MS 401
Production and Service Systems Operations
Spring 2009-2010
Supply Chain Management (SCM)
Slide Set #15
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What is Supply Chain Management?
• Supply chain management is a set of approaches utilized to
efficiently integrate suppliers, manufacturers, warehouses,
and stores, so that merchandise is produced and distributed
– at the right quantities
– to the right locations
– and at the right time
• in order to minimize system-wide costs
– while satisfying service level requirements
• Today, competition is between “supply chains” of firms
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A Simple Supply Chain Example
Raw Material Sources
Suppliers
Consumers
Manufacturers
Distributors
Retailers
Customers
Material, Information and Funds Flow
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A Supply Network Example
Manufacturing
Centers
Raw Material
and SemiFinished
Products
Suppliers
Distributors and
Warehouses
Consumers
Material, Information and Funds Flow
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Traditional Management Perspective
• “Company-centric” thinking
• Local optimum in major decisions
– process development
– inventory control and management
– structuring the distribution networks
– price policies
– contracts
• Information is an asset which should not be shared with
other companies
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Supply Chain Management Perspective
• Supply chain oriented thinking
• Global optimum in major decisions
–
–
–
–
–
process development
inventory control and management
structuring the distribution networks
price policies
contracts
• Both upstream companies and downstream companies are
partners
• Information sharing with your partners may improve the
performance of all parties in the supply chain
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The Objective of SCM
• The objective of SCM is to minimize related costs while
maintaining a reasonable service level
– customer satisfaction, quality, on time delivery, etc.
• Focus is on minimizing costs across the whole supply chain
– not on minimizing local costs
• Inter- and intra- company integration is essential
– building synergies by integrating business functions, departments
and companies
• Systems thinking is a must
– each member of the supply chain has roles in the establishment of
the price, quality and customer satisfaction
• 3 Key words:
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Key Components of Supply Chain Analysis
1. Location
2. Transportation and logistics
7. Product design and new
product introduction
3. Inventory and forecasting
8. Service and after sales support
4. Marketing and channel
restructuring
9. Reverse logistics and green
issues
5. Sourcing and supplier
management
10. Outsourcing and strategic
alliances
6. Information and electronic
mediated environments
11. Metrics and incentives
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12. Global issues
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Supply Chain Management: Key Issues
• Distribution Network Configuration:
• for ex: selecting a set of warehouse locations and capacities,
determining production levels and locations, flow patterns (from
plant to warehouse to retailer)
• Distribution Strategies (Wal-Mart’s cross-docking
strategy, direct shipping)
•
Inventory Control (uncertainty in demand, forecasting)
•
Supply Contracts
• Supply Chain Integration and Strategic Partnership
• information sharing
• operational planning
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Supply Chain Management: Key Issues
• Product Design
– postponement or delayed differentiation
• Information Technology and Decision Support Systems
– main motivation for SCM practice
– which data to keep and analyze?
– impact of internet and e-commerce?
– the primary competitive advantages of IT and DSS?
• Customer Value
– measuring the value of a customer to the company
– measuring company’s contribution to its customer
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Decision Making in a Supply Chain
• Strategic level decisions (long term)
–
–
location, capacity, new product development, technology
management
scale: years
• Tactical level decisions (medium term)
–
–
inventory policies, distribution channel, resource and product
allocation
scale: month-year
• Operational level decisions (short term)
–
–
scheduling, vehicle assignment and routing, sourcing and
production orders
scale: minutes-days
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Why SCM?
• What happens in the absence of collaboration,
coordination and cooperation ?
• We will illustrate through two well-known examples
– bullwhip effect
– prisoners’ dilemma
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The Bullwhip Effect
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Bullwhip Effect: Demand Observations
• Procter and Gamble (P&G) manufactures Pampers diapers
• Demand at various members of the supply chain observed as follows
Retailer’s
OrderstotoManufacturer
Wholesaler
Retailer’s Order
20
Order Quantity
Order Quantity
Consumer
Demand
Consumer
Sales at Retailer
15
10
5
0
Time
20
15
10
5
0
20
Order Quantity
Order Quantity
Wholesaler’sOrders
OrderstotoManufacturer
Manufacturer
Wholesaler’s
15
10
5
0
Time
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Time
Manufacturer’sOrders
OrderstotoSupplier
Supplier
Manufacturer’s
20
15
10
5
0
Time
Variability in Demand
• Variability in demand for Pampers
– low at the retailer stage
– much higher in the upstream stages
• This result can be observed in the well-known beer game
• High variability is not preferred because it leads to
–
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The Reasons of Bullwhip Effect
1.
2.
3.
4.
5.
Demand forecast updating
Long lead times
Order batching
Price fluctuations
Rationing and shortage gaming
•
It is not possible to eliminate the bullwhip effect only
through local improvements
•
We need a global perspective that involves all members
of the supply chain
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Reducing the Bullwhip Effect
• Avoid demand forecast updates
• Reduce order batch sizes
• Stabilize prices
• Eliminate speculations
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1- Avoid demand forecast updates
• Forecasts are usually based on historical customer orders
• Whenever there is a change in customer orders, the firms
update their forecasts and their MRP
– hence, the update is reflected in the demand values of the upstream
firms as well
– each firm amplifies the updates
• One solution is providing the real customer demand data
to upstream firms of the supply chain
– increased visibility through information sharing
– IBM, HP, and Apple require sell-through data on withdrawn stocks
from their resellers' central warehouse
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1- Avoid demand forecast updates
•
• EDI is common particularly in the retail business
– reduces the cost of data interchange
– increases information sharing
• Vendor Managed Inventory (VMI): The vendor* determines
the inventory parameters in the retailer and replenishes
accordingly
– both forecasting and inventory policy are the vendor’s responsibility
– the vendor has access to the demand and inventory information at
retail sites
* The “vendor” can be referred to as a “supplier” or a “manufacturer”, depending on the context
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1- Avoid demand forecast updates
Continuous Replenishment Program (CRP)
• The retailer itself determines the inventory parameters
• Manufacturer or wholesaler has access to the demand and
inventory information at retail sites and replenishes the
inventories without a purchase order
• Inventory reductions up to 25% are observed
• Many companies such as Campbell Soup, M&M/Mars,
Nestle, Quaker Oats, Nabisco, P&G, and Scott Paper use
CRP with some or most of their customers
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2- Reduce order batch sizes
• Companies often batch or accumulate demands before
issuing an order
• EDI can reduce the cost of the paperwork in generating an
order
– ex: P&G has introduced standardized ordering terms across all
business units to simplify the process
– this leads to lower order batch sizes
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2- Reduce order batch sizes
• Transportation costs
• Differences in the costs of full truckload and less-thantruckload (LTL) may be very high
– improvements in order efficiency are wasted due to the full-truckload
constraint
• Some manufacturers induce their distributors to order
assortments of different products
– hence, a truckload may contain different products from the same
manufacturer instead of a full load of the same product
• Third-party logistics (3PL) companies help make small batch
replenishments economical
– by consolidating loads from multiple suppliers
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3- Stabilize prices
•
: Retailers may buy items in advance of
requirements as a result of attractive price offerings
– when pricing returns to normal, the customer stops buying and
waits for the next discount period
• The customer’s buying pattern does not represent its
consumption pattern
• P&G, Kraft, and Wal-Mart have moved to an
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4- Eliminate speculations
• When demand exceed supply, the supplier rations
the product
• Knowing this, customers exaggerate their need in their
orders. This inflates the true need. When demand goes
down, customers reduce or cancel orders
• How to eliminate exaggerated orders?
General Motors allocates products in proportion to past
sales instead of orders in case of short supply
– customers then have no incentive to exaggerate their orders
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Bullwhip Effect: Summary
• Initiatives such as Electronic Data Interchange (EDI),
Vendor Managed Inventory (VMI), Continuous
Replenishment Program (CRP) and Everyday Low Pricing
Policy (EDLP) helps in
– sharing information and increasing visibility
– achieving supply-chain optimality
• rather than firm-wide optimality
– reducing lead times
• by increasing the speed of data interchange
• Hence, in reducing the bullwhip effect
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Prisoner’s Dilemma
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Prisoner’s Dilemma
• Two people arrested in a crime site. They will be punished
if at least one of them confesses that they committed the
crime
• They are kept in two different rooms
– so that they cannot cooperate
• Two choices for each prisoner
– C: Confess, N: Not confess
• Their utilities, depending on their own action and the other
prisoner’s action are as follows
Prisoner B
Confess
Prisoner A
Not confess
Confess
Not confess
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Prisoner’s Dilemma
• Prisoner “A” thinks: I do not know what “B” will do, but
he can do two things:
– B confesses: In this case, if I confess my punishment will be 5
years. If I don’t, than it will be 10 years. Better to confess.
– B does not confess: In this case, if I confess I won’t be punished at
all. If I don’t, than I will be punished for 2 years. Better to confess.
• Hence, for prisoner A,
• Same thing for prisoner B
Prisoner B
C
N
Prisoner A
C
N
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-5, -5
0, -10
-10, 0
-2, -2
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Prisoner’s Dilemma
• Hence, both prisoners will choose to confess a crime that
they did not conduct
• If the prisoners could cooperate the outcome might be
different
– they might both choose not to confess and they might both get less
punishment
– of course, this depends on how much they trust each other
• This simple example shows how local decision making
may lead to socially inferior solutions
• An application of Game theory
• Implications for supply chain management?
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Back to SCM…
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Challenges in SCM
• Achieving global optimization
– conflicting objectives
– complex network of facilities
– system variations over time
• Managing uncertainty
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Conflicting Objectives - 1
• Lot size – Inventory trade-off
– manufacturers prefer larger lot sizes; however, this causes higher
inventory levels for distributors and retailers
• Inventory – Transportation cost trade-off
– suppliers prefer to ship full truck loads; however, this causes
higher shipping cost for retailers (or, customers)
– cross-docking may be a solution
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Conflicting Objectives - 2
• Lead time – Transportation cost trade-off
– suppliers prefer to ship full truck loads, which cause higher lead
time for customers
• Product variety – Inventory trade-off
– high product variety causes less accurate forecasts and requires
higher safety stock levels to offer the same service level
– delayed differentiation may help
• SCM and IT tools can mitigate these conflicts
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Complex Network of Facilities
National Semiconductor Example
•
Production
–
–
•
produces chips in six different locations: four in the US, one in
Britain and one in Israel
chips are shipped to seven assembly locations in Southeast Asia
Distribution
–
–
–
–
–
the final product is shipped to hundreds of facilities over the world
20,000 different routes
12 different airlines are involved
95% of the products are delivered within 45 days
5% are delivered within 90 days
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Complex Network of Facilities
•
Globalization of supply chains result in additional
complexities mainly due to outsourcing to low cost countries
such as China and India
•
Increased transportation costs and lead times
Language and cultural differences
Currency fluctuations
Armed conflicts
Customs operations
Intellectual property (IP) problems
•
•
•
•
•
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Variations Over Time
• Supply chain evolves over time
– customer demand and supplier capabilities
– customer-supplier relationship
– seasonality
– competitors’ pricing strategies
– advertising and promotions
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Managing Uncertainty
• Demand is not the only source of uncertainty
– delivery lead times, component availability, machine breakdowns,
natural disasters etc.
• For example: supply disruptions…
– September 1999 earthquake in Taiwan. Hewlett Packard and Dell,
who source a variety of components from Taiwanese
manufacturers, were impacted by supply interruptions
– 2005 strike in Oakland harbor: Serious blow to San Francisco area
(including the Silicon Valley) industry
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Matching Supply with Demand
•
Becomes even more difficult when considering the whole
supply chain
•
Compaq computer estimates it lost $500 million to $1
billion in sales in 1995
–
•
because its laptops and desktops were not available when and
where customers were ready to buy them
Boeing Aircraft was forced to announce loss of $2.6 billion
in October 1997
– the reason? “Raw material shortages, internal and supplier parts
shortages…” (Wall Street Journal, Oct. 23, 1997)
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New Technology: RFID
• RFID:
• A technology that uses radio waves to identify objects,
such as goods in a supply chain. Two components:
– RFID tags attached to objects containing a chip and an antenna
– network of readers
• RFID tags provide unique identification
– within the range of a tag reader
• Similar to bar codes, but better
–
–
– multiple RFID tags can be read simultaneously and automatically
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New Technology: RFID
• RFID can alter supply chain management drastically
• Eliminates the need for manual counting and bar-code
scanning of goods at receiving docks, warehouses and on
retail shelves
•
•
•
•
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Outsourcing
• Outsourcing: Buying goods or services from other
companies instead of producing or providing them in the
company
• Started with manufacturing outsourcing
• Continued with other functions such as procurement and
product design
– Apple Computer example
• Motivation: Reduce costs and focus on core business
– an easy way to cut costs
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Outsourcing: Advantages & Disadvantages
• Advantages
–
• Disadvantages
–
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Supply Contracts
• The relation between a buyer and a seller (supplier) is
administered by a supply contract
• The contract may specify
– pricing and volume discounts
– minimum and maximum purchase quantities
– delivery lead times
– product or material quality
– product return policies
• The contract may have a powerful impact on supply chain
performance
– determines the incentives of the supply chain members
– determines how risk is shared between the members
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Contract Type Examples
•
: The manufacturer (seller) agrees to buy back
unsold items from the retailer (buyer) for some agreed-upon price
• Quantity-flexibility contract: The manufacturer provides full
refund for unsold items, up to a certain quantity of items
•
: The manufacturer makes a rebate payment to
retailer for each unit sold above a certain quantity
• Quantity discount contract
•
: The buyer pays one price to purchase options,
and another price to exercise the purchased options. Often used
when a buyer wants a supplier to build capacity in advance
• Revenue sharing contract (see next slide)
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Example: Revenue Sharing Contract
• Until 1998, Blockbuster Video (video rental chain)
– purchased copies of films for $65
– rent them to customers for $3
• Because of high purchase price, Blockbuster did not purchase
enough copies to cover peak demand (first 10 weeks)
• Result: Low customer service (product availability)
– 20% of customers could not get their first choice of movie
• In 1998: Revenue sharing contract between Blockbuster and
movie studios
–
–
• Huge impact on Blockbuster revenue and market share
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Supply Chain Product Design
• Design-for-Logistics (DFL)
– IKEA: Modular and easily-stored furniture
• Postponement
– Postponing the configuration of the final product as long as
possible
–
– Benetton example
• before: wool was dyed before knitted
• now: garments are dyed after they are knitted
• advantages: additional time before committing to the final mix of
colors (better information)
– HP example
• printer localization at the distribution centers, rather than in factory
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Risk Pooling
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Risk Pooling Concept
Decentralized system
Warehouse 1
Market 1
Warehouse 2
Market 2
Supplier
Centralized system
Supplier
Market 1
Warehouse
Market 2
• To achieve the same service level, which system will require more
inventory? Why?
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Risk Pooling Concept
• Why is pooling advantageous?
• Intuitively,
• As the number of locations go up, this likelihood also goes up
• Let’s analyze risk pooling with a simple example
– consider a particular product sold at two locations (markets): 1 and 2
– 97% type-1 service level
– 1 week delivery lead time from the factory to the warehouse(s)
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Example: Historical Data
Week
1
2
3
4
5
6
7
8
Market 1
33
45
37
38
55
30
18
58
Market 2
46
35
41
40
26
48
18
55
Total
79
80
78
78
81
78
36
113
AVG
STD
CV
Market 1
39.3
13.2
0.34
Market 2
38.6
12.0
0.31
Total
77.9
20.71
0.27
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CV=STD/
AVG
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Example: The Inventory Policy
• (Q,R) policy with Q=EOQ
• Order Q units when inventory level falls to R
• R= safety stock (SS) + lead time demand (1 week demand)
• SS = z * std(leadtime demand)
where z= 1.9 (approx.) for type-1 service level of 0.97
• Average inventory = SS + Q/2
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Risk Pooling Example
AVG
STD
SS
R
Q
Market 1
39.3
13.2
25
65
132
Market 2
38.6
12.0
22.8
62
131
Centralized
77.9
20.7
39
118
186
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Avg.
Inventory
%
Decrease
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Observations
• Risk pooling idea: demand variability is reduced if one
aggregates demand across locations
• Centralizing inventory reduces both safety stock and
average inventory level for the same service level
• This works best for
– high coefficient of variation, which reduces required safety stock
– negatively correlated demand between the two locations (markets)
• This was an example of pooling across different locations
– delayed differentiation was an example of pooling across different
products
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