are liners.

Global Transportation Options Liners are operated by large steamship companies, which usually belong to ship-
ping conferences. These conferences are voluntary associations of ocean carriers that
Global transportation is usually much more complex than domestic U.S. transporta- operate over common trade routes and use a common tariff for setting rates on the
tion. The distances involved are greater, and the number of parties involved is typically commodities they handle. Conferences also work together to attract customers and to
more extensive. Because of the large expanses of water separating most regions of the utilize member ships as effectively as possible.
world, the major modes of global transport are ocean and air. Land modes also carry
freight between contiguous countries, particularly in Europe, where land routes are In general, conferences provide good service with frequent and reliable schedules,
short. published daily in the Journal of Commerce. Additionally, conferences help to stan-
dardize shipping on many routes by stabilizing prices and offering uniform contract
Ocean rates.
Transport by ship is by far the most pervasive and important global shipment method, Firms contract charter ships for specific voyages and/or for specified time periods.
accounting for two-thirds of all international movements. Ocean transportation's Voyage charters are contracts covering one voyage. The carrier agrees to carry a cer-
major advantages are low rates and the ability to transport a wide variety of products tain cargo from an origin port to a destination. The price the carrier quotes includes all
and shipment sizes. The primary disadvantages include long transit times (slow speed), of the expenses of the sea voyage. Time charters allow the use of a ship for an
low accessibility, and higher potential for shipment damage. The pervasive use of agreed-upon time period. The carrier usually supplies a crew as part of the contract.
containers has reduced damage and increased accessibility via connections with other The charterer has exclusive use of the vessel to carry any cargo that the contract does
modes (rail and truck) for inland origins and destinations. not prohibit and assumes all expenses for the ship's operation during the charter pe-
riod. Bareboat or demise charter transfers full control of the vessel to the charterer.
Ocean shipping comprises three major categories. One is liner service, which offers
The charterer is then responsible for the ship and all expenses necessary for the vessel's
scheduled service on regular routes. Another is charter vessels, which firms usually
operation, including hiring the crew.
hire on a contract basis and which travel no set routes. Finally, private carriers can be
part of a firm's own supply chain. Table 3-2 contains the top 10 ocean carriers. Note Chartering usually takes place through ship brokers, who track the location and
the changes that occurred between 2000 and 2006 in ocean carrier rankings. status of ~hin~ th!lt !lrP onPn for hlrP WhPn 'l. c'h-innP1 r\PPrlc +n rnntr'.lrt frw 'l ch-in thco
98 Chapter 3 Global Dimensions of Supply Chains 99

shipper contacts a broker, who then negotiates the price with the ship owner. The ship oceans, or to the weather. A firm using air transportation may also be able to use the
owner pays the broker a commission on the charter's cost. same packaging for international shipping as for domestic shipping. In addition, ship-
In a logistics system, private ocean carriers play the same role as private carriage in pers have developed special containers for air transport. These containers reduce han-
general. In other words, companies utilize private ocean vessels to lower their overall dling costs and provide protection, but they also make intermodal shipments difficult.
costs and/or to improve their control over transportation service. The major differ- Their odd shapes usually require shippers to repack the shipment before transporting
ences between domestic and international private ocean transportation are the scale of it by another mode. Recent container-handling innovations have made it possible to
investment, the complexity of regulations, and the greater risk international transport load standard 20-foot containers onto large freight aircraft.
entails. In international operations, chartering often provides a very viable substitute A disadvantage of air carriage is high rates, which have precluded many shippers
for private carriage. from transporting international shipments by air. Generally, only highly valuable, highly
perishable, or urgently needed commodities can bear the higher cost of airfreight.
The fast transit times that air transport provides have had an impact on global distri- Motor
bution. The speed of airplanes combined with a frequency of scheduled flights has re- Companies will often use motor transport when shipping goods to an adjacent coun-
duced some global transit times from as many as 30 days to 1 or 2 days. These transit try-between the United States and Mexico or Canada, for example. It is very common
times have spurred the development of global freight services. These carriers offer in Europe, where transport distances are relatively short. Motor also plays a large part
door-to-door, next-day services for packages between most large American cities and a in intermodal shipments.
growing number of overseas points.
The advantages of international motor transport are basically the same as those for
The world's air carriers have usually focused on passenger service, and air cargo ac- domestic shipments: speed, safety, reliability, and accessibility to the delivery site.
counts for a small percentage of international freight by weight. However, the nature of However, motor shipment across multiple national boundaries involves a number of
the cargo, mostly high-value, low-density items, causes the total value of airfreight different import regulations. To minimize paperwork, these shipments are often made
cargo to be a greater proportion of the world total. Air cargoes include high-value in bond-the carrier seals the trailer at its origin and does not open it again until it
items such as computers and electronic equipment, perishables such as cut flowers and reaches its destination country.
live seafood, time-sensitive documents and spare parts, and even whole planeloads of
cattle for breeding stock. Table 3-3 provides a list of major international cargo air Rail
International railroad use is also highly similar to domestic rail use, but rail's accessi-
Most airfreight travels as belly cargo in the baggage holds of scheduled passenger bility is much more limited internationally because border crossing points are scarce.
flights. Only a few major airlines have all-freight aircraft. Differing track gauges in various countries also prevent long-distance shipments.
In addition to short transit time, air transportation offers an advantage in packag- Intermodal container shipments by rail are increasing. Various maritime bridge
ing. This mode requires less stringent packaging than ocean transport, since air trans- concepts involve railroads both for transcontinental shipments and to and from inland
port will not expose the shipment to rough handling at a port, to a rough ride on the points. For example, a shipper using a land bridge substitutes land transportation for
part of a container's ocean voyage, taking several days off the transit time and saving
in-transit inventory costs. A prime example of a land bridge occurs on the trade route
between Japan and Europe. The all-water route takes anywhere from 28 to 31 days. If
'J'aHie 3-3 the shipment travels by water from Japan to Seattle (10 days), then by rail to New York
Major International Cargo Air Carriers
(five days), and by water from New York to Europe (seven days), the total shipping
time is approximately 22 days.
Airborne Express
British Airways
BAX Global
DHL Worldwide Express Strategic Channel Intermediaries
Emery Worldwide
Intermediaries play a much larger role in global supply chain operations than in the
Federal Express
domestic United States. The scope of services that intermediaries offer is very compre-
Japan Airlines
hensive. Intermediaries play a strategic role in helping new and established companies
KLM Royal Dutch Airlines
venture into the global arena. Some companies require assistance in comprehending
complex operations involving sources and destinations in other countries.
Singapore Airlines
United Airlines
United Parcel Service
Foreign Freight Forwarders
For a company with little international shipping expertise, the foreign freight for-
, . ~ ,.. "" .. . . .. . . -.. ..
Global Dimensions of Supply Chains 101
100 Chapter 3

who are knowledgeable in all aspects of international shipping, supplies its experts to Export Management Companies
small international shippers that find employing such individuals in their shipping de- Often, a firm wishes to sell its products in a foreign market but lacks the resources to
partments uneconomical. Foreign freight forwarders are regulated by the Federal Mari- conduct the foreign business itself. An export management company (EMC) can sup-
time Commission. ply the expertise such firms need to operate in foreign environments.
Foreign freight forwarders, like their domestic counterparts, consolidate small ship- EMCs act as agents for domestic firms in the international arena. Their primary
ments into more economical sizes. In the international arena, these larger sizes range function is to obtain orders for their clients' products by selecting appropriate markets,
from containers up to entire ships. Foreign freight forwarders also perform the routine distribution channels, and promotional campaigns. The EMC collects and analyzes
actions that shipments require. credit data for foreign customers and advises exporters on payment terms. It also usu-
Since no two international sales are exactly alike and since shippers have varying in- ally collects payments from foreign customers. EMCs may also supply documentation,
ternational traffic capabilities, the forwarder usually performs the export work that the arrange transportation, provide warehouse facilities, maintain a foreign inventory, and
shipper cannot handle. The supply chain manager must weigh the forwarder's cost handle break-bulk operations.
against the cost of hiring personnel to perform the same tasks. A firm can contract with an export management company to provide its exclusive
The forwarder derives income from different sources. One source is the fees representation in a defined territory. The EMC may either purchase the goods or sell
charged for preparing export documentation. Another source is the commissions them on commission. In order to present a complete product line to importers, an
the forwarder receives from carriers. These commissions are based on the amount EMC will usually specialize in a particular product type or in complementary
of revenue the forwarder generates for the carrier. The third type of income comes products.
from the price difference between the rate the forwarder charges a shipper and Using an export management company has several advantages. First, EMCs usually
the lower rate per pound it pays for the consolidated shipments. The final two specialize in specific markets, so they understand in detail what an area requires. They
sources are from the provision of inland transportation and warehousing will have up-to-date information on consumer preferences and will help the exporter
functions. to target its products most effectively. Second, EMCs will usually strive to maintain
good relations with the governments of importing countries. This enables them to re-
Airfreight Forwarders Airfreight forwarders perform the same functions as surface
ceive favorable customs treatment when introducing new products. EMCs also remain
freight forwarders, but for air shipments only. They do not require a license from the
current on documentation requirements. This helps the goods they are importing to
federal government as foreign freight forwarders do. Airfreight forwarders primarily
enter with few holdups.
consolidate small shipments, which they present to the air carrier for movement to the
Export Trading Companies
Like the foreign freight forwarder, the airfreight forwarder generates income from
An export trading company (ETC) exports goods and services. The ETC locates over-
fees charged for services provided and the difference between the rate charged the
seas buyers and handles most of the export arrangements, including documentation,
shipper and that paid to the air carrier. The major competitors of airfreight forwarders
inland and overseas transportation, and the meeting of foreign government require-
are the air carriers, who can go directly to the shipper and eliminate the forwarder. For
ments. The ETC may or may not take title to the goods.
small shipments, air express carriers, such as Federal Express, Emery, UPS Air, and
DHL, compete directly with the forwarders. A trading company may also engage in other aspects of foreign trade, in which case
it becomes a general trading company. One reason Japan has been successful in inter-
Non-Vessel-Operating Common Carriers national trade is because of its large general trading companies, the sogo shosha. These
The non-vessel-operating common carrier (NVOCC) consolidates and dispenses firms, which consolidate all aspects of overseas trade into one entity, may include
containers that originate at or are bound to inland points. The need for these firms banks, steamship lines, warehouse facilities, insurance companies, sales forces, and
arose from the inability of shippers to find outbound turnaround traffic after unload- communications networks.
ing inbound containers at inland points. Rail and truck carriers often charge the same A trading company allows small- to medium-size firms, which do not in and of
rate to move containers, whether they are loaded or empty. NVOCCs are regulated by themselves possess the resources, to engage in foreign trade. The trading company
the Federal Maritime Commission. purchases their goods and sells them on the international market, taking care of all the
To reduce these costs, the NVOCC disperses inbound containers and then seeks intermediate steps. Having all the functional areas under one control makes coordina-
outbound shipments in the same containers. It will consolidate many containers for tion easy and speeds response time when markets fluctuate.
multiple-piggyback-car or whole-train movement back to the port for export. It also
provides scheduled container service to foreign destinations. Customs House Brokers
Shippers and receivers of international shipments gain from the shipping expertise Customs house brokers oversee the movement of goods through customs and ensure
that NVOCCs possess and from the expanded and simplified import and export op- that the documentation accompanying a shipment is complete and accurate for entry
portunities. The ocean carrier gains from the increased market area made possible by into the country. U.S. customs house brokers are licensed by the Department of the
1\..T\Tnrrp, c-'\.llr-it<J.-tiAn cPnrirPc Treasury.
102 Chapter 3 Global Dimensions of Supply Chains 103

Customs house brokers operate under power of attorney from the shipper to pay all handling usually occurs under unfavorable conditions-in inclement weather or with
import duties due on the shipment. The importer is ultimately liable for any unpaid antiquated handling equipment, for example. If storage facilities are inadequate, the
duties. The brokers keep abreast of the latest import regulations and of the specific re- goods may remain exposed to the elements for a long time.
quirements of individual products. The next section discusses storage facilities and
packaging from a global perspective. The shipper may find settling liability claims for damage to export goods very diffi-
cult. Usually, the freight handling involves many firms, and these firms are located in
different countries. Stringent packaging is the key to claims prevention for export
Storage Facilities and Packaging shipments.

Storage Facilities
At several points during an international shipment, the goods being shipped may re-
quire storage. Storage may be necessary while the shipment waits for loading on an
ocean vessel, after it has arrived at the destination port and is awaiting further trans-
portation, or while customs clearance is being arranged for the merchandise. When
packaged in a container, goods are protected from the weather, theft, and pilferage.
A carrier or shipper can store containers outside between a journey's stages with little
effect on the contents.
Noncontainerized cargo, on the other hand, requires protection if it is to arrive in
good order. Ports supply several types of storage facilities to fill this need. Transit
sheds, located next to the piers or at the airport, provide temporary storage while the
goods await the next portion of the journey. Usually, the port usage fee includes a fixed
number of days of free storage. After this time expires, the user pays a daily charge.
In-transit storage areas allow the shipper to perform some required operation on the
cargo before embarkation. These actions may include carrier negotiations and waiting
for documentation, packing, crating, and labeling to be completed. The carrier usually
provides hold-on-dock storage free of charge until the vessel's next departure date, al-
lowing the shipper to consolidate goods and to save storage costs.
When goods require long-term storage, the shipper uses a warehouse. Public ware-
houses are available for extended storage periods. The services and charges offered by
these facilities are similar to those of public warehouses in the domestic sphere, which
are discussed in a later chapter.
Bonded warehouses, operated under customs supervision, are designated by the
U.S. secretary of the treasmy for the purpose of storing, repacldng, sorting, or cleaning
imported merchandise entered for warehousing without paying import duties while
the goods are in storage. Only bonded carriers may move goods into and out of
bonded warehouses. Bonded warehouses are very important in global commerce.
One purpose of bonded warehouses is to hold imported goods for reshipment out
of the United States. The owner can store items in a bonded warehouse for up to three
years, allowing time to decide on the goods' ultimate disposition without having to pay
import duties or taxes on them. If the owner does not reexport the goods before the
three years elapse, they are considered imports and are subject to all appropriate duties
and taxes.

Export shipments moving by ocean transportation require more stringent packaging
than domestic shipments normally do. An export shipment undergoes more handling:
it is loaded at the origin, unloaded at the dock, loaded onto a ship, unloaded from
the ship at port, loaded onto a delivery vehicle, and unloaded at the destination. This
104 Chapter 3
Global Dimensions of Supply Chains 105

SUMMARY 1. Why are customer service and its related strategy so important for companies
Companies competing in global supply chains need to address some important ques- operating global supply chains?
tions for their global networks to ensure their efficiency and effectiveness.
8. What is meant by the phrase "that supply chain security, especially on a global
There have been three phases of globalization: the first was driven by countries, the basis," is a balancing act?
second by large companies, and the third by individuals and small organizations.
Successful global companies have transformed their supply chains on an ongoing 9. Why are ports so important for global supply chains?
basis to enable them to deliver low cost and high value to the ultimate customer. 10. Discuss the major alternatives for global transportation.
The scope and magnitude of trade flows between the United States and other coun-
tries have grown considerably in the last several decades. One interesting develop- NOTES
ment has been the growth in importance of trade with China and several other
Asian countries. 1. "China, India Lure Global Investors with Booming Economics and Robust Trade," T. Rowe Price Re-
port, Issue 96 (Summer 2007): 1-10.
Success in the global marketplace requires developing a cohesive set of strategies
with respect to customer service, product development, business model, and overall 2. Thomas L. Friedman, The World Is Flat (New York: Farrar, Strauss and Giroux, 2005): 6-11.
supply chains.
3. Ibid.
Supply chain security has taken on increased importance since September 11, 2001.
Companies individually, jointly, and in cooperation with the various levels of gov- 4. Ibid.
ernment need to be actively involved. The federal government, in particular, has ex-
5. Ibid.
panded the scope of its regulations and policies for global security.
U.S. ports play a critical role in global supply chains since over 90 percent of global 6. Charles Fishman, The Wai-Mart Effect (New York: Penguin Press, 2006): 1-22.
trade passes through them. Ports are also an important focus for security.
7. The Wall StreetJoumal (August 9, 2007): 1.
Canada and Mexico are ranked number 1 and 3, respectively, on the list of most im-
portant trading partners with the United States. That relationship is enhanced by the 8. Adam Smith, Wealth of Nations.
North American Free Trade Agreement ratified by Congress in 1994. While the 9. Edward Iwata, "lnfosys Kicks up Growth Mode," USA TOOAY(August4, 2006): lB.
treaty had lofty goals, it still is experiencing problems with full implementation of its
objectives. Nevertheless, it has fostered trade in North America. 10. Bob Fernandez, "U.S. Research Making Great Leap," Philadelphia Inquirer (November 5, 2006):
Global supply chains have a number of transportation and related service options
available to managers. Each of the options has advantages and disadvantages that 11. Timothy Aeppel, "Overseas Profits Help U.S. Firms Through the Tumult," The Wall Street Journal
need to be analyzed. (August 9, 2007): AlO.

12. J. J. Coyle, E. J. Bardi, and R. A. Novack, Transportation, 6th ed. (Mason, Ohio: Thomson South-
Western, 2006): 232-240.
13. Ibid.
1. Globalization has developed in three phases or eras. What are the major differ-
ences between today's third phase and the previous two phases? Do you think that 14. Ibid.
there will be a fourth phase? Why or why not?
15. Ibid.
2. It has been alleged that the world has become flat. What does this description
16. Ibid.
mean from a global economic perspective? What factors have contributed to this
phenomenon? 17. "Securing the Global Supply Chain," U.S. Customs and Border Protection (Washington, DC: Office
of Field Operations, November 2004): 1-25.
3. A number of authors have observed that traditional, hierarchical organizations
18. "America's Ports Today," American Association of Port Authorities (Alexandria, VA: 2007): 1-8.
have changed in the current global economy. How have organizations changed?
Why have they changed? 19. Ibid.

4. Wal-Mart has frequently been cited for being a successful supply chain company. 20. "Measurement of Commercial Motor Vehicle Travel Time and Delay at U.S. International Border.
Why? Stations," U.S. Federal Highway Administration, 2002.

5. What special role do supply chains play in the globalization of organizations? Will
supply chains continue to be important in the future?
6. What is meant by the current description of the global economy that "time and
distance have been collapsed or compressed"? Do you agree? Do you think that
our trading relationships will be affected in the future by this phenomenon?
106 Chapter 3

CASE 3-1
Red Fish, Blue Fish, LLP: A Sequel
Fran Fisher, CEO of Red Fish, Blue Fish, was meeting with Eric Lynch who now was
vice president for global supply chain management for Red Fish, Blue Fish. Fran
started the meeting by praising Eric for his management of their growing global enter-
prise. "Eric, I can hardly believe how far we have come during the last three years. Our
sales have quadrupled and there is every reason to believe that we can double our cur-
rent sales in more years. Our consulting sales business appears to be stabilizing, and we
have to decide if we want to extend our sales area eastward into the Philadelphia, Balti-
more, and DC markets. Our Internet sales have been growing geometrically not only in
the United States and Canada but also in Western Europe. Interestingly, we have also
had some sales in several South American countries during the last year."
"China is still our principal source for the fish that we sell, and Liu-Sheng Trading
Company has become almost an extension of our company. Connie Que, COO of Liu-
Sheng, and I met in Hong Kong recently to discuss our long-term needs. She assured
me that they could handle our continued growth and wanted to be a 'partner' with Red
Fish, Blue Fish."
Fran told Eric that he was concerned, for the long run, in depending on one source
of supply, that is, Liu-Sheng Trading Company. Also, he was unsure about South
American countries as a future growth market. Finally, he told Eric that the complexity
of the supply chain needed to be considered.

1. What are the advantages and potential disadvantages to Red Fish, Blue Fish of hav-
ing China (Liu-Sheng Trading Company) as its sole source of supply? What would
you recommend?
2. What supply challenge would Red Fish, Blue Fish face in expanding into South
America? Do you recommend expanding aggressively into South America? Why or
why not?
Cha ter 4

Learning Objectives
After reading this chapter, you should be able to do the following:
Understand the types of supply chain relationships and their importance.
Describe a process model that will facilitate the development and
implementation of successful supply chain relationships.
Recognize the importance of "collaborative" supply chain relationships.
Define what is meant by third-party logistics (3PL) and know what types of
firms provide 3PL services.
Know what types of 3PL services are used by client/customer firms and what
types of 3PL providers are used.
Discuss the role and relevance of information technology-based services to
3Pls and their clients/customers.
Know the extent to which customers are satisfied with 3PL services and
identify where improvement may be needed.
Understand some of the likely future directions for outsourced logistics
108 Chapter4

Supply Chain Supply Chain Relationships-

Profile There Is No "Magic Bullet"
One of the most fundamental yet more challenging requirements for supply chain integration is
changing the nature of traditional relationships between suppliers and customers in the supply
chain. Relationship management affects all areas of the supply chain and has a dramatic im-
pact on performance. In many cases, the information systems, technology, inventory, and trans-
portation management systems required for the supply chain management (SCM) effort are
available and ready to be implemented, but the initiatives fail due to poor communication of
expectations and the resulting behaviors. Managers often assume that the personal relation-
ships important to the supply chain will fall into place; however, managing relationships
among organizations can be the most difficult part of the SCM initiative.
Moreover, the single most important ingredient for successful SCM may be trusting rela-
tionships among partners in the supply chain, where each party has confidence in the other
members' capabilities and actions. And trust building is characterized as an ongoing process
that must be continually managed. One materials management vice president at a Fortune
500 manufacturer expressed this feeling as follows:
Supply chain management is one of the most emotional experiences I've ever
witnessed. There have been so many mythologies that have developed over the
years, people blaming other people for their problems, based on some incident
that may or may not have occurred sometime in the past. Once you get everyone
together into the same room, you begin to realize the number of false percep-
tions that exist. People are still very reluctant to let someone else make deci-
sions within their area.
In the early stages of supply chain development, organizations often eliminate suppliers
or customers that are unsuitable, because they lack the capabilities to serve the organization,
they are not well aligned with the company, or they are simply not interested in developing a
more collaborative relationship. Then, organizations may concentrate on supply chain members
who are willing to contribute the time and effort required to create a strong relationship. Firms
may consider developing a strategy with this supplier to share confidential information, invest
assets in joint projects, and pursue significant joint improvements.
However, many firms lack the guidelines to develop, implement, and maintain supply
chain alliances. In creating new value systems, companies must rethink how they view their
customers and suppliers. They must concentrate not just on maximizing their own profits, but
on maximizing the success of all organizations in the supply chain. Strategic priorities must
consider other key alliance partners that contribute value for the end customer. Instead of en-
couraging companies to hold their information close, trust-building processes promote the
sharing of all forms of information possible that will allow supply chain members to make bet-
ter, aligned decisions. Whereas traditional accounting, measurement, and reward systems tend
to focus on individual organizations, a unified set of supply chain performance metrics should
be utilized as well.
Strategic alliances can occur in any number of different markets and with different
combinations of suppliers and customers. A typical supplier-customer alliance involves a sin-
gle supplier and a single customer. A good example is the relationship between Procter &
Gamble and Wai-Mart, which have worked together to establish long-term electronic data inter-
change (EDI) linkages, shared forecasts, and pricing agreements. Alliances also can develop
between two horizontal suppliers in an industry, such as the relationship between Dell and
Supply Chain Relationships 109

Microsoft-organizations that collaborate to ensure that the technology road map for Dell com-
puters (in terms of memory, speed, etc.) will be aligned with Microsoft's software requirements.
Finally, a vertical supplier-supplier alliance may involve multiple parties, such as trucking
companies that must work with railroads and ocean freighters to ensure proper timing of deliv-
eries for multimodal transshipments.

Overall, creating and managing a strategic alliance means committing a dedicated team
of people to answering these questions, and working through all of the details involved in man-
aging the relationship. Unfortunately, there is no "magic bullet" to ensure that alliances will
always work. However, it is reasonable to assume that, like a marriage, the more you work at it,
the more successful it is likely to be!
Source: Adapted from Robert Handfield, "Managing Supply Chain Relationships," North Carolina State
University. Reproduced by permission.

As indicated throughout this book, many firms have directed significant attention to-
ward working more closely with supply chain partners, including not only customers
and suppliers but also various types of logistics suppliers. Considering that one of the
fundamental objectives of effective supply chain management is to achieve coordina-
tion and integration among participating organizations, the development of more
meaningful "relationships" through the supply chain has become a high priority.
This chapter focuses on two highly related topics. The first is that of supply chain
relationships in general, with an emphasis on the types of relationships, the processes
for developing and implementing successful relationships, and the need for firms to
collaborate to achieve supply chain objectives. The second is that of the third-party
logistics (3PL) industty in general and how firms in this industty create value for their
commercial clients. The 3PL industry has grown significantly over recent years and is
recognized as a valuable type of supplier of logistics services.
As suggested by the late Robert V. Delaney in his 11th Annual State of Logistics
Repmt/ relationships are what will carry the logistics industty into the future. In com-
menting on the current rise of interest in e-commerce and the development of electronic
markets and exchanges, he states, "We recognize and appreciate the power of the new
technology and the power it will deliver, but, in the frantic search for space, it is still
about relationships." This message not only captures the importance of developing logis-
tics relationships but also suggests that the ability to form relationships is a prerequisite
to future success. Also, the essence of this priority is captured in a quote from noted
management guru Rosabeth Moss Kanter2 who stated that, "being a good partner has
become a key corporate asset; in the global economy, a well-developed ability to create
and sustain fruitful collaborations gives companies a significant leg up."

Logistics Relationships
es of Relationships
, there are two types of logistics relationships. The first is what may be
vertical relationshios: these refer to thf' tnlClition:ll link:lo-f's hf'twf'f'n firms in
110 Chapter 4 Supply Chain Relationships 111

the supply chain such as retailers, distributors, manufacturers, and parts and materials Alternatively, the relationship suggested by a strategic alliance is one in which two
suppliers. These firms relate to one another in the ways that buyers and sellers do in all or more business organizations cooperate and willingly modify their business objec-
industries, and significant attention is directed toward making sure that these relation- tives and practices to help achieve long-term goals and objectives. The strategic alli-
ships help to achieve individual firm and supply chain objectives. Logistics service pro- ance by definition is more strategic in nature and is highly relational in terms of the
viders are involved on a day-to-day basis as they serve their customers in this firms involved. This form of relationship typically benefits the involved parties by re-
traditional, vertical form of relationship. ducing uncertainty and improving communication, increasing loyalty and establishing
The second type of logistics relationship is horizontal in nature and includes those a common vision, and helping to enhance global performance. Alternatively, the chal-
business agreements between firms that have "parallel" or cooperating positions 1h the lenges with this form of relationship include the fact that it implies heavy resource
logistics process. To be precise, a horizontal relationship may be thought of as a service commitments by the participating organizations, significant opportunity costs, and
agreement between two or more independent logistics provider firms based on trust, high switching costs.
cooperation, shared risk and investments, and following mutually agreeable goals. Each Leaning more toward the strategic alliance end of the scale, a partnership represents
firm is expected to contribute to the specific logistics services in which it specializes, a customized business relationship that produces results for all parties that are more
and each exercises control of those tasks while striving to integrate its services with acceptable than would be achieved individually. Partnerships are frequently described
those of the other logistics providers. An example of this may be a transportation firm as being "collaborative," which is discussed further at a later point in this chapter.
that finds itself working along with a contract warehousing firm to satisfy the needs of
the same customer. Also, cooperation between a third-party logistics provider and a Note that the range of alternatives suggested in Figure 4-1 is limited to those that do
firm in the software or information technology business would be an example of this not represent the ownership of one firm by another (i.e., vertical integration) or the
type of relationship. Thus, these parties have parallel or equal relationships in the lo- formation of a joint venture, which is a unique legal entity to reflect the combined op-
gistics p1:ocess and likely need to work together in appropriate and useful ways to see erations of two or more parties. As such, each represents an alternative that may imply
that the customer's logistics objectives are met. even greater involvement than the partnership or strategic alliance. Considering that
they represent alternative legal forms of ownership, however, they are not discussed in
Intensity of Involvement detail at this time.
As suggested by Figure 4-1, the range of relationship types extends from that of a ven- Regardless of form, relationships may differ in numerous ways. A partial list of
dor to that of a strategic alliance. In the context of the more traditional "vertical" con- these differences follows:
text, a vendor is represented simply by a seller or provider of a product or service, such
that there is little or no integration or collaboration with the buyer or purchaser. In es-
sence, the relationship with a vendor is "transactional," and parties to a vendor rela-
tionship are said to be at "ann's length" (i.e., at a significant distance). The analogy of Expectations
such a relationship to that experienced by one who uses a "vending" machine is not in- Interaction/Communication
appropriate. While this form of relationship suggests a relatively low or nonexistent Cooperation
level of involvement between the parties, there are certain types of transactions for Planning
which this option is desirable. One-time or even multiple purchases of standard prod- Goals
ucts and/or services, for example, may suggest that an "arm's length" relationship
Performance analysis
would be appropriate.
Benefits and burdens
In general terms, most companies feel that there is significant room for improvement
Figure 4-1 Relationship Perspectives in terms of the relationships they have developed with their supply chain partners. The
content of this chapter should help to understand some key ways in which firms may
T improve and enhance the quality of relationships they experience with other members
r of their supply chains.
a R
n e
s I
a a
Length Collaborative Strategic t
Model for Developing and lmpler:nenting Successful
i 0 Supply Chain Relationships
0 n
n a Figure 4-2 outlines the steps in a process model for forming and sustaining supply
a I chain relationships. For purposes of illustration, let us assume that the model is being
I applied from the perspective of a manufacturing firm, as it considers the possibility of
Vendor Partner Strategic Alliance
forming a relationship with a supplier of logistics services (e.g., transport firm, ware-
112 Chapter 4 Supply Chain Relationships 113

Figure 4-2 Process Model for Forming Logistics Relationships Figure 4-3 What Does It Take to Have an Area of Core Competency?


Ability to

to Form Q) Evaluate cr> Structure @Implementation
Strategic Operating and Continuous
Relationship Alternatives
Assessment Model Improvement


Source: Copyright 2001, C. John Langley Jr., Ph.D. Used with permission. indicated in Figure 4-3, for a firm to have core competency in any given area, it is
necessary to have expertise, strategic fit, and ability to invest. The absence of any one
or more of these may suggest that the services of an external provider are
Step 1: Peliorm Strategic Assessment This first stage involves the process by which appropriate.
the manufacturer becomes fully aware of its logistics and supply chain needs and the over- If the relationship decision involves a channel partner such as a supplier or cus-
all strategies that will guide its operations. Essentially, this is what is involved in the con- tomer, the focus is not so much on whether or not to have a relationship but on what
duct of a logistics audit. The audit provides a perspective on the firm's logistics and supply type of relationship will work best. In either case, the question as to what type of rela-
chain activities, as well as developing a wide range of useful information that will be help- tionship is most appropriate is one that is very important to answer.
ful as the opportunity to form a supply chain relationship is contemplated. The types of in-
formation that may become available as a result of the audit include the following: Lambert, Emmelhainz, and Gardner have conducted significant research into the
topic of how to determine whether a partnership is warranted and, if so, what kind of
Overall business goals and objectives, including those from a corporate, divi- partnership should be considered. 3 Their partnership model incorporates the identifica-
sional, or logistics perspective tion of "drivers" and "facilitators" of a relationship; it indicates that for a relationship to
Needs assessment to include requirements of customers, suppliers, and key have a high likelihood of success, the right drivers and facilitators should be present.
logistics providers
Drivers are defined as "compelling reasons to partner." For a relationship to be suc-
Identification and analysis of strategic environmental factors and industry
trends cessful, the theory of the model is that all parties "must believe that they will receive signi-
ficant benefits in one or more areas and that these benefits would not be possible without
Profile of current logistics network and the firm's positioning in respective
supply chains a partnership." Drivers are strategic factors that may result in a competitive advantage and
may help to determine the appropriate type of business relationship. Although other
Benchmark, or target, values for logistics costs and key performance
measurements factors may certainly be considered, the primary drivers include the following:

Identification of "gaps" between current and desired measures of logistics ( Asset/Cost efficiency
performance (qualitative and quantitative) Customer service
Given the significance of most logistics and supply chain relationship decisions, and Marketing advantage
the potential complexity of the overall process, any time taken at the outset to gain an Profit stability/Growth
understanding of one's needs is well spent.
Facilitators are defined as "supportive corporate environmental factors that en-
Step 2: Decision to Form Relationship Depending on the type of relationship hance partnership growth and development." As such, they are the factors that, if pres-
being considered by the manufacturing firm under consideration, this step may take ent, can help to ensure the success of the relationship. Included among the main
types of facilitators are the following:
on a slightly different decision context. When the decision relates to using an external
provider oflogistics services (e.g., trucking firm, express logistics provider, third-party Corporate compatibility
logistics provider), the first question is whether or not the provider's services will be Management philosophy and techniques
needed. A suggested approach to malting this decision is to make a careful assessment Mutuality of commitment to relationship formation
of the areas in which the manufacturing firm appears to have core competency. As
Svmmetrv on kev factors such as relative size. financial stren!!th. and so on
114 Chapter 4 Supply Chain Relationships 115

In addition, a number of additional factors have been identified as keys to successful

relationships. Included are factors such as exclusivity, shared competitors, physical Figure 4-4 Implementation and Continuous Improvement
proximity, prior history of working with a partner or the partner, and a shared high-
value end user. Q) Customer
~--~ Value
Step 3: Evaluate Alternatives Although the details are not included here, Lambert
and his colleagues suggest a method for measuring and weighting the drivers and fa-
cilitators that we have discussed. 4 Then, they discuss a methodology by which the
apparent levels of drivers and facilitators may suggest the most appropriate type of
relationship to consider. If neither the drivers nor the facilitators seem to be present,
then the recommendation would be for the relationship to be more transactional, or
"arm's length" in nature. Alternatively, when all parties to the relationship share com- Supply Chain Value
mon drivers, and when the facilitating factors seem to be present, then a more struc-
tured, formal relationship may be justified. Statistical
In addition to utilization of the partnership formation process, it is important to Process
conduct a thorough assessment of the manufacturing company's needs and priorities
in comparison with the capabilities of each potential partner. This task should be sup- @)Activity-
ported with not only the availability of critical measurements and so on, but also the ~--....J Based 14-----
results of personal interviews and discussions with the most likely potential partners.
Although logistics executives and managers usually have significant involvement in Source: Ray A. Mundy, C. John Langley Jr., and Brian J. Gibson, Continuous Improvement in Third Party
the decision to form logistics and supply chain relationships, it is frequently advanta- Logistics (2001). Reproduced by permission.
geous to involve other corporate managers in the overall selection process. Representa-
tives of marketing, finance, manufacturing, human resources, and information
systems, for example, frequently have valuable perspectives to contribute to the discus- Trust and commitment
sion and analysis. Thus, it is important to ensure a broad representation and involve- Contr~ct style
ment of people throughout the company in the partnership formation and partner Scope of the relationship
selection decisions. Financial investment
Step 4: Select Partners While this stage is of critical concern to the customer, the
Step 6: Implementation and Continuous Improvement Once the decision to form
selection of a logistics or supply chain partner should be made only following very
~ ~el~tionship has been made and the structural elements of the relationship identified,
close consideration of the credentials of the most likely candidates. Also, it is highly
It IS Important to recognize that the most challenging step in the relationship process
advisable to interact with and get to know the final candidates on a professionally inti-
~as just begun. Depending on the complexity of the new relationship, the overall
mate basis.
lffi~lement~tion process may be relatively short, or it may be extended over a longer
As was indicated in the discussion of Step 3, a number of executives will likely play penod of time. If the situation involves significant change to and restructuring of the
key roles in the relationship formation process. It is important to achieve consensus on ~anufacturing firm's logistics or supply chain network, for example, full implementa-
the final selection decision to create a significant degree of "buy-in" and agreement tion may take longer to accomplish. In a situation where the degree of change is more
among those involved. Due to the strategic significance of the decision to form a logis- modest, the time needed for successful implementation may be abbreviated.
tics or supply chain relationship, it is essential to ensure that everyone has a consistent
Fin~lly, the future success of the relationship will be a direct function of the ability
understanding of the decision that has been made and a consistent expectation of what
of the mvolved organizations to achieve both continuous and breakthrough improve-
to expect from the firm that has been selected.
~ent. As indicated in Figure 4-4, a number of steps should be considered in the con-
Step 5: Structure Operating Model The structure of the relationship refers to the tmuous improvement process. In addition, efforts should be directed to creating the
activities, processes, and priorities that will be used to build and sustain the relation- breakthrough, or "paradigm-shifting," type of improvement that is essential to enhance
ship. As suggested by Lambert and his colleagues, components "make the relationship ~e functioning of the relationship and the market positioning of the organizations
operational and help managers create the benefits of partnering."5 Components of the mvolved.
operating model may include the following: 6
Need for Collaborative Relationships 7
Whet?er the relationship may or may not be with a provider of logistics services,
Joint operating controls
today s supply chain relationships are most effective when collaboration occurs among
Communication the participants who are involved. Collaboration may be thought of as a "business
Risk/Reward sharing ' VlLaC1tice that encourages individual organizations to share information and resources
Supply Chain Relationships 117
116 Chapter 4

for the benefit of all." 8 According to Dr. Michael Hammer, collaboration allows com- Figure 4-5 Types of Collaboration
panies to "leverage each other on an operational basis so that together they perform
better than they did separately."9 He continues by suggesting that collaboration be-
comes a reality when the power of the Internet facilitates the ability of supply chain Supplier #l H Supplier #2
participants to readily transact with each other and to access each other's
information. I Manufacturer #1 H Manufacturer #21
While this approach creates a synergistic business environment in which the sum of
the parts is greater than the whole, it is not one that comes naturally to most organiza-
tions, particularly those offering similar or competing products or services. In terms of Distributor #l H Distributor #2
a logistics example, consider that consumer products manufacturers sometimes go to
great lengths to make sure that their products are not transported from plants to cus- Retailer #l ~~ Retailer #2
tomers' distribution centers with products of competing firms. While this practice does
have a certain logic, a willingness of the involved parties to collaborate and share re- (a) Vertical Collaboration (b) Horizontal Collaboration
sources can create significant logistical efficiencies. Also, it makes sense, considering
that retailers routinely commingle competing products as they are transported from
distribution centers to -retail stores. When organizations refuse to collaborate, real
losses may easily outweigh perceived gains.
The contemporary topic of importance is "collaboration." Most simply, collabora-
tion occurs when companies work together for mutual benefit. Since it is difficult to
imagine very many logistics or supply chain improvements that involve only one firm,
the need for effective relationships is obvious. Collaboration goes well beyond vague
expressions of partnership and aligned interests. It means that companies leverage each
other on an operational basis so that together they perform better than they did sepa-
rately. It creates a synergistic business environment in which the sum of the parts is
greater than the whole. It is a business practice that requires the following: (c) Full Collaboration

Parties involved to dynamically share and interchange information Source: Copyright C. John Langley, Jr., Ph.D. Used with permission.
Benefits experienced by parties to exceed individual benefits
All parties to modify their business practices
~ull collabo~ation (see Figure 4-Sc) is the dynamic combination of both ver-
All parties to conduct business in a new and visibly different way tical and honzontal collaboration. Only with full collaboration do dramatic
All parties to provide a mechanism and process for collaboration to occur efficiency gains begin to occur. With full collaboration, it is intended that
benefits accrue to all members of the collaboration. The development of
Figure 4-5 provides illustrations of three important types of collaboration: vertical,
agreed-upon methods for sharing gains and losses is essential to the success
horizontal, and full. Descriptions of these are as follows: of the collaboration.
Vertical collaboration (see Figure 4-Sa) refers to collaboration typically ~hile there are numerous sources of suggestion and insight as to how to most ef-
among buyers and sellers in the supply chain. This refers to the traditional
fectively create successful, collaborative relationships, Table 4-1 lists each of the "Seven
linkages between firms in the supply chain such as retailers, distributors,
manufacturers, and parts and materials suppliers. Transactions between Immutable Laws of Collaborative Logistics." The collective impact of these principles is
buyers and sellers can be automated, and efficiencies can be significantly im- that they represent a course of action that, if followed, should enhance the success and
proved. Companies can share plans and provide mutual visibility that causes benefits to be derived from truly collaborative relationships.
them to change behavior. A contemporary example of vertical collaboration
is collaborative planning, forecasting, and replenishment (CPFR), an
approach that helps buyers and sellers to better align supply and demand by Third-Party logistics-Industry Overview
directly sharing critical information such as sales forecasts. As i~dicated throughout this book, firms have directed considerable attention toward
Horizontal collaboration (see Figure 4-Sb) refers to a relationship that is w~rking more closely with other supply chain participants, including customers sup-
buyer to buyer and/or seller to seller, and in some cases even between com- phers, and various providers of logistics services. In essence, this has resulted in the de-
petitors. Essentially, this type of collaboration refers to business arrange-
velopment of more meaningful relationships among the companies involved in
ments between firms that have parallel or cooperating positions in the overall .supp 1Y ch am
As a result, many companies have been in the process of
logistics or supply chain process. Horizontal collaboration can help find and
extendmg .. their 1 f
og1s lCs orgamzatwns
mto t h ose of other supply chain participants
eliminate hidden costs in the supply chain that everyone pays for by allowing
;,..;,.,t nrnrlnrt rlPdcrn wmrrin11. manufacturin2:. and lo2:istics.
and faClhtators.
Supply Chain Relationships
118 Chapter 4

Definition of Third-Party Logistics

On the Line Don't Underestimate the Essentially, a third-party logistics firm may be defined as an external supplier that
Importance of Guanxi performs all or part of a company's logistics functions. This definition is purposely
broad and is intended to encompass suppliers of services such as transportation, ware-
"Guanxi" is the Chinese term for the reliance on trust and partnership within a web of relation- housing, distribution, financial services, and so on. As is discussed later, there are other
ships to achieve certain advantages. To do business in China successfully, a foreigner needs to desirable characteristics of a "true" 3PL. Among these, multiple logistics activities are
understand and respect this ancient social system. included, those that are included are "integrated" or managed together, and they pro-
Guanxi provides an entree into Chinese society that no other form of introduction can vide "solutions" to logistics/supply chain problems.
rival. During the early years of the 20th century, when Chinese markets were opening up to in-
Recently, there have been significant increases in the number of firms offering such
ternational competition, some foreign companies were able to use the guanxi of their Chinese
services, and this trend is expected to continue. While many of these firms are small,
partners to build fast and reliable distribution networks of considerable scope. Yet guanxi can
niche players, the industry has a number of large firms as well. Examples of the latter
also be a formidable constraint to geographic expansion if relationships run out of energy be-
include UPS Supply Chain Solutions, FedEx Supply Chain Services, IBM Supply Chain
fore market space does. Furthermore, because relationships are innately personal, guanxi only
Management Services, Ryder, DHL-Exel, Menlo Logistics, Penske Logistics, Schneider
gets you so far: It does not globalize easily, nor is it readily transferable. Further, guanxi is not
Logistics, Caterpillar Logistics, UTi Worldwide, Inc., and Agility, Inc.
"owned" by an organization but by the individual, and consequently, its influence can apply
only to a very particular circumstance and time. Depending on the firm and its positioning in the industry, the terms contract logis-
But isn't guanxi being superseded by an age of Web and e-mail connections? Aren't today's tics and outsourcing are sometimes used in place of third-party logistics. While some
Chinese managers much more attuned to merit and objective performance than to kinship, refer- industry executives take care to distinguish among terms such as these, each of these
rals, and shared experience? It is true that the mindset is changing, but there are many enduring terms refers to the use of external suppliers of logistics services. Except for the sugges-
cultural reasons why we should expect guanxi to be around for a long time. Author Francis tion that the term contract logistics generally includes some form of contract, or formal
Fukuyama has argued that in societies where people cannot trust "the system" for fairness, they agreement, this text does not suggest any unique definitional differences between these
put their trust in relationships they know they can depend upon.* This is as true for business terms. Although most customers who use 3PLs choose to have some formal contract to
leaders in many parts of the Western world as it is for business people in China. define the terms of the agreement, it is interesting to note that a small number of com-
panies choose not to have formal contracts with their suppliers of logistics services.
Source: Adapted from Robert Handfield and Kevin McCormack, "What You Need to Know About
Sourcing from China," Supply Chain Management Review (September 2005): 35. Reproduced by
permission of Robert Handfield. Types of 3Pl Providers
* Francis Fukuyama, Trust: The Social Virtues and the Creation of Prosperity (New York, NY: The Free Although most 3PL firms promote themselves as providers of a comprehensive
Press, 1995). range of logistics services, it is useful to categorize them in one of several ways.
Included are transportation-based, warehouse/distribution-based, forwarder-based,
financial-based, and information-based firms. Each of these is discussed briefly in the
following paragraphs.
Seven Immutable Laws of Collaborative Logistics
Transportation Based Included among the transportation-based suppliers are firms
such as UPS Supply Chain Solutions, FedEx Supply Chain Services, DHL, Ryder,
Collaborative logistics Networks Must Support:
Menlo Logistics, and Schneider Logistics; most of these are subsidiaries or major divi-
Real and recognized benefits to all members
sions of large transportation firms. Some of the services provided by these firms are
Dynamic creation, measurement, and evolution of collaborative
leveraged in that they utilize the assets of other companies; some are nonleveraged,
where the principal emphasis is on utilizing the transportation-based assets of the par-
Co-buyer and co-seller relationships
ent organization. In all instances, these firms extend beyond the transportation activity
Flexibility and security
to provide a more comprehensive set of logistics offerings.
Collaboration across all stages of business process integration
Open integration with other services In early 2000, Transplace was formed through the merger of the logistics business
Collaboration around essential logistics flows
units of several of the largest publicly held truckload carriers in the United States.
While this company is transportation based in that major elements of its corporate
Source: Copyright 2000, C. John Langley Jr., Ph.D., used with permission. heritage do involve the commercial transportation industry, its approaches to opera-
tions, management, and planning significantly utilize and leverage information tech-
nologies. For this reason, a more comprehensive description of this company is found
One way of extending the logistics organization beyond the boundaries of the com- later in this section under the topic of information-based providers.
pany is through the use of a supplier of third-party or contract logistics services. The
following section provides some background information on how best to define this Warehouse/Distribution Based Traditionally, most warehouse/distribution-based
type of logistics provider and what services might be included. logistics suppliers have been in the public or contract warehousing business and have
Supply Chain Relationships 121
120 Chapter 4

service, and delivery cycle from a single application; and improved contract
expanded into a broader range of logistics services. Examples of such firms include
and relationship management. As of this writing, Nistevo was purchased by
Ozburn-Hessey Logistics, DSC Logistics, Saddle Creek Corporation, and Standard Sterling Commerce. 11
Corporation (now operating as UTi Integrated Logistics). Based on their traditional
orientation, these types of organizations already have been involved in logistics activi- Further details concerning information technologies and their applicability to logis-
ties such as inventory management, warehousing, distribution, and so on. Experience tics and supply chain management are discussed in Chapter 6: Supply Chain Technol-
has indicated that these facility-based operators have found the transition to integrated ogy-Managing Information Flows.
logistics services to be less complex than have the transportation providers.
3PL Market Size and Scope
This category also should include a number of 3PL firms that have emerged from
Table 4-2 contains an excerpt from a summary of specific shippers who were identified
larger corporate logistics organizations. Prominent among these are Caterpillar Logis-
by Armstrong & Associates, Inc., as utilizing multiple 3PLs. Based on Table 4-2,
tics Services (Caterpillar, Inc.), Intral Corporation (Gillette), and IBM Supply Chain
General Motors was ranked highest with 43 third-party providers of logistics services.
Management Services (IBM Corporation). These providers have significant experience
Other representative shippers using multiple 3PLs are also indicated.
in managing the logistics operations of the parent firm and, as a result, prove to be
very capable providers of such services to external customers. While the idea that a Indicated in Table 4-3 are estimates of the global 3PL industry revenues for the year
3PL firm may emerge from a corporate logistics organization is an interesting one, not 2005. As can be seen, the total revenues for North America of US $119 billion
all of these conversions have been commercially successful as a 3PL. represents about one-third of the total estimated global spending of US $370 billion.
Figure 4-6 provides a look at growth of the 3PL logistics market in the United States,
Forwarder Based This category includes companies such as Kuehne & Nagel, Fritz, where turnover growth has risen from US $30.8 billion in 1996 to an estimated US
C. H. Robinson, Hub Group, and UTi Worldwide that have extended their middleman $103.7 billion in 2005. Since many 3PL providers are "non-asset-based," another rele-
roles as forwarders and/or brokers into the broader range of 3PL services. Essentially, vant figure is "net" revenue, which is calculated as "gross" revenue minus the expense
these firms are nonasset owners, are very independent, and deal with a wide range of of purchased transportation and logistics services. Generally speaking, estimated net
suppliers of logistics services. They have proven quite capable of putting together third-party logistics revenues would be approximately 55 to 60 percent of the totals in-
packages of logistics services that meet customers' needs. dicated in Table 4-3 and Figure 4-6.
Financial Based This category of 3PL provider includes firms such as Cass Informa-
tion Systems (a division of Cass Commercial Corporation), CTC (Commercial Traffic
Corporation), GE Information Services (General Electric), AIMS Logistics, and Fleet-
lfaHie ll-2 Top Buyers of 3PL Services
Boston Financial Corporation. These firms provide services such as freight payment
and auditing; cost accounting and control; and logistics management tools for moni-
Rank Shippers Number of 3Pls Used
toring, booking, tracking, tracing, and managing inventory.
General Motors 43
Information Based At the time of the writing of this text, growth and development
of Internet-based, business-to-business, electronic markets for transportation and lo- 2 DaimlerChrysler 32
gistics services was significant. Since these resources effectively represent alternative
3 Ford Motor Company, Wai-Mart 30
sources for those in need of purchasing transportation and logistics services, they may
be thought of as a newer, innovative type of third-party provider. Examples of two 4 Volkswagen 28
firms that would be representative of this category are Transplace and Nistevo.
5 Hewlett-Packard 26
Transplace is an Internet-based company that represents the merger of the
3PL business units from six of the largest publicly held trucldoad carriers in 6 Unilever 24
the United States. The founding carriers are Covenant Transport, Inc.; J.B. 22
7 Procter & Gamble
Hunt Transport Services, Inc.; M.S. Carriers, Inc. (since merged with Swift
Transportation Co., Inc.); Swift Transportation Co., Inc.; U.S. Xpress Enter- 8 General Electric 21
prises, Inc.; and Werner Enterprises, Inc. Transplace offers a Web-enabled
platform to bring together shippers and carriers worldwide to collaborate on 9 Siemens 19
their transportation logistics planning and execution in the most efficient 17
10 BMW
and effective manner.
Nistevo is a recognized provider of an Internet-based, collaborative logistics 11 Georgia-Pacific, IBM, Nestle, Royal Philips Electronics, 16
network. Nistevo's collaborative network is an Internet service that allows Toyota Motor
shippers and carriers to collaborate to improve profitability and perfor- 12 Home Depot, Sara Lee 15
mance. Among the results experienced by both shippers and carriers through
use of Nistevo's capabilities are improved operating performance through Source: 3PL Market Overview (Stoughton, WI: Armstrong & Associates, Inc., 2006). Copyright 2006.
online, real-time network visibility; management of the entire procurement, Reproduced by permission.
Supply Chain Relationships 123
122 Chapter 4

was sponsored by Georgia Tech, Capgemini LLC, DHL, and SAP; it provides a com-
'l"aHie ~-3 Global 3PL Market-2005 prehensive look at the third-party logistics industry from the perspectives of customers
and users of third-party logistics services. 12 Specific study objectives are as follows:
Measure the development and growth of the 3PL industry across major in-
104 dustry segments and across several diverse regions of the world.
United States
Summarize the current use of 3PL services.
Canada and Mexico 15
Identify customer needs and how well 3PL providers are responding to those
119 needs.
Total North America
Understand how customers select and manage 3PL providers.
17 "Old Europe" Countries 133
Examine why customers outsource or elect not to outsource to 3PL
"New Europe," Russia, and Turkey 9 providers.
Investigate leading topics, including 3PL service offerings and capabilities,
Total Europe
technology enablement, structuring and managing effective 3PL relation-
Pacific Rim & Asia 85 ships, and how customers view success and value from 3PL relationships.
Understand contemporary issues relating to relationships between 3PLs and
South America customers and look into key issues relating to how 3PL services may be an
Africa, Middle East & Others 16 effective component of a well-functioning supply chain.
Provide a strategic assessment of the future of the 3PL industry.
Total Global 3PL Market 370
The principal vehicle for gathering customer perspectives was a survey sent via the
source: 3PL Market overview(Stoughton, WI: Armstrong & Associates, Inc., 2006). Copyright 2006.
Internet to the chief logistics executives at prominent companies in the following indus-
Reproduced by permission.
tries: automotive, chemical, consumer products, food and beverage, high-tech and elec-
tronics, industrial manufacturing/defense industry, life sciences and healthcare, retail,
and telecommunications. These industries were selected because they view logistics as
Figure ~-6 3PL Logistics Market Turnover Growth (US $Billion)
strategically important and are malting purposeful moves toward integrated supply chain
management. Figure 4-7 provides a map indicating the major geographies in which the
study was conducted. Included were North America, Europe, Asia-Pacific, and Latin
America. Last, a key element of the study methodology included holding workshops with
customers of 3PLs at Accelerated Solutions Environment (ASE) facilities operated by
Capgemini in Chicago, Illinois, and Paris, France. 13 An additional customer workshop
was held with key logistics executives in Shanghai, China.

$40 Figure ~-7 Eleventh Annual 3PL Study Geographic Areas Studied


1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: 3PL Market Overview(Stoughton, WI: Armstrong & Associates, Inc., 2006). Copyright 2006.
Reproduced by permission.

Third-Party logistics Research Study-

Industry Details
One significant research study, "Third-Party Logistics Study: Views from the
mers" is conducted on an annual basis by Dr. C. John Langley Jr. and Capgemm1,
Source: 2006 Eleventh Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission.
LLC.' The most recent of these, the 2006 Eleventh Annual Third-Party Logistics Study,
124 Chapter 4 Supply Chain Relationships 125

Figure 4-8 Overall Use of Third-Party logistics Service Providers-1996-2005 iraHie 4-4 Outsourced logistics Services


Transportation 83% 95% 95% 90%

Warehousing 74 74 74 54
Customs Clearance and Brokerage 74 54 84 64

Forwarding 54 54 64 14
Freight Bill Audit and Payment 54 24 14 14
Shipment Consolidation 44 54 54 34
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
Year Cross-Docking 34 44 34 14
Ill North America D Western Europe Ill China/Asia-Pacific Reverse Logistics 24 44 34 34
IIlilJ Latin America !!South Africa Transportation Management 24 34 44 14

Source: 2005 Tenth Annual 3PL Study, Georgia Tech and Capgemini LLC. Used with permission. Product Labeling, Packaging, Assembly, Killing 24 44 34 24
Supply Chain Consulting Services Provided by 3Pls 24 14 14 14
Order Entry, Processing, and Fulfillment 14 14 14 14
Profile of logistics Outsourcing Activities Fleet Management 14 24 24 34
Overall Use of 3Pls The use of 3PL services is significant in the regions of the world LLP/4PL Services 14 14 4 14
that were studied. Figure 4-8 provides a 10-year profile of the firms using 3PL ser-
vices.14 Between 1996 and 2001, the percentage of 3PL users remained relatively con- Customer Service 4 4 14 14
stant among North American respondents (between 68% and 73%). Between 2002 and Source: 2006 Eleventh Annual 3PL Study, Georgia Tech and Capgemini LLC. Used with permission.
2005, the percentage of North American users showed modest growth coupled with
some stability. In the three most recent years of survey data, the percentage of firms
using 3PL services in Western Europe has been between 76 percent and 79 percent. In
Asia-Pacific, 3PL use for the past two years has been 84 percent in 2004 and 83 percent customer preferences in certain situations for a single-source solution or a "lead logis-
in 2005. Based on two years of 3PL usage data from Latin America, outsourced logis- tics manager" role to the provision of integrated logistics services.
tics services here are less prevalent than in the other regions.
Views of Noncustomers To help better understand those who were not among the
logistics Activities Outsourced Table 4-4 summarizes the use of specific logistics users of 3PL services, the study asked a number of questions regarding their choice not
services that were reported as being outsourced by respondents in the various regions to be so involved. Table 4-5 profiles their responses. Based on these figures, the most
studied in 2006. Based on this information, the logistics services most frequently out- important reason that organizations have elected not to outsource logistics services is
sourced are those that are more operational, transactional, and repetitive in nature. the belief that logistics is a "core competency" at those organizations. Other reasons in-
Looking at the results over all of the regions studied, the most frequently outsourced clude the belief and/or expectations that cost reductions would not be realized, control
services include transportation (90%), warehousing (74%), customs clearance and bro- over outsourced function(s) would diminish, service level commitments would not be
kerage (70%), and forwarding (54%). The responses to this question provide support realized, and they have more logistics expertise than the 3PL providers.
that the services that are outsourced less frequently tend to be customer related, in-
volve the use of information technology, and are more strategic in nature. Interestingly, and as reported in earlier years, many existing customers of 3PLs have
been satisfied with such relationships because they help to improve (rather than di-
A strategic issue is how customers feel that 3PLs should position themselves in minish) control over certain outsourced activities. Also prevalent among the reasons
terms of depth and breadth of service offerings. Based on findings reported over recent not to outsource is the belief that firms can perform internally at least as effectively as
years of the study, users of 3PL services indicate significant agreement with the state- would be expected of a 3PL. If this assertion is true, then the choice of not using a 3PL
ment that "third-party suppliers should provide a broad, comprehensive set of service is understandable. The results from user firms, however, document that, although
offerings" and disagreement with the statement that "third-party suppliers should there is room for improvement, users historically have been satisfied with 3PLs, both
focus on a limited range of service offerings." This suggests the continued relevance of from ~ co~t :tnr1 from !l ~PrvirP viPlilrloint
126 Chapter 4
Supply Chain Relationships 127

Table 4-5 Non-user Respondents' Rationale for Not Using 3Pl Services*
Table 4-6 Current-Future IT-Based Services (North America Results)

OVERALL NORTH AMERICA EUROPE ASIA-PACIFIC Functionality Currently Used Future Needs
logistics is a core competency at our firm 38% 51% 30% 42% Warehouse/Distribution Center Management 65% 17%
Cost reductions would not be experienced 34 34 24 24 Web-Enabled Communications (3PL-User) 61 28
Control over outsourced function(s) would diminish 24 44 14 24 Visibility Tools (e.g., tracking/tracing; event management) 60 29
Service level commitments would not be realized 24 24 14 24 Transportation Management (Execution) 55 21
We have more logistics expertise than 3Pl providers 24 24 14 34 Transportation Management (Planning) 31 32
logistics too important to consider outsourcing 14 14 24 14 Supplier Relationship Management (e.g., procurement; payables) 30 26
Corporate philosophy excludes outsourcing logistics 14 14 14 14 Customer Order Management 25 21
Global capabilities of 3Pls need improvement 4 14 14 4 Collaboration Tools (e.g., inventory levels; production schedules) 25 35
Inability of 3Pl providers to form meaningful and trusting relationships 4 4 14 4 Internet-Based Transportation/logistics Exchanges 23 31
Issues relating to security of shipments 4 4 4 4 Yard Management 22 16
Source: 2006 Eleventh Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission.
*Latin America results insufficient for meaningful analysis. Supply Chain Planning (e.g., forecasting; inventory planning) 19 30
Customer Relationship Management 17 25

Strategic Role of Information Technology RFID (radio-frequency identification and asset tracking) 13 57

A major objective of the 2006 study was to gain further insight into customer needs for Source: 2006 Eleventh Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission.
information technology-based services, as well as evaluating how 3PLs are responding.
Considering the importance of information technology to supply chain management
in general, this topic also is of great relevance to the topic of supply chain relationships Management and Relationship Issues
and the use of 3PLs.
The need for competency as it relates to the formation and continuation of successful
Table 4-6 provides a look at the currently used and future needs for IT -based relationships has become critical in today's 3PL industry. Although both providers and
services among 3PL users in North America. As indicated, the most currently used users of 3PL services have been improving in their ability to create more productive,
services include warehouse/distribution center management (WMS), web-enabled com- effective, and satisfying business relationships, the media is replete with examples of
munications, visibility tools (e.g., tracking/tracing, event management), and transpor- failed relationships. Then, the important question is "what can we do to improve in
tation management-execution (TMS). Looking at the future requirements for this area?"
technology-based services, the ones in greatest need for enhanced availability are RFID An interesting finding from one of the earlier year's studies 15 was that the chief ex-
(i.e., radio-frequency identification and asset tracking), collaboration tools (e.g., inven- ecutive in the logistics area is the one who clearly is most aware of the need for 3PL
tory levels, production schedules), supply chain planning (e.g., forecasting, inventory services. While available evidence supported the fact that the president or CEO and
planning), and visibility tools (e.g., tracking/tracing, event management). the finance executive are many times involved with the identification of the need for
Although the results of recent studies suggest that customers would like to look to such services, executives from other areas such as manufacturing, human resources,
their 3PLs for leadership in information technology, any existing shortcoming may be marketing, and information systems are also aware of such needs but to a lesser degree.
due to the fact that they do not perceive the 3PL sector to be as involved or as strong in Looking specifically at the task of implementing a 3PL relationship, however, it was
this area as the technology providers themselves. While this may be true in certain in- apparent that information systems executives are becoming increasingly involved. This
stances, many 3PLs are using the technology area to distinguish themselves from their is not surprising, considering the key role of IT in many of today's logistics and supply
competitors. For example, the availability of competent transportation management chain processes.
software and/or warehouse management software from 3PLs is something that may be A very insightful topic is that of the "selection" factors that are important to custo-
expected. This is particularly relevant, considering a finding of recent years' studies mers as they choose 3PLs which they want to work. Based on the results of the 2006
that "having the 'right' software" is a major competitive advantage for a 3PL. When Eleventh Annual 3PL Study, the two most prevalent 3PL selection factors were price of
asked about their overall satisfaction with the software and IT support available from 3PL services and quality of tactical, operational logistics services. Based on all of the
3PLs, most users indicate that improvement is needed.
2006 study responses, 87 percent of respondents indicated that price was a factor, and
128 Chapter4 Supply Chain Relationships 129

Supply Chain 3PLs Need to Fill an Table 4-7 Expectation Setting Relative to 3PL Relationship Management
Technology Expanded Role in Today's
Supply Chains
Superior service and execution (proven results Mutually beneficial, long-term relationship with

T hose who manage logistics and supply chain services are increasingly asking about what
the right 3Pl service would be for outsourcing certain supply chain processes or functions.
and performance)
Trust, openness, and information sharing
Trust, openness, and information sharing
Interestingly, many of these concerns relate less to traditional logistics needs such as trans- Solution innovation and relationship Dedicating the right resources at the right levels,
portation and warehousing, and more to key changes such as the following: reinvention including executives
Supply chains are increasingly global in scope. Ongoing executive-level support Clearly defined service-level agreements
" Inventory optimization strategies have stretched beyond single corporation bound- Service offering aligned with customer Fiduciary responsibility and overall fairness relative
aries to include partners and customers working in cooperation. strategy and deep industry knowledge to pricing

Business process outsourcing (BPO) of noncore functions has executive

Source: 2005 Tenth Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission.
last year's global trade management research indicated that more than 90 percent of
companies surveyed relied on outsourced logistics providers to execute their global logistics 85 percent indicated that quality of service was a factor. Looking beyond these two se-
needs. Their high degree of outsourcing reliance for deep competency and capable technologies lection criteria, others that were of greater importance included geographic presence in
to manage more complex logistics problems will likely spread to adoption of outsourcing in required regions (75%), expected capability to improve service levels (67%), range of
other areas of supply chain management. Also, companies reporting "far-shore" outsourcing available value-added logistics services (63%), and capable information technologies
want to make sure that "total landed costs" continue to be attractive. As an example, consider (60%).
the popular high-end consumer electronics company that regularly expedites a particular high- Also, successful 3PL relationships establish appropriate roles and responsibilities for
selling product from Asia because of inaccurate forecasting and the long lead times of its both 3PLs and client firms. While sometimes the use of a 3PL is interpreted simply as
Asian supply chain. The rub? The product cost is $100 per unit, and the expediting costs are "turning over all logistics activities" to an outsourced provider, respondents to recent
$80 per unit.
years' studies suggested that a "hybrid" management structure represents a highly effec-
For more than a decade, companies have been using advanced supply chain planning tive way to manage 3PL relationships. Essentially, this reflects a desire on the pmi of the
techniques and technologies to reduce inventory. Today, the best performing companies are client firm to have sufficient power over operations for a track record of performance or
able to sense and respond to demand much more frequently, with just the right amount of in- "trust" factor to be built up. Although most client firms (appropriately) retain control
ventory across a multi-tier supply chain network. As a result, 3Pls are being called upon more over strategy formulation and direction setting for the logistics areas of responsibility, this
frequently to help customers respond to these challenges. hybrid approach to the management of operations is an innovative response to the
Also, it is reasonable to expect that the increasing prevalence of business process o~t challenge of successfully managing 3PL-client relationships. Table 4-7 provides a useful
sourcing should make logistics an even more attractive candidate for outsourcing. By studying summary of some of the expectations that 3PLs and their customers have of each other.
the positioning that other BPO companies use and modifying the pitch, 3Pls should be able to Last, an important issue relates to how customers think of their 3PLs. Based on re-
form stronger, higher-level strategic relationships with their corporate customers. sults from the 2006 study and as shown in Figure 4-9, approximately two-thirds of the
Many companies are transforming their logistics departments into a global corporate lo- customers think of their 3PLs as providers of tactical or operational services, while ap-
gistics services function. But international logistics over the next five to seven years is set to proximately one-third think of them as strategic or integrative. While there may be a
explode, with global logistics dramatically increasing compared to what is predominantly do- temptation to think that the strategic or integrative relationships are superior to or
mestic today. Global logistics outsourcing should remain high or possibly even increase as more advanced than the former, the fact is that the best relationships are ones that
companies are not eager to take over the detailed management of logistics from or to all come closest to meeting the logistics and supply chain needs of the customer and of
stretches of the globe. With the steady growth of outsourcing, corporate logistics departments the provider. While there are some very excellent relationships that are strategic or in-
will have to change to manage increased outside parties and global processes without losing tegrative in nature, there also are some very excellent examples of relationships that are
control and while increasing visibility. This will involve use of technological advances and more tactical or operational, and that conform very closely to the stated needs and require-
seamless integration between companies and their suppliers, and customers and their ments of the customer.
Source: Adapted from Greg Aimi, "3Pls Need to Fill an Expanded Role in Today's Supply Chains,"
Customer Value Framework
AMR Research, November 9, 2006. Reproduced by permission of AMR Research. Generally, 3PL users across the several regions studied characterized their outsourcing
efforts as having been successful. This is supported by the information contained in
Figure 4-10 that provides a 10-year perspective on the percentages of 3PL users in vari-
ous regions that rated their 3PL services as being either "extremely" or "somewhat"
130 Chapter 4 Supply Chain Relationships 131

Figure 4-9 Customers' Perspectives on 3PL Relationships FaHie 4-8 Average Customer Results from Use of Third-Party Logistics Providers

2/3 Thought of as "Tactical" CosVBenefit North America Western Europe Asia-Pacific Latin America

Logistics cost reduction 10% 11% 14% 12%

Fixed logistics asset reduction 13% 22% 22% 37%

Average order-cycle length change (days) From ll.Oto8.4 From 10.1 to 6.5 From 15.7 to 13.9 From 14.9 to 10.0

Service level improvement (percent "yes") 62% 67% 64% 77%

Source: 2006 Eleventh Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission. Service-level improvement figures taken from
2005 Tenth Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission.

Tactical service Logistics Supply chain

provider strategist integrator were discussed in further detail in the section entitled "Management and Relationship
II North America 0 Western Europe !lill Asia-Pacific Ill Latin America Respondents in recent studies reported experiencing a number of problems. Cate-
gorically, their responses tended to focus on several key areas of concern as follows:
Source: 2005 Tenth Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission.
Service-level commitments not realized
Time and effort spent on logistics not reduced
Cost reductions have not been realized
Cost "creep" and price increases once relationship has commenced
Customer Evaluations of Outsourcing (Percent Successful-Yearly Unsatisfactory transition during implementation stage
Figure 4-10 Comparisons) Inability to form meaningful and trusting relationships
Lack of ongoing improvements and achievements in offerings
Lack of strategic management and/or consultative/knowledge-based skills
Lack of global capabilities
This list should be viewed as a starting point for continuous improvement by 3PL
providers. Overall, it suggests a need to meet service-level and cost objectives and to
avoid unnecessary increases in price to the customer once the relationship has com-
menced. Also, it appears that some 3PLs need to improve in the areas of strategic man-
agement, technology, and knowledge-based skills. These suggest expectations by the
customers that currently are not being met. Finally, some users of 3PL services feel that
the time and effort spent on logistics have not decreased and that their control over the
outsourced function may have lessened. In the latter instance, the previously discussed
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 move to "hybrid" management of the 3PL's responsibilities may be a useful
Year alternative.
II North America 0 Western Europe ! Asta-Pacific II Latin America
logistics Strategic View and the Role of 3Pls
One major accomplishment of the past 10-15 years has been establishing the validity
Source: 2005 Tenth Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission.
of the logistics outsourcing model and specifically of the 3PL provider. As we look to
the future, we already see increasing acceptance of the 4PL model, likely growth in ex-
penditures by current users of 3PL services, and a growing sophistication in the out-
In addition, participating executives provided continuing evidence of logistics and sourced business approaches that respond to a dynamic set of customer logistics and
supply chain metrics that provide tangible documentation of the benefits they have supply chain needs.
experienced from the use of 3PL services. Examples of these metrics are included in
Table 4-8. Again in 2006, however, the survey respondents highlighted a number of Fourth-Party Relationships Although it has been around for some time, the concept
areas where improvement in their 3PL relationships would be desirable. These topics a "fourth-party logistics" (4PL) provider is becoming more evident in the business
132 Chapter 4 Supply Chain Relationships 133

world. 16 Essentially a supply chain integrator, a 4PL may be thought of as a firm that
"assembles and manages the resources, capabilities, and technology of its own organi- Figure 4-12 Current vs. Projected Logistics Expenditures Directed to Outsourcing
zation with those of complementary service providers to deliver a comprehensive sup-
ply chain solution." 17 As suggested by Figure 4-11, a 4PL leverages the capabilities of
3PLs and suppliers of technology-based services through a centralized point of contact.
In one sense, an important role of the 4PL is to manage and direct the activities of
multiple 3PLs. In another, more strategic role, the 4PL serves as the integrator that
brings together the needs of the client and the resources available through 3PL provi-
ders, the IT providers, and the elements of business process management.

Expected Growth in Customers' Use of 3PL Services One way to look at the
future plans for outsourcing is to ask users of 3PL services to estimate the expected three-
to five-year growth rate of outsourcing expenditures as a percent of overall logistics expen-
ditures. Based on the results for 2006 as shown in Figure 4-12, the average percentage in-
creases expected in the next three to five years would be 17 percent in North America, 11
North America Western Europe Asia-Pacific Latin America
percent in Western Europe, 11 percent in Asia-Pacific, and 20 percent in Latin America.
2006 0 2009-2011
Logistics Outsourcing Model for the Future Figure 4-13 suggests a possible future
direction for the further development of logistics outsourcing models. Starting with the
Source: 2006 Eleventh Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission.
proprietary provision of logistics services, or insourcing, at the bottom of the diagram,
the model evolves through several successive stages. Included are basic services (e.g.,
transportation, warehousing, etc.), value-added or third-party logistics services, lead lo-
gistics or 4PL services, and advanced services. The diagram also identifies key attri-
butes for each of these stages and specifies a typical geographical coverage for each of
the stages.

Figure 4-13 Next Generation of Logistics Outsourcing Models?

Figure 4-11 Fourth-Party Logistics*
Key Attributes Geographic CoFerage
+ Greater Functional Integration
+ Broader Operational Autonomy Speed oflmplementation
Knowledge Transfer
Shared Risk & Reward
', 1990s-2000s
Project Management an-Regional Integrators
Single Point of Contact

Enhanced Capabilities
Broader Service Offerings

Resident Client nfrastructure

Insourcing Knowledge

Source: Accenture, Inc. Used with permission. Registered Trademark of Accenture, Inc. Source: 2005 Tenth Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission.
Supply Chain Relationships
134 Chapter 4

Future 3PL Industry Trends The two most basic types of supply chain relationships are "vertical" (e.g., buyer-
seller) and "horizontal" (e.g., parallel or cooperating).
Continued expansion, acquisition, and consolidation IT capabilities to become an even greater In terms of intensity of involvement, interfirm relationships may span from transa~
of 3PL industry differentiator tional to relational and may take the form of vendor, partner, and strategiC
Expansion of global markets and needed services Increased efforts to update, enhance, and improve alliances.
3PL provider-user relationships There are six steps in the development and implementation of successful relatio~
Continued broadening of service offerings across
supply chain, and broad-based business process Emphasis on relationship reinvention, mechanisms ships. These six steps are critical to the formation and success of supply cham
outsourcing for continual improvement, and solution
Two-tiered relationship models (strategic and tactical) Collaborative relationships, both vertical and horizontal, have been identified as
Growing range of "strategic" services offered by highly useful to the achievement of long-term supply chain objectives. The "Seven
3Pls and 4Pls Immutable Laws of Collaborative Logistics" provide a framework for the develop-
ment of effective supply chain relationships.
Source: 2005 Tenth Annua/3PL Study, Georgia Tech and Capgemini LLC. Used with permission.
Third-party logistics providers may be thought of as an "external supplier that pe~
forms all or part of a company's logistics functions." It is desirable that these suppli-
ers provide multiple services and that these services are integrated in the way they
To conclude the discussion of outsourced logistics services as a key element of sup- are managed and delivered.
ply chain relationships, Table 4-9 identifies a number of trends that seem to character- The several types of 3PLs are transportation-based, warehouse/distribution-based,
ize the future direction of the 3PL sector. Regardless of how quickly these trends forwarder-based, financial-based, and information-based suppliers.
become apparent, the topic of logistics outsourcing is likely to be central and critical to Based on the results of a comprehensive study of users of 3PL services in the United
the future successes of logistics and supply chain management. States, over 70 percent of the firms studied are, to some extent, users of 3PL
User experience suggests a broad range of 3PL services utilized; the most prev~lent
are transportation, warehousing, customs clearance and brokerage, and forwardmg.
While nonusers of 3PL services have their reasons to justify their decision, these
same reasons are sometimes cited by users as justification for using a 3PL.
Customers have significant IT -based requirements of their 3PL providers, and they
feel that the 3PLs are attaching a priority to respond to these requirements.
Approximately two-thirds of the customers suggest 3PL involvement in their global
supply chain activities.
Although most customers indicate satisfaction with existing 3PL services, there is no
shortage of suggestions for improvement.
Customers generally have high aspirations for their strategic use of 3PLs and con-
sider their 3PLs as keys to their supply chain success.
There is a growing need for fourth-party logistics 18 relationships that provide a wide
range of integrative supply chain services.

1. What are the basic types of supply chain relationships, and how do they differ?
2. How would you distinguish between a vendor, a partner, and a strategic alliance?
What conditions would favor the use of each?
3. What does it take to have an area of "core competency"? Provide an example.
4. Describe the steps in the process model for forming and implementing successful
supply chain relationships. What step(s) do you feel is (are) most critical?
5. What are some of the more common "drivers" and "facilitators" of successful sup-
ply chain relationships?
136 Chapter 4 Supply Chain Relationships 137

6. What is meant by "collaboration" between supply chain organizations? What are 11. See
the different types of collaboration?
12. C. John Langley Jr., Capgemini LLC, DHL, and SAP, 2006 Eleventh Annual Third-Party Logistics
7. What are the basic types of 3PL firms, and which are in most prevalent use? Study. Information concerning this study and a download of the final report is available at http:// This report provides details concerning the results and findings from the elev-
8. What are some of the more frequently outsourced logistics activities? Less fre- enth annual study. Certain items of relevant information from earlier versions of the same study are
also included from time to time.
quently outsourced?
13. Additional information concerning the Accelerated Solutions Environment (ASE) operated by Cap-
9. Why do some firms choose not to use the services of 3PL firms? gemini may be found in the 2006 Eleventh Annual Third-Party Logistics Study, available at http://
10. In what ways are clients/customers counting on 3PLs for involvement with infor-
mation technology-based services? 14. Results shown in Figure 4-8 are from 2005 Tenth Annual 3PL Study, Georgia Tech, Capgemini
LLC, DHL, and SAP.
11. To what extent are clients/customers satisfied with 3PL services? What is the rela-
15. C. John Langley Jr., Brian F. Newton, and Gary R. Allen, Third-Party Logistics Services: Views from
tive importance of cost, performance, and value creation as determining factors the Customers (Knoxville, TN: University of Tennessee, 2000). This report includes the results and
for evaluating and selecting 3PLs? findings from the fifth annual version of this comprehensive study.

12. To what extent do clients/customers think of their 3PL providers in a strategic 16. 4PL and fourth-party logistics are registered trademarks of Accenture, Inc.
sense? What evidence suggests that this may change in the future, and what kind
17. Accenture, Inc., by permission.
of change may be expected?
18. Trademark, Accenture, Inc.
1. Robert V. Delaney, 11th Annual State of Logistics Report (St. Louis, MO: Cass Information Systems,
June 5, 2000).

2. Rosabeth Moss Kanter, "Collaborative Advantage: The Art of Alliances," Harvard Business Review
(July-August 1994).

3. Douglas M. Lambert, Margaret A. Emmelhainz, and John T. Gardner, "Developing and Implement-
ing Supply Chain Partnerships," The International Journal of Logistics Management?, No.2 (1996):
1-17. The content of this section relating to drivers and facilitators has been quoted from this excel-
lent research article.

4. Ibid., 4-10.

5. Ibid., 10.

6. Ibid., 10-13.

7. For an overview of collaborative logistics, see C. John Langley Jr., "Seven Immutable Laws of Col-
laborative Logistics," 2000 (white paper published by Nistevo, Inc.).

8. Ibid., 4.

9. Ibid., 2.

10. For further information, see Armstrong & Associates, Inc., Who's Who in International Logistics:
Armstrong's Guide to Global Supply Chain Management, 13th ed. (2005); C. John Langley Jr., et
a!., Eleventh Annual Third Party Logistics Study: Views from the Customers (Georgia Tech and Cap-
gemini LLC, 2006); Robert Lieb, Brooks Bentz, and Richard O'Meara, "Insights, Innovations in
Third-Party Logistics from Accenture, Northeastern University," Global Logistics & Supply Chain
Strategies (January 2006): 16-21; Robert Lieb, "The 3PL Industry: Where It's Been and Where It's
Going," Supply Chain Management Review 9, No. 2 (September 2005) 20-27; Robert Lieb and
Brooks Bentz, "The Use of Third-Party Logistics Services by Large American Manufacturers: The
2004 Survey," Transportation Journal44, No.2 (2005): 5-15; Bryan Ashenbaum, Arnold Maltz,
and Elliot Rabinovich, "Studies of Trends in Third-Party Logistics Usage: What Can We Conclude?"
Transportation Journal44, No. 2 (Summer 2005): 39-50; Thomas A. Foster, "The Trends Chang-
ing the Face of Logistics Outsourcing Worldwide," Global Logistics & Supply Chain Strategies (June
2004); Yemisi A. Bolumole, "Evaluating the Supply Chain Role of Logistics Service Providers," In-
ternational Journal of Logistics Management 14, No.2 (2003): 93-107; Harry L. Sink and C. John
Langley Jr., "A Managerial Framework for the Acquisition of Third-Party Logistics Services," Journal
of Business Logistics 18, No.2 (1997): 163-190; and C. John Langley Jr., Brian F. Newton, and
Gene R. Tyndall, "Third-Party Logistics: Has the Future Already Arrived?" Supply Chain Manage-
ment Review3, No.3 (Falll999): 85-94.
0 Chapter 4

CASE 4-2 Chapter 5

Ocean Spray Cranberries, Inc.
August is typically a challenging month for Ocean Spray Cranberries, Inc., when the SUPPLY CHAIN PERFORMANCE MEASUREMENT
Lakeville, Massachusetts-based firm has to pump up volume to meet the surge in de-
mand for the upcoming holiday season. Ocean Spray is an agricultural co-op owned by
more than 750 citrus growers in the United States and Canada. The company produces
canned and bottled juice, juice drinks, and food products at distribution centers in
Bordentown, New Jersey; Kenosha, Wisconsin; Sulphur Springs, Texas; and Hender- learning Objectives
son, Nevada.
After reading this chapter, you should be able to do the following:
Ocean Spray was managing its transportation operations internally, but the com- Understand the scope and importance of supply chain performance
pany decided it wanted to focus on its core competency, which, according to its direc- measurement.
tor of logistics, was "maintaining our leadership in the shelf-stable juice drink
Explain the characteristics of good performance measures.
category." The company also wanted to centralize its transportation operations. Look-
ing carefully at the issue of overall performance in the logistics and transportation Discuss the various methods used to measure supply chain costs, service,
areas, a significant amount of variability was found ~n its operations. For purposes of prof1t, and revenue.
uniformity and control, a major priority was attached to centralization of its logistics Understand the basics of an income statement and a balance sheet.
operations. Demonstrate the impacts of supply chain strategies on the income statement,
balance sheet, profitability, and return on investment.
In addition, Ocean Spray wanted to be able to reach markets for which it did not al-
ready have access, which would require expansion of its logistics network According Understand the use of the strategic profit model.
to the director of logistics, an analysis was undertaken to study how long it would take Analyze the financial impacts of supply chain service failures.
and what it would cost to build up Ocean Spray's transportation capabilities to be able Utilize spreadsheet computer software to analyze the financial implications
to support such a network As a result, a recommendation was made to seriously inves- of supply chain decisions.
tigate the use of a third-party logistics (3PL) provider.

1. What rationale is offered by Ocean Spray in support of the idea of using a 3PL? Do
you agree with the reasons cited for the interest in a 3PL?
2. Based on your understanding of Ocean Spray and its business needs, what type of
3PL firm do you feel might be of greatest potential value in terms of a
3. What steps would you suggest be considered by Ocean Spray as it begins to analyze
the feasibility of forming a relationship with individual 3PL providers?
4. Once the selection process is complete, what kind of relationship do you feel would
be most appropriate: vendor, partner, strategic alliance, or some other option?
Source: Adapted from Adrienne Breiner, "Outsourcing Helps to Take Squeeze Out of Surge," Food Logistics (April
15, 1999): 62.

Supply Chain Performance Measurement and Financial Analysis 143
Chapter 5

Prior to the supply chain operating managers' meeting, Ms. Fish bay received the following
SupplyChain CLGNBook 2007 fmanc1al mformatJOn from Tracie Shannon,
CLGN Book (CLGN) is a new Internet company that began operation in 2001 CLGN Book
for the sale and distribution of college textbooks and supplies. During the first few years, CLGN
struggled with the normal technical glitches associated with an Internet-based company, but
the concept of online purchasing of college textbooks proved immensely popular with college Sales $150,000,000
students. After obtaining information as to the textbook(s) required for a course, the students
would use their computers to place their orders, avoiding the dreaded long lines at the campus Cost of goods sold 80,000,000

bookstore. Gross margin $ 70,000,000

CLGN's original mission was to be a low-price seller of college textbooks and
Transportation $ 6,000,000
instructional materials in the United States. The typical textbook price at CLGN averaged
15 percent below that of the local bookstore, and supplies averaged 20 percent lower. Warehousing 1,500,000
When the cost of shipping was included, the landed cost of the textbook was about 10
Inventory carrying 3,000,000
percent lower and materials 15 percent lower than purchases at the local bookstore. This
lower cost and the convenience of online purchasing resulted in double-digit sales Other operating cost 30,000,000
increases every year.
Total operating cost 40,500,000
Beginning in 2002, CLGN made a profit and has done so every year since then. In
2007, CLGN had sales of $150 million with a net income of $10.5 million. This net profit mar- Earnings before interest and taxes $ 29,500,000
gin of 7 percent was above average for business-to-consumer (B2C) Internet companies. How-
Interest 12,000,000
ever, net income as a percent of sales, or net profit margin, was lower than in the previous
years. In 2005, net profit margin was 10.3 percent, and in 2006, it was 9.1 percent This de- Taxes 7,000,000
creasing profit margin trend was causing considerable concern with top management and
Net income $ 10,500,000
CLGN's stockholders.
Following release of the 2007 financial data, Ed Bardi, CEO, held a meeting with
the executive committee consisting of the vice presidents of marketing, finance, infor- CLGN Book
mation systems, and supply chain management After reviewing the 2007 financial
results and discussing the underlying causes for the lower net profit margin, each vice BALANCE SHEET 2007
president was given the assignment of examining his/her respective area for process
changes that would remove costs while maintaining the same level of service customers
expected. Cash $ 15,000,000
Particular attention was given to the supply chain area because supply chain cost Accounts receivable 30,000,000
increases exceeded those in other areas of the company. Dr. Bardi also pointed out that
during the past year he had been receiving complaints from irate customers regarding Inventory 10,000,000
late deliveries of orders and receipt of improperly filled orders (wrong items or not all Total current assets $ 55,000,000
items ordered). Lauren Fishbay, vice president of supply chain management, said she was
aware of these problems and was working on solutions for order fulfillment problems as Net fixed assets 90,000,000
well as the escalating shipping costs. She said her area was developing plans to transi-
Total assets $145,000,000
tion from measuring orders shipped on time and orders shipped complete to measuring
the perfect order (orders received on time, orders received complete, and accurate Liabilities
documentation). Current liabilities $ 65,000,000
Following the executive committee meeting, Ms. Fish bay gathered her operating man-
agers to review the situation and explore alternatives. She asked Tracie Shannon, supply longwterm debt 35,000,000
chain analyst, to prepare financial data measuring the supply chain process. Sharon Cox, Total liabilities $100,000,000
warehouse manager, was asked to examine the nature and cause of the order fulfillment
problems and to suggest solutions. Finally, Sue Purdum, transportation manager, was Stockholders' equity 45,000,000
charged with examining the rising transportation costs and longer, and less reliable, delivery Total liabilities and equity $145,000,000
Supply Chain Performance Measurement and Financial Analysis 145
Chapter 5

Ms. Shannon determined that the inventory carrying cost rate was 30 percent of the value of
Dimensions of Supply Chain Performance Metrics
the average inventory held per year. The corporate tax rate was 40 percent. Total orders in Before beginning a discussion of the dimensions of supply chain metrics, it is impor-
2007 amounted to 1.5 million ($150 million in sales at an average sale per order of $100). She tant to answer two questions. First, what is the difference between a measure and a
estimated the lost sales rate to be 10 percent of the service failures caused by late transporta- metric? Traditionally, the term measure was used to denote any quantitative output of
tion delivery and 20 percent of the service failures caused by improper order fulfillment. The an activity or process. Today, the term metric is being used more often in place of the
cost of a lost sale per order is the gross profit per order, or $46.67 ($70 million gross margin term measure. What is the difference? A measure is easily defined with no calculations
divided by 1.5 million orders). and with simple dimensions. Supply chain examples would include units of inventory
and backorder dollars. A metric needs definition, involves a calculation or is a combi-
Sharon Cox concluded that the cost of a service failure, whether caused by order fulfill-
nation of measurements, and is often a ratio. Supply chain examples would include in-
ment or delivery problems, resulted in an invoice reduction of $10 per order (to appease the
ventory future days of supply, inventory turns, and sales dollars per stock-keeping
customer) and a rehandling cost of $20 per order (to reship the order). Currently CLGN's order
unit. 1
fill rate is 97 percent. The causes of the improper order fulfillment could be attributed to the
lack of warehouse personnel training. ln the current economic environment, it is very difficult to Second) what are the characteristics of a good metric? Figure 5-1 is an excellent
obtain experienced warehouse workers, and many of the current warehouse employees do not framework that can be used to determine the characteristic of a good metric. Several
have a high school diploma. Other problems could be traced to a lack of discipline regarding questions need to be asked to determine if 3. metric is appropriate for its intended use.
order-picking procedures and the computer-generated pick slip. At least $100,000 was required A short discussion of the 10 characteristics in Figure 5-1 is necessary here to lay the
annually for ongoing training. foundation for the remainder of this chapter.
Sue Purdum traced the escalating transportation costs to the 35 percent increase in resi-
dential delivery rates charged by CLGN's ground delivery carrier for standard service (three to
five days transit time). The residential delivery rates charged by other ground express carriers
Figure 5-1 1 Characteristics of Good Measures
were comparable or higher. An alternative to reducing transportation costs was to switch to the
U.S. Postal Service, but delivery times would increase and become less reliable. However,
CLGN's current on-time delivery pertormance is only 95 percent because of the longer order
processing times at the warehouse and longer transit times via the ground package carrier to Is quantitative The measure can be expressed as
an objective value.
residential delivery locations. By using the carrier's expedited ground service, CLGN could
improve service and on-time delivery to 96 percent and increase transportation costs by 10
Is easy to understand The measure conveys at a glance
what it is measuring and how it
percent. is derived.
Given this information, Lauren Fishbay was pondering what actions she should explore Encourages appropriate behavior The measure is balanced to reward
productive behavior and discourage
with the operating managers in preparation for the next executive committee meeting. She
"game playing."
knew whatever course of action she proposed had to be financially sound and provide the
Is visible The effects of the measure are
greatest benefit to CLGN's stockholders. readily apparent to all involved in
the process being measured.
Is defined and mutually understood The measure has been defined by
and/or agreed to by all key process
participants (internally and externally).
Encompasses both outputs and The measure integrates factors from
Introduction inputs all aspects of the process measured.
The CLGN Book case highlights the need for all organizations to be Measures only what is important The measure focuses on a key
performance indicator that is of real
able to measure supply chain performance and link that performance to its impacts on
value to managing the process.
financial performance. Many organizations today have realized that performance
Is multidimensional The measure is properly balanced
metrics are critical to managing the business and achieving desired results. Many orga- between utilization, productivity, and
nizations want to do the "right things" (effectiveness) and do them "right" (efficiency). performance and shows the tradeoffs.
However, simply stating those two objectives is not adequate unless they have spec~fic, Uses economies of effort The benefits of the measure outweigh
measurable metrics that enable the organization to gauge whether or not these obJeC- the costs of collection and analysis.

tives are achieved. Facilitates trust The measure validates the

participation among the various
The purpose of this chapter is to (1) introduce the dimensions of supply chain parties.
performance metrics, (2) discuss how supply chain metrics are developed, (3) offer
Source: J. S. Keebler, D. A. Durtsche, K. B. Manrodt, and D. M. Ledyard, Keeping Score: Measuring the
some methods for classifying supply chain metrics, and (4) use quan!ltat1ve tools
Business Vafue of Logistics in the Supply Chain (University ofTennessee, Council of Logistics Management,
to show how these metrics can be linked to the financial performance of the 1999), p. 8. Reproduced with permission from Council of Supply Chain Management Professionals. .

146 Chapter 5
Supply Chain Perfo~mance Measurement and Financial Analysis

The first question to be asked about a metric is, "Is it quantitative?" While not all
metrics are quantitative, this is usually a requirement when measuring the outputs of This is wher~ the terms scorecard and key performance indicators (KPis) will apply.
processes or functions. Qualitative performance metrics are better suited for measuring Many orga~IZah?ns will have a few strategic metrics to manage their supply chains.
perceptions or assigning products or people to categories (e.g., excellent, good, poor). These metncs will :epres~nt productivity, utilization, and performance in a balanced
approach to managmg their supply chain processes. 5
Qualitative metrics are backed up with quantitative data. For example, a transportation
carrier might be rated "excellent" if it has only one late delivery for every 100 The ninth question to be asked is, "Does the process use economies of effort?" An-
attempts. other way to ask this question is, "Do we get more benefits from the metric than we in-
The second question to be asked about a metric is, "Is it easy to understand?" This cur c~sts to generate it?" In many cases, much time and effort are devoted to
question is directly related to the fifth question, "Is it defmed and mutually under- collect_m_g data to generate a specific metric, while the resulting actions from the metric
stood?" Experience has shown that individuals will understand a metric if they are in- are mm1mal. Some firms find this to be the case when they first develop a metric.
volved in its definition and calculation. 2 For example, one of the most commonly used H?wever, the longer a firm has a metric in place, the more likely there is to be econo-
mies of effort. 6
metrics in the supply chain is on-time delivery. This is also one of the most commonly
misunderstood metrics in the supply chain. Disagreements can occur between shippers The last question to be asked about a good metric is probably the most important
and customers or between marketing and transportation. Research has shown that if "Does i~ facilitate tr~st?" If it does not, complying with the other nine characteristic~
all parties affected by the metric are involved in its definition and calculation, it will be ~akes little o~ n_o dtfference for the effectiveness of the metric. However, if the first
easy to understand. 3 nme ch~ractenstics are present for a supply chain metric, trust should be an expected
The third question to be asked about a metric is, Does it encourage appropriate be-
havior?" A basic principle of management is that' metrics will drive behavior. A well-
intentioned metric could very well drive inappropriate behavior. For example, if a
warehouse manager is measured by cubic space utilization, he will try to keep the
warehouse filled, which could lower inventory turns, drive up inventory costs, and re-
sult in product obsolescence.
A food manufacturing company finds the perfect recipe for increasing profit growth and cost
The fourth question to be asked is, "Is the metric visible?" Good metrics should be
savmgs. And a hand and power tool manufacturer nails its targets for improving year-over-year
readily available to those who use them. A distinction can be made here betw-een a re- return on net assets.
active metric and a proactive metric. Some firms state that metrics are available in the
system for employees to see and use. However, this means that they must attempt to . What helped these companies achieve amplified success in their supply chains-and
find them. These are reactive metrics. Leading firms, however, "push" metrics to ultimately throug~out their organizations? "World-class purchasing/sourcing measurement sys-
metrics owners so they can react immediately. These are called proactive metrics. In tems are the key, says Philip Carter, a professor and executive director of the Center for Stra-
both cases, metrics are visible. However, proactive metrics will be acted upon quicker tegiC Supply Research at Arizona State University's W. P. Carey School of Business.
because employees need little or no effort to see them. 4 . Comprehensive ~easurin_g systems allow organizations to clearly set priorities for pur-
The sixth question to be asked is, "Does the metric encompass both outputs chasmg and strategiC sourcmg, measure accomplishments, and effectively demonstrate
and inputs?" Process metrics, such as on-time delivery, need to incorporate causes purch~Sing/strategic sourcing's contribution to the company's overall goals, according to
Carters research.
and effects into their calculation and evaluation. For example, a decreasing on-time
delivery rate might be caused by late pickups, shipments not being ready on time, or "Corporations today rely on outside suppliers more than ever, and consequently, need
even by production shutdowns. So, the outputs must be somehow related to the measurements to determme If their supplier relationships are effective," Carter says.
inputs. "It is vitally important that companies use metrics to measure the performance of both
The seventh question to be asked is, "Does it measure only what is important?" The purchasmg/supply activities within the company, and the performance of the supplier base "
he explains. '
supply chain operation generates huge volumes of transactional data on a daily basis.
Many times, firms will measure those activities or processes for which large amounts BEST PRACTICES
of data are available. Just because data are available to calculate a metric does not mean Carter's Iindings-gleaned from extensive research at 15 Fortune 500 organizations in a multi-
the metric is important. In some cases, data are hard to generate for important metrics. tude of mdustnes-show several best practices prevalent among companies with world-class
For example, data for on-time delivery must be generated by either the carrier or purchasmg/supply measuring systems. To succeed, Carter says, these measuring systems
receiving location. Matching arrival data in a timely and accurate manner with bills of should be,
lading can be a cumbersome process. So, it is important to decide what is important Aligned with other strategic business units within the company and with overall
and then gather the data rather than identifyillg what data are available and then gen- corporate goals;
erating metrics. Comprehensive, dynamic, and aggressive;
The eighth question to be asked about a good metric is, Is it multidimensional?" Communicated efficiently throughout the organization;
Although a single metric will not be multidimensional, a firm's metric program will be. Tied to performance-based initiatives;
Chapter 5 Supply Chain Performance Measurement and Financial Analysis 149

Evaluating current or potential supply chain metrics is critical to a sound metrics

Backed by organizational resources; program. Also important to note is that metrics need to change over time; not only the
Supported by technology systems; and performance standard, for example, 85 percent, but also the individual metric, for ex-
Championed by C-leve! executives. ample, percentage of orders shipped on time. With regard to the first example, the
Cutting costs, naturally, is the primary driver for many companies implementing measuring standard might change to 90 percent as new processes and/or technologies are intro-
systems. But companies are also starting to gauge how efficient operations are by measuring duced that enable the organization to consistently exceed the old standard. Advocates
such benchmarks as dollars spent per employee in purchasing, number of suppliers per buyer, of the Six Sigma concept have stressed the focus on continuous improvement, which
percentage of sourcing done through electronic systems, and number of suppliers being used, should result in increasing performance expectations over time.
among others.
The second example, indicated previously, regarding changing metrics is also very
Strategic measures, while harder to quantify, are also gaining attention. important. Orders shipped on time and orders shipped complete were frequently used
"These measurements can be subjective, but they are vital," Carter says. "Chief purchas- as performance metrics in logistics. These could be considered "internal" rnetrics be-
ing officers need to know whether or not their purchasing department has an impact on new cause they focus on the performance of the shipping firm. However, as customer ser-
product/new service development, brings good ideas from the supplier base back to the com- vice receives more attention in industry, the metrics have changed to "orders delivered
pany, and impacts revenue generation." on time" and "orders delivered complete." These are more "external" metrics because
they measure the experience of the customer. Both "internal" and "external" metrics
WORLD-CLASS METRICS are essential components to a balanced approach to supply chain performance mea-
Companies that look at cost, efficiency, and strategic measures together gain a greater under-
surement. Figure 5-2 shows the results of a recent survey conducted by the Aberdeen
standing of their supply chain and its overall impact on the organization. But they are
group asking shippers what supplier performance metrics they use. As can be seen
uncommon. from the results, on-time delivery is once again the most often used metric to measure
"Only 10 percent of Fortune 500 companies have a world-class measurement system," supplier service performance.
says Carter. "Most companies employ some type of system, but outside of leading companies,
Figure 5-3 explains how the dimensions and importance of performance measure-
the systems are usually random-they measure a little of this and a little of that.
ment have expanded. This figure clearly indicates that expectations have increased
"Poor metrics make it difficult for organizations to make decisions and allocate since the 1960s and 1970s and that in each of the decades identified there have been
resources," he continues. "How can you gauge the number of people to add to a department,
for example, if you don't track that department's efficiency?"
"It's not that companies with sub-par measuring systems don't care," Carter explains; Figure 5-2 What Supplier Performance Metrics Do Companies Use?
"rather they lack available financial and/or technological resources. Such measuring systems
can be cumbersome, time-consuming, and expensive to develop and maintain." What Supplier Performance
Metrics Do Companies Use?
"Going forward, the importance of efficient measurement systems will increase," Carter On-time delivery 90%
Improvements in technology will enhance current systems, improve workflow and data Quality of goods/services 83%"
sharing, and reduce the time it takes to produce measurement.
Service capability/performance 69%
"The next phase is Web technology allowing companies to access the right tools and see
metric information in a more comprehensive way," says Carter. He also predicts an increase in Price competitiveness 55%
Web portals, used internally as well as between companies and their supply base.
"Web portals are a better way of collecting information. They help establish standards Compliance with contract terms 51%
and data definition models for supply/purchasing measurements," he says.
Response 50%
Over-extensive measuring, however, can be detrimental. With lean staffs the norm at
most companies these days, measurement systems can place a burden on the workforce. The Leadtime
key is moderation.
"Companies have to be careful; they can get lost in the forest of measure," says Carter. Technical capability
"The pros outweigh the cons overall, but companies must shoot for the sweet spot-the Environmental, health,
amount of measuring that makes sense to them." and safety performance
Source: Inbound Logistics (January 2006): 26--27. Reprinted with permission, http://www Innovation I

Source~ Logistics Management(January 2006): 41. Reproduced by permission.

supply Chain Pelformance Measurement and Financial Analysis 151
;a Chapter 5

The important point to remember is that successful supply chain performance mea-
surement relies on appropriate metrics that capture the entire essence of the supply
Figure 5-3 Raising the Performance Bar
chain process. Supply chain metrics must also be reviewed to assure that they are rele-
Drivers of Better Logistics Performance Standards: 1960s-2000+
vant and focusing on what is important. A sound, comprehensive set of supply chain
performance metrics is critical for an organization to manage its business and identify
Superior opportunities to increase profit and market share.

Developing Supply Chain Performance Metrics 7
The implementation of new technologies, for example, enterprise resource planning
(ERP) systems, and the changing business environment have prompted many firms to
reexamine their supply chain metrics programs. Another driving influence for this
Good reexamination has been the desire of organizations to change their supply chain focus
from a "cost" center to an "investment" center. In other words, how can organizations
justify investments in supply chain processes? This will be discussed in a later section
in this chapter. This section will offer some suggestions concerning the successful
Acceptable development of a supply chain metrics program.
First, the development of a metrics program should be the result of a team effort.
Successful metrics implementations involve development teams comprised of indivi-
Fair duals representing functional areas within the firm that will be impacted by the
metrics. Because this phase of development requires metric identification and defini-
tion, it is critical that all impacted areas agree on the appropriate metrics and their
1960s 1970s
definitions. This agreement will lead to a more successful implementation and use of
the metrics to manage the business.
-Pr~4udioii ;' :-ari~factli~ng DistribUtion arid i Supply Chain
Key 1 ,~d Cl!Sto'rlle:r
Performance Costs l 'all<i IIJ.J~ntory LOgis:tic_S1::oSts Second, involve customers and suppliers, where appropriate, in the metrics develop-
! CQsts' Seivice_ Costs ment process. Because customers feel the impact of metrics and suppliers are actively
Measures 'i
involved in the execution of the metrics, their involvement is also critical to successful
Source: J. s. Keebler, D. A. Durtsche, K. B. Manrodt, and D. M. Ledyard, Keeping Score: Measuring the Business ~a/ue of Logistic~ in the Supply implementation.
Chain (University of Tennessee, Council of Logistics Management, 1999). Reproduced with permission from Counc1l of Supply Cham Management
Third, develop a tiered structure for the metrics. Many organizations develop a
small number (usually less than five) of KP!s or "executive dashboard" metrics that are
viewed at the executive level for strategic decision making. Tied to each strategic KPI
important drivers for better performance. Each new decade, however, built upon the are tactical and operational metrics. In this hierarchy, operating unit metrics are tied
improvements in the previous decade(s). directly to corporate strategic metrics.
A question might be raised as to whether or not the focus on performance measure- Fourth, identify metric "owners" and tie metric goal achievement to an individual's
ment is a recent event in industry. The answer to that question is a definite "no." Recall or division's performance evaluation. This provides the motivation to achieve metric
from Chapter 2 that the development of the physical distribution and logistics con- goals and use metrics to manage the business.
cepts was based upon systems theory with the specific application focused upon least
Fifth, establish a procedure to mitigate conflicts arising from metric development
total cost analysis. Total cost is a measure of efficiency and was the rationale support-
and implementation. A true process metric might require a functional area within an
ing physical distribution management. Least total cost was later used to support the
organization to suboptimize its performance to benefit the organization as a whole.
logistics management approach.
This might result in conflict from tl1e suboptimized function. For example, achieving
The focus upon a least total cost system required measuring the tradeoff costs when , the desired on-time delivery metric might require transportation to increase its expen-
a suggested change was made in one of the components or elements of the system. For ditures, resulting in an unfavorable freight expense. A resolution process must be
example, this could include switching from rail to motor transportation or adding a established to allow the transportation manager to realize the desired on-time delivery
distribution center to the distribution network. Cost has long been recognized as an goal without being penalized for excess freight expense.
important metric for determining efficiency. This is still true today. However, we have
evolved from measuring functional cost to supply chain cost. This means the relevant Sixth, the supply chain metrics must be consistent with corporate strategy. If the
point of measurement has changed from totally internal to a firm to the collective costs overall corporate strategy is based upon effectiveness in serving customers, a supply
of many firms involved in the supply chain.
Supply Chain Performance Measurement and Financial Analysis 153
Chapter 5

cycle time might be 10 days, plus or minus 4 days, or 10 days, plus or minus 2 days.
. am that emphasizes low cost or efficiency could be in conflict with
chain metncs progr Both cycle times have the same absolute length but have different variability. The dif-
ex ected corporate outcomes. . ference in variability will have an impact on safety stocks in the supply chain. The im-
p ort for the development of a supply cham portant point is that metrics should measure both absolute time and its variability.
Finally, establish top managen_>ent supp t ore than expected, take longer to
S ful metncs programs cos m . . The second category indicated in Figure 5-4 is cost, which is the measurement for
metrics program. uccess . 'd and outside the orgamzatiOn.
. bl d impact many areas ms1 e . f efficiency. Most organizations focus on cost since it is critical to their ability to com-
implement than des1ra e, an th d 1 ment and implementatiOn o
To management support is necessary to se~ e eve op pete in the market and make adequate profit and returns on assets and/or investments.
th[metrics program to its successful conclusiOn. A number of cost metrics related to logistics and supply chain management are impor-
tant to organizations.
Some of the cost metrics shown in Figure S-4 are obvious and easy to understand.
Performance Categories . For example, total delivered cost or landed cost will have an impact on the prices
d o classify supply chain performance metncs.
A number of approaches can be use. t f l ification This figure identifies four that will have to be charged in the market. Total delivered cost is multidimensional
Figure 5-4 is one method to use for thls typde o c asfsull way f~r examining logistics and and includes the cost of goods, transportation, inventory carrying costs, and warehous-
. 'th mples that proVl e a use ing. Inventory turns and days sales outstanding are not as obvious. Inventory turns
major categones Wl exa . l'ty cost and supporting metrics.
su 1 chain performance: tune, qua 1 , ' . . reflect how long an organization holds inventory and its resulting impact on
PP Y . . ortant indicator of log1st1cs inventory carrying cost. Days sales outstanding impacts service levels to customers
Time has traditionally been given attentiOn ~s Figure 5-4 lists five
ll 'th regard to measurmg ene d and can affect the rate of order fill. The cash-to-cash cycle is receiving increased atten-
Performance, espeoa y WI . ture two elements of time: the elapse tion in organizations because it measures cash flow. Organizations are interested in
. r e The metncs cap d
widely used metncs or rm . . il' ( . bil'ty) for the activity. For example, or er getting their money back as quickly as possible in order to enhance their financial
time for the activity and the rehab lty vana 1
Quality is the third category of metrics identified in Figure 5-4. Several dimensions
Figure 5_4 \ Process Measure Categories in the Quality category are important to logistics and supply chain management.
The perfect order concept is a good example of the increased emphasis being placed
Cost upon customer service because it simultaneously measures multiple metrics that must
Time Finished goods inventory turns
be achieved to get a positive metric. 8 The fourth category indicated in Figure S-4 offers
On-time delivery/Receipt Days sales outstanding some supporting metrics such as approval of exceptions to standards.
Order cycle time Cost to serve
Order cycle time variability Another metric classification scheme that has been receiving increased attention is
Cash-to-cash cycle time
Response time
that developed by the Supply Chain Council and contained in the Supply Chain
Total delivered cost
Forecasting/Planning cycle time
Operations and Reference (SCOR) model. Figure 5-5 is an example of the metrics
Cost of goods
categories used to measure the performance of Process Dl: Deliver Stocked Product.
Transportation costs
Quality This figure identifies five major categories of metrics that need to be used to measure
Overall customer satisfaction Inventory carrying costs the performance of Process D 1: reliability, responsiveness, flexibility, cost, and assets.
Processing accuracy Material handling costs Reliability is the performance of the supply chain in delivering the correct product,
Perfect order fulfillment* All other costs
to the correct place, at the correct time, in the correct condition and packaging,
On-time delivery Information systems in the correct quantity, with the correct documentation, to the correct customer.
Complete order
Responsiveness is the speed at which the supply chain provides products to the cus-
Accurate product selection
tomer. Flexibility is the agility of the supply chain in responding to marketplace
Cost of excess capacity changes to gain or maintain competitive advantage. Costs are the costs associated
cost of capacity shortfall with operating the supply chain. Asset management is the effectiveness of an organi-
Accurate invoice
zation in managing assets to support demand satisfaction; this includes the manage-
Forecast accuracy ment of all assets and fixed and working capital. 9 .Figure 5-6 identifies metrics in tbe
Approval exceptions to standard
Planning accuracy categories for the single activity of D 1.3, Reserve Inventory and Determine
Minimum order quantity
Budgets and operating . D<,livery Date.
plans Change order timing
Finally, another perspective (see Figure 5-7) suggests that performance metrics for
Schedule adherence Availability of information
:to15istics and supply chain management should include logistics operations costs, legis-
service metrics, transaction cost and revenue quantification, and channel satisfac-
dt d D, M Ledyard Keeping Scoie: Measuring the metrics.
Source: J. s.-Keebler, ?_A. ?Urtsche, Ki BCh~~n[~ni~=~lty ~fTennesse~. Council of Logistics Management, , _
Business Value of Log~~!~~-s. m ~he. Su~py Council of Supply Chain Management.
1999). Reproduced Wlth permlSS\on rom
Supply Chain Pertormance Measurement and Financial Analysis 155
Chapter 5

Figure 5-6 SCOR Model: Process 01.3 Metrics

Delivery Date n ory an Determine Process Element Number: Dl.J

a dehvery date is committed and scheduled. scheduled) IS Identified and reserved for specific orders and

Performance Attributes Metric

Reliability Delivery Performance To Customer Commit Date
Responsiveness Reserve Inventory and Determine Delivery Date C cl T'
Cost Finished Goods Inventory Days of Su 1
F''hd ppy
Assets mrs e Goods Inventory Carry Cost
Best Practices Features
EDI links betvveen manufacturin d d" .
g ~n rstnbutor
None Identified
to achieve visibil"ty f
1 0 camp1ete fimshed goods

mventory and expected shipment
Automatic reservation of invento and d . Integrated order managements t h
sourcing of product for single shi~ent t!~~~~~er
as a separate order with integraJs em t_ at treats each order line
status Real-ti on to mventory source and
, me mventory management
ATP and Product Reservation Integration with scheduling and inventory mana em
Priority based inventory reservstion 1
customers, with FIFO allocation for ~ll ~~h~Js
~~~~~ry ~~o~at~on exception process is clearly None Identified
sales an JOlllt y owned by manufacturing and

Inputs Plan Source Make Deliver Return

In terms oflogistics operations costs, a good example is transportation costs. By cal- Sourcing Plans P2.4
culating the tradeoffs between using less expensive (slower and less reliable) and more Production Plans P3.4
expensive (faster and more reliable) transportation service, an organization could Delivery Plans P4.4
quantifY the total cost impact on transportation and inventory costs. Using faster and Inventory Availability s M
more reliable transportation would result in higher transportation costs but lower Production Schedule Ml.l
inventory costs, usually resulting in an increase in cash flow for the organization. Outputs Plan Source Make Deliver Return
Logistics service can fall into any one of five categories. These categories can be seen Order Bacldog Pl.!, P4.1
in Figure 5-8. Product availability is a logistics metric that is used frequently because it Inventory Availability/Delivery Date P4.2
is a good indicator of supply chain performance and its influence on customer inven- Replenishment Signal Sl.l
Available to Promise Date M
tory requirements, order fill rates, and seller revenue. Inventory Status p s M D
Order cycle time (OCT) is another very important logistics service metric. OCT
influences product availability, customer inventories, and the seller's cash flow and .Source: Supply Chain Council, 2007. Reproduced bYpermiSSion.
. .
profit. Once an expected order cycle time is established for customers, service failures
can be measured. One such measure is the number of late deliveries per 100 ship-
ments. From a revenue or cash flow perspective, an organization can calculate the im-
are three basic alternatives a~ follows: gis lCS v ue from the seller's perspective, there
pact of a late delivery on revenue, profit, and cash flow. perception of service quality' To add lo . t' a!
All of the logistics outputs listed in Figure 5-8 can be utilized in some form to de-
velop metrics for service performance. As indicated previously, the service output ~creasedservice with a constant price to the customer
metrics reflect the quality of service being provided to customers, which is important onstant service with a reduced price
to sustain and, hopefully, increase revenue and cash flow. Increased service with a reduced price
Transaction cost and revenue relates to the value added by logistics. In other words,
what is the service and price relationship, and what specifically is the customer's
;n of. these alternatives result in the customers recei .
he pnce they are paying for the se .
vmg more semce per dollar for
Supply Chain Performance Measurement and Financial Analysis 157
Chapter 5

service. Leading-edge organizations are beginning to identify the impacts of customer

satisfaction on revenues and market share.
Logistics Quantification Pyramid
Figure 5-7 Overall, much progress has been made during the last few years towards developing
appropriate metrics and using them proactively to measure performance in terms of
the impacts upon the financial results of the organization and its customers. However,
as this discussion has highlighted, there is much more to be accomplished. The next
section will introduce the supply chain-finance connection, which will be used in the
Channel appropriate chapters throughout the remainder of this book

The Supply Chain-Finance Connection

As noted in the Supply Chain Profile at the beginning of this chapter, CLGN Book Dis- is focusing its attention on the supply chain process as a means to improv-
ing its fiuancial performance. CLGN recognizes the impact supply chain performance
has on customer satisfaction and future sales. In addition, the effectiveness of the supply
chain process impacts the cost of fulfilling customer orders and transporting these orders
to the customer, both of which impact the overall landed cost of the product
More specifically, the supply chain process influences the flow of products from the
' 'ty (2007) . supplier to the final point of consumption. The resources utilized to accomplish this
Center for Supr)ly Chain Research, Penn State
Source: R. A. Novac k , flow process determine, in part, the cost of making the product available to the con-
swner at the consumer's location. This landed cost, then, impacts the buyer's decision
to purchase a seller's product.
Logistics Outputs That Influence Customer Service
Figure 5-8 The cost of providing logistics service not oniy affects the marketability of the prod-
Product availability uct (via the landed cost, or price), but it also impacts profitability. For a given price,
Order cycle time level of sales, and level of service, the higher the logistics cost the lower the organiza-
Logistics operations responsiveness tion's profit. Conversely, the lower the logistics costs, the higher the profits,
Logistics system information The decision to alter the supply chain process is essentially an optimization issue.
Post-sale logistics support Management must view the supply chain alternatives as to their ability to optimize the
Center fot Supply Chain Research, Penn State University (2007).
corporate goal of profit maximization. Some alternatives might minimize costs but re-
Source: R. A. Novack duce revenue, and possibly, profits. By implementing supply chain alternatives that op-
.c n how a seller's cost timize profits, the decision maker is taking the systems approach and trading off
. t' n cost and revenue tocuses o revenue and costs for optimum profit.
Another perspective on transac 10 h 11 ' se.... "ce impacts a customer's reve-
, fit and on ow a seers .LVL fi
influences a customer s pro 1 . . all ws a customer to make more pro t Supply chain management involves the control of raw material, in-process, and fin-
nue. If the cost of a seller's logisttcs se~c\d ~ illing to buy more products from ished goods inventories. The financing implication of inventory management is the
from the seller's product, the customer ~ o~l t ed:liver its product to the buyer's re- amount of capital required to fund the inventory. In many organizations, capital is in
the seller. For example, a manufactu; IS t~ e o~petitor can deliver its product to the short supply but is required to fund critical projects, such as new plants or new ware-
tail store for $0.25 cheaper per case an e ch h If the buyer can realize an addi- houses. The higher the inventory level, the more capital is constrained and the less
. the pnce constant at t e s e ' I 'II h
same store. By 1zeepmg . '1 1 manufacturer's logistics service leve WI a~e capital is available for other investments.
tiona! $0.25 per case profit Stmt ar yF, a I the same manufacturer in the prevt-
th t il r's revenues or examp e, d 90 The recent focus on inventory minimization is a direct response to the competing
an impact on e re a e . h b , tore of 98 percent, compare to
ous example has an in:~tockT~i~e h:t ~e; in~~~c~ :ervice level allows the buyer to real-
needs for capital and the difficulty some organizations have in raising additional capi-
tal. Logistics techniques such as just-in-time and vendor-managed inventories are
p ercent for the competltwn.
. g d
the htgher pro uct avat a
'1 bilt'ty So transaction cost and reve-
. , l directed toward reducing an organization's inventory levels and making more capital
ize higher revenues rom . th . t f logistics cost and service on supp Y
nue highlight the need to emphastze e tmpac s o available for other projects
chain profits and revenues. . As indicated previously, the level of logistics service provided has a direct impact on
. . 5 7 is channel satisfaction. This essentlally
The fmal category, shown m Ftgure - ' , d by channel members. The research customer satisfaction. Providing consistent and short lead times helps manage supply
. t and seiVICe are perceiVe . chain inventories and can build customer satisfaction and loyalty. However, the cost of pro-
looks at how logistiCs cos t has been on the perceptiOns
. d M t f the focus on measuremen d viding this service must also be examined for its results on a firm's profit and revenues.
in this area is limite .- os o 11 1' rs are performing on logistics cost an -
of supply chain members of how we supp te
Supply Chain Performance Measurement and Financial Analysis 159
Chapter 5

Finally, efficiency of the supply chain impacts the time required to process a custo- Table 5-1 Sales Equivalent of Supply Chain Cost Savings
mer's order. Order processing time has a direct bearing on an organization's order-to-
cash cycle. The order-to-cash cycle includes all of the activities that occur from the time CLGN 2007 SALES EQUIVALENT FOR COST SAVINGS OF
an order is received by a seller until the seller receives payment for the shipment. Typi-
cally, the invoice is sent to the customer after the order is shipped. If the terms of sale are (000) % $200.000 $500,000 $1,000,000
net 30 days, the seller will receive payment in 30 days plus the time needed to process the $150,000 100.0% $2,857,143. $7,142,857 ..
Sales $14,285,714'
order. The longer the order-to-cash cycle, the longer it takes for the seller to get its pay-
ment. The longer the order-to-cash cycle, the higher the accounts receivable and the Total cost 139,500 93.0 2,657,143 6,642,857 13,285,714
higher the investment in "sold" finished goods. So, the lengfb of the order-to-cash cycle
Net profit 10.500 7.0 200,000 500,000 1,000,000
direcdy relates to the amount of capital tied up and not available for other investments.
*$200,000 cost saving' : o.o7 profit margin
**$500,000 cost saving+ o:o? prOfit margin
The Revenue-Cost Savings Connection t$1,000,000 cost saving+ 0.07 profit margin

Throughout this text, attention is given to supply chain efficiency and cost reduction.
While process efficiency and cost savings are worfby goals, top management generally
refers to corporate improvements in terms of increases in revenue and profit. The Table 5-2 Equivalent Sales with Varying Profit Margins
apparent conflict between the goals of top management and supply chain management
can be readily resolved by converting cost savings into equivalent revenue increases. PROFIT MARGINS
To improve communications effectiveness with top management, it behooves the sup-
ply chain manager to relate efficiencies and cost savings in a language that top man- 20% 10% 5% 1%

agement uses-that is, revenue and profit. Sales $50,000 $100,000 $200,000 $1,000,000
Logistics and supply chain managers find it advantageous to transform cost reductions Total cost 40,000 90,000 190,000 990,000
into equivalent revenue increases to explain to top management the effects of improved
supply chain cost performance. To accomplish this, fbe following equations can be used: Cost saving/Profit 10,000 10,000 10,000 10,000

Profit ;: : : Revenue - Costs

CLGN has a profit margin of 7 percent G" . .
where cost saving has fbe same effect . . . Iven this profit margm, a $200,000 logistics
. as mcreasmg revenue b $2 857
Cost~ (X%)(Revenue) crease m revenue. Likewise, a $500,000 and $1 m y ' . ,143, a 1.9 percent in-
eqmvalent revenue equal to $7 142 857 ( ilhon logistlcs cost savings have
then $14,285,714 (9.52 percent r .' ' 4.76 percent revenue increase) and
evenue mcrease), respectively.
Profit~ Revenue- (X%)(Sales) ~ Revenue(1 -X%)
The lower the profit margin, the hi her the .
cost because it takes a greater g I revenue eqmvalent for a given logistics
where h revenue vo ume to p d .
s. ows the equivalent revenue of a given lo s . ro uce a given profit. Table 5-2
(1 - X%) ~ Profit Margin gms. For a $10,000 logistics cost savin th gi tl~s cost savmg With varying profit mar-
Sales ~ Profit/Profit Margin organization with a 1 percent profit r!~r : e~:valent revenue equals $1 million for an
a 20 percent profit margin L . t" g . only $50,000 for an organization with
Assuming that everyfbing else remains unchanged, a logistics cost saving will direcdy ogts tcs cost savmgs h h
increase pre-tax profits by the amount of the cost saving. If a logistics cost saving or organizations with low profit margins. ave a muc greater revenue impact
increases profit by the same amount, the revenue equivalent of this cost saving is found
by dividing the cost saving by the profit margin as shown in the preceding equations. . In the following section, the financial im li .
dtscussed. Following that section st t p catwns of supply chain strategies are
For example, if cost is 90 percent of revenue and the profit margin is 10 percent of CLGN Book ar~ a:a~::~~s contained in the Supply Chain Profile for
revenue, a $100 cost saving is equivalent to additional revenue of $1,000:
Revenue ~ Cost Saving (or Profit)/Profit Margin

Revenue~ $100/0.10
The Supply Chain Financial Impact
A maJor fmancial objective for an or aniza . .
Revenue~ $1,000 stockholders. This requires the gy gt" tlfon IS to produce a satisfactory return for
enera ton o suffi t fi .
Table 5-1 provides examples of equivalent revenue for different logistics cost savings of t e stockholders' investment t h . Clen pro It m relation to the size
h o assure t at mventors will maintain confidence in
using the data found in the Supply Chain Profile for CLGN. As shown in fbe table,
Supply Chain Performance Measurement and Financial Analysis 161
Chapter 5

, ir to manage its investments. Low returns over time will see ill
the organizations ab 1ty th . .t l Hl'gh returns over time, however, W
f e uses for e1r cap1 a . .
investors seek a1 terna IV . th . . stments with the orgamzatiOn. CEOs have a lot on their minds, particularly revenue growth and responsiveness. logistics can
buoy investor confidence to maintam eir mve kh ld ,
b considered in relation to the stoc o ers support both those goals, according to Communicating the Value of Supply Chain Management
The absolute size of the profit must e if C A makes a profit of $1 million to Your CEO, a newly released report published by the Council of Supply Chain Management
th For example, ompany B Professionals (CSCMP).
net investment, or net war . fi f $100 million, it would appear that Company
and Company B makes a pro t o if A h s a net worth of $10 million and B $10 logistics supports revenue growth by improving speed to market, reducing cost to market,
would be a better investment. However, ckha ld . Company A is 10 percent ($1 and increasing customer service without adding cost. Companies can achieve revenue growth
billion, the return on n
et worth for a sto o er m
B 't. 1 ercent ($100 millionl$10 b! on .
ru )
through differentiated supply chain processes, even when products are viewed as commodities,
millionl$10 million) and for Company 1 !S p . .
according to the report. Success in global markets and the ability to efficiently source materials
. , . erformance is also judged by the profit lt gen7rates m
An organizatwn s finanCial P t (ROA) An organizations return or sell products globally depend largely on supply chain capabilities and processes.
u d return
relationship to the assets ut Ize , or
on asse s
t . th t is used as a benchmark to compare logistics supports responsiveness by affecting speed to market, increasing turns, accel-
. r: a1 performance me nc a . . h
on assets lS a !lnann r t th t of other organizatiOns m t e same erating the cash-to cash cycle, increasing ROI, reducing the risk of inventory obsolescence, cre-
ation penormance o a . d
management and orgamz . t worth return on assets 1s epen- ating leaner supply chains, and enabling companies to enter and exit markets faster.
industry or similar industries. As With r~tu~n on ne ,
rofits for the orgamzatwn. Senior managers today are more exposed to logistics and supply chain management
dent on the 1eve1 o f P bT . terminology, the report notes, supporting a growing awareness that wasn't there even five
.. le in determining the level of profita llty m an
The supply chain plays a cnbcal ro d t' th supply chain the greater is the years ago.
ffi t and pro uCJve e '
organization. The more e l~Ien. Converse} the less efficient and less productive, "leaders invest in their supply chains, but what's scary is that some current market
profit potentiahl of th; or~::;:~~~and the lo!~r the profitability. leaders won't be leaders in three to five years," says Karl Manrodt, associate professor, Georgia
the h!gher !S t e supp y c . t and Southern University, and coauthor of the CSCMP report, along with Brian Gibson of Auburn Uni-
. . b su ply cham managemen
Figure 5-9 shows the financial relatwnslhlph etweencepuupacts the level of revenue, versity and Stephen Rutner of Georgia Southern University.
f f ss of supp y c am serVI .
return on assets. Thee ec lVene . . , t tal costs As noted earlier, revenue mmus "If my competitor is investing to be more efficient and build in greater flexibility and I am
and the efficiency affects the orgamzatwn s o . . .ROA not, how long do you think I can run the race? I'll be reduced to competing on price, and I will
rna) or component m determmmg .
cost equa1s profit1 , a be overtaken," Manrodt says. "Smart CEOs look at logistics and supply chain as a way to
CEOs have become more interested in supply chain management because they see it as
a strategic advantage, agrees John T. (Tom) Mentzer, professor of marketing, logistics, and
Supply Chain Impact on Return on Assets
Figure 5-9 I transportation, University of Tennessee.
CEOs, however, are driven by Wall Street to pertorm this month, this quarter, Mentzer
Supply chain \ Revenue i- notes. Many advantages that come from effective supply chain management take several busi-
- H Profit
1-- ness cycles to accomplish and may actually hurt a company's stock in the short term.
"If I form a strategic partnership with one of my retail customers for a vendor-managed
Supply chain
I Costs
inventory program that will take 40 percent of inventory out of the supply chain, for example,
during the first quarter it will look like sales went down," Mentzer says. "Wall Street will see
this as a poor pertormance, and downgrade the stock."
Inventory l- +
Return on
"On the other hand, say I'm on the board of a clothing retailer whose stock was trading
+ at $18 two years ago, but is trading at $40 today," he continues. "This clothing company
Asset bought another profitable retailer, and in due diligence discovered it could cut $4 million in
deployment Accounts
supply chain costs. These cuts mean the company, which earns $56 million annually, increased
and utilization receivable
Capital earnings by eight percent. That makes Wall Street analysts believers."
+ employed 1- Poor supply chain management can lead to huge global mistakes. Take a company that
t- moves production to Southeast Asia as an example, says Mentzer. It does this because it can
save $1 million in labor costs. But, as a result of that decision, the supply chain is now five
+ months long, so the company has to carry more inventory in the United States-a fact the
management team forgot to account for.
Supply Chain Pelformance Measurement and Financial Analysis 163
2 Chapter 5

"This costs the company $1.5 million more in inventory, plus another $1 million in trans-
Figure 5-11 I Supply Chain Decisions and ROA
portation," says Mentzer. "So the company spent $2.5 million to make $1 million."
Channel structure management Inventory management
Mistakes of this magnitude certainly get the attention of CEOs.
Source: Inbound Logistics, June 2005: 44. Reprinted with permission, http:!/ www. inboundlogistics Use of outsourcing Minimize safety stock
Minimize channel inventories Optimize availability

Improve information Improve information

Figure 5-1 0 \ Supply Chain Impacts on the Balance Sheet Efficient channel structure Eliminate obsolete excess items
,------Cash [ Order cycle time/ order to cash increased
11------j. Order completion rate
Order management Transportation management
A Receivables ___j Invoice accuracy
On-time delivery
s Reduce stockouts Improve on-time delivery
E Inventories - - - - - - - - Service levels/stockout rates
T Optimize order fill rate Improve information
t___ and equipment
-----c:= Transportation
Property, plant, Distribution facilities
equipment Reengineer order-to-cash cycle Optimize mode mix

Current liabilities - - - - - Outsourcing policies Improve information Reduce transit time variability

Debt-----,'1-------- Financing options for inventory,

Equity ____jI warehouses, and equipment Source: R. A. Novack, Center for Supply Chain Research, Penn State University (2007),

The level of inventory owned by an organization in its supply chain determines the
assets, or capital, devoted to inventory. The order-to-cash cycle affects the time
required to receive payment from a sale, thereby impacting the accounts receivable and Channel structure managem t 1 d d ..
channel inventories informaf en me u es eCiswns regarding the use of outsourcing,
ply chain activities,, the organ~~~ti:;~t:sh:~;alc~:~nel structure. By. outsourcing sup-
cash assets. Finally, the supply chain decisions regarding the type and number of ware-
houses utilized impacts fixed assets. cing firms possess greater functional g t' dower supply cham costs (outsour-
exper 1se an efficiencies) d t .
Lastly, Figure 5-9 shows that the calculation of ROA is the division of the profit re- ( use of an outsourcing firm's fa il't' ) d . ' a re uc wn m assets
alized by the capital (assets) employed (profit/capital employed). As noted earlier, the chain service). Decisions that cl~::: 's~;pllync~~:~:d rev~nue (dfr/om .improved supply
through s p 1 h . 1 asse s an or nnprove revenue
higher the profits for a given level of assets (capital) utilized, the higher is the ROA. u P y c am service Improvements result in a higher ROA.
Another way to examine the impacts of supply chain services and costs can be seen Minimization of channel inventories results i d' . .
in Figure 5-10. As shown in this figure, cash and receivables for an organization are tion's assets. The use of improved in . n a Irect reductiOn m an organiza-
influenced by supply chain time (order cycle time/order-to-cash), supply chain reliabil- ter monitor inventory levels, produ~~:~ti~c~;~stems enables the organization to bet-
ity (order completion rate and on-time delivery), and information accuracy (invoice current levels of demand. Streamlinin th h ul~s, and demand forecasts to meet
accuracy). All of these supply chain services will determine when the customer begins
processing the shipment delivery for payment. Inventory investment for an organiza- ~~;~;~:::;t~~a;~:i::~::me!;"~;sgl. f:r ~x:";;le:t~~~~:; ~~::c~t!~ ~:~~:~~e~
tion is influenced by required service levels and stockout rates for the organization. reduce the channel cost of transpo~ati:~::;~:~';:nto.ry f~:- th~ ch~nn~l, ~s well as
Property, plant, and equipment investment is impacted by decisions regarding private results in a direct increase in ROA. ousmg. e re uction m mventory
warehouses and transportation fleets. Decisions regarding the outsourcing activities
such as warehousing and transportation will influence current liability levels (accounts Inventory management decisions that reduce i
and/or excess stock) and opt . . 1 nventory (safety stock, obsolete
payable). Finally, decisions regarding financing for inventories and infrastructure will Imize mventory ocation (i 1 t' a]
terns) reduce the investm t . . n rea lOU to s es or use pat-
readJye~:~ ~~ ys~~ of sales
determine debt and equity levels. d en m mventory These decisions a1
. ata and inventory levels by channellocat;on, which is
Figure 5-11 summarizes the supply chain strategic areas affecting return on assets. m ormation systems. a e WI current
The decisions made by the supply chain manager with regard to channel structure,
Supply Chain Performance Measurement and Financial Analysis 165
Chapter 5

Effective order management not only reduces supply chain costs but also supports Figure 5-13 1 CLGN Book Balance Sheet: December 31, 2007
increased revenue, the combined effect resulting in a higher ROA. Reducing stockouts
implies that sufficient inventories are available to meet demand. Optimizing the order SYMBOL (000)
fill rate implies a reduction in the order-to-cash cycle, which reduces the accounts re-
ceivable collection time. Reductions in the order processing times, coupled with a re- Assets
duction in the length of credit period extended to customers, reduce accounts payable
and the cost of capital required to fund accounts payable. All of these reductions in Cash CA $ 15,000

time improve the ROA. Accounts receivable AR 30,000

Finally, reducing transportation transit time and the variability of transit time will Inventory IN 10,000
have a positive impact on revenues as well as on inventory levels. By providing short,
consistent transit time, a seller can differentiate its product in the market by lowering Tota! current assets TCA CA+AR+IN $ 55,000
the buyer's inventories and stockout costs. This product differentiation should produce Net fixed assets FA 90,000
increased revenues and a potential for increased profits. Modal optimization affords
the opportunity to lower transportation cost by utilizing a lower-cost method of trans- Total assets TA-FA+TCA $145,000
portation that does not increase other costs above the transportation cost savings.
Transportation management decisions, then, offer the opportunity to increase reve-
nues and lower inventories and costs, resulting in a higher ROA. Current liabilities CL $ 65,000
Long term debt LTD 35,000
Total liabilities TO CL+ LTD $100,000
Financial Statements
Attention must now be given to two very important financial statements: the Stockholders' equity SE 45,000
income statement and the balance sheet. The data contained in the Supply Chain Total liabilities and equity TLE TD+SE $145,000
Profile for CLGN Book will be used in this section. Figure 5-12
contains the CLGN income statement, and Figure 5-13 shows the balance sheet for
CLGN. Both financial statements have bee! .
program, and the symbol column . d' 1 phrepared usmg a spreadsheet software
m Kates t e symbol d/ .
eac o t e entries. an or equatiOn used for
Figure 5-12 \ CLGN Book Income Statement: 2007 h f h

(000) CLGN's income statement shows a net income (N .

(000) $150 million, a profit margin of 7 . G I) of $10.5 million on sales (S) of
t f percent. ross margin (GM) . db
cos o goods sold (CGS) from sales (S) E . . IS oun y subtracting
gross margin minus total operating cost. (;~~mg~ be~ore mterest ~nd taxes (EBIT) are
80,000 est cost (!NT) and taxes (TX) Th 1 ).. et mcome (NI) IS EBIT minus inter-
Cost of goods sold CGS warehousing (WC) and . . e supp y cham costs include transportation (TC)
$ 70,000 . , mventory carrymg cost (!C) I . ,
GM~S- CGS to average mventory (IN) times th . . . nventory carrymg cost is equal
Gross margin e mventory carrymg cost rate (W)
TC The balance
. sheet in Figure 5- 13 m . d.!Cates CLGN utilized t t. I
1,500 $145 m illwn to generate $150 million in al . o a assets (TA) of
warehousing we of cash (CA), $30 million of s es. Total assets (TA) consist of $15 million
accounts receivable (AR) $10 'II'
3,000 an 90 million of net fixed assets FA , mi wn of inventory (IN),
and stockholders' equity; that is, th~ $;~~:~~i~:~t; were financed by debt (liabilities)
Inventory carrying
Other operating cost ooc millwn of current liabilities (CL) a d $35 ill' total debt (TD), consiStmg of $65
40,500 million of stockholders' equity (SE)n 'd r mhwn of long-term debt (LTD), plus $45
TOG~ TC+ WC+ IC+ OOC pal j_or t ese assets.
Total operating cost
$ 29,500
Earnings before interest
and taxes
TX ~ (8/T- INTl x 0.4 to determme the impacts of alternativ gur 1 d 5 13, an analysis can be undertaken
$ 10,500 to improve CLGN's profitability. Th:~~pp y cham actwns available to Lauren Fishbay
Nl sic supply cham alternatives are reductions in
Net income
Supply Chain Performance Measurement and Financial Analysis 167
Chapter 5

or a profit margin of7.0 percent. CLGN utilized $145 million in assets to produce this
. . and inventory costs. To determine the sup.ply
the areas of transportatiOn, warehousm~al, . t d then the focus of initial profit lffi- profit, thereby generating a return on assets of 7.24 percent. The inventory turn rate
1 t financl lmpac an d . . for 2007 was 8.0, transportation costs were 4.0 percent of sales, warehousing costs were
chain area that affords th e d k f the effect of a 10 percent re uctwn m
cc nalysis 1s un erta en o . 1.0 percent of sales, and inventory carrying costs were 2.0 percent of sales.
provement euorts, an a . d 10 percent reduction in mventory.
. d warehousmg costs an a
transportation an d ct,on in transportation If CLGN can reduce transportation costs by 10 percent, net income will increase
. . t fa 10 percent re u
Figure 5-14 shows the fmanCla1 llllpac o f$10 5 million on sales of$150 million, $360,000 to $10,860,000, and the profit margin will increase to 7.24 percent. ROA will
. c 2007 CLGN had a net mcome o . increase from 7.24 percent to 7.49 percent. Transportation costs as a percent of sales
costs. F1rst, 1or ,
will decrease from 4.0 percent to 3.6 percent. Warehousing and inventory carrying
costs as a percent of sales will not change (assuming the transportation changes do not
Financial impact of a 10 Percent Reduction in Transportation Cost result in longer or undependable transit times that would cause inventory levels to
Figure 5-14 \ increase).
CLGN, 2001 $(000)
SYMBOL lD PERCENT Figures 5-15 and 5-16 show the results of a similar analysis of a 10 percent reduc-
tion in warehousing costs and a 10 percent reduction in inventory. In each case, the
$150,000 comparison is made to the 2007 CLGN performance; that is, transportation cost and
s 80,000 inventory are computed at the 2007 level when the 10 percent warehouse cost reduc-
CGS tion is analyzed. As would be expected, the reduction in warehousing cost and inven-
cost of goods sold $ 70,000
$ 70,000 tory results in increases in profits, profit margin, and ROA.
Gross margin $5,400
$ 6,000 The analyses contained in Figures 5-14 to 5-16 provide the input data necessary to
Transportation 1,500 answer the question regarding which of the basic supply chain alternatives will provide
we the greatest potential for increased profitability. Figure 5-17 contains a comparison of
Warehousing 3,000
3,000 the financial results of the alternative supply chain strategies just examined.
!C !NxW
Inventory carrying 30,000 From Figure 5-17, it is evident that CLGN's profit margin will be increased the
ooc greatest amount by utilizing a supply chain alternative that reduces transportation
other operating cost $ 39,900
$ 40,500 costs. This is to be expected, because transportation cost is a larger percentage of sales
Total operating cost $ 30,100 than the other two supply chain functional areas: 4.00 percent of sales versus 1.0 per-
$ 29,500
EBIT cent and 2.0 percent for warehousing and inventory, respectively. If the cost to CLGN
Earnings before interest and taxes $ 12,000
!NT $ 12,000 to realize a 10 percent reduction in these functional areas is the same, it is prudent for
Interest 7,240 Lauren Fishbay to dedicate her resources and efforts to realizing a reduction in trans-
TX portation costs.
Taxes $ 10,860
Nf $ 10,500
The largest increase in ROA was generated by the transportation alternative. How-
Net income
ever, the inventory reduction alternative increased ROA by almost the same amount:
Asset Deployment $ 10,000 7.49 percent versus 7.42 percent. The financial benefit of an inventory reduction is
IN $ 10,000
twofold: (1) a reduction in the inventory carrying cost and (2) a reduction in assets.
Inventory 30,000
30,000 Annual inventory turns are increased with the inventory reduction strategy, requiring
Accounts receivable 15,000 CLGN to utilize less capital for inventory and malting more capital available for other
CA uses in the organization. Thus, an inventory reduction strategy has a double effect on
Cash 90,000
90,000 ROA by increasing profits and reducing assets deployed.
Fixed assets $145,000
$145,000 Another methodology available to perform the same fmancial analysis is the strate-
Total assets gic profit model (SPM). The SPM makes the same calculations that were made in the
spreadsheet analysis. Figure 5-18 contains the SPM for CLGN for 2007 operations and
Ratio Analysis 7.24% the 10 percent transportation cost reduction.
Profit margin 7.49% The SPM shows the same results as those calculated in Figure 5-14. Two ratios were
NIITA added to the SPM -asset turnover and return on equity. Asset turnover is the ratio of
Return on assets 8.00
8.00 sales to total assets and indicates how the organization is utilizing its assets in relation
Inventory turns/year 3.60% to sales. Return on equity indicates the return the stockholders are realizing on their
Transportation as percentage of sales
ras equity in the organization. Asset turnover was 103 percent for both scenarios, but re-
1.00% turn on equity increased from 23.33 percent ($10,500/$45,000) for the CLGN 2007
Warehousing as percentage of sales
Inventory carrying as percentage of sales
Supply Chain Performance Measurement and Financial Analysis 169
Chapter 5

servi~e Imphcatwns accompanying the

capital required to achieve the reduction and the . . . .
changes. For example, to accomplish the t
scenario to 24.13 percent ($10,860/$45,000) with the reduced transportation cost
have to revert to a mode of transportation t~~~;~::~on c~streduction, CLGN_ mi.ght
scenario. pact on customer satisfaction and result . l l r. This could have a negative Im-
The preceding analysis and its conclusion examine only the returns from the alterna- .gh
m ower sa es Or the
t require the expenditure of $500 000 . , ~areh ouse cost reduction
tive actions. The risks associated with each must also be considered. The conclusions that increases the assets deployed and ;educ:r t~~t~~~~d
matenals handling equipment
that cannot be made from the preceding analysis are those regarding the risks associated
with the added cost necessary to realize the functional cost reductions, the additional

Figure 5-16 Financial Impact of a 10 Percent Reduction in Inventory

Financial Impact of a 10 Percent Reduction in Warehousing Costs
SYMBOl ClGN, 2007 $(000)
Sales s $150,000 $150,000
s $150,000
Sales Cost of goods sold CGS 80,000 80,000
Cost of goods sold
CGS Gross margin GM s CGS $ 70,000 $ 70,000
$ 70,000
GM~ S- CGS $ 70,000
Gross margin Transportation TC $ 6,000 $ 6,000
$ 6,000
$ 6,000
Warehousing we 1,500 1,500
we 1,500
Warehousing Inventory carrying /C /NxW 3,000 2,700
Inventory carrying Other operating cost ooc 30,000 30,000
ooc 30,000
other operating cost Total operating cost TOG $ 40,500 $ 40,200
$ 40,350
TOG $ 40,500
Total operating cost Earnings before interest and taxes EBIT $ 29,500 $ 29,800
$ 29,500 $ 29,650
EBIT Interest /NT $ 12,000 $ 12,000
Earnings before interest and taxes
$ 12,000
/NT $ 12,000
Interest Taxes TX 7,000 7,120
Taxes Net income Nl $ 10,500 $ 10,680
$ 10,590
Nl $ 10,500
Net income Asset Deployment

Asset Deployment Inventory IN $ 10,000 $ 9,000

$ 10,000
$ 10,000
Inventory Accounts receivable AR 30,000 30,000
AR 30,000
Accounts receivable Cash CA 15,000 15,000
Cash Fixed assets FA 90,000 90,000
FA 90,000
Fixed assets Total assets TA $145,000 $144,000
TA $145,000
Total assets Ratio Analysis

Ratio Analysis Profit margin NilS 7.00% 7.12%

NilS Return on assets NIITA 7.24% 7.42%
Profit margin
NIITA Inventory turns/year CGS/IN 8.00 8.89
Return on assets
Inventory turns/year Transportation as percentage of sales ras 4.00% 4.00%
TCIS 4.00%
Transportation as percen?age of sales Warehousing as percentage of sales WC/S 1.00% 1.00%
WCIS 1.00%
Warehousing as percentage of sales Inventory carrying as percentage of sales /CIS 2.00% 1.80%
Inventory carrying as percentage of sales
Supply Chain Performance Measurement and Financial Analysis 171

Chapter 5

Comparison of Supply Chain Alternatives

7.24% 7.06%
Profit margin 7.42%
7.49% 7.30%
Return on assets 8.89
8.00 8.00
Inventory turns/year 4.00%
3.60% 4.00%
Transportation as percentage of sales 1.00%
1.00% 0.90%
Warehousing as percentage of sales 1.80%
2.00% 2.00%
Inventory carrying as percentage of sales

The preceding issues can be added to the financial analysis presented. For example,
the added cost associated with reengineering the warehouse or any additional invest-
ment in fixed warehouse assets such as facilities or equipment can be added to the fi-
nancial analysis along with the resulting warehouse cost savings.
Given the financial analysis and the preceding caveats, CLGN has a better insight
into the supply chain areas that will result in the greatest improvement in profitability

and the accompanying risks (costs). The next section addresses the fmancial implica- ~
tions of CLGN's supply chain service failures. c.
c 0
0 17i
~ 0
0 u

Supply Chain Service Financial Implications 'C

~ o"'

As noted in the Supply Chain Proflle, CLGN Book has experienced 'C <E0 0

" 0 c
service failures in the areas of on-time deliveries and order fill rates. The 95 percent 00
"' 00

z ~
"' "'
on-time delivery rate means that only 95 percent of CLGN orders are delivered when ~
"' "'
promised (on-time delivery). Also, only 97 percent of the orders are filled correctly. D

The alternative view of this service is that 5 percent of the orders are delivered after the

0 0

promised delivery date and 3 percent of the orders are ftlled incorrectly. "'
0 '
0,.._ 00 n
-~ "'
The results of these supply chain service failures are added to the cost to correct the ~
~ "' D

a; "' tl0
rl c
problem and lost sales. Figure 5-19 shows the methodology for determining the cost of "
s 0 0 0 ~
0 0 0 0

""" "'""


u -
::;;; 0
service failures. When supply chain service failures occur, a portion of the customers 00
"' v 'U

experiencing the service failure will request that the orders be corrected and the others
~ "'
~ "
will refuse the orders. The refused orders represent lost sales revenue (refused orders ~ "" ~

times revenue per order) that must be deducted from total sales. For the rectified orders, Sn m

2l 0 0

the customers might request an invoice deduction to compensate them for any inconve- 0 0 M

- ~ 0
"'- 'v
nience or added costs. Finally, the seller incurs a rehandling cost associated with cor- 0
<>0 rl Cil ~
recting the order such as reshipping the correct items and returning the incorrect and :3u -~ n0
tl0 v

0 u m
00 0 00 0 t;- 0 v ~
refused items (rectified orders plus refused orders times rehandling cost per order). 0 u 0 0

.,' ~ ~v " "E
- -

Referring to the data provided in the Supply Chain Proftle for CLGN's on-time de- ._


0 -B"
s ~
u 0 <
livery and order fill rates, the fmancial impact of improving these two supply chain
service metrics is given in Figures 5-20 and 5-21. Assume that there are 1.5 million
"' >--'
orders for the year, the average revenue per order is $100, and the cost of goods per or-
der is $53.33. Also, the lost sales rate for on-time delivery failure is 10 percent and, for
urt~mnr. RATE 55%
$ 30,000,000
$ 30,000,000
other operating cost
$ 42,300
$ 42,000,000
Total operating cost
$ 26,884,980
$ 26,979,975 g
Earnings before interest
and taxes $ 3,000,000
$ 3,000,000 "'
9,591,990 $ 9,553,992
Tax (40% x CEBIT -!NT))
$ 14,330,988
$ 14,387,985
Nl~ 8/T -/NT- TX
Net income
Profit increase of 1% improvement

Figure 5-21 I Financial Impact of Improving Order Fill Rate I ~



Annual orders AO 1,500,000 1,500,000 %CF 97% 98% I "'3


Orders filled correctly OFC~AOx %CF 1,455,000 1,470,000 Annual orders 1,500,000 1,500,000 I n

Service failure orders SF~ AO- OFC 45,000 30,000 SP= Revenue/order $ 100 $ 100 ~
lost sales orders LS~ SFx LSR 9,000 6,000 CG =Cost of goods/order $ 53.33 $ 53.33 ~

Rectified orders RO~SF-LS 36,000 24,000 Lost sales rate 20% 20% I

Net orders sold NOS~AO- LS 1,491,000 1,494,000 RCO= Rehandling costlorder $ 20 $ 20 I ~

Sales s~ SPx AO $150,000,000 $150,000,000 /DR= Invoice deduction rate $ 10 $ 10 I ~


Less: Invoice deduction 10~ IDRx RO $ 360,000 $ 240,000 Transportation cost $ 6,000,000 $ 6,000,000

lost sales revenue LSR~ LSx SP $ 900,000 $ 600,000 Warehousing cost $ 1,500,000 $ 1,600,000

Net sales NS~ S-ID- LSR $148,740,000 $149,160,000 Interest cost $ 3,000,000 $ 3,000,000

Cost of goods sold CGS~ CGx CNOS) $ 79,515,030 $ 79,675,020 Other operating cost $30,000,000 $30,000,000

Gross margin (GM) GM~ NS- CGS $ 69,224,970 $ 69,484,980 Inventory $10,000,000 $10,000,000

Rehandling cost RC~ RCOx SF $ 900,000 $ 600,000 Cash $15,000,000 $15,000,000

Transportation TC $ 6,000,000 $ 6,000,000 Accounts receivable $30,000,000 $30,000,000

Warehousing we $ 1,500,000 $ 1,600,000 Fixed assets $90,000,000 $90,000,000

Inventory carrying IC~ /Nx W $ 3,000,000 $ 3,000,000 W= Inventory carrying rate 30% 30%


Chapter 5
Supply Chain Performance Measurement and Financial Analysis

Supply Chain
Technology Metrics for Measuring Your
Software's Success
M etrics are not only keeping tabs on internal and supplier performance, but they are also
proving useful for tracking pertormance of the transportation management systems (TMS)
and warehouse management systems (WMS) software itself. "An example of this trend," says
Adrian Gonzalez, director of ARC Advisory Group's Logistics Executive Council, "is Descartes
Systems Group's "Descartes Challenge" offer for potential customers to "test drive" its

"Customers who take the Descartes Challenge pay only for the implementation, then pay
for the solution itself later, once its value has been proven," explains Gonzalez. "The measure-
ments used to evaluate the software's pertormance are different than those for supplier pertor-
mance, but the analogy is valid," he says.


m &l
"Software vendors are saying, 'Here are certain metrics that we're going to put in place to
~ c5
0 cz 0 c0 0 <0 prove our value,"' says Gonzalez, who points to cost reduction and delivery improvements as
" "
0 N N o_ ~ ~ N
two areas where vendors are vying to prove themselves. Some vendors also are including
=' ~-

"' "'
"' "' "' "' "'
~ ~
payment-for-performance "milestones" in their customer agreements. When those predeter-
mined improvements, which are tracked and monitored via a metrics-based system, have been

attained, the customer shells out another installment payment.

"Expect to see more vendors using these metrics-based models in the future," forecasts
Gonzalez, who believes the pay-for-pertormance approach will gain popularity among shippers.

00 "The metrics help paint the 'before and after' picture and assist the vendor and the user in
~ c5
m getting to that goal," he says. "!hat in turn triggers the customer's decision on whether they
co_ o_ :13 want to implement the system or not."
:::! 0
c5 "- "'
m "-
"' " "
"' N ~

Source: Bridget McRea, "Metrics Take Center Stage," Logistics Management {January 2006): p. 42.
"' "' "' "' "' "'
~ Reproduced by permission.

r< Examination of Figure 5-21 shows that the $100,000 cost to provide training to the
0 I warehouse personnel will improve the order fill rate from 97 percent to 98 percent and
::' f-
'S result in an increase in net income of $276,006. The combined savings of $420,000
I (rehandling cost saving of $300,000 and invoice deductions saving of $120,000) are
[jj greater than the additional training cost of$100,000.

Given the two options~improve on-time delivery or order fill rate-CLGN would
0 0 f- II
0 ::' [jj 'S r< 2
be advised to implement the order fill improvement strategy.

The SPM for these two alternatives are given in Figures 5-22 and 5-23. The profit
~ c margin, ROA, and return on stockholders' equity are greater with the order fill rate
"'"'=> ~

E improvement strategy than with the on-time delivery improvement strategy. For the
= ~
order fill rate improvement from 97 percent to 98 percent, the ROE increases to 33.71
~ =

. percent from 33.10 percent, the profit margin increases to 10.17 percent from 10.01
<f. percent, and the ROA increases to 10.46 percent from 10.27 percent.
'=""" ..,'="""

c c .'1
u u t:: 0
!!! !el ~
The financial goal for supply chain management is to increase return to stock-
c ~

~ ~
X ~
holders. Examining alternative courses of action in light of the bottom-line impact (net
if< E l3
g>, c income) and resultant ROE accomplishes this goal.
"'6'. =;; "'="
~ ~
~ c
=E '2l"
!!! s u

Li: 5
>- w
" z "-
Strategic Profit Model for On-Time Delivery Improvement
Figure 5-22

Gross margin

COGS ----

/ Net profit
$79,675,020 "'
Net profit margin

Logistics costs 9.68%

Sales 9.63%
Total costs $148,575,000
$54,591,990 ~
Return on equity
$54,853,992 Return on assets


Current assets

Accts. receivable

Fixed assets

Cash $90,000,000


Note: Numbers above diagonal are for 95 percent on-time, and below are for 96 percent.

Figure 5-23 Strategic Profit Model for Order Fill Rate Improvement


$148,740,000 "

Gross margin ~
Sl49,160,000 ~
$69,484,980 "'
$79,515,030 c
$79,675,020 Net profit m
$14,894,982 =

Logistics costs $15,170,988 Net profit margin


$11,400,000 10.01%
Sales ~
Total costs S'
$ 11,200,000 10.17% ~

Other costs
$54,329,988 ,.,
_,/'"" Return on assets Return on equity


Current assets Asset turnover
Accts. receivable
Total assets
I<~'""""" ,..~~ 102.9%



Note: Numbers above diagonal are for 97 percent order fill, and below are for 98 percent
Supply Chain Performance Measurement and F.manc1al
. Analys 1.s 181
Chapter 5

Inventory carrying cost ""' 28%

Performance measurement for logistics systems and, especially, for supply chains is
Cost of goods sold ~ $70,000,000
Other operating costs ~ $65,000,000
necessary but challenging because of their complexity and scope.
Certain characteristics should be incorporated into good metrics-be quantitative, Average inventory~ $10,000,000
be easy to understand, involve employee input, and have economies of effort.
Accounts receivable ~ $30,000,000
Important guidelines for metric development for logistics and supply chains include
consistency with corporate strategy, focus on customer needs, careful selection and Cash~ $15,000,000
prioritization of metrics, focus on processes, use of a balanced approach, and use of
Net fixed assets ~ $90,000,000
technology to improve measurement effectiveness.
There are four principal categories for performance metrics: time, quality, cost, and Interest~ $10,000,000
miscellaneous or support. Another classification for logistics and supply chains sug-
gests the following categories for metrics: operations cost, service, revenue or value, Taxes~ 40% of (EBIT- Interest)
and channel satisfaction. Current liabilities ~ $65,000,000
The equivalent sales increase for supply chain cost saving is found by dividing the
Long-term liabilities~ $35,000,000
cost saving by the organization's profit margin.
Supply chain management impacts ROA via decisions regarding channel structure Stockholders' equity ~ $45,000,000
management, inventory management, order management, and transportation
6. Using the supply chain finance model develo ed for .
management. the nnpact on profit margin ROA . P Study QuestiOn 5, calculate
Alternative supply chain decisions should be made in light of the financial implica- d ' ' mventory turns and tr .
mg, an mventory costs as a perce t f , ansportatwn, warehous-
tions to net income, ROA, and ROE. Tr . n age o revenue for the following scenarios:
The SPM shows the relationship of sales, costs, assets, and equity; it can trace the fi-
ansportatwn costs increase= 15%
nancial impact of a change in any one of these fmancial elements.
Supply chain service failures result in lost sales and rehandling costs. The financial Warehousing costs increase= 15%
impact of modifications to supply chain service can be analyzed using the SPM. Average inventory increase""' 15%
Warehousing is outsourced with:
STUDY QUESTIONS Net fixed assets reduced~ 15%
1. "Performance measurement for logistics managers is relatively recent. Their focus
was previously directed toward other managerial activities." Do you agree or dis- Inventory reduced = 5%
agree with these statements? Explain your position. Warehousing costs ~ $O
2. What role should employees, in general, play in the development of performance Outsourcing provider costs~ $1,200,000
metrics? Why is this role important?
7. Develop
and 6. a strategic model to depiCt
. the scenarios given in Study Questions 5
3. "Metrics must focus upon customer needs and expectations." Explain the meaning
of this statement. Why have customers become more important for performance
measurement? What role, if any, should customers play in developing supply B. ~on~truct a fmancial model to determine the re . .
mvmce deduction cost and t . dehvery/rehandlmg cost lost sales
, ne mcome for the following: , ,
chain metrics?
4. It is generally recognized that organizations go through several phases on the path a. On-time delivery increases from 98 ercent t
to developing appropriate supply chain metrics. Discuss the stages of supply devel- crease in transportation cost P o 99 percent with a 2 percent in-
opment for supply chain metrics. Choose which of the stages of evolution you Order fill rate
b. remaining decreases fro m 99 percent to 98 percent with operating cost
think would be most challenging for an organization. Explain your choice. constant.

5. Using a spreadsheet computer software program, construct a supply chain finance Selling price/order~ $!50/order
model and calculate the profit margin; ROA; inventory turns; and transportation,
warehousing, and inventory costs as a percentage of revenue for the following: Gross profit/order~ $35/order
Lost sales rate:
Sales ~ $200,000,000
On-time delivery failure= 20%
Transportation cost ~ $7,000,000
Order fill failure ~ 25%
Warehousing cost~ $1,600,000
Supply Chain Performance Measurement and Financial Analysis 183
Chapter 5

Annual orders ~ 200,000

CASE 5-1
Rehandling cost~ $100/order CPDW
Invoice deduction/service failure~ $75/order
Harry Groves, CEO of Central PA Distribution and Warehouse (CPDW), had just
Transportation cost~ $1,000,000 called the monthly meeting of the board of directors of CPDW to order. Harry looked
tired and grim, thought Joe Zimmerman (a local entrepreneur and board member).
Average inventory~ $1,000,000
Harry's opening statement gave reason for the body language. CPDW had another dis-
Interest cost~ $1,500,000 mal month that was delineated in the monthly financial statements and Harry's de-
scription of monthly activities.
Inventory carrying cost rate ~ 25%/$/yr.
Warehousing cost ~ $750,000 Company Background
CPDW is located in Milroy, Pennsylvania, adjacent to an interchange on a major
Other operating cost ~ $500,000
east-west roadway in central Pennsylvania. The company was founded five years ago
Cash ~ $3,000,000 by a group of individuals who owned local businesses or held management positions in
local companies. The board members were all limited partners in the venture so they
Accounts receivable ~ $4,000,000
had a very special interest in the financial viability of the organization.
Fixed assets ~ $30,000,000
The partners, under the leadership of Harry Groves, had purchased a building
(120,000 square feet) and parcel ofland (32.6 acres) from the Sanyo Corporation. The
NOTES building had been used primarily as a manufacturing facility by Sanyo. The partners
S Davis Center for Supply Chain Research, Penn State University (2007).
1. Thomas . , purchased the building with the express purpose of utilizing it as a distribution facility
S Davis "Developing a Supply Chain Performance Metrics for providing logistics services for companies within central Pennsylvania. While the
2. Robert A.,Novacbklanhd J~~~=~ch. Cent~r for Supply Chain Research, Penn State building was not ideal for storage because of the ceiling height, the partners believed
Program, unpu IS e
University (2007). that it was versatile enough to be used for various logistics activities including repack-
aging, order fulfillment, reverse logistics, etc.
3. Ibid.
The paradox of the situation was that the facility was completely filled with pallet
4. Ibid.
loads of glass from a local glass manufacturer. In fact, the original estimate on useable
5. Ibid. storage space, excluding aisles, offices, restrooms, etc., was 99,500 square feet. How-
ever, )on Parton, COO of the company, had pushed and squeezed until they were uti-
6. Ibid.
lizing 110,000 square feet.
7. Ibid.
N ack and Douglas J. Thomas, "The Challenges of Implementing the Pertect Order Con-. Board Meeting
~~~t~'~ t~nZ;ortation Journal, Vol. 43, No. 1 (Winter 2004): 5---16. After reviewing the usage rate, Jay Lenard asked Harry for some additional insight into their
9. SCOR Model (Pittsburgh, PA The Supply Chain Council, 2005) 297. situation. He prefaced his question with the comment, "I thought that we wanted to fill the
facility and in doing so, we would be profitable. When I look at square foot utilization,
which I thought was our best performance metric, I'm pleased, but you are telling us that
this is a problem. I just don't understand our financial situation based on this metric."
Harry let out a sigh and said, ")ay, I really wish it was that easy. I have come to real-
ize that our base metric for pricing square feet of space utilized is too narrow. With our
current situation, even though we are using more square feet than I thought we had
available, thanks to )on, we are not breaking even. When the building is full and noth-
ing is moving in or out, we are in trouble. We need to change our metrics and align
them with a new pricing strategy."

1. Describe the nature of CPDW's problem.
2. What metrics would you recommend that CPDW use to enhance its pricing strat-
egy? Provide a rationale for your recommendations.
Supply Chain Peliormance Measurement and Financial Analysis 185
Chapter 5

CASE 5-2
Financial Terms Account receivable A current asset showing
. the amount of sales currently owed by a is one of the many new firms that have a presence on the Web. It spe- customer.
cializes in manufacturing and selling one type of high-end DVD player. By purchasing
Balance sheet A snapshot of everythin the
large volumes from a small number of suppliers, it receives a significant quantity dis- nanc:al year in question. g company owes and owns at the end of the fi-
count This reduced cost is passed on to its customer. manages to sell
its DVD player for $200 less than all of its high-end competitors, thereby creating its Cash cycle Time between payment of inventor .
Cash flow statement Show h . y and collect:on of cash from receivables.
f .. s cas rece:pts and pa t f
competitive advantage. . . ymen s rom all company financial ac- receives 112,000 orders for DVD players annually. Each DVD
t f
earnings before interest taxes d
, , eprec~at:on, and amortization (EBITDA)
os o goods sold Total cost of the ood .
player sells for $500, of which $200 is retained as gross profit. Last year, it filled 97 per- Cost of lost sales The sh rt f g s sold to customers during the period.
cent of all orders correctly. Of the orders filled incorrectly, estimates C o -run orgone profit associated with a stockout
that 20 percent of the customers cancel the order and the remainder will accept a sec- urrent
ing cycle. assets Cash and other ass ets that will
. be converted into cash during
. one operat-
ond shipment, which results in a rehandling cost of $20 per order. To maintain cus-
tomer goodwill, the firm gives a $35 invoice reduction for all units rehandled. liabilities
Currentone An obligation that mu st be pa:d
. dunng
. the normal operating cycle,
usually year. pays $1,950,000 annually for the transportation of its materials
and delivery of its products. Its warehousing costs average $1,460,000 annually for the Current ratio Current assets divided b cu . . ..
pay short-term debt with assets easl y rrent l:ab:l:t:es; measures company's ability to
storage of its materials. has $30 million of debt outstandlng at an an- ' Yconverted to cash.
nual interest rate of 10 percent. The total cost for all selling and general administrative ~ebt:to-equity ratio Long-term debt divided by shareholders' equity
expenses (other operating costs) comes to $750,000, and $50,000 is held in cash at all arnmgs
ing costs. before interest and !axes {E BIT) Sales minus
. .
cost of goods sold and operat-
times. has an average inventory of $5 million. This large inventory is par- Earnings per share Net earnings divided by avera e
Gross margin Sales minus t f g number of shares outstanding.
tially attributed to its purchasing policy and also to its inventory management system. cos o goods sold.
The inventory carrying cost rate is estimated at 25 percent of the average inventory
Income ~t~tement Summarizes revenues and ex .
value per year. Its accounts receivable averages $250,000 throughout the year primarily for a specific accounting period. penses, reportmg the net income or loss
due to sales to medium-sized retailers. has a large fixed asset base. It
. carryi ng cost The annual cost of h ld. .
is comprised of land, the manufacturing facility, machinery, and various administrative Inventory times the inventory carrying cost rate(~). mg :nventory; the value of the average
offices that are valued at $64 million. Inventory carrying cost rate {W) The cost of h . . has explored a variety of options to improve its correct order fill ally expressed as a percentage includ t old:ng $1 of mventory for one year usu-
space. ' es cos of capital, risk, item servicing, and st,orage
rate. It is also interested in lowering its average inventory to improve its overall profit-
ability. After weeks of presentations and heated debates, the decision is made to out-
~ve~t~ry turns Cost of goods sold divided by average inventory
source its warehousing operations and inventory management. Many third-party
:quodoty ratio Cash flow from operations divided b ..
logistics providers bid for the contract; in the end, it is awarded to Basileo Logistics for term cash available to pay current liabilities. y current liabilities; measures short-
an annual cost of $500,000 (this is classified as other operating cost). By outsourcing, manages to save $760,000 in warehousing expenses, reduces its aver- Net income {or loss) Final result of all rev .
mmus cost of goods sold operating cost . t enue and expense Jtems for a period sales
age inventory by 30 percent, and now meets its 99 percent correct order fill rate. All . ' s, In erest, and taxes. '
Operatmg expense
and income tax. Ever ex e
y p nse other than cost of goods sold, depreciation, interest,
other costs remain the same. The tax rate is 40 percent.

Operating ratio Percentage of revenues used .

CASE QUESTIONS by operating income. for operations; operating expenses divided
As the supply chaln management analyst at
receivables. cycle Time between receiving customer orders and collection of
1. Calculate the net savings of the outsourcing of the warehousing and inventory
management to Basileo Logistics. Profit margin Net income divided by sales.
2. Develop a strategic profit model of both the old system and the modified system of Return on assets Net income divided by total assets
reflecting the required adjustments.'s net worth is $30 million. Return on equity Net mcome d:v:ded
by average stockholders' equity.
Cllapter 5

. een the value of all the things owned by the

Shareholder's equity The difference bet~ b the company; the investment made by the Cha er 6
company and the value of all the thmgs owe lly issued plus all past earnings that have not
stockholders atthetime the stock ;~slor;g~~~r~holders' investment in a company smce it
been paid out m diVIdend:';. ~um o a o SUPPLY CHAIN TECHNOLOGY-MANAGING
was formed, minus its liabilities. . r blf . working capital finances the
Working capital Current assets ml~us current Ia I I leS, INFORMATION flOWS
business by converting goods and services to cash.

learning Objectives
After reading this chapter, you should be able to do the following:
Appreciate the overall importance of information to supply chain
Understand the role of information technology in the supply chain.
Explain the key components of an integrated supply chain information
Describe and differentiate between the primary types of supply chain
solutions and their capabilities.
Discuss the critical issues in technology selection and implementation
Recognize the role of emerging technologies for improving supply chain
information management.

86 Chapter 5

Shareholder's equity The difference between the value of all the things owned by the
company and the value of all the things owed by the company; the investment made by the
stockholders at the time the stock was originally issued plus all past earnings that have not
been paid out in dividends; sum total of shareholders' investment in a company since it
was formed, minus its liabilities. SUPPLY CHAl N TECH NOLO GY-MANAG IN G
Working capital Current assets minus current liabilities; working capital finances the
business by converting goods and services to cash. INFORMATION FLOWS

Learning Objectives
After reading this chapter, you should be able to do the following:
Appreciate the overall importance of information to supply chain
Understand the role of information technology in the supply chain.
Explain the key components of an integrated supply chain information
Describe and differentiate between the primary types of supply chain
solutions and their capabilities.
Discuss the critical issues in technology selection and implementation
Recognize the role of emerging technologies for improving supply chain
information management.

8 Chapter 6 Chain Technology-Managing Information Flows 189

Supply Chain Respect the Bottom Line

Profile Kn>WleOise is essential for supply chain success. Information, along with materials and
m<mev, must readily flow across the supply chain to enable the planning, execution,
Fast-food retail chain Wendy's International, Inc., is implementing new technology tools that al- evaluation of key functions. Each participant in the supply chain needs relevant
low inventory managers to look at individual restaurants. ljnformat'ion to make effective forecasts and operational decisions as highlighted by the
"We're trying to get as granular as possible," states Tony Scherer, director of supply chain Chain Profile. For example, timely, accurate information regarding the demand
management with Wendy's, "but mostly we're looking at tools to forecast demand in an area of Apple iPods is needed by retailers to order more products, by Apple to schedule
40 to 50 stores. Overall, our total volume might be predictable, but different regions vary production and purchase needed components from suppliers, and by contract
greatly. For lll'ample, while ski season heats up in the Rockies, eastern markets tend to slow 1ll:mttfac:tmus to assemble additional iPods. If each organization in the supply chain
down in colder weather. Regional volume differences make it difficult to do a general forecast, to operate without this sales information, it would be very difficult to maintain a
but we can predict seasonality and note different patterns for different locations." flow of the right quantities of the right components and models. A shortage of
sellers and overage of unwanted models would be the consequence of such poor
To date, Scherer's team has rolled out a restaurant forecasting tool to about 20 percent of
the chain's 6,000 stores. The tool allows individual stores to receive a weekly forecast based on
i infonnation flows.
historic sales data. It forecasts volume of sales per product every half hour throughout each Fortunately, existing supply chain information teclmologies support timely, cost-
day. While the original purpose of the forecasting tool was to better plan labor needs, it has al- sharing of information between suppliers, manufacturers, intermediaries,
lowed the fast-food chain to also reduce safety stock in the store and the warehouse. lo:gistics services providers, and customers. Organizations recognize the potential value
nflhPoP tools and are investing vast sums of money to collect, analyze, and make more
Stores receive three deliveries per week and those on the new system typically maintain
eight hours of safety stock on perishable items. However, the majority of stores do not have the effective use of supply chain information. ARC Advisory Group estimates that global
automated ordering system. Those stores tend to hold two to three days safety stock on Sf<mding on supply chain management (SCM) software applications exceeded $5.5 bil-
perishables. lion in 2005 and will grow to $8.3 billion by 2010I Additional investments are being
made in radio-frequency identification (RFID) and other hardware.
"Too much inventory costs us money. We try to operate restaurants as tightly as manu-
facturers operate under just-in-time programs," Scherer states. "By implementing the technol- The changing nature of supply chains underlies the need for information and the
ogy across our network, we can greatly reduce safety stock." investment in technology. As supply chains become more global, complex, and de-
mand driven, information technologies must evolve. Staying ahead of the evolutionary
To minimize safety stock, the forecasting program generates a suggested order for the
curve requires companies to continually pursue the next level of supply chain perfor-
manager that, 90 percent of the time, the manager uses as is. However, if an individual store
mance and adopt relevant information technologies. 2 "Supply chain organizations are
manager knows that, say, a local high school football game will mean a surge in business,
under intense pressure to meet demands for greater customer intimacy, lower cost of
they can alter the order.
goods sold, and increased global business processes," says Beth Enslow, senior vice
Another piece of Wendy's' technology tool-a collaborative program-is in the testing president of research for Aberdeen Group. "To succeed, these organizations are identi-
stage. It supplies certain supply chain metrics upstream to suppliers and distributors. "We fying that they need to change their supply chain technology footprints."'
take sales data from our 6,000 restaurants and load them into a database to create 18-month
forecasts for suppliers. The forecast can be to the individual store level but more commonly it's This chapter focuses on the role of information and technology in the supply
for all stores served by a distributor," says Scherer. chain. It is intended to introduce key information issues and tools that will be ad-
dressed in further detail throughout the book We have divided the chapter into five
Wendy's' marketing group plugs factors into the forecast such as promotions past and
sections that address the following topics: the role of information in SCM, a supply
future, holidays, and seasonality. In the pilot, forecast accuracy is running about 96 percent in
chain information system framework, software solutions, technology selection, and
the shorter time frames, a major improvement over the 60-65 percent accuracy suppliers and
emerging information tools. As you will learn, effective technology for the manage-
distributors were forecasting on their own. On some items, inventory forecasts are 80 percent
ment of information flows is vital for synchronizing supply chain processes that span
accurate as far as 18 months out.
companies and countries, meet customer requirements, and create responsive supply
"With a more accurate forecast, suppliers and distributors can plan inventory more chains.
closely. Those in the pilot can plan several months in the future to avoid out of stocks," Scherer
adds. "To avoid stock outs, suppliers not in the system now carry a month worth of inventory.
With our new collaborative program, they could reduce to a week or even a half week on The Role of Information in the Supply Chain
many items. This investment should allow us to remove enough supply chain cost to give us a
It has been said that information is the lifeline of business, driving effective decisions
competitive edge," he concludes.
and actions. It is especially critical to supply chain managers because their direct line of
Source: Adapted from Helen Richardson, "Respect the Bottom line," Logistics Today{February sight to supply chain processes is very limited. Information provides them with in-
2006): 23-24. Reprinted with permission.
sights and visibility into the supply chain activities taking place at distant supplier and
customer locations. This visibility of demand, customer orders, delivery status, inven-
tory stock levels, and production schedules provides managers with the knowledge
190 Chapter 6 Technology-Managing Information Flows 191

inl'ormaLtlC>n systems that are owned by external organizations. Technical issues

Figure 6-1 Supply Chain Information Flows addressed and trust built between the organizations sharing information.

Carriers & 3PLs Supply chain managers must have pertinent information to make dedsions.
know what information is needed and be able to quickly acquire only that
applicable to their current situation. The goal is to avoid being overwhelmed
trane<Ju' data that are not useful to decision makers and waste their time. When
expediter logs on to the FedEx Web site to track a critical delivery, he doesn't
PrOduction Logistics
know about every Toyota shipment handled by FedEx that day. He wants to
assess the status of the one shipment in question and react accordingly.
Suppliers Customers
The information must be correct and depict reality; otherwise, it will be diffi-
make appropriate decisions. Information inaccuracies can lead to inventory
transportation delays, governmental penalties, and dissatisfied customers. For
major retailers rely upon their checkout clerks to accurately scan each item sold
these scans drive the replenishment system. If a clerk scans one bottle of soda
when a customer actually purchases four different flavors, the store-level
Governmental & loses accuracy and eventually the wrong product will be replenished.
Financial Institutions
The information must be up to date and available in a reasonable tirneframe.
chain managers attempt to synchronize activities, become leaner, and ad-
problems before they become crises, they need the knowledge embedded in real-
needed to make effective situational assessments and develop appropriate responses. data. Envision that a computer hardware manufacturer is experiencing quality
contrast, limited awareness of external activity would leave the supply chain m;lll<tger and must postpone shipments of 200-gigabyte hard drives. If informed in a
blind to the true situation and unable to make knowledge-driven decisions. Actions'. fashion, Dell could update its Web site so that customers could not configure
would be based on educated guesses with no guarantee of effective outcomes. 5mputers with that model. The result would be no backlog of orders or unhappy
A wide variety of information is needed for a supply chain to perform as antici- ,
pated. As you read through this book, it will become evident just how important infor- The final characteristic of information has multiple meanings. Just as
mation is for both long-range and day-to-day decision making. Supply chain
need translators to convert words from one language to another, supply chain man-
professionals require information from across the channel for strategic planning issues
need the ability to transfer supply chain data from one format to another to
such as network design, tactical planning and collaboration with supply chain partners, it understandable and useful. Information also needs to be transferred quickly
and execution of key processes. This information must effectively flow within the orga-
one location to another to facilitate accessibility and timeliness. A paper-based
nization and between key participants, as outlined in Figure 6-1, to ensure the timely
chain cannot support these requirements or a demand-driven supply chain.
flow and control of materials and money in the supply chain. information must reside in electronic formats that can be readily transmitted
converted via supply chain information technology.
Information Requirements
Information quality is a critical characteristic of the knowledge flowing across the sup-
ply chain. If you think about it, the seven R's definition of logistics applies to informa-
n Technology Capabilities
tion as much as products with some slight alterations-getting the right information to value and importance of supply chain information technology is not lost on sup-
the right partners, in the right quantity, in the right format, at the right place, at the chain leaders. Study after study of executives reveals that organizations are putting
right time, and at the right cost. Change any "right" to "wrong" and the capabilities of emphasis on information technology to help them become more competitive, in-
the decision maker will decline. Thus, information quality is paramount to effective novative, and adaptive. Their efforts are not only well intended, but they also have a
management of the supply chain. positive influence on supply chain performance. Recent research by Sanders and Pre-
mus found that information technology has a direct and positive impact on organiza-
To ensure that valuable, actionable knowledge "readily flows across the supply chain, tional performance, internal collaboration, and external collaboration.

information must be accessible, relevant, accurate, timely, and transferable.

In their ongoing research regarding trends and issues in supply chain manage-
Accessible Information must be available to supply chain managers who have a ment, Capgemini, Georgia Southern University, and the University of Tennessee have
legitimate need for it, regardless of their location or employer. For example, Whirlpool identified six drivers of excellence that are found in adaptive enterprises. These drivers
supply chain managers need access to daily sales information at Lowe's stores to are identified in Figure 6-2. Information technology supports the pursuit of these six
schedule delivery and installation of appliances. Obtaining needed information can be drivers, facilitating the evolution to highly coordinated, dynamically responsive supply
difficult because supply chain data often are dispersed among multiple locations on dif- chains. In their 2005 report, the authors recognize the link between information tech-
192 Chapter 6 Technology-Managing Information Flows 193

Properly implemented technologies help organizations rapidly respond to cus-

Figure 6-2 Six Drivers of Supply Chain Excellence requirements for faster, more consistent flows of materials and information.
chains are dynamic, and managers need tools to help them adapt to change, re-
inoblerns, and avoid disruptions. New categories of software are emerging with
;p,tbtlity to manage events dynamically, provide recommendations, and autornati-
sorne problems.
what exactly do these technology-assisted drivers of excellence do for an organi-
. When executed properly, they generate adaptive capabilities, help synchronize
t'vc:loc:ity supply chains, and serve as valuable weapons in the ongoing battle for
rim,titive advantage. AMR Research concurs in its annual identification of the Sup-
Top 25, the world's best manufacturers and retailers in terms of supply
capabilities and performance. By embracing supply chain best practices and
hnc>lof:ies, "these supply chain leaders are able to shape demand, instantly respond
changes, and crush their competitors."6

Source: Karl Manrodt, Peter Moore, and Mary Holcomb, Collaboration: Enabling Synchronized Supply
Technology Challenges
Chains: Year 2005 Report on Trends and Issues in Logistics and Transportation, New York, NY: Capgemini, previous section indicates, information technology holds great promise for en-
2005). Reproduced by permission of Karl Manrodt, Peter Moore, and Mary Holcomb.
supply chain performance and organizational competitiveness. However, the
iplemen1tati1on of new technologies and software does not guarantee success. Tech-
nology and excellence, stating: "firms that have real-time (or near real-time) inl'onna, is only an enabler. Many organizations have spent lavishly on supply chain
tion about products, customers, and order fulfillment across the supply chain are (chnolo1:ie' only to achieve limited results. Too often, organizations view information
effective and deliver customer service that surpasses their competition.'' :chnolo1:y as the solution to specific problems rather than as a facilitating tool in the
supply chain excellence. The problem is that technology cannot make ill-
Connectivity Information technology is the primary focus of this driver. C'.eoaro,,hL
iln<cei,red supply chains productive, prompt adversarial organizations to collaborate,
cally dispersed supply chain partners and facilities are linked electronically via the make use of poor quality data (as discussed earlier). In the next few paragraphs, we
ternet, extranets, and other means. These connections facilitate seamless
discuss some of the major barriers and challenges that must be addressed to make
sharing through the use of supply chain solutions and processes that are integrated chain technology work as intended.
A recent study by Computer Sciences Corporation (CSC) reveals that people are a
Visibility The critical ability to monitor what is happening across the supply chain barrier to the effective use of information technology. As Figure 6-3 reveals, half
achieved via technology. Supply chain tools generate actionable information by the study's interviewees blame a lack of understanding as the primary issue. Most
ing vast amounts of data regarding demand, inventory flows, and orders; filtering the business executives are to blame as their expectations of technology capabili-
data; and presenting it in a form that can be readily used. That is, these tend to be too high. That is, they purchase technology based on the hype and
technology tools allow users to "see" product as it flows through the supply chain. 'prc>mised benefits without real knowledge regarding how it would impact their busi-
Information technology executives also shoulder some of the blame as they do
Collaboration By virtue of providing connectivity and visibility, technology facilitates always understand the business processes for which technology is being purchased.
real-time data sharing between supply chain participants. They can use this informa-
knowing the key needs and requirements of the business unit can lead to poor
tion to make collaborative decisions regarding processes standardization and strategy
, techno:lo1:y selection and inefficient implementation.
The CSC study points to another technology use challenge that has been widely re-
Optimization A variety of software is available to help organizations maximize the Often, organizations do not change their supply chain processes concurrent
performance of supply chain activities. Optimization tools analyze all possible options with the adoption of new information technology tools. They automate existing activi-
to find the best solution to a supply chain problem, such as finding the most cost effi- ties that may well be outdated rather than improve processes or streamline the supply
cient delivery routes within a set of delivery requirement constraints. chain network to take full advantage of the technology's capabilities. While incremen-
tal productivity improvements are made, the failure to address process issues and root-
Execution Supply chain technology promotes efficient execution and integration
cause problems will limit the impact of the technology and reduce the return on
of key activities on an hourly and a daily basis to achieve operational excellence. investment.
These tools help organizations manage inventory, transportation, and other key supply
chain functions more effectively than could be accomplished manually. Operational Another challenge facing supply chain professionals is the wide variety of software
success in terms of customer service and cost control goals can also be monitored solutions that are promoted as being "supply chain" tools. Often, these software solu-
through performance measurement software. tions support the automation of individual activities to ensure optimal efficiency but
.94 Chapter 6 Technology-Managing Information Flows 195

Be prepared to change business processes.

Figure 6-3 Technology Use Barriers
Keep end users informed and involved.
Don't know The IT department's Measure success with key performance indicators (KPis). 9
l% lack of understanding
of business issues
None of these
mework for Managing Supply Chain
Business people's inabilitiy 12% ation 10
to understand what can and
can't b$ done with IT supply chain information system (SCIS) is widely used, although few for-
41% definitions exist. One such attempt describes SCIS as "information systems that
the flow of information between a firm and its suppliers to optimize the
The inability of sourcing, manufacturing, and delivery of products and services." 11 While the
business to change in provides a general idea of the needed links between key supply chain fuuc-
order to take advantage additional issues must be addressed. SCIS should also have the capacity to collect
of new capabilities
synchronize data, manage exceptions, and help streamline key processes, among
Source: Lynette Ferrara and Alex Mayall, "Successful Business Relationship Management: Collaboration for additional issues are effectively encapsulated in a model created by Capge-
Co-Creation of Value," CSC World (January/March 2006). Retrieved from
to link the traditional functional areas of the supply chain to promote visibility of
;tio>nable information and enhanced decision making. This master model for achiev-
excellence in SCM is depicted in Figure 6-4. Although it is not specifically a con-
are inadequate for managing supply chain processes across multiple orga!lizations? model of SCIS, it does identity key capabilities of a well-integrated technology
Also, supply chain technology may be implemented in piecemeal fashion, leading to a Thus, it will serve as our framework for the effective management of supply
"patchwork quilt" ()f technologies. Both issues can result in the creation of dysfunc- information.
tional information systems that do not seamlessly share information or foster demand-
responsive capabilities.
Poor planning and preparation for technology implementation is also problem- ability to capture and manage supply chain information depends upon a strong,
atic. Some organizations do not take the time to create a change management plan foundation of people, processes, and technology. All three elements
with a staged, logical approach to adopting new technologies. This can cause supply
chain disruptions and problems. For example, a furniture manufacturer's software
installation was problematic due to implementation miscues, not technical chal- Master Model of Supply Chain Excellence
lenges. The resulting manufacturing problems and shipping delays led to the first
quarterly loss in company history. 8 Other organizations fail to prepare employees for
the new technology. Limited training may lead to suboptimal use of technology as
employees do not understand the full array of software features and capabilities.
Finally, some organizations do not establish adequate budgets for technology instal-
lation and implementation.
The good news is that these challenges are not insurmountable if the organization
views technology implementation as a business improvement project rather than an
information technology project. Supply chain leaders must take an active role in the
planning, implementation, and evaluation of the new tools. They would do well to fol-
low these 10 golden rules for success compiled by Favilla and Fearne.
1. Secure the commitment of senior management. Technology
2. Remember that it is not just an information technology project.
3. Align the project with business goals.
4. Understand the software capabilities.
5. Select partners carefully. Source: Adapted from Jeff Abott, Karl Manrodt, and Peter Moore, Visibility to Action: Year 2004 Report on Trends and fssues in Logistics and
Transportation (New York, NY: Capgemini, 2004) and Peter Moore, Karl Manrodt, and Mary Holcomb, Collaboration: Enabfing Synchronized Supply
6. Follow a proven implementation methodology. Chains: Year 2005 Report on Trends and Issues in Logistics and Transportation (New York, NY: Capgemini, 2005). Reproduced by permission of
the authors.
7. Take a step-by-step approach for incremental value gains.
196 Chapter 6 Technology-Managing Information Flows 197

must be considered in the development of a SCIS or problems will used by sk:illed individuals in the planning and execution of supply chain pro-
highlighted in our discussion of technology use barriers. Scor~rds and da..bboards are also needed to monitor performance and make ..--
adjustments. With these requirements satisfied, managers are able to take
People ultimately determine the success or failure of a SCIS. Today, tec:nnolc>gic
capabilities are not usually the problem when it comes to improving supply chain ~~;;~:~;;;ico~rf:e~S<CIS data analysis and decision support capabilities. They are also
bility and performance. The sheer computing power and speed of information
k to pursue supply chain excellence.
capabilities available today adequately meet the needs of most supply chains. collection of relevant information is needed at every point in the supply chain. V
""problem more commonly lies with the competence of the people involved with it is captured via b~des,- radio-frequency
identification, or other technol-
technology. Individuals making information technology selection decisions must information must be relevant, accwate, and accessible to users in real time.
reasonable expectations regarding the technology being considered and access to information leads to dysfunctional decisio~s that spread across the
members with operational expertise in its functionality. The people tasked 'With
menting and integrating technology need the requisite skills, as well as adequate
synchronization focuses on the timely and accurate updating of item informa- ../
and financial resources to complete the work. Finally, the day-to-day technology
and across enterprises to ensure dependable, consistent product informa-
must be properly trained in the appropriate, accurate use of the tools.
Within a company's systems and between business partners. It is critical foi:' every
Process management also plays a role in SCIS performance. Organizations ;ilrization in the supply chain to have s~nd0rdiz,~;d, _cowple_ts:,_aca;u:at~:, 'l!ld-ro!!lli- ~
0eview existing methods in light of the new technology adoption. The risk of not lJ.l(...'J!'ix'"- Q&a in_lheir Q~_to perf?r~p~u:.ffeGtW.ness. It is impossible for
this is that inefficient, outdated, or unnecessary processes will be automated, pnwi<iin, chain partners to effectively collaborate, utilize RFID, or leverage demand-
little benefit to the organization. Supply chain professionals and their technology replenishment techniques ifthe product, price, or in~e data being transferred
terparts must also determine how the SCIS tools can be used to enhance internal im1ccur:rte. Thus, organizations must clean and align data internally before sharing
cedures and streamline information flows to supply chain partners. Standard operating;
procedures and goals regarding supply chain productivity, accuracy, timeliness,
cost also must be established for technology-enhanced processes. Without them,
<F1lll'dnerm<Jre, p~s~ have to be in place to maintain high-data quality. This re- 71.. ./
11n,ment has both technology and organizational structure implications. Fjrst, the or-
would be impossible to ensure that processes are being performed correctly across
ni2oati.on must be willing to make data management processes a priority. Se;gQ:d,
supply chain or generatillg the desired outcomes.
must be strong business ownership of product data and aligned SCIS that enables
,/Technologies used in SCIS have the greatest impact when they are based on to timely, accurate data. Those who succeed will achieve inventory and logistics
open systems concept and take advantage of the Internet. Software applications reductions, as well as fewer out-of-stock situation?.
are based on well-defmed, widely used, nonproprietary open standards require
Functional expertise in each organization will be enhanced by access to the synchro-
mal changes to intemperate with other SCIS tools and interact with users in a style
data. Managers must be able to le~rage information from the SCIS to support
facilitates portability (i.e., is easy to transfer). Interoperability can be achieved through
and decision making across all supply chain operations-procmement, produc-
enhanced, standardized Web links and simplified protocols that allow different sys-
delivery, and returns. For example, timely point-of-sale (POS) data are needed to
tems to work together in a unified manner. Data transfer becomes seamless, and there
the replenishment cycle in a retail supply chain. This sales information is used to
is a reduced need for data manipulation by each organization. As a result, you have a
store orders, initiate order preparation at the distribution center, alert the buyer to
handy, easy-to-use package that works like a Swiss Army knife, rather than a random
12 additional units, and signal the manufacturer to make additional units.
gathering of the latest gadgets that may not work well togetl1er.
Metrics, as discussed in Chapter 5, help organizations articulate their impact on the
The Internet provides the platform for supply chain activities to be carried out in
chain. Just as a baseball manager reviews the standings, statistics, and box
a synchronized, instantaneous manner to maximum performance. Just as we leverage
to assess the team's strengths and weaknesses, so do supply chain managers
the speed and efficiency of the Web to place orders, track shipments, and communi-
SCOJ,e.Cards and dashb~s to help them evaluate performance and make neces-
cate, organizations are dramatically increasing their use of the Internet to manage their
adjustments when things aren't going as planned. These metrics must be defined
supply chain strategies and processes. Information can be shared among collaborating
understood by all parties, measure service issues that are critical to the customer,
companies quicldy and at low cost using Internet tools as an alternative to or as the
provide actionable information. Given the importance of time, accurCJ,.Cy, and cost
platform for electronic data interchange (EDI). Supply chain activities like procure-
the supply chain, valuable metrics include order cycle time, proportion of perfect o;_
ment can be conducted via the Web, and process performance can be monitored.
and cash-to-cash cycle time.
Organizations can even access supply chain software over the Internet as a cost -saving
alternative to purchasing, installing, and maintaining it on their own networks. These
are just a few examples of the ways that Internet -enhanced SCIS promote efficient, ifferentiating Capabilities
responsive supply chains. state that all SCIS are not created equal may be the greatest understatement of
fact in this textbook. While leveraging technology for more adaptive capabilities is
Key Requirements widely desired goal, the process of transforming the organization and its SCIS is a
By themselves, software and other SCIS components cannot pvovide actionable knowl~ complex, multilayered effort. After the foundation has been built and the key
edge for supply chain managers. Data must be collected and synchronized so that it requirements attained, supply chain partners must integrate processes and achieve

198 Chapter 6 Technology-Managing Information Flows 199

SCIS connectivity to support cross-chain visibility, event management, and

mated decision making.
key components of a strong SCIS is the software that is used to manage the
The planning and execution infrastructure consists of the software tools that ,
chain. The supply chain software market space includes technologies that ad-
utilized to provide supply chain speed, optimization, and connectivity. In the
:Vllrrwwv every function and task that occurs in the supply chain. Whether you
infrastructure was largely comprised of narrowly focused functional applications
develop a sales and operations forecast, analyze facility relocation options, op-
targeted automation and efficiency. The focus has shifted to applications that
the delivery of goods, maintain visibility of inventory, or monitor order fulfill-
process effectiveness and the creation of actionable information. Major cai:eg:ories j
.. n,,rfcmTlartce. there is software available (or under rapid development) to assist
SCIS software applications are identified and explored in the next section
,:e~~oln>. These tools attempt to harness the computational power and communica-
~>.ili<He< of today's technology to help organizations plan, execute, and control
Visibility tools focus on providing a s~s flow of timely, important n1tormati1 chain activities in real time. ,_ - -
across the supply chain. Accurate knowledge of what is occurring outside the
>llowirtg the implosion and subsequent years of spending declines, orga-
tion via Web-enabled SCIS allows managers to monitor sourcing, transportation,
are investing more money on software solutions according to a recent study
inventory data at the order and item level. As the supply chain becomes more
,berdt,en Group. Of the 208 companies included in the research, over 90 percent
parent, managerial vision and control extend beyond internal activities and
to spend the same amount or more in the upcoming year. The amounts are
This enhanced intelligence propels supply chain managers from a reactive to a
as over half the respondents plan six-figure expenditures on new technology
tive mode, which promotes proactive strategic planning, collaboration, and
Organizations are looking beyond efficiency-focused applications to systems
making. Ultimately, the objective is to have the right information available so that
provide the ability to react quiCkly to marketing and demand changes, communi-
tion can be taken when needed, not after the fact.
:e rlectSl<lllS clearly and quickly to everyone affected, and flexibly manage multiple
Exception management capabilities take the next logical step beyond visibility. of supply chains. In short, they are looldng to establish the "sense and respond"
one industry pundit explains it: "Think of a guy walking on a sidewaik where a )at>ilitlies of agile, adaptive organizations.
about to hit. A visibility solution tells him that the piano is falling. An intelligent
you might expect, it takes a wide array of tools to accomplish these goals. Not
ception management solution tells him to get out of the way." 13 Thus, SCIS
is it difficult for managers to understand the functionality of these different types
support the detection of performance problems and signal exception alerts to the
)oftware tools, but it can also be challenging to categorize them. This task is made
fected organizations. Immediate corrective action can be taken to resolve the situal:i01
by an inconsistent technology lexicon, a changing software vendor landscape,
before it impacts the supply chain, and efforts can be made to eliminate the root
the fact that supply chain software is possibly the most fractured group of applica-
of the problem. Such SCIS capabilities promote supply chain agili!)' and enhance
on the planet, according to CIO magazine. 17 With these challenges in mind,
tamer service.
6-5 provides an overview of the generally recognized supply chain solutions cate-
A~ated decision making is the pinnacle of differentiating capabilities but We use a P\!ZZle~ to highlight the critical need for linkages and informa-
mains a future prospect for many SCIS. Software tools are rapidly being developed sharing betw'een each software category. The more integrated the tools are in a
recognize exception alerts, assess the problem, evaluate alternatives, and re<:ornrr1ertd the better support they will provide for effective management of the supply
solutions. In some cases, these supply chain event management tools will dynamicallY hmn--tr<Jm planning to execution, event response, and performance evaluation. This
replan activities and take corrective action without human intervention, and then isctlssion will focus on the general purpose and issues in each category while the de-
tify stakeholders that the exception has been resolved. regarding specific software applications will be handled in upcoming chapters.
It is important to remember that the foundation, requirements, and caj>abilitie"
must be developed in a logical, sequentiai fashion. Wilson provides the follmv:ing
recommendations for pursuing SCIS capabilities: "Before pursuing extended chain planning applications and suites help organizations evaluate demand for
chain optimization, a company's own system needs to be functioning pn)p<erl-y. nateri;lis, capacity, and services so that effective fulfillment plans and schedules can be
mentation should be done in segments, company data needs to be accurate, obiectives. leveJc,ped. These planning tools are employed across supply chain processes, assisting
need to be clearly defined, recommendations need to be reliable, and personnel decisions regarding the number and location of facilities (network design), where
the system must believe in the system and its results." 14 purchase materiais (strategic sourcing), when to build goods (production planning
scheduling), and how to deliver the goods (routing and scheduling), just to name
Also, organizations cannot expect to quickly activate this world-class supply chain few tasks. This category encompasses a comprehensive set of software tools designed
management framework or the supporting SCIS. Integrating systems, synchronizing
help managers gain more accurate, detailed insight into issues that affect their devel-
data, institutionalizing collaboration, and adopting the other drivers of supply chain .Of<mt,nt and planning of supply chain activities.
excellence require more than a one- or two-year effort. Achieving supply chain excel-
lence is a long-term goai that demands dedication and hard work to reach the desired These tools address a range of longer-term planning horizons (weeks, months, or
end state, according to the study authors. 15 -Years) and important issues like demand forecasting. Moving from manual, indepen-
processes to software that leverages real-time data and enables collaboration
00 Chapter 6 Chain Technology-Managing Information Flows 201

chain execution doesn't rely upon a single software program. Instead, it

Figure 6-5 Supply Chain Software Categories of a group of tightly integrated tools that link well with supply chain pa~tners'
to share relevant data and provide visibility. Interest and investment in execu-
is growing because of the strong capabilities being developed, cost savings,
on investment being achieved. Successful implementation can provide users
improved inventory visibility, improved data accuracy, faster throughput and
inventory turns, better control of transportation costs, and improved customer
The tools also support supply chain planning, event management, and per-
rnetrics. "The secret of execution, the reason it's so important," notes a soft-
executive, "is that the data generated is what drives the rest of the business." 20
!ncliviidu1ally we also rely upon these supply chain execution tools to carry out order
Supply Chain you want to purchase a digital camera from, you in-
its order management system via the Internet to prepare and transmit your
This system checks the availability of inventory through its link to the ware-
management system. If the inventory is available, your order is processed and
to the warehouse management system, which schedules the picking and
of your camera. When it is ready to be shipped, the transportation manage-
system selects a carrier, optimizing delivery cost within your transit time require-
You can also use the carrier's transportation management system to monitor
delivery status of your order until it arrives at your front door. Without these exe-
capabilities, the order to delivery process could take weeks instead of days and
would have little visibility into the process.

chain event management tools collect data in real time from multiple sources
across departments, suppliers, and customers has a positive effect on forecast
the supply chain and convert them into information that gives business man-
and enhances accuracy. Shorter-range planning tools that support sales and
a clear picture of how their supply chain is performing. These systems track the
tions, production, and distribution planning can leverage these accurate forecasts.
rivc:nt<Jry as it flows through the supply chain, providing graphical displays of ex-
ply chain managers will ultimately be able to make better operational and <o.-,;,.,p
and actual inventory levels and other key data at each location. An important
decisions, leading to more efficient process execution, reduced waste and sl<KI,otltS,
is their ability to defme business rules that trigger alerts when specified events
and improved profitability.
or when they fail to occur. This capability allows supply chain managers to fa-
Can better planning make that much of a difference? In the case of Welch's, the an- their attention on managing exceptions rather than having to monitor every move-
swer is yes. The maker of juice products implemented a demand planning system and compare it against plan. 21
coordinate information from marketing, sales, finance, and production to create a sin-
As the geographic scope and number of companies involved in a supply chain grow,
gle, accurate, companywide forecast and better coordinate trade promotions, produc-
ability to monitor activities exceeds manual capabilities. Hence, supply chain event
tion, and distribution. Welch's expects the new planning system will help
tools are becoming more important, and more organizations are turning
organization trim its inventory by 15 percent, cut inbound raw material expediting
these solutions to help them detect, evaluate, and resolve issues before they
30 percent, and reduce product obsolescence by 30 percent. 18
sric>wl>all into major problems. The newest tools use optimization techniques to evalu-
the severity of the situation and propose alternative solutions to decision makers or
Execution action based on established guidelines. Interest in these capabilities is so high
Wintergreen Research predicts spending on these tools will grow from $1.7 billion
Supply chain execution tools and suites carry out key tasks from the time an order is 2005 to $7.1 billion in 2012. 22
placed until it is fulfilled. This order-driven category of software focuses on the day-to-
day activities required to buy, make, and deliver the materials that flow through the A U.S.-based retailer uses an event management system to monitor on-time supply
supply chain. Traditionally, execution tools have focused on a company's internal lo- status and received an alert when a late delivery occurs or is likely to occur. By
gistics activities-order management, warehouse management, inventory management, early visibility into delayed shipments, the company can automatically identify
labor optimization, and transportation management. As attention shifts to integrated alternative source of supply to avoid stock-outs. It also has taken steps to reduce
supply chain capabilities, the category is encompassing a broader array of functionality stock levels. With the new system, the company has increased its confidence in
including procurement and supplier relationship management, manufacturing execu- iPJoduct availability, visibility, and control over its inbound supply chain. It has been
tion and shop floor control, and customer relationship management. to reduce in-transit inventory by 50 percent (valued at over $20 million) in the
)2 Chapter 6 Chain Technology-Managing Information Flows 203

intelligence software were geared toward trained analysts who had to define
Table 6-1 Supply Chain Event Management Opportunities problems for the software to analyze. However, emerging capabilities make it
to interpret data via simple dashboard items, such as charts, graphs, and maps
1. DECIDE WHAT YOU 2. DECIDE WHAT ACTIVITIES 3. DRIVE TOWARD RESOLUTION easier to understand than pages of data. Because these graphics are linked to
WANT TO KNOW AND AND INFORMATION YOU OF PROBLEMS TO THE APPROPRIATE data warehouse, it is possible to manipulate them, review the effect of different
on results, and test alternative scenarios, in addition to monitoring perfor-
MEASURE MONITOR/NOTIFY SIMULATE/CONTROL Gartner Research predicted that spending for new licenses for business intel-
software would reach $2.5 billion for the year. 25
Orders Customer-satisfaction Late deliveries or Choose alternative
levels across products notifications of past-due transportation modes Wyeth Phar~aceuticals uses scorecards to share information regarding its supply
dates or alternative suppliers
~' performance and service problems with its customers (pharmaceuticals distribu-
The' scorecard combines reporting data on order fill rates and accuracy, delivery
Shipments On-tirne shipments Late arrivals of Notify carrier of lateness
shipments \erforrnimc:e,, return rates, and related supply chain issues in an easy-to-re~d spread-
Carrier pick-up Choose alternative carriers
Transactional data received each day from transportation companies via EDI are
performance levels Projected carrier or alternative modes of
pick-up behind schedule transportation ;seJnbled in Wyeth's data warehouse and their business intelligence tools assemble
data into the tables that make up the scorecard. The scorecards are sent to Wyeth's
Inventory Inventory levels and Stock-outs Determine alternative istribtttoJrs via EDI, and the information is used to diagnose problems. This compre-
adherence to source of inventory
safety-stock levels
Inventory below timely tool has helped move the Wyeth supply chain closer to just-in-time
safety levels Increase orders to suppliers ;ap:1bilities.

Manufacturing WIP levels by family Delays in production Choose alternative Resource Planning (ERP)
manufacturing solution
WIP build-ups as the boundaries between supply chain planning and execution tools are blurring,
Push WIP into finished goods
is becoming more difficult to completely segment SCIS from enterprise resource
(ERP) systems. Many of the supply chain software applications discussed
Financial Order-to-catch cycle Payments pending Remind suppliers of
time payments are growing increasingly reliant upon the type of information that is stored in-
Late payments
ERP systems. Thus, it is important to briefly discuss ERP systems and their rela-
Late invoicing Renegotiate pricing
. to supply chain software tools.

2002) .
ERP systems are multirnodule application software platforms that help organiza-
Source: . Improving Responsiveness with Supply Chain Event
manage the important parts of their businesses. Initially concentrated on
,man,ufa.clllfing issues, ERP systems now focus on integrating information and activities
the organization (i.e., the enterprise) via a common software platform and cen-
first year. 23 Additional examples of supply chain event management opportunities are ;tr:uu:eu database system. Key business processes linked via ERP include accounting
provided in Table 6-1. finance, planning, engineering, human resources, purchasing, production, inven-
'to'ry''materiaLls management, order processing, and more. The centralized and shared
Business Intelligence Matabase system ties the entire organization together, allowing information to be en-
Business intelligence tools build upon the traditional reports and output systems that once and made available to all users. Business processes can also be automated
provided historical accounts of functional performance for internal planning, opera- rapid, accurate execution.
tions, and control. The newer capabilities are more dynamic, frequently delivering data
As the ERP systems branch out to include supplier relationship management, cus-
from transactional systems across the supply chain to a data warehouse. The data can
relationship management, and other supply chain components, the connections
be analyzed and fresh information sent to frontline employees and executives for more
betwt,en SCIS and ERP grow stronger. Supply chain members can access the organiza-
effective planning and decision making.
through the ERP system to assess inventory availability, production schedules,
In addition to the data collection and analysis capabilities, business intelligence and delivery information. In short, the ERP system provides a mechanism for supply
software supports self-service reporting, performance scorecarding versus goals, de- members to efficiently share information so that visibility is improved, transac-
velopment of dashboards and other graphical report displays, and activity monitor- are completed with more speed and accuracy, and decision making is en-
ing in support of event management. These tools can provide better access to data ; hanc:ed. 27 Figure 6-6 reveals the supply chain planning and execution capabilities that
residing on multiple SCIS without the need for technology department involvement, SAP, a leading ERP software provider, can integrate with its NetWeaver ERP platform
improve knowledge of decision makers, and support collaboration across the supply link the enterprise with its suppliers and customers.
C. R. Bard, a medical device manufacturer, uses a combination of ERP and supply
Interest in business intelligence applications is rising, due primarily to a software chain execution systems to manage the production and distribution of its catheters and
vendor focus on increasing user-friendliness of the tools. Previous generations of heart stents. A product requisition begins as a work order in the ERP system, which

Chapter 6 Chain Technology-Managing Information Flows 205

igure 6-6 ERP Integration of Supply Chain Technology Capabilities Supply Chain Software Suite

Distributed Order Management

', Shipment To Consumption
- Management


Reverse Logistics Management

creates a master record that is complete and readily accessible. The ERP system
the product through various processes (assembly, packaging, and sterilization)
multiple facilities and signals the global distribution center that a delivery is on
way. The warehouse management system receives the signal and prepares for
This system also receives customer orders through the ERP system, fills orders, Spreadsheets and database software. You may be surprised to think of these
pares them for delivery, and updates the ERP system when the order is shipped. commonly used applications as relevant to this discussion, but Excel has
linked tools provide the company with real-time visibility of customer orders, been coined "the most widely used supply chain software" ouly half jokingly
proved fulfillment accuracy and speed, and lot traceability. 28 by industry pundits. Spreadsheet software provides managers with handy,
portable tools for gathering, consolidating, and analyzing supply chain data.
However, it is critical that the planning and analytical work done via these
Related Tools tools be linked to the SCIS so that information does not become fragmented
While the four categories of supply chain software (plus the ERP tools) cover much and visibility lost.
the solutions spectrum, other valuable tools exist. Some fall in between the categories,
while other software applications are not supply chain specific. Although difficult to Throughout this discussion of the supply chain software categories, we have men-
categorize, they help improve the flow and usefulness of supply chain irrformaticm, some of the individual applications available to supply chain managers. Figure 6-7
support the development and implementation of key strategies, and enhance analysis. a diagram of one vendor's software suite that links applications from the four
These valuable tools include, but are not limited to, the following: ategories. Regardless of the system, tool, or vendor involved, it is important to consider
factors before moving forward. First, it is important to understand the capabilities
Supply chain collaboration tools. The software helps users integrate their software-its functionality (malting sure to separate the reality from the hype), ease
information technology systems with those of trading partners to streamline use, and applicability to your supply chain requirements. Second, the software must
and automate supply chain processes. These middleware tools provide inter-
with existing tools, integrating well with your current SCIS and ERP system. Finally,
operability between different SCIS to support collaboration initiatives.
ap,plicatiorl:s must link effectively to supply chain partners, supporting the overall goals of
Leveraging Internet standards, these applkations support collaborative plan-
ning, forecasting, and replenishment, vendor managed inventory, and other vi':ibulitv, responsiveness, and cross-enterprise agility.
strategic supply chain initiatives.
Data synchronization applications. These tools provide a platform for
manufacturers, distributors, and retailers to aggregate and organize item- vuuuly Chain Technology Implementation
related data (item number, price, description, weight, etc.). Cleaning up the
data so that they are consistent across multiple organizations is required for the preceding section indicates, a wide array of software tools support supply chain
using RFID technology, streamlining and automating processes, and improv- '.pl:anrring, execution, and control. Companies spend billions of dollars on these tech-
ing supply chain visibility. ;no,Jog;ies with the goal of malting their supply chains more productive and effective.
)6 Chapter 6 Technology-Managing Information Flows 207

However, spending does not guarantee success. Implementation headaches, only or to purchase software from an external vendor. Wal-Mart and
integration complexities, and training requirements translate into significant are two organizations that largely depend upon their own information
(often twice the cost of the software) and time (frequently in excess of six m>nthsl departments to build supply chain applications. Many iliird-party logistics
achieve software functionality. Thus, gaining a positive return on technology ;develof in-house solutions as welL While this requires significant resources and
ments can be very challenging. f6vment time, all of the tools are tailored to ilieir specific industries and supply
i p 1rocesses. They are able to achieve a level of customization and flexibility that is
The key to overcoming these issues and harnessing the capabilities of supply with off-the-shelf tools. Such capabilities can lead to a competitive advan-
technology within a reasonable timeframe is informed decision making. Supply . supplyh
t he1r c ams.
managers must not make rush decisions regarding technology selection. They
take the time to investigate a variety of technology-related issues and base decisions organizations, especially small to mid-size companies, are not able to build
the specific re!juirements of ilieir supply chain. It is possible to achieve a 12- supply chain software. In reality, many supply chain managers struggle just
18-month return on investment if an organization effectively assesses its specific supply chain technology on ilie priority list of the information technology de-
understands software application and delivery options, addresses the technical Thus, they rely heavily on external software vendors to develop and imple-
and asks the right questions before making a purchase decision. the tools needed to plan and execute supply chain processes. These tools
support supply chains that are not overly unique or complex. Because they
Needs Assessment implemented faster than what could be accomplished in house, are built with
as a key focus, and have some ability to be tailored, ilie vendor-
The most important step in software selection and implementation is to urtde:rstan
tools are the proper choice for most organizations.
the supply chains that the technology is intended to support. Too often, supply
managers undertake the software selection process in isolation and without kn,o;leod2
of the processes to be automated. They may also attempt to use the technology to Packages Should an organization choose to purchase software rather
prove inadequate or outdated processes. Any of these situations will lead to the develop it in house, it has to determine what types of applications are needed and
ment of technologies that are poorly matched to the true needs of the supply iliey should be purchased. Historically, software packages were purchased inde-
unable to link departments, suppliers, and customers; and/or too narrowly focused from different vendors and the organization's information technology staff
support supply chain visibility and event management. tasked wiili making ilie various tools work together if possible. Today, buyers have
option. Due to mergers and acquisitions in the software industry and ERP
Organizations must start with a diagnosis of their situation. They should
moving into the supply chain applications market space, it is possible to pur-
their supply chain process capabilities and benchmark them against the needs of
supply chain software suites that combine planning, execution, event manage-
supply chain partners. If the current capabilities are deemed inadequate, unormerr1ents
and related capabilities.
and innovations must be developed for relevant processes. Only then should tec:hnoF
ogy be considered, based upon its ability to facilitate the planning and execution The polar options are to work with a single vendor's software or to purchase indi-
these enhanced processes. Technology can also be used to improve adequate prDC<,sses applications from leading providers in each software category, commonly called
but only after deficiencies have been addressed. " solutions. A food example will highlight ilie differences. If you have a
catered by one restaurant that offers a main course plus a selection of side items,
This needs assessment sequence highlights the link between effective business pro-
working with a single vendor. This is similar to purchasing an integrated soft-
cesses, appropriate technology, and supply chain performance. Companies like Wal-
package iliat includes an ERP system (the main course) and supply chain applica-
Mart, Dell, and Zara have generated a competitive advantage in their respective industries
(the side items). In contrast, if you purchase your party items independently-
because they support innovative supply chain practices with technology. They properly
main course from a butcher shop, the side items from ethnic restaurants, and the
view supply chain software as an enabler of process improvement rather than a "quick
from the local bakery-you're effectively employing specialists that conceivably
fix" solution. This ultimately leads to realistic expectations of the technology, more effec-
considerably more expertise in their respective areas. This is similar to purchasing
tive implementation, and greater returns on supply chain software investments.
ERP system from one company, a forecasting and planning system from another,
a warehouse management system from a third company. Of course, you could also
Software Options for the middle ground, purchasing the main applications from an organization that
Supply chain managers face a multifaceted decision when selecting supply chain '' pro,>id<os a supply chain software suite and a few tools obtained from the best-of-breed
software. As we previously discussed, the manager must determine which type of
software-planning, execution, event management; or business intelligence-is appro-
priate for the given process or situation. Additionally, supply chain managers must Each strategy has its merits. Single vendor supply chain suites should take less time
compare the advantages of commercial software to in-house solutions, choose between to implement than a variety of tools from different vendors since there are fewer com-
single vendor suites and applications from multiple vendors, and consider licensing . and connectivity issues to overcome. Also, there is only one vendor to work
versus on-demand purchases, among other issues. with rather than multiple companies, which reduces administrative and coordination
effort. Single vendor suites also require less training time and have lower implementa-
Development Alternatives The first issue involved in software selection focuses on tion costs as there is only one set of integration requirements to master. Although the
who will develop the solution. The choices are to develop the tools in house for your best-of-breed tools are more complex and typically take longer to integrate into the
:J8 Chapter 6 Technology-Managing Information Flows 209

SCIS, they are working to streamline the process. Also, they offer more powerful
cations for specific functions that provide greater flexibility and can be better Software. Gets "Friendlier"
to an individual company's supply chain issues. Some suites, especially those
vendors, do not yet contain the advanced functionality or industry-specific ca]Jabili best-of-breed software vendors, which specialize in specific supply chain appli-
found in specific best -of-breed applications, though they are working to close the are making their products easier to install and use these days. They've adopted ease
The challenge for the supply chain executives choosing between these options is as a selling point-and perhaps a survival strategy-as they confront the growing mar-
derstand the implementation issues; their organization's need for tailored, ,jpr,eserrcE of the big enterprise resource planning vendors.
capabilities; and the changing vendor landscape (this topic is discussed in the Competition has gotten fiercer as the ERP developers have taken a page from the best-
Line feature). vendors' playbook: industry specialization. Many vendors of transportation manage-
systems {TMS) and warehouse management systems (WMS)-the two most commonly
Purchase Opffons Historically, supply chain software buyers had one opnoJO-p supply chain execution programs-have focused on niche markets, tailoring their prod-
chase solutions from software vendors for their own information systems. The to the information needs of specific industries.
software is installed on the buyer's powerful client-server systems, which is a
method, given the intense computational activity required by most supply chain Now the dominant ERP vendors are doing the same. "SAP and Oracle are augmenting
cesses. The downside of this purchase option is the high capital investment and supply chain software offerings with more vertical competencies," observes James
plex deployment associated with conventional licensed applications. Buyers have manager director at Benchmarking Partners.
pay for the software upfront; manage the implementation issues; and deal with To ward off the ERP developers, makers of supply chain execution software are doing their
ing issues of software upgrades, fixes, and maintenance costs. to make it easier for logistics managers to pick up their tools and use them. Many TMS
V.Emoors,, for example, have shifted to an on-demand model for their wares. On-demand TMS
The Internet brought another option-application service providers (ASP)-that
include such companies as Leanlogistics, Descartes, Nistevo, and Cube Route, says
fered a new way to buy software. The ASP owns and operates the software apj>licatio
Gonzalez, director of the Logistics Executive Council of ARC Advisory Group.
and the servers that run the application. It also employs the staff needed to
the application and the information system. Users access the software via the The on-demand model represents an advance over Web-hosted software. In a typical
using a Web browser or small software tooL They are billed for the application hosted environment, Gonzalez explains, the application would reside on a computer outside a
per-use basis or on a monthly/annual fee basis. The benefit of the ASP purchase company's watts, and the user would access the software via the Internet. A drawback of that
is low-cost access to solutions because there are no major upfront license or approach is that every time a vendor made a change to the application, it would have to do so
tion costs. The downside of ASPs is the inefficiency of hosting one copy of the solttw:1ii for each individual user. Not so in the on-demand model, he notes. If, for example, a TMS ven-
application for each client. Also, because these solutions were traditional cll,ent-serveJ dor updated a freight-rate data table, it would only have to make the change once, and every
applications with HTML front ends added as an afterthought, performance was user would automatically see the updated information when connected to the network.
and application updates difficult. Hence, the ASP model did not prosper in
chain management, though some software vendors now provide similar services
In the market for warehouse software, however, the on-demand model isn't practical, as that
their own tools.
type of application must be heavily customized to meet the user's specific needs. However,
Some of the software-as-a-service issues that hampered ASP efforts are being WMS vendors are also moving to make their applications easier to use by embracing "service-
dressed by on-demand solutions providers. These companies provide software that based architecture," which allows applications to leverage networked resources. That model
accessible by multiple parties via the Internet. Because the application is shared, makes it easier to configure and upgrade their solutions, Gonzalez says.
riers, suppliers, shippers, and customers can all work together using a standard Many WMS makers are building "adapter sets"-ready-made interfaces that allow their
ness process and have a common view of supply chain activity. This purchase option-', applications to exchange data with ERP systems. This approach makes data mapping easier,
is gaining in popularity as more supply chain tools are offered via this method. Faster says Philip Obal, president of Industrial Data and Information Inc. "It will do more than just
implementation and return on investment, lower hardware costs, and an ability to map data," he says. "It will treat your WMS like a set of subroutines from (ERP) software."
manage growth more economically are cited as key reasons for interest in this
method. 30 Of course, certain issues must be addressed. On-demand solution providers Adapter sets may soon become a required offering for WMS vendors. "If you don't have an
must prove that they can protect client data, maintain system availability and reliabil- adapter set for a WMS, your days are numbered," predicts John Fontanella, a senior vice presi-
ity, and streamline the integration of their tools with licensed software. dent with the Aberdeen Group.
Vendors that are focusing their efforts on making their applications easier to use should
Technical Issues also be thinking about how to do that in several languages. That's because North American
Supply chain managers tend to focus on functionality when considering software, but sales of supply chain software are slowing, and future sales are more likely to come from Eur-
they also must consider the technical issues related to its operation. Otherwise useful ope or Asia, analysts say. "We'll see the stronger players that are multilingual flourish," pre-
software will become "shelfware" if it is difficult to install, unable to link to other tools in dicts Obal. "If you have an English-only solution, I would be worried."
support of visibility and event management, or too cumbersome to use on a daily basis. Source: Adapted from James A. Cooke, "Software Gets Friendlier," Logistics Management(July
Hence, upfront effort must be expended to assess implementation challenges before 2005): 49. Reprinted with permission.

selecting a supply chain software suite or best-of-breed application. We have already

Chapter 6 Technology-Managing Information Flows 211

identified some of the key considerations such as interoperability and data syrtchrot The greater the variety of applications, the more challenging connectivity and
tion. Here, we briefly discuss two additional technical issues in SCIS<ementaHon sharing issues become. The problem lies in the fact that these applications
present data differently, making communication between them difficult. 31
Data Standardization Given the variety of software vendors, proprietary tools, efforts have been made over the last 10 years to improve application inte-
legacy systems, coordinating and sharing information across the supply chain can and foster supply chain information synchronization. The initial work focused
significant challenge. just as different languages, dialects, and alphabets hamper development of application programming interfaces (API) to allow companies
communication, the variety of systems and programming languages used in scrs their SCIS with supplier and customer applications. ERP vendors like SAP tar-
it difficult to bring data together in an efficient, useful manner. One option is to API efforts on making it easier for third-party vendors to build ERP-
late data as they move between software applications, but this can be as cmnbersol supply chain software. Other organizations developed tools to fit between
as two peoplBi\trying to communicate through a translator. Rather than mamuall:r .ccmnect existing applications, such as linking a warehouse management system
electronically translating data, a better solution is to use a standardized format to ERP-based order management system. While beneficial, the process can be costly
hance communication between partners. Just as English is the standard consuming as an API needs to be developed for each type of software that
of global business, ED! and extensible markup language (XML) are key elements connected. Also, the connectivity achieved may be temporary, as a change in
data standardization. These tools improve the data flows between applications appli<:ation can break the API-created link to other tools.
recently, the focus has shifted toward adapter sets (see the On the Line fea-
EDI provides interorganizational, computer-to-computer exchange of structured and a newer technology model called service-oriented architecture (SOA). SOA
formation in a standard, machine-processable format. It has been the primary underlying structure supporting communications between services with "plug
of transaction data sharing between vendors and customers for over two decades, play" functionality as a key goal. A service is defined as a unit of work to be per-
porting the exchange of trade-related documents, such as purchase orders, inwicei an behalf of some computing entity, such as a human user or another pro-
and corporate electronic fnnds transfer (EFTs) in a standard format. ED! allows SOA defines how two computing entities interact in such a way as to enable one
rapid exchange of large amounts of information, reduces errors, and lowers the to perform a unit of work on behalf of another entity. For example, when you
per transaction, allowing supply chain partners to work more efficiently and an online purchase, you are using an order management service that, in turn,
tively. ED! does have its drawbacks. Implementation can be complex and vallue-acldec ;orrununica,tes with an inventory service to determine product availability. If available,
network services that provide the company-to-company linkages charge trans;Ktiion order and shipping details are submitted to another service that calculates the
fees, making this standardization method infeasible for smaller organizations. cost and furnishes a shipment number that, through another service, allows you
XML is a robust, logically verifiable text format based on international standarcls. track product delivery. This sequence of software linkages is made possible by the
It provides a flexible way to create structured, common information formats nderlyirtg framework that SOA provides. 33
share both the format and the data via the Internet, intranets, and other netw<Jrks:. It is anticipated that SOA will standardize the way applications ask for and retrieve
XML can be used to define complex documents and data structures such as in'oic:es, [ipJonnatiOJo, allowing disparate software systems to talk to each other without forcing
inventory descriptions, shipment records, and other supply chain information. f.Com!>anies to scrap or rebuild their existing systems. SOA will allow users to access the
benefits of XML are numerous-it is a simultaneously human- and macllinLe-:rea.dable ;fw1ctiionality and data of many different applications at the same time, thus creating a
format. it supports multiple languages, its plain text file displays are unencumbered, that meets the needs of the business, according to the Aberdeen Group. Ulti-
by licenses or restrictions, and it is platform-independent and thus relatively immune SOA is expected to simplify integration of applications, improve information
to changes in technology. XML is gaining traction in the supply chain because it sup- facilitate communication, and increase availability of affordable software
ports the integration of various information systems, is less complex than EDI, and SAP's Netweaver and Oracle's Fusion are two examples of SOA-based
eliminates the need for value-added networks, which reduces cost while speeding data ,'applicaticms. 34
Supply chain technology buyers need to understand the challenges of application
When selecting individual applications, buyers must seek out these data standard- inLte);ration while pursuing improved SCIS connectivity. They must assess and compare
ization capabilities. Such capabilities will ensure that information is quickly transferred integration methods, and then choose those that best fit current needs while providing
in a format that is usable by the SCIS and key decision malcers. Newer tools should the flexibility to meet future functionality requirements. Finally, buyers must monitor
provide "out-of-the-box" support for XML-based data exchange standards and/or ED! the development of SOA and its impact on the software applications landscape. If
standards. This will help buyers avoid costly, time-consuming software integration SOA-based applications revolutionize the way applications are built, sold, and distrib-
projects and improve SCIS interoperability. Enhanced visibility and faster communica- uted, as promised by SOA proponents, buyers will need to alter their supply chain soft-
tion across the supply chain will also be achieved. ware procurement practices.

Application Integration Not only is it important to put data into a standardized and
common format, but it is also imperative that different tools seamlessly share the data. Asking the Right Questions35
This can be readily accomplished within a self-contained supply chain software suite, Senior management plays a key role in facilitating the implementation of supply chain
but supply chain partners often rely on different vendors, applications, or software technology. Executives must provide the vision, the required resources, and an
12 Chapter 6

unshakable commitment to SCIS initiatives if the organization is to achieve its ly Chain Technology Innovations
This vision must clearly explain how technology upgrades will facilitate the oqlan,iza.c.,
tion's overall supply chain strategy and improved performance. 36 An intelligent supply chain industry transformation of the last 20 years has been enabled by
tive will take the time to ask important questions and gather appropriate ".""""'"''0Ili !chnollogy. Innovations in supply chain and ERP software, automatic identification
in order to establish and refine the vision. Only then should the organization communications systems, and Internet functionality have forever
forward with technology investment and implementation. Some of these key questions the way the supply chain works. When effectively deployed, these techni-
include the following: advances improve information speed and access, support process improvement
optimization, and provide product visibility from global supplier to local con-
Who will lead our implementation effort? Senior management has neither Ultimately, these innovative technologies enable fast execution of supply
the time nor direct knowledge of SCIS to supervise the selection and installa- strategies, helping organizations to leverage time as a source of competitive
tion ci new applications. Hence, they must identify people who possess the
internal expertise regarding current supply chain processes and related soft-
ware functionality, as well as general technical capabilities of the organiza- We have discussed a number of innovations throughout the chapter. Certainly, the
tion, and assign these experts to direct the process. This person or small provides a critical platform for the development and execution of technologies
team of experts must be given the authority and accountability to make tech- can be used in a supply chain context. Innovative tools such as on-demand appli-
nology decisions that span functions. They must also be given the ability to and software-as-a-service, XML, data synchronization, and event management
manage the implementation process without interference.
:ap:lbiliti'es all leverage the Internet. Increases in raw computing power and data star-
How will technology support our business needs and processes'? As dis- facilitate supply chain data mining, visibility, and optimization. And, innovative
cussed previously, there is a propensity to adopt software without consider- :~clmolog:y models like SOA support the integration of supply chain applications and
ing the processes that it will support, leading to automation of
change the software landscape from the current focus on monolithic applications
inefficiencies. Senior management must ensure that their implementation
team takes the time to document current processes and identify desired ca- suites to streamlined functionalities.
pabilities before embarking upon software reviews. Having a business plan The good news is that the technology landscape is not stagnant. Innovations will
prior to dealing with vendors will ensure that solutions support this plan 'icontiJoue to emerge to address the supply chain technology needs that have been dis-
rather than the business having to adapt to proposed solutions. throughout this chapter: connectivity, visibility, collaboration, optimization,
What is the status of our existing data'? It is critical to assess data quality, iexectrticm, and speed. However, the second coming of the Internet or other ground-
relevance, and completeness to ensure that the needed information is avail- .bn:aking new tools is not likely to occur anytime soon. We agree with the assessment
able to use with the technology being considered. If the data are lacking in one software vendor who states: "Businesses will be disappointed if they expect
any of these key requirements, the software cannot function as needed and
new technologies to give them an edge. New technology will definitely play a
the organization will encounter a garbage in-garbage out scenario. Also,
having an accurate data set available is important for testing potential soft- role, but the innovation will be more evolutionaty than revolutionary. A majofity
ware solutions to determine how well they model reality. emphasis will be on developing better standards to allow for real-time exchange
inlformilticm and interoperability of systems." 37
How well does our existing system integrate with suppliers and custo-
mers? SCIS fall woefully short on vital capabilities if they are unable to com- The challenge for supply chain managers is to find and implement the right tools.
municate with supply chain partners in an efficient manner. Systems must separate the innovations with the potential to positively impact supply
structures and capabilities should be mapped to identity where compatibility performance and gain widespread adoption from those that are impractical, inef-
challenges exist. Senior management must use this knowledge to support
: "'''""' and/or insignificant. With this challenge in mind, we conclude the chapter with
improved linkages of SCIS with key partners. Executive sponsorship of in-
a discussion of technologies that hold significant promise for the future enhancement
vestment in new tools, authorization of supply chain partner access to key
data, and support of intercompany systems connectivity will enhance supply of supply chain management.
chain information integration.
What external issues must our systems address'? Given the financial and Radio-Frequency Identification (RFID)
product flow data contained within most SCIS, they have a major impact on No other technology has garnered the attention of the supply chain industry and the
an organization's ability to address government mandates. Because supply media over the last three years than has RFID. While the technology used in RFID has
chain activities generate expenses and impact revenues, senior management is been available for decades and is widely used for aircraft identification, toll collection,
ultimately responsible for ensuring that the SCIS will feed accurate, complete, and library book tracking, supply chain applications were largely conceptual until ma-
and timely information into the organization's fmancial reporting mechan-
jor organizations began to develop RFID mandates. As of 2005, Wal-Mart's top 100
isms. This is critical to ensure compliance with Sarbanes-Oxley regulations.
The SCIS must also provide visibility of orders from suppliers through cus- suppliers were required to tag shipments with RFID labels and another 200 suppliers
tomer delivery so that the organization can monitor and control its operations, were added at the start of2006. Wal-Mart has deployed RFID at 117 ofits warehouses
its inventories and other assets, and its fmancial results. This visibility is also and 500 of its stores and planned to double the RFID-capable store count by the end
imperative for compliance with governmental security initiatives related to in- of 2007. 38 Similar mandates by the U.S. Department of Defense and other retailers
ternational trade such as the Customs-Trade Partnership Against Terrorism (Germany-based Metro Group, United Kingdom-based Tesco, and Target) have driven
(C-TPAT) and the Advanced Trade Data Initiative. the intense focus on RFID in supply chain management.

214 Chapter 6 Technology-Managing Information Flows 215

Like barcoding, RFID is an automatic identification method. RFID tags what I malce" to "malting what I sell," which resolves some of the major supply
a microchip and a printed antenna that can be packaged into many forms, 'fmecatstilog challenges and facilitates lean inventories. The ASCNs also support true
label or imbedded in between the cardboard layers in a carton or product so that buyers and sellers can simultaneously eliminate inefficiencies in their
Unique product identification information, in the form of a universal chains by synchronizing information flows and activities across the supply chain.
product code (EPC) identifying the manufacturer, product category, and the participants will achieve a valuable blend oflow-cost, high-quality supply
item, is stored on these 96-bit tags. The tags are affixed to the pallet, case, or
product and are read when they pass within proximity of an RFID reader. These
contain unique identifiers not found on barcodes, and direct line of sight is Automation
required to read RFID tags. The collected information is relayed back to the ~chmc,loi,Y advances and becomes more affordable, we will come closer to the reali-
updating the location status of the associated product. ofvroduct connectivity where Internet -enabled microprocessors provide digital
Initial results of RFID implementations have been positive. Wal-Mart reports and connectivity for almost every commercial and industrial product. 42 Al-
mamafa.cttmn and service providers are able to communicate with their prod-
out-of-stocks decreased 16 percent on RFID-tagged items and that out-of-stocks
replenished three times faster on tagged items than on items with only barcodes. 39 equipment without direct human involvement. Railroad company computer
Strauss can complete a storewide inventory in 30 minutes thanks to RFID. It monitor refrigerated boxcars and automatically adjust temperature and hu-
reduce out-of-stocks and enhance customer satisfaction while reducing theft. levels, oil companies remotely examine inventory levels in storage tanks, and
these success stories, the migration to RFID could slow if key challenges are not company satellite tracldng systems can pinpoint the location of en route
dressed. RFID technology costs must continue to decline to make product tagging These applications are made possible by pervasive automation, which is essen-
nomically feasible; equipment issues such as reader range, sensitivity, and dutralbili the networldng of tiny controllers in ordinary items to make them "smart" de-
must improve; the case for supplier return on investment of RFID mandates must capable of real-time assessment and information sharing. 43
made; and consumer privacy issues must be resolved. automation is viewed by some people as the next big thing in supply
As these issues are overcome and future enhancements are made (e.g., the management. They hypothesize that a convergence of valuable technologies-
ment of firm universal standards, sharing of best practices, and integration oten1ergir ASCNs, wireless communication, and others-that do not require human inter-
wireless and sensor technologies with RFID), adoption will grow and greater will support supply chain innovation. Not only will we be able to avoid supply
will be achieved. RFID and EPC will provide organizations with an unpn:ce<lente disruptions related to equipment breakdowns and inventory shortages, but it will
real-time view of their invento1y, item-level traceability of products, and true be possible to fundamentally alter the way items are produced, warehoused, and
management capabilities. Improvements in inventory management cost and eftkienc Managing product flows across the supply chain will also become much
in the form of greater product availability, reduced product shrinkage, and irn<Pr<JVe as item-level traceability and exception management will be facilitated by RFID,
product integrity will also be realized. and automated machine-to-machine communication.44
any of these three technology innovations gain traction and fundamentally
41 supply chain management as we know it today? RFID is the most likely to play
Adaptive Supply Chain Networks role in the evolution of the supply chain, but the prospects for radical changes
If supply chains are to become more flexible and responsive, the supply chain tec:hn<>l\ pervasive automation are much less certain. Only time and organizations' invest-
ogies discussed in this chapter must be effectively connected. Integration of all in these innovations will tell. Of course, the technology landscape is constantly
chain and other support systems and processes both within a company and New tools may render existing ones obsolete and supplant emerging innova-
trading partners is needed to allow true, full supply chain visibility and flexibility. The only way to keep up with the latest advances in supply chain technology is
can be accomplished via the creation of an adaptive supply chain network lll.''-"l'Ji monitor industry developments. Table 6-2, on the following page, provides a list of
These integrated, flexible networks of companies, technology tools, and processes sites that focus on information technology innovations and issues.
on customers and their changing requirements. The hallmark of an effective ASCN
its ability to respond to changes in real time, allowing the network to prevent or
mize supply chain problems.
ASCNs help meet the growing need for supply chain connectivity and collab<ora-
tion, two key information issues identified in an earlier section. Connectivity pnJvides
visibility. Collaboration enables a joint response with channel partners to avoid a
sible problem identified via the visibility. "Adaptive" in ASCN is the ability to w;pond
to and thrive on unexpected changes as they emerge, not after the fact. The "n,otVi'Orlc"
is a dynamic compendium of business partners and their supply chain technology
working together to provide increased benefit across the supply chain.
When ASCNs are established, companies will move from forecast-driven to dem1mdk
driven supply chains. In effect, the ASCN will help them shift from a perspective
'16 Chapter 6 Chain Technology-Managing Information Flows

Table 6-2 Sources of Additional Information: Supply Chain Technology

,fn:tati1on is critical to the success of a supply chain and must flow freely between
chain partners. Without accurate, timely information, it is extremely difficult
NAME WEB ADDRESS DESCRIPTION SIMILAR SOURCES chain managers to make effective decisions regarding the purchase, produc-
Achieving Supply Addresses timely topics distribution of materials. To facilitate the knowledge links and foster supply
Chain Excellence regarding supply chain visibility, many organizations are investing heavily in computer hardware, SCIS,
through Technology technology and processes i.ermn.orlive technologies like RFID. They realize that real-time information and the
via whitepapers, case
studies, and vendor profiles. to dynamically respond to changing conditions in the supply chain are critical
success of the organization. Industry leaders are using supply chain information
ARC Advisory Group http://www Provides access to ARC's http://www .aberdeen. com to create adaptive supply chain capabilities and substantial competitive
supply chain technology http://www .am rresearch. com
research studies and ran1taJ(eS in their respective markets.
industry news summaries.
Harn<"siing information technology in support of supply chain excellence is an on-
RFID Update Newsletter highlighting http://www .a imgloba challenge, given the continuing evolution of SCIS capabilities. Supply chain
breaking news and analysis http:/lwww. rfidgazette .org must work diligently to appreciate the growing role of information, under-
pertinent to RFID technology
and implementations.
each type of supply chain software, choose solutions wisely, and overcome key
iplcementation challenges to gain maximum benefit from information technology.
Reed Business Provides links to a variety
Information of publications that address index.html order for supply chain managers to utilize information, it must be readily accessi-
supply chain strategy, trends, http:/lwww. inbound logistics. com relevant to their decision-malting needs, accurate, timely, and in a format that
technology, and related topics. http://www .logisticstoday .com be shared.
Relevant titles include
Logistics Management, pr<Jp<:rly implemented, information technology supports critical supply chain
Purchasing, Supply Chain capalJiltties and strategies, including supply chain connectivity, product visibility,
Management Review, nortr>er collaboration, and process optimization.
and others.
well-designed SCIS framework links people, processes, and technology in a man-
that provides actionable information and enhances decision making.
data collection and synchronization support supply chain visibility, excep-
tion management, and effective response to changing customer requirements.
Supply chain software falls into four general categories: planning tools for forecast-
ing and related activities, execution systems for management of day-to-day pro-
cesses, event management tools to monitor supply chain flows, and business
> inte:lli!~enc< applications that help organizations analyze performance.
Given the potential stumbling blocks, software selection and implementation are not
a minor undertaking. Needs must be assessed, software options studied, technical
issues addressed, and important questions asked before major SCIS investments are
Change is the norm when it comes to supply chain technologies. It is critical that
developments related to RFID and other innovations are understood so that organi-
zations can take full advantage of worthwhile technologies.

Discuss the role of information in the supply chain and how it supports supply
chain planning and execution.
Describe the components of information quality and how they impact supply
chain decision making.
3. What are the primary capabilities created by supply chain technology? How can
they drive supply chain excellence?
4. Describe a supply chain information system in terms of its key elements, require-
ments, and capabilities.

il i

18 Chapter 6 219

5. Identify the four primary categories of supply chain management software Major portions of this section have been adapted from Jeff Abott, Karl Manrodt, and Peter Moore,
From Visibility to Action: Year 2004 Report on Trends and Issues in Logistics and Transportation
discuss their primary functions.
(New York, NY: Capgemini, 2004); and Peter Moore, Karl Manrodt, and Mary Holcomb, Collabora-
tion: Enabling Synchronized Supply Chains, Year 2005 Report on Trends and Issues in Logistics
6. Using the BCRC Web site ( and
and Transportation (New York, NY: Capgemini, 2005).
pany Web sites, develop a profile (types of supply chain software offered,
sales, and recent news) of the following organizations: Kenneth C. Laudon and Jane P. Laudon, Essentials of Business Information Systems, 7th ed. (Up-
per Saddle River, NJ: Prentice Hall, 2006).
a. SAP (http:/ /
Ken Mark, "Technology: Search for Next "Killer App" Replaced by Need to Coordinate Working of
b. Manhattan Associates (http:/ / Existing Systems," Canadian Transportation Logistics, VoL 108, No. 11 (2005): 58-59.
c. i2 Technologies ( Bob Trebilcock, "How Smart Is Your Software?" Logistics Management, Vol. 41, No. 8 (August
2002) 68-70.
7. What is '!he role of enterprise resource planning systems in supply
management? Scott Wilson, "Extending Visibility?" Metal Producing and Processing, Vol. 41, No. 1 (January
2003), 36-37.
8. Discuss the relative advantages of best-of-breed software versus supply chain
Peter Moore, Karl Manrodt, and Mary Holcomb, Collaboration: Enabling Synchronized Supply
Chains, Year 2005 Report on Trends and Issues in Logistics and Transportation (New York, NY:
Capgemini, 2005).
9. Why would companies choose to use on-demand software versus licensed
software? The Supply Chain Innovator's Technology Footprint: A Benchmark Report on What Companies
Want in Their Next Supply Chain Solution (Boston, MA: Aberdeen Group, 2006).
10. What are XML and service-oriented architecture? Discuss how they are used to
support supply chain technology improvement. Ben Worthen, "The ABCs of Supply Chain Management," CIO Magazine Supply Chain Manage-
ment Research Center, http://www.cio.comlresearch/scm/edit/012202_scm.html#scm_do,
11. When preparing to purchase and implement SCIS components, what issues and accessed June 30, 2006.
questions must managers address? Ann Bednarz, "Grape Grower Juices Up its Planning Systems," Network World, Vol. 21, No. 24
(June 14, 2004), 21-22.
12. Why is there so much interest in radio-frequency identification? What supply
chain benefits does RFID facilitate? David Maloney, "More than Paper Savings," DC Velocity, Vol. 4, No. 1 (January 2006): 62-64.

Peter Tirschwel!, "Planning vs. Execution," Journal of Commerce (July 5, 2004): 1.

NOTES David Taylor, "A Master Plan for Software Selection," Supply Chain Management Review, Vol. 8,
No. I (January 2004), 20-27.
1. ARC Advisory Group, "The SCM Market Expected to Grow 8.6% Annually: Growth Driven by SCE
Segment,", accessed June 22, 2006. Ellen Curtiss and Susan Eustis, Supply Chain Event Management: Market Opportunities, Strategies,
and Forecasts, 2006 to 2012 (Lexington, MA: Wintergreen Research, 2006).
2. David R. Butcher, "Supply Chains Increasing Tech Spending ... Subtly," Industrial
Market Trends (April25, 2006),, accessed June 22, Tackling Uncertainty: Improving Responsiveness with Supply Chain Event Management
2006. (Cambridge, MA: Sapient Corporation, 2002).

3. "Enterprises Increasing Technology Spending to Drive Supply Chain Innovation, Says New Aberdeen Michael Totty, "Technology Special Report: Business Intelligence," The Waif Street Journal (April3,
Report," PR Newswire (May 23. 2006). 2006), R6.

4. Robert Premus and Nada Sanders, "Modeling the Relationship Between Firm IT Capability, Rick Whiting, "Intelligence Spending," lnformationWeek, Issue 1079 (March 2, 2006): 63--64.
Collaboration, and Performance," Journal of Business Logistics, Vol. 26, No. 1 (2005): 1-23.
Tony Kontzer, "Wyeth Resolves to Aid its Distributors," lnformationWeek, Issue 1056 (September
5. Peter Moore, Karl Manrodt, and Mary Holcomb, Collaboration: Enabling Synchronized Supply 19, 2005), 96-97.
Chains, Year 2005 Report on Trends and Issues in Logistics and Transportation (New York, NY:
Capgemini, 2005). For an extensive discussion of Enterprise Resource Planning Systems, see Joel Wisner, G. Keong
Leong, and Keah-Choon Tan, Principles of Supply Chain Management: A Balanced Approach
6. Kevin Reilly, "AMR Research Releases Second Annual Supply Chain Top 25," AMR Research (Mason. OH, South-Western, 2005), 187-205.
(November 8, 2005),,
accessed June 21, 2006. Bob Trebilcock, "A Tale of Two ERP Systems," Modern Materials Handling, Vol. 60, No. 13
(December 2005), 27-29.
7. Mark Smith, "Improving Supply Chain Performance," Achieving Supply Chain Excellence through
Technology, Vol. 6 (San Francisco, CA: Montgomery Research, Inc., 2004). William Hoffman, "Doing it Their Way," Traffic World(November 21, 2005): 15-16.

8. Marc L. Songini, "Difficult ERP Rollout Slows Furniture Maker, Computerworld, Vol. 39, No. 18 Bridget McCrea, "Smarter, Faster, Cheaper," Logistics Management, Vol. 45, No. 5 (May 2006):
(May 2, 2005), 12. 49-51 and John Fontana, "What's Behind On-Demand Software's Rise," Network World, Vol. 22,
No. 49 (December 12, 2005), 1-2.
9. Jose Favilla and Andrew Fearne, "Supply Chain Software Implementations: Getting it Right," Supply
Chain Management, Vol. 10, Issue 3/4 (October 2005): 241-243. Michael Levans, "Get More Bang for Your IT Bucks," Logistics Management, Vol. 45, No.4
(April 2006), 32-35.
20 Chapter 6 Chain Technology-Managing Information Flows 221

32. John Dix, "The Three Levels of SOA Maturily," Network World, Vol. 23, No.9 (May 15, 2006), 42.

33. "Service-Oriented Architecture: A Definition," htlpd,'se;>rclhwrebs;e"ices.t<echtan,e

.com/gDefinition/0,294236,sid26_gci929153,00.htm, accessed July 18, 2006.

34. Bridget McCrea, "Is SOA the Answer to Supply Chain Software Limitations?" Logistics
ap Pet Products
ment, Vol. 44, No. 11 (November 2005): 20. Pet Products (CPP) of Saskatoon, Saskatchewan, in Canada manufactures
35. This section is adapted from the following presentation: Chris Norek, "Using Evolving Technology pet kennels. Unlike traditional wire cage kennels, the Catnappers synthetic
Manage Complex Supply Chains," Transformation '06: a Business and Logistics Co.nfp,;~;; kennels are attractive and functional. They are available in six colors and six
(Las Vegas, NV, February 1, 2006). to accommodate all sizes of cats and dogs. Annual sales have averaged 50,000
36. Jim Welch an.d Peter Wietfeldt, "How to Leverage Your Systems Investment," Supply Chain over the past three years. CPP has no sizeable competitors and sells the product
agement ReJtJeW, Vol. 9, No. 8 (November 2005): 24-30. via the Internet on and through five home furnish-
37. "Supply Chain Management~Edgewater Technology," http://www.edgewater . c;orrtllnrl''''''"'
mail order catalogs at prices ranging from $99.95 to $279.99 CDN plus shipping
Retail/solutions_supplyChain.htm, accessed July 19, 2006. handling.
38. Anita French, "Wai-Mart Prods Suppliers on RFID," The Morning News (January 3, 2006). Catnappers consist of four primary components: the wire frame and door (sourced
Nampa, Idaho), a plastic floor pan (Calgary, Alberta), weaved resin panels
39. "Wai-Mart, RFID Reducing Out-of-Stocks," RFID Update(October 25, 2005), htt;,.IA'IWiv.rflldu;,date'
.com/articles/index.php?id=977, accessed July 19, 2006.
Mexico), and shipping boxes (from nearby Regina, Saskatchewan). The com-
are assembled, packaged, and warehoused at CPP's Saskatoon facility. CPP
40. "Gillette, Wai-Mart, Levi, Michelin Share RFID Results," RFID Update (May 27, 2005), nartagemcenl develops quarterly forecasts using Excel macros and shares them via, accessed July 19, 2006.
with each supplier along with the monthly orders for components.
41. This section is adapted from the following whitepaper: Chris Norek, "Adaptive Supply Chain Net-
works: The Next Supply Chain Summit" {Atlanta, GA: Chain Connectors, Inc., 2006). Approximately 35 percent of customer orders are placed through CPP's Web site
the remaining 65 percent coming through its mail order partners. The two largest
42. Jim Pinto, "Pervasive Networks," Automation World {December 2004), http://www.automationworld place daily orders using Internet-based ED!, two others send weeldy orders via
.com/a rticles/De pa rtme nts/1 038. htm l?ppr_key= 12. 2004&s ky_key= 12 .2004&term= 12 .2004, ac_
cessed July 19, 2006. and the smallest catalog company periodically faxes in orders. All customer or-
are sent from CPP via small package carriers as no inventory is held by the catalog
43. Shane Schick, "Expert Warns of Emerging Pervasive Workplace," Computing Canada, Vol. 26,
No. 21 (October 13, 2000), 36.

44. George Brody, "The Smart, Sensor-Based RF!D Network," Achieving Supply Chain Excellence
Over the years, the company has cobbled together a variety of technology tools to
through Technology, Vol. 7 {San Francisco, CA: Montgomery Research, Inc., 2005). its efforts. Key components include an e-commerce package to manage the
site and order taking, a basic warehouse management system that helps CPP
:mronitor inventory levels and manage order picking, and shipment management tools
its primary package carrier to help with routing, documentation, labeling, and
!!racking. Other processes are managed using a structured query language (SQL) data-
spreadsheets, and an accounting software package.
At a recent trade show, CPP executives were approached by two major retailers,
"Plm:o and Target, about carrying the Catnappers product line. The projected volume
of these two customers would take annual sales to 250,000 units. While company ex-
". ec:uti.ves were initially ecstatic, they quicldy realized that the current capabilities of the
Saskatoon facility and the CPP "information system" could not sustain such volume.
Still, they did not want to turn down the business windfall and began working on a
plan to handle their new customers.
The first planning meeting generated a basic strategy. The company would continue
to serve its current customers through existing facilities and processes. In terms of the
additional volume, CPP would manage the sourcing of components and use a contract
manufacturer in China to produce the Catnappers for PETCO and Target. The prod-
uct would be shipped to San Diego, California, via ocean container service and a third-
party logistics company would warehouse the inventory and manage final delivery to
PETCO and Target stores.
222 Chapter 6

1. Given its volume growth and supply chain process changes, what technolo
d Reading
lenges will CPP face? gy
2. As the scope of the CPP supply chain expands, which information technolow~
pabilities will be most important for the company to pursue? Global Supply Chains
"Mexican Trucks Entering U.S. Sparks Critics," Logistics Today (March 2007): 11.
3. From an information sharing standpoint, how will the requirements of
~::~~:;~;;~~;and Chian-Yu Yeh, "Core Competencies and Sustainable Competitive Advantage in
and Target differ from CPP's current customer base? How should CPP resp 011 d r~ :Evidence from Taiwan," Transportation Journal (Summer 2007): 5-20.
these requirements? M. et al., "The Real-Time Global Supply Chain Game: New Educational Tool for
4. "'
What type(s) of software will be most beneficial for CPP to adopt? Why?
Supply Chain Management Professionals," Transportation Journal (Summer 2006): 61-73.
claDasU,gue, Sebastian J. and Douglas M. Lambert, "Interorganizational Time-Based Postponement in
," Transportation Journal, No. 1 (2007): 57-80.

~~:~t:~~s)'"~,d;~~C::hing-Chiao Yang, "Comparison of Investment Preferences for International Logistics
, Hong Kong, and Shanghai Ports from a Taiwanese Manufacturer's Perspective,"
(Winter 2006): 30-50.
Ricardo Castillo, "Mexican Trucks to Cross U.S. Border," Logistics Today (April2007): 1, 9.

Roger, "Off the Beaten Track," Logistics Today (November 2006): 27.
Phillip M., "A Model for Logistics Mailagement in a Post-Soviet Central Asian Transitional
"Transportation Journal, No.2 (2006): 301-331.
Perry A., "Optimizing for European Distribution," Logistics Today (February 2007): 16-17.

Supply Chain Relationships

& Associates, Inc., Who's Who in International Logistics: Armstrong's Guide to Global Supply
Management, 13th ed. (2005}.
, Bryan, Arnold Maltz, and Elliot Rabinovich, "Studies of Trends in Third-Party Logistics
What Can We Conclude?" Transportation Journal, Vol. 44, No. 3 .(2005): 39-50.
Mohsen, and Sharmin Attaran, "Collaborative Supply Chain Management: The Most Promising
for Building Efficient and Sustainable Supply Chains," Business Process Management Journal,
13, No. 3 (2007}: 390-404.
Bolurrok,, Yemisi A., "Evaluating the Supply Chain Role of Logistics Service Providers," International
of Logistics Management, Vol. 14, No.2 (2003): 93-107.
Emma, "Don't Be the Weakest Link," Supply Management, Vol. 10 (May 2007): 26-28.
Robert L. et al., "Mapping the Value of Employee Collaboration," The McKinsey Quarterly, Vol. 3
Delaney, Robert V., 11th Annual State of Logistics Report (St. Louis, MO: Cass Infonnation Systems, June
5, 2000).
Fearne, Andrew, et al., "Implanting the Benefits of Buyer-Supplier Collaboration in the Soft Fntit Sector,"
Supply Chain Management, Vol. 11, No.1 (2006): 3-5.
Foster, Thomas A., "The Trends Changing the Face of Logistics Outsourcing Worldwide," Global Logistics
& Supply Chain Strategies (2004).
Horibe, Kathlyn, "Canada's Grand Realignment," Traffic World, VoL 11 (September 2006): 18-23.
Hult, G. Tomas M., et aL, "Strategic Supply Chain Management: Improving Performance Through a
Culture of Competitiveness and Knowledge Development," Strategic Management Journal, Vol. 28, No. 10
(2007), 1035.
Jain, Vipul et al., "A Negotiation-to-Coordinate (N2C) Mechanism for Modeling Buyer-Supplier
Relationship in Dynamic Environment," International Journal of Enterprise Information Systems, VoL 3,
No.2 (2007): 1-10,12-15,17-18, and 20-22.
Kanter, Rosabeth Moss, Harvard Business Review (July-August 1994).
Krause, Daniel R. eta\., "Bargaining Stances and Outcomes in Buyer-Seller Negotiations: Experimental
Results," Journal of Supply Chain Management, Vol. 42, No. 3 (2006): 4-15.

Part III~--------- _j

Up to this point, the topics in this text have provided a basic understanding of the supply chain,
how it is managed and measured, and the technology used to help manage information flows.
Part Ill will focus on the concept of forecast to cash, i.e., all of the functional activities involved in
developing the forecast up to the collection of cash. This section will discuss the planning and
execution of the movement of products to the end customer with the goal of minimizing cost and
maximizing customer satisfaction.
Chapter 7 begins by discussing the typical imbalance between supply and demand lor an organi-
zation and how this imbalance can be mitigated by understanding the various factors that a!!ect
demand and using this knowledge in forecasting. Next, the basic elements of customer service
are identified and discussed from the perspective of how they a!!ect both buyers and sellers, and
the concept of stockout costs is introduced. Finally, this chapter reviews various channels of dis-

The next two chapters present a detailed discussion on two logistics areas critical to supply chain
fulfillment-transportation systems and management. Chapter 8 first discusses the importance
of transportation to the economy, followed by a general analysis of the transportation market and
the various modes of transportation. Chapter 9 o!!ers perspective on strategizing for e!!ective
transportation planning, execution, and control.
Chapter 10 o!!ers a detailed examination of the concept of inventory decision making and man-
agement. This chapter begins with a general discussion of the roles of inventory in the economy,
why organizations carry inventory, and the various types of inventory held in the supply chain.
Next, an in-depth discussion is o!!ered on the various techniques for managing inventory, with a
special focus on the economic order quantity (EOQ). Final sections of the chapter cover managing
for multiple locations, dealing with outbound systems, and demand pull approaches.
Finally, Chapter 11 explains the role of warehousing and its relationship to supply chain manage-
ment. The chapter goes on to explore warehousing decisions, operations, layout, and design, and
concludes with a discussion of materials handling and packaging.

Cha r7

learning Objectives
After reading this chapter, you should be able to do the following:
Understand the critical importance of outbound-to-customer logistics
Appreciate the growing need for effective demand management as part of a
firm's overall logistics and supply chain expertise.
Know the types of forecasts that may be needed, and understand how
collaboration among trading partners will help the overall forecasting and
demand management process.
Identify the key steps in the order-fulfillment process, and understand how
effective order management can create value for a firm and its customers.
Realize the meaning of customer service, and understand its importance to
logistics and supply chain management.
Understand the difference between logistics and marketing channels, and
understand that goods may reach their intended customer via a number of
alternative channels of distribution.

Demand Management and Customer Service
Chapter 7

torical interest in the study of logistics and supply chain management, and this chapter
highlights key areas of concern relating to this general topic.
Supply Chain How Scan-J3a$ed Trcuiirtg
Profile Changed Distribvtion at Correspondingly, the topic of inbound-to-operations logistics systems refers to the
activities and processes that precede and facilitate value-adding activities such as
Dreyer's. manufacturing, assembly, and so on. Other terms that focus on these elements of the
supply chain include materials management and physical supply. A typical example
Not only has scan-based trading changed the payment process at Dr~~~::mG~:~e;c:e~~~,i~: would be the movements of automotive parts and accessories that need to move from
but it has altered distribution operatmns as w:~L t~l: ::;:h:~~ p~;s ~~~e manufacturer for prod- vendor locations to automotive assembly plants. Although many of the principles of
stituting scan-based tradrng, a practrcedwhte~h: checkout counter. According to the director of inbound logistics are conceptually similar to those of outbound logistics, there are
ucts based on what I; actuaol\:~:~n~al~ornia-based company, the retailers send them daily important differences that must be recognized. Thus, the topic of inbound logistics
distributmn for Dreyer s, an a , systems is the focus of Chapter 13, which is titled "Procurement and Supply
and they pay Dreyer's directly from the scanned data.
scanne d data , t Management."
for starters, the implementation of s::;;,b~:e~o~:~;n;w~:;s~~;:~et~:hs~o~:Y,;I~v::s~~c~
managed because there IS n~ longer a tra t'l 't' pscanned " says the director of distribution. Examples of Successes
the inventory remains Dreyer s mventory un 1 I s ,
"The handoff at the back door doesn't happen." As a practical matter, in many firms the outbound-to-customer logistics system re-
, t k the ice-cream manufacturer ceives far more attention than the inbound-to-operations system. While this is chang-
Because consumer tak;;:~::u::i~e:ys~eh~t ::~~::ul:, ~~e: reported having more detailed ing quickly, it is largely due to the historical priority firms have had on improving
has shifted to a closed-loop t h I \'on and the traditional invoice discrepancies are be- service to their customers. This has led to an emphasis on attributes such as product
knowledge of what rs selling a eac oca I ' availability, on-time and order delivery, timely and accurate logistics information,
ing eliminated. . - f overall responsiveness, and post-sale customer support. Very simply, providing the
In-store vendor control of inve.ntory a~so has e~imina~edt::en!i~:~c~~~~~~nc~~~~~~:::~~o~ customer with an acceptable level of service has been of greater concern, historically,
product delivery at each store. Prevlo,usly,_ It to~kl drrvTe~:s :as had other benefits as welL Nota- than assuring the efficient and effective flow of materials to value-adding operations.
and validate items agarnst the stores prrcrng Ies. I receiving hours of the retail stores. Also, In today's business environment, successful firms find it necessary to place an equal
bly, deliveries are no longer restrrcted toDthe ","'~'able to promote 24/7 availability of product emphasis on being proficient in both of these areas.
from the perspective of fleet operatrons, reye~ s I constraints has allowed Dreyer's to optimize The automotive industry provides an interesting example of the kinds of progress
to its customers. The removal of dehve~-wm ow an has experienced sales in- being made. In order to make sure buyers get the vehicle they want, top executives of
its 800-vehicle fleet for direct store delivery. Atl~hough /~:dc::~d/vehicles to its fleet since it one U.S.-based auto manufacturer recently held a "customer insight day," in which
creases of 10 percent to 15 percent per year, I as no
they sat at a table and talked with real customers about their cars and how their cars fit
adopted scan-based trading. . .
into their lives. In addition, these same executives visit at least two of the company's
Improved fleet utilization has :~~:~ u~:e:~:;~:s s:~i~:~:~:~:;~~ec~~er~;~:~;: s~~::~;:
: dealerships each year. In essence, they are worldng to change the basic dealer strategy,
stockrng tasks. (Unlike other camp h' saved on distribution has been reinvested rn which currently is to sell from stock. Since studies have shown that only 60 percent of
workforce does the stockrng.) In short, t ~s ~:;te~reyer's can take the money saved on distribu- auto customers typically get what they want, their goal is to make it 100 percent To
stocking and merchandiSing. The feeling h d' . g If ava'llable funds can be spent on people achieve this, emphasis has been placed on developing a process whereby a dealer can
. - t 't 111 tacking and mere an 1sm . . change an order shortly before the car is built, and on identifying better means to
tmn and remves 1 s . ffered to the customer With the increases m
in stores, instead of trucks, then more v~ ue ~~ ohas shifted from deliv~ry of the product to a
transport finished vehicles to consumer buyers in a more timely and consistent
efficiency of truck delivery, the focus att relyer Is If the product does not sell, the manufacturer manner.
partnership of selling products at the s ore eve .
Another goal is to make order entry and vehicle configuration more accurate and
~~-~~ .. efficient They want to be able to tell a buyer when his/her vehicle will be ready, and
"Scan and Supply " Logistics Management and Dtstnbu-
Source: Adapted from James Aaro~ ~~~ehners Business lnfo~mation. Reprinted by permission. stand by it Not long ago, this particular manufacturer was making only 60 percent of
tion Reporl(June 2000): 67. Copyng a
the vehicles in the week that were planned; this percentage has increased to 90 percent
in recent years. Last, the company has created a special team to work with its suppliers
to align its production strategy with its forecast. The desired end result is to shorten
Outbound-To-Customer logistics Systems .. the time needed to get a car to the customer.I
. man firms have placed sigmficant empha-
In an effort to better serve thel: custbomerds, t -cuystomer logistics systems. Also referred Another example is that of a major computer disk drive manufacturer that experi-
b t rmed their out oun - o d enced rapid consolidation in its supply chain. In response to a series of acquisitions
sis on w h at may e. e . . f 11 refers to the set of processes, systems, an
to as physical distnbutiOn, this .ess~~la { serve its customers. For example, the ways that brought together eight different companies operating in eight different ways, the
capabilities that enhance a firms a Ity od , E d d Eddie Bauer fulfill their custo- company initiated a supply chain project that focused everyone's attention on the
il h LLBeanLans n,an h' needs of the customer. This action enabled them to begin breaking down all of the silos
in which ret a ers sue as . . ' d 1 . t. This topic has been of significant IS-
mers' orders are examples of outboun ogis ICS. -
Chapter 7 Demand Management and Customer Service
2 233

that existed between the companies and, in the process, drove out inefficiencies. In ad-
dition to being able to lower prices for its customers, this firm was able to reduce pro- Ollthe Line IngratnA'pcro ADemand
duction time for its disk drives by 50 percent. Shortening the forecast was another
benefit of this effort., Previously, monthly sales forecasting cycles-a long time in the
Chai.n Leader
high-tech/electronics\ industry-were used on a regular basis. More recently, the focus Demand chain creation usually begins with the vision of a company leader who is determined
has shifted to weekly forecasts and, ultimately, to having forecasts on a daily basis. As to make operatiOns fully complement a consumer-centered strategy. In many cases, the com-
a result, costs are expected to continue to decline, with service to the customer ex- pany wrll take the lead role, inculcating its supply chain partners with that same vision. In
pected to improve.
other_ cas~s, It may turn to outside resources, such as a consulting firm or service provider for
help rn thrs effort. '
. Ingram Micro took the leadership approach in creating a demand chain among its supply
Organization of This Chapter charn partners. The Seattle-based company is the world's leading wholesale distributor of tech-
Considering the complexity of the topic at hand, this chapter has a relatively aggressive nology products and services. This $22 billion giant distributes more than 200,000 products
agenda of topics to be discussed. First, a discussion of demand management provides from 1,500 manufacturers to over 140,000 resellers in 130 countries.
an overview of the importance of effectively managing outbound-to-customer activities
and processes. Second, the topic of forecasting is addressed in a general sense. Third, . . The company's COO explains that Ingram Micro is committed to reinventing technology
the more recent emphasis on collaborative forecasting approaches is covered. Fourth, drstrrbutron by puttrng the customer first ... but the company's initiative does not stop there.
attention is directed to the customer order cycle and how orders are placed, received, The focus goes beyond Ingram's customers to address the needs of its customers' customers-
processed and shipped to the customer. Fifth, the role and importance of customer ser- or end-use customers. The role of distribution in any industry is to extract products from a mul-
vice are examined. A sixth topic is how to understand and quantify the costs that may trtude of manufacturers and distribute them to a broad set of businesses, markets, and consu-
be incurred when needed merchandise is not available for the customer. Last, a few mers. Thrs rs true rn the technology market in which Ingram competes as well. Consumers look
comments regarding channels of distribution are necessary to put the overall topic of for solutrons to their computing needs, which can involve putting together a complex system of
products and features-not just a single product from a single vendor.
outbound logistics in its broader, more meaningful context.
_ The accompanying diagram depicts Ingram Micro's model for technology distribution. The
rntent rs that the model begrns and ends with the end user-the consumer. After listening to
:he needs of t.he end consumer, Ingram communicates this information to its customers (resell-
Demand Management rs), who desrgn, sell, and support the products and services consumers want. In conjunction
According to Blackwell and Blackwell,3 demand management may be thought of as wrth manufacturers, the company then puts the products together and delivers them directly to
"focused efforts to estimate and manage customers' demand, with the intention of the end user on the reseller's behalf. The company has chosen the terminology demand chain
using this information to shape operating decisions." Traditional supply chains typi- rather than supply chain, because its central focus is to meet consumer demand. '
cally begin at the point of manufacture or assembly and end with the sale of product to
consumers or business buyers. Much of the focus and attention has been related to the
topic of product flow, with significant concern for matters such as technology, infor- \t\\ormation drive
mation exchange, inventory turnover, delivery speed and consistency, and transporta-
tion. This notwithstanding, it is the manufacturers-who are many times far removed / ICons~mers/~r~
end users ~
from the end user or consumer market-who determine what will be available for sale,
where, when, and how many. If this seems to reflect a disconnect between manufactur-
ing and demand at the point of consumption, that is exactly what it is. Thus, any atten-
tion paid to demand management will produce benefits throughout the supply chain.
The essence of demand management is to further the ability of firms throughout
I solut1ons tJ

the supply chain-particularly manufacturing through the customer-to collaborate

on activities related to the flows of product, services, information, and capital. The de-
M_ anufacturer~f-i--.II
sired end result should be to create greater value for the end user or consumer, for
whom all supply chain activity should be undertaken. The following list suggests a
I.. .n "I Ingram
Micro ~ l.JI
1 1 1 - !_ _

Resellers !li
mnnber of ways in which effective demand management will help to unity channel
~ource. Figure and_text adapted from Roger D. Blackwell and Kristina Blackwell "The Century of the
members with the common goal of satisfYing customers and solving customer onsumer: Converting Supply Chains i~to Demand Chains," Supply Chain Man~gement Review 3
no.b3(F~11 1999): 24-25. Repnnted With permission of Supply Chain Management Review. a Cah~ers
1 1
pu ICB 10n
Gathering and analyzing knowledge about consumers, their problems, and
their unmet needs
Identifying partners to perform the functions needed in the demand chain
Demand Management and Customer Service 235

Moving the functions that need to be done to the channel member that can Figure 7-1 Supply-Demand Misalignment
perform them most effectively and efficiently
Sharing with other supply chain members knowledge about consumers and
customers, available technology, and logistics challenges and opportunities . Channel I True end-customer demand.
Developing products and services that solve customers' problems ~~orders 2 Pro?uction cannot meet initial
Developing and executing the best logistics, transportation, and distribution :3 Channel I True end-customer proJected demand, resulting
methods to deliver products and services to consumers in the desired ; fill and\ demand In real shortages.
: phantom 3 ~hannel partners over-order
format : demand In an attempt to meet demand
As firms identify the need for improved demand management, a number of prob-
lems occur. First is that lack of coordination between departments (i.e., the existence
of "functional silos") results in little or no coordinated response to demand informa-
; 2 Real
-- 5 Over-supply
and stock their shelves.
4 As supply catches up with
demand, orders are canceled
tion. Second is that too much emphasis is placed on forecasts of demand, with less at- or returned.
tention on the collaborative efforts and the strategic and operational plans that need to
be developed from the forecasts. Third is that demand information is used moreso for
tactical and operational than for strategic purposes. In essence, and since in many
Production ' --
5 Financial and production
planning are not aligned with
real demand; therefore,
production continues.
cases historical performance is not a very good predictor of the future, demand infor- Returns/
6 6 As demand declines, all parties
mation should be used to create collective and realistic scenarios of the future. Primary
emphasis should be on understanding likely demand scenarios and mapping their rela- Launch
... of
attempt to drain inventory to
prevent write-down.
tionships to product supply alternatives. The end result will be to better match demand date life
as it occurs with appropriate availability of needed product in the marketplace.
Source: Accenture, Stanford University and Northw . . 1 en "value m
Computer Supply Chain {Accenture, 1997) ' 15 estern University, Customer-Driven Demand Networks: Un/ockin<Y
o H'dd . the Personal
Figure 7-1 provides a view of how supply-demand misalignment may impact over-
all supply chain effectiveness. Using the PC industry as an example, this figure charts
production, channel orders, and true end-user demand over the life cycle of a product.
According to Langabeer,s there IS . growmg. and .
Ignoring the early adopters, end-user demand for PCs typically is at its highest level at standing and managing mark t d d persuasive evidence that under-
the time new products are launched-which is also the time that availability is most a e eman are central d t
ASl e from this observation , reiat.IVeIy 1ew
cornpa h
e ermmants of business success

precarious. As new, competing products become available, end-user demand begins to management with corporate strate T bl 7 1 mes. ave successfully linked demand
taper off, eventually reaching a modest level, at which time the product, now much may be used strategically to enh gy. a e - ~roVJdes a view of how demand data
ance a company s growth c li .. .
more available, is generally phased out. mvestrnent strategies. As suggested cc . , portiO o, posthonmg, and
t a
o gm e strategic resources in a numb
, euectlve use of dem d d
f. an ata can help companies
Looking more closely at Figure 7-1, in the first phase of a new product launch, when er o Important ways.
end-user demand is at its peak and opportunities for profit margins are greatest, PC as-
semblers are not able to supply product in quantities suffkient to meet demand-thus
creating true product shortages. Also during this time frame, distributors and resellers
tend to over-order," often creating substantial "phantom" demand. In the next phase,
Traditional Forecasting
as production begins to ramp up, assemblers ship product against this inflated order A major component of demand mana ernen . .
that will be purchased by cons g t IS forecastmg the amount of product
situation and book sales at the premium, high-levellaunch price. As channel invento- throughout the supply chain th umelrs or end users. Although forecasts are made
ries begin to fill, price competition begins to set in, as do product overages and returns. ' e smg e, most Important for t. h
man d . In a truly integrated supply h . . ecas IS t at of primary de-
This further depresses demand for the PC product, and the PC assemblers are the r tl f c am scenano all other d d "II
ec Y rom-or at least be influenc d b . ' eman WI emanate di-
hardest hit. of integrated supply chain manage:,e~-:-P:Im~y demand. One of the key objectives
In the final phase noted in Figure 7-1, as end-user demand begins to decline, the cham decisions anticipate, as well as res ~n; rth~r the extent to which all supply
situation clearly has shifted to one of over-supply. This is largely due to the industry's marketplace. p to, pnmary demand as it occurs in the
planning processes and systems, which are primarily designed to use previous period
demand as a gauge. Since much of the previous period's demand was represented by Figure 7-2 outlines one firm's ap roach t al .
production scheduling activities Th p fi o s. es forecasting and its integration with
the previously mentioned "phantom" demand, forecasts are distorted. The net result of
~emand by n1onth by applying .tr.ldfti6~~t~~a~~~"velop,at;velve:ll1Qnth forecast of
orecastmg approach~s (e.g., mov--
these behaviors in aliguing supply and demand is that a large majority of product is
mg average, exponential smoothin B- --.
_y_ear ~ist()ry!~e ()f ~ata_on_factors s~ch ~:-~:~~~~ regression analysis, etc.)_toathree, -
sold during the declining period of profit opportunity, thereby diminishing substantial
value creation opportunities for industry participants. Adding insult to injury, substan-
~l1d promotwns. fn the second step.- b .. d .d..... , pnce, seasonahty, availabi!'ty, deals,
tial amounts of inventory are held throughout the supply chain as a hedge against sup- - . ____ . . --- relevant changes 'The
and recommend ran anl .product managers review this forecast
ply uncertainty. Overall, this situation is one that needs considerable attention. . resu t IS an agreed-upon statement of gross
Demand Management and Customer Service
Chapter 7

How Demand Management Supports Business Strategy

Figure 7-2 I Integration of Sales Forecasting and Production
Table 7-1
STRATEGY History file Brand and product
(3 ~ears-demand, Aggregate
Perform "what if" analyses on total industry volume to gauge how managers review production schedules
Growth specific mergers and acquisitions might leverage market share. pnce, seasonality, and recommend
deals, promotions, etc.) (12 months)
strategy changes
Analyze industry supply/demand to predict changes in product pricing
structure and market economics based on mergers and acquisitions.
1 1 1
I l
Build staffing models for merged company using demand data.
Allocation of
Forecasting model
(moving average, Revised aggregate
Manage maturity of products in current portfolio to optimally time forecast
Box-Jenkins, requirements to
Portfolio overlapping life cycles.
strategy regression plants

Create new-product development/introduction plans based on life
analysis, etc.)
1 l
Balance combination of demand and risk for consistent "cash cows"
with demand for new products.
Ensure diversification of product portfolio through demand forecasts.
12 -month forecast
Gross market
( 1- to 3-year periods)
(by month) scheduling
Manage product sales through each channel based on demand and
product economics.
Manage positioning of finished goods at appropriate distribution centers,
to reduce working capital, based on demand.
Define capability to supply for each channel.
S~ort-term forecasts are most im ort
nmg process. They project deman~. t~or the operational logistics plan-
Manage capital investments, marketing expenditures, and research focusing increasingly on shorter f m. o e several months ahead and are
Investment and development budgets based on demand forecasts of potential units, by actual items to be ship ~e mdt~rvals. _These forecasts are needed in
strategy products and maturity of current products. . pe ' an tor fimte periods of tim
Determine whether to add manufacturing capacity. An rmportant distinction involves th t f e.
supply chain, in contrast to the strate ic :s:~ leal use of .demand information by the
Source: Jim R. Langabeer ll, "Aligning Demand Management with Human Strategy," SuPply Chain Manage- On the one hand, "tactical" use of d g d d y an executive-controlled supply chain 6
ment Review {May/June 2000): 68. Reprinted with permission of Supply Chain Management Review, a
velop a forecast of proJ'ected sales Alemtan , ata Will probably help a company to d~-
: ra e~c use of the same data can
Cahners publication. h 1 . ernatiVely "st t , "
e P a. company to analyze its roduct
strategies, This strategic use of d~mand d!~r::~ho and Its new product development
Ity and market positioning of a company, help to Improve the overall profitabil-
market requirements for the succeeding one- to three-year periods. The third step in-
volves developing aggregate production schedules for the next twelve-month period
and allocating specific production requirements to various manufacturing facilities. Fi-
nally, the logistics function commonly assumes responsibility for scheduling produc- Collaborative Planning, forecasting and
tion on a short-term basis, in order to coordinate demand for finished product with
the timing and availability of needed production inputs.
Replenishment '
Actually, different approaches to forecasting serve different purposes:
Ove~ time, there have been numerous indust
effiCiency and effectiveness through int
. .. .
mttlatiVes that have attempted to create
cesses, They have been identified by n egra IO~ of supply chain activities and pro-
Long-term forecasts usually cover more than three years and are used for
long-range planning and strategic issues, These naturally will be done in terchange (EDI), short cycle rnanu~m;s ~uc as quick response, electronic data in-
broad terms-sales by product line or division, throughput capacity by ton continuous-replenishment planning (C~~rmg,d vendor-managed inventory (VMI)
per period or dollars per period, and so on. These forecasts might easily go One by one, each fell short of expe t t' , an efficient consumer response (ECR)'
beyond customer demand to other key corporate resources such as produc- chain activities among the many p~r~:i~:~t~~rticularly
in its ability to integrate suppl;
tion capacity and desired inventory asset levels.
Midrange forecasts-in the one- to three-year range-address budgeting is- One of the most recent initiatives aimed . .
sues and sales plans. Again, these might predict more than demand. The de- collaborative planning, forecastin , at ac~tevmg true supply chain integration is
mand forecasts will very likely still be in dollars and now, perhaps, at the recognized as a breal<through b .g, and replemshment (CPFR)-' CPFR has beco:Ue
m ent . Usmg
, this approach retailers
tr model for pla ,
. nmng, c
IOrecasting, and replenish-
level of product family or product line, The first year in a multiyear forecast
, , ansport proVIders, distributors' and manufac tu rers
might be by month, while the following years may be by quarter.
Figure 7-3 CPFR Business Model
Chapter 7

can utilize available Internet-based technologies to collaborate from operational planning

through execution. Whereas historically. for a single product, retailers and manufacturers
may have had twenty or more types of forecasts between them-each developed for a
special purpose, each more or less accurate, and all trying to predict behavior of buyers in
the marketplace-CPFR simplifies and streamlines overall demand planning. Create joint Business
The impetus for the development of CPFR came from an effort in 1995 by Wal-Mart Plan
and one of its suppliers, Warner-Lambert Company, particularly with regard to its Lis-
terine"'-brand product. In addition to rationalizing inventories of specific line items and
addressing out-of-stock occurrences, these two companies collaborated to increase their Create Sales Forecast
forecasting accuracy, so as to have just the right amount of inventory where it was
needed, when it was needed. The three-month pilot produced significant results and
improvements for both parties, sufficient to be responsible for further utilization by ' ;
W al-Mart of this approach that used the Internet to facilitate the collaboration.
As suggested in Figure 7-3, CPFR emphasizes a sharing of consumer purchasing
data among and between trading partners for the purpose of helping to govern supply
chain activities. In this manner, CPFR creates a signiflcant, direct link between the
consumer and the supply chain. The effective implementation of CPFR is based on
systematic collaboration between trading partners, whereas predecessor approaches are ci'
not. In addition, the CPFR movement is responsible for the creation of new technology
tools to facilitate the sharing, analysis, and ultimate application of the information by
trading partners. Use of the Internet as a low-cost, neutral systems platform and the
development of "between-ware" applications are showing great promise.
Create Order Forecast
The CPFR initiative begins with the sharing of marketing plans between trading part-
ners. Once an agreement is reached on the timing and planned sales of speciflc products,
and a commitment is made to follow that plan closely, the plan is then used to create a
forecast, by stock-keeping nnit (SKU), by week, and by quantity. The planning can be for Identify Exceptions for
thirteen, twenty-six, or fifty-two weeks. A typical forecast is for seasonal or promotional Order Forecast
items that represent approximately 15 percent of sales in each category. The regular turn Exception
items, or the remainder of products in the category, are forecast statistically. Then, the fore- Items

cast is entered into a system that is accessible through the Internet by both supplier and
buyer. Either party is empowered to change the forecast, within established parameters.
Only a few CPFR initiatives have published the results of their collaborative efforts,
but those that are available are impressive.' Nabisco and Wegmans, for example, noted Supply Constraints
an increase in category sales of more than 50 percent. Wal-Mart and Sara Lee reported
a reduction of 14 percent in store-level inventory, with a 32 percent increase in sales.
Kimberly-Clark and IZrnart have achieved steady increases in category sales growth Order/PO

that exceeded margin growth.


Order Fulfillment and Order Management Delivery Execution

As suggested by Figure 7-4, three critical elements of collaborative planning are collab-
orative demand planning, joint capacity planning, and synchronized order fulfillment. Order illi
This type of planning improves quality of the demand signal for the entire supply
Distributor Either/joint Manufacturer
chain through a constant exchange of information from one end to the other that goes
well beyond traditional practices. As a result, the downstream supply chain firms share
relevant and useful order information and demand forecasts with those farther up-
Activities D Activities Activities

stream. At the same time, upstream firms share updated information relating to prod-
ntary lntenndustry Commerce Standards (VICS) Assod~t~ Commerce Standards (VICS) Association. CPFR is a reg t d
n. IS ere trademark ofthe Vol-
uct availability and expected inventory levels.
Demand Management and Customer Service
Chapter 7

Figure 7-5 identifies four key stages of order fulfillment (i.e., information sharing,
decision-making, performance measures, and technology) and suggests how these stages
Figure 7-4 Collaborative Planning
differ as supply chain activity matures from transactional to interactive to interdepen-
dent. This figure clarifies the significant enhancements to the order-fulfillment process
demand that may be expected as supply chain activities become increasingly collaborative.
The Order-Management System
The order-management system represents the principal means by which buyers and
sellers communicate information relating to individual orders of product. The orde-r-
processing system, extremely important to the firm's logistics area, is also one of the
joint most important components of the firm's overall management information system.
Synchronized Collaborative
planning and capacity
order Effective order management is a key to operational efficiency and customer satisfaction.
execution planning
fulfillment Figure 7-6 provides a list of typical order-management functions. To the extent that a firm
conducts all activities relating to order management in a timely, accurate, and thorough
manner, it follows that other areas of company activity can be similarly well coordinated.
In addition, both present and potential customers will tal<e a positive view of consistent
and predictable order cycle length and acceptable response times. By starting the process
with an understanding of customer needs, firms can design order-management systems
that will be viewed as superior to those of competitor firms. A company's order-management
capabilities will contribute toward producing a competitive advantage.

Supply &hal~ M;ta,Vest


/~ . . . . . >>
Figure 7-5
l Stages of Order Fulfillment


. . . .. harmaceutical company manufactures approximately 15,000 different prod- Information Limited to basic Some sharing of Extensive sharing of
Alarge Midwest p . . h d estic United States. These products are grouped mto five sharing order information inventory availability inventory, shipment,
ucts m liS tour locatiOns m t e om 0 d t History is collected at the product leveL and shipment and sell-through
families, each with, approximately 3,00 p~oduc s~d-management system, a state-ot-the-art information information
Using the company s statistically advance ema t s ot demand and determine whether the Decision making Independent order Some negotiation of Synchronized
technology,_ the company can analyze ch~~;i~s '~r ~e~line phase ot its lite cycle. With relatively decisions- order decisions ordering decisions
product IS man mtroductl:nd ~;~:~; ~e and;he data the product was introduced, the system
"phantom demand" among partners driven by shared
lew mputs, such as expelc e d trend components and determine each product's position in the policies, channel
can 1so!ate the seasona an inventory data, and

POS information
an rolled this information up to the higher or "tamily" level, demand-cham (VMI)
As the comp y . t 'I 72 percent of the products were in the mature stage, Performance Limited performance
:~i~:;;sp~~c~~t ~:r:hi~t ~:c:~: ;~; ~indding trdoudbl:~ ~o:~~a~~n::;;~~u~:;u~~~s~n~~v~~~~
Some shared Extensive use of
measures measures performance performance
measures like lead measures tied to
th pharmaceutiCal busmess epen e 'd d
Fi~~~:~::o p~~~~~~~~::~~:sg:ob~e;~a~:;;~~;;~n~:~~~~;~::she~~~~~;~;l~~:~:c~:~~:tn~o~~~~ o:t-
times, on-time shared risks and
delivery, and rewards
inventory availability

set those in decline. . Technology Limited use of Some use of Extensive use of
T f al use ot demand data would have given this company only a forecast ot projected technology technology to track technology to allow
sales. ~~r~~egic use ot the same data, on the other hand, led management to modi~:".~':~
orders and material real-time tracking of
flow orders and material
prove the portfolio and its product investment strategy. In essence, demand ma g and an automatic
h I d make this company more profitable and etfectlve.
e pe . t "
. l "Ali nin Demand Management With Busmess Stra egy, .
Source: Edited from Jtm R. Lan~abeer I '/J g 20~0) 69 Reprinted with permission of Supply Cham
Supply Chain Management Rev1ew n~ay . une Source: Accenture, Stanford University, and Northwestern University, Customer-Driven Demand Networks:
Management Review, a Cahners pubhcat1on. I. Unlocking Hidden Value in the Personal Computer Supply Chain (Accenture, 1997), 32.
Demand Management and Customer Service 243
Chapter 7

Figure 7-7
Figure 7-6 l Order-Management Functions I Major Components of the Order Cycle

Receive order Identify shipping point

1.. ----
---- Order

Enter order- manual/electronic Generate picking documents ~ = Principal product flows

Verify and check order for accuracy Originate shipment --- = Principal information flows

Check credit Inquire order status

Check inventory availability Deliver order

Measure service level Figure 7-8 Order-Placement Trends
Process back order
Measure quality of service
Acknowledge order
Assure continuous improvement
Modify order 17% E-marketplaces
Suspend order trade
Check pricing and promotion '
' Extra nets
The logistics area needs timely and accurate information relating to individual cus- ' E-mail
tomer orders; thus, more and more firms are placing the corporate order-management
function within the logistics area. The move is good not only from the perspective of EDI
the logistics process but also from that of the overall organization. The area of order
management has been a primary beneficiary of the enhanced and more responsive
computer and information systems available today. In many firms, the area of order
management has become an innovator in exploiting new technological advances. Phone and fax

Order and Replenishment Cycles

When referring to outbound-to-customer shipments, we typically use the term order 2002
cycle. The term replenishment cycle is used more frequently when referring to the ac- Based o~ fifty companies responding
(multiple responses accepted)
quisition of additional inventory, as in materials management. Basically, one firm's or-
der cycle is another's replenishment cycle. For simplicity, we shall use the term order "THROUGH WHAT MECHANISMS DO YOU PURCHASE YOUR DIRECT MATERIALS TODAY'
IN 2002?"
cycle throughout the remainder of this discussion.
Four principal activities, or elements, constitute lead time, or the order cycle: order Source; Forrester Research, !nc., The Forrester R
Forrester Research, !nc., 2000), .
. .
eport. On-Lme Supply Chain Rea!ities(Cambridge, Mass.:
placement, order processing, order preparation, and order shipment. These activities are 3

shown in Figure 7-7, along with arrows indicating the principal directions in which prod-
uct and information flow. Traditionally, the order cycle includes only those activities that significant increases were pro'ected for ..
E-marketplaces, Extranets and EJ il Th Internet-facilitated resources such as
occur from the time an order is placed to the time that it is received by the customer. ' -rna . ose that
re lahve use were electronic data int h ( were expected to show declines in
Special activities such as backordering and expediting will affect the overall length of the ere ange EDI) and phone/fax
order cycle. Subsequent customer activities, such as product returns, claims processing, 0 rd er processmg.
The order-processin fu .
and freight bill handling, are not technically part of the order cycle. tamer credit, transferring informatio t ~ nchon usually involves checking cus-
tory and shipping areas, and prepari~ o ~. es. records, sending the order to the inven-
Order Placement. Order-placement time can vary significantly, from taking days or c~n occur simultaneously through thege;fe~J:~g doctunex:ts. M~ny of these functions
weeks to being instantaneous. Company experiences indicate that improvements in gtes. Recent improvements in com uter and . use o~ avmlable rnformation technolo-
order-placement systems and processes offer some of the greatest opportunities for sig- able reductions in the times needed t ml:ormatmn systems have led to consider-
nificantly reducing the length and variability of the overall order cycle. Figure 7-8 o accomp Ish these activities
shows results of a study by Forrester Research, Inc., showing the means by which com- 0 rd er Pr eparaf IOn. Depending on the commodit b .
panies purchased direct materials in 2000, and their advance plans for 2002. Clearly, the order-preparation process sometimes m b y ~mg handled and other factors,
ay e very Simple and performed manually
Demand Management and Customer Service
Chapter 7

or, perhaps, may be relatively complex and highly automated. Since tbe time needed to
prepare orders for shipment frequently represents a significant bottleneck in the overall
Figure 7-9 I Example of Order Cycle Time Analysis

order cycle, advance in~ormation concerning the composition of individual shipments

has become highly desirable. The availability of real-time information systems has helped
Step 0 2 4 6 8 10 12 14 16 18 20 22 24 26 28 30 32
significantly to see that this information is available in a timely and functional manner.
Order transmission 2,0 I' IIO.OL_
Order Shipment. Shipment time extends from the moment an order is placed upon
the transport vehicle for movement, until the moment it is received and unloaded at ''
the buyer's location. Measuring and controlling order-shipment time sometimes can
Order edit/entry : 1.5
- Average
be difficult when using for-hire transportation services; however, most carriers today
have developed the ability to provide their customers with this type of information.
Pick-ticket generation
' 2.5 (6.0) '
- 95th percentile

One way for receivers of product to increase the likelihood of timely delivery is to ask Order picking 1.1 (50), '''
for advance shipment notification (ASN) from supplier firms. Alternatively, shippers ''
Transit to customer 5.0 ' ( 120l
may prefer to receive proof-of-delivery (POD) documentation, preferably electronically, '
from carriers. This helps to pinpoint the exact time and location of delivery. To improve : ''
Complete cycle 12.1 ' (32.0)
service to customers, transport firms have moved to the use of Internet -enabled capabili-
ties to provide services such as these to their customers. In addition, carriers have made it j


Receipt of Receipt of
easier for customers to track and trace shipments when needed and have provided these
of order by of order material material
same customers with summary reports of shipment times, service levels, and so on. customer (average) (95th percentile)
One of tbe major U.S. automobile companies has established an integrated private/
Source: William C. Copacino ' "Time to Rev1ew
. Order Managemen't" T,raffic Management(June 1993) 32 U
contract carriage system and a computerized parts locating and ordering system to pro- . permission.
sed w1th
duce prompt and dependable delivery service for small, less-than-truckload shipments.
The system provides next-day delivery to most of its dealers from the company's eigh-
teen distribution centers located throughout the United States. Approximately 80 per- This phenomenon is supported by more recent d
merly Andersen Consulting) which i h . . ata developed by Accenture (for-
cent of the parts deliveries are made at night through a passkey operation. Company tota1 t'nne <lOr order transmission 111 Figure 7 9 In th'
and strs own
't - . 1
IS examp e, the average
drivers are given keys to the dealers' facilities and make deliveries to secured areas. The time spent on more internally focused a~~r. ~o customer {7.0 days) exceeded the average
night deliveries reduce delays normally caused by daytime highway traffic and conges- eration, and order picking (51 d ) Alae IVIlies such as order edit/entry, pick-ticket gen-
tion at dealer facilities. This example shows how a precisely planned and well-executed . ays so, there were sigru'fi d"c
average times for completing th . Kant werences between the
. per~entile times. Results such
transportation capability can help to reduce needed time to fulfill customer orders. h' e various steps and tbe 9Stb .
as t IS have caused manufacturers to be m
Because of the positive changes that have occurred in the transportation environ- ?lacement activity experienced b their c ore aggressr:e m facilitating the order-
ment over a number of years, capable, time-sensitive logistics services are increasingly Information-based and lnteriiet y bl d ustomers, particularly through the use of
b -ena e capabilit' s '1
becoming available. While each of the modes of transport has evidenced considerable ecome more interested in seeing that h' re_s. um arly, manufacturers have
improvement in this area, there are signifiCant opportunities to further enhance value- a timely manner. This has resulted in st~p~ent~ amve at their customers' locations in
added services for customers. Also, the availability of accurate information on a real- control over the speed, consistency, and ov:ral~ve c;rmen; of strategi~s to assure greater
time basis has been identified as a key priority for a growing number of transportation A qu rty o transportation services
ny reduction in the length of one or m ,
and logistics service providers. ther additional planning time for th o;e order cycle components will provide ei-
Length and Variability of the Order Cycle. While interest has traditionally centered buyer. If a manufacturing firm I'd tefimanu acturer or a shortened order cycle for the
en 1 1es an opport t d
more on the overall length of the order/replenishment cycle, recent attention has been fo- more components of the order cycle it th um y to re uce the length of one or
cused on the variability or consistency of this process. Consistent with the contemporary into its own system (perhaps as addi;ionatnl~:choose to either absorb the extra time
interest in meeting customer requirements, there also is a concern for making sure that the by shortenmg the order eye! . P mg lime) or share It With the customer
su h t. e m a matenal fashion In ..
first priority is to deliver shipments at tbe time and location specified by tbe customer. c nne savings along to the custorne h . competitive markets, passing
marketplace for the manufacturer. r w enever possible may be of great value in the
One landmark customer service study incorporated a series of questions pertaining
to the time needed to complete the total order cycle as well as the relative time needed
Variability in the order cycle length also
by purchasers of the firm's products S ~anllaffect the levels of safety stock carried
to complete the individual elements of the order cycle A significant finding was that
the greatest portion of the total order cycle time occurred either before the manufac- needed safety stock levels also incre; pCeci rca y, as order cycle variability increases
turer received the order from the customer or after the order was shipped. In other abil'ty se. onversely as firm d d ,
I , customers may choose to I fi ' s re uce or er cycle vari-
words, activities that were at least somewhat external to the manufacturer and over variability links directly to the lev ~ar'; e~s sa ety stock. In either instance, order cycle
e s o sa ety stock a customer must carry.
which the manufacturer traditionally bad little control consumed more tban one-half
of the total order cycle time.
Demand Management and Customer Service
Chapter 7

. m of shorter order cycle lengths, coupled with E-Commerce Order-Fulfillment Strategies

Ideally, improvement will takethe fo'; re 7-10 illustrates a before-and-after situa As firms become more and more involved in E-commerce, it has become apparent that
improved consistency and rehabihty.dFl~ th length and variability of most of the order fulfillment and product distribution are among the most overlooked and, per-
tion in which a firm successfully Ire Auced fre the improvement in each individual haps, the most underestimated in terms of importance. Success in the E-commerce
.. . . the order eye e. sl e om . l
activities compnsmg . d . b 'lity have decreased notlceab Y arena is just as much about designing and implementing the basic principles of logis-
activity, the total order cycle time an vana 1
tics and supply chain management as it is about marketing the latest technologies.
According to Ricker and Kalakota, IO three forces are converging to create an explo-
sion in consumer direct business models: technology forces are malting it possible, mar-
Order Cycle length and Variability ket forces are making it viable, and social forces are malting it inevitable. According to
'igure 7-10 these authors, some of the critical decisions to be made by companies are related to the
AFTER SYSTEM CHANGE evaluation of multiple fulfillment planning strategies. Among those that are cited are:
COMPONENTS Profitable to promise: Should I take the customer order at this time?
'' Available to promise: Is inventory available to fulfill the order?
Order placement '' Capable to promise: Does manufacturing capacity allow order
'' commitment?
'' Thus, five alternative fulfillment strategies are suggested for consideration by firms in \
'' 2 3
5 the -commerce business: (I) distributed delivery centers; (2) partner fulfillment opera-
tions; (3) dedicated fulfillment centers; (4) third-party fulfillment centers; and (5) build
'' to order (which involves no stock inventory) 11 Regardless of the strategy that is selected,
Order processing '' a fundamental requirement of fulfillment logistics is the dedicated collaboration of all

supply chain trading partners to eliminate the costs associated with inefficient movement
'' of goods, redundant practices and processes, and excess inventory. Effective collaboration
'' tends to foster not oruy supply chain efficiency and effectiveness but also the ability to
3 5 change when needed and to see that strategic processes are continuously improved.
2 4 6
'' Customer Service
Order preparation '' ''
'' '
'' No discussion of outbound logistics systems would be considered complete without the
' ' '' inclusion of customer service, since customer service is really the fuel that drives the
'' ' 3 logistics supply chain engine. Having the right product, at the right time, in the right
0 2 4 quantity, without damage or loss, to the right customer is an underlying principle of
logistics systems that recognizes the importance of customer service.

Order shipment

/~ 4 7
/~ 4 5
Another aspect of customer service that deserves mention is the growing consumer
awareness of the price/quality ratio and the special needs of today's consumers, who are
time conscious and who demand flexibility. The 1980s and the 1990s evidenced a grow
ing awareness of the special needs of consumers and the distribution network that serves
them. Today's consumers are a different breed. They have high standards for quality,
Average: I I days and brand loyalty is not necessarily something that they always support. Essentially, they
Average: ! 3 days Range: 6 to I6 days want products at the best price, with the best level of service, and at times convenient to
Range: 4 to 22 days their schedules. Successful companies have adopted customer service approaches that
Total order cycle
recognize the importance of speed, flexibility, customization, and reliability.

~22 ~ 13
6 II 16
The logistics/Marketing Interface
Customer service is often the key link between logistics and marketing. If the logistics
system, particularly outbound logistics, is not functioning properly and a customer
does not receive a delivery as promised, the company could lose future sales. Remem-
R St ck "Using Advanced Order-Processing Systems to Improve Profitability," Business ber that manufacturing can produce a good product at the right cost, and marketing
Source: Adapted from Douglas M. lambert and James' . o ---'--
(April-June 1982): 26.
Demand Management and Customer Service 249
Chapter 7

d here promised, the customer the interface between marketing and logistics. The relationship manifests itself in this
can sell it; but if logistics does not deliver it when an w perspective through the "place" dimension of the marketing mix, which is often used
will be dissatisfied. . . d _ synonymously with channel-of-distribution decisions and the associated customer ser-
. . . of the relationship between logistlCs an mar vice levels provided. In this context, logistics plays a static role that is based upon mini-
We could conside~ this descnptiOn . h" t d"t"onal role of customer service at
keting a traditional VIew. F.Igure 7 -11 deptcts t ts ra 1 1 mizing the total cost of the various logistics activities within a given set of service
levels, most likely as dictated by marketing.
It is safe to say that this particular vision of logistics and its relationship to market-
Figure 7-11 The Traditional Logistics/Marketing Interlace ing is one that dominated the logistics literature in the years preceding what might be
termed the "supply chain revolution." From this traditional point of view, the usual
trade-off was seen as, "if we increase the level of customer service, then logistics costs
will automatically increase."
An interesting example, however, is that of National Semiconductor, a company
that reengineered its supply chain to reduce the overall cost of logistics. In so doing,
this company also improved in-stock inventory levels, experienced shortened and
more consistent order cycles, and significantly improved overall service to its global
Promotion customers. This situation required a more dynamic, proactive approach that recog-
Price nized the value-added role of logistics supply chains in creating and sustaining com-
petitive advantage and providing win-win outcomes.
In an effort to promote the true competitive advantages that can arise from a
well-run logistics operation, the chief financial officer of Compaq Computer
Customer service We've done most of what we have to do to be more competitive. We've
levels changed the way we develop products, manufacture, market, and advertise.
The one piece of the puzzle that we haven't addressed is logistics. It's the next
source of competitive advantage, and the possibilities are astounding. 12
This new perspective emphasizing value added is providing the basis for National
carrying costs Semiconductor and other companies-such as Sears, Procter & Gamble, Nabisco, Her-
shey, and Dell Computer-to improve both efficiency and effectiveness. Becton Dick-
inson (BD) is a good example of a compa':ly that has recognized the proactive, value-
adding role of customer service in the logistics supply chain. BD has focused on man-
aging the supply chain on an integrated basis, with the intent of providing high levels
of customer service and high-quality goods to satisfy customers throughout its supply
Lot quantity costs chain. Essentially, the company envisions delivering the best product and services at
costs the lowest total system cost. Becton Dickinson's commitment to effective supply chain
management resulted several years ago in the creation of a Supply Chain Services oper-
ating division of the company. 13
Order processing
and information
Defining Customer Service
Anyone who has ever struggled to define customer service soon realized the difficulty
Marketing objective: . . to maximize the long-run profitability of the f1rm.
of explaining this nebulous term. Thus, different people will understandably have dif-
Allocate resources to the marketing miX ferent interpretations of just what customer service means.
We can think of customer service as something a firm provides to those who pur-
Logistics objective: . th customer service objective, where:
Minimize total costs, g1ven e . chase its products or services. According to marketers, there are three levels of product:
. . t + order processing and information
ts + warehousmg cos s
(I) the core benefit or service, which constitutes what the buyer is really buying; (2) the
Total costs ::;:TransportatiOn cos t.t costs+ inventory carrying costs tangible product, or the physical product or service itself; and (3) the augmented prod-
costs + lot quan 1Y
uct, which includes benefits that are secondary to, but an integral enhancement to, the
C r Methodology: A Study of the Costs Associated with Holding
tangible product tl1e customer is purchasing. In this context, we can think of logistical
b rt The Development of an Inventory os mg
Source: Adapted from Douglas M. L_am ;h' . I Distributioi"fManagement, 1976), 7.
Inventory (Chicago: National Council of yslca
Demand Management and Customer Service
Chapter 7

. f the au mented product that adds value for the buyer. Customer service as a philosophy. This level elevates customer service to a
customer service as a feature o g . 1 de installation, warranttes, and firm-wide commitment to providing customer satisfaction through superior
Other examples of augmented product eatures me u customer service. This view of customer service is entirely consistent with
after-sale service. . ff dvan- many firms' contemporary emphasis on quality and quality management.
;' lines a firm could achieve a compe 1 lYe a Rather than narrowly viewing customer service as an activity or as a set of
Extending our thinking along these ,I rvice Thus a potential bene- performance measures, this interpretation involves a dedication to customer
. I els oflogistica customer se . , I f
tage by providing supenor ev . " duct" that may add significant va ue or service that pervades the entire firm and all of its activities.
fit exists in viewing customer semce as a pro -
The least important level of involvement for most companies would be viewing cus-
a buyer. t d product is quite consistent with tomer service simply as an activity. From this perspective, customer service activities in
. 1 tes to the augmen e
This view of logistiCS as 11 rea . h t . tday's environment plays a maJOf logistics are at the transactional level. For example, accepting product returns from
. . tive and 1s one t a m o ..
the Becton Dickinson perspec 1 h . It may not be as exCitmg to some m- customers in a retail store adds no value to product: it is merely a transaction to ap-
. menting value along the supp y c am. pease the customers. With the possible exception of malting it extremely convenient
role m aug 1 . 'tical for success in the marketplace.
dividuals, but the ro e 18 en . whose im- for customers to return products, this level of customer service typically offers limited
. . that customer serviCe lS a concept opportunities to add value for the customers.
A fundamental point to recogmze ~s . C tamer service frequently affects
c b nd the loglst!CS area. us h h th
portance reaches tar eyo . e customer satisfaction t roug e The focus upon performance measures for customer service is very important be-
every area of the firm by attemptmg to ensur cause it provides a method of evaluating how well the logistics system is functioning.
.. f aid or service to the customer. Over time, such measures provide benchmarks to gauge improvement, which is espe-
proVISion o customer service may take include the
Examples of the various forms that cially important when a firm is trying to implement a continuous improvement pro-
gram. But this level of involvement is not sufficient.
following: ' request
Revamping a billing procedure to accommodate a customer s The final level, customer service as a philosophy, broadens the role of customer ser-
Providing financial and credit terms . vice in the firm. However, this still may not be sufficient unless the value-added di-
Guaranteeing delivery within specified time peno~s mension is included as the goal of the corporate customer service philosophy.
Providing prompt and congenial sales representatives The defmition of customer service that is used in this text is as follows:
Extending the option to sell on consignment . Customer service is a process for providing competitive advantage and add-
Providing material to aid in a customer's sales presentatiOn ing benefits to the supply chain in order to maximize the total value to the
Installing the product . . ultimate customer.
Maintaining satisfactory repair parts mventones . The customer service issue has many dimensions and is truly complex. A firm must fully
. rvice within a logistics supply cham. How~ver, control numerous customer service elements through effective business logistics manage-
This section exammes customer se . I' . d' tes have many interpretatiOns
th precedmg 1St m !ca ' dd ment. Successfully implemented, high levels of logistics customer service can easily be-
customer service can, as e nl . f cal aspects of customer service may a come a strategic way for a company to differentiate itself from its competitors.
throughout the firm. The numerous :~dofn:l~de these aspects within its overall mar-
value for the customer, and a firm s o
Elements of Customer Service
keting effort. f
. . le widel used defmition, customer semce Is o - Customer service is an important basis for incurring logistics costs. Economic advan-
While customer serviCe has no smg : nl f them as three levels of customer tages generally accrue to the customer through better supplier service. As an example,
ten viewed in three principal way~S We can t 1 c o a supplier can lower customer inventories by utilizing air rather than truck transporta-
. mvolvement or awareness: tion. Lower inventory costs result from air transport's lower transit time, which will
serviCe ice as a par-
. . ty This level treats customer serv lower order cycle time, but the transportation costs will be higher than those for truck
Customer servtce as an acttVI . r h t satisfy the customer's needs. Or-
ticular task that a firm mus~ ac~o~p IS ~uct returns and claims handling transportation. The supplier's logistics manager must balance the high service level the
der processing, billing and m.vo{cn~g~f~~stomer servi~e. Customer service customer desires and the benefits the supplier may gain from possible increased sales
are all typical examhpbles o~~~~::~le customer problems and complaints, against the cost of providing that service. The logistics manager must strike a balance
departments, whK asK y . among customer service levels, total logistics costs, and total benefits to the firm. How-
t this level of customer semce.
also represen This level emphasizes cus- ever, as the National Semiconductor example illustrated, there are situations where
. performance measures. h cost can be lowered and service improved.
Customer servtce as f 'fi erformance measures, such as t e per-
tamer service in terms o speo ~c p d mplete and the number of
d delivered on l!me an co I I The food industry illustrates the importance of customer service factors and how
centage of or ers . . e table time limits. Although this eve en-
orders processed wtthm ace P I kb d the performance measures they will probably change over time. Table 7-2 lists customer service factors that are
firm must oo eyon important in the food industry. The first column is for 1995; the second column pro-
hances the fiIrst one, a . . f rts achieve actual customer
themselves to ensure that tts serviCe e o jected customer expectations for 2000. If the table provided data from another indus-
satisfaction. try, the percentages would probably be different, but the upward direction of customer
Demand Management and Customer Service
Chapter 7

. . To some customers dependabil"ty b
time. The customer can rninimiz "t : I can e more important than lead
Customer Service Elements for the Food Industry to th kn e 1 s mventory level if lead t. . fi
Table 7-2 mer at ows with 100 percent as h Ime IS txed. That is a cus-
. surance t at I d tim '
mventory levels to correspond to th d ea e IS ten days could adjust its
would have no need for safety stock ~:verag; emand (usage) during the ten days and
ELEMENT mg lead times. guar agamst stockouts resulting from fluctuat-
Product availability
7 days Cyc/e time. Lead time dependability th d.
le:el and stockout costs. Providing a d~ e:~~bl~ectly ~ffects the customer's inventory
9 days
Order cycle time
90% tamty a customer faces. A seller h P lead time reduces some of the uncer-
Complete orders shipped f 1 w o can assure the custo 0f .
93% nne, Pus some tolerance distinct] d"f:C: . . mer a giVen level of lead
90% of invoices tor Th 11 , y 1 ,erentlates lts produ t f h
Accurate invoices provided . e se er that provides a dependabl l d . c rom t at of its competi-
0.5% total cost of inventory, stockouts orde e ea ~nne permits the buyer to minimize the
Damaged products F , r processmg, and production scheduling
Source: Grocery Manufacturers of America and A. T. Kearney; Customer Service D8ta for Fdod lndustiy lgure 7-12 graphs a frequency distribution . . .
sured m days. The graph is bimodal It . d. pertammg to overall lead time mea
(1995), 5. Used with permission.
ity of either four days or twelve d . T~
!Cates that lead time tends to be in th; vicin-
orders that the seller can fill from :~s. k ~ ~ustomer typically receives within four days
service standards would be the same. Companies both within and outside of the food stock, and for which the custo oc . r ers that the seller cannot fill from available
d mer must place a b k d
industry implement such improvements in response to market pressures, and lower or er cycle time of approximately twelve days. ac or er, typically result in a total
costs frequently accompany these improvements.
Dependability encompasses more than ust I d . .
Customer service has multifunctional interest for a company; but, from the point of pendability refers to delivering a custom J, ~a llme vanability. More generally, de-
view of the logistics function, we can view customer service as having four traditional ill safe condition; and in harmony withe~~ or er With a re~ar, consistent lead time;
ordered. e type and quahty of items the customer
dimensions:; time, dependability, communications, and convenience. This section ex-
plores the ways in which these elements affect the cost centers of both buyer and seller
Safe delivery. A n ord er,s safe delivery is the ultim al
firms. was noted earlier, the logistics function is th ~te ~o of any logistics system. As
goods arrive damaged or are lost th e culmmatwn of the selling function If
Time. The time factor is usually order cycle time, particularly from the perspective of sh" ' e customer cannot th .
the seller looldng at customer service. On the other hand, the buyer usually refers to tpment containing damaged good use e goods as intended A
to d s aggravates several c t
ry, pro uction, and marketing. us omer cost centers-inven-
the time dimension as the lead time, or replenishment time. Regardless of the perspec-
tive or the terminology, several basic components or variables affect the time factor.
Successful logistics operations today have a high degree of control over most, if not
all, of the basic elements of lead time, including order processing, order preparation, Figure 7-12 Example of the Frequency Distribution of Lead Time
and order shipment. By effectively managing activities such as these, thus ensuring that
order cycles will be of reasonable length and consistent duration, seller firms have im-
proved the customer service levels that they provide to buyers. National Semiconduc-
tor Company, discussed previously, is a good example of a firm achieving a significant Filled from stock

reduction in order cycle time.

Modifying all of the elements that contribute to lead time may be too costly. The
firm may therefore make modifications in one area and permit the others to operate at
existing levels. For example, investing in automated materials-handling equipment Back orders
may be financially unwise for the firm. To compensate for its higher manual order-
processing time, the firm could switch from fax to Internet-enabled order transmittal
and use motor transportation instead of rail. This would permit the firm to reduce lead
time without increasing its capital investment in automated materials-handling
Guaranteeing a given level of lead time is an important advancement in logistics
management. We may see its impact in the efficiencies that accrue both to the cus- 2 3 4 5 6 7 8 9 10 II 12 13 14
tomer (inventory costs) and to the seller's logistics system and market position. But the Lead time length (days)
concept of time, by itself, means little without dependability.
Demand Management and Customer Service
Chapter 7

rail; another may require truck d r ul .

Receiving a damaged shipment deprives the customer of items for sale or produc- quest special delivery times. Basic~veryl ~ ! With ~o palletization; still others may re-
tion. This may increase stockout costs in the form of foregone proftts or production. agmg, the mode and carrier the c ty, ogisllcs .reqmrements d"ffi .h
1 er Wit regard to pack-
To guard against these costs, the customer must increase inventory levels. Thus, unsafe . us omer reqmres, routing, and delivery times.
delivery causes the buy'er to incur higher inventory carrying costs or to forego profits Convemence recognizes customers' different re uir
group customer requirements b h c q ernents. A seller can usually
or production. This situation would be unacceptable for a company interested in mini- . y sue Iactors as custome . k
pro d uct 1me the customer is pur h . Th' r SIZe, mar et area, and the
mizing or eliminating inventories through some form of just-in-time program. c asmg IS grouping k
ables th e logistics manager to . ' or mar et segmentation en-
c.'cil recogmze customer serv '
In addition to the preceding costs, an unsafe delivery may cause the customer to in- to wuJ l those demands as eco . all . ICe reqmrements and to attempt
nomiC Y as possible.
cur the cost of filing a claim with the carrier or returning the damaged item to the
seller for repair or credit. (Depending upon the FOB terms of sale and other sales We can attribute the need for convenience i . . .
consequences the service levels have for di:ffi n logtshcs service levels to the differing
agreement stipulations, the seller, not the buyer, may be responsible for these costs.) oflost sales will differ among th t erent customers. More specifically, the cost
The seller will probably be aware of these two costs, since the seller will be more or less e cus orner groups p l
mg 30 percent of a firm's output loses 1 . or examp e, a customer purchas-

directly involved in any corrective actions that may be necessary. less than 0.01 percent of the firm's out es for the firm than a customer buYing
Correct orders. Finally, dependability embraces the correct filling of orders. A cus- market areas will differ highly com r es. Also, the degree of competitiveness in
tomer who has been anxiously awaiting the arrival of an urgently needed shipment ~evel than less-competit;ve market ar~:si~~ ~~~<e: areas. ':"ill require a higher service
may discover upon receiving the shipment that the seller made an error in filling the m a firm's market basket willlim"t th . P ofitabihty of different product lines
. I e service level the fi cc
order. The customer who has not received what was requested may face potential lost may proVIde a lower service level for lo fi Irm can o_uer; that is, a firm
w-pro It product lines.
sales or production. An improperly filled order forces the customer to reorder, if the
customer is not angry enough to buy from another supplier. If a customer who is an . However, the logistics manager must lace .
twnal perspective. At the extreme meet' p th the convemence factor in proper opera-
intermediary in the marketing channel experiences a stockout, the stockout cost (lost
mean providing a specific servic,e 1 ~g 1' e convenience needs of customers would
sales) also directly affects the seller. would set the stage for operational c~:os:~hlCY
prevent the logistics manager fr
tor each cust~mer. Such a situation
. .' . e P ethora of service level policies would
Communications. The two logistics activities vital to order filling are the communi- "hili. . om optumzmg the logisti fu .
cation of customer order information to the order-filling area and the actual process of I ty m service level policies is w t d b cs nctwn. The need for flex-
th.IS fl eXI"bil"Ity to easily identifiabl arran e , ut the logisti cs manager sh ould restrict
picking out of inventory the items ordered. In the order information stage, the use of
. . ~us examme the trade-off
b tw h e customer groups and t .
EDI or Internet-enabled communications can reduce errors in transferring order infor- e een t e benefits (improved sales and rofi
mation from the order to the warehouse receipt. The seller should simplify product costs associated with unique servi l 1 ~ ts or ehmmatiOn oflost profits) and the
ce eve s m each specific situation.
identification such as product codes in order to reduce order picker errors.
However, customer contact can be as important as accurate, electronic flow of infor- Performance Measures for Customer Service
mation between buyers and sellers. Communication with customers is vital to monitoring The four ~r~ditional dimensions of customer servi . .
dependability, convenience and . . ce from a logistics perspective-time
customer service levels relating to dependability. Customer communication is essential to 1 . , commun.:.catwn-are ess t"al "d ,
ve opmg a sound and effective c t . en 1 const erations in de-
the design oflogistics service levels. The communication channel must be constantly open t . us omer serviCe program Th d.
omer service also provide th d l . ese rmensions of cus-
and readily accessible to all customers, for this is the seller's link to the major external performance for customer se . e. unh elr ~n? basis for establishing standards of
constraints that customers impose upon logistics. Without customer contact, the logistics rviCe ill t e ogishcs area.
manager is unable to provide the most efficient and economical service; in other words, Table 7-3 expands these four elements in
the logistics manager would be playing the ball game without fully knowing the rules. nies in developing customer servic li to a format that has been used by compa-
The traditional performance measu~e~~h~r :;d 1erformance measurement standards.
However, communication must be a two-way street. The seller must be able to
colwnn. Typically, such measures were stated ;;o een used are s:ated in the right-hand
transmit vital logistics service information to the customer. For example, the supplier
ample, orders shipped on time, orders shi d m the perspective of the seller, for ex-
would be well advised to inform the buyer of potential service level reductions so that
order was received, order preparati t' ppe dcomplete, product availability when an
the buyer can make necessary operational adjustments. on tme, an so on.
In addition, many customers request information on the logistics status of ship- . The new supply chain environment for .
ngorous standards of performanc Th cu~tomer service has resulted in much more
ments. Questions concerning shipment date, the carrier, or the route, for example, are
the point of view of the customer: e. e per ormance measures are now stated from
not uncommon. The customer, who needs this information to plan operations, expects
the logistics manager to provide answers on a timely basis. Orders received on time
Convenience. Convenience is another way of saying that the logistics service level Orders received complete
must be flexible. From the logistics operations standpoint, having one or a few stan- Orders received damage free
dard service levels that applies to all customers would be ideal; but this assumes that all Orders filled accurately
customers' logistics requirements are homogeneous. In reality, this is not the situation. Orders billed accurately
For example, one customer may require the seller to palletize and ship all shipments by
Demand Management and Customer Service
Chapter 7

Another aspect of the supply chain environment is that the excellent companies are
Elements and Measurement of Customer Service using multiple measures of customer service simultaneously. Using multiple measures
Table 7-3 makes it much more difficult to achieve high levels of customer service. For example,
TYPICAL MEASUREMENT assume that a company was using only one of the following:
BRIEF DESCRIPTION 95 percent of orders delivered on time
%availability in base
The most common measure of cust?mer 93 percent of orders filled completely
Product units
service. Usually defined as perc~nt tn
stoc~ (target pertormance level) In some 97 percent of orders delivered damage free
base unit (i.e., order, product, dollars).

Elapsed time from order placem~nt ~o

Speed and consistency Achieving one of these performance levels-for example, 95 percent of orders de-
Order cycle time livered on time-would be challenging but very possible by focusing upon the activi-
order receipt. Usually measured In time
units and variation from standard or target ties necessary to attain the required performance. But trying to achieve all three
order cycle. Note: Frequentl.y, product
availability and order cycle ttme are
performance levels simultaneously for every order and to attain a "perfect order"
combined into one standard. For :x~mple, level like 95 percent would be difficult. For example, even if a company hit each of
"95 percent of orders delivered wtthtn 10 the preceding standards individually, it might fmd its perfect order measure to be 72
days." percent or less because the misses would not occur at the same time for a single or-
Response time to der. That is, an order might be on time and damage free, but it might not be com-
Ability of system to respond to special and/
Distribution special requests
system flexibility
or unexpected needs of cust?mer. . plete because of a stockout. Consequently, it would not be a perfect order. Achieving
Includes expedite and substttute
a perfect order performance level of 95 percent with three or more measures being
utilized simultaneously is indicative of the requirements of today's supply chain
Speed, accuracy, and
Ability of firm's information system to
message detail of
respond in timely and accurate ~anner to
system response
customers' requests for informatton.
Response and recovery Implementing Customer Service Standards
Efficiency of procedures and time required
Distribution time requirements This section highlights the keys for successfully developing and implementing cus-
to recover from distribution system . .
system malfunction (i.e., errors in billing, shlppmg, tomer service standards.
damage, claims).
Response time, quality The first point is to be wary of adopting easily achievable performance standards;
Efficiency in providing produc~ support such standards may be too low to be of practical value. While setting and adhering to a
Postsale product of response
after delivery, including technic~ I
support meaningful standard should help to differentiate your firm from the competition, set-
information, spare parts . or equtpment
modification, as appropnate. ting standards at unrealistically low levels will not help to establish a competitive
. . fThe Free Press a division of Simon & Schuster, Inc., from The Dis-
Source: Reprinted with the permission o d R b rt G H~use editors. Copyright 1985 by The Free
tribution Handbook, James F. Robeson an o e . ' Second, some current management philosophies-such as an emphasis on total qual-
Press. ity or on creation of the "petfect order" -are very critical of any acceptable quality level
set below 100 percent. Tills does not mean that a firm can achieve 100 percent perfor-
. as per tradi- mance at all times, for the use of 100 percent represents an attitude more than a mea-
nl 'th customer service prior to sh lppmg,
If the seller is concerned o y WI . fi d d the seller may not know it, because surement. From a practical viewpoint, however, establishing a desired quality level that is
ay not be salts te an . d. less than 100 percent will generally limit, rather than encourage, superior performance.
tional measures, th e b uyer m Furthermore the seller usmg tra 1-
. d th delivery process. ' . d
of problems occurrmg unng e h' h to evaluate the extent and magmtu e Third, the firm should develop customer service policies and standards through
tional measures would have no basis ~p~n w. lC the measurement at the delivery level, customer consultation. After adopting these standards, the firm should formaliy com-
of the problem. The current approac ~~u::Yuation but also, and perhaps more im- municate them to customers. Certain firms prefer to keep silent about their customer
not only provides the database to. rna f bl s as they are developing. For example, service standards and avoid letting their customers know their exact policies and per-
portantly, provides an early warnmg o pro em t nd it slips during a given month to formance targets. The best approach, however, is to communicate these policies and
if the standard for on-time dehvery IS 98 percen a. is not following instructions or standards to customers very openly.
. . t' may show that a earner
95 percent, an mves!tga ;ouln b t being ready to accept shipments.
even that the buyer IS at la t y no 've Fourth, the firm should develop procedures to measure, monitor, and control the
. demanding today because buyers often gi customer service quality called for by the firm's performance measures and standards.
The on-time delivery measure ts even more d r . on the outbound side of logistics. Using techniques such as statistical process control (SPC), obtaining feedback, and tak-
appointment times for warehouse and/or store ~ ~~ene~a~ necessitated the establishment ing corrective action are essential to success. "When customer service standards are in-
For example, the move to ju~t-in-ti~e ~a~ufd~w~Fo~ vendors. Overall, making deliveries effective, the firm should not hesitate to amend or discontinue them as appropriate.
. arrow delivery time Will fu
of somellmes very n tl d will be even tougher in the ture.
on time is much more difficult curren y an
Demand Management and Customer Service
Chapter 7

available inventory, one of four possible events may occur: (1) the customer waits until
the product is available; (2) the customer back orders the product; (3) the seller loses a
Figure J-13 \ customer Service Issues .
sale; or (4) the seller loses a customer. From the viewpoint of most companies, these
What do our customers feel about present levels of service. four outcomes are listed from best to worst in terms of desirability and cost impact.
Do their perceptions match up with ours? Theoretically, scenario 1 (customer waits) should cost nothing; this situation is more
likely to occur where product substitutability is very low.
How do our services compare to those of our competitotsrst?o monitor our service performance?
. t standards and measuremen
Are we usmg appropna e d' t the varying degrees of service they require? Back Order
Is it possible to segment our customers accor mg o . . . more
Can we produce the same levels of service we are presently provldmg m a A company having to back order an item that is out of stock will incur expenses for
special order processing and transportation. The extra order processing traces the back
cost-effective manner? . rt t
Can improved customer service be used as a strategic weapon to provide an lmpo an order's movement, in addition to the normal processing for regular replenishments.
The customer usually incurs extra transportation charges because a back order is typi-
~~~:.~:~::::::::::tamers, how important is servic; compared to other elements of the cally a smaller shipment and often incurs higher rates. Also, the seller may need to ship
the back-ordered item a longer distance-for example, from a plant or warehouse in
marketing mix, such as price, promotion, and products.
another region of the country. In addition, the seller may need to ship the back order
by a faster and more expensive means of transportation. Therefore, we could estimate
the back-order cost by analyzing the additional order processing and additional trans-
of customer Service
di .
11 the SCUSSlOll a
n d analysis related to customer
portation expense. If customers always back ordered out-of-stock items, the seller
It would be difficult to summanze a t t apture some important overal could use this analysis to estimate the cost of stockouts. The seller could then compare
b resented here. In an attemp o c this cost with the cost of carrying excess inventory.
service that have een P . f the following observations:
oints about customer servlce, we o er
P Lost Sales
. P1ace, no thing else matters.
If the