PRODUCTION & OPERATIONS

MANAGEMENT - 2
Supply Chain Management
March 6, 2024 2

What is a supply chain?

March 6, 2024 3

What is Supply Chain Management?

It is co-ordination of material, information and financial
flows among suppliers, manufacturers, distributors and
customers of products/services to enable high supply
chain efficiency, superior quality, quick delivery and high
customer service
Strategic Decisions: Make or Buy Decisions,
Network Design
 5

General Rationale for Outsourcing and Offshoring

Outsource
Pro Con
• Operational and strategic focus • Strategic risks:
• Cost and risk pooling efficiencies: • Dependence/Loss of control
• Scale economies • Leakage of proprietary skills/
• Risk pooling information;
• Operational and financial flexibility • Incentive problems (hold up, dual
• Access to technology/innovation marginalization)
• Market competition/discipline • Transaction costs
• No “learning by doing/owning”

Pro
• Cost reductions
• Proximity to local or new markets
• Domestic labor market constraints
Offshore • Operational hedge
• Foreign trade barriers
Con
• Transportation costs
• Lead times
• Risks
• Quality, including health,
environmental and CSR
• Currency, IP, political,
competitive
• Domestic trade barriers
• Global operations’ complexity and
social implications
March 6, 2024 6

Peron Appliances is a Spanish company that is considering moving its manufacturing

of dishwashers from Spain to Mexico. It requires three hours of labor to make a
dishwasher. In Spain, the cost of each hour of labor is 25 euros. In Mexico, the cost of
each hour would be 5 euros. The holding cost per dishwasher per week in Spain is 2
euros, while in Mexico it is 1.5 euros. In Spain, there is a three-week lead time. If
production moves to Mexico, the lead time would be 15 weeks. Weekly demand is 500
dishwashers with a standard deviation of 100 dishwashers. It operates with a safety
factor of 3. What would be the change in the cost per dishwasher (holding cost and
labor cost) if it moves production to Mexico?
Supply Chain Fundamental Concepts
March 6, 2024 11

Example: Intangible Losses

Product 1 Product 2 Product 3 Total
Unit cost of acquisition (Rs.) 80 75 70
Unit full sale price (Rs.) 100 95
90
Unit clearance sale price (Rs.) 50 50 50
Demand forecast (units) 60 70
80 210
Actual demand (units) 50 70
90 210
Potential profit (Rs.) 1000 1400 1800
4200
Inventory (based on forecast) 60 70 80
210
Actual sales (units) ____ ____ ____
____
Clearance sales (units) ____ ____ ____
____
Actual profit (Rs.) ____ ____ ____
____
Intangible loss (Rs.) ____ ____ ____
____
 Session 16, 17 (Ch.15,16): Supply Chain Management
March 6, 2024
(Partha P. Datta)
12

Intangible Losses
Product 1 Product 2 Product 3
Total
Unit cost of acquisition (Rs.) 80 75 70
Unit full sale price (Rs.) 100 95 90
Unit clearance sale price (Rs.) 50 50 50
Demand forecast (units) 60 70 80
210
Actual demand (units) 50 70 90
210
Potential profit (Rs.) 1000 1400 1800
4200
Inventory (based on forecast) 60 70 80
210
Actual sales (units) 50 70 80
200
Clearance sales (units) 10 -
- 10
Actual profit (Rs.) 700 1400 1600
3700
Intangible loss (Rs.) 300 -
200 500
 Session 16, 17 (Ch.15,16): Supply Chain Management
March 6, 2024
(Partha P. Datta)
13

Push/Pull View of Supply Chain

Processes
• Supply chain processes fall into one of two categories
depending on the timing of their execution relative to
customer demand
• Pull: execution is initiated in response to a customer order
(reactive)
• Push: execution is initiated in anticipation of customer
orders (speculative)
• Push/pull boundary separates push processes from pull
processes
March 6, 2024 14

The Amplification Effect

Variance of Customer
Demand: 4 units!

Variance of OEM
production: 10 units!

Variance of 1st tier

supplier production: 54
units!

Variance of 2nd tier

supplier production: 377
units!

Variance at Third Tier

supplier production:
2818 units!
March 6, 2024 15

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
(a.k.a. the bullwhip effect)
• Excessive inventories due to the need for large safety stocks
• Larger and more variable production batches
• Unacceptable service levels
• Product obsolescence

Manufacturer’s Wholesaler’s
orders to Store’s orders Sales from
orders to its
manufacturer to wholesaler store
suppliers

Orders
Orders

Orders
Orders

0 Time
0 0 Time
0
Time
Time Time

Manuf- Whole - Retail

Supplier Consumers
acturer saler store
March 6, 2024 16

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
• Often difficult to implement
• when lead times are long
• impractical to react to demand information.
• more difficult to take advantage of economies of scale
March 6, 2024 17

Push-Pull Strategy
• Some stages of the supply chain operated in a push-based manner
• Remaining stages employ a pull-based strategy.
• Interface between the push-based stages and the pull-based stages is the
push–pull boundary (a.k.a. the decoupling point).
March 6, 2024 18

Postponement in Paint Mixing

Factory Store Sale

Color separation at factory

No
Postponement
Unit cost
cheap
Color separation at store

Postponement
Unit cost
expensive
Organizing the production and distribution of products so that customization of products occurs as close as
possible to the point at which demand is known as postponement or delayed differentiation
March 6, 2024 19

Impact of Risk pooling on Safety Stocks: precondition for

postponement to yield benefits
• s1 and s2 are the standard deviation of weekly demand at store 1 and store 2 & r12 is
the correlation between them
• Safety stock at store 1 with safety factor z: z 1 L
• Safety stock at store 2 with safety factor z: z 2 L
• Total safety stocks = z ( 1   2 ) L … (1)
• If inventory is aggregated and kept at a distribution center then safety stocks =

z (  12   22  2 12 1 2 ) L … (2)

• (2)<(1) except when   1 (2)=(1)

12
• In case of aggregation, with lesser number of safety stocks identical service levels can
be maintained
Consider a paint retailer who sells 100 different colours of paint. Assume that weekly demand for each colour
is independent and is normally distributed with a mean of 30 and a standard deviation of 10. The
replenishment lead time from paint factory is 2 weeks and the retailer aims for a CSL=0.95. How much safety
stock will the retailer have to hold if paint is mixed at the factory and held in inventory at the retailer as
individual colours? How does the safety stock requirement change if the retailer hold base paint and mixes
colours on demand? Normsinv (0.95)=1.65
March 6, 2024 21

Uncertainty Framework

Source: Lee, 2002

March 6, 2024 22

Supply Chain Matching

Source: Lee, 2002

 Session 16, 17 (Ch.15,16): Supply Chain Management
March 6, 2024
(Partha P. Datta)
23

Contract design: Alignment of goals

You are a retailer who buys a widget at a wholesale price $3 from a supplier
and retails it for $4. It costs your supplier $2 to make the widget. Unsold
widgets are marked down and sold for $1.5. Demand is uncertain and uniformly
distributed between 5 and 10 units. That is, it is equally likely that demand is
5,6,7,8,9,10 units.
a) How many widgets should you stock?
b) What is the channel optimum stock quantity?
c) What is the reason of difference between a and b, if any?
d) What if the retailer and supplier enter into a revenue sharing contract?
Assume the retailer gives 25% of revenue to the supplier and the supplier
sells at a reduced price of $2. What is the change from earlier stock
quantity in a?
e) What will be the change if the supplier pays for all the excess inventory –
[that means retailer only sells as per actual, any unsold inventory is not
paid and supplier takes ownership and salvages (VMI)]?
 Session 16, 17 (Ch.15,16): Supply Chain Management
March 6, 2024
(Partha P. Datta)
24

Solution
• a) – c)
Demand
Starting Inventory

5 6 7 8 9 10
1/6 1/6 1/6 1/6 1/6 1/6
Expected Expected Expected
Expected Fill
Profit for each demand situation Retailer Supplier Channel
Rate
Profit Profit Profit
5 5 5 5 5 5 5 5 5 10 70.47
6 3.5 6 6 6 6 6 5.6 6 11.6 81.23
7 2 4.5 7 7 7 7 5.75 7 12.75 89.21
8 0.5 3 5.5 8 8 8 5.5 8 13.5 94.81
9 -1 1.5 4 6.5 9 9 4.83 9 13.83 98.33
10 -2.5 0 2.5 5 7.5 10 3.75 10 13.75 100.00
• d) Demand
Starting Inventory

5 6 7 8 9 10
1/6 1/6 1/6 1/6 1/6 1/6
Expected Expected Expected
Probability
Profit for each demand situation Retailer Supplier Channel
of Stockout
Profit Profit Profit
R 3 4.5 6 7.5 9 9
9 6.50 7.33 13.83 16.67
S 5 6 7 8 9 9

Demand
• e)
Starting Inventory

5 6 7 8 9 10
1/6 1/6 1/6 1/6 1/6 1/6
Expected Expected Expected
Probability
Profit for each demand situation Retailer Supplier Channel
of Stockout
Profit Profit Profit
R 5 6 7 8 9 9
9 7.33 6.50 13.83 16.67
S 3 4.5 6 7.5 9 9