Supply Chain Management Chapter 1 - Students (1) - Merged

Supply Chain Management
Chapter 1
Umar Farooq
Management Sciences Department
3/5/2021 1
GIK Institute
Course Outline
Text and Reference Books
Text Book:
Wisner, J. D., Tan, K.-C., & Leong, G. L. Principles of Supply Chain Management: A Balanced
Approach (3rd ed.). Mason, OH: South-Western
Reference Books:
Chopra, Sunil, and Peter Meindl. Supply chain management. Strategy, planning & operation. Gabler,
2007.
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Course Outline
Lecture Breakdown
Week Topics Covered
1 Supply Chain Management: An Overview
Introduction to Supply Chain Management Supply Chain Management .The Importance of Supply Chain Management.
The Origins of Supply Chain Management in the U.S. The Foundations of Supply Chain Management. Current Trends
in Supply Chain Management.
2 Purchasing Management
The Purchasing Process. Sourcing Decisions: The Make-or-Buy Decision. Roles of Supply Base. Supplier Selection.
Purchasing Organization. The Transaction Management Foundation.
3 Creating and Managing Supplier Relationships
Developing Supplier Relationships. Supplier Evaluation and Certification. Supplier Development. Supplier Recognition
Programs. Supplier Relationship Management.
4 Operations Issues in Supply Chain Management.
Demand Forecasting. Demand Forecasting. Forecasting Technique. Qualitative Methods. Quantitative Methods.
Forecast Accuracy.
Quiz – 1
5&6 Inventory Management.
Inventory Types. Inventory Types Supply Chain View. Managing Inventories In Supply Chains. Categories Of
Inventory Cost. Inventory Characteristics. The Inventory Management System. The EOQ Model. The EOQ Calculation.
The EOQ Model Annual Inventory Cost Calculation. The Periodic Review Or Fixed Period System.
7&8 Resource Management.
The Resource Management Planning Framework. The Aggregate Planning. The Disaggregation Framework. Materials
Requirements Plan & Inputs. Calculations.
Quiz - 2
9 Mid Term Examination
3
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Course Outline
Lecture Breakdown
Process Management
Lean Operating Systems. The Lean Thinking. The Lean Operating Systems Principles. The Lean
10 Operating Systems Tools & Approaches. Just-in-Time Systems. TQM & Supply Chain
Management.
11 Supply Management Bull-whip effect in supply chains
Managing bull-whip in supply chains• Collaborative planning, replenishment and global visibility
in supply chains• Tactical considerations• Total value perspective• Contract design• Reverse
auctions.
Quiz - 3
12 Information Technology in a Supply Chain
The Role of Information Technology in the Supply Chain. The Supply Chain IT Framework.
Importance of traceability and technologies for SCM monitoring. The Future of IT in the Supply
Chain. Supply Chain Information Technology in Practice. Internet of things (IoT) and Industry 4.0
13 Logistics Management
Define Logistics. Difference between logistics and SCM. Areas of Logistics.
Quiz - 4
14 Project Presentations
15 Project Presentations
16 Case Analysis/Revision
17 Final Exams.
4
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Course Outline
Grading Policy
Announced/Surprise Quizzes/ 10%
Assignment 5%
Project 10%
Class Participation (attendance) 5%
Mid Term Exam 30% -35%
Final Exam 40% -45%
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What is Supply Chain Management?
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Denotation
• What is Supply Chain Management?
• Supply Chain:
 Network of integrated activities and/or processes
used to deliver products and services, from raw
material to final product, to the final consumer.
• Management: (What should we manage?)
Effectively manage back and forth flows;
 Material flow
 Information flow
 Cash flow
• For one common purpose reduce cost and increase
profit
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UK’s biggest delivery company - it had stopped collecting parcels from
retailers as it struggled to deliver the vast volume of online present
shopping
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General Composition of Supply Chain
Three Main Channel entities/Actors
• Supplier
 A provider of raw goods or services.
 e.g. Raw material, Energy, Services, Components. Farmers, Ore
mines, Spare parts manufacturers etc.
• Manufacturer
 Receives raw materials and components to convert it into
finished products
 e.g. Finished Goods manufacturer, Denim industry, Aerospace
Industry, Automobile Industry, Cement Industry, Sugar Industry etc.
• Distributor
 Receives and distribute finished products to final consumers
 e.g. Macy’s, Wall Mart, Nestle, Nike, Cash & Carry etc.
• Customer
3/5/2021
Consume to utilize the final product or services. 12
General Composition of Supply
Chain…Cont.
• Supply Chain includes four main Flows
o Material and services flow

 From suppliers toward customer
o Information Flow
 Information flows both ways
o Cash Flow
 Payment flows from customers toward suppliers
o Reverse Flow????
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General Composition of Supply
Chain…Cont.
Information Flow
Reverse Flow
Rejected or Defected
products
Supplier Manufacturer Distributor Customer

Downstream flow
Upstream flow
Product Flow
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Cash Flow
Introduction –Supply Chain Management
• Network of integrated activities and/or processes used to deliver products and
services, from raw material to final product, to the final consumer.
Origin of Supply Chain Management
• 1930-1950s (Early years of SCM)
 Mass Production age
 Women induction into industries
 Pallet, Pallet Lift and concepts from break-
bulk shipping concepts
 Set the stage for supply chain globalization
• 1950s & 1960s (Quality Era)
 More focus on cost reduction
 Improve productivity
 Less focus on quantity
 Systems innovation
• 1960s-1970s (Integration Era)
 Introduction of computer technology
 Development of software like MRP-I & MRP-II
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Fredrik Taylor
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Origin of Supply Chain Management
1980s & 1990s (Globalization
Era)
 Personal Computers
 Intense global competition led manufacturers to
adopt
 Just-In-Time (JIT),
 Total Quality Management (TQM), and
 Business Process Reengineering (BPR)
practices
2000s and Beyond (SCM 2.0)
 Industrial buyers will rely more on third-party
service providers to improve purchasing and
supply management.
 Wholesalers/retailers will focus on transportation
and logistics more as quick response service
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Main Supply Chain Structures
Question: Can we apply same supply chain management concepts to
all types of industries?
• You can improve operating efficiency by employing the right
supply chain structure.
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Journey of Main Supply Chain Strategies
• Stable Supply Chain:
 Less variability and innovation in product’s demand and design.
Produced in bulk quantities.
 A heavy focus on execution, efficiencies, and cost performance.
 Slight focus on communication technologies.
 Strong relationship with business partners.
 Examples: ????? Cement Industry, Pharmaceuticals, Fertilizers
• Reactive supply chain:
• Seasonal or on-demand manufacturing.
• Required good communication technologies in order to react quickly.
• Example: ?????? Ice cream, Clothing industry, Sugar industry, Agriculture industry
• Efficient reactive supply chain:
• Acts as an efficient, low-cost provider of goods and services.
• Operate in highly competitive environment.
• Required highly efficient communication systems to reduce lead time and
operational costs.
Supply Chain Models
• Vertical integration
• Horizontal Integration
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Supply Chain Models
• Vertical integration
• It is a strategy to gain control

over its suppliers or
distributors, retailers in order
to increase the firm’s power
in the marketplace, reduce
transaction costs and secure
supplies or distribution
channels.
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Supply Chain Models
• Examples(Vertical
Integration):
 Amazon, Ford, Hyundai,
Apple, Google,
Microsoft
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AMAZON Case
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Supply Chain Models
• Examples: Apple
• They are completely vertically
integrated. They own the OS, the
hardware and the ecosystem. The
result of this vertical integration is that
they have complete control of their
future.
• Samsung
• They do their own design, their own
chips, and in their case they even do
their own screens and manufacture
their own products.
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Supply Chain Models
• Horizontal integration
is a strategy where a
company acquires, or
mergers or takes over
another company in the
same industry value
chain.
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Supply Chain Models
• Examples (Horizontal
Integration):
• Marriott's 2016 acquisition of
Sheraton (hotels)
• AstraZeneca's 2015
acquisition of ZS Pharma
(biotech)
• Volkswagen’s 2012
acquisition of Porsche
(automobiles),
• Facebook's 2012 acquisition
of Instagram (social media),
• Disney's 2006 acquisition of
Pixar (entertainment media)
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Supply Chain Models
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Importance of Supply Chain
Management
• Globalization and Global Competition in business

• Shorter Product Life Cycle
• Low Cost Distribution Channels
• More Concerned and well informed customers
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Importance of Supply Chain
Management Profit
Supply Chain
• Supply Chain Cost 20% Cost
Marketing
• Marketing Cost 25% Cost
• Manufacturing Cost 45%

Manufacturing
• Other Costs 10% Cost
Effort spent for supply chain activities are invisible to the

customers.
• $3 trillion spent domestically for SC activities.

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What can Supply Chain
Management do?
• If you cannot bring big change, Start doing small changes.
• The need for Cost savings and better coordination of resources are
reasons to employ Supply Chain Management.
• Some Examples:
• The grocery industry could save $30 billion (10% of operating cost)
by using effective logistics and supply chain strategies.
 A typical box of cereal spends 104 days from factory to sale

 A typical car spends 15 days from factory to dealership
o Faster turnaround of the goods is better???
• National Semiconductor used air transportation and closed 6

warehouses, 34% increase in sales and 47% decrease in delivery lead
time.
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Benefits For Effective Supply Chain
Management
o "The biggest issue enterprises face today is intelligent visibility
of their supply chains both upstream and downstream" (AMR
Research)
• Compaq lost $0.5 B to $1 B in sales because laptops were not

available when and where needed.
• P&G (Proctor&Gamble) estimates it saved $65 M (in 18 months)

by collaboration with retailers resulting in a better match of supply
and demand
• When the 1 gig processor was introduced by AMD (Advanced

Micro Devices), the price of the 800 meg processor dropped by
30%
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Benefits For Effective Supply Chain
Management
• When a firm, its customers and suppliers all know
each other future plans and are willing to
coordinate,
 They can reduce cost significantly
 Much easier planning and scheduling
 Quality improvement
 More Productivity
• All leads to more profit and customer satisfaction
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Bullwhip Effect
• Lack of communication, coordination and
disorganization within supply chain can result one of
the most common problem of supply chain.
• This common problem is known as the bullwhip
effect or whiplash effect.
o Increasing fluctuations in inventory in response to shifts in
customer demand as one moves further up the supply
chain.
• Bullwhip effect is a phenomenon in Forecast driven
distribution channels
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Bullwhip Effect
• The bullwhip effect in the supply chain occurs when
changes in consumer demand causes the companies
in a supply chain to order more/less goods from their
suppliers to meet the new demand.
• The bullwhip effect usually flows up the supply
chain, starting with the retailer, wholesaler,
distributor, manufacturer and then the raw materials
supplier.
• It occurs because the demand for goods is based on
the poor demand forecasts from companies, rather
than actual consumer demand.
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Causes of Bullwhip Effect
• The main causes of bullwhip effect are;
 Disorganization
 Lack of communication
 Wrong Demand Forecasting
 Longer Lead-Time
 Price Fluctuation (Discounts)
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Example: Bullwhip Effect
• Lets say;
• Actual demand from a customer = 8 units
• The retailer order from distributer = 10 units
– (Extra 2 units are to ensure they don’t run out of stock)
• Distributer orders to manufacturer = 20 units
– (To ensure that they should have enough stock to
guarantee timely shipment of goods to the retailer)
• Manufacturer order raw material for = 40 units
– (In order to balance the economy of scale in production)
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Foundation Elements of Supply Chain
Management
• Supply/Purchasing Elements
• Operations Elements
• Logistics/Transportation Element
• Integration Elements
Supplier Manufacturer Distributor Customer

Important Elements of Supply Chain
Management Cont….
Management Cont….
Supply Supplier alliances, supplier management,

Strategic sourcing, Supply base
Operations Demand management, MRP, ERP, JIT, TQM
Distribution Transportation management, Customer

relationship management, Network design
Integration Coordination/Integration activities, global

integration problems, performance
measurement
Management Cont….
Supply/Purchasing Element
 Traditional Purchasing Approach:

o Many Suppliers (Supply-Base)
o Short-term contracts
o Purchase-price based seller-buyer relationship
• Over the past two decades shift towards more

strategic approach to purchasing known as supply
management/procurement.
Management Cont….
• Supply/Purchasing Elements
 Raw material quality, delivery timing,
reliability and purchase price are important
factors….
 Supplier Management
 Supplier evaluation: Determining the capabilities “If we truly want to be
of suppliers world-class, we have to
 Supplier certification: Third party or internal be in tune with our
certification to assure product quality requirements. suppliers. If we cannot
respond because we
 i.e. ISO certifications: ISO 9000, ISO 14001 don’t have the right
 Long-term Relationship materials at the right
 To get a reliable supplier time, we will fail,”
Harvey Kaylie
 Better quality of material president of Mini-
 Better payment terms and discounts Circuits.
 Priority manufacturing status
Management Cont….
Islamabad—Qatar recently signed 15 years long term agreement

Management Cont….
 What does supplier get from long term contracts???
 The Supplier can benefits from the closer relationship
by getting bulk and consistent orders from customers.
 Such kind of long-term trading partnership is called
Strategic Partnership.
• Suppliers can have a significant impact on a firm’s
reputation.
• Ethical and Sustainable sourcing:
o Purchasing from those suppliers that
are governed by environmental
sustainability and social and ethical
practices.
The Dark Side of Chocolate
Management Cont….
• After Delivery…….
• Once raw material has delivered to buyer, the
internal operations begin, to convert raw
material into final product.
• Operation Element
 Demand Management
 During a calendar year, seasonal demand If forecast is wrong
variations commonly occur. then firm is left with
• Firms can predict these variations, using too much inventory or
historic demand patterns, and forecasting. too little inventory.
• Over-Stock and Out-of-Stock situations are
costly and can result in lose of business.
Management Cont….
• Using Demand Forecasting to minimize these costs (Out of stock &
Over stock).
 Linking buyers & suppliers via MRP-Material Requirement
Planning (for managing inventory) and ERP-Enterprise
Resource Planning.
 Provide sales data, inventory and production information related
to all business units to supplier.
 Quality of the incoming purchased items and sub-assemblies
• Firms and supply chains employing concepts of lean
 Use Lean/JIT to improve the “pull” of materials to reduce
inventory levels.
 Employ TQM or Six Sigma to improve quality compliance
among suppliers
Management Cont….
• How the Large Super-Store keep track of
their inventory?
• Wal-Mart MRP System: Wal-Mart retail
stores, scan the barcodes of the products
purchased by customers, causing the local
store’s MRP system to deduct units from the
inventory until a preset reorder point is
reached.
• When this occurs, the local computer system
automatically contacts Wal-Mart’s regional
distribution center’s MRP system and generates
an order.
• At the distribution center, the order is filled and
sent along with other orders to the particular
Wal-Mart store. Eventually, the distribution
center’s MRP system automatically generates
an order to the manufacturer who produces the
product for Wal-Mart, reducing the likelihood
of stock outs or excess inventories.
Management Cont….
Distribution Trends: Deliver at Right Time, Right
Quality and Right Amount
– Transportation management-
Motor carriers (trucks), are
tradeoff decisions between cost & more expensive than rail but
timing of delivery/customer provide more flexibility for
short routes.
service via trucks, rail, water & Air carriers are most expensive
air but fastest mode.
Water carriers are least
– Customer relationship expensive
But also slowest.
management (CRM)- strategies
National Semiconductor
to ensure deliveries, resolve used air transportation and
complaints, improve closed 6 warehouses, 34%
communications, & determine increase in sales and 47%
after sales service requirements decrease in delivery lead
time.
California-based clothing company
Anchor Blue, was having many problems
few years ago with its distribution centre
and inventory management system,
leading to problems stocking its retail
stores. Consequently, they outsourced
their logistics function to UPS Supply
Chain Solutions, resulting in a 40 percent
decrease in unit processing costs and a 37
percent increase in merchandise pieces
moved per year.
According to Richard Space, senior vice president for logistics at Anchor Blue,
“We have increased delivery to stores and seen better fill rates. What used to
take ten days from DC to stores now takes two. And that means improved cash
flow.” In the end, Space says the keys to a successful outsourcing arrangement
are communication and trust with partners.
Management Cont….
• Network design- creating distribution networks based on
tradeoff decisions between cost & sophistication of
distribution system
• Large number of warehouses: The transportation cost
from factory to warehouse, the inventory holding cost
and the cost to build and operate warehouses would be
quite high, but the payoff would be better customer
service.
• Few Warehouses: Low transportation cost from factory
to warehouse, low construction and operating cost but
limited customer services.
Management Cont….
Integration Trends:
If one key activity fails or is
– Supply Chain Process Integration- performed poorly, then the
when supply chain participants work flow of goods moving along the
for common goals. Requires intra-firm supply chain is disrupted,
functional integration. Based on efforts jeopardizing the effectiveness
of the entire supply chain
to change attitudes & adversarial
relationships
– Firms act together to maximize total
supply chain profits.
– Supply Chain Performance
Measurement- Crucial for firms to
know if procedures are working as
expected—or not before they become
financial drains.
Future Trends in Supply Chain
Management
Expanding (and Contracting) the Supply Chain
Today, firms are increasing their partnerships with

foreign firms and building foreign production facilities
to accommodate their market expansion plans.
The expansion involves:

• breadth- foreign manufacturing, office & retail
sites, foreign suppliers & customers
• depth- second and third tier suppliers & customers
Management
 Increasing Supply Chain Responsiveness
 Firms will increasingly need to be more flexible and

responsive to customer needs
 Supply chains will need to benchmark
industry performance and, meet and
improve on a continuous basis
 Responsiveness improvement will come
from more effective and faster product &
service delivery systems
Management- Cont.
 The Greening of Supply Chains

 Sustainability
Sustainability: Basedmeeting
means on three pillars
our own
needs without
 Social, compromising
Economical, the ability
Environmental
 of future
Supply generations
chains will workto harder
meet their own
to reduce
needs.
environmental degradation
 Large majority (75%) of U.S. consumers
influenced by a firm’s environmental
friendliness reputation
 Recycling and conservation are a growing
alternative in response to high cost of natural
resources.
Future Trends in Supply Chain Management-
Reducing Supply Chain Costs
• Cost reduction can be achieved throughout the supply chain by
reducing waste by reducing purchasing and product distribution costs.
• By reducing excess inventories and non-value-adding activities
among the supply chain participants.
Cost reduction achieved in the supply chain through:

Reduced purchasing costs
Reducing waste
Reducing excess inventory
And reducing non-value added activities
 Continuous Improvement through
• Benchmarking- improve over competitors’
performance
• Trial & error
• Increased knowledge of supply chain processes
Purchasing Management
MS 391
Chapter 2 - Lecture 5
Umar Farooq
Department of Management Sciences
GIK Institute
Background
• Historically, the management of materials has
been the most neglected element in the production
process.
• In the past, businesses emphasized minimizing the
cost of capital and labor.
• The focus on labor was logical
because the industrial
revolution had generated many
labor-intensive manufacturers.
Background
• Within a firm, purchasing and supply management
grappled with the stigma of being labeled a
clerical function.
• However, in the past 30 years, purchasing has

made many strides toward shedding this label and
has emerged as a viable professional career path.
Background
• All organizations need inputs of goods and services from
external suppliers.
• But
• It should be in such a way that;
oTo reduce cost and increase profit
• How can you reduce cost and what cost should be

reduced first?
Background
• Businesses have had to change radically in

response to changing technologies
• The reality is that technology is rapidly displacing

labor.
• During the next decade, the supply management

function is likely to contribute to profits more
than any other function in the company.
Purchasing
• The Annual Survey of

Manufactures,
conducted by the U.S.
Census Bureau, shows
that manufacturers
spent more than 50
percent of each sales
dollar on raw materials.
Purchasing vs. Fabrication-Past
Triangle = Inventory Storage

CP = Component Parts
RM = Raw Material
FG = Finished Goods
Purchasing vs. Fabrication-Present
Triangle = Inventory Storage

CP = Component Parts
RM = Raw Material
FG = Finished Goods
OPR = Operations
PURCHASING
 Purchasing/Procurement/Sourcing
Obtaining goods (merchandise, capital equipment; raw materials,
services, or MRO supplies) to satisfy internal needs in exchange for
money or its equivalent.
• Purchasers can be classified into two categories;
 Merchant Buyers-
wholesalers and retailers who purchase for resale.
e.g. Retailer, wholesaler
 Industrial Buyers-
– Purchasing raw materials for conversion, services, capital
equipment and MRO supplies.
e.g. Manufacturer
• Acquisition of services is widely called supply management.

• Term “Supply Management/Procurement” is used instead of
purchasing.
The Role of Purchasing in an
Organization
Key purchasing Variable
Organization
The primary goals of purchasing are:
1. Ensure uninterrupted flows of raw
materials at the lowest total cost.
2. Improve quality of the finished goods
produced, and
3. Optimize customer satisfaction.
Purchasing contributes to these

objectives by:
 Actively seeking better materials and
reliable suppliers,
 Work closely with strategic suppliers to
improve quality of materials, and
 Involving suppliers and purchasing
personnel in new product design and
development efforts.
Purchasing vs Procurement
• One is a strategic process and other is a transactional
function.
• Procurement concentrates on the strategic process
of product sourcing, for example
o Researching (Identifying needs and requirement,
identify and evaluate supplier)
o Negotiation (Negotiate terms, conditions and
contracts)
o Planning (Profit margin analysis, build and
manage supplier relationships)
• Purchasing process focuses on how products and services are
acquired and ordered, such as
o Raising purchase orders (Receive purchase requisitions, Evaluate
quotes from suppliers, process purchase orders)
o Arranging payment (Process and organise payment with supplier)
Organization
• Purchasing Cycle
• Obtaining a purchase requisition
• Obtaining proposals and quotations
• Evaluating quotations and supplier selection
• Dispatching official purchase orders
• Receiving products and services
• Checking the quality of delivered items
• Payment to vendors
The Role of Purchasing in an Organization
• A purchase requisition is a initial document/request
form that is used when an employee needs to
purchase or order something on behalf of their
organization.
• The purchase order (PO) is where the buying
happens. Once the purchasing department has
approved the purchase requisition, it issues a
purchase order to the vendor.
• A Supplier Quotation is document by a potential
supplier specifying the cost of goods or services
they'll provide within a specified period.
The Role of Purchasing in an Organization
Procurement is an umbrella term
• Spotting internal needs (Need Identification)
• Surveying/Research the market
• Spotting potential suppliers
• Creating an approved list of vendors
• Creating a purchase order
• Requesting proposals and evaluating quotations
• Selecting the right supplier and negotiating effectively
• Receiving goods and performing quality checks
• Developing and managing contracts
• Obtaining invoice approvals and fulfilling payment terms
• Establishing a good supplier relationship
Purchasing vs Procurement
Purchasers: Target
• Determine the best value,
• Choose the appropriate suppliers
• Get best quality of supplies
• Negotiate the best price, and
• Award contracts that ensure that the correct amount of

the product or service is received at the appropriate
time.
Purchasers/Buyers
• Purchasing managers, buyers, and agents must
become experts on the services, materials, and
products they purchase.
• Purchasing managers, buyers, and purchasing

agents evaluate suppliers on the basis of price,
quality, service support, availability, reliability,
and selection.
• Once all of the necessary information on suppliers

is gathered, orders are placed and contracts are
awarded to those suppliers who meet the
purchaser’s needs.
Purchasing a key strategic business
process
• Global competition intensified in the 1980s
executives realized the impact of large quantities of
purchased material and WIP inventories on;
 Manufacturing cost,
 Quality requirements,
 New product development
 Delivery lead time
Pull and Push Strategy
• What instigates the movement of the work in the system?
• In Push systems, work release is based on downstream demand

forecasts
• Keeps inventory to meet actual demand
• Acts proactively
• e.g. Making generic job application resumes today
• In Pull systems, work release is based on actual demand or the actual
status of the downstream customers
• May cause long delivery lead times
• Acts reactively
• e.g. Making a specific resume for a company after talking to the
recruiter
Purchasing Dollar Responsibility
• The cost of acquiring, storing, and moving materials is an
increasingly large portion of the cost of goods sold.
• Example: Consider the dollar responsibility of one General

Motors’ materials management groups:
1.Parts and (materials) = 10 times of direct labor dollars
2.Supply management expenditures = $100 billion
3.Transportation bill = $3 billion
4.Purchasing buys 97 percent of all component parts.
The Financial Significance of Supply Management
Profit-Leverage Effect
• Measures the impact of a change in purchase spend on a firm’s profit
before taxes.
• Purchase spend is the money a firm spends on goods and services.
• The measure is commonly used to demonstrate that a dollar decrease
in purchase spend directly increases profits before taxes by the same
amount.
• But, a decrease in purchase spend must be achieved through better
purchasing strategy that acquire materials of similar or better quality.
• The profit leverage effect dictates that reducing operating expenses is
more efficient than increasing sales.
• Three options to increase bottom line (profit)
 Increase sales,
 Reduce COG (Cost of Goods)
 Cut Operating cost
The Financial Significance of Supply
Management cont….
• Example: Income Statement
• Gross sales/revenue = $100 $100
• Cost of Goods(COG) = $50 $40
• Gross Profit = $50 $60
• Fixed cost (20%) = $20 $20
• Total Profit before tax = $30 $40
Cost of Goods(Material + Manufacturing Cost)

o Options for increasing profit
 Increase sales,
 Reduce COG (Cost of Goods)
 Cut Operating cost
• Every dollar saved in purchasing goes straight to the bottom line
(profit)
• Company statistics: Your material purchasing cost is 80% of COG
• 42428 x 80% = $33942 (Purchasing cost)
Sales $84167 100% How much 8% reduction in
Cost of Goods Sold(COGS) $42428 50.4% purchasing cost will impact our
profit?
Gross Profit $41739 49.6%
Operating Expenses $26950 32%
$33942 x 8% = $2715
Income/Profit $14789 17.6%
o Options for increasing profit
(profit)
• Company statistics: Your material purchasing cost is 80% of COG
• How much are you spending on purchasing?
• 42428 x 80% = $33942 (Purchasing cost)
• 8% reduction in purchasing cost = $33942 x 8% = $2715
Sales $84167 100% Sales $84167 100%

Cost of Goods Sold(COGS) $42428 50.4% Cost of Goods Sold $39713 47.2%
Gross Profit $41739 49.6% Gross Profit $44454 52.8%
Operating Expenses $26950 32% Operating Expenses $26950 32%
Income/Profit $14789 17.6% Income/Profit $17504 20.8%
The Financial Significance of Supply
Management
(profit)
Sales $84167 100%

Cost of Goods Sold(COGS) $39713 47.2%
Gross Profit $44454 52.8%
Operating Expenses $26950 32%
Income/Profit $17504 20.8%
8% 18.4%
Increase sales
How much does marketing needs to sell to get same $2715 increase in
profit?
+15454
Operating Profit Margin of the company is 17.6% Which is more easier?
How much does marketing needs to sell

to get same $2715 increase in profit? 8% 18.4%
$2715/0.176 = $15454 Purchasing Sales

• Return on Assets Effect (ROA)
• Return on assets (ROA) is an indicator of how profitable a
company is relative to its total assets.
• (ROI) financial ratio of a firm’s net income in relation to its
total assets
• Total assets consist of current and fixed assets.
• Current assets include cash, accounts receivable and
inventory
• Fixed assets include equipment, buildings and real estate
• ROA indicates how efficiently management is using its total
assets to generate profits.
Return on Assets Effect (ROA)
• Example:
Gross sales/revenue = $100
Cost of Goods(COG) = $50
Gross Profit = $50
Fixed cost or expenses= $20
Total Profit before tax = $30
Total assets = $1000

ROA = Net Profit/Income ÷ Total assets
= 30 ÷ 1000
= 3%
Return on Assets Effect (ROA)
• Imagine two companies, one with a net income of
$50 million and assets of $500 million, the other
with a net income of $10 million and assets of $15
million.
• Which company would you rather own?
• = 0.1 x 100 = 1 millions
• = 0.66 x 100 = 67millions

• Inventory Turnover Effect
• Shows how many times a firm’s inventory is utilized and
replaced over an accounting period, such as a year.
• A low turnover implies weak sales and possibly excess
inventory.
• ITF = Cost of Goods (COG)/ Average Stock
Gross sales/revenue = $100
Cost of Goods(COG) = $50
Gross Profit = $50
Fixed cost or expenses = $20
Total Profit before tax = $30
Inventory turnover ratio = Sales / Average inventory

Average Stock Cost = $10
ITF = 50 ÷ 10 = 5 Times
Inventory Turnover Effect
• Company ABC has $1 million in sales and
$250,000 in COGS. The average inventory is
$25,000.
$
• = 40
$
• = 9.1
The Purchasing Process
• Manual Purchasing - slow system,
prone to duplication of effort and
errors.
o Step 1-Material Requisition/Purchase

Requisition- stating product, quantity,
and delivery due date are clearly.
Step 2- The Request for Quotation
(RFQ) - Buyer identifies suppliers &
issues a request for quotation (RFQ).
o Step 3- Request for Proposal - allows
suppliers to propose new material and
technology, thus enabling the firm to
exploit the technology and expertise of
suppliers
o Step 4- The Purchase Order (PO)- The
purchase order is the buyer’s offer &
becomes a binding contract when
accepted by supplier.
Purchase
Requisition
Purchase
Order
The Purchasing Process –
e-Procurement
• The rapid advent of Internet technology in the 1990s
spurred the growth of more flexible Internet-based e-
procurement systems
• Step 1- Material user inputs a materials requisition - Relevant
information such as quantity and date needed.
• Step 2- Materials requisition submitted to buyer - At purchasing

department (hardcopy or electronically).
• Step 3- Buyer assigns qualified suppliers to bid - Product

description, closing date, & conditions are given.
• Step 4- Buyer reviews closed bids & selects a supplier

Materials User Purchasing Department/Buyer
Start
Extracts and merges
Prepares Materials
Buyer reviews Materials Requisition
Requisition – inputs
Materials Requisition data into Internet
information into
based B2B system
computer system
Assigns suppliers to
Collects and reviews bids
requisition on B2B
Materials Requisition submitted by suppliers
system for bidding and
is transmitted through Internet based
specifies closing date and
electronically to a B2B system or fax
other conditions
buyer
Selects a supplier
based on quality, cost and Purchase Order is
delivery performance, transmitted electroni-
then issues a cally (or faxed) to the
Purchase Order supplier
• Advantages of the e-Procurement System
o Time savings
o Cost savings
o Accuracy
o Real time- The system enables buyers to initiate bids
in real time on a 24/7 basis.
o Mobility- The buyer can submit, process and check
the status of bids regardless of the buyer’s
geographical location
o Trackability
o Benefits to the suppliers- lower barriers to entry and
transaction costs, access to more buyers and the
ability to instantly adjust to market conditions,
Small Value Purchase Orders
• The administrative costs to process a single order can be quite
substantial.
• The cost of placing an order using the manual purchasing system
could be as high as $175.
(Ohmae, K., “The Global Logic of Strategic Alliances,” Harvard Business Review, March-April 1989: 143–152. )
• The purchase order value must not be less than small dollar value.
• Small dollar value a relative term depending on the size of the
firm, $500 to $1,000 can be considered a reasonable cutoff point.
• Purchasing managers have various alternatives to deal with small
value purchases.
• Procurement Credit Card/Corporate
Purchasing Card (P-Cards) are credit
cards with a predetermined credit limit,
issued to authorized personnel of the
buying organization.
• e.g. American Express, Diners Club,
MasterCard and Visa cards
• The card allows the material user to
purchase the material directly from the
authorized suppliers, without going through
purchasing.
• At the end of the month, an itemized
statement is sent to purchasing, or directly
to the accounting department.
• Blank Check Purchase Orders: a special purchase order with a
signed blank check attached, usually at the bottom of the purchase
order.
• Due to the potential for misuse, it is usually printed on the check
that it is not valid for over a certain amount, usually $500 or
$1,000.
• The supplier enters the amount due on the check and cashes it after
the material is shipped.
• Phasing out blank check purchase orders with the use of
procurement credit cards.
• Stockless Buying or System Contracting
• The supplier is required to maintain a minimum
inventory level to ensure that the required items
are readily available for the buyer.
• Stockless purchase system can be defined as
arrangement in which a supplier holds the items
ordered by the customer in its own warehouse, and
releases them as and when required by the
customer. It is also known as just-in-time.
• It is stockless buying from the buyer’s perspective
because the burden of keeping the inventory is on
the supplier
• Petty Cash
• Petty cash is a small cash reserve maintained by a
mid-level manager or clerk.
• Petty cash is a small amount of cash on hand that is
used for paying small amounts owed, rather than
writing a check.
 paying the postal carrier the 17 cents.
 paying $14 for bakery goods delivered for a company's
early morning meeting.
• Material users buy the needed materials and then
claim the purchase against the petty cash by
submitting the receipt to the petty cashier.
• Standardization and Simplification of Materials and
Components
• These concepts can be effectively used in industry to minimize
unnecessary activity, reduce inventory costs, simplify controls and
improve product quality.
• Purchasing department should work with design and engineering
departments to standardize materials and components to increase the
usage of standardized items.
• Simplification refers to reduction of the number of components,
supplies or standard materials used in the product or process.
• e.g. Intel’s Systems Group reduced 20,000 active part numbers to
500 part types! Of 2,000 resistors, capacitors, and diodes, they
reduced 2,000 to 35 types.
• Accumulating Small Orders to Create a Large
Order
• Numerous small orders can be accumulated and mixed into a large
order, especially if the material request is not urgent.
• Purchasing can simply increase the order quantity if the ordering
cost exceeds the inventory holding cost.
• Larger orders also reduce the purchase price and unit transportation
cost.
• Using a Fixed Order Interval
• To group materials and supplies into categories
and then set fixed order intervals for each
category.
• Order intervals can be set to biweekly or monthly
depending on usage.
• This increases the dollar value and decreases the
number of small orders.
Boeing 787
Sourcing Decisions: The Make-or-Buy
• The Make or Buy decision is a strategic decision.
e.g. Honda Motors make their engines but outsource the brake
drums from the outsource suppliers (high quality, less price)
• Example: Traders from all over Europe hired warehouses for
their goods in Venice since 14th century.
• Factors to be analyzed;
Evaluate whether outsourcing is right for your company;
Determine exactly what functions to outsource and the
performance expectations
Use a well-defined professional selection process to evaluate and
select which provider(s) are right for the job.
More than 60% of the total outsourcing market is composed
of IT workers.
• Outsourcing -buying materials and components from
suppliers instead of making them in-house.
• Outsourcing is a practice used by different companies to reduce
costs by transferring portions of work to outside suppliers rather
than completing it internally.
• Generally, firms outsource noncore activities while focusing on
core competencies.
• Traditionally firms preferred the make option by means of
backward or forward vertical integration
 Backward integration refers to acquiring sources of supply
 Forward integration refers to acquiring customer’s operations.
Sourcing Decisions: The Make-or-
Buy Decision…Cont.
Reasons for Buying or Outsourcing
• Cost advantage: Especially for components that are non-vital

to the organization’s operations.
• Insufficient capacity: A firm may be at or near capacity.
• Lack of expertise: Firm may not have the necessary

technology and expertise.
• Quality: Suppliers have better technology, process, skilled

labor, and the advantage of economy of scale.
Buy Decision…Cont
Reasons for Making
• Protect proprietary technology

• No competent supplier
• Better quality control
• Use existing idle capacity
• Control of logistics- Leadtime transportation, and
warehousing cost
• Lower cost
Sourcing Decisions: The Make-or-Buy Decision
• Make-or-Buy Break-Even Analysis
 The make-or-buy decision is the action of deciding between
manufacturing an item internally (or in-house) or buying it from
an external supplier (also known as outsourcing).
 Break-even analysis is a tool for computing the cost-effectiveness
of sourcing decisions.
• Several assumptions must be consider for the analysis:
1. All costs involved can be classified as fixed or variable cost.
2. Fixed cost remains same.
3. Variable cost has linear relationship with quantity.
4. Fixed cost of the make option is higher because of initial capital
investment in equipment.
5. Variable cost of the buy option is higher because of supplier
profits margin.
Decision
• Example:
• Consider a firm has the option to make or buy a part.
Its annual requirement is 15,000 units.
• A supplier is able to supply the part at $7 per unit.
• The firm estimates that it costs $500 to prepare the
contract with the supplier.
• To make the part, the firm must invest $25,000 in
equipment and the firm estimates that it costs $5 per
unit to make the part.
Buy Decision…Cont
• Example:
• Requirement of parts = 15000 units
• Buy Option: Supplier is able to supply the part at $7 per unit. The
firm estimates that it costs $500 to prepare the contract with the
supplier.
• Make Option: To make the part, the firm must invest $25,000 in
equipment and the firm estimates that it costs $5 per unit to make
the part
Decision…Cont
Sourcing Decisions: The Make-or-Buy Decision
• For the annual requirement of 15,000 units
Total Cost = Fixed Cost + Variable Cost
 The analysis shows that the break-even point is 12,250 units.

Total cost at the breakeven point is $86,250.
 If the requirement is less than 12,250 units, it is cheaper to buy.
If the firm needs more than 12,250 units it is cheaper to make parts
Class Exercise
• You are given the following information:
• Find the break-even quantity and the total cost at

the break-even point.
• If the requirement is 150,000 units, is it more cost-
effective for the firm to buy or make the
components?
• What is the cost savings for choosing the cheaper
option?
Procurement Terms
• Arbitration – Third party dispute resolution, is a way to resolve disputes
outside the courts. An arbitration award is legally binding on both sides and
enforceable in the courts.
• Breach/Default – When a contract provision or condition is not met.
• Force Majeure (superior force) – Riots, wars, weather, or other
“Acts of God”. Unforeseeable circumstances that prevent someone
from fulfilling a contract.
• Liquidated Damages – Estimated damages for specific types of
defaults as defined in the contract.
• These are the damages whose amount the parties designate during the
formation of a contract for the injured party to collect as compensation
upon a specific breach (late performance).
• Material Breach – A violation of the contract of sufficient
magnitude that the contract cannot be completed.
• Termination – Stopping the work before it is completed
• Waiver – Statements in the contract that indicate that rights cannot be
ignored or modified without written agreement between the two
parties
Roles of Supply Base
Supply Base- list of suppliers that a firm uses to
acquire its materials, services, supplies, and
equipment.
• Firms emphasize long-term strategic supplier
alliances consolidating volume into one or fewer
suppliers, resulting in a smaller supply base.
 Early involvement of preferred suppliers provide:
Information on the latest trends in materials, processes, or
designs
Information on the supply market
Capacity for meeting unexpected demand
Cost efficiency due to economies of scale
Importance of Supplier Selection
• Today the average U.S. manufacturer
Reliability
spends roughly half of its revenue to
purchase goods and services.
Service Distance
• This makes a company's success
dependent on its interactions with
suppliers.
• The process of selecting competent
suppliers for important materials, is a
complex one and should be based on
multiple criteria.
• A recent cross-industry survey of
companies placed companies’ average
total spend per procurement at $115
million.
Importance of Supplier Selection
• Supplier non-performance on even the most basic level
can have dire consequences for the buyer.
• Many product safety issues have been traced back to

suppliers failing to meet a buyer’s requirements.
• Production delays due to parts shortages and recalls of

faulty products have cost buyer firms millions of dollars
through recalls, warranty costs.
• Can severely damage their reputations and future sales

potential
Supplier Selection
42 million cars
Toyota Corporation
800,000 cars
Supplier Selection
• 2014, General Motors (GM)
recalled about 800,000 of its
small cars due to faulty ignition
switches, which could shut off
the engine while the vehicle
was in motion
• Before it was removed from

the market in 2004, Vioxx
may have hurt hundreds of
thousands of patients, killing a
third of them
Supplier Selection
There were two battery issues;
1. The first one related to battery
size: batteries made by
Samsung's SDI group, were too
small in one corner, causing
negative electrodes to be bent
and increase the likelihood of
short circuiting.
2. The second issue was with
batteries from a third party
provider, Amperex Technology
Ltd, which were found to be
incorrectly wielded.
Supplier Selection
Components for the Organic Light Emitting Diode (OLED) screens,

which are in short supply in Asia
Boeing’s 787
Dreamliner production
schedule was
significantly affected by
shortages of fasteners,
essentially bolts that
secure sections of the
fuselage together.
Supplier Selection
• Product and process • Order System and

technologies cycle time
• Willingness to share • Capacity
technologies and • Communication
information capability
• Quality • Location
• Cost • Service
• Reliability
How Many Suppliers to use
• Single-sourcing- a risky proposition.
• Poor supplier performance will result in plant
shutdowns or poor quality finished products.
Sole sourcing and Single sourcing
• Sole sourcing typically refers to the situation
when the supplier is the only available source of
the required material.
• Single sourcing refers to the practice of
concentrating purchases of an item with one
source from a pool of many potential suppliers.
 Reasons Favoring a Single Supplier
• To establish a good relationship
• Less quality variability
oVariability in the quality levels is less than if the parts are purchased
from multiple suppliers
• Lower cost
• Transportation economies
oSingle sourcing concentrates volume, the firm can take advantage
of truckload (TL) shipments.
• Proprietary product or process
oIf the supplier holds the patents to the product or process
• Volume too small to split
oIf the requirement is too small, it is not worthwhile to split the order
among many suppliers.
Reasons Favoring More than One Supplier
• Need capacity
o When demand exceeds the capacity of a single supplier
• Spread risk of supply interruption
o Due to a strike, quality problem, political instability
• Create competition
o Encourages competition to get best price and quality.
• Information
o Multiple suppliers usually have more information about market
conditions, new product developments and new process
technologies
• Dealing with special kinds of business
o The firms may need to give portions of their purchases to small,
local or women or minority-owned businesses, either
voluntarily or as required by law.
Purchasing: Centralized vs. Decentralized
• Purchasing Organization
depends on many factors, such
as market conditions & types of
materials required.
Centralized Purchasing-
purchasing department located at
the firm’s corporate office makes
all the purchasing decisions.
Decentralized Purchasing-
individual, local purchasing
departments, such as plant level,
make their own purchasing
decisions.
Purchasing: Centralized vs.
Decentralized
Advantages- Centralization
• Concentrated volume
• The purchase volume to create quantity discounts,
less-costly volume shipments
• Suppliers are willing to give better terms and share
technology due to the higher volume.
• Avoid duplication
• Eliminates the duplication of job functions.
• Specialization
• Allow purchasing professionals to specialize in one
area
• Lower transportation costs
• Allows larger shipments to be made to take
advantage of truckload shipments
Advantages- Centralization
• No competition within units

• when different units Purchase the same material,
a situation may be created in which units are
competing among themselves.
• Common supply base
• A common supply base is used, thus making
it easier to manage and to negotiate
contracts.
• Advantages of Decentralization
 Closer knowledge of requirements
• A buyer at the individual unit is more likely to know its
exact needs better than a central buyer at the home
office
 Local sourcing
• A local buyer will know more about local suppliers
 Less bureaucracy
• Allows quicker response, due to less bureaucracy and
closer contact between the user and the buyer
• Hybrid purchasing organization- both decentralized at the
corporate level and centralized at the business unit level may be
warranted.
Countertrade
• Goods of domestic firms are exchanged for
goods of equal value from foreign firms.
• In countertrade transactions cash does not
change hands
• It is used if there is a shortage of hard
currency or as a means to acquire
technologies.
• The various forms of countertrade include
barter
o No currency convertibility
o Weak reserves prohibit access to hard
currency
o Structures an international sale when means of
payment are difficult, costly, or non-existent
Types of Countertrade
• Counter purchase-is an arrangement whereby the

exporter agrees to sell goods or services to a foreign
importer and simultaneously agrees to buy specific goods
or services from the foreign importer.
• Barter- Barter is the complete exchange of goods or
services of equal value without the exchange of currency.
• Offset- is an exchange agreement for industrial goods or
services as a condition of military related export.
• Switch Trading : It involves at least three parties.
• This means a country may barter goods from another
country which may be of no use to itself so it sells the
goods to third country for hard cash.
o Brazil exported corn to East Germany (before Unification)
and received products in return. Germany did not use corn
so it sold the corn to other countries for hard cash
• Buyback:
• It occurs when a firm builds a plant in a country - or
supplies technology, equipment, training, or other
services to the country and agrees to take a certain
percentage of the plant's output as partial payment for
the contract.
o BOT contracts (Build, Operate and Transfer)
Countertrade-Example
• Indo-Iraq Barter Deal :
• In 2000, India and Iraq agreed on an "oil for
wheat and rice" barter deal, subject to UN
approval under Article 50 of the UN Gulf War
sanctions, that would facilitate 300,000 barrels
of oil delivered daily to India at a price of $6.85
a barrel while Iraq oil sales into Asia were
valued at about $22 a barrel. In 2001, India
agreed to swap 1.5 million tones of Iraqi crude
under the oil-for-food program.
Countertrade-Example
Public Procurement
• Public procurement that is completed within
the context of not-for-profit organizations
(NFP’s).
• The procurement that occurs in this context is
typically government affiliated, which can be
central, state, or local.
• Private procurement that is completed within
the context of for-profit organizations (FP’s).
Private procurement happens within privately
owned companies.
Public Procurement
• Private procurement is typically in FP (for-profit)
organizations, while public procurement functions to
support NFP’s (not-for-profit)
• Invitation to Tender (ITT): An invitation to third
parties to submit offers
• Tendering is the beginning of the contracting process
and serves as an ITT
• Bid/proposal submission
• Requests for Proposals (RFP)
• Request for Quotations (RFQ)
• Bid/proposal evaluation
• Contract award recommendation
• Contract negotiations
• Contract Award (signing)
CREATING & MANAGING
SUPPLIER RELATIONSHIPS
Chapter 3
Umar Farooq
Management Sciences
GIK Institute, Topi, Pakistan
Introduction
• Core Competitive factors: In today’s
competitive environment, it is very
important that suppliers deliver innovative
and quality products not only in just-in-
time (JIT) fashion, but also at a
competitive price.
Reasons given for failure of alliances:

• Overly optimistic
• Poor communications
• Lack of shared benefits
• Slow payback results
• Lack of financial commitment
• Misunderstood operating principles
Keys to Successful Partnerships
Building Trust
• With trust, partners are more willing to
work together, find compromise
solutions to problems, work toward
achieving long-term benefits for both
parties, and, in short, go to the extra
mile.
Shared Vision and Objectives

• Both partners must share the same
vision and have objectives that are not
only clear but mutually agreeable.
• The focus must move beyond tactical
issues and toward a more strategic path
to corporate success.
• “You don’t want a partnership that is based on
necessity. If you don’t think that the partnership is
a good mix, but you do it because you have to—
possibly because that supplier is the only provider
of that material in the market, because you’ve
signed an exclusive contract in the past, or for
some other reason—it’s not a true partnership and
is likely to fail”
Keys to Successful Partnerships Cont…
Personal Relationships
• It is people who communicate and make
things happen.
• An alliance isn’t really a relationship
between companies, it’s a relationship
between specific individuals.
Mutual Benefits and Needs

• Partnership should result in a win-win
situation, which can only be achieved if
both companies have compatible needs.
• An alliance is much like a marriage, and if
only one party is happy, then the marriage
is not likely to last for long.
Keys to Successful Partnerships Cont…
Commitment and Top Management Support
• Commitment must start at the highest
management level.
• Partnerships tend to be successful when top
executives are actively supporting the
partnership.
• Without involvement, there is no commitment.
Mark it down, asterisk it, circle it, underline it.
No involvement, no commitment.”
• Since partnerships are likely to encounter
bumps along the way, it is critical that
management adopt a collaborative approach to
conflict resolution instead of assigning blame.
Change Management
• Companies must be prepared to manage change
that comes with the formation of new
partnerships.
Cont…
Information Sharing & Lines of Communication
• Both formal and informal lines of communication
should be set up to facilitate free flow of information.
• Confidentiality of sensitive financial, product, and
process information must be maintained.
• Sign a nondisclosure agreement.
Capabilities
• Key suppliers must have the right technology and
capabilities to meet cost, quality, and delivery
requirements.
• In addition, suppliers must respond quickly to
changing customer requirements.
Cont…
Performance Metrics
You can’t improve what you can’t
measure.
• Measures related to quality, cost,
delivery, & flexibility are used to
evaluate suppliers.
Keys to Successful Partnerships-
Cont.
Continuous Improvement
• The process of evaluating suppliers
based on a set of mutually agreed-
upon performance measures
making a series of small
improvements over time results in
the elimination of waste in a
system.
• Buyers and suppliers must be
willing to continuously improve
their capabilities in meeting
customer requirements of cost,
quality, delivery, and technology.
Performance Metrics
• FedEx not only has performance scorecards for their suppliers
but has also developed a Web-based “reverse scorecard” that
allows suppliers to provide constructive performance feedback to
enhance the customer–supplier relationship
Supplier Evaluation and Certification-
Cont.
The Weighted-Criteria Evaluation System
1. Select the key dimensions of performance mutually
acceptable to both customer and supplier.
2. Monitor and collect performance data.
3. Assign weights to each of the dimensions.
4. Evaluate performance measures between 0 and 100.
5. Multiply dimension rating by weight and sum overall
score.
6. Classify vendors based on their overall score:
Unacceptable, Conditional, Certified, & Preferred
7. Audit and perform ongoing certification review.
Supplier Evaluation and
Certification- Cont.
Performance Metrics
• Total cost of ownership (TCO), made up of all costs
associated w/acquisition, use, & maintenance of a good or
service.
• Three major cost categories are;
o Pre-transaction costs: These costs are incurred prior to
order and receipt of the purchased goods.
o Examples: the cost of certifying and training suppliers,
investigating alternative sources of supply.
o Transaction costs: These costs include the cost of the
goods/services and cost associated with placing and
receiving the order.
o Examples are purchase price, preparation of orders
and delivery costs.
o Post-transaction costs: These costs are incurred after the
goods are in the possession of the company, agents or
customers.
o Examples: maintenance costs and warranty costs.
Performance Metrics
Examples of Performance Metrics
• Total Cost of Ownership
• Cost/Price- Competitive price & availability
of cost breakdowns
• Quality- Zero defects, Fit for use, ISO 9000
• Delivery- Fast, Reliable/on time
• Responsiveness & Flexibility-
Responsiveness to customers & to changing
situations
• Environment- Environmentally responsible,
ISO 14000
• Technology- Superior product/service design
• Business Metrics- Reputation, information
sharing
Supplier Evaluation and Certification
• A process to identify best and most
reliable suppliers.
• Sourcing decisions are made based on
facts and not merely on perception.
• Providing frequent feedback on supplier
performance can help avoid surprises
and maintain good relationships.
• Supplier Certification refers to “an

organization’s process for evaluating the
quality systems of key suppliers in an
effort to eliminate incoming
inspections.” -Institute for Supply
Management.
Supplier Evaluation and Certification
Criteria Used in Certification Programs
• No incoming product lot rejections (e.g., less than 0.5
percent defective) for a specified time period.
• No incoming non-product rejections for a specified
time period.
– (e.g., late delivery)
• No significant supplier production-related negative
incidents for a specified time period
• ISO 9000/Q9000 certified or successfully passing a
recent, on-site quality system evaluation
• Fully documented process and quality system with
cost controls and continuous improvement
capabilities
Supplier Development
Supplier development refers to buyer’s activities undertakes
to improve a supplier’s performance and/or capabilities based
on the following approach:
1. Identify critical products and services
2. Form a cross-functional team
3. Meet with top management of supplier
4. Identify key projects to improve those areas
5. Define details of Agreement
6. Monitor status and modify strategies
Supplier Awards
Companies should recognize and celebrate
the achievements of their best suppliers.
Award winners exemplify true partnerships

continuous improvement, organizational
commitment, and excellence.
Award-winning suppliers serve as role

models for other suppliers.
Supplier Relationship Management
Software
Supplier relationship management (SRM) software
improves profits and reduces costs.
• SRM refers to “extended procurement processes such as

sourcing analytics (e.g., spend analysis), sourcing
execution, procurement execution payment and
settlement, and-closing the feedback loop-supplier score-
carding and performance monitoring.”
Software
Software
Five key points of an SRM system:
• Automation
• Integration spans multiple departments, processes, and
software applications.
• Visibility of information and process flows
• Collaboration through information sharing
• Optimization of processes and decision making
Demand Forecasting
Chapter 5
Umar Farooq
Introduction – Demand Driven
Economy
• Organizations are moving from
supply driven to demand-driven
supply chain.
• Customers dictating to the
supplier
what products they desire and
when they need them delivered.
• Consumers have become more
demanding and discriminating.
• If you build it, they will come. Not anymore

Introduction – Demand Driven
Economy
Introduction
• There are several ways to match supply and demand.
 Different Approaches to match supply-demand:
1) Supplier hold plenty of stock available for delivery at any
time.
 It is also expensive because of the cost of carrying inventory
 The possibility of write-downs at the end of the selling season
2) Use of flexible pricing is another approach.
3) Companies can also use overtime, subcontracting, or
temporary workers to increase capacity to meet demand.
4) Companies use the forecast approach to match its supply and
demand cycle.
Introduction
Write-Down of prices
• “If customers don’t want the item, you may be

forced to write-down the item’s price below
what you paid. Thus, if the value of inventory
declines, your company incurs a financial loss.
Holding stock for too long increases your chance
the market price for the item will fall below
what you actually paid for it.”
So, hold plenty of stock is not a good idea

Introduction
• Push and Pull Strategy:
• In the push system production orders begin upon
inventory reaching a certain level.
• While on the pull system production begins based
on demand (forecasted demand).
Introduction
• It is important to manage demand, especially in pull
manufacturing environments.
• Improved forecasts benefit all trading partners to mitigates

supply-demand mismatch problems.
Demand Forecasting
• Estimate about the future is very important in the changing
business scenario.
• Customer behavior, technologies available and need for
individual products is changing faster than ever.
• Accurate estimates provides strong base for planning and
sound business decisions.
Where to invest?
How much to invest?
When to invest?
Demand Forecasting
• PREDICTIONS ABOUT THE FUTURE ARE DIFFICULT,.
• A forecast is an estimate of future demand & provides the basis
for planning decisions.
• The goal is to minimize forecast error (Supply-Demand errors).
What are the risks of wrong forecast in business?
• The benefits of better forecasts are

 lower inventories,
 reduced stock-outs,
 smoother production plans,
 reduced costs
 improved customer service.
Zara produces around 450 million
items a year.
How can it stay so efficient with
the sheer volume that passes
through its supply chain?
Demand Forecasting - Zara
• Zara introduces 10,000 new designs every year.
• Distributes 5.2 million clothing articles per week to
a network of over 2200 stores in more than 96
countries.
• Their high product mix and vast global network
makes demand forecasting for Zara a challenging
endeavor.
• How can it stay so efficient with the sheer volume
that passes through its supply chain?
The secret behind Zara's retail
success
Demand Forecasting
• Having accurate demand forecasts allows;
 The purchasing department to order the right
amount of products,
 The operations department to produce the right
amount of products at right time and
 The logistics department to deliver the right
amount of products at right time.
Examples
Examples of Forecasting:
Traffic flow at a major junction

Pre-poll opinion survey amongst
voters
Weather forecast
Demand Forecasting
Demand Forecasting
 Elements of a Good Forecast
A properly prepared forecast should meet
the following requirements:
1. The forecast should be accurate.
2. The forecast should be timely.
3. The forecast should be reliable.
4. The forecasting technique should be
simple to understand and use.
5. The forecast should be expressed in
meaningful units.
6. The forecast should be in writing.
7. Forecast will never be 100% true.
8. Forecasts are more accurate for
shorter than longer time horizons
15
Steps involved in Forecast
Demand Forecasting
Demand Forecasting
 Steps in the Forecasting Process
There are seven basic steps in the forecasting process:
1. Determine the purpose of the forecast.
2. Select the items to be forecast.
3. Establish a time horizon.
4. Select the forecasting technique.
5. Gather and analyze relevant data.
6. Prepare the forecast.
7. Monitor the results.

17
Demand Forecasting
Demand Forecasting
Classification of Forecasting Methods
Forecasting
Quantitative Qualitative
Time Series Associative Executive

Models Models Opinions
Salesforce
Naive Techniques Techniques Techniques Simple Multiple
Forecast for Averaging for Trend for Seasonality Linear Regression Linear Regression Opinions
Consumer
Simple Trend Trend and Seasonal
Moving Average Exponential Smoothing Exponential Smoothing Surveys
Weighted
Moving Average
Trend
Projection
Trend
Projection
Market
Research
Simple
Exponential Smoothing
Market
Surveys
Market
Tests
Delphi
18
Method
Forecasting Techniques
Qualitative
Forecasting
Quantitative
“If you don't have the numbers,

Time Series
it's just your opinion.”
• Qualitative forecasting is based on opinion &
intuition.
• Quantitative forecasting uses mathematical
models & historical data to make forecasts.
 Time series models are the most frequently used
among all the forecasting models. Look at the
information in a time series of data.
Causal Models future is a function of cause and
effect relationship between ‘any other factors’
other than time.
Forecasting Techniques (Cont.)
Quantitative Methods
• Time series forecasting- based on the assumption
that the future is an extension of the past.
• Historical data is used to predict future demand.
• Cause & Effect forecasting- assumes that one or
more factors (independent variables) predict future
demand.
It is generally recommended to use a combination
of quantitative & qualitative techniques.
Qualitative Forecasting Methods
•Based on intuition or judgmental evaluation.
•Uses expert judgment, rather than numerical analysis.
•Generally use
 when data are limited,
 Unavailable
 Not currently relevant.
Four qualitative models used are:
1. Jury of executive opinion
2. Delphi method
3. Sales force composite
4. Consumer survey
• Jury of executive opinion
Panel of experts in same field with
experience & working knowledge.
Exchange of ideas and claims.
Combines input from key
information sources.
Final decision is based on majority
or consensus, reached from
expert’s forecasts.
• Applicable for long-range planning
and new product introductions.
• Advantages
Can be undertaken easily without the use of statistical tools.
Several individuals with considerable experience working
together
• Disadvantages
The statistics are not collected from the market.
If one member’s views dominate the discussion, then the
value and reliability of the outcome can be diminished
Delphi method
 Very similar to jury of executives method
but this time members are both from inside
and outside of the company
 One coordinator is chosen by members of
the jury
 Group members do not physically meet.
 A questionnaire is given to each member of
the team which asks question.
 Translate opinion into some conclusion for
forecast.
 The summary of responses is then sent out
to all the experts
 2 to 3 cycles are undertaken
 Convergence and diversion is acceptable.
 Forecasts are revised until a consensus is
reached by all.
• Advantages
Eliminates need for group meetings
Participants can change their opinions anonymously
• Disadvantages
Time consuming –reaching a consensus takes a lot of
time.
Participants may drop out.
• Sales Force Composite
– Each sales-person makes a product-by-product forecast for their particular sales
territory.
– Is generated based on the sales personal’s knowledge of the market and
estimates of customer needs.
• Advantages
 Due to the proximity of the sales personnel to the consumers, the forecast tends
to be reliable
• Disadvantages
 Individual biases could negatively impact the effectiveness of forecast.
 some agents may give a lower forecast than the actual potential of sales
to easily achieve their target and get the money bonus from the company
on the extra sales generated.
• Consumer Survey
• Involves asking consumer about there buying habits, new product
ideas and opinions about existing products.
• The survey is administered through telephone, mail, Internet, or
personal interviews
• Data collected from the survey are analyzed using statistical tools
and judgment
• Advantage: Simple and Easy

• Disadvantage: buyers might change their opinions
Quantitative Methods
Time series forecasting
Cause & Effect forecasting (Causal)
Time series forecasting
• The time series analysis method predicts the future sales by analyzing the historical
relationship between sales and time.
– The forecaster looks for patterns in the data and tries to obtain a forecast by projecting that
patterns.
Components of Time Series
• The first step is to visualize the data using a time series plot.
• The time series plot is a graphical representation of the relationship
of time with the variable we need to forecast
Data should be plotted to detect for the following components:
 Level Variations: Data follow a horizontal pattern around the mean
 Trend variations: increasing or decreasing trend
 Cyclical variations: wavelike movements that are longer than a year
and are not of fixed period (e.g., business cycle)
 Seasonal variations: show ups and downs that repeat over a
consistent/fix interval such as The effect of seasons – spring, summer,
Autumn and winter, or seasons
 Random variations: due to unexpected or unpredictable events; such as
natural disasters (hurricanes, tornadoes, fire), strikes and wars.
• Horizontal Pattern: A horizontal pattern
exists when the data fluctuate randomly
around a constant mean over time.
• Trend Patterns: Data are progressively
increasing (shown) or decreasing. Linear or
exponential.
• Seasonal variations: A seasonal pattern(e.g.
quarter of the year, month of the year, week
of the month, day of the week) exists when
demand is observing recurring patterns
over successive periods.
• Cyclical variations: Demand gradually
increases and decreases over an extended
period of time, such as years. Business
cycles (recession/expansion) product life
cycles influence this component of demand
• Averaging Techniques: work best when a series tends
to vary about an average (i.e. smooth variations
around mean)
• Common Time Series approaches are
naïve forecast,
simple moving average,
weighted moving average and
exponential smoothing
Time Series Forecast
Naive forecast:
• The estimate for the next period is equal to the actual demand for the
immediate past period.
Ft+1 = At
Where Ft+1 = forecast for period t+1

At = actual demand for period t
• This method is inexpensive to understand and develop.

• The method may not generate accurate forecasts.
Example- Naïve Forecast
Simple Moving Average Forecast
• Calculates the overall trend in a data set using
historical data.
• Works well if demand is stable over time and is
extremely useful for forecasting long-term trends .
• For Example: if you have sales data for a twenty-year
period, you can calculate a five-year moving average,
a four-year moving average, a three-year moving
average and so on.
• Stock market analysts often use a 50 or 200 day
moving average to help them see trends in the stock
market and forecast where the stocks are headed.
Simple Moving Average Forecast
• Puts equal weight on each of the historical results being used
Forecast = Sum of last “n” demands

n
Example-Moving Average Forecast
Example-Moving Average Forecast
Each of the observations used to compute the forecasted

value is weighted equally.
Weighted Moving Average Forecast
• The weighted average of the n-period observations, using
unequal weights.
• The weights should be non-negative and sum to one.
• Weighted Moving Average puts more weight on recent data and
less weight on old data.
Weighted Moving Average Forecast
Fourth most recent period = 0.1

Third most recent period = 0.2
Second most recent period =0.3
Most recent period = 0.4
Total 1.0
Exponential Smoothing Forecast
• A type of weighted moving average. Only two data points are needed.
• The forecast for next period’s demand is the current period’s forecast
adjusted by a fraction of the difference between the current period’s
actual demand and forecast.
• This approach requires less data than the weighted moving average
method because only two data points are needed.
• This method is suitable for forecasting data with no trend or seasonal
pattern.
Ft+1 = Ft+(At - Ft) or
Ft+1 = At + (1 – ) Ft
Where
Ft+1 = forecast for Period t + 1
Ft = forecast for Period t
At = actual demand for Period t
 = a smoothing constant (0 ≤  ≤1)
Ft+1 = Ft+(At - Ft)
Smoothing Constant
0≤α≤1
The forecast for next period’s demand is the current period’s forecast
adjusted by a fraction of the difference between the current period’s
actual demand and forecast.
Next period Current period Difference b/w Current period’s

forecast forecast actual demand and forecast
Ft+1 = Ft+(At - Ft)
Ft+1 = At + (1 – ) Ft
At Ft
Calculate the forecast for period 3 using the exponential smoothing
method. Assume the forecast for period 1 is 1600. Use a smoothing
constant (α) of 0.3.
F11600
= A1 1-α = 1-0.3 = 0.7
1600
1780 Ft+1 = At + (1 – ) Ft
Ft+1 = 0.3(At) + 0.7(Ft)
F2 = 0.3(1600) + 0.7(1600)
F2 = 1600
F3 = 0.3(2200) + 0.7(1600)
F3 = 1780
Linear Trend Forecast
• Linear Trend Forecast
• Linear trend forecasting is used to impose a line of

best fit to time series historical data.
• Line of best fit is that line which has least sum of
square value, which tells us how well this line fits
to our data.
• Purpose is to find the best possible trend for future
demand forecasts.
Lets Visualize it first

Y = mx + b
Ŷ = b1x + b 0
where
Y = forecast or dependent variable
x = time variable
b = intercept of the line
m = slope of the line
m = Rise/Run
m = ∑xy – nx y
∑x2 – n (x)2
Example: Linear Trend Forecast
Y = mx + b
Y = mx + b
x = ∑x / n =3.5
y = ∑y / n =2233.4
x = 3.5
y = 2233.4
m = 285
Y = mx + b
y = mx + b x = 3.5
Y = 2233.4
b = y - mx = 1235.9
M = 285
Y = mx + b
Y = 285x + 1235.9
Forecast for 7th month or July = Y = 285(7) + 1235.9 = 3230.9

Class Activity
• The demand for toys produced by the Miki Manufacturing
Company is shown in the table below.
• What is the trend line?

• What is the forecast for period 13?
Class Activity
Y = mx + b
Y=? X=? m=?

Class Activity
Trend Line for first 12 months = Y = 1236.4 + 286.7X

Y = 1236.4 + 286.7(13)
Forecast for period 13 = Y = 4964 Toys

Cause and Effect Forecasting
• Cause and Effect forecasting assumes that
one or more factors are related to demand
and that the relationship between cause and
effect can be used to estimate future
demand.
• The cause-and-effect models have a cause
(independent variable or variables) and an
effect (dependent variable).
• Cause and Effect Forecasting Models
Simple Linear Regression Forecast
Multiple Linear Regression Forecast
• Regression analysis is a statistical technique that attempts to
explore and model the relationship between two or more variables.
• For example: An analyst may want to know if there is a relationship
between road accidents and the age of the driver.
• Simple Linear Regression Forecast: Demand is dependent on
only one variable.
Ŷ = b0 + b1x
Y = mx + b
Y = forecast or dependent variable
x = time variable Explanatory or independent Variable
b = intercept of the line
m = slope of the line
x variable is no longer time but instead an explanatory variable of demand.

For example, demand could be dependent on the size of the advertising budget.
• Multiple Regression Forecast: When several
explanatory variables are used to predict the dependent variable
• There is one variable to be forecast and several predictor variables.
Intercept Independent variables
Ŷ = b0 + b1x1 + b2x2 + . . . Bkxk + Error

Y = c + m1x1 + m2x2 + m3x3 + …+ mkxk + error
where
Ŷ = forecast or dependent variable
xk = kth explanatory or independent variable
b0 or m = intercept of the line
bk or mk = regression coefficient of the independent
variable xk
• Example: Banks score loan customers based on a lot of
personal information. A sample of 500 customers from an
Australian bank provided the following information.
Forecast Error
• Forecast error is the difference between the actual

quantity and the forecast.
• The ultimate goal of any forecasting endeavour is to have
an accurate and unbiased forecast.
• Forecast error can be expressed as:
Forecast error, et = At - Ft
where
et = forecast error for Period t
At = actual demand for Period
Ft = forecast for Period t
Forecast Error
• There are several measures of forecasting accuracy
follow:
Mean absolute deviation (MAD)

Mean squared error (MSE)
Mean absolute percentage error (MAPE)
Forecast Error
• Mean absolute deviation (MAD):
• It is the average of the absolute value, or the difference between
actual values and their average value.
• The mean absolute deviation of a dataset is the average distance
between each data point and the mean. It gives us an idea about the
variability in a dataset.
where et = At -Ft
et = forecast error for period t
At = actual demand for period t;
n = number of periods of evaluation
Forecast Error
• Mean absolute percentage error (MAPE)-Provides a perspective
of the true magnitude of the forecast error.
where
At = actual demand for period t;
Forecast Error
• Mean squared error (MSE)-
• The mean squared error tells you how close a regression line is to a
set of points.
• It does this by taking the distances from the points to the
regression line (these distances are the “errors”) and squaring them.
• The squaring is necessary to remove any negative signs.
Where
Forecast Error
• Running Sum of Forecast Errors (RSFE)-
• Indicates bias in the forecasts or the tendency of a forecast to be
consistently higher or lower than actual demand.
• The RSFE tells us whether our forecast is biased to always be too
high, or always be to low.
n
Running Sum of Forecast Errors, RSFE = e
t 1
t
Where
How big is a big enough error that we should do something about

it?
Forecast Error
• Tracking signal determines if forecast is within acceptable
control limits.
• If the tracking signal falls outside the pre-set control limits,
there is a bias problem with the forecasting method and an
evaluation of the way forecasts are generated is warranted.
• If Tracking Signal > 3.75 then there is persistent under
forecasting.
• If this is < -3.75 then, there is persistent over-forecasting
• Positive tracking signals indicate that demand is greater than
forecast.
• Negative signals mean that demand is less than forecast.
RSFE
Tracking Signal =
MAD
Given the following data, compute the tracking
signal and decide whether or not the forecast
should be reviewed.
Actual Forecast
Month Sales Sales
1 8 10
2 11 10
3 12 10
68
Tracking signal is computed as the running sum of forecast error
(RSFE) divided by MAD. We compute RSFE by summing up
the forecast errors over time. Forecast errors for January is the
difference between its actual and forecast sales. RSFE for
January is equal to the cumulative forecast errors.
e
Actual Forecast Forecast
Month Sales Sales Error RSFE t
1 8 10 -2 -2 t 1
2 11 10
3 12 10
4 14 10
Forecast Error = RSFE = -2
Actual – Forecast =
8 -10 = -2
69
Forecast errors for April is the difference between its actual
and forecast sales. RSFE for April is equal to the
cumulative forecast errors of January, February, March
and April.
Actual Forecast Forecast

Month Sales Sales Error RSFE
1 8 10 -2 -2
2 11 10 1 -1
3 12 10 2 1
4 14 10 4 5
Forecast Error =
RSFE = 1 + 4
Actual – Forecast =
= 5
14 -10 = 4
70
MAD for January is computed by averaging the absolute
errors over time. Tracking signal for January is computed
by dividing its RSFE by MAD.
Actual Forecast Absolute Tracking

Month Sales Sales RSFE Error MAD Signal
1 8 10 -2 2 2 -1
2 11 10 -1
3 12 10 1
4 14 10 5
Absolute Error = MAD = 2 TS = RSFE/MAD
Absolute (Actual – Forecast) = = -2/2 = -1
Absolute(8 -10) = 2
71
MAD for April is computed by averaging the absolute
errors of January, February, March and April. Tracking
signal for April is computed by dividing its RSFE by MAD.
Actual Forecast Absolute Tracking

Month Sales Sales RSFE Error MAD Signal
1 8 10 -2 2 2 -1
2 11 10 -1 1 1.5 -0.67
3 12 10 1 2 1.67 0.6
4 14 10 5 4 2.25 2.22
Absolute Error =
TS = RSFE/MAD
Absolute (Actual – Forecast) =
MAD = (2+1+2+4)/4 = 5/2.25 = 2.22
Absolute(14 -10) = 4
= 2.25
72
Since the tracking signals for months January to April are
within +/- 4, the forecast needs not be reviewed.
Tracking
Month Signal
1 -1
2 -0.67
3 0.6
4 2.22
73
Tracking signal
Signal exceeded limit
Tracking signal
Upper control limit = +4MAD
+
0 0 MAD
-
Lower control limit = -4MAD
Time
Resource Planning System
Chapter 6
Introduction
• Resource planning is the process of determining the
production capacity required to meet demand.
• Capacity refers to the maximum workload that an
organization is capable of completing in a given
period of time.
• A discrepancy between an organization’s capacity and
demand results in an inefficiency.
• The goal of resource planning is to minimize this
discrepancy.
Introduction
• Problem: A missed due date or stock-out
cascades downstream, magnifying the bullwhip.
Introduction
Boeing’s 787
Dreamliner production
schedule was significantly
affected by shortages of
fasteners, essentially bolts
that secure sections of the
fuselage together.
Introduction
• Operations managers are continuously involved in
resource and operations planning to balance capacity
and output.
• Firms generally run their operations at less than 100
percent capacity.
To allow time for scheduled repairs
Maintenance and to meet unexpected increases in
demand.
Resource Planning Common Problems
• Manual data entry is eating up your time
• manual tasks become increasingly error prone
• Stand-alone software systems are slowing you
down
• Integrated software can consolidate the information
available across various departments
• Efficiency is suffering due to poor
communication
• It can lead to misallocation of resources can lead to
lost orders, the late delivery
– One piece (Common channel) software
Resource Planning Common Problems
• Projects inside the company are competing for

resources
• Prioritize the projects and their activities.
• Resources need to be in the same location to work
effectively
• Not working in the same location as the project team
can impact on the effectiveness of your resources,
but thankfully the cloud can solve this problem
Operations planning
• Operational Planning can be divided into three
categories:
Long-range
Intermediate or medium-range and
Short-range planning
Operations planning
• Long-Range Planning:
Usually cover a year or more,
Tend to be more general
Involve major strategic decisions in capacity, such as the construction
of new facilities and purchase of capital equipment.
The aggregate production plan (APP) is a long-range materials plan.
• Medium-range plans
normally span six to eighteen months.
Can adjust minor changes in capacity such as changes in employment
levels, production scheduling
Master production schedule (MPS) is a medium-range plan
• Short-range plans
usually cover a few days to a few weeks.
Plans are the most detailed and specify the exact end items and
quantities to make on a weekly, daily or hourly basis.
Material requirements planning (MRP) is a short-range materials plan
Operations planning
Rough-Cut planning
A printer Company makes computer printers.
Each printer requires an average of 24 labor-
hours.
The company makes plan for orders. This plan
provides a weekly capacity of 5,000 labor-hours.
Does enough capacity exist to execute the MPS?

If not, what changes do you recommend?
Rough-Cut planning
24 x 100
5000 x 2400
Aggregate Production Plan(APP)
• Planning process that translates annual business plans and
demand forecasts into a production plan for all products.
• In simple terms, aggregate planning is an attempt to balance
capacity and demand in such a way that costs are
minimized.
• Aggregate production plans are typically stated in terms of
product families or groups.
A product family consists of different products that share similar
characteristics, components or manufacturing processes.
Aggregate resources could be total number of workers, hours of
machine time, or tons of raw materials.
• Planning horizon of APP- at least one year.
• Aggregate planning does not distinguish among sizes,
colors, features
• Aggregate plans serve as a foundation for future short-
range planning, such as production scheduling,
sequencing, and loading.
• It Includes costs relevant to the aggregate planning
decision include inventory, setup, machine operation,
hiring, firing, training, & overtime costs
• Three basic production strategies in APP :

o Chase Strategy
o Level Strategy
o Mixed Production Strategy
Chase Strategy –
 Produces exactly what is needed each period
Adjusts capacity to match demand period by period.
Finished goods inventory remains constant but the workforce
fluctuates from month to month.
The major advantage of a chase strategy is that it allows inventory
to be held to the lowest level possible
Works well for make-to-order firms.
Firm hires & lays off workers to match demand.
 It assumes that workers can be hired and trained easily to perform
the job
Hiring, training and termination costs are significant cost
components in the chase production strategy
Chase Strategy –
It is basically “Chasing demand” by doing it dynamically and
quickly.
Produce products or services just-in-time
Typical for services industry
Example: An Aggregate Production Plan for the ATV Corporation
The ATV Corporation makes three models of all-terrain vehicles: Model

A, Model B and Model C. Model A uses a 0.4-liter engine, Model B
uses a 0.5-liter engine and Model C uses a 0.6-liter engine. The
aggregate production plan is the twelve-month plan that combines all
three models together in total monthly production. The planning horizon
is twelve months. The APP determines the size of the workforce, which
is the constrained resource.
On average, one unit of ATV requires eight labor hours to produce,
and a worker contributes 160 hours (8 hours × 5 days × 4 weeks) per
month
120 x 8 960/160
Level Strategy –
 Maintains a steady production rate and/or a steady employment
level.
 In order to satisfy changes in customer demand, the firm must
raise or lower finished inventory levels in anticipation of
increased or decreased levels of forecast demand.
 Level strategy is a strategy the firm maintains a constant capacity
over a period of time irrespective of the fluctuations in demand.
 This strategy is used when the skill level, training required, or the
cost of hiring people and terminating them is high.
Level Strategy –
 The firm maintains a level workforce and a steady rate of output
when demand is low. This allows the firm to maintain higher
inventory levels than are currently needed.
 As demand increases, the firm is able to continue a steady
production rate/steady employment level, while allowing the
inventory surplus to absorb the increased demand
 Works well for make-to-stock firms.
Quarter Sales Forecast (lb)
Spring 80,000
Summer 50,000
Fall 120,000
Winter 150,000
• Hiring cost = $100 per worker

• Firing cost = $500 per worker
• Inventory carrying cost = $0.50 pound per quarter
• Production per employee = 1,000 pounds per quarter
• Beginning work force = 100 workers
• Chase Demand Strategy
Sales Production Workers Workers Workers
Quarter Forecast Plan Needed Hired Fired
Spring 80,000 80,000 80 - 20
Summer 50,000 50,000 50 - 30
Fall 120,000 120,000 120 70 -
Winter 150,000 150,000 150 30 -
100 50
Cost = (100 workers hired x $100) + (50 workers fired x $500)

= $10,000 + 25,000 = $35,000
Production per employee = 1,000 pounds per quarter

Level Strategy
Sales Production
Quarter Forecast Plan Inventory
Spring 80,000 100,000 20,000
Summer 50,000 100,000 70,000
Fall 120,000 100,000 50,000
Winter 150,000 100,000 0
400,000 140,000
Cost = 140,000 pounds x 0.50 per pound = $70,000

Master Production Scheduling
Master Production Schedule (MPS) - A detailed disaggregation
of the aggregate production plan, listing the exact end items to be
produced by a specific period.
More detailed than APP & easier to plan under stable

demand.
Planning horizon is shorter than APP, but longer than the
lead time to produce the item.
Note: For the service industry, the master production
schedule may just be the appointment log or book, where
capacity (e.g., skilled labor or professional service) is
balanced with demand.
• Start with Aggregate plan
(Aggregate Sales & Ops Plan)
Output level designed to meet targets
• Disaggregates
 Converts into specific schedule for each item
• Example:
• APP = Total number of Automobiles
• MPS = Disaggregate into different Models of automobile
 Plan for Model A, Model B, Model C
• APP = Total number of furniture items
• MPS = Disaggregate into various furniture items
 Plan for chairs, tables, beds, cabinets
Corporate Strategy
Aggregate Unit Aggregate Planning

Demand (Plan. Hor.: 1 year, Time Unit: 1 month)
Capacity and Aggregate Production Plans
End Item Master Production Scheduling

Demand (Plan. Hor.: a few months, Time Unit: 1 week)
SKU-level Production Plans
Manufacturing Materials Requirement Planning

and Procurement (Plan. Hor.: a few months, Time Unit: 1 week)
lead times
Component Production lots and due dates
Part process Shop floor-level Production Control
plans (Plan. Hor.: a day or a shift, Time Unit: real-time)
Capacity Company Product Economic

Consts. Policies Charact. Considerations
Placed Orders Master Production

Forecasted Demand Schedule:
Current and Planned MPS When & How Much
Availability, eg., to produce for each
•Initial Inventory, product
•Initiated Production,
•Subcontracted quantities
Planning Time
Horizon unit
Capacity
Planning
System nervousness - small changes in the upper-level-production plan
cause major changes in the lower-level production plan.
Example: If the demand for the current month gets double, then,
 Production plan should be revised
 Purchase order should be revised
 Component assembly order should be revised
• It will cause a ripple effect of change within the firm as well as in all
supply chain
• Firms use a time fence system to deal with nervousness
• The Time fence system separating the planning horizon into two
segments:
1. Firmed Segment (AKA demand time fence) from current period to
several weeks into future. Can only be altered by senior
management.
2. Tentative segment (AKA planning time fence), from end of firmed
segment to several weeks into the future.
6+
weeks
4-6
2-4 weeks
1-2 weeks
weeks
+/- 5% +/- 10% +/- 20%
No Change
Change Change Change
Frozen
Firm
Full
Open
• Available-to-Promise (ATP) Quantity
ON HAND = 200 Committed Orders = 200
How many can he promise

200 Planned Production For sales in next week?
Available-to-Promise (ATP) Quantity –
• The uncommitted portion of the firm’s planned production.
• The difference between confirmed customer orders & the quantity
the firm planned to produce.
• The MPS also provides vital information on whether additional
orders can be accepted for delivery in specific periods.
• The available-to-promise quantity allow the sales personnel to
quickly negotiate new orders and delivery due dates with
customers.
• It is the means by which we are able to give reliable delivery
promises to customers.
Three basic methods of calculating the available-

to-promise quantities:
1. Discrete available-to-promise
2. Cumulative available-to-promise without look ahead, &
3. Cumulative available-to-promise with look ahead.
• Discrete available-to-promise (ATP :D)
Planned Beginning
Production Inventory
• Remember these terms;

• MPS = Master Production Schedule
• ATP = Available to Promise Quantity
• CCO = Committed Customer Orders
ATP = On-hand + Supply - Demand

• Calculating Discrete Available-to-Promise
Quantities
1. Add the Beginning Inventory to the MPS for Period 1,
subtracting the Committed Customer Orders from Period 1
MPS up to, but not including the period of the next scheduled
production run.
2. For all subsequent periods, there are two possibilities:
 If no MPS has been scheduled for the period (if MPS is

zero), the ATP is zero.
 If an MPS has been scheduled for the period, the ATP is

the MPS minus the sum of all the CCOs from that period
up to the period of the next scheduled MPS.
3. If an ATP for any period is negative, the deficit must be

subtracted from the most recent(previous) positive ATP, and the
ATP quantities must then be revised to reflect these changes.
4. A negative available to promise means that more

production has been committed to customer orders than
is available.
• Model A
• Add the Beginning Inventory to the MPS for Period 1, subtracting the
Committed Customer Orders from Period 1 up to but not including the
period of the next scheduled MPS.
• ATP = On-hand + Supply - Demand
• ATP1 = BI + MPS1 − CCO1 = 30 + 10 − 10 = 30

• If an MPS has been scheduled for the period, the ATP is the MPS minus
the sum of all the CCOs from that period up to the period of the next
scheduled MPS.
• ATP2 = MPS2 − CCO2 = 10 − 0 = 10
• ATP3 = MPS3 − CCO3 − CCO4 = 20 − 28 − 0 = −8
• Revising: ATP2 = 10 − 8 = 2 and ATP3 = −8 + 8 = 0
10 -8
• If an ATP for any period is negative, the deficit must be subtracted from
the most recent positive ATP, and the quantities must be revised to reflect
these changes.
• Revising: ATP2 = 10 − 8 = 2 and ATP3 = −8 + 8 = 0
• ATP4 = 0 (no scheduled MPS)

• ATP5 = MPS5 − CCO5 − CCO6 − CCO7 = 20 − 0 − 20 − 0 = 0
• ATP8 = MPS8 − CCO8 = 20 − 10 = 10
• CHECK: The sum of the BI and MPS quantities for all periods
must equal the sum of all CCOs and ATPs
• Calculate ATP for Model B
Add the Beginning Inventory to the MPS for Period 1, subtracting the Committed
Customer Orders from Period 1 up to but not including the period of the next
scheduled MPS.
ATP = On-hand + Supply - Demand
If an MPS has been scheduled for the period, the ATP is the MPS minus
the sum of all the CCOs from that period up to the period of the next
scheduled MPS.
• ATP1 = BI + MPS1 − CCO1 = 30 + 10 − 20 = 20

• ATP2 = MPS2 − CCO2 − CCO3 = 10 − 10 − 7 = −7 (use 7 units from
ATP1) Revising: ATP1 = 20 − 7 = 13 and ATP2 = −7 + 7 = 0
• ATP4 = MPS4 − CCO4 − CCO5 = 20 − 0 − 0 = 20
• ATP6 = MPS6 − CCO6 − CCO7 = 20 − 20 − 18 = −18 (use 18 units from
ATP4 since ATP5 = 0) Revising: ATP4 = 20 − 18 = 2 and ATP6 = −18 +
18 = 0
• ATP8 = MPS8 − CCO8 = 20 − 0 = 20
Dependent & Independent Demand
Independent Demand
• The demand for final products & has a demand pattern affected by trends,
seasonal patterns, & general market conditions.
• However, if the components or subassemblies are sold as service parts to
customers for repairing their ATVs, then they are independent demand items.
• The demand for finished products
• Does not depend on the demand of other products
Dependent Demand
• Describes the internal demand for parts based on the demand of the final
product in which the parts are used.
• It is the demand derived from finished products-
• It is the demand for component parts based on the number of end items
being produced.
• Subassemblies, components, & raw materials are examples of dependent
demand items.
Bill of Material (BOM)
• Engineering document that shows a listing of all component parts and
subassemblies making up the end item. Or
• A bill of materials (BOM) is an extensive list of raw materials,
components and assemblies required to construct, manufacture or
repair a product or service.
• Planning Factor- the exact quantity of each component required for
making a higher-level part or assembly.
• Multilevel Bill of Materials
• Shows the parent-component relationships.
• The multilevel bill of materials can be presented as an indented bill of
materials. At each level of indentation, the level number increases by
one.
• Super Bill of Materials (AKA planning BOM, pseudo BOM,
phantom BOM, or family BOM) useful for planning purpose.
• Instead of planning factor, the percentage of each option is used.
Bill of Material (BOM)
Super Bill of Materials (AKA planning BOM, pseudo BOM,
phantom BOM, or family BOM) useful for planning purpose. Instead
of planning factor, the percentage of each option is used.
Material Requirement Planning (MRP)
Lead Time = 2 weeks
BI 1 2 3 4 5 6 7 8
Gross 110 145 228 450 - 154 227
Requirement
Schedule 150
Receipt
On Hand 350 350 390 245 17 0 0 0
Net 0 0 0 433 0 154 227
Requirement
Planned 0 0 0 433 0 154 227
Order receipt
Planned 433 154 227
Order Release
• Once the independent demand of the final product is known
• The dependent demand item requirements can be calculated using
material requirements planning (MRP) software.
• MRP- is a production planning, scheduling, and inventory control
system used to ensure right quantity of material are available when
needed.
• A computer-based materials management system.
• Determines quantity & timing of dependent demand items
o Calculates
How much is needed? (the exact quantities),
When is needed? (need dates),
When to order? (planned order releases for subassemblies).
MRP Inputs MRP Processing MRP Outputs
Changes
Order releases
Master
schedule Planned-order
schedules
Primary
reports Exception reports
Bill of Planning reports
materials MRP computer Secondary
Performance-
programs reports control
reports
Inventory
records Inventory
transaction
Data Files Output Reports
MRP by period
BOM Master report
production schedule
MRP by date
report
Lead times
(Item master file) Planned order

report
Inventory data
Purchase advice
Material
requirement
planning programs
(computer and
software) Exception reports
Purchasing data
Order early or late or
not needed
Order quantity too

small or too large
Extension of MRP- MRP-II
• Closed-loop MRP- MRP that integrate aggregate production
planning, master production scheduling and capacity requirements
planning.
• The system contains an information feedback feature that enables
plans to be continuously checked and adjusted.
• The development of closed-loop MRP was a second generation
of MRP by adding capacity requirements planning and the
progress of orders.
• Demand/Forecast MPS MRP Capacity Planning
• MRP-II- It further evolved into manufacturing resource planning
(MRP-II) by including resource planning and other aspects.
• MRP system provides input to the capacity plan, MPS, and production
planning process.
MRP-II
MRP-II
Production plan
Priority Planning Capacity Planning
Desired Resource
master production planning
schedule First cut Planning
No
Realistic? capacity
Yes
Material Capacity
requirements requirements
(detailed) (detailed)
MRP-II
Priority Control Capacity Control

(detailed scheduling) (work center throughput)
Input/output
Dispatch list report Execution
No No
Is Is
specific capacity Yes average
adequate capacity
? adequate
Execute ?
the plan
MRP requires:
 The independent demand information.
 Parent-component relationships from the bill of materials.
 Inventory status of the final product & all of the
components.
 Planned order releases (output of the MRP system)
Advantage of MRP- provides planning information
Disadvantage of MRP- loss of visibility,

• especially acute for products with a deep bill of
materials, & ignore capacity & shop floor conditions.
• Poor information and lack of understanding of the
impact of average lot sizes and lead times can cause
implementation failure and costly reimplementation.
MRP & ERP
MRP & ERP
Customer Relationship Management
Sales Order Shipping

(order entry, Distributors,
Invoicing product configuration, retailers,
sales management) and end users
MRP & ERP
Master
Production
Schedule
Inventory Bills of
Management Material
MRP
Work
Orders
Purchasing Routings
and and
Lead Times Lead Times
Table 13.6
MRP & ERP
Vendor Communication
(schedules, EDI, advanced shipping notice,
e-commerce, etc.)
Figure 14.11
MRP & ERP
Finance/
Accounting
Accounts
Receivable
General
Ledger
Accounts
Payable
Payroll
Table 13.6
Figure 14.11
Important Terms in MRP
• Parent: The item generating the demand for lower level
components. Level 0 is the final product. It is the parent of
all Level 1 components.
• Components: The parts demanded by a parent.
E.g: Piston assembly” is a component of “engine assembly.”
• Gross requirement: Gross requirements are the total of
independent and dependent demand for a component
before the netting of on-hand inventory and scheduled
receipts.
• The total requirement for raw materials, other
components, and subassemblies required to produce a
certain item
• Net requirement: the amount of material required for the
coming productive period, after netting the scheduled
receipts and the on-hand inventory, from the gross
requirements.
• In simple terms, we add up the orders scheduled to arrive
and the material that we have in store and then subtract it
from the total of the gross requirements
• Net requirement = gross requirement – (current on-hand inventory +
scheduled receipts)
• Scheduled receipt: A committed order awaiting delivery for a
specific period.
• Pre-ordered materials scheduled to arrive at some point in the
future.
• Planned order release: A specific order to be released to the
supplier including expected lead time to ensure that it is
available on the need date.
• Projected on-hand inventory: The projected inventory at the
end of the period.
• Time bucket: The time period used on the MRP. It is usually
expressed in days or weeks.
• Explosion: The process of converting a parent item’s planned
order releases into component gross requirements.
• Planning factor: The number of components needed to produce
one unit of the parent item.
• Pegging: Relates gross requirements for a component to the
planned order releases. It shows the relationship between
demand and incoming supply.
o The process of identifying the parent items that have generated a given
set of material requirements for an item
o Tracing upward the bill of material from the component to the parent
item.
• Safety stock: Protects against uncertainties in demand, supply,

quality and lead time.
• Low-level coding: Assigns the lowest level on the bill of
materials to all common components to avoid duplicate MRP
computations
Enterprise Resource Planning (ERP)
• The typical ERP system is an umbrella system that
ties together a variety of specialized systems using a
common, shared, centralized database
• ERP modules include
 Basic MRP
 Finance
 Production
 Human resources
 Supply chain management (SCM)
 Customer relationship management (CRM)
Advantages of ERP
• ERP uses a single database and to provide a broader scope and up-to-
date information.
• ERP helps organizations reduce supply chain inventories due to the
added visibility throughout the entire supply chain.
– Supply chain visibility leads to reductions of the bullwhip effect and
helps to better plan production and end-product deliveries to customers.
• ERP systems enable the firm to automate the steps of a manufacturing
process.
• Process standardization eliminates redundant resources and increases
productivity.
• Performance can be monitored across the entire organization using the
same measurements and standards.
• The use of a single software platform and database also allows the
ERP system to integrate financial, production, supply and customer
order information
Disadvantages of ERP System
• A substantial capital investment is needed to purchase
and implement the system.
– Total cost of ERP ownership includes hardware, software,
professional services, training and other internal staff costs.
• ERP systems are very complex and have proven
difficult to implement, particularly in large multi-
business unit organizations.
• The adopting firm must restructure its processes to be
compatible with the new ERP system.
• This has resulted in a very unusual situation where a
software system determines the business practices and
processes a firm should implement
ERP Cost Breakdown
• Where it is hosted
• Number of Users
• Application Required
• Customization Level
ERP Cost Breakdown
• Product Selection Costs
o Number of modules
o The more modules you need, the more it’ll cost, so businesses
should add modules wisely.
o Licensing costs
o There are going to be monthly/yearly licensing costs associated
with the product. This is usually in the form of number
users/month or number of users/year.
o Infrastructure
o Where you going to host your software on your own
infrastructure or on the cloud of software company.
ERP Cost Breakdown
• Implementing your ERP system:
o Consultation costs
o The software company will do a business and/or gap analysis of
your company. This stage then requires a fee for the time and
input of the consultants involved.
o Development costs
o Next, the ERP provider company has to modify the software
you chose earlier to fit your requirements. This will include
configuring it, adding customizations for new features, as well
as creating integrations with other software.
o Training
o After the product is developed, your users will have to go
through training to make sure it works correctly both in
function and in workflow.
ERP Software Provider
• There are hundreds of ERP
software providers, each
targeting a specific market
segment and industry type.
• SAP, Oracle, PeopleSoft,
JD Edwards and Baan have
been among the most
popular ERP providers.
• Microsoft has also gained a
foothold in the ERP market
with its purchase of “Great
Plains” in 2001 and
“Navision” in 2002.
ERP Implementation in Hershey
• One of the leading chocolate
manufacturer across world,
Founded in 1876 by Milton
Hershey.
• The company was running on
“legacy systems”, needed
modernization of IT System to:
o Solve Y2K Problem
o Have better coordinated deliveries to
retailers
• Harshey’s management decided to
replace existing systems with modules
from three IT partners:
o SAP's R/3 ERP software
o Manugistics SCM software
o Seibel's CRM software
• Management decided to go with “Big

Bang “approach instead of “phased
“approach
• Overall Project Cost: $112 million
• Implementation Time: Shift to the
new system by the end of year
1999.
• The recommended implementation
time for the project was 4 yrs. and
Hershey demanded for 2.5 yrs.
• Decided to go with “Big Bang”
approach instead of “phased”
approach.
• Project Expectations:
o Fine-tune deliveries to suppliers.
o Upgrade and standardize companies
business processes.
o Efficient customer driven processes
capable of managing changing
customer needs.
o Reduce order cycle times and boost
inventory accuracy.
o Reduce inventory costs.
• Project Results in Failure:
o Order Cycle time Doubled
o 15 days delay in orders to customers
o Accumulating Inventories increased 25%
o Stock Price declined to 8% in one day.
o Profits declined 18%
o Sales Declined 12%
o Failed to deliver $100 million orders on Halloween.
“Enterprise software isn’t just software.

It requires changing the way you do
business.”
• What went wrong:
o Squeezed deadlines:
o Project originally scheduled for 4 years
o Company forced the implementation to 30 months
o Wrong timing:
o The company went live at their busiest time
o Released the solution just before the Halloween
o Big-Bang Approach:
o To quicken the implementation process, Hershey opted for Big Bang
o implementation.
o Simultaneously implemented a customer-relations package and a logistics
package even without testing some of the modules
o Un-entered data:
o Surge Storage capacity not recorded as storage points in the ERP
o Orders from many retailers and distributors could not be fulfilled, even
though Hershey had the finished product stocked in its warehouses.
• Lessons Learned:
o Go Slow:
o The evolutionary way
o Test each module before release
o Data is King:
o Data migration is important
o Discipline in inventory
o Big-Bang Approach:
o Oversight Matters.
o Management should keep a close watch

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Supply Chain Management

o Material and services flow

Supplier Manufacturer Distributor Customer

• It is a strategy to gain control

• Globalization and Global Competition in business

• Manufacturing Cost 45%

Effort spent for supply chain activities are invisible to the

• $3 trillion spent domestically for SC activities.

 A typical box of cereal spends 104 days from factory to sale

• National Semiconductor used air transportation and closed 6

• Compaq lost $0.5 B to $1 B in sales because laptops were not

• P&G (Proctor&Gamble) estimates it saved $65 M (in 18 months)

• When the 1 gig processor was introduced by AMD (Advanced

Supplier Manufacturer Distributor Customer

Supply Supplier alliances, supplier management,

Operations Demand management, MRP, ERP, JIT, TQM

Distribution Transportation management, Customer

Integration Coordination/Integration activities, global

 Traditional Purchasing Approach:

• Over the past two decades shift towards more

Islamabad—Qatar recently signed 15 years long term agreement

Today, firms are increasing their partnerships with

The expansion involves:

 Firms will increasingly need to be more flexible and

 The Greening of Supply Chains

Cost reduction achieved in the supply chain through:

• However, in the past 30 years, purchasing has

• How can you reduce cost and what cost should be

• Businesses have had to change radically in

• The reality is that technology is rapidly displacing

• During the next decade, the supply management

• The Annual Survey of

Triangle = Inventory Storage

Triangle = Inventory Storage

• Acquisition of services is widely called supply management.

Purchasing contributes to these

• Choose the appropriate suppliers

• Get best quality of supplies

• Negotiate the best price, and

• Award contracts that ensure that the correct amount of

• Purchasing managers, buyers, and purchasing

• Once all of the necessary information on suppliers

• In Push systems, work release is based on downstream demand

• Example: Consider the dollar responsibility of one General

Cost of Goods(Material + Manufacturing Cost)

Sales $84167 100% Sales $84167 100%

Sales $84167 100%

Operating Profit Margin of the company is 17.6% Which is more easier?

How much does marketing needs to sell

$2715/0.176 = $15454 Purchasing Sales

Total assets = $1000

• Which company would you rather own?

• = 0.1 x 100 = 1 millions

• = 0.66 x 100 = 67millions

Inventory turnover ratio = Sales / Average inventory

o Step 1-Material Requisition/Purchase

• Step 2- Materials requisition submitted to buyer - At purchasing

• Step 3- Buyer assigns qualified suppliers to bid - Product

• Step 4- Buyer reviews closed bids & selects a supplier

• Cost advantage: Especially for components that are non-vital

• Insufficient capacity: A firm may be at or near capacity.

• Lack of expertise: Firm may not have the necessary

• Quality: Suppliers have better technology, process, skilled