Supply chain assignments

Designing and Managing the supply chain:

concepts, strategies and case studies. Simchi- Levi, Kaminsky & Simchi-Levi written by Mx92 The Marketplace to Buy and Sell your Study Material On Stuvia you will find the most extensive lecture summaries written by your fellow students. Avoid resits and get better grades with material written specifically for your studies.

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concepts, strategies and case studies . Chapters: 1 – 11 (including 11) Het auteursrecht is het uitsluitend recht van de maker van een werk van letterkunde, wetenschap of kunst, of van diens rechtverkrijgenden, om dit openbaar te maken en te verveelvoudigen, behoudens de beperkingen, bij de wet gesteld. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 I. Chapter 1: Introduction to supply chain management: The supply chain, which is also referred to as the logistics network, consists of suppliers, manufacturing centers, warehouses, distribution centers and retail outlets, as well as raw materials, work in process inventory and finished products that flow bet ween the facilities. Supply chain management is a set of approaches utilized to efficiently integrate suppliers, manufactures, warehouses and stores, so that merchandise is produced and distributed at the right quantities, to the right locations and at th e right time, in order to minimize systemwide costs while satisfying service level requirements. This definition lead to several observations:  Supply chain management takes into consideration every facility that has an impact on cost and plays a role in m aking the product conform to customer requirements: from supplier and manufacturing facilities through warehouses and distribution centers to retailers and stores.  The objective of supply chain management is to be efficient and cost effective across the e ntire system: total systemwide costs, from transportation and distribution to inventories of raw materials, wip, and finished goods are minimized. The emphasis is not on simply minimizing transportation cost or reducing inventories but, rather, on taking a systems approach to supply chain management.  Supply chain management resolves around efficient integration of suppliers, manufactures, warehouses and stores, it encompasses the firm’s activities at many levels, from strategic level through the tactical t o the operational level. What makes supply chain management difficult:  Supply chain strategies cannot be determined in isolation. They are directly affected by another chain most organizations have, the development chain that includes the set of activitie s associated with new product introduction.  It is challenging to design and operate a supply chain so that total sytemwide costs are minimized and systemwide service levels maintained.  Uncertainty and risk are inherent in every supply chain; customer dem and can never be forecast exactly, travel times will never be certain and machines and vehicles will break down. The development chain: is the set of activities and processes associated with new product introduction. It includes the product design phase, the associated capabilities and knowledge that need to be developed internally, sourcing decisions and production plans. What makes finding the best sytemwide or globally optimal, integrated solutions so difficult:  The supply chain is a complex network of facilities dispersed over a large geography and in many cases, all over the globe.  Different facilities in the s upply chain frequently have different, conflicting objectives. Suppliers’ goals can be in direct conflict with the manufactures’ desire for flexibility.  The supply chain is a dynamic system that involves over time.  System variations over time are also an important consideration. Global optimization only implies that it is not only important to optimize across supply chain facilities, but also across processes associated with the development and supply chains. Global optimizations is made even more diffi cult because supply chains need to be designed for and operated in uncertain environments, thus creating sometimes enormous risks to the organization. A variety of factors contribute to this: Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  Matching supply and demand is a major challenge. This difficulty stems from the fact that months before demand is realized, manufactures have to commit themselves to specific production levels. These advance commitments imply huge financial and supply risks.  Inventory and back -order levels fluctuate considerably acros s the supply chain, even when customer demand for specific products does not vary greatly.  Forecasting doesn’t solve the problem.  Demand is not the only source of uncertainty. Delivery lead times, manufacturing yields, transportation times and component a vailability also can have significant supply chain impact.  Recent trends such as lean manufacturing, outsourcing and offshoring that focus on cost reduction increase risks significantly. An important building block in effective supply chain strategies is strategic partnerships between suppliers and buyers, partnerships that can help both parties reduce their costs. At the same time, many supply chain partners engage in information sharing so that manufactures are able to use retailers’ up to date sales data to better predict demand and reduce lead times. A number of approaches have been applied by industry to manage risk in their supply chains:  Building redundancy into the supply chain so that if one portion fails, the supply chain can still satisfy demand.  Using information to better sense and respond to disruptive events  Incorporating flexibility into supply contracts to better match supply and demand  Improving supply chain processes by including risk assessment measures. If firms have improved supply chain performance by focusing on strategic partnering, using information sharing and technology, or by applying risk mitigation strategies, what inhibits other firms from adopting the same techniques to improve their supply chain performance? The answer involves three critical abilities that successful firms must possess:  The ability to match supply chain strategies with product characteristics. There is a difference in fast clock speed products and slow clock speed products.  The ability to replace traditional supply chain strategies, in which each facility or party in the chain makes decisions with little regard to their impact on other supply chain partners, by those that yield a globally optimized supply chain.  The ability to effectively manage uncertainty and risk. In this section we introduce some of the supply chai n management issues that we discuss in much more detail throughout the remaining chapters. These issues span a large spectrum of a firm’s activities, from the strategic through the tactical to the operational level:  The strategic level: deals with decision s that have a long lasting effect on the firm. This includes decisions regarding product design, supplier selection, strategic partnering, decisions on the location, capacity of warehouses.  The tactical level: includes decisions that are typically updated anywhere between once every quarter and once every year. These include purchasing and production decisions. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  The operational level: refers to the day to day decisions such as scheduling, lead time quotations, routing and truck loading. Discussion of key issues, questions and tradeoffs associated with different decisions: (blz. 12,13,14,15). II. Chapter 3: Network planning: Network planning: the process by which the firm structures and manages the supply chain in order to:  Find the right balance between inv entory, transportation and manufacturing costs.  Match supply and demand under uncertainty by positioning and managing inventory effectively.  Utilize resources effectively by sourcing products from the most appropriate manufacturing facility. It is useful to divide the network planning process into three steps:  Network design: this includes decisions on the number, locations and size of manufacturing plants and warehouses, the assignment of retail outlets to warehouses and so forth. The typical planning ho rizon is a few years.  Inventory positioning: this includes identifying stocking points as well as selecting facilities that will produce to stock and thus keep inventory, and facilities that will produce to order and hence keep no inventory.  Resource allo cation: given the structure of the logistics network and the location of stocking points, the objective in this step is to determine whether production and packaging of different products is done at the right facility. Network design: We concentrate on the following strategic decisions:  Determining the appropriate number of facilities such as plants and warehouses.  Determining the location of each facility  Determining the size of each facility  Allocating space for products in each facility  Determining so urcing requirements  Determining distribution strategies. The objective is to design or reconfigure the logistics network in order to minimize annual systemwide cost, including production and purchasing costs, inventory holding costs, facility costs and tr ansportation costs, subject to a variety of service level requirements. Increasing the number of warehouses typically yields:  An improvement in service level due to the reduction in average travel time to the customers.  An increase in inventory costs due to increased safety stocks required to protect each warehouse against uncertainties in customer demands.  An increase in overhead and setup costs.  A reduction in outbound transportation costs: transportation costs from the warehouses to the customers. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  An i ncrease in inbound transportation costs: transportation costs from the suppliers and or manufactures to the warehouses. A typical network configuration problem involves large amounts of data. An essential first step is data aggregation. This is carried o ut using the following procedure:  Customers located in close proximity to each other are aggregated using a grid network or other clustering technique. All customers within a single cell or a single cluster are replaced by a single customer located at the center of the cell or cluster. This cell or cluster is referred to as a customer zone.  Items are aggregated into a reasonable number of products groups, based on:

distribution patterns or product type. The next step in constructing an effective distribut ion network design model is to estimate transportation costs. We distinguish between transportation costs associated with an internal and an external fleet. Estimating transportation costs for company -owned trucks is typically quite simple. It involves an nual costs per truck, annual mileage per truck, annual amount delivered and the truck’s effective capacity. All this information can be used to easily calculate cost per mile per SKU. Incorporating transportation rates for an external fleet into the model is more complex. We distinguish here between two modes of transportation: truckload (TL) and less than truckload (LTL). In the US, TL carriers subdivide the country into zones. The carriers provide their clients with zone to zone table costs. In the LTL industry, rates typically belong to one of the three basic types of freight rates:

class, exception and commodity. Warehouse costs: Warehousing and distribution center costs include three main components:  Handling costs: these include labor and utility costs that are proportional to annual flow through the warehouse.  Fixed costs: these capture all cost components that are not proportional to the amount of material that flows through the warehouse.  Storage costs: represent inventory holding costs, which are proportional to average inventory levels. Inventory turnover ratio: annual sales / average inventory level. The inventory turnover ratio of the total annual outflow from the warehouse to the average inv entory level. Warehouse capacities: Every pallet stored in the warehouse require an empty space for aisles, picking, sorting and processing facilities. We typically multiply the required storage space by a factor >1. Consider a situation where the annua l flow through the warehouse is 1000 units and the inventory turnover ratio is 10. This implies that the average inventory level is about 100 units and hence, if each unit takes 10 square feet of floor space, the required space for the products is 2000 squ are feet. Therefore the total space required for the warehouse is about 6000 square feet. Potential warehouse locations: Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 Locations must satisfy a variety of conditions:  Geographical and infrastructure conditions  Natural resources and labor availability  Local industry and tax regulations  Public interest As a result only a limited number of locations would meet all the requirements. Service level requirements: There are various ways to define service levels in this context. Decisions regarding the number , location and size of warehouses have an impact on the firm for at least the next three to five years. This implies that changes in customer demand over the next few years should be taken into account when designing the network. This is commonly addressed using a scenario based approach incorporating net present value calculations. The previous subsections document the difficulties in collecting, tabulating and cleaning the data for a network configuration model. Once this is done, how do we ensure that the data and model accurately reflect the network design problem? The process used to address this issue is known as model and data validation. This is typically done by reconstructing the existing network configuration using the model and collected data, and comparing the output of the model to existing data. The model validation process typically involves answering the following questions:  Does the model make sense?  Are the data consistent?  Can the model results be fully explained?  Did you perform sensiti vity analysis? Validation is critical for determining the validity of the model and data, but the process has other benefits. In particular, it helps the user make the connection between the current operations, which were modeled during the validation proc ess and possible improvements after optimization. Once the data are collected, tabulated and verified, the next step is to optimize the configuration of the logistics network. In practice, two techniques are employed:  Mathematical optimization technique: these tools can determine strategies that will significantly reduce the total system cost.  Simulation models. Simulation -based tools take into account the dynamics of the system and are capable of characterizing system performance for a given design.

Sim ulation is not an optimization tool. It is useful in characterizing the performance of a particular configuration, but not in determining an effective configuration from a large set of potential configurations. A detailed simulation model that incorporates information about individual customer ordering patterns, specific inventory and production policies, daily distribution strategies, may require enormous computational time to achieve a desired level of accuracy in system performance.

This implies that typ ically one can consider very few alternatives using a simulation tool. Both techniques can also be used: Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  Use an optimization model to generate a number of least cost solutions at the macrolevel, taking into account the most important cost components.  Use a simulation model to evaluate the solutions generated in the first phase. One of the key requirements of any supply chain planning tool for network design is flexibility. In this context we define flexibility as the ability of the system to incorporate a large set of preexisting network characteristics. It may be necessary to incorporate the following features in the optimization model:  Customer specific service level requirements  Existing warehouses  Expansion of existing warehouses  Specific flow pattern s  Warehouse to warehouse flow  Production and bill materials. The objective of the firm is to manage the inventory so as to reduce systemwide cost; thus it is important to consider the interaction of the various facilities and the impact this interaction has on the inventory policy that should be employed by each facility. One way to manage the inventory for whatever product is produced in a facility is to wait for specific orders to arrive before starting to manufacture them. We call such a facility a make to order facility and it contrast it to the make to stock facilities . An important question that arises when managing inventory in a complex supply chain is where to keep safety stock. In other words, which facilities should produce stock and which should produce to order. The answer to this question clearly depends on th e desired service level, the supply network, lead times as well as a variety of operational issues and constraints. To understand the issues involved, consider the following model:  SI: the amount of time that passes from when an order is placed until the facility receives a shipment. This time is referred to as incoming service time.  S: be the committed service time made by the facility to its own customers.  T: be the processing time at the facility. Of course we must assume that SI+T>S, since otherwise, no inventory is needed in the facility. The level of safety stock that the facility needs to keep is: zh= √ Where Z is the safety stock factor associated with a specified level of service and h is the inventory holding cost. The value SI+T -S is r eferred to as the facility net lead time. Example of safety stock in the supply chain (blz 97) Our experience is that many companies try to keep as much inventory close to the customers, hold some inventory at every location and hold as much raw material s as possible. Clearly, the focus of this strategy is on local optimizations, where each facility in the supply chain optimizes its own objective with very little regard to the impact of its decisions on other facilities in the supply chain. This typically yields:  Low inventory turns  Inconsistent service levels across locations and products  The need to expedite shipments, with resulting increased transportation costs. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 The supply chain strategy should be different for different products categories. For exa mple, inventory risk is the main challenge for high -variability –low volume products. Thus these products should be positioned mainly at the primary warehouses so that demand from many retail outlets can be aggregated, reducing inventory costs. On the oth er hand, low variability – high volume products should be positioned close to the retail outlets, as the secondary warehouses, since this allows the supply chain to ship fully loaded tracks as close as possible to the customer, thus reducing transportation costs. Finally, positioning low -variability -low volume products requires as bit more analysis since other characteristics are important, such as profit margins. Demand uncertainty is a critical factor for high variability low volume products and hence the supply chain strategy will position inventory at the primary warehouses so as to take advantage of risk pooling. Thus in this case, the strategy is a pull strategy. On the other hand, for low variability -high volume products, the focus is on economics of scale in transportation costs and hence these products are positioned as close as possible to the customers to reduce transportation costs, a push based strategy. Resource allocation: Given a fixed logistics network, the firm needs to decide on a mont hly, quarterly or annual basis how to utilize resources efficiently. This is done by developing a supply chain master plan. Supply chain master planning is defined as the process of coordinating and allocating production and distribution strategies and res ources to maximize profit or minimize systemwide cost. The challenge of allocating production, transportation and inventory resources in order to satisfy demand can be daunting. This is especially true when the firm is faced with seasonal demand, limited c apacities, competitive promotions or high volatility in forecasting. Depending on the objective of the planning process, the output can focus on either of the following:  Sourcing strategies: where should each product be produced during the planning horizon  Supply chain master plan: what are the production quantities, shipment size and storage requirements by product, location and time period? In some applications, the supply chain master plan serves as an input for a detailed production scheduling s ystem. In this case, the production scheduling system employs information about production quantities and due dates received from the supply chain master plan. The focus of tactical planning, that is, the process by which the firm generates a supply chai n master plan, is on cost minimization or profit maximization. Finally, the focus in the detailed manufacturing scheduling portion of the supply chain is on feasibility. That is, the focus is on generating a detailed production schedule that satisfies all production constraints and meets all due date requirements generated by the supply chain master plan. Tactical planning tools have the ability to analyze demand plans and resource utilization to maximize profit. Naturally one has to decide whether to foc us on cost minimization or on profit maximization. It is clear that cost minimization is important when the structure of the Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 supply chain is fixed or at times of a recession and therefore oversupply. In this case, the focus is on satisfying all demand at t he lowest cost by allocating resources efficiently. On the other hand, profit maximization is important at times of growth, that is, at time when demand exceeds supply. In this case, capacity can be limited because of the use of limited natural resources o r because of expensive manufacturing processes that are hard to expand. Finally, an effective supply chain master planning tool also must be able to help the planners improve the accuracy of the supply chain master planning model. III. Chapter 2: inventory management and risk pooling: A typical supply chain consists of suppliers and manufacturers, who covert raw materials into finished products and distribution centers and warehouses, from which finished products are distributed to customers. Inventory appear in many places in the supply chain:  Raw material inventory  Work in process inventory  Finished product inventory If inventory is typically expensive and difficult to manage, why hold it at all? Inventory is held due to:  Unexpected changes in customer demand. Customer demand has always been hard to predict, and uncertainty in customer demand has increased in the last few years due: 1. The short life cycle of an increasing number of products. 2. The presence of many competing products in the marketplace. The proliferation of products makes it increasingly difficult to predict demand for a specific model.  The presence in many situations of a significant uncertainty in the quantity and quality of the supply, supplier costs and delivery times.  Lead times: even if there is no uncertainty in demand or supply, there is a need to hold inventory due to delivery lead times.  Economies of scale offered by transportation companies that encourage firms to transport large quantities of items and therefore hold large inventories. Since demand is uncertain in most situations, the demand forecast is critical for determining what to order and when to order it. But what is the relationship between forecast demand and the optimal order quantity? Should the ord er quantity be equal to, greater than, or smaller than forecast demand? The strategy, approach, or set of techniques used to determine how to manage inventory is known as a firm’s inventory policy. To decide on an effective inventory policy, managers have to take many characteristics of the supply chain into account:  First and foremost is customer demand, which may be known in advance or may be random.  Replenishment lead time, which may be known at the time the order is place or may be uncertain.  The num ber of different products being considered. These products compete on budget or space. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  The length of the planning horizon  Costs, including order cost and inventory holding cost: 1. Typically order cost consists of two components: the cost of the product and t he transportation cost. 2. Inventory holding cost or inventory carrying costs of: state taxes, property taxes, insurance, maintenance costs, obsolescence costs and opportunity cost (represent the return on investment that one would receive had money been inve sted in something else.  Service level requirements: specify acceptable level of service. We start by considering inventory management in a single supply chain stage. There are a variety of techniques and approaches that can be effective for managing inv entory in a single stage.  The economic lot size model: simple model that illustrates the tradeoffs between ordering and storage costs. The model assumes the following: 1. Demand is constant at a rate of D items per day. 2. Order quantities are fixed at Q items p er order. 3. A fixed cost (setup cost), K, is incurred every time the warehouse places and order. 4. An inventory carrying cost, h, also referred to as a holding cost, is accrued per unit held in inventory per day that the unit is held. 5. The lead time, the time t hat elapses between the placement of an order and its receipt. 6. Initial inventory is zero 7. The planning horizon is long. Our goal is to find the optimal order policy that minimizes annual purchasing and carrying costs while meeting all demand. Inventory cost in a cycle of length T is:

The order quantity Q* that minimizes the cost function above is Q* = √ The simple model provides two important insights: 1. An optimal policy balances inventory holding cost per unit time with setup cost per unit time. Thus as one increases the order quantity q, inventory holding costs per unit of time increase while setup cost per unit of time decrease. 2. Total inventory cost is insensitive to order quantities; that is, changes in order quantities have a relatively small impact on annual setup costs and inventory holding costs. The previous model illustrates the tradeoffs between s etup costs and inventory holding costs. It ignores however, issues such as demand uncertainty and forecasting. One needs to remember the following principles of all forecasts:  The forecast is always wrong.  The longer the forecast horizon, the worse the for ecast.  Aggregate forecasts are more accurate. (while it is difficult to predict customer demand for individual SKU’s, it is much easier to predict demand across all SKUs within one product family. This principle is an example of risk pooling concept. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 So what is the relationship between the optimal order, or production, quantity and average demand? Should the optimal order quantity always be less than average demand? To answer these questions, we compare the marginal profit and the marginal cost of orderin g an additional unit. If an additional unit is sold, the marginal profit is the difference between the selling price per unit and the variable ordering cost per unit. Example 2.4 Blz 38. In summary:  The optimal order quantity is not necessarily equal to f orecast or average, demand. The optimal quantity depends on the relationship between marginal profit achieved from selling an additional unit and marginal cost.  As the order quantity increases, average profit typically increases until the production quant ity reaches a certain value, after which average profit start decreasing.  As we increase the production quantity, the risk always increases. At the same, the probability of large gains also increases. In the previous model, we considered a situation in which the firm has only a single ordering or production opportunity to meet demand during a short selling season. We next consider a similar situation, but one in which the firm already has some inventory of the product on hand, perhaps inventory left ove r from the previous season. Whenever the inventory level is reviewed, if it is below a certain value, say, s, we order to increase inventory to level S. Such a policy is referred as an (s,S) policy or a min max policy.

We typically refer to s as the reor der point or the min and to the S as the order up to level or the max. The situations we considered above all focus on a single ordering or production opportunity.

This may be the case for fashion items where the selling season is short and there is no second opportunity to reorder products based on realized customer demand. In many practical situation, the decision maker may order products repeatedly at any time during the year. Consider for instance, a distributor that faces random demand for a product and meets that demand with product ordered from a manufacturer. Of course, the manufacturer cannot instantaneously satisfy orders placed by the distributor; there is a fixed lead time for the delivery whenever the distributor places an order. Since demand is random and the manufacturer has a fixed delivery lead time, the distributor needs to hold inventory, even if no fixed setup cost is charged for ordering the products. There are at least three reasons why the distributor holds inventory:  To satisfy demand occurring during lead time.  To protect against uncertainty in demand  To balance annual inventory holding costs and annual fixed order costs. To manage inventory effectively, the distributor needs to decide when and how much to order. We di stinguish between two types of policies: Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  Continuous review policy: in which inventory is reviewed continuously and an order is placed when the inventory reaches a particular level or reorder point. Can be used when computerized inventory systems are used.  Periodic review policy: in which the inventory level is reviewed at regular intervals and an appropriate quantity is ordered after each review. This type of policy is most appropriate or systems in which it is impossible or inconvenient to frequently revie w inventory and place orders if necessary. Continuous review policy:  Daily demand is random and follows a normal distribution  Every time the distributor places an order from the manufacturer, the distributor pays a fixed cost, K, plus an amount proportion al to the quantity ordered.  Inventory holding cost is charged per item per unit time  Inventory level is continuously reviewed and if an order is placed, the order arrives after the appropriate lead time.  If a customer order arrives when there is no inven tory on hand to fill the order, the order is lost.  The distributor specifies a required service level. The service level is the probability of not stocking out during lead time. We need the following information:  AVG: average daily demand faced by the di stributor  STD: standard deviation of daily demand faced by the distributor  L: replenishment lead time from the supplier to the distributor in days  H: cost of holding one unit of the product for one day at the distributor  α : service level. This implies tha t the probability of stocking out is 1 - α. We need to define the concept inventory position. Inventory position at any point in time is the actual inventory at the warehouse plus items ordered by the distributor that have not yet arrived minus items that are backordered. The reorder level, R, consists of two components. The first is the average inventory during lead time, which is the product of average daily demand and the lead time. This ensures that when the distributor places and order, the system h as enough inventory to cover expected demand during lead time. The second component represents the safety stock, which is the amount of inventory that the distributor needs to keep at the warehouse and in the pipeline to protect against deviations from average demand during lead time. This quantity is calculated as fo llows: √ Where z is a constant referred to as the safety factor. This constant is associated with the service level. Thus reorder level is equal to: √ What about the order quantity Q. The EOQ is very effective for this mod el. Q is calculated as follows: Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 √ Average inventory level is equal to: √ (Example 2.8 blz 44) Variable lead times: blz 45 Periodic review policy: In many real -life situations, the inventory level is reviewed periodically at regular intervals and an appropriate quantity is ordered after each review. If these intervals are relatively short, it make sense to use a modified version of the (Q,R) policy. We define two inventory level s and S during each inventory review. If the inventory falls below s, order enough to raise the inventory position to S. We call this modified (Q,R) policy and (s,S) policy. If there is a larger time between successive revi ews of inventory (weekly or monthly), it may make sense to always order after and inventory level review. Since an order is place after each inventory review, the fixed cost of placing an order is a sunk cost and hence can be ignored; presumably, the fixed cost was used to determine the review interval. The quantity ordered arrives after the appropriate lead time. Fixed costs do not play a role in this environment, the inventory policy is characterized by a single parameter, the base stock level. That is, t he warehouse determines a target inventory level, the base stock level, and each review period, the inventory position is reviewed and the warehouse orders enough to raise the inventory position to the base stock level. The base stock level (blz 4 6) shou ld include two components: average demand during an interval of r+ L days, which is equal to ( ) And safety stock, which is the amount of inventory that the warehouse needs to keep to protect against deviations from average demand during a period of r+L days. This quantity is calculated as follows: √ Where z is the safety factor. The e xpected level of inventory after receiving an order is: √ The expected level of inventory before an order arrives is just the safety stock. Average inventory level is: √ Service level optimization: So far we have assumed that the objective of this inventory optimization is to determine the optimal inventory policy given a specific service level target. The question is how the facility should decide the appropriate level of service. Sometimes this is determ ined by the downstream customer. In other words, the retailer can require the facility, for example, the supplier, to maintain a specific level of service and the supplier will use this target t o manage Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 its own inventory. In other cases, the facility has t he flexibility to choose the appropriate level of services. Tradeoffs: (blz 47). The higher the service level, the higher the inventory level. Service level will be higher for products with:  high profit margin  High volume  Low variability  Short lead time Risk pooling: One of the most powerful tools used to address variability in the supply chain is the concept of risk pooling. Risk pooling suggests that demand variability is reduced if one aggregates demand across locations. This is true since, as we agg regate demand across different locations, it become more likely that high demand from one customer will be offset by low demand from another. This reduction is variability allows a decrease in safety stock and therefore reduces average inventory. To unde rstand risk pooling, it is essential to understand the concepts of standard deviation and coefficient of variation of demand. Standard deviation is a measure of how much demand tends to vary around the average and the coefficient of variation is the ratio of standard deviation to average demand: The standard deviation measures the absolute variability and the coefficient of variation measures variability relative to average demand. Three critical points we have made about risk pooling:  Centralizing inventory reduces both safety stock and average inventory in the system. In a centralized distribution system, whenever demand from one market area is higher than average while demand in another market area is lower than average, items in the warehouse that were originally allocated for one market can be reallocated to the other.  The higher the coefficient of variation, the greater the benefit obtained from centralized systems; that is the greater the benefit from risk pooling. This is explained as follows: average inventory includes two components: on e proportional to average weekly demand and the other proportional to the standard deviation of weekly demand. Since reduction in average inventory is achieved mainly through a reduction in safety stock, the higher the coefficient of variation, the larger the impact of safety stock on inventory reduction.  The benefits from risk pooling depends on the behavior of demand from one market relative to demand from another. Centralized versus decentralized systems: What are the tradeoffs that we need to conside r?:  Safety stock: safety stock decreases as a firm moves from a decentralized to a centralized system. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  Service level: when the centralized and decentralized systems have the same total safety stock, the service level provided by the centralized system is h igher.  Overhead costs: much greater in decentralized system because there are fewer economies of scale.  Customer lead time: since warehouses are much closer to customers in a decentralized system, response time is much shorter.  Transportation costs: the impact on transportation costs depends on the specifics of the situation. On one hand, as we increase the number of warehouses, outbound transportation costs(costs incurred for delivering the items from warehouses to customers) de crease. On the other hand inbound transportation costs (costs from supply and manufacturing to warehouses) increase. Managing inventory in the supply chain: In this section we consider a multifacility serial supply chain that belongs to a single firm. A serial supply chain is one in which there are a series of stages, each of which supplies a single downstream stage until the final stage, which meets customer demand. In this serial supply chain is owned by a single firm, the objective of that firm will be to manage inventory so as to reduce systemwide cost, Thus it is important for the firm to consider the interaction of the various facilities and the impact this interaction has on the inventory policy that should be employed by each facility. In this ca se, an approach based on the concept of the echelon inventory policy is an effective way. To understand this policy, it is necessary to introduce the concept of echelon inventory. In a distribution system, each stage or level often is referred to as an ech elon. Thus, the echelon inventory at any stage or level of the system is equal to the inventory on hand at the echelon plus all downstream inventory. (blz 53). The reorder point is: √ Where: Le= echelon lead time, defined as the lead time between the retailer and the distributor plus the lead time between the distributor and its supplier, the wholesaler. AVG= average demand at the retailer STD= Standard deviation of demand at the retailer What if there is more than one facility at a particular stage of the supply chain? For example, what about a two -stage supply chain where a warehouse supplies a set of retailers? Exactly the same approach can be used in this case, except that, now the echelon inventory at the warehouse is the inventory at the warehouse, plus all of the inventory in transit to and in stock at each of the retailers. √ Le= echelon lead time, defined as the lead time between the retailer and the distri butor plus the lead time between the warehouse and its supplier AVG= average demand across all retailers STD= standard deviation of (aggregate) demand across all retailers. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 In a recent study, materials and inventory managers were asked to identify effective inventory reduction strategies. The top seven strategies are:  Perform periodic inventory review: inventory is reviewed at a fixed time interval and every time it is reviewed, a decision is made on the order size.  Provide tight management for usa ge rates, lead times and safety stock: this allows the firm to make sure inventory is kept at the appropriate level. Such an inventory control process allows the firm to identify situations in which usage rates decrease for a few months.  Reduce safety sto ck levels: focus on lead time reduction.  Introduce or enhance cycle counting practice: this process replaces the annual physical inventory count by a system where part of the inventory is counted every day and each item is counted several times per year.  Follow the ABC approach: in this approach, items are classified into three categories.

Class A include all high revenue products, which typically account for about 80 percent of annual sales and represent about of inventory SKUs (Stock Keeping Units).

Clas s B include products that account for about 15 percent of annual sales. Class C represent low revenue items, products whose value is no more than 5 percent of sales. Because Class A account for the major part of the business, a high frequency periodic revi ew policy is appropriate.  Shift more inventory or inventory ownership to suppliers.  Follow quantitative approaches: focus on the right balance between inventory holding and ordering costs. We have seen a significant effort by industry to increase the in ventory turnover ratio, defined as: This definition implies that an increase in inventory turnover leads to a decrease in average inventory levels. Three rules of forecasting:  The forecast is always wrong  The longer the forecast horizon, the worse the forecast  Aggregate forecasts are more accurate Forecasts aren’t just for inventory decision making; decisions about whether to enter a partic ular market at all, about whether to expend production capacity or about whether to implement a given promotional plan can all benefit from effective forecasting. There are many forecasting tools and methods, they can be split into four general categories :  Judgment methods: involve the collection of expert opinions. Panels of experts can be assembled in order to reach a consensus. This approach assumes that by communicating and openly sharing information a superior forecast can be agreed upon. These expert s can be external experts, or internal experts.  Market research methods: involve qualitative studies of consumer behavior. Market testing and market surveys can be valuable tools for developing forecasts particularly of newly introduced products. In market testing, focus groups of potential customers Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 are assembled and tested for their response to products and this response is extrapolated to the entire market to estimate the demand for products. Market surveys involve gathering these data from a variety of potential customers.  Time -series methods: are m athematical methods in which future performance is extrapolated from past performance. Some common time series methods: 1. Moving average: each forecast is the average of some number of previous demand points. 2. Exponential smoothing: each forecast is a weight ed average of the previous forecast and the last demand point. Thus this method is similar to the moving average, except that it is a weighted average of all past data points, with more recent points receiving more weight. 3. Methods for data with trends. The two previous approaches assume that there is no trend in the data. If there is a trend, methods such as regression analysis and :olt’s methods are more useful, as they specifically account for trends in the data. 4. Methods for seasonal data: seasonal decom position methods remove the seasonal patterns from the data and then apply the approaches listed above. Winter’s method is a version of exponential smoothing that accounts for trends and seasonality. 5. More complex methods.  Causal methods: are mathematical methods in which forecasts are generated based on a variety of system variables. Causal methods generate forecasts based on data other than the data being predicted. Selecting the appropriate forecasting technique:  What is the purpose of the forecast? How is it to be used? If gross sales estimates are sufficient, a less complex technique may be appropriate.  What are the dynamics of the system for which the forecast will be made? Is the system sensitive to the type o f economic data that would indicate that a causal model makes sense.  How important if the past in estimating the future? If the past is very important, time series methods make sense. IV. Chapter 4: Supply contracts Effective procurement strategies require the development of relationships with suppliers. These relationships can take many forms, both formal and informal, but often, to ensure adequate supplies and timely deliveries, buyers and suppliers typically agree on supply contracts. In a typical supply contract, the buyer and supplier will agree on:  Pricing and volume discounts  Minimum and maximum purchase quantities  Delivery lead times  Product or material quality  Product return policies Consider a typical two stage supply chain consisting of a buyer a nd a supplier. The sequence of events in such a supply chain is as follows. The buyer starts by generating a forecast, Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 determines how many units to order from the supplier and places an order to the supplier so as to optimize his own profit; the supplier r eacts to the order placed by the buyer. Thus, in this supply chain, the supplier has a make to order supply chain while the buyer is purchasing items prior to knowing customer demand, based on a forecast. This sequence of events represents a sequential d ecision making process and thus, the supply chain is referred to as a sequential supply chain. In such a sequential supply chain, each party determines its own course of action independent of the impact of its decisions on other parties. Obviously, this ca nnot be an effective strategy for supply chain partners since it does not identify what’s best for the entire supply chain. Example swimsuits blz 126: The buyer assumes all of the risk of having more inventory than sales, while the supplier takes no risk . Indeed, since the supplier takes no risk, he would like the buyer to order as much as possible, while the buyer limits his order quantity because of huge financial risk. Of course, since the buyer limits his order quantity, there is a significant increas e in the likelihood of out of stock. If the supplier is willing and able to share some of the risk with the buyer, it may be profitable for the buyer to order more items, thereby reducing out of stock probability and increasing profit for both supplier and buyer. It turns out that a variety of supply contracts enable risk sharing and therefore increase profits for both supply chain entities. Buy -back contracts: In this contract, the seller agrees to buy back unsold goods from the buyer for some agreed - upon price higher than the salvage value. This gives the buyer the incentive to order more units, since the risk associated with unsold items is decreased. On the other hand, the supplier’s risk clearly increases. Thus the contract is designed such that the increase in order quantity place by the buyer, and hence the decrease in the likelihood of out of stock, more than compensates the supplier for the increase in risk. Revenue sharing contracts: In a revenue sharing contract, the buyer shares some of its revenue with the seller, in return for a discount of the wholesale price. That is, in this contract, the buyer transfers a portion of the revenue from each unit sold to the end customer. Other types of supply contracts can be equally effective:  Quantity -flexibility contracts: are contracts in which the supplier provides full refund for returned items as long as the number of returns is no larger than a certain quantity. Thus, this contract gives full refund for a portion of the returned items, whereas a buy -back contract provides partial refund for all returned items.  Sales rebate contracts: provide a direct incentive to the retailer to increase sales by means of a rebate paid by the supplier for any item sold above a certain quality.  Global optimization: the various contracts described above raise an important question: what is the most profit for both the supplier and the buyer can hope to achieve. To answer this question, we take a completely different approach. What if an unbiased decision maker is allowed to identify the best strategy for the whole supply chain. The decision maker will maximize supply chain profit. This kind of unbiased decision maker doesn’t usually exist. However, effective supply chain Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 contracts provide incentives for supply chain partners to replace traditional strategies, in which each partner optimizes its own profit, with global optimization, where supply chain profit is maximized. The difficulty with global optimizatio n is that it requires the firm to surrender decision making power to an unbiased decision maker. Supply contracts help firms achieve global optimization, without the need for an unbiased decision maker, by allowing buyers and suppliers to share the risk an d the potential benefit. Effective supply contracts allocate profit to each partner in such a way that no partner can improve his profit by deciding to deviate from the optimal set of decisions. If these contracts are so effective, why do we not see mor e and more applications in practice. The answer has to do with the various implementation drawbacks. For example, buy -back contracts require the supplier to have an effective reverse logistics system. Revenue sharing contracts also have important limita tions. They require the supplier to monitor the buyer’s revenue and thus increase administrative cost. Another important limitation is that, in revenue sharing, buyers have an incentive to push competing products with higher profit margins. That is, r evenue sharing contracts typically reduce the buyer’s profit margin since some of the revenue is transferred to the supplier. Thus the buyer has an incentive to push other products. Contracts for make to stock/make to order supply chains A key assumpti on in all contracts discussed so far is that the supplier has a make to order supply chain. This implies that, in the sequential supply chain, the supplier takes no risk while the buyer takes all the risk. (example blz 131) Again, a variety of supply con tracts enable risk sharing and hence reduce manufacturer’s risk and motivate the manufacturer to increase production capacities. This increases profit for both the supplier and distributor.  Pay back contracts: in this contract, the buyer agrees to pay som e agreed -upon price for any unit produced by the manufacturer but not purchased by the distributor. This gives the manufacturer the incentive to produce more units, since the risk associated with unused capacity is decreased. On the other hand, the distrib utor’s risk increases.  Cost -sharing contracts: In the sequential supply chain, one important reason why the manufacturer does not produce enough is the high production cost. If somehow the manufacturer can convince the distributor to share s ome of the prod uction cost, then the manufacturer will have an incentive to produce more units. Of course, paying part of the production cost will decrease the distributor’s profit if it is unable to sell more units. In a cost -sharing contract, the buyers shares some of the production cost with the manufacturer, in return for a discount on the wholesale price. One problem with the cost sharing contract is that it requires the manufacturer to share its production cost information with the distributor; something manufacture rs are reluctant to do. Contracts with asymmetric information: An important assumption made in the discussion so far is that the buyer and supplier share the same demand forecast. It is easy to see, however, that when the supplier needs to build capacity based on forecast received from manufacturers, the buyer has an incentive to Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 inflate its forecast. The question is whether one can design contracts that achieve credible information sharing. The following two contracts achieve credible information sharing :  Capacity reservation contracts: manufacturer pays to reserve a certain level of capacity with the supplier.  Advance purchase contracts: supplier charges the advance purchase price for firms’ orders place prior to building capacity and a different price for any additional order placed when demand is realized. Contracts for nonstrategic components: Some companies have started looking at more flexible contracts for nonstrategic components. In this case, products can be purchased from a variety of suppliers and flexibility to market conditions is perceived as more important than a permanent relationship with suppliers. Commodity products are typically available from a large number of suppliers and can be purchased in spot markets. By selecting multi ple supply sources, the buyer can reduce supply costs and be more responsive and flexible to market conditions.

Thus an effective procurement strategy for commodity products has to focus on both driving costs down and reducing risks. These risks include:  Inventory risk due to uncertain demand  Price, or financial, risk due to volatile price  Shortage risk due to limited component availability. Contracts for nonstrategic components: (blz 138)  Long term contracts: also called forward or fixed commitment contracts, longterm contracts eliminate financial risk. These contracts specify a fixed amount of supply to be delivered at some point in the future; the supplier and the buyer agree on both the price and the quantity to be delivered to the buyer. In this case, the buyer bears no financial risk while taking huge inventory risks due to uncertainty in demand and the inability to adjust order quantities.  Flexible or option contract: one way to reduce inventory risk is through option contracts, in which the buyer prepays a relatively small fraction of the product price upfront, in return for a commitment from the supplier to reserve capacity up to a certain level. The initial payment is typically refer red to as a reservation price or premium. If the buyer does not exercise the option, the initial payment is lost. The buyer can purchase any amount of supply up to the option level by paying an additional price agreed to at the time the contract is signed, for each unit purchased. This additional price is referred to as the execution price or exercise price. Option contracts provide the buyer with flexibility to adjust order quantities depending on realized demand and these contracts reduce inventory risk. These contracts shifts risk form the buyer to the supplier.  Spot purchase: buyers look for additional supply in the open market.  Portfolio contract: Buyers sign multiple contracts at the same time in order to optimize their expected profit and reduce thei r risk. To find an effective contract, the buyer needs to identify the appropriate mix of low price yet low flexibility contracts, reasonable price but better flexibility contracts or unknown price and quantity supply but no commitment. The buyer must opti mize between the different contracts. We refer to this commitment as the base commitment level. How much capacity to buy from companies selling option contracts? We refer to this as the option level. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 V. Chapter 5: the value of information Information change s the way supply chains can and should be effectively managed and these changes may lead to, among other things, lower inventory. We show that by effectively harnessing the information now available, one can design and operate the supply chain much more ef ficiently and effectively than ever before. It should be apparent to the reader that having accurate information about inventory levels, orders, production and delivery status throughout the supply chain should not make the managers of a supply chain less effective than if this information were not available. Information does:  Helps reduce variability in the supply chain  Helps suppliers make better forecasts, accounting for promotions and market changes  Enables the coordination of manufacturing and distrib ution systems and strategies  Enables retailers to better serve their customers by offering tools for locating desired items  Enables retailers to react and adapt to supply problems more rapidly  Enables lead time reductions The bullwhip effect: Many suppliers and retailers have observed that while customer demand for specific products does not vary much, inventory and back -order levels fluctuate considerably across their supply chain. The increase in variability as we travel up in the supply chai n is referred to as the bullwhip effect. Example( blz 155): The wholesaler receives orders from the retailer and places orders to his supplier, the distributor. To determine these order quantities, the wholesaler must forecast the retailer’s demand. =f th e wholesaler does not have access to the customer’s demand data, he must place orders by the retailer to perform his forecasting. Since variability in orders placed by the retailer is higher than variability in customer demand, the wholesaler is forced to carry more safety stock than the retailer or else to maintain higher capacity than the retailer in order to meet the same service level as the retailer. It is important to identify techniques and tools that will allow us to control the bullwhip effect; th at is, to control the increase in variability in the supply chain. For this purpose, we need first understand the main factors contributing to the increase in variability in the supply chain:  Demand forecasting: As discussed in chapter 2, an attractive policy used in practice by each stage of the supply chain is the periodic review policy where the inventory policy is characterized by a single parameter, the base stock level. That is, the wareh ouse determines a target inventory level, the base stock level, and each review period, the inventory position is reviewed and the warehouse order enough to raise the inventory position to the base stock level. The base stock level is typically set equal to the average demand during lead time and review period plus a multiple of the standard deviation of demand during lead time and review period. The latter quantity is referred to as safety stock. Typically mangers use standard forecast smoothing technique s to estimate average demand and demand variability. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  Lead time: it is easy to see that the increase in variability is magnified with increasing lead time. Thus with longer lead times, a small change in the estimate of demand variability implies a signific ant change in safety stock and base stock level, leading to a significant change in order quantities.  Batch ordering: the impact of batch ordering is quite simple to understand. If the retailer uses batch ordering, as happens when using a (Q,R) inventory p olicy or a min - max policy, then the wholesaler will observe a large order, followed by several periods of no orders. Thus the wholesaler sees a distorted and highly variable pattern of orders.  Price fluctuation also can lead to the bullwhip effect. If pri ces fluctuate, retailers often attempt to stock up when prices are lower. This is accentuated by the prevailing practice in many industries of offering promotions and discounts at certain times or for certain quantities. This is referred to as forward buyi ng.  Inflated orders: inflated orders placed by retailers during shortage periods tend to magnify the bullwhip effect. Such orders are common when retailers and distributors suspect that a product will be short in supply and therefore anticipate receiving supply proportional to the amount ordered. Quantify the bullwhip effect: Quantify the increase in variability that occurs at every stage of the supply chain. This would be useful not only to demonstrate the magnitude of the increase in variability but als o to show the relationship between the forecasting technique, the lead time and the increase in variability. To quantify the increase in variability for a simple supply chain, consider a two stage supply chain with a retailer who observes customer demand and places an order to a manufacturer. Suppose that the retailer faces a fixed lead time, so that an order placed by the retailer at the end of period t is received at the start of period t + L. The base stock level is: √ Where AVG an d STD are average and standard deviation of daily (or weekly) customer demand. The constant z is the safety factor. To implement this inventory policy, the retailer must estimate the average and standard deviation of demand based on its observed customer demand. Thus, in practice, the order up to point may change from day to day according to changes in the current estimate of the average and the standard deviation. The order up to point is estimated form the observed demand as: √ Where t and S t are the estimated average and standard deviation of daily customer demand at time t. Suppose the retailer uses one of the simplest forecasting techniques: the moving average. In other words, in each period, the retailer estimates the mean demand as an average of the previous p observation of demand. Calculate the t and S t: (blz 157) Note that the expressions on this page imply that, in every period, the retailer calculates a new mean and standard deviation based on the p most rece nt observations of demand. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 Then, since the estimates of the mean and standard deviation change every period, the target inventory level also will change in every period. In this case we can quantify the increase in variability; that is, we can calculate the variability faced by the manufacturer and compare it to the variability faced by the retailer. If the variance of the customer demand seen by the retailer is VAR(D) then the variance of the orders placed by the retailer to the manufacturer, Var(Q) rel ative to the variance of customer demand satisfies: ( ) ( ) (blz 158). When p is large and L is small, the bullwhip effect due to forecasting error is negligible. The bullwhip effect is magnified as we increase the lead time and decrease p. For instance, suppose the retailer estimates the mean demand based on the last five demand observations, that is p=5. Suppose that an order placed by the retailer at the end of period t is received at the start of period t+1. This implies that the lead time equals 1, that is, L=1. In this case, the variance of the orders placed by the retailer to the manufacturer will be at least 40 percent larger than the variance of the customer demand seen by the retailer: ( ) ( ) If p=1 0. Then the variance of the orders placed by the manufacturer will be at least 1.2 times the variance of the customer demand seen by the retailer. In other words, by increasing the number of observations used in the moving average forecast, the retailer ca n significantly reduce the variability of the orders it places to the manufacturer. The impact of centralized information on the bullwhip effect: One of the most frequent suggestions for reducing the bullwhip effect is to centralize demand information within a supply chain. That is to provide each stage of the supply chain with complete information on the actual customer demand. If demand informatio n is centralized, each stage of the supply chain can use the actual customer demand data to create more accurate forecasts, rather than relying on the orders received from the previous stage, which can vary significantly more than the actual customer deman d. To determine the impact of centralized demand information on the bullwhip effect, we distinguish between two types of supply chains: one with centralized demand information and a second with decentralized demand information:  Supply chain with centrali zed demand information: the retailer or the first stage in the supply chain observes customer demand, forecasts the demand mean and variance using a moving average with p demand observations, finds his target inventory level (base stock) based on forecast mean and variance of demand and places an order to the wholesaler. The wholesaler, or the second stage of the supply chain, receives the order along with the retailer’s forecast information, uses this forecast to determine its target inventory level and pl aces an order to the distributor. Etc.. The variance of the orders by the kth stage of the supply chain, VAR(Q k), relative to the variance of the customer demand, VAR(D) is just: (blz 159). Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 We see that the variance of the orders placed by a given stage of a supply chain is an increasing function of the total lead time between that stage and the retailer. This implies that the variance of the orders becomes larger as we move up the supply ch ain, so that the orders placed by the second stage of the supply chain are more variable than the orders placed by the retailer.  Decentralized demand information: In this case, the retailer does not make its forecast mean and variance of demand available to the remainder of the supply chain. Instead the wholesaler must estimate the demand mean and variance based on the orders received from the retailer. The wholesaler and the distributor uses a moving average with p observations of the orders placed. It t urns out that in this system, the variance of the orders placed by the kth stage of the supply chain, VAR(Q k), relative to the variance of the customer demand, VAR(D) satisfies: (blz 160). This expression is very similar to the expression for the variabili ty of orders placed by the retailer in the centralized case, but now the variance increases multiplicatively at each stage of the supply chain. Again, the variance of the orders becomes larger as we move up the supply chain so that the orders placed by the wholesaler are more variable than the orders placed by the retailer. Managerial insights on the value of centralized information: We have already seen that, for either type of supply chain, centralized or decentralized, the variance of the order quantit ies becomes larger as we move up the supply chain so that the orders placed by the wholesaler are more variable than the orders placed by the retailer and so on. The difference in the two types of supply chains is in terms of how much the variability grows as we move from stage to stage. A decentralized supply chain in which only the retailer knows the customer demand, can lead to significantly higher variability than a centralized supply chain, in which customer demand information is available at each stag e of the supply chain, particularly when lead times are long. We therefore conclude that centralizing demand information can significantly reduce the bullwhip effect. When demand information is centralized, each stage of the supply chain can use the actu al customer demand data to estimate the average demand. On the other hand, when demand information is not shared, each stage must see the orders placed by the previous stage to estimate average demand. Centralizing demand information can significantly redu ce, but will not eliminate, the bullwhip effect. Methods for coping with the bullwhip effect:  Reducing uncertainty: one of the most frequent suggestions for decreasing or eliminating the bullwhip effect is to reduce uncertainty throughout the supply chai n by centralizing demand information. Note, however, that even if each stage uses the same demand data, each may still employ different forecasting methods and different buying practices, both of which may contribute to the bullwhip effect.  Reducing varia bility: the bullwhip can be diminished by reducing the variability inherent in the customer demand process. For example, if we can reduce the variability of the customer demand seen by the retailer, then even if the bullwhip effect occurs, the variability of the demand seen by the wholesaler also will be reduced. We can reduce the variability of customer demand through for example, the use of an everyday low pricing strategy. When a retailer uses EDLP, it offers a Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 product at a single consistent price, rathe r than offering a regular price with periodic price promotions.  Lead time reductions: the results presented in the previous subsections clearly indicate that lead times serve to magnify the increase in variability due to demand forecasting. Lead time redu ction can significantly reduce the bullwhip effect throughout a supply chain. Lead times typically include two components: order lead times and information lead times.  Strategic partnerships: The bullwhip effect can be eliminated by engaging in any of a nu mber of strategic partnerships. These strategic partnerships change the way information is shared and inventory is managed within a supply chain, possibly eliminating the impact of the bullwhip effect. However in some industries the different parties inv olved in the supply chain do not have the same strategy. So there can be a assemble to order strategy while their contract manufacturers typically have to build capacity due to long lead time, in advance to receiving orders from the other party. One possib le response is to inflate their forecast so that the supplier is motivated to build more capacity. Two contracts have been discussed in the literature and shown to provide incentives for buyers to reveal their true forecasts:  Capacity reservation contracts: in which the supplier provides the other party with a menu specifying different level of capacities he is willing to build and the corresponding price for each one.  Advance purchase contracts: in which the contract manufact urer charges an advance purchase price for orders placed prior to building capacity and a different price for any additional order placed when demand is realized. A related challenge that firms face when sharing their information with supply chain partne rs is how to guarantee that their information does not help their competitors. Effective forecasts: Information leads to more effective forecasts. The more factors that predictions of future demand can take into account, the more accurate these predictions can be. Retailer forecasts are based on an analysis of previous sales at the retailer. However, fut ure customer demand is clearly influenced by such issues as pricing, promotions and the release of new products. Similarly, distributor and manufacturer forecasts are influenced by factors under retailer control. For example, the retailer may design promot ions or set pricing. Information for coordination of systems: Within any supply chain there are many systems , including various manufacturing, storage, transportation and retail systems. All of these systems are connected. The outputs from one system wit hin the supply chain are the inputs to the next system. Trying to find the best set of trade -offs for any one stage isn’t sufficient. We need to consider the entire system and coordinate decisions. The issue is whose best interest is it to reduce overall s ystem cost and how will these savings be shared among the system owners? When the system is not coordinated, each facility in the supply chain does what is best for that facility, with the result of local optimization. The alternative for this approach i s global optimization, which implies that one identifies what is best for the entire system. Two issues need to be addressed: Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  Who will optimize?  How will the savings obtained through the coordinated strategy will be split between the different supply chain facilities. Lead time reduction: The importance of lead time reduction cannot be overstated. It typically leads to:  The ability to quickly fill customer orders that can’t be filled from stock.  Reduction in the bullwhip effect  More accurate forecasts due to decreased forecast horizon  Reduction in finished goods inventory levels. Information and supply chain trade -offs: In global optimization, the objective is to coordinate supply chain activities so as to maximize supply chain performance. The managers of different stages in the supply chain have conflicting goals and it is exactly these conflicts that necessitate the integration and coordination of the different stages in the supply chain. Trade -offs have to be made between reducing inventory or transpo rtation costs or between increasing product variety or reducing inventory levels. Suppliers would like to see stable volume requirements with little variation in the mix of required material. They also prefer flexible delivery times and see large volume demands. Manufacturing management wants to achieve high productivity. The materials, warehousing and outbound logistics management would minimize transportation costs by taking advantage of quantity discounts, minimizing inventory levels and quickly replenishing stock. In the following section we discuss many of these perc eived trade -offs and how, through the use of advanced technology and creative network design, they don’t have to be trade -offs at all in a modern supply chain:  The lot size -inventory trade -off: Manufacturers would like to have large lot sizes. Per unit setup costs are reduced, manufacturing expertise for a particular product increases and processes are easier to control. Unfortunately, typical demand doesn’t come in large lot sizes, so large lot sizes lead to high inventory. Setup time reduction, kanban and CONWIP(constant work in process) systems were geared toward reducing inventories and improving system responsiveness.  The inventory -transportation cost trade -off: If a truck is always full when it makes a delivery, the cost of operating the truck is spread out over the largest possible number of items. However demand is in units of far less than a single truckload. Thus when items are delivered in full truckloa ds, they typically have to wait for longer periods of time before they are consumed, leading to higher inventory costs. We can use advance production control systems to manufacture items as late as possible to ensure full truckloads.  The lead time -transpo rtation cost trade -off: Transportation costs are lowest when large quantities of items are transported between stages of the supply chain.

However, lead times often can be reduced if items are transported immediately after they are manufactured or arrive f rom suppliers. Thus there is a trade -off between Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 holding items until enough accumulate to reduce transportation costs and shipping them immediately to reduce lead time.  The product variety -inventory trade -off: product variety increases the complexity of supply chain management. To maintain the same lead times as a company may have had with fewer products, smaller amounts will probably be shipped so warehouses will need to hold a larger variety of products; thus increasing product variety increases both tra nsportation and warehousing costs. One way to support the required product variety efficiently is to apply the concept called delayed differentiation. In a supply chain in which delayed differentiation is utilized, generic products are shipped as far as po ssible down the supply chain before variety is added.  The cost -customer service trade -off: All of these trade -offs are examples of the cost - customer service trade -off. Reducing inventories, manufacturing costs and transportation costs typically comes at t he expense of customer service. It may not be necessary to exchange all of the available information or to exchange information continuously. In many cases there is a decreasing marginal value of information, in the sense that once key pieces of informat ion have been exchanged, there is little benefit in exchanging additional information. VI. Designing and managing the supply chain: A fully effective supply chain requires the integration of the front end of the supply chain, customer demand, with the back end of the supply chain, the production and manufacturing processes. The objective of this chapter is to illustrate various possibl e distribution strategies and the opportunities and challenges associated with these strategies. Fundamentally, there are two possible distribution strategies. Items can be directly shipped from the supplier or manufacturer to the retail stores or end cust omer or one or more intermediate inventory storage points can be used. Warehouses can be used in a variety of different ways depending, among other things, on the manufacturing strategy (make to stock versus make to order), the number of warehouses, the in ventory policy, the inventory turnover ratio and more. Direct shipment distribution strategies: Direct shipment strategies exist to bypass warehouses and distribution centers. The advantages:  The retailer avoids the expenses of operating a distribution c enter  Lead times are reduced Disadvantages:  Risk pooling effects are negated because there is no central warehouse  The manufacturer and distributor transportation costs increases because it must send smaller trucks to more locations For these reasons, dire ct shipment is common when the retail store requires fully loaded trucks, which implies that the warehouse does not help in reducing transportation cost. It is most often mandated by powerful retailers or used in situations where lead time is critical. Intermediate inventory storage point strategies: Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 There are a variety of characteristics that can be used to distinguish between different intermediate inventory storage point strategies. One of the most fundamental involves the length of time that inventor y is stored at warehouses and distribution centers. In a traditional warehousing strategy, the distribution centers and warehouses hold stock inventory and provide their downstream customers with inventory as needed. In a cross docking strategy, warehouses and distribution centers serve as transfer points for inventory, but not inventory is held at these transfer points. Traditional warehousing: There are a variety of issues and decisions in a traditional warehousing system:  Centralized versus decentrali zed management: in a centralized system, decisions are made at a central location for the entire supply network. Typically the objective is to minimize the total cost of the system subject to satisfying some service level requirements. We have already seen that centralized control leads to global optimization. In a decentralized system, each facility identifies its most effective strategy without considering the impact on the other facilities in the supply chain.

Thus a decentralized system leads to local o ptimization. In a logistics system in which each facility can access only its own information, a centralized strategy is not possible. With advances in information technologies, however, all facilities in a centralized system can have access to the same da ta. With single point of contact, information can be accessed from anywhere in the supply chain and is the same no matter what mode of inquiry is used or who is seeking information. Centralized systems allow the sharing of information and the utilization o f this information in ways that reduce the bullwhip effect and improve forecasts. Sometimes, a system cannot be centralized naturally, in these cases it is often helpful to form partnerships to approach the advantages of a centralized system.  Central vers us local facilities: Another critical decision in supply chain design involves whether to use centralized or local production and warehousing facilities. Centralized facilities imply both fewer warehouses and fewer distribution centers and these facilities are located further from customers. Additional important considerations: 1. Safety stock: Consolidating warehouses allows the vendor to take advantage of risk pooling. The more centralized, the lower the safety stock levels 2. Overhead: economies of scale suggest that operating a few large central warehouses leads to lower total overhead cost relative to operating many smaller warehouses. 3. Economies of scale: economies of scale can be realized if manufacturing is consolidated. 4. Lead time: can often be reduced if a large number of warehouses are located closer to the market areas 5. Service: Centralized warehousing enables utilization of risk pooling, which means that more orders can be met with lower total inventory level. On the other hand, shipping time for the warehouse to the retailer will be longer than in a decentralized system. 6. Transportation costs: as the number of warehouses increases, transportation costs between the production and the warehouses also Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 increase because total distance traveled is greater a nd quantity discounts are less likely to apply. It is also possible that some products will be stored in a central facility, while others will be kept in various local warehouses. For instance, very expensive products with low customer demand and high de mand uncertainty may be stocked at a central warehouse while low cost products facing high customer demand and low demand uncertainty may be stocked at many local warehouses. In the former, the objective is to take advantage of risk pooling by using a cent ralized warehouse and hence reduce inventory levels, while in the latter, the objective is to ship fully loaded trucks across the supply chain and hence reduce transportation cost. Cross docking: In this system, warehouses function as inventory coordinat ion points rather than as inventory storage points. In a typical cross -docking systems, goods arrive at warehouses from the manufacturer, are transferred to vehicles serving the retailers and are delivered to the retailers as rapidly as possible. This syst em limits inventory costs and decreases lead times by decreasing storage time. Cross docking systems require a significant start -up investment and are very difficult to manage:  Distribution centers, retailers and suppliers must be linked with advanced info rmation systems to ensure that all pickups and deliveries are made within the required time windows.  A fast and responsive transportation system is necessary for a cross docking system to work  Forecasts are critical, necessitating the sharing of informatio n.  Cross docking strategies are effective only for large distribution systems in which a large number of vehicles are delivering and picking up goods at the cross dock facilities at any one time. In such systems, there is enough volume ever day to allow sh ipments of fully loaded trucks from the suppliers to the warehouses. For the same inventory level, a centralized system provides a higher service level and hence higher sales. Inventory pooling program. Search will have no impact on the centralized system, since both retailers have access to the same inventory pool. However, it is intuitive that customer search will impact the decentralized system. Indeed, customer search implies that if a dealer knows th at its competitors do not keep enough inventory, this dealer should raise its inventory level to satisfy not only its own demand, but also the demand of customers who initially approach other dealers with limited inventory. On the other hand, if the dealer somehow learned that its competitors keep a significant amount of inventory, then this dealer is not likely to see customers who switch from a competitor and hence will reduce its inventory level. Thus, a dealer’s strategy depends on its competitor’s stra tegy. The more inventory the competitor keeps, the less inventory the dealer should order. The problem is that dealers do not know how competitors decide upon their inventory level. This question is addressed using concepts from game theory and the concept of Nash equilibrium. If two competitors are making decisions, we say that they have reached Nash equilibrium if they have both made a decision, in this case decided on an amount to order, and neither can improve his or her Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 expected profit by changing the order amount if the other dealer doesn’t change his order amount. The centralized system does not dominate the decentralized system. While retailers still prefer the centralized system, the manufacturer’s profit is higher in the decentralized system. The re is a unique Nash equilibrium in these systems: each retailer’s order quantity and profit increase as the fraction of customers searching in the system increases and whatever the fraction of customers searching is, retailers’ total expected profit will b e higher in the centralized pooling system than in the decentralized system. The situation for the manufacturer is not so clear. For large search percentages, t he retailers will order more in a decentralized system than in a centralized pooling one, incr easing manufacturer’s profit. If the search percentage is small, retailers order less in a decentralized system than in a centralized system, so that both the retailers and the manufacturer will prefer a centralized pooling strategy. Figure 7.12 (blz 238). Shows the amount ordered by the dealers as a function of the search level, a in the decentralized system of our example. Manufactures always prefer a higher search level. This can be achieved by increasing brand loyalty and information technology initiatives to increase communication between retailers. If brand loyalty increases, customers will more likely to search for a particular brand at another retailer if their first choice does not have the product in inventory. Information technology enhanc es communication between dealers and between dealers and customers, thus increasing the ease with which customers can search in the system. Transshipment: Sometimes, it isn’t necessary to literally have a centralized inventory deposit to take advantage o f inventory pooling. Indeed, the growth of rapid transportation options and advanced information systems has made transshipment an important option to consider when sel ecting supply chain strategies and other way to implement inventory pooling strategies. By transshipment we mean the shipment of items between different facilities at the same level in the supply chain to meet some immediate need. Transshipment capability allows the retailer to meet customer demand from the inventory of other retailers. To do this, the retailer must know what other retailers have in inventory and must have a rapid way to ship the items either to the store or to the customer’s home. Selecting an appropriate strategy: Very few major supply chains utilize one of these strategie s exclusively. Typically, different approaches are used for different products, making it necessary to analyze the supply chain and determine the appropriate approach to sue for a particular product or product family. The main factors that influence distr ibution strategies are: customer demand and location, service level and costs, including transportation and inventory costs all play a role. Both transportation and inventory costs depend on shipment size, but in opposite ways. Increasing lot sizes reduc es the delivery frequency and enables the shipper to take advantage of price breaks in shipping volume, therefore reducing transportation costs.

However, large lot sizes increase inventory cost per item because items remain in inventory for a longer period of time. Demand variability also has an impact on the Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 distribution strategy. The larger the variability, the more safety stock needed. Thus, stock held at the warehouses provides protection against demand variability and uncertainty, and due to risk po oling, the more warehouses a distributor has, the more safety stock is needed. On the other hand, if the warehouses are not used for inventory storage, as in the cross docking strategy, or if there are no warehouses at all, as in direct shipping, more safe ty stock is required in the distribution system. VII. Chapter 10: Global logistics and risk management In many ways, international supply chain management is the same as domestic supply chain management spread over a larger geographic area. However, internat ional supply chain networks can provide a wealth of additional opportunities if they are managed effectively.

At the same time, there are many potential problems and pitfalls to be aware of. Integrated systems:  International distribution systems: in this t ype of system, manufacturing still occurs domestically but distribution and typically some marketing take place overseas.  International suppliers: in this system, raw materials and components are furnished by foreign suppliers, but final assembly is perfor med domestically.  Offshore manufacturing: in this type, the product is typically sourced and manufactured in a single foreign location and then shipped back to domestic warehouses for sale and distribution.  Fully integrated global supply chain: here produ cts are supplied, manufactured and distributed from various facilities located throughout the world. Clearly a supply chain can fit more than one of these categories. Forces that collectively drive the trend toward globalization:  Global market forces: involve the pressures created by foreign competitors as well as opportunities created by foreign customers. Even if companies don’t do business overseas, the presence of foreign competitors in home markets can affect their business significantly. To defend do mestic markets successfully, companies may find it necessary to move into foreign markets. Much of the demand growth available to companies is in foreign and emerging markets. Recently companies have made great sacrifices and taken on considerable busin ess risk to become involved in ventures in mainland China.  Technological forces : are related to the products themselves. Various subcomponents and technologies are available in different regions and locations around the world and many successful firms nee d to have the ability to use these resources quickly and effectively. Global location of research and development facilities is becoming more common, primarily for two reasons: First as product cycles become shorter and time more important, companies have discovered how useful it is to locate research facilities close to manufacturing facilities. In addition, specific technical expertise may be available in certain areas or regions.  Global cost forces : cost forces often dictate global location decisions. C heaper skilled labor is drawing an increasing number of companies overseas. Supplier and manufacturer supply chain must often be tightly integrated to deliver certain products effectively. Often this can be accomplished most cost effectively if the various participants are located close together. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  Political and economic forces : Regional trade agreements may drive companies to expand into one of the countries in the regional group. Various trade protection mechanisms can affect international supply chain dec isions. Risk management: Costs can be lowered with a larger number of options for sourcing raw material, labor and outsourcing opportunities and a greater number of potential manufacturing sites. At the same time, the increase in potential markets allow for an increase in sales and profits. These advantages are due to the increase in the size and scope of the supply chain - they are independent of the specific characteristics of the global supply chain. Unfortunately, all these advantages and opportunities associated with global supply chains come with significant increase in the level of risks faced by today’s global companies. Outsourcing and offshoring imply that the supply chain is geographically more diverse and hence more exposed to various risks. M any sources of risks: (figure 10.1, blz 316). Unknown -unknown risks: are risks associated with scenarios where one cannot identify the likelihood of occurrence. Known -unk nown risk s: risks such as supplier performance, forecast accuracy and operational prob lems. The unknown -unknown are difficult to control while the known -unknown are more controllable. Currency fluctuations pose a significant risk in today’s global operations. They change the relative value of production and the relative profit of selling a product in a particular country. Relative costs change so that manufacturing, storing, distributing or selling in a particular region at a particular price can change from being extremely profitable to a total loss. Cost differences between domestic reg ions are not typically as dramatic as those across countries and more importantly, they don’t change as frequently. It should be stressed that although managers typically think of exchange rates as affecting the dollar value of assets and liabilities den ominated in foreign currencies, it is the operating exposure that can have the most dramatic effect on annual operating profit. The operating exposure reflects the fact that, in the short run, changes in currency exchange rates do not necessarily reflect c hanges in relative inflation rates between countries. Thus, over the short term, regional operations can become relatively more or less expensive in terms of dollars. Managing the unknown -unknown: Are there strategies that the firm can use to deal with the unknown -unknown? Unfortunately, these are the sources of risks that may create a mega disaster that not only can wipe out years of profit but also can force a company to exit a certain region or a specific market. The following methods for managing sup ply chain risks and in particular strategies for managing the unknown -unknown:  Invest in redundancy: built at the design stage. A key challenge in risk management is to design the supply chain so that it can effectively respond to unforeseen events, the unknown -unknown, without significantly increasing costs. This can be done Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 through careful analysis of supply chain cost trade -offs so that the appropriate level of redundancy is built into the supply chain . For example: (figure 10.2, blz 318).  Increase velocity in sensing and responding: require accurate information in a timely fashion  Create an adaptive supply chain community: in w hich all its elements share similar culture . This is the most difficulty risk management method to implement effectively. It requires all supply chain elements to share the same culture, work towards the same objectives and benefit from financial gains. It creates a community of supply chain partners that morph and reorganize to better react to sudden crisis. Managing global risks: Other risks faced by global supply chains, including those risks that can be, to a certain extent, quantified and controlled. Three ways a global supply chain can be employed to address global risks: speculative, hedge and flexible strategies.  Speculative strategies: using a speculative strategies, a company bets on a single scenario, with often spectacular results if the scenario is realized and dismal ones if it is not.  Hedge strategies: using hedge strategies, a company designs the supply ch ain in such a way that any losses in part of the supply chain will be offset by gains in another part.  Flexible strategies: enable a company to take advantage of different scenarios.

Flexible supply chains are designed with multiple suppliers and excess m anufacturing capacity in different countries. When considering the implementation of a flexible strategy, managers have to answer several questions:  Is there enough variability in the system to justify the use of flexible strategies?  Do the benefits of s preading production over various facilities justify the costs?  Does the company have the appropriate coordination and management mechanisms in place to take rapid advantage of flexible strategies. If the supply chain is appropriately designed, several app roaches can be utilized to implement flexible strategies effectively:  Production shifting: flexible factories and excess capacity and suppliers can be used to shift production from region to region to take advantage of current circumstances.

Exchange rates or labor costs.  Information sharing: having an increased presence in many regions and markets often will increase the availability of information.  Global coordination: having multiple facilities worldwide provides a firm with a certain amount of market l everage that it might otherwise lack. If a foreign competitor attacks one of your main markets, you can attack back.  Political leverage: the opportunity to move operations rapidly gives firms a measure of political leverage in overseas operations. Requir ements for global strategy implementation: Important developments that are necessary to set the stage for huge global integration.

These developments are outlined below for each of the five basic functions of firms: basic development, purchasing, production, demand management and order fulfillment. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  Product development: it is important to design products that can be modified easily for major markets and which can be manufactured in various facilities. While it is dangerous to design a product to be the average of what several markets require, it may be possible to design a base product or products that can be more easily adapted to several different markets.  Purchasing: a company will find it useful to have management teams responsible for the purch ase of important materials from many vendors around the world. In this way, it is much easier to ensure that the quality and delivery options from various suppliers are compatible and that a qualified team is present to compare the pricing of various suppl iers.  Production: excess capacity and plants in several regions are essential if firms are to take full advantage of the global supply chain by shifting production as conditions warrant. To utilize this kind of strategy, effective communications systems m ust be in place so that this global supply chain can be managed effectively.  Demand management: involves setting marketing and sales plans based on projected demand and available product, is carried out on a regional basis.  Order fulfillment: to successf ully implement a truly flexible supply chain management system, a centralized system must be in place so that regional customers can receive deliveries from the global supply chain with the same efficiency as they do from local or regionally based supply c hains. Only when a company is sufficiently prepared to implement flexible strategies can it take advantage of all that the global supply chain has to offer. Issues in international supply chain management:  International versus regional products: region specific products: some products have to be designed and manufactured specifically for certain regions. True global products: these products are truly global in the sense that no modification is necessary for global sales.  Local autonomy versus central control: centralized control can be important in taking advantage of some of the strategies we have discussed, but in many cases it makes sense to allow local autonomy in the supply chain.  Miscellaneous dangers : There are many dangers that firms must face as they expand their supply chains globally. Exchange rate fluctuations. The promise of cheap labor may mask the threat of reduced productivity. Expensive training may be required. Regional differences in log istics:  Cultural differences: language consists not only of words but also of expressions, gestures and context. Beliefs or specific value about something can differ widely from culture to culture. Customs vary greatly from country to country.  Infrastruct ure: road widths, bridge heights. Larger distances in the USA so more inventory might be held.  Performance expectation and evaluation: among first world nations, operating standards are generally uniform and high. In emerging nations, operating standards typically vary greatly. Some firms may have high expectations and place great value on contracts and agreements. Other might not be so scrupulous. In the third world, traditional performance measures have no meaning. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  Information sharing availability: supp ort systems in the emerging nations may not be in place to implement efficient information systems. Communications networks may be incomplete and not reliable enough to support the traffic.  Human resources: It may be true that skilled managerial and techn ical personnel are frequently not available in emerging nations, sometimes this is not the case. VIII. Chapter 11: Coordinated product and supply chain design In many organizations we find two interacting chains:  The supply chain, which focuses on the flow of physical products from suppliers through manufacturing and distribution all the way to retail outlets at customers  The development chain, which focuses on new product introduction and involves product architecture, make/buy decisions, earlier supplier inv olvement, strategic partnering, supplier footprint and supply contracts. Unfortunately, in most organizations, different managers are responsible for the different activities that are part of these chains. Each of these managers frequently has performance incentives that focus on his or her individual responsibilities, often ignoring the impact of his or her decisions on the other portion of the development and supply chains. Key characteristics of the supply chain include:  Demand uncertainty and variabil ity  Economies of scale  Lead time The development chain provides a different set of challenges. It can be characterized by:  Technology clockspeed: the speed by which technology changes in a particular industry.  Make/buy decisions, or decisions regarding what to make internally and what to buy from outside suppliers  Product structure, the level of modularity that a product musty have. Each of these characteristics has a significant impact on the supply chain strategy that the firm must use. There can be made a distinguish between two extreme type of products, innovative products and functional products. Functional products are characterized by slow technology clockspeed, low product variety and typically low profit margins. Products with fast clockspeed (innovative products) require a different approach than products with slow clockspeed (functional products). At the same time, both the supply chain strategy and the product design strategy must take into account the level of demand uncertainty. Figure 1 1.3 (blz 340) The impact of demand uncertainty and product introduction frequency on product design and supply chain strategy. It provides a framework for matching product design and supply chain strategies with characteristics of the development chain (cl ockspeed) and the supply chain (demand uncertainty). The horizontal axis provides information on demand uncertainty while the vertical axis represents product introduction frequency, or clockspeed. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 Higher demand uncertainty leads to a preference for mana ging the supply chain based on a pull strategy. Dealing with low economy of scale and achieving responsiveness Smaller demand uncertainty leads to an interest in managing the supply chain using a push strategy. High economies of scale and achieving cost e fficiency. High product introduction frequency suggest a focus on modular product architecture since this allows the independent development of product subcomponents so that final feature set selection and product differentiation are postponed as much as possible. Speeding up product development and postponing differentiation and thus product modularity is not that important when product introduction frequency is low. Four boxes:  A: predictable demand and slow product introduction. Diapers, soup and pas ta. Focus is on push strategy, supply chain efficiency and high inventory turns.  B: fast clockspeed and highly unpredictable. :igh tech products, PC’s, printers. Focus is on responsiveness, on pull strategy as well as modular product architecture.  C: fast clockspeed and low demand uncertainty. Cell phone engine. Demand uncertainty is low. It is part of a modular product but not in itself. Push. Efficiency and cost reduction.  D: slow clockspeed and high demand uncertainty. Combination push and pull. Lead time reduction is important. High end furniture, chemical products. Design for logistics: Transportation and inventory costs are often critical supply chain cost drivers. These are exactly the issues that DFL addresses. Three key components:  Economic packaging and transportation: Products can be packed more compactly so that they can efficiently packed and stored. Another reason to design products to pack compactly is that it takes up less stor age space. Efficient storage reduces certain components of inventory costs because handling costs decrease, space per product decrease and revenue per square foot can increase.  Concurrent and parallel processing : Modifying the manufacturing process. It in volves modifying the manufacturing process so that steps that were previously performed in a sequence can be completed at the same time. This reduce manufacturing lead time, lower inventory costs through improved forecasting and reduce safety stock require ments. A key to keeping the manufacturing process parallel is the concept of decoupling. If many of the components of the product can be decoupled, or physically separated, during manufacturing, it is possible that these components can be manufactured in p arallel. An added advantage of this strategy is that it may be possible to design different inventory strategies for the various decoupled components. If the supply of raw materials or manufacturing yield is uncertain for a particular component, a higher i nventory level can be held of that single component, rather than for the entire end product.  Standardization : By using standardization it may be possible to make effective use of the information in aggregate forecasts. Specifically, approaches based on pr oduct and process commonality make it possible to delay decisions about which specific product will be manufactured until after some of the manufacturing or purchasing decisions have been made. Product modularity and process modularity are the key Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 drivers that enable a standardization strategy that lowers inventory costs and increases forecast accuracy: 1. A modular product: is a product assembled from a variety of modules such that, for each module, there are a number of options. For example personal computer. 2. A modular process: is a manufacturing process consisting of discrete operations so that inventory can be stored in partially manufactured form between operations. Products are differentiated by completing a different subset of operations during the manufacturing process. Four different approaches to standardization:  Part standardization: common parts are used across many products. Common parts reduce required part inventories due to risk pooling and reduce part costs due to economies of scale. Excessive part commonality can reduce product differentiation, so that less expensive customization options might cannibalize sales of more expensive parts.  Process standardization : involves standardizing as much of the process as poss ible for different products and then customizing the products as late as possible. In this case, products and manufacturing processes are designed so that decisions about which specific product is manufactured – differentiation - can be delayed until afte r manufacturing is under way. The manufacturing process starts by making a generic or family product that is later differentiated into a specific end product. For this reason, this approach is also known as postponement or delayed product differentiation.

Design for delayed product differentiation can be effectively used to address the uncertainty in final demand even if forecasts cannot be improved. It may be necessary to resequence the manufacturing process to take advantage of process standardization. Re sequencing refers to modifying the order of product manufacturing steps so that those operations that result in the differentiation of specific items or products are postponed as much as possible. Part and process standardization are frequently connected. Sometimes part standardization is necessary for implementing process standardization. In some cases, the concepts of resequencing and commonality allow the final manufacturing steps to be completed at distribution centers or warehouses instead of a the fa ctory. One advantage of this approach is that if DCs are much closer to the demand than the factories, products can be differentiated closer to the demand and thus increasing the firm’s ability to respond to rapidly changing markets.  Product standardization : a large variety of products may be offered, but only a few kept in inventory. When a product not kept in stock is ordered, the order may be filled by a product that offers a superset of the features required by a customer. This process is known as downward substitution. For example, fill reservations with higher end rooms when lower end rooms are not available.  Procurement standardization : involves standardizing processing equipment and approaches even when the product itself is not standa rdized. Selecting a standardization strategy: (blz 348).  If process and product are modular, process standardization will help to maximize effective forecast accuracy and minimize inventory costs. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  If the product is modular but the process is not, it is not possible to delay differentiation. Part standardization is effective.  If the process is modular but the product is not, procurement standardization may decrease equipment expenses.  If neither the process nor the product is modula r, some benefits may s till result from focusing on product standardization. The various strategies described above are designed to deal with inaccurate forecasts and product variety; frequently, it may not be possible or cost effective to implement these strategies in the con text of a particular product or a specific supply chain. Even if implementing a particular strategy is theoretically possible, in many cases the expenses resulting from product and packaging redesign will exceed the savings under the new system. It may als o be more expensive to manufacturer a product with a new process. It is therefore necessary to estimate the savings produced by a more effectively designed product or process and compare these savings to the increased cost of manufacturing. Many of the ben efits of implementing such a system are very difficult to quantify; increased flexibility, more efficient customer service and decreased market response times may be hard to place a value on. Process modifications such as resequencing will cause the leve l of inventory in many cases to go down but the per unit value of inventory being held will be higher. The push -pull boundary: It is not always practical to implement a pull -based system throughout the entire supply chain. Lead times may be too long, or it may be necessary to take advantage of economies of scale in production or transportation. The standardization strategies we have been discussing in this section can be viewed as a method to combine push and pull systems within a sing le supply chai n. The point of differentiation is the push -pull boundary, since this is the point where the system changers from a push based system to a pull based system. An additional advantage of postponement is that it allows firms to realize many of the advantages of pul l-based systems, while at the same time allowing for the economies of scale inherent in push -based systems. Supplier integration into new product development: Another key supply chain issue involves the selection of appropriate suppliers for components of the new product. Firms often realize tremendous benefits from involving suppliers in the design process. Benefits include a decline in purchased material costs, an increase in purchased material quality, a decline in development time and cost and in manufacturing costs. The supplier integration study notes that there is no single appropriate level of supplier integration. Instead they develop the notion of a spectrum of supplier integration. They indentify a series of steps from least to most supplier responsibility as follows:  None: the supplier is not involved in design.  White box: this level of integration is informal. The buyer consults with the supplier informally when designing products and s pecifications, although there is no formal collaboration.  Grey box: this represents formal supplier integration. Collaborative teams are formed between the buyer’s and the supplier’s engineers and joint development occurs. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92  Black box: the buyer gives the s upplier a set of interface requirements and the supplier independently designs and develops the required component. Of course, just because the black -box approach is at one end of the continuum doesn’t mean that it is the best approach in all cases. Inste ad firms must develop a strategy that helps them determine the appropriate level of supplier integration for different situations. Three steps can help management determine what is going to be procured from suppliers and what level of supplier expertise is appropriate:  Determine internal core competencies  Determine current and future new product developments  Identify external development and manufacturing needs. If future products have components that require expertise that the firm does not possess and de velopment of these components can be separated from other phases of product development, then taking a black box approach makes sense. Keys to effective supplier integration: Simply selecting an appropriate level of supplier integration is not sufficient . Much work goes into ensuring that the relationship is a success. The next steps of the strategic planning process help to ensure this success:  Select suppliers and build relationships with them  Align objectives with selected suppliers. Mass customizat ion: Has evolved from the two prevailing manufacturing paradigms of the 20 th century: craft production and mass production . Mass production involves the efficient production of a large quantity of a small variety of goods. Craft production on the other hand, involves highly skilled and flexible workers, often craftsmen in the manufacturing setting, who are governed by person al or professional standards and motivated by the desire to create unique and interesting products or services. These workers, found in so -called organic organizations, are typically trained through apprenticeships and experience. The organization is flexi ble and continually changing. In the past, managers often had to make a decision between these two types of organizations with their inherent trade -offs. The development of mass customization demonstrates that it is not always necessary to make this trade -off. Mass customization involves the delivery of a wide variety of customized goods or services quickly and efficiently at low cost. The key to making mass customization work is highly skilled and autonomous workers, processes and modular units, so tha t managers can coordinate and reconfigure these modules to meet specific customer requests and demands. Each module continually strives to upgrade its capabilities; a module’s success depends on how effectively, quickly and efficiently it completes its tas k and how good it is at expanding its capabilities. Managers are charged with determining how these capabilities fit together efficiently. Thus, management’s success depends on how effectively it can develop, maintain and creatively combine the links betwe en modules in different ways to meet different customer requests and on the creation of a work environment that encourages the development of a variety of different modules. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 Since these units or modules can be assembled in many ways, the differentiation o f craft production is achievable. There are several key attributes that a company, or, more specifically, the systems within a company that link different modules, must possess to implement mass customization successfully. They are:  Instantaneousness: modules and processes must be linked together very quickly. This allows rapid response to various customer demands.  Costless: the linkages must add little if any cost to the processes. This attribute allows mass customization to be a low cost alternative.  Seamless: the linkages and individual modules should be invisible to the customer, so customer service doesn’t suffer.  Frictionless: Networks or collections of modules must be formed with little overhead. With these attributes in place, it become possible to design and implement a dynamic flexible firm that can respond to varying customer needs quickly and efficiently. IX. Chapter 6: Supply chain integration The objective of this chapter is to illustrate the opportunities and the challenges associated with s upply chain integration. The availability of information plays an important role in supply chain integration. In some cases, the supply chain must be designed to make this information available. In other cases, the supply chain strategy must be designed t o take advantage of information that is already available. Push, pull and push -pull systems:  In a push based supply chain, production and distribution decisions are based on long -term forecasts. Typically, the manufacturer bases demand forecasts on order s received from the retailer’s warehouses. =t therefore takes much longer for a push - based supply chain to react to the changing marketplace, which can lead to: 1. The inability to meet changing demand patterns 2. The obsolescence of supply chain inventory as demand for certain products disappears. Variability of orders received from the retailers and the warehouses is much larger than the variability in customer demand, due to the bullwhip effect. This increase in variability leads to: 1. Excessive inventories due to the need for large safety stocks 2. Larger and more variable production batches 3. Unacceptable service levels 4. Product obsolescence The bullwhip effect leads to inefficient resource utilization because plan ning and managing are much more difficult. In a push based supply chain, we often find increased transportation costs, high inventory levels and or high manufacturing costs.  Pull based supply chain: production and distribution are demand driven so that they are coordinated with true customer demand rather than forecast demand. In a pure pull system the firm does not hold any inventory and only responds to specific orders. Pull systems are intuitively attractive since they lead to: 1. A decrease in lead times achieved through the ability to better anticipate incoming orders from the retailers Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 2. A decrease in inventory at the retailers since the inventory levels at these facilities increase with lead times 3. A decrease in variability in the system and in parti cular variability faced by manufacturers 4. Decreased inventory at the manufacturer due to the reduction in variability. On the other hand, pull -based systems are often difficult to implement when lead times are so long that it is impractical to react to d emand information. Also, in pull based systems, it is frequently more difficult to take advantage of economies of scale in manufacturing and transportation since systems are not planned far ahead in time.  Push -Pull supply chain: some stages of the supply chain, typically the initial stages are operated in a push based manner, while the remaining stages employ a pull based strategy. The interface between the push based stages and the pull based stages is known as the push -pull boundary. To better understan d this strategy, consider the supply chain time line defined as the time that elapses between the procurement of raw material, that is, the beginning of the time line and the delivery of an order to the customer, that is, the end of the time line. The push -pull boundary is located somewhere along the time line. In this case the manufacture takes advantage of the fact that aggregate forecasts are more accurate. Demand for a component is an aggregation of demand for all finished products that use this compone nt. Since aggregate forecasts are more accurate, uncertainty in component demand is much smaller than uncertainty in finished goods demand and this leads to safety stock reduction. Postponement or delayed differentiation is also an excellent example of a push -pull strategy. Identifying the appropriate supply chain strategy: Framework: (blz 191). Higher demand uncertainty leads to a preference for managing the supply chain based on realized demand: pull strategy. Smaller demand uncertainty leads to an in terest in managing the supply chain based on a long term forecast: push strategy. Since uncertainty in the push portion of the supply chain is relatively small, service level is not an issue, so the focus can be on cost minimization. This portion of the s upply chain is characterized not only by low demand uncertainty and economies of scale in production and or transportation, but also by long lead times and complex supply chain structures. Thus cost minimization is achieved by better utilizing resources su ch as production and distribution capacities while minimizing inventory, transportation and production costs. On the other hand, the pull portion of the supply chain is characterized by high uncertainty, simple supply chain structure and a short cycle ti me. Here the focus is on service level. High service level is achieved by deploying a flexible and responsive supply chain. Notice that the push portion and the and the pull portion of the supply chain interact only at the push -pull boundary. This is the point along the supply chain time line where there is a need to coordinate the two supply chain strategies, typically through buffer inventory. In the push portion, buffer inventory at the boundary is part of the output generated by the tactical planning process, while in the pull part it represents the input to the fulfillment process. Thus the interface between the push portion of the supply chain and the pull Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 portion of the supply chain is forecast demand. This forecast is used to drive the supply chain planning process and determines the buffer inventory. The impact of lead time: The longer the lead time, the more important it is to implement a push -based strategy. Impact of lead time: (blz 195). Box C: products with short supply lead time and highly predictable demand: for example bread or dairy products. Retailers and supermarkets use a strategy referred to as continuous replenishment. Since customer demand drives production and distribution deci sions in this supply chain, this strategy is a pull strategy at the production and distribution stages and push at the retail outlets. Box D: lead times are long and demand is not predictable. Different stages of the supply chain are managed in different ways, depending among other things, on economies of scale; those stages that keep inventory are managed based on push and others are managed based on pull. Demand driven strategies: The framework we have developed in this chapter requires the integrating demand information into the supply chain planning process. This information is generated by applying two different processes:  Demand forecast: a process in which historical demand data are used to develop long term estimates of expected demand.  Demand sha ping: a process in which the firm determines the impact of various marketing plans such as promotion, pricing discounts, rebates, new product introduction and product withdrawal on demand forecasts. Of course the forecast is not completely accurate, an important output from the demand - forecast, the so called forecast error, measured according to its standard deviation. Can the firm employ supply chain strategies to increase forecast accuracy and decrease forecast error:  Select the push -pull boundary so t hat demand is aggregated over one or more of the following dimensions: demand is aggregated across products, demand is aggregated across geography and demand is aggregated across time.  Use market analysis and demographic and economic trends to improve for ecast accuracy.  Determine the optimal assortment of products by store so as to reduce the number of SKUs competing in the same market.  Incorporate collaborative planning and forecasting processes with your customers so as to achieve a better understandin g of market demand, impact of promotions, pricing events and advertising. The impact of the internet on supply chain strategies: The internet and the emerging e -business models have produced expectations that many supply chain problems will be resolved m erely by using these new technology and business models. E -business strategies were supposed to reduce cost, increase service level and increase flexibility. In reality, these expectations have frequently gone unmet as many of the new e -businesses have not been successful. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 Why is it that, in some cases these new business models fail, while, in other cases, they are incredible successful? To answer this question, we require a better understanding of internet based supply chain strategies. What is E -busine ss:  E-business is a collection of business models and processes motivated by Internet technology and focusing on improvement of extended enterprise performance.  E-Commerce is the ability to perform major commerce transactions electronically. Table 6.3 (b lz 202) summarizes the impact of the Internet on fulfillment strategies. X. Chapter 8: Strategic alliances: There are four basic ways for a firm to ensure that a logistics -related business is completed:  Internal activities: A firm can perform the activity using internal resources and expertise if they are available. If this activity is one of the core strengths of the firm, this may be the best way to perform the activity.  Acquisitions: =f a firm doesn’t have the expertise o r specialized resources internally, it can acquire another firm that does. This certainly gives the acquiring firm full control over the way the particular business functions is performed. However, acquiring a successful company can be difficult and expens ive.  Arm’s length transactions: most business transactions are of this type. A firm needs a specific item or service , such as the delivery of a load of items, the maintenance of a vehicle or the design and installation of logistics management software an d purchases or leases the item or service.  Strategic alliances: these are multifaceted, goal oriented, long term partnerships between two companies in which both risks and rewards are shared. Framework for strategic alliances: To determine whether a particular strategic alliance is appropriate for your firm consider how the alliance will help address the following issues:  Adding value to products: a partnership with the appropriate firm can help add value to existing products.  Improving market access : partnerships that lead to better advertising or increased access to new market channels can be beneficial.  Strengthening operations: alliances between appropriate firms can help to improve operations by lowering system costs and cycle times.  Adding tec hnological strength: partnerships in which technology is shared can help add to the skills base of both partners.  Enhancing strategic growth: partnerships might enable firms to pool expertise and resources to overcome high entry barriers and explore new o pportunities.  Enhancing organizational skills: alliance provide a tremendous opportunity for organizational learning.  Building financial strength: alliances can help to build financial strength. Strategic alliances have their downsides:  The core strengths or competencies of a company must not be weakened by the alliance. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 Third party logistics (3PL): Third party logistics is simply the use of an outside company to perform all or part of the firm’s materials management and product distribution functions. 3 PL relationships are true strategic alliances. 3PL providers come in all sizes and shapes, from small companies to huge companies. Most of these companies can manage many stages of the supply chain. Some third party logistics providers own assets such as t rucks and warehouses; other may provide coordination services but not own assets on their own. Advantages of 3PL:  Focus on core strengths: the most frequently cited benefit of using 3PL logistics is that it allows a company to focus on its core competenc ies. It is difficult to be an expert in every facet of the business.  Provide technological flexibility: the ever increasing need for technological flexibility is another important advantage of the use of 3PL providers. As requirements change and technolog y advances the better 3PL providers constantly update their information technology and equipment. Often individual companies do not have the time, resources or expertise to constantly update their technology.  Provide other flexibilities: third parties also may provide greater flexibility to a company. One example is flexibility in geographic locations. Increasingly, suppliers are requiring rapid replenishment, which in turn may require regional warehousing.

By utilizing third part providers for this warehousing, a company can meet customer requirements without committing capital and limiting flexibility by constructing a new facility or committing to a long term lease. Disadvantages of 3PL:  Loss of control  If logistics is one of the core competencies of a firm, it makes no sense to outsource these activities. A third party logistics contract is typically a major and complex business decision. There are many considerations that are critical in deciding whether an agreement should be entered into with a particular 3PL provider:  Known your own costs  Customer orientation of the 3PL: the value of a 3PL relationship is directly related to the ability of the provider to understand the needs of the hiring firm and to adapts its services to the special requirements of that firm.  Specialization of the 3PL: when choosing a potential 3PL provider, some experts suggest that companies should consider firms whose roots lie in the particular area of logistics that is most rel evant to the logistics requirements in question.  Asset owning versus non -asset owning 3PL. Asset owning companies have significant size and systems in place but they may tend to favor their own decisions in awarding work, to be bureaucratic and to have a long decision making cycle. Non asset owning companies may become more flexible and able to tailor services that have the freedom to mix and match providers. 3PL implementation issues: Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 Once a potential partner has been selected, the process has only begu n. Agreements need to be reached and appropriate efforts must be made by both companies to initiate the relationship effectively. Experts point to one lesson in particular that has come from failed 3PL agreements: devote enough time to start -up considerati ons. The company purchasing the services must identify exactly what it needs for the relationship to be successful and be able to provide specific performance measures and requirements to the 3PL firm. In general effective communication is essential for an y outsourcing project to succeed. Other important issues:  The third party and its service providers must respect the confidentiality of the data that you provide them  Specific performance measures must be agreed upon  Specific criteria regarding subcontract ors should be discussed  Arbitration issues should be considered before entering into a contract  Escape clauses should be negotiated into the contract  Methods of ensuring that performance goals are being met should be discussed Retailer -supplier partnersh ips: Suppliers have far better knowledge of their lead times and production capacities than retailers do. As margins get tighter and customer satisfaction becomes even more important, it makes sense to create cooperative efforts between suppliers and retai lers in order to leverage the knowledge of both parties. These are called retailer -supplier partnerships (RSP). Types of RSP:  Basic response strategy: suppliers receive POS data from retailers and use this information to synchronize their production and i nventory activities with actual sales at the retailer.  In a continuous replenishment strategy: vendors receive POS data and use these data to prepare shipments at previously agreedupon intervals to maintain specific levels of inventory. In an advanced form of continuous replenishment, suppliers may gradually decrease inventory levels at the retail store or distribution center as long as service levels are met.  Vendor managed inventory system: the supplier decides on the appropriate inventory levels of each of the products and the appropriate inventory policies to maintain these levels. The goal of many VMI programs is to eliminate retailer oversight in specific orders. Requirements for RSP: The most important requirement is advanced information systems. Electronic data interchange – to relay POS information to the supplier and delivery information to the retailer – are essential to cut down on data transfer time and entry mistakes. Bar coding and scanning are essential to maintain data accuracy. RSP requires the partners to develop a certain level of trust without which the alliance is going to fail. Suppliers need to demonstrate that they can manage the entire supply chain; that is, they can manage not only their own inventory but also that of the retailer. Inventory ownership in RSP: Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 One major issue is the decision concerning who makes the replenishment decisions. Some VMI partnerships are moving to a consignment relationship in which the supplier own the goods until they are sold. The benefit of this kind of relationship to the retailer is obvious:

lower inventory costs. One possible criticism of the original VMI scheme is that the vendor has an incentive to move to the retailer as much in ventory as the contract allows. Issues in RSP implementation: For any agreement to be a success, performance measurement criteria also must be agreed to. These criteria should include nonfinancial measures as well as traditional financial measures. For e xample, nonfinancial measures could include point of sale (POS) accuracy, inventory accuracy, shipment and delivery accuracy, customer fill rates and lead times.

When information is being shared between retailers and supplier, confidentiality becomes an is sue. When entering any kind of alliance, it is important for both parties to realize that there will initially be problems that can only be worked out through communication and cooperation. Steps in RSP implementation:  The contractual terms of the agreem ent must be negotiated.  Integrated information systems must be developed for both supplier and retailer.  Effective forecasting techniques to be used by the vendor and the retailer must be developed.  A tactical decision support tool to assist in coordinat ing inventory management and transportation policies must be developed. Advantages and disadvantages of RSP:  Huge advantage of RSPs is the knowledge the supplier has about order quantities, implying an ability to control the bullwhip effect.  Implementin g a strategic partnership provides a variety of side benefits. It provides a good opportunity for the reengineering of the retailer -supplier relationship. For example, redundant order entries can be eliminated. Many of the problems with retailer -supplier partnerships:  It is necessary to employ advanced technology, which is often expensive  It is essential to develop trust in what once may have been an adversarial supplier - retailer relationship  In a strategic partnership, the supplier often has much more res ponsibility than formerly.  Finally, and perhaps most critically, expenses at the supplier often increase as managerial responsibilities increase. Thus it may be necessary to work out a contractual relationship in which the retailer shares decreased system inventory costs with the supplier. Distributor integration For years, business experts have advised manufacturers, particularly industrial manufactures to treat their distributors like partners. This meant appreciating the value of the distributors and their relationship with the end users, and providing them with the necessary support to be successful. Distributors have a wealth of information about customer needs and wants Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 and successful manufacturers use this information when developing new products and product lines. Types of distributor integration: Distributor integration can be used to address both inventory related and service related issues. In terms of inventory, DI can be used to create a large pool of inventory across the entire distributor network, lowering total inventory costs while raising service levels. Similarly, D= can be used to meet a customer’s specialized technical service re quests by steering these requests to the distributors best suited to address them. In a DI arrangement, each distributor can check the inventories of other distr ibutors to locate a needed product or part. Dealers are contractually bound to exchange the part under certain conditions and for agreed -upon remuneration. This type of arrangement improves services levels at each of the distributors and lowers the total s ystem inventory required. DI can be used to improve each distributor’s perceived technical ability and ability to respond to unusual customer requests. There are two major issues involved in implementing a DI alliance:  Distributors may be skeptical of the rewards of participating in such a system. There is the chance that they will feel they are providing some of their expertise in inventory control to less skilled partners.  This new kind of relationship also tends to take responsibilities and areas of ex pertise away from certain distributors and concentrate them on a few distributors. It is not surprising that distributors might be nervous about losing these skills and abilities.

Distributors must feel sure that this is a long term alliance. Organizers mu st work hard to build trust among the participants. Chapter 9: Procurement and outsourcing Throughout the 90s, strategic outsourcing, outsourcing the manufacturing of key components, was used as a tool to rapidly cut costs. Some of the motivations for o utsourcing are:  Economies of scale: an important objective in outsourcing is to reduce manufacturing costs through the aggregation of orders from many different buyers.  Risk pooling: outsourcing allows buyers to transfer demand uncertainty to the CEM (con tract equipment manufacturers). One advantage that the CEMs have is that they aggregate demand from many buying companies and thus reduce uncertainty through the risk pooling effect.  Reduce capital investment: The CEM can make this investment because it i s implicitly shared between many of the CEM’s customers.  Focus on core competency: By carefully choosing what to outsource, the buyer is able to focus on its core strength, that is, the specific talent, skills and knowledge sets that differentiate the com pany from its competitors and give it an advantage in the eye of the customers.  Increased flexibility: three issues: 1. The ability to better react to changes in customer demand 2. The ability to use the supplier’s technical knowledge to accelerate product deve lopment cycle time 3. The ability to gain access to new technologies and innovation. Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 These are critical issues in industries where technologies change very frequently, for example, high tech. Two substantial risks associated with outsourcing:  Loss of competitive knowledge: outsourcing critical components to suppliers may open up opportunities for competitors. Outsourcing implies that companies lose their ability to introduce new designs based on their own agenda rather than the supplier’s agend a.  Conflicting objectives: Suppliers and buyers typically have different and conflicting objectives. Increased flexibility is a key objective when buyers outsource the manufacturing of various components. This implies an ability to better match supply and demand by adjusting production rates as needed. Unfortunately, this objective is in direct conflict with the suppliers’ objectives of long -term, firm and stable commitment from the buyer. In good times, when demand is high, buyers are willing to make long term commitments to purchase minimum quantities specified by a contract. However, in a slow economy, when there is a significant decline in demand, these long term commitments entail huge financial risks for the buyers. Framework for buy/make conditions: How can the firm decide on which component to manufacture and which to outsource? To introduce the framework, the reasons for outsourcing are divided into two major categories:  Dependency on capacity: the firm has the knowledge and the skills r equired to produce the component but for various reasons decides to outsource  Dependency on knowledge: the company does not have the people, skills or knowledge required to produce the component and outsources in order to have access to these capabilities. We distinguish between integral and modular products. A modular product can be made by combining different components. The definition of modular products:  Components are independent of each other  Components are interchangeable  Standard interfaces are u sed  A component can be designed or upgraded with little or no regard to other components  Customer preference determines the product configuration An integral product is a product made up from components whose functionalities are tightly related:  Integral products are not made from off -the -shelf components  Integral products are designed as a system by taking a top -down design approach  Integral products are evaluated based on system performance, not based on component performance  Components in integral produ cts perform multiple functions. Of course, in real life, very few products are either modular or integral. Indeed, the degree of modularity or integrality may vary with personal computers being on one part of the spectrum, that is, highly modular product s and airplanes as highly integral products. The framework: (Blz 284). Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 For modular products, capturing knowledge is important, whereas having production capacity in -house is less critical. Thus if the firm has the knowledge, outsourcing the manufacturing process provides an opportunity to reduce cost. On the other hand, if the firm has neither the knowledge, nor the capacity, outsourcing may be a risky strategy as the knowledge developed by the supplier may be transferred to a competitor’s products. For integral products, capturing both knowledge and capacity is important as long as it is possible to have both. This implies that if the firm has both the knowledge and the capacity, then in -house production is appropriate. On the other hand, if the firm does not have both, perhaps it is in the wrong business. How do a firm determine whether a specific component should be outsourced or made internally? Five criteria :  Customer importance: how important is the component to the customer. What is the value the customers attached to the component  Component clockspeed: how fast does the component’s technology change relative to other components in the system?  Competitive position: does the firm have a competitive advantage producing the component  Capable suppl iers: how many capable suppliers exist  Architecture: how modular or integral is this element to the overall architecture of the system? Depending on these criteria, the decision may be to outsource, keep in house, acquire capability, develop strategic part nering with a supplier or help develop supplier capabilities. For example:  When the component is important to the customer, the clockspeed is fast and the firm has a competitive advantage, clearly keeping the component manufacturing in - house is appropriate .  If the customer value is high, clockspeed is fast and the competitive position is weak, the firm should either invest to develop in -house capability, acquire a supplier or develop strategic partnering depending on the number of suppliers in the market.  If customer value is high, clockspeed is slow and competitive position is weak, the strategy depends on the component architecture. When the architecture is modular, outsourcing is appropriate. On the other hand, when the component is an integral part of the entire system, joint development with suppliers, or even development of in-house capability is the right course of action. Procurement strategies: Today procurement is used as a competitive weapon that distinguishes successful, highly profitable comp anies from others within the same industry. The smaller the profit margins, the more important it is to focus on reducing procurement costs. The appropriate procurement strategy depends on the type of products the firm is purchasing and the level of risk a nd uncertainty involved. So how can the firm develop an effective purchasing strategy? What are the capabilities needed for a successful procurement function? What are the drivers of effective procurement strategies? Kraljic’s supply matrix: (blz 287) Stuvia.com - The Marketplace to Buy and Sell your Study MaterialStuvia.com - The Marketplace to Buy and Sell your Study Material Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 Fir m’s supply strategy should depend on two dimensions: Profit impact and supply risk. Supply risk is assessed in terms of availability, number of suppliers, competitive demand, make or buy opportunities and storage risks and substitution opportunities. On th e other hand, profit impact is determined in terms of the volume purchased, percentage of total purchased cost or impact on product quality or business growth.  The top right corner represents items where supply risk and impact on profit are high. Example s: car engines and transmission systems.  Bottom right: items with high impact on profit but low supply risk. Items that have many suppliers and small percentage of cost savings will have a large impact on the bottom line.  Top left: high supply risk but l ow profit impact items. These components, referred to as bottleneck components, do not contribute a large portion of the product cost, but their supply is risky. For these bottleneck items, ensuring continuous supply, even possibly at a premium cost is imp ortant.  Bottom right: for noncritical items, the objective is to simplify and automate the procurement process as much as possible. In this case, a decentralized procurement policy is appropriate, where authorized employees order directly without going through a f ormal requisition and approval process. Supplier footprint: The supply chain strategy that should be applied to innovative products is quite different than the supply chain strategy for functional products. When the firm procures functional products, the focus should be on minimizing total landed cost, that is the total cost of purchasing and delivering the product to its final destination. This cost includes:  Unit cost  Transportation cost  Inventory holding cost  Handling cost  Duties and taxation  Cost of financing On the other hand, when procuring innovative products, the focus should be on reducing lead times and on supply flexibility. When a retailer or a distributor procures functional products, sourcing from low cost countries is appropriate. When so urcing innovative products, the focus is on suppliers close to the market area, that is, where products are sold. Sourcing strategy for components: Four criteria:  Component forecast accuracy  Component supply risk  Component financial impact  Component cloc kspeed Depending on these criteria, the decision may be to focus on the sourcing strategy on minimizing total landed costs, lead time reduction or increasing flexibility. For example, when the component forecast accuracy is high, supply risk is low, financ ial impact is high and Stuvia.com - The Marketplace to Buy and Sell your Study Material Powered by TCPDF (www.tcpdf.org) Downloaded by: rayracks | [email protected] Distribution of this document is illegalAuteursrecht: Mx92 clockspeed is slow, a cost based sourcing strategy is appropriate. In contrast, when component forecast accuracy is low, financial risk is high and clockspeed is fast, a sourcing strategy based on lead time reduction is appropriate E-procurement: The value proposition offered to buyers by many of the start -up e -markets included:  Serving as an intermediary between buyers and suppliers  Identifying saving opportunities  Increasing the number of suppliers involved in the bidding event  Identifying, qualifying and supporting suppliers  Conducting the bidding event. E-markets allow relatively small suppliers to expand their market horizon and reach buyers that they could not have reached otherwise. E -markets allow suppliers, particularly in fragmented industries, to access sport markets where buyers are looking not for long -term relationships but rather for a great price at an acceptable quality. Many e -markets have completely modified their value proposition. The focus of the value proposit ion was on market reach for buyers and sellers as well as lower purchase cost. The landscape has completely changed in the last few years with the introduction of four types of markets:  Value -added independent (public) e-markets: independent e -markets have expanded their value proposition by offering additional services such as inventory management, supply chain planning and financial services.  Private e -markets: in the last few years, many companies have established their own pri vate e -market to allow them to run reverse auctions and online supplier negotiation. In a reverse auction, suppliers submit bids and buyer selects the winning bids typically based on cost.  Consortia based e -markets: these e -markets are very similar to pub lic e -markets except that they are established by a number of companies within the same industry.

The objective of these consortia based e -markets is not only to aggregate activities and use the buying power of consortia members but, more importantly, to p rovide suppliers with a standard system that supports all the consortia’s buyers and hence allows suppliers to reduce cost and become more efficient.  Content based e -markets: these include two types of markets. The first focuses on maintenance, repair and operations goods while the second focuses on industry specific products.