International Operations
Management
MGMT 6367
Lecture 03
Instructor: Yan Qin
Fall 2013
Outline
 Introduction to Supply Chain Management
 Definition of Supply Chain Management
 Bullwhip effect
 Causes and Mitigating strategies
 Achieving coordination in practice
 Supply chain performance measures
 Supplement: Common demand forecasting methods
2
A Supply Chain
 This supply chain includes all the interactions among suppliers,
manufacturers, distributors, and customers. Each manufacturer
can have different tiers of suppliers.
S3
S2
Distributor(s)
S1
Manufacturer
S2
Retailer(s)
Tier 3
Suppliers
Tier 2
Suppliers
Tier 1
Suppliers
Customers
3
Example: Supply Chain of Bottled Water

YouTube Video:
http://www.youtube.com/watch?v=Mi1QBxVjZAw

This video “describes the complex supply chain of a
simple product, a bottle of water. The video also illustrates
the importance of supply chain managers and their skill
sets in our modern global economy for both
manufacturing and service industries.”
4
Supply Chain Management
 Definitions of Supply Chain Management
Supply Chain Management is the integration of the activities
that procure materials and services, transform them into
intermediate good and final products, and deliver them to
customers.
Supply Chain Management deals with the management of
materials, information, and financial flows in a network
consisting of suppliers, manufacturers, distributors, and
customers. -- Prof. Hau Lee, Stanford Supply Chain Forum
5
Typical Questions to ask
 Examples of questions to be answered in a Supply Chain:
 It is less costly to transport product by boat or truck, but air
freight sometimes can save you a lot of time. So which one to pick?
 Number, size, and location of warehouses, plants, and terminals
 How much inventory to stock and what control policies to use?
 Make or Buy? That is, shall we produce a component or service in-
house or purchase it from an outside source?
 What type of relationship should be established among members in
the same supply chain?
 …
6
Bullwhip Effect
 Local Optimization
 Members of the chain are inclined to focus on maximizing
local profit or minimizing immediate cost based on their
limited knowledge.
 Prisoner’s dilemma can be a good example of the sub-optimal
result of local optimization.
 The result is that the fluctuation in orders increases as orders
move through the supply chain, which is called Bullwhip
effect.
7
Bullwhip Effect (Cont.)
 Why called Bullwhip effect?
End Customer
(Downstream)
Suppliers
(Upstream)
8
Behavioral causes of Bull-whip effect
1.
Failure to understand the impact of individual decisions
on the supply chain as a whole is one cause of the
bullwhip effect.
2.
Risk-averse attitudes of decision makers
9
Major Non-behavioral Causes
 Demand Forecast update
 Explanation:
 When a downstream player places an order, the upstream
manager take it as a signal about future demand.
 Many of the forecasting methods place substantial weight on
recently observed demand, leading to distortion when there is a
sudden peak or drop in orders.
 Remedies:
 In-time demand sharing among members.
 Some companies convinced their suppliers to locate their
production faculties nearby.
10
Examples of Remedies - Demand Forecast

JC Penny and Levi Strauss are linked with an EDI that allows
Levi Strauss to obtain sales data. These data allow Levi Strauss
to better plan the production process as well as better control
inventory and delivery. The savings leads to a reduction in costs
and prices, benefitting both JC Penny and Levi Strauss.

McKesson developed a close relationship with Johnson &
Johnson, one of its major suppliers. Both firms receive data on
inventory, POS, and customer information through a joint
information system. This enables Johnson & Johnson to provide
better services to McKesson, which in turn improves the level
of service that McKesson is able to provide to its customers.
11
Major Causes of Bullwhip Effect
 Order Batching
 Explanation: Companies may want to accumulate demand
before issuing an order to take advantage of the economies of
scale in order placing or transportation.
 Remedies:
 Use Electronic purchasing to reduce ordering costs
 One solution to discourage shipment consolidation can be to
outsource the transportation activities.
12
Major Causes of Bullwhip Effect
 Price Fluctuation
 Explanation: Companies may buy supplies well in advance of
demand as a result of special trade deals and consumer
promotions, such as discounts and rebates.
 Remedies:
 Every-Day-Low-Price can be one solution;
 Adopt Continuous Replenishment Program (CRP), that is,
products are replenished only for the sold amount.
13
Major Causes of Bullwhip Effect
 Rationing and Shortage Gaming
 Explanation:
 When product demand exceeds product supply,
manufacturers tend to ration their products to customers
by allocating in proportion to the amount ordered.
 Remedies:
 One possible way is to allocate products in proportion to
past sales.
 Impose high order cancellation fee.
14
Achieving SC Coordination in Practice
Steps to follow:
1. Quantify the bullwhip effect
2. Get top management commitment for coordination
3. Devote resources to coordination
4. Focus on communication with other stages
5. Try to achieve coordination in the entire supply chain
network
6. Use technology to improve connectivity in the supply
chain
7. Share the benefits of coordination equitably
The slides on “Achieving SC Coordination” are written based on the relevant
chapter from “Supply Chain Management” by Chopra and Meindl.
15
How to evaluate Supply Chain performance
 The evaluation of Supply Chain with focuses on procurement
and inventory tends to answer two questions:
 How well the supply chain is performing; and
 How well assets are utilized.
 Benchmarking is used to answer the 1st question.
 To answer the 2nd question, three measures can be of help.
◦ Percent of assets invested in inventory
◦ Inventory Turnover
◦ Weeks-of-Supply
16
Benchmarking

Benchmarking is the process of comparing one’s own
business processes to the industry bests or the best
practices in other industries.
Typical Firms
Benchmark Firms
Lead time (in weeks)
15
8
Time spent placing and order
42 mins
15 mins
Percent of late delivery
33%
2%
Percent of rejected material
1.5%
0.0001%
Number of shortages per year
400
4
17
How well assets are utilized
 Percent of assets invested in inventory
Example: Home Depot had $11.4 billion invested in inventory
and total assets of $44.4 billion in 2006.
Then, its Percent of assets invested in inventory =
(11.4/44.4)* 100% = 25.7%
18
Inventory Turnover
 Inventory turnover (computed on an annual basis)
Inventory turnover = Cost of goods sold / Inventory
Investment
Cost of goods sold is the cost to produce the goods or
services sold for a given period.
The inventory investment can be:
(1) The sum of the beginning and the ending inventory values
divided by 2; OR
(2) The sum of the values of different types of inventories being
held in the system.
19
Example: Inventory Turnover
 PepsiCo. Inc provides the following in its 2005 annual report
(in $ billion). Determine its inventory turnover.
Net Revenue
$32.5
Cost of goods sold
$14.2
Inventory:
Raw Material inventory $.74
WIP inventory $.11
Finished good inventory $.84
20
Weeks-of-Supply
 Weeks-of-supply indicates for how long the average
amount of on-hand inventory may last based on the
current demand.
Weeks-of-supply = Inventory Investment / (cost of
goods sold / 52 weeks)
For weeks-of-supply, it is usually the lower the better.
21
Supplement: Demand Forecasting Methods
 There are two general approaches to forecasting:
 Qualitative, which incorporate factors such as decision
maker’s intuition, emotions, personal experience, and so on.
 Quantitative, which uses a variety of models that rely on
historical data to forecast demand.
22
Common types of Qualitative Methods
 Jury of execution opinion: The opinions of a group of
high-level experts or mangers are pooled together to
arrive at a group estimate of demand.
 Delphi method: Surveys and questionnaires are
distributed to a group of selected respondents. Then a
group of 5-10 experts make the decision based on the
responses.
 The state of Alaska used Delphi method to develop its long-
range economic forecast.
23
Common types of Qualitative Methods
 Sales force composite: Combine each sales person’s
estimate of future demand.
 Lexus dealers meet every quarter to talk about the sales, such
as what is selling, in what colors, so the manufacturer has an
idea what to build.
 Consumer market survey: Collect information from
current or potential customers about future purchasing
plan.
24
Common Quantitative Methods
 Time series models predict on the assumption that the
future is a function of the past.
 Naïve approach
 Moving averages
 Exponential smoothing
 Associative Models incorporate variables that might
influence the quantity being forecast.
 For example, an associative model for lawn mowers sales
might use factors such as new housing starts, advertising
budget and so on.
25
Naïve Approach
 Assume that demand in the next period will be equal to
the most recent period.
 Bull-whip effect will be maximized under this forecasting
method.
26
Moving averages
 A moving-average forecast uses a number of historical actual
data values to generate a forecast.
 It is useful if we can assume that market demands will stay fairly
steady over time.
 An n-period moving-average model:
Moving average forecast for demand in period (n+1)
=
𝑆𝑢𝑚 𝑜𝑓 𝑡ℎ𝑒 𝑎𝑐𝑡𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑛 𝑝𝑒𝑟𝑖𝑜𝑑𝑠
𝑛
Usually the n is 3, 6, 9 months.
27
Example: 3-/6-month moving average forecast
Month Actual Sales 3-Month forecast
6-Month
Forecast
Jan
10
NA
NA
Feb
12
NA
NA
March
13
NA
NA
April
16
(10+12+13)/3
NA
May
19
(12+13+16)/3
NA
June
23
NA
July
26
(10+12+13+16+19+23)/6
Aug
30
28
Weighted moving averages
 Weights can be used to place more emphasis on recent values or
older values.
 A weighted n-period moving average:
Forecast for the demand in period (n+1)
=
𝑛
𝑖=1(𝑤𝑖 ×𝐷𝑖 )
𝑛 𝑤
𝑖=1 𝑖
𝑤𝑖 is the weight attached to the actual demand in period i
𝐷𝑖 is the actual demand in period i
29
Example: Weighted moving average

The following table summarizes the actual demands for a
product in the past 6 weeks.
Week
1
2
3
4
5
6
Actual Demand
25
34
60
25
30
38
What is the forecast for Week 4 if the company wants to use
the 3-period weighted moving average method with the weight
of 0.6 for the most recent demand, 0.3 for the 2nd most recent
demand, and 0.1 for the oldest actual demand.
30
Limitations of moving averages
 Increasing the size of n makes the method less sensitive to
real changes in the data;
 Moving averages cannot predict changes to either higher or
lower levels in time. They lag the actual values.
 Moving averages require extensive records of past data.
31
Exponential smoothing
 Exponential smoothing is a sophisticated weighted-
moving-average method.
 Call 𝛼 a smoothing constant, valued between 0 an 1.
Usually from 0.05 to 0.50 for business application.
 New forecast =
𝐿𝑎𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑 ′ 𝑠 𝑓𝑜𝑟𝑒𝑐𝑎𝑠𝑡 + 𝛼
× (𝐿𝑎𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑′ 𝑠 𝑎𝑐𝑡𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑
− 𝐿𝑎𝑠𝑡 𝑝𝑒𝑟𝑖𝑜𝑑′ 𝑠 𝑓𝑜𝑟𝑒𝑐𝑎𝑠𝑡)
32
Example: Exponential smoothing

Suppose the actual demand for year 2012 was 250 and the
forecast for the demand was 230. Set the smoothing
constant α = 0.1.

What is the exponential smoothing forecast for year 2013?
33
Next Week
 Design for Supply Chain efficiency
 Supply Chain Coordination
 Buy Back contract
 Quantity Discount
 More Supply Chain contracts
 Cycle inventory
34