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Supply Chain Strategy

Chapter 10

© 2007 Pearson Education

How Supply Chain Strategy
fits the Operations Management

Operations As a Competitive
Operations Strategy
Project Management Process Strategy
Process Analysis
Process Performance and Quality
Constraint Management
Process Layout Supply Chain Strategy
Lean Systems Location
Inventory Management
Sales and Operations Planning
Resource Planning

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Dell, Inc.

 Dell is a leader because of their fast response time.

 Customer orders are on delivery trucks in 36 hours.
 Their focus is on how fast inventory moves.
 The bulk of its components are housed within 15
minutes of each of its plants.
 As customers place orders, suppliers know when to
ship components.
 Suppliers restock the warehouse and manage the
 Careful supply chain management is the key.

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Supply Chain

 Supply chain: The network of services, material,

and information flows that link a firm’s customer
relationship, order fulfillment, and supplier
relationship processes to those of its supplier and
 Supply chain management: Developing a strategy
to organize, control, and motivate the resources
involved in the flow of services and materials within
the supply chain.
 Supply chain strategy: Designing a firm’s supply
chain to meet the competitive priorities of the firm’s
operations strategy.

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Supply Chain for

 Supply chain design for a service provider is

driven by the need to provide support for the
essential elements of the various service
packages it delivers.

 A service package consists of

 supporting facilities
 facilitating goods
 explicit services
 implicit services
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Supply Chain for a Florist

Home Commercial
customers customers

Required for facilitating goods Required for implicit services

Required for explicit services Florist Required for supporting

Packaging Local Arrangement Maintenance

delivery materials services

FedEx Flowers – Internet

delivery local/ services
service international

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Creation of Inventory
Inventory: A stock of materials used to satisfy
customer demand or to support the production of
services or goods.
Input flow of materials

Inventory level

Output flow of materials

Scrap flow
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Supply Chain for
 Raw materials (RM): The inventories needed for
the production of services or goods.

 Work-in-process (WIP): Items, such as

components or assemblies, needed to produce a
final product in manufacturing.

 Finished goods (FG): The items in

manufacturing plants, warehouses, and retail
outlets that are sold to the firm’s customers.

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Inventory at Successive
Stocking Points

Raw Work in Finished

materials process goods

Supplier Manufacturing plant Distribution center Retailer

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Customer Customer Customer Customer

Distribution Distribution
center center

Supply Chain Manufacturer

Tier 1

Tier 2

Tier 3

Supplier of services Supplier of materials

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Inventory Measures of
Supply Chain Performance
 Average aggregate inventory value (AGV) is the total
value of all items held in inventory for a firm.
AGV = (# of A items)(Value of each A)+(# of B items)(Value of each B)+…

 Weeks of supply: The average aggregate inventory value

divided by sales per week at cost.

Average aggregate inventory

Weeks of supply = value
Weekly sales (at cost)

 Inventory turnover is annual sales at cost divided by the

average aggregate inventory value maintained for the year.

Annual sales at (cost)

Inventory turnover =
Average aggregate inventory
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Calculating Inventory Measures
Example 10.1
The Eagle Machine Company averaged $2 million in inventory last year, and the cost of goods
sold was $10 million. The best inventory turnover in the industry is six turns per year. If the
company has 52 business weeks per year, how many weeks of supply were held in inventory?
What was the inventory turnover? What should the company do?

Using Inventory
Estimator Solver

Weeks of supply =
$2 mil/($10 mil)(52 wks.) =
10.4 weeks
Inventory turns =
$10 mil./$2 mil. = 5
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Application 10.1

Average aggregate inventory value

Weeks of supply =
Weekly sales (at cost)
= = 18.5 weeks
( $19,200,000) ( 52 weeks )
Inventory turnover = = 2.8 turns
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Supply Chain Process Measures
Customer Order Supplier
Relationship Fulfillment Relationship

 Percent of orders  Percent of incomplete  Percent of

taken accurately orders shipped suppliers’
 Time to complete  Percent of orders deliveries on time
shipped on time
the order placement
 Time to fulfill the  Suppliers’ lead
process order times
 Customer  Percent of botched  Percent defects in
satisfaction with services or returned services and
the order placement items purchased
process  Cost to produce the materials
service or item  Cost of services
 Customer satisfaction and purchased
with the order materials
fulfillment process
 Inventory levels of
WIP and FG
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Links to
Financial Measures
 Return on Assets (ROA): is net income divided by
total assets.
 Managing the supply chain so as to reduce the aggregate
inventory investment will reduce the total assets portion of
the firm’s balance sheet.

 Working Capital: Money used to finance ongoing

 Weeks of inventory and inventory turns are reflected in
working capital.
 Decreasing weeks of supply or increasing inventory turns
reduces the working capital.

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Links to
Financial Measures
 Cost of Goods Sold: Buying materials at a better price, or
transforming them more efficiently, improves a firm’s cost of
goods sold measure and ultimately its net income.

 Total Revenue: Increasing the percent of on-time deliveries to

customers increases total revenue because satisfied
customers will buy more services and products.

 Cash Flow: Cash-to-cash is the time lag between paying for

the services and materials needed to produce a service or
product and receiving payment for it.
 The shorter the time lag, the better the cash flow position of the
firm because it needs less working capital.

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Supply Chain Dynamics

 Supply chain dynamics can wreak havoc on

supply chain performance measures.
 Actions of downstream supply chain members
can affect the operations of upstream members.

 The bullwhip effect: The phenomenon in

supply chains whereby ordering patterns
experience increasing variance as you
proceed upstream in the chain.

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Supply Chain Dynamics for Facial Tissue

Bullwhip Effect
Quantity ordered

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Value-Chain Linkages

First-Tier Supplier Service/Product Provider

Support Processes Support Processes

New Service/ Business-to- New Service/ Business-to-

External Consumers
External Suppliers

Product Business Product Customer

Development (B2B) Development (B2C)
Process Customer Process Customer
Relationship Relationship
Process Process

Supplier Order- Supplier Order-

Relation- Fulfill- Relation- Fulfill-
ship ment ship ment
Process Process Process Process

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External Causes of
Supply Chain Disruption

 Volume changes.
 Customers may change ordered quantity or
delivery date.
 Service and product mix changes.
 Customers may change the mix of ordered items.
 Late deliveries.
 Late deliveries can force a switch in production
 Underfilled shipments.
 Partial shipments can cause a switch in
production schedule or quantity produced.
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Internal Causes of
Supply Chain Disruption

 Internally generated shortages of parts.

 Engineering changes to the design of services
or products are disruptive.
 New service or product introductions
disrupt the supply chain and may require a new
supply chain.
 Service or product promotions may create a
demand spike.
 Information errors such as demand forecast
errors, faulty inventory counts, or miscommunication
with suppliers.
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The Customer Relationship
E-Commerce and the Marketing Process
 Electronic Commerce (e-commerce) is the
application of information and communication
technology anywhere along the value chain of
business processes.
 Business-to-Consumer Systems (B2C) allows
customers to transact business over the Internet.
 Business-to-Business Systems (B2B) involves
commerce between firms.
 The biggest growth area, it is currently about 70% of the
regular economy.
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The Customer Relationship
E-Commerce and the Order Placement Process
 Cost reduction: Using the Internet can
reduce the costs of processing orders.
 Revenue flow increase: Reduction in the
time lag associated with billing the
customer or waiting for checks.
 Global Access: Available 24 hours a day.
 Price flexibility: Prices can easily be
changed as the need arises.
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Order Fulfillment at
Dell, Inc.
1. Customers buy from Dell by web site, voice-to-voice, and
2. Order information is transmitted to the inventory system.
3. Unique product configuration information is contained in
the Traveler, a sheet that travels with the system the
customer has ordered throughout its assembly and
4. When the Traveler is pulled, all required internal parts and
components for a system are picked and put in a tote or
kit. (Procedure is called Kitting)
5. A team uses the kit to assemble and initially test the
6. Systems are thoroughly tested.
7. Completed systems are boxed and placed on trucks.
8. The entire assemble-to-order cycle takes only a few hours.
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Order Fulfillment Process

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The Order Fulfillment
Inventory Placement
 Centralized placement: Keeping all the inventory at
one location such as a firm’s manufacturing plant or
a warehouse and shipping directly to customers.
 Inventory pooling is a reduction in inventory and
safety stock because of the merging of variable
demands from customers.
 A higher than expected demand from one customer can be
offset by a lower-than-expected demand from another.

 Forward placement is locating stock closer to

customers at a warehouse, wholesaler, or retailer.
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The Order Fulfillment
Vendor-Managed Inventories
 Vendor-managed inventories (VMI): An extreme
application of forward placement involving locating
inventories at the customer’s facilities.

 Key ingredients are:

 Collaborative effort requires trust & accountability.
 Cost savings is realized by eliminating excess inventory.
 Customer service: The supplier is frequently on site for
improved response times and reducing stockouts.
 Written agreement on procedures, methods, and schedules
are clearly specified.
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Order Fulfillment Programs
 Continuous Replenishment Program (CRP)
A VMI method in which the supplier monitors the
customer’s inventory levels and replenishes stock as
 Collaborative planning, forecasting, and replenishment (CPFR)

 Radio Frequency Identification (RFID)

A method for identifying items through the use of radio
signals from a tag attached to an item.
 Wal-Mart and Gillette are among a number of large retailers,
manufacturers, government agencies, and suppliers currently
implementing RFID in their supply chains.
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Distribution Processes

 Ownership: Rather than negotiate with a contract carrier, a firm

has the most control over the distribution process if it owns and
operates it, thereby becoming a private carrier.

 Firms may use a combination of the five basic modes of

transportation: truck, train, ship, pipeline, and airplane.

 Cross-Docking: The packing of products on incoming shipments

so that they can be easily sorted at intermediate warehouses for
outgoing shipments based on their final destinations.
 Items are carried from the incoming-vehicle docking point to the
outgoing-vehicle docking point without being stored in inventory at the

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Continuous Replenishment

 Each morning Campbell uses Electronic Data
Interchange to link with retailers.
 Retailers inform Campbell of demands for its
products and the current inventory levels in their
distribution centers.
 Campbell determines which products need
replenishment based on upper and lower
inventory limits established with each retailer.
 Campbell makes daily deliveries of needed

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The Supplier Relationship
 The sourcing process qualifies, selects, manages
the contracts, and evaluates suppliers.
 The design collaboration process focuses on
jointly designing new services or products with key
suppliers, seeking to eliminate costly delays and
mistakes incurred when many suppliers concurrently,
but independently, design service packages or
manufactured components.
 The negotiation process process focuses on
obtaining an effective contract that meets the price,
quality, and delivery requirements of the supplier
relationship process’s internal customers.
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The Supplier Relationship

 The buying process relates to the actual

procurement of the service or material from the
supplier. This process includes the creation,
management, and approval of purchase orders.

 The information exchange process facilitates

the exchange of pertinent operating information,
such as forecasts, schedules, and inventory levels
between the firm and its supplier.

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Supplier Selection
and Certification
 Purchasing: The activity that decides which
suppliers to use, negotiates contracts, and
determines whether to buy locally.
 Supplier selection often considers the criteria of
price, quality and delivery.
 Green purchasing: The process of identifying,
assessing, and managing the flow of
environmental waste and finding ways to reduce it
and minimize its impact on the environment.
 Supplier certification programs verify that
potential suppliers have the capability to provide
the services or materials the buyer firm requires.
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Supplier Relations

 Competitive orientation views negotiations

between buyer and seller as a zero-sum
game. Whatever one side loses, the other
side gains, and short-term advantages are
prized over long-term commitments.
 Cooperative orientation is where the buyer
and seller are partners, each helping the
other as much as possible.
 Sole sourcing is the awarding of a contract
for a service or item to only one supplier.
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Electronic Purchasing

 Electronic Data Interchange (EDI) enables the

transmission of routine, standardized business
documents from computer to computer.
 Catalog hubs: A system whereby suppliers post their
catalog of items on the Internet and buyers select
what they need and purchase them electronically.
 Exchange: An electronic marketplace where buying
firms and selling firms come together to do business.
 Auction: A marketplace where firms place
competitive bids to buy something.
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Centralized versus
Localized Buying
 Centralized buying increases purchasing clout.
Savings can be significant, often 10% or more.
 Increased buying power can mean getting better
service, ensuring long-term supply availability, or
developing new supplier capability.
 The biggest disadvantage is loss of local control.
 Centralized buying is undesirable for items unique to
a particular facility.
 The best solution may be one where both local
autonomy and centralized buying are possible.
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Value Analysis

 Value analysis is a systematic effort to reduce

the cost or improve the performance of services or
products, either purchased or produced.
 Early supplier involvement is a program that
includes suppliers in the design phase of a service
or product.
 Presourcing: A level of supplier involvement in
which suppliers are selected early in a product’s
concept development stage and given significant,
if not total, responsibility for the design of certain
components or systems of the product.

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Supply Chain Strategies

 Efficient supply chains focus on the

efficient flows of services and materials,
keeping inventories to a minimum.
 Work best where demand is highly predictable.

 Responsive supply chains are designed

to react quickly.
 Work best when firms offer a great variety of
services or products and demand predictability
is low.

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Environment & Design Factors
Environment Factors Efficient Supply Responsive Supply Chains

Design Factors Efficient Supply Chains Responsive Supply Chains

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Mass Customization
 Mass Customization: A strategy whereby a firm’s flexible
processes generate a wide variety of personalized services or
products at reasonably low costs. Competitive advantages:
 Managing customer relationships. It requires detailed
inputs from customers so that the ideal service or product
can be produced.
 Eliminating finished goods inventory. Producing to a
customer’s order eliminates finished goods inventory.
 Increasing perceived value. It increases the perceived
value of services or products.
 Postponement is when some of the final activities in the
provision of a service or product are delayed until the orders
are received.
 Channel assembly is when members of the distribution
channel act as if they were assembly stations in the factory.
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Lean Supply Chains

 Three key activities are required to attain a lean

supply chain:
1. Strategic Sourcing: Identifying items or services
that are of high value or complexity and purchase
them from a select set of suppliers with whom the
firm establishes a close relationship.
2. Cost Management: Limiting the number of
suppliers and focusing on helping them reduce
their costs through trust and friendly collaboration.
3. Supplier Development: Shifting from price
negotiations to cost management and working
with suppliers to achieve lean operations.
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 A Make-or-buy decision is a managerial choice

between whether to outsource a process or do it
 Outsourcing: Paying suppliers and distributors to
perform processes and provide needed services and
 Backward integration is a firm’s movement upstream
toward the sources of raw materials, parts, and
services through acquisitions.
 Forward integration is acquiring more channels of
distribution, such as distribution centers (warehouses)
and retail stores, or even business customers.
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 Offshoring is a supply chain strategy that involves

moving processes to another country. Factors that
influence the offshoring decision include:
Comparative labor costs Tariffs and Taxes
Logistics costs Internet
Labor Laws and Unions

Pitfalls of offshoring include:

Pulling the plug too quickly. Not making a good-faith
effort to fix the existing process
Technology transfer
Difficulties integrating processes
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Virtual Supply Chains

 Virtual Supply Chain: Outsourcing some part of the entire

order fulfillment process with the help of sophisticated, Web-
based information technology support packages.
 Benefits include:
 Reduced investment in inventories and order fulfillment
 Greater service or product variety without the overhead of
one’s own order fulfillment process.
 Lower costs due to economies of scale. The supplier typically
handles more volume than does the firm doing the outsourcing.
 Lower transportation costs. With drop shipping in a virtual
supply chain, the only transportation cost is shipping the goods
from the wholesaler to the customer.

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Which Type of
Supply Chain?

Traditional Supply Chain Virtual Supply Chain is

is preferred when: preferred when:

1. Sales volumes are high. 1. Demand is highly volatile.

2. Order consolidation is 2. High service or product
important. variety is important.
3. Small-order fulfillment
capability of suppliers is

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