The value of information in SCM

Supply chain management involves coordinating and integrating flows of products, finances, and information both within and among companies.

A company may share data with its suppliers; these data are called 'upstream' data. On the company's other side, the client's side, data are 'downstream'.

By providing an effective scheme for information management, SCM can integrate procurement, operations and logistics from raw materials to customer satisfaction. However, building an information network across the companies on a supply chain is not easy. Any slip in the information network due to physical or logical defects on the network may lead to immediate and tangible losses to one or more members of the supply chain.

Strategic information is vital to the supply chain as a whole; however, appraising the value of strategic information of individual members or of the entire chain is also difficult. In practice, SCM focuses on valuing tactical and operational information. Theoretically, information delivered across a supply chain should be adequate, reliable and delivered in a timely manner

Coordination in a supply chain

Coordination in a supply chain relies on the information links and decisions that determine the flow of materials and services in order to match supply with demand throughout the supply chain. Traditionally, supply chain coordination has been the core activity of SCM.

Without coordination, local sub-optimization of individual members in a supply chain will lead to sub-optimal results for the chain as a whole. To promote the efficiency and effectiveness of the entire supply chain (termed 'global optimization' in your textbook), coordination begins with a thorough understanding of the demand and supply of each member on the chain, resolving boundary issues

and prioritization conflicts, and developing mechanisms to cope with perceived change in demand and supply.

Obstacles to coordination in a supply chain

Coordination in a supply chain is related to how each member in the chain knows about the actual demand and how they might respond to that knowledge.

There are always obstacles that hinder effective coordination in a supply chain. Chopra and Meindl (2001) divide these major obstacles into five categories -- incentive obstacles, information processing obstacles, operational obstacles, pricing obstacles and behavioral obstacles. Each of them is briefly explained below.

1. Incentive obstacles -- Local sub-optimization is a common incentive, in which members of a supply chain take actions to benefit themselves but not the entire chain. Another example is that the efficiency of a sales force might be appraised by the quantity of sales as compared with the companies next in the downstream supply chain but not as compared with end-users (final customers). In this case, sales size is hardly related to actual customer demand.

2. Information processing obstacles -- A supply chain with poorly organized or managed information channels leads to deterioration in information quality (e.g. information on customer demand cannot reach members in a supply chain in a timely manner, or information is not available to some members who might need it).

3. Operational obstacles -- Certain practices such as placing and filing orders may have adverse effects on coordination. For example, orders of larger sizes, larger replenishment lead times, rationing and shortages can all mean orders are unable to reflect true customer demand.

4. Pricing obstacles -- Certain pricing practices and factors that affect pricing are also ways to detach orders from actual demand. For example, a company may overbuy if its

supplier offers a discount on a larger lot of orders, or if its demand is exceptionally large, but members in the upstream supply chain can't rely on these sales figures to forecast future demand.

5. Behavioral obstacles -- It is highly likely that members in the supply chain respond to local situations and neglect root causes. They may blame each other for fluctuations in local demand, resulting in loss of trust or even turning themselves into mutual enemies.

The bullwhip effect

The bullwhip effect is the term used to describe the variability of the order pattern faced by a firm in a supply chain. It refers to the amplification of the order pattern as one moves up the supply chain. In other words, firms at the top of a supply chain face a much higher variance in orders than firms facing retail demand. Needless to say, in the real world, the bullwhip effect means those firms upstream in a supply chain are more likely to suffer from increased costs and poorer services

However, the causes of the bullwhip effect can be eliminated by automating the passage of information across the chain.

The bullwhip effect is a symptom of a poorly coordinated supply chain. The obstacles to coordination that we discussed in the last section definitely explain the bullwhip effect itself. Maltz (2001) identifies, more precisely, four major causes of the bullwhip effect:

Forecast problems -- Each member of a supply chain receives its customer's orders based on the customer's forecast but not its actual sales. Secondly, suppliers do their own forecasts for their operations and their suppliers. Forecast errors are amplified with longer lead times.

Order size/order cost tradeoff -- Customers tend to place orders of larger sizes as unit prices may thereby decrease, and order review and placement costs are lower as well. If daily demand is accumulated to make up larger weekly

orders, daily information will be lost and forecasts will become less accurate.

Forward buying -- Customers tend to 'overbuy' when they are offered a discount, especially when prices change frequently. This kind of ordering does not reflect demand that is usually more stable.

New product game -- Whenever new products are promoted, they are expected to yield higher profits. However, it is extremely difficult to make accurate forecasts on such profits. Secondly, the technology of production may not yet be stabilized and supplies may be uncertain. Once again, orders will not reflect actual demand.

Maltz argues that all these problems can be solved by improving the information channels in a supply chain. His suggestions are summarized in Table 4.1.

Table 4.1 Causes of the bullwhip effect and their remedies (Maltz 2001)

Cause Information remedy Managerial remedy

Forecast problems

Visibility to final demand throughout the supply chain

Single responsibility for forecast and fulfillment, e.g. vendor-managed inventory

Order size/ order cost tradeoff

Same as above, plus electronic linkages and computer-aided ordering

Blanket purchase orders with quantity pricing; freight consolidation across multiple customers and locations

Forward buying  Visibility to final

demand and early notice of product obsolescence

Level pricing; active development of producers for obsolete parts

 New Visibility to new product manufacturing

Contracts with limited 'upside' flexibility

product game

schedules

Strategic alliances

The functioning of the supply chain also relies on the cross-supply-chain business relationships that are based on mutual trust and openness, and shared risk and rewards. If it succeeds, a supply chain can yield a strategic competitive advantage for all its members and result in business performance greater than any one member could achieve individually.

Companies do not develop strategic alliances overnight. They approach each other with care, and close relationships are built step-by-step. For example, three such steps might be:

Step 1

The alliance conceptualization -- Staff must know about the alliance. Open communication and internal training programs will help solve problems that may occur. At this stage, the management needs to cope with the firm's fear of change and the inability to relinquish traditional business practices.

Step 2

The definition of the new alliance strategies -- Usually urged by the firm that initiates the alliance, a detailed company profile (including staff and manager capacity, cost structure, strategies, etc.) of the potential alliance members should be assessed to set an alliance strategy for the supply chain. The written form of the alliance is a contract that specifies how to deal with power imbalances, conflicts in the supply chain, allocation of net benefits,

and matches between members.

Step 3

Formation of joint ventures and projects -- Possible joint investments or projects are considered, as is the possible need for more investment in physical resources and human resources.

The success of the alliance can be evaluated by a performance measurement system to ensure that all members are operating according to expectations and are meeting the objectives as stated in the alliance agreement.

The so-called 'relationship-oriented levers' help management to build cooperation and trust within the supply chain.

In each of the three steps discussed, namely alliance conceptualization, definition of alliance strategies and formation of joint ventures and projects, a business alliance can only be tied together with an equivalent amount of trust established on all sides.

Chopra and Meindl (2001) elaborate Step 2 (from the previous subsection) as comprising four separate issues:

a. assessing the value of the relationship; b. identifying operational roles and decision rights for each

party; c. creating effective contracts; and d. designing an effective conflict resolution mechanism.

Assessing the value of a relationship

To build a strategic alliance, companies involved must study carefully what they need and what their partners can provide. There are three major tasks within this assessment issue:

to identify mutual benefits;

to identify criteria for evaluating the relationship and contribution of each party -- commonly such criteria include total profits and Equity; and

to clarify the benefits that will accrue to each party -- this involves studying the role and contribution of each party, and seeing how the increased profits are shared between contributing parties.

Note that Equity is the first step to building trust among partners. Without ensuring the management of partner companies that the resulting increase in profits will be shared equitably, the supply chain relationship is bound to fail.

Identifying operational roles and decision rights for each party

If parties in an alliance have to work as a team, the operational role of each party must be identified. In particular, how tasks are allocated among different parties has a direct consequence for the operational management of each company. Without careful planning and leveraging, a company may find that other companies design tasks that depend on its tasks. Such over-dependence is a source of conflict in later days.

Chopra and Meindl (2001) describe two kinds of task allocation:

Sequential interdependence -- activities of one party precede the others.

Reciprocal interdependence -- all parties come together and exchange information and inputs in both directions.

Most supply chains rely on reciprocal interdependence to maximize their profitability. However, this requires more careful

management, greater mutual trust and increased interaction among all parties involved.

Creating effective contracts

Business alliances can occur in many forms (e.g. Consortiums, joint ventures, license agreements and service/product agreements) and can be finalized by creating contracts which detail effective governance and contingency information.

However, Chopra and Meindl suggest that it is almost impossible to design a contract with all contingencies included. It is more important to develop a relationship that allows trust to compensate for gaps in a contract. Trust supports informal understanding and commitment; and these informal arrangements can be solidified by being added to new contracts when they are drawn up later on.

Designing an effective conflict resolution mechanism

Conflicts in supply chains are inevitable because the future value of its relationships is unknown. However, an effective mechanism to resolve conflicts can strengthen relationships and nurture trust among members in a supply chain.

Chopra and Meindl indicate that an initial formal specification of rules and guidelines for financial procedures and technological transactions can help develop trust between members.

Sharing information, which is essential for effective coordination, helps move the relationship from deterrence-based trust to process-based trust. These two kinds of trust are explained below.

Deterrence-based trust -- parties involved rely on rules and regulations written on formal contracts to ensure cooperation. They act in a trusting manner only for their self-interest.

Process-based trust -- trust and cooperation are built as a result of a series of interactions between parties involved.

Trust and collaboration

The competitive advantages of Collaborative SCM is that it lets companies share data that were previously only internal such as daily sales reports, production schedules, product designs and logistics details. Trusting that the supply-chain partners will respond to that information in an agreed manner is critical to the success of the collaborative supply chain. But gaining others' trust is not easy.

Obviously, distrust violates the spirit of collaboration and brings the entire supply chain down.

To break the ice, a supply chain needs something more than SCM software and demand planning tools. Change management and strong leadership are often regarded as the impetus behind successful collaboration. That is, companies need to prepare for changes in organizational structure, corporate culture, and organization process and measurement. Careful planning and good leadership are essential to making these changes happen.

Information and communication technologies for SCM

A sound system of information capture, processing, storage, retrieval and passing is a key to the success of SCM. This system must be able to connect each member on a supply chain, to maintain information in a distributed environment, and to deliver information in a timely manner.

In the Internet era, information does not travel in a linear way as in traditional supply chains. Companies and their information systems are Internet-connected and information is exchanged in a networked and non-sequential manner. In general, the evolution of supply chains (or more specifically the evolution of the traditional supply chain into the e-supply chain) goes through four stages:

1. Functional coordination -- IT is harnessed to first build intra-organizational information systems for collaboration between departments. Later, inter-organizational systems may be built to coordinate activities among a firm and its suppliers and customers.

2. Spatial integration -- inter-organizational systems emerge to allow companies to do joint planning and scheduling with their business partners across vast geographical areas. Activities such as purchasing, manufacturing and distribution are planned for the entire supply chain.

3. Inter-temporal integration -- exchange of information on the Internet among companies in a supply chain, irrespective of the size of the companies, urges each firm to reconsider its operational, tactical and strategic plans.

4. Enterprise integration -- further deployment of information systems to integrate supply chain activities with local demand and corporate financial management.

That is to say: a supply chain begins by integrating information systems of different members on the chain. ICT always plays a key role in such coordination. With the advent of Internet technology, supply chains of today rely on message exchanges on the Internet, and SCM is often called e-SCM or i-SCM to highlight the importance of the Internet.

E-SCM and e-business strategy

We have seen the development of various forms of ICTs to improve the performance of supply chains. We have also emphasized that the use of ICTs doesn't necessary convert a traditional supply chain into an e-supply chain.

The essence of e-SCM lies in the ability of supply chain partners to integrate and cooperate in their business processes to form a seamless path for the smooth delivery of goods and products from suppliers, manufacturers, distributors and retailers into the hands of customers. We have introduced a number of ICTs that can be

deployed for the purpose of information sharing and workflow coordination between supply chain partners. Before embarking on the use of any ICT, a company must make a complete evaluation of its own needs and capabilities so that it can develop an appropriate strategy for the adoption of the correct ICT.

According to the white paper 'E-business and supply chain integration' published by the SCM guru H L Lee, there are four dimensions in which we can see the impact of e-business on SCM, namely:

1. information integration; 2. planning synchronization; 3. workflow coordination; and 4. new business models.

For the first dimension of information integration, we have studied how the sharing of information among SCM partners can eliminate the bullwhip effect.

The emergence of e-business has created new electronic channels such as the Internet for sharing information and creating transparency among supply chain partners. The use of enterprise systems such as ERP has also facilitated the information sharing capabilities of supply chain partners.

The H L Lee white paper proposes one approach for Internet-based SCM, the information hub as shown in Figure 4.4. The overall network forms a hub-and-spoke system with the supply chain partners' ERP systems being the spokes.

Figure 4.4 An information hub

The following case indicates how efficient information sharing can lead to continuous replenishment for the CVS Pharmacy-McKesson demand chain.

Once an information sharing framework has been established between supply chain partners, planning synchronization can be carried out by establishing rules and agreement on what critical actions should be taken to achieve the full integration of the supply chain based on the shared information. The final object of planning synchronization is to have a common forecast and replenishment plan all the way from the beginning to the end of the supply chain so that variance -- and the bullwhip effect -- can be completely eliminated.

The following case is extracted from the VICS site and demonstrates the CPFR pilot undertaken by Procter & Gamble. Pay particular attention to how Internet-based data exchange technologies assist the planning and replenishment processes between the business The Internet permits companies to take collaboration one step further, from planning synchronization to fully integrated workflow coordination.

Workflow coordination allows supply chain partners to establish fully integrated business and manufacturing activities that may include procurement, order execution, engineering and manufacturing optimization and even necessary financial data exchanges.

This tight integration of all critical business and manufacturing processes across all partners is vital to the success of businesses such as those in high-tech industries where the product cycle is very short and market demand is highly unpredictable.

Finally, as the techniques in SCM evolve, companies have begun to realize the value of e-SCM strategy to the overall success (or sometimes survival) of e-businesses. E-SCM doesn't merely mean shifting traditional SCM activities to the electronic channels; it also often leads to entirely new ways of doing business, developing new business strategies and new e-business models.