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Supply Chain Management:

From Vision to Implementation

Chapter 5: The Order Fulfillment Process: Managing the Physical Flow Infrastructure

Chapter 5: Learning Objectives

1. Describe how purchasing, production, and logistics decisions work together to create customer value. 2. Identify and describe the steps in the purchasing process. 3. Identify and discuss design and control decisions in production operations management. Describe the underlying principles and practices lean manufacturing. Describe the characteristics of service operations.

Chapter 5: Learning Objectives

4. Identify the key decision-making elements of the logistics process. Discuss order fulfillment, transportation, and distribution strategies. 5. Describe how physical flow decisions affect the cost and service positions of the company as well as the design of the overall supply chain.

Order Fulfillment
Order fulfillment is the process that actually makes and delivers a product or service Three functions are responsible:
Purchasing acquires the inputs used to support production Production converts inputs into outputs that customers value Logistics transports and stores goods assuring access

SCOR Model
When purchasing, production, and logistics work in concert directed by overall strategy, they help deliver value to the customer. The SCOR model helps to create a common vision for managing and coordinating five primary SC processes.

Elements of the SCOR Model

Plan: Processes that balance demand and supply to develop a course of action to meet sourcing, production, and delivery needs. This process aligns the supply chain plan with the financial plan. Source: Processes that purchase goods and services to meet planned or actual demand. Emphasis is on selecting suppliers, establishing policies, scheduling deliveries, and assessing performance. Make: Processes that transform product to a finished product to meet demand. Emphasis is on scheduling production, measuring performance, managing inventory, and configuring the network. Deliver: Processes that provide finished goods and services to customers. Emphasis is on order management, warehouse management, and transportation management. Return: Processes associated with the return of products for any reason, and includes post-delivery customer support. Emphasis is on reverse logistics and long-term customer support.

SCOR Model

Purchasing Management
Four developments during the 80s and 90s increased the importance of purchasing:
1. Purchased inputs became a primary operating cost 2. Just-in-time emphasized cooperative, long-term buyer-supplier relationships 3. Information technology provided information needed to strategically manage relationships 4. Better trained and more competent managers entered supply arena

Purchasing Costs
Manufactures spend 55% of each dollar on purchased goods and services Approximately 60-80% of operating expense Direct manufacturing costs have declined to between five and 15% of total operating costs
As little as 2% for some high-tech industries

Service industries spend less on purchased materials than manufacturing


Purchased Inputs as a Percent of Sales


Outsourcing Purchasing Role

Focusing on core competencies has led many companies to outsource value added activities Sourcing professionals take on the role of acquiring and managing:
Inputs Supplier capacity Supplier capabilities


The Sourcing Process

Supplier Selection: Identification Evaluation Approval Monitoring

Need Communication: Recognition Description

Transaction Management: Price Determination Purchase Order Follow-Up and Expediting Receipt and Inspection Supplier Payment

Relationship Management: Performance Monitoring and Improvement


Recognition and Description of Need

Well-managed companies use a purchasing policy or procedure handbook to guide interactions between internal users and sourcing Purchase requisition is used to clearly describe and communicate needs to sourcing
Item description, requisitioning department, authorizing signature, purchase quantity, delivery day, and location are necessary information

Supplier Selection
1. Identification involves making a list of all potential suppliers. A purchaser might look to the companys purchasing database or directories such the Thomas Register of American Manufacturers, which lists over 150,000 companies. Evaluation involves the identification of supplier selection criteria and the gathering of performance information that can be used to assess and compare possible suppliers.
Frequently used criteria include quality, price, delivery dependability, capacity (current and future), service responsiveness, technical expertise, managerial ability (attitude, skills, and talent), and financial stability.



Approval identifies the suppliers that are eligible to receive an order. The number of suppliers on the approved list depends on the nature of the item being purchased.
For commodity-type items, multiple suppliers are generally used; for unique items, a sole-sourcing arrangement may be preferable.


Monitoring assures high levels of performance. Scorecards are often used to provide an overall supplier rating.
John Deere uses categories to rate suppliers into one of four groups: partner, key approved supplier, approved supplier, or conditional supplier

Transaction Management - Price

Price is the factor used most frequently to evaluate the sourcing groups performance Best price is pursued using:
List price low-volume or low-value items Competitive bidding relies on market forces to obtain a fair price
Reverse auctions may achieve 10-30% reductions

Negotiation high dollar value high uncertainty items, or when a long-term relationship is desired

Transaction Management - Orders

Purchase orders specify the terms and conditions of the purchase agreement and initiate supplier action Blanket orders specify the overall terms of agreement for a given time period and cover the entire quantity to be purchased
Smaller quantities are periodically delivered under this agreement


Transaction Management - Expediting

Regular follow-up allows identification of quality or delivery problems Expediting refers to efforts to speed up delivery of an order Penalty clauses can be used in purchase agreements


Transaction Management - Inspection

Receipt and inspection matches the invoice the contents via physical count and quality inspection Primary reason for failure:
The count is off (too much, too little) Quality is inferior

Supplier certification programs focus on improving suppliers abilities to produce high quality products, eliminating the need for inspection

Transaction Management - Payment

Efficient procedures for invoice clearance improve:
Supplier relationships Financial performance
Discounts for prompt payment


Performance Monitoring
Performance monitoring allows identification of candidates for increased collaboration and long-term supplier relationships Four types of information should be tracked:
1. 2. 3. 4. Current status of all purchase orders Select evaluation criteria for all suppliers Part or commodity information Information regarding contracts of relationships

Purchasing Manager Skills

Knowledge Management commodity expertise and understanding of supplier capacity and capability Relationship Management - alliance relationships with critical suppliers, fair relationships with all; design of efficient transaction mechanisms Process Management - continuous improvement, collaborative processes, supplier education Technology Management - employed new technology to reengineer the sourcing process

Production Management
Also known as operations or manufacturing management - creates value by transforming capital, technology, labor, and materials into more highly valued products and services Operations drive product of the growth, innovation, and generates higher living standards


Production Management
Operational excellence is a prerequisite for success Operations managers must manage two groups of decision variables:
Design Decisions Control Decisions


World Class Operations Management


Design Decisions
Facility location affect access to factor inputs and customer markets Facility layout determine the positioning of equipment, the flow and handling of materials Product design impact the ability to profitably capture future market share Process design involves technology selection and work design

Control Decisions
Forecasting estimate of what needs to be produced and when Inventory control determines how much and when to make specific products Scheduling two types:
Aggregate planning determines what needs to be produced Process planning determines work done at each station

Quality control designing, building, and inspecting quality into both the process and product

Product/Service Continuum
Pure Products Product/Service Solutions Pure Service

Tangible, Physical Low Customer Contact Can be Inventoried Economies of Scale Exits Control is Highly Objective Output can be Transported

Intangible, Perishable High Customer Contact Cannot be Inventoried Minimal Economies of Scale Control is More Subjective Location is Critical


Labor Productivity- Manufacturing


Labor Productivity- Services


Operations Management Skills

Operational excellence is a prerequisite for success; however, competition is now between chains not just companies. Therefore, managers must understand and develop skills in dealing with:
Outsourcing Supplier Integrated Manufacturing Best Practices Dissemination


Lean Production
Lean production relies on a number of interrelated practices: Waste Elimination
Waste is defined as anything more than the absolute minimum necessary to add value Inventory covers up problems, Lean works to systematically reduced inventory to identify problems

Workforce Participation
Jidoka - the authority to stop the line Requires training, personal responsibility, and integration

Basic 5S Principles
The 5 Ss Sort Basic Principle Eliminate clutter. Remove all supplies, materials, tools, and paperwork not required in the operation. Keep only that which is needed to perform the process.

Organize the work area to make it easy to find what is needed. Set In Order Everything has a place and everything is in its place.


Clean the work area. Make it shine. This includes aisles, walls, meeting and storage places.
Create and use policies, procedures, and practices to assure that the first three of the 5S activities are performed regularly.



Create a 5S culture by putting in place mechanisms that support, enhance, and extend 5S practices. Involving, measuring, and recognizing people is critical.

Lean Production
Managerial Responsibility
Managers take on the role of teacher, team facilitator, and motivator

Process Development
Line workers are trained and empowered to solve problems and improve processes

Network Orientation
Lean should be practiced by critical suppliers

Lean Production
Synchronization of material movement is accomplished by a pull or kanban system

Continuous Improvement
Kaizen - the quest for incremental productivity gains and consistent innovation


Logistics Management
Logistics management is that part of SCM 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 Supply Chain Management Professionals


The Logistics Process

Materials management is concerned with the inbound movement and storage of raw materials, purchased components, and subassemblies entering and flowing through the conversion process. Physical distribution focuses on the outbound transportation and storage of finished products from point of manufacture to where customers wish to acquire them.

Basic Logistics Activities

Activity Basic Roles and Responsibilities

Customer Service
Demand Forecasting

Customer service focus on understanding what customers want and measuring logistics performance against these customer requirements.
Forecastsestimates of demandmust be developed to help plan other logistics activities, allocate resources, and provide high levels of service at low costs.

Accurate documentation helps assure that the product gets to the customer Documentation on time. Documentation is particularly vital in international shipments. Information Management Inventory Management Data on carriers, customers, and inventories must be turned into useful decision-making information. Information replaces inventory in today's logistics systems. Product must be available to meet production requirements and customer demand. However, inventory is expensive. Inventory control must support high levels of customer service with as little inventory as possible.

Basic Logistics Activities

Activity Material Handling Order Processing Packaging Basic Roles and Responsibilities Because handling materials costs money and can lead to damage, factories and warehouses are designed to minimize the total amount handling. Order processing initiates work. Many orders are transmitted electronically, improving speed and accuracy of the fulfillment process.

Packaging protects the product throughout the distribution process. Packaging also conveys information about the product and presents an attractive appearance.

Needed spare and replacement parts must be available to support sales. Parts and Caterpillar promises delivery of needed replacement parts anywhere in the Service Support world within 48 hours. This type of support increases customer loyalty. Site Selection Location Location can provide access to inputs like low-cost labor and materials. It can also affect customer service levels, providing access to important consumer markets.

Basic Logistics Activities

Activity Return Goods Handling Salvage and Recycling Transportation Management Warehouse/DC Management Basic Roles and Responsibilities

Defective products and inaccurate orders must be returned efficiently. Reverse logistics" is very important to achieving high levels of customer satisfaction. Handling excess materials is often overlooked. However, this is an important logistics activity, especially when hazardous materials or recyclable items must be managed.
Transportation is the most visible logistics activity. Five modal options exist: rail, truck, air, water, and pipeline. Storing products until they are ready for use is the role of warehousing. A variety of products are also consolidated into a single customer shipment.

The Order Cycle


Order Fulfillment Activities


Order Fulfillment Activities

Placing facilities in the right location and leveraging appropriate process technologies to reduce the combined production and delivery time. Carrying the right quantity and mix of inventory. Streamlining order processing eliminating unnecessary steps.
Assure order-entry accuracy

Developing good relationships with reliable transportation companies reduces transit times and increases on-time delivery performance. Adopting appropriate technologies and implementing innovative materials handling processes can increase flow speed through warehouses.

Transportation Modes - Rail

Rail Cost Speed Quantities Geographical Coverage Environmental Concerns Distances Required Infrastructure Product Variety Reliability Flexibility

High fixed, low variable cost structure Inexpensive, especially for bulk goods Relatively slow, average car speed 20 MPH (unless utilizing double stack unit trains, effectively doubling speed) Large quantities; full car load increments most cost effective

Widespread on some continents; limited by tracks, landmass

High impact of new tracks, low air pollution Medium to long Tracks, rolling stock Large variety of products; ideally suited for bulk goods Low loss, damage, less timely (delays at sidings, terminals) Routing limited to track location, little door to door delivery (side spur required)

Transportation Modes Motor Carrier

Motor Carriers Cost Speed Quantities Geographical Coverage Environmental Concerns Distances Required Infrastructure Product Variety Reliability Flexibility High variable (90%), low fixed (10%) More expensive than rail Medium speed where sufficient roads exist, about twice as fast as rail (50 MPH) Limited capacity of about 80,000 lbs; larger capacity combination vehicles are geographically limited

Widespread on some continents; limited by roads, landmass

High pollution, especially in developing countries, high impact of new roads Short to Medium Roads, vehicles

Routing limited by road location

Large variety of products Limited loss, damage, more timely than rail Routing limited to road locations, but still good for JIT, extensive access in countries with well-developed highway systems, door to door delivery possible with appropriate 44 roads

Transportation Modes - Pipeline

Pipeline Cost Speed Quantities Geographical Coverage Environmental Concerns Distances Required Infrastructure Product Variety Reliability Flexibility

High fixed, low variable Very inexpensive Nature of product makes speed a non-issue Large quantities of limited products

Widespread on some continents; limited by unidirectional movement, and the availability of landmass to support pipelines
Pipeline leakage, high impact on wildlife, scenic value Medium most common Pipeline between two points required Primarily petroleum products; only practical for liquid, liquid-carried, or gas products Very low loss or damage, usually timely Routing limited to pipelines

Transportation Modes - Ship

Cost High variable, low fixed Very inexpensive, about $.008 /ton mile (1/4 cost of railroad) Less fuel needed Inland waterway: Slow, about 4 to 5 MPH Ocean: faster, fewer stops (10-12 days Pacific crossing) Large. Container ships carry up to forty equivalent unit containers. Global, but limited to natural and constructed waterways. Spillage from accidents, leakage, high impact on fisheries Long to very long Ports, ships Routing limited by waterway, ocean availability Low variety of heavy, bulk, or low-value-by-weight items, often commodities Port to port

Quantities Geographical Coverage Environmental Concerns Distances Required Infrastructure Product Variety Flexibility


Transportation Modes - Airplane

Cost High variable, low fixed Very expensive (2 to 3 times as high as motor carriers, 12 to 15 times as high as rail); lower packing costs than ship Fast speed within and between continents; measured in hours or days

Speed Quantities Geographical Coverage Environmental Concerns Distances Required Infrastructure

Relatively small
Widespread on some continents; limited by air terminal availability Noise pollution near major population centers Medium to very long

Airports, navigational aids, airplanes

Routing limited by airport location Product Variety Flexibility Large variety of small, high-value-by-weight, often perishable items Air terminal to air terminal


Transportation Modes - Internet

Internet Extremely inexpensive, where infrastructure is in place. Cost Low fixed, low variable costs Extremely fast Limited by number of source transmission lines available, or satellite access Widespread on some continents; limited by transmission capability availability None except where new transmission line construction occurs, then less than other modes Very short to very long Telephone lines, satellite, cellular transmission capability Required Infrastructure Routing limited by transmission path Product Variety Flexibility Limited to digital information; software, music, video, documents, information Computer to computer

Speed Quantities

Geographical Coverage
Environmental Concerns Distances


Warehouse Activities
Shipping and receiving goods and materials Materials handling and order processing Consolidating and distributing shipments Transportation management, such as routing, tracing, and monitoring movements Product packaging and labeling (form postponement) Re-packaging and mixing of products Preparation of in-store displays (ready store delivery pallets) Light manufacturing or assembly Scrap and disposal


Cross-Dock Operations


Logistics Manager Skills

Logistics may be the next source of competitive advantage. To tap that advantage managers must understand: Logistics Outsourcing Shared Logistics Services Network Rationalization


A Return to the Opening Story

Based on what you have now read and discussed: Why is Charlene interested in making the entire order fulfillment process visible? What do you think the root-cause of Coco Locos problems is? What questions would you ask Terry, Jack, and Robert? Are the organization structure, reporting relationships, and reward systems at Coco Loco relevant to the current crisis? Why or why not? What mechanisms might help the order fulfillment process better meet customer requests? Specifically, what policies, procedures, processes, and measures are needed?

Supply Chain Management:

From Vision to Implementation
Supplement E: Forecasting and Inventory Management

Forecast are estimates of future demand and in some cases costs Companies use forecasts when making decisions about purchasing, production, logistics, and capacity planning. Forecasts can be:
Quantitative mathematically derived Qualitative derived from surveys, test markets, panel of experts, etc.

Simple Moving Average

Averages actual demand/cost data for a specified number of previous time periods. Each period has equal weight. The number of periods represent a trade-off between stability and responsiveness
Fewer time periods will be more responsive but less stable More time periods will be less responsive but more stable Managers should use MAD to test various forecast periods to determine the best to accurately reflect their environment

Simple Moving Average - Example

Week 1 2 3 Demand 350 397 375

3 Period Moving Average Forecast 8 348 366 381 3

Forecast 365 8
5 Period Moving Average

4 5
6 7

342 381
366 348

Forecast 8

348 366 381 342 375 5

Forecast 362.4 8

Weighted Moving Average

Newer/older data may be more representative of the current environment Any combination of weights that sums to 1.00 may be used Any number of periods may be used


Weighted Moving Average - Example

Week 1 2 3 Demand 350 397 375

Using the data from the previous example, calculate a 4 week weighted moving average with the weights of .1,.2,.3, and .4 (oldest to newest)
4 Period Weighted Moving Average Forecast (0.1)(342) (0.2)(381) (0.3)(366) (0.4)(348) 8 Forecast 359.4 8

4 5
6 7

342 381
366 348


Exponential Smoothing
Helps managers balance stability and responsiveness Corrects the forecast by a percentage () of the forecast error The greater the value of , the more responsive the forecast to changes in the data


Exponential Smoothing - Example

Period 7 8 9 10 11 Actual Forecasted Demand Demand 48 45 47 45 40 52.69 51.15 49.13 48.43 47.31

Using the given data, calculate demand in week 12 using an exponential smoothing forecast with an alpha = 0.328
Forecast12 (0.328)(40 ) (1 - 0.328)(47. 31) Forecast12 44.91


Least squares regression can be used to determine the straight line that minimizes total forecast error. Capable of multi-year forecasts into the future
Y b 0 b1x Where : b0

y b x intercept of the line


b1 slope of the line

n xy - x y n x 2 x

Regression - Example
Week (x) 1 2 3 Number of Repairs (y) 59 73 41 x

xy 59 146 123

1 4 9

5 6 7

48 57 69

25 36 49

240 342 483

9 10

46 50

81 100

414 500

x 55

y 575


xy 3115


Regression - Example
10(3115) - 55(575) b1 the slope of the line 0.5758 2 10(385) - 55

575 55 b0 the intercept of the line ( 0.5758) 60.67 10 10

Y 60 .67 ( 0.5758 ) x

Forecast for Period 15 would be:

Y 60 .67 ( 0.5758 )15 52 .03

Mean Squared Error (MSE)

MSE is the average of all of the squared errors The forecast with the smallest MSE best fits the data

Actual Demand - Forecasted Demand MSE

Number of Periods


Mean Squared Error - Example

Period 7 8 9 10 Actual Demand 48 45 47 45 Forecasted Demand 52.69 51.15 49.13 48.43 Error -4.69 -6.15 -2.13 -3.43 Squared Error 22 37.82 4.54 11.76






129.56 MSE 25.91 5


Mean Absolute Deviation (MAD)

MAD is the average of the absolute deviation between actual and forecasted values The forecast with the smallest MAD best fits the data

Actual Demand - Forecasted Demand MAD

Number of Periods


MAD - Example
Period 7 8 9 10 Actual Demand 48 45 47 45 Forecasted Demand 52.69 48.97 45.82 46.76 Error -4.69 -3.97 1.18 -1.76 Absolute Error 4.69 3.97 1.18 1.76






16.96 MAD 3.39 5


Inventory Management
Inventory can be either:
Raw Materials Work-in-Process (WIP) Finished Goods

Inventory is one of the largest expenses for most companies


Inventory Management
Inventory Management involves 2 questions:
1. How much inventory should be ordered? 2. When should orders be placed?

Two basic models address these questions:

1. Fixed order quantity orders the same quantity at different intervals 2. Fixed order interval orders different quantities at fixed intervals

Fixed Order Quantity

Orders the quantity, Economic Order Quantity (EOQ), that minimizes the total cost of inventory each time an order is placed. Orders are placed at different intervals. Assumptions:
Demand rate is constant and known All of the consumer demand is satisfied (no shortages) Lead time or order cycle time is constant and known Price paid for the units of inventory is constant


EOQ Model Costs

Order Costs Placing order Tracking shipment Receiving shipment Inspecting shipment Document costs Invoice Costs Setup Cost Labor and materials used in setup Carrying Costs Warehousing Overhead Capital Insurance Labor Tax costs


EOQ Costs
A S Q 1 1 Annual Carrying Costs QCP or QW 2 2 1 A Total Costs QCP S 2 Q Where : Annual Order Costs A Annual Demand Q Order Quantity C Cost per Unit of Inventory S Cost per Order or Setup P Carrying Cost as a Percentage W CP or the Annual Cost to Carry One Unit in Dollars

EOQ Total Cost Curve



EOQ - Example
The manager of Hogan Kitchenware gathered the following data. He expects to sell 44,000 measuring cups this year. Hogan purchases the measuring cups for $0.75 each from its supplier, Shatter Industries. Every order that is placed costs Hogan $8.00 to process. The manager at Hogan estimates his companys inventory carrying cost to be 12 percent. Hogan Kitchenware is open for business 365 days per year. Calculate the number of measuring cups that should be ordered. What is the order, holding, and total cost of inventory?


2(44,000)(8.00) 2,796.82 units 0.75(0.12)

44,000 8.00 $125.86 2796.82 1 Annual Carrying Costs (2796.82)( 0.75)(0.12 $125.86 ) 2 Annual Order Costs
Total Cost of Inventory is $251.72

Fixed Order Quantity Approach


Reorder Point
Reorder point is the level of inventory that triggers an order in the amount of the EOQ Assumes demand and lead time is known and constant If demand and/or lead time is not known and constant, you must add safety stock to prevent stockouts during periods of increased demand



Reorder Point - Example

Using the data from the previous example and an 8 days lead time, calculate the reorder point for Hogan Kitchenware.

Reorder Point Daily Demand X Order Lead Time Reorder Point 120.55 X 8 Reorder Point 964.40 Units


Purchase Point Discount

When offered quantity discounts, the problem may be restated in terms of a choice between total inventory cost on two different orders. To determine whether a quantity discount offers a true advantage, you must:

Calculate the EOQ. If the EOQ is greater than the quantity required to take advantage of the discount, then do so. If not, move to step 2. Calculate the total annual costs of both options and select the option with the lowest annual total costs.

1 A Total Cost QCP S AC 2 Q


Purchase Point Discount - Example

Using the data from the pervious example and a purchase price discount of $0.73 for orders in excess of 5,000 units; how many units should be ordered each time?
1 44000 Total CostsEOQ 2796.82(0. 75)(0.12) 8.00 44000(0.75 ) 2 2796.82 Total CostsEOQ $33,251.72

1 44000 Total Costs5,000 5000(0.73) (0.12) 8.00 44000(0.73 ) 2 5000 Total Costs5,000 $32,409.40

EOQ Implications
EOQ Model is fairly robust despite assumptions that are unrealistic for most companies. Technology can reduce the order costs by automating the process. By reducing order/setup cost, batch size can be reduced meaning that companies can hold less inventory but receive shipments more often.