Supply Chain Planning - Accenture

SUPPLY CHAIN PLANNING: DEMAND
PLANNING
Introduction
Why is Demand Planning Important?
The goal of demand planning (DP) is to forecast what products customers will want, how
many of those products they will want, and when they will expect to have them.
The primary business issues addressed by demand planning include:
• Consolidating multiple demand plans into a single plan usable by the entire
organization
• Achieving more stable end-to-end planning and improved visibility of demand
• Eliminating "seat of the pants" decision making
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Why is Demand Planning Important?
Demand planning is one component of the supply chain planning (SCP) process. SCP is
an integrated process that allows companies to plan and integrate the supply chain
functions of procurement, manufacturing, and fulfillment.
Demand, supply, production, and fulfillment planning operate as interdependent SCP

functions. The goal is to integrate these processes so that all the plans are synchronized
with one another. Plans generated during one process are used by one or more of the
other processes.
Specifically, the demand plan is the first step and a key input in the supply chain planning
process. The demand plan must be communicated to the supply and production planners
so that they can consider the impact on their capability to build and supply customer
requirements.
Objectives
After completing this module, you should be able to:
• Describe the purpose, objectives, and benefits of demand planning
• Describe the demand planning process and identify the stakeholders
• Describe key concepts related to demand planning activities, including planning

horizons, product hierarchy, and forecast allocation techniques
• Identify key inputs and understand other considerations that impact the demand
forecast
• Define demand forecasting techniques
• Describe the measurements and metrics for demand planning
Introduction to Demand Planning
Overview
Demand planning helps a company develop their best estimate of:
• What customers will want

• How much they will want
• When they will want it
The answers to these questions serve as the foundation of the demand plan.
The goal of the demand planning process should be to create a single demand plan
across the organization. Often, organizational units within a company will have different
objectives and viewpoints, and consequently, develop separate demand plans. For
instance, Sales may have an item-by-item forecast by key customer, while Marketing
may have a separate plan that reflects the planned promotions for the year.
A good corporate demand plan is one that builds on the inputs from a variety of sources
to create a single consensus demand plan. This plan should reflect the corporate vision
that has been accepted and is being used by the entire organization.
Demand Planning Stakeholders
The forecasting process has many different stakeholders, often with competing
objectives; organizations must consider input from all of the stakeholders. The different
organizational units (Sales, Marketing, Finance, and Manufacturing) generate forecasts
and then work together with the demand planner during the Sales & Operations Planning
process to generate a one number consensus forecast that is used to drive business
operations as follows:
Sales Function
Responsible for ensuring that sales quotas and corporate sales objectives are met.
Typically, sales representatives generate time-phased forecasts for key customers or key
product groupings. Sometimes, they may also project the dollar volume of business they
expect to conduct with each customer. They then monitor the performance of actual sales
versus forecasted sales to determine their variance from forecast.
Marketing Function
Responsible for developing promotion plans and advertisement campaigns that maximize
product revenue streams. Marketing uses historical data and competitive information to
determine the influence of promotion plans and ad campaigns on customer demand.
Marketing is also responsible for forecasting the demand of new product introductions.
Because no history is available for the new products, they forecast the demand for such
products by using historical patterns of similar products.
Finance Function
Monitors forecasted sales to ensure that the organization will generate sufficient cash
flow to meet corporate financial obligations. Finance also uses demand projections for
budgeting purposes, and depends on forecast accuracy to effectively manage operating
expenses and determine whether capital investments are appropriate.
Manufacturing Function
Uses the demand plan to determine if enough resources are available to fulfill projected
demand. If they do not have the resources, the difference between the manufacturing
capability and forecasted demand must be resolved.
Demand Planner
The demand planner is part of the SCP organization, responsible for ensuring the
accuracy of the demand forecast and that the organization reaches a one number
consensus forecast.
Reaching Consensus
A single demand forecast is needed to effectively drive the operations and planning for a
company. The adjustments required to reach this consensus plan are identified during
the Sales and Operations Planning process (S&OP). The goal of the S&OP process is to
coordinate supply and demand to develop a single plan for the company. This plan will be
used to maximize customer fill rates at the minimum asset investment.
As we have seen, companies have several demand forecasts from different stakeholders
with competing objectives. S&OP can assist in balancing these different plans and
objectives. This is accomplished with a cross-functional team comprised of
representatives from Sales, Marketing, Finance, and Manufacturing, as well as planners
from the SCP function.
Although S&OP is a broad concept, we will limit our discussion to the role of demand
planning within S&OP that strives to reach consensus with a one number forecast.
Scenario: Reaching Consensus
Consider the following example of a company with two customers that manufactures just
one product that sells for $5/unit. In the table below, Sales and Finance have both
forecasted the sales of the product to each customer for the next three months.
Finance has forecasted total sales of $8,500 based on corporate cash flow requirements,
whereas the total dollar volume for Sales (who forecasted unit sales) is only $7,950
based on what they feel they can sell to their customers. This creates a difference of
$550 that must be resolved.
Scenario: Reaching Consensus - continued
During an S&OP meeting, the team decides that there are many possibilities for resolving
this issue, three of which are:
1. Finance revises its forecast to $7,950
2. Sales increases its forecast by focusing on customer acquisition
o Sales then needs to determine which customer(s) to target during what

month(s)
3. Marketing will run a promotion to stimulate customer demand during the third
month
The S&OP team agrees that all three solutions are viable. However, the third option
exceeds the revenue requirements from finance and should be more thoroughly
evaluated. Using historical sales data and statistical models, Marketing determines that
such promotions usually result in an increase (lift) of demand by 20 percent for each
customer. The sales forecast is then revised as follows:
Hence, the sales forecast matches the finance forecast (the $10 difference is within
tolerance limits), and the one number consensus demand forecast is reached.
Activities of a Demand Planner
Once a consensus demand forecast has been reached and communicated to the rest of
the organization, the demand planner must focus on a number of other crucial activities,
such as the ability to:
• Manage by exception
• Review ABC classification
• Capture metrics to continuously improve forecast
Manage by Exception
Depending on the industry, the total number of SKUs a company plans for could range
from a few hundred to several thousand. From a workflow efficiency perspective,
therefore, companies strive to develop a systematic method of planning "high priority"
SKUs.
Demand planners commonly use exception-based management to organize a large

number of SKUs. Exceptions are generally defined as high volume SKUs that
consistently have high forecast error values. By labeling these SKUs as "high priority,"
demand planners are able to manage the SKUs with highest impact on the business
before the other lower priority titles.
First, a demand planner will establish how much the actual demand may differ from the
forecasted demand for each SKU. This is known as the acceptable deviation. If the
actual demand of the SKU is outside the established acceptable deviations, an exception
is generated for the demand planner to resolve. The demand planner will then resolve the
exception by one of the following three approaches:
1. Reallocating the demand to other SKUs (allocation is discussed later in this

module)
2. Revising the forecast for the SKU, in conjunction with the cross-functional S&OP
team, and aggregating the forecast up the product hierarchy (product hierarchies
are discussed later in this module)
3. Doing nothing because there are some exceptions that the demand planner will
choose to ignore and not attempt to resolve
Review ABC Classification
Another commonly used method of product analysis is known as ABC classification.

Using this analysis, companies identify a small percentage of items that account for a
large percentage of the dollar value of annual sales (Class A items). Studies have
repeatedly shown that in most companies, five to 20 percent of all items account for 55 to
65 percent of sales (Class A); 20 to 30 percent of all items account for 20 to 40 percent of
sales (Class B); and 50 to 75 percent of all items account for only five to 25 percent of
sales (Class C).
Beyond demand planning, ABC classification is used in conjunction with forecast

accuracy metrics and other supply planning parameters to set the safety stock levels for
each SKU. Since the safety stock is used for ensuring a certain service level to the
customers, it is important to ensure that the ABC classification is accurate and current.
Hence, the demand planner is responsible for periodically reviewing the classification of
items, and initiating a reclassification effort if needed.
Capture Metrics to Continuously Improve Forecast
Performance monitoring is a fundamental and necessary part of achieving high marks in

forecast accuracy. In many companies, forecast performance measures are not well
defined, which leads to a lack of motivation to improve forecasting. In other companies,
the greater challenge is to consistently measure, track, and report forecast accuracy
metrics by relevant product families.
Since many groups (Sales, Operations, Finance) are contributing to the final consensus
forecast, it is very important to capture the various adjustments made to a baseline
forecast as it develops over time. Monitoring these inputs as independent contributions
allows for more valuable insight into areas for process improvements, and sometimes to
incentive-based rewards for those groups committed to forecasting accuracy
improvements.
Topic Summary
Demand planning helps a company develop their best estimate of what product
customers will want, how much they will want, and when they will want it. Different
organizational units (Sales, Marketing, Finance, and Manufacturing) will have different
objectives and develop separate demand plans. A good corporate demand plan is one
that, during the sales and operations planning process, incorporates inputs from the
different sources to create a consensus demand plan. The demand planner then
manages the plan by reviewing exceptions, and captures metrics to help continuously
improve the forecast.
Key Concepts in Demand Planning
Overview
Some of the key questions companies seek to answer about the process of forecasting
customer demand include:
• How often is the forecast updated?

• In what time buckets is the demand forecast—week, month, quarter?
• What is the right planning structure to support a corporate demand planning
process?
• What is the appropriate level of detail to develop a forecast?
• How do we aggregate or allocate the demand forecast throughout the planning
structure?
Key Concepts - Demand Planning Horizons
A company should update the demand forecast for its products based on the type of
demand forecast that is generated, such as:
• Strategic Forecast - Used for strategic purposes, this forecast usually spans
several years. Most companies will update their long-term strategic forecast twice
a year or quarterly at most.
• Tactical Forecast - Used to understand the demand for the company's products
in the near future, the tactical forecast is generally updated every month as part
of sales and operations planning. For products with long lead-times, the forecast
generated during this horizon is critical to ensure that these special products are
available for customers at the appropriate times.
• Operational Forecast - Used to drive the business operations and to understand

immediate and near future demand for the company's products, the operational
forecast is usually updated every week to reflect current market conditions.
Companies who use advanced technology in an environment where speed-to-
decision is key can update the operational forecast more frequently (e.g., every
shift or every few hours).
Key Concepts - Forecast Bucket Granularity
Companies determine whether the demand forecast should predict the demand for each
day, week, month, or quarter. This is referred to as forecast bucket granularity. Buckets
are differentiated as follows:
• Quarterly Buckets - Equates to four buckets per year of data. The forecast
number is a quarterly sales figure. Generally this is most useful for forecasting
long-term demand.
• Monthly Buckets - Equates to 12 buckets, one for each month of the year.
Monthly buckets are used for forecasting demand on a monthly basis, and the
forecast is generally used for providing visibility into the upcoming near future
demand.
• Weekly Buckets - Equates to 52 buckets, one for each week of the year. Weekly
buckets are used for providing visibility into the near-term and the immediate
future demand.
Most companies forecast demand for one year at a time, using smaller buckets for the
near-term quarter, and larger buckets to represent demand that is three or four quarters
in the future. This ensures that they have explicit visibility into immediate future demand,
and aggregated information regarding longer-term demand.
A soda can producer, for example, will forecast the next quarter's demand in 12 weekly
buckets, the following quarter's demand in three monthly buckets, and all future demand
in quarterly buckets.
If a company is forecasting for strategic reasons, they may only use quarterly buckets.
Key Concepts - Planning Structure
As a demand planner moves through the various planning horizons over time, and closer
to the expected customer delivery date, they are challenged to provide more accurate
forecasts at lower levels of detail. In addition, many companies view their data in a variety
of different ways; this capability is also referred to as a multi-dimensional view of data.
Companies organize their data in such a way to have maximum flexibility to view the data
in different dimensions, e.g., total sales by product family, or total sales by sales regions.
They may also use this structure to have the flexibility to aggregate or allocate forecasts
in different ways. To accomplish this, companies utilize product and geographical
hierarchies.
Product Hierarchy
A manufacturer of women's clothing in the apparel industry may define their product
hierarchy in the following way:
• Product Family - Trousers
• Product Category - Jeans, Casual, Business
• Color - Blue, Gray
• SKU - Trouser/Jeans/Blue
A product hierarchy can be several layers deep, and it will usually vary from company to
company and from product to product. The lowest layer of a product hierarchy is usually
a SKU. Thus, a blue business trouser would be considered a SKU.
Geographical Hierarchy
Companies also commonly develop a geographical hierarchy, typically used to segment

their customer base. A sample geographical hierarchy might be:
• Company - Clothing Manufacturer
• Region - Southern, Midwest, West
• Location - Dallas, Atlanta, San Francisco
• Customer - Store 1, Store 2
The figure depicts a graphic representation of a geographic hierarchy.
Key Concepts - Methods of Forecast Allocation
Since manually entering a forecast for each SKU is cumbersome, companies strive to
find the optimal level of detail at which to generate forecast. If using statistical forecasting
techniques, forecast generation at higher levels of detail reduces model error. Once
aggregate forecasts are generated, demand planners use the product and geography
hierarchies, along with "allocation strategy," to create forecasts at lower levels of detail.
A simplified version of the women's trousers example follows:
• Product Family - Trousers
• Product Category - Casual, Business
• Color - Blue, Black
A company could forecast the sales at any of the levels above and would need to allocate
or aggregate the forecast (depending on the level at which they forecast sales). There
are essentially three methods of allocation and aggregation:
The process of forecasting at a lower level and then aggregating the forecast to a higher
level is known as bottom-up. For the trouser example, a blue casual trouser would be one
SKU.
The company could choose to forecast at the SKU level. In that case, they may need to
aggregate their sales into the different categories and/or family because the product
category manager may be more interested in managing the forecast of each product
category. The product manager, on the other hand, may be more interested in managing
the total sales of all trousers.
The company could choose to forecast at the product category level, i.e., for each week,
they forecast both the number of business trousers and casual trousers they can sell.
For manufacturing purposes, they then have to allocate the forecast to each color. Most
companies use percentages to allocate forecast. For example, the company may have
determined (from historical data) that of the business trousers they sell, 60 percent are
black and 40 percent are blue; of the casual trousers, 60 percent are blue and 40 percent
black.
Similarly, the forecast must be aggregated up to the product family level.
This is known as middle-out.
Middle-Out Forecast
The shaded forecast represents the product category level. The forecast is then allocated
to each SKU, and aggregated up to the product family level.
The company could also forecast its sales at the product family level, i.e., they forecast
the total number of trousers that will be sold during each week. They then use
percentages to allocate the forecast to each product category (e.g., 30 percent business
and 70 percent casual) and then allocate to each SKU. This is known as top-down
forecasting.
Top-Down Forecast
Note that while the two tables appear identical, in the Top-Down Forecast, weekly trouser
sales are the forecasted numbers, whereas in the Middle-Out Forecast, weekly sales of
business and casual trousers are the forecasted numbers.
Topic Summary
Several concepts are important during demand planning to ensure that the company
generates a good demand plan. These are:
• Demand Planning Horizons - the frequency at which a company updates the

demand plan for its products
• Forecast Bucket Granularity - whether the demand forecast predicts demand

for each day, week, month, or quarter
• Level of Forecast - the level at which product and geographical hierarchy

forecasts are generated
Inputs, Techniques and Considerations
Overview
Organizations must consider a number of factors to arrive at an accurate demand plan.

The figure shown illustrates the key inputs and outputs for demand planning.
It is also important for companies to consider appropriate demand forecasting

techniques. Common quantitative approaches include exponential smoothing and
moving averages.
Key Inputs - Historical Sales Data
Companies usually base a customer demand forecast on sales history, using one or
more of the following sources:
Shipments
Many companies do not have access to actual customer sales data, but they do
accurately capture customer shipments. Since it is the most prevalent data available, it is
often used as a starting point for companies to begin forecasting. Companies then use
historical shipment data to forecast future demand (shipments).
Orders
A more accurate representation of actual demand is actual customer orders. Historical
customer order data can be used to forecast future customer orders. This is prevalent in
the consumer product goods (CPG) industry, e.g., a yogurt manufacturer would use
historical order data from customers, such as grocery stores, to forecast future yogurt
demand.
Point-of-Sales Data (POS)

POS data is the most accurate form of actual demand since it is captured at the time a
customer sale is made. This was made popular by diaper manufacturers, who
collaborated with their customers to capture actual diaper sales at the points of sales,
and then used that to forecast future demand.
Generally, a company needs about two years of sales history to capture any trends and
seasonal variations. More data is even better. If sufficient data is not available for
statistical forecasting, a company should immediately start to capture data so that they
can use statistical forecasting in the future.
Key Inputs - Promotions
Promotions are used to increase product sales, but companies must ensure that enough
product is available during the promotion period to avoid losing sales and customers.
Marketing is responsible for determining the timing and the type of promotions run for
products.
Suppose that, due to some advertising promotions in July, a company's demand for a
product increases during August. This is important information for demand planning to
model for several reasons. For instance, if the company does not run a promotion during
July next year, the demand for its products during next August will be lower than the
August demand this year. Alternatively, if the company decides to run the promotion at a
different time of the year, they can use this information to better estimate the anticipated
increase in demand.
Marketing uses many types of promotions, such as:
In-store Coupons
Coupons for items are provided in the aisles where the product is sold. This type of
promotion is very common for food items and other commonly consumed items (e.g.,
toothpaste, soaps, cereal, etc.) found at grocery stores and large drug store chains.
While promotional timing is determined by Marketing, the impact may be based on
historical analysis or the managerial judgment of demand planners.
Buy-One-Get-One-Free
Most commonly used for grocery and other food items, the timing of these events is also
determined by Marketing, but the impact on sales can be based on historical analysis or
managerial judgment.
Mail-in Rebates
Mail-in rebates are a commonly used promotion for several types of items, such as
computer disks, CD ROM disks, televisions, cell phones, tax software, etc. Mail-in
rebates usually require the consumers to purchase a product during a specific time
period. Once again, it is important for demand planners to model the effect of mail-in
rebates on product sales.
Free Standing Inserts (FSI)

Popular in the Consumer Packaged Goods (CPG) industry, a company will offer a free
tenth item in a 9-piece box of cooking utensils, for example. This is referred to as an FSI.
Once again, such promotions are usually run for very specific and short time periods, and
the impact on sales is taken into account in the forecasting models.
Model Close Out

As the life cycle for a model comes to an end, companies may offer incentives for their
distributors to push product to customers.
Quantity Discounts
Often companies will offer their distributors quantity discounts if they purchase product in
large quantities. This type of promotion generally generates a significant amount of
demand activity during the promotion period. If not accounted for during demand
planning, it may lead to a serious efficiency in the supply.
Key Inputs - Causal Factors
Sales of certain products are influenced by some external factors. For example, the sales
for beer will increase during a period when the weather prediction is for unseasonably
higher temperatures. If a company can model the effect of temperatures on the sales for
beer, the results from their forecasting model will be more accurate. Other causal factors
include sporting events such as the World Cup Soccer Tournament.
For many items, sales increase or decrease during specific times of the year. For
example, ice cream sales will usually soar during hot summer months, candy sales will
increase around holidays, and snow blower sales will increase during cold winter months.
On the other hand, ice cream sales are likely to dip during those same cold winter
months.
There are a number of statistical techniques used for forecasting the sales for products
with seasonal variations. Demand planners need to ensure that if seasonal effects are
suspected for a particular product, they include sufficient data to capture past seasonal
effects. This usually translates to at least two years of data.
Additional Considerations
There are additional inputs that the demand planner may take into account while
developing a demand plan. We classify these as additional considerations:
• New Product Introductions

• Substitute Products
• Complementary Products
• Collaborative Inputs
• Lag Analysis
Additional Considerations - New Product Introductions
Statistical forecasts are usually based on historical data. In the case of new product
introductions, where there is no sales history, companies often analyze items similar to
the new product, and use their demand patterns as a gauge for the demand pattern of
the new product—referred to as like-item analysis. Marketing usually provides inputs to
demand planners who compare product characteristics, features, functions, price, etc.
Demand planners then use historical data and forecasting models for "like-items" to
develop forecasting models for the new product introductions.
As new products are introduced, some products are phased out. The complete cycle of a
product (from introduction to phase-out) is known as the product life cycle. During
demand planning, planners must also consider product phase-out, which leads to the
idea of product life cycle planning. The demand for products at the end of their cycles
may decrease rapidly, and planners must use like-item analysis to determine how quickly
the demand deteriorates.
Additional Considerations - Substitute Products
Companies offer substitute products, as alternatives to buyers, that satisfy a common set
of basic needs (as the original product), but that differ slightly in their specific
characteristics. For example, a manufacturer may offer four models of a dishwasher,
each of which has slightly different features and is offered at a slightly different price.
While modeling the behavior for substitute products is a challenging assignment, it will
enhance the accuracy of a company's modeling results.
Similar to forecasting demand for new product introductions, planners must analyze items
similar to the substitute product to forecast demand. However, the difficulty here is the
fact that substitute products are usually very similar to each other, and the demand for
one product affects the demand for another product. Thus, a demand planner may have
to analyze the demand patterns to understand the correlation in the demand patterns for
one or more substitute products. As in the case above, like-item analysis is conducted by
comparing product characteristics such as features, functions, and price. Marketing
usually provides such inputs to demand planners who then use historical data and
forecasting models for like-items to develop forecasting models for substitute products.
Additional Considerations - Complementary Products
Two products are said to be complementary when the purchase of one product increases
the likelihood that the second will be purchased. An increase in the sales of cell phones,
for instance, impacts the sales of earphones and travel chargers used with the cell
phones. Earphones and travel chargers would thus be considered complementary to cell
phones. A forecasting model can be enhanced significantly if, in the forecasting model for
earphones and travel chargers, a company could model the effect of cell phone sales.
Additional Considerations - Collaborative Inputs
Some leading companies use collaborative input from their trading partners to further
enrich their demand planning models. Collaboration involves the strategic and tactical
sharing of information between trading partners for the purpose of developing a joint plan
of action, and then working together to execute that plan. The objective of collaboration is
to eliminate inefficiencies with trading partners by sharing information and integrating
processes. For demand collaboration to be effective, vendor and customers jointly
develop a business plan. They collaborate on demand forecast, promotions, and order
forecast, and generate purchase orders (customer) and sales orders (vendor). Before
developing the demand forecast for a business, partners share information such as:
• What their customers, e.g., retailers, think they can sell to consumers
• What color(s) of sweaters are popular at a particular mall, and which ones are
still sitting on the shelf
Additional Considerations - Lag Analysis
Marketing promotions and advertisement campaigns impact sales, but not immediately.
Usually, there is a lag between the time an ad campaign runs and the time companies
see an actual increase in sales. To accurately model this, planners must determine how
many time periods in the past have a significant influence on the present, as well as what
the weight of each past period is relative to the other periods. For example, planners will
decide whether or not advertising levels from more than three months ago will be used to
determine present sales; their effects may no longer be important given more recent
advertising levels and impacts.
Overview of Forecasting Techniques
There are many different forecasting methods and techniques frequently used by
companies. We will discuss two common methods companies use:
• Qualitative Methods - The process of forecasting demand based on "market

feel." Planners have historically forecasted demand using their judgment and
factors such as:
o Promotions - Planners may know from experience that a marketing

promotion usually increases the demand for their product by about 15
percent, and they model the effect of promotional activity based on this
information.
o Causal Factors - Planners may also use their judgment to determine the
impact of other causal factors, e.g., the impact that temperatures have
on the sales of beer during a hot summer holiday weekend.
o Manual Forecasts - Some companies may simply use their sales

organization's estimates to develop a forecast.
• Quantitative Methods - The process of using statistical methods to forecast

customer demand. While there are many different statistical forecasting
techniques, we limit our discussion to the two simplest ones:
o Exponential smoothing
o Moving averages
Companies also use variations of these quantitative methods to forecast the effect of
seasonality.
Quantitative Forecasting Techniques - Exponential Smoothing
The most basic form of exponential smoothing is simple exponential smoothing. This is
useful when companies don't expect significant seasonal variations, trends, or other
cyclical variations. This technique simplifies forecasting calculations and has small data
storage requirements.
The simple exponential smoothing procedure creates a forecast based on a weighted

calculation, combining the most recent period's actual demand and forecast numbers,
using the formula:
Forecast (t+1) = α*Actual (t) + (1- α)*Forecast (t)
The smoothing factor (a) is a number between 0 and 1 that changes the weight on the
last period demand versus the last period forecast (higher a will give more weight to
recent actual demand rather than the forecast). The smoothing factor is chosen by the
planner, and can be revised as market conditions change. If the planner feels that recent
actual demand trend will continue, a should be closer to 1. If the actual demand has
significant variations in recent periods, the smoothing factor will most likely be reduced to
dampen the variation.
For example, assume that the sales data for soda cans for certain periods is given as
shown. The forecast for period 3 is then given by:
Forecast (3) = α *Actual (2) + (1- α)*Forecast (2)
In this example, we use a value of a equal to 0.20. Thus,
Forecast (3) = .2*4910 + .8*4890 = 4894
Using this method, we can forecast the sales for each time period.
The graph shows the relative accuracy of the forecasting model compared to actual
sales.
Quantitative Forecasting Techniques – Moving Average
The moving average method calculates the next period's forecast based on a simple
average of some previous periods. Suppose that a company has sales of 200, 250, and
300 for the first three months (Jan, Feb, and March) of the year. The sales for April would
thus be computed as (200+250+300)/3, which is 250.
There are no rules about the number of periods used in computing this average. The
planner usually determines this by trying different numbers and determining the one that
best fits the data.
As an example, let's consider the sales data for the soda cans again. In the attached
table, we compute the forecasted sales for each period based on averaging three and
four periods respectively. The forecasted values for the two different averaging periods
are similar, but it appears that the three-period moving average is a slightly better
estimate of the actual sales than the four-period moving average.
Topic Summary
A forecast for customer demand is usually based on sales history, which could consist of
shipment history, order history, or point-of-sales information. The effect of several other
factors can enhance the forecast, including:
• Promotion Plans - Marketing is usually responsible for determining the timing

and the type of promotions.
• Causal Factors - External factors, such as seasonality, that affect the forecast of
a product.
• New Product Introductions - The forecast for new products is based on a like-
item analysis. New products may also impact the sales forecast of older
products.
• Substitute Products - Available alternatives to the product that is forecasted.
• Complementary Products - Represent products where the purchase of one

product increases the likelihood that a second will be purchased.
• Collaborative Inputs - Using input from trading partners.
• Lag Analysis - Considering the effect of a lag between the times at which an ad
campaign is run and actual increase in sales.
There are two common methods that companies use to forecast demand:
• Qualitative Methods - Based on "market feel."
• Quantitative Methods - Based on statistical models. There are many such

models—the two most common ones are:
o Exponential smoothing
o Moving averages
Demand Planning Process
The Demand Planning Process
The demand planning process allows a company to create a single demand plan across
the organization. Often, organizational units within a company will have different
objectives and viewpoints, and consequently develop separate demand plans. The
demand planning process results in a single plan that is visible and usable by the entire
organization, and can assist in balancing these different plans and objectives. Press the
arrow below for more information.
A Demand Planning Case Study
Consider a company that has three customers, C1, C2, and C3. They manufacture two
products, products A and B, which both belong to a single class, Class 1. The company
typically forecasts demand for their products at the class level and then disaggregates
the forecast to product A and product B using percentages. The revenue from each unit
of product A is $2, and the revenue from each unit of product B is also $2.
In addition, the company has just introduced a new Class 2 product, product C, for which
they also need to forecast demand. The revenue from each unit of product C is $12.
Planners generally forecast demand quarterly, forecasting for the next three months in
monthly buckets.
Case Study - Create Baseline Forecast
Using historical orders for the next three months for each of the three customers, the
demand planner generates a statistical forecast for Class 1.
The forecast is then disaggregated for each of the products with 60 percent of the
forecast allocated to Product A, and 40 percent to Product B.
Using like-item analysis (and modeling the demand for the new product based on the
demand pattern for a similar product), the demand planner forecasts the demand for
product C for the next three months for each of the three customers.
Case Study - Create Functional Forecasts
Next, each of the functional areas will create their own forecasts that can be compared to
the Baseline Forecast created by the demand planner. See below to view the Sales &
Marketing, Financial, and Manufacturing Forecasts.
SALES & MARKETING FORECASTS

Sales and Marketing, and Finance also generate their own forecasts. Based on
discussions with customers and customers’ historical buying patterns, Sales and
Marketing work together to generate a forecast for each customer.
FINANCIAL FORECASTS
Finance generates a dollar forecast that reflects the financial targets for the company.
MANUFACTURING CAPABILITY FORECAST
At the same time, Manufacturing projects what they can produce during each of the
months, referred to as Manufacturing Capabilities.
Case Study - Reaching Consensus - Identify Discrepancies
A company's demand planner is puzzled by the fact that the statistical forecast (baseline)
during the third month is so much lower than the forecast by Sales and Marketing. She
decides to consult Sales and Marketing to resolve the discrepancy.
Solution
Upon consulting with Sales and Marketing, she learns that the reason for the high
forecast during the third month is that Sales and Marketing intends to run a promotion
that will impact sales during that month. She requests the promotional plan details from
Sales and Marketing to prepare a new baseline forecast.
Case Study - Reaching Consensus - New Baseline Forecast
After obtaining the promotional plan details from Sales and Marketing, the demand
planner uses historical data from a similar promotion and creates a demand-planning
model (i.e., Promotional Forecast) that models the anticipated lift in sales.
The Promotional Forecast replaces the original Baseline Forecast as the new Baseline
Forecast.
Case Study - Reaching Consensus - Adjusted Forecast
While further analyzing the new Baseline Forecast, the demand planner wonders why the
forecast for C2 is always higher than the corresponding forecast by Sales and Marketing.
She decides to adjust the baseline to reflect the numbers that Sales & Marketing is
forecasting. This creates a new demand plan, referred to as the Adjusted Forecast.
Adjusted Forecast
Based on changes made to the Baseline Forecast to adjust the forecast for C2, as noted
in the previous paragraph, the revised Baseline Forecast is revised again to become the
Adjusted Forecast.
Case Study - Reaching Consensus - Confirm Manufacturing Capabilities
The demand planner is now satisfied with the forecast. However, one issue still remains
to be resolved. Although the demand forecasts by the demand planner, Sales and
Marketing, and Finance are very close, Manufacturing is unable to meet the requirements
for Class 1 products. The forecast is for 60,000 units, but Manufacturing can only build
18,000 units per month for a total of 54,000 units.
Noticing this discrepancy, Manufacturing discussed this with Procurement and together
they have identified a vendor who is willing to supply 2,000 units/month of Class 1
products for three months at a cost of $1.60 per unit. While Manufacturing can
manufacture the Class 1 products at a cost of $1.50 per unit, Finance finds this
arrangement acceptable. The company agrees to outsource 6,000 units of Class 1
products to the vendor in spite of the lower margins this will generate. This is reflected in
the Final Demand Plan.
Case Study - Publish Demand Plan
Demand planners communicate the final demand plan to the executive team, bringing to
their attention the outsourcing decision and reduced margins. The executive team agrees
with the final demand plan and then publishes and distributes it to the rest of the
organization.
Case Study - Review Forecast - Manage Exceptions
During the month, actual sales data starts coming in, and the demand planner notices
that sales for Product C are much higher than expected, and those for the Class 1
products (Products A and B) are much lower than expected.
The demand planner discusses this trend with Sales and Marketing, who informs her that
Ultra Corp., a competitor for Class 1 products, has announced the release of a newer set
of Class 1 products with enhanced features and functionality. As a result, many
customers are waiting for the new product to hit the market.
Case Study - Review Forecast - Manage Exceptions
Since Ultra expects to capture a significant portion of the market for the Class 1 product,
they are delaying the launch of their product that competed with Product C in addition to
releasing the enhanced product that will compete with Class 1 products. Hence the sales
for Product C have increased whereas the sales for A and B have decreased.
Using this market intelligence, the demand planner updates her demand-planning model
and creates a revised forecast for Months 2 and 3, referred to as the Market Intelligent
Forecast.
Note: The numbers for M1 are the actual orders, and the numbers for M2 & M3 are the
revised forecast.
Case Study - Finalize Revised Plan
The Market Intelligent Forecast is acceptable to everyone except for Manufacturing, who
cannot meet the combined requirements for Products A, B, and C. The demand planner
points out that the contract with the vendor for Products A and B is still in effect, which
means that Manufacturing does not have to manufacture all the requirements for
Products A and B. Manufacturing analyzes their final requirements and agrees to the
plan.
The executive team approves the Final Revised Plan, and publishes and circulates it to
the rest of the organization.
Metrics Demand Planning
Overview
Companies monitor the "health" of their supply planning processes using a variety of
metrics, including:
• Metrics to ensure process is being followed

• Metrics used to measure supply chain effectiveness
An organization that implements an effective demand planning process will obtain a

consolidated view of customer demand that, together with effective procurement,
manufacturing, and fulfillment functions, increases shareholder value.
Demand Planning Process Control
The goal of planning is to trust and use the process-generated plans, and to minimize the
number of manual changes to those plans. This ensures that an organization can
maximize the value of their investment in supply chain initiatives.
Companies use the number of manual overrides as a crucial metric to monitor whether
they have sufficient control of the planning processes. This metric measures the number
of occurrences in which plans have been manually revised, and identifies the level of
intervention in the planning process.
A high level of intervention may indicate that there are process, organizational, or training
issues that need to be resolved.
Demand Planning Effectiveness Oriented Metrics
Companies engage in demand planning to improve their supply chain effectiveness. To

that end, forecasting accuracy is frequently used to measure demand planning
effectiveness.
Forecast accuracy, and conversely, forecast error, are key drivers of product
availability, customer service, cost, and inventory levels. In measuring forecast error,
companies must also look for what is called forecast bias. Bias is the tendency for a
forecast to be consistently "off" in the same direction. When present, forecast bias
indicates there is a problem with one or more data inputs, or the process itself. Bias is
often injected when an organization attempts to manipulate a forecast to match a
functional goal, such as a sales objective or a manufacturing volume commitment. A high
bias will drive increased inventories in proportion to lead-times, while a low bias will hurt
product availability, and ultimately, revenues.
While there are many ways to measure the accuracy of the demand planning process,
we will discuss the following metrics:
• Mean Absolute Percent Error (MAPE) and Weighted Mean Absolute Percent
Error (WMAPE)
• Percent Hit or Miss
• Mean Squared Error (MSE)
Metric for Forecast Accuracy - MAPE/WMAPE
The most common and effective measure of forecast accuracy is mean absolute
percent error (MAPE). MAPE has the advantage of being relatively easily to understand
and correlate with business results. The formula for MAPE is generally applicable across
groups of items, e.g., to evaluate forecast accuracy for the most recent period. It is
important to note, however, that all errors are weighted equally. This means that a large
error on a low-value item can skew the overall measure.
For the above reason, some companies prefer to use a weighted mean absolute
percent error (WMAPE). Typically, item cost or revenue is used as the "weight." With
the formula for WMAPE, those items driving the largest weighted volume have the
greatest impact on the error measurement. WMAPE has the added benefit of being
highly correlated with safety stock inventory requirements, making it easy to relate
performance on this measure to business performance.
Metric for Forecast Accuracy - Percent Hit or Miss
The purpose of percent hit or miss is to measure the accuracy of forecast generated
during supply chain planning prior to any manual intervention. This KPI measures the
percentage of hits against the total number of SKUs for each SKU class. This is
accomplished by:
• Assessing forecast error against a specified allowable tolerance.
• Measuring the accuracy of the SCP forecast against actual demand by SKU, and
aggregating the demand for all SKUs within a class.
• Classifying each SKU using ABC Classification to determine the SKU class.
Each SKU class has an assigned allowable tolerance for the forecast error.
Forecasts within the tolerance are recorded as a hit.
Metric for Forecast Accuracy - MSE
Mean Squared Error (MSE) is a measure that summarizes the variability of the forecast
errors. Forecast error is the difference between the actual value and the forecasted
value.
MSE is also important to capture because it is used by supply planning for safety stock
calculations. MSE is calculated based on actual values and forecasted values.
Demand Planning Influences on Shareholder Value
Forecast accuracy, or conversely, forecast error, are key drivers of product availability,
customer service, cost, and inventory levels. When a company is able to forecast
demand accurately, they are able to set lower inventory safety stock levels while
maintaining the same customer service level. This eventually leads to an increased
number of inventory turns as well as reduced work in process inventory, finished goods
inventory, and inventory-carrying costs.
A more accurate demand forecast also leads to increased product availability for
customers. This increases customer service levels, and results in lower costs for fulfilling
customer orders because fewer customer orders will need to be expedited. Furthermore,
less expediting also leads to reduced manufacturing and distribution overtime, as well as
reduced FTEs in the supply chain management function.
It is important for companies to identify expected benefits, set a baseline, and then
measure the benefits relative to that baseline and to industry standards. This will
demonstrate the value of the demand planning initiatives and activities, and provide
justification for further improvements in demand planning or other supply chain planning
areas if industry standards are not being achieved.
Topic Summary
Performance monitoring is fundamental to achieving a highly effective demand planning

process. The best companies define a set of measurements to measure forecast
effectiveness and use these measures to help them improve their forecasting models.
There are many ways to measure the performance of the demand planning process,
such as:
• Mean Absolute Percent Error (MAPE), and Weighted Mean Absolute Percent
Error (WMAPE)
• Percent Hit or Miss
• Mean Squared Error (MSE)
• Number of manual changes
A more accurate demand forecast leads to lower safety stock levels and increased
product availability for customers. This increases customer service levels, and results in
lower costs for fulfilling customer orders because fewer customer orders will need to be
expedited. These benefits ultimately translate into increased shareholder value.
CONCLUSION
Course Summary
Demand planning helps a company develop their best estimate of what product
customers will want, how much they will want, and when they will want it. A good
corporate demand plan is one that, during the S&OP process, incorporates inputs from
the different sources to create a consensus demand plan. The demand planner then
manages the plan by reviewing exceptions, and captures metrics to help continuously
improve the forecast.
Several concepts are important during demand planning to ensure that the company
generates a good demand plan, including demand planning horizons, forecast bucket
granularity, and the level of forecast. A forecast for customer demand is usually based on
sales history. Other factors, such as causal factors and lag analysis, can enhance the
forecast.
Performance monitoring is also fundamental to achieving a highly effective demand

planning process. The best companies use measures, such as MAPE and percent hit or
miss, to measure forecast effectiveness and then use this information to improve their
forecasting models.
A more accurate demand forecast leads to lower safety stock levels and increased
product availability for customers. This increases customer service levels and results in
lower costs to fulfill customer. These benefits ultimately translate into increased
shareholder value.
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Supply Chain Planning:

Supply Planning
CLOSE
Introduction
Introduction
Availability…feasibility…and service. The goal of supply planning is to ensure an adequate supply of

products at the right place and time to meet customer demand. Companies use the supply planning
process to plan finished goods requirements and determine how to satisfy customer orders. If there
is insufficient production capacity to meet the requirements, they evaluate other options, including
alternate sourcing and product allocation. The result: a match between demand and supply. Supply
planning helps address tough business problems, like these:
● Improving customer fill rates

● Reducing inventory levels and costs
● Minimizing transportation costs
● Lowering capital investments and expenditures
How Is Supply Planning Integrated with Supply Chain Planning?
Supply planning is one of the four supply chain planning processes: supply, demand, production,
and fulfillment. Note in the figure how these processes overlap the three supply chain functions:
procurement, manufacturing, and fulfillment. (Click the boxed-in arrows for more details.)
In a well-run supply chain, the planning processes are interdependent. Plans from one process
depend on and feed the other plans. The goal is to synchronize the plans—and the planners—by
integrating the processes. This helps you answer key questions:
● How do the planning processes relate to each other?

● What should I do with the information from my or another planning process?
Let's look at each of these questions before we get into the details of supply planning.
Course Objectives
After completing this module, you should be able to do the following:
● Identify the purpose, objectives, and benefits of supply planning.
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● Describe the different components of supply planning, the business problems they solve, and
the key capabilities they require.
● Identify key inputs, outputs, and concepts for each of the components of supply planning.
● Describe the metrics used to measure the effectiveness of supply planning.
Introduction to Supply Planning

Overview
A supply chain is a network of the entities—within and across companies—involved in producing,

shipping, and distributing products. Each entity is a link in the movement of a product from its raw
materials stage to its consumption by the customer. A typical supply chain has the following entities:
● Inventory Plan – Determine and plan for how much inventory to hold (finished goods) and
where to place the inventory (in which distribution centers).
● Distribution Plan – Determine how, when, and where to replenish this inventory.
● Sourcing Plan – Plan when and where to manufacture a product.
● Materials Plan – Determine what materials are needed and when.
Supply Planning Constraints
Every company is restricted in some ways in its ability to produce and deliver goods. This concept
called "constraints" is central to the supply planning process. For something to qualify as a
constraint, it must be definable in terms of a resource—for example, transportation, manufacturing,
labor—and a given time period. With money and resources, a constraint is addressed and is no
longer an issue.
Capacity Constraints
Refers to the number of products that can be produced over a period of time. For instance, a
manufacturing line can produce only a certain number of motorcycles in a week.
Materials Constraints
Occurs when the number of red motorcycles produced in a week, for example, is limited by the
number of red fenders available from a supplier. (This is not just a materials constraint for the
manufacturer, but also a capacity constraint for the fender supplier.)
Transportation Constraints
Occurs when transportation capacity is limited for a given time period; when the preferred mode
(truck, rail, air) is not available or usable; or when customer requirements (for service or a
preferred mode) cannot be met.
Lead-Time Constraints
Reflects the time it takes for material to progress from one stage to another. For example,
"manufacturing lead time" refers to the time it takes for product to be manufactured. "Transportation

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lead time" is the time it takes for product to move from one location to another.
Components of Supply Planning
Supply planning has three components—Inventory Planning, Distribution Planning, and Master
Production Scheduling (MPS). How much…where…and when (see the figure).
SUPPLY PLANNING
Inventory Planning
Plan how much inventory to maintain to meet customer demand.
Distribution Planning
Plan where to manufacture the product to meet actual customer demand. Plan how to distribute the
product to distribution centers and customers.
Master Production Scheduling

Plan when to manufacture the product to meet actual customer demand. Plan material requirements
to meet production schedule.
Supply Planning Process Flow
Supply planning is an iterative process. Click on the boxed-in arrows to see where and why the
process repeats.
Inventory Planning – This process results in a plan that specifies target safety stock levels at each
location (based on replenishment policies). This is input into the distribution planning process.
Distribution Planning – After taking into account both current inventory and high-level
manufacturing constraints, this process creates a plan to fulfill customer orders; generates the net
finished goods requirements for manufacturing; and specifies which factories should replenish the
inventories at each distribution center (the sourcing plan). Most discrepancies in the plans are
resolved by going back and forth between distribution planning and master production scheduling.
Master Production Scheduling – This process results in a feasible production plan/schedule. It is

"feasible" because it takes into account more detailed capacity as well as materials constraints.
Production Planning then uses the master production schedule to generate more detailed production
schedules and materials requirements.
Here, we differentiate explicitly between the components of supply planning. In reality, there may be
a lot of overlap among them.

Transcript
Although the general principles of inventory planning, distribution planning, and master production
scheduling are much the same, planning challenges can vary by industry. Next, we will look at the
planning challenges in two industries: semiconductor and consumer product goods.
Supply Planning in Different Industries: Semiconductor
The semiconductor industry is capacity constrained. Few manufacturers produce this type of product
without first having a customer order. This business model is known as Make-To-Order (MTO).
Because these manufacturers have limited capacity to satisfy customer orders, demand often
exceeds supply. As a result, master production scheduling—which considers detailed capacity and
materials constraints—is critical in this industry. Let's look at some of their challenges:
Chronic Capacity Shortages

Occurs when demand exceeds supply. Planners need to be able to allocate capacity among
different customers so as to maximize business objectives.
Inaccurate Due-Date Promises

Since there is no inventory on hand in an MTO environment, manufacturers must be able to quote
accurate order-promise dates to customers. Unfortunately, they rely on predetermined lead times, so
the promises may not reflect reality. With supply planning, manufacturers know precisely when and
where product will be manufactured, so they can quote more accurate order-promise dates to
customers.
Visibility into Contract Manufacturers' Plans

Many semiconductor companies outsource manufacturing to other manufacturers (known as
contract manufacturers). The semiconductor companies need visibility into the contract
manufacturers’ plans to ensure accurate order promise dates to customers and to manage any
delays.
Ability to Quickly Adjust Plans

Actual demand never follows the exact pattern of forecasted demand. As companies receive
updated demand and customer order information, they must be able to react quickly.
Supply Planning in Different Industries: Consumer Products
The consumer product goods (CPG) industry is low-margin and distribution intensive. That
combination makes both inventory and distribution planning key to managing costs. Challenges in
the CPG industry include the following:
Numerous Production Facilities and DCs

With lots of final points-of-sale, CPG depends on distribution planning to minimize cost. These
planners need visibility into the entire network to ensure that they can fulfill customer orders from
other DCs if planners project that a key DC will be stocked out. They carefully plan safety stock
levels to avoid having too much or too little inventory in the supply chain.

Transcript
Exploit Alternative Manufacturing Sources

When primary manufacturing facilities are unable to meet projected demand, CPG manufacturers
must have a plan that allows them to obtain product from alternative sources.
Topic Summary
Supply planning has three components: inventory planning, distribution planning, and master
production scheduling. Through this process, you can balance supply and demand using
inventory, distribution, sourcing, and materials plans.
Constraints restrict the ability to produce and deliver goods. Supply planning constraints include
limits on capacity, material, transportation, and lead time.
Supply planning also differs by industry. A capacity constrained industry, such as the
semiconductor industry, conducts supply planning differently from the consumer product goods
industry, which is distribution intensive.
Inventory Planning
Overview
The demand plan forecasts what customers will want, how much, and when. It is only a forecast,
though…actual demand could be higher or lower. If actual demand is higher, you may not be able to
meet it unless you have inventory on hand or can expedite production. If demand is lower, you are
stuck with excess inventory.
You want to avoid excess costs, either from carrying too much inventory or from too much
expediting. That brings us to the goals of inventory planning:
"To determine how much inventory to maintain at each location…to meet actual
customer demand…within a pre-established, acceptable service level."
Introduction to Inventory Planning
Inventories are stocks of goods and materials used for many purposes: for resale to others, to use in
further manufacturing and assembling processes, or for the operation or maintenance of existing

Transcript
equipment. Inventories serve as cushions while items are replenished (arrive) in one pattern and
demanded (depart) in another pattern.
To meet demand on time, companies carry inventory to protect against rising and falling demand
(demand fluctuation). As inventory dwindles in each location, replenishment policies govern when
to place an order for more items, and what quantities to order. In developing these policies,
companies strive to optimize: not too much inventory in the network, and not too little.
Inventory Planning Capabilities
To achieve inventory-planning objectives, companies must develop these capabilities:
● Set inventory targets – Determine the amount of buffer required (safety stock) to meet the
service level target (order fill rate).
● Define replenishment policies – Decide on order quantity (how much finished goods to order
each time inventory needs to be replenished) and when to place the order.
● Monitor and track inventory – Set acceptable inventory ranges and ensure that inventory is
maintained within those ranges.
Usually conducted monthly or quarterly, inventory planning requires advanced modeling techniques
and specialized software. Course Note
Although inventory is carried for many purposes and in many forms, we limit our discussion to
finished goods inventory and to subassemblies and components that are defined as critical to the
manufacturing process. In reality, inventory planning may be done for all subassemblies and
components and for raw materials as well. In addition, we discuss only those inventory planning
activities performed internally (not across entities in the supply chain).
Inventory Planning: Stakeholders and Business Objectives
The functions most affected by inventory planning are Fulfillment and Finance:
● Fulfillment ensures that product is available to meet customer demand and target customer
service levels.
● Finance is concerned with the amount of money spent on meeting service levels. Finance
monitors inventory levels closely to ensure they are within set limits, and not too high or too
low.
Effective inventory planning addresses the following business issues:
Improve Customer Service Levels

Increase the total number of orders that are filled completely and on time.

Transcript
Manage Inventory Costs

Minimize the total cost of inventory across the supply chain, focusing on these costs:
● Inventory Carrying Costs – what it costs to carry inventory at each location, based on the cost
of capital.
● Ordering Costs – what it costs to place an order, including paperwork, time, and processing
costs.
● Stock-out Costs – the lost revenue opportunity when a product is out of stock when a
customer wants it.
Smooth the Effect of Demand Fluctuation

Operate manufacturing facilities as if demand were constant (which it never is): ensure that they run
at a constant rate—facilities and resources are not underused or overused. Without inventory
planning, demand could fluctuate wildly.
Inventory Planning: Inputs, Outputs, and Concepts
Now let's focus on how inventory planning works: its inputs and outputs (see the figure), and two key
concepts (predictable demand and demand variability). First, let's look at the key outputs.
Key Outputs – Safety Stock Levels
The demand forecast is a best guess; actual demand can be higher or lower. Because demand is
variable, some excess inventory is kept on hand as a buffer. Referred to as "safety stock," this is a
key output of the inventory planning process.
At the same time, companies strive for a high level of customer service. For example, you may
decide that 95 percent of all demand will be met on time—a 95 percent service level. In general, the
higher the service level goal, the more safety stock required. But you cannot simply carry large
inventories to ensure that all customer demands are met. Carrying inventory is expensive. It is not
only the cost of carrying the inventory, but also the cost of the capital tied up in the inventory
investment. What you want is a balance, between service level and total cost.
Key Outputs – Safety Stock Levels (continued)
In the chart, the curve illustrates a trade-off: the better the service, the more safety stock required.
And, the higher the cost of carrying that stock.
Note also how the curve rises as service levels increase. Between 80 to 90 percent, the safety stock
needed to meet the service level increases only gradually. As the service level rises from 90 to 95

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percent, the safety stock needed rises more sharply. And note the big jump in safety stock when the
service level increases from 95 to 99 percent.
You must balance this trade-off between high customer service levels and the costs to meet those
service levels.
Key Outputs – Replenishment Policies
As inventory dwindles at each location, the question is, when and how much to reorder? If you
reorder in small quantities, you have to reorder more often. If you reorder in large quantities, you
have to carry some excess inventory.
The answer is to determine optimal order quantities that minimize total costs. This is sometimes
called the economic order quantity, or EOQ. And, the best time to place an order must also be
determined:
● Periodically: for example, every week or every month

● When inventory has fallen below a certain point, called the reorder point
Replenishment policies set out your EOQ's and reorder points. (In this course, we focus only on
these two replenishment policies; there are many others). Click below for an example.
EOQ Example
Suppose that demand is 100 units per day. You can choose to reorder 100 units to arrive every day.
That might incur high transportation costs if that small quantity only partially fills a truck. Or, you can
order a full truckload at a time, which lowers the transportation costs, but increases the inventory
carrying cost. You want to use an economic order quantity for the lowest total cost.
Key Concepts – Predictable Demand
When demand can be predicted, the result is lower overall costs: better on-time delivery, fewer stock-
outs, and higher levels of customer service with less inventory. This takes a strong planning focus.
Sophisticated modeling techniques compute safety stock levels and replenishment policies, and tie
them directly to customer service targets. If the model is accurate—if demand is accurately predicted
and actual demand equals forecast—a company can meet its customer demand without dipping into
their safety stock.
The figure shows a predictable demand scenario. A company places orders weekly, using an order
quantity, and maintains a safety stock to account for demand variability. The actual demand over
time does not require any safety stock.
Predictable demand works best with your "bread and butter" products. Meaning—your big sellers,
with high volumes, where the planning is straightforward. Predictable.

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SAFETY STOCK
is the amount of inventory kept on hand to buffer for unplanned events. Safety stock can be driven
by service level requirements, forecast error, demand and lead-time variability.
Key Concepts – Demand Variability
Actual demand seldom equals forecast. That variability is why we have safety stock. The following
figures show how safety stock can be used to lessen the effects of demand variability.
If actual demand exceeds forecast, you have to use some safety stock. This helps meet customer
demand even though the forecasted demand was lower than actual.
If actual demand is less than forecast, you do not need to use any safety stock to meet demand.
However, some inventory carrying costs are incurred.
Key Inputs
Most companies use modeling techniques to determine the right level of safety stock to carry for
each item (as well as their economic order quantities and reorder points). Safety stock calculations
require several inputs:
Forecast
The forecast of customer demand. If demand for a product is an average of 10 items per week, the
safety stock required will be less than if demand were 1,000 items per week.
Forecast Error
The expected difference between actual and forecasted demand, based on history and experience.
So, if the forecasted demand is 100 items per day, but actual demand varies between 80 and 120
items per day (the forecast error), safety stock can cover for this fluctuation. In general, the higher
the forecast error, the higher the safety stock required to cover it.
Lead Time
The time that elapses between placing an order and actually receiving it. Assume that demand is
100 units per week, and the lead time for an order is one week. That means an order must be placed
at the end of Week 1 to receive it at the beginning of Week 3. Knowing this, you can place an order
at the end of every week to ensure there is enough supply on hand for the following week. Typically,
the longer the lead time, the earlier you must place orders.
Lead-Time Variability
The amount by which lead time varies. For example, if the lead time for an order is seven days, and
the lead-time variability is two days, then actual lead time varies between five days (–2) and nine
(+2). Despite variability, an order might still be placed every week, but some extra inventory would
also have to be carried in case the order took the full nine days to arrive. So, the higher the lead-time

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variability, the more safety stock required.
Supply Variability
The difference between the actual supply quantity and the quantity ordered. Supply variability could
be due to defective items or incomplete orders being shipped. In general, the higher the supply
variability, the more safety stock required.
Order Quantities
As inventory is depleted, you must decide how much to order for the next replenishment. You can
use several different methods to compute the reorder quantity, but the simplest and most commonly
used is EOQ, the economic order quantity. The simplest form of EOQ minimizes total cost computed
as the sum of inventory carrying costs and order processing costs. More advanced formulae are
available to include stock-out costs, backorder costs, and price discounts (Winston 2003).
Winston, Wayne L. [1991] 2003. Operations Research: Applications and Algorithms. 4th ed. Boston: PWS-Kent
Publishing Co.
Inventory Planning Considerations
We have seen that inventory planning is based on goals that may seem to conflict: minimize total
costs and increase customer service levels. Companies pursue these goals based on their
business objectives:
Improve Customer Service Levels:

Targeted Service A company may segment its service level targets by customer or by product:
● Segment service levels by customer – provide a higher level of service to your best
customers. For example, the airline industry provides a higher level of service to those who
fly a lot. A food-processor distributor could choose to provide a higher level of service to
large, high-volume housewares stores, and a lower service level to smaller independent
stores. This requires setting safety stock levels by item and by customer, which is more
complex than the standard process (by item only).
● Segment service levels by product – set a higher service level for fast-moving and high-
margin products. Using an ABC classification scheme, you set higher service levels for the
class A products.
Smooth the Effect of Demand Fluctuation:

Plan for Your Suppliers A company may set inventory and safety stock levels for their suppliers.
Based on demand pattern, you create customer service level agreements with targets not only for
your customers, but also for your suppliers. Companies may do this instead of embarking on big
supply chain improvement projects, which can be too expensive and too daunting for some. To help
your key suppliers—and of course, to keep your own operations running smoothly—you could take
this approach.

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Inventory Planning: Example
One output of the inventory planning process is the level of safety stock required for each item at
each location. Safety stock is calculated to ensure a targeted level of customer service. Two
measures of customer service include:
● On-Time Delivery – the percentage of all customer demand that is met on time
● Number of Stock-Outs – the expected number of times a shortage will occur per year
Often, a safety stock level is computed for each measure. In some cases, one safety stock level can
meet both objectives. Or, the choice may be to meet only one objective.
Let's do some inventory planning.
Inventory Planning: Example (continued)
We have seen that inventory planning is based on goals that may seem to conflict: minimize total
costs and increase customer service levels. Companies pursue these goals based on their
business objectives:
A computer store in a remote township in Ireland sells an average of 1,000 CD boxes per year.
Annual demand for the CD boxes is normally distributed with a standard deviation of 69.28 boxes
(see Course Note below). The store orders the boxes from a regional distributor and each order is
fulfilled within one month. The cost of placing an order is 50, and the cost of carrying a box of
inventory for one year is 10.
The store has the following customer service objectives:
● On-Time Delivery – The store would like to determine the most economic order quantity
(EOQ), the reorder point, and the safety stock they should carry to meet 80 percent of all
demand on time (Y equals 80 percent)
● Number of Stock-Outs – The store would also like to determine the reorder point and the
safety stock they should carry to yield an average of two stock-outs per year (Z equals 2).
Course Note
"Standard deviation" is determined using statistical computations. We do not show the computations
here, but they can be found in any operations research or inventory theory textbook.
To compute the right economic order quantity, safety stock, and reorder points, the store takes the
following steps.

Transcript
Determine the EOQ
● EOQ is calculated based on average annual demand, ordering costs, and holding costs. This
is the formula:
The square root of ((2 x Ordering cost x Average annual demand)

÷ Holding cost)
● To calculate our EOQ:
The square root of ((2 x 50 x 1,000) ÷ 10) = 100
Determine the reorder point so that Y=80% (where Y is customer service level)
● The reorder point so that Y equals 80 percent is 65.33.

● This is determined using inventory theory and statistical computations.
● Inputs to the reorder point calculation include EOQ (100), annual demand (1,000 CD boxes),
and the standard deviation for demand (69.28).
● We do not show the computations here but they can be found in any operations research or
inventory theory textbook.
Compute the safety stock so that Y=80% (where Y is customer service level)
● Inputs to the safety stock calculation are reorder point (computed in the previous step) and
average demand during lead time (lead time is one month):
Reorder point – Average demand during lead time
● So, here is the amount of safety stock needed to achieve an 80 percent customer service
level:
65.33 – (1,000 ÷ 12), or, 65.33 – 83.33 = –18
● The negative number (–18) means they do not need to carry any safety stock to meet the 80
percent target. They can meet it (and probably beat it) if they simply use the EOQ (100
boxes) every time safety stock falls below the reorder point (65.33 boxes).
Determine the reorder point that yields a set number of stock-outs (Z) so that Z=2
● The reorder point so that Z equals 2 is 100.13.

● This is determined using inventory theory and statistical computations.
● Inputs to the reorder point calculation include EOQ (100), annual demand (1,000 CD boxes),
and the standard deviation for demand (69.28).
● We do not show the computations here but they can be found in any operations research or
inventory theory textbook.
Determine the safety stock that yields a set number of stock-outs (Z) so that Z=2

Transcript
● We use the same safety stock calculation, only this time, we use the stock-out reorder point:
Reorder point (for Z=2) – Average demand during lead time
● To calculate the amount of safety stock needed to yield only two stock-outs per year:
100.13 – 83.33 = 16.8
● So, with 16.8 boxes in safety stock, there will be only two stock-outs per year.
This table shows what happens to reorder points and safety stock levels as service levels increase.
On-Time Delivery Reorder Point Safety Stock
80% 65.33 0
90% 79.53 0
95% 90.13 6.8
99% 108.33 25.0
99.9% 127.13 43.8

Number of Stock-Outs = 2 100.13 16.8
Note that both objectives—on-time delivery and the number of stock-outs—can be met with the
same safety stock level. In fact, a safety stock level of about 17 boxes will ensure that the store has
no more than two stock-outs per year and meets more than 95 percent of demand on time. (This is a
higher level of service than the store originally wanted.)
Topic Summary
What is it? Key outputs
● Determine how much inventory to maintain at the ● Inventory plan

different locations to meet actual customer demand ❍ Safety stock levels
❍ Replenishment policies:
■ Order quantity (EOQ)
■ Order frequency
■ Reorder point
Sample business problems addressed Key capabilities

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● Improve customer service levels ● Set inventory targets

● Manage inventory costs, including: ● Define replenishment policies
❍ Carrying costs ● Monitor and track inventory costs
❍ Ordering costs
❍ Stock-Out costs
■ Smooth the effect of demand
fluctuation
Distribution Planning
Overview
At this point, you have demand forecasts and inventory targets for each supply chain location
(including distribution centers). Now, you want to maintain those targets by replenishing product from
your production facilities. That brings us to the goals of distribution planning:
"To determine the net finished good requirements, taking into account demand,
inventory levels, and inventory targets…to inform the manufacturing side what
product is needed, by item and location…and to inform the distribution centers when
to replenish inventory and the locations from which to source this inventory."
Distribution Network
A typical supply chain is an extended network of suppliers, factories, distribution centers, and
customers. Finished goods can flow along many different paths in a network.
Introduction to Distribution Planning
Distribution planning replenishes finished goods so that inventory is balanced across the supply
chain network. The balance is achieved by determining how much, when, and where finished goods
are needed. Specifically, distribution planning produces the following:
● Net Finished Goods Requirements – what is needed for each item at each location and
when. Planners determine the net requirements starting with demand, and then netting out
inventory on hand as well as any expected receipts.
● Sourcing Plan – which factories, suppliers, or distribution centers should replenish
inventories at each distribution center
● Distribution Plan – which distribution centers should satisfy which customer orders

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Distribution Planning Capabilities
To achieve distribution-planning objectives, companies must develop these capabilities:
● Match supply and demand – Develop a plan with no discrepancy between demand and
expected supply.
● Apply business constraints – Ensure that supply constraints are considered during the
planning process. These include manufacturing capacity constraints, transportation
constraints, and lead-time constraints.
● Manage exceptions – Manage plans by resolving any variances to those plans.
For example, after the sourcing plan is first generated, capacity decreases at one of
the facilities because of a machine failure. This causes a discrepancy between
available supply and demand. This is flagged as an exception. Planners then resolve
this by sourcing the demand from a facility (or supplier) that can handle the added
capacity.
Distribution Planning: Stakeholders and Business Objectives
The functions most affected by distribution planning include the following:
● Manufacturing and Purchasing need the outputs from distribution planning to determine the
net amount of product that must be manufactured or purchased from suppliers.
● Fulfillment needs the distribution plan to determine which distribution centers will ship
products to which customers.
● Finance needs the output from distribution planning to monitor total costs and compare them
with budgeted costs.
These stakeholders strive to meet the following business objectives:
Maintain Target Inventory Levels

Optimal inventory levels are established (based on minimizing costs) during inventory planning.
Distribution planners strive to maintain these levels to keep the process within guidelines.
Maximize Customer Service

In inventory planning, planners maximize customer service by setting target safety stock levels.
Now, in distribution planning, planners strive to minimize inventory while keeping service levels high.
Minimize Transportation Costs

Minimize the cost of transporting goods across the entire supply chain network. Some companies
determine their sourcing plan based on minimizing transportation costs and on transportation
capacity constraints.
Minimize Order Expediting

By planning ahead, there is enough inventory on hand to meet customer demand without expediting.
Expediting orders increases costs: for example, rush delivery, overtime, or premium charges for

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materials.
Distribution Planning: Inputs and Outputs
Now let's focus on how inventory planning works: its inputs and outputs (see the figure), and two key
concepts (predictable demand and demand variability). First, let's look at the key outputs.
Key Outputs – Distribution Plan
When you have multiple distribution centers and multiple customers, more than one distribution
center may fill orders for any given customer. The plan that specifies which distribution center fulfills
which customer orders is the distribution plan.
Consider a company with two distribution centers (Kuala Lumpur and Manila) and two customers
(Calcutta and Hong Kong). For simplicity, assume that the lead time to fulfill a customer demand
from a distribution center is zero, referred to as instantaneous replenishment. A simple solution
follows:
Course Note
Note that in this example, we assumed that demand at one location (for example, Calcutta) could be
met by supply at one distribution center (Kuala Lumpur). In the real world, this is a process: the
planner/software has to consider the existing inventory position at each distribution center to match
demand to supply.
Key Outputs – Net Finished Goods Requirements
As the distribution centers fulfill customer orders, inventory is depleted and must be replenished. The
DCs determine the quantity of product they need and place their orders with the manufacturing
facilities or other suppliers of finished goods. To determine "net" finished goods requirements,
inventory on hand and expected receipts are netted out (subtracted) from demand.
Assume that the lead time to replenish inventory at the distribution centers is zero. Also assume that
the inventory at the beginning of Week 1 is 25 for Kuala Lumpur and 20 for Manila.
Course Note
To simplify our example, we do not discuss other variables involved in determining net finished
goods requirements. These include lead time (the time between placing an order and receiving the
goods), expected receipts (finished goods that have been ordered and are expected to arrive),
safety stock level, and order quantities.

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Key Outputs – Sourcing Plan
Net finished goods requirements are not specific about how the requirements are to be met. With
multiple factories supplying goods to distribution centers, the question is: which factories should
replenish the inventories at each distribution center? The result is a sourcing plan. The sourcing
plan can specify finished goods purchase orders (purchase from suppliers), transfer orders (move
from one DC to another), and manufacturing orders (produce at factories).
Consider the case of a company that has distribution centers in Reno and Pittsburgh and two
manufacturing facilities in Taipei and Bangkok. The cost of transportation from Taipei to Reno is
higher than the cost from Bangkok to Reno. Similarly, the cost of transportation from Bangkok to
Pittsburgh is higher than the cost from Taipei to Pittsburgh. As a result, the company prefers to
supply the Reno DC from Bangkok, and the Pittsburgh DC from Taipei whenever possible. The
manufacturing capacity of Taipei is 125 units per week, and the manufacturing capacity of Bangkok
is 125 units per week. Click on the button to see a sample sourcing plan.
Capacity, Requirements, and Sourcing Plans

As you can see, the sourcing plan is to source as much product as possible from Bangkok for Reno,
and to source any remainder from Taipei. Similarly, the plan for Pittsburgh is to source the entire
product from Taipei. For the sake of simplicity, we did not consider manufacturing and transportation
lead times in this example.
Key Inputs
Several inputs are required for distribution planning. Let's look at the most common and important
ones, classified as demand inputs, supply inputs, and static inputs (inputs that seldom change).
Demand, Supply, and Static Inputs
Demand Inputs – visibility into customer demand
● Forecast: The forecast of customer demand for the products.

● Safety Stock: The level of safety stock required for each item. Levels are predetermined
during the inventory planning process.
● Orders: As placed by the customers.
Supply Inputs – used to determine net requirements
● On-Hand Inventory: Inventory of goods currently available.

● Inventory In-Transit: Inventory of goods already shipped and en route to the appropriate
location.
Static Inputs – inputs that seldom change

Transcript
● Network Nodes: A model/map of the supply chain network that identifies each network node
(location) as a manufacturing facility, distribution center, warehouse, or customer.
● Transportation Modes: The method used (air, rail, truck, or ship) to transport goods
between locations. There could be multiple transportation modes between locations. The
preferred modes are used to develop a distribution strategy that minimizes the total
transportation cost across the supply chain network.
● Lead Time: The time required to fulfill an order. This determines when an order needs to be
placed. For example, if lead time is one week, the order is placed one week before the goods
are required. If it is two weeks, the order is placed two weeks prior.
● EOQ: The "economic order quantity"—the quantity that allows you to minimize your total
cost. Some companies place orders in any quantity while others will order only in the EOQ
amount.
● Lot Sizes: The quantity in which manufacturing orders must be placed. If a manufacturer
uses a predetermined lot size of 100 for manufacturing, then they always make 100 items at
a time.
● Minimum Quantities: The minimum quantity of any replenishment order. If the minimum
quantity is 50, and the net requirements are fewer than 50, the order must still be for at least
50 units. If the requirement is for more than 50, the order can be for the exact amount.
Distribution Planning: Example
Now, let's consider an example of the distribution planning process in action. This example
introduces how planners take into account variables such as safety stock, economic order quantities,
expected receipts, and lead times.
Assume that a company has one distribution center in Kuala Lumpur and one customer in Calcutta.
The company has one manufacturing facility in Bangkok and a finished goods supplier in Taipei.
● The lead time to fulfill an order from the manufacturing facilities or the supplier to the DC is
one week, and the lead time to fill the Calcutta customer order from Kuala Lumpur is zero.
● The Calcutta customer demand is projected at 125 per week with some variability. So,
inventory planning has determined that the safety stock at Kuala Lumpur should be 100.
● The transportation cost from Bangkok to Kuala Lumpur is much lower than the transportation
cost from Taipei to Kuala L umpur. Ideally, the company would like to source as much
product from Bangkok as possible.
● The manufacturing capacity is 75 units at Bangkok and 150 units at Taipei.
● The company has also determined that the EOQ is 125 units per week.
Based on this information, the optimal sourcing solution is to source 75 units per week from Bangkok
to the Kuala Lumpur DC, and 50 per week from Taipei. Click on the button to see the solution in
more detail.
Distribution Planning: Example (continued)

Transcript
The Optimal Sourcing Solution specifies that Kuala Lumpur is to hold 100 units of safety stock in
inventory to account for demand variability.
● Due to demand variability, actual orders do not follow the forecasted pattern. Assume that the
orders from Calcutta in four consecutive weeks are for 125, 135, 175, and 145 units.
● To fulfill these orders (and comply with the EOQ), Kuala Lumpur has to use its safety stock.
Click on the Safety Stock Solution button. The safety stock position is shown as "Final Safety
Stock."
As you can see, with proper distribution planning, you can respond to customer demand variability
using safety stock.
Distribution Planning Considerations
Special Software
In the real world, supply chain networks are complex. Unlike our simple example, they have multiple
manufacturing facilities…more than one supplier…and more than one manufacturer of
subassemblies and components. And, their distribution centers are in central and regional locations.
Distribution planning for such a complex network requires the use of specialized supply chain
planning software.
Collaboration
Today, the company doing distribution planning may not even own some of the nodes on its
network. Companies are increasingly collaborating with trading partners, and may include their
partners' facilities in their own supply chain models. So, instead of planning distribution only for their
"owned" nodes, they could suggest inventory levels and distribution plans to their partners.
Distribution Planning Considerations (continued)
Adaptability
Distribution plans should be adaptable to supply chain and business processes that make good
business sense. For example, so far, we have assumed that manufacturers complete the
manufacturing process and ship finished items to their customers. This is not always the best way.
Consider a computer manufacturer that assembles computers at their manufacturing facility and
purchases monitors from a supplier:
● The manufacturer could have the monitors shipped to their manufacturing facility; complete
the assembly of the PC by packing the monitor and the computer together; and then ship the
product to the DC.
● Or, they could ship the computer and the monitor separately to a central distribution center
where final assembly, packing, and shipping of the finished product are done. This is referred
to as merge-in-transit. Distribution planning in this case has to account for the supplier's
inventory as well.

Transcript
Topic Summary
● Determine which distribution center fulfills which ● Distribution plan

customer orders ● Net finished goods requirements
● Determine the net finished goods requirements by ● Sourcing plan
"netting" existing inventory levels and expected receipts
from demand
● Determine how inventory will be replenished at each
location
● Maintain target inventory levels ● Match supply and demand

● Maximize customer service ● Apply business constraints
● Minimize transportation costs ● Manage exceptions
● Minimize expediting of orders
Master Production Scheduling

Overview
Once the distribution and sourcing plans have been created, the next step is to schedule production.
The master production schedule details the daily or weekly production requirements for each factory
or manufacturing facility. In this topic, we explore the goal of master production scheduling, or, MPS:
"To develop a feasible production schedule that enables you to meet expected
customer demand—using net requirements from distribution planning…to specify
which items will be produced on what days in which factories…and making sure
enough material is available in the network."
MPS Network
Recall that a distribution network has multiple suppliers, factories, distribution centers, and
customers. The network for master production scheduling consists of multiple finished goods
manufacturing facilities ("FG factories" in the diagram), multiple subassembly and components
manufacturing facilities ("component factories"), and suppliers. An FG factory could source much of
its subassembly and component requirements from more than one of the component factories or
suppliers.

Transcript
Work in process (WIP) can flow along many different paths in the network. Click on each Path button
beneath the diagram to see the ways WIP can flow through the MPS network.
Introduction to Master Production Scheduling
The master production schedule spells out which items will be used on what days to satisfy
customer demand. Recall that in most instances, the distribution plan has net requirements in
weekly or monthly buckets. The MPS converts that into daily or weekly buckets. Further, materials
constraints were not considered during distribution planning. Constraints are introduced during the
MPS process because this is where feasibility becomes a central theme. (The "materials" we refer to
here are the subassemblies and raw materials required for production of the finished goods.)
Master production scheduling creates the following outputs:
● Master Production Schedule (MPS)

Defines which items will be produced on what days for each factory. The MPS may also
consider materials constraints to ensure that the plan is material-feasible.
● Material Requirements
Material requirements are generated for suppliers of components, subassemblies, and/or raw
materials. These requirements are normally time-phased (by week, by day) and are used to
provide visibility to suppliers so that they can plan their own production. Detailed material
requirements are generated during the materials requirements planning process. (That
process is part of production planning, which is not covered in this course.)
Master Production Scheduling Capabilities
To achieve MPS objectives, companies must develop these capabilities:
● Apply materials constraints – determine if sufficient materials are available to manufacture

the required product. (More detailed than distribution planning constraints.)
● Apply capacity constraints – ensure that sufficient capacity is available for production.
(More detailed than distribution planning constraints.)
● Manage exceptions – support manufacturing decisions. For example, determine if the
product will be prebuilt, or if the order will be satisfied late, or if the material will need to be
expedited.
Often, a person known as the Master Production Scheduler is empowered to make any decisions
associated with master production scheduling.
MPS: Stakeholders and Business Objectives

Transcript
The functions most affected by distribution planning include the following:
● Manufacturing uses the output from MPS to schedule production resources—labor,

machines, and materials.
● Fulfillment may use the master production schedule to quote due dates and monitor the
progress of customer orders throughout the planning processes.
Here are some of the key business objectives that MPS addresses:
Meet Sourcing and Distribution Requirements

The requirements generated during distribution planning are scheduled so that inventory can be
replenished at the distribution centers.
Provide Visibility into Material Requirements for Suppliers

Material requirements are sent to suppliers so that they can plan for their own production. Early
visibility into material requirements alerts suppliers to unusual fluctuations in the demand for raw
materials.
MPS: Inputs and Outputs
Now let's take a closer look at MPS: its key inputs and outputs (see the figure), and an example of
MPS in action. First, the key outputs.
Key Outputs – Master Production Schedule
The master production schedule defines which items will be produced on what days for each factory.
Planners focus on feasibility during MPS: they consider capacity constraints at a more detailed level
than in distribution planning to assure enough product is available. They may also consider materials
constraints to ensure the plan is material-feasible. Consider the case of a company that
manufactures two types of motorcycles, fuel-injected and non–fuel-injected. They conduct inventory
planning and distribution planning at the motorcycle level. So, the company plans for total
motorcycles, not each individual SKU (fuel-injected or non–fuel-injected). For distribution planning
purposes, the company uses a weekly capacity of 120 bikes.
The Weekly Production Schedule shows the requirements from distribution planning. These
requirements are capacity-feasible during distribution planning, given the total capacity
constraint of 120 bikes.
Key Outputs – Master Production Schedule (continued)

Transcript
In MPS, they must now consider capacity constraints at a more detailed level. They have the
capacity to manufacture a combination of fuel-injected and non–fuel-injected motorcycles. But to see
capacity-feasible combinations, click the "ADVANCE" button:
Manufacturing Capacity: Feasible Combinations
The Feasible Constraint Combinations table shows that the company cannot manufacture 60 non–
fuel-injected and 60 fuel-injected motorcycles during a single week. As you can see, 60–60 is not
one of the possible combinations.
Revised Weekly Production Schedule
MPS must modify the requirements: it generates a Revised Weekly Production Schedule based on a
Daily Master Production Schedule. ("Daily" is a 5-day workweek.) This detailed approach assures a
feasible schedule.
Daily Master Production Schedule
MPS must modify the requirements: it generates a Revised Weekly Production Schedule based on a
Daily Master Production Schedule. ("Daily" is a 5-day workweek.) This detailed approach assures a
feasible schedule.
Key Outputs – Material Requirements
In our MPS example so far, we looked only at the manufacturing constraints. Many companies
look at both manufacturing and materials constraints. Why? Because suppliers may be unable to
provide materials when needed due to their own capacity constraints.
Bills of material (BOM's) list all material requirements. Also, material requirements must be offset by
lead time—the time it takes for the materials to arrive at the manufacturing facility after an order is
placed with the supplier. The resulting material requirements plan is a time-phased look at the
components, subassemblies, and/or raw materials required to meet the production schedule.
Although this is the same process as material requirements planning (a part of production planning),
it is often done now during MPS to provide visibility to suppliers. With long lead-time items
especially, suppliers need this time to consider their own materials constraints.
Key Outputs – Material Requirements (continued)
Let's revisit the motorcycle example from earlier. Assume that the bill of material (BOM) has several
components. One of the key components is the electronic fuel injector assembly from one of the
suppliers. (We will not look at the entire BOM, but only at this assembly.) The lead time for the fuel

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injectors is one week, so orders must be placed one week prior to when they are needed for
assembly. Option 1 shows this.
However, the supplier for the fuel injectors has a plant shutdown scheduled for Week 3, and is not
able to supply the 50 units needed during that week. But, they do have sufficient capacity during the
previous weeks to fulfill the orders for all four weeks as shown in Option 2.
The planner notes that Option 2 allows all the demand to be met. But, this will require the
manufacturer to carry some excess inventory during the earlier weeks. This is still considered a
feasible plan and is accepted as such. With this early visibility, the supplier's capacity constraint was
not an issue.
Key Outputs – Material Requirements (continued)
Prioritizing Suppliers
In many cases, there is more than one supplier for a given material. In such cases, you can decide
to procure based on priority—naming a primary supplier, a secondary supplier, a tertiary supplier 1,
tertiary supplier 2, and so on. If higher-priority suppliers are unable to meet requirements, you would
procure from the next supplier on the priority list.
In our motorcycle example, assume that there are two suppliers for the fuel injectors. The primary
supplier has the planned shutdown during Week 3 and cannot meet the deadline. As a result, the
planner will consider obtaining the fuel injectors from the secondary supplier. If the secondary
supplier is able to commit to supplying the required fuel injectors during Week 3, the planner will be
able to generate a feasible material requirements plan.
Key Inputs
While there are numerous inputs into MPS, we focus on the most frequently used inputs. We classify
them into three types—demand, supply, and static (inputs that seldom change).
Demand, Supply, and Static Inputs
Demand Inputs
Sourcing Plan
The plan generated during distribution planning that specifies the manufacturing
facility that should manufacture products, or the suppliers from which the finished
goods should be purchased.
Net Finished Goods Requirements

The requirements generated during distribution planning that specify the total amount

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of items that must be manufactured or purchased from suppliers of finished goods.

The net requirements are determined by netting out (subtracting) inventory on hand
and expected receipts from demand.
Supply Inputs
Materials Inventory
An inventory of what materials are currently available.
Materials Inventory in Transit

Inventory of materials that have already been shipped and are en route to the
appropriate location. This information is used to determine the net requirements for
materials.
Work In Process (WIP)

Work that has already started and is partially completed. WIP can be used in the
calculation of net manufacturing requirements.
Bill of Material (BOM)

Used to plan for materials and subassemblies that are purchased from suppliers. A
detailed BOM at this stage helps determine the requirements for all materials, and
provides early visibility to suppliers. Final material requirements are determined during
production planning and sent to suppliers.
Static Inputs
Capacity Constraints
The capacity constraints at each manufacturing facility. These are more detailed than
the capacity constraints used during distribution planning.
Items
A list of the manufactured items that need to be built.
Lead Times
The time it takes for material to become available after an order is placed with a
supplier.
MPS Planning Considerations
In developing master production schedules, other considerations are taken into account:
● Global vs. Regional Planning – A company that plans globally, for all its factories, can also
plan for regional and local diversity. ("Diversity" could include laws, regulations, customer
preferences, and so on). In these cases, the global MPS process generates a region– or
locale-specific MPS.
● Customer Prioritization – When developing master production schedules, customer

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priorities assure that delivery dates are met for your big, important customers. (This could
cause delivery dates to slip for other customers.)
● Supply Prioritization – We have already discussed "supplier" prioritization (primary,
secondary, and so on). "Supply" prioritization goes into even more detail. You establish how
much product you want to source from each supplier, based on a set split. For example, you
could decide that 75 percent of a product's requirements will be sourced from the primary
supplier, and 25 percent from the secondary.
● Alternate Production Routes – In many instances, product can follow more than one route
through the network. You can specify a primary route and one or more alternate routes. The
alternate routes may be used in cases of insufficient capacity and/or materials.
MPS: Example
Recall the motorcycle example in which a company manufactures two types of motorcycles, fuel-
injected and non–fuel-injected.
Manufacturing Capacity: Feasible Combinations

For distribution planning purposes, the company uses a weekly capacity of 120 motorcycles. The
company has the capacity to manufacture 80 non–fuel-injected motorcycles every week, and 40 fuel-
injected. The company can also manufacture in other combinations:
Distribution Center Requirements

We will add more complexity to that example by introducing manufacturing lead times and work in
process (WIP). First, let's look at the requirements generated for a distribution center during
distribution planning.
Manufacturing Requirements
With a one-week manufacturing lead time, the manufacturer must start production of the motorcycles
the week prior to when they are needed. This is capacity-feasible during distribution planning
because the total capacity constraint is 120 per week. So, MPS produces the Manufacturing
Requirements for building the motorcycles.
Master Production Schedule (MPS) The manufacturing facility has a WIP inventory of 10 fuel-
injected motorcycles during Week 1. From the possible capacity combinations presented, however,
we can see that the company cannot manufacture 60 non–fuel-injected and 60 fuel-injected
motorcycles during a week. As a result, 10 of the fuel-injected motorcycles cannot be manufactured
as desired, and their production will have to be pushed out to Week 4. This is reflected in the Master
Production Schedule.
The plant will manufacture 50 fuel-injected motorcycles during Weeks 1, 2, and 3, and 10 during
Week 4. The planner already knows that 10 of the fuel-injected motorcycles will be late because of
capacity constraints at the plant.
Let's further assume that the bill of material (BOM) has several components, one of which is the
electronic fuel injector assembly provided by one of the suppliers. (For the purpose of this example,
we will look only at this one assembly.) The lead time for the fuel injectors is one week, so orders
have to be placed one week prior to when they are required. This is shown in Table 1. Table 2

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shows the capacity of the fuel injector manufacturer. Looks like the material requirements can be
satisfied, and a feasible plan is generated.
Topic Summary
● Determine if sufficient manufacturing capacity and ● Master production schedule

material are available to manufacture product in each ● Material requirements
factory
● Meet sourcing and distribution requirements ● Apply material constraints

● Provide material requirements visibility to suppliers ● Apply capacity constraints
● Manage exceptions
Metrics for Supply Planning

Overview
Use metrics to gauge the health of your supply planning processes:
● Metrics to ensure process is being followed

● Metrics to measure supply chain effectiveness
A company that has an effective supply planning process develops capabilities that—along with well-
run procurement, manufacturing, and fulfillment functions—increase shareholder value.
Supply Planning: Process Control
One of the goals of planning is to trust in the process-generated plans, and to minimize the changes
people make to them. Otherwise, why invest so much in a process?
The number of manual overrides is a measure of whether you have control of the planning
processes. This metric measures the number of times someone manually revises a plan, and
identifies the level of intervention in the planning process. A high level of intervention may mean
that there are process, organizational, or training issues that need to be resolved.

Transcript
Supply Planning: Effectiveness-Oriented Metrics
In addition to tracking how well the processes work, companies track a variety of metrics that
measure the effectiveness of the supply chain itself.
Inventory Turns
The number of times inventory is turned over during a year. The more turns per year, the more
working capital available to the business.
Number of Stock-Outs
The number of times a product is out of stock when a customer orders it. This number is a measure
of service level to customers, and has a cost measured in lost revenues. The lower it is the better.
Order Lead Time

The average time it takes to deliver an order once the order is received. This is a measure of "lead
time to customer delivery" performance against other industry benchmarks and against your own
targets. This is a measure of customer service.
Delivery in Full
The percentage of all orders in which the quantity is delivered in full, on first delivery. Delivery in full
shows how often an order is 100 percent right upon delivery and, conversely, how often a company
misses this goal. (Even if the miss is one unit per order.) You want to maximize the percentage of
orders that are delivered in full.
On-Time Delivery
The percentage of customer orders delivered on time, on the date promised to the customer at the
time the order was placed. You want to maximize the percentage of orders delivered on time.
Supply Planning: Influences on Shareholder Value
What these metrics typically show is that supply planning can increase shareholder value.
Companies strive to ensure product availability and high service levels for their customers. At the
same time, they set safety stock levels as low as they can go without harming customer service
levels. This leads to good news for the bottom line:
● Increased inventory turns

● Reduced work in process inventory
● Reduced finished goods inventory
● Reduced inventory carrying costs.
Accurate safety stock levels mean product is available when customers want it. This increases the
service level to customers. It also lowers costs for fulfilling customer orders because fewer orders

Transcript
are expedited and most orders can be delivered in full. Plus, less expediting leads to reduced
manufacturing and distribution overtime: people involved in expediting can be redeployed to other,
more productive roles.
Topic Summary
Companies use metrics to gauge the health of their supply planning processes. They use metrics to
make sure the process is being followed, and to measure how well the supply chain itself is working.
Companies reap benefits through well-run supply planning. Benefits include improved order fill rates,
reduced inventory, and reduced transportation costs. These benefits ultimately translate into
increased shareholder value.
Supply Planning Case Study

Overview
Here are the facts of our case study:
● A company has one computer distributor in France and two manufacturing facilities.
● The distributor sells an average of 85 CD boxes per month.
● The monthly demand for the CD boxes is normally distributed with a standard deviation of 20.
● The distributor orders the boxes from its manufacturing facilities, and each order is fulfilled
within one month.
● The cost of placing an order is 50.
● The cost of holding a box of inventory (for one year) is 10.
The company would like to determine how much safety stock the distributor should carry so they can
meet 95 percent of all demand on time and have an average of only two stock-outs per year.
Now that planners know how much safety stock they need—with seven boxes of CDs they can meet
demand 95 percent of the time—they go a step further. They determine that with an increase in
safety stock to 15 boxes, they can also ensure that the distributor has an average of only two stock-
outs per year. (They used theory and statistics to compute this.)
The company decides it is cost effective to meet both customer service objectives, and they set the
safety stock level at 15.
A Supply Planning Case Study (continued)

Transcript
The company's forecast for the next five months is 100, 80, 75, 80, and 90 respectively. Thus, given
the order lead time, the company must place an order at the beginning of month one to receive it at
the beginning of month two. The company has also determined that the optimal way to source the
product from the two manufacturing plants (Plant 1 and Plant 2) is to take 40 percent of demand
from Plant 1 and 60 percent of demand from Plant 2.
Click the arrow to see how the requirements for each of the plants are determined.
The Manufacturing Requirements are equal to the forecast but offset by the one-month lead-time.
The Requirements for Plants 1 and 2 are determined by allocating the Manufacturing Requirements
to each plant using the allocation percentages - 40% to Plant 1 and 60% to Plant 2.
The Scheduled Receipts are equal to the quantity manufactured and shipped (Manufacturing
Requirements) but offset by the one-month lead-time.
The Beginning Inventory during each month is equal to the Ending Inventory of the previous month.
The Ending Inventory for each month is computed as (Beginning Inventory + Scheduled Receipts -
Forecast).
Supply Planning: Effectiveness-Oriented Metrics
Sourcing Plan 1 is only feasible if the company has enough manufacturing capacity at each of their
two plants. Current capacity is 40 boxes at Plant 1 and 80 boxes at Plant 2. That total capacity of
120 boxes per month is more than enough: the average demand is 85 boxes per month.
Actual customer orders begin to hit the distributor. The company notices unusually heavy demand in
the first three months and less demand in the next two months. (The orders are 110, 120, 110, 45,
and 40 for each month respectively.)
A negative number means "on back order." So, if they were to use this original plan, they would have
a shortage during several months. Recall how ending inventory is computed:
Beginning inventory + Scheduled receipts – Forecast = Ending inventory
A new Ideal Sourcing Plan must be developed based on actual customer orders.

Transcript
If you need help with these questions, just click on "MORE DETAIL."
Why is the Ideal Sourcing Plan infeasible?

The Ideal Sourcing Plan is not feasible because capacity at Plant 1 (40 boxes) is not sufficient to
meet the requirements.
What should the company do to make the plan feasible?

The company should shift some of the requirements from Plant 1 to Plant 2, to take advantage of its
higher capacity of 80 boxes per month.
The company realizes that there isn't enough capacity at Plant 1, and that Plant 2 must take on
some of Plant 1's requirements. Also, due to planned capital improvements, they expect to shut
down Plant 2 during months three and four. However, in spite of the shutdown, the company is able
to develop a Feasible Sourcing Plan to meet the expected demand by prebuilding five units during
month two to satisfy the demand during months four and five. (This does mean the distributor has to
carry some excess safety stock during month four.)
The Master Production Schedule shows each plant's monthly manufacturing requirements broken
out by week.
Conclusion
Module Summary
Supply planning ensures the right supply of product, at the right place, at the right time to meet
demand. During this process, companies develop inventory, distribution, sourcing, and materials
plans. They also consider constraints on capacity and materials to make sure their plans are feasible.
Supply planning has three main components:
● Inventory planning – set safety stock levels and replenishment policies. The goal is to keep
customer service up while keeping inventory costs down.
● Distribution planning – determine net finished goods requirements: what do we need,
when, and from which locations? This balances inventory across the supply network.
● Master production scheduling – determine if enough manufacturing capacity and materials
are on hand to meet demand. Often used to provide suppliers with early insight into demand.
Supply planning metrics show lower safety stock levels, shorter order fulfillment lead times, more
inventory turns, and lower transportation costs. That translates into increased shareholder value.

Transcript
References
Winston, Wayne L. [1991] 2003. Operations Research: Applications and Algorithms. 4th ed. Boston:
PWS-Kent Publishing Co.

Supply Chain Planning: Production Planning
Introduction
Why is Production Planning Important?
The goal of production planning is to support the manufacturing process by determining the
resources and sequence of operations required to build a product. During the production planning
process, a company generates the detailed production schedule required to build a product. The
production schedule must be tightly linked with a detailed materials plan to ensure the raw
materials are available when needed. The planning process also communicates required
materials to the purchasing department.
The primary business issues addressed by production planning include:
• Ensuring machines and materials are available for production when needed
• Maximizing throughput and utilization of factory resources
Copyright (c) 2004 Accenture. All rights reserved. You may only use and print one copy of this document for private study
in connection with your personal, non-commercial use of a Supply Chain Academy course validly licensed from
Accenture. This document, may not be photocopied, distributed, or otherwise duplicated, repackaged or modified in any
way.
How is a Production Planning Integrated with Supply Chain Planning?
Production planning is one component of the supply chain planning process. Supply chain
planning is an integrated process that allows companies to plan and integrate the supply chain
functions of procurement, manufacturing, and fulfillment.
Demand, supply, production, and fulfillment planning operate as interdependent supply chain
planning functions. The goal is to integrate these processes so that all the plans are synchronized
with one another. Plans generated during one process are used by one or more of the other
processes. In other words, planners need to know:
• What to do with the information generated

• How the different processes relate to one another
Specifically, a materials planner may wonder, "What if my suppliers can't deliver to our requested
quantities and timing?" There are many ways to resolve this issue. One viable option is to delay
the production of some of the items until materials are available, and inform fulfillment planning
about the delay in meeting customer requirements. Another option may be to work with
Procurement to determine if the finished goods could be sourced from another vendor.
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Objectives

• Discuss the purpose, objectives, and benefits of production planning
• Describe the different components of production planning, the business problems it
solves, and the key capabilities production planning offers
• Identify key inputs, constraints, and other considerations for the components of
production planning
• Describe the measurements and metrics for production planning
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Introduction to Production Planning
Overview
Once a company has developed demand and supply plans, it must plan how to manufacture the
product. Production planning (sometimes referred to as factory planning) includes two
components:
• Production Schedule - Determine the resources required (labor and machines) and the
sequence (time frame) of the manufacturing operations. In some cases, the production
schedule specifies the start times for the different items; it is occasionally referred to as
the start plan.
• Materials Plan - Identify the materials needed (raw materials or sub-components) to
meet manufacturing requirements, along with the time and factory floor location where
the material will be needed. This differs in the level of detail from the materials plan
generated during supply planning.
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Production Planning Constraints
Production planning is limited by capacity and materials constraints. For example, a machine can
produce a maximum number of items per hour, or is scheduled to run a set number of times per
week. This differs from supply planning in the level of detail. An example of a supply planning
constraint is the daily production capacity of one line, while an example of a production planning
constraint is the production capacity for one station on the entire manufacturing line. The
production capacity may be stated as either the number of items processed per time unit, or the
processing time required per item.
Similarly, there could be materials constraints that affect production. The materials plan
generated during supply planning considers only key components, while the materials plan
generated during production planning considers all materials required for manufacturing the
products.
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Components of Production Planning
Production planning consists of the following two components:
• Production Scheduling
• Materials Planning
Important Note
Many companies conduct production scheduling simultaneously with materials planning. For
simplicity, however, we have explicitly differentiated between production scheduling and materials
planning. Furthermore, depending on the industry, a company could implement one or both
processes.
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Production Planning in Different Industries
Planning emphasis on the different production planning components can vary by industry. For
example, capacity constraints are very important in the semiconductor industry, while materials
planning is very important in the computer industry.
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Production Planning in Different Industries - Semiconductor
The semiconductor industry is a capacity constrained industry. In addition, very few

manufacturers produce product without orders from their customers. A new factory can cost in
excess of $2 billion. In addition, while wafers are made of sand (a negligible material cost), it may
take several weeks to manufacture a wafer. Thus, manufacturers have limited capacity to satisfy
customer orders, and demand often exceeds supply. Some of the challenges of the
semiconductor industry are:
Maximizing product throughput

Since demand exceeds supply in this industry, maximizing product throughput becomes
extremely important. Companies strive to develop "optimal" production schedules that maximize
machine utilizations and product throughput. Furthermore, because different products are
processed on the same resource (i.e., machine), the resource requires a certain amount of
"changeover" time (e.g., tool changes, cooling down). The amount of changeover time required
depends on what product was just processed and which will be processed next. As a result, the
sequence in which products are processed on resources is also very important.
Inaccurate due date promises

Manufacturers must ensure that they can provide accurate order promise dates to their
customers. Unfortunately, most manufacturers provide promise dates for customer orders based
on predetermined lead-times that do not always reflect reality. With accurate production planning
information (when product will be manufactured), manufacturers can quote more accurate order
due dates to customers.
Industry Sector Production Planning

High-Tech - Semiconductor • Maximize product throughput
o Maximize machine utilization
o Minimize changeover and other "down" times
o Develop "optimal" production schedules
• Ability to quote due dates accurately
The semiconductor industry thus tends to focus on production scheduling.
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Production Planning in Different Industries - Computer
In contrast to the semiconductor industry, the computer industry is not capacity constrained at all,
i.e., there is sufficient capacity to meet all customer demand. However, the profit margins for
computer manufacturers are thin, and customers demand customized configurations. Thus,
ensuring that sufficient material is available (without incurring excessive inventory costs) is very
important in this industry. Challenges in the computer industry include:
High fluctuations in demand

Consumers want new and improved products. As a result, demand often hits a peak very
soon after a new product is introduced and declines rapidly after that. If the company
carries too much material, they could be left holding obsolete inventory.
Increasing customer demand for customized products

Customers want to customize their computer products; this makes it difficult for
manufacturers to forecast demand for end products accurately. At the same time, the
manufacturer must be able to assemble a computer relatively quickly. Hence, they must
plan for material to be available when needed. By creating production schedules quickly
and for short time horizons, manufacturers can communicate with their materials suppliers
to provide material just in time for production.
Industry Production Planning

Sector
Computer • Ability to plan for customized configurations
• Ability to create production schedules quickly
• Ability to create materials plan for a short time horizon and communicate with
suppliers
The computer industry thus tends to focus on materials planning.
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Production Planning in Different Industries - Automotive
The automotive industry is an example in which production scheduling and materials planning are
both very important. Each car requires several thousand parts; therefore, material coordination is
extremely important. At the same time, manufacturers must ensure that assembly lines are
balanced and assembly stations are not over or under-utilized (idle). Some challenges of the
automotive industry are:
Production Flexibility
Every car traveling down an assembly line is different from the preceding or succeeding car.
Despite this, the assembly line must remain in balance to ensure minimal disruptions to
production.
High Number of Parts

Despite the fact that automotive makers use an extremely high number of parts—a typical car
manufacturer uses approximately 1.5 million parts every day—they must ensure that the right
parts with the right quality are available at the right place, at the right time.
Maintaining Inventory
Due to the large number of parts, manufacturers cannot afford to keep a high inventory of each
part. They must therefore minimize their inventory for parts and ensure availability.
Collaboration with Suppliers

To maintain a low inventory of parts, manufacturers must communicate effectively, i.e.,
collaborate, with their suppliers. Manufacturers receive parts just in time for production. To ensure
this, they must share their production schedules with their suppliers. The best manufacturers
provide their suppliers a daily (and sometimes hourly) delivery schedule four to 10 days ahead of
delivery.
Industry Sector Production Planning
Automotive • Balance assembly line

• Coordinate material availability
o Provide a four - 10 day rolling delivery schedule to suppliers
o Collaborate with suppliers
• Maintain low inventory
o Provide a four - 10 day rolling delivery schedule to suppliers
o Collaborate with suppliers
Both production scheduling and materials planning are thus critical in the automotive industry.
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Topic Summary
What is it? Key output

• Production schedule
• Determine how to manufacture the product (i.e.,
what resources will be used, what materials are • Detailed materials plan
required, and in what sequence (and time) the
manufacturing operations will be performed)
Determine what materials will be required to meet
the manufacturing requirements

• Scheduling and sequencing production activities
• Ensure that machines/materials are available for
production when needed • Defining material requirements
• Maximize resource utilization • Communicating purchase order
recommendations to purchasing
• Managing exceptions
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Production Scheduling
A Manufacturing Facility
In a typical organization, a manufacturing facility (factory) is capable of manufacturing multiple

items. The factory also has many resources available for manufacturing products.
Consider a simple factory that is capable of manufacturing three products, Products A, B, and C.
The factory has four machines, Machines M1, M2, M3, and M4. Furthermore, many different raw
materials (RM1, RM2, RM3, and RM4) are required for manufacturing the products. Click on
Product A, Product B, and Product C to view the routes through the manufacturing facility.
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Introduction to Production Scheduling
The master production schedule (MPS) created during supply planning defines what must be
produced in the factory to meet customer demand. The MPS now needs to be converted into a
production schedule that is used to drive manufacturing on the factory floor. The production
schedule will determine the resources required and the sequence in which operations will be
performed on each resource to manufacture the product. The production scheduling process
strives to respect the capacity constraints of each resource and reflect cycle times. This is
inherently a very complex process because planners generate the schedule while considering
dozens of business rules and constraints.
In many cases, a company will have many different products to manufacture and could do so in a
variety of ways. For effective production scheduling, a company must implement key capabilities,
including the ability to:
Schedule production activities

Convert the MPS into a production schedule that specifies the sequence in which the product is
processed on multiple resources, as well as the processing times (or starting and stopping times
of each operation) for each operation. This also includes matching work in process (WIP) and
manufacturing orders (supply/demand match).
Consider different constraints

Two types of constraints are generally considered during production scheduling—capacity
constraints and materials constraints. The production schedule generated must ensure that
sufficient capacity is available on each resource, and that the materials are available when
required.
Evaluate multiple scenarios

Certain orders must be processed, or expedited, through the factory quickly. This may affect the
completion date of other orders. The company must be capable of understanding the impact of
expediting one or more orders on other orders, as well as evaluating multiple production
schedules and their impact on customer order completion dates.
Production schedulers use the production schedule to drive production through the factory shop
floor. They will usually receive a report that specifies the sequence and start times for each item
to be manufactured during a given day or shift. They may also use specialized software to
evaluate multiple scenarios before making a final decision on the production schedule for the day.
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Production Scheduling Stakeholders and Business Issues
We have established the outputs from and the capabilities required for production scheduling.
During production scheduling, companies strive to:
Maximize throughput
The MPS process during supply planning considers high-level capacity constraints and creates a
daily schedule for production scheduling to follow. The goal of the production scheduling process
is to ensure that manufacturers can produce maximum product using available resources.
Maximize resource utilization

Since factory resources are very expensive and require large capital expenditures, a company
must ensure that they utilize such resources effectively to obtain a high return on investment. Idle
resources are resources not fully utilized; in other words, the factory may not be operating to its
optimal capacity.
Minimize changeover times and costs

Many resources can be used for manufacturing multiple products. In many instances, when a
resource is switched from manufacturing one type of product to another, there is some
changeover time and cost. Generally, machines are not usable during changeover periods,
leading to lost capacity. One of the goals during production scheduling is to minimize such
changeover times and costs.
Minimize lateness
Orders scheduled in the factory have a due date, i.e., a date prior to which they must be
completed. In many cases, sufficient capacity and/or materials are not available to meet all due
dates. During the detailed scheduling process, manufacturers strive to minimize late orders.
Minimize earliness
Orders scheduled in the factory have a due date, i.e., a date prior to which they must be
completed. In many cases, sufficient capacity and/or materials are not available to meet all due
dates on the exact date specified, and items may be manufactured ahead of that date. Early
completion means incurring undesirable inventory-carrying costs. During the detailed scheduling
process, manufacturers strive to minimize early orders.
Manufacturing uses the output from the production scheduling process to ensure that machines,
labor, and materials are available when required. Fulfillment may use the production schedule as
an input to determine when transportation is needed to move the product from the factory to the
distribution centers and/or customers. Customer service may use the production plan to
determine whether orders will be met on time or late.
Production scheduling is typically performed for one to seven days, and updated daily. Some
advanced companies update their schedules more frequently, e.g., a high-volume discrete
manufacturer has a four-hour scheduling horizon.
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Key Inputs, Outputs, and Considerations
A key concept related to production scheduling is the concept of production scheduling

algorithms, including:
• Shortest process time

• Earliest due date
• Minimum total manufacturing time
Additional considerations include:
• Business objectives
• Customer prioritization
• Supply prioritization
• Alternate production routes
The figure illustrates the key inputs and outputs for production scheduling.
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Key Outputs - Production Schedule
The production schedule specifies what items are started on which resources at what times. The
schedule considers capacity constraints and manufacturing cycle times while trying to ensure
maximum utilization of resources and maximum throughput of product.
Example
Consider the example of a cookie manufacturer that bakes two types of cookies—chocolate chip
(CC) and peanut butter (PB).
• The CC cookies are baked at 275 degrees F for one hour, and the PB cookies are baked
at 350 degrees F for one hour.
• The company only has one oven in which to bake these cookies.
• If the oven is already set at 275 degrees, it requires another 15 minutes for it to heat up
to 350 degrees, whereas if it has been set at 350 degrees, it takes 45 minutes for it to
cool down to 275 degrees (both of these times are analogous to changeover times).
• Due to the capacity constraints of the oven, the company can bake a maximum of 15 CC
cookies or 10 PB cookies at one time.
• The baker (and hence the oven) works from 7 a.m. to 3:30 p.m.
• According to the Cookie Delivery Schedule, the company needs to produce 30 CC
cookies and 50 PB cookies.
Quantity Due Time

Chocolate Chip 10 10 a.m.
10 12 noon
10 2 p.m.
Peanut Butter 20 11 a.m.
30 4 p.m.
Solution Approach
The following information is required to create a solution:
• Identify the factory resources required - an oven is the only resource that is required.
• Understand the manufacturing process/routes - in this case, the process and the
route is very simple. Put the cookies in the oven at the appropriate temperature and bake
for the required time period.
• Define the raw materials required to make the cookies - the dough for each type of
cookie is premixed.
• Identify the constraints - the constraint for baking cookies is that only one oven is
available from 7 a.m. to 3:30 p.m., and the set-up time to change the temperature from
275 degrees to 350 degrees is 15 minutes, while the set-up time to change the
temperature from 350 degrees to 275 degrees is 45 minutes. The company can bake a
maximum of 15 CC cookies or 10 PB cookies at one time.
• Determine when the items are demanded - the schedule of demand for the cookies is
identified in the problem description.
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Key Outputs - Production Schedule - continued
There are many ways to go about determining a feasible production schedule. One approach is
trial and error—try a sequence of activities and determine if the resulting sequence satisfies all
the constraints. If it does, you have a solution. If it does not, you then must modify some aspect of
the sequence, and try again until you reach a feasible solution.
Determine which of the following sequences provides a feasible production schedule. Be sure to
consider the Cookie Delivery Schedule and Capacity Constraints. Click the button below to
review the schedule and constraints.
Sequence A Sequence B Sequence C

1. Bake 15 Chocolate 1. Bake 15 Chocolate 1. Bake 10 Peanut
Chip Cookies Chip Cookies Butter Cookies
2. Bake 15 Chocolate 2. Heat Oven to 350 2. Cool Oven to 275
Chip Cookies degrees degrees
3. Heat Oven to 350 3. Bake 10 Peanut 3. Bake 15 Chocolate
degrees Butter Cookies Chip Cookies
4. Bake 10 Peanut 4. Bake 10 Peanut 4. Bake 15 Chocolate
Butter Cookies Butter Cookies Chip Cookies
5. Bake 10 Peanut 5. Cool Oven to 275 5. Heat Oven to 350
Butter Cookies degrees degrees
6. Bake 10 Peanut 6. Bake 15 Chocolate 6. Bake 10 Peanut
Butter Cookies Chip Cookies Butter Cookies
7. Bake 10 Peanut 7. Heat Oven to 350 7. Bake 10 Peanut
Butter Cookies degrees Butter Cookies
8. Bake 10 Peanut 8. Bake 10 Peanut 8. Bake 10 Peanut
Butter Cookies Butter Cookies Butter Cookies
9. Bake 10 Peanut 9. Bake 10 Peanut
Butter Cookies Butter Cookies
10. Bake 10 Peanut
Butter Cookies
Schedule and Constraints
Cookie Delivery Schedule Capacity Constraints

Only one oven is available from 7 a.m. to 3:30 p.m. The
Quantity Due Time set-up time to change the temperature from 275 degrees
to 350 degrees is 15 minutes, while the set-up time to
Chocolate Chip 10 10 a.m.
change the temperature from 350 degrees to 275 degrees
10 12 noon is 45 minutes. The company can bake a maximum of 15
10 2 p.m. CC cookies or 10 PB cookies at one time.
Peanut Butter 20 11 a.m.
30 4 p.m.
Production Schedule Solution

way.
In most cases, a product would have to go through multiple resources before it is completely
manufactured. To simplify this example, we considered only one resource.
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Key Concepts - Production Scheduling Algorithms
Generating a production schedule is extremely difficult, especially in cases where the goods must
be processed on multiple machines and can have multiple routes through the manufacturing
facility. Commonly used methods for solving such scheduling problems include:
Shortest Process Time

On a given machine, complete the job that has the shortest process time first, and the job with the
longest process time last. This ensures that short jobs move through the manufacturing facility
more quickly than long jobs. This tends to reduce congestion.
Earliest Due Date

Order jobs according to their due dates, with the earliest due date first and the latest due date
last. This minimizes the maximum lateness of any one job. This approach will also allow the
manufacturer to finish all jobs on time if it is possible to do so.
Minimum Total Manufacturing Time

Minimize the time to complete n jobs through m machines in a manufacturing facility. While this is
a well-known and well-researched problem by practitioners and researchers, obtaining an optimal
solution for this is extremely difficult. One possible heuristic approach is used to schedule jobs
using their latest possible start times (LPST) for each machine, which allows manufacturers to
take into consideration the due dates for the jobs and the manufacturing lead-times. To
accomplish this, planners use a job and its due date, then subtract the manufacturing lead-time
for the last operation (in its manufacturing sequence) to determine its LPST for the last operation.
They continue this process backwards until they determine the start time for the first operation.
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Inputs for Production Scheduling
There are several inputs required for production scheduling. The most common and important
inputs are classified into three types—demand inputs, supply inputs, and static inputs (inputs that
seldom change).
Demand Inputs
Customer Orders
Orders placed by customers and given top priority for scheduling to ensure that due
dates are met.
Manufacturing Orders
Generated during distribution planning and master production scheduling, and used as
the key input for developing the production schedule.
Stock Orders
Requests to increase inventory (demand) at certain locations. Stock orders are not
customer specific, but placed according to inventory location (e.g., distribution centers)
and are not tied to any specific customers.
Supply Inputs
On-hand Inventory
Inventory of materials currently available; this information is used to determine the net
material requirements.
Scheduled Receipts
Inventory of materials that has been shipped and is en route to the appropriate location;
this information is used to determine the net material requirements.
Work in Process (WIP)

Work that has already started and is partially completed. The WIP may be used during
the calculation of net material requirements.
Static Inputs
Run Rates
The rate at which resources manufacture goods, e.g., a machine may be capable of
manufacturing 30 units of Product A per hour, or 20 units of Product B per hour. Its run
rate would then be 30 units per hour for Product A, and 20 units per hour for Product B.
Cycle Times
The time it takes to manufacture an item.
Set-up Times
Some resources may require an initial set-up time before they can become operational
for production. Set-up time is usually defined in units of time, e.g., 30 minutes or two
hours.
Transfer Times
The amount of time required to move product from one factory resource to another. As
product is moved from one resource to another, there may a time lag between the time
the product is finished being processed by one resource and started on the next
way.
resource.
Capacities
The manufacturing capacity of a resource.
Batch Sizes
The number of items that can be simultaneously processed on a resource. There are
numerous resources that can produce many units of a product at the same time. A
conventional oven able to bake several cookies simultaneously is one such example
(e.g., 15 chocolate chip cookies or 10 peanut butter cookies per oven batch).
way.
In developing production schedules, companies may account for additional considerations, such
as:
• Business Objectives - In addition to maximizing product throughput and resource

utilization, a company may consider additional business objectives at this time, e.g.,
minimizing the cost of production, or minimizing the cost of goods sold.
• Customer Prioritization - Some customers are more important than others, and
companies go to great lengths to satisfy this customer base (e.g., meeting delivery dates).
Companies develop production schedules that accomplish this even if it means slippage
in delivery dates to some other customers.
• Supply Prioritization - A company may have multiple sources of supply for certain raw
materials, or sub-assemblies and components, and they will typically specify the primary
source and a secondary source of supply for each of these items. They will use
secondary sources only if the primary source is unable to meet requirements.
• Alternate Production Routes - In many instances, a product can follow more than one
manufacturing route through a factory. In such cases, the company may be able to
specify a primary route and one or more alternate routes. The alternate routes may be
used in cases of insufficient capacity and/or materials.
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Organizational Implications
Currently, many organizations create production schedules manually, e.g., by using spreadsheets,
pegboards, and/or whiteboards. Consequently, they cannot consider all the possible inputs and
constraints. To use and benefit from the production scheduling process, companies must
implement scheduling software that, in turn, leads to fundamental changes in the process,
including:
• Centralized Decisions - Often there is a central schedule coordinator who works with
schedulers from each manufacturing line or factory to coordinate all production schedules
and ensure that the business objectives of the organization are met.
• Team-based Decisions - Decisions made by the schedulers are team-based, preventing
individual schedulers from making isolated decisions.
• Coordinated Decision Support - The schedule coordinator, who provides coordinated
decision support to all schedulers, now coordinates any changes and decisions that must
be made in the production schedules.
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Organizational Implications - continued
Such changes to the production scheduling process also lead to several organizational changes
within the company:
• Decreased Number of Schedulers - The use of advanced software usually leads to a

decrease in the number of schedulers required to create production schedules. In many
cases, it may even lead to centralized scheduling in which schedules for multiple plants
are handled by one scheduler. With increased responsibility for the centralized scheduler,
other associates and planners may interpret it as an increase in power.
• Different Performance Metrics - Measurement of individual performance will likely
change. For example, while in the past a scheduler may have been measured on
resource utilization, they may now be measured on the ability to achieve the goals set
forth in the production schedule.
• Different Skill Requirements - Skill requirements for the scheduler change, e.g., ability
to manage multiple schedules simultaneously, increased analytical capability, and the
ability to manage more complexity. This may lead to retraining or even a new job grade.
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A Production Scheduling Example
We will now consider a complex example by taking into account work in progress (WIP) and
alternate routes.
Example
A company manufactures two products—Product A and Product B. It has three machines—

Machine 1, Machine 2, and Machine 3.
• Product B has only one route—process on Machine 3 for 30 minutes and then on
Machine 2 for 30 minutes
• Product A has two routes; the primary route is to process on Machine 1 for two hours,
and then on Machine 2 for 90 minutes; the alternate route is to process on machine 3 for
three hours, and then on Machine 2 for one hour
• We will assume that there are no materials constraints, set-up times, or changeover
times
• The figure shows the routes
The factory is required to complete five units of Product B today, and four units of Product A
today. The only available WIP today is one unit of Product B that has completed processing on
Machine 3. The machines are available during the hours of 8 a.m. and 4 p.m. The company's
goals are to maximize resource utilization and product throughput.
Solution Approach
The following information is required to create a production schedule.
• Determine the materials required - The problem states that there are no materials
constraints, but in this case there is one WIP unit of Product B.
• Identify the resources required - Machines 1, 2, and 3.
• Understand the manufacturing process/routes - In this case, there is a different route
for each product; there is also an alternate route for Product A.
• Identify the constraints - The constraints for the machines are the times they are
available (8 a.m. to 4 p.m.).
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• Determine when the items are demanded - The schedule of demand for the products is
to complete five units of Product B today, and four units of Product A today.
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A Production Scheduling Example - continued
There are many ways to go about solving this problem. Select the Sample Solution button to
reveal one feasible solution.
Sample Solution
A sample production schedule for each machine and product is shown in the tables (note that we
have used A1, A2, etc., to differentiate between each unit of the product).
Select the Sample Solution Considerations button to reveal how this solution addresses capacity
and materials constraints and achieves production scheduling objectives.
Sample Solution Considerations
Although the problem appears to be relatively simple, the solution procedure is very complex; it
may take several minutes, or sometimes hours, for specialized software to generate a good
solution for the typical company that has several products and resources. For this example, note
the following:
• Only four units of Product B are manufactured on Machine 3 because one unit was
already a WIP and was netted out to determine the net requirements for the day.
• Schedulers consider cycle time for each machine and unit in developing the schedule.
• The capacity constraints are satisfied for each resource.
• One unit of Product A is manufactured on the alternate route because not enough
capacity is available on the primary route.
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• The goal of maximizing factory utilization is met because all the resources are fully
utilized and are not idle at any time.
• The goal of maximizing product throughput is met because after completing the required
number of units for Product A, some additional units of Product A are manufactured, and
they will serve as WIP for the subsequent days.
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Topic Summary

• Detailed production schedule
• How to manufacture the product (i.e., what
resources will be used, and in what sequence (and time)
the manufacturing operations will be performed)
Business problems addressed Key capabilities

• Maximize throughput • Schedule production activities
• Maximize resource utilization • Ability to consider different constraints
• Minimize changeover times and costs • Evaluate multiple scenarios
• Minimize lateness
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Materials Planning
Overview
The materials planning process ensures materials are available at the right time and in the right
factory location to manufacture product. The production schedule is synchronized with the
materials plan and defines the time that each operation on a product is performed, which in turn
defines what materials are needed for operations. The materials plan used during production
planning is therefore more detailed than the materials plan generated during supply planning
(which only defines the day/week on which materials are needed). In contrast, the materials plan
generated during production planning will define the exact time at which the materials are needed
on any given day. Furthermore, the materials plan generated during supply planning considers
only key materials and components, while the materials plan generated during production
planning considers all the required materials.
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Introduction to Materials Planning
The detailed production plan sets forth the time at which product production starts and stops on
each resource. As the product moves from one resource to another, it requires additional
materials. The materials plan lists exactly what material is required for the product at each of the
resources. Many companies conduct materials planning simultaneously with production
scheduling.
The key output of this process is a material requirements plan, which is used to pull materials
from suppliers. The materials plan is thus execution-oriented, just like the production schedule,
and serves to:
Communicate purchase orders to Procurement

Purchase orders serve as the trigger for materials to be moved from the suppliers to the
manufacturing facility.
Generate transfer orders

Transfer orders serve as a signal to move materials from one location to another, e.g., from a
local warehouse to the factory. This is analogous to distribution planning except that this plan is
generated for materials, whereas the distribution plan was generated for finished goods.
Provide suppliers with forward visibility

Such a materials plan usually covers a six to 12 month horizon, with the requirements broken
down into daily buckets, weekly buckets, and monthly buckets. The materials plan that is used to
draw materials from suppliers and warehouses usually has a seven-day horizon.
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Materials Planning - Planning Horizon and Key Capabilities
The materials planning horizon generally depends on the lead-time of materials—longer lead-
time items require a longer planning horizon. A typical company may create their requirements in
daily buckets for two weeks, then weekly buckets for six weeks, and monthly buckets for the
remainder. We will discuss how a company generates requirements for the daily buckets, on
which manufacturers determine what materials to pull from their suppliers. Most organizations
plan for materials based on their daily needs, but some advanced supply chain planning
companies may do so more often.
For effective materials planning, companies must develop key capabilities, including the ability to:
Create a BOM Explosion

The most basic capability for materials planning, a company creates a BOM explosion by taking a
bill of materials (BOM) and decomposing it such that they obtain the total requirements for each
material. They achieve this by netting out inventory-on-hand and expected receipts from demand
(to ensure a supply/demand match).
Consider supplier constraints

Suppliers may have capacity constraints, and a materials plan must be able to consider such
constraints while planning requirements.
Consider lead-time of materials

Generally, there is a lag between the time the company places an order for materials and the time
material becomes available for production; thus, it is imperative that planners consider lead-time
constraints during materials planning.
Manage by exception
No planner can possibly manage each part when there are so many parts included in a plan.
Thus, planners manage by exception—an exception message is created if the supply for a part
does not meet the requirements. The materials planner will then intervene and resolve the
exception.
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Materials Planning - Stakeholders and Business Issues
Procurement is the business function that interacts most closely with materials planning, using
the output from materials planning to purchase materials. They may use the long-term materials
plan to negotiate contracts and terms with suppliers, e.g., establish blanket purchase orders, and
then use the detailed materials plan to pull materials against the blanket purchase orders.
Some of the key business issues that companies attempt to address during materials planning
include the ability to:
• Minimize backorders. If material is not available when needed, the company may have
to backorder the product, and consequently not meet current demand. A goal of materials
planning is to ensure materials are available to minimize backorders.
• Minimize inventory. While a company can always ensure that sufficient material is
available for production by carrying a large inventory, they incur the associated costs of
doing so. Thus, companies try to carry as little inventory as possible while still meeting
requirements.
• Minimize ordering costs. Every time a company places an order for materials, it incurs
some ordering costs (e.g., paperwork and order processing costs). To minimize ordering
costs, a company will strive to place fewer orders, i.e., orders for larger quantities. Thus,
companies constantly grapple with the tradeoff between ordering costs and inventory
costs.
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Key Inputs, Outputs, and Considerations
The bill of materials (BOM) explosion is a key concept related to the materials planning process.
Additional considerations include:
• Part Substitution
• Part Effectivities
o Date Effectivity
o Use-up effectivety
• Advanced BOM
o Planning BOM
o As-build BOM
• Customer Prioritization
• Supply Prioritization
The figure illustrates the key inputs and outputs for materials planning.
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Key Concept - Bill of Materials Explosion
A key concept related to the materials planning process is the bill of materials (BOM) explosion.
Let's look at how a BOM explosion is done.
A company manufactures cookies. Each pack of cookies requires ½ lb of chocolate chips, 2 lbs of
flour, and ½ cup of sugar. Each pound of chocolate chips requires ½ lb of vanilla and ½ lb of
chocolate. Thus, the exploded BOM for a pack of cookies is:
• ½ lb of chocolate chips
• 2 lbs of flour
• ½ cup of sugar
• ½ lb of vanilla and ½ lb of chocolate (required per pound of chocolate chips)
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Key Outputs - Materials Plan
The materials plan will specify what materials are needed on what days for the factory to
manufacture the required product. This requires a complete BOM explosion, as well as
knowledge of current inventory, expected receipts, and expected demand. Some suppliers
require manufacturers to place orders in minimum quantities (e.g., 100) and also in multiples of
lot sizes (e.g., if a lot size is 50, the order sizes are in multiples of 50—50, 100, 150, 200, etc.).
Planners also use these quantities as inputs when developing the materials plan.
Example
The demand for the cookies for each of the next four days is 50, 60, 100, and 80 respectively. By
exploding the BOM, we can determine the quantity needed of each material per day to
manufacture the cookies. This example focuses only on expected demand, and does not
consider beginning inventory or expected receipts.
Materials Plan
Day 1 Day 2 Day 3 Day 4

Cookie Demand 50 60 100 80
Chocolate Chips (in lbs.) 25 30 50 40
Flour (in lbs.) 100 120 200 160
Sugar (in cups) 25 30 50 40
Vanilla 12.5 15 25 20
Chocolate 12.5 15 25 20
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Key Outputs - Materials Plan - continued
Materials plans must take into consideration beginning inventory levels and expected receipts, as
well as expected demand. Consider the case of a yogurt manufacturer that is planning its
materials for days three and four (today is day one).
• For simplicity, assume that they are only planning materials for six-ounce containers, and
that supplier lead-time is two days (so they must place an order today to receive it in time
for day three).
• Also, the supplier specifies a minimum quantity of 75 and lot sizes of 75.
On day three, there are 10 containers in inventory, with expected demand of 205. Based on this
expected demand and existing inventory, the company needs 195 additional containers (i.e., net
material requirements) on day three (as shown below).
Current Material Inventory Position

Product Demand 100 130 205 130
Beginning Inventory 15 65 10
Net Requirements 85 65 195
Expected Receipts 150 75
Because of the lot size restrictions, they cannot order 195 exactly but must order in multiples of
75 (75, 150, 225, etc.). Click on the Materials Plan button to view the adjusted materials plan and
related purchase order recommendations.
Materials Plan

Product Demand 100 130 205 130
Beginning Inventory 15 65 10 30
Net Requirements 85 65 195 100
Expected Receipts 150 75 225 150
Final Inventory 65 10 30 50
Minimum Quantity 75
Lot Size 75
Purchase Order 225 150
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Inputs for Materials Planning
There are several inputs for materials planning that can be classified into three types—demand
inputs, supply inputs, and static inputs (inputs that seldom change).
Demand Inputs
Customer Orders
Customer orders are given top scheduling priority to ensure that due dates are met.
Production Schedule
Daily manufacturing requirements are used to determine the total material requirements.
Master Production Schedule

Longer-term material requirements are derived from the master production schedule.
Demand Plan
Long-term material requirements are derived from the long-range demand plan.
Supply Inputs
On-hand Inventory
Currently available inventory of materials. This information is used to determine the net
Supplier Inventory
Inventory of materials currently available at the suppliers.
Scheduled Receipts
Inventory of materials that has already been shipped and is en route to the appropriate
locations. This information is used to determine the net material requirements.
WIP
Work that has already started and is partially completed. The WIP may be used during the
calculation of net material requirements.
Purchase Orders
Orders placed so that materials will arrive in time for production.
Supplier Capacity Constraints

Supplier capacity constraints for each material they supply.
Static Inputs
Items
Goods planned for production that have bills of materials associated with them.
BOM
Detailed bill of material that is used to explode finished goods requirements into detailed
Supplier Lead-times
The time between placing an order with a supplier and receiving it so that it is available for
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manufacturing.
Minimum Quantities
The minimum quantity in which an order must be placed with a supplier.
Lot Sizes
Multiples in which orders must be placed with suppliers, e.g., if lot size is 75, then the orders
must be in multiples of 75 (75, 150, 225, 300, etc.).
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In developing materials plans, companies may also take into account additional considerations,
such as:
Part Substitution
Use of an alternate part, or substitute part, when a primary part is not available.
Part Effectivities
A company may choose to terminate the usage of one part and use a different part instead; they
can accomplish this in various ways, including:
• Date Effectivity - After a predetermined date, the original part is replaced with a different
part. For example, if the date effectivity of component A is May 16, then component A will
no longer be used after May 16 (even if the company still has existing inventory of
component A).
• Use-up Effectivity - The original part is replaced with a different part after all the current
inventory of the original part is used up. For example, if component A is affected by use-
up effectivity, when the entire current inventory for component A is used up, it will no
longer be used and will be replaced by a different part.
Advanced BOM
There may be many different types of bills of material that could be used for different purposes:
• Planning BOM - A company uses such BOMs during long-range planning. Planning
BOMs usually do not specify each part that is required to build an item, but are limited to
parts (materials) that need to be planned early, e.g., parts with long lead-times.
• As-build BOM - The most detailed level of the BOM; the As-build BOM lists in great
detail every part that is required to manufacture an item, including routing information.
Customer Prioritization
Some customers are more important than others, and companies go to great lengths to satisfy
this customer base, and meet delivery dates, by developing production schedules that
accomplish this even if it means slippage in delivery dates to some other customers.
Supply Prioritization
A company may have multiple sources of supply for certain raw materials, or sub-assemblies and
components, and they will typically specify the primary source and a secondary source of supply
for each of these items. They will use secondary sources only if the primary source is unable to
meet requirements.
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Organizational Implications
Use of the materials planning process usually involves implementation of supply chain planning
software. This leads to several organization changes within the company:
Centralized Planning
Use of an integrated materials planning process usually means that there is one planner who
plans the material requirements globally and communicates those to the suppliers as well as
within the organization. Previously, there may have been several planners/buyers who were each
responsible for materials planning for a product, region, or division. Centralized planning changes
that balance of power and shifts it to the centralized planner. This could also lead to
organizational realignment.
Change in Performance Metrics

Individual performance measurement may change. In the past, for example, a materials planner
may have been measured on meeting material requirements on products for which he was
responsible, or on minimizing inventory levels at the plants for which he was responsible. Now,
the same individual may be measured on his ability to ensure that sufficient material is available
for manufacturing finished goods across the entire network.
Change in Skill Requirements

Skill requirements for the materials planner change. For example, the materials planner now
requires the ability to simultaneously handle multiple parts, regions, and divisions. This skill
requires increased analytical capability and the ability to manage more complexity. This may lead
to retraining or even a new job grade.
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A Materials Planning Example
We will now consider a complex materials planning example by taking into account substitute
parts and date effectivities.
A motorcycle manufacturer has forecasted demand as reflected in the table.
Demand
12-May 13-May 14-May 15-May 16-May 17-May
Number of motorcycles 100 80 80 85 130
Date Effectivity Case Details
The manufacturer uses one gear assembly (GA1) per motorcycle. However, their supplier has
developed a modification for GA1 in which a new assembly (GA2) will replace GA1 effective May
15. The supplier has suggested a lot size of 25 for GA2 (so orders have to be in multiples of 25—
25, 50, 75, 100, etc.). The lot size for GA1 is 35. The motorcycle manufacturer has decided to
carry a safety stock of 15 GA2 to account for possible manufacturing mishaps (on their supplier's
part). The order lead-time is one day for GA1 and two days for GA2.
The manufacturer needs to create a feasible materials plan for GA1 and GA2 from May 12
through May 17.
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A Materials Planning Example - continued
The following is a feasible materials plan for GA1 and GA2 for May 12 through May 17. Due to
the date effectivity on GA1, it will be replaced by GA2 on May 15. GA1 is no longer used after
May 14 even though there are five units still in inventory.

GA1 Beginning Inventory 10 15
Order 105 70
Expected Receipts 105 70
Ending Inventory 15 5
GA2 Beginning Inventory 0 0 15
Order 75 100 125

Expected Receipts 75 100 125
Ending Inventory 0 15 10
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Substitute Parts Case Details
The motorcycle manufacturer also uses fuel injectors (F1); the order lead-time for F1 is one day.
The primary supplier for fuel injectors has the F1 Capacity as shown in the table.
F1 Capacity

F1 Capacity 85 85 85 85 85
Fortunately, there is an alternate part available for F1 (named F2) from the same supplier. If F1 is
unavailable, then F2 can be substituted for F1 (as reflected in the F2 Capacity table).
F2 Capacity

F1 Capacity 85 85 85 85 85
F2 Capacity 15 15 15 15 15
The manufacturer needs to create a material plan for F1 and F2 from May 12 through May 17.
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Considering the availability of F1 and substitute part F2, this solution highlights the materials plan
for F1 and F2 from May 12 through May 17.
F1 Capacity 85 85 85 85 85
F2 Capacity 15 15 15 15 15
F1 Beginning of Inventory 0 0 5 15 15
Order 85 85 85 85 85
Expected Receipts 85 85 85 85 85
Expected Inventory 0 5 15 15
F2 Beginning Inventory 0 0 0 0 15
Order 15 0 15 15
Expected Receipts 15 0 15 15
Ending Inventory 0 0 15 0
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Topic Summary

• Materials plan
• What materials will be required to meet the
manufacturing requirements
Business problems addressed Key capabilities

• Minimize backorders • BOM explosion
• Minimize inventory • Ability to consider supplier constraints
• Minimize ordering costs • Ability to consider lead-time of materials
• Manage by exception
• Communicate purchase orders to purchasing
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Metrics for Production Planning
Overview
Companies monitor the "health" of their supply planning processes using a variety of metrics,
including:
• Metrics to ensure process is being followed

• Metrics used to measure supply chain effectiveness
An organization that implements and uses an effective production planning process can provide
capabilities that, together with effective procurement, manufacturing, and fulfillment functions,
increase shareholder value.
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Production Planning Process Control
The goal of supply chain planning is for individuals within organizations to trust and use the
process-generated plans to minimize the number of manual changes to those plans. This ensures
that an organization can maximize the value of their investment in supply chain initiatives.
Thus, companies use the number of manual overrides as a crucial metric to monitor whether
they have sufficient control of the planning processes. This metric measures the number of
occurrences in which plans have been manually revised, and identifies the level of intervention in
the planning process.
A high level of intervention may indicate that there are process, organizational, or training issues
that need to be resolved.
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Production Planning Effectiveness Oriented Metrics
Companies engage in production planning processes to improve their supply chain effectiveness,
and they can track a variety of effectiveness-oriented metrics, including:
Schedule Adherence
The percentage of time a company adheres to the established schedule during the week (i.e.,
producing the correct items in the right quantity on the day scheduled). Changing production to a
different day (later in week) might result in lost sales since product may not be available when
customers want it. Companies seek to maximize their ability to complete all production in the
correct volumes at the correct times, within the specified week.
Capacity Utilization
The percentage of a factory's capacity utilized during a period. Low capacity utilization suggests
that the company has excess capacity to meet customer requirements, while high capacity
utilization suggests that the company may occasionally not have sufficient capacity to meet
customer requirements. This is reported as a percent of total available capacity.
Inventory Turns
The number of times that inventory turns over during the year. An organizational objective is to
maximize the frequency of inventory turns per year to promote the release of working capital to
the business.
Number of Stock-outs
The number of times a company is out of stock on items ordered by customers. Companies seek
to minimize this number because it correlates to customer service level measurement.
Order Lead-time
The average time it takes a company to deliver an order once the order has been received. This
enables organizations to measure "lead-time to customer delivery" performance against their own
targets as well as other industry benchmarks. Companies seek to minimize the number of days it
takes to deliver the requested quantities to customers once the order has been placed.
Furthermore, customers may have pre-scheduled delivery days that will impact the order delivery
date. Some customers also place orders weeks in advance, which may further distort this metric.
Delivery in Full
The percentage of all orders for which the quantity and lines ordered have been delivered in full,
on first delivery, as a proportion of total orders. This shows how often an order is 100 percent
right upon delivery, and how often a company "misses" (even if the miss is one unit per order).
Companies seek to maximize the proportion of orders that are delivered completely to order
quantity. The percentage of orders delivered in full decreases when product is not available to fill
customer orders or when product is not delivered as per the customer orders.
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Production Planning Influences on Shareholder Value
Companies seek to ensure product availability and high service levels for their customers, while
simultaneously maintaining low inventory levels. Production planning processes seek to ensure
machines and materials are available for production when needed. Furthermore, production
planning processes are used to maximize asset utilization and throughput. This eventually leads
to an increased number of inventory turns and reduced inventory-carrying costs. To maintain low
inventory levels, companies strive to manufacture product as close to the dates needed without
using any manufacturing overtime and without expediting materials from suppliers.
More accurate production schedules and timely materials availability also leads to increased
product availability for customers. This increases service levels to the customers. In addition, it
results in lower costs to fulfill customer orders because fewer customer orders need to be
expedited, and most orders can be shipped accurately and completely. Furthermore, less
expediting also leads to reduced manufacturing and distribution overtime, as well as reduced
FTEs in the supply chain management function.
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Topic Summary
Companies monitor the "health" of their supply chains using a wide variety of metrics. Two such
metrics are metrics to ensure process is followed and metrics to measure supply chain planning
effectiveness. Companies achieve benefits from improved production planning, including
increased schedule adherence, increased capacity utilization, increased number of inventory
turns, reductions in order lead-time, and an increase in orders delivered in full. These benefits
ultimately translate into increased shareholder value.
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A Production Planning Case Study
A cookie manufacturer makes many different types of cookies. It has several bakeries across the
world, but uses some common raw materials for making the cookies, e.g., flour, oats, butter,
chocolate chips, peanut butter, etc. For illustrative purposes, we will look at the production
schedule for one of its bakeries. The bakery bakes two types of cookies—chocolate chip and
peanut butter. The chocolate chip cookies are baked at 275 degrees F for one hour, and the
peanut butter cookies are baked at 350 degrees F for one hour. The bakery only has one oven for
baking cookies. If the oven is already set at 275 degrees, it requires another 15 minutes to heat
up to 350 degrees, whereas if it is at 350 degrees, it takes 45 minutes for it to cool down to 275
degrees (both of these times are analogous to changeover times).
The bakery is constrained by the following: The "due time" for each of type of cookie is
different as shown in the cookie delivery
• A maximum of 1,500 chocolate chip schedule below.
cookies can be baked at one time
• A maximum of 1,000 peanut butter Quality Due Time
cookies can be baked at one time Chocolate Chip 1,000 10 a.m.
1,000 12 noon
• The baker (and hence the oven)
1,000 2 p.m.
only works from 7 a.m. to 3:30 p.m.
Peanut Butter 2,000 11 a.m.
• The company needs to produce 3,000 4 p.m.
3,000 chocolate chip cookies (CC)
and 5,000 peanut butter (PB)
cookies
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A Production Planning Case Study - continued
There are many ways to go about determining a feasible production schedule. One approach is
trial and error—try a sequence of activities and determine if the resulting sequence satisfies all
the constraints. If it does, you have a solution. If it does not, you then must modify some aspect of
the sequence, and try again until you reach a feasible solution.
Determine which of the following sequences provides a feasible production schedule. Be sure to
consider the Cookie Delivery Schedule and Capacity Constraints. Click the button below to
review the schedule and constraints.
Schedule and Constraints
Cookie Delivery Schedule Capacity Constraints
Quality Due Time Only one oven is available from 7 a.m. to 3:30 p.m. The
Chocolate Chip 1,000 10 a.m. set-up time to change the temperature from 275 degrees
to 350 degrees is 15 minutes, while the set-up time to
1,000 12 noon
change the temperature from 350 degrees to 275 degrees
1,000 2 p.m. is 45 minutes. The company can bake a maximum of
Peanut Butter 2,000 11 a.m. 1,500 CC cookies or 1,000 PB cookies at one time.
3,000 4 p.m.
Sequence A Sequence B Sequence C

1. Bake 1,500 Chocolate 1. Bake 1,500 Chocolate 1. Bake 1,000 Peanut
Chip Cookies Chip Cookies Butter Cookies
2. Bake 1,500 Chocolate 2. Heat Oven to 350 2. Cool Oven to 275
Chip Cookies degrees degrees
3. Heat Oven to 350 3. Bake 1,000 Peanut 3. Bake 1,500 Chocolate
degrees Butter Cookies Chip Cookies
4. Bake 1,000 Peanut 4. Bake 1,000 Peanut 4. Bake 1,500 Chocolate
Butter Cookies Butter Cookies Chip Cookies
5. Bake 1,000 Peanut 5. Cool Oven to 275 5. Heat Oven to 350
Butter Cookies degrees degrees
6. Bake 1,000 Peanut 6. Bake 1,500 Chocolate 6. Bake 1,000 Peanut
Butter Cookies Chip Cookies Butter Cookies
7. Bake 1,000 Peanut 7. Heat Oven to 350 7. Bake 1,000 Peanut
Butter Cookies degrees Butter Cookies
8. Bake 1,000 Peanut 8. Bake 1,000 Peanut 8. Bake 1,000 Peanut
Butter Cookies Butter Cookies Butter Cookies
9. Bake 1,000 Peanut 9. Bake 1,000 Peanut
Butter Cookies Butter Cookies
10. Bake 1,000 Peanut
Butter Cookies
Production Schedule Solution
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Global Material Requirements
While there are many materials required for baking the cookies, we will concentrate on flour only.
For each cookie, one gram of flour is required. Thus, the bakery needs 8,000 grams of flour for
the day (to produce a total of 8,000 cookies).
The planner runs the requirements for all the bakeries across the world (assume the company
has bakeries in Asia, Australia, Europe, and North America), and determines the total flour
requirements by region for the next five days. The planner then communicates the requirements
to all the suppliers in each region, as well as internally within the organization.
Day 1 Day 2 Day 3 Day 4 Day 5

Flour Required (in Kg) 32,000 33,000 31,000 35,000 29,000
Asia 6,000 7,000 5,000 7,000 7,000
Australia 8,000 9,000 8,000 7,000 8,000
Europe 8,500 9,000 9,500 9,000 9,000
North America 9,500 8,000 8,500 12,000 5,000
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Change in Forecast
During the day, the planner receives an update on the forecast and notes that the demand for
cookies has increased substantially in Asia from day five onwards (for day 5, the requirements
have changed from 7,000 kg of flour to 10,000 kg of flour). By quickly determining the additional
quantities needed in Asia, the planner updates the material requirements and communicates
them internally, as well as to the supplier.
Day 1 Day 2 Day 3 Day 4 Day 5

Flour Required (in Kg) 32,000 33,000 31,000 35,000 32,000
Asia 6,000 7,000 5,000 7,000 10,000
Australia 8,000 9,000 8,000 7,000 8,000
Europe 8,500 9,000 9,500 9,000 9,000
North America 9,500 8,000 8,500 12,000 5,000
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Resolving Material Availability Exceptions Using Secondary Supplier
Unfortunately, Procurement informs the planner that the supplier has just informed them of a
labor strike in the mill, and will not be able to commit to the additional quantities that are required.
Procurement has contracted with a secondary supplier who will supply the required quantities but
at a slightly higher price. Procurement also informs the planner of the delivery schedule of the
material.
The planner updates this information and generates a revised production schedule for the
bakeries in Asia.
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Resolving Manufacturing Capacity Constraints
To further hinder production, the planner is told that one of the ovens in a bakery in Australia has
broken down and will require at least 24 hours to be repaired. The planner quickly updates this
information and generates a new production schedule for the Australian bakery. Unfortunately,
the bakery does not have sufficient capacity to meet the requirements. However, one of the Asian
bakeries has excess capacity available. The planner then shifts some of the production to the
Asian bakery (while ensuring that enough materials will be available) and generates a revised
production schedule for the affected bakeries.
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Conclusion
Module Summary
Companies plan how to manufacture product during the production planning process. Production
planning is comprised of the production schedule and the materials plan, and is limited by
constraints, including capacity and materials constraints.
Planning emphasis on different production planning components varies by industry. While

production scheduling is very important to the semiconductor industry, materials planning is
critical in the computer industry. The production scheduling process is used by companies to
drive production on the factory floor. A detailed production schedule determines the resources
required (labor and machines) and the sequence (time frame) of the manufacturing operations.
Planners must consider capacity and materials constraints as well as alternate product routes,
and customer and supply prioritization. The goal is to minimize late (or early) orders, and
maximize throughput and utilization of factory resources while balancing the load on that resource.
The materials plan developed during materials planning is a detailed schedule that defines the
exact time at which materials are needed on any given day. Planners consider supplier
constraints, along with part substitutions, part effectivities, and customer and supply prioritizations.
The goal is to minimize backorders, inventory, and ordering costs during materials planning.
Organizational implications of production planning include centralized, team-based decisions, as

well as a change in performance metrics and an increase in job complexity for the planning role.
Companies use metrics to ensure the process is followed and to measure production planning
effectiveness. The benefits of production planning ultimately translate into increased shareholder
value.
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Supply Chain Planning: Finding the Right Model
Introduction
Overview
A supply chain planning (SCP) model serves as an internal market mechanism or process for
companies. Its purpose is to match supply and demand, and align the entire organization around
key operational plans that drive success and profitability given the demand for their products in
the marketplace.
In a competitive market, customers have many options to satisfy their demand for a product.
Companies must therefore anticipate that demand and provide products to customers on a timely
basis and at a marketable price. They do this by managing the functions and activities in the
supply chain.
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Benefits of a Supply Chain Planning Model
Companies that define and implement an effective SCP model realize tangible economic and
qualitative benefits.
• Economic Benefits
o Increased asset utilization, e.g., raw material, work in progress (WIP), and
finished goods inventory
o Lower operating expense, e.g., fewer expedited shipments and less manual
effort
o Improved margin, e.g., right product, right place, and right time
• Qualitative Benefits
o Improved customer service, e.g., increased fill rates and on-time delivery
o Improved competitive advantage
o Lower cross-functional and organizational friction
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Objectives
• Define a supply chain planning (SCP) model

• Discuss why it is important for companies to have the "right" model in place
• Discuss how various factors (i.e., business model, manufacturing class, manufacturing
operating model, procurement operating model, and fulfillment operating model) influence
a company's SCP model
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Supply Chain Planning Model
Overview
A supply chain planning (SCP) model is comprised of process, technology, and organizational
assets. Companies use these assets to intelligently commit, build, and deploy a company's
physical assets (e.g., supply, manufacturing capacity, and labor) to meet the market demand for a
product over time, and in the most profitable manner possible.
SCP helps ensure that product is available to meet the customer's desired quantity and date. In
other words, it is the process of balancing available supply against demand. Companies
accomplish this by understanding and predicting customer demand, and then fulfilling it with the
most efficient allocation of available inventory and production capacity.
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Supply Chain Planning Functional Areas
Supply chain planning allows companies to manage their supply chains by connecting the
functions in the supply chain via a set of plans and processes. Companies use SCP capabilities
to plan and integrate the supply chain functions at the execution, operational, and strategic levels.
Supply chain functions include:
• Procurement - buying materials to support the manufacturing process

• Manufacturing - making the product
• Fulfillment - managing the activities involved in delivering the product, i.e., moving and
storing
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Supply Chain Planning Processes
SCP capabilities are grouped into four main planning processes—demand, supply, production,
and fulfillment planning. Click on the "Output" button to see process outputs.
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Factors that Influence SCP Models
Business characteristics that influence a company's SCP model include:
Business Model
A business model describes in simple terms why a company exists and how it makes money. The
business model identifies the product a company makes, the customers they serve, and the unique
aspect(s) of the business that enable the company to create value and generate income.
Manufacturing Class
A company's manufacturing process usually differs based on the type of products they
manufacture. Manufacturers are classified into three main classes—repetitive, discrete, and
process.
Supply Chain Operating Models

Supply chain operating models explain the details of how a company manages its assets to execute
against the business model strategy. These operating models act as a set of rules under which a
company operates, and are defined within the context of the key functional areas across a
company's supply chain—manufacturing, procurement, and fulfillment.
The SCP model for a company is also influenced by the degree of integration between each
supply chain functional area. Most supply chains are owned "piece-meal" (not "end-to-end"), with
one executive responsible for each functional area—procurement, manufacturing, fulfillment, and
so on. To achieve the potential benefits of an effective supply chain, companies must develop
truly integrated supply chain planning capabilities. To that end, the different functional areas must
share with one another their operating decisions as well as their SCP models.
Companies within a particular industry segment generally have common demand and supply
characteristics, as well as operating constraints. The unique characteristics of a particular
industry cause companies within that industry to have similar business model and supply chain
operating model characteristics. These common characteristics also drive similar SCP models
from company to company within an industry.
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Check Your Understanding
Indicate whether each of the following statements is true or false.
True False
An SCP model is comprised of process, technology, and
organizational assets.
Manufacturers can be classified into three main

classes—repetitive, discrete, and process.
Supply chain operating models explain the details about
how a company executes its financial and marketing
strategies.
way.
Topic Summary
A supply chain planning (SCP) model, comprised of process, technology, and organizational
assets, is used to intelligently commit, build, and deploy a company's physical assets (e.g.,
supply, manufacturing capacity, and labor) to meet the market demand for a product over time,
and in the most profitable manner possible. Supply chain planning allows companies to plan and
integrate their supply chain functions at the execution, operational, and strategic levels.
A company's SCP model may be influenced by their business characteristics, including their:
• Business model
• Manufacturing class
• Supply chain operating models
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Business Model Influences
Overview
A business model describes in simple terms why a company exists and how it makes money. The
business model identifies the product the company makes, the customers they serve, and the
unique aspect(s) of the business that enable the company to create value and generate income.
It could be with a new type of product (such as a wireless cell phone or a laser disc), a new way
of selling or distributing old products (such as online retailing), or a new twist on new or old
products, sales and marketing techniques, and distribution strategies.
The bottom line is that a business model answers several key strategic questions about a
company:1
• What is the product or service provided?

• Where is the product in its life cycle, e.g., early growth, maturity, or decline?
• Who is the customer?
• What does the customer value?
• What is the underlying economic logic that explains how a company can deliver value to
customers at an appropriate cost?
It is critical for every company to define its business model as they address strategic and tactical
issues concerning their business, including which SCP models they ultimately use.
1
Magretta, Joan. "Why Business Models Matter." Harvard Business Review (May 2002): 86-92.
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Business Model Example
Amazon.com is a well-known example of a new twist on the old business model concept of
retailing.2 The online retailer began with the simple premise to sell books directly to consumers
while minimizing the distribution assets it owned. The idea was to capture consumer demand
while simultaneously building relationships with book publishers to gain favorable wholesale
prices based on large volumes. Amazon would then mark up the product, receive an order, and
have a carrier ship it directly to consumers.
Amazon.com has since grown to carry most consumer durable products. And, while they have
acquired some of their own distribution assets to maintain appropriate service levels, the
business model (illustrated in the responses to the key strategic questions below) remains
essentially the same.
Key Strategic Questions Amazon.com Business Model
What is the product or service provided? Books, printed materials, and other consumer durable
products
Where is the product in its life cycle? Products vary in their marketplace maturity, e.g., for books,
the product ranges from new releases to "classics"
Who is the customer? Consumers on the Internet
What does the customer value? Selection, convenience, and home delivery at a reasonable
price
What is the underlying economic logic? Drive scale/volume over time with a lower fixed-asset base
Aggregate demand to command low wholesale prices and
have a lower break-even point because they have fewer assets in
place
2
Spector, Robert. Amazon.com: Get Big Fast. New York: HarperCollins, 2002.
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Business Model and SCP Model Alignment
It is critical that a company's SCP model supports its business model. If it does not, two things
can happen:
1. The SCP model can fail because the investment required to build the model does not see
an adequate return.
2. The business model can fail because it requires changes, along with the planning model,
to be viable over the long term.
Decision makers must be keenly aware of this dynamic as they strive to ensure alignment and
consistency between the two models—business and supply chain planning.
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Indicate which of the questions below are answered by a company's business model. Check all
that apply.
Answered by a company's
business model
What is the product or service provided?
Who is the customer?
Who are the suppliers?
What is the underlying economic logic that explains how a company can
deliver value to customers at an appropriate cost?
None of the above
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Business Model Influence on SCP Model
The influence a company's business model has on the SCP model varies from case to case.
Decision makers must consider the basic characteristics of their company's business model and
how those characteristics impact the supply chain.
Specifically, they must consider the following:
• Influence of customer and customer values on the SCP model

• Influence of product mix and product life cycle on the SCP model
• Influence of underlying economic strategies on the SCP model
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Influence of Customer on SCP Model
Supply chain planners analyze and react to customer needs based on who they are and what
they value, including:
Customer Size
Large customers with many locations may be interested in collaborating on demand and
promotion planning to better enable their own production and distribution processes. A large
customer may want to replenish or place orders on a daily basis to own less inventory and ensure
appropriate in stock positions. In addition, they may require visibility to the status of their orders,
as well as receipt of product at a regional distribution center.
On the other hand, a small company will likely want to place orders and replenish stock monthly,
with a focus on customer service and minimal activity related to restocking. They may also prefer
to have the product delivered directly to their stores rather than a regional distribution center. A
supplier dealing with both large and small customer groups must consider their different needs
when determining the appropriate supply chain planning models to use.
Service Level Expectation

Different customers may have different service level expectations that may influence the SCP
model. For example, an automotive company places significant value on receiving the product
just prior to needing it for production so they don't have to carry excess inventory. This dictates a
certain service level provided by suppliers, which in turn drives safety stock and inventory
deployment decisions.
Price Sensitivity
A customer that values low product cost usually requires minimum quantities for orders (to ensure
that a full truckload can be shipped to the customer), as well as a minimum lead-time. Companies
take these factors into account when planning for the supply and fulfillment of orders from such
customers.
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Influence of Customer on SCP Model - Customer Segmentation
Customer service involves balancing customer needs against profitability. This includes
assessing trade-offs and creating an optimal balance between meeting customer demands or
service levels, and incurring the costs associated with doing so.
Customer segmentation or prioritization is the process of segmenting customers based on

their strategic value and profitability, and establishing service guidelines accordingly. Customer
segments could include:
• Strategic Customer Segment - comprised of high-volume, high-profit level customers

that a company does not want to lose to competitors.
• Growth Segment - comprised of up-and-coming customers that have the potential to
become strategic customers in the future.
• Low Profitability Customer Segment - account for a small percentage of the company's
business. While they may be good for brand awareness, they do not warrant costly
service levels.
Because a company may choose to segment their customers into different groups and provide
each group with the different levels of service, they may not be able to use the same SCP model
for each segment. Hence, planners must take into account the various segments and service
levels when determining the SCP strategies for the company.
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Influence of Product on SCP Model
Product characteristics also affect the SCP model, including:
• Product Mix - A company that produces the same products over and over again may
require specialized manufacturing capability. Furthermore, their objective during
production planning would be to ensure material availability and maximize capacity
throughput. On the other hand, a company that produces unique and complex products
requires significant manufacturing flexibility to manufacture the products.
• Product Life Cycle Considerations - The life cycle of the product is an important
consideration in determining the appropriate SCP model. For a new product introduction,
planners do not have historical data on which to base demand projections. They must be
able to forecast the demand for such products using historical profiles of one or more
similar or "like" products, and possibly even combine the profiles of such products. In this
case, the supply planning model must be able to quickly react to variations in the forecast.
For mature markets and products, on the other hand, planners use the historical demand
pattern to statistically forecast future demand, and develop the appropriate safety stock
and inventory policies.
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Influence of Underlying Economic Strategy on SCP Model
The underlying economic strategy of a company also influences the SCP model.
Consider the impact of Amazon's strategy of driving scale and volume over time with a lower
fixed asset base. The company does not actually manufacture the products it sells, and may not
carry some of the products in its inventory. As a result, it must tightly integrate itself with its
suppliers' information base to meet customer requirements. It would be bad business for
Amazon to promise to ship a book in two days when the book is actually out of print and not
available through any of their suppliers.
Conversely, a company such as Wal-Mart has invested heavily in its distribution system. Their
supply chain model3 requires that product demand at their stores be fulfilled through this
distribution system (exceptions to this rule exist, but we will not discuss them here). In this
situation, it is important for the company to plan their safety stock levels, inventory policies,
and transportation to optimize the cost of their entire network.
3
Walton, Sam, with Huey, John. Made in America: My Story. New York: Doubleday Books, 2000.
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SCP Model Influence on Business Model
There is a symbiotic relationship between business models and SCP capabilities. Supply chain
strategies or capabilities often drive and influence the business model. A good business model is
often anchored around a carefully designed customer channel and supply chain strategy that
leverages a company's SCP and execution capabilities to gain advantage in its marketplace.
Dell and Wal-Mart are recognized for creating a competitive advantage through their respective
supply chain advancements.4 Both companies have invested in supply chain assets to enable,
and then create, unique and effective business models that are increasingly difficult for
competitors to replicate or compete against.
In fact, it is often difficult to delineate where a good business model ends and where a supply
chain strategy or unique capability begins. What matters is that the business model works, drives
value, and allows a company to effectively compete in whatever they do.
Example
4
Copacino, William C., and Byrnes, Jonathan L. "How to Become a Supply Chain Master." Supply Chain Management
Review (Sept/Oct 2001): 24-32.
A less publicized, but equally relevant example of this symbiotic phenomenon is Scholastic5, the
world's leading publisher and distributor of children's books. They combine a diverse set of titles,
from Clifford the Big Red DogTM to the market darling Harry PotterTM, with a unique business
model and innovative supply chain capabilities.
Scholastic has invested heavily in high-volume fulfillment capabilities that allow them to target
and dominate the direct-to-classroom book club business in the United States. In this case, who
their customers are is really influenced by what Scholastic can do from a supply chain
perspective. Without their fulfillment capabilities, they might not have the direct-to-classroom
customers.
5
Mulani, Narendra P., and Lee, Hau. "New Business Models for Supply Chain Excellence." Achieving Supply Chain
Excellence Through Technology (ASCET), Volume 4. San Francisco: Montgomery Research, May 2002, www.ascet.com.
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Influence of Technology Advancement on Business and SCP Models
The advancement of technology influences the dynamic between business models and key SCP
capabilities.
Despite the collapse of many Internet-based businesses, the promise of an Internet-based

network economy has driven numerous technology advancements. Technology will continue to
fundamentally shift how people and companies exchange information and work together to
conduct business.
As companies strive for productivity improvements and innovation, new business models and
supply chain capabilities will depend on information sharing and low cost networking capabilities.
Businesses will interact differently with customers, suppliers, and employees. New software
packages will also continue to leverage this underlying technology, influencing how companies do
business and how they choose to compete.
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True False
Business models are stories of how companies
were initially capitalized.
A good business model describes the underlying

economics of a business.
A company with "early stage products" relies on
its historical data to forecast demand.
The Internet and other types of technology have

little influence on business models.
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Topic Summary
A good business model answers key strategic questions about a company, telling us who their
customers are and what they value, and how the company makes money. A business model
often influences the choice of an SCP model. At the same time, supply chain planning and
execution capabilities can also influence business models. Finally, technology plays a major role
in influencing business models and supply chain capabilities.
Business Model: Key Influence on the Supply Chain Business Model

Strategic Questions
What is the product or Production Planning
service provided?
A company that produces the same products over and over must have
manufacturing capabilities that focus on materials planning and resource utilization
A company that produces unique and complex products may need to have
manufacturing capabilities that can quickly adjust to changes
Where is the product in its Demand and Supply Planning

life cycle?
New products that don't have a market history require various modeling
techniques to estimate their demand and to set initial supply levels
More mature products rely on history to drive statistical demand plans
Who is the customer? Demand Planning
Larger, strategic customers are candidates for collaborative demand planning
Supply and Fulfillment Planning
Larger customers receive products in regional distribution centers, while

smaller customers may need store or factory location delivery
Customer segmentation and prioritization may lead to multiple SCP models,
with more costly service levels provided to the most strategic customers
Production Planning
Larger customers may need visibility into order status and shared production
plans
What does the customer Supply and Fulfillment Planning

value?
Need for speed of delivery drives service levels as well as inventory

deployment and safety stock settings
Need for low cost drives minimum order quantities and lead-times
What is the underlying Supply and Fulfillment Planning

economic logic?
A company such as Amazon.com must be tightly integrated with suppliers to

plan supply and deployment to meet customer needs
A company such as Wal-Mart must optimize the cost of inventory, safety stock,
transportation, etc., for its entire network
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Manufacturing Class Influence
Overview
A company's manufacturing processes usually differ based on the type of products they
manufacture. Furthermore, the processes used to create a company's finished goods influence
the design of the SCP model. Companies generally fall into one of three manufacturing classes.
SC Manufacturing Manufacturing Class Definition

Class
Discrete Product uniquely manufactured, requiring resources capable of being
retooled to work on different products (e.g., aircraft manufacturer)
Repetitive Production lines repeatedly manufacture a product from the same product
family (e.g., automobiles)
Process Large batches of product produced simultaneously (e.g., wine and beer)
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Manufacturing Class - Discrete
In discrete manufacturing, each manufactured item is different from the previous one, requiring
customized machinery and specialized tools. Manufacturing resources are capable of working on
different products at different times; for example, a lathe machine may be used to make an auto
transmission axel at one time, and a long cylindrical steel bar at another. Given that each item is
unique, it does not make sense to forecast the demand for each. Thus, companies forecast
requirements for raw materials, semi-finished goods, and sub-assemblies.
Emphasis in discrete manufacturing is placed on the production planning process. Each item may
have multiple alternative routes through the production facility. Thus, during the planning process,
companies must ensure the availability of resources, materials, and labor, while at the same time
considering alternate routes for the product. In addition, companies must minimize production
lead-time. The goal of production planning in this environment is to maximize throughput
(produce the maximum amount of product given a limited set of resources), as well as resource
utilization (keep the resources working and minimize down times).
Once the goods have been manufactured, they must be shipped and distributed to the customers
at the lowest possible cost.
Manufacturing Demand Planning Supply Planning Production Planning

Class
Discrete Forecast for Raw Schedule production facility to maximize
raw materials, material inventory throughput
semi-finished planning Schedule production to minimize
goods, and sub- Minimize production lead-time
assemblies distribution lead- Schedule production to maximize
times and costs utilization of resources
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Manufacturing Class - Repetitive
In repetitive manufacturing, a company repeatedly produces the same item on a manufacturing

line. For instance, the same family of motorcycles or cars is produced on the same motorcycle or
automotive assembly line, e.g., an automotive plant assembly line produces different versions of
the same car model, another plant produces different versions of a different model, and so on.
It is important for such manufacturers to continuously operate their assembly lines. There are also
a limited number of "slots" on an assembly line; if an assembly line has 150 slots during a shift,
the assembly line can produce 150 items during that shift, and items are slotted on the line to
ensure that the line is balanced. Furthermore, the amount of time needed to complete the
operations at each station is approximately equal. Planners must ensure that items are scheduled
such that the line is always balanced.
Once the items are off the line, the manufacturer sends them to the locations where they will be
sold, i.e., car dealers. During distribution planning, companies decide on the modes of
transportation that minimize costs and lead-times. When doing so, the manufacturer must also
ensure that transportation is available when needed, taking into consideration the number of
stops, and the number of truckloads to ensure minimal unloading and reloading.

Class
Repetitive Forecast the Distribution planning to Schedule lines to
number of items by type ensure: ensure balance
o Minimum
transportation lead-times
o Minimum total
distance traveled
o Minimum total travel
times
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Manufacturing Class - Process
Process manufacturing is a capital-intensive process due to large and expensive machinery

(e.g. wine vats, oil refineries), and high stopping and starting costs. Producers would rather run a
machine continuously at any given capacity than stop production to ensure 100 percent capacity
or to avoid build up of finished goods inventory.
The paper industry is an example of this class of manufacturing. There are essentially two steps
to the production process. The first step is to convert the trees into paper. The second step is to
take the paper, print on it, cut it to the right shape and size, and then use it (e.g., by sticking it
onto a juice carton). Not only is the capital investment in the machines large, the stopping and
restarting costs are very high as well. Hence, manufacturers want to continuously operate the
machines, which means that raw material must be available to do so. Forecasting the demand for
the end paper products, however, is not as crucial.
Deciding what shape and size to cut the paper is not simple either. Paper manufacturers model
this problem using various operations research techniques to determine the optimal "cuts" for the
paper. The manufacturers then need to determine the best way to distribute and ship the product
to their customers.

Class
Process Forecast Ensure raw material availability at all Maximize
demand for the final times machine utilization
product Determine optimal product mix to be Minimize
produced stopping and
Distribution plan to ensure: restarting
o Product availability
o Minimum transportation
lead-times
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Topic Summary
A manufacturer plans for the use of materials and resources depending on its manufacturing
class. Manufacturing classes influence the SCP model in different ways.
Functional Area SC Operating Model Influence on SC Planning Model

Manufacturing Discrete Heavy reliance on an accurate forecast for raw
Class (Product uniquely materials, semi-finished goods, and sub-assemblies
manufactured)
Heavy emphasis on supply planning to make sure
required material is available to meet production plan
Heavy emphasis on reducing production lead-
times/ensuring flexible schedule
Repetitive Some reliance on demand forecast and inventory

(Product mass produced on planning
production line)
Heavy emphasis on maximizing production capacity
and determining the right production sequencing
Process Some reliance on demand forecast and inventory

(Large batches of product planning
simultaneously produced)
More reliance on continuous production and
avoiding costly starting and stopping of the process
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Manufacturing Model Influence
Overview
Manufacturing operating models determine the way in which a company plans and produces their
finished goods inventory. The major differentiation between the four primary manufacturing
operating models is whether the manufacturer builds a product to stock or waits for a more
specific demand signal to complete the product.
The primary manufacturing operating models include:
Functional Area SC Operating Model Operating Model Description

Manufacturing Make to Stock Product produced prior to orders
Make to Order Product produced after order received
Configure to Order Build base product, then build add-ons after order
Engineer to Order Design product with customer, produce after order
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Manufacturing Operating Models - Make to Stock (MTS)
A make to stock (MTS) manufacturer produces product in advance of receiving customer orders,
and then stores inventory at its warehouses. When an order then comes into the order
management system, they locate product at a preferred distribution center for shipment to a
customer. During demand planning, MTS organizations rely heavily on forecasting and inventory
planning.
Example
An example of an MTS company would be a canned food producer. There are a limited number
of months in the year in which food products are canned; yet the company must project demand
and ensure availability of product on grocery store shelves for the entire season. Lack of product
on the shelves translates directly to lost customer sales. Click the example button to see an
illustration of how goods flow through the supply chain of an MTS canned food producer.
Example
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Influence of the MTS Model on SCP Model
An MTS company must forecast demand for their products and then ensure availability of the
product when customers demand it. Companies in this environment consider several important
factors, including:
Forecasting Customer Demand

Forecasting customer demand is critical; under-forecasting translates to lost sales while over-
forecasting means that product could sit on the shelf and perish. To avoid this, companies
typically use advanced statistical techniques to forecast customer demand. Statistical techniques
are most useful where historical data is a good predictor of the future, and where demand trends
(due to variables such as seasonality, temperature variations, etc.) are apparent.
Distribution of Product
Distribution of the product is also crucial. Even if companies forecast demand accurately, they
must still ensure availability of the product at the locations where customers want it. To develop
optimal distribution plans, planners need to understand the demand pattern and set optimal
inventory and safety stock targets, which assist in managing demand fluctuations.
Product Allocation
Allocating product to important customers plays an important role in this environment. Typically,
long-term agreements are established with such customers. Failure to honor these commitments
carries a financial penalty.
Scheduling Production Facilities

Scheduling production facilities is key to maximizing throughput and resource utilization. After
forecasting the demand for the product, companies have a very good idea about what, when, and
how much must be produced.
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MTS Summary
The make to stock manufacturing model influences the SCP model in all supply chain planning
areas.

Operating
Model
MTS Forecast product sales Develop optimal Schedule production
o Use distribution and sourcing facility for maximizing
statistical models plans throughput and utilization
o Use Maintain and manage
historical sales inventory targets
o Use Manage safety stock
extraneous factors, e.g., levels
seasonality, economic
Allocate supply
conditions, competitor
capacity to largest and most
information
important customers
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Manufacturing Operating Models - Make to Order (MTO)
A make to order (MTO) company manufactures products only when an order is placed, keeping
little, if any, inventory on hand in a warehouse, and placing less emphasis on finished goods
inventory planning. However, because they rely on available resource capacity when an order is
placed, they must perform advanced production and capacity planning.
Example
An example of an MTO industry is aircraft manufacturing. An aircraft manufacturer produces

aircrafts for a particular airline after receiving a commitment from the customer for a certain
number of airplanes.
The figure illustrates the flow of goods through the supply chain of an MTO aircraft manufacturer.
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Influence of the MTO Model on SCP Model
An MTO company receives an order before starting the manufacturing process (e.g., an aircraft
manufacturer). Every airplane ordered is customized and made to order. Companies in this
environment consider several important factors, including:
Forecasting total dollar sales

Knowing customer demand for finished goods is not as important in the MTO environment as in
the MTS environment. A manufacturer of heavy customized machinery or airplanes would have
difficulty forecasting what, when, and how many specific machines or airplanes they might sell.
However, they could probably accurately forecast dollar sales, as well as the raw material
needed to manufacture each of these customized machines.
Forecasting long-term raw

material requirements
Companies could use information based on historical sales, marketing plans, and sales
relationships with clients to establish a long-term plan for raw materials to provide visibility to
their suppliers. Although planning for raw materials is usually conducted during supply
planning, companies sometimes plan for raw materials (and semi-finished goods and
components) during demand planning. This is especially true in cases where they cannot
forecast finished goods accurately, but can more accurately forecast raw materials or semi-
finished goods.
Ensuring material availability to start production quickly

The manufacturer waits for an order before beginning production. Therefore, they need
materials available to start production quickly, manufacture the product at the fastest rate
possible, and ensure rapid delivery times to customers. Once a customer order has been
received, companies strive to meet order delivery commitments to their customers at the lowest
possible cost (including transportation).
way.
MTO Summary
The make to order manufacturing model influences the SCP model in all supply chain planning
areas.

Operating
Model
MTO Forecast raw material Ensure material Schedule production
requirements, not finished availability (critical) facility for maximum speed
product Develop strategic through the facility—minimize
Forecast dollar sales materials plans based on production lead-time,
historical orders and changeover times, and costs
marketing insights
Plan for efficient
delivery to customer—
minimize transportation costs
and transportation lead-time
way.
Manufacturing Operating Models - Configure to Order (CTO)
A configure to order (CTO) manufacturer offers a base product with a variety of options, or
configurations, that can be added when they receive customer orders. The production of a PC is
a good example of such an environment; customers can customize their personal computer by
specifying the RAM, hard disk size, size of monitor, etc. Since there are many possible
configurations of a product, the manufacturer waits for an actual order before configuring the
finished good.
Example
The classic example of a configure to order company is Dell Computers. Dell pre-assembles a
base model computer and then adds the components upon receiving a customer order. Dell relies
on a crucial link between their order management systems and their manufacturing sites to serve
customers. Advanced supply and materials planning that reduces the lead-times of component
parts assists in quick turnaround times of finished products to customers.6
6
way.
Influence of the CTO Model on SCP Model
The CTO manufacturing model is mostly used when there are a few critical components that
need to be put together based on a specific configuration of those components as desired by the
customer. Companies consider several important factors in a CTO environment, including:
• Forecasting Individual Component Requirements - There may be so many possible

configurations of the product that it makes sense for the manufacturer to wait for an
actual order before configuring the final product. The manufacturer does not forecast the
sales of each individual configuration, but instead forecasts the requirements of each
component.
• Efficient Production - Once the manufacturer receives an order, they must configure the
product quickly and efficiently, and ensure that the product is delivered when desired by
the customer at the lowest possible cost.
• Material Availability - Note that CTO and MTO are quite similar. The major distinction
between the two is that for the CTO, the manufacturer must ensure the availability of
components and sub-assemblies (the manufacturer may choose to manufacture or
purchase the components), while in the case of the MTO, the manufacturer must ensure
availability of raw material to begin production as soon as an order is received.
way.
CTO Summary
The configure to order manufacturing model influences the SCP model in all supply chain
planning areas.

Operating Model
CTO Forecast Ensure component Schedule production
component and sub- availability facility for maximum speed
assembly Plan for efficient through the facility—minimize
requirements production and delivery to production lead-time
Forecast dollar customer—minimize
sales transportation costs and
transportation lead-time
way.
Manufacturing Operating Models - Engineer to Order (ETO)
An engineer to order (ETO) environment is one in which a manufacturer works with the
customer to design or engineer a product before it is produced. Similar to CTO, there are many
possible configurations of a product in this environment, all driven from customer orders. The
manufacturer must wait for the order before producing the finished good. This model emphasizes
production planning, customer collaboration, and research and development.
Example
An example of an ETO company is a semiconductor manufacturer that designs and creates

products based solely on the specifications of their customers. Another example would be a
defense contractor for high-tech goods, spacecrafts, or other defense equipment. Such
companies engineer the product required by the Department of Defense (DOD) based on the
specific engineering requirements set forth by them.
way.
Influence of the ETO Model on SCP Model
The ETO manufacturing model is mostly used when customer specifications are unique and each
product needs to be designed and engineered specifically for the customer. Companies consider
several important factors in an ETO environment, including:
• Limited Production Capacity - Companies usually invest in limited production capacity

because actual demand is more uncertain; there is more risk and they hold back capital
to maximize their return. Many times the capital equipment required for manufacturing is
not known prior to the order, and may even have to be custom ordered and manufactured.
• Capacity and Resource Utilization - Much of the capital equipment used in this industry
is generally quite flexible and can be adapted for use for different products. However, due
to limited available capacity, companies need to allocate the capacity on their machines
to orders and continuously monitor capacity and resource utilization.
• Collaborative Forecasting - The manufacturing organization must rely on the forecast of
their customers in planning the materials for the final products, and is therefore very
dependent on customer orders for the specialized product to determine material
requirements. However, many of the required materials may have long lead-times, and
thus the manufacturers must collaborate closely with their customers to forecast demand
accurately. Customer collaboration is key in this type of industry.
way.
ETO Summary
The engineer to order manufacturing model influences the SCP Model in all supply chain
planning areas.

Operating
Model
ETO Strong emphasis on Supply planning tightly High emphasis on
collaboration to determine coupled and integrated with capacity planning and
specifications and help demand planning or customer utilization
forecast material and order requirements
production requirements
way.
Topic Summary
Functional SC Operating Model Influence on SC Planning Model

Area
Manufacturing Make to Stock Heavy reliance on accurate demand forecast and
(Product produced prior to inventory planning to mitigate finished goods inventory risk
orders)
Make to Order Little reliance on demand forecast and inventory planning

(Product produced after order
Heavy reliance on production and capacity planning to
received)
make sure orders can be built when placed
Configure to Order Some reliance on base model forecasts and inventory

(Build base product, then build planning
add-ons after order)
Heavy emphasis placed on supply planning for add-on
components to ensure build-outs can occur on demand
Engineer to Order Heavy emphasis placed on production and capacity

(Design product with customer, planning, as well as customer collaboration capability
produce after order)
way.
Procurement Model Influence
Overview
Procurement operating models determine the way in which a company interacts with its suppliers.
In recent years, the procurement mindset of even the largest, most powerful buyers, such as the
automotive industry, has shifted from the traditional adversarial cost-reduction procurement
mindset, to a more collaborative model designed to reduce joint costs and improve overall
product quality. Given this shift in dynamic, there are now two primary procurement operating
models—Hub (Just in Time) and the Classic Procurement Model.
Functional Area SC Operating Model Operating Model Description

Procurement Hub or "Just in Time" Company co-locates with its suppliers, tightly coupled operations
Classic Procurement Model Centralized or decentralized, company manages purchase orders
way.
Procurement Operating Model - Hub or JIT Model
A company employs a Hub or Just in Time (JIT) strategy when it co-locates with its suppliers—
the company's suppliers place their facilities close to the manufacturer's manufacturing facility.
This may be a supplier's manufacturing facility, an "assembly or finishing" plant, or a warehouse.
The close proximity allows the suppliers to respond more quickly and frequently to the customer's
requirements.
In this model, the manufacturer often limits the number of suppliers. Typically, in a Hub
environment the supplier is responsible for monitoring and replenishing inventory at their
warehouse. The manufacturer's procurement group does not need to generate a purchase order
(PO), through the PO execution process, to replenish the warehouse.
Example
The suppliers of Dell Computer have warehouse locations near the Dell manufacturing sites.
When Dell manufactures computers, they are able to pull components directly from these supplier
warehouses on an "as needed" or JIT basis.7
Wal-Mart is another example of a company using the JIT procurement strategy. Wal-Mart
collaborates with many of its vendors in providing them with point-of-sale (POS) data so that the
vendors can understand the market demand pattern. In return, the vendors manage the inventory
of their products at the Wal-Mart stores, determining when the shelves need to be replenished as
well as the replenishment quantities. In many cases, the vendors do not get paid until the product
has been sold by Wal-Mart to its customers. This concept is sometimes also referred to as
Vendor Managed Inventory (VMI).
7
way.
Influence of the Hub Procurement Model on SCP Model
The Hub procurement model is mostly used when the manufacturer has quick turnaround
requirements from their suppliers. In many cases, the response times to material requirements
are measured in hours, not days. As a result, the supplier must have a steady stream of material
available to meet these requirements. Companies consider several important factors in the Hub
procurement environment, including:
Collaboration with Suppliers

There is tight integration between the manufacturer and the suppliers; the manufacturer shares its
supply and production plans with its suppliers. The suppliers generally use the production plans
to understand the manufacturer's requirements in the short-term, and plan their production
accordingly. They simultaneously use the information to gain visibility into the manufacturer's
longer-term plans.
Optimal Inventory and Safety Stock Levels

The manufacturer typically specifies a required service level from their suppliers and measures
their performance based on this service level. The suppliers then must use the manufacturer's
plans to determine their inventory and safety stock levels to meet these requirements. If the
supplier is incapable of determining the inventory, safety stock and replenishment policies, the
manufacturer may develop such policies for the supplier.
Blanket Purchase Orders

Because of the close relationship between the manufacturer and supplier, many manufacturers
place a blanket purchase order (PO) with their suppliers and pull material against that PO. A PO
is not created each time material is ordered from the suppliers.
way.
Hub or JIT Procurement Model Summary
The just in time strategy influences the SCP model in all planning areas.
Procurement Demand Planning Supply Planning Production Planning

Model
Hub or JIT Forecast component PO automatically Manufacturer's
Strategy and sub-assembly generated and managed by production plans continuously
requirements shared with suppliers shared with suppliers to
suppliers so that they can Suppliers' inventory ensure availability of parts and
factor into their own production planning is tightly coupled with components
and inventory plans manufacturer's production
plans
way.
Procurement Operating Model - The Classic Procurement Model
In a classic procurement model, the manufacturer is responsible for monitoring and

replenishing its component inventories. When they realize they have fallen below a certain
inventory level, they issue a purchase order to a supplier to replenish the component.
Example
Consider the case of a seasonal producer of canned fruits and vegetables. The producer must
plan in advance the demand for their products, and contract with a farmer for a crop. Strategic
planning usually encompasses their entire network of manufacturing facilities, and is generally
conducted at their headquarters by a planning and procurement group.
During the pack season, one manufacturing facility may need more sugar to can fruits. In this
case, that particular manufacturing facility places an order for the sugar. In such instances where
the manufacturing facilities are reacting to unanticipated situations, they may procure materials
directly from their suppliers without having to involve the centralized procurement group.
way.
Influence of the Classic Procurement Model on SCP Model
The classic procurement model is used when manufacturers determine their own material
requirements, and then pass those material requirements onto their suppliers. There are several
variations to the classic procurement model; a company may employ one or more of such
variations, including:
Centralized Procurement
A company purchases components for its entire manufacturing network. Such a company often
engages in centralized planning to aggregate the material requirements across its global network.
Decentralized Procurement
Each manufacturing facility orders components to meet its own demand. Purchase orders in such
an environment are often recommended by a material requirements planning (MRP) execution
system.
Collaborative Procurement
Companies share information with suppliers in advance so that they can plan to replenish
components in a given time frame. In such an environment, the manufacturers share their
production plans with suppliers, and may also provide visibility to their inventory positions.
Operational Integration
The manufacturer and the supplier engage early in the design process to jointly design the
required components. Once the design in finalized, the manufacturer and the supplier may jointly
create a forecast for the requirements of the designed component.
way.
Classic Procurement Model Summary
The classic procurement model influences the SCP model in all planning areas.
Procurement Demand Planning Supply Planning Production Planning

Model
Classic Forecast component Manufacturer is Manufacturer's
Procurement and sub-assembly responsible for maintaining production plans not shared
requirements sometimes appropriate levels of supply to with suppliers
shared with suppliers so that meet production schedule and Contingency plans
they can factor into their own customer demand often required in case of a key
production and inventory Limited collaboration material shortage from
plans with suppliers—material suppliers
requirements are sent and
confirmation is requested
way.
Topic Summary

Area
Procurement Hub or "Just in Time" Model Heavy emphasis on integration between production
(company co-locates with its planning/scheduling and inventory planning capabilities across
suppliers, tightly coupled companies to facilitate "pull" based replenishment
operations)
Classic Procurement Model Heavy emphasis on accuracy of production schedules and

(centralize or decentralized, material release plans so a company can generate accurate POs to
company manages POs) suppliers
Heavy reliance on raw material planning to ensure
production feasibility
way.
Fulfillment Model Influence
Overview
The way in which a company chooses to distribute product to fulfill customer orders may also
have an impact on the SCP model. In an MTS manufacturing environment, product is typically
pulled from stock at central or regional distribution centers for shipment to customers. In such
an environment, companies rely on an accurate demand plan to develop stocking and inventory
policies for their distribution centers.
For some seasonal products, or for those with highly uncertain demand patterns (e.g., the retail
fashion industry), product may be distributed in a flow through model, in which cross-dock
facilities are used to receive product from manufacturers, and merchandise is dynamically
allocated to customers and regions according to the latest market demand.
For configure to order products such as Dell Computers, a direct model of distribution from
manufacturers to customers/consumers may be appropriate.8
Functional SC Operating Influence on SC Planning Model

Area Model
Fulfillment Pulled from Product shipped from central or regional distribution centers to customers
Stock
Flow Through Product received in a cross-dock facility pre-allocated or allocated at time of receipt
Model to customers and then shipped
Direct Model Product shipped directly from supplier or manufacturer to customer/consumer
8
way.
Fulfillment Operating Models - Pull from Stock Model
A company that pulls from stock manufactures product in advance of receiving a customer
order and stores finished goods inventory in its warehouse(s). When an order comes into the
order management system, they allocate product at a preferred distribution center for shipment to
the customer. To be successful, these types of companies rely heavily on forecasting and
inventory planning to meet customer demand and drive profitability.
Example
Consider a manufacturer of school supplies. The manufacturer typically manufactures product

and stores the product at one or more of its distribution centers so that it can be shipped to retail
customers when they need it.
In addition, while school supplies are sold throughout the year, this business is also seasonal; the
big push is in the late summer months prior to new school year. Also, while some school supply
products are in the mature stage of the product life cycle (e.g., binders, paper, pencils), others,
such as fashion accessories (e.g., hair clips, temporary tattoos, etc.), come and go by the season.
As a result, companies in this business must use different forecasting and inventory planning
models for the different products.
way.
Influence of the Pull From Stock Model on SCP Model
The pull from stock model is most often used in the MTS environment, in which product is
manufactured, stocked, and then shipped to customers when demand arises. Companies
consider several factors in this model, including:
Long Lead-Times
Companies, such as the school supplies company, must have accurate forecasts to take full
advantage of once-per-year opportunities. Production lead-times are too long to try and correct
insufficient initial production and inventory stocking decisions. Since some of their products have
a stable historical demand pattern, they can accurately base the forecast for these products on
history.
Seasonality
Planners must base the demand forecast for trendy seasonal items on other items with similar
characteristics. Companies must also be able to respond quickly should the actual demand be
much different from the forecasted demand.
Demand planners need to integrate closely with the Sales and Marketing functions that are
closest to the customer. This allows them to better anticipate the latest back to school fads, so
that when orders come in, they can be pulled from stock and shipped to customers.
Optimal Inventory Policies

Companies must efficiently manage their inventories in a pull from stock model. If they carry too
much inventory, they risk product obsolescence and high inventory-carrying costs. Conversely, if
they carry too little inventory, they will lose sales and customers. Thus, companies in such an
environment use their "best" forecast to develop inventory policies. However, the supply chain
must also be flexible enough to quickly respond to drastically different demand patterns.
way.
Pull from Stock Model Summary
A pull from stock fulfillment model influences the SCP model in all planning areas.
Fulfillment Demand Planning Supply Planning Production Planning

Model
Pull from Collaborative demand Emphasis on finished Production schedule
Stock planning with the largest, most goods inventory planning and aligned to forecast, factoring in
strategic customers statistical based inventory other economies of scale
Historical-based safety stock calculations that within the production
forecast consider variability of supply environment
and demand when setting
Forecast accuracy is
inventory targets
key
way.
True False
In the Pull from Stock Model, companies store product at distribution
centers and warehouses, and then allocate the product to customer
orders as they receive such orders.
A Pull from Stock Model does not require the company to worry about
forecasting. They should concentrate on manufacturing product and
distributing to their distribution centers and warehouses.
In a Pull from Stock Model, companies must develop sophisticated
inventory policies that consider demand and supply variability.
way.
Fulfillment Operating Models - Flow Through Model
A company that utilizes a flow through model to distribute product manufactures product in
advance of receiving a customer order. However, instead of storing product in a warehouse and
waiting for an order to pull it, the company ships product to a cross-dock facility. It then allocates
the inventory "in-transit" or at "time of receipt" of an actual customer order, shipping directly to a
store location.
Companies benefit from this approach because they avoid finished goods carrying costs and
customer allocation decisions, enabling them to react to more timely market conditions in
deploying product. In the make to stock and pull from stock models, the company incurs more
finished goods inventory risk and storage costs.
Example
Consider a large national specialty retailer that sells fashion apparel for men, women, and young
adults. While they sell product year around, more and more specialty retailers such as this are
trying to anticipate and even drive trends in the youth market, turning over merchandise
assortments 15-20 times a year. The majority of the capital and energy is used to stock, sell, and
introduce new attire that is "hip" and the latest in fashion.
For such a company, the new product lines may not have a historical precedent; similarly, they
will not be certain of what specifications will be popular (e.g., colors, zippers or buttons, pocket
style, etc.) for items such as shirts or slacks, leaving uncertainty about what will "take off" across
the numerous stores across a country. To solve this dilemma, they may assess trends on similar
merchandise introduced in some earlier seasons and follow the sales patterns at the stores very
closely. The company can then analyze store level POS data to know what fashions are selling
and in what areas. As this data begins to show a trend, the company can leverage it and allocate
product to the highest demand areas as it is shipped and sent to its cross-dock facilities.
way.
Influence of the Flow Through Model on SCP Model
The flow through model is most often used in environments where items are first shipped to
cross-docking facilities and then moved quickly to points of demand once the company has
obtained a better demand signal. Companies consider several factors in this model, including:
Accurate Forecasting
A company deals with products in various stages of their life cycles. As a result, they need to use
different types of forecasting models to forecast the demand for each of their products. For new
products, the company must have the ability to analyze similar items, and use their historical data
to forecast the demand for the new items.
Product Allocation
One advantage of the flow through model is that the distribution of the product to demand points
is delayed until the company is able to obtain a better demand signal. This is an extremely
valuable capability because it leverages the latest market intelligence to distribute product where
it could be sold for the highest retail price or margin. Furthermore,
• If product is not allocated correctly, stores may have to reduce price dramatically to move
it in order to free up space for the next wave of products.
• If a product completely "bombs," this approach also allows companies to signal changes
in original product plans and divert capacity to more popular products.
Efficient Distribution Network

Because a company may wait for a better demand signal before distributing the product to its
demand points, the company must also have a very efficient distribution network because the
lead-times to replenish inventory are short. Since the company replenishes product based on
actual sales, they must ensure that product gets to the stores quickly.
way.
Flow Through Model Summary
A flow through fulfillment model influences the SCP model in all planning areas.

Model
Flow "Like-item" forecasting Ability to allocate Flexible production
Through capability is important to help finished goods inventory to planning is important so that
Model determine initial wave of ship to points of highest and capacity can be diverted to
distribution most profitable consumption better-selling or higher-margin
Ability to analyze POS (store and region) product
data and respond in a timely An efficient distribution
fashion to help influence network is vital to ensure that
distribution and production product gets to the demand
decisions is vital point with the shortest possible
lead-times
way.
Check all of the SCP capabilities that are most important in the flow through model.
Important in the
Flow
Through Model
"Like-item" forecasting
Ability to analyze POS data
Efficient distribution network
Optimal inventory policies
Ability to aggregate demand to obtain better terms and

conditions from suppliers
way.
Fulfillment Operating Models - Direct Model
A company that utilizes a direct model to distribute product most often produces product in a
configure to order or engineer to order manufacturing model, and distributes it directly to the end
customer or consumer. Many companies in the high tech industry fall into this category. In most
cases the product itself is not very capital intensive, allowing companies to produce and market
directly to a large, but highly fragmented, customer base.
Example
Dell Computers9 is the prototypical example of the direct model. Dell pre-assembles a base
model computer, and then adds the components upon receiving a customer order. For Dell,
linkage between their order management systems and manufacturing sites is crucial. Advanced
supply and materials planning reduces the lead-times for acquiring components and parts, and
this assists in ensuring short lead-times for customer orders.
Dell needs to forecast at a various product levels—component, intermediate product, and finished
goods. Because the configuration of products influences the required components on hand, Dell
must link supply planning closely with the demand forecast. Furthermore, Dell needs to tightly
integrate with its suppliers so that they can respond rapidly to Dell's materials requirements.
9
way.
Influence of the Direct Model on SCP Model
The direct fulfillment model is mostly used when a company ships directly to their customers. In
many cases, there is a base product that is configured to suit the customer's preferences. There
are a few critical components that need to be put together based on a specific configuration of
those components as desired by the customer. Companies consider several important factors in
a direct fulfillment model environment, including:
• Forecasting requirements for each component - There may be so many possible

configurations of the product that it makes sense for the manufacturer to wait for an
actual order before configuring the final product. The manufacturer does not forecast the
sales of each individual configuration, but can forecast the requirements of each
component.
• Efficient production - Once the manufacturer receives an order, the manufacturer must
then configure the product quickly and efficiently, and ensure that the product is delivered
when desired by the customer at the lowest possible cost.
• Material availability - The manufacturer must ensure the availability of raw materials,
components and sub-assemblies to begin production as soon as an order is received. To
help shorten the lead-times to acquire material, suppliers have dedicated facilities near
the final assembly and packaging locations so there is a ready supply of material and
components to meet customer demand.
• Capacity and resource utilization - In many cases, the company has limited
manufacturing capacity and resources. Because of the limited available capacity,
companies need to allocate the capacity on their machines to customer orders and
continuously monitor capacity and resource utilization.
way.
Direct Model Summary
A direct model distribution strategy influences the SCP model in all planning areas.

Model
Direct Required to forecast at Demand and production Base product production
Model various product levels— plans must be shared and schedule driven by demand
component, intermediate tightly integrated with key forecasts
product, and finished goods material and component Final assembly and
Demand planning must suppliers configuration operations tightly
be tightly integrated with Suppliers often co- coupled with customer order
supply planning locate with final assembly management systems
facilities
way.
Topic Summary

Area
Fulfillment Pull from Stock Model Heavy reliance on accurate demand forecast and
(Product shipped from central or inventory planning to mitigate finished goods inventory risk
regional DCs to customers)
Goes hand-in-hand with make to stock manufacturing
model
Flow Through Model Some reliance on demand forecast and inventory

(Product received in a cross-dock planning
facility, allocated to customers, and
Heavier reliance on timely and accurate demand
then shipped)
signal (POS or customer order) to perform accurate
customer allocations and shipments
Direct Model Reliance on demand planning for production, capacity

(Product shipped directly from supplier and inventory planning
or manufacturer to
In a configure to order manufacturing model, heavy
customer/consumer)
emphasis placed on supply planning for add-on components
to ensure build-outs can occur on demand
Commonly used in engineer to order and configure to
order manufacturing environments
way.
Conclusion
Module Summary
A supply chain planning (SCP) model serves as an internal market mechanism or process for
companies. Its purpose is to match supply and demand, aligning the entire organization around
key operational plans that drive success and profitability given the demand for their products in
the marketplace.
An SCP model is comprised of process, technology, and organizational assets. Companies use
these assets to intelligently commit, build, and deploy a company's physical assets (e.g., supply,
manufacturing capacity, and labor) to meet the market demand for a product over time, and in the
most profitable manner possible.
There are many factors that influence a company's SCP model, including the company's
business model, manufacturing class, and supply chain operating models (manufacturing,
procurement, and fulfillment).
A good business model answers key strategic questions about a company, telling us who their
customers are and what they value, and how the company makes money. A business model
influences the choice of an SCP model.
A manufacturer plans for the use of materials and resources depending on their manufacturing
class—discrete, repetitive, or process. These manufacturing classes influence the SCP model
in various ways.
Companies use various supply chain operating models: manufacturing (make to stock, make to
order, configure to order, and engineer to order), procurement (just in time and the classic
procurement model), and fulfillment (pull from stock, flow through model, and the direct model).
These SC operating models each influence a company's SCP model.
way.
Supply Chain Planning: Integration
Introduction
Why is Integration Important?
Companies manage their supply chains by connecting the functions in the supply chain—
Procurement, Manufacturing, and Fulfillment—via supply chain planning (SCP) processes.
Supply chain planning processes coordinate and share information among the other supply chain
functions to create an integrated supply chain. Supply chain functions must be integrated for
companies to ensure that material is available for manufacturing, manufacturing resources are
available when required, and customer orders are fulfilled on time.
Companies must also integrate the different SCP processes—demand planning, supply planning,
and production planning—to ensure that demand does not exceed supply, or vice versa, and that
customer orders get fulfilled. Companies must coordinate the different supply chain planning
processes so that all the plans are synchronized. The Sales and Operations Planning process,
referred to as S&OP, is normally responsible for coordinating this integration.
Companies make decisions at different operational levels, including the strategic, tactical, and
execution levels, to facilitate their supply chain processes. SCP allows companies to plan and
integrate the supply chain functions across all entities at all operational levels.
way.
How Does a Company Achieve Integration?
An integrated supply chain passes information back and forth between the business functions
and planning processes. The diagram below shows an example involving supply and production
planning. Press the arrow below to see additional information.
way.
Objectives
After completing this module, you will be able to:

• Identify the interrelationships between supply chain planning (SCP) processes and the
related business functions
• Describe the basic process performed by each business function
• Describe how each function can be integrated with SCP
• Explain why it is critical for SCP to receive and send information to support both strategic
and execution functions
• Describe how Sales and Operations Planning (S&OP) integrates planning processes
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Procurement
Overview
Leading organizations view procurement as a strategic part of their business that drives benefits.
Purchased materials and external services constitute a major portion—about 55 percent—of the
cost of goods sold for a manufacturing company.
During SCP, planners model lead-times for materials procurement assuming that the material will
be available when needed. But if a supplier's lead-time performance is erratic; i.e., sometimes
they deliver on time, at other times they are late; this variability will require them to carry more
safety stock, resulting in additional cost. Companies strive to work with suppliers who have little
lead-time variability. Quality is also an important criterion for working with suppliers. If a supplier
frequently supplies inferior product, the manufacturer has to discard the low-quality product and
re-order, which has an adverse impact on manufacturing.
We will explore other such procurement issues that either impact SCP or are impacted by it.
Although procurement is used to procure both direct material, which is used for manufacturing
goods, as well as indirect material, like pens, pencils, and paper, we will limit our discussion to
the procurement of direct materials because indirect materials have no impact on supply chain
plans.
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Decisions in Procurement
Procurement has moved from the traditional model of buying products at the lowest possible price
to developing strategic relationships with suppliers to streamline lead-times. A supplier with
erratic delivery lead-times forces a manufacturer to carry excess safety stock. If the manufacturer
can purchase from another supplier who guarantees delivery times, the manufacturer will not
have to carry as much safety stock. While this second supplier may not provide the lowest price,
the long-term cost benefit may outweigh that of the lowest-cost supplier.
Typical Procurement Decisions
• Who - decide on which suppliers to use

• What - decide on what to purchase from which suppliers
• How much - decide on the product volume to purchase from each supplier
• What price - negotiate pricing strategy with each supplier
• Terms and conditions - decide on lead-times, lead-time variability, inventory levels,
frequency of deliveries, etc.
Since companies don't change such decisions frequently, they are generally considered strategic.
Once strategic decisions are made, manufacturers need to make execution decisions involving:
• Buying the product

• Managing the confirmations and receipt of goods, i.e., schedule receipts
• Tracking the status of material, i.e., in-transits
SCP, integrated with strategic and execution activities, provides the highest level of benefit to a
company.
way.
How SCP Supports Strategic Procurement
Strategic procurement decisions, such as identifying suppliers and negotiating price terms and
conditions, require input from SCP activities. Procurement relies on a long-term demand plan that
has been disaggregated into a long-term materials plan to decide on what and how much to buy.
Deciding on who (what suppliers) to buy from is significantly more complex because decision
makers must know suppliers' past performance, e.g., reliability, lead-time variability, service level.
Companies obtain this information from their planning systems to help determine and manage the
best suppliers. Companies also identify primary suppliers and secondary suppliers—secondary
suppliers are used when the primary supplier is unable to meet requirements.
The price negotiated with each supplier also takes into account terms and conditions—e.g.,
service levels, delivery frequency, and delivery lead-time required—as well as the variability of
the demand pattern. Some companies are now entering into dynamic pricing agreements with
suppliers in which both parties agree to some pricing rules, and the actual price depends on
volume, lead-time, frequency, demand pattern stability, and materials expediting.
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How Strategic Procurement Supports SCP
Just as planning supports strategic procurement, strategic procurement supports planning by

providing key inputs to SCP. During SCP, companies identify and associate every relevant
variable with the planning model—primary and secondary suppliers, available materials, and
delivery lead-time. Manufacturers must also understand suppliers' volumes and/or constraints
that could impact the receipt of materials needed for production. Finally, they must know the
product price to optimize any cost decisions they may make during SCP.
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How SCP Supports Procurement Execution
Procurement execution activities that require supply chain planning inputs include:
• Buying the product

• Managing the confirmations and receipt of goods, i.e., schedule receipts
• Tracking the status of material, i.e., in-transits
To buy the product, companies must issue purchase orders or draw material against a blanket
purchase order. The purchase orders recommended by SCP are based on the short-term
materials plan generated during production planning.
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How Procurement Execution Supports SCP
Procurement execution includes managing the confirmation and receipt of goods as well as
tracking the status of material. These functions provide valuable input to SCP, e.g.,
confirmation of the receipt of goods implies that material is available and manufacturing can
proceed as planned. After the suppliers confirm their commitment to delivering the product when
needed, the procurement function must ensure that the goods are received and placed in
inventory to be used by manufacturing.
Procurement also provides planners with a delivery schedule and the status of the material on
order. This can provide early warning signs to SCP—if planners know early enough that some
material is going to be delayed, i.e., exceptions to the plan, they may be able to alter production
plans to account for the delay. Early visibility also allows planners to consider expediting the
material from an alternate or secondary supplier if needed.
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Integrated Example
A manufacturer generates a long-term demand plan.

Procurement uses that plan to identify Ultra as the
primary supplier for a certain item, and Supra as the
secondary supplier for the same item. Ultra is to
supply 520,000 units during the year—approximately
10,000 units per week. While generating the
appropriate supply plans, using 10,000 units per
week from Ultra, supply planners ensure a
demand/supply match for the company.
In February, however, the manufacturer's executive

team increases its revenue targets; Marketing plans
to run a promotion during April that will lead to
increased demand of 15,000 units per week for eight
weeks during May and June. Procurement discusses
the increased material requirements with Ultra, and
Ultra responds by saying that they can supply 12,000
units per week during that time period. The secondary supplier, Supra, agrees to supply the
additional 3,000 units per week. Procurement agrees to the price and delivery terms with both
suppliers.
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Integrated Example - Continued
In the second week of May, Ultra informs

Procurement that, due to a manufacturing problem,
they cannot supply 5,000 units during the third week
of May. Procurement then contacts Supra who
confirms that they can air-ship the 5,000 units to
arrive in time for production. The manufacturer
agrees to purchase the units from Supra and absorb
the additional transportation cost.
At the end of the year, the manufacturer analyzes

Ultra's performance and realizes that Ultra has forced
them to expedite material several times during the
year due to manufacturing problems at their end.
Using this information, the manufacturer negotiates
an additional contractual term with Ultra to carry a
higher safety stock to avoid this situation in the
future.
What strategic procurement decisions did the manufacturer make? Show answer
Strategic Decisions:
• Identify Ultra as the primary supplier and Supra as the secondary supplier
• Ultra will supply 520,000 units during the year—approximately 10,000 units per week
• Negotiate an additional contractual term with Ultra to carry a higher safety stock to avoid
excessive expediting of materials in the future
What procurement execution decisions did the manufacturer make? Show answer
Procurement Execution Decision:
• Purchase an extra 5,000 units from Supra during the third week of May
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Topic Summary
Procurement is a strategic part of any business and must be integrated with SCP. The strategic
and execution decisions that are made in Procurement both support and are supported by SCP.
Procurement decisions that are supported by SCP include determining what to purchase, who to
purchase from, and how much to purchase. SCP uses these decisions to develop supply and
production plans to meet the demand requirements of the company. Once plans have been
developed, SCP must know the status and delivery schedule of incoming material because those
plans can be executed successfully only if material is available when needed.
Inputs Outputs
Strategic Procurement • Long-term materials plan • List of primary suppliers
• Supplier performance • List of secondary suppliers
• Expected lead-times
• Expected volumes
• Contract terms and conditions
• Price
Procurement Execution • Recommended purchase orders • Purchase order confirmations

• Short-term materials plan • Delivery schedule
• Material status
• Exceptions
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Manufacturing
Overview
Organizations that manufacture products invest a large amount of capital in manufacturing assets.
To maximize this investment, they must balance two goals: ensuring that enough material and
machines are available when needed while avoiding idle machines and/or labor resources.
SCP helps manufacturing organizations develop the capability to increase their return on assets
by maximizing throughput, minimizing machine downtimes, or maximizing asset utilization.
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Decisions in Manufacturing
Some organizations view manufacturing simply as the ability to manufacture the required product
and meet demand requirements. When business and demand grows and manufacturing capacity
cannot meet demand, companies must evaluate several options. Known as strategic
manufacturing decisions, companies consider issues such as:
• Should manufacturing be outsourced to a subcontractor or vendor?

• Should we increase the manufacturing capacity by building or acquiring new plants?
• Can we increase the manufacturing capacity by increasing the workforce and/or the
hours of operation of the facilities?
• Are our suppliers capable of providing the required material for new product
introductions?
Once these strategic manufacturing decisions are made, planners must think about
manufacturing execution, and make decisions such as:
• When should we take down a machine for routine maintenance?

• How do we move material from its inventory location to the workstation where it is
needed?
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How SCP Supports Strategic Manufacturing
How SCP Supports Strategic Manufacturing
Companies make two strategic manufacturing decisions that require SCP inputs—deciding
whether to outsource manufacturing of certain components or products, and determining the
material to use when designing a new product.
Outsourcing Decisions Materials Decisions
To make outsourcing decisions, manufacturers must know whether they have a shortage of
capacity. To determine this, SCP provides the demand plan as well as the supply plan—which is
made up of the sourcing, inventory, and distribution plans—to satisfy that demand. A review of
these plans will highlight the variance between the two, i.e., a variance that shows a shortage of
capacity or a surplus of capacity. The manufacturer can then evaluate multiple demand and
supply plans to see if they can develop a plan that eliminates capacity variance while satisfying
the business objectives of the company.
If they do decide to outsource a portion of their manufacturing, they will need information to
evaluate the subcontractors in terms of cost, quality, and reliability. They could use some of the
supplier performance information (from manufacturing or procurement as appropriate) combined
with the relevant business planning rules from SCP—e.g., lead-time, and lead-time variability—to
evaluate if certain contract manufacturers are likely to be more reliable than others, and award
the contract based on the above factors.
When organizations design a new product, they must first ensure material availability and
identify potential suppliers to manufacture it and introduce it into the market. To accomplish this,
they again need the demand plan and the materials plan, both generated during SCP, for the new
product. To determine the best vendors, they use the performance information to identify the
more reliable vendors, and then work with procurement to develop the procurement terms from
the suppliers.
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How Strategic Manufacturing Supports SCP
Strategic manufacturing supports supply and production planning with the following key inputs:
• Bill of Material - Manufacturing will determine the bill of materials (BOM) and work with
Procurement to finalize the terms and conditions with material suppliers. Planners use
this information during SCP to create the appropriate plans. The materials plan generated
during supply planning is at a higher level of granularity while the plan generated during
production planning is more detailed.
• Manufacturing Capacity - Manufacturing capacity is a key input during the supply
planning and the S&OP processes. The capacity constraints applied during supply
planning are less detailed than the capacity constraints during production planning. For
example, the capacity constraints during supply planning may be the capacity of a
manufacturing line, whereas during production planning, the manufacturing capacity
constraint would be for each resource.
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How SCP Supports Manufacturing Execution
Manufacturing execution decisions include issues such as:
• When should we take down a machine for routine maintenance?

• How do we move material from its inventory location to the appropriate workstation?
The manufacturing facility uses the detailed production schedule and the materials plan as inputs
to determine how and when material should be moved from its inventory location to the
appropriate workstations. Robots, or people, are then scheduled to move the material. If sufficient
material is not available, suppliers may be notified to expedite the material to ensure continuous
production. Many organizations use safety and other kinds of buffer stocks to cover for such
eventualities—by first using up safety stock for production and then using the expedited material
to replenish the safety stock. SCP helps companies to determine the appropriate level of safety
stock to carry.
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How Manufacturing Execution Supports SCP
Three manufacturing execution activities that impact SCP include:
Actual Build - As manufacturers produce goods, SCP systems are updated. Future production
plans must be adjusted if the amount of goods produced either exceeds or is less than the
planned quantity. For example, suppose a production schedule calls for the assembly line to
produce 150 motorcycles during the first four days of the week and 180 more on Friday by using
some overtime. If the factory actually produces 160 motorcycles every day for the first three days
of the week, the overtime on Friday must be adjusted.
Maintenance Scheduling - As manufacturing takes down machines for maintenance, they

provide the maintenance schedule to the planning systems. Machine maintenance typically
reduces the factory's manufacturing capacity, and decision makers should reflect this in the
planning systems, i.e., as constraints.
Product Design Changes - At times, the BOM must be updated, e.g., due to different parts or a
minor product design change. Manufacturing execution usually tracks such changes and updates
the planning systems to reflect the new BOM. SCP can then determine the material requirements
more accurately.
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Integrated Example
A manager has just learned in a monthly S&OP
meeting that his company has subcontracted some
of its manufacturing capacity to external vendors.
Management has decided that the optimal way to
satisfy increased demand for products is as follows:
Vendor A will provide 2,000 units per week and
Vendor B will provide 1,000 units per week, while the
factory will continue to produce 15,000 units per
week. Since the manager has not used
subcontractors before, he is skeptical and wonders
about vendor reliability.
In addition, Independence Day is near and he is

concerned for several reasons. First, the vacation
schedule for employees is rather ad-hoc at this time; Independence Day falls on a Wednesday
this year, and a large number of employees have taken the remainder of the week off. Second,
one senior engineer has informed him that a critical machine is not functioning optimally and may
need unexpected maintenance soon.
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The machine in question does fail and must be sent for

maintenance and repairs. Given these constraints, the
manager realizes that they cannot meet this week's
manufacturing commitments, which will result in a
shortfall of 2,000 units, so he works with supply
planners and contacts the new manufacturing
subcontractors. While Vendor A is unable to provide
any extra units this week, Vendor B can provide the
extra 2,000 units at a five percent price increase. Given
the circumstances, the manager agrees to the higher
terms in order to meet demand.
As the manager hangs up the phone, his senior

engineer informs him that the critical machine just sent
in for maintenance and repairs requires new parts. The
parts will not be available for at least two weeks, and the repairs will require at least a week to
complete, making the machine unavailable for the next three weeks. Therefore, he updates the
machine availability appropriately in the system. SCP then creates a new supply plan for the next
three weeks by reducing the manufacturing commitments of the factory and ordering more
products from the vendors.
What is the manufacturing capacity? Show answer
15,000 units per week
What is the impact of the critical machine "going down"? Show answer
It reduces the manufacturing capacity and forces the manager to order more units from the
subcontractors and at a higher price
Were any strategic sourcing decisions made in this example? Show answer
The strategic sourcing decision was:
• Source 15,000/week internally

• Source 2000/week from vendor A
• Source 1000/week from vendor B
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Topic Summary
Manufacturing and SCP must be integrated to ensure that the product is manufactured at the
right time to satisfy customer demand. We identified two main manufacturing functions—strategic
manufacturing and manufacturing execution. Each of these functions uses specific information
from SCP as well as sending some information back to SCP.
Inputs Outputs
Strategic Manufacturing • Long-term supply and demand plans • Manufacturing capacity
• Capacity variance • BOM
• Supplier performance
Manufacturing Execution • Detailed production schedule • Actual build

• Materials plan • BOM
• Safety stock levels • Updated capacity constraints
• Maintenance schedule
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Fulfillment
Overview
The fulfillment process ensures that customers receive orders on time. A company's earlier
efforts to procure materials, plan for manufacturing, and manufacture the product are only
successful if customer orders are fulfilled as needed. Fulfillment must know where the product is
stored and how long it takes to move the product from one location to another. Furthermore,
companies strive to minimize fulfillment costs while maximizing customer service. This function is
also closely related to SCP.
To efficiently fill customer orders while adhering to acceptable customer service levels, planners
must model the supply chain network with the associated lead-times and costs to move the
product between different locations. Then they develop a fulfillment model that satisfies customer
demand at the lowest cost within acceptable service levels.
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Fulfillment Decisions
Fulfillment is the final link in the supply chain. Some companies will fulfill a customer order even if
they have to expedite the order due to the lack of available inventory, resulting in increased costs.
Companies must evaluate factors such as this when making fulfillment decisions.
Companies often have multiple manufacturing facilities and distribution centers for their products.
They must therefore decide on network design and configuration—this dictates from which
location they satisfy each customer. Known as strategic fulfillment decisions, companies
consider issues such as:
• Should we fulfill customer demand directly from the manufacturing facility or from the
distribution center (DC)?
• What is the optimal mode of transportation for shipping customer orders?
Once these decisions have been made, the company must also manage the fulfillment operations.
Among other things, they consider the critical fulfillment execution decision of allocating product
to customer demand.
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How SCP Supports Strategic Fulfillment
Companies answer a variety of questions when they design their supply chain network. Network
design is a complex issue and, in addition to the questions on the previous page, companies seek
to answer other questions during the network design process, such as:
• Do we have the right number of factories and are they in the right locations, or should
one or more be consolidated?
• Do we have the right number of distribution centers (DC) and are they in the right
locations to most efficiently and cost effectively serve customers?
• Are there conditions under which it is profitable to serve customers from more than one
DC, or from a DC in another region?
To facilitate the decision-making process, companies use operations research and/or other
optimization models. These models require information that comes from SCP, such as:
• Possible location of the facilities (e.g., factories, distribution centers, or warehouses)

• Long-term demand plans
• Transportation providers
• Associated transportation costs and lead-times
• Material suppliers
• Material costs and lead-times
• Manufacturing and transportation capacities
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How Strategic Fulfillment Supports SCP
The net result of the network design exercise is a distribution network that determines a time-
phased flow of goods through the network, i.e., sourcing and distribution strategies. The flow is
time-phased because it is possible for goods to flow along one link in the network during one time
period and along a second link during another time period. Furthermore, the network design
exercise determines the optimal location of the facilities. SCP uses facilities locations, sourcing
strategy, and distribution strategy to create distribution and sourcing plans.
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How SCP Supports Fulfillment Execution
During fulfillment execution, companies must allocate supply to customer orders when the
demand at any location along the supply chain network exceeds the supply for that node. If
companies use distribution centers to fulfill customer demand, and if the demand at a DC is
higher than its supply (e.g., on-hand inventory + expected receipts), the company may have to
allocate the available supply among the different customer orders.
For example, a DC manager has 350 units of product on hand, of which 50 are allocated to safety
stock, and he expects to receive another 300 units tomorrow. His objective is to allocate this
supply to two customer orders; Customer A requires 300 units and Customer B requires 100 units.
There are several alternatives for resolving this supply/demand discrepancy:
1. Using order allocation rules, allocate the 350 units to the two customer orders, e.g., 275
to customer A and 75 to customer B
2. Backorder the remaining demand and fulfill it from tomorrow's expected stock
3. Determine if another DC has excess stock and use that to fulfill the 50 units of excess
demand
To make such decisions, the manager needs the inventory plan, distribution plan, production
schedule, and order allocation rules, all of which SCP provides.
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How Fulfillment Execution Supports SCP
Customers frequently want to know their order status, e.g., in-production, in-transit. The order
status is based on either the production schedule (if the order is in production) or on the shipping
status of the finished goods (if the order has been shipped). Fulfillment execution regularly
updates the inventory position of finished goods. SCP uses the inventory position to determine
the variance from the planned inventory levels and safety stocks. SCP also determines if the
inventory levels and the safety stock levels need to be adjusted based on actual inventory levels
and actual demand.
Similarly, SCP uses customer orders to determine the variance between actual and forecasted
demand, and whether they should adjust the demand plan.
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Integrated Example
A manufacturer has two manufacturing plants—one in

Birmingham and one in Stockholm; two distribution
centers—one in Paris and one in Helsinki; and two
customers—one in Madrid and one in Gdansk. He has
initial inventory of 100 units in Paris that he wants to
maintain as safety stock to compensate for the volatile
demand pattern of the Madrid customer. The
manufacturer has forecasted the demand by the Madrid
customer at 500 units per month (at a rate of
125/week), and the demand by the Gdansk customer at
400 per month (100/week). He also knows that the
Birmingham plant can produce 400 units per month
(100/week) and the Stockholm plant can produce 800
units per month (200/week). Click on the "Supply Chain
Parameters" button to see the transportation costs per
unit between each of the cities.
Supply Chain Parameters
Using these supply chain parameters, he runs an optimization engine and determines the optimal
distribution and sourcing solution to minimize the cost of satisfying customer demand.
Initial Optimal Solution
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At the end of two weeks, the Madrid customer has ordered 300 units while Gdansk has only
ordered 100. The manufacturer's inventory position is 50 units at Paris and 100 units at Helsinki.
The Madrid customer places an order for 225 units for the third week, and the Gdansk customer
orders 100 units for the same week. The Paris DC manager decides to supply 125 units to the
Madrid customer from Paris and the other 100 units from Helsinki so that she can continue to
maintain a small safety stock at her DC, i.e., at the end of the week, she will have 50 units on
hand.
What does the initial solution optimize? Show answer
It optimizes the transportation cost of satisfying customer demand based on the forecast.
Why does the initial solution need to be modified? Show answer
The initial solution needs to be modified, because the demand from Madrid is higher than
expected and not all the demand can be met from the Paris DC.
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Topic Summary
Fulfillment must be very closely integrated with SCP to ensure that customers receive orders. The
fulfillment function uses information from SCP to make fulfillment decisions and provides
information to SCP for planning.
Inputs Outputs
Strategic Fulfillment • Possible facilities locations • Facilities locations
• Material suppliers, lead-times, and costs • Sourcing strategy
• Manufacturing capacity • Distribution strategy
• Transportation providers, lead-times, and
costs
Fulfillment • Order allocation rules • Customer orders

Execution
• Inventory plan • Inventory position
• Distribution plan • Shipping and receiving
• Production schedule status
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Sales and Operations Planning
Overview
Companies use the S&OP process to coordinate supply and demand and ensure alignment with
the strategies or financial goals of the company. Different functions within the company create
plans used to achieve different, and sometimes competing, objectives. S&OP can assist in
balancing these different plans and objectives.
Companies strive to develop a single plan that is used to maximize customer fill rates at the
minimum asset investment. The S&OP process brings together a cross-functional team with
representatives from Sales, Marketing, Finance, and Manufacturing. As members of the S&OP
team, these supply chain stakeholders develop a single company game plan and manage
inventories to maximize investment returns and customer satisfaction. The team also helps
ensure integration between planning functions—demand, supply, and production planning—and
the different functions of the organization.
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Purpose of S&OP
S&OP is a formal management process that reviews and communicates future business, tactical,
and demand and supply plans; the goal is to ensure that they are realistic, aligned with strategy,
and executed effectively. S&OP maintains a balance between meeting marketplace needs and
using key company resources, i.e., a trade-off between customer service and costs, while
matching demand and supply. For example, suppose marketing runs unexpected promotions, the
impact of which was not considered during S&OP. This will result in unanticipated demand during
the promotion period. Given the short notice, manufacturing may not be able to respond to the
increased demand due to insufficient capacity or lack of inventory, possibly resulting in a severe
product shortage in the marketplace. This could lead to lost sales, or even worse, lost customers.
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Enabling the S&OP Process - Overview
The cross-functional S&OP team—comprised of representatives from Sales, Marketing, Finance,

and Manufacturing—meets periodically, e.g., monthly, to review the supply and demand plans
and determine if they need to be modified. The team reviews actual versus planned data,
addressing issues such as:
• How to balance inventory and customer service

• How to evaluate net income and cash flow impacts with changing demand and supply
schedules
• How to influence demand with marketing and sales programs
• How to allocate product in short supply
• How to secure required resources
S&OP then modifies the demand and supply plans as needed, communicating the modified plans
to the rest of the organization. The team also meets regularly to review variances from plan,
agree on actions to correct the variances, and execute the supply and demand plans.
S&OP Stakeholders
Stakeholders Information Provided

Finance Planned Demand
Sales & Marketing Allocation Priorities
Customer Service Levels
Promotion Plans
Demand Planning Demand Forecast (includes customer input)
Supply Planning Projected Inventory
Safety Stock Targets
Inventory Cost
Net Requirements
Projected Inventory
Factory Utilization
Production Planning Production Plan with Restrictions
Factory Utilization
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Enabling the S&OP Process - Details
We know that the S&OP team conducts a weekly or bi-weekly review meeting followed up by a
long-range, e.g., monthly, review meeting. The team must also communicate decisions made in
these meetings to the organization. Click on the arrow below to see how the S&OP process can
be divided into four steps: preparation, monthly meeting, communication, and weekly review.
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True False
Sales and Operations are key participants in S&OP.
S&OP reviews are conducted weekly and any deviations from plans are
addressed and agreed upon by all participants.
One objective of the S&OP process is to review the supply and demand plans,
and ensure that they are not modified.
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The S&OP Process - Preparation
Preparation is particularly important for a successful S&OP meeting. Prior to the meeting, the
S&OP facilitator updates reports to reflect actual forecast versus plan as well as performance
measures, and then distributes the reports to team members. Each team member knows their
decision role and must be aware of the important issues for discussion. This role-based decision-
making makes the S&OP process successful.
Sales will compare the sales plan with product availability, and match the plan with orders. If
there is an excess, Sales must present plans to consume that excess inventory, e.g., special
sales promotions and incentives. If there is insufficient supply, Sales must allocate the limited
supply among the different customers.
Manufacturing will look at the current report and run simulations around the best way to utilize
capacity and available materials given the updated information. Manufacturing will also prioritize
customers orders if necessary to ensure that they are able to meet the required order due dates.
Finance will view the reports from a financial perspective, analyzing cost of goods sold,
contribution margins, and overall profit margins to ensure they are in line with company
expectations.
Roles and Responsibilities
S&OP Facilitator Each Team Member
• Identify new issues related to misaligned supply • Review meeting materials to understand current
and demand plans, inventory levels, customer service and expected performance and identity issues
levels, new product introductions, etc. • Identify alternatives to solve any potential issues
• Calculate inventory based on supply and
demand information, compare to actuals, and reconcile
differences
• Modify S&OP reports to reflect updated actuals,
forecasts, and plans
• Distribute all meeting materials to members
enabling review prior to the meeting
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The S&OP Process - Meeting
During a regular, e.g., monthly, meeting the S&OP team:

• Reviews actual versus planned data, discusses the reasons for variations, and plans how
to minimize future variations
• Reviews current month performance to determine if the company is on track to meet
sales commitments
• Reviews economic and market conditions to ensure that original assumptions remain
valid, and determine if future sales forecasts are feasible and aligned with business plan
commitments
• Reaches consensus on the future plans for each product, or product family, for both
demand and supply
• Creates action items for each team member to ensure completion by next meeting
Sample Agenda
• Review S&OP report as needed
• Review sales and production actuals versus plan; discuss reasons for
variations and means to minimize in the future
• Review current month's performance to date (i.e., are we on track to
meeting our sales commitments?)
• Ensure sales forecasts are feasible, realistic, and will achieve business
plan commitments; resolve any issues or identify them to be put on the Issues
List
• Review assumptions
o Has the marketplace changed?
o Are economic conditions changing?
o Has the competitive situation changed?
o Have changes occurred in the company's structure, roles,
reward system, information systems, etc. that will affect our capabilities?
o Have our exposures changed?
o Are there new assumptions that need to be considered?
• Review Issues List and resolve existing issues
o Supply/demand planning problems
o inventory levels too high or too low
o Distribution of product
o New product scheduling
• Document new issues identified at the meeting and assign responsibility
and resolution date
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The S&OP Process - Communication
Once the team revises sales forecasts and production plans based on the team decisions, they
update the S&OP reports to reflect the latest plans, including any items that require higher
management review (e.g., shorting an important customer, buying additional capacity at premium
prices) and then send the reports to the organization's executive team.
• Revise sales forecasts, marketing sales plans, and production plans as necessary
• Revise and distribute S&OP reports to reflect the latest decisions
• Communicate new plans to the other organizations that are impacted
• Review performance and plans with the executive team
o Review performance versus goals/budgets
o Discuss expected sales and inventory, including forecast scenarios (upsides &
downsides)
o Discuss plans for major upcoming product introductions
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The S&OP Process - Weekly Review
The weekly meeting is used to review variances between actual and planned data. The team
agrees on an action plan to resolve such variances.
• Review current month's performance to date

• Review variances from the plan and agree on actions to take to correct the variances
During preparation, what is the responsibility of Sales? Show answer
• Sales will compare the sales plan with product availability, and match the plan with
orders. If there is excess, Sales must present plans to consume that excess inventory,
e.g., special sales promotion, and incentives. If there is insufficient supply, Sales must
allocate the limited supply among the different customers.
What are the key activities of the S&OP team during their regular (e.g., Show
monthly) meeting? answer
• Review actual versus planned data, discuss the reasons for variations, and plan how to
minimize future variations
• Review current month performance to determine if the company is on track to meet sales
commitments
• Review economic and market conditions to ensure that original assumptions remain
valid, and determine if future sales forecasts are feasible and aligned with business plan
commitments
• Reach consensus on the future plans for each product, or product family, for both
demand and supply
• Create action items for each team member to ensure completion by the next meeting
What are the purposes of the S&OP weekly review meeting? Show answer
• The weekly meeting is used to review variances between actual and planned data
• The team agrees on an action plan to resolve variances between actual and planned
data
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Business Issue - Misalignment of Finance and Demand Plans
One business issue S&OP members might tackle is misalignment of finance and demand plans.
In this scenario, a manager reviews the financial plan for one product line and notices that it
projects a ten percent increase in sales (total sales of 400,000 units) for the second quarter. The
demand plan, on the other hand, is forecasting a 20 percent decrease (a total of 290,000 units)
for the same quarter. It is his job to resolve the demand/supply misalignment, which he plans to
do at tomorrow's S&OP meeting.
Before the S&OP team can reach a decision, they must consider the following:
• Impact on the financial plan

• Root causes of the decrease
• Whether forecasted demand will increase in the following quarters
• Whether the 20 percent decrease could be absorbed by another product line, and if so,
how this will impact the financial and production plans
What is the best approach for this company? Solution
Based on business objectives, the S&OP team generates and evaluates multiple options to solve
this business issue, ultimately deciding to identify a new sales and marketing strategy to increase
sales and accomplish the financial plans for this product line. Team members receive action
items for the next meeting. Note that the options presented in the figure are not exhaustive.
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Business Issue - Demand Greater than Supply
A mismatch of demand and supply is another typical issue addressed by the S&OP process. In
the following example, the S&OP team must decide what to do when demand is greater than
supply.
Process improvement efforts initiated have increased a Naperville plant's capacity to 2,000,000
units per month. In reviewing demand forecast for the 3rd quarter of 2002, the manager is
shocked to see the forecast for the month of July—with demand on the Naperville plant's
increasing to 2,500,000 units. Current capacity will fulfill 80 percent. She plans to discuss this
issue at Monday's S&OP meeting.
Before reaching a decision, the S&OP team must consider the following:
• Review the inventory, distribution, and production plans for this product line
• Verify the customer priority and service levels
• Verify the accuracy of the forecast for this product line
• Identify products for which the demand can remain unfulfilled and consider using that
capacity to build the required products
What is the best approach for this company? Solution
The S&OP team reviews the options and decides to change service levels and allocation
priorities for some of their customers. They also decide on the products for which the demand will
not be fulfilled. This leads to several action items for the team members to accomplish before the
next meeting. Note that the options presented in the figure are not exhaustive.
way.
Topic Summary
S&OP is a formal monthly management process that reviews and communicates future business,
tactical, and demand and supply plans to ensure that they are realistic, aligned with strategy, and
executed effectively. S&OP maintains a balance between meeting marketplace needs and using
key company resources, i.e., a trade-off between customer service and costs, while matching
demand and supply. The team reviews actual versus planned data and discusses the reasons for
variations as well as the means to minimize these variations in the future. The team reaches
consensus on the future plans for each product or product family for both demand and supply,
and communicates these to the organization and the executive team.
way.
Conclusion
Module Summary
Companies manage their supply chains by connecting the functions in the supply chain—
Procurement, Manufacturing, and Fulfillment—via supply chain planning processes. Supply chain
functions must be integrated to ensure that the materials are available for manufacturing,
manufacturing can produce the product, and fulfillment can deliver the product to the customer
when desired. SCP allows companies to plan and integrate the supply chain functions across all
entities at the execution and strategic levels.
S&OP is a critical, regular, and formal management process that reviews and communicates
future business, tactical, and demand and supply plans to ensure that they are realistic, aligned
with strategy, and executed effectively. S&OP maintains a balance between meeting marketplace
needs and using key company resources, i.e., a trade-off between customer service and costs,
while matching demand and supply.
way.
Supply Chain Planning: Leading Practices
Introduction
Why are leading practices important?
Leading edge companies are using supply chain planning (SCP) capabilities to reduce costs,
enhance revenue and yields, and achieve other operational benefits. Such companies pull ahead
of their competitors with significantly reduced costs and/or increased yields. Supply chain leaders
put increased pressure on competitors to implement leading SCP practices as well.
A company may choose to use a subset of leading practices that best meets their industry profile
and company needs. Following are four leading practices that differentiate a company's supply
chain planning capabilities:
Global SCP
The emergence of a global economy has driven companies to rethink their competitive strategies
and globalize their supply chains. The impact on the supply chain can lead to increased lead-
times and planning complexity. Global SCP practices allow companies to take advantage of the
benefits of globalization while managing the risks and complexities across the supply chain.
Collaboration
With increased pressure to reduce lead-times and become more cost competitive, companies can
eliminate inefficiencies with trading partners by sharing information and integrating processes.
Known as collaboration, we define it as "the sharing of information among trading partners and
across enterprises for the purpose of developing a joint plan of action, and then working together
to execute that plan."
Financial Optimization
Companies are looking for techniques to optimize the cost of delivering value to customers.
Financial optimization strategies help various supply chain entities achieve the common
objectives of satisfying the final customers and obtaining dominant market share in a cost-
efficient manner.
Postponement
A strategy that delays product differentiation until a point further along the supply chain. Supply
chain inventories have a direct impact on company profitability. Companies are increasingly using
postponement to manage inventory levels while improving customer order fill rates. We will
explore the impact of postponement strategies on SCP processes.
Objectives
• Discuss how businesses have responded to new challenges by using supply chain
planning concepts
• Describe the leading practices in supply chain planning, including Global SCP,
collaboration, financial optimization, and postponement
• Identify and discuss the benefits of leading practices
GLOBAL SUPPLY CHAIN PLANNING
Overview
The emergence of a global economy is forcing companies to rethink their competitive strategies.
Many companies are embracing global initiatives that allow them to:
• Pursue new markets

• Achieve greater economies of scale
• Leverage unique aspects of different countries and cultures
• Eliminate redundancies
• Improve organizational learning through international integration
Business Drivers of Globalization
Other factors that have impacted globalization include:
• Tax laws and labor costs have created opportunities for companies to remain cost
competitive with dispersed manufacturing and distribution. For example, pharmaceutical
companies realize significant tax benefits for manufacturing drugs in Puerto Rico. In
addition, the Internet has increased alliance and partnership opportunities by bringing
together companies that were either previously unknown to one another or
geographically dispersed.
• Trade agreements have had a significant impact on organizational supply chains.

Implementing trade agreements in Europe, e.g., via the European Union (EU) or the
European Free Trade Association (EFTA), as well as the opening of Eastern Europe to
free markets has created newfound business opportunities. Similarly, NAFTA has made
significant advances toward integrating the North American marketplace. It has
eliminated tariff and non-tariff barriers; enhanced the ability to operate carriers across
borders; liberalized foreign investment; and standardized customs initiatives and local
content rules.
Impact of Globalization on Supply Chains
Global supply chain entities are much more geographically dispersed. This has created some
challenges for global companies, including:
• Vertical Disintegration - The impact of trade agreements allows companies to

outsource competencies and operations globally. This leads to vertical disintegration and
a greater need for information sharing in the form of collaboration—a positive byproduct.
• Increased Lead-Times - Consider the impact of manufacturing computer chips in

Taiwan and assembling the final product in the United Kingdom. This substantially
increases the lead-time for available material and impacts the company's supply chain.
• Increased Complexity of Planning - Globalization increases the complexity of planning.

For example, a significant challenge for companies migrating to Eastern Europe is
collecting and entering freight rates into their modeling tools for transportation planning.
o Increased Nodes in the Network - The number of facilities increases and hence
the number of nodes in the network increases. This more complex network
makes it challenging to collect and calculate facility data across countries (e.g.,
cost accounting is not standardized across the globe).
o Multiple Non-integrated Cultures - Companies must adapt to very different
business cultures, work ethics, and problem solving approaches.
Global SCP as a Response
Some companies have addressed these new challenges with global supply chain planning.
Global SCP is the process of performing supply chain planning globally rather than locally or
regionally. In the early stages of supply chain planning, SCP consisted of creating plans locally.
Factories created their production plans and "threw them over the wall" to other entities. Some
companies learned early that this silo-based process was very inefficient and began to plan
regionally. However, regional planning also had its shortcomings because it considered only
regional entities and did not take global demand and supply into account. The leading practice
today is to plan at a global level, considering global demand and the entire set of global
supply options in the process. In this topic, we consider the impact of global SCP in four
dimensions: processes, supply chain configuration, information systems, and organization.
Impact on Processes
Global SCP implies a single planning model for the organization; that is, a single demand plan
that is used to drive the other planning activities. This single global SCP model is visible to all
participants; any change to the plans is reflected globally and enhances communication between
entities, reducing the chances for supply-demand mismatches. In a global supply chain planning
model:
• Supply chain planning determines the requirements for each plant, and each plant is then
responsible for production according to those requirements.
• Strategic procurement is performed centrally as well. During regional planning, each plant
or region is responsible for procuring its own materials. Several plants could be buying
materials from the same supplier but are not able to negotiate optimal volume discounts.
With a single procurement entity, the organization is now in a much better position to
negotiate such discounts and get more favorable pricing policies.
Example
Regional Planning
A large high-tech manufacturer employs a global constraint-based planning model across
more than 20 factories, producing over 30,000 products. Demand includes all customer
orders and forecasts. The company generates a production plan that takes into account
all customers and products globally. All factories worldwide then use the plan to
manufacture product.
Impact on Supply Chain Configuration
Supply chain configuration is impacted when organizations consider facilities locations, service
levels, and factory types. As a company globalizes its business operations, for instance, it could
find that there are multiple factories producing the same goods. Also, the cost of production in
one country may be significantly lower than current production costs in a different country. Hence,
it might make financial sense to close down one or more facilities.
It is also critical for global organizations to configure their supply chains to ensure world-class
service to their customers. A company could use different supply chain configurations for serving
different products or product lines.
Another distinguishing element of supply chains is factory type.
• Specialized factories are used for products that have a consistent demand pattern.
Production optimizes the use of resources and labor.
• Flexible factories, capable of turning various products around quickly, are used for
products with unstable demand patterns. Such factories require extensive capital
investment and often require a well-trained and educated set of labor as well. This also
dictates the location of such factories and hence impacts supply chain configuration.
Example
A global consumer electronics manufacturer analyzes their product lines and finds that
they can classify them into two broad categories—new and innovative products for which
it is difficult to establish accurate forecasts, and established products for which the
demand is reasonably predictable. The company decides to serve each category using
different supply chain configurations. A supply chain that is capable of reacting to rapid
changes produces the new and innovative products. On the other hand, a highly efficient
supply chain that ensures customer orders are fulfilled at the lowest cost with an
acceptable service level produces the established products.
Impact on Information Systems
In a single global SCP model all decision makers must have visibility into the relevant parts of the
model, including changes made to any plan—buying, production, material, and promotion plans,
as well as demand forecasts. To facilitate the sharing of information, companies are developing
information systems that are tightly coupled across geographic locations.
A single global SCP model must consider information from all its global entities, requiring a
standard format from which to send and receive information. Technology enablement is therefore
crucial to global visibility and must provide the following core capabilities:
• Standardization - Maintaining regional consistency so that software upgrades, rapid

deployment, and common reporting and support are possible
• Architectural Performance and Stability - Deploying applications that provide adequate

response times and reliable service
• Post-deployment Maintainability - Putting in place simple and effective processes that

provide consistent technical support and maintenance, global standardized training, and
timely upgrades
Impact on Organization
Cultural Differences - Global companies conduct business in multiple countries with different
business and ethnic cultures, and even different business ethics cultures. Business practices that
are commonplace and acceptable in one country may be frowned upon in another. To be
successful globally, companies must adapt to different cultures.
Organizational Realignment - Global SCP invariably requires some organizational realignment.

For example, prior to global SCP, multiple planners were likely responsible for planning and
buying material, or for developing demand forecasts for their regions. With global SCP, planning
is done centrally. Companies must therefore redefine individual roles and responsibilities.
Collaborative Global SCP - It is equally important for organizations to involve all regions in the
design and implementation of global supply chain models. One company solved the problem by
creating a global user council (GUC) for their global supply chain implementation, responsible for
establishing global requirements and defining and shaping the global solution over time. The
counsel includes recognized business leaders, subject matter experts, key stakeholders, and IT
representatives from each site/region. This globally implemented solution has helped the
company realize their ambitious supply chain vision of centrally managing all shipment orders to
local sites, with local sites no longer responsible for creating orders and managing inventory.
Benefits of Global SCP
Global SCP impacts a company in several ways. Responding to these impacts is a costly
process, both in terms of money and resources. Despite this, companies realize benefits that
make it worthwhile, such as:
Better Solutions
A global planning model allows for global optimization and leads to better solutions, such as
reduced lead-times and greater order fill rates.
• Factory A (Region 1) 100 this week, 100 next week

• Factory B (Region 2) 100 this week, 100 next week
Consider the fill rates shown—the numbers are Available-To-Promise (ATP) quantities. Assuming
a regional planning and ordering model, Region 1 can only view the ATP quantities from Factory
A, and Region 2 can only view the ATP quantities from Factory B. Suppose there is an order for
150 units to be delivered this week, and 150 to be delivered next week. If either Region 1 or 2
receives the order, they cannot fulfill the order, and it may have to be backordered or lost. On the
other hand, in a global planning (and ordering) model, both regions have access to the entire
table and that same order is fulfilled.
Improved Performance Management

Information sharing, visibility, and data availability lead to efficiencies and facilitate performance
management in the extended end-to-end supply chain—including common training, processes,
systems, metrics, and culture. Trading partner performance can then be measured by the overall
value the partner contributes to supply chain effectiveness. For example, partners can measure
their distributors on overall stocking and inventory effectiveness.
Increased Procurement Leverage

Global planning, made possible by an effective SCP model, allows the organization to understand
the volume of business it does with each supplier, i.e., direct and indirect materials. In a regional
model, different regions may be procuring the same items from the same suppliers, but in small
quantities. By aggregating such purchases, the organization has better leverage to reduce its
procurement costs. They may also extend this leverage to include other products and services,
e.g., transportation.
Topic Summary
• Among the drivers for business globalization are the emergence of a global economy and
the Internet, international trade agreements, tax laws, and labor laws.
• Globalization impacts supply chains in numerous ways, such as: increased lead-times
and planning complexity; a larger number of network nodes; and the need to integrate
multiple cultures and business practices.
• Organizations are using global supply chain planning as a means to respond to these
challenges. Global SCP implies a single planning model for the organization that
considers global demand and supply options to optimize the company's supply chain
plans. Some companies have integrated information systems, streamlined business
processes, and overhauled supply chain configurations to meet customer needs.
• Global SCP has helped leading companies reduce long lead-times, increase customer
order fill rates, and realize additional savings—e.g., through increased procurement
savings and transportation leverage.
COLLABORATION
Overview
Companies must effectively connect with customers and suppliers to retain competitiveness.
Without collaboration, buyers often surprise sellers with cancelled orders or with order quantities
inconsistent with forecast; sellers continue to surprise buyers with unmet delivery commitments or
short quantities. This happens when buyers and sellers do not share information about their
plans. This sharing of information is known as collaboration.
Over the past ten years, many companies have invested substantially within the "four walls"
(within their own organizations) as a result of Enterprise Resource Planning (ERP) and SCP
initiatives. They are now realizing that extended trading partner collaboration is also imminent and
a key driver to realizing benefits. In fact, of 105 companies surveyed by Meta Group, 51 percent
are currently engaged in some type of collaboration, 19 percent are in the piloting stage, and 25
percent are either planning or interested.*
*Market Study: Meta Group, The State of Collaboration, 2001.
What is Collaboration?
Collaboration involves the strategic and tactical sharing of information between trading partners
for the purpose of developing a joint plan of action, and then working together to execute that
plan. By sharing information and integrating processes, trading partners strive to eliminate
inefficiencies. Plans are shared more and more throughout the supply chain as a result of
collaboration.
Example
Marketing is considering whether to run a promotion for certain products, with the
potential for a 10 percent lift in sales. Using SCP simulation capabilities, the company
runs a feasibility check to determine if they have the internal manufacturing capacity to
meet increased demand. Although internal manufacturing capacity is available, the plan
runs up against a constraint on the availability of a key component from one of their
suppliers in the Far East. Supply Planning immediately shares the new plans with the
vendor who is able to modify its supply plan to resolve the constraint, making it possible
for Marketing to plan the promotion. In this case, collaboration between trading partners
removes the "silo-based" approach to SCP in which different entities in the supply chain
generate plans in isolation without considering the effect on other functions.
Types of Collaboration
Companies collaborate with one another in various ways. We will discuss five types of
collaboration:
• Demand Collaboration - synchronizing output with customer demand
• Supply Collaboration - synchronizing suppliers and their capacity with production

material needs
• Manufacturing Collaboration - sharing information to enable real-time joint decision

making so that manufacturing produces exactly what is needed when it is needed
• Logistics Collaboration - coordinating logistics providers to align

transportation/fulfillment activities with supply, manufacturing, and demand
• Design Collaboration - R&D and Operations working jointly, and with suppliers and
customers, on design issues
Demand Collaboration
Prior to developing the demand forecast for a business, trading partners share information such
as:
• What their customers, e.g., retailers, think they can sell to consumers
• More specific sales information, e.g., what specific colors are popular at a particular store
versus what colors are still sitting on the shelf
For demand collaboration to be effective, vendors and customers jointly develop a business plan.
They collaborate on demand forecast, promotions, and order forecast, as well as generate
purchase orders (customer) and sales orders (vendor). Exceptions are identified automatically
and both parties are notified electronically
By engaging in such collaboration, companies can increase demand forecast accuracy and
quickly resolve any demand discrepancies. They can also use this information to lower inventory
levels and improve customer service and sales.
Type of Information
Type of Collaboration Benefits
Shared
Demand Collaboration Sales Forecasts, • Increase accuracy and trust in forecasts
Promotional Plans, Point- • Solve demand discrepancies upfront
of-Sale (POS) Data, • Improve customer service
Business Goals, Orders, • Increase sales
Inventory • Lower inventory levels
• Provide internal and external visibility and
hence improve responsiveness of supply
chain
Supply Collaboration
Companies on the leading edge of SCP often share relevant information with their suppliers to
respond to unforeseen circumstances and perhaps avert a small or large production catastrophe.
If the company knows a supplier's available capacity, for instance, they can plan for unforeseen
demand. In turn, they should share their order and replenishment plans with suppliers so that
they can plan accordingly. In addition, if the company's plans change, they should immediately
provide the suppliers with updated visibility.
Type of
Type of
Information Benefits
Collaboration
Shared
Supply Inventory Status, • Enhanced supply visibility and rapid response to unforeseen
Collaboration Capacity supply constraints
Availability, Order • Optimized relationships with multiple suppliers resulting in:
and o Preferential allocations from a supplier during times
Replenishment of short supply
Plans o Improved continuity of supply for critical components
without substitutes
o Minimized order lead-time and procurement cycle
time
Example
An overseas shipment consisting of critical subcomponents has been delayed. Plants in Illinois,
California, and Pennsylvania urgently need those components to continue production. Logging
into a newly designed system, the manufacturer looks at a partner suppliers' available inventory
and determines that there is enough inventory to support immediate needs. Despite the fact that
these items have to be air-freight, which increases costs, the manufacturer makes the decision to
procure the materials and continue production.
Manufacturing Collaboration
Many consumer electronic manufacturers, known as Original Equipment Manufacturers (OEM),

outsource much of their manufacturing to other companies, sometimes known as an Electronic
Manufacturing Services (EMS). Since the OEM is the supplier of the final product to the
consumer, they cannot afford any surprises in the orders that they place with the EMS. The OEM
operates under the assumption that the product will be available on the dates they have
requested it from the EMS, unless they hear otherwise.
Leading SCP companies now model the EMS in their OEM planning systems as if the EMS is
one of their own facilities. The OEM also plans the production at the EMS facility. They
automatically identify exceptions and electronically notify both parties.
Type of Information
Shared
Manufacturing Manufacturing Orders, • Enables firms to get out of the reactive
Collaboration Material Availability, "fire fighting" mode of operation
Capacity Availability, Bills • Improves return on assets because
Of Material, Engineering company is able to outsource non-core
Change Orders competency work
• Lowers manufacturing costs
Logistics Collaboration
Efforts to collaborate with customers and suppliers are only successful if the product is delivered
to customers when they want it. To reduce the uncertainty in this process, some companies also
engage in collaboration with their logistics providers, sharing their demand plans so the logistics
providers can ensure transportation capacity is available when needed. The logistics providers
share their resource availability with the manufacturers so that the manufacturer can use the
information in quoting accurate delivery dates to customers.
Type of Information
Shared
Logistics Collaboration Demand Plans, Inventory • Decrease in order-to-ship cycle times
Status, Transportation • Decrease in days-on-hand inventories
Resource Availability • Service levels in retail channels at plan
Example
Suppose a customer places an order and wants to know the delivery date. The manufacturer
looks up the transportation information and provides the customer with options, such as:
• The order can be delivered in seven days, and will be shipped by truck
• The order can be delivered in two days, will be air-flown to the nearest location, and
shipped by truck from there
The customer decides to air-fly the product to receive it five days earlier. The manufacturer is
able to provide an accurate delivery date because their logistics providers have shared their
resource and capacity availability.
Design Collaboration
In this type of collaboration, Operations and R&D work together, with suppliers and customers, on
design issues. Customers provide information on new product requirements, and suppliers
provide information on the cost of materials for the new product. Operations ensures that new
products are designed in a manner that ensures effective sourcing and 'quality manufacturing.'
The manufacturer and R&D are responsible for ensuring the manufacturability of the design as
well as the product specifications.
Collaborative design helps companies reduce product development cycle times because
suppliers, designers, and customers work from the same data, and they can quickly integrate
feedback into the development and manufacturing cycle. Furthermore, companies identify
preferred suppliers early in the process, which will eventually lead to reduced material and
procurement costs.
Type of Information
Shared
Design Collaboration Market Research, • Suppliers, designers and customers work
Product/Design from the same data, documentation, and
Information, Engineering drawings
Drawings/Models, • Feedback is obtained rapidly from the field
Prototypes and is integrated into the development and
manufacturing cycle
• Product development cycles are
dramatically reduced by integrating
suppliers and customers into the
development process
• Procurement transaction and material costs
are reduced by centralizing and
standardizing preferred supplier
information, component data, and supplier
performance
• Early collaboration avoids costly and time-
consuming engineering change orders
(ECO)
Example
Consider a manufacturer that wants to introduce a new 13" television. The manufacturer is not
sure whether or not the television should have a built-in DVD player. Due to their proximity to
consumers, retailers understand consumer wants and needs. Both the retailer and the
manufacturer have a common objective—satisfy consumer requirements. Unless the
manufacturer and retailer collaborate during the design process, the end result is unlikely to
accomplish this. Collaboration between these trading partners helps them design a product that
more accurately represents customer requirements.
The Leading Edge of Collaboration
While most companies collaborate in one form or another, trading partners benefit more or less
depending on the extent of that collaboration. "Leading Edge" companies involved in advanced
collaboration achieve more significant benefits than those lower on the continuum, referred to as
"Basic" and "Progressive."
Demand Collaboration
BASIC PROGRESSIVE LEADING EDGE

Collect customer's monthly sales Access the customer's Suppliers and customers jointly develop a
forecast and compare it to internal weekly or daily sales data business plan by collaborating on demand
forecasts at sales & operations electronically and use it 'as- forecast, promotions and order forecast.
(S&OP) planning meeting. is' to provide input to They compare one organization's initial
internal demand planning plans with the other's—including previous
process. plans and actual results—so they can
manage variances in real-time. Companies
also participate in sharing long term and
mid-term forecasts with their suppliers to
provide visibility into longer-term plans.
Supply Collaboration

E-mail weekly material
Advanced Planning and Scheduling
Share quarterly or monthly material replenishment plans and
(APS) system with links into a supplier's
replenishment forecasts with a forecasts to a supplier and
ERP system that enables real-time (or
supplier and ask whether they will address exceptions with
close) confirmation of production plans,
be able to provide the material. them on weekly a
and inventory and order status.
conference call.
Manufacturing Collaboration

Place monthly manufacturing Manufacturing maximizes Manufacturing operates from lean
orders and issue engineering asset utilization by inventory and ensures that it has
change orders as needed. participating in sales and complete visibility into any changes to
operations planning the demand plans. It also shares any
meetings. changes to such plans with external
manufacturers.
Logistics Collaboration

After building shipments from Shipper shares order forecasts Supplier and customer jointly
orders, shipper contacts carrier to and shipment plans with collaborate with the carrier to create a
tender the shipment. carrier and its trading partner logistics plan, share order and shipment
so they can both use the forecasts, and execute shipment
information in their own tenders, pickup, delivery, payment, and
planning processes. performance management activities.
Design Collaboration

R&D shows prototype product Collaborative Product Commerce
R&D periodically collects
designs to suppliers and/or (CPC) system enables customers,
consumer/market insights about a
customers and solicits design suppliers and manufacturers to
product when designing the next
feedback. simultaneously collaborate on a
generation of the product.
product's design online.
Benefits of Collaboration
Collaboration reduces costs, increases asset utilization, and improves customer service and
revenues. In addition, collaborating partners can achieve the following quantitative and qualitative
benefits:
Reduction of Order to Cash Cycle Time
• Decreased cycle time for communication and decision making

• Faster reaction to unexpected changes in demand or supply
• Ability to meet end-customer needs, increasing revenue and market sharec
Insight into Trading Partner Strategic Plans
• As a supplier, facilitates synchronized focus with customers

• As a manufacturer, visibility to changes in suppliers' capacity or priorities
Optimized trading partner relationships
• Increased accuracy in demand forecast

• Reduced inventory requirements across the supply pipeline due to accurate, timely
projection of needs
• Planned service levels from suppliers, including improved availability and reduced or
favored pricing
• Minimized product development cycles and fewer engineering change orders with
manufacturing partners
• Decreased order-to-ship cycle times
• Ability to meet planned service levels from logistics partners
Creation of Benefits Through Collaboration
Each type of collaboration drives supply chain activities that generate different types of benefits.
Topic Summary
There are five types of collaboration:
• Supply Collaboration
• Manufacturing Collaboration
• Design Collaboration
• Logistics Collaboration
• Demand Collaboration
Companies may engage in one or more types of collaboration. The greater the collaboration
between companies, the greater the benefits for all trading partners. Some benefits from
collaboration include:
• Insight into trading partner strategic plans Optimized trading partner relationships
resulting in increased demand forecast accuracy, lower inventories, and improved service
levels
• Reduction of order-to-cash cycle time
FINANCIAL OPTIMIZATION
Overview
Manufacturers often face the business problem of allocating scarce resources while meeting
customer demand. Most companies must make trade-offs, allocating these scarce resources to
optimize business objectives. While finding the optimal solution to supply chain planning
problems is not always possible, companies use financial optimization techniques to accomplish
this.
Drivers for Financial Optimization
Companies today are looking to financial optimization to stay ahead of the competition and
increase shareholder value. Solutions that merely generate profit are not necessarily sufficient; if
competitors use optimization techniques to increase their throughput and hence increase profit
margins, they will realize greater benefits. Other reasons companies use optimization techniques
include:
Low Margin Business

Many businesses operate with razor-thin margins. If they can determine how to identify and serve
their most profitable customers, they will achieve greater margins. For instance, financial
optimization is very prevalent in commodity businesses.
Varying Cost of Resources

In many capital-intensive organizations, the cost of goods sold (COGS) is significantly influenced
by the resources utilized during production. For example, a motorcycle manufacturing facility's
paint-shop could have two different painting resources—one that uses older technology and
another that uses newer technology. The cost of production using the older resource is usually
significantly higher than using the newer resource. Using financial optimization techniques, the
manufacturer would be able to determine how to optimize the use of multiple resources.
Asset Optimization
Some industries prioritize the optimal use of assets over managing inventories. For example, the
production process in the paper industry consists of essentially two steps: first, cut trees and
convert them into paper; and, second, imprint the paper, cut it to the right shape and size, and
then use it, e.g., by putting it onto a juice carton. The capital investment in the machines as well
as the stopping-and-restarting costs is very high, while the carrying cost of excess inventory is
relatively low. Hence, the paper industry's number one priority is continuous use of the machines.
Optimization
Optimization models seek the "best" answer to a problem by using a variety of mathematical
techniques. Such models seek to maximize a business objective, such as profit, while staying
within the constraints of the business.
Companies use a variety of techniques to achieve optimization. Complete enumeration by hand,

i.e., looking at every conceivable combination of variables in a problem, is only possible for the
most basic problems. More commonly, companies today use mathematical algorithms to achieve
optimization, including: computer-based linear programming, network optimization, integer
programming, mixed-integer linear programming, and non-linear programming techniques.*
Optimization approaches are most useful when it is important not only to find feasible solutions,
i.e., that do not violate any constraints, but that also meet business objectives, such as to
minimize cost or maximize profit.
Wagner, Harvey M. 1975. Principle of Operations Research. 1st ed. Englewood Cliffs: Prentice Hall
Winston, Wayne L. 1991. Operations Research: Applications and Algorithms. 2nd ed. PWS Kent
Optimization Scenario – Profit Maximization
A manufacturer of children's toys is considering making two types of toys: soldiers and trains.
They can sell a soldier for £15 and a train for £17. The cost of raw materials for a soldier is £12
and for a train is £15. Manufacturing each toy requires two types of operations: carpentry and
finishing. A soldier requires one hour of carpentry and two hours of finishing labor, whereas a
train requires one hour of carpentry labor and one hour of finishing labor. While the manufacturer
has an unlimited supply of raw material, they have a maximum of 80 carpentry hours and 100
finishing hours available per week.
Trains are in great demand, with unlimited sales potential, but soldier demand tops out at 40
soldiers per week. The manufacturer must determine how best to use available resources to
maximize profit. Given the constraints on labor, they will have to make some trade-offs on what to
manufacture.
Feasible Solution
One feasible solution is to manufacture 40 soldiers and as many trains as possible—for
example, make 40 soldiers and 20 trains for a total profit of £160. This may seem like the
right solution since the contribution margin of a soldier is £3 per unit and that of a train is
£2 per unit. But this solution may not maximize profit.
Maximum Profit Solution

An alternative approach is to use optimization techniques to formulate a model for this
problem and then obtain an optimal solution. By using such a technique, the optimal
solution would be to make 20 soldiers and 60 trains for a total profit of £180. This solution
provides a higher overall profit even though it manufactures more of the product (trains)
with a lower contribution margin. This optimization approach searches for the best
allocation of labor to the different products that will maximize overall profit.
Optimization Scenario – Cost Minimization
Review the following scenario about a company, which manufactures high-end bicycles, and think
about how the company could minimize costs.
The Demand for these high-end bicycles over the next four quarters is:
Quarter 1 Quarter 2 Quarter 3 Quarter 4 Total

40 70 50 20 180
Bicycles produced in a quarter can be used to satisfy demand for that quarter as well as
subsequent quarters, e.g., bicycles produced in Q1 can be used to satisfy demand in Q1 as well
as Q2, Q3, or Q4.
Costs - The bicycle manufacturer has determined that they incur the following types of costs:
• £400 to manufacture each bicycle

• £100 per bicycle at the end of each quarter for a holding cost
• £700 per bicycle if production is increased from one quarter to the next
• £600 per bicycle if production is decreased from one quarter to the next
Inventory - During the quarter preceding Q1, they manufactured 50 bicycles and sold all of them
in the same quarter—thus, bicycle inventory at the beginning of Q1 is zero. Since all demand
must be met on time, the manufacturer strives to develop a production plan that will minimize total
cost during the next four quarters. In solving this problem, the manufacturer wants to balance the
cost of carrying excess inventory against the cost of increasing/decreasing production from one
quarter to the next.
Feasible Solution
One feasible solution is to manufacture just enough bicycles every quarter so that they won't
incur any inventory carrying costs. However, this will lead to high costs for increasing/decreasing
production after each quarter.
Minimum Cost Solution

Using optimization techniques, the manufacturer can solve this problem and get an optimal
solution that requires them to manufacture 55 bicycles during Q1, 55 during Q2, 50 during Q3,
and 50 during Q4—for a total cost of €95,000. This implies a total production of 210 bicycles
whereas the demand is only 180 bicycles. Bringing the inventory down to zero at the end of Q4
will mean decreasing production during Q4, which will lead to very high production costs—
because they incur a cost of €600 per bicycle if production is decreased from one quarter to the
next. Rather than incur this high cost, the optimal solution is to hold an inventory of 30 bicycles at
the end of Q4.
Alternative Approaches – Heuristics and Simulation Techniques
Optimization models are time and resource intensive. Typical supply chain solutions generated
today leverage alternative approaches, such as heuristic algorithms and simulation techniques
that employ approximations and generally accepted principles to quickly search for satisfactory
rather than optimal solutions.
Heuristics - Heuristic algorithms employ logical short cuts and computational procedures that
restrict the number of alternative solutions to a problem. Hence, decision makers can frequently
reiterate a plan to make faster decisions. In turn, these decisions render feasible solutions that
meet certain pre-established business criteria.
Simulation Techniques - Some companies are actively using simulation techniques to get even
better solutions. They use probabilistic techniques to model a company's environment, evaluate
that under many scenarios, and then determine the best available solution based on the
simulated scenarios. Simulation is generally used when there is uncertainty in some of the
information, be it outcomes or availability of resources—e.g., capital or labor. If a company
expects a product's demand to fall within a certain range, they could use simulation to model and
evaluate the effect of different demand numbers in the said range. Simulation tools vary from
simple spreadsheet models to large probability theory-based algorithms.
Combining Optimization and Alternative Approaches
Traditionally, companies have not used optimization because generating optimal solutions
requires complex models and is time consuming. Most optimization models in the past also
assumed that the information presented to the model was known with certainty, which was not
the case in any real business situation. As things changed in real time, therefore, companies
were unable to respond quickly.
Companies utilizing today's "best practice" approach combine both heuristics and
optimization, enabling them to reap the benefits of cost/profit optimizing solutions while
responding quickly to changes in the marketplace, leading to improved margin performance. By
performing optimization on a weekly or monthly basis, they employ heuristics more frequently,
such as daily or weekly, to determine a feasible solution. This allows the company to continue
operating within the optimal solution's established guidelines as well as meet demand.
Companies also benefit from this approach in the consistent application of established guidelines.
For example, when a company is operating under allocation rules, these rules can be established
based on profit maximization. Hence, they avoid allocating goods based on "whoever is yelling
the loudest" or on personal relationships. This approach also reduces the number of "maverick
solutions" in an organization.
Best Practice Example
Imagine that a manufacturer has two manufacturing plants in Bangkok and Taiwan, two
distribution centers in Kuala Lumpur and Manila, and two customers in Calcutta and Hong Kong.
The initial inventory in Kuala Lumpur is 100 units, and this stock should be maintained as a safety
stock to compensate for the volatile demand pattern of the Calcutta customer. Demand for the
Calcutta customer is forecasted as 500 units for the month at a rate of 125 per week, and for the
Hong Kong customer at 400 per month at a rate of 100 per week. We also know that the Bangkok
plant can produce 400 units per month, or 100 per week, and the Taiwan plant can produce 800
units per month, or 200 per week.
Best Practice Example – Optimal Solution
The company runs a optimization engine to find an optimal solution that minimizes the cost of
satisfying customer demand for that month.
The result of the optimization process using the Supply Chain Parameters (button below)
produces an initial monthly optimal solution (button below).
Initial Monthly Optimal Solution
Best Practice Example – Impact of Increased Demand
At the end of two weeks, the Calcutta customer has already ordered 300 units—50 more than the
forecast of 250. The Kuala Lumpur DC uses some of its safety stock to satisfy the higher demand
and now has only 50 units in inventory. The manufacturer revises the forecast for the Calcutta
customer to 100 per week for the next two weeks, and also runs a heuristic algorithm for each
week. They determine that the best way to increase the inventory at Kuala Lumpur is to order the
extra 50 units immediately from the Taiwan plant, because it has excess capacity, and not have
them ship anymore after that.
Optimal Solution for Week 3 and 4
As a result of combining optimization and heuristics, the company continues to operate within the
guidelines established under the optimal solution, and yet is able to respond to changes in
demand that have occurred. They are now able to reap the benefits of an optimal-cost solution
and yet respond quickly to changes in the marketplace.
Topic Summary
Companies are turning to financial optimization to stay ahead of their competition and increase
shareholder value. These companies use optimization techniques to achieve profit maximization
and/or cost minimization. Many industries prioritize optimal asset utilization over inventory
savings because of the costs associated with purchasing, operating, and maintaining those
assets.
Companies employing leading practices combine optimization techniques with heuristic

algorithms—using optimization to develop the optimal solution and heuristics to respond to
market changes, while staying within the guidelines established by the optimal solution.
POSTPONEMENT
Overview
Postponement helps companies reduce exposure to inventory problems. Leading edge

companies utilize postponement techniques to delay product differentiation until a point further
along the supply chain. These techniques allow companies to optimize supply inventories—
sometimes with drastic inventory reductions—and ensure the supply chain's ability to meet
customer service requirements.
There are two primary postponement strategies:
• Form Postponement - stocking work in process (WIP) and sub-assemblies closer to the
customer, delaying conversion to finished goods until a firm order is received
• Location Postponement - stocking finished goods centrally, delaying inventory moves
until a firm order is received
These strategies and the techniques to achieve them have an impact on supply chain planning
processes and modeling decisions.
Impact of Inventory on Profitability
Supply chain inventories have a direct impact on company profitability in a number of ways:
• When inventories are too low, customer service suffers and revenue declines;
conversely, high inventories result in excess carrying charges.
• Inventories tie up working capital that could be more profitably used elsewhere.
Ultimately, excess inventories may create liquidity problems and even lead to bankruptcy.
• A company can have both too much and too little inventory. This occurs when they invest
in the "wrong" inventory items—i.e., too many items not required and too few of those
needed. A company can only ensure that it does not have the "wrong" inventory by not
carrying any inventory at all and manufacturing the product only when they receive an
order. Unfortunately, this is not always possible.
Impact of Inventory on Profitability
The graph below illustrates that both too little inventory and too much inventory have a negative
impact on profitability.
If inventories are too low, customer service suffers and revenues decline.
The width of the profitable region varies by industry. Retailer profitability is particularyly sensitive
to inventory levels. Manufacturers tend to be much less sensitive.
It is not unusual for a company to have both too much and too little inventory. This occurs when
inventory is invested in the "wrong" items.
When inventories are too high, excess carryin charges are incurred. Also, inventories tie up
working capital that could be more profitably used elsewhere. Ultimately excess inventories may
create liquidity problems and even lead to bankruptcy.
Postponement Strategies – Form Postponement
Form postponement entails stocking work in process (WIP) and sub-assemblies closer to the
customer. The company delays actual conversion to finished goods until a firm order is received.
Consider the case of a brewery that bottles its beer in 12 oz bottles and by six-pack and 12-pack
only. Compare the following scenarios:
Postponement Strategies – Location Postponement
Location postponement entails stocking finished goods centrally. A company delays inventory
moves until firm orders are received—refer to the figure shown. Consider the brewery in the
previous example that stored inventory at the distribution centers and the retail outlets. Let's
assume they have one distribution center (DC) and three retail outlets. Compare the following
scenarios:
Impact of Postponement on Planning
When a company uses postponement techniques, SCP is impacted in various ways, including:
Supply Chain Network Configuration

The typical supply chain discussed thus far has been based on the principle that a company
makes a product, stores it, and then sells the product, i.e., make-store-sell. During postponement,
however, the supply chain network configuration changes. Now the company may manufacture
and store some intermediate products, and finish manufacturing the products closer to the points-
of-sale. The new paradigm becomes make-store-make-store-sell; that is; they make and store
intermediate products, then manufacture the finished goods, store them again, and then sell
them.
Distribution Network and Strategy

As a result of the new paradigm, distribution strategy is impacted. Supply planning (distribution
and inventory planning) is now conducted for intermediate goods as well as finished goods.
Furthermore, capacity planning now has to consider the ability to produce the intermediate
products as well as the finished goods, often at different locations.
Forecasting
The use of intermediate goods is equivalent to aggregating several SKUs into one SKU. Thus,
forecasting is now done at aggregated levels and not by item and customer. This tends to make
the forecast more accurate and thus provides for better planning throughout the supply chain.
Furthermore, forecasting (and production) of the final SKUs is delayed until closer to the demand
signal, making the SKU forecast more accurate as well.
Summary of Postponement Impact on SCP Processes
Demand Planning Supply Planning Production Planning
• Forecasting is
• Distribution plan for SKUs
Without done for each • Manufacture SKUs
• Inventory plan for SKUs
Postponement SKU
With • Forecasting • Distribution plan for • Manufacture

Postponement done at an intermediate SKUs intermediate SKUs
aggregated • Inventory plan for • Manufacture final
level intermediate SKUs SKUs
• Forecast for • Distribution plan for SKU
SKUs delayed • Inventory plan for SKUs
until later, or • Move inventory upstream
until better in the supply chain, closer
demand signal to manufacturing point
is available • Inventory plans are now
developed using advanced
inventory theory
techniques, i.e., multi-
echelon inventory theory
Ways to Achieve Postponement
Companies use postponement concepts to drive business benefits and delay customization
features. All supply chains are effectively a mix of Make-To-Stock (MTS) and Make-To-Order
(MTO) environments, because most companies manufacture the product to a certain point based
on forecast (MTS), and then complete the product to the specifications of an order (MTO). The
leading practice is to use postponement to determine the optimal separation point. Companies
achieve this using one or more of the following techniques:
• Re-sequencing
• Differentiate-to-order
• Push-pull
• Commonality
Ways to Achieve Postponement – Re-sequencing
Re-sequencing changes the product sequence to delay the riskiest differentiations until the point
at which better information becomes available.
For example, a fashion apparel manufacturer can forecast relatively accurately the total number
of a particular style of sweater they will sell in the fall season. When they try to forecast sweaters
by color, however, they can be significantly inaccurate, resulting in end-of-season merchandise
that must be sold at clearance prices.
One leading fashion apparel manufacturer was buying dyed cotton and wool in many colors and
then weaving the sweaters. To mitigate for the uncertainty in color demand, they changed the
order of production, dyeing the sweaters after they were weaved, and waiting until later to predict
color and dye the sweaters. With this simple step, they were able to reduce forecast errors and
inventory levels, while improving customer satisfaction levels.
Impact of Re-sequencing on Planning
In the sweater example, re-sequencing follows the new paradigm—weave-store-dye-store-sell.

Forecasting is now done at the aggregate level (weave), and the forecast for the final product is
delayed until a better demand signal is obtained. In the case of the sweaters, the demand signal
is unlikely to be actual orders and more likely to be point-of-sale (POS) data.
Consider the impact of re-sequencing techniques on supply chain planning activities:
Without Re-sequencing

• Forecast SKUs, e.g., • Inventory plan for
• Manufacture SKU
red sweaters, blue each SKU—colored
(dye-weave)
sweaters, etc. sweater
With Re-sequencing

• Inventory planning • Manufacture
• Forecast at aggregate
for aggregated items aggregate items and
level (sweaters)
(sweaters) SKUs
• Delay forecast of color
• Reduced number of • Different production
until POS data is
subassemblies planning route
obtained
and/or components (weave-dye)
Ways to Achieve Postponement – Differentiate to Order
Differentiate to order is the process of producing, and possibly distributing, undifferentiated

intermediate goods and then completing the finished goods to order.
A simple example is paint. Very seldom does a do-it-yourself (DIY) paint store stock all colors,
except the most basic colors. Instead, they mix the paint at the store according to consumer
specifications, thereby differentiating to order.
Impact on Planning
When the number of SKUs is reduced, as in the sweater example, companies plan at the
aggregate level and therefore forecast more accurately. They also develop distribution and
inventory plans for aggregated items.
Consider the impact of differentiate-to-order techniques on supply chain planning activities:
Without Differentiate-to-order

• Forecast SKUs • Inventory plan for each
• Manufacture SKU
(each color of SKU (each color of
(each color of paint)
paint) paint)
With Differentiate-to-order

• Forecast at
aggregate level
(basic paint colors) • Manufacture
• Inventory planning for
• No forecast for aggregate items and
aggregated items (basic
SKUs needed complete SKUs closer
paint colors)
because they are to point of sale
manufactured to
order
Ways to Achieve Postponement – Push-pull
Referred to as push-pull, a manufacturer uses actual demand data to drive the supply chain back
to a certain point, and then waits for a pull signal to complete the order.
For example, a computer manufacturer knows that customers typically configure their computers
based on speed of the processor, hard disk capacity, and the amount of memory (RAM), while
other components are undifferentiated. The manufacturer thus forecasts the number of total PCs
that it will sell in the market along with the requirements for all its components—except
processors, RAM, and hard disks—that they forecast separately. The manufacturer then pushes
the production of the undifferentiated PCs and completes the PCs when it receives actual
customer orders, i.e., pull signal.
Impact on Planning
Instead of forecasting each possible PC configuration, the company forecasts the sale of
undifferentiated PCs (aggregate level—increased forecast accuracy), as well as the number of
each differentiable component (RAM, processor, hard disk—increased forecast accuracy).
Furthermore, the company plans inventory for the undifferentiated PCs and the differentiable
components rather than for each individual configuration of the PC. Consider the impact of push-
pull techniques on supply chain planning activities:
Without Differentiate-to-order

• Forecast SKUs (each • Inventory plan for each SKU • Manufacture SKU (each
configuration of PC) (each configuration of PC) configuration of PC)
With Differentiate-to-order

• Forecast at aggregate • Inventory planning for • Manufacture aggregate
level (undifferentiated aggregated items items (undifferentiated
PC) (undifferentiated PC) PC) and complete SKUs
• No forecast for SKUs • Material plan for differentiable closer to point of sale
needed because they are components (RAM, (actual customer order)
based on customer order processors, hard disks) • Two-step assembly
process (assemble
undifferentiated PC first,
then complete based on
customer order)
Ways to Achieve Postponement – Commonality
Commonality delays the differentiation point by standardizing parts and processes.
For example, a leading printer manufacturer was manufacturing printers with different power
supplies for their U.S. and European customers. However, they found that they were unable to
meet customer requirements in spite of carrying large inventories—consistently having the
"wrong" printers on hand; for instance, if they received an order from a European customer, they
frequently found themselves stocked out of European printers but with excess inventory of U.S.
printers.
A primary reason was that while their forecast for total printer sales was very accurate, they could
not forecast specific printer demand accurately. By shifting to dual-voltage power supplies, they
were able to eliminate an important point of differentiation between U.S. and European printer
models, reduce total inventories, and increase fill rates.
Impact on Planning
The biggest impact of commonality is that it reduces the number of items that companies forecast
and manufacture. This has the same impact as forecasting at an aggregate level which increases
the forecast accuracy. In the printer example, forecasting total printer sales is significantly more
accurate than forecasting sales of individual printer types (European and U.S.). In addition, the
company reduces the number of raw materials or components needed.
Consider the impact of commonality techniques on supply chain planning activities:
With Commonality

• Inventory plan for each
• Forecast SKU (U.S. • Manufacture SKUs (U.S.
SKU ( U.S. printer,
printer, European printer) printer, European printer)
European printer)
Without Commonality

• Forecast at aggregate • Inventory planning for
level, i.e., printers aggregated items (printers)
• Reduced number of • Manufacture aggregate
subassemblies and/or items (printers)
components (one type of
power supply)
Tying Postponement with Financial Optimization
In most cases, postponement and financial optimization are related. Consider a computer
manufacturer that allows customers to customize their own computers. This is financially feasible
and even optimal for this company. The marginal utility to a customer of choosing their own
computer attributes is higher than the savings they would realize if the company built in those
attributes, which would limit the number of configurations from which customers could choose. In
other words, in this situation customers are willing to pay a higher price for customizing to their
own preferences. This is equally attractive for the manufacturer because they can recover the
cost of postponement and better serve their customers.
Topic Summary
Inventory levels have a high impact on company profitability, revenues, and customer service. To
alleviate some of the issues associated with inventory, companies are using both form and
location postponement techniques to optimize inventories and ensure the supply chain's ability to
meet customer requirements. Companies achieve this in four ways:
• Re-sequencing - change the product sequence to delay the riskiest differentiations

• Differentiate to order - produce, and possibly distribute, undifferentiated intermediate
goods and complete differentiation to order
• Push-pull - use actual demand data to drive the supply chain back to some point
• Commonality - delay the differentiation point by standardizing parts, products and
processes
Some of the benefits of postponement include:
• Reduced waste and obsolescence

• Decreased inventory levels
• Increased customer order fill rates
• Improved forecast accuracy
CONCLUSION
Course Summary
In this module, we have discussed several leading practices in the supply chain arena:
• Global SCP - the use of a single planning model in a global business environment to
facilitate supply-demand match and information sharing throughout the organization.
• Collaboration - extending the use of a single planning model beyond the entities within a
given organization. By sharing information and collaborating on several dimensions with
customers and suppliers, all partners achieve benefits.
• Financial Optimization - Companies are increasingly looking to create financially

optimal solutions to plan their activities and establish operational guidelines. Companies
using today's "best practice" reap the benefits of cost/profit optimizing solutions (using
optimization techniques) while responding quickly to changes in the marketplace (using
heuristics techniques).
• Postponement - delaying the production of completed goods until a better demand

signal is received.

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SUPPLY CHAIN PLANNING: DEMAND

The primary business issues addressed by demand planning include:

Demand, supply, production, and fulfillment planning operate as interdependent SCP

After completing this module, you should be able to:

• Describe the purpose, objectives, and benefits of demand planning

• Describe the demand planning process and identify the stakeholders

• Describe key concepts related to demand planning activities, including planning

• Define demand forecasting techniques

• Describe the measurements and metrics for demand planning

Demand planning helps a company develop their best estimate of:

• What customers will want

1. Finance revises its forecast to $7,950

2. Sales increases its forecast by focusing on customer acquisition

o Sales then needs to determine which customer(s) to target during what

Demand planners commonly use exception-based management to organize a large

1. Reallocating the demand to other SKUs (allocation is discussed later in this

Another commonly used method of product analysis is known as ABC classification.

Beyond demand planning, ABC classification is used in conjunction with forecast

Performance monitoring is a fundamental and necessary part of achieving high marks in

• How often is the forecast updated?

• Operational Forecast - Used to drive the business operations and to understand

• Product Family - Trousers

• Product Category - Jeans, Casual, Business

• Color - Blue, Gray

Companies also commonly develop a geographical hierarchy, typically used to segment

• Company - Clothing Manufacturer

• Region - Southern, Midwest, West

• Location - Dallas, Atlanta, San Francisco

• Customer - Store 1, Store 2

The figure depicts a graphic representation of a geographic hierarchy.

A simplified version of the women's trousers example follows:

• Product Family - Trousers

• Product Category - Casual, Business

• Color - Blue, Black

Similarly, the forecast must be aggregated up to the product family level.

This is known as middle-out.

• Demand Planning Horizons - the frequency at which a company updates the

• Forecast Bucket Granularity - whether the demand forecast predicts demand

• Level of Forecast - the level at which product and geographical hierarchy

Organizations must consider a number of factors to arrive at an accurate demand plan.

It is also important for companies to consider appropriate demand forecasting

Point-of-Sales Data (POS)

Marketing uses many types of promotions, such as:

Free Standing Inserts (FSI)

Model Close Out

• New Product Introductions

• Qualitative Methods - The process of forecasting demand based on "market

o Promotions - Planners may know from experience that a marketing

o Manual Forecasts - Some companies may simply use their sales

• Quantitative Methods - The process of using statistical methods to forecast

The simple exponential smoothing procedure creates a forecast based on a weighted

Forecast (t+1) = α*Actual (t) + (1- α)*Forecast (t)

Forecast (3) = α *Actual (2) + (1- α)*Forecast (2)

In this example, we use a value of a equal to 0.20. Thus,

Forecast (3) = .2*4910 + .8*4890 = 4894

• Promotion Plans - Marketing is usually responsible for determining the timing

• Substitute Products - Available alternatives to the product that is forecasted.

• Complementary Products - Represent products where the purchase of one

• Collaborative Inputs - Using input from trading partners.

• Qualitative Methods - Based on "market feel."

• Quantitative Methods - Based on statistical models. There are many such

SALES & MARKETING FORECASTS

• Metrics to ensure process is being followed

Forecast (t+1) = αActual (t) + (1- α)Forecast (t)

Forecast (3) = α Actual (2) + (1- α)Forecast (2)

Forecast (3) = .24910 + .84890 = 4894