Supply Chain Management
Unit-1
Introduction to Supply Chain Management
Definition of Supply Chain:  A supply chain is a chain consisting of all parties involved directly or indirectly in fulfilling a customer
request.
 A supply chain not only consists of the manufacturer and suppliers but also transporter, warehouses,
retailers and even customer themselves.
 Within an organization, such as a manufacturer, Supply Chain consists of all functions involve in
fulfilling the customer request.
 These functions include, but are not limited to New Product Development, marketing, operations,
distribution, finance and customer service.
 Primary Purpose of an SC is to satisfy customer need and at the same time make profit for itself.
 A Supply Chain is dynamic and involves constant flow of information, product and funds among
different stages in different directions.
 A typical SC may involve various stages such as:
 Customer
 Retailer
 Wholesaler/Distributor
 Manufacturer
 Raw Material Supplier/Vendor
 Objective of an SC is to maximize the profit generated.
 Value: surplus of and SC = value of the final product to the customer - cost the entire SC incurs in
fulfilling the customer request.
 Value for the customer: Maximum value willing to pay
Customer Value - Price = Customer Surplus
Revenue - Profit = SC Profitability
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For most promising supply chain SC surplus will strongly be correlated with profits.
SC success would be measured in terms of SC surplus.
Only source of revenue is the customer
SC designing, planning and operation decisions play a significant role in success or failure of a
firm.
 To stay competitive a SC must adapt to changing technology and customer expectations.
 By managing the supply chain, companies are able to cut excess costs and deliver products to the
consumer faster.
Phases in a Supply Chain
Or
Decision Phases in Supply Chain:  Successful SC Management requires many decisions relating to the flow of information, products and
funds. Each decision raises the SC surplus.
 There are total three phases in Supply Chain Management depending upon frequency and time frame
during which a decision phase has an impact.
 Supply Chain Design or Strategic Phase: 
How to structure the SC over the next several years?
 Configuration
 Allocation of resources
 Processes each stage will perform
 Outsource or in-house function
 Location and capacities of production
 Warehouse Facilities
 Number of locations for storage and manufacturing
 Modes of transportation
 Information System
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A company must ensure SC configuration supports its strategic objectives and increases the SC
surplus during this phase.
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Supply chain design decisions are typically made for the long term (a matter of years) and are
expensive to alter on short notice.
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Consequently, when companies make these decisions, they must take into account uncertainty
in anticipated market conditions over the next few years.
 Supply Chain Planning: 
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For decisions made during this phase, the time frame considered is a quarter to a year.
Therefore, the supply chain’s configuration determined in the strategic phase is fixed. This
configuration establishes constraints within which planning must be done.
The goal of planning is to maximize the supply chain surplus that can be generated over the
planning horizon given the constraints established during the strategic or design phase.
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Companies start the planning phase with a forecast for the coming year (or a comparable time
frame) of demand and other factors such as costs and prices in different markets.
Planning includes making decisions regarding:  Which markets will be supplied from?
 Which locations?
 The subcontracting of manufacturing
 The inventory policies to be followed
 The timing and size of marketing and price promotions.
Planning establishes parameters within which a supply chain will function over a specified
period of time.
In the planning phase, companies must include uncertainty in demand, exchange rates, and
competition over this time horizon in their decisions.
Companies in the planning phase try to incorporate any flexibility built into the supply chain in
the design phase and exploit it to optimize performance.
Companies define a set of operating policies that govern short-term operations.
 Supply Chain Operation: 
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The time horizon here is weekly or daily.
During this phase, companies make decisions regarding individual customer orders.
At the operational level, supply chain configuration is considered fixed, and planning policies
are already defined.
The goal of supply chain operations is to handle incoming customer orders in the best possible
manner.
During this phase:  firms allocate inventory or production to individual orders
 set a date that an order is to be filled
 generate pick lists at a warehouse
 allocate an order to a particular shipping mode and shipment
 set delivery schedules of trucks.
 place replenishment orders.
Because operational decisions are being made in the short term (minutes, hours, or days), there
is less uncertainty about demand information.
Given the constraints established by the configuration and planning policies, the goal during the
operation phase is to exploit the reduction of uncertainty and optimize performance.
Process Views of a Supply Chain:  A supply chain is a sequence of processes and flows that take place within and between different stages
and combine to fill a customer need for a product.
 There are two ways to view the processes performed in a supply chain: 1. Cycle View: The processes in a supply chain are divided into a series of cycles, each performed at the interface
between two successive stages of a supply chain.
2. Push/Pull View: The processes in a supply chain are divided into two categories depending on whether they are
executed in response to a customer order or in anticipation of customer orders. Pull processes are
initiated by a customer order, whereas push processes are initiated and performed in anticipation of
customer orders.
Cycle View:  All supply chain processes can be broken down into the following four process cycles: 
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Each cycle occurs at the interface between two successive stages of the supply chain.
Not every supply chain will have all four cycles clearly separated.
Each cycle consists of six subprocesses: -
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6.
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Customer Order Cycle
Replenishment Cycle
Manufacturing Cycle
Procurement Cycle
Each cycle starts with the supplier marketing the product to customers.
A buyer then places an order.
That is received by the supplier.
The supplier supplies the order.
Which is received by the buyer.
The buyer may return some of the product or other recycled material to the supplier or a
third party.
The cycle of activities then begins all over again.
Within each cycle, the goal of the buyer is to ensure product availability and to achieve economies
of scale in ordering.
The supplier attempts to forecast customer orders and reduce the cost of receiving the order.
The supplier then works to fill the order on time and improve efficiency and accuracy of the order
fulfilment process.
The buyer then works to reduce the cost of the receiving process.
Even though each cycle has the same basic subprocesses there are a few important differences
among the cycles.
1. In the customer order cycle, demand is external to the supply chain and thus uncertain. In all
other cycles, order placement is uncertain but can be projected based on policies followed by
the particular supply chain stage.
2. The second difference across cycles relates to the scale of an order.
Sharing of information and operating policies across supply chain stages becomes more important as
we move further from the end customer.
A cycle view of the supply chain is useful when considering operational decisions because it clearly
specifies the roles of each member of the supply chain.
The cycle view is useful, for example, when setting up information systems to support supply chain
operations.
Push/Pull View:  All processes in a supply chain fall into one of two categories depending on the timing of their
execution relative to end customer demand.
 With pull processes, execution is initiated in response to a customer order.
 With push processes, execution is initiated in anticipation of customer orders based on a
forecast.
 Pull processes may also be referred to as reactive processes because they react to customer demand.
 Push processes may also be referred to as speculative processes because they respond to speculated
(or forecasted) rather than actual demand.
 The push/pull boundary in a supply chain separates push processes from pull processes.
 Push processes operate in an uncertain environment because customer demand is not yet known.
 Pull processes operate in an environment in which customer demand is known. They are, however,
often constrained by inventory and capacity decisions that were made in the push phase.
 A push/pull view of the supply chain is very useful when considering strategic decisions relating to
supply chain design.
 The goal is to identify an appropriate push/pull boundary such that the supply chain can match supply
and demand effectively.
Competitive and Supply Chain Strategies:  A company’s competitive strategy defines, relative to its competitors, the set of customer needs that it
seeks to satisfy through its products and services.
 For example, Wal-Mart aims to provide high availability of a variety of products of reasonable quality
at low prices. What Wal-Mart provides is a low price and product availability. Whereas
McMaster-Carr sells maintenance, repair, and operations (MRO) products. It offers more than 500,000
products through both a catalogue and a Web site. Its competitive strategy is built around providing
the customer with convenience, availability, and responsiveness. McMaster-Carr does no focus on
Low Price.
 Clearly, the competitive strategy at Wal-Mart is different from that at McMaster.
 In each case, the competitive strategy is defined based on how the customer prioritizes product cost,
delivery time, variety, and quality.
The Value Chain in a Company
 Competitive strategy targets one or more customer segments and aims to provide products and services
that satisfy these customers’ needs.
 To see the relationship between competitive and supply chain strategies, we start with the value chain
for a typical organization.
 Finance, accounting, information technology, and human resources support and facilitate the
functioning of the value chain.
 To execute a company’s competitive strategy, all these functions play a role, and each must develop its
own strategy. Here, strategy refers to what each process or function will try to do particularly well.
 A product development strategy specifies the portfolio of new products that a company will try to
develop. It also dictates whether the development effort will be made internally or outsourced.
 A marketing and sales strategy specifies how the market will be segmented and how the product will
be positioned, priced, and promoted.
 A supply chain strategy determines
 The nature of procurement of raw materials,
 Transportation of materials to and from the company,
 Manufacture of the product or operation to provide the service,
 Distribution of the product to the customer,
 Any follow-up service and a specification of whether these processes will be performed in-house
or outsourced, should do particularly well.
Supply chain strategy includes a specification of the broad structure of the supply chain and what many
traditionally call “supplier strategy,” “operations strategy,” and “logistics strategy.”
 Supply chain strategy also includes design decisions regarding inventory, transportation, operating
facilities, and information flows.
 For a firm to succeed, all functional strategies must support one another and the competitive strategy.
Achieving Strategic Fit:  Strategic fit requires that both the competitive and supply chain strategies of a company have aligned
goals.
 It refers to consistency between the customer priorities that the competitive strategy hopes to satisfy and
the supply chain capabilities that the supply chain strategy aims to build.
 For a company to achieve strategic fit, it must accomplish the following:
1. The competitive strategy and all functional strategies must fit together to form a coordinated
overall strategy. Each functional strategy must support other functional strategies and help a firm
reach its competitive strategy goal.
2. The different functions in a company must appropriately structure their processes and resources
to be able to execute these strategies successfully.
3. The design of the overall supply chain and the role of each stage must be aligned to support the
supply chain strategy.
 A company may fail either because of a lack of strategic fit or because its overall supply chain design,
processes, and resources do not provide the capabilities to support the desired strategic fit.
How Is Strategic Fit Achieved?
 What does a company need to do to achieve that all-important strategic fit between the supply chain and
competitive strategies? A competitive strategy will specify, either explicitly or implicitly, one or more
customer segments that a company hopes to satisfy.
 To achieve strategic fit, a company must ensure that its supply chain capabilities support its ability to
satisfy the needs of the targeted customer segments.
 There are three basic steps to achieving this strategic fit, which we outline here and then discuss in more
detail:
1. Understanding the Customer and Supply Chain Uncertainty: First, a company must
understand the customer needs for each targeted segment and the uncertainty these needs impose
on the supply chain. These needs help the company define the desired cost and service
requirements. The supply chain uncertainty helps the company identify the extent of the
unpredictability of demand, disruption, and delay that the supply chain must be prepared for.
2. Understanding the Supply Chain Capabilities: Each of the many types of supply chains is
designed to perform different tasks well. A company must understand what its supply chain is
designed to do well.
3. Achieving Strategic Fit: If a mismatch exists between what the supply chain does particularly
well and the desired customer needs, the company will either need to restructure the supply chain
to support the competitive strategy or alter its competitive strategy.
STEP-1
 To understand the customer, a company must identify the needs of the customer segment being
served.
 Even for the same product or service, customer demand attributes change as soon as the
customer segment changes.
 In general, customer demand from different segments varies along several attributes as follows:
 The Quantity of the Product Needed in Each Lot: An emergency order for material needed
to repair a production line is likely to be small. An order for material to construct a new
production line is likely to be large.
 The Response Time That Customers Are Willing to Tolerate: The tolerable response time
for the emergency order is likely to be short, whereas the allowable response time for the
construction order is apt to be long.
 The Variety of Products Needed: A customer may place a high premium on the avail-ability
of all parts of an emergency repair order from a single supplier. This may not be the case for
the construction order.
 The Service Level Required: A customer placing an emergency order expects a high level of
product availability. This customer may go elsewhere if all parts of the order are not
immediately available. This is not apt to happen in the case of the construction order, for
which a long lead time is likely.
 The Price of the Product: The customer placing the emergency order is apt to be much less
sensitive to price than the customer placing the construction order.
 The Desired Rate of Innovation in the Product: Customers at a high-end department store
expect a lot of innovation and new designs in the store’s apparel. Customers at Walmart may
be less sensitive to new product innovation.
 Each customer in a particular segment will tend to have similar needs, whereas customers in a
different segment can have very different needs.
 Our goal is to identify one key measure for combining all of these attributes. This single measure
then helps define what the supply chain should do particularly well.
 Implied Demand Uncertainty. This is the one measure that is used to establish the customer need
metrices. At first glance, it may appear that each of the customer need categories should be viewed
differently, but in a fundamental sense, each customer need can be translated into the metric of
implied demand uncertainty, which is demand uncertainty imposed on the supply chain because of
the customer needs it seeks to satisfy.
 We make a distinction between demand uncertainty and implied demand uncertainty.
 Demand uncertainty reflects the uncertainty of customer demand for a product.
 Implied demand uncertainty, in contrast, is the resulting uncertainty for only the portion of
the demand that the supply chain plans to satisfy based on the attributes the customer desires.
 Supply uncertainty is also strongly affected by the life-cycle position of the product. New products
being introduced have higher supply uncertainty because designs and production processes are still
evolving. In contrast, mature products have less supply uncertainty.
 We can create a spectrum of uncertainty by combining the demand and supply uncertainty.
The Implied Uncertainty (Demand & Supply) Spectrum
STEP 2: UNDERSTANDING THE SUPPLY CHAIN CAPABILITIES
 After understanding the uncertainty that the company faces, the next question is: How does the firm
best meet demand in that uncertain environment?
 Creating strategic fit is all about creating a supply chain strategy that best meets the demand a company
has targeted given the uncertainty it faces.
 We now consider the characteristics of supply chains and categorize them based on different
characteristics that influence their responsiveness and efficiency.
 First, we provide some definitions. Supply chain responsiveness includes a supply chain’s ability to do
the following:
 Respond to wide ranges of quantities demanded
 Meet short lead times
 Handle a large variety of products
 Build highly innovative products
 Meet a high service level
 Handle supply uncertainty
 These abilities are similar to many of the characteristics of demand and supply that led to high implied
uncertainty.
 The more of these abilities a supply chain has, the more responsive it is.
 Responsiveness, however, comes at a cost. For instance, to respond to a wider range of quantities
demanded, capacity must be increased, which increases costs.
 This increase in cost leads to the second definition: Supply chain efficiency is the inverse of the cost of
making and delivering a product to the customer.
 Increases in cost, lower efficiency.
 For every strategic choice to increase responsiveness, there are additional costs that lower efficiency.
The Responsiveness Spectrum
STEP 3: ACHIEVING STRATEGIC FIT
 After mapping the level of implied uncertainty and understanding the supply chain position on the
responsiveness spectrum, the third and final step is to ensure that the degree of supply chain
responsiveness is consistent with the implied uncertainty.
 The goal is to target high responsiveness for a supply chain facing high implied uncertainty, and
efficiency for a supply chain facing low implied uncertainty.
 Increasing implied uncertainty from customers and supply sources is best served by increasing
responsiveness from the supply chain.
 This relationship is represented by the “zone of strategic fit” illustrated in Below Figure. For a high
level of performance, companies should move their competitive strategy (and resulting implied
uncertainty) and supply chain strategy (and resulting responsiveness) toward the zone of strategic fit.
 The next step in achieving strategic fit is to assign roles to different stages of the supply chain that
ensure the appropriate level of responsiveness.
 It is important to understand that the desired level of responsiveness required across the supply chain
may be attained by assigning different levels of responsiveness and efficiency to each stage of the supply
chain.
Different Roles and Allocations of Implied Uncertainty for a Given Level of Supply Chain
Responsiveness
Tailoring the Supply Chain for Strategic Fit
 Our previous discussion focused on achieving strategic fit when a firm serves a single market segment
and the result is a well-defined and narrow strategic position.
 While such a scenario holds for some firms, many firms are required to achieve strategic fit while
serving many customer segments with a variety of products across multiple channels.
 In such a scenario, a “one size fits all” supply chain cannot provide strategic fit, and a tailored supply
chain strategy is required.
 When devising supply chain strategy in these cases, the key issue for a company is to design a tailored
supply chain that is able to be efficient when implied uncertainty is low and responsive when it is high.
 By tailoring its supply chain, a company can provide responsiveness to fast-growing products, customer
segments, and channels while maintaining low cost for mature, stable products and customer segments.
 Tailoring the supply chain requires sharing some links in the supply chain with some products, while
having separate operations for other links. The links are shared to achieve maximum possible efficiency
while providing the appropriate level of responsiveness to each segment. For instance, all products may
be made on the same line in a plant, but products requiring a high level of responsiveness may be
shipped using a fast mode of transportation such as FedEx. Those products that do not have high
responsiveness needs may be sent by slower and less expensive means such as truck, rail, or even ship.
In other instances, products requiring high responsiveness may be manufactured using a flexible process,
whereas products requiring less responsiveness may be manufactured using a less responsive but more
efficient process. The mode of transportation used in both cases, however, may be the same. In other
cases, some products may be held at regional warehouses close to the customer, whereas others may be
held in a centralized warehouse far from the customer.
FINANCIAL MEASURES OF PERFORMANCE
 From a shareholder perspective, return on equity (ROE) is the main summary measure of a firm’s
performance.
 Whereas ROE measures the return on investment made by a firm’s shareholders, return on assets (ROA)
measures the return earned on each dollar invested by the firm in assets.
 The difference between ROE and ROA is referred to as return on financial leverage (ROFL).
 An important ratio that defines financial leverage is accounts payable turnover (APT).
 ROA can be written as the product of two ratios—profit margin and asset turnover—as shown below:
 The key components of asset turnover are accounts receivable turnover (ART); inventory turnover
(INVT); and property, plant and equipment turnover (PPET). These are defined as follows:
DRIVERS OF SUPPLY CHAIN PERFORMANCE
 To understand how a company can, improve supply chain performance in terms of responsiveness and
efficiency, we must examine the logistical and cross–functional drivers of supply chain performance:
facilities, inventory, transportation, information, sourcing, and pricing.
1. Facilities are the actual physical locations in the supply chain network where product is stored,
assembled, or fabricated.
 The two major types of facilities are production sites and storage sites.
 Decisions regarding the role, location, capacity, and flexibility of facilities have a significant
impact on the supply chain’s performance.
2. Inventory encompasses all raw materials, work in process, and finished goods within a supply chain. \
 The inventory belonging to a firm is reported under assets.
 Changing inventory policies can dramatically alter the supply chain’s efficiency and
responsiveness.
3. Transportation entails moving inventory from point to point in the supply chain.
 Transportation can take the form of many combinations of modes and routes, each with its own
performance characteristics.
 Transportation choices have a large impact on supply chain responsiveness and efficiency.
4. Information consists of data and analysis concerning facilities, inventory, transportation, costs, prices,
and customers throughout the supply chain.
 Information is potentially the biggest driver of performance in the supply chain because it
directly affects each of the other drivers.
 Information presents management with the opportunity to make supply chains more responsive
and more efficient.
5. Sourcing is the choice of who will perform a particular supply chain activity such as production,
storage, transportation, or the management of information
 At the strategic level, these decisions determine what functions a firm performs and what
functions the firm outsources.
 Sourcing decisions affect both the responsiveness and efficiency of a supply chain.
6. Pricing determines how much a firm will charge for the goods and services that it makes available in
the supply chain.
 Pricing affects the behaviour of the buyer of the good or service, thus affecting supply chain
performance.
 Any change in pricing impacts revenues directly but could also affect costs based on the impact
of this change on the other drivers.
 Supply chain management includes the use of logistical and cross-functional drivers to increase the
supply chain surplus.
 Cross-functional drivers have become increasingly important in raising the supply chain surplus in
recent years.
 While logistics remains a major part, supply chain management is increasingly becoming focused on the
three cross-functional drivers.
 Before we discuss each of the six drivers in detail, we put these drivers into a framework that
helps clarify the role of each in improving supply chain performance.
FRAMEWORK FOR STRUCTURING DRIVERS
 A company must structure the right combination of the three logistical and three cross-functional drivers
to ensure the balance between responsiveness and efficiency.
 The combined impact of these drivers then determines the responsiveness and the profits of the entire
supply chain.
 Most companies begin with a competitive strategy and then decide what their supply chain strategy
ought to be.
 The supply chain strategy determines how the supply chain should perform with respect to efficiency
and responsiveness.
 The supply chain must then use the three logistical and three cross-functional drivers to reach the
performance level the supply chain strategy dictates and maximize the supply chain profits.
 Although this framework is generally viewed from the top down, in many instances, a study of the six
drivers may indicate the need to change the supply chain strategy and potentially even the competitive
strategy.
Facilities
Role in Supply Chain
 If we think of inventory as what is being passed along the supply chain and transportation as how it
is passed along, then facilities are the where of the supply chain.
 They are the locations to or from which the inventory is transported.
 Within a facility, inventory is either transformed into another state (manufacturing) or it is stored
(warehousing).
Role in the Competitive Strategy
 Facilities are a key driver of supply chain performance in terms of responsiveness and efficiency.
 For example,
 Companies can gain economies of scale when a product is manufactured or stored in only one
location; this centralization increases efficiency.
 Locating facilities close to customers increases the number of facilities needed and
consequently reduces efficiency.
 If the customer demands and is willing to pay for the responsiveness that having numerous
facilities adds, however, then this facilities decision helps meet the company’s competitive
strategy goals.
Components of Facilities Decisions
 ROLE
 Firms must decide whether production facilities will be flexible, dedicated, or a combi-nation
of the two.
 A product-focused facility performs all functions (e.g., fabrication and assembly)
needed for producing a single type of product.
 A functional-focused facility performs a given set of functions (e.g., fabrication or
assembly) on many types of products.
 For warehouses and Distribution Centres, firms must decide whether they will be primarily
cross-docking facilities or storage facilities.
 At cross-docking facilities, inbound trucks from suppliers are unloaded; the product is broken
into smaller lots and is quickly loaded onto store-bound trucks.
 For storage facilities, firms must decide on the products to be stored at each facility.
 LOCATION
 Deciding where a company will locate its facilities constitutes a large part of the design of a
supply chain.
 A basic trade-off here is whether to centralize in order to gain economies of scale or to
decentralize to become more responsive by being closer to the customer.
 CAPACITY
 Companies must also determine a facility’s capacity to perform its intended function or
functions.
 A large amount of excess capacity allows the facility to respond to wide swings in the
demands placed on it.
 Excess capacity, however, costs money and therefore can decrease efficiency.
 FACILITY-RELATED METRICS
 Facility-related decisions impact both the financial performance of the firm and the supply
chain’s responsiveness to customers.
 On the financial side, facilities decisions impact the cost of goods sold and the assets in
property plant and equipment.
 Following Facility Related Matrices affect the supply chain performance.
 Capacity
 Actual average flow/cycle time
 Utilization
 Flow time efficiency
 Processing/setup/down/idle
 Product variety
time
 Volume contribution of top 20
 Production cost per unit
percent SKUs and customers
 Quality losses
 Average production batch size
 Theoretical flow/cycle time
 Production service level
of production
 OVERALL TRADE-OFF: RESPONSIVENESS vs EFFICIENCY
 Increasing the number of facilities increases facility and inventory costs but decreases
transportation costs and reduces response time.
 Increasing the flexibility or capacity of a facility increases facility costs but decreases
inventory costs and response time.
Inventory
Role in the Supply Chain
 Inventory exists in the supply chain because of a mismatch between supply and demand.
 An important role that inventory plays in the supply chain is to increase the amount of demand that can
be satisfied by having the product ready and available when the customer wants it.
 Inventory impacts the assets held, the costs incurred, and responsiveness provided in the supply chain.
 Inventory also has a significant impact on the material flow time in a supply chain.
 Material flow time is the time that elapses between the point at which material enters the supply chain
to the point at which it exits.
 If inventory is represented by I, flow time by T, and throughput (rate of sales occurs) by D, the three can
be related using Little’s law as follows:
I = DT
Role in Competitive Strategy
 The form, location, and quantity of inventory allow a supply chain to range from being very low cost to
very responsive.
 Large amounts of finished goods inventory close to customers allow a supply chain to be responsive but
at a high cost.
 Centralized inventory in raw material form allows a supply chain to lower cost but at the expense of
responsiveness.
 The goal of good supply chain design is to find the right form, location, and quantity of inventory that
provides the right level of responsiveness at the lowest possible cost.
Components of Inventory Decisions
 CYCLE INVENTORY
 Cycle inventory is the average amount of inventory used to satisfy demand between receipts of
supplier shipments.
 The size of the cycle inventory is a result of the production, transportation, or purchase of
material in large lots.
 Companies produce or purchase in large lots to exploit economies of scale in the production,
transportation, or purchasing process.
 SAFETY INVENTORY
 Safety inventory is inventory held in case demand exceeds expectation; it is held to counter
uncertainty.
 Because demand is uncertain and may exceed expectations, however, companies hold safety
inventory to satisfy an unexpectedly high demand.
 SEASONAL INVENTORY
 Seasonal inventory is built up to counter predictable seasonal variability in demand.
 Companies using seasonal inventory build-up inventory in periods of low demand and store it for
periods of high demand when they will not have the capacity to produce all that is demanded.
 LEVEL OF PRODUCT AVAILABILITY
 Level of product availability is the fraction of demand that is served on time from product held in
inventory.
 The basic trade-off when determining the level of product availability is between the cost of
inventory to increase product availability and the loss from not serving customers on time.
 INVENTORY-RELATED METRICS
 Following are the metrices needed to be consider before taking inventory decisions:
 Cash-to-cash cycle time
 Average replenishment batch
size
 Average inventory
 Seasonal inventory
 Inventory turns
 Fill rate
 Products with more than a
specified number of days of
 Fraction of time out of stock
inventory
 Obsolete inventory
 OVERALL TRADE-OFF: RESPONSIVENESS VERSUS EFFICIENCY
 Increasing inventory generally makes the supply chain more responsive to the customer.
 A higher level of inventory also facilitates a reduction in production and transportation costs
because of improved economies of scale in both functions.
 This choice, however, increases inventory holding cost.
Transportation
Role in the Supply Chain
 Transportation moves product between different stages in a supply chain and impacts both
responsiveness and efficiency.
 Faster transportation allows a supply chain to be more responsive but reduces its efficiency.
 The type of transportation a company uses also affects the inventory and facility locations in the supply
chain.
Role in the Competitive Strategy
 Transportation allows a firm to adjust the location of its facilities and inventory to find the right balance
between responsiveness and efficiency.
 A firm selling high-value items such as pacemakers may use rapid transportation to be responsive while
centralizing its facilities and inventory to lower cost.
 In contrast, a firm selling low-value, high-demand items like light bulbs may carry a fair amount of
inventory close to the customer but then use low-cost transportation like sea, rail, and full trucks to
replenish this inventory from plants located in low-cost countries.
Components of Transportation Decisions
 DESIGN OF TRANSPORTATION NETWORK
 The transportation network is the collection of transportation modes, locations, and routes
along which product can be shipped.
 A company must decide whether transportation from a supply source will be direct to the
demand point or will go through intermediate consolidation points.
 Design decisions also include whether or not multiple supply or demand points will be
included in a single run.
 CHOICE OF TRANSPORTATION MODE
 The mode of transportation is the manner in which a product is moved from one location in
the supply chain network to another.
 Companies can choose among air, truck, rail, sea, internet (for information goods) and
pipeline as modes of transport for products.
 TRANSPORTATION-RELATED METRICS
 Inbound transportation decisions impact the cost of goods sold while outbound transportation
costs are part of the selling, general, and administrative expenses.
 Thus, transportation costs affect the profit margin.
 Main Transportation metrices are:  Average inbound
 Average outbound shipment
transportation cost
size
 Average incoming shipment
 Average outbound
size
transportation cost per
shipment
 Average inbound
 Fraction transported by
transportation cost per
shipment
mode
 Average outbound
transportation cost
 OVERALL TRADE-OFF: RESPONSIVENESS VERSUS EFFICIENCY
 The fundamental trade-off for transportation is between the cost of transporting a given
product (efficiency) and the speed with which that product is transported (responsiveness).
 Using fast modes of transport raises responsiveness and transportation cost but lowers the
inventory holding cost.
Information
Role in the Supply Chain
 Good information can help improve the utilization of supply chain assets and the coordination of supply
chain flows to increase responsiveness and reduce costs.
 Seven-Eleven Japan uses information to improve product availability while decreasing inventories.
 Wal-Mart uses information on shipments from suppliers to facilitate cross-docking and lower inventory
and transportation expense.
 Information as a key driver that can be used to provide higher responsiveness while simultaneously
improving efficiency.
Role in the Competitive Strategy
 The right information can help a supply chain better meet customer needs at lower cost.
 The appropriate investment in information technology improves visibility of transactions and
coordination of decisions across the supply chain.
 Coordination is essential if all stages of the supply chain are to work together toward a common goal.
 The goal in general should be to share the minimum amount of information required to achieve
coordination because, beyond a certain point, the marginal cost of handling additional information
increases, whereas the marginal benefit from the additional information decreases.
Components of Information Decisions
 PUSH VERSUS PULL
 When designing processes of the supply chain, managers must determine whether these
processes are part of the push or pull phase in the chain.
 Push systems start with forecasts that are used to build the master production schedule and roll it
back, creating schedules for suppliers with part types, quantities, and delivery dates.
 Pull systems require information on actual demand to be transmitted extremely quickly
throughout the entire chain so that production and distribution of products can reflect the real
demand accurately.
 COORDINATION AND INFORMATION SHARING
 Supply chain coordination occurs when all stages of a supply chain work toward the objective of
maximizing total supply chain profitability based on shared information.
 Lack of coordination can result in a significant loss of supply chain surplus.
 Coordination among different stages in a supply chain requires each stage to share appropriate
information with other stages.
 SALES AND OPERATIONS PLANNING
 Sales and operations planning (S&OP) is the process of creating an overall supply plan
(production and inventories) to meet the anticipated level of demand (sales).
 The S&OP process starts with sales and marketing communicating their needs to the supply
chain, which in turn communicates to sales and marketing whether the needs can be met and at
what cost.
 The goal of S&OP is to come up with an agreed-upon sales, production, and inventory plan that
can be used to plan supply chain needs and project revenues and profits.
 The sales and operations plan becomes a critical piece of information to be shared across the
supply chain because it affects both the demand on a firm’s suppliers and the supply to its
customers.
 ENABLING TECHNOLOGIES
 Many technologies exist to share and analyse information in the supply chain.
 Important decision needed to be taken is which technologies should be used and where should be
implemented.
 Electronic data interchange
 Enterprise resource planning (ERP)
 Radio frequency identification (RFID)
 Supply chain management (SCM) Software
 INFORMATION-RELATED METRICS
 Forecast horizon identifies how far in advance of the actual event a forecast is made. The
forecast horizon must be greater than or equal to the lead time of the decision that is
driven by the forecast.
 Frequency of update identifies how frequently each forecast is updated. The forecast
should be updated somewhat more frequently than a decision will be revisited, so that
large changes can be flagged and corrective action taken.
 Forecast error measures the difference between the forecast and actual demand. The
forecast error is a measure of uncertainty and drives all responses to uncertainty such as
safety inventory or excess capacity.
 Seasonal factors measure the extent to which the average demand in a season is above or
below the average in the year.
 Variance from plan identifies the difference between the planned production/inventories
and the actual values. These variances can be used to raise flags that identify shortages
and surpluses.
 Ratio of demand variability to order variability measures the standard deviation of
incoming demand and supply orders placed. A ratio less than one potentially indicates the
existence of the bullwhip effect.
 OVERALL TRADE-OFF: COMPLEXITY VERSUS VALUE
 Good information clearly helps a firm improve both its efficiency and responsiveness.
 There is a danger, however, in the assumption that more information is always better.
 As more information is shared across a supply chain, the complexity and cost of both the
required infrastructure and the follow-up analysis grow exponentially.
 The marginal value provided by the information shared, however, diminishes as more and more
information is available.
 It is thus important to evaluate the minimum information required to accomplish the desired
objectives.
Sourcing
Role in the Supply Chain
 Sourcing is the set of business processes required to purchase goods and services.
 Managers must first decide whether each task will be performed by a responsive or efficient source and
then whether the source will be internal to the company or a third party.
 As supply chains have globalized, many more sourcing options now offer both considerable opportunity
and potential risks.
 Thus, sourcing decisions have a significant impact on supply chain performance.
Role in the Competitive Strategy
 Sourcing decisions are crucial because they affect the level of efficiency and responsiveness the supply
chain can achieve.
 In some instance, firms outsource to responsive third parties if it is too expensive for them to develop
this responsiveness on their own.
 An example is the outsourcing of next-day package delivery by all firms to a few package carriers
because it is too expensive for a firm to develop next-day delivery capability on its own.
 In other instances, firms have kept the responsive process in-house to maintain control.
 Firms also outsource for efficiency if the third party can achieve significant economies of scale or has a
lower underlying cost structure for other reasons.
Components of Sourcing Decisions
 IN-HOUSE OR OUTSOURCE
 The most significant sourcing decision for a firm is whether to perform a task in-house or
outsource it to a third party.
 Within a task such as transportation, managers must decide whether to outsource all of it,
outsource only the responsive component, or outsource only the efficient component.
 This decision should be driven in part by its impact on the total supply chain surplus.
 It is best to outsource if the growth in total supply chain surplus is significant with little
additional risk.
 SUPPLIER SELECTION
 Managers must decide on the number of suppliers they will have for a particular activity.
 They must then identify the criteria along which suppliers will be evaluated and how they will be
selected.
 For the selection process, managers must decide whether they will use direct negotiations or
resort to an auction.
 If an auction is used, it must be structured to ensure the desired outcome.
 PROCUREMENT
 Procurement is the process of obtaining goods and services within a supply chain.
 Managers must structure procurement with a goal of increasing supply chain surplus.
 For example, a firm should set up procurement for direct materials to ensure good coordination
between the supplier and buyer.
 In contrast, the procurement of MRO products should be structured to ensure that transaction
costs are low.
 SOURCING-RELATED METRICS
 Sourcing decisions directly impact the cost of goods sold and accounts payable.
 The performance of the source also impacts quality, inventories, and inbound transportation
costs.
 Days payable outstanding
 Supply quality
 Average purchase price
 Supply lead time
 Range of purchase price
 Fraction of on-time deliveries
 Average purchase quantity
 Supplier reliability
 OVERALL TRADE-OFF: INCREASE THE SUPPLY CHAIN SURPLUS
 Sourcing decisions should be made to increase the size of the total surplus to be shared across the
supply chain.
 The total surplus is affected by the impact of sourcing on sales, service, production costs,
inventory costs, transportation costs, and information costs.
 Outsourcing to a third party is meaningful if the third party raises the supply chain surplus more
than the firm can on its own.
 In contrast, a firm should keep a supply chain function in-house if the third party cannot increase
the supply chain surplus or if the risk associated with outsourcing is significant.
Pricing
Role in Supply Chain
 Pricing is the process by which a firm decides how much to charge customers for its goods and services.
 Pricing affects the customer segments that choose to buy the product, as well as the customer’s
expectations.
 This directly affects the supply chain in terms of the level of responsiveness required as well as the
demand profile that the supply chain attempts to serve.
 Pricing is also a lever that can be used to match supply and demand especially when the supply chain is
not very flexible.
 Short-term discounts can be used to eliminate supply surpluses or decrease seasonal demand spikes by
moving some of the demand forward.
 In short, pricing is one of the most significant factors that affect the level and type of demand that
the supply chain will face.
Role in Competitive Strategy
 Pricing is a significant attribute through which a firm executes its competitive strategy.
Components of Pricing Decisions
 PRICING AND ECONOMIES OF SCALE
 Most supply chain activities display economies of scale.
 Changeovers make small production runs more expensive per unit than large production runs.
 Loading and unloading costs make it cheaper to deliver a truckload to one location than four.
 In each case, the provider of the supply chain activity must decide how to price it appropriately to
reflect these economies of scale.
 A commonly used approach is to offer quantity discounts.
 Care must be taken to ensure that quantity discounts offered are consistent with the economies of
scale in the underlying process.
 Otherwise, there is a danger of customer orders being driven primarily by the quantity discounts
even though the underlying process does not have significant economies of scale.
 EVERYDAY LOW PRICING VERSUS HIGH–LOW PRICING
 A firm such as Costco practices everyday low pricing at its warehouse stores, keeping prices
steady over time.
 Costco will go to the extent of not offering any discount on damaged books to ensure its
everyday low-pricing strategy.
 In contrast, most supermarkets practice high–low pricing and offer steep discounts on a subset of
their product every week.
 The Costco pricing strategy results in relatively stable demand.
 The high–low pricing strategy results in a peak during the discount week, often followed by a
steep drop in demand during the following weeks.
 \The two pricing strategies lead to different demand profiles that the supply chain must serve.
 FIXED PRICE VERSUS MENU PRICING
 A firm must decide whether it will charge a fixed price for its supply chain activities or have a
menu with prices that vary with some other attribute, such as the response time or location of
delivery.
 If marginal supply chain costs or the value to the customer vary significantly along some
attribute, it is often effective to have a pricing menu.
 PRICING-RELATED METRICS
 Pricing directly affects revenues but can also affect production costs and inventories depending
upon its impact on consumer demand.
 With menu pricing, each metric should be tracked separately for each segment in the menu
 Following are the different metrices:  Profit margin measures profit as a percentage of revenue. A firm needs to examine a wide
variety of profit margin metrics to optimize its pricing, including dimensions such as type
of margin (gross, net, etc.), scope (SKU, product line, division, firm), customer type, and
others.
 Days sales outstanding measures the average time between when a sale is made and when
the cash is collected.
 Incremental fixed cost per order measures the incremental costs that are independent of
the size of the order. These include changeover costs at a manufacturing plant or order
processing or transportation costs that are incurred independent of shipment size at a
mail-order firm.
 Incremental variable cost per unit measures the incremental costs that vary with the size
of the order. These include picking costs at a mail-order firm or variable production costs
at a manufacturing plant.
 Average sale price
 Average order size
 Range of sale price
 Range of periodic sales
 OVERALL TRADE-OFF: INCREASE FIRM PROFITS
 All pricing decisions should be made with the objective of increasing firm profits.
 This requires an understanding of the cost structure of performing a supply chain activity and the
value this activity brings to the supply chain.
 Strategies such as everyday low pricing may foster stable demand that allows for efficiency in
the supply chain.
 Other pricing strategies may lower supply chain costs, defend market share, or even steal market
share.
 Differential pricing may be used to attract customers with varying needs, as long as this strategy
helps either increase revenues or shrink costs, preferably both.
SCM - Performance Measures
 Supply chain performance measure can be defined as an approach to judge the performance of supply
chain system. Supply chain performance measures can broadly be classified into two categories  Qualitative measures − For example, customer satisfaction and product quality.
 Quantitative measures − For example, order-to-delivery lead time, supply chain response time,
flexibility, resource utilization, delivery performance.
 Here, we will be considering the quantitative performance measures only. The performance off a supply
chain can be improvised by using a multitier-dimensional strategy, which addresses how the company
needs to provide services to diverse customer demands.
 Mostly the measures taken for measuring the performance may be somewhat similar to each other, but
the objective behind each segment is very different from the other.
Quantitative Measures
 Quantitative measures are the assessments used to measure the performance, and compare or track the
performance of products.
 We can further divide the quantitative measures of supply chain performance into two types.
1. Non-Financials Measures
 The metrics off non-financial measures comprise cycle time, customer service level, inventory
levels, resource utilization ability to perform, flexibility, and quality. In this section, we will discuss
the first four dimensions of the metrics –
 Cycle Time –
 Cycle time is often called the lead time. It can be simply defined as the end-to-end delay in a
business’s processes. For supply chains, cycle time can be defined as the business’s processes
of interest, supply chain processes and the order-to-delivery processes. In the cycle time, we
should learn about two types of lead times. They are as follows –
 Supply chain lead time
 Order-to-delivery lead time
 The order-to-delivery lead time can be defined as the time off delay in the middle of the
placement of order by a customer and the delivery off products to the customer. In case the
item is in stock, it would be similar to the distribution lead time and order management time.
If the ordered item needs to be produced, it would be the summation off supplier lead time,
manufacturing lead time, distribution lead time and order management time.
 The supply chain processes lead time can be defined as the time taken by the supply chain to
transform the raw materials into final products along with the time required to reach the
products to the customer’s destination addresses. Hence it comprises supplier lead time,
manufacturing lead time, distribution lead time and the logistics lead time for transport off
raw materials from suppliers to plants and for shipment of semi-finished/finished products in
and out of intermediate storage points. Lead time in supply chains is governed by the halts in
the interface because off the interfaces between suppliers and manufacturing plants, between
plants and warehouses, between distributors and retailers and many more.
 Lead time compression is a crucial topic to discuss due to the time-based competition and the
collaboration of lead time with inventory levels, costs, and customer service levels.
 Customer Service Level –
 The customer service level in a supply chain is marked ass an operation off multiple unique
performance index. Here we have three measures to gauge performance. They are as follows.
 Order fills rate - The order fills rate is the portion off customer demands that can be
easily satisfied from the stock available. For this portion off customer demands, there
is no need to consider the supplier lead time and the manufacturing lead time. The
order fills rate could be with respect to a central warehouse or a field warehouse or
stock at any level in the system.
 Stockout rate - It is the reverse of order fills rate and marks the portion of orders lost
because of a stockout.
 Backorder level - This is yet another measure, which is the gauge of total number of
orders waiting to be filled.
 Probability off on-time delivery - It is the portion of customer orders that are
completed on time, i.e. within the agreed-upon due date. In order to maximize the
customer service level, it is important to maximize order fills rate, minimize stockout
rate, and minimize backorder levels.
 Inventory Levels –
 As the inventory-carrying costs increases the total costs significantly, it is essential to carry
sufficient inventory to meet the customer demands. In a supply chain system, inventories can
be further divided into four categories.
 Raw materials
 Work-in-process, i.e. unfinished and semi-finished sections
 Finished goods inventory
 Spare parts
 Every inventory is held for a different reason. It’s a must to maintain optimal levels off each
type of inventory. Hence gauging the actual inventory levels will supply a better scenario off
system efficiency.
 Resource Utilization –
 In a supply chain network, huge variety of resources is used. These different types of
resources available for different applications are mentioned below.
 Manufacturing resources − Include the machines, material handlers, tools, etc.
 Storage resources − Comprise warehouses, automated storage and retrieval systems.
 Logistics resources − Engage trucks, rail transport, air--cargo carriers, etc.
 Human resources − Consist of labour, scientific and technical personnel.
 Financial resources − Include working capital, stocks, etc.
 In the resource utilization paradigm, the main motto is to utilize all the assets or resources
efficiently in order to maximize customer service levels, reduce lead times and optimize
inventory levels.
2. Financial Measures
 The measures taken for gauging different fixed and operational costs related to a supply chain are
considered the financial measures. Finally, the key objective to be achieved is to maximize the
revenue by maintaining low supply chain costs. There is a hike in prices because off the inventories,
transportation, facilities, operations, technology, materials, and labour. Generally, the financial
performance off a supply chain is assessed by considering the following items –
 Cost of raw materials
 Revenue from goods sold
 Activity--based costs like the material handling, manufacturing, assembling rates etc.
 Inventory holding costs.
 Transportation costs.
 Cost of expired perishable goods.
 Penalties for incorrectly filled or late orders delivered to customers.
 Credits for incorrectly filled or late deliveries from suppliers.
 Cost of goods returned by customers.
 Credits for goods returned to suppliers
 In short, we can say that the financial performance indices can be merged ass one by using key
 modules such ass activity-based costing, inventory costing, transportation costing, and
inter-company financial transactions.
Unit-2
Demand Management in Supply Chain
The Role of Demand Forecasting in A Supply Chain
 Demand forecasts form the basis of all supply chain planning.
 Consider the push/pull view of the supply chain, all push processes in the supply chain are performed in
anticipation of customer demand, whereas all pull processes are performed in response to customer
demand.
 For push processes, a manager must plan the level of activity, be it production, transportation, or any
other planned activity.
 For pull processes, a manager must plan the level of available capacity and inventory but not the actual
amount to be executed.
 In both instances, the first step a manager must take is to forecast what customer demand will be.
 Example: A Home Depot store selling paint orders the base paint and dyes in anticipation of customer
orders, whereas it performs final mixing of the paint in response to customer orders. Home Depot uses a
forecast of future demand to determine the quantity of paint and dye to have on hand (a push process).
Farther up the supply chain, the paint factory that produces the base also needs forecasts to determine its
own production and inventory levels. The paint factory’s suppliers also need forecasts for the same
reason.
 When each stage in the supply chain makes its own separate forecast, these forecasts are often very
different. The result is a mismatch between supply and demand.
 When all stages of a supply chain work together to produce a collaborative forecast, it tends to be much
more accurate. The resulting forecast accuracy enables supply chains to be both more responsive and
more efficient in serving their customers.
 Leaders in many supply chains, from PC manufacturers to packaged-goods retailers, have improved their
ability to match supply and demand by moving toward collaborative forecasting.
Characteristics of Forecasts
 Companies and supply chain managers should be aware of the following characteristics of forecasts.
1. Forecasts are always inaccurate and should thus include both the expected value of the forecast and
a measure of forecast error.
2. Long-term forecasts are usually less accurate than short-term forecasts; that is, long-term forecasts
have a larger standard deviation of error relative to the mean than short-term forecasts.
3. Aggregate forecasts are usually more accurate than disaggregate forecasts, as they tend to have a
smaller standard deviation of error relative to the mean. (Smaller the unit for which forecast is to be
done higher are the chances of errors.)
4. In general, the farther up the supply chain a company is (or the farther it is from the consumer), the
greater is the distortion of information it receives. The farther up the supply chain an enterprise is,
the larger is the forecast error. Collaborative forecasting based on sales to the end customer helps
upstream enterprises reduce forecast error.
Components of A Forecast and Forecasting Methods
 One may be tempted to treat demand forecasting as magic or art and leave everything to chance.
 However, what a firm knows about its customers’ past behaviour, sheds light on their future behaviour.
 Demand does not arise in a vacuum. Rather, customer demand is influenced by a variety of factors and
can be predicted, at least with some probability, if a company can determine the relationship between
these factors and future demand.
 To forecast demand, companies must first identify the factors that influence future demand and then
ascertain the relationship between these factors and future demand.
 Companies must balance objective and subjective factors when forecasting demand.
 A company must be knowledgeable about numerous factors that are related to the demand forecast,
including the following:
1. Past demand
2. Lead time of product replenishment
3. Planned advertising or marketing efforts
4. Planned price discounts
5. State of the economy
6. Actions that competitors have taken
 A company must understand such factors before it can select an appropriate forecasting methodology.
 For example, historically a firm may have experienced low demand for chicken noodle soup in July and
high demand in December and January. If the firm decides to discount the product in July, the situation
is likely to change, with some of the future demand shifting to the month of July. The firm should make
its forecast taking this factor into consideration.
 Forecasting methods are classified according to the following four types:
1. Qualitative: Qualitative forecasting methods are primarily subjective and rely on human judgment.
They are most appropriate when little historical data are available or when experts have market
intelligence that may affect the forecast. Such methods may also be necessary to forecast demand
several years into the future in a new industry.
2. Time series: Time-series forecasting methods use historical demand to make a forecast. They are
based on the assumption that past demand history is a good indicator of future demand. These
methods are most appropriate when the basic demand pattern does not vary significantly from one
year to the next. These are the simplest methods to implement and can serve as a good starting point
for a demand forecast.
3. Causal: Causal forecasting methods assume that the demand forecast is highly correlated with
certain factors in the environment (the state of the economy, interest rates, etc.). Causal forecasting
methods find this correlation between demand and environmental factors and use estimates of what
environmental factors will be to forecast future demand.
4. Simulation: Simulation forecasting methods imitate the consumer choices that give rise to demand
to arrive at a forecast. Using simulation, a firm can combine time-series and causal methods to
answer such questions as: What will be the impact of a price promotion? What will be the impact of
a competitor opening a store nearby? Airlines simulate customer buying behaviour to forecast
demand for higher fare seats when there are no seats available at the lower fares.
 A company may find it difficult to decide which method is most appropriate for forecasting.
 In fact, several studies have indicated that using multiple forecasting methods to create a combined
forecast is more effective than using any one method alone.
