Vertical Vs Horizontal Integration

Vertical vs horizontal integration
9
Michael Porter’s Value Chain
14
Syllabus
Importance of Supply chain Chapter 1 (Text)

management in present scenario, Effective SCM by Tom Davis
Basic concepts, importance and
objectives of supply chain
management and logistics
Strategic Framework of SCM The 7 principles of supply chain
management by David L. Anderson,
Frank F. Britt and Donavon J. Favre
Global supply chains in a post-
pandemic world – Willy C. Shih
26
Syllabus
Designing an effective supply The triple-A supply chain by

chain Hau L. Lee
Managing major disruptions Business and Markets: The
in supply chains Coronavirus Ticker
Global supply chains in a
post-pandemic world – Willy
C. Shih
27
Syllabus
Achieving strategic fit What is the right supply chain for
your product? By Marshall L. Fisher
Making supply meet demand in an
uncertain world by Marshall L. Fisher
et al
Supply Chain Chapter 3 (Reference 1) Supply Chain
Performance: Outcome-driven supply chains by Management
Determinants and metrics Steven A. Melnyk et al at World Co.
Ltd.
Network Planning Chapter 3 (Text) ElecComp
Inc. (Text)
28
Syllabus
Supply Chain Integration Chapter 6 (Text) Dell Inc.
The Bullwhip Effect in Supply (Text)
Chains by Hau L. Lee et al
Designing Distribution Chapter 7(Text)
network/
Logistics - transportation Design for logistics
Chapter 11 (text)
Inventory Management: Chapters 11,12 (Reference 1)
Managing Economies of
scale & uncertainties
Procurement, outsourcing Chapter 4, 9 (Text) Solectron
and supply contracts Purchasing must become (Text)
supply management by Peter
Kraljic
29
Syllabus
Global Supply Chain Chapter 10 (Text) Wal-Mart

Management Fast, Global and (Text)
entrepreneurial SCM:
Hongkong style
Information Technology & Chapter 14 (Text) Ford Motor
Supply Chain The power of virtual Co.
integration: Interview with
Michael Dell
Sustainability issues and Chapter 16 (Text)
Reverse logistics Don’t tweak your supply chain
– rethink it end to end by Hau
L. Lee
Summarizing the learning from the course
30
Traditional View: Magnitude of
Cost
□ Estimated that the grocery industry could
save $30 billion (10% of operating cost)
by using effective logistics and supply
chain strategies
■ A typical box of cereal spends 104 days from
factory to sale
□ Laura Ashley turns its inventory 10 times

a year, five times faster than 3 years ago
32
Supply Chain Management:
True Magnitude of Cost
□ Compaq estimates it lost $.5 billion to $1
billion in sales in 1995 because laptops
were not available when and where needed
□ When the 1 gig processor was introduced
by AMD, the price of the 800 mb processor
dropped by 30%
□ P&G estimates it saved retail customers
$65 million by collaboration resulting in a
better match of supply and demand
33
Dynamics of the Supply Chain
Customer
Order
Demand
Size
Retailer Orders
Distributor Orders
Production Plan
Time
34
Customer
Order
Demand
Size
Production Plan
Time
35
Source: Tom Mc Guffry, Electronic Commerce and Value Chain Management, 1998
Traditional Planning Approach
Sequential, Decomposed, Slow
Procurement Manufacturing Sales & Distribution

(Material) (Capacity) (Demand)
C
U
S
T
O
M
E
R
Optimize to Optimize to Optimize to

Mfg objectives Logistics obj Sales & Mktg obj
36
Globally Integrated Planning
“The sum of the local optima do not

equal the global optimum.”
(Goldratt, Theory of Constraints,

1986)
37
Dell Computers
□ SC practices support competitive
strategy
□ Basic model of SC
■ Direct built-to-order to customers
38
PC Value Chain: Performance of
Traditional PC Manufacturer
39
Dell Computers
40
Dell Computers
□ Direct contact
■ Fine segmentation
■ Analyze needs & profitability of each
segment
■ Make better forecast
■ Improves supply-demand matching
■ Steer customers towards configurations
that can be given readily
41
Dell Computers
□ Less inventory
■ High inventory turns
■ <10 days worth inventory (competitors
60 – 80 days)
■ Faster adoption to changes
■ Less affected by price reductions &
obsolescence
■ Real time information exchange with
suppliers
42
Dell Computers
□ Less inventory
■ Defects not introduced in large quantity
of products
□ Manages payables & receivables
(cash flows)
□ Centralize manufacturing &
inventories
□ Postponement
□ Information
43
Supply Chain Management
Today’s discussion points
□ Supply Chain & Logistics
□ Costs in a supply chain
□ Dynamics of the chain
□ Objectives of supply chain
□ Examples
45
Supply Chain
All stages
&
functions
involved in
fulfilling a customer request
46
Supply Chain
Network of facilities including connected &

independent organizations mutually & co-
operatively working together to control,
manage & improve
□ Material flow from suppliers & upstream
suppliers at all levels
□ Transformation of materials into semi-
finished & finished products &
□ Distribution of products to customers &
their downstream customers at all levels
47
Supply Chain Flows
Material Flow
Converter
Supplier Retailer
Distributor
Source
Converter Consumers
Distributor End-User
Supplier
Value-Added Services
Funds/Demand Flow
Information Flow
Reuse/Maintenance/After Sales Service Flow

48
Supply Chain Management
“the integration of business processes

from end-user through original suppliers
that provides products, services and
information and add value for customers”
▪ Processes cross organisations and link
organisations
▪ Efficient integration
49
Objective of a Supply Chain
□ Maximize overall value (profit) generated

■ difference between what the final product is worth to
the customer & the effort the supply chain expends in
filling the customer’s request
■ total profit to be shared by all stages of the chain
⮚ Minimize system-wide costs while satisfying

system level requirements
50
Objective of a Supply Chain
□ Sources of supply chain revenue
■ customers
□ Sources of supply chain cost
■ flows of information, products, or funds between
stages of the supply chain
⮚ Supply chain management is the management

of flows between and among supply chain
stages to maximize total supply chain
profitability
51
Business functions
□ Plan (Forecasting & Planning)
□ Buy (Purchasing )
□ Make (Manufacturing & Assembly)
□ Store (Inventory, Warehousing)
□ Move (Distribution, Transportation
& Returns)
□ Sell, Return (Order Management)
52
Logistics
□ The organization of moving, lodging &
supplying troops & equipments
□ “that part of supply chain process that
plans, implements and controls the
efficient, effective forward and reverse flow
and storage of goods, services and related
information between the point of origin and
the point of consumption in order to meet
customers’ requirements”
(Council of Logistics Management)
53
Logistics
□ Encompass
■ distribution, transportation & inventory
management
□ Simply put, it involves

■ Store & move functions only
54
In the New Economy the focus is on the customer
In-house core Rigid Products/

competencies infrastructure/ Services Channels Customers
Processes
Traditional Business Design (Product-Focused)
Transition
“Customer Centric” Design (Customer-Focused)
Flexible In-house and

Customers’ Integrated Products/
Infrastructure outsourced
Value Channels Services
Processes core
Needs
competences
55 2000
Reversing the value chain (Based on paper given by A Lai, HP Greater China Marketing Director: Global June 23/24,
Old Success New Success
Factors Factors
• Size • Speed
• Role Clarity • Flexibility
• Specialisation • Integration
• Control • Coordination
56
Requirement
" …managers need to be good at mobilizing,

managing, and using resources rather than at
formally acquiring and necessarily owning resources.
The ability to reconfigure, to use resources inside
and particularly outside the boundaries of the
traditional corporation more effectively becomes a
mandatory skill for managements."
57
Evolution
Purchasing & Logistics 3rd Party service
Supplier & customer Supply Management providers
Relationships Management
2000 ?
1980s - 2000 ?
Managing External Supply Demand

Value Chain
Relationships Chain Chain
Management
Management Management
Process Integration
End-User Customer Focus
1960-1970s
MRP &
MRP- II Materials Management
1950-1960s
Mass Productivity Management

Production 58
Cisco’s Value Network
Supply Network
60
Costs in Supply Chain
□ GDP : Rs. 88.32 lakh Crore
□ Logistics Cost : 14% of our GDP
□ Logistics Cost : Rs. 1236480 Crore
□ 1% Reduction in LC : Rs. 12365 Crore
61
Traditional View: Magnitude of
Cost
□ Estimated that the grocery industry could
save $30 billion (10% of operating cost)
by using effective logistics and supply
chain strategies
■ A typical box of cereal spends 104 days from
factory to sale
□ Laura Ashley turns its inventory 10 times

a year, five times faster than 3 years ago
62
Supply Chain Management:
True Magnitude of Cost
□ Compaq estimates it lost $.5 billion to $1
billion in sales in 1995 because laptops
were not available when and where needed
□ When the 1 gig processor was introduced
by AMD, the price of the 800 mb processor
dropped by 30%
□ P&G estimates it saved retail customers
$65 million by collaboration resulting in a
better match of supply and demand
63
Customer
Order
Demand
Size
Retailer Orders
Distributor Orders
Production Plan
Time
64
Customer
Order
Demand
Size
Production Plan
Time
65
Source: Tom Mc Guffry, Electronic Commerce and Value Chain Management, 1998
Traditional Planning Approach
Sequential, Decomposed, Slow
Procurement Manufacturing Sales & Distribution

(Material) (Capacity) (Demand)
C
U
S
T
O
M
E
R
Optimize to Optimize to Optimize to

Mfg objectives Logistics obj Sales & Mktg obj
66
Globally Integrated Planning
“The sum of the local optima do not

equal the global optimum.”
(Goldratt, Theory of Constraints,

1986)
67
Dell Computers
□ SC practices support competitive
strategy
□ Basic model of SC
■ Direct built-to-order to customers
68
Traditional PC Manufacturer
69
Dell Computers
70
Dell Computers
□ Direct contact
■ Fine segmentation
■ Analyze needs & profitability of each
segment
■ Make better forecast
■ Improves supply-demand matching
■ Steer customers towards configurations
that can be given readily
71
Dell Computers
□ Less inventory
■ High inventory turns
■ <10 days worth inventory (competitors
60 – 80 days)
■ Faster adoption to changes
■ Less affected by price reductions &
obsolescence
■ Real time information exchange with
suppliers
72
Dell Computers
□ Less inventory
■ Defects not introduced in large quantity
of products
□ Manages payables & receivables
(cash flows)
□ Centralize manufacturing &
inventories
□ Postponement
□ Information
73
EFFECTIVE SUPPLY CHAIN
MANAGEMENT
OUTLINE FOR DISCUSSION
🞆 Why a complete SCM methodology?
🞆 Understanding uncertainty
🞆 Modeling supply chains
🞆 Using strategic modeling tool
🞆 Case studies
⚫ Remote localization of low-cost Deskjet printers
⚫ JV with low-cost Asian manufacturer
🞆 Conclusions
75
WHY A COMPLETE SCM
METHODOLOGY?
Improve customer satisfaction while reducing costs
🞆 Increasing competition
🞆 Multisite manufacturing
🞆 Complex channels of independent dealers
🞆 Increasing demand for local products
🞆 Customer demand of exceptional service
76
UNCERTAINTY IN SUPPLY CHAIN
🞆 Complexities in manufacturing network
⚫ Multiple suppliers
⚫ Complex processes to make subassemblies/ final product
⚫ Variety of customers
⚫ Varied transportation options
🞆 Uncertainties propagate through a manufacturing network
🞆 Inventory protects against uncertainties
⚫ How much to hold?
⚫ Where to hold?
🞆 System optimization
⚫ Reapportion stock to reduce overall inventory 77
🞆 Approach analytically
UNCERTAINTY IN SUPPLY CHAIN
🞆 3 steps for improvement
⚫ Benchmarking current performance
🞆Possible performance given existing operating characteristics like
order review period, forecast accuracy
🞆Metrics: Inventory investment , Inventory turnover ratio, order fill
rate
⚫ Controlling uncertainty
🞆Understand relative impact of different sources of uncertainty
⚫ Planning changes
🞆Costs/ benefits of sweeping changes to inventory network
78
MODELING SUPPLY CHAINS
🞆 3 steps
⚫ Develop a simple, generic framework to describe supply
chains
⚫ Model propagation of uncertainty up & down the chain
⚫ Create modeling approach to support strategic decision
makers
79
SIMPLE GENERIC MODEL
Supply Demand
Material
transformation
🞆 Inventory control
⚫ Understand impact of uncertainty
🞆 Consider distribution function like
traditional manufacturing process
80
INCLUDE UNCERTAINTY
🞆 Sources of uncertainty
⚫ Suppliers
🞆On-time performance, average lateness, degree of inconsistency
⚫ Manufacturing
🞆Frequency of downtime, repair time & its variation
🞆Probability distribution of performance & reliability
⚫ Customers
🞆Average demand & its variability
🞆Effective variability vs. actual variability
81
ACT STRATEGICALLY
🞆 Customer service affected by uncertainties
🞆 How to reduce these?
Uncertainty cycle
Manufacturing Customer
•Process design Deliveries
•Product design
•Capacity
•Quality
Supplier Customer Demand

Performance •Past performance
•Responsiveness •Market research
•Transportation •Analytical techniques
•Location •Incentive programs
82
•Quality
USING A STRATEGIC MODELING TOOL
1. Valid input
⚫ Data collection problems
⚫ Accuracy of data
⚫ Valid data
2. Iterative analysis
⚫ Tool to measure benefits/ costs of changes in alternative SC
policy
83
USING ANALYTICAL MODELS
84
USING A STRATEGIC MODELING TOOL
3. Useful output
⚫ 2 key measures of customer service
🞆Line-item fill rate (Compare fill rate vs. weeks of supply for alt.
policies)
🞆Order aging curve (Compare days late vs. cum. portion of orders
shipped for alt. policies)
🞆 Benchmarking with data on historical performance
⚫ Fill rate vs. FGI (weeks of supply)
⚫ Plot on monthly basis
⚫ Compare actual & predicted
85
USEFUL ANALYSIS RESULTS
86
BENCHMARKING HISTORICAL RESULTS
Efficient frontier
87
HP CASE 1: LOCALIZING GENERIC
PRODUCTS
🞆 Low cost DeskJet printers
⚫ 5 separate facilities for manufacturing & distribution
⚫ 6 months long pipeline
⚫ Excessive inventory
⚫ How to reduce costs without sacrificing customer goodwill?
🞆 Postponement of localization
⚫ Remote localization at distribution centers
⚫ Risk pooling
88
LOCALIZATION
89
POSTPONEMENT
🞆 Benefits
⚫ Lower safety stocks
⚫ Stock of less valuable generic models
⚫ Offsetting demand risks
⚫ Drop in shipping costs
🞆 When does this strategy work?
⚫ In regions having demand of many printer options
⚫ During new product introduction
90
HP CASE 2: ADDING A MANUFACTURING
PARTNER
🞆 JV with a low cost Asian partner
⚫ High shipping time
⚫ Lead time increases by 3 months
⚫ Benefits of analysis
🞆Showed that stock increases from usual 1 month (FGI at US) to 5
months
🞆Choose best alternative
⚫ Co-location of 2 firm’s factories

🞆Cut down 3 months shipping delay
🞆More attractive deal with partner
91
INTERPRETING FINDINGS
🞆 Root causes of inventory
⚫ Minimum stock
🞆 WIP, pipeline, periodic review
🞆 About 40%
⚫ Supply variance
⚫ Process variance
⚫ Demand variance
🞆 Inventory reduction
⚫ Traditional focus
🞆 Improving manufacturing
🞆 Working with suppliers
⚫ Required focus
92
🞆 Forecast demand better
🞆 Design products that allow better risk pooling
CONCLUSIONS
🞆 Focus on thorough SC analysis with data and
quantitative techniques
🞆 Change product and process of each stage to reduce
uncertainties and improve performance
🞆 Take a systems view of the problem
93
The Triple-A Supply Chain
Outline of discussion
🞂 Introduction
🞂 Perils of efficiency
🞂 Fostering agility
🞂 Adapting your SC
🞂 Creating the right alignment
🞂 7-Eleven Japan’s three aces
🞂 Conclusion
Three A’s
🞂 Agile
🞂 React speedily to sudden changes in demand & supply
🞂 Adaptable
🞂 Adapt supply networks when markets or strategies change
🞂 Aligned
🞂 Align interest of SC partners with their own
Perils of efficiency
🞂 Focus on economies of scale
🞂 Inability to respond quickly to changes
🞂 Discounts
🞂 New product launch
🞂 Cannot adapt to change in market structures
🞂 Lucent’s Electronic Switching Systems
Agile chains
🞂 Both quick & cost efficient
🞂 ‘…big price for disregarding agility’
🞂 Compaq
🞂 Exemplary chains
🞂 H&M, Mango, Zara
🞂 Better quipped to recover from sudden shocks
🞂 Dell vs. Compaq, Apple & Gateway
🞂 Nokia vs. Ericsson
Fostering agility
🞂 Rules of thumb
🞂 Share real time data with partners
🞂 Collaborate with suppliers and partners
🞂 Postponement
🞂 Keep small inventory of inexpensive, non-bulky materials
🞂 Build dependable logistics system by 3 PL collaborations
🞂 Have contingency plans
Adapting your supply chain
🞂 Identify structural shifts by capturing latest data & tracking key
patterns
🞂 HP ink-jet printers supply chain
🞂 New products or new markets
🞂 More than one supply chain
🞂 Cisco
🞂 Gap
🞂 Defining appropriate markets
🞂 Level of technology
🞂 Stage of PLC
🞂 Toyota
Adapting your supply chain
🞂 Spot changes/ future patterns
🞂 Track economic changes, specially in developing countries
🞂 Decipher needs of ultimate customers to avoid bullwhip effect
🞂 Change supply networks
🞂 Develop new suppliers to complement existing ones
🞂 DFS (commonality, postponement and standardization)
Creating the right alignment
🞂 Problem of misalignment
🞂 Cisco supply chain
🞂 Why VMI has not reduced costs?
🞂 Aligning interests
Redefine terms of relationship to share risks, costs & rewards
🞂 Align information
🞂 Align identities
🞂 Align incentives
🞂 Predict possible behavior of partners
🞂 RR Donnelley
🞂 Saturn service parts chain
Supply chain of 7-Eleven Japan
🞂 Competitive strategy
🞂 Micro-matching supply and demand
🞂 Replenishment cycle time less than 12 hours for fresh & fast-food (3
times a day delivery for rice dishes)
🞂 Supply chain design
🞂 Rapid replenishment for responsiveness
🞂 Transportation
🞂 High cost of transportation and receiving at stores

🞂 Aims to aggregate transportation and receiving to make both cheaper
🞂 TransfleetLtd. (set up by Mitsui & Co.) for exclusive use of 7-
eleven Japan
🞂 Flexible to get both efficiency and responsiveness
🞂 Location: Area dominance strategy
🞂 Both franchise & Co. owned network of stores
🞂 Small size of stores
🞂 Lowers cost of replenishment
🞂 Centralized facilities
🞂 Dedicated manufacturing plants
🞂 Dedicated Distribution Centers (DCs) which carried no inventory
🞂 Combined distribution system
🞂 All suppliers deliver to the DC where products are sorted by
temperature
🞂 Maximum benefit of aggregation of capacity & demand
🞂 Reduces outbound transportation cost from DC because of
aggregation of deliveries across multiple suppliers & retail stores
🞂 Lowers receiving cost & minimizes disruption at retail outlets
🞂 Lower transportation cost to DC from manufacturer
🞂 Better utilization of trucks
🞂Direct store delivery by suppliers appropriate if
🞂 Items being delivered do not need bulk broken at a DC
(stores are large and nearly-full truck load quantities are
coming from a supplier to a store)
🞂 Have special handling requirements
🞂 Supplier has information system integrated with stores
🞂 Inventory
🞂 Aggregation, run on information system
🞂 Minimize total system inventory
🞂 Information infrastructure
🞂 Allow store managers to place orders based on analysis of
consumption data
🞂 Transmits POS information directly to the supplier and
distribution center
🞂 Goods are produced using a pull system to replace what has been
sold during that delivery period
🞂 Facilitates the sorting of an order at the DC and receiving of the
order at the store
🞂 7dream.com
🞂 Are customers ready to take deliveries from store?
🞂 Can use existing distribution network
🞂 Better utilization of trucks
🞂 Use storage space
🞂 Extra work at stores
🞂 More successful in Japan
🞂 given the existing distribution network
🞂 the frequency of visits by customers
🞂 Duplicating structure of supply chain in US
🞂 Lower density of stores
🞂 Larger distance between stores
🞂 getting both direct store deliveries as well as wholesaler
deliveries to its stores
🞂 Customers have many other options
🞂 Cost of operating in suburban/ rural regions will be extremely
high
🞂 Distributors add more value in US
🞂 Lower store density in US – distributors aggregate bulk
🞂 Advantages
🞂 less transportation, material handling, and labor costs for 7-
Eleven system
🞂 Disadvantages
🞂 overall loss of control
🞂 increased number of deliveries to each store
🞂 difficulty of integrating information flows across disparate
systems
7-Eleven Japan’s three aces
🞂 Agility
🞂 Through real-time information sharing supported by location,
transport, inventory strategies
🞂 Adaptability
🞂 Changed strategy with time & location
🞂 Alignment
🞂 Clear incentives and disincentives
🞂 Works with suppliers to develop products & share revenues
🞂 7dream.com created with 6 partners
Conclusion
🞂 Adopting triple A
🞂 Does not necessarily need more technology & investment
🞂 Needs a change of mind-set
🞂 Look beyond efficiency
🞂 Keep changing network
🞂 Look beyond organizational boundaries & take care of entire network
The 7 principles of Supply Chain
Management
Introduction
⚫Successful managers
⚫Think of supply chain as a whole
⚫Pursue tangible outcomes focused on
⚫ Revenue growth
⚫ Asset utilization
⚫ Cost
Principle 1
⚫Segment customers
⚫Based on service needs (against traditional ways of
grouping by industry, product or trade channels)
⚫Adapt supply chain to serve them
⚫Types of needs?
⚫Segments?
Segment customers
Need based segmentation may produce odd

Principle 1
⚫ Helps understand
⚫ Relative value customers place on service offerings
⚫ Which customers are most profitable to serve?
⮚ Important to correctly match accounts with service packages
⚫ Analyze
⚫ Profitability of segments
⚫ Costs & benefits of alternate service packages
⚫ Helps to
⚫ Better align their investment in particular customer relationship with the return the
customer generates
⚫ Strike & sustain appropriate balance between service and profitability
⚫ Set priorities and provide tailored services to maximize customer impact
⚫ Activity Based Costing

Activity Based Costing
⚫ABC reveals the links between performing particular
activities and the demands those activities make on the
organization's resources
⚫It can give managers a clear picture of how products,
brands, customers, facilities, regions, or distribution
channels both generate revenues and consume
resources
⚫ABC analysis helps managers focus their attention and
energy on improving activities that will have the
biggest impact on the bottom line
Principle 2
⚫Customize logistics network
⚫To service requirements & profitability of customer
segments
⚫Multi level networks

⚫Cross docking
⚫3rd party logistics
Principle 3
⚫
Principle 4
⚫Differentiate products closer to customer & speed
conversion
⚫Cellular manufacturing
⚫Just-in-time
⚫Mass customization
⚫Postponement
⚫Modular design
Principle 5
⚫ Source strategically
⚫ To reduce total cost of owning materials & services
⚫ Long term contracts
⚫ SCORE: Chrysler
⚫ Keiretsu
⚫ Business network of different companies with close business
relationships and shareholdings in each others companies
⚫ Japan – after World War II and collapse of family controlled
monopolies
⚫ Horizontal (financial) keiretsu – banks
⚫ Vertical (industrial) keiretsu – link suppliers, manufacturers
and distributors in one industry
Principle 6
⚫Develop SC technology strategy
⚫Enterprise wide information systems
⚫Integrate
⚫ Short term transaction & operation management
⚫ Mid-term planning & decision support
⚫ Long term strategic analysis
⚫Bar coding vs. RFID
⚫SCM software
Principle 7
⚫Adopt channel spanning measures
⚫Gauge collective success, not functional
⚫Perfect order
⚫Activity based costing
⚫ Identify actual costs & revenues required to serve an account
⚫ Data warehouse
Translating principles into practice
⚫Orchestrate improvement efforts

⚫Blueprint to map linkages among initiatives &
implementation sequence
⚫Rigorous assessment of entire supply chain
⚫Set explicit outcome targets for revenue growth, asset
utilization & cost
Translating principles into practice
⚫Rome wasn’t built in a day
⚫Massive task
⚫Balance long term & immediate business needs
⚫Recognize difficulty of change

⚫Extensive visible participation by top managers
Cross-Docking
⚫Popularized by Wal-Mart
⚫Warehouses function as inventory coordination points
rather than as inventory storage points.
⚫Goods arriving at warehouses from the manufacturer:
⚫are transferred to vehicles serving the retailers
⚫are delivered to the retailers as rapidly as possible.
⚫Goods spend very little time in storage at the warehouse
⚫Often less than 12 hours
⚫Limits inventory costs and decreases lead times
Issues with Cross-Docking
⚫Require a significant start-up investment and are very
difficult to manage
⚫Supply chain partners must be linked with advanced
information systems for coordination
⚫A fast and responsive transportation system is necessary
⚫Forecasts are critical, necessitating the sharing of
information.
⚫Effective only for large distribution systems
⚫Sufficient volume every day to allow shipments of fully
loaded trucks from the suppliers to the warehouses.
⚫Sufficient demand at retail outlets to receive full truckload
quantities
PANDEMIC AND SUPPLY
CHAINS
POINTS TO DISCUSS
Impact of pandemic on supply chains
Making supply chains resilient
GLOBAL NATURE OF
SUPPLY CHAINS
Over the previous three decades, supply chains moved from
regional/national to become increasingly global
🢝to benefit from low costs of labor, materials, and land
COUNTRY TRADE
IMPACT OF PANDEMIC
COVID-19 pandemic
🢝Led to major disruptions in the flow of goods and services and shortages
🢝affected China’s manufacturing sector, which was a large supplier for the
world
Already faced threats from trade wars
Supply shock that started in China in February
🢝Temporary trade restrictions and shortages of pharmaceuticals, critical
medical supplies and other products
Demand shock that followed as the global economy shut down
IMPACT OF PANDEMIC
The pandemic exposed vulnerabilities in the production
strategies and weaknesses in global supply chains of firms just
about everywhere
Highlighted that some supply chain models, which relied on
just-in-time and efficient (cheapest) sourcing and
subcontracting, might have to change or at least be seriously
reconsidered
The disruption unleashed by the new coronavirus is different in
that it has highlighted country risk at an unprecedented scale
CHANGING FOCUS
Those developments have triggered a rise in economic
nationalism
Manufacturers worldwide are going to be under greater political
and competitive pressures to
🢝increase their domestic production
🢝grow employment in their countries
🢝reduce or even eliminate their dependence on sources that are perceived as
risky,
🢝rethink their use of lean manufacturing strategies that involve minimizing the
amount of inventory held in global supply chains
IMPACT OF PANDEMIC
Companies had already began rethinking their far-flung supply chains in response to changing
labor costs, advances in automation, rising protectionism, and external shocks, such as natural
disasters
But it took the COVID-19 pandemic to more fully expose structural flaws that have prompted
organizations to fundamentally reassess their approach to global manufacturing and sourcing
Factory lockdowns, transportation disruptions, and panic buying led to shortages of everything
from medical supplies and household necessities to critical automotive and electronics
components
The crisis also heightened geopolitical tensions, trade restrictions, and nationalist policies aimed
at promoting domestic industry that are likely to continue reshaping the global business
landscape.…. Now, companies are exploring various ways to build more resilience into their
manufacturing and supply networks—even if that resilience leads to extra costs
Boston Consulting Group
SOLUTIONS
Uncover and address hidden risks
Diversify your supply base
Mediate inventory or safety stock
Take Advantage of Process Innovations
Revisit the Trade-Off Between Product Variety and Capacity
Flexibility
IDENTIFY
VULNERABILITIES
Uncover and address hidden risks/ vulnerabilities
🢝Products include critical components/ sophisticated materials that need
specialized technological skills to make
🢝Difficult for single firm to have all the capabilities
🢝Depend on suppliers/ subcontractors
🢝Flexibility and ability to incorporate new technology
🢝Vulnerable if you depend on single supplier somewhere deep in the
network and if that supplier produces items in only one plant or one country
IDENTIFY
VULNERABILITIES
Understanding where the risks lie so that your company can protect itself
may require a lot of digging
It entails going far beyond the first and second tiers and mapping your
full supply chain, including distribution facilities and transportation hubs
This is time-consuming and expensive, which explains why most major
firms have focused their attention only on strategic direct suppliers that
account for large amounts of their expenditures
But a surprise disruption that brings your business to a halt can be much
more costly than a deep look into your supply chain is
IDENTIFY
VULNERABILITIES
The goal of the mapping process should be to categorize suppliers as
low-, medium-, or high-risk.
Applying metrics such as
🢝impact on revenues if a certain source is lost
🢝time it would take a particular supplier’s factory to recover from a disruption
🢝availability of alternate sources
It’s vital to ascertain
🢝how long your company could ride out a supply shock without shutting down
🢝how quickly an incapacitated node could recover or be replaced by alternate sites
when an entire industry faces a disruption-related shortage
IDENTIFY
VULNERABILITIES
The answers to those questions depend on
Whether your manufacturing capacity is flexible and can be reconfigured and
redeployed as needs evolve
🢝as is the case for many manual or semi-automated assembly operations or
Whether it consists of highly specialized and difficult-to replicate operations
🢝Examples include production of the most advanced smartphone chips, which is concentrated
in three facilities in Taiwan owned by the Taiwan Semiconductor Manufacturing Company;
fabrication of exotic sensors and components, which happens largely in highly specialized
facilities in a handful of countries, including Japan, Germany, and the United States; and
refining of neodymium for the magnets in AirPods and electric-vehicle motors, almost all of
which is done in China
NEXT STEPS
Once you’ve identified the risks in your supply chain, you can
use that information to address them by
🢝either diversifying your sources
🢝or stockpiling key materials or items
DIVERSIFY YOUR SUPPLY
BASE
Obvious way to address heavy dependence on one medium- or
high-risk source (a single factory, supplier, or region) is to add
more sources in locations not vulnerable to the same risks
The U.S.-China trade war has motivated some firms to shift to a
“China plus one” strategy of spreading production between
China and a Southeast Asian country such as Vietnam,
Indonesia, or Thailand.
But region-wide problems like the 1997 Asian financial crisis or
the 2004 tsunami argue for broader geographic diversification
BASE
Managers should consider a regional strategy of producing a
substantial proportion of key goods within the region where
they are consumed.
🢝North America might be served by shifting labor-intensive work from
China to Mexico and Central America.
🢝To supply Western Europe with items used there, companies could increase
their reliance on eastern EU countries, Turkey, and Ukraine.
🢝Chinese firms that want to protect their global market share are already
looking to Egypt, Ethiopia, Kenya, Myanmar, and Sri Lanka for low tech,
labor intensive production
BASE
Reducing dependency on China will be easier for some
products than others
🢝furniture, clothing & household goods will be easy to obtain elsewhere
because the inputs—lumber, fabrics, plastics, and so forth—are basic
materials
🢝It will be harder to find alternative sources for sophisticated machinery,
electronics, and other goods that incorporate components such as high-
density interconnect circuit boards, electronic displays, and precision
castings
BASE
Building a new supplier infrastructure in a different country or
region will take considerable time and money, as China’s
experience illustrates
🢝When China first opened its special economic zones in the 1980s, it had
almost no indigenous suppliers and had to rely on far-flung global supply
chains and on logistics specialists who procured materials from around the
world and kitted them for assembly in Chinese factories
🢝Even with government incentives, it took 20 years for the country to build a
local base capable of supplying the vast majority of electronic components,
auto parts, chemicals and drug ingredients needed for domestic
manufacturing
BASE
Shifting production from China to Southeast Asian countries will necessitate
different logistics strategies
🢝Unlike China, those locations often do not have the efficient, high-capacity ports that can handle
the largest container ships or the direct marine liner services to major markets
🢝That will mean more transshipment through Singapore, Hong Kong, or other hubs and longer
transit times to reach markets
In the long run, though, it would be a mistake to cut China completely out of
your supply picture
🢝The country’s deep supplier networks, its flexible and able workforce, and its large and efficient
ports and transportation infrastructure mean that it will remain a highly competitive source for
years to come
🢝And because China has the second-largest economy in the world, it is important that firms
maintain a presence to sell in its markets and obtain competitive intelligence
MEDIATE INVENTORY OR
SAFETY STOCK
If alternate suppliers are not immediately available, a company should
determine how much extra stock to hold in the interim, in what form,
and where along the value chain
Safety stock, like any inventory
🢝carries with it the risk of obsolescence and
🢝ties up cash.
🢝runs counter to the popular practice of just-in-time replenishment and lean inventories
🢝But the savings from those practices have to be weighed against all the costs of a
disruption, including lost revenues, the higher prices that would have to be paid for
materials that are suddenly in short supply, and the time and effort that would be
required to secure them.
TAKE ADVANTAGE OF
PROCESS INNOVATIONS
As firms relocate parts of their supply chain, some might ask their suppliers
to move with them, or they might bring some production back in-house
Either course—transplanting a production line or setting up a new one—is
an opportunity to make major process improvements
🢝because as part of the change, you can unfreeze your organizational routines and revisit
design assumptions underpinning the original process
🢝One challenge for companies with existing production lines is that when those assets are
fully depreciated, executives may be tempted to retain them rather than invest in newer,
more competitive plants and equipment
🢝Since the depreciation expense is no longer factored into the calculated cost of production,
the marginal cost of boosting production at a plant with idle capacity is lower
EXAMPLES
New Chinese factory of a major American industrial-equipment company
🢝When creating it, the company had started with the designs of its U.S. and Japanese
factories and then improved on them by introducing newer equipment and ways of
working
🢝The result was a streamlined operation that was much more efficient than those in the
United States and Japan
🢝When the company built its next new factory, in the United States, it repeated the
process, using the Chinese factory as the starting point
Flex factory complex in Guadalajara, Mexico
🢝When increases in productivity plateaued, the company often moved smaller assembly
lines to another building (or part of the same building). During each move, workers
redesigned steps to use less space and less labor, boosting productivity
NEW TECHNOLOGIES
New technologies already or soon will allow companies to
lower their costs or switch more flexibly among the products
they manufacture, rendering obsolete the installed bases of
incumbent competitors or suppliers
Many of these advances also present an opportunity to make
factories more environmentally sustainable
NEW TECHNOLOGIES
Examples include
⮚ Automation
🢝As the cost of automation declines and people see that robots can operate safely
alongside humans, more kinds of work are being automated
🢝The pandemic has made automation even more attractive, because social
distancing in factories is now a necessity
🢝As a result of these developments, it’s becoming more practical to return
offshored production to higher-cost countries
🢝Robotic palletizers, which can sharply reduce the need for labor in preparing
products for shipping, will pay for themselves quickly, as will automated optical
inspection systems for quality control
NEW TECHNOLOGIES
⮚New processing technologies
🢝The latest chemical manufacturing equipment uses less energy and solvents,
produces less waste, is less capital-intensive, and is less expensive to operate
🢝Similarly, a new generation of compact bioreactors could allow makers of
biopharmaceuticals and vaccines to produce smaller batch sizes economically
⮚Continuous-flow manufacturing
🢝This innovation could significantly increase the resilience of the supply chain
for small-molecule generic drugs by making producers less dependent on
imported active pharmaceutical ingredients (APIs)
NEW TECHNOLOGIES
Additive manufacturing
🢝This production method, also known as 3D printing (refer to a variety of processes
in which material is deposited, joined or solidified under computer control to create
a three-dimensional object)t, can dramatically reduce the number of steps required
to make complex metal shapes; it can also lessen dependence on distant suppliers
of the machinery and tools needed for, say, the injection molding of plastics
🢝Rapid advances in 3D printing are making it possible to economically produce an
ever these promise to upend the traditional strategy of seeking economies of scale
by concentrating production in a few large facilities
🢝They will allow companies to replace large plants that serve global markets with a
network of smaller, geographically distributed factories that is more resistant to
disruption
REVISIT THE TRADE-OFF BETWEEN
PRODUCT
VARIETY AND CAPACITY FLEXIBILITY
During the pandemic, when demand surged in many product categories,
manufacturers struggled to shift from supplying one market segment to
supplying another, or from making one kind of product to making another
🢝Example: In the U.S. groceries market, companies had difficulty adjusting to the plunge
in demand from restaurants and cafeterias and the rise in consumer demand
🢝SKU proliferation—the addition of different forms of the same product to serve different
market segments—was partly responsible
🢝For example, one obstacle to meeting heightened demand for toilet paper at supermarkets
was that manufacturers had to change over their production lines, because consumers
prefer soft multi-ply rolls rather than the thinner toilet paper that many hotels and offices
purchased in much larger rolls. Adding to the complexity, different retail chains wanted
their own packaging and assortments
REVISIT THE TRADE-OFF BETWEEN
PRODUCT
VARIETY AND CAPACITY FLEXIBILITY
Researchers have long argued that more choice isn’t always
better
🢝Separating demand into many different SKUs makes forecasting more
difficult, and trying to fill needs by substituting products during periods of
shortage causes a real scramble
The lesson
🢝Companies should reconsider the pros and cons of producing numerous
product variations
CONCLUSIONS
Manufacturers need to use this crisis to take a fresh look at
their supply networks
Take steps to understand their vulnerabilities, and then
Take actions to improve robustness
WHAT IS THE RIGHT SUPPLY
CHAIN FOR YOUR PRODUCT?
POINTS FOR DISCUSSION
🞆 Introduction
🞆 Nature of product
🞆 Devising ideal SC strategy
🞆 Efficient supply of functional products
🞆 Responsive supply of innovative products
🞆 Conclusion
162
163
164
INTRODUCTION
🞆 Technology & brainpower has not improved SC
performance
🞆 Framework to decide the best SC
🞆 Consider nature of demand for product before devising
SC strategy
🞆 Match type of product and type of SC
165
STRATEGIC FIT
🞆 Consistency between customer priorities of competitive
strategy and supply chain capabilities specified by the
supply chain strategy
🞆 Competitive and supply chain strategies have the same
goals
🞆 All functional strategies support the above
166
COMPETITIVE AND SUPPLY
CHAIN STRATEGIES
🞆 Competitive strategy
⚫ Defines the set of customer needs a firm seeks to satisfy through
its products and services
🞆 Supply chain strategy

⚫ determines the nature of material procurement, transportation of
materials, manufacture of product or creation of service,
distribution of product
167
NATURE OF PRODUCT
🞆 Functional or innovative?
🞆 Functional
⚫ Stable, predictable demand
⚫ Long life cycles
⚫ Low profit margins
🞆 Innovative
⚫ Uncertain demand
⚫ Short life cycles
⚫ High profit margins
168
🞆 Physically same products can be either functional or innovative
Causes demand uncertainty to
increase because …
CUSTOMER NEED
Range of quantity required Greater variance in demand
increases
Lead time decreases Less time to react to orders
Variety of products required Demand per product becomes

increases more disaggregated
Number of channels increases Total customer demand is now
disaggregated over more
channels
Rate of innovation increases New products tend to have more
uncertain demand
Required service level increases Firm now has to handle unusual
169
surges in demand
SUPPLY UNCERTAINTY
Supply source incapability like
🞆 Frequent breakdowns
🞆 Unpredictable & low yields
🞆 Poor quality
🞆 Limited or inflexible supply capacity
🞆 Evolving production process
causes supply uncertainty to increase
170
IMPLIED UNCERTAINTY SPECTRUM
Highly
Predictable
uncertain
supply &
Mix supply &
demand
Demand
Salt at a Existing New

supermarket automobile communication
model device
Price Responsivenes
171
s
Customer
SUPPLY CHAIN FUNCTIONS
🞆 Physical function
⚫ Conversion, storage & transportation between points in SC
⚫ Efficiency
⚫ More important for functional products
🞆 Market mediation function
⚫ Matching supply with demand
⚫ Responsiveness
⚫ More important for innovative products
🞆 Sport Obermeyer vs. Campbell Soup
172
SUPPLY CHAIN EFFICIENCY VS.
RESPONSIVENESS
🞆 Supply chain responsiveness -- ability to
⚫ Respond to wide ranges of quantities demanded
⚫ meet short lead times
⚫ Handle a large variety of products
⚫ Build highly innovative products
⚫ Meet a very high service level
⚫ Handle supply uncertainty
🞆 Supply chain efficiency

⚫ cost of making and delivering the product to the customer
🞆 Increasing responsiveness results in higher costs that

lower efficiency 173
COST-RESPONSIVENESS EFFICIENT
FRONTIER
High Responsivenes
s
Low
Cost174
High Low
RESPONSIVENESS SPECTRUM
Highly Somewha Somewhat Highly

efficient t responsiv responsiv
efficient e e
Integrated Ready-made Most Seven eleven

steel mill garments automotive Japan
production
175
ACHIEVING STRATEGIC FIT
🞆 Ensure that what the supply chain does well is consistent
with target customer’s needs
🞆 All functions in the chain must support the competitive

strategy to achieve strategic fit
176
UNCERTAINTY/ RESPONSIVENESS MAP
Responsive
supply chain
Responsiveness e of it
n F
spectrum Zo egic
t
t ra
S
Efficient
supply chain
Certain Implied Uncertain 177

demand uncertainty demand
spectrum
DEVISING IDEAL SC STRATEGY
🞆 Understand type of product
⚫ Functional or innovative
🞆 Understand supply chain capabilities

⚫ Efficient or responsive
🞆 Correct any mismatch
178
TYPE OF PRODUCTS
Functional Innovative
products products
Attribute (predictable (unpredictable
demand) demand)
PLC > 2 yrs 3 months to 1 yr
Contribution margin 5-20% 20-60%

Product variety Low (10-20) High (millions)
Avg. forecast error 10% 40%-100%
Avg. stock out rate 1%-2% 10%-40%
Avg. forced season-end 0% 10%-25%

markdown
Lead time for make to 6mth-1yr 1day-2wks 179
order product
SUPPLY CHAIN CAPABILITIES
Efficient Responsive
Primary goal Lowest cost Quick response

Product design strategy Max performance & Min Modularity to allow
product cost postponement
Pricing strategy Lower margins Higher margins
Mfg strategy High utilization Capacity flexibility
Inventory strategy Minimize inventory Buffer inventory
Lead time focus Reduce but not at Aggressively reduce even
expense of greater cost if costs are significant
Supplier selection Cost and low quality Speed, flexibility, quality
strategy
180
Transportation strategy Greater reliance on low Greater reliance on
cost modes responsive (fast) modes
MATCHING SUPPLY CHAIN WITH
PRODUCT
Functional Innovative
Products Products
Efficient Match Mismatch

Supply
Chain
Responsive Mismatch Match
Supply
Chain 181
GETTING OUT OF UPPER RH CELL
🞆 Efficient supply of innovative products
⚫ Automobile industry
⚫ Computer industry
🞆 Move down
🞆 Move left
⚫ Toothpaste
⚫ Functional cars
182
EFFICIENT SUPPLY OF FUNCTIONAL
PRODUCTS
🞆 Campbell soup
⚫ Continuous replenishment program
⚫ EDI links with retailers
⚫ Showed negative impact of price promotions viz. forward

buying
⚫ Everyday low price
⚫ Improved service (in-stock availability)
⚫ Improved efficiency (reduction of retailers inventory)

183
184
EFFICIENT SUPPLY OF FUNCTIONAL
PRODUCTS
🞆 Partners can interact to cut costs
🞆 Get higher profits for the chain of price sensitive
products
🞆 Cooperation & competition?
🞆 Share cost information
185
RESPONSIVE SUPPLY OF INNOVATIVE
PRODUCTS
🞆 Accept, reduce, avoid and hedge against uncertainty
⚫ Mass customization at National Bicycles Japan
⚫ Accurate response at Sport Obermeyer

🞆Accept that uncertainty exists
🞆3 coordinated strategies to manage that uncertainty
🞆Reduce (new data, component commonality to make component

demand more predictable)
🞆Avoid (cutting lead time, increase flexibility)
🞆Hedge against remaining (buffers of inventory/ excess capacity)

186
ACCURATE RESPONSE
🞆 Article
⚫ Making supply meet demand in an uncertain world
187
188
189
190
OTHER ISSUES AFFECTING STRATEGIC
FIT
🞆 Multiple products and customer segments
⚫ How many supply chains?
🞆 Product life cycle

⚫ Technological changes
⚫ As product goes through the life cycle, supply chain changes
from one emphasizing responsiveness to one emphasizing
efficiency
🞆 Competitive changes over time

⚫ Mass customization
191
CONCLUSION
🞆 There is no right supply chain strategy independent of
competitive strategy
🞆 There is a right supply chain strategy for a given
competitive strategy
192
Drivers & Metrics
of
Supply Chain
Performance
Drivers of Supply Chain
Performance
• Logistical drivers
– Facilities
– Inventory
– Transportation
• Cross functional drivers
– Information
– Sourcing
– Pricing
194
Framework for Structuring
Drivers
Competitive strategy
Supply chain strategy
Efficiency Responsivenes
s
Supply chain
structure
Transportatio Inventory
Facilities
n
Logistical Drivers
Information Sourcing Pricing
195
Cross functional Drivers
Facilities
• Role in the supply chain
– “where” of the supply chain
– manufacturing or storage (warehouses)
• Role in the competitive strategy

– economies of scale (efficiency priority)
– larger number of smaller facilities
(responsiveness priority)
196
Components of Facilities
Decisions
• Role
– Operations methodology
– Warehousing methodology
• Location
• Capacity
197
Role of Facilities
• Operations Methodology
– Product focused vs. process focused
– Flexible vs. dedicated capacity
• Warehousing Methodology
– SKU storage
– Job lot storage
– Cross-docking
198
Fit of Process, Volume, and Variety
Low-Volume Repetitive Process High-Volume
(Intermittent) (Modular) (Continuous)
High Variety
Process focus Mass Customization
One or few units per run, projects, job shop, (difficult to achieve,
high variety (print, carpentry) but huge rewards)
(allows customization) Standard Register Dell Computer Co.,
Levis Jeans
Changes in modules Repetitive
Modest runs, standardized (autos, motorcycles)
modules Harley Davidson
Low Variety; Changes in Product focus
attributes (such as (commercial baked
grade, quality, size,
goods, steel, glass)
thickness, etc.)
Long runs only Steel, Cement
Process-Focused
Strategy
● Facilities are organized by process
● Similar processes are together
● Example: All drill presses are together
● Low volume, high variety products
● ‘Jumbled’ flow Product A
Operation
● Other names
1 2 3
● Job shop
Product B
Process-Focused Example
Custom Woodworking Shop
Assemb Finishin
Cutting Planing Shaping Sanding
ly g
1 2 5 6 7
Job 2 3
A
Job B 3 4
1 4 5 6
Drilling Turning
Process Focus - Pros & Cons
• Advantages
– Greater product flexibility
– More general purpose equipment – equipments
not dedicated to one product
• Disadvantages
– High production cost per unit
– More difficult production planning & control
– Low equipment utilization (5% to 25%)
Process-Focus Examples
Bank
Hospital
Machine
Shop
Repetitive Focused
Strategy
• Facilities often organized by assembly lines
• Characterized by modules
– Parts & assemblies made in modules
• Modules combined for many output options

• Other names
– Assembly line
– Production line
– E.g. auto-manufacturing, pc’s, house-hold appliances, etc
Assembly Line Example
Raw Material Components
2 4 Su
Co b as
m se
po m
ne .
nt
s. Assemblies Fin. Goods
1 3 5 7
Raw Material Components Subassem.
Product/Material Flow
Production Operation
Repetitive Focus - Considerations
• Product focused process that uses modules

• More structured than process-focused, less
structured than product focused
• Enables semi-customization
• Using modules, it enjoys economic advantage
of continuous process, and custom advantage
of low-volume, moderately high-variety model
Repetitive Focus - Examples
Fast
Clothes
Food
Dryer
McDonald’s
over 95 billion served
Truck
Repetitive Focus
Product-Focused Strategy
● Facilities are organized by product
● High volume, low variety
● Conversion or further processing of undifferentiated
materials such as petroleum, chemicals, or food
processing
● Follows a predetermined sequence of steps, but flow is
continuous rather than discrete – highly standardized
● Other names
● Line flow production
● Continuous production
Production Process at
NUCOR Steel
Product Focus - Pros & Cons
• Advantages
– Lower production cost per unit
– Lower but more specialized labor skills
– Easier production planning and control
– Higher equipment utilization (70% to 90%)
• Disadvantages
– Lower product flexibility
– More specialized equipment
Product-Focused
Examples
Soft Drinks
(Continuous, then
Discrete)
Paper (Continuous)
Mass Customization
• Using technology and imagination to rapidly
mass-produce products that cater to
unique customer desires
• Under mass customization the three
process models become so flexible that
distinctions between them blur, making
variety and volume issues less significant
Location
• Basic tradeoff: Centralization (efficiency)
vs. decentralization (responsiveness)
• Quality & cost of workers
• Cost of facility
• Infrastructure
• Proximity to customers & rest of network
• Tax benefits
214
Capacity
• Excess capacity
– Flexible (responsive) but less efficient
• High utilization
– Efficient
215
Facility related metrics
• Capacity
• Utilization
• Processing/Setup/Down/Idle time
• Production cost/ unit
• Quality losses
• Theoretical Flow/ Cycle Time
• Actual Average Flow/ Cycle Time
• Flow Time Efficiency
216
Facility related metrics
• Product variety
• Volume contribution of top 20%
SKUs & customers
• Processing/ Setup/ Down/ Idle Time
• Average Production batch size
• Production service level
217
Inventory
• Role in the supply chain
– the “what” of the supply chain
– exists because of a mismatch between
supply and demand
– Source of cost and influence
responsiveness
• Impacts
– material flow time (T)
– Throughput (D)
Little’s Law
I = DT 218
Inventory
• Role in the competitive strategy
– Locate large amount close to customer
(responsiveness priority)
– Centralized stocking (efficiency

priority)
219
Components of Inventory
Decisions
• Cycle inventory
• Safety inventory
• Seasonal inventory
• Level of product availability
• Overall trade-off: Responsiveness versus
efficiency
220
Level Production
Demand
Production
Units
Time
221
Chase Demand
Demand
Production
Units
Time
222
Inventory related
metrics
• Average inventory
– Units
– Days of demand
– Financial value
• Products with more than a specified
number of days inventory
• Average replenishment batch size
– Units & days of demand of each SKU
223
Inventory related
metrics
• Average safety inventory
• Seasonal inventory
• Fill rate
• Fraction of time out of stock
• Obsolete inventory
224
Transportation
• Role in the Supply Chain
– Moves the product between stages in
the supply chain
– Speed & amount transported impact
responsiveness and efficiency
– Affects inventory and facilities
225
Transportation
• Role in the Competitive Strategy
– Faster transportation modes
(responsiveness) to customers willing to
pay for it
– Slower transportation modes for

customers whose priority is price (cost)
– Find the right balance between
inventory and transportation
226
Components of
Transportation Decisions
• Mode of transportation:
– Air truck, rail, ship, pipeline, electronic
transportation
– Vary in cost, speed, size of shipment,
flexibility
227
Components of
Transportation Decisions
• Route and network selection
– route: path along which a product is
shipped
– network: collection of locations and
routes
• In-house or outsource
228
Transportation related
metrics
• Average inbound transport cost
• Average outbound transport cost
• Average incoming shipment size
• Average outgoing shipment size
• Average inbound transport cost per shipment
• Average outbound transport cost per shipment
• Fraction transported by mode
229
Information
• Role in the Supply Chain
– Connection between the various stages
in the supply chain – allows coordination
between stages
– Crucial to daily operation of each stage
in a supply chain – e.g., production
scheduling, warehouse management
230
Information
• Role in the Competitive Strategy
– Allows supply chain to become more
efficient and more responsive at the
same time (reduces the need for a
trade-off)
– Information technology
– What information is most valuable?
231
Components of
Information Decisions
• Push (MRP) versus pull
• Coordination and information sharing
• Forecasting and aggregate planning
• Enabling technologies
– EDI
– Internet
– ERP systems
– Supply Chain Management software
– RFID
232
Information related
metrics
• Forecast horizon
• Frequency of update
• Forecast error
• Seasonal factors
• Variance from plan
• Ratio of demand variability to order
variability
233
Sourcing
• Role in the SC
– Set of business processes required to
purchase goods and services
– Which tasks to outsource
– Single/ multiple suppliers
– Criteria to select suppliers & measure
their performance
234
Sourcing
• Role in the SC
– Negotiate contracts
• Define role of each supply source
– Procurement processes
• Placement and delivery of orders
• Role in competitive strategy

– Affect efficiency and responsiveness
– Compare in-house/ outsource costs
235
Sourcing related metrics
• Days payable outstanding
• Average purchase price
• Range of purchase price
• Average purchase quantity
• Fraction on-time deliveries
• Supply quality
• Supply lead time
236
Pricing
• How much to charge customers for
goods & services
• Role in SC
– Affects customer segments &
expectations
– Demand profile SC attempts to serve &
level of responsiveness required
– Lever to match supply & demand
237
Components of Pricing
decisions
• Pricing & economies of scale
– Quantity discounts
• EDLP vs. High-low pricing
• Fixed price vs. menu pricing
– Yield/ revenue management
238
Pricing related metrics
• Profit margin
– Profit as % of revenue
– Metrics
• Type of margin (gross, net)
• Scope (SKU, product line, division, firm)
• Customer type
• Days of sales outstanding
239
Pricing related metrics
• Incremental fixed cost per order
• Incremental variable cost per unit
• Average sale price
• Average order size
• Range of sale price
• Range of periodic sales
240
Supply Chain Drivers
241
Obstacles to Achieving
Strategic Fit
• Increasing variety of products
• Decreasing product life cycles
• Increasingly demanding customers
• Fragmentation of supply chain
ownership
• Globalization
• Difficulty executing new strategies
242
Both responsiveness
& efficiency
• Higher responsiveness at given cost
Or
• Same responsiveness at lower cost
• Asian Paints
– Dealer tinting systems based on
• postponement
• mass customization
243
244
OUTCOME-DRIVEN
SUPPLY CHAINS
Outcomes
245
◻ Cost
◻ Responsiveness
◻ Security
◻ Sustainability
◻ Resilience
◻ Innovation
Options
246
◻ Focus on an outcome
◻ Blend outcomes
Blending outcomes
247
◻ Tradeoffs
◻ One outcome must stand out
◻ Emphasis on alignment of incentives
◻ Complicates performance measurement
◻ Allows leveraging
◻ Different paths
🞑 When to blend?
Adaptability
248
◻ Critical drivers
◻ Locations
◻ Difference in culture
◻ Corporate cultures
◻ Stages of product life
Network Planning
Topics
🞂 Introduction
🞂 Network design
🞂 Data collection & aggregation
🞂 Transportation
🞂 Warehousing
🞂 Models & data validation
🞂 Heuristics & exact algorithms
🞂 Inventory positioning & logistics coordination
🞂 Case: ElecComp Inc.
🞂 Resource allocation
250
Network Planning
🞂 Process by which a firm structures and manages supply
chain in order to
🞂 Find the right balance between inventory, transportation and
manufacturing costs
🞂 Match supply and demand under uncertainty by positioning and
managing inventory effectively
🞂 Utilize resources effectively by sourcing products from the
most appropriate manufacturing facility
251
Planning process
🞂 Network design
🞂 Number, locations and size of manufacturing plants & warehouses
🞂 Assignment of retail outlets to warehouses
🞂 Major sourcing decisions
🞂 Typical planning horizon is a few years
🞂 Inventory positioning
🞂 Identifying stocking points
🞂 Selecting facilities that will produce to stock and thus keep inventory
🞂 Facilities that will produce to order and hence keep no inventory
🞂 Related to the inventory management strategies
🞂 Resource allocation
🞂 Determine whether production and packaging of different products is
done at the right facility
🞂 What should be the plants sourcing strategies?
🞂 How much capacity each plant should have to meet seasonal demand?
252
Network Design
🞂 Physical configuration and infrastructure of the supply
chain
🞂 Strategic decision with long-lasting effects on the firm
🞂 Decisions relating to plant and warehouse location as well
as distribution and sourcing
253
Key Strategic Decisions
🞂 Determining the
🞂 appropriate number of facilities
🞂 location of each facility.
🞂 size of each facility.
🞂 space allocation for products in each facility.
🞂 sourcing requirements.
🞂 distribution strategies i.e. allocation of customers to warehouse
254
Reevaluation of Infrastructure
🞂 Changes in:
🞂 demand patterns
🞂 product mix
🞂 production processes
🞂 sourcing strategies
🞂 cost of running facilities.
🞂 Mergers and acquisitions may mandate the integration of
different logistics networks
255
Supply Chain Optimization
🞂 Objective
🞂 Design or reconfigure the logistics network in order to minimize
annual system-wide cost subject to a variety of service level
requirements
🞂 Some issues
🞂 Data collection
🞂 Data aggregation
🞂 Transport rates
🞂 Mileage estimation
256
Data Collection
🞂 Locations of customers, retailers, existing warehouses and
distribution centers, manufacturing facilities, and suppliers.
🞂 All products, including volumes, and special transport modes
(e.g., refrigerated)
🞂 Annual demand for each product by customer location.
🞂 Transportation rates by mode
🞂 Warehousing costs, including labor, inventory carrying
charges, and fixed operating costs
🞂 Shipment sizes and frequencies for customer delivery
🞂 Order processing costs
🞂 Customer service requirements and goals
🞂 Production and sourcing costs and capacities
257
Data Aggregation
🞂 Customer Zone
🞂 Aggregate customers in close proximity as a cluster
🞂 Replace all customers within a single cluster by a single customer
located at the center of the cluster
🞂 Product Groups
🞂 Distribution pattern
🞂 Products picked up at the same source and destined to the same customers
🞂 Logistics characteristics like weight and volume
🞂 Product type
🞂 product models or style differing only in the type of packaging
258
Replacing Original Detailed Data with
Aggregated Data
🞂 Technology exists to solve the logistics network design
problem with the original data
🞂 Data aggregation still useful because forecast demand is
significantly more accurate at the aggregated level
🞂 Aggregating customers into about 150-200 zones usually
results in no more than a 1 percent error in the estimation
of total transportation costs
259
Value of Aggregation
Annual Demand
Average Standard CV
deviation
Customer 1 24237 4658 0.192
Customer 2 20905 3427 0.173
Total 45142 6757 0.150
260
Typical aggregation approach
🞂 Aggregate demand points into at least 200 zones
🞂 If customers classified according to their service levels/
frequency of delivery, each class will have at least 200
aggregated points
🞂 Make sure each zone has approximately equal demand
🞂 Zones may be of different geographic sizes
🞂 Place aggregated points at the center of the zone
🞂 Aggregate products into 20 to 50 product groups
261
Transportation Rates
🞂 Rates are almost linear with distance but not with volume
🞂 Differences between internal rate and external rate
🞂 Internal fleet
🞂 Data Required:
🞂 Annual costs per truck
🞂 Annual mileage per truck
🞂 Annual amount delivered
🞂 Truck’s effective capacity
🞂 Calculate cost per mile per SKU
🞂 External
🞂 TL or LTL?
262
Warehouse Costs
🞂Handling costs
🞂 Labor and other costs
🞂 Proportional to annual flow through the warehouse.
🞂Fixed costs
🞂 All cost components not proportional to the amount of flow
🞂 Typically proportional to warehouse size (capacity) but in a
nonlinear way.
🞂Storage costs
🞂 Inventory holding costs
🞂 Proportional to average positive inventory levels.
263
Determining Fixed Costs
Warehouse fixed costs as a function of the warehouse capacity

264
Warehouse Capacity
🞂 Estimation of actual space required
🞂 Average inventory level
= Annual flow through warehouse/Inventory turnover ratio
🞂 Space requirement for item = 2*Average Inventory Level
🞂 Multiply by factor to account for
🞂 access and handling
🞂 aisles,
🞂 picking, sorting and processing facilities
🞂 AGVs
🞂 Factor value > 1
🞂 Typical factor value = 3 (varies)
265
Warehouse Capacity Example
🞂 Annual flow = 1,000 units
🞂 Inventory turnover ratio = 10.0
🞂 Average inventory level = 100 units
🞂 Assume each unit takes 10 sqft. of space
🞂 Required space for products = 2,000 sqft.
🞂 Total space required for the warehouse is about 6,000
square feet
266
Potential Locations
🞂 Geographical and infrastructure conditions.
🞂 Natural resources and labor availability.
🞂 Local industry and tax regulations.
🞂 Public interest.
🞂 Not many will qualify based on all the above conditions
267
Service Level Requirements
Different ways to define service levels
🞂 Specify a maximum distance between each customer and
the warehouse serving it
🞂 Proportion of customers whose distance to their assigned
warehouse is no more than a given distance
🞂 E.g. 95% of customers be situated within 200 miles of the
warehouses serving them
🞂 Appropriate for rural or isolated areas
268
Future Demand
🞂 Strategic decisions have lasting impact
🞂 have to be valid for 3-5 years
🞂 Identify possible scenarios
🞂 expected future demand over planning horizon
269
Model & Data Validation
🞂 Reconstruct the existing network configuration using the
model and collected data
🞂 Compare the output of the model to existing data
🞂 Make local or small changes in the network configuration to
see how the system estimates impact on costs and service
levels.
🞂 Posing a variety of what-if questions
🞂 Answer the following questions:
🞂 Does the model make sense?
🞂 Are the data consistent?
🞂 Can the model results be fully explained?
🞂 Did you perform sensitivity analysis?
270
Solution Techniques
🞂Mathematical optimization techniques
🞂 Exact algorithms: find optimal solutions
🞂 Heuristics: find “good” solutions, not necessarily optimal
🞂Simulation models
🞂 provide a mechanism to evaluate specified design
alternatives
271
Example
🞂A distribution system of a single product
🞂Two plants p1 and p2
🞂 Plant p2 has an annual capacity of 60,000 units.
🞂The two plants have the same production costs
🞂There are two warehouses w1 and w2 with identical
warehouse handling costs
🞂There are three markets areas c1,c2 and c3 with
demands of 50,000, 100,000 and 50,000 respectively
272
Unit Distribution Costs
Facility p1 p2 c1 c2 c3
warehouse
w1 0 4 3 4 5
w2 5 2 2 1 2
Find distribution strategy that specifies flow of product

from suppliers through warehouse to the markets
Heuristic #1:
Choose the Cheapest Warehouse to Source Demand
D = 50,000
$2 x 50,000
$5 x 140,000 D = 100,000
$1 x 100,000
$2 x 60,000
Cap = 60,000
$2 x 50,000 D = 50,000
Total Costs = $1,120,000
274
Heuristic #2:
Choose the warehouse where the total delivery costs to and from the warehouse are the
lowest
[Consider inbound and outbound distribution costs]
$0
$3 D = 50,000
P1 to WH1 $3
P1 to WH2 $7
P2 to WH1 $7
$4 $2 P2 to WH 2 $4
$5
$5 D = 100,000
P1 to WH1 $4
$4 P1 to WH2 $6
$1 P2 to WH1 $8
$2 P2 to WH 2 $3
Cap = 60,000
$2 D = 50,000
P1 to WH1 $5
P1 to WH2 $7
P2 to WH1 $9
P2 to WH 2 $4
Market #1 is served by WH1, Markets 2 and 3
are served by WH2
275
Heuristic #2:
Choose the warehouse where the total delivery
costs to and from the warehouse are the lowest
$0 x 50,000
$3 x 50,000 D = 50,000
Cap = 200,000 P1 to WH1
P1 to WH2
$3
$7
P2 to WH1 $7
P2 to WH 2 $4
$5 x 90,000 D = 100,000
P1 to WH1 $4
P1 to WH2 $6
$1 x 100,000 P2 to WH1 $8
$2 x 60,000 P2 to WH 2 $3
Cap = 60,000
$2 x 50,000 D = 50,000
P1 to WH1 $5
P1 to WH2 $7
P2 to WH1 $9
P2 to WH 2 $4
Total Cost = $920,000

276
The Optimization Model
The problem described earlier can be framed as the following
linear programming problem.
Let
🞂 x(p1,w1), x(p1,w2), x(p2,w1) and x(p2,w2) be the flows from
the plants to the warehouses.
🞂 x(w1,c1), x(w1,c2), x(w1,c3) be the flows from the warehouse
w1 to customer zones c1, c2 and c3.
🞂 x(w2,c1), x(w2,c2), x(w2,c3) be the flows from warehouse w2
to customer zones c1, c2 and c3
The Optimization Model
The problem we want to solve is:
min 0x(p1,w1) + 5x(p1,w2) + 4x(p2,w1)
+ 2x(p2,w2) + 3x(w1,c1) + 4x(w1,c2)
+ 5x(w1,c3) + 2x(w2,c1) + 2x(w2,c3)
subject to the following constraints:

x(p2,w1) + x(p2,w2) ≤ 60000
x(p1,w1) + x(p2,w1) = x(w1,c1) + x(w1,c2) + x(w1,c3)
x(p1,w2) + x(p2,w2) = x(w2,c1) + x(w2,c2) + x(w2,c3)
x(w1,c1) + x(w2,c1) = 50000
x(w1,c2) + x(w2,c2) = 100000
x(w1,c3) + x(w2,c3) = 50000
all flows greater than or equal to zero.

Optimal Solution
Facility p1 p2 c1 c2 c3
warehouse
w1 140,000 0 50,000 40,000 50,000

w2 0 60,000 0 60,000 0
Total cost for the optimal strategy is $740,000

Inventory Positioning and Logistics
Coordination
🞂 Multi-facility supply chain that belongs to a single firm
🞂 Manage inventory so as to reduce system wide cost
🞂 Consider the interaction of the various facilities and the impact
of this interaction on the inventory policy of each facility
🞂 Ways to manage:
🞂 Wait for specific orders to arrive before starting to manufacture them
[make-to-order facility]
🞂 Otherwise, decide on where to keep safety stock?
🞂 Which facilities should produce to stock and which should produce to
order?
280
Push/Pull Boundary for grocery shop
Pull Customer Order Cycle
Customer
comes
Replenishment &
Push Manufacturing Cycle
Procurement Cycle
Push/Pull Boundary for Dell
Pull Customer Order &

Manufacturing Cycle
Customer
comes
Push Procurement Cycle

Single Product, Single Facility Periodic
Review Inventory Model
🞂Assume -
🞂 SI: amount of time between when an order is placed until the
facility receives a shipment (Incoming Service Time)
🞂 S: Committed Service Time made by the facility to its own
customers
🞂 T: Processing Time at the facility
🞂
🞂Net Lead Time = SI + T - S
🞂Safety stock at the facility:
283
2-Stage System
● Reducing committed service time from facility 2 to

facility 1 impacts required inventory at both facilities
● Inventory at facility 1 is reduced
● Inventory at facility 2 is increased
● Overall objective is to choose:
● the committed service time at each facility
● the location and amount of inventory
● minimize total or system wide safety stock cost
284
ElecComp Case
🞂 Large contract manufacturer of circuit boards and other high
tech parts
🞂 About 27,000 high value products with short life cycles
🞂 Fierce competition => Low customer promise times <
Manufacturing Lead Times
🞂 High inventory of SKUs based on long-term forecasts =>
Classic PUSH STRATEGY
🞂 High shortages
🞂 Huge risk
🞂 PULL STRATEGY not feasible because of long lead times
285
New Supply Chain Strategy
🞂 OBJECTIVES:
🞂 Reduce inventory and financial risks
🞂 Provide customers with competitive response times.
🞂 ACHIEVE THE FOLLOWING:
🞂 Determining the optimal location of inventory across the various stages
🞂 Calculating the optimal quantity of safety stock for each component at each
stage
🞂 Hybrid strategy of Push and Pull
🞂 Push Stages produce to stock where the company keeps safety stock
🞂 Pull stages keep no stock at all.
🞂 Challenge:
🞂 Identify the location where the strategy switched from Push-based to Pull-
based
🞂 Identify the Push-Pull boundary
🞂 Benefits:
🞂 For same lead times, safety stock reduced by 40 to 60%
🞂 Company could cut lead times to customers by 50% and still reduce safety
stocks by 30%
286
Notations Used
How to read the diagrams
287
288
289
Trade-Offs
🞂 If Montgomery facility reduces committed lead time to 13 days
🞂 assembly facility does not need any inventory of finished goods
🞂 Any customer order will trigger an order for parts 2 and 3.
🞂 Part 2 will be available immediately, since it is held in inventory
🞂 Part 3 will be available in 15 days
◻ 13 days committed response time by the manufacturing facility
◻ 2 days transportation lead time.
🞂 Another 15 days to process the order at the assembly facility
🞂 Order is delivered within the committed service time.
🞂 Assembly facility produces to order, i.e., a Pull based strategy
🞂 Montgomery facility keeps inventory and hence is managed
with a Push or Make-to-Stock strategy.
290
Current Safety Stock Location
Current safety stock location
291
Optimized Safety Stock Location
Optimized safety stock
292
Current Safety Stock with Lesser Lead
Time
Optimized safety stock with reduced lead time
293
Supply Chain with
More Complex Product Structure
294
Current supply chain
Optimized Supply Chain with
More Complex Product Structure
295 Optimized supply chain

Key Points
🞂 Identifying the Push-Pull boundary
🞂 Taking advantage of the risk pooling concept
🞂 Demand for components used by a number of finished
products has smaller variability and uncertainty than that
of the finished goods.
🞂 Replacing traditional supply chain strategies that are
typically referred to as sequential, or local,
optimization by a globally optimized supply chain
strategy.
296
Local vs. Global Optimization
297 Trade-off between quoted lead time and safety stock

Global Optimization
🞂 For the same lead time, cost is reduced significantly
🞂 For the same cost, lead time is reduced significantly
🞂 Trade-off curve has jumps in various places
🞂 Represents situations in which the location of the Push-Pull
boundary changes
🞂 Significant cost savings are achieved.
298
Problems with Local Optimization
🞂Prevalent strategy for many companies:
🞂 try to keep as much inventory close to the customers
🞂 hold some inventory at every location
🞂 hold as much raw material as possible.
🞂This typically yields leads to:
🞂 Low inventory turns
🞂 Inconsistent service levels across locations and products, and
🞂 The need to expedite shipments, with resulting increased
transportation costs
299
Resource Allocation
🞂Supply chain master planning
🞂 process of coordinating and allocating production, and
distribution strategies and resources to maximize profit or
minimize system-wide cost
🞂Process takes into account:

🞂 interaction between the various levels of the supply chain
🞂 identifies a strategy that maximizes supply chain
performance
300
Global Optimization and DSS:
Factors to consider
🞂 Facility locations: plants, distribution centers and demand
points
🞂 Transportation resources including internal fleet and common
carriers
🞂 Products and product information
🞂 Production line information such as min lot size, capacity,
costs, etc.
🞂 Warehouse capacities and other information such as certain
technology (refrigerators) that a specific warehouse has and
hence can store certain products
🞂 Demand forecast by location, product and time.
301
Focus of the Output
🞂Sourcing Strategies
🞂 where should each product be produced during the planning
horizon, OR
🞂Supply Chain Master Plan:
🞂 production quantities, shipment size and storage requirements
by product, location and time period.
302
The Extended Supply Chain: From
Manufacturing to Order Fulfillment
303
Conclusion
🞂 Optimizing supply chain performance is difficult
🞂 conflicting objectives
🞂 demand and supply uncertainties
🞂 supply chain dynamics.
🞂 Through network planning, firms can globally optimize
supply chain performance
🞂 Combines network design, inventory positioning and resource
allocation
🞂 Consider the entire network
🞂 account production
🞂 Warehousing
🞂 transportation inventory costs
🞂 service level requirements.
304
Conclusion
🞂 Demonstrate applicability of risk pooling and
postponement, EOQ modeling, and inventory sizing to
improve customer service in make-to-order job shop
setting
🞂 Demonstrates value from getting and looking at data
305
Supply Chain Integration
Introduction
⚫Effective SCM implies
⚫Efficient integration of suppliers, manufacturers, warehouses,
and stores.
⚫Coordinate activities across the supply chain
⚫Improve performance
⚫reduce cost, increase service level, reduce the bullwhip effect,
better utilize resources, and effectively respond to changes in
the market place
Introduction
⚫Challenges can be met by integrating

⚫the front-end, customer demand
⚫to the back-end, manufacturing portion of the supply chain
⚫Various supply chain integration strategies

⚫Push, pull, push–pull strategy
⚫Framework for matching products and industries with
supply chain strategies
⚫Demand-driven supply chain strategies
⚫The impact of the Internet on supply chain integration
Push, Pull, Push-Pull Systems
⚫Push and Pull traditional categories of manufacturing
operations
⚫More recent hybrid strategy of combining the two,
Push-Pull systems
Push-Based Supply Chains
⚫Production and distribution decisions based on long-
term forecasts.
⚫Manufacturer demand forecasts based on orders
received from the retailer’s warehouses.
⚫Longer reaction time to changing marketplace:
⚫Inability to meet changing demand patterns.
⚫Obsolescence of supply chain inventory as demand for
certain products disappears.
⚫Variability of orders received much larger than the
variability in customer demand due to the bullwhip effect.
⚫Excessive inventories due to the need for large safety stocks
⚫Larger and more variable production batches
⚫Unacceptable service levels
⚫Product obsolescence
Bullwhip Effect in Push-Based Supply
Chains
⚫Leads to inefficient resource utilization
⚫Planning and managing are much more difficult.
⚫Not clear how a manufacturer should determine
production capacity? Transportation capacity?
⚫Peak demand?
⚫Average demand?
⚫Results:
⚫Higher transportation costs
⚫Higher inventory levels and/or higher manufacturing
costs
⚫more emergency production changeovers
Pull-Based Supply Chains
⚫Production and distribution demand driven
⚫Coordinated with true customer demand rather than forecast
demand
⚫firm does not hold any inventory and only responds to
specific orders.
⚫Intuitively attractive:
⚫Reduced lead times through the ability to better anticipate
incoming orders from the retailers.
⚫Reduced inventory since inventory levels increase with lead
times
⚫Less variability in the system
⚫Decreased inventory at the manufacturer due to the
reduction in variability.
Implementation of Pull-Based Systems
⚫Often difficult to implement
⚫when lead times are long
⚫ impractical to react to demand information.
⚫more difficult to take advantage of economies of scale
⚫Advantages and disadvantages of push and pull
supply chains:
⚫new supply chain strategy that takes the best of both.
⚫Push–pull supply chain strategy
Push-Pull Strategy
⚫Some stages of the supply chain operated in a push-based
manner
⚫typically the initial stages
⚫Remaining stages employ a pull-based strategy.
⚫Interface between the push-based stages and the pull-
based stages is the push–pull boundary.
Supply Chain Timeline
Push-pull supply chains

General Strategy
⚫Make a part of the product to stock – generic product
⚫The point where differentiation has to be introduced is the
push-pull boundary
⚫Based on extent of customization, the position of the
boundary on the timeline is decided
Identifying the Appropriate Supply Chain
Strategy
Push-pull supply chains

Impact of Demand Uncertainty and Economies
of Scale
⚫Demand Uncertainty:
⚫Higher demand uncertainty leads to a preference for pull
strategy.
⚫Lower demand uncertainty leads to an interest in managing the
supply chain based on a long-term forecast: push strategy.
⚫Economies of scale:
⚫The higher the importance of economies of scale in reducing
cost
⚫ The greater the value of aggregating demand
⚫ The greater the importance of managing the supply chain based on long-
term forecast, a push-based strategy.
⚫Economies of scale are not important
⚫ Aggregation does not reduce cost
⚫ A pull-based strategy makes more sense.
Implementing a Push–Pull Strategy
⚫Achieving the appropriate design depends on many
factors:
⚫product complexity
⚫manufacturing lead times
⚫supplier–manufacturer relationships.
⚫Many ways to implement a push–pull strategy
⚫location of the push–pull boundary.
⚫ Dell locates the boundary at the assembly point
⚫ Furniture manufacturers locate the boundary at the production point
Impact of the Push-Pull Strategy
⚫Push portion
⚫Low uncertainty
⚫Service level not an issue
⚫Focus on cost minimization.
⚫Long lead times
⚫Complex supply chain structures
⚫Cost minimization achieved by:
⚫ better utilizing resources such as production and distribution
capacities
⚫ minimizing inventory, transportation, and production costs.
⚫Supply Chain Planning processes are applied.
Impact of the Push-Pull Strategy
⚫Pull portion
⚫High uncertainty
⚫Simple supply chain structure
⚫Short cycle time
⚫Focus on service level.
⚫Achieved by deploying a flexible and responsive supply
chain
⚫Order-fulfillment processes are applied
Characteristics of the Push and Pull Portions of
the Supply Chain
Portion Push Pull
Objective Minimize cost Maximize service
level
Complexit High Low
y
Focus Resource Responsiveness
allocation
Lead time Long Short
Processes Supply chain Order fulfillment
planning
Interactions of the Two Portions
⚫Only at the push-pull boundary
⚫Typically through buffer inventory
⚫Different role for the inventory in each portion
⚫In the push portion, buffer inventory is part of the output
generated by the tactical planning process
⚫In the pull system, it represents the input to the
fulfillment process.
⚫Interface is forecast demand
⚫Forecast based on historical data obtained from the pull
portion
⚫Used to drive the supply chain planning process and
determine the buffer inventory.
Impact of Lead Time
⚫Longer the lead time, more important it is to
implement a push based strategy.
⚫Typically difficult to implement a pull strategy when
lead times are so long that it is hard to react to demand
information.
Impact of Lead Time
Matching supply chain strategies with products: the impact of lead time
and demand uncertainty
Impact of Lead Time
⚫ Box A
⚫ Items with short lead time and high demand uncertainty
⚫ Pull strategy should be applied as much as possible.
⚫ Box B
⚫ Items with long supply lead time and low demand uncertainty.
⚫ Appropriate supply chain strategy is push.
⚫ Box C
⚫ items with short supply lead time and highly predictable demand.
⚫ Continuous replenishment strategy
⚫ Suppliers receive POS data
⚫ They use these data to prepare shipments at previously agreed-upon intervals
⚫ A pull strategy at the production and distribution stages and push at the retail
outlets.
⚫ Box D
⚫ Items with long lead times are long and unpredictable demand
⚫ Inventory is critical in this type of environment
⚫ Requires positioning inventory strategically in the supply chain
Demand-Driven Strategies
⚫Requires integrating demand information into the supply
chain planning process
⚫Demand forecast:
⚫ Use historical demand data to develop long-term estimates of
expected demand
⚫Demand shaping:
⚫ Firm determines the impact of various marketing plans such as
promotion, pricing discounts, rebates, new product introduction, and
product withdrawal on demand forecasts.
Forecast Errors Are Always Present!
⚫ High demand forecast error has a detrimental impact on supply
chain performance
⚫ Approaches to improve accuracy
⚫Aggregate forecasts are more accurate,
⚫ Select the push–pull boundary so that demand is aggregated over one or more
of the following dimensions:
⚫ Across products/geography/time
⚫Use market analysis and demographic and economic trends to
improve forecast accuracy
⚫Determine the optimal assortment of products by store
⚫ Reduce the number of SKUs competing in the same market.
⚫Incorporate collaborative planning and forecasting processes with
your customers
⚫ Demand forecast by SKU by location has to be supported by the
supply chain
⚫Interaction of demand planning and tactical supply planning
⚫Iterative process
Impact of the Internet on Supply Chain
Strategies
⚫Expectation that increasing use of the internet would
solve a lot of the business problems
⚫Reality was very different
⚫Many of the problems in the internet-based businesses
were related to logistics strategies
Successes and Failures
⚫Notable Failures
⚫Furniture.com
⚫Peapod.com
⚫Notable Successes
⚫Amazon.com
⚫Hybrid of successes and failures
⚫Cisco
⚫ $2.2B inventory write-off in 2001
⚫ Has been successful in leveraging the internet subsequently
E-Business
⚫E-business: a collection of business models and processes
motivated by Internet technology and focusing on
improvement of extended enterprise performance.
⚫E-commerce: ability to perform major commerce
transactions electronically.
Key Observations
⚫e-commerce is only part of e-business.
⚫Internet technology is the force behind the business
change.
⚫Focus on the extended enterprise
⚫Business-to-consumer (B2C)
⚫“direct to customer,”
⚫Retail activities over the Internet, and includes products,
insurance, banking, and so forth.
⚫Business-to-business (B2B)
⚫Conducted over the Internet predominantly between
businesses.
⚫Includes:
⚫ electronic sourcing (the so-called eSourcing)
⚫ reverse auctions
⚫ collaboration with suppliers and vendors to achieve common
goals.
Grocery Industry
⚫ Typical supermarket employs a push-based strategy
⚫ Peapod was built on pure pull strategy with no inventory and
no facilities.
⚫ Significant service problems with high stockout rates
⚫ Changed to a push–pull strategy by setting up a number of warehouses
⚫ Warehouse covers a large geographical area
⚫ Aggregated demand
⚫ Other challenges:
⚫ Reducing transportation costs
⚫ Short response time
⚫ Low customer density
⚫ Products have low demand uncertainty
⚫ high economies of scale in transportation cost
⚫ push-based strategy is more appropriate.
Book Industry
⚫ Initial model of Amazon.com a pure pull system with no
warehouses and no stock.
⚫ Ingram Book Group supplied most of Amazon’s customer demand.
⚫ As volume and demand increased:
⚫ Amazon.com’s service level was affected by Ingram Book’s distribution
capacity
⚫ Using Ingram Book in the first few years allowed Amazon.com to avoid
inventory costs but significantly reduced profit margins.
⚫ As demand increased distributor no longer required.
⚫ Current Amazon.com:
⚫ Several warehouses around the country where most of the titles are
stocked.
⚫ Inventory at the warehouses is managed using a push strategy
⚫ Demand satisfied based on individual requests, a pull strategy.
⚫ Slow moving low volume books and CDs are not stocked at
Amazon distribution centers
⚫ Amazon orders those when demand arrives.
General Retail Industry
⚫Late to respond to competition from virtual stores and
to recognize the opportunities provided by the
Internet.
⚫Brick-and-mortar companies are adding an Internet
shopping component to their offering.
⚫Already have the distribution and warehousing infrastructure
⚫Click-and-mortar firms
⚫High-volume, fast-moving products stocked in stores
⚫ Push strategy
⚫Low-volume, slow-moving products are stocked centrally
⚫ Push-Pull strategy
Traditional Fulfillment Versus e-Fulfillment
Traditional E-fulfillment
fulfillment
Supply chain Push Push–pull
strategy
Shipment Bulk Parcel
Reverse logistics Small part of the Important and
business highly complex
Delivery Small number of Large number of
destination stores geographically
dispersed
customers
Lead times Relatively long Relatively short
Summary
⚫Implementation of push-pull strategies and demand-
driven strategies have helped many companies to
improve performance, reduce costs, increase service
levels.
⚫Collapse of many Internet companies shows that e-
business has great challenges.
⚫Companies need to:
⚫Identify the appropriate supply chain strategy for individual
products.
⚫Case for no physical infrastructure or inventory is tenuous
⚫Push–pull strategy
⚫ advocates holding inventory
⚫ although it pushes the inventory upstream in the supply chain.
Designing distribution
network
in a Supply Chain
338
Role of distribution
⮚ Distribution
● Steps taken to move & store a product from
the supplier stage to a customer stage in a
supply chain
● Occurs between every pair of stages
● Directly affects cost and customer experience
& hence overall profitability
339
⮚ Network choice
● Achieve supply chain objective
● Companies in same industry select different
networks
● Using distributors
● What determines design choice?
340
Basis for evaluating distribution
network performance
⮚ Customer needs that are met
⮚ Cost of meeting customer needs
341
Elements of customer service
influenced by network structure
⮚ Response time
⮚ Product variety
⮚ Product availability
⮚ Customer experience
⮚ Time to market
⮚ Order visibility
⮚ Returnability
● What level of performance customer wants in above?
342
Supply chain costs affected by
network structure
⮚ Inventories
⮚ Transportation
⮚ Facilities and handling
⮚ Information
343
Desired Response Time and
Number of Facilities
Number of
Facilities
Response Time
344
The Cost-Response Time Frontier
H Local
FG
Mi
i x
Regional
FG
Local WIP
Cos Central
t FG
Central
WIP
Central Raw Material and Custom
production
Custom production with raw material at
Low suppliers
Low Response Time H

i
345
Inventory Costs and Number
of Facilities
Inventory
Costs
Number of
facilities
346
Transportation Costs and
Number of Facilities
Transportation
Costs
Number of
facilities
347
Facility Costs and Number
of Facilities
Facilit
y
Costs
Number of
facilities
348
Total Costs vs. Number of Facilities
Total Costs
Total Costs
Facilitie
s
Inventory
Transportation
Number of
Facilities 349
Logistics Costs & Response Time
vs. Number of Facilities
Response Time
Total Logistics Costs
Number of
Facilities 350
Design Options for a Distribution
Network
Key decisions
⮚ Product to be delivered or picked up?

⮚ Intermediary?
⮚ Where to store?
351
Design Options for a Distribution
Network
⮚ Manufacturer Storage with Direct Shipping
⮚ Manufacturer Storage with Direct Shipping and
In-Transit Merge
⮚ Distributor Storage with package carrier Delivery
⮚ Distributor Storage with Last Mile Delivery
⮚ Manufacturer/ Distributor Storage with Consumer
Pickup
⮚ Retail Storage with Consumer Pickup
352
Manufacturer Storage with
Direct Shipping
Manufacturer
Retailer
Customers
Product Flow
Information Flow
353
Direct Shipping
⮚ Centralize inventory at manufacturer
● High availability with low inventory
● Ownership structure of inventory
● High value, low demand items with uncertain demand
⮚ Postponement
● Lowers inventory
⮚ Can increase product variety

⮚ Fast time to market
354
Direct Shipping
⮚ Transportation costs high
● Average outbound distance
● Package carriers
● Multiple shipments for a customer
⮚ Fixed facilities cost low
● Warehousing
⮚ Handling costs may increase
355
Direct Shipping
⮚ Response time large

⮚ Good information infrastructure needed
⮚ Order visibility
⮚ Handling returns difficult
356
Direct Shipping
Best suited for

⮚ Low demand high value items
⮚ Customers willing to wait & accept partial
shipments
⮚ Postponement
⮚ Few sourcing locations per order
⮚ Ideal for direct sellers who BTO 357
In-Transit Merge Network
Factories
Retailer In-Transit Merge by

Carrier
Customers
Product Flow
Information Flow
358
⮚ Combines pieces of order from different
locations
⮚ Single delivery to customer
⮚ Aggregation
⮚ Postponement
⮚ Lower transport costs
⮚ Facility & processing cost higher
⮚ Lower receiving cost
359
⮚ Information infrastructure
● Coordination may be more difficult
⮚ Response time marginally higher

⮚ Product variety, availability, time to market
similar
⮚ Returnability problem
⮚ Improved customer experience
⮚ Best if 4-5 sourcing locations
360
⮚ Advantages:
● Lower transport cost
● Better customer experience
⮚ Disadvantage
● Additional merge effort
⮚ Best for
● Low to medium demand high value items
● Obtained from few manufacturers
361
Distributor Storage with
Carrier Delivery
Factories
Warehouse Storage by
Distributor/Retailer
Customers
Product Flow
Information Flow
362
Carrier Delivery
⮚ Inventory held by distributors/ retailers
⮚ Package carriers between intermediate
location to customers
⮚ Higher inventory than last options
⮚ Medium to fast moving items
⮚ Postponement if warehouse has
assembly capacity
363
Carrier Delivery
⮚ Transport costs lower
⮚ Facility cost higher
⮚ Processing & handling costs comparable
⮚ Information infrastructure less complex
⮚ Better response time
⮚ Customer convenience, returnability better
⮚ Time to market higher
⮚ Order visibility easier
364
Last Mile Delivery
Factories
Distributor/Retailer
Warehouse
Customers
Product Flow
Information Flow
365
Last Mile Delivery
⮚ No package carrier used
⮚ Limited radius can be served
● Warehouse closer to customer
● More warehouses
⮚ Higher inventory
● Fast moving items
⮚ Transport cost highest
⮚ Facility & processing costs high
366
Last Mile Delivery
⮚ IT infrastructure similar
● Capabilities to schedule deliveries
⮚ Response time faster
⮚ Product variety lower

⮚ Ensuring availability costly
● Less than retail stores
367
Last Mile Delivery
⮚ Customer experience good

⮚ Time to market high
⮚ Order visibility not an issue

⮚ Returnability good
● More expensive than retail
368
Last Mile Delivery
Best suited where

⮚ Labor costs low
⮚ Customer segment large

⮚ Eliminate free delivery
⮚ Couple with existing distribution network

● Exploit economies of scale
● Increase utilization
369
Manufacturer or Distributor Storage
with Customer Pickup
Factories
Retailer Cross Dock DC
Pickup Sites
Customers
Customer Flow
Product Flow
370
Information Flow
⮚ Orders shipped from storage to pickup points
⮚ Low inventory costs
⮚ Low transport costs
⮚ Facility costs high if new pickup points
⮚ Processing costs high
● Comparable at manufacturer/ warehouse
● High at pickup sites
⮚ Significant information infrastructure
371
⮚ Response time same as package carriers
⮚ Variety & availability comparable to distributor/
manufacturer storage
⮚ Some loss of customer experience
⮚ Order visibility important
⮚ Returns handled at pickup sites
372
⮚ Advantages
● Lower delivery costs
● Increased set of products sold
● More customers served online
⮚ Disadvantages
● Increased handling costs
● Pickup sites
• Build new
• Develop capabilities in old
373
Retail Storage with Customer
Pickup
⮚ Most traditional
⮚ High inventory costs
⮚ Best for fast moving goods
⮚ Transport cost low
⮚ Facility cost high
⮚ Information infrastructure
● Minimal if customers order at store
● High for online orders
374
Pickup
⮚ Good response time

⮚ Lower product variety
⮚ Expensive to provide high availability
⮚ Customer experience varies
⮚ Time to market highest
375
Pickup
⮚ Order visibility important
⮚ Returnability fairly good
⮚ Best for
● Fast moving items
● Customers value fast response
376
Selecting a distribution
network design
377
Comparative Performance of
Delivery Network Designs
Retail Distributor Distributor
Storage with Manufacturer Manufacturer Storage with storage with Manufacturer
Customer Storage with Storage with In- Package Carrier last mile storage with
Pickup Direct Shipping Transit Merge Delivery delivery pickup
Response Time 1 4 4 3 2 4
Product Variety
4 1 1 2 3 1
Product Availability
4 1 1 2 3 1
Customer varies
4 3 2 1 5
Experience
Order Visibility 1 5 4 3 2 6
Returnability 1 5 5 4 3 2
Inventory 4 1 1 2 3 1
Transportation 1 4 3 2 5 1
Facility & Handling
6 1 2 3 4 5
Information 1 4 4 3 2 5
378
Product Characteristics & Customer
Preferences vs. Network Design
Retail Manufacturer Manufacturer Distributor Distributor Manufacturer
Storage Storage with Storage with Storage with storage with last storage with
with Direct In-Transit Package Carrier mile delivery pickup
Customer Shipping Merge Delivery
Pickup
High demand product
+2 -2 -1 0 +1 -1
Medium demand product
+1 -1 0 +1 0 0
Low demand product
-1 +1 0 +1 -1 +1
Very low demand
product -2 +2 +1 0 -2 +1
Many product sources
+1 -1 -1 +2 +1 0
High product value
-1 +2 +1 +1 0 -2
Quick desired response
+2 -2 -2 -1 +1 -2
High product variety
-1 +2 0 +1 0 +2
Low customer effort
-2 +1 +2 +2 +2 -1
379
E-business & Distribution Network
Impact on customer service
⮚ Response time to customers
● Delay for physical products
● No delay for downloadable products
⮚ Greater product variety
⮚ Improved product availability
● Faster dissemination of customer demand
● Aggregation of inventory
● Access, customization, convenience
380
Impact on customer service
⮚ Faster time to market
⮚ Order visibility better
⮚ Returnability difficult
⮚ Direct sales to customer
● Higher margins
⮚ Flexible pricing, product portfolio & promotions
⮚ Efficient funds transfer
381
Impact on cost
⮚ Inventory costs lower
● Better coordination
● Aggregation
● Postponement
⮚ Facilities costs lower
● Number & location costs
• Centralization
● Operations
• Customer participation lower resource costs
• Order fulfillment cost lower
• Fewer stages
• Handling costs higher for groceries
382
⮚ Impact on cost
● Transportation costs
• Higher for physical products
● Increased outbound distance
● Information
• Share to improve visibility
• Reduce overall cost by improving coordination
• Cost of information infrastructure
383
Examples of E-business
⮚ PCs
● Dell
⮚ Books
● Amazon.com
⮚ Grocery
● Peapod
⮚ MRO supplies
● Grainger.com
384
Value of Distributors
in the Supply Chain
⮚ Distributing Consumer Goods in India

⮚ Distributing MRO Products
⮚ Distributing Electronic Components
385
Distributing Consumer Goods in
India
⮚ Numerous small retail outlets

⮚ FMCGs of low value
● Transport cost important
⮚ Retailers small size
● Small replenishment lots
● Store variety of products
⮚ Manufacturers need to
● Bring FTLs close to market
● Distribute locally using milk runs with smaller vehicles
386
Distributing Consumer Goods in
India
⮚ Intermediaries
● Receive FTL
● Store inventory
● Break bulk
● Give smaller deliveries to retailers
● Aggregate products from multiple manufacturers
● Lower replenishment response time
● Lower transport costs
387
Distributing MRO Products
⮚ Emergency
⮚ Small quantities
⮚ Unplanned orders
⮚ Large variety of items required
● From various manufacturers
⮚ Distributors act as intermediaries

● Store inventory
• More stable replenishment orders
• Easier response for manufacturers
• TL deliveries possible
● Carry emergency inventory for customers
• Decreases total safety stock in SC
• Value of aggregation high for slow moving products
388
Distributing Electronic Components
⮚ Few major component manufacturers
● Intel, Texas Instruments, Motorola
⮚ Produce for large number of OEMs

⮚ 80:20 rule holds
● 20% OEMs use 80% of components
● Small OEMs through distributors
389
Value added by distributors
⮚ Reduction in inbound transport costs

● TL shipments from manufacturer to distributor
⮚ Reduction in outbound transport costs

● Aggregate over different manufacturers
⮚ Reduction in inventory costs

● Aggregates safety inventory
390
Value added by distributors
⮚ Stable order stream from distributor to

manufacturer
● Lowers cost by planning production better
⮚ Carry inventory closer to point of sale

● Better response time
⮚ Offer one-stop shopping

● For products from several manufacturers
391
DESIGN FOR LOGISTICS
Design for Logistics (DFL)
⚫Product and process design that help to control logistics
costs and increase service levels
⚫Economic packaging and transportation
⚫Concurrent and parallel processing
⚫Standardization
Economic Transportation and Storage
⚫Design products so that they can be efficiently packed
and stored
⚫Design packaging so that products can be consolidated
at cross docking points
⚫Design products to efficiently utilize retail space
Examples
⚫Ikea
⚫World’s largest furniture retailer
⚫131 stores in 21 countries
⚫Large stores, centralized manufacturing, compactly and
efficiently packed products
⚫Rubbermaid
⚫Clear Classic food containers - designed to fit 14x14” Wal-
Mart shelves
Final Packaging
⚫Delay until as late as possible
⚫Repackaging at the cross-docking point is common for
many products
Concurrent/Parallel Processing
⚫Objective is to minimize lead times
⚫Achieved by redesigning products so that several
manufacturing steps can take place in parallel
⚫Modularity/Decoupling is key to implementation
⚫Enables different inventory levels for different parts
The Network Printer Example
Concurrent processing
Traditional Manufacturing
⚫Set schedules as early as possible
⚫Use large lot sizes to make efficient use of equipment and
minimize costs
⚫Large centralized facilities take advantage of economies
of scale
Standardization
⚫Recall: aggregate demand information is more reliable
⚫We can have better forecasts for a product family (rather
than a specific product or style)
⚫How to make use of aggregate data ?
⚫Designing the product and manufacturing processes so
that decisions about which specific product is being
manufactured (differentiation) can be delayed until after
manufacturing is under way
Modularity in Product and Process
⚫Modular Product:
⚫Can be made by appropriately combining the different
modules
⚫It entails providing customers a number of options for each
module
⚫Modular Process:
⚫Each product undergo a discrete set of operations making it
possible to store inventory in semi-finished form
⚫Products differ from each other in terms of the subset of
operations that are performed on them
⚫Semiconductor wafer fabrication is modular since the
type of chip produced depends on the unique set of
operations performed
⚫Oil refining is not modular since it is continuous and
inventory storage of semi-finished product is difficult
⚫Modular products are not always made from modular
processes
⚫Bio-tech and pharmaceutical industries make modular
products but use non-modular processes; many products
are made by varying the mix of a small number of
ingredients
Swaminathan’s Four Approaches to
Standardization
⚫Part standardization
⚫Process standardization
⚫Product standardization
⚫Procurement standardization
Part Standardization
⚫Common parts used across many products
⚫Common parts reduce:
⚫inventories due to risk pooling
⚫costs due to economies of scale
⚫Excessive part commonality can reduce product
differentiation
⚫May be necessary to redesign product lines or families to
achieve commonality
Process Standardization
⚫Standardize as much of the process as possible for
different products
⚫Customizing the products as late as possible
⚫Decisions about specific product to be manufactured
is delayed until after manufacturing is under way
⚫Starts by making a generic or family product
⚫Differentiate later into a specific end-product
⚫Postponement or delayed product differentiation
Delayed Differentiation
⚫May be necessary to redesign products specifically
for delayed differentiation
⚫May be necessary to resequence the manufacturing
process to take advantage of process standardization
⚫Resequencing
⚫modify the order of product manufacturing steps
⚫resequenced operations result in the differentiation of
specific items or products are postponed as much as possible
Postponement
Point of
differentiation
Benetton Background
⚫A world leader in knitwear
⚫Massive volume, many stores
⚫Logistics
⚫Large, flexible production network
⚫Many independent subcontractors
⚫Subcontractors responsible for product movement
⚫Retailers
⚫Many, small stores with limited storage
Benetton Supply Cycle
⚫Primary collection in stores in January
⚫Final designs in March of previous year
⚫Store owners place firm orders through July
⚫Production starts in July based on first 10% of orders
⚫August - December stores adjust orders (colors)
⚫80%-90% of items in store for January sales
⚫Mini collection based on customer requests designed
in January for Spring sales
⚫To refill hot selling items
⚫Late orders as items sell out
⚫Delivery promised in less than five weeks
Benetton Flexibility
⚫Business goals
⚫Increase sales of fashion items
⚫Continue to expand sales network
⚫Minimize costs
⚫Flexibility important in achieving these goals
⚫Hard to predict what items, colors, etc. will sell
⚫Customers make requests once items are in stores
⚫Small stores may need frequent replenishments
It Is Hard to Be Flexible When...
⚫Lead times are long
⚫Retailers are committed to purchasing early orders
⚫Purchasing plans for raw materials are based upon
extrapolating from 10% of the orders
Benetton
Old Manufacturing Process
Spin or Purchase Yarn
Dye Yarn
Finish Yarn
Manufacture Garment Parts
Join Parts
Benetton
New Manufacturing Process
Spin or Purchase Yarn
Manufacture Garment Parts
Join Parts
This step is
Dye Garment postponed
Finish Garment
Benetton Postponement
⚫Why the change?
⚫The change enables Benetton to start manufacturing before
color choices are made
⚫What does the change result in?
⚫Delayed forecasts of specific colors
⚫Still use aggregate forecasts to start manufacturing early
⚫React to customer demand and suggestions
⚫Issues with postponement
⚫Costs are 10% higher for manufacturing
⚫New processes had to be developed
⚫New equipment had to be purchased
Product Standardization
⚫Downward Substitution
⚫Produce only a subset of products (because producing each
one incurs high setup cost)
⚫Guide customers to existing products
⚫Substitute products with higher feature set for those with
lower feature set
⚫Which products to offer, how much to keep, how to
optimally substitute ?
Procurement Standardization
⚫Consider a large semiconductor manufacturer
⚫The wafer fabrication facility produces highly customized
integrated circuits
⚫Processing equipment that manufactures these wafers are
very expensive with long lead time and are made to order
⚫Although there is a degree of variety at the final product
level, each wafer has to undergo a common set of operations
⚫ The firm reduces risk of investing in the wrong equipment
by pooling demand across a variety of products
Operational Strategies for Standardization
Process
Nonmodular Modular
Parts Process
Produc Modular standardization standardization
t Nonmod Product Procurement
ular standardization standardization
Selecting the Standardization Strategy
⚫If process and product are modular, process standardization
will help to maximize effective forecast accuracy and minimize
inventory costs.
⚫If the product is modular, but the process is not, it is not
possible to delay differentiation. However, part standardization
is likely to be effective.
⚫If the process is modular but the product is not, procurement
standardization may decrease equipment expenses.
⚫If neither the process nor the product is modular, some benefits
may still result from focusing on product standardization.
Important Considerations
⚫Strategies designed to deal with demand uncertainty
and/or inaccurate forecasts
⚫Changes suggested in the strategies may be too expensive
to implement
⚫Redesign related costs should be incurred at the beginning of
the product life cycle
⚫Benefits cannot be quantified in many cases:
⚫increased flexibility, more efficient customer service, decreased
market response times
Important Considerations
⚫Resequencing causes:
⚫level of inventory in many cases to go down
⚫per unit value of inventory being held will be higher
⚫Tariffs and duties are lower for semi-finished or non-
configured goods than for final products
⚫Completing the manufacturing process in a local distribution
center may help to lower costs associated with tariffs and
duties.
Push-Pull Boundary
⚫Pull-based systems typically lead to:
⚫reduction in supply chain lead times, inventory levels, and
system costs
⚫making it easier to manage system resources
⚫Not always practical to implement a pull-based
system throughout the entire supply chain
⚫Lead times may be too long
⚫May be necessary to have economies of scale in production
or transportation.
⚫Standardization strategies can combine push and pull
systems
⚫Portion of the supply chain prior to product differentiation is
typically a push-based supply chain
⚫Portion of the supply chain starting from the time of
differentiation is a pull-based supply chain.
Back to the HP Case
⚫Long lead times, high inventory levels, imbalance of inventory
⚫Localization (labeling and manuals, power supply, plug)
⚫One cause of imbalance (too much inventory for printers
localized for one market, too little inventory for another
market)
⚫Significant uncertainty on how to set safety stock
⚫Too many localization options
⚫Uncertainty in local markets
⚫Some options
⚫Air shipment
⚫A factory in Europe
⚫Improve forecasting practices (how?)
Back to the HP Case
⚫HP management considered postponement as an option
⚫Ship “unlocalized” printers to European DC and localize them
after observing the local demand
⚫At 98% service level, safety stock dropped from 3.8 weeks supply to 2.6
weeks supply on the average
⚫Annual savings around $800,000
⚫Value of inventory in transit (and hence insurance costs) goes down
⚫Some of the localization material can be locally sourced (cheaper)
⚫European DC had to be modified to facilitate localization. Printer needed
to be redesigned.
⚫All Vancouver products now DC-localizable (postponement). One of the
best of such practices.
Managing Inventory
in supply chains
426
427
Role of Inventory
428
Role of Cycle Inventory
• Lot, or batch size = Q
• Cycle inventory = Q/2
• Inventory profile: plot of the inventory level over time
• Average flow time = Avg inventory / Avg flow rate

= Q/(2D)
D = demand per unit time
429
Cycle Inventory
Q = 1000 units
D = 100 units/day
Cycle inventory = Q/2 = 1000/2 = 500 = Avg

inventory level from cycle inventory
Avg flow time = Q/2D = 1000/(2)(100) = 5
days
430
Cycle Inventory
• Adds to the time a unit spends in the
supply chain
• Lower cycle inventory is better because:

■ Average flow time is lower
■ Working capital requirements are lower
■ Lower inventory holding costs
431
• Held to take advantage of economies of
scale
• Supply chain costs influenced by lot size

■ Material cost = C ($/unit)
■ Fixed ordering cost = S ($/lot)
■ Holding cost = H = hC
⬥ h = cost of holding $1 in inventory for one year (fraction of
unit cost of product)
⬥ H = cost of holding 1 unit in inventory for one year
432
• To purchase products in lot sizes that
minimize total material, ordering, and
holding costs
• Each stage generally makes its own cycle

inventory decisions
433
Exploiting Economies of Scale
3 typical situations:
• Fixed cost incurred for each order

• Supplier offers price discounts based on
quantity
• Supplier offers short-term discounts or
holds trade promotions
434
Economies of Scale
to Exploit Fixed Costs
• Lot sizing for a single product (EOQ)
• Aggregating multiple products in a single
order
• Lot sizing with multiple products or
customers
Lots are ordered and delivered
■ independently for each product
■ jointly for all products
■ jointly for a subset of products
435
Lot sizing for a single product
(EOQ)
D: Annual demand
S: Setup or Order Cost
C: Cost per unit
h: Holding cost per year as a fraction of
product cost
H: Holding cost per unit per year
Q: Lot Size
n: Ordering frequency
T: Reorder interval 436
437
Lot sizing for a single product
Number of orders per year = D/Q
Annual material cost = CD
Annual order cost = (D/Q)S
Annual holding cost = (Q/2)H = (Q/2)hC
Total annual cost = TC
= CD + (D/Q)S + (Q/2)hC
438
Optimal Lot Size (EOQ)
439
EOQ Model
Demand for Deskpro computers at Bestbuy
d = 1000 computers/month
Costs for retailer:
Unit cost, C = $500
Holding cost fraction, h = 0.2
Fixed cost, S = $4,000/order
How many should the retailer order?
440
EOQ Model
Q* = Sqrt[(2)(12000)(4000)/(0.2)(500)] = 980 computers
Cycle inventory = Q/2 = 490
Average Flow time = Q/2D = 980/(2)(12000) = 0.041 year
= 0.49 month
n* = 12.24
Reorder interval, T = 0.98 month
Annual ordering and holding cost =

= (12000/980)(4000) + (980/2)(0.2)(500) = $97,980
441
EOQ Model
• In deciding optimal lot size, the tradeoff is
between
■ setup (order) cost and
■ holding cost.
• Order convenient lot size close to EOQ

• If demand increases by k, optimal lot size and n
increases by √k and flow time (for cycle
inventory) reduces by √k
442
EOQ Model
Suppose lot size is reduced to Q=200 to reduce
flow time:
Annual ordering and holding cost =
= (12000/200)(4000) + (200/2)(0.2)(500) =
$250,000
• Significantly higher
• To make it economically feasible to reduce lot size, the
fixed cost associated with each lot would have to be
reduced
443
EOQ Model
If desired lot size = Q* = 200 units, what would S
have to be?
D = 12000 units
C = $500
h = 0.2
Use EOQ equation and solve for S:
S = [hC(Q*)2]/2D = [(0.2)(500)(200)2]/(2)
(12000) = $166.67
To reduce optimal lot size by a factor of k, the fixed order

cost must be reduced by a factor of k2 444
Aggregating Multiple Products
in a Single Order
• Transportation is a major fixed cost per
order
• Can combine shipments of different
products from the same supplier
■ same overall fixed cost
■ shared over more than one product
■ effective fixed cost is reduced for each product
■ lot size for each product can be reduced
445
Example
• Suppose there are 4 computer products :
Deskpro, Litepro, Medpro, and Heavpro
• Demand for each is 1000 units per month
• If each product is ordered separately:
■ Q* = 980 units for each product
■ Total cycle inventory = 4(Q/2) = (4)(980)/2 =
1960 units
446
Example
• Aggregate orders of all four products:
■ Combined Q* = 1960 units
■ For each product: Q* = 1960/4 = 490
■ Cycle inventory for each product is reduced to
490/2 = 245
■ Total cycle inventory = 1960/2 = 980 units
■ Average flow time & inventory holding costs will
be reduced
447
Aggregating Multiple Products
in a Single Order
• Can have single delivery from multiple suppliers or
single truck delivering to multiple retailers
■ Cross docking
• Aggregating across products, retailers, or

suppliers in a single order
■ fixed ordering and transportation costs are spread out
■ allows for a reduction in lot size for individual products
■ Increase in product variety increases receiving/ loading
costs
⬥ ASN &/ or RFID can help
448
Lot Sizing with Multiple
Products or Customers
• Fixed ordering cost is dependent at least in part
on the variety associated with an order of
multiple models
• With an order of multiple models the fixed
ordering cost has
■ A portion related to transportation
(independent of variety)
■ A portion related to loading and receiving
(not independent of variety)
449
Products or Customers
• To find lot sizes & ordering policy to minimize
total cost
• Three scenarios:
■ Lots are ordered and delivered independently
for each product
■ Lots are ordered and delivered jointly for all
products in each lot
■ Lots are ordered and delivered jointly for a
selected subset of products
450
Products
• Demand per year
■ DL = 12,000; DM = 1,200; DH = 120
• Common transportation cost, S =
$4,000
• Product specific order cost
■ sL = $1,000; sM = $1,000; sH = $1,000
• Holding cost, h = 0.2
• Unit cost
■ CL = $500; CM = $500; CH = $500 451
Delivery Options
• No Aggregation: Each product ordered
separately
• Complete Aggregation: All products
delivered on each truck
• Tailored Aggregation: Selected subsets
of products on each truck
452
No Aggregation
Total cost = $155,140 453

Complete Aggregation
S* = S + sL + sM + sH
= 4000+1000+1000+1000 = $7000
n* = Sqrt[(DLhCL+ DMhCM+ DHhCH)/2S*]
= 9.75
QL = DL/n* = 12000/9.75 = 1230
QM = DM/n* = 1200/9.75 = 123
QH = DH/n* = 120/9.75 = 12.3
Cycle inventory = Q/2

454
Complete Aggregation
Annual order cost = 9.75 × $7,000 = $68,250

Annual total cost = $136,528
455
Aggregation with capacity constraint
Aggregating for products from 4 suppliers:
• Truck capacity = 2500 units

• Demand per product: Di = 10,000
• Holding cost, h = 0.2
• Unit cost per product Ci = $50
• Common order cost S = $500
• Supplier specific order cost si = $100

456
Aggregation with capacity constraint
S* = 500+100+100+100+100 = $900 per order

n* = Sqrt[(D1hC1+ D2hC2+ D3hC3 + D4hC4)/2S*]
= 14.91 (number of orders per year)
Q= 10,000/14.91 = 671 units per order from each supplier
Needs truck capacity = 4 X 671 = 2684 units
Order from each can be = 2500/4 = 625 units
Ordering frequency = 10,000 /625 = 16
• Annual order cost per supplier increases from $3354 to $3600
• Annual holding cost per supplier decreases from $3355 to $3125
457
Aggregation
• Allows firm to lower lot size without
increasing cost
• Use complete aggregation
If product specific fixed cost is a small
fraction of joint fixed cost
• Use tailored aggregation
If product specific fixed cost is a large
fraction of joint fixed cost
Products vary significantly in terms of sales458
Tailored Aggregation
• Lots are ordered & delivered jointly for
a select subset of products
• Step 1
■ Identify most frequently ordered product,
assuming each product is ordered
independently
459
• Step 2
■ For all products i≠i*, evaluate the desired
ordering frequency if product I incurs the
product-specific fixed cost si only each
time it is ordered
460
• Step 3
■ Have to include each product i≠i* with
the most frequently ordered product
i*after an integer number of orders
■ For all i≠i* evaluate the frequency of
product i relative to the most frequently
ordered product i*
■ Product i will be included with the most

frequently ordered product i* every m
orders (mi*=1) 461
• Step 4
■ Having decided the ordering frequency of
each product I, recalculate ordering
frequency n of the most frequently
ordered product i*
■ This takes into account the fact that each

of the other products are included with i*
every mi orders
462
• Step 5
■ For each product, evaluate ordering
frequency ni=n/mi
■ Total annual cost of such ordering policy
463
Annual order cost = $65,383.5

Annual total cost = $130,767
464
Quantity Discounts
• Lot size based
■ All units
■ Marginal unit
• Volume based
465
Economies of Scale to
Exploit Quantity Discounts
• When should supplier offer discounts?

■ What are appropriate discounting schemes?
• How should the buyer react?
466
All-Unit Quantity Discounts
• Pricing schedule has specified quantity
break points q0, q1, …, qr, where q0 =
0
• If an order is placed that is at least as
large as qi but smaller than qi+1, then
each unit has an average unit cost of
Ci
467
All-Unit Quantity Discounts
• The unit cost generally decreases as
the quantity increases, i.e., C0>C1>…
>Cr
• The objective for the company is to
decide on a lot size that will minimize
the sum of material, order, and
holding costs
468
All-Unit Quantity Discount:
Example
Order quantityUnit Price
0- <5000 $3.00
5000- <10000 $2.96
10000 or more $2.92
q0 = 0, q1 = 5000, q2 = 10000
C0 = $3.00, C1 = $2.96, C2 = $2.92
D = 120000 units/year, S = $100/lot,
h = 0.2 469
Example
Q0 = Sqrt[2DS/h C0] = 6324 units
Since 6324 > q1 move to i = 1
Q1 = 6367 units
Since 5000<6367<10,000 set lot size = 6367 (get
discounted price C1 )
TC1 = 358,969 (ordering+ holding+ material costs)
For i=2, Q2 = 6410 units
Since 6410<10,000 set lot size = 10,000 (to get
discount price C2 )
TC2 = 354520
Since TC is lowest for i=2, optimal order quantity = 470
10,000 units
Effects of Quantity Discounts
• Retailers are encouraged to increase the
size of their orders
• Average inventory (cycle inventory) in the
supply chain is increased
• Average flow time is increased
■ Is quantity discount an advantage in the
supply chain?
471
Value of Quantity Discounts
• Improved coordination to increase supply
chain profits
■ Commodity products
■ Products for which firms have market power
• Extraction of surplus through price

discrimination
472
Commodity products: Example
D =10,000 / month
For retailer:
Fixed Order cost=100; C=$3; h=.2
Q=6324
Annual Order & holding cost=$3795
For manufacturer:
Order filling cost=$250;
Production cost =$2/bottle ; h=.2
Annual Order & holding cost=$6009
Total SC cost=$9804
473
• Convince retailer to increase lot size to say 10,000
units
• Implications:
For retailer:
Annual Order & holding cost =$1200+$3000 =$4200
Cost increases by $(4200-3795) = $405
For manufacturer:
Annual Order & holding cost=$(3000+2000) = $5000
Cost decreases by $(6009-5000) = $1009
Total SC cost decreases by=$(9804-9200) =$604

474
• Why should retailer agree?
• Give just enough discount to offset his
increased ordering & holding costs
• Cost increased by 405 for 120000 units
• Discount to be given per unit
= 405 / 120000 =0.003375
• New C= 3- 0.003375 = $2.996625
475
Products for which firms have
market power: Example
Final Demand D=360,000 – 60,000p

Production cost of manufacturer: $2 per
unit
How much manufacturer charges?

How much retailer charges?
What is the optimal price for SC?
■ Double Marginalization
476
477
SUPPLY CONTRACTS
INTRODUCTION
🞆Significant level of outsourcing
🞆Many leading brand OEMs outsource complete
manufacturing and design of their products
🞆More outsourcing has meant
⚫ Search for lower cost manufacturers
⚫ Development of design and manufacturing expertise
by suppliers
🞆Procurement function in OEMs becomes very
important
🞆OEMs have to get into contracts with suppliers
479
STRATEGIC COMPONENTS
Supply Contract can include the following:
🞆 Pricing and volume discounts.
🞆 Minimum and maximum purchase quantities.
🞆 Delivery lead times.
🞆 Product or material quality.
🞆 Product return policies.
480
2-STAGE SEQUENTIAL SUPPLY
CHAIN
🞆A buyer and a supplier
🞆Buyer’s activities
⚫ generating a forecast
⚫ determining how many units to order from the
supplier
⚫ placing an order to the supplier so as to optimize his
own profit
⚫ Purchase based on forecast of customer demand
🞆Supplier’s activities
⚫ reacting to the order placed by the buyer.
⚫ Make-To-Order (MTO) policy
481
SWIMSUIT EXAMPLE
🞆 2 Stages:
⚫ a retailer who faces customer demand
⚫ a manufacturer who produces and sells swimsuits to the retailer.
⚫ Demand distribution
8000 10000 12000 14000 16000 18000

0.11 0.11 0.27 0.23 0.18 0.10
🞆 Retailer Information
⚫ Summer season sale price of a swimsuit is $125 per unit.
⚫ Wholesale price paid by retailer to manufacturer is $80 per unit.
⚫ Salvage value after the summer season is $20 per unit
🞆 Manufacturer information
⚫ Fixed production cost is $100,000
⚫ Variable production cost is $35 per unit
482
WHAT IS THE OPTIMAL ORDER
QUANTITY?
🞆 Retailer marginal profit is the same as the marginal profit
of the manufacturer, $45.
🞆 Retailer’s marginal profit for selling a unit during the
season, $45, is smaller than the marginal loss, $60,
associated with each unit sold at the end of the season to
discount stores.
🞆 Optimal order quantity depends on marginal profit and
marginal loss but not on the fixed cost.
🞆 Retailer optimal policy is to order 12,000 units for an
average profit of $470,700.
🞆 If the retailer places this order, the manufacturer’s profit
is 12,000(80 - 35) - 100,000 = $440,000
483
SEQUENTIAL SUPPLY CHAIN
Retailer’s expected profit as a function of order quantity
484
RISK SHARING
🞆In the sequential supply chain
⚫ Buyer assumes all of the risk of excess inventory
⚫ Buyer limits his order quantity because of the huge financial risk
⚫ Supplier takes no risk
⚫ Supplier would like the buyer to order as much as possible
⚫ Since the buyer limits his order quantity, there is a significant
increase in the likelihood of out of stock
🞆If the supplier shares some of the risk with the buyer
⚫ it may be profitable for buyer to order more
⚫ reducing out of stock probability
⚫ increasing profit for both the supplier and the buyer.
🞆Supply contracts enable this risk sharing
485
BUY-BACK CONTRACT
🞆 Seller agrees to buy back unsold goods from the buyer
for some agreed-upon price.
🞆 Buyer has incentive to order more
🞆 Supplier’s risk clearly increases.
🞆 Increase in buyer’s order quantity
⚫ Decreases the likelihood of out of stock
⚫ Compensates the supplier for the higher risk
486
BUY-BACK CONTRACT
SWIMSUIT EXAMPLE
🞆Assume the manufacturer offers to buy unsold
swimsuits from the retailer for $55.
🞆Retailer has an incentive to increase its order
quantity to 14,000 units, for a profit of $513,800,
while the manufacturer’s average profit increases
to $471,900.
🞆Total average profit for the two parties
= $985,700 (= $513,800 + $471,900)
🞆Compare to sequential supply chain when total
profit
= $910,700 (= $470,700 + $440,000) 487
BUY-BACK CONTRACT
SWIMSUIT EXAMPLE
488
REVENUE SHARING CONTRACT
🞆 Buyer shares some of its revenue from each unit sold
with the supplier
⚫ in return for a discount on the wholesale price
489
SWIMSUIT EXAMPLE
🞆Manufacturer agrees to decrease the wholesale
price from $80 to $60
🞆In return, the retailer provides 15 percent of the
product revenue to the manufacturer.
🞆Retailer has an incentive to increase his order
quantity to 14,000 for a profit of $504,325
🞆This order increase leads to increased
manufacturer’s profit of $481,375
🞆Supply chain total profit
= $985,700 (= $504,325+$481,375).
490
SWIMSUIT EXAMPLE
491
OTHER TYPES OF CONTRACTS
🞆 Quantity-Flexibility Contracts
⚫ Supplier provides full refund for returned (unsold) items
⚫ As long as the number of returns is no larger than a certain
quantity.
🞆 Sales Rebate Contracts

⚫ Provides a direct incentive to the retailer to increase sales by
means of a rebate paid by the supplier for any item sold
above a certain quantity.
492
GLOBAL OPTIMIZATION STRATEGY
🞆 What is the best strategy for the entire supply chain?
🞆 Treat both supplier and retailer as one entity
🞆 Transfer of money between the parties is ignored
493
GLOBAL OPTIMIZATION
SWIMSUIT EXAMPLE
🞆Relevant data
⚫ Selling price, $125
⚫ Salvage value, $20
⚫ Variable production costs, $35
⚫ Fixed production cost
🞆Supply chain marginal profit, 90 = 125 - 35
🞆Supply chain marginal loss, 15 = 35 – 20
🞆Supply chain will produce more than average
demand
🞆Optimal production quantity = 16,000 units
🞆Expected supply chain profit = $1,014,500
494
GLOBAL OPTIMIZATION
SWIMSUIT EXAMPLE
495
GLOBAL OPTIMIZATION AND
SUPPLY CONTRACTS
🞆 Unbiased decision maker unrealistic
⚫ Requires the firm to surrender decision-making power to an
unbiased decision maker
🞆 Carefully designed supply contracts can achieve as much
as global optimization
🞆 Global optimization does not provide a mechanism to
allocate supply chain profit between the partners.
⚫ Supply contracts allocate this profit among supply chain
members.
🞆 Effective supply contracts allocate profit to each partner
in a way that no partner can improve his profit by
deciding to deviate from the optimal set of decisions.
496
IMPLEMENTATION DRAWBACKS OF
SUPPLY CONTRACTS
🞆Buy-back contracts
⚫ Require suppliers to have an effective reverse logistics
system and may increase logistics costs
⚫ Retailers have an incentive to push the products not under
the buy back contract
🞆Retailer’s risk is much higher for the products not under the
buy back contract
🞆Revenue sharing contracts
⚫ Require suppliers to monitor the buyer’s revenue and thus
increases administrative cost
⚫ Buyers have an incentive to push competing products with
higher profit margins
🞆Similar products from competing suppliers with whom the
buyer has no revenue sharing agreement
497
CONTRACTS FOR MAKE-TO-STOCK/
MAKE-TO-ORDER SUPPLY CHAINS
🞆 Previous contracts examples were with Make-to-Order
supply chains
🞆 What happens when the supplier has a Make-to-Stock
situation?
498
SUPPLY CHAIN FOR FASHION PRODUCTS
SKI-JACKETS
Manufacturer produces ski-jackets prior to
receiving distributor orders
🞆 Season starts in September and ends by December
🞆 Production starts 12 months before the selling season
🞆 Distributor places orders with the manufacturer six months
later
🞆 At that time, production is complete; distributor receives
firms orders from retailers
🞆 The distributor sales ski-jackets to retailers for $125 per unit
🞆 The distributor pays the manufacturer $80 per unit
🞆 For the manufacturer, we have the following information:
⚫ Fixed production cost = $100,000.
⚫ The variable production cost per unit = $55
⚫ Salvage value for any ski-jacket not purchased by the distributors= 499
$20.
PROFIT AND LOSS
🞆For the manufacturer
⚫ Marginal profit = $25
⚫ Marginal loss = $60
⚫ Since marginal loss is greater than marginal profit, the distributor
should produce less than average demand, i.e., less than 13, 000
units
🞆How much should the manufacturer produce?
⚫ Manufacturer optimal policy = 12,000 units
⚫ Average profit = $160,400
⚫ Distributor average profit = $510,300
🞆Manufacturer assumes all the risk limiting its
production quantity
🞆Distributor takes no risk
500
MAKE-TO-STOCK
SKI JACKETS
Manufacturer’s expected profit

501
PAY-BACK CONTRACT
🞆 Buyer agrees to pay some agreed-upon price for any unit
produced by the manufacturer but not purchased.
🞆 Manufacturer incentive to produce more units
🞆 Buyer’s risk clearly increases.
🞆 Increase in production quantities has to compensate the
distributor for the increase in risk.
502
PAY-BACK CONTRACT
SKI JACKET EXAMPLE
🞆 Assume the distributor offers to pay $18 for each unit
🞆 Manufacturer marginal loss = 55-20-18=$17
🞆 Manufacturer marginal profit = $25.
🞆 Manufacturer has an incentive to produce more than
average demand.
🞆 Manufacturer increases production quantity to 14,000
units
🞆 Manufacturer profit = $180,280
🞆 Distributor profit increases to $525,420.
⚫ Total profit = $705,400
🞆 Compare to total profit in sequential supply chain
= $670,000 (= $160,400 + $510,300) 503
PAY-BACK CONTRACT
SKI JACKET EXAMPLE
Manufacturer’s average profit (pay-back contract)

504
PAY-BACK CONTRACT
SKI JACKET EXAMPLE (CONT)
Distributor’s average profit (pay-back contract)

505
COST-SHARING CONTRACT
🞆 Buyer shares some of the production cost with the
manufacturer, in return for a discount on the wholesale
price.
🞆 Reduces effective production cost for the manufacturer
⚫ Incentive to produce more units
506
SKI-JACKET EXAMPLE
🞆In return, distributor pays 33% of the
manufacturer production cost
🞆Manufacturer increases production quantity to
14,000
🞆Manufacturer profit = $182,380
🞆Distributor profit = $523,320
🞆The supply chain total profit = $705,700
Same as the profit under pay-back contracts
507
SKI-JACKET EXAMPLE
508
Manufacturer’s average profit (cost-sharing contract)

SKI-JACKET EXAMPLE (CONT)
509
Distributor’s average profit (cost-sharing contract)

IMPLEMENTATION ISSUES
🞆 Cost-sharing contract requires manufacturer to share
production cost information with distributor
🞆 Agreement between the two parties:
⚫ Distributor purchases one or more components that the
manufacturer needs.
⚫ Components remain on the distributor books but are shipped
to the manufacturer facility for the production of the finished
good.
510
GLOBAL OPTIMIZATION
🞆 Relevant data:
⚫ Fixed production cost.
🞆 Cost that the distributor pays the manufacturer is
meaningless
🞆 Supply chain marginal profit, 70 = 125 – 55
🞆 Supply chain marginal loss, 35 = 55 – 20
⚫ Supply chain will produce more than average demand.
🞆 Optimal production quantity = 14,000 units
🞆 Expected supply chain profit = $705,700
Same profit as under pay-back and cost sharing
contracts 511
GLOBAL OPTIMIZATION
Global optimization 512

SUPPLY CONTRACTS
INTRODUCTION
🞆Significant level of outsourcing
🞆Many leading brand OEMs outsource complete
manufacturing and design of their products
🞆More outsourcing has meant
⚫ Search for lower cost manufacturers
⚫ Development of design and manufacturing expertise
by suppliers
🞆Procurement function in OEMs becomes very
important
🞆OEMs have to get into contracts with suppliers
514
STRATEGIC COMPONENTS
Supply Contract can include the following:
🞆 Pricing and volume discounts.
🞆 Minimum and maximum purchase quantities.
🞆 Delivery lead times.
🞆 Product or material quality.
🞆 Product return policies.
515
2-STAGE SEQUENTIAL SUPPLY
CHAIN
🞆A buyer and a supplier
🞆Buyer’s activities
⚫ generating a forecast
⚫ determining how many units to order from the
supplier
⚫ placing an order to the supplier so as to optimize his
own profit
⚫ Purchase based on forecast of customer demand
🞆Supplier’s activities
⚫ reacting to the order placed by the buyer.
⚫ Make-To-Order (MTO) policy
516
SWIMSUIT EXAMPLE
🞆 2 Stages:
⚫ a retailer who faces customer demand
⚫ a manufacturer who produces and sells swimsuits to the retailer.
⚫ Demand distribution
8000 10000 12000 14000 16000 18000

0.11 0.11 0.27 0.23 0.18 0.10
🞆 Retailer Information
⚫ Summer season sale price of a swimsuit is $125 per unit.
⚫ Wholesale price paid by retailer to manufacturer is $80 per unit.
⚫ Salvage value after the summer season is $20 per unit
🞆 Manufacturer information
⚫ Fixed production cost is $100,000
⚫ Variable production cost is $35 per unit
517
WHAT IS THE OPTIMAL ORDER
QUANTITY?
🞆 Retailer marginal profit is the same as the marginal profit
of the manufacturer, $45.
🞆 Retailer’s marginal profit for selling a unit during the
season, $45, is smaller than the marginal loss, $60,
associated with each unit sold at the end of the season to
discount stores.
🞆 Optimal order quantity depends on marginal profit and
marginal loss but not on the fixed cost.
🞆 Retailer optimal policy is to order 12,000 units for an
average profit of $470,700.
🞆 If the retailer places this order, the manufacturer’s profit
is 12,000(80 - 35) - 100,000 = $440,000
518
SEQUENTIAL SUPPLY CHAIN
Retailer’s expected profit as a function of order quantity
519
RISK SHARING
🞆In the sequential supply chain
⚫ Buyer assumes all of the risk of excess inventory
⚫ Buyer limits his order quantity because of the huge financial risk
⚫ Supplier takes no risk
⚫ Supplier would like the buyer to order as much as possible
⚫ Since the buyer limits his order quantity, there is a significant
increase in the likelihood of out of stock
🞆If the supplier shares some of the risk with the buyer
⚫ it may be profitable for buyer to order more
⚫ reducing out of stock probability
⚫ increasing profit for both the supplier and the buyer.
🞆Supply contracts enable this risk sharing
520
BUY-BACK CONTRACT
🞆 Seller agrees to buy back unsold goods from the buyer
for some agreed-upon price.
🞆 Buyer has incentive to order more
🞆 Supplier’s risk clearly increases.
🞆 Increase in buyer’s order quantity
⚫ Decreases the likelihood of out of stock
⚫ Compensates the supplier for the higher risk
521
BUY-BACK CONTRACT
SWIMSUIT EXAMPLE
🞆Assume the manufacturer offers to buy unsold
swimsuits from the retailer for $55.
🞆Retailer has an incentive to increase its order
quantity to 14,000 units, for a profit of $513,800,
while the manufacturer’s average profit increases
to $471,900.
🞆Total average profit for the two parties
= $985,700 (= $513,800 + $471,900)
🞆Compare to sequential supply chain when total
profit
= $910,700 (= $470,700 + $440,000) 522
BUY-BACK CONTRACT
SWIMSUIT EXAMPLE
523
🞆 Buyer shares some of its revenue from each unit sold
with the supplier
⚫ in return for a discount on the wholesale price
524
SWIMSUIT EXAMPLE
🞆In return, the retailer provides 15 percent of the
product revenue to the manufacturer.
🞆Retailer has an incentive to increase his order
quantity to 14,000 for a profit of $504,325
🞆This order increase leads to increased
manufacturer’s profit of $481,375
🞆Supply chain total profit
= $985,700 (= $504,325+$481,375).
525
SWIMSUIT EXAMPLE
526
OTHER TYPES OF CONTRACTS
🞆 Quantity-Flexibility Contracts
⚫ Supplier provides full refund for returned (unsold) items
⚫ As long as the number of returns is no larger than a certain
quantity.
🞆 Sales Rebate Contracts

⚫ Provides a direct incentive to the retailer to increase sales by
means of a rebate paid by the supplier for any item sold
above a certain quantity.
527
GLOBAL OPTIMIZATION STRATEGY
🞆 What is the best strategy for the entire supply chain?
🞆 Treat both supplier and retailer as one entity
🞆 Transfer of money between the parties is ignored
528
GLOBAL OPTIMIZATION
SWIMSUIT EXAMPLE
🞆Relevant data
⚫ Fixed production cost
🞆Supply chain marginal profit, 90 = 125 - 35
🞆Supply chain marginal loss, 15 = 35 – 20
🞆Supply chain will produce more than average
demand
🞆Optimal production quantity = 16,000 units
🞆Expected supply chain profit = $1,014,500
529
GLOBAL OPTIMIZATION
SWIMSUIT EXAMPLE
530
GLOBAL OPTIMIZATION AND
SUPPLY CONTRACTS
🞆 Unbiased decision maker unrealistic
⚫ Requires the firm to surrender decision-making power to an
unbiased decision maker
🞆 Carefully designed supply contracts can achieve as much
as global optimization
🞆 Global optimization does not provide a mechanism to
allocate supply chain profit between the partners.
⚫ Supply contracts allocate this profit among supply chain
members.
🞆 Effective supply contracts allocate profit to each partner
in a way that no partner can improve his profit by
deciding to deviate from the optimal set of decisions.
531
IMPLEMENTATION DRAWBACKS OF
SUPPLY CONTRACTS
🞆Buy-back contracts
⚫ Require suppliers to have an effective reverse logistics
system and may increase logistics costs
⚫ Retailers have an incentive to push the products not under
the buy back contract
🞆Retailer’s risk is much higher for the products not under the
buy back contract
🞆Revenue sharing contracts
⚫ Require suppliers to monitor the buyer’s revenue and thus
increases administrative cost
⚫ Buyers have an incentive to push competing products with
higher profit margins
🞆Similar products from competing suppliers with whom the
buyer has no revenue sharing agreement
532
CONTRACTS FOR MAKE-TO-STOCK/
MAKE-TO-ORDER SUPPLY CHAINS
🞆 Previous contracts examples were with Make-to-Order
supply chains
🞆 What happens when the supplier has a Make-to-Stock
situation?
533
SUPPLY CHAIN FOR FASHION PRODUCTS
SKI-JACKETS
Manufacturer produces ski-jackets prior to
receiving distributor orders
🞆 Season starts in September and ends by December
🞆 Production starts 12 months before the selling season
🞆 Distributor places orders with the manufacturer six months
later
🞆 At that time, production is complete; distributor receives
firms orders from retailers
🞆 The distributor sales ski-jackets to retailers for $125 per unit
🞆 The distributor pays the manufacturer $80 per unit
🞆 For the manufacturer, we have the following information:
⚫ Fixed production cost = $100,000.
⚫ The variable production cost per unit = $55
⚫ Salvage value for any ski-jacket not purchased by the distributors= 534
$20.
PROFIT AND LOSS
🞆For the manufacturer
⚫ Marginal profit = $25
⚫ Marginal loss = $60
⚫ Since marginal loss is greater than marginal profit, the distributor
should produce less than average demand, i.e., less than 13, 000
units
🞆How much should the manufacturer produce?
⚫ Manufacturer optimal policy = 12,000 units
⚫ Average profit = $160,400
⚫ Distributor average profit = $510,300
🞆Manufacturer assumes all the risk limiting its
production quantity
🞆Distributor takes no risk
535
MAKE-TO-STOCK
SKI JACKETS
Manufacturer’s expected profit

536
PAY-BACK CONTRACT
🞆 Buyer agrees to pay some agreed-upon price for any unit
🞆 Manufacturer incentive to produce more units
🞆 Buyer’s risk clearly increases.
🞆 Increase in production quantities has to compensate the
distributor for the increase in risk.
537
PAY-BACK CONTRACT
SKI JACKET EXAMPLE
🞆 Assume the distributor offers to pay $18 for each unit
🞆 Manufacturer marginal loss = 55-20-18=$17
🞆 Manufacturer marginal profit = $25.
🞆 Manufacturer has an incentive to produce more than
average demand.
🞆 Manufacturer increases production quantity to 14,000
units
🞆 Manufacturer profit = $180,280
🞆 Distributor profit increases to $525,420.
⚫ Total profit = $705,400
🞆 Compare to total profit in sequential supply chain
= $670,000 (= $160,400 + $510,300) 538
PAY-BACK CONTRACT
SKI JACKET EXAMPLE
Manufacturer’s average profit (pay-back contract)

539
PAY-BACK CONTRACT
SKI JACKET EXAMPLE (CONT)
Distributor’s average profit (pay-back contract)

540
🞆 Buyer shares some of the production cost with the
manufacturer, in return for a discount on the wholesale
price.
🞆 Reduces effective production cost for the manufacturer
⚫ Incentive to produce more units
541
SKI-JACKET EXAMPLE
🞆In return, distributor pays 33% of the
manufacturer production cost
🞆Manufacturer increases production quantity to
14,000
🞆Manufacturer profit = $182,380
🞆Distributor profit = $523,320
🞆The supply chain total profit = $705,700
Same as the profit under pay-back contracts
542
SKI-JACKET EXAMPLE
543
Manufacturer’s average profit (cost-sharing contract)

SKI-JACKET EXAMPLE (CONT)
544
Distributor’s average profit (cost-sharing contract)

IMPLEMENTATION ISSUES
🞆 Cost-sharing contract requires manufacturer to share
production cost information with distributor
🞆 Agreement between the two parties:
⚫ Distributor purchases one or more components that the
manufacturer needs.
⚫ Components remain on the distributor books but are shipped
to the manufacturer facility for the production of the finished
good.
545
GLOBAL OPTIMIZATION
🞆 Relevant data:
⚫ Fixed production cost.
🞆 Cost that the distributor pays the manufacturer is
meaningless
🞆 Supply chain marginal profit, 70 = 125 – 55
🞆 Supply chain marginal loss, 35 = 55 – 20
⚫ Supply chain will produce more than average demand.
🞆 Optimal production quantity = 14,000 units
🞆 Expected supply chain profit = $705,700
Same profit as under pay-back and cost sharing
contracts 546
GLOBAL OPTIMIZATION
Global optimization 547

CONTRACTS WITH ASYMMETRIC
INFORMATION
🞆 Implicit assumption so far: Buyer and supplier share the
same forecast
🞆 Inflated forecasts from buyers a reality
🞆 How to design contracts such that the information shared
is credible?
548
TWO POSSIBLE CONTRACTS
🞆Capacity Reservation Contract
⚫ Buyer pays to reserve a certain level of capacity at the
supplier
⚫ A menu of prices for different capacity reservations
provided by supplier
⚫ Buyer signals true forecast by reserving a specific
capacity level
🞆Advance Purchase Contract
⚫ Supplier charges advanced purchase price before
building capacity
⚫ When demand is realized, price charged is different
for additional orders
⚫ Buyer’s initial commitment reveals his true forecast
549
CONTRACTS FOR NON-STRATEGIC
COMPONENTS
🞆Variety of suppliers
🞆Market conditions dictate price
🞆Buyers need to be able to choose suppliers and
change them as needed
🞆Long-term contracts have been the tradition
🞆Recent trend towards more flexible contracts
⚫ Offers buyers option of buying later at a different
price than current
⚫ Offers effective hedging strategies against shortages
550
LONG-TERM CONTRACTS
🞆Also called forward or fixed commitment
contracts
🞆Contracts specify a fixed amount of supply to be
delivered at some point in the future
🞆Supplier and buyer agree on both price and
quantity
🞆Buyer bears no financial risk
🞆Buyer takes huge inventory risks due to:
⚫ uncertainty in demand
⚫ inability to adjust order quantities. 551
FLEXIBLE OR OPTION CONTRACTS
🞆 Buyer pre-pays a relatively small fraction of the product
price up-front
🞆 Supplier commits to reserve capacity up to a certain level.
🞆 Initial payment is the reservation price or premium.
🞆 If buyer does not exercise option, the initial payment is lost.
🞆 Buyer can purchase any amount of supply up to the option
level by:
⚫ paying an additional price (execution price or exercise price)
⚫ agreed to at the time the contract is signed
⚫ Total price (reservation plus execution price) typically higher
than the unit price in a long-term contract.
552
FLEXIBLE OR OPTION CONTRACTS
🞆 Provide buyer with flexibility to adjust order quantities
depending on realized demand
🞆 Reduces buyer’s inventory risks.
🞆 Shifts risks from buyer to supplier
⚫ Supplier is now exposed to customer demand uncertainty.
🞆 Flexibility contracts
⚫ Related strategy to share risks between suppliers and buyers
⚫ A fixed amount of supply is determined when the contract is
signed
⚫ Amount to be delivered (and paid for) can differ by no more
than a given percentage determined upon signing the
contract.
553
SPOT PURCHASE
🞆 Buyers look for additional supply in the open market.
🞆 May use independent e-markets or private e-markets to
select suppliers.
🞆 Focus:
⚫ Using the marketplace to find new suppliers
⚫ Forcing competition to reduce product price.
554
PORTFOLIO CONTRACTS
🞆Portfolio approach to supply contracts
🞆Buyer signs multiple contracts at the same time
⚫ optimize expected profit
⚫ reduce risk.
🞆Contracts
⚫ differ in price and level of flexibility
⚫ hedge against inventory, shortage and spot price risk.
⚫ Meaningful for commodity products
🞆a large pool of suppliers
🞆each with a different type of contract.
555
APPROPRIATE MIX OF CONTRACTS
🞆 How much to commit to a long-term contract?
⚫ Base commitment level.
🞆 How much capacity to buy from companies selling
option contracts?
⚫ Option level.
🞆 How much supply should be left uncommitted?
⚫ Additional supplies in spot market if demand is high
🞆 Hewlett-Packard’s (HP) strategy for electricity or
memory products
⚫ About 50% procurement cost invested in long-term contracts
⚫ 35% in option contracts
⚫ Remaining is invested in the spot market.
556
RISK TRADE-OFF IN PORTFOLIO
CONTRACTS
🞆 If demand is much higher than anticipated
⚫ Base commitment level + option level < Demand,
⚫ Firm must use spot market for additional supply.
⚫ Typically the worst time to buy in the spot market
🞆 Prices are high due to shortages.
🞆 Buyer can select a trade-off level between price risk,
shortage risk, and inventory risk by carefully selecting the
level of long-term commitment and the option level.
⚫ For the same option level, the higher the initial contract
commitment, the smaller the price risk but the higher the inventory
risk taken by the buyer.
⚫ The smaller the level of the base commitment, the higher the price
and shortage risks due to the likelihood of using the spot market.
⚫ For the same level of base commitment, the higher the option level,
the higher the risk assumed by the supplier since the buyer may 557
exercise only a small fraction of the option level.
RISK TRADE-OFF IN PORTFOLIO
CONTRACTS
Low High
Base commitment level
Inventory risk
Option level High N/A*
(supplier)
Price and
Inventory risk
Low shortage risks
(buyer)
(buyer)
*For a given situation, either the option level or the base commitment level may
be high, but not both.
Global SCM
Wal-Mart in South America
• What reason does Wal-Mart have for opening
stores globally?
• Why Wal-Mart will benefit by having suppliers in
different countries?
• Why Wal-Mart will want strong centralized control
of its stores?
• Why Wal-Mart will want local control of its stores?
• Why is Wal-Mart not as successful in Latin
America as they are in the US?
• What were the major problems Wal-Mart faced
during the initial years of operations in South
America?
• What were the major drivers of these problems?
What mistakes did Wal-Mart make?
• Wal-Mart’s Mr. Glass characterized the problems
they faced in South America as temporary. Do
you agree or not? Give reasons
• What opportunities may Wal-Mart have in coming
years?
• If you were running Wal-Mart, what would you
have done differently?
• Product differences
– Are there global products?
– Is this a trend?
– What is the balance between local
tastes, global products?
• Dealing with established competition, aggressive
competitors
• Developing market knowledge
• Lack of critical mass
– the point at which a growing company becomes self-
sustaining, and no longer needs additional investment to
remain economically viable
• Different infrastructure/ business environment
– distribution problems
– different equipment standards
– cultural differences
– postdated checks
• Issues with foreign governments
• Deep pockets for success
– possession of abundant financial resources
Li & Fung
• Explain the differences between what Li and Fung was
doing in late 1990s (when the case was written) and what
it was doing in its inception stages some 90 years back?
• “Managing dispersed production forced us to get smart

about dissecting the value chain.” Explain.
• The multinational is essentially its own supply chain

manager. Explain with reference to a typical order.
• When large manufacturing companies manage their own

Li & Fung
• Explain the role of Li & Fung in shortening the buying
cycle?
• How does shortening the buying cycle help Li & Fung to

lower the cost in the supply chain? Explain with example.
• How is the organization of Li & Fung different from others

in the industry? How does this help the company achieve
its strategic objectives?
• Explain how Li & Fung’s involvement in venture capital fits

into its SCM activities?
Li & Fung
• What were the basic changes that took place in Li & Fung
as it grew over the last few years both in size and
geographic scope? What effort did the company take to
hold the organization together?
• With advent of IT, doing business became both easier and

difficult for the company. How did the company envisage
reconciling with the new systems and also retaining the
traditions they had built over the years?
• Do you think professional management training of the Fung

brothers from US help in running their business in Asia in a
better manner?
Good/Information Flows in
Linear Supply Chain
Flow of physical goods (downstream flow)
Manufactur
Supplier Distributor Wholesaler Retailer
er
Flow of demand information (upstream flow)

Increasing Globalization
• 1/5 of output of US firms produced
abroad
• US Companies hold $500 Billion in
foreign asset stocks (7% annual
growth)
• 1/4 of US imports between foreign
affiliates and US parent companies
• Over half of US companies increased
the number of countries in which
they operate (late 80’s to early 90’s)
International SCM
• Same as domestic SCM spread over
larger geographical area?
• Additional opportunities & problems
90% of global demand
is not fully satisfied by
local supply
Supply chains are
driving growth in world
trade
Source: The World Bank World

Development Indicators
Globalization of Supply Chains
(n=7,642 Companies)
Companies’
Expected
14
SCM % 43
Companies’
Expected
25 Globalization
%
SCM % 5
Globalizatio
Companie
s’
n 7
Current 5
SCM
Globalizati 0
4on
0
Factors in Global Supply Chain
• Substantial geographic distances
• Foreign market forecasting
difficulties
• Exchange rate fluctuations
• Infrastructural inadequacies
• Explosion in product variety in global
markets
Taxonomy of International
Supply Chains
1. International distribution systems
• Domestic manufacturing, overseas distribution &
marketing
2. International suppliers
• Foreign suppliers, final assembly domestic, foreign
markets
3. Off-shore manufacturing
• Sourcing & manufacturing in single foreign
location, shipped to domestic warehouses for sale
& distribution
4. Fully integrated global supply chain
• Products supplied, manufactured & distributed from
various facilities throughout the globe
Forces Driving Globalization
• Global Market Forces
• Technological Forces
• Global Cost Forces
• Political and Economic Forces
Global Market Forces
• Foreign competition in local markets
• Growth in foreign demand
– Domestic consumption from 40% to <30% of
world consumption since 1970
– Foreign sales fuel growth
– Global citizens
– TV & internet gives international exposure
• Global presence as a defensive tool
– Nestle and Kelloggs
• Presence in state-of-the-art markets
– Japan -- consumer electronics
– Germany -- machine tools
– US: SUV’s
Technological Forces
• Diffusion of knowledge
– Many high tech components developed
overseas
– Need close relationships with foreign suppliers
• Technology sharing/collaborations
– Access to technology/markets
• Global location of R&D facilities
– Microsoft opened lab in Cambridge
– Close to production (as cycles get shorter)
– Close to expertise
Global Cost Forces
• Low labor cost
– Diminishing importance (Costs
underestimated, benefits overestimated)
• Other cost priorities
– Integrated supplier infrastructure (as suppliers
become more involved in design)
– Skilled labor (Indian programmers?)
• Capital intensive facilities
– Government tax breaks/ cost sharing
arrangements
– Supplier cost sharing joint ventures & price
breaks
Political and Economic Forces
• Exchange rate fluctuations and operating
flexibility
• Regional trade agreements (Europe, North
America, Pacific Rim)
– Value of being in a country in one of
these regions
– Implications for supply network design
– Reevaluation of foreign facilities
(Production processes designed to avoid
tariffs)
• E.g. almost finished goods may be shipped
into a trading block to avoid tariffs on
finished goods
Political and Economic Forces
• Trade protection mechanisms
– Tariffs
– Quotas
– Voluntary export restrictions
• Japanese automakers in US
– Local content requirements
• TI/Intel factories in Europe
• Japanese automakers in the EU
– Health/environmental regulations
• Japanese refused to import US skis for many years
(different snow)
– Government procurement policies
• Up to 50% advantage for American companies on US
Defense contracts
Added Complexities
• Substantial geographic distances
• Added forecasting difficulties
• Infrastructural Inadequacies
– Worker skill, performance expectations
– Supplier availability, reliability, contracts
– Lack of local technologies
– Inadequacies in transportation,
communications infrastructure
Added Complexities
• Exchange rate uncertainties
• Cultural differences
– accepted partnerships, styles
– value of punctuality
• Political instability
– tax rates
– government control
Additional Issues In Global
SCM
• Regional vs. International Products
– Cars vs. Coca-cola
• Local Autonomy vs. Central Control
– SmithKline introducing Contac600 to
Japan
– Short term expectations
• Collaborators become competitors
– China
– Toshiba copiers (3M), Hitachi
microprocessors (Motorola)
Exchange Rates
• Transaction Exposure
– The results of transactions denominated
in foreign currencies change (cash
deposits, debt obligations)
• Translation Exposure
– Result of translating foreign financial
statements into the currency of the
parent company
• Financial instruments used to hedge
these
Risks
• Sources Unknown-Unknown Uncontrollable
– Natural disasters
– Geopolitical risks
– Epidemics
– Terrorist attacks
– Volatile fuel price
– Currency fluctuations
– Port delays
– Market changes
– Supplier performance
– Forecasting accuracy
– Execution problems
Known-Unknown Controllable
Managing Global Risks
• Sensing and responding
• Adaptability
• Speculative strategies
– Co. bets for a single scenario – may or may not work
– Japanese automakers in late 1970s and early 1980s bet that if
they did all manufacturing in Japan, high labor cost will be
more than offset by exchange rate benefits, rising productivity
and increasing levels of investment
• Hedge strategies
– Losses in 1 part offset by gains in another
– Volkswagen in US, Brazil, Mexico, Germany
Managing Global Risks
• Flexible strategies
– Enable Co. to take advantage of different scenarios
– Flexible supply chains with multiple suppliers and excess
manufacturing capacity in different countries
– Factories designed to be flexible so that products can be
moved at minimal cost from region to region as economic
conditions demand
– Approaches to implement
– Production shifting
– Information sharing
– Global coordination
– Political leverage
Major Differences Between
Different Regions
First World Emerging Third World
North America,
Western Europe, Japan,
World Togo, Madagaskar,
Afganisthan.Mozambiq
Brazil, Chile, China, Col
Australia ue
ombia, Hungary, Indon
esia, India, Malaysia, M
exico,
Philippines, South
Africa, Thailand
Infrastructure Highly Under Insufficient to

developed development support
advanced
logistics
Supplier High Variable Typically not
Operating considered
Standards
Information Generally Support Not available
system available systems not (slightly
availability available available?)
Human Available Available with Often difficult to
Resources some searching find
Safety Inventory
Managing Uncertainty in the

Supply Chain
Outline
⚫Role of safety inventory in a supply chain
⚫Determining the appropriate level of safety inventory
⚫Impact of supply uncertainty on safety inventory
⚫Impact of aggregation on safety inventory
⚫Impact of replenishment policies on safety inventory
⚫Managing safety inventory in a multi-echelon supply chain
⚫Estimating and managing safety inventory in practice
11-
590
Role of Safety Inventory
in a Supply Chain
⚫Forecasts are rarely completely accurate
⚫If average demand is 1000 units per week, then half the time
actual demand will be greater than 1000, and half the time
actual demand will be less than 1000; what happens when
actual demand is greater than 1000?
⚫If you kept only enough inventory in stock to satisfy average
demand, half the time you would run out
⚫Safety inventory: Inventory carried for the purpose of
satisfying demand that exceeds the amount forecasted in a
given period
11-
591
Role of Safety Inventory
⚫Average inventory is therefore cycle inventory plus safety
inventory
⚫There is a fundamental tradeoff:
⚫Raising the level of safety inventory provides higher levels of
product availability and customer service
⚫Raising the level of safety inventory also raises the level of
average inventory and therefore increases holding costs
⚫ Very important in high-tech or other industries where obsolescence is a
significant risk (where the value of inventory, such as PCs, can drop in
value)
⚫ Compaq and Dell in PCs
11-
592
Two Questions to Answer in Planning Safety
Inventory
⚫What is the appropriate level of safety inventory to
carry?
⚫What actions can be taken to improve product
availability while reducing safety inventory?
11-
593
Determining the Appropriate
Level of Safety Inventory
⚫Appropriate level of safety inventory determined by:
⚫supply or demand uncertainty
⚫desired level of product availability
11-
594
Measuring Demand Uncertainty
⚫Higher levels of uncertainty require higher levels of
safety inventory given a particular desired level of
product availability
⚫Higher levels of desired product availability require
higher levels of safety inventory given a particular level
of uncertainty
11-
595
⚫Demand has a systematic component and a random component
⚫The estimate of the random component is the measure of
demand uncertainty
⚫Random component is usually estimated by the standard
deviation of demand
⚫Notation:
D = Average demand per period
σD = standard deviation of demand per period
L = lead time = time between when an order is placed and
when it is received
⚫Uncertainty of demand during lead time is what is important
11-
596
⚫Demand in each period i (i= 1,…,L) is normally
distributed with mean Di and standard deviation σi
⚫Total demand during L periods is normally distributed
with mean = DL & std dev = σL
⚫Correlation coefficient of demand between periods i & j
=ρij
⚫Coefficient of variation = cv = σ/μ
= size of uncertainty relative to demand
11-
597
Measuring Product Availability
⚫ Product availability
⚫ a firm’s ability to fill a customer’s order out of available
inventory
⚫ Stockout
⚫ a customer order arrives when product is not available
⚫ Product fill rate (fr)
⚫ fraction of demand that is satisfied from product in inventory
⚫ Order fill rate
⚫ fraction of orders that are filled from available inventory
⚫ Cycle service level
⚫ fraction of replenishment cycles that end with all customer
demand being met
11-
598
Replenishment Policies
⚫Replenishment policy
⚫decisions regarding when to reorder and how much to reorder
⚫Continuous review
⚫inventory is continuously monitored and an order of size Q is
placed when the inventory level reaches the reorder point ROP
⚫Periodic review
⚫inventory is checked at regular (periodic) intervals and an
order is placed to raise the inventory to a specified threshold
(the “order-up-to” level)
11-
599
Continuous Review Policy: Safety Inventory
and Cycle Service Level
L: Lead time for replenishment
D: Average demand per unit
time
σD:Standard deviation of demand
per period
DL: Mean demand during lead time
σL: Standard deviation of demand
during lead time
CSL: Cycle service level
ss: Safety inventory
ROP: Reorder point
Average Inventory = Q/2 + ss

11-
600
Estimating Safety Inventory (Continuous Review
Policy)
D = 2,500/week; σD = 500
L = 2 weeks; Q = 10,000; ROP = 6,000
DL = DL = (2500)(2) = 5000
ss = ROP - DL = 6000 - 5000 = 1000
Cycle inventory = Q/2 = 10000/2 = 5000
Average Inventory = cycle inventory + ss = 5000 + 1000 = 6000
Average Flow Time = Avg inventory / throughput = 6000/2500 =
2.4 weeks
11-
601
Estimating Cycle Service Level (Continuous Review
Policy)
D = 2,500/week; σD = 500
L = 2 weeks; Q = 10,000; ROP = 6,000
Cycle service level, CSL = F(DL + ss, DL, σL) =

= NORMDIST (DL + ss, DL, σL) = NORMDIST(6000,5000,707,1)
= 0.92 (This value can also be determined from a Normal
probability distribution table)
11-
602
Fill Rate
⚫ Proportion of customer demand
satisfied from stock
⚫ Stockout occurs when the demand
during lead time exceeds the reorder
point
⚫ ESC is the expected shortage per
cycle (average demand in excess of
reorder point in each replenishment
cycle)
⚫ ss is the safety inventory
⚫ Q is the order quantity
ESC = -ss{1-NORMDIST(ss/σL, 0, 1, 1)} + σL NORMDIST(ss/ σL, 0, 1, 0)

11-603
Evaluating Fill Rate
ss = 1,000, Q = 10,000, σL = 707, Fill Rate (fr) = ?
ESC = -ss{1-NORMDIST(ss/σL, 0, 1, 1)} +
σL NORMDIST(ss/σL, 0, 1, 0)
= -1,000{1-NORMDIST(1,000/707, 0, 1, 1)} +
707 NORMDIST(1,000/707, 0, 1, 0)
= 25.13
fr = (Q - ESC)/Q = (10,000 - 25.13)/10,000 = 0.9975
11-
604
Factors Affecting Fill Rate
⚫Safety inventory: Fill rate increases if safety inventory
is increased. This also increases the cycle service
level.
⚫Lot size: Fill rate increases on increasing the lot size
even though cycle service level does not change.
11-
605
Evaluating Safety Inventory Given CSL
D = 2,500/week; σD = 500
L = 2 weeks; Q = 10,000; CSL = 0.90
DL = 5000, σL = 707 (from earlier example)
ss = FS-1(CSL)σL = [NORMSINV(0.90)](707) = 906

(this value can also be determined from a Normal probability
distribution table)
ROP = DL + ss = 5000 + 906 = 5906
11-
606
Evaluating Safety Inventory
Given Desired Fill Rate
D = 2500, σD = 500, Q = 10000
If desired fill rate is fr = 0.975, how much safety inventory
should be held?
ESC = (1 - fr)Q = 250, σL = 500√L = 707
Solve
11-
607
Evaluating Safety Inventory Given Fill Rate
11-
608
Impact of Required Product Availability and
Uncertainty on Safety Inventory
⚫As desired product availability (cycle service level or fill

rate) increases, required safety inventory increases
⚫As demand uncertainty (σL) increases, required safety
inventory increases
⚫Managerial levers to reduce safety inventory without
reducing product availability
⚫reduce supplier lead time, L (better relationships with suppliers)
⚫reduce uncertainty in demand, σD(better forecasts, better
information collection and use)
11-
609
Impact of Supply Uncertainty
⚫D: Average demand per period
⚫σD: Standard deviation of demand per period
⚫L: Average lead time
⚫ sL: Standard deviation of lead time
11-
610
D = 2,500/day; σD = 500
L = 7 days; Q = 10,000; CSL = 0.90; sL = 7 days
DL = DL = (2500)(7) = 17500
ss = F-1s(CSL)σL = NORMSINV(0.90) x 17550

= 22,491
11-
611
Safety inventory when sL = 0 is 1,695
11-
612
Impact of Aggregation
on Safety Inventory
⚫Models of aggregation
⚫Information centralization
⚫Specialization
⚫Product substitution
⚫Component commonality
⚫Postponement
11-
613
Impact of aggregation
⚫Consider k regions, with demand normally distributed
in each
Di: mean weekly demand in region i, i= 1, 2,..k
σi: Standard deviation of weekly demand in region i, i=
1, 2,..k
ρij: correlation of weekly demand for regions i, j
For decentralized option, total safety inventory

ss =∑ FS-1(CSL)X √L X σi
11-
615
⚫Safety inventory savings on aggregation increase with
⚫Desired cycle service level (CSL)
⚫Replenishment lead time L
⚫Holding cost H
⚫Safety inventory savings on aggregation decrease as
⚫Correlation coefficients increase
Car Dealer : 4 dealership locations (disaggregated)
D = 25 cars; σD = 5 cars; L = 2 weeks; desired CSL=0.90
What would the effect be on safety stock if the 4 outlets are
consolidated into 1 large outlet (aggregated)?
Assume demand in each area independent
At each disaggregated outlet:
For L = 2 weeks, σL = 7.07 cars
ss = Fs-1(CSL) x σL = Fs-1(0.9) x 7.07 = 9.06
Each outlet must carry 9 cars as safety stock inventory, so
safety inventory for the 4 outlets in total is (4)(9) = 36 cars
11-
617
One outlet (aggregated option):
DC = D1 + D2 + D3 + D4 = 25+25+25+25 = 100 cars/wk
σDC = Sqrt(52 + 52 + 52 + 52) = 10
σLC = σDC Sqrt(L) = (10)Sqrt(2) = (10)(1.414) = 14.14
ss = Fs-1(CSL) x σLC = Fs-1(0.9) x 14.14 =18.12
or about 18 cars
11-
618
Impact of demand correlation
ρ Disaggregate ss Aggregate ss
0 36.34 18.12
.2 36.34 22.92
.4 36.34 26.88
.6 36.34 30.32
.8 36.34 33.41
1.0 36.34 36.24
⚫If number of independent stocking locations decreases by n, the
expected level of safety inventory will be reduced by square
root of n (square root law)
⚫Many e-commerce retailers attempt to take advantage of
aggregation (Amazon) compared to bricks and mortar retailers
(Borders)
⚫Aggregation has two major disadvantages:
⚫Increase in response time to customer order
⚫Increase in transportation cost to customer
⚫ Some e-commerce firms have reduced aggregation to mitigate these
disadvantages
11-
620
Information Centralization
⚫Virtual aggregation
⚫Information system that allows access to current
inventory records in all warehouses from each
warehouse
⚫Most orders are filled from closest warehouse
⚫In case of a stockout, another warehouse can fill the
order
⚫Better responsiveness, lower transportation cost, higher
product availability, but reduced safety inventory
⚫Examples: McMaster-Carr, Gap, Wal-Mart
11-
621
Specialization
⚫Stock all items in each location or stock different items
at different locations?
⚫Different products may have different demands in
different locations
⚫Evaluate benefits from aggregation
⚫Benefits of aggregation can be affected by:
⚫Nature of demand (low or high)
⚫Coefficient of variation of demand (higher cv yields
greater reduction in safety inventory from centralization)
⚫Value of item (high value items provide more benefits
from centralization)
11-
622
Value of Aggregation at Grainger
⚫1600 stores
⚫Consider 2 products
⚫Large electric motors (high-value low demand)
⚫Industrial cleaners (low-value high demand)
⚫Weekly demands normally distributed
⚫Demand at each store independent
⚫Supply lead time = 4 weeks
⚫Holding cost = 25%
⚫Desired CSL = 0.95
⚫Find reduction in ss if inventory carried only in central DC
Value of Aggregation at Grainger
11-624
Product Substitution
⚫Substitution: use of one product to satisfy the demand
for another product
⚫Substitution may be
⚫Manufacturer-driven
⚫Customer-driven
⚫Substitution may be
⚫One-way
⚫Two-way
11-
625
Component Commonality
⚫Using common components in a variety of different
products
⚫Can be an effective approach to exploit aggregation
and reduce component inventories
11-
626
Value of Component Commonality
⚫ Dell makes 27 different PCs with 3 distinct components:
processor, memory and hard drive
⚫ Disaggregate option:
⚫ Dell designs specific components for each PC, resulting in 3X27 = 81
distinct components
⚫ Common component option:
⚫ Dell designs s.t. 3 distinct processors, 3 distinct memory units & 3 distinct
hard drives can be combined to make 27 different PCs
⚫ Each component used in 9 different PCs
⚫ Monthly demand for each PC independent & normally distributed
with mean 5000 & std. dev. 3000.
⚫ Lead time = 1 month
⚫ Target CSL for component inventory = 0.95
⚫For 81 components across 27 PCs
Total ss = 81XNORMSINV(0.95)x√1x3000 = 399,699
units
⚫For component commonality, each component in 9
different finished products
Safety inventory per common component
=NORMSINV(0.95)x√9 x3000 = 14,804 units
Total ss for 9 components = 9X 14,804 =133,236 units
11-629
Postponement
⚫The ability of a supply chain to delay product
differentiation or customization until closer to the time
the product is sold
⚫Goal is to have common components in the supply
chain for most of the push phase and move product
differentiation as close to the pull phase as possible
⚫Examples: Dell, Benetton
11-
630
Value of postponement
⚫ A paint retailer sells 100 different colors of paint.
⚫ Assume independent & normally distributed weekly demand
⚫ D=30/week, σD=10, L= 2 weeks, CSL =0.95
⚫ In disaggregate option (paint mixed at factory and held at
retailer as individual colors)
⚫ Total ss = 100XNORMSINV(0.95)x√2x10 = 2326
⚫ If retailer holds base paint and mixes on demand
Std. dev. of wkly demand of base paint σ CD = √100x10 =100
Total ss = NORMSINV(0.95)x√2x100 = 233
⮚ Postponement reduces safety inventory
⮚ More powerful in online channel as customers are implicitly
willing to wait
Impact of Replenishment
Policies on Safety Inventory
⚫Continuous review policies
⚫Periodic review policies
11-
632
Periodic review policies
⚫D: Average demand per period
⚫σD: Standard deviation of demand per period
⚫L: Average lead time
⚫T: Review interval
⚫CSL: desired cycle service level
⚫Identify a OUL for which
Probability (demand during L+T≤ OUL) = CSL
Mean demand during T+L periods, DT+L=(T+L)D

Std. Dev. of demand during T+L periods,
σT+L=√(T+L) σD
OUL= DT+L + ss
ss = Fs-1(CSL) x σΤ+L = NORMSINV((CSL)x σΤ+L
Average lot size Q = DT = DT
⚫D = 2500 σD = 500
⚫L= 2 weeks T = 4 weeks
⚫CSL =0.90
⚫DT+L= (2+4)X2500 = 15000
⚫σT+L=500X√(4+2) = 1225
⚫ss = 1570
⚫OUL = 15000 + 1570 = 16570
⚫Manager orders the difference between 16570 and

current inventory every 4 weeks
□THANKS SCM
636

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Vertical Vs Horizontal Integration

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Vertical vs horizontal integration

Importance of Supply chain Chapter 1 (Text)

Designing an effective supply The triple-A supply chain by

Global Supply Chain Chapter 10 (Text) Wal-Mart

□ Laura Ashley turns its inventory 10 times

Procurement Manufacturing Sales & Distribution

Optimize to Optimize to Optimize to

“The sum of the local optima do not

(Goldratt, Theory of Constraints,

Network of facilities including connected &

Reuse/Maintenance/After Sales Service Flow

“the integration of business processes

□ Maximize overall value (profit) generated

⮚ Minimize system-wide costs while satisfying

⮚ Supply chain management is the management

□ Simply put, it involves

In-house core Rigid Products/

Traditional Business Design (Product-Focused)

“Customer Centric” Design (Customer-Focused)

Flexible In-house and

• Size • Speed

• Role Clarity • Flexibility

• Specialisation • Integration

• Control • Coordination

" …managers need to be good at mobilizing,

Managing External Supply Demand

Mass Productivity Management

□ GDP : Rs. 88.32 lakh Crore

□ Logistics Cost : 14% of our GDP

□ Logistics Cost : Rs. 1236480 Crore

□ 1% Reduction in LC : Rs. 12365 Crore

□ Laura Ashley turns its inventory 10 times

Procurement Manufacturing Sales & Distribution

Optimize to Optimize to Optimize to

“The sum of the local optima do not

(Goldratt, Theory of Constraints,

Supplier Customer Demand

⚫ Co-location of 2 firm’s factories

🞂 High cost of transportation and receiving at stores

Need based segmentation may produce odd

⚫ Activity Based Costing

⚫Multi level networks

⚫Orchestrate improvement efforts

⚫Recognize difficulty of change

🞆 Supply chain strategy

Variety of products required Demand per product becomes

causes supply uncertainty to increase

Salt at a Existing New

🞆 Supply chain efficiency

🞆 Increasing responsiveness results in higher costs that

Highly Somewha Somewhat Highly

Integrated Ready-made Most Seven eleven

🞆 All functions in the chain must support the competitive

Certain Implied Uncertain 177

🞆 Understand supply chain capabilities

🞆 Correct any mismatch

PLC > 2 yrs 3 months to 1 yr

Contribution margin 5-20% 20-60%

Avg. forecast error 10% 40%-100%

Avg. stock out rate 1%-2% 10%-40%

Avg. forced season-end 0% 10%-25%

Primary goal Lowest cost Quick response

Efficient Match Mismatch