Logistics Collected

Understanding the
1 Supply Chain
PowerPoint presentation
to accompany
Chopra and Meindl
Supply Chain Management, 6e
Copyright © 2016 Pearson Education, Inc. 1–1
Learning Objectives
1. Discuss the goal of a supply chain and explain the
impact of supply chain decisions on the success of a
firm.
2. Identify the three key supply chain decision phases
and explain the significance of each one.
3. Describe the cycle and push/pull views of a supply
chain.
4. Classify the supply chain macro processes in a firm.

What is a Supply Chain?
• All stages involved, directly or indirectly, in fulfilling a
customer request
• Includes manufacturers, suppliers, transporters,
warehouses, retailers, and customers
• Within each company, the supply chain includes all
functions involved in fulfilling a customer request
(product development, marketing, operations,
distribution, finance, customer service)

• Customer is an integral part of the supply chain
• Includes movement of products from suppliers to
manufacturers to distributors and information,
funds, and products in both directions
• May be more accurate to use the term “supply
network” or “supply web”
• Typical supply chain stages: customers, retailers,
wholesalers/distributors, manufacturers,
component/raw material suppliers
• All stages may not be present in all supply chains
(e.g., no retailer or distributor for Dell)
FIGURE 1-1

Flows in a Supply Chain
FIGURE 1-2

The Objective of a Supply Chain
• Maximize overall value generated

Supply Chain Surplus
= Customer Value – Supply Chain Cost

• Example: a customer purchases a wireless router
from Best Buy for $60 (revenue)
• Supply chain incurs costs (information, storage,
transportation, produce components, assembly, etc.)
• Difference between $60 and the sum of all of these
costs is the supply chain profit
• Supply chain profitability is total profit to be shared
across all stages of the supply chain
• Success should be measured by total supply chain
profitability, not profits at an individual stage

• Customer the only source of revenue
• Sources of cost include flows of information,
products, or funds between stages of the
supply chain
• Effective supply chain management is the
management of supply chain assets and
product, information, and fund flows to grow
the total supply chain surplus

Importance of
Supply Chain Decisions
• Wal-Mart, $1 billion sales in 1980 to $469 billion in
2013
• Seven-Eleven Japan, ¥1 billion sales in 1974 to ¥1.9
trillion in 2013
• Webvan folded in two years
• Borders, $4 billion in 2004 to $2.8 billion in 2009
• Dell, $56 billion in 2006, adopted new supply chain
strategies
Copyright © 2016 Pearson Education, Inc. 1 – 10

Key Point
Supply chain design, planning, and

operation decisions play a significant role
in the success or failure of a firm. To stay
competitive, supply chains must adapt to
changing technology and customer
expectations.

Decision Phases in a Supply Chain
1. Supply chain strategy or design
How to structure the supply chain over the next
several years
2. Supply chain planning
Decisions over the next quarter or year
3. Supply chain operation
Daily or weekly operational decisions

Supply Chain Strategy or Design
• Decisions about the configuration of the supply chain,
allocation of resources, and what processes each
stage will perform
• Strategic supply chain decisions
– Outsource supply chain functions
– Locations and capacities of facilities
– Products to be made or stored at various locations
– Modes of transportation
– Information systems
• Supply chain design must support strategic objectives
• Supply chain design decisions are long-term and
expensive to reverse – must take into account market
uncertainty
Supply Chain Planning
• Definition of a set of policies that govern
short-term operations
• Fixed by the supply configuration from
strategic phase
• Goal is to maximize supply chain surplus given
established constraints
• Starts with a forecast of demand in the
coming year

Supply Chain Planning
• Planning decisions:
– Which markets will be supplied from which locations
– Planned buildup of inventories
– Subcontracting
– Inventory policies
– Timing and size of market promotions
• Must consider demand uncertainty, exchange rates,
competition over the time horizon in planning
decisions

Supply Chain Operation
• Time horizon is weekly or daily
• Decisions regarding individual customer orders
• Supply chain configuration is fixed and planning
policies are defined
• Goal is to handle incoming customer orders as
effectively as possible
• Allocate orders to inventory or production, set order
due dates, generate pick lists at a warehouse, allocate
an order to a particular shipment, set delivery
schedules, place replenishment orders
• Much less uncertainty (short time horizon)

Key Point
Supply chain decision phases may be

categorized as design, planning, or
operational, depending on the time frame
during which the decisions made apply.
Design decisions constrain or enable good
planning, which in turn constrains or
enables effective operation.

Process Views of a Supply Chain
1. Cycle View: The processes in a supply chain are
divided into a series of cycles, each performed at
the interface between two successive stages of the
supply chain.
2. Push/Pull View: The processes in a supply chain are
divided into two categories, depending on whether
they are executed in response to a customer order
or in anticipation of customer orders. Pull processes
are initiated by a customer order, whereas push
processes are initiated and performed in
anticipation of customer orders.

Cycle View
of Supply
Chain
Processes
FIGURE 1-3

Cycle View of
Supply Chain Processes
FIGURE 1-4

Key Point
A cycle view of the supply chain clearly

defines the processes involved and the
owners of each process. This view is useful
when considering operational decisions
because it specifies the roles and
responsibilities of each member of the
supply chain and the desired outcome for
each process.

Push/Pull View of Supply Chains
FIGURE 1-5

Push/Pull View of
Supply Chain Processes
• Supply chain processes fall into one of two categories
depending on the timing of their execution relative
to customer demand
• Pull: execution is initiated in response to a customer
order (reactive)
• Push: execution is initiated in anticipation of
customer orders (speculative)
• Push/pull boundary separates push processes from
pull processes

Push/Pull View – L.L. Bean
FIGURE 1-6

Push/Pull View – Ethan Allen
FIGURE 1-7

Key Point
A push/pull view of the supply chain

categorizes processes based on whether
they are initiated in response to a
customer order (pull) or in anticipation of
a customer order (push). This view is
useful when considering strategic
decisions relating to supply chain design.

Supply Chain Macro Processes
Supply chain processes discussed in the two
views can be classified into
1. Customer Relationship Management (CRM):
all processes at the interface between the firm
and its customers
2. Internal Supply Chain Management (ISCM):
all processes that are internal to the firm
3. Supplier Relationship Management (SRM):
all processes at the interface between the firm
and its suppliers

Key Point
Within a firm, all supply chain activities

belong to one of three macro processes:
CRM, ISCM, and SRM. Integration among
the three macro processes is crucial for
successful supply chain management.

Supply Chain Macro Processes
FIGURE 1-8

Examples of Supply Chains
• Gateway and Apple
• Zara
• W.W. Grainger and McMaster-Carr
• Toyota
• Amazon
• Macy's

Gateway and Apple
1. Why did Gateway choose not to carry any finished-product
inventory at its retail stores? Why did Apple choose to carry
inventory at its stores?
2. Should a firm with an investment in retail stores carry any
finished-goods inventory? What are the characteristics of
products that are most suitable to be carried in finished-goods
inventory? What characterizes products that are best
manufactured to order?
3. How does product variety affect the level of inventory a retail
store must carry?
4. Is a direct selling supply chain without retail stores always less
expensive than a supply chain with retail stores?
5. What factors explain the success of Apple retail and the failure
of Gateway country stores?

Zara
1. What advantage does Zara gain against the competition by having
a very responsive supply chain?
2. Why has Inditex chosen to have both in-house manufacturing and
outsourced manufacturing? Why has Inditex maintained
manufacturing capacity in Europe even though manufacturing in
Asia is much cheaper?
3. Why does Zara source products with uncertain demand from local
manufacturers and products with predictable demand from Asian
manufacturers?
4. What advantage does Zara gain from replenishing its stores
multiple times a week compared to a less frequent schedule? How
does the frequency of replenishment affect the design of its
distribution system?
5. Do you think Zara’s responsive replenishment infrastructure is
better suited for online sales or retail sales?
W.W. Grainger and McMaster-Carr
1. How many DCs should be built and where should they be
located?
2. How should product stocking be managed at the DCs? Should
all DCs carry all products?
3. What products should be carried in inventory and what
products should be left with the supplier to be shipped
directly in response to a customer order?
4. What products should W.W. Grainger carry at a store?
5. How should markets be allocated to DCs in terms of order
fulfillment? What should be done if an order cannot be
completely filled from a DC? Should there be specified backup
locations? How should they be selected?

Toyota
1. Where should the plants be located, and what
degree of flexibility should be built into each? What
capacity should each plant have?
2. Should plants be able to produce for all markets or
only for specific contingency markets?
3. How should markets be allocated to plants and how
frequently should this allocation be revised?
4. How should the investment in flexibility be valued?

Amazon
1. Why is Amazon building more warehouses as it grows? How
many warehouses should it have and where should they be
located?
2. Should Amazon stock every product it sells?
3. What advantage can bricks-and-mortar players derive from
setting up an online channel? How should they use the two
channels to gain maximum advantage?
4. What advantages and disadvantages does the online channel
enjoy in the sale of shoes and diapers relative to a retail
store?
5. For what products does the online channel offer the greater
advantage relative to retail stores? What characterizes these
products?

Macy's
1. Should online orders be filled from stores or
fulfillment centers?
2. How should store inventories be managed in an
omni-channel setting?
3. Should returns be kept at a store or sent to a
fulfillment center?

Summary of Learning Objectives
1. Discuss the goal of a supply chain and explain the
impact of supply chain decisions on the success of a
firm.
2. Identify the three key supply chain decision phases
and explain the significance of each one.
3. Describe the cycle and push/pull views of a supply
chain.
4. Classify the supply chain macro processes in a firm.

Chapter 2
ROLE OF LOGISTICS
IN SUPPLY CHAINS
Learning Objectives
After reading this chapter, you should be able to do the following:
● Understand the role and importance of

logistics in private and public
organizations.
● Discuss the impact of logistics on the
economy and how effective logistics
management contributes to the vitality of
the economy.
● Understand the value-added roles of
logistics on both a macro and micro level.
©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in 2
part.
Learning Objectives, continued
● Explain the relationships between logistics

and other functional areas such as
manufacturing, marketing, and finance.
● Discuss the importance of management
activities in the logistics function.
● Analyze logistics systems from several
different perspectives to meet different
objectives.
● Determine the total costs and understand
the cost tradeoffs in a logistics system.
part.
Figure 2.1
Contemporary Supply Chain Profile
Source: Center for Supply Chain Research, Penn State University.

part.
What is Logistics
● Business logistics:
• That part of the supply chain process that plans,
implements, and controls the efficient, effective flow
and storage of goods, service, and related information
from point of use or consumption in order to meet
customer requirements.
● Military logistics:
• The design and integration of all aspects of support
for the operational capability of the military forces
(deployed or in garrison) and their equipment to
ensure readiness, reliability, and efficiency.
©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in
part.
What is Logistics, continued
● Event logistics:
• The network of activities, facilities, and personnel
required to organize, schedule, and deploy the
resources for an event to take place and to efficiently
withdraw after the event.
● Service logistics:
• The acquisition, scheduling, and management of the
facilities/assets, personnel, and materials to support
and sustain a service operation or business.
part.
Table 2.1
Logistics Definitions
Perspective Definition
Source: Adapted from Stephen H. Russell, “A General Theory of Logistics Practices”,

Air Force Journal of Logistics 24, no 4 (2000): 15
part.
Value-Added Roles of Logistics
● Form Utility
● Time Utility
● Place Utility
● Quantity Utility
● Possession Utility
part.
Figure 2.2
Utility Creation in the Economy
Source: Center for Supply Chain Research, Penn State University

part.
Logistics Activities
● Transportation
● Warehousing and storage
● Industrial packaging
● Materials handling
● Inventory control
● Order fulfillment
part.
Logistics Activities, continued
● Demand forecasting
● Production planning/scheduling
● Procurement
● Customer service
● Facility location
part.
Figure 2.3
Logistics Cost as a Percentage of GDP
Source: Council of Supply Chain Management Professionals

part.
Figure 2.5
Macro Inventory as a Percentage of GDP
Source: Council of Supply Chain Management Professionals

part.
Figure 2.4
Total Logistics Costs – 2011
Interest 4
Taxes, obsolescence, depreciation, 280
insurance
Warehousing 112
Subtotal 336
Transportation Costs
Motor Carriers
Truck—Intercity 403
Truck—Local 189
Subtotal 592
Other Carriers
Railroads 60
Water (international 32, domestic 8) 33
Oil pipelines 10
Air (international 15, domestic 23) 33
Forwarders 32
Subtotal 168
Shipper–related costs 9
Logistics administration 47
Total logistics cost 1211
Source: 22nd Annual State of Logistics Report, http://www.cscmp.org (2011) reproduced with permission
from Council of Supply Chain Management Professionals
part.
Logistics in the Firm: The Micro
Dimension
● Logistics interfaces with manufacturing or
operations
● Logistics Interfaces with marketing
• Price
• Product
• Promotion
• Place
part.
Logistics in the Firm: Factors Affecting
the Cost and Importance of Logistics
● Competitive relationships
• Order cycle
• Sustainability
• Inventory effect
• Transportation effect
● Product relationships
• Dollar value
• Density
• Special handling & susceptibility to damage
● Spatial relationships
part.
Figure 2.6
Required Inventory and Order Cycle

part.
Figure 2.7
Lost Sales Cost to Inventory Cost

part.
Figure 2.8
Lost Sales Cost to Transportation Cost

part.
Figure 2.9
Product Dollar Value to Logistics Costs

part.
Figure 2.10
Product Weight Density to Logistics Costs

part.
Figure 2.11
Susceptibility to Loss & Damage to Costs

part.
Figure 2.12
Logistics and Spatial Relations

part.
Table 2.3
Logistics Mode Cost Comparison
COST CENTER RAIL MOTOR

Transportation 3 4.3
Inventory 5 3.75
Packaging 3.5 3.2
Warehousing 1.5 0.75
Cost of Lost Sales 2 1
Total Cost (per unit) 15 13

part.
Approaches to Analyzing Logistics
Systems
● Materials management versus physical
distribution
● Cost centers
● Nodes versus links
• Nodes are fixed spatial points where goods stop for
storage or processing.
• Links represent the transportation network and
connect the nodes in the logistics system.
● Logistics Channels
part.
Figure 2.13
Dynamic Analysis

part.
Figure 2.14
Nodes and Links in a Logistics System

part.
Figure 2.15
Simple Logistics Channel

part.
Figure 2.16
Multi-Echelon Logistics Channel

part.
Figure 2.17
Complex Logistics Channel

part.
Summary
● Logistics has developed as an important area or function
of business since World War II. It has gone through
several phases of development in achieving its present
status.
● Logistics is a critical part of supply chain management.
The coordination and, perhaps, integration of the
logistics systems of all the organizations in a supply
chain are necessary requirements for successful
management of the supply chain.
● Logistics has a number of different definitions because of
the broad-based interest in its activities and the
recognition of its importance. The definition developed
by the Council of Supply Chain Management
Professionals is the primary definition used in this text. 31
part.
Summary, continued
● Logistics is an area of management that has four sub-

disciplines: business, military, service, and event.
● On a macro basis, logistics-related costs have been
decreasing on a relative basis, which has helped the
U.S. economy regain its competitive position on a global
basis.
● Logistics adds place, time, and quantity utilities to
products and enhances the form and possession utilities
added by manufacturing and marketing.
● Logistics has an important relationship to manufacturing,
marketing, finance, and other areas of the organization.
● Logistics managers are responsible for a number of
important activities, including transportation, inventory,
warehousing, materials handling, industrial packaging,
customer service, forecasting, and others.
part.
Summary, continued
● Logistics systems can be viewed or approached in

several different ways for analysis purposes, including
materials management versus physical distribution, cost
centers, nodes versus links, and channels. All four
approaches are viable for different purposes.
● Logistics systems are frequently analyzed from a
systems approach, which emphasizes total cost and
tradeoffs when changes are proposed. Either a short- or
a long run perspective can be used.
● The cost of logistics systems can be affected by a
number of major factors, including competition in the
market, the spatial relationship of nodes, and product
characteristics.
part.
Supply Chain Drivers
3
to accompany
Chopra and Meindl
3
Learning Objectives
1. Identify the major drivers of supply chain

performance.
2. Discuss the role of each driver in creating strategic
fit between the supply chain strategy and the
competitive strategy.
3. Define the key metrics that track the performance
of the supply chain in terms of each driver.

3
Drivers of Supply Chain Performance
1. Facilities
– The physical locations in the supply chain
network where product is stored, assembled,
or fabricated
2. Inventory
– All raw materials, work in process, and finished
goods within a supply chain
3. Transportation
– Moving inventory from point to point in the
supply chain

3
Drivers of Supply Chain Performance
4. Information
– Data and analysis concerning facilities,
inventory, transportation, costs, prices, and
customers throughout the supply chain
5. Sourcing
– Who will perform a particular supply chain
activity
6. Pricing
– How much a firm will charge for the goods and
services that it makes available in the supply
chain

3
Framework for
Structuring
Drivers
Figure 3-1

3
Facilities
• Role in the supply chain
– Increase responsiveness by increasing the
number of facilities, making them more
flexible, or increasing capacity

3
Facilities
• Role in the supply chain
– Tradeoffs between facility, inventory, and
transportation costs
• Increasing number of facilities increases facility
and inventory costs, decreases transportation
costs and reduces response time
• Increasing the flexibility or capacity of a facility
increases facility costs but decreases inventory
costs and response time

3
Facilities
• Components of facilities decisions
– Role
• Flexible, dedicated, or a combination of the two
• Product focus or a functional focus
– Location
• Where a company will locate its facilities
• Centralize for economies of scale, decentralize for
responsiveness
• Consider macroeconomic factors, quality of
workers, cost of workers and facility, availability of
infrastructure, proximity to customers, location of
other facilities, tax effects

3
Facilities
– Capacity
• A facility’s capacity to perform its intended
function or functions
• Excess capacity – responsive, costly
• Little excess capacity – more efficient, less
responsive

3
Facilities
– Facility-related metrics
• Capacity
• Utilization
• Processing/setup/down/idle time
• Production cost per unit
• Quality losses
• Theoretical flow/cycle time of production
• Actual average flow/cycle time

3
Facilities
– Facility-related metrics
• Flow time efficiency
• Product variety
• Volume contribution of top 20 percent SKU's and
customers
• Average production batch size
• Production service level

3
Inventory
• Role in the Supply Chain
– Mismatch between supply and demand
– Exploit economies of scale
– Reduce costs
– Improve product availability
– Affects assets, costs, responsiveness, material
flow time

3
Inventory
• Overall trade-off
– Increasing inventory generally makes the
supply chain more responsive
– A higher level of inventory facilitates a
reduction in production and transportation
costs because of improved economies of
scale
– Inventory holding costs increase

3
Inventory
– Material flow time, the time that elapses
between the point at which material enters the
supply chain to the point at which it exits
– Throughput, the rate at which sales occur
– Little’s law
I = DT
where
I = flow time, T = throughput, D = demand

3
Components of Inventory Decisions
• Cycle inventory
– Average amount of inventory used to satisfy
demand between supplier shipments
– Function of lot size decisions
• Safety inventory
– Inventory held in case demand exceeds
expectations
– Costs of carrying too much inventory versus cost
of losing sales

3
• Seasonal inventory
– Inventory built up to counter predictable
variability in demand
– Cost of carrying additional inventory versus cost of
flexible production
• Level of product availability
– The fraction of demand that is served on time
from product held in inventory
– Trade off between customer service and cost

3
• Inventory-related metrics
– C2C cycle time
– Average inventory
– Inventory turns
– Products with more than a specified
number of days of inventory
– Average replenishment batch size

3
• Inventory-related metrics
– Average safety inventory
– Seasonal inventory
– Fill rate
– Fraction of time out of stock
– Obsolete inventory

3
Transportation
– Moves the product between stages in the supply
chain
– Affects responsiveness and efficiency
– Faster transportation allows greater
responsiveness but lower efficiency
– Also affects inventory and facilities
– Allows a firm to adjust the location of its facilities
and inventory to find the right balance between
responsiveness and efficiency

3
Transportation
• Components of Transportation Decisions
– Design of transportation network
• Modes, locations, and routes
• Direct or with intermediate consolidation points
• One or multiple supply or demand points in a single
run

3
Transportation
• Components of Transportation Decisions
– Choice of transportation mode
• Air, truck, rail, sea, and pipeline
• Information goods via the Internet
• Different speed, size of shipments, cost of shipping,
and flexibility

3
Transportation
– Transportation-related metrics
• Average inbound transportation cost
• Average income shipment size
• Average inbound transportation cost per shipment
• Average outbound transportation cost
• Average outbound shipment size
• Average outbound transportation cost per shipment
• Fraction transported by mode

3
Transportation
• Overall trade-off: Responsiveness versus
efficiency
– The cost of transporting a given product
(efficiency) and the speed with which that product
is transported (responsiveness)
– Using fast modes of transport raises
responsiveness and transportation cost but lowers
the inventory holding cost

3
Information
– Improve the utilization of supply chain assets
and the coordination of supply chain flows to
increase responsiveness and reduce cost
– Information is a key driver that can be used to
provide higher responsiveness while
simultaneously improving efficiency

3
Information
• Role in the Competitive Strategy
– Improves visibility of transactions and
coordination of decisions across the supply chain
– Right information can help a supply chain better
meet customer needs at lower cost
– More information increases complexity and cost
of both infrastructure and analysis exponentially
while marginal value diminishes
– Share the minimum amount of information
required to achieve coordination

3
Components of Information Decisions
• Push versus Pull
– Different information requirements and uses
• Coordination and information sharing
– Supply chain coordination, all stages of a supply
chain work toward the objective of maximizing
total supply chain profitability based on shared
information
• Sales and operations planning (S&OP)
– The process of creating an overall supply plan
(production and inventories) to meet the
anticipated level of demand (sales)
3
• Enabling technologies
1. Electronic data interchange (EDI)
2. The Internet
3. Enterprise resource planning (ERP) systems
4. Supply chain management (SCM) software
5. Radio frequency identification (RFID)

3
• Information-related metrics
– Forecast horizon
– Frequency of update
– Forecast error
– Seasonal factors
– Variance from plan
– Ratio of demand variability to order variability

3
Sourcing
– Set of business processes required to purchase
goods and services
– Will tasks be performed by a source internal to the
company or a third party
– Increase the size of the total surplus to be shared
across the supply chain

3
Sourcing
• Role in the Competitive Strategy
– Sourcing decisions are crucial because they
affect the level of efficiency and
responsiveness in a supply chain
– Outsource to responsive third parties if it is
too expensive to develop their own
– Keep responsive process in-house to maintain
control

3
Components of Sourcing Decisions
• In-house or outsource
– Perform a task in-house or outsource it to a
third party
– Outsource if it raises the supply chain surplus
more than the firm can on its own
– Keep function in-house if the third party
cannot increase the supply chain surplus or if
the outsourcing risk is significant

3
• Supplier selection
– Number of suppliers, criteria for evaluation
and selection
• Procurement
– Obtain goods and service within a supply
chain
– Goal is to increase supply chain surplus

3
• Sourcing-related metrics
– Days payable outstanding
– Average purchase price
– Range of purchase price
– Average purchase quantity
– Supply quality
– Supply lead time
– Fraction of on-time deliveries
– Supplier reliability

3
Pricing
– Pricing determines the amount to charge
customers for goods and services
– Affects the supply chain level of responsiveness
required and the demand profile the supply
chain attempts to serve
– Pricing strategies can be used to match demand
and supply
– Objective should be to increase firm profit

3
Components of Pricing Decisions
• Pricing and economies of scale
– The provider of the activity must decide how to
price it appropriately to reflect economies of
scale
• Everyday low pricing versus high-low
pricing
– Different pricing strategies lead to different
demand profiles that the supply chain must
serve

3
• Fixed price versus menu pricing
– If marginal supply chain costs or the value to
the customer vary significantly along some
attribute, it is often effective to have a pricing
menu
– Can lead to customer behavior that has a
negative impact on profits

3
• Pricing-related metrics
– Profit margin
– Days sales outstanding
– Incremental fixed cost per order
– Incremental variable cost per unit
– Average sale price
– Average order size
– Range of sale price
– Range of periodic sales

3
1. Identify the major drivers of supply chain
performance
2. Discuss the role of each driver in creating strategic
fit between the supply chain strategy and the
competitive strategy
3. Define the key metrics that track the performance
of the supply chain in terms of each driver

3
Chapter 4
SUPPLY CHAIN
RELATIONSHIPS
Learning Objectives
● Understand the types of supply chain

relationships and their importance.
● Describe a process model that will
facilitate the development and
implementation of successful supply chain
relationships.
● Recognize the importance of
“collaborative” supply chain relationships.
part.
● Know the extent to which customers are

satisfied with 3PL services and identify
where improvement may be needed.
● Understand some of the likely future
directions for outsourced logistics
services.
part.
Logistics Relationships
● Types of Relationships
• Vertical relationships
○ these refer to the traditional linkages between firms in the
supply chain such as retailers, distributors, manufacturers,
and parts and materials suppliers.
• Horizontal relationships
○ includes those business agreements between firms that have
“parallel” or cooperating positions in the logistics process.
● Intensity of Involvement
• Ranges from vendor to strategic alliance
part.
Logistics Relationships, continued
● Intensity of Involvement
• Transactional
○ Both parties in a vendor relationship are said to be at “arm’s
length”
• Collaborative
○ the relationship suggested by a strategic alliance is one in
which two or more business organizations cooperate and
willingly modify their business objectives and practices to
help achieve long-term goals and objectives
• Strategic
○ represents an alternative that may imply even greater
involvement than the partnership or strategic alliance.
part.
Figure 4.1
Relationship Perspectives
Source: C. John Langley Jr., Ph.D. Used with permission

part.
Logistics Relationships, continued
● Relationships may differ in numerous

ways. A partial list includes:
• Duration
• Obligations
• Expectations
• Interaction/Communication
• Cooperation
• Planning
• Goals
• Performance analysis
• Benefits and burdens
part.
Figure 4.2
Process for Forming Relationships

part.
Figure 4.3
Required for a Core Competency Area

part.
Model for Developing and Implementing
Successful Supply Chain Relationships
● Step 1: Perform strategic assessment
● Step 2: Decision to form relationship
● Step 3: Evaluate alternatives
● Step 4: Select partners
● Step 5: Structure operating model
part.
Figure 4.4
Implementation & Continuous Improvement
Source: Ray A. Mundy C. John Langley Jr., and Brian J. Gibson Used with permission
part.
Need for Collaborative Relationships
● Vertical collaboration refers to the
relationship between buyer and supplier in
the supply chain.
● Horizontal collaboration refers to buyer-
buyer or seller-seller relationships.
● Full collaboration is the dynamic
combination of both vertical and horizontal
collaboration.
part.
Figure 4.5
Types of Collaboration

part.
Table 4.1
7 Laws of Collaborative Logistics
● Collaborative Logistics Networks Must
Support:
• Real and recognized benefits to all members
• Dynamic creation, measurement, and evolution of
collaborative partnerships
• Co-buyer and co-supplier relationships
• Flexibility and security
• Collaboration across all stages of business process
integration
• Open integration with other sources
• Collaboration around essential logistics flows

part.
Third-Party Logistics – Industry
Overview
● Definition of Third-Party logistics
• Essentially, a third-party-logistics firm may be defined
as an external supplier that performs all or part of a
company’s logistics functions. Among these, multiple
logistics activities are included, those that are
included are “integrated” or managed together, and
they pro-vide “solutions” to logistics/supply chain
problems.
part.
Third-Party Logistics – Industry Overview, continued
● Types of 3PL providers

• Transportation-based
• Warehouse/distribution-based
• Forwarder-based
• Financial-based
• Information-based firms
● 3PL market size and scope
• Total NA revenue $143.3 billion
• Global revenue $539.1 billion
part.
Table 4.2
Top Buyers of 3PL Services
part.
Table 4.3
Global 3PL Market Revenue Estimate
part.
Figure 4.6
3PL Market – U.S. Turnover Growth
Source: Predictions and major trends for third part logistics 2011,
Armstrong & Assoc., Inc. Used with permission
part.
Third-Party Logistics Research Study –
Industry Details
● Profile of logistics outsourcing
• Operational, transactional, and repetitive services
were the most likely to be outsourced.
● Strategic role of information technology
• Most frequently used services were
transportation and warehouse management
systems.
● Management and relationship issues
• Must establish appropriate roles for 3PL and
clients
part.
Third-Party Logistics Research Study– Industry Details , continued
● Customer Value Framework

• 3PL’s enable reduced costs, fewer assets, less
working capital, and improved order performance.
● A Strategic View of Logistics and the Role
of 3PL’s
• Fourth-party relationships
• Logistics outsourcing model for the future
○ Proprietary provision evolving through stages to
lead logistics provider
part.
Figure 4.7
Outsourced Logistics Services
Source: Fifteenth Annual 3PL Study, C. John Langley Jr. Ph.D. . Used with permission
part.
Figure 4.9
Customer’s Perspectives on 3PL Relationships
Source: 2005 Tenth Annual 3PL Study, C. John Langley Jr. Ph.D. and Cap Gemini LLC.
Used with permission
part.
Figure 4.10
Evolution of 3PL / LLP / 4PL Services

part.
Figure 4.11
Next Generation Logistics Outsourcing Models
Source: 2005 Tenth Annual 3PL Study, C. John Langley Jr. Ph.D. and Cap Gemini LLC.
Used with permission
part.
Summary
● The two most basic types of supply chain relationships
are “vertical” (e.g., buyer-seller) and “horizontal” (e.g.,
parallel or cooperating).
● In terms of intensity of involvement, inter-firm
relationships may span from transactional to relational
and may take the form of vendor, partner, and strategic
alliances.
● There are six steps in the development and
implementation of successful relationships. These six
steps are critical to the formation and success of supply
chain relationships.
part.
Summary, continued
● Collaborative relationships, both vertical and horizontal,

have been identified as highly useful to the achievement
of long-term supply chain objectives. The “Seven
Immutable Laws of Collaborative Logistics” provide a
framework for the development of effective supply chain
relationships.
● Third-party logistics providers may be thought of as an
“external supplier that per-forms all or part of a
company’s logistics functions.” It is desirable that these
suppliers provide multiple services, and that these
services are integrated in the way they are managed and
delivered.
● The several types of 3PLs are transportation-based,
warehouse/distribution-based, forwarder-based,
financial-based, and information-based suppliers.
part.
Summary, continued
● Based on the results of a comprehensive study of users

of 3PL services in the United States, over 70 percent of
the firms studied are, to some extent, users of 3PL
services.
● User experience suggests a broad range of 3PL services
utilized; and the most prevalent are transportation,
warehousing, customs clearance and brokerage, and
forwarding.
● While nonusers of 3PL services have their reasons to
justify their decision, these same reasons are sometimes
cited by users as justification for using a 3PL.
● Customers have significant IT-based requirements of
their 3PL providers, and they feel that the 3PLs are
attaching a priority to respond to these requirements.
part.
Summary, continued
● Approximately two-thirds of the customers suggest 3PL

involvement in their global supply chain activities.
● Although most customers indicate satisfaction with
existing 3PL services, there is no shortage of
suggestions for improvement.
● Customers generally have high aspirations for their
strategic use of 3PLs and consider their 3PLs as keys to
their supply chain success.
● There is a growing need for fourth-party logistics
relationships that provide a wide range of integrative
supply chain services.
part.
Chapter 57
DEMAND
MANAGEMENT
Learning Objectives
● Understand the critical importance of

outbound-to-customer logistics systems.
● Appreciate the growing need for effective
demand management as part of an
organization’s overall logistics and supply
chain expertise.
part.
● Know the types of forecasts that might be

needed, and understand how collaboration
among trading partners will help the
overall forecasting and demand
management processes.
● Understand the basic principles underlying
the sales and operations planning
process.
part.
● Identify the key steps in the order

fulfillment process and appreciate the
various channel structures that might be
used in the fulfillment process.
part.
Demand Management
● The ability of firms throughout the supply
chain to collaborate on activities related to
the flow of product, services, information,
and capital.
● Problems in achieving goal:
• Lack of coordination between departments
• Too much emphasis on forecasts of demand, with
less attention on the collaborative efforts and the
strategic and operational plans
• Demand information is used more for tactical and
operational than for strategic purposes
part.
Figure 7.1
Supply / Demand Misalignment
Source: Acenture, Stanford and Northwestern Universities, Customer Driven Demand Networks:
Unlocking the Hidden Value in the Personal Computer Supply Chain (Accenture, 1997) 15
part.
Table 7.1
Demand Management Supports Strategy
Source: Jim R. Langbeer II, “Aligning Demand Management with Human Strategy, Supply Chain
Management Review (May/Jun 2000) 58
part.
Balancing Supply and Demand
● External balancing methods
• Change demand
• Change lead time
● Internal balancing methods
• Production flexibility
• Inventory
part.
Traditional Forecasting
● Factors Affecting Demand
• Independent demand
• Dependent demand
● Simple Moving Average
● Weighted Moving Average
● Exponential Smoothing
● Adjusted Exponential Smoothing for Trend
● Seasonal Influences on Forecasts
part.
Table 7.2
Seasonal Moving Average Forecast
Source: Robert A. Novak, Ph.D.

part.
Table 7.3
Weighted Moving Average Forecast

part.
Table 7.4
Exponential Smoothing Forecast

part.
Table 7.5
Trend Adjusted Exponential Smoothing Forecast

part.
Forecast Errors
● Cumulative sum of forecast errors (CFE)
● Mean squared error (MSE)
● Mean absolute deviation (MAD)
● Mean absolute percentage error (MAPE)
part.
Table 7.9
Forecast Error

part.
Sales and Operations Planning
● Step 1: Run sales forecast reports
● Step 2: Demand planning phase
● Step 3: Supply planning phase
● Step 4: Pre-S&OP meeting
● Step 5: Executive S&OP meeting
part.
Figure 7.2
Monthly S&OP Process
Source: Thomas F. Wallace, Sales and Operations Planning: The How-to Book (2000) 43
part.
Collaborative Planning, Forecasting, &
Replenishment
● Using internet technologies retailers,
distributors, and manufacturers collaborate
on operational planning.
• Transportation providers have now been included
with the concept of collaborative transportation
management (CTM).
part.
Figure 7.3
CPFR Model
Source: Larry Smith, “West Marine: A CPFR Success Story”, Supply Chain Management Review
(March 2006) 31
part.
Fulfillment Models
● Channels of Distribution
• A distribution channel can be thought of as the
physical structures and intermediaries through which
goods, services, information, and finances flow.
● Direct to Customer (DTC) Fulfillment
• Advantages:
○ low start-up costs
○ workforce efficiency because of consolidated operations
• Disadvantages:
○ the order profile will change (store orders in case and/or pallet
quantities, consumer orders, “eaches” in smaller order quantities)
○ products might not be available in consumer units (eaches)
○ “fast pick,” or broken case, operation to be added to the distribution
center
○ conflict between a store order and an Internet order
part.
Figure 7.5
Logistics and Marketing Channels
Source: Robert A. Novak Ph.D.

part.
Figure 7.7
Direct to Consumer Fulfillment

part.
Fulfillment Models, continued
● Integrated Fulfillment
• Retailer maintains both a “bricks-and-mortar” and
“clicks-and-mortar” presence
• operates one distribution network to service both
channels
• Advantage
○ low start-up costs
○ existing network can service both
• Disadvantages
○ order profile will change with addition of Internet orders
○ case lots versus “eaches”
○ would require a “fast pick,” or broken case operation
○ conflict might arise between a store order and an Internet
order
part.
Figure 7.8
Integrated Fulfillment

part.
● Dedicated Fulfillment
• Both a store and an Internet presence with two
separate distribution networks.
• Advantage:
○ separate distribution network for store delivery and
consumer delivery eliminates most of the disadvantages of
integrated fulfillment
• Disadvantage:
○ duplicate facilities and duplicate inventories
• Retailer maintains both a “bricks-and-mortar” and
“clicks-and-mortar” presence.
part.
Figure 7.9
Dedicated Fulfillment

part.
● Outsourced Fulfillment
• Assumes that another firm will perform the fulfillment.
• Advantages:
○ low start-up costs for the retailer to service the Internet
channel
○ possible transportation economies
• Disadvantage:
○ loss of control over service levels
part.
Figure 7.10
Outsourced Fulfillment

part.
● Drop Shipped Fulfillment

• Also called direct store delivery, vendor delivers
directly to retailer, bypassing retailer’s distribution
network.
• Works best for products that have a short shelf life.
• Advantages:
○ reduction of inventory in the distribution network
○ vendor has direct control of its inventories
• Disadvantage:
○ possible reduction of inventory visibility
part.
Figure 7.11
Drop-Shipped Fulfillment

part.
● Store Fulfillment
• The order is placed through the Internet site and sent
to the nearest store for customer pick up.
• Advantages:
○ short lead time to the customer
○ low start-up costs for the retailer
○ returns can be handled through the store
○ product availability in consumer units
• Disadvantages:
○ reduced control and consistency over order fill
○ conflict may arise between inventories
○ must have real-time visibility to in-store inventories
○ stores lack sufficient space to store product
part.
Figure 7.12
Store Fulfillment

part.
● Flow-Through Fulfillment
• Product is picked and packed at distribution center,
then sent to the store for pickup.
• Advantages:
○ eliminates the inventory conflict
○ avoids the cost of the “last mile”
○ returns can be handled through the existing store network
• Disadvantage:
○ Storage space at the store for pickup items a problem
part.
Figure 7.13
Flow-Through Fulfillment

part.
Summary
● Outbound-to-customer logistics systems have received
the most attention in many companies; but, even in
today’s customer service environment, outbound and
inbound logistics systems must be coordinated.
● Demand management may be thought of as “focused

efforts to estimate and manage customers’ demand, with
the intention of using this information to shape operating
decisions.
part.
Summary, continued
● Although many forecasts are made throughout the

supply chain, the forecast of primary demand from the
end user or consumer will be the most important. It is
essential that this demand information be shared with
trading partners throughout the supply chain and be the
basis for collaborative decision making.
● Various approaches to forecasting are available, each

serving different purposes. The S&OP process has
gained much attention in industry today. It serves the
purpose of allowing a firm to operate from a single
forecast.
part.
Summary, continued
● The S&OP process is a continual loop involving

participation from sales, operations, and finance to arrive
at an internal consensus forecast.
● CPFR is a method to allow trading partners in the supply

chain to collaboratively develop and agree upon a
forecast of sales. This allows for the elimination of
inventories held because of uncertainty in the supply
chain.
● A number of distribution channel alternatives might be

considered by organizations today. Effective
management of the various choices requires
coordination and integration of marketing, logistics, and
finance within the firm, as well as coordination of overall
channel-wide activities across the organizations in the
channel. 37
part.
Chapter 86
ORDER
MANAGEMENT AND
CUSTOMER SERVICE
Learning Objectives
● Understand the relationships between

order management and customer service.
● Appreciate how organizations influence
customers’ ordering patterns as well as
how they execute customers’ orders.
● Realize that activity-based costing (ABC)
plays a critical role in order management
and customer service.
part.
● Identify the various activities in the SCOR

process D1 (deliver stocked product) and
how it relates to the order-to-cash cycle.
● Know the various elements of customer
service and how they impact both buyers
and sellers.
● Calculate the cost of a stockout.
● Understand the major outputs of order
management, how they are measured,
and how their financial impacts on buyers
and sellers are calculated.
part.
● Be familiar with the concept of service

recovery and how it is being implemented
in organizations today.
part.
Introduction
● Influencing the Order
• This is the phase where an organization attempts to
change the manner by which its customers place
orders.
● Order Execution
• This occurs when the order is received.
● Customer service
• Anything that touches the customer. This
includes all activities that impact information
flow, product flow, and cash flow between the
organization and its customers.
part.
Figure 8.1
Relationship Between Order Management & Customer
Service

part.
Influencing the Order – Customer
Relationship Management
● Customer relationship management:
• Is the art and science of strategically positioning
customers to improve the profitability of the
organization and enhance its relationships with its
customer base.
• Is not a new concept used by service industries.
• Has not been widely used in the business-to business
environment until lately.
• Customer action affects firm’s cost
○ how customers order
○ how much customers order
○ what customers order
○ when customers order an order
part.
Influencing the Order – Customer Relationship Management, continued
● Step 1: Segment the Customer Base by

Profitability.
● Step 2: Identify the Product/Service
Package for Each Customer Segment.
● Step 3: Develop and Execute the Best
Processes.
● Step 4: Measure Performance and
Continuously Improve.
part.
Table 8.1
Hypothetical Product/Service Offerings

part.
● Activity-Based Costing
• ABC measures the cost and performance of activities,
resources, and cost objects. Resources are assigned
to activities, then activities are assigned to cost
objects based on their use.
• Traditional cost accounting is well suited to situations
where an output and an allocation process are highly
correlated.
• Traditional cost accounting is not very effective in
situations where the output is not correlated with the
allocation base.
part.
Figure 8.2
Traditional vs. Activity Based Costing

part.
Figure 8.3
Distribution Center Process Flow Chart

part.
Figure 8.4
Flow-Through Costing for a Distribution Center

part.
● Classifying customers by profitability

• Protect Zone
○ Those customers who fall into the “Protect” segment are the
most profitable.
• Danger Zone
○ Customers in the “Danger Zone” segment are the least
profitable and incur a loss.
 The firm has three alternatives for danger zone customers:
 Change customer interaction with firm so the customer can
move to another segment
 charge the customer the actual cost of doing business
 switch the customer to an alternative distribution channel
• Build Zone
○ These customers have a low cost to serve and a low net
sales value, so the firm should maintain the cost to serve and
build net sales value to help drive the customer into the
“Protect” segment.
part.
Figure 8.5
Customer Segmentation Matrix

part.
Executing the Order – Order
Management & Fulfillment
● Order-To-Cash (OTC) and Replenishment
Cycles
• Order cycle
○ all activities that occur from when an order is received until
the product is received
• Replenishment cycle
○ refers to acquisition of additional inventory
○ one firm’s order cycle is another’s replenishment cycle
• Order to cash
○ Thirteen principle activities constitute the OTC cycle:
 D1.1 through D1.7 represent information flows
 D1.8 through D1.12 represent product flows
 D1.13 represents cash flow
part.
Executing the Order – Order Management & Fulfillment, continued
● Length and Variability of the Order-to-

Cash Cycle
• Recent attention has centered on the variability or
consistency of this process.
• Absolute length of time is important, variability is more
important.
• A driving force is safety stock, as absolute length of
the order cycle will influence demand inventory.
part.
Figure 8.7
Order Cycle Length and Variability
Source: Adapted from Lambert & Stock, “Using advanced order processing systems to improve
profitability”, Business (April-June 1982) 26
part.
E-Commerce Order Fulfillment
Strategies
● Many firms use Internet technology to
capture order information for fulfillment
systems for picking, packing, and
shipping.
● Internet allows faster collection of cash by
the seller.
part.
Customer Service
● The Logistics / Marketing Interface
• Customer service is the key link between logistics and
marketing within an organization.
• Manufacturing can produce a quality product at the
right cost and marketing can sell it, but if logistics
does not deliver it when and where promised, the
customer will not be satisfied.
● Defining Customer service
• Three perspectives:
○ philosophy
○ as a set of performance measures
○ as an activity
part.
Figure 8.8
Traditional Logistics/Marketing Interface
Source: Adapted from Lambert, “The development of an inventory costing methodology: A study of the
costs associated with holding inventory”, National Council of Physical Distribution (1976) 7
part.
Customer Service, continued
● Elements of Customer Service

• Time
• Dependability
○ Cycle time
○ Safe delivery
○ Correct orders
• Communications
• Convenience
● Performance Measures for Customer
Service
• Stated from the customer’s perspective
○ Orders received on time
○ Orders received complete
○ Orders received damage free
part.
Figure 8.9
Customer Service and ROI

part.
Figure 8.10
Lead Time Frequency Distribution Example

part.
Figure 8.11
SCOR Model: Process D1 Metrics
Source: Adapted from Supply Chain Council (2011)

part.
Expected Cost of Stockouts
● Stockout occurs when desired quantities
are not available.
● Four possible events:
• the buyer waits until the product is available.
• the buyer back-orders the product.
• the seller loses current revenue.
• the seller loses a buyer and future revenue.
part.
Expected cost of Stockouts, continued
● Back Orders
• Occurs when a seller has only a portion of the
products ordered by the buyer.
• Are created to secure the portion of the inventory that
is currently not available.
● Lost Sales
• Some customers will turn to alternative supply
sources.
● Lost Customers
• Customer permanently switches to another supplier
part.
Figure 8.12
Linking Order Management Outputs

part.
Order Management Influences on
Customer Service
● Product Availability
• Did I get what I wanted, when I wanted it, in the
quantity I wanted?
• Internal Metrics
○ Item fill rate
○ Line fill rate
• External Metrics
○ Order fill rate
○ Perfect order
● Financial Impact
• Improving fill rates improves financial performance.
part.
Order Management Influences on Customer Service, continued
● Financial Impact, continued

Cash Flow Lost =
(Number of Incomplete Orders Back-Ordered x Back Order Cost per Order) +
(Number of Incomplete Orders Cancelled x Lost Pretax Profit per Order) +
(Number of Incomplete Back-Ordered x Invoice Deduction per Order)
part.
Table 8.7
Cash Flow and Inventory Investment

part.
Figure 8.13
Fill Rate and Inventory Investment

part.
Figure 8.14
Cash Flow Lost / Inventory Investment Tradeoff

part.
● Order Cycle Time

• The time that elapses from when a buyer places an
order until receipt of the order.
• Absolute length and reliability of order cycle time
influences both firm’s inventories, resulting in impacts
on both revenues and profits for both organizations.
• Metrics
○ Customer wait time
• Financial impact
○ Order cycle time impacts safety stock and cycle stock
part.
Figure 8.15
Customer Wait Time

part.
● Logistics Operations Responsiveness

(LOR)
• Examines how well a seller can respond to a buyer’s
needs.
• This “response” can take two forms
○ LOR can be how well a seller can customize its service
offerings to the unique requirements of a buyer
○ LOR can be how quickly a seller can respond to a sudden
change in a buyer’s demand pattern
part.
● Logistics System Information

• Is critical to the logistics and order management
processes.
• Underlies ability to provide quality product availability,
order cycle time, logistics operations responsiveness,
and post-sale logistics support.
• Timely and accurate information can reduce
inventories in the supply chain and improve cash flow
to all supply chain partners.
Cast Flow Increase =

Invoice Value x (Cost of Capital/365) x Difference in Days in the
Order-to-Cash Cycle
part.
Table 8.9
Information Needed to Manage the Transportation
Process

part.
● Postsale Logistics Support (PLS)

• PLS can be the management of product returns from
the customer to the supplier.
• The second form of PLS is product support through
the delivery and installation of spare parts.
• Calculation to determine the spare part service cost is
as follows:
Service Cost =
Penalty Cost + Lost Purchase Margin + Lost Support Margin
part.
● Service Recovery
• No matter how well an organization plans to provide
excellent service, mistakes will occur.
• Recovery requires a firm to realize that mistakes will
occur and have plans in place to fix them.
part.
Summary
● Order management and customer service are not
mutually exclusive; there is a direct and critical
relationship between these two concepts.
● There are two distinct, yet related, aspects of order
management: influencing the customer’s order and
executing the customer’s order.
● Customer relationship management (CRM) is a concept
being used today by organizations to help them better
understand their customers’ requirements and
understand how these requirements integrate back into
their internal operations processes.
part.
Summary, continued
● Activity-based costing (ABC) is being used today to help

organizations develop customer profitability profiles
which allow for customer segmentation strategies.
● Order management, or order execution, is the interface
between buyers and sellers in the market and directly
influences customer service.
● Order management can be measured in various ways.
Traditionally, however, buyers will assess the
effectiveness of order management using order cycle
time and dependability as the metric, while sellers will
use the order-to-cash cycle as their metric.
● Customer service is considered the interface between
logistics and marketing in seller organizations.
part.
Summary, continued
● The three definitions of customer service are: (1) as an

activity, (2) as a set of performance metrics, and (3) as a
philosophy.
● The major elements of customer service are time,
dependability, communications, and convenience.
● Stockout costs can be calculated as back order costs,
the cost of lost sales, and/or the cost of a lost customer.
● The five outputs from order management that influence
customer service, customer satisfaction, and profitability
are: (1) product availability, (2) order cycle time, (3)
logistics operations responsiveness, (4) logistics system
information, and (5) postsale logistics support.
part.
Summary, continued
● The concept of service recovery is being used by

organizations today to help identify service failure areas
in their order management process and to develop plans
to address them quickly and accurately.
part.
Transportation in a
7 Supply Chain
to accompany
Chopra and Meindl
Learning Objectives
1. Understand the role of transportation in a supply
chain
2. Evaluate the strengths and weaknesses of different
modes of transportation
3. Discuss the role of infrastructure and policies in
transportation
4. Identify the relative strengths and weaknesses of
various transportation network design options
5. Identify trade-offs that shippers need to consider
when designing a transportation network

The Role of Transportation
in a Supply Chain
• Movement of product from one location to
another
• Products rarely produced and consumed in the
same location
• Significant cost component
• Shipper requires the movement of the product
• Carrier moves or transports the product

Modes of Transportation and Their
Performance Characteristics
• Air
• Package carriers
• Truck
• Rail
• Water
• Pipeline
• Intermodal

Modes of Transportation and Their
Performance Characteristics
Freight Value Added
Freight Value Freight Tons Ton-Miles to GNP
($ billions) (billions) (millions) ($ billions)
Mode in 2002 in 2002 in 2002 in 2009
Air (includes
truck and air) 563 6 13 61.9
Truck 9,075 11,712 1,515 113.1
Rail 392 1,979 1,372 30.8
Water 673 1,668 485 14.3
Pipeline 896 3,529 688 12.0
Multimodal 1,121 229 233
TABLE 14-1

Air
• Cost components
1. Fixed infrastructure and equipment
2. Labor and fuel
3. Variable depending on passenger/cargo
• Key issues
– Location/number of hubs
– Fleet assignment
– Maintenance schedules
– Crew scheduling
– Prices and availability

Package Carriers
• Small packages up to about 150 pounds

• Expensive
• Rapid and reliable delivery
• Small and time-sensitive shipments
• Provide other value-added services
• Consolidation of shipments a key factor

Truck
• Significant fraction of the goods moved
• Truckload (TL)
– Low fixed cost
– Imbalance between flows
• Less than truckload (LTL)
– Small lots
– Hub and spoke system
– May take longer than TL

Rail
• Move commodities over large distances

• High fixed costs in equipment and facilities
• Scheduled to maximize utilization
• Transportation time can be long
– Trains ‘built’ not scheduled

Water
• Limited to certain geographic areas

• Ocean, inland waterway system, coastal
waters
• Very large loads at very low cost
• Slowest
• Dominant in global trade
• Containers

Pipeline
• High fixed cost

• Primarily for crude petroleum, refined
petroleum products, natural gas
• Best for large and stable flows
• Pricing structure encourages use for
predicable component of demand

Intermodal
• Use of more than one mode of
transportation to move a shipment
• Grown considerably with increased use of
containers
• May be the only option for global trade
• More convenient for shippers – one entity
• Key issue – exchange of information to
facilitate transfer between different modes

Transportation Infrastructure
and Policies
• Governments generally take full
responsibility or played a significant role in
building and managing infrastructure
elements
• Without a monopoly, deregulation and
market forces help create an effective
industry structure
• Pricing should reflect the marginal impact
on the cost to society

Transportation Infrastructure
and Policies
FIGURE 14-1

Key Point
Transportation infrastructures often require government

ownership or regulation because of their inherently
monopolistic nature. In the absence of a monopoly,
deregulation and market forces help create an effective
industry structure. When the infrastructure is publicly
owned, it is important to price usage to reflect the
marginal impact on the cost to society. If this is not done,
overuse and congestion result because the cost borne by
a user is less than the user’s marginal impact on total
cost.

Design Options for a
Transportation Network
• When designing a transportation network

1. Should transportation be direct or through an
intermediate site?
2. Should the intermediate site stock product or
only serve as a cross-docking location?
3. Should each delivery route supply a single
destination or multiple destinations (milk run)?

Direct Shipment Network
to Single Destination
FIGURE 14-2

Direct Shipping with Milk Runs
FIGURE 14-3

All Shipments via Intermediate
Distribution Center with Storage
FIGURE 14-4

All Shipments via Intermediate Transit
Point with Storage
• Suppliers send their shipments to a

central distribution center
• Stored until needed by buyers
• Shipped to each buyer location

All Shipments via Intermediate Transit
Point with Cross-Docking
• Suppliers send their shipments to an

intermediate transit point
• They are cross-docked and sent to buyer
locations without storing them

Shipping via DC Using Milk Runs
FIGURE 14-5

Tailored Network
Network Structure Pros Cons
Direct shipping No intermediate warehouse High inventories (due to

Simple to coordinate large lot size)
Direct shipping with Lower transportation costs for small lots Increased coordination
milk runs Lower inventories complexity
All shipments via central Lower inbound transportation cost through Increased inventory cost
DC with inventory storage consolidation Increased handling at DC
All shipments via central Low inventory requirement Increased coordination
DC with cross-dock Lower transportation cost through complexity
consolidation
Shipping via DC using Lower outbound transportation cost for Further increase in
milk runs small lots coordination complexity
Tailored network Transportation choice best matches needs Highest coordination
of individual product and store complexity
TABLE 14-2

Selecting a Transportation Network
• Eight stores, four supply sources

• Truck capacity = 40,000 units
• Cost $1,000 per load, $100 per delivery
• Holding cost = $0.20/year

Annual sales = 960,000/store Direct shipping
Batch size shipped from each

supplier to each store = 40,000 units
Number of shipments/yr from
each supplier to each store = 960,000/40,000 = 24
Annual trucking cost
for direct network = 24 x 1,100 x 4 x 8 = $844,800
Average inventory at each
store for each product = 40,000/2 = 20,000 units
Annual inventory cost
for direct network = 20,000 x 0.2 x 4 x 8 = $128,000
Total annual cost of
direct network = $844,800 + $128,000 = $972,800

Annual sales = 960,000/store Milk runs

supplier to each store = 40,000/2 = 20,000 units
Transportation cost per shipment
per store (two stores/truck) = 1,000/2 + 100 = $600
for direct network = 48 x 600 x 4 x 8 = $921,600
direct network = $921,600 + $64,000 = $985,600
Annual sales = 120,000/store Direct shipping

supplier to each store = 40,000 units
for direct network = 3 x 1,100 x 4 x 8 = $105,600
direct network = $105,600 + $128,000 = $233,600

Annual sales = 120,000/store Milk runs

supplier to each store = 40,000/4 = 10,000 units
Transportation cost per shipment
per store (two stores/truck) = 1,000/4 + 100 = $350
for direct network = 12 x 350 x 4 x 8 = $134,400
direct network = $134,400 + $32,000 = $166,400
Mumbai Dabbawalas
• Lunchbox delivery system

• Factors facilitating success
1. Low uncertainty of demand
2. Temporal aggregation of demand
3. Use of transportation resources when
they are underutilized

Trade-offs in Transportation Design
• Transportation and inventory cost

trade-off
– Choice of transportation mode
– Inventory aggregation
• Transportation cost and
responsiveness trade-off

Trade-offs in Transportation Design
Cycle Safety Transportation Transportation

Mode Inventory Inventory In-Transit Cost Time Cost
Rail 5 5 5 2 5
TL 4 4 4 3 3
LTL 3 3 3 4 4
Package 1 1 1 6 1
Air 2 2 2 5 2
Water 6 6 6 1 6
TABLE 14-3

Trade-offs When Selecting
Transportation Mode
Demand = 120,000 motors, Cost = $120/motor,
Weight = 10 lbs/motor, Lot size = 3,000,
Safety stock = 50% ddlt
Range of Quantity
Carrier Shipped (cwt) Shipping Cost ($/cwt)
AM Railroad 200+ 6.50
Northeast Trucking 100+ 7.50
Golden Freightways 50–150 8.00
Golden Freightways 150–250 6.00
Golden Freightways 250+ 4.00
TABLE 14-4

Transportation Mode
Cycle inventory = Q/2 = 2,000/2 = 1,000 motors
Safety inventory = L/2 days of demand
= (6/2)(120,000/365) = 986 motors
In-transit inventory = 120,000(5/365) = 1,644 motors
Total average inventory = 1,000 + 986 + 1,644
= 3,630 motors
Annual holding cost
using AM Rail = 3,630 x $30 = $108,900
Annual transportation
cost using AM Rail = 120,000 x 0.65 = $78,000
The total annual cost for
inventory and transportation
using AM Rail = $186,900

Transportation Mode
Transpor-
Lot Size tation Cycle Safety In-Transit Inventory
Alternative (Motors) Cost Inventory Inventory Inventory Cost Total Cost
AM Rail 2,000 $78,000 1,000 986 1,644 $108,900 $186,900
Northeast 1,000 $90,000 500 658 986 $64,320 $154,320
Golden 500 $96,000 250 658 986 $56,820 $152,820
Golden 1,500 $96,000 750 658 986 $71,820 $167,820
Golden 2,500 $86,400 1,250 658 986 $86,820 $173,220
Golden 3,000 $80,000 1,500 658 986 $94,320 $174,320
Golden (old 4,000 $72,000 2,000 658 986 $109,320 $181,320

proposal)
Golden (new 4,000 $67,000 2,000 658 986 $109,320 $176,820
proposal)
TABLE 14-5

Key Point
When selecting a mode of transportation, managers

must account for unit costs and cycle, safety, and in-
transit inventory costs that result from using each mode.
Modes with high transportation costs can be justified if
they result in significantly lower inventory costs.

Inventory Aggregation
• Can significantly reduce safety inventories
• Transportation costs generally increase
• Use
– When inventory and facility costs form a large fraction
of a supply chain’s total costs
– For products with a large value-to-weight ratio
– For products with high demand uncertainty

Tradeoffs When
Aggregating Inventory
HighVal – weekly demand  H = 2, H = 5, weight = 0.1 lbs, cost = $200
LowVal – weekly demand  L = 20, L = 5, weight = 0.04 lbs, cost = $30
CSL = 0.997, holding cost = 25%, L = 1 week, T = 4 weeks
UPS lead time = 1 week, $0.66 + 0.26x
FedEx lead time = overnight, $5.53 + 0.53x
• Option A. Keep the current structure but replenish inventory

once a week rather than once every four weeks
• Option B. Eliminate inventories in the territories, aggregate all
inventories in a finished-goods warehouse at Madison, and
replenish the warehouse once a week

Tradeoffs When
1. HighMed inventory costs (current scenario, HighVal)
Average lot size, QH = expected demand during T weeks

= T m H = 4 ´ 2 = 8 units
Safety inventory, ssH = F –1(CSL) ´ s T +L = F –1(CSL) ´ T + L ´ s H
= F –1(0.997) ´ 4 +1´ 5 = 30.7 units
Total HighVal inventory = QH / 2 + ssH = (8 / 2) + 30.7 = 34.7 units
All 24 territories, HighVal inventory = 24 x 34.7 = 832.8 units

Tradeoffs When
1. HighMed inventory costs (current scenario, LowVal)
Average lot size, QL = expected demand during T weeks

= T m H = 4 ´ 20 = 80 units
Safety inventory, ssL = F –1(CSL) ´ s T +L = F –1(CSL) ´ T + L ´ s L
= F –1(0.997) ´ 4 +1´ 5 = 30.7 units
Total LowVal inventory = QL / 2 + ssL = (80 / 2) + 30.7 = 70.7 units
All 24 territories, LowVal inventory = 24 x 70.7 = 1696.8 units

Tradeoffs When
Annual inventory
holding cost
for HighMed = (average HighVal inventory x $200
+ average LowVal inventory x $30) x 0.25
= (832.8 x $200 + 169.8 x $30) x 0.25
= $54,366 ($54,395 without rounding)

Tradeoffs When
2. HighMed transportation cost (current scenario)
Average weight of each replenishment order

= 0.1QH + 0.04QL = 0.1 x 8 + 0.04 x 80 = 4 pounds
Shipping cost per replenishment order
= $0.66 + 0.26 x 4 = $1.70
Annual transportation cost = $1.70 x 13 x 24 = $530
3. HighMed total cost (current scenario)
Annual inventory and transportation cost at HighMed

= inventory cost + transportation cost
= $54,366 + $530 = $54,896
Tradeoffs When
Current Scenario Option A Option B
Number of stocking locations 24 24 1
Reorder interval 4 weeks 1 week 1 week
HighVal cycle inventory 96 units 24 units 24 units
HighVal safety inventory 737.3 units 466.3 units 95.2 units
HighVal inventory 833.3 units 490.3 units 119.2 units
LowVal cycle inventory 960 units 240 units 240 units
LowVal safety inventory 737.3 units 466.3 units 95.2 units
LowVal inventory 1,697.3 units 706.3 units 335.2 units
Annual inventory cost $54,395 $29,813 $8,473
Shipment type Replenishment Replenishment Customer order
Shipment size 8 HighVal + 80 LowVal 2 HighVal + 20 LowVal 1 HighVal + 10 LowVal
Shipment weight 4 lbs. 1 lb. 0.5 lb.
Annual transport cost $530 $1,148 $14,464
Total annual cost $54,926 $30,961 $22,938
TABLE 14-6

Tradeoffs When
Average weight of
each customer order = 0.1 x 0.5 + 0.04 x 5 = 0.25 pounds
Shipping cost per
customer order = $5.53 + 0.53 x 0.25 = $5.66
Number of customer orders
per territory per week = 4
Total customer orders
per year = 4 x 24 x 52 = 4,992
Annual transportation cost = 4,992 x $5.66 = $28,255
Total annual cost = inventory cost
+ transportation cost
= $8,474 + $28,255 = $36,729

Tradeoffs When
Aggregate Disaggregate
Transport cost Low High
Demand uncertainty High Low
Holding cost High Low
Customer order size Large Small
TABLE 14-7

Key Point
Inventory aggregation decisions must account for

inventory and transportation costs. Inventory
aggregation decreases supply chain costs if the product
has a high value-to-weight ratio, high demand
uncertainty, low transportation cost, and customer
orders are large. If a product has a low value-to-weight
ratio, low demand uncertainty, large transportation cost,
or small customer orders, inventory aggregation may
increase supply chain costs.

Trade-off Between Transportation Cost
and Customer Responsiveness
• Closely linked to degree of responsiveness

– High responsiveness, high transportation costs
– Decreased responsiveness, lower
transportation costs
• Temporal aggregation – combining orders
across time

and Responsiveness
Steel shipments LTL = $100 + 0.01x
Monday Tuesday Wednesday Thursday Friday Saturday Sunday
Week 1 19,970 17,470 11,316 26,192 20,263 8,381 25,377
Week 2 39,171 2,158 20,633 23,370 24,100 19,603 18,442
TABLE 14-8

and Responsiveness TABLE 14-9
Two-Day Response Three-Day Response Four-Day Response
Quantity Quantity Quantity
Day Demand Shipped Cost ($) Shipped Cost ($) Shipped Cost ($)
1 19,970 19,970 299.70 0 0
2 17,470 17,470 274.70 37,440 474.40 0
3 11,316 11,316 213.16 0 48,756 586.56
4 26,192 26,192 361.92 37,508 475.08 0
5 20,263 20,263 302.63 0 0
6 8,381 8,381 183.81 28,644 386.44 54,836 648.36
7 25,377 25,377 353.77 0 0
8 39,171 39,171 491.71 64,548 745.48 0
9 2,158 2,158 121.58 0 66,706 767.06
10 20,633 20,633 306.33 22,791 327.91 0
11 23,370 23,370 333.70 0 0
12 24,100 24,100 341.00 47,70 574.70 68,103 781.03
13 19,603 19,603 296.03 0 0
14 18,442 18,442 284.42 38,045 480.45 38,045 480.45
$4,164.46 $3,464.46 $3,264.46
Key Point
Temporal aggregation of demand results in a reduction of

transportation costs because it entails larger shipments
and reduces the variation in shipment sizes from one
shipment to the next. It does, however, hurt customer
response time. The marginal benefit of temporal
aggregation declines as the time window over which
aggregation takes place increases.

Tailored Transportation
• The use of different transportation networks
and modes based on customer and product
characteristics
• Factors affecting tailoring
– Customer density and distance
– Customer size
• Transportation cost based on total route distance
• Delivery cost based on number of deliveries
– Product demand and value

Short Distance Medium Distance Long Distance

High density Private fleet with Cross-dock with Cross-dock with
milk runs milk runs milk runs
Medium density Third-party milk runs LTL carrier LTL or package
carrier
Low density Third-party milk runs LTL or package Package carrier
or LTL carrier carrier
TABLE 14-10

Product Type High Value Low Value

High demand Disaggregate cycle inventory. Disaggregate all inventories and
Aggregate safety inventory. use inexpensive mode of
Inexpensive mode of transportation for replenishment.
transportation for replenishing
cycle inventory and fast mode
when using safety inventory.
Low demand Aggregate all inventories. If Aggregate only safety inventory.
needed, use fast mode of Use inexpensive mode of
transportation for filling transportation for replenishing
customer orders. cycle inventory.
TABLE 14-11

Key Point
Tailoring transportation based on customer

density and distance, customer size, or product
demand and value allows a supply chain to
achieve appropriate responsiveness and low
cost.

Role of IT in Transportation
• The complexity of transportation decisions
demands use of IT systems
• IT software can assist in:
– Identification of optimal routes by minimizing
costs subject to delivery constraints
– Optimal fleet utilization
– GPS applications

Making Transportation
Decisions in Practice
1. Align transportation strategy with competitive

strategy
2. Consider both in-house and outsourced
transportation
3. Use technology to improve transportation
performance
4. Design flexibility into the transportation
network

1. Understand the role of transportation in a supply chain
2. Evaluate the strengths and weaknesses of different
modes of transportation
3. Discuss the role of infrastructure and policies in
transportation
4. Identify the relative strengths and weaknesses of
various transportation network design options
5. Identify trade-offs that shippers need to consider when
designing a transportation network

Chapter89
MANAGING
INVENTORY IN THE
SUPPLY CHAIN
Learning Objectives
● Appreciate the role and importance of

inventory in the economy.
● List the major reasons for carrying
inventory.
● Discuss the major types of inventory, their
costs, and their relationships to inventory
decisions.
● Understand the fundamental differences
among approaches to managing inventory.
part.
● Describe the rationale and logic behind the

economic order quantity (EOQ) approach
to inventory decision making, and be able
to solve some problems of a simple
nature.
● Understand alternative approaches to
managing inventory—just-in-time (JIT),
materials requirement planning (MRP),
distribution requirements planning (DRP),
and vendor-managed inventory (VMI).
part.
● Explain how inventory items can be

classified.
● Know how inventory will vary as the
number of stocking points changes.
● Make needed adjustments to the basic
EOQ approach to respond to several
special types of applications.
part.
Introduction
● Inventory is an asset on the balance sheet
and a variable expense on the income
statement.
● Inventories also have an impact on return
on investment (ROI) for the firm.
● Inventories also have an impact on return
on investment (ROI) for an organization.
part.
Inventory in the U.S. Economy
● Nominal GDP grew by 106.7 percent
between 1994 and 2010.
● The value of inventory increased by 83.1
percent during the same time period.
● Inventory costs as a percent of GDP
declined from 15.9 percent in 1994 to 14.1
percent in 2010.
part.
Table 9.1
Macro Inventory vs. GDP
Source: 22nd Annual State of Logistics Report, CSCMP 2011

part.
Inventory in the Firm
● Batching Economies or Cycle Stocks
• Arises from three sources.
○ procurement
○ production
○ transportation
● Uncertainty and Safety Stocks

• All organizations are faced with uncertainty.
• On the demand side, there is usually uncertainty in
how much customers will buy and when they will buy
it.
part.
Inventory in the Firm, continued
● Uncertainty and Safety Stocks, continued

• On the supply side, there might be uncertainty about
obtaining what is needed from suppliers and how long
it will take for the fulfillment of the order.
● Time/In-Transit and Work-in-Process
Stocks
• The time associated with transportation means that
even while goods are in motion, an inventory cost is
associated with the time period. The longer the time,
the higher the cost.
part.
● Time/In-Transit and Work-in-Process

Stocks, continued
• WIP inventories, associated with manufacturing, can
be significant while the length of time the inventory
sits in a manufacturing facility waiting and should be
carefully evaluated in relationship to scheduling
techniques and the actual manufacturing/assembly
technology.
● Seasonal Stocks
• Seasonality can occur in the supply of raw materials,
in the demand for finished product, or in both.
• Those faced with seasonality issues are constantly
challenged when determining how much inventory to
accumulate.
part.
● Seasonal Stocks, continued

• Seasonality can impact transportation.
● Anticipatory Stocks
• A fifth reason to hold inventory arises when an
organization anticipates that an unusual event might
occur that will negatively impact its source of supply.
● The Importance of Inventory in Other
Functional Areas
• Logistics interfaces with an organization’s other
functional areas.
○ Marketing
○ Manufacturing
○ Finance
part.
Table 9.2
Logistics Costs – 2010
Source: 22nd Annual State of Logistics Report, CSCMP 2011

part.
Figure 9.1
ABC Power Tools – In-Transit Inventory Analysis

part.
Table 9.3
ABC Power Tools In-Transit Inventory Analysis – Current

part.
Table 9.4
ABC Power Tools In-Transit Inventory Analysis –
Proposed

part.
Inventory Costs
● Inventory Carrying Costs

• Capital Cost (interest or opportunity cost)
○ cost of capital tied up in inventory and the resulting lost
opportunity from investing that capital elsewhere
○ hurdle rate
○ weighted average cost of capital (WACC)
● Storage Space Cost

• Includes handling costs associated with moving
products into and out of inventory, as well as such
costs as rent, heat, and light.
• Can be variable.
part.
Inventory Costs, continued
● Inventory Service Cost

• Includes insurance and taxes.
● Inventory Risk Cost
• Reflects the possibility that inventory value might
decline for reasons beyond firm’s control.
● Calculating the Cost of Carrying Inventory
• First, determine the value of the item stored in
inventory.
• Second, determine the cost of each individual
carrying cost component to determine the total direct
costs consumed by the item while being held in
inventory.
• Third, divide the total costs calculated in Step 2 by the
value of the item determined in Step 1. 17
part.
Table 9.5
ABC Power Tools – Inventory Carrying cost for Item 1

part.
Table 9.6
ABC Power Tools – Inventory Carrying cost for Item 1 to
Customer

part.
Table 9.7
Inventory Carrying Costs for ABC Power Tools

part.
● Order and Setup Cost

• Order Cost
○ cost of placing order which may have both fixed and variable
components
• Setup Costs
○ expenses incurred each time an organization modifies a
production or assembly line to produce a different item for
inventory
● Expected Stockout Cost

• Back order - results in the vendor incurring incremental variable
costs associated with processing the extra shipment.
• Customer might decide to purchase a competitor’s product
resulting in a direct loss for the supplier.
• Customer might decide to permanently switch to a competitor’s
product with loss of income.
part.
Table 9.9
Summary of Inventory and Order Cost
Source: C. John Langley, Ph.D.

part.
Figure 9.2
Inventory Costs

part.
● In-Transit Inventory Carrying Cost

• Owner of product while it is in transit will incur
resulting carrying costs.
• In-transit inventory carrying cost becomes especially
important on global moves since both distance and
time from the shipping location both increase.
• Owner should consider its delivery time part of its
inventory carrying cost.
● Key Differences Among Approaches to
Managing Inventory
• Dependent versus Independent Demand
○ independent when such demand is unrelated to the demand
for other items
○ dependent when it is directly related, or derives from, the
demand for another inventory item or product
part.
Figure 9.3
Safety Stocks and Service Levels

part.
Figure 9.4
Inventory and Service Levels

part.
● Key Differences Among Approaches to

Managing Inventory, continued
• Pull versus Push
○ The “pull” approach relies on customer orders to move
product through a logistics system, while the “push” approach
uses inventory replenishment techniques in anticipation of
demand to move products
● Principle Approaches & Techniques for

Inventory Management
• Fixed order quantity model involves ordering a fixed
amount of product each time reordering takes place
part.

Inventory Management, continued
• Simple EOQ Model
○ The following are the basic assumptions of the simple EOQ
model:
 A continuous, constant, and known rate of demand
 A constant and known replenishment or lead time
 All demand is satisfied
 A constant price or cost that is independent of the order
quantity (i.e., no quantity discounts)
 No inventory in transit
 One item of inventory or no interaction between items
 Infinite planning horizon
 Unlimited capital
part.
Figure 9.5
Fixed Order Quantity Model with Certainty
Source: John C. Coyle, DBA

part.
Figure 9.8
Inventory Costs

part.

Inventory Management, continued
• Simple EOQ Model, continued
○ Mathematical formulation
part.
Figure 9.11
Graphical Representation of EOQ

part.
Figure 9.12
Fixed Order Quantity with Uncertainty

part.
Figure 9.13
Normal Distribution

part.
Additional Approaches to Inventory
Management
● The Just-in-Time (JIT) Approach
• Four major elements underlie the JIT
approach.
○ zero inventories
○ short, consistent lead times
○ small, frequent replenishment quantities
○ high quality, or zero defects
● Materials Requirements Planning

• Deals specifically with supplying materials and
component parts whose demand depends on the
demand for a specific end product.
part.
Additional Approaches to Inventory Management, continued
● Materials Requirements Planning, continued

• Consists of a set of logically related procedures,
decision rules, and records designed to translate a
master production schedule into time-phased net
inventory requirements and the planned coverage of
such requirements for each component item needed
to implement this plan.
• Uses the following elements:
○ Master production schedule (MPS)
○ Bill of materials file (BOM)
○ Inventory status file (ISF)
○ MRP program
○ Outputs and reports
part.
Figure 9.18
Normal Distribution
Source: Adapted from William M. Boyst III, “JIT American Style”, Proceedings of the 1988 conference
of the American Production and Inventory Control Society (1988) 468
part.
Figure 9.15
An MRP System

part.
Figure 9.16
MRP Egg Timer Example

part.
Table 9.19
Inventory Status File: MRP Egg Timer Example

part.
Figure 9.17
Master Schedule: MRP Egg Timer Example

part.
● Distribution Requirements Planning (DRP)

• Purpose is to more accurately forecast demand and
to explode that information back to develop
production schedules.
• Firm can minimize inbound inventory in conjunction
with production schedules.
• Outbound (finished goods) inventory is minimized
• DRP develops a projection for each SKU requiring the
following:
○ Forecast of demand for each SKU
○ Current inventory level of the SKU (balance on hand, BOH)
○ Target safety stock
○ Recommended replenishment quantity
○ Lead time for replenishment
part.
Table 9.20
DRP Table for Chicken Soup
Source: A.J. Stenger, “Distribution Resources Planning”, Penn State Univ. class example
part.
● Vendor-Managed Inventory (VMI)

• The basic principles:
○ The supplier and its customer agree on which products are to
be managed using in the customer’s distribution centers.
○ An agreement is made on reorder points and economic order
quantities for each of these products.
○ As these products are shipped from the customer’s
distribution center, the customer notifies the supplier, by
SKU, of the volumes shipped on a real-time basis.
part.
Figure 9.19
Inventory Management Techniques in the Logistics
Network

part.
Classifying Inventory
● ABC Analysis
• Assigns inventory items to one of three groups
according to the relative impact or value of the items.
○ A items are considered to be the most important
○ B items being of lesser importance
○ C items being the least important
• Pareto’s Law, or the “80–20 Rule”
○ Many situations were dominated by a relatively few vital
elements
part.
Figure 9.20
ABC Inventory Analysis

part.
Table 9.21
ABC Analysis for Big Orange

part.
Figure 9.21
Quadrant Model

part.
Classifying Inventory, continued
● Inventory at Multiple Locations—The

Square-Root Rule
• The square-root rule states that total safety stock
inventories in a future number of facilities can be
approximated by multiplying the total amount of
inventory in existing facilities by the square root of the
number of future facilities divided by the number of
existing facilities.
part.
Table 9.22
Example of Square-Root Rule of Inventories

part.
Summary
● Inventory as a percent of overall business activity
continues to decline. Explanatory factors include greater
expertise in managing inventory, innovations in
information technology, greater competitiveness in
markets for transportation services, and emphasis on
reducing cost through the elimination of non-value-
adding activities.
● As product lines proliferate and the number of SKUs
increases, the cost of carrying inventory becomes a
significant expense of doing business.
● There are a number of principal reasons for carrying
inventories. Types of inventory include cycle stock, work-
in-process, inventory in transit, safety stock, seasonal
stock, anticipatory stock, and anticipatory stock. 52
part.
Summary, continued
● Principal types of inventory cost are inventory carrying

cost, ordering and setup cost, expected stockout cost,
and in-transit inventory carrying cost.
● Inventory carrying cost is composed of capital cost,
storage space cost, inventory service cost, and inventory
risk cost. There are precise methods to calculate each of
these costs.
● Choosing the appropriate inventory model or technique
should include an analysis of key differences that affect
the inventory decision. These differences are determined
by the following questions: (1) Is the demand for the item
independent or dependent? (2) Is the distribution system
based upon a push or pull approach? (3) Do the
inventory decisions apply to one facility or to multiple
facilities?
part.
Summary, continued
● Traditionally, inventory managers focused on two

important questions to improve efficiency, namely, how
much to reorder from suppliers and when to reorder.
● The two aforementioned questions were frequently
answered using the EOQ model, trading inventory
carrying cost against ordering costs, and then calculating
a reorder point based on demand or usage rates.
● The two basic forms of the EOQ model are the fixed
quantity model and the fixed interval model. The former
is the most widely used. Essentially, the relevant costs
are analyzed (traded off), and an optimum quantity is
decided. This reorder quantity will remain fixed unless
costs change, but the intervals between orders will vary
depending on demand.
part.
Summary, continued
● The basic EOQ model can be varied or adapted to focus

more specifically on decisions that are impacted by
inventory-related costs, such as shipment quantities
where price discounts are involved.
● Just-in-time inventory management captured the
attention of many U.S. organizations during the 1970s,
especially the automobile industry. As the name implies,
the basic goal is to minimize inventory levels with an
emphasis on frequent deliveries of smaller quantities and
alliances with suppliers or customers. To be most
effective, JIT should also include quality management.
part.
Summary, continued
● Materials requirements planning and distribution

requirements planning are typically used in conjunction
with each other. In addition, a master production
schedule is utilized to help balance demand and supply
of inventory. DRP is used on the outbound side of a
logistics system. Demand forecasts of individual SKUs
are developed to drive the DRP model. Then, an MPS
schedule is developed to meet the scheduled demand
replenishment requirements.
● VMI is used to manage an organization’s inventories in
its customers’ distribution centers. Using pull data,
suppliers monitor inventory levels and create orders to
ship product to bring inventory levels up to an economic
order quantity in the customers’ distribution centers.
part.
Summary, continued
● ABC analysis is a useful tool to improve the

effectiveness of inventory management. Another useful
tool is the quadrant model.
● When organizations are adding warehouses to their
logistics networks, a frequently asked question is, “How
much additional inventory will be required?” The square
root rule is a technique that can be used to help answer
this question.
part.
1
ECONOMIC ORDER QUANTITY
EOQ
• It assumes that there is an optimal and
economically feasible order quantity, so that
inventory costs at this quantity are at the
lowest levels.
• Basic EOQ Model
2
In case of purchasing the items used to produce the product from a supplier.
EOQ
Annual Total Cost
cost ($)
Slope = 0
CcQ
Carrying Cost =
Minimum 2
total cost
CoD
Ordering Cost =
Q
Order Quantity, Q
Optimal order
Qopt
3
Basic EOQ Model
Model Assumptions
- The quantity of the order is precisely known, and
fixed over time.
- The rate of consumption is constant.
- Stock out of stock is not allowed.
- The lead time is always fixed.
- The required quantity is received at once.
4
• Inventory requisition cycle:
5
costs of EOQ model
D - annual demand Co - cost of placing order
Q - order quantity Cc - annual per-unit carrying cost
Deriving Qopt Proving equality of costs at

optimal point
Co D CcQ
TC = +
Q 2 Co D CcQ
=
TC Co D Cc Q 2
= +
Q Q2 2
2CoD
C0 D Cc Q2 =
Cc
0= 2 +
Q 2
2CoD
2CoD Qopt =
Qopt = Cc
Cc
6
D = 10,000 yards Co = $150 Cc = $0.75 per yard
2CoD CoD CcQ

Qopt = TCmin = +
Cc Q 2
2(150)(10,000) (150)(10,000) (0.75)(2,000)
Qopt = TCmin = +
(0.75) 2,000 2
Qopt = 2,000 yards TCmin = $750 + $750 = $1,500
7
Reorder point
Reorder point is a certain level of stock, if the •
stock is reached, a new quantity is requested.
R = dL
where
d = Daily demand rate.
L = lead time.
8
Order quantity, Q
Demand
rate
Inventory Level
Reorder point, R
0 Time
Lead Lead
time time
Order Order Order Order
placed receipt placed receipt
9
Reorder point
Annual Demand = D = 10,000 yards/year
(Store open 311 days/year)
Daily demand = d = 10,000 ÷ 311 = 32.154 yards/day
Lead time = L = 10 days
R = dL = (32.154)(10) = 321.54 yards
10
Production Quantity Model
• Second: Production Quantity Model:
• It is an inventory system in which the new
quantity is received gradually, and at the same
time the old quantities are being used up.
• It is a non-instant system.
• (The immediate system assumes that receiving
the required quantity at once is more
convenient).
• P = daily production rate
• d = Average daily demand for inventory
11
In case producing the items used to
produce the product inside the same
company
Inventory
level
Maximum
Q(1-d/p) inventory
level
Average
Q
(1-d/p) inventory
2
level
0
Begin End Time
order order
Order
receipt receipt
receipt period
12
d = demand rate p = production rate
Q
Maximum inventory level = Q - d
p
=Q 1- d
p 2CoD
Qopt =
Q d Cc 1 - d
Average inventory level =
2
1-
p p
CoD CcQ d
TC = + 1-
Q 2 p
13
In case of given as percent

p = 150 yards per day d = 10,000/311 = 32.2 yards per day
2CoD 2(150)(10,000)
Qopt = = = 2,256.8 yards
Cc 1- d 0.75 1 -
32.2
p 150
Co D CcQ d
TC = Q + 2 1 - p = $1,329
Q 2,256.8
Production run = = = 15.05 days per order
p 150
14
15
Economic Order Quality
Follow chapter 8
“EOQ”
 It is the most important technique that used to manage
inventory using the data of carrying cost and order cost to
DECREASE the total cost of inventory as a follow:
Total Cost carrying Cost
Annual Cost
Order Cost
Order Quantity “Units”

 We can use the basic formulas for this model as a follow:-
1- EOQ or “Q” = 2xRxA

VxW
 R= annual rate of the Demanded unites
 A= cost of placing an order
 V= Cost of one unit of inventory
 Or “the price per units”
 W= inventory carrying cost per unit per year
2- Total Cost = Carrying Cost + Ordering Cost
 Carrying cost = Q/2 x V x W
 Ordering Cost = Number of orders x A
 Numbers of orders = R/Q
Example “1”:
An item has an annual demand of 25000 Units, A unit cost of $10 and
order preparation cost of $10, and a carrying cost of 20%.
I- Calculate the EOQ. Use both formula and graph to show your answer
and determine numbers of orders.
500 000
I-EOQ = 2 x 10 x 25 000 = = 250 000 = 500 Units
0.2 x 10 2
carrying Cost
$
1000
II- Optimal number of orders = 25000 500
500
Order Cost
500
= 50 orders “Units”
II- Optimal number of orders = 25000 = 50 orders
500
III- Calculate total cost?
Carrying cost = ordering cost
0.2 x 500 x 10 = 500 10 x 50 = 500

2
 Total cost = 500+500 = $1000
Example “2”:
 If the supplier offers a discount of 2% an order of 1000 units or more.
Should the offer be accepted?
Total cost
Without discount With discount

ordering Cost
EOQ = 500 Carrying Cost = Number of orders x A
Total cost = 1000 = 0.2 x 1000/2 x 9.8 = 25000\1000
= $980 =25
=25x10
=250
Total cost = 980 + 250 = 1230
We DON’T accept the discount
6
Not: the price after discount = 10 x.98 = 9.8
Example “3”:
 If we have the following data:
 EOQ = 200 Units\Order
 Price\Unit= 50 LE
 Demand (annual) = 1000 units
 Order cost = 100
 Carrying cost = 10%
 Discount 10% if buying 250 units ( or more) per order
Should you accept the discount ?

Answers:
Total Cost
carrying Cost
$
Order Cost
Q = 200 “Units”
Without Discount
Example “4”:
 If we have the following data:

 The annual Demand = 49000 Units
 The unit price = $100
 The carrying cost = 0.2
 The ordering cost = $100
1- Determine EOQ and number of order
2- if we have discount = 5%, Should we accept if you knew the discount
on 1000 unit.
Answer:
1- EOQ = 2 x 100 x 49000 = 200 x 49000 = 490000 = 700 Units

0.2 x100 2
2- 49000 \ 700 = 70 Orders
Without With
 Number of Orders = 49000\1000
= 49 Order
• Ordering Cost = 70 x 100 = 7000
 Ordering Cost = 49 x 100 =
• Carrying cost = 0.2 x100x (700\2)
$4900
= 7000
 Carrying cost = 0.2 x (1000\2) x
• Total cost = 7000 + 7000 =
95 = $9500
$14000  Total cost = 4900 + 9500 =
$14400
So, We DONOT Accept
Not: the price after discount=100 x.95 = 95
ECONOMIC ORDER QUANTITY
EOQ
• It assumes that there is an optimal and

economically feasible order quantity, so that
inventory costs at this quantity are at the
lowest levels.
• Basic EOQ Model
1
EOQ
Annual Total Cost
cost ($)
Slope = 0
CcQ
Minimum Carrying Cost =
total cost 2
CoD
Ordering Cost =
Q
Optimal order Order Quantity, Q

Qopt
2
Basic EOQ Model
Model Assumptions
- The quantity of the order is precisely known, and
fixed over time.
- The rate of consumption is constant.
- Stock out of stock is not allowed.
- The lead time is always fixed.
- The required quantity is received at once.
3
• Inventory requisition cycle:
Order quantity, Q
Demand
rate
Inventory Level
Reorder point, R
0 Lead Lead Time

time time
4
• costs of model EOQ:
D - annual demand Co - cost of placing order

Q - order quantityCc - annual per-unit carrying cost
CoD
Annual ordering cost =
Q
CcQ
Annual carrying cost =
2
CoD CcQ
Total cost = Q + 2
5
Deriving Qopt Proving equality of costs at
optimal point
Co D CcQ
TC = +
Q 2 Co D CcQ
=
TC Co D Cc Q 2
= +
Q Q2 2
2CoD
C0 D Q2 =
Cc Cc
0= 2 +
Q 2
2CoD
2CoD Qopt =
Qopt = Cc
Cc
6
Annual Total Cost
cost ($)
Slope = 0
CcQ
Minimum Carrying Cost =
total cost 2
CoD
Ordering Cost =
Q
Optimal order Order Quantity, Q

Qopt
7
2CoD CoD CcQ

Qopt = TCmin = +
Cc Q 2
2(150)(10,000) (150)(10,000) (0.75)(2,000)
Qopt = TCmin = +
(0.75) 2,000 2
Qopt = 2,000 yards TCmin = $750 + $750 = $1,500
8
Quantity discount
CoD CcQ
TC = + + PD
Q 2
where
P = price per unit.
D = annual demand.
9
Example
QUANTITY PRICE
1 - 49 $1,400
50 - 89 1,100
90+ 900
Co = $2,500
Cc = $190 per computer
D = 200
10
solution
Qopt = 2CoD = 2(2500)(200) = 72.5 PCs

Cc 190
For Q = 72.5 TC = CoD + CcQopt + PD = $233,784

Qopt 2
For Q = 90 TC = CoD + CcQ + PD = $194,105

Q 2
11
Example 2
QUANTITY PRICE
1 - 49 $1,400
50 - 89 1,100
90+ 900
Co = $3000
Cc = $3000 per computer
D = 200
12
soluion
Qopt = 2CoD = 2(3000)(200) = 20 PCs
Cc 3000
For Q = 20 TC = CoD + CcQopt + PD = $340,000

Qopt 2
For Q = 50 TC = CoD + CcQ + PD = $289,000

Q 2
For Q = 90 TC = CoD + CcQ + PD = $450,666

Q 2
13
ORDER SIZE PRICE
$100 - 99 TC = ($10 )
100 – 199 8 (d1)
200+ 6 (d2)
TC (d1 = $8 )
TC (d2 = $6 )
Inventory cost ($)
Carrying cost
Ordering cost
Q(d1 ) = 100 Qopt Q(d2 ) = 200

14
Reorder point
Reorder point is a certain level of stock, if the •
stock is reached, a new quantity is requested.
R = dL
where
d = Daily demand rate.
L = lead time.
15
Order quantity, Q
Inventory Level Demand
rate
: ‫• دورة طلب المخزون‬
Reorder point, R
0 Time
Lead Lead
time time
16
Reorder point
Demand = D = 10,000 yards/year
(Store open 311 days/year)
Daily demand = d = 10,000 / 311 = 32.154 yards/day
Lead time = L = 10 days
R = dL = (32.154)(10) = 321.54 yards
17
Production Quantity Model
• Second: Production Quantity Model:
• It is an inventory system in which the new
quantity is received gradually, and at the same
time the old quantities are being used up.
• It is a non-instant system.
• (The immediate system assumes that receiving
the required quantity at once is more
convenient).
• P = daily production rate
• d = Average daily demand for inventory‫عل‬
18
Inventory
level
Maximum
Q(1-d/p) inventory
level
Average
Q
(1-d/p) inventory
2
level
0
Begin End Time
order order
Order
receipt receipt
receipt period
19
d = demand rate p = production rate
Q
Maximum inventory level = Q - d
p
=Q 1- d
p 2CoD
Qopt =
Q d Cc 1 - d
Average inventory level =
2
1-
p
p
Co D CcQ d
TC = Q + 2 1 - p
20
p = 150 yards per day d = 10,000/311 = 32.2 yards per day
2CoD 2(150)(10,000)
Qopt = = = 2,256.8 yards
Cc 1- d 0.75 1 -
32.2
p 150
Co D CcQ d
TC = Q + 2 1 - p = $1,329
Q 2,256.8
Production run = = = 15.05 days per order
p 150
21
D 10,000
Number of production runs = = = 4.43 runs/year
Q 2,256.8
d 32.2
Maximum inventory level = Q 1 - = 2,256.8 1 -
p 150
= 1,772 yards
22
Reorder point for variable order
R = dL + z d L
where
d =average daily demand
L =lead time
d =the standard deviation of daily demand
z =number of standard deviations
corresponding to the service level
probability
zd L= safety stock
23
Sourcing Decisions in a
9 Supply Chain
to accompany
Chopra and Meindl
Learning Objectives
1. Understand the role of sourcing in a supply
chain
2. Discuss factors that affect the decision to
outsource a supply chain function
3. Identify dimensions of supplier performance
that affect total cost
4. Describe the sharing risk and reward
5. Design a tailored supplier portfolio

The Role of Sourcing
in a Supply Chain
• Purchasing, also procurement, is the process by

which companies acquire raw materials,
components, products, services, or other
resources from suppliers to execute their
operations
• Sourcing – entire set of business processes
required to purchase goods and services
• Outsourcing – supply chain function being
performed by a third party

The Role of Sourcing
in a Supply Chain
• Outsourcing questions
1. Will the third party increase the supply
chain surplus relative to performing the
activity in-house?
2. To what extent do risks grow upon
outsourcing?
3. Are there strategic reasons to outsource?

Benefits of Effective Sourcing Decisions
• Higher quality and lower cost
• Better economies of scale
• Reduced the overall cost of purchasing
• Design collaboration resulting in easier manufacturing and
distribution, lower overall costs
• Facilitate coordination with the supplier and improve
forecasting and planning, lower inventories, improved
matching of supply and demand
• Appropriate sharing of risk and benefits can result in higher
profits for both the supplier and the buyer
• Lower purchase price through the use of auctions

In-House or Outsource?
• Decisions based on supply chain surplus and risk incurred
• Third parties increase surplus through
1. Capacity aggregation
2. Inventory aggregation
3. Transportation aggregation by transportation intermediaries
4. Transportation aggregation by storage intermediaries
5. Warehousing aggregation
6. Procurement aggregation
7. Information aggregation
8. Receivables aggregation
9. Relationship aggregation
10. Lower costs and higher quality

Key Point
A third party may be able to provide a sustainable

growth of the surplus by aggregating to a higher level
than the firm itself. The growth in surplus comes from
aggregating capacity, inventory, inbound or outbound
transportation, warehousing, procurement, information,
receivables, or relationships to a level that the firm
cannot achieve on its own. A growth in surplus may also
occur if the third party has lower costs or higher quality
because of specialization or learning.

Factors Influencing Growth of Surplus
by a Third Party
• Scale
– Large scale it is unlikely that a third party can achieve
further scale economies and increase the surplus
• Uncertainty
– If requirements are highly variable over time, third party
can increase the surplus through aggregation
• Specificity of assets
– If assets required are specific to a firm, a third party is
unlikely to increase the surplus

Factors Influencing Growth of Surplus
by a Third Party
Specificity of Assets Involved in Function

Low High
Firm scale Low High growth in surplus Low to medium growth in
surplus
High Low growth in surplus No growth in surplus unless
cost of capital is lower for
third party
Demand Low Low to medium growth in Low growth in surplus
uncertainty surplus
for firm
High High growth in surplus Low to medium growth in
surplus
TABLE 15-1

Key Point
A firm gains the most by outsourcing to a third

party if its needs are small, highly uncertain, and
shared by other firms sourcing from the same
third party.

Risks of Using a Third Party
1. The process is broken
2. Underestimation of the cost of coordination
3. Reduced customer/supplier contact
4. Loss of internal capability and growth in third-party
power
5. Leakage of sensitive data and information
6. Ineffective contracts
7. Loss of supply chain visibility
8. Negative reputational impact

Strategic Factors in Sourcing
1. Support for the business strategy

2. Improve firm focus

Third-Party Logistics Providers
• Third-party logistics (3PL) providers performs

one or more of the logistics activities relating to
the flow of product, information, and funds that
could be performed by the firm itself

Total Cost of Ownership
Performance
Category Category Components Quantifiable?
Acquisition Costs
Supplier price Labor, material, and overhead Yes
Supplier terms Net payment terms, delivery frequency, Yes
minimum lot size, quantity discounts
Taxes and duties All tariffs and compliance costs Yes
Delivery costs All transportation costs from source to Yes
destination, packaging costs
Incoming quality Cost of inspection, defectives, and rework Yes
costs
Management Cost of managing and planning the Difficult
costs purchase
TABLE 15-2

Performance
Ownership Costs
Inventory costs Supplier inventory, including raw material, Yes
in process and finished goods, in-transit
inventory, finished goods inventory in
supply chain
Warehousing cost Warehousing and material handling costs Yes
to support additional inventory
Manufacturing Cost of manufacturing associated with the Yes
costs sourced part
Production Impact of sourced part on finished Difficult
quality costs product quality
Cycle time costs Impact of sourced part on production Yes
cycle time
TABLE 15-2 continued
Performance
Post-Ownership
Costs
Reputation Reputation impact of quality problems No
Warranty and Warranty and product liability costs Difficult
product liability associated with sourced part
costs
Environmental Environmental costs affected by sourced Difficult
costs part
Supplier Replenishment lead time, on-time To some
capabilities performance, flexibility, information extent
coordination capability, design
coordination capability, supplier viability
TABLE 15-2 continued

Key Point
Supplier performance should be compared

based on the impact on total cost of ownership.
In addition to acquisition costs, ownership and
post-ownership costs should also be considered.
In many instances, a higher acquisition cost is
more than compensated for by lower ownership
and post-ownership costs.

Supplier Selection –
Auctions and Negotiations
• Single sourcing or multiple sourcing
• Selection using
– Offline competitive bids
– Reverse auctions
– Direct negotiations
• Supplier selection should be based on the total
cost of using a supplier

• Auctions are best used when the quantifiable
acquisition cost is the primary component of
total cost
• Auctions are not appropriate if ownership or
post-ownership costs are significant
– Direct negotiations often lead to the best outcome

• Elements of auctions
– Qualify potential suppliers
– Suppliers bid on requirements
– When unit price is important, buyer must specify
performance expectations
– Setting up auctions when not all attributes can be
quantified is difficult
– When there are many important non-price attributes,
use direct negotiations
– Second-price (Vickrey) auctions
– Collusion among bidders

Basic Principles of Negotiation
• The difference between the values of the
buyer and seller is the bargaining surplus
• The goal of each negotiating party is to
capture as much of the bargaining surplus as
possible
– Have a clear idea of your own value and as good
an estimate of the third party’s value as possible
– Look for a fair outcome based on equally or
equitably dividing the bargaining surplus
– A win-win outcome

Sharing Risk and Reward
in the Supply Chain
• Independent actions by two parties often

result in lower profits than could be
acheived
• Stronger firms tend to push risk on to
supply chain partners

Impact of Local Optimization
• Selling compact disks – Independent retailer
Manufacturing cost = $1 Mean demand = 1,000
Wholesale price = $5 Standard deviation = 300
Retail price = $10 Co = $5 Cu = $5
Target service level = 5 / (5 + 5) = 0.5
Order = NORMINV(0.5, 1000, 300) = 1,000 disks
Expected profit = ( p – s)m NORMDIST éë(O – m ) / s ,0,1,1ùû

–( p – s)s NORMDIST éë(O – m ) / s ,0,1,0ùû
–O(c – s)NORMDIST (O, m ,s ,1)
+O( p – c) éë1– NORMDIST (O, m ,s ,1ùû

• Selling compact disks – Independent retailer
Expected profit = $3,803

Manufacturer makes $4,000
Total supply chain profit = $3,803 + $4,000
= $7,803
• Selling compact disks – Vertically integrated
Total supply chain profit = $8,474

Key Point
The absence of risk sharing in a supply chain

results in locally optimal decisions that decrease
the total supply chain profits. In the absence of
risk sharing, retailers aim for a lower level of
product availability than would be required to
maximize supply chain profits.

Sharing Risk to Grow
Supply Chain Profits
• Three approaches to risk sharing increase
overall supply chain profits
1. Buyback or returns
2. Revenue sharing
3. Quantity flexibility

Sharing Risk to Grow
Supply Chain Profits
• Three questions
1. How will risk sharing affect the firm’s profits
and total supply chain profits?
2. Will risk sharing introduce any information
distortion?
3. How will risk sharing influence supplier
performance along key performance
measures?

Sharing Risks Through Buybacks
• Allows a retailer to return unsold inventory up to a
specified amount at an agreed upon price
• Buyback contract
– The manufacturer specifies a wholesale price c and a
buyback price b
– The manufacturer can salvage $sM for any units that the
retailer returns
– The manufacturer has a cost of v per unit produced and the
retail price is p
Expected manufacturing profit = O * (c – v) – (b – sM )

´ expected overstock at retailer

Impact of Risks Sharing
Through Buybacks
• Selling compact disks – Buybacks
Buyback price = $3 Co = $5 – $3 = $2
Cu = $10 – $5 = $5

Order = NORMINV(5/7, 1000, 300) = 1,170 disks
Expected profit = $4,286 Expected overstock = 223

( ) (
Manufacturer profit = 1170 ´ 5 – 1 – 223 ´ 3 = $4,011 )
= $8,297
Buyback Contracts
Optimal
Order Size Expected Expected Expected Expected
Wholesale Buyback for Music Profit for Returns to Profit for Supply
Price c Price b Store Music Store Supplier Supplier Chain Profit
$5 $0 1,000 $3,803 120 $4,000 $7,803
$5 $2 1,096 $4,090 174 $4,035 $8,125
$5 $3 1,170 $4,286 223 $4,009 $8,295
$6 $0 924 $2,841 86 $4,620 $7,461
$6 $2 1,000 $3,043 120 $4,761 $7,804
$6 $4 1,129 $3,346 195 $4,865 $8,211
$7 $0 843 $1,957 57 $5,056 $7,013
$7 $4 1,000 $2,282 120 $5,521 $7,803
$7 $6 1,202 $2,619 247 $5,732 $8,351
TABLE 15-3

Buyback Contracts
• Holding-cost subsidies
– Manufacturers pay retailers a certain amount for every
unit held in inventory over a given period
– Encourage retailers to order more
• Price support
– Manufacturers share the risk of product becoming
obsolete
– Guarantee that in the event they drop prices they will
lower prices for all current inventories

Revenue-Sharing Contracts
• Manufacturer charges the retailer a low wholesale
price c and shares a fraction f of the retailer’s
revenue
– Allows both the manufacturer and retailer to increase
their profits
– Results in lower retailer effort
– Requires an information infrastructure
– Information distortion results in excess inventory in the
supply chain and a greater mismatch of supply and
demand

Cu (1– f ) p – c
CSL* = probability (demand £ O*) = =
Cu + Co (1– f ) p – sR
Expected manufacturers profits = (c – v)O *

+ fp(O * – expected overstock at retailer)
Expected retailer profit

= (1– f ) p(O * – expected overstock at retailer)
+sR ´ expected overstock at retailer – cO *

• Selling compact disks – Revenue sharing
Wholesale price c = $1 sR = 0
Revenue share f = .45 Co = c – sR = $1 – $0 = $1
Cu = (1 – f)p – c = (1 – 0.45) x 10 – 1 = $4.50
Target service level CSL* = 4.5 / (4.5 + 1) = 0.818
Order = NORMINV(4.5/5.5, 1000, 300) = 1,273 disks
Expected profit = $4,369 Expected overstock = 302

Manufacturer profit = $4,068
= $8,437
Optimal Expected
Revenue- Order Size Overstock Expected Expected Expected
Wholesale Sharing for Music at Music Profit for Profit for Supply
Price c Fraction f Store Store Music Store Supplier Chain Profit
$1 0.30 1,320 342 $5,526 $2,934 $8,460
$1 0.45 1,273 302 $4,064 $4,367 $8,431
$1 0.60 1,202 247 $2,619 $5,732 $8,350
$2 0.30 1,170 223 $4,286 $4,009 $8,295
$2 0.45 1,105 179 $2,881 $5,269 $8,150
$2 0.60 1,000 120 $1,521 $6,282 $7,803
TABLE 15-4

Risk Sharing Using
Quantity Flexibility
• Allows the buyer to modify the order (within limits)
after observing demand
• Better matching of supply and demand
• Increased overall supply chain profits if the supplier
has flexible capacity
• Lower levels of information distortion than either
buyback contracts or revenue sharing contracts

Risk Sharing Using
Quantity Flexibility
• Retailer orders O units

• Manufacturer commits to Q = (1 + a)O
• Retailer commits to q = (1 – b)O
• 0 < a, b < 1

Quantity Flexibility Contracts
Expected quantity purchased by retailer, QR
= qF(q) + Q éë1– F(Q)ùû
é æQ – m ö æ q – m öù
+m ê Fs ç ÷ – Fs ç ÷ú
ë è s ø è s øû
é æQ – m ö æ q – m öù
–s ê f s ç ÷ – fs ç ÷ú
ë è s ø è s øû
Expected quantity sold by retailer, DR
= Q éë1– F(Q)ùû
æQ – m ö æq – mö
+m Fs ç ÷ – s fs ç ÷
è s ø è s ø
Expected quantity overstock

at manufacturer = QR – DR
(
Expected retailer profit = DR ´ p + QR – DR sR – QR ´ c )
Expected manufacturer profit = QR ´ c + Q – QR sM – Q ´ v ( )

• Selling compact disks – Quantity flexibility
v = $1 c = $5 p = $10
a = 0.05 b = 0.05 O = 1,017
sR = 0 sM = 0
Manufacturer commits to between
q = (1 – b)O = (1 – 0.05) x 1017 = 966 units
Q = (1 + a)O = (1 + 0.05) x 1017 = 1,068 units

• Selling compact disks – Quantity flexibility
Expected quantity
Total supply
purchased by retailer, QR = 1,015 units
chain profit = $4,038 + $4,007
Expected quantity = $8,045
sold by retailer, DR = 911 units
Expected overstock
at retailer = QR – DR = 1,015 – 911 = 104 units
Expected retailer
profit = DR x p + (QR – DR) – QR x c
= 911 x 10 + (1015 – 911) x 0 – 1015 x 5 = $4,038
Expected
manufacturer profit = QR x c + (Q – QR)sM – Q x v
= 1015 x 5 + (1068 – 1015) x 0 – 1068 x 1= $4,007

Expected
Expected Expected Expected Expected Supply
Wholesale Order Purchase Sale by Profits for Profits for Chain
a b Price c Size O by Retailer Retailer Retailer Supplier Profit
0.00 0.00 $5 1,000 1,000 880 $3,803 $4,000 $7,803
0.05 0.05 $5 1,017 1,014 966 $4,038 $4,004 $8,416
0.20 0.20 $5 1,047 1,023 967 $4,558 $3,858 $8,416
0.00 0.00 $6 924 924 838 $2,841 $4,620 $7,461
0.20 0.20 $6 1,000 1,000 955 $3,547 $4,800 $8,347
0.30 0.30 $6 1,021 1,006 979 $3,752 $4,711 $8,463
0.00 0.00 $7 843 843 786 $1,957 $5,056 $7,013
0.20 0.20 $7 947 972 936 $2,560 $5,666 $8,226
0.40 0.40 $7 1,000 1,000 987 $2,873 $5,600 $8,473
TABLE 15-5

Key Point
Risk sharing in a supply chain increases profits

for both the supplier and the retailer. Risk
sharing mechanisms include buybacks, revenue
sharing, and quantity flexibility. Quantity
flexibility contracts result in lower information
distortion than buyback or revenue-sharing
contracts when a supplier sells to multiple
buyers or the supplier has excess, flexible
capacity.

Contracts to Coordinate
Supply Chain Costs
• Differences in costs at the buyer and supplier can
lead to decisions that increase total supply chain
costs
• A quantity discount contract may encourage the
buyer to purchase a larger quantity which would
result in lower total supply chain costs
• Quantity discounts lead to information distortion
because of order batching

Contracts to Increase Agent Effort
• In many supply chains, agents act on behalf of a

principal and the agents’ efforts affect the reward for
the principal
• A two-part tariff offers the right incentives for the
dealer to exert the appropriate amount of effort
• Threshold contracts increase information distortion
• Offer threshold incentives over a rolling horizon

Contracts to Induce
Performance Improvement
• A buyer may want performance improvement from a
supplier who otherwise would have little incentive to
do so
• A shared-savings contract provides the supplier with
a fraction of the savings that result from performance
improvement
• Effective in aligning supplier and buyer incentives
when the supplier is required to improve
performance and most of the benefits of
improvement accrue to the buyer

Design Collaboration
• 50-70% of spending at a manufacturer comes from
procurement
• 80% of the cost of a purchased part is fixed in the
design phase
• Design collaboration with suppliers can result in
reduced cost, improved quality, and decreased time
to market
• Design for logistics, design for manufacturability
• Modular, adjustable, dimensional customization

Key Point
Supply chain incentives can have unintended

consequences when the third party’s
information and actions are hard to observe. It is
important to understand and address the
negative consequences of these incentives.

Designing a Sourcing Portfolio: Tailored
Sourcing
• Options with regard to whom and where to
source from
– Produce in-house or outsource to a third party
– Will the source be cost efficient or responsive
– Onshoring, near-shoring, and offshoring
• Tailor supplier portfolio based on a variety of
product and market characteristics

Sourcing
Responsive Source Low-Cost Source

Product life cycle Early phase Mature phase
Demand volatility High Low
Demand volume Low High
Product value High Low
Rate of product High Low
obsolescence
Desired quality High Low to medium
Engineering/design High Low
support
Table 15-6

Sourcing
Onshore Near-shore Offshore
Rate of innovation/product High Medium to High Low
variety
Demand volatility High Medium to High Low
Labor content Low Medium to High High
Volume or weight-to-value High High Low
ratio
Impact of supply chain High Medium to High Low
disruption
Inventory costs High Medium to High Low
Engineering/management High High Low
support
Table 15-7

Key Point
Firms must consider a tailored sourcing strategy

that couples responsive onshore or near-shore
sources with low-cost offshore sources. The
responsive onshore sources should focus on
high-value products with high demand volatility,
whereas the low-cost, offshore sources should
focus on lower-value, high-volume products with
high labor content.

Differences Between Direct
and Indirect Materials
Direct Materials Indirect Materials
Use Production Maintenance, repair, and
support operations
Accounting Cost of goods sold Selling, general, and
administrative expenses
(SG&A)
Impact on production Any delay will delay Less direct impact
production
Processing cost relative to Low High
value of transaction
Number of transactions Low High
Table 15-8

Product Categorization
Figure 15-1

Risk Management in Sourcing
• Inability to meet demand on time

• An increase in procurement costs
• Loss of intellectual property

Making Sourcing
Decisions in Practice
1. Use multifunction teams
2. Ensure appropriate coordination across
regions and business units
3. Always evaluate the total cost of
ownership
4. Build long-term relationships with key
suppliers

1. Understand the role of sourcing in a supply chain

2. Discuss factors that affect the decision to outsource a
supply chain function
3. Identify dimensions of supplier performance that affect
total cost
4. Structure successful auctions and negotiations
5. Describe the impact of risk sharing on supplier
performance and information distortion
6. Design a tailored supplier portfolio

Chapter 10
SUPPLY CHAIN
TECHNOLOGY:
Managing Information
Flows
Learning Objectives
● Appreciate the overall importance of

information to supply chain management.
● Understand the role of information
technology in the supply chain.
● Explain the key components of an
integrated supply chain information
system.
● Describe and differentiate between the
primary types of supply chain solutions
and their capabilities.
part.
● Discuss the critical issues in technology

selection and implementation processes.
● Recognize the role of emerging
technologies for improving supply chain
information management.
part.
The Role of Information in the Supply
Chain
● Information requirements
• Accessible
• Relevant
• Accurate
• Timely
• Transferable
part.
The Role of Information in the Supply Chain, continued
● Information technology capabilities

• Information technology has a direct positive impact on
organizational performance, internal and external
collaboration.
● Information technology challenges
• Viewed as a solution rather than a facilitating tool.
• People do not understand or use it properly.
• Supply chain practices not changed to match new
technological capability.
• Patchwork quilt of technologies.
• Poor planning and preparation.
part.
Figure 6.1
Supply Chain Information Flows
Source: Brian J. Gibson, Ph.D.

part.
Table 6.1
Drivers of Sustainable Supply Chain Practice

part.
A Framework for Managing Supply
Chain Information
● Foundation elements
• People
○ Competence of staff influences success
• Processes
○ Must be current and aligned with Supply Chain technology
• Technology
○ Should be based on open systems concept
● Key requirements
• Data collection
• Data synchronization
part.
A Framework for Managing Supply Chain Information, continued
● Differentiating capabilities
• Visibility tools to provide seamless flow of timely
important information.
• Exception management to detect problems and alert
organizations enabling rapid corrective action.
• Automated decision making are in the future but will
take input from exception management systems and
develop the optimal response.
part.
Figure 6.2
Master Model of Supply Chain Excellence
Source: Moore, Manrodt, and Holcomb, Collaboration: Enabling synchronized supply chains, 2005
report on Trends and Issues in Logistics and Transportation, Capgemini 2005
part.
Figure 6.3
Supply Chain Software Categories

part.
SCM Software
● Planning
● Execution
• Supply chain execution tools and suites carry out key
tasks from the time an order is placed until it is
fulfilled. This order-driven category of software
focuses on the day-to-day activities required to buy,
make, and deliver the materials that flow through the
supply chain.
part.
Supply Chain Management Software, continued
● Event Management
• Supply chain event management tools collect data in
real time from multiple sources across the supply
chain and convert them into information that gives
business managers a clear picture of how their supply
chain is performing.
● Business Intelligence
● Related Tools
• Supply chain collaboration
• Data synchronization
• Spreadsheets and database software
part.
Supply Chain Management Software, continued
● Enterprise Resource Planning

• ERP systems are multi-module application software
platforms that help organizations manage the
important parts of their businesses.
• ERP systems branch out to include supplier
relationship management, customer relationship
management, and other supply chain components,
the connections between SCIS and ERP grow
stronger.
• ERP system provides a mechanism for supply chain
members to efficiently share information.
part.
Figure 6.4
SCM Application Adoption Phase
Source: Dan Gilmore, “Annual Gartner Supply Chain Study Highlights”, Supply Chain Digest, 6/18 2010
part.
Supply Chain Technology
Implementation
● Needs assessment
● Software selection
• Develop alternatives
• Solutions packages
• Purchase options
● Technical issues
• Data standardization
• Application integration
● Asking the right questions
part.
Supply Chain Technology Innovation
● Radio frequency Identification (RFID)

• RFID is an automatic identification method. RFID tags
consist of a microchip and a printed antenna that can
be packaged into many forms, such as a label, or
imbedded in between the cardboard layers in a carton
or product packaging.
• RFID technology costs must continue to decline to
make product tagging economically feasible;
equipment issues such as reader range, sensitivity,
and durability must improve; the case for supplier
return on investment of RFID mandates must be
made; and consumer privacy issues must be
resolved.
part.
Supply Chain Technology Innovation, continued
● Cloud Computing
• The excitement around cloud computing is based on
its economic, architectural, and strategic value.
• Allows companies to focus on core competence while
allowing a third party expert to manage technical
elements at a competitive price.
• At its most basic is an extension of on-demand
computing. The next level enables economies
through shared resources. At the highest level, which
is not yet recognized, it allows the automation of
hundreds of processes throughout the supply chain.
● Mobile Computing
• Supply chain execution and event management is
going mobile with basic visibility and traceability.
part.
Supply Chain Technology Innovation, continued
● 3PLs as Technology Providers

• The next logical step in their development is to take
on managerial roles and strategic activities. Cost
continues to be a driver of this trend as 3PLs can offer
scale economies
part.
Table 6.2
Sources of Additional Information

part.
Summary
● In order for supply chain managers to utilize information,
it must be readily accessible, relevant to their decision
making needs, accurate, timely, and in a format that can
be shared.
● When properly implemented, information technology
supports critical supply chain capabilities and strategies,
including supply chain connectivity, product visibility,
partner collaboration, and process optimization.
● A well-designed SCIS framework links people,
processes, and technology in a manner that provides
actionable information and enhances decision making.
part.
Summary, continued
● Timely data collection and synchronization support

supply chain visibility, exception management, and
effective response to changing customer requirements.
● Supply chain software falls into four general categories:
planning tools for forecasting and related activities,
execution systems for management of day-to-day
processes, event management tools to monitor supply
chain flows, and business intelligence applications that
help organizations analyze performance.
● Given the potential stumbling blocks, software selection
and implementation are not a minor undertaking. Needs
must be assessed, software options studied, technical
issues addressed, and important questions asked before
major SCIS investments are made.
part.
Summary, continued
● Change is the norm when it comes to supply chain

technologies. It is critical that developments related to
RFID and other innovations are understood so that
organizations can take full advantage of worthwhile
technologies.
part.

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Understanding the

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• Maximize overall value generated

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Supply chain design, planning, and

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Supply chain decision phases may be

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A cycle view of the supply chain clearly

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A push/pull view of the supply chain

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Within a firm, all supply chain activities

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● Understand the role and importance of

● Explain the relationships between logistics

Source: Center for Supply Chain Research, Penn State University.

Source: Adapted from Stephen H. Russell, “A General Theory of Logistics Practices”,

Source: Center for Supply Chain Research, Penn State University

Source: Council of Supply Chain Management Professionals

Source: Council of Supply Chain Management Professionals

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

COST CENTER RAIL MOTOR

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

Source: Center for Supply Chain Research, Penn State University

● Logistics is an area of management that has four sub-

● Logistics systems can be viewed or approached in

1. Identify the major drivers of supply chain