Logistics and Supply Chain Management

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LESSON 7
Logistics Management
1
LOGISTICS MANAGEMENT
CONTENTS
1.0 Aims and Objectives
1.1 Introduction
1.2 Logistics - Evolution
1.3 Definition and Concept of Logistics
1.3.1 The Concept of Logistics
1.4 Importance of Logistics
1.5 Components of Logistics Management
1.5.1 Types of Logistics
1.6 Logistics Management Cycle
1.7 Functions of Logistics Management
1.7.1 Logistics as an Operational Function
1.8 Logistics Network
1.8.1 Logistical Competency
1.9 Let us Sum up
1.10 Lesson End Activity
1.11 Keywords
1.12 Questions for Discussion
1.13 Suggested Readings
1.0 AIMS AND OBJECTIVES

After studying this lesson, you should be able to:
z Define logistics management
z Describe the concept of logistics Management.
z Study the importance of logistics
z Explain the components of logistics management
z Discuss about the logistics management cycle
z Identify the functions of logistics management
z Describe the logistics network
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Logistics and 1.1 INTRODUCTION
Supply Chain Management
Logistics has developed from a series of separate activities, largely based on transport,
warehousing, and procurement, where decisions were seen as largely operational or
tactical. As it evolved into a single function, the strategic impact of logistics has
become more evident. Logistics is the one of the most important segment of the
phenomenon of Marketing in business. It is a subset of Supply Chain Management. In
the business functioning, the trader gets order for supply of his goods or services
through his marketing executives or directly from customers and then to execute the
order to the satisfaction of the customer, the trader or his supplier company prepares the
Logistics i.e., procures the product or services, puts labels on them, or gives some
identification trademark name to them, makes necessary packing and packaging so as to
save them from damage of any kind during loading, unloading, handling, transportation
etc., till is supplied to the end customer. More simply, it is a bundle of goods finally
ready to be supplied to the customer. In Logistics study, all factors contributing till the
last stage, when the goods or service is finally supplied to the consumer are
systematically studied.
1.2 LOGISTICS - EVOLUTION

The birth of Logistics can be traced back to ancient war times of Greek and Roman
empires when military officers titled as 'Logistikas' were assigned the duties of
providing services related to supply and distribution of resources. This was done to
enable the soldiers to move from their base position to a new forward position
efficiently, which could be a crucial factor in determining the outcome of wars. This
also involved inflicting damage to the supply locations of the enemy and safeguarding
one's own supply locations. Thus, this will lead to the development of a system which
can be related to the current day system of logistics management.
During the Second World War (1939-1945), logistics evolved greatly. The army
logistics of United States and counterparts proved to be more than the German army
could handle. The supply locations of German armed forces were inflicted with
serious damages and Germany was not able to wreak the same havoc on its enemy.
The United States military ensured that the services and supplies were provided at the
right time and at the right place. It also tried to provide these services when and
wherever required, in the most optimal and economical manner. The best available
options to do the task were developed. This also gave birth to several military logistics
techniques which are still in use, albeit in a more advanced form.
Logistics has now evolved itself as an art and science. However, it cannot be termed
as an exact science. Logistics does not follow a defined set of tables nor is it based on
skills inherited from birth. A logistics manager performs his duties and responsibilities
based on his educational experiences, skills, past experiences and intuition. These
skills are nourished by a constant application of the same by him for the betterment of
his organization. The logistics manager ensures that the company is benefited by an
effective and efficient system of logistical management. He also needs to ensure that
the right kind of products and services are provided at the right time and for a right
price, whether inside the organization's premises or delivery of shipments outside the
premises of the organization.
Logistics has come to be a kind of relief for many organizations that formerly looked
upon it as a burden. Companies nowadays are hiring people with the requisite
knowledge to deliver sustainable enhancements in the field of supply chain
management. As has been the case throughout most of logistics history, the task of a
logistics manager involves a clear vision and a drive within to deliver results under
strict deadlines in addition to his usual responsibilities.
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1.3 DEFINITION AND CONCEPT OF LOGISTICS Logistics Management
According to the Council of Logistics Management (CLM) “Logistics is the process

of planning, implementing and controlling the efficient and effective flow of goods,
services and related information from point of origin to point of consumption in order
to meet customer requirements”.
The word ‘Logistics’ is derived from French word 'Loger', which means art of war
pertaining to movement and supply of armies.
1. A military concept
2. Fighting a war requires:
(i) Setting an objective
(ii) Meticulous planning to achieve the objective
(iii) Proper deployment of troops
(iv) Supply lines consisting of weaponry, food, etc.
3. A logistics plan should be such that there is minimum loss of men and material.
Similar to fighting a war in battlefield, marketing managers also prepare a suitable
logistics plan that is capable of fulfilling the company objective of meeting the
demand of targeted customers in a profitable way.
Inbound logistics + Material Management + Physical Distribution = Logistics
1. Inbound logistics means the movement of materials received from suppliers.
2. Material management means the movement of material and components inside a
firm.
3. Physical distribution refers to movement of goods outward from the end of the
assembly line to the customer.
4. Supply-chain management is larger than logistics and it links logistics more
directly within the user's total communication network and with the firm
engineering staff. It not only includes manufacturer and suppliers but also
transporters, warehouses, retailers and customers themselves.
5. According to Council of Logistics Management: "Logistics is the process of
planning, implementing and controlling the efficient, effective flow and storage of
goods, services and related information from the point of origin to the point of
consumption for the purpose of conforming the customer requirement".
Logistics management includes the design and administration of systems to control the
flow of material, work-in-process, and finished inventory to support business unit
strategy.
1.3.1 The Concept of Logistics

Logistics is that part of the supply chain process that plans, implements and controls
the effective forward and reverse flow and storage of goods, services, and related
information between the point of origin and the point of consumption, in order to meet
the customer's requirements.
Logistics Activities
1. Customers service
2. Demand forecasting
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10 3. Distribution communication
Logistics and
Supply Chain Management 4. Inventory control
5. Material handling
6. Order processing
7. Part and service support
8. Plant and warehouse side selection
9. Procurement
10. Packaging
11. Return goods handling
12. Salvage and scrap disposal
13. Traffic and transportation
14. Warehousing & storage
Few areas of business involve the complexity or span the geography typical of
logistics. Logistics is concerned with getting products and services wherever they are
needed whenever they are required.
Most consumers take a high level of logistical competency for granted. When they go
to store, they expect products to be available and be fresh. It is rather difficult to
visualize any marketing or manufacturing without logistical support.
Logistics has been carried out since the beginning of civilization – it is hardly new.
However, implementing best practice of logistics has become one of the most exciting
and challenging operational areas of business and public sector management.
Logistics is the designing and managing of a system in order to control the flow of
material throughout a corporation. This is a very important part of an international
company because of geographical barriers. Logistics of an international company
includes movement of raw materials, coordinating flows into and out of different
countries, choices of transportation, and cost of the transportation, packaging the
product for shipment, storing the product, and managing the entire process.
1.4 IMPORTANCE OF LOGISTICS

Logistics has gained importance due to the following trends:
1. Transportation costs have risen rapidly due to the rise in oil prices
2. Production efficiency has scaled new heights
3. Fundamental changes in inventory
4. Proliferating product lines
5. Computer technology
6. Increased use of computers
7. Increase in public concern about the product. Growth of several new, large retail
chains or mass merchandise with large demands and very sophisticated logistics
services, bypassing traditional channels and distribution
8. Economic regulation reduction
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9. Increase in power of retailers 11
10. Globalization
The interrelation of different logistic elements and their costs should be based on total
cost rather than individual costs.
Operating Importance
In case of logistical system design and administration, the firm must simultaneously
achieve at least six different operational objectives. These operational objectives,
which are the primary determinants of logistical performance, should include rapid
response, minimum variance, minimum inventory, movement consolidation, quality,
and life-cycle support.
Rapid Response
Rapid response is concerned with a firm's ability to satisfy customer service
requirements in a timely manner. Information technology has increased the capability
to postpone logistical operations to the latest possible time and then accomplish rapid
delivery of required inventory. The result is elimination of excessive inventories
traditionally stocked in anticipation of customer requirements. Rapid response
capability shifts operational emphasis from an anticipatory posture based on
forecasting and inventory stocking to responding to customer requirements on a
shipment-to-shipment basis. Because inventory is typically not moved in a time-based
system until customer requirements are known and performance is committed, little
tolerance exists for operational deficiencies.
Minimum Variance
Variance is an unexpected event that disrupts performance of the system. Variance
may result from any aspect of logistical operations. Delays in expected time of
customer order receipt, an unexpected disruption in manufacturing, goods arriving
damaged at a customer's location, or delivery to an incorrect location. These result in a
time disruption in operations that must be resolved. Potential reduction of variance
relates to both internal and external operations. Operating areas of a logistical system
are subject to potential variance. The traditional solution to accommodate variance
was to establish safety stock inventory or use high-cost premium transportation. These
practices, given their expense and associated risk, have been replaced by using
information technology to achieve positive logistics control. To the extent, variances
are minimised; logistical productivity improves as a result of economical operations.
Hence a basic objective of overall logistical performance is to minimize variance.
Minimum Inventory
The aim of minimum variance involves assets, commitment and relative turn velocity.
Total commitment is the financial value of inventory deployed throughout the
logistical system. Turn velocity involves the rate of inventory usage over a period of
time. High turn rates, coupled with inventory availability, means that assets devoted to
inventory are being utilized effectively. The aim is to reduce inventory deployment to
the least level consistent with customer service goals to achieve the least overall total
logistics cost. Zero inventories have become increasingly important as managers seek
to reduce inventory storage. The reality of reengineering a system is that operational
defects do not become apparent until inventories are reduced to their least possible
level. The goal of eliminating all inventories is attractive; it is important to note that
inventory can and does facilitate some important benefits in a logistical system.
Inventories can provide improved return on investment when they result in economies
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12 of scale in manufacturing or procurement. The aim is to reduce and manage inventory
Logistics and
Supply Chain Management to the lowest possible level while simultaneously achieving desired operating aim.
To achieve the aim of minimum inventory, the logistical system design should control
commitment and turn velocity for the entire firm, not only for each business location.
Consolidated Movement
The most important logistical costs are transportation. Transportation cost is directly
proportional to the type of product, size of shipment, and distance. Logistical systems
that feature premium service depend on high-speed, small-shipment transportation.
Premium transportation is typically high-cost. To decrease transportation cost, it is
desirable to achieve movement consolidation. The larger the overall shipment and the
longer the distance it is transported, the lower is the transportation cost per unit. To
achieve this, it requires innovative programmes to group small shipments for
consolidated movement. These kinds of programmes must be facilitated by working
arrangements that transcend the overall supply chain.
Improvement in Quality
Another logistical aim is to seek continuous improvement in quality. Total Quality
Management (TQM) has become a major commitment in all departments of industry.
Total commitment to TQM is one of the major forces which contribute to the logistics.
In case a product becomes defective or if service promises are not kept, value is added
by the logistics. Logistical costs, once increased, cannot be reversed. When quality
fails, the logistical performance typically needs to be reversed and then repeated.
Logistics itself must perform to the required quality standards. The challenge of
achieving zero defect logistical performance is illustrated by the fact that logistical
operations typically must be performed across a wide geographical area at all times of
the day and night. The quality challenge is illustrated by the fact that most logistical
work is performed due to supervisor's vision. Reworking a customer's order due to
incorrect shipment or due to in-transit damage is more costly than performing it right
the first time. Logistics is a main part of developing and maintaining continuous TQM
improvement.
Life-cycle Support
The final logistical aim is life-cycle support. Very few items are sold without some
guarantee that the product will perform as advertised over a period. The normal value-
added inventory flow toward customers must be reversed. Product recall is an
important competency that results from increasing rigid quality standards, product
expiration dating and responsibility for hazardous consequences. Return logistics
requirements also result from the increasing number of laws prohibiting disposal and
encouraging recycling of beverage containers and packaging materials. The most
important aspect of reverse logistical operations is the need for maximum control
when a potential health liability exists. A recall programme is similar to a strategy of
maximum customer service that must be executed regardless of cost. The operational
requirements of reverse logistics range from lowest total cost, such as returning bottles
for recycling, to maximum performance solutions for critical recalls. The important
point is that sound logistical strategy cannot be formulated without careful review of
reverse logistical requirements.
The importance of service support logistics changes directly with the product and
buyer. This applies especially to firms marketing consumer durables or industrial
equipment. The commitment to life-cycle support constitutes a demanding operational
requirement as well as one of the largest costs of logistical operations. The life-cycle
support capabilities of a logistical system must be carefully designed. Reverse
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logistical competency, as a result of worldwide attention to environmental concerns, 13
requires the capacity to recycle ingredients and packaging materials.
Caselet 1: Logistics and Transportation Management — Oracle

Gains New Product with G-Log Buy
Krishnan Thiagarajan
Adding to the string of acquisitions made in the past ten months, Oracle
Corporation announced that it has snapped up G-Log, a provider of logistics
and transportation management software here. This acquisition, which will be
its tenth one over the past nine months, is expected to boost Oracle's
capability in the supply chain and logistics management space. However, the
financial terms of the deal have not been disclosed as a part of the deal
announcement. This announcement comes just a week after the $ 5.85-billion
proposed acquisition of Siebel Systems.
Earlier, in a question and answer session with over 300 journalists
participating in Oracle OpenWorld, 2005, Mr. Charles Phillips, President,
Oracle, said that, "Speed and clarity in communication are the lessons that we
learnt from PeopleSoft acquisition that were applied to other acquisitions
made by Oracle this year."
Decisions on people were taken quickly and communication with customers
initiated as soon as the acquisition was announced and these had helped
Oracle handle integration issues smoothly, he added.
The decision on people and changes within the PeopleSoft/JD Edwards and
Oracle organisation were taken within 30 days of the announcement of
acquisition in January this year.
In the Siebel Systems acquisition announced last week, "advisory boards"
within Oracle contacted Siebel customers on the announcement day.
He also claimed that part of the reason for the successful integration of
PeopleSoft acquisition was that a substantial number of people had worked
earlier for Oracle and it had been a "homecoming" for quite a few of them.
Highlighting another data point confirming this view, Mr. Phillips said that
the PeopleSoft customer support satisfaction score had actually gone up post-
merger, indicating that customers appeared satisfied with this merger.
Since January, when the PeopleSoft acquisition was announced, Oracle has
added eight more acquisitions to its portfolio, starting with Oblix focusing on
the identity management technology, Retek (retail management software),
Triple Hop (enterprise search products), Times Ten (real time data
management), Profit Logic (retail), Context Media (enterprise content
integration software), i-flex (banking) and the latest being Siebel in the
customer relationship management space.
Source: www.thehindubusinessline.com
1.5 COMPONENTS OF LOGISTICS MANAGEMENT

Logistics services, information systems and infrastructure/resources are the three
components of this system and closely linked. The interaction of the three main
components in the logistics system is interpreted as follows. Logistics services support
the movement of materials and products from inputs through production to consumers,
as well as associated waste disposal and reverse flows. They include activities
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14 undertaken in-house by the users of the services (e.g. storage or inventory control at a
Logistics and
Supply Chain Management manufacturer’s plant) and the operations of external service providers.
Logistics services comprise physical activities (e.g. transport, storage) as well as non-
physical activities (e.g. supply chain design, selection of contractors, freightage
negotiations). Most activities of logistics services are bi-direction. Information
systems include modelling and management of decision making, and more important
issues are tracking and tracing. It provides essential data and consultation in each step
of the interaction among logistics services and the target stations. Infrastructure
comprises human resources, financial resources, packaging materials, warehouses,
transport and communications. Most fixed capital is for building those infrastructures.
They are concrete foundations and basements within logistics systems.
1.5.1 Types of Logistics

1. Reverse Logistics: Reverse logistics is also known as Product Recall. It may be
defined as a process of moving goods from their place of use, back to their place
of manufacture for re-processing, refilling, repair, and recycling or waste disposal.
Reasons for Reverse Logistics

Rigid quality standards- it is critical in case of contaminated products, which
can cause environmental hazard.
Rigid laws prohibiting unscientific disposal of items.
Rigid laws making recycling mandatory.
Transit damage – e.g. leaking containers containing hazardous material.
Product expiration.
Erroneous order processing by supplier.
Exchange of new product for the old ones.
Return for repair or refill.
Drivers in Reverse Logistics

The success of reverse logistics depends upon the efficiency of following
subsystems:
Product Location: For product recall it is necessary to identify the product
location in the physical distribution system of the firm. It is difficult in case of
consumer goods but easier in case of industrial goods.
Product Collection System: After the product location is identified, product
collection is to be done through company’s field force or third party.
Recycling/Disposal Centres: This may be company’s plant, warehouse or any
other location. Called back products must be inspected before recycling or
disposal etc.
Documentation System: Proper documents should be maintained at each level,
this would help in tracing the product location.
2. Inbound Logistics: All the activities related to the material movement till the
dispatch of the products out of the factory gate are called as inbound logistics
activities.
Creation of value in the products depends upon availability of inputs on time.
Making available these inputs on time at minimum cost is the essence of
Inbound Logistics.
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Activities of a procurement performance cycle come under the scope of 15
Inbound Logistics. They are transportation during procurement operation,
storage, handling and overall management of inventory of inputs.
3. Outbound Logistics: All the activities in which the value added goods are to be
made available in the market for customers are called as outbound logistics
activities.
Success of the firm depends upon the supply of products to the customer on
time. Supplying the products of firm at marketplace at minimum cost is the
essence of Outbound Logistics.
Activities of distribution performance cycle come under the scope of
Outbound Logistics. They are order management, transportation,
warehousing, packaging, handling etc.
4. Third-Party Logistics (3PL): In order to keep the costs of inbound and outbound
logistics activities under control, an outside agency appointed to perform these
logistics functions is called “Third Party Logistics”.
5. Forth-Party Logistics (4PL): Forth Party Logistics is a complete outsourcing of
manufacturing and logistics functions including selection of Third Party service
provider.
Need for 4PL

Ever-increasing customer requirements.
Competitive and complex market scenario.
Rising globalisation, liberalization and privatisation.
Rising accessibility of supply chain technology.
Inclination of companies to enter into higher margin business.
Services provided by 4PL

Procurement and storage of materials.
Manufacturing of products.
Selection of 3PL companies.
Transportation and warehousing management.
Collection of payment and cash flow management.
Risk management and insurance.
Sharing of information, IT solution.
Check Your Progress 1
Fill in the blanks:
1. ………………means the movement of materials received from suppliers.
2. …………………..means the movement of material and components
inside a firm.
3. …………………………refers to movement of goods outward from the
end of the assembly line to the customer.
Contd…
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16 4. ……………….. plans, implements and controls the effective forward and
Logistics and
Supply Chain Management reverse flow and storage of goods, services, and related information
between the point of origin and the point of consumption, in order to meet
the customer's requirements.
5. Logistics services, information systems and infrastructure/resources are
the three components of …………………………………
1.6 LOGISTICS MANAGEMENT CYCLE

Following are the components of logistics management cycle:
1. Serving Customers: This is the priority of the cycle. Customers are the
clients/patients who determine what is done within the cycle.
2. Product selection: This is dependent on what customers are using or what service
providers are prescribing. The products here are single use syringes and needles,
safety boxes and needle removers.
3. Forecasting and procurement: Forecasting and Procurement functions are
critically important to injection safety commodity availability. This requires that
financial resources, technical skills, and management systems are in place.
4. Inventory Control: Inventory management is the process of receiving, storing,
issuing, ordering and distribution of injection safety commodities to various sites.
Figure 1.1: Logistics Cycle
1.7 FUNCTIONS OF LOGISTICS MANAGEMENT

Logistics can be classified into various positions depending on how it is viewed as a
function in a company. If logistics plays a critical role in a company’s success, it
makes sense to position it in the functional organization beside the basic functions of
finance, production or human resources. Another option could be further
centralization of logistics. But it is debatable whether this serves the cross-sectional
function of logistics.
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1.7.1 Logistics as an Operational Function 17
The functional organization is based on the classification criterion of operations, and
is frequently used in small and mid-sized companies. Logistics can be included
centrally or decentrally in the current organizational structure as an additional
operation. As a result, it is put on the same level as other fundamental operational
functions such as production, sales and procurement. The basic condition for this is
that logistics is considered an operational function:
Figure 1.2: Functions of Logistics Management

Broad centralization can be achieved if logistics is placed directly under the
managerial level. However, the functional organization opens up wide design
possibilities as there are various types of this organizational form - this depends on the
degree of centralization, the hierarchical classification and the functional place of
logistics tasks in the present organizational units.
Despite the possibility of creating a comprehensive centralization, it must be stressed
that a functional classification does not reflect the cross-sectional character of
logistics. For this reason, this classification is termed sceptically as the “functional-
silo approach”.
1.8 LOGISTICS NETWORK

Some qualifications are in order regarding the formal organization of human resources
devoted to logistics. Managers are acutely interested in organizational structure
because it directly reflects responsibility, title, compensation, and power. Many
managers have the perception that grouping responsibility for all logistical activity
into a single organizational unit will automatically stimulate effective integration. This
perception is wrong because it emphasizes structure over managerial practice.
A formal organization structure alone is not sufficient to guarantee integrated
logistical performance. Some of the most highly integrated logistical operations exist
without organizational accountability to a single executive. Other enterprises that have
highly formalized logistics reporting arrangements also achieve superior results.
Generalization regarding how logistics organizations should ideally be structured is
premature at this point of subject development. Logistical organization structures vary
significantly depending on specific mission, type of business, and available human
resources. The goal in creating logistical sensitivity is to stimulate all managers within
an enterprise to think and act in terms of integrated capabilities and economies.
1.8.1 Logistical Competency

Logistical competency is achieved by coordinating
1. Network design
2. Information
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18 3. Transportation
Logistics and
Supply Chain Management 4. Inventory
5. Warehousing
6. Material handling
7. Packaging.
Work related to these functional areas is combined to create the capabilities needed to
achieve logistical requirements. Attention is directed to an introductory discussion of
each facet of logistical work and how they interact in a typical business.
Two qualifications are important when discussing logistical work from the vantage
point of a single enterprise. First, all firms require the support and cooperation of
many other businesses to complete their overall logistical process. Such cooperation
unites the firms in terms of common goals, policies and programmes. From the
perspective of the total supply chain, efficiency is improved by eliminating
duplication and waste. However, cross-organizational coordination requires joint
planning and relationship management.
Second, there are service firms that perform logistical work on behalf of their
customers such as transportation carriers or warehouse firms. Such specialists are
supplemental to or may be substitutes for a customer's employees performing the
involved work. When outside specialists are used in a logistical system, they must be
willing to accept reasonable managerial direction and control from their customers.
Therefore, while the performance of a specific task may be outsourced to specialists,
the contracting firm's management remains responsible for successful performance of
the required work.
Network Design
Classical economics neglected the importance of facility location and overall network
design. When economists originally discussed supply-and-demand relationships,
facility location and transportation cost differentials were assumed to be either
nonexistent or equal among competitors. However, the number, size, and geographical
relationship of facilities used to perform logistical operations directly affect customer
service capabilities and cost. Network design is a primary responsibility of logistical
management since a firm's facility structure is used to provide products and materials
to customers.
Typical logistics facilities are manufacturing plants, warehouses, cross-dock
operations, and retail stores. Determining how many of each type of facility are
needed, their geographic locations, and the work to be performed at each is a
significant part of network design. In specific situations, facility operation may be
outsourced to service specialists. Regardless of who does the actual work, all facilities
must be managed as an integral part of a firm's logistical network.
The network design requirement is to determine the number and location of all types
of facilities required to perform logistics work. It is also necessary to determine the
quantum inventory and how much to stock at each facility and where to assign
customer orders for shipment. The network of facilities forms a structure from which
logistical operations are performed. Thus, the network incorporates information and
transportation capabilities. Specific work tasks related to processing customer orders,
maintaining inventory, and material handling are all performed within the network
design framework.
The design of a network must consider geographical variations. The fact that a great
deal of difference exists between geographical markets is easy to illustrate. The fifty
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largest United States metropolitan markets in terms of population account for over 19
55 per cent of all product sales. Therefore an enterprise, marketing on a national scale,
must establish logistical capabilities to service these prime markets. A similar
geographic disparity exists in typical material and component part source locations.
When a firm is involved in global logistics, issues related to network design become
increasingly more complex.
Strategic focus of new activities in this area is on the integration of various networks
within and between logistics centre’s in order to improve and develop the quality of
logistics networks as well as to spatially widen the networking activities. The key
objectives are to integrate the links between logistics centre’s, ports and other logistics
operators in a functional and sustainable way, to promote spatial integration by
creating sustainable and integrated approaches to spatial planning of logistics centre’s
and transport infrastructure approaches to spatial planning of logistics centre’s and
transport infrastructure, to improve networking and communication practices of the
field of transport and logistics and to increase the competence of logistics centre’s and
associated actors by organising educational and training events.
Information
The importance of information to logistical performance has historically not been
highlighted. This neglect resulted from the lack of suitable technology to generate
desired information. Managements also lacked full appreciation and in-depth
understanding of how fast and accurate communication could improve logistical
performance. Both these historical deficiencies have been eliminated. Current
technology is capable of handling the most demanding information requirements. If
desired, information can be obtained on a real-time basis. Managers are learning how
to use such information technology to devise new and unique logistical solutions.
However, the technology is only as good as the quality of information. Deficiencies in
the quality of information can create countless operational problems. Typical
deficiencies fall into two broad categories. First of all, information received may be
incorrect with respect to trends and events. Because a great deal of logistics takes
place in anticipation of future requirements, an inaccurate appraisal or forecast can
cause inventory shortage or over commitment. Overly optimistic forecasts may result
in improper inventory positioning. Second, information related to order processing
may be inaccurate with respect to a specific customer's requirements. The processing
of an incorrect order creates all the cost of logistics but typically does not result in a
sale. Indeed, logistics costs are often increased by the expense of inventory return and,
if the sales opportunity still exists, the cost of once again trying to provide the desired
service. Each error in the composition of information requirements creates potential
disturbance for the total supply chain.
The benefit of fast information flow is directly related to the balance of work
procedures. It makes little sense for a firm to accumulate orders at a local sales office
for a week, mail them to a regional office, process the orders on a batch basis, assign
them to a distribution warehouse, and then ship them via air to achieve fast delivery.
Electronic data interchange (EDI) from the customer's office with slower surface
transportation may have achieved even faster overall delivery at a lower total cost.
The key objective is to balance components of the logistical system.
Forecasting and order management are two areas of logistical work that depend on
information. The logistics forecast is an effort to estimate future requirements.
The forecast is used to guide the positioning of inventory to satisfy anticipated
customer requirements. The track record of logistics managers in forecasting is not
impressive. Therefore, one of the main reasons managers use information to achieve
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20 positive control of logistical operations is their desire to replace forecasting inaccuracy
Logistics and
Supply Chain Management with faster response to customer requirements. Control concepts such as just-in-time
(JIT), quick response (QR), and continuous replenishment (CR) represent approaches
to positive logistical control made possible by the application of recently developed
information technology. One of the main jobs of logistics managers is to plan and
implement their firm's strategy regarding the desired combination of forecasting and
operational control.
Transportation
Given a facility network and information capability, transportation is the operational
area of logistics that geographically positions inventory. Because of its fundamental
importance and visible cost, transportation has received considerable of managerial
attention over the years. Almost all enterprises, big and small, have managers
responsible for transportation.
Transportation requirements can be accomplished in three basic ways. First of all, a
private fleet of equipment may be operated. Second, contracts may be arranged with
transport specialists. Third, an enterprise may engage the services of a wide variety of
carriers that provide different transportation services on an individual shipment basis.
These three forms of transport are typically referred to as private, contract and
common carriage. From the logistical system viewpoint, three factors are fundamental
to transportation performance: cost, speed, and consistency.
The cost of transport is the payment for movement between two geographical
locations and expenses related to administration and maintaining in-transit inventory.
Logistical systems should be designed to utilize transportation that minimizes total
system cost. This means that the least expensive transportation does not always result
in the lowest total cost of movement.
Speed of transportation is the time required to complete a specific movement. Speed
and cost of transportation are related in two ways. First, transport firms, capable of
providing faster service, typically charge higher rates. Second, the faster the
transportation service, shorter is the time interval during which inventory is in transit
and unavailable. Thus, a critical aspect of selecting the most desirable method of
transportation is to balance speed and cost of service.
Consistency of transportation refers to variations in time required to perform a specific
movement over a number of shipments. Consistency is a reflection of the
dependability of transportation. For years, transportation managers have considered
consistency the most important characteristic of quality transportation. If a given
movement takes two days one time and six days the next, the unexpected variance can
create serious logistical operational problems. If transportation lacks consistency,
inventory safety stocks will be required to protect against unpredictable service
breakdowns. Transportation consistency affects both the seller's and the buyer's
overall inventory commitment and related risk. With the advent of new information
technology to control and report shipment status, logistics managers have begun to
seek faster service while maintaining consistency. The value of time is important and
will be discussed repeatedly. It is also important to understand that the quality of
transportation performance is critical to time-sensitive operations. Speed and
consistency combine to create the quality aspect of transportation.
In the design of a logistical system, a delicate balance must be maintained between
transportation cost and quality of service. In some circumstances of low cost, slow
transportation will be satisfactory. In other situations, faster service may be essential
to achieve operating goals. Finding and managing the desired transportation mix is a
primary responsibility of logistics.
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There are three aspects of transportation that managers should keep in mind 21
concerning the logistical network. First, facility selection establishes a network
structure that creates the framework of transportation requirements and simultaneously
limits alternatives. Second, the total cost of transportation involves more than the
freight bill. Third, the entire effort to integrate transport capability into a logistical
system may be defeated if delivery service is sporadic and inconsistent.
The World Bank’s ports and transport specialists organize and deliver training in key
areas of transport system regulation, organization and management, to increase overall
efficiency of national transport networks and enhance external trade competitiveness.
In addition, a world-class knowledge base is provided which addresses all relevant
public management aspects of ports and logistics operations.
As part of the World Bank PRAL group, comprising ports and waterborne transport,
trade logistics and facilitation, railways, and aviation, the mission of the ports and
waterborne transport team is to promote awareness and exchange of good practice in
ports and logistics activities, in terms of institutional development, operations, and
finance, through training courses, study tours, and sharing of experience.
Inventory
The inventory requirements of a firm depend on the network structure and the desired
level of customer service. Theoretically, a firm could stock every item sold in a
facility dedicated to service each customer. Few business operations could afford such
a luxurious inventory commitment because the risk and total cost would be
prohibitive. The objective is to achieve the desired customer service with the
minimum inventory commitment, consistent with lowest total cost. Excessive
inventories may compensate for deficiencies in basic design of a logistics network and
to some degree, inferior management. However, excessive inventory used as a crutch
will ultimately result higher than necessary total logistics cost.
Logistical strategies are designed to maintain the lowest possible financial assets in
inventory. The basic goal of inventory management is to achieve maximum turnover
while satisfying customer commitments.
Inventory strategies need to be focused on meeting requirements of such core
customers. The key to effective segmented logistics rests in the inventory priorities
designed to support core customers.
Most enterprises experience a substantial variance in volume and profitability across
product lines. If no restrictions are applied, a firm may find that less than 20 per cent
of all products marketed account for more than 80 per cent of total profit. While the
so-called 80/20 rule or Pareto principle is common, the management can avoid
excessive cost by implementing inventory strategies that consider fine-line product
classification. A realistic assessment of which low-profit or low-volume products
should be carried is the key to avoiding excessive cost. For obvious reasons, an
enterprise wants to offer high availability and consistent delivery on more profitable
products. High-level support of less profitable items, however, may be necessary to
provide full-line service to core customers. The trap to avoid is high service
performance on less profitable items purchased by fringe or non-core customers.
Therefore, product line profitability must be considered when developing a selective
inventory policy. Many enterprises find it desirable to hold slow moving or low-profit
items at a central distribution warehouse. The actual delivery performance can be
matched to customer importance when orders are received. Core customers may be
serviced by fast, reliable air service, while other orders to fringe customers are
delivered by less expensive ground transportation.
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22 Selection of the product assortment to be stocked at a specific facility has a direct
Logistics and
Supply Chain Management impact on transportation performance. Most transportation rates are based on the
volume and size of specific shipments. Thus, it may be sound strategy to stock
sufficient products at a warehouse to be able to arrange consolidated shipments to a
customer or geographic area. The corresponding savings in transportation may more
than offset the increased cost of holding the inventory.
Commitments to deliver products rapidly to fulfil customer requirements are
important drivers of logistics. Such time-based arrangements seek to reduce overall
inventories by developing the capability to respond rapidly to exact requirements of
manufacturing or retail customers. If products and materials can be delivered quickly,
it may not be necessary to maintain inventories at manufacturing plants. Likewise, if
retail stores can be replenished rapidly, less safety stock must be maintained forward
in the supply chain. The alternative to stockpiling and holding safety stock is to
receive the exact quantity of inventory at the time required. While such time-based
programs reduce customer inventory to absolute minimums, the savings must be
balanced against other costs incurred in the time-sensitive logistical process. For
example, time-based programs tend to reduce shipment sizes, which increase the
number, frequency, and cost of shipments. This, in turn, can result in higher
transportation costs. For a logistical arrangement to be effective and efficient it must
achieve trade-offs that result in the desired customer service at the lowest total cost.
Finally, inventory strategies cannot be created in a competitive vacuum. A firm is
typically more desirable to do business with if it can promise and perform rapid and
consistent delivery. Therefore, it may be necessary to position inventory in a specific
warehouse to provide logistical service even if such commitment increases total cost.
Sound inventory policies are essential to gain a customer service advantage or to
neutralize a strength that a competitor currently enjoys. Material and component
inventories exist in a logistical system for different reasons than finished product
inventory. Each type of inventory and the level of commitment must be viewed from a
total cost perspective.
Warehousing, Material Handling and Packaging

Four of the functional areas of logistics - network design, information, transportation,
and inventory – can be engineered into a variety of different operational arrangements.
Each arrangement will have the potential to achieve a level of customer service at an
associated total cost. In essence, these four functions combine to create a system
solution for integrated logistics. The final function of logistics – warehousing, material
handling, and packaging – also represents an integral part of an operating solution.
However, these functions do not have the independent status of the four previously
discussed. Warehousing, material handling, and packaging are an integral part of other
logistics areas. For example, merchandise typically needs to be warehoused at selected
times during the logistics process. Transportation vehicles require material handling
for efficient loading and unloading. Finally, the individual products are most
efficiently handled when packaged together into shipping cartons or other types of
containers.
When warehouses are required in a logistical system, a firm can choose between
obtaining the services of a specialist and operating its own facility. The decision is
broader than simply selecting a facility to store inventory, since many activities
essential to the overall logistical process are typically performed while products are
warehoused. Examples of such activities are sorting, sequencing, order selection,
transportation consolidation, and, in some cases, product modification and assembly.
Within the warehouse, material handling is an important activity. Products must
be received, moved, sorted and assembled to meet customer order requirements.
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The direct labour and capital invested in material-handling equipment are a major part 23
of total logistics cost. When performed in an inferior manner, material handling can
result in substantial product damage. It stands to reason that the fewer times a product
are handled, the less potential exists for product damage, and the overall efficiency of
the warehouse is increased. A variety of mechanized and automated devices exist to
assist in material handling. In essence, each warehouse and its material-handling
capability represent a mini system within the overall logistical process.
To facilitate handling efficiency, products in the form of cans, bottles, or boxes are
typically combined into larger units. The initial unit, the master carton, provides two
important features. First of all, it serves to protect the product during the logistical
process. Second, the master carton facilitates ease of handling by creating one large
package rather than a multitude of small, individual products. For efficient handling
and transport, master cartons are typically consolidated into larger units. The most
common units for master carton consolidation are pallets, slip sheets and various types
of containers.
When effectively integrated into an enterprise's logistical operations, warehousing,
material handling and packaging facilitate the speed and overall ease of product flow
throughout the logistical system. In fact, several firms have engineered devices to
move, broad product assortments from manufacturing plants directly to retail stores
without intermediate handling.
Fill in the blanks:
1. The overall purpose of ……………………………..information is to
provide the detailed data required for integrated performance of physical
distribution, manufacturing support, and procurement operations.
2. ………………………….flows provide information concerning planned
activities, operational requirements are needed to direct the day-to-day
logistics work.
3. ………………………..is concerned with the information necessary to
complete purchase order preparation, modification, and release while
ensuring overall supplier compliance.
4. …………………..operations involve information flows required to
facilitate and coordinate performance within logistics facilities.
5. …………………management refers to the transmission of requirement
information between value chain members involved in finished product
distribution.
1.9 LET US SUM UP

Logistics is a challenging and important activity because it serves as an integrating or
boundary spanning function. It links suppliers with customers and it integrates
functional entities across a company. With the ever-growing competition in today’s
market place it becomes necessary for a firm to use its resources to focus on strategic
opportunities. This includes several internal factors like management style, culture,
human resources, facilities and several external factors like technology, globalization
and competition. This is where the concept of logistics plays a major role, i.e. it helps
to leverage certain advantages the firm has in the marketplace.
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26
Logistics and
LESSON
2
CUSTOMER SERVICE AND
LOGISTICS MANAGEMENT
CONTENTS
2.1 Introduction
2.2 Customer Service and Logistic management – A perspective
2.2.1 Basic Service Capability
2.2.2 Increasing Customer Expectations
2.2.3 Value-added Services
2.3 Logistics and Consumer Satisfaction
2.4 Measure of Effectiveness of Logistics System
2.4.1 Possible Measures of Customer Service Performance
2.5 Customer Perception of Service Quality
2.6 Phases of Customer Services
2.7 Value Added Services
2.7.1 Responsive Supply Chain
2.7.2 The ‘Cost-Benefit’ of Customer Service
2.7.3 Setting Customer Service Priorities
2.7.4 Managing Product Service Levels
2.7.5 Setting Service Standards
2.7.6 Customer Value Creation
2.8 Let us Sum up
2.10 Keywords

z Explain the perspective of customer service and logistic management
z Measure of Effectiveness of Logistics System
z Identify the Customer perception of service quality
z Understand the value added services concept
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27
2.1 INTRODUCTION Customer Service and
In a competitive business environment, management needs to implement the customer
service management process in order to proactively respond to situations before they
negatively impact the customer. It is this proactive perspective that makes the
customer service management process different from the customer service activity in
logistics. The customer service group in logistics is where customers might call in to
place orders; to inquire about an order that has not arrived as scheduled; to complain
about damaged products, invoice errors, products shipped in error; and/or to change an
order. It might be argued that the greater the number of calls to the customer service
group, the more service failures customers is experiencing and thus a more appropriate
name might be customer non-service group.
2.2 CUSTOMER SERVICE AND LOGISTIC

MANAGEMENT – A PERSPECTIVE
Marketing identifies the appropriate logistical performance. The critical strategic issue
is to determine the combination of services and their desired format that will support
and stimulate profitable transactions.
Although most senior managers agree that customer service is important, they find it
difficult to explain exactly what it is and does. Two interpretations commonly
expressed are easy to do business with and sensitive to customer needs. While such
generalizations have appeal from a qualitative perspective, it is difficult to interpret
what "easy to do business with" means for firms that deal with numerous customers on
a daily basis. To develop a customer service strategy, it is necessary to develop a
working definition of customer service.
LaLonde and Zinszer have researched various ways that customer service can be
viewed: (1) as an activity, (2) in terms of performance levels, and (3) as a philosophy
of management.
Viewing customer service as an activity suggests that it is capable of being managed.
Thinking of customer service in terms of performance levels has relevancy providing
it can be accurately measured. The notion of customer service as a philosophy of
management exemplifies the importance of customer-focused marketing. All three
dimensions are important to understand what is involved in successful customer
service.
A broad definition of customer service should embody elements from all three
perspectives.
Customer service is a process for providing significant value-added benefits to the
supply chain in a cost-effective way.
It is clear that excellent customer service performance seems to add value for all
members of the supply chain. Thus, a customer service program must identify and
prioritize all activities important to accomplish operating objectives. A customer
service program also needs to incorporate measures for evaluating performance.
Performance needs to be measured in terms of goal attainment and relevancy. The
critical question in planning a customer service strategy remains, Does the cost
associated with achieving the specified service goals represent a sound investment
and, if so, for what customers? Finally, it is possible to offer key customers something
more than high-level basic service. Extra service beyond the basics is typically
referred to as value-added. Value-added services, by definition, are unique to specific
customers and represent extensions over and above a firm's basic service program.
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28
Logistics and
2.2.1 Basic Service Capability
Supply Chain Management Three fundamental dimensions of customer service are identified: availability,
performance, and reliability. These attributes are now discussed in greater detail.
Numerous research studies have examined the relative importance of the three service
attributes in different business situations. The general conclusion is that all three
aspects of service are important. However, a given service attribute may be more or
less important depending on the specific marketing situation.
Availability
Availability is the capacity to have inventory when it is desired by a customer.
Availability can be achieved in a variety of ways. The most common practice is to
stock inventory in anticipation of customer orders. The appropriate number, location,
and stocking policy of warehouses are the basic issues in logistical system design.
Typically an inventory stocking plan is based on forecasted requirements and may
incorporate differential stocking strategies for specific items as a result of sales
popularity, importance of the specific item to the overall product line, profitability,
and the value of the merchandise. Inventory can be classified into two groups: base
stock determined by forecasted requirements and held to support basic availability,
and safety stock to cover demand that exceeds forecasted volumes and to
accommodate unexpected operational variances.
An important aspect of availability is a firm's safety stock policy. Safety stock exists
to accommodate forecast error and cushion delivery delays during base stock
replenishment. Generally, the greater the desire to protect against out-of-stocks, the
larger the safety stock required. Thus, high safety stock commitment typically means
larger average inventory. In high-variance situations, safety stock can constitute
greater than half of a firm's average inventory.
It should be clear that achieving high levels of consistent inventory availability
requires a great deal more planning than allocating inventory to warehouses based on
sales forecasts. In fact, the key is to achieve high levels of inventory availability for
selected or core customers while holding overall investment in stock and facilities at a
minimum. Such exacting performance requires total integration of all logistical
resources and clear goals regarding availability commitments to specific customers.
Exacting programs of inventory availability are not conceived or managed on "the
average." Therefore, availability is based on the following three performance
measures: stockout frequency, fill rate, and orders shipped complete. These three
measures determine a firm's ability to meet specific customer inventory requirements.
Stockout Frequency
Stockout frequency is the probability that a stockout will occur. In other words, this
measure indicates if a product is available to ship to customers. A stockout occurs
when demand exceeds product availability. The stockout frequency is a measure of
how many times demand for a specific product exceeds availability. The aggregation
of all stockouts across all products is an indication of how well a firm is positioned to
provide basic service commitments. This measure does not consider the fact that some
products may be more critical in terms of availability than others. However, stockout
frequency is a starting point in measuring inventory availability.
Fill Rate
Fill rate measures the magnitude or impact of stockouts over time. Just because a
product is out of stock does not necessarily mean that a customer requirement is going
unsatisfied. Before a stockout affects service performance, it is necessary to confront a
customer requirement. Then it becomes important to identify that the product is not
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available and to determine how many units the customer wanted. Fill rate performance 29
Customer Service and
is typically specified in customer service objectives. By measuring the magnitude of Logistics Management
stockouts, a firm's track record in meeting customer requirements can be determined.
For example, if a customer orders 50 units and only 47 units are available, the order
fill rate is 94 percent (47/50). To effectively measure fill rate, the typical procedure is
to evaluate performance over a specified time that includes multiple customer orders.
Thus, fill rate performance can be calculated for a specific customer or for any
combination of customers or business segment desired.
Fill rate can also be used to differentiate the level of service to be offered on specific
products. In the earlier example, if all 50 products were critical, an order fill rate of 94
percent could result in a stockout in the customer's operation and create considerable
dissatisfaction. However, if most of the 50 products were relatively slow movers, a fill
rate of 94 percent could be satisfactory. The customer may accept a back-order or
even be willing to reorder the short items. A firm can identify products that are critical
and should have higher fill rates on the basis of customer requirements. Fill rate
strategies can then be developed to meet customer expectations.
Stockout frequency and fill rate both depend on customer order practices. For
example, if a firm places frequent replenishment orders for small quantities, the
probability of stockout frequency will increase as a result of shipment variability. In
other words, each replenishment order represents an equal chance for a delivery delay.
Thus, as the number of orders that impact safety stock increases, more stockouts will
occur. On the other hand, if a firm places fewer large replenishment orders, the
potential stockout frequency will be less and the expected fill rate will be higher.
Orders Shipped Complete

An order shipped complete is a measure of the times that a firm has the entire
inventory ordered by a customer. It is the strictest measure since it views full
availability as the standard of acceptable performance. Orders shipped complete
establishes the potential times that customers will receive perfect orders, providing all
other aspects of performance have zero defects. These three availability measures
combine to identify the extent to which a firm's inventory strategy is meeting customer
expectations. They also form the basis to evaluate the appropriate level of availability
to incorporate in a firm's basic service platform.
Operational Performance
The performance cycle was positioned as the operational structure of logistics.
Mission, type of customer being serviced, differentiated performance cycles and the
degree of operational variance experienced over time. Operational measures specify
the expected performance cycle in terms of (1) speed, (2) consistency, (3) flexibility
and (4) malfunction/recovery. Operational performance involves logistical
commitment to expected performance time and acceptable variance.
Speed Performance-cycle speed is the elapsed time from when an order is placed until
shipment arrival. Such commitment must be viewed from a customer's perspective.
The time required for performance-cycle completion can be very different depending
on logistical system design. Given today's high level of communication and
transportation technology, order cycles can be as short as a few hours or as long as
several weeks.
Of course, the highest commitment to both inventory availability and operational
speed is customer inventory consignment. In consignment arrangements, the product
is inventoried at a customer's business establishment in anticipation of need. While
consignment may be ideal from a customer's perspective, it can be an expensive way
for a supplier to do business. Consignment arrangements are typically limited to
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30 critical items that can result in significant loss in efficiency or effectiveness if they are
Logistics and
Supply Chain Management not available exactly when required, such as machine parts and emergency medical
supplies. Typical consignment situations are found in business-to-business marketing
and the health care industry. The decision for a supplier to consign as contrasted to a
customer holding safety stock is often a reflection of the relative power in a business
relationship.
The more typical business arrangement is for a supplier's delivery commitment to be
based on customers' expectations in terms of performance-cycle speed. In critical
situations, service can be performed in a few hours by special delivery from a local
warehouse or on an overnight basis using highly reliable transportation services.
Usually, the business relationship is formed around performance-cycle expectations
that facilitate efficient logistical operations while meeting customer requirements. In
order words, not all customers need or want maximum speed if it results in an increase
in price or effective logistics cost.
Performance-cycle timing has a direct relationship to inventory requirements.
Typically, the faster the planned performance, the lower the level of inventory
investment required by customers. This relationship between performance time and
customer inventory investment is at the heart of time-based logistics arrangements
reliability.
Consistency
While speed of service is critical, most logistical managers place greater emphasis on
consistency. Consistency refers to a firm's ability to perform at the expected delivery
time-over a large number of performance cycles. Failure to be consistent translates
directly into customers needing to carry extra safety stock to protect against possible
late delivery. Whereas availability is concerned with the ability to ship products when
required and performance-cycle speed is concerned with the commitment to complete
all work requirements necessary to deliver specific orders at a prescribed time,
consistency deals with compliance to delivery commitments over time. The issue of
consistency is fundamental to logistical operations.
Flexibility
Operational flexibility refers to a firm's ability to handle extraordinary customer
service requests. A firm's logistical competency is directly related to how well
unexpected circumstances are handled. Typical events requiring flexible operations
are:
1. Modifications in basic service arrangements such as onetime changes in ship-to
destinations
2. Support of unique sales and marketing programs
3. New-product introductions
4. Product phase-out
5. Disruption in supply
6. Product recall
7. Customization of service levels for specific markets or customers
8. Product modification or customization performed while in the logistics system,
such as pricing, mixing; or packaging. In many ways the essence of logistical
excellence rests in the ability to be flexible. As a rule, a firm's overall logistical
competency depends on the capability to "go the extra yard" when appropriate to
satisfy a key customer requirement.
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Malfunction/Recovery 31
Regardless of how fine-tuned a firm's logistical operation is, malfunctions will occur. Logistics Management
The continuous performance of service requirements under all types of operational
situations is a difficult task. Sometimes, programs can be established to prevent or
accommodate special situations, thereby preventing malfunction. As will be discussed
later, such extraordinary commitments must be reserved for justifiable situations. In
terms of the basic service program, the key is to anticipate that malfunctions or service
breakdowns will occur and to have in place contingency plans to accomplish recovery.
Thus, the basic service program guarantees a high level of service with the realization
that no program is fail-safe. When service failures occur, the customer service
program should have contingency plans that identify expected recovery and measure
compliance.
Logistics quality is all about reliability. A fundamental quality issue in logistics is the
ability to comply with levels of planned inventory availability and operational
performance. Beyond service standards, quality compliance involves a capability and
willingness to rapidly provide accurate customer information regarding logistical
operations and order status. Research indicates that the ability of a firm to provide
accurate information is one of the most significant measures of customer service
competency. Increasingly, customers indicate that advanced information concerning
the contents and timing of an order is more critical than complete order fulfilment.
Customers detest surprises! More often than not, customers can adjust to a stockout or
late delivery situation if they receive advanced notification.
In addition to service reliance, a major part of service quality is continuous
improvement. Logistical managers, similar to other managers within the firm, are
concerned with meeting operational objectives with as few malfunctions as possible.
One way to achieve these objectives is to learn from malfunctions and improve the
operating system to prevent reoccurrence.
The key to achieving logistical quality is measurement. Inventory availability and
operational performance are critical in the eyes of customers. However, high level
performance can be maintained only by exacting measurement of achievements and
failures. Three aspects of measuring service quality are important: Variables, units,
and base.
2.2.2 Increasing Customer Expectations

An important consideration in determining a firm's basic service program rests on
understanding customer expectations. In almost every industry one or more firms use
logistics as a core strategy to gain customer loyalty. These firms commit resources to
achieve high levels of basic service competency that are difficult for competitors to
duplicate. The result is a form of competition that is forged in a "catch me if you can"
approach to logistical operations that tends to increase overall customer expectations.
Figure 2.1: Shrinking Service Window

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32 In actual practices, when a firm places a purchase order that specifies an exact
Logistics and
Supply Chain Management delivery requirement or appointment in terms of time and location, it is clear that the
traditional concept of an acceptable service window is instantaneously transformed to
a point in time. If the customer's expectation is that suppliers will provide 100 percent
inventory availability in a timely, error-free manner, then the service commitment is
for perfect order performance.
The Perfect Order

The ultimate in logistics quality is to do everything right and do it right the first time.
The notion of the perfect order is that desired customer service capability, in terms of
availability and operational performance, should be synchronized to achieve target
service goals each and every time. The order should also be complete in terms of all
aspects of service from order receipt to delivery coupled with error-free invoicing. In
other words, the total order cycle performance must be orchestrated with zero defects.
This means that availability and operational performance must be perfectly executed
and that all support activities, such as invoice accuracy and appropriate product
presentation, must be completed exactly as promised to the customer. In many ways
the concept of a perfect order is the logical extension of quality. Such service
performance is possible given today's technology, but it is expensive. Therefore, few
firms commit to zero defects as a basic service strategy offered across the board to all
customers. The point is that such high-level performance is a strategic option and it
can be committed to on a selective basis.
In terms of resources committed, zero defect performance typically cannot be
supported solely by virtue of inventory commitment and positioning. Extremely high
fill rates typically require high inventory commitments to cover all potential order
requirements and operational variations. One service location may not have sufficient
inventory to meet all customer availability requirements. To facilitate timely
shipments from secondary locations, it is desirable to have predetermined procedures
to accommodate service requirements in a timely manner.
The typical perfect order program involves activities that exceed the basic service
program. The commitment to perfect order performance is usually based on
agreements that develop from close working relationships between a supplier and
selected customers. At this point, it is sufficient to underline the fact that perfect order
commitments are usually implemented in highly structured working arrangements.
These arrangements develop over time and often are supported by significant amounts
of information exchange between involved businesses to facilitate and maintain an
in-depth understanding of requirements. Perfect order expectations are not typically
dropped on suppliers without advanced warning.
2.2.3 Value-added Services

The notion of value-added service is significantly different from the logistical
performance involved in basic customer service capability and perfect order
accommodation. Value-added services refer to unique or specific activities that firms
can jointly work out to increase their effectiveness and efficiency. Value-added
services solidify business arrangements. Value-added services are easy to illustrate but
difficult to generalize because they are customer-specific.
A clear distinction exists between basic service, zero defect, and value-added services.
Basic service is the customer service program upon which a firm builds its
fundamental business relationships. All customers are treated equally at a specified
level to build and maintain overall customer loyalty. Zero defects leading to perfect
order performance is the maximum level of logistical availability, operational
performance, and reliance. Perfect order commitments can be offered to select
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customers as a way to gain and maintain preferred supplier status. Value added 33
services represent alternatives to a zero defect commitment as a way to build customer Logistics Management
solidarity.
In a logistical context, a great number of the day-to-day value-added options that
buyers and sellers agree to are performed by service specialists such as carriers,
warehousing firms, and companies that specialize in such operations. For example, in
the case of a trucking company, value-added service goes beyond the provision of
basic transportation and may incorporate additional services such as sorting and
sequencing to meet unique requirements of specific shippers.
Companies today face lot of dynamic situations where changes keep happening
continuously. As a result, Companies have adopted a strategy of Flexibility in their
business. Logistics too has been facing ever-changing scenarios and has been making
all efforts to overcome its problems without any compromises.
The Challenging issues faced by Logistics are:
A. The Customer Service Explosion
B. Time Compression
C. Globalization of Industry
D. Organizational Integration.
A. The Customer Service Integration

Customer has become more demanding, as regards to quality as well as service.
Hence, the edge has to be created through value addition and the primary source for
this is ‘customer service’.
“Customer Service” may be defined as the consistent provision of time and place
utility.
Products or Services do not have value till they are in the hands of the Customer at the
required time and place. In fact, these do not have any value till these are used by the
Customer and he/she comes for a repeat purchase.
Companies who have accorded high priority to Logistics have done well, e. g., Xerox,
BMW, Benetton, Dell Computers, Asian Paints, etc. Companies like McDonald’s,
British Airways, etc. have succeeded since they strongly believed that managing the
logistics of service delivery consistently is crucial to gain the edge.
B. Time Compression
Users/Customers have started insisting on JIT deliveries. End users do not mind
switching over to an alternate, if their first choice is not available. There is a need to
improve the quality of Market feedback given to R&D. The main issue here is the
problem of extended logistics lead-times. This could be the result of a “Just-in-case”
attitude.
What is essential is the integration of marketing and manufacturing planning. Very
often, purchasing and manufacturing have restricted view of the final demand,
normally due to extended supply and distribution pipeline. Hence, a new approach to
the management of lead-time is required.
C. Globalization of Industry
In the global business, materials and components are sourced worldwide,
manufactured offshore and sold in different countries perhaps with local
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34 customization. Very soon, Multi National Companies (MNCs) will dominate most
Logistics and
Supply Chain Management markets. For such companies, Logistics will become the main concern.
They seek to achieve the competitive edge by identifying world markets for its
product and then developing a manufacturing and logistics strategy to support its
marketing strategy. Where required or possible, they use the service of a third party
for this purpose. Companies can also attempt to achieve cost advantage through
standardization of parts, components and modules.
D. Organizational Integration
The classical business organization is based upon strict functional divisions and
hierarchies.
It is difficult to achieve a closely integrated, customer-focused materials flow under
such conditions. Broad based integrators are required to achieve marketplace success
based upon managing processes and people that deliver service. The new Managers
will be market-oriented with a sharp focus on customer service.
2.3 LOGISTICS AND CONSUMER SATISFACTION

Customer satisfaction is the degree to which customer expectations of a product or
service are met or exceeded. Logistics exists to satisfy customer requirements by
facilitating important manufacturing and marketing operations.
The various operational objectives which logistics help in achieving and hence
maximizing customer satisfaction are:
z Rapid Response: Rapid response is concerned with a firm's ability to satisfy
customer service requirements in a timely manner. Information technology has
increased the capability to postpone logistical operations to the latest possible time
and then accomplish rapid delivery of required inventory. The result is elimination
of excessive inventories traditionally stocked in anticipation of customer
requirements. Rapid response capability shifts operational emphasis from an
anticipatory posture based on forecasting and inventory stocking to responding to
customer requirements on a shipment-to-shipment basis. Because inventory is
typically not moved in a time-based system until customer requirements are
known and performance is committed, little tolerance exists for operational
deficiencies.
z Minimum Variance: Variance is an unexpected event that disrupts performance
of the system. Variance may result from any aspect of logistical operations.
Delays in expected time of customer order receipt, an unexpected disruption in
manufacturing, goods arriving damaged at a customer's location, or delivery to an
incorrect location. These result in a time disruption in operations that must be
resolved. Potential reduction of variance relates to both internal and external
operations. Operating areas of a logistical system are subject to potential variance.
The traditional solution to accommodate variance was to establish safety stock
inventory or use high-cost premium transportation. These practices, given their
expense and associated risk, have been replaced by using information technology
to achieve positive logistics control. To the extent, variances are minimized;
logistical productivity improves as a result of economical operations. Hence a
basic objective of overall logistical performance is to minimize variance.
z Minimum Inventory: The aim of minimum variance involves assets, commitment
and relative turn velocity. Total commitment is the financial value of inventory
deployed throughout the logistical system. Turn velocity involves the rate of
inventory usage over a period of time. High turn rates, coupled with inventory
LSCM
availability, means that assets devoted to inventory are being utilized effectively. 35
The aim is to reduce inventory deployment to the least level consistent with Logistics Management
customer service goals to achieve the least overall total logistics cost. Zero
inventories have become increasingly important as managers seek to reduce
inventory storage. The reality of reengineering a system is that operational defects
do not become apparent until inventories are reduced to their least possible level.
The goal of eliminating all inventories is attractive; it is important to note that
inventory can and does facilitate some important benefits in a logistical system.
Inventories can provide improved return on investment when they result in
economies of scale in manufacturing or procurement. The aim is to reduce and
manage inventory to the lowest possible level while simultaneously achieving
desired operating aim. To achieve the aim of minimum inventory, the logistical
system design should control commitment and turn velocity for the entire firm,
not only for each business location.
z Consolidated Movement: The most important logistical costs are transportation.
Transportation cost is directly proportional to the type of product, size of
shipment, and distance. Logistical systems that feature premium service depend
on high-speed, small-shipment transportation. Premium transportation is typically
high-cost. To decrease transportation cost, it is desirable to achieve movement
consolidation. The larger the overall shipment and the longer the distance it is
transported, the lower is the transportation cost per unit. To achieve this, it
requires innovative programmes to group small shipments for consolidated
movement. These kinds of programmes must be facilitated by working
arrangements that transcend the overall supply chain.
z Improvement in Quality: Another logistical aim is to seek continuous
improvement in quality. Total Quality Management (TQM) has become a major
commitment in all departments of industry. Total commitment to TQM is one of
the major forces which contribute to the logistics. In case a product becomes
defective or if service promises are not kept, value is added by the logistics.
Logistical costs, once increased, cannot be reversed. When quality fails, the
logistical performance typically needs to be reversed and then repeated. Logistics
itself must perform to the required quality standards. The challenge of achieving
zero defect logistical performance is illustrated by the fact that logistical
operations typically must be performed across a wide geographical area at all
times of the day and night. The quality challenge is illustrated by the fact that
most logistical work is performed due to supervisor's vision. Reworking a
customer's order due to incorrect shipment or due to in-transit damage is more
costly than performing it right the first time. Logistics is a main part of developing
and maintaining continuous TQM improvement.
z Life-cycle Support: The final logistical aim is life-cycle support. Very few items
are sold without some guarantee that the product will perform as advertised over a
period. The normal value-added inventory flow toward customers must be
reversed. Product recall is an important competency that results from increasing
rigid quality standards, product expiration dating and responsibility for hazardous
consequences. Return logistics requirements also result from the increasing
number of laws prohibiting disposal and encouraging recycling of beverage
containers and packaging materials. The most important aspect of reverse
logistical operations is the need for maximum control when a potential health
liability exists. A recall programme is similar to a strategy of maximum customer
service that must be executed regardless of cost. The operational requirements of
reverse logistics range from lowest total cost, such as returning bottles for
recycling, to maximum performance solutions for critical recalls. The important
LSCM
36 point is that sound logistical strategy cannot be formulated without careful review
Logistics and
Supply Chain Management of reverse logistical requirements.
The importance of service support logistics changes directly with the product and
buyer. This applies especially to firms marketing consumer durables or industrial
equipment. The commitment to life-cycle support constitutes a demanding operational
requirement as well as one of the largest costs of logistical operations. The life-cycle
support capabilities of a logistical system must be carefully designed. Reverse
logistical competency, as a result of worldwide attention to environmental concerns,
requires the capacity to recycle ingredients and packaging materials.
Logistical service is measured in terms of:
z Availability: Availability denotes having inventory to consistently meet the need
of the customer material or product requirements.
z Operational Performance: Operational performance means the elapsed time from
order receipt to delivery. Operational performance involves delivery speed and
consistency. A firm's operational performance can be measured in terms of how
flexible it is in accommodating unusual and unexpected request of customer.
z Service Reliability: Service reliability pertains to the quality attributes of logistics.
For logistics performance to continuously meet customer expectations, it is
necessary that management should be committed to continuous improvement.
2.4 MEASURE OF EFFECTIVENESS OF

LOGISTICS SYSTEM
Ideally, Organizations should establish standards and monitor performance across a
range of customer service measures. For example, using the pre-transaction,
transaction and post-transaction framework, there can be some measures that provide
valuable indicators of performance.
2.4.1 Possible Measures of Customer Service Performance

Pre-transaction
z Stock availability – ensuring that enough stocks are available to meet any
emergency orders.
z Target delivery dates – making all efforts to accept & meet the delivery dates as
desired by the Customers.
z Response time to queries – providing responses at the earliest to any queries raised
by the Customers.
z Regular calls by Sales Representatives – ensuring that the Sales staff visits the
customers periodically to understand their needs and requirements.
z Quality of Sales Representatives – employing qualified, well-trained sales
personnel who can handle the customers in the most appropriate way.
z Consultation on New Products/Packaging Development – involving
customers/suppliers as early as possible in New Product/Packaging Development
so that best possible solution is arrived at.
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Transaction 37
z Order fill rate – Ascertaining the fulfilment of the ‘perfect order’ concept. Logistics Management
z On-time delivery – Making sincere efforts and succeeding in executing deliveries

on time.
z Back-orders by age – keeping track of pending orders by date and prioritizing the
deliveries of the same to meet Customer expectations.
z Shipment delays – avoiding any delays in the dispatch of goods.
z Product substitutions – where required, helping customers with product
substitutions, with a view to bring down cost and/or improve quality.
z Credit Terms offered – ensuring that these are acceptable to the customers without
any hesitation.
z Order Tracing capability – installing proper systems to trace orders.
z Handling of queries – giving quick response to any query a customer may have
regarding his/her order/s.
z Ability to handle emergency orders – being flexible enough to respond positively
to any emergency or urgent orders placed at short notice.
Post-transaction
z First Call Fix Rate – having a system where customer complaints, if any are
resolved without any reminders from the customer.
z Customer Complaints – ensuring zero defect supplies or at least, minimizing
complaints.
z Returns/Claims – installing an appropriate system to handle returns / claims.
z Invoice Errors – having appropriately trained personnel who can generate error-
free invoices.
z Service Parts Availability – ascertaining the timely availability of spare parts in
sufficient quantity.
z Damage (concealed and visible) – having a suitable system to address any damage
related issues.
z Well stacked pallets – Using pallets and other such storage systems to take care of
the Product while in storage or in movement.
z Easy to read “use by dates” on packaging – designing an informative packaging.
z Quality of packaging for in-store display – packaging acts as a silent sales person;
hence, selecting good quality packaging.
2.5 CUSTOMER PERCEPTION OF SERVICE QUALITY

Many Firms today fix Customer Service Levels if not for everybody, at least for class
customers. Customers have to be provided whatever they need, if an Organization
wants to retain them. The cost of Lost Sales from existing customers would no doubt
affect the Company’s profits. But what is more damaging perhaps is the impact of
negative publicity on prospective customers who may not approach the Organization
at all for their requirements.
LSCM
38 It is said that:
Logistics and
Supply Chain Management Every disgruntled customer tells on an average nine others about his/her
dissatisfaction!!!
Hence, Organizations need to exercise lot of caution while handling customers.
The impact of an ‘out-of-stock’ situation on the retailer is significant – User may go
elsewhere or choose an alternate item. But, the impact on the manufacturer is even
greater. The retailer may decide to go to an alternate manufacturer!
In industrial markets, the pressure is much more. The demand now a day is more for
shorter lead-times and reliable delivery. Further, since everybody wants JIT deliveries,
the manufacturer may be forced to carry more stocks! At the same time,
manufacturers should not be over-enthusiastic about cost reductions. Care should be
taken to ensure that such a drive does not have any negative impact. Low cost
strategies may lead to efficient logistics but may not result in effective logistics.
Customer Service plays a vital role in developing new Customers. However, it is more
important to retain the existing Customers. Thus, the prime objective of any Customer
Service Strategy should be to enhance customer retention. The level of satisfaction
created should be so high that they do not even find it necessary to search for
alternates. An Organization should consciously strive to maintain and strengthen
customer loyalty, e.g., Frequent Flier programs.
2.6 PHASES OF CUSTOMER SERVICES

What is Customer Service?
We have already seen that ‘Service’ is directly related to ‘availability’. Availability is
impacted by factors like delivery frequency, reliability, stock levels, ‘order cycle’
time etc.
Customer Service can be examined under three areas:
(a) Pre-transaction elements
(b) Transaction elements
(c) Post-transaction elements.
Pre-transaction elements relate to corporate policies or programs – e.g., written
statements of service policy, adequacy of organizational structure, system
flexibility etc.
Transaction elements are those customer service variables directly involved in
performing the physical distribution function – e.g., product and delivery reliability.
Post-transaction elements are generally supportive of the product while in use – e.g.,
product warranty, parts and repairs service, procedures for customer complaint and
product replacement.
Pre-transaction Elements
z Is there a Written Customer Service Policy and has it been communicated to the
Customer?
z What is the accessibility of the Organization to the Customer? Is it easy or does
the Customer find it difficult to locate the exact point of contact?
z What is the Organization Structure as far as Customer Service is concerned? Is
there a Customer service structure in place?
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z Is the System flexible to tackle the ever-changing demands of the Customer? Can 39
we adapt our service delivery system to meet particular needs? Logistics Management
Transaction Elements
z What is the Order Cycle Time? What is the reliability/variation?
z How good is the Inventory Availability? Is there too much Inventory or is it so
inadequate that the Customer suffers?
z What is the Order Fill Rate? What is the success rate of the order fill?
z What system does the Firm have for providing the customer information on Order
status? Also, how long does it take to respond to a query? Does the Organization
inform the customer of problems or do they have to contact the Company?
Post-transaction Elements
z How good the Spare Parts Management is? Are the Spares available easily?
z What is the Call-out time? How long does it take for the engineer to arrive and
what is the ‘first call fix rate’, where a complaint is attended to without any
reminder/s from the Complainant?
z Is there a proper process for tracing Product tracing? How well the Warranty
system works? Can the location of individual products once purchased be
identified? Can the Company maintain/extend the warranty to customers’
expected service levels?
z How efficiently are Customer Complaints, Claims etc. handled? Are these
promptly dealt? Is there a system of surveying Customer Satisfaction regularly?
Service Attributes
Some of the Service Attributes are:
z Ability of Manufacturer to meet promised delivery date (on-time shipments)
z Accuracy in filling orders (correct product is shipped)
z Competitiveness of Price
z Advance notice on shipping delays
z Updated and current price data, specifications and promotion materials provided
by manufacturer.
z Timely response to requests for assistance from manufacturer’s client service
personnel
z Order Cycle consistency
z Length of the Lead Time
z Completeness of order [% of Items eventually shipped complete] etc.
Fill in the blanks:
1. …………………identifies the appropriate logistical performance.
2. Customer Service plays a vital role in developing new …………………
Contd…
LSCM
40 3. In the global business, materials and components are sourced worldwide,
Logistics and
Supply Chain Management manufactured ……………………. and sold in different countries perhaps
with local customization.
4. The prime objective of any …………………. should be to enhance
customer retention.
5. …………………………… elements relate to corporate policies or
programs e.g., written statements of service policy, adequacy of
organizational structure, system flexibility etc.
2.7 VALUE ADDED SERVICES

The Organization must have its Customer Service Strategy in place right from the
beginning. The Strategy depends on the Organization’s Vision and Mission
Statements. Very often, it is noticed that the Organizations do not have any such
Statements and as a result, the Employees work without any proper direction. Even
those Companies that have evolved a Vision Statement do not bother to articulate the
same among the staff.
Now business is not about selling Products or Services. It is about selling
relationships, solutions, supports and care. When the Vision of the Organization is not
known or when it is known, but is not evolved by the Employees, not much
enthusiasm is shown by them in accomplishing the dreams of the Management. This is
primarily because of lack of ownership. Ideally, the Vision should be a ‘Shared
Vision’ evolved by all stakeholders.
The major factors that influence this Strategy are:
A. Identification of Service Needs
B. Cost of Service
C. Revenue Management
A. Identification of Service Needs

This exercise calls for steps like:
(a) Segmentation of Customers,
(b) Identification of Segments unique to the Company,
(c) Identification of Service needs relevant to each customer segmentation/
product/geographic location.
B. Cost of Service
Identify current costs vis-à-vis costs of providing newly identified level of service to
the customer.
C. Revenue Management
Increased Customer Service, however, must also result in optimum profit as well as
growth. Therefore, rationalization of customer segments or levels of service may be
essential.
LSCM
2.7.1 Responsive Supply Chain 41
Service drove SCM Systems: Logistics Management
One must understand the service needs of the various markets and then seek to
develop low cost Logistics solutions.
Sequence to be followed:
1. Identify Customers’ service needs
2. Define Customer service objectives
3. Design the Logistics system
Identifying Customers’ Service Needs

No two customers will ever be the same in terms of their service requirements.
Through Market Research, ‘service segments’ can be identified.
Process for service segmentation:
(a) Identify the key components of customer service as seen by customers themselves.
(b) Establish the relative importance of those service components to customers.
(c) Identify ‘clusters’ of customers according to similarity of service preferences.
(a) Identify the key components of customer service as seen by customers
themselves. It is wrong to assume that ‘we know all of what our customers want’.
It is, hence, important to develop an understanding of the service needs of
customers through proper research. One has to identify the key sources like, who
are the decision makers, depending on the type of business. The purpose of the
research is to find out the needs of the customer in various areas like price,
product quality, promotion etc.
(b) Establish the relative importance of those service components to customers.
Normally, during the research itself, the Customers are asked to rank the relative
importance. However, a newly evolved technique helps in evaluating the implicit
importance that a customer attaches to different elements of Customer Service.
The technique is based on the concept of trade-offs of the desired attributes. e.g.,
in case of a car – speed performance, fuel efficiency, passenger & luggage
capacity etc.
Under the Technique, the respondents are provided with the feasible combinations
of customer service elements and are asked for their ranking of preferences.
Computer Analysis then determines the implicit importance attached by the
respondents to each service element.
(c) Identify ‘clusters’ of customers according to similarity of service preferences.
Once the preferences are ranked, the next step is to check if any similarities of
preference emerge. The technique used to identify the segments is known as
‘Cluster Analysis’. Cluster Analysis is a computer-based tool for looking across a
set of data and seeking to ‘match’ respondents across as many dimensions as
possible. Examples of Segments: Delivery Reliability, Price, Technical Support,
etc.
Defining Customer Service Objectives

As already discussed, the aim of any market-driven Logistics Strategy is to achieve
‘service excellence’. Moreover, the achievement should be consistent and cost-
effective.
LSCM
42 The concept of Perfect Order: The Perfect order is achieved when the customers’
Logistics and
Supply Chain Management requirements are met fully.
The measure of service is expressed as “the percentage of occasions in which the
customer’s requirements are met in full.” Also, the performance can be measured at
any levels, e.g., segment, country or by distribution centre. One frequently
encountered measure of the perfect order is ‘on-time, in-full’ (OTIF). An extension to
this is ‘error free’ (e.g., documentation, labelling, packaging, etc.).
Example: Actual performance across all orders for the last 12 months was as
follows:
On-time: 90%,
In-full: 80%,
Error-free: 90%.
Thus, the actual perfect order achievement would be:
90% × 80% × 90% = 64.8%
Designing Logistics System

A frequent problem in logistics system design is that projects are undertaken
piecemeal, without an organized framework for analysis. Consequently, systems are
developed that are too complex or too inflexible to change as the program
environment changes. The following pages discuss some of the most important issues
in the design of logistics systems and describe briefly several different types of
systems.
The purpose of a logistics system is simple: to obtain and move supplies and
equipment in a timely fashion to the places where they are needed, at a reasonable
cost. Matters are complicated by the fact that equipment and supplies usually cannot
go directly from their source to the end user; they frequently must be held as inventory
at one or more intermediate points along the way.
A logistics system’s physical structure consists of two things: stationary facilities and
the transportation links between those facilities. Logistics jargon further distinguishes
those facilities that are outside the system (such as drug manufacturers) from which
commodities are supplied; these are called “sources.” Facilities that receive supplies
from a source (such as a central medical store) are called “primary supply points.”
Facilities that dispense commodities to end users are called “outlets.”
The essential questions in understanding the management structure of a logistics
system are—Who decides what (and when and how many) commodities move
through a link from one facility to the next, and how does he/she decide?
2.7.2 The ‘Cost-Benefit’ of Customer Service

There will be significant differences in the profitability between customers. This is
because the cost to service different customers may vary considerably from customer
to customer. This is due to different requirements of quantities or service
requirements. In such a case, Pareto’s Law can be used to prioritize customers &
service to each of them. This Law needs to be used since the appropriate level and mix
of service will need to vary by customer type.
However, one must remember that:
(a) If improved service levels cost more to achieve than they produce by way of long-
term sales revenue, then such costs are clearly not justified.
LSCM
(b) Similarly, different segments in the total market may respond in quite different 43
ways to higher or lower levels of service. Logistics Management
(c) Also, identifying customer response to service level changes is not easy.
2.7.3 Setting Customer Service Priorities

As mentioned earlier, Pareto’s 80/20 rule can provide the basis for developing a more
cost-effective service strategy. This rule helps in providing the highest service to key
customers and key products. This rule is extended as ABC Analysis and Customers
are classified as A, B or C Categories and serviced accordingly.
The split could be 20%, 50% and 30% respectively and can be modified from industry
to industry. However, care should be taken to ensure that ‘Profit’ is considered as a
‘measure’ and not sales revenue or volume, as these are misleading. In addition, the
customer-wise profitability is to be measured ideally at each SKU level. Apart from
this, the ABC Analysis can also be used to decide the stock-holding policy.
For example:
Product Category Stock Availability
A 99%
B 97%
C 90%
Alternatively, ‘A’ items may be stocked as close as possible, to the customers
whereas, ‘B’ & ‘C’ class items may be stocked further back up the SC. The savings in
stock-holding costs achieved by holding ‘B’ & ‘C’ items at fewer places would
normally cover the additional cost of dispatching them to customer by means of a
faster means of transportation (e.g., overnight delivery)
2.7.4 Managing Product Service Levels
Actions to be taken:
Quadrant 1: Re-examine the Product and Logistics costs to see if these can be
reduced.
Quadrant 2: Offer highest levels of service by holding items close to the customers.
Quadrant 3: Probably, there is a strong case for dropping these items due to their low
contribution.
Quadrant 4: Practice JIT deliveries in order to reduce total investment in inventories.
2.7.5 Setting Service Standards

If service performance is to be controlled, then there has to be some pre-determined
standards. Really speaking, the only standard to be achieved is 100% conformity to
LSCM
44 the expectations of the customer! These standards can be set after conducting
Logistics and
Supply Chain Management customer survey and study of the benchmarks set by the competitors.
Some of the key areas where standards are essential are:
z Order Cycle Time
z Stock availability
z Order-size constraints
z Ordering convenience
z Frequency of delivery
z Delivery reliability
z Quality of documentation
z Claims procedure
z Technical support
z Order status information
2.7.6 Customer Value Creation

Customer value is the difference between what a customer gets from a product, and
what he or she has to give in order to get it. It is created by applying the concept of
total cost to logistical analysis. Earlier, the Managers used to focus on minimizing
functional cost, such as transportation, in the expectation that such effort would
achieve the lowest combined cost. But this total-cost concept has opened the door to
examining how functional costs interrelate.
To maximize the value which the customer receives, the right level of logistics cost
expenditure must be related to desired service performance. The simultaneous
attainment of high availability, operational performance, and reliability is expensive.
An important managerial challenge comes from the fact that logistical cost and
increased performance have no proportional relation.
The typical logistical system in a firm seeks to develop and implement an overall
logistical competency that satisfies important customer expectations at a realistic total-
cost expenditure.
Logistical management is concerned with operations and coordination. Operations
mean strategic movement and storage. To complete the total operations mission
attention must be given to integrating physical distribution, manufacturing support,
and procurement into a single logistical process. Functioning as an integrated and
coordinated process can best provide operational management of materials; semi-
finished components, and finished products moving between locations, supply
sources, and customers of a firm.
The mission of the logistical system is measured in terms of total cost and
performance. Performance measurement is concerned with the availability of
inventory, operational capability, and quality of effort. Logistical costs are directly
related to required level of performance. The greater the required performance, the
higher is the total logistics cost. The key to effective logistical performance is to
develop a balanced effort of service performance and total-cost expenditure.
The strategic integration of logistics is fundamental to a firm’s success. A firm may
not opt to differentiate competitively on the basis of logistical competency; it must
perform logistical responsibilities as part of the fundamental process of creating
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customer value. The relative importance that a firm places on logistical competency 45
will determine the degree of importance on achieving internal and external integration. Logistics Management
Flexibility is important to logistical competency. Logistical flexibility results from
integration and from implementing time-based control techniques.
Fill in the blanks:
1. The …………………… integration of logistics is fundamental to a firm’s
success.
2. If service …………………… is to be controlled, then there has to be
some pre-determined standards.
3. …………………… Law can be used to prioritize customers and service
to each of them.
4. One must understand the service needs of the various markets and then
seek to develop low cost …………………… solutions.
5. An important …………………… challenge comes from the fact that
logistical cost and increased performance have no proportional relation.
2.8 LET US SUM UP

Logistics too has been facing ever-changing scenarios and has been making all efforts
to overcome its problems without any compromises. Customers have to be provided
whatever they need, if an Organization wants to retain them. The cost of Lost Sales
from existing customers would no doubt affect the Company’s profits. The Strategy
depends on the Organization’s Vision and Mission Statements.
The Organization must have its Customer Service Strategy in place right from the
beginning. The Strategy depends on the Organization’s Vision and Mission
Statements. Very often, it is noticed that the Organizations do not have any such
Statements and as a result, the Employees work without any proper direction. Even
those Companies that have evolved a Vision Statement do not bother to articulate the
same among the staff.
2.9 LESSON END ACTIVITY

Why customer service is given preference for smooth functioning of business?
2.10 KEYWORDS
Customer Service: Customer service is a process for providing significant value-
added benefits to the supply chain in a cost-effective way.
Transaction Elements: These are those customer service variables directly involved
in performing the physical distribution function.
Variance: Variance is an unexpected event that disrupts performance of the system.
Rapid Response: This response is concerned with a firm's ability to satisfy customer
service requirements in a timely manner.
Customer Satisfaction: It is the degree to which customer expectations of a product or
service are met or exceeded.
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48
Logistics and
LESSON
3
DISTRIBUTION PLANNING AND
INVENTORY MANAGEMENT
CONTENTS
3.1 Introduction
3.2 Concepts of Logistics and Physical Distribution
3.2.1 Physical Distribution
3.2.2 Distribution Channel
3.3 Distribution and Inventory
3.3.1 Inventory
3.3.2 Types and Characteristics of Inventory
3.3.3 Planning the Inventory Resource
3.4 Let us Sum up
3.6 Keywords

z Explain the concepts of logistic and physical distribution
z Understand the concept of Distribution and Inventory
3.1 INTRODUCTION
Distribution Services can handle the receipt of stock and returns into our warehouse
facility, model and manage the logical representation of the physical storage facilities
(e.g. racking etc.), manage the stock within our facility and enable a seamless link to
order processing and logistics management in order to pick, pack and ship product out
of our facility so you don’t have to manage this part of the supply chain.
Inventory management has many benefits for companies of all types. Most companies
are required to have a certain amount of inventory to run their business, but they do
not want to have too much. Inventory costs money, so a company with too much
inventory is wasting money and potentially hurting the bottom line. Inventory
management can help make it so that a company has the exact inventory needed. No
more, no less. Inventory management is also an effective way to keep track of exactly
what products a company has in the supply chain. Many companies are using third
LSCM
party inventory management companies like Distribution Services to help them save 49
Distribution Planning and
money on their capital expenditures for inventory. Inventory Management
3.2 CONCEPTS OF LOGISTICS AND PHYSICAL

DISTRIBUTION
Logistics is concerned with co-ordinating the flow of goods from suppliers to the
manufacturer, through the production process, and onto the customer. In other words,
it considers both “inbound” and “outbound” logistics (and physical distribution
management), as well as the handling of inventory within companies.
Physical distribution refers to the movement of finished goods outward from the end
of the manufacturer’s assembly line to the customer, frequently via intermediaries.
Functions under this heading can include warehousing, transportation (often
undertaken by third-party specialists), customer service and administration. Logistics
describes the entire process of materials and products moving into, through, and out of
a firm. Physical distribution may be therefore be seen as "outbound logistics", while
"inbound logistics" covers the movement of materials from suppliers and is closely
linked to the manufacturer’s purchasing or procurement function. "Materials and
inventory management" typically describes the movement and stockholding of goods
within a firm. The notion of supply chain management is often viewed as somewhat
larger than logistics. It links organisations more directly with the manufacturer’s total
communication network or "supply pipeline".
3.2.1 Physical Distribution

Physical distribution does not mean only movement and storage of goods. Nowadays
physical distribution or marketing logistics encompasses planning, implementing and
controlling the physical flow of materials, final goods and related information from
points of origin to points of consumption to meet customer requirements for earning
profit. Traditionally, physical distribution is aimed at directing the flow of goods from
the producer to consumer at a minimum cost. But modern marketers have reversed the
idea and adopted market logistics thinking. It starts with the buyers and works
backwards to the producer. Logistics seek solution to the problems of both outbound
distribution (moving products from producer to consumers) and inbound distribution
(moving products and materials from suppliers to the producer). Thus, the logistics
management coordinates the whole channel physical distribution system which
involves the activities of suppliers, purchasing agents, marketers, channel members,
and customers. This is accomplishing through forecasting information systems,
purchasing, production planning, order processing, inventory, warehousing, and
transportation planning.
Today firms are giving greater emphasis on logistics for a number of
reasons. First, efficient distribution through effective logistics contributes in earning
customer service and satisfaction which is the prime goal of many firms. Better
distribution attracts new customers; poor distribution brings in the opposite
results. Second, logistics is a major cost element for most firms. So, they always try to
keep it at a minimum level through .sound distribution system. Raising the level of
physical distribution efficiency can result in cost savings for both the firm and its
customers. Third tremendous expansion in product variety has increased the need and
importance of improved logistics management. Ordering, shipping, stocking, and
controlling a wide variety of products offers a big logistics challenge.
Finally, advancement in information technology is being utilized for gaining
distribution efficiency. The increased use of computers, point-of-sale scanners,
uniform product codes, satellite tracking, electronic data interchange, and electronic
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50 funds transfer has enabled firms to build more efficient systems for order processing,
Logistics and
Supply Chain Management inventory control and handling, and transportation routing and scheduling.
3.2.2 Distribution Channel

Distribution Channel is a set of interdependent organizations involved in the process
of making a product or service available for use or consumption by the consumer or
business user.
How Channel Members Add Value

The use of intermediaries results from their greater efficiency in making goods
available to target markets. Offers the firm more than it can achieve on its own
through the intermediaries:
z Contacts
z Experience
z Specialization
z Scale of operation
Channel Functions
The different functions of a Channel are:
z Information
z Promotion
z Contact
z Matching
z Negotiation
z Physical distribution
z Financing
z Risk taking
The Distribution Channel helps in creating time and place utilities of the product. And,
Logistics helps Distribution Channel in the movement of the Product to make it
available in the right quantity whenever the Customer needs it. The effectiveness of
the Distribution Channel depends on the efficiency of the Logistics Function. To
achieve this objective, what is essential is a great degree of planning to coordinate
material availability, cost and speed.
Channel Behaviour
The channel will be most effective when each member is assigned tasks it can do best
and all members cooperate to attain overall channel goals. If this does not happen,
conflict can occur among the channel partners. The conflict can be horizontal or
vertical.
z Horizontal Conflict occurs among firms at the same level of the channel (e.g.,
retailer to retailer).
z Vertical Conflict occurs between different levels of the same channel (e.g.,
wholesaler to retailer).
Some conflicts can lead to healthy competition, too.
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Channel Structure 51
The Channel Structure is the group of channel members to which a set of distribution Inventory Management
tasks has been allocated. The Channel structure plays a vital role in the physical
distribution of products. A FMCG (Fast Moving Consumer Goods) or a Personal Care
(PC) Products Company will have a multi structure. An Industrial Product Company
or a Capital Goods Company will have no such structure, as the sale is direct to the
user.
Structuring a Distribution Channel

Important Factors in Building a Distribution Channel:
(a) Costs associated with establishing a direct channel distribution
(b) Coverage is increased through the use of indirect channels of distribution.
(c) Control is enhanced using a direct distribution channel.
What is also important is the flow of information, which in a channel structure, is two-
way. There is continuous exchange of information between the Manufacturer and
various members of the Channel. The timely flow of information is imperative for the
success of Logistics Operations.
Requirements of Channel Members

The Channel Structure consists of various intermediaries performing the distribution
services. The different Members are: Wholesalers, Retailers, Dealer/Stockiest,
Selling/Manufacturer’s Agents, Brokers, etc.
Physical distribution does not mean only movement and storage of goods. The use of
intermediaries results from their greater efficiency in making goods available to target
markets. Logistics helps Distribution Channel in the movement of the Product to make
it available in the right quantity whenever the Customer needs it. Wholesalers need
large consignments at scheduled intervals and prefer freight consolidation for lower
per unit transportation charges. Retailers, quite common in mass distributed consumer
products, buy small quantities from wholesalers and prefer frequent supplies in small
quantities, as storage space is a major constraint for them.
Dealer/Stockiest carries stocks of the Company’s Products on a consignment sale
basis, gets the stocks with a time frame for sale and has enough backup facility for
warehousing. Selling/Manufacturer’s Agents are appointed on contract basis and deal
on behalf of the selling firm/manufacturer. Brokers facilitate sales/purchase deals and
do not handle any product directly as they do not permanently represent either the
buyer or the seller.
Further, the design of a Logistic Program depends on the Channel Strategy of the
Firm.
The Channel Strategy decisions depend on the following three aspects:
(a) Length of the Channel (This is concerned with the levels in the Channel structure)
(b) Channel Breadth (This is regarding the Market Coverage)
(c) Market Strategy
Support to Distribution Channel

The Distribution Channel cannot exist without an efficient flow of material at the right
time and place. And, this particular aspect is taken care of by Logistics Function.
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52 Hence, there has to be a great coordination between the two so that the physical
Logistics and
Supply Chain Management distribution of products is efficient as well as effective.
This Objective can be achieved by following the steps shown below:
(1) Planning of Logistics Service Level Requirements.
(2) Analyzing the Cost Benefits.
(3) Implementing the Program and Monitoring the Progress.
Planning of Logistics Service Level Requirements

Different members need different levels of service. Therefore, a Logistics Manager
should first study their requirements. After a survey, he/she should fix service
standard/s for each category of channel members, depending on their service
requirements.
Analyzing the Cost Benefits

While taking any major decision, the Logistics Manager has to carry out a Cost-
Benefit Analysis. At times, the returns may be superior and yet, may cause a drain on
the profits.
Hence, a Logistics Program has to be designed and implemented to reap maximum
benefits at optimum cost.
Implementing the Program and Monitoring the progress

The implementation needs excellent managerial skills. Material movement at the
planned speed needs close coordination between various departments/functions. Close
monitoring of the Program through regular feedback is a must to remove bottlenecks,
if any.
Fill in the blanks:
1. Physical …………………… does not mean only movement and storage
of goods.
2. The use of …………………… results from their greater efficiency in
making goods available to target markets.
3. Logistics helps …………………… in the movement of the Product to
make it available in the right quantity whenever the Customer needs it.
4. …………………… need large consignments at scheduled intervals and
prefer freight consolidation for lower per unit transportation charges.
5. The Distribution Channel cannot exist without an …………………… of
material at the right time and place.
3.3 DISTRIBUTION AND INVENTORY

It is important to make a wise, informed decision about how extensive your business’s
distribution channel shall be. If you want to achieve wider distribution, then the cost
will be a lot lower if you use intermediaries. In fact, the vast majority of product
manufacturers are unable to sell directly to customers, as it would be way too costly
for them. The bigger the producer, the more intermediaries should be used in order to
have a cost effective operation.
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Most of the concepts surrounding distribution channels are related to costs. Many of 53
the practical matters relating to distribution channels, however, have to do with Inventory Management
customer control. A lot of businesses think that by selling their product in to the
distribution channel, their role in the matter has come to an end and they no longer
have to do any work. But in order to be effective, it is vital for businesses to take a
market-oriented approach and manage every level of their product’s distribution until
it arrives at the end user.
As a general rule, the greater the weight of an order, the lower is the cost per pound of
transportation from any origin to destination. There are three levels of channel
distribution membership. The first one is intensive, wherein a large majority of the
resellers are stocking the product. The normal pattern, however, is selective
distribution. In this membership model, only suitable resellers are selling the product.
Finally, there is exclusive distribution, in which only selected resellers are permitted
to sell the product – this is usually one seller per geographical region.
Sometimes it can be tough for suppliers to motivate their distribution team to provide
the sales they require. There are many ways a company might motivate their
distributors to make more sales on behalf of their organization. One way is through
“bribery,” wherein you offer a better profit margin to tempt your distributors to push
your product rather than the competitions. Alternately, competition might be offered
to the sales personnel of the distributor, tempting them to push the product. There is
another side of the spectrum wherein the personnel of the agent are trained to the same
standard as the supplier’s own sales staff. These instances are quite rare, though.
A vital element of supply chain management is the management and monitoring of the
distribution channels. Just like a company’s own sales and distribution departments
have to be overlooked and taken care of, each level of the distribution chain will have
to be managed in a similar vein. In reality, however, most companies utilize a mixture
of different distribution channels. They might help compliment a direct sales team,
call on bigger accounts, work with agents, or help take care of smaller accounts and
prospects.
One of the more recent developments in distribution is the concept of vertical
marketing. This unites the producer, wholesalers, and retailers in to one integrated
channel. Sometimes this happens as a result of one of the members of the distribution
chain owning the others outright – this is referred to as “corporate systems
integration.” For example, a supplier might own its own retail outlets; in this case, it is
called “forward integration.” “Backward integration,” in which the retailer owns its
own suppliers, is a much more common example. The furniture retailer, MFI, falls in
to this category, as they own Hugena, who manufactures their kitchen and bedroom
units. Another integration model occurs via franchising, as is the case with
McDonald’s fast food restaurants. Another model occurs with simple cooperation, in
the sense that Marks and Spencer cooperates with their suppliers.
Another approach is via a contractual system. These are often dictated by retail or
wholesale cooperatives.
Then there are administered marketing systems. When one member of the distribution
chain with more power is able to use its position to coordinate the activities of other
members, then there could be said to be an administered marketing system. Typically,
it is the manufacturer who has the dominant position in this scenario.
The point of vertical marketing is to give everyone on the distribution channel some
power over what goes on there especially the retailers and suppliers. Research shows,
however, that it is best to pursue these strategies at the mature stage. If one sets out at
an early stage of the product using these methods, it could do more harm than good in
terms of profits. These methods can also pull attention away from more important
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54 business matters. Theoretically, suppliers do not do well in retail situations, whereas
Logistics and
Supply Chain Management retailers should focus on selling rather than on bothering with manufacturing facilities.
Then there is horizontal marketing, which is used less often and has less to do with
marketing. It typically refers to situations in which several non-competing businesses
work together on a venture because it is beyond their capacity to go at it alone.
3.3.1 Inventory
Inventory generally constitutes the second largest item after fixed assets. Though one
may feel that this current asset is worth maximizing to add value to the firm, in the
long run, it may not be a good idea.
In all probabilities, business is run on borrowed funds and it would be a waste to pay
interest on borrowed money. Let us first study the types of Inventories carried by the
Industry:
z Raw materials and purchased parts
z Partially completed goods called work in progress
z Finished-goods inventories (manufacturing firms) or merchandise (retail stores)
z Replacement parts, tools and supplies
z Goods-in-transit to warehouses or customers
While too inventory is expensive and wasteful much, not enough inventories can
result in lost sales! Thus, it is really a tight rope walk for any Inventory Controller!
Nature of Inventory
If at all one is forced to carry inventory, the same must add Value. Right amount of
Inventory can add value in the following areas:
z Quality: inventory can be a “buffer” against poor quality; conversely, low
inventory levels may force high quality.
z Speed: location of inventory has gigantic effect on speed.
z Flexibility: location, level of anticipatory inventory both have effects.
z Cost: direct: purchasing, delivery, manufacturing; indirect: holding, stock-out.
Definitions
z Inventory: A physical resource that a firm holds in stock with the intent of selling
it or transforming it into a more valuable state.
z Inventory System: a set of policies and controls that monitors levels of inventory
and determines what levels should be maintained, when stock should be
replenished, and how large orders should be.
Inventory is carried by a Firm to take care of the following goals:
z To meet anticipated demand
z To smooth production requirements
z To decouple operations
z To protect against stock-outs
z To take advantage of order cycles
z To help hedge against price increases
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z To permit operations 55
z To take advantage of quantity discounts Inventory Management
Functional Roles of Inventory

z Transit
z Buffer
z Seasonal
z Decoupling
z Speculative
z Lot Sizing or Cycle
z Mistakes
3.3.2 Types and Characteristics of Inventory

1. Manufacturing: For the manufacturer, inventory risk has a long-term dimension.
The manufacturer's inventory commitment starts with raw material and
component parts, includes work-in-process, and ends with finished goods.
In addition, prior to sale, finished goods must often be transferred to warehouses
in close proximity to wholesalers and retailers. Although a manufacturer may have
a narrower product line than retailers or wholesalers, the manufacturer's inventory
commitments is relatively deep and have long duration.
2. Wholesaler: Wholesaler risk exposure is narrower but deeper and of longer
duration than that of retailers. The merchant wholesaler purchases large quantities
from manufacturers and sells small quantities to retailers. The economic
justification of the merchant wholesaler is the capability to provide retail
customers with assorted merchandise from different manufacturers in smaller
quantities. When products are seasonal, the wholesaler is also forced to take an
inventory position far in advance of selling, thus increasing depth and duration of
risk.
One of the greatest hazards of wholesaling is product-line expansion to the point
where the width of inventory risk approaches that of the retailer, while depth and
duration of risk remain characteristic of traditional wholesaling.
3. Retail: For a retailer, inventory management is fundamentally a matter of buying
and selling. The retailer purchases a wide variety of products and assumes a
substantial risk in the marketing process. Retailer inventory risk can be viewed as
wide but not deep. Because of high rents, retailers place prime emphasis on
inventory turnover and direct product profitability. Turnover measures inventory
velocity and is calculated as the ratio of annual sales divided by average
inventory.
If an individual enterprise plans to operate at more than one level of the distribution
channel, it must be prepared to assume additional inventory risk. For example, the
food chain that operates. A regional warehouse assumes risk related to the wholesaler
operation over and above the normal retail operations. To the extent that an enterprise
becomes vertically integrated, inventory must be managed at all levels of the
marketing channel.
3.3.3 Planning the Inventory Resource

The previous sections reviewed inventory's role in the value-added process and
documented the cost of holding or maintaining inventory. This section describes the
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56 key parameters and procedures for planning inventory. The discussion focuses on
Logistics and
Supply Chain Management three issues: when to order, how much to order, and inventory control procedures.
Determining Order Point (When to Order?)

As discussed earlier, the reorder point determines when a resupply shipment should be
initiated. The reorder point, which is defined by item and distribution centre, can be
specified in terms of units or days of supply.
This discussion focuses on determining reorder points under conditions of demand and
performance-cycle certainty. The certainty conditions imply that future demands and
performance-cycle lengths are known.
The basic reorder point formula is
R = D×T
Where R = reorder point in units
D = average daily demand
T = average performance-cycle length
To illustrate this calculation, assume demand of 10 units/day and a 20-day
performance cycle. In this case,
= 10 units/day × 20 days = 200 units
The use of the reorder point formulations discussed above implies that the resupply
shipment will arrive just as the last unit is shipped to a customer. This approach is
satisfactory as long as both demand and performance cycles are certain. When there is
uncertainty in either demand or performance-cycle length, an inventory buffer is
necessary to compensate for the uncertainty. The buffer, which is usually called safety
stock, handles customer demands during longer than expected performance cycles or
above average daily demand. When this buffer stock is necessary for conditions of
uncertainty, the reorder point formula is
R = D × T + SS
Where R = reorder point in units
D = average daily demand
T = average performance-cycle length
SS = safety or buffer stock in units
Determining Lot Size (How Much?)

The lot sizing concept balances the cost of maintaining inventories against the cost of
ordering. The key to understanding the relationship is to remember that average
inventory is equal to one-half the order quantity. Therefore, the larger the order
quantity, the larger the average inventory and, consequently, the greater the
maintenance cost per year. However, the larger the order quantity, the fewer orders
required per planning period and, consequently, the lower the total ordering cost. Lot
quantity formulations identify the precise quantities at which the annual combined
total cost of ordering and maintenance is lowest for a given sales volume.
Economic Order Quantity: The economic order quantity (EOQ) is the replenishment
order quantity that minimizes the combined cost of inventory maintenance and
ordering. Identification of such a quantity assumes that demand and costs are
relatively stable throughout the year. Since an EOQ is calculated on an individual
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product basis, the basic formulation does not consider the impact of joint ordering of 57
products. EOQ extensions are discussed later in this lesson. Inventory Management
The most efficient method for calculating economic order quantity is mathematical.
Earlier in this lesson a policy dilemma regarding whether to order 100, 200, or 600
units was discussed. The answer can be found by calculating the applicable EOQ for
the situation.
To make the appropriate calculations, the standard formulation for EOQ is
EOQ =√2CoD/CiU
Where EOQ = economic order quantity (EOQ)
CO = cost per order
Ci = annual inventory carrying cost
D = annual sales volume, units
U = cost per unit
While the EOQ model determines the optimal replenishment quantity, it does require
some rather stringent assumptions that constrain its direct application. The major
assumptions of the simple EOQ model are:
1. Satisfaction of all demand
2. Continuous, constant, and known rate of demand
3. Constant and known replenishment performance-cycle time.
4. Constant price of product that is independent of order quantity or time (i.e., no
purchase quantity or transportation price discounts are available)
5. Infinite planning horizon
6. No interaction between multiple items of inventory
7. No inventory in transit
8. No limit on capital availability. The constraints imposed by some of these
assumptions can be overcome through computational extensions, as discussed
next. However, the EOQ concept illustrates the importance of the trade-offs
associated with holding and acquisition cost.
EOQ Extensions
While the EOQ formulation is relatively straightforward, there are some other factors
that must be considered in actual application. The most persistent problems are those
related to various adjustments necessary to take advantage of special purchase
situations and unitization characteristics.
Three typical adjustments are volume adjustment, Quantity discounts, other
adjustments, volume transportation rates
In the EOQ formulation discussed previously, no consideration was given to the
impact of transportation cost on order quantity. When products are purchased on a
delivered basis and the seller pays transportation cost from origin to the inventory
destination, such neglect may be justified. The seller is responsible for the shipment
until it arrives at the customer's place of business. However, when product ownership
is transferred at origin, the impact of transportation rates on total cost must be
considered when determining order quantity.
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58 As a general rule, the greater the weight of an order, the lower is the cost per pound of
Logistics and
Supply Chain Management transportation from any origin to destination. A freight-rate discount for larger-size
shipments is common for both truck and rail and is found in most transportation rate
structures. Thus, all other things being equal, an enterprise naturally wants to purchase
in quantities that maximize transportation economies. Such quantities may be larger
than the purchase quantity determined using the EOQ method. Increasing order size
has a twofold impact on inventory cost.
Rates
In the EOQ formulation discussed previously, no consideration was given to the
impact of transportation cost on order quantity. When products are purchased on a
delivered basis and the seller pays transportation cost from origin to the inventory
destination, such neglect may be justified. The seller is responsible for the shipment
until it arrives at the customer's place of business. However, when product ownership
is transferred at origin, the impact of transportation rates on total cost must be
considered when determining order quantity.
As a general rule, the greater the weight of an order, the lower is the cost per pound of
transportation from any origin to destination. A freight-rate discount for larger-size
shipments is common for both truck and rail and is found in most transportation rate
structures. Thus, all other things being equal, an enterprise naturally wants to purchase
in quantities that maximize transportation economies. Such quantities may be larger
than the purchase quantity determined using the EOQ method. Increasing order size
has a twofold impact on inventory cost.
The second impact is a decrease in the number of orders required. The decreased
number of orders increases the shipment size, which provides better transportation
economies.
To complete the analysis, it is necessary to formulate the total cost with and without
transportation savings. While this calculation can be directly made by modification of
the EOQ formulation, comparison provides a more insightful answer. The only
additional data required are the applicable freight rates for ordering in quantities to
complete the analysis.
The second impact is a decrease in the number of orders required. The decreased
number of orders increases the shipment size, which provides better transportation
economies.
To complete the analysis, it is necessary to formulate the total cost with and without
transportation savings. While this calculation can be directly made by modification of
the EOQ formulation, comparison provides a more insightful answer. The only
additional data required are the applicable freight rates for ordering in quantities.
The impact of volume transportation rates on total cost of procurement cannot be
neglected. Thus, any EOQ must be tested for transportation cost sensitivity across a
range of weight breaks if transportation expenses are the buyer's responsibility.
Finally, two factors regarding inventory cost under conditions of origin purchase are
noteworthy. (Origin purchase means that the buyer is responsible for freight cost and
product risk when the product is in transit.) First, the buyer assumes full risk on
inventory at time of shipment. Depending on time of required payment, this could
mean that transit inventory is part of the enterprise's average inventory and therefore
subjected to an appropriate charge. It follows that any change in weight break leading
to a shipment method with a different in-transit time should be assessed the added cost
or savings as appropriate in a total-cost analysis.
Second, the transportation cost must be added to the purchase price to obtain an
accurate assessment of the value of goods tied up in inventory. Once the inventory has
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been received, the amount invested in the product must be increased by the 59
transportation expenses. Inventory carrying cost should then be assessed on the Inventory Management
combined cost of the item plus transportation.
Quantity discounts can be handled directly with the basic EOQ formulation by
calculating total cost at any given volume-related purchase price to determine
associated EOQs. If the discount at any associated quantity is sufficient to offset the
added cost of maintenance less the reduced cost of ordering, then the quantity discount
offers a viable alternative. It should be noted that quantity discounts and volume
transportation rates each affect larger purchase quantities. This does not necessarily
mean that the lowest total-cost since it represents a fixed cost once the decision is
made to replenish product. If it is decided to use a private fleet to transport
replenishment product, the enterprise should fill the truck regardless of the EOQ. It
does not make sense to transport a half-empty truck simply so that the order quantity
represents the EOQ.
Another consideration when establishing the order quantity is the unitization
characteristic. Many products are stored and moved in standard units such as cases or
pallets. Since these standardized units are designed to fit transportation or handling
vehicles, there may be significant diseconomies when the EOQ is not a unit multiple.
Other EOQ Adjustments

A variety of special situations may occur that will require adjustments to the basic
EOQ. Examples are:
1. Production lot size
2. Multiple-item purchase
3. Limited capital
4. Private trucking.
Production lot size refers to the most economical quantities from a manufacturing
perspective. Multiple-item purchase describes situations when more than one product
is bought concurrently, so that quantity and transportation discounts must consider the
impact of product combinations. Limited capital refers to situations with budget
limitations for total inventory investment. Since the product line must be satisfied
within the budget limitations, order quantities must recognize the need to allocate the
inventory investment across the product line. In private trucking getting a full truck
(FTL) becomes significant from cost perspective as against EOQ.
Discrete Lot Sizing

Not all resupply situations operate with uniform usage rates like those in the previous
EOQ computations. In many manufacturing situations, the demand for a specific
component tends to occur at irregular intervals and for varied quantities. The irregular
nature of usage requirements is a consequence of demand being dependent upon the
production schedule. That is, the required assembly parts must be available at the time
manufacture occurs. Between requirement times, no need exists to maintain
component inventory in stock if it can be obtained when needed. Inventory servicing
of dependent demand requires a modified approach to the determination of order
quantities, referred to as discrete lot sizing. Identification of the technique as
"discrete" means that the procurement objective is to obtain a component quantity
equal to net requirements at a specific point in time. Because component requirements
fluctuate, purchase quantities using discrete lot sizing will vary between orders.
Varieties of lot sizing techniques are available. The options of
1. Lot-for-lot sizing
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60 2. Period order quantity
Logistics and
Supply Chain Management 3. Time-series lot sizing
Lot-for-Lot Sizing
The most basic form of discrete ordering is to plan purchases to cover net
requirements over a specified period. No consideration is given to the cost of ordering
under lot-for-lot sizing. In one sense, the lot-for-lot technique is pure dependent-
demand-oriented, since no ordering economies are considered. The order quantity
exactly matches manufacturing or demand quantity. The basic technique is often used
when the item being purchased is inexpensive and the requirements are relatively
small and irregular. Lot-for-lot sizing often uses electronic order transfer and premium
transportation to minimize processing and delivery time.
Period Order Quantity

The period order quantity (POQ) technique builds on the EOQ logic. Here, three steps
are performed to accomplish component procurement. First, the standard EOQ is
calculated. Second, the EOQ quantity is divided into forecasted annual usage to
determine order frequency. Third, the number of orders is divided into the relevant
time period (e.g., fifty-two for weeks or twelve for months) to express the order
quantity in time periods.
To illustrate, let's work with an EOQ of 300 and a forecast of 2,400. To adjust to a
twelve-period year, the POQ technique would be as follows:
EOQ = 300
FORECAST = 2400
ORDERS PER YEAR = 2400/300
= 8.00
ORDER INTERVAL = 12/8.00
=1.5 months
Under the POQ application, orders are planned approximately every six weeks. The
typical order is 300 units unless usage deviates from planned quantity and requires a
"catch-up" or "light" re supply order.
The main advantage of the POQ approach is that it considers inventory-carrying cost
and thereby minimizes inventory carryover. The disadvantage is that similar to the
basic EOQ, POQ also requires stable demand to realize its full potential.
Time-Series Lot Sizing

The fundamental objective of time-series lot sizing is to combine requirements over
several periods to arrive at procurement logic. The time-series approach is dynamic
because the order quantity is adjusted to meet current requirement estimates. This is in
contrast to basic EOQ, which is static in the sense that once the order quantity is
computed, it continues unchanged for the demand-planning horizon.
The key to dynamic lot sizing is that requirements are expressed in varying quantities
across time rather than in usage rates per day or week, as is typical of the basic EOQ.
Given substantial usage fluctuation, fixed order quantities are replaced by a lot sizing
system that can calculate an economical order given changing and intermittent usage.
Three such techniques are widely discussed in the literature and are briefly reviewed
here: least unit cost, least total cost, and part period balancing.
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(a) Least Unit Cost 61
Inventory Management
It seeks to identify a combination of requirements over a number of periods resulting
in the lowest cost per SKU. Starting with initial period net requirements, each future
period's per unit requirements are evaluated to determine a combined quantity for a
given number of periods in which the unit cost is minimized. The least-unit-cost
approach essentially evaluates purchasing requirements in incremental number of
weeks of supply into the future.
The first week considers one week of supply. The analysis then considers adding a
second week. Unit cost-including quantity discounts, ordering cost, inventory-carrying
cost, and transportation cost is evaluated for each option.
While the discount, ordering, and transportation costs will cause average unit cost to
decline as more periods are added, inventory-carrying cost will increase as more time
periods are added because of the additional inventory. Thus, order quantities and order
frequency will vary substantially under the least-unit-cost technique. While this
approach does provide a way to overcome the static features of EOQ and POQ, the
technique may cause unit costs to vary widely between time periods.
(b) Least Total Cost
The least-total-cost approach seeks the quantity that minimizes total cost for
successive periods. In this sense, least total cost, which is the balancing of ordering
and carrying, is similar to EOQ in objective. The fundamental difference is that order
interval is varied to seek the least total cost. The calculation is based on a ratio of
ordering to carrying cost (CdCi), called the economic part period. The economic part
period defines the quantity of a specific component that, if carried in inventory for one
period, would result in a carrying cost equal to the cost of ordering. The least-total-
cost technique selects order sizes and intervals that most nearly approximate the
economic part-period calculation. Thus, order sizes remain fairly uniform; however,
substantial differences do occur in elapsed time between order placements. The least-
total-cost technique overcomes the failure of the least unit cost to consider trade-offs
across the overall planning period.
(c) Part-Period Balancing
Part-period balancing is a modified form of the least-total-cost technique that
incorporates a special adjustment routine called look-ahead look-back.
The main benefit of this feature is that it extends the planning horizon across more
than one ordering point to accommodate usage peaks and valleys when calculating
order quantities. Adjustments are made in order time or quantity when a forward or
backward review of more than one order requirement indicates that modifications to
the economic part-period may be beneficial. The typical procedure is to first test the
look ahead feature to determine if more time results in approximation of the economic
part-period quantity. Look-back is typically utilized if look-ahead leaves the lot size
unchanged. In this sense, look-back means that a future order, which under the
economic part-period rule would normally be scheduled for delivery during the fourth
period, should be advanced if earlier delivery would reduce total cost. The net result
of incorporating the look-ahead/look-back feature is that it turns the application of the
economic part-period concept into a simultaneous review of multiple periods.
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62
Logistics and Check Your Progress 2
State True or False:
1. In many manufacturing situations, the demand for a specific component
tends to occur at irregular intervals and for varied quantities.
2. Quantity discounts cannot be handled directly with the basic EOQ
formulation by calculating total cost at any given volume-related purchase
price to determine associated EOQs.
3. A freight-rate discount for larger-size shipments is not common for both
truck and rail and is found in most transportation rate structures.
4. When products are purchased on a delivered basis and the seller pays
transportation cost from origin to the inventory destination, such neglect
may be justified.
5. The main benefit of Part-period balancing is that it extends the planning
horizon across more than one ordering point to accommodate usage peaks
and valleys when calculating order quantities.
3.4 LET US SUM UP

Most of the companies plan their inventory management, along with the warehousing
and distribution of their supply chain. A well designed inventory management system
is a key part of the supply chain and it can help you control the movement and storage
of materials within our warehouse and process the associated transactions, including
shipping, receiving, put away and picking.
Many companies are outsourcing some or all of their warehousing functions as a
method of becoming more efficient and cost effective. Proper inventory management
implies that the inventory should be managed in such a way that the supply chain can
function without any shortages or excess burdens of large supplies.
With all the complexities of planning and inventory control, how are distribution
centres accommodating the channels? When multichannel marketing was in its
infancy more than a decade ago, the prevalent thinking was to have a single
Distribution Centre that would process both direct and retail replenishment orders.
There would be one pooled inventory; one staff and one facility — end of discussion.
But logistics thinking is changing.

Name the different types of physical distribution system in India.
3.6 KEYWORDS
Physical Distribution: It refers to the movement of finished goods outward from the
end of the manufacturer’s assembly line to the customer, frequently via intermediaries.
Logistics: It describes the entire process of materials and products moving into,
through, and out of a firm.
Least-total-cost Approach: It seeks the quantity that minimizes total cost for
successive periods.
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LESSON 67
Inventory Control
4
INVENTORY CONTROL
CONTENTS
4.1 Introduction
4.2 Meaning of Inventory Control
4.3 Inventory Metrics
4.4 Inventory Measures
4.4.1 Customer Perspective
4.4.2 Implementing Decisions
4.5 Types of Inventory Control
4.5.1 Inventory Control and Supply Chain Management
4.5.2 Inventory Classification Models
4.6 Let us Sum up
4.8 Keywords

z Discuss the meaning of inventory control
z Explain the inventory metrics
z Identify the inventory measures
z Recognize the types of inventory control
4.1 INTRODUCTION
Inventories are materials and supplies carried on hand either for sale or to provide
material or supplies to the production process. They provide a buffer against the
differences in demand rates and production rates.
Inventory Management involves the control of current assets being procured or
produced in the normal course of the company's operations i.e. or "how many" parts,
pieces, components, raw material and finished goods the firm should hold and when
should it replenish the stock. What should be the trigger points for action?
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68 The purpose of holding inventories is to allow the firm to separate the processes of
Logistics and
Supply Chain Management purchasing, manufacturing, and marketing of its primary products. In other words, the
inventory forms a buffer that ensures the flow of the goods and services of the firm is
maintained on a continuing basis, based on the customer's requirements.
Inventories not only separate processes, but also reduce risk of production shortages.
For example, manufacturing firms frequently produce goods with hundreds or even
thousands of components. If any of these components are not available on time, the
entire production operation can be halted. This would mean a heavy loss to the firm.
To avoid starting a production run and then discovering the shortage of a vital raw
material or other component, firms maintain inventories.
The goal of effective inventory management is to minimize the total costs: direct and
indirect that is associated with holding these assets. However, the importance of
inventory management to the company depends upon the extent of investment in
inventory. As the value of the inventory goes up, the criticality of the function in
Inventory Management enables an organization to meet or exceed customers'
expectations of product availability while maximizing net profits or minimizing costs.
4.2 MEANING OF INVENTORY CONTROL

Inventory control includes control over raw materials, stores supplies, space parts,
partly finished goods and finished goods. It is a system which ensures the required
quantity of inventories of the required quality, at the required time and with the
minimum amount of capital. The function of inventory turnover is to obtain maximum
inventory turnover with sufficient stock to meet all requirements. The quantum of
inventory to be kept is decided after taking into consideration the availability of
finance, the quantum of discount allowed, the cost of storage and storage space
available etc.
Inventory Control deals with physical control of inventories. It is the
process/techniques of deciding as to when, what and how much of each item is to be
kept in stock, minimizing the ineffective stock and optimising the various costs
associated with the inventories.
Objectives of Inventory Control are to:
1. Maintain availability of materials whenever and wherever required in optimal
quantity.
2. Minimize the ineffective stock.
3. Optimize the various costs associated with inventories.
4.3 INVENTORY METRICS

Managing inventory at manufacturing and service companies is critically important. In
manufacturing, material accounts up between 60–85 percent of the revenue from sales,
depending upon the industry. In the electronics sector, it is about 85 percent, with
overheads of about 12 percent, and direct labour of around 3 percent. All these figures
point in the direction of Inventory.
Inventory is by far the single greatest cost that needs to be examined. Too much or too
little, or the wrong inventory, all have detrimental impacts on operational and
financial results as inventory represents a large capital investment. It also is an idle
resource. Companies that can operate with lesser inventory are considered to operate
more efficiently.
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Though there are many factors that determine the level of inventory in an 69
Inventory Control
organization, a cursory study reveals the main factors that contribute to these huge
expenses. The most common factors on which the levels of inventory depend are:
Production Rate: The production rate can be defined as number of units manufactured
over a period of time.
Production Rate = No. of Units Manufactured/time.
The time can be measured in days, weeks, or on an annual basis. Production rate is
also influenced by the demand for the product, which could be either periodic
(seasonal/cyclic) or a constant.
Lead-time: Lead-time is defined as time period from initiation of an activity to its
completion. For inventory management, we need following lead times: Purchase lead-
time, Manufacturing lead-time, Delivery lead-time.
Rework/Scrap Rate: This rate is dictated by the efficiency of the manufacturing
process. It involves knowing the number of defective units that are produced by a
manufacturing unit. This is a highly empirical rate and very much depends upon the
skill of the labour operating the machine and the accuracy offered by the machine.
Excess inventory is the quantity of material in stock or on order that is greater than the
anticipated demand for an agreed time period.
Obsolete inventory on the other hand is the inventory that results from an
unanticipated demand. This inventory typically occurs due to model run outs,
engineering change notes, or supplier minimum/multiple order quantities. Companies
tend to be reluctant to write off this value as it is a loss in the books of accounting, and
so affects the profit.
4.4 INVENTORY MEASURES

Inventory measures reflect, in part, the success in structuring systems to optimize the
production rate, the lead time and the scrap rate. Several aggregate performance
measures can be used to judge how well a company is able to control these factors and
utilizing its inventory resources.
Average Inventory Investment: The rupee value of a company's average level of
inventory is one of the most common measures of inventory. The information is easily
available and it is easy to interpret. It represents the average investment of the
company. However, it does not take into account the differences between companies.
For example, a larger company will generally have more inventory than a smaller
company, though it could be using its inventory more efficiently. This makes it
difficult for the company to make comparisons with other companies.
Inventory Turnover Ratio: In order to overcome this problem, inventory turnover
ratio is used. This measure allows for better comparison among companies. This is
calculated as a ratio of company's sales to its average inventory investment:
Inventory turnover = annual cost of goods sold/average inventory investment
This is a measure of how many times during a year the inventory turns around. It is
the ratio of the cost of annual sales to the average inventory level. The higher the
inventory turns, the better the firm uses its inventory assets. Another common measure
is days of supply. A firm's days of supply is found by dividing the average inventory
level by the cost of one day's sales.
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70 Example: As an example of these measures, assume a firm has an annual cost of sales
Logistics and
Supply Chain Management of ` 180 million and an average inventory level for the year of ` 20 million, then:
Inventory Turns = Cost of Sales/Average Inventory Level = ` 180/` 20 = 9 turns
The cost of sales for a day is ` 180 million/360 days = ` 0.5 million.
Because it is a relative measure, companies of different sizes can be more easily
compared. A higher turnover ratio reflects there are less idle resources in the company
and therefore, the company is using its inventory more efficiently.
This ratio can only be used in this manner to compare companies that are similar. For
example, even in the same industry depending on the distribution channels, a retailer
would have a much lower inventory turnover ratio than the wholesaler or distributor.
Days of Inventory: A measure that tries to overcome the disadvantage, to a limited
degree, and is closely related to inventory turnover is 'days of inventory'. This measure
is an indication of approximately how many days of sales can be supplied solely from
inventory. The lower this value, the more efficiently inventory is being used if
customer demands are being met in full. There are two ways of calculating 'days of
inventory', it can be directly calculated or inventory turnover can be converted to days
of inventory. Both procedures are shown below:
Days of inventory = avg. inventory investment/annual cost of goods sold/days per year
Days of inventory = days per year/inventory turnover rate
As an example of these measures, assume a firm has an annual cost of sales of `18
crore and an average inventory level for the year of `2 crore, then:
Inventory Turnover Ratio = annual cost of goods sold/average inventory investment
= ` 18 crore/` 2 crores = 9 turns
The cost of sales for a day is `18 crore/360 days = `5 lacs
Days of Inventory = avg. inventory investment/annual cost of goods sold/days per
year
= ` 2 crore/` 5 lacs = 40 days inventory
4.4.1 Customer Perspective

From a customer's perspective, there are a number of ratios that are very important.
The fill rates are extremely important and reflect the responsiveness of the
organization to customer needs.
The line item fill rate measures the percentage of line items on the order shipped in
their entirety.
The order fill rate is a measure of the percentage of orders shipped completely.
Finally, the item fill rate is the ratio of the total number of items shipped divided by
the total number of items ordered. This measure is probably the strictest of the three
measures of customer service fill rates discussed above.
To illustrate these fill rate measures, consider the order where 10 lines of items are
ordered, and of these 10 line items, only 5 of them were filled in their entirety, thus
the line item fill rate is:
Line Item Fill Rate = 5/10 = 50 percent
Since, the order fill rate is the percentage of orders filled completely, clearly, this
order counts in the unfilled category.
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Other customer based metrics are On-Time Delivery Percentage and Order-Entry 71
Inventory Control
Lead Time.
On-Time Delivery Percentage is generally analyzed over a year. Higher the value, the
better is the customer satisfaction. Generally, it has a value between 96-100 percent as
a benchmark.
Order-Entry Lead Time measures the time taken to take customer order. Manual
systems can be quite time consuming but with the implementation of the online
ordering systems, Order-Entry lead times can be quite short. The benchmark could be
set to be less than a day.
In addition to the metrics described above, there are many other measures of success
in satisfying both the customers as well as the organizational objectives. Some of the
more common measures are shown in the Table 4.1:
Table 4.1: Additional Inventory Metrics
Inventory Metrics Customer Perspective
Order Quantity Reliability
Order processing/ Setup cost, Inventory Stockout percentage, delays, loss and paperwork
Carrying cost involved.
Back order cost
Excess and obsolete stock cost
Critical Inventory Stock out percentage,
Average Inventory Percentage of orders fulfilled
EOQ
Industry Ratio Part Count Accuracy Percentage
Comparison with others Quality- Percentage Defects
Price of Non-Conformance (PONC)
4.4.2 Implementing Decisions

Detailed measures of inventory accuracy and availability are very important in order
to maximize manufacturing and non-manufacturing efficiency and financial results.
In addition to the measures described above, inventory obsolescence measures can be
very important for items with short shelf lives, due to aging or technological changes.
Finally, collecting accurate data on which to construct inventory measures can be
challenging. Processes have to be in place to ensure that inventory is counted
accurately and on a timely basis.
In general, supply chain inventories have been declining significantly in all parts of
the world. In 1970, U.S. manufacturers held more than 50 percent of aggregate
inventory stocks, but this share has fallen to about 35 percent in 2000. By sector, the
manufacturing share of durable goods inventories has declined from 60 percent in the
late 1960s to about 40 percent by the end of 2000; for non-durable goods, the
manufacturing share has decreased from 40 percent to about 25 percent over the same
period.
This trend is true for all inventory types, be it retail or manufacturing. Companies
today must be fast and nimble enough to react quickly to changes in customer demand
and do it with little inventory to remain competitive in the market.
The challenge for retailers, in reducing inventories, is due to the high value added
content of the inventory because they hold finished products. A significant cost to
retail organizations is the inventory carried to support customers and sales. Companies
have to reduce these costs to maintain competitive advantage and bottom-line benefits.
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72 The challenge of manufacturers is due to the diversity of their inventory holdings
Logistics and
Supply Chain Management which cumulatively add up to a very high capital commitment for the organization.
Effectively managing and minimizing investments in inventory can certainly help the
organization to manage its manufacturing processes and reduce its costs to stay ahead
of competition.
Fill in the blanks:
1. The goal of effective inventory management is to minimize the
……………………………. that are associated with holding these assets.
2. Inventory Control deals with …………………..control of inventories.
3. ………………………………= No. of Units Manufactured/time.
4. …………………….inventory is the inventory that results from an
unanticipated demand.
5. Inventory turnover = ………………………………../average inventory
investment.
4.5 TYPES OF INVENTORY CONTROL

Control of inventory, which typically represents 45% to 90% of all expenses for
business, is needed to ensure that the business has the right goods on hand to avoid
stock-outs, to prevent shrinkage (spoilage/theft), and to provide proper accounting.
Many businesses have too much of their limited resource, capital, tied up in their
major asset, inventory. Worse, they may have their capital tied up in the wrong kind
of inventory. Inventory may be old, worn out, shopworn, obsolete, or the wrong sizes
or colours, or there may be an imbalance among different product lines that reduces
the customer appeal of the total operation.
Inventory control systems range from eyeball systems to reserve stock systems to
perpetual computer-run systems. Valuation of inventory is normally stated at original
cost, market value, or current replacement costs, whichever is lowest. This practice is
used because it minimizes the possibility of overstating assets. Inventory valuation
and appropriate accounting practices are worth a book alone and so are not dealt with
here in depth.
The ideal inventory and proper merchandise turnover will vary from one market to
another. Average industry figures serve as a guide for comparison. Too large an
inventory may not be justified because the turnover does not warrant investment. On
the other hand, because products are not available to meet demand, too small an
inventory may minimize sales and profits as customers go somewhere else to buy
what they want where it is immediately available. Minimum inventories based on
reordering time need to become important aspects of buying activity. Carrying costs,
material purchases, and storage costs are all expensive. However, stock-outs are
expensive also. All of those costs can be minimized by efficient inventory policies.
Inventory control involves the procurement, care and disposition of materials. There
are three kinds of inventory that are of concern to managers:
1. Raw materials,
2. In-process or semi-finished goods,
3. Finished goods.
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If a manager effectively controls these three types of inventory, capital can be released 73
Inventory Control
that may be tied up in unnecessary inventory, production control can be improved and
can protect against obsolescence, deterioration and/or theft,
The reasons for inventory control are:
z Helps balance the stock as to value, size, colour, style, and price line in proportion
to demand or sales trends.
z Help plan the winners as well as move slow sellers.
z Helps secure the best rate of stock turnover for each item.
z Helps reduce expenses and markdowns.
z Helps maintain a business reputation for always having new, fresh merchandise in
wanted sizes and colours.
Three major approaches can be used for inventory control in any type and size of
operation. The actual system selected will depend upon the type of operation, the
amount of goods.
4.5.1 Inventory Control and Supply Chain Management

It is important for managers to realize that how they run items using inventory control
logic relates directly to the financial performance of the firm. A key measure that
relates to company performance is inventory turn. Recall that inventory turn is
calculated as follows:
Cost of goods sold
Inventory turn =
Average Inventory Value
So what is the relationship between how we manage an item and the inventory turn for
that item? Here, let us simplify things and consider just the inventory turn for an
individual item or a group of items. First, if we look at the numerator, the cost of
goods sold for an individual item relates directly to the expected yearly demand (D)
for the item. Given a cost per unit (C) for the item, the cost of goods sold is just D
times C. Recall this is the same as what was used in our total cost equation when
calculating. Next, consider average inventory value. Recall from EOQ that the average
inventory is Q /2, which is true if we assume that demand is constant. When we bring
uncertainty into the equation, safety stock is needed to manage the risk created by
demand variability. The fixed-order quantity model and fixed-time period model both
have equations for calculating the safety stock required for a given probability of
stocking out. In both models, we assume that when going through an order cycle, half
the time we need to use the safety stock and half the time we do not. So on average,
we expect the safety stock (SS) to be on hand. Given this, the average inventory is
equal to the following:
Average inventory value = (Q/2 + SS) C
The inventory turn for an individual item then is
Inventory turn = DC/ (Q/2 + SS) C
= D/ (Q/2 + SS)
4.5.2 Inventory Classification Models

It is useful to visualize the inventory of a medium sized business organization. The
inventory would comprise thousands of items, each item with different usage, price,
lead time and specifications. There could be different procurement and technical
problems associated with different items. In order to escape this quagmire, many
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74 selective inventory management techniques are used based on thorough analysis of the
Logistics and
Supply Chain Management items that constitute the inventory.
We have discussed the MRP response time in the last section. Due to the inability for
firms and the entire chain of suppliers to respond promptly, it is often prudent to
classify inventory so as to improve response time and bring it within the capability of
the supply chain partners. Some of the classifications that facilitate this process are
given below.
ABC Classification
ABC classification, or the alphabetical approach, is based on the annual consumption
value. Typically, only 20 percent of all the items account for 70 percent to 80 percent
of the total rupee usage; while the remaining 80 percent of the items typically account
for remaining 20 percent to 30 percent of the rupee value. The ABC classification is
based on focusing efforts where the payoff is highest i.e. high-value, high-usage items
must be tracked carefully and continuously. As these items constitute only 20 percent,
the ABC analysis makes the task relatively easier.
After calculating the rupee usage for each inventory item, the items are ranked by
rupee usage, from highest to lowest. The first 20 percent of the items are assigned to
class 'A'. These are the items that warrant closest control and monitoring through a
perpetual inventory system.
One of the major costs of inventory is annual carrying costs, and your money is
invested largely in class 'A'. Tight control, sound operating doctrine, and attention to
security on these items would allow you to control a large rupee volume with a
reasonable amount of time and effort.
The next 30 percent of the items are classified as 'B' items. These deserve less
attention than 'A' items. Finally, the last 50 percent of items are 'C' items. These have
the lowest rupee usage and can be monitored loosely, with larger safety stocks
maintained to avoid stock outs. They should have carefully established but routine
controls.
Table 4.2: ABC Analysis of Chest of Drawers
Item Description Annual Percent of total Cumulative ABC
stock Rupee usage Rupee usage Usage Classification
number
B 101 Sides 43600 21.96 21.96 ‘A’
H 107 Drawer sides 31000 15.61 37.57 ‘A’
F 105 Drawer front 25215 12.70 50.27 ‘A’
J 109 Drawer back 20020 10.08 60.35 ‘A’
A 100 Top 15000 7.55 67.91 ‘B’
G 106 Drawer front 13080 6.59 74.50 ‘B’
D 103 Frame rail 12075 6.08 80.58 ‘B’
M 112 Web frame end 11000 5.54 86.12 ‘B’
L 111 Web frame rail 7000 3.53 89.64 ‘C’
C 102 Frame rail 6250 3.15 92.79 ‘C’
I 108 Drawer sides 6000 3.02 95.81 ‘C’
E 104 Toe kick 4140 2.09 97.90 ‘C’
K 110 Drawer back 4000 2.01 99.91 ‘C’
N 113 Nails 80 0.04 99.95 ‘C’
O 114 Screws 55 0.03 99.98 ‘C’
P 115 Knobs 40 0.02 100.00 ‘C’
Total 198555.00
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The ABC Analysis for the 'chest of drawers' shows that in the16 items in the BOM, 75
Inventory Control
the first 4 items (20 percent) have a rupee usage of 60.35 percent, the next thirty
percent have a rupee usage of 25.77 percent, and the last 50 percent have a rupee
usage value of only 13.88 percent. You can also see that only 4 items fall in the 'A'
category, 4 items in the 'B' category, and the remaining 8 items fall in the 'C' category.
Pareto Distribution
The Pareto (80/20) distribution is similar in concept to ABC method of stock control.
Its name is derived from an economist, Vilfredo Pareto, who suggested that 80 percent
of a nation's wealth is held by 20 percent of its population and so the remaining 80
percent of the population hold only 20 percent of its net wealth.
This 80/20 analysis has been applied to stocks so that 20 percent of stores items
account for 80 percent of the value of stocks in hand. This indicates that rigorous
stock control methods should be applied to these 20 percent of items in order to derive
maximum benefits from stock control. The remaining 80 percent of items do not
require such rigorous control methods applied to them because the cost and effort
might not be justified by the savings obtainable.
The example, we have discussed earlier, indicates a trend towards the 80 - 20 rule
which is reflected in the illustration shown as Figure 4.1. Through performing 80/20
analysis, many companies are optimizing their investment in inventory, and
production, procurement and distribution assets. These companies are able to analyze
their inventory network as well as policies and able to add inventory where there are
opportunities for winning additional market share and reduce inventory where they are
not needed. They do not trim inventories across the board to reduce cost.
Figure 4.1: ABC Analysis

This classification is commonly used by companies, as very often they need not keep
extremely accurate track of all inventory items.
Through this approach, they are able to increase their overall customer service levels
while simultaneously reducing their total inventory carrying costs. Thus, these
companies are able to improve other key metrics like customer retention, gross margin
and inventory turns.
The importance of each item is determined while procuring and storing it to improve
the purchase efficiency. The fundamental idea behind selective control techniques is
to put the efforts where the results are worth it. Even if an organization uses millions
of items, only a few items become important - from the finance view, availability
considerations, seasonality, criticality of performance, etc.
The materials are classified according to their importance and increased attention is
paid to the items that are more important. For instance, high-value, high-usage items
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76 must be tracked carefully and continuously but certain parts with a relatively low
Logistics and
Supply Chain Management value or infrequent use can be monitored loosely.
Example: ABC System Classification
The maintenance department for a small manufacturing firm has responsibility for
maintaining an inventory of spare parts for the machinery it services. The parts
inventory, unit cost, and annual usage are as follows:
The department manager wants to classify the inventory parts according to the ABC
system to determine which stock of parts should be closely monitored.
Part Unit Cost (`) Annual Usage
1 60 90
2 350 40
3 30 130
4 80 60
5 30 100
6 20 180
7 10 170
8 320 50
9 510 60
10 20 120
Solution
First rank the items according to their total value and also compute each item's
percentage of total value and quantity.
Part Total Value (`) % of Total Value % of Total Quantity
9 30,600 35.9 6.0
8 16,000 18.7 5.0
2 14,000 16.4 4.0
1 5,400 6.3 9.0
4 4,800 5.6 6.0
3 3,900 4.6 10.0
6 3,600 4.2 18.0
5 3,000 3.5 13.0
10 2,400 2.8 12.0
7 1700 2.0 17.0
The data provided in the last table provides the basis for classifying the inventory
parts according to the ABC system.
Class Items % of Total Value % of Total Quantity
A 9, 8, 2 71 15
B 1, 4, 3 16.5 25.0
C 6, 5, 10, 7 12.5 60.0
Items 9, 8, and 2 need to be closely monitored.

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The ABC Classification Analysis 77
Inventory Control
The ABC Analysis is also a guide to physical count of items of inventory. Counts are
conducted depending on the importance of inventory items. 'A' items are counted
frequently, 'B' items less frequently and 'C' items are counted the least frequently.
Accuracy of the count also depends on the classification. The Association for
Operations Management (APICS) recommends ± 0.2 percent for 'A' items, ± 1 percent
for 'B' items and ± 5 percent for 'C' items. These issues are discussed in greater detail
below.
Controls For Class 'A' Items: All Class 'A' items require close control. However,
where stock-out costs are high, special attention is required. Raw materials that are
used continuously, in extremely high volume, are often purchased at rates that match
usage rates. Contracts are often executed with vendors, with penalty clauses, for the
continuous supply of these materials. Buffer stocks that provide excellent service
levels are justified for such items.
Where purchase of inventory items is not guided by either economical quantities or
cycles, the items need careful monitoring. It is possible to achieve significant savings
by changing the rate of flow periodically as demand and inventory positions change.
Minimum supplies need to be ensured to guard against demand fluctuations and
possible interruptions of supply.
For the balance of Class 'A' items, normally reports are generated on a weekly basis,
to provide the necessary close surveillance over inventory levels. Close surveillance
reduces the risk of a prolonged stockout. Depending upon the inventory system used,
time triggered or event triggered orders are released.
Control for Class 'B' Items: These items are generally monitored and controlled by a
computer-based exception reporting system. Periodic review by the management is
necessary, but model parameters are reviewed less often than with Class A items.
Normally, stockout costs for Class B items should be moderate to low, and buffer
stocks should provide adequate control for stockouts, even thought the ordering may
occur less often.
Controls for Class 'C' items: Class C items account for the bulk of inventory items. In
many cases, reorder point system is designed such that it does not require a physical
stock evaluation, for example using a "two-bin" system. The inventory is physically
separated into two bins one of which contains an amount equal to the reorder
inventory level. Stock is drawn from the second bin. For each item, action is triggered
when inventories when the bin gets empty.
It must be kept in mind that 'C' items are not necessarily unimportant. Therefore,
controls should adequately cover the requirements for this class of inventory. Semi-
annual or annual review of the system parameters should be preformed to update
usage rates, re-establish supply lead times, and the reorder points. Cost savings that
might result in changes in EOQ, but they may not be significant.
However, ABC analysis should be used prudently. It cannot always be applied across
the board. Some categories of items where the application of ABC analysis is fraught
with high risk are identified below:
1. Difficult Procurement Items
2. Short Shelf Life
3. Large Storage Space Requirements
4. Item's Operational Criticality
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78 5. Likelihood of Theft
Logistics and
Supply Chain Management 6. Difficult Forecast Items
For items that are scarce, lead time analysis and purchasing strategies can be critical.
There is a tendency to hold too little inventory for items with lumpy demand and too
much for items with steady demand. Purchase strategies can also be critical for a
number of items that may have to be imported and in addition to normal transportation
times, time required for clearance through customs may not be highly predictable.
Companies that use ABC inventory policies or simple weeks-of supply rules
frequently have 15-30 percent more inventory than they need and lower service levels.
Therefore, classification models should be used in combination with mathematical
models or new optimization methods that manage inventory holistically across
multiple stages in the supply chain. By doing so, it can commonly drive 20-30 percent
reductions in on-hand inventory and 10-20 percent improvements in time to market.
These models will be discussed in the chapters that follow.
FSN Analysis
Here the items are classified according to Fast-moving (F), Slow moving (S) and Non-
moving (N) on the basis rate of consumption. The non-moving items are items not
consumed for a long period say 24 months. Such non-moving items block quite a lot
of capital and as such they should be disposed of as quickly as possible without further
deteriorating.
The classification of fast and slow moving items is determined on the basis of stores
turnover and it helps in proper arrangement of stocks in stores and distribution and
handling methods.
Other Models
Material items are classified based upon their commercial importance, demand
patterns (regular, sporadic etc.) and supply reliability (of both raw material suppliers
and own manufacturing), etc.
Most of these systems operate in a similar manner to the ABC Classification. All these
techniques are used to focus management attention in deciding on the degree of
control necessary for different items in the inventory. However, it should be kept in
mind that changes in the business environment, e.g. customer demand patterns or
material costs, can cause material item classifications to change. This in turn can
affect key planning and scheduling decisions.
A brief description and comparison of these classifications are given in Table 4.3.
Table 4.3: Comparison of Different Classification Systems
S. No. Title Basis Main Uses
1. ABC (Level of Value of To control raw material components and
Usage) consumption work-in progress inventories in the normal
course of business
2. HML (High, Unit price of the Mainly to control purchase
medium, low usage) material
3. FSND (Fast moving, Consumption To control obsolescence
Slow moving, Non- pattern of the
moving, Dead items) component
4. SDE (Scarce, Problems faced Lead time analysis and purchasing strategies
difficult, easy to in procurement
obtain items)
Contd…
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5. Golf (Government, Source of the Procurement strategies 79
Ordinary, Local, material Inventory Control
Foreign Sources)
6. VED (Vital, Criticality of the To determine the stocking levels of spare
Essential, Desirable) component parts
7. SOS (Seasonal, Off- Nature of Procurement/ holding strategies for seasonal
seasonal) suppliers items like agriculture products
8. XYZ (Value of Value of items in To review the inventories and their use
Stock) storage scheduled intervals
Other similar types of classifications are the XYZ Classification, VED Classification,
and the HML classification of inventory. The basic difference between the ABC
Classification and the XYZ Classification is that it is based on the inventory in stock
rather than usage.
The VED Classification is based on the criticality of the inventory item. In normal
practice, items in the 'V' category are often monitored manually; in addition to the
computer monitoring that may be in place. The HML reflects a classification based on
the unit price of the item. Obviously, the 'H' category items require additional
attention, especially if the lead times are long, as it may often be in imported
components. The 'time' triggered reorder system has some advantages in production
cycling, in such high value items.

True or False:
1. The fixed-order quantity model and fixed-time period model both have
equations for calculating the safety stock required for a given probability
of stocking out.
2. ABC classification is based on the annual consumption value.
3. The Pareto (80/20) distribution is similar in concept to ABC method of
stock control.
4. The Association for Operations Management (APICS) recommends ± 0.5
percent for 'A' items, ± 2 percent for 'B' items and ± 5 percent for 'C'
items.
5. The classification of fast and slow moving items is determined on the
basis of stores turnover.
4.6 LET US SUM UP

Inventory control is a system which ensures the required quantities of inventories in
stores so that materials are available at the required time and with the minimum
amount of investment. For proper control over inventory goes a long way in reducing
the cost of production and improving the profitability of concern.
Inventory measures reflect, in part, the success in structuring systems to optimize the
production rate, the lead time and the scrap rate. Several aggregate performance
measures can be used to judge how well a company is able to control these factors and
utilizing its inventory resources.
From a customer's perspective, there are a number of ratios that are very important.
The fill rates are extremely important and reflect the responsiveness of the
organization to customer needs. Control of inventory, which typically represents 45%
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80 to 90% of all expenses for business, is needed to ensure that the business has the right
Logistics and
Supply Chain Management goods on hand to avoid stock-outs, to prevent shrinkage (spoilage/theft), and to
provide proper accounting. It is important for managers to realize that how they run
items using inventory control logic relates directly to the financial performance of the
firm. A key measure that relates to company performance is inventory turn.
ABC classification, or the alphabetical approach, is based on the annual consumption
value. Only 20 percent of all the items account for 70 percent to 80 percent of the total
rupee usage, while the remaining 80 percent of the items typically account for the
remaining 20 percent to 30 percent of the rupee value. The Pareto (80/20) distribution
is similar in concept to ABC method of stock control. Its name is derived from an
economist, Vilfredo Pareto, who suggested that 80 percent of a nation's wealth is held
by 20 percent of its population and so the remaining 80 percent of the population hold
only 20 percent of its net wealth.

“The nice thing about inventory models is that you can pull one off the shelf and apply
it so long as your cost estimates are accurate.” Comment.
4.8 KEYWORDS
Inventories: Inventories are materials and supplies carried on hand either for sale or to
provide material or supplies to the production process.
Inventory Control: A system which ensures the provision of the required quantity of
inventories of the required quality at the required time with the minimum amount of
investment.
ABC Analysis: A system of stock control based on the annual consumption wise.
Production Rate: The production rate can be defined as number of units manufactured
over a period of time.
Lead-time: Lead-time is defined as time period from initiation of an activity to its
completion.
Rework/Scrap Rate: This rate is dictated by the efficiency of the manufacturing
process.
Pareto (80/20) Distribution: 80 percent of a nation's wealth is held by 20 percent of
its population and so the remaining 80 percent of the population hold only 20 percent
of its net wealth.
4.9 QUESTIONS FOR DISCUSSION

1. What do you understand by inventory control? What are its objectives?
2. What do you understand by ABC analyses? How is the control of stores items
affected through ABC analysis?
3. What is the purpose of classifying items into groups, as the ABC classification
does?
4. What is economic order quantity? How is it calculated'?
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83
LESSON Demand Planning
and Forecasting
5
DEMAND PLANNING AND FORECASTING
CONTENTS
5.1 Introduction
5.2 Concept of Planning and Forecasting Demand
5.2.1 Managing Demand in the Manufacturing Industry
5.2.2 Managing Demand in the Service Industry
5.2.3 Patterns of Demand
5.3 Developing a Model
5.3.1 Forecasting Methods
5.3.2 Accuracy and Validation Assessments
5.3.3 IT-based Models
5.4 Collaborative Planning Forecasting and Replenishment (CPFR)
5.5 Quantitative Methods
5.5.1 Time Series
5.5.2 Moving Average Method
5.5.3 Weighted Moving Averages
5.5.4 Exponential Smoothing
5.6 Regression Analysis
5.6.1 Simple Linear Regression
5.6.2 Multiple Regressions
5.7 Let us Sum up
5.9 Keywords

z Discuss the fundamental concepts of planning and forecasting demand
z Understand the different concepts behind forecasting
z Learn about the relevance of collaborative forecasting for supply chain
z How to develop a forecasting model and assess its validity and accuracy
z Learn the basics of quantitative forecasting methods
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84
Logistics and 5.1 INTRODUCTION
Our vision of the future guides us in deciding what product to provide, what process to
use, and what values are to be provided to the customers. We need to be able to see
around the corner to ensure that things do not go out of hand. To do so we require a
variety of tools. Forecasting tools help in the analysis of the environment and provide
inputs on how the organization can use its resources for maximum leverage. This
lesson will explore some of these forecasting techniques.
An analysis of the factors that influence future values determines how future values
are estimated. One way to characterize different kinds of forecasting can be based on
how far into the future they focus. Detailed forecasts for individual items are generally
short-term forecasting. Such forecasts are used to plan the short-run decisions which
are used for inventory control, order sizing, or transport scheduling, etc. Medium-term
forecasts are used to plan for capacity, location and layout over a much longer time
span. Long-term forecasts are used for strategic decision-making.
5.2 CONCEPT OF PLANNING AND FORECASTING

DEMAND
Forecasting demand levels is a part of medium term forecasts. This is vital to the firm
as a whole, as it provides the basic inputs for the planning and control of all functional
areas including the supply chain. The need for demand projections is a general need
throughout the planning and control process. Demand planning tries to answer the
questions raised by these concerns. Some such broad basic questions are the
following:
z How to determine which new products or services to introduce or discontinue;
which markets to enter or exit; and which products to promote?
z What sales plans to make, since sales quotas are generally based on estimates of
future sales?
z How to absorb the fluctuations in demand that will occur over the next 6 to 18
months; how to make production, procurement, and logistical plans?
z What should be our financial plans; how can demand fluctuations be absorbed
through inventory, workforce, work hours, supplier’s activity, etc and what is their
impact on earnings expectations?
z Will the organization lose orders if it does not meet all demands? What policy
should the firm adopt?
Each of these choices determines the tactical moves (medium term policy) of the
organization. Once decided upon, the policy drives the activities of the organization.
A successful policy needs to be based on a fundamental understanding of what
customers’ value. For example, if a policy of not meeting all demands shifts customers
to a competitive product, the company may find it difficult to wean them back when
demand falls.
Demand levels and their timing greatly affect capacity levels, financial needs, and
general structure of the business. Each functional area has its special forecasting
problems. Forecasting demand is also a critical component of supply and demand
management.
Supply chain forecasting concerns the spatial as well as variation of demand with
time, the extent of its variability, and its degree of randomness. Planning and
controlling supply chain activities require accurate estimates of the product and
service volumes to be handled by the chain. These estimates are typically in the form
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of forecasts and predictions. The supply chain professional often finds it necessary to 85
Demand Planning
take it upon him or herself to produce forecasts for short-term planning such as and Forecasting
inventory control, order sizing, or transport scheduling. For longer term decisions,
demand planning becomes necessary.
Supply and demand reflect the time dimension. It is important to recognize that both
supply and demand can be influenced by management actions. In business and
economics forecasting has various meanings. There are two distinct quantities
involved in forecasting, a forecast and a prediction. A prediction is a broader concept.
It is an estimate of a future event achieved through subjective considerations other
than just past data; this subjective consideration need not occur in any predetermined
way.
In supply chain management we adopt a rather specific definition of a forecast, which
is given below:
A forecast is an estimate of a future event achieved by systematically combining and
casting forward in a predetermined way data about the past.
The supply chain has both space and time dimensions. That is, the supply chain
professional must know where demand volume will take place as well as when it will
take place. Spatial location of demand is needed to plan warehouse locations, balance
inventory levels across the supply chain network, and geographically allocate
transportation resources.
The nature of demand can differ greatly, depending on the operations of the firm and
the activity for which the forecast is required. There are two types of demand. The
first is when demand is generated from many customers, each of whom purchases
only a small fraction of the total volume. This type of demand is said to be
independent. The second type of demand comes into play when the demand is derived
from a production schedule. This type of demand is said to be dependent.
Independent demand uses statistical forecasting techniques. These models are based
on independence and randomness of demand. In contrast, the demand is known in the
case of dependent demand.
5.2.1 Managing Demand in the Manufacturing Industry

Supply and demand management is used to optimize the operations of the
organization. A number of options are available to manage supply and demand. When
the organization has excess capacity, it tries to manage supply and when it has less
capacity it tries to manage demand. These options permit realization of better returns
to the organization. Forecasting demand, therefore, is a critical component of supply
and demand management.
Once the demand has been determined, there are basically three strategies in aggregate
planning to managing supply:
(a) Chase Strategy: It is a strategy aimed at adjusting capacity in anticipation of
demand. You are "chasing demand" by regulating capacity to the demand doing it
as dynamically and quickly as you can. Here an organization regulates capacity to
the demand doing it as dynamically and quickly as it can.
(b) Level Strategy: In a level strategy, an organization maintains a constant capacity
over a period of time, irrespective of fluctuations in demand.
(c) Mixed Strategy: Individual firms devise infinite combinations of these three pure
strategies to suit their own circumstances.
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86 5.2.2 Managing Demand in the Service Industry
Logistics and
Supply Chain Management In service industries, there is often a high level of interaction with the customer in the
production of a service. This can result in uncertainty about processing time. Many
services require the customer to come to the service delivery system. This has
important implications for managing the demand.
Individual firms devise infinite combinations of these three pure strategies to suit their
own circumstances. In managing demand, we are attempting to influence demand so
that it will fit better with capacity offerings to maximize cost and maximize efficiency.
z Differential pricing schemes designed to shift demand from peak to off-peak or
stimulate off-peak demand to obtain better utilization of capacity: One
commonly used strategy in business is differential pricing designed to shift
demand from peak to off-peak or to stimulate off-peak demand to obtain better
utilization of capacity.
Hotels do this with their rooms. Airlines are an example of this as well. The
pricing structure of hotels is geared towards getting you to use the hotel rooms
during the off peak periods. In power utilities, there is a differential pricing plan
so that your benefits are greater if you use less electricity. The idea of these
incentives is to try and influence demand pattern.
z Develop complimentary services that address imbalances between capacity and
demand: In many industries there is a tradition of overbooking. Airlines and
hotels are examples. You may arrive at the airport and find that the airline has
overbooked the flight. What do they do? They ask for volunteers to give up their
seats, by offering them incentives like free tickets or financial rewards. Instead of
deciding who is going to give up their seats, they have a complimentary
programme to deal with the conflict between demand and capacity. In this
manner under capacity is managed so that it doesn’t affect the relationship
between the customer and the company.
z Use of reservation systems to slot demand in accordance with available
capacity: You want see a movie. Now you can call ahead and make a
reservation. That is a way in which demand can be managed. Doctors schedule
you into time slots to control their capacity. Other kinds of businesses use
reservation systems to manage their demand.
z Variable-hours strategy: The variable-hours strategy tries to achieve the best of
both worlds. It seeks to keep its key human skills while avoiding the costs and
risks of holding large inventories. Using this strategy, the organization tries to
maintain a level production rate equal to the demand, at the same time it also
keeps staffing levels stable. It compensates for demand variations by adjusting the
number of hours that individuals work to make capacity match. Clearly, the
success of this strategy depends on the extent of demand variability and the
willingness of workers to accept variable hours.
This strategy has been very successful in a large number of service organizations
as well as offices. In manufacturing, variations of this strategy have been
successfully used.
z Coordination with other organizations: One of the common managerial strategies
has been to subcontract requirements above certain capacity limits when possible.
Such a managerial strategy usually involves coordination between two different
firms in the marketplace. A larger, integrated firm may make subcontracting
arrangements with smaller, more flexible firms operating in the same line of
business. For example, an electric bulb manufacturer in North India has tied up
subcontracting arrangements with another firm in South India to manufacture its
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product for certain markets. This arrangement speeds up deliveries and smoothes 87
Demand Planning
the workload. Similarly, airlines have found that by sharing equipment when route and Forecasting
structures that is non-competitive and counter seasonal, they can achieve
somewhat better equipment utilizations.
5.2.3 Patterns of Demand

Time, or temporal, concerns about demand levels are common in forecasting. Demand
variation with time is a result of growth or decline in sales rates, seasonality in the
demand pattern, and general fluctuations caused by a multitude of factors. Most short-
term forecasting methods deal with historical data which is considered the determinant
of future demand. This type of temporal variation may have different patterns; these
patterns are called a ‘time series’. There are five basic patterns that have been
identified below:
z Horizontal: The demand fluctuates around a constant mean.
z Trend: There is a systematic increase or decrease in the mean of the series over a
period of time.
z Seasonal: There is a pattern of increase or decrease for the product or service,
depending on the season or time of day, week or month.
z Cyclical: There is a gradual increase or decrease in demand with a change in
direction after a period of time. Cycles are normally of long duration.
z Random: There is no discernable pattern in the change in demand.
The first four patterns of demand either independently or in different combinations
horizontal, trend, seasonal and cyclical—define the demand characteristics for most
products and services. However, the last pattern i.e. random variation is due to
fortuitous causes and cannot be predicted using an underlying time pattern for
demand.
Figure 5.1: Different patterns of demand (Time Series)

Figure 5.1 shows the different patterns of demand. The turning point shown in the
figure refers to the point at which the demand will change. This occurs when there is
seasonal or cyclical change in demand. Although it is difficult to predict the exact
timing of turning points, some estimates can be established that are useful in
establishing demand.
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88 The factors affecting demand can also be described in terms of the turning point
Logistics and
Supply Chain Management z Leading indicators are factors with turning points that typically precede the peaks
and troughs of a business cycle.
z Coincident indicators are factors with turning points that coincide with the
business cycle.
z Lagging indicators are those factors that follow after the turning points. For
example, an increase in interest rates might precede a downturn in spending for
consumer durables—this would be a leading indicator. An example of a lagging
indicator could be the impact of electricity tariffs on the prices of aluminium
metal.
Another way to determine demand is to find a relationship between demand and other
indicators. Demand can be dependent on one or more independent factors like price,
income, advertising and promotion, tastes and preferences etc. These are called
‘causal relationships’ and these relationships can be used to forecast demand through
regression analysis.
The factors that impact demand can be divided into two main categories:
(a) External factors are those factors that are beyond the control of the organization
but affect the demand of the product or service. For example, certain economic
activities such as changes in interest rates, government regulations, budgetary
allocations, rate of unemployment etc., and
(b) Internal factors are those factors that the organization controls. These may be
decisions about the product and service, price, after-sales service, advertising and
promotions, publicity, packaging design or incentives etc.
Though the firm has no or very little influence on external demand, internal factors are
controlled by management through demand management. The case given below
explains how demand management works.
A leading manufacturer of brass hardware, based in Aligarh, faced a serious problem
of unpredictable demand. One month, it would sell 20,000 units and the next month it
would be 2000 units. This caused huge supply chain disruptions – it had to hire
additional workers and pay overtime. It was riddled with excessive inventory and
often lost business due to shortages.
It usually took four weeks to fill an order of 10,000 units. However, due to this
problem, the production had become erratic and the estimated cost of manufacturing
had gone up by nearly 15 percent. The company also incurred higher supply chain
costs when it received a last-minute order. This meant expediting production, put up
with higher inventory levels, purchase copper, tin and zinc from the spot-market. In
addition to the procurement costs being higher, the quality of the spot-market metal
purchased was not reliable, which increased rejections.
The company appointed a consultant to help out. The consultant found that the
demand spikes were related to the heightened construction activities in and around
Delhi. It was usual for a contractor to place a 10,000 unit order the week before they
were needed, even though the plan for the construction may have been finalized weeks
if not months earlier. This was causing the spikes, because regular market purchases
produced an aggregate demand that was fairly smooth and predictable.
This information came as a breakthrough. The firm was able to make a crucial
distinction between demand derived from contractor's bulk orders and regular market
demand. The company put in a new demand planning policy in place. It offered
contractors an 8 percent price discount on any orders in excess of 10,000 with a
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delivery time of five or more weeks. The savings were significant for contractors, and 89
Demand Planning
the policy was a success. and Forecasting
This approach to the problem has led to higher sales for the manufacturer. More
importantly, the new approach has meant production smoothing and control of costs,
which on an average has increased the profitability of the company by around
10 percent. This example illustrates the role of effective demand management.
Demand management requires more than just forecasting techniques. It requires a
basic understanding of the market and the needs of the customer. In order to be
successful at achieving this you need have a model that generates predictions that are
precise, accurate and reflect market conditions. This is discussed in the next session.
5.3 DEVELOPING A MODEL

The uncertainty of the future and unpredictability of the course of environmental
forces that determine events impacts all organizations. To reduce this uncertainty, you
need to find the right balance between having what your customers want and the cost
of carrying that inventory. If you are short on demand, you could have backorders,
cancellations and unsatisfied customers. But if you overstock the product, you waste
time, money and space.
This solution lies in generating predictions that are precise and accurate. In order to
reduce the uncertainty, the organization has to be able to anticipate demand before it
happens and prepare for what is ahead. It has to find means to understand how
environmental forces will impact its business.
Not all factors will be relevant to every organization. Environmental forces that are
important to one organization may not be important for another. A small scale or
medium scale manufacturer may be interested in demand in the local market,
governmental plans in infrastructure development, cost and availability of power, etc.
in his own geographical area. On the other hand, a manufacturer of tobacco products
would like relevant information on the decline in tobacco use over the past few years
that will ensure the forecast for those products is sensible.
Analysis of the environmental forces has three goals:
1. Forecasting,
2. Modelling, and
3. Characterization.
Figure 5.2: Forecasting and Decision-making

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90 The ‘logical order’ in which these three goals are to be tackled depends on the
Logistics and
Supply Chain Management objective of the organization. Often, modelling and forecasting proceed in an iterative
way; however, there is no 'logical order' in the broadest sense. The process of
forecasting and decision-making is shown in Figure 5.2.
Forecasting is the start of any planning activity. Forecasting systems generally provide
three pieces of information:
1. Indications of whether a product market is static or dynamic (i.e. Growth or
decline after seasonal adjustment);
2. The best forecast in the next n periods;
3. The forecast range within which the actual value is expected to fall.
Therefore, the main purpose of forecasting is to estimate the occurrence, timing or
magnitude of future events. Forecasting is not precise because of the interaction
between many factors or environmental forces that lead to the events. The effect of
these interactions is increased uncertainty. This often leads to indecision.
Is this an oxymoron? It need not be so. We must remember that indecision and delays
are the parents of failure. In order to avoid indecision and delays in decision- making,
we need to use forecasting which can play a pivotal role in assisting decision-making.
Interactions among the different environmental forces generally follow certain logical
rules. This makes it possible to use mathematical functions to represent the cause-and-
effect relationship among inputs, resources, forecasts, and the outcome.
The relationships are captured in a model that reflects how these environmental forces
impact the future. There should be no compromise in the quality of the model.
The model establishes a link between planning, controlling systems and the forecasts
necessary for planning, scheduling, and controlling the system for an efficient output.
Models reflect the realization of the uncertainty in forecasting and reflect the level of
sophistication and accuracy required for effective decision-making. Therefore, in
building a model, it is essential that the model provides satisfaction on these two
critical questions:
1. Is the model adequate?
2. Is the model stable?
This also means that the model should reflect the objectives of the management. For
example, the type of model that will be adequate for short-term forecasts may not be
adequate for long-term forecasts. In order that the model forecasts are stable, it will
have to reflect and compensate for the actual performance. This is done by developing
a model so that the forecast is an iterative process, which means the forecasts are
updated so as to form a feedback loop to correct the original forecast.
Figure 5.3 highlights the systematic development and the relationship between the
modelling and forecasting and highlights the relationship between the model and the
forecast.
Even simple business problems require good models. For example, your boss calls
you. He wants you to make a sales forecast for the next two years for the major
products manufactured and marketed by your organization. At first glance this seems
to be a very easy exercise. In a static world, perhaps, you can take last year’s sales
figures and add an appropriate internal growth to these figures and arrive at the
projections.
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91
Demand Planning
and Forecasting
Figure 5.3: Modelling and Forecasting

But the world is dynamic. Things change and any projection should consider the
changes that have taken place and the changes that are expected in the business
environment. You know that the figures you give your boss will be used to determine
the resources of your department. Therefore, you would like the figures to reflect the
real situation on the ground.
Knowing that it is more important for organizations to grow their market share rather
than just try to protect the sales volumes, the model should reflect this reality. First
you need to identify outside factors that have an impact on the forecast. If the
historical growth of the market was 5 percent and it is projected to grow at 10 percent,
your historical sales figures will not be a good guide for the future, as this would result
in a reduction of market share. So, if you need to protect your market share, you need
different forecasting models to determine the parameters within which you will
operate.
5.3.1 Forecasting Methods

Different forecasting methods can be used to develop the forecast. The appropriate
method will depend on the nature of the item being forecast and the availability of
historical data. These are two factors that often determine the method you choose to
form the forecast.
There are four common approaches to forecasting which are given below:
1. Qualitative: These forecasts are used where there is little or no historical
performance data to determine demand. They are typically based on an expert’s
familiarity of products, the industry and customer preferences. An expert’s
opinion is usually useful when new products are being introduced into the market.
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92 2. Time Series: Time series forecasts rely on historical demand in order to predict
Logistics and
Supply Chain Management the future demand. There are a variety of computational methods that can be used
which will be discussed in the next section. Usually, this method is ideal for items
that have a generally defined historical pattern that does not change radically from
one year to the next e.g. “staple stock” items in a retail store.
3. Causal: Causal forecasting is used when there is a visible correlation between one
or more variables to the demand for the product. For example, disposable income,
lifestyle indicators, etc. may be used to determine the demand for many consumer
durable items. The method, however, requires a high level of sophistication in
modelling.
4. Simulation: This method is highly sophisticated and is mainly used where the
organization needs to generate multiple ‘what-if’ scenarios. For example, such a
model would be able to provide answers on the impact on product demand if
prices are increased or if disposable income decreases? In many cases, firms
require to evaluate these types of sensitivities so as to have a more robust forecast.
The method used should adequately meet the objectives of the forecasting model
requires. More than one method may be used to provide the types of outputs desired.
For example, the method used for short-term forecasts could be different than the one
used for long-term forecasts.
5.3.2 Accuracy and Validation Assessments

All models need to be validated and verified. Validation is concerned with the
question "Are we building the right system?" Verification, on the other hand, seeks to
answer the question "Are we building the system right?"
Since validation is used for the purpose of establishing a model’s credibility it is
important that the method used for the validation is, itself, credible. Features of time
series, which might be revealed by examining its graph, with the forecasted values,
and the residuals behaviour, condition forecasting modelling.
An effective approach to modelling forecasting validation is to hold out a specific
number of data points for estimation validation (i.e., estimation period), and a specific
number of data points for forecasting accuracy (i.e., validation period). The data,
which are not held out, are used to estimate the parameters of the model, the model is
then tested on data in the validation period, if the results are satisfactory, then the
forecasts are generated beyond the end of the estimation and validation periods.
A good model should have small error measures in both the estimation and validation
periods and its validation period statistics should be similar to its own estimation
period statistics.
Holding data out for validation purposes is probably the single most important
diagnostic test of a model: it gives the best indication of the accuracy that can be
expected when forecasting the future. It is a rule that one should hold out at least
20 per cent of data for validation purposes.
5.3.3 IT-based Models

Many new approaches to forecasting are emerging, with different levels of
sophistication. Some of these forecasting packages are very powerful. They
mechanize the entire forecasting process. However, they are based on the
organization’s ability to provide consistent historical data. They cleanse the data and if
needed, break it up monthly data into weekly or daily buckets, or aggregate it by
grouping SKU data into categories and category data into overall totals. They also
look for problems in the data, and then provide the forecast.
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Though many companies have made dramatic improvements in their operations using 93
Demand Planning
these packages, some companies lack such data creating capabilities and the and Forecasting
sophistication to run such systems. There is a need for them to develop these abilities
use packages to improve performance.
Numerous firms supply forecasting software. These range from open source solutions
to SAP, Oracle and SPSS. A number of very sophisticated systems are also available,
which can use subjective information, including the forecast risk as the basis of
generating forecasts. An example of such new developments is the Customer Demand
Planning (CDP) system created by Lucent Technologies.
Lucent Technologies was formed in 1995, when AT & T divided into three major
businesses. The CDP system that it designed is capable of generating over 16,000
monthly forecasts for over 2,000 product lines. The CDP forecasting system forecasts
in units, which can then be converted to revenue forecasts using historical average
price data.
The special features of this system are:
z It uses a single global schedule, data repository, and set of procedures.
z The CDP system is ’user friendly’. The user interface is designed to provide a
‘point and click’ environment.
z In order to provide salespeople making inputs into the forecast with the most
recent information.
z It provides three years of global customer demand history, plus year-to-date
customer demand. This history is updated weekly.
z Known future demand, for which takes there are not yet specific orders, is detailed
for 12 months into the future.
z Order-level information is available for the previous three months and for all
future-committed orders.
z The normal time horizon for the CDP forecasting process is a rolling 12-month
horizon.
z The system also provides the capability for sales teams to enter subjective
information, including the forecast risk and the significant upside or downside
variables.
Lucent’s success with the CDP system demonstrates the value of forecasting. This
type of system has the ability to enter forecasts using a number of different forecast
individual products broken down by customer, project, or total application.
A note of caution; though forecasting is an important component of strategic and
operational planning, we should not immerse ourselves in the techniques of
forecasting and lose track of the reasons for forecasting. Sometimes, an expert’s
experience and knowledge of the marketplace may be superior to the forecasting
techniques that could be used. For instance, the effect of future events such as the
launch of new products cannot be deduced from historical data. Therefore, a
combination of systems that use mathematical prediction and expert opinion may be
required for such applications.
5.4 COLLABORATIVE PLANNING FORECASTING AND

REPLENISHMENT (CPFR)
As technology becomes faster and smarter and as the willingness of supply chains to
share information increases, companies will benefit from such forecasting models.
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94 Inventory will increasingly be replaced with information. This hope is reflected in
Logistics and
Supply Chain Management Collaborative Planning Forecasting and Replenishment (CPFR). CPFR is accepted as
an extension of supply chain management and as a part of supply chain philosophy.
The first CPFR exercise was undertaken by Wal-Mart and Warner-Lambert for
Listerine products. They used special CPFR software to exchange forecasts.
Supportive data, such as past sales trends, promotion plans and even the weather, were
transferred in an iterative fashion. This allowed them to develop a single forecast
based their original forecasts. The results were gratifying. Listerine sales increased,
the fill rates improved, and there was a significant reduction of inventory investment.
CPFR is forecasting based on the concept of supply chain management. It is a
business model that takes a holistic approach to supply chain management and
information exchange among trading partners. It uses common metrics, standard
language, and firm agreements to improve supply chain efficiencies for all
participants.
In other words, collaborative forecasting is based on considering the entire supply
chain or partnerships as a single unit and the sharing of information between the links
in the chain. The objective is to collectively, as members of the supply chain, meet the
needs of the final consumer. This is accomplished by supplying the right product at
the right place, right time and right price to the customer.
According to the Roundtable held at the University of Denver in May, 2002, the
“CPFR Overview Committee.” developed target objectives of business benefits using
CPRF. These are shown below:
z Increased in-stock at shelf 5-8%
z Reduced average network inventory10%
z Increased sales 8-10%
z Reduced operating expense 1-2%
z Reduced cost of goods 3-4%
z Reduced lead time/cycle time 25-30%
z Decreased account receivables 8-10%
z Reduced forecast error +/- 20% (six weeks out) and +/- 30% (twelve weeks out)
To successfully implement a supply chain management strategy, forecasting along
with demand planning, are key factors. Bringing down investments in inventory and
enhancing customer service levels is directly connected to the level of accuracy and
efficiency with which this demand is forecast and is communicated up and down the
supply chain.
Though accurate and effective forecasting is an elusive target, many companies are
now using an approach of collaborative forecasting. Collaborative forecasting
involves the entire supply chain who participates in decisions about demand. This
demand involves gathering forecasting information both internally and externally and
is used to drive the activities of the supply chain.
Collaborative forecasting overcomes some of the inherent problems with traditional
forecasting. It is a method by which enterprise-wide knowledge, is unified into a
forecast more accurate than a traditional forecast, and has the support of the entire
supply chain. The objective is to be able to provide the best and most timely
predictions of demand.
The need for collaborative forecasting arises due to increasing competition and the
requirement that manufacturers in a supply chain must synchronize operations to
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derive the benefits of collaboration. Under stocking as well as overstocking of 95
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inventory, both cause problems and decrease a manufacturer's competitiveness. and Forecasting
Collaborative forecasting can help eliminate excess inventory and at the same time,
support the supply chain management initiative of the participating companies.
A generic model of CPFR system is shown in Figure 5.4.
Figure 5.4: CPFR Model

Collaborative Planning, Forecasting, and Replenishment is a nine-step approach to
improving supply chain management, and ties demand planning and supply planning
into one process. The CPFR process has three major sub-processes – namely planning,
forecasting and replenishment – each of which is formed by a number of steps as is
shown in Figure 5.5.
Figure 5.5: Activities in the CPFR Process

It usually begins with identifying a ‘forecasting champion’. The forecasting champion
can be a single person, a department, or a firm. Identification of a ‘forecasting
champion’ is critical to the collaborative forecasting technique. The role of the
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96 champion is to effectively communicate and lead the organizations involved to share
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Supply Chain Management and agree upon information sharing, forecasting methods and technologies. There are
a number of methods used for collaborative forecasting. These forecasting processes
are generally custom-built and developed to meet the specific needs of individual
companies. To be successful in the task, the champion has to understand and
emphasise the critical nature of the process. The champion also has to facilitate cross-
functional efforts required for improved forecasting.
The next step is forming the forecast collaboration group. Each organization should
choose its member in this group. However, the composition of the group should be
such that its members represent a variety of functional areas including sales,
marketing, logistics/operations, finance, and information systems. This description
includes the members from external partners like suppliers and customers. The effort
has to be focused to ensure two objectives, (a) the most recent and best possible
information is included in the final forecast, and (b) the forecast addresses the
changing needs and environments facing the business.
The group is given the responsibility of deciding on the goals, objectives and
immediate needs of the collaborative forecast process. These are based on the
informational needs of all forecast users. The group will identify the factors,
processes, technologies that impact the forecast, and the relevant sources of
information available. The sources could be internal or external. The final result is
dependant of the ability of the group to ensure that information can be accessed at all
necessary levels by all the users.
Companies often hold at least two meetings during the month, scheduled on a regular
basis. The first meeting is for the purpose of gathering information and preparing the
base forecast. The second meeting is to bring alternative forecasts together and work
through issues to arrive at a consensus.
Once the relevant information is decided upon and available, the next step is at the
level of the firm. The members of the supply chain decide on the process by which the
various pieces of information will be brought together. After necessary approvals, the
consensus forecast is used for the company's sales and planning systems.
For example, Gillette found that senior managers connect to each other; distributors
connect with Gillette; and so on. The aligned teams give it an added advantage; they
support the company's mission to strengthen key customer relationships through an
effective, collaborative, improvement-oriented process. From doing it in this way,
Gillette found numerous opportunities to improve issues such as shrinkage, shelf
replenishment, packaging, and display design. It also makes sense because by
worrying about customers’ performance issues they reduce the retailer loss of sale,
and in the bargain increase their own sale, too.
However, to make this type of synergy happen, measurements and incentives must be
a part of the process. These ensure that the forecast accuracy and related supply chain
performance actually do improve as a result of the collaborative process.
Measurements should be such that demonstrate the success of the collaborative
efforts, not just at a fixed point in time, but that measure the rate of improvement over
time.
Measurements can vary, but should include the measurement of the actual versus the
forecast. These provide the firms the ability to compare the forecasts both for
consistency and comparability. A common method is to compute the absolute error for
each item (the actual minus the forecast, divided by the actual, without the sign).
Another key measurement is a bias indicator. This shows the percentage of items that
were either over or under forecasted. The bias indicator points out trends and
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can be critical to improving the affected forecasts. and Forecasting
The collaborative approach is a deviation from tradition and requires members to
make significant changes in the ways they worked in the past. The changes in working
methods often result in resistance issues. If participants do not actually change their
behaviour, the effort that goes into creating an improved forecast process will
generally not produce the best results. In addition to changing old work habits, the
collaborative process also demands more work for many of the participants.
Participants who were previously not involved with the forecasting process often may
view the process as extra work.
However, results do not come in immediately. It takes time to put the system in place
and get results from it. There is a learning curve for participants, systems and sub-
systems have to be developed and process decisions have to be made, before results
come in. All of these issues combine to make a change to collaborative forecasting as
a challenge to each of the organizations in the entire supply chain.
In the collaborative forecasting environment the information is current and more
accurate as companies supplement statistics with information gathered directly from
the customer, the market, and other sources. This supplemental information reduces
the uncertainty that exists in the forecast and therefore minimizes the inventory carried
as it the need for inventory to cover uncertainty is reduced.
The driving premise of CPFR is that all supply chain participants develop a
synchronized forecast. A company can collaborate with numerous other supply
network members both upstream and downstream in the supply network. Every
participant in a CPFR process: supplier, manufacturer, distributor, retailer — can
view and amend forecast data to optimize the process from end to end. Essentially,
CPFR puts an end to guesswork in forecasting. It means that manufacturers and
retailers share their plans, with detailed knowledge of each others’ assumptions and
constraints.
However, there is a high investment involved and sophistication required in using
such systems. Gillette found that not everyone in the supply chain could become a
member of the integrated supply chain. Finally, it decided to differentiate its customer
strategy by customer size. More complex, sophisticated retail chains received the more
differentiated and integrated service based on Gillette's value chain structure. Smaller,
independent operators receive a standardized set of supply chain services. Both the
cost-to-serve and the sophistication of the customer drive this distinction. Thus,
Gillette only does CPFR with its largest accounts.
There are many successful examples of CPFR. Heineken USA employs CPFR and has
successfully cut its order-cycle time. It is extending its programme and is
currently providing collaborative planning and replenishment software to its top
100 distributors.
Fill in the blanks:
1. ……………………………are those factors that are beyond the control of
the organization but affect the demand of the product or service.
2. …………………….forecasts rely on historical demand in order to predict
the future demand.
3. ……………………..is used when there is a visible correlation between
one or more variables to the demand for the product.
Contd…..
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98 4. An effective approach to modelling forecasting validation is to hold out a
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Supply Chain Management specific number of data points for estimation ……………………..and for
forecasting………………………………...
5. Under stocking as well as overstocking of inventory, both cause problems
and …………………….a manufacturer's competitiveness.
5.5 QUANTITATIVE METHODS

Most firms, especially small and medium firms do not find the use of such IT-based
models economical, even when they have the capability and sophistication to use these
models. The option they have is to use traditional quantitative methods for generating
their forecasts. The most commonly used method is the ‘time series’.
5.5.1 Time Series

Time series is a characterization of change that takes place over a period of time. It is
a quantitative model that reflects the change in demand for goods and services and the
pattern in the order of occurrence, using historical data. These patterns or
characteristics of the change process are known as a ‘times series’.
One major theme in the continuing development of inventory theory is to develop
inventory models that are realistic and reflect product demand. In real life, demand is
uncertain and hard to forecast. Furthermore, as product life cycles get shorter, the
randomness and unpredictability of these demand processes have become even
greater.
In practice, inventory managers often rely on forecasts based on a time series of prior
demand, such as a weighted moving average. Typically these forecasts are predicated
on a belief that the most recent demand observations are the best predictors for future
demand. Time series are, therefore, commonly used for inventory decisions in
order to:
z Generate and maintain forecasts at different levels of product,
z Provide appropriate forecasts for planning and replenishment for product and
location, and
z Optimize demand history through demand cleansing and seasonal profiling.
The method chosen will depend on the accuracy demanded of the forecast and the
pattern of historical demand. Some of the methods used to solve such problems are
discussed below.
5.5.2 Moving Average Method

The simplest form of time series is the ‘moving average method’. In this type of
model, the raw data is converted into a moving average that reflects the trend in
change of demand. The moving average is an arithmetic average of data over a period
of time. By averaging historical data, the attempt is to remove the random
fluctuations.
In this method, the data is updated regularly by replacing the item in the average by
the new item. This type of model is especially useful when demand has no pronounced
trend or seasonal influence. It is generally used to study this type of data, which
superior to the raw data because it eliminates or smoothens out the irregularity in the
time series.
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The general formula for moving average is: 99
Demand Planning
Ft+1 = (At + At-1 + At-2 + At-3 + ……+ At-n+1) / n and Forecasting
Where: Ft+1 is the moving average for the period t+1,

At, At-1, At-2, At-3 etc. are actual values for the corresponding period, and ‘n’ is the total
number of periods in the average.
For example, suppose the prices for a product are given for 12 months and a five
monthly average is to be computed. Each month sequentially designated as A1, A2, A3,
A4, A5.…………etc.
Then the first 5-month moving average would be;
F5 = [(A1 + A2 + A3 + A4 + A5)/5]
The second moving average of the next five months would be;
F6 = [(A2 + A3 + A4 + A5 + A6)/5]
And so on.
The last item would be the average
F12 = [(A8 + A9 + A10 + A11 + A12/5]
The stability of the series often determines how many periods to include in the moving
average. Large values of ‘n’ should be used when the series is relatively stable,
including more historical data in the average results in a forecast that is less
susceptible to random variations. However, where the individual values are prone to
change, small values of ‘n’ are recommended.
Simple Moving Averages (MA) is an effective and efficient approach to forecasting
the future provided the time series is stationary in both mean and variance. This is
important and needs to be ascertained. Also, if there is a trend in the data, the moving
average has the adverse characteristic of lagging the trend.
5.5.3 Weighted Moving Averages

In a simple moving average, each period has the same weight. However, very often it
may be desirable to emphasize specific elements more than others. For example you
may decide that recent demand needs more emphasis over earlier demand. In such a
case, weights can be placed on each element as desired, subject to the condition that
the total of the weights should add up to ‘1’.
The general formula for the weighted moving average then changes to:
Ft+1 = [(wtAt + wt-1At-1 + wt-2At-2 + wt-3At-3 + ……+ wt-n+1At-n+1) / n
Where: Ft+1 is the weighted moving average for the period t+1,
And, wt is the weighing factor, and ∑nt=1 wt = 1
For example, if ‘n’ is 5, we could weight the moving average as follows:
w1 = 5/ (1 + 2 + 3 + 4 + 5) = 5/15 = 1/3;
w2 = 4/15;
w3 = 3/15 = 1/5;
w4 = 2/15 and w5 = 1/15.
∑ w = 1/3 + 4/15 + 1/5 + 2/15 + 1/15 = 1
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100 In this example, the most recent period has the highest weight compared to the earlier
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Supply Chain Management periods. The weight progressively reduces as the period increases.
An advantage of this model is that it allows one to compensate for seasonality or any
unusual event by carefully fitting the coefficients, wAt. However, it must be
remembered that the choice of the coefficient has to be made by management and this
choice is critical to the applicability of the model.
5.5.4 Exponential Smoothing

A forecast based on an exponential-weighted moving average is based on a belief that
the most recent demand observations can best predict future demand. Therefore,
exponential smoothing models are very popularly used in Supply Chain Management.
It produces a smoothed time series when the forecasting horizon is relatively short and
when there is little information about cause and effect relationship between the
demand of an item and the independent factors that influence it.
Unlike regression models, which are discussed in the next section, exponential
smoothing does not make use of information from series other than the one being
forecast. These models are also readily available in standard computer software and
require limited data storage and computational capacity.
The Exponential Smoothing method is:
z Easy to adjust for past errors,
z Easy to prepare follow-on forecasts from,
z Ideal for situations where many forecasts need to be prepared.
Since exponential smoothing is an iterative process, we only need to define an initial
value.
Single Exponential Smoothing: The Single Exponential Smoothing method
calculates the values for a smoothed series. You choose a damping coefficient which
is called the weighting factor. This factor is used to smooth the data. It can have a
value ranging from ‘1’ to ‘0’ and determines the sensitivity of the smoothing effect.
The exponential relationship that was shown earlier can now be written as using
standard notations:
Ft+1 = α Dt + (1 - α) Ft
Where: Dt is the actual value
Ft is the forecasted value
α is the weighting factor, which ranges from 0 to 1
t is the current time period
Since Ft+1 = α Dt + (1 - α) Ft
Ft = α Dt-1 + (1 - α) Ft-1 and so on
Therefore Ft+1 = α Dt + (1 - α) (α Dt-1 + (1 - α) Ft-1)…….
Ft+1 = α Dt + α (1 - α)Ft-1 + α (1 - α)2Ft-2 + α (1 - α)3Ft-3…….
Thus the forecast for the next period is the algebraic sum of the forecast for the last
period and ‘ά’ times error in forecast in the last period.
Exponential Smoothing assigns exponentially decreasing weights as the observation
get older. This means that recent observations are given relatively more weight in
forecasting than the older observations.
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A small ‘ά’ smoothens the values by assigning lower weightages to recent changes, 101
Demand Planning
while a large ‘ά’ provides a fast response to the recent changes in the time series but and Forecasting
provides a smaller amount of smoothing.
When the data is smoothed exponentially, the smoothed value becomes the forecast
for period ‘t + 1’. Also, only three items of data are required for the analysis, unlike
the moving averages where the first value is for the fifth week. It is interesting to note
how for this particular series, the moving average, the weighted moving average and
simple exponential smoothing smooth out the seasonality. The difference between the
different weighting factors is increasingly visible as the number of reading increases.
The basic decision that needs to be taken by the manager is the selection of the
smoothing constant. How should it be taken? The constant has to be either equal to or
between the value range of ‘0’ and ‘1’. The variance of the error increases as ά
increases. To minimize the error, we would like to make ά as small as possible (0), but
this makes the forecast unresponsive to a change in the underlying time series. To
make the forecast responsive to changes, we want ά as large as possible (1), but this
increases the error variance.
There are no specific rules of selecting the value for ‘α’. If more weight has to be
given to recent data, then the value should be closer to ‘1’. Values between 0.1 and
0.3 are most commonly used.
However, a method of choosing the best fit is by choosing the value of α such that the
error variance is the minimum. This is shown in the worked example below:
Worked Example
Problem – Choosing the best fit (ά)
Saluja Brothers manufactures simple lathes for the export market. The manufacturing
manager uses exponential smoothing technique to arrive at his forecasts. He has made
a forecast using a smoothing constant of 0.2.
The sales manager has also made his forecast using the exponential smoothing
method, but has used a smoothing constant of 0.5.
Compare the forecasts for the series data under two situations and determine which
forecast will you accept and why?
Period 1 2 3 4 5 6 7 8 9 10
Observations 30 32 35 34 31 30 33 36 36 34
Answer
The basic exponential smoothing model is Ft = ά Dt + (1- ά) Ft-1
Where: Dt is the actual value,
Ft is the forecasted value,
ά is the smoothing constant or weighting factor, and
Ft-1 is the current time period.
Assume that the smoothed value of the time series for the first period is equal to the
actual first value of the time series. You can calculate the values as shown in the table
below. The calculations are simple.
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102 The table shows the forecasts under the two specified conditions i.e. ά = 0.2 and
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Supply Chain Management ά = 0.5:
ά = 0.2 ά = 0.5
Period Dt Dt- Ft-1 ά* Dt- Ft-1 Ft (Dt- Ft-1)² Dt- Ft-1 ά* Dt- Ft-1 Ft (Dt- Ft-1)²
1 30 0.00 0.00 30.00 0.00 0.00 0.00 30.00 0.00
2 32 2.00 0.40 30.40 4.00 2.00 1.00 31.00 4.00
3 35 4.60 0.92 31.30 21.16 3.00 1.50 33.00 9.00
4 34 2.70 0.54 31.85 7.29 1.00 0.50 33.5 1.00
5 31 -0.85 -0.17 31.68 0.73 -2.50 -1.25 32.25 6.25
6 30 -1.68 -0.34 31.35 2.83 -2.25 1.13 31.13 5.06
7 33 1.65 0.33 31.68 2.73 1.88 0.94 32.06 3.54
8 36 4.32 0.86 32.54 18.67 2.94 1.97 34.03 8.65
9 36 3.46 0.69 33.23 11.97 1.97 0.99 35.00 3.88
10 34 0.77 0.15 33.38 0.60 -1.00 -0.50 34.50 1.00
Total 69.98 42.38
Σ (Dt- Ft-1)² i.e. Total Variance when ά = 0.2 is 69.98 [Col. 6]

Therefore,
Error Variance of the series is = Σ (Dt- Ft-1)² / (n -1) = 69.98/9 = 7.75
Similarly, Σ (Dt- Ft-1)² i.e. Total Variance with ά = 0.5 is 42.38 [Col. 10]
Therefore,
Error Variance of the series is = Σ (Dt- Ft-1)² / (n – 1) = 42.38/9 = 4.70
Where ‘n’ is the number of observations
One measure of the accuracy of the forecast is the error variance, which is the mean
squared error between the forecast and the actual data in the next period [Σ (Dt- Ft-1)² /
(n – 1)] which has been calculated above. You have to pick the ά that gives you the
smallest mean squared error or error variance.
Since the error variance for the case of ά = 0.2 is greater than for ά = 0.5, the forecast
with ά = 0.5 is the correct choice as it is more accurate.
Simple Moving Average and Exponentially Weighted Moving Average: An
exponentially weighted moving average with a smoothing constant ‘α’, roughly
corresponds to a simple moving average period of length ‘n’, where ‘α’ and ‘n’ are
related by the following equation:
α = 2/(n+1) OR n = (2 - α)/ α.
Therefore, an exponentially weighted moving average with a smoothing constant
equal to 0.1 would roughly correspond to a 19 day moving average. Similarly, a 40-
day simple moving average would correspond roughly to an exponentially weighted
moving average with a smoothing constant equal to 0.04878. These values are based
on the equations given above.
This goes to show that ‘simple moving average’ is a special case of exponential
smoothing. The forecasts generated by exponential smoothing have the same average
age as a moving average of order ‘n’ such that the integer part is (2- α)/ α.
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Double Exponential Smoothing: An exponential smoothing over an already 103
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smoothed time series is called double-exponential smoothing. Double exponential and Forecasting
smoothing allows forecasting data with trends. While the single exponential method is
used for problems where the trends are stationery, the double exponential method is
used to handle trends that are not stationary.
By exponentially smoothening a smoothened series again, a linear trend in the
forecasted value is obtained. The extrapolated series has a constant growth rate, equal
to the growth of the smoothed series at the end of the data period.
Triple Exponential Smoothing: When the trends are non-linear, it may be necessary
to extend it even to a triple-exponential smoothing. Triple Exponential Smoothing is
better at handling parabola trends and is normally used for such data.
While simple exponential smoothing requires stationary conditions in the demand
parameters, the double-exponential smoothing can capture trends when the demand is
changing in a linear fashion. Triple-exponential smoothing can be used to handle
almost all other business time series.
The advantages of exponential smoothing are that it does not impose any deterministic
model to fit the series other than what is inherent in the time series itself. It can be
modified to capture seasonal patterns for a time series. Whereas moving averages
provide for equal weights for past observations, exponential smoothing assigns
exponentially decreasing weights as the observation get older.
5.6 REGRESSION ANALYSIS

Regression Analysis is a method of predicting the value of one variable based on the
value of other variables. It reflects the casual relationship underlying the demand
being forecast and an independent variable. Examples of casual relationships are, say,
relationships between income levels and disposable income, cost and demand, etc.
Regression analysis is of two types, (a) Simple Linear Regression, and (b) Multiple
Regressions. In a simple regression the regression uses only one predictor, while there
are two or more predictors in multiple regression analysis.
5.6.1 Simple Linear Regression

These models are based on functional relationships between variables that define the
environment. The value of one variable is based on the value of other variables. To
make predictions or estimates, we must identify the effective predictors of the variable
of interest. We need to identify variables that are important indicators and can be
measured at the least cost to use for the forecast.
There are two types of variables, one that is being forecasted and one from which the
forecast is made. The first one is known as the dependent variable, the latter as the
independent variable. In the examples given above, ‘income levels’ and ‘cost‘, are the
independent variables and ‘disposable income’ and ‘demand are the dependent
variables.
In addition to the two types of variables an additional type, the intervening variable,
needs to be kept in mind. The intervening variable carries only a little information or
is redundant or has little effect on the dependent variable’s magnitude. This variable
type is not considered in the decision space of the forecast.
A major restriction in using this method is that it assumes that the past data and
projects of future data fall in a straight line. This limitation is often overcome using
shorter periods for forecasts during which the relationship between the variables
approximates that of a straight line. Many relationships that have an exponential form
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104 can also be handled by using a ‘log’ and ‘log-log’ relationship, which converts the
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Supply Chain Management function into a straight line.
Regression analysis can be used to forecast both time series and cross-sectional data.
When the dependent variable, normally represented by the ‘y’ axis, changes with
‘time’, which is the independent variable, it is a time series analysis. With time series,
this analysis is often used to estimate the slope of a trend line.
Goodness of Fit: The equation given in Figure 5.6 is a time series and has been
generated by the least squares method. The pairs of data based on actual sales have
been plotted in the graph above and are represented by the zigzag line. Though, we
can say there is a linear relationship between the pair of ‘x’ and ‘y’ values, it is
difficult to draw a straight through all the points. This type of dispersion of points is
common to almost all data and the pattern of dispersion is normally called a scatter
diagram i.e. the points lie within a band described by parallel lines, shown as AA and
BB in the Figure 5.6.
4000
3500 A
Multiple R 0.98
3000 R Square 0.96
Monthly Sales
2500 B
2000
A
1500
y = 1059 + 199.2 x
1000
B
500
0
1 2 3 4 5 6 7 8 9 10 11 12
Month
Figure 5.6: Simple Regression and Correlation Model

The points do not fall in a straight line and we need to determine the relationship
between the points. To predict the mean y-value for a given x-value, we need find a
line that passes through the mean value of both ‘x’ and ‘y’. This is achieved through
the least squares method.
Take the equation:
Y = a + bx
The least square method tries to fit the data such that it minimizes the sum of the
distance between each of the points and the predictive line. Such an approach should
result in a line, which we can call a ’best fit’ to the sample data. It calculates the
minimum average squared deviations between the sample ‘Y’ points and the points on
the estimated line, ‘y’. If ‘y’ is known, it is possible to find the values of the intercept
‘a’ and the slope ‘b’.
(y1 – Y1)2 + (y2 – Y2)2 + (y3 – Y3)2 + (y4 – Y4)2 +……..+ (yi – Yi)2 = minimum
Where: ‘Y’ is the sample points of the dependent variable
‘y’ is the actual value of the dependent variable
We know:
∑ y = na + b ∑ x, and ∑ xy = a∑ x + b ∑ x2
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The solution reduces itself to that of simultaneous linear equations. Solving the two 105
Demand Planning
equations for ‘y’ and ‘xy’, we calculate the values of ‘y’. One of the most common and Forecasting
uses of this procedure is for determining the value of the intercept and the slope of a
trend line.
The ‘standard error of estimate’ or how well the line fits the data is calculated as
follows:
Syx = √ {[∑i=1n (yi – Yi) 2] / (n – 2)} or Syx = 95.12
5.6.2 Multiple Regressions

Generally, it is preferable to use as few variables as predictors as necessary to get a
reasonably accurate forecast. However, in many cases this may not give accurate
results. Multiple regressions can use more than one predictor. The forecast takes the
form:
Y = β0 + β 1X1 + β 2X2 + . . .+ β nXn,
Where, β 0 is the intercept, and
β 1, β 2, . . . β n are coefficients representing the contribution of the independent
variables X1, X2,..., Xn.
Multiple regressions are used when two or more independent factors are involved, and
it is widely used for short to intermediate term forecasting. They are used to assess the
factors which have to be included or excluded. They can be used to develop alternate
models with different factors.
Decomposition of a Time Series

Historical data of the time series, which the user may have, often needs to be filtered
to provide reliable statistical estimates. Historical data may represent more than one
component of demand. Based on professional judgment, when more than one
component of demand is present in the data, the data has to be separated into each
component pattern so that it can be used to project the future.
De-seasoning and smoothing operations on data eliminates disruptive elements that
can compromise the accuracy of forecasts. For example, spot electricity prices exhibit
strong seasonality on the annual, weekly and daily level and sometimes infrequent, but
large jumps, due to outages etc. These spikes are normally quite short-lived, and
prices fall back to a normal level. Undesirable characteristics can be removed from
series by de-seasoning and smoothing operations.
Figure 5.7: Multiplicative Seasonal Variation

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106 Decomposition of a time series means separating these components. The first
Logistics and
Supply Chain Management question, however, is as to how they relate to each other. The seasonal variation can
be additive or multiplicative. An additive variation means that the seasonal component
is a constant, no matter what the trend or average amount is. In the multiplicative
seasonal variation, the size of the seasonal variation depends on the trend. It increases
with increasing values of the variables. This type of seasonal variation is usually
encountered. The nature of the variation is shown in Figure 5.7.
When demand data contains both seasonal and trend effects at the same time, we need
to know how they relate to each other and how to separate their impacts.
Seasonal Index
Seasonality is a pattern that repeats over a period of time. For example, if the periods
are quarters then the annual seasonal pattern is 4 periods long. Seasonal index reflects
the extent of seasonal influence on the time series for a particular segment of the year.
The calculation involves a comparison of the expected values of that period with the
grand mean for the entire year.
An accurate estimate for the seasonal index is obtained by computing the average of
the first period of the cycle, and the second period, etc, and then by dividing each by
the overall average.
The formula for computing seasonal factors is:
Si = Di/D,
th
where: Si = the seasonal index for i period,
Di = the average values of ith period,
D = grand average,
i = the ith seasonal period of the cycle.
For example, a seasonal index of 1.00 for a particular month indicates that the
expected value of that month is 1/12 of the overall average.
Seasonal Adjustment: Sometimes there are periodic variations which are recurrent
over a short time frame. Seasonal Adjustment is the process used to remove these
variations.
The seasonal adjustment data is or the deseasoned demand is obtained by simply
dividing each time series observation by the corresponding seasonal factor (sometimes
also called ‘seasonal index’).
An example is given, in Table 5.1 below, to demonstrate the method. The sales data
for two years are given with the sales data aggregated in periods of two months.
Table 5.1: Sales Data for ABC Corporation
1 2 3 4 5 6 7 8
Month, Sales Deseasoned Month, Sales 2 yr. Seasonal Deseasoned
2003 Demand 2004 Average factor Demand
January – 109.0 125.29 January – 115.0 112.0 0.87 132.18
February February
March – 104.0 125.30 March – 112.0 108.0 0.83 130.12
April April
May – 150.0 126.05 May – June 159.0 154.5 1.19 133.61
June
Contd…
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July – 170.0 125.00 July – 182.0 176.0 1.36 133.82 107
August August Demand Planning
and Forecasting
September 120.0 126.32 September – 126.0 123.0 0.95 132.63
– October October
November 100.0 125.00 November – 106.0 103.0 0.80 132.50
– December
December
The initial information given has been shown in columns 1, 2, 4 and 5. The first step is
to add the total sale of the periods i.e. data in column 2 and column 5 are added up,
and the average is determined by dividing it by the number of periods. In the case of
data in Table 5.1, the average sales per period, during the two years under
consideration, comes to 129.42. Then find the average sales for the same period for
the two years under consideration.
This is accomplished by adding data in column 2 and column 5 and dividing the total
by 2 (in this case). The seasonal factor can now be obtained. The seasonal factor is
obtained by dividing the average given in column 6 by the general average, which has
been computed earlier (129.42). The data is now ready to be de-seasoned.
De-seasoning is carried out by dividing the actual sales by the seasonal factor i.e.
dividing data in column 2 by column 7 for the year 2003 and data in column 5 by
column 7 for the year 2004.
You can cross check your calculations by adding up the actual demand and the
de-seasoned demand for the total period. The two totals should be the same.
After de-seasoning has been carried out, a new regression line can be constructed
using the values in columns 3 and 8 to construct a trend line independent of the
variations due to seasonal demand.
Trend Effects in Exponential Smoothing: The exponential forecast just, like the
moving averages, has the adverse characteristic of lagging the trend. Exponentially
smoothed forecasts can be corrected somewhat by introducing a trend correction
adjustment. In this case, the equation is modified to add an additional smoothing
constant ‘δ’.
The exponential smoothing equation now changes to:
FITt+1 = [α Dt + (1 - α) Ft] + Tt+1
Where: Tt+1 = Tt + β (Ft+1 - FITt)
Here: FITt+1 is Forecast including trend
α = Smoothing Constant
β = Trend Smoothing Constant
Tt+1 = Correction Factor for time period t+1
Cyclical Analysis: In cyclical analysis, the trend itself is removed for the cycles. To
do this each actual value in the time series is expressed as a percentage of the
calculated trend for the same date. The resulting time series has no trend, but oscillates
around a central value of 100.
Solved Problem
ABC Ltd. manufactures small diesel generators. The management uses exponential
smoothing technique to arrive at the forecasts. It uses a smoothing coefficient of 0.10
(α = 0.10).
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108 The actual demand in units and the simple exponential forecast up to the 9th month is
Logistics and
Supply Chain Management shown in the table below:
Month Actual Demand Old Forecast Month Actual Demand Old Forecast
(Dt-1) (Ft-1) (Dt-1) (Ft-1)
1 110 105 6 126 109
2 111 106 7 135 111
3 115 107 8 133 113
4 115 107 9 142 115
5 119 108 10 ?
Using the simple exponential smoothing method, ABC Ltd. wants to forecast the
demand for the 10th month. Also, the firm wishes to include a trend adjustment factor,
β = 0.8.
If the firm assumes an initial trend adjustment of zero (Tt = 0) in the 8th month, what
will be the value for the forecasted demand for the 10th month.
Answer
The problem has a smoothing constant (α = 0.10).
The smoothing constant for the trend (β = 0.8).
Let us find the exponentially smoothed demand:
Here: Ft = α Dt-1 + (1 - α) Ft-1 will give the smoothened demand in the current period
Where Ft-1 is forecasted demand in the last period
Dt-1 is the actual demand in the last period
α = Smoothing Constant
β = Trend Smoothing Constant
Ft = α Dt-1 + (1 - α) Ft-1 = α Dt-1 + Ft-1 - α Ft-1
= Ft-1 + α (Dt-1 - Ft-1)
=115 + 0.1(142-115) = 115 + 2.7
=117.7
We now need to correct the forecast with the trend adjustment.
Tt = Correction Factor for time period t
Tt-1= Correction Factor for time period t - 1
Tt = β (Ft-1 - Ft-2) + (1 – β) Tt-1
T9 = 0.8(115 -113) + (1- 0.8) * 0 = 1.6. [Tt-1 = 0, is given]
Therefore, the forecasted demand for the 10th month including trend (FIT10) is:
FITt = Ft + [(1 – β) / β] x Tt
FIT10 = 117.7 + {(1 - 0.8) / 0.8} * 1.6
= 118.1
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Check Your Progress 2 109
Demand Planning
and Forecasting
State whether the following statements are True or False:
1. Regression analysis can be used to forecast both time series and cross-
sectional data.
2. De-seasoning and smoothing operations on data creates disruptive
elements that can compromise the accuracy of forecasts.
3. Sometimes there are periodic variations which are recurrent over a short
time frame. Seasonal Adjustment is the process used to remove these
variations.
4. The exponential forecast just, like the moving averages, has the adverse
characteristic of lagging the trend.
5. In cyclical analysis, the trend itself is removed for the cycles.
5.7 LET US SUM UP

A forecast is an estimate of a future event achieved by systematically combining and
casting forward in a predetermined way data about the past. A number of options are
available to manage supply and demand. In the manufacturing industry, once the
demand has been determined, there are basically three strategies in aggregate planning
to managing supply: (a) Chase Strategy: It is a strategy aimed at adjusting capacity in
anticipation of demand. You are "chasing demand" by regulating capacity to the
demand doing it as dynamically and quickly as you can. Here an organization
regulates capacity to the demand doing it as dynamically and quickly as it can; (b)
Level Strategy: In a level strategy, an organization maintains a constant capacity over
a period of time, irrespective of fluctuations in demand; and (c) Mixed Strategy:
Individual firms devise infinite combinations of these three pure strategies to suit their
own circumstances.
There are two types of demand. The first is when demand is generated from many
customers, each of whom purchasing only a small fraction of the total volume. This
type of demand is said to be independent. The second type of demand comes into play
when the demand is derived from a production schedule. This type of demand is said
to be dependent. Independent demand uses statistical forecasting techniques. These
models are based on independence and randomness of demand. In contrast, the
demand is known in the case of dependent demand.
The model establishes a link between planning, controlling systems and the forecasts
necessary for planning, scheduling, and controlling the system for an efficient output.
In building a model, it is essential that the model provides satisfaction on these two
critical questions: (a) is the model adequate? And (b) is the model stable?
The simplest form of time series is the ‘moving average method’. In this type of
model, the raw data is converted into a moving average that reflects the trend in
change of demand. The moving average is an arithmetic average of data over a period
of time. By averaging historical data, the attempt is to remove the random
fluctuations.
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110 Regression Analysis is a method of predicting the value of one variable based on the
Logistics and
Supply Chain Management value of other variables. It reflects the casual relationship underlying the demand
being forecast and an independent variable. Regression analysis is of two types, (a)
Simple Linear Regression, and (b) Multiple Regressions. In a simple regression the
regression uses only one predictor, while there are two or more predictors in multiple
regression analysis. The independent and dependent variable have a relationship,
y=f(x) or y=f(x1, x2, .. xn ) depending upon whether it is simple or multiple regression.
Historical data may represent more than one component of demand. De-seasoning and
smoothing operations on data eliminates disruptive elements that can compromise the
accuracy of forecasts.
Even when the demand is not independent, forecasting is often required. A different
set of techniques are used here. In the case of the service industry this is very often the
case. The ability to service depends on the capacity to serve, and the capacity is
perishable. One of the more popular methods is Systems Capacity Determination.

How will you determine which new products or services to introduce or discontinue;
which markets to enter or exit; and which products to promote?
5.9 KEYWORDS
Collaborative Planning Forecasting and Replenishment (CPFR): CPFR is a
business model that takes a holistic approach to supply chain management and
information exchange among trading partners.
Error: in a forecast is the difference between the forecast value and the actual value.
Forecast Control: is used to determine if the accuracy of the forecast is within
acceptable limits.
Correlation Analysis: measures the degree of relationship between two variables.

1. Why do organizations use collaborative forecasting? What are the steps required
to make collaborative forecasting successful?
2. Distinguish between moving average, exponential smoothing, and trend projection
methods of forecasting.
3. Use exponential smoothing technique to compute forecasts for the following
series data under two situations, when smoothing constant is 0.3, and when
smoothing constant is 0.7. Which forecast will you accept and why?
Period: 1 2 3 4 5 6 7 8 9 10
Observation: 27 30 32 31 28 27 30 33 33 31
4. Work out a 3 period moving average and weighted moving average with weights
reducing with time for the observations. Calculate the errors in all the cases and
determine the best method that fits this data.
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113
LESSON Warehousing and
Stores Management
6
WAREHOUSING AND STORES MANAGEMENT
CONTENTS
6.1 Introduction
6.2 Store/Warehouse Functionality
6.3 Warehousing Planning and Cost Reduction
6.3.1 Cost Benefits Through Operational Techniques
6.4 Warehousing Options
6.5 Warehousing and Stores Operations
6.6 Let us Sum up
6.7 Lesson End Activities
6.8 Keywords

z Discuss the Store/Warehouse functionality
z Explain the warehousing planning and cost reduction
z Describe warehousing options
z Provide insight into warehousing and stores operations
6.1 INTRODUCTION
A store or warehouse is typically viewed as a place to store inventory. However, in
modern logistical system designs, the role of the warehouse is more properly viewed
as a switching facility as contrasted to a storage facility. Warehousing, in fact, are the
nodes of the supply chain network that extend the operational reach of the firm and
provide a strategic thrust to its objectives.
There have been stupendous developments in stores and warehousing technology. We
have already discussed developments in IT on warehousing like Warehouse
Management Systems (WMS). In this lesson we look at warehousing from a number
of different perspectives. It focuses on storage functionality. It describes storage or
warehouse principles in terms of both economic and service benefits. It addresses the
operational aspects of warehousing, its infrastructure and risk mitigation. The lesson
finally describes the concepts used in the design of a modern warehouse.
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114
Logistics and 6.2 STORE/WAREHOUSE FUNCTIONALITY
A store or warehouse (these two words are used interchangeably in this lesson) is a
static unit in the material and product pipeline, necessary to match products in a
timing sense with consumers, for storage of products. Many consider warehouses ‘a
necessary evil’ that add costs to the distribution process. However, in the broader
logistical spectrum, warehousing plays a vital role to group products into assortments
desired by customers.
A warehouse is a godown or storage space where a firm stores or holds raw materials,
semi-finished goods or the finished goods, for different periods in time. It helps to
create time utility for raw materials, industrial goods and finished products. The basic
nature of raw materials, parts, and finished goods flowing through and between a vast
network of facilities makes warehousing a labour-intensive process. Productivity has
been an issue in warehousing.
The typical warehouse receives merchandise by railroad car or truck. The items are
moved to a storage area within the warehouse and piled in stacks. When customer
orders are received, products are handpicked for placement on wagons and transported
to the shipping area where the merchandise is assembled and loaded onto delivery
trucks. The description of the operations of a traditional warehouse also explains the
reasons for low labour productivity. It is low because few, if any, skills are required to
perform many of the manual tasks.
However, this limitation has been largely overcome through new operational concepts
and technology. Technology has had a great impact on the quality of service, costs and
operations of warehousing and improved the flexibility of warehousing. Warehousing
has developed into a strategic tool with state-of-the-art systems capable of providing
necessary manufacturing and retail support.
Technology-based improvements, especially information technology, make it possible
to respond to growing customer demands in terms of product and shipment profiles.
With advanced information technology, warehouse operators can quickly react to
changes in market conditions. Information technology also provides the wherewithal
to measure performance under a wide range of operational conditions.
Efficient warehousing permits reduction in material and parts storage and handling
costs while optimizing production, for manufacturers producing products at multiple
locations. Some of the concepts used for strategic warehousing include the following:
Hub and Wheel Concept: A central warehouse is used to maintain a basic stock of
parts, thereby reducing the need to maintain inventory at each assembly plant. Using
consolidated shipments, products are purchased and transported to the supply
warehouse and then distributed to manufacturing plants as needed. When fully
integrated, the warehouse is a vital extension of manufacturing.
JIT Support: Warehousing has become an integral part of JIT and stockless
production strategies. The JIT concept reduces work-in-process inventory, but its
success is based on the support of a highly dependable delivery system. Such
logistical support is possible only through the use of strategically located warehouses.
Market-oriented Warehousing: On the outbound side of manufacturing, warehouses
also create the possibility of direct customer shipment of mixed products. The
capability to provide factory direct mixed product shipments enhanced service
capability of the marketing organization. As the level of competition in the
marketplace increases, manufacturers capable of rapidly providing direct mixed
shipments gain a competitive advantage.
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Similarly, as the cost to retail stores to transporting small shipments makes direct 115
Warehousing and
ordering prohibitive, manufacturers and wholesalers have a need to utilize warehouses Stores Management
to provide timely and economical inventory assortments to retailers. At the wholesale
level of the channel of distribution, the warehouse is a support unit for retailing.
Market-oriented warehousing allows a firm to provide the customer with shorter lead
times. This warehousing function continues to be progressively more important, as
companies and industries utilize customer services as dynamic, value-adding,
competitive tools.
Direct Mixed Shipments: For the customer, direct mixed shipments have two specific
advantages. First, logistical cost is reduced because full product assortment can be
delivered while also taking advantage of the benefits of consolidated transportation.
Second, inventory of slow-moving products can be reduced because they can be
received in small quantities as part of consolidated shipments.
Improvement in Time and Place Capability: From a conceptual perspective, no
warehouse should be included in a logistical system unless it is fully justified on a
cost-benefit basis. The supporting rationale of warehousing is an improvement in the
time and place capability of the overall logistical system both in terms of economic
benefits and service. For example, placing a warehouse in a logistical system to
service a specific market segment may increase cost. These costs must be exceeded by
the benefits of increases in market share, revenue, and gross margin to make the
decision acceptable.
6.3 WAREHOUSING PLANNING AND COST REDUCTION

Strategic Warehousing Logistics planning has become a means to competitive
advantage. It permits the organization to align the operations with overall business
objectives. Such a network has various objectives such as, speeding the supply of the
products and thereby, speeding the cash flow.
Warehousing enhances the time and place capability of the overall logistical system.
Nonetheless, it has to be fully justified on a cost-benefit basis. This justification can be
quantified by the return on investment reflected in the direct cost-to-cost trade-off. For
example, if adding a warehouse to a logistical system reduces overall transportation
cost by an amount exceeding the fixed and variable cost of the warehouse, the
warehouse is economically justified. This means that total costs have been reduced.
However, the cost-benefit basis of service is often difficult to quantify. At a
conceptual level, a service-justified warehouse would be justified if the net effect
would contribute to an increase in profitability. But, at an operational level, the
problem is how to measure the direct revenue impact.
From the service point of view, logistics planning in warehousing helps to ensure a
high level of growth in the revenue for all the companies involved in the chain. It
enhances customer loyalty through commitment and competence. It provides options
to keep costs as low as possible, while maintaining excellent customer service. The
five basic benefits achieved through warehousing from a service point of view:
z Spot stock,
z Distribution Assortment,
z Mixing,
z Production support, and
z Market presence.
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116 Spot Stock: Utilizing warehouse facilities for stock spotting takes place when a
Logistics and
Supply Chain Management selected amount of a firm's product line is placed or "spot stocked" in a warehouse to
fill customer orders during a critical marketing period in a variety of markets, allows
manufacturers with limited or highly seasonal product lines substantially reduce
delivery times to strategic markets. For example, stock spotting is commonly used in
physical distribution for agricultural products to farmers during the growing season.
At the end of the season, the remaining inventory is withdrawn to a central warehouse.
Distribution Assortment: A distribution warehouse is used to stock product
combinations in anticipation of customer orders. It may represent multiple products
from the manufacturer or special assortments of products as specified by customers.
For example, a manufacturer supplying JIT components would stock products so that
it could be offered to the customer as and when required. Distribution warehouses
improve service by have inventory at hand to supply the principal and also allow
larger shipment quantities, which in turn reduce transportation cost.
Customer A Manufacturer A
Distribution
Customer B Center Manufacturer B
Customer C Manufacturer C
Figure 6.1: Distribution Assortment Warehouse

Mixing: Warehouse mixing is similar to the consolidation process. In mixing, full
truckloads of products are shipped from manufacturing plants to warehouses. Upon
arrival at the mixing warehouse, the shipments are unloaded and the desired
combination of each product for each customer or market is selected. In-transit mixing
brings economies when plants are geographically separated, reducing overall
transportation charges and warehouse requirements. From the service point of view,
warehouses that provide in-transit mixing have the net effect of reducing overall
product storage and customer service is improved as the inventory is sorted to precise
customer specifications.
Production Support: Production support warehousing meets actual requirements of
raw material, part, sub-assemblies and assemblies required for production in an
efficient manner. It provides for safety stocks on items purchased from outside
vendors protecting against long lead times or significant variations in usage. The
different types of warehousing could be Raw Materials Stores, Processed or Semi-
Finishing Materials Store, Finished Goods Store, Yard Store and so on. The
economics is reflected in the ability of providing the most economical total-cost
solution by supplying or ‘feeding’ processed materials, components, and
subassemblies into the assembly plant in an efficient and timely manner.
Market Presence: The major advantage of local warehouses is that local warehouses
can be more responsive to customer needs and offer quicker delivery than more distant
warehouse. As a result, a local warehouse increases the speed of delivery. In many
cases, especially for FMCG products, this can result in increased market share and
potentially increases profitability.
6.3.1 Cost Benefits Through Operational Techniques

Some of the commonly used operational logistic techniques for cost reductions are,
(a) consolidation, (b) break bulk, (c) processing/postponement, (d) stockpiling, and
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(e) cross docking. These basic techniques are described below. Cross docking has had 117
Warehousing and
a great impact on logistics costs and therefore will be described in greater detail. Stores Management
z Consolidation,
z Break bulk,
z Processing/postponement,
z Stockpiling, and
z Cross docking.
Consolidation
Consolidation warehousing is a concept for supply chain simplification and cost
reduction. In this concept, manufacturers move away from multiple warehouses for
downstream storage and combine their inventories with that of other manufacturers in
huge warehouses that take the place of internal distribution centres or third party
logistics providers.
It is called consolidation warehousing, because these warehouses perform functions
otherwise found in manufacturers' distribution centres or at wholesale grocery
warehouses. Shipment consolidation is when a warehouse receives and consolidates
materials from a number of manufacturing plants destined to a specific customer on a
single transportation shipment. The consolidation warehouse is a third party storage
and consolidation point for the manufacturers and a storage and order selection facility
for wholesale grocers and retail supermarket chains.
The concept calls for multiple manufacturers to combine their output into just a few
consolidation warehouses instead of placing product in distribution centres or
individual private warehouses. In turn, the consolidation warehouses serve multiple
wholesale grocers and supermarket chains much like private warehouses now provide
load consolidation.
Plant A
Consolidation
Plant B Warehouse A B C
Plant C
Figure 6.2: A Consolidation Warehouse

The difference is the scale of the operation. With the consolidation warehouse serving
multiple wholesalers and chains, manufacturers could ship full truckloads, often
truckloads of a single product to the warehouse. On the other side of the equation, the
consolidation warehouse, pulling product from a wide array of manufacturers, could
build full truckloads for shipment to wholesaler and chain distribution centres.
The primary benefit of consolidation is that it combines the logistical flow of several
small shipments to a specific market area. They realize the lowest possible
transportation rate. In order to provide effective consolidation, each manufacturing
plant must use the warehouse as a forward stock location or as a sorting and assembly
facility. Through the use of such a program the manufacturer can optimize total
distribution cost.
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118 Break Bulk
Logistics and
Supply Chain Management In break bulk warehouse operations no storage is involved. A break-bulk facility is for
the consolidation of long-distance transportation movement for less-than-truckload
freight to lower transport costs. It is meant for cargoes that are not in bulk. A break
bulk operation receives combined customer orders from manufacturers, sorts or splits
individual orders and delivers them to individual customers. Break bulk as used in this
text should not be confused with the maritime term. In shipping terminology, break
bulk cargo is typically loose material stacked on wooden pallets in contrast to material
that is containerized.
Customer A
Break Bulk
Manufacturer Warehouse Customer B
Customer C
Figure 6.3: Break Bulk Operation

The philosophy behind the "break bulk approach" is that by consolidating a large
amount of freight from different locations, a larger and more diverse pool of freight is
available to choose from so as to achieve better freight mix for the long haul. For
example, the freight coming from one customer or terminal location may be relatively
light and bulky, whereas the freight from another customer or terminal location may
tend to be much denser. Some freight may be irregular in shape. By consolidating the
freight originating from the different customers or terminals in one location, there is a
wider range of freight to choose from, so as to efficiently use each truck for the longer
journey.
Normally many 3PL operators create a terminal-break bulk network. In this system, a
typical shipment would first be picked-up from a customer location and dropped off at
the local terminal. It would then be moved a relatively short distance to the terminal's
associated break bulk facility. From there, the shipment would be trucked a relatively
long distance to the break bulk facility associated with the destination terminal. From
this break bulk facility it would finally trucked to the destination terminal, to be
delivered to the customer. The continual goal in this network is, however, to minimize
transfers of freight. Ideally, only one break bulk should be involved in the process.
Processing/Postponement
Stores can also be used to postpone, or delay production. For example, a warehouse
with packaging or labelling capability allows postponement of final production until
actual demand is known. Once a specific customer order is received, the warehouse
can complete final processing and finalizing the packaging.
Processing and postponement provide two economic benefits. First, risk is minimized
because final packaging is not completed until an order has been received. Second, the
required level of total inventory can be reduced by using the basic product for a
variety of labelling and packaging configurations.
Stockpiling
In the case of seasonal products, like agricultural commodities which are harvested at
specific times but consumed throughout the year, or products like sarees which are
manufactured throughout the year but sold mainly during festival seasons, such
products require warehouse stockpiling. Stockpiling provides an inventory buffer,
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which allows production efficiencies within the constraints imposed by material 119
Warehousing and
sources and consumer behaviour while at the same time supporting marketing Stores Management
requirements.
Cross Docking
A cross-docking is a practice in logistics of unloading materials from an incoming
truck or rail car and loading these materials in outbound trucks or railway wagons,
with little or no storage in between. The idea is to transfer incoming shipments
directly to outgoing trailers without storing them in between. Shipments typically
spend less than 24 hours at the facility, sometimes less than an hour.
Cross-docking may be done to change type of conveyance, or to sort material intended
for different destinations, or to combine material from different origins. Simply, stated
cross-docking, means receiving goods at one door and shipping out through the other
door almost immediately without putting them in storage.
Typical applications of cross docking are as follows:
z "Hub and spoke" arrangements, where materials are brought in to one central
location and then sorted for delivery to a variety of destinations.
z Consolidation arrangements, where a variety of smaller shipments are combined
into one larger shipment for economy of transport.
z Deconsolidation arrangements, where large shipments (e.g. railcar lots) are broken
down into smaller lots for ease of delivery.
Cross-docking may also involve offloading pre-assembled products for integration
with other core orders before onward delivery to retail outlets. The process takes place
without stock going into storage. Product categories considered suitable for cross-
docking include slower-moving lines, fast-moving bulk products, chilled and frozen
food, and product lines where sales are skewed geographically.
In a sense cross docking shifts the focus from "supply chain" to "demand chain". For
example, stock coming into a cross docking centre has already been pre-allocated
against a replenishment order generated by a retailer in the supply chain. It works like
this: goods arriving from the vendor already have a customer assigned, so workers
move the shipment from the inbound truck to an outbound truck bound for the
appropriate destination. Truckloads of product arrive from multiple manufacturers.
The products are received, sorted by customer, moved "across the dock" to be loaded
into the truck destined for the appropriate customer.
Figure 6.4: Cross-docking Warehouse Operations

The operations of cross docking are in contrast to a traditional warehouse, where
goods are received from vendors and stored in devices like pallet racks or shelving.
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120 When a customer (e.g., the consumer or perhaps a retail outlet) requests an item,
Logistics and
Supply Chain Management workers pick it from the shelves and send it to the destination. Figure 6.4 is a
simplistic illustration of how cross docking works.
Cross docking can take many other forms like manufacturing cross docking,
distributor cross docking, transportation cross docking, retail cross docking (Wal-Mart
uses this type) and opportunistic cross docking. Based on different classification exact
execution of cross docking may vary.
Manufacturing Cross Docking: Receiving and consolidating inbound supplies to
support Just-In-Time manufacturing. For example, a manufacturer might lease a
warehouse close to its plant, and use it to prep subassemblies or consolidate kits of
parts. Because demand for the parts is known, say from the output of an MRP system,
there is no need to maintain stock.
Distributor Cross Docking: Consolidating inbound products from different vendors
into a multi-SKU pallet, which is delivered as soon as the last product is received. For
example, computer distributors often source components from different manufacturers
and consolidate them into one shipment in merge-in-transit centres, before delivering
them to the customer.
Transportation Cross Docking: Consolidating shipments from different shippers in
the LTL and small package industries to gain economies of scale. For small package
carriers, material movement in the cross dock is by a network of conveyors and
sorters; for LTL carriers it is mostly by manual handling and forklifts.
Retail Cross Docking: Receiving product from multiple vendors and sorting onto
outbound trucks for different stores. Cross docking has been cited as a major reason
Wal-Mart surpassed Kmart in retail sales in the 1980's. Figure 6.5 illustrates a retail
cross dock in a post-distribution operation.
Figure 6.5: A Typical Two-stage Cross Dock

Opportunistic Cross Docking: In any warehouse, transferring an item directly from
the receiving dock to the shipping dock to meet a known demand.
The common elements to all of these operations are consolidation and extremely short
cycle times, usually less than a day. The short cycle time is possible because the
destination for an item is known before or determined upon receipt.
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Another way to classify cross docking operations is according to when the customer is 121
Warehousing and
assigned to an individual pallet or product. There are two major systems: Stores Management
1. Pre-distribution, and
2. Post-distribution.
Pre-distribution Cross Docking: This is when the customer is assigned before the
shipment leaves the vendor, so it arrives to the cross dock bagged and tagged for
transfer. Pre-distribution is difficult to implement because the vendors of the cross
dock must know which customers of the cross dock need what before they send the
shipment. This involves extensive information transfer, system integration, and
coordination.
Post-distribution Cross Docking: This is when the cross dock itself allocates material
to its stores. For example, a cross dock at a Big Bazaar might receive 10 pallets of
Surf detergent without labels for individual stores. Workers at the cross dock allocate
2 pallets to the Gurgoan store, 5 pallets to Connaught Place Store, and so on.
What is the economics of cross docking? Warehousing has four major functions:
receiving, storage, order picking, and shipping. Storage and order picking are typically
the most costly. Storage is a high cost item because of inventory holding costs; and
order picking because it is labour intensive.
Issues in Cross Docking: Cross docking is a logistics technique that eliminates the
storage and order picking functions of a warehouse while still allowing it to serve its
receiving and shipping functions. There is also reduced handling cost at the cross-dock
facility since products are not stored. Cross docking, when properly executed, enables
firms to eliminate inventory costs and reduce transportation costs, often at the same
time.
The most common cross docking system is a two-stage system. It has the advantage of
allowing workers in shipping to pick from among several pallets in a shipping queue
(which results in more tightly packed loads), while still allowing value-added
processing by workers in receiving.
Design of the cross dock becomes important from the point of view of efficiency. In
order to improve efficiency, docks in the shape of an L, T, and H, in addition to the
traditional rectangular design, have been experimented with. Cross docks for many
firms can be very large, so to reduce the interior distances that workers have to travel,
some have experimented with different dock shapes.
Therefore an important design question involves the size of the cross dock, or the
number of doors and the width of the dock. For example, in a two-stage system the
disadvantage is the cross dock must be wide enough to accommodate two queues.
Different theoretical concepts have been developed to determine congestion and
throughput levels for different dock configurations.
From a management perspective, cross docking is a complex operation involving
extensive coordination between the distributor and its suppliers and customers. The
distributor must know what is on each inbound truck before it arrives, the carrier must
know the required delivery window, and so on. Increased communications between
channel partners is often a big obstacle.
Cross docking is successful when the product quality is high. The requirement for
high quality is there because in cross docking, products are immediately transferred to
outbound trucks; there is no time to inspect quality on the receiving dock.
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122 Cross docking is attractive for two main reasons:
Logistics and
Supply Chain Management 1. For items with stable, high demand, cross docking is seen as a way to reduce
inventory holding costs. Cross docking provides cost savings as full trucks move
from the manufacturer’s end to the warehouse and from the warehouse to retailers.
The retailer essentially replaces inventory with information and co-ordination.
For less-than-truckload (LTL) and small package carriers, cross docking is a way
to reduce transportation costs. Cross docking is a way to consolidate small
shipments to achieve truckload quantities.
2. Generally speaking, a product is a good candidate for cross docking when its
demand meets two criteria: low variance and high volume. Retail chains make
extensive use of cross-dock operations to replenish fast-moving store inventories.
Fill in the blanks:
1. A ………………………is a godown or storage space where a firm stores
or holds raw materials, semi-finished goods or the finished goods, for
different periods in time.
2. ……………………………warehousing allows a firm to provide the
customer with shorter lead times.
3. Warehouse mixing is similar to the …………………………..process.
4. Consolidation warehousing is a concept for supply chain simplification
and……………………………...
5. A ……………………………………is for the consolidation of long-
distance transportation movement for less than truckload freight to lower
transport costs.
6.4 WAREHOUSING OPTIONS

It is not necessary for the firm to own and operate its warehousing requirements. The
different options include owner operated, private, and public warehousing.
An owner operated warehouse is owned or/and managed by the same enterprise that
owns the merchandise handled and stored at the facility.
A private warehouse facility is warehousing on a contractual basis by Third Party
Logistics Providers (3PL), who provide unique and specially tailored warehousing and
logistics services to clients. .
A public warehouse, in India, is a warehouse operated by the Central Warehousing
Corporation of India or by State Warehousing Corporations.
These definitions are often confusing; especially as terminology of ‘private’ and
‘public’ in many US learned papers are differently used. Therefore, this clarity is
important.
These different distribution options, described above, are described in greater detail
below in the remaining part of this section.
Owner-operated Warehouses
An owner-operated warehouse is operated by the firm owning the product. The actual
facility, however, may be owned or leased. The decision to own or lease the facility is
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essentially a financial decision. The major benefits of owner operated warehousing are 123
Warehousing and
that there is better control and flexibility. Control, especially, facilitates the ability to Stores Management
integrate warehouse operations with the rest of the firm's internal logistics processes.
Where there is need for flexibility, owner-operated facilities provide the freedom to
adjust operating policies and procedures to meet unique requirements of the firm. In
many cases, owner operated warehouse could be less costly than private warehousing
because the profit markup is eliminated. This benefit may be misleading since private
warehouses often are more efficient as they utilize their resources more effectively.
There could also be a number of other intangible benefits particularly with respect to
market presence. A private warehouse with a firm's name on it may produce customer
perceptions of responsiveness and stability. This perception can provide a marketing
advantage over other enterprises.
It is not uncommon now for private investors and property owners to build distribution
warehouses to a firm's specifications or provide land on a leased basis. This reduces
the capital investment for the firm in such transactions.
Private Warehouses
Private warehouses charge clients a basic fee for handling and storage. The handling
charge is based on the number of cases or weight handled. For storage, the charge is
assessed on the number of cases or weight in storage during the month. When
economies of scale are not possible in a private facility, public warehousing is a low-
cost alternative.
A classification of private warehouses, on the basis of the range of specialized
operations performed, is as follows:
1. General merchandise,
2. Refrigerated,
3. Special commodity, and
4. Bonded warehouse.
Each warehouse type differs in its material handling and storage technology as a result
of the product and environmental characteristics.
General Merchandise Warehouses: This is a warehouse that is used to store goods
that are readily handled, are packaged, and do not require a controlled environment,
such as paper, small appliances, and household supplies.
Traditional general warehousing companies receive and ship goods on behalf of their
customers, serving as middlemen in the transportation process and a vital part of the
logistics business. The carrier is chosen either by the customer or by the warehouse
operator who then acts as the customer's agent.
The increased reliance on warehouse operators for services other than storage
prompted some warehouses to diversify into different transportation areas, such as
operating private trucking fleets used for distribution. Others became involved in
combining small shipments of freight from various shippers into truckload shipments.
These types of services were more typical of freight forwarders or transport
companies than of general warehouse operators. Such overlap in services resulted in
the emergence of the 3PL industry with many warehouse operators developing from
temporary caretakers of raw materials and finished goods into logistics experts.
Just-in-Time (JIT) inventory management is being used by more companies than ever
before. The successful execution of JIT requires constant monitoring of inventory
levels and flexibility on the part of shippers. JIT generally requires more frequent, but
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124 smaller shipments of goods to and from warehouses. Private and contract warehouses
Logistics and
Supply Chain Management are often better equipped than in-house warehouses to execute time-based inventory
management. A critical advantage of private warehouses is their ability to create
economies of scale in distribution. With this volume, the warehouses often have more
leverage than small manufacturers with suppliers and carriers and better meet JIT
inventory requirements.
General warehouses use EDI and other electronic devices such as bar coding and radio
frequency monitoring to enhance the productivity and efficiency of warehouse
operations and simplified inventory tracking. As customer expectations have become
more stringent and competition in the general warehouse industry has increased, more
warehouses are investing in technology to remain contenders in the market.
Private warehouses owned by 3PL operators are extensively used in logistical
systems. Almost any combination of services is offered by such operators, either for a
short term or over a long duration.
Refrigerated Warehouses (either frozen or chilled): These are specialist warehouses
designed to handle and maintain products that are perishable such as food, medical
items, and chemical products with special temperature requirements. For example,
onions are available year round because they are stored in such warehouses and
released to the market based on demand. Onions must be cured and stored at an
optimum temperature of 0°C with 65-70 percent relative humidity.
Beyond consistently meeting high standards for product quality and safety, these
warehouses must also possess the efficiency and reliability. Energy is a major
contributor to the cost of business, and the prospect of power price hikes can heighten
the pressure on the profit margin. There are also issues of environmental regulation,
equipment flexibility, and logistics management to deal with. Even a minor change in
consumer's eating habits such as the advent of in-store take-out and heat-and-serve
products can create a ripple affecting the refrigerated food supply chain.
Unfortunately, the nature of refrigeration systems makes it difficult to implement
wholesale changes. The standard operating procedures and process hazard analyses
need to be undertaken regularly. Planning on a long term basis and partnerships with
equipment manufacturers is increasing in importance. Many such warehouses work
with professional service providers for solutions with regard to preventive
maintenance, special lubrication systems and filtration, consistent chemical water
treatment, etc.
New technologies in refrigeration design are proving quite successful in eliminating
pathogens from processed foods. Ammonia refrigeration systems are replacing
systems based on Freon, due to environmental concerns. Operators of private
refrigerated warehouses are increasingly using automation technology to provide the
efficient, cost-effective services demanded by today’s food processors.
Commodity Warehouses: These are designed to handle bulk material such as wheat,
rice, sugar, lentils, cotton, edible beans, and milk etc. Non-food commodities include
jute, fertilizers, tires wood pulp, tobacco, etc. Some commodities can also be in liquid
form, this includes most petroleum products as well as many chemicals.
Due to the diverse nature of commodities, many commodity items require special
handling or storage considerations, such as grain storage warehouses may require
elevators, liquid commodities may require tank farms, and a commodity like tobacco
requires a barn.
In India most agricultural commodities are handled by the Central and State
Warehousing Corporations. These are discussed in the section on public warehouses.
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Bonded Warehouses: These warehouses are licensed by the government to store 125
Warehousing and
goods prior to payment of taxes or duties. The facility of warehousing of imported Stores Management
goods in Customs Bonded Warehouses, without payment of Customs duty otherwise
leviable on import, is permitted under the Customs Act, 1962. Basically, goods after
landing are permitted to be removed to a warehouse without payment of duty and duty
is collected at the time of clearance from the warehouse. The law lays down the time
period up to which the goods may remain in a warehouse, without incurring any
interest liability and with interest liability.
The warehouses are to be appointed/licensed at particular places only which have been
so declared by Central Board of Excise and Customs. The Board has delegated its
power for declaring places to be Warehousing Stations to the Chief Commissioners of
Customs. In respect of 100 percent EOUs, the powers to declare places to be
Warehousing Stations have been delegated to the Commissioners of Customs.
Licences are issued by Customs and are classified into two categories viz., storage of
sensitive goods such as liquor, cigarettes, foodstuffs, consumables, etc. and other non-
sensitive goods. All warehoused goods are subject to the control of the Customs
officers. The owner of the warehoused goods may inspect, sort, show for sale, and
take samples etc. from the bonded goods with the permission of the proper officer.
The owner of the bonded goods has also to pay warehouse-keeper rent and warehouse
charges at the rates fixed under law.
In addition to bonded warehouses for imported items, bonded warehouses are also
used for items that are subject to excise. Excise duty is a tax on manufacture or
production of goods. Excise duty on alcohol, alcoholic preparations, and narcotic
substances is collected by the State Government and is called "State Excise" duty. The
Excise duty on rest of goods is called "Central Excise" duty. Manufacturers can have
holding bonded warehouses for storing non-duty paid goods. While different
procedures have been prescribed for levy and collection of Central Excise Duties
keeping in view the needs of different industries sectors, Self Assessment Procedure
covers a major portion of excisable items. However, for state excise, each state has its
own procedures.
Public Warehousing
The Central Warehousing Corporation (CWC) was set up in 1957 under the
Agricultural Produce Development and Warehousing Corporations Act, 1956.
Functions of CWC under the provisions of the Act are:
1. Acquire and build godowns and warehouses at such suitable places in India as it
thinks fit;
2. Run warehouses for the storage of agricultural produce, seeds, manures,
fertilizers, agricultural implements and notified commodities offered by
individuals, cooperative societies and other institutions;
3. Arrange facilities for the transport of agricultural produce, seeds, manures,
fertilizers, agricultural implements and notified commodities to and from
warehouses;
4. Subscribe to the share capital of a State Warehousing Corporation;
5. Act as agent of the government for the purposes of the purchase, sale, storage and
distribution of agricultural produce, seeds, manures, fertilizers, agricultural
implements and notified commodities; and
6. Carry out such other functions as may be prescribed.
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126 The Central Warehousing Corporations Act of 1962 had twin objectives, that is, to
Logistics and
Supply Chain Management provide scientific storage for agricultural produce and also to provide market finances.
CWC plays an important role in the chain of marketing for agricultural produce.
It serves not only as a time and space value but also adds place value to the goods.
There are three agencies in the public sector which are engaged in building large scale
storage/warehousing capacity namely, Food Corporation of India (FCI) Central
warehousing Corporation (CWC) and 17 State Warehousing Corporation (SWCs).
The total capacity of public warehousing as of October, 2006 was 56.50 million
tonnes.
The Central Warehousing Corporation (CWC) was set up in 1957 and is the largest
public warehousing organization. It had a turnover of `6,190 million during the year
2005-06 with a net profit of `1060 million. The CWC has two types of warehouses:
Owned Capacity and Hired Capacity. CWC holds 4,564 warehouses in India with a
capacity of 8.00 million MTs, under the owned capacity category. The hired capacity
is around 2.40 million tonnes.
Apart from storage, CWC also offers services in the area of clearing and forwarding,
handling and transportation, distribution, disinfestation, fumigation and other ancillary
services like safety and security, insurance, standardization and documentation. The
CWC has also introduced a scheme, called the Farmers’ Extension Service at selected
centres to educate farmers about the benefits of a scientific storage.
The CWC is also operating custom bonded warehouses. These bonded warehouses are
constructed at a seaport or airport and accept imported commodities for storage till the
payment of customs duties by the importer of the commodities. Though the primary
focus of CWC is on trade and commerce in and supply and distribution of food grains,
the most lucrative and profitable segment of CWC is custom-bonded warehouses.
The Food Corporation of India (FCI) is a public sector undertaking which is also
in warehousing. It has warehousing capacity of 24.40 million tonnes of which
7.90 million tonnes is hired from the CWC and SWCs. A large part of the remaining
capacity comes from private operators and rural and mandi godowns.
In addition, seventeen states also have State Warehousing Corporations (SWCs) that
supplement the capacity of CWC. If any state provides 50 percent of the initial capital
for state warehouses, CWC is obligated to invest the remaining 50 percent of the
equity capital of the SWCs, though CWC may have no representation on the Boards.
State Warehousing Corporations have a warehousing capacity of 19.40 million tonnes.
These state warehouses are primarily for the storage of agricultural produce, seeds,
manures, fertilizers, etc.
The Warehousing Corporations (Amendment) Bill, 2001 is being introduced that
facilitates the Central Warehousing Corporation to diversify and widen its activities
further to strengthen the service sector. This also allows it to place its members on the
boards of the SWCs.
6.5 WAREHOUSING AND STORES OPERATIONS

Stores range from ordinary ones with shelves and bins to cold or dehumidified
storages, huge silos for storage of food grains or bonded stores for keeping goods on
which customs and excise duties have not been paid. The number of different storage
devices is almost as large as the number of different materials. A schematic diagram
of production support store’s activities is given in Figure 6.6.
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127
Warehousing and
Stores Management
Figure 6.6: General Schematic of Stores Activities

Stores functions focus on the physical movement and storage of goods and materials.
This involves managing the physical flow of materials into and out of the organization
and developing and managing networks of warehouses when needed.
The stores department should be under the control of a store’s manager. He is
responsible for receipt, storage and issue of materials. The functions shown in
Figure 6.6 can be divided into a number of duties and responsibilities. These are as
follows:
(a) To receive materials, arrange for inspection and accept them after proper
verification of documents.
(b) To prepare stores received note promptly and circulate the copies to other
departments.
(c) To store the accepted materials of right quantities against authorized stores
requisitions.
(d) To issue correct materials of right quantities against authorized stores requisitions.
(e) To enter receipt, issues and return of materials in the bin cards, and to maintain
other stores records.
(f) To issue purchase requisition when reordering level is reached.
(g) To check bin card balances with the physical quantities in the bins periodically.
(h) To follow rotation of stocks to avoid holding old stocks.
(i) To report on waste, scrap, slow-moving, non-moving and obsolete items.
(j) To maintain stores in a tidy manner for easy access to bin at any time.
(k) To receive and issue finished products for despatch to the distribution chain.
The procedures for receipt start even before the time the material reaches the plant:
when a purchase order is placed, a copy is sent to the stores. Once a Purchase Order
has been issued the information sits in the system until the goods/service is received.
Inbound deliveries which include stock transport orders, production orders, and
Advanced Shipping Notification (vendor document) contain the exact materials,
quantities, and the delivery date with reference to a purchase order. This becomes the
basis for the receipt process.
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128 Check Your Progress 2
Logistics and
Supply Chain Management Fill in the blanks:
1. An ……………………………………..warehouse is operated by the firm
owning the product.
2. ……………………….warehouses are licensed by the government to
store goods prior to payment of taxes or duties.
3. Excise duty on alcohol, alcoholic preparations, and narcotic substances is
collected by the State Government and is called …………………………
duty.
4. …………………………functions focus on the physical movement and
storage of goods and materials.
6.6 LET US SUM UP

A store or warehouse (these two words are used interchangeably in this lesson) is a
static unit in the material and product pipeline, necessary to match products in a
timing sense with consumers, for storage of products. Strategic Warehousing Logistics
planning has become a means to competitive advantage. It permits the organization to
align the operations with overall business objectives. Such a network has various
objectives such as, speeding the supply of the products and thereby, speeding the cash
flow.
Stores can also be used to postpone, or delay production. For example, a warehouse
with packaging or labelling capability allows postponement of final production until
actual demand is known. Cross-docking may also involve offloading pre-assembled
products for integration with other core orders before onward delivery to retail outlets.
The process takes place without stock going into storage. It is not necessary for the
firm to own and operate its warehousing requirements. The different options include
owner operated, private, and public warehousing. These definitions are often
confusing; especially as terminology of ‘private’ and ‘public’ in many US learned
papers are differently used. Therefore, this clarity is important. Stores range from
ordinary ones with shelves and bins to cold or dehumidified storages, huge silos for
storage of food grains or bonded stores for keeping goods on which customs and
excise duties have not been paid.
6.7 LESSON END ACTIVITIES

1. Why is stock verification important? How do excesses and shortages occur?
Discuss how you would treat them and why.
2. Which are the different documents required to issue material? Explain the
different documents and their roles.
6.8 KEYWORDS
Store: A store is a static unit in the material and product pipeline, necessary to match
products in a timing sense with consumers, for storage of products.
Warehouse: A warehouse is a godown or storage space where a firm stores or holds
raw materials, semi-finished goods or the finished goods, for different periods in time.
Retail Cross Docking: This includes receiving product from multiple vendors and
sorting onto outbound trucks for different stores.
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131
LESSON Transportation Management
7
TRANSPORTATION MANAGEMENT
CONTENTS
7.1 Introduction
7.2 Transportation Functionality and Principles
7.2.1 Product Movement
7.2.2 Objectives of Modern Transportation Systems
7.3 Transportation Economics Concepts
7.3.1 Transport Economics
7.3.2 Total Transportation Costs
7.4 Transportation Networks
7.4.1 The Inbound Transportation Network
7.4.2 The Inter-facility Transportation Network
7.4.3 The Outbound Transportation Network
7.5 Routing
7.5.1 Routing and Scheduling
7.6 Let us sum up
7.8 Keywords

z Understand the concept of transportation
z Learn the transportation economics
z Discuss the total cost involved in transportation
z Explain the routing and scheduling
7.1 INTRODUCTION
Physical distribution managers must decide on which mode of transport is best to
distribute their products to their customers. By mode of transport we mean the
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132 technology which is used to move goods. The modes of transport available to the
Logistics and
Supply Chain Management physical distribution manager are:
z road
z rail
z water
z air
z pipeline
Each of these modes has different characteristics which affect its suitability for the
transportation of particular products. For example, air transport is very expensive and
limited in the space available. It is therefore typically used for low-volume, high-value
goods which require rapid delivery. Conversely, bulk raw materials such as coal or
iron ore lend themselves to carriage by slower, cheaper forms of transport such as
water or rail.
Not all modes of transport will be suitable for all types of products. The physical
characteristics of the product could limit the choice available to distribution managers.
7.2 TRANSPORTATION FUNCTIONALITY AND

PRINCIPLES
Transportation is the operational area of the supply chain that geographically positions
inventory. Facility selection establishes a network structure that creates the framework
of transportation requirements and simultaneously limits alternatives.
Transportation requirements can be accomplished in three basic ways.
z By a private fleet of equipment
z Contracts with transport specialists
z Engage the services of carriers on individual shipment basis
From the supply chain viewpoint, three factors related to performance are fundamental
to the selection of the mode of transportation: cost, speed, and consistency.
Speed of transportation is the time required to complete a specific movement. Speed
and cost of transportation are related in two ways.
1. Transport firms capable of providing faster service, typically charge higher rates;
and
2. The faster the transportation service, the shorter the time interval during which
inventory is in transit and is unavailable.
Thus, a critical aspect of selecting the most desirable method of transportation is to
balance speed and cost of service.
Consistency of transportation refers to variations in time required to perform a
specific movement over a number of shipments. Consistency is a reflection of the
dependability of transportation. If transportation lacks consistency, inventory safety
stocks will be required to protect against unpredictable service breakdowns. The
quality of transportation performance is critical to time-sensitive operations. Speed
and consistency combine to create the quality aspect of transportation. .
In the design of a logistical system, a delicate balance must be maintained between
transportation cost and quality of service. The cost of transport is the payment for
movement between two geographical locations and expenses related to administration
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and maintaining in-transit inventory. Logistical systems should be designed to utilize 133
Transportation Management
transportation that minimises total system cost.
Transportation cost, which is one of the major logistical costs, can be optimized
through movement consolidation. As a general rule, the larger the overall shipment
and the longer the distance it is transported, the lower the transportation cost per unit.
In addition, the cost is also directly related to the product characteristics. Innovative
programmes to consolidate movement by grouping small shipments through overall
supply chain integration can lower transportation costs significantly.
Transportation creates time and place utility in goods. Logistics costs are in the range
of 12 to 15 per cent of the GDP for a developing country while it is around 18 to 20
percent for a developed country.
The term ‘transportation’ is derived from the Latin trans ("across") and portare ("to
carry"). In fact, the backbone of the entire supply chain is the transportation
management that makes it possible to achieve the well known seven ‘R’s— the right
product in the right quantity and the right condition, at the right place, at the right
time, for the right customer at the right cost.
7.2.1 Product Movement

Transportation functionality is product movement. Whether the product is in the form
of materials, components, assemblies, work-in-process, or finished goods,
transportation is necessary to move it up and down the value chain. Since
transportation utilizes temporal, financial, and environmental resources, it is important
that items be moved only when it truly enhances product value.
During the transportation process the product is inaccessible. Transportation,
therefore, uses temporal resources. Such product, commonly referred to as in-transit
inventory, is becoming a significant consideration as a variety of supply chain
strategies such as just-in-time and quick-response practices reduce manufacturing and
distribution centre inventories.
Transportation uses financial resources. Driver cost, vehicle operating cost, and
allocation for general and administrative costs are required if it is a private fleet.
External expenditures are required for commercial or public transportation. In
addition, provision is required for other expenses relating from product loss or
damage.
Transportation uses environmental resources, both directly and indirectly. In direct
terms, it is one of the largest consumers of energy as it burns most of the world's
petroleum. Hydrocarbon fuels produce carbon dioxide, a greenhouse gas widely
thought to be the chief cause of global climate change, and petroleum-powered
engines, especially inefficient ones, create air pollution, including nitrous oxides and
particulates (soot). Although vehicles in developed countries have been getting cleaner
because of environmental regulations, this has been offset by an increase in the
number of vehicles and more use of each vehicle.
Other environmental impacts of transport systems include traffic congestion, toxic
runoff from roads and parking lots that can pollute water supplies and aquatic
ecosystems, and automobile-oriented urban sprawl, which can consume natural habitat
and agricultural lands and noise pollution. These are environmental expenses
attributable to transportation.
7.2.2 Objectives of Modern Transportation Systems

The major objective of a modern transportation system is to move product from an
origin location to a prescribed destination while minimizing temporal, financial, and
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134 environmental resource costs. At the same time, the system must meet customer
Logistics and
Supply Chain Management demands regarding delivery performance and shipment information availability while
minimizing losses and damage. In meeting the objectives, three fundamental
principles guide transportation management and operations.
Mode of Transport
1. Economy of scale and
2. Economy of distance.
Mode of transport is a general term for the different kinds of transport facilities that
are often used to transport people or cargo. Where more than one mode of transport is
used for a journey, or for transport analysis, the journey can be described as multi-
modal.
Each mode moves cargo in different configurations. The six basic transportation
modes used in India are:
z Roads,
z Railways,
z Water,
z Pipeline,
z Air, and
z Animal and animal drawn vehicles.
Truck
Rail
Water
Freight Rate
B C
Distance
Figure 7.1: Freight Rate vs. Distance of different Modes of Transport

Each mode of transport is unique and has different costs. Figure 7.1 shows the cost of
freight using three different modes of transport; road, rail and water. For example,
road transportation is cheaper than railways for shorter distances shown by ‘B’ in the
figure, however as the distance increases, water transportation becomes cheaper than
rail, shown by ‘C’ in the figure 7.1.
The relative importance of each mode can be measured in terms of system mileage,
traffic volume, revenue, and the nature of traffic composition.
System mileage is generally given in terms of ton kilometre. The most widely used
modes for freight transport on an international basis are sea (40,000 bn ton km),
followed by road (7,000 bn ton km), railways (6,500 bn ton km), oil pipelines (2,000
bn ton km) and inland navigation.
Economy of scale refers to the characteristic that transportation cost per unit of weight
decreases when the size of the shipment increases. This reflects in two ways,
(a) shipments that utilize the entire vehicle's capacity cost less per kilogram than part
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load shipments, and (b) larger capacity transportation vehicles such as rail or water are 135
less expensive per unit of weight than smaller capacity vehicles. Transportation
economies of scale exist because fixed expenses associated with moving a load can be
spread over the load's weight, thereby decreasing costs per unit of weight. The fixed
expenses that include administrative costs, time to position the vehicle for loading or
unloading, invoicing, and equipment cost do not vary with shipment volume.
Economy of distance refers to the characteristic that transportation cost per kilometre
of distance decreases as distance increases. For example, shipping a product for a
distance 500 kilometers will cost less than making two shipments of the same
combined weight over a distance of 250 kilometres each. This is also called the
tapering principle — since rates or charges taper with distance. The rationale for
distance economies are similar to that for economies of scale, as the fixed expenses
incurred to load and unload the vehicle are spread over more kilometers, resulting in
lower overall per kilometer charges.
These principles are important considerations when evaluating alternative
transportation strategies or operating practices. The objective is to maximize the size
of the load and the distance that it is shipped while still meeting customer expectations
and demands on delivery performance.
7.3 TRANSPORTATION ECONOMICS CONCEPTS

The area of physical distribution concerns movement of a finished product to
customers. In physical distribution, the customer is the final destination of a marketing
channel. It is through the physical distribution process that the time and space of
customer service become an integral part of marketing, linking marketing channels
with its customers.
The typical physical distribution performance cycle involves five activities: order
transmission, order processing, order selection, order transportation and customer
delivery. These activities have been shown in Figure 7.2.
Figure 7.2: Physical Distribution Cycle Activities

This cycle links the seller and the buyer. We will discuss one element in this cycle,
namely transportation. Transportation decisions should be based on sound economics.
In order to understand transportation economics, it is necessary to first understand the
transportation environment, which is unique compared to many commercial
enterprises.
The Players: Transportation transactions are influenced by five parties: the shipper
(originating party), the consignee (destination party or receiver), the carrier, the
government, and the public. The relationship is shown in Figure 7.3. In order to
understand the complexity of the transportation environment, it is necessary to review
the role and perspective of each party.
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136
Logistics and
Goods Flow
Information Flow
Figure 7.3: The Transportation Environment
The shipper and consignee have the common objective of moving goods from origin
to destination within a prescribed time at the lowest cost. Carriers, as the intermediary,
want to charge the highest rate that the shipper (or consignee) will accept and
minimize the labour, fuel, and vehicle costs required to move the goods. To achieve
this objective, the carrier desires flexibility in pickup and delivery times to allow
individual loads to be consolidated into economic moves.
The government is the largest investor in infrastructure and therefore maintains a high
interest in transportation's impact on the economy. The government provides rights-of-
way such as roadways, ports, airports and air traffic control systems. Government’s
involvement takes the form of regulation, promotion, or ownership. As a monopoly
owner who maintains absolute control over markets, services and rates, the
government can regulate carriers by restricting the markets they can service or by
setting the price they can charge. For example, Indian Railways is a government
monopoly.
The final participant, the public, is concerned with transportation accessibility,
expense, and effectiveness, as well as environmental and safety standards. The public
ultimately determines the need for transportation by demanding goods and services
and determining the value of such services. The development of the airfreight industry
shows that consumers may find cost less important than speed and service. Very often,
trade-offs are associated with cost, environmental and safety standards.
The transportation relationship is complex because of the interaction between the
parties. This leads to frequent conflicts between parties with a micro interest: shippers,
consignees, and carriers-as well as parties with a macro interest: government and the
public. These conflicts lead to duplication, regulation, and restrictions of
transportation services which impact the economics of transportation.
7.3.1 Transport Economics

Transport economics and pricing are concerned with the factors and characteristics
that determine transport costs and rates. Transport economics is influenced by seven
factors. These factors are important while developing transportation rates. The specific
factors are discussed below.
Distance: Distance is a major influence on transportation cost since it directly
contributes to variable cost, such as labour, fuel, and maintenance. This is reflected by
the cost-distance curve. The cost curve does not begin at the origin because there are
fixed costs associated with shipment pickup and delivery regardless of distance.
It increases at a decreasing rate as a function of distance. This is shown in Figure 7.4
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137
Figure 7.4: Relationship between Distance and Transportation Cost

Volume: The load volume relationship reflects economies of scale in transportation
activities. This is illustrated in Figure 7.4. The curve indicates that transport cost per
unit of weight decreases as load volume increases. The relationship is limited to the
maximum size of the vehicle. Economic transportation requires the consolidation of
small loads into larger loads to take advantage of scale economies.
Figure 7.5: Relationship between Weight and Transportation Cost

Density: The product weight is a function of the product density and volume. Figure
7.5 reflects weight considerations. If the product is light, it is not possible to increase
the amount carried if the space consideration has been met. Since vehicles are limited
by both space and weight considerations, once the vehicle is full, actual labour and
fuel expenses are not dramatically influenced. Generally, higher density products are
assessed at lower transport costs per unit of weight as the capacity is better utilized.
Storability: Storability refers to vehicle space utilization as is reflected by product
dimensions. Odd sizes and shapes, as well as excessive weight or length, do not stow
well and typically waste space. For example, while steel blocks and rods have the
same density, rods are more difficult to stow because of their length and shape.
Sometimes large numbers of items can be ‘nested’ that might otherwise be difficult to
stow in small quantities, improving storability. Products with good storability attract
lower transportation rates.
Handling: Special handling equipment may be required for loading or unloading
trucks, railway wagons or ships. By grouping together products, e.g. taping, boxing, or
palletizing products, for transport and storage, handling costs can be reduced.
Liability: Liability includes susceptibility to damage, property damage to freight,
perishability, and susceptibility to theft, susceptibility to spontaneous combustion or
explosion, and value per kilogram. Carriers insure their cargoes to protect against
possible claims or accept responsibility for any damage. Shippers can reduce their
risk, and ultimately the transportation cost, by improved protective packaging or by
reducing susceptibility to loss or damage.
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138 Market Factors: Since transportation vehicles and drivers must return to their origin,
Logistics and
Supply Chain Management either they must find a load to bring back ("back-haul") or the vehicle is returned
empty ("deadhead"). When deadhead movements occur, labour, fuel, and maintenance
costs must be charged to the shipper. A “Balanced” move, where volume is equal in
both directions, is rarely possible because of factors such as demand imbalances in
manufacturing and consumption locations, seasonality, etc. For example, the
movement of fruits and vegetables coincide with the growing season. These result in
transport rates changing with direction and season. Logistics system design must take
this factor into account and add back-haul movement where possible.
7.3.2 Total Transportation Costs

In addition to the basic cost charged for movement of goods, the total transportation
cost reflects a large number of other factors, such as transit time costs, obsolescence
and deterioration costs, protective packaging costs, and transit insurance costs, etc.
These components are discussed below.
Transit Time Cost: This element reflects the temporal cost of transportation. From
total logistics costs point of view, cost of inventory in transit is a very significant
factor. The longer the transit time of a particular mode of transport, the inventory is
inaccessible to the user. This adds to the safety stock the company has to carry and the
requirement of working capital. The transportation cost must consider that if inventory
is available after a longer period of time, it will result in higher total costs.
Obsolescence and Deterioration Costs: There are certain categories of products
which are perishable and delicate in nature, whose physical attributes deteriorate over
a period of time, gradually resulting into devaluation of the product. For instance,
vegetables such as tomatoes are transported from Punjab to Delhi; any delay in transit
or poor stowing may force the marketers to sell them at a less-than-desired price. Such
a cost is classified as obsolescence and deterioration costs during transportation.
Protective Packaging Costs: For many products there may be requirements of special
packaging. This cost is also a part of the total transport cost. For instance, if a product
is shipped using a container, it may require less protective packaging for safe
shipment in comparison being shipped in a truck. Another example is given later on
for transportation of glass in the rating system for goods transportation.
Insurance Cost: Goods in transit insurance covers property against loss or damage
while it is in transit from one place to another or being stored during a journey. This
insurance can be for goods being distributed in company’s vehicle or by a third-party
carrier, both domestically and abroad. Policies often specify the means of transport to
be used, which may include the postal service.
Class Rates: In transportation terminology, the price per kilogram to move a specific
product between two locations is referred to as the rate. The rate is also called the
tariff. The classification does not define the price charged for movement of a product.
It refers to a product's transportation characteristics in comparison to other
commodities.
Classification of individual products is based on a relative percentage index of 100.
Class 100 is considered the class for an average product, while other classes run as
high as 500 and as low as 35. Each product is assigned an item number for listing
purposes and then given a classification rating. As a general rule, the higher the class
rating, the higher the transportation cost for the product.
Products are also assigned different ratings on the basis of packaging. Glass may have
a different rating when shipped loose, in crates, or in boxes than when shipped in
wrapped protective packing. Very often, packaging differences influence product
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density, stowability, and liability. The same product may be differently classified 139
depending on where it is being shipped, shipment size, transport mode, and product
packaging.
Other Costs: Common costs, such as terminal or management expenses are often
allocated to a shipper according to a level of activity like the number of shipments
handled. Other costs may also include local taxes, octroi, toll taxes, etc. These are
generally applicable in case of road transportation.
Joint Costs: Joint costs are expenses unavoidably created by the decision to provide a
particular service. For example, when a carrier transports a truckload from point A to
point B, there is an implicit decision to incur a ‘joint’ cost for the back-haul from point
B to point A. Either the cost must be covered by the original shipper from A to B, or a
back-haul shipper must be found. These costs have significant impact on
transportation charges as in the absence of an appropriate backhaul shipper; the
original shipper pays for an empty trip.
Transportation has been recognized for many years as being one of the most important
activities in the physical distribution function. The shipper’s choice of transportation
option in a single market could be viewed as a cost model that provides the total
transportation and inventory cost associated with each transportation option. There
exists a correlation between purchase quantity and transportation mode decision.
Strategic transportation decisions include choice of transportation mode (rail, truck,
air, ship) and choice of type of carriage (common, contract, private). Other decisions
can include the size of shipments (or shipment frequency), and assignment of loads to
vehicles. These decisions are generally taken with the help of models.
Fill in the blanks:
1. ……………………………is a reflection of the dependability of
transportation.
2. Transportation cost, which is one of the major logistical costs, can be
optimized through ………………………………………
3. …………………………………..is a general term for the different kinds
of transport facilities that are often used to transport people or cargo.
4. ………………………………refers to the characteristic that
transportation cost per kilometre of distance decreases as distance
increases.
5. The cost curve does not begin at the origin because there are
……………………..associated with shipment pickup and delivery
regardless of distance.
7.4 TRANSPORTATION NETWORKS

The typical networks are:
z The inbound transportation network
z The Inter-facility transportation network
z The outbound transportation network
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140 7.4.1 The Inbound Transportation Network
Logistics and
Supply Chain Management This network links a firm’s suppliers to its own facility. The network includes
feedstock shipments from sources located in several continents to plants perhaps
located in several continents. Hence, the tactical planning of shipments is complicated
by decisions about ship capacities, shipment sizes, timing of the shipments arrival etc.
While making decisions, the objective is to balance between transportation costs and
inventory costs.
An important aspect of the decision making process would be to locate and size
warehousing and cross-docking facilities for consolidating inbound supplies. For
many supplies, the inbound cost of transportation is included in the delivered cost of
the product and this could hide inefficiencies too.
7.4.2 The Inter-facility Transportation Network

This connects a firm’s facilities with one another. Cross docking of products from
other plants of the company enable it to provide the entire range of its products to the
market.
Inter-facility shipments also help those firms that manufacture products in stages at
geographically distant locations to minimize production and inventory costs. This
concept is quite useful to those companies who have the ‘product differentiation’
issues.
7.4.3 The Outbound Transportation Network

This network connects the company’s facilities to its customers and markets. Efficient
management of this particular aspect is very critical for the success of a Supply Chain.
This is vital since, the objective of a firm is to deliver the right product in the right
quantity at the right time to its customers. The goals are to achieve an appropriate
balance between minimising total cost and maximising customer service. The total
cost includes operating costs such as depot and transportation costs, investment costs
(made in real estate, delivery trucks, inventories) etc.
7.5 ROUTING
The routing decision involves determining which of the demands will be satisfied by
each vehicle and what route each vehicle will follow in servicing its assigned demand
in order to minimize total delivery cost.
Whenever organizations, in the business of providing mobility, are entrusted with
moving goods and people a natural question that arises is how efficiently that
organization can provide the services. This basic requirement of efficient mobility of
goods and passengers gives rise to, among many other things, the subject areas of
optimal routing and scheduling.
The scheduling of customer service and the routing of service vehicles are at the heart
of many service operations. For some services, such as school buses, public health
nursing, and many installation or repair businesses, service delivery is critical to the
performance of the service. For other services, such as mass transit, taxis, trucking
firms, and the U.S. Postal Service, timely delivery is the service. In cases, the routing
and scheduling of service vehicles has a major impact on the quality of the service
provided.
7.5.1 Routing and Scheduling

A proper Routing and Scheduling process certainly helps in a significant contribution
to the bottom-line. Assistance can be sought from agencies like Automobile
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Association of India or their regional offices to fix up the most ideal & economic 141
routes. A reduction in the frequency of pick-ups and deliveries, for example, can result
in a reduced level of transportation necessary to deliver the same quantity of goods.
Thus, the cost of transportation is reduced & productivity is increased.
Benefits to a Carrier and Shipper

For the Carrier, the benefits are:
(a) Greater utilization of vehicles
(b) Higher levels of customer service
(c) Lower transportation costs
(d) Reduced capital investment in equipment
(e) Better management decision-making.
For the Shipper, the benefits include:
(a) Cost, and
(b) Improvements in Service.
Wastages in Transportation
Wastages in transportation can also be reduced by:
(a) Elimination of unnecessary transportation
(b) Change in mode of transport
(c) Better planning whereby the number of handlings is minimised.
Principles of Good Routing and Scheduling

The following are the key principles of good routing and scheduling:
(a) Load trucks with deliveries for customers closest to each other
(b) Stops on individual days arranged together
(c) Start routes with farthest stops first
(d) Circular routes – don’t cross paths
(e) Use largest vehicles first if can be filled
(f) Mix pickups in with deliveries, not at end
(g) If one stop far from other, use other truck
(h) Avoid narrow stop time windows, or handle separately.
Example: Applying principles of vehicle routing and scheduling in case of trucks:
Decision makers such as truck dispatchers can go a long way towards developing
good truck routes and schedules by applying five guideline principles. These are:
z Truck routes should be formed around clusters of stops that are closest to each
other. For example, the truck may choose to distribute to all the Woolworths
outlets situated in Randburg first.
z Stops at different times of the day should be well planned. The right people and
equipment should be available to receive the goods delivered. If staff is on lunch,
this will further delay transport.
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142 z Start routes with the first stop being the one furthest from the depot. Efficient
Logistics and
Supply Chain Management routes can be developed by building stop clusters around the furthest stop from the
depot and then working back toward the depot.
z The major routes should be developed using the largest and most efficient vehicles
available. Ideally, using a vehicle large enough to handle all stops on one route
will minimize the total distance or time travelled to serve the stops. Therefore, the
largest vehicles should be allocated first, so that they will be optimally utilized.
Such principles can be easily taught to operating personnel so that vehicles and routes
can be optimized. These principles provide for good route scheduling, yet operating
personnel should still be given some flexibility to plan as situations arise (rush orders,
road detours). Effective routing and scheduling can result in reduced diesel,
maintenance and tyre savings, and thus increase profits in the long-term.
Other important principles of routing and scheduling:
z Load trucks with stop volumes that are in the closest proximity to each other –
minimizes interstop travel between them.
z Stops on different days should be arranged to produce tight clusters – develop
overall route, plus daily routes.
z Build routes beginning with the farthest stop from the depot.
z Sequence of stops on a truck route should form a teardrop pattern – try to keep
route paths from crossing.
z The most efficient routes are built using the largest vehicles available – allocate
largest vehicles first, then smaller.
z Pickups should be mixed into delivery routes rather than assigned to the end of
routes.
z A stop that is greatly removed from the other stops in a route cluster is a good
candidate for an alternative means of delivery.
z Narrow stop time window restrictions should be avoided see if you can
renegotiate the time window restrictions.
Routing Requirements
z Any kind of communications system requiring either fixed-line facilities (such as
cables) or relay stations is likewise constrained to a limited set of routes. Transfer
is really "as the crow flies" only within the range of direct wave or beam
transmission.
z Scale economies apply not only to route facilities such as trails, track, roads,
pipelines, cable, and navigational aids, but also to "service points" where transfer
by the mode in question can originate and terminate. Thus there are certain
minimum costs of establishing a railroad station or even a siding; the same applies
to piggyback terminals, ports for ships and aircraft, transformer stations on long-
distance electric transmission lines, and telephone exchanges and switchboards.
z There is an economic constraint on the spacing of transit stops along a route, since
more stops slow the service. People making shopping trips generally prefer to do
all their errands with a minimum number of separate stops—except for those who
view shopping as a recreation.
Consequently, the pattern of transfer services offered by any particular mode is always
spotty; linking up a limited number of pairs of points by routes usually longer than the
straight-line distance; and a transfer of a specific shipment, person, or item of
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information from initial origin to final destination frequently entails the use of more 143
than one link or mode.
True or false:
1. The scheduling of customer service and the routing of service vehicles are
at the heart of many service operations.
2. Effective routing and scheduling can result in increased diesel,
maintenance and savings, and thus increase profits in the long-term.
3. The major routes should be developed using the largest and most efficient
vehicles available.
4. There is an economic constraint on the spacing of transit stops along a
route, since more stops slow the service.
7.6 LET US SUM UP

Transportation cost, which is one of the major logistical costs, can be optimized
through movement consolidation. As a general rule, the larger the overall shipment
and the longer the distance it is transported, the lower the transportation cost per unit.
In addition, the cost is also directly related to the product characteristics.
Transportation is the operational area of the supply chain that geographically positions
inventory. Facility selection establishes a network structure that creates the framework
of transportation requirements and simultaneously limits alternatives. Transportation
functionality is product movement. Whether the product is in the form of materials,
components, assemblies, work-in-process, or finished goods, transportation is
necessary to move it up and down the value chain. Transport economics and pricing
are concerned with the factors and characteristics that determine transport costs and
rates. Transport economics is influenced by seven factors. The routing decision
involves determining which of the demands will be satisfied by each vehicle and what
route each vehicle will follow in servicing its assigned demand in order to minimize
total delivery cost.

Take any transport company of your choice and discuss its transportation functionality
within a group or in a class?
7.8 KEYWORDS
Transportation: Transportation is the operational area of the supply chain that
geographically positions inventory.
Consistency of transportation: Consistency of transportation refers to variations in
time required to perform a specific movement over a number of shipments.
Speed: Speed of transportation is the time required to complete a specific movement.
Consistency: Consistency of transportation refers to variations in time required to
perform a specific movement over a number of shipments.
Mode of transport: Mode of transport is a general term for the different kinds of
transport facilities that are often used to transport people or cargo.
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146
Logistics and
LESSON
8
DISTRIBUTION CHANNEL MANAGEMENT
CONTENTS
8.1 Introduction
8.2 Concept of Distribution Channel
8.3 Role of Distribution in the Supply Chain
8.4 Designing Distribution Channels
8.4.1 Different Types of Deliveries
8.5 Factors Influencing Distribution
8.6 Some Commercial Aspects in Distribution Management
8.6.1 Laws relating to Commercial Taxes
8.7 Codification
8.7.1 Characteristics of Codes
8.7.2 Objectives of Codification
8.7.3 Advantages of Codification
8.8 Distribution Resource Planning (DRP)
8.9 Logistic in 21st Century
8.9.1 Vendor Managed Inventory (VMI)
8.9.2 Third Party Logistics
8.9.3 Fourth Party Logistics
8.9.4 Reverse Logistics
8.10 Let us Sum up
8.12 Keywords

z Discuss the concept of distribution channel
z Identify the role of distribution in the supply chain
z Explain the designing distribution channels
z Discuss the factors influencing distribution
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z Describe some commercial aspects in distribution management 147
Distribution Channel Management
z Explain codification
z Provide insight into Distribution Resource Planning (DRP)
z Discuss the logistic in 21st Century
8.1 INTRODUCTION
Distribution refers to the steps taken to move and store a product from the supplier
stage to a customer stage in the supply chain. Distribution is a key driver of the overall
profitability of a firm because it directly impacts both the supply chain cost and the
customer experience. Good distribution can be used to achieve a variety of supply
chain objectives ranging from low cost to high responsiveness. As a result, companies
in the same industry often select very different distribution networks.
Dell distributes its PCs directly to end consumers, while companies like Hewlett
Packard and Compaq distribute through resellers. Dell customers wait several days to
get a PC while customers can walk away with an HP or Compaq PC from a reseller.
Gateway opened Gateway Country stores where customers could check out the
products and have sales people help them configure a PC that suited their needs.
Gateway, however, chose to sell no products at the stores, with all PCs shipped
directly from the factory to the customer.
8.2 CONCEPT OF DISTRIBUTION CHANNEL

A distribution channel consists of a set of people and firms involved in the transfer of
title to a product as the product moves from producer to consumer. Thus, a
distribution channel is primarily concerned with the movement of goods from the
point of production to the point of consumption, which involves a variety of functions.
The main participants in the distribution system are:
1. The manufacturers,
2. The intermediaries,
3. The facilitating agencies, and
4. The consumers.
Manufacturers produce the goods. This is the starting point in the distribution system.
The second category of participants, i.e. intermediaries, are involved in direct
negotiation between buyers and sellers whether or not they take title to goods. These
intermediaries locate the manufacturers who produce various products, identify the
needs of the consumers and distribute the goods. In the process, they perform various
functions like buying, selling, assembling, standardization and grading, packing and
packaging, risk bearing, etc. Facilitating agencies are the independent business
organisations other than intermediaries. These agencies facilitate the smooth
distribution of goods from producers, through intermediaries, to consumers. The major
facilitating agencies are banking institutions, insurance companies, and transportation
agencies and warehousing companies. The fourth category of participants in the
distribution system, i.e. consumers, are the final destination for goods in the
distribution system.
A Channel of distribution is mainly concerned with second participant, i.e. the
intermediaries. The term 'Channel of Distribution' refers to the route taken by goods
as they flow from the producer to the consumer. This flow of goods may mean its
physical distribution and/or the transfer of title (ownership). Channels of distribution
are mainly concerned with the transfer of title to a product which may be affected
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148 directly or through a chain of intermediaries. You know most producers do not sell
Logistics and
Supply Chain Management goods directly to the consumers. They make use of a variety of intermediaries known
as middlemen. These middlemen who take title to goods or assist in transferring the
title to goods as they move from the producer to the consumer is called the channel of
distribution. Thus, the channel of distribution is a network of institutions that perform
a variety of interrelated and coordinated functions in the movement of goods from
producers to consumers.
A distribution channel creates place, time, form and possession utilities to the products
by prompt and efficient performance of the function of physical distribution.
In modem societies the production of goods takes place on a large scale in factories
concentrated in few localities while the consumers are scattered throughout the
country. For instance, textile mills are concentrated at few places like Bombay,
Ahmedabad, Coimbatore, etc. while the cloth is used by all the people in the country.
Similarly, Maruti cars are manufactured at Delhi while the users are spread in all parts
of the country. Same thing is true of agricultural commodities. Apples are produced
mainly in Kashmir Valley and Himachal Pradesh whereas they are consumed by
people throughout the country. Another such example is tea which is mainly produced
in Assam while it is consumed everywhere in the country. Thus, in most of the cases
goods are produced at one place while they are consumed at various other places and
contact the producers directly. Similarly it is not possible for all the producers to
contact the consumers directly and sell the goods. Hence, it is essential to move the
goods from the place of production to the markets where consumers can buy them.
Otherwise, production has no value and it becomes waste. A distribution channel
helps in the movement of goods from producer to consumer and, thus, creates place
utility to the product.
There is another barrier which arises due to time lag between production and
consumption. The goods produced are not consumed at the same point of time.
A distribution channel makes it possible for the consumers to get the products in a
convenient shape, unit size, style and package. Thus, it creates convenience value.
Distribution channel also makes it possible for the consumer to obtain goods at a price
he is willing to pay and under conditions which bring him satisfaction and pride of
ownership. Thus, it creates possession utility. Thus, it is the distribution system which
moves the goods from the place of production and makes them available to the
consumers at the right place, time and form.
8.3 ROLE OF DISTRIBUTION IN THE SUPPLY CHAIN

A supply chain is a network of facilities and distribution options that performs the
functions of procurement of materials, transformation of these materials into
intermediate and finished products, and the distribution of these finished products to
customers. Supply chains exist in both service and manufacturing organizations,
although the complexity of the chain may vary greatly from industry to industry and
firm to firm. Many manufacturing operations are designed to maximise throughput
and lower costs with little consideration for the impact on inventory levels and
distribution capabilities. Alongside product management, promotion, and pricing,
distribution is one of the four key components of marketing.
There are four major decision areas in supply chain management: (1) location,
(2) production, (3) inventory, and (4) transportation (distribution), and there are both
strategic and operational elements in each of these decision areas. In simple terms,
distribution provides an inlay between the producer of a product and the seller of that
product. After a product is made, it is usually then sold to a distributor, who in turn
will sell the product either directly to customers, or to retailers who will in turn sell it
to customers. Throughout history, distribution has been related to questions in the
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field of logistics, namely, how one gets a particular product to a customer. Thus, the 149
distribution end of supply chain management must contend with such decisions as to
whether to sell the product directly, or through a retailer; whether the product should
be distributed on a wholesale basis; whether the product should be sold via
multi-level marketing channels; whether members of the channel should
share advertising costs, etc.
8.4 DESIGNING DISTRIBUTION CHANNELS

Channels of distribution are of vital importance to all types of firms – producers,
wholesalers and retailers. Each member of a channel is a link in a distribution network
of organizations that extends from the producer to the end users of products or
services. Although some firms perform all channel functions, typically, several
organizations are linked together in a distribution channel to carry out the various
activities of storage, transportation, and warehousing, material handling service.
Sorting and re-packing organizations that perform these marketing functions between
producers and end users are called middlemen, intermediaries or resellers.
8.4.1 Different Types of Deliveries

Because of the wide variety of channel arrangements that exist, it is difficult to
generalise the structure of channels across all industries. However, distribution
channels are usually of two types: Direct Marketing Channel (or Zero Level); Indirect
Marketing Channel.
Direct Marketing Channel (or Zero Level)

This type of channel has no intermediaries. In this distribution system, the goods go
from the producer directly to the consumer, e.g., Eureka Forbes.
Indirect Marketing Channel

This may further be classified into the following categories:
1. One-level Channel: In this type of channel, there is only one intermediary
between producer and consumer. This intermediary may be a retailer or a
distributor.
0 Level
Producer Consumer
1 Level
Producer Retailer Consumer
If the intermediary is a distributor, this type of channel is used for specialty

products like washing machines, refrigerators or industrial products.
Producer Distributor Consumer
2. Two-level Channel: This type of channel has two intermediaries, namely,

wholesaler/distributor and retailer.
2 Level
Producer Wholesaler/Distributor Retailer Consumer
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150 3. Three-level Channel: This type of channel has three intermediaries, namely,
Logistics and
Supply Chain Management distributor, wholesaler and retailer. This pattern is also used for convenience
products.
3 Level
Producer Distributor Wholesaler Retailer Consumer
4. Four-level Channel: This type of channel has four intermediaries, namely, agent,
distributor, wholesaler and retailer. This channel is similar to the previous two.
This type of channel is used for consumer durable products also.
4 Level
Producer Agent Distributor Wholesaler Retailer Consumer
In addition to the above mentioned channels, some different types of channels are also
possible. There is no watertight classification of channels. The use or selection of a
channel also depends upon the product under consideration. Basically there are three
or four types of products, viz. (i) Consumer non-durables, (ii) Consumer durables,
(iii) Industrial products and (iv) agricultural products. Distribution channels of
different types also depend on the nature of product and services. Therefore, we can
say that for different products, there are different types of channels.
8.5 FACTORS INFLUENCING DISTRIBUTION

At the highest level, performance of a distribution network should be evaluated along
two dimensions:
1. Customer needs that are met
2. Cost of meeting customer needs
The customer needs that are met influence the company's revenues, which along with
cost decide the profitability of the delivery network.
While customer service consists of many components, we will focus on those
measures that are influenced by the structure of the distribution network. These
include:
z Response time
z Product variety
z Product availability
z Customer experience
z Order visibility
z Returnability
Response time is the time between when a customer places an order and receives
delivery. Product variety is the number of different products/configurations that a
customer desires from the distribution network. Availability is the probability of
having a product in stock when a customer order arrives. Customer experience
includes the ease with which the customer can place and receive their order. Order
visibility is the ability of the customer to track their order from placement to delivery.
Returnability is the ease with which a customer can return unsatisfactory merchandise
and the ability of the network to handle such returns.
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It may seem at first that a customer always wants the highest level of performance 151
along all these dimensions. In practice, however, this is not always the case.
Customers ordering a book at Amazon.com are willing to wait longer than those that
drive to a nearby Borders store to get the same book. On the other hand, customers
can find a far larger variety of books at Amazon compared to the Borders store.
Firms that target customers who can tolerate a large response time require few
locations that may be far from the customer and can focus on increasing the capacity
of each location. On the other hand, firms that target customers who value short
response times need to locate close to them. These firms must have many facilities,
with each location having a low capacity. Thus, a decrease in the response time
customer’s desire increases the number of facilities required in the network, as shown
in Figure 8.1. For example, Borders provides its customers with books on the same
day but requires about 400 stores to achieve this goal for most of the United States.
Amazon, on the other hand, takes about a week to deliver a book to its customers, but
only uses about 5 locations to store its books.
Figure 8.1: Relationship between Desired Response Time and Number of Facilities
Changing the distribution network design affects the following supply chain costs:
z Inventories
z Transportation
z Facilities and handling
z Information
Figure 8.2: Relationship between Number of Facilities and Logistics Cost

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152 As the number of facilities in a supply chain increases, the inventory and resulting
Logistics and
Supply Chain Management inventory costs also increase as shown in Figure 8.2. For example, Amazon with
fewer facilities is able to turn its inventory about twelve times a year, while Borders
with about 400 facilities achieves only about two turns per year. As long as inbound
transportation economies of scale are maintained, increasing the number of facilities
decreases total transportation cost, as shown in Figure 8.2. If the number of facilities is
increased to a point where there is a significant loss of economies of scale in inbound
transportation, increasing the number of facilities increases total transportation cost.
A distribution network with more than one warehouse allows Amazon.com to reduce
transportation cost relative to a network with a single warehouse. Facility costs
decrease as the number of facilities is reduced as shown in Figure 8.2, because a
consolidation of facilities allows a firm to exploit economies of scale.
Total logistics costs are the sum of inventory, transportation, and facility costs for a
supply chain network. As the number of facilities is increased, total logistics costs first
decrease and then increase as shown in Figure 8.3. Each firm should have at least the
number of facilities that minimise total logistics costs. As a firm wants to further
reduce the response time to its customers, it may have to increase the number of
facilities beyond the point that minimises logistics costs. A firm should add facilities
beyond the cost-minimising point only if managers are confident that the increase in
revenues because of better responsiveness is greater than the increase in costs because
of the additional facilities.
Figure 8.3: Variation in Logistics Cost and Response Time with Number of Facilities
8.6 SOME COMMERCIAL ASPECTS IN DISTRIBUTION

MANAGEMENT
As well as the physical Supply Chain (storing and distributing products according to
GDP) the commercial aspects of the supply chain should also be optimised. The
commercial arrangements, and the consequent flow of money along the chain, need to
be designed and closely managed. The standard sales force promotion of a product can
be enhanced by additional commercial arrangements that complement these demand
creation efforts and can add significant additional profit to the product. There are
many different commercial arrangements and opportunities that can be used to gain
maximum value from a product's supply chain.
Broadly, distribution channels perform the transactional functions, logistical functions
and facilitating functions. Transactional functions involve buying, selling and risk
bearing activities. Facilitating functions facilitate both the transaction as well as
physical exchange of goods like post-purchase service and maintenance, financing,
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market information, etc. In specific terms, distribution channel perform the following 153
functions:
z Facilitate selling by being physically close to customers
z Provide distributional efficiency by bridging the manufacturer with the user
efficiently and economically
z Break the bulk and cater to the small requirements of buyers
z Assemble products into assortments to meet buyer's needs;
z Look after a part of physical distribution1 marketing logistics
z Share the financial burden of the principal; provide deposits; finance the stocks till
they are sold to the ultimate consumers; extend credit to the retailers1 consumers.
z Provide salesmanship and after-sale service
z Assist in sales promotion
z Assist in merchandising
z Assist in introducing new products
z Assist in implementing the price mechanism: assist in price negotiations
z Assist in developing sales forecasts/sales plans for the territory
z Provide market intelligence and feedback
z Maintain records
z The searching out of buyers and sellers (contacting).
z Matching goods to the requirements of market. (Merchandising).
z Offering products in the form of assortments or packages of items useable or
acceptable by the consumers.
z Persuading and influencing the prospective buyers to favour a certain product and
its maker (personal selling/sales promotion)
z Implementing pricing strategies in such a manner that will be acceptable to the
buyers and ensure effective distribution.
z Looking after all physical distribution function.
z Participating actively in the creation and establishment of the market for a new
product.
z Offering pre and after sales services to the customer
z Transferring new technology to the users along with the supply of products and
playing the role of change agents
z Providing feedback information, marketing intelligence and sales forecasting
services for their regions to their suppliers
z Offering credit to retailers and consumers
z Risk bearing with reference to stock holding/transport.
8.6.1 Laws relating to Commercial Taxes

Excise Duty
Manufacture of goods in India attracts Excise Duty under the Central Excise act 1944
and the Central Excise Tariff Act 1985. Most products attract excise duties at a rate of
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154 16%. Some products also attract special excise duty/and an additional duty of excise at
Logistics and
Supply Chain Management the rate of 8% above the 16% excise duty. There is a 2% education cess which is also
applicable on the aggregate of excise duties. In most cases excise duty is levied on ad
valorem basis, however, in some cases it is based on the maximum retail price.
Excise laws allow the storage of goods in bonded warehouses under certain
conditions. A bond will have to be furnished to the satisfaction of the authorities for
the desired amount. The advantage of a bonded warehouse is that the duty need not be
paid when the purchase is made. It can be deferred till its use or sale as the case
may be.
Customs Duty
The levy and the rate of customs duty in India are governed by the Customs Act 1962
and the Customs Tariff Act 1975. There are three levies on imported goods, attract
basic customs duty, additional customs duty and education cess. The rates are
different for different items and are specified under the Tariff Act and are calculated
on the transaction value of the goods.
In the recent past, the peak rate of basic customs duty has been reduced to 15% for
industrial goods. The additional customs duty that is applicable is the same as the
excise duty payable on similar goods manufactured in India. As in the case of excise,
education cess at 2% is leviable on the aggregate of customs duties.
There are special rates of customs duty for goods imported from countries with whom
India has entered into free trade agreements such as Thailand, Sri Lanka, BIMSTEC,
south Asian countries and MERCOSUR countries. These rates are provided on the
website of CBEC.
Similar to excise duty, bonded warehouses are permitted for certain categories of
goods. Taxes are paid when the goods are released from the bonded warehouses.
Service Tax
Service tax is levied at the rate of 10% (plus 2% education cess) on certain services
provided by specified service providers. Taxable services rendered in India are
exempt, if payment is received in convertible foreign exchange and is not repatriated
outside India.
The Cenvat Credit Rules allow a service provider to utilise the credit of additional
duty of customs/excise duty that may have accrues to it for payment of service tax.
Credit is also given for the payment of service tax made on inputs used for the
discharge of output, which attracts the service tax liability.
Sales Tax/VAT
Central Sales tax is generally payable on the sale of all goods by a dealer in the course
of inter-state Trade or commerce or, outside a State or, in the course of import into or,
export from India. The seller and the buyer must register themselves with the tax
authorities and quote their state and sales tax numbers in the invoices and related
transit documents.
Movable goods attract sales tax. From April 01, 2005, in most states, sales tax has
been replaced with a new Value Added Tax (VAT). VAT is applied on each stage of
sale with a mechanism of credit for the input VAT paid. There are four slabs of VAT:
z 0% for essential commodities
z 1% on bullion and precious stones
z 4% on industrial inputs and capital goods and items of mass consumption
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z On all other items 12.5% 155
z Petroleum products, tobacco, liquor, etc. attract higher VAT rates that vary from
state to state
VAT is imposed on goods and not services. It does not replace other indirect taxes
such as excise duty, service tax, etc. VAT is implemented at the State level by State
Governments. Central Sales Tax at the rate of 4% is also levied on inter-State sales
and is gradually being eliminated.
Goods in transit are often checked by the authorities to find out whether the taxes have
been paid. If there is any doubt, they are liable to be impounded. The purchasing
executive must take care that documents like invoice and C form are correctly filled
and accompany the goods. He should also be familiar with the use of D, G, EI and Ell
forms.
Octroi
Octroi is a tax collected by local authorities, e.g. municipal and other similar local
authorities on goods unloaded for trade purposes within their areas of jurisdiction.
Goods that pass by in transit or those that enter to reach a port or rail head are not
levied. The rates of taxation, the items covered and the forms for exemption are
decided by the concerned local authority and the purchase executive must update his
knowledge about the prevailing structure in his area.
8.7 CODIFICATION
An article of stores is identified by its simple description or nomenclature. Difficulty
arises when the same article is known by different names. For example, chipping
goggles, grinder goggles, or white goggles are one item but may be stored separately
under same nomenclature as different items. One storekeeper might classify an item as
Sal Ammoniac, whereas a research chemist might identify it under the name of
Ammonium Chloride, only to be told that it is not available. A classic example comes
from the U.K. An electric firm found that a simple item of a screw with a width of
3/8” and length of 6” had as many as 118 names depending on the type of usage and
the department using the screw.
A few names are: (a) Plunger, (b) dowel pin, (c) roller, (d) locating peg, (e) drive pin
(f) pinion spindle, (g) pin mould holding, (h) motor drive spindle, (i) trip arm pin,
(j) armature stud, etc. Two firms in Western India have been able to reduce the variety
of lubricating oils from 30 and 32 to 9 and 7 respectively. At a control depot of State
Road Transport Authority, 583 hardware items were reduced to 105 through
codification. In a large electrical firm, it was found that excessive stocks of copper
items were due to designers specifying too many sizes. A planned reduction of say
20 per cent in number of items would not only reduce the material cost, but would also
correspondingly bring about reduction in routine work, stores purchase, inspection,
production and accounts. In short, a rationalised system of codification would reduce
the number substantially and at the same time make their identification an easier job
avoiding lengthy description and confusion.
The need for Codification arises because of the following reasons: (i) Speed,
(ii) Unambiguity, (iii) Saving of Effort, (iv) Space Saving on forms, (v) Ease of
classification, (vi) Mechanisation.
8.7.1 Characteristics of Codes

As far as possible uniform dimension say, the metric system should be adopted.
(i) Code should be Simple.
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156 (ii) Code should be unique.
Logistics and
Supply Chain Management (iii) Coding should be compact, concise and consistent.
(iv) Code should be sufficiently flexible to meet future demands.
The Basic requirements of a code are:
(i) Identify commodities
(ii) Name commodities
(iii) Specify commodities
(iv) Classify commodities
(v) Indicate inter-relationships between commodities
(vi) Indicate the source of origin of commodities
(vii) Refer specifically to an individual and unique commodity.
8.7.2 Objectives of Codification

In order to identify the items correctly and logically for processing the transactions,
and to facilitate easy location in stores, a codification system should be evolved with
the following objectives:
(i) Accurate and logical identification: A separate code allotted to each of the items
available in the warehouse indicating the size, quality price, usability, special
characteristics, specification, etc.
(ii) Prevention of duplication: All items are separately codified and are arranged in a
logical order. Similar materials are grouped together (such as stationery items,
hardware items) and given a code.
(iii) Standardisation and reduction of varieties: For codification, grouping of
identical item is done and it enables the stores to examine the entire range of
items. It facilitates the elimination of those varieties in place of which other
varieties of the same quality can be used. This reduces the number of varieties to
a minimum. If proper standardisation is achieved and the number of items is kept
at the minimum, it will considerably reduce investment in various items as well
as the cost of inventory carrying.
(iv) Efficient purchasing: The filling up of purchase requisition, and preparation of
purchase orders are simplified by the use of codes which easily indicates the
materials required. Buying instructions to the suppliers become easy and quick if
there is proper understanding of codification by the suppliers.
(v) Efficient Recording: Efficient recording and accounting codes leads to effective
stock control, efficient recording and it results in yielding accounting. Chances of
mistakes are minimised. Pricing and valuation also become more accurate and
reliable.
(vi) Easy locating, indexing and inspection of all materials are possible.
(vii) Easy computerization: The computer works better with codes then with long
description of materials.
8.7.3 Advantages of Codification

Let us discuss some advantages of codification in material management.
(a) As a result of rationalised codification, many firms have reduced the number of
items.
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(b) It enables systematic grouping of similar items and avoids confusion caused by 157
long description of the items.
(c) Since standardisation of names is achieved through codification, it serves as the
starting point of simplification and standardisation.
(d) It helps in avoiding duplication of items and results in the minimisation of the
number of items, leading to accurate records.
(e) Codification enables easy recognition of an item in stores, thereby reducing
clerical efforts to be minimum.
(f) If items are coded according to the sources, it is possible to bulk the items while
ordering.
Fill in the blanks:
1. …………………………….is primarily concerned with the movement of
goods from the point of production to the point of consumption.
2. ……………………………..involved in direct negotiation between buyers
and sellers whether or not they take title to goods.
3. ………………………………..refers to the route taken by goods as they
flow from the producer to the consumer.
4. …………………………………….type of channel has three
intermediaries, namely, distributor, wholesaler and retailer.
8.8 DISTRIBUTION RESOURCE PLANNING (DRP)

There are numerous models to determine optimal inventory holding. The standard
results of these models provide a framework for identifying the determinants of
inventory levels in practice. Some predictions apply to specific types of inventory raw
materials, work-in-process (WIP), or finished goods. However, requirements for these
three types of inventory are often interrelated, making it difficult to pinpoint
predictions for one inventory type.
There are three structures that combine to form the distribution channel from the
manufacturer to the customer. The structure at one end of the channel is the
manufacturer. The manufacturer is responsible for the development and production of
products or goods. The end structure is the retailer who sells goods and services
directly to the customer. In between the two lies a process called distribution, which
originates at the manufacturer’s end and connects to the retailer.
Distribution involves a number of activities centred on the physical flow of goods and
information. The distribution system, therefore, is the physical link between suppliers
and customers. Each of the areas shown below represents the functions carried out by
the distribution network:
z Order processing
z Warehousing and storage
z Finished goods management
z Material handling and packaging
z Shipping
z Transportation
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158 In a complex production environment, it ties the various stages of production into the
Logistics and
Supply Chain Management production chain. The central focus of distribution is to increase the efficiency of time,
place, and delivery utility of the organisation.
In order to meet this objective, there are a number of critical functions performed by
the different channels of distribution:
z Product acquisition: This means the distribution facilities of manufacturing
companies facilitates the acquisition of products in a finished or semi-finished
state to another distributor or retailer who is lower up in the supply channel. This
function can be performed by the manufacturer, independent channel
intermediaries like distributors or wholesalers or by retailers.
z Product movement: Very few companies are completely vertically integrated;
generally several companies participate in building a complex product before it is
delivered to the customer. The product has to be moved up or down the supply
channel, constituting the manufacturer, the distributor, the wholesaler and the
retailer. There is considerable effort as well as costs involved in this function.
z Product transaction: Product transactions take place at different levels:
distributors and wholesalers sell products in bulk quantities solely for the purpose
of resale or business use. Downstream businesses will then sell these products to
other wholesalers or retailers who will sell them directly to the end customer, or to
manufacturers who will consume the material/components in their own production
processes.
One of the major issues in controlling finished goods inventory is an optimal
distribution network that is intelligently designed to minimise costs by providing the
customer the right goods, in the right quantity, at the right place, and at right time. In
order to meet the customer and service requirements successfully, the distribution
system can have several distinct levels. Inventory may be maintained for distribution
to customers in all or any combination of these levels:
z The supplier’s facility/ factory
z In transit
z Regional warehouses
z Distribution centres/depots, and
z Customer’s facility/retailers
In transit
Figure 8.4: Finished Goods Distribution Network

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These levels of a typical distribution chain are shown in Figure 8.4 which shows the 159
flow of finished goods through these levels. The figure illustrates a very simple and
basic distribution network.
The factory supplies the finished goods to the regional warehouses. These may be
owned by the manufacturer or by its distributors. The distributors, in turn, send the
finished goods to the depots, which they may run themselves or are run by the
wholesalers. Distributors and wholesalers provide goods to different categories of
retailers.
The different categories of retailers are differentiated on how they combine different
decisions regarding location, assortment, selection of target markets, etc.
In descending order of product support, the retail outlets are turnkey, specialty shops,
discount shops, and mail order. The retail decision, therefore, entails a trade-off
between price and service.
Turnkey operations obtain finished goods from an assemble-to-order producer. It
delivers material to the user, sets it up, and ensures it is working properly. A specialty
shop is a retailer of one type of item, such as men’s or women's clothing, sporting
goods, jewellery, and so on. A discount shop is a retailer carrying a very broad line of
products that competes by offering lower prices. For items that are small enough to be
mailed or shipped by common carrier, mail order is an increasingly popular
alternative.
In real life distribution networks are quite complex. For example, Hindustan Unilever
Ltd. (HUL) is the market leader in the detergent and soap industry. HUL has about
130 brands and over 1,200 SKUs in its portfolio and 7,000 stockists filling up shelves
in over one million retail outlets. HUL has 100 factories, 13 sales branches and 121
warehouse depots, along with 93 third-party manufacturing sites, all of which
constitute its distribution network. Each of these entities provides HUL with data that
is used in the company’s planning the distribution system as well as the flow of its
products to the customer.
Distribution systems store large amounts of materials for rapid delivery to a customer
to buffer inflexible production systems that were incapable of making the swift
adjustments required to keep pace with rapidly changing customer needs. Each of the
above may receive finished goods from a central or regional warehouse. Therefore,
considering the extensive distribution network that is characteristic of all finished
goods, the distribution between stockings points within the distribution chain becomes
a critical decision variable.
An optimal policy to manage finished goods allows companies to achieve higher
profitability levels. In general terms, policies should be aimed at lowering the holding
costs through higher inventory rotation, but without triggering substantial stock-outs
and backorders, caused by demand peaks and/or lead time delays. An organization
must choose distribution outlets and design the field support system. The distribution
system choice affects several inventory and product support issues.
Finished goods inventory is finally a trade-off between inventory costs and schedule
stability, once the decisions on the distribution network are firmed up. Therefore, the
goal of finished goods inventory is to manage inventory levels so as to minimise costs
deriving from holding inventory and from adjustment to the master production
schedule (MPS) to prevent stock-outs.
As mentioned in the last section, as the number of distribution points increase, there is
an increase in the average inventory held by the firm. The firm has little control on the
inventory in transit, but safety stock can be reduced if the corresponding uncertainty in
supply is reduced. This mean that demand variability is a key determinant of safety
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160 stock. To achieve a high customer service level stock must be held as a buffer against
Logistics and
Supply Chain Management this variability in demand. Therefore, inventory management becomes a struggle to
minimise investment in inventory while filling every customer order on time. This
places a premium on the use of accurate demand forecasting techniques.
In real life, applications demand distribution is a priori, that is, it seldom known
accurately. Customer demand for finished goods is variable and unpredictable. In
FMCG, the situation is further complicated by frequent sales promotions which are
commonplace. Often, the information flows do not provide sufficient advance warning
of a promotion, thus causing further difficulties with a planned buildup of stock. These
increase the variability in demand thus making prediction much more difficult.
It is highly important for companies to increase service levels without increasing
inventory investment. Because the amount of inventory needed to meet service levels
is directly related to lead times and variability, reducing lead times and supply chain
variability is also highly important.
The problem of variable demand is compounded by the fact that there is usually a
variable lead time associated with delivery from production. A big cost in production
is lost production due to resetting machines and changing products. Consequently, in
most production shops, reducing manufacturing costs is achieved by planning long
production runs which minimise changeover time. This enhances the variable lead
time associated with delivery from production. Often, production does not provide
sufficient advance warning of scheduled maintenance. Therefore, matching finished
goods quantities becomes difficult. Goods arrive in larger or smaller than requested
quantities and in a sequence that may not match the sales forecast.
In addition, the uncertainty of the future and unpredictability demand and lead time,
and the lack of precision in forecasting need to be resolved. This is not only a cost but
also a risk to the firm. In order to reduce the uncertainty, the organization has to
realise that these uncertainties exist and also find means to understand how their
impact on the business can be minimised.
We have discussed Collaborative Forecasting (CPFR) as a technique in improving the
accuracy and reliability in forecasting. An extended benefit of using the CPFR is that
it reduces the impact of the bull-whip effect and increase the trust and cooperation
between members of the distribution chain. The problem still remains — how to
optimise this complex system.
The most commonly used method is an extended application of MRP systems. This
method is known as Distribution Requirement Planning (DRP). This technique is used
for planning of distribution networks. DRP emerged as a major tool during the 1970s.
By the 1980s DRP had become a standard approach for planning and controlling
distribution logistics activities. The concept was extended to embrace all business
functions in the supply channel renamed distribution resource planning (DRP II).
DRP II is widely used not just for inventory and logistics, but a number of other
functions required to minimise inventories.
Distribution resource planning provides a framework for determining the need to
replenish inventory by:
z Linking market requirements with manufacturing and demand management
z Relating current inventory positions and demand forecasts to production
scheduling, and
z Matching material supply to manufacturing demand, and customer demand to
product supply
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The logic of DRP very closely resembles the logic of MRP systems. Distribution 161
networks in the retail business consist of a network of outlets, distribution centres and
warehouses. Regional warehouses are fed by a national distribution centre, and the
regional centres feed the regional outlets, and these feed the distribution chains at the
local level. However, DRP needs the following information:
z Demand in a future time period.
z Scheduled receipts at the beginning of a time period.
z Safety stock requirement for a period.
z On-hand inventory at the beginning of a period.
By thinking of each level in the distribution network as a level in a bill of materials,
the gross requirements are first calculated. Orders or forecasted demand, or some
combination of both are used to arrive at the numbers. If orders are used, orders placed
by the distribution points will generate gross requirements at the different levels in the
network, from local to regional and finally national. This structure is captured in the
DRP for determining finished goods requirement.
Table 8.1: A DRP Calculation
The scheduled receipts are the goods the distributor expects to receive from orders that
already have been released. On-hand inventory balance constitutes the goods that
already are received and entered into inventory. By subtracting scheduled receipts and
on-hand inventory from gross requirements the program determines the net
requirements. Based upon the distributor's lot-sizing policy and receiving behaviour,
planned order receipts and capacity planning are generated.
You define all nodes in the network including plants, distribution centres (DCs),
warehouses, and stock transfer points. You set up the material master record for each
node. In MRP 4 of the material master record, you must define the deployment
strategy for each material (the fair and push distribution options) as well as
deployment horizon (push horizon). For the push horizon, you need to enter the
number of days for which the system considers the available to deploy (ATD) quantity
and any additional quantity produced. Any quantity produced beyond the push horizon
is not considered in the deployment calculation.
You create a forecast for each DC; for example, sales forecast, and transfer the
forecasted data to Demand Management. The system creates independent
requirements. You can then perform a DRP run in each DC and in each supplying
plant. The DRP run considers the quota arrangements defined in the network,
available stock, sales orders, and independent requirements.
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162 The DRP run in the DCs creates releases for stock transport requisitions in the
Logistics and
Supply Chain Management supplying plants and planned orders for production. These are then converted to
production orders for manufacturing.
Table 8.2 describes some of the important DRP key figures. How these key figures are
calculated is given below:
z Independent requirements are calculated for each distribution centre using
statistical forecasting. The programme has a tool for this. Alternatively, you can
manually create the independent requirements.
z Sales orders are obtained from the sales force.
z The demand fence in the MRP is defined by the user. The demand fence is
represented in days and indicates the time during which certain demand types
contribute to the demand key figure. Beyond the demand horizon, the maximum
value of the sales order and the forecast is taken as the demand.
z For the selection of demand types within the demand fence, you define a checking
group and a checking rule for the demand key figures.
z The system calculates the on-hand stock using the initial stock (stock of the
previous day) plus the in transit stock of the current day minus the demand of the
current day.
z The system calculates the target stock level by taking the sum of the forecast
within the safety time (in this example, three days) plus the safety stock for the
current day.
z The system calculates the safety stock automatically and stores it in the material
master record.
Table 8.2: DRP Key Figures
The system calculates the replenishment orders by adding the target stock level to the
demand and subtracting the initial stock. As should be apparent, DRP enables the user
to set certain inventory control parameters (like a safety stock) and calculate the time-
phased inventory requirements.
DRP is usually used with an MRP system, although most DRP models are more
comprehensive than stand-alone MRP models and can schedule transportation. The
underlying rationale for DRP is to more accurately forecast demand and then use that
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information to develop delivery schedules. This way, distribution firms can minimise 163
inbound inventory by using MRP in conjunction with other schedules.
For example, Hindustan Lever (HUL) ERP module includes a distribution resource
planning (DRP) module which integrates manufacturing and distribution operations.
Distribution centres give the demand to the factories. The DRP module helps Lever to
compute demand dynamically based on daily sales orders. Forward sales orders
likewise provide the basis for a dynamic calculation of inventory norms at the
company’s regional and local distribution centres.
The system has helped HUL workflow automation of the supply chain. It handles
exceptions involving dispatching, a wide range of truck capacities, lead-time
variances, and changes in both demand and sourcing. These have helped it minimise
inventory levels.
The planning cycle of HUL used to be monthly, and this has now become daily. The
improved planning has resulted in significant inventory reduction. For example, the
stock levels in the detergent business alone dropped from 105,000 tons to less than
55,000 tons. Measured in days, stock levels fell from six weeks of sales to less than
three weeks. The volume of finished goods languishing in distribution centres fell
from three weeks to less than one week. In the factories, HUL now keeps a one-day
inventory, while at the buffer depot it is four to five days. Supplier inventory levels are
at three days, down from the previous seven days.
DRP calculates requirements into the future by taking current inventory, adding
shipments that are already on the way, and subtracting expected demand. Whenever
the projected inventory drops below the desired safety stock level, it calculates the
desired shipment date from the plant based on the desired arrival time.
This simple replenishment and shipment logic of traditional DRP are often not
sufficient in the real world situation. Firstly, DRP ignores costs. Secondly, limitations
of the real world exist that prevent the ideal plan from becoming reality. For example,
plants have limited production capacity, warehouses have limited floor space,
shipping docks can only unload a certain number of trucks per hour, and truck
availability may limit the timely movement of product. Finally, the problem of
distribution is much more complicated than reflected in most DRP modules. Due to
these limitations and constraints, DRP often produces non-feasible plans. New
systems using dynamic distribution logic are being developed to overcome these
shortcomings.
8.9 LOGISTIC IN 21ST CENTURY

Management of the logistics has evolved over the last two decades from an emphasis
on integrating supply chain and lowering cost to providing better products and
services that provide value to ultimate customers. Managing uncertainty and
understanding customers in the global market is the challenge that current supply
chain systems are facing the world over. Efforts are being made to manage demand
flow, supplier collaboration and customer services using cutting-edge information
technology. Traditionally, the focus of companies has been on the intra-organizational
flows over which the organization had some control. However, companies are
increasingly recognizing that supply chain management involves the management of
the complete chain starting from inbound logistics, processing, outbound logistics,
marketing and sales, customer service and also reverse flow of unused materials and
waste for successful value reclamation through reuse, remanufacturing and
recycling.
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164 This involves a large and complex network of suppliers, transporters, manufacturers,
Logistics and
Supply Chain Management distributors and customers. Successful supply chain flow requires synchronization of
operations through effective collaboration among the various channel players.
Organizations must provide world-class services to remain profitable and continue
serving the society in an effective manner in the ever-changing and turbulent market
space. The following sections are devoted to a discussion of the issues and trends that
supply chains are likely to adopt in times to come.
8.9.1 Vendor Managed Inventory (VMI)

VMI has been recognised as an effective strategy for combating irregularities in the
supply chain caused due to demand variability. In this system, the vendor plays an
intermediate role between the manufacturer and the wholesaler/retailer. The vendor
collects point-of-sales (POS) data from the wholesaler/retailer and accordingly plans
their demand from manufacturers in order to manage the wholesaler’s inventory. This
eliminates the wholesaler’s/retailer’s need for dual buffering against customer
demands on one hand and supply disruptions on the other. In fact, by adopting a
process of just-in-time or continuous replenishment, the inventory can be reduced to a
bare minimum; thereby lowering both risks and costs.
Vendors are in an excellent position to manage inventory for the wholesaler/retailer
because they are a middle link in the supply chain and can track the needs both from
the supplier’s and the customer’s ends. Since the supplier/vendor understands his/her
own product better than anyone else, they can handle the replenishment needs of the
retailer who has to otherwise keep track of numerous products. The buyers’ role of
creating purchase orders from sales and supply forecasts is eliminated as the vendor
does handle this on behalf of the wholesaler/retailer. The buyers’ role becomes one of
assessing the recommendations made by the supplier and providing adequate
aggregate data and insightful information while collaborating on sales/demand
forecasts. Once VMI has been implemented, customers can benefit from 30 to 40 per
cent reductions in inventory and 75 percent forecast accuracy.
When the supplier plays the role of a vendor, this strategy is called Supplier Managed
Inventory (SMI). This is an offshoot of the Retailer-Supplier Partnership (RSP) that
can be used to synergise the flow inventory between the retailer and the supplier.
Accordingly, suppliers like Shell, a company manufacturing automotive lubricants
etc., integrate customer’s forecast, consumption data and inventory information to its
own production and shipping capabilities for creating rolling production schedules.
This reduces inventory-carrying costs in the supply chain. This way, besides managing
the inventory, Shell does not need to pad its own inventory in anticipation of varying
demands from its customers. This technique can in-turn is carried upstream to Shell’s
suppliers. Similarly, Shell’s customers can now emulate the strategy and reap benefits
accruing out of reduced inventory in the supply chain. Implementing VMI or SMI can
be difficult when the supplier starts accounting for the time and cost involved in
managing the inventory. Some customers may not be using computers and may be
reluctant to allow suppliers to manage their inventory, if it is a crucial business secret.
Moreover, plant managers may be forced to stop production if they stock out and
suppliers are not able to replenish them just in time.
8.9.2 Third Party Logistics

Third-party logistics (3 PLs) is the use of an outside company to perform all or part
of the company’s materials management and product distribution functions. The
competitive advantage for any company is to focus on their core competencies, and let
the 3PL firm handle those supply chain functions in which they specialise. In order to
provide truly value-added services, 3PL firms must interact with customers to
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understand their needs and then adjust their offerings to meet them. It is obvious that 165
companies can parcel out numerous supply chain processes to entities that specialise
in the efficient performance of those processes.
Outsourcing a wide array of supply chain processes can generate greater value across
the entire supply chain because specialised firms performing the selected processes
enjoy a level of expertise and leverage that would not be available to manufacturers,
wholesalers or retailers. Transportation, warehousing, order processing and
fulfillment, packaging, labeling, and bill payment are some of the key processes that
can be outsourced to specialist firms called third-party logistics firms, or 3PLs.
If these firms are efficient and effective, then the entire supply chain can benefit from
improved capacity utilization, enhanced service levels and lower costs. 3PLs can
provide technological and other flexibility to client companies. For instance, channel
partners may need to change their technology for implementing quicker systems.
Similarly, they may have changing needs for warehousing and transportation facilities.
Such changing demands can be easily taken care of by third-party logistics companies.
Customers of 3PL companies look for four dimensions of value to be derived from
outsourcing a process to a 3PL firm. These values include trust, information, capital
utilization and cost control. The 3PL’s customer orientation, level of specialization,
asset ownership status and the price at which the service is offered form some of the
main issues that a client will consider while selecting an appropriate service provider.
3PL companies must provide reliable services and solve channel problems so that
smooth flow of goods and information can take place. This helps customers to trust
3PL companies. 3PLs can create value for their customers in the accuracy, quality and
timeliness of the information that they provide their clients, different channel partners
and to ultimate customers. This information can be electronically integrated into the
customer’s MIS for direct access.
8.9.3 Fourth Party Logistics

The term “fourth-party logistics provider” is a trademarked term owned by Andersen
Consulting. It refers to the evolution in logistics from suppliers focused on
warehousing and transportation (third-party logistics providers) to suppliers offering a
more integrated and value added solution. Among other services, fourth-party logistics
providers include supply chain management and solutions, change management
capabilities, and value added services as part of their offering. A 4PL company
delivers a comprehensive supply chain solution and adds value by influencing the
entire supply chain. A 4PL leverages a full range of service providers (3PLs, IT
providers, contract logistics providers, call centers, etc.) along with the capabilities of
the client and its supply chain partners. The 4PL acts as a single point of interface with
the client organization and provides the management of multiple service providers
through a teaming partnership or an alliance. A 4PL adds value to the entire supply
chain, through reinvention, transformation, and execution.
A 4PL can use any of the three operating models to deliver supply chain solutions.
1. A partnership can be forged between the 4PL organization and a third-party
service provider to market supply-chain solutions that capitalise on the capabilities
and market reach of both organizations. The 4PL provides a broad range of
services to the 3PL including technology, supply chain strategy skills, capability
to go to market, and program management expertise.
2. The 4PL can operate and manage a comprehensive supply chain solution for a
single client. This arrangement encompasses the resources, capabilities, and
technology of the 4PL and complementary service providers to provide a
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166 comprehensive integrated supply chain solution that delivers value throughout a
Logistics and
Supply Chain Management single client organization’s supply chain components.
3. As a supply chain innovator, a 4PL organization can develop and run a supply
chain solution for multiple industry players with a focus on synchronization and
collaboration. The formation of industry solutions provides the greatest benefits;
however, this model is complex and can challenge even the most competent
organizations.
8.9.4 Reverse Logistics

Reverse Logistics is the process of moving goods from the ultimate customer to
another point, for extracting value that is otherwise unavailable, or disposing them
properly. Goods returned to the supplier may be in the form of:
z Manufacturing returns from the production floor consisting of products having
unsatisfactory quality or left over materials
z Commercial returns arising out of contracts for taking back obsolete stocks of
short-life products
z Product recalls arising out of the detection that defective products have been
released in the supply chain
z Warranty returns of defective products under warranty
z Service returns of products for servicing
z End-of-use returns for re-manufacturing or re-cycling
z End-of-life returns for appropriate disposal
Reverse Logistics activities include the following activities:
z Processing returned products
z Recycling packaging materials and reusing containers
z Reconditioning, remanufacturing and refurbishing products
z Disposing obsolete equipment
z Reuse or disposal of hazardous materials
z Asset recovery
Reverse logistics is a part of the closed-loop supply chain. The reverse logistics parts
of the supply chain starts with collection of returned goods or refuse which then pass
through sorters to reprocessing (reuse, recycle, recondition, remanufacture,
refurbishing and asset recovery) or to disposal. One of the main objectives of reverse
logistics is to keep the cost of reprocessing returned/refused materials lower than that
of new products in order to keep the venture profitable. Accordingly, transportation
and handling costs have to be kept to a minimum. Often the extra cost incurred in
reverse logistics is added to the products when they are first sold new. Moreover,
recycling and disposal procedures must incorporate applicable government and
environment protection laws.
At most companies, returns are primarily managed through a series of disconnected
and paper-intensive processes. As a result, it takes the average company between 30
and 70 days to get a returned product back into the market, including return
transportation, repair or refurbishing, and redistribution to the customer or market.
Moreover, both companies and customers have limited visibility into the returns
process. In fact, a manufacturer frequently finds out about a return only after it lands
on the receiving dock. Long reverse logistics cycles are harmful for products that have
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short lifecycles such as high-tech products that can lose up to half their value in a 167
single business quarter. Moreover, Internet-based sales have increased the incidence
of returns to around 60%. Delays and lack of visibility into the reverse logistics
process can result in lost sales, customer dissatisfaction and inventory carrying costs.
Web-based applications are being developed that focus on automating and
streamlining the process and information flows associated with returns management,
these application connect customers, collectors, manufacturers, and carriers while
providing much needed visibility into, and control over, the returns process. This can
help suppliers maintain customer satisfaction levels.
Fill in the blanks:
1. The distribution system is the physical link between ……………………..
and ………………………….
2. Turnkey operations obtain finished goods from an ………………………..
producer.
3. ………………………… has been recognised as an effective strategy for
combating irregularities in the supply chain caused due to demand
variability.
4. …………………………………. is the use of an outside company to
perform all or part of the company’s materials management and product
distribution functions.
8.10 LET US SUM UP

A distribution channel consists of a set of people and firms involved in the transfer of
title to a product as the product moves from producer to consumer. Thus, a
distribution channel is primarily concerned with the movement of goods from the
point of production to the point of consumption, which involves a variety of functions.
There are four major decision areas in supply chain management: (1) location,
(2) production, (3) inventory, and (4) transportation (distribution), and there are both
strategic and operational elements in each of these decision areas.
Channels of distribution are of vital importance to all types of firms – producers,
wholesalers and retailers. Each member of a channel is a link in a distribution network
of organizations that extends from the producer to the end users of products or
services. As well as the physical Supply Chain (storing and distributing products
according to GDP) the commercial aspects of the supply chain should also be
optimised. The commercial arrangements, and the consequent flow of money along
the chain, need to be designed and closely managed. There are three structures that
combine to form the distribution channel from the manufacturer to the customer. The
structure at one end of the channel is the manufacturer. The manufacturer is
responsible for the development and production of products goods.
Distribution involves a number of activities centred on the physical flow of goods and
information. The distribution system, therefore, is the physical link between suppliers
and customers. Traditionally, the focus of companies has been on the intra-
organizational flows over which the organization had some control. However,
companies are increasingly recognizing that supply chain management involves the
management of the complete chain starting from inbound logistics, processing,
outbound logistics, marketing and sales, customer service and also reverse flow of
unused materials and waste for successful value reclamation through reuse,
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LESSON 173
9
SUPPLY CHAIN MANAGEMENT
CONTENTS
9.1 Introduction
9.2 The Need for Supply Chain
9.2.1 Develop Needed Supply Chain Capabilities
9.3 Evolution of Supply Chain Management
9.4 Understanding the Supply Chain Management
9.4.1 Typology of Supply Chains
9.4.2 Supply Chain Management as a Philosophy
9.4.3 Supply Chain Flows
9.4.4 Product/Material Flow
9.5 Let us Sum up
9.6 Lesson End Activities
9.7 Keywords

z Discuss the need for supply chain
z Explain the evsolution of supply chain management
z Describe the supply chain management
9.1 INTRODUCTION
A supply chain is a system of organisations, people, technologies, activities,
information and resources involved in moving a product or service from supplier to
customer. Maintaining a flawless supply chain across all its operations thus becomes
absolutely necessary for any business. Importance of supply chain management need
not be over emphasized as it has become the cutting edge of business, after product
quality and manufacturing capabilities of any business firm. Supply chain activities
transform natural resources, raw materials and components into a finished product that
is delivered to the end user. In sophisticated supply chain systems, used products may
re-enter the supply chain at any point where residual value is recyclable.
Supply chains encompass the companies and the business activities needed to design,
make, deliver, and use a product or service. Businesses depend on their supply chains
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174 to provide them with what they need to survive and thrive. Every business fits into one
Logistics and
Supply Chain Management or more supply chains and has a role to play in each of them. The pace of change and
the uncertainty about how markets will evolve has made it increasingly important for
companies to be aware of the supply chains they participate in and to understand the
roles that they play. Those companies that learn how to build and participate in strong
supply chains will have a substantial competitive advantage in their markets.
9.2 THE NEED FOR SUPPLY CHAIN

The need of every supply chain is to maximize the overall value generated. The value
a supply chain generates is the difference between what the final product is worth to
the customer and the effort the supply chain expends in filling the customer’s request.
For most commercial supply chains, value will be strongly correlated with supply
chain profitability, the difference between the revenue generated from the customer
and the overall cost across the supply chain. For example, a customer purchasing a
computer from Dell pays $2,000, which represents the revenue the supply chain
receives. Dell and other stages of the supply chain incur costs to convey information,
produce components, store them, transport them, transfer funds, and so on. The
difference between the $2,000 that the customer paid and the sum of all costs incurred
by the supply chain to produce and distribute the computer represents the supply chain
profitability. Supply chain profitability is the total profit to be shared across all supply
chain stages. The higher the supply chain profitability, the more successful the supply
chain. Supply chain success should be measured in terms of supply chain profitability
and not in terms of the profits at an individual stage.
Main need of SCM is to optimize the overall performance of the entire network of the
supply chain. The word “entire” is very important here. With experience in enterprise-
research, we have realised that despite each factory, distribution centre and other
elements of supply chain operating at the best levels, the supply chain as a whole may
operate sub-optimally. Let us examine this issue.
All the constituents of supply chain have their own short-term and long-term needs.
Their operating decisions are based on these needs. It is very common that the
decisions of the constituents may not be aligned to the overall strategic goal of the
entire supply chain. For example, the optimal strategy for the logistics may be bulk
shipments, one-time order, selection of nearest vendor/supplier, etc. In many
situations, when entire chain performance is considered, these individual strategies fail
to deliver the best. It is, therefore, an integrated-holistic view of supply chain, which is
essential. Many situations force management to go for incurring more than the double
cost in order to build up inventories to support some increase in customer’s service.
Companies in any supply chain must make decisions individually and collectively
regarding their actions in five areas:
1. Production: What products does the market want? How much of which products
should be produced and by when? This activity includes the creation of master
production schedules that take into account plant capacities, workload balancing,
quality control, and equipment maintenance.
2. Inventory: What inventory should be stocked at each stage in a supply chain?
How much inventory should be held as raw materials, semi-finished, or finished
goods? The primary purpose of inventory is to act as a buffer against uncertainty
in the supply chain. However, holding inventory can be expensive, so what are the
optimal inventory levels and reorder points?
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3. Location: Where should facilities for production and inventory storage be 175
located? Where are the most cost efficient locations for production and for storage
of inventory? Should existing facilities be used or new ones built? Once these
decisions are made they determine the possible paths available for product to flow
through for delivery to the final consumer.
4. Transportation: How should inventory be moved from one supply chain location
to another? Air freight and truck delivery are generally fast and reliable but they
are expensive. Shipping by sea or rail is much less expensive but usually involves
longer transit times and more uncertainty. This uncertainty must be compensated
for by stocking higher levels of inventory. When is it better to use which mode of
transportation?
5. Information: How much data should be collected and how much information
should be shared? Timely and accurate information holds the promise of better
coordination and better decision making. With good information, people can make
effective decisions about what to produce and how much, about where to locate
inventory and how best to transport it.
The sum of these decisions will define the capabilities and effectiveness of a
company’s supply chain. The things a company can do and the ways that it can
compete in its markets are all very much dependent on the effectiveness of its supply
chain. If a company’s strategy is to serve a mass market and compete on the basis of
price, it had better have a supply chain that is optimized for low cost. If a company’s
strategy is to serve a market segment and compete on the basis of customer service
and convenience, it had better have a supply chain optimized for responsiveness. Who
a company is and what it can do is shaped by its supply chain and by the markets it
serves.
9.2.1 Develop Needed Supply Chain Capabilities

Once you know what kind of markets your company serves and the role your
company does or will play in the supply chains of these markets, then you can take
this last step, which is to develop the supply chain capabilities needed to support the
roles your company plays. This development is guided by the decisions made about
the five supply chain drivers. Each of these drivers can be developed and managed to
emphasize responsiveness or efficiency depending on the business requirements.
1. Production: This driver can be made very responsive by building factories that
have a lot of excess capacity and that use flexible manufacturing techniques to
produce a wide range of items. To be even more responsive, a company could do
their production in many smaller plants that are close to major groups of
customers so that delivery times would be shorter. If efficiency is desirable, then a
company can build factories with very little excess capacity and have the factories
optimized for producing a limited range of items. Further efficiency could be
gained by centralizing production in large central plants to get better economies of
scale.
2. Inventory: Responsiveness here can be had by stocking high levels of inventory
for a wide range of products. Additional responsiveness can be gained by stocking
products at many locations so as to have the inventory close to customers and
available to them immediately. Efficiency in inventory management would call
for reducing inventory levels of all items and especially of items that do not sell as
frequently. Also, economies of scale and cost savings could be gotten by stocking
inventory in only a few central locations.
3. Location: A location approach that emphasizes responsiveness would be one
where a company opens up many locations to be physically close to its customer
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176 base. For example, McDonald’s has used location to be very responsive to its
Logistics and
Supply Chain Management customers by opening up lots of stores in its high volume markets. Efficiency can
be achieved by operating from only a few locations and centralising activities in
common locations. An example of this is the way Dell serves large geographical
markets from only a few central locations that perform a wide range of activities.
4. Transportation: Responsiveness can be achieved by a transportation mode that is
fast and flexible. Many companies that sell products through catalogs or over the
internet are able to provide high levels of responsiveness by using transportation
to deliver their products, often within 24 hours. FedEx and UPS are two
companies who can provide very responsive transportation services. Efficiency
can be emphasized by transporting products in larger batches and doing it less
often. The use of transportation modes such as ship, rail, and pipelines can be very
efficient. Transportation can be made more efficient if it is originated out of a
central hub facility instead of from many branch locations.
9.3 EVOLUTION OF SUPPLY CHAIN MANAGEMENT

The 1990s were a decade that brought in a quantum jump in many areas of
management. One major area of great change was in the fields of Materials
Management, Procurement, Physical Distribution Management and Business
Logistics. These disciplines went through several evolutionary stages.
Traditional Procurement, Physical Distribution Management and Materials
Management in the 1970s, evolved into Logistics Management in the 1980s. Logistics
Management consolidated the traffic and transportation activities of the firm. Logistics
then evolved into Supply Chain Management in the 1990s. Supply Chain Management
combined the activities of Materials Management and Logistics.
This change began in the 1960s and 1970s. With growth of computer capabilities new
systems to handle material requirements were devised. The first of these was Material
Requirement Planning (MRP). This was followed by Manufacturing Resource
Planning (MRPII). These systems brought about recognition of the importance of the
impact of high levels of inventories on manufacturing and storage costs. As the
sophistication of inventory tracking software grew, it became possible to further
reduce inventory costs.
The concept of the supply chain had already been proposed by Forrester in 1958.
However, the first widely recorded use of the term supply chain management came
about in a paper published by Keith and Webber in 1982. Globalisation and intensified
competition, in the 1990s, finally made organisations realise the potential benefits and
importance of strategic and cooperative supplier-buyer-customer relationships. The
concept of these partnerships or alliances emerged as US manufacturers tried to
compete with the Japanese and experimented with Just-in-time (JIT) and Total Quality
Management (TQM).
This led manufacturers to purchase from a select number of certified, high-quality
suppliers with excellent service reputations. As they this strategy successful, they
started giving only their best suppliers most of their business, and in return, they
expected these relationships to help generate more sales through improvements in
delivery, quality, and product design and to generate cost savings through closer
attention to the processes, materials, and components they used in manufacturing their
products. With quality suppliers, firms also found it beneficial to involve them in their
new product design and development activities as well as in cost, quality, and service
improvement initiatives.
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The success in the materials function led companies to understand the necessity of 177
integrating all key business processes among the supply chain participants. This
encompassed the distribution network. As finished goods are the value added products
of the supply chain, they constituted a huge investment in inventory, often greater than
that of raw materials and components. This encouraged the thought of enabling the
supply chain to act and react as one entity, from suppliers to the retailers.
Companies saw the benefits in the creation of alliances or partnerships with their
customers. In time, when market share improved for its customers' products, the result
was more business for the firm. Developing these long-term, close relationships with
customers meant holding less finished product safety stock (as discussed earlier about
the Forrester effect) and allowed firms to focus their resources on providing better
products and services to these customers. Today, logistics is viewed as one important
element of the much broader supply chain management concept.
Supply chain management, as explained above, has evolved along two parallel paths:
1. The materials and supply management emphasis from industrial buyers, and
2. The transportation and logistics emphasis from wholesalers and retailers.
For the manufacturing firm, the supply chain management focus is on the impact of
high levels of inventories on manufacturing and storage costs. For the wholesaling and
retailing industries, the supply chain management focus is on location and logistics
issues more often than on manufacturing.
Sharing information with supply chain partners through EDI and the Internet has
enabled firms to integrate stocking, logistics, materials acquisition, shipping, and other
functions to create a more proactive and effective style of business management and
customer responsiveness starting out from the source of raw materials right up to the
user of the final product.
One major change that has taken place is in the manner in which management now
treats functions and processes. From the functional view, i.e. viewing it as a
departmental activity; management studies started looking at these functions as parts
of business processes.
What are the differences between a function and a business process? The distinctions
between functions and processes are explained below.
A business function is:
z A group of business activities that together completely support one aspect of
furthering the mission of the business.
z It is ongoing and continuous.
z It reflects the organisational component responsible for the activities.
z It is concerned with what has to be done to operate the business.
A business function does not include how the work is carried out. Examples are
purchasing, stores, receipt, materials management, etc.
In contrast, a business process is:
z A task or group of tasks carried out to furthering the mission of the business.
z It is executed repeatedly.
z It has a beginning and an end.
z It is only concerned with what has to be done.
z It is described in terms of inputs and outputs.
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178 A business process addresses the question of how work is organized and managed
Logistics and
Supply Chain Management across the organisation i.e. grouping similar activities together. A business process
does not include the organisational component responsible. Examples are Aggregate
Planning, Material Requirement Planning, Supply Chain Management, etc.
As has been mentioned in the last section, supply chain relationships can be quite
complex. Instead of the process view, we will start with the functional view. It is
easier to understand the workings of Supply Chain Management if we start with this
traditional view of supplier-buyer relationships as reflected by the materials function.
The concepts and the relationships that will be discussed will also be applicable to
Supply Chain Management.
9.4 UNDERSTANDING THE SUPPLY CHAIN

MANAGEMENT
The traditional concept of business is obsolete. Companies, both manufacturing and
service, are creators of value, not simply makers of products. Supply Chain
Management (SCM) focuses on globalization and information management tools
which integrate procurement, operations, and logistics from raw materials to customer
satisfaction. Future managers are prepared to add product value, increase quality,
reduce costs, and increase profits by addressing the needs and performance of:
supplier relations, supplier selection, purchasing negotiations, operations,
transportation, inventory, warehousing, benchmarking, third-party vendors, electronic
commerce, recycling, supply chain electronic software and customer relations.
A "supply chain" consists of interconnected components required to transform ideas
into delivered products and services. Supply chain management is a business approach
that focuses on integration, and partnerships, in order to meet customers' needs on a
timely basis, with relevant and high quality products, produced and delivered in a cost
effective manner. Current interest in supply chain management stems from the need of
world-class organisations to purchase, produce, move, and market goods and services
on a global basis.
Supply Chain Management is involved in the process of planning, implementing and
controlling operations for serving customers as efficiently as possible. It encompasses
all activities involved in sourcing, procurement, conversion and logistics. The supply
chain is based on two core concepts:
1. The first; practically every product that reaches an end user represents the
cumulative effort of multiple organisations. These organisations are referred to
collectively as the supply chain. A supply chain consists of multiple firms, both
upstream (suppliers) and downstream (distribution).
2. The second; organisations have to minimize conflicts in objectives outside their
“four walls” and manage the entire chain of activities that ultimately delivers
products to the final customer in order that each stage of the supply chain and all
its constituents can maximize profits.
Historically built on Procurement, Operations and Logistics foundations; Supply
Chain Management exceeds these traditional concepts. Supply chain management is
involved with integrating three key flows, between the different stages, across the
boundaries of the companies:
z Flow of information,
z Product/materials, and
z Funds.
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Members of the supply chain act as partners who are “linked” together through 179
both physical and information flows. It is this that makes an effective supply chain.
The flows that involve the transformation, movement, storage of goods and materials
and money are called physical flows. These flows are easily visible.
The physical flows are reinforced by information flows. Information flows are used by
the various supply chain partners to coordinate their long-term plans, as well as
efficiently control the day-to-day flow of goods and material to the supply chain.
In essence, the supply chain enables the flow of products, services, and information
goes both up and down the chain. Successful integration or coordination of these three
flows produces improved efficiency and effectiveness for business organisations.
‘Supply Chain Management’ can be defined as the active management of supply chain
activities to maximize customer value and achieve a sustainable competitive
advantage. It represents a conscious effort by the supply chain firms to develop and
run supply chains in the most effective and efficient ways possible.
There can be various types of supply chains. There is a basic supply chain, and an
extended supply chain. The definition of a basic supply chain is a set of three or more
companies directly linked by one or more of the upstream or downstream flows of
products, services, finances and information from a source to a customer.
An extended supply chain includes suppliers of the immediate supplier and customers
of the immediate customer, all linked by one or more of the upstream and downstream
flows of products, services, finances and information.
SELLER BUYER (a)
SUPPLIER SELLER BUYER (b)
Figure 9.1: (a) Traditional Supplier-Buyer Relationship, (b) Basis Supply Chain
Figure 9.1 shows a traditional seller-buyer relationship (a) and a basic supply chain
(b). An extended supply chain is the supply chain shown in Figure 9.2. An extended
supply chain consists of a number of relationships. These are called tiers. The
simplified version of the supply chain of Kalyani Breweries, exemplifies this.
2nd tier 1st tier
supplier supplier Distributor Retailer
Kalyani Final
Supertech UBSN
NALCO Breweries DSIDC customers
Industries Ltd.
Transportation Companies
Figure 9.2: A Simplified View of Kalyani Breweries Supply Chain

For the product to reach a typical customer who goes to the shop to buy beer, these
linkages and the steps necessary to bring the product to him are not probably apparent.
Take cans, for example. National Aluminium (NALCO) extracts the aluminium ore
and converts it into aluminium metal. The aluminium metal is shipped to Supertech
Industries at Bangalore, who convert the aluminium into cans. Supertech Industries
supplies cans to Kalyani Breweries. As Supertech Industries supplies directly to
Kalyani Breweries, it is a first-tier supplier in the supply chain. Using the same logic,
NALCO is a second-tier supplier. It is the supplier of a supplier.
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180 The beer is produced from other raw materials, such as barley, hops, yeast, and water.
Logistics and
Supply Chain Management Aluminium cans from Supertech Industries used to contain the product and combined
with cartons, to produce the packaged beverage. Kalyani Breweries then sells the
packaged beverage to UBSN Ltd., the distributor, who in turn sells the finished good
to retailers like DSIDC. Transport carriers, who move the inputs and outputs from one
place to the next along the supply chain, provide the logistic support.
In the example given, we see that goods and information flow travels both ways.
In other words, members in a supply chain are both customers and suppliers, with
respect to these flows. For example, Supertech Industries places an order
(information) with Nalco, who in turn ships aluminium (product) to Supertech
Industries.
Supertech Industries is therefore a customer to Nalco and a supplier to Kalyani
Breweries. We can visualise an extended relationship where Kalyani Breweries
returns empty pallets or containers to its first-tier suppliers. This would result in a flow
of physical goods back up the supply chain. If this happens, Kalyani Breweries
becomes a supplier to Supertech Industries. This is in addition to its being the
customer. An organisation can be part of numerous supply chains. This follows from
the definition given earlier.
For any supply chain, there is only one source of revenue: the customer. At DSIDC, a
customer purchasing beer is the only one providing positive cash flow for the supply
chain. All other cash flows are simply fund exchanges that occur within the supply
chain given that different stages have different owners. When DSIDC pays its
supplier, it is taking a portion of the funds the customer provides and passing that
money on to the supplier. It is all these flows — information, products, or funds – that
generate the costs within the supply chain.
The appropriate design of the supply chain will depend on both the customer’s needs
and the role of the stages involved. This relationship, we have described above,
reflects a single strand in the supply chain. In a typical supply chain there are many
more participants than the ones shown above — Kalyani Breweries has hundreds of
suppliers who provide barley, hops, yeast, cartons etc. It also has a large extended
network of retailers throughout the country whose number is even higher.
Regardless of the number and different types suppliers a firm uses to satisfy its
requirements, the overall structure and its essential interfaces and control processes
have to be identified, irrespective how vast and complex the system is.
Any operation or facility in one supply chain arrangement may also be a part of
different supply chains. For example, as was mentioned earlier, Dabur is a part of the
supply chain for consumer care products, consumer health products, food products,
and home products.
A supplier typically participates in numerous different supply chains, which may
involve a wide variety of industries and customers. In the case of the mail order
business, such as Amazon.com, the company maintains an inventory of product from
which it fills customer orders. In the case of retail stores, the supply chain may also
contain a wholesaler or distributor, the store and, the manufacturer. The final
consumer is always considered a member of the supply chain.
There can be many types of supply chains. For example, a third-party logistics (3PL)
provider may be a member of two supply chains where it is performing the logistics
activities between companies that conventionally compete with each other. An
example of an even more complex relationship could be the case of Reliance
Communications. Reliance Communications might find Nokia to be a customer in one
supply chain, a partner in another, a supplier in a third, and a competitor in still a
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fourth supply chain. This multiple supply chain phenomenon also explains the 181
complex nature of the network created by many supply chains.
Figure 9.3: Conceptual Diagram of a Supply Chain

In large enterprises, like Dabur, involved in marketing a broad product line to
numerous customers – engaging in basic manufacturing and assembly, and procuring
materials and components on a global basis, the supply chain is very complex.
However, for any supply chain, there is only one source of revenue, the customer.
Logically, the sources of cost are all flows of information, product or funds. Thus, the
appropriate management of these flows is a key to supply chain success. The
conceptual framework of a supply chain is shown in figure 9.3.
In evaluating the success of the supply chain, the links between the manufacturer and
the retailer have to function at a desired level. Even when the performance at earlier
stages of the supply chain is outstanding, this is not important: if the product is not
available to support retail sales. This is because the end customer is the only source of
revenue for the supply chain and the linkage is the ultimate test to the success of the
supply chain.
The basic objective of Supply Chain Management is to maximise the supply chain
profitability. A more successful supply chain will, therefore, have higher profitability.
The profitability of a supply chain is the difference between what the customer pays
for the final product and the costs the supply chain expends in filling the customer's
request.
FMCG major Hindustan Lever has reduced its inventory from about 45 days to
less than 5 days; Mahindra & Mahindra has been able to reduce its inventory by
20-50 days, while in LG’s case the reduction has been around 30 days. These
companies attribute a significant part of their success to the way they manage the
operations of their supply chain.
9.4.1 Typology of Supply Chains

In most organisations, some products or services are produced internally or others are
purchased. The supply chain concept covers both internal as well as external parts.
Therefore, there are (a) Internal Supply Chains, and (b) External supply chains.
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182 Internal Supply Chains
Logistics and
Supply Chain Management The flows of the supply chain that occur within the individual organisation are called
the internal supply chain. The first step in moving towards supply chain management
is to develop these internal chains. Given the multidivisional, international
organisational structures found in many businesses, internal supply chains can be quite
complex. In transnational companies that have globalized operations, the internal part
of a supply chain often has multiple “links” that span the globe.
Complications in multi-divisional and globalized companies are created, when the
employees of one division view the ‘other’ divisions in much the same manner as they
would external suppliers or customers. In some cases, this creates competition and
conflict of interest between divisions. The supply chain initiative in such structures
should start from the organisation’s internal supply chain. Developing an
understanding of this is often an appropriate starting point. This makes integrating
cross-divisional functions and processes simpler.
The supply chain is a set of interrelated processes and should not be visualized as a
series of discrete, independent activities. Process maps are developed to understand
the overall internal supply chain linkages. These maps provide the basic information
required to link the different entities. Some of the key processes and their extensions
include order preparation by purchasing, different activities related to manufacturing,
order information from sales, order entry for materials planning, warehousing and
distribution operations, and order shipment for transportation and delivery. Each of
these key processes needs to be documented along with current performance
information.
In order to establish an effective and successful supply chain it is necessary that
supply chain process maps (flow charts) are developed for major supply chains and
their related processes. This is a basic requirement. It helps when the different
divisions understand the steps in their portion of the supply chain and also have an
appreciation of “what happens” outside their part of the process.
External Supply Chains

The decisions, to purchase a product or service from external suppliers, are the basis
for the external supply chain. From the supply chain point of view, the external
portion of the supply chain (i.e., key suppliers and customers) is an extension of the
internal supply chain. The firm's external networks, including suppliers, complement
its internal capabilities in the pursuit of offering products and services at competitive
prices and quality.
The processes involved in the analysis of the external supply chain are similar to that
of the internal supply chain. Therefore, by understanding the internal supply chain, it
is relatively easy to extend the concept of the analysis to the external supply chain.
Extending this analysis, and then including the internal supply chain in the analysis, is
an important step in the development of supply chain management. In this composite
picture there are multiple organisations involved and their representatives are now also
participating and a part in the analysis.
However, the extension of the analysis to the external supply chain from the internal
supply chain adds a greater level of complexity. Considering that the task is enormous,
most organisations focus their efforts on those supply chains that are most important
to their success. An organisation, therefore, has to determine which linkages need to
be considered as important.
The most significant opportunities for improvement in a supply chain are often at the
interfaces between the various supply chain member organisations. An example is
cross-docking applied to warehousing which can improve the efficiency of
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transportation as well as reduce the costs of warehousing and inventory. There are 183
numerous such opportunities at the different interfaces. Identifying and implementing
these opportunities provides a challenge to supply chain managers.
Internal or External Solutions

The costs that must be considered when investing in and using internal or external
solutions to the supply chain include not only the cost of running and maintaining the
systems, but also the cost of purchasing and implementing the functionalities
(transition cost) e.g. linking internal processes or systems to the supplier.
In addition to these costs, which can be measured relatively easily, the firm must also
consider the opportunity cost of not running efficient supply chain processes. This cost
is termed competitive cost. The competitive cost can be thought of as the opportunity
cost of using inefficient (relative to the firm's competitors) supply chain processes for
serving customers and suppliers.
Lastly, the firm should realize a long-term benefit from the acquisition of capabilities
(salvage value). The salvage value reflects the benefit the firm realizes from building
long-term capabilities either internally or externally. The benefits derived from this
are reflected in a decrease in the competitive and/or the running and maintenance
costs.
The firm's decision has to be one that seeks supply chain efficiencies through internal
capabilities, through the participation of external supply chain members, or through a
combination of both.
Fill in the blanks:
1. Efficiency in ………………….management would call for reducing
inventory levels of all items and especially of items that do not sell as
frequently.
2. A ………………………….consists of interconnected components
required to transform ideas into delivered products and services.
3. Supply Chain Management is involved in the process of
………………………., implementing and ……………………operations
for serving customers as efficiently as possible.
4. An extended supply chain consists of a number of relationships. These are
called ……………………
5. The flows of the supply chain that occur within the individual
organisation are called the………………………
9.4.2 Supply Chain Management as a Philosophy

Supply chain management is also a philosophical approach that incorporates a body of
tools and techniques to improve the flow of materials from and between more than
two participants. A lot of interaction and trust between companies is required to make
the supply chain work. In that respect, it is significantly different from materials
management.
Consider the supply chain shown in Figure 9.4. The component supplier after making
the component sends the material to the material warehouse. From the material
warehouse, the material goes to the manufacturer. After completion of manufacturing
operations, the material goes to the finished goods warehouse, where it is transferred
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184 to the customer warehouse on receipt of an order. From the customer warehouse, the
Logistics and
Supply Chain Management product moves to the retail outlet, from where it is purchased by the customer.
Figure 9.4: Different Stages of a Supply Chain

This is basically what the philosophy of the supply chain management recognizes.
Without the retail store the supplier does not make any profit and without the supplier,
the retail store has no business. In either case, the customer gets no value. But what
does this mean in terms of the supply chain?
Firstly, every product that reaches an end user represents the cumulative effort of
multiple organisations. And secondly, organisations have to pay attention to what is
happening outside their “four walls” and manage the entire chain of activities that
ultimately delivers products to the final customer in order to maximize profits. This
means that the supply chain philosophy extends the concept of partnerships into a set
of beliefs that each firm in the supply chain directly and indirectly affects the
performance of all the other supply chain members. It also affects the ultimate, overall
channel performance.
This philosophy recognizes that the purpose of supply chain management is to
improve customer value and satisfaction. It directs supply chain members to focus on
developing innovative solutions to create unique, individualized sources of customer
value. The ultimate objective of Supply Chain Management (SCM) translates into a
philosophy which has the following characteristics:
1. Systems approach to viewing the channel as a whole, and to managing the total
flow of goods inventory from the supplier to the ultimate customer,
2. Strategic orientation toward cooperative efforts to synchronize and converge intra-
firm and inter-firm operational and strategic capabilities into a unified whole, and
3. Customer focus to create unique and individualized sources of customer value,
leading to customer satisfaction.
SCM philosophy drives supply chain members to have a customer orientation. To do
this successfully you need to synchronize the intra-firm and inter-firm operational and
strategic capabilities into a unified, compelling marketplace force. Therefore, the SCM
philosophy suggests the boundaries of SCM include not only logistics, but also all
other functions within a firm and within a supply chain to create customer value and
satisfaction.
This follows directly from Forrester’s early concepts. Forrester recognized the
integrated nature of organisational relationships and argued that these influence the
performance of different functions. He said, “Managements need to understand better
the interrelationships between separate company functions and between the company
and its markets and its industry”. The ‘Forrester Effect’ illustrates the phenomenon
that he described. It shows the influence of order information flow on production and
distribution performance for each supply chain member, as well as the entire supply
chain system.
In adopting a supply chain management philosophy, firms must establish management
practices that permit them to act or behave consistently with this philosophy. There
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are a number of activities that are necessary to implement an SCM philosophy 185
successfully. In adopting a supply chain management philosophy, firms must establish
management practices that permit them to act or behave consistently with the
philosophy. Previous research has suggested various activities necessary to implement
an SCM philosophy successfully. The primary SCM activities are:
1. Integrated behaviour and integration of processes
2. Mutually sharing information
3. Mutually sharing channel risks and rewards
4. Cooperation
5. Goal-sharing and partnership
To be fully effective in today's competitive environment, firms must exhibit integrated
behaviour with the supply chain partners, such as suppliers, carriers, and
manufacturers, to dynamically respond to the needs of the end customer. Customer
Relationship Management (CRM) and Demand Planning have given today’s
businesses better tools for managing and integrating customers’ demands across a
company’s entire value chain. These tools, coupled with proven business strategies
and processes, produce a uniform picture of demand that can then integrate the
behaviour and drive all subsequent planning and operations helping in the integration
of processes. The end result is an agile organisation, capable of rapidly recognizing
and responding to changes in the market.
Integrated behaviour and integration of processes leads to information sharing.
Information sharing is the willingness to make strategic and tactical data available to
other members of the supply chain. Open sharing of information such as inventory
levels, forecasts, sales promotion strategies, and marketing strategies reduces the
uncertainty between supply partners and results in enhanced performance.
Effective SCM also requires supply chain partners mutually sharing channel risks and
rewards that yield a competitive advantage. Risk and reward sharing should happen
over the long term. According to many experts, for long-term focus and cooperation
among the supply chain members, risk and reward sharing is extremely important.
Risk and reward sharing is a very, very difficult task. Though conceptually, it is
possible, but no organisation likes to forego its revenues and profits, and it becomes
very difficult unless you can sell the benefits to the organisation.
Cooperation among the channel members is required for effective SCM. Cooperation
starts with joint planning and ends with joint control activities to evaluate performance
of the supply chain members. It happens at several management levels involving
cross-functional coordination across the channel members.
Getting people to cooperate is the most difficult part of supply chain management,
even when it may produce superior mutual outcomes. As mentioned in the last
paragraph, people are generally concerned about themselves and would like to
promote their individual parochial objectives and cooperation limits the freedom of
firms to act in their own interest when performing similar or complementary activities.
A supply chain succeeds if all the members of the supply chain have the same goal
and the same focus on serving customers. Establishing the same goal and the same
focus among supply chain members means that they are working towards a form of
policy integration. Most organisations go through four stages of policy integration:
z Stage 1 represents the base line case. At this point, the supply chain is a function
of fragmented operations within the individual company. It is based on traditional
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186 concepts and characterized by staged inventories, independent and incompatible
Logistics and
Supply Chain Management control systems and procedures, and functional segregation.
z Stage 2 is the start of internal integration. It begins with a focus on cost reduction
rather than performance improvement. It is characterized by an emphasis on
internal trade-offs and reactive customer service.
z In Stage 3 the firm reaches toward internal corporate integration. It is
characterized by full visibility of purchasing through distribution, medium-term
planning, tactical focus, emphasis on efficiency, extended use of electronics
support for linkages, and a continued reactive approach to customers.
z Stage 4 has a strategic focus. The organisation achieves supply chain integration
by extending the scope of integration outside the company to embrace suppliers
and customers.
All firms go through these four stages. Ultimately, policy integration is made possible
by the supply chain members trying to create compatible cultures and management
techniques. Collaboration takes place when two or more independent companies work
jointly to plan and execute supply chain operations with greater success than when
they are acting in isolation. This is not easy and requires a sustained effort through
cross-functional teams, in-plant supplier personnel, and third party service providers.
Firms that have reached stage 4, precede to build-up a series of partnerships.
Successful partnerships aim to integrate supply chain policy to avoid redundancy and
overlap, while seeking a level of cooperation that allows participants to be more
effective at lower cost levels. The organisation should select a small number of
partners to facilitate increased cooperation. You have an effective SCM when these
partners build and maintain long-term relationships where the relationship time
horizon extends beyond the life of the contract - perhaps indefinitely.
Supply Chain Management extends the supply chain philosophy across all members of
the chain. By integrating behaviour and processes, sharing information, planning in
collaboration with each other, sharing the risks and rewards, co-operation, goal
sharing and partnerships, the operations in the supply chain can be streamlined and the
profitability of all members in the chain improved.
Dell and Wal-Mart have been the pioneers in this concept of Supply Chain
Management. They reflect some of the most successful examples of effective supply
chain management. What is interesting is that they have created world-class supply
chains by tackling the ‘Forrester Effect’ from different ends. Dell has been a pioneer
in the build-to-order (‘pull’) cycle i.e. reducing forecasting based demand uncertainty,
and Wal-Mart has been a pioneer in the use of information flow to reduce demand
uncertainty.
Dell Computers builds-to-order, i.e. a customer order initiates manufacturing at Dell.
Dell does not have retailers, wholesalers, or distributors in its supply chain. While
other computer companies must stock a month of inventory, Dell carries only a few
days worth of stock. It plans orders and signals suppliers every two hours, which
enables it to manufacture and deliver exactly what its customers want. In fact, many of
the components are delivered to Dell within a few hours of assembly and shipped to
the customer.
The success of Wal-Mart is drawn from new technologies combined with new ways of
doing business. It has used the power of information flow to create a global supply
chain designed down to the last atom of efficiency. Automated replenishment and the
smooth functioning of the Wal-Mart supply chain depend on reliable connectivity
between the stores, the centralized database, and the distribution centres. The Wal-
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Mart network connects more than 2,400 stores, 100 distribution centres worldwide, 187
and 950,000 Wal-Mart associates.
The success of supply chains is based on their ability to deliver superior cost, quality,
delivery, and technological performance. These, along with the process linkages
between the participants, are critically important factors to make for a successful
supply chain.
Finally, it is necessary to appreciate that in order to operate a supply chain
successfully you need to clearly understand intra-organisational and inter-
organisational supply chain processes. Where organisations do not keep this in view or
take too much time to evolve inter-organisational processes, it generally becomes too
late for the supply chain to succeed. There are more failures in SCM than there are
successes.
9.4.3 Supply Chain Flows

Supply chain management, as we have seen, involves the proactive management of a
two-way movement and flows of goods and services, information, and funds. It starts
with the raw material and goes through to the end user or customer.
Figure 9.5: Supply Chain Flows

Figure 9.5 shows the flows in a supply chain. While the product/service flows
outwards from the manufacturer to the customer, both information and funds flow
from the customer to the manufacturer.
There is a close connection between the design and management of supply chain
flows. Both design and management are critical to the success of a supply chain.
Firms, who have been successful in designing a good supply chain, and used practices
to support the chain, have found that the supply chain has the ability to greatly impact
the success of the firm’s competitive strategy.
In contrast, firms that have shown an inability to design and manage supply chain
flows properly have often been led to failure. In order to match the design and
management of supply chain flows we need to understand supply chain flows. We will
discuss these flows in this section.
9.4.4 Product/Material Flow

The product/material flow in a supply chain is concerned with the procurement,
movement and storage of materials and finished products. For a large manufacturer,
these operations may consist of thousands of components, raw materials and parts and
their movements, which ultimately culminate in the delivery of products to an
industrial user, retailer, wholesaler, dealer, or other customer. For a large retailer,
supply chain operations may commence with the procurement of products from the
manufacturer and may terminate with consumer pickup or delivery of the product.
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188 For better understanding it is useful to divide product/service flows into three areas:
Logistics and
Supply Chain Management procurement, manufacturing support and physical distribution.
Procurement: Procurement is concerned with purchasing and arranging inbound
movement of materials, parts, and/or finished inventory from suppliers to
manufacturing or assembly plants, warehouses, or retail stores. Whereas physical
distribution is concerned with outbound product shipments, it is inbound movement to
the buyer of the product.
Inbound Logistics
Inbound logistics or the process of acquisition of materials is typically called
purchasing. Materials are involved in the process of adding value through
manufacturing. Purchasing is concerned with availability of the desired material
assortments where and when needed.
Figure 9.6: Procurement Activities

Procurement involves five activities: sourcing, order placement and expediting,
supplier relationship, transportation (inbound and outbound logistics) and receiving.
These activities are shown in Figure 9.6.
On the operational side, inventory turns is a key performance measure that be watched
very closely. Let us take an example. There are two companies, ‘A’ and ‘B’, who have
identical sales and profit margins over a one-year period.
‘A’ buys one crore worth of parts at the beginning of the year. It sells the finished
products by year's end at a 10 percent profit, which generates ` 1.1 crore in total
revenues.
‘B’ uses a more aggressive inventory management strategy. It buys parts four times
during the year, spending only ` 25 lac at a time, and reordering just before running
out of components. Essentially, the company reinvests the same ` 25 lacs to replace
sold inventory. By year's end, ‘B’ generates the same ` 1.1 crore.
However, since ‘B’ is only investing ` 25 lac at a time, it is spending ` 75 lac less on
inventory than ‘A’. Considering an interest rate of 15 percent, ‘B’ pays an interest of
` 5 lacs for inventory, while ‘A’ pays ` 20 lacs. If ‘A’ makes a profit of ` 10 lacs, the
‘B’ has made a profit of ` 25 lacs. ‘B’ has also reduced his capital risk for the year
compared to ‘A’.
This example shows that simply by increasing inventory turnover, the company
generates more profit and more free cash flow. The procurement system has the ability
to control inventory turnover as it initiates orders.
In retailing and wholesaling, buying is the most widely used term for procurement. It
is also called outbound logistics. Products (inventory that is available for consumer
purchase) are ready for consumption. A unique characteristic of outbound logistics is
that the customer base it services is typically more than the number of suppliers a firm
uses.
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In its physical distribution operations, each firm is only one of many participants in an 189
overall supply chain. Materials and parts are often purchased directly from either the
original manufacturer or a specialized industrial wholesaler. The utilization of direct
channels is an important factor in the design of a supply chain system for
procurement.
It is more complex than inbound logistics, since customer order processing handles
orders in response to customers' requirements; random ordering must be
accommodated by the physical distribution system. The ability to determine when and
where products are purchased serves to substantially reduce operational variance
compared to purchasing where operational variances are much lower.
Physical Distribution
The area of physical distribution concerns movement of a finished product to
customers. In physical distribution, the customer is the final destination of a marketing
channel. It is through the physical distribution process that the time and space of
customer service become an integral part of marketing, linking marketing channels
with its customers.
This links marketing and the supply chain, the interface between these two functions
is critical. Very often, there is a potential for conflict in this relationship.
In a typical organisation, marketing tries to accommodate customer requirements,
while manufacturing requires long stable production runs to control costs. Inventory is
used to reconcile the difference in perspectives of marketing and manufacturing. This
compels supplies to use forward deployment throughout the system on the basis of
forecasted sales. This is often the reason for the confrontation with marketing as there
is always the possibility that inventories are moved to the wrong markets and at the
wrong time.
The key to understanding physical distribution dynamics is to realize that customers
initiate the process by placing an order. Although similar or even identical
requirements may be involved, the degree of managerial control and risk related to
performance failure varies substantially between physical distribution and
procurement.
Figure 9.7: Physical Distribution Cycle Activities

Typical physical distribution involves five activities: order transmission, order
processing, order selection, order transportation and customer delivery. These
activities have been shown in Figure 9.7.
Analysis, of how customers order products, is necessary to minimise operational
variance and simplify transactions. This requires improving forecast accuracy. There
should be proper coordination between customers and order management to reduce
uncertainties. And finally, the physical distribution system should be designed to be as
flexible as possible.
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190 Manufacturing Support
Logistics and
Supply Chain Management The area of manufacturing support concentrates on managing an orderly and
economic flow of materials and work-in-process inventory between the different
stages of manufacturing. This constitutes movement and storage of product, materials,
semi-finished parts and materials between the firm’s facilities.
Manufacturing support is treated as a distinct operating area. This is because
manufacturing support represents the most complex internal support operations and
has one significant difference when compared with physical distribution. Unlike
physical distribution, which attempts to service the desires of customers and therefore
must accommodate the uncertainty of consumer and industrial demand, manufacturing
support involves supply and movement requirements that are under the control of the
manufacturing enterprise.
Supply chain capabilities are stretched by the requirements of quick manufacturing
switchover and shorter production runs. This requires numerous handlings and
transfers of materials and economies of scale have often to be discarded. As the
number of plants with specific production activities of the firm increase, the
manufacturing support system gets to become more complex.
Integrating Material/Product Flows

Within a typical enterprise the three areas, physical distribution, manufacturing
support, and procurement overlap to provide integrated management of materials,
semi-finished components, and products moving between locations, supply sources,
and customers of the enterprise. Viewing each as an integral part of the overall value-
adding process creates an opportunity to capitalize on the unique attributes of each
while facilitating the overall process.
Supply chain can also be viewed as an integral part of the value chain. Michael Porter,
from Harvard University, first articulated the value chain concept in the 1980s. The
value chain reflects the addition of value of activities in a firm. It is comprised of both
the primary and support activities. Two of the primary activities of the value chain –
inward and outward logistics – are included in the activities of the supply chain. The
supply chain, therefore, is a subset of the value chain
Figure 9.8: Supply Chain is part of the Value Chain

The value a supply chain generates is the difference between what the final product is
worth to the customer and the effort the supply chain expends in filling the customer’s
request. Therefore, the profitability of the supply chain is based on the flows between
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and among stages in a supply chain, unlike the traditional measure of organisational 191
success in terms of the profits at an individual stage. The final price of the goods
should be such that it covers all of the costs involved, with a profit share for each
participant in the chain. Figure 9.8 shows the supply chain as a network and also as a
part of the value chain.
(i) Information Flows: Within individual supply chain areas, different requirements
exist with respect to size of order, availability of inventory and urgency of
movement. Information flow identifies specific locations within a supply chain
that requires attention. The primary objective of information sharing is to
reconcile any disparity in the system. Accurate information makes the supply
chain become more effective.
Supply chain information also integrates different operating areas. The
information facilitates coordination of planning and control of day-to-day
operations. This integration of different areas involves three major types of
information flows:
Coordination flows,
Cash flows and
Operational flows.
As mentioned earlier, the flow of goods/inventory is in forward direction, the
direction of money flow is in the backward direction and the flow of information
is in both directions.
Forward information deals with the availability of goods, order processing,
inventory status, documentation, quality assurance reporting, warranty, etc.
Backward information provides quality feedback, customer orders, procurement
quality, quantity, specification and timing, production and dispatch planning.
These information flows facilitate the coordination function.
(ii) Fund Flows: The ability to convert purchased components into products — and
then cash — in the most efficient way possible reflect on the profits of the supply
chain. There is only one source of funds — the customer. You pay for the product,
the retailer pays the wholesaler, and the wholesaler pays the manufacturing
company. Similar information, material, and fund flows take place across the
entire supply chain. Hence it is also transfer of money.
There are solutions that reduce processing costs significantly by offering enhanced
visibility and less uncertainty in accounts receivable and accounts payable, with a
significant reduction in working capital needs. Furthermore, they also accelerate
the process of procuring goods, accelerating payment and invoice reconciliation.
Sainsbury, the leading food retailer in UK, for example, has introduced a system
that enables its suppliers to get access to sources of funds potentially using their
borrowing rate rather than the rate they might be used to using. They found this
very attractive as according to them, financing methods can add up to 4 percent of
the cost of goods.
The higher the speed of transfer of money, the better is the financial position of
the firm, as the flow of money supports the movement of products and may also
add to the cost. It is important, therefore, to expedite the flow of funds because it
determines the financial position of the company. Dell, for example, manages its
cash flows very effectively. By managing receivables and payables very closely, it
is able to collect cash from its customers, on average, ten to fifteen days before it
has to pay its suppliers. This is one of Dell’s major competitive advantages.
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192 Supply chain decisions in the management of product, information, and cash flows
Logistics and
Supply Chain Management play a key role in the success or failure of a firm. The information flow determines the
speed of material flow and increased responsiveness to customer requirements, which
will in turn ensure faster money flow back into the supply chain and greater supply
chain profits.
State whether the following statements are True or False:
1. The component supplier after making the component sends the material to
the material warehouse.
2. Information sharing is the willingness to make strategic and tactical data
available to other members of the supply chain.
3. Effective SCM also requires supply chain partners mutually sharing
channel risks and rewards that yield a competitive advantage.
4. In physical distribution, the customer is not the final destination of a
marketing channel.
5. The value a supply chain generates is the difference between what the
final product is worth to the customer and the effort the supply chain
expends in filling the customer’s request.
9.5 LET US SUM UP

A supply chain is a partnership of firms who are involved in providing a product or
service. There are a number of stages involved in the supply chain. Generally, more
than one player is involved at each stage. A typical supply chain may involve a
variety of stages. These supply chain stages include: (a) Customers, (b) Retailers,
(c) Wholesalers/Distributors, (d) Manufacturers, and (e) Component/Raw material
suppliers.
The definition of a basic supply chain is: a set of three or more companies directly
linked by one or more of the upstream or downstream flows of products, services,
finances and information from a source to a customer.
An extended supply chain includes suppliers of the immediate supplier and customers
of the immediate customer, all linked by one or more of the upstream and downstream
flows of products, services, finances, and information.
‘Supply Chain Management’ can be defined as the active management of supply chain
activities to maximize customer value and achieve a sustainable competitive
advantage. It represents a conscious effort by the supply chain firms to develop and
run supply chains in the most effective and efficient ways possible.
Supply chains can be internal or external. The internal supply chain is that portion of a
given supply chain that occurs within an individual organisation. The external portion
of the supply chain connects key suppliers and customers.
Supply Chain Management is involved with integrating three key flows, between the
different stages, across the boundaries of the companies: (a) Flow of information,
(b) Product/materials, and (c) Funds. While the product/service flows outwards from
the manufacturer to the customer, both information and funds flow from the customer
to the manufacturer.
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Supply chain management is also a philosophical approach that incorporates a body of 193
tools and techniques to improve the flow of materials from and between more than
two participants. This translates into the following characteristics:
z Systems approach to viewing the channel as a whole, and to managing the total
flow of goods inventory from the supplier to the ultimate customer,
z Strategic orientation toward cooperative efforts to synchronize and converge intra-
firm and inter-firm operational and strategic capabilities into a unified whole, and
z Customer focus to create unique and individualized sources of customer value,
leading to customer satisfaction.
Supply Chain Management extends the supply chain philosophy across all members of
the chain. The three characteristics of the supply chain philosophy can be met by
integrating behaviour and processes, sharing information, planning in collaboration
with each other, sharing the risks and rewards, co-operation, goal sharing and
partnerships. In achieving these objectives, the operations in the supply chain can be
streamlined and the profitability of all members in the chain improved.
The product/material flow in a supply chain is concerned with the procurement,
movement and storage of materials and finished products. For a large manufacturer,
these operations may consist of thousands of components, raw materials and parts and
their movements, which ultimately culminate in the delivery of products to an
industrial user, retailer, wholesaler, dealer, or other customer. For a large retailer,
supply chain operations may commence with the procurement of products from the
manufacturer and may terminate with consumer pickup or delivery of the product.
9.6 LESSON END ACTIVITIES

Identify the errors in the different statements given below:
1. A supply chain is a sequence of processes that take place within and between
different stages and combine to fill a customer need for a product.
2. Push processes are initiated by a customer order whereas pull process are initiated
and performed in anticipation of customer orders.
3. The internal supply chain is that portion of a given supply chain that occurs within
an individual organisation.
4. The external portion of the supply chain connects the firm with key customers.
9.7 KEYWORDS
Supply Chain Management: Supply Chain Management is a business approach that
focuses on integration, and partnerships, in order to meet customers' needs on a timely
basis, with relevant and high quality products, produced and delivered in a cost
effective manner.
Information flows: Information flows are used by the various supply chain partners to
coordinate their long-term plans.
Internal Supply Chains: The flows of the supply chain that occur within the
individual organisation are called the internal supply chain.
External Supply Chains: The decisions, to purchase a product or service from
external suppliers, are the basis for the external supply chain.
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196
Logistics and
LESSON
10
PARTICIPANTS AND RELATIONSHIPS
IN SUPPLY CHAIN
CONTENTS
10.1 Introduction
10.2 Participants in Supply Chain
10.3 Supplier Selection
10.4 Role of Manufacturers and Distributors in Supply Chain
10.4.1 Challenges
10.4.2 What is the Value of Distributors?
10.4.3 A Supplier Perspective
10.5 Supplier – Buyer Relationships
10.5.1 Transactional Relationships
10.5.2 Collaborative Relationships
10.5.3 Supply Alliances
10.6 Strategic Supplier Relationships
10.6.1 Situations where Alliances are Appropriate
10.6.2 Situations where Alliances may not be Appropriate
10.7 Let us Sum up
10.9 Keywords

z Explain supplier selection
z Discuss the role of manufacturers and distributors in supply chain
z Analyse value of distributors
z Explain supplier perspective
z Describe strategic supplier relationships
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197
10.1 INTRODUCTION Participants and Relationships
in Supply Chain
Supply chain management is the combination of the enterprise strategies, business
process and information technologies that integrates the suppliers of raw materials or
components, the manufacturers or assemblers of the finished products, and distributors
of the products or services into one cohesive process to include demand forecasting,
materials requisition, order processing, order fulfilment, transportation services,
receiving, invoicing, and payment processing.
Supply Chain Management (SCM) is a concept that is used right across the world in
many industries. SCM involves the management of relationships with all parties
including client, contractor and sub-contractor in order to achieve the specific needs of
a client's objectives in a project. Construction organisations that have an effective
Supply Chain Management in place can expect reduced project costs and increased
reliability and speed of facility construction.
10.2 PARTICIPANTS IN SUPPLY CHAIN

Following are the participants in supply chain:
1. Suppliers: They organizations that provide goods and/or services to a purchasing
organization (a manufacturer or a distributor). It is often used synonymously with
vendors but may also refer to an internal company resource.
2. Manufacturers: They are the companies engaged in the original production and
assembly of products, equipment or services. They sometime refer to companies
that purchase such products or services manufactured or assembled in accordance
with company specifications.
3. Distributors: Those are the external entities that sell for suppliers or
manufacturers directly and often collect all payments from customers and
maintain an inventory of the supplier’s or manufacturer’s products.
Now let us discuss the selection of supplier and role of manufactures and distributors
in supply chain.
10.3 SUPPLIER SELECTION

Once the product is designed and/or specifications are firmed up, purchasing has the
following responsibilities:
(i) Supplier selection: It is the process by which firms identify, evaluate, and contract
with suppliers. The supplier selection process deploys a tremendous amount of a
firm’s financial resources. In return, firms expect significant benefits from
contracting with suppliers offering high value. Purchasing also has to ensure that
the specifications are consistent with accepted commercial standards and the
material satisfies the purposes intended. Purchasing has to judge whether the
specifications and delivery requirements can be met by the suppliers. It has to
determine the availability of parts and material. Also, it has to collect up-to-date
cost data that can be used to negotiate the cost of the product. Finally, it has to
classify suppliers according to their performance.
(ii) Expediting: It is the monitoring of supplier deliveries of materials that in some
way have become critical for the customer. For example, production schedulers
may have forgotten to order billets of a specific size, and now they are needed
quickly. Inventory records may overstate the number of pistons available. The
supplier may not have met the delivery date due to a slowdown in his factory.
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198 Planned follow-up is generally required for job orders or custom built capital
Logistics and
Supply Chain Management equipments, sometimes at a higher level when the cost of equipments is high.
Periodical visits to the supplier are often necessary in case of such items.
There may be occasions when the buyer has to expedite the order to prevent
shortages due to change in demand. Many companies are caught in a scheduling
"doom loop," where the change in demand causes a change in the assembly
schedule. Companies can extricate themselves from the doom loop through a
combination of stabilizing their schedules and working with suppliers to
implement just-in-time or separate out those parts which are volatile so that the
remaining schedule is stable.
But total stability is seldom possible, so some companies give suppliers direct
access to their inventory of parts, allowing them to monitor usage rates on a
virtually real-time basis, so they can anticipate the company’s needs without ever
having its manufacturing and purchasing departments involved in the loop.
Whatever be the circumstance, the buyer has to keep track of what is happening to
orders released. The buyer has to have good liaison with receipt section, supplier,
transportation, clearing section, forwarding section, inspection at works, etc. to
make this possible. The principle of selective control can be used to determine
who should follow-up with which group of items. Expediters phone suppliers to
talk about the importance of an order. They plead with and threaten suppliers to
get their order moved up in line for fast delivery.
Expediting is usually caused by a failure of the organization or its suppliers.
Efforts should be made to solve the problem by eliminating the source of the
problem, rather than by relying on expediting. Eliminating the source of the
problem involves better supplier selection and improved control of purchasing
functions. A well-run purchasing operation should strive to eliminate expediting
by making suppliers responsive to the organization’s needs.
(iii) Receiving: A critical part in supply chains that involve manufacturing is getting
all the required parts and raw materials in the right sequence, the right quantity,
the right quality and the right time to the manufacturing and assembly plants.
Receiving is a follow-on activity to a purchase order. It forms the basis for
updating the financials and inventory records and can trigger stores management
and the quality management processes. Traditionally, receiving and inspection
shared facilities. As soon as material was received, it was documented and passed
on to quality control for inspection and then moved to stores for inward
distribution to manufacturing.
For planning and controlling operations, accurate information regarding materials
must be available. Information regarding description of all the materials, quantity
received and their locations is entered into the organization’s information system
in receiving. With the warehouse management systems, you can control the goods
receipt and goods issue processes at a physical level.
Goods receipts are possible from purchase order, inbound deliveries (advanced
shipping notice), stock transport orders, or from production orders. Advanced
Shipping Notification is a vendor document that contains the exact materials,
quantities, and the delivery date with reference to a purchase order. This document
becomes the Inbound Delivery in the receipt process.
The importance of receiving is reflected by Tata Steel who is spending `60-70
crore to upgrade its various facilities. Tata Steel's Jamshedpur plant handles about
13 million tonnes of raw materials per annum. It estimates raw material
requirement to jump to 25 million tonnes annually during 2008 i.e. it will need to
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handle 250,000 tonnes of material per day. Tata Steel can only do this by taking 199
Participants and Relationships
steps to improve its infrastructure. Keeping in view the projected increased in Supply Chain
volume of raw materials it will have handle, it is introducing engine-on-load
system within the plant. This will halve the unloading time of an iron ore rake
which presently takes from eight to nine hours. The coal unloading system is also
being revamped, and with it the tippling capacity, so that rakes unloading time is
halved to 12 hours or so.
The role of receiving has changed in SCM. In this context, receiving has, as its
objective, the rapid flow of material into a facility. Ideally, the material would
move directly to the production line without making an intermediate stop in a
warehouse or other storage area. If the material cannot be used immediately, it is
placed in storage. However, as materials have to be transported to the buyer's
premises from the seller’s premises, formalities like sales tax, octroi often form
bottlenecks. Proper filling of necessary forms and adherence to procedures are
essential; else the goods can remain impounded at one of the numerous check
posts.
In the case of excisable goods, formalities such as assessing and rate fixing have to be
carried out. The buyer has often to take additional care of the insurance and freight
formalities. The buyer has to coordinate with rail, road, ship, customs and clearance
agencies to minimize the transportation bottlenecks and obtain the items in the
shortest time at the lowest rates.
On receipt of the materials in stores, the receipt section checks the quantity with that
mentioned in the invoice. The buyer has to be satisfied about the quality of the
materials. Sometimes inspection procedures and methods are also mentioned in the
purchase order. Delays in inspection can occur due to lack of inspection staff, lack of
testing equipments, and where relaxation in specifications is required.
10.4 ROLE OF MANUFACTURERS AND DISTRIBUTORS

IN SUPPLY CHAIN
The manufacturing process produces and supplies products to the distribution
channels based on past forecasts. Manufacturing processes must be flexible to respond
to market changes and must accommodate mass customization. Orders are processes
operating on a just-in-time (JIT) basis in minimum lot sizes. Also, changes in the
manufacturing flow process lead to shorter cycle times, meaning improved
responsiveness and efficiency in meeting customer demand. Activities related to
planning, scheduling and supporting manufacturing operations, such as work-in-
process storage, handling, transportation, and time phasing of components, inventory
at manufacturing sites and maximum flexibility in the coordination of geographic and
final assemblies postponement of physical distribution operations.
In the ever-changing coatings industry, distributors play an important role in the
supply chain. From just-in-time procurement strategies to risk management,
distributors can bring real value to customers. In today’s economic environment,
distributors are being relied on heavily as our customers are more likely to order
smaller volumes of products on a more frequent basis. Established partnerships with
distributors provide for continuity and trust of supply. The following discussion
highlights some of the challenges that distributors face, as well as benefits that they
can offer to both customers and suppliers.
10.4.1 Challenges
Chemical distributors are facing a wide variety of challenges. First and foremost,
similar to most of our customers and manufacturing partners, we are experiencing
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200 unprecedented price increases for materials, energy and transportation. Unfortunately
Logistics and
Supply Chain Management we have little control over our number-one cost, which are raw materials. This is
driven by our suppliers and their exposure to global market factors, including the price
of oil at $120/barrel. We can certainly pull selling and administrative costs out of the
system and implement some controls on freight expenses by establishing strong
relationships with local carriers, innovative consolidation and the utilization of third-
party logistics providers; but we need to get savvier in finding new ways to bring real
value to the customer base. Manufacturers are driving increases through and
customers are pushing back. As this happens, distributors are faced with reduced
profitability or walking away from business.
Fortunately for our sake, most distributors do not have the cost structures that most
manufacturers have. This is largely a result of the size and scope of our operations.
We are quick to act and more willing to take entrepreneurial risks that manufacturers
cannot.
Industry consolidation on both the customer and supplier side greatly affects the long-
term viability of distribution companies. As the North American coatings industry has
consolidated over the past decade, there are far fewer coatings manufacturers for
distributors to supply. From a distributor’s perspective, this problem is compounded
by the fact that the top tier coatings companies are often times handled as “house”
accounts for our manufacturers. This consolidation is expected to continue, as small
and mid-size coatings manufacturers need to realize economies of scale to compete.
Some of the smaller coating manufacturers with a retail presence are beginning to
displace their own products by selling well-recognized national brands at their owned
and operated stores. The increasing operations, human resource and marketing costs
prohibit these customers from making small batches of paint, when they can simply
order cases to stock the shelves. If this trend continues, distributors will be faced with
a further cannibalization of our sales.
Nearly every distributor in every industry touts its ability to offer outstanding
customer service and promotes its fantastic sales relationships. If everyone offers this,
then it cannot be a competitive advantage. Distributors need to strive to offer a
complementary range of products that meet the needs of their customers at the right
price, with the right quality, in the right package, at a lead-time acceptable to their
clients. The ability of a distributor to differentiate is value driven. What can a supplier
do to increase the value that can be offered to a customer? It’s critical to understand a
customer’s process, product mix, cost structures and competitive landscape before you
can offer solutions. Developing a consultative sales force that sells multiple layers in
an organization allows you to identify value and provide tailored solutions.
10.4.2 What is the Value of Distributors?

A Customer Perspective
Customers may sometimes think, “Why do I need to buy from a middle man when
I can just go direct at a lower cost?” There are several answers to this question, but the
most straightforward is that either the buyer or seller in a direct relationship will have
to perform the function of the distributor. This adds cost to the equation, as can be
seen in several key areas.
Distributors can typically offer a greater level of flexibility than manufacturers. This
includes quicker turnaround times on orders, often in as little as two hours. Most
manufacturers today supply orders based on 7- to 30-day lead-times, excluding the
transit time to import products to the United States. With just-in-time manufacturing
principals in place at many customer’s facilities and ever changing production
schedules, customers do not have the luxury of waiting four to eight weeks for
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materials to arrive. With customers focused on increasing inventory turns and 201
improving working capital and revenue through operational efficiencies, the in Supply Chain
distribution channel is critical to maintain inventory strategically located near the
customer base. Tony Carignano, Sales Manager Americas Technical Sales & Market
Development, Solutia Inc., states “Successful distributors can move at a velocity
unmatched by most multinational chemical manufacturers. In today’s economic
environment, customers have come to demand immediate shipment of materials. The
infrastructure of manufacturers strives to optimize process efficiencies and distributors
are relied on heavily to meet the logistics needs of the customers.”
This flexibility also extends to financial considerations such as extended payment
terms and consignment programs. Publicly traded, multi-billion dollar chemical
manufacturers often times are not willing to extend payment terms and rarely consider
consignment programs. International suppliers often demand payment prior to
shipment delivery. Agile, privately held distributors have more flexibility to
implement programs that bring a greater level of value to the customer.
From a sourcing standpoint, distributors greatly reduce risk for their customers. As our
industry continues to expand globally, small and mid-size customers have to take
advantage of global sourcing to realize cost benefits and technology advancements.
However, customers of this size often times do not have the resources available to
visit facilities that are located thousands of miles away to qualify materials, audit
plants, manage international logistics and establish the supply relationship.
Furthermore, it is cost prohibitive for customers to buy full container quantities of
products when they only need a few thousand pounds per month. Good distributors
can fill this role by bridging this “international gap” through a systematic approach of
identifying new sources for products, conducting regular plant audits, having local
representatives active in developing countries, and importing full container quantities
of products and selling pallet or bag quantities.
One of the most prevalent advantages that distributors can offer is in the area of
product bundling. Customers have the ability to purchase several items from one
supplier, greatly reducing administrative and freight costs. Most successful
distributors offer a complementary portfolio of products that can be combined in less
than truckload quantities. If a customer requires resin, additives, pigment and
containers, they can combine these on one order, from one supplier, and pick them up
on the day they are needed for a production batch.
Finally, due to their geographic proximity, distributors can maintain close
relationships with customers to gain an in-depth understanding of their processes,
formulations and competitive advantages. Most distributors visit customers on a much
higher frequency than manufacturers can. This is prevalent in today’s economy where
the cost of business travel has skyrocketed. Customers don’t have to wait weeks to see
someone in case of emergency; distributors can be in your plant by the end of the
shift. Additionally, this level of relationship affords the distributor the opportunity to
bring innovative end products that can generate new revenue and profitability.
Because of their vast range of market knowledge, distributors can often times help the
customer better tailor their research dollars.
10.4.3 A Supplier Perspective

In addition to the benefits already highlighted, distributors offer unique advantages to
suppliers. Effective sales channel management will lead to greater profitability,
increased market share and higher customer satisfaction. Distributors can be viewed as
an extension of a supplier’s sales force in markets where it is not economically viable
to establish a permanent facility or direct staff. This outsourcing of the sales function
results in lower costs and allows the manufacturer to concentrate on R&D and
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202 manufacturing disciplines. With rising health care costs, travel expenses and language
Logistics and
Supply Chain Management barriers, etc., some manufacturers simply would not be able to access the North
American market without local distribution partners.
Furthermore, due to their established market presence, distributors can typically
develop business in a much shorter timeframe than suppliers new to a market. The
ability to gather market intelligence is more likely to be achieved by a distributor than
a new face. Continuity of long-standing geographic coverage creates business
relationships that are built on trust and mutual dependency. Where a direct sales force
is employed, distributors can still offer an advantage because of these relationships.
With the explosion of the internet, manufacturers throughout the world can be easily
identified. Establishing the logistics flow is a more complex challenge. Navigating
through a sea of federal, state and local regulations can affect the transport of certain
products and provide hurdles that cannot be readily overcome. Additionally, the
ability to provide samples, custom labels or contract packaging is all services that
most distributors offer. With facilities equipped to handle hazardous goods,
distributors certified in the NACD’s Responsible Distribution Process SM are
qualified to safely and efficiently deal with damages, spills or other unexpected
occurrences.
Distributors are often the first call when chemists are working to develop new
formulations. Our wide breadth of knowledge based on experience supplying multiple
components to the formulation is an asset for our partners. Distributors are able to
cross fertilize from one product group to another and one industry to the next.
There are significant financial advantages to working with a distributor.
Notwithstanding the tax benefit of not establishing a local presence, distributors carry
the receivables. Manufacturers are set up to optimize production capacity and do not
want to sell a couple of bags or single pallets to 100 different customers who speak
different languages, want custom labelling and need immediate delivery. Furthermore,
when it’s time to get paid, contacting one distributor is much more cost effective than
trying to collect from multiple customers.
State whether the following statements are True /False:
1. With the explosion of the internet, manufacturers throughout the world
can be easily identified.
2. Establishing the logistics flow is a more complex challenge.
3. The ability to provide samples, custom labels or contract packaging is all
services that most distributors offer.
4. Distributors are often the second call when chemists are working to
develop new formulations.
5. Our wide breadth of knowledge is totally unrelated to experience.
10.5 SUPPLIER – BUYER RELATIONSHIPS

As we identified that the basic driver of the Supply Chain is the concept that for a
single company to successfully compete in a market where there is increasing demand
from customers; escalating competition, etc. it has to seek partners who are willing to
share risks and rewards. It has to enter into collaborative activities and work, on a
reciprocal basis, so that it may be able to show superior performance. Firms enter into
inter-firm integrative and collaborative arrangements through the supply chain. The
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strategic role of the supply chain is in securing higher performance through the 203
linkages that would not be possible by firms operating individually. in Supply Chain
This means aligning the operational processes of a large number of firms into a single
integrated supply chain system. It permits each of the firms to compensate for their
individual weaknesses and/or resource constraints. They can do this by linking with
other firms that have offsetting strengths. Collectively, this allows all firms to apply
their resources toward areas that they see as important and where they can contribute
the most. These types of processes are fostered through relationships management.
Supply Chain relationships have their historical origins in the Japanese keiretsu
structure. Keiretsu is an example of a group of firms using supply chain strategies to
achieve a common purpose. Suppliers, with some degree of vertical ownership with
the manufacturer, enjoy high volume and long-term supply contracts. The keiretsu did
not need to have a typical cross-organizational structure because of its traditional
relationship. However, the keiretsu offers an insight of how suppliers enjoy close ties
with manufacturers. Firms establish ties with each other on the basis of a mutual belief
exchange personnel; share technology and information; in effect sharing both the risk
and rewards of the relationship.
The supplier – buyer relationships have seen a paradigm change in the transition from
Materials Management to Supply Chain Management. The supply chain structure has
been sculpted on the Japanese keiretsu. But, Japan has a culture where the keiretsu is
possible. How does this reflect on SCM in general? Before we discuss this question,
the question we need to focus on first is: What are the different types of supplier-buyer
relationships?
There are three types of relationships:
z Transactional
z Collaborative, and
z Alliance
These are described in greater detail below.
10.5.1 Transactional Relationships

The most common and most basic type of relationship is "transactional." Virtually all
buying firms will have transactional relationships. For example, Directorate General
of Supplies and Disposal (DGS&D) is a government organization under the Ministry
of Commerce. The organization provides procurement services to Central & State
Government Departments/Organizations, Public Sector Undertakings and
Autonomous Bodies, by placing Rate Contracts for common user items and contracts
against their ad-hoc demands. This is a typical transactional relationship. This type of
relationship simply means that neither party is especially concerned with the well-
being of the other. It is neither good nor bad. Transactional purchases lend themselves
to e-procurement and, in some cases, reverse auctions.
Characteristics of Transactional Relationships

Transactional relationships have several characteristics. To start with, the relationship
is formal. It is characterized by an absence of concern by both the buyer and the seller
about the other party's well-being. They see the relationship as a zero sum game i.e.
what one party wins, the other loses.
The transactions are also seen as a series of independent deals. Each transaction is
entered into on its own merits. Therefore, there is limited contact between the buyer
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204 and the seller. There is also little or no basis for collaboration and learning from each
Logistics and
Supply Chain Management other.
Basic data relating to technical data, special features, costs, and forecasts, etc. are not
shared. As these are arm's-length transactions, the focus is on price. For example,
DGS&D uses open tenders for each transaction. Both the buyer and the seller try to
get the best price. There is no openness in such a relationship.
If there is any cost analysis, it precedes the procurement transaction. It is done
separately by the buyer and the seller, and they do not share data. Since the prices are
established by market forces, neither buyer nor supplier will rush to the other's
assistance in bad times or when problems arise.
Most of the procurement effort is in establishing rules, regulations, and procedures
governing such transactions. Therefore, little purchasing time and energy are required
to establish prices, as market forces establish prices in transactional relationships.
Advantages of Transactional Relationships

Though transactional relationships are formal and inflexible, in certain cases they are
advantageous to the firm. The major advantage is that transactional purchases lend
themselves to e-procurement and, in some cases, reverse auctions.
In the case of conventional procurement transactions, there is relatively less
purchasing time and effort required to establish price, as these are established
primarily by market forces. With the vast majority of transactional procurements,
judgment and managerial expertise are seldom required. This is advantageous for
commodity items as little purchasing time and efforts are required to establish price.
The transactions are mechanical and hence, lower skill levels of procurement
personnel are required.
Disadvantages of Transactional Relationships

The disadvantage of such relationships stem from the fact that since the supplier
recognizes the transactional and price nature of the relationship and is not motivated to
invest time and energy in the development of the potential buyer's products.
Transactional procurements tend to provide for products where quality is only as good
as required. It often results in more problems. As there are many unknowns about the
seller’s capabilities, considerable investment in expediting and the monitoring of
incoming quality is required to ensure timely delivery of the right quality. There is
little incentive and opportunity to improve quality and delivery in this type of
relationship.
Transactional relationships are generally inflexible. Very often, flexibility may be
required in supplier-buyer relationships due to changing technology or changing
market conditions. It is generally not possible in transactional purchases.
Transactional suppliers tend to provide the minimum service required. There is little
communication between the buyer and the seller. Transactional suppliers have little to
lose from a dissatisfied customer, if they can meet with the contractual requirements
of the buyers.
The risks and uncertainties present with transactional relationships reduce the
likelihood of investments in R&D and training as well as the procurement of new,
more efficient equipment focused on the customer firm's needs.
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10.5.2 Collaborative Relationships 205
The awareness of the interdependence and necessity of cooperation is the key in Supply Chain
difference between collaborative relationships and transactional ones. Organizations

perform a series of value-adding activities working together by recognizing the
interdependency and need of cooperation, to provide benefits to both parties. These
include cost reduction, improved quality, reduced time to market, and the leveraging
of supplier technology.
The three most important factors required for a successful collaborative relationship
between a buyer and a supplier is:
(a) Two-way communication,
(b) Responsiveness to supply management's needs, and
(c) Clear product specifications.
Collaboration happens because both parties are aware that money enters their supply
chain (or supply network) only if the chain's end products are cost competitive. When
collaborative relations replace the market forces employed by transactional
procurement there is overall improvement in many areas. There is controlled
competition, benchmarking, and advanced supply management pricing practices. The
end results are lower total costs, higher quality, reduced time to market, and reduced
risk of supply disruptions.
An example of a collaborative relationship is between Tata Motors and Mahendra
Ugine. Tata Motors has a large requirement of alloy steel billets for its Forge Division
at Jamshedpur. Of the large number of possible suppliers, Tata Motors chose
Mahendra Ugine as one of the three suppliers with whom they negotiate prices and
quantities for their different requirements, based on quality, R&D, timeliness of
supply, process capability, and after sales service ability. The criterion was not price,
but the value delivery of the seller. Based on their past performance, Tata Motors
would reward its strategic partners with a larger proportion of the total orders. This
acts as an incentive to perform better than the others.
As both parties recognize their relationship is long-term, their interdependence and the
need for cooperation, this is reflected in their continual effort to mutually work
together towards cost reduction and improved quality. For example, Mahendra Ugine
offers new alloy developments to Tata Motors to develop components with improved
specifications and lower costs. Such acts extend the relationship between the two
parties.
Advantages of Collaborative Relationships

Continuous improvement is far easier to implement and manage with recognized
interdependence and cooperation. The end objective with continuous improvement is a
reduction in total costs.
Improved quality and timeliness also result. The likelihood of supply disruptions is
greatly reduced.
With a high level of certainty and continuity of demand, sellers are prone to explore
improving processes and adopting technical innovations. They are also willing to
work with their buyers on new ideas. This often results in cost reduction for both the
buying and supplying organizations.
Cost reductions resulting from Value Engineering and Value Analysis (VENA) are
much more likely with collaborative relationships. Suppliers are more likely to take
the initiative to reduce costs through VENA when they are involved in long-term
relations. Longer-term performance agreements are an incentive to suppliers to reduce
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206 their costs. The extended learning curve effects with both production and services
Logistics and
Supply Chain Management allowing collaborative and alliance suppliers to reduce their costs and share these
savings with customers.
Disadvantages of Collaborative Relationships

The major disadvantage of collaborative relationships is the amount of human
resources and thought that is required to develop and manage such relationships.
It takes a lot of time and energy, judgment and managerial expertise to make
collaborative relationships successful.
10.5.3 Supply Alliances

Supply alliances go one step further. These relationships are based when there is
institutional trust between the buyer and the seller. A high level of recognized
interdependence and commitment is present in such relationships. There is a visible
atmosphere of cooperation. The buyer and the seller address potential conflicts and
resolve them openly. When problems occur, the focus is a search for the root cause,
not to assign blame.
Alliances are not legal entities, but mutually beneficial and open relationships wherein
the needs of both, the buyer and the seller, are satisfied. They are similar to
collaborative relationships, but stronger. But, these are difficult to develop, because
supply alliances only work when the buyer and the seller are able to develop and
manage institutional trust.
Properly configured, supply alliances reap incredible benefits. Sellers are willing to
invest in customized machinery, tools, information systems, delivery processes, etc.
due to the long-term relationship with the buyer. This gives the buyer faster
throughput and allows for product differentiation. It also leads to improved overall
quality as the product integrity increases.
Sellers also accumulate specific know-how of the buyer’s market and requirements by
working together. This accumulated specialized information and language allows both
the buyer and the seller to communicate and coordinate effectively with each other.
They are both less likely to have communication breakdowns that result in errors. The
final result is higher quality, faster development times, and lower costs for the
customer.
The focus of most supplier alliances is achieving the simultaneous objectives of
continuous improvements along with squeezing cost out. Negotiations and
renegotiations occur in a win-win manner.
An example of a supply alliance in India is between General Motors (GM) and H.P.
Pelzer (India) Ltd. Alliances are very difficult to establish; however, the Pelzer
alliance was made possible because a similar relationship existed between GM,
Germany, and H.P. Pelzer, Germany. For their plant at Hallol, GM developed all their
automotive insulation parts from Pelzer. They chose one supplier from the many who
could make their parts. GM and Pelzer actively participated together in process control
and process improvement. Pelzer was connected through an information system with
GM. Both parties used cross-functional teams that would meet from time to time. In
return, Pelzer willingly invested in redesigning the insulative package to Indian
conditions.
An alliance is a living system that progressively evolves with the objective of creating
new benefits for both parties. The alliance partners share a vision of the future in the
area of the interface. Ethics take precedence over expediency. The relationship is
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adaptable in the face of changing economics, competition, technology, and 207
environmental issues. in Supply Chain
In most supply alliances, the use of supplier certification is common. By improving
the process, the manufacturing quality is raised, which reduces requirements to inspect
for errors. The result is improved quality at lower total cost.
Executive level commitment and alliance champions protect the alliance from
incursions by non-believers.
Advantages of Supply Alliances

The primary benefits of supply alliances include lower total costs. Synergies are
created in alliances that cannot happen in transactional or even collaborative
relationships. The synergies result in reductions of direct and indirect costs associated
with labour, machinery, materials, and overhead. Alliance customers are the least
likely to experience quality problems or supply disruptions.
Buyers enjoy the benefits of early supplier involvement (ESI) in the development of
new components. Reducing the time to design, develop and distribute products and
services becomes a competitive advantage and leads to improved market share and
better profit margins.
Openness and institutional trust enhance the inflow of technology from alliance
partners that leads to many successful new products. For example, in the case of GM
and Pelzer, Pelzer invested in R&D to bring down the cost of the entire insulative
package for GM. They were able to reduce their costs by nearly 20 percent in a period
of two years and passed on the cost benefit on to GM so that their product could be
priced competitively. The result was higher volumes for Corsa, which benefited both
the alliance partners.
Alliance relationships help cushion bad times. Both customers and suppliers who
value each other, based on long-term relations and respect, are more likely to come to
each other's aid during times of adversity.
Disadvantages of Alliances
The major disadvantage of alliance relationships is the amount of human resources
and thought that is required to develop and manage such relationships. Alliances are a
very resource-intense approach to supply management.
The focus on relationship management requires that all elements of relationship
management, including trust building, communications, joint efforts, and planning and
fostering interdependency, will be increasingly studied and managed to achieve
competitive advantage in the relationship.
It takes cross-functional teams, early supplier involvement, target costing, improved
communications through techniques such as co-location of supplier engineers, and a
constant contact with the supplier. This requires a lot of time and energy, judgment
and a very high level of managerial expertise to make collaborative relationships
successful.
10.6 STRATEGIC SUPPLIER RELATIONSHIPS

It is generally believed that supply alliances cement strategic supplier relationships,
For example, while steel and aluminium are both important to General Motors, it
treats the relationship with its suppliers for these items differently. The steel market
has many qualified suppliers and is a mature and even declining material in cars and
trucks. Aluminium, on the other hand, is increasing in importance, and there are only
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208 two major North American producers that can meet GM's requirements. From a
Logistics and
Supply Chain Management supply perspective, GM treats aluminium as a strategic item that would benefit from a
supply alliance.
Very often the evaluation and strategic supply chain requirements determine the
relationship that best satisfies a particular requirement. However, the firm has to
determine whether the benefits of an alliance will outweigh the effort, risk, and
resources required. Some of issues that need to be considered in this context are:
z Is the buyer willing to take the risk of reducing its supply base?
The shared values with the supplier. The supplier should not act in an
opportunistic manner over time.
z Are both supplier and buyer aligned in their respective visions to be able to make
long term commitments to each other?
z Are both the purchasing and supplier organizations willing to keep attention
focused on the joint customer, in order to establish supply chain objectives and
goals?
z Are both supplier and buyer aligned in what their ultimate customer considers to
be valuable?
z The resources of the firms to optimally share communication and information.
z The training of personnel to manage an alliance relationship. Can the buyer and
the seller present a joint marketing front for the links further downstream in the
supply chain?
z The knowledge, expertise, and resources, of the partner to stay current in the
industry.
z The type of cooperation envisaged in sharing risks for development of new
technologies, sub-systems, products, processes, or service support.
If an alliance is in order, it is essential to identify areas of synergy, e.g. joint
development programs, just-in-time inventory, electronic communication, or
co-location of service personnel. A good agreement will provide clarity on how these
areas will provide synergy and provide benchmarks to assess performance.
10.6.1 Situations where Alliances are Appropriate

The SCM Segmentation Matrix, that we studied in the last section, tries to narrow the
gap and identify those areas where collaborative efforts i.e. either alliances or
partnerships should be sought. Very often, organizations do not follow the matrix
shown in the figure. This is because, first, alliances are very difficult to establish; and
secondly few, if any, relationships are pure alliances, (it is the degree of difference
with other relationships that determines how the relationship is described).
However, it may be defined, some factors will always be important in determining
when an alliance is necessary. The factors are as follows:
1. If one supplier is head and shoulders above other suppliers in terms of the value it
provides the firm, which may include price, innovation, ability to adapt to
changing situations, capacity to work with as a team, task joint risks, then an
alliance is beneficial. The supplier sometimes may not be willing to enter into
such an interdependent relationship.
2. "Strategic" suppliers who provide a unique product, technology, or service and
have a major impact on your competitive advantage in the marketplace. Such
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suppliers may be vital to the interests of the organization and should be 209
encouraged to join the supply chain as an alliance. in Supply Chain
3. When the company benefits greatly and the supplier is "integrally connected" i.e.
their engineers are working side by side, or they are co-locating their
manufacturing facilities, then an alliance is appropriate.
4. If customers require high degrees of flexibility and speed of responsiveness, it is a
classic alliance driver for suppliers who can match the performance.
5. If the potential supplier possess economic power which it is willing to employ
over its customers, a very carefully developed and managed collaborative
relationship is usually appropriate.
There are some issues that must be considered here. Even when both parties recognize
the potential benefits of an alliance, but either of them does not have adequately
qualified human resources, a collaborative relationship is not appropriate till such time
the shortfall is overcome. Very often, it is better to start with a collaborative
relationship as a first step to develop a strategic alliance.
The most attractive supplier may have already established an exclusive relationship
with the buying firm's key competitor and not be available. Or the supplier may decide
that a collaborative or alliance relationship with the potential buyer is not in its best
interest, as it possesses economic power that it can exercise to further maximize its net
income.
It must be remembered that alliances are controlled through a complex web of formal
and informal interpersonal connections, information systems, and internal
infrastructures that enhance learning. Openness exists in all areas of the relationship
including, cost, long-term objectives, technology, and the supply chain itself. This
should be the objective of both parties.
10.6.2 Situations where Alliances may not be Appropriate

Quite obviously, alliances are not always appropriate. There are 5 major categories
which can be used to examine the appropriateness of a supply alliance:
1. Stability of the prices, market, and buyer's demand.
2. Capability of potential suppliers.
3. Competition in the supply market.
4. Benefits to the buying firm from the relationship.
5. Internal Buy-In to partnership.
Stability of the Prices, Market and Buyer's Demand

There are three areas under this category. The first relates to price volatility. Where
there is price volatility, an alliance is desirable the partners are willing to share its
risks and benefits. Arrangements such as price adjustment mechanisms based on costs
or indexes and, for some commodities, hedging in futures markets, have been used as
solutions.
The second relates to demand volatility. Where there is significant volatility and
forecasts are not reliable, the supplier may experience the likelihood of overstock,
stock-out, or erratic productions schedules. Very often, it is advantageous to explore if
the supplier (due to the customer mix) can minimize the impact of the additional costs
into the price that the buyer pays.
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210 The third area relates to high switching costs which generally involve changing
Logistics and
Supply Chain Management technology or critical quality or other characteristics. Where such cases exist, buyers
would find it desirable to have maximum flexibility.
Capability of Potential Suppliers

Sometimes there are items for which there is no full-service, world-class supplier
capable of a partnership/alliance relationship. At other times there are no
partnership/alliance-capable suppliers in the geographic area. The lack of a capable
supplier would dictate some other form of supply relationship. In such cases, no
partnership or alliance would be preferable to one with a supplier who does not have
the ability to deliver.
In situations of rapid industry wide technological change the buyer would like to have
an assurance that the supplier has the capability to remain technologically competitive.
Sometimes, the buying firm's industry is changing and developing more rapidly than
that of the supplier's industry. In both cases, it may be difficult to arrive at a
partnership or alliance that is fully beneficial to the buyer.
Competition in the Supply Market

In non-competitive markets or in situations where extreme dependency on a particular
supplier would be created by a partnership or strategic alliance, the buyer may be in a
position of disadvantage with respect to the supplier.
Generally, a partnership or strategic alliance will reinforce the supplier's power
relative to the buying firm. This might pose a risk in securing future supplies.
If there are few supply alternatives available and/or if there is high supplier switching
costs, in order to obtain the lowest total cost a strategic alliance may not be the
answer. The firm will benefit from a collaborative relationship that leverages the free
market partnerships may be appropriate.
One should be careful to avoid situations where the supplier uses an alliance as a
strategy to eliminate competition and reduce industry capacity. An alliance may save
cost in the short run but, if the supplier's strategy truly is to reduce capacity and
competition, costs may increase in the long run.
Benefits to the Buying firm from the Relationship

Typically, a partnership or alliance will leverage some aspect of the exchange
involved. Leveraged items may include volume, total cost, process or procedural cost,
inventory, or innovation. An alliance is only desirable if there are leverage
possibilities.
One has to distinguish between hard savings and soft savings (such as quality
improvements, staff reductions, etc.). It is generally wise not to establish a partnership
or alliance, if there are no hard savings to justify the work involved in.
Internal Buy-In to Partnership

Most buyers and sellers use a team approach to develop, implement, and maintain
partnership and alliance agreements. If that is not done, or if the firm’s internal
members do not agree with such terms, the partnership or alliance is likely to fail and
will not be advantageous.
One option is to choose a few, select suppliers, thereby making it easier to set-up a
system for informal interaction and information sharing. Reducing the number of
suppliers also helps as the supplier will often see himself as an extension of the buyer.
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In the final analysis, the supplier–buyer relationship will generally have to depend 211
upon the "strategic" elements that will give the firm a competitive advantage. in Supply Chain
Fill in the blanks:
1. A partnership or ……………………….. .will leverage some aspect of
the exchange involved.
2. …………………… items may include volume, total cost, process or
procedural cost, inventory, or innovation.
3. An alliance is only desirable if there are leverage ………………………..
4. Most buyers and sellers use a team approach to develop, implement, and
maintain partnership and ………………………..agreements.
5. The partnership or alliance is likely to …………………… and will not be
advantageous.
10.7 LET US SUM UP

Supply chain management is the combination of the enterprise strategies, business
process and information technologies that integrates the suppliers of raw materials or
components, the manufacturers or assemblers of the finished products, and distributors
of the products or services into one cohesive process to include demand forecasting,
materials requisition, order processing, order fulfillment, transportation services,
receiving, invoicing, and payment processing
Purchasing has to judge whether the specifications and delivery requirements can be
met by the suppliers. It has to determine the availability of parts and material. Also, it
has to collect up-to-date cost data that can be used to negotiate the cost of the product.
Finally, it has to classify suppliers according to their performance.
Typically, a partnership or alliance will leverage some aspect of the exchange
involved. Leveraged items may include volume, total cost, process or procedural cost,
inventory, or innovation. An alliance is only desirable if there are leverage
possibilities.
One has to distinguish between hard savings and soft savings (such as quality
improvements, staff reductions, etc.). It is generally wise not to establish a partnership
or alliance, if there are no hard savings to justify the work involved in.

‘Distributors are facing a wide variety of challenges’, what are those challenges?
10.9 KEYWORDS
Supply Chain Management: Supply chain management is the combination of the
enterprise strategies, business process and information technologies that integrate the
suppliers of raw materials or components..
Suppliers: They are the organizations that provide goods and/or services to a
purchasing organization (a manufacturer or a distributor).
Manufacturers: They are the companies engaged in the original production and
assembly of products, equipment or services.
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214
Logistics and
LESSON
11
LEVELS AND DESIGN IN SUPPLY CHAIN
CONTENTS
11.1 Introduction
11.2 Levels of Activities in the Supply Chain
11.3 Supply Chain and the Value Chain
11.4 Functional Strategies that Impact Supply Chain Performance
11.4.1 Cost Leadership Strategy
11.4.2 Differentiation Strategy
11.4.3 Focus and Niche Strategies
11.4.4 Customer Service Strategy
11.4.5 Information Technology Strategy
11.5 Parameters for Supply Chain Design
11.5.1 Understanding the Customer
11.5.2 Implied Demand Uncertainty
11.5.3 Understanding the Supply Chain
11.6 Let us Sum up
11.8 Keywords

z Explain levels of activities in the supply chain
z Discuss supply chain and the value chain
z Identify various parameters for supply chain design
z Explain responsiveness spectrum
11.1 INTRODUCTION
The design of any supply chain must take into account the balance of customer service
and cost. On the surface this might seem to be a simple task. However, design
decisions are complex due to multiple, underlying variables. Likewise, the balance of
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these variables must also take into account a view of future needs and alternatives that 215
Levels and Design
will drive various options in how best to develop a flexible, cost-effective, service in Supply Chain
oriented, “implementable” supply chain design.
Successful supply chain design is about deploying assets in ways that enhance
profitability and shareholder value. You need to consider market and sourcing
strategies that will generate the best financial performance. You must identify the
optimal number of plants, warehouses and distribution centres to maximize long-term
profit.
It is important to understand exactly how and where to deploy assets for optimal
operational and financial performance. Personnel involved in supply chain design
require a tool that considers business objectives, resource constraints and subsequent
financial impacts in order to define an optimal supplier-to-customer supply chain
structure – one that cuts costs and increases profitability.
11.2 LEVELS OF ACTIVITIES IN THE SUPPLY CHAIN

In order to make sure that the supply chain is running smoothly and also to ensure
maximum customer satisfaction at the lowest possible cost, organizations adopt supply
chain management processes and various technologies to assist in these processes.
There are three levels of activities supply chain management in that different
departments of an organization focus on to achieve the smooth running of the supply
chain. They are:
1. Strategic: At this level, senior management is involved in the supply chain
process and makes decisions that concern the entire organization. Decisions made
at this level include the size and site of the production area, the collaborations
with suppliers, and the type of that product that is going to be manufacture and so
forth.
2. Tactical: Tactical level of activity focuses on achieving lowest costs for running
the supply chain. Some of the ways this is done is by creating a purchasing plan
with a preferred suppliers and working with transportation companies for cost
effective transport.
3. Operational: At the operational level, activity decisions are made on a day to day
basis and these decisions affect how the product shifts along the supply chain.
Some of the decisions taken at this level include taking customer orders and the
movement of goods from the warehouse to the point of consumption.
11.3 SUPPLY CHAIN AND THE VALUE CHAIN

Supply chain management typically requires a great deal of interaction and trust
between companies to work. Many organizations do not clearly understand their intra-
organizational or inter-organizational supply chain processes. In many cases, inter-
organizational processes are the product of evolution, rather than the result of a
precision design effort. Re-engineering inter-organizational processes across the
supply chain holds benefits of an even greater magnitude to those associated with
internal reengineering efforts.
Superior cost, quality, delivery, and technological performance do not guarantee
success for a supply chain. This does not mean that cost, quality, delivery, and
technology considerations are no longer important; they are critically important.
However, the process linkages between the supply chains are equally important. These
linkages depend upon the design of the supply chain.
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216 Supply Chain Design is a strategic decision. It reflects the structure of the supply
Logistics and
Supply Chain Management chain over the next several years. It decides what the chain’s configuration will be,
how resources will be allocated, and what processes each stage will perform.
Successful design requires a high degree of functional and organizational integration.
Supply chain performance improves if all stages of the chain take actions that together
increase total supply chain profits.
Traditionally, marketing, distribution, planning, manufacturing, and the purchasing
organizations along the supply chain operated independently. These organizations
have their own objectives and these are often conflicting. Marketing's objective is high
customer service; manufacturing operations are designed to maximize throughput;
purchasing focus is on lower costs. Contracts are often negotiated with very little
information beyond historical buying patterns.
The result of these factors is that there is a need for a mechanism through which these
different functions can be integrated together. Supply chain management integrates the
different objectives of the functional areas. Its configuration and design, therefore,
should support the organization’s strategic objectives. It should support the
competitive strategy of the firm and its ability to satisfy the targeted customer
segments. This becomes crucial to the growth of the organization, as the competitive
strategy is based on how the customer prioritizes product cost, delivery time, variety,
and quality.
We have introduced the value chain earlier. Porter’s value chain is a systematic
approach to examining the development of competitive advantage. It has made two
major contributions to our understanding. First, it has placed a major emphasis on the
supply chain in value adding mechanism, raising the subject to a strategic level in the
minds of senior executives. Secondly, it has placed the customer in an important
position in the value chain.
In order to understand the relationship between competitive and supply chain strategy,
we need to begin with the value chain. The conventional value chain, shown as Figure
11.1, reflects the addition of value of activities in a firm. It is comprised of both the
primary and support activities. Two of the primary activities of the value chain –
inward and outward logistics — are included in the primary activities of the supply
chain. This emphasizes the importance of the supply chain in the value chain concept
and also establishes the role of the supply chain as a subset of the value chain.
Figure 11.1: Porter’s Value Chain

The value a supply chain generates is the difference between what the final product is
worth to the customer and the effort the supply chain expends in filling the customer’s
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request. Therefore, the profitability of the supply chain is based on the flows between 217
Levels and Design
and among stages in a supply chain. in Supply Chain
The revised version of the value chain is shown as Figure 11.2. The chain consists of a
series of activities that create and build value. Unlike the conventional value chain
which is based on a ‘push’ system, this value chain is shown to be a ‘pull’ system.
This means that it is the customer who determines the product requirements and the
product value.
Figure 11.2: The Value Chain

The first stage of the value chain, shown in Figure 11.2 above, is the birth of a new
product. This is shown as product development in the value chain. The primary
functions that are of key importance to draw up the specifications are marketing,
materials (to ensure that the materials in whatever form flow efficiently and
effectively to satisfy this demand), engineering (to make sure that the firms have the
capability to add value to products in the most effective way), quality (to ensure that
all members of all firms are monitoring all stages of production so that problems are
identified early and removed). They culminate in the total value delivered by an
organization to the customer.
Thus, the integrated team (with members from the different functions) works together
to create the value required of the product at each stage of its transition from raw
material to consumption. The specifications for the product come from marketing and
sales, as well as engineering. Marketing finds out from the consumer the value that is
required now and in the future, as well as the volume, place and timing of production
required.
It also identifies the customer priorities that the product and services will satisfy by
bringing customer input into the new product development. Marketing also generates
demand for the product. The transformation process of inputs to outputs, using the
product specifications, is taken up by operations. The supply chain either takes the
product to the customer or brings the customer to the product. Customer requests,
during or after the sale, is the responsibility of service. These core functions are basic
to a successful sale. Finance, accounting, information technology, and human
resources support and facilitate the functioning of the value chain.
Table 11.1 shows the relationships between supply chain activities and functional and
organizational relationships. The value chain emphasizes the close relationship
between the functional strategies of the supply chain and that of the other functions,
within a company. To execute a company's competitive strategy, all these functions
play a role. The organization's purpose is a never ending search for continuous
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218 improvement in the cost base and value of the product. If this is accepted by all, then
Logistics and
Supply Chain Management relations between functions are not of an adversarial win-lose nature but based on
mutual problem solving for shared win-win solutions.
Table 11.1: Summary of Key Operations and Supply Chain Activities
Put another way, the product development strategy i.e. portfolio of new products that a
company will try to develop, the marketing and sales strategy i.e. how the market will
be segmented and the product positioned, priced, and promoted, the supply chain
strategy cannot be formulated in isolation. They are closely intertwined and must fit
and support each other if a company is to succeed.
The supply chain strategy determines the nature of procurement of raw materials,
transportation of materials to and from the company, manufacture of the product or
operation to provide the service, and distribution of the product to the customer, along
with any follow-up service.
From a value chain perspective, supply chain strategy specifies what operations,
distribution, and service will try to do particularly well. Decisions regarding
inventory, transportation, operating facilities, and information flows in the supply
chain are all part of supply chain strategy. There has to be a link between a company's
competitive strategy and supply chain strategies. The question is: given the
competitive strategy, what should the company's supply chain strategy try to do?
This simple example illustrates the point. If marketing requires the company to have
the ability to provide a large variety of products very quickly; and the supply chain
management is targeting the lowest cost means of transportation, it is very likely that
there will be delay in fulfilling orders. It is unlikely that you can get a variety of
products quickly to the customer, if you are grouping several orders together to get
better transportation economies. The action of the supply chain management conflicts
with marketing's stated goal of providing variety quickly.
For any company to be successful, its supply chain strategy and competitive strategy
must fit together. This is called strategic fit. In designing the supply chain, strategic fit
refers to consistency between the customer priorities that the competitive strategy
hopes to satisfy and the supply chain capabilities that the supply chain strategy aims to
build. All the functions in the value chain contribute to the success or failure of this
effort. As functions in a company do not operate in isolation; no one function can
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ensure the chain's success. Though, however, failure at any one of the functions can 219
Levels and Design
lead to failure of the overall chain. in Supply Chain
For any company, there are three key considerations that require to be kept in mind
during the supply chain strategy or design phase:
1. Functional strategies must be coordinated so that the overall strategy fits with the
competitive strategy.
2. Each functional strategy must support other functional strategies and help a firm
reach its competitive strategy goal.
3. Processes and resources must be structured to help execute these strategies
successfully.
A company may fail because of any the three reasons mentioned above: a lack of
strategic fit, functional strategies that are not supportive, or if processes and resources
are not provided to execute the desired strategy.
To elaborate, let us take the example of Wal-Mart and L.L. Bean. Both these
organizations are in the FMCG and consumer durables trade. Wal-Mart is one of the
largest retail outlets in the world. A customer has to come to the store to purchase
products. L.L. Bean sells through a catalogue. This sector i.e. catalogue sales, is
growing at more than twice the rate of overall retail growth. Therefore, L.L. Bean
poses a competitive challenge to Wal-Mart. To face this challenge, the strategy of
Wal-Mart is based on a low price and product availability. L.L. Bean’s strategy is built
around providing the customer with convenience, availability and responsiveness.
With a focus on availability and responsiveness, L.L. Bean and Wal-Mart compete
with each other with different competitive strategies.
In terms of supply chain strategy, Wal-Mart and L.L. Bean have a range of options. At
one extreme, they can have an efficient supply chain with a focus on the ability to
deliver low-cost products by limiting variety and exploiting economies of scale. At the
other extreme, they can have a highly flexible and responsive supply chain that is very
good at producing a large variety of products. In this second case, costs will be higher
than in an efficient supply chain. Both supply chain strategies are viable by
themselves. Both do not fit with the same competitive strategy. A supply chain
strategy that emphasizes flexibility and responsiveness has a better strategic fit with
L.L. Bean's competitive strategy, while an efficient supply chain has a better fit with
the strategy of Wal-Mart.
This notion of fit also extends to other functional strategies. For example, new product
development strategy for Wal-Mart should emphasize products that provide good
value, while for L.L. Bean it may include designing products that can be manufactured
quickly. This feature will allow both the companies to meet their strategic goals.
A strong strategic fit between the different functional strategies and the competitive
strategy, makes these companies world leaders in their areas of operations.
A major job of top management is to align the core functional strategies with the
overall competitive strategy, because processes and resources are structured to support
functional goals. If this alignment is not achieved, conflicts between different
functional goals arise and the firm cannot possibly achieve strategic fit. These
conflicts result in different functions targeting different customer priorities, conflict in
functional goals, conflicts during execution, and finally a dissatisfied customer. In the
long run, the very existence of the company is threatened.
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220
Logistics and 11.4 FUNCTIONAL STRATEGIES THAT IMPACT SUPPLY
CHAIN PERFORMANCE
Many functional strategies will have a major impact on creating value for a company
and its supply chain partners. An effective supply chain is integrated with the
competitive strategy of the firm. The result should generate the highest level of
customer satisfaction while delivering the highest value to the shareholders.
It is more fruitful to look at these strategies and their integration with the supply chain
strategy if we look at each separately. These are described below:
z Cost Leadership Strategy
z Differentiation Strategy
z Focus and Niche
z Customer service strategy, and
z IT strategy.
11.4.1 Cost Leadership Strategy

A cost-leadership strategy means that the firm is attempting to reduce its economic
costs below its competitors to gain a competitive advantage. This policy once
achieved provides high margins and a superior return on investments.
The skills and resources required to be successful in this strategy are sustained capital
investment and access to capital; superior process engineering skills; good supervision
and motivation of its labour force; product designed for ease in manufacturing; low-
cost distribution system. The organization attempts to exploit economies of scale by
aggressive construction of efficient economies of scale through:
z Volume of production and specialized machines
z Volume of production and cost of plant and equipment
z Volume of production and employees specialization
z Volume of production and overhead costs
This strategy requires tight cost control. The structure of the organisation should be
clear-cut and responsibilities clearly laid out. Organizations often provide incentives
based on meeting strict quantitative targets, etc.
In order to remain a cost leader, the firm attempts to avoid those factors that can cause
the economies of scale to be affected. It has to work within the physical limits to
efficient size; worker motivation; and focus on markets and suppliers, sometimes, in
restricted geographical areas. Firms that are known to have successfully used this
strategy in a number of their businesses include Black and Decker, Texas Instruments,
and Du Pont.
The circumstances under which the low-cost producer strategy works best are:
z Buyers are large and have significant bargaining power;
z Price competition among rival sellers is extremely important as a competitive
force;
z The product is a standard item which is readily available from a variety of sellers;
z The buyer does not generally differentiate the value of the product from its price;
and
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z Buyers incur low switching costs in changing from one seller to another and are 221
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prone to shop for the best price. in Supply Chain
A low-cost leader sets the floor on market price, and by doing so it provides an
attractive defence against competitive forces. Because of his lower costs, the leader
can still earn returns as its competitors have depleted their profits through rivalry. The
leader is protected from powerful buyers because buyers can exert power only to
lower prices, and this will be possible only with next most efficient competitor. Lower
cost provides it protection against suppliers because there is more flexibility in the
organization to cope with input cost increases. Any new entrant will find it difficult to
overcome entry barriers because of (a) scales of economy and (b) as the activities
taken to achieve low costs are both rare and costly to imitate.
Finally, it places the organization in a favourable position when pitted against
substitutes compared to competitors in the industry.
Cost leadership is valuable if:
1. Differentiation is not valued very much by the buyers,
2. Buyers are price-sensitive and are looking for money value,
3. Competitors are not in a position to immediately match lower prices, and
There are no major changes in:
z Consumer Tastes
z Technology
z Exogenous Prices/Costs
11.4.2 Differentiation Strategy

A differentiation strategy requires the firm to provide products that are unique along
some dimensions that are widely valued by buyers. It has to select one or more
attributes that many buyers in an industry perceive as important, and then uniquely
position it to meet those needs. Differentiation should result in buyers preferring the
company's product/service over brands of rivals. An organization that is successful in
pursuing such a strategy can expect a competitive advantage through higher
revenues/margins and enhanced economic performance.
The challenge is finding ways to differentiate that create value for buyers and that are
not easily copied or matched by rivals. A company has to find different options that
create value for buyers and each option can represent a potential basis for
differentiation. Ways to differentiate products/services include:
z Product features
z Linkage between functions
z Timing
z Location/convenience
z Product mix
z Links with other firms
z Customization
z Product complexity/sophistication
z Marketing (image, etc.)
z Service and support
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222 Successful differentiation creates lines of defense against the five competitive forces.
Logistics and
Supply Chain Management It provides insulation against competitive rivalry because of brand loyalty of
customers and hence lower sensitivity to price. The customer loyalty also provides a
disincentive for new entrants who will have to overcome the uniqueness of the product
or service. Competitors are not likely to follow a similar approach if buyers value the
differentiated products and services. If they do, this will lead to a lose-lose situation
for them.
The higher returns of the strategy, provides a higher margin to deal with supplier
power. Buyer power is mitigated as there are no comparable alternatives. Finally a
company that has differentiated itself to achieve customer loyalty should be better
placed to compete with substitutes than its competitors. Some successful examples of
this strategy are Mercedes in Automobiles, Bose in Audio Systems, and Caterpillar in
construction equipment.
Competitive advantage through differentiation is sustainable if the activities taken to
achieve differentiation are rare and costly to imitate. The most appealing types of
differentiation strategies are those least subject to quick or inexpensive imitation.
Differentiation is most likely to produce an attractive, long-lasting competitive edge
when it is based on technical superiority, quality, giving customers more support
services, and on the core competencies of the organization.
Differentiation strategy works best when there are many ways to differentiate the
product/service and these differences are perceived by buyers to have value or when
buyer needs and uses of the item are diverse. The strategy is more effective when not
many rivals are following a similar type of differentiation approach. There are risks in
this strategy when the cost of differentiation becomes too great or when buyers
become more sophisticated and need for differentiation falls.
11.4.3 Focus and Niche Strategies

The generic strategy of focus is based on the firm choosing a narrow competitive
scope within an industry. This could be a segment or group of segments in the
industry, or buyer groups, or a geographical market. The firm then tailors its strategy
to serving these customers to the exclusion of others. The attention of the organization
is concentrated on a narrow section of the total market with an objective to service
buyers in the target niche market better than its competitors. The idea is that the firm
will have an edge over their rivals, who service the entire market. Two aspects to this
strategy are the cost focus and the differentiation focus.
In cost focus a firm seeks a cost advantage, similar to the cost-leadership strategy
discussed earlier, but limited to its target market. The objective is to achieve lower
costs than competitors in serving the market. This low cost producer strategy of the
firm requires it to identify buyer segments with needs/preferences that are less costly
to satisfy as compared to the rest of the market.
Differentiation focus is again similar to the differentiation strategy discussed earlier,
but limited to its target market. The firm tries to offer niche buyers something
different from other competitors and seeks product differentiation in its target market.
Both types of the focus strategy rest on differences that can be generated by the
focuser firm between its target market and other markets in the industry. The need to
identify buyers with unusual needs or else design a production/delivery system that
best serves the target market. Target markets defined by the focuser firm must differ is
some ways from that of other industry segments.
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Focus strategies are best visualized in the strategies used by local kirana stores in all 223
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parts of India. On an international scale, examples of successful focus strategy are the in Supply Chain
strategies used by Mercedes Benz, Lexus and Cadillac in luxury automobiles.
It should be clear that the focus strategy may not achieve low cost or differentiation
from the perspective of the market as a whole. It achieves this only in its narrow target
market. Therefore, it is important that the market segment is big enough to be
profitable and has growth potential.
Organizations that use a focus strategy have to develop the skills and resources to
serve the market effectively. They have to develop the ability to defend themselves
against challengers through the customer goodwill they have built up and the superior
capabilities they have developed to serve buyers in the market.
Some of the situations and conditions where a focus strategy works best are:
z When it is costly or difficult for multi-segment rivals to serve the specialized
needs of the target market niche;
z When no other rivals are concentrating on the same target segment;
z When a firm's resources do not permit it to go after a wider portion of the market;
z When the industry has many different segments, creating more focusing
opportunities and allowing a focuser to pick out an attractive segment suited to its
strengths and capabilities.
11.4.4 Customer Service Strategy

Customer service strategy is directly derived from the three competitive strategies we
just discussed. This strategy is often considered by academics as being a supply chain
strategy. This is true to the extent that there is a strong relationship between marketing
and supply chain management. However, marketing considerations lead the supply
chain decisions.
The customer satisfaction level is directly proportional to the service provided by the
company. Evaluation of service quality becomes difficult due to three characteristics
that are inherent in services – intangibility, heterogeneity, and inseparability.
A framework consisting of ten determinants or dimensions of service quality are:
z Reliability,
z Access,
z Understanding of the customer,
z Responsiveness,
z Competence,
z Courtesy,
z Communication,
z Credibility,
z Security, and
z Tangible Considerations.
The service quality dimensions of reliability, access, understanding the customer,
responsiveness and competence are linked to the competitive strategy of the firm.
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224 Reliability
Logistics and
Supply Chain Management Service reliability means consistently performing the service dependably and
accurately. Service reliability is the service “core” to most customers. Portraying the
reliability and consistency with which the service is delivered can take two routes. The
first involves emphasizing the technological superiority and dependability of the
process by which the service is produced – a high-tech approach. While technological
drivers such as advances in telecommunications, satellite, digital, and web technology
are increasing the tradability of services. The second concerns the consistent and
dependable performance of the service personnel – a high touch approach. Continuous
improvement is the key to providing reliable service.
Access
Since production and consumption of the service are inseparable, a customer's ease of
contact with and timely access to the service supplier is crucial. The highly advanced
and reliable communication infrastructure in developed countries presents various
alternatives through which the customer/supplier connection is possible.
Understanding/Knowing the Customer

The premise of “knowing the customer” serves as the underlying basis behind a
consistently growing area of interest in marketing: relationship marketing. For service
business, strong customer relationships are of particular importance because of their
inherently interpersonal focus and the relative lack of objective measures for
evaluating service quality.
There are essentially three levels of relationship marketing: The first level is based on
financial incentives, such as price discounts, given to the customers to retain them; the
second level is where firms combine financial and social benefits, emphasizing
staying in touch with clients, learning about their wants and needs, customizing the
relationship, etc.; the last level adds a strategic dimension in the levels of relationship
whereby value-added benefits are provided by both relational partners as in strategic
alliances.
Responsiveness
One of the major determinants of service quality is timely and adequate response. The
relative importance of timely versus substantive response (e.g. decision convenience,
access convenience, transaction convenience, and benefit convenience) differs. There
is a relationship between time scarcity and consumers’ desire for goods and services
that offer convenience.
Competence
Possession of the required knowledge and skills to provide the service is critical to the
success of any service supplier. Competence of the firm has to be centralized around
the organization as a whole. Expertise and skills are to be reflected in the organization.
Formulating a customer service strategy involves a decision on the segment it wants to
target for a particular commodity. It is required to project the cost of the support
system and its feasibility of execution. The response which maximizes the firm's
profitability and growth should be determined.
11.4.5 Information Technology Strategy

Developments in IT have enabled the integration of business information flows, both
horizontally and vertically. Organizations are moving towards a concept known as
electronic commerce, where information transactions are automatically completed via
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Electronic Data Interchange (EDI), Electronic Funds Transfer (EFT), Point of Sale 225
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(POS) devices, and a variety of other approaches. This is being covered in detail later in Supply Chain
on in the book.
The proliferation of new telecommunications and computer technology has made
instantaneous communications a reality. Information systems and satellite networks
can link together suppliers, manufacturers, distributors, retail outlets, and ultimately,
customers, regardless of location. A number of IT-based supply chain information
management tools are now available to provide intelligent decision support and
execution management. Decisions have to be made in the areas of: (a) data capture,
display and organization; (b) communication; and (c) processing.
Based on the managerial scope of application, IT applications can be classified as
Transaction Processing Systems (TPS), Management Information Systems (MIS) and
Decision Support Systems (DSS).
z A TPS deals with individual transactions and interactions between different
entities and is governed by simple logical rules of operation. Its role is to ensure
reliable information exchange with improved response time, as compared to a
manual system. Typical examples in SCM are computerized stock issue registers
or sales order recording.
z An MIS goes one level further and provides information in different ways to
management at different levels. For example, an MIS may aggregate different
stock issue transactions for an item and provide information on appropriate
ordering levels and vendors. Similarly, sales orders over a period of time are
aggregated and it is possible to survey them by region or by customer, etc.
z A DSS has the provision for decision models in the relevant domain. A DSS is
flexible and may have various policies and built-in rules, which the user can
invoke. It is usually possible to include more decision rules or models as time
progresses.
A further level of planning and control is achieved through Enterprise Resource
Planning (ERP). This software has a relational database, client-server architecture and
appropriate graphical user interfaces. The term 'enterprise' in ERP is intended to cover
the supply chain interfaces that a firm deals with from customers to vendors. ERP
products provide various modules to link the basic planning and operational decisions
of a firm with its other functions and provide the information backbone and
coordinated requirements at different stages. Many ERP packages have options that
encode efficient ways of conducting standard transactions, such as order acceptance,
issuing of purchase orders, managing payments and receipts to vendors and dealers.
Such 'best-practices' offer companies an option to streamline their systems using this
benchmark.
The IT strategy of the firm is based on the functionality of the IT applications, the
requirement of flow of information in a supply chain. From the supply chain point of
view, flow of information is a continuum that stretches from activities that are
‘company-centric’ to ‘partner-centric’ activities, i.e. activities that are carried out
within the firm and those that are sources out. Therefore, one needs to define each
activity or process on the basis which are central to an organization's identity and must
be maintained in-house (for example, price information or financial valuation); and
those activities and processes that are peripheral, can be shared, and maintained by
business partners.
This simple exercise reduces the risk factor of the firm, supports its core
competencies, and determines the interfaces between the firm and its suppliers. This
concept makes business scalable and flexible to respond to changing customer needs.
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226 It enables all supply chain partners to have more capacity and capability in providing
Logistics and
Supply Chain Management value to their customers.
State whether the following statements are True or false:
1. Based on the managerial scope of application, IT applications can be
classified as Transaction Processing Systems (TPS), Management
Information Systems (MIS) and Decision Support Systems (DSS).
2. A TPS deals with individual transactions and interactions between
different entities and is governed by simple logical rules of operation.
3. An MIS goes one level further and provides information in different ways
to management at different levels.
4. A DSS has no provision for decision models in the relevant domain.
5. The IT strategy of the firm is based on the functionality of the IT
applications, the requirement of flow of information in a supply chain.
11.5 PARAMETERS FOR SUPPLY CHAIN DESIGN

The current method that most companies choose for improving supply chain
performance is to implement sophisticated advanced planning systems, operations
management software and real time inventory management processes. These
processes and systems have improved inventory management practices and clearly
reduced the cost structure. But the focus of these processes and systems is operational
and does not quite influence the design, manufacturing and supply chain decisions that
set basic targets for supply chain performance of a product.
SCM extends to a much higher level than that of a concern with improved inventory
management practices and clearly reduced the cost structure, which relate to the
physical flow of material. The supply chain will, if properly designed and managed:
(a) Improve customer service.
(b) Achieve the necessary balance between costs and service.
(c) Give the corporation a competitive advantage.
These are required to reinforce the strategic objectives of the firm, but makes the
design the supply chain a challenging exercise. A good supply chain achieves the
objectives of SCM, and simultaneously the strategic objectives of the firm.
Before the design of the supply chain is started, there are three basic requirements that
need to be met.
Understanding these, it is possible to decide on the supply chain strategy and design a
supply chain that has a strategic fit with the functional strategies of the firm.
11.5.1 Understanding the Customer

The supply-chain management philosophy is to treat the entire SC as a single,
integrated entity; the cost, quality, and delivery requirements of the manufacturing
customer are objectives shared by every firm in the chain; and inventory is the last
resort in solving supply-and-requirement imbalances between the tiers.
In order to meet the requirements of this philosophy, each supplier in the supply chain
should understand its customers. This understanding includes more than just
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knowledge of delivery, quality, quantity, and cost requirements; it includes also the 227
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knowledge of the customer's markets, processes, and organizational cultures as well as in Supply Chain
their problems, constraints, and requirements.
To understand the customer, a company must identify the needs of the customer
segment being served. Let us compare Palika Bazaar in Delhi with Shopper’s Stop.
When customers go to Shopper’s stop, they go there to purchase quality goods and are
not necessarily looking for the lowest price. In contrast, a low price is very important
to a customer going to Palika Bazaar. This customer may be willing to tolerate less
variety and even purchase very large package sizes as long as the price is low. Even
though the customers may purchase the same products at both places, the demand
varies along certain attributes.
In general, customer demand from different segments may vary along several
attributes as follows:
z The quantity of the product needed.
z The response time that customers are willing to tolerate.
z The variety of products needed.
z The service level required.
z The price of the product.
z The desired design and innovation in the product.
Each customer segment will tend to have similar needs. The goal of the firm is to
identify key measures that combine the attributes the firm’s customer’s demand.
These key measures help define what the supply chain should do particularly well.
The best situation is when these attributes can be reflected by a single measure.
While the aim of the supply chain is to eliminate waste in the chain and improve
customer service, the objective of SCM is to achieve revenue growth and cost
reduction simultaneously. This means a balance between the goals of a high customer
service level and the goals of low inventory investment and low unit cost. These are
difficult trade-offs. These trade-offs are made easier when the organization
understands the customer.
Ultimately, the measure of the supply chain is in terms of service quality. The major
output from the supply chain has always been considered to be customer service. All
the activities in the supply chain must be in balance, in order to provide a higher level
of customer service without incurring an undue burden of cost.
11.5.2 Implied Demand Uncertainty

It views each of the customer needs and categorizes the attributes into one measurable
metric. Implied demand uncertainty is the resulting uncertainty for only the portion of
the demand that the supply chain must handle and the attributes the customer desires.
For example, a firm supplying ordinary groceries will face a higher implied demand
uncertainty than a firm that supplies the same groceries which are organically grown.
A customer will shop in the first place for convenience, but in the other grocery store
he will be willing to provide for a long lead time.
Another example to illustrate the concept is the impact of service level. A supply
chain that boasts of a high service level is expected to meet a higher percentage of
actual demand. This means that it should be prepares for unusual surges in demand.
This increases the implied demand uncertainty. Raising the service level means higher
implied demand uncertainty even though the product's underlying demand uncertainty
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228 does not change. Both the product demand uncertainty and various customer needs
Logistics and
Supply Chain Management that the supply chain tries to fill affect implied demand uncertainty.
As each individual customer need contributes to the implied demand uncertainty,
implied demand uncertainty is a common metric with which to distinguish different
types of demand. From the supply chain manager’s point of view, products with lower
demand uncertainty can facilitate more accurate forecasting, as demand is more
predictable.
The impact of customer needs on implied demand uncertainty is shown in Table 11.2.
Table 11.2: Impact of Customer Needs on Implied Demand Uncertainty
Customer Need Impact on Implied Demand Uncertainty
Range of quantity required Increases because a wider range of the quantity required implies
greater variance in demand
Lead time decreases Increases because there is less time in which to react to orders
Variety of products required Increases because demand per product becomes more
disaggregate
Number of channels through Increases because the total customer demand is now
which product may be acquired disaggregated over more channels
Rate of innovation Increases because new products tend to have more uncertain
demand
Required service level Increase because the firm now has to handle unusual surges in
increases demand
An example of a product with low implied demand uncertainty is flour. Flour has a
very low contribution margin, accurate demand forecasts, low stock out rates, and
virtually no markdowns. An example of a product with high implied demand
uncertainty is a new "palmtop" computer. It will have a high margin; demand forecasts
will not be very accurate. If it is successful it will have high stockout rates and if it
fails there will be large markdowns. This is shown in Table 11.3.
Table 11.3: Correlation between Implied Demand Uncertainty and Other Attributes
Low Implied Uncertainty High Implied Uncertainty
Product margin Low High 40% to 100%
Average forecast error 10% 10% to 40%
Average stock out rate 1 % to 2% 10% to 25%
Average forced season end 0%
markdown
Implied demand uncertainty is often correlated with other characteristics of demand.

For example, implied demand uncertainty is strongly affected by the product life
cycle. New products at the ‘inception stage’ have higher supply uncertainty. This is
because designs and production processes are still evolving. In contrast, mature
products have a more stable demand and the products also do not change much. Such
products show less implied demand uncertainty.
Products with uncertain demand are often less mature and have less direct
competition. As the implied demand uncertainty increases there is greater difficulty
matching supply with demand. Increased implied demand uncertainty leads to both
higher oversupply and a higher stock out rate. As a result, margins for such products
tend to be high. Such products also have higher markdowns because oversupply often
results due to high implied demand uncertainty.
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11.5.3 Understanding the Supply Chain 229
Levels and Design
The supply chain strategy needs to be designed such that it best meets demand that a in Supply Chain
company has targeted given the uncertainty it faces. Supply chains have many
different characteristics. The characteristics of the supply chain which meet these
criteria are responsiveness and efficiency.
Supply chain responsiveness is those abilities of a supply chain necessary to meet the
demand and supply requirements of the supply chain. It includes a supply chain's
ability to:
z Cater to wide demand fluctuations in the market;
z Deliver with short lead times;
z Handle a large variety of products;
z Provide a very high service level; and
z Handle supply uncertainty promptly.
These abilities are similar to many of the characteristics of demand and supply that
lead to high implied uncertainty.
Supply chain efficiency is the cost of making and delivering a product to the customer.
By definition, increases in supply chain costs reflect a lower efficiency of the supply
chain. The supply chain design framework should consider three specific costs that are
relevant: unit manufacturing cost, safety stock cost, and pipeline stock cost. The
supply chain design problem should attempt to minimize the sum of these costs when
designing a supply chain.
To respond to a wider range of quantities demanded, the supply chain capacity must
be increased, this in turn increases costs. Therefore, increased responsiveness means
additional costs and therefore, lower efficiency. There is this trade-off between
responsiveness and efficiency that determines the design of the supply chain.
Figure 11.3: Responsiveness Efficient Frontier

The cost-responsiveness efficient frontier is the curve in Figure 11.3. The efficient
frontier represents the benchmark for cost-responsiveness performance. A firm that is
not on the efficient frontier can improve both its responsiveness and its cost
performance by moving toward the efficient frontier. However, when a firm reaches
the efficient frontier, it can then only improve its responsiveness by increasing cost
and becoming less efficient.
Given the competitive environment, firms on the efficient frontier continuously
improve their processes and change technology to shift the efficient frontier itself.
A key strategic choice for any supply chain is the level of responsiveness it seeks to
provide.
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230 Table 11.4: The Responsiveness Spectrum
Logistics and
Supply Chain Management Highly Efficient Somewhat Efficient Somewhat Highly Responsive
Responsive
Integrated steel mills: Vikas Publications: Most automotive Most fast food
Production scheduled Books are traditional production: businesses: Orders are
weeks or months in make-to-stock items Delivering a large satisfied within
advance with little with production lead variety of products in minutes
variety or flexibility time of several months a couple of weeks
These parameters are the basic blocks for the design of the supply chain. Based on
these, supply strategies are integrated into the design of the supply chain.
A supply chain can be viewed as a network with precedence constraints among the
functions. A function might be the procurement of a raw material, the manufacture of
an assembly, or the shipment of a product to a distribution centre. For each of these
functions, there are a number of constraints. Furthermore, there are one or more
options available to satisfy the function. The role of the design is to identify the
options that can satisfy each function and then to decide which options to select.
This is not easy. A question every firm faces, one time or the other, is whether to
create a higher unit manufacturing cost, but more responsive, supply chain versus a
lower manufacturing cost, less responsive supply chain. The correct answer to this
question, finally, should lead to a supply chain that has a strategic fit in terms of
meeting customer aspirations, efficiency and responsiveness.
Fill in the blanks:
1. A supply chain can be viewed as a …………………….. with precedence
constraints among the functions.
2. A …………………………… might be the procurement of a raw material,
the manufacture of an assembly, or the shipment of a product to a
distribution centre.
3. There are one or more ………………………… available to satisfy the
function.
4. The role of the design is to …………………………….. the options that
can satisfy each function and then to decide which options to select.
5. Increased responsiveness means additional costs and, therefore,
……………………….efficiency.
11.6 LET US SUM UP

It is important to understand exactly how and where to deploy assets for optimal
operational and financial performance. Personnel involved in supply chain design
require a tool that considers business objectives, resource constraints and subsequent
financial impacts in order to define an optimal supplier-to-customer supply chain
structure – one that cuts costs and increases profitability.
There are three levels of activities in supply chain management in that different
departments of an organization focus on to achieve the smooth running of the supply
chain. They are strategic, tactical and operational.
Supply chain design is a strategic decision. It reflects the structure of the supply chain
over the next several years. It decides what the chain’s configuration will be, how
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resources will be allocated, and what processes each stage will perform. Successful 231
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design requires a high degree of functional and organizational integration. Supply in Supply Chain
chain performance improves if all stages of the chain take actions that together
increase total supply chain profits.
The skills and resources required to be successful in this strategy are sustained capital
investment and access to capital; superior process engineering skills; good supervision
and motivation of its labour force; product designed for ease in manufacturing; low-
cost distribution system. A differentiation strategy requires the firm to provide
products that are unique along some dimensions that are widely valued by buyers.
The generic strategy of focus is based on the firm choosing a narrow competitive
scope within an industry. Focus strategies are best visualized in the strategies used by
local kirana stores in all parts of India.
Based on the managerial scope of application, IT applications can be classified as
Transaction Processing Systems (TPS), Management Information Systems (MIS) and
Decision Support Systems (DSS).

‘Supply Chain Design is a strategic decision’. Justify the statement.
11.8 KEYWORDS
Strategic Level: At this level, senior management is involved in the supply chain
process and makes decisions that concern the entire organization.
Tactical Level: Tactical level of activity focuses on achieving lowest costs for running
the supply chain.
Cost-leadership Strategy: A cost-leadership strategy means that the firm is attempting
to reduce its economic costs below its competitors to gain a competitive advantage
Reliability: Service reliability means consistently performing the service dependably
and accurately.

1. What are strategic level activities?
2. What are tactic level activities?
3. What are operational level activities?
4. ‘The design of any supply chain must take into account the balance of customer
service and cost’. Comment.
5. Discuss porter’s value chain in detail.
6. Differentiate cost leadership strategy and differentiation strategy.
7. Differentiate focus and niche strategy and customer service strategy.
8. Discuss supply chain and the value chain.
9. Describe various parameters for supply chain design.
10. What is responsiveness spectrum?
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LESSON 235
Role of Managers in
Supply Chain
12
ROLE OF MANAGERS IN SUPPLY CHAIN
CONTENTS
12.1 Introduction
12.2 Characteristics and Role of Supply Chain Managers
12.3 Skills and Competency Requirements for Supply Chain Managers
12.4 Let us Sum up
12.6 Keywords

z Discuss the characteristics of supply chain managers
z Describe the role of supply chain managers
z Identify the skills of supply chain managers
z Identify the competency requirements for supply chain managers
12.1 INTRODUCTION
Supply chain management handles the resources a company uses to build product for
customers. The supply chain begins before a company purchases raw materials with
research and planning to find the highest quality at the lowest price. Planning,
purchasing, production, shipping and receiving are all part of the supply chain in an
organization. With the growing acceptance of logistics and supply chain management
as critical business concerns, there is an emerging realisation that more investment is
needed to develop appropriate managerial skills and competencies.
Whilst recognising that logistics and supply chain management can be, and often are,
managed separately we argue that at this early stage in the acceptance and
implementation of these ideas the reality is that they tend to be managed conjointly.
For this reason we will use the label ‘supply chain manager’ as a generic descriptor.
Supply chain managers not only need to be equipped with the skills and knowledge to
manage logistics but also they must be relationship managers.
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236
Logistics and 12.2 CHARACTERISTICS AND ROLE OF SUPPLY CHAIN
MANAGERS
Supply chain managers are a quite varied group and to an extent reflect the disparate
origins of the subject in terms of their functional background – they often come into a
logistics/supply chain role from other areas such as transportation, procurement, IT,
finance, etc. Indeed it is only in recent years, with the advent of focused undergraduate
courses in logistics and SCM that people are coming into the logistics/SCM function
directly from University. The annual survey of logistics managers and directors in the
US carried out by the Supply Chain Management Research Group at the Ohio State
University (LaLonde and Ginter, 2004) gives an insight into the characteristics of the
typical supply chain manager; respondents to their 2004 survey were: 93.5% male,
6.5% female; median age for logistics directors was 43 and for managers was 39; of
the survey respondents 89% had a baccalaureate degree, 63% had a masters degree
and 18% had professional qualifications (for example APICS); for the respondents
who were logistics managers average time worked in logistics was 18.5 years, time
with current firm 4.2 years and time in current position 3.7 years.
Similar profiles were obtained in a survey of Australian logistics managers by Sohal
and D'Netto (2004): 62.5% of their survey respondents were aged between 35 and 49,
76% had a higher degree or diploma, and 63% had worked in the logistics function for
over 10 years. While these data are not necessarily typical of supply chain managers
everywhere, they are nonetheless indicative of general perceptions of the sector which
are that females are under-represented, people work within the function for many
years, and rotate jobs relatively frequently.
In recent years, there has been a growing awareness of the critical role played by
people, knowledge and talent in the context of supply chain success. In a panel
discussion with seven of the leading thinkers in the field of supply chain management,
the issue of management talent came to the fore: ‘despite years of process
breakthroughs and elegant technology solutions, an agile, adaptive supply chain
remains an elusive goal. Maybe it’s the people who are getting in the way ….. supply
chains, it seems are really about talent, not technology, especially as the marketplace
grows ever more complex’ (Kirby, 2003).
Similarly, van Hoek et al. (2002) describe managers in the supply chain as 'the critical
dimension'. On an anecdotal level, we recently heard a bank manager point out in a
presentation to managers from various medium-sized logistics companies that in his
view three factors were of utmost importance for the success of these companies:
management, management and management Quinn (2004) suggests that to achieve
any measure of supply chain success, three critical elements (people, process and
technology) need to be kept in balance. He adds that there is no single answer as to
which of these three is the most important to supply chain success, although he does
add that 'you can't do anything without the right people'. Research by Langabeer and
Seifert (2003) has pointed to the critical role played by supply chain managers in
ensuring the success of intercompany mergers; they show that a correlation exists
between merger successes and how well integrated the supply chains are, and this in
turn is dependent upon the role played by supply chain managers.
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Role of Managers in
State whether the following statements are True or False: Supply Chain
1. With the growing acceptance of logistics and supply chain management

are critical business concerns.
2. More investment is needed to develop appropriate managerial skills and
competencies.
3. Supply chain managers are a quite varied group and to an extent reflect
the disparate origins of the subject in terms of their functional
background.
4. Van cock et al (2005) describes managers in the supply chain as 'the
critical dimension'.
5. Supply chain managers not only need to be equipped with the skills and
knowledge to manage logistics but also they must be relationship
managers.
12.3 SKILLS AND COMPETENCY REQUIREMENTS FOR

SUPPLY CHAIN MANAGERS
Murphy and Poist (1991, 1994) suggested that the senior-level logistics manager
needs to be proficient in three skills categories namely: business skills, logistics skills
and management skills. In their survey of executive search firms, logistics
practitioners and logistics educators, management skills emerged as the most
important of the three categories, followed by logistics skills and then business skills.
Gammelgaard and Larson (2001) posited a three- factor model of SCM skill areas for
executive development and other programmes aimed at logistics managers:
interpersonal/managerial basic skills, quantitative/technological skills, and SCM core
skills. They also stressed the importance of good communications skills for today’s
logisticians, both upward and downwards communication within the organisation, as
well as being able to communicate across functions and organisations so as to
coordinate SCM. The consensus view across studies of supply chain managers would
appear to be that respondents regard themselves as 'managers first and logisticians
second with requisite skills and competencies sets that comprise both general
management skills and competencies and specific logistics/supply chain skills and
competencies (see, for example, Mangan et al., 2001).
Supply chain management implies a ‘horizontal’ organisational orientation rather than
a ‘vertical’ one. Traditional businesses are organised on functional lines with strong
hierarchical underpinnings. The managers who work in those types of business have
typically been trained and/or gained experience in very specific areas such as
marketing, production management, accountancy, etc. They will move upwards
through the hierarchy as they demonstrate increasing capability in that narrow
functional area.
The performance measurement systems that are frequently used in these organisations
mirror the vertical structure, i.e. they monitor progress towards the achievement of
functional goals.
By contrast, in the ‘horizontal’ organisation, managers work across functions often as
part of teams where different functional skills are brought together with a common
process focus. Because business processes are the means by which customer value is
created in any business, there is a strong logic in arguing that process management
rather than functional management should be the basis for organisational design.
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238 To enable ‘horizontal’ or process-focused management to become a reality, clearly
Logistics and
Supply Chain Management requires appropriate skill sets amongst managers. The implication is that the
management development process must focus on a holistic view of the way in which
customer value is created and delivered. This in turn suggests the need to develop an
awareness of how the interface in a supply chain needs to be managed and how
actions taken in one area might affect the performance of the whole. Thus, the need
for a greater level of ‘cross-training’ across functional boundaries is to ensure that the
whole becomes more than the sum of its parts.
The implication of this re-orientation is that the supply chain manager of the future
will require a ‘T-shaped’ skills profile (see Figure 12.1).
Effective process management requires significant cross-functional skills.
Figure 12.1: Skills Profile

The idea is that as well as bringing specific logistics management skills to the job (the
vertical bar) supply chain managers need to have a wide understanding of related areas
such as for example business process engineering, asset management and activity
based costing (the horizontal bar).
Recently Christopher (2004) identified seven major business transformations which
will have significant implications for supply chain management skills profiles. In his
presentation (Table 12.1), Christopher mapped each of these seven business
transformations against both their direct impact on the supply chain and the skills
which would as a result be required.
Table 12.1: The Key Business Transformations and the Implications for
Management Skills (Christopher, 2004)
Business Leading to Skills required
Transformation
1. From supplier-centric The design of Market understanding;

to customer-centric customer-driven customer insight
supply chains
2. From push to pull Higher levels of Management of complexity

agility and flexibility and change
3. From inventory to Capturing and sharing Information systems and

information information on real information technology
demand expertise
4. From transactions to Focus on service and Ability to define, measure

relationships responsiveness as the and manage service
basis for customer requirements by market
retention segment
Contd…
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5. From ‘trucks and A wider definition of Understanding of the ‘cost- 239
sheds’ to end-to end supply chain cost to-serve’ and time-based Role of Managers in
Supply Chain
pipeline management performance indicators
6. From functions to The creation of cross Specific functional

processes functional teams excellence with cross-
focused on value functional understanding.
creation Team working capabilities
7. From stand alone More collaborative Relationship management
competition to working with supply and win-win orientation
network rivalry chain partners
Christopher's framework again comprises both management skills and competencies

and logistics/supply chain management skills and competencies. These skills
requirements for future supply chain managers are wide and varied (perhaps more so
than might be the case with other categories of managers), with an emphasis in
particular on what could be described as interpersonal and communications skills.

Fill in the blanks:
1. Supply chain management implies a ‘…………………..’ organisational
orientation rather than a ‘…………………..’ one.
2. Traditional businesses are organised on ………………….. lines with
strong hierarchical underpinnings.
3. The managers will move ………………….. through the hierarchy as they
demonstrate increasing capability in that narrow functional area.
4. Christopher's framework comprises both management skills and
………………….. .
5. The skills requirements for future supply chain managers are ………… .
12.4 LET US SUM UP

With the growing acceptance of logistics and supply chain management as critical
business concerns, there is an emerging realisation that more investment is needed to
develop appropriate managerial skills and competencies.
Supply chain managers are a quite varied group and to an extent reflect the disparate
origins of the subject in terms of their functional background – they often come into a
logistics/supply chain role from other areas such as transportation, procurement, IT,
finance, etc. Indeed it is only in recent years.
On an anecdotal level, we recently heard a bank manager point out in a presentation to
managers from various medium-sized logistics companies that in his view three
factors were of utmost importance for the success of these companies: management,
management and management Quinn (2004) suggests that to achieve any measure of
supply chain success, three critical elements (people, process and technology) need to
be kept in balance.
Supply chain management implies a ‘horizontal’ organisational orientation rather than
a ‘vertical’ one. Traditional businesses are organised on functional lines with strong
hierarchical underpinnings. The managers who work in those types of business have
typically been trained and/or gained experience in very specific areas such as
LSCM
240 marketing, production management, accountancy, etc. They will move upwards
Logistics and
Supply Chain Management through the hierarchy as they demonstrate increasing capability in that narrow
functional area.
Christopher's framework again comprises both management skills and competencies
and logistics/supply chain management skills and competencies. These skills
requirements for future supply chain managers are wide and varied (perhaps more so
than might be the case with other categories of managers), with an emphasis in
particular on what could be described as interpersonal and communications skills.

Being a manager of supply chain department, what essential guidelines will you
follow for smooth and efficient functioning in an organisation?
12.6 KEYWORDS
Supply Chain: A supply chain is a system of organizations, people, technology,
activities, information and resources involved in moving a product or service from
supplier to customer.
Supply Chain Management (SCM): Supply chain management (SCM) is the
management of a network of interconnected businesses involved in the provision of
product and service packages required by the end customers in a supply chain.
Supply Chain Manager: Supply chain manager is a person who develops procedures
for coordination of supply chain management with other functional areas, such as
sales, marketing, finance, production, or quality.
Management Skills: Managerial skills are the essential skills possessed by a manager
which are the basis for successful management.

1. What is meant by supply chain?
2. What is supply chain management?
3. When does supply chain begins and how does it continues?
4. Who is a supply chain manager?
5. What are the characteristics/features of supply chain managers?
6. Explain the role of supply chain managers.
7. What is meant by competencies?
8. What are the desirable skills of supply chain managers?
9. Identify the competency needs for supply chain managers.
10. What are the additional skills requirements for the future SCM?
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242
Logistics and
LESSON
13
SUPPLY CHAIN PERFORMANCE DRIVERS
CONTENTS
13.1 Introduction
13.2 Supply Chain Drivers
13.2.1 Inventory Requirements
13.2.2 Logistical Drivers
13.2.3 Cross Functional
13.2.4 Need for Performance Measurement
13.2.5 Objectives of Performance Measurement
13.2.6 Performance Levels
13.3 Outsourcing and Sourcing
13.4 Sourcing Strategy
13.4.1 Single Sourcing
13.4.2 Network Sourcing
13.5 Let us Sum up
13.7 Keywords

z Explain different supply chain drivers
z Differentiate between sourcing and outsourcing
z Discuss Sourcing Strategy
z Define the term single sourcing
z Discuss for network sourcing
13.1 INTRODUCTION
In this lesson we introduce the logistical drivers-facility, inventory and transportation
and the three cross functional drivers – information, sourcing and pricing that
determine the performance of any supply chain. We discuss how these drivers are
LSCM
used in the design, planning and operation of the supply chain. We define several 243
Supply Chain
metrics that can be used to gauge the performance of each driver. Performance Drivers
13.2 SUPPLY CHAIN DRIVERS

Performance of the supply chain can be determined with the help of the drivers. The
drivers of the supply chain consist of three logistical drivers and three cross functional
drivers.
13.2.1 Inventory Requirements

Inventory "stockage" exists in all supply chains because of a mismatch between
supply and demand. Inventory plays a significant role in a supply chain's ability to
support a firm's competitive strategy. A supply chain manager must make routine
decisions to create a more responsive and more efficient supply chain.
Mismatches are often intentional, such as the case when cost effectiveness dictates
batch sizes or when future demand is unclear and immediate customer delivery is
required. The spread of inventory throughout the supply chain includes raw materials,
work in process, and finished goods by suppliers, manufacturers/repairers,
distributors, and retailers. Inventory also has a significant impact on the material flow
time of a supply chain. A major conclusion for those who manage inventory is that
decreasing inventory (without increasing cost or decreasing responsiveness to the
customer) can provide a significant flow time advantage in performance in the supply
chain.
Inventory also plays a significant role in a supply chain's ability to support a firm's
competitive strategy. If a business requires a very high level of responsiveness, the
company can use inventory to achieve this responsiveness by locating large stocks of
inventory close to the customer. In a pull or just-in-time environment, suppliers may
elect to locate inventories within a customer's stockroom with scheduled shipments on
an hourly or minute-by-minute basis. An extreme case is a supplier co-locating their
specialized manufacturing within the factory of their customer, providing instant
responsiveness to the customer's demand. Conversely, a business can also use
inventory to become more efficient by decreasing inventory through centralised
stocking. The tradeoff is efficiency versus responsiveness.
A supply chain manager must make routine decisions to create a more responsive
and more efficient supply chain. These decisions typically focus on decreasing
procurement, repair or delivery cycle inventory, safety inventory, and seasonal
inventory.
13.2.2 Logistical Drivers

Facilities
Facilities are the physical locations where the products stored or assembled. The major
types of facilities are production sites and the storage sites. Economies of scales are
used in centralisation of facilities to increase supply chain efficiency.
Facilities include all locations in the supply chain to store, assemble, or fabricate
inventory. In DoD, it is where personnel repair weapon systems and secondary items.
The two major types of facilities are:
z Manufacture/repair sites
z Storage (warehouse, distribution) sites
LSCM
244 Whatever the function, decisions regarding location, capacity, and flexibility of
Logistics and
Supply Chain Management facilities significantly affect supply chain performance. For example, a company can
increase responsiveness by setting up warehouses near its customers instead of
creating only one remote stock facility. This usually decreases cost while increasing
responsiveness. Since facilities are a key driver of supply chain performance, factors
such as location, capacity, manufacture/repair methodology, and warehousing
methodology also affect supply chain performance by way of the facilities component.
In DoD, depot and field repair facilities are cornerstones of the supply chain.
Components of facilities Decision
z Location
centralization (efficiency) vs. decentralization (responsiveness)
other factors to consider (e.g., proximity to customers)
z Capacity (flexibility versus efficiency)
z Manufacturing methodology (product focused versus process focused)
z Warehousing methodology (SKU storage, job lot storage, cross-docking)
z Overall trade-off: Responsiveness versus efficiency
Inventory
Inventory consists of the raw materials, work in progress and the finished goods.
Changing inventory policies can largely affect the efficiency and the responsiveness of
the supply chain. Three basic decisions to be taken by the business regarding
inventory are cycle, safety and the seasonal inventory decisions.
Inventory Management involves the control of current assets being procured or
produced in the normal course of the company's operations i.e. or "how many" parts,
pieces, components, raw material and finished goods the firm should hold and when
should it replenish the stock. What should be the trigger points for action?
The purpose of holding inventories is to allow the firm to separate the processes of
purchasing, manufacturing, and marketing of its primary products. In other words, the
inventory forms a buffer that ensures the flow of the goods and services of the firm is
maintained on a continuing basis, based on the customer’s requirements.
Inventories not only separate processes, but also reduce risk of production shortages.
For example, manufacturing firms frequently produce goods with hundreds or even
thousands of components. If any of these components are not available on time, the
entire production operation can be halted. This would mean heavy loss to the firm. To
avoid starting a production run and then discovering the shortage of a vital raw
material or other component, firms maintain inventories.
The goal of effective inventory management is to minimize the total costs: direct and
indirect that is associated with holding these assets. However, the importance of
inventory management to the company depends upon the extent of investment in
inventory. As the value of the inventory goes up, the criticality of the function in
Inventory Management enables an organization to meet or exceed customers'
expectations of product availability while maximizing net profits or minimizing costs.
Transportation
Transportation functionality is product movement. Whether the product is in the form
of materials, components, assemblies, work-in-process, or finished goods,
transportation is necessary to move it up and down the value chain. The major
objective of a modern transportation system is to move product from an origin
LSCM
location to a prescribed destination while minimizing temporal, financial, and 245
Supply Chain
environmental resource costs. Performance Drivers
Three fundamental principles guide transportation management and operations;
(a) Mode of transport, (b) Economy of scale and (c) Economy of distance. Mode of
transport is a general term for the different kinds of transport facilities that are often
used to transport people or cargo; each is unique and has different cost attributes.
Economy of scale refers to the characteristic that transportation cost per unit of weight
decreases when the size of the shipment increases. Economy of distance refers to the
characteristic that transportation cost per kilometre of distance decreases as distance
increases. Transportation refers to the modes and routes for moving inventory
throughout the supply chain. Faster transportation ensures more responsiveness but
less efficiency of supply chain. Transportation supports a firm's competitive strategy.
The different ways of transportation includes rail, road, sea water, pope lines and the
air ways. Electronic transport is the fastest and the efficient mode of transportation.
Transportation decisions includes mode, routes and in house or outsourcing the
transportation.
Transportation is prominent in a company's competitive strategy when considering
customer need. If a firm's competitive strategy targets a customer that demands high
responsiveness and that customer is willing to pay for this level, then they can use
transportation as a driver for increasing supply chain responsiveness.
The fundamental trade-off for transportation is cost (efficiency) versus speed
(responsiveness). A transportation cost analysis must consider the effects of speed on
inventory required.
13.2.3 Cross Functional

Information
Information connects various supply chain partners and allows them to coordinate
activities. Information is crucial to the daily operations at each stage of the supply
chain. An information system can enable a firm to get a high variety of customized
products to customers rapidly and to understand the changing customer’s tastes and
preferences.
Even though information does not have a physical presence, it is still a major supply
chain driver. Information deeply affects every part of the supply chain in several ways.
Information serves as the connection between the supply chain's various stages,
allowing them to coordinate their actions and bring about many of the benefits of
maximizing total supply chain profitability. Information is also crucial to the daily
operations of each stage in a supply chain, such as the case for production scheduling,
order status and inventory status.
A growing trend is the importance of information and information systems in
balancing responsiveness versus efficiency. The tremendous growth of information
technology as a functional discipline and a science is testimony to the impact that
information has on the effective and efficient operation of a business.
Similar to all other drivers, businesses must trade-off between efficiency and
responsiveness when trying to include more supply chain information.
A key decision regarding information is determining what information is most
valuable in decreasing cost and increasing responsiveness within a supply chain. This
decision depends on the supply chain structure and market segments served. For
example, some companies target customers who require costly customized products.
These companies might find that an investment in information helps them to respond
more quickly to their customers' needs.
LSCM
246 Sourcing
Logistics and
Supply Chain Management Sourcing is defined as the procurement of products or services from sources that are
external to the organization, while ‘outsourcing’ involves the transfer or sub-
contracting of the management and/or day-to-day execution of an entire business
function to an external service provider. Till recently i.e. the end of the 1980s, the
manufacture of parts and components through third party participation, i.e. sourcing
was the largest part of purchasing. The bulk of purchasing was focused on these items
with some peripheral services such as legal and travel services as add-ons. However,
this pattern has undergone a sea change.
Pricing
Pricing involves determining the charges for the goods or services offered by the
manufacturers. The price of the product effect’s the buying patterns of the customers
thus affecting the supply chain performance.
All the above stated drivers are very crucial in determining the success of the supply
chain management process.
Figure 13.1: Drivers of Supply Chain Management
13.2.4 Need for Performance Measurement

Having implemented strategies, a firm needs to know how it is performing. It has to,
not only track the health of the Supply Chain, but also improve its health
continuously. A higher output to input ratio is the measure of the system’s efficiency
and effectiveness.
However, these have to achieve within the quickest possible time and faster than the
competitor!
Companies deploy lot of resources in logistics related functions. Hence, it is necessary
to monitor, control and improve the performance. The performance measurement
system also helps in identifying and reducing or eliminating non-value adding
activities. Then only the set goals of cost reduction and customer satisfaction can be
achieved.
13.2.5 Objectives of Performance Measurement

The various objectives of a Performance System [PMS] are:
Monitoring: Focuses on reporting on the current status of operations, periodically
depending on the volume & criticality.
LSCM
Controlling: These measures compare the actual performance with the set standards 247
Supply Chain
and report deviations. Performance Drivers
Directing: The objective of the PMS is to motivate the individual in the system to
enhance his/her performance, resulting in an overall improvement of the entire
structure.
13.2.6 Performance Levels

The Performance measure can be external (Customer Satisfaction) and internal
(productivity, cost, quality, asset management, etc.). Companies at times ignore
external results in the belief that internal measures are enough. At times, they sacrifice
internal development for external results.
Customer Perception Measures

A Firm has to get regular feedback from its customers, review the same and improve
where required so that the competitive edge is maintained. The feedback can be on
delivery performance, reliability, responsiveness and the relationship initiatives of the
Firm vis-à-vis that of the competitors.
Typical Benchmarking Measures in Logistics are:
z Order Processing procedure
z Transportation – Routes, Modes, Freight rationalization
z Warehousing – Storage, Material Handling System, Automation
z Packaging
z Delivery Service
z Information Flow & Connectivity, etc.
State True/False
1. The performance measure can be external and internal both.
2. Most of the companies at times ignore internal results in the belief that
external measures are enough.
3. A firm has to get irregular feedback from its customers, review the same
and improve where required so that the competitive edge is maintained.
4. The feedback can be on delivery performance, reliability, responsiveness
and the relationship initiatives of the firm vis-à-vis that of the competitors.
5. Performance of the supply chain cannot be determined with the help of
the drivers
13.3 OUTSOURCING AND SOURCING

Purchasing has found its way as an activity on the top of management’s agenda,
because it has been found to be one of the most powerful ways to enhance economic
performance. This has brought about a shift in the concept of procurement to strategic
procurement. ‘Sourcing’ and ‘Outsourcing’ are its two components.
Sourcing is defined as the procurement of products or services from sources that are
external to the organization, while ‘outsourcing’ involves the transfer or sub-
contracting of the management and/or day-to-day execution of an entire business
function to an external service provider.
LSCM
248 Till recently, i.e. the end of the 1980s, the manufacture of parts and components
Logistics and
Supply Chain Management through third party participation was the largest part of purchasing. The bulk of
purchasing was focused on these items with some peripheral services such as legal and
travel services as add-ons. However, this pattern has undergone a sea change.
Statistics of US companies show that, by the mid-1990s, legal work which constituted
59 per cent of outsourcing activities by value followed by logistics at 41 per cent, and
computer information systems with 36 per cent, were the main components of
purchasing. Purchasing activity has dramatically changed from sourcing, i.e. the
traditional manufacture of parts and components (which accounts for only 31 per
cent), to outsourcing activities (which constitute 69 per cent of purchasing activities)
in business organizations.
This change has come about because companies no longer assume that all
organizational services must be provided and managed internally. Many products or
services, when produced by outside suppliers who are more effective and efficient,
can provide competitive advantage to the firm. Because of this phenomenon, the
outsourcing of selected organizational activities has become an integral part of
corporate strategy. Many tasks like human resources, payroll and benefits, information
systems, etc. that are not considered core competencies of the organization, are being
contracted out.
Why do firms outsource? Some of the reasons to justify outsourcing as a corporate
strategy are as follows:
z It allows companies to focus their resources on their core business.
z It allows companies to buy technology from vendors that would be too expensive
for them to acquire internally.
z It makes companies more efficient, as it saves them time and money while
improving efficiencies in the tasks that they continue to carry out.
z It allows companies to improve the service level to their employees.
z Finally, it reduces overall costs over the longer term.
The advantages of outsourcing are sometimes operational and sometimes strategic.
Sometimes it can be both. These advantages may not accrue to particular
organizations because sometimes determining core competence can be tricky. Very
often the best reason for outsourcing is the knowledge the supplier can provide. While
outsourcing helps control costs, simplifies operations, and keeps a company focused
on its core competencies, it works as a strategy only if it is properly implemented
Take for example, "outsourcing", of business functions. It is qualitatively different
from traditional relationships between traditional buyers and sellers as it requires a
degree of two-way information exchange, coordination and trust between the
outsourcer and its client. Such a relationship involves transferring or sharing
management control and/or decision-making to an outside supplier. To make it
succeed, the organizations involved in such an "outsourcing" relationship have to
dynamically integrate and share management control of the labour process. This type
of outsourcing is being successfully implemented in many organizations because fears
of allowing someone else controlling a principle resource have evaporated. Instead,
organizations often see outsourcing as a legally enforceable contract with an external
supplier that controls costs and improves the quality of the service they get.
An example is third party participation in the information systems (I/S) function.
Though information is regarded as a principal resource in most businesses, many large
LSCM
companies today, give external control of the firm's information system to third party 249
Supply Chain
vendors. For example, General Electric Corporation (GE) has a five-year, $500 Performance Drivers
million contract with Electronic Data Systems (EDS) to handle the company’s desktop
computer procurement, service and maintenance activities.
Most business function outsourcing is profitable because companies target a minimum
15 per cent cost savings, sometimes between 20 to 25 per cent in such contracts. These
goals become practicable when multi-year and usually multi-million dollar agreements
are negotiated. With assured business, the seller can have economies of scale and take
the necessary steps towards cost-cutting measures in the long term. But this also
makes it apparent; it has become mandatory for firms to examine the basis for the
outsourcing strategy, with such large contracts at stake. You must first find answers to
these questions before taking the jump.
z What is your business, what are your core competencies, and what are your
primary sources of revenue? Whatever isn't on this list may be outsourced.
z What are the areas that do not contribute in making the company unique or do not
offer a clear competitive advantage over other businesses? Such non-strategic
areas are outsourcing opportunities.
z Evaluate costs and set objectives. Realistically decide what an outsourcing partner
does, and how it cuts costs, improves focus, or frees up resources. Is there an
objective measure of the net gain in efficiency and cost-effectiveness by
outsourcing? What will be the net gain in performance quality by outsourcing?
Make certain these goals of outsourcing are attainable.
z Look internally at ways processes can be improved. Be flexible and find out the
net effect on profitability if the processes in question are not outsourced?
z A careful examination must be made of the supplier’s reliability and service
quality. Will dependence on a third party be created by outsourcing, and how
vulnerable would the organization be if that third party somehow became unable
to perform as expected? Be cautious and don't select an outsource partner without
thinking these aspects over.
z Find out why he charges you less. Does the outsourcer have economies of scale
not available to you? Can the outsourcer buy equipment and hardware cheaper?
Does this justify the lower prices?
z Review the information on pricing with similar criteria in-house to measure the
provider's performance. What are the proposed savings measured against? Is that
the right basis for comparison? Is the guaranteed price a good deal?
z Is it cost effective to do so in the long term? Outsourcing should not be
automatically embraced if a change isn't needed.
Additional issues that typically need to be considered in the context of a specific firm's
situation include the following:
z What is the number of suppliers you need for the activity?
z Does the firm retain the ability to return to in-house operations as and when
required?
z How does the flexibility in the products offered by the supplier compare to your
present situation?
z Does the outsourcer provide you access to the latest/advanced technology and
expertise that he may have?
However, when taking the outsourcing decision, there are two things that are
important, the first is that the specific needs of the organization match the supplier's
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250 capabilities and, secondly, outsourcing should provide the firm advantages such as
Logistics and
Supply Chain Management when processes or products are completed faster, cheaper, or better by the outside
organization.
Sourcing, is the way in which companies select their suppliers, determine the number
they will work with, and define the type of contractual agreements that will exist. This
often includes determining parameters for supplier pre-qualification, supplier analysis
and evaluation. Sourcing is the key to the development of a successful supply chain.
Figure 13.2 summarizes the object of sourcing.
Figure 13.2: Procurement Object and Sourcing

Sourcing decisions have to be consistent with supply chain strategy of the firm. To
ensure this compatibility, generally a cross-functional team with purchasing
representation carries out the analysis. Analysis is in two parts:
z Internal/external analysis: Details of the company's internal capabilities as well
as the capability of outside suppliers are collected. This is the heart of the review.
To carry out the analysis, some answers are required:
What competence factors to use in analyzing the firm and evaluating
suppliers (e.g. flexibility, understanding the company's business, technology
leadership).
Who has the technical capabilities to provide the good or service?
Who can deliver a quality product?
Who can make timely deliveries?
What costs are associated with each alternative?
z Generate/evaluate options: From the information generated purchasing has to
decide the number of suppliers the firm will utilize. There are three sourcing
alternatives or combinations of these three that the firm can choose from:
Multiple Sourcing,
Single Sourcing, and
Network Sourcing.
It also has to decide who can qualify to make the product or component required by
the firm and what type of relationship it has to develop with the supplier.
13.4 SOURCING STRATEGY

Traditional purchasing was dominated by a multi-sourcing strategy. This meant that
the firm had business relationships with a number of suppliers. The base of suppliers
was large and the duration of contracts was short. Suppliers would be sent enquiries
and they would respond with quotations, meeting the demands and specifications of
the firm, and negotiate with purchasing for the contract.
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This approach was based on the perception that certain advantages accrue to the 251
Supply Chain
buying company. These include: Performance Drivers
1. Creating competition by playing one supplier against another.
2. Obtaining bids with low prices and shipping costs.
3. Increasing leverage over suppliers.
4. Greater degree of flexibility in technical areas, and
5. With a number of sources, it provided protection in times of shortages against
failure at any one supplier's plant.
From the buyer's point of view, the responsibility to maintain the necessary
technology, expertise, and forecasting abilities plus cost, quality, and delivery
competencies lay with the supplier. However, dealing with several suppliers required a
longer time in negotiation that could often result in a delay or disturb the buyer's
production schedules.
The approach placed emphasis on achieving the lowest possible price for a particular
product. Long-term partnership was not the goal of the buying firm and the initial
price was more important than the total price of a product.
The multiple sourcing was, therefore, a preferable and suitable purchasing alternative.
Transactional relationships were the desired outcome. In today’s environment,
multiple sourcing is generally limited to and used for commodity items, non-strategic
buying and standard items.
There has been a change from the traditional model. The number of suppliers to use
for one type of purchase has changed to the use of fewer, reliable suppliers and even
to the extent of using sole or single suppliers.
Buyer-supplier relationships, in integrated supply chains, have evolved into trusting,
cooperative, and mutually beneficial long-term relationships. Firms' today reduce their
supply base to only the best suppliers, while further developing suppliers who are
continuously improving their quality, delivery, service, price, and information
performance. These strategic issues of sourcing are discussed below.
13.4.1 Single Sourcing

Single sourcing as a concept evolved from the Japanese just-in-time (JIT) philosophy
which has been growing in popularity. The central idea of JIT is to eliminate waste
and to emphasize value added activities. This also involves reducing the number of
suppliers a firm does business with. The purchasing objectives have a focus to
consolidate a partnership or alliance with the supplier.
Consolidation alone, however, does not provide a competitive advantage. The
advantage comes when limited resources can be focused on a manageable number of
suppliers, which can then receive the attention they need to achieve top performance.
Relationships with suppliers improve since there is no competition between suppliers
and company. Once the supplier and manufacturer begin working together and a long-
term commitment is established, the need for additional suppliers also diminishes.
Eliminating redundancy also reduces overall costs, cutting out dual sourcing, dual
tooling, and dual process development. With the security of part-for-life agreements,
suppliers are much more open to suggestions about cost reduction and are more
willing to invest in optimizing their processes. Suppliers receive enough volume from
the company to warrant investing their own internal resources to optimize their
production process and thus produce a component at a more competitive price.
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252 For example, one firm had over 300 suppliers in the late 1980s. It identified the
Logistics and
Supply Chain Management following problems which resulted in high costs for purchased materials and low
profitability:
z Many suppliers were low-quality manufacturers;
z Many were geographically dispersed; and
z There were multiple suppliers for the same part family, so that suppliers saw no
long-term economic gain in working with the company.
The company undertook a three-part initiative to consolidate its supplier base and
upgrade its approach to supply management:
z The first phase eliminated suppliers that were poor-quality performers or whose
relationships with the company were irreparable.
z The next phase was to train the remaining suppliers in just-in-time, statistical
process control and continuous improvement. They were asked to develop plans to
meet the new cost, quality, and delivery goals required for just-in-time. After
evaluating these plans, the company eliminated more suppliers.
z In the last phase the remaining suppliers of the company were asked to invest in
value engineering to reduce the cost of the part to the company. The company
supported them through dedicated teams who visited suppliers’ factories and help
improve their manufacturing operations.
As the suppliers had sufficient volume to justify making improvements to tooling and
operations, the company was able to improve the quality and reduce the total costs of
the product significantly, allowing the company to advance from a declining 17
percent market share in 1982 to the 83 per cent market share it enjoys in 2005.
In a single sourcing relationship, all suppliers are treated equally, whether they are
internal or external. Suppliers set their own goals and evaluate their own performance.
The company monitors their goals and encourages them continually to improve their
performance. Where it feels the goals are too low, the company provides support for
process and operations improvement.
Orders are understood to be placed at current prices and there are no annual price
renegotiations. Company and suppliers constantly work together to reduce the cost of
purchased materials. Using this approach, most companies are able to cut material
costs significantly. Suppliers are expected to make up for any increases in the cost of
raw materials that arise from normal inflation, but they are compensated for unusual
swings in the raw materials market.
Relationships built on trust and mutual understandings have allowed companies to
simplify their contracts to straightforward two- to three-page agreements. That the
supplier has the part for the life of the product is understood. However, developing
this type of relationship generally takes a five- to eight-year effort for both parties.
The best place to start is with A category products (ABC analysis), as these tend to
provide the greatest initial benefits.
Once the company outsources a part, its supplier keeps the part for life unless a quality
or delivery problem arises. Eliminating redundancy reduces overall costs, cutting out
dual sourcing, dual tooling, and dual process development
Single sourcing is preferred as the purchasing method, when the strategic emphasis is
on the supplier's availability of technical support, the reliability of the product, and the
total cost of the product. As companies gain experience with single-sourcing, they
tend to move beyond individual parts to entire part families, further reducing the
complexity of supplier management.
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Successful day-to-day collaboration between a company and its suppliers relies on 253
Supply Chain
supplier evaluation, investment for improvement, integration of suppliers, effective Performance Drivers
use of transportation, and open communication.
Table 13.1: Advantages and Disadvantage of Single Sourcing
Advantages Disadvantages
Buyers' perspective
1. Improved communication from the close 1. A strike or a production resulted disruption
buyer-seller relationship could cause major difficulties
2. To cooperatively design quality system 2. The absence of bargaining control power a
and to share quality output data buyer has in dealing with a single source
3. Lower price stemmed from reduction of 3. The relationship must be a genuine
costs in ordering, shipping, and material cooperation
handling
4. Improved stability for both parties
Vendor's perspective
1. Quality considerations 1. Without competition the vendor may
2. Cost considerations attempt to cut costs
3. Dependability 2. Vendor needs to exercise great care when

negotiating a contract
4. Flexibility of reacting to demand and
environmental changes
In conclusion, the advantages and disadvantages of single sourcing, both from the
buyer’s perspective as well as the vendor’s perspective are shown in Table 13.1.
13.4.2 Network Sourcing

Many have successfully consolidated their supplier bases by using a phased approach.
In a majority of firms, the debate on multiple and single sourcing is bypassed using a
hybrid model. This model overcomes the drawbacks of the two methods discussed
earlier. This hybrid is often termed networking.
In networking, bought in content of their final product is based on the skills and
specialized knowledge of different tiers of subcontractors. The supply network is a
hierarchical pyramid. The top tiered suppliers are the most skilled and possess the
most advanced technologies, while the suppliers at the bottom have adequate skills for
their particular operations. Communication is shared between the buyer and all the
suppliers within the network.
Generally, the suppliers at the first tier are largely responsible for complete systems,
whereas those at the lower tiers become subcontractors to the upper level suppliers
providing individual components. In this way the number of supply sources can be
reduced and the impact of the network is enhanced due to the transfer of technology
between the firms.
The system is similar to the multi-sourcing system in that, typically, but not
exclusively, it relies on multiple sources for the parts or services purchased. The key
point is that the purchasing expenditure is maximized within a pre-selected and
relatively long lasting array of sources. In this type of system, some suppliers may be
direct competitors.
Generally, manufacturing organizations with an assembly-type of operation choose
network sourcing as the sourcing choice. This sourcing alternative is particularly
appropriate to industries with a heavy reliance on a high purchased content of parts
designed and made uniquely for the particular assembler under consideration.
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254 Automobile producers, such as Maruti or Hyundai, find this mode of purchasing
Logistics and
Supply Chain Management particularly beneficial.
Companies that have traditionally used vast numbers of suppliers have successfully
made the transition to best practice in supply management by reducing their supplier
base by 50 per cent or more. However, it is not easy. Most companies and suppliers go
through three phases before achieving a healthy relationship.
In the beginning, an obvious distrust exists: the company is evaluating its suppliers’
performance and deciding whether to retain or drop them. During the second phase,
successful companies develop long-term agreements with their best suppliers as a
basis for good relationships. Over time, such agreements will, in conjunction with
supplier training and dedicated company teams, build a strong supplier base with high
technical capabilities and greater willingness to share information.
The advantages of network sourcing allow a company to outperform competitors who
use multiple sourcing, especially in areas such as cost reduction, improved
communication, flexibility and stability. This has made it a very attractive step for
companies as they move to ‘World-class Supply Management’.

Fill in the blanks:
1. When taking the outsourcing decision, there are two things that are
important, the first is that the specific needs of the organization match the
………………. and, secondly, ………………. should provide the firm
advantages.
2. ………………. , is the way in which companies select their suppliers,
determine the number they will work with, and define the type of
contractual agreements that will exist.
3. Sourcing is defined as the procurement of products or services from
sources that are ………………. to the organisation .
4. Sourcing is the ………………. to the development of a successful supply
chain.
5. ‘……………….’ involves the transfer or sub-contracting of the
management and/or day-to-day execution of an entire business function to
an external service provider.
13.5 LET US SUM UP

Performance of the supply chain can be determined with the help of the drivers. The
drivers of the supply chain consist of three logistical drivers and three cross functional
drivers.
Inventory plays a significant role in a supply chain's ability to support a firm's
competitive strategy. A supply chain manager must make routine decisions to create a
more responsive and more efficient supply chain. These decisions typically focus on
decreasing procurement, repair or delivery cycle inventory, safety inventory and
seasonal inventory.
Facilities are the physical locations where the products stored or assembled. The major
types of facilities are production sites and the storage sites. Economies of scales are
used in centralisation of facilities to increase supply chain efficiency.
Facilities include all locations in the supply chain to store, assemble, or fabricate
inventory. In DoD, it is where personnel repair weapon systems and secondary items.
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257
LESSON Key Enablers in
Supply Chain Improvement
14
KEY ENABLERS IN
SUPPLY CHAIN IMPROVEMENT
CONTENTS
14.1 Introduction
14.2 IT-Enabled Supply Chain
14.2.1 Electronic Data Interchange (EDI)
14.2.2 Enterprise Resource Planning (ERP)
14.2.3 Bar Coding
14.2.4 Communication Technology
14.3 Inter-relation between Enablers and Levels of Supply Chain Performance
14.3.1 Incentive Obstacles
14.3.2 Information Processing Obstacles
14.3.3 Operational Obstacles
14.3.4 Pricing Obstacles
14.3.5 Behavioural Obstacles
14.4 Supply Chain Integration
14.4.1 Seamless Concept
14.4.2 Supply Chain Uncertainty
14.5 Let us Sum up
14.7 Keywords

z Discuss about IT-Enabled Supply Chain
z Explain the Inter-relation between enablers and levels of supply chain
performance
14.1 INTRODUCTION
The first step toward supply chain collaboration is to look beyond any immediate costs
or benefits and to focus on the long term. Organizations should remember that it is
impossible to collaborate with everyone in their supply chain. They need to identify
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258 those partners who are willing and able to collaborate and who will create the biggest
Logistics and
Supply Chain Management benefits (mutual). Then they should select key initiatives to begin with. These
initiatives should be evaluated based upon their importance to the supply chain's
competitive advantage, the degree to which enablers are in place, and the level and
intensity of any impediments.
Successful supply chain collaboration is a function of how well people work internally
and with their supply chain partners. Although technology is a powerful enabler, it is
not the key to supply chain collaboration. The key to collaboration lies with the
people.
14.2 IT-ENABLED SUPPLY CHAIN

Information Technology is a Key Driver of SCM. Information Technology is an
organized collection of computer hardware, software, data, telecommunications,
database management, other technologies and personnel designed to capture, store,
update, manipulate, analyze and immediately display information about worldwide
business activities. It is a tool for providing past, present and projected information on
internal operations and external activities.
14.2.1 Electronic Data Interchange (EDI)

Electronic Data Interchange (EDl) describes both the capability and practice of
communicating information between two organizations via computer systems instead
of traditional forms of communication for managing distribution and procurement
systems. It facilitates the ability of the two organizations to effectively utilise the
information exchanged using business documents in standard formats.
EDI has a highly structured message communication system, with tight, pre-decided
formats of documents, which allows effective, speedy and reliable communication
between different locations. It uses a service provider who transfers data and provides
translators between different formats. The service provider also handles the EDI
traffic between various sources and destinations.
Industry organizations have developed and refined two general standards as well as
numerous industry-specific standards in an effort to standardize both communication
and information interchange. ASC X.12 is promoted as the United States standard,
while UN/EDIFACT is used by the United Nations as a global standard for
communications. Information exchange is based on transaction sets that are generally
application specific on an industry basis. The use of EDI requires adherence to certain
document standards. Standards are emerging in various industries worldwide. In India,
the automobile industry, along with some major auto component manufacturers with
other players like banks have agreed on common formats of EDI documents.
A typical EDI system is shown in Figure 14.1. EDI formats typically have a layered
structure, containing identification of the firm making the transaction, functional
specification of documents, the document structure, and the data elements, all in a
strict format.
The major advantage of EDI is that it provides fast, error-free and reliable exchange of
data between different entities in a supply chain. Documents (especially standard and
repetitive format ones), such as purchase orders and dispatch advices, are ideally suited
for EDI. Other common applications are invoices, payment advices, requests for
quotations, advance shipping notices (dispatch advices) and order status inquiries and
response. Real-time data on company operations – inbound material flows, production
status, product inventories, customer shipments and incoming orders, among others are
also suited for EDI.
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B uy er’s S ystem 259
Key Enablers in
Supply Chain Improvement
P urch asin g T ra nsa ctio n C o m m un ica tion
S ystem S oftw a re S oftw a re
T ra din g T ra din g
M ail P artn er
P artn er
B ox D a ta
D a ta
C o m m un ica tion T ra nsa ctio n O rde r E ntry

S oftw a re S oftw a re S ystem
Figure 14.1: A Typical EDI System

Benefits: Direct EDI benefits include (1) increased internal and external productivity
through faster information transmission as well as reduced information entry
redundancy. Accuracy is improved by reducing the number of times and individuals
involved in data entry; (2) reduced labour and material cost associated with printing,
mailing, and handling paper-based transactions; (3) reduced telephone, fax, and telex
communication; (4) reduced clerical costs; (5) decreased operating cost; (6) enhancing
supply chain relations; and (7) improving customer responsiveness.
In addition, EDI improves channel relationships, the quality of decision-making and
enhances the ability to compete internationally.
14.2.2 Enterprise Resource Planning (ERP)

One of the newest types of intra-firm information systems that facilitate information
sharing within the firm is Enterprise Resource Planning (ERP). ERP was a product of
the emergence of more powerful, lower-cost computers, local area networks and client
server technologies. As these became the norm, data tended to be stored in desktop
computers and less to the use of the many different systems that were incompatible.
This led to problems when attempting to share information and spurred the
development of ERP systems, which had a focus on enterprise-wide data.
The major impact of ERP systems is the development of common hardware, common
resource planning software, and common database systems throughout the enterprise.
ERP systems allow companies to use a single, integrated system, thereby streamlining
data flows throughout an organization. ERP systems have helped companies reduce
inventories, shorten cycle times, and lower costs, which in turn have helped improve
overall supply chain management practices. These systems promise dramatic gains in
a company's efficiency and bottom line.
The ERP vendors such SAP, Oracle, i2 technologies and enterprise consulting
companies such as Deloitte, Infosys and Tata Consultancy, have become notable
brands in this field. Each of these adopts common standards for data.
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260 14.2.3 Bar Coding
Logistics and
Supply Chain Management A bar code is a grouping of parallel bars (usually blocks) of varying widths separated
by light spaces (usually white) of varying width. Scanner is used to read the bars and
spaces and it uses software to interpret their meaning. In the supply chain, the
accurate, rapid identification of products and use of this information in controlling the
entire process have been key factors. The following are the benefits of bar code
technology in supply chain:-
z Speed data entry
z Enhances data accuracy
z Reduces materials handling labour
z Verifies orders at receiving and shipping
z Improves customer service
14.2.4 Communication Technology

Information and Communication Technology (ICT) also significantly enhances the
supply chain performance through faster and widespread communication.
Applications of radio frequency, satellite communications and image processing
technologies have overcome the problems caused by product movement and
geographic decentralization. Improved customer service is provided in the form of
more timely definition of tasks, quicker transport tracing, and faster transfer of sales
and inventory information. The availability of shared information has led to increase
efficiency and effectiveness across the supply chain.
Fill in the blanks:
1. EDI has a highly structured message ……………………………..system,
with tight, pre-decided formats of documents, which allows effective,
speedy and reliable communication between different locations.
2. The major advantage of ……….……………… is that it provides fast,
error-free and reliable exchange of data between different entities in a
supply chain.
3. …………………………….was a product of the emergence of more
powerful, lower-cost computers, local area networks and client server
technologies.
4. …………………is used to read the bars and spaces and it uses software
to interpret their meaning.
14.3 INTER-RELATION BETWEEN ENABLERS AND

LEVELS OF SUPPLY CHAIN PERFORMANCE
In traditional systems, the focus is on the specific transaction between the buyer and
the seller; therefore the bullwhip effect is a phenomenon that firms have to live with.
The supply chain concept implies that members of the channel coordinate their efforts.
Despite this, there are a number of factors that form obstacles to coordination. This is
because many companies often have no idea what the bullwhip effect is and what
effect it has in their supply chain. Coordination becomes critical to a firm when it is
convinced that it stands to lose from lack of coordination.
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Traditional methods of coordination and measurement approaches may have to be 261
Key Enablers in
reviewed if supply chain optimization is desired. Traditional performance measures Supply Chain Improvement
are internal and therefore limit the possibilities to optimize supply chains.
Management has to “see” beyond its four walls into supply chain wide areas for
improvement. Considering this limitation, issues that are critical to coordinating the
supply chain and measuring its performance such that supply chain competitiveness is
achieved, are a direct challenge to management.
The beginning is by comparing the variability in the orders the firm receives from
their customers with the variability in orders they place with their suppliers. This helps
a firm quantify the firm’s contribution to the bullwhip effect. Once its contribution is
visible, it becomes easier for a firm to invest significant amounts in inventory
management, scheduling systems and coordination. Evidence of the size of the
bullwhip effect is also very effective in getting different stages of the supply chain to
focus on efforts to achieve coordination and eliminate the variability created within
the supply chain.
There are three kinds of coordination in supply chains. These are across channel
members, across management levels and across functions. Coordination is achieved
when all parties involved devote significant managerial resources to this effort.
Companies often assume that lack of coordination is something they have to live with
or hope that coordination will occur on its own. The problem with this approach is that
all managers are involved with only their separate areas of control, while no one is
responsible for highlighting the impact one manager's actions on other parts of the
supply chain.
This is the major problem with optimizing the supply chain. Obstacles can occur when
there is local optimization by different stages of the supply chain, or information is
delayed, or distorted within the supply chain. Generally, obstacles can be categorised
into five classes:
z Incentive obstacles,
z Information processing obstacles,
z Operational obstacles,
z Pricing obstacles, and
z Behavioural obstacles.
The obstacles identified above are discussed below. We will also discuss how they can
be overcome.
14.3.1 Incentive Obstacles

This refers to situations where incentives offered to different stages or participants in a
supply chain lead to independent actions by the supply chain participants increasing
variability and thereby reducing conformity. For example, if a production manager has
compensation linked to the average cost per unit, the manager is likely to take actions
that lower manufacturing costs even if they increase inventory costs or delay products
reaching the customer. Improperly structured incentives are a significant obstacle to
coordination in the supply chain.
The impact of the bullwhip effect can reduced by aligning goals and incentives such
that every member in supply chain works to maximize total supply chain profits. This
is possible for the members of the supply chain if there is joint planning of activities
such as material flow and new product development between member partners and an
alignment of goals. Also, channel partners can agree to risk and reward sharing over
the long run. This becomes easier when the breadth of the supplier base is reduced.
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262 In addition, all facility decisions should be evaluated based on their impact on the
Logistics and
Supply Chain Management supply chain and total profitability. This can avoid situations where a production
manager makes decisions that lower manufacturing costs at the expense of increases
in overall supply chain costs. Some firms use sales force incentives based on sales
over a rolling horizon to reduce the incentive to push the product and also reduce
forward buying and its resulting fluctuation in orders.
14.3.2 Information Processing Obstacles

In the traditional supply chain end consumer demand is converted into order
information and passed down through the supply chain to trigger product release to the
customer. Each ‘player’ receives an order from its immediate customer, from which a
decision on the required internal order rate to satisfy its stock targets (which may be
zero) is made.
In supply chains, the information has in practice to be transferred to channel partners.
There is both bias and noise in the transference process distorting the demand
information between each echelon. This leads to vast stock holding in the chain. Not
only does stock holding across the chain cost money to maintain, but it also leads to
increased variability in orders within the supply chain. In addition, it also results in
excessive write-offs due to obsolescence.
Forecasting, when it is based on orders and not customer demand, magnifies
variability in customer demand. This happens as orders move up the supply chain to
manufacturers and suppliers. Consider for example, a random increase in customer
demand at the retailer. He interprets it to be a growth trend and places an increased
order on the wholesaler. The increased order is inferred by the wholesaler as a growth
trend that will be larger than that inferred by the retailer. As we go further up the
supply chain, the growth trend becomes magnified. In periods of random decrease in
demand, using the same logic, the retailer will now anticipate a declining trend and
reduce his order size to the wholesaler. This reduction will also become magnified as
the order moves up the supply chain. If both these trends are back to back, it creates
the bull whip effect.
The lack of information sharing between stages of the supply chain magnifies the
bullwhip effect. For example, say the marketing department in Colgate (India) plans a
promotion and the manufacturing unit is not aware of the promotion. The increased
requirement from marketing may be interpreted by manufacturing as a permanent
increase in demand. Manufacturing place orders with suppliers for its production
requirements accordingly. The manufacturer and suppliers thus have a lot of inventory
right after the promotion has finished. Given the excess inventory, as future orders
return to normal, the manufacturing requirements will be smaller than before. Over the
long run, it leads to a large fluctuation in manufacturing and well as in their supplier
production schedules.
In a supply chain, the implementation of IT is not so much about the technology and
the speed at which the information is transferred; for example, EDI, RFID and bar-
coding have helped in speeding and managing the flow of information from the
customer. However, the major problem in the supply chain is when companies are
unwilling to communicate or share information with their partners.
Implementation of IT is about the quality of information that is transferred; the
information should be such that it leads to the success of the supply chain. Good
communication with other stages of a supply chain is a prerequisite for coordination
between supply chain partners. Regular communication between the parties involved
helps different stages of the supply chain share their goals and identify common goals
and mutually beneficial actions that improve coordination.
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A good example of how market sales information is being utilized within the 263
Key Enablers in
consumer market is the business link between Wal-Mart and one of its main suppliers Supply Chain Improvement
Procter & Gamble as shown in Figure 14.2. Wal-Mart basically broke down the
barriers to information sharing and opened its consumer information to Procter &
Gamble for their usage. Successful information enriched supply chains must view
their information as a strategic asset and ensure that it flows with minimum delay and
minimum distortion. Such an approach benefits all companies in the supply chain
individually and hence their supply chain is far more flexible.
Figure 14.2: Enriched Information Pipeline

Sharing point of sales (POS) data across the supply chain helps reduce the bullwhip
effect. By sharing this data, all stages respond to the same change in customer
demand. Once point of sales data is shared, this should lead to a situation where
different stages of the supply chain forecast and plan jointly. This is essential for
complete coordination to be achieved.
Unfortunately, sharing of POS data does not guarantee coordination, without
collaborative planning. This means that top managements of the various members
should be involved in the planning process, to ensure that the entire supply chain is
operating to a common forecast. The Wal-Mart example given earlier exemplifies this
approach. The alternative is to design a system in which a single stage controls
replenishment decisions for the entire supply chain. This can also help diminish the
bullwhip effect.
The Internet and a variety of different types of software systems can be used to
increase the visibility of information throughout the supply chain. In most cases, this
requires additional effort. The Internet can be used to share information and increase
connectivity in the supply chain. However, many firms have made massive
investments required in IT systems, particularly ERP systems. If firms are to realise
the full benefit of these investments, it is crucial that they make the extra effort
required to use these systems to facilitate collaborative forecasting and planning
across the supply chain.
14.3.3 Operational Obstacles

Increase in variability can also be due to actions taken in the course of placing and
filling orders. Some of the causes could be ordering in large lots, large replenishment
times, or a policy of rationing due to excess demand. Firms may order in large lots
because there is a significant fixed cost associated with placing, receiving, or
transporting an order or due to quantity discounts based on lot size. Because orders are
batched, the manufacturer will face an order stream that is much more variable than
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264 the demand the retailers. It is a similar situation in the case of large replenishment
Logistics and
Supply Chain Management cycles. In the case of rationing, retailers try to increase the size of their orders to
increase the amount supplied to them. For example, a retailer needing 15 units of a
product will order 25 units in the hope that he will get 15 units. The net impact is to
artificially inflate orders for the product.
All levels in the supply chain must understand the commitments for the supply chain
to operate smoothly. Be agreed upon across the channel by its members and
understood at all levels.
Some practical implications of this are in areas discussed earlier. The uncertainty of
demand during the lead time can be decreased by reducing replenishment lead time.
This can be especially beneficial for seasonal items. Multiple orders placed in the
season allow for a significant increase in the accuracy of the forecast.
In manufacturing, reducing replenishment lead time can be achieved by increased
flexibility and cellular manufacturing. Information technologies can be used to
achieve a significant reduction in lead times in processing. Cross-docking can be used
to reduce the lead time associated in transportation.
In order to reduce lot sizes, actions need to be taken that help reduce the fixed costs
associated with ordering, transporting, and receiving each lot. Today, the growing use
of Web-based ordering, the growth of B2B e-commerce, and information technology
is helping in reducing ordering costs. By managing part loads without increasing
transportation costs disadvantages in reduction lots sizes can be overcome. Some
companies fill a truck using smaller lots from a variety of products to the retailer or
organize runs that combine shipments for several retailers on a single truck. Similarly,
there are many new technologies that simplify the receiving process and reduce the
costs associated with receiving.
Another simple way to minimize the impact of batching is to encourage different
customers to order in a way that demand is evenly distributed over time. Regular
ordering days may be scheduled in advance for each customer. For example,
customer’s ordering once a month agrees to particular days across all days of the
month to place their order.
To diminish the bullwhip effect, due to rationing schemes, the management may
allocate the available supply based on past sales rather than current orders. In fact,
during low-demand periods, this approach pushes retailers to try and sell more to
increase the allocation they receive during periods of shortage, dampening the
bullwhip effect. Other firms have tried to use the pull strategy to minimize shortage
situations. For example, some firms offer incentives to their large customers to pre-
order at least a part of their annual order. This allows the firm to improve forecast
accuracy and optimize its allocation of production capacity. In a large number of
cases, if capacity is appropriately allocated across different products, the likelihood of
shortage situations is reduced.
14.3.4 Pricing Obstacles

When pricing policies lead to an increase in variability of orders placed for the
product, it creates pricing obstacles. Two common reasons are lot size based quantity
discounts, and/or price fluctuations. Lot size discounts have been discussed earlier.
Price fluctuations often are the result of forward buying. Forward buying results in
large orders during the speculative period followed by very small orders after that,
resulting in variability in shipments. This magnifies the bullwhip effect within the
supply chain.
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A manufacturer can use lot size based quantity discounts use two-part tariffs and 265
Key Enablers in
volume discounts to help achieve coordination. Buy-back, revenue sharing, and Supply Chain Improvement
quantity flexibility contracts are options that can optimize levels of product
availability and at the same time maximize supply chain profits. They also compensate
for demand uncertainty. According to Chopra and Meindl, buy-back contracts have
been used in the publishing industry and Benetton has used quantity flexibility
contracts to help increase supply chain profits.
The firm can reduce the bullwhip effect by using pricing strategies that encourage
retailers to order in smaller lots and reduce forward buying for example by moving
from lot size-based to volume-based quantity discounts. This results in smaller lot
sizes, thus reducing order variability in the supply chain.
An important reason for forward buying is promotional programs that cause price
variations. A number of options are to reduce its impact. Firms can place limits on the
quantity that may be purchased during a promotion to decrease forward buying or tie
the promotion dollars paid to the retailer on sale quantities rather than order quantities.
14.3.5 Behavioural Obstacles

The supply chain structure and the communication between different stages are
problems that are often related behavioural obstacles. Some of these are described
below:
1. Organizational myopia, when each stage of the supply chain is unable to see the
impact of its actions on others in the supply chain.
2. Reactive behaviour when members of the supply chain react to problems without
trying to identify the root causes.
3. Conflict resolution, when different members of the supply chain blame each other
for the fluctuations, and become antagonists rather than partners.
4. Learning problems, when members of the supply chain do not learn from their
actions and a vicious cycle is started where actions taken by a stage create the
very problems that the stage blames on others.
5. A lack of trust between supply chain partners. This results in significant
duplication of effort. More important, information available at different stages is
either not shared or is ignored because it is not trusted.
There are a number of steps that can be taken by management in the supply chain to
increase coordination and moderate the bullwhip effect. Building trust and cooperation
in strategic partnerships are perhaps the most critical requirements to remove
behavioural obstacles. This succeeds only with top management's commitment.
Coordination requires managers at all stages of the supply chain to subordinate their
local interests to the greater interest of the firm and even the supply chain.
Coordination often requires a tradeoff where the firm has to change its traditional
practices. Such changes cannot be implemented without strong top management
commitment.
Coordination problems can be tackled through teams made up of members from
different companies throughout the supply chain. These teams should be made
responsible and given the power to implement the changes required. However, even
with responsibility and power, such teams can only be effective once a sufficient level
of trust builds between members from different firms.
The complete benefit of coordination is only achieved when the entire supply chain
network is coordinated. The most powerful party in a supply chain should make an
effort to achieve coordination in the entire network. A side-effect of the better
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266 relationship achieved through coordination is that it tends to lower the transaction
Logistics and
Supply Chain Management costs. For example, a supplier can reduce its forecasting effort if it trusts orders and
forecast information received from the retailer. Similarly, the retailer can save on
receiving costs by decreasing counting and inspections if it trusts the supplier's quality
and delivery.
The greatest hurdle to coordination in the supply chain is the feeling on the part of any
stage that the benefits of coordination are not being shared equitably. Managements,
especially from the stronger party, must be sensitive to this fact. They have the prime
responsibility to ensure that all parties in the supply chain relationship perceive that
the way benefits are shared is fair.
14.4 SUPPLY CHAIN INTEGRATION

The Supply Chain (SC) begins with the sourcing of raw materials and extends through
to the delivery of end items to the final customer. It links the set of resources and
processes that make this possible. The separation of SC activities among different
companies enables specialization and economies of scale to be exploited, but to do so
successfully, many important issues and problems need to be resolved the resolution
of these issues is the main purpose of Supply Chain Management (SCM).
14.4.1 Seamless Concept

The ultimate objective of an integrated supply chain is a supply chain which is
seamless. The seamless supply chain is an idealized concept of perfect information
flow and perfect material flow, facilitated by all supply chain players thinking and
acting as one. Yet, although it is an idealized concept, the seamless supply chain is not
beyond reach in reality. The concept is shown in Figure 14.3.
Figure14.3: The Seamless Supply Chain

Today, supply chains consist of potentially hundreds, or even thousands, of
independently owned enterprises. For example, Maruti Udyog has hundreds of
suppliers from MRF to Motorola, and this number increases as number of tiers of the
supply chain increases. It also makes the supply chain more complex. The integration
of supply chain processes through investment in cooperative arrangement and
technologies is difficult to separate from, or consider independently of, the strategic
positioning of organizations.
Effective supply chain integration requires effective implementation, and
implementation must be a part of the firm’s strategy. Uninformed by strategy, it will at
best produce little in the way of tangible benefits for the parties involved. It might be
counter-productive and erode competitive advantage. The way to go about it is first to
adopt it as the firm’s strategy and consolidate it around the following practices:
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z Simplicity: Start with those ideas that have already been proven, such as inventory 267
Key Enablers in
reduction, simplified processes and products, flexibility, and commitment to Supply Chain Improvement
continuous and incremental improvement.
z Smooth Material Flow: Progressively move on to tasks along the value stream so
that a product proceeds from design to launch, from order to delivery, and from
raw materials to a finished product in the hands of the customer with no
stoppages, scrap or backflows.
z Value Stream Management: Value stream management makes sure that products
move, in a more effective fashion, from concept to launch, from order to delivery,
and from sourcing of raw materials to delivery to the customer. Focus on
managing the specific activities required to design, order, and provide a specific
product.
z Lean Thinking: Lean is a philosophy for adapting to change and continuous
improvement. It seeks to shorten the time between customer order and product
delivery by eliminating sources of waste and delay. It provides a structure and a
philosophy that ensures that tasks are performed and value-added activities are
linked in the most effective way possible.
All of these concepts focus on the basic principles that guide supply chain thinking:
reduce friction, eliminate waste, and drive velocity through the supply chain. If these
concepts are deployed across the extended supply chain, they will carry the enterprise
toward establishing a true seamless supply chain. Supply chain performance also
improves as all stages of the chain take actions that together increase total supply
chain profits.
14.4.2 Supply Chain Uncertainty

A logical extension of these concepts i.e. simplicity, smooth material flow, value
stream management, and lean thinking, ultimately have to reduce uncertainty in the
supply chain. There are four different types of supply chain uncertainty. These are
discussed below:
z Process uncertainty: The organization's internal ability to meet a production
delivery target reflects process uncertainty. Process uncertainty can be established
by understanding each work process's yield ratios and lead time estimates for
operations. Also, if the particular product delivery process is competing against
others for resources, then the interaction between these must be studied and
codified.
z Supply uncertainty: Supply uncertainty results from poorly performing suppliers'
not meeting an organization's requirements and affecting value-added processes. It
can be measured through the supplier’s delivery performance, time series of
orders placed or call-offs and deliveries from customers, actual lead times,
supplier quality reports, and raw material stock time series.
z Demand uncertainty: Demand uncertainty can be quantified by measuring how
well companies meet customer demand.
z Control uncertainty: Control uncertainty is associated with information flow. It is
the way a firm carries out customer orders, from production targets and supplier
raw material requests. The level of control uncertainty can be determined by
comparing customer requirements, supplier requests to deliver, and production
targets over the same time periods. In a pure demand-pull environment, the
linkage between supply and demand is clear and control uncertainty is eliminated.
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268 However, companies typically use order batching and lot sizing, which often
Logistics and
Supply Chain Management makes it difficult to understand the linkage between demands placed and true
requirements.
Each of these uncertainties is a handicap to operational performance. The issue is
complicated even further as the company not only has to confront the uncertainty
generated by activities within the operational domain of the organization, but must
also manage uncertainty across a host of supply chain participants.
Figure 14.4: Uncertainty Reduction

This makes it important now to understand how the supply chain can handle this
uncertainty. The first step in supply chain integration is to look internally, because a
company’s own processes are the most visible and accessible area to influence. Full
supply chain integration is achieved by extending the scope of management outside
the company to embrace the suppliers and customers. This is shown in Figure 14.4.
First, the firm has to identify the supply chain level of integration. There are a number
of techniques available to make this assessment. The goal of the organization should
be to move to the next level of integration. This can be accomplished by developing
re-engineering programmes that address the problems that are causing high levels of
uncertainty. For example, moving from the baseline level to the functional integration
level requires reducing process and control uncertainty. A company can introduce
process performance measures, proactive maintenance, more frequent Materials
Resource Planning (MRP) runs, and better stock auditing, to accomplish this. This
process of supply chain reengineering continues until external integration is reached.
Inherently, it embodies a change of orientation away from product to customer. A high
level of integration with the customer organization is involved in order to understand
the products, culture, market, and organization. It also involves integration back down
the supply chain to include all supplier partners. The stated aims of full integration are
thus seen to be entirely consistent with the establishment of our concept of the
seamless supply chain.
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Key Enablers in
Fill in the blanks: Supply Chain Improvement
1. Traditional performance measures are ………………and therefore limit

the possibilities to optimize supply chains.
2. Sharing ………………………data across the supply chain helps reduce
the bullwhip effect.
3. The supply chain begins with the sourcing of raw materials and extends
through to the delivery of end items to the………………………..
14.5 LET US SUM UP

In today's competitive global environment, the onus is now on supply chain
management. Companies whose SCM is competitive will gain in the long run. The
advances in information technology have transformed the supply chain elements and
enabled organizations to make significant improvements in productivity and
competitiveness. The IT- enabled options available today for supply chain facilitate
real time information flow through networking and electronic data transfer, faster
response time and improved decision making, through timely availability of relevant
information.
In traditional systems, the focus is on the specific transaction between the buyer and
the seller; therefore the bullwhip effect is a phenomenon that firms have to live with.
Traditional methods of coordination and measurement approaches may have to be
reviewed if supply chain optimization is desired. Traditional performance measures
are internal and therefore limit the possibilities to optimize supply chains. There are
three kinds of coordination in supply chains. These are across channel members,
across management levels and across functions. Coordination is achieved when all
parties involved devote significant managerial resources to this effort. The supply
chain (SC) begins with the sourcing of raw materials and extends through to the
delivery of end items to the final customer. It links the set of resources and processes
that make this possible.

How can ERP improve a company's business performance?
14.7 KEYWORDS
Enterprise Resource Planning (ERP): Enterprise Resource Planning (ERP) systems
integrate internal and external management information across an entire organization,
embracing finance/accounting, manufacturing, sales and service, customer
relationship management, etc.
Electronic Data Interchange (EDI): Electronic Data Interchange (EDI) is the
structured transmission of data between organizations by electronic means, which is
used to transfer electronic documents or business data from one computer system to
another computer system.
Bar Coding: A bar code is a grouping of parallel bars (usually blocks) of varying
widths separated by light spaces (usually white) of varying width.
Information and Communications Technology (ICT): Information and
Communications Technology or Information and Communication Technology (ICT),
is often used as an extended synonym for Information Technology (IT), but is a more
specific term that stresses the role of unified communications.
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LESSON 273
Strategic
15
STRATEGIC SUPPLY CHAIN MANAGEMENT
CONTENTS
15.1 Introduction
15.2 Supply Chain Growth
15.2.1 Trends in SCM
15.2.2 Strategic Decisions
15.2.3 Strategic Supply Management Activities
15.3 Supply Alliances
15.3.1 Developing and Managing the Relationship
15.4 Supplier Quality Management
15.4.1 Problems of Quality
15.4.2 How to Find the Qualified Supplier?
15.4.3 Quality Survey of Suppliers
15.6 Let us Sum up
15.8 Keywords

z Discuss the imperatives for supply chain and strategy development
z Acquainted with the issues in supply chain domain and strategic decisions in the
supply chain
z Discuss supplier alliances
z Illustrate supplier quality management and related problems
z Explain supply chain re-engineering
15.1 INTRODUCTION
The successes in the manufacturers of today revolve around certain basic services
related to both product management and consumer satisfaction. The imperatives are:
z Shorter product life cycle.
z Quality control.
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274 z Timely delivery.
Logistics and
Supply Chain Management z Low cost delivery options.
z Reduction in costs, both production and to the end user.
z Waste management.
The imperatives above create a continuous pressure on the companies for frequent
changes, both in terms of policies and strategies, and in a way force the companies to
stay abreast of the latest. According to the world competitiveness report
competitiveness is equal to multiplication of competitive assets and competitive
process (Deshmukh & Mohanty).
Where, competitive assets include technology, infrastructure, people and government
institutions, and competitive process include quality, speed, customization and
services. Logistics has always been the backbone to infrastructure for the
manufacturers. Within the purview of SCM logistics has been the art and science of
procuring, producing and delivering products and services at the right time, in right
quantity and at the appropriate place. As we have seen earlier, SCM involves
planning, implementation, controlling, storage, and transportation and end delivery
from the point of origin to the point of consumption as part of consumer/customer
requirements. It is a network of facilities that perform the tasks of procuring the raw
materials, transport them, transformation of materials to finished products and further
distribution of goods to the end user, the customers. During initial evolution it was felt
that logistics that involved transporting and warehousing couldn’t effectively
influence the strategic goals and hence, extensive investment needn’t be done.
Activities relating to customer services, warehousing, order processing, inventories
and sales were also ignored.
Production, marketing and finance operated independently, and inventories and sales
ignored. It was in the seventies that the management explored the scope of reducing
the distribution costs. The concept of total cost management was evolved in order to
optimize the total costs rather than costs of activities taken in isolation. A centralized
logistics function was given the responsibility of controlling costs with emphasis on
maximization of service level. Slowly but steadily the aspects of logistics got
integrated with the other functional activities of the supply chain, and the functional
chain emanating from supplier to the delivery options to the end user, were formulated
and incorporated with the operational and strategic plans. In the final stage logistics
were accorded due importance in the strategic planning. The imperatives for supply
chain strategy are:
z Global sourcing
z Global networking and marketing
z Revolution in global business process
z Customer centric management activities
z Integrated planning system
z Integration of functional activities in the supply chain towards a common goal for
competitive advantage
15.2 SUPPLY CHAIN GROWTH

According to Hicks, the imperatives for growth of supply chain are:
z Enhanced customer expectation: Competition worldwide has led to maximum
emphasis on customer service over the years. The value of the product can only be
determined when the product reaches the customer in time and at the required
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place. The value of customer service has acquired such dimension that, if the 275
Strategic
product doesn’t reach in time, the sale will be lost to a competitor who offers in Supply Chain Management
time, an ideal substitute. This can further be classified under:
z Pre-transaction Elements: Relating to corporate policies and program.
z Transaction Elements: These are those variables involved directly in physical
distribution, i.e. product and delivery reliability.
z Post-transaction Elements: These are those aspects dealing with after sales
service, warranty, repair, customer complaints and replacements.
z Pressure for Quick Response: Customers today expect a better and quicker
response owing to the value added services being provided by the manufacturers.
This is mainly due to shortened product life cycles, consumer’s drive and volatile
markets, making reliance on forecasts difficult and dangerous. The key to quick
response is pipeline management, i.e. a process where manufacturing and
procurement procedures are linked to requirements of the market. It seeks to meet
the competitive challenges of increasing the speed of response to the market
needs.
z Impact of Globalization: Present global environment is forcing the organizations
to incorporate the world in their strategies and analysis. Certain key factors like,
economic trends, competitiveness, technological advances, the firms today cannot
ignore them. Companies therefore must identify and analyse factors that differ
across nations and determine the impact on the operations functions.
Transportation and distribution therefore assumes greater importance in such
scenario, and the companies have to rightfully integrate and manage the facilities
and markets available in this backdrop. Logistics, therefore, assumes greater
strategic significance.
z Organizational Integration: Organizations today need to be broad-based
integrators, inclined towards the achievements of market place successes, based
on managing systems and people that deliver the service. Generalists, therefore,
assume greater importance to specialists to integrate materials and operation
management with delivery. Today, IT is slowly proving to be a great integrator for
various functions, spanning from supplier to the customers.
15.2.1 Trends in SCM

The major trends in SCM are:
z Co-maker Ship: It is defined as the development of a long-term relationship with
limited number of suppliers on the basis of mutual confidence. The benefits are:
Shorter delivery lead times
Reliable delivery
Lesser schedule disruption
Lower stock levels
Lesser quality problems
Stable prices
Higher priority to orders
The basic philosophy of this alliance is that the supplier is considered to be the
extension of customer relationship, with emphasis on continuity and a seamless
end-to-end pipeline. With growth in outsourcing the trend towards co-maker ship
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276 also increases manifold. This principle can be extended both ways in the supply
Logistics and
Supply Chain Management chain-upstream to customers and downstream to distributor, retailer and users.
z Third Party Logistics: Outsourcing operations like storage, transportation and
delivery, improve service levels, reduce costs and increase flexibility. It also helps
in reducing costs on trucks, warehouses and certain infrastructure requirements,
and allows firms to acquire new technologies and enter newer markets. Yet,
certain aspect does merit attention. These outside service providers may not at
times perform up to the requirements of the manufacturer and would result in loss
of image of the firm. Therefore though third party logistics could be cost effective,
at times the firm should use these depending upon the organization’s needs,
capabilities of the service provider and the resulting pay off.
z Principle of Postponement: The time when the product is ready for sale is known
to the organisation, and consequent delay in labelling, packaging and pricing till
the last moment is called principle of postponement. The sole objective is to
minimize the risk of carrying finished product to the various points of the supply
chain by delaying the product differentiation to the latest possible moment before
customer purchase. The cost savings on transportation and storage are attained by
keeping products at the highest level and by moving goods through the supply
chain in large, generic quantities (Deshmukh & Mohanty 2004). Examples of
postponement are:
Delayed labelling
Shipping in bulk
Transferring to small containers at warehouses
Delay final assembly
Stocking fuel, oil & lubricants (FOL) in unblended state
However, it has to be noted that postponement shouldn’t compromise the desired
service level.
Enterprise Resource Planning (ERP) & DRP: ERP systems are basically information
integrators and they help in binding various business processes in an enterprise. It also
helps in streamlining and re-engineering of various processes, focusing on value
activities and eliminating non-value added activities. Due to influx of IT, ERP has
been able to provide a wide information base with an aim to optimize resources. This
has further helped in in-bound logistics, transportation, material management and
accounting at large. DRP on the other hand helps in estimating inventory requirements
at stocking areas and ensures supply sources are able to meet the demand. It
incorporates policies on safety stocks, information and relation between demand
forecasts, inventory levels, manufacturing and distribution schedules. DRP helps in
both short term and future production and distribution resources, in order to match
both supply and demand. Because of minimal inventory that is held, DRP can be
called the key to logistics and JIT productions.
15.2.2 Strategic Decisions

Strategies are a set of important decisions derived from a decision making process of
the top management in the organization. In order to ensure success, the strategic
changes that are being incorporated in the supply chain, has to conform to well-
defined strategies formulated by the company from time to time. The top management
in the company forms the strategic decisions and successful execution of these
decisions should provide a cutting edge to the organization. Areas that require
strategic decisions are warehousing, transportation, IT, and make versus buy.
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IT Solutions and Integration: IT solutions will play a significant role in information 277
Strategic
building all through the supply chain. However, companies should address several Supply Chain Management
queries centred on proper alignment of information technology tools and the expected
increase in productivity and services. Identifying the very scope of the business
problem that is to be addressed is the most important in this complete exercise. This
effort will help in identifying the best course available to the manufacturer and the
area that it is to be applied, the core business issues. At the same time, it is also
important to assess the effect of IT on the organization as a whole and its capabilities.
More often than not, IT affects the business in three ways:
z The integrated process requires managers for restructuring the cultures and
capabilities on values providing continuous improvement and teamwork.
z It enables the organization not only to rethink but also leverage new information,
like graphics, computer integration and workstation technology.
z Application of new information requires redefinition of goals and skills of the
enterprise’s people resources.
The response to the issue of managing the supply chain included having a fully
integrated business, and some of the vehicle manufacturing companies were structured
in a way where the input were raw materials and output the finished product.
However, the driving forces for global manufacturers have ranged from becoming a
tiered global supply system in the West to the Japanese Kereitsu based company
supply system, although there are quite a few near fully integrated companies in the
developing nations till date. The following are the reasons propounded by Christopher
(1992) for not following the integrated supply chain:
z Few managers retain a grasp of a process from one end of the pipeline to the
other. As a result, the way things get done can reflect convenience for doers, a
desire to protect functional boundaries and a lack of understanding the related
consequences, both up and down streams of individual processes.
z Initiatives of changes are functional in nature and seldom reflect the cost of the
system.
z Their custodians as a means of providing breathing space and as ways of
providing some hidden flexibility respond to protect lead times. The individual
functional lead times contain slack and where these become embodied in a
processing system, they are institutionalised. Actually, companies that have
benefited from integration are pacing ahead with confidence and IT as a whole
have further aided in integration vigorously.
z Make versus Buy: The main organization focus today is on outsourcing of non-
critical components. These decisions are arrived at after considering the factors
like, capacity, leverage an organization gets and the quality and confidence in
working with the vendor. Make buy decision is a strategic decision and the area
that has to addressed in this is development of the total cost model (Deshmukh &
Mohanty). It has been seen that having a supplier that can work in a simultaneous
engineering way with the company is the main aspect in order to avoid costs
associated with unnecessary design complexity. This may also mean having a
supplier who can provide the same support through IT rather than having an
engineer in site, and achieve the same result. The next consideration is the aspect
of labour elements. Here, once again the need for simultaneous engineering is
required mainly in those off-shore areas with low labour rates, over and above
issues like labour rate inflation and challenges of overseas sourcing. All these
have to be considered in a structured manner and not in isolation.
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278 15.2.3 Strategic Supply Management Activities
Logistics and
Supply Chain Management As per Burt and Dobler, supply management focus on ten strategic activities:
z Environment Monitoring: Monitoring the supply environments to identify threats
and opportunities, is an important task of supply managements, to include material
shortages affecting both price and availability of purchased materials and services.
They can further be classified as:
Changes in legislation affecting the workplace. This can affect both price and
availability.
Wars and conflicts that can affect availability of materials resulting in price
increase.
Consolidation among suppliers to the extent of monopoly. A firm should
change its strategy based on such changes.
z Integrated Supply Strategy: Supply management should develop and manage the
firm’s supply strategy based on wholesome integration strategy and not in isolated
strategies.
z Commodity Strategy: Must develop and update sound commodity supply strategy.
The following activities have to be performed to ensure effectiveness of the
strategies:
Strategy Updating: Commodity teams must identify materials, items of
equipment and services that are strategic in nature or should formulate a
strategic plan for obtaining them.
Technology Access Control: All supply management organization’s developed
and update technology road maps, which lists critical current and future
technologies to be pursued. Action should be at hand to protect these
technologies that yield a competitive edge and ensure are not transferred to
competitors.
Supply Management Organization: The organization of the supply
management system must enhance the effectiveness and efficiency of the
system in attaining the primary objective.
Risk Management: Actions should be taken to ensure minimum disruption of
supplies and price increase.
z Data Management: Supply management, accounting and information technology
must cooperate in the collection and application of supply data to facilitate the
strategic supply planning.
z Corporate Strategic Plan: Supply management should join the marketing and
operations as the key players in development of each of the firm’s corporate
strategic plan. Supply management provides input to the strategic planning
process on threats and opportunities in the supply world. It also provides inputs on
constraints that may affect strategic initiatives. Its knowledge of the firm’s supply
world may be a vital source of input for strategic planning.
z Strategic Sourcing: The firm should manage and develop its supply base in line
with firm’s strategic objectives. Several actions that should be taken are:
Periodic review of the active suppliers.
Identification of the appropriate relationship (transactional, collaborative or
alliance) for each commodity class.
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Optimization of supply base with coordination and combination with several 279
Strategic
forces to increase the importance of the firm’s supply base. Supply Chain Management
z Strategic Supply Alliances: Developing and managing the supply alliances
frequently are two of the most crucial and most strategic activities undertaken by
any firm. Institutional trust is a key prerequisite to supply alliances. Rapid growth
of American society of Alliance Professionals is a testimony to the industry’s
recognition of importance of these activities.
z Supply Chain/Networks: These help in developing and managing of supply
alliances, but are more complex. IT & relationship skills are essential prerequisite
for personnel assigned to the task. Charles Fine in his book Clock speed writes,
‘the farther you look upstream in your technology supply chain, the more
volatility you see. Customers are foolish if they don’t spend any time or resources
thinking of the health, survival, and possible independence of their core
technology suppliers’.
z Social Responsibilities: Supply management must develop and implement
programs that will protect the environment, facilitating the inclusion of woman-
owned, minority based and small business in our economy to promote values in
the workplace.
z Understand Key Supply Industry: Its impact is directly proportional to the
knowledge of related industries in which it buys. They study and understand the
industries that provide the key materials, equipment, and services, cost structures,
technologies, competitive nature and culture.
The above provides the understanding of supply managements responsibilities both
strategic and tactical, which if executed effectively and efficiently will be a key to the
firm’s success and survival.
Fill in the blanks:
1. The concept of ……………… was evolved in order to optimize the total
costs rather than costs of activities taken in isolation.
2. …………………..are those variables involved directly in physical
distribution.
3. ………………………… is defined as the development of a long-term
relationship with limited number of suppliers on the basis of mutual
confidence.
4. ……………….. are a set of important decisions derived from a decision
making process of the top management in the organization.
5. Supply management should develop and manage the firm’s supply
strategy based on wholesome……………… and not in isolated strategies.
15.3 SUPPLY ALLIANCES

As seen above supplier alliances plays a key role in strategic supply chain
management activities across the board. Therefore in order to develop and manage
these relationship and alliances a firm has to continuously endeavour to identify
methods to facilitate these relations. Supplier is as important as the customer and that
has to be realised in the true sense. Riggs & Robbins spelt out these relations in their
book ‘The Executive Guide to Supply Management Strategies’, they are:
z Annual Supplier Meetings: Annual supplier meeting is a common phenomenon
in maintaining direct relationship with the suppliers by the buyer firm. It is used
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280 both as a teaching and learning platform as well as the opportunity to distinguish
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Supply Chain Management one’s organisation as a supply management leader. It dwells on the buyer’s
management performance, learning and future goals. The main objective being
learning of key strategies to support the buyer’s business. It requires extensive
planning and is expensive, but it lays the foundation of a buyer supplier
relationship in the long run.
z Supplier Discussions: It’s an informal forum for gaining and sharing learning,
between the representatives, like the chief executive, chief operating officer, and
representatives from marketing, supply management and research divisions. It
reviews the buyer’s progress and goals in the backdrop of shift in strategies and
policies. It’s a forum that builds trust and respect, towards a successful supplier
relationship.
z Workshops and Seminars: These are aimed at creating opportunities for supply-
stream innovations, which will benefit all the participants. It composes of
members of supplier participants who provide material and services that are
critical to the products made available at the marketplace. Such discussions open
the door for newer set of goals and collaborations. It provides the base for
continual improvement, concepts and innovations required to guide and organize
discussion and work sessions.
z Collaborations/Partnership: This is supposed to be the most successful supplier
buyer relationship in recent times. These are based on mutual interdependence and
respect. These alliances begin with careful selection of source during the product
design process. This is the time when the buyer requires a dependable supplier
who can provide the required process, design and technological support for a
successful product. The supplier at the same time requires a responsible customer
for its product and services. They both require each other and have to work hand
in glove. Unexpected criticalities that may arise can be sorted out with a ‘we shall
overcome’ attitude. The most important in these relationships is the integration of
the buyer and supplier as long as the relationship is beneficial to each other.
15.3.1 Developing and Managing the Relationship

Supply managers at all levels should ensure and tailor appropriate actions during the
planning and management of such alliances mentioned above. Like:
z Instituting a Cross-Functional Team: A team so designated should be in place to
handle such alliances, which are responsible for development, integration, and
develop and manage appropriate measures for the alliance to be successful.
z Training: Teams from both sides as designated should undergo appropriate
training in being constructive team players, and also in cross-functional team
skills.
z Communication System: The teams should develop and integrate an effective
communication system responsive to the needs and requirements of both the
firms.
z Trust Building: Measures to improve trust between the two organizations have to
be developed and implemented too.
z Visits: Periodic visits by the respective team members to each other’s site have to
be resorted to for confidence building and co-location of key technical persons.
z Specialised Training: Plans have to be evolved and developed for specialized
training involving variance of products, designing, value analyses, engineering,
cost analysis and cost management.
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z Objectives: Certain objectives have to be established in areas, including quality, 281
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cost and time aspects. Supply Chain Management
z Monitoring: Results have to be continuously monitored and reported to the
management level.
z Supportive: Inter-firm team members should realise the importance of such
alliances and support the alliance goal in letter and spirit. It’s in the interest of
both the firms to support each other’s operations and their respective goals, ethics
over expediency.
Management of supply contract is a challenging responsibility and a critical too.
Companies have to continuously generate and develop newer ideas and innovations to
maintain these relations and work in unison to a common goal without jeopardizing
each other’s interest in the overall gambit of supplier buyer alliances and relationship.
15.4 SUPPLIER QUALITY MANAGEMENT

After having seen the supplier-buyer relationship, we will now see the quality control
aspects of supplier units. Quality management dates back to the 80’s, wherein the
Japanese companies developed a zero-defect program for their products, primarily
based on quality of the raw materials they procured. This was resorted to by traditional
methods of sampling of the incoming raw materials, which implicitly inferred that
there will be some non-conforming parts that will be used in the manufacturing
operations resulting in lower material productivity and higher manufacturing costs.
This was never a full proof system and the lacunas were too many, and resulted in
longer lead-time to correct the specific problems or adjustments to the operating
systems.
This would generally lead to longer customer delivery time and cascading decrease
in profits. In every organization there is a wide diversity of functions and structures
for quality planning and control, and hence the first step to quality assurance is a
structural basis for the procurement system that should be organic in character and
reflect the concern for quality control in developing the relationship of the
interdependent organization throughout the supply chain. With this as a preamble let
us see the problems of vendor / supplier quality.
15.4.1 Problems of Quality

The suppliers till late had been providing natural/semi-processed materials to the
manufacturers for their finished products. Under such circumstances, quality control
was never a problem since it was dependent on the quality of raw materials. “The
buyer and suppliers were almost quasi-independent and had little interaction between
them”. Today things have changed considerably and most of the companies are
engaged in different type of purchases and procurements, particularly very complex
and highly engineered subsystems with critical interfacing with other components.
Therefore, some key features have to be evolved for a better buyer-supplier
relationship and its effect on the quality assurances on the whole. However, for quality
assurance, some activities that are to be followed are:
z Mission: The Company’s mission and policies on supplier quality relations have
to be spelt out clearly (as for ISO-9000).
z Identification: Identify and develop qualified and capable suppliers who can
assure of quality, and weeding out the lesser variants.
z Communication: Communicating essential and helpful information, designs, and
specifications and also engineering changes promptly.
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282 z Development: Developing methods for detecting the deviations through
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Supply Chain Management reproduction and trials.
z Assistance: Provide assistance to the supplier on quality related problems and
overcome them.
z Review: Periodic review of the performance of the supplier through supplies
rating and follow up actions against poor suppliers.
These activities are not sacrosanct and depend on the following:
z Nature of goods being purchased
z Volume of the purchase
z Total suppliers
z Repeat purchase
z Research, design and subcontract management.
15.4.2 How to Find the Qualified Supplier?

A very tedious process and action at hand by the buyer firm is to find a suitable
supplier who can generally meet the benchmark of the purchaser, i.e. ‘the best from
the best within the cost’, under ideal conditions of course. However the following
evaluation methods could be used to get the best from the best:
z Reputation: This is a variable factor and differs from company to company, big
and small. For a big company it is of significance and for a smaller company it’s
almost obscure. A detailed survey and market search will help in identifying the
best that can deliver the best within the cost per se. The buyers’ generally
maintain database on prior performance of these companies.
z Database: Maintaining a database in financial function has been very effective;
however, it is in development stage for use in quality functions (Desmukh &
Mohanty, 2004).
z Surveys: The purchasing and procurement division of a company is carrying out
the selection of the appropriate supplier. Clarity of information is an important
factor in this selection process, and such information on the supplier will provide
the right weightage for the supplier selection.
z Trial & Error: Sometimes this procedure will also help in choosing the correct
supplier for the manufacturer. At times certain obscure suppliers qualify to the
requirements of the manufacturer and provide the goods as required. The limiting
factor is the right chance at the right time.
z Faith & Reliance: This is another aspect that will help in getting the right supplier
when the company requires the most. No supplier would like to loose
out/compromise on the aspects of faith and reliability that has been bestowed on it
by the buyer unit.
z Opportunity: This is another factor because of which many small suppliers loose
out on a buyer’s search radar. The buyer should carry out an in-depth selection of
the supplier and provide a fair opportunity to even the smallest to prove its worth,
sometimes, it does pay huge benefits in the long run.
15.4.3 Quality Survey of Suppliers

It’s an evaluation process, which enables the buyer to select the appropriate supplier
conforming to the buyer’s requirements. Does the supplier have the ability to respond
to the buyer’s requirements? Does he require assistance in any form? This and many,
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can be answered by help of visits to the supplier’s site by a team of specialists or 283
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through a balanced questionnaire. The following are the survey evaluation on the Supply Chain Management
supplier:
z Policies/Practices on Quality: These are the basic guidelines based on which the
quality assurance of the supplier can be determined. They are the real intentions
that are to be implemented in a variety of degrees, the main problem is to evaluate
the policies and determine the degree to which they are to be implemented.
z Facilities: These are related to tests and inspection that meet the quality
requirement of the purchased product. Samples are taken and checked with the
vendor and buyer’s gauge to compare the gauging systems. This kind of checking
reduces the risk to both the supplier and the buyer.
z Procedures and Actions: These are the procedures for handling quality problems
like gauge control deviations from existing specifications. The aim of the survey
is to determine whether the procedures are in vogue or not.
z Appraisal: Appraisal of personnel from viewpoint of quality is very difficult, but
discovering the technical competence and attitude to quality can be established.
But, this could be just subjective at times, due to turnover of key personnel. Yet, a
general attitude of quality control can be found out through auditing, discipline,
and maintenance and housekeeping records.
For a new product line searching for a capable supplier is indeed a difficult task and
this can well spell the difference between success and failure of any new product.
Geographical location and close proximity is a reason to search for a supplier closer
home, without a rating of sorts, but selection for a long-term supplier in high volumes
is a tedious process and should start early. The prospective suppliers can be located by
any methods, but the pertinent questions that should be addressed are:
z How well do the objectives of the quality program conform to the buyer’s needs?
z How well the practices of the quality control program conform to the objectives?
The objective of this evaluation is to arrive at a judgment of how well supplier’s
programme operates, neither to tabulate the efficiencies nor rationalize the
shortcomings. The areas for evaluation are:
z Quality
z Price
z Performance
z Production capabilities
A supplier survey is analogous to a profit and loss statement, that is, it speaks of the
status at any one point in time and will not guarantee of the status at any other time.
Therefore, the communication of the survey must continue for a long time towards a
good partnership.
Increased competition in the economic scene worldwide results in heavy dependence
on quality as both an endogenous and exogenous factor. This results in the other
elements that aid in quality control to have an ever-expanding role. Procurement
function therefore plays a key role in getting the best from the best available in the
open market. It plays a predominant role in the in ensuring quality in an organization.
Improving quality therefore should shift from desire to compulsion in the quality
assurance of supply agencies.
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284
Logistics and 15.5 SUPPLY CHAIN RE-ENGINEERING
Business structure is continuously changing from one phase to another, and today
has reached the stage of professionalism where it is revolving around customer focus
in a big way. These changes have shown remarkable improvement in company
performance measures such as quality, costs, services and lead times. Hammer &
Champy in 1993 identified these changes and improvements and packaged these ideas
into concept of ‘business re-engineering’, which was later termed as ‘business process
re-engineering’ (BPR).
The areas in common between BPR and SCM seems to be very few at a cursory
glance, but SCM is not a traditional improvement technique, but a philosophy that
helps in improvement not involved with functional reviews, as highlighted by
Stevens’ model of supply chain integration. However, in an introspection of BPR &
SCM reveals that there is more than one common link between the two. Business
transformation from the concept ‘what we make we sell’ to a more flexible concept of
‘what the market want us to sell’ can effectively be achieved after a competitive
analysis and a supply chain diagnostic review. It is well understood, that effective
transformation is only possible after a series of phased step involving technological
reorganization, attitudinal and organizational attribute, and integration between the
competition and customer demands.
The comparison between SCM and BPR is as shown in the table 15.1
Table 15.1: SCM and BPR
Business (Process) The fundamental rethinking and radical redesign of business process to
Re-Engineering achieve dramatic improvements in critical, contemporary measures of
performance, such as cost, quality, service and speed.
Supply Chain The management of material suppliers, production facilities, and
Management distribution services and customer linked together via the feed forward
(Stevens’ 1989) flow of material and the feedback flow of information.
Source: Adopted from Deshmukh & Mohanty, 2004 (Essentials of SCM)
Achieving internal integration is a desirable stage, however, performance of pockets

of excellence is generally downgraded (from customer’s viewpoint) due to poorly
performing suppliers and customers in the supply chain. In order to understand this
further a wider perspective of the supply chain needs to be taken keeping in mind the
12 steps of BPI, as evolved by Harrington, to streamline the process. They are:
1. Elimination of bureaucracy
2. Eliminating duplication
3. Value added assessment
4. Simplification
5. Process cycle time reduction
6. Error proofing
7. Upgrading
8. Simple language
9. Standardization
10. Supplier partners
11. Broader picture improvement
12. Automation
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From the above it’s evident that the first 9 steps are operational, step 10 is for supplier 285
Strategic
side, and step 11 is for the customer satisfaction. Therefore, to attain this step, if a Supply Chain Management
radical redesign is taken, business process integration turns to business process re-
engineering, in the supply chain scenario. Side by side in the Stevens’ model step 3
moves to step 4, i.e. full integration is achieved. Therefore, this integration involves
extending the internal management to supplier focus and customer orientation in order
to create a strategic partnership, by reducing the suppliers. Customer understanding
will in a big way change the entire philosophy from pushing products to selling goods
as per customer requirements. Backward integration is a very difficult process in
supply chain integration, since; it involves a change in inter-company attitudes from
adversarial to that of mutual support, which is in fact very crucial to successful supply
chain integration. We should as a matter of fact, never lose sight of the fact that
business in the supply chain, is directly dependent on customer finances which enables
the continuity of the supply chain.
Therefore, the strategies in the supply chain should have common aim of improving
the performance of the chain from the perspective of the consumer/customer. Stevens’
integration, in stage 4 of the supply chain is generally successful because of the
financial position enjoyed by the big companies. Such companies generally bend rules
of supply chain integration and manipulate smaller members of the chain to their
financial ends, in order to benefit the most. Therefore, backward integration is a
contentious issue. Both internal and external integration is required to be achieved for
improving performance in the supply chain management, under ideal conditions. Yet,
internal or external or a combination approach may be the goal depending upon
product, industry, market conditions or where advantage could be gained for the
supply chain. Though, Stevens’ model suggests that external integration, without
internal reorganization does not exploit all the benefits of true supply chain
integration.
Now, let us see whether BPR internal re-engineering is equivalent to the functional
and internal integration stages in the Stevens’ model? Actually, the first and the final
stages are similar in both BPR & Stevens’ model. Initially, non-existent planning and
control structures across departments are optimized to departmental goals resulting in
customer necessities not being catered to, but the final structure is customer centric
with major changes in culture, structure and technology. The intermediate steps are
different, since BPR calls for one-leap changes on a process-by-process basis.
Whereas, Stevens’ model opts for functional integration, followed by internal
integration; functional integration in BPR is not necessary, only the process should be
sought and redesigned. Efforts to optimize a function are considered a waste in this
system. The functional integration stage does bring together a trans-departmental
view which, if performed correctly, will lead to improved operating performance
(Deshmukh & Mohanty).
Improvement in the overall performance level and integrating of the core functional
areas as one single function does negate the poor performance of the surrounding
functions. Therefore, it is mandatory to initially bind the functions along a process
line, and then integrate the appropriate cross-functional processes at a later stage.
Therefore in spite of BPR being a later model, Stevens’ model is still valid in the light
of BPR concept, though more details of reorganization stages are required. Therefore,
cross-relationship between both the stages is to be highlighted more vigorously. This
can be achieved by examining the pre-requisites and techniques used in integration
stages of SCM and in virtuality, i.e. by philosophy. Let us now see the various
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286 categories covering the parallels of essentials between SCM & BPR, through this
Logistics and
Supply Chain Management table:
Table 15.2: Parallels of Essentials between SCM & BPR
Area for change BPR (Business Process Supply Chain Management
Reengineering) Terminology
Process z Elimination of wastes z Reduce non-value added activities
z Speed up process z Lead time reduction
z Concentration on core z SCM positions each firm to do
processes what it does best
People z Board level commitment z Board level commitment with a
z A management that questions logistics champion at board
z A workforce that questions. z A management that questions
z Multi-skilled workforce z A workforce that questions
z Attitudinal changes z Multi-skilled workforce
z Attitudinal changes
Technology z Technological changes z Technological changes
z IT a key to BPR z IT a key to SCM
z Break the rule z Partnership sourcing
z Treat vendors as adversaries z Deep penetration to customers
bases
Innovation z Customer focus z Constant innovation at the
z Constant innovation interfaces of the company
z Constant product/process z Streamline processes
innovation
Analysis z Analysis by paralysis is not z Aggregate modelling can aid the
Beneficial redesign strategy and take a
z Take a holistic view systems view

Fill in the blanks:
1. ……………………………..is as important as the customer and that has
to be realised in the true sense.
2. The teams should develop and integrate an effective …………………….
responsive to the needs and requirements of both the firms
3. These are the basic guidelines based on which the ………………………..
of the supplier can be determined.
4. Improving …………………..should shift from desire to compulsion in
the quality assurance of supply agencies.
5. Hammer & Champy in 1993 identified these changes and improvements
and packaged these ideas into concept of …………………
15.6 LET US SUM UP

This lesson highlights the common foundations, which underlie both SCM & BPR
philosophies, which are indicative of the important difference between the two, the
drive for improved business operations. Those who follow the SCM philosophy would
have traversed the path as BPR after having re-engineered own processes. The
existing philosophies such as SCM (integrated) as mentioned in this lesson cover a
large portion of the BPR ideas, yet a few ideas have to be added to the model:
z Radical approach for internal integration.
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289
LESSON Aligning the Supply Chain
with Business Strategy
16
ALIGNING THE SUPPLY CHAIN WITH
BUSINESS STRATEGY
CONTENTS
16.1 Introduction
16.2 Process of Strategy
16.2.1 Steps to Align Supply Chain with Corporate Strategy
16.3 Identification of Strategic Alternatives
16.4 Strategic Alliance
16.4.1 Factors Promoting the Rise of Strategic Alliances
16.4.2 Benefits of Strategic Alliances
16.5 Linking Supply Chain and Business Performance
16.6 Let us Sum up
16.8 Keywords

z Discuss the process of strategy
z Explain the identification of strategic alternatives
z Discuss the strategic alliance
z Discuss about the linking supply chain and business performance
16.1 INTRODUCTION
To understand, let us review some of the basic concepts of strategy. Strategy was
initially postulated as a balancing act between the external and internal forces in a
corporation where the firm matched its (internal) strengths and weaknesses against the
(external) opportunities and threats. Since then, many researchers have added their
own work to the field of defining what is corporate strategy, how to think about it,
how to formulate good strategy, and have provided various frameworks to help the
evolution of the concept of corporate strategy. In short, the goal of any corporate
strategy is to create competitive advantages for the business in its industry segment so
that it is well-positioned for financial success. There are two dimensions of every
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290 action – substantive and procedural. The former involves determination of what to do
Logistics and
Supply Chain Management and the latter is concerned with determination of how to do. Both of these dimensions
are interdependent and taken together help in achieving the objectives for which the
action is contemplated. In the context of an organization engaged in strategy
formulation and implementation, the substantive dimension deals with the
determination of strategy or set of strategies and procedural dimension deals with
putting a strategy into operation. Besides these, it has to be decided that who will do
what in completing the action. The logic of a process is that its particular elements are
undertaken in a sequence over a period. The strategy process involved in strategy
includes a number of elements. The process can be defined as a set of management
decisions and actions which determines the long run direction and performance of the
organization. It is a dynamic and continuous process. However, there are two
problems in identifying and sequencing the elements:
(i) There is no unanimity among various authors about the elements and their
interaction.
(ii) After the elements have been identified, their sequential arrangement is another
problem.
Both these problems highlight the complexity of strategic process. The process
includes definition of organizational vision, mission and objectives, environmental
analysis, identification and evaluation of strategic alternatives, making a choice,
implementing it and evaluating and controlling the strategy.
Strategies in supply chain management involve how the company should accomplish
this. Success with regard to supply chain strategy requires adopting a supply chain
management strategy that meshes with the company's business strategy and takes
advantage of its capabilities and resources.
16.2 PROCESS OF STRATEGY

A company's business strategy plays an important role in the success of a company's
supply chain management strategy, in that the business strategy is the basis on which
the company wants to compete. The way the company operates has to mesh with that.
For example, a company that offers a high degree of customization in its products has
to have a supply chain management strategy that reflects that the same way that a
company that competes on cost has to manage its supply chain to produce a high
volume of goods cheaply.
The process of strategy is cyclical in nature. The elements within it interact among
themselves. The process has to be adjusted for multiple SBU firms because there it is
conducted at corporate level as well as SBU levels as these firms insert SBU strategy
between corporate strategy and functional strategy. Initially, the process of strategy
was discussed in terms of four phases which are:
z Identification phase
z Development phase
z Implementation phase
z Monitoring phase
The process of strategy does not have the same steps as stated by different authors.
According to C.K. Prahalad, the process comprises of five steps. They are:
z Strategic Intent
z Environmental Analysis
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z Evaluation of strategic alternatives and choice 291
Aligning the Supply Chain
z Strategy Implementation with Business Strategy
z Strategy Evaluation and Control

For our understanding, the process has been divided into the following steps:
z Strategic Intent
z Environmental and Organizational Analysis
z Identification of Strategic Alternatives
z Choice of Strategy
z Implementation of Strategy
z Evaluation and Control
16.2.1 Steps to Align Supply Chain with Corporate Strategy

Some managers believe that there are universal definitions of good or bad supply
chains. We often see companies attempt to build the most efficient supply chain,
regardless of whether their market strategy is to compete on price. Optimizing cost
and inventory may come at the expense of lead-times, flexibility and risk. Your supply
chain needs to compete the same way your company does. Supply chains cannot be
measured in absolutes or designed in isolation of the corporate strategy. Here are six
steps to align your supply chain with your corporate strategy:
1. Define and communicate a clear corporate strategy: One of the biggest failure
points in aligning strategy is when the supply chain organization doesn’t know
what to align with. Strategies cannot be too limited and fail to consider and
prioritize all the market requirements and factors on which participants compete
(features, price, delivery, etc). And strategies cannot be platitudes promising all
things to all people. Corporate strategy needs to define how you are going to be
different and better than your competitors, and it needs to set specific, measurable
goals. Then the strategy needs to be communicated to the organization thoroughly
and repeatedly.
2. Identify the areas of your corporate strategy that are enabled by the supply
chain: You need to connect the dots between your strategic goals and how those
get delivered by the company. This process defines what your supply chain needs
to be good at, and it allows you to prioritize supply chain objectives. Ask the
question, "What part of my core competence and competitive differentiation falls
within or derives from my supply chain activity?" This step is especially critical in
making in-house/outsource decisions.
3. Align supply chain performance metrics with the corporate strategy: One of the
most common issues we see is the belief that there are standard supply chain
performance measures, and the company should strive to maximize them all. This
belief fails to account for the fact that there are tradeoffs in optimizing different
goals. There are also no absolutes in competitive strategy. Goals should be set
based on your performance relative to your competitors.
We have a client who had operated their supply chain with the goal of shipping
product within one day after an order. But their mature market no longer needed
that level of performance. Relaxing that delivery requirement opened up a
significant opportunity for inventory improvement. It is important to note that they
didn't stop delivering in a timely manner or stop measuring delivery performance;
they just re-prioritized their goals to optimize a different objective.
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292 4. Structure your supply chain to optimize the strategic goals: This step is where
Logistics and
Supply Chain Management you address the elements of supply chain design: Supply chain network, locations,
supplier selection and business terms, inventory and planning policy,
organizational structure. Supply chains that are optimized for cost efficiency will
look different than supply chains that are optimized for flexibility and
responsiveness. Your organization and the skill sets of your people will be
different, too.
5. Align incentives end to end: Internal performance evaluations and bonus
structures need to match the aligned metrics that have been set. Supplier
performance management and business models should align the suppliers'
incentives with yours. Don't forget that channel and demand management are part
of the supply chain, too. Build a robust S&OP process and drive your sales and
marketing teams with objectives that aren't at odds with your supply chain
objectives. One common failure is when sales and marketing have no incentive to
control inventory. They will overdrive the forecast to guarantee availability and
then the supply chain organization is left with the excess inventory.
6. Keep refreshing the strategy and alignment process: Most companies have
strategic planning cycles of one to three years, but we have seen companies that
literally go decades without re-aligning their supply chain strategy. Put your
supply chain strategy on the same schedule as the rest of your planning.
16.3 IDENTIFICATION OF STRATEGIC ALTERNATIVES

After environmental analysis, the next step is to identify the various strategic
alternatives. After the identification of strategic alternatives they have to be evaluated
to match them with the environmental analysis. According to Glueck & Jauch,
“strategic alternatives revolve around the question whether to continue or change the
business, the enterprise is currently improving the efficiency or effectiveness with
which the firm achieves its corporate objectives in its chosen business sector” the
process may result into large number of alternatives through which an organization
relates itself to the environment. All alternatives cannot be chosen even if all of these
provide the same results. Obviously, managers evaluate them and limit themselves.
According to Glueck, there are basically four grand strategic alternatives:
z Stability
z Expansion
z Retrenchment
z Combination
These are together known as stability strategies/basic strategies.
z Stability: In this, the company does not go beyond what it is doing now. The
company serves with same product, in same market and with the existing
technology. This is possible when environment is relatively stable. Modernization,
improved customer service and special facility may be adopted in stability.
z Expansion: This is adopted when environment demands increase in pace of
activity. Company broadens its customer groups, customer functions and the
technology. These may be broadened either singly or jointly. This kind of a
strategy has a substantial impact on internal functioning of the organization.
z Retrenchment: If the organization is going for this strategy, then it has to reduce
its scope in terms of customer group, customer function or alternative technology.
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It involves partial or total withdrawal from three things. For example, L&T getting 293
out of the cement business. The objective varies from company to company. with Business Strategy
z Combination: When all the three strategies are taken together, this is known as
combination strategy. This kind of strategy is possible for organizations with large
number of portfolios.
Apart from these four grand strategies, different strategies which are used commonly
are as follows:
z Modernization: In this, technology is used as the strategic tool to increase
production and productivity or reduce cost. Through modernization, the company
aims to gain competitive and strategic strength.
z Integration: The company starts producing new products and services of its own
either creating facility or killing others. Integration can either be forward or
background in terms of vertical integration. In forward integration it gains
ownership over distribution or retailers, thus moving towards customers while in
backward integration the company seek ownership over firm’s suppliers thus
moving towards raw materials. When the organization gains ownership over
competitors, it is engaged in horizontal integration.
z Diversification: Diversification involves change in business definition either in
terms of customer functions, customer groups or alternative technology. It is done
to minimize the risk by spreading over several businesses, to capitalize
organization strength and minimize weaknesses, to minimize threats, to avoid
current instability in profit and sales and to facilitate higher utilization of
resources. Diversification can be related or unrelated, horizontal or vertical, active
or passive, internal or external. It is of the following types:
Concentric diversification
Conglomerate diversification
Horizontal diversification
z Joint Ventures: In joint ventures, two or more companies form a temporary
partnership (consortium). Companies opt for joint venture for synergistic
advantages to share risk, to diversify and expand, to bring distinctive
competences, to manage political and cultural difficulty, to take technological
advantage and to explore unexplored market.
z Strategic Alliance: When two or more companies unite to pursue a set agreed
upon goals but remain independent it is known as strategic alliance. The firms
share the benefits of the alliance and control the performance of assigned tasks.
The pooling of resources, investment and risks occur for mutual gain.
z Mergers: It is an external approach to expansion involving two or more than two
organizations. Companies go for merger to become larger, to gain competitive
advantage, to overcome weaknesses and sometimes to get tax benefits. Merger
takes place with mutual consent and common goals.
z Acquisition: For the organization which acquires another, it is acquisition and for
organization which is acquired, it is merger.
z Takeovers: In takeovers, there is a strong motive to acquire others for quick
growth and diversification.
z Divestment: In divestment, the company which is divesting has no ownership and
control in that business and is engaged in complete selling of a unit. It is referred
to the disposing off a part of the business.
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294 z Turnaround Strategy: When the company is sick and continuously making
Logistics and
Supply Chain Management losses, it goes for turnaround strategy. It is the efforts in reversing a negative trend
and it is the efforts to keep an organization alive.
All these alternatives are available to an organization and according to its objectives, it
can decide on the one which is most suitable.
Now that we have refreshed the basic concepts of strategy, let us see what can supply
chains offer to corporate strategy? Supply chains primarily focus on the operations of
a firm; supply chain council defines the five basic supply chain functions as Plan,
Source, Make, Deliver and Return. Depending on the industry you are in, all or some
of these functions will be part of your supply chain. All the supply chain functions
primarily offer the firm cost reduction opportunities directly or indirectly. Supply
chain functions like warehouse automation and transportation optimization direct
reduce their Cost of Goods Sold (COGS), and other functions like inventory
optimization reduce the requirements for working capital thus increasing Return on
Assets (ROA). All these options provide opportunities for creating competitive
advantages for a firm. These supply chain functions can direct affect the cost basis and
provide the firm with the cost advantages. You can read more about the financial
impact of supply chain functions in this article here.
Then, there are other supply chain functions that can provide differentiators through
process integration, such as those in the order fulfillment area. These functions not
only add to the operational efficiency but can also provide differentiation in customer
service through perfect order fulfillment and ability to track and communicate the
customer order status throughout the fulfillment process.
Better planning through better demand forecasting can affect all the operations in a
supply chain in a made-to-stock or retail situations. These planning functions can
substantially reduce the cost basis by reducing inventory, increasing manufacturing
operations efficiency, increasing distribution operations efficiency, and in reducing
plan volatility that stabilizes the operations.
Optimization based supply chain solutions such as manufacturing planning,
scheduling, and sequencing; inventory optimization, transportation optimization,
purchase planning, etc. make use of powerful mathematical models to represent the
real-life supply chain constraints with the objective of reducing cost or increasing
throughput. Both of these (reducing cost or increasing throughput) can help
organizations create and sustain competitive advantages by creating cost, delivery, and
customer service differentiators.
Fill in the blanks:
1. The ………………….can be defined as a set of management decisions
and actions which determines the long run direction and performance of
the organization.
2. The process of strategy is ……………….in nature.
3. ………………………and inventory may come at the expense of lead-
times, flexibility and risk.
4. According to Glueck, there are basically four grand strategic alternatives:
…………………., Expansion, Retrenchment and …………………
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16.4 STRATEGIC ALLIANCE Aligning the Supply Chain
with Business Strategy
Strategic alliance, a form of corporate partnering, is the joining of two or more
companies to exchange resources, share risks, or divide rewards from a joint
enterprise. It can take any number of forms such as: a strong relationship with a major
customer, a partnership with a source of distribution, a relationship with a supplier of
innovation or product, or an alliance in pursuit of a common goal. Sometimes partners
form a new jointly owned company. In other instances a firm purchases equity in
another. Most often the relationship is defined by a contract. Many features of
strategic alliances are very similar to other forms of partnering. The differences relate
to the greater difficulty of achieving a good partnering relationship or developing the
strategic nature of an alliance. They are harder to do because of the need to match the
expectations of different cultures and business practices.
Strategic alliances are becoming more and more prominent in the global economy.
According to Peter F. Drucker, the management guru, the greatest change in corporate
culture, and the way business is being conducted, is the accelerating growth of
relationships based not on ownership, but on partnership (Drucker, 1996). He also
observed that there is not just a surge in alliances but a worldwide restructuring of
companies in the shape of alliances and partnerships.
His views are endorsed by the fact that even a cursory search for strategic alliances in
business dailies produces numerous press releases about companies forming alliances.
According to a recent survey by the global consulting major, Booz, Allen and
Hamilton, strategic alliances are spreading in every industry and are becoming an
essential driver of superior growth. The number of alliances in the world is surging —
for instance, more than 20,000 new alliances were formed in the U.S. between 1987
and 1992, compared with 5100 between 1980 and 1987 and 750 during the 1970s. The
firm also predicts that within the next five years, the value of alliances is projected to
range between $30 trillion to $50 trillion. The survey also reveals that more than 20%
of the revenue generated from the top 2,000 U.S. and European companies now comes
from alliances, with more predicted in the near future. These same companies also
earned higher Return on Investment (ROl) and Return on Equity (ROE) on their
alliances than from their core businesses. The report also concludes that leading edge
alliance companies are creating a string of interconnected relationships, which allows
them to overpower the competition (www.boozeallen.com).
Generally two or more companies collaborate to create a new product or a service in a
strategic alliance. Ideally this new product or service will bring a unique value
proposition to the market as agreed by the collaborating parties. The potential of
strategic alliances’ strategy is enormous and if implemented correctly can dramatically
improve an organization’s operations and competitiveness (Brucellaria, 1997).
According to a survey conducted by Coopers & Lybrand, 54 percent of firms that
formed alliances did so for joint marketing and promotional purposes (Coopers and
Lybrand, 1997). Companies are also forming alliances to obtain technology, to gain
access to specific markets, to reduce financial risk, to reduce political risk and to
achieve or ensure competitive advantage (Wheelen and Hungar, 2000). However,
while many organizations often rush to jump on the bandwagon of strategic alliances,
few succeed (Soursac, 1996). The failure rate of strategic alliances strategy is
projected to be as high as 70 percent (Kalmbach and Roussel, 1999), and hence, an
appreciation of the factors that contribute to strategic alliance success and failure is
critically important.
The rest of the unit explores why and how companies are forming strategic alliances,
examine risks and problems associated with entering and maintaining successful
strategic alliance and identify factors that may impact the success of strategic alliances
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296 in an increasingly competitive marketplace. Important implications for the successful
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Supply Chain Management introduction and implementation of strategic alliances are also discussed.
16.4.1 Factors Promoting the Rise of Strategic Alliances

Since the 1980s, strategic alliances have been very popular. Alliances can be a
powerful tool, particularly in today’s world, due to the need to build differential
capabilities in more areas than a company has resources or time to develop. The
legendary Jack Welch, who headed GE in the past, echoing this sentiment once said,
“If you think you can go it alone in today’s global economy, you are highly mistaken.”
It is becoming more difficult for organizations to remain self-sufficient in an
international business environment that demands both focus and flexibility. As
companies are increasingly feeling the effects of global competition, they are trying to
achieve a sustainable competitive advantage through strategic alliances.
Competitive boundaries are blurring as advances in communication and the trend
toward global markets link formerly disparate products, markets, and geographical
regions. Competition is no longer confined to a single nation’s borders – making all
firms vulnerable to threats posed by cooperative strategies. Both, rapid technological
shifts and the need for rapid product innovation, are putting pressure on management
to act faster and smarter with fewer resources. Effectively identifying, protecting, and
enhancing one’s core capabilities is the key challenge of our time. In this environment,
successful companies need to select, build, and deploy the critical capabilities that can
come from strategic alliances, which will enable them to gain competitive advantage,
enhance customer value, and drive their markets.
The alliance approach better matches and responds to the uncertainties and
complexities of today’s globalised business environment. These partnerships allow
access to skills and resources of other parties in order to strengthen the organization’s
competitive strategies. Alliance partnerships are initiated as effective strategies to
overcome the skill and resource gaps encountered in gaining access to global markets.
Establishing strategic alliance relationships provides access to new markets,
accelerates the pace of entry, encourages the sharing of research and development,
manufacturing, and/or marketing costs, broadening the product line/filling product;
and learning new skills. Dowling et al, suggest “the partner’s pool, exchange, or
integrate specified business resources for mutual gain. Yet, the partners remain
separate businesses”. In today’s fast changing business landscape, strategic alliances
enable business to gain competitive advantage through access to a partner’s resources,
including markets, technologies, capital and people. Teaming up with others adds
complementary resources and capabilities, enabling participants to grow and expand
more quickly and efficiently. Especially fast-growing companies rely heavily on
alliances to extend their technical and operational resources. In the process, they save
time and boost productivity by not having to develop their own, from scratch. They
are thus freed to concentrate on innovation and their core business.
Many fast-growth technology companies use strategic alliances to benefit from more
established channels of distribution, marketing, or brand reputation of bigger, better
known players. However, more-traditional businesses tend to enter alliances for
reasons such as geographic expansion, cost reduction, manufacturing, and other
supply chain synergies. As global markets open up and competition grows, midsize
companies need to be increasingly creative about how and with whom they align
themselves to go to the market. All these factors have hastened and highlighted the
need for strategic alliances. To summarize, few companies have everything they need
to succeed in a competitive market place alone. No matter what they need, there is
someone who has it. They can, therefore, either buy what they need or partner with
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others. Partnering is frequently quicker and less costly. While avoiding difficult and 297
time-consuming internal changes, partnering allows a company to: with Business Strategy
z Rapidly move to decisively seize opportunities before they disappear.
z Respond more quickly to change with greater flexibility.
z Increase your market share.
z Gain access to a new market or beat others to that market.
z Quickly shore up internal weaknesses.
z Gain a new skill or area of competence.
z Succeed although the company lacks key resources.
16.4.2 Benefits of Strategic Alliances

In the new economy, strategic alliances enable business to gain competitive advantage
through access to a partner’s resources, including markets, technologies, capital and
people. Teaming up with others adds complementary resources and capabilities,
enabling participants to grow and expand more quickly and efficiently. Strategic
alliances also benefit companies by reducing manufacturing costs, and developing and
diffusing new technologies rapidly. Alliances are also used to accelerate product
introduction and overcome legal and trade barriers expeditiously. In this era of rapid
technological changes and global markets forming alliances is often the fastest, most
effective method of achieving growth objectives. However, companies must ensure
that the objectives of the alliance are compatible and in tune with their existing
businesses so their expertise is transferable to the alliance.
Many fast-growth technology companies use strategic alliances to benefit from more
established channels of distribution, marketing, or brand reputation of bigger, better
known players. However, more-traditional businesses tend to enter alliances for
reasons such as geographic expansion, cost reduction, manufacturing, and other
supply-chain synergies. As global market opens up and competition grows, midsize
companies need to be increasingly creative about how and with whom they align
themselves to go to the market. Firms often enter into alliances based on opportunity
rather than linkage with their overall goals. This risk is greatest when a company has a
surplus of cash. In recent years, Mercedes-Benz and Toyota Motor Corporation have
been investing surplus funds into seemingly unrelated businesses, with Benz already
facing difficulties as a result. Especially fast-growing companies rely heavily on
alliances to extend their technical and operational resources. In the process, they save
time and boost productivity by not having to develop their own, from scratch. They
are thus freed to concentrate on innovation and their core business.
Entering New Markets

The Coopers & Lybrand study rates growth strategies and entering new markets
among the top reasons for forming strategic alliances (Coopers and Lybrand, 1997).
As Ohmae (1992) points out, (companies) simply do not have the time to establish
new markets one-by-one. In today’s fast-paced world economy, this is increasingly
true. Therefore, forming an alliance with an existing company already in that
marketplace is a very appealing alternative. Partnering with an international company
can make the expansion into unfamiliar territory a lot easier and less stressful for a
company. According to the Coopers & Lybrand (1997) study, 160 percent of firms
involved in alliances market their goods and services internationally versus 30 percent
of non-allied participants. For instance, Tata Motors has short listed Brilliance
Automotive Holdings of China to set up a joint venture for producing cars. Tata
Motors, which recently acquired the commercial truck facility of Daewoo Motors in
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298 South Korea for `4616 crore, is also reported to be scouting for another joint venture
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Supply Chain Management in Northern China in order to have a full-fledged presence in China.
Reducing Manufacturing Costs

Strategic alliances may allow companies to pool capital or existing facilities to gain
economies of scale or increase the use of facilities, thereby reducing manufacturing
costs. In the increasingly competitive European automobile market, when the Japanese
are seeking to gain market share as they did in the U.S. during the 1980s, many
European companies have formed joint ventures to reduce manufacturing costs. Ford
and Volkswagan are jointly planning to make four-wheel-drive vehicles in Portugal,
and Nissan and Ford intent to build a plant in Spain to produce vans. These companies
will benefit from cost sharing and will reduce expenses by building and operating
facilities in relatively low-cost countries, at least by West European standards.
Companies may also reduce costs through strategic alliances with suppliers or
customer reaching agreements to supply products or services for longer periods and
working together, meet customers’ needs, each partner may apply its expertise, and
benefits may be shared in the form of lower costs or new products.
Developing and Diffusing Technology

Alliances may also be used to build jointly on the technical expertise of two or more
companies in developing products technologically beyond the capability of the
companies acting independently. Not all companies can provide the technology that
they need to effectively compete in their markets on their own. Therefore, they are
teaming up with other companies who do have the resources to provide the technology
or who can pool their resources so that together they can provide the needed
technology. Both sides receive benefit from the partnership. Technology transfer is not
only viewed as being significant to the success of a strategic alliance, according to
Hsieh (1997): “host countries now demand more in the way of technology transfer”.
As evidence of this growing trend, Hsieh cites China as a prime example.
Reduce Financial Risk and Share Costs of Research and Development

Some companies may find that the financial risk that is involved in pursuing a new
product or production method is too great for a single company to undertake. In such
cases, two or more companies come together and agree to spread the risk among all of
them. One example of this is found in strategic alliance between the ` 235 crore Elder
Pharma, which has 25 international partners for strategic alliances, has entered into a
tie-up with Reliance Life Sciences. The company is focusing on dermatology and the
tie-up with Reliance is to obtain aloe vera extracts for cosmetics. Elder has launched a
dedicated skincare division with products under El-Dermis brand and plans to launch
a number of over the counter products in the skincare segment.
Achieve or Ensure Competitive Advantage

Alliances are particularly alluring to small businesses because they provide the tools
businesses need to be competitive. For many small companies the only way they can
stay competitive and even survive in today’s technologically advanced, ever-changing
business world is to form an alliance with another company. Small companies can
realize the mutual benefits they can derive from strategic alliances in areas such as
marketing, distribution, production, research and development, and outsourcing. By
forming alliances with other companies, small businesses are able to accomplish
bigger projects more quickly and profitably, than if they tried to do it on their own.
According to Booz, Allen and Hamilton the world has entered a new age – an age of
collaboration – and that only through allying can companies obtain the capabilities
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and resources necessary to win in the changing global marketplace. Self-reliance is an 299
option few companies will be able to afford (Booz, Allen and Hamilton, 1997). with Business Strategy
Caselet: Ambalal Sarabhai Enterprises Ltd-Profiting through

Strategic Alliances
The US$300 billion global pharmaceutical industry is research driven. New
drug R&D cost being prohibitive, it is limited to pharmaceutical MNCs in
developed nations where product patents are enforced. High prices of under-
patent drugs are causing a shift to generics, especially in USA and European
markets. So, to spread their R&D costs over a larger base, pharma MNCs are
consolidating through mergers/ alliances. Historically, India has recognized
only process patents.
Under WTO, as per TRIPs agreement India too has to enforce product patents
latest by year 2005 AD. In the ` 130 billion Indian pharma sectors, prices of
over 60% of the drugs/formulations are Government controlled (through
DPCO). In the domestic bulk drugs market, low entry barriers have resulted in
overcapacity and price wars. So, major players are focusing on formulations,
where brand image and distribution network act as entry barriers. Most
players are increasing their overseas marketing/manufacturing network in
order to enhance exports (under patent drugs to third world countries and
generics to developed nations).
In anticipation of WTO, MNCs are strengthening their ranks in India – either
setting up new 100% subsidiaries or marketing tie-ups with major domestic
players. Large local players are consolidating through brand acquisitions, co-
marketing/contract manufacturing tie-ups with MNCs etc. In this scenario,
Ambalal Sarabhai Enterprises Ltd (ASMA) has aggressively formed alliances
in the last couple of years to leverage upon the technical expertise and strong
brands. ASMA has major presence in anti-infectives, anti-epileptic and
NSAIDs.
The company is the largest manufacturer of Vitamin C in India. ASMA is the
market leader in Veterinary healthcare sector. On domestic front the company
has formed 50:50 JV to market the brands. The company has tied up with BV
Chiron, Netherlands for marketing anti-cancer products in India, Grunenthal
of Germany to manufacture and market Tramadol (an analgesic), with
Biobrass of Brazil for the marketing of procine and insulin and with Abic of
Israel for the marketing of poultry vaccines in India. ASMA is pursuing major
restructuring program and to further strategic alliances and collaborations.
With commitment of the management to turnaround the company through
alliances, restructuring of operations and cutting down the high cost debt,
ASMA is expected to improve profitability in the next two years.
16.5 LINKING SUPPLY CHAIN AND BUSINESS

PERFORMANCE
Metrics are developed by organisations in various stages. It starts with awareness or
recognition of the importance of metrics in the development of appropriate
performance measurement for the supply chain. This is often not easy because of the
focus of the organisation. Internally the focus may be on marketing or manufacturing
but externally the metrics have to focus on managing activities which span the
boundaries of organisations.
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300 In order to develop the actual metrics which will be utilised by the organisation to
Logistics and
Supply Chain Management track supply chain performance, it requires reconciling definitions and reaching
general agreement with supply chain partners on which metrics are most appropriate.
Reaching an agreement here may be more challenging than it is if the metrics were to
be used for internal functions. Fortunately, this effort has been made easier by the
development of the SCOR Model by the Supply Chain Council (USA). The Council
has worked towards an inter-organisational agreement on metrics, which are used in
the SCOR Model. The next stage is implementing the metrics in the system for
performance improvement. The process of measurements will require proper
monitoring and analysis to determine if the desired outcomes – improved efficiency
(lower cost) and increased effectiveness (better service to internal and external
customers) – are being achieved by the use of the metrics.
With the development of appropriate metrics, it is now possible to take the process
further onwards by instituting a system of comparison with comparable best-in-class
supply chains. This is called benchmarking, and the benchmarking process usually
provides insight into how performance can be enhanced. Understanding the
underlying processes driving performance will lead to estimating the costs and
benefits of making changes and then in implementing the change(s) to achieve the
desired results. However, this process becomes challenging when it comes to inter-
organisational changes. These are often more difficult to achieve.
The final stage is the integration stage. Performance measurement, in this stage,
requires cross functional coordination with special emphasis upon the financial
aspects of performance improvement. To be able to do this requires the integration of
the financial metrics internally and across the supply chain. Supply chain
professionals recognise that understanding the impact of their activities on financial
metrics such as ROA and ROI, which are commonly used for other comparisons, are
very important. It enhances the creditability and awareness of the contributions of
supply chain management to gaining market share and improving profits. A number of
studies have shown that customers use measures to evaluate customer service by the
firm. Many firms are now trying to identify measures by creating and defining metrics
jointly with the customer or by the customer. The percentage of firms using this
method has been steadily increasing over time, demonstrating the increased attention
being paid to metrics and, especially, customer service metrics.
Fill in the blanks:
1. ………………………….are initiated as effective strategies to overcome
the skill and resource gaps encountered in gaining access to global
markets.
2. …………………………are also used to accelerate product introduction
and overcome legal and trade barriers expeditiously.
3. A ……………………..is an agreement between firms to do business
together in ways that go beyond normal company-to-company dealings.
4. ………………… represents a sale of technology or product based
knowledge in exchange for market entry in a manufacturing industry.
16.6 LET US SUM UP

A company's business strategy plays an important role in the success of a company's
supply chain management strategy, in that the business strategy is the basis on which
the company wants to compete.
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The process of strategy is cyclical in nature. The elements within it interact among 301
themselves. The process has to be adjusted for multiple SBU firms because there it is with Business Strategy
conducted at corporate level as well as SBU levels as these firms insert SBU strategy
between corporate strategy and functional strategy. After environmental analysis, the
next step is to identify the various strategic alternatives. After the identification of
strategic alternatives they have to be evaluated to match them with the environmental
analysis.
Strategic alliance, a form of corporate partnering, is the joining of two or more
companies to exchange resources, share risks, or divide rewards from a joint
enterprise. It can take any number of forms such as: a strong relationship with a major
customer, a partnership with a source of distribution, a relationship with a supplier of
innovation or product, or an alliance in pursuit of a common goal. Sometimes partners
form a new jointly owned company. In other instances a firm purchases equity in
another. Metrics are developed by organisations in various stages. It starts with
awareness or recognition of the importance of metrics in the development of
appropriate performance measurement for the supply chain.

In the context of the organization you are associated with, examine whether quality is
an integral part of the strategic process. Give reasons for whatever your answer is.
16.8 KEYWORDS
Cross-Holdings, Equity Stakes, and Consortia: These alliances bring together
companies more closely than licensing and joint venture mechanism. Broadly
amalgamated together as consortia, these alliances represent highly complex and
intricate linkages among groups of companies.
Joint Ventures: This arrangement involves partners’ creation of a third entity
representing the interests and capital of the two partners. Both partners contribute
capital, distinctive skills, managers, reporting systems, and technologies to the venture
in certain proportions.
Licensing Arrangements: Licensing represents a sale of technology or product based
knowledge in exchange for market entry in a manufacturing industry. In service-based
firms, licensing is the right to enter a market in exchange for a fee or royalty.
Strategic Alliance: A strategic alliance is an agreement between firms to do business
together in ways that go beyond normal company-to-company dealings, but fall short
of a merger or a full partnership.

1. Explain the different types of strategic alliances that companies follow? Give
examples of Indian companies for each type of strategic alliance.
2. What do you understand from the term strategic alliances?
3. Why do companies form strategic alliances?
4. Briefly explain the linking of supply chain and business performance.
Check Your Progress: Model Answers

CYP 1
1. process
2. cyclical
Contd…
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LESSON Supply Chain Performance
17
SUPPLY CHAIN PERFORMANCE
CONTENTS
17.1 Introduction
17.2 Performance Measurement Systems
17.2.1 Balanced Scorecard Model
17.2.2 The Performance Prism (PPR)
17.2.3 Productivity Measurement and Enhancement System (ProMES)
17.3 SCOR Model
17.3.1 Performance Measurements in the Service Industry
17.3.2 Other Performance Measures
17.4 Let us Sum up
17.6 Keywords

z Discuss about the performance measurement systems
z Explain the SCOR Model
17.1 INTRODUCTION
The nature of organizations has been fundamentally changed by the supply chain
concept by its integrated approach. In this concept, control is no longer based on direct
ownership, but rather based on integration between functions and companies. This
integration has consequences for the efficiency, seamlessness and profits of the supply
chain. It also is a measure of the performance of the supply chain.
In the first part of this lesson, we will discuss the coordination issue as represented by
the beer game and its consequence, bull-whip effect. We will see how to minimize its
impact. We will then look at supply chain integration and the seamless concept. We
will also discuss the different models used in determining performance in supply
chains and the SCOR model. We will examine some of the performance
measurements that individual companies can use in estimating how they have
performed. Finally, we will look at supply chains and future challenges.
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Logistics and 17.2 PERFORMANCE MEASUREMENT SYSTEMS
Each stage of the supply chain trying to maximize its own profits, disregarding the
benefits of the SC as a whole (local instead of global optimization), does not
necessarily result in the maximization of supply chain surplus. The maximum
efficiency of each chain also does not necessarily lead to global optimization. Supply
chain surplus is maximized only when all supply chain stages coordinate strategy
together.
Another problem is more and more companies are succeeding because they are able to
respond quickly to market needs and get the right product to the right customer at the
right time. This shift toward speed has forced companies to ask what creates the level
of speed that customers are demanding. The answer for most companies is that the
most significant delays, however, are created at the interface between the boundaries
of different stages of a supply chain. Thus, managing these interfaces becomes a key
to providing speed to customers.
In addition, one should consider human factors. Decision-makers at various points
along the SC do not usually make perfect decisions. This may be due to the lack of
information, their personal hindrances, or sometimes, the decision may be influenced
by employee reward systems.
Regardless of the number of difficulties and problems, the core concept for the success
in SCM, is efficient information transfer/information sharing. Taking this view requires
that each company evaluate its actions in the context of the entire supply chain. This
means treating stages in the supply chain that a company does not own as belonging to
the company. This creates a problem in performance measures. An example is the
inventory reduction effort of many companies. Many companies strive to reduce their
own inventories by changing ownership of inventory to downstream stages in the
supply chain. Do they achieve any real reduction in overall inventory? Firms may feel
they will not have to finance this inventory and therefore their costs will go down. But
they forget that holding this inventory increases the suppliers' costs, and the supplier is
charging higher prices so in the end, there is no real reduction in total cost because the
supply chain merely shifts costs back and forth between its links.
As the example above shows, measurements of performance in a supply chain do not
follow historic and traditional conventions used till now. In measuring performance in
the supply chain, where control is no longer based on ownership only, but rather on
networking across interfaces, the measurement system may reflect a system of
measuring the immeasurable.
Companies are discovering new ways of working together to achieve the ultimate
supply chain goal: the ability to fill customer orders faster and more efficiently than
the competition. This is changing traditional company boundaries. To achieve that
goal, organizations need performance measures, or ‘metrics’, which are formal, well
defined processes that can be documented and measured to facilitate supply chain
improvements.
Activities not under the direct control of an individual company have to be measured
and controlled by the firm and its supply chain partners. This requires making the
supply chain transparent to a level not experienced before. For example, if the cost of
transportation and the cost of inventory in a firm are managed separately instead of
jointly, we would not be able to discuss the trade-off between the two cost components.
The entity ''total cost'' encompassing both components would not exist unless there is
total transparency. An important opportunity for improvement will be lost.
Developing and maintaining a supply chain performance measurement system
represents one of the more significant challenges faced in supply chains. Thus,
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performance improvements require different measurements. The supply chain 305
Supply Chain Performance
generally consists of a number of departments each; perhaps, reporting to different
supervisors or a number of firms each having its own top management. Given the
cross-functional and cross-organizational nature of many supply chain improvements,
metrics must be based on transparency that assists supply chain performance, as
shown schematically in the Figure 17.1 below.
Traditional System of Measurements
Firm A Firm B Firm C
Measurement Measurement Measurement

System System System
Supply Chain
Supply Chain Measurements System
Firm A Firm B Firm C
Measurements System
Supply Chain
Figure 17.1: Traditional and Supply Chain Performance Measurements

The use of financial accounting information is another problem in measuring supply
chain performance, as it promotes a functional perspective within an organization.
This is because resources are allocated from the top down, in contrast to goods and
services which flow horizontally through the firm. Matching top-down flow to
horizontal flow becomes a challenging problem.
Top management is often affected by external stakeholders to assess the performance
of the firm using financial information. Though the top management uses this
information, people on the shop floor prefer other kinds of information. Therefore,
what follows is that the concept of performance clearly varies between different levels
in an organization. This often becomes a major cause of difficulties in integrating
measurements across the operational, tactical and strategic levels.
As the success of an SCM initiative largely rests on performance, one consequence of
these arguments is that a supply chain must be viewed as one entity. The structure of the
measurement system should span the entire supply chain. Figure 17.2 presents the
structural view of the measurement system applicable to supply chains. What is important
is that, each of the components outlined in the figure, must be considered throughout the
entirety of the supply chain, if relevant measurement criteria are to be obtained.
Performance
model
Measurement
Metrices
Methods
Figure 17.2: A Structural View of the Measurement System

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306 During the Performance Measurement Revolution, many Performance Measurement
Logistics and
Supply Chain Management Systems (PMSs) have been developed to overcome the drawbacks of traditional
performance measurements systems. We will examine some influential PMSs, and
assess their suitability as performance measurement system for the supply chain: the
Balanced Scorecard, the Performance Prism, and the Productivity Measurement and
Enhancement System.
17.2.1 Balanced Scorecard Model

A well-known model showing important relationships within the firm is the balanced
scorecard. This model was created by Kaplan and Norton (1992) of the Harvard
Business School. It introduces the concept of balancing four different dimensions of
performance, and also uses cause-and-effect relationships to describe how the four
dimensions of performance are connected.
The model is not only a measurement tool; it is also a management system that
translates strategy and vision into strategic objectives. The model communicates and
links strategic objectives and measures in the organization. It is used in the process of
planning, setting targets and aligning strategic initiatives. Ultimately, its aim is to
enhance strategic feedback and learning.
Figure 17.3 illustrates how the four different dimensions of performance can be linked
by cause-and-effect relationships. The dimensions used are financial, customer,
business processes, and learning and growth.
The balanced scorecard provides an enterprise view of an organization’s overall
performance: it complements the traditional financial performance measures with key
performance indicators (KPIs) in three non-financial areas. The four building blocks
of the BSC are:
z Financial Perspective. The financial perspective answers the question: “To
succeed financially, how should we appear to our shareholders?” and is typically
related to profitability. Some measures are, for example, the Return on Investment
(ROI), Return on Capital Employed (ROCE), and Economic Value Added (EVA),
etc.
z Customer Perspective. The customer perspective addresses the question: “To
achieve our vision, how should we appear to our customers?” It includes several
measures like, customer satisfaction, and market share in targeted segments, etc.
z Internal Processes. The internal perspective answers the following question:
“To satisfy our shareholders and customers, what business processes must we
excel at?” It focuses on the internal processes that will have the greatest
impact on customer satisfaction and on achieving the organization’s financial
perspectives.
z Learning and Growth. The ‘learning and growth’ perspective looks at the
organization to answer the question: “To achieve our vision, how will we sustain
our ability to change and improve?” It measures the infrastructure the
organization has to build and manage to create long-term growth and
improvement through people, systems and organizational procedures, is identified
in this perspective.
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307
Figure 17.3: Balanced Scorecard Model

The BSC is a logical framework for implementing and aligning complex programs of
change. Kaplan and Norton use a linear cause-and-effect relationship in their model.
Though each organization is unique and can follow its own path for building a
scorecard, this procedure can be used with modifications by different organizations.
Following are examples of financial goals, (including supply chain performance),
appropriate for consideration on the balanced scorecard:
z 5 percent Increase in sales for the current year to reach 15 percent overall increase
for next three years
z Inventory reduction to `50 crore in the current year and to `40 crore in the next
three years
z Increase current profit margins from 20 to 25 percent.
z Increase inventory turnover from 1.9 to 2.6 in the current year to 4.3 times within
three years.
The examples of non-financial goals are not directly reported on traditional financial
statements. The metrics for these are, however, related to process and execution
issues. Many of these can substantially impact and influence the financial metrics.
Examples might include the following:
z Improve customer satisfaction levels to 4.5 from 4.8 (on a 5 point scale)
z Improve on-time delivery to 99 percent from 95 percent
z Reduce obsolete inventory from 3 percent of sales turnover to 1 percent
z Reduce the number of stock keeping units by 10 percent
z Reduce employee turnover by 10 percent
z Create a positive working environment through continuous education, job
stability, and competent management so that employees can grow professionally
and financially (measure through employee surveys).
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308
Logistics and
Figure 17.4: Linking Measurements to Supply Chain Strategy

The model tries to uncover the “mechanisms'' of the business. It makes possible to
connect different phenomena and describe how they interact. In many cases, the
number of links is high, and the model needs for simplification. However, the model
does provide a means of communicating the ideas about adopting non-obvious
solutions for such things like increased sales or improved overall productivity, etc. A
criticism is that it fails to answer one of the most important questions of all: what are
the competitors doing?
Though BSC is highly regarded, it should be kept in mind when using the model for
inter-firm evaluation the problems of designing and implementing the BSC may be no
different from those associated with any major change in performance-measurement
systems.
17.2.2 The Performance Prism (PPR)
Figure 17.5: Performance Prism of Neely

The Performance Prism (PPR) developed by Neely and Adams (2000) is organized
around five distinct but linked perspectives of performance: stakeholder satisfaction,
strategies, processes, capabilities, and stakeholder contributions. Neely visualized
these perspectives by a three dimensional model in the shape of a prism, which can be
seen in Figure 17.5.
The top and bottom faces of the prism reflect stakeholder satisfaction and stakeholder
contribution respectively. The three vertical side faces represent strategies, processes
and capabilities. The model looks at these five distinct, but logically interlinked,
perspectives on performance together with five key questions for measurement design.
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z Stakeholder Satisfaction: The key question in this perspective is: who are the key 309
stakeholders and what do they want and need? This perspective is broader than the
BSC view of stakeholders, which is limited to shareholders and customers.
z Strategies: What strategies do we have to put in place to satisfy the wants and
needs of these key stakeholders — is the key question here? The Performance
Prism’s strategy measures monitor the success of the organization in meeting its
goals.
z Processes: The question defines, “What critical processes do we require if we are
to execute these strategies?”
z Capabilities: The main question in this perspective is: what capabilities do we
need to operate and enhance these processes? Capabilities are fundamental
building blocks of a corporation’s ability to compete. This includes people,
practices, technology and infrastructure that together enable the execution of the
organization’s business processes (both now and in the future).
z Stakeholder contribution: What contributions do we require from our
stakeholders, if we are to maintain and develop these capabilities? This facet
recognizes the fact that not only organizations have to deliver value to their
stakeholders, but also that organizations enter into a relationship with their
stakeholders, which should involve the stakeholders contributing to the
organization. Organizations should have a clear understanding of what constitutes
and drives good performance.
The PPR distinguishes itself from other models by taking a more holistic view of
essential stakeholder groups to consider. Especially, suppliers are important because
companies become more and more dependent on their suppliers since they outsource
non-core business. PPR’s principal appeal lies in the logical interrelationships between
the five perspectives; its comprehensiveness and adaptability.
17.2.3 Productivity Measurement and Enhancement System (ProMES)

The Productivity Measurement and Enhancement System (ProMES) was developed
by Pritchard (1990). ProMES is a participative development method for performance
management systems. It is a formal, step-by-step process that identifies organizational
objectives, develops a measurement system to assess how well the unit is meeting
those objectives, and develops a feedback system that gives management information
on how well the unit is performing.
ProMES system is built up around the theory of work behaviour. Motivation is seen as
a resource allocation process, which is allocated across possible actions or tasks.
Motivational force is defined as the degree to which a person believes that changes in
the amount of personal resources in the form of time and energy (effort) devoted to
different acts (tasks) over time will result in a change in anticipated need satisfaction.
ProMES system is shown as Figure 17.6. According to Pritchard, motivational force
of a person is the result of his acts, products, evaluations, outcomes and need
satisfaction.
z An act is the ‘doing’ of something, which is characterized by amplitude and
direction. An example is eating.
z Products are the results of acts and are a consequence of the person’s output.
z When products are observed and evaluated, this results in evaluations where an
evaluator places the measured product on a good to bad evaluative continuum.
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310 z Outcomes follow evaluations. These are intrinsic such as a feeling of
Logistics and
Supply Chain Management accomplishment from getting a pat on the back from the boss, or some intrinsic
satisfaction.
z Outcomes get their motivating power because of their ties to need satisfaction.
Figure 17.6: Productivity Measurement and Enhancement System

Positive affect occurs when needs are satisfied and negative affect occurs when needs
are not satisfied. The relationship between each of these elements determining
motivational force, are called contingencies. These contingencies can be linear as well
as non-linear.
Let us see how the ProMES system is developed and implemented. There are a
number of steps involved:
z A design team is formed, which is composed of those who will be measured, one
or two supervisors, and one or two facilitators.
z The team identifies objectives for the unit.
z For each objective, one of more quantitative measures, called indicators that
measure how well these objectives are being met, are selected. Indicators have to
be largely under control of the people being measured.
z The indicator is defined in terms of contingencies. A contingency is a function
that defines how much of an indicator is how good for the organization.
z Design a system to obtain feedback.
z Give and respond to feedback.
z Monitor the project over time and adjust if needed.
The most interesting feature of ProMES is the bottom-up approach. People are really
involved in the design of the system, which increases the acceptance of the system.
Also, by using contingencies and accepting non-linearity, priorities for improvement
are more flexible as the amount of contribution that level of indicator makes to the
overall functioning of the organization is set.
However, these contingencies make the system more difficult to develop. Also
ProMES does not necessarily require the contingencies to be balanced. The fact that
objectives are not balanced is often seen as a disadvantage, as it could result in a
business unit’s PMS being not in line with the company’s PMS.
Evaluating these performance measurement systems for the supply chain
How do these performance measurement systems help develop a performance
measurement system for the supply chain? On a strategic level, supply chain
performance is determined by the extent to which it is able to contribute to the
organization’s desired objectives.
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On an operational level, supply chain performance is determined by the extent to 311
which it achieves the demands and needs of three principal sets of stakeholders:
customers, suppliers and senior management. Typical performance measures may
include inbound delivery performance, quality of incoming goods, total cost of
ownership of purchased goods, spend per employee, amount of non-contractual spend,
and exposure to supply risks, etc.
The scores of the performance measurement systems, we have discussed, on different
dimensions are summarized in Table 17.1. These factors include both strategic and
operational factors.
Table 17.1: Assessment of Performance Measurement Systems
BSC PPR ProMES
Strategic and operational measures + + +
All stakeholders considered - + +/-
Lead and lag indicators ++ ++ +/-
Individual-level performance measured +/- - ++
Effectiveness and efficiency measures + + +/-
All of the performance management systems claim to include performance measures

that range from the strategic to the operational level. However, these systems are
basically with a strategic focus, except for ProMES which is focused at the level of the
individual. It needs to be remembered that none of these systems was developed
specifically for the supply chain function.
It may be possible to use the following approach for developing a supply chain
performance measurement system using these systems. It will require the following
steps:
z Define the purpose(s) of the supply chain performance management system. The
purpose could be accountability to the board, motivation of individual purchasing
employees, and/or a tool for continuous improvement.
z Seek a close fit between the supply chain performance management system and
the organization-wide performance management system. Pursue opportunities to
adapt the organization-wide system to include supply chain performance
parameters such as suppliers and/or sourcing inputs as performance areas for total
business performance measurement.
z Supply chain performance indicators should be linked to the supply chain strategy,
which in turn, should be derived from overall organization goals and strategy.
z Ensure that the final list of performance indicators is balanced in terms of
financial vs. non-financial indicators, lead vs. lag indicators, indicators of
operational vs. strategic performance, and indicators related to effectiveness vs.
indicators related to efficiency.
z Involve supply chain personnel in developing the performance indicators and
connect the performance indicators to the job descriptions of all employees.
Review the system and its supply chain performance indicators periodically to make
sure it stays in line with changes in strategies and context in which the systems
operates.
Using the above six steps, a purchasing manager can develop a purchasing
performance measurement system that is well-connected to the rest of the
organization, is balanced in terms of measuring short-term and long-term
performance, and which helps motivate and guide purchasing employees.
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312 However, it must be accepted though, that this approach can be used to integrate
Logistics and
Supply Chain Management supply chain performance management system with the overall performance
management system of the organization, the end result needs improvement.
Fill in the blanks:
1 Developing and maintaining a supply chain ………………………
represents one of the more significant challenges faced in supply chains.
2. The ………………………….is organized around five distinct but linked
perspectives of performance: stakeholder satisfaction, strategies,
processes, capabilities, and stakeholder contributions.
3. The Productivity Measurement and Enhancement System (ProMES) was
developed by……………………….
4. ………………………are the results of acts and are consequences of the
person’s output.
17.3 SCOR MODEL

One of the early attempts to develop such a model specifically for the supply chain
was taken up by the Swedish firm IKEA. It developed a performance model called
“the product management model”. This model consists of measures within five
different areas:
1. Product range;
2. Cost;
3. Quality;
4. Availability; and
5. Service.
These areas of measurement were identified by consumers during the buying process,
who were asked to assess whether the products offered value for money or not, and
whether the product was available in stock. As the model did not develop a standard
cause-and-effect relationship, it was based on each manager developing his/her own
idea of what created business success based on the customer information on these
measures.
IKEA’s desire to make explicit the priorities of the supply chain is illustrated in the
product management model. It viewed performance to be interrelated; the different
dimensions of performance were considered part of a greater whole, which is
fundamental in systems thinking. Though the model was not intended to make explicit
the relationships between the different dimensions of performance, its scope of
measurement activities encompassed several organizations.
Since the IKEA model, a lot of water has passed under the bridge. The Supply Chain
Operations Reference (SCOR) model has been developed by the Supply-Chain
Council as the cross-industry standard for supply-chain management. The SCOR
model is based on a benchmarking process and used to measure the performance of an
existing supply chain and its related processes. It covers customer interactions starting
from order entry through paid invoice. It also covers product transactions and market
interactions from helping understand demand to fulfilling individual orders.
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The SCOR model, whose conceptual framework and linkages are shown in Figure 313
17.6, is a process reference model that expands to analyze processes involving cross-
functional activities. It looks at five distinct management processes that constitute the
basic elements of a value chain:
z Plan: Processes that balance aggregate demand and supply to develop a course of
action which best meets sourcing, production and delivery requirements
z Source: Processes that procure goods and services to meet planned or actual
demand
z Make: Processes that transform product to a finished state to meet planned or
actual demand
z Deliver: Processes that provide finished goods and services to meet planned
or actual demand, typically including order management, transportation
management, and distribution management, and
z Return: Processes associated with returning or receiving returned products for any
reason. These processes extend into post-delivery customer support.
Figure 17.7: The SCOR Model

The model uses a four-level pyramid; Process-Type Level; Configuration Level;
Process Element Level; and Implementation Level — that defines the steps a company
needs to take to measure and improve supply chain performance. Table 17.2 gives the
configuration toolkit for determining the process type.
Table 17.2: The SCOR Model Configuration Toolkit
The process involves comparing practices and procedures to those of the ‘best’ to
identify ways in which an organization (or organizations) can make improvements.
This is accomplished through benchmarking.
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314 The SCOR Model endorses twelve performance metrics. The level 2 and 3 are keys to
Logistics and
Supply Chain Management these twelve levels 1 metrics. Metrics can include a wide variety of performance
measures. A list of the commonly used metrics is given below:
z Delivery (in-full, on-time, in-specification)
z Order fulfillment
z Fill rate (for make-to-stock)
z Lead time or supply-chain response time
z Production flexibility
z Total cost
z Realized margin
z Warranty costs
z Returns processing costs and more
At level 3, different suppliers under consideration are added and compared on the
criteria laid out in level 2. Benchmarking is an effective means of determining the
supply chain’s performance relative to those of other organizations. A data bank of
benchmarking studies is provided with the SCOR model to make relevant
comparisons. A company is not likely to meet best practice norms in all metrics, but
the metrics it should focus on, should reflect its customer needs and market realities.
The model draws attention to process gaps rather pointing to specific departments'
performance. This is meant to help the company communicate without ambiguity and
help measure, manage and refine processes. Based on a data bank on different
industries, it helps the organization quantify operational performance and set
improvement targets using best practices in similar companies. Organizations have to
devise means to relate departmental performance metrics to the SCOR model.
Figure 17.8: Integrated SCOR Model

The challenge is in SCM is to integrate the functional performance measures into
overall measures that will reflect the performance of the entire supply chain. The
performance measures must show not only how well you are providing for your
customers (service metrics) and how you are handling your business (speed,
asset/inventory, and financial metrics), but also for the supply chain as a whole.
Measurement is also an ideal way to communicate requirements to other members of
the supply chain and to promote continuous improvement and change.
Many organizations are willing to receive information from other supply chain
members, but are reluctant to share their information with other members. The issue of
the organization’s willingness to share information with other supply chain members
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is something that needs management attention and a solution to make the SCM 315
initiative successful. Working together, organizations can better satisfy the customer’s
requirements for quality, cost, product and service.
By providing a complete set of supply chain metrics, industry best practices and
enabling systems’ functionality, the SCOR model allows firms to conduct a thorough
fact-based analysis of all aspects of the supply chain.
17.3.1 Performance Measurements in the Service Industry

Historically, measurement of service industry has focused on financial and operational
metrics comparable to that of traditional industries. However, these measures are
generally lagging in nature and effective performance measurements have to also look
at intangibles. Some of the models that we discussed in the last section e.g. BSC,
Performance Prism of Neely, and Productivity Measurement and Enhancement
System have been successfully used, but as mentioned earlier they have to be
specifically designed for such measurements.
Parasuraman and Johnston et al. have independently developed a way of describing
service quality measures which specifically focus on the characteristics of the service
industry. These models have also been successfully implemented in a number of
service organizations. For example, Jet Airways has adopted the Parsuraman model.
Parsuraman identified these as service dimensions while Johnston et al. identified
these as quality factors. These can be called service determinants and can be used to
measure perceived as well as delivered quality. Performance measurements for service
industries based on both these classifications are shown in Table 17.3.
Table 17.3: Service Dimensions and Quality Factors
Service Dimensions Service Quality Factors
Reliability (ability to perform the promised service) z Access
Appearance of physical facilities (personnel, z Aesthetics/Appearance
equipment, communication materials) z Availability
Responsiveness (willingness to help customers z Cleanliness/Tidiness
promptly) z Comfort
Assurance (knowledge, courtesy of employees) z Communication
z Competence
Empathy (of employees) z Courtesy
z Friendliness
z Reliability
z Responsiveness
z Security
Defining service quality is a complex and ambiguous task. Therefore, it is important to

specify this service quality definition before trying to build an information and
measurement system regarding service quality.
Models like the ones described above differentiate between soft skills and hard skills.
Different elements can be included in the different definitions: perceived or delivered
service quality, quality of process, inputs or outputs, service quality characteristics
such as reliability, comfort, responsiveness, quality of core or peripheral services, etc.
17.3.2 Other Performance Measures

Measurement systems that measure inter-firm and inter-functional performance are
already in force in the area of logistics and have been used for quite some time. These
have to be extended in supply chain management also. Based on this experience, some
functional performance measures are given in this section.
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316 Purchasing Metrics
Logistics and
Supply Chain Management Measuring performance of the purchasing function continues to be a vexing problem.
The performances metrics in purchasing and supply are not necessarily tied directly to
economic value add. Some of the strategic areas that encompass the measures in
purchasing and supply:
1. Purchase cost savings/avoidance
2. Managing supplier base. This includes time to market, supplier satisfaction,
partnerships, supplier health (financial and/or management stability),
3. Internal customer satisfaction
4. Purchasing cost
5. Resource utilization
Each organization is unique and requires measures tailored to its current environment
and people. However, in addition some other areas of focus can be:
z Savings versus purchase expenditure plan (PEP): The cost savings goal is in
addition to the yearly PEP cost saving goal.
z Design for cost (DFC) savings: Cost savings initiated by purchasing/supply in the
product design stages.
z Return on enabling: Getting value from suppliers beyond cost reduction.
z Cost of inventory: The cost of inventory holding and obsolescence.
z Indirect spend reduction
The measures in the organization, managing supplier base, and overall performance
evaluation areas simply are not receiving the same relative attention as those in
developing supplier base, cost effectiveness, and systems utilization.
Logistics Metrics
The objective of logistics performance measurement is to determine whether or not
the organization has improved customer service at lower logistics costs and a
reduction in the cost of services. Some of the common measures are:
z Overhead as % of Total Costs
z Overhead to Cost of Goods Sold Ratio
z Order Fulfillment Costs
z Order Fulfillment Costs as a % of Order Management Costs
z Process Costs
z Total Supply Chain Costs as a % of Revenue
z Total Supply Chain Costs as a % of Total Costs
The basic business goals in logistics are to improve customer service and provide
better service levels that reflect in improved quality and with increased accuracy. In
addition, volatile consumer demand situation requires increased speed and efficiency.
Many organizations are automating processes to eliminate errors due to manual
processes. They are also increasing collaboration (internally and externally) to
reducing operating costs and increase efficiency.
Collaborating on performance measurements is only possible when partner firms in
the supply chain are getting closer to each other. It means that the borders are
becoming less distinct. This is a great achievement because trust and cooperation are
required to get access to information beyond a single firm. Obtaining access makes it
possible for firms to develop and act in accordance with wider objectives e.g. that of
an integrated supply chain.
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Fill in the blanks:
1. The ……………….is based on a benchmarking process and used to
measure the performance of an existing supply chain and its related
processes.
2. ……………………on performance measurements is only possible when
partner firms in the supply chain are getting closer to each other.
3. The objective of logistics performance measurement is to determine
whether or not the organization has improved customer service at lower
…………………
17.4 LET US SUM UP

Supply chain performance improves if all stages of the chain take actions that together
increase total supply chain profits. A lack of coordination can impact the performance.
This occurs either because different stages of the supply chain have objectives that
conflict or because information moving between stages gets delayed and distorted.
Supply chain coordination requires each stage of the supply chain to take into account
the impact it actions have on other stages.
A number of models have been used for supply chain performance measurements. The
Balanced Scorecard model uses four different dimensions of performance. These
dimensions are financial, customer, business processes, and learning and growth. The
Performance Prism (PPR) developed by Neely and Adams (2000) is organized around
five distinct but linked perspectives of performance: stakeholder satisfaction,
strategies, processes, capabilities, and stakeholder contributions. Neely visualized
these perspectives by a three dimensional model in the shape of a prism.
ProMES is a participative development method for performance management systems.
It is a formal, step-by-step process that identifies organizational objectives, develops a
measurement system to assess how well the unit is meeting those objectives, and
develops a feedback system which gives management information on how well the
unit is performing.
These models are not specific to the supply chain operations. The IKEA model and the
SCOR model meet this need. The IKEA model consists of measures within five
different areas: product range; cost; quality; availability and service. The SCOR model
looks at five distinct management processes that constitute the basic elements of a
value chain: plan, source, make, deliver, and return. The model uses a four-level
pyramid; Process-Type Level; Configuration Level; Process Element Level; and
Implementation Level. By providing a complete set of supply chain metrics, industry
best practices and enabling systems’ functionality, the SCOR model allows firms to
conduct a thorough fact based analysis of all aspects of the supply chain.

Find out any five measures of supply chain performance.
17.6 KEYWORDS
Productivity Measurement and Enhancement System (ProMES): ProMES is a
participative development method for performance management systems. It is a
formal, step-by-step process that identifies organizational objectives, develops a
measurement system to assess how well the unit is meeting those objectives.

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LSCM

1.0 AIMS AND OBJECTIVES

1.2 LOGISTICS - EVOLUTION

According to the Council of Logistics Management (CLM) “Logistics is the process

1.3.1 The Concept of Logistics

1.4 IMPORTANCE OF LOGISTICS

Caselet 1: Logistics and Transportation Management — Oracle

1.5 COMPONENTS OF LOGISTICS MANAGEMENT

1.5.1 Types of Logistics

Reasons for Reverse Logistics

Drivers in Reverse Logistics

Need for 4PL

Services provided by 4PL

1.6 LOGISTICS MANAGEMENT CYCLE

Figure 1.1: Logistics Cycle

1.7 FUNCTIONS OF LOGISTICS MANAGEMENT

Figure 1.2: Functions of Logistics Management

1.8 LOGISTICS NETWORK

1.8.1 Logistical Competency

Warehousing, Material Handling and Packaging

1.9 LET US SUM UP

2.0 AIMS AND OBJECTIVES

2.2 CUSTOMER SERVICE AND LOGISTIC

Orders Shipped Complete

2.2.2 Increasing Customer Expectations

Figure 2.1: Shrinking Service Window

The Perfect Order

2.2.3 Value-added Services

A. The Customer Service Integration

2.3 LOGISTICS AND CONSUMER SATISFACTION

2.4 MEASURE OF EFFECTIVENESS OF

2.4.1 Possible Measures of Customer Service Performance

z On-time delivery – Making sincere efforts and succeeding in executing deliveries

2.5 CUSTOMER PERCEPTION OF SERVICE QUALITY

2.6 PHASES OF CUSTOMER SERVICES

2.7 VALUE ADDED SERVICES

A. Identification of Service Needs

Identifying Customers’ Service Needs

Defining Customer Service Objectives

Designing Logistics System

2.7.2 The ‘Cost-Benefit’ of Customer Service

2.7.3 Setting Customer Service Priorities

2.7.4 Managing Product Service Levels

2.7.5 Setting Service Standards

2.7.6 Customer Value Creation

2.8 LET US SUM UP

2.9 LESSON END ACTIVITY

3.0 AIMS AND OBJECTIVES

3.2 CONCEPTS OF LOGISTICS AND PHYSICAL

3.2.1 Physical Distribution

3.2.2 Distribution Channel

How Channel Members Add Value

Structuring a Distribution Channel

Requirements of Channel Members

Support to Distribution Channel

Planning of Logistics Service Level Requirements

Analyzing the Cost Benefits

Implementing the Program and Monitoring the progress

3.3 DISTRIBUTION AND INVENTORY

Functional Roles of Inventory

3.3.2 Types and Characteristics of Inventory

3.3.3 Planning the Inventory Resource

Determining Order Point (When to Order?)

Determining Lot Size (How Much?)