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Operation Management

Operations management focuses on carefully managing the processes to produce and

distribute products and services. Usually, small businesses don't talk about "operations
management", but they carry out the activities that management schools typically
associate with the phrase "operations management." Major, overall activities often
include product creation, development, production and distribution. (These activities are
also associated with Product and Service Management. However product management is
usually in regard to one or more closely related product -- that is, a product line.
Operations management is in regard to all operations within the organization.) Related
activities include managing purchases, inventory control, quality control, storage,
logistics and evaluations. A great deal of focus is on efficiency and effectiveness of
processes. Therefore, operations management often includes substantial measurement and
analysis of internal processes. Ultimately, the nature of how operations management is
carried out in an organization depends very much on the nature of products or services in
the organization, for example, retail, manufacturing, wholesale, etc.

Operations management is an area of business that is concerned with the production of

goods and services, and involves the responsibility of ensuring that business operations
are efficient and effective. It is also the management of resources, the distribution of
goods and services to customers, and the analysis of queue systems.

APICS The Association for Operations Management also defines operations management
as "the field of study that focuses on the effective planning, scheduling, use, and control
of a manufacturing or service organization through the study of concepts from design
engineering, industrial engineering, management information systems, quality
management, production management, inventory management, accounting, and other
functions as they affect the organization" (APICS Dictionary, 11th edition).

Operations also refers to the production of goods and services, the set of value-added
activities that transform inputs into many outputs.[1] Fundamentally, these value-adding
creative activities should be aligned with market opportunity (see Marketing) for optimal
enterprise performance.

Historically, the body of knowledge stemming from industrial engineering formed the
basis of the first MBA programs, and is central to operations management as used across
diverse business sectors, industry, consulting and non-profit organizations.

[edit] Operations Management Planning Criteria

Control by creating and maintaining a positive flow of work by utilizing what
resources and facilities are available
Lead by developing and cascading the organizations strategy/mission statement to
all staff
Organize resources such as facilities and employees so as to ensure effective
production of goods and services
Plan by prioritizing customer, employee and organizational requirements
Maintaining and monitoring staffing, levels, Knowledge-Skill-Attitude (KSA),
expectations and motivation to fulfill organizational requirements
Performance Measures for the measurement of performance and consideration
of efficiency versus effectiveness[2]

Are You Giving Your Management These Results?

Cost Savings Management wants Purchasing to save money. But successfully
achieving and reporting cost savings requires a careful approach. Be sure to align your
definition of cost savings with managements definition, track your cost savings, and
focus on total cost reduction, not just price reduction at any cost.

Productivity Improvements Management will always expect you to do more work with
fewer resources. No matter whether youre in a tactical or strategic purchasing
organization, there are many productivity metrics that you can choose from to track
productivity gains: POs per buyer per day, average length of sourcing cycle, man-hours
per dollar saved, etc.

Brand/Differentiation Support Your organizations mission or vision statement should

give you some clues as to how your organization wants to be perceived in the
marketplace and how it wants to be differentiated from its competition, such as offering
higher quality, faster cycle time, better service, lower cost, or something similar. Make
sure that your decisions and metrics support your managements brand and
differentiation strategy. As brainless as this sounds, youd be surprised how many
organizations have a mission of being the highest quality provider in their industry, yet
their purchasing departments measure only cost savings.

Customer Satisfaction Sometimes, being in purchasing can make you feel separated
from your organizations customers. But management relies on things that youre
responsible for, like assuring continuity of supply, to keep its promises to its customers.
Realize that you can personally be responsible for your organizations failure to meet
customer expectations. In this day of tough competition, organizations simply have to
meet customer expectations to survive and you have a critical role in that survival.

Positive Cash Flow In some organizations, the timing of monetary receipts and
payments is critical. Those organizations cannot afford to have more cash leaving the
company than coming in during certain periods. Be aware of that and negotiate
appropriate terms with your suppliers. But dont just pay them late and hope that they
dont notice like some organizations do!
Published by the Massachusetts Institute of Technology, Center for Advanced
Educational Study (MIT-CAES), Cambridge, MA 02139

What Is Supply Chain Optimization?

Some sourcing situations involve constraints and complexities. Constraints are limits on
your decision, for example:

A requirement that you must select two suppliers (as opposed to one, three, or any
other number)
No supplier has the capacity to handle 100% of your business

A requirement that a certain percentage of your award must be placed with diversity

Examples of complexities may be:

A large number of line items being bid

Suppliers offering discounts at different volume levels and/or combinations of line

Various delivery locations with differences in the suitability of certain bidders to
supply some of them
A choice of freight lanes at differing costs

When you encounter situations with lots of constraints and complexities, it becomes quite
challenging to figure out the best supplier selection. For these types of situations, some
purchasing departments utilize supply chain optimization technology to support their

Simplified, supply chain optimization is a technology that applies rigorous

mathematical techniques to a well-defined sourcing scenario to produce an
optimal award allocation, according to Michael Lamoureux, president of ToP
KaTS Consulting and editor of the Sourcing Innovation Blog. Supply chain
optimization helps purchasing departments arrive at the best decision out of all
the possible alternatives.

When there are multiple bidders, multiple constraints, and lots of complexities,
there can be a massive number of alternatives and combinations! And the more
options there are, the higher the probability that you will make a suboptimal

While it is possible to work out some slightly complex bid analyses by hand, there is a
significant chance that using supply chain optimization technology can save money, save
time, and reduce errors. But supply chain optimization may not be appropriate for every
organization or spend category.
According to Lamoureux, You would use [supply chain optimization] to source high-
value core commodities, parts, and materials for which there are capacity constraints,
associated risks, and multiple potential suppliers. And because supply chain
optimization technology requires a significant investment Lamoureux estimates a
premium of anywhere from $100,000 per year to a few million dollars above the cost of
a standard eSourcing application - it is typically adopted by larger organizations who are
able to achieve a larger return on investment due to their spend volume.

Are Major Technology Breakthroughs Looming?

In the late 90s, the field of supply chain technology exploded with new
innovations such as eProcurement, reverse auctions, and more. The bursting of
the dot-com bubble slowed the pace of innovation but, in 2006, we are seeing the
return of innovative technology in the supply chain field as well as the Internet in

Todays PurchTips explores three emerging supply chain technology innovations:

software delivery, community intelligence, and buyer-supplier collaboration.

Software Delivery: You cant shop the supply chain technology market without
noticing the buzzword On Demand. On Demand is the delivery of software
functionality over the Internet from a single application instance thats shared
across all clients, explains Tim Minahan, Senior Vice President of Procuri, a
supply chain solutions provider. On Demand solutions require only a Web
browser for access, eliminating hardware and software installation and
maintenance, reducing costs, and speeding implementation.

Community Intelligence: Todays supply chain technology providers are oriented to

create a virtual community thats constantly transacting and collaborating and
exchanging information, says Minahan. Community Intelligence includes inter-company
information about supplier capabilities and performance, benchmarking data, and best
practices that are accessible to the Community of users of a supply chain system.
Some speculate that supply chain systems will someday feature Community-wide access
to peer-input supplier ratings, not unlike a corporate purchasing version of eBays seller
feedback functionality.

Buyer-Supplier Collaboration: A casualty of the dot-com bust was the buzzword C-

Commerce for Collaborative Commerce a vision of the future that buyers and
suppliers would collaborate seamlessly online. With collaborative tools like wikis now
populating other portions of todays cyberspace, the buyer-supplier collaboration
envisioned earlier is likely ready for prime time. Minahan cites three particular examples
of technology-facilitated collaboration:

1. Both buyers and sellers will be able to expose and share their excess inventory
across the Community.
2. Community members will engage in collaborative supply chain planning and
logistics route sharing.
3. Buyers will grant suppliers access to buy from their contracts where pricing or
availability is more favorable, thereby reducing total supply chain costs.

What Is A 21st Century Procurement Department?

A recently certified SPSM had been asked to do a presentation on characteristics of "The
21st Century Procurement Department." He asked me for input on a few key areas and
I'll share that input with you...

Structure & Alignment - Modern procurement departments structure themselves to

achieve the perfect mix of centralized and decentralized buying. End users - not
procurement - place orders for low-dollar items, using contracts set up by a centralized
procurement staff. So transactions are decentralized, not decisions.

A centralized procurement staff is concerned not with order placement, but with
establishing enterprise-wide contracts, managing relationships with those suppliers, and
providing processes for decentralized transactions.

There is no one-size-fits-all way of aligning a procurement department. Some

organizations align their procurement staff according to customer. Others align according
to commodity. Still others align by supplier. The "best" way depends of the goals of the

Qualifications, Knowledge, & Skills - Because of the higher-level responsibilities of

modern purchasers, they must have solid fundamental procurement capabilities,
analytical skills (particularly in financial analysis), advanced computer expertise, and
skills in contracts, project management, relationship building, strategy development, and

The manager needs to have all of the skills of his/her employees plus the ability to:

Align the procurement department with the mission and vision of the overall
Implement initiatives and best practices that support the mission and vision of the
overall organization
Lead people and the procurement function in general

Software & Intangibles - Modern organizations are adopting or "growing into" spend

technology solutions which blend eProcurement, reverse auction, spend analysis, and
other capabilities. As far as intangibles, they focus on delivering measurable results
aligned with organizational objectives and collaborating with suppliers to achieve a
competitive advantage.

In addition, procurement departments are enlarging their role in the supply chain. Once
simply just the interface for external "inputs," procurement departments are now also
expanding towards the organization's "outputs." This involves managing inventory, taking
responsibility for logistics, and, in the future, even being a more significant part of a
customer collaboration team.

Here are three ways you can reduce costs in the supply chain without driving your
suppliers out of business...

1. Eliminate Redundancies In The Supply Chain. For all supply chain partners,
create a flow chart of all activities involved in the procurement, set up, production,
inspection, storage, and transportation of all materials and components that go into
the final product. You will likely find activities that are repeated by different supply
chain partners (e.g., outgoing inspection by one supply chain partner immediately
followed by incoming inspection by another). If you can work with your supply chain
partners to eliminate such redundancies, you can reduce their costs and, as a result,
your price.
2. Shift Tasks To The Most Efficient Supply Chain Partner. Sometimes the
capabilities of supply chain partners overlap. Let's consider a customer's purchase
of engraved plaques. The customer's immediate supplier may do direct marketing,
fulfillment, and engraving. That supplier's supplier may do design, manufacturing,
and engraving. In this case, who should do the engraving? The most efficient supply
chain partner should, assuming that either can meet quality, delivery, and service
standards. But this means that you have to question "the way we've always done it"
so that you can do it the best way.
3. Leverage The Supply Chain's Buying Power. Often, the products and services
purchased by second tier suppliers are also purchased by a first-tier supplier. Many
times, that first-tier supplier gets a better price than the second-tier suppliers. In
cases like these, the first-tier supplier can negotiate to add second-tier suppliers'
volume onto its agreements, thereby getting even deeper discounts for itself and
reducing total cost throughout the supply chain.

Are You Planning For Procurement Risks?

Risk analysis is a powerful project management technique. You can use risk analysis to
address the risks that make your procurement job unnecessarily difficult.

A risk analysis is figuring out what can go wrong and how to either avoid it or fix it, said
Diana Lindstrom, a former strategic sourcing manager for a huge telecommunications
firm and currently the president of Los Lobos Consulting a company specializing in
project management and coaching project managers. By figuring out what can go wrong
identifying risks were one step ahead of Murphys Law.

Great project managers see projects in a logical sequence of systematically executed

events. Developing a procurement risk analysis is no different.

Once weve identified the risk, then we assign a level to that risk, Lindstrom explains.
You can use 1 through 10, ABC, or any other ranking system.

The final piece of the procurement risk analysis is the plan. The risk plan includes the
steps necessary to avoid the risk or mitigate the fallout from the risk if it does happen,
she says. By knowing the risks, understanding how likely each one is to occur, and
having a plan in place to deal with it, were able to successfully complete projects.

Using a risk plan can help a procurement department demonstrate its value to the
organization. Most internal customers dont understand why procurement needs to
follow all the steps that are laid out by the company. And they dont care, she notes. So,
using a risk plan becomes an educational tool. It teaches folks what happens if the
procurement steps are not followed. It shows them in black and white what can happen
the risk and how procurement professionals deal with it the plan. It shows them that
procurement wants to help them do business in a less risky way.

So, in summary, identify risks, assign levels to those risks, determine the steps to avoid
or mitigate the risks, and share the plan with stakeholders.

How Modern Is Your Purchasing Department?

The purchasing function has changed dramatically over the last several years. And it
continues to change and evolve almost daily. This edition of PurchTips contains 10
characteristics of modern purchasing departments. Use it as a checklist.

If your department doesnt meet each criterion on this list, dont be discouraged. Instead,
use this checklist as a set of goals to which you aspire. So, without further fanfare, here
are 10 signs of a modern purchasing department

1. The head of purchasing reports directly to the CEO of your company

2. Your department is responsible for procurement in non-traditional spend areas
such as healthcare benefits, fleet management, facilities and construction,
temporary labor, and travel
3. Purchasing is actively involved in senior management level, long-term strategic
4. The purchasing staff is responsible for manually placing only a small percentage of
your organizations purchase orders
5. Logistics and inventory functions either fall under Purchasing on the organizational
chart or are integrated into the work of purchasing staff
6. Maverick buying is a thing of the past
7. When dealing with large, frequently used suppliers, no paper is exchanged between
the time that a need for a product or service is defined until the time that the supplier
receives payment
8. No major sourcing process is conducted without the use of a cross-functional team
9. You are buying from global sources and measuring non-domestic spend as a
percentage of total spend
10. Your department has social responsibility goals and measurements in place

Is Your Purchasing Department Strategic or Tactical?

Most purchasing departments aspire to be strategic. They seek to minimize their
tactical tasks and spend more time on strategic ones. Here are 10 characteristics of
strategic, in contrast to tactical, purchasing.

Spend Analysis: Strategic purchasing teams examine the amount of money they spend
in each category of goods and services and use this analysis to identify opportunities for

Supplier Relationship Management: Strategic purchasing teams measure supplier

performance and regularly spend time meeting with their most important suppliers to
implement improvements.

Technology Implementation: Strategic purchasing teams frequently update and add

technologies that measurably reduce costs, decrease cycle time, and make the
purchasing process more efficient.

Developing Project Plans: Strategic purchasing teams use project management

practices to map out both recurring activities and one-time projects.

Enterprise-wide Contracts: Strategic purchasing teams consolidate spend across all

parts of their organizations and enter into contracts with a limited supply base to serve
the needs of the entire organization.

Forecasting: Strategic purchasing teams regularly document changes that they foresee
in price levels, availability, and markets to ensure a competitive advantage for their

Involvement in Spec Development: Strategic purchasing teams are involved at the

early stages of specification development, lending specialized knowledge in material
availability, cost drivers, standard parts, and reliability of supply.

Development of Productivity Tools: Strategic purchasing teams develop tools (e.g.,

RFP templates) so repetitive tasks can be done more quickly and error-free.

Supplier Development: Strategic purchasing teams dont blindly accept the suppliers
and products that are currently available. They work with suppliers to develop new
capabilities or products that will improve cost or quality.

Work Responsibility Refinement: Strategic purchasing teams constantly identify ways

to automate, delegate, or eliminate tactical, non-value-added work.

Should You Dual Source Or Single Source?

To dual source means to use two preferred suppliers to provide the same product or
service. To single source means to use just one preferred supplier, despite there being
multiple capable suppliers available.

Many purchasers decide to single or dual source prior to issuing an RFP or tender based
on certain assumptions. Common assumptions are that there is a lower cost with a single
source due to you leveraging your volume but less risk with a dual source due to having
a qualified supplier up and running if the other fails to perform.

Those assumptions may be right sometimes but, as a professional, you should make
decisions on facts, not assumptions. To acquire facts, request three prices from your
suppliers: (a) for 100% of your business, (b) for 70% of your business, and (c) for 30% of
your business.

Upon bid receipt, compute the cost of doing business with the two qualified suppliers
who bid the lowest for the 70% and 30% chunks of your business. Compare that cost
with the lowest qualified single source bid. Is there a cost difference between the single
and dual source options? If so, does the lower risk justify the premium?

I must close this article with these caveats:

Executives may resist paying a premium for goods and services. If they need to be
sold on the concept, compare it to buying insurance - expending funds to protect
your company from the unexpected.
A dual source situation can have disadvantages beyond just a higher cost. Consider
any potential problems from inconsistencies in quality or the extra work involved in
managing two suppliers.
For simplicity, I used price as the only decision criterion above. Make complex
supplier decisions on a total cost of ownership basis, considering quality, delivery,
service, and other variables.
Keep in mind that just because you contract with a single source doesnt mean that
a non-contracted supplier wont be available if you might need one.
Why might one of the dual source suppliers fail? Could any such reason cause both
to fail at the same time? If so, dual sourcing may either (a) not truly reduce your risk
and/or (b) work well only if you choose suppliers with materially different traits.

Deming's 14 Points
(Excerpted from Chapter Two of OUT OF THE CRISIS by W. Edwards Deming )
1. Create constancy of purpose toward improvement of product and service, with
the aim to become competitive and to stay in business, and to provide jobs.

2. Adopt the new philosophy. We are in a new economic age. Western

management must awaken to the challenge, must learn their responsibilities, and
take on leadership for change.

3. Cease dependence on inspection to achieve quality. Eliminate the need for

inspection on a mass basis by building quality into the product in the first place.

4. End the practice of awarding business on the basis of price tag. Instead,
minimize total cost. Move toward a single supplier for any one item, on a long-
term relationship of loyalty and trust.

5. Improve constantly and forever the system of production and service, to

improve quality and productivity, and thus constantly decrease costs.

6. Institute training on the job.

7. Institute leadership The aim of supervision should be to help people and

machines and gadgets to do a better job. Supervision of management is in need
of overhaul as well as supervision of production workers.

8. Drive out fear, so that everyone may work effectively for the company

9. Break down barriers between departments. People in research, design, sales,

and production must work as a team, to foresee problems of production and in
use that may be encountered with the product or service.

10. Eliminate slogans, exhortations, and targets for the work force asking for zero
defects and new levels of productivity. Such exhortations only create adversarial
relationships, as the bulk of the causes of low quality and low productivity belong
to the system and thus lie beyond the power of the work force.

11a. Eliminate work standards (quotas) on the factory floor. Substitute leadership.

b. Eliminate management by objective. Eliminate management by numbers,

numerical goals. Substitute leadership.

12a. Remove barriers that rob the hourly worker of his right to joy of
workmanship. The responsibility of supervisors must be changed from sheer
numbers to quality.

b. Remove barriers that rob people in management and in engineering of their

right to joy of workmanship. This means abolishment of the annual merit rating
and of management by objective
13. Institute a vigorous program of education and self-improvement.

14. Put everybody in the company to work to accomplish the transformation. The
transformation is everybody's job.

Excerpted with permission from OUT OF THE CRISIS, copyright (c) 1986 by the
W. Edwards Deming Institute, Washington, DC.

Deming's System of Profound Knowledge

The following is excerpted from Chapter 4 of The New Economics, second
edition by W. Edwards Deming.

The prevailing style of management must undergo transformation. A system can

not understand itself. The transformation requires a view from outside. The aim of
this chapter is to provide an outside view-a lens-that I call a system of profound
knowledge. It provides a map of theory by which to understand the organizations
that we work in.

The first step is transformation of the individual. This transformation is

discontinuous. It comes from understanding of the system of profound
knowledge. The individual, transformed, will perceive new meaning to his life, to
events, to numbers, to interactions between people.

Once the individual understands the system of profound knowledge, he will apply
its principles in every kind of relationship with other people. He will have a basis
for judgment of his own decisions and for transformation of theorganizations that
he belongs to. The individual, once transformed, will:

Set an example
Be a good listener, but will not compromise
Continually teach other people
Help people to pull away from their current practice and beliefs and move
into the new philosophy without a feeling of guilt about the past

The layout of profound knowledge appears here in four parts, all related to each
Appreciation for a system
Knowledge about variation
Theory of knowledge
One need not be eminent in any part nor in all four parts in order to understand it
and to apply it. The 14 points for management in industry, education, and
government follow naturally as application of this outside knowledge, for
transformation from the present style of Western management to one of

The various segments of the system of profound knowledge proposed here can
not be separated. They interact with each other. Thus, knowledge of psychology
is incomplete without knowledge of variation.

A manager of people needs to understand that all people are different. This is not
ranking people. He needs to understand that the performance of anyone is
governed largely by the system that he works in, the responsibility of
management. A psychologist that possesses even a crude understanding of
variation as will be learned in the experiment with the Red Beads (Ch. 7) could
no longer participate in refinement of a plan for ranking people.

Further illustrations of entwinement of psychology and use of the theory of

variation (statistical theory) are boundless. For example, the number of defective
items that an inspector finds depends on the size of the work load presented to
him (documented by Harold F. Dodge in the Bell Telephone Laboratories around
1926). An inspector, careful not to penalize anybody unjustly, may pass an item
that is just outside the borderline Out of the Crisis, p. 266). The inspector in the
illustration on page 265 of the same book, to save the jobs of 300 people, held
the proportion of defective items below 10 per cent. She was in fear for their jobs.

A teacher, not wishing to penalize anyone unjustly, will pass a pupil that is barely
below the requirement for a passing grade.

Fear invites wrong figures. Bearers of bad news fare badly. To keep his job,
anyone may present to his boss only good news.

A committee appointed by the President of a company will report what the

President wishes to hear. Would they dare report otherwise?

An individual may inadvertently seek to cast a halo about himself. He may report
to an interviewer in a study of readership that he reads the New York Times,
when actually this morning he bought and read a tabloid.

Statistical calculations and predictions based on warped figures may lead to

confusion, frustration, and wrong decisions.

Accounting-based measures of performance drive employees to achieve targets

of sales, revenue, and costs, by manipulation of processes, and by flattery or
delusive promises to cajole a customer into purchase of what he does not
need(adapted from the book by H. Thomas Johnson, Relevance Regained, The
Free Press, 1992).

A leader of transformation, and managers involved, need to learn the psychology

of individuals, the psychology of a group, the psychology of society, and the
psychology of change.

Some understanding of variation, including appreciation of a stable system, and

some understanding of special causes and common causes of variation, are
essential for management of a system, including management of people (Chs. 6

Excerpted with permission from The New Economics for Industry, Government, Education,
second edition, copyright 1994 by the W. Edwards Deming Institute.

All rights reserved. Permission is hereby granted to print a single copy of this material for
personal, scholarly, non-commercial use provided such copy includes the text in its entirety and
the copyright notice stated above. Any other use requires written permission in advance from the

Published by the Massachusetts Institute of Technology, Center for Advanced Educational

Services, Cambridge, MA 02139 (E-mail:

The Indy Quality, Productivity, and Involvement Council for the use of their
Deming/PDSA image.
SPC Press for the use of their Deming background image.
Clemson University for the use of their CQI server and support.
Del Kimbler for his technical support for the DEN.

The URL for this page is

This page was created by Jim Clauson on 05OCT97 and last updated on

Contents, images, and structure Copyrighted by the Deming Electronic Network,

1995-98 (unless otherwise noted). All rights reserved.

A supply chain is a network of facilities and distribution options that performs the
functions of procurement of materials, transformation of these materials into intermediate
and finished products, and the distribution of these finished products to customers.
Supply chains exist in both service and manufacturing organizations, although the
complexity of the chain may vary greatly from industry to industry and firm to firm.

Below is an example of a very simple supply chain for a single product, where raw
material is procured from vendors, transformed into finished goods in a single step, and
then transported to distribution centers, and ultimately, customers. Realistic supply chains
have multiple end products with shared components, facilities and capacities. The flow of
materials is not always along an arborescent network, various modes of transportation
may be considered, and the bill of materials for the end items may be both deep and large.

Traditionally, marketing, distribution, planning, manufacturing, and the purchasing

organizations along the supply chain operated independently. These organizations have
their own objectives and these are often conflicting. Marketing's objective of high
customer service and maximum sales dollars conflict with manufacturing and distribution
goals. Many manufacturing operations are designed to maximize throughput and lower
costs with little consideration for the impact on inventory levels and distribution
capabilities. Purchasing contracts are often negotiated with very little information beyond
historical buying patterns. The result of these factors is that there is not a single,
integrated plan for the organization---there were as many plans as businesses. Clearly,
there is a need for a mechanism through which these different functions can be integrated
together. Supply chain management is a strategy through which such an integration can
be achieved.

Supply chain management is typically viewed to lie between fully vertically integrated
firms, where the entire material flow is owned by a single firm, and those where each
channel member operates independently. Therefore coordination between the various
players in the chain is key in its effective management. Cooper and Ellram [1993]
compare supply chain management to a well-balanced and well-practiced relay team.
Such a team is more competitive when each player knows how to be positioned for the
hand-off. The relationships are the strongest between players who directly pass the baton,
but the entire team needs to make a coordinated effort to win the race.

Supply Chain Decisions

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

There are four major decision areas in supply chain management: 1) location, 2)
production, 3) inventory, and 4) transportation (distribution), and there are both strategic
and operational elements in each of these decision areas.

Location Decisions
The geographic placement of production facilities, stocking points, and sourcing points is
the natural first step in creating a supply chain. The location of facilities involves a
commitment of resources to a long-term plan. Once the size, number, and location of
these are determined, so are the possible paths by which the product flows through to the
final customer. These decisions are of great significance to a firm since they represent the
basic strategy for accessing customer markets, and will have a considerable impact on
revenue, cost, and level of service. These decisions should be determined by an
optimization routine that considers production costs, taxes, duties and duty drawback,
tariffs, local content, distribution costs, production limitations, etc. (See Arntzen, Brown,
Harrison and Trafton [1995] for a thorough discussion of these aspects.) Although
location decisions are primarily strategic, they also have implications on an operational

Production Decisions
The strategic decisions include what products to produce, and which plants to produce
them in, allocation of suppliers to plants, plants to DC's, and DC's to customer markets.
As before, these decisions have a big impact on the revenues, costs and customer service
levels of the firm. These decisions assume the existence of the facilities, but determine
the exact path(s) through which a product flows to and from these facilities. Another
critical issue is the capacity of the manufacturing facilities--and this largely depends the
degree of vertical integration within the firm. Operational decisions focus on detailed
production scheduling. These decisions include the construction of the master production
schedules, scheduling production on machines, and equipment maintenance. Other
considerations include workload balancing, and quality control measures at a production

Inventory Decisions
These refer to means by which inventories are managed. Inventories exist at every stage
of the supply chain as either raw materials, semi-finished or finished goods. They can
also be in-process between locations. Their primary purpose to buffer against any
uncertainty that might exist in the supply chain. Since holding of inventories can cost
anywhere between 20 to 40 percent of their value, their efficient management is critical in
supply chain operations. It is strategic in the sense that top management sets goals.
However, most researchers have approached the management of inventory from an
operational perspective. These include deployment strategies (push versus pull), control
policies --- the determination of the optimal levels of order quantities and reorder points,
and setting safety stock levels, at each stocking location. These levels are critical, since
they are primary determinants of customer service levels.

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

Supply Chain Modeling Approaches

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

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

Network Design Methods

As the very name suggests, these methods determine the location of production, stocking,
and sourcing facilities, and paths the product(s) take through them. Such methods tend to
be large scale, and used generally at the inception of the supply chain. The earliest work
in this area, although the term "supply chain" was not in vogue, was by Geoffrion and
Graves [1974]. They introduce a multicommodity logistics network design model for
optimizing annualized finished product flows from plants to the DC's to the final
customers. Geoffrion and Powers [1993] later give a review of the evolution of
distribution strategies over the past twenty years, describing how the descendants of the
above model can accommodate more echelons and cross commodity detail.

Breitman and Lucas [1987] attempt to provide a framework for a comprehensive model
of a production-distribution system, "PLANETS", that is used to decide what products to
produce, where and how to produce it, which markets to pursue and what resources to
use. Parts of this ambitious project were successfully implemented at General Motors.

Cohen and Lee [1985] develop a conceptual framework for manufacturing strategy
analysis, where they describe a series of stochastic sub- models, that considers annualized
product flows from raw material vendors via intermediate plants and distribution
echelons to the final customers. They use heuristic methods to link and optimize these
sub- models. They later give an integrated and readable exposition of their models and
methods in Cohen and Lee [1988].

Cohen and Lee [1989] present a normative model for resource deployment in a global
manufacturing and distribution network. Global after-tax profit (profit-local taxes) is
maximized through the design of facility network and control of material flows within the
network. The cost structure consists of variable and fixed costs for material procurement,
production, distribution and transportation. They validate the model by applying it to
analyze the global manufacturing strategies of a personal computer manufacturer.

Finally, Arntzen, Brown, Harrison, and Trafton [1995] provide the most comprehensive
deterministic model for supply chain management. The objective function minimizes a
combination of cost and time elements. Examples of cost elements include purchasing,
manufacturing, pipeline inventory, transportation costs between various sites, duties, and
taxes. Time elements include manufacturing lead times and transit times. Unique to this
model was the explicit consideration of duty and their recovery as the product flowed
through different countries. Implementation of this model at the Digital Equipment
Corporation has produced spectacular results --- savings in the order of $100 million
Clearly, these network-design based methods add value to the firm in that they lay down
the manufacturing and distribution strategies far into the future. It is imperative that firms
at one time or another make such integrated decisions, encompassing production,
location, inventory, and transportation, and such models are therefore indispensable.
Although the above review shows considerable potential for these models as strategic
determinants in the future, they are not without their shortcomings. Their very nature
forces these problems to be of a very large scale. They are often difficult to solve to
optimality. Furthermore, most of the models in this category are largely deterministic and
static in nature. Additionally, those that consider stochastic elements are very restrictive
in nature. In sum, there does not seem to yet be a comprehensive model that is
representative of the true nature of material flows in the supply chain.

Rough Cut Methods

These models form the bulk of the supply chain literature, and typically deal with the
more operational or tactical decisions. Most of the integrative research (from a supply
chain context) in the literature seem to take on an inventory management perspective. In
fact, the term "Supply Chain" first appears in the literature as an inventory management
approach. The thrust of the rough cut models is the development of inventory control
policies, considering several levels or echelons together. These models have come to be
known as "multi-level" or "multi-echelon" inventory control models. For a review the
reader is directed to Vollman et al. [1992].

Multi-echelon inventory theory has been very successfully used in industry. Cohen et al.
[1990] describe "OPTIMIZER", one of the most complex models to date --- to manage
IBM's spare parts inventory. They develop efficient algorithms and sophisticated data
structures to achieve large scale systems integration.

Although current research in multi-echelon based supply chain inventory problems shows
considerable promise in reducing inventories with increased customer service, the studies
have several notable limitations. First, these studies largely ignore the production side of
the supply chain. Their starting point in most cases is a finished goods stockpile, and
policies are given to manage these effectively. Since production is a natural part of the
supply chain, there seems to be a need with models that include the production
component in them. Second, even on the distribution side, almost all published research
assumes an arborescence structure, i. e. each site receives re-supply from only one higher
level site but can distribute to several lower levels. Third, researchers have largely
focused on the inventory system only. In logistics-system theory, transportation and
inventory are primary components of the order fulfillment process in terms of cost and
service levels. Therefore, companies must consider important interrelationships among
transportation, inventory and customer service in determining their policies. Fourth, most
of the models under the "inventory theoretic" paradigm are very restrictive in nature, i.e.,
mostly they restrict themselves to certain well known forms of demand or lead time or
both, often quite contrary to what is observed.
The preceding sections are a selective overview of the key concepts in the supply chain
literature. Following is a list of recommended reading for a quick introduction to the area.

1. Arntzen, B. C., G. G. Brown, T. P. Harrison, and L. Trafton. Global Supply Chain
Management at Digital Equipment Corporation. Interfaces, Jan.-Feb., 1995.
2. Ballou, R. H. 1992. Business Logistics Management, Prentice Hall, Englewood
Cliffs, NJ, Third Edition.
3. Breitman, R. L., and J. M. Lucas. 1987. PLANETS: A Modeling System for
Business Planning. Interfaces, 17, Jan.-Feb., 94-106.
4. Cohen, M. A. and H. L. Lee. 1985. Manufacturing Strategy Concepts and
Methods, in Kleindorfer, P. R. Ed., The Management of Productivity and
Technology in Manufacturing, 153- 188.
5. Cohen, M. A. and H. L. Lee. 1988. Strategic Analysis of Integrated Production-
Distribution Systems: Models and Methods. Operations Research, 36, 2, 216-228.
6. Cohen, M. A. and H. L. Lee. 1989. Resource Deployment Analysis of Global
Manufacturing and Distribution Networks. Journal of Manufacturing and
Operations Management, 81-104.
7. Cooper, M. C., and L. M. Ellram. 1993. Characteristics of Supply Chain
Management and the Implications for Purchasing and Logistics Strategy. The
International Journal of Logistics Management, 4, 2, 13-24.
8. Deuermeyer, B. and L. B. Schwarz. 1981. A Model for the Analysis of System
Service Level in Warehouse/ Retailer Distribution Systems: The Identical Retailer
Case, in: L. B. Schwarz (ed.), Studies in Management Sciences, Vol. 16--Multi-
Level Production / Inventory Control Systems, North-Holland, Amsterdam, 163-
9. Geoffrion, A., and G. Graves. 1974. Multicommodity Distribution System Design
by Benders Decomposition. Management Science, 29, 5, 822-844.
10. Geoffrion, A., and R. Powers. 1993. 20 Years of strategic Distribution System
Design: An Evolutionary Perspective, Interfaces. (forthcoming)
11. Houlihan, J. B. 1985. International Supply Chain Management. International
Journal of Physical Distribution and Materials Management, 15, 1, 22-38.
12. Lee, H. L., and C. Billington. 1992. Supply Chain Management: Pitfalls and
Opportunities. Sloan Management Review, 33, Spring, 65-73.
13. Lee, H. L., and C. Billington. 1993. Material Management in Decentralized
Supply Chains. Operations Research, 41, 5, 835-847.
14. Masters, J. M. 1993. Determination of Near-Optimal Stock Levels for Multi-
Echelon Distribution Inventories. Journal of Business Logistics, 14, 2, 165-195.
15. Schwarz, L. B. 1981. Introduction in: L. B. Schwarz (ed.), Studies in
Management Sciences, Vol. 16--Multi-Level Production / Inventory Control
Systems, North-Holland, Amsterdam, 163-193.
16. Stenross, F. M., and G. J. Sweet. 1991. Implementing an Integrated Supply Chain
in Annual Conference Proceedings, Oak Brook, Ill: Council of Logistics
Management, Vol. 2, 341-351.
17. Vollman, T. E., W. L. Berry, and D. C. Whybark. 1992. Manufacturing Planning
and Control Systems, Irwin, Homewood, IL.

Refers to: Production planning, inventory management, distribution and

transportation, mathematical programming
Referenced by:
Contributors: Ram Ganeshan (, Terry Harrison
Status: Work that is updated on a regular basis

Last Update: 22 May 1995

Terry P. Harrison,