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Lecture Notes

The basic theme discussed in this chapter is the understanding of what really
supply chain management is, and what are the different decisional phases
involved in any decision pertaining to supply chain management.

The different supply chain macro processes both within the supply chain and
at the input and output of the supply chain have been identified.

After the introduction of the macro processes a classification approach have

been introduced, in this classification approach the different processes can
be either classified as push or pull.

The basic distinction between push and pull process is that push process is in
the anticipation of the customer demand while the pull process is triggered
after the arrival of the customer demand.

Definition: Supply Chain Management is primarily concerned with the

efficient integration of suppliers, factories, warehouses and stores so that
merchandise is produced and distributed in the right quantities, to the right
locations and at the right time, and so as to minimize total system cost
subject to satisfying service requirements.

Note: Who is involved Cost and Service Level It is all about


Todays Supply Chain Challenges

Global supply chain with long lead times

Rising and shifting customer expectations

Increase in labor costs in developing countries

Increase in logistics costs

Importance of sustainability

Unprecedented Volatility

Conflicting Objectives in the Supply Chain


Stable volume requirements

Flexible delivery time

Little variation in mix

Large quantities


Long run production

High quality

High productivity

Low production cost


Low inventory

Reduced transportation costs

Quick replenishment capability


Short order lead time

High in stock

Enormous variety of products

Low prices

Strategic Fit

What is "Strategic Fit"? - in a business scenario "strategic fit means aligning

supply chain strategy with competitive strategy." Companies build a competitive
strategy to target a set of customer segments and build strategies to satisfy needs
and priorities of those customer segments. Companies also study what competitors
are doing and what changes they can offer to have a competitive advantage, like
winning customers by offering a lower price on the product or by providing large
varieties of the product or by providing better services. Companies can achieve
these strategies by ensuring that their supply chain capabilities are able to support
these strategies.

Companies have to understand the need and priorities of targeted customer

segments and the uncertainty of their demand. There are many factors which
influence the demand of customer like price, convenience of purchase, urgency of
the product, size of the lot, delivery lead time, etc. The customers of one segment

tend to have more or less the same demand pattern, so to satisfy the uncertainty of
demand for the target segments the supply chain has to build the strategy and
capabilities accordingly. The demand uncertainty of target segments is called
"Implied Demand Uncertainty" which is different from "Demand Uncertainty"
which reflects the overall uncertainty of demand for a product.

Now the question arises as to how to handle this implied demand uncertainty? For
this, companies have to build the supply chain capabilities of responsiveness and
efficiency. Being a strategic fit is all about building the supply chain strategies to
face the customer demand and uncertainty or in other words a supply chain which
is able to supply big quantities required, in the shortest lead time, covering large
product portfolios and providing better services (responsive supply chain features).
Having these capabilities makes a responsive supply chain. Responsiveness
towards customer demand for quantity and quality comes at a price. For example,
to respond to a large product portfolio a company needs to increase the production
and storage capacity which will increase the cost. The increase in cost will have an
inverse effect on the efficiency of the supply chain. So a strategic decision to
increase the responsiveness will have additional cost which will lower the
efficiency. It's a trade-off between responsiveness and efficiency. Some companies
being more responsive will have less efficient supply chain and if companies need
an efficient supply chain then they have to lower the level of responsiveness.
Strategically companies have to decide on the level of responsiveness they need to
provide and try to bring the efficiency by enhancing the processes and

From purchase of raw material to delivery of final product to the customer, a

supply chain has different stages and the demand uncertainty is different for each
stages. It is very important to understand the demand at each stage of supply chain
and choose the appropriate level of responsiveness or efficiency for that level. To
make it clearer let's have an example of Dell computers which uses the direct order
model where customers can configure computers and place orders online. Dell
gives a choice to customers to make customized models for their requirement, and
delivers them at their door steps. This increased the implied demand uncertainty
for Dell which needs a responsive supply chain. To provide these services to the
customer there will be additional costs involved for carrying huge inventory for all
the parts which cannot be charged to the customers because Dell has to be
competitive in the market to survive. As a solution to this increased cost Dell
closely collaborates with suppliers, which allows Dell to operate with only a few
hours of inventory for some parts and a few days of inventory for other common
components. This way the supplier will have less demand uncertainty which can be
handled through an efficient supply chain. Thus Dell absorbs most the uncertainty
and provides responsiveness in supply chain and its supplier being efficient
absorbs very little uncertainty. To achieve strategic fit companies need to bring
consistency between implied demand uncertainty and supply chain
responsiveness. For a high implied demand uncertainty we need a responsive
supply chain and for a low implied demand uncertainty we need an efficient
supply chain.

Supply Chain Drivers

Drivers of Supply Chain: The major drivers of Supply chain performance consists
of three logistical drivers & three cross-functional drivers.

Logistical drivers: Facilities Inventory Transportation

Cross-functional drivers: Information Sourcing Pricing Companys supply
chain achieve the balance between responsiveness & efficiency that best meets the
needs of the company competitive strategy.

Drivers of Supply Chain Performance Efficiency Responsiveness Supply chain

structure Inventory Transportation Facilities Information Drivers Sourcing Pricing

FACILITIES are the actual physical locations in the supply chain network where
product are stored, assembled or fabricated. The two major types of facilities are:

Production sites (factories)

Storage sites (warehouses)

Factories can be built to accommodate one of two approaches to manufacturing:

1. Product Focus: A factory that takes a product focus performs the range of
different operations required to make a given product line from fabrication of
different product parts to assembly of these parts.

2. Functional focus: A functional focus approach concentrates on performing just a

few operations such as only making a select group of parts or doing only assembly

Warehousing: There are three main approaches to use in warehousing:

1. Stock keeping unit (SKU) storage: In this approach all of a given type of product
is stored together.

2. Job lot storage: In this approach all the different products related to the needs of
a certain type of customer or related to the needs of a particular job are stored

3. Crossdocking: In this approach, product is not actually warehoused in the
facility, instead the facility is used to house a process where trucks from suppliers
arrive and unload large quantities of different products. These large lots are then
broken down into smaller lots. Smaller lots of different products are recombined
according to the needs of the day and quickly loaded onto outbound trucks that
deliver the product to their final destination. So the fundamental trade-off that
managers face when making facilities decision between the cost of the number,
location & type of facilities (efficiency) & the level of responsiveness that these
facilities provide the companys customer.

INVENTORY encompasses all the raw materials, work in process, and finished
goods within a supply chain. Changing inventory policies can dramatically alter
the supply chains efficiency & responsiveness. There are three basic decisions to
make regarding the creation and holding of inventory:

1. Cycle Inventory (Economies of scale): This is the amount of inventory needed to

satisfy demand for the product in the period between purchases of the product.

2. Safety Inventory: inventory that is held as a buffer against uncertainty. If

demand forecasting could be done with perfect accuracy, then the only inventory
that would be needed would be cycle inventory.

3. Seasonal Inventory: This is inventory that is built up in anticipation of

predictable increases in demand that occur at certain times of the year.

TRANSPORTATION entails moving inventory from point to point in the supply

chain . Transportation can take the form of many combinations of modes & routes,
each with its own performance characteristics. There are six basic modes of
transport that a company can choose from: Ship which is very cost efficient but

also the slowest mode of transport. It is limited to use between locations that are
situated nest to navigable waterways & facilities such as harbor & canals. Rails
which is also very cost efficient but can be slow. This mode is also restricted to use
between locations that are served by rail lines. Pipelines can be very efficient but
are restricted to commodities that are liquid or gases such as water, oil & natural
gas. Trucks are a relatively quick & very flexible mode of transport. Trucks can
go almost anywhere. The cost of this mode is prone to fluctuations though, as the
cost of fuel fluctuates and the condition of road varies. Airplanes are a very fast
mode of transport and are very responsive. This mode is also very expensive mode
& is somewhat limited by the availability of appropriate airport facilities.
Electronic transport is the fastest mode of transport and it is very flexible & cost
efficient. However , it can be only be used for movement of certain types of
products such as electric energy, data, & products composed of data such as music,
pictures & text.

INFORMATION serves as the connection between various stages of a supply

chain, allowing them to coordinate & maximize total supply chain profitability. It
is also crucial to the daily operations of each stage in a supply chain for e.g a
production scheduling system. Information is used for the following purpose in a
supply chain: 1. Coordinating daily activities related to the functioning of other
supply chain drivers: facility, inventory & transportation.

2. Forecasting & planning to anticipate& meet future demands. Available

information is used to make tactical forecasts to guide the setting of monthly &
quarterly production schedules & time table

3. Enabling technologies: many technologies exist to share & analyze information
in the supply chain. Managers must decide which technologies to use & how to
integrate these technologies into their companies like internet, ERP, RFID.

SOURCING is the set of business processes required to purchase goods &

services. Managers must first decide which tasks will be outsourced & those that
will be performed within the firm. Components of sourcing decisions In-House or
outsource: The most significant sourcing decision for a firm is whether to perform
a task in-house or outsource it to a third party. This decision should be driven in
part by its impact on the total supply chain profitability. Supplier selection: It
must be decided on the number of suppliers they will have for a particular activity.
The must then identify the criteria along which suppliers will be evaluated & how
they will be selected like through direct negotiations or resort to an auction.

PRICING determines how much a firm will charge for goods & services that it
makes available in the supply chain. Pricing affects the behavior of the buyer of the
good or services, thus affecting supply chain performance, for example, if a
transportation company varies its charges based on the lead time provided by the
customers, its very likely that customers who value efficiency will order early &
customers who value responsiveness will be willing to wait & order just before
they need a product transported. This directly affects the supply chain in terms of
the level of responsiveness required as well as the demand profile that the supply
chain attempts to serve. Pricing is also a lever that can be used to match supply &
demand. Components of Pricing Decisions: Fixed Price versus Menu pricing: A
firm must decide whether it will charge a fixed price for its supply chain activities
or have a menu with prices that vary with some other attribute, such as response
time or location of delivery. Everyday low pricing versus High-Low pricing

Obstacles to Achieving Strategic fit Increasing variety of products Decreasing
product life cycles increasingly demanding customers Fragmentation of supply
chain ownership Globalization

In theory, everyday low pricing (EDLP) is a great idea. It refers to a pricing strategy in which a
retailer offers its customers consistently low prices on every product, without running sales or
price promotions. The store sets prices fairly and then maintains them for a long time (until costs
change significantly).

Highlow pricing (or hilow pricing) is a type of pricing strategy adopted by companies, usually
small and medium-sized retail firms, where a firm charges a high price for an item and later when the
item's popularity has passed, sell it to customers by giving discounts or through clearance sales. E.g
wardrobe sales.

Made To Order (MTO)

Make to order (MTO) is a business production strategy that typically allows consumers to
purchase products that are customized to their specifications. MTO (Make to Order) is
a manufacturing process in which manufacturing starts only after a customer's order is
received. Forms of MTO vary, for example, an assembly process starts when demand
actually occurs or manufacturing starts with development planning. Manufacturing after
receiving customer's orders means to start a pull-type supply chain operation because
manufacturing is performed when demand is confirmed, i.e. being pulled by demand.

Companies that provide made to order (MTO) create competitive advantages by
providing what other companies cannot -- custom-made products. However, the made-
to-order approach costs much more because companies must retool, redesign or restart
production processes for each order. This in turn often means that customers pay much

more. This creates a competitive disadvantage, though this is easily overcome if the
companies in the sector are competing on features rather than price

There are also BTO (Build to Order) and ATO (Assemble To Order) in which assembly
starts according to demand.

Made to Stock (MTS)

Made to Stock (MTS) is a production and inventory strategy in which companies manufacture
products or provide services according to their forecast of customer demand.

In MTS (Make to Stock), products are manufactured based on demand forecasts. Since
accuracy of the forecasts will prevent excess inventory and opportunity loss due to stock out,
the issue here is how to forecast demands accurately.

MTS (Make to Stock) literally means to manufacture products for stock based on
demand forecasts, which can be regarded as push-type production. MTS has been
required to prevent opportunity loss due to stockout and minimize excess inventory
using accurate forecasts. (Prevent stock out and minimize excess inventory cost)


Let's say Company XYZ produces widgets, which are popular Christmas presents.
Because retailers often buy thousands more widgets in August, in preparation for the

holiday season, Company XYZ manufactures triple the amount of widgets in July to
fulfill these orders. Company XYZ is using an MTS approach

Companies that provide MTS products and services create competitive advantages by
providing what other companies cannot -- more product or service at a crucial time.
However, the MTS approach costs much more because companies must retool,
redesign or ramp up production processes at certain times rather than operate at an
even keel all year. This in turn often means that customers pay more but get product
when they want it. This creates a competitive disadvantage because sometimes this
means they must pay more, though this is easily overcome if the companies in the
sector are competing on service and timing rather than price. Of course, being wrong
about demand forecasts can also be an expensive mistake.

If demand can be accurately forecasted to some extent then there is no problem in

creating a forecast production schedule.

One issue of MTS is to handle supply management so as not to have excess

inventory. Therefore, small-batch supply should be frequently performed by pull-
type demand such as QR (quick response), ECR (efficient consumer response),
CRP (continuous replenishment program), and VMI (vendor managed inventory).
By doing so, product flow will accelerate and cash flow will increase. Changing
push-type MTS to pull-type supply chain models such as CRP and VMI is the key
to successful supply chain management.

The (MTS) method requires an accurate forecast of demand in order to determine how
much stock should be produced. If demand for the product can be accurately forecasted,
the MTS strategy is an efficient choice for production.

The effectiveness of an MTS strategy is completely reliant on the ability of a company to

predict the future demand of its customers. This becomes increasingly challenging when a
company operates in an industry with cyclical sales cycles or seasonality. It is also generally
hard to implement an MTS strategy due to the fact that the business cycle is naturally

Therefore, the main drawback to the MTS method of production is that inaccurate forecasts
will lead to losses, stemming from excessive inventory or stockouts. Common alternative
production strategies that avoid this downside include make-to-order (MTO) and assemble-
to-order (ATO).

Assemble To Order ATO
Assemble to order (ATO) is a business production strategy where products ordered by
customers are produced quickly and are customizable to a certain extent.

The assemble-to-order (ATO) strategy requires that the basic parts for the product are
already manufactured but not yet assembled. Once an order is received, the parts are
assembled quickly and sent to the customer.

The assemble-to-order (ATO) strategy is a hybrid between a make-to-stock strategy - where

products are fully produced in advance - and the make-to-order strategy - where products
are manufactured once the order has been received. The ATO strategy attempts to combine
the benefits of both strategies - getting products into customers' hands quickly while
allowing for the product to be customizable.

Bullwhip effect
The Bullwhip Effect Bullwhip effect - the inaccurate or distorted demand information created in

the supply chain

The bullwhip effect on the supply chain occurs when changes in consumer demand causes
the companies in a supply chain to order more goods to meet the new demand. The bullwhip
effect usually flows up the supply chain, starting with the retailer, wholesaler, distributor,
manufacturer and then the raw materials supplier. This effect can be observed through most
supply chains across several industries; it occurs because the demand for goods is based on
demand forecasts from companies, rather than actual consumer demand.

Decoupling point:

Creating independence between supply and use of material. The point at

which demand changes from independent to dependent. It is the point at which the
firm becomes responsible for determining the timing & quantity of material to be
purchased made, or finished. Its the last point at which inventory is held.
Selection of decoupling points is a strategic decision that determines customer
lead times and inventory investment.

Decoupling point selection factors:

Protect zone:

Those customers who are high on net sale and low cost to serve, the most profitable.

Danger zone:
Low net sale and high on cost to serve. Customers are the least profitable and incur a loss.
3 alternatives: change customer interaction with firm so the customer can move to another
segment, charge the customer the actual cost of doing business, and switch the customer to an
alternative distribution channel

Build zone:

Customers have low cost to serve and low net sales value, so the firm should
maintain the cost to serve and build to drive the customer into the protect segment

Cost engineering: have a high net sales and high cost to serve.

Agency theory

The one who has the information is called the agent.

Others who lack the information are called the principal.

Firms in supply chain have the overall goal to improve the supply chains
competitive power because the market competition is no longer the
competition among the firms but among the supply chain.

Firstly, the agent may make false quality promises for not having the
ability to provide some level of quality; the principals cant correctly
identify the true ability of the agent, which brings the problem of adverse

Secondly, the agent may take cheating actions that causes the problem of
moral hazard.

Adverse selection happens when the principal of the supply chain tries
to choose a suitable partner in a big range of related enterprises before
implementing the supply chain management

To assure the supply chains efficiency and effectiveness, its very crucial
to choose the most suitable partner from the underlying agents by
preventing the adverse selection in supply chain.

The principal works at choosing the appropriate agent to guarantee the

successful implementation of the supply chain, while the agent engages in
benefiting greatly from participating in the excellent supply chain by
defeating the massive competitors.

There is a game between the two sides in information: the

principal claims to know about the agent as much as possible,
while the agent may hide his private information or weakness
in order to win the bid. So it is a critical problem to balance
the profits between the two sides.

The third party is put forward here creatively to help prevent

the adverse selection in supply chain. Thus, the problem can
be settled through the efforts of the principal, the agent and
the third party together. The third party is a new concept
raised here by the author and detailed explanation will be
given then. And this part will explore this problem from the
viewpoint of the third party, the principal and the agent

The total profit of the supply chain may be higher when there is information
asymmetry between the supplier and retailer.