Drake’s Supply Chain Management Primer
ISyE 3103 Introduction to Supply Chain Modeling: Transportation and Logistics
Spring 2006
1
From Business Logistics to Supply Chain Management
The information explosion that has taken place over the past two decades has fundamentally
changed the ways that companies do business. Today’s markets are driven more and more by
information than by physical goods. Companies that cannot collect data and transform it into
information are likely to experience difficulty competing in the near future (if they are not finding
it difficult already). The exponential amount of data and information available now as compared to
that before the 1980s has aided the evolution of classic logistics into a new discipline called supply
chain management.
1.1
What is Business Logistics?
Even among professionals in the industry, there is still confusion between these concepts. The
Council of Supply Chain Management Professionals (CSCMP), formerly known as the Council of
Logistics Management (CLM), defines the management of “business logistics” as
the process of planning, implementing, and controlling the efficient and effective flow
and storage of goods, services, and related information from the point of origin to the
point of consumption for the purpose of conforming to customer requirements (pg. 4)
[3].
This definition emphasizes several important facets of business logistics management. The first
point is that business logistics includes planning, implementing, and controlling. Logistics personnel
should be involved in all three of these processes, which correspond to the three kinds of decisions
made by managers: strategic (planning), tactical (implementing), and operational (controlling).
Strategic decisions are generally long-term in scope such as building a distribution network of
warehouses and crossdocks. Once these strategic choices are made, they are difficult to change in
the short run. Tactical decisions have a time horizon of several months up to one year. These
include setting a production schedule and signing service contracts with transportation providers.
Operational decisions involve day-to-day choices such as weekly workforce scheduling and shop-floor
controls.
The second important takeaway from the CSCMP’s definition of business logistics management
is that the goal is an efficient and effective flow. Effectiveness in the supply chain occurs when a
firm performs the actions to which it commits. For example, most online retailers display a typical
delivery time for each of their shipping options. These retailers could be described as “effective” if
their actual delivery performance corresponds with these standards close to 100% of the time. A
company’s supply chain is efficient if it utilizes its resources (assets) in the “best”1 way.
Another distinction made by the definition of business logistics is that the flows of goods,
services, and information must be managed from the point of origin to the point of consumption.
This emphasizes that logistics involves both inbound flows from suppliers as well as outbound flows
to distributors and customers. Historically, the inbound flows fell under the umbrella of “materials
1
Each company’s definition of the “best” use of its assets should be defined according to its competitive strategy
and overall mission.
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management” in organizations, and outbound flows were considered “physical distribution.” In
recent years the management of information flows between firms and between functional areas
within the same form has assumed equal importance with that of the physical flows of goods and
materials as a determinant of a firm’s competitive performance.
The final important characteristic of business logistics management is that every decisionmaking agent should have the overall objective of satisfying the customer. Strategies that reduce
a firm’s costs at the expense of customer satisfaction are doomed to fail in the long run. The
importance of the customer in logistics management emphasizes the necessity of a dialog between
a firm’s logistics operations and its marketing organization. Only through this interaction can the
logistics personnel obtain feedback on the customers’ requirements.
1.2
The Extension to Supply Chain Management
The formal definition of “supply chain management” extends upon the above concept of business
logistics management as follows:
The supply chain encompasses all activities associated with the flow and transformation
of goods from the raw materials stage (extraction), through to the end user, as well as
the associated information flows. Material and information flow both up and down the
supply chain. Supply chain management is the integration of these activities through
improved supply chain relationships to achieve a sustainable competitive advantage (pg.
2) [8].
Several parts of the preceding definition warrant significant further discussion. Supply chain
management is the process of coordinating three flows: physical, financial, and information. Classic
business logistics also attempted to manage these flows to a point, but its main focus was on the
flows within the company itself and between the firm and its immediate suppliers and customers.
Supply chain management extends this effort beyond the physical boundaries of the company to
coordinate the flows with all of the entities involved in the entire process of obtaining raw materials
from nature to the end-user’s consumption of the product.2 The surplus of information that recent
technological advancements have made available (and affordable!) has helped companies begin to
implement initiatives with their supply chain partners for the betterment of each individual party.
Successful supply chain management programs can create a sustainable competitive advantage for
each company in the chain because, at a bare minimum, the level of demand distortion between
different levels of the distribution chain can be mitigated [1].
1.3
Business Activities in the Supply Chain
Hopefully it is clear that the broad-natured definition of logistics and supply chain management
implies that these concepts touch almost every activity performed in business operations. Murphy
and Wood [12] identify the following lengthy, but not all-encompassing, list of business activities
and functional areas that comprise supply chain management operations.
• Customer service
• Demand management (forecasting, pricing, customer segmentation)
2
In fact, many supply chains currently manage the end-of-life return flow of products back from the consumers
and the recycling, remanufacturing, and reuse of these units. This is the concept known as “closed-loop supply chain
management” or “reverse logistics.”
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• Procurement (purchasing, supplier selection, supplier base rationalization)
• Inventory management (raw materials, finished goods, MRO3 items)
• Warehousing and material handling
• Production planning and control (aggregate planning, workforce scheduling, factory operations, etc.)
• Packaging (industrial and consumer)
• Transportation management
• Order management
• Distribution network design (facility location, distribution strategy, etc.)
• Product return management
2
Supply Chain Management as a Basis of Competitive Advantage
Since supply chain management can help firms become more competitive in their particular industry,
it becomes relevant to examine how it affects each of the four common bases of competition: cost,
quality, flexibility, and response time.
In order to increase net income, a company can either try to earn more revenue (often quite
a difficult task) or lower its operating costs. Effective supply chain management can reduce a
firm’s operating expenses by eliminating wasteful redundancies and inefficiencies within the chain.
Many of the solutions take advantage of technological applications either to execute historically
paper transactions electronically or to provide more accurate information for managers to utilize
when making decisions. E-procurement allows purchasing personnel to execute transactions in a
fraction of the time and for a fraction of the cost that it took them before. This frees them to
concentrate the bulk of their day on building supplier relations and monitoring the performance
of existing suppliers [16]. One of the most obvious cost reduction opportunities lies in the area
of inventory management. Better relations and information-sharing with suppliers and customers
allows a company to reduce the required levels of inventory that flow through the channel, thus
improving the turnover ratios and decreasing the amount of capital that must be invested in risky
inventory.
Very few companies are entirely vertically integrated–that is, able to perform every act necessary
from extracting the raw materials that are the inputs for the product to delivering the finished
good to the end user’s dock. Companies, therefore, must rely on suppliers, service providers, and
distribution channel partners to perform many of the functions required to deliver a quality product
that meets the customers’ increasingly demanding needs. Cooperation and collaboration among
the members in the chain can help to reduce the delays that often result in lower levels of customer
satisfaction. Reliable sourcing and collaborative product development helps the firm to produce
the product correctly the first time so that the level of defects decreases without the addition of
costly thorough inspection procedures.
More and more, customers are increasing their demands of vendors for customized products. In
some cases the customer is large enough that these requests must be honored or else the fate of the
3
MRO refers to maintenance, repair, and operating goods. These are products such as office supplies and housekeeping goods that facilitate the execution of other operations.
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company is in danger. The question arises when a company tries to meet the individual demands
of thousands of customers for customizable products. Firms can utilize production techniques like
mass customization and postponement to improve their flexibility in responding to specific customer
demands. The added demand visibility that effective supply chain management provides enables
firms to see this data almost in real time and react to any changes. The customer receives a higher
degree of service without the need for additional inventory investment within the channel.
Many industries have become increasingly dynamic as new technological advancements have
shortened product life cycles for many products to six months or one year. Firms must be able
to cut their product development time so that they can be first to the market with the latest
technological innovation. Cross-functional teams are now being used to reduce the time that it
takes for new products to be designed. The reduction of inventory in the pipeline makes a firm
more nimble in the market. Since the product life cycle is so short, companies want to carry lean
levels of stock so that they reduce the possibility of obsolescence when the next innovation hits
the market. Without the problem of excess inventory, firms are much more eager to introduce new
products that threaten to cannibalize the sales of existing ones.
2.1
Supply Chain Management as an Advantage in Cost
The most visible benefit of integrated supply chain management is a reduction of operating costs.
Almost every supply chain integration initiative has cost savings as one of the primary motivating factors. Any savings that can be extracted from supply chain operations manifest themselves
as direct additions to net income (the proverbial “bottom line”). Many opportunities exist for
companies to capture “low hanging fruit” by implementing supply chain projects because these opportunities were much more difficult to recognize and capitalize on without the recent technological
progress and the business community’s endorsement. Some of the techniques and methodologies
include E-procurement and inventory reduction programs.
The main goal of E-procurement is to reduce the transactional (operational) costs involved with
classic procurement. By moving paper-based transactions to an electronic form, companies can save
the costs of expensive three-copy requisitions and mailing expenses. An important aspect of Eprocurement is empowering the employees to make certain non-strategic purchases (generally MRO
items) right from their desktop without getting approval from a supervisor. This saves each person
time in their workday and drastically reduces the time that it takes for a requisition to be filled once
it is initially made [10]. It also reduces the likelihood that employees will become frustrated with the
approval process and just purchase the item at an office supply store. This “maverick” purchasing
costs the company because the employee is not taking advantage of the firm’s negotiated rates with
suppliers based on its aggregate purchasing power [13]. E-procurement also reduces manual errors
in purchase order processing that ultimately provide greater quality of information and reduce
the rework expenses. By reducing the time and effort that it takes employees to make day-today purchases, procurement personnel are free to concentrate their efforts on strategic activities
like managing supplier relations, working with engineering in cross-functional teams on product
development, and evaluating supplier performance. These value-added activities help to elevate
procurement to a strategic-level activity as a source of competitive advantage [10].
Conservative reports of the benefits of implementing an E-procurement system show that companies can expect to save 10 to 30% of procurement expenses. Deloitte Consulting made headlines
by claiming that firms can expect a 300% return on investment (ROI) in only two to three years
after implementation. Four out of every five e-commerce projects are concerned with improving the
performance of procurement and the supply chain. IBM spent $43 billion in procurement in 1999,
and they were able to save $260 million by simply moving a third of its purchasing activities to the
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Internet. IBM’s E-procurement solution includes electronic purchase orders, which automatically
generate electronic invoices that are ultimately paid via an electronic funds transfer [16].
Even though inventory is technically classified as an asset according to the accountants, most
supply chain professionals regard it as a liability. While there are several valid reasons for carrying
inventory, these goods represent a cash investment in materials, production, and assembly; require
costly storage space; and carry the risk of obsolescence before they are sold. Many firms have
been able to realize substantial cost savings by engaging in inventory reduction programs. Swedish
furniture manufacturer Ikea had a major problem in matching production with demand for its
goods. After an unsuccessful adoption of an enterprise resourse planning (ERP) system, the firm
implemented a new demand-planning decision support system from Manugistics in 2002 that has
since resulted in a 20% reduction in inventory levels for the products included in the pilot program
[14].
One might be inclined to think that only enormous companies like IBM could afford to implement supply chain programs, but to the contrary, small- to medium-sized companies can also
take advantage of the benefits. Town Shoes, a 49-store Canadian shoe retailer, understands that it
cannot exert much influence over its suppliers. It purchased a new merchandising software package
to keep track of the actual stock at each specific store. For the first time, the managers were able
to develop a model for the projected sales of each style and each size. Since the stores now had
the sizes that each market group demanded, sales for fiscal year 2000 were up 12.8% even with
a reduction by inventory levels of 20%. Store replenishment expenses were also reduced by 50%
because the stores were restocked from the central distribution center rather than being mailed
individually from store to store [6].
2.2
Supply Chain Management as an Advantage in Quality
The quality of a manufactured good is largely dependent upon the raw materials that are utilized
in the production process. When a firm has strategic partnerships with its suppliers, its product
development teams can tap into the vast knowledge that its suppliers have about the materials and
components that will be used to produce the new product. Suppliers can help the designers determine which of their offerings would produce the best quality finished product. Sun Microsystems’
director of corporate supply management cites supplier involvement as crucial in the firm’s new
product development process [4].
Quality is currently being interpreted as not only producing a defect-free product but also delivering it to meet the customer’s requirement as well. Customers are more demanding than ever
before, and just like suppliers, their input is inseparable from the development process. The customer must set the standards of acceptable performance along with the manufacturer so that every
party can agree on what metrics should be measured and what constitutes satisfactory performance
[9]. When suppliers also understand the customer requirements, they are generally more willing to
work with the manufacturer to satisfy the ultimate customer. Many suppliers recognize that they
lose business as well if the end customer is not satisfied, so they strive to meet the quality and
delivery requirements of the manufacturer. Relationships between all of the parties in the channel
are absolutely critical to the competitive position of all of the companies involved in the product’s
supply chain [4].
2.3
Supply Chain Management as an Advantage in Flexibility
As discussed above, customers are more demanding now than ever before. Companies have always
dropped everything at the requests of large customers. The loss of any of these accounts would
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be devastating to the corporation, so managers always have done anything they could to satisfy
them. The difference now is that many of the smaller customers as well are demanding some
form of customized product whether it be a choice of color or the ability to design the product
specifications themselves. Forecasting at the specific stock-keeping unit (SKU) level has always
been much more difficult than considering the aggregated product group. Firms cannot afford
to tie up capital in enough inventory of each style and color to meet customers’ highly variable
demands. These manufacturers must develop flexible methods of production in order to respond to
customer desires. One such production method is mass customization, in which the manufacturer
assembles a customized product from mass-produced components. Buyers think that they are
getting a customized product, but they are merely purchasing a standard product with a certain
added feature.
Mass customization requires several attributes in order to be successful. The products should be
modularly designed, thus facilitating quick, easy assembly. Companies need to have a sophisticated
order management information system that can capture customer profiles, accommodate a large
volume of wide-ranging orders, and retain every minute detail about each order. Real-time inventory
levels and lead time information become critical so that the assembly operation can determine if it
has enough components in order to meet the production schedule [7]. (Supplier relationships again
become especially important here regarding current lead time information.)
Postponement, also known as delayed differentiation, is the delay of the final identity of the
product until the last possible moment. This allows for production of base units to be made
according to aggregate forecasts, which are more accurate than those for a specific SKU. The
costs are postponed until the goods are actually assembled, and the manufacturing operation is
able to reduce the risk of obsolescence and produce the exact product that a customer demands.
Thus, postponement practices can be used to combat demand uncertainties that are unable to
be forecast. Hewlett-Packard has used mass customization with postponement in its European
distribution center (DC) to reduce stockouts for its printers. Production facilities manufacture
generic printers which are customized for individual international markets at the DC only after
firm orders from customers have been received. This strategy has simultaneously resulted in higher
service levels, inventory reductions, and increased profitability [15]. Dell, Gateway, Titleist, John
Deere, Black & Decker, and Motorola are more examples of companies currently utilizing mass
customization techniques [7].
A related supply chain strategy that some firms have utilized to establish a competitive advantage is flexible manufacturing. Many production facilities have dedicated manufacturing and
assembly operations that can take hours or even days to change over to the production of another
product. Firms that are able to design their manufacturing operations so that they can produce
multiple products can more-effectively tailor their production runs to actual customer demand.
Nissan Motors opened a massive facility in Canton, MS, in May 2003 that produces five distinct
automobile and truck models including the popular Altima sedan and Titan truck. This flexibility
is unprecedented in the automobile industry, where many facilities are dedicated to a single model.
The Canton plant played a crucial role in Nissan’s record earnings of $4.8 billion in 2004 and its
strategy of capturing North American market share from General Motors and Ford. Nissan also
posted the highest year-over-year growth (16%) in the automobile industry [18].
2.4
Supply Chain Management as an Advantage in Response Time
Flexibility and response time are inseparable in practice. Most companies can do almost anything
if they have a year with which to work. Flexibility in the current business sense is not measured in
years but in days and possibly hours. In order to be truly deemed “flexible,” a firm must be able to
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respond quickly to changes in customer requirements. Inventory must be able to be acquired in a
short period of time if the production schedule must be adjusted to meet unexpected demand. The
Takaoka Toyota plant literally holds minutes of inventory as opposed to days like many American
auto plants. Even in 1982, 52% of Japanese suppliers delivered daily, and 31% delivered hourly to
the plants. In contrast, only 10% of American suppliers delivered either daily or hourly in 1988 [17].
This increased level of service gave Japanese auto makers a distinct advantage over their American
counterparts in the ability to respond to changing customer demands.
Speed is crucial in today’s business environment. With many product life cycles being one year
or less in length, companies must look for ways to develop their products quickly and get them to
market to meet the customers’ current needs before their competitors can. Supported by supply
chain management’s focus on the organization (and the chain) as a whole instead of as functional
silos, many companies have introduced cross-functional teams into their design process. These
teams include representatives from engineering, purchasing, finance, marketing, operations, and
strategic suppliers and customers. With input from the experts in all of these functional areas, the
team can design a feasible finished product in much less time that before. This technique almost
eliminates the need for engineering redesign when purchasing looks at the specs and says that it
cannot procure the appropriate materials at the projected cost or when operations explains that the
die exchange time would be too long. With real-time input from all of these entities, engineering can
draft a design that satisfies each party without the need for countless drafts. Chrysler has utilized
cross-functional teams in its development of new models, and it has reduced the development cycle
time by more than 40%, saving millions of dollars. While its competitors took five years to develop
a new automobile, Chrysler could do it in less than three. Quality and manufacturability of the new
products has also increased dramatically. The shorter development cycle helped Chrysler become
the world’s most profitable car company on a per-unit basis in the mid-1990s [11].
A supply chain that is built for speed and quick response does not come without a price. Often
firms must absorb high transportation costs for small, frequent shipments or maintain excess production capacity in its factories. If the increased responsiveness results in a competitive advantage,
though, these extra costs may be willingly incurred. The lightning-fast supply chain maintained
by Zara, a Spanish designer clothier, enables the firm to design, manufacture, and distribute a new
product to its stores’ shelves in fifteen days. Most firms in the fashion industry must make product
design and stocking decisions several months before the selling season, and their lengthy fulfillment
processes make them unable to utilize to new demand information obtained within the selling season. This quick-response supply chain has enabled Zara to experience annual profit growth of 20%
and enjoy a net margin of 10.5%, which is tops in the industry [5].
Response time is especially important in service supply chains, where a service delay or interruption could cost the customer thousands of dollars per minute. Saturn has adopted a joint inventory
management program with its dealers (which Saturn calls “retailers”) in which they share inventory
risks for service parts. The dealers’ inventories turn over seven times per year, a figure well above
the industry average; at the same time, the dealers exhibit excellent off-the-shelf parts availability,
which ensures customer satisfaction. Inventory replenishment is accomplished according to a oneto-one pull-based procedure. Consequently, inventory decisions are the basis of incorrect forecasts;
instead, these decisions are driven by actual customer demand. This replenishment speed and the
corresponding high degree of customer service have resulted in increased customer loyalty and a
higher number of repeat Saturn purchases [2].
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8
Challenges to Supply Chain Integration
The previous section highlighted many advantages of effective supply chain management initiatives.
The truth is that while many companies have benefitted from recalibrating a portion of their
supply chains, very few, if any, supply chains are fully integrated throughout the entire channel.
Consequently, these firms have failed to experience all of the benefits of supply chain management.
Simchi-Levi et al. [15] identify two major challenges to supply chain integration: global optimality
and managing uncertainty.
Traditional supply chain strategies have sought to improve a specific piece of the supply chain,
such as transportation cost reduction or increased capacity utilization, without regard to its effect
on the total system performance. Effective supply chain managers must balance many competing
costs and performance metrics. Decision makers in a fully-integrated channel must consider global
optimality by improving the performance of the entire supply chain, which can encompass many
disparate firms. Even though the potential benefits are great, many decision makers are reluctant
to sacrifice their firm’s short-term profit for the long-term benefit of the entire channel. The metrics
that evaluate supply chain decisions must be modified to encompass this broader objective.
Uncertainty affects practically all of the decisions made within the supply chain. These are not
simply those decisions based on customer demand, but supplier and intermediary performances are
uncertain as well. The effects of uncertainty can be dampened by the availability and exchange of
information throughout all levels of the supply chain. Working more closely with suppliers, customers, and intermediaries enables each entity to understand the others’ operations and incentives
so that contracts and agreements can be designed and managed to make the entire supply chain
operate more predictably.
4
Summary
Supply chain management provides enormous opportunities for all companies to improve their
competitiveness. No matter how many strides a firm may have made in the last two decades,
many more opportunities still exist because no one has yet figured out how to manage the entire
supply chain completely. Even small companies with a relatively simple operation can find ways to
improve their market position with supply chain techniques. The main thing to remember in any
supply chain initiative is the importance of strategic relationships and partnerships with suppliers
and customers. None of these techniques will work without support from all of the players in the
chain. The information needed to utilize the systems will not be available without the cooperation
of suppliers and customers. The biggest challenge facing executives and managers is the difficulty in
getting all of the parties in the chain to make decisions based on what is best for everyone involved
rather than on what is best for each individual organization. This shift in mentality is critical as
competition ceases to be between businesses but moves toward being between supply chains.
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